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3 Reasons To Avoid Bank Stocks

|Includes: AMBC, BAC, Citigroup Inc. (C), FAS, FAZ, JPM, USB, UYG, XLF

It isn’t hard to find. No seriously, not one bit. What am I talking about? It’s simple and easy to find numerous reasons to not touch bank stocks. First and foremost I would like to indicate to the reader that yes, there could be a lot of potential in a lot of bank stocks in general. However, if you look at it from a logicians point of view and assess not only potential reward, but the potential risks, there truly is no reason to touch bank stocks until these uncertainties fade away.

I. Mortgage Fraud Allegations Against Banks By Mortgage Insurers

Let is be known, I am net long on shares of Ambac (ABK) as my Twitter followers found out on October 11th when Ambac (ABK) was only trading in the low $0.70′s. The shares of Ambac have skyrocket to over $1.00 per share and this price action has also been prevalent in shares of similar insurance companies like MBIA (NYSE:MBI) and PMI Group (PMI). So now this is out of the way, I am extremely skeptical of any and all banks that hold mortgages and received insurance payments on defaulted mortgages over the past three to five years.

These banks have allegedly had these loans insured based upon certain characteristics that they claim the mortgages met. These standards are allegedly not found in their entirety on the vast majority of these pools of loans. Ambac (ABK) has filed a lawsuit against Bank of America (NYSE:BAC) indicating in the lawsuit that they claim the Countrywide Bonds Ambac insured, which were $16.7 billion in total value we fraudulent. According to Bloomberg Businessweek, “Ambac found that 97 percent of 6,533 loans it reviewed across 12 securitizations sponsored by Countrywide didn’t conform to the lender’s underwriting guidelines.”  It is going to be extremely hard to quantify how much money this could amount to across the whole industry of banks, but if you look at the losses by the insurers of these mortgages, we may be able to start to indicate how much money we are talking about.

In essence, the banks are saying that they were told they were insuring mortgages of higher standards than what the standards really were. So as an extreme example, if you were to tell a bank you made $500,000 a year, even though you made $50,000 a year, and you took out a $500,000 5-Year ARM, and the bank did not verify your income, they would then have the mortgage insured based upon your credit and income. Even though you only made $50,000, this was never discovered and the bank asked companies like Ambac (ABK) and PMI Group (PMI) to insure the mortgage. They run these pools of mortgages through their credit risk models and then generate a premium amount to charge you. The companies have no chance of surviving if the banks are taking these actions of fraud. Although this is not being proven yet, some moves by banks are making us believe this is going to turn into something big.

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Disclosure: Net long ABK.