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Banks Surprise with No Surprises

Jason Stipp

Jason Stipp: I'm Jason Stipp for Morningstar. Earning season has kicked off now with Citigroup and J.P. Morgan both reporting.

Here with me to talk about their earnings as well as what's coming up on the bank front is Jaime Peters. She's an equity analyst covering the banking sector.

Thanks for joining me, Jaime.

Jaime Peters: Hello.

Stipp: So let's start off with the two big ones that have reported. What's your initial take after Citi reported today and how do you compare the two?

Peters: I guess the big surprise is: There were no major surprises. We expected fixed income trading revenues to go down; they did. We expected consumer loan losses to kind of stabilize; they did. As a result, actual earnings expectations fell right in line with what we thought was going to happen.

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Stipp: So, coming up, Bank of America and Wells Fargo also reporting. Do you expect no surprises on that front as well? What are you looking at there?

Peters: For Wells Fargo, we're not expecting a lot of surprises. We're going to see consumer loan losses again, probably be about the same as third quarter. They're going to have TARP charges though. As a result, earnings are probably going to be closer to break even rather than the 50 cents they made last quarter.

On the other hand, for Bank of America, there could be some surprises there. Brian Moynihan, new CEO, very possibly could decide to go ahead and take that big bath and try to level the playing ground for future times as far as credit losses go. So, they're really the big question mark.

Stipp: Interesting. So, you mentioned the TARP charges. Now, that played into the J.P. Morgan versus Citigroup results, because Citi did have to charge for that TARP. So, is there really, bottom line, taking that out, was there a huge difference in the performance of those two banks that we've seen so far?

Peters: There certainly is, because J.P. Morgan is the much better bank. Citigroup still lost about a billion dollars after the TARP charges were removed. And that's a result of the fact that they are just not as large in investment banking and not quite as good as J.P. Morgan has been with that sterling reputation that they have. And J.P. Morgan benefited from that sizable investment banking income. As a result, J.P. Morgan made 74 cents, whereas Citigroup lost it.

Stipp: OK. So, certainly some differences on the quality side. Now, looking at the valuation front, where are these banks on the valuation spectrum? Do they look reasonably valued, undervalued, overvalued? Where do you see them?

Peters: Actually, across the board, slightly undervalued. We have all of them rated at 4 stars right now. Twenty to thirty percent undervalued over the long run. But, it's probably going to take some time to get there.

Stipp: So, J.P. Morgan results, in some ways, beat analyst's expectations, but the stock was taken down. I know you're looking out longer term, but what catalyst do you see, what's it going to take, maybe, for those stocks to reach their potential value?

Peters: Well, right now we're still talking about consumer loan losses. They've stabilized in the quarter. The banks may be expecting them to get slightly worse next quarter, here in the first quarter of 2010. But, if you look out into the second half, if we find that peak and it definitively turns for the better, what we have is accounting for banks being really favorable for earnings to really pop.

Because they're now going to probably start under-provisioning for credit losses, rather than over-provisioning. And that's going to fall straight to the bottom line. And that should probably help drive those stock prices up.

Stipp: Interesting, so on the risk side of the equation, what question marks, what potholes, could the banks hit between here and there? [laughs]

Peters: [laughs] There are a lot of potholes, unfortunately. We do have commercial loan losses that have not been as bad as, maybe, some people expect. It's always been the next shoe to drop--commercial real estate. Jamie Dimon actually suggested that it dropped a while ago, everybody just missed it, and it's going to probably stay bad.

You have consumer loan losses, which people are expecting kind of a sharp recovery, in my opinion. And it's probably going to be much more rounded at the top, which means that people are going to have to push out their expectations a little bit. Additionally, we have Obama administration's TARP tax that they suggested last week.

Is that really going to go through? Because, that's going to affect banks with investment banking businesses like J.P. Morgan, Citigroup, and Bank of America. Much more than a Wells Fargo, who is mainly deposit funded.

Stipp: Well interesting things to keep an eye on. Jaime, thanks for joining me today.

Peters: Thank you.

Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.