This week is going to be all about banks, specifically US banks: zombies a month or so ago, now many on Wall Street will be hailing their rebirth.

But don’t be fooled, while the results are going to be an improvement on the 4th quarter of 2008 in many cases, that will come from the cheap money now financing the US, courtesy of the Fed. US banks are essentially borrowing at less than 1% (and lower in some cases), their debts and their assets are being protected by the Fed, and they are making money as easily as they have ever earned it.

Wells Fargo, the West Coast bank that surprised with a huge profit upgrade to around $US3 billion for the first quarter last week, is going that not only from the revamping of the Wachovia businesses it took over last year (with the help of the US Government), but is making 4.1% net in interest margin. Australian banks make just over 2%.

Wells Fargo and other US banks (and those elsewhere are ‘riding the yield curve’) borrowing low and lending it out at higher rates. US home mortgage rates may now be well under 5% and easing slowly (and that’s around a 50-year low), but its almost pure profit to the banks (and then there’s the fee income on top of that for all the transactions that are starting to occur). That is still higher than 10- and 30-year bonds.

But the banks remain riddled with toxic assets. Goldman Sachs analysts reckons banks are pricing their loans at 91 cents in the dollar across their portfolios, when the real value is much lower, especially with corporate defaults starting to soar (35 in the US and around the world in March) and prime mortgages now defaulting at higher and higher rates.

Overnight Goldman Sachs reported better than expected earnings for the first quarter and plans to raise $US5 billion.

In reporting its results a day earlier than expected, Goldman said it earned $US1.81 billion, or $US3.39 a share, for the quarter ending 31 March.

Reuters reported that analysts surveyed by Thomson Financial were looking for a profit of $US1.64 a share. So the result was far better than expected.

The US$5 billion issue will go to repaying US government aid of $US10 billion. Goldman shares, which have surged more than 70% during the past month, rose 4.7% overnight ahead of the report.

The reason for the recent rally in bank stocks was a shift in focus from balance sheets towards the sector’s renewed earnings power. That’s fair enough — banks are making hay from strong cashflows and a steep yield curve, and will make it through the results season with not too many woes.

But the bigger issue for investors is whether banks’ new earnings potential can counteract the inevitability of further write-downs. That depends on forecasts for revenues and the extent, and timing, of losses that still lurk in balance sheets.

After Goldman Sachs earlier than expected report, JPMorgan Chase, then the forlorn Citigroup will report. Citi on Friday (along with another fallen idol, General Electric which has the troubled GE Money division whose results and commentaries will be of considerable interest).

Goldman and the other banks have been ordered by the US Government not to disclose or discuss in any way the results of the stress tests conducted on them by regulators.

The tests are in their final stages with the 19 biggest US banks and discussion could trigger another bout of volatility if it was implied or became known that some banks had failed or had been found to have problems.

That’s why US markets shrugged off the news over the Easter break that Federal regulators shut down two more banks, raising the number of bank failures so far this year to 23. That’s two less than the 25 failures in 2008, and we are not a third of the year through 2009 yet.

The first bank was Cape Fear Bank in Wilmington, N.C., the first North Carolina bank to collapse for almost 16 years. The second and bigger bank was New Frontier Bank of Greeley, Colo., the second Colorado bank this year to collapse. It is the biggest failure so far this year in the US.

The Federal Deposit Insurance Corp. took over both banks after their respective state regulators closed them down. New Frontier Bank has $US2 billion in assets and $US1.5 billion in deposits. Cape Fear Bank has $US403 million in deposits and $US492 million in assets. New Frontier in particular proved unsalable. The FDIC reckons the two closures will cost it $US801 million in payouts from its insurance fund, but over $US150 million will be lost because some deposits exceeded the $US250,000 maximum that its insurable.

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Peter Fray
Peter Fray
Editor-in-chief of Crikey
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