Meredith Whitney: First quarter bank earnings are due to marking up assets, not fundamentals

Meredith Whitney talks to Bloomberg’s Jonathan Weil in a wide-ranging interview about the banking sector. This is a good one – the best I have seen – because you get to hear Whitney’s views on the sector’s stocks from a fundamental and a trading perspective.

Her view is that the banks do not have the same earnings power they once did and that the rally in their shares from last year had a lot to do with government action in helping to recapitalize the banks. For example, she estimates that $100 billion in capital was replenished just through what she calls the Federal Reserve’s "Great Agency Trade.’ You can see other stealth recapitalization due to the steep yield curve (Free money: JPM paid to borrow on $271 billion worth of repos).

Whitney also says that book value at the Too-Big-To-Fail banks actually decreased in Q1 2010 for the first time since 2008 and this is a sign that their earnings uptick is more accounting driven than fundamental. Weil points out the under-reserving at Wells Fargo as a case in point. And Whitney pounces on this as an example of how accounting is driving the earnings.

Question: how can an analyst actually take any view on the banking sector when so much of what drives value is due to government action, which is inherently political and not economic? That’s what Jonathan Weil asks Whitney. Her answer, while not entirely convincing, points to one of the only ways to do. Whitney takes a macro view based on her knowledge and experience and applies this view to individual firms to have the individual company’s data confirm or disprove her thesis. I think that’s the best you can do in this environment.

Apropos theses, mine on this is that the too-big-to-bail banks are going to feel the regulatory and political pressure that is almost certain to form due to populist outcries against them. We see that with Goldman Sachs, but it is likely to extend to other firms over time. Whitney makes similar statements.

The fundamentals regarding the housing market and government largesse are disappearing this year (see October’s Bearish on bank stocks and Extend and pretend and the growing divide between delinquencies and foreclosures). If housing double-dips as the Case-Shiller data suggest it could, the under-reserving will come a-cropper as credit writedowns.

Bottom line: I am still pretty negative on the banks and I outlined the writedown issue with The fake stress tests and the coming wave of second mortgage writedowns. I also think reading between the lines on CEO statements about dividends makes clear they are concerned about their need for more capital (see JPMorgan is not substantially increasing lending anytime soon). This is something that Whitney mentions in response to a question near the end of the interview.

Her interview was the most detailed look you will see of her thinking on specific institutions. It is a must-see high-quality interview which runs almost a half-hour.