One bank after another has been reporting "surprise" earnings over the past week or so, but given the refinancing boom and a months-long trend in interest rates, it shouldn't have been such a huge shock. The surprise is that analysts continue to earn paychecks and retain clients after being so far off the mark, whether in expecting huge writedowns and losses last year, or the ensuing turnaround. The Big Miss of 2009 began a week ago when Wells Fargo ( WFC) preannounced a $3 billion first-quarter profit on Friday. The results translated into 55 cents a share, more than double the average analyst estimate of 23 cents a share, according to Thomson Reuters. Goldman Sachs ( GS) followed up with its own surprises: $1.7 billion in quarterly earnings and a $5 billion capital raise. Its profit was also more than twice what the average analyst expected, at $3.39 a share. The story was more of the same this week with JPMorgan Chase ( JPM), General Electric ( GE), whose finance arm has stirred great anxiety and apparently brought forecasts far too low, and Citigroup ( C). JPMorgan topped expectations by 8 cents a share, GE beat by 5 cents, and Citi's loss was only about half as bad as expected, 18 cents a share vs. a 34-cent estimate. The trend wasn't particular to the big kahunas, either. Regions Financial ( RF) and BB&T ( BBT) both blew forecasts away, as well. Following Wells' preannouncement, Sandler O'Neill analysts said they "would be curious to know exactly how the
net interest margin was able to come in so far ahead of our expectations."
Well, here's one explanation. The Federal Reserve slashed its key interest rate target all the way down to zero back in December. Since then, metrics that represent interbank lending rates -- like LIBOR -- have crumbled to just above 1%, while some types of Treasury securities have actually touched below 0%. At the same time, banks are hiking rates on consumer debt like credit cards and auto loans, while benefiting from a surge in mortgage business and government support in the capital and housing markets. Therefore, it costs less for them to borrow, and apparently, they are charging more to lend. They're also banking bigger profits on things like fixed-income trading, as huge arbitrage opportunities have emerged amid wide yield differentials. Sometimes this has occurred in equity and debt of the firms themselves, like Citi, GE, BofA, Wells or AIG ( AIG). None of this is new, unexpected, or especially surprising. Anyone paying attention to the capital markets or economic trends could have pointed it out. In fact, several CEOs did just that in February and March, saying that credit conditions were improving. Some said they expected to at least operate at a profit in the first couple of months of the year. In other words, duh. All the analysts had to do was adjust assumptions to reflect the shifting trends over the past few months. Had they done that, some might have been off the mark, but they would have been closer to what was really developing. The story is all too familiar, since analysts were widely criticized during the bust cycle, as few failed to predict mammoth losses at the huge firms they were supposed to know inside and out. At least during that forecasting failure, there were outliers such as Meredith Whitney, who is still heralded for predicting Citigroup's impending doom, and Mike Mayo for his sometimes unpopular, but ultimately correct, calls on bank stocks.
Massive chaos in the financial markets last year was largely unexpected, and the economy's decline was swifter and sharper than conventional wisdom. Some might argue that no one expected banks to turn around this year so abruptly, but the writing this time seems to have been on the wall. Of course, hindsight is 20/20 and investors have been told repeatedly throughout the economic crisis that no one has a "crystal ball." But the purpose of analysts -- and credit-rating firms, for that matter -- is to see through the clutter and give advice on where a stock is headed so that investors can make better picks. A look at ratings on top bank stocks, and how they have changed over the past few months, shows that analyst recommendations were reflecting existing conditions rather than predicting those ahead accurately. For instance, as Wells' has disclosed details outlining improvement in its financial condition, its mean rating has improved 34 basis points. But instead of charging ahead with the bulls or taking a step back into hibernation with the bears, after Wells' surprise profit report, many waited on the sidelines to glean further details from the firm's full report on April 22. KBW's Frederick Cannon bucked that trend, downgrading Wells to underperform, saying that despite a "premier banking franchise with exceptionally strong pre-provision earnings," the firm will see earnings and capital remain "under pressure due to continue
d economic weakness." He may be wrong, he may be right, but at least he earned his paycheck.