Have the Banks Really Bottomed?

Includes: C, FMCC, FNMA, XLF
by: Barry Ritholtz

Barrons_bank_covr Very strange confluence of media coverage this morning on the banking sector. All three major financial papers (WSJ, NYT, Barron's) have stories on the bottom of the banking sector: 

WSJ: Jitters Ease as Citi, Rivals Show Signs of Bottoming Out

NYT: Hope, and Hints, That Financial Stocks Have Finally Touched Bottom   

Barron's: Buy Banks -Selectively  (cover story)

Can you recall the last time 3 major media players all picked the bottom in a market or sector on the exact same day -- and were all proven correct?

Perhaps the caveats are worth noting -- I found it interesting that all publications had some moderating hedges in place (as opposed to some recent embarrassing cover articles).

Bounce As we noted early this week, we covered most of our shorts in the financials, and are now looking for a bounce play in these names. However I remain unconvinced that Banks are now a good long term investment.

Why? The business model of Leverage and Capitalization is now kaput. It's a new era of De-leveraging, and Re-capitalizing.

A long time ago, Banks were 3-6-3 spread players. Pay your depositors 3%, make loans at 6%, be on the golf course at 3pm. But the end of Glass Steagell, and the mergers with investment banks, have put an end to that simple but profitible business. For the past 10 years or so, we seen a model that involved taking on a lot of risk, then leveraging it up 25X, 35X, even 65X (for Fannie).

Now that model has come unglued. Banks of all types are unwinding risk, de-leveraging (selling off assets held on borrowed money) and raising capital. This means that until a new model is developed, profits will be anemic and the shareholder capital structure is about to get wildly diluted.

Bad_but_better Freddie Mac (FRE), with its $6B cap, is seeking to raise $10B. That will be enormously dilutive to both future earnings, and shareholder equity.  Remember that Lehman Brothers (LEH) capital raise? $6 Billion secondary priced at $28 with 8.75% coupon and an %18 conversion premium? The stock is now $19m, the cap is $13.3B. After the last debacle, good luck with future capital raises -- they are likely to be treated much more skeptically.

Is "the" bottom in?

Well, it certainly looks like "a" bottom is in.

But longer term, this is a sector that is likely to have continued write downs, weak earnings prospects, and a whole lot more regulation and government supervision than it got away with in the past. P/E compression may also be in the cards -- especially if we see some dividend cuts from some of the bigger houses. 

Unless you have a decade long time horizon, does that make you want to rush out and own these things anytime soon?  Me neither . . .


Charts & Tables:
Bank_table_2 click for larger graphic




Forbes Video: More bank write-downs, U.S. recession, Avoid Home Builders (3/28/08)

Quote of the Day: Citibank on Glass Steagall (July 08, 2008)   

Video: Still Too Bullish (Apr. 1 2008)

What to Bank On
Barron's JULY 21, 2008

Jitters Ease as Citi, Rivals Show Signs of Bottoming Out
WSJ, July 19, 2008; Page A1

Hope, and Hints, That Financial Stocks Have Finally Touched Bottom
NYT, July 19, 2008