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Monday, October 02, 2006

Analyzing Key Trends & Outperformers (JPM, BAC & WFC) In The Banking Sector Ahead Of The 3Q Earnings Season

By Yaser Anwar, CSC of Equity Investment Ideas

Key Trends-

Banks continue to add to mortgages and securities in 3Q, but not as aggressively as last quarter. Loan growth continues to slow, and I found banks adding securities as Fed data shows that residential mortgages were up 10% annualized vss up 9% in 2Q and investment securities are up 8% annualized vs. up 27% in 2Q. Implying a weighted average growth of 8% annualized vs last quarter vs 19% in 2Q.

Key trends in 3Q are likely to be large Net Interest Margin compression , slowing commercial loan growth, weak deposit trends, and good expense control. Consumer credit quality should show signs of deterioration, but I do not expect large uptick in credit costs.

Investors should keep a close eye on continued yield curve flattening. According to Bloomberg, the average spread between the fed funds and the 3yr swap rate has fallen to 9bp in 3Q which compares to 54bp in 2Q. However, the average spread between fed funds and the 10 year in 3Q is a negative 35bp which compares to 17bp in 2Q.
My favorite stocks heading into 3Q Earnings Season are:

JP Morgan

JPM has been driven by better than expected investment banking and sustained progress in it's corporate line.

Overall, I believe most banks will be struggling to meet EPS estimates, and think JPM has the most flexibility to hit and exceed estimates.

Keys in the quarter should be relatively strong investment banking numbers, and sustained improvement in other corporate.
Bank of America

BAC should benefit from expense related tailwinds from MBNA. Similar to JP Morgan, I expect Bank of America’s 3Q numbers to come in better than expected. Why?

Due to BAC's ability to reduce expenses and strong underlying trends in its payment businesses.

Bank of America continues to be my favorite in the sector because it has above average growth, great dividend and the cheapest valuation in the sector.
Wells Fargo

Since 2Q earnings, WFC shares have slightly underperformed the group due to fears about consumer credit quality.

Investors should not expect much deterioration in 3Q, which may help alleviate some of these fears.

Plus, I continue to strongly believe the top line growth and expense flexibility at WFC is among the best in the sector, and this should be evident in the 3Q results.

Disclosure: I don't have a position in the aforementioned stocks.

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