It's been four years, but it feels to be a lot longer than that.
The U.S. housing sector started to quickly deteriorate in the
spring of 2008, and though many hoped industry conditions would
improve in a year or two, we're still waiting for signs of life.
And looking more deeply into a blockbuster agreement signed by the
U.S. government and major banks last week, housing bulls may still
have a considerable wait ahead of them. But for the major banks
that were also decimated in the housing and
crisis, last week's agreement is a huge positive that remains
[block:block=16]Details of the $25 billion agreement have been
widely covered elsewhere, so I'll just summarize the key points:
• The big banks have agreed to large cash and non-cash liabilities,
Bank of America (NYSE:
Wells Fargo (NYSE:
) ($5.4 billion)
J.P. Morgan Chase (NYSE:
) ($5.3 billion)
) ($2.2 billion)
• The banks may still be exposed to liabilities relating to how
loans were originated and secured in coming quarters, though that
would likely be a far smaller amount than the settlement we just
• Future bank
will be slightly diminished because some refinanced loans will
carry lower rates.
• Banks have largely taken out reserves in the past against this
settlement and have little or no forward write-downs to take.
It's that last point that highlights why I remain quite
on many bank stocks.
As I've written in the past
, the fact that they were selling well below
was the result of massive housing-related damage yet to come, and
potentially huge exposure to the problems in Europe. Neither of
these issues is likely to weigh on banks any more in the quarters
to come. Meanwhile, here's a quick snapshot of where banks are now
valued in relation to book value and projected 2013 profits.
Valuing bank stocks in terms of tangible book value has always been
a fluid target. Throughout most of the 20th century, they traded
for between 1.0 and 1.5 times book value. In the past decade, this
multiple often rose well above 2.0, or 200% of tangible book value.
It may be a while before such lofty valuations are again spoken of,
but big banks trading BELOW tangible book value is extremely
Looked at another way, banks tend to trade at a high single-digit
earnings multiple at the peak of their cycle, but the multiple is
often far higher when gauged against bottom-of-the-cycle earnings.
The fact that many of the major banks trade for less than 10 times
projected 2013 earnings, even as the potential for mid-decade
profits is far higher, re-affirms that these stocks are solid
Pretty quickly, you come to understand why
has a key place
, especially when you consider that the bank has above-average
long-term growth prospects, thanks to its emerging-market exposure.
Simply trading up to tangible book value implies a 50% gain for
Citigroup. Trading up to 1.3 times tangible book value, which is
the historical mean of the last 40 years, implies a 100% gain from
current levels. It will take quite some time for that to happen,
but the runway is in place.
Another false dawn for housing
At first glance, the landmark $25 billion settlement with the major
banks would imply great news for the major home builders. On second
glance, the deal just implies more challenges to come. The banks
have up to three years to sort out all of the troubled loans they
are carrying, so any major relief to most struggling "underwater"
homeowners may still be several quarters away. Second, this entire
class of consumers remains under financial duress, and few will be
in a position look at new home purchases any time soon.
The clearest outcome from the settlement is that the thousands of
homes frozen by the
mess will become unfrozen, meaning that banks will finally be in a
better position to start unloading distressed properties, likely
through short sales. As a result, the supply of existing homes on
is likely to swell, obliterating demand for newly-built homes.
Meanwhile, housing stocks are on fire in hopes that the market for
newly-built homes will soon turn up. The Philadelphia Housing
(HGX) has surged more than 50% since the start of the third
This sector rally not only overestimates the still-tough housing
environment in 2012, but already accounts for some of the upside
that we may see in 2013 as housing indeed starts to perk up. [I
looked at some
specific housing stocks
that may be especially ripe for a pullback last week.]
Risks to Consider:
Bank stocks continue to be dogged by concerns that the U.S.
is not yet healthy. Indeed, there are enough challenges in place
from a regulatory and macro-economic perspective to retain pressure
on bank stocks, so any rebound will likely be slow to build,
perhaps over a few years, not a few quarters.
Action to Take -->
I'm not comfortable recommending any homebuilding stocks at this
point, but there are several measures of housing data you need to
For example, the National Association of Home Builders (NAHB)
releases its monthly survey of industry sentiment around the middle
of every month. The index, which scored low last summer and fall,
rose from 21 in December to 25 in January, and economists expect to
see an even higher number ( in the 26 to 28 range) for February. As
soon as the index appears to have reached a short-term peak, which
a reading at 25 would imply, then housing stocks are likely to drop
as investors seek to take profits.
If you were to invest in one bank stock, then it would be
Citigroup. Indeed, I already have -- I bought 300
(worth roughly $9,000) in my
$100,000 Real-Money Portfolio
. To find out more about the stocks in my portfolio,
to sign up and receive my latest ideas, which is completely free
for a limited time only.
-- David Sterman
David Sterman does not personally hold positions in any
securities mentioned in this article. StreetAuthority LLC owns
shares of C in one or more if its "real money" portfolios.