NEW YORK (
) -- The light at the end of the loan-loss tunnel grew brighter over the past week, as the Big Four U.S. banks issued earnings reports with a largely optimistic spin. A couple even earned money.
But the question for investors is no longer when credit costs will peak; it's when industry earnings will return to "normal" again -- without the help of hedging and other market activity.
Executives and analysts have been trying to provide their best-guess answers to that question. The time horizon and vagueness varies with their level of optimism and their experience in economic cycles. The consensus seems to be something along the lines of, "It might take two years...or three...or perhaps four. Here are a bunch of complicated models to help you predict it, but we really don't know."
Given the punitive regulations likely to be imposed upon the banking industry, it may not even matter. Major equity indexes plunged on Thursday after President Obama unveiled more tough rules aimed at Wall Street, and
. The Dow Jones Industrial Average posted its biggest two-day losing streak in months, dropping more than 200 points, or 2%, at times on Thursday. Financial loss-leaders were down 5% to 8% in intraday trading.
As the largest U.S. bank,
Bank of America
may be the best indicator of where the country's economic cycle stands. CFO Joe Price assured investors this week that "we are past the peak in total credit costs." And newly installed CEO Brian Moynihan asserted "we still have several quarters before we can discuss the actual, normalized earnings."
How long that is depends on one's definition of "several" and whether the discussion will occur before or after the normalization has begun to take shape.
CFO Michael Cavanagh didn't go so far as to provide a time horizon, but noted that the company's credit portfolio had negative revenue of $669 million during the quarter, due to swerves in valuation and hedging.
"On average you'd expect credit portfolio revenues to be a couple hundred million positive ... so just as you think about what to expect as quote unquote, 'normal,' there," Cavanagh cracked.
In their defense, last quarter was anything but normal on either side of the ledger. One end showed elevated credit costs, oddball valuation adjustments, one-time TARP repayment fees and other regulatory expenses. The other had emaciated loan income, sharp drops in trading revenue, and wild swings in items with interest-rate hedging involved, such as mortgage-servicing rights.
Capital levels, too, are out of whack.
required an enormous government bailout because of depleted cash just over a year ago. But CFO John Gerspach noted that the firm's liquidity is now at least twice as high as what the bank would "normally" carry, adding that "some people might argue that it's even perhaps three times as much."
In other words, nothing in banking is anywhere near normal just yet. Given the unexpected and unprecedented events of the past couple of years, few are bold enough to predict with any certainty just when that new normal will emerge. If one thing is for sure, it's that normal won't be here in 2010, and given tectonic regulatory shifts, the next normal won't look like the old one, anyway.
Ladenburg Thalmann's Brad Ball may be the most bullish among bank analysts, predicting a return to normalized earnings by 2012. He recently initiated
Bank of America and
with buy ratings and set 12-month price targets of $23 and $35, respectively, based on that view.
Others believe the horizon extends out a bit further, perhaps out into 2014. Among the more bearish is Ball's predecessor at Ladenburg, Richard Bove, who now makes bank-stock calls at Rochdale Securities.
"Normalized earnings will be a 11 to 12% return on equity," Bove said in a response to an unscientific poll of experts by
. "Banks should be there in three to four years."
Bove reiterated his sell rating on Wells Fargo on Wednesday, predicting that Wells will have difficulty meeting core earnings targets in the foreseeable future because of loan losses. He holds a buy rating on Bank of America due its cheaper valuation, but has expressed concern about its ability to seize opportunities in a dramatically changed banking environment with a fledgling CEO.
Oppenheimer's Chris Kotowski has something of a middle-of-the-road view, noting that last quarter provided "a better line of sight towards 'normalized' two or three years down the road."
It's hard to say where bank stocks will be at that point, however. If
are any indication, a normalization in business won't necessarily lead to a normalization in stock price. Take a look at their 2009 results -- weighted mostly in capital markets activities -- vs. big banks with greater consumer exposure, and how stocks have reacted since bank earnings kicked off a week ago.
Citigroup remained $1.6 billion in the red last year and Bank of America swung to a $2.2 billion loss in 2009 from a $2.6 billion profit in the prior year. JPMorgan's earnings soared to $11.7 billion, while Wells Fargo's more than tripled to $8 billion, but the bottom line at both firms was helped by mammoth acquisitions. Executives spent a lot of time discussing credit quality this week, and both stocks were held back by the outlook for top-line growth or concerns about loan-losses ahead.
On the other hand, Goldman Sachs, which didn't acquire anything of significance last year besides new business, reported earnings of $13.9 billion. Since Goldman changed its fiscal reporting calendar, year-to-year comparisons aren't quite fair. But whether one measures by the $2.3 billion earned in the 12 months ending November 2008, or factors in the $1.3 billion loss it posted for December 2008, its performance is stunning.
Morgan Stanley's 2009 loss widened, to $907 million, largely because of an accounting oddity. As far as its core operations go, Colm Kelleher, co-president of institutional securities summed it up nicely during the conference call on Wednesday.
"Global equity markets are reasonable healthy and open across industries and geographies," he said. "Public credit markets are functioning normally, although bank lending remains slow. Global M&A activity is improving as funding becomes available and corporate confidence recovers. IPO activity has returned to a more normalized level and the momentum in completed offerings and file backlogs are encouraging for 2010."
But with Obama and regulators promising to crack down on lending and trading alike, investors shrugged off any optimism about the capital markets. Since the first bank reported last Friday, the group is markedly lower with the initial move down for most exacerbated by Thursday's market fallout to Obama's reform proposal.
The reaction showed that shareholders staring down the financial tunnel, hoping for a glimpse of light, are not wearing rose-colored glasses.
-- Written by Lauren Tara LaCapra in New York