This column was originally published on RealMoney on June 14 at 1:00 p.m. EDT. It's being republished as a bonus for TheStreet.com readers.
While the massive size and diversification of the biggest U.S. banks have kept their Federal Deposit Insurance Corporation (FDIC) ratios well below red lines indicating overexposure to real estate, the extent of their underwriting in construction lending and multifamily and commercial real estate lending is a matter of concern. If the
continues to raise rates, defaults on these types of loans will put a damper on future profits of all the financial institutions participating in what has been a major boom.
The selloff in stocks hasn't affected the finance sector as much as the rest of the market, partially due to the expectation that the Federal Reserve will soon stop raising rates. The finance sector is currently the most overvalued, but by just 3.5%.
It appears that the FOMC is hell-bent to raise the federal funds rate to 5.25% at its next meeting at the end of June. I believe additional rate hikes will increase the probability that defaults on real estate loans will rise.
The top six banks by total assets and
Bank of America
Bank of America has the most exposure to construction loans, followed by Wachovia and Wells Fargo and the smaller banks
Branch Banking & Trust
All of the financial institutions in the table below are rated hold by ValuEngine, except for JPMorgan. Only JPMorgan and Wachovia are trading slightly below fair value. The weekly chart profiles are mixed. What's interesting is that BB&T and SunTrust, the stocks that are most exposed to real estate, have positive profiles.
The FDIC compiles two ratios for financial institutions based on quarterly reporting of their underwriting activities in construction lending and lending for multifamily properties and commercial real estate:
- The CD loans ratio measures construction lending vs. Tier 1 capital. When this ratio exceeds 100%, it's a warning.
- The CRE loans ratio measures the total of construction, multifamily and commercial real estate lending vs. Tier 1 capital. When this ratio exceeds 300%, it's a danger sign.
Bank of America has the largest exposure to construction loans of any financial institution at $20.7 billion, but given its tremendous level of assets, its CD ratio is a mere 29%, below the FDIC 100% threshold. With this balance, investors should add to holdings on weakness to my annual value levels of $46.07 and $44.12 and reduce holdings at my semiannual risky levels of $51.95 and $54.44.
The much smaller BB&T Bank is fifth in the size of its exposure to construction loans at $11 billion, putting its CD ratio way above the FDIC's red line at 197%. Its CRE ratio is also above danger levels at 364%. The stock isn't much below its 52-week high at $43.90. Investors should reduce holdings now, with shares between my monthly and semiannual pivots of $41.24 and $41.96.
Citigroup's exposure to CD loans is only 1% of capital and isn't a major concern for investors. Add to positions on weakness to my quarterly value level of $45.44 and reduce holdings if it rises to my monthly pivot of $51.30.
JPMorgan's exposure to CD loans is only 10% of capital, and it was upgraded to buy Wednesday morning by ValuEngine. With shares trading around my quarterly value level of $39.85, I'd increase my stake now. If it rises to my annual risky level of $49.50, I'd reduce holdings.
SunTrust has the fourth-largest construction-loan portfolio at $12.1 billion, putting its CD ratio at 101%, just over the FDIC guideline. With the stock recently pushing at its 52-week high of $78.33, investors should reduce holdings now, or on a weekly close below the five-week MMA of $76.22.
Wachovia has a manageable CD ratio of 57%. Investors should add to holdings if it falls to my quarterly value level of $52.98 and pare back positions if it rises to my annual risky level of $57.84.
Wells Fargo has a manageable CD ratio of 55%. Investors should add to positions on weakness to my monthly and annual value levels of $64.30 and $63.23 and reduce holdings on strength to my semiannual risky level of $70.50.
Washington Mutual's exposure to CD loans is only 13% of capital. I'd buy more if it drops to my monthly and annual value levels of $42.19 and $41.59 and reduce holdings on strength to my annual and semiannual risky levels of $47.34 and $47.67.
If you have a bank you wish me to profile, send me an email.
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Richard Suttmeier is president of Global Market Consultants, Ltd., and chief market strategist for Joseph Stevens & co., a full service brokerage firm located in lower Manhattan. Early in his career, Suttmeier became the first U.S. Treasury Bond Trader at Bache. He later began the government bond division at L. F. Rothschild. Suttmeier went on to form Global Market Consultants as an independent third-party research provider, producing reports covering the technicals of the U.S. capital markets. He also has been U.S. Treasury Strategist for Smith Barney and chief financial strategist for William R. Hough. Suttmeier holds a bachelor's degree from the Georgia Institute of Technology and a master's degree from Polytechnic University.