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?
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
Another problem for banks are legal problems connected to
allegations of mortgage foreclosure abuse. Banks like Ally
Financial, Bank of America (
), Citigroup (
), JP Morgan Chase (
), and Wells Fargo (
) 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
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
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.