In my previous post we discussed how to analyze the balance sheet of a financial institution. We went over some of the key metrics needed to determine the health of a given bank and researched/calculated these metrics for Wells Fargo. I've gone ahead and performed the same analysis for several other banks and (drumroll please!) here are the results (click image for full size view):
For me there were a few surprises and a few clarifications that I think are important in these results. They may look somewhat close in terms of statistics, but some information here stands out more than others:
JP Morgan - This bank looks pretty strong in all categories. It isn't the best in any of them, but it performs well across the board - something I think is more important than being strong in a single area.
US Bancorp - I was surprised to see the weakness associated with USB's balance sheet. A very low loan loss reserve and a relatively high Nonperforming assets ratio concerns me in that the bank hasn't adequately shielded itself from future losses and writedowns.
Goldman Sachs - This perennial powerhouse seems to perform decently well. No major concerns here, but given the high valuations the market likes giving this company, I expected it to perform better.
Morgan Stanley - I would probably buy this bank over Goldman Sachs at this point. It's the closest remaining competitor to Goldman and its balance sheet is pretty comperable. However, the stock is trading at a significant discount to Goldman, and I'm starting to believe not all of it is justified.
Citigroup - I wanted to put Citi here because I wanted a comparison point to arguably the most troubled of banks. The biggest concern I see here is the Tangible Common Equity. However, with the recent injections of additional government capital, this numbers has probably increased somewhat. Overall, if you have the guts to ride out a roller
Wells Fargo - After comparing it to the other banks, Wells still looks like it's in the upper echelon of banks. It's low nonperforming assets ratio reflects the companies principles of mainly lending to higher quality borrowers. When taken as a ratio to loan loss reserves (.42), it is much better equipped to handle further uncertainty than even JP Morgan (.49).
NP Assets For GS and MS - I wasn't able to find this information for those to banks. I'm guessing this is because up until recently, they weren't retail banks and, instead, were investment banks. I might be wrong here, and, if anyone has the corrected information, please let me know.
Overall, against historical standards, all these banks look fairly healthy for most metrics. But, as we all know, historical standards may not apply here. Therefore, I would rank these banks as the following. In terms of buying, I would only really consider buying anyone with an A grade, unless you want to take on significant additional risk:
JP Morgan
A
Well Fargo
A-
Morgan Stanley
B+
Goldman Sachs
B
Citigroup
C+
US Bancorp
C+
Questions/Comments/Feedback?
Please don’t hesitate to let me know of any questions or comments you have about this post or any other. If you want me to write about something else investing related, do let me know!
The Standard Disclaimer:
The stuff I just wrote above is my opinion and my opinion only. Please do not take it as fact. Perform all necessary research and analysis prior to acting on anything I’ve said above. This includes consulting with a financial advisor.
With the recent and severe decline in bank stock prices, I've been getting the impression that it may be a good buying opportunity. However, as I'm sure you guys already know, there's a lot of risk associated with buying a bank right now (and a lot of potential reward too). Therefore, due diligence is always important, and for today's post, I will go through some of this due diligence for a stock that I already own, and am thinking of buying more of. I will use this blog as a sounding board for my thought process of whether or not to buy stocks in a specific bank. We'll go through the due diligence for a few key banks including:
Wells Fargo
US Bank
JP Morgan Chase
Goldman Sachs
Morgan Stanley
Citi (just to see if there's a hint of light there)
Once I complete the analysis, we'll pick the best one and make a recommendation.
The due diligence I want to perform is really useful information I found in the following article about key performance metrics for banks. I'm basically going to be using the guidance in the article and do some digging to find the metrics for Wells Fargo. Also, since I probably won't be able to describe the metrics better than the article already does, I will be quoting it directly.
"The Tier 1 ratio tells you how much capital a bank has set aside to absorb losses. “Essentially, it shows how strong its balance sheet is,” says Chris Fortune, an analyst at investment firm T. Rowe Price who covers regional banks. Generally, a Tier 1 ratio needs to be at least 6% for a bank to be well capitalized, but in today’s environment, banks should have 8% or 9% to be considered healthy, he says. Look for Tier 1 information in the Management Discussion section in 10-K Annual Report forms."
For WFC, the most recent quarterly filing has the (12/08) says the following regarding it's Tier 1 Ratio:
"At December 31, 2008, consolidated Tier 1 regulatory capital was $86.4 billion, after the impact of purchase accounting for credit impairments of loans and write-down ofnegative cumulative other comprehensive income at Wachovia, which, in the aggregate, reduced the Tier 1 capital ratio by approximately 230 basis points to 7.8% at year end,well above regulatory minimums for a well-capitalized bank."
The Nonperforming Asset Ratio
"The nonperforming asset ratio, also known as NPA ratio, tells you how much exposure your bank has to assets that are a potential problem. Loans that are 90 or more days late, for example, are considered nonperforming assets. This ratio is determined by dividing these problem assets by the bank's total assets. “Today, anything below 1% is really good,” says Fortune. “Below 2% is OK. And, as you start to get above 4%, you start to worry.”"
For WFC, the most recent quarterly filing has the (12/08) says the following regarding it's Nonperforming Asset Ratio:
"Total nonperforming assets (NPAs) were $9.01 billion (1.04% of total loans) at December 31, 2008, compared with $3.87 billion (1.01%) at December 31, 2007."
Tangible Common Equity Ratio
"The tangible common equity ratio shows how much of a loss a bank can take, as a percentage of assets, before common shareholders are wiped clean, says Jamie Peters, an equity analyst with financial research firm Morningstar. If a bank’s common equity ratio is 3%, for example, the bank would have to write off 3% of its assets before shareholders lose everything. (As a rule of thumb, anything below 3% is too low, says Peters.)
Figuring this ratio out is tricky, since banks don't generally disclose it in their financial statements. To calculate it, divide your bank’s tangible common equity by its tangible assets. (Tangible common equity is total shareholders’ equity minus preferred stock minus goodwill and intangibles; tangible assets is total assets minus goodwill and intangibles). All of the numbers you need to calculate this are listed in the bank’s balance sheets."
I took a look the balance sheet for WFC (check it out at the end of the post) and did a quick calculation based on the description in the article.
Common Equity = $67,752million
Total Liabilities & Shareholders Equity = $1,309,639million
Dividing the 2 results in a TCER of 5.2%
However, this number has likely dropped since the end of 2008. I would think a more realistic number for this is more like 4.5%
Loan Loss Reserves
"This is the amount a bank has set aside to deal with problem loans. This figure will give you a good idea of the bank's ability to remain healthy in an unhealthy environment. To calculate your bank’s loan loss reserve ratio, simply divide its allowance for loan losses by its total loan portfolio. The higher the percentage, the better your bank’s ability is to cover potential losses. A reserve of 1% or less is considered weak, according to Fortune, while anything over 2% is considered strong."
As is mentioned in the article itself, WFC's LLR is 2.4% - well above the healthy threshold.
Overall Results
So, WFC's numbers breakdown as follows:
Tier 1 Ratio - 7.8%
Nonperforming Asset Ratio - 1.01%
Tangible Common Equity Ratio - 5.2% (but we'll be conservative and say 4.5%)
Loan Loss Reserves - 2.4%
Overall, I think WFC met my expectations as one of the healthier banks. In none of the above categories does it perform poorly and it's definitely poised to withstand more downside. At the same time, it's strength will definitely enable it to capitalize on future opportunities.
Final Grade: A-
Appendix: Check out WFC numbers and Annual Report here:
Questions/Comments/Feedback?
Please don’t hesitate to let me know of any questions or comments you have about this post or any other. If you want me to write about something else investing related, do let me know!
The Standard Disclaimer:
The stuff I just wrote above is my opinion and my opinion only. Please do not take it as fact. Perform all necessary research and analysis prior to acting on anything I’ve said above. This includes consulting with a financial advisor.
Instead of writing about a specific topic in finance and providing background and context (as well as dangerously getting ever closer to making this blog sound more like a textbook), I wanted to take a break and talk about something more political in nature.The reason I want to talk about this topic in particular is because it’s been grabbing a lot of headlines lately on various news wires and I’m beginning to believe that both politicians and news agencies are grandstanding this issue and twisting the truth.
The issue that is frustrating me is the scrutiny financial companies have begun receiving with how they spend their money.The populist argument today is that since these financial firms received government assistance by way of the TARP funding (the $700 billion dollar bank bailout that was passed last year to save the US banking system), they should not be spending money on things like vacations for their employees or sport sponsorships.Politicians and ‘experts’ (PLEASE notice how I put them in 2 distinctly different groups) have come out vehemently protesting specific banks as they held these controversial events.
Now, to a certain extent I agree with this argument.If you run a company that is performing so poorly that you had to beg the government for assistance, then you should by no means be awarding lavish vacations to your employees.That is just a blatant misuse of taxpayer money.However, the key to this argument is that the company is performing poorly enough to require government aid.In reality, many of the financial firms that received money from the TARP were not performing poorly at all – in fact, some are even still profitable.Why then would they go to the government begging for money?That’s the thing, they didn’t.
TARP – The Ultimate Political Trump Card
When the initial $350 Billion of TARP funds was approved, it was initially supposed to go to buying the toxic assets (i.e. mortgage backed securities and collateralized debt obligations) that banks could not get rid of.However, then Treasury Secretary Hank Paulson soon dropped that strategy in favor of directly investing in banks and essentially buying their stocks.The interesting thing about this strategy change was that the banks had no say whether or not they actually wanted any TARP funds.The treasury basically picked a bunch of major financial institutions and forcibly invested in them.In fact, some bank executives came out in protest of the TARP saying they didn’t want the government owning a part of them (and I don’t blame them in the least).The government’s justification was that it would not interfere in their day-to-day operations – it would be a silent partner.
Well, here we are now.Over the last few weeks, and the silent partner is being anything but silent.2 examples in particular come to mind where financial institutions that are relatively healthy are being scrutinized since they were recipients (albeit unwilling) of the government bailout.
Wells Fargo – As I’ve mentioned in previous posts, I believe WFC is one of the best positioned banks in this downturn.Yes they have been experience extensive losses during the last few quarters (mostly due to the poor performance of Wachovia which they acquired in late 2008).But the losses were expected and they have continually said that they did NOT want and need any TARP funds.However, certain government politicians have recently gone on rants about WFC and an annual Vegas vacation that WFC gives it top performing brokers basically saying “How dare companies that were recently begging for government money hold these kinds of event?”
Northern Trust – Another forced recipient of TARP money, Northern Trust has actually been performing fairly well in the downturn – mainly because it’s more of an asset manager and less of a bank.Here, the politicians vilified the company for continuing to sponsor a PGA golf tournament even though they received TARP funds basically saying “These companies spends millions to sponsor these events to wine and dine themselves and their clients.”In fact, this outrage recently forced Wells Fargo to cancel it’s sponsorship of its own PGA event (thereby losing out on millions of dollars worth of exposure and contract cancellation fees).
I strongly believe that the above 2 examples are situations where politicians are using the financial crisis to gain support from voters by twisting the truth.Granted both companies received TARP funds, but neither wanted or needed them. The government forced it upon them and the changed the rules – that’s what I think is not fair.I whole-heartedly agree in situations where truly poor institutions should be scrutinized (e.g. Citi and AIG), but Wells and Northern Trust are not those cases.
Think Before You Judge
I agree that banks played an integral role in the collapse of the financial system.They made many irresponsible decisions that caused the current situation.However, it is also important to separate the good from the bad.Not all banks were irresponsible.So next time you hear about politicians ranting about how companies are spending the TARP funds, take a step back and make sure the context around the issue is correct – then make an appropriate judgment. The government unfortunately has done a poor job of distinguishing between the good and bad apples in the financial sector, so I hope you’re able to pick up the slack.
Questions/Comments/Feedback?
Please don’t hesitate to let me know of any questions or comments you have about this post or any other. If you want me to write about something else investing related, do let me know!
The Standard Disclaimer:
The stuff I just wrote above is my opinion and my opinion only. Please do not take it as fact. Perform all necessary research and analysis prior to acting on anything I’ve said above. This includes consulting with a financial advisor.
