A fresh batch of earnings reports in recent days have definitely called into question the likelihood of a near-term recovery in the financial services sector. Some financial services and lending companies have performed better than anticipated. Unfortunately, a couple big companies, disappointed Tuesday (July 22). The size of the losses from Wachovia and Washington Mutual heightened concerns for a delayed recovery. The recent earnings coincide with new Federal regulations for the credit industry to help prevent future crises from developing. Unfortunately, the new regulations will have little effect on the current struggles faced by the financial sector.

Wachovia is the fourth-largest US bank. It had an incredible second quarter loss of $8.86 billion. The loss was much larger than expected because of charges and reserve funds that were used to combat bad mortgage loans. Wachovia is a prime example of the turmoil that has impacted even the strongest banks. Large creditors are suffering from a lack of capital recovery tied to record foreclosures.

More bad news for Wachovia includes a second successive dividend cut and the elimination of nearly 11,000 jobs. Neither of these news items is bound to excite investors or concerned consumers. Wachovia’s share price is currently $16.79, which is nearly $36 below its 52-week high.

Washington Mutual is the largest savings and loan company in the US. The company posted a $3.33 billion loss, with its loan loss reserve reaching $8 billion. The company said it was diligently working on plans to cut nearly $1 billion in expenses before the end of 2009. It is likely, as is the case with Wachovia that much of the large cost cutting measure will come from job cuts.

Washington Mutual’s closing share price Thursday was $5.82. It has been hammered since reaching its 52-week high of $40.20 during 2007. The one year price target is just below $10 per share, indicating analysts do not expect a significant boost in investor confidence in the next twelve months. A year ago, the company reported $830 million in profit for its second quarter

All combined, five of the largest US banks, including Wachovia and Washington Mutual, reported over $11 billion in quarterly losses on Tuesday. In spite of the bad earnings news, the bank stocks soared in equity trade thanks largely to the broad market’s reaction to a $3 drop in oil prices. Many investors are using the oil drop as a motivator to jump into the most beaten down stock sectors, of which financial services is definitely one.

Light sweet crude oil closed at $127.95 in New York, bringing its recent slide to a total of $20 from its high of over $147, which was reached less than two weeks ago. A prolonged slide in oil, combined with a drop in retail gas, would be welcomed by consumers. Investors would also be more likely to take advantage of low cost buys of financial services companies if oil declines, likely pushing the dollar higher.

Many analysts have suggested the timing of the recent sequence of negative financial services earnings could not be better. With much of the market and consumer focus on oil and gas prices, the sting of sharp losses has been somewhat diverted. Other credit market hopefuls believe the present earnings challenges are the culmination of previous market turmoil and that many companies appear to be reaching bottom with their reliance of reserve funds to cover bad mortgages.

Market Recap

Stocks were fairly flat Monday, with the Dow down 29 points. The NASDAQ and S&P dropped 3 points and 1 point. Oil rose to $131 per barrel. Earnings reports were generally poor from the likes of Bank of America, Wachovia, and American Express. The Dow jumped 135 points Tuesday and the NASDAQ and S&P followed with 24 and 17 point gains. A $3 drop in crude oil was the major catalyst for stock enthusiasm as earnings in the financial sector called the credit recovery into question. The dollar moved higher. Yahoo posted a disappointing second quarter result, but not as bad as expected.

Neil Kokemuller
Tuesday, July 22, 2008
11:15 PM EST

Neil Kokemuller is an Associate Professor of Marketing at Des Moines Area Community College in Des Moines, Iowa, USA. He has a MBA from Iowa State University.

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