December 12 2007: 3:36 PM EST
Email | Print    Type Size  -  +

Banks saving for a rainy day

Statements from banks on Wednesday show that beleaguered bank stocks have farther to fall, and investors are getting bad news from some unlikely quarters.

By Colin Barr, senior writer

NEW YORK (Fortune) -- Financial firms aren't ringing any bells this holiday season. Indeed, as Wednesday's rash of bad news shows, many banks may soon find themselves rattling tin cups instead.

This week alone, big banks including Bank of America (Charts, Fortune 500) and Washington Mutual (Charts, Fortune 500) have said they'll have to set aside billions of dollars to bolster their reserves for loan losses. Other banks sent a raft of worrisome signals out Wednesday: PNC (Charts, Fortune 500) blamed depressed real estate and trading results for a quarterly earnings shortfall, Wachovia (Charts, Fortune 500) nearly doubled its fourth-quarter credit-loss provision, and Capital One (Charts, Fortune 500) said more consumers are late on their credit card bills.

A slowing economy, falling house prices and the collapse of the market for mortgage-backed securities are wreaking havoc with profits at banks everywhere. Bank stocks have fallen sharply, but Wednesday's action shows the declines may have further to go. Merrill Lynch on Wednesday downgraded Wachovia and BofA, saying credit losses will rise and investment banking profits will fall next year.

So which bank will be next to give investors some bad news? No one is safe, given the problems in the housing market. But it's only natural to focus on lenders with huge mortgage books and those that lend in distressed areas. That could mean Countrywide (Charts, Fortune 500), the nation's biggest mortgage lender, as well as Midwest regional banks such as National City and KeyCorp, whose customers are already suffering from job losses and soaring foreclosures.

"Any firm involved in the mortgage sector is dealing with significant problems," said Sean Egan, managing director at Egan-Jones Ratings in Haverford, Pa. He says the Federal Reserve is doing the best it can to contain the damage, by reducing interest rates and through actions such as Wednesday's bid to encourage bank-to-bank lending. Still, central bankers' maneuvering room is limited, Egan says, because a rash of unwise risk-taking by lenders means "the problems are baked in."

Take Wells Fargo (Charts, Fortune 500), the fourth-biggest U.S. bank by revenue. The bank has had a reputation as a prudent lender and was thus seen as unlikely to be pulled into the subprime muck. Yet Wells last month took a $1.4 billion charge to reduce the value of some bad home equity loans it bought from mortgage brokers. Chairman Dick Kovacevich recently told Bloomberg the experience has been painful.

"We made mistakes and we shouldn't have made mistakes,'' he said. "So we give ourselves 20 lashes and remind people for the next 10 years not to do it again. That's why this is such a tough business, because when you get out on the edge, you get a $1.4 billion hit.''

Billion-dollar hits are becoming all too common. Bank of America said Wednesday it expects to boost its loan-loss reserve by $1.3 billion in the fourth quarter, as commercial real estate and small business loans go bad. Washington Mutual increased its loan-loss provision forecast for the next two quarters by $1 billion on Monday. Wachovia now believes its loan-loss provision will be about $1 billion in excess of charge-offs for the fourth quarter, up from an earlier forecast in the $500 million-$600 million range.

Despite the losses, BofA and Wachovia appear to have abundant capital to absorb further loan problems. But every bank isn't so fortunate. Earlier this week, Washington Mutual slashed its dividend after taking hefty writedowns tied to dropping house prices and a deteriorating mortgage market. WaMu shares have fallen 16 percent since its Monday afternoon announcement that it would raise $2.5 billion - a figure later raised to $3 billion - via a preferred stock sale. In selling big chunks of stock, WaMu joined Fannie Mae and Freddie Mac, among many others, in coming to the market for new funds.

WaMu rival Countrywide has already raised $2 billion this year through a sale of preferred stock to Bank of America. In the wake of WaMu's problems and with BofA chief Ken Lewis speaking Wednesday of "considerable dislocations in the capital markets" tied to the housing bust, investors are again questioning Countrywide's financial standing.

Egan of Egan-Jones Ratings says he believes Countrywide will have no choice but to follow in Washington Mutual's fundraising footsteps. He says the bank hasn't yet taken writedowns that fully reflect depreciating house prices and rising defaults. A 5 percent writedown on its $209 billion asset book, he ventures, could mean an $11 billion charge at Countrywide - a hefty hit that could seriously reduce its capital cushion.

"There's no question Countrywide will have to come back to market," Egan said. Countrywide didn't immediately return a call seeking comment.

Despite the pain, bank executives remain mostly optimistic. Bank of America's Lewis, for instance, shrugged off the 20 percent decline in BofA shares this year as he addressed the Goldman Sachs Investor Conference in New York.

"It is important for investors to ask which organizations are going to be best positioned to grow when the cycle again turns," Lewis told investors in his prepared remarks at a conference Wednesday. "Bank of America should be on their list."

For now, though, the next turn in the cycle seems to be a long ways off. To top of page