The timing couldn’t be better for a financial institution to report earnings…
The economy has recovered from the depths of the crisis. The real estate market has seemingly bottomed. Unemployment is at 8.2% – lower than in 2008 and 2009.
Yet when it comes to banks like Bank of America (NYSE: BAC), Citigroup (NYSE: C) and Wells Fargo (NYSE: WFC), investors obviously haven’t been too optimistic. Shares of all three dropped the day before the banks reported earnings.[ad#Google Adsense 336×280-IA]What gives?
Well, since 2008, it seems that investors are only looking favorably on banks that excel at one thing: being boring.
That is, banks that are a bit more stringent when it comes to doling out loans.
To demonstrate my point, let’s briefly recap why each of the above banks is struggling right now…
Then I’ll show you how my favorite bank, U.S. Bancorp (NYSE: USB), is getting it right…
~ Bank of America: Talk about getting neck deep in bad debt. Bank of America’s been clawing itself out of a hole ever since July 2008, when it took over Countrywide – the nation’s largest mortgage lender at the time.
I’d chalk that up as the worst move of the decade.
It’s not all bad for Bank of America this time around, though. It actually reported a profit of $0.19 per share this quarter – a solid improvement over last year’s loss.
Of course, much of the gain didn’t come from actual growth, but – you guessed it – lower provisions for bad loans instead.
~ Citigroup: Citigroup was one of the biggest recipients of aid during the financial crisis – a clear sign that it was handing out risky loans left and right.
The losses the bank has incurred since then have forced Citigroup to reduce its capital base. This means the bank needs to be more restrictive in lending money, and that’s certainly a good thing. But considering Citi failed the government’s stress test in March, it’s obvious that the bank hasn’t been stringent enough.
To top it off, the firm still has a huge presence in emerging markets, which can boost profits considerably during good times. But with the slowing global economy creating serious headwinds for emerging markets, Citigroup’s not doing so hot.
~ Wells Fargo: Wells Fargo might have the strongest footing of all the major banks, but its massive mortgage portfolio is hampering growth.
Like Bank of America with Countrywide, Wells Fargo’s bad loan count ballooned when it acquired Wachovia during the financial crisis.
It also bought Golden West, which handed Wells Fargo a ton of crummy mortgages from the western part of the country (i.e. – California).
That certainly didn’t help Wells Fargo on the bad loans front. As Fox Business’ Elizabeth MacDonald said in May 2009, “Golden West was a mom and pop shop that went berserk rubberstamping reckless loans for the worst of California’s borrowers.”
Not to mention, Wells Fargo is currently behind one out of every three mortgages issued in the United States today. Doling out a slew of mortgages with interest rates this low means the bank’s costs will be higher over the long term.
Alright, now that we’ve seen how taking on bad debt has been a huge drag on the major banks, let’s take a look at a bank doing just the opposite…
The Key to Successful Banking
Banks that are booming right now are the ones that avoided risky mortgages and other questionable loans like the plague.
Case in point: U.S. Bancorp.
I alerted Wall Street Daily readers to USB back in May because it’s proven time and again that it can increase its earnings and dividends right up there with top-tier financial companies.
Most important, I noted that USB has a history of running its business in a low-risk fashion.
Indeed, the company’s CEO credits the bank’s strength and growth to a simple formula of taking deposits and making conservative loans, while steering clear of riskier deals.
Not surprisingly, the company reported an 18% increase in earnings last week. And shares are now setting new 52-week highs. If you didn’t follow my initial recommendation, however, there’s still plenty of room for growth.
Bottom line: In this new era of stronger financial regulation and lower growth, the key to successful banking is to stay as boring as possible. Or only lend money to those who can pay it back.
Ahead of the tape,
Karim Rahemtulla[ad#jack p.s.]
Source: Wall Street Daily