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Good News and Bad News: The Plot Thickens

Posted by Larry Doyle on April 13, 2009 6:39 PM |

It seems as if Wall Street banks are releasing “surprisingly positive” earnings in stealth fashion these days. Goldman Sachs was expected to release 1st quarter 2009 earnings tomorrow. Well, Goldman just released that they “blew the doors off” the building in a very explosive and positive fashion. Bloomberg reports Goldman Sachs to Sell $5 Billion in Stock, Repay TARP:

The New York-based bank earned $1.81 billion, or $3.39 a share, in the first quarter as a surge in trading revenue outweighed asset writedowns. The results beat the $1.64 a share estimate of 16 analysts surveyed by Bloomberg.

The earnings were driven by a sizable increase in trading activity which reads as a major gain in market share. With Bear, Lehman, and Merrill all gone and Citi and BofA in the hospital, the crowd at Goldman is sowing while the sun shines. What does that mean? For those who want or need to “play,” Goldman is now one of the few shops truly open for biz. The price to “get in the game” just went up and Goldman’s franchise is clearly benefiting:

Goldman Sachs benefited as the gap between what banks pay to buy fixed-income securities and the price at which they sell, the so-called bid-ask spread, almost doubled to 19 basis points in six months, according to data compiled by Bloomberg.

Over and above the earnings, Goldman has sent a clear signal to Uncle Sam requesting him to leave the Goldman “casino.” With Goldman’s earnings power clearly defined, the firm has announced its intention to raise more equity capital and pay back the TARP money it received last Fall. It will make that equity raise after the release of the Bank Stress Tests at the end of the month. Uncle Sam’s intentions to oversee compensation, business practices, and the like is the antithesis of how Goldman operates. While the actual cost of the government TARP money is cheap, the unknown costs are enormous. Goldman has no interest in maintaining those risks.   

In agricultural terms, Goldman’s performance and capital raise is the equivalent of “separating the wheat from the chaff.”

Assuming Goldman has a successful equity capital raise, and it will, and does repay the government money, it will truly distinguish itself from other financial institutions. Uncle Sam –  in the persons of Tim Geithner, Ben Bernanke, and Barack Obama – may not like the distinction between strong banks and weak banks. Bloomberg offers:

If Goldman Sachs returns the TARP money, it may pressure other banks to follow suit or to risk appearing dependent on the government, Brad Hintz, an analyst at Sanford C. Bernstein Co. in New York, said before today’s announcement.

“The right thing for government officials to do will be to delay the GS repayment until a significant group of banks are able to repay simultaneously under some organized plan,” Hintz said.

In another corner of the farm, Wells Fargo is operating. Please recall that last Thursday Wells surprised the market with very strong earnings. The criticism of the quality of Wells’ earnings has been rampant. That questioning of quality is due to the lack of transparency provided by Wells. To wit, Bloomberg reports Wells Fargo May Need $50 Billion in Capital KBW Says:

Wells Fargo & Co., the second- biggest U.S. home lender, may need $50 billion to pay back the federal government and cover loan losses as the economic slump deepens, according to KBW Inc.’s Frederick Cannon.

KBW expects $120 billion of “stress” losses at Wells Fargo, assuming the recession continues through the first quarter of 2010 and unemployment reaches 12 percent, Cannon wrote today in a report. The San Francisco-based bank may need to raise $25 billion on top of the $25 billion it owes the U.S. Treasury for the industry bailout plan, he wrote.

First-quarter net income rose 50 percent to about $3 billion, Wells Fargo said last week in announcing preliminary results that topped the most optimistic Wall Street estimates and sparked a 32 percent jump in the stock. The bank attributed the profit to a surge in mortgage originations and revenue from Wachovia Corp., acquired in December. Full results are scheduled for April 22.

“Details were scarce and we believe that much of the positive news in the preliminary results had to do with merger accounting, revised accounting standards and mortgage default moratoriums, rather than underlying trends,” wrote Cannon, who downgraded the shares to “underperform” from “market perform.” “We expect earnings and capital to be under pressure due to continued economic weakness.”

Wells Fargo raised its provision for loan losses by $4.6 billion in the quarter, below Cannon’s estimate of $5.4 billion. FBR Capital Markets analyst Paul Miller wrote after the announcement last week that he expected a $6.25 billion increase.

How in good conscience can the executives of Wells Fargo post a $3 billion earnings figure in the face of such enormous projected losses and outstanding obligations? The Wells earnings release is the epitome of “managed earnings.”

The quality and transparency of Goldman’s earnings versus those of Wells Fargo present a real challenge for Turbo-Tim, Big Ben, and Barack. Do they let free markets founded on the principles of capitalism reign, or do they jawbone Goldman into not raising new equity in an attempt to truly maintain government control over the world of Wall Street?

The plot thickens. Stay tuned!!

LD






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