Banks shares recover, but remain down

Even though financial stocks rose along with the market on Tuesday, the stock market declines of the last few weeks have been especially harsh on banking stocks.

The KBW bank index climbed 7 percent Tuesday to $39.58, following an 11 percent decline on Monday. A month ago it traded around $48.

Investors remain worried about regulatory probes, investor lawsuits and additional problems that could emerge as big banks continue to work through toxic mortgages and other remnants of the financial crisis.

When will financials recover? Analysts say that investors first need to get over the initial shock of the S&P's downgrade of U.S. debt on Friday, a development that rattled the broader market as well. Bank executives say the economy and housing prices must improve before their mortgage businesses can fully recover.

Investors need more certainty about when banks' mortgage problems might be over.

"People don't know what's going on," said Chris Whalen, co-founder and managing director at Institutional Risk Analytics, a bank rating agency and consulting firm.

Bank of America Corp. has been especially hard hit, in large part because of its $4 billion purchase of Countrywide Financial Corp., a lender known for exotic mortgages, in 2008. Countrywide's former executives later settled regulators' charges of insider trading and fraud. So far Bank of America has agreed to pay $12.7 billion to settle claims from investors who say they were misled into buying mortgage securities that were poor quality. The bank has set aside another $18 billion for potential claims — roughly eight times what it made in 2009, its last profitable year.

Banks must also win back investors' trust, which means not making statements they can't live up to, said James Early, an analyst at The Motley Fool. One example he cited: Brian Moynihan's hints that Bank of America would raise its dividend this year, since the Federal Reserve already denied one request in March by the bank to do so.

Bank of America, the country's largest bank by assets, is perhaps the most vulnerable to the two biggest lingering mortgage problems: investor claims and investigations by regulators. Claims from investors who say they were misled into buying bad mortgage-backed securities continue. Regulators continue to investigate paperwork problems on foreclosures.

Bank spokesman Jerry Dubrowski said Bank of America is "aggressively working on getting those challenges behind us as quickly as we can."

"They are losses related to legacy issues and the housing crisis," Dubrowski said. The bank is the country's largest mortgage servicer.

Dubrowski declined to speculate on whether Bank of America should have bought Countrywide, a purchase executed by Moynihan's predecessor, Ken Lewis. "I don't think it's useful to think about that," he said.

One of Bank of America's major problems is that it bought Countrywide too early, said Guy Cecala, publisher of Inside Mortgage Finance. Three months later as the financial industry imploded, regulators didn't make JP Morgan Chase & Co. take on all of Washington Mutual's most toxic mortgage assets when it agreed to buy the failing thrift, Cecala said.

Gary Townsend, CEO of Hill-Townsend Capital in Maryland, said he believes clearing up mortgage-related litigation could take years. "If you think about Exxon Valdez, that took 25 years," he said, referring to the 1989 oil spill in Alaska and its resulting lawsuits.

Bank of America's Moynihan sent a letter to employees Monday night reminding them that there was "great short-term cost" to working through mortgage problems. Citigroup Inc. CEO Vikram Pandit sent a voice mail to employees Tuesday telling them that the current problems aren't the same as the ones that preceded the 2008 plunge.

Scott Talbott, spokesman for the Financial Services Roundtable trade group, said his member banks have raised their capital ratios to an average of 7 percent, up from 4 percent three years ago. Big banks also now have "living wills," per new financial regulations, which would result in an orderly unwinding of an illiquid bank rather than a frantic collapse — though Talbott emphasizes that he doesn't expect that.

New and pending regulations have also forced banks to curb riskier practices and investment tools, such as the collateralized debt obligations that rolled subprime mortgages into securities to be bought by investors. The banks also point out that many of the "bad actors" that churned out exotic mortgages, such as Countrywide or Golden West Financial Corp., have been absorbed — although they're still causing problems for their owners, Bank of America and Wells Fargo & Co.

Chris Mutascio, a banking analyst at Stifel Nicolaus, said that the forced capital increases have positioned the banking industry to weather turbulent markets, like the last few weeks. Bank of America's "global excess liquidity" is at $402 billion, up from $293 billion a year ago, according to the bank.

Still, the banks are going through a painful shrinking process. Customer defaults have declined, but so have revenues, according to the FDIC's latest quarterly banking profile.

The industry's net operating revenue fell 3.2 percent — just the second decline in 27 years — in the first quarter, the latest data available.