NO EASY WAY FOR BANKS TO SHOW GROWTH / THE WALL STREET JOURNAL ( HIGHLY RECOMMENDED READING )

HEARD ON THE STREET

OCTOBER 12, 2009

No Easy Way for Banks to Show Growth

By PETER EAVIS

Normality, if it comes, will be nasty for most banks.

When financial firms' third-quarter earnings roll in, the immediate debate will be over which lenders' earnings will be the first to return to normal.

Such chatter could lift bank stocks, because when bad-loan provisions start falling, it will juice profits for several quarters to come. But, beyond any initial euphoria, investors need to realize how hard it will then be for most banks to post consistent loan and revenue growth.

The main problem: Household balance sheets still look stretched.

Coming out of the 1990-91 recession, household liabilities were just under 90% of disposable income. There was enough borrowing capacity among individuals to drive solid loan growth through the 1990s to leave that ratio at 101% in 2000. The credit bubble hoisted that metric to a scary 138% in 2007 -- and left the banks swamped with bad debt as the recession hit. An adjustment back to around 100% might set the stage for a prolonged upturn in lending. But that yardstick has dropped only to 129%.

As a result, banks now have two choices: Repeat their recent mistake of lending to overburdened individuals. Or battle with each other to lend to a small amount of credit-worthy customers.

American Express nicely illustrates this dilemma. During the boom, it chose to pursue strong growth in its credit-card portfolio. But that book has shown surprisingly high credit losses. No surprise that AmEx isn't now pointing to it as a big growth engine.

AmEx trades at nearly four times tangible-book value, far higher than other lenders. If credit cards aren't going to be a strong source of growth, other businesses really need to kick in to justify that multiple.

Granted, banks don't lend just to individuals. They also earn fees from them. But new regulation could crimp that source.

Many also lend to companies. But regular corporate loans make up only 15% of bank lending, and large corporations are currently bypassing the banking sector to raise huge sums in the bond markets. Commercial real estate, another big area for some banks during the boom, will remain a drag for several years.

Absent easy loan growth, the banks will have to posses one or more of the following advantages. First, they must be able to sharply cut costs, which favors banks that have recently done big mergers. Second, banks will benefit if they are deemed too big to fail, and thus enjoy low funding costs. Third, if capital markets remain buoyant, lenders with top-tier investment banks could outperform. Fourth, banks with excess capital should be able to boost per-share earnings with buybacks.

Without those advantages, the main tactic left for banks is stealing market share. That is never easy -- particularly when the country's biggest banks now have an even stronger grip on most areas of the market.

Copyright 2009 Dow Jones & Company, Inc. All Rights Reserved