We'll See M&I Played Over And Over

I continue to dislike almost all banking stocks. The only positive they have going for them is a large short position that could trigger a short lived spurt upward on any bullish news, but I don't believe it would be sustainable.

Banking faces large earnings headwinds and those are not all credit and spread driven issues. All banks have had to change their approach to excessive overdraft fees and now they face a dramatically smaller fee stream on debitcard transactions. Any real estate refi mini-boom is nearing an end as interest rates are rising, so the non- interest income contribution to earnings is going to be putrid.

On the interest income side of the P&L, I don't think banks can build enough reserves, through earnings, to cover past lending mistakes. They just have to keep doing what the banks and government have been trying to accomplish, and have to a large degree, that is talk a good story, defer losses, and raise equity. So far so good, unless you were among the diluted. Loan demand is anemic, bond yields minimal, and trading is being curtailed. I don't look for growth in net interest income. You won't reverse those trends by what a bank can earn on excess reserves held at the Fed.

I don't think a big short position and the prospect of dividend increases are more important than the lack of earnings growth in the long run. plus the guys running the banks today are proving to be less than brilliant as some some are already treading back into past mistakes. Credit card banks are already offering credit, at higher rates, to strategic and first time defaulters! Where are the regulators and Boards of Directors?

M&I was a good case of the walking wounded and sold to Bank of Montreal for about 1/2 book. More will be forced into the arms of the world's remaining healthy banks. Regions, Suntrust, Fifth Third, Huntington,Key etc. all are some degree of toast as they probably aren't too big to fail and will be forced into a sale at some fraction of book value as earnings growth will not be adequate to keep the balance sheet sound.

Banks Require Zero Cost of Funds

It's well known that commercial banks have faced strong headwinds for the past several years. While banking commentators acknowledge that all of the problem mortgage loans haven't been foreclosed yet and commercial real estate problems loom, the industry has been saved by the combined action of the Fed and the Treasury. Share prices have moved dramatically upward off the fear induced bottom. Many seem inclined to believe that there is more upside to be had as long as the Fed keeps interest rates near zero.

Even with a very accommodative Federal Reserve, bank share prices will not stabilize at higher prices. Earnings power is becoming an issue. Where investors were once willing to celebrate the lack of failure and push shares up, they will shortly start to concentrate on what can banks earn with more capital, less leverage, a changed fee and expense structure, and examiners breathing down their backs. The answer is going to be that banks will earn substantially less than at their peak earnings.

Zero interest cost for overnight funds is necessary to offset the following:

1. Continued Loan Loss Reserve funding so mortgages can be foreclosed, HELOCs and credit cards can be written off, and commercial real estate loans restructured. Cummulative LLRs are not adequate to avoid future provisons on a grand scale.

2.Reflecting the above, the FDIC must be refunded and the two year advance premium payment the banks are now required to pay, even with the funny accounting treatment, will impact the banks ability to lend.

3.Regulatory changes in credit card rate changes will start to impact P&Ls.

4.The same will be true for Overdraft Fees, a major source of income for banks.

5.With quality loan demand slack, investment alternatives are not carrying high yields.

Treasuries and Agencies barely exceed overnight funding costs which has pushed bankers into GinnieMaes to find yield.

6.Finally, Regulators are behaving excessively tough on existing portfolios and requiring more reserves for a growing number of loans that are being classified as "substandard". Pressure is not inducive to extending new credit.

Earnings are apt to be "substandard" for banks for the next several years.