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  • Tonight we will be going through an analysis of the financial sector in both the S&P 500 as well as the SIM. We will also look at how the financial sector is broken up into industries and what the current and future outlook is for the sector in general. Ryan will take us through the business and industry cycles (which you’ve seen 3 times tonight), financial evaulation of the sector, economic indicators and lastly, our recommendations.
  • We’ll be quick here, since you’ve already since this chart a bunch tonight. The current weight of the financial sector is 10.62%, down from 18.6% a year ago. This can all be explained by the implosion of the financial world.
  • The current weight of the financial sector in the SIM is 9.59%, making the SIM underweighted by 113 basis points. It was the recommendation last quarter to underweight by 200 basis points, so you can see that as the market continued the correction, we fell more in line with the S&P 500.
  • We currently hold Goldman Sachs, Wells Fargo, and BRK/A (which holds a stake in each of these companies. You can see that BRK/A is our largest holding in the sector, comprising 46%.
  • Just to give you some idea, if you had your head buried in the sand recently, of the chaos in the sector. The S&P has declined 8.6% in the YTD, while the financials have declined by 25.4%. Both BRKA and GS are performing well compared to the sector, and Wells Fargo, not so much.
  • The financial sector is pretty convoluted, with a ton of industries. The S&P breaks up the classification into 8 categories, which you can see here. These classifications are subjective, with most sources grouping them together differently. The largest is in the diversified financial industry, which is consumer and commercial based products and services, including lending, insurance, securities and investment services. Commercial banks are also pretty heavily weight within the S&P 500 financials. Stories: Diversified financial services: SEC regulations, don’t know what that looks like, people becoming unemployed, a lot of companies cutting 401K matching Commercial Banks: low interest rates leading to smaller profit margins, stricter lending requirements leading to fewer loans originating, but within the industry, regional banks might be a place to look (low exposure to sub-prime and mid-prime securities, people looking to smaller and local banks to put money into, national savings rate is slowing increasing). Insurance: when people are unemployed, insurance premiums might become a luxury (example auto, home, health, pet). Also have increased payouts due to stress related illnesses. Capital markets: due to recession, less people have as much discretionary income to invest into the capital markets, even if still employed, some may be cutting back on retirement savings REITs: just bad bad bad. Housing taken a hit, speculation that commercial will be next, many projects being put on the back burner, less money to expand. Consumer finance: again, layoffs mean less savings for retirement, companies are trying to save money by not matching 401Ks, stricter lending practices, greater foreclosure rates; forced by gov’t to take a loss, bankruptcy judges may changes terms of loan Thrifts and mortgage finance: fewer people making large purchases in recession, large number of foreclosures occuring Real estate management and development: prices are falling after boom, large number of inventory on the market
  • This is a list generated from Yahoo Finance so you can get a taste for all the various segments within the industry. Not quite 83, but I’m sure that you could break these up further if you delve a little deeper.
  • These are the top 5 leaders within the monetary banking industry based on market cap. You can see that the P/E ratio is pretty variable at the moment. Again, WFC is highlighted because we own it currently.
  • These are the leaders in the property and casualty insurance industry, the P/E ratios are fairly consistent if you exclude BRKA.
  • Goldman Sachs currently leads the diversified investment industry, but as you all know, there’s been fast and furious reorganization throughout many of the industries, but pretty apparent here. Also, there is a large amount of variability in P/E ratios across the sector and within the industries in general.
  • Currently, things are pretty horrific within the financial industry. Many banks are continuing to delever and thus most have lost money in the 4 th quarter. There is also rapid consolidation with the sector, BOA purchasing Merrill Lynch, Wells Fargo acquiring Wachovia. The interest rates in the US are at historic lows, as well as in Britian. The EU hasn’t gone below 2% but there is speculation that it will soon follow. Many companies are laying off workers in a bid to save costs. There is also a very poor perception of the sector due to the bailout, most people don’t think it was necessary, and the bonuses that were paid, and in some cases are being paid. The recession is being blamed on the risks that were taken by the financial sector due to decreased regulation. The other issue is the evolving TARP rules. Many banks have qualified for the loans but are actually turning them down because the gov’t keeps changing the rules, specifically regarding executive compensation, dividends and what can be done with the money.
  • Program is supposed to address roots of problem (defaulting loans and rotten assets.) Receipents will be required to lend the funds Politics at it’s finest: if America doesn’t like it, we’ll just rename it Injected money will purchase preferred shares Top government officials, including Mr. Geithner, his predecessor Henry Paulson and Federal Reserve Chairman Ben Bernanke have said there needs to be a government entity empowered to wind down failed financial institutions that aren't banks.
  • The future of the financial sector is really uncertain. The SEC has said it will step up regulation of Wall Street but not how it will be done. We think there will be further consolidations as the recession takes a further toll on banks/investment houses. There is also speculation that nationalization of banks could become a real possibility if the new bailout package doesn’t “work.” In addition, some experts are saying that the removal of bad debt will actually cause further problems initially because banks will have to remove it from the balance sheets at current prices, leading to further losses. John Q. Public doesn’t have a lot of faith in the financial sector at the moment, due to the huge losses suffered, in addition to the Madoff scandal. This will cause less investment into the market.
  • Taking out bubble, showing mean decreasing, but we are still high compared to historic values.
  • This puts us 150 bps below. By underweighting, we are reducing exposure, but not putting us so unexposed we miss potential upswing.
  • Financials

    1. 1. Financial Sector Kate Farley Ryan O’Connor
    2. 2. Agenda <ul><li>S&P and SIM Sector Analysis </li></ul><ul><li>Financial Sector Analysis </li></ul><ul><li>Current and Future Sector Outlook </li></ul><ul><li>Business and Industry Cycles </li></ul><ul><li>Financial Evaluation </li></ul><ul><li>Economic Indicators </li></ul><ul><li>Recommendations </li></ul>
    3. 3. S&P 500 Sector Weights
    4. 4. SIM Sector Weight <ul><li>S&P Financial Weight: 10.72% </li></ul><ul><li>SIM Weight: 9.59% </li></ul><ul><li>Currently underweighted by 113 bps </li></ul>
    5. 5. Current Holdings in 1Q09 <ul><li>Berkshire Hathaway (BRKA) </li></ul><ul><li>Goldman Sachs (GS) </li></ul><ul><li>Wells Fargo (WFC) </li></ul>
    6. 6. SIM Financial Sector Returns Berkshire Hathaway Goldman Sachs Wells Fargo SP 500 SP Financials % YTD -7.35% -4.34% -35.89% -8.62% -25.45% % 2008 -31.78% -60.76% -2.35% -37.44% -52.62%
    7. 8. Select Financial Segments <ul><li>Foreign Money Center Banks </li></ul><ul><li>Money Center Banks </li></ul><ul><li>Property & Casualty Insurance </li></ul><ul><li>Life Insurance </li></ul><ul><li>Diversified Investments </li></ul><ul><li>Foreign Regional Banks </li></ul><ul><li>Closed-End Fund - Debt </li></ul><ul><li>Credit Services </li></ul><ul><li>Regional - Midwest Banks </li></ul><ul><li>Asset Management </li></ul><ul><li>REIT - Retail </li></ul><ul><li>Investment Brokerage – National </li></ul><ul><li>Regional – Northeast Banks </li></ul><ul><li>Savings & Loans </li></ul><ul><li>Accident & Health Insurance </li></ul><ul><li>Investment Brokerage – Regional </li></ul><ul><li>Closed-End Fund - Equity </li></ul><ul><li>REIT - Residential </li></ul><ul><li>Regional - Mid-Atlantic Banks </li></ul><ul><li>REIT - Industrial </li></ul><ul><li>Insurance Brokers </li></ul><ul><li>REIT - Healthcare Facilities </li></ul><ul><li>Regional - Pacific Banks </li></ul><ul><li>Property Management </li></ul><ul><li>Regional - Southwest Banks </li></ul><ul><li>Regional - Southeast Banks </li></ul><ul><li>REIT - Diversified </li></ul><ul><li>Mortgage Investment </li></ul><ul><li>Surety & Title Insurance </li></ul><ul><li>Closed-End Fund - Foreign </li></ul><ul><li>REIT - Office </li></ul><ul><li>REIT - Hotel/Motel </li></ul><ul><li>Real Estate Development </li></ul>
    8. 9. Leaders in Monetary Banks Market Cap P/E JP Morgan 89.77B 17.58 Wells Fargo 78.63B 24.58 Royal Bank of Canada 33.49B 9.23 Bank of NY Mellon Co. 31.18B 22.57 BOA 26.59B 9.57
    9. 10. Market Cap P/E Berkshire Hathaway 140.20B 17.91 Travelers 22.93B 8.13 Chubb Corporation 15.13B 8.73 ACE Limited 14.27B 8.30 Allstate 11.73B NA
    10. 11. Market Cap P/E Goldman Sachs 116.90B 15.3 Morgan Stanley 38.24B 18.51 CME Group 11.49B 11.17 NYSE Euronext 5.52B 7.35 Nasdaq OMX 4.29B 11.10
    11. 12. Current Industry Conditions <ul><li>Firms getting rid of “toxic” assets </li></ul><ul><li>Recession and layoffs </li></ul><ul><li>Poor public perception </li></ul><ul><li>Evolving TARP Rules - Executive compensation limits - Dividends - Monies loaned only used for lending </li></ul>
    12. 13. Financial Stability Plan <ul><li>Vagueness released today </li></ul><ul><li>Four main routes of action </li></ul><ul><ul><li>Equity injections into banks </li></ul></ul><ul><ul><li>Programs to help homeowners </li></ul></ul><ul><ul><li>Expansion of consumer lending </li></ul></ul><ul><ul><li>Allow banks to get rid of bad assets </li></ul></ul><ul><ul><ul><li>Public-private joint venture </li></ul></ul></ul>
    13. 14. Future Industry Conditions <ul><li>SEC to increase regulation </li></ul><ul><li>Further consolidations </li></ul><ul><li>Possible nationalization of banks </li></ul><ul><li>Removing “toxic” debt could make things worse before they get better </li></ul><ul><li>Less faith in the markets </li></ul>
    14. 15. &quot;There will be time for them to make profits, and there will be time for them to get bonuses. Now is not that time.” ~ President Obama
    15. 16. Seguin-Associates Financial Services Ltd.
    16. 19. Problems With Financial Valuation <ul><li>Stock Val data doesn’t have 2008 sector data </li></ul><ul><li>- Based on 2007, nothing has changed except profit. 2008 was when deleveraging occurred. </li></ul><ul><li>Price to Book Ratios’ accuracy questionable </li></ul>
    17. 23. Industry Safety <ul><li>Broad categories have performed worse than S&P 500 since 2006 </li></ul><ul><li>Individual industries may provide some safety </li></ul><ul><li>Individual companies have outperformed with respect to the market </li></ul>
    18. 24. Real Estate Woes <ul><li>Estimated $3.3 Trillion loss to date </li></ul><ul><li>“mid-prime” loans are failing </li></ul><ul><ul><li>Brought down Indy-Mac </li></ul></ul><ul><ul><li>Poses problems for insurance companies </li></ul></ul><ul><ul><li>US Banks hold ~ $800B </li></ul></ul><ul><li>Commercial Real Estate is expected to decline in value </li></ul>
    19. 25. 4Q08 SIM Activity <ul><li>Sold Bank of America and Merrill Lynch </li></ul><ul><li>Purchased Wells Fargo </li></ul><ul><li>Recommended to hold underweighting at 200bps </li></ul>
    20. 26. Recommendations <ul><li>Further underweight to a total of 150 bps </li></ul><ul><ul><li>Reduces Exposure </li></ul></ul><ul><ul><li>Keeps the fund in the game when upside occurs </li></ul></ul>