Money and Investing Thoughts

Check out this video from the Financial Times:

Banking with Bird and Fortune

“About the future of the world’s economy” Banker: “So long as it is about nothing important.”

Funny piece and probably pretty close to the truth.

HT: Felix Salmon

The article linked below by Tom Brown of Bankstocks.com gives and excellent recap of what went wrong with the financial sector and his not so good results as a money manager. Tom puts the purpose of the article best:

So this is as good a time as any for me to step back and reflect on how I screwed up so royally in the runup to greatest economic hurricane of our lifetimes, and what I’ve learned as a result of it all.

The article is a great read so go read it here: Bankstocks.com.

If you read the common Internet buzz concerning the current financial crisis you would get the impression that this is the worst crisis ever to hit the economy. Yet, on Friday the FDIC announced only the 10th bank failure for 2008. With over 8,000 banking institutions in the U.S., 10 failures seem a long ways away from a crisis. I decided to take a closer look at some of the data to see how “big” the banking crisis has become. Here are a few points I find of interest:

• The 10 banks taken over by the FDIC had just under $40 billion of assets in total.
• The total assets of the 10 largest banks in the U.S. is a combined $6 trillion.
• Total assets of all 8,451 FDIC insured institutions is $13.3 trillion.
• Percentage of failed assets, year to date, of total: 0.3%. Or written as a decimal: 0.003 of all banking assets were in failed banks so far this year.

In comparison, during the Savings and Loan debacle of the 1980′s and early 1990′s there were over 1,000 federally insured S&L’s disolved. The Resolution Trust Corp. took down 747 institutions over 6 years, or a rate of 125 per year. The current situation is showing no signs of getting anywhere near those levels.

The current situation has most banks taking severe write downs on any asset that has any chance of being impaired. If these assets under-perform less than anticipated, many banks could be recouping the write downs as outsized profits in the next few years.

I know many believe we are just at the beginning of a major financial crisis in the U.S. I see a financial system where home prices peaked almost 3 years ago and the mortgage meltdown started in earnest over a year ago and we still have only 10 bank failures and less than 1/3 of 1% of banking assets taken over by the feds. I do not see failures accelerating this late in the game as the economy starts to recover and the housing market is showing signs of a pending bottom.

City Bank (CTBK: 0.00 N/A N/A) of Lynnwood, WA released their 2nd quarter earnings today, and they were not pretty. They took a large charge off and a significant portion of their loan portfolio is nonperforming. Here are a few of the pertinent figures compared to the 2nd quarter of 2007.

• Net earnings of $5.3 million vs. $10.5 million, the difference can be accounted for mainly by the $4.4 million increase in loan loss reserves and $1.8 million in charge offs.
• Net per share of 34¢ vs. 67¢.
• Non-performing loans of $63 million vs. just under $2 million one year ago.
• Foreclosed assets of $40 million vs. none a year ago.
• Non-performing loans are 8.0% of assets vs. 0.18%.

City Bank’s main business is residential construction loans and it is obvious the company has a lot (8%!!) of assets in that area that are in trouble. The slowdown in residential housing construction definitely hits this bank where it hurts the most.

On the positive side, the City Bank predicts it will remain profitable, though reduced from previous years. The 15¢ per quarter dividend should be safe. Loan loss reserves now total about $15 million, which appears adequate and their Tier 1 capital ratio of 17% is well above the 4% minimum.

At this point the question for me is how long will it take the bank to work out it’s problem loans? If earnings are another 60¢ per share for the remaining half of the year the PE and yield are still around 6 at a $10 share price. Not bad valuations if this is the worst, however at this time I think it will take several quarters to work out the problems. I believe that City Bank has excellent management, but current economic conditions are working against a speedy recovery.

On Monday I plan to reduce my holdings in CTBK by about 2/3.

I hate to do this but I feel a bit good about the fact that the Ultrashort Financials ProShares (SKF: 46.76 -2.36 -4.80%) has dropped by 35% since Tuesday. This ETF is designed to give twice the gain as the loss of the Financial Select Sector SPDR (XLF: 14.735 +0.385 +2.68%). Also, double the losses if XLF rises.

Over the past couple of months I have believed the share prices of many good financial institutions have been driven down to stupid levels. At the same time my reading of comments at online articles about financial stocks showed a tremendous level of belief that the U.S. financial system and companies were in a death spiral. I hope some of those naysayers were among those who bought 35 million shares of SKF on Tuesday and now have lost a third of their investment.

I understand the beliefs of both bulls and bears, and readers here know I am pretty much of a perma-bull on the stocks I like. I have no sympathy for those who take a double exposure bet against a big part of the U.S. economy hoping the sector collapses. So here is hoping for continued gains for my financial sector picks: (CTBK: 0.00 N/A N/A) and (AYR: 14.29 +0.10 +0.70%) and I hope XLF doubles from here and SKF goes to $0. Can that happen? I don’t have a clue.

Note: I have long positions in CTBK and AYR.