Analysts across field are calling for the U.S. economy to "bottom out" in the second half of 2009, calling for GDP growth in Q4 but hesitant to take a stand regarding the near term economic forecast. Meredith Whitney drew her own proverbial line in the sand, calling for shares of Goldman Sachs (GS) to reach $186/share. Goldman has profited from the volatility of the market throughout the recession and will most likely blow out the street's estimates yet again, but does this tell us anything about the banking sector as a whole? Unfortunately Goldman doesn't foreshadow strength in commercial banks, yet the XLF Financial ETF gained 6.4% on Monday compared to a lessor 5.3% for GS. The bar is high for commercial banks to beat earnings given a steep yield curve that offers banks a comfortable Fed Funds to 30 year fixed spread, offering a 5% yield for banks, yet purchase and refinance mortgage levels have been lackluster of late. The contentions unknowns facing banks moving forward are credit card and commercial mortgage defaults.
Credit card default rates in May ranged from 8.3% on JP Morgan's (JPM) books to 10.5% of Citigroup's (C) card holders missing payments, while Bank of America (BAC) expects to write off 12.5% of remaining balances. Credit card legislation signed into law on May 22, 2009 will force banks to treat borrowers to notices of rate hikes and the option of recapturing their lower premiums if minimum payments have been made on time for six consecutive months following an increase. While the law is less pressing on banks' balance sheets than some had expected, the end result must be lower profits from credit card arms of all commercial thrifts.
Commercial real estate prices, vacancy and sales have been deteriorating at increasing rates of late and are still well far from recessionary levels of 2002 and 2003, suggesting that trouble in this sector will worsen in the near future. CIT Group (CIT), not to be confused with Citigroup, specializes in holding commercial mortgage paper and is now seeking government aid with hopes of avoiding bankruptcy. The group presently holds $2.3 billion of TARP funds on the balance sheets but needs more funding to avoid collapse. The following charts offer a visual perspective to the commercial real estate market, begging investors to do their homework before piling into thrifts with exposure to the space.
Goldman Sachs reported earnings of $4.93/share before the market open on Tuesday, crushing estimates as expected, yet the all financial valuations suffered from the admission of reality... Goldman isn't a bank and shouldn't move bank shares! Goldman Sachs is a trading house and investment bank but isn't exposed to any of the issues facing traditional banks and thrifts. The later banks begin reporting Thursday as JP Morgan (JPM) announces results followed by Citigroup (C), BB&T (BBT) and Bank of America (BAC) on Friday. Dissecting the books of these giants and separating the TARP infected tissue from the healthy muscle may prove impossible, but results from credit card and commercial mortgage arms will read clearly in black and white. Judging from statements by Johnson and Johnson (JNJ) and Alcoa (AA) it seems that we may get our fair share of BS as forward looking statements describe the "signs of a bottom" cliche in one hundred different ways. Will investors and traders be satisfied by shaky rhetoric combined with disconcerting top and bottom lines? Can financial institutions really be trusted with TARP funds and FASB revisions still clinging to balance sheets like decaying scar tissue over infected internal organs? Only the analysis of revenue growth and earnings potential among banks will begin answering these questions, while time is the ultimate decision maker in such a volatile era.
Don't be surprised by negative reactions to neutral results among banks for the quarter. This isn't the time to play guessing games with positions. While passion and technicals move markets in the short term, ultimately shares revert to the mean of fundamental analysis.
