Betting on Bailouts

With all the reports of financial trouble and central bank bailout packages in Europe, some investors are interested in buying distressed financial stocks on the theory that a government or the central bank won't let them fail.

After big drops and likely backstops, companies like Allied Irish Banks (NYSE: AIB  ) and Bank of Ireland (NYSE: IRE  ) may look like tempting, if high-risk, buys. Rather than run the investment case for those banks, I want to review the share price history of some recent U.S. bailouts on the theory that history at least rhymes, even if it doesn't repeat.

General Motors highlights the risk of investing based on bailout expectations. The U.S. government stepped in and saved the operation with cash loans and an equity stake. The stock recently returned to the market with an initial public offering, but not before a bankruptcy that wiped out investors in the old GM, which is now called Motors Liquidation. Shares of Fannie Mae and Freddie Mac have lost more than 90% since bailouts were widely anticipated. Clearly a bailout for a company doesn't mean shareholders are safe.

The table below presents a broader picture using share prices of the first eight banks to participate in the U.S. Treasury's TARP. The Friday before plan details were announced is used for the prebailout price. The table also shows the low over the remainder of 2008 for each of the stocks and the recent closing price. Historical prices are adjusted for dividends.

Stock

10/10/08 Prebailout Price

2008 Post-TARP Low

11/26/2010 Price

10/10/08 – 11/26/10 Change

Bank of America (NYSE: BAC  )

$20.26

$10.92

$11.12

(45.11%)

Bank of New York Mellon

$25.37

$23.50

$27.14

6.98%

Citigroup (NYSE: C  )

$13.90

$3.76

$4.11

(70.43%)

Goldman Sachs (NYSE: GS  )

$86.82

$50.99

$158.22

82.24%

JPMorgan Chase (NYSE: JPM  )

$40.75

$22.24

$37.50

(7.98%)

Morgan Stanley

$9.30

$8.95

$24.70

165.59%

State Street (NYSE: STT  )

$42.84

$28.45

$43.84

2.33%

Wells Fargo

$27.17

$21.09

$26.65

(1.91%)

Source: Yahoo! Finance and author's calculation.

The results aren't decisive. Investors buying Goldman Sachs on prebailout speculation have done quite well; those who banked on a backstop for Citigroup aren't so happy. However, patience was rewarded across the board. Investors who waited on the details got opportunities to buy every one of these stocks at lower prices before the year ended. Those that waited for the March 2009 lows got even better deals. Even now, more than two years after TARP kicked in, my Foolish colleague Alex Dumortier makes the case that a basket of big, bailout bank stocks make for a cheap industry leader.

I don't know how the European bailouts, banks, and backstops will play out. I'm sure some investors will find great bargains in the wreckage and some will lose lots of euros. I do know that in the recent U.S. version of this play, there was no need to rush in. Investors who waited on the details and then waited for bad news or panic to depress share prices did much better than those who bought on bailout and backstop speculation.

Related Foolishness:

Fool contributor Russ Krull owns shares of Wells Fargo, but has no position in any other companies mentioned. The Fool's disclosure policy is well-capitalized, doesn't need a bailout, and serves as a Foolish backstop.


Read/Post Comments (6) | Recommend This Article (11)

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  • Report this Comment On November 29, 2010, at 5:52 PM, Momentum21 wrote:

    Hi Russ,

    Fannie and Freddie certainly come to mind when thinking about IRE and AIB but remember that these 2 banks have been getting crushed from the same point as all of the other financials back in 2008.

    Many folks were playing 2.17 as a "bailout bet" for AIB back in June.

    The current shakedown to a low of .76 was the very real threat of the default of a nation...and the point at which I think panic was pretty darn high.

    AIB is no GS (or even Citi for that matter) but I would contend that if you are drawing parallels to the bailouts we are beyond those post bailout 2008 numbers.

    That said, AIB is a risky play on a variety of levels. A conservative investor looking to play these bailout fears can probably find more compelling stories in more stable European economies and/or sectors that have been taken down by the bailout fears.

    More diversified banks like STD, energy plays like STO, or a diversified basket of German stocks like EWG.

    I do own AIB @ 1.14 and realize that the only thing I know for sure is that it is somewhere between 2.17 and zero. : )

  • Report this Comment On November 29, 2010, at 9:41 PM, rd80 wrote:

    Hi Mo,

    Thanks for the comment and perspective. I picked start points shortly before the US bailouts were finalized simply because the European bailouts hadn't been finalized. Your point that the European banks are farther down the timeline because this is a global problem that's been well under way does make sense.

    As I'm sure you know, there have been several developments over the past couple of days. There's a little more clarity, but there are still a lot of details to be hammered out for the banks and lots of opportunities for something to go badly.

    FWIW, I think you've got the right attitude on your AIB. Nothing wrong with high risk/high reward as long as you understand and accept the risks.

    Good luck with AIB, my guess is it'll continue to be a choppy ride for some time.

    Russ

  • Report this Comment On December 01, 2010, at 11:33 AM, IAO1985 wrote:

    What about NBG?

  • Report this Comment On December 01, 2010, at 7:14 PM, rd80 wrote:

    I haven't done any digging into NBG, so no opinion there. My main point was that, based on the US track record, investors have time to wait for details and pick entry points, no need to make a rushed decision.

  • Report this Comment On December 02, 2010, at 12:50 PM, puccini3005 wrote:

    Excellent article, thanks for the chart.

    Who failed the stress tests? Is there a link or something to look at those in more detail?

    Thanks!

  • Report this Comment On December 02, 2010, at 9:50 PM, rd80 wrote:

    @puccini3005

    Recommend a search on the keywords European bank stress test. That turned up a number of articles. Here's one that lists the seven banks that failed the test - http://www.bbc.co.uk/news/business-10732597

    The Committee of European Banking Supervisors' detailed results are linked at http://www.c-ebs.org/EuWideStressTesting.aspx

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