Are The Banks Back?

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Banks are back in the news.  In a good way.  Speculation is that mergers and acquisitions will be picking up, so are profits.  Some are looking to raise their dividend and/or buy back more shares.  Bank of America (BAC) is one of them.

The CEO, Brian Moynihan, announced that B of A wasn't looking to buy other banks.  Instead, the bank would be focused on returning more capital to shareholders in the form of a regular dividend (now 4 cents a year), share buybacks and special cash dividends.  The reason: he feels the bank will earn between $35 billion and $40 billion a year (yes, billion....a year) in pretax earnings when the business normalizes.  (But there's the catch: when does business get to normal?)

Right now, it's good to be in banking, if you're making solid loans.  That's because the yield curve is steepening (that means the short rates are lower than the long rates).  When that happens, banks make more money as they can borrow short term and lend longer term, though nowadays most banks will look to match assets and liabilities as to minimize interest rate risk.  They can do that with floating rate assets so their borrowings will float up the same way their loans do.  However, there is still some room on most balance sheets to be a little lopsided and have some shorter rate borrowings support longer term loans.  That spread is much wider and creates better profits.

The banking world is also busy with acquisitions.  BMO Financial Group (BMO) just bought Marshall & Ilsley Corp with one analyst saying that it was the inflection point in the mergers and acquisitions cycle, turning the buyers' market into a sellers' market.  Other deals done in the last few months: Hancock Holding Co. (HBHC), Comerica Inc. (CMA), People's United Financial (PBCT), and Susquehanna Bancshares (SUSQ).  Look for more consolidation as larger banks begin to pull out of their shells, trying to expand their markets. 

Those are all positive elements.  They point to renewed health for a much maligned (and deserved) industry that is beginning to heal.  But it's not all good news.

There are still plenty of bad mortgages.  Whether they're still in the hands of the homeowner or already at the bank, delinquent and defaulted mortgages continue.  Not at the same fast pace as in 2008 and 2009, but they're still coming.  Add those to the large pools banks already own, and there's no reason to believe everything is positive in banking world.  All of the foreclosed homes have to be sold at some point.  That will add inventory to existing homes for sale, but they should be written down to levels where banks won't have to take too much of a hit when they are sold.

Also, there's new legislation being considered that will force banks to adjust existing mortgages so that payments are lower (extend the maturity, lower the interest rate, forgive some of the mortgage).  If these are enacted banks will take a big hit (at least the ones that make home mortgage loans), especially if they have to write off some or a large portion of the mortgage due.  That comes right out of earnings.

There are also plenty of bad commercial loans and new construction loans waiting to hit the books.  New, empty buildings are evident in most parts of the country.  Partially finished homes and apartment buildings also dot the landscape.  Banks will own those and will most likely take losses on them as well.

As always, there's good and bad for the industry.  But right now, it's beginning to feel a little better.  Foreclosures are slowing.  Write-offs are lower.  Profits are coming back.  With prudent use of leverage (Capital can be anywhere from 8% to 12% of a loan, allowing for leverage), a bank can make large profits quickly.  It's when those loans go bad that they can lose money even faster.  Currently, it's looking like there are more good loans going on the books, ones that use today's valuations for the real estate and have higher down payments.  Those loans will no doubt have very few defaults.

The banks are back.  They're out of the grave most investors dug for them in the dark days of 2008 and 2009.  How far out is the question.  And if oil stays above $100 a barrel, will it slow the economy down enough to cause more unemployment, with the ripple effect of more foreclosures?  No one can say.  But if the economy continues to heal, look for the banks to book very solid profits for some time to come.

- Ted Allrich
March 8, 2011



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Stocks , Banking and Loans

Referenced Stocks: BAC , BMO , CMA , HBHC , PBCT , SUSQ

Ted Allrich

Ted Allrich

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