T-H-E Banks!

[Guest dealraker]

Packer16 wrote (from the conference he went to):

 

I just got back from the CFA valuation conference and there was one hedge fund manager that had some interesting insights into financials.  Namely, that loan demand is going to be weak along with higher capital requirements which will lead to declining RoE for most balance sheet based institutions to pre-1980s levels of 7 to 9%.  This type of decline in demand has been present in Japan since the bust and there has been a net destruction of capital since the bust.  Similar to what may happen in the US.  If you use this benchmark of 7% to 9% RoE, many banks look overvalued and the future does not look bright with delevering going on throughout the economy. 

 

This old fellow AGREES for the most part with whoever said this.  So paying 2 times tangible book value for a BBT and 4 times tangible book value for a Wells Fargo may not be the wonderful investment some think- although surely Wells will do MUCH better than its peers. 

 

Normalized earnings?  What's normal now may be different!

[Packer16]

One caveat however is the lower RoE is for lending based activities versus processing/asset management activities.  I did talk with the speaker after his talk and he does not consider processing/asset management activities part of financials only balance sheet lending activities (which typically comprise most of bank earnings).

 

Packer

[Guest dealraker]

Fees for running funds have simply got to fall DRAMATICALLY don't they?

 

A 1% fee for a 6% world is taking a whopping cut - to nearly 100% guarantee underperform an cheap Vanguard index fund.

[tyska]

Fees for running funds have simply got to fall DRAMATICALLY don't they?

 

A 1% fee for a 6% world is taking a whopping cut - to nearly 100% guarantee underperform an cheap Vanguard index fund.

 

They will only fall when their marketing campaign no longer works on the masses.

 

Dan

[wabuffo]

Namely, that loan demand is going to be weak along with higher capital requirements which will lead to declining RoE for most balance sheet based institutions to pre-1980s levels of 7 to 9%.  This type of decline in demand has been present in Japan since the bust and there has been a net destruction of capital since the bust.

 

Well unlike Japan - much lending was done, not by banks, but the shadow banking system via securitizations and captive/non-captive finance subsidiaries of manufacturers/retailers.  Much of that has disappeared -- eg, mortgage, home equity, new auto loans, used auto loans, student loans, jumbo mortgages, mezzanine financing, DIP financing, etc....

 

Plus -- two of the biggest banks (Wamu, Wachovia) disappeared -- not many big Japanese banks folded, IIRC.

 

I actually think its quite the opposite -- big banks is where you want to be in 2010.

 

wabuffo

[goldfinger]

Wabuffo,

 

Can you tell us more about your current pick CASH? I would be interested in your analysis about this bank.

 

[SharperDingaan]

 

All banks will suffer a lower ROE as the capital requirement increases. While most of the securitization boosts (earned fees on zero 'net' assets) are out of earnings at this point; that wasn't the case 2-3 years ago. Pick your reference point carefully!

 

WEB has pointed out that part of the bailout is effectively recapitalizing the banks via earnings on artifically high loan spreads (courtesy of ultra-low central bank rates). About 6-8 quarters (from memory), so it should stop by the end of 2010. Projecting off 2010 forward earnings could be a mistake.

 

Banks probably are over-priced for the medium-term, but its unlikely to harm them at this point.

 

SD 

[wabuffo]

Can you tell us more about your current pick CASH? I would be interested in your analysis about this bank.

 

I like it because of its rapidly growing stored value/open-loop prepaid card business.  Open-loop prepaid is basically a debit card that can run on the VISA/MasterCard network or at ATM's.  But unlike traditional debit cards, its pre-loaded and is not tied to a bank account.  There are many uses for it and its the fastest-growing segment in the bank payments sector (though from a small base).

 

Its a very speculative pick and I wouldn't recommend it unless you are comfortable analyzing banks.

 

wabuffo

[Munger_Disciple]

Its a very speculative pick and I wouldn't recommend it unless you are comfortable analyzing banks.

 

Wabuffo,

 

Can you recommend some resources for someone trying to learn how to analyze banks? Thanks in advance.

[Guest Broxburnboy]

Its a very speculative pick and I wouldn't recommend it unless you are comfortable analyzing banks.

 

Wabuffo,

 

Can you recommend some resources for someone trying to learn how to analyze banks? Thanks in advance.

 

For the bear case on the state of the banking industry, bankimplode.com is a fun resource.

 

Some of their points are well taken:

1. More small/regional bank busts are expected, FDIC is broke, they have resorted to billing the industry for next and future years contributions. This allows the industry to carry the payments as prepaid expenses, an asset, instead of

a current liability which has the effect of eroding their capital base.

2. The TBTF banks are protected from failure by TARP and other implied future bailouts.

3. The TBTF banks have all recently done huge capital raises which will further dilutes shareholder equity (which may in some cases be simply accounting fiction anyway)

 

Cheers

 

 

[goldfinger]

Thanks a lot Wabuffo, I'll take a look. You are a very talented investor by the way.