Bank Stocks to Bottom in 2009: The Only
Question is When?
Our 2009 Outlook Still Sees A Meaningful Downside
Before the Bottom Arrives as Credits Problems
Spread to CRE and C&I Loans
• Banks Stocks to Bottom in 2009: We believe bank stocks will likely
bottom in 2009 as investors fully discount the credit problems for the
industry, see Exhibit 28.....
• ........But Credit problems Will Spread: We believe the credit problems
with the housing industry have been mostly discounted but substantial
increases in C&I and CRE credit problems, see Exhibits 20-23, will push
stocks lower before they bottom, in our opinion.
• More Dividend Cuts On The Way: We anticipate the pressure to cut
and/or eliminate dividends will intensify in 2009, especially for banks that
have accepted TARP funding, see Exhibit 41.
• Stock Valuations are Low But Not Low Enough: On a median
price-to-book basis and price-to-tangible book basis, the top 25 banks trade
at 0.55x and 1.07x (compared to 1990 lows of 0.79x & 0.79x) and the top
50 banks trade at 0.91x and 1.81x (compared to 1990 lows of 0.91x &
0.91x), respectively. See Exhibits 33-36.
• Bank Investment Strategy: As we enter 2009 investors that must own
bank stocks should stick with the highest quality names but investors will
want to switch the strategy to a basket of "Credit Challenged" names when
bank stocks hit bottom.
• More TARP Funds On The Way: We expect TARP recipients could
receive additional equity infusions to weather the credit crisis and additional
restrictions will be included with the new investments.
• Nonperforming Assets to Peak Late 2009/Early 2010: Historically, NPAs
peak shortly after the recession ends, see Exhibit 28, and if the current
recession ends in the second half of 2009, NPAs should peak at end of
2009/early 2010.
• Net Interest Margins To Remain Under Pressure: As a result of
continued intense deposit competition, rapidly rising NPAs and low interest
rates, net interest margins for the banking industry are expected to remain
under pressure in 2009, see Exhibit 40.
• Bank Stocks Have Underperformed: In the last 4 years bank stocks have
underperformed the S&P 500, which is the worst four year performance
investors have seen since 1990, see Exhibit 37.
• Great Opportunities On The Other Side of "Valley": We anticipate after
the financial crisis ends, the opportunities for increased bank profits from
traditional banking products will be strong but.....
• ......Significant Bank Regulation on the Horizon: As a result of the
financial debacle the markets are experiencing, we expect the US Congress
to impose stifling regulation on the US banking industry which will limit
earnings growth and profitability.
• Bank Failures: We continue to believe hundreds of banks are expected to
fail over next 12-24 months.

Summary
For over the last two years we have alerted investors to the problems the commercial banking industry was going to confront in terms
of higher credit costs and the negative impact that would have on profitability and stock prices. These problems have been driven by
two separate and distinct forces, in our view; First, the bursting of the housing bubble; and, second, the credit cycle. The bursting of
the housing bubble is in the 6th or 7th inning, in our opinion. The losses from the bursting of the housing bubble are enormous and
will continue into 2010 as foreclosures continue at record levels, in our view. The credit cycle, however, is in the 2nd or 3rd inning
and its effects on the industry will be felt throughout all of 2009 and into 2010. Additionally, investment portfolio impairment charges
are expected to rise in 2009 as Other Than Temporary Impairment (OTTI) charges work its way through the industry’s income
statement. Bank stock investors will need to weigh these dynamics when considering whether to buy bank stocks.
We anticipate sometime in 2009 investors will want to go "all-in" in buying bank stocks but we need to be patient because as the
down leg of the credit cycle tears through the industry's profitability, the stocks could decline another 20-30% before they reach
bottom, in our opinion. We believe at the bottom for bank stocks investors will want to own a basket of "Credit Challenged Stocks"
also known as "Wealth Creation Stocks" which purchased at below 50% of book value will reward investors with out-sized returns in
the subsequent 2-3 year time period, in our opinion. Until the time comes for investors to buy the Garbage Stocks, we would avoid
bank stocks but for investors that have to own bank stocks, the stocks that should go down less relative to the group are the "Flight to
Quality” stocks. Our coverage list includes three large cap “Flight to Quality” stocks: PNC Financial Corporation, (NYSE: PNC;
$48.10; Sector Perform; Average Risk), US Bancorp, (NYSE: USB; $24.01; Outperform; Average Risk) and Wells Fargo &
Company, (NYSE: WFC; $28.06; Outperform; Average Risk). Finally, our bank stock views are based upon the US recession lasting
into the latter part of 2009. Should the recession extend into the second half of 2010, the credit problems for banks will last much
longer than we are expecting at this time and buying the bank stocks in 2009 could prove to be premature.
Industry Trends
We have learned in our careers as bank analysts that "banks are only as good as the economy in which it operates." Therefore, it is
very important for bank investors to have understanding of the economic trends that will impact bank stock prices and since the
majority of most bank loans are tied to the commercial real estate, construction, commercial and residential housing markets, an
investor needs to analyze these markets carefully before buying a bank stock, in our opinion. Ideally, if the banking industry published
financial statements that were not so opaque, investors would have a better handle on which companies have exposure to the weakest
borrowers. Unfortunately banks do not provide to outsiders a list of its largest 100-200 borrowers and the amount of money they are
owed from these borrowers. As a result, we need to review what has happened in the past to the banks that overextended themselves
prior to a recession in these loan categories, analyze current industry trends in the commercial real estate and housing markets,
corporate lending arena, etc., and ferret out information from contacts from around the country with first hand accounts on what they
are seeing in these respective areas.
Often times these anecdotal first hand accounts prove to be the most useful in creating our "mosaic" because this data spots trends
before it is captured by industry associations or government data. Recent anecdotal evidence that is showing up--just in the last two
weeks both the Wall Street Journal (WSJ) and New York Times (NYT) have run lead stories on the problems in commercial real
estate--suggests to us banks with excessive exposures to commercial real estate borrowers are going see significant increases in
nonperforming assets in 2009. The increases will come in different forms from loan extensions to existing borrowers, defaulted loans
or foreclosures. Banks are very willing to renegotiate loan terms for these large credits but even after they are renegotiated, they still
have to be carried as a nonperforming asset for at least 6 months and sometimes a full year. Coinciding with the rise in nonperforming
assets will be a significant increase in credit losses, in our opinion.
What is most interesting in this cycle for the commercial banking industry and global financial markets is the first "dent in the armor"
(and in some cases it was more then a dent) came from an asset bubble bursting and not the down leg of a credit cycle. As a result,
many banks and nonbanking companies have been severely weakened as we head into the down leg of this credit cycle which is why
we believe The Federal Reserve, US Treasury and other Central Banks from around the globe have aggressive implemented programs
and strategies to enable the system to survive the asset bubble bursting and the credit cycle, see Exhibit 1. We believe the involvement
from these respective government agencies will continue indefinitely into the future. As we saw in 2008, common shareholders will
bear the brunt of any future fallout from increased government involvement in the US banking industry, in our opinion.