Despite Writedowns and Loan Losses, Core Banking Businesses Remain Very Profitable

Since earnings season gets underway in full force this week, the headlines are going to look bad for the financial services industry as loan losses and asset writedowns lead to severe first quarter losses. However, investors need to focus on where these losses are coming from and how the core banking business is holding up during this mess.

I bring this up because the media would have you believe that the banking business is broken and loan defaults by consumers on their mortgages, credit cards, car loans, and student loans are crippling the banks. Interestingly, that is simply not the case.

Consider the first quarter earnings report from Wachovia (WB) issued this morning. The company reported revenue of $7.9 billion and a loss of more than $300 million, or $0.20 per share. That sounds bad, and it is, but digging deeper into the company’s income statement reveals that more than 90% of WB’s business remains extremely profitable, as you can see from the numbers below.

Why is this important? Because these three segments represent 93% of Wachovia’s business and all three are very profitable even in today’s economy. Now, should you simply ignore the losses from asset backed securities and leveraged loans? Of course not. Those losses are real and are resulting in capital infusions, equity dilution, and dividend cuts that are melting away shareholder value.

That said, the banking operations are here to stay whereas record levels of structured product issuance and leveraged loans are not. For those investors who are willing to take a long term view, these large banks are going to make a lot of money from their core businesses going forward, and investors need to take this into account when trying to value financial stocks. Wall Street will not ignore these short term losses in coming days, weeks, and even months, and they shouldn’t, but two or three years from now the core business segments highlighted above will be the driving force behind bank earnings, and as a result, bank share prices.

Full Disclosure: I do not have a position in Wachovia. I simply used their numbers as an example since they just reported this morning, before all of the other banks. Given that Wachovia purchased Golden West Financial and AG Edwards at the peak of the market, there are likely better investment opportunities in the banking sector, taking both fundamentals and senior management teams into consideration. That said, Wachovia’s numbers are relevant because most banks have similar profit margins in their core banking businesses.

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2 Thoughts on “Despite Writedowns and Loan Losses, Core Banking Businesses Remain Very Profitable

  1. Freedom 45 on April 15, 2008 at 8:50 AM said:

    I am also wondering when we might start to see some write-ups of the written-down assets. With rumours that Citi was sellign 12B for 90cents on the dollar, I suspect that while not this quarter, we might start to see them next.

  2. madhatter on April 15, 2008 at 11:03 AM said:

    USB (US Bank) is one i’ve been eyeing for sure. Conservative management, solid business, will have a strong ’09, and good dividend (although dividend growth should slow i think). add in writing some covered calls on that and you’ve got a solid play i think.

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