Financial Sector
Finance 724/824, Fall 2010
Jason Isaacs, Kevin Neebes,
David Wilkes & Yuange Yang
Financial
Sector
Table of Contents
Section
Section Name
Slide No
1.
Overview
3-5
2.
Economic Analysis
6-7
3.
Business Analysis
8-9
4.
Financial Analysis
10-14
5.
Valuation Analysis
15-20
6.
Recommendation
21
Financial
Sector
Largest Companies in Financial Sector
Investment Banking and Brokerage
•Goldman Sachs
•Morgan Stanley
•Charles Schwab
•E*Trade Financial
Thrifts and Mortgage Finance
•Hudson City Bank
•Peoples United Financial
Financial
Sector
Insurance – Life/Health
•Aflac
•Lincoln National
•Metlife
•Principal Financial Group
•Prudential Financial
•Torchmark
•UnumProvident
Financial Sector Performance
Sector
Last 12 months
Last 3 months
Last 1 month
S&P500 (SPX)
8.4%
11.6%
6.1%
Energy (XOM.S)
6.7%
14.2%
6.7%
Material (DD.S)
13.9%
19.5%
5.8%
Industrials (GE.S)
20.0%
14.5%
7.2%
Consumer Discretionary (TGT.S)
24.7%
13.9%
7.5%
Consumer Staples (PG.S)
10.9%
9.8%
3.9%
Healthcare (MRK.S)
7.8%
9.2%
6.5%
Financials (JPM.S)
1.5%
6.1%
3.1%
Information Technology (MSFT.S)
12.7%
11.7%
9.1%
Telecom (VZ.S)
15.0%
19.7%
7.1%
Utilities (EXC.S)
9.7%
12.2%
1.0%
The Financial Sector has
lagged in performance
compared to the S&P
500
Financial
Sector
Financials
•Market Cap: $4,157 B
•SIM Weight: 11.83%
•S&P Weight: 15.57%
•Underweight: -3.74%
Top Industries In The Financial Sector
Industry
Financial Sector By Industry
Market Cap
(B)
Percent
Money Center Banks
$
772
19%
Foreign Money Center Banks
Foreign Money Center Banks
$
574
14%
Property & Casualty Insurance
Property & Casualty Insurance
$
460
11%
Foreign Regional Banks
Foreign Regional Banks
$
411
10%
Life Insurance
Life Insurance
$
286
7%
Asset Management
$
196
5%
Regional - Mid-Atlantic Banks
$
177
4%
Diversified Investments
$
124
3%
Credit Services
$
115
3%
Investment Brokerage - National
Closed-End Fund - Debt
$
110
3%
Regional - Midwest Banks
Investment Brokerage - National
$
109
3%
Other
Regional - Midwest Banks
$
103
2%
Other
$
720
17%
Financial Sector
$
4,157
Money Center Banks
Asset Management
Regional - Mid-Atlantic Banks
Diversified Investments
Credit Services
Closed-End Fund - Debt
Financial
Sector
Financial Sector Correlation with Economic Indicators
10-Year Treasury Yield; r = .73
Economic Indicators as proxies
•Treasury yields at low point: 10 yr Treasury = 2.612%
•Employment rate at low point: Unemployment at 9.6% in
September 2010
•Fed. Funds Target Rate-(Interest rate that banks charge
each other)-has dropped to nearly zero: 0.25%
•Economic indicators point to poor performance and outlook
for Financial Sector due to high correlation
Fed. Funds Target Rate; r = .78
Financial
Sector
Employment; r = .84
2-Year Treasury Note; r = .82
Economic Analysis: Financials
Economic Indicators as proxies
- Moderate correlation (r=.44) between real GDP and financial equities.
- Strong correlation (r=.85) between consumer confidence and financials.
- Strong correlation (r=.75) between real capital spending and financials.
- Strong correlation (r=.81) between money supply velocity and financials.
•At end of the third fiscal quarter, the WSJ reported historically low consumer
confidence.
•Notwithstanding saturating the money supply, Businessweek Bloomberg
reports the Federal Reserve’s second round of quantitative easing will
deteriorate the value of the dollar relative to other global currencies.
Financial
Sector
Economic Analysis: Financials
External factors influencing demand
-“Deleveraging”
- Keynesian “Animal spirits”
- Hoarding behavior in the cash account for both businesses and consumers
- Deflationary pressure
- Material disruptions in capital markets (CP, Money Market)
- Unemployment approximately twice the historic average
- U.S. savings rate rising
- Dodd-Frank Legislation:
- Investment bank proprietary trading
- Derivative instruments onto SEC-regulated exchanges
- Regulation E modifications
- Regulation Q repeal
- Graham Leech Bliley (1999) repeal?
* Personal savings rates are expressed in nominal terms. During several quarters between 2005 and 2008, real savings
were negative.
Financial
Sector
Economic Analysis: Financials
Industry Attributes (of equities held in
the SIM portfolio)
Investment Banking Activities
- Underwriting debt and equity securities
- Raising capital for underwriting activities
- Advising on mergers and acquisitions
- Market making for securities
- High net worth banking services
Mortgage & Thrift Banking Activities
- Accept deposits from consumers
- Originate mortgage loans and home
equity lines of credit (HELOC’s), credit
cards, and other consumer finance
activities.
Asset Management Products
- Life insurance
- Annuities
- Retirement plans
- Group policy insurance
Investment Banks
- Bulge bracket
- Middle market
- Boutique firms
Mortgage & Thrift Banks
- Thousands of savings banks and
mortgage companies
- Asset size from $20mm - $6,000mm
- Formerly supervised by OTS, now OCC
Asset Management Firms
- Ten in the S&P 500, 100-200 total
- Heavy concentration of AUM in the top
25 asset management firms
- Large network of NASD licensed
representatives acting as independent
agents for insurer or broker-dealers.
Michael Porter’s 5 Forces Analysis
- Strong buyer and supplier power
- Rivalry is fierce among banks and money managers for new funds, relationships, and fee-income
- Minimum capital requirements and regulatory approval to form new FI can be steep for most
- Outside of competitors in each industry, there can be little exact perfect substitutes for the services rendered
Financial
Sector
Current Ownership in SIM
Ticker Shares Held Cost Basis
Market Value Day's Gain
GS
6000
$1,000,620.00 $966,780.00 ($12,660.01)
HCBK
60900
$776,475.00
$708,876.00 $4,872.00
LAZ
18300
$578,280.00
$675,270.00 ($11,345.98)
Financial
Sector
Overall Gain Overall Gain (%)
($33,840.00)
-3.38%
($67,599.00)
-8.71%
$96,990.00
16.77%
Financial Analysis: Sector Earnings
Financial Sector Revenues
60
SPFN 2005 2006 2007 2008 2009 2010
Revenues Per Share
55
50
45
40
35
Mar
37.5
46.9
52.2
42.7
41.0
38.3
June
44.6
48.2
54.3
45.7
40.7
36.8
Sep
44.4
48.1
48.1
34.6
37.5
Dec
40.2
49.4
40.8
31.5
33.5
Yr.
30
Yr. to
Yr.
25
2005
2006
Financial
Sector
2007
2008
2009
2010
166.7 192.6 195.4 154.5 152.7
16%
1%
-21%
-1%
Financial Analysis: Industry Earnings
Financial
Sector
Financial Analysis: Major Players
Ticker
Company
JPM
JP Morgan
BAC
Bank of America
WFC
Wells Fargo
C
Citigroup
GS
Goldman Sachs
UBS
UBS AG
DB
Deutsche Bank AG
AXP American Express Company
CS
Credit Suisse
USB
U.S. Bancorp
UNH
United Health Group
MS
Morgan Stanley
BLK
Blackrock
PNC
PNC Financial Services
AIG
American Intl' Group
BEN
Franklin Resources Inc.
TRV
The Travelers Company
WLP
Wellpoint Inc.
STT
Statestreet
CB
Chubb Corporation
COF
Capital One Financial
L
Loews Corporation
TROW
T. Rowe Price
HCBK
Hudson City Bancorp
LAZ
Lazard LTD
Financial
Sector
Mkt Cap (B)
147.73
144.88
136.67
121.14
83.08
64.61
53.71
49.92
49.15
46.4
40.53
34.74
32.75
28.35
28.03
25.82
25.34
21.72
20.95
18.25
16.87
16.52
14.17
6.08
3.96
EPS
$ 3.88
$ 1.08
$ 2.20
$ 0.40
$ 13.76
$ 1.94
$ 5.16
$ 3.40
$ 4.69
$ 1.68
$ 3.96
$ 2.43
$ 10.22
$ 5.33
$ 5.95
$ 7.76
$ 6.09
$ 6.93
$ 3.37
$ 5.81
$ 5.64
$ 2.67
$ 2.47
$ 1.07
$ 1.87
ROE
N/A
1.8%
11.0%
6.7%
16.4%
20.0%
21.9%
24.6%
13.0%
11.8%
18.3%
6.1%
2.7%
9.5%
N/A
19.3%
11.6%
11.4%
11.4%
12.4%
11.2%
9.8%
21.9%
10.2%
22.0%
P/E
11.2
31.8
12.8
15.4
8.3
9.6
5
13.5
11.4
15.4
9.1
14.6
17.3
10.3
N/A
18.1
8.4
8.3
11.8
9.8
6
10.2
23.3
11.1
N/A
NP Margin
13.4%
3.2%
12.3%
10.6%
25.1%
57.2%
27.5%
13.6%
14.7%
17.1%
4.8%
7.7%
6.6%
16.7%
N/A
24.3%
12.7%
4.1%
19.3%
16.5%
18.2%
11.0%
26.9%
40.3%
4.4%
Financials Relative to S&P 500
Trailing
P/E
Current: 1.0
Median: .77
ROE
Current: .5
Median: .9
Financial
Sector
Financial Sector Valuation
Absolute Basis
P/Trailing E
P/Forward E
P/B
P/S
P/CF
High
135.2
20.1
3.4
3.5
140.7
Low
10.5
10.6
0.5
0.6
7.2
Median
14.6
12.7
2.0
2.4
9.9
Current
15.9
12.1
1.1
1.3
9.7
Relative to SP500
P/Trailing E
P/Forward E
P/B
P/S
P/CF
High
7.8
1.4
0.9
1.9
13.4
Low
0.65
0.6
0.3
0.9
0.7
Median
0.77
0.76
0.7
1.6
0.9
Current
1.0
0.95
0.5
1.1
1.0
•On absolute basis, 80% of ratios are below historical
median values (i.e. relatively cheaper)
oInvestment Bank prices have been battered and earnings
are improving, decreasing forward P/E
•On relative basis, trailing P/E and P/CF are inline with
S&P500, and forward P/E and P/S are close to being inline
at 0.95 and 1.1, respectively
Financial
Sector
Industry Valuation – Relative to S&P500
Investment Banking & Brokerage
Absolute Basis
P/Trailing E
P/Forward E
P/B
P/S
P/CF
High
151.5
70.5
5.0
3.1
29.8
Low
8.0
8.5
0.5
1.0
6.8
Median
13.9
12.1
2.1
2.4
10.0
Current
9.0
11.6
1.2
1.6
8.0
Relative to SP500
P/Trailing E
P/Forward E
P/B
P/S
P/CF
High
8.7
5.9
1.0
3.1
2.8
Low
0.52
0.56
0.3
1.1
0.7
Median
0.76
0.75
0.7
1.6
0.9
Current
0.59
0.70
0.5
1.3
0.9
Low
9.0
8.5
0.1
0.3
3.8
Median
11.0
11.6
1.9
3.8
5.7
Current
15.9
16.1
1.0
4.3
13.0
Relative to SP500
P/Trailing E
P/Forward E
P/B
P/S
P/CF
High
1.2
5.1
1.2
5.1
29.0
Low
0.48
0.45
0.1
0.4
0.3
Median
0.61
0.71
0.6
2.6
0.5
Current
1.0
1.2
0.4
3.5
1.4
Median
13.3
12.6
1.5
1.1
10.9
Current
9.6
8.8
1.1
0.9
8.7
Relative to SP500
P/Trailing E
P/Forward E
P/B
P/S
P/CF
High
0.87
0.90
0.70
1.0
1.1
Low
0.38
0.35
0.30
0.4
0.6
Median
0.70
0.71
0.50
0.7
1.0
Current
0.62
0.64
0.50
0.7
0.9
Thrifts & Mortgage
Absolute Basis
P/Trailing E
P/Forward E
P/B
P/S
P/CF
High
19.4
70.5
4.0
8.9
324.4
Insurance – Life/Health
Absolute Basis
P/Trailing E
P/Forward E
P/B
P/S
P/CF
High
17.2
16.6
2.4
1.5
13.8
Financial
Sector
Low
4.0
4.4
0.5
0.3
4.6
Industry Valuation – Relative to Sector
Investment Banking & Brokerage
Absolute Basis
P/Trailing E
P/Forward E
P/B
P/S
P/CF
High
151.5
70.5
5.0
3.1
29.8
Low
8.0
8.5
0.5
1.0
6.8
Median
13.9
12.1
2.1
2.4
10.0
Current
9.0
11.6
1.2
1.6
8.0
Relative to Sector
P/Trailing E
P/Forward E
P/B
P/S
P/CF
High
4.6
4.9
1.6
2.6
1.3
Low
0.5
0.5
0.8
0.7
0.2
Median
1.0
1.0
1.0
1.0
1.0
Current
0.6
1.0
1.1
1.2
0.8
Low
9.0
8.5
0.1
0.3
3.8
Median
11.0
11.6
1.9
3.8
5.7
Current
15.9
16.1
1.0
4.3
13.0
Relative to Sector
P/Trailing E
P/Forward E
P/B
P/S
P/CF
High
1.5
6.7
1.6
4.1
6.9
Low
0.5
0.7
0.1
0.3
0.1
Median
0.8
0.9
1.0
1.5
0.6
Current
1.0
1.3
0.9
3.2
1.3
Median
13.3
12.6
1.5
1.1
10.9
Current
9.6
8.8
1.1
0.9
8.7
Relative to Sector
P/Trailing E
P/Forward E
P/B
P/S
P/CF
High
1.2
1.2
1.4
0.7
1.6
Low
0.1
0.3
0.6
0.4
0.1
Median
0.9
0.9
0.8
0.5
1.0
Current
0.6
0.7
1.0
0.6
0.9
Thrifts & Mortgage
Absolute Basis
P/Trailing E
P/Forward E
P/B
P/S
P/CF
High
19.4
70.5
4.0
8.9
324.4
Insurance – Life/Health
Absolute Basis
P/Trailing E
P/Forward E
P/B
P/S
P/CF
High
17.2
16.6
2.4
1.5
13.8
Financial
Sector
Low
4.0
4.4
0.5
0.3
4.6
Industry Valuation ‐Assessment
•Absolute Basis:
Investment Banking & Brokerage / Insurance Life & Health both appear
relatively inexpensive compared to median values
Thrifts & Mortgages are becoming increasingly expensive compared to
median values
•Relative Basis:
S&P500 – Investment Banking & Brokerage / Insurance Life & Health
are both relatively inexpensive to inline with S&P500 index
oThrifts and Mortgages display relative expense as 80% of ratios higher than
index
Sector – All industries have median values very much inline with the
sector
oInvestment Banking & Brokerage / Insurance Life & Health still
approximately inline with sector
oThrifts and Mortgages currently have 80% of ratios relatively more expensive
than median and 60% of ratios more expensive than sector
Financial
Sector
Technical Analysis – Price Action
Financial
Sector
Technical Analysis – Resistance to 200 Day
Financial
Sector
Pros and Cons of Financial Sector
•Financial Services will always be necessary.
•Uncertain Government oversight will continue to limit profits.
•Financial industry is very cyclical and has shown poor performance in
economic downturn. High correlation with economic indicators.
•Both aging and growing population will need more financial services.
Recommendation
•Continue to underweight Financials at roughly -3.74%
•Outlook opportunities include Deutsche Bank and UBS
•Recommend selling HCBK and Lazard
•Reallocate gain to another segment and further underweight
Financials
•Underweight mortgage and thrift companies.
Financial
Sector
Financial
Sector
Thank You
Financial
Sector