What do these seven banks have in common -- JPMorgan Chase, Wells Fargo, Bank of Hawaii, Hudson City Bancorp, People’s United Financial, PrivateBancorp, and Prosperity Bancshares?

Mainly this: all seven rank exceptionally high for the credit quality of their loans and the strength of their balance sheets. Indeed, we think those two characteristics -- high credit quality and strong capital positions -- will likely separate the winners from the losers in banking in these troubled economic times. In our judgment, all seven of these banks are now in good financial shape because they resolutely resisted the siren’s song of compromising their loan-underwriting standards and over-leveraging their balance sheets earlier in the decade -- a song that mesmerized many of their competitors.

Indeed, we can think of no better examples of rock-ribbed banking discipline than JPMorgan Chase (market capitalization: about $115 billion), Wells Fargo (market capitalization: about $87 billion), Bank of Hawaii (about $2 billion), Hudson City Bancorp (about $90 billion), People’s United Financial (about $6 billion), PrivateBancorp (about $1 billion), and Prosperity Bancshares (about $1.3 billion). They are proof that in banking, as in any business, there’s no substitute for sweating the details: they have paid, and continue to pay, attention to matters such as maintaining strict lending standards, adjusting loan-loss reserves when warranted, sustaining healthy capital ratios, and holding each of their businesses accountable for delivering an acceptable level of risk-adjusted profits.

Some of these practices seemed to acquire an almost fuddy-duddy quaintness in the go-go era of banking that prevailed just a few years ago, during the housing boom. Now those same practices seem prudently foresightful. For instance, when some banks were in a frenzy about booking as many mortgages as possible and couldn’t be bothered to even ask about the creditworthiness of borrowers, these seven banks atypically asked the hard credit questions and focused on loan quality rather than quantity. And it paid off subsequently for all of them in sound balance sheets.

After all of the excesses of easy credit and overleveraged balance sheets that helped trigger the current financial crisis, we can’t help but admire that the seven banks walked the talk, as illustrated by this observation by JPMorgan Chase Chairman Jamie Dimon about the business model that his bank has followed: "A fortress balance sheet is a strategic imperative -- especially in turbulent market conditions such as these. No matter what conditions are, we always want to have the capital, liquidity, reserves, and overall strength to be there for our clients and to continue investing wisely in the business." We think it’s a banking credo that Wells Fargo, Bank of Hawaii, Hudson City, People’s United, PrivateBancorp, and Prosperity share as well.

Beyond that, what JPMorgan Chase and Wells Fargo share in common is size: they are two of the seven largest banks in the U.S. JPMorgan Chase is based in New York and has assets of $2.3 trillion. Wells Fargo is headquartered in San Francisco and has $609 billion in assets. The other five banks are smaller and serve regional markets: Bank of Hawaii (headquarters: Honolulu; assets: $10 billion), Hudson City (Paramus, New Jersey; $44 billion), People’s United (Bridgeport, Connecticut; $21 billion), PrivateBancorp (Chicago; $6 billion), and Prosperity (Houston; $4.6 billion).

In the course of walking its own talk, Wells Fargo estimates that between 2004 and 2006 it lost 2-4% of market share in mortgage loans by not plunging heavily into subprime loans to borrowers who had what could be described charitably as questionable credit histories. "We’re glad we did," says Chairman Richard Kovacevich. "Such lending would have been economically unsound and not right for many borrowers."

Such lending would have been economically unsound and not right for many borrowers -- that is perhaps one of the great understatements of our time, in light of all the global financial havoc that subprime mortgages helped to produce. Equally unsound was the use of leverage by many banks to purchase subprime-related collateralized debt obligations and other forms of derivatives, which, as everyone except possibly a member of the most remote Amazon tribe knows by now, proved to be extraordinarily risky.

Instead, by steering clear of economically unsound banking practices, the seven banks maintained solid capital positions, as reflected in their equity-to-assets ratios. Their ratios are such that they could provide a good buffer to any prospective loan losses -- a more effective buffer than that possessed by most foreign banks, particularly the European banks.

For instance, the equity-to-assets ratio for Hudson City is 9.6%; for Wells Fargo, 7.9%; and JPMorgan Chase, 7.2%, according to Risk Metrics Group, an investment-research firm. In contrast, these prominent European banks have considerably more modest (and more potentially hazardous) ratios: Royal Bank of Scotland, 3.2%; BNP Paribas, 2.8%; and Deutsche Bank, 1.6%. Overall, European banks have an average equity-to-assets ratio of 4.0%; banks in the Asia/Pacific region, 6.7%.

As we see it, being well capitalized furnishes JPMorgan Chase, Wells Fargo, Bank of Hawaii, Hudson City, People’s United, PrivateBancorp, and Prosperity with several competitive advantages:

*  All of them are unlikely to need to make significant write-offs -- a boon to their cost structure and ability to make new loans. Some of their competitors, however, are short of capital because they’ve been compelled to write off bad loans to a degree unprecedented in modern times. As a result it may be unrealistic to expect these less-well-heeled banks to lend aggressively soon and help ease the credit crunch.

*  They have considerable pricing power, partly because of the reduced availability of capital in the entire banking industry. So they have the luxury of dictating the terms of loans and thereby enhancing their profit margins. In fact, we think they have the potential to generate earnings growth that’s above-average by industry standards over the next two years.

*  They each have the means to acquire smaller, often ailing banks at depressed prices and expand their franchises and market shares. We think they could be active buyers, in light of the massive consolidation that seems likely in an industry that’s now weighed down by too much capacity. Consolidation has also been made more feasible by recent changes in Treasury Department policy that permit acquirers to use the acquired banks’ net operating losses to offset future tax payments.

*  Their financial soundness may serve as a magnet for deposits, particularly from millions of risk-averse consumers who perceive bank accounts and certificates of deposit as a haven from a stock market that’s nastier than your average bear. For the banks, the deposits are a cheap source of money for new loans.

Among other things, that financial soundness also makes them highly unlikely to need rescue by the federal government. Actually, with the exceptions of JPMorgan Chase and Wells Fargo, none of  these banks applied for funds from the Treasury Department’s Troubled Asset Relief Program (TARP).

An offer they couldn’t refuse

JPMorgan Chase and Wells Fargo, it should be noted, received TARP funds specifically to purchase troubled banks. And they were subtly and not-so-subtly pressured by the Treasury Department in October to accept TARP aid as a way to help rebuild confidence and stability in a faltering banking system. About 60 banks have applied for TARP funds, according to Keefe, Bruyette & Woods, an investment bank. Conversely, more than 40 financial institutions have expressly announced they don’t want any help from TARP, thank you.

Richard Kovacevich of Wells Fargo expressed the same sentiment in a more visceral way. At a meeting in Washington in October, when Treasury Secretary Henry Paulson made an offer that couldn’t be refused -- the federal government was going to buy stakes in Wells Fargo and eight other major banks -- Mr. Kovacevich "pounded his fist on the table in frustration," The Wall Street Journal reported. Accepting the inevitable, he subsequently told the Journal, "I admire what they [the government] are trying to do. That is not saying I agree with everything being done."

For his part, Ron Hermance, president of Hudson City, took pains to point out that his bank wasn’t looking for a TARP bailout in part because it had avoided subprime mortgages during the housing boom and stuck to what he called "dull and boring" lending.

Of course, "dull and boring" now trump "rash and irresponsible" as desirable qualities, in the wake of all the banking blunders and blight that have been exposed by the harsh X rays of the financial crisis. As The Wall Street Journal summarized the current banking environment: "With many banks crippled by billions of dollars in losses on exotic loans and securities and no longer able to sell their troubled assets, institutions have gone back to basics. They are now concentrating on making loans that are of high enough quality that they can reside on the banks’ books for years."

We think that, fortunately for them, JPMorgan Chase, Wells Fargo, Bank of Hawaii, Hudson City Bancorp, People’s United Financial, PrivateBancorp, and Prosperity Bancshares don’t have to go back to the basics. They never abandoned them in the first place.

The views expressed represent the opinions of Turner Investment Partners as of the date indicated and may change. They are not intended as a forecast, a guarantee of future results, investment recommendations, or an offer to buy or sell any securities. Opinions about individual securities mentioned may change, and there can be no guarantee that Turner will select and hold any particular security for its client portfolios. Earnings growth may not result in an increase in share price. Past performance is no guarantee of future results.

Turner Investment Partners, founded in 1990 and based in Berwyn, Pennsylvania, is an investment firm that manages more than $22 billion in stocks in separately managed accounts and mutual funds for institutions and individuals, as of September 30, 2008.

As of October 31, 2008, Turner held in client accounts 1.9 million shares of JPMorgan Chase, 1,420 shares of Wells Fargo, 166,962 shares of Bank of Hawaii, 3.3 million shares of Hudson City Bancorp, 1.8 million shares of People’s United Financial, 637,150 shares of PrivateBancorp, 806,825 shares of Prosperity Bancshares, and 2,590 shares of BNP Paribas. Turner held no shares of Royal Bank of Scotland and Deutsche Bank.