How Low Can Banks Go?

Forbes
How Low Can Banks Go?
Liz Moyer, 12.01.08, 04:00 PM EST
Financial shares tumble again as quarterly results approach.

It's anything but festive on Wall Street these days.

Canceled holiday parties, lower bonuses and job cuts combined with expectations of a miserable fourth quarter, numbers-wise, weighed on financial stocks Monday. In one stark example, Goldman Sachs shares fell 17%, and analysts almost uniformly predict it will have a fourth-quarter loss after sailing through the 16-month-old credit crisis relatively unscathed.

Other bank shares tumbled Monday as well. Morgan Stanley declined 22%, JPMorgan Chase 18%, Citigroup 22%, Merrill Lynch 23% and Bank of America 21%.

The pessimism extends to the outlook for financial markets in general, especially after a report Monday by the National Bureau of Economic Research confirmed what everyone suspected all along: The U.S. is in a recession and has been so since last December. A recession, combined with rising unemployment, could translate into lower spending, lower corporate profits and less deal activity all around.

One potentially alarming trend is banks pulling back consumer credit lines, says Oppenheimer analyst Meredith Whitney. She estimates that $2 trillion worth of credit lines will be canceled in the coming months.

Since many households use credit cards to manage monthly cash flow for necessities like groceries and gas, "pulling credit at a time when job losses are increasing by over 50% year-on-year in most key states is a dangerous and unprecedented combination," Whitney wrote in a research note.

Risk aversion is one big reason banks are pulling back, however. Despite well more than $100 billion in write-downs so far, there are tens of billions more yet to be taken. Write-downs related to deteriorating asset values could take a huge chunk out of the $250 billion the U.S. Treasury has pledged as direct equity investments into banks to help them start lending again.

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A volatile fourth-quarter trading environment may also wreak havoc on bank earnings. Credit Suisse analyst Susan Roth Katzke said Monday that Goldman could have a fourth-quarter loss of $4 a share (or $1.5 billion) largely because of an estimated $4 billion loss in its trading activities. That is quite a difference from the record $3.2 billion profits ($7 a share) it reached in the fourth quarter last year. So far this year, Goldman has reported profits of $4.3 billion.