This Just In: Upgrades and Downgrades

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At The Motley Fool, we poke plenty of fun at Wall Street analysts and their endless cycle of upgrades, downgrades, and "initiating coverage at neutral." Today, we'll show you whether those bigwigs actually know what they're talking about. To help, we've enlisted Motley Fool CAPS to track the long-term performance of Wall Street's best and worst.

JPMorgan, landslide-starter
On a generally sunny day for the stock market yesterday, one investment banker took it upon itself to play the role of storm cloud... and rained all over the parades of its brother bankers. In a slew of downgrades, analysts at JMP Securities (not to be confused with "JPMorgan") slapped the equivalent of sell ratings on Bank of America (NYS: BAC) , Citigroup (NYS: C) , Goldman Sachs (NYS: GS) , and Morgan Stanley (NYS: MS) -- oh, and on JPMorgan Chase (NYS: JPM) itself.

According to JMP, the primary risk to investing in the megabankers today arises from Europe, and the probability of a Greek default and exit from the eurozone. According to JMP, the good news here is that if the EU contains the fallout and prevents any other dominoes (Portugal, Italy, Ireland, and Spain -- the other four European "PIIGS") from falling, then the bankers may suffer only "significant" declines in market cap. Worst case, though, if "contagion" spreads throughout Europe (a scenario that JMP gives a 30% chance of happening), the losses could be staggering.


JMP forecasts share prices falling as low as:

  • $23 at Citi (a 12% drop).
  • $28 at JPMorgan (14%).
  • $11 for Morgan Stanley (a 17% haircut).
  • $5.50 for Bank of America, and $77 for Goldman (20% drops, in each case).

And that's the good news
The bad news is that Europe may be the biggest of the bankers' problems, but it's far from the only one. Fact is, the reasons are legion to worry about this sector. For example, all five of these banks underwrote Facebook's fiasco of an IPO. With the stock's immediate post-IPO sell-off, there are going to be a lot of angry shareholders out there looking for someone to blame. Sure, they could blame themselves for buying the hype and ignoring the numbers, but I wouldn't bet on it. Lawsuits, ahoy!

Facebook poses additional problems for the underwriters, who reportedly spared no expense last week trying to salvage the IPO -- when shares began selling off, Morgan Stanley in particular is said to have dipped into its overallotment option to try to support the stock price by buying extra shares. With the stock now down more than 10% from its IPO price, Morgan Stanley and its co-underwriters are presumably sitting on a heaping helping of paper losses.

And the bankers' problems don't end there, either. There's also the fallout from JPMorgan's $2 billion (and counting) hedging loss to consider. The size of JP's loss, and its potential to grow and repeat elsewhere, has investors feeling skittish -- perhaps rightly so -- about the unknown damage that derivatives trading might be doing to other bankers' balance sheets.

Adding legal insults to injury, we learned on Monday that the FDIC has filed suit against the majority of the banks named above -- JP, Citi, and Bank of America for certain. The FDIC alleges the bankers misled customers who invested in their mortgage-backed securities during the housing boom, and is seeking $77 million in compensation. Granted, next to the size of JP's hedging loss, or the massive losses potentially inbound from Europe, this last risk sounds pretty penny-ante. But so far, the FDIC's complaint is on behalf of just two failed banks it's taken into receivership. There are many more where those came from, and it's impossible to rule out the risk of additional lawsuits being filed in the future.

Foolish takeaway
Is it correct to say that many of these risks are known, and may already have been "baked into" the share prices? Of course. That's why the stocks look so cheap. Is it true that some of the smartest investors out there are buying these banking stocks? Yes.

But even so, the risks here seem sufficiently big that I think JMP is right to be cautious. I'm avoiding the whole banking sector myself, and I think you should, too.

At the time this article was published You'll no doubt be shocked to hear that Fool contributor Rich Smith does not own shares of any company named above (but he's also not short any of 'em). You can find him on CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 320 out of more than 180,000 members. The Motley Fool has a disclosure policy.The Motley Fool owns shares of Citigroup, JPMorgan Chase, and Bank of America. Motley Fool newsletter services have recommended buying shares of The Goldman Sachs Group. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

Copyright © 1995 - 2012 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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