5 Reasons to Avoid Bank Stocks

The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.

NEW YORK ( TheStreet) -- As of this writing, threats that Greece will default on its debt have European markets in turmoil. Rumors of a bailout by France and Germany were denied by both governments.

European Bank Stocks Plummeting

As a result, European banks like Société Generale, Crédit Agricole and Deutsche Bank are watching their stock values plummet. Absent an eleventh-hour agreement from other nations in the eurozone to prop up Greece, however, many analysts are predicting another European recession that will echo in markets worldwide. European bank stocks can only suffer additional losses if that occurs.

U.K. Bank Reforms a 'Net Negative'

Meanwhile, U.K. banks were hit Monday with a bill for more than $11 billion each year to put into place sweeping new reforms proposed by the Independent Commission on Banking. The new rules would require banks to segregate their retail activities from their investment banking operations. The "ring-fenced" retail divisions would be required to operate independently and to conduct all transactions with their investment banking counterparts at arm's length. Additionally, the largest banks would be required to hold as much as 20% in equity and loss-absorbing debt against their assets. According to The Wall Street Journal, bank analysts at Citigroup ( C) call the proposal a "net negative" for U.K. banks. Again, U.K. banks can expect their stock prices to fall if the proposal ultimately goes through.

Capital Requirements Put More Pressure on Banks

The U.K. is not alone in seeking to impose additional capital requirements on banks. The Basel Group of global bank regulators' capital rules are intended to shore up the financial system by making banks accrue risk-absorbent "core tier one" capital up to at least 7% of risk-weighted assets; the largest banks would be required to reach 9.5%. Reuters reports that Jamie Dimon, chief executive of JPMorgan Chase ( JPM) (a bank that would be required to meet the 9.5% level) has called for the U.S. to consider pulling out of Basel, calling Basel's capital requirements "blatantly anti-American" and criticizing liquidity rules that discount government-backed, mortgage backed securities commonly held by U.S. banks. If Dimon's criticisms are well-founded, the additional capital requirements may put additional pressure on U.S. bank stock prices.

U.S. Banks' Declining Profits

It would be hard for the timing to be much worse. The London Telegraph reported this week that Citibank analysts are calling for U.S. bank profits to drop by an average of 45% in the third quarter. According to Citibank, Goldman Sachs ( GS) will lose the most, though profits at JPMorgan Chase, Morgan Stanley. Lazard and Bank of America ( BAC) were also predicted to fall.

The reason for BoA's declining profits seems clearest. Of all major banks, BoA may be sitting on the single largest block of subprime mortgages, acquired when BoA bought out Countrywide Financial. Losses on those mortgages are draining profits from other, more successful units within the company, and angry investors who purchased securities from BoA that were backed by subprime mortgages are lining up to sue the bank, claiming to have been misled. Rumors that the Countrywide section of BoA will declare bankruptcy about but, at this point, BoA won't confirm or deny them.

What BoA has done is shore up its stock price in the short term by announcing plans to cut 30,000 jobs over the next few years. According to news reports, the expected layoffs are intended to save about $5 billion per year and to streamline its operations. Wall Street responded favorably when the layoffs were announced, giving a small but undoubtedly welcome boost to BoA's stock, which has lost about half its value this year.

Bank Layoffs All Around

BoA isn't the only bank with layoffs in the works. Last month, Royal Bank of Scotland ( RBS) announced plans to cut 2,000 jobs, primarily at its investment banking subsidiary. UBS ( UBS) announced in July that it might fire up to 5,000 workers, primarily in its FICC and trading units. Credit Suisse Group ( CS) announced plans to cut up to 2,000 jobs in equities, debt, finance and investment banking, including several hundred in the U.S. HSBC ( HBC) reportedly hopes to shed 30,000 jobs across the globe 2013, and Barclays ( BCS) reportedly intends to lay off about 3,000 employees from its corporate banking and retail banking arms. Overall, the layoffs could cut over 70,000 jobs n the banking industry.

In the short run, those cuts might look good to investors -- after all, aren't increased efficiency and reduced labor costs always desirable goals? Over the longer term, though, the results might not seem so sweet. There's a bottom limit somewhere to how much the banks can reduce staff before seriously harming their ability to conduct meaningful investment analysis, much less the level of service they can provide to their customers. At some point, there simply won't be any more fat to cut.

And, in the long run, it's hard to believe that massive layoffs in any industry will help the world economy. The specter of continued recession continues to threaten in part due to ongoing high unemployment levels. Adding tens of thousands of bankers to the ranks of the unemployed is bound to have at least some negative impact on consumer spending and income tax revenues that governments desperately need. It's ironic that, at the very time President Obama is fighting to put Americans back to work, the nation's biggest bank is planning a massive layoff.

Here's the bottom line. Banks need to address the flaws in their internal processes that led them to make the mistake of lending billions in subprime mortgages and buying up the securities they backed. Although banks can complain that the various regulatory schemes on the table are too burdensome, those complaints shouldn't carry much weight unless they're backed up by meaningful, voluntary reforms. It's up to the banks to get their own houses in order. Until they do, banks may not be the safest place for anybody's money.

Readers Also Like:


This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.