Q4 Outlook: Real Life Stress Tests Begin

Friday marked a gloomy day for the U.S. financial services industry: as the nation’s largest small business lender got closer to filing for bankruptcy protection, nine banks were shuttered, bringing the total headcount this year to 115.

While the Dow Jones Index plummeted more than 2 percent, many on Wall Street are now asking if the recovery in financial companies has come to a temporary standstill. Despite solid quarterly GDP numbers, there is some evidence that a sustained revival in the health of the U.S. banking system might be some way off.

At the top of the pile of evidence for this theory are the dismal third-quarter earnings of Citigroup (C) and Bank of America (BAC). While Citigroup managed to eke out a $100 million profit, most of that was in one-time gains from its trading operations, rather than from the day-to-day process of making loans and arranging corporate finance transactions. Bank of America didn’t even manage to get into the green: instead it made a giant $2.2 billion loss. Earnings among other banks have been mixed, but so far it appears as if Morgan Stanley (MS) and Goldman Sachs (GS) are pretty much the only firms who can present a genuinely encouraging picture of growth across all their divisions.

The shuttering of nine banks Friday brings the tally of annual U.S. bank closures to more than 100 for the first time since 1992. While the banks were quickly snapped up by U.S. Bancorp (USB), the failures cost the increasingly cash-strapped Federal Deposit Insurance Corporation (FDIC) another $2.5 billion. Analysts such as Meredith Whitney and Nouriel Roubini estimate that we may be only half-way through the total number of bank closures the economy will face as a result of the credit crisis.

CIT Group (CIT), which provides crucial financing requirements to small and medium-sized businesses (including many well-known brands such Dunkin’ Donuts), is now arranging a Chapter 11 filing, according to sources close to the proceedings.

I wrote previously that I don’t think a bankruptcy filing is as much of a sure thing as others do. Still, if one does go ahead, it will mark the fifth-largest bankruptcy ever in the U.S., and may even set off another Lehman Brothers-style panic among investors. That in turn would lead to another round of deleveraging.

For all the momentum this year, deleveraging is a scenario few — if any — banks can afford to weather a second time round. While most banks’ sales and trading units have done well in 2009, divisions such as Prime Finance — which is in part responsible for making loans — have been much slower to return to growth. Investor confidence would return to an all-time low too, hurting small brokers such as E*Trade Financial (ETFC), which have only just managed to start recovering.

In the first quarter of the year, all government-supported banks underwent stress tests to determine their financial strength. What remains of the final quarter may represent this year’s greatest test to a sustained recovery for many financial firms.

Disclosure: I own shares in CIT Group.

Comments

[apppro:]

Those somewhat 'pre-arranged' bankruptcies appear more to be the process by which we now allow vultures to swoop in and devour the carcasses of what used to be viable companies. The fact that Carl Ichann is trying to pick the bones of CIT at the end is just proof of our collective ignorance and their collective greed. Where was he 10 months ago when Pimco and GS were placing the nails in CIT's coffin?
Has anyone given any thought to how all this REALLY started? Oh yeah, I forgot > some bad housing and loans - BS!

Nov 01 07:15 AM

[Ricard:]

"Disclosure: I own shares in CIT Group."

I see why you are so pessimistic.

Nov 01 07:37 AM

[BRUCE E. W.:]

It is beginning to appear that handling banks one at a time is a system of attrition that will only serve scavenger interests and bonanza seeking private equities. There should be some better way to set up assorted levels of banking coallitions from mid range regional pools to work ou alternative potentials. It could be feasible that a struggling bank might be simply cut into divisions and merged into a team of banks to manage jointly.
I suppose there are many healthy mid-range banks that would be interested in expanding by joint venture into a market share by accepting a manageable proportion of toxic junk to process.
It just doesn't make sense that after all this year, there has been no experiences to alter the fate and rate of approaching these banks. This idea of just let them straggle along till they fail does not seem like the cheapest or the best approach in the long run.

Nov 01 11:47 AM

[Northstar10000:]

Can't you see it is so over. You believe the government is making things better!!! Lets all collectively run off a cliff since that is what the government is inviting us to do. GET PUTS NOW...

Nov 01 10:12 PM

[bbro:]

Another poorly written article on the banks....answer me these two equations......is preprovision earnings greater than the increase in non
performing assets and total net chargeoffs and what is the differential
between preprovision earnings and loan loss reserve to nonperforming
assets and total chargeoffs...oh lets through another one in there
tangible common equity plus annual preprovision earnings to the
differential in the Fair Value assesment of Financial Instruments found
in the Companies 10Q.....

Nov 02 04:51 AM

[platehead:]

ETFC is a sinking ship.

Nov 02 06:00 AM

[Lockstep In...:]

Woops! I hope it was a small position. It sounds like you did not hedge it at all.

Nov 02 02:31 PM

[Daniel Harr...:]

Yeah, it was very minimal.


On Nov 02 02:31 PM Lockstep Investing wrote:

> Woops! I hope it was a small position. It sounds like you did not
> hedge it at all.

Nov 03 08:36 AM