Six Reasons Why Goldman Is Wrong to Call a Banking Recovery in 2011On Thursday night, I appeared on CNBC's The Kudlow Report to debate whether the banking industry is at the start of a period of recovery. Goldman Sachs (GS) this week stated that thanks to economic growth in 2011, the banking industry will enjoy a recovery. I argued that Goldman was wrong -- for many reasons.

Why did Goldman suggest that banks were on the rise? Its analysts, led by Richard Ramsden, said that stronger economic growth, higher stock prices and low interest rates would cause financial stocks to outperform the broader market in 2011 and 2012, according to Dow Jones Newswires. Ramsden's note said, "With a better macro backdrop, the growth outlook for the sector improves significantly next year." Goldman notes that "financials will deliver market-leading earnings growth" in each of the next two years.

How dare I disagree with Goldman Sachs? Perhaps because banks are suffering from a huge overhang of bad loans, as well as declining revenues with little prospect for growth. Here are six observations to support those conclusions:

  • Declining revenues. I analyzed the quarterly statements of three big banks and found that each suffered declining revenues in the first nine months of 2010. JPMorgan Chase's (JPM) revenues dropped 1%, Citigroup (C) suffered an 18% decline, and Bank of America's (BAC) revenues lost 7%.
  • Ongoing huge overhang of bad loans. Big banks are still boosting how much they set aside to cover the cost of that uncollectable debt. Allowances for loan losses grew by 17% to $44 billion at Bank of America, 13% to $35 billion at J.P. Morgan, and 21% to $43.6 billion at Citigroup.
  • Big piles of illiquid, hard-to-value assets. Huge proportions of bank assets are classified Level 2 or Level 3, meaning they're illiquid and lack a definite value -- the institutions have put book values on them that may or may not reflect reality. For example 94% of BofA's assets -- more than $2.6 trillion worth -- are Level 2 or Level 3 which means that a 9% decline in their value could wipe out BofA's capital base. For Citigroup, the percentages are 86% and 14% respectively while JPMorgan's comparable figures are 88% and 7%.
  • No reason for banks to take the risk of boosting new loans. Why loan money to real people when you can take advantage of the risk-free trade of borrowing from the Fed at near 0% rates and buying U.S. government securities yielding over 2%?
  • Corporate loan demand is unlikely to rise. Corporations are hoarding cash -- $1.84 trillion worth at last count -- so there is no need for them to borrow from banks. If they do need to borrow, they can issue bonds at extremely low rates of around 2.5% -- much lower than the rate of a bank loan (the prime rate is 3.5%).
  • Consumers are in no mood to borrow. In fact, they're paying down debt. Americans are deleveraging because there are 15 million people out of work, the unemployment rate is 9.8%, wages are flat. Therefore banks won't make as much money on excessive consumer credit card borrowing as they did before.
Given those facts, either Goldman is making its case for bank stocks based on reasons that it's not disclosing, or its rationale is flimsy. In any case, I would avoid bank stocks -- even if they do end up paying dividends. After all, if another negative surprise leaks out, those share prices will tumble fast -- regardless of whether they're paying a dividend.


Increase your money and finance knowledge from home

Introduction to ETFs

The basics of Exchange Traded Funds and why ETFs are hot.

View Course »

Asset Allocation

Learn the most important step in structuring an investment portfolio.

View Course »

Add a Comment

*0 / 3000 Character Maximum

9 Comments

Filter by:
jakob_oram

A loan is a financial transaction in which one party - the lender - agrees to give another party - the borrower a specific amount of money which must be paid back in full.


http://www.reversemortgagelendersdirect.com/questions-answered/
http://www.reversemortgagelendersdirect.com/reverse-mortgage-loan/
http://www.reversemortgagelendersdirect.com/reverse-mortgage-rates/
http://www.reversemortgagelendersdirect.com/reverse-mortgage-calculator/
http://www.reversemortgagelendersdirect.com/reverse-mortgage-information/
http://www.reversemortgagelendersdirect.com/reverse-mortgages-how-they-work/
http://www.reversemortgagelendersdirect.com/who-qualifies-for-a-reverse-mortgage/

July 19 2013 at 3:55 PM Report abuse rate up rate down Reply
bfpowersjr

It would seem to me that illiquid, hard-to-value assets DO have MATURITY DATES that may become due (soon) in coming years. Most of the articles I read imply that many of them (derivitives) are still "under water." Most of my knowledge about derivitives is about commodity futures/spreads and puts/calls which do have a maturity date. I wonder if these "bad bets" we read so much about are now just about to start maturing?

December 05 2010 at 8:26 PM Report abuse rate up rate down Reply
hustonlaw

Don't forget, though; the banks mentioned are still too big to fail.

December 03 2010 at 4:28 PM Report abuse -1 rate up rate down Reply
imcri

This article has good point, but relies on some points that seem rather naive. * "Declining revenues" Interest rates are at all time lows. As older loans and investments payoff, and are replaced with newer loans, revenues decline. Also, so does cost of funds. What is happening to "net interest margin".. for many banks, steady or going up. * "Ongoing huge overhang of bad loans." Thats true, and will be true for some time to come. Yet, all of those entities are still mildly profitable even with those increased reserve costs. * "Big piles of illiquid, hard-to-value assets." Liquidity and valuation of bank assets only matters if you actually need to sell the assets. Those rating are based upon values if traded, and there is little or no market for them, and plenty of other liquidity. Whats important is whether those assets will actually return principal and interest at or above the book value. Now thats a question. * "No reason for banks to take the risk of boosting new loans. Why loan money to real people when you can take advantage of the risk-free trade of borrowing from the Fed at near 0% rates and buying U.S. government securities yielding over 2%?" Great thought, except that they have to borrow those funds at a variable daily rate and by 7 year securities with them. If short term rates pop up at all in those 7 years, they're screwed. We has a S&L crsis in the 70s based upon banks making 30 year loans funded by savings accounts. That's not proper asset/liability management and you won't find many banks considering it. * Corporate loan demand is unlikely to rise. True, but its a catch 22 that will unwind sometime. Money doesn't sleep. * "Consumers are in no mood to borrow. In fact, they're paying down debt. Americans are deleveraging because there are 15 million people out of work, the unemployment rate is 9.8%, wages are flat. Therefore banks won't make as much money on excessive consumer credit card borrowing as they did before." True, another good point. They may also pay more on their reserved, bad debt, which is good for banks. And consumer borrowing is another catch 22--more borrowing more jobs more jobs more income... it will take a while to get that all back to anywhere..maybe 2-3 more years.

December 03 2010 at 2:14 PM Report abuse +1 rate up rate down Reply
2 replies to imcri's comment
bfpowersjr

Mr. IMCRI: I have read and reread your comment at least 8 times. I can tell that you have intuitive knowledge about economics. Are you saying that you are marginally bullish about the U.S. economy, but, expect that it will take some time for the economy to recover. I don't get the impression you expect a "lost decade" in the U.S. economy ???

December 03 2010 at 3:46 PM Report abuse +1 rate up rate down Reply
excelsior6127

in exchange fore the feds larges, where is their demand that the banks cooperate in putting the economy back on its feet. in the meantime, the banks are sitting on money and dc is sitting on their handswaiting for the next election..

December 03 2010 at 3:49 PM Report abuse -1 rate up rate down Reply
bfpowersjr

Some questions I ask myself are: 1. Will the stock market (in general) rally back to it's highs of 2008? 2. Should I be "hedging my bets" in favor of what I (on balance) perceive to be somewhat bearish fundamentals regarding our country's financial future? 3. Will it be inflation, or, deflation, or, stagflation? 4. Will financial stocks rally back to their former highs, or, will they lag the market and act something like the "dot.com darlings of yesterday"?

December 03 2010 at 2:10 PM Report abuse rate up rate down Reply
1 reply to bfpowersjr's comment
bfpowersjr

I should have said the highs of 2007.

December 03 2010 at 2:22 PM Report abuse rate up rate down Reply
RonRuthNik

I sure wish the public would storm that G-S citadel. Drag those rich sob's out in the street & treat them to some good old fashion 'head on a stick' justice.

December 03 2010 at 1:02 PM Report abuse -1 rate up rate down Reply