Morningstar Advisor - February/March 2012 - (Page 44)

Spotlight Exhibit 3 Putting It All Together: How each bank scored in Morningstar’s tests. We also tested the top four U.S. banks. Green indicates pass, orange signifies cause for caution, and purple means trouble. Company Customer loans / Customer deposits Customer deposits/ Adjusted liabilities TCE / Adjusted assets loan/deposit ratios below 100% (meaning that all of their loans are funded by customer deposits) and deposits that make up 40% or more of their adjusted liabilities. The top four U.S. banks—Bank of America BAC, Citigroup C, JPMorgan Chase JPM, Wells Fargo WFC—also meet both of these standards. Conversely, we find that Unicredit UCG and Lloyds Banking Group LLOY remain dangerously reliant on wholesale funding to shore up their inadequate deposit bases. Both have loan/deposit ratios of more than 140%. While the results underscore the riskiness of European banks relative to U.S. banks, they also speak to competitive issues. Julius Baer, HSBC, Deutsche Bank, and Standard Chartered—as well as Credit Suisse and UBS UBSN—all not only have sufficient deposit bases for their current loan portfolios, but also have room to grow, which we think will prove to be a competitive advantage in this environment of funding scarcity. A hefty low-cost deposit base will also provide a cost advantage as competitors pay up for pricy wholesale funding. Finding the Healthiest European Banks opportunities for risk-tolerant investors. Looking across our metrics, we are particularly interested in Lloyds, Royal Bank of Scotland RBS, and UBS. Lloyds scores badly on the customer loans/ customer deposits test, with a 143% ratio, but it does much better on the other funding test. We also note that it has a 4.4% tangible common equity ratio—not quite as strong as we would like to see, but comfortably above the 4% level we see as minimally acceptable. We’re also pleased that it has relatively small exposures to sovereign debt, although it has more-substantial exposure to consumer and commercial lending in Ireland. RBS looks even better through these lenses. Its customer loan/customer deposit ratio is only marginally above 100%, and customer deposits make up 45% of its adjusted liabilities. Most intriguing of all, its tangible common equity ratio is 5.5%, and the bank is one of the few that appears to meet U.S. standards. RBS also has minimal exposure overall to peripheral sovereign debt, but it does hold a large portfolio of troubled Irish loans. Banco Popular POP Banco Santander SAN Barclays BARC BBVA BBVA BNP Paribas BNP Commerzbank CBK Credit Agricole ACA Credit Suisse CSGN Deutsche Bank DBK HSBC HSBA Intest Sanpaolo ISP Julius Baer BAER KBC KBC Lloyds LLOY 121% 118% 118% 122% 121% 119% 124% 72% 70% 76% 96% 54% 78% 143% 66% 58% 36% 52% 36% 43% 40% 33% 44% 56% 70% 73% 64% 45% 45% 37% 70% 39% 45% 52% 48% 52% 77% 5.8% 3.8% 3.9% 4.9% 3.9% 3.8% 1.7% 2.4% 2.7% 5.2% 5.0% 6.0% 5.1% 4.4% 5.5% 3.3% 6.6% 4.7% 3.9% 5.8% 7.5% 5.2% 6.4% Royal Bank of Scotland RBS 112% Societe Generale GLE Standard Chartered STAN UBS UBSN UniCredit UCG Bank of America BAC Citi C JPMorgan JPM Wells Fargo WFC 110% 79% 80% 143% 86% 71% 61% 83% Sources: Morningstar and company filings. Data as of Sept. 30, 2011 Looking at all of our metrics together (Exhibit 3), we see that only three of the European banks that Morningstar covers—Julius Baer, HSBC, Standard Chartered—pass all three of our tests with flying colors—no surprise given that Baer is an overcapitalized, low-risk private bank and that HSBC and Standard Chartered are more emerging-markets banks than Europe banks. While the shares of none of the three are cheap, especially compared with banks trading at half of book value, all are now selling at material discounts to our fair value estimates and look particularly secure from both capital and sovereign-debtexposure perspectives. All European banks face risk from an economic slowdown, at a minimum, and most at least face some peripheral sovereign exposure, but we think that the sector has punished them fairly indiscriminately. This has created Finally, our metrics also suggest that UBS is a good pick. Its funding metrics are all within or near our target ranges, and its tangible common equity ratio is a fairly reasonable 4.7%. This is much higher than the 2.4% that we calculate for Credit Suisse, but we think that Credit Suisse is the better operator and risk manager. UBS benefits from being a non-euro bank and has minimal exposure to peripheral Europe, although its earnings are stressed by the crisis and by the strong Swiss franc. K Erin Davis is a senior equity analyst with Morningstar. Jim Sinegal, associate director, financial services; and David Wang, equity intern, financial services, contributed to this article. 44 Morningstar Advisor February/March 2012

Table of Contents for the Digital Edition of Morningstar Advisor - February/March 2012

Morningstar Advisor - February/March 2012
Contents
Contributors
Letter From the Editor
Make a Difference Stories, Not Debates
How Concerned Are You About Europe?
Analytical and Independent
What to Ask When a Fund Manager Leaves
Past, Present, Future
Have Financials Gotten Cheap Enough?
Four Picks for the Present
Investment Briefs
Tactical Funds Miss Their Chance
Specialty Retail: Ad Hoc Opportunity
How Europe Is Making Its Crisis Worse
Impact on U.S. Economy Will Be Minimal
European Banks: Bargains or Value Traps?
Don’t Count the Euro Out Yet
Europe on the Brink
GoodHaven Realizes Its Vision
How Index Trading Increases Market Vulnerability
Nonlisted REITS: Handle With Care
Safety Picks for the Many Moods of Mr. Market
On the Prowl for Large- Blend Index-Beaters
Our Favorite Mutual Funds
50 Most Popular ETFs
Undervalued Stocks With Wide Moats
The Math That Matters

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