Big banks try to gird for crises as a matter of course. So investors will soon learn how
prepared the banks were for this summer's credit crunch.
Analysts and investors are speculating how badly Citigroup, Bank of America, JPMorgan Chaseand smaller rivals may have gotten caught by a flight from risk that caused the value of billions of dollars of mortgages and loans to evaporate.
Hurt by write-downs and loan losses, many banks are expected to post lower earnings for the third quarter. The question is how long their hangover from the end of the housing and merger booms will last.
"Generally, the view is banks will use the third quarter to build reserves or take losses stemming from liquidity issues," said Gary Townsend, an analyst at Friedman, Billings, Ramsey.
"The market will overlook what is reported in the third quarter as it looks toward improving conditions in 2008."
Investors will also weigh whether depressed share prices already reflect expected bad news, or may fall further. They want banks to be up front about problems, and show their ills will not endure.
"Transparency will be huge," said Richard Moroney, chief investment officer at Horizon Investment Services in Hammond, Indiana. "Investors want clarity that banks have a
handle on the credit crunch. Banks that are straightforward will be received more favorably."
Recent results at Bear Stearns, Goldman Sachs Group, Lehman Brothers Holdings and Morgan Stanley were driven heavily by write-downs for riskier mortgages and leveraged loans that investors avoided.
Similar exposures will be evident in July-September results at commercial banks. They could even be worse because Wall Street banks' results included June, before much of the credit
malaise took hold.
Many banks' shares have already been beaten down.
Through Sept. 26, the Philadelphia KBW Bank Index of 24 large banks was down 10 percent this year, while the KBW Regional Bank Index had lost 11 percent. The KBW Mortgage Finance Index was down 22 percent, including a 57 percent decline at Countrywide Financial.
The Standard & Poor's 500 is up 7.6 percent. That index traded at 15.2 times expected 2008 earnings, well above the 10.8 multiple for the 10 largest banks, according to Reuters Estimates.
Citigroup, Bank of America and JPMorgan, sometimes called "universal" or "money-center" banks, may offset some of the market turmoil from their many businesses that are less
affected, such as retail banking and credit cards.
Rocky Capital Markets
Still, the three largest providers of leveraged loans may suffer losses from rocky capital markets. Bank of America has said it expects a "meaningful impact" on corporate and
investment banking results.
Wachovia has expressed disappointment its $24.2 billion purchase a year ago of mortgage lender Golden West Financial has not gone better. And Washington Mutual may boost loan
loss reserves by $500 million, its fourth increase this year.
Wells Fargo has largely been spared because it never offered the exotic mortgages that got many rivals in trouble.
"For a high-quality issue with a good yield and a pretty cheap stock price, it's a good play," Moroney said. Wells Fargo carries a 11.9 price-earnings multiple for 2008.
Regional Banks Hit
Even Salt Lake City-based Zions Bancorp this week warned of rising loan losses amid declining land values and residential construction activity in the southwest.
Lehman Brothers analyst Jason Goldberg said his profit forecasts are farthest below consensus on banks exposed to mortgages, including National City and First Horizon, or construction, including Marshall & Ilsley, Regions Financial and Synovus Financial.
A reason for optimism: lending margins. These have been tight as the rates at which banks borrow and pay out deposits have been high relative to the rates they charge on loans.
The Federal Reserve's recent decision to cut its benchmark federal funds rate to 4.75 percent from 5.25 percent may help loosen margin pressures, though more likely in
"The principal headwind over the last 18 months, the rate environment, is improving," Townsend said. "The outlook for 2008, due to the Fed's action, is an improving one, so long as
the Fed was nimble enough for the economy to avoid recession."