Morningstar Advisor - Summer 2008 - 71

well as anyone. Out of the banks that made big mistakes, I think Morgan Stanley is in position to recover rather quickly because it never was a large CDO underwriter, and its core business appears to be in good shape. JF: Which are you still most concerned about? RL: There are lingering issues about Citigroup and how effective CEO Vikram Pandit will be in improving efficiency. Across the board I would not rule out further write-downs or capital raises, especially, if the credit markets weakened further. Continued stability and liquidity in the credit markets is the real key for the banks, going forward. Additionally, my colleague Jaime Peters has some concerns about Bank of America’s capital level, which she believes could need some new equity when, or should I say if, it closes the Countrywide CFC merger. Jaime Peters: Bank of America is currently operating with less capital than its long-term goal, despite dipping into the capital markets multiple times already. If Bank of America acquires Countrywide, the potential writedowns on Countrywide’s held-for-investment loan portfolio could wipe out all of the target’s book value. Consequently, Bank of America would need to provide capital to support Countrywide’s balance sheet at a time when it has little to spare. At this point, we peg the chance Bank of America has to go back to the capital markets/cut its dividend around 50%. JF: What do you think this means for investors? RL: I think long-term investors will do well RL: This is probably not a surprise, but I think JP Watch List: Money-Center Banks Company Morningstar Rating Fair Value Estimate Fair Value Uncertainty Consider Buying Consider Selling Bank of America BAC Citigroup C JP Morgan Chase JPM Merrill Lynch MER Morgan Stanley MS Data as of June 30, 2008 QQQQQ QQQQQ QQQQQ QQQQQ QQQQ $54 $34 $60 $58 $59 High High High Very High Very High $35.10 $22.10 $39.00 $31.90 $32.50 $81.00 $51.00 $90.00 $104.40 $106.20 run. At their core, investment banks are in the business of buying and selling risk. They will likely be paid somewhat more for this service going forward. Additionally, the securitization market is virtually closed today, which cuts off one revenue stream to banks. Some were more dependent on the securitization than others. Merrill Lynch was a big collateralized debt obligation underwriter. However, Merrill has a diverse revenue stream, including an army of retail brokers, that will help to offset the lost securitization revenue. For other banks, especially banks like JP Morgan Chase that did little of this business, the effect will be minimal. JF: Who do you think is best positioned to do well coming out of this environment? over time investing in these banks. However, investors should expect continued volatility in the near term. The issues in the housing in the credit markets are not going to disappear overnight and will continue to pressure the banks and produce negative headlines. I would caution investors to look at each bank individually. Each bank has a specific set of risks. K Justin Fuller, CFA, is an equity strategist with Morningstar Morgan Chase is one of the best positioned. Its balance sheet is in probably as good of shape as any of its competitors’. This allowed JP Morgan to acquire Bear Stearns, and I believe that this will likely be a highly accretive acquisition. Additionally, JP Morgan’s strong balance sheet will allow CEO Jaime Dimon to undertake another acquisition on the retail banking side if he can find a target at the right price. Additionally, Goldman Sachs has managed the crisis as MorningstarAdvisor.com 71

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Morningstar Advisor - Summer 2008

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