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1,000 Banks Will Fail In Next Two Years

Paul Miller, Managing Director and head of financial institutions research at FBR Capital Markets, is well known in the investment community for providing in-depth, fundamental analysis and investment recommendations on thrifts and mortgage finance companies….

TWST: Are there any good stories out there?

Mr. Miller: In my coverage list, I don’t have any. But you have to really pick out small – some of the small, good community banks that have done very well. There is one that’s out there that I do not cover, it’s called First Niagara (FNFG), and it has been able to pick up some of the branches that PNC had to divest in the Nat City (NCC) deal. It’s in upper New York; they were very conservative, had a lot of capital on the sidelines and they raised capital for growth. And that’s the type of company that you want to look at – companies that are raising capital not to shore up their balance sheets but to take advantage of dislocations. It’s just one example. I think the Northeast area is the area that you can dig around to find some nice gems.

TWST: Is that because there are more community banks in that area than in other parts of the country?

Mr. Miller: Not necessarily. Every region has their unique flavor. The Northeast had its share of mergers, but the Midwest has unit banking, which created a ton of banks in Illinois and some other Midwestern states. And so you might say you have too many banks sitting out there – too many small banks that can’t overcome these crises. Illinois didn’t have a big run-up in its housing market, but yet it’s leading – one of the leading states – in bank failures because so many of its banks are just not big enough to overcome the crisis. I think every region is unique. There are 8,000 banks out there, of which probably close to a 1,000 will fail over the next couple of years. But I would think mostly the big failures have already taken place. On an asset side, it’s definitely going to be smaller but the numbers will be mind-boggling. Still, it really won’t mean a lot, if that makes sense.

TWST: To have all those small banks fail?

Mr. Miller: It’s not going to be as devastating as you think because the asset size will not be that big. You’re not going to have any more WaMus, which really caused a lot of panic in the system when they took place.

TWST: On the list you’re following, do you rate anything as a “sell” currently?

Mr. Miller: We have a few “sells,” more than I would like to have. We think Wells Fargo is very rich at these levels. We believe that their credit losses are coming slower in the late cycle, but they have not recognized the losses like some of these other companies have. So we are very concerned about Wells Fargo’s valuation, with it trading at three times book. It’s one of the highest-valued stocks that we have on our coverage list.

TWST: Are there any other stocks or any developing stories you are following that are worth noting?

Mr. Miller: Yes, the big issue that we are watching right now has to do with another foreclosure wave and the impact it will have. The foreclosure moratoriums really shut down foreclosures for six months, from last year up to March 31 of this year. Now that the foreclosure moratorium has been lifted, it takes about six months to take possession of a home and get it ready for sale. And so you are going see at the end of the year a hidden inventory start to come out putting what we think could be significant pressure on home prices. If so it would put another leg down on home prices. Now what we don’t know – which we hope, because nobody wishes for negative news on a constant basis – is that there is enough demand out there to buy up this excess inventory sitting on the banks’ balance sheets on foreclosed properties. If there is not, you could see some more downward home pricing pressure, which could have a self-fulfilling impact on people exiting the market, which would then see more pricing pressure on the downside than you really want to see in the market.

Bank takeovers worsened the financial crisis by making firms that were already too big even bigger, said Nouriel Roubini, the New York University professor who predicted the financial crisis.

“The institutions are insolvent,” Roubini said in a Bloomberg Radio interview. “You have to take them over and you have to split them up into three or four national banks, rather than having a humongous monster that is too big to fail.”

JPMorgan Chase & Co. agreed to buy Bear Stearns Cos. in March 2008, with help from the Federal Reserve, while Bank of America Corp. purchased Merrill Lynch & Co. Wells Fargo & Co. took control of Wachovia Corp. and PNC Financial Services Group Inc. got National City Corp.

Banks around the world have reported $1.29 trillion in credit losses tied to the housing market collapse since 2007. The deficits, which spurred the first simultaneous recessions in the U.S., Europe and Japan since World War II, pushed the American government to pledge $12.8 trillion to stabilize the banking system and revive economic growth. That figure amounts to $42,105 for every man, woman and child in the country.

The Standard & Poor’s 500 Index, which tumbled 38 percent in 2008, has rallied 22 percent after sinking to a 12-year low on March 9. Roubini said in a Bloomberg interview that day that the S&P 500 is likely to drop to 600 or lower this year as the global recession intensifies.

Bloomberg has an article on: FDIC may run Bad Banks

The Federal Deposit Insurance Corp. may manage the so-called bad bank that the Obama administration is likely to set up as it tries to break the back of the credit crisis.

U.S. stocks gained, extending a global rally, on optimism the bad-bank plan will help shore up the economy. The Standard & Poor’s 500 Stock Index rose 2.4 percent, Bank of America Corp., down 54 percent this year before today, rose 15 percent. Citigroup Inc., which had fallen 47 percent this year, climbed 18 percent.

FDIC Chairman Sheila Bair is pushing to run the operation, which would buy the toxic assets clogging banks’ balance sheets.

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The government will likely use its ownership of toxic assets to rework soured mortgages and prevent foreclosures.

The bad-bank initiative may allow the government to rewrite some of the mortgages that underpin banks’ bad debt, in the hopes of stemming a crisis that has stripped more than 1.3 million Americans of their homes. Some lenders may be taken over by regulators and some management teams could be ousted as the government seeks to provide a shield to taxpayers.

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Still, nationalization of a swath of the banking industry is unlikely. House Financial Services Chairman Barney Frank said yesterday “the government should not take over all the banks.” Bair said earlier this month she would be “very surprised if that happened.”

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Obama is under increasing pressure to drastically revamp the $700 billion Troubled Asset Relief Program for the ailing industry. While setting up a bank to buy underwater assets is emerging as a favored approach, it could drive up the cost of the rescue in excess of $1 trillion.

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Billionaire investor George Soros said in Davos today the plan to buy toxic assets won’t be enough to get financial institutions to start lending again. “It’s not the measure that would turn the situation around and enable the banks to lend. You are nationalizing the debt and keeping the upside in private hands.”

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A key question for the bad bank would be how to value the toxic assets it would buy. Geithner, outlined three possible alternatives: look at how the market is pricing similar assets; use computer model-based estimates from independent firms; and seek the judgment of bank supervisors.

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Bair has said that cash from the TARP may help capitalize the bad bank and that commercial lenders may kick in some money of their own. One possibility that’s been discussed is issuing firms some kind of stock in the new organization as partial payment for their impaired assets.

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The financial sector stocks and ETFs are taking off today. Financial Select Sector SPDR (XLF) is up 11% today. WellsFargo is up 25%, Citi is up 17% and Bank of America is up 15%. These are mind-blowing returns for a day. The question is how long will this rally continue ? Again and again we have seen these rallies fizzle out.