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A financial fall: interest rate spreads hurt the stock performance of KeyBanc's Fred Cummings.

When banking analyst Fred Cummings picked a portfolio of stocks exclusively for BLACK ENTERPRISE last year, he had mixed feelings about the banking sector. At the time, the U.S. economy was slowly recovering from a recession, and companies had taken a conservative stance and weren't lining up to take out loans. On the other hand, historically low interest rates had induced consumers to spend as they took advantage of cheaper borrowing costs.

Since then, the Federal Reserve has raised short-term interest rates at a pace it believed would encourage growth without sparking inflation. However, complicating the situation for banks, long-term interest rates remained low as foreign investors bought up U.S. treasuries. The narrowing span between short- and long-term rates limited banks from profiting from investments and loans. "The bank stocks, in general, have been struggling due to the fact that the Federal Reserve continues to raise interest rates," says Cummings. "Banks are getting squeezed in their investment portfolios."

Unfortunately, just about all of Cummings' picks got squeezed as well. His portfolio fell 6.66% in the 12 months from Sept. 21, 2004, to Sept. 20, 2005. During that same period, the Dow Jones Industrial Average rose 2.31% and the Standard & Poor's 500 Index gained 8.15%.

Fifth Third Bancorp (Nasdaq: FITB), had been out of favor with investors because of internal control issues. Cummings thought those issues were behind the bank and expected 12% growth over the next three years, but it turned out to be the worst performing of his picks.

The company had a large percentage of securities on its balance sheet and its investment portfolio would have been well-positioned if long-term rates had risen along with short-term ones. As long-term rates lagged, Fifth Third sold off some of its securities and paid off some of its short-term borrowing. Unfortunately, those efforts weren't enough and the company's earnings took a hit. The stock fell 19%, from $46.64 to $37.76. "Fifth Third just hasn't executed well." Says Cummings.

His next pick, Oak Hill Financial Inc. (Nasdaq: OAKF), fell almost 12%, from $34.43 to $30.33. The company, which provides banking services in Ohio, surprised investors with news about bad loans and fell to a 52-week low of $25 before regaining some ground. Cummings reduced his investment recommendation on the stock on Jan. 18 when it was trading at $37.

Fulton Financial Corp. (Nasdaq: FULT) slipped only .12%, from $16.62 to $16.60, and Cummings says he's not disappointed with the bank. "Fulton Financial executed quite well. Even though the stock is down slightly, it sold off due to sentiment being negative for the entire group."

Fulton Financial invested in short-term duration securities, allowing its portfolio to gain, and used cash flow from its investment portfolio to help fund loan growth. Cummings says he would still recommend owning the shares and he expects earnings to increase by 8% this year.

Cummings' final selection, U.S. Bancorp (NYSE: USB), had the best performance out of all the stocks he chose, increasing 4.42%, from $27.82 to $29.05. The company experienced revenue growth from fees, and Cummings expects earnings to increase by 9% to 10% this year. "We would prefer to buy them even though we don't see a near-term catalyst to spark a rally," says Cummings. "We think the banks will rally next year because the Fed will stop raising interest rates. But they still have some challenges."




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Title Annotation:banking analysts service
Author:Patterson, Philana
Publication:Black Enterprise
Geographic Code:1USA
Date:Jan 1, 2006
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