Nobody Knows What Bank Stocks Are Really Worth

First-Quarter Results Are A Mixed Bag

Bank and "investment firm" earnings have been a mixed bag. Through yesterday evening, 10 S&P 500 banking companies topped estimates and 7 missed.

This morning, Morgan Stanley (MS) increased the number of disappointments to 8, joining other firms such as First Horizon National (FHN) and Comerica (CMA).

To be fair, Wells Fargo (WFC) beat by 18 cents, so we could change the score to 11 beats and 8 misses. Even with the changes, it is still a mixed bag.

Bank stocks had rallied over the past several weeks, due in part to speculation that first-quarter earnings would be better than feared. Several banks preannounced that they were enjoying good first quarters. Thanks to the Treasury and the Fed, money was cheap. Changes to FASB rules allowed banks to adjust their toxic assets. Not to mention that lenders were very choosy about their borrowers.

Yet, the realities of the current economic crisis and the mistakes of the past continue to haunt the financial sector. And brokerage analysts remain fearful about further quarters of poor earnings.

Even Positive Surprises Are Not Leading To Higher Forecasts

Even for firms that topped expectations, changes to full-year forecast are not optimistic. Though there have been some positive revisions, the majority of covering analysts are keeping their forecasts unchanged or are cutting them further.

Consider these examples:

• BB&T (BBT) earned 48 cents per share, 15 cents better than expected. Since the positive surprise, the full-year consensus earnings estimate has fallen 3 cents to $1.47 per share. Though 7 analysts have raised their projections, 6 others cut. Nearly half of the covering analysts have left their projections unchanged.
• Citigroup (C) generated a better-than-feared loss of 18 cents, 6 cents narrower than the consensus estimate. Just 2 of the 15 covering analysts raised their full-year forecasts during the last 7 days, whereas 4 lowered their projections. (Eight others have not changed their forecasts.) The average full-year projection now calls for a loss of 40 cents, 3 cents wider than a week ago.
• JPMorgan Chase (JPM) beat by 9 cents with adjusted profits of 40 cents per share. Despite the positive news, the full-year consensus earnings estimate has since fallen by 2 cents to $1.51 per share. Though 5 analysts did raise their projections, 4 others cut. More than half have not made any changes.

In all 3 cases, the positive earnings surprise did not result in higher earnings estimates. This suggests that brokerage analysts do not view last quarter's positive trends as sustainable.

There is a reason for this. Even with the new FASB rules, the amount of write-downs will increase. The ending of the temporary moratorium on foreclosures, rising credit card default rates and higher unemployment will all have a negative impact on earnings. Further, the ability to borrow at ultra low interest rates will end at some point.

To be fair, it is very possible that some of the covering analysts have yet to adjust their full-year forecasts in response to the first-quarter earnings. Nearly all of the bank results have been released within the past 7 days.

On the other hand, there has been a sustained trend of negative estimate revisions for the financial sector that has lasted more than a year. Given the poor economic backdrop, the ongoing risk that an acceptable solution to the toxic asset problem won't be found, the threat of further share dilution, and the government's ever-evolving bailout plan, nobody really knows what banks will earn this year.

Nobody Knows What Banks Stocks Are Really Worth

The lack of a clear sense of what earnings will be combined with questionable balance sheets have made it impossible to assign a value to banking stocks. Brokerage analysts simply have no idea what a proper price target should be and neither does anybody else.

The fact that there isn't a clear exit plan out of TARP only adds to the uncertainty.

This is why bank stocks continue to trade based on sentiment, and not fundamentals or chart patterns. Bluntly put, the short-term risks of trading banking stocks remain extremely high.

--Charles Rotblut

Comments

[morph366:]

For a real "Through the Looking Glass" view on what bank stocks are really worth this posting from Paul Krugman entitled "Alice in Financeland" is worth a look:

krugman.blogs.nytimes..../

Apr 22 03:43 PM

[fcharlie:]

I for one can say that i am not at all attempting to guess what earnings will be and slap a multiple on it to decide what these stocks are worth... there is no point...the reality is that many banks need only to survive and they are seriously undervalued, and the federal reserve is ensuring their survival with 0% interest rates as far as the eye can see.

Take Bank of America, if you net out the value of it's interest in China Construction Bank, it's selling for one times normalized earnings. You can argue all day long that it is technically insolvent, bankrupt, etc.. but the Federal Reserve is seeing to it that they are not going to fail.....deposits are growing, so they have no funding problem, and with $29 billion in loan loss allowances and $60+ billion pre tax pre provision earnings, all they have to do is continue to operate and eventually BofA will see the end of this. It may not be fair, but it's reality. The banks will survive, and once they have, it won't matter whether you bought them in feb. march, or april. you don't have to nitpick over what earnings will be next quarter or what multiple should apply to those earnings, because long term, the margin of safety is huge and the opportunity to make money is so great that you just have to buy them and either take some dramamine, or just tune out the noise....

Apr 22 05:22 PM

[tk77mann:]

Great article and conclusion, but I think bank stocks are even more unpredictable than just their current earnings statements. Lots of banks (like NCC a year ago) said they were in great shape, their dividends were secure, they were buying back shares, etc. but the assets on their books turned out to be significantly toxic.

If we can not determine the quality of their balance sheets, we can not reasonably predict their earnings, and their cash flows are impossible to use for valuation, banks as an investment class are an unpredictable crap shoot.

Apr 22 05:28 PM

[balois:]

Mr Cetin H, Keep on googling and be happy.

If your English is as good (or bad) as mine, do not read the following. It might cause you nightmares (albeit the brave comptrollers get lost in their own contradictions. Seriously deadly funny)

www.occ.treas.gov/ftp/...

have a good day

Apr 22 05:49 PM

[Alan Young:]

I can't believe this-- Krugman stole my line! See seekingalpha.com/insta... (posted 2 days ago)


On Apr 22 03:43 PM morph366 wrote:

> For a real "Through the Looking Glass" view on what bank stocks are
> really worth this posting from Paul Krugman entitled "Alice in Financeland"
> is worth a look:
>
> krugman.blogs.nytimes..../
>

Apr 22 05:50 PM

[Ergo:]

You know, even in gambling, I have some idea of the probability. I don't with bank stocks.

Apr 22 06:15 PM

[Donald Johnson:]

What makes banks stocks volatile and risky?
First, politicians are messing with the money and banking markets as never before, and predicting what they will do to and demand from banks is like reading Barney Frank’s mind. Impossible.
Second, it’s almost impossible to predict spending trends for consumers or businesses. As a result, only 23% of the companies that have reported earnings for the first quarter have provided guidance on the sales and earnings for the rest of the year. If banks’ customers can’t predict their futures, how can banks?
Third, the critical housing market remains in decline and probably will for a long time. We just don’t know how bad the toxic assets on the big banks’ balance sheets are and we probably won’t even after the government gives a peek at its stress tests. Results of the stress tests, or at least some of them, are due on May 4.
Fourth, the world continues to have the ability to cause turmoil, and we don’t know when some dictator will decide to turn on the heat on the U.S. and the West in an effort to take his people’s eyes off their domestic problems. I own USB, and I have sold covered calls against the stock.

Apr 22 06:21 PM

[Lin:]

re

Obviously members of the PPT post frequent comments on Seeking Alpha . The situation is so dire that all they can do is lie + jawbone about " how strong the consumer + the economy is ". Believe it at your own risk .

Apr 22 08:24 PM

[Moon Kil Woong:]

The problem analysts are having is the same the owners of banks have, that is management obscures owners rights to know what positions they have. This is compounded by the fact analsts can't compare past performance to current performance because changes in FASB rules, bailouts with unknown obligations, and weird transactions like AIG's are further clouding the results.

The fact Wells Fargo's reporting was unclear and nebulous about where its earnings actually came from and it's loan loss reserves sank the stock even though "earnings" were positive shows the complete lack of financial credibility banks have made their financial reports. The more they ask for black boxes and exceptions the worse their plight becomes. If they didn't get what they asked for they would be better off.

In the end "earnings" must mean earnings, not cute ways of changing the value of your unsellable assets. When will bank management figure this out. Apparently never since the government is helping incompetent management stay in power.

Bankruptcy has never had a poster child extolling its virtues over preventing it as much as looking at present day financial companies. Present day management and board members must go. Their lies are choking up the whole system.

Apr 22 10:06 PM

[mrmillergd:]

This is the best argument I've seen yet for buying the toxic waste that is today's megabank. Unfortunately I think it is possible on the brink of failure may be forced into a Bear Stearns-like deal where equity holders get destroyed. Still too speculative IMO.


On Apr 22 05:22 PM fcharlie wrote:

> I for one can say that i am not at all attempting to guess what earnings
> will be and slap a multiple on it to decide what these stocks are
> worth... there is no point...the reality is that many banks need
> only to survive and they are seriously undervalued, and the federal
> reserve is ensuring their survival with 0% interest rates as far
> as the eye can see.
>
> Take Bank of America, if you net out the value of it's interest in
> China Construction Bank, it's selling for one times normalized earnings.
> You can argue all day long that it is technically insolvent, bankrupt,
> etc.. but the Federal Reserve is seeing to it that they are not going
> to fail.....deposits are growing, so they have no funding problem,
> and with $29 billion in loan loss allowances and $60+ billion pre
> tax pre provision earnings, all they have to do is continue to operate
> and eventually BofA will see the end of this. It may not be fair,
> but it's reality. The banks will survive, and once they have, it
> won't matter whether you bought them in feb. march, or april. you
> don't have to nitpick over what earnings will be next quarter or
> what multiple should apply to those earnings, because long term,
> the margin of safety is huge and the opportunity to make money is
> so great that you just have to buy them and either take some dramamine,
> or just tune out the noise....

Apr 22 10:06 PM

[Bill S. Friend:]

As defaults continue to rise, people will look across their street and see their neighbors houses selling for half of what they paid, and wonder, "How am I ever, in my lifetime, going to make up for this huge deficit?". Then they will stop making payments with their credit cards and look for a rental home. Its happening right now in Florida, and Vegas, and California. It will spread out from these locations in a snowball effect, cascading throughout the economy. Many have yet to confront the truth of their unsustainable lifestyle. Add to that awful truth skyrocketing unemployment as construction jobs fall off a cliff.
It will be the largest transfer of wealth to the richest few in the history of The United States.

Apr 22 10:09 PM

[InvestBaboo:]

"Things are never as bad as they seem while they certainly are not as good as they seem" -- so goes the old adage and it is probably an accurate description of the uncertainty surrounding banks.

To know what will happen to banks earnings we need to look at the broader economy. If you make a future prognosis while looking in the rearview mirror you see massive unemployment, foreclosures, even more dramatic fall-off in consumer spending, plunging housing prices and thus plunging equity markets. However, if you survey the scene around you see something interesting happening. Many companies are announcing better-than-expected earnings. Best Buy did it, Bed Bath and Beyond did it, Apple and RIMM blew it out the door and likely Amazon will do the same tomorrow and (get this!!!) JC Penney raised estimates! If it is true that the companies are feeling more optimistic about their future they are probably going to start hiring people. As they start to hire people the fear psychosis that has gripped the nation will start loosening. As people lose fear those that have jobs and money but are affraid to spend will start doing so. When this happens manufacturers that are operating with low inventory and low production capacity will start expanding their operations and they start hiring more people! All these wheels are in motion but meanwhile banks are raking in money as they get money at ridiculously low rates and lend it out at an exorbitant rate making a ton of money which many believe will help them cover the impending loan losses until the economy turns around. And when the economy turns around the banking frachises that have positioned themselves right will become financial behemoths.

Therefore, banks will be fine -- they are not going anywhere. The U.S. of A is not going anywhere -- rumors of her death have been greatly exaggerated. The strongest franchises will survive and thrive. The weaker will be eaten by the stronger ones (Look at what Mack the knife said Morgan Stanley is likely to do with regional banks). Those that invest today in these behemoths will reap huge dividends down the road.

Behemoths as per my book -- JPM, MS, GS, WFC, BAC.

Banks are a longer term investment. For the shorter term bank equities price movement will be driven by traders.

Apr 22 10:46 PM

[Jasper M:]

Ergo: Oh, I think you do.

Apr 22 11:40 PM

[mooky:]

Really? BAC is also at risk of having the government's preferred shares exchanged for common which will take the stock back to $2/share. No one knows for sure if this will happen but its absolutely a risk! And to say it isn't is an complete roll of the dice at this point. I personally will wait for the government to announce the stress test results and reassure me that this won't happen before i buy. No one trusts the govt right now and they are changing the rules of the game on the fly. I'd rather have my entry point at $2 rather than $8 and i'm willing to wait until May 4th to find out! Good luck


On Apr 22 05:28 PM jasonjim wrote:

> Why all the worry about what a bank is really worth? Who cares? When
> Bank of America (seekingalpha.com/symbo...) is selling for
> $8 and change, it is the bargain of the century regardless of the
> numerous problems analysts and writers try to throw into the pot
> to confuse everybody including themselves. Buy BAC and hold, and
> you will be pleasantly rewarded. The shares will double, maybe triple,
> in one year or so because banks like BAC are money-making machines.
> They have a monopoly. Monopolies make money. Just the buildings and
> real estate that BAC owns are probably worth more than $8 a share.
> Countrywide by itself is worth more than $8 a share. Ditto for Merrill-Lynch
> and Blackstone.

Apr 23 08:24 AM

[nobby73:]

There are two basic ways of considering insolvency: firstly, does it have sufficient assets to pay all of its debts or secondly, does it have sufficient cash to discharge debts as they come due.

By the first measure, the banks are insolvent, as if you broke up any of these firms, the distressed value of the assets would not match the debts. This does not mean that the banks will fail, but it does increase the loss on defaults and does mean that if this is your measure for valuing the equity, it's not worth anything. Of course, as we saw this Merrill and Bear, another bank could buy the whole business, thus preventing break-up and the going concern value (with a few govt gtees thrown in for good measure) would see the shareholders get something. It is clear nobody wants to repeat the Lehman chaos.

By the second measure, the banks are not going to run out of cash as the government stands as the lender and buyer of last resort and guarantor over depositors to prevent a run on the bank.

So, as I said on 9th April...

"Frankly, nobody fully understands any of the banks' balance sheets. Nobody properly understands the true quality of the assets, the likely defaults rates or recovery rates. Nobody fully understand what the correlation is between say leveraged loans, equity tranches of SIVs. Nobody knows what lawsuits may arise, what the true risks of credit card debts are. The derivatives positions are off-balance sheet and many Black Swans lurk in the fat tails that MVaR can't see. Seems to me it doesn't matter if you are long or short, it's poker. The only thing to give comfort is that the dealer is the government and it seems it doesn't want the players to leave the game having lost all their money..."

If we assume survival from this point, perhaps the biggest lurking uncertainty is the number of lawsuits that will hit these banks (at least the most solvent ones) when the situation improves. Remember, that's how the cycle works in American capitalism...

Apr 24 02:23 AM

[ocean 2026:]

Few people bother to look beyond the major banks but there are several smaller and traded banks with much better rations on their coverage of non-performing loans by their allowance for losses. Many of these sell for less than half book value.

Research UWBK, SVBI, PFBI all bargains. I have interest in all and they have appreciated slightly since I bought them a few weeks ago.

May 10 09:05 PM