Nancy Bush
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Bank Statements
What Now?
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It occurred to me while I was
on vacation recently (and ostensibly not thinking about banking) that TARP may
have been the best thing to happen to the banking industry in the last couple
of years. In spite of the financial cost to the industry—which is now
becoming even more apparent as banks start to buy their way out of bondage and
have to deal with negotiations over warrants, etc.—the existence of TARP
gave both bank shareholders and managements a common cause around which to
unite. And that cause was a simple one—getting out of TARP. We were
all in agreement that TARP, with its pay restrictions and endless opportunities
for government meddling, had turned from a welcomed plan to save the financial
system into a banking industry nightmare, and only a quick exit would allow the
industry’s largest players a chance to reclaim their own momentum and pace
of change.
The exodus recently of ten major
financial institutions marks the beginning of that process—but likely also
marks the beginning of a couple of other not-so-positive things as well.
Attention will now naturally turn to those large banks not yet out of
TARP—Bank of America (BAC-Hold) and Wells Fargo (WFC-Hold), most
notably—and there will be endless speculation about whether these
companies will need to raise even more capital in order to ransom their way
out. (I’m assuming here that Citigroup [C-Not covered] will not emerge
from government ownership for some time, and then likely in a much different
form and size.) My concern is that BAC and WFC will somehow become
“special” in the eyes of investors—and not in a good
way—if their departure from TARP drags out beyond the end of this
year, which is a real possibility. Bank of America seems not only mired in
endless and unproductive speculation about the minutiae of the Merrill
Lynch deal, but is undergoing forced change to its management and Board
structure, while Wells Fargo management has gone uncharacteristically silent
on the issues of TARP and regulatory overkill.
The focus on TARP also allowed us
all to overlook a few other things—like the underlying fundamentals of
these companies, which are now looking a bit less positive. While I’m
not different from the consensus in foreseeing a modestly positive second
quarter—which I would remind readers is usually a good one for the banking
industry historically, due to seasonally strong mortgage activity—the real
test will be earnings momentum going into the third quarter. At that point,
capital markets activity will have quieted (and may be VERY quiet, if recent
market volumes are any indication), consumer credit quality trends may be
reaching their nadir (i.e., the greatest point of loss) as recent job losses
work their way through the system, and mortgage trends will likely slow as
higher mortgage interest rates take hold. And at that point we will all be
looking forward to another very messy fourth quarter when the banks will likely
take whatever steps that their capital levels will allow to put much of the
chaos of 2009 behind them.
And then there’s
Washington. While I studiously tried to avoid reading anything about the
new regulatory regime for the financial services industry while I was away,
the topic was impossible to avoid. And my main takeaway was
this—the present Administration and the existing regulatory regime do
not give a rat’s whiskers about the shareholders of banks. They
don’t care whether the banking industry can grow earnings at 1% or at 10%,
they don’t care whether dividends are restored or not, they don’t
care whether bank stocks are viewed as good investment vehicles. They care
only that there not be a repeat of the events of September, 2008—and
the blunt instrument that they will use to make sure that there is not a
repeat of that chaotic month will be the required regulatory capital
levels.
To that end, expect the Tier 1
common equity requirement—the new Holy Grail of banking—to be pushed
higher. The 4% targeted Tier 1 common equity level has by all accounts now
been informally raised to a 7% expectation, and according to commentary
coming out of Washington in recent days, the requirements will be higher for
“large and systemically important” financial institutions. (Et tu,
Bank of America?) In addition, there has also been—according to the Wall
Street Journal, anyway—an attack of common sense on the part of the
regulators that will dictate that banks be allowed to build loan loss
reserves during good times for use during down cycles, which we take to mean
that the loan loss allowance will not be available for repatriation to bank
earnings as this credit cycle winds down.
So where does that leave us? Back
where we always begin—with an admonition that junk will not be
miraculously transformed into gold. Yesterday showed us the beginning of a
rolling over of the market—and particularly of the financial services
stocks—as the reality of the next couple of quarters comes more sharply
into view and the prospect of higher long-term interest rates periodically
becomes a real worry for the markets. This is not a bad thing. This market
generally, and the bank stocks particularly, have gone pretty much straight up
since March, and the junkiest banks have been in the forefront of this
recovery. I do not see this trend continuing. Most of these companies will face
continuing regulatory demands for higher capital, may face increased management
scrutiny (not a bad thing, but disruptive nonetheless), and will almost
certainly face years of balance sheet repair even as the healthier banks march
on. This is NOT a recipe for success in coming years—even if these
companies survive in the present environment.
Instead, I would counsel that we
return to some of the healthier companies as this bank stock correction
continues. While I have chosen to exit most recommendations at this point,
with the exception of PNC (PNC-Buy, Target $52) and State Street (STT-Buy,
Target $56), there’s lots out there that I’m interested in. On
the quality end, there’s Northern Trust, U.S. Bancorp, and
BB&T—all presently rated HOLD—and any further material
declines from present prices will put those stocks in a much more favorable
light. (I’d love to upgrade J.P. Morgan Chase [JPM-Hold]—but
at $30, not $35.) As for the “edgier” stories, both WFC and BAC are
seeing some waning of enthusiasm as TARP drags on, and the view of the
immediate prospects for both is becoming a bit more realistic—a good thing
for those with a longer-term perspective.
So all is not lost—the summer
is shaping up to be one where calm and rationality will be more in evidence
than last summer, and that should give us all some breathing room to sort out
the banks. In addition, the exit from TARP of some of the largest banks
should give these companies some leeway to discuss how they will rebuild
shareholder confidence—like the plans for restoration of their
dividends—and what they see as their challenges for the remainder of this
year and early 2010. The Q209 earnings conference calls should provide the
perfect venues for companies like USB and BBT to discuss their agendas, as
opposed to those of the U.S. government. I hope that they will not pass up that
opportunity. |
