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Financial Stock Analysis

This analysis reviews the current status of financial holdings, focusing on the implications of recent interest rate hikes and their effects on regional banks. With the Federal Reserve raising rates by 0.25% and continuing consecutive rate hikes, the effects on net interest margins for banks, particularly undiversified regional banks facing declining revenues, are scrutinized. We explore the inverted yield curve's impact on loan and deposit interest rates, alongside specific investment recommendations for key players like Fifth Third Bancorp, Capital One, Citigroup, Deutsche Bank, Merrill Lynch, and MasterCard.

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Financial Stock Analysis

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  1. Financial Stock Analysis Adam Riegle, Nikolas Ristev, and James Rochowiak

  2. Status Quo – Current Holdings

  3. Industry Analysis – Interest Rates • Interest Rates • Fed just raised interest rates another 0.25% and continued 2 years of consecutive rate hikes • Undiversified regional banks suffer from rising interest rates that cause net interest margins to decline • Fed expected to pause rate hikes in the short term as commodity prices decline and US bond activity rises over fears of a slowing economy

  4. Industry Analysis – Yield Curve • Inverted Yield Curve • Higher short-term yield rates create a situation where overexposed banks cannot generate higher net interest revenues • The traditional view of the banking business holds that banks pay interest on their deposits based upon shorter-term interest rates while making loans tied to longer-term interest rates • The difference between interest paid and received—the margin—should be influenced by the slope of the yield curve

  5. Industry Analysis – Yield Curve

  6. Industry Analysis - Banks

  7. Industry Analysis – Div. Fin. Services

  8. Industry Analysis – Sec. Brokerages

  9. Fifth Third Bancorp

  10. Fifth Third Bancorp • Risks • Flattening yield curve and rising interest rates are narrowing net interest margins • NIM down 5% YTD despite 4% growth in average earning assets • Recently switched to daily competitive rates to attract core deposits, but this will create higher interest expense in 2006 • Potential acquisitions may distract management from organic improvement

  11. Fifth Third Bancorp • Target Price: $40.07 • Current Price: $38.05 • Potential: 5.3% • Technical Recommendation: HOLD • Yahoo! Finance Target Price: $39.18 • However, we recommend that we SELL all of our FITB holdings for a better investment • Trade a “single” for a “double” or “triple”

  12. Capital One

  13. Capital One • Current Price: $82.48 • Yahoo! Finance Target Price: $99.83 • Potential Upside: 21% • Technical Recommendation: BUY • Outlook: • Acquisition of Hibernia Bank added $16.3 billion in loans, $23 billion in assets, and 262 banking centers located in Texas and Louisiana • Auto finance division continues to outperform as auto loans increased over 16% YTD • Credit card business is struggling from stiff competition and inverted yield curve impacts margins

  14. Citigroup

  15. Citigroup • Current Price: $48.66 • Yahoo! Finance Target Price: $55.35 • Potential Upside: 13.8% • Technical Recommendation: HOLD • Outlook: • Smith Barney Division experienced healthy increases in assets under management • Result of steady internal growth and the acquisition of Legg Mason (124 branches and 1,200 financial advisors) • Has a strong foothold across a number of businesses with solid growth prospects • Credit card business has experienced poor performance in the past years due to high numbers of bankruptcy filings • This effect should decline due to tougher legislation that is now in effect

  16. Deutsche Bank

  17. Deutsche Bank • Current Price: $114.86 • DCF Target Price: $137.39 • Upside: 19.6% • Yahoo! Finance Target Price: $133.11 • Technical Recommendation: HOLD • Outlook: • Exposure to US interest rate risk limited • Recent announcement of acquisition of Chapel Funding to strengthen residential mortgage backed securities business • 1st qtr profits rose 55% over last year’s 1st qtr results

  18. Merrill Lynch

  19. Merrill Lynch • Current Price: $69.94 • Personal Target Price: $84.33 • Upside: 20.6% • Yahoo! Finance Target Price: $88.00 • Technical Recommendation: BUY • Outlook: • 1st qtr profits were their highest quarterly net revenues ever, rising 28% over last year’s 1st qtr results • 1st qtr EPS were $0.12 higher than analysts’ expectations • 4 of the last 5 changes in analysts’ opinions have been upgrades to buy or overweight

  20. MasterCard

  21. MasterCard • IPO Price: $40.00-$43.00 • IPO scheduled for May 24th • Target Price: $63.07 • Upside: 46.7% • DCF Recommendation: BUY

  22. MasterCard Sensitivity Analysis

  23. Pros 1st qtr revenue is up 12.3% from 2005 1st qtr EPS were up $0.34 an increase of 36.6% Increasing cash flows even in year with negative NI Decreasing A/R and steady A/P Cons Did have a year with negative NI (2003) Currently involved in several legal cases Costs of more than $700million since 2003 Several more cases pending MasterCard Outlook

  24. Recommendation Summary • Hold – DB, COF, C, MER • Sell all of Fifth Third • Performing poorly for several quarters in a row • Fairly valued (both analysts and our opinion) • Buy MasterCard • Use proceeds from Fifth Third and additional money to buy • At $45.00, buy to make it 427 basis points of the SIM Class portfolio • Has a strong upside potential even with conservative estimates

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