Bank Earnings: The Longest Yard (C)(MER)(LEH)(BAC)

May 17, 2008 by Douglas A. McIntyre

Banks will post much better earnings as the year goes on. Most of their write-offs are behind them. What else is there on their balance sheets to revise down in value? That thinking is a colossal example of delusional thinking. It has been spread, due to excess optimism or mediocre analysis, by bank and brokerage CEOs.

The matters of fact are that housing prices continue to fall, default rates on ARM subprime mortgages continue to rise, and inflation in the costs of food and gas suck the spending power of the lower middle classes to zero.

Reuters makes the point that "Finance firms continue to underestimate exposure to mortgage losses, missing their earnings targets as a result."

The greatest dislocation in the data surrounding money center banks and brokers is the value of their share prices. Institutional income from loans and underwriting may be slow for the rest of the decade. Consumers are going to stop paying credit card bills and there will almost certainly be a spike in bankruptcies, both corporate and personal.

Citigroup (C) hit a low of $17.99 in mid-March. It has not tested that and now trades up from that price by 28% at $23.12. The movement for shares in Merrill Lynch (MER), Lehman (LEH), and Bank of America (BAC) does not look terribly different.

If Wall St. could look out and see substantial losses at these companies for the next three quarters, their valuations would not be so robust. Which is to say, almost all of them trade too high.

Douglas A. McIntyre