The Overnight Report: Financials Sour Again

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By Greg Peel

The Dow closed down 24 points or 0.2%. The S&P fell 0.2% while the rejuvenated Nasdaq rose 0.2%. Volume was weak.

With little economic data in the offing this week attention turns more specifically to earnings once more. Friday’s not-as-bad-as-it-could-have-been result from Citigroup provided impetus for a strong Dow rally but last night it was a different story from leading commercial bank rival and Dow component Bank of America.

“I think first it would be too early to strike up the band and sing ‘Happy Days Are Here Again’,” was the comment from the BA CEO as he announced a 77% fall in first quarter profit. BA is not a big investment banker but it did write down US$1.5bn in CDO valuations. What it is big in is the old fashioned business of lending money on mortgages and credit cards and to businesses. The bank quintupled its bad loan loss provisions from US$1.24bn to US$6bn. Loans it believes it will never recover rose to US$2.72bn. Guidance suggested consumer weakness and the housing slump means the economy will not improve for some time.

The loss was greater than Wall Street expected, and more bad news was to come in the earnings report of regional bank National City. After posting a US$171m loss for the quarter National City announced a US$7bn capital infusion that severely diluted existing shareholdings. If that wasn’t bad enough, the bank cut its dividend from US27c to US1c. National City shares ended the day down 27%.

And the reality of a 50% Citigroup quarterly loss was made more stark by a suggestion from Oppenheimer bank analyst Meredith Whitney that the bank may have to eliminate its dividend altogether in the short term. Whitney has garnered a lot of credibility in the market since the credit crunch began by constantly downgrading bank earnings expectations, slashing dividend forecasts and predicting capital raisings in the face of smiling denial from bank CEOs. Whitney has been proven correct to date and many of those CEOs are now gone.

Whitney suggested last night that Citi faces “seriously constrained earnings” ahead and aside from posting a first quarter loss would likely post a full-year loss in 2008. Citi has already raised a further US$20bn in capital – mostly from sovereign wealth funds whose investments are now underwater – and Whitney believes lack of earnings will make it difficult for the bank to pay a dividend at all.

The market is not quite ready to believe it however, and turned a 74 point loss into only a 24 point loss in the Dow by day’s end. Ongoing strength in oil and gas prices and subsequent strength in producers and related businesses has helped to hold up a market that should otherwise be looking at US$117 oil with some trepidation.

Oil added another US48c to US$117.48/bbl last night. The BA result was enough to send the US dollar tumbling once more, and the euro racing back to US$1.5910. Oil was assisted by the falling dollar while gold was unable to find the support it might otherwise have received and closed almost unchanged at US$916.10/oz.

The Aussie dollar added a solid US0.77c to US$0.9420 despite yen buying but the move had more to do with yesterday’s alarming PPI number than US dollar weakness per se.

The realities that the BA result brought to the surface regarding the state of the US economy was enough to put a dampener on base metals as well, despite the lower dollar. Aluminium and copper were down a little under 1% while the others saw 1-3% falls. As copper has tried and failed to breach new highs on supply issues, commentators are now looking for demand concerns to spark a pullback in the metal complex at least in the short term.

The SPI Overnight was down 7 points.

Weakness in US financials overnight will make it interesting for the local financial sector today. Australian banks posted an astonishing rally yesterday, initially encouraged by Friday’s supposedly good Citi result but kicked on by the news the RBA had acquired another $780m of mortgage-backed securities on one-year repo following $320m purchases exchanged for cash on Friday.

The RBA move is designed to assist smaller banks and non-bank lenders who have found themselves frozen in the ice of the now defunct mortgage securitisation market. Those with small or non-existent deposit bases have found it impossible to package and sell mortgage securities so the RBA’s move is an attempt to provide some relief. This proved a positive for all banks and the extent of short positions in the financial sector was clearly evident, particularly given ANZ ((ANZ)) kicks of the bank half-year reporting season on Wednesday. With that sort of uncertainty lurking, one might have otherwise expected some restraint in the financial sector.

Interestingly, the RBA’s purchases straddled a weekend which saw the suggestions arising from the “Kevin on Earth” 2020 summit include the RBA packaging up and selling prime mortgages itself in order to create more affordable loans for the strugglers. Some sort of Aussie Fannie Mae in the offing?

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