Has the Banking Sector lost its Mojo?


Even though the S&P 500 (NYSEArca: SPY) has posted a modest 6.4% year-to-date gain, financial stocks (NYSEArca: XLF) are down almost 3% in value over the same period. Bank ETFs (NYSEArca: KBE) are down even more - posting an almost 7% loss. What's ailing the financial sector and is a recovery on the horizon? 

What Lending?

The Fed's two rounds of quantitative easing (QE1 and QE2) unfortunately haven't reversed the powerful forces of a declining economy. Nonetheless, both programs have kept a lid on borrowing rates. The fixed rate on a 30-year mortgage is 4.70%, while the 15-year rate is at 3.87%. Under most circumstances, low rates like these would mean a boom in lending, but has it?

The nation's 10 largest mortgage lenders (NYSEArca: KME) rejected 26.8% of loan applications in 2010, a steady increase from 23.5% in 2009, according to the Wall Street Journal. Banks are in business to lend money but in many cases even qualified mortgage borrowers are being turned away. Even regional banks (NYSEArca: KRE) are guilty. Gun shy lenders with overly restrictive borrowing standards are bad for business.

Have you recently applied for a mortgage loan or spoken with someone that has? Most will agree it was an experience similar to being interrogated by the KGB. Anyone who says the lending environment has returned to normalcy obviously hasn't tried to get a loan.

Legal Headaches
Another problem for banks are legal problems connected to allegations of mortgage foreclosure abuse. Banks like Ally Financial, Bank of America ( BAC ), Citigroup ( C ), JP Morgan Chase ( JPM ), and Wells Fargo ( WFC ) are still embroiled in the mess. In May, they offered $5 billion to settle charges but the settlement price tag has since jumped to around $20 billion.

How complicated has the legal morass become? Any potential settlement would have to satisfy all of the state attorneys general, the Department of Justice, the Department of Housing and Urban Development along with the Federal Trade Commission. Meanwhile, other potential liabilities have popped up. A federal audit last month revealed that banks may have also defrauded taxpayers by illegally foreclosing on homes bought with government backed loans.

Other Mortgage Problems
The other lingering trouble for banks is non-performing loans. Almost 20% of the mortgage loans inside banks' portfolios were delinquent at the end of March according to the Office of the Comptroller of the Currency. That compares to delinquency rate of just 6.8% for mortgage backed loans from Fannie and Freddie Mac. Also, roughly one quarter of homeowners are in a situation of where they own more than what their homes are actually worth. 


Things are bad but the worst might not be over. Home prices continue to fall and a second wave of mass foreclosures could be on the horizon. And it won't be good for the prices of either new or existing homes (NYSEArca: XHB).

New Capital Requirements
A new deal known as 'Basel III' requiring the world's top banks to hold between 1% to 2.5% of extra capital is another problem that clouds the future profitability of global banks (NYSEArca: IXG). International regulators, like the rest of the world, have seen the sort of financial chaos that too-big to fail institutions can cause.

The reworked Basel rules have a penalty feature which requires an additional 1% of capital on large banks that grow even larger. Cleary, regulators are doing everything possible to avoid a repeat Lehman Brothers scenario. And in the process, they're making the business of large global banking less and less attractive.

Banks and Your Money Market Funds
As U.S. banks got into trouble during the 2008 credit crisis, money market mutual funds piled into European bank debt which in turn was heavily invested in garbage quality sovereign debt. (See Greece, Ireland andPortugal.) This has raised serious questions about the stability of money market funds, which are sometimes referred to as 'cash.' How 'safe' are money funds?

At the end of June, there was $2.69 trillion in money market funds, according to the Investment Company Institute. Have the problems in the global banking system already spread to this usually quiet and dull corner of the market? Could this be a major setup for round two of a run on money market funds? ETFguide's latest weekly pick analyzed the Fidelity Cash Reserves Fund (Nasdaq: FDRXX) as a case study. With roughly $116 billion in assets it's a good barometer of what's been occurring in money market funds.  

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

This article appears in: Investing , ETFs

Referenced Stocks: BAC , C , JPM , WFC



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