Here's my pal Meredith Whitney on CNBC yesterday, explaining why she disagrees with my view that, at 1.2 times tangible book, bank stocks are attractive:
Last year, what happened was, in the first quarter of '09, it marked the first quarter where [the big banks] started to actually create their own capital and a lot of that was through writing up their carrying values of government mortgage-backed securities"”Fannie and Freddie"”that put, we estimate, $100 billion in the capital reserves of the top banks. In the first quarter of '10, you actually saw the first decline in capital values, a reversal of that. Second quarter, I don't think the banks will be creating their own capital. Why would you pay more than capital for a bank that is not creating its own capital? So what will happen is they will have raised money to buffer writedowns somehow, and so you see the banks"”and this is really important"”the banks shrinking to free up capital. So you're buying a shrinking entity to free up capital to play a capital arbitrage to buy back shares. There's got to be a simpler way to invest.
And here I thought the gal was incoherent! That second-to-last sentence, in particular, is something to behold. In a way, I guess, it's a sort of bizarre gift.
Some of the other chunks of Meredith's wad of words above are almost as impenetrable. I have no idea what she means, for example, when she says "I don't think the banks will be creating their own capital" in the second quarter.
Warning! What follows is so darn basic that it gets covered in the very first month of Accounting 101, right after debits and credits. I apologize in advance if I sound condescending: A bank, like any business, "creates capital" in one of two ways. It can either a) earn a profit and retain that profit in the retained earnings portion of its equity account, or b) raise capital in the securities market via the sale of common shares or some other equity-like instrument such as a convert.
As I say, this is basic. Further, it is overwhelmingly likely that the banking industry will make money in the second quarter, and for the full year, and in 2011 and 2012, as well. Everyone"”including Meredith Whitney herself, judging by the earnings estimates from her firm I see on the Bloomberg"”agrees with that. Which is to say, the industry is creating its own capital. Even Meredith says so! I honestly don't have a clue as to what she's talking about when she says otherwise.
Speaking of me not having a clue about what Meredith is talking about, I don't have a clue, either, about what she means when she says that banks will have to "raise money to buffer writedowns." The loan loss provisions for the banks she covers have declined for last three quarters, and there's little doubt that the decline will continue. As provisions decline, earnings will rise, so there will be no need for Meredith's banks to raise more equity.
No doubt there's a credible bearish case to be made on the banks, and Meredith Whitney is of course free to have her own opinion. But her views ought to be based on objective facts in our own world, not ones from the fantasyland she seems to have constructed for herself.
What do you think? Let me know!
Bankstocks.com is a public web site operated by individuals who also operate investment advisory firms that serve as investment advisers to hedge funds (the "Firms"). Some articles are authored by employees of the Firms while others are authored by third parties. Under no circumstances does any article posted on Bankstocks.com represent a recommendation to buy or sell a security. This article is intended to provide insight into the financial services industry and is not a solicitation of any kind. The Firms do not vouch for the accuracy of any information contained in any article posted herein and the views expressed in any article herein do not necessarily reflect the views of the Firms. The Firms buy and sell securities on behalf of their fund investors and may do so, before and after any particular article herein is published, with respect to the securities discussed in any article posted herein. The Firms' appraisal of a company's prospects is only one factor that affects the Firms' decision whether to buy or sell shares in that company. Other factors might include, but are not limited to, the presence of mandatory limits on individual positions, decisions regarding portfolio exposures, and general market conditions, and liquidity needs. As such, there may not always be consistency between the views expressed in this article and the Firms' trading on behalf of their fund investors. There may be conflicts between the content posted on Bankstocks.com and the interests of the Firms. For an explanation of these conflicts, including an explanation of our trading policy, and how we resolve them, click here.
Neither the authors nor any Bankstocks.com team members can provide investment advice or respond to individual requests for recommendations. However, we encourage your feedback and welcome your comments on any of the articles on this site. Neither the authors nor Bankstocks.com has undertaken any responsibility to update any portion of this article in response to events which may transpire subsequent to its original publication date.
Read Full Article »