Friday, May 13, 2011

Banks way out of favor

Since the mid-April reporting of first quarter earnings until now, bank stocks have been in significant decline. The numbers reported for first quarter were generally fine but the market had some concerns.

Core earnings in the banking industry showed continued modest improvement and reported earnings were significantly strengthened by declines in reserves for loan losses as the credit environment has improved and as required reserving during the downturn had exceeded what was eventually needed. The short term wisdom of the market is to punish the stocks when they did the large reserving in the first place because the credit deterioration hurt earnings, and then when those excess reserves are reversed and, by accounting necessity, reflected in earnings they are seen as useless because they are not core earnings. Makes sense.

Another major concern is the lack of loan growth across the industry. Banks reflect the economy and our economic recovery is languid, real as in real slow. Loan demand is not strong and banks are not bending credit requirements to attract incremental growth. Even banks have short term memories.

Those are the popular reasons for the weakness. They reflect weak visibility for any near term upside and there are other sectors that are seen to offer better opportunity now.

A major reason for the weakness not often mentioned in the popular pundit world is litigation risk. For major banks the stream of litigation as a follow on to the economic crisis seems to be never ending, and in fact some days it seems to be accelerating. It is clear from the administration and the Congress that there is a green light for regulatory agencies, state governments, and investment enterprises of all stripes to sue the banks. It is clear from recent history that "juries of our peers" faced with complex legal issues will ignore all legal precedent and all enforceable contracts when presented with losses suffered by some while the banks eventually turned the corner after losing billions and got back on track. Suing the banks now is like throwing mud at a wall and seeing what will stick. Some will and sizeable settlements will be reached. It's ugly. For this investor, that is by far the biggest issue.

When the real investors can see a slowdown in the legal attack and a let up in abusive comments and actions by the bitter Obama team and a barbell mix of right and left in Congress, then those investors can look ahead and see that beyond the next few quarters many of our banks have great franchises, have clean balance sheets, are not polluting those clean balance sheets, and have efficient cost structures that have been fine tuned over the last twenty years. They have exceptional technology platforms and are global leaders in many commercial banking products. Retail delivery has continued to advance. Dividends will begin to grow and capital will continue to strengthen. If economic growth, global economic growth, hits a more even stride the banks will have an opportunity for an investor sea change in thinking, a light bulb going on type of reversal in thinking that leads to a significant and possibly rapid turnaround in the stocks.

But that's not now. Maybe in this fast moving world that's a possibility later this year, perhaps it's deferred to 2012. At the moment, the banks are adrift.

A broader concern from all of this is the fact that banks have often been an economic barometer for the overall market. When have the banks had a period of any sustained weakness when the economy does not follow. When has placing the government's heel on the neck of an industry helped it compete globally. The answer my friend... oh, that's not appropriate.


Post a Comment

<< Home