Should You Buy Banks Now?

Here's the toughest part about buying banks: you can't get all the information you need to make an informed decision. Why's that? Because banks don't fully disclose the age of their loans, when they were made, the quality. The quality is reflected in the loan loss reserve and the actual loan losses, but it would be beneficial to know when loans were put on the books.

For example, any loans made after 2008 are almost assuredly good loans. By then, banks had stopped their frivolity and made sure appraisals were accurate, that substantial down payments were made, and, most of the time, made sure the borrower had a job. In other words, loans made after 2008 will most likely keep paying. They were made with very conservative underwriting. Loans made before then, well, good luck.

Another problem: regulations are going to change. No one knows to what levels new capital requirements will go but they won't be down. More capital will be required to bolster a bank's cushion to weather any new economic storm (the skies are pretty dark right now). With that in mind, many banks will have to issue new equity, even at these low valuations. Bank of America added $5 billion from Warren Buffett at these levels (yes, it was a convertible preferred, but it will become equity). You can bet they didn't do that because they like him. More banks will follow. When they do, their stock prices will most likely go lower. And there will be lots of competition for that new capital so expect to see some real bargains. One study suggest between now and 2015, banks will need to raise

$500 billion to $1.7 trillion to meet new and recently approved banking regulations.

One more uncertainty: how big is the liability for all the mortgages that were put into securities? Seventeen large banks are now being pursued by the Federal Housing Finance Agency for their part in issuing $200 billion worth of mortgage-backed bonds that are owned by Fannie Mae and Freddie Mac. Among the bigger names: Bank of America, Citigroup, JPMorgan Chase and Goldman Sachs. The U.S. regulator of credit unions is also suing Goldman Sachs for more than $491 million in damages over losses incurred by five failed wholesale credit unions that bought mortgage-backed securities from the investment bank. There are too many lawsuits to name against all the banks. How much all this will cost is totally unknown.

So is there any reason to buy banks now? Given all the above, there doesn't seem to be a rush, except for those banks that aren't involved in mortgage-backed securites, or have only a small exposure. Some names include Wells, Fargo (WFC), US Bancorp (USB), Bank of New York Mellon (BK). This is not to say these don't have lawsuits, but so far, they haven't been deeply embroiled in federal ones. In fact, USB, as a trustee and at the direction of the investors in the trust, is suing Bank of America (BAC) over mortgage-backed securities it bought from the them, saying that the loans in the pools which Countrywide originated had such high loss rates due to lax underwriting standards. BAC bought Countrywide and is now feeling the full effects of that purchase.

Smaller banks are also a good place to look. Many are in deep trouble with loan portfolios that are taking large losses. But many are doing just fine. It's a matter of sifting through all the thousands of banks that serve local communities. Many pay a nice dividend as well.

As with any time, it's a great opportunity to buy in a sector that is completely, totally out of favor and for good reason. Furthermore, the next few years seem to have lots of challenges. But there are good banks to buy. It just takes a little more homework to find the good ones. When you do, see if there's an analyst's report you can purchase about the bank. They usually have more information as well as analysis than can be found on the Web.

- Ted Allrich

September 6, 2011

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

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

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