Financials Have Bottomed? Readers Say We're Nuts

Reader e-mail has come streaming after I posted a piece here yesterday that argues the financial stocks are at or near a bottom. Let’s just say a lot of people aren’t convinced. Here’s a sample, along with my reaction:

You must have a lot of bank stocks you need to sell to the general public and get out of your bad positions. Anyone that follows these companies’ balance sheets knows they are ticking time bombs. PUMPER.

TKB: “PUMPER” in all caps! He must really mean it. . . . Actually, I agree with part of what this reader has to say. Everyone does know many banks’ balance sheets are under very severe stress. That’s a given, even an article of faith, among investors. Which is why they have driven the stocks down by 80%, 90% or more over the past year, to the point that the typical large-cap regional bank traded at 70% of book value at the end of last week. By now the stocks are more or less discounting the collapse of the banking system. I say that won’t likely happen. (For one thing, the federal government will move heaven and earth to prevent it.) As I noted yesterday, based on the second-quarter earnings reports we’ve seen so far, the incremental news on credit appears, at the margin, to be encouraging. Is there more bad news in store for the banks? Of course there is. But it won’t be nearly as severe, in my view, as what investors seem to expect. As people slowly realize that, the stocks should continue to rise.

LOL that's a funny one.  The financial institutions of the world are completely riddled with toxic crap loans. We have a market that is full of the likes of Lehmanron, Merrillron, Morgan Stanleyron, Citiron, Bank of Americaron.  Institutions just full of level 3 crap that they refuse to mark to market. In a few months you will be able to look back on your article and you'll know that you were completely full of crap.  I already know!!

TKB: So many -rons! Do you think he smells a conspiracy? By now, I’d hope readers who write me that “the financial institutions of the world are completely riddled with toxic crap loans” don’t think they’re telling me something I don’t already know. But again, the stocks valuations don’t merely reflect the huge losses the banks have already taken on those bad loans, but huge future losses, as well. And, indeed, incremental losses are presumably on the way. All that has to happen, in my view, is that those losses are less bad than are generally expected. That doesn’t mean that the assets aren’t severely impaired. They are. So what? As for the certainty that “level 3 crap” has been systematically mis-marked throughout the industry, I don’t see how he can know that. If anything, pressure from auditors and regulators must be enormous to mark those assets extremely conservatively. For that matter, newly installed CEOs (of which there are more than a few in the industry lately) have zero incentive to do anything but put their Level 3 risk behind them.

A year from now I going to send you an email that says "I TOLD YA SO"

We're just now entering the second inning of this Bear Market ball game....and you "market pumper pig men" haven't a clue as to what is coming. In the mean time those that actually listen to you and make decisions based on your "propaganda" are going to rue the day they were sucked in.

I pray to God that you see many sleepless nights in the year ahead.

TKB: Merry Christmas to you, too! So now I’m a “market pumper pig man”? Sounds like something out of a Bud Light ad. Anyway, I’d respond to this guy’s arguments, except that . . .  he doesn’t really offer any. But his note offers a good indication of the level of hysteria that’s become common in certain bearish precincts. There, it’s not about money anymore, and has more to do with a weird religious, end-is-nigh fervor. If these people really do expect to happen what they say they expect, I don’t understand why they haven’t sold everything they own and barricaded themselves in their houses with year’s supply of bullets, bottled water, and beef jerky.

I have extensive background in financials (particularly P&C insurance stocks) and I think we still have a way to go down before they go up.  Here is why:

1. Soft market continues and pricing levels have not rebounded yet.
2. Investment return is poor.  Particularly those with CDO exposures.
3. Poor first and second quarter catastrophic loss results.
4. Mismanagement of loss reserves (i.e. loss reserve deficiencies) which will result in adverse loss reserve development.

Many companies have been bleeding out their investment losses and offsetting them with prior accident year loss reserve redundancy take downs (which are running out).  They don't want to have what happened to AIG...happen to them. Therefore the write downs will continue and more blood will be spilled.  The PC market will firm (even harden by late 2009 or early 2010), but they are still going down.

TKB: This fellow is talking about insurance. I’m mainly talking about lending. The P&C industry hasn’t gotten clobbered nearly as badly as the banks and non-bank lenders have. And for good reason: the issues facing the two sectors are pretty different.

Reader reaction is still coming in. If you want to add your views, by all means pop me an e-mail.

Tom Brown is head of BankStocks.com.

Comments

[fxtrader07]

Hi Tom, appreciate your follow-up on the surely controversial piece. However, if JPM's Dimmon said that pain froma recession will be far worse than the pain suffered so far from subprime and CDOs, SIVs etc- i wonder how the market could have really figured this coming pain out? And how can you be so certain? 70 percent book may sound like a decent margin of safety. but given the high leverage and the L3-assets and lots of loans that have not been written down but may well start to default i wonder whether books will not be further impaired soon. and that current 70% may soon turn into 150%?
I also disagree on your L3-notion and accountants , regulators and (new) CEOs. I think regulators and ceos have every incentiv NOT to tell the truth if it is too devastating. rather hide it as long as possible, adjust those valuations step by step over many years. if they did otherwise, they might well be required to raise billions of fresh capital instantly - which may be next to impossible or extremely dilutive right now.
for me, these banks are way too high risk because i have no way to find out if they tell or told me the truth until after the bomb exploded. i will gladly skip a reward of 300% or 400% if the downside is that i could easily lose 80-100% pretty much overnight (remember bear stearns? it sure was a high reward-high risk play at $30-$40 - only to get killed over a weekend)

[bbzz24]

To me the biggest problem seems to be that those entities are leveraged to the eyeballs just as the 'consumer' who either way is pumping their profits. Do you expect that to be remedied soon since the 'consumer' is suffering real wage declines and further sinks into debt? Add to this that helicopter Ben prints money like a loose maniac. It will 'support' the prices of troubled assets but everyone will be much poorer to get the wheel spinning in the same old way. Oh, don't you read that BofA, Wachovia are out of the wholesale mortgage business? And there are many other banks that simply can't lend due to the lack of funds. And who is going to buy the MBSs that will be coming forward in the markets knowing that the currency will be debased once 20% haircut is taken. Doesn't this make all foreign buyers (30%) of U.S. mortgages just scared of this crap? It's sounds like bankruptcy for the government is the quicker way out of this mess.

[CLH]

I dont know if this is the bottom and it isnt important. Im up 54% in six days with UYG. Are we here to make money or or argue about things that no one can know?

[buyitcheap]

I'm with CLH on this one - I'm long UYG too. Keep the stops tight.

[apppro]

I think what one of your bloggers said is an excellent representation of what is wrong with this market and our society in a more macro view: “Are we here to make money or argue about things that no one can know?”
This trader mentality and the need to show a short-term profit, both on the personal and corporate levels will be the death of us all. It promotes the short-seller and short-term gain’s scenarios that cause the volatility and do NOT add to societies greater good.
What is it building? What product is it making?
We all need to step back and see what we are trying to create here, or in the current case, what we are trying to destroy. The stock market was meant for building a business and therefore the American economy. It was become an extension of Vegas and needs to get back to its roots. I have a fix posted on my site under the 3/22 blog that most everyone will hate. You should check it out. In the meantime just think of the TV show ‘FastMoney’ as the poster child for poor trading behavior and just an example of the real reasons behind the current ills.

[Dusty]

Credit Suisse published a chart last winter that says it all. "Subprime" mortgage resets all Spring "08. High (compared to 'normal') rough intermission this Summer. Fall '08 (Sept 01 through Dec) mortgage resets go back up to the levels of the Spring; the name changes to "Alt-A" added to "Agency Resets." The Fall drop will be as much as the Spring drop. How about chuck holes in Aug and Oct similar to the ones back in Jan and March?

Market bottom best guess as a Chinese New Year gift but there will not be any real Bull Recovery for two or three years. Target Summer of 2012 for the beginning of really better times.

Game plan is to do what presents itself in short time frames and also look at dividend accumulation.

[JimmyLathrop]

The main problem with your argument is that is does not address how financial institutions will continue to make profit moving forward. No one has suggested what will substitute the triple crown of easy money supply, rising home prices and lower lending standards. Mortgage rates are increasing which means even with a low Fed rate there is still a lot of unrest in the market. Your main thesis states that the market has priced in the downside of up to 30 years in rotten mortgages and illiquid investments.

The banks have an extremely limited window to attempt to catch a breath before the other Governors on the Fed Board pitch a fit and force rates higher to fight inflation. At that point, the water wings are going to be taken off the banks and there is going to be some sinking.

If investors don't trust CBOs,CMOs and other securitized instruments, and banks need to return to a portfolio based model of lending, the profit margin is going to be low. Speculative trades in the market using the Fed's money isn't going to win the beauty contest. It's when they strip down to the swimsuit that they lose. What business model is going to replace the 2002-2006 model?

[CharlieStromeyer Jr]

Tom, I appreciate that you are willing to defend your case, but could you or someone else please help me to understand this question:

Many CDOs and other crap are still tied to home prices, so how can the financials make a long term bottom before there is some more compelling evidence that home prices have started to bottom? Thanks.

[satelliteradio isdead]

We are here to talk money. And you guys who've made 50% in UYG over the course of a week had best sell quickly.

[Tom Brown'sIntern]

Tom, why don't you respond to some of the comments made under your Seeking Alpha article? You seem to like playing softball.

[Tom Brown'sIntern]

Nevermind Tom, I didn't see your new article. Processing...

[oldtrdr]

I've got to agree with Dusty and Jimmy on this one....btw, I'm overweight financials, too, but BDCs, not banks, either commercial, or I-Banks, and am even MORE overweight energy, with a position in SDS as a hedge, to boot.

old trader

[E Nuff Sed]

I am with Tom here, the gloom and doom is way over-done. Look at this forum - the bears out number the bull 5 to 1.

Not every financial is toxic. Even the big offenders like C, UCB, AIG, WB, etc. have taken the kitchen sink write-offs. (If I remember correctly, AIG write down was forced by the auditors) and raised capital.

People and companies are still going to take out loans and want financial services and insurance. Also most of the CDO's are still producing virtually the same income as before even though their value has been written down 50%+ because of an illiquid market.

The private equity boys will be making a killing buying them at 25cents on the dollar. This is the time to go long on LUK, BX, KFN & FIG.

[AmesTiedeman]

I say anyone claiming this should be institutionalized for no less than 6 months.

[bonanza60]

Wake me up when the banks have written off CDO's and off balance sheet SIV's to 10-20 cents on the dollar. Right now all they are doing is playing "hide the sausage" with this crap and not very well.

Until, I trade what I see, not what I hope.

I am in the mtg cap mkts and regardless of what Brown says, this is definatley not over.

This is confirmed by a memo today from Chase to its mortgage brokers telling them they are exiting the jumbo business because it does not come with govt backing:

CHASE JUMBOS ARE A GONER .


Friday, August 1, 2008

Today we are announcing the elimination of all Non-Agency/Jumbo Fixed and ARM (Amortizing and Interest Only) product offerings within our Wholesale Lending Business. We have made this decision based on a variety of reasons.

First, we have seen a dramatic reduction in Jumbo volume levels over the past six months. To a point, it has become a very small percentage of our overall business. Secondly, Capital Markets continue to exhibit no interest in this product, as it sees safer and more liquid products such as Fannie Mae, Freddie Mac and Ginnie Mae Mortgage-Backed Securities as better investments. Thirdly, our delinquency performance on these loans has been substantially worse than both our expectations and standards allow. Due to all of these factors, we feel it is in our best interest to suspend these products at this time.

It has been quite a tumultuous time in mortgage banking for the past 12 months. In fact, we are in the midst of the worst mortgage and real estate crisis in American history. Despite this, Chase continues to remain unwavering in its commitment to both mortgage lending, and specifically the Wholesale business.

We will closely monitor changes in this offering, including performance and salability in Capital Markets, calibrate the product set as appropriate and possibly re-introduce it in the future.

Thank you for your business and your continued loyalty to Chase.

Sincerely,

Rod Brace - Full Sig