Wednesday, April 1, 2009

Selling the News on Accounting Changes

Posted on the Wall Street Journal MarketBeat by David Gaffen:

Will Thursday’s expected ruling on mark-to-market accounting rules be a ‘sell the news’ moment for the banking stocks?

Shares of the nation’s largest banks boomed in March, putting together a sharp rally after dealing with months of losses. Investors reduced holdings in banking shares in recent months in response to painful write-downs of billions of dollars in assets, and the stocks remained buried amid uncertainty over the government’s plan to resolve the ongoing financial crisis.

The stocks kicked off a recovery in early March, after Citigroup CEO Vikram Pandit said that Citi had been profitable in the first two months of the year, a sentiment echoed by a number of other banking executives. In the meantime, the Financial Accounting Standards Board moved to relax certain rules that stipulate that banks have to mark down assets held to observable market levels. The official vote to change the rule takes place tomorrow, and some investors have argued that it could be a catalyst for banks to bounce even higher.

But the banks have come along way already. The Financials Select Sector SPDRs exchange-traded fund has gained nearly 45% since it closed at 6.26 on March 9, compared with a gain of more than 19% for the Standard & Poor’s 500-stock index.

“I like financial services, but one of the issues you have right now is that with such significant ownership by the federal government, private capital is a little nervous to invest in some of these companies,” says Michael Cuggino, president of Permanent Portfolio Funds in San Francisco.

Furthermore, more headwinds loom for the banks. J.P. Morgan Chase’s chief executive, Jamie Dimon, and Bank of America’s head Kenneth Lewis both said recently that March’s environment had not been as favorable for profitability to the banks than the first two months of the year.

They, along with several other large institutions, are currently going through the government’s stress tests of 19 large banks to determine whether they need more capital or whether more drastic measures are needed. The Obama Administration’s surprisingly aggressive efforts to resolve the problems at the nation’s auto makers has led some to believe that certain banks are also on the firing line.

In addition, the banks are expected to report a 37% year-over-year decline in profits, with little expectation of improvement for the moment. “The moves from the Fed increase the odds that the system starts to improve, but having said that, you have significant specific company risk in owning any of the individual large banks, because there may be some [risk] that the government says, ‘You have to raise a lot more capital,’” says Jim McDonald, chief investment strategist at Northern Trust.

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