April 18, 2008

Banks' Earnings

Banks have been reporting earnings this quarter and they have been terrible, yet their stocks are rallying.

Today Citi reported a huge $6 billion loss, give or take few billions who is counting at this point, and the stock is up 6% or so last time I checked. J.P. Morgan earnings slumped and the market rallied, yet JP Morgan is quietly raising money, although it is one of the better capitalized banks, so its situation is not as strong as everyone believe.

The view is that the huge writedowns are coming to an end and the biggest losses are behind them. I am fine with that point view, but investors tend to underestimate the unpredictability of the consumer lending business losses that banks have yet to absorb. Loss provisions could continue rising in the coming months as the effects of the US slowdown are felt. In prior recessionary periods, credit problems typically followed as a result of the weakening economy.

Another risk is where the earning going to come from going forward?

With housing market on the rocks, the employment situation is shaky and real earnings are being eroded by high inflation, how banks are going to lend or earn fees from the strapped consumers. More importantly banks like Citi have a weakened franchise that can not go after market share.

I have bought USB and BofA recently and I still like them as a business. My picks are for the heavy presence of BofA and USB in their states and the strong market share that can be leveraged to gain additional business from all their weak competitors. I think BofA and USB will grow earnings as a result of gaining business from others rather than nominal growth.

I will not add to my positions or look for another opprtunity in banks, as I think better returns can be had elsewhere.

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