Sunday, July 26, 2009

Fantasyland for the Financials

Yours truly was so upset with what happened to the WSJ after Mr. Murdoch took it over that he canceled his subscription of many years and makes does with the free stuff available on the Net. Here are two teaser intros from the WSJ available online which do not paint a pretty picture about the Large Complex Financial Institutions (LCFIs, "banks"). First:

Banks Profit From U.S. Guarantee: Lenders' Earnings Reap the Benefit of FDIC Backing on Company Debt.

It is the gift that keeps on giving.

The government's guarantee since November on new debt issued by financial firms such as Citigroup Inc. and General Electric Co. will save those companies about $24 billion in borrowing costs during the next three years, according to an analysis by The Wall Street Journal.

In the second quarter alone, the eight largest issuers of corporate debt under the Federal Deposit Insurance Corp.'s Term Liquidity Guarantee Program cut their interest costs by about $2.2 billion, increasing their profits and delivering an extra jolt to the stock market's two-week rally.


Loans Shrink as Fear Lingers.

Lending continues to slow as bankers and borrowers refrain from taking risks, in a bearish sign for the economy.

The total amount of loans held by 15 large U.S. banks shrank by 2.8% in the second quarter, and more than half of the loan volume in April and May came from refinancing mortgages and renewing credit to businesses, not new loans, an analysis by The Wall Street Journal shows.

Despite this massive help from the government and newly conservative lending practices, many banks have been both playing games with their earnings and simultaneously seeing the analysts (their friends) nonetheless lower earnings estimates for late 2009 and for 2010. David Reilly had a post Friday at demonstrating aggressive (lowered) loan-loss reserves by a number of banks during Q2, in Bankers Bet Jobs on a Roaring V-Shaped Recovery: David Reilly:

The country’s biggest banks are doubling down on a bet that the economy will improve in the latter half of the year. If they’re wrong, and borrowers don’t pull out of a tailspin, bankers and their investors will take a beating.

That’s because banks will have to rebuild diminishing reserves that they set aside for soured loans, which results in charges that lower profit. . .

It's a good read, especially in what has become a manic bull market. A few months ago, it was going to be Great D II, now it's Dow 36,000 after all.

Here are some facts. Despite all the accounting changes and other help for the LFCIs, Yahoo/Finance can be clicked on to provide changing consensus earnings estimates, in this case for BofA. Scroll down to "EPS Trends". All of a sudden, BofA ("BAC") is tipped to report losses this quarter and next. EPS estimates for 2010 have plunged in one week from 98 to 90 cents, and in the past 90 days from $1.32 to the aforementioned 90 cents. What has the brilliant stock market done for BAC the past 90 days? Up about 35%. Pretty good. If you buy the stock now, what yield do you get based on the current dividend? 0.3%. Hmmm . . . I got to get me some of that, you must be thinking. Sinking earnings, no real dividend, uncertain asset quality-- all this in the setting of unprecedented assistance from the Fed and the Feds. A steal!

Now move on to other LFCIs by typing in the stock symbol in the top right box labeled "Get Analyst Estimates for" and click go. Try WFC (Wells Fargo), STI (SunTrust), ZION and PNC. Even worse, try a truly strong bank, Northern Trust (NTRS), which is based in Chicago and helped young Barack Obama with the purchase of his home and therefore may have some special political clout despite not even needing to be a "stress test" bank. Earnings estimates for NTRS have recently come down for Q4 2009 and for 2010. If I were to own a larger bank, it would be NTRS. But it sells for more than twice book value, only yields 1.9%, and should be showing growth in earnings estimates this far into a major stock rally and this far into a Fed easing cycle.

In the meantime, WMT has been such a laggard that it (almost) has to move up if the stock rally is to prove durable, but now that McDonald's stock has "collapsed" despite good news and RISING earnings estimates (same page as above, type in MCD), much is making little sense in the financial world.

The S&P 500 yields 2.5%, the NASDAQ yields almost nothing, dividends are not rising, and over the sweep of financial history stock dividends yielded more than high-grade bonds. One of the few stocks mentioned favorably here this year, Ross Stores (ROST), has rising earnings, rising earning estimates and a record stock price is way above its 200 day moving average and may be a good long-term hold but is vulnerable to profit-taking at best and declines in earnings estimates at worst if the end of the downturn means that people trade up to Wal-Mart and even Macy's.

At the very bottom of the stock market and top of the panic move down in Treasuries last fall and winter, this relationship briefly reasserted itself. It may do so again: Real Yields Highest Since ‘94 Aid Treasury $115 Billion Auction (a great year to buy bonds after yields surged).

We are entering the two weakest consecutive months of the year for stocks and seasonally strong times for bonds. The end of the Great Recession is fully priced into the stock and bond markets. This should be interesting. Watch bank earnings and their expectations.

Copyright (C) Long Lake LLC 2009

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