Count thy sins: Negative analysis decimates banking stocks

On Monday, several major banks got a firsthand lesson in the dangers posed by an unsure market, as an analyst's report immediately caused a sharp drop in their stock values. This episode, a strong demonstration of the volatility of the current financial sector, shows that Wall Street faces a long road to stability.

The report, written by Calyon Securities analyst Mike Mayo, stated that eleven of America's banks were "underweight," and predicted that their loan losses could exceed Great Depression levels. When this analysis hit the market, shares in the banks -- including BB&T, Fifth Third, Bank of America, Citi, Wells Fargo, PNC, KeyCorp, and JP Morgan Chase -- all dropped in value, and the KBW Bank Index fell by 3.8 percent.

It's not surprising that Mayo's prediction had such a huge effect. Until last month, he was employed by Deutsche Bank, and has also held prominent posts at Credit Suisse and Prudential Equity Group. He has a record for outstanding analysis and somewhat bearish tendencies.

Mayo predicted that the current mortgage crisis is only the first wave as "other areas are likely to accelerate, reflecting a rolling recession by asset class." Over the coming months, the mortgage crisis, which has only gotten halfway to its peak, will continue to expand; meanwhile, the credit card crisis, which is one third of the way into its ultimate denoument, would also spread massively. This nightmare scenario has "underweight" and "underperforming" banks possibly getting taken over by the government as loan losses increase to somewhere between 3.5 percent and 5.5 percent by the end of 2010.

Mayo's analysis took on the lofty tones of a modern-day Jonathan Edwards as he cited the banks' "seven deadly sins" of "greedy loan growth, gluttony of real estate, lust for high yields, sloth-like risk management, pride of low capital, envy of exotic fees, and anger of regulators." To be honest, Mayo's list seemed a little belabored; personally, I would have gone with anger at risk management, greed for exotic fees, and sloth-like regulation, but this might have gotten in the way of the medieval tone that he was trying to adopt. Further, it would have really infuriated all of the fans of Seven who were ticking off the sins on their fingers.

Mayo's experience and keen analytical skill make him an ideal choice for the role of Biblical prophet in the bargain-basement Sodom and Gomorrah that today's financial sector has become. He has an outstanding track record and seems very comfortable with the requisite finger-wagging. However, Monday's quick reaction to his report seems to say more about the skittishness of the market than about Mayo's skill and reputation. To put it mildly, faith is a rare commodity these days and, for better or worse, the market is bullish on fear and pessimism.
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