The Reality of Bank Earnings in Question?
Smoking stuff here…
Last month, many banks reported strong earnings. Market sentiment has changed substantially. Only a few months ago, the collapse of the whole US banking industry threatened to bring the whole global economy down. Now, suddenly, the picture looks rosier than ever and this financial crisis seems to be over. Or is it?
With very limited transparency of bank earnings, there are several so-called earnings areas investors should question whether they are sustainable, and a few other areas investors should ask whether they are even real. They are as follows:
1) The sudden increase of financing activities on residential mortgages. Thanks to the historically low mortgage rates at Q1, some home owners have been refinancing their mortgages, resulting in both spread and fees contributing to bank’s earnings. This trend could spill into Q2, but unlikely further. About one out of 5 home owners in this country are under water, meaning their home value falling below their mortgages, which in turn means they are unable to refinance. I also believe real estate has another three years to fall, until 2012, at the national basis (see my previous article “The Real Estate Apocalypse” here), further discouraging any new home buying and sending more home owners under water. I expect this part of the bank earnings is temporary and short-lived.
2) Bank analyst, Michael Mayo said last month, “Mortgage-related losses are about halfway to their peak, while credit-card and consumer losses are only a third of the way to their expected highest levels. While certain mortgage problems are farther along, other areas are likely to accelerate, reflecting a rolling recession by asset class”. He also estimated for the whole US banking industry, the total bad loans could be at the range of $7 – $11 trillion, or 3.5 – 5.5% of all loans, worse than the 3.4% peak at the great depression. We have written off only about 2% so far, about the 4th inning of a 9 inning game. There will still be a very long and dark night ahead. Same as real estate, I believe it won’t be until 2012 that banks would be getting close to the end of the asset write-off process.
3) Banks postponing charges to earnings for their loan and credit losses. Write-off due to their loan and credit losses by banks is a very discretionary, arbitrary and dedicated process. Most importantly, it is a delayed process. When rates fall, their portfolio rise in value immediately which they reflect in their Q1 financial statement, but they delay to mark down the value of the credit losses until they can’t hide them anymore. They realize if they really reflect the real and true losses, their equities, including the huge investment by US government bailout money, will show up as a negative number. In other words, all the taxpayers’ money disappears from this money pit of the banking industr
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