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Banking blues won't last
The interest rate environment is tough. But the financial giants offer solid growth at good prices.
July 19, 2005: 6:29 AM EDT
By Michael Sivy, CNN/Money contributing columnist
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NEW YORK (CNN/Money) - The major banks are reporting this week, and so far the results have been mixed. In particular, Bank of America reported a 12 percent earnings gain for the second quarter, while Citigroup announced a 7 percent decline in earnings from continuing operations.

Overall, the environment is decidedly discouraging for banks, largely because short-term interest rates and long-term yields have come closer together.

Since January 2004, the Federal Reserve has raised short rates by 2.25 percentage points, while yields on 10-year bonds have actually declined by almost one-quarter percentage point over the same period.

As the gap between the two narrows, profit margins on bank lending shrink, since banks typically borrow short-term money to make long-term loans.

Citigroup felt this margin squeeze particularly keenly, which is one of the major reasons earnings were down for the second quarter. Citigroup also suffered a sharp drop in profits from bond and other fixed-income trading, although equity trading gains were up.

In addition, the company was hurt by a jump in loan losses as some financially strapped borrowers declared bankruptcy in advance of changes in the law.

Bank of America has also felt the shrinkage of interest-rate margins, but has been able to offset that with strength in other businesses. In particular, B of A has added 1.6 million credit card accounts and has steadily been cutting expenses.

Other banks have felt the squeeze, too. MBNA on Monday reported a 4 percent decline in earnings. And J.P. Morgan warned that its results, due out later this week, may be disappointing.

What it means for the stocks

What does all this mean for investors? Is the entire banking sector dead money? Or should you buy Bank of America in preference to Citigroup and possibly even J.P. Morgan?

In my view, these second-quarter earnings reports don't mean much beyond the obvious: The interest-rate environment is challenging, and that's hurting banks' profits from lending and bond trading.

It may look as though Bank of America is a better buy at the moment -- and perhaps it is. It may be slightly cheaper than Citigroup and it does pay a higher yield.

In fact, though, all the banks are feeling the interest-rate squeeze. They just show it to different degrees because of differences in their business mix. And indeed those mixes are constantly changing.

Citigroup has sold Travelers Life & Annuity to MetLife, and agreed in June to sell asset management businesses to Legg Mason in exchange for brokerage operations and other compensation.

Bank of America, by contrast, bought FleetBoston Financial last year and has agreed to buy MBNA.

In the process, Citigroup (Research) has increased its exposure to current market trends, while B of A (Research) has buffered its position with more consumer lending. In addition, absorbing acquisitions gives B of A the opportunities to combine operations and reduce overhead.

In the long run, I'm not sure how much these differences matter. Bank of America, Citigroup and J.P. Morgan (Research) are all financial behemoths, selling at dirt-cheap price/earnings ratios below 12, based on expected 2006 results. The stocks also all pay yields above 3.5 percent and offer long-term total returns averaging more than 12 percent a year.

One or another of them may profit at any particular point from a business mix more attuned to market conditions -- and I expect that J.P. Morgan's second-quarter results will bear this out.

But in a slightly different economy, the first might be last and the last first. All three stocks look like solid long-term values, and I wouldn't spend too much energy trying to choose among them.

Sivy on Stocks resources:

Sivy 70: America's best stocks

Guide to Growth

___________________

Michael Sivy is an editor-at-large for MONEY magazine. Click here to receive Sivy on Stocks via e-mail every Tuesday.  Top of page

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