Bank Stock Investors: Listen to the FDIC!

The results of the government's stress tests appear to have reassured investors. Bank stocks have enjoyed a massive rally since the market's March 9 low:


Market Value

Return since March 9

JPMorgan Chase (NYSE: JPM  )

$137.4 billion


Wells Fargo (NYSE: WFC  )

$120.7 billion


Goldman Sachs Group (NYSE: GS  )

$71.5 billion


Bank of America (NYSE: BAC  )

$70.3 billion


US Bancorp (NYSE: USB  )

$36.1 billion


Bank of New York Mellon (NYSE: BK  )

$34.5 billion


Morgan Stanley (NYSE: MS  )

$31.4 billion


Source: Capital IQ, a division of Standard & Poor's.

However, the banking industry isn't out of the woods yes, as data released today from the Federal Deposit Insurance Corp.'s Quarterly Bank Profile makes abundantly clear.

Despite adding aggressively to their reserves in the first quarter in order to offset expected losses, banks have seen non-current loans increase even more quickly. Reserves as a percentage of non-current loans dropped to 66.5% -- a 17-year low -- from 74.8% in the fourth quarter.

The FDIC's chief economist, Richard Brown, also highlighted commercial real estate as one specific area showing increasing stress.

On the bright side, banks recorded an aggregate $7.6 billion in profit in the first quarter, a notable improvement over their $36.9 billion loss in the previous quarter. That's important, because banking profits will enable most (but not all) institutions to earn their way out of the crisis. However, super-low mortgage rates fueled a mortgage refinancing boom, and the industry's normal earning power in the post-bubble era remains a mystery.

I persist in thinking that several hundred banks will fail before this crisis is out. Most of them will be smaller institutions, but investors should be extremely cautious in looking at all banks, large or small. At mid-March prices, bank shares could be purchased with a true margin of safety. Bank stocks' subsequent rise has significantly eroded that margin – in the case of many lesser-quality banks, I'd go so far as to say it's negative, leaving investors facing the prospect of inadequate returns going forward. Be wary!

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Fool contributor Alex Dumortier, CFA,has a beneficial interest in Wells Fargo, but not in any of the other companies mentioned in this article. The Motley Fool has a disclosure policy.

Read/Post Comments (8) | Recommend This Article (12)

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  • Report this Comment On May 28, 2009, at 10:59 AM, Deepfryer wrote:

    Can someone explain WHY the stress tests have reassured investors? From what I can understand, the stress tests showed that the banks need more money - in other words, the banks are still insolvent despite all the bailouts we've already given them. I guess I must have missed the good news that came from the stress tests.

  • Report this Comment On May 28, 2009, at 11:01 AM, catoismymotor wrote:

    I wonder if Sealy makes a matteress with a built-in zipper in which to make stashing your cash easier. Hmmm?

    With commercial real estate and credit cards inching closer to the fan every day I would stay away from banks until the end of the first quarter of 2010. I think this will give enough time to see past the smoke and dust of those that are doomed to fail.

  • Report this Comment On May 28, 2009, at 11:16 AM, PricePro12 wrote:

    FDIC:The stress test only showed, that the "money" banks have recived is being put to use. Banks have also grown little by little since then, this is why investors are set a little bit to ease.

  • Report this Comment On May 28, 2009, at 12:25 PM, catoismymotor wrote:

    BAC or MGM? AIG or WYNN? Yeah, I would choose the casinos if the gov't would step out of the way to make it a fair fight.

    I just had a thought! I know, beginners luck. How would a bank behave if it were operated by former casino CEOs?

  • Report this Comment On May 28, 2009, at 12:39 PM, PricePro12 wrote:

    The casinos are hurting becuase of the Govt. the Govt really need to back off. If it is 'David vs. Goliath" Why does there need to be so many Goliaths vs little ol david. Let My Casinos go.

  • Report this Comment On May 28, 2009, at 1:06 PM, Deepfryer wrote:

    Cato: good points, and you reminded me of something.

    People don't realize that millions, if not billions of U.S. dollars are being sent overseas to a tiny island known as the Isle of Man in the United Kingdom. Why? Because the U.S. gov't continues to bury its head in the sand by not legalizing, regulating, and taxing the online poker industry. I hope everyone is writing to their senators about this, because it's just one more way that our elected officials are depriving us of our civil liberties, while at the same time sending U.S. dollars overseas. Repeal the UIGEA!

  • Report this Comment On May 28, 2009, at 2:50 PM, Sovestor wrote:

    The rules of the game to invest in financial companies are:

    - Focus on financial companies with strong fundamentals and run by shareholder-friendly management team that will benefit from the government's actions and investments.

    - Focus on financial companies with strong insider ownerships and market shares.

    - Focus on financial companies with low exposure to subprime and alt-a loans and low exposure to real-estate and commercial loans in overpriced areas.

    - Focus on financial companies that have high probability and possibility to be able to grow their revenues and profits over the long-term.

  • Report this Comment On June 08, 2009, at 2:35 AM, Levi09 wrote:

    We all need a little quick cash from time to time. A little quick cash comes in handy, for qualified borrowers, if we have a sudden emergency. Some people can go to the banking industry, maybe cash in a little bank stock (although most of it is owned by the Treasury) and some people get short term loans. The traditional avenues for short term financing, such as banks or credit cards, are not exactly the most reliable these days, and a lot of people are looking for different options. As the largest of financing firms are desperate to raise capital to pay their balances and get some <a href=" consolidation</a>, the rest of us look to other options for quick cash.

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