Why Would Anyone Want to Own a Bank Stock?

 |  Includes: KME, KRE
by: Tony Abbate, CFA
For banks, the worst is probably yet to come. This is illustrated by the fact that this past week the FDIC announced the most number of bank failures, eight, since the week ending October 30, 2009 when nine banks failed. This is the second highest weekly total in the past decade. The year-to-date total of failed banks is now up to 118. I think we are certain to pass last year’s total. If we continue at the same pace as the first seven and one-half months this year, we will have 175 to 185 bank failures by the end of the year. This will easily exceed the 140 bank failures last year.
Below is the number of bank failures by year for the past decade:
Bank Failures by Year
Year Failures
2000 2
2001 4
2002 11
2003 3
2004 4
2005 0
2006 0
2007 3
2008 25
2009 140
2010 118 and counting
Source: fdic.gov
Click to enlarge
You will notice that in 2005 and 2006 there were no bank failures. This was when the housing bubble was at its peak as home prices peaked in mid-2006. There is no need for a bank to fail if the underlying collateral on its loans is appreciating at 10 percent per year. Now banks are beginning to experience the opposite effect of what happened in 2005 and 2006 – falling real estate prices and loans that are valued higher than the underlying collateral.
Below is a chart (click to enlarge) of trailing 12 month bank failures compared to the KBW Regional Bank ETF:
Click to enlarge
Outside of government intervention, I think we are about to see Act II of the “Great Banking Debacle”. I cite two reasons. First, with the expiration of the tax credit for home buyers on June 30, we should start to see resumption in the decline of real estate prices. This will create more problems for banks and their loan portfolios. Second, as the chart below illustrates, in the next year we are going to see a large amount of adjustable rate mortgages reset.

Unfortunately, these folks will not be able to refinance into the lowest fixed rates we have seen in a generation. The only possible saving grace for these homeowners and banks is if the government was to step in and refinance the loans at a fixed sub-five percent rate for 30 years. (As an editorial comment, I would not put it past the government to do this. Over the past two years I have seen government intervention far above what I could have imagined.)
Outside of government intervention, the most likely scenario is increased foreclose, more inventory of houses and increased downward pressure on real estate prices. At some point, like all things, the problem with real estate prices will pass. However, at that point, banks will have loaned out money at the lowest levels in a generation and their interest rate margins will be at risk if we see higher interest rates. The valuation on regional banks are still not that attractive since they trade above tangible book value.

Hence, why would anyone want own a bank? I do not. Neither do my clients.

Disclosure: The author and his clients have no long or short positions in bank stocks.