Mark-to-Profit: Why I No Longer Hate Banks

Allow me to start off by illustrating my sentiment from January 2008 – February 2009: I hate banks and I have no idea what they are doing. I hate anything financially related.

But, I find myself not hating banks anymore. What happened? I’ve got eight leading indicators that people might be aware of but aren’t catching headlines like they should be and I’ve got four monster catalysts. What do I know? I’m only the Motley Fool’s Hottest Player going into Easter Weekend. Further, my entire college tuition is riding on the stock market.

Leading Indicators:

1. Federal Funds Target Rate is nil. This means that banks can borrow as cheaply as they ever have been able to. When you borrow at these interest rates, the net present value of any opportunity where you can at least get your money back is a good one to be taking.

2. Banks as a sector cheap from a historical perspective. I wonder why? Fear, panic, disorder, lack of trust, lack of speculation --- just a few ideas.

3. There is tons of cash on the sidelines. Blood is in the streets. There has definitely been “the slaughtering of the speculator” over the past year and a half. I believe now is the time when the speculator finally gets congratulated.
4. We are up 28% off the bottom according to the S&P500.
5. Global Markets are leading the way. They are up 53.4% according to EEM [iShares MSCI Emerging Markets Index (ETF)].
6. My uncle who is a banker panicked and sold out of the market at Dow 6700.
7. Mark-to-market has been relaxed to ‘mark-to-whatever-makes-us-look-good.’ A.K.A mark-to-profit.
8. The uptick rule might come back. In my opinion, this isn’t necessary at this point.

Monster Catalysts:

1. Citigroup (C) and Bank of America (BAC) said they were profitable in the first two months of 2009. Great! Now they can do whatever they want to their balance sheet with the relaxation of mark-to-market. What does that imply? How can you lose money when you get to put whatever you want on a balance sheet? Especially if you’re a bank and you thoroughly understand how to crunch numbers and make them look favorable, you’re going to be looking really good now. It’s the Enron dilemma of “mark-to-model.” I could come up with some great spreadsheet models that make me look like an undervalued opportunity.
2. It’s already happening! Wells Fargo (WFC) is coming in crushing analysts. Well, of course! What do you expect when you can borrow money to invest in opportunities and you’re not paying a significant interest rate on what you borrow?
3. Analysts are going to get caught with their pants down this week. Earnings are coming out. Tuesday: Goldman Sachs (GS); Thursday: JPMorgan Chase (JPM); Friday: Citigroup (C). There is so much upside that they simply can’t see because they don’t really understand what’s going on. If they did, they wouldn’t be analysts. They’d be retired. What does this do? This sets up an opportunity for some huge price target upgrades, usually after the price actually appreciates to that target. Have you noticed that analyst price targets seem to be a lagging indicator of stock prices --- or is it just me?
4. Debt upgrades. Once mark-to-profit kicks into full swing, the ratings agencies have to think a little more highly of these poor banks.

How to play this one:

I like a couple insurance agencies in decreasing order: CNO, GNW, PNX. I think GNW didn’t need the TARP anyway. That’s a sign of strength. Am I the only one seeing this?

I like a couple bank plays, also in decreasing order: FAS, C, BAC. I’m not into the Wells Fargos and the Goldman Sachs or even JPMorgans of the world --- where is the upside there? 100%? Not enough.

Disclosure: Glen Bradford owns CNO, GNW, PNX, FAS, C, BAC and/or options on them in his and his investor’s accounts.

Comments

[Shorts Are ...:]

Good point about GNW not needing TARP is a sign of strength. Great article and insight.

Apr 13 05:28 AM

[Robert DiAl...:]

I hold some bank stocks and I hope things keep getting better. But what happens with bad news from General Motors? I hope they can pull a rabbit out of their hat.

Apr 13 08:40 AM

[rdondamike:]

With '08 looking so bad the uptick in '09 will make any year look good. The leaner companies will survive working steadily with earnings coming in. Like clock work with the Fed it will happen. Shorts for now.Go long later in this quarter.

Apr 13 10:06 AM

[prairiedog555:]

I wish I could borrow at .025 % and loan at 5-32%.

Apr 13 11:06 AM

[Leftfield:]

I guess Enron had a few good years.

Apr 13 11:53 AM

[Steven Vincent:]

Check out my piece: VIX Breakdown Forecasts Bear Panic

seekingalpha.com/insta...

There is panic buying after hours in Citigroup, now up to $4.20. Also BAC.

Here is an addendum to my piece:
Question from this posting on MarketOracle.com:

VIX showing buying panic?

Just wanted to ask about your interpretation of the VIX. When I saw the VIX break down below 40, I took it as a sign that we'll see less panic in general, on the long side and the short side. Options implied volatility works both ways. Why did you see it as a set up for panic buying?

Reply:

It's interesting that there are many divergent interpretations of this indicator that has become widely monitored.

First, clearly historical volatility has not diminished in this bull phase...we all know that this is "the fastest rally since 1933."

The VIX tends to move inversely to the market. Technically the index had reached a point that demanded resolution implying a sharp break in either direction. A break down from the 200 DMA and the triangle formation would imply a continuation of the bull trend in stocks...and a sharp one. A move away from the 200 DMA is a fundamental change of trend. It means something very important is happening. Bears had been expecting an upside resolution to the VIX, coinciding with a top in the "bear market rally". They have tried to short the market again at this level on the blanket assumption that the bear must return. The breakdown in the VIX in an indication (and a strong one) that they are probably wrong. It is possible that on Tuesday or Wednesday there may be a sharp pullback in the markets and the signal that the VIX has given may prove to be a bull trap (or bear trap from the perspective of the VIX chart). However that would need to happen in the next few days or the shorts will start to cover and sideline money will pile on driving the market to the 200 DMA on the SPX.

Apr 13 08:16 PM

[Francisco M...:]

That makes great sense; but you seem to forget that if banks cannot find the courage to actually deploy their cash what good is it anyway.

Apr 13 11:13 PM

[Glen Bradford:]

I also agree with your interpretation on the VIX. I noticed it as well. When the market is crashing and the VIX is stable, as it was these past 2 months... I turned super bullish. I don't really have an opinion on the VIX right now. My opinion is that Financials are still severly underpriced based on the EPS that they're going to put out this year (2009). I also believe that even though banks are going to be cheating their way into earnings by mark-to-profit and no interest rates --- they are a steal right now. I am a bank-hater at heart.

I think this week financials will run. The dumb money out there will see banks going up and buy in --- because they see an upward trend. The smart money has already bought in. There is 90% dumb money to smart money. Get ready to ride. These things are going to be blasting off. That's just my opinion.

I didn't mention FITB. I like that one too because all the day traders I know cant stop yelling about it. My disclaimer is that buying FAS is the for sure winner. The rest are all hypothetically gambles. Citigroup can't go under and will probably go x3 this week. Just wait till the mutual funds can get it at $5.

I base most of my analysis on discounted cash flows. In a situation like this, I look at historic cash flows and ask myself: "Will this company survive?"

Hope this helps.


On Apr 13 08:16 PM Steven Vincent wrote:

> Check out my piece: VIX Breakdown Forecasts Bear Panic
>
> seekingalpha.com/insta...
>
>
> There is panic buying after hours in Citigroup, now up to $4.20.
> Also BAC.
>
> Here is an addendum to my piece:
> Question from this posting on MarketOracle.com:
>
> VIX showing buying panic?
>
> Just wanted to ask about your interpretation of the VIX. When I saw
> the VIX break down below 40, I took it as a sign that we'll see less
> panic in general, on the long side and the short side. Options implied
> volatility works both ways. Why did you see it as a set up for panic
> buying?
>
> Reply:
>
> It's interesting that there are many divergent interpretations of
> this indicator that has become widely monitored.
>
> First, clearly historical volatility has not diminished in this bull
> phase...we all know that this is "the fastest rally since 1933."
>
>
> The VIX tends to move inversely to the market. Technically the index
> had reached a point that demanded resolution implying a sharp break
> in either direction. A break down from the 200 DMA and the triangle
> formation would imply a continuation of the bull trend in stocks...and
> a sharp one. A move away from the 200 DMA is a fundamental change
> of trend. It means something very important is happening. Bears had
> been expecting an upside resolution to the VIX, coinciding with a
> top in the "bear market rally". They have tried to short the market
> again at this level on the blanket assumption that the bear must
> return. The breakdown in the VIX in an indication (and a strong one)
> that they are probably wrong. It is possible that on Tuesday or Wednesday
> there may be a sharp pullback in the markets and the signal that
> the VIX has given may prove to be a bull trap (or bear trap from
> the perspective of the VIX chart). However that would need to happen
> in the next few days or the shorts will start to cover and sideline
> money will pile on driving the market to the 200 DMA on the SPX.
>

Apr 13 11:23 PM

[Willy Walnuts:]

Good insight. Are you really still in college?

I like the exchange with Mr. Vincent, I would like to sit in on a poker game between you two...

Now if the G men make the rules, and you play by the rules, is it cheating?

I love this new economy... Do you need some more money? Ok, we'll print some for you. You don't like paying interest? It's gone! Are the rules cramping your style? I tell you what, let's bend a few of them for you, and make you nice an comfy. Anything else we can do for you? Well, look who's feeling better today!

Chicken soup for the bankers (soul?)

(BTW, I am a self loathing FAS owner too)

Apr 14 01:31 AM

[ifuwish2:]

finally someone now writing gloom and doom,all the others have been ,,i like to know how they will now,,im sure they will ,i bought 3000 shares of C at 1.28 and 500 shares of FITB at 1.03 and 3625 shares of AIG at 1.00, everyone told me to sell and told me im crazy for holding..wonder what they say now?

Apr 14 03:40 AM

[ifuwish2:]

i meant not writing gloom and doom sorry


On Apr 14 03:40 AM ifuwish2 wrote:

> finally someone now writing gloom and doom,all the others have been
> ,,i like to know how they will now,,im sure they will ,i bought 3000
> shares of C at 1.28 and 500 shares of FITB at 1.03 and 3625 shares
> of AIG at 1.00, everyone told me to sell and told me im crazy for
> holding..wonder what they say now?

Apr 14 03:41 AM

[suttoda:]

very nice

Apr 14 07:42 PM

[Glen Bradford:]

I left out a couple things, I'll add them as I remember them. Another feeling of mine is that I've been looking through lots of insurance and bank financial statements closing out 2008. It seems to be a fairly large trend that they were writing off more than they had to. Looking at this from a game theory perspective, it makes sense. They may have wanted to close out a terrible year by writing off so much that they could avoid write-offs in 2009. Looking at things this way, and the adjustments of mark-to-market to mark-to-profit, I believe that these huge write-offs will slowly start factoring in over the next couple years as unrealized gains. I don't fully expect these institutions to bring them all back in 1 quarter. Analysts love good trends and when mark-to-market comes back, the companies are going to want to be able to continue posting profits. It's as if they all have a safety bank account now that they can start dipping into in order to normalize their future earnings. I have also been picking up HBAN. My disclaimer is that by diversifying across C, FITB, HBAN, AIG; you can land a couple big winners (400%+ in less than a year) and probably tank one. Overall, you'll outperform the market. That's why I fully recommend FAS.

Hope this helps.


On Apr 14 07:42 PM suttoda wrote:

> very nice

Apr 15 04:11 PM

[Nathaniel C:]

Just wait until commerical real estate collapses (GGP filed bankruptcy). The majority of banks carry their commerial real estate at 95 cents on the dollar. The only one that has taken appropriate marks is Goldman Sachs who has written down the value of their CRE to 60 cents.

Apr 21 11:48 PM

[Glen Bradford:]

Notice how I didn't recommend buying GGP. I actually believed that one was going under.

I'm still iffy on Citi. It's not one of my brightest ideas. My list of ideas: Note that the ones near the bottom might not be on my buy list, but could be on my watch list as potential turn-around plays. The closer you are to the top --- the safer you are.

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On Apr 21 11:48 PM Nathaniel C wrote:

> Just wait until commerical real estate collapses (GGP filed bankruptcy).
> The majority of banks carry their commerial real estate at 95 cents
> on the dollar. The only one that has taken appropriate marks is Goldman
> Sachs who has written down the value of their CRE to 60 cents.

May 02 06:54 PM