Jefferies-Bank-Primer.pdf

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COMMERCIAL BANKS A SHORT BANK STOCK PRIMER

JUNE 2006

Andrew B. Collins Senior Research Analyst 212 284-9310 [email protected]

Piper Jaffray & Co. does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decisions. This report should be read in conjunction with important disclosure information, including an attestation under Regulation Analyst Certification found on pages 52-54 of this report or at the following site: http://www.piperjaffray.com/research disclosures. Customers of Piper Jaffray in the United States can receive independent, third-party States research on the company or companies covered in this report, at no cost to them, where such research is available. Customers can access this independent research by visiting piperjaffray piperjaffray.com .com or can call 800 747-5128 to request a copy of this research.

Steven M. Truong Research Analyst 212 284-9307 [email protected] Peter A. Froehlich Research Analyst 212 284-9405 [email protected] [email protected]

H

E Q U I T Y

R E S E A R C H

June 2006

COMMERCIAL BANKS

Andrew B. Collins Senior Research Analyst 212 284-9310 [email protected]

A Short Bank Stock Primer •

Steven M. Truong Research Analyst 212 284-9307 [email protected] •

Peter A. Froehlich Research Analyst 212 284-9405 [email protected] •

•

•

The Basics Of Banking Remain Unchanged —Over Unchanged —Over the past 12 months months we have have witnessed significant pressure on the financial services sector, primarily reflecting deterioration in spreads following the sustained Fed rate campaign, which has involved 16 rate hikes in two years. We can now revisit the basics of bank stock investing within the context of a completely new economic environment as we near the end of the Fed rate hike cycle. The Economy Is 80% Of The Call On Bank Stocks — Stocks — We must make certain assumptions regarding the U.S. economy to consider investing in bank stocks, including that the U.S. consumer will remain somewhat healthy, while corporate profits slow only modestly after three years of good growth. Key economic drivers of bank stock price performance are explored. Credit Quality Can Cut Hard Both Ways —Unquestio Ways —Unquestionably, nably, the biggest swing factor in bank stock earnings remains credit quality. We do not anticipate the U.S. economy falling into recession over the 2006-2007 time frame; however, under such a scenario we might witness increased corporate bankruptcies, as well as a weakening consumer and poor relative bank stock price performance. We have provided the key “dials and needles” in bank stock financial statement analysis. Consolidation And Nonbanking Remain The Mega Trends —In Trends —In our assessment, assessment, consolidation has been one of the biggest 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 dominated the mid-1990s that has more recently reversed itself somewhat is the single-minded focus on fee-based revenues. Risks —Risks to achievement of our 12-month 12-month price price targets include, include, but are not not limited to, deterioration in the broader market; significant weakness weakness in the U.S./global economy; or specific unforeseen fundamental company-related events that may result in failure to achieve our EPS estimates.

Piper Jaffray & Co. does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decisions. This report should be read in conjunction with important disclosure information, including an attestation under Regulation Analyst Certification found on pages 52-54 of this report or at the following site: http://www.piperjaffray.com/researchdisclosur http://www.piperjaffray.com/researchdisclosures. es. Customers of Piper Jaffray in the United States can receive independent, third-party research on the company or companies covered in this report, at no cost to them, where such research is available. Customers can access this independent research by visiting piperjaffray.com or can call 800 747-5128 to request a copy of this research.

June 2006

TABLE OF CONTENTS

Viewpoint ............................................................ .................................................................................................................. ...................................................... 4 Economics And And Bond Market Market Indicators Indicators.............................................................. .............................................................. 5 Dials And Needles—What Is Really Important When Modeling..........................13 Loans And Credit Quality...................................................................................16 Quality...................................................................................16 Revenue Components ................................................................ .........................................................................................20 .........................20 Noninterest Expenses Expenses ............................................................... .........................................................................................21 ..........................21 Capital .............................................................. ...............................................................................................................22 .................................................22 Valuation Methods ...................................................................... ...................................................................................................25 .............................25 Price-To-Earnings...............................................................................................25 PEG Ratio .......................................................... ..........................................................................................................27 ................................................27 Price-To-Book Price-To-Book ....................................................... ....................................................................................................27 .............................................27 Some Attractive Yield Opportunities...................................................................28 Opportunities...................................................................28 Mega Trends—Consolidation, Trends—Consolidation, Credit Quality, And Non-Banking Non-Banking .............................32 Consolidation.....................................................................................................32 Branching Versus Consolidation ........................................................... .........................................................................33 ..............33 Credit Quality ............................................................. ....................................................................................................34 .......................................34 Non-Banking Non-Banking Trends ............................................................... ..........................................................................................36 ...........................36 Investment Banking ............................................................... ............................................................................................36 .............................36 Asset Management Management ................................................................... .............................................................................................37 ..........................37 Processing...........................................................................................................37 Credit Cards....................................................................................... Cards.......................................................................................................37 ................37 Mortgage Banking ...................................................................... ..............................................................................................38 ........................38 Technology And The Evolution .............................................................. ..........................................................................41 ............41 History of Banking ............................................................ ....................................................................................................42 ........................................42 Regulatory And Legislative History—The History—The Pendulum Pendulum Swings Back ......................42 Definitions ........................................................ ................................................................................................................44 ........................................................44 Important Research Disclosures......................................................... Disclosures.................................................................................52 ........................52

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| Commercial Banks: A Short Bank Stock Primer Piper Jaffray Investment Research

June 2006

Exhibits 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27. 28. 29. 30. 31. 32. 33. 34. 35.

The Primer Pyramid ................................................................. ............................................................................................ ........................... 4 Fed Funds Target Rate And Fed Funds Futures Futures .................................................... 6 MBA Composite Index (Weekly) (Weekly) Versus 10-Year 10-Year U.S. Treasury Treasury Yield (%) ........... 7 10-Year Versus Three-Month Three-Month U.S. Treasury Treasury Yield And Spread............................. 8 High Yield Spread Versus Versus Bank Stock Index......................................................... Index......................................................... 9 ISM Purchasing Purchasing Managers Index.........................................................................10 Money Fund Flows ...................................................................... .............................................................................................11 .......................11 Deposits Growth Percentage Percentage Year-Over-Year Year-Over-Year Change Versus Dollar Amount .....12 Example Bank–Net Interest Interest Income And Margin Margin ................................................13 Example Bank–Average Bank–Average Balance Sheet ............................................................ ................................................................14 ....14 Three-month T-Bill Versus 10-year U.S. Treasury Historical Spread Monthly Historical Data ................................................................ ...................................................................................................15 ...................................15 Example Bank–Income Statement ....................................................... .......................................................................16 ................16 Example Bank–Credit Bank–Credit Quality ................................................................ ............................................................................17 ............17 Reserve Ratio, All Banks................................................. Banks.....................................................................................18 ....................................18 Total Home Equity Outstanding With Growth Rates..........................................19 Total Revolving Credit Credit Outstandings Versus Versus Growth Rate .................................20 Noninterest Expense................................................................. Expense...........................................................................................21 ..........................21 Regulatory Capital Requirements Requirements ....................................................... .......................................................................22 ................22 Components Components of Capital............................................................. Capital.......................................................................................23 ..........................23 Top 50 Banks Benchmark Averages, Averages, 1Q06 ..........................................................24 Historical 2006 Consensus Estimates...................................................................26 Estimates...................................................................26 Fastest and Most Consistent Earnings Growers...................................................27 Top 50 Banks Relative Relative ROE ................................................................... ...............................................................................28 ............28 Bank Stock Dividend Yield Versus Versus 10-Year U.S. Treasury Treasury Yield (%) ...................29 Dividend Payout Ratio and Dividend Yield .........................................................30 Dividend Payout Ratio............................... Ratio........................................................................................31 .........................................................31 Bank M&A Deals...............................................................................................32 Branch Count and Growth..................................................................................34 Growth..................................................................................34 Industry Net Charge-Off Ratios..........................................................................35 Large-Cap Banks 2007E 2007E Earnings Mix .......................................................... ................................................................36 ......36 Average Managed Balances – Full Year ...............................................................38 Mortgage Originations Originations ............................................................ .......................................................................................39 ...........................39 Top 10 Mortgage Originators ................................................................... .............................................................................40 ..........40 Top 10 Mortgage Servicers Servicers .................................................................. .................................................................................40 ...............40 Collins Industry and Company Company Reports Reports ..............................................................51

Piper Jaffray Investment Research

Commercial Banks: A Short Bank Stock Primer | 3

June 2006

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). determines 80% of the success in The Economy------We think U.S. economic growth determines bank stock investing. Among key economic indicators we pay particularly close attention to are the following: personal unemployment, purchasing managers index, bankruptcies, bankruptcies, loan growth, demand levels, and inflation. 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 modest uptick in unemployment. We view this as a solid environment in which to invest in bank stocks.

Fundamentals Fundamen tals And Accounting-Account ing------From a fundamental standpoint, we monitor credit quality statistics closer than any other category of fundamental fundamental analysis, given a historical tendency for credit to generate enormous swings in bank earnings. We also constantly monitor interest rates and loan growth as a basic function of banking profitability. In our assessment, credit quality in 2006-2007 2006-2007 may remain stable, following three years of continued improvement, while basic banking trends may suffer from deteriorating optics, reflecting the significant recent increase in short-term interest rates, limited steepening in the yield curve, and heightened competition. competition.

Exhibit 1

THE PRIMER PYRAMID

History

Reg Regul ulat atio ion n

Mega-Trends

Consolidation

Val u at i o n s

Fu n d am en t al s

Economy

Pr i c e-to -Ear n i n g s

Cred i t Qu al i t y

GDP Growth

Credit Quality

Nonbanking

Pr i c e-t o -B o o k

Net Interest Margin

Interest Rates

Legi Legisl slat atio ion n

Fee Revenues

Unemployment

Bankruptcies

PEG Ratios

Investments

Purchasing Mgrs.

Source: Piper Jaffray

4 | Commercial Banks: A Short Bank Stock Primer Piper Jaffray Investment Research

Loans

Loan Aggregates

June 2006

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/E 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. Earnings momentum in several sectors seems to be deteriorating, while bank earnings are stabilizing to improving. 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 fundamental trends to impact commercial banking over the last 20 years. Although industry consolidation all but ground to a halt in 2005, we would expect some catalyst to lead to an acceleration in activity within the next two years. Further, while the push into non-banking businesses has also slowed—due primarily to significant deterioration in market-sensitive revenues in the early part of this decade— we think banks will once again focus on fee-based businesses during 2006-2007. 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 recent initiatives to curtail the sub-prime consumer and mortgage markets, and increased scrutiny of commercial real estate lending habits. Most of these moves have not severely impacted banking profitability, unlike some historical negative regulatory efforts.

Economics And Bond Market Indicators

We monitor seven or eight key economic/bond market data points when following bank stocks, including the Treasury market rates (three-month and 10-year maturities), high-yield credit spreads, loan market aggregates, unemployment, purchasing managers index, consumer price index, 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 3.5% GDP growth or more, investors often become concerned with higher interest rates and seek out fastergrowing areas within the investor spectrum (e.g., 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 made steady progress since the slowdown earlier this decade. In our view, somewhere between 1.5% and 3.0% GDP growth is optimal for bank stock investing 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 Reserve’s significant campaign to raise the fed funds rate by 400 basis points since mid-2004 to its current level of 5.00% (see Exhibit 2) has had little impact on the corporate side to decelerate corporate demand and capital spending, primarily due to significant international growth and demand.



June 2006

Exhibit 2

FED FUNDS TARGET RATE AND FED FUNDS FUTURES May 2004 - December 2006 % % % % 8 0 2 0 2 . . 3 . 3 2 % % . 4 5 5 5 5 0 0 . . 5 % % 0 5 5 5 . 7 . % % 7 0 0 4 4 5 5 . % . 5 4 4 . % 2 0 4 . % % 0 5 5 4 . 7 . % 7 0 3 3 . % % 5 5 5 3 . 2 . % 2 0 3 3 . % % 0 5 5 3 . 7 . % 7 0 2 2 . % % 5 5 5 2 . 2 . % 2 0 2 2 . % % 0 2 5 5 . 7 . % 7 0 1 1 . % % 5 5 5 1 . 2 . % 2 0 1 1 0 . 1

4 4 0 - 0 y n a u J M

4 0 l u J

4 0 g u A

4 0 p e S

4 4 4 5 0 - 0 - 0 - 0 t c n c v o e a O N D J

5 0 b e F

5 5 0 0 r r a p M A

5 5 0 - 0 y n a u J M

5 0 l u J

5 0 g u A

5 0 p e S

5 5 5 6 0 - 0 - 0 - 0 t c n c v o e a O N D J

6 0 b e F

6 6 0 0 r r a p M A

6 6 0 - 0 y n a u J M

6 0 l u J

6 0 g u A

6 0 p e S

% 2 3 . 5

% 0 3 . 5

6 6 6 0 - 0 - 0 t c c v o e O N D

Source: Source: Piper Jaffray, Federal Reserve and Chicago Board of Trade. Note: Priced as of 6/8/06

Also, higher short-term rates have had minimal impact on pushing up long-term rates such as the 10-year Treasury, which has increased by only 34 basis points over the past 24 months to a current yield of 5.00% as of May 24, partially due to foreign central bank buying, as well as relatively lower government bond yields in most foreign countries. Despite these somewhat stable long-term interest rates, we have witnessed a mild slowdown in mortgage-related activity during the past two to three years and a meaningful drop from the refinance-driven boom during the 2001-2003 time frame (see Exhibit 3).


June 2006

Exhibit 3

MBA COMPOSITE INDEX (WEEKLY) VERSUS 10-YEAR U.S. TREASURY YIELD (%) 2,000

0.06

1,800

MBA Composite Index

0.055

10-Year U.S. Treasury Yield

1,600 x e d 1,400 n I e t i 1,200 s o p m1,000 o C A 800 B M

0.05

0.045

0.04

600

1 0 Y e a r U . S . T r e a s u r y Y i e l d

0.035 400 200

0 1 0 - 0 t c n a O J

1 0 r p A

1 0 l u J

1 0 p e S

1 0 c e D

2 2 0 0 r a n u M J

2 0 g u A

2 3 0 - 0 v b o e N F

3 3 0 - 0 l y u a J M

3 4 0 - 0 t c n a O J

4 0 r p A

4 0 n u J

4 0 p e S

4 0 c e D

5 5 0 0 r a n u M J

5 0 g u A

5 6 0 - 0 v b o e N F

0.03 6 0 r p A

Source: Federal Reserve and Mortgage Bankers Association

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. The yield curve has flattened steadily during the mid-2004 to present time frame to a 10year to three-month spread of 27 basis points from 368 basis points (see Exhibit 4). Nevertheless, net interest margins have held up surprisingly well, compressing by only three basis points among the top 100 banks over the last 24 months.



June 2006

Exhibit 4

10-YEAR VERSUS THREE-MONTH U.S. TREASURY YIELD AND SPREAD (May 2004-May 2006)

6.00 ) % ( 5.00 s d l e i Y 4.00 T S U 3.00 o m 3 d 2.00 n a r y 0 1.00 1

10yr. UST Yield, May 2006=4.99% 3mo. UST Yield, May 2006=4.72% Spread(bps ), May 2006=27 bps

400 350 300 250 200 150

S p r e a d ( b p s )

100 50

0.00

0

4 4 0 5 0 5 0 5 0 5 0 5 0 5 0 5 0 5 0 5 0 5 0 5 0 5 0 6 0 6 0 6 0 6 4 4 0 4 0 4 0 4 0 4 0 0 - - - b - r - r - u - - - n 0 - - b - r - r - y - n - u l - g - p - c t - v - c 0 y a A p a J u J l u g e p c t - o v e c J a n e a a J u J A u S e O N o D e J a n F e M M F M A p A S O N D M Source: Federal Reserve, Piper Jaffray

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 2002, credit spreads widened dramatically. In sum, these measures track credit fears as well as reality (see Exhibit 5).


June 2006

Exhibit 5

HIGH YIELD SPREAD VERSUS BANK STOCK INDEX (Sept. 1992 - To Date)

Oct-8-02 SNC Results

3-Jan-01 Fed 2001 rate cut campaign begins

900bps

30-Jun-04 Fed 2004 rate hike campaign begins

110 100

800bps

High Yield Spread Bank Stock Index

700bps

90 80

d a e r p S d l e i Y h g i H

600bps

70

500bps

60

11-Sep-01 WTC Attack

50

400bps 300bps

40

10-Mar-00 NASDAQ reaches record high

23-Sep-98 LTCM Bailout

30

200bps 100bps

x e d n I k c o t S k n a B

20

2 9 p e S

3 3 9 9 r p a e M S

4 4 9 9 r p a e M S

5 5 9 9 r p a e M S

6 6 9 9 r p a e M S

7 7 9 9 r p a e M S

8 8 9 9 r p a e M S

9 9 9 9 r p a e M S

0 0 0 0 r p a e M S

1 1 0 0 r p a e M S

2 2 0 0 r p a e M S

3 3 0 0 r p a e M S

4 4 0 0 r p a e M S

5 5 0 0 r p a e M S

6 0 r a M

10

Source: Piper Jaffray, ILX and Bloomberg

We generally view consumer and corporate loan aggregate trends as early indicators of economic growth. Although corporate loan expansion remains robust, consumer loan growth has been somewhat sluggish over the last three years. In contrast, mortgage trends were extremely strong through year-end 2004 and have since declined. 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 following the adoption of more restrictive personal bankruptcy laws in the fourth quarter of 2005.



June 2006

Purchasing managers index remains important to gauging potential expansion within the business sector and thus the potential for increased loan demand. In our assessment, capacity remains somewhat tight within the corporate sector, implying healthy corporate demand. The most recent ISM purchasing managers index was 57.3 at April 2006, indicating corporate growth (see Exhibit 6). Exhibit 6

ISM PURCHASING MANAGERS INDEX (Jan 2000-May 2006) 65 60 55 50 45 40 35

0 0 1 1 2 2 3 3 4 4 5 5 6 0 - y - 0 p - 0 0 n 0 - y - 0 p - 0 1 n 0 - y - 0 p - 0 2 n 0 - y - 0 p - 0 3 n 0 - y - 0 p - 0 4 n 0 - y - 0 p - 0 5 n 0 n J a M a S e J a M a S e J a M a S e J a M a S e J a M a S e J a M a S e J a Source: ISM

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 Exhibit 7). Many of our analyst peers wrongly anticipated that with any improvement in the equities markets we might witness a material outflow of bank deposits.


June 2006

Exhibit 7

MONEY FUND FLOWS Equity Fund Flows - 6/1/2006 (4 Wk Moving Avg)

6.00 5.00 s r 4.00 a l l 3.00 o D 2.00 f o s 1.00 n o 0.00 i l l i B-1.00

-2.00 -3.00

3 3 4 0 - 0 - 0 v c n o e a J N D

4 0 b e F

4 4 0 0 r r a p M A

4 4 0 - 0 y n a u J M

4 0 l u J

4 0 g u A

4 0 p e S

4 4 4 5 0 - 0 - 0 - 0 t c n c v o e a O N D J

5 0 b e F

5 5 0 0 r r a p M A

5 5 0 - 0 y n a u J M

5 0 l u J

5 0 g u A

5 0 p e S

5 5 5 0 - 0 - 0 t c c v o e O N D

5 6 0 - 0 c n e a J D

6 6 6 0 0 0 r r r a a p M M A

6 0 y a M

Money Market Fund Flow s - 6/1/2006 (4 Wk Moving Avg)

20.00 15.00 s r 10.00 a l l o 5.00 D f o 0.00 s n -5.00 o i l l i -10.00 B

-15.00 -20.00

3 3 4 0 - 0 - 0 v c n o e a N D J

4 0 b e F

4 4 0 0 r r a p M A

4 4 0 - 0 y n a u M J

4 0 l u J

4 0 g u A

4 0 p e S

4 4 4 5 0 - 0 - 0 - 0 t c n c v o e a O N D J

5 0 b e F

5 5 0 0 r r a p M A

5 5 0 - 0 y n a u M J

5 0 l u J

5 0 g u A

5 0 p e S

5 5 5 5 6 0 - 0 - 0 - 0 - 0 t c c n c v o e e a O N D D J

6 6 6 0 0 - 0 r r r a a p M M A

6 0 y a M

5 0 l u J

5 0 g u A

5 0 p e S


6 6 6 0 0 0 r r r a a p M M A

6 0 y a M

5 0 g u A

5 0 p e S


6 6 6 0 0 0 r r r a a p M M A

6 0 y a M

Taxables Fund Flows - 6/1/2006 (4 Wk Moving Avg)

1.50 1.00

s r a l l 0.50 o D 0.00 f o s -0.50 n o i l l -1.00 i B

-1.50 -2.00

3 3 4 0 - 0 - 0 v c n o e a J N D

4 0 b e F

4 4 0 0 r r a p M A

4 4 0 - 0 y n a u J M

4 0 l u J

4 0 g u A

4 0 p e S

4 4 4 5 0 - 0 - 0 - 0 t c n c v o e a O N D J

5 0 b e F

5 5 0 0 r r a p M A

5 5 0 - 0 y n a u J M

Municipal Fund Flows - 6/1/2006

0.80 0.60 s r a 0.40 l l o 0.20 D f 0.00 o s -0.20 n -0.40 o i l l i -0.60 B -0.80 -1.00

(4 Wk Moving Avg)

3 3 4 0 - 0 - 0 v c n o e a J N D

4 0 b e F

4 4 0 0 r r a p M A

4 4 0 - 0 y n a u J M

4 0 l u J

4 0 g u A

4 0 p e S

4 4 4 5 0 - 0 - 0 - 0 t c n c v o e a O N D J

5 0 b e F

5 5 0 0 r r a p M A

5 5 0 - 0 y n a u J M

5 0 l u J

Source: AMG Data Services and Piper Jaffray Fundamental Market Strategy



June 2006

Material Deposit Outflows Did Not Happen —In response, we anticipate deposit growth remaining roughly 4%-8% annually, reflecting a more modest risk appetite; however, several other events such as increased loan growth and higher rates may precede that trend. Bank deposits grew by 8.5% on average throughout the last five years versus a current growth rate of 7.8% year over year (see Exhibit 8).

Exhibit 8

DEPOSITS GROWTH PERCENTAGE YEAR-OVER-YEAR CHANGE VERSUS DOLLAR AMOUNT ( Jan 2001-May 2006, $ In Billions)

$5,942.5 Bil . on 5/10/06

$5,900

Percent changes to date: Year-over-Year: +7.8% Year-to-Date: +3.5%

18% 16% 14%

$5,400

12% $4,900

10% 8%

$4,400 6% 8.5% avg YoY growth rate during 2001-2006

$3,900

$3,400

1 0 n a J

1 1 1 0 0 0 l r u a y a J M M

1 1 2 0 - 0 - 0 p v n e o a S N J

2 2 2 0 0 0 l r u a y a J M M

2 2 3 0 - 0 - 0 p v n e o a S N J

3 3 0 0 r p n u A J

3 3 3 4 0 - 0 - 0 - 0 c b g t c e e u A O D F

4 4 0 0 r p n u A J

4 4 4 5 0 - 0 - 0 - 0 c b g t c e e u A O D F

Note: Seasonally adjusted Source: Federal Reserve


5 5 0 0 r p n u A J

4% 2% 5 5 6 0 - 0 - 0 g v n u o a A N J

0%

6 6 0 0 r a y a M M

June 2006

Dials And Needles— What Is Really Important When Modeling

We usually begin a commercial banking model with assumptions regarding loan and asset growth . Our loan growth assumptions rely somewhat on historical economic growth levels within a given marketplace, plus an additional one to two percentage points of growth (i.e., 5%-7% loan growth) (see Exhibit 9). 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: mortgages, consumer loans, business loans, and commercial real estate.

Exhibit 9

EXAMPLE BANK – NET INTEREST INCOME AND MARGIN (Current Year, Average Balance Sheet) Averag e Balance Securities Loans

$500 1,300

Earning Assets

Other Assets Total Assets

Calculations:

$1,800

Yield s/ Rates

Inter est Income

4.50%

$22.5

6.00% 5.58%

78.0 $100.5

300 $2,100

Averag e Balance Deposits Borrowings Bearing Liabilities

Inte rest Expense

$1,300

1.61%

$20.9

630

3.62%

22.8

$1,930

2.27%

$43.7

Equity Total Liab. & Eq.

Yield s/ Rates

170 $2,100

$100.5 - $43.7 = $56.8

Net Interest Income (NII)

$56.8

$56.8 / $1,800 = 3.15%

Net Interest Margin (NIM)

3.15%

5.58% - 2.27% = 3.32%

Interest Rate Spread

3.32%


Over the last 24 months, business loans (or commercial and industrial) have been accelerating due to increased demand, more favorable customer pricing, and more lenient underwriting standards. In contrast, demand for mortgage loans—including first and second liens—has been waning, reflecting higher U.S. interest rates. Meanwhile, rates on credit cards have remained somewhat stable. We may witness card balance growth accelerate under a scenario where consumers notice little difference between home equity and credit card interest rates.

Investment securities comprise the bulk of a bank’s remaining average earning assets and are primarily composed of government and mortgage-backed bonds. Average earning asset levels are somewhat a function of loan growth, and the opportunity to leverage deposit growth and any underutilized capital. 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 the last two years banks have increasingly maintained consumer loans on the balance sheet, given an opportunity to fund these loans with abnormally cheap deposits.



June 2006

Exhibit 10

EXAMPLE BANK – AVERAGE BALANCE SHEET

Securities Loans Earning Assets Other Assets Total Assets Deposits Borrowings Bearing Liabilities Equity Total Liab. & Eq. Net Interest Margin & Net Interest Income

Prior Year $ 524 1,200 1,724 285 2,009 1,200 650 1,850 159 2,009

Avg .

Int. In c.

Yield

& Exp.

4.21% $ 5.34% 5.00%

22.1 64.1 86.1

1.01% 2.52% 1.54%

12.1 16.4 28.5

3.34% $

57.6

Current Year $ 500 1,300 1,800 300 2,100 1,300 630 1,930 170 2,100

Avg .

Int. In c.

Yield

& Exp.

4.50% $ 22.5 6.00% 78.0 5.58% 100.5

1.61% 3.62% 2.27%

20.9 22.8 43.7

3.15% $

56.8

Year-over-Year % Change Balance Yi el d In c./Ex p. -5% 29bps 2% 8% 66bps 22% 4% 59bps 17% NM 5% 8% 60bps 73% -3% 110bps 39% 4% 73bps 53% 7% 5% -19bps

-2%


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 10). Over the last two years, interest yields and costs have been increasing, given a significant increase in interest rates within the U.S. market. In fact, over this period the fed funds rate has increased by 400 basis points to 5.00% currently, while the long bond has increased by 34 basis points as of May 24, 2006. The short end of the yield curve (see Exhibit 11), namely, three-month, one- and two-year money, has continued to increase. As a result, deposit rates have been escalating while short-term wholesale funding costs have increased as well.


June 2006

Exhibit 11

THREE-MONTH T-BILL VERSUS 10-YEAR U.S. TREASURY HISTORICAL SPREAD MONTHLY HISTORICAL DATA Basis Points

May-04 Recent High 360 basis points

400 350 300 250 200

50-Year Aver age of 131 basis points

150 100

May-06 33 basis points

50 0

Dec-00 Low Negative 70 basis points

(50) (100)

0 9 9 1 / 1 / 1

0 9 9 1 / 1 / 8

1 9 9 1 / 1 / 3

1 9 9 1 / 1 / 0 1

2 9 9 1 / 1 / 5

2 9 9 1 / 1 / 2 1

3 9 9 1 / 1 / 7

4 9 9 1 / 1 / 2

4 9 9 1 / 1 / 9

5 9 9 1 / 1 / 4

5 9 9 1 / 1 / 1 1

6 9 9 1 / 1 / 6

7 9 9 1 / 1 / 1

7 9 9 1 / 1 / 8

8 9 9 1 / 1 / 3

8 9 9 1 / 1 / 0 1

9 9 9 1 / 1 / 5

9 9 9 1 / 1 / 2 1

0 0 0 2 / 1 / 7

1 0 0 2 / 1 / 2

1 0 0 2 / 1 / 9

2 0 0 2 / 1 / 4

2 0 0 2 / 1 / 1 1

3 0 0 2 / 3 / 6

4 0 0 2 / 3 / 1

4 0 0 2 / 4 / 8

5 0 0 2 / 5 / 3

5 0 0 2 / 5 / 0 1

6 0 0 2 / 1 3 / 5

Source: Federal Reserve and ILX

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 12 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, benefiting from the spread or a steep yield curve. The yield curve at 33 basis points is currently relatively flat (i.e., unfavorable) versus a historical 131 basis point average, meaning banks are now lending out at rates relatively closer to the rates being paid out on deposits, resulting in tighter incremental spreads. However, banks could stand to benefit under a scenario where the yield curve returns to a more historically normal steepness. A bank’s 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.



June 2006

Exhibit 12

EXAMPLE BANK – INCOME STATEMENT Prior Year + Net Interest Income - Loan Loss Provision + Noninterest Income - Noninterest Expense = Income before Taxes - Taxes (35%) = Net Income Total Revenue

Current Year

% Chg.

$57.6 3.0 45.0 65.0 34.6 12.1 $22.5

$56.8 4.0 50.0 70.0 32.8 11.5 $21.3

-2% 33% 11% 8% -5% -5% -5%

$102.6

$106.8

4%

Average Earning Assets x Net Interest Margin (annualized) = Net Inter est Inco me (NII)

$1,800 3.15% $56.8

Source: Piper jaffray

Net interest income often contributes between 20% and 60% of a bank’s 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 borrower’s ability to repay loan balances and make interest payments on an ongoing basis. Under a scenario in which a borrower’s 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 non-accrual 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 for this 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. However, since the bank has already provisioned for this $25,000 write-down, no additional impact is recognized.


June 2006

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 chargeoff 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. The accounting methodology for loan loss reserves is somewhat complicated (see Exhibit 13). 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.

Exhibit 13

EXAMPLE BANK – CREDIT QUALITY Current Year $25 10 1 $9 4 $20

Beginning Reserves Charge-offs Recoveries - Net Charge-offs + Loan Loss Provision Ending Reserves Nonperforming Loans (NPLs) + OREO (oth er real estate owned) = No np er f or mi n g A ss et s (NPA s)

$13 1 $1 4

Calculations: Net Charge-Off Ratio = Net Charge-Offs / Avg. Loans NPAs-to-Assets = Nonperforming Assets / End of Period Assets Reserves Ratio = Reserves / End of Period Loans Reserves-to-NPAs = Reserves / Nonperforming Assets

Key Credit Quality Ratios*: Net Charge-Off Ratio = $10 / $1,300 = NPAs-to-Assets = $14 / $2,100 =

0.69% Good when 0.67% Relatively LOW

Reserves Ratio = $20 / $1,300 = Reserves-to-NPAs = $20 / $14 =

1.54% Good when 143% Relatively HIGH

*Note: For illustration purposes, average balances used for period end balances. Source: Piper Jaffray.

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 consumeroriented portfolios because these loans are generally underwritten with some anticipation of loss and can be fully charged off (e.g., credit cards) without first being placed on nonperforming status. In contrast, commercial loans usually have some collateral support and are much lumpier in nature.

Commercial loans , or business loans, have been the source of the biggest credit problems through the last three banking cycles. 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 increased significantly on a national basis, given increasing supply and demand by borrowers.



June 2006

In our assessment, supply has improved at many larger banks reflecting a lack of adequate returns on most asset classes. 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. The SNC market has bounced back significantly over the last 24 months. 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. Many larger banks including SunTrust, Wachovia, and Colonial are experiencing exceptionally low net charge-off ratios as a percentage of loans of only 0.07%-0.24% range versus a more normal 40-60 basis points. These low ratios reflect recoveries relative to significant losses during the 2002-2003 time frame. Over the last few years, the SEC has increasingly been cautioning banks regarding maintaining potentially too high reserve levels, given a low level of credit losses. Partly in reaction to this, banks have been reducing reserve ratios somewhat consistently during the past nine years from a peak of 276 basis points in 1987 to an estimated 120 basis points by 2007 (see Exhibit 14).

Exhibit 14

RESERVE RATIO, ALL BANKS (1959-2007E) 3.00%

1987 2.76%

2.75% 2.50% 2.25% 2.00%

Ave ra ge 1.86%

1.75% 1.50% 1.25%

2007E 1.20%

1.00% 0.75%

9 5 9 1

1 6 9 1

3 6 9 1

5 6 9 1

7 6 9 1

9 6 9 1

1 7 9 1

3 7 9 1

5 7 9 1

7 7 9 1

9 7 9 1

1 8 9 1

3 8 9 1

5 8 9 1

7 8 9 1

9 8 9 1

1 9 9 1

3 9 9 1

5 9 9 1

7 9 9 1

9 9 9 1

1 0 0 2

3 0 0 2

E 5 0 0 2

E 7 0 0 2

Source: FDIC, Piper Jaffray estimates

Going forward, we would 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 could experience elevated losses associated with commercial real estate as loan standards in that area have weakened. Nevertheless, banks have increasingly been using the securitization markets (i.e., CDOs, CLOs, and CMBS) to address exposures in these areas.


June 2006

Consumer loans include a broad variety of credits including home mortgages, home equity, credit cards, and personal loans (e.g., purchase of boats, cars, etc.). Most banks have been significantly increasing exposure to mortgages and home equity (see Exhibits 15 and 16) over the last five years, 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.

Exhibit 15

TOTAL HOME EQUITY OUTSTANDING WITH GROWTH RATES (1991-2005) 500

70% 62%

450

60%

400

g n i d 350 n a t s 300 t u O250 Q E 200 H l a 150 t o T

100

50% 40%

39% 32% 19%

32%

21% 19%

18%

19%

19%

18%

13%

50

30%

G r o w t h R a t e

20% 15%

10% 6%

0

0%

2 9 3 9 4 9 5 9 6 9 7 9 8 9 9 0 0 0 1 0 2 0 3 0 4 0 5 9 1 9 9 1 9 1 9 1 9 1 9 1 9 1 9 1 9 1 9 2 0 2 0 2 0 2 0 2 0 2 0 1

Source: SNL DataSource



June 2006

Exhibit 16

TOTAL REVOLVING CREDIT OUTSTANDINGS VERSUS GROWTH RATE 900

16%

850

14%

) l i m800 $ ( g n 750 i d n a t s 700 t u O t 650 n u o 600 m A

12% 10% 8% 6% 4%

550 500

2% 0 0 0 0 1 1 1 1 2 2 2 0 0 0 - 0 - 0 - 0 - 0 - 0 - 0 - 0 - 0 l t t r l r l n r u c n u c n u a p J a p J a p J A A A O O

2 3 0 - 0 t c n a O

3 3 3 4 0 0 - 0 - 0 t r l u c n p J a A O

4 4 4 5 5 5 5 6 0 0 0 - 0 - 0 - 0 - 0 - 0 t t r l r l u c n u c n p J a p J a A A O O

0%

Source: Federal Reserve

Mortgage lending in particular expanded dramatically during the 2001-2004 time frame, 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. 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 on exotic mortgage instruments.

Revenue Components

Total revenue, which is the sum of net interest income and non-interest income, typically grows anywhere from 4%-9% annually. 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. Investment banking fees, or non-interest income, is highly reliant upon the type of investment banking done at an individual organization. Loan syndications are a big part of a commercial bank’s 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.


June 2006

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.

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 bank’s noninterest expense base expands by 3%-6% per year 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%.

Exhibit 17

NONINTEREST EXPENSE ($ In Millions)

Prior Year $50.0 50.0 $100.0

Current Year $54.0 55.0 $109.0

Noninterest Expenses

$50.0

$52.5

Key I/S Ratio s: Efficiency Ratio Operating Leverage

50.0% NA

48.2% 400bps

Net Interest Income Noninterest Income Total Revenues

% Chg 8.0% 10.0% 9.0% 5.0%

Current Year Calculations: Efficiency = Nonint. Exp. / Ttl. Rev. = 48.2% Operating Leverage = Rev.-Exp. Growth Spread = 9.0% - 5.0% = 400bps Source: Piper Jaffray



June 2006

The efficiency ratio , or overhead ratio, is one of the analyst community’s 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 17). 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. 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.

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 deterioration to be the result of a somewhat poor calculation of the riskiness of selected assets on the balance sheet combined with insufficient capital. 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 18).

Exhibit 18

REGULATORY CAPITAL REQUIREMENTS Well Capitalized Adequatel y Capit ali zed Undercapitalized

Tot. Capital Tier 1 Cap. >+10% >=6% >+8% >=4%

Leverage >=5% >=4%

Neither Well nor Adequately Capitalized

Source: FDIC

There is significant excess capital within the banking system estimated at almost $19.5 billion among the top 50 banks, using a tangible common equity cutoff of 5.0%. 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.


June 2006

Exhibit 19

COMPONENTS OF CAPITAL Total Assets (TA) Risk-Weight Risk-W eighted Assets (RWA) Common Equity (CE) - Goodwill & Other Adj. (GW) Tier 1 Capital + Tier 2 Capital Total Capital

$1,100 64% $700 $85 25 $60 20 $80

Key Capital Ratios: Common Equity Tangible Common Equity Tier 1 Ratio Total Capital Leverage Ratio

7.73% 5.58% 8.57% 11.43% 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: Piper Jaffray

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.



June 2006

Exhibit 20

TOP 50 BANKS BENCHMARK AVERAGES, 1Q06 (Excluding BAC, And Processors BK, IFIN, MEL, NTRS, STT)

Balance Sheet and P&L ($000 except EPS)

Total Loans Total Deposits Total Revenues Non-Interest Expense Core EPS

1Q05

4Q05

1Q06

62,180,271 66,564,698 68,067,516 64,580,111 69,060,464 70,945,847 1,673,497 1,703,672 1,783,632 974,363 997,951 1,083,274 $0.70 $0.74 $0.74

Statistics (%)

1Q05

4Q05

1Q06

Net Interest Margin (reported) Efficiency Ratio ROAA ROAE NPAs / Total Assets NCOs / Average Loans Equity/Assets Leverage Ratio

3.81 56.31 1.40 15.60 0.31 0.26 9.31 7.62

3.75 57.00 1.41 15.52 0.28 0.32 9.48 7.63

3.75 57.49 1.42 15.64 0.29 0.21 9.52 7.71

Growth Qtr./Qtr. Yr./Yr.

2.3% 2.7% 4.7% 8.5% 0.4%

9.5% 9.9% 6.6% 11.2% 5.0%

Bps Change Qtr./Qtr. Yr./Yr.

-0.2 49.2 1.3 12.5 0.7 -10.5 3.3 7.6

-6.1 118.0 1.7 3.6 -2.8 -4.7 20.6 9.2



1Q06 Results High Low 5.02 2.17 83.08 38.90 2.28 0.77 36.83 4.01 1.37 0.06 1.07 -0.11 19.97 5.94 10.45 5.22

June 2006

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 1990s fed this growth.

Price-To-Earnings

In our assessment, the price-to-earnings (P/E) and price-to-tangible book ratios continue 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 21).



June 2006

Exhibit 21

HISTORICAL 2006 CONSENSUS ESTIMATES (January 2004 - May 2006) Rank 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50

Company East West Bancorp, Inc. Colonial BancGroup, Inc. Bank of Hawaii Corporation Cullen/Frost Bankers, Inc. Zions Bancorporation PNC Financial Services Group, Inc. Comerica Incorporated Synovus Financial Corp. Compass Bancshares, Inc. KeyCorp Mercantile Bankshares Corporation Northern Trust Corporation Bank of America Corporation City National Corporation Wilmington Trust Corporation U.S. Bancorp Cathay General Bancorp, Inc. Wachovia Corporation Marshall & Ilsley Corporation Associated Banc-Corp M&T Bank Corporation SunTrust Banks, Inc. AmSouth Bancorporation BOK Financial Corporation Wells Fargo & Company UnionBanCal Corporation Huntington Bancshares Incorporated Investors Financial Services Corp. State Street Corporation Fulton Financial Corporation Commerce Bancorp, Inc. Bank of New York Company, Inc. Mellon Financial Corporation Commerce Bancshares, Inc. TD Banknorth Inc. JPMorgan Chase & Co. BB&T Corporation Citigroup Inc. TCF Financial Corporation Sky Financial Group, Inc. Regions Financial Corporation National City Corporation Valley National Bancorp North Fork Bancorporation, Inc. FirstMerit Corporation Webster Financial Corporation Popular, Inc. First Horizon National Corporation South Financial Group, Inc. Fifth Third Bancorp Aver age

Source: FactSet


Ticker EWBC CNB BOH CFR ZION PNC CMA SNV CBSS KEY MRBK NTRS BAC CYN WL USB CATY WB MI ASBC MTB STI ASO BOKF WFC UB HBAN IFIN STT FULT CBH BK MEL CBSH BNK JPM BBT C TCB SKYF RF NCC VLY NFB FMER WBS BPOP FHN TSFG FITB

Chg. 28% 16% 6% 5% 5% 5% 5% 5% 4% 4% 3% 2% 1% 1% 0% -1% -2% -2% -2% -2% -3% -3% -4% -4% -4% -5% -6% -6% -7% -7% -8% -9% -11% -11% -11% -11% -12% -12% -13% -13% -13% -14% -15% -17% -21% -25% -25% -30% -31% -38% -6%

June 2006

Historically, investors have begun to trade on a bank’s forward-year earnings sometime during May, June, or July of the current year. However, in recent years trading on forward-year earnings has come earlier. In our judgment, this trend has been somewhat a function of the broader market having little confidence in current-year earnings. This year, the banks began trading on 2007 sometime in March/April.

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, in our opinion (see Exhibit 22).

Exhibit 22

FASTEST AND MOST CONSISTENT EARNINGS GROWERS (20 Highest Among Top 50 Banks as Ranked by Average Annual Growth) Rank

Company Name

Averag e

Avg. Ch g. In

2007E

Ticker

Annual Gr.

Gr. Rate (bps)

PEG

IFIN

35.7

-596.3

50% 80%

1

Investors Financial Services Corp.

2

East West Bancorp, Inc.

EWBC

33.6

202.5

3

Commerce Bancorp, Inc.

CBH

17.4

110.0

70%

4

City National Corporation

CYN

17.1

-180.0

130%

5

U.S. Bancorp

USB

15.9

-607.5

100%

6

North Fork Bancorporation, Inc.

NFB

15.9

54.0

100%

7

Zions Bancorporation

ZION

15.8

-138.0

110%

8

Synovus Financial Corp.

SNV

15.5

-85.0

110%

9

State Street Corporation

STT

14.4

51.0

100%

10

TCF Financial Corporation

TCB

14.3

-269.0

110%

11

M&T Bank Corporation

MTB

13.9

112.0

130%

12

Popular, Inc.

BPOP

13.7

-83.0

-

13

BOK Financial Corporation

BOKF

13.6

144.0

-

14

Marshall & Ilsley Corporation

MI

13.5

-152.0

120%

15

Fifth Third Bancorp

FITB

13.1

-305.0

100%

16

First Horizon National Corporation

FHN

12.7

-215.0

110%

17

Citigroup Inc.

C

12.5

-277.5

80%

18

Wells Fargo & Company

WFC

12.5

24.0

90%

19

UnionBanCal Corporation

UB

12.2

150.0

120%

20

Northern Trust Corporation

NTRS

AVERAGE TOP 50 BANKS

12.2

24.0

-

11.3

-80.9

116%

Note: outliers excluded from calculations Source: SNL DataSource, Baseline

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 two to three times for the regional banks, and four to five times for the processing banks during the 19992000 time frame.



June 2006

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 23).

Exhibit 23

TOP 50 BANKS RELATIVE ROE (1990-2005) 1 140% 104% Average 120% 100% 80% 60% 40% 20% 0% 0 9 9 1

1 9 9 1

2 9 9 1

3 9 9 1

4 9 9 1

5 9 9 1

6 9 9 1

7 9 9 1

8 9 9 1

9 9 9 1

0 0 0 2

1 0 0 2

2 0 0 2

3 0 0 2

4 0 0 2

5 0 0 2

Source: Baseline

Some Attractive Yield Opportunities

The spread between bank stock dividend yields and the 10-year U.S. Treasury is currently 235 basis points, as compared to a recent historical low of 70 basis points in June 2003, while still relatively narrow versus what we have typically witnessed during the last 15 years (see Exhibit 24).


June 2006

Exhibit 24

BANK STOCK DIVIDEND YIELD VERSUS 10-YEAR U.S. TREASURY YIELD (%) 9.00 Avg. Div. Yld, Top 50 Banks

8.00

10-Year UST Yield 7.00 6.00 5.00 4.00 3.00 2.00 1.00 0.00 1 9 9 1 / 3 0

1 9 9 1 / 1 1

2 9 9 1 / 7 0

3 9 9 1 / 3 0

3 9 9 1 / 1 1

4 9 9 1 / 7 0

5 9 9 1 / 3 0

5 9 9 1 / 1 1

6 9 9 1 / 7 0

7 9 9 1 / 3 0

7 9 9 1 / 1 1

8 9 9 1 / 7 0

9 9 9 1 / 3 0

9 9 9 1 / 1 1

0 0 0 2 / 7 0

1 0 0 2 / 3 0

1 0 0 2 / 1 1

2 0 0 2 / 7 0

3 0 0 2 / 3 0

3 0 0 2 / 1 1

4 0 0 2 / 7 0

5 0 0 2 / 3 0

5 0 0 2 / 1 1

Source: FactSet, Federal Reserve

0%

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 4.13% as of June 6 versus the 10-year Treasury at 5.01%, while TCF Financial is yielding 3.47%, and Wachovia is yielding 3.85% (see Exhibit 25).



June 2006

Exhibit 25

DIVIDEND PAYOUT RATIO AND DIVIDEND YIELD (Top 50 Banks, LTM As Of 1Q06, As Ranked By Payout Ratio) Dividends Declared

Core EPS

Dividend Payout

Dividend

Company Name

Ticker

LTM ($)

LTM ($)

Ratio LTM (%)

Yield (%)

South Financial Group, Inc.

TSFG

$0.66

$1.60

66%

2.46%

Regions Financial Corporation

RF

$1.37

$2.45

60%

3.94%

Whitney Holding Corporation

WTNY

$1.02

$1.75

59%

2.99%

Valley National Bancorp

VLY

$0.84

$1.44

59%

3.52%

Fifth Third Bancorp

FITB

$1.49

$2.68

55%

3.98%

Fulton Financial Corporation JPMorgan Chase & Co.

FULT

$0.55

$1.01

54%

3.81%

JPM

$1.36

$2.90

52%

3.23%

U.S. Bancorp

USB

$1.26

$2.49

51%

4.26%

BancorpSouth, Inc. BB&T Corporation

BXS BBT

$0.76 $1.52

$1.46 $3.11

50% 50%

3.12% 3.63%

Huntington Bancshares Incorporated

HBAN

$0.90

$1.84

50%

4.27%

TD Banknorth Inc.

BNK

$0.86

$1.96

49%

3.07%

AmSouth Bancorporation

ASO

$1.02

$1.97

49%

3.60%

North Fork Bancorporation, Inc. Sky Financial Group, Inc.

NFB SKYF

$0.94 $0.90

$1.90 $1.85

49% 48%

3.42% 3.68%

Bank of America Corporation

BAC

$1.95

$4.03

48%

4.13%

Wilmington Trust Corporation

WL

$1.20

$2.47

48%

3.00%

KeyCorp National City Corporation

KEY NCC

$1.32 $1.46

$2.78 $3.04

47% 47%

3.83% 3.98%

Wachovia Corporation

WB

$1.99

$4.20

47%

3.85%

Mellon Financial Corporation

MEL

$0.80

$1.94

45%

2.46%

PNC Financial Services Group, Inc.

PNC

$2.00

$4.73

44%

3.20%

Associated Banc-Corp Mercantile Bankshares Corporation

ASBC MRBK

$1.08 $1.02

$2.38 $2.30

44% 44%

3.52% 2.85%

Wells Fargo & Company

WFC

$2.04

$4.46

44%

3.10%

Comerica Incorporated Compass Bancshares, Inc.

CMA CBSS

$2.24 $1.44

$4.98 $3.38

44% 44%

2.86%

4.29%

TCF Financial Corporation

TCB

$0.87

$1.89

44%

3.47%

Synovus Financial Corp.

SNV

$0.74

$1.71

43%

2.95%

First Horizon National Corporation

FHN

$1.76

$2.72

43%

4.47%

Bank of Hawaii Corporation SunTrust Banks, Inc.

BOH STI

$1.40 $2.26

$3.40 $5.70

41% 41%

2.88% 3.20%

Colonial BancGroup, Inc.

CNB

$0.63

$1.52

40%

2.64%

Bank of New York Company, Inc.

BK

$0.83

$1.98

39%

2.57%

Cullen/Frost Bankers, Inc.

CFR

$1.20

$3.16

38%

2.40%

Citigroup Inc.

C

$1.81

$3.64

37%

4.03%

Popular, Inc.

BPOP

$0.64

$1.78

36%

3.35%

City National Corporation Northern Trust Corporation

CYN NTRS

$1.49 $0.88

$4.61 $2.93

32% 32%

1.64%

Marshall & Ilsley Corporation

MI

$0.96

$2.94

31%

2.37%

Webster Financial Corporation

WBS

$1.00

$3.33

30%

2.27%

Commerce Bancorp, Inc.

CBH

$0.46

$1.61

29%

1.23%

Commerce Bancshares, Inc.

CBSH

$0.93

$3.20

29%

1.96%

UnionBanCal Corporation

UB

$1.64

$5.20

28%

2.77%

Zions Bancorporation

ZION

$1.44

$5.32

28%

1.78%

State Street Corporation

STT

$0.74

$2.97

27%

1.23%

M&T Bank Corporation BOK Financial Corporation

MTB BOKF

$1.80 $0.40

$7.04 $3.05

26% 13%

2.08% 1.26%

East West Bancorp, Inc.

EWBC

$0.20

$2.02

10%

0.51%

Investors Financial Services Corp. AVERAGE TOP 50 BA NKS

IFIN

$0.08 $1.16

$2.19 $2.90

4% 41%

0.20% 2.95%

2.28%

Note: dividend yield as of 6/6/06 Source: SNL DataSource, ILX

Dividend payout ratios are currently averaging 41% for the bank group, down from 47% in 2001 (see Exhibit 26). 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.


June 2006

Exhibit 26

DIVIDEND PAYOUT RATIO ( Top 50 Banks, 1990-1Q06 LTM) 55% 51% 50%

47% 44%

43%

45%

40%

40% 35%

35% 36% 35% 36%

32%

40% 39%

37%

41% 42% 41%

29%

30% 25% 20% 15% 10% Y 0 9 9 1

Y 1 9 9 1

Y 2 9 9 1

Y 3 9 9 1

Y 4 9 9 1

Y 5 9 9 1

Y 6 9 9 1

Y 7 9 9 1

Y 8 9 9 1

Y 9 9 9 1

Y 0 0 0 2

Y 1 0 0 2

Y 2 0 0 2

Y 3 0 0 2

Y 4 0 0 2

Y 5 0 0 2

6 0 Q 1 M T L




June 2006

MEGA TRENDS—CONSOLIDATION, CREDIT QUALITY, AND NON-BANKING

In our assessment, three major trends impact investing in bank stocks: consolidation, credit quality, and exposure to non-banking businesses. In our assessment, the expansions into non-banking 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 organization’s 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 witnessed six years of weak M&A within the financial services space (see Exhibit 27) primarily due to lack of willing sellers at reasonable prices. The takeout multiples–namely, price-to-book and price-to-earnings–have remained exceptionally high.

Exhibit 27

BANK M&A DEALS (Target Asset Size > $10 Billion, 1991-2006) 10

7

7

6

6

5

5

5

3

3

2 1

1 9 9 1

2 9 9 1

2 1

3 9 9 1

4 9 9 1

1

5 9 9 1

6 9 9 1

7 9 9 1

8 9 9 1

9 9 9 1

0 0 0 2

Source: SNL DataSource, Piper Jaffray


1 0 0 2

2 0 0 2

1

3 0 0 2

4 0 0 2

5 0 0 2

D T Y 6 0 0 2

June 2006

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 continued net interest margin-related pressure and slowing retail banking growth. Additionally, banks must now utilize a purchase method of accounting for consolidation versus a historical performance for pooling-of-interest method. First Union’s 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. 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 branch networks by opening up new offices or on a de novo basis. Recent merger transactions within the New York marketplace, such as Capital One’s announced acquisition of North Fork and JPMorgan’s announced asset swap for Bank of New York’s branches, symbolize the increasing battle for market share in that region. Several other banks h ave aggressively expanded in New York during the last four years through de novo efforts, including Wachovia, Commerce Bancorp, and Bank of America. Among additional recent deals, Wachovia has announced the $26 billion acquisition of Golden West, expected to close in the fourth quarter of 2006. As part of the transaction, the company is expanding into faster growth regions in California, namely Los Angeles and San Francisco, while increasing total branches by 9%, or 285, to 3,503. In our assessment, Wachovia also improves its retail product breadth particularly in mortgages, establishing a pro forma No.7 mortgage banking market share. Nevertheless, the opportunities for bank acquisition-related growth in the southwestern and western United States remain limited, with many banks choosing instead to expand through de novo branching efforts in those markets. United Statesbased banks with the most aggressive de novo plans in 2006 include Wintrust, Commerce Bancorp, and AmSouth (see Exhibit 28).



June 2006

Exhibit 28

BRANCH COUNT AND GROWTH (As Ranked by 2006 New as % of Total) 12/03 Q

12/04 Q

12/05 Q

04-05

03-05

2006

2006 New

Company Name

Ticker

(Actual)*

(Actual)

(Actual)

Growth

Growth

Planned

Wintrust Financial Commerce Bancorp

WTFC CBH

36 270

50 319

62 373

24.0% 16.9%

72.2% 38.1%

11 65

as % of Tot. 17.7%

AmSouth

ASO

611

688

684

-0.6%

11.9%

64

9.4%

Washington Mutual

WM

1,680

1,930

2,140

10.9%

27.4%

175

8.2%

17.4%

Synovus

SNV

272

281

284

1.1%

4.4%

17

6.0%

Colonial BancGroup Inc.

CNB

274

292

301

3.1%

9.9%

18

6.0%

JPMorgan Chase^^^

JPM

2,471

2,508

2,641

5.3%

6.9%

150

5.7%

TCF Financial

TCB

401

430

453

5.3%

13.0%

25

5.5%

Fifth Third

FITB

952

1,011

1,119

10.7%

17.5%

50

4.5%

BB&T

BBT

1,359

1,413

1,404

-0.6%

3.3%

60

4.3%

Compass

CBSS

376

382

384

0.5%

2.1%

15

3.9%

Webster Financial

WBS

119

152

157

3.3%

31.9%

6

3.8%

Wells Fargo

WFC

3,000

3,112

3,146

1.1%

4.9%

100

3.2%

Zions Bancorp. First Citizens

ZION FCNCA

412 379

386 386

473 391

22.5% 1.3%

14.8% 3.2%

15

3.2%

12

3.1%

Regions Financial

RF

681

1,322

1,311

-0.8%

92.5%

PNC National City

PNC NCC

719 1,114

776 1,222

840 1,220

8.2% -0.2%

16.8% 9.5%

40 25

3.1% 3.0%

35

2.9%

Wachovia^^

WB

3,314

3,344

3,131

-6.4%

-5.5%

85

2.7%

TD Banknorth

BNK

359

386

396

2.6%

10.3%

10

2.6%

SunTrust U.S. Bancorp

STI USB

1,183 2,243

1,676 2,370

1,657 2,419

-1.1% 2.1%

40.1% 7.8%

35 50

2.1% 2.1%

Bank of America^

BAC

5,594

5,885

5,873

-0.2%

5.0%

100

1.7%

KeyCorp

KEY

906

935

947

1.3%

4.5%

13

1.4%

M&T Bank

MTB

684

663

658

-0.8%

-3.8%

5

0.8%

Citigroup

C

816

817

896

9.7%

9.8%

70-100#

na

Note: midpoint used when company gives range *June 2003 at BAC, WFC, WB, C încludes FBF; ^încludes SOTR; ^^încludes ONE # global new branch openings BOLD denotes acquisition Source: SNL DataSource, company reports, Piper Jaffray estimates

As deposits have become an increasingly valuable source of funding, many banks have increased the 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 non-performing assets did not surface until shortly thereafter. 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. Real estate concentrations were cited for bank failures in the southwestern and the northeastern United States. The ratio of net charge-offs to total loans increased to 1.57% in 1991 versus current levels of roughly 0.60% (see Exhibit 29).


June 2006

Exhibit 29

INDUSTRY NET CHARGE-OFF RATIOS (1960-2007E) 1991 1.57%

1.60% 1.40%

2002 1.11%

1.20% 1.00% 0.80%

Ave ra ge 0.58%

0.60% 0.40%

2007E 0.62%

0.20% 0.00%

0 6 9 1

2 6 9 1

4 6 9 1

6 6 9 1

8 6 9 1

0 7 9 1

2 7 9 1

4 7 9 1

6 7 9 1

8 7 9 1

0 8 9 1

2 8 9 1

4 8 9 1

6 8 9 1

8 8 9 1

0 9 9 1

2 9 9 1

4 9 9 1

6 9 9 1

8 9 9 1

0 0 0 2

2 0 0 2

4 0 0 2

E 6 0 0 2

Source: Piper Jaffray, FDIC

Several of the nation’s 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 (both now under Bank of America) 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 2001-2002 when the government effectively defaulted, many companies went out of business, and unemployment soared. The most pronounced weakening during the 2001-2003 time frame was overexposure to telecom, technology, and merchant energy businesses. In our assessment, these credit losses were 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 during 2001-2003. We are currently focused on automobiles, airlines, and asset-based lending exposure as potential areas of weakness in 2006-2007. 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.



June 2006

Non-Banking Trends

Among the top 10 major U.S. banks, fee-related businesses generate 38% of total earnings at U.S. commercial banks, including investment banking at 13%, processing at 10%, asset management at 8%, and credit cards at 7% (see Exhibit 30). The traditional commercial and consumer banking businesses contribute 62% of total earnings.

Exhibit 30

LARGE-CAP BANKS 2007E EARNINGS MIX NonTraditional

Cards, 7%

Asset Mg mt , 8%

Retail, 37%

Processing, 10%

Traditional Banking, 62% Investment Banking, 13% Corporate, 12%


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 JPMorgan and Bankers Trust, which had pushed into investment banking products in the early 1990s. Several regional banks also acquired small investment bank boutiques in 1997-1998, including NationsBank’s acquisition of Montgomery, Bank of America’s purchase of Robertson Stephens, and U.S. Bancorp’s acquisition of Piper Jaffray. In addition, many foreign banks acquired U.S. investment banks including Credit Suisse’s purchase of DLJ Securities in the summer of 2000, UBS’s acquisition of Paine Webber, and Chase Manhattan’s acquisition of JPMorgan in the summer of 2000. Many of the biggest investment banks have increasingly expanded into trading in commodities, foreign exchange, and derivatives, ignoring historical drivers such as equity issuance and mergers and acquisitions. In fact, we estimate the top four pureplay investment banks generated roughly 2/3 of total revenues from trading in various instruments during 2005. In contrast, traditional commercial banks such as JPMorgan Chase and Citigroup have attempted to expand in all areas of investment banking with particular success in equity, fixed income, and international M&A.


June 2006

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 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 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 feebased 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 economiesof-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 JPMorgan 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 with State Street, Northern Trust, and Bank of New York recently paying very high prices for acquisitions. Processing revenues are highly dependent upon equity market values and volumes across several markets; thus with a generally improving capital markets environment, we would expect revenues to increase also.

Credit Cards

The competitive environment within the U.S. card market has become increasingly economies-of-scale driven, with a focus on unit cost reduction and portfolio diversification. As a result, we have witnessed significant card industry consolidation over the last ten years, as the top ten players now control 85% of the U.S. credit card market, up from 55% in 1996. Perhaps more surprisingly, the share of the top three players—namely Bank of America, Citigroup, and JPMorgan Chase—has nearly doubled to 53% of industry outstandings from 27% for the top three in 1996. The recent combinations of JPMorgan Chase and Bank One, as well as Bank of America and MBNA, have created two additional credit card behemoths to compete with Citigroup, with roughly $140 billion in U.S. outstandings each, as of year-end 2005 (see Exhibit 31).



June 2006

Exhibit 31

AVERAGE MANAGED BALANCES – FULL YEAR

BAC* JPM*** C ** AXP MS COF HSBC WM WFC USB Total

2003 $137,638 $128,692 $143,700 $41,600 $50,864 $41,308 $35,288 $17,640 $7,640 $5,525 $609,895

2004 $139,324 $135,370 $136,800 $45,400 $47,387 $45,813 $38,253 $17,204 $8,878 $6,090 $620,519

2005 $140,004 $138,389 $136,500 $48,900 $47,330 $46,827 $25,642 $18,537 $10,663 $6,615 $619,407

03-05 % chg 0.9% 3.7% -2.5% 8.4% -3.5% 6.5% -14.8% 2.5% 18.1% 9.4% 0.8%

04-05 % chg 0.5% 2.2% -0.2% 7.7% -0.1% 2.2% -33.0% 7.7% 20.1% 8.6% -0.2%

* Pro-forma MBNA, including foreign ** Including Sears addition of $27 billion in 2003E & foreign ***Includes ONE in 2003 Source: Company reports, Piper Jaffray

In our assessment, managed credit card balance growth has been anemic over the last few years. Card economics could certainly improve with a steepening in the yield curve. Additionally, we may witness card balance growth accelerate under a scenario in which consumers notice little difference between home equity and credit card interest rates. Home equity has clearly supplanted card growth during the last five years.

Mortgage Banking

Overall, mortgage originations in the United States fell to $2.76 trillion in 2005, down from $2.77 trillion in 2004. Mortgage Bankers Association estimates $2.37 billion in originations during 2006 (see Exhibit 32). Expectations for the mortgage market beyond 2006 seem to be somewhat mixed, since sales and prices of single family homes reached a peak in July 2005.


June 2006

Exhibit 32

MORTGAGE ORIGINATIONS (1990-2008E) $ Bn $4,500 $4,000 $3,500

Refinance Originations Purchase Originations

$3,000 $2,500 $2,000 $1,500 $1,000 $500 $ 0 9 9 1

1 9 9 1

2 9 9 1

3 9 9 1

4 9 9 1

5 9 9 1

6 9 9 1

7 9 9 1

8 9 9 1

9 9 9 1

0 0 0 2

1 0 0 2

2 0 0 2

3 0 0 2

4 0 0 2

5 0 0 2

E 6 0 0 2

E 7 0 0 2

E 8 0 0 2

Source: Mortgage Bankers Association

We think rising short-term interest rates will continue to have a modest dampening impact on demand for housing and thus mortgages, as evidenced by increasing inventory and modest pricing pressure—particularly in the western United States . Although some of this decline may be attributable to seasonality, home sales in the west have dropped somewhat steadily by 12% year over year to a 1.43 million monthly rate in March. In contrast, monthly home sales have been increasing in the northeast and southern U.S. markets over this same time frame. Countrywide and Wells Fargo have continued to take mortgage market share from the competition with leading positions in the traditional one- to four-family mortgage origination and servicing markets. These two generated 4% of total origination volumes during 2005, with respectable results also at Washington Mutual, JPMorgan Chase, and Bank of America (see Exhibits 33 and 34).



June 2006

Exhibit 33

TOP 10 MORTGAGE ORIGINATORS ($ In Billions) Countrywide Financial

$1,111.1 $838.3

Wells Fargo Home Mtg.

$1,005.4 782.4 $746.8 727.6

Washington Mutual Chase Home Finance

$604.2 562.7 $403.2 364.3

CitiMortgage, Inc.

$368.4 332.5

Bank of America

Dec-05

$288.8 231.8

GMAC Residential

Dec-04

$206.0 201.2

ABN Amro Mo rtg age National City Mortgage

$169.6 165.1 $157.3 145.7

PHH Mortgage

Source: National Mortgage News and SourceMedia Inc.

Exhibit 34

TOP 10 MORTGAGE SERVICERS ($ In Billions) $133.1

Countrywide

$95.3 $116.5

Wells Fargo

69.1 $60.0 59.0

Washington Mutual Chase Home Finance

$44.5 44.4 $40.2 34.6

Bank of America

$32.0 25.4

CitiMortgage EMC Mortgage GMAC-RFC GMAC Residential IndyMac

$23.2 16.2 $20.9 10.9 $19.4 24.1 $18.0 11.2

Source: National Mortgage News and SourceMedia Inc.


4Q05 4Q04

June 2006

In our assessment, strong retail distribution networks appear to generate healthier margins and more limited reliance on gain on sale accounting. Offsetting any higher rate-related downturn in originations could be significant increases in mortgage servicing income, as the value of servicing portfolios generally reacts favorably to higher rate environments.

Technology And The Evolution

Banks have traditionally spent anywhere from 10%-15% of total expenses on technology 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 Fargo’s 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.



June 2006

HISTORY OF BANKING

Regulatory And Legislative History— The Pendulum Swings Back

In our assessment, banks are once again becoming subjected to increased levels of scrutiny by regulators and legislators after experiencing several years of positive regulatory developments. On the national level, the regulators have recently created “tactical” rules, such as increased scrutiny of those banks with high levels of commercial real estate exposure relative to capital and disclosure of exotic mortgage lending totals. 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 bank’s 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 statemember 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 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.


June 2006

Throughout the 1970s and 1980s, banks found it increasingly difficult to compete with non-banks as regulatory barriers were lifted. Funding cost advantages narrowed and asset securitization became more typical. Banks became unsheltered from non-bank 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 non-banks 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. More recent regulatory measures include guidance on home mortgage exposure, particularly exotic mortgages, and commercial real estate exposure relative to riskbased capital. Under a scenario of increased economic weakness, we would expect some more overt moves by legislators and regulators to ensure safety and soundness within the banking system.



June 2006

DEFINITIONS

Basic Analysis

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+GainAFS 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 Leverage Ratio

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

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 InterestBearing 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)

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


June 2006

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.

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 Non-Interest 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 non-interest 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 Non-Interest Expense

The total of salaries, employee benefits, and expenses of premises and fixed assets and other non-interest expense.

Income Before Income Tax & Extra Items

The bank's pretax operating income: Net interest income less provisions for loan and lease losses and provision for allocated transfer risk and total non-interest income plus or minus gains (losses) on securities not held in trading accounts less total non-interest 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.

Income Before Extraordinary

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



June 2006

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 bank’s 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


June 2006

Balance Sheet

Cash & Balances Due

The total of all non-interest-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 passthrough 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.

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.



June 2006

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 l ease 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 offbalance 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 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 non-majority-owned corporations whose principal activity is the ownership of land, buildings, equipment, furniture, etc., occupied or used by the bank.

OREO (Including Real Estate Held for Investment)

The book value, less accumulated depreciation, if any, of all real estate other than bank premises owned or 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.


June 2006

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.

FHLB Advances

Advances from the Federal Home Loan Bank. Includes advances used to purchase AsAgent 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



June 2006

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 & Mandatory Convertible Security

The amount of outstanding subordinated notes and 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 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 non-interest-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.


June 2006

COLLINS INDUSTRY AND COMPANY REPORTS Industry Reports June-06

The Zing In Consumer Banking: Bankruptcies, Customer Service & The Internet

May-06

U.S. Card Industry In Transition: From Borrower to Transactor

May-06

Retail Banking: The Next Industry Consolidation Catalyst?

April-06

A Seismic Shift In Loan Profitability

March-06

Regulators Sharpen Pencils On CRE

November-05

Competing For Deposit Market Share

November-05

Spanning the Lone Star State

October-05

Bank Stock Investing Strategies for 2006-2007

October-05

Competitive State of the U. S. Personal W ealth Business

October-05

Exploring The Banking Opportunity In Asia

July-05

Housing Market & Bank Stocks

June-05

Watching The Dividend Calendar

May-05

Farewell to Deposit Fee Golden Goose?

May-05

Middle-Office Outsourcing

April-05

Deposit Competition And The Fed

March-05

Simulating For A 'Bear' Rate Flattening Outlook for Pension Restatements

February-05 January-05

Myths & Realities of Retail Banking

Company Reports April-06

OSBC

Healthy Long-Term Fundamentals, But Near-Term Headwinds

March-06

WFC

A Consistent Growth Story; Reiterate Outperform

March-06

TCB

Dark Cloud Lifting, Attractive Valuation

March-06

ZION

A Well-Prepared Game Plan In High-Growth Markets

February-06

SNV

Initiated Coverage With Outperform Rating; $30 Price Target

January-06

BAC

A Look At The 2005-2007 Growth Drivers

January-06

CNB

Initiated Coverage With Market Perform; $26 Price Target

January-06

WTFC

A Great Little Customer Service-Focused Franchise; Reiterate Outperform

September-05

C

Continued Work In Progress; Maintain Market Perform

September-05

BAC

Addressing Investor Concerns; Reiterate Outperform

June-05

C

The Dark Cloud Begins To Dissipate

May-05

MEL

Initiated Coverage With Market Perform

May-05

NTRS

A Day With Customer-Service-Focused Northern Trust

March-05

WFC

Managing For Higher Growth; Reiterate Outperform

Periodicals May-06

1Q06 Earnings Wrap-Up

April-06

1Q06 Earnings Preview

April-06

Growth Banks 1Q06 Earnings Preview

February-06

4Q05 Earnings Wrap-up

January-06


January-06

Smid-cap 4Q05 Earnings Preview

November-05

3Q05 Earnings Wrap-Up

October-05


October-05

Smid-cap 3Q05 Earnings Preview

July-05

2Q05 Earnings Wrap-Up/Model Update

July-05

2Q05 Smid-Cap Earnings Preview

July-05

Second Quarter 2005 Earnings Preview

April-05


April-05


April-05

1Q05 Large-Cap Earnings Preview

February-05


January-05


January-05





June 2006

Important Research Disclosures

Note: Distribution of Ratings/IB Services shows the number of companies in each rating category from which Piper Jaffray and its affiliates received compensation for investment banking services within the past 12 months. NASD and NYSE rules require disclosure of which ratings most closely correspond with "buy," "hold," and "sell" recommendations. Accordingly, Outperform corresponds most closely with buy, Market Perform with hold, and Underperform with sell. Outperform, Market Perform and Underperform, however, are not the equivalent of buy, hold or sell, but instead represent indications of relative performance. See Rating Definitions below. An investor's decision to buy or sell a security must depend on individual circumstances.

Analyst Certification – Andrew B. Collins, Senior Research Analyst The views expressed in this report accurately reflect my personal views about the subject company and the subject security. In addition, no part of my compensation was, is, or will be directly or indirectly related to the specific recommendations or views contained in this report.

This report has been prepared by Piper Jaffray & Co. or its affiliate Piper Jaffray Ltd., both of which are subsidiaries of Piper Jaffray Companies (collectively “Piper Jaffray”). Piper Jaffray & Co. is regulated by the NYSE, NASD and the United States Securities and Exchange Commission, and its headquarters is located at 800 Nicollet Mall, Minneapolis, MN 55402. Piper Jaffray Ltd. is incorporated under the laws of the England and Wales and is authorised and regulated by the UK’s Financial Services Authority, and is a member of the London Stock Exchange, and is located at 18 King William Street, London, EC4N 7US. . Piper Jaffray research analysts receive compensation that is based, in part, on overall firm revenues, which include investment banking revenues.

Complete disclosure information, price charts and ratings distributions on companies covered by Piper Jaffray Equity Research can be found on the Piper Jaffray website: http://piperjaffray.com/researchdisclosures or by writing to Piper Jaffray, Equity Research Department, 800 Nicollet Mall, Minneapolis, MN 55402


June 2006

Rating Definitions Investment opinions are based on each stock’s return potential relative to broader market indices, not on an absolute return. The relevant market indices are the S&P 500 and Russell 2000 for U.S. companies and the FTSE Techmark Mediscience index for European companies. • • • •

Expected to outperform the relevant broader market index over the next 12 months. Expected to perform in line with the relevant broader market index over the next 12 months. Expected to underperform the relevant broader market index over the next 12 months. No active analyst investment opinion or no active analyst coverage; however, an analyst investment opinion or analyst coverage is expected to resume.

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 i ndividual investor. Rather, it identifies the volatility of a particular stock. • •

•

The stock price has moved up or down by more than 10% in a month in fewer than 8 of the past 24 months. The stock price has moved up or down by more than 20% in a month in fewer than 8 of the past 24 months. 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.



June 2006

Other Important Information The material regarding the subject company is based on data obtained from sources deemed to be reliable; it is not guaranteed as to accuracy and does not purport to be complete. This report is solely for informational purposes and is not intended to be used as the primary basis of investment decisions. Because of individual client requirements, it is not, and it should not be construed as, advice designed to meet the particular investment needs of any investor. This report is not an offer or the solicitation of an offer to sell or buy any security. Unless otherwise noted, the price of a security mentioned in this report is the market closing price as of the end of the prior business day. Piper Jaffray does not maintain a predetermined schedule for publication of research and will not necessarily update this report. Piper Jaffray policy generally prohibits research analysts from sending draft research reports to subject companies; however, it should be presumed that the analyst(s) who authored this report has had discussions with the subject company to ensure factual accuracy prior to publication, and has had assistance from the company in conducting diligence, including visits to company sites and meetings with company management and other representatives. This report is published in accordance with a conflicts management policy, which is available at http://www.piperjaffray.com/researchdisclosures. This material is for the use of i ntended recipients only and only for distribution to professional and institutional investors, i.e. persons who are authorised persons or exempted persons within the meaning of the Financial Services and Markets Act 2000 of the United Kingdom, or persons who have been categorised by Piper Jaffray Ltd. as intermediate customers under the rules of the Financial Services Authority. This report is distributed in the United States by Piper Jaffray & Co., member SIPC and NYSE, Inc., which accepts responsibility for its contents. The securities described in this report may not have been registered under the U.S. Securities Act of 1933 and, in such case, may n ot be offered or sold in the United States or to U.S. persons unless they have been so registered, or an exemption from the registration requirements is available. Customers in the United States who wish to effect a transaction in the securities discussed in this report should contact their Piper Jaffray & Co. sales representative. This material is not directed to, or intended for distribution to or use by, any person or entity if Piper Jaffray is prohibited or restricted by any legislation or regulation in any jurisdiction from making it available to such person or entity. This report may not be reproduced, re-distributed or passed to any other person or published in whole or in part for any purpose without the written consent of Piper Jaffray. Additional information is available upon request. © 2006 Piper Jaffray & Co. and/or Piper Jaffray Ltd. All rights reserved.


June 2006

NOTES



June 2006

Equity Research MINNEAPOLIS 800 Nicollet Mall Suite 800 Minneapolis, MN 55402 612 303-6000 800 333-6000

CHICAGO Hyatt Center, 24th Floor 71 South Wacker Drive Chicago, IL 60606 312 920-3200 800 973-1192

SAN FRANCISCO 345 California Street Suite 2200 San Francisco, CA 94104 415 277-1500 800 214-0540

EAST PALO ALTO 1950 University Avenue Suite 200 East Palo Alto, CA 94303 650 838-1300 800 981-1203

NEW YORK 245 Park Avenue, 33 rd Floor New York, NY 10167 212 284-9300 800 982-0419

LONDON 18 King William Street London EC4N 7US +44 20 7743 8700

Web Site: http://www.piperjaffray.com

06-0063

Jefferies-Bank-Primer.pdf

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