Bank Credit Healthier Now Than Before Crisis

Jeremy Glaser: For Morningstar.com, I'm Jeremy Glaser. We recently launched our bank credit ratings, and I'm here today with Associate Director of the Banking Team, Jim Sinegal, and Credit Analyst, Barry White, to dive a little bit deeper.

Gentlemen, thanks for joining me today.

Jim Sinegal: Good to see you again.

Barry White: Good to be here.

Glaser: So one of the things that strikes me is that bank credit analysis is actually pretty different from looking at a company like IBM. Why did we have to develop this new methodology, did you guys develop this new methodology to look at if it's advisable to invest in a bank bond?

Sinegal: Banks are highly levered institutions and they are a lot different from a company like IBM. There are factors like capital and credit quality that you need to evaluate when looking bank credit that just aren't issues for industrial companies.

Glaser: So when you're diving into issues like credit quality and loan mix, you know what are some of the metrics specifically that you're evaluating?

White: I look at obviously nonperforming loans and not just that but how much are they growing relative to the prior quarter because one thing that we saw throughout the crisis, a lot of growth early on, things were tempering a little bit, makes you a little more positive about the future of the bank's credit quality.

Glaser: So speaking of that, I mean, I think certainly during the credit crisis, there's a lot of worries about banks going completely bust, a lot of that seems to have left the discourse now. Where do you see kind of the trajectory of bank credit generally going?

Sinegal: I think bank credit is actually improving. We've seen some stabilization in various credit quality metrics and compared to the beginning of the crisis, a lot of banks have raised capital first through the TARP then in the equity markets and banks have been able to build their reserves through provisioning over the last eight quarters now. So banks are actually in general in a bit of a healthier position than they were going into the crisis.

White: I think also if you look at regulatory reform there could be some earnings headwinds out there, but I think you're going to see banks across the board holding more capital which certainly is a positive for credit holder, or for bond holders.

Glaser: And then other major banks, how does some of your credit rating shake out, which were some of the strongest ones, and which ones do you think are on weaker footing?

White: For the major banks, JPMorgan and Wells Fargo are the two best. Wells mainly because their profitability and their focuses is on banking as opposed to some of the capital markets type businesses. JPMorgan just has a better reserve position, better credit quality, just an overall better hold on their business than let's say BofA or Citi.

Glaser: And those are the ones that you'd be the most worried about from a credit perspective?

White: I wouldn't say we're worried about them. Just from a credit quality standpoint, they are just not quite as strong as the other two.

Glaser: And for a potential equity investor, is there anything they can learn from these credit ratings or learn from this methodology that could help them to evaluate if it makes sense to buy the stock of say JPMorgan or Wells Fargo.

Sinegal: Equity analysis and credit analysis go hand in hand. Banks with stronger earnings power, stronger capital position, better reserves, they're going to score better as far as credit quality goes, and they're also probably going to be in general better equity investments. You're a lot less likely to lose money obviously when you are investing in a company that has a good credit.

White: And I think they need to go hand in hand. You look at confidence, that's what credit ratings are all about, when you see confidence fall, funding costs go up and earnings go down. I think, those are things that equity analysts have to be cognizant of.

Glaser: Jim, Barry, thanks for talking with me today.

Sinegal: Thanks for having us.

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