I like to poke around after a crisis has burned out. I’ve been spending a lot of time of late looking at bank stocks of every stripe across the country. The beauty of doing this kind of work is that sometimes you find things you never expected to find.
I’ve discovered an idea unique to this post-2008 world and perhaps one that will never repeat to quite this extent. I want to share this esoteric idea with you in what follows below.
I first saw it happen with a little bank stock I own personally. It announced earnings that were three times higher than expected because of “the reversal of the majority of its deferred tax asset (‘DTA’) valuation allowance.” The stock rose 9% in the next two trading days.
I decided to look into this wrinkle a little more. I found it happening in other places as well. Here are the biggest reductions in DTA valuation allowances this year with the return on the stock year-to-date. Once you see these figures, you’ll understand why this is a worthy inquiry:
An average portfolio gain of 73% for 2012 so far and only one loser! So what is this “DTA valuation allowance”? And how you can make a little scratch with it?
The DTA valuation allowance is a leftover from the crisis days when banks were losing money. Put simply, some banks had deferred tax assets. These assets were a kind of tax shield. But if you are losing money and unlikely to benefit from your tax assets, then accounting rules require that you take a DTA valuation allowance — in essence, you must mark down the asset.
This happened quite a bit back in the financial crisis when many banks lost money and it was uncertain when they’d turn it around, if ever. But now as the crisis is receding, banks are starting to reverse out these allowances.
But here’s the catch: It is not easy to reverse out the allowance. A management team has to prove to both its auditors and its regulators that its bank is back on the road to regular profits. When it does so, management can enact a reversal. The market takes such reversals to mean that a bank has turned the corner. The reversal means a bank’s problems are behind it. Stock prices jump as a result.
I decided to dig a little and come up with a list of banks with large amounts of DTA valuation allowances. Several of the banks I identified are still in really bad shape. Some even looked like they may not survive. In other words, no reversal is likely.
But several other banks are making money again. And they seem likely to do so in 2013 and beyond. These are good candidates for further research. The table below features six of the more interesting names that had huge DTA valuation allowances as a percentage of their current market caps:
Each of these is making profits now and expects to make profits next year. If these trends hold, a drop in the DTA valuation allowance is inevitable. And as you can see, the potential allowance reversals are big relative to the market caps of these stocks.
A few have high insider ownership positions from private equity players: UCBI (Corsair Capital, Fletcher Asset Management), FBP (Oaktree, Thomas H. Lee Advisors) and CPF (The Carlyle Group). I haven’t done all the work on how these ownership positions came about. I’ll guess that these players took their positions during the crisis and provided much-needed capital. I take their presence as a plus. As large owners, they are likely to keep management focused on delivering for shareholders.
If you are looking for banks with squeaky-clean loan books, these are not the ones. The trends, though, are good. I’m not officially recommending these stocks. I’m just sharing some interesting research as I go. We’ll see how this group looks a year from now.
Chris Mayerfor The Daily Reckoning
Chris Mayer is managing editor of the Capital and Crisis and Mayer's Special Situations newsletters. Graduating magna cum laude with a degree in finance and an MBA from the University of Maryland, he began his business career as a corporate banker. Mayer left the banking industry after ten years and signed on with Agora Financial. His book, Invest Like a Dealmaker, Secrets of a Former Banking Insider, documents his ability to analyze macro issues and micro investment opportunities to produce an exceptional long-term track record of winning ideas. In April 2012, Chris released his newest book World Right Side Up: Investing Across Six Continents.
With so much of the national media focused on negative stories, it's easy to feel a bit depressed and to think that the world is hopelessly doomed to failure. But, as Alexander Green points out, there are several things for which humanity, especially in the developed world, should be eternally thankful. Read on...
The president and his supporters are trying to convince Americans that all of the problems with the implementation of Obamacare are simply bumps in the road, normal as part of any new program in its early days. Of course, that's not true. In fact, that's exactly what one should expect when the government is in charge.
With the markets rallying so much this year, it's natural to think that 2014 could start with a correction. But that's not what the data tell us. Greg Guenthner explains why you can expect the rally to continue in the early part of next year. Read on...
There's been a lot of press lately about the 3-D printing revolution - much of it right here on The Daily Reckoning. But there is one technology that's already threatening to make 3-D printing yesterday's news. Josh Grasmick examines a new kind of printing... that takes place in the 4th dimension. Read on...
Rejoice! What was perhaps the freest market in the entire world is now ended. Crushed. Wiped out by the swift hand of the state. Wait... That's NOT a good thing? (Sigh)... Oh well. It was fun while it lasted. Dominic Frisby explains why the shutdown of the Silk Road is such a travesty. Read on...
Say's Law fell out of favor among economists with the rise of Keynes. But if it still holds true, we can at least take comfort that there is economic life after monetary death.
The dollar in your pocket is worth a whole lot less today than 100 years ago. And you have the Federal Reserve to thank for you. So, as the Fed approaches its 100th birthday, Gregory Bresiger reflects on the controversial institution, relaying the criticisms of several of the Fed's most vocal opponents. Read on...