It’s NOT Time to Buy Banking Stocks

Chris is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Earnings season for the financial sector has been a mix.  JPMorgan (NYSE: JPM) and Wells Fargo (NYSE: WFC) both reported positive earnings numbers.  However, those numbers can be tricky – the banks are still laced with risks.

Housing Turns a Corner?

JPMorgan’s CEO Jamie Dimon and Wells’ CFO Tim Sloan both argue that this housing market has upside. 

“The housing market has turned the corner,” said Dimon.  Sloan agrees: “We do believe that we’ve seen a turn.”

JPMorgan and Wells Fargo both posted strong numbers last quarter, an indication that the banks are on the right track.  JPMorgan’s mortgage-lending revenue was up 57%, and Well’s increased 50%.

Another positive for the banks is the Federal Reserve’s desire to push down interest rates.  Lower interest rates spur mortgage refinancing.  Mortgage refinancing boosts net income for banks because they profit from the multi-thousand-dollar transaction cost.  According to The Wall Street Journal:

J.P. Morgan Chase said 75% of third-quarter mortgage volume came from refinancings; Wells Fargo said 72% of its applications during the quarter were for refinancings. 

Dimon’s and Sloan’s opinions about the housing market are nice to hear – but should investors interpret their words as a reason to go long the banking sector?  No.

Underlying Problems

Despite positive numbers, the industry still has a number of problems.

  1. Low interest rate margins – JPMorgan’s net interest margin, the spread it makes on loans, fell to 2.43% from 2.66% one year prior.  Wells’ dropped to 3.66% from 3.84%.  If the Fed keeps its low interest rate policies in place, I do not see this trend reversing soon.
  2. Legal expenses – fallout from the financial collapse is still haunting large banks.  For example, JPMorgan’s litigation costs increased by $684 million in the third quarter, mostly the result of increased “mortgage-related” legal issues.
  3. Written off loans – Large banks are still writing off mortgage loans made in the boom years.  According to The Wall Street Journal:

Millions of homeowners still owe more than their homes are worth and foreclosures remain high.  Even though prices are up this year, they are still down by 30% nationally from the peak before the U.S. housing bust.

  1. Incoming lawsuits – this is perhaps the worst of all. 

Mortgage-related costs and litigation have cost seven major U.S. banks $76 billion since 2008, according to a report by Credit Suisse.  Bank of America (NYSE: BAC) tops the list, with estimated costs that run to $39.1 billion through the end of the second quarter this year.  Citigroup (NYSE: C) also faces trouble.

According to an article I wrote entitled: “A Huge Sigh of Relief for Wells, Citi, and Bank of America:”

Taking the average (of the $76 billion costs), this works out to be $10.86 billion per bank, and $2.9 billion per bank per year (assuming 3.75 years).

Also, Fannie Mae (NASDAQOTCBB: FNMA) and Freddie Mac are asking large banks to repurchase $66 billion in mortgages made between 2006 and 2008.  Repurchasing the loans would mean instantaneous losses for banks, which would be paying Fannie and Freddie for written down (worthless) assets.

Bank of America already doesn’t have much breathing room.  The bank posted just $340 million in net income last quarter, representing $0.00 per share.  Citigroup also faces headwinds.  These “put-backs” as they are called could cause Citi huge losses from its past reckless loans.  It already set aside $1.2 billion last year as a provision.  Finally, Citi paid a fine earlier this year for knowingly falsifying loans that it sold to Fannie and Freddie.

Banks Recovered?

The worst of the housing crisis may be behind us.  But does that mean that it is time to jump in to banking stocks?  No.

With likely additional losses on the way, and a potential stock market dip ahead, I am sitting on my heels.


ChrisMarasco has no positions in the stocks mentioned above. The Motley Fool owns shares of Bank of America, Citigroup Inc , JPMorgan Chase & Co., and Wells Fargo & Company. Motley Fool newsletter services recommend Wells Fargo & Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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