Who's the Next IndyMac?

The past decade was headlined by record bank profits and explosive growth, turning a once ho-hum industry into a road to easy riches. Fortunes were made investing in mortgages. Huge dividends were paid. It was a great time to own bank stocks.

Those days are over. Welcome to banking 2.0.

The recent collapse of IndyMac caused the banking industry to turn a corner. Forget about a rebound. Forget about pending write-offs and dividend cuts. The big question in the banking market today is much more pressing: Which bank is next to fail?

This is a pretty serious question we're addressing here, people. Banking is one of the economy's most vital sectors, providing the lifeblood of nearly every industry. It isn't just home loans and foreclosures in jeopardy; everything from a healthy mergers-and-acquisitions market to the capital that funds tech companies relies on the strength of banks.

Who might be next on the chopping block? Before the specific names get tossed around, let's address an important point: IndyMac, Bear Stearns, and even Freddie Mac and Fannie Mae were all handed their respective problems because of investor fear, rather than just the problems on their books. Yes, all of them got in way over their heads, but judgment day usually comes from investors and depositors getting the heck out of Dodge before things get worse, rather than banks failing on their own watch. There are several banks right now that, strictly from an analytical viewpoint, have more than enough capital to stay alive -- but that doesn't mean they're out of the woods. The big question isn't just which banks have the gnarliest books ... it's which banks have the gnarliest books and a spotlight in their face.

And now, the names...
Richard Bove, one of the banking industry's most respected and widely followed analysts, came up with a list of banks in seriously deep water. He divided banks' non-performing assets by reserves and common equity -- anything greater than 40% was relegated to the "danger zone." Washington Mutual (NYSE: WM  ) , Santander BanCorp (NYSE: SBP  ) , and Flagstar Bancorp (NYSE: FBC  ) are a few of the largest names currently imperiled, according to Bove's calculations.

Two other names that have taken serious beatings lately are Wachovia (NYSE: WB  ) and Bank of America (NYSE: BAC  ) , both of which made untimely acquisitions of alternative mortgage lenders that saddled their books with who-knows-what mortgage products. Wachovia slapped down $25 billion for Golden West Financial near the peak of the real estate bubble -- a move that littered its books with adjustable-rate mortgages that are now greeted like the plague. Meanwhile, Bank of America is the new proud papa of Countrywide, a lender that ventured down the same shady-mortgage road as its now-defunct neighbor IndyMac.

Both Wachovia and B of A are huge, well-known institutions that have diversified lines of business in their favor, and they're unlikely to croak anytime soon. But their high-profile status comes at a price. The size of their companies and the magnitude of their writedowns make them vulnerable to media attention, which can leave them hammered by investors and depositors who treat them like toxic waste.

The Foolish bottom line
Many banks will fail over the next several years. Most of them, however, will likely be so small that you'll barely hear a peep about them. 

The banks that should pop up on your radar are those prone to both fatal credit concerns and widespread panic -- names like Washington Mutual (NYSE: WM  ) and National City Corporation (NYSE: NCC  ) . Both banks may be small enough to bypass the need for a bailout, but large enough to gain serious attention when the bad news starts pouring in. Both have been completely hammered in the past few days, to the point where there's hardly any outcome that gives you reason to own the stock. 

Either they go kaput, or they raise huge amounts of capital with shares so depressed that there'll be little left over for you if they manage to survive. Buckle up, Fools. The fun is just beginning.

For related Foolishness:

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. Bank of America is a Motley Fool Income Investor recommendation. The Fool has a disclosure policy.

Read/Post Comments (6) | Recommend This Article (10)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 15, 2008, at 5:15 PM, ihadtosay wrote:

    From someone who works at one of the banks wrongly put on the list, it pays to check CNBC for corrections or retractions, like the one printed today:

    Meantime, Bove himself is trying to "clarify" his report using the two ratios. He says he meant them to show that the banking industry is actually not so bad compared to 1990. “This data, we thought, indicated that banks were in better condition than generally perceived,” writes Bove.

    "Apparently, it has been misinterpreted to suggest that there are significant problems in the financial system. This is not my point at all.” Addressing concerns by clients about specific big banks, Bove says only Washington Mutual is “on the edge of danger,” adding that “We are definitely not suggesting that National City or First Horizon, (which he has Buys on) is in dangerous condition at the present time.”

  • Report this Comment On July 15, 2008, at 7:07 PM, banker2008 wrote:

    I totally agree with "ihadtosay". I also work for a bank on the "danger" list. These poorly written articles are trying to scare people into pulling their money out of their "said" danger banks, which WILL cause a collapse. So the reporters should be held responsible for spreading panic. Check out your bank, learn about its finances and balance sheet before pulling your money out. All this (and that stupid CNBC one) article is going to do is put a lot of people out of jobs. Shame on them!

  • Report this Comment On July 15, 2008, at 8:04 PM, nemesisinvestor wrote:

    I agree with "ihadtosay" and "banker2008". This kind of broad sweeping panic mongering for the sake of a news story is not what we need.

  • Report this Comment On July 15, 2008, at 10:30 PM, whoelsetoblame wrote:

    I agree with the other readers. I don't work for any of the banks listed but that doesn't stop me from using common sense. This is like a witch hunt. Let's just start pointing fingers and say "Hey, they could be in trouble!" Guess what-- everyone is in trouble if there isn't some reasonability and responsibility required by these 'so called' business writers on the internet. Shame on you-- "Who's Next?" Why don't you just cry 'FIRE" in a crowded movie theatre.

  • Report this Comment On July 15, 2008, at 10:50 PM, mcdmario1 wrote:

    Foolish, First of all the writer is a bit ignorant. On the Street Bank it is known that Bank of America has one of the strongest balance sheets in the business. To compare Wachovia's purchase of Golden with Bank of Americas of Countrywide is also assinine. One was bought at a steep premium and the other a bargain along the lines of Bear Stearns discount.

    Beyond the apparent, is also the different business models, Wachovia thrived in sub-prime skip pay mortgages where BofA got out of the sub prime business many years ago.

  • Report this Comment On July 19, 2008, at 8:55 PM, tgiles04 wrote:

    I read this article the other day when first published- The same day I purchased an idiotic amount of wamu stock. My current portfooolio is now made up of tech,bio,energy and 50% wamu. I must say I'm sitting on a pretty penny because I made a foolish decision. Thanks again for the good advice...

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