Banks' Rare Good News Spurs Hopes of Recovery

After months of turmoil, banks are slowly showing signs of stability, thanks in part to the government's extensive rescue efforts and a shift in investor sentiment. Citigroup and Bank of America have reported operating profits for the year so far, prompting a rally in bank stocks and offering a glimmer of hope that the battered financial sector may be healing. However, analysts caution that the banks are not out of the woods yet, and several risks still threaten their stability.

Key Takeaways:

• Citigroup and Bank of America have reported operating profits for the year so far, but are likely to face big losses on loans in the first quarter.
• The government's extensive rescue efforts, including over $200 billion in cash investments and massive cash infusions into bank funding markets, have helped keep the ailing giants afloat.
• Analysts credit the government's rescue efforts and a shift in investor sentiment, including a lessening of fears about nationalization, for the rally in bank stocks.
• Bank executives have declared their intent to avoid nationalization by not seeking additional capital funds from the Treasury.
• Investors are more comfortable with assurances from the Obama Treasury Department that it does not want to take over the banks.
• A push by Federal Reserve Chairman Ben S. Bernanke and House Financial Services Committee Chairman Barney Frank to ease accounting rules has driven some banks to the point of near-insolvency and forced them to seek government aid.
• Fair-value accounting rules have been criticized for punishing banks when asset prices fall steeply during market busts.
• Most analysts do not expect a wholesale suspension of accounting rules, but rather small changes that would only be cosmetic.
• Accounting purists argue that even small changes would exacerbate the problems investors and public companies currently face.
• Bank charge-offs for defaults on credit cards and mortgages are expected to jump by nearly $80 billion this year if the unemployment rate rises to 10 percent.
• Loan losses could go much higher, posing a threat to the economic outlook.
• The fate of the nation's banks lies largely on a recovery in the broader economy.
• News of some stabilization in the economy helped banking stocks as well as the overall market.

Statistics:

• Over $200 billion in cash investments by the Treasury
• $80 billion expected increase in bank charge-offs for defaults on credit cards and mortgages if the unemployment rate rises to 10 percent
• 8.1% current unemployment rate
• 10% projected unemployment rate
• 1 stock price of Citigroup at its lowest point
• 3 weeks timeframe for easing accounting rules as promised by accounting regulators
• Japanese-style stagnation as a potential consequence of the banking crisis

Sources:

• The Washington Times
• Citigroup
• Bank of America
• Barclays Capital
• Ashish Shah, analyst at Barclays Capital
• Bob McTeer, former president of the Federal Reserve Bank of Dallas
• Kurt N. Schacht, managing director of the CFA Institute
• Harm Bandholz, economist at Unicredit Markets
• Doug Roberts, chief investment strategist for Channel Capital Research