Bank Stock Profits

Why?

Mon, 21 Jul 2008 12:42:45 -0500

Shares of Citigroup are up another 3% on Monday, flowing Friday's better than 8% rise. My overriding question is why? Investors seem pleased that the banking and financial services giant lost less than Wll Street expected. The Street has not gotten anything right on the bank stocks all year so why being wrong about Citigroup is a cause for optimism escapes me. The fact of the matter is that the report was simply awful. Is the fact that a company that has lost over $40 billion in the last year ONLY lost an additional $2.5 billion really a bullish case for its stocks? Look at some of the "highlights" of Friday's earnings report:
Revenues, down 29%
Expenses up 9% year over year
$4.4 billion in Credit losses
Loan Loss provision increased $2.5 billion
Third straight losing quarter
Increased credit card losses
Increased auto loan losses
Total assets down $99 billion

At least one large shareholder was skeptical of the results. One of the largest unions in the united sates, the American federation of State, County and Municipal Employees urged the bank to just give up and break the company up into separate division. The union sent charman Win Bischoff a letter stating that the bank was too large and unwieldy to over see and should be split up.
Speaking of Bischoff, he told investors over the weekend that he thought housing prices in the US and Britain could continue to fall for the next two years. This is unfortunate as a continued housing decline is going to continue to wreak havoc on his bank's balance sheet until they stabilize. He also told the BBC in the interview that he thought the credit crunch would last 2009.

If Citigroup's chairman does not think it is going to get better, why does Wall Street?

Bot bad wells, not bad at all

Wed, 16 Jul 2008 11:07:55 -0500

That wasn't so bad at all. Wells Fargo reported earnings today and, unlike many other banks of late, it wasn't that bad. The bank reported total earnings of $1.8 billion ($.53 a share) down from $2.3 billion ($.67) a year ago. Revenues were up 16% year over year reaching a record $11.46 billion. They did take a #3 billion dollar credit provision in the quarter, with half of that provision being added to loan loss reserves. As anticipated most of the credit problems were in the home equity and retail loan portfolios. Given the backdrop of the economy, the Wells Fargo report was really strong across the board. Total loans were up 18% and earnings assets rose 205 in the quarter. Core deposits grew in the quarter rose 65 and the bank increased its capital ratio during the three months. Most surprisingly in light of all the dividend cuts in the banking industry, Wells Fargo announced that it would be increasing its dividend for the 21st straight year.

Wells Fargo is not exempt from the credit and real estate problems. They will have write offs and credit losses in their mortgage and home equity portfolio. There will be some problems with credit cards, auto loans and other personal loans as consumer struggle with a weak economy and inflationary pressures. However, Wells was much better prepared than it s competitors. They avoided the alphabet soup of toxic derivative products and applied reasonable lending standards. CEO John Stumpf remarked on this in the press release when he said "We're still affected by the weak economy, but we believe we're one of the best positioned in financial services to grow through this adversity and to build an even stronger company for our team members, customers, communities and shareholders." CFO Howard Atkins expressed it even better in my opinion when he said Wells Fargo continued to profitably build its franchise this quarter, at a time when many in our industry are primarily focused on fixing rather than growing their companies,"

The company is in the catbird seat. They will be able to cherry pick opportunities to expand all of its financial services businesses. Although it has been speculated they might be interested in acquiring troubled rival Wachovia, Management suggested that they were focused on their core markets in the Western United Sates. Indeed, it would seem to me to make little sense for Wells to buy all the problems at Wachovia when they avoided the same mistakes themselves. Even with tightened lending standards and tougher credit underwriting standards, Wells Fargo is going to be able to fill a credit vacuum as other lenders withdraw form the marketplace.

The stock is ahead of itself this morning and I would wait for a pullback but if you have to own a large cap bank stock, Wells Fargo is clearly the one to own. Once again, when buying bank stocks it is best to date the good looking smart sister instead of the super sexy vixen with the sassy convertible.

An end in sight?

Tue, 15 Jul 2008 10:52:01 -0500

It seems like it will never end. The situation in the banking industry just keeps getting worse. No matter how often pundits and prognosticators declare the bottom, the news keeps getting worse and the stocks continue to decline. Bank Indexes fell as much as 10% on Monday amidst the troubles at Fannie and Freddie. We have even had the first run on the bank in the US in decades as depositors clamored to withdrawal their money from IndyMac bank. The FDIC seized Indymac this week, marking the largest bank failure since Continental Illinois in 1984.

This morning we have even more bad news. Citigroup CFO Gary Chittenden lay to rest any talk of a near term turnaround for Citi. He told investors today that it will be two to three years for the impact of asset sales to make a difference. It will be at least that long, he said, before earnings begin to improve in any significant manner. He added that the turnaround would be a marathon, not s sprint. Citigroup is expected to report a $3billion dollar loss for the second quarter adding to its impressive streak of losses in the last year. The bank has lost $46 billion since the crisis began last August and has raised a staggering $40 billion of new capital to keep the doors open. There are concerns about Citigroup's ability to continue raising the capital it needs since those who put money into the bank in the first go round have lost as much as 505 on their capital.

Wachovia is under fire as well. Meredith Whitney of Oppenheimer, the analyst who has been the most negative, and therefore the most correct, downgraded the shares again on Tuesday. She thinks the mortgage portfolio will continue to lose money and threaten Wachovia's ability to generate profits. She thinks that the scenario of declining assets and rising losses may threaten the banks ability to recover form the credit turmoil. Wachovia shares are down over 80% in the last 52 weeks and trade well below $10 after trading above $50 just last year.

Rating agency Standard and Poors got in the act as well. The agency lowered its outlook for regional banks on Monday. They believe that credit quality continues to decline and banks will have to increase loan loss provisions in 2009 and 2010 far more than originally believed. Loans to developers are one of the areas S&P highlighted as those loans are dependent on a real estate market recovery to remain performing. They fell many of the regional's will have to raise capital in the form of common and preferred stock offerings that will be dilutive to current shareholders. It is also highly likely that will be more dividend cuts amongst the group this year.

We are staring to see some signs of the baby going out with the bathwater right now. All bank stocks are falling. Many of the nation's banks are struggling on the current environment but will be just fine in the long run. I am now staring to see banks with healthy capital ratios that re profitable trade well below book value. My two local favorites Severn savings and Annapolis Bancorp have continued to decline and are cheap. I still think Sovereign bank is going to survive and the stock is finally below tangible book value. I am not quite ready to put on the puke trade (where you have to stop and vomit two or three times before just loading up on stocks) but it is getting closer. I would focus on the highest quality balance sheets with equity to asset ratios over 10 and capital ratios at least twice the minimum for being categorized as well capitalized. I also would not even consider paying over tangible book value. Check loan loss ratios carefully and avoid those with heavy exposure to development loans.

Earnings season is upon us and many banks, both large and regional are going to disappoint investors once again. The stock declines as a result of this continuing bad news may give long term investors a chance to buy quality small banks at a discount. I caution that this will take a while to yield profits and the stocks are probably going to go down before they go up. But five years from now, these prices may well seem to be the bargain and investment of a lifetime.

Wells fargo-Almost there

Mon, 07 Jul 2008 11:34:26 -0500

So far 2008 has not been a lot of fun for the management and shareholders of Wells Fargo (WFC).Shares in the bank trade at the lowest levels in 5 years and are less than a dollar off of 52 week lows. The bank has been hit by its large exposure to residential real estate, particularly the difficult California markets. Analysts have steadily downgraded the stock pointing out that continued consumer weakness is going to make it difficult for debts to be repaid until the economy picks up. Wells is seeing rising delinquencies across the board in its consumer lending portfolio. Although home equity delinquencies are the most troubling, consumers are increasingly late with their auto loan and credit card payments as well.

Even bank bull Richard Bove got into the act, kicking Wells while it is down. Bove cut both his earnings estimates and price targets for the bank. He also cited consumer weakness as the reason for the downgrade. Analysts at JP Morgan included the bank on its list of bank with loan loss ratios that were far too low and would have to be increased in the near future. Although this could cause reduced earnings for them, Wells Fargo is in the comfortable position of having total and risk based capital ratios far above the current industry averages.

It has been thought since the credit crisis began that Wells Fargo would an opportunistic buyer of other financial institutions. Its excess capital puts them in the comfortable position of being a buyer at fire sale prices. The bank has begun buying but is being extraordinarily careful, and in my opinion prudent in its purchases. So far they have announced just one bank purchase, FSB Bancorp of Fort Morgan Colorado. Wells Fargo is already the number one depository institution in Colorado and the move adds to their base of operations in the state. They also purchased Flatiron premium Finance company headquartered in Denver but active in several sates. Finally, they purchased Transcorp Associates, an inventory fianance and factoring firm. There will be a lot of smaller banks and finance companies available below asset value before the credit and real estate mess is over and Wells Fargo should be able to profitably expand as a result.

The stock is still not a screaming buy. The bank is expected to report more write downs and credit related problems in its second quarter earnings report. They are expected to announce earnings on July 16th and investors will be watching closely to see how management fared in the second reporting period of 2008. Should the stock continue to fall closer to or below $20 a share long term investors will almost have to buy the stock.

Insiders would seem to agree. CEO John Stumpf recently added to his position as did outgoing Chairmen Richard Kovacevich.

No Help from the Fed

Wed, 25 Jun 2008 15:02:35 -0500

The Fed has now lost all credibility. After the report cam out today announcing that they were leaving rates unchanged, the dollar fell strongly against the Euro, and Eurodollars rallied. Stocks might have risen but bonds fell. The rest of the world views the fed as a toothless creature . They cannot raise rates to halt inflation as the US economy remains very weak. Hey cannot lower rates because of very real and very strong inflationary pressures.

To make matter worse the report contains a sentence that says "Recent information indicates that overall economic activity continues to expand, partly reflecting some firming in household spending."Interesting. The previous report stated that economic conditions remained weak. When, exactly was this activity continuing to improve from? Not the last fed meeting. Today's headlines indicated that spending remains weak, and real estate was still falling in price. Warren Buffett indicated that consumer activity was getting worse in his opinion. Bill Gross of Pimco said the fed was jawboning and that there was more deleveraging and turmoil to come in the markets.

The report also expressed the feds belief that inflation pressure would abate later this year. Again, this is flies in the face of what is happening in the world. Wheat price rose on concerns of Midwest flooding. General Mills raised cereal prices as grain prices were hurting profit margins.

The fed is out of bullets. Hey lowered rates form over 5% to the current 2%. Nothing improved in the economy. Unemployment continues to rise and real estate continues to fall. None of this bodes well for banks for the next six months. There will continue to be an increase in credit card delinquencies and home equity loans. Charge offs and losses still lie ahead of us no matter what the fed does or does not do. The major banks are still much more of a sell than a buy.

Bad Week for Banks

Sun, 22 Jun 2008 13:31:44 -0500

Another week past, another bad week for bank stocks. Naturally, as always when it comes to bad news, the leader was Citigroup. The banking giant announced that they would have to take additional write downs in the next quarter. Although the losses will not be as large as the $10.5 billion last quarter, CFO Gary Crittenden did say they would be substantial. Continuing real estate and economic woes are having a negative impact on the banks real estate and credit card lending portfolios Mr Crittenden said that consumer credit remains challenging especially in the credit card portfolio where the losses are expected to be more than $5 billion. Results will also suffer form the inclusion of a $325 million loss on the sale of leasing company CitiCapital. This quarter Citi won't have a billion plus dollar gian form the sale of Visa shares to offset the losses either.

Ohio based Fifth Third bank announced last week that they would have to raise additional capital as a result of poor credit experience. In addition to cutting the dividend by better than 60%, Fifth Third announced that they were doing a billion dollar offering of preferred stock and hoped to raise another billion by years end with the sale on assets considered to be non core operations. Bank officials cited continued weakness in credit markets for the decisions. KeyCorp, another Ohio based bank cut its dividend by netter than 505 and said they would raise $1.65 billion to offset credit losses. In addition KeyCorp said that they would take a charge of over 41 billion as a result of an adverse tax ruling on a leveraged lease transaction.

Several research and investment firms noted that things are just not getting any better for the banks. Goldman Sachs released a report that said it was unlikely conditions improved in the sector until at least 2009. The Investment firm said that banks are going to have harder time raising money as the year goes on. So far this year, over $60 billion has been raised by banks via the sale of stock sand convertible securities. They also noted that as conditions worsened analysts will lower their estimates for banks earnings and this will push the price of banks stocks even lowered than they have already fallen. Merrill Lynch research analysts said that they did not expect the credit crisis to end until 2010 and that there will be more dividend cuts head for larger banks in the United Sates. Analyst Edward Najarian cut his estimates for banks earnings by an average of 22% he also expects loan charge offs and loan loss provisions to triple in 2008

It simply is not getting any better for the larger banks in the US. Calling a bottom in banks stocks is an exercise in futility. Several analysts and fund manager have done so in recent months only to see shares continue to fall. Faced with credit problems that now look to last at least a year longer than anticipated, dividend cuts, layoffs and falling earnings the industry is simply unlikely to offer attractive returns for awhile yet.

When the last bank stock bull throws in the towel and the shares trade 40% or more below where they are now, it might be time to buy the group. Until then, the risks far outweigh the rewards and I would avoid money center and regional banks for the foreseeable future.

Insiders Betting on a Brighter Future

Tue, 17 Jun 2008 14:08:48 -0500

Small bank stocks have continued to fall lately as pressure form difficult real estate markets continue to weigh heavily on their results. The index of community bank stocks, ABAQ, is once again flirting with new 52 week lows. Most of the banks have reported small earnings gains but have had to take large increases in loan loss provisions as well as rising net charge offs. Many of had to raise capital to protect their balance sheets and capital ratios.

As bad as business has been, it is starting to be reflected in the share price of many stocks. At least one group is starting to pay attention. Insiders at small banks are starting to buy stock at increasing levels as they bet on an eventual turnaround. In reviewing filings form just the last week I found more than 50 small to mid size banks where insiders have purchased stock in the open market place.

Sandy Spring Bancorp (SASR0 a bank based not far from me In Annapolis Maryland actually reported better profits for the quarter. In spite of loan loss provisions that almost tripled in the r Sandy Spring reported earnings of $.50 a share, a penny better than the year ago period. The stock is fairly cheap, trading at less than 1.5 times tangible book value. Sandy Springs is expected to earn over $2 a share, putting the stock at less than 10 times earnings. They also raised the dividend by a penny this quarter and the shares yield of almost 5%. Insiders have noticed with 4 different officers and directors buying stock in the open market in recent weeks.
Parke Bancorp (PKBK) is a small bank operating out of Sewell, New Jersey. The company announced earnings of $.31 a share, exactly the same as a year ago on a fully diluted basis. Deposits and assets both grew by double digits in the quarter, a period when many banks were struggling with decreasing asset values. Parke raised its cash and equivalents in the quarter to ensure that they had sufficient liquidity in the difficult operating environment. Although the company does not pay a cash dividend it recently distributed a 15% stock dividend to shareholders, the fifth time since 2002 they have done so. There have been 15 different insider purchases in the last six months, totaling over 21,000 shares. Currently insiders own almost 30% of the shares outstanding in the bank.

These are just two examples of small banks where insiders are confident enough of the future ot back their opinions with their checkbook. There are literally dozens of these small banks right now with equity to asset and tier one capital ratios that out them well into the well capitalized category. They are becoming extraordinarily cheap on the basis of price to book value and price to earnings. Although they are felling the effects of the weak real estate market, they do not have the complicated securities and leveraged loan problems of larger banks. As the economy recovers so will these banks. I except there to be substantial consolidation among small banks as well/larger banks will buy them to gain high quality assets and earning power going forward. At 1 times book value and 10 times earnings or less, the small banks are trading at about half the level where takeovers are usually priced in the small to mid size banking arena. Based on that, upside potential over a 3 to 5 year period would seem substantial.

Small Bank, Big Potential

Fri, 13 Jun 2008 17:04:08 -0500

I make no secret that I think the profits in bank stocks going forward will be in the smaller banks. The large banks seem to have all got caught up in the subprime and exotic securities business trying to squeeze out every possible dollar of profit. Those chickens have come to roost in he past nine months and large banks have had literally billions of dollars of asset write offs and credit losses. They have collectively had to raise about $100 billion to repair and support their balance sheets. Small banks may have some problems in the difficult real estate markets and weak economy but they are nowhere near those of their larger competitors.

A prime example of this is one of my favorite small banks, Severn Savings bank (SVBI) is a small federal savings bank located in Annapolis, Maryland. The company has three divisions, the bank itself, Hyatt real Estate which operates as commercial real estate broker and investor, and SBI Mortgage. In the first quarter the bank did reveal that they were facing difficult conditions due to a weak real estate market. For the quarter the company reported that earnings fell 38% compared to 2007 with earnings per share dropping to just $.21 compared to $.35 a year ago. Net interest income was down 12% as a result of declining interest rate spreads. Since smaller banks rely more on deposit based funding than on the interbank and fed funds markets that larger banks favor. As a result their cost of funds does not decline as rapidly and margins can get squeezed. Other income fell 69% as real estate gains at commissions at Hyatt Real Estate felt the impact of a soft real estate market. Non accrual loans almost doubled in the quarter to $15.3 million. The bank increased its loan loss provision to $7.9 million to protect against further declines.

The news was not all bad for Severn, however. Both total deposits and total asset rose slightly in the quarter. Net cash grew by 77%, primarily due to rises in cash due form other banks. The loan portfolio shrank slightly in spite of the asset increase as management has been slow to deploy cash in the current real estate market. Severn also recently declared its regular quarterly dividend.

The company continues to have a strong balance sheet. The equity to assets ratios is 11.45, double that of the level I consider adequate for smaller banks. Leverage and capital ratios are all well above the level to be consider well capitalized. Severn's efficiency ratio is 46% as the bank continues to control expenses even in difficult times. The return in equity in what is considered a bad quarter for the bank is 9.33, well above many of the larger banks in the United States. Because of its sound operating performance and financial condition Severn Savings was recently named one of the best saving institutions in the nation by SNL Financial, a financial research firm that ranks savings banks and thrifts. In fact, Severn was number overall of the top 100 savings banks in the United States.

Severn conducts the bulk of its operations in Anne Arundel County, Maryland. The county is one on of the wealthiest in the country with average income and net worth levels that place them comfortably in the top 100. Anne Arundel County benefits not only from not only being on the shores of the scenic Chesapeake Bay, but its proximity to Washington DC. The county counts a large number of government employees as residents and is somewhat insulated from a jobs recession. It also contains the state capital in Annapolis. Annapolis is a tourist destination, rich with history, scenery and of course, seafood. Alan Hyatt is the current Chairman and CEO of the ban and his father, Lou is still active in the real estate operations. The Hyatt family has been in the real estate business in Annapolis and Anne Arundel County for decades. They have an in depth knowledge of property and developers in the county which gives them an advantage over out of town lenders.

Severn is cheap as well. The stock trades at about 8 times trailing earnings. There are no forecasts fo earnings since the bank has no analyst coverage, but based on the latest t quarter it should be below 10 times 2008 earnings well. Currently the stock trades at less than 80% of book value, a level not seen since the very early 1990s. On an absolute basis the shares have not traded at this price since 2003. Severn shares are down almost 60% from the 52 week highs.

The road ahead for Severn Savings undoubtedly contains more bumps. The economy shows no signs of recovering as the real estate market can be generously described as difficult. However, to long term investors, the chance to buy a conservative savings bank that is well run and well capitalized should pay handsome dividends over a 5 year market cycle.

WITH A $75 MILLION DOLLAR MARKET CAPITALIZATION,SEVERN IS A MICROCAP STOCK. TAKE GREAT CARE IN PLACING ORDERS.

Fed is bearish on banks

Thu, 05 Jun 2008 11:20:44 -0500

Until today I thought Meredith Whitney of Oppenheimer was the most negative observer of banks. That was, until I read the transcript of federal reserve Vice Chairman Donald Kohn's report to the Senate committee on Banking , Housing and urban Affairs. Kohn was there to report on the health of the industry since it falls under the fed's responsibilities to oversee the United sates banking system They also have primary supervisory responsibility over any state banks that choose to join the Federal Reserve system, that is to say, most of them.
According to the Vice Chairman, conditions are not so good for the banking industry. Led by credit losses in residential real estate portfolios and sharp markdowns in securitized loan products, the banking industry suffered losses of $8 billion in the fourth quarter of 2007. Interestingly, the 50 largest banks lost a total of $9 billion. This would seem to underpin my theory that the smaller banks are not quite as bad as their more free wheeling cousins in the big cities. In the first quarter the industry was profitable earning a total of $10 billion. Although the largest 50 contributed slightly over half of the earnings, seven of them continued to struggle and reported large losses. Again, it would seem that the larger banks that ventured into sophisticated loan and investment products suffered far more than small town banks in the quarter. Indeed Kohn testified that the larger institutions continue to have problems with loan portfolios, especially real estate development loans and home equity lines of credit. As a result of this continued weakness, non performing assets for US banks better than doubled in the quarter to $81 billion. This is the highest level of troubled assets since 2002. Loan loss provisions jumped in the quarter as well to $32 billion while loan charges offs totaled $14 billion.

Kohn also stated that the industry will probably have to continue raising capital to bolster beleaguered balance sheets. So far in 2008 Bank holding companies have raised over $80 billion of new capital. Some of this, Kohn admitted, was at the urging of banking supervisors and regulators. He pointed out the the growth in nonperforming assets was far outpacing the growth of reserves to protect against those losses. Combined with what the Fed Vice Chairman expects to be a very weak earnings environment for banks, future dividend cuts and capital infusions will be needed. In his words, the Fed is urging bank holding companies to bolster their financial positions.

State banks were in much better shape than their larger brethren. The state banks reported net earrings of about $3.7 billion in the first quarter and had a return on assets of about 1%. 98% of all state banks had risk based capital ratios that met or exceeded the regulatory definition of well capitalized. However, they did escape the troubled real estate markets entirely. Non performing asset ratios for the group better than doubled in the quarter to reach the highest level since 1993/ Loan loss provisions climbed as well and are now at 1.14% of average loans at state banks. The losses are primarily the result of the weak real estate markets across the United States.

Vice Chairman Kohn's outlook was less than rosy for the banking industry going forward. He expects continued declines in the real estate markets to continue to cause growing loan losses. He further warns that if the economy continues to weaken the losses could spread to credit card and consumer lending. He warned Senators that if liquidity and capital market conditions do not improve the number of banks that do not meet satisfactory capital ratios will increase from the low levels of the past few years.

He also discussed what the fed was doing to improve supervisory procedures over the nations banking system. This is a lot like locking the door behind the burglar in my opinion. What he did do, however, was set the ground work for additional regulations for the banking system. The impact of new regulations on the industry will be interesting to observe ion the months ahead. If we had enforced the regulations on the books and the fed had done its job, I doubt we would have gotten this deep into a financial crisis. I have yet to see an instance where increased regulation increased profits for any industry.

Where does this leave us? It is simple really. For right now avoid bank stocks. They have too many issues still in front of them. There will be further losses and their balance sheets are still weak. Many of them will have to raise capital, diluting the equity of existing shareholders. The bargains that do emerge in the banking industry will far away from Wall Street and outside the beltway. The smaller banks will have problems with real estate loans but it is much easier to recover loan losses form real property than an alphabet soup of securitized paper. Small banks with high capital ratios, high equity to asset ratios and adequate loan loss provisions can be profit machines. We are starting to get an opportunity to buy these at less than tangible book value. For patient investors, this will be better than the internet boom with a fraction of the risk!

State of the banking Industry

Sat, 31 May 2008 16:25:06 -0500

Bad does not even begin to describe it. The Federal Deposit Insurance Corporation (FDIC) issued its quarterly report for the banking industry late last week and it was not a pretty picture. Bank earnings were off a whopping 46% as banks continued to be hit by losses from real estate related problems and worsening credit conditions.. The industry as a whole took over $37 billion in loan loss reserve increases in the quarter. This was over 24% of the industry's operating earnings, compared to just 6% in the same quarter last year. Slightly over half of all FDIC insured financial institutions reported lower earnings for the quarter. For larger banks, those with assets over $10 billion, the percentages were even worse with about 66% of all major banks reporting lower earnings. Four of the largest institutions accounted for over half of the industry earnings decline. They were not named but it is not to hard to figure this includes such stalwarts as Citigroup, Bank of America and Wachovia. The poor operating performance of the industry led to the lowest average return on assets since the fourth quarter of 1991.

Net interest margins at banks fell in the barter as well. 70% of banks had net interest margins lower than the fourth quarter of 2007 and 61% were lower than a year ago. Larger institutions had a slightly better time of it as their funding costs shifted much faster in response to moves by the Fed. Net margins at community banks, which is defined as those with les than $1 billion in assets, reported the lowest net interest margin since 1988! Smaller banks tend to use retail deposits as their core funding source and they reprice much slower than the fed funds borrowings of larger financial intuitions.

Loan quality was simply awful for the banking industry in the first quarter. Total loan charge offs totaled $19.6 billion, an increase of 139%. Charge offs increased in every single loan category. It comes as no surprise that it was real estate and construction lending the showed the highest growth in loan charge offs. The rate that these loans turned bad was surprising however. Home equity lines of credit charge offs increased 614%. Second mortgage charge offs were up over 1000%. First mortgage loans being written off were up 542%. The real winner (loser),however, was construction loans where charge offs rose 1508%. It does not look to get better in the near future as loans over 90 days past due but not yet charged off surged as well. Overall noncurrent loans rose by $26 billion with over 90% of the rise attributed to real estate related loans. 1.75% of all loans were not current the highest level for the industry since 1994.

In spite of the increase in loan loss reserves, the coverage ratio at US banks fell in the quarter. Bad loans increased quicker than banks could reserve against them causing coverage ratios to fall to just $.89 on the dollar of non current loans. This is the lowest ratio in 15 years.

Simply put, it was a disastrous quarter. As mentioned, over half of all banks had lower earnings. 48% cut their dividends and as an industry banks paid out $12 billion less in dividends in the first three months of the year compared to 2007.Over 600 banks paid no dividend at all. Retained earnings fell over 40% as well. All capital ratios showed at least a slight decline. Overall, total equity for all banks fell by better than $12 billion despite several massive capital infusions for larger institutions. 24 banks were added to the problem list, the sixth quarter in a row that the ranks of banks considered troubled by the FDIC has risen. Two banks failed in the quarter but many more expected by the end of the year.

With the foreclosure rate continuing to increase nationally, the next few quarters for the banking industry do not figure to be any better. In addition credit card and auto loans are falling into the noncurrent category at an alarming rate. Loan growth and demand remains slow and it is going to be difficult for banks to earn their way to health until economic conditions improve.

Te full report is available here: http://www4.fdic.gov/qbp/2008mar/qbp.pdf

Is The Worst Over for Sovereign?

Wed, 21 May 2008 13:14:12 -0500

The corner may be about to be turned at Sovereign Bank (SOV). The banks last earnings report showed that profits had doubled in spite of ongoing credit concerns. The company has been plagued by credit problems with its portfolio of auto and home loans. The bank set aside loan loss provisions of $135 million and charged off $74 million of bad loans in the first quarter. In all, non performing assets rose a stomach churning 74%. In spite of this, operating income at the bank doubled to $.20 a share from the year ago reporting period.

The company has moved in a fairly aggressive manner to survive the credit problems it faces. It drastically cut back on its auto lending basis in the southeast and southwestern parts of the United States. They sold $7 billion of non core assets and suspended the dividend. Now, to shore up its balance sheet it has taken the route used by many other banks and financial institutions this year. Sovereign just completed a $1.9 billion capital raise. The bank sold 179 million shares of stock at $8 and entered the debt market with a successful offering of $500 million 10 year bond with an 8.75% coupon. Once the offering was complete Moody's Investor Service raised their ratings on the bank saying that they now had the financial strength to absorb any foreseeable losses in their portfolio.

One of the most interesting things about the offering was who bought shares. Madrid based banco Santander bought $ 312 million of stock to keep their position in Sovereign at 24.7%. Activist hedge fund Relational Investors also increased their stake in the bank buying 22 million shares in the offering. These purchases have led many to speculate that Banco Santander may, at some point, bid for the shares of SOV it does not already own. Insiders have also been buying the stock, including new CFO Kirk Walters who bought 65,000 in the open market. Five other directors also purchased stock at the $8 offering price.

Insider and institutional buyer could be a signal that the worst is over for Sovereign. The stock has fallen almost 70% in the last 52 weeks. The latest capital infusion may give them the ammunition they need to weather the current environment and begin to position the bank to grow again later this year.

Smal Bank Stocks

Mon, 21 Apr 2008 14:47:38 -0500

Billionaire vulture investor Wilbur Ross has announced that he intends to invest as much as $4 billion in small regional and community banks around the United States. Ross has already made large investments in financial institutions during the current credit and financial market turmoil including mortgage servicing companies and bond insurance companies. He made his fortune exploiting similar market sector collapse including the steel and textile industries. Ross is also planning to fly to Abu Dhabi in the near future to pitch the idea to Arab investors including the giant sovereign wealth funds in the region.
Mr. Ross thinks that there are at least 1000 smaller banks that will need additional capital before the crisis is over. He told reporters recently that most US depository institutions were quite overexposed to real estate and would need outside capital. He has apparently compiled a list of between 100 and 200 smaller banks that are of interest to him as potential investments for his hedge fund.
His thinking is in line with my own. Smaller banks should recover much quicker than their larger counterparts. Although they are exposed to real estate, they do not in most cases have exposure to the complex and volatile mortgage backed securities markets. You will not find the alphabet soup of leveraged securities that are on the books fo industry giants like Citigroup ( C) and Bank of America (BAC). Nor do they make corporate buyout loans for highly leveraged transactions. They will be the prime beneficiaries of the recent Fed rate cuts. As the yield curve steepens they will be able to increase earnings form the yield spread. Recent stock market volatility should also make it easier to attract depositors in local institutions.
It is also likely that there will be substantial consiolidation in the industry. One of the easiest ways for larger institutions to grow earnings and repair their balance sheets is to buy smaller, healthy, profitable institutions.

Wilbur Ross has made billions bottom fishing in various industry groups. His intent to move into smaller banks should awaken investors to the profit potential in small regional and community bank stocks

Bank Stock April Fools?

Tue, 01 Apr 2008 11:19:32 -0500

As we begin a new month and a new quarter financial stocks are flying. After the disastrous first quarter, the market seems to want to put the losses and bad news behind them and move forward. The question is should they?

Sometimes, as long term investors, we need to take a step back and look at what is happening instead fo what we hope is happening. This morning UBS AG (UBS) was out with its earnings report. It was so bad the chairman resigned in its wake. The bank reported a loss of over $12 billion. Total write-down's came to about $19billion. This brings the total losses for UBS to a staggering $40 billion so far in the mortgage and credit crisis. As a result of this Standard and Poors cut their credit rating to AA-. As a result of the downgrade the bank will be looking to raise as much as $15 billion of new capital. This will bring their capita ratios back up to over 10% when completed, well above the minimum of 4 set by the European Union. The bank also announced that it was continuing to cut its exposure to the US mortgage market. Subprime exposure has fallen from 27 billion to $15 billion and the portfolio of Alt-A mortgages shrank from $26 billion to $16 billion.

Also this morning Deutsche Bank said that it expected to announce at least $4 billion in asset write-down's when they release earnings on April 29. The losses are from the banks exposure to leveraged loans, Commercial real estate, and of course residential mortgage backed securities.

Influential banking industry analyst William Tanona of Goldman Sachs was out with reports this morning lowering his estimates on two bellwether financial stocks. He estimated that first quarter losses for Citigroup (c ) would be in 50% higher than his previous estimate. He expects the bank to have over $12 billion of new write downs from asset backed securities in the quarter and report a total loss of $1.55 a share, well above his previous estimate of a loss of just $.50 a share. He also cuts his full year profit estimate by 60% to $.50 a share. For Merrill Lynch (ML), Tanona estimated another $2.5 billion of write-down's and a quarterly loss $2.45. He also cuts his full year estimate to just $.70, down from $3.85, a cut of over 80%.

Major financial stocks are rallying this morning in expectations of better days ahead. The reality seems to be that the situation is still cloudy and best. Asset values continue to fall and earnings are expectations are drastically reduced. This appears to be one of those times where it is best to sit out the early rally to avoid the possibility of a permanent impairment of investment capital, sustaining huge losses that would take years to recover.

The Week in Bank Stocks

Fri, 28 Mar 2008 14:33:41 -0500

It has not been a good week for bank stocks. The Keefe Bruyette Woods Bank Index (BKX) has fallen about 6% so far this week. The stocks tried to rally for a brief period early in the week but where hit by a wave of analyst downgrades and earning estimate reductions. Merrill Lynch and Goldman Sachs both cut estimates for Bank of America (BAC) citing concerns about further write downs of assets and growing loan losses. The same concerns led Merrill and Sandler O'Neil to cut estimates for Wachovia bank (WB). The reduced estimates caused a sharp drop n share prices with Wachovia off 8% and Bank O f America down 7%.

The big bomb this week was thrown by Oppenheimer analyst Meredith Whitney. Originally last year thought the bearish bank analysts was something of a Cassandra with her drastic forecast for banks. Time has of course, proven her to be correct about the dire straits at the big banks. In her reports this week she said that Citigroup ( C), Wells Fargo (WFC) JP Morgan Chase (JPM) and Bank of America would have to cut their dividends. Her report said "Banks under coverage are dangerously approaching earnings levels that will not support high relative payouts. Beginning with first quarter 08 results, which will be announced in two weeks banks will seriously address their ability to maintain the current dividend level."

She was not upbeat on the immediate future for the sector. Whitney told investors this week, "The best case scenario is that the financial firms take the pain quickly and purge assets form their balance sheets. That could bring stock valuations down as much as 50%, which would be enough that you could legitimately buy long term positions. If they do not purge, there is a slow bleed of capital and pressure on stock prices for an extended period of time. We will most likely see a combination of the two, with more of the latter scenario. It will not be pretty."

Banks continued to shy away for corporate buyout deals this week. Fear of the risks in the highly leveraged deal and concerns about the somewhat shaky shape of their own balance sheets led Citigroup, Deutsche Bank(DB) and Wachovia to back away for financing the buyout of Clear Channel Communications (CCU). Clear Channel, as well as the buyout firms of Bain Capital and Thomas Lee Partners have sued the banks to attempt to force them to put up the capital. For their part, the banks say the lawsuits have no merit. Hearings are being held on the case April 8 in Texas and April 3 in New York courts. As the price of leveraged loans has dropped in 2008, funding the deal could cause losses of up to $2.8 billion for the financing banks.

The outlook for the major banks remains murky at best. There will be more downgrades and losses in the months ahead and this is likely to continue weighing heavily on the shares of the money center banks. It is difficult to make a case for investing in them at these levels.

The Week in Bank Stocks

Fri, 28 Mar 2008 14:33:41 -0500