24 April 2009

Banking Euphoria Is Premature ~ Once off profits

Good news from six US banks has raised hopes that an end to the financial crisis might be in sight. But German experts think the euphoria is wishful thinking. As they see it, things are going to get worse soon -- and banks will be forced to make billions more in write-downs.

The news spreads like wildfire and hope starts to bloom. One after the other, six US banks -- including the largest, Bank of America -- have submitted performance figures for the first quarter of 2009 that are far better than experts had predicted.

Banks like Wells Fargo and JPMorgan Chase have posted profits reaching into the billions. Goldman Sachs has even announced that it plans to pay back the billions in emergency bailout funds it received from the US government. And analysts are also expecting to see positive first-quarter earnings from German banks.

The results have fuelled hope that the financial sector has started its climb out of the economic abyss, and the first batch of optimists are already announcing that the financial crisis, which has already lasted almost two years, will soon come to an end. "We expect that the banks' reporting season will bring more positive results like the ones JPMorgan has submitted," says Robert Halver, for example, an expert on capital markets at Baader Bank.

But some experts think such conclusions are dangerously misguided. "We're far from being out of the woods," says Dirk Schiereck, a professor of banking at Darmstadt Technical University. "The banks are still extremely vulnerable." And Hans-Peter Burghof, an expert on finance at Hohenheim University, even goes so far as to speak of an "expansion of the crisis, which might soon even get new banks into serious trouble."

Just a Brief Burst

Analysts are also looking at the rest of the year with extreme skepticism. "To a very significant degree, the bank profits from the first quarter can be attributed to a very special constellation of fortunate factors that are very atypical for banks," says Guido Hoymann, an analyst at Bankhaus Metzler. In fact, in the first three months of the year, major corporations like Siemens and Porsche have taken advantage of rock-bottom prices in the banking sector to refinance expiring bonds.

Hoymann estimates that in the first quarter alone, the volume of debt refinancing amounted to 45 percent of the usual annual volume. As he sees it, this boom has boosted commission income and investment banking profits for many US banks. German banks are likely to have enjoyed a similar interim boost in the first quarter, he adds.

"But it's not going to last," Hoymann says. "Current forecasts already indicate that the lending business will normalize." And when that happens, the banks will once again lose a major source of profits.

An additional factor is that many US-based financial institutions are taking full advantage of relaxed accounting rules. Such rules make it possible, for example, for companies to postpone write-downs. Goldman Sachs has also benefited from the fact that the government pressured it into transforming itself from an investment bank into a completely normal bank. As such, it has become subject to different accounting rules, which has meant that the company did not have to report results for the month of December.

Bleaker Prospects

The prospects for the coming months are worrying. "It might be that the recession doesn't get any worse," Burghof says. "But there is no doubt that it will expand -- and affect the banks once again."

In fact, the economic situation is anything but secure. Experts argue over whether the economy in 2009 will decline by 4, 5 or 6 percent and whether the turnaround will take place in the summer, fall or winter. But there is one point on which the majority of experts agree. "The economy is unlikely to grow as quickly as it shrank," says Jörg Hinze, an economic analyst at the Hamburg Institute of International Economics (HWWI). "It might stagnate for a long time at a very low level or only gradually start climbing again."

But a slow rebound will not stop the crisis. If the economy improves too slowly, the pressure on companies will mount, and hundreds of thousands of workers in Germany currently on short time might find themselves out of a job in the fall.

And that would present the banks with even more risks. Many banking establishments anticipate an explosion of loan defaults from private and business clients. Bank of America and JPMorgan, for example, have built up reserves reaching into the tens of billions to respond to possible new write-downs.

The New Risks of Market Deregulation

At present, the banks are hardly feeling the recession yet. "Currently, the attitude among politicians is that you should bail out anything that could cause any pain," says Hoymann. But doing so does not correct the structural problems of markets and businesses. As Hoymann puts it, it's "like avoiding going to the dentist" -- in the short term, you save yourself some pain, but in the long term everything gets rotten.

"The government can't keep following its current line forever," Hoymann adds. As soon as politicians start leaving the market to its own devices again, the restructuring that had been deferred will hit companies and people all the harder. And that would mean new strains on the banks as well.

Burghof fears that lingering weakness in the economy will soon pull even more financial institutions into the crisis. "The longer the recession lasts, the more job losses and serious financial difficulties there will be for small- and mid-sized companies," he says. "A number of savings banks are currently worried that they will have to make some major write-downs soon as well."


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