Bank Earnings: Scrutinize Recent 'Beats' Very Carefully

Includes: BAC, C, JPM, WFC
by: Markham Lee

The recent earnings trend for the big banks has been big earnings surprises, with the obvious suggestion that the financial sector is recovering, the economy is coming back and the government's intervention efforts are working.


Not Quite.

(From Barons): "The question naturally arises: How did the banks, so many of which seemed to be slouching toward extinction, get their act together to the point where they were in the black in January and February?

In search of an answer, we turned up an intriguing explanation for this magical metamorphosis by Zero Hedge, a savvy and punchy blog focusing on things financial. Not to keep you in suspense, Zero Hedge fingers AIG , that repository of financial ills and insatiable consumer of taxpayer pittances, as the agent of the banks' miraculous recovery.

But not quite the way you might think. As Zero Hedge explains, AIG, desperate to hit up the Treasury for more moola, decided to throw in the towel and unwind its considerable portfolio of default-credit protection. In the process, the badly impaired insurer, unwittingly or not, "gifted the major bank counterparties with trades which were egregiously profitable to the banks."

This would largely explain, according to Zero Hedge, why a number of major banks actually, as they claimed, were profitable in January and February. But the profits, it is quick to point out, are of the one-shot variety, and, ultimately, they entailed a transfer of money from taxpayers to banks, with AIG acting as intermediary."

Now am I saying each and every bank reporting an earnings surprise is really just the beneficiary of the AIG bailout, or is just reporting a taxpayer funded single quarter earnings anomaly? Not necessarily, just saying that you should scrutinize the bank's earnings very carefully and that you should wait to see a multi-quarter trend before celebrating or hopping on the "the recession is almost over" bandwagon. Better yet, it's a perfect example of the need to always heavily scrutinize earnings reports.

A virtual "fist-bump" to Barry Ritholtz's Big Picture Blog for bringing this one to my attention; you can read more from Barry on this topic here and the original Barron's article here. "Don't Bank on It" -- Saturday April 18, 2009.

Disclosure: at the time of publishing the author didn't own a position in any of the companies mentioned in this article; the ideas expressed are solely the opinions of the author and shouldn't be viewed as financial or investment advice.