Abnormally low loan-loss provisions were the biggest factor in what looks like a 20% inflation of big-bank earnings in the last quarter, a veteran analyst says.
The result, says Raphael Soifer of Brown Brothers, Harriman & Co., is that bank stock prices probably have little room to rise. "The profitability of major U.S. banks generally remains above levels likely to be sustained over the long term," Mr. Soifer said.
Accordingly, Mr. Soifer currently sees bank stocks, even after the recent market downdraft, as "expensive in historical terms" and likely to underperform other sectors of the stock market this year.
Year over year, 23 of the 24 banks comprising the Brown Brothers industry universe - which covers money-center and major superregional companies - reported higher earnings per share in the fourth quarter.
At the same time, these banks withdrew a combined $222 million from their aggregate loss reserves, Mr. Soifer noted. Net loan chargeoffs exceeded provisions by 12%.
Indeed, net chargeoffs exceeded provisions at eight of the 24 banks. Three - Wells Fargo & Co., First Interstate Bancorp, and J.P. Morgan & Co. - made no provision for loan losses. Eight made net additions to reserves, meaning loss provisions exceeded chargeoffs, and five matched provisions to chargeoffs.
Mr. Soifer and some other Wall Street analysts have previously called attention to the underprovisioning trend in the industry and how it skews earnings upward.
The Brown Brothers analyst adjusted bank earnings in his quarterly survey of bank operating trends by estimating the level of provisions likely to be sustainable over an entire credit cycle. He assumed losses would amount to 60 basis points (annualized) on average loans, plus 2% of net new loans, adjusted for mergers under purchase accounting rules.
Mr. Soifer also added the cost of funding and servicing a cyclical average level of nonperforming assets. He assumed costs of 8% yearly on a nonperforming asset ratio of 2.5%.
In figuring his adjusted economic return for banks, Mr. Soifer arrived at a 14.1% return on common equity rather than the 17% the banks reported on average. He gave full benefit to the reduction in Federal Deposit Insurance Corp. insurance premiums in the calculation.
Mr. Soifer currently has no "buy" rating on any bank stock. His highest rating, short-term "outperform" and long-term "buy," goes to U.S. Trust Co. His colleague, regional bank analyst Nancy A. Bush, has similar ratings on Bank of Boston Corp. and First Union Corp.
In addition, Mr. Soifer rated J.P. Morgan & Co. a short-term outperform and long-term "hold."