The slumping housing market and lingering credit crunch have pummeled financial stocks over the past year to lows not seen in almost two decades. Last year, banks were feeling the pinch from writedowns related to securities backed by mortgages and unsold leveraged loans. This year, banks are getting socked in the stomach as a consumer-led recession results in the rapid deterioration in credit beyond just residential mortgages and into other consumer and commercial-related loans, such as credit cards and residential construction loans.
As banks and consumer finance companies begin to report second-quarter earnings results next week, profits -- if any -- will continue to be weak. Banks will be busy continuing to add to their pile of loan-loss reserves, marking down leftover leveraged loans and mortgage-backed securities, and shoring up capital wherever they can, likely in the form of dividend cuts.
This week, TheStreet.com asked several high-profile equity analysts about how the credit crisis is affecting banks and other consumer finance businesses. Today, Jason Goldberg, a senior research analyst at Lehman Brothers, provides his take on the large-cap banks.
TheStreet.com: Capital, capital, capital. This year, a primary focus of investors has been on the ability of banks to remain well-capitalized by regulatory standards, despite the massive writedowns and loan reserving they have been forced to do. Goldman Sachs predicted that banks will have to raise an additional $65 billion before the credit crisis peaks next year. What do you think?
We expect the industry to continue to deleverage and note that quarter to date, assets are down by roughly $170 billion. Given recent equity raises have not gone smoothly, we would expect more immediate capital needs be served by further dividend cuts, as well as the sale of business units, as opposed to the issuance of common stock, if possible.
TheStreet.com: Other large-cap bank analysts are predicting further writedowns, particularly by Citigroup (C) - Get Report and Merrill Lynch (MER) . In what areas do you expect the banks to take writedowns, and will they be as bad as previous quarters?
For our coverage, market-related writedowns totaled $28 billion in fourth quarter 2007 and $20 billion in first quarter 2008. While we expect this figure to remain elevated, we do foresee modestly lower marks in second quarter 2008.
TheStreet.com: Aside from the securities writedowns, large banks have taken big provisions to protect against mortgage-related loan losses, and now increasingly in credit cards and other consumer loans. What assets could be the next problem areas for the banks?
In second quarter 2008, we expect real-estate-related credits to be the main source of problems with increased severity rates on mortgage, home equity and construction loans weighing heavily on results. We also expect auto and credit card to be more of an issue, particularly in the most housing-stressed states.
TheStreet.com: Of the five largest banks -- Citi, Bank of America (BAC) - Get Report, JPMorgan Chase (JPM) - Get Report, Wells Fargo (WFC) - Get Report and Wachovia (WB) - Get Report -- who is in the worst shape?
No bank is immune in the current environment. Citi is grappling with subprime
asset backed securities and collateralized debt obligations and its consumer finance operations; BofA has home equity,
credit card and now
; JPMorgan is busy integrating
and has run into trouble with brokered home equity; Wells Fargo also has home-equity woes; and Wachovia is grappling with a very large option-adjustable rate mortgage book.
TheStreet.com: Is anyone in danger of going under?
From 1988 to 1991, almost 700 banks and thrifts failed. Year to date, there have been four. I'm not sure how many we get this cycle, but the number is likely somewhere in between.
TheStreet.com: Who are the best merger candidates?
The number of banks have halved in the past 15 years, and we expect it to half again over the next 15 years. At the moment, many buyers appear concerned with their own portfolios and don't want to inherit someone else's. Still, the current environment does highlight the value of core deposits.
TheStreet.com: Will Citi CEO Vikram Pandit break up the company? What assets are most at risk?
We do not see Citi breaking up in the near term. The company has set out on a two- to three-year plan, and we expect it to continue on that path. This includes shedding low-return or non-core assets and cutting costs. We believe there is a great deal of low-hanging fruit.
TheStreet.com: Will Wachovia sell? There are lots of rumors these days regarding a JPMorgan Chase and Wachovia pairing. What do you think?
Wachovia has several attractive attributes, including one of the best retail banks in the country as measured by footprint, customer service and deposit growth. Additionally, it's one of the few scale players in retail brokerage. Unfortunately, however, they are saddled with a $120 billion option-
adjustable-rate mortgage portfolio that is seeing a surge in nonperforming assets. That is the piece one really needs to get their arms around. They also lack a CEO at the moment.