Goldman Cuts 2011 Bank EPS And Price Targets By 7% On Fears That "We Are Turning Japanese"
Goldman's Richard Ramsden has cut his Price Targets and EPS estimates virtually across the board for his coverage universe, while keeping ratings the same, on increasing concerns that loan shrinkage at banks, and portfolio run offs will pressure bank Net Interest Margins/Income, in what he dubs as the "Turning Japanese" syndrome. The primary culprit - lack of loan growth as not only are banks squeezed by declining LT rates, but by an increasing lack of willingness by US consumers to borrow: "Loans were down 1% this quarter, with chargeoffs remaining a big source of shrinkage. We analyze the economic factors driving loan growth and conclude that year-over-year growth will not turn positive until 2011. Run-off portfolios which account for 10% of system wide loans will drive a further 3% shrinkage in 2011." Ramsden rhetorically asks: "Shrinking loan levels and low interest rates have prompted many to ask if we are headed down the same path as Japan in the late 1990s." And while the banking analyst is contractually obligated to answer every question bullishly (no matter if real or rhetorical), we are confident that particular question has only one correct answer, and it is most certainly not "No."
Below is a summary table of Ramsden's 'before and after' opinion on Goldman's key peers. The net result of the newfound bearishness is a 7% reduction in both Price Targets and 2011 EPS estimates for the coverage universe.
While Ramsden discusses the various nuances of his negative view on the financial sector in the attached presentation (something those with a very bullish bent on financials will likely not be too happy about), the key point can be summarized by his concern that the US is increasingly turning Japanese.
The collapse of an enormous asset bubble, a banking and credit crisis, zero interest rates, central bank balance sheet expansion, and massive fiscal stimulus have caused some people to question whether the scenario here could continue to play out like Japan, where loans declined for eight years after the peak and interest rates remained near zero. When it comes to loan growth, the US and Japanese experience look remarkably similar, with loans falling by about 10% from the peak over the subsequent eight quarters (see Exhibit 21). NIMs have been very similar as well, with margins increasing initially despite loan declines as deposits re-priced faster, driving funding costs lower (see Exhibit 22).
Yet being a sellside analyst who by definition is forbidden from saying the outright deflationary truth, Ramsden's response is sufficiently well telegraphed.
But that being said, the size of the policy response, faster loss recognition and subsequent recapitalization should help US banks avoid a Japan-like scenario.
Some more on the tried and true excuse of a lightning response, which now has the same veracity as the whole discredited money on the sidelines fallacy. The simple observation all these permabulls ignore is that by stepping in to provide trillions of monetary (and fiscal) stimuli overnight, all the Fed and the administration did was to create a rapid and dramatic bounce, which will be all the more vicious and fast when it does the inevitable mean reversion acrobatics (unless of course double the dose of the initial stimulus is injected, and so forth at an exponential rate). In other words, what went up, is about to come crashing down: while Japan's pain has been prolonged, gradual and chronic, ours is about to be extremely painful and acute.
Then again, maybe Ramsden is right:
However, there are many differences as well. Japanese banks notoriously took a long time to recognize losses and raise capital, which US banks have been much quicker to do. Also, while the housing bubble in the United States was large, by some metrics it was even greater in Japan, and also was combined with an equity bubble (see Exhibit 23). Perhaps the most dramatic difference is the policy response. The Bank of Japan took more than a year to cut rates and more than seven years to expand its balance sheet. On the other hand, in the first 18 months of the crisis, the Federal Reserve cut interest rates 500 basis points, instituted numerous liquidity facilities, and announced plans to purchase assets worth 9% of GDP to further ease monetary policy (see Exhibit 24). Fiscal stimulus was also much faster in the United States than in Japan.
These policies have helped US capital generation and pre-provision operating profits perform much better than Japan. Perhaps
most notable is the difference between the capital generation between the two regions. As Exhibit 25 shows, tangible common
equity ratios were much lower in Japan heading into the crisis and never really recovered in the two years following. In the United
States, on the other hand, US banks were able to re-capitalize fairly quickly as investors gained confidence as a result of the stress
test and took some comfort in the fact that the banks were quick to realize losses. Profitability was also much better in the United
States (see Exhibit 26), driven by a strong operating environment for business, which thrives in a low rate environment (i.e., Fixed
Income and Mortgage origination).
Only time will tell just how much off the mark the Goldman analyst may be.