Bank_Failures_2011-06-29_1214

Banks stocks may seem cheaper but they are going to get cheaper.

A great deal is being written about vague plans to re-capitalize European banks. And, truthfully, the balance sheets and capitalization of many US banks look terrific compared to their European brethren. Of course, living in a high crime neighborhood appears to be desirable -and is safer – after you just survived a tsunami. (See my recent article on “Trading the Market Madness”).

US banks survived their tsunami due the strenuous efforts by Mssrs. Paulson, Bernanke and Geithner – not to mention the $787 billion Congress threw their way. But they still constitute a dangerous neighborhood – not a place for you to wander around anytime soon.

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Three reasons – busted balance sheets, little growth and new capital requirements.

US banks survived not just due to the cash they received – and for the most part have paid back. They survived because regulators suspended accounting rules that are still suspended and have willfully ignored their off balance sheet obligations as if they were just there, generating profits with no risk of losses. Bank stress tests seemingly ignored the off balance sheet assets of the banks – and also never tested where the banks would be if accounting rules would revert back to 2008.

The banks know this. Savvy investors know this.  So what is next?

Investors are Avoiding Bank Stocks

Lack of Transparency: The first reason investors are avoiding bank stocks is that more than anything, they hate the lack of transparency in bank balance sheets – no one really knows had bad things are on the banks books, and the banks make it very hard to find out, with one exception, a little more on that later. That is why there no tailwinds supporting bank stocks, why there is no rush to “buy cheap.”

Lack of Growth: The second reason to avoid or short the US bank stocks is growth – or lack thereof. Most money center and investment banks have little earnings power going forward. They earn money by lending it out – and they are not doing this nearly a much as they used to. They earn money based on the spread between short term interest rate s- what it costs them to borrow – and long term interest rates,what7 they lend out at.

These spreads are narrowing. And foreclosures are accelerating which means they must take more loan loss reserves —out of their profits.

Required Regulations: Third, there are long list of regulations from US authorities and from something called Basel III. Bottom line – the banks are going to be required to have more “core” capital and to do this many of them will have to sell stock in the next 2-5 years. This is preventing longer term investors from coming in and they are waiting to see exactly how much capital the banks will need to raise. When they know this, they will do some calculations and decide what a good or real price is for the stock.

You don’t need to do that calculation – you just need to know it has yet to be done and will not be done for a while, so investors will continue to stay away. Without these investors, the bank stocks are a short term trade based on news coming from anywhere and everywhere, from the Fed to politicians in Slovakia.

What you should do?

First, do no harm – stay away – banks stocks may seem cheaper but they are going to get cheaper.

Second, if you have some capital to speculate with, consider buying some longer term puts that expire sometime past next January. Give yourself some time to get through a relief rally that may come when Europe spends more money on Greece, the announcement coming around the first week of November. The dog in the sector is Citigroup(C). I know a little something about Citi – I recommended buying puts on it when the stock was the equivalent of $430. It is now just below $30.

 

Third, be a bit contrarian, always a way to make serious money. What is the most hated bank stock? Bank of America (BAC). Bad headlines, bad rumors, bad karma. What bank has the most transparent about its problems and has a balance sheet that can actually be understood? BAC. My point? If BAC comes down to near $6, start nibbling. And in case of a sharp correction be ready and consider putting in what the Street calls a “silly bid” – a Good until Canceled Order to buy BAC around $4.50. The stock is around $6.60 right now.

 

 

Just don’t forget about that order!

 

 

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