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By Matthew Coffina, CFA and Jeremy Glaser | 06-09-2015 01:00 PM

New Wide Moats in Banks and Software

We recently upgraded a few banks and enterprise software firms to wide moat status, and raised our fair value estimates on health-care REITs.

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser.

I'm joined today by Matt Coffina, editor of our StockInvestor newsletter. We are going to look at some recent ratings changes and moat upgrades from our equity research team.

Matt, thanks for joining me.

Matt Coffina: Thanks for having me, Jeremy.

Glaser: Let's start with banks. We recently upgraded the moat to "wide" on several global banks. Can you talk about what precipitated this move and how we think about competitive advantage when it comes to these institutions?

Coffina: Our thinking here has really evolved over the years. Before the financial crisis we had way too many wide-moat banks, and of course we all know what happened to the banking sector during the financial crisis. Around that time, we downgraded the vast majority of those wide-moat banks to narrow moat, and I think the pendulum may have swung a little too far.

There are still are a handful of banks with very strong competitive advantages, usually resulting from cost advantages--for example, lower credit losses, lower operating costs, especially lower costs of funds if they have a lot of low-cost deposits. At the same time, a lot of these banks have high customer-switching costs or at least customers usually take the path of least resistance. If you already have your direct deposit set up, you have your automatic bill-pay set up, you have some credit cards linked to your bank account, and so on, customers would just as soon stay with their existing bank. Given that, banks can get away with charging some fees here and there, and the bank has to do something really bad for customers to go out and look for a different bank.

The combination of cost advantages and customer-switching costs, we think, does allow for wide moats with a very small minority of banks.

Glaser: Which banks did we recently upgrade?

Coffina: We really went through our coverage universe country-by-country, and we found that some countries are more conducive to wide-moat banks than others. We looked at, for example, macroeconomic and regulatory factors, the competitive environment, and so on.

We found that, for example, the U.S market is actually one of the least attractive banking markets in the world; it's still very, very competitive. Whereas a lot of international banking markets have consolidated around just a few large banks, the U.S. still has thousands of banks competing aggressively for deposits and loans. The U.S. also has multiple regulators. Regulators in general are more stringent these days in terms of capital requirements and other factors like that.

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