IN: SIVY ON STOCKS from money.com June 6, 2001 Why aren't banks doing better? Interest rate trends couldn't be more favorable, but leading banks such as J.P. Morgan and Bank One can't get any traction. By Michael Sivy If I were asked to name the single most important stock market indicator, I'd say the tilt of the yield curve. When long-term interest rates are at least half a percentage point higher than short-term rates, the economy typically grows at a healthy rate. But when short-term rates are even with or higher than long-term rates, the economy almost always stagnates or starts contracting. The yield curve is especially important for banks, since they have to borrow short-term money that they lend to long-term borrowers. The difference between short- and long-term rates, therefore, is a rough gauge of banks' profit margins. After five cuts in short-term interest rates this year by the Federal Reserve, the difference between short and long rates is two full percentage points. With loan margins that fat, you'd think that the top U.S. bank stocks would be in great shape. But they aren't. Shares of leading banks such as J.P. Morgan Chase [JPM] and Bank One [ONE] are flat to down so far this year. And both stocks have announced that their earnings for the current quarter will be below what analysts were expecting. What's the explanation for the lousy results? Essentially, there are two problems. Many of the big banks lent aggressively during the boom of the past five years and now find themselves saddled with lots of problem loans. In the case of J.P. Morgan Chase, those loans are to tech firms, such as telecoms. Bank One's problem loans, by contrast, represent credit-card debt. But in both cases, the banks will have to clean up their portfolios before they can truly profit from the improved interest-rate environment. Global giants, such as J.P. Morgan Chase, have a second set of problems. Over the past five years, their earnings became increasingly dependent on investment banking activity, such as IPO underwriting, private equity investments and proprietary trading. All of those businesses are depressed and will likely remain so until the tenor of the market improves substantially. And even though the Nasdaq is up 35 percent from the April lows, J.P. Morgan's losses on past investments are still outpacing its gains on those that are recovering. Where does that leave the stocks? Basically, they have a lot of sewage to wade through for the rest of this year. But they should be coming back strongly by the start of 2002. And, of course, share prices normally anticipate such improvements by at least a few months. I recommended J.P. Morgan Chase in January at $53 a share, saying the bank faced a rough six months, followed by accelerating growth over the coming three years. That scenario is unfolding more slowly than I expected, and the share price has declined by six bucks. But for long-term investors, I continue to believe that this is the must-own bank stock. However long it takes to clean everything up, the bank will be a powerhouse a couple of years from now. And after slipping back since January, the share price seems absurdly cheap. The bank's earnings power is well over $4 a share, a rate it should reach sometime next year. At the current $47 share price, that's a price/earnings multiple of less than 12 for a stock with a 12 percent compound growth rate and a 2.8 percent dividend yield. I'm less enthusiastic about Bank One. Consumer indebtedness has doubled since 1992. So I can't help but wonder how quickly the bank's problem loans will be taken care of. It's true that consumers will be getting some tax relief and that recent mortgage refinancings have boosted disposable income. But we all know that most of that money is going to be spent instead of going to reduce household debt. As a result, I think Bank One will be working through problem loans for a while -- and it's a more

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OUT: Sivy on Stocks: Why aren't banks doing better?

IN: I will likely begin polling the Board tomorrow for availability for a special meeting to consider Project Southwood (again!). Please advise if you are aware of any other agenda items that are critical in terms of timing. Thanks. Paula

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OUT: Board Meeting

IN: The following items were discussed in this week's ETS and Corporate Change Control Item... Oct. 21 From 10:00 a.m. - 2:00 p.m., the Unix team will perform maintenance and reboot app server emerald. The following applications will be affected: CAS, ERP/TRV, IZZIE, SIEBEL, WEBMODAL, Commodity Logic. No impact to ETS users is expected. Oct. 27 From 4:00 - 8:00 p.m., Trizechan Properties has scheduled a shutdown of all electrical service at 3 Allen Center. Enron Network Services will power down the 3AC network infrastructure between 3:30-4:00. There will be no network access during the electrical maintenance and the outage will continue until ENS is able to power up all of the networking devices. If you need access to 3AC anytime that Saturday, you will need to contact Trizechan Properties beforehand with your security information. Anyone to attempts to enter the building on Saturday that is not on the list will be denied access.

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OUT: The following items were discussed in this week's ETS and Corporate Change Control Item

IN: Here's the latest Tino-gram: 1. Tino's environ. consultants have not discovered any stop signs. 2. The Isleta is interested in granting Dennis ROW/lease for the power plant as well as the pipeline. The power plant could be located on Isleta land adjacent to the South boundary of the Scandia reservation. Thus, the power plant could be connected to DOE's existing powerline infrastructure without ever leaving the Isleta and DOE land. PNM would not be necessary to move power to DOE. Unclear to me whether this approach would give the power plant optimal access to the power grid for sales of surplus power. (maybe this could be done through DOE to an interconnect with PNM on the Scandia reservation?) 3. Dennis is using Jim Slattery, an ex law partner of mine in DC (and ex Dem. U.S. Congressman from Kansas), as his primary contact with Bill Richardson at DOE. My recollection is that Jim does have a good relationship with Richardson, so this seems very likely to be effective. Tino reports that "DOE is OK with the deal" and the next step is negotiating the power contract itself. Tino said that DOE is aware that the capital for the project will not come from the tribe so the tribe's interest will be fairly thin. It is unclear exactly how much indian ownership Dennis and Slattery promised DOE. 4. Tino has run into a power plant consultant named Jack Maddox who says he's working on a 230MW plant to be located west of Belen. Tino thinks he's working for the Laguna tribe, but wanted us to find out who is planning a big power plant out there. Is this ours? PNM's? El Paso? Finally, the next key step is obviously the economics. Based on what Tino told me, I'm convinced that Dennis and Tino don't have a real good sense of how much $$$ might be in this deal. They are groping a bit and our initial analysis of the numbers will likely carry a lot of weight. How are those efforts coming? Thanks. DF

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Pueblo: CONFIDENTIAL