Well-Capitalized Regional Banks: The Bottom Is In 27 comments
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I am calling a bottom in well-capitalized regional bank stocks. When the New York Times publishes an article titled, "Analysts Say More Banks Will Fail" (by Louise Story) we have a good contrarian indicator. But here's what makes me angry: the reporter cites Richard Bove in her article as support for her thesis that despite being better capitalized in general, more banks will collapse. Take a look at this Nightly Business Report link to an interview with Mr. Bove:
http://www.pbs.org/nbr/site/onair/transcripts/080714c/
He expressly says he believes regional banks are in good condition:
"I think that the regional banks are actually in relatively good condition...I think if you look a year from now, the prices of bank stocks will be considerably higher than they are today."
Of course, he also says it is risky to bet on bank stocks now, in a time of panic, but overall, the clear sentiment is that the overwhelming majority of banks are healthy. The article itself states that 150 out of 7,500 banks might fail--or just 2%.
I have been very disappointed in my own stock picking ability because I bet on Colonial Bancgroup (CNB). While I bought almost all of my shares at under 5 dollars, the market has decided that CNB is worth only 3 dollars a share. I continue to believe I am correct, and the market is being irrational. The question is whether I can stay solvent until the market becomes rational again.
Bank stock balance sheets are abstruse because they defy normal value analysis. Usually, value investors like myself look at a company's total cash and total debt. My own personal yardstick is to deem a company undervalued if its net cash exceeds 10% of its market capitalization. For example, Intel has a market cap of 108 billion. Therefore, I want its net cash to be at least 10.8 billion before I view it as undervalued. Intel has about 11 billion in net cash, passing my test (I own shares in Intel).
Banks, on the other hand, cannot be analyzed in this way, because they make money through loans. As a result, Shakespeare's advice, "Neither a borrower nor a lender be," doesn't apply. In addition, more debt on a bank's balance sheet does not necessarily denote irresponsible spending. Indeed, as an investor, you want your bank to have more debt on its balance sheet, because banks make money by loaning to others, not by keeping their cash.
The problem lies in evaluating whether a bank's debt as shown on its balance sheet is likely to be repaid by its debtors. As debtors default on loans, they cause an immediate downward spiral: the bank that loaned them money has to stop lending others as much money; perhaps raise the rate on its CDs to attract more money; and take other steps that decrease its ability to take advantage of normal business conditions. What we forget is in a non-panicked world, banks have the easiest job: they get money from the Fed Reserve or their depositors at 2.25%, and then loan out the money at 5.5% or more. They make an automatic 3.25% just for being a middleman. (You can see why online banks are even better--they eliminate the fixed costs of a bank, like its numerous tellers/employees, ATM machines, and physical structures, and just get paid for being a middleman, minus the normal overhead. That's why an online bank like ING can offer higher CD rates.)
Having established that a bank's balance sheet cannot be analyzed in the same way as a non-bank's, how do we ascertain whether a bank might go under? One informal measure might be to measure the amount of total cash vs. total debt. It's a similar analysis as above, except that in these precarious times, if a bank has too much debt relative to its cash deposits, it is more likely to collapse. All figures are from Yahoo Finance's "Key Statistics" pages as of July 14, 2008:
IndyMac, which has collapsed, had about 2 billion in total cash and 11 billion in debt. That's a 9 billion dollar difference.
Washington Mutual (WM0 has 15 billion in total cash and 97 billion dollars in total debt. That's an 82 billion dollar difference.
Regions Financial (RF) has 5.5 billion in total cash and 29.5 billion in total debt, a 24 billion dollar difference.
M&T Bank (MTB), considered to be a healthy, well-capitalized bank, has 2 billion in total cash, and 16.8 billion in total debt, a difference of almost 15 billion.
US Bancorp (USB) has 7.3 billion in total cash and 72.6 billion in total debt, a 65.3 billion dollar difference.
Wells Fargo (WFC), considered to be a conservative lender, has 25 billion dollars in total cash, and 157 dollars in total debt, or a difference of 132 billion. This high level of debt is very surprising. Warren Buffett extolled the virtues of Wells Fargo in a recent annual shareholder letter, and Mr. Buffett is the classic value investor. Wells Fargo might have a high debt load because it didn't sell off its loans to Wall Street and held them on its own books instead, but I am just speculating. As a direct holder of the debt, Wells Fargo can hold it till kingdom come, and would have no external pressure to dump loans at a discount. In some ways, its refusal to spread its risk creates an advantage. (I own some shares in Wells Fargo.)
Now we come to Colonial Bancgroup (CNB). CNB has 2.5 billion in total cash and 5.3 billion in total debt, a 2.8 billion dollar difference. It has the lowest total debt of any other bank above, and plenty of cash relative to its debt.
Whatever you may think of banks collapsing, CNB probably won't be among them--its debt load just isn't high enough to make a collapse imminent. At 3.36 dollars a share, if you have an iron will, you may want to consider buying 1000 shares and leaving it alone for a while. A prudent investor would probably wait until after July 21, 2008 to buy, because CNB reports earnings on July 21, 2008. I will hold onto my 1100 shares of CNB and be patient--like Wells Fargo, I can wait a long time, but I hope next week brings good tidings and immediate vindication.
Disclosure: Long CNB
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This article has 27 comments:
Maybe, just maybe, 50% of these may just survive... But I doubt it.
Sorry...
I noticed there was a lot of insider buying in CNB, at higher prices. And I did not think that had any signaling power either, b/c if the management is dumb enough to go overboard on real estate lending w/out proper credit standards, they are sure not smart enough to figure out when to buy the stock.
All that said, we are in fact getting close to or at some compelling valuation levels in banks, based on tangible book values. The key is where are we in the credit loss cycle. I believe we are in the 3rd or 4th inning, but by the end of this year could be nearing the 7th inning "stretch". So it is a good time to be doing lots of homework.
I also want to point out I published the article yesterday, and today, FHN and CNB are up around 20%. So I suppose I was correct in calling at least a short-term bottom.
I direct you all to a very cogent piece by Anatole Karetsky (Chief Economic Correspondent for the Times of London) from July 14th, in which he states, "if this test [the slavish application of mark-to-market accounting rules] were applied with full rigor, every bank that has ever existed since the Fuggers and Medicis would have been insolvent.
I own stocks in a few banks and while I am unhappy with the trend in their share prices, I cannot say that I believe the fundamental soundness of the institutions (at least the ones I own) is in jeopardy and do not see permanent loss of capital in any of my positions as a likely outcome.
The so called "conservative banks" are labeled conservative because they usually increase their loan loss reserves during bad times and often during good times (when they can afford to). The conservative banks will put more money aside than required by the regulators. This is not money that sits in the cash account.
You have to dig much deeper than yahoo's balance sheet numbers to figure out a banks loan loss reserves since it is usually a contra account against the loan asset base. So a bank showing say $1B in loans on their balance sheet could actually have $1.1B in outstanding loans because they have been netted out their loan portfolio by $.1B ($100Million) to account for loan loss reserves.
To determine how a bank's loan portfolio is performing charge offs as a % of loans is a good metric. charge off's for banks tend to be <1%, uptrends in charge offs could be a huge red flag.
Banks that are very profitable can afford to put more money aside for losses. Conservative banks that are very profitable are specially attractive that is why Warren Buffet is a big fan of WFC.
The big unknown in banks today is portfolio values. For banks that relied more heavily on securitization to continue growing, the well has dried up as we have already seen with mortgage companies. Banks that traditionally relied on deposits for funding and held on to their loans have had the infrastructure to service and work their loans will end up fairing much better.
Down the road (I mean, down the road), some banks may end up making a very strong come bank. Those that were too conservative in their loan loss reserves and in valuing their assets during this period of gloom and doom could potentially have write ups and release their excess loan reserves (a windfall to earnings).
Bottomline, banks with conservative loan loss reserve practices, lower charge offs as % of loans, and healthy profit margins stand better chances of surving this crisis -and it is a crisis, not just media hype.
> The so called "conservative banks" are labeled conservative because
> they usually increase their loan loss reserves during bad times and
> often during good times (when they can afford to). The conservative
> banks will put more money aside than required by the regulators.
> This is not money that sits in the cash account.
Wells Fargo didn't do this. They only got serious about reserves in Q407.
> You have to dig much deeper than yahoo's balance sheet numbers to
> figure out a banks loan loss reserves since it is usually a contra
> account against the loan asset base. So a bank showing say $1B in
> loans on their balance sheet could actually have $1.1B in outstanding
> loans because they have been netted out their loan portfolio by $.1B
> ($100Million) to account for loan loss reserves.
It's usually fairly prominent in quarterly and yearly reports - just go to the SEC site to make sure Yahoo isn't missing something.
> To determine how a bank's loan portfolio is performing charge offs
> as a % of loans is a good metric. charge off's for banks tend to
> be <1%, uptrends in charge offs could be a huge red flag.
WFC is well over 1%, mostly due to HELOCs.
> Banks that are very profitable can afford to put more money aside
> for losses. Conservative banks that are very profitable are specially
> attractive that is why Warren Buffet is a big fan of WFC.
They've got the history of profitability, but I don't know that reserves are going to be adequate. It depends on how well they did dumping HELOCs early in the quarter when people were thinking "maybe the sky isn't falling". We'll see tomorrow.
Want to save a bank tell all your friends to go to a professional loan modification company. Yes good honest companies exist. I just modified my loan for less then it cost me to get it in the first place.
A pay option arm in a neighborhood with matching forclosed homes
they lowered the loan amount, by 150,000 and matched the selling price in the neighborhood. gave me a 30 year fixed at 6%. a loan I can afford. With my reduced income.
They now have a performing loan on their books. WoW what a concept.. Tell your friends The state of California now has a law they have to try to modify the loan before going to Forclousure.
A non performing or suspect loans have to have an equal amount of cash on hand dollar for dollar. You don't get this from sensational yellow journelism that is the reason they are writing down assets that is the tekkie jargon. Oh by the way when the market does turn do you write up assetts. This is not the first rodeo for this. How about a pundent who is 50 something and can remember. Oh no lets all panic like huge cracks are appearing in the earth and large rocks are falling from the sky.
Good luck to you all
Having said that, the author is incorrect in assuming his stock should have gone higher, because there is too much uncertainty in the securities held by these companies. CNB might well be worth $20 a share, but then again it might be worthless. That's the real problem with Bank stocks. There's simply too much uncertainty and even with Wells Fargo's 'everything is great' earnings report, everything isn't great, because at the end of the day, there are still an awful lot of people holding on to houses they still can't afford.
Your belief gives good proof of irrational false belief.
The price of any stock can rise only when [1] number of buyers > number of sellers, share float constant [2] number of buyers = number of sellers, share float shrinking [3] growth rate of number of buyers to sellers faster than growth rate of change in share float
Most folks fail to see that they are gambling at Stock Exchange Casinos.
These folks fail to see that what they ought to be betting on is cash flow into the casino and net cash flow into the specific game (stock) they are playing.
What drives Stock Exchange Gambling is growth in Disposable Personal Income for 401k (Middle Class Lottery Ticket) holders, lack of favorable bets in other places (commodities, commerical paper, government debt).