Mexx

Well-Capitalized Regional Banks: The Bottom Is In

Mr. Market has spoken. Profitable banks with solid margins like WFC can afford losses and have money to spare to raise their dividend.

Well-Capitalized Regional Banks: The Bottom Is In

While it is easy to be a bear of banks stocks these days. we all know however that no matter how bad things get, we will still have banks in this country after this crisis passes. The % of survivors is anyone's guess. But a 2% failure rate may be conservative. To put this in context, during the S&L crisis, 50% of S&Ls failed. Banks are not S&Ls and the circumstances are completely different. But in the extreme case, it is completely conceivable that bank failure rates approach the double digits. What is more probable is that as a fewer but bigger will fail because of the consolidation in the industry in the last two decades.

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.