Mar

18

The combination of hysteria about sub prime which presumably has a one percent impact on big banks, a recent decline of some 10% in many of the bank stocks, (the KBW bank index fell from 122 to 111 in last month), and good dividend growth and return on capital would seem to provide meals for scientific study and or caneology.

To me, the case for avoiding these stocks seems particularly like pseudo talk. It depends on a general tendency of banks to lend too much in good times, and to gamble. I've never found banks overly aggressive in lending to anyone I know, and I see no reason to believe they are not as good at learning from past mistakes and getting a proper return from the risk they take as others.

Nor do I believe that the financial market suffers when weak fringe players are forced to go to bigger entities to help bail them out. this happened in the Long Term Capital case, in the large and in the small, every day, when banks confide to their stakeholders how their privileged position often enables them to make opportunistic investments in times of crisis for the common good.

J T Holly adds: 

I myself am taking the cane out and looking more into finding the hypothesis that will unlock the significance other than my intuition. A couple of things that seem different this time that the "critics" and "bear camp" aren't taking into consideration have to do with legislation and government doings that make banks more apt to produce revenues since before the reversal of legislation happened.

1) Clinton signed to reverse the Glass Stegal Act. Banks now are not only banks but also brokerages, trading houses, insurance companies, and lend in millions of ways via auto, credit cards, and such.

2) "Do Not Call List." Having experienced the adverse effect of this as a broker in a former life, the banks use this to their advantage whereas the smaller players can't "reach out and touch someone." They have the legal right to call existing clients and cross sale products that the first aforementioned points allow now.

3) Bankruptcy Act recent development. Complete utter hypothesis on my part or conspiracy theory, but banks don't make any margin on perfect scores or good credit other than those folks feeding the system with deposits. The ability of banks through forcing those who are losing more than they deserve to go below 700 on a round number and be classified as sub prime allows them higher margins. The average score across America is around 670 allowing for this higher margin to be maintained. Not to fuel the Dead Horse last week, but this wasn't mentioned in the espousing.

It's plain and simple. They have the government, numbers of clients, and ecosystem to survive flourish and devour and recycle their own folks and keep on truckin'.

I had a client when I got into this business who told me that the best business to run was a whorehouse because "you got it, you sell it, and you still got it." It seems banks these days are about as close to this as possible.

The only legislation that I could find that limits growth and has prevented me further is some 10% rule that states that they can't have more than 10% of the total amount of money in circulation in business. Are C and BAC the closest if not at the max? Does anyone have more clarity or know of such Fed Reserve law that prevents this? I guess they can't make acquisitions or grow organically. It seems like an anti-competition type law, like in Atlas Shrugged!

Mathematically most pay a yield of around four and higher via dividends, and you have the wonderful drift of the market that they belong in to add on top of that. If you look at the Fed Fund Model, they are a sexy and attractive piece of the pie. To be able to get that which is equivalent to risk free and have something also that is apart from the earnings yield of the S&P is nice.

I guess the bear camp feels that the dividend can't be maintained. They can't re-invent themselves over and over like they've done thus far. It is called Citicorp not Citibank! I always have to remind myself that they get paid to write, versus getting paid to be right.

J T Holly continues:

The other one to test is the old utility adage that everyone hangs onto: "They are heavy borrowers and go down when rates rise." It's like they don't see the diversification that utilities have gone through for the past two decades. They also have a government hedge internally with fixed cost controls that they've adapted to and work to their advantage.

Andrea Ravano adds:

The first reason one should be interested in banking stocks is of course the fact that the industry is selling the "do it yourself" online strategy as a great breakthrough, whereas what it amounts to is just pay less for employees, get rid of risk, and get fees.

I suspect that the years to come will see the trend of home banking increasing to the point of having a human-free bank. It's every banker's dream to be able to use a switch to stop operations instead of laying off people. Yet the greatest interest lies in the fact that the banking industry is scattered around the globe, fragmenting the market pie in such a way that none has a dominant position.

The epitome of this is Italy, where the banking industry's biggest players don't exceed five percent of the entire market. Hence, I believe more takeovers, mergers, and other such measures to consolidate and reduce the number of players in the market will and must occur. As I'm writing the market buzz is on Barclays, which should announce merging activities with ABN Amro bank of Nederland. This would have been hardly thinkable just a few years ago.

Other reasons include the combination of hysteria about sub prime, which presumably has a one percent impact on big banks; a recent decline of some 10% in many of the bank stocks (the KBW bank index fell from 122 to 111 in last month), and good dividend growth and return on capital. 

Jeff Rollert adds:

I have found bankers at large firms (not referring here to investment bankers) do not share much investment courage as it isn’t part of their compensation plan.

Small and community bankers are pure salespeople, chasing after the highest spread product to the greatest extent the regulators permit. They start, build, sell, repeat. They also have higher construction and R/E spec lending.

Regional bankers are difficult, as they have both personality types. My point for making money is that their manner in approaching risk is very different.


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  1. art vandalay on March 18, 2007 7:12 pm

    “Seven years ago, the optimists argued that equities as a broad asset class were in reasonably good shape – that any excesses were concentrated in about 350 of the so-called Internet pure-plays that collectively accounted for only about 6% of the total capitalization of the US equity market at year-end 1999. That view turned out to be dead wrong. The dot-com bubble burst, and over the next two and a half years, the much broader S&P 500 index fell by 49% while the asset-dependent US economy slipped into a mild recession, pulling the rest of the world down with it. Fast-forward seven years, and the actors have changed but the plot is strikingly similar. This time, it’s the US housing bubble that has burst, and the immediate repercussions have been concentrated in a relatively small segment of that market – sub-prime mortgage debt, which makes up around 10% of total securitized home debt outstanding. As was the case seven years ago, I suspect that a powerful dynamic has now been set in motion by a small mispriced portion of a major asset class that will have surprisingly broad macro consequences for the US economy as a whole.”

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