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.
There have been quite a few disappointing numbers in the global economy recently. But as these numbers are just economic "snowflakes" building toward a financial avalanche. All you need is one to push it over the edge. And as Dave Gonigam explains, the deciding snowflake may come from Switzerland. Read on...
After the 2008 financial crisis, little could be heard over the deafening cries of "mission accomplished." And while the Fed's massive QE program seemed to work, the question remains: for how long? Addison Wiggin explains why the next round of QE will fail miserably, paving the way for the IMF to step in with something called "special drawing rights." Read on...
Global warming is one of the most debated subjects of the last few years. But regardless of whether you're a "true believer" or a merely an unconvinced skeptic, there are significant ways to make serious money from this controversial topic. Today, Addison Wiggin brings you three of them. Read on...
Under the auspices of benefiting public health, the government has been administering medication to you and your family for generations. But is it really necessary? Or worse... Could it actually be harmful? Chris Campbell takes a closer look at this, and other personal health decisions the feds don't trust you to make...
Commodities have been in freefall lately. Everything from corn to soy beans to precious metals is headed lower right now. But is this just a brief downturn, or is this the beginning of a long-term trend? Greg Guenthner explains, with a closer look at one specific precious metal that could snap back violently before heading lower. Read on...
The inflation vs. deflation debate is a heated one. Heck, it almost brought Peter Schiff and Harry Dent to blows. But at the core of this debate is a common misunderstanding of the nature of both inflation and deflation. Today, Jim Mosquera seeks to explain each... and which one the U.S. is more likely to experience. Read on...