After Bank Stress Tests, Worries About Earnings

By Mara Der Hovanesian

Investors have reacted favorably to the recent release of the government’s stress test results. But skeptics still abound. Dan Alpert, managing director of Westwood Capital, is one of them. His specific worry: he isn’t so sure that the Fed’s assumption that the banks can earn their way out of some of their woes is justified.

Sure, many of the largest U.S. banks posted good earnings in the first quarter, beating analysts’ dour estimates. But Alpert points out those results were artificially bolstered due to near zero cost of funds, a residential mortgage refinancing boom, and “government guarantees against losses from nearly every activity inherent in banking. The Stressed 19 are fighting valiantly to prove that they should be granted the right to continue business as usual and recover what they can on what everyone knows to be highly compromised assets,” he says.

Alpert and others are highly skeptical about whether the big banks can earn enough money to plug the gap that the Fed is assuming they are going to need: the $362 billion of the $600 billion shortfall is supposed to come from future earnings plus existing reserves. He is not so sure that the banks are going to be able to turn out a repeat performance of the first quarter. Moreover, slower profit growth means banks will be more concerned about preserving their capital then lending it out, a bad sign for those with hopes of a speedy recovery.

“We need access to credit and banks that are experiencing losses that are eroding earnings and capital bases are not in the position to create new credit,” adds Alpert. “So there is still the question: wither the economy?” Joshua Siegel of New York’s StoneCastle Partners, which specializes in bank investments and has $3.1 billion under management, agrees: “The reality is that no matter what we’d like to imagine, the rest of the year will continue to be stressful for banks. How can bank performance be meaningfully better, if nonperforming loans get continually worse? The results of the stress test are no justification for thinking this is over.”

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