No downturn lasts forever, but this is an unlikely time to jump back into the sector THE investors who wildly bid US bank stocks higher over the past few days appear to have been motivated mostly by relief that the appalling results being posted by US banks hit by the credit crunch were not even worse
     In particular, investors were thrilled to see second-quarter losses of "only" $US8.9billion ($9.1 billion) for Wachovia, America's fourth-largest bank and one of the financial institutions most heavily exposed to dodgy mortgages, thanks to its ill-judged 2006 acquisition of Golden West, a Californian home lender
     Wachovia managed to convince the market that its underlying earnings (plus cuts in its workforce and dividend payout) were likely to be enough over the next year or two to cover additional bad loan provisions against its mortgage portfolio, averting the need for a dilutive capital raising
     Whether or not that turns out to be the case remains to be seen
     Although there are signs many banks are becoming more realistic in their provisioning, nobody can forecast what will happen to mortgage default rates if the US economy really does slide into recession in the second half of 2008, or if US home prices really do slump 30 per cent from their 2006 peak, as the bears argue they ultimately will
     After all, it needs to be kept in mind that the surge in defaults and foreclosures since early 2007 -- which triggered the collapse of the credit markets -- has all taken place at a time when the US economy has continued to grow, in defiance of predictions of recession, and employment has held up
     Where does the rally of the past few days leave financial stocks, which have so far borne the brunt of the downturn? Broadly, US bank stocks halved in value over the past seven months as the realisation sank in that the financial crisis was not going to be over any time soon, and that further falls in home prices would flow through into further write-downs of both mortgage portfolios and the holdings of complex debt assets many banks were saddled with
     In the past week, bank stocks have recovered fully half of those losses
     While the rebound has reflected a sense that bank stocks "could not go any lower", and was assisted by the SEC's steps to curb short selling of the stock of 19 select financial firms, it has also been completely at odds with the earnings that have so far been posted
     Among US financial firms reporting for the June quarter so far, earnings are down about 80 per cent from a year ago, and in aggregate are about 50 per cent worse than consensus published analyst expectations, according to Thomson Reuters
     In other words, the rally is built on tenuous foundations indeed: relief that current-quarter bank earnings have not so far included any utterly shocking or disastrous revelations, as opposed to simply failing to get within shouting distance of expectations, and a regulatory intervention that reeks of crony capitalism
     That is hardly the basis for an extended upswing in valuations
     To be fair, three major commercial banks did report strong June-quarter results -- JPMorgan Chase, PNC and Wells Fargo
     JPMorgan Chase, currently the US commercial bank with the largest market capitalisation, announced earnings of $US2billion for the quarter
     But CEO Jamie Dimon was hardly positive about the outlook. Dimon warned that credit problems were beginning to spread from less well-pedigreed borrowers to households with prime credit, and said the prospects for 2009 were bleak indeed
     The JPMorgan CEO may in part have been talking his own book -- having already snapped up the remains of Bear Stearns, his bank may be able to exploit its resilience and its rivals' weakness to expand further if the crisis continues, entrenching its newly achieved position as the industry leader
     But the prospect of a broad-based further deterioration in credit quality should chill investors, particularly those who believe banks can earn enough from their "core" activities to cover their mortgage losses and ward off dilutive raisings
     Another ominous sign that the housing mess may be spreading in ways that threaten the other earnings streams of financial institutions came this week from American Express, which reported that almost 5 per cent of credit card repayments were now more than 30 days past due -- a rise of about 50 per cent from the top-of-the-cycle low in overdue payments reached two years ago
     While credit card spending weakened as a whole, Amex also reported sharply higher spending by consumers in several US markets where other sources of credit have dried up -- such as a surge of 16 per cent in Nevada, one of the epicentres of the sub-prime disaster
     Even more worryingly, and echoing Dimon's warning, rising overdue repayments were spread across all classes of borrowers, including those with prime credit, rather than being concentrated among consumers with poor past credit records
     Add the faltering consumer credit market to the housing disaster, throw in flat or contracting asset bases and the troubles many regional US banks face over commercial construction-related financing, and it is not easy to see how most banks are going to be able to ride out the rest of the US deleveraging without their earnings taking a further battering
     In addition, with few easy-to-tap sources of capital out there other than sovereign wealth funds (and even those are hesitant to double down on US dollar denominated financial assets), Wachovia will not be the last major US bank to slash -- or even eliminate -- dividends to conserve Tier One capital
     No downturn lasts forever, and at some point there will be a reasonable case for arguing the US banking sector has been oversold and it is time to buy
     But with so much uncertainty and so many risks still out there, it seems unlikely that point is now.

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