Monday, January 14, 2008

Bank Earnings Week

The banking sector appears to be a desolate landscape, looking like a forest after the timbering crew has bull-dozed their way through it. The troubles in this industry are now well recognized which may be the starting point for a recovery.

Citi kicks off the bank reporting season on Tuesday morning. Few of the major banks expected to show rises in fourth-quarter profit when reporting over the next two weeks. Citi and WaMu, are anticipated to post large quarterly losses. Analysts hope the banks get all the bad news out in the fourth quarter reports so the beaten-down sector can recover over the upcoming months. Nevertheless the industry trends of consolidation and foreign capital investment are expected to continue.

Investors should expect to see further consolidation over the coming months. Bank of America (BAC) has kicked this off with their recently announced acquisition of Countrywide (CFC). Press reports late last week indicate that JPMorgan Chase (JPM) is in advanced talks to acquire the shipwreck Washington Mutual (see WaMu on the chopping block: Can JPMorgan Chase really turn this bank around?) The trend towards consolidation will continue as banks in distress are merged with stronger partners. The WaMu acquisition situation may present another merger arbitrage opportunity; however investors should proceed cautiously because even at a mere $14 the Washington Mutual stock price may already be above any proposed acquisition price.

Many banks such as Citi are still seeking investment from overseas Sovereign Wealth funds to shore up their capital ratios. Preliminary figures indicate Citi is seeking an additional $14 billion as they cut an additional 17,000 to 24,000 staff members while writing down up to $24 billion in the fourth quarter. Merrill Lynch is also seeking additional overseas funding.

Some of the stronger bank stocks are appearing attractive from a valuation perspective. There are a number of mid-sized banks with solid finances and minimal credit risk exposure. Of particular interest are Bank of New York Mellon (BK), State Street (STT), and US Bancorp (USB). With the recent market rout, USB touts an attractive 5.7% yield. All these banks offer strong balance sheets and will likely weather the financial sector crisis in good order.