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Special Report

Making Sense of the Banks

Maybe you've considered owning your own piece of Wall Street, a la shares in Chase Manhattan or Citigroup. Or your neighbor, the local bank president, has been after you to invest in his community bank.

What's stopping you? Not sure what you would be getting yourself into?

You're not alone. Evaluating whether a bank is worthy of your investment dollars can be tricky. Customer confidentiality laws allow these buyers and sellers of money to keep much of their business under wraps, and Morningstar's handy Quicktake reports unfortunately don't give a complete picture of banks' financial results. That means extra work for you, the savvy investor, but the good news is the data you need to properly evaluate a bank is easy to find.

What's more, now appears to be a smart time to buy in the banking sector. Stock prices have been down so far this year due to concerns over rising interest rates and the lengthening economic cycle. When the sector rebounds, expect the stronger-performing banks to do well.

Know Thy Institution
Before diving into a bank's financial statements, take time to understand its business. A three-branch neighborhood savings and loan, known in the industry as a "thrift," will have a much different strategy than a regional commercial bank that caters to mid-sized businesses or a huge international bank with branches worldwide. A bank's size and scope affects its financial performance--something to keep in mind during your analyses of these companies.

Get Crunching
Now, on to the numbers. The data you need to determine if a bank has been doing well is available in a publicly held bank's 10Q and 10K reports. Those reports can be retrieved for free from All banks--including privately owned banks--must also file quarterly financial information with the Federal Deposit Insurance Corporation. Those results, as well as performance averages for banks of different sizes and regions of the country, are available for free at

Now that you're armed with a few 10Qs and Ks, let's start by looking at a bank's performance ratios, specifically the return-on-equity and return-on-assets figures. Those ratios can quickly tell you whether an institution is prudently managing its cash and assets. In recent quarters, highly profitable commercial banks have posted ROEs in the high teens to low 20s, while ROAs have been be around 2%. For example, Fifth Third FITB, one of the industry's best-run regional banks, reported a 19.6% ROE and a 2.12% ROA for the second quarter.

Thrifts, on the other hand, tend to have slightly lower ROE and ROA ratios than commercial banks because most thrifts specialize in services for consumers--not businesses. Unfortunately for those thrifts, corporate customers are usually more profitable than consumer customers. Businesses' deposit accounts often do not earn interest (giving a bank access to free cash) and the loans companies take out have higher interest rates than consumers' mortgages. A look at Dime DME, a well-regarded New York-based thrift, illustrates this difference. Dime reported an ROE of 16.73% in the second quarter and an ROA of 1.15%. Fifth Third's ratios were higher, but corporate customers make up about 44% of its loan portfolio.

If a bank or thrift's ROE and ROA have been below the high-performance level in recent quarters, don't immediately disregard their investment potential. If the ratios have been rising quarter-over-quarter, it may indicate that the company is reallocating its resources. That may be a promising reason to buy the stock.

 Banks vs. Thrifts
Bank or Thrift 2Q ROE % 2Q ROA %
Chase Manhattan CMB Bank 22.5 1.33
Fifth Third FITB Bank 19.6 2.12
Fleet Financial FLT Bank 19.4 1.65
National City NCC Bank 21.9 1.68
Wells Fargo WFC Bank 17.5 1.86
Bank Industry Average 15.0 0.90
Dime DME Thrift 16.7 1.15
Peoples Heritage PHBK Thrift 18.8 1.25
Thrift Industry Average 12.6 0.90
Banks typically reported higher second quarter ROE's than thrifts.
Sources: Companies, Morningstar