It is natural that some on Wall Street would start thinking ahead to happier times with the financial services in the grip of a messy downturn.
Count UBS Warburg among them.
While stopping well short of declaring a victory in the banking industrys battle with deteriorating credit quality, banking analysts at the company have calculated how much an improvement in commercial loan chargeoff rates would boost per-share earnings for a group of 15 top money-center and superregional banking companies.
A 50% drop in commercial loan chargeoffs next year would translate to an average 4.9% gain in per-share earnings for the 15 companies, according to the UBS Warburg study.
A few of the most embattled companies last year and this year would stand to gain much more.
For example, Bank One Corp.s per-share earnings would climb 10.3% next year under UBS Warburgs scenario. Bank of America Corp. would have a 6.8% increase, as would FleetBoston Financial Corp.
Per-share earnings at Wachovia Corp. and U.S. Bancorp would rise 6.6%, according to the research.
The companies would benefit even from a 25% decline in commercial net chargeoffs. Per-share earnings next year would jump 5.1% at Bank One, 3.4% at Bank of America and Fleet, and 3.3% at Wachovia and U.S. Bancorp., according to the study. The average per-share earnings for the whole group would increase 2.4%, UBS Warburg says.
Diane Glossman, an analyst at UBS Warburg, said the study assumes that chargeoffs would match provisions. Banks have been saying Weve reserved so much. So we decided to see how much earnings leverage there really was.
For over a year the headlines have been dominated by several large commercial credits that went bust, including loans to movie theater operators, equipment finance companies, and companies with asbestos-related problems. Banks shared these loans in several large syndicates, and when the loans went sour, some of the biggest participants in the syndicated loan market took hits to their earnings as they were forced to raise provisions and reserves.
Companies such as Bank One and Fleet also started scouring their portfolios and selling off problematic loans early.
Lately some bankers notably those from Bank One and Fleet have been saying they expect the credit quality problem to bottom out by yearend and corporate credit quality to improve starting at the beginning of next year.
Some analysts agreed that the end is in sight for the big blowups in large commercial loans, but they also said they expect middle-market loans to continue to come under pressure.
Things will continue to get worse for the balance of the year, said David Berry, a director of research at Keefe, Bruyette & Woods Inc. My guess is that were in a world of sluggish growth for a while.
Bank One reported commercial chargeoffs of $510 million for the first six months of this year. UBS Warburg assumed in its study that the company would charge off the same amount in the second half, for a full-year total of $1.02 billion.
But the study looks at improved conditions. A 50% reduction in chargeoffs for all of next year would persuade UBS Warburg to raise its per-share earnings estimate on Bank One by 10.3%, to $3.09.
Similarly, FleetBoston has reported commercial loan chargeoffs of $382 million through the first six months of this year, or $764 million on an annualized basis. If chargeoffs fell 50% next year, UBS Warburg would boost its 2002 earnings estimate for the company by 6.8%, to $3.69 per share.
Banks that stand to benefit from an improvement in credit quality have some earnings cushion next year to meet or perhaps beat expectations, said the report, written by Ms. Glossman and her colleagues, Michael Plodwick and Robert Patten.
But before investors rush out to buy these companies stocks, Ms. Glossman sounds a note of caution Bank One and Fleet face other issues besides credit quality.
Namely, both companies have been hit by an economic slowdown that has led to a steep drop in some fee-generating activities. As a result, these banking companies and most others have resorted to cost-cutting to make up for the revenue shortfalls, Ms. Glossman said.
Mr. Berry said several companies have probably fallen behind in building reserves, and they may use the fourth quarter the traditional period for making adjustments and cleaning the slate for a new year to take those charges.
Until banking companies can demonstrate revenue growth from their businesses, Wall Street seems to be remaining cautious.
An improvement in credit quality will be helpful, but it will not be the difference between a fantastic year next year and a mediocre year, Ms. Glossman said. Its still the same story. Whatll make the difference is revenue growth.
From Our Archive
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- Credit Quality Takes Rising Toll on Profits - January 22, 2001