<meta content="text/html; charset=utf-8" http-equiv="CONTENT-TYPE" /> <title> </title> <meta name="GENERATOR" content="OpenOffice.org 2.4 (Linux)" /> <style type="text/css"> <!-- @page { size: 8.5in 11in; margin: 0.79in } P { margin-bottom: 0.08in } --> </style>
Yesterday saw the biggest rally in financial s in the last 16 years-Wall Street was happy and we should be happy too-we could short at higher levels.
Two days back everyone was predicting the end of the world as we know it and now the clouds have lifted. With Indymac blowing up everybody who was anybody was bearish and short regional banks and I watched in envy. I was too early once and I was shaken out by a massive rally. This rally is the time to get to add to positions in your short funds,add new short funds,short the banks,short the -you get the idea.19 banks have been protected by the SEC (allowed to fatten for the killing?).
KRE is an ETF covering regional banks.
Banks may be of two types basically
1.Commercial banks who basically take in money from savers in the form of checking accounts,CD etc at a lower rate and lend it at a higher rate in the form of loans or invest in government or corporate debt. Thus the liabilities of the bank are the deposits and the assets are the loans and bonds. Regional banks are not countrywide(unlike money market banks),they operate in some regions of the country. They are commercial banks.
2.Investment banks like GS,MS etc help corporations to raise money for their business by issuing equity or bonds. They may help arrange mergers etc. At the time of the Great Depression these two types were separated but since the 1980s many banks evolved into financial services firms offering a wide gamut of services and assuming multiple risks.
Losses
Alan Greenspan fueled a massive credit bubble which went into housing after the internet bubble burst. Regional banks have high exposure to the housing sector. But the difference is unlike investment banks they do not package and sell their portfolios. So the portfolio most probably is not as toxic as the mortgage companies who immediately repackaged and sold it(well at least they did that when the going was good).But with years of relentless credit expansion,it is unlikely that any CEO would have managed to be fiscally prudent. If he was his quarter on quarter results would have sucked vis a vis his peers and analysts and investors would have called for his head and most likely would have got it. Besides with pay packets linked to short term performance nobody is likely to think long term. Another problem these banks faced was with falling interest rates,it was difficult to generate returns without taking risk. Banks therefore extended credit to speculators who would flip the house and make a profit. The bank got higher yields. Americans were encouraged to spend and banks were happy to extend home equity loans. With falling housing prices,this pack of cards is coming tumbling down. There is going to be increasing write downs as people fail to pay their loans. Home equity loans will take a hit as the value of the homes fall off the cliff. Bankruptcies are at an all time high fueling commercial loan defaults. This would contribute to commercial real estate falling in value with businesses boarding up,consumer cutting down as wages fall or they are laid off at a time when prices are rising. Thus banks face losses in all segments-mortgage loans,home equity loans,construction loans to build commercial real estate and commercial loans to businesses. These losses would be amplified given that most of the banks are using high degrees of leverage as well over and above their credit base.
Decreased credit off take
Banks are already lending less-one view was that they are being very selective so even the ones with the best credit will not be able to borrow,another less charitable view is that many banks are under capitalized(translation-broke).A bank makes profit when it lends the money it borrows at a higher rate. When credit off take declines margins are affected adversely.
Higher cost of money
With the credit crisis in full swing,cash is in short supply. This presents huge problems to regional banks who want cash to shore up their balance sheets-they have to pay exorbitant yields to get loans. Investment banks have the advantage of having a former CEO of GS on the inside. This enables them to get taxpayer money in return for toxic securities. Regional banks are local players dealing with ordinary Americans,hence they can be allowed to fail. Who cares about the ordinary American? In fact when depositors had the temerity to ask for their OWN money to be returned by Indymac,they were threatened with arrest. Paulson had come out and said some financial institutions will fail. No prices for guessing who he wants to survive. Interest rates will also harden going forward with rising inflation making the cost of deposits higher reducing net interest margins.
Risk
1.momentum keeps the market going higher
2.some banks outperform but it is unlikely. It is to reduce the risk that I am shorting the ETF rather than any single stock where the possibility of an out lier event is higher.
Considering the possibility of losses resulting from write downs,inability to raise cash to cover the losses,the Fed not deeming them important enough to bail them out and decreasing profit margins with narrowing NIMs,regional banks make a good case for a short.
Readings
http://en.wikipedia.org/wiki/Commercial_bank
http://en.wikipedia.org/wiki/Investment_bank
http://www.sfgate.com/cgi-bin/article.cgi?f=/c/a/2008/07/15/B...
http://globaleconomicanalysis.blogspot.com/2008/06/regional-b...
$25.68 (07/16/08)
