Meridith Whitney Slashes 2nd Quarter Bank Earnings

At first glance, when you see Meredith Whitney cut her earnings outlooks on banks, you may say there goes Meridith beating up the banks again.

After researching why Meredith decided to do this, I found a startling new accounting change that is forcing banks to mark assets to what they are now worth at current market prices. This change occurred in February and could have a dramatic effect on 2nd quarter bank earnings.

Here are the details from Reuters:

Some highlights:

Oppenheimer cut its earnings estimates on some U.S. brokers based on its outlook on the capital markets and sizable estimated revenue reversals due to a new accounting rule that allows companies to change the way they value financial securities. "We expect that most of the gains booked in the first quarter will be reversed in the second quarter," analyst
Meredith Whitney said in a note to clients.

The Financial Accounting Standards Board (FASB), which sets
accounting rules in the United States, adopted a fair value
option in February that allows companies to irrevocably choose
to record the value of certain financial instruments on their
balance sheets based on what that instrument could be traded
for in a current market transaction.

Q2 new Q2 '08 new '08 '09 new
Goldman Sachs (GS.N: Quote, Profile, Research) $3.48 $4.09 $14.65 $17.35 $16.30 $22.25 Lehman Brothers (LEH.N: Quote, Profile, Research) $0.72 $1.10 $3.45 $4.43 $4.45 $5.53 Merrill Lynch (MER.N: Quote, Profile, Research) $0.20 $1.00 -$0.45 $1.15 $4.05 $5.25 Morgan Stanley (MS.N: Quote, Profile, Research) $0.94 $1.44 $5.00 $5.85 $5.80 $6.55"


My take:

As you can see this is going to hit earnings pretty hard in the second quarter. Merrill's earnings will basically be reduced by 80% in the second quarter. The other IB's are seeing anywhere from 15-45% reductions.

Who knows what additional writedowns these investment banks will have to take in addition to these losses. Any regulation of these banks should be viewed as a negative for the banks.


Libor Shakeup:

Another piece of regulation news also hit the wires around the Libor rate. It looks like the English regulators are now going to do a full review of the Libor rate. This may include changing the way in which Libor is calculated. Here is the Libor story:

"May 13 (Bloomberg) -- The benchmark interest rate for $62 trillion of credit derivatives and mortgages for 6 million U.S. homeowners faces its biggest shakeup in a decade as lawmakers question if banks are understating borrowing costs.
For the first time since 1998, the British Bankers' Association is considering changing the way it sets the London interbank offered rate, according to Chief Executive Officer Angela Knight, who appeared before a parliamentary committee in London today. ``We've put Libor under review,'' Knight said in an interview yesterday. The BBA will announce changes May 30, she said."


Quick Take:

This could dramatically increase the Libor rate if the regulators find that this rate has been totally manipulated. Anyone with an adjustable mortgage needs to take notice of these potential changes.

It sounds to me like the banks ignored the British regulators warning a month ago. It looks like they are now taking matters into their own hands.

Bottom Line:

These are all positive steps in my eyes as the banks will be forced to clean up their act. We have a long ways to go, but I think the SEC and the FASB are finally starting to clamp down on these financial institutions.