Welcome, Guest | Register or Login
Jim on Facebook Jim on Twitter Jim's YouTube Channel Jim on Google+

Important Stuff


Stuff Jim Reads

Reverse Goldilocks bank stocks: The best buys weren’t really terrible or really good but just bad enough

posted on December 15, 2009 at 8:30 am
Print This Post

Ah, to be healthy bank that dodged the last financial crisis in residential mortgages and isn’t cowering in fear of the new one in commercial mortgages and loans.

You be hovering up deposits from savers looking for safety. Licking your chops at all the tasty businesses that competitors not as skilful or lucky were selling off at bargain prices. And enjoying the steepest yield curve in 30-years where short-term deposits or borrowing costing almost 0% can be turned into loans prime (currently 3.25%) plus.


Actually, a bank doesn’t have to be quite as pure as the driven snow to enjoy that paradise. You can even have taken a bath in the financial crisis. Issued mortgages to dead-beats unable to pay. Bought your way into businesses you didn’t understand at what turned out to be the peak of the market.

You could have done any and all of that—and still be in a position to clean up on the woes in the financial sector—as long as you’ve recovered more quickly than your peers. So desperate as investors and regulators for anyone to take the worst turkeys off their hands before they turn into billion dollar liabilities that all past sins are forgiven if you’ve got a  balance sheet now that looks strong enough to bear the load.

Banks like these—I’d call them reformed sinners—are to me the most interesting and potentially profitable segment of the banking sector. Because they didn’t dodge all the damage of the financial crisis, they didn’t snap up big deals in the early days of the crisis. So they’re not full up. But now that they have put their sins behind them to emerge as potential “rescuers” rather than candidates for rescue, they’re in a position to pick through what is still a most attractive and still growing pile of distressed financial companies.

I’ve got two banks like this to tell you about in this post. One I’ll add as a buy to Jubak’s Picks with this post. The financial sector is correcting now and it’s a reasonable time to add a financial stock. The other I’m going to put in my Watch List because the financial sector correction might have a way to go yet and what’s a bargain now might become a still bigger bargain not too far down the road.

(And by the way, I’ll be launching a formal watch list on this blog, following much the same format as one of my portfolios, in January. A number of readers have asked for a watch list, saying that it would help them keep track of potential buys. I think it’s a good idea so I’ll have it up as soon as the wonderful people I work with can get it built.)

Here’s why I think reformed sinners are the best buys in the financial sector right now.

Regulators and worried investors have already tapped the most visible survivors of the financial crisis and banks such as JPMorgan Chase (JPM) are sitting back, stomachs full, still trying to digest the assets they “rescued.” JPMorgan Chase, for instance, acquired most of Washington Mutual for $1.9 billion to help out the Federal Deposit Insurance Corp. (FDIC). That deal expanded JPMorgan Chase’s market share in California but on top of the acquisition of Bear Stearns and the still ongoing integration of BankOne, I’d have to say that JPMorgan is done “rescuing” troubled financial companies for a while.

That means investors and Wall Street analysts are looking at something like a finished product. The JPMorgan Chase to a year from now will be different from the JPMorgan Chase of today but in ways that are relatively predictable. The changes will be continuations of current trends. The company will integrate and rebrand acquisitions, get costs out, port products from one unit to another to create a uniform selling proposition, and build market share in key businesses by exploiting the base gained in these deals.

Nothing wrong with predictability, especially when current trends are running so strongly in JPMorgan Chase’s favor, but since, with a little intelligent extrapolation, what you see today is what you get tomorrow, the stock is likely to be more accurately priced by the market for its level of risk.

“More accurately than what?” you ask. Than reformed sinner banks who are still in acquisition, I mean “rescue,” mode, I answer.

One of these is U.S. Bancorp (USB). On October 30, the bank helped out the FDIC by rescuing nine banks with $18 billion in assets and 150 branches in Texas, California, Illinois and Arizona that had belonged to FBOP Corp. of Oak Park, Illinois. (U.S. Bancorp subsequently sold off the three Texas banks it has acquired as part of this rescue.) Just weeks before that, in another transaction U.S. Bancorp acquired $800 million in deposits in Arizona that BB&T (BBT) had recently acquired in another “FDIC facilitated transaction.”

I think you get the idea.

There’s no reason to believe that U.S. Bancorp is done—because the FDIC isn’t done facilitating transactions. The agency’s list of troubled banks climbed to 552 at the end of the third quarter. That’s up from 416 at the end of the second quarter. That’s the largest the troubled bank list has been since December 31, 1993 when, in the middle of the savings and loan crisis, the troubled bank list hit 575.

The troubled bank list this time around could still challenge the 1993 numbers. The banking crisis, rather than being over, has simply shifted focus. In 2008 and 2009 the crisis was all about residential mortgages and the derivatives built on them. That stage in the crisis isn’t by any means resolved—mortgage foreclosures will hit a new record in 2009 (see my December 10 post http://jubakpicks.com/2009/12/10/household-wealth-and-foreclosure-rate-both-rise-what-kind-of-recovery-is-this/)

But the crisis now expanded to loans and mortgages on commercial real estate—you know loans on malls, hotels, condominium developments, etc. Projections say defaults on these loans will be on the rise into 2011 at least.

Which is extremely troubling since the default rate on these loans had already reached a 16-year high of 3.4% in the third quarter of 2009. According to Real Estate Economics, defaults could hit 5.3% within two years.

The names you’re likely to hear in this commercial real estate phase of the financial crisis aren’t the big boys like Citigroup (C) and Bank of America (BAC) who played starring roles in the residential mortgage crisis. The commercial real estate crisis is focused at regional and community banks. Not only did they make lots and lots of these loans to local real estate developers but these loans make up a huge proportion of their portfolios. According to data compiled by Bloomberg, these smaller banks have about four-times the concentration in commercial real estate as the portfolios of the biggest U.S. lenders.

The size of the banks that are likely to be in trouble over their commercial real estate loans works to U.S. Bancorp’s advantage too. Acquiring one of these banks or a bunch of its branches and a hunk of its deposits is small change to a JPMorgan Chase. The deal is too small to be a game changer. That company needs a deal like its acquisition of Washington Mutual, which added 2300 branches to move the needle.

U.S. Bancorp isn’t tiny by any means but with just 2,800 branches in the United States, adding a few hundred branches here and a few hundred has a bigger relatively impact on the bank’s bottom line. And especially on its strategy of funding its lending by gathering deposits. A bank’s ability to grow its deposit base depends on its ability to dominate geography with branches and its brand.

Reformed sinner banks aren’t limited to the United States. HSBC (HBC), for example, is a reformed sinner that is using this crisis to increase its already formidable presence in Asia.

HSBC sinned deeply and fell hard in the crisis. The company spent $15 billion in 2003 to buy Household International in order to enter the U.S. mortgage market. The timing of that deal was just right so that HSBC could get hammered in the U.S. housing bubble and bust. Actual write downs from the Household International business were about the same as what HSBC had paid to acquire the company.  The math of that deal turned into paying $15 billion to buy $15 billion in losses.

But reform took hold of HSBC hard in 2009. The bank closed its U.S. consumer finance unit to new business in February 2009 and to close its 800 HSBC branches that specialize in consumer lending. The bank has been running down its $62 billion U.S. consumer lending portfolio since then. In April the bank raised $17.7 billion in capital through a stock offering that it used to buttress its capital ratios. And finally HSBC CEO Michael Geoghegan has announced that he will be moving his office to Hong Kong from London. That’s a very visible affirmation of the bank’s decision to return to its Asian roots. Hong Kong and the rest of Asia accounted for 26% of the bank’s assets at the end of 2008.

That percentage looks like to rise now that HSBC has emerged as the front runner to buy the Asian assets of troubled Royal Bank of Scotland (RBS). Those assets looked like they would go to Standard Chartered (SCBFF) earlier in the year but that bank and Royal Bank of Scotland couldn’t come to terms. On December 10, the Financial Times was reporting that HSBC was close to striking a deal with Royal Bank of Scotland for the sale of 28 branches in India and 13 in China. In March Royal Bank of Scotland posted the biggest loss in United Kingdom corporate history. The bank is now majority owned by the government.

The Royal Bank of Scotland stake in Asia isn’t the last set of assets that troubled United Kingdom, European, and Middle Eastern banks will have to put up for sale. And HSBC will be there to make a go at any distressed asset sale.

With the Chinese economy set to return to 10% economic growth in 2010—how sustainable that is for the long term is another story—and with Chinese exports likely to return to growth this quarter or next (see my post http://jubakpicks.com/2009/12/10/when-will-chinas-currency-strart-to-climb-against-the-dollar/ ), owning a bank that owns an increasing bit of Asia’s banking business seems like a good investment.

I’m adding HSBC to Jubak’s Picks with this post. I’ll post a full buy spelling out my logic in more detail later today.

Full disclosure: I own shares of HSBC, Standard Charted, and U.S. Bancorp in my personal portfolio. I will buy more shares of HSBC three days after this is posted.

Related Posts

No related posts.


  • bsorge on 15 December 2009

    This looks expensive at these levels per earnings and PE

  • lotteollie on 15 December 2009

    Jim: Any concerns with this stock holding a lot of assets in Dubai? Thanks.

  • EdMcGon on 15 December 2009

    Jim, HSBC has some godawful ugly financials (4X debt/equity for starters, not much better than Citigroup). You’re gambling that their business plan will work spectacularly. Based on their history, I don’t see it. In fact, I bet their return to Asia is a knee-jerk reaction to getting burned in the U.S.

    If I were you, I’d wait until after Groundhog Day. If you still like HSBC then, go for it.

  • drogala2 on 15 December 2009

    Jim this is an off topic question about one of your other Jubak Pick’s stocks. What’s the deal with Ormat Technologies lately (ORA)? The shares have taken a beating the past few days on no tangible news I’ve seen. If you have some insight on this or if anyone else does either I’d really appreciate. I have a moderate position in @ $40.

  • terryw on 15 December 2009

    always been a fan of hsbc, im in.

  • YX on 15 December 2009

    I think after Citigroup’s retreat, HBC and STD are in better position than others to become the next major global banks. Disclosure: I own both HBC and STD, thanks to Jim.
    This makes me think again about those who ruined Citi, once the greatest global bank and the flagship American bank!

  • Amos on 15 December 2009

    I have been accumulating shares in another regional bank that I think is moving into acquisition mode and was still hoping to buy more but then Jim’s article comes out today and the stock jumps 6%. Thanks Jim……

  • Jim Jubak on 15 December 2009

    lotteolie, the exposure to Dubai World and to Dubai turned out to be small. I posted on that on December 4. Her’s the link: http://jubakpicks.com/2009/12/04/hsbc-and-standard-chartered-have-little-to-fear-from-dubai-world/

  • Jim Jubak on 15 December 2009

    drogala, an off the topic question deserves an off the topic answer. The best I can figure is that the drop in Ormat is related to negative news on a DOE-funded geothermal project that recently pulled the plug. This was one of the pilot projects that got government funding in an effort to jump start the sector. I think Ormat is reacting to the disappointment but it doesn’t have much to do that I can find with Ormat

  • Jim Jubak on 15 December 2009

    Ed, I’ve never seen anyone pay much attention to debt to equity ratios for banks. Most bank borrowing is for funds to lend out so as a bank’s business expands its borrowing goes up. You’ll note that most of HSBC’s borrowing is short-term–that’s exactly how banks fund loans these days. Much more important is the capital ratio and here HSBC is in good shape after the rights offering. The bank should list in China in 2010 and that should provide another shot of capital. I thought you were going to raise the issue of the big liabilities still in the U.S. business. HSBC is trying to wind down this portfolio but if the U.S. economy and the housing sector in particular dips back into recession the losses will be greater than I now expect. (My buy is based on my belief in a modest 1.5% to 2% growth in the U.S. in 2010.) In the short-term while the business in China is promising it is still generating losses so HSBC can’t expect profits there to offset unexpected losses in the U.S. I think the biggest danger is that the recovery I’m looking for won’t arrive in 2010 but will be delayed until 2011. I don’t think that will happen but that is the downside. Current expectations at S&P are for operating earnings of $4.05 in 2010 so the stock isn’t expensive if that projection is accurate.

  • drogala2 on 15 December 2009

    Thanks for the response Jim! Keep up the great work, love reading it 5 times a day now.

  • EdMcGon on 15 December 2009

    Jim, while you are correct about banks and debt/equity, in a fragile economy such as we are currently in, I think that’s a reasonable concern. For example, Bank of America’s debt/equity is at 3X.

    I guess what I am trying to say is the banking industry has not recovered from the real estate collapse, and there are still real dangers out there, which your Citigroup post brought up perfectly. IF a “too big to fail” bank like Citigroup were to go under again, as you stated there would be more losses, even for an HSBC.

  • lotteollie on 15 December 2009

    Thanks for your reference on Dubai. I managed to get in before the closing bell. Everything you do is much appreciated.

Post a comment

You need to login in order to post a comment.

Comments that include profanity, or personal attacks, or antisocial behavior such as "spamming" or "trolling," or other inappropriate comments or material will be removed from the site. We will take steps to block users who violate any of our terms of use. You are fully responsible for the content that you post.

Jubak in your Inbox

Get Email Alerts

Sign up now and download Jim's latest Special Report

Get the RSS feed

Quick Quote

Quotes provided by Yahoo! Finance and are delayed up to 20 minutes.