Trust Banks: Steady in Crunch Time

The slumping housing market and lingering credit crunch have pummeled financial stocks over the past year to lows not seen in almost two decades. Last year, banks were feeling the pinch from writedowns related to securities backed by mortgages and unsold leveraged loans. This year, banks are getting socked in the stomach as a consumer-led recession results in the rapid deterioration in credit beyond just residential mortgages and into other consumer and commercial-related loans, such as credit cards and residential construction loans.

As a broad swath of banks and consumer finance companies begin to report second-quarter earnings results next week, profits -- if any -- will continue to be weak. Banks will be busy continuing to add to their pile of loan loss reserves, marking down leftover leveraged loans and mortgage-backed securities, and shoring up capital wherever they can, likely in the form of dividend cuts.

This week, TheStreet.com asked several high-profile equity analysts about how the credit crisis is affecting banks and other consumer finance businesses. In this final installment in the series, Gerard Cassidy, managing director of bank equity research at RBC Capital Markets, discusses how the credit crisis has affected trust and processing banks.

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TheStreet.com: Goldman Sachs (GS Quote) recently said that it expects the banking sector to raise an additional $65 billion before the credit crisis peaks next year, but notes trust banks like Bank of New York Mellon (BK Quote) and State Street(STT Quote) are buys. Are trust banks better choices for investors during this market downturn? How are these businesses relatively safe from the credit crisis?

Cassidy: The basic long-term business for the trust banks -- Northern Trust(NTRS Quote), Bank of New York Mellon and State Street -- are some of the best businesses a financial institution can be in today, [because they primarily bring in recurring fee-generated revenue from businesses like] asset servicing for institutional customers, asset management, wealth management, securities lending and foreign exchange trading.

In the commercial banking system, companies that have exposure to the highest risk loan areas, which today are construction loans, commercial mortgages and leveraged loans, are witnessing a dramatic increase in credit problems. The trust banks do not have any meaningful exposure in those three areas, which is one of the reasons they have been identified as great hide-out names during this economic or credit crisis.

What are the biggest potential problems looming for these specific banks?

We're becoming increasingly concerned that if the global equity markets continue to decline, then the fee-based banks will be impacted negatively not by the credit defaults, but by [lower] revenue growth from their fee-based businesses associated with the global equity markets. These trust banks are influenced more, and are impacted more, by the day-to-day levels of the equity markets than a traditional commercial bank. There aren't any credit issues per se with the trust banks, but the volatility that's created from the capital markets appears to be picking up.

The trust-based banks are paid on a percentage of assets under custody or assets under management, so if you've got rising equity and fixed income values and you don't even touch your pricing, you get an automatic price increase from your customers, which helps drive revenue and earnings growth. The opposite happens when the values decline.