Are the financials finally worth buying?

By David Russell,

Shutterstock photo

It's taken longer than many had hoped, but banks are finally a buy.

This sector has punished some highly successful investors who tried to bargain-hunt too soon after the 2008 crash. In my view, their mistake was ignoring business momentum in favor of abstract concepts such as "capital levels" and "valuations."

My bullishness is not simply based on banks being oversold (which they are). Nor is it just a question of them being overcapitalized (which they are). Nor is it a matter of all the bad news being priced in (which it is).

No, the real reason to buy the banks is that the growth story is back.

For years we have heard complaints about how lenders have been shrinking their balance sheets and refusing to make loans. But that giant battleship is now turning, and there are reasons to think that it will continue.

The Federal Reserve's H.8 data , which details bank finances, shows that commercial and industrial loans have grown at a double-digit annualized pace since the middle of last year. That hasn't happened since late 2007 and early 2008.

The pace of contraction in mortgage lending has also moderated from readings of -5 to -10 percent in 2009 and 2010 to little-changed now. Those are the official numbers. Anecdotal evidence paints a similar picture.

For instance, I and my acquaintances have noticed more credit-card offers in the mail over the last month. One small-level real-estate investor I know was also just contacted by his bank to refinance a mortgage. Two years ago, that same lender refused to take his calls.

We're also seeing increased mention of loan growth in analyst reports on the banks in researchLAB .
But there's even more. The Fed's quarterly survey of loan officers shows that underwriting standards are being relaxed because of "aggressive competition" in the industry.

This is a big deal because banks follow a herd mentality. Years of gloom are now lifting and will be followed by years of credit expansion. So far, no one is pricing in that growth. In fact, most banks are still priced for depression.

There are also good opportunities to make profitable loans because millions of houses--especially multi-family homes in cities--now make sound investments because they've gotten cheaper while rents have gone up. Headlines just this week are bullish as well: Case-Shiller home prices yesterday, pending home sales today, and good earnings from Lennar. Fitch Ratings also raised its credit-rating outlook on D.R. Horton because of "better prospects for the housing industry."

Lastly, banks have plenty of dry powder to lend. Their holdings of "safe" assets such as Treasury and agency bonds now stands at 18.6 percent of balance sheets, the highest level since 2003. That figure was below 12 percent back in 2007 and 2008.

You may ask, "Why banks, instead of some other sector that's beaten down, such as energy or steel?"

The first reason is that banks are less sensitive to global economic issues, notably in Europe and China. Second, exchange-traded funds such as the XLF (broad financials) and the KBE (just banks) have been consolidating above their 200-day moving averages, while energy and materials remain well below theirs.

People have tried to call a bottom in banks for years. But now it's finally true.

Disclosure: I own FAS, which is triple-leveraged to the financial sector.

(A version of this article appeared in optionMONSTER's What's the Trade? newsletter of June 27.)

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

Copyright © 2010 OptionMonster® Holdings, Inc. All Rights Reserved.

This article appears in: Investing Options
Referenced Stocks: KBE , XLF

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