Joined Jan 1, 1970
509 Blog Posts

Buy the Banks! (Part II)

Look, I realize that some of you out there are praying and hoping for the banks to fail, just so you can bank coin on your short positions, including FAZ and SKF. All I can say is that men with straight-jackets will be showing up at your door shortly. Anyone wanting our financial system to fail, and bank stocks to get pummeled, needs to have their head examined, and their Taliban-laden camel parade cancelled.

I think people can start to look at buying banks (selectively) here. Just be aware that there is always a possibility of a correction and that things may move lower, but we can view that as a buying opportunity. The main thing is to begin to establish a position now with some of your money. You will not be sorry in the end.

I say that because it’s highly probable that the worst of the global financial crisis has passed. I say the worst, because there is probably still more to come, most likely in the form of CRE and corporate defaults. But since the fall of 2008, central banks around the globe have stepped in to stabilize markets. Yeah, I know there’s a cost, but we’ll deal with that later. In the meantime, it’s about the survival of the system, and I think we can start to see that it will survive, in some form or fashion.

And yes, I know that the banks, as a group, have rallied over 100% from the March lows, but they are still down over 70% from their peak in 2006. There is still room for upside, and it could be quite enormous.

The “Ring of Fire” that the government and the Fed have created around the 19 largest banks tells me that the question of bank insolvency has already been answered. Those 19 represent over 70% of U.S. bank assets, and are the primary elements for systemic risk. They will not be allowed to fail, politically, or economically.

Having been stress tested, these banks have been able to successfully raise the capital required and will most likely trade much differently from the rest of the banking industry. Barring a complete global meltdown, due to Comet 2012, these banks will survive and thrive, having already raised the mandatory capital required by Geithner and Bernanke.

As a result, I believe that many of the credit issues raised 6 months ago will NOT be a big determining factor when analysts look at valuations on these banks.

It’s simple. You take the estimated pool of credit losses generated from the “stress tests”, and use that estimated pool as the starting point. After each quarter’s reported credit losses, you deduct the actual losses from the pool going forward the next 8 quarters. If the bank stays in-line, or exceeds expectations, their stock will not only hold steady, but most likely increase in value. Also, as long as a banks pretax/pre-provision revenue stays in line with expected losses, those banks should trade better than the non-19 who were not stress tested, no?

In summary, the 19 banks should trade at higher valuations than the rest of the banks, unless those other banks volunteer and submit to stress tests as well.

Having raised sufficient capital to meet the stress tests, those banks will trade at normalized earnings out one to two years, versus the non-stress tested banks which will trade based on capital concerns and credit quality issues.

That said, expect more bad news and more bank failures, but realize that banking, like blogging, is a multi-tiered system now.

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