“Bank stocks have never been so cheap, and their core profit generators (deposit growth, loan growth, spreads and net interest income) remain intact and will, in the fullness of time, turn more positively.”
This one is hard to resist. Kass is way too early.
Go long the banks now? Have you received death threats from Hank Paulson and “The Bearded One”?
In case some of you may be thinking, “maybe Kass is right…”, consider this….
Presently, we have an instance where the bearish consensus is correct in avoiding the bank stocks. The biggest issue I have with the Kass thesis is the juggernaut of credit deterioration facing the banking industry over the next one to two years. With the slowing economy, the credit problems are spreading to the commercial real estate and leveraged loans markets, i.e., “the next shoe to drop”. These are the markets that the banks have been counting on to help mitigate the earnings massacre. In addition, loan loss reserves are woefully inadequate.
If you haven’t seen it, there are some great articles highlighted in “The Big Picture” of some analysts opinions of the housing industry and banking.
Pertinent to the Kass thesis, RBC Capital Markets Banking Analyst, Gerard Cassidy presents an excellent case, citing:
” 5 Reasons Why Bank Stocks Have Not Bottomed
If you enjoy the content at iBankCoin, please follow us on Twitter1) Bank Stock Valuations Are Still Excessive:
• Current stock valuations of the Top 50 banks relative to historical valuations, remain expensive — even with the recent poor performance.• The Top 50 banks’ forward 12-month P/E ratio stands at 13.2x, which is roughly one standard deviation above the mean (25-year avg of 10.9x).
• During the trough of the last two bank stock bear markets, 1990-91 and 2000-01, P/E ratios for the top 50 banks declined to 5.7x and 10.1x, respectively.
2) Recessionary Forces Will Lead To Bigger Credit Quality Problems:
• In prior recessionary periods, credit problems typically followed as a result of the weakening economy. We believe the U.S. economy is currently facing recessionary pressures that will only worsen extending into 2009.3) Exposure to Riskiest Loan Areas Remains Extreme:
• Construction, Commercial Real Estate (CRE) and leveraged loans have provided steady growth over the past few years. Commercial loans outstanding for the US banking industry grew 64% from 2004 to 2007 due to demand from the syndicated loan market, in our opinion. As the economy weakens further in 2008, the underlying fundamental strength in commercial real estate and industrial America will soften leading to higher defaults in poorly underwritten CRE and leveraged loans.
4) Loan Loss Reserves Are Too Low:
• Bank management teams will often claim loan loss reserve adequacy only to boost reserves in subsequent quarters. We have adopted the Eyles Test (ET) for loan loss reserve strength. Banks should build and maintain reserves that will ensure survival during the down leg of the credit cycle.5) Credit Problems Are Not Likely To Peak Until 2009:
• Given our belief that CRE, construction and leveraged loan portfolios have significant room to weaken in 2008, we believe credit problems will not reach their peak until sometime 2009.”Unless we see fundamentally positive changes to the economy, improving loan performance and a drop in commodity prices, particularly crude oil, WE COULD SEE OVER 100 BANK FAILURES OCCUR BEFORE THE FAT LADY SINGS.
Finally, ignore any death threats from The PPT to buy the bank stocks.
That is all.
Note: I will be in meetings all Wednesday and most of Thursday, so I may not post again until later in the week.
