Tuesday, January 20, 2009


How low will the banks go?  Today, I was unhinged- somewhat- by the sheer magnitude of losses in bank stocks.  The S & P Banking Index fell 21.04%  MSN Money  Let's not mince words to describe what happened today with the banks, this was a crash in bank stocks. Bank of America fell 28.97%.  Wells Fargo was down  23.82%.   J P Morgan, widely considered the healthiest of the major banks, lost 20.73%.  There are a few conclusions that can be reasonably drawn from today's carnage. First, it would be reasonable to expect most banks to eliminate or reduce their dividends. They can no longer be viewed as reliable dividend stocks. Most bank stocks are nothing more or less than pure speculative stocks now. Most of the funds that are marketed as dividend funds have a lot of bank stocks which no longer fit the dividend objectives of those funds. I do not see how they can justify continuing to hold most of them.   Second, I have been looking at the prices during the last major banking crisis in 1989 to 1991. I believe that the current crisis will end up being far worse than the one in the late 1980s and early 1990s, which was also precipitated by careless lending, culminating in the taxpayer funded bailout of the S & L industry and major losses by the large commercial banks particularly in construction lending.  The GAO recently released a study calculating that the S & L bailout almost twenty years ago cost one-half trillion dollars.  New York Times Some bank stocks have already returned to the prices prevalent during that previous debacle which shows once again how history finds a way to repeat itself with any lessons learned soon forgotten.  Thus, I would expect many bank stocks to end up lower than the prices reached during that last banking crisis.  Third, this downdraft could not have occurred in my opinion if investors believed the TARP funds, which have already been made available to the banks on generous terms with few conditions, had arrested the banks' decline.  Thus, the market has just said loud and clear that the first 350 billion of taxpayer money did not come anywhere close to resolving the problems in the banking system.  Fourth, and related to the third point, the market's message today says to me, and this is debatable, that there is no confidence left that the second 350 billion will be sufficient or even close to being adequate.  Five, after Summers recent memo to Congress expressing that tougher conditions will be imposed on the second phase of the government bailout,  shareholders are starting to see the writing on the wall in this quasi-nationalization process. Common stockholders are not a high priority for anyone, as Abby Cohen with a gift of understatement phrased it in the Barron's Roundtable.  Anyone requesting further government assistance will have to reduce the common share dividend to the 1 cent a quarter recently agreed to by the hapless Citigroup and disclosure challenged Bank of America.  A higher dividend than that nominal amount will have to wait until the government is paid back and that may take years.  Some banks will eliminate the dividend entirely and may even eliminate their regular preferred dividends and postpone paying their Trust Preferred dividends. The best case scenario for many common shareholders is that prices will stabilize at lower levels, meander around for a few years at these extremely depressed levels, with no or nominal dividends and an uncertain recovery potential.   Whoever has been selling the regular preferred issues of Citigroup would not have much confidence in the bank continuing to pay dividends on its non-cumulative preferred stock.  Over 3 million shares changed hands of CPRP today, falling $2.26 to $6.60 with a $25 par value which gives this recently issued non-cumulative issue a 31% yield. Are there any takers at 31%?CPRP Stock Quote - Citigroup Inc Stock Quote - CPRP Quote - CPRP Stock Price

It is hard to see how the banks can re-capitalize with private capital unless the bank is first seized by the FDIC, with shareholders and bond holders wiped out, and then sold to private equity similar to what just happened with IndyMac. This has to be in the back of many investors' minds.  The banks can not issue new preferred stock to private investors for the simple reason that few would buy a new issue of  preferred stock now or buy it at a price the bank could afford to pay.  Even the bond market has dried up for them. The only source of funding now is the government and the government will start to get tough with them. The government will be far tougher on the next 350 billion than the first installment, which was a gift to the banks with a mere 5% preferred dividend and no meaningful restrictions or even requirements to lend the money.  After the next 350 billion is exhausted, I suspect that government's patience will be near an end and more FDIC seizures of larger institutions will start in earnest.  

For now, I will continue to stay away from all bank stocks and their preferred issues. I am stuck in my Bank of America positions and will just wait and see.  I do look forward to voting against the Board.  At some point, as time passes, it may become clearer who will survive and who will be relegated to the dustbin.  An opportunity to engage in intelligent speculation may arise by early 2010, and speculation is the only appropriate word to describe an investment in banks now in my opinion.  And, it would not be intelligent speculation at this time.  
This is a link to an article expressing a different opinion. WSJ.com

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