STRESS TEST: Focus Can Now Shift To 'Normalized' Earnings
May 08 2009 - 10:46AM
Dow Jones News
The government stress test results of the 19 largest U.S. banks
contained few surprises for analysts, who generally agreed the data
appeared to be stringent enough to help restore confidence in the
banking system.
The results also allowed analysts who are bullish on the banking
sector to put their worst-case fears aside and refocus on prospects
for "normalized" earnings. Even some bearish analysts conceded the
tests showed banks can withstand a moderately severe economic
scenario.
"We feared that the government's stress test would be too
lenient or would attempt to build confidence in banks without real
substance," said FBR Capital analyst Paul Miller, who has taken a
negative stance on U.S. banks. "We now acknowledge that the loan
loss expectations and earnings power assumptions in the test are
credible if the unemployment rate peaks at 10.3%."
The Labor Department reported Friday morning that the rate of
increase in unemployment began to decline in April compared to
March, though the unemployment rate rose to 8.9% from 8.5%. Bank
stocks on the KBW Bank Index opened 6% higher, with many of the
stress test candidates showing even stronger gains, including Fifth
Third Bancorp (FITB), which soared more than 45% in recent
trading.
Bank stocks will now begin pricing in the "next phase of the
crisis," Goldman Sachs Group Inc. (GS) analyst Richard Ramsden
said, which said would focus on "diluted, normalized and discounted
earnings."
The dilution part of Ramsden's forecast means that investors
will be pricing bank stocks to account for the dilution of their
required capital raising, plus potentially more capital raising for
banks to repay the money they received from the government's
Troubled Asset Relief Program.
Then investors will calculate when and at what level banks will
begin to see "normalized" earnings growth again, Ramsden wrote in a
note to clients. Assuming it will take three years to achieve
normalized earnings, bank stocks on average imply a 10%-15%
discount rate compared with their average annual return of 11% over
several decades before the crisis began, he said.
The move to focus on normalized bank earnings is a "paradigm
shift" in a market that not long ago was concerned about solvency,
Bernstein analyst John McDonald said. McDonald cautioned investors
against making too many assumptions about normalized earnings that
are at least two years away. He said that regulators would likely
impose new regulations for bank capital and leverage levels to
prevent future financial crisis. That could limit banks' normalized
earnings and return on equity potential, he said.
"While we see some room for bank stocks to move higher if the
macro economic data continues to support this paradigm shift,"
investors should be careful about paying too much for "for
normalized EPS that are likely to be at least two years away and
subject to numerous assumptions about the economy, future
regulation, and leverage," McDonald said.
While most mainstream sell-side analysts felt the tests were a
success, some analysts outside Wall Street remained skeptical.
Institutional Risk Analytics, a research firm that assesses bank
strength for large depositors, said banks' solvency problems were
only temporarily solved - not through more capital or the stress
tests, but by strong government support.
"Those banks which can end their dependence on federal
guarantees will be the visible winners in the post stress test
market," the firm said in its newsletter. "Valuations and spreads
will reflect this divergence between zombies and viable private
banks."
-By Ed Welsch, Dow Jones Newswires; 201-938-5244;
edward.welsch@dowjones.com