Regional Banks Beware
It all started with a rumor. A bank was to fail this week — a big one. Hit the bid.
We’re hearing plenty of grumbling now — that stocks “are no longer trading on fundamentals.” If they were, yesterday’s bullish manufacturing news would have sent stocks through the roof… those damn short sellers and their “bear raids” are at it again. But is it possible that (gasp!) the fundamentals for banks are still lousy? The SPDR KBW Bank ETF is up 137% from its March low… has the banking sector really gotten 137% better?
“These bulls are misdiagnosing the situation, and here’s the main reason,” writes Dan Amoss, our resident short seller and de facto banking analyst. “The banking system has no experience managing through the current ‘negative home equity’ environment. This is an environment in which mortgage rates are already about as low as they can get and consumer balance sheets are as stressed as ever. Due to the nonrecourse nature of mortgages, most borrowers have no financial incentive to keep paying. Many are choosing to mail the keys back to the lender.
“This problem will cap the upside of bank stocks for years to come, and this sector will offer lots of short selling opportunities.
“The next move in the financial stocks will be down and regional banks and thrifts will lead this move. Most banks are reluctant to book the provision expenses necessary to maintain loss reserves, because this cuts into net income. But delaying recognition doesn’t mean they’ll go away; delay just means that losses in the future could be bigger and exacerbate the trend toward tighter credit. The market for bank stocks is not discounting this development right now, but it will over time. None of these smaller institutions are ‘too big to fail,’ so many will be resolved by the FDIC, and acquired or liquidated.”
“This month, we’re shooting for 150% gains in put options on a thrift that strayed from its humble roots and is now dangerously undercapitalized.”
“I think there will be at least 500 more banks to fail between now and the end of next year,” said legendary distressed investor Wilbur Ross this week. Ross, like Dan Amoss, said he’s particularly worried about regional banks, which will be hit hardest by a “commercial real estate time bomb.”
Commercial real estate is a “looming problem” for bank balance sheets, FDIC chairwoman Sheila Bair admitted yesterday. While she would not wager a guess as bold as Amoss’ or Ross’, Ms. Bair did hint that losses on commercial real estate loans will be the driver for bank failures this year and next.