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E Q U I T Y R E S E A R C H

LARGE COMMERCIAL BANKS


T H E 6 0 S E C O N D B A N K S T O C K P R I M E R

A P R I L 2 0 0 3

Andrew B. Collins
Senior Research Analyst
212-284-9310

Steven M. Truong
Research Analyst
212-284-9307

R. Neal Kohl
Research Associate
212-284-9455
E Q U I T Y R E S E A R C H April 2003

LARGE COMMERCIAL BANKS

THE 60 SECOND BANK STOCK PRIMER

The Basics Of Banking Remain UnchangedOver the last 12 months we have witnessed
significant turmoil within the financial services sector, primarily reflecting severe
deterioration in the equities market. We can now revisit the basics of bank stock
investing within the context of a completely new, lower valuation environment.

The Economy Is 80% Of The Call On Bank StocksWe must make certain assumptions
regarding the U.S. economy to consider investing in bank stocks, and those include that
the U.S. consumer will remain somewhat healthy, while the corporate environment will
slowly stabilize after wringing out the severe excesses of the late 1990s. Key economic
drivers of bank stock price performance are explored.

Credit Quality Can Cut Hard Both WaysUnquestionably, the biggest swing factor in
bank stock earnings remains credit quality. We do not foresee a double-dipping U.S.
economy; however, under such a scenario we might witness another round of corporate
bankruptcies and a weakening consumer. We have provided the key dials and needles
in bank stock financial statement analysis.

Consolidation And Nonbanking Remain The Mega TrendsIn our assessment,


consolidation has been one of the big trends in commercial banking for the last 15 years
and may resurface as a support for stock valuations under a scenario of increased earnings
stress. Another mega trend that has turned increasingly detrimental to earnings over the
last two years has been the single-minded focus on fee-based revenues, which dominated
the mid-1990s.

Risks to achievement of our 12-month price targets include, but are not limited to,
deterioration in the broader market; significant weakness in the U.S./global economy; or
specific unforeseen fundamental company-related events which may result in failure to
achieve our EPS estimates.
April 2003

TABLE OF CONTENTS

Viewpoint .................................................................................................................... 4
Economics And Bond Market Indicators ....................................................................... 5
Deals And Needles What Is Really Important When Modeling.................................... 8
Loans And Credit Quality .......................................................................................... 11
Revenue Components ................................................................................................. 15
Noninterest Expenses ................................................................................................. 16
Capital ..................................................................................................................... 18

Valuation Methods .................................................................................................... 21


Price-To-Earnings ................................................................................................ 21
PEG Ratio ........................................................................................................... 22
Price-To-Book ..................................................................................................... 22
Some Attractive Yield Opportunities .................................................................... 23

Mega Trends Consolidation, Credit Quality, And Nonbanking ................................. 27


Consolidation ...................................................................................................... 27
Credit Quality ..................................................................................................... 28
Nonbanking Trends ............................................................................................. 30
Investment Banking ............................................................................................. 30
Asset Management .............................................................................................. 31
Processing ........................................................................................................... 31
Credit Cards ....................................................................................................... 32
Mortgage Banking ............................................................................................... 33
Technology And The Evolution ............................................................................ 33

History of Banking .................................................................................................... 34

Definitions ................................................................................................................. 36
Index ......................................................................................................................... 46

2 | Large Commercial Banks U.S. Bancorp Piper Jaffray Equity Research


April 2003

TABLE OF CONTENTS CONTINUED

Exhibits

1. The Primer Pyramid .............................................................................................. 4


2. High Yield Spread Versus Bank Stock Index ........................................................... 6
3. Equities Fund Flows Weekly Change ................................................................... 7
4. Money Markets Fund Flows Weekly Change .......................................................... 7
5. Taxable Bond Fund Flows Weekly Change ............................................................. 7
6. Bank Deposit Flows Weekly Change ....................................................................... 7
7. Example 1: Balance Sheet ....................................................................................... 8
8. Example 2: Average Balance Sheet .......................................................................... 9
9. 3-Month T-Bill Versus 10-Year U.S. Treasury Historical Spread ............................. 10
10. Example 3: Income Statement .............................................................................. 11
11. Example 4: Credit Quality ................................................................................... 12
12. Total Home Equity Outstanding And Committed With Growth Rates................... 14
13. Revolving Consumer Credit Outstanding ............................................................. 14
14. San Francisco Bay Area Unemployment Rate ........................................................ 15
15. Example 5: Noninterest Expenses ......................................................................... 17
16. Regulatory Capital Requirements ......................................................................... 18
17. Example 6: Components Of Capital ..................................................................... 19
18. Benchmark Averages ............................................................................................ 20
19. 2003 Historical Consensus Estimates ................................................................... 21
20. Fastest And Most Consistent Earnings Growers .................................................... 22
21. Top-50 Banks Price To Book And ROE ............................................................... 23
22. Bank Stock Dividend Yield Versus 10-Year U.S. Treasury ...................................... 24
23. Top-50 Banks (By Market Cap) Dividend Yield .................................................... 25
24. Top-50 Banks (By Market Value) 2002 Dividend Payout Ratios ............................ 25
25. Dividend Payout Top-50 Banks ............................................................................ 26
26. Bank And Thrift M&A Activity ........................................................................... 27
27. Industry Net Charge-Off Ratios ........................................................................... 29
28. Large-Cap Banks 2003E Earnings Mix ................................................................. 30
29. State Street Investor Services Competitive Wins And Losses ................................... 31
30. U.S. Credit Card Industry Overview ..................................................................... 32
31. Top-10 Residential Servicers ................................................................................. 33
32. Top-10 Residential Originators ............................................................................ 33

U.S. Bancorp Piper Jaffray Equity Research Large Commercial Banks | 3


April 2003

Viewpoint In our judgment, investing in bank stocks is highly dependent upon a healthy
understanding of U.S. economics, bank accounting, and key industry trends. Bank stock
investing can entail sorting through large databases of historical and valuation
benchmarks. We have attempted to simplify these investment factors into a short primer
on bank stock investing (see Exhibit 1).

The Economy - We think U.S. economic growth determines 80% of the success in bank
stock investing. Among key economic indicators we pay particularly close attention to are
the following: personal unemployment, purchasing managers index, bankruptcies, loan
growth, and demand levels and money flows. Using these statistics, our current macro
view on the U.S. economy includes: limited interest rate movements over the next 12
months, low single-digit GDP growth, and a continued healthy consumer, despite potential
for a near-term uptick in unemployment. We view this as a solid environment from which
to invest in bank stocks.

Fundamentals And Accounting From a fundamental standpoint, we monitor credit


quality statistics closer than any other category of fundamental analysis, given a historical
tendency for credit to generate enormous swings in earnings. We also constantly monitor
interest rates and loan growth as a basic function of banking profitability. In our
assessment, credit quality in 2003 may finally stabilize after three years of weakness, while
basic banking trends may suffer from deteriorating optics, reflecting the unique
phenomenon of market rates declining too much.

Exhibit 1

THE PRIMER PYRAMID

History Regulation Legislation

Mega -Trends Consolidation Credit Quality Nonbanking

Valuations Price-to-Earnings Price-to-Book PEG Ratios

Fundamentals Credit Quality Net Interest Margin Fee Revenues Investments Loans

Economy GDP Growth Interest Rates Unemployment Bankruptcies Purchasing Mgrs. Loan Aggregates

Source: U.S. Bancorp Piper Jaffray

4 | Large Commercial Banks U.S. Bancorp Piper Jaffray Equity Research


April 2003

Valuations We view bank stock valuations primarily within the context of the broader
market, focusing on relative price-to-earnings (P/E), price-to-book (P/B), and return on
equity (ROE) throughout a full cycle. Although P/Es and P/B ratios appear to be at the
high end of relative historical ranges at 75%, ROEs are higher than normal, and a lot
depends on earnings expectations for the broader market. We think the broader market
may be subject to more severe downward earnings adjustments in 2003. Traditional bank
stocks or spread banks tend to trade as a group based on interest rate developments,
whereas the conglomerates are generally more sensitive to equity market fluctuations.

Mega Trends Consolidation, credit quality, and fee-income business developments have
been the biggest trends to impact commercial banking over the last 20 years. Although
industry consolidation grinded to a halt in 2002, we would expect some catalyst to lead to
an acceleration in activity within the next two years. Further, while the push into non-
banking business has also slowed due primarily to significant deterioration in market
sensitive revenues we think banks will once again focus on fee-based businesses by 2004.
Diversity of earnings and capital has proven extremely useful during times of stress, while
many larger banks attempt to cross-sell products through healthy distribution networks.

History And Regulation On a historical basis, we think regulatory and legislative


oversight of the financial services space is currently in an expansionary phase, as
exemplified by the global settlement with investment banks, recent initiatives to curtail the
sub-prime consumer markets, and regulation of the asset-backed finance market (VIEs).
Most of these moves have not severely impacted banking profitability, unlike some
historical negative regulatory efforts. We are waiting for a true litmus test regulatory or
legislative event.

Economics And Bond We monitor seven or eight key economic/bond market data points when following bank
Market Indicators stocks including the Treasury market rates (3-month and 10-year maturities), high-yield
credit spreads, loan market aggregates, unemployment, purchasing managers index,
money flows, and GDP growth.

In our assessment, the state of the U.S. economy is probably 80% of the call on traditional
bank stock price performance. Under a scenario of 3.0% GDP growth or more, investors
often become concerned with higher interest rates and seek out faster-growing areas within
the investor spectrum (i.e., technology), often ignoring financials in the process. If GDP
growth drops below roughly 1.0%, investors should be concerned with slowing loan
growth and potential for weakening credit quality. So far, the consumer who makes up
two-thirds of the U.S. economy has held up remarkably well while large corporate
America has suffered. In our view, somewhere between 1.5% and 3.0% GDP growth is
optimal for bank stocks on a relative basis.

The absolute direction of interest rates signals the level of demand for funds within the
various markets. The Federal Reserve has a direct impact on the shorter end of the yield
curve through the Fed funds rate, which can be adjusted at each of the FOMC meetings,
whereas longer-term rates are primarily a function of the markets. We think the Federal
Reserves significant campaign to lower the Fed funds rate by 525 basis points to its
current level of 1.25% has had little impact on the corporate side to reaccelerate corporate
demand and capital spending, primarily due to the massive bubble created by over-
investment in the technology sector throughout the late 1990s.

U.S. Bancorp Piper Jaffray Equity Research Large Commercial Banks | 5


April 2003

Nevertheless, lower short-term rates probably led to lower long-term rates such as the 10-
year Treasury, which has declined by roughly 115 basis points over the past 27 months to
a current yield of 3.94% as of March 26. And since this rate has a high correlation with
mortgage rates, we have witnessed a dramatic strengthening in the housing market as
many Americans have refinanced at lower interest rates.

Further, interest rates have a significant impact on net interest revenues at U.S. commercial
banks. A steep yield curve, i.e., a big difference between short-term and long-term interest
rates, is usually very favorable for bank stock net interest income and thus earnings as
banks tend to lend longer term and borrow shorter term.

Exhibit 2

HIGH YIELD SPREAD VERSUS BANK STOCK INDEX


Negative 0.6 High Yield Spread Oct-8
Correlation Coefficient Bank Stock Index SNC Results
Jan-3
900bps Fed 2001 rate cut May-21 1000
campaign begins Merrill settles
850bps Dec-2 $100 million 950
Enron files
800bps Ch.11
900
750bps
High Yield Spread

Bank Stock Index


850
Sep-11
700bps WTC Attack
800
650bps
Avg.
Spread 750
600bps
616 bps
700
550bps

500bps 650

450bps 600
17-Aug-00

29-Sep-00

6-Aug-01

19-Sep-01

29-Apr-02

11-Sep-02
13-Feb-01

28-Mar-01

10-May-01

22-Jun-01

31-Jan-02

15-Mar-02

13-Jun-02

30-Jul-02

21-Jan-03
5-Jul-00

13-Nov-00

29-Dec-00

14-Dec-01
31-Oct-01

24-Oct-02

5-Dec-02

Source: U.S. Bancorp Piper Jaffray, ILX and Bloomberg


Note: As of March 13, 2003.

High yield credit spreads tracked against the 10-year Treasury can often signal increased
credit concerns in the marketplace and thus potential systemic disruptions. Prior to Enron
declaring bankruptcy during the fall of 2001, and then again leading up to the shared
national credit results in October of 2002, credit spreads widened dramatically. In sum,
these measures track credit fears as well as reality (see Exhibit 2).

We generally view consumer and corporate loan aggregate trends as early indicators of
economic growth. Although corporate loan shrinkage appears to finally be slowing after
several quarters of deterioration, consumer loan growth has continued to expand, albeit at
much slower rates over the past six months.

6 | Large Commercial Banks U.S. Bancorp Piper Jaffray Equity Research


April 2003

We are also closely tracking unemployment trends, which have a significant bearing on the
levels of unsecured consumer net charge-offs. With the unemployment rates trending up,
we would expect to witness an increase in credit card delinquencies and potentially net
charge-offs. Nevertheless, recent credit card master trust trends (which are reported on a
monthly basis) appear to have been somewhat benign with limited increases in
bankruptcies and net charge-offs.

Purchasing managers index remains important to gauging potential expansion within the
business sector and thus the potential for increased loan demand. In our assessment,
overcapacity remains high within the corporate sector, thus corporate demand is hard to
recognize. The most recent ISM Manufacturing data was very weak at 46.2, indicating
corporate contraction.

Exhibits 3,4,5,6

MARKET FLOWS
Bank Deposit Flows Weekly Change Taxable Bond Fund Flows Weekly Change
4 Week Moving Average (Billions) 4 Week Moving Average (Billions)
$150 $3.5

$3.0

$100
$2.5

$2.0
$50
$1.5

$1.0
$0
$0.5

$0.0
($50)

($0.5)

($100) ($1.0)
2/2/00

4/2/00

6/2/00

8/2/00

2/2/01

4/2/01

6/2/01

8/2/01

2/2/02

4/2/02

6/2/02

8/2/02

2/2/03
10/2/00

12/2/00

10/2/01

12/2/01

10/2/02

12/2/02

8/ 2/00

10/2/00

12/2/00

2/ 2/01

4/ 2/01

6/ 2/01

8/ 2/01

10/2/01

12/2/01

2/ 2/02

4/ 2/02

6/ 2/02

8/ 2/02

10/2/02

12/2/02

2/ 2/03
Source: U.S. Bancorp Piper Jaffray and Federal Reserve. As of February 26, 2003. Source: U.S. Bancorp Piper Jaffray Fundamental Market Strategy Group and AMG Data. As of March 5, 2003.

Money Markets Fund Flows Weekly Change Equities Fund Flows - Weekly Change
4 Week Moving Average (Billions) 4 Week Moving Average (Billions)
$50 $10

$8
$40
$6
$30
$4

$20 $2

$10 $0

($2)
$0
($4)
($10)
($6)
($20)
($8)

($30) ($10)
1/26/00
2/26/00
3/26/00
4/26/00
5/26/00
6/26/00
7/26/00
8/26/00
9/26/00

1/26/01
2/26/01
3/26/01
4/26/01
5/26/01
6/26/01
7/26/01
8/26/01
9/26/01

1/26/02
2/26/02
3/26/02
4/26/02
5/26/02
6/26/02
7/26/02
8/26/02
9/26/02

1/26/03
2/26/03
1/26/00
2/26/00
3/26/00
4/26/00
5/26/00
6/26/00
7/26/00
8/26/00
9/26/00

1/26/01
2/26/01
3/26/01
4/26/01
5/26/01
6/26/01
7/26/01
8/26/01
9/26/01

1/26/02
2/26/02
3/26/02
4/26/02
5/26/02
6/26/02
7/26/02
8/26/02
9/26/02

1/26/03
2/26/03

10/26/00
11/26/00
12/26/00

10/26/01
11/26/01
12/26/01

10/26/02
11/26/02
12/26/02
10/26/00
11/26/00
12/26/00

10/26/01
11/26/01
12/26/01

10/26/02
11/26/02
12/26/02

Source: U.S. Bancorp Piper Jaffray Fundamental Market Strategy Group and AMG Data. As of March 5, 2003. Source: U.S. Bancorp Piper Jaffray Fundamental Market Strategy Group and AMG Data. As of March 5, 2003.

U.S. Bancorp Piper Jaffray Equity Research Large Commercial Banks | 7


April 2003

Money flows include the levels of deposits, equities, and money markets on an aggregate
basis, and willingness of investors to invest in each of these categories (see Exhibits 3-6).
Many bank stock investors anticipate that with any improvement in the equities markets
we may witness a material outflow of bank deposits. In response, we would anticipate
deposit growth slowing to around 3.0%-4.0% when retail equity dollars flow back into
the stock market; however, several other events such as increased loan growth and higher
rates may precede that trend. Bank deposits grew by 5.5% on average throughout the last
ten years versus a current growth rate of 5.9% year over year.

Dials And Needles We usually begin a commercial banking model with assumptions regarding loan and asset
What Is Really Important growth. Our loan growth assumptions rely somewhat on historical economic growth
When Modeling levels within a given marketplace, plus an additional 1-2 percentage points of growth (i.e.,
5%-7% loan growth) (see Exhibit 7). This general loan growth rule can also be broken
down into economic and interest rate cycle assumptions. Loans can generally be slotted
into four broad categories including mortgages, consumer loans, business loans, and
commercial real estate.

Exhibit 7

EXAMPLE 1: BALANCE SHEET


2002 2003E % Chg 2002 2003E % Chg.
Investment Securities $130.0 $136.5 5.0% Deposits $170.0 $179.4 5.5%
Loans 150.0 159.0 6.0% Borrowings 110.0 115.5 5.0%
Other Assets 20.0 20.4 2.0% Equity Capital 20.0 21.1 5.2%
Total Asset $300.0 $315.9 5.3% Total Liab. & Eq. $300.0 $315.9 5.3%

Source: U.S. Bancorp Piper Jaffray


Note: Some figures may not add up due to rounding.

Over the last 18 months business loans (or commercial and industrial) have been declining
due to limited demand and tighter underwriting standards. In contrast, mortgage loans
including first and second liens have been expanding rapidly, reflecting much lower U.S.
interest rates. We would anticipate these trends to reverse themselves at some point over
the next 12 to 18 months.

Investment securities comprise the bulk of a banks remaining average earning assets and
are primarily composed of government and mortgaged-backed bonds. Average earning
asset levels are somewhat a function of loan growth, and the opportunity to leverage
deposit growth and any underutilized capital.

8 | Large Commercial Banks U.S. Bancorp Piper Jaffray Equity Research


April 2003

Investment securities and loans provide an asset yield, which combined with balances
results in interest income, and eventually to the income statement item, net interest
income, at commercial banks. Banks typically charge an upfront fee as well as ongoing
interest rate to the borrower, which can range anywhere from 2%-3% on large, highly
rated commercial credits to 12% on credit card loans, and can either be a fixed or floating
interest rate priced off of a standardized rate. Over the last ten years, banks have
securitized or packaged a large percentage of credit card and mortgage balances, thus
removing them from the reported balance sheet. However, in recent months banks have
temporarily reversed this trend, maintaining loans on the balance sheet, given an
opportunity to fund these loans with abnormally cheap deposits.

Exhibit 8

EXAMPLE 2: AVERAGE BALANCE SHEET


Average Yields/ Interest Average Yields/ Interest
Balance Rates Income Balance Rates Expense
Securities $50 5.00% $2.5 Deposits $150 3.00% $4.5
Loans 180 7.00% 12.6 Borrowings 75 4.00% 3.0
Earning Assets $230 6.57% $15.1 Bearing Liabilities $225 3.33% $7.5
Other Assets 10 Equity 15
Total Assets $240 Total Liab. & Eq. $240

Net Interest Income (NII) $7.6


Net Interest Margin (NIM) 3.30%
Interest Rate Spread 3.23%

Calculations: $15.1 - $7.5 = $7.6


$7.6 / $230 = 3.30%
6.57% - 3.33% = 3.23%

Source: U.S. Bancorp Piper Jaffray


Note: Some figures may not add up due to rounding.

Bank deposits and wholesale funding typically provide the bulk of financing for average
earning asset growth at commercial banks and are considered costs, which when combined
with balances results in interest expense and eventually the income statement item, net
interest income. The difference between interest income and interest expense is typically
called spread income (see Exhibit 8).

Over the last two years, interest yields and costs have been declining rapidly, given a
significant reduction in interest rates within the U.S. market. In fact, over this period the
Fed funds rate has declined by 525 basis points to 125 basis points currently, while the
long bond has declined by 115 basis points as of March 26. The short end of the yield
curve (see Exhibit 9), namely, 3-month, one- and two-year money, has reached 40-year
historical lows. As a result, deposit rates have hit near historical lows, while short-term
wholesale funding has declined as well.

U.S. Bancorp Piper Jaffray Equity Research Large Commercial Banks | 9


April 2003

Exhibit 9

3-MONTH T-BILL VERSUS 10-YEAR U.S. TREASURY HISTORICAL SPREAD


Basis Points Monthly Historical Data
400

350 Mar-03 Latest


251 basis points
300

250 Aug-00 Recent Low


153 basis points
200

150 50-year average of


131 basis points
100

50

0
Dec-00 Low
(50)
Negative 70 basis points
(100)
Jan-90

Jan-91

Jan-92

Jan-93

Jan-94

Jan-95

Jan-96

Jan-97

Jan-98

Jan-99

Jan-00

Jan-01

Jan-02

Jan-03
Source: Federal Reserve and ILX
Note: As of March 12, 2003.

An income statement item, net interest income is a function of the level of average earning
assets multiplied by the net interest margin (see Exhibit 10 for calculation). The net
interest margin is a function of balance sheet balances, yields, and costs. Historically, net
interest margins have demonstrated a significant correlation to the steepness of the yield
curve, as well as to absolute levels of interest rates. Banks have traditionally lent out
funds on a longer-term basis and borrowed funds at short-term rates, allowing them to
benefit from the spread or a steep yield curve. And although the yield curve is still
relatively steep (i.e., favorable) by historical standards, rates have fallen so significantly
that banks are unlikely to benefit from further rate reductions. A banks ability to manage
through fluctuations in interest rates is called asset-liability or interest rate risk
management. Larger banks often use off- balance sheet instruments such as swaps to more
effectively manage rate risks.

10 | Large Commercial Banks U.S. Bancorp Piper Jaffray Equity Research


April 2003

Exhibit 10

EXAMPLE 3: INCOME STATEMENT


Average Earning Assets $250
x Net Interest Margin (NIM) 3.60%
= Net Interest Income (NII) $9.0

+ Net Interest Income $9.0


- Loan Loss Provision 1.0
+ Noninterest Income 5.0
- Noninterest Expense 7.0
= Income before Taxes 6.0
- Taxes (35%) 2.1
= Net Income $3.9

Key Income Statement Stats:


Total Revenue = NII + Nonint. Inc. = $14.0
Nonint. Inc. / Total Revenue = 35.7%
Efficiency = Nonint. Exp. / Ttl. Rev. = 50.0%

Source: U.S. Bancorp Piper Jaffray


Note: Some figures may not add up due to rounding.

Net interest income often contributes between 20% and 60% of a banks total revenues
with smaller banks usually experiencing the higher percentages of net interest income.
During the 1990s many larger banking organizations sought to diversify away from
spread-based revenues by acquiring investment banks, asset managers, and processing,
given concern over the competitive nature of traditional spread-based banking.

Loans And Credit Quality Historically, credit quality (or asset quality) has been the biggest area of potential risks at
U.S. commercial banks. And unfortunately, investors have few ways in which to analyze
the quality of an individual loan portfolio other than to rely on bank examiners and rating
agencies. The regulatory statements, including the FRY-9C, Call Report, and SEC
quarterly filings, are often the best source of credit-related information. Banks seldom
willingly discuss specific credits within their portfolio, given requirements of client
confidentiality.

The Loan Review Process What Is Behind The Scenes. A commercial loan is usually
reviewed by an internal review committee to determine a borrowers ability to repay loan
balances and make interest payments on an ongoing basis. Under a scenario in which a
borrowers ability to meet future obligations is questioned, a loan might be placed on an
internal credit watch list. These loans might then fall delinquent on payment of interest
and at some point be placed on nonaccrual status, which is to stop accruing interest
payments and is usually 90 days or more past due. Management must make a judgment
at some point regarding how collateral for the loan might cover claims in a situation in
which the borrowing company ceases to be an ongoing entity. For instance, if collateral in
a building is worth $125,000 and the loan is for $150,000, there is a chance the bank
may provision $25,000 of the loan. When the borrower ceases to make payments on the
loan, this could result in net charge-offs or a write-down on the $25,000 difference.

U.S. Bancorp Piper Jaffray Equity Research Large Commercial Banks | 11


April 2003

Nonperforming Assets, Delinquencies And Charge-Offs When analyzing publicly


available financial statements, we often focus on levels and growth in nonperforming
assets, or those assets which are no longer accruing interest and/or more than 90 days
delinquent. We also review delinquency trends within the portfolio, or when a borrower
becomes past-due on the loan payments. And finally, we analyze net charge-off trends
within the portfolio, or those loans that are written down and off the balance sheet.
Another indicator of problem loans that banks will sometimes discuss with investors is the
watch list, which is a broader definition of troubled loans than nonperforming assets and
is an early indicator of potential credit problems.

Exhibit 11

EXAMPLE 4: CREDIT QUALITY


Beginning Reserves $25
Charge-offs 5
Recoveries 1
- Net Charge-offs $4
+ Loan Loss Provision 4
Ending Reserves $25

Nonperforming Loans (NPLs) $195


+ OREO (other real estate owned) 1
= Nonperforming Assets (NPAs) $196

Key Credit Quality Ratios:


Net Charge-Off Ratio = Net Charge-Offs / Avg. Loans
Reserves Ratio = Reserves / End of Period Loans

Source: U.S. Bancorp Piper Jaffray


Note: Some figures may not add up due to rounding.

The accounting methodology for loan loss reserves is somewhat complicated (see Exhibit
11). The allowance for loan loss reserves is a contra-asset account, similar to an allowance
for bad debt account. Provisions for loan losses are run through the income statement to
establish this account. Banks usually begin to reserve for losses when there is some
potential for loss, and then begin to charge them off (remove them from the balance sheet)
when there is a reasonable doubt of collection in full. Banks often match provisions and
net charge-offs to maintain a constant level of loan loss reserves.

To analyze reserve adequacy, we focus on reserves as a percentage of total loans the


reserve ratio for consumer banks, and reserves-to-nonperforming loans when reviewing
commercial loan losses. The reserve ratio is more crucial for consumer-oriented portfolios
because these loans are generally underwritten with some anticipation of loss and can be
fully charged off (i.e., credit cards) without being placed on nonperforming status. In
contrast, commercial loans usually have some collateral support and are much lumpier in
nature.

12 | Large Commercial Banks U.S. Bancorp Piper Jaffray Equity Research


April 2003

Commercial loans, or business loans, have been the source of the biggest credit problems
within the banking space over the last three years. Commercial loans and unused credit
lines can be used for a variety of purposes but are often used to support working capital
and capital investment needs. Over the past two years, levels of commercial loans have
declined significantly on a national basis, given both lack of supply and demand by
borrowers.

In our assessment, supply has been constricted as many larger banks pulled back after
experiencing significantly higher-than-normal net charge-offs on large credits. Shared
national credits (SNC), or those large loans originated by a lead lender and then
syndicated to a group of participants usually to either other domestic and foreign banks
or insurance companies have experienced the most deterioration. Currently, the SNC
market is very weak with few participants willing to accept risk without a significantly
higher-than-normal reward, i.e., interest rate or collateral support. Over the next year,
most large banks plan on further reducing their exposure to the large corporate loan
market.

We view the SNC market as increasingly synonymous with the fixed income, or bond
market, in both maturity and interest rates charged. Many of the larger banks are active
in providing both services to their customers. Although certainly the syndicate market is
damaged near term, we do not believe the impact is permanent; and when lending does
reaccelerate there will be opportunities for growth at more reasonable returns. Many
larger banks including FleetBoston, J.P. Morgan Chase, Citigroup, Bank One, and Bank of
America are experiencing commercial net charge-off ratios as a percentage of loans in the
1.00% to 2.00% range versus a more normal 40 to 60 basis points.

In our judgment, most of the commercial loan weakness at large banks over the last two
years has been associated with the large new economy exposures, such as telecom,
technology, cable, and merchant energy loans. Going forward, we would also be
somewhat cautious on large automobile, trucking, and airline industry exposures reflecting
a slight slowing in the broader economy. In contrast, the small and middle market loan
environments have not experienced the same levels of credit quality deterioration and
appear to be recovering somewhat from weak demand levels.

Consumer loans include a broad variety of credits including home mortgages, home equity,
credit cards, and personal loans (i.e., purchase of boats, cars, etc.). Most banks have been
significantly increasing exposure to the consumer (see Exhibits 12 & 13), given what have
historically been more benign loss characteristics and a more annuity-like loss pattern,
which is dissimilar to generally lumpy commercial loan losses. Further, there is a well-
developed securitization market for mortgages and credit cards. In addition, the regulators
require less capital be placed against mortgages remaining on the books.

U.S. Bancorp Piper Jaffray Equity Research Large Commercial Banks | 13


April 2003

Exhibits 12,13

Total Home Equity Outstanding And Committed With


Growth Rates, 1991 - 2003E
500,000 40%

Total Home Equity 38%


450,000
35%
Y/Y Growth Rate
400,000
30%
350,000
25% 25% 25% 25%
Total HE Lines (Mil.)

Growth Rate (%)


23% 25%
300,000
20%
250,000 19% 20%
18%
16% 20% 20%
200,000
15%

150,000
10%
100,000

5%
50,000

- 0%
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 09/02 2003E
Note: Estimated historic data for Charter One pre-97 and TCF Financial pre-96.
Source: Regulatory data from SNL DataSource and U.S. Bancorp Piper Jaffray estimates.

Revolving Consumer Credit Outstanding


Monthly Data, 1990 To Date

Revolving Consumer Credit Outstanding ($ Bn)


$800 25%
Year-Over-Year Growth Rate

20%
$600

15%

$400

10%

$200
5%
Jan-03 $729 Bn
YoY %chg. 2.3%

$- 0%
Jan-90

Jan-91

Jan-92

Jan-93

Jan-94

Jan-95

Jan-96

Jan-97

Jan-98

Jan-99

Jan-00

Jan-01

Jan-02

Jan-03

Source: Federal Reserve.

Consumer loan growth has continued somewhat unabated throughout the last decade.
Mortgage lending in particular has expanded dramatically in the last two years, given a
significant decline in mortgage rates. Although levels of personal debt as a percentage of
income have increased dramatically, debt-servicing costs have remained steady given lower
interest rates and increased income (see report published in April 2003, Bank Stocks and
the Housing Bubble).

14 | Large Commercial Banks U.S. Bancorp Piper Jaffray Equity Research


April 2003

Nevertheless, consumer loans are not without risk. We generally watch personal income,
unemployment trends, and housing values within specific markets to judge potential for
deterioration in loan quality. Additionally, we believe regulators may be somewhat
uncomfortable with recent growth in sub-prime loan exposures. In response, the FFIEC
released guidelines (dated January 8, 2003) in which all loans with a FICO score of under
660 are considered sub-prime. Although we view this as a somewhat arbitrarily
determined high hurdle, it effectively dampens growth of exposures to this sector of the
market.

We are closely monitoring developments in the San Francisco Bay Area housing market, as
perhaps a barometer for how higher unemployment (see Exhibit 14), reductions in
personal income, and interest rates may negatively impact housing values. So far, housing
values have held up reasonably well since 2001, despite a 400 basis point increase in
unemployment on average, and pressure in personal income within that market.

Exhibit 14

SAN FRANCISCO BAY AREA UNEMPLOYMENT RATE


7.5%

6.3%
5.9%6.1% 6.1%
5.3% 5.2% 5.2%
4.9%
4.4% 4.5% 4.4%
4.2%
3.6% 3.7%
3.4% 3.4%
2.8%

San San Mateo Santa Alameda Contra Marin Sonoma Napa Solano
Francisco Clara Costa

December-01 December-02

Source: Grubb & Ellis Research & Advisory Services.

Revenue Components Total revenue, which is the sum of net interest income and noninterest income, typically
grows anywhere from 4%-9%. We expect net interest revenues to expand by 2%-4% in
most cases on a normal basis, while fee-based revenues expand by 8%-12%. Overall, fees
as a percentage of total revenues expanded to a peak of 56% of revenues in 1999 for the
top 10 banks, up from only 41% of total revenues in 1990, partially reflecting a
significant drive to exit low-return, high-risk traditional banking and expand in fee-based
businesses.

Usually the biggest component of fee-based revenue at commercial banks is service charges
on deposits, which include checking account fees, overdraft fees, monthly service fees,
usage fees, etc. In general, service charge fee growth has kept up with accelerated deposit
growth over the last three to five years. In fact, improving customer service has recently
resulted in service-charge growth outstripping deposit growth.
U.S. Bancorp Piper Jaffray Equity Research Large Commercial Banks | 15
April 2003

Investment banking fees, or noninterest income, is highly reliant upon the type of
investment banking done at an individual organization. Loan syndications are a big part
of a commercial banks revenue stream as well as fixed income issuance and M&A
activity. Citigroup remains the only large bank with meaningful exposure to the equities
issuance business.

Trading fees at commercial banks have been highly geared toward foreign exchange,
derivatives, and fixed income. These products can often be cross-sold easily to larger
corporate banking clients.

Asset management fees are usually somewhat related to aggregate investment levels,
including equity prices. These fees can either be coincident in revaluation against the
market or lag the market impact, depending upon the asset management pricing structures
at these organizations. Over the last two years, we have witnessed a steady outflow from
the higher-margin equity products and into lower-yielding fixed income portfolios at many
of the commercial banks we follow.

Commercial banks have also aggressively entered the insurance agency business over the
last few years, recognizing a consolidation opportunity as well as cross-selling primarily
for the corporate client base. The biggest insurance agencies within the banking space
include Wells Fargo and BB&T.

Securities gains and loan sales have been contributing a larger percentage of total revenues
over the last few years, which could be construed as poor quality; however, most
organizations still have ample capital and securities gains to address any shortfalls. In fact,
we estimate that the top 10 banks could boost EPS by between 1% and 52% by taking
securities gains as of December 31, 2002. Most of these gains are attributable to the
extended rally in the 10-year Treasury, when many banks have significant government
bond portfolios.

Noninterest Expenses Expense management usually takes on two different dimensions at commercial banks
including synergies related to merger savings, or improvement of processes/six sigma
efforts. The typical banks nonintrust expense base expands by 3%-6% with most
variation tied to incentive compensation structures in the capital markets and investment
management business, as well as any acceleration in branch office openings or technology
expenditures. Typically, salaries and compensation expands by 4%-5% per year,
occupancy by 2%-3%, and technology by 7%-10%.

16 | Large Commercial Banks U.S. Bancorp Piper Jaffray Equity Research


April 2003

Exhibit 15

EXAMPLE 5: NON-INTEREST EXPENSES


2002 2003E % Chg
Net Interest Income $50.0 $54.0 8.0%
Noninterest Income 50.0 55.0 10.0%
Total Revenues $100.0 $109.0 9.0%

Noninterest Expenses $50.0 $52.5 5.0%

Key I/S Ratios:


Efficiency Ratio 50.0% 48.2%
Operating Leverage NA 400bps

Calculations 2003E:
Efficiency = Nonint. Exp. / Ttl. Rev. = 48.2%
Operating Leverage =
Rev.-Exp. Growth Spread = 9.0% - 5.0% = 400bps

Source: U.S. Bancorp Piper Jaffray


Note: Some figures may not add up due to rounding.

The efficiency ratio, or overhead ratio, is one of the analyst communitys standard expense
management measurements and is defined as expenses as a percentage of total revenues.
We tend to focus on any declining trend in this ratio as a positive contributor to earnings
leverage (see Exhibit 15). Among those businesses with the highest or worst efficiency
ratios are asset managers (70%-90%), followed in descending order by investment
banking (70%-75%), retail (60%-65%), commercial (45%-50%), thrifts/mortgage
banking (40%-50%), and credit cards (30%-40%). The discrepancy in these ratios has
very little to do with pretax profit margins or returns on equity, given differences in
compensation as well as required regulatory capital to conduct various businesses.

As an example of banks relatively conservative accounting, a majority of the banks we


follow have decided to begin expensing stock options and conservatively adjusting pension
plan return assumptions for 2003 and beyond. In fact, S&P estimates only a 7% negative
impact to EPS for financial services companies from adjustments, while the adjustments
for Corporate America are an average of 31%.

Historically, many banks have posted significant restructuring and merger-related charges
throughout the last 10 years, which have been steadily increasing as a percentage of
earnings among the top 50 banks.

U.S. Bancorp Piper Jaffray Equity Research Large Commercial Banks | 17


April 2003

Capital Risk-based capital guidelines were created during the early 90s, primarily as a result of
concerns over safety and soundness within the U.S. banking system. Many savings and
loans defaulted and were taken over by the government, due to excessive exposure to real
estate. Congress and regulators considered this deteration to be the result of a somewhat
poor calculation of the riskiness of selected assets on the balance sheet combined with
insufficient capital.

Exhibit 16

REGULATORY CAPITAL REQUIREMENTS

Ttl. Capital Tier 1 Leverage


Well Capitalized >=10% >=6% >=5%
Adequately Capitalized >=8% >=4% >=4%
Undercapitalized Neither Well nor Adequately Capitalized

Source: FDIC.

In our judgment, the two most important capital ratios to focus on at U.S. Commercial
banks are the tangible common equity and tier 1 capital ratio. Failure to meet certain
minimum capital requirements (see Exhibit 16) can trigger corrective regulatory action.
Rating agencies usually pay close attention to tier 1 capital for the larger banks and
tangible common equity for the smaller banks (see Exhibit 17).

There is significant excess capital within the banking system estimated at almost $60
billion, using a tangible common equity cutoff of 5.5%. Consequently, we have not
witnessed a significant round of capital raising for commercial banks since the 1990-1992
time frame when many banks were emerging from severe commercial real estate-related
credit problems.

18 | Large Commercial Banks U.S. Bancorp Piper Jaffray Equity Research


April 2003

Exhibit 17

EXAMPLE 6: COMPONENTS OF CAPITAL


Total Assets (TA) $1,100
Risk-Weight 64%
Risk-Weighted Assets (RWA) $700

Common Equity (CE) $85


- Goodwill & Other Adj. (GW) 25
Tier 1 Capital $60
+ Tier 2 Capital 20
Total Capital $80

Key Capital Ratios:


Common Equity 7.73%
Tangible Common Equity 5.58%
Tier 1 Ratio 8.57%
Total Capital 11.43%
Leverage Ratio 5.58%

Calculations:
Common Equity = CE / TA
Tangible CE = (CE - GW) / (TA - GW)
Tier 1 Ratio = Tier 1 Capital / RWA
Total Capital = Tier 1 and Tier 2 / RWA
Est. Leverage Ratio = Tier 1 Capital / (TA - GW)

Source: U.S. Bancorp Piper Jaffray


Note: Some figures may not add up due to rounding.

Tier 1 capital which is a regulatory definition includes common stockholders equity,


qualifying preferred stock and trust preferred securities, less goodwill and certain other
deductions. Tier 2 capital includes preferred stock not qualifying as Tier 1 capital,
subordinated debt, the allowance for loan losses, and net unrealized gains on marketable
securities. Total capital includes Tier 1 and Tier 2 capital.

Risk-weighted assets used when calculating Tier 1 and total capital ratios measures the
risk included in the balance sheet, as one of four risk weights (0%, 20%, 50%, 100%) is
applied to the different balance sheet and off-balance sheet assets based on the credit risk
of the counterparty. For instance, claims guaranteed by the U.S. government are risk-
weighted at 0% while commercial real estate loans are weighted at 100%.

The leverage ratio somewhat considered similar to the tangible common equity ratio
consists of Tier 1 capital divided by quarterly average total assets, excluding goodwill and
certain other items.

U.S. Bancorp Piper Jaffray Equity Research Large Commercial Banks | 19


April 2003

Exhibit 18

TOP 50 BANKS BENCHMARK AVERAGES FOURTH QUARTER 2002


Avg. Avg.
Growth Seq. Y/Y
Loan Growth 2% 5%
Deposit Growth 4% 9%
Revenue Growth 4% 10%
Non-Int Exp. Growth 4% 7%
EPS Growth 4% 1%

Avg. Avg. Avg. BP Chg. BP Chg. 4Q02 Results


Avg. Stats. (%) 12/01 Q 09/02 Q 12/02 Q Seq. Y/Y High Low
NIM 4.07 4.04 3.93 -0.11 -0.13 5.43 1.22
Efficiency Ratio 55.45 55.94 56.86 0.92 1.42 79.82 31.82
ROAA 1.37 1.50 1.49 -0.01 0.11 3.20 -0.20
ROAE 15.51 16.40 16.83 0.43 1.32 42.75 -3.60
NPAs/Assets 0.56 0.61 0.57 -0.04 0.01 1.82 0.01
NCOs/Avg. Loans 0.90 0.78 0.69 -0.09 -0.21 2.88 -0.09
T. Equity/T. Assets 7.08 7.26 7.13 -0.13 0.05 12.31 3.57
Leverage Ratio 7.72 7.97 7.70 -0.27 -0.01 11.96 5.10

Source: SNL DataSource

20 | Large Commercial Banks U.S. Bancorp Piper Jaffray Equity Research


April 2003

VALUATION METHODS

The methods for valuing stocks within the broader sell-side analytical community have
gone through a major change throughout the last 10 years with little impact on how we
value bank stocks. More specifically, we have consistently utilized price-to-earnings, price-
to-book, P/E to secular growth, and dividend yield measurements as a way to determine
relative value against the market and against peer commercial banks. Counting eyeballs
and forecasting web hits or even measuring price to revenues for that matter have
seldom proven to be useful exercises within the bank stock investing space.

During the mid-1990s, traditional commercial banks sold at higher P/Es and P/Bs than
brokers and asset managers; however, that changed dramatically throughout the late
1990s as the market rewarded significant growth and higher returns on equity with bigger
P/Es and P/Bs. The bubble in the equity markets throughout the late 1970s fed this
growth.

Price-To-Earnings In our assessment, the price-to-earnings (P/E) ratio continues to be the primary method by
which to value traditional bank stocks. We can use the price-to-earnings ratio fairly freely,
adjusting for some level of uncertainty in future earnings. Banks that have experienced the
most significant reductions to consensus earnings throughout the last two years and may
experience further reductions should sell at a discount, while those that have experienced
limited impact should sell at a premium (see Exhibit 18).

Exhibit 19

2003 HISTORICAL CONSENSUS ESTIMATES, MARCH 2001-MARCH 2003


1-Yr. 2-Yr.
Ticker Mar-01 Jun-01 Sep-01 Dec-01 Mar-02 Jun-02 Sep-02 Dec-02 Mar-03 % Chg. % Chg.
Large-Cap Banks
WFC (#=) $3.90 $3.75 $3.58 $3.55 $3.64 $3.67 $3.69 $3.64 $3.64 0% -7%
BAC (#=) 5.50 5.65 5.84 6.13 6.27 6.30 6.27 6.21 6.19 -1% 13%
ONE (#>=) NA 3.53 3.12 3.13 3.13 3.14 3.14 3.07 3.06 -2% NA
WB (#@=) 3.08 3.05 3.33 3.18 3.13 3.14 3.10 3.03 3.00 -4% -3%
C (#@>) NA NA 3.70 3.76 3.75 3.73 3.42 3.30 3.25 -13% NA
STT (#=) 2.80 2.76 2.72 2.53 2.56 2.52 2.47 2.36 2.00 -22% -29%
NTRS (#) NA NA 2.92 2.77 2.72 2.61 2.43 2.16 1.93 -29% NA
BK (#=) 2.81 2.80 2.57 2.64 2.47 2.35 2.26 1.86 1.75 -29% -38%
FBF (#) NA NA 3.77 3.56 3.54 3.33 2.69 2.50 2.43 -31% NA
JPM (#>) NA NA 3.44 3.62 3.41 3.41 2.64 2.44 2.16 -37% NA
Small-Cap Banks
CBH (#>) NA NA NA $2.02 $2.13 $2.24 $2.35 $2.37 $2.43 14% NA
WTFC (#@>) NA NA NA 1.61 1.72 1.75 1.81 1.81 1.82 6% NA
TCB (#>=) NA NA NA NA 3.50 3.49 3.54 3.49 3.48 -1% NA
CFBX (#@>) 2.05 2.05 2.05 2.05 2.15 2.16 2.16 2.14 2.12 -1% 3%
SWBT (#>) 2.02 2.00 1.95 2.05 2.00 2.00 2.08 1.94 1.93 -3% -4%
GBBK (#>=) NA NA NA 2.31 2.48 2.58 2.58 2.34 1.95 -21% NA
BPFH (#>) NA NA NA NA 1.29 1.29 1.27 1.18 0.99 -23% NA
Brokers
MWD (#=) NA NA NA $4.08 $4.06 $3.85 $3.29 $3.06 $3.13 -23% NA
MER (#+=) NA NA NA NA 3.80 3.56 3.26 2.99 2.68 -29% NA
S&P 500 Index
SPX NA NA 62.50 59.59 56.04 57.32 54.39 52.80 51.82 -8% NA

Source: FactSet and Baseline


U.S. Bancorp Piper Jaffray Equity Research Large Commercial Banks | 21
April 2003

Historically, investors have begun to trade on a banks forward-year earnings sometime


during June or July of the current year. However, in recent years trading on forward-year
earnings has come earlier and earlier. In our judgment, this trend has been somewhat a
function of the broader market having little confidence in current year earnings. Last year,
the banks began trading on 2003 sometime in February/March.

PEG Ratio Generally speaking, we can also use a P/E to secular growth ratio for banks, particularly
for those that have been consistent earnings growth performers over several years. This
ratio is particularly important for smaller banks because using a simple P/E ratio may not
make much sense. In select cases, some banks should be selling higher than the market
(see Exhibit 19).

Exhibit 20

FASTEST AND MOST CONSISTENT EARNINGS GROWERS


Based on Core EPS Growth, 1990-2002

Avg. Chg. in
Avg. Annual Growth Rate 2004E
Rank Company Ticker Growth (%) (bps) PEG
1 TCF Financial Corporation (#>=) TCB 17.5 (24.7) 0.54x
2 Synovus Financial Corp. SNV 16.4 (57.2) 0.75x
3 State Street Corporation (#=) STT 15.1 (69.1) 0.86x
4 Compass Bancshares, Inc. CBSS 12.7 (73.8) 0.81x
5 City National Corporation CYN 14.5 (96.1) 0.71x
6 Zions Bancorporation ZION 14.4 (104.3) 0.65x
7 M&T Bank Corporation MTB 16.8 140.5 0.74x
8 Fifth Third Bancorp FITB 16.4 177.7 0.84x
9 SouthTrust Corporation SOTR 12.5 191.3 0.88x
10 Banknorth Group, Inc. BNK 15.8 (202.8) 0.54x
11 Union Planters Corporation UPC 12.8 (204.2) 0.71x
12 Citigroup, Inc. (#@>) C 12.7 (210.6) 0.69x
13 BB&T Corporation (#) BBT 11.8 229.2 0.84x
14 Wells Fargo & Company (#=) WFC 12.0 231.6 0.91x
15 National Commerce Financial Corp. NCF 15.3 238.4 0.74x
16 Commerce Bancorp, Inc. (#>) CBH 11.6 279.4 1.12x
17 North Fork Bancorporation, Inc. NFB 20.0 314.7 0.48x
18 Investors Financial Services Corp. IFIN 35.7 486.3 0.40x
19 Charter One Financial, Inc. (#) CF 13.2 (518.9) 0.70x
20 Bank of New York Company, Inc. (#=) BK 13.9 (598.3) 0.73x
Average Top 50 Banks by Mkt. Cap. 11.4 3.4 1.18x

Source: U.S. Bancorp Piper Jaffray, ILX, Baseline, and SNL DataSource

Price-To-Book In our assessment, price-to-book (P/B) is usually the last backstop valuation measurement
for bank stocks when all other methods fail. Under such a scenario, investors must
develop a comfort level in which the assets on the books are worth stated levels according
to GAAP. This is typically a very difficult process, given that public values for loan and
venture capital portfolios are usually difficult to determine.

Historically, price-to-book values for the banking industry have ranged from lows of close
to book value during the 1991-1992 time frame, to highs of 2 to 3 times for the regional
banks and 4 to 5 times for the processing banks during the 1999-2000 time frame.

22 | Large Commercial Banks U.S. Bancorp Piper Jaffray Equity Research


April 2003

Currently price-to-book values range from 1.0-2.0 times for most banks, while processor
price-to-books are rather high at 2.3-2.5 times. We must also weigh these ratios within the
context of the broader market. Although price-to-books are still rather high for many
banks, so are returns on equity (see Exhibit 20).

Exhibit 21

TOP-50 BANKS PRICE TO BOOK AND ROE


160% Rel. ROE
160%
Rel. Bank P/B
140%
Oct-02: 88%
120%
100%
80%
60%
60%
40%
40%
20%
20%
0%
0%
1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002
Source: U.S. Bancorp Piper Jaffray and Baseline

Some Attractive Yield The spread between bank stock dividend yields and the 10-year U.S. Treasury are
Opportunities currently as narrow as they have been at any time over the last 13 years, reaching a recent
historical low of 50 basis points versus 102 basis points in October of 2002 and 167 basis
points in October of 1990 (see Exhibit 21).

U.S. Bancorp Piper Jaffray Equity Research Large Commercial Banks | 23


April 2003

Exhibit 22

BANK STOCK DIVIDEND YIELD VERSUS 10-YEAR U.S. TREASURY


10.0

10-yr. UST
9.0 Avg. Dividend Yield Top 50 Banks

8.0 Current Spread 50 bps


Historical Average Spread 327 bps
7.0

6.0
Yields in %

5.0

4.0

3.0

2.0

1.0

-
Dec-89

Jun-90

Dec-90

Jun-91

Dec-91

Jun-92

Dec-92

Jun-93

Dec-93

Jun-94

Dec-94

Jun-95

Dec-95

Jun-96

Dec-96

Jun-97

Dec-97

Jun-98

Dec-98

Jun-99

Dec-99

Jun-00

Dec-00

Jun-01

Dec-01

Jun-02

Dec-02
Source: U.S. Bancorp Piper Jaffray, Federal Reserve, and FactSet
Note: As of March 14, 2003.

Over the last three years, credit spreads on large bank bonds with 10-year maturities have
narrowed somewhat against the 10-year Treasury to between 60 and 122 basis points,
currently from 100 and 170 basis points in December of 1999. Clearly, the implied
riskiness to bank stock capital has declined significantly.

We think these high yields represent a good opportunity to purchase bank stocks,
particularly those for which we feel relatively comfortable with the intermediate-term
earnings growth outlook. For instance, Bank of America is currently yielding 3.80% as of
March 14, 2003 versus the 10-year Treasury at 3.70%, TCF Financial is yielding 3.40%,
and Wachovia is yielding 3.10% (as of March 14, 2003) (see Exhibit 22).

24 | Large Commercial Banks U.S. Bancorp Piper Jaffray Equity Research


April 2003

Under a scenario in which the Presidents tax bill is passed and elimination of the double
taxation of dividends is supported, we would expect several banks to raise their dividend
payout ratio meaningfully. We think passage of this bill partially depends on length of war
with Iraq and the resultant deficit associated with financing it. Dividend payout ratios are
currently averaging 39% for the bank group, down from 44% in 2001 (see Exhibit 24). A
scenario of a 10% increase in the dividend payout ratio could imply immediate 15% to
20% appreciation in bank stock values when utilizing a dividend discount model.

Exhibits 23 & 24

TOP-50 BANKS (BY MARKET VALUE)


DIVIDEND YIELD AND 2002 DIVIDEND PAYOUT RATIOS
Dividend Dividend Core Dividend
Ticker Yield (%) Company Name Ticker Declared EPS Payout
JPM 6.30 J.P. Morgan Chase & Co. JPM $1.36 $1.14 119%
FBF 6.00 FleetBoston Financial Corporation FBF 1.40 1.50 93%
CMA 5.20 Comerica Incorporated (#) CMA 1.92 3.25 59%
KEY 5.20 Huntington Bancshares Incorporated HBAN 0.64 1.09 59%
UPC 5.00 Valley National Bancorp VLY 0.89 1.60 55%
ASO 4.50 Bank of New York Company, Inc. BK 0.76 1.39 55%
NCC 4.40 AmSouth Bancorporation ASO 0.89 1.66 54%
PNC 4.40 Union Planters Corporation UPC 1.33 2.53 53%
USB 4.00 Wilmington Trust Corporation WL 1.01 1.99 51%
BAC 3.80 Synovus Financial Corp. SNV 0.59 1.19 50%
RF 3.80 PNC Financial Services Group, Inc. PNC 1.92 3.94 49%
WL 3.80 Charter One Financial, Inc. CF 0.83 1.73 48%
ASBC 3.70 Fulton Financial Corporation FULT 0.59 1.23 48%
MRBK 3.70 National City Corporation (#) NCC 1.20 2.55 47%
VLY 3.70 Regions Financial Corporation RF 1.16 2.57 45%
BK 3.60 BB&T Corporation BBT 1.13 2.52 45%
BBT 3.60 U.S. Bancorp USB 0.78 1.74 45%
CBSS 3.60 Mercantile Bankshares Corporation MRBK 1.18 2.71 44%
NFB 3.60 Associated Banc-Corp ASBC 1.21 2.79 43%
HIB 3.50 First Virginia Banks, Inc. FVB 1.09 2.55 43%
HBAN 3.50 Bank of America Corporation BAC 2.44 5.70 43%
SNV 3.40 National Commerce Financial Corporation NCF 0.64 1.53 42%
TCB 3.40 Compass Bancshares, Inc. CBSS 1.00 2.41 41%
FULT 3.30 SunTrust Banks, Inc. STI 1.72 4.23 41%
SOTR 3.30 KeyCorp (#) KEY 0.90 2.26 40%
STI 3.30 Bank of Hawaii Corporation BOH 0.73 1.84 40%
FTN 3.20 North Fork Bancorporation, Inc. NFB 1.01 2.55 40%
CF 3.10 Fifth Third Bancorp FITB 0.98 2.56 38%
WB 3.10 TCF Financial Corporation TCB 1.15 3.03 38%
BNK 3.00 Wachovia Corporation WB 1.00 2.70 37%
NCF 2.90 SouthTrust Corporation SOTR 0.68 1.85 37%
FVB 2.80 First Tennessee National Corporation FTN 1.05 2.95 36%
UB 2.80 Hibernia Corporation HIB 0.57 1.61 35%
WFC 2.60 Mellon Financial Corporation MEL 0.49 1.43 34%
BOH 2.50 Northern Trust Corporation NTRS 0.68 2.04 33%
MI 2.50 Wells Fargo & Company WFC 1.10 3.37 33%
ONE 2.40 UnionBanCal Corporation (#) UB 1.09 3.46 32%
C 2.40 Bank One Corporation ONE 0.84 2.67 31%
MEL 2.40 Popular, Inc. BPOP 0.80 2.61 31%
BPOP 2.40 Commerce Bancorp, Inc. CBH 0.62 2.04 30%
NTRS 2.30 Marshall & Ilsley Corporation MI 0.63 2.20 28%
FITB 2.10 Banknorth Group, Inc. BNK 0.58 2.05 28%
ZION 2.00 Citigroup, Inc. C 0.70 2.58 27%
CYN 1.90 State Street Corporation STT 0.48 1.97 24%
CBSH 1.80 Zions Bancorporation ZION 0.80 3.53 23%
CBH 1.70 City National Corporation CYN 0.78 3.57 22%
DRL 1.70 Commerce Bancshares, Inc. CBSH 0.62 2.85 22%
MTB 1.50 M&T Bank Corporation MTB 1.05 5.07 21%
STT 1.50 Doral Financial Corporation DRL 0.42 2.63 16%
IFIN 0.30 Total: $47.42 $120.96 39%
Average: 3.21 Average: $0.97 $2.47 42%

Source: FactSet, Baseline, and SNL DataSource


Note: As of March 14, 2003.

U.S. Bancorp Piper Jaffray Equity Research Large Commercial Banks | 25


April 2003

Exhibit 25

DIVIDEND PAYOUT TOP-50 BANKS


60%
54%
51%
50%
44%
42%
39% 39%
40% 38% 38%
37% 37% 37%
35% 35%

30%

20%

10%

0%
1990 Y 1991 Y 1992 Y 1993 Y 1994 Y 1995 Y 1996 Y 1997 Y 1998 Y 1999 Y 2000 Y 2001 Y 2002 Y

Source: SNL Datasource

26 | Large Commercial Banks U.S. Bancorp Piper Jaffray Equity Research


April 2003

MEGA TRENDS
CONSOLIDATION, CREDIT QUALITY, AND NONBANKING

In our assessment, three major trends impact investing in bank stocks include
consolidation, credit quality, and exposure to nonbanking businesses. In our assessment,
the expansions into nonbanking businesses and consolidation throughout the 1990s have
recently slowed but could reaccelerate with any meaningful improvement in the economy.
Credit quality is also likely to improve with an accelerating economy.

Consolidation Large mergers within the banking industry have been commonplace throughout the last
75 years, with the most recent waves of activity occurring in the 1994-1997 and 1998
time frames. The rationale for the first waves of merger activity in the 1990s was to create
economies of scale and reduce overcapacity within the banking system.

Combinations in the first wave of mergers often included an initial year of dilution with
an anticipated cost savings (20%-50% of acquired organizations expenses taken out) in
the second year due to combining technology systems and reducing branch office overlaps.
The mega-mergers of 1998 generally involved fewer expected cost savings and were often
billed as mergers of equals (or MOEs) in which the senior managers of both firms played
nearly an equal role in the new organization. The MOE concept often proved more
difficult to execute than expected, given cultural differences.

We have now witnessed four years of declining M&A within the financial services space
(see Exhibit 25) primarily due to lack of willing sellers at reasonable prices. The takeout
multiples, namely, price-to-book and price-to-earnings, have been declining meaningfully.

Exhibit 26

BANK AND THRIFT M&A ACTIVITY


600 50%
565
M&A Deals
504 M&A Growth 40%
41.2%
500 480
463 457 462
30%
30.5%
Year-Over-Year Growth Rate
Number Of Deals Per Year

398
400 20%
20.6% 357
17.7%
305 10%
300 9.1% 281
260
0%
216 1.1%
-1.3%
189
200 -10%
-7.5%

-20%
-18.1%
100 -21.3%
-27.3% -30%
-29.2%

0 -40%
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
YTD

Source: SNL DataSource

U.S. Bancorp Piper Jaffray Equity Research Large Commercial Banks | 27


April 2003

At the same time, the basic business of banking has experienced relative strength over the
last two years, posting double-digit earnings growth per year for the industry. In our
judgment, we would have to experience a significant catalyst to encourage managements
to sell out, before takeout activity accelerates. This could include a rapid rise in interest
rates or deteriorating credit quality.

Additionally, banks must now utilize purchase method of accounting for consolidation
versus a historical performance for pooling-of-interest method. First Unions 2001
combination with Wachovia was the first major deal in the new environment.

Branching Versus Consolidation - For several years branch closings were viewed as
potential cost-saving opportunities for larger banks acquiring smaller banks with
overlapping infrastructures. This worked exceptionally well throughout the 1990s as the
acquisition environment heated up to a frenzied state in 1998. And then as the Internet
came of age, many analysts increasingly believed that the branch was dead and that the
Internet would supplant the branch infrastructure as the preferred method of banking. We
have now come full circle with many banks building out their branch networks by
opening up new offices or on a de novo basis. In Chicago alone, Bank One plans for at
least 30 new branch openings over the next two years.

As deposits have become an increasingly valuable source of funding, many banks have
increased their focus on customer retention. Historically, banks have experienced
customer turnover of anywhere between 10% and 20% of the deposit base annually,
primarily reflecting poor customer service as well as perhaps some rate shopping by the
depositors. In recent years, many of the larger banks have attempted to stop this normal
outflow by offering more competitive rates, reduced error rates, and extended branch
hours.

Credit Quality Credit quality has been one of the biggest determinants of bank stock earnings or lack
thereof throughout the last 20 years, often causing earnings shortfalls for the industry. In
contrast, prior to the 1970s, credit quality was virtually a non-event In fact, the term
nonperforming assets did not surface until shortly there after. We view the surfacing of
credit problems as a function of increased competition to bank lending, and thus the
compromise of otherwise healthy credit standards and spreads.

Perhaps one of the largest credit-related challenges for the U.S. banking industry came
during the early 1990s, when many banks were overexposed to weakening commercial
real estate (see Exhibit 26). Real estate concentrations were cited for bank failures in the
southwestern and the northeastern United States. Nonperforming assets to total assets
increased to more than 2.2% in 1991 versus current weak levels of 0.75%.

28 | Large Commercial Banks U.S. Bancorp Piper Jaffray Equity Research


April 2003

Exhibit 27

INDUSTRY NET CHARGE-OFF RATIOS


y g
in basis points FY91 FY92 FY93 FY94 FY95 FY96 FY97 FY98 FY99 FY00 FY01 9M02 Avg.
1-4 Family 23 18 29 13 8 7 7 7 10 12 17 16 14
Commercial RE 193 121 79 47 18 2 3 1 1 7 18 11 42
Commercial 152 144 83 32 13 20 29 35 44 56 114 119 70
Consumer 180 159 114 70 115 160 193 183 154 129 141 142 145
Credit Cards 444 297 252 178 247 363 477 450 406 521 603 521 396
Other Consumer 150 128 76 36 56 84 93 104 108 97 110 110 96
Other 57 2 42 53 28 31 19 21 27 19 65 74 37
Total Loans and Leases 124 98 61 34 32 38 43 43 39 41 62 65 57

Note: Top 50 banks by market cap.


Source: U.S. Bancorp Piper Jaffray and SNL DataSource (Common Regulatory Fins.)

Several of the nations largest banks, including Citicorp, were on the verge of failure in
1991, given excessive real estate concentrations. Collateral values were often well below
loan amounts, as office vacancy rates soared. Several banks were taken over by the federal
government, restructured, and sold at open bid. NationsBank and Fleet were two of the
early beneficiaries of these government-assisted transactions.

During the late 1980s, large U.S. multinational banks also suffered through an LDC (less
developed country) debt problem. Many of these weaknesses arose from a Latin American
sovereign debt binge, in which countries took on massive levels of debt to finance fiscal
programs, and then revenues failed to materialize. These issues were primarily with
governments and country restructurings as opposed to corporate or consumer borrowers,
unlike the recent shortfalls in Argentina during 2001-02 when the government effectively
defaulted, many companies went out of business, and unemployment soared.

The most pronounced weakening in recent times has been due to overexposure to telecom,
technology, and merchant energy business. In our assessment, recent credit losses have
been due primarily to loans made with inadequate collateral support, excessive exposure
concentrations, and a weakening in the equities markets. Many banks that sought to lend
to the new economy companies during the late 1990s have experienced serious loan
losses since 2000. We are currently focused on airlines and merchant-energy-related
exposure as potential areas of weakness in 2003.

Unlike commercial lending, which has gone through two or three distinct cycles during the
last 20 years, we have yet to go through an applicable consumer-based credit cycle. In fact,
it is difficult to get applicable historical consumer loss trends when we are operating in a
significantly different environment. The U.S. consumer debt has expanded to 104% of
income from 85% in 1990. We would expect consumer loan losses to peak at a higher
rate if unemployment increases significantly.

U.S. Bancorp Piper Jaffray Equity Research Large Commercial Banks | 29


April 2003

Nonbanking Trends Among the top 10 major U.S. banks, fee-related businesses generate 41% of total earnings
at U.S. commercial banks, including processing at 13%, credit cards at 11%, investment
banking at 10%, and asset management at 7% (see Exhibit 27). The traditional
commercial and consumer banking businesses contribute 59% of total earnings.

Exhibit 28

LARGE-CAP BANKS 2003E EARNINGS MIX

Cards
11%
Asset Mgmt
Non-Traditional Traditional
7%
Banking Banking
41% Retail 59%
Processing 44%
13%

Investment
Banking
10% Corporate
15%

Source: U.S. Bancorp Piper Jaffray

Investment Banking During the 1990s, commercial banks increasingly became involved in investment banking
through a loophole in the bank holding company act known as Section 20, which allowed
up to 10% of total revenues from a subsidiary to be derived from securities activity (this
limit was later raised to 25%). Upwards of 25 domestic banking organizations had some
authority to underwrite and deal in ineligible securities activities by 1995. Those
organizations at the forefront of transformation were J.P. Morgan and Bankers Trust,
which had pushed into investment banking products in the early 1990s. Several regional
banks also acquired small investment bank boutiques in 1997-98, including
NationsBanks acquisition of Montgomery, Bank of Americas purchase of Robertson
Stephens, and U.S. Bancorps acquisition of Piper Jaffray. In addition, many foreign banks
acquired U.S. investment banks including Credit Suisses purchase of DLJ Securities in the
summer of 2000, UBSs acquisition of Paine Webber, while Chase Manhattan acquired J.P.
Morgan in the summer of 2000 as well.

Since the summer of 2000 when the global equities market began to deteriorate, several
foreign banks have abandoned their U.S. capital markets efforts, while others have started
massive downsizing programs. We estimate J.P. Morgan Chase has cut roughly 45% of its
investment banking staff since the peak, while Merrill Lynch has reduced personnel by
30%. Nevertheless, securities industry employment remains somewhat high, down only
10% since reaching a peak in 2000. In our assessment, many investment banks chased a
technology issuance bubble, where tech and telecom issuance activity during 1996-2001
was nearly four times what it was compared to the previous six years.

30 | Large Commercial Banks U.S. Bancorp Piper Jaffray Equity Research


April 2003

Asset Management During the 1990s, banks became increasingly active in selling investment products or
revamping existing Trust organizations. Mellon acquired Dreyfus and PNC purchased
Blackrock. These two deals, along with an effort to cross-sell investment products
including mutual funds and annuities, were prompted by concerns that investors would
increasingly shun traditional bank savings and deposit accounts for faster growth
opportunities in the public markets. Ironically, deposit growth never slowed materially,
while investment outflows and weak equities market performance have impaired some
banking organizations ability to post up earnings quarters.

Asset management remains a potentially very attractive business for banks as they cross-
sell their deposit clients a broad array of products and services. Banks were heavily
involved in providing trust-related services during the early 1990s, but have tried to
develop groups of mutual fund families to address the needs of the retail investor.

Processing Banks have increasingly sought out processing-related acquisitions to expand their fee-
based businesses. Processing is primarily the function of handling transactions for asset
managers, money managers, pension funds, and corporations. Securities clearance,
custody, wire transfer, corporate trust, and ADRs are the most common types of
processing. And processing banks have typically attempted to cross-sell additional fee-
based products to their customers, including foreign exchange and analytical support
tools.

During the 1990s, the U.S. processing business went through a significant consolidation
phase in which several banks recognized they could not compete from an economies of
scale perspective and thus sold out to larger players. Today, Bank of New York, State
Street, and Northern Trust are among the major players in this business, while Citigroup
and J.P. Morgan Chase are also well represented. The major processing companies
continue to acquire new contracts from other financial services players, while also
competing heavily amongst each other for existing books. We view the processing
environment as exceptionally competitive (see Exhibit 28) with State Street, Northern
Trust, and Bank of New York recently paying very high prices for acquisitions.

Exhibit 29

STATE STREET INVESTOR SERVICES COMPETITIVE WINS AND LOSSES


01/01/2001 03/31/2002 04/01/2002 09/30/2002
Assets Won From Assets Lost To Assets Won From Assets Lost To
($US billions) ($US billions) ($US billions) ($US billions)
Bank of New York (#=) 67 56 8 28
Citibank (#@>) 5 83 40 1
Deutsche 86 3 7 0
J.P. Morgan Chase (#>) 123 12 21 7
Northern Trust (#) 5 4 81 2
Mellon 20 9 3 25
PFPC 161 0 1 1
All Others 181 15 40 40
Totals 648 182 201 104

Source: Company report

U.S. Bancorp Piper Jaffray Equity Research Large Commercial Banks | 31


April 2003

Processing revenues are highly dependent upon equity market values and volumes across
several markets; thus with a generally deteriorating capital markets environment, we
would expect revenues to decline also. We have significantly below-consensus estimates on
all the processor banks in 2003 and expect revenue growth to be 12% in 2003.

Credit Cards In our assessment, the credit card market is becoming increasingly competitive with fewer
and fewer players each year. Over the last five years there has been significant
consolidation with 10 players now controlling 80% of the overall market, up from 55%
in 1995 (see Exhibit 29). We think some of the monoline credit card companies could
potentially be acquired, while many marginal players continue to exit the business. In
times of economic stress, monolines have suffered as the markets become less willing to
support increased funding costs given the potential for higher credit costs.

Exhibit 30

U.S. CREDIT CARD INDUSTRY OVERVIEW


End Of Period Outstandings
($ In Billions)

Rank Company 1995 Company 4Q02


1 Citibank (#@>) $ 44.8 Citibank $ 116.6
2 Discover 27.8 MBNA 79.5
3 MBNA (#) 25.2 Bank One 74.0
4 First Chicago 17.5 Chase 50.7
5 First USA 17.4 Discover * 49.4
6 AT&T 14.1 Capital One 43.2
7 Household (#>) 12.9 Bank of America 30.7
8 Chase (#>) 12.8 Providian 19.6
9 Chemical 10.8 Household 17.0
10 Capital One (#>) 10.4 Fleet 16.2
11 Advanta 10.0 Sears (#) 12.4
12 Banc One (#>=) 9.7 Metris (#>=) 11.3
13 Bank America (#=) 9.2 Wells Fargo 11.3
14 Bank of New York (#=) 8.6 U.S. Bancorp (~+) 9.7
15 NationsBank 7.4 USAA Federal 5.4
16 First Union 5.4 First National * 3.4
17 Wells Fargo (#=) 4.9 Target (#>=) 3.3
18 Wachovia (#@=) 4.5 Advanta 2.6
19 Providian (#>) 4.5 Cross Country 1.9
20 Chevy Chase 4.3 CompuCredit 1.9
Industry Total * $ 348.6 $ 560.1

Top 10 Market Share 55% 80%

*Note: Includes Visa, MasterCard and Discover


Source: Company reports and The Nielson Report (U.S. bankcard only)

32 | Large Commercial Banks U.S. Bancorp Piper Jaffray Equity Research


April 2003

Mortgage Banking Similar to credit cards, the mortgage banking business has increasingly become
concentrated among a few large players (see Exhibit 30 & 31). This involves both the
origination of loans and servicing of mortgage portfolios. And ideally, there is an offset
between these two functions. There is a natural hedge between mortgage origination and
servicing. When the economy begins to accelerate and interest rates increase, that
generally translates into lower origination levels and higher servicing values.

Exhibits 31, 32

TOP 10 - RESIDENTIAL SERVICERS AND ORIGINATORS


(In $ Billions)
Rank Servicer 4Q02 Y/Y Chg. 4Q01 Rank Originator 4Q02 Y/Y Chg. 4Q01
1 Washington Mutual (#>+) $ 723.15 45.6% $ 496.70 1 Wells Fargo Home Mtg. $ 112.58 56.4% $ 71.97
2 Wells Fargo Home Mtg. 570.32 16.9% 487.82 2 Washington Mutual 108.60 97.7% 54.94
3 Countrywide Credit Ind. 452.41 34.4% 336.63 3 Countrywide Credit Ind. 102.10 106.5% 49.44
4 Chase Manhattan Mtg. 429.02 -0.2% 429.84 4 Chase Manhattan Mtg. 60.86 20.8% 50.40
5 Bank of America CFG RE 264.52 -11.6% 299.09 5 ABN Amro Mtg. 40.58 42.8% 28.42
6 GMAC Mortgage 198.64 3.5% 191.99 6 Bank of America Cons. RE 31.88 39.6% 22.84
7 ABN Amro Mtg. 184.46 25.9% 146.48 7 National City Mtg. 29.49 43.4% 20.57
8 National City Mortgage 123.10 38.4% 88.92 8 GMAC Mtg. 25.14 64.9% 15.25
9 Cendant Mortgage 115.85 17.3% 98.80 9 Cendant Mortgage 19.20 38.6% 13.85
10 CitiMortgage, Inc. 115.40 11.5% 103.51 10 Homecoming/GMAC-RFC 17.20 48.9% 11.55
TOP 10 Total $ 3,176.87 6.8% $ 2,973.31 TOP 10 Total $ 547.63 54.3% $ 354.96

Source: National Mortgage News

Technology And The Banks have traditionally spent anywhere from 10%-15% of total expenses on technology
Evolution each year with the bulk of the investment in maintaining existing IT systems. The
opportunity has always been to transition from spending on maintenance to spending on
R&D and enhancing the customer experience. For instance, banks are currently investing
incremental dollars in data warehousing and intelligence software. Some have recently
outsourced technology programs to such companies as IBM and EDS (#).

Turning back the clocks to 1999, there was a time when the Internet was the dominant
investment theme within the equity markets that some banks were quick to adopt. For
instance, Bank One developed a stand-alone Internet channel called Wingspan given
fears that the Internet might disintermediate existing pricing for bank customers. In
contrast, better run organizations such as Wells Fargo continually stressed the Internet as
just one more distribution channel used to enhance the customer experience. Today,
roughly a third of Wells Fargos customers are using online banking services, of which
about 30% pay bills online. In our assessment, those customers with bill payment
capabilities are less likely to leave the bank.

U.S. Bancorp Piper Jaffray Equity Research Large Commercial Banks | 33


April 2003

HISTORY OF BANKING

Regulatory And In our assessment, banks are once again becoming subjected to increased levels of scrutiny
Legislative History The by regulators and legislators after experiencing several years of positive regulatory
Pendulum Swings Back developments. More specifically, increased attention has come from state attorney general
offices in New York and California, while the state of Massachusetts attempts to
retroactively tax banks located in that state. On the national level, the regulators have
recently created tactical rules, such as curtailing marketing programs to sub-prime
credit card clients.

Throughout the last 100 years legislators have sought to improve the safety and soundness
of the banking system by enhancing regulations. Occasionally, these regulatory efforts
have gone beyond reasonable, resulting in overly burdensome hindrances to free market
activity.

In exchange for a commercial banks sole ability to collect deposits comes a social
responsibility as well as immense regulatory infrastructure. The banking organization is
usually examined by at least three regulatory entities including the Federal Reserve as the
holding company inspector, the FDIC, and either the state or Office of Comptroller of the
Currency (OCC) examiners. The Federal Reserve will also usually examine state-member
banks as well.

During the early years of modern banking, significant bank failures such as those at the
turn of the twentieth century were somewhat commonplace and depositors typically lost
their entire savings. Legislators sought to add stability to both the U.S. banking system and
the domestic economy through increased regulation. The Federal Reserve System was
formed in 1913 to regulate banks, act as a lender of last resort, and create a more formal
monetary/liquidity system.

The next significant legislation was the Pepper-McFadden Act of 1927, which prohibited
national banks from establishing interstate branching networks. This act somewhat
allowed both small and large banks to flourish within their local markets without fear of
large-scale competition.

The stock market crash of 1929 was followed by numerous bank failures and the great
depression. In 1930, security affiliates of banks were sponsoring 54.4% of all new
securities issuances. There were several incidences of individual excess and fraud leading
up to the stock market crash, which resulted in creation of the somewhat misguided Glass
Steagall Act of 1933. This legislation sought to separate and limit banks investing
activities in an attempt to stabilize the banking industry. Recurring and stable returns
became significantly more important.

After several years, regulatory barriers began to slowly fade away during the second half
of the twentieth century, punctuated by the Bank Holding Company Act of 1956, the one
Bank Holding Company Act of 1970, and finally, perhaps the most important
development, the Depository Institutions Deregulation and Monetary Control Act of
1980. The Control Act phased out Regulation Q interest rate ceilings and introduced
negotiable-order-of-withdrawal (NOW) accounts so banks could compete with money
market funds for deposits.
34 | Large Commercial Banks U.S. Bancorp Piper Jaffray Equity Research
April 2003

Throughout the 1970s and 1980s banks found it increasingly difficult to compete with
nonbanks as regulatory barriers were lifted. Funding cost advantages narrowed and asset
securitization became more typical. Banks became unsheltered from nonbank competition
during the 1980s, reducing profitability and spreads in traditional corporate and consumer
businesses.

In the late 1980s, U.S. commercial banks were beset by a number of high-profile
difficulties, as loan concentrations in LDC debt and commercial real estate negatively
impacted many of the largest players in the industry. Citicorp was on the verge of failure
and was under constant regulatory watch in 1990-1991. In some ways these severe
problems may have been a function of increased competition from nonbanks and a
resultant stretch for profitability. Risk-based capital guidelines were established in January
1987 to address banks responsibility to apply certain risk weightings (or levels of capital)
to selected activities.

Also, throughout the 1990s regulatory barriers to bank consolidation began to fall. The
Riegle-Neil Interstate Banking Act of 1995 allowed banks to buy other banks across the
nation, while also phasing out banks restrictions against branching across state lines.
NationsBank went on an acquisition binge, buying Barnett Banks, Boatmens Bank, and
finally, Bank of America, to become the first truly nationwide commercial bank. The
nationwide deposit cap remains at 10%.

The year 1998 was the year of the mega-merger with combinations between NationsBank/
Bank of America, Bank One/First Chicago NBD, Citicorp/Travelers, and Wells Fargo/
Norwest. The Financial Modernization Act was passed in 2000, essentially eliminating the
walls of Glass Steagall and rubber stamping the Citicorp/Travelers merger, which included
commercial banking, investment banking, and insurance.

In our judgment, regulator influence in recent years has been more tactical in nature. We
would cite the FFIECs draconian guidance on what is considered as a sub-prime-
borrowing program (targeting borrowers with an FICO score below 660, which is still
relatively high) placed on credit card companies. Other measures include behind-the-
scenes criticism of technology and telecom exposure at the major banks (leading to several
third quarter preannouncements). Under a scenario of continued economic weakness, we
would expect some more overt moves by legislators and regulators to ensure safety and
soundness within the banking system.

U.S. Bancorp Piper Jaffray Equity Research Large Commercial Banks | 35


April 2003

DEFINITIONS

Basic Analysis

Net Interest Margin Net Interest Margin: Net Interest Income/


Average Earning Assets

Yield/ Cost Spread Yield on Earning Assets (Total Interest & Dividend
Income/Avg Earning Assets) minus Cost of Funds
(Total Interest Expense/ Average Interest-Bearing
Liabilities)

Total Equity Capital The total of perpetual preferred stock, common


stock, surplus, undivided profits and capital reserves
(net), and cumulative foreign currency translation
adjustments.

Tier 1 Capital Total equity capital - Net unrealized gains on AFS


Securities - Net unrealized loss on AFS Equity
Securities - Accumulated net gains (losses) on cash
flow hedges - Nonqualifying perpetual preferred
stock + Qualifying minority interests in consolidated
subsidiaries - Disallowed goodwill & other
intangible assets - Disallowed servicing assets &
purchased credit card relationships - Disallowed
deferred tax assets + Other additions to (deductions
from) Tier 1 capital

Equity/ Assets Total Equity (Perpetual Preferred


Stock&Surplus+Common Stock&Surplus+Retained
Earnings+Gain<Loss>AFS Securities+Cumulative
Foreign Currency Translation)/ Total Assets

Tangible Equity/ Tangible Assets Total Equity-Intangible Assets (excluding Mtg Serv
Rights)/ Total Assets-Intangible Assets (excluding Mtg
Serv Rights)

Risk-Based Capital Ratio Total Risk-Based Capital Ratio: Total Capital (Tier 1
Core Capital + Tier 2 Supplemental Capital)/ Risk-
Adjusted Assets

Tier 1 Risk-Based Ratio Tier 1 Risk Ratio: Core Capital (Tier 1)/ Risk-
Adjusted Assets

Leverage Ratio Leverage Ratio: Core Capital (Tier 1)/ Adjusted


Tangible Assets

36 | Large Commercial Banks U.S. Bancorp Piper Jaffray Equity Research


April 2003

Yield on Loans Total Interest Income on Loans (Excludes Lease


Income)/ Average Consolidated Loans (Domestic and
Foreign Office)

Yield on Total Securities Total Interest & Dividend Income on Securities/


(Debt+Eq) Average Total Securities (Debt & Equity)

Yield on Earning Assets Total Interest & Dividend Income/ Average Earning
Assets (Bal Due+Securities+Fed Funds &
Repos+Loans+Trade Assets)

Cost of Interest-Bearing Deposits Total Interest Expense on Deposits (Domestic &


Foreign Office)/ Average Interest-Bearing Deposits
(Domestic & Foreign Office)

Cost of Borrowings (Non Deposits) Total Interest Expense on Borrowings/ Average


Borrowings (Avg Interest-bearing Liabilities - Average
Interest-bearing Deposits)

Cost of Funds Total Interest Expense/ Average Interest-Bearing


Liabilities (Deposits + Fed Funds Purchased & Repos
+ Commercial Paper + Mortgage Debt + Sub Debt +
Other Borrowed Money)

Income Statement Analysis

Total Interest Income The total of interest and fee income on loans; income
from lease financing receivables; interest income on
balances due from depository institutions; interest
and dividend income on securities; interest income
from assets held in trading accounts; and interest
income on federal funds sold and securities purchased
under agreements to resell in domestic offices of the
bank and of its Edge and Agreement subsidiaries, and
in IBFs.

Total Interest Expense Total of interest expenses. Includes interest expense


on deposits; interest expense on Federal funds
purchased and securities sold under agreements to
repurchase in domestic offices of the bank and of its
Edge and Agreement subsidiaries, and in IBFs; interest
expense on demand notes issued to the U.S. Treasury
and on other borrowed money; interest expenses on
mortgage indebtedness and obligations under
capitalized leases; and interest expense on notes and
debentures subordinated to deposits.

Net Interest Income Total interest income less total interest expense.

U.S. Bancorp Piper Jaffray Equity Research Large Commercial Banks | 37


April 2003

Total Provision Expense The amount needed to make the allowance for loan
and lease losses adequate to absorb expected loan and
lease losses, based upon management's evaluation of
the bank's current loan and lease portfolio and the
amount of the provision for allocated transfer risk, if
the bank is required to maintain an allocated transfer
reserve by the International Lending Supervision Act
of 1983.

Total Noninterest Income The total of income from fiduciary activities; service
charges on deposit accounts in domestic offices;
trading gains (losses) from foreign exchange
transactions; other foreign transaction gains (losses);
gains (losses) and fees from assets held in trading
accounts; and other noninterest income.

Total Realized Gs(Ls)-Securities The net gain or loss realized during the calendar year-
to-date from the sale, exchange, redemption, or
retirement of all securities reported as held to
maturity securities and available-for-sale securities.
The realized gain or loss on a security is the difference
between the sales price (excluding interest at the
coupon rate accrued since the last interest payment
date, if any) and its amortized cost.

Total Noninterest Expense The total of salaries, employee benefits, and expenses
of premises and fixed assets and other noninterest
expense.

Income Before Income Tax & The bank's pretax operating income: Net interest
Extra Items income less provisions for loan and lease losses and
provision for allocated transfer risk and total
noninterest income plus or minus gains (losses) on
securities not held in trading accounts less total
noninterest expense.

Income Taxes The total estimated federal, state, and local, and
foreign income tax expense applicable to income
(loss) before income taxes and extraordinary items
and other adjustments, including the tax effects of
gains (losses) on securities not held in trading
accounts. Includes both the current and deferred
portions of these income taxes and tax benefits from
operating loss carrybacks realized during the
reporting period. Applicable income taxes include all
taxes based on a net amount of taxable revenues less
deductible expenses.

38 | Large Commercial Banks U.S. Bancorp Piper Jaffray Equity Research


April 2003

Income Before Extraordinary Income (loss) before Income taxes and extraordinary
Items items and other adjustments less applicable income
taxes to such income (loss).

Extraordinary Items, Net Tax Extraordinary items and other adjustments, gross of
income taxes less applicable income taxes on
extraordinary items and other adjustments.

Net Income (Loss) The sum of income (loss) before extraordinary items
and other adjustments and extraordinary items; and
other adjustments, net of income taxes.

Capital Analysis Total Equity Capital/ Average Total Assets

Tier 1 Capital Qualifying subordinated debt and redeemable


preferred stock + Cumulative perpetual preferred
stock includible in Tier 2 capital + Allowance for loan
and lease losses includible in Tier 2 capital +
Unrealized gains on AFS equity securities includible in
Tier 2 capital + Other Tier 2 capital components.

Tier 2 Capital The amount of the bank's total risk-based capital.


The amount reported in this item is the numerator of
the banks total risk-based capital ratio. Total risk-
based capital is the sum of Tier 1 and Tier 2 capital
net of all deductions. Deductions are made for
investments in banking and finance subsidiaries that
are not consolidated for regulatory capital purposes,
intentional reciprocal cross-holdings of banking
organizations' capital instruments, and other
deductions as determined by the reporting bank's
primary federal supervisory authority.

Total Capital The amount of the institution's risk-weighted assets


net of all deductions. The amount reported in this
item is the denominator of the institution's risk-based
capital ratio.

Risk Weighted Assets Leverage Ratio: Core Capital (Tier 1)/ Adjusted
Tangible Assets

Leverage Ratio Tier 1 Risk Ratio: Core Capital (Tier 1)/ Risk-
Adjusted Assets

Tier 1 Risk-Based Ratio Total Risk-Based Capital Ratio: Total Capital (Tier 1
Core Capital + Tier 2 Supplemental Capital)/ Risk-
Adjusted Assets

Risk-Based Capital Ratio Tangible Common Equity/ Tangible Assets

U.S. Bancorp Piper Jaffray Equity Research Large Commercial Banks | 39


April 2003

Balance Sheet

Cash & Balances Due The total of all noninterest-bearing balances due from
depository institutions, currency and coin, cash items
in process of collection, and unposted debits.
Includes balances due from banks in the United
States, banks in foreign countries and foreign central
banks, foreign branches of other U.S. banks, Federal
Home Loan Banks, and Federal Reserve Banks: and
the total of all interest-bearing balances due from
depository institutions and foreign central banks that
are held in offices of bank holding company or its
consolidated subsidiaries.

Fed Funds Sold & Repos The gross dollar amounts outstanding of Federal
funds sold and securities purchased under agreements
to resell.

Cash & Equivalents Total balances due from depository institutions; plus
Fed funds sold and securities purchased under
agreements to resell.

U.S. Treasury Securities All available-for-sale (AFS) and held-to-maturity


(HTM) U.S. Treasury Securities not held for trading.
AFS securities are reported at fair value while HTM
Securities are reported at amortized cost. Includes all
bills, certificates of indebtedness, notes, and bonds,
including those issued under the Separate Trading of
Registered Interest and Principal of Securities
(STRIPS) program and those that are "inflation-
indexed."

Mortgage-Backed Securities All held-to-maturity (at amortized cost) and


available-for-sale (at fair value) holdings of
certificates of participation in pools of residential
mortgages, i.e., single-class pass-through securities. A
certificate of participation in a pool of residential
mortgages represents an undivided interest in a pool
that provides the holder with a pro rata share of all
principal and interest payments on the residential
mortgages in the pool.

Other Investment Securities Total securities minus U.S. Treasury Securities and
Mortgage-backed securities.

Total Securities The total book value of all securities. Includes U.S.
Treasury securities, U.S. government agency and
corporation obligations, securities issued by states and
political subdivisions in the United States, mortgage-
backed securities, other domestic and foreign debt
securities, and all equity securities.

40 | Large Commercial Banks U.S. Bancorp Piper Jaffray Equity Research


April 2003

Total Cash & Securities Total balances due from depository institutions; plus
securities; plus Fed funds sold and securities
purchased under agreements to resell.

Gross Loans & Leases Total loans and leases plus unearned income on
loans.

Unearned Income Unearned income on consolidated loans.

Total Loans & Leases The total of loans and lease financing receivables, net
of unearned income. Includes loans secured by real
estate; loans to depository institutions; loans to
finance agricultural production and other loans to
farmers; commercial and industrial loans; acceptances
of other banks (both U.S. and foreign); loans to
individuals for household, family, and other personal
expenditures; loans to foreign governments and
official institutions; obligations of states and political
subdivisions in the United States; other loans (e.g., for
purchasing or carrying securities, and not including
consumer loans); lease financing receivables (net of
unearned income); and less any unearned income on
loans reflected in items above.

Total Reserves The total of the loan loss reserve and the transfer risk
reserve.

Net Loans & Leases Loans and leases, net of unearned income, less: the
allowance for loan and lease losses and less: the
allocated transfer risk reserve.

Trade Account Assets The fair value of assets used to (a) regularly
underwrite or deal in securities, interest rate
contracts, foreign exchange rate contracts, other off-
balance sheet commodity and equity contracts, other
financial instruments, and other assets for resale, (b)
acquire or take positions in such items principally for
the purpose of selling in the near term or otherwise
with the intent to resell in order to profit from short-
term price movements, or (c) acquire or take positions
in such items as an accommodation to customers or
for other trading purposes.

Premises & Fixed Assets The book value, less accumulated depreciation or
amortization, of all premises, equipment, furniture,
and fixtures purchased directly or acquired by means
of a capital lease. Includes premises that are actually
owned and occupied by the bank, its branches, or its
consolidated subsidiaries; leasehold improvements,
vaults, and fixed machinery and equipment;
remodeling costs to existing premises; real estate
acquired and intended to be used for future

U.S. Bancorp Piper Jaffray Equity Research Large Commercial Banks | 41


April 2003

expansion; parking lots that are used by customers or


employees of the bank, its branches, and its
consolidated subsidiaries; furniture, fixtures, and
movable equipment of the bank, its branches, and its
consolidated subsidiaries; automobiles, airplanes, and
other vehicles owned by the bank and used in the
conduct of its business; the amount of capital lease
property; and stocks and bonds issued by
nonmajority-owned corporations whose principal
activity is the ownership of land, buildings,
equipment, furniture, etc., occupied or used by the
bank.

OREO The book value, less accumulated depreciation, if any,


(Including Real Estate Held of all real estate other than bank premises owned or
for Investment) controlled by the bank and its consolidated
subsidiaries. Mortgages and other liens on such
property are not deducted. Amounts are reported net
of any applicable valuation allowances. Any
property necessary for conducting banking business is
excluded.

Investments in Subsidiaries The total amount of the institution's investments in


all subsidiaries that have not been consolidated;
associated companies; and those corporate joint
ventures, unincorporated joint ventures, general
partnerships, and limited partnerships over which the
institution exercises significant influence. Includes
loans and advances to investees and holdings of their
bonds, notes, and debentures; and the amount of the
consolidated bank's investments in real estate joint
ventures and all loans and other extensions of credit
to such joint ventures.

Mortgage Servicing Rights The carrying value of mortgage servicing rights, i.e.,
the unamortized cost of acquiring the rights to
provide servicing for mortgage loans that have been
securitized or are owned by another party, net of any
related valuation allowances.

Goodwill & Other Intangible The amount (book value) of unamortized goodwill.
This asset represents the excess of the cost of a
company over the sum of the fair value of the
tangible and identifiable intangible assets acquired
not including the fair value of liabilities assumed in a
business combination accounted for as a purchase.
The amount of goodwill reported in this item should
not be reduced by any negative goodwill. Any
negative goodwill arising from a business
combination accounted for as a purchase must also
be reported. Include the unamortized amount of
identifiable intangible assets other than purchased
mortgage servicing rights.
42 | Large Commercial Banks U.S. Bancorp Piper Jaffray Equity Research
April 2003

Other Assets The total amount of income earned, not collected on


loans; net deferred tax assets; interest-only strips
receivable (not in the form of a security) on; mortgage
loans; customers liability to the institution on
acceptances outstanding; and other financial assets.

Total Assets The total of cash and balances due from depository
institutions; interest and noninterest-bearing balances
and currency and coin; securities; Federal funds sold
and securities purchased under agreements to resell;
loans and lease financing receivables, net of unearned
income, allowance for loan and lease losses, and
allocated transfer risk reserve; assets held for trading;
premises and fixed assets; other real estate owned;
investments in unconsolidated subsidiaries and
associated companies; customers' liability to the
reporting bank on acceptances outstanding;
intangible assets; other assets.

Total Deposits All unpaid balances of money or its equivalent


received or held by a bank in the usual course of
business and for which it has given or is obligated to
give credit to a commercial checking, savings, time, or
thrift account, or which is evidenced by a deposit,
thrift, investment, or indebtedness certificate; checks
or drafts drawn against deposit accounts and certified
by the bank, or letters of credit or traveler's checks on
which the bank is primarily liable; trust funds
received or held in any department of the bank;
money received or held by a bank, or the credit given
for money or its equivalent received or held by a
bank, in the usual course of business for a special or
specific purpose, including but not limited to escrow
funds; outstanding drafts, cashier's checks, money
orders, or other officer's checks issued; other
obligations of a bank as the Board of Directors, after
consultation with the Comptroller of Currency and
the Board of Governors of the Federal Reserve
System.

Fed Funds Purchase & Repos The dollar amount outstanding of Federal funds
purchased and securities sold under agreements to
repurchase in domestic offices of the bank and of its
Edge and Agreement subsidiaries, and in IBFs.

Commercial Paper The total amount outstanding of commercial paper


issued by the reporting bank holding company or its
subsidiaries.

U.S. Bancorp Piper Jaffray Equity Research Large Commercial Banks | 43


April 2003

FHLB Advances Advances from the Federal Home Loan Bank.


Includes advances used to purchase As-Agent CDs;
reverse repurchase agreements with the FHLB; and
deferred commitment fees paid on FHLB advances.
Does not include accrued interest, and FHLB
advances that have decreased in-substance in
accordance with GAAP.

Other Borrowings Includes Demand notes issued to the U.S. Treasury;


mortgage indebtedness and obligations under
capitalized leases; and The total dollar amount
borrowed by the consolidated bank: (1) on its
promissory notes; (2) on notes and bills rediscounted;
(3) on loans sold under repurchase agreements that
mature in more than one business day and sales of
participations in pools of loans that mature in more
than one business day; (4) on loans or other assets
sold with recourse or sold in transactions in which
risk of loss or obligation for payment of principal or
interest is retained by, or may fall back upon, the
seller that must be reported as borrowings; (5) by the
creation of due bills representing the bank's receipt of
payment and similar instruments, whether
collateralized or uncollateralized; (6) from Federal
Reserve Banks and Federal Home Loan Banks; (7)
by overdrawing "due from" balances with depository
institutions, except overdrafts arising in connection
with checks or drafts drawn by the reporting.

Total Other Borrowings Commercial Paper + Advances from FHLB + All


Other Borrowings

Trading Liabilities The dollar amount of liabilities from the bank's


trading activities. Include liabilities resulting from
sales of assets that the bank does not own and
revaluation losses from the "marking to market" (or
the lower of cost or market") of interest rate, foreign
exchange rate, and other off-balance sheet
commodity and equity contracts into which the bank
has entered for trading, dealer, customer
accommodation, and similar purposes.

Subordinated Debt & The amount of outstanding subordinated notes and


Mandatory Convertible Security debentures (including mandatory convertible debt).
Other Liabilities The total of all other liabilities, not elsewhere
classified. Includes interest accrued and unpaid on
deposits in domestic offices; other expenses accrued

44 | Large Commercial Banks U.S. Bancorp Piper Jaffray Equity Research


April 2003

and unpaid; net deferred income taxes, if credit


balance; and liability on acceptances executed and
outstanding. Excludes minority interest in
consolidated subsidiaries.

Total Liabilities Includes noninterest-bearing and interest-bearing


deposits held in both domestic and foreign offices;
Federal funds purchased and securities sold under
agreements to repurchase in domestic offices of the
bank and of its Edge and Agreement subsidiaries, and
IBFs; demand notes issued to the U.S. Treasury; other
borrowed money; mortgage indebtedness and
obligations under capitalized leases; the bank's
liability on acceptances executed and outstanding;
notes and debentures subordinated to deposits; and
other liabilities.
Source: SNL DataSource.

U.S. Bancorp Piper Jaffray Equity Research Large Commercial Banks | 45


April 2003

INDEX PAGE NUMBERS

Asset-Liability ............................................................................................................ 10
Asset Management Fees ............................................................................................. 16
Call Report ................................................................................................................ 11
Charge-Off ................................................................................................................ 12
Commercial Loans ..................................................................................................... 13
Consumer Loans ........................................................................................................ 13
Costs ....................................................................................................................... 9
Delinquencies ............................................................................................................. 12
Delinquency ............................................................................................................... 12
Direction of Interest Rates ............................................................................................ 5
Dividend Payout Ratio ............................................................................................... 25
Economic and Interest Rate Cycle ................................................................................. 8
Efficiency Ratio ......................................................................................................... 17
Fed Funds .................................................................................................................... 5
Fixed Income ............................................................................................................. 13
FRY-9C ..................................................................................................................... 11
High Yield Credit Spread ............................................................................................. 6
Housing Values .......................................................................................................... 15
Insurance Agency ....................................................................................................... 16
Interest Expense ......................................................................................................... 16
Interest Income ............................................................................................................ 9
Interest Rate Risk ....................................................................................................... 10
Investment Securities .................................................................................................... 8
Leverage Ratio ........................................................................................................... 19
Loan Aggregate Trends ................................................................................................ 6
Loan And Asset Growth ............................................................................................... 8
Loan Loss Reserves .................................................................................................... 12
Master Trust ................................................................................................................ 7
Money Flows ............................................................................................................... 8
Net Charge-Off Ratio ................................................................................................ 13
Net Interest Income ...................................................................................................... 9
Net Interest Margin ................................................................................................... 10
Nonaccrual Status ...................................................................................................... 11
Noninterest Expense .................................................................................................. 16
Nonperforming Assets ................................................................................................ 12
P/E to Secular Growth ................................................................................................ 22
Personal Income ......................................................................................................... 15
Price-to-Book ............................................................................................................. 22
Price-to-Earnings Ratio .............................................................................................. 21
Provisions .................................................................................................................. 12
Purchasing Managers Index .......................................................................................... 7
Risk-Based Capital ..................................................................................................... 18
Risk-Weighted Assets ................................................................................................. 19
SEC ..................................................................................................................... 11
Securitization Market ................................................................................................. 13
Securities Gains .......................................................................................................... 16
Service Charges On Deposits ...................................................................................... 15
Shared National Credits (SNC) .................................................................................. 13
Small and Middle Market .......................................................................................... 13

46 | Large Commercial Banks U.S. Bancorp Piper Jaffray Equity Research


April 2003

INDEX PAGE NUMBERS

Spread Income ............................................................................................................. 9


Sub-Prime .................................................................................................................. 15
The Reserve Ratio ...................................................................................................... 12
The Watch List .......................................................................................................... 12
Tier 1 Capital ............................................................................................................ 19
Total Revenue ............................................................................................................ 15
Trading Fees .............................................................................................................. 16
Unemployment ...................................................................................................... 7, 15
Unused Credit Lines ................................................................................................... 13
Watch List ................................................................................................................. 12
Yield ....................................................................................................................... 9
Yield Curve ................................................................................................................. 9

U.S. Bancorp Piper Jaffray Equity Research Large Commercial Banks | 47


April 2003

RATING DEFINITIONS
Investment Opinion: Investment opinions are based on each stocks return potential relative to the overall market*, not on an absolute
return.
Strong Buy: Expected to outperform the relevant broader market index over the next 6 to 12 months. An identifiable catalyst is
present to drive appreciation.
Outperform: Expected to outperform the relevant broader market index over the next 12 to 18 months.
Market Perform: Expected to perform in line with the relevant broader market index over the next 6 to 12 months.
Underperform: Expected to underperform the relevant broader market index over the next 6 to 12 months.

* Broader market indices = Russell 2000 and S&P 500

Volatility Rating:Our focus on growth companies implies that the stocks we recommend are typically more volatile than the overall stock
market. We are not recommending the suitability of a particular stock for an individual investor. Rather, it identifies the volatility of a
particular stock.
Low: The stock price has moved up or down by more than 10% in a month in fewer than 8 of the past 24 months.
Medium: The stock price has moved up or down by more than 20% in a month in fewer than 8 of the past 24 months.
High: The stock price has moved up or down by more than 20% in a month in at least 8 of the past 24 months. All IPO stocks
automatically get this volatility rating for the first 12 months of trading.

The following disclosures apply to stocks mentioned in this report if and as indicated: (#) U.S. Bancorp Piper Jaffray (USBPJ) was
making a market in the Companys securities at the time this research report was published. USBPJ may buy and sell the Companys
securities on a principal basis. (^) A USBPJ analyst who follows this Company or a member of the analysts household has a financial
interest (a long equity position) in the Companys securities. (@) Within the past 12 months, USBPJ was a managing underwriter of an
offering of, or dealer manager of a tender offer for, the Companys securities or the securities of an affiliate. (>) USBPJ has either received
compensation for investment banking services from the Company within the past 12 months or expects to receive or intends to seek
compensation within the next three months for investment banking services. (~) A USBPJ analyst who follows this Company, a member
of the analysts household, a USBPJ officer, director, or other USBPJ employee is a director and/or officer of the Company. (+) USBPJ and
its affiliates, in aggregate, beneficially own 1% or more of a class of common equity securities of the subject Company. (=) One or more
affiliates of U.S. Bancorp, the ultimate parent company of USBPJ, provided commercial banking services (including, without limitation,
loans) to the Company at the time this research report was published.

Nondeposit investment products are not insured by the FDIC, are not deposits or other obligations of or guaranteed by U.S. Bank
National Association or its affiliates, and involve investment risks, including possible loss of the principal amount invested.

USBPJ research analysts receive compensation that is, in part, based on revenues of USBPJ Equity Capital Markets which include
investment banking revenues. USBPJ research analysts who follow this Company report to the Head of Equity Research who, in turn,
reports only to the Head of Equity Capital Markets.

This material is based on data obtained from sources we deem to be reliable; it is not guaranteed as to accuracy and does not purport to
be complete. This information is not intended to be used as the primary basis of investment decisions. Because of individual client
requirements, it should not be construed as advice designed to meet the particular investment needs of any investor. It is not a
representation by us or an offer or the solicitation of an offer to sell or buy any security. Further, a security described in this release may
not be eligible for solicitation in the states in which the client resides. U.S. Bancorp and its affiliated companies, and their respective
officers or employees, or members of their families, may have a beneficial interest in the Companys securities and may purchase or sell
such positions in the open market or otherwise. This report is a communication made in the United Kingdom by U.S. Bancorp Piper
Jaffray to market counterparties or intermediate customers and is exclusively directed at such persons; it is not directed at private
customers and any investment or services to which the communication may relate will not be available to private customers. In the United
Kingdom, no persons other than a market counterparty or an intermediate customer should read or rely on any of the information in this
communication. Securities products and services offered through U.S. Bancorp Piper Jaffray, member SIPC and NYSE, Inc., a subsidiary
of U.S. Bancorp.
Gotoanalysts.com

2003 U.S. Bancorp Piper Jaffray, 800 Nicollet Mall, Suite 800, Minneapolis, Minnesota 55402-7020

Additional information is available upon request.

48 | Large Commercial Banks U.S. Bancorp Piper Jaffray Equity Research


April 2003

NOTES

U.S. Bancorp Piper Jaffray Equity Research Large Commercial Banks | 49


April 2003

NOTES

50 | Large Commercial Banks U.S. Bancorp Piper Jaffray Equity Research


April 2003

NOTES

U.S. Bancorp Piper Jaffray Equity Research Large Commercial Banks | 51


Equity Capital Markets
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Securities products and services are offered through U.S. Bancorp Piper Jaffray Inc.,
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(c)2003 U.S. Bancorp Piper Jaffray Inc., 800 Nicollet Mall, Suite 800, Minneapolis, Minnesota 55402-7020 03-0091
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Equity Capital Markets


Equity Research

MINNEAPOLIS

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Securities products and services are offered through U.S. Bancorp Piper Jaffray Inc.,
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04/03-0091 GLS