Banking on another bad year in '09

Rising loan losses, the threat of more regulation and tougher competition adds up to another year of poor profits for banks.

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By David Ellis, staff writer

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NEW YORK ( -- Bankers are counting down the days until they officially close the book on a terrible 2008. Too bad the outlook for 2009 is just as dismal.

It may seem hard to imagine how 2009 can be worse than this year for the industry. Governments around the globe were forced to institute massive bailout programs.

Citigroup (C, Fortune 500) lost more and more money as the credit crisis gained momentum and needed a more than $300 billion backstop from the government to keep it afloat. IndyMac and Washington Mutual both failed. Investment bank Lehman Brothers went bankrupt.

And investors lost tons of money in bank stocks. Through late December, the Standard & Poor's banking index and the regional bank-focused KBW Bank Index had both lost more than half their value in 2008.

Credit remains the big story

Banks this year suffered largely due to troubles with mortgages. With few signs of an imminent turnaround in housing, bad home loans are likely to remain front and center for the industry in 2009. But they're likely to face more problems with other types of loans as well.

Many banks have already experienced a significant deterioration in the health of their credit cards and home equity loan portfolios, and are bracing for those troubles to become even worse. In addition, problems in commercial real estate and business loans are starting to surface as well.

"There is loan quality deterioration across a number of sectors," said Tanya Azarchs, veteran industry analyst and managing director for Standard & Poor's. "It is not just the consumer anymore."

Barclays Capital analyst Jason Goldberg warned clients in a research note earlier this month that he expected large-cap banks to record close to $130 billion in net charge offs, or uncollectible loan losses, in 2009 - almost twice what the group is expected to experience in 2008.

Banks have tried to prepare for such a scenario by setting aside cash in recent quarters. Capital injections from the Treasury Department as part of the bank bailout program are also expected to help to cushion the blow..

To date, Treasury has either invested, or pledged more than $207 billion to over 200 banks across the country, according to analysts at Keefe, Bruyette & Woods.

Analysts are expecting an increase in earnings next year, but much of that is due to the fact that 2008 was so bad. Few are expecting the industry's profits in 2009 to return to the level prior to the crisis.

Earnings per share for all financial services firms in the S&P 500 are expected to be a third lower than 2007 levels, according to Thomson Baseline. For regional banks, profits are expected to be down nearly two-thirds from where they were in 2007.

The regulatory threat

But bankers' problems don't end with weak earnings outlooks.

Lawmakers will probably be looking for ways to extract the proverbial pound of flesh from banks now that they've extended $700 billion to them, said Seamus McMahon, vice president in the financial services group at consulting firm Booz & Company.

Members of Congress could push banks to restructure mortgages or limit foreclosures and push banks harder on making loans to small businesses, much in the same way that Bank of America (BAC, Fortune 500) was pressured to extend credit to a Chicago window and door maker earlier this month.

"You are not going to have a Congress that is even remotely sympathetic to big banks," McMahon said.

Some veteran bankers worry that the industry could revert to the highly regulated era of the 1980s, where banks were required to impose rate caps on interest-bearing savings accounts, for example.

No such regulatory threat has emerged yet. And according to McMahon, it could be at least several more months before one does. But the industry is bracing for stricter rules.

"A lot of bankers are saying, 'We are living in a new world - we better come to grips with it,' " he said.

Winners in '09?

Another challenge looming in the year ahead is good old-fashioned competition, especially for deposits.

Goldman Sachs (GS, Fortune 500) and Morgan Stanley (MS, Fortune 500), for example, are now classified as bank holding companies, which will allow them to compete more directly with the likes of Citigroup, Bank of America and JPMorgan Chase (JPM, Fortune 500) for traditional banking customers.

At the same time, plenty of banks still face issues related to liquidity, including being able to meet the needs of customers wanting to withdraw funds and borrowers who need credit.

But from among this troubled group, analysts think some winners will emerge in 2009.

One favorite is US Bancorp (USB, Fortune 500), which has won praise for showing restraint in the years leading up to the crisis while its peers doubled down on the U.S. housing market.

There has been plenty of speculation that the Minneapolis-based bank could soon try and expand its footprint, possibly by acquiring some of its harder-hit Midwestern peers such as KeyCorp (KEY, Fortune 500) or Fifth Third (FITB, Fortune 500).

Analysts also cite PNC (PNC, Fortune 500) as one bank that should emerge from 2009 in relatively good health.

Fresh off its acquisition of National City in late October, the Pittsburgh-based bank didn't overextend itself in the housing market, notes Jennifer Thompson, regional banking analyst at the New York-based financial services research firm Portales Partners.

"They are facing the same issue every other bank is, but they have a cleaner balance sheet and are good operators," said Thompson.

Further consolidation among banks does seem inevitable in 2009 given how drastically valuations have fallen across the sector over the past year.

But analysts are doubtful that the industry will experience the same high-profile mergers that defined 2008, such as Bank of America's acquisition of Merrill Lynch, Wells Fargo's (WFC, Fortune 500) move to purchase Wachovia and JPMorgan Chase's deals for investment bank Bear Stearns and failed savings and loan WaMu. To top of page

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