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Will bank earnings be bad ... or less-than-bad?
April 11, 2008 / 1:17 PM / 9 years ago

Will bank earnings be bad ... or less-than-bad?

<p>A customer counts hundred dollar bills in a file photo. REUTERS/Beawiharta</p>

NEW YORK (Reuters) - U.S. banks suffered a tough winter and may see credit losses grow as the economy flounders, yet investors may react positively later this month to lenders that appear to be on top of the problem.

As banks start reporting first-quarter results next week, analysts expect more losses from subprime and other mortgages, credit cards, and commercial real estate, especially in markets such as the Southwest, Florida, Michigan and Ohio.

But some observers say bank stocks already reflect expectations for plenty of bad news. Market sentiment has been growing that the sector may have already cratered.

“We’re watching to see if news is ‘less bad’ than expected,” said Chris Armbruster, an analyst at Al Frank Asset Management in Laguna Beach, California, which owns shares of Citigroup Inc (C.N) and Washington Mutual Inc (WM.N).

Banks, savings-and-loans and mortgage lenders have suffered more than $200 billion of write-downs for credit and other losses, an amount some analysts expect to grow this year by hundreds of billions of dollars.

The industry is also exposed to well over $100 billion of loans used to fund corporate buyouts, which it can’t unload.

Banks are “constipated from all these bigger deals that they have stuck on their shelves,” Lawrence Schloss, who runs private equity firm Diamond Castle Holdings LLC, said at this week’s Reuters Hedge Funds and Private Equity Summit.

“It’s a bad liquidity environment,” he added.

And yet, some outside investors are showing support. Since the credit crisis began, they have infused well over $100 billion into the industry, helping lenders shore up capital.

Washington Mutual, the largest thrift and a big mortgage lender, was the latest, raising $7 billion this week even as it forecast a second straight, $1 billion-plus quarterly loss.

CRISIS OF CONFIDENCE

In the first quarter, the Philadelphia KBW Bank Index .BKX of 24 large banks fell 10.9 percent, and the KBW Regional Bank Index .KRX fell 6.2 percent. These compared with a 9.9 percent drop in the Standard & Poor's 500 .SPX.

Longer-term, the damage has been more severe. In the 12 months ended March 31, the large bank and regional bank indexes fell a respective 30.7 percent and 25.9 percent, while the S&P 500 was off just 6.9 percent.

“There is a crisis of confidence for many investors in bank stocks,” Armbruster said.

Problems have prompted some banks to seek buyers, including Cleveland-based National City Corp NCC.N, which has been hurt by exposure to mortgages and Florida.

And some analysts fear banks haven’t set aside enough for sour loans. “Delinquencies on credit cards, home equity, autos: they’re all moving upwards,” said Peter Winter, an analyst at BMO Capital Markets. “Banks are still under-reserved.”

Nevertheless, some investors have begun treating some news that might ordinarily be seen as bad, as good.

Disclosures last week that UBS AG UBSN.VX wrote off $19 billion and Lehman Brothers Holdings Inc LEH.N sold $4 billion of convertible securities sent shares of both soaring.

Why? Investors saw the news as one bank scrubbing its books clean, and the other getting a crucial vote of confidence.

Moreover, lending margins may also rise, helped by 3 percentage points of cuts in a key Federal Reserve lending rate since September. Washington Mutual said net interest margin has risen to 3.05 percent from 2.86 percent the prior quarter.

Most of the nation’s largest lenders report results between April 15 and 22.

Analysts on average expect earnings per share excluding items to fall from a year earlier at all but one of the 15 largest commercial banks and thrifts, Reuters Estimates said.

The exception is U.S. Bancorp (USB.N), where profit may be little changed. Operating profit may increase at the large securities servicers and asset managers Bank of New York Mellon Corp (BK.N) and State Street Corp (STT.N).

And compared with the fourth quarter, earnings per share may grow at 13 of the 15 largest commercial banks and thrifts.

TIME TO CHERRY-PICK?

Much of this quarter’s focus will be on Citigroup, the largest bank. It wrote off $18.1 billion in the fourth quarter, and several analysts said it may write off more than $10 billion by the time it reports results on April 18.

Chief Executive Vikram Pandit is expected to soon unveil an overhaul that could result in thousands of layoffs, on top of 6,200 already set this year. He is already preparing to sell $12 billion of leveraged loans to some private equity firms.

Profit per share may fall by more than half from a year earlier at Bank of America Corp (BAC.N), hurt by write-downs and credit losses.

It may fall a similar amount at Wachovia Corp WB.N, which has been hurt by its $24.2 billion foray into adjustable-rate mortgages in 2006 when it bought Golden West Financial Corp.

Other lenders may fare better. Though profit per share may fall by nearly half at JPMorgan Chase & Co (JPM.N), which had an estimated $26.4 billion of leveraged loan exposure, the bank has steered clear of other credit minefields.

And earnings may drop by only a mid-teens percentage at Wells Fargo & Co (WFC.N), the second-largest mortgage lender.

Some observers have begun to cherry-pick.

“We believe that it is too early to overweight U.S. financials as a whole, but believe that investors can benefit by distinguishing ‘exaggerated fears’ from legitimate, ongoing problems,” Goldman Sachs & Co analysts wrote on Tuesday.

Among the companies they rated “buy” were Bank of New York Mellon, SunTrust Banks Inc (STI.N) and U.S. Bancorp.

Additional reporting by Jennifer Ablan and Herbert Lash, editing by Dave Zimmerman

Our Standards:The Thomson Reuters Trust Principles.
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