It's the end of the world as we know it -- but U.S. bank stocks feel fine!
As per my bold prediction early in January, U.S. money-center banks have been on fire to start the year. The continuing sovereign debt crisis in Europe and the impending $130 billion-plus euro bailout of Greece has hardly affected the valuations of the United States' largest banks. In fact, Bank of America (NYSE: BAC ) continues to be the best-performing stock in the Dow Jones so far this year.
The question on everyone's mind though is whether or not this rally is sustainable. I continue to see signs that the answer resoundingly points to "Yes!"
Bank on this trend
One of my favorite measures to keep an eye on is bank closures. The Federal Deposit Insurance Corporation, or FDIC, acts as an independent agent of the U.S. Government and, essentially, polices the banking sector, making sure all banks maintain certain safety and soundness requirements in order to operate. When banks don't meet the bare minimum conditions, the FDIC closes them down.
Since the credit crisis in 2008 that saw central banks flood the financial system with liquidity and bailouts, banks in general have done a very good job of focusing on increasing their capital levels, and regulators have raised the bar for them in case of another global meltdown. This isn't to say that banks haven't failed -- but the trend of failure has fallen off dramatically in the past year.
Source: FDIC Failed Bank List.
There's actually a very interesting similarity to note with these figures and the Great Depression. In the 1920s, roughly 70 banks failed each year. In 1930, this number grew to 744 -- about 10 times as many as in the preceding decade. This is fairly similar to the failure rate we saw in 2009-2010, which was slightly higher than 10 times as high as the worst year in the preceding decade.
But a more important fact to keep in mind is that as many as 4,000 banks may have failed in 1933 alone. The banking system back then was less concentrated and populated by smaller banks, so that accounts for a big part of the difference. And the Fed this time around has been much more accommodating of the economy and financial system. But the regulations that are put in place today by the FDIC and the requirement that banks keep more capital at their disposal is a testament to why our banking system, no matter how similar the current credit crisis seem to the Great Depression, is unlikely to get that bad again.
This isn't to say that nine bank failures in the first six weeks of 2012 should be considered a "success" -- we still have a long way to go, obviously. It does, however, signal what I believe is a trend toward banks taking more responsibility for their holdings and at least attempting to be more prudent with their investment strategies.
One nation, under debt, indivisible …
U.S. Government securities don't have exactly the type of return that many shareholders would approve of, but they are unmistakably one of the safest investments to choose from. Just look at how rapidly commercial banks have flocked to U.S. Government securities -- they've doubled their holdings since the recession of 2002.
Source: St. Louis Federal Reserve.
Providing stability in their investment portfolios while fortifying their liquidity positions, America's banks, both big and small, are beginning to look healthy once again.
It's the capital, stupid!
As one last piece of evidence, I introduce a side-by-side comparison of tier-one equity ratios (often used to determine the health in terms of liquidity for financial institutions) at the height of the credit crisis in 2008 versus now. Please note the stunning differences:
2008 Tier-One Capital Ratio
Latest Quarter Tier-One Capital Ratio
|Bank of America
|JPMorgan Chase (NYSE: JPM )
|Wells Fargo (NYSE: WFC )
|Citigroup (NYSE: C )
|US Bancorp (NYSE: USB )
Source: Investors Relations for each company.
These banks have definitely had different paths to freeing up capital. For Bank of America, it meant issuing shares and shedding a good chunk of its assets, including its holdings in China Construction Bank. For Citigroup, it involved spinning off Primerica in 2010 and selling its remaining stake in 2011. For Wells Fargo, JPMorgan Chase, and US Bancorp, share offerings made up a big chunk of their capital raises, with each company adding roughly 2 billion, 400 million, and 200 million shares respectively to their previous outstanding totals, since 2008 B of A and Citigroup were certainly no slouches in the share-issuance department either.
I'm not ready to discharge the U.S. banks from the hospital yet, but it's clear they've entered the "Forrest Gump playing ping-pong in the hospital" stage of their recovery. Capital positions and asset quality are improving and bank failures are falling. This bank rally is just getting started, in my opinion.
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