Streetwise
Lauren Rudd
Sunday, July 27,
2008
A Winner in the Banking Industry
“We've had five bank failures this year with 90 banks now on
the FDIC's ‘troubled bank’ list. Historically, that's not a lot,” said Sheila
Bair, chairman of the Federal Deposit Insurance Corp. “During the S&L crisis we
were closing one a day and 1,500 were on the troubled list.”
Stop! To begin with banks are not supposed to fail. That is
why we have bank regulators, although nowadays I use the term loosely. Banks and
major investment houses have been playing fast and loose with the rules for some
time. Yet, with a rising stock market and rapidly rising real estate prices no
one wanted to admit that Camelot would one day fall.
Yet, fall it did. Mortgage securities resembled Hollywood sets, realistic façades with nothing behind
them. At the same time, the tremendous deficits resulting from Iraq and Afghanistan brought the dollar to
its knees.
The Administration favored a weak dollar because it meant
increased exports and favorable currency translations for corporations. The
economic cost was skyrocketing energy and commodity prices with the associated
inflationary pressures.
Now the time has come to pay the piper only the cupboard is
bare. Giants like Merrill Lynch are reduced to selling off the family jewels.
Banks are in dire straights. Some, like IndyMac, are being resuscitated by the
FDIC. Others have chosen to implement the smoke screen defense, filing suit
against anyone pointing out the error of their ways.
This debacle was not created overnight and it will not be
fixed overnight. President Bush made the profound statement, “Wall Street got
drunk and now it's got a hangover.” Nonetheless, there are investment
opportunities to be had in the interim if you have the foresight to see through
the carnage.
As an aside, please note that if you keep less than $100,000
in a bank account, your money is safe, period. Keeping more is foolish. Treasury
securities are available at auction for zero cost. They have no risk, are the
equivalent of cash and pay interest.
Because Wall Street often throws the baby out with the bath
water, you might want to consider Bank of America as an addition to your
portfolio. I have recounted the veracity of this bank’s assets and management on
several occasions. Recently Ken Lewis, BofA CEO, proved the point when second
quarter results exceeded Street expectations, despite a set aside of $5.83
billion for bad loans.
BofA earned $3.41 billion, or 72 cents per share, in the
quarter, down from $5.76 billion or $1.28 per share a year ago. The shares have
increased nearly 80 percent since hitting a low of $18.52 on July 15. That was a
nice return for those with foresight.
During the bank's recent conference call with analysts, Lewis
indicated that "Credit losses are still going up, but given what we see today
they are manageable. Second, the fact that we can absorb $3.6 billion in credit
losses, take $1.2 billion in additional write-downs, add $2.2 billion to our
allowance for credit losses and still earn $3.4 billion should tell you
something about the extent and consistency of our earnings power." Lewis also
reiterated his intention to maintain the quarterly dividend at 64 cents a share.
The recent dividend yield is 9 percent.
Nonetheless, losses on home-equity loans continue to be a
problem, rising to 3.1 percent on an annualized basis in the quarter, up from
1.7 percent in the first quarter. The bank also wrote off $645 million of
collateralized debt obligations. But that was down from $1.47 billion in the
first quarter.
Meanwhile, investors who own debt securities issued by Countrywide are not
guaranteed repayment and they are concerned that BofA will absorb the best
assets of Countrywide, while keeping as much as $38 billion of debt in a new
unit created by the acquisition, Red Oak Merger. Red Oak could then file for
bankruptcy protection, shielding BofA from liability.
