Does This Mean Banks Are Out of the Woods?

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Recession? Never heard of it. Financial crisis? I don't know what you're talking about.

Bank of America (NYSE: BAC  ) is a four-bagger from its low just over a month ago. Citigroup (NYSE: C  ) has more than tripled in value. Wells Fargo (NYSE: WFC  ) announced that it expects to post a $3 billion quarterly profit, sending the stock up over 30%.

On Friday, our suggestion that banks permanently attached to the government's teat might make inferior long-term investments was sharply rejected by readers as "utter crap."

Panic hasn't shifted to jubilation this quickly since ... well ... last fall -- the last time Citigroup tripled in value and Wells Fargo announced better-than-expected earnings.

Which makes us wonder: Is the worst really behind us, or is this just another emotional outburst by investors who've swung from chaotic pessimism to blind optimism?

While there are indeed sprouts of hope, investors have plenty of reasons to remain suspicious. Here are a few arguments for and against jumping back into bank stocks.

Reasons to be bullish

(1) Buffett was right
"The spreads have never been wider." Warren Buffett told us last month. "This is a great time to be in banking." Boy, was he right.

With borrowing costs at zero, it's almost impossible for banks to not post operating profits. That boost is largely behind Wells Fargo's earnings surprise, as well as Citigroup's recent announcement of operating profitability. When you can borrow money at 0% and lend it out at 5%, good things are bound to happen.

(2) Good news from the stress test
While official results haven't been released, The New York Times reports all 19 major banks will not only pass the Treasury's "stress test," but regulators have found banks' books in better shape than they expected.

The stress test was never meant to be pass/fail -- and some banks will be found to need more capital -- but the results are apparently strong enough to avert taking over a major bank in its entirety.

(3) Get ready for the write-ups?
We're doing everything humanly possible to get frozen portions of the credit market flowing again. Sooner or later, it'll work.

Between the public-private investment program, TALF, and trillion-dollar purchases of Fannie and Freddie securities, new prices might be discovered in a way that allows banks to write up the value of previously depressed assets. Relaxation of mark-to-market accounting rules could also let banks gain the upper hand on writedowns.

Reasons to be bearish

(1) Wells Fargo isn't your average bank
Sure, Wells Fargo appears to be doing great, but be honest -- Wells Fargo isn't exactly the poster child for financial fallout.

First and foremost, legacy Wells Fargo didn't have nearly the exposure to toxic CDO assets other major banks do, and the toxic waste inherited from the Wachovia acquisition was written down substantially as soon as it hit Wells Fargo's books. It also has a relatively small exposure to credit cards -- widely considered the next shoe to drop -- compared to Citi, B of A, JPMorgan Chase (NYSE: JPM  ) , or American Express (NYSE: AXP  ) . Most importantly, it priced risk better than almost anyone during the boom years.

That one bank is doing well means little for the industry as a whole. Since last fall, Goldman Sachs (NYSE: GS  ) , Morgan Stanley (NYSE: MS  ) , and Wells Fargo itself have trudged along while other banks have teetered on bankruptcy. Taking results of the strongest banks and assuming it's universal to the entire industry is the same sort of baseless optimism that got us here in the first place.

(2) There's so much more pain ahead
Fun facts:                                                                            

  • The International Monetary Fund now expects total global writedowns to reach $4 trillion -- a mere $3 trillion more than banks have already absorbed.
  • Meredith Whitney estimates nationwide home prices will fall 30% more than they already have.
  • Even the government admits unemployment could breach 10% by next year.
  • The pain of commercial real estate and credit card loans has barely been acknowledged yet.
  • Even the strongest banks have historically slim tangible common capital ratios.

(3) What did I miss?                         
Bank-stock investors have been slaughtered over the past year because balance sheets turned into a black hole of trillion-dollar complexities no honest investor could fully comprehend.

Yet now that shares have rallied, investors feel like financial geniuses with all the right answers. Message boards are suddenly filled with investors triumphantly giddy over the riches of bank stocks ... but what's really changed besides the share price? Very little.

The truth is, the same problems we had last month -- exploding delinquencies, rising unemployment, falling home values, and opaque balance sheets -- are still here. As Paul Krugman said last week, "We have some real real problems. They are not going to go away through self-fulfilling optimism."

Just a few thoughts to consider. Got your own opinion on bank stocks? Feel free to share it with us in the comment section below.

For related Foolishness:

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. American Express is a Motley Fool Inside Value recommendation. The Fool owns shares of American Express, and has a disclosure policy.

Read/Post Comments (13) | Recommend This Article (35)

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 April 13, 2009, at 5:00 PM, FinancialFellow wrote:

    I think all that's really happened with bank stocks is that it's become apparent that they aren't going to immediately collapse. That's what's helped Citibank go from $1 a share to almost $4 a share. To Krugman's point, though, there is still all that toxic debt just sitting on the bank's balance sheets. Until that gets figured out the banks will only be able to recover so much - both on their stock price and fundamentals. I feel like bank stocks like Citi are going to be a grand slam or a strikeout over the long haul. There won't be an in between.

    In case you'd like to see how the banks got into this mess in the first place this is a really cool, simple explantion:

  • Report this Comment On April 13, 2009, at 7:10 PM, docmjr1 wrote:

    This article emphasizes the right thing when it comes to banks: not all banks are alike. Never have been and never will be. I still believe that Citi, Bank of America, and that ilk have considerably more pain to endure before this is over. Wells Fargo....not so much. WFC's loans and deposits are growing and the total loan portfolio stands at 178 billion. And they've written off how much...a little over 1%. USB is in this same boat, the one that doesn't have all the leaks and is in danger of capsizing. Both of these banks will wind up taking market share and improving their margins as this crisis unfolds. The large multinational banks won't.

  • Report this Comment On April 13, 2009, at 7:49 PM, oghowie wrote:

    My advisor keeps telling me not to chase the market and buy into the bank stocks, but the returns people are getting right now are ridiculous.

  • Report this Comment On April 13, 2009, at 7:55 PM, bigdividends wrote:

    The fear for both b of a and citi was nationalization. Now that seems to be off the table. Citi is in worse shape than B of A. I have a feeling that B of A is actually going to come out of this extremely strong. Will they have huge asset losses. Most definitely. But in the long term, they will have a larger piece of the pie in commercial lending, mortgages and credit card lending. Add to that, they are now a "major" player in global asset management with the Merrill lynch acquisition.

    5 years from now I see JP morgan, B of A and Wells being the MEGA banks with Citi being a shell of itself. One of the regionals will probably be move into the Mega bank status. A telling sign will be who starts acquiring deposits off the failed banks (and yes, more banks will definitely fail this year.

  • Report this Comment On April 13, 2009, at 8:19 PM, bigpeach wrote:

    Mr. Housel, I think you're over simplifying the situation. People are realizing several things, the main one being that the selling was over done. When you ask the question, "What has changed?" you could have asked the same question about tech stocks in 2003. The answer of course was not much of anything. People had woken up and realized the valuation they had previously been applying was insane.

  • Report this Comment On April 14, 2009, at 7:25 AM, Varchild2008 wrote:

    I have non bank stocks with plenty of problems. I didn't give up on them... Then 1 month later I see signs of a recovery..

    So why not bank stocks? They have plenty of problems, but I don't think any amount of doom and gloom is going to somehow justify a complete reversal in share prices. The *hurt* banks like Citi and Bank of America have not even recovered to trade at ZERO year to date. And that's THIS YEAR to date... That's not even counting the ridiculously, dramatic, insane plummet that happened all last year.

    We won't see $40 a share for BOA for several years. Maybe a decade. But, I don't think people are jumping into these financials with short term illusions of grandeur here. People wanted the banks to be merely "investable" for the long haul. The fact that they won't fail and go under puts them in investable territory.

    I'll just hang on to my shares for the next 10 to 20 years and I bet the scary, doom, and gloom, stories will eventually be rendered meaningless by then.

  • Report this Comment On April 14, 2009, at 7:53 AM, KWT8011 wrote:

    I think it's great that you acknowledged the commentary from the last article. Maybe there'll be a little more substance and a little less "buy our newsletter" from TMF.

  • Report this Comment On April 14, 2009, at 10:02 AM, vasplieon wrote:

    Banks are marking to profit again and this will bite them and everybody else in the ass in the end. Watch C and BAC have incredible earnings just like GS and Wells Fargo did. So all these banks are raking in the cash by ????? My guess being full of crap like they were before the meltdown. If it was just one of these having record profits or all of them doing well but not astronomically well I may have hesitated in calling foul, but something stinks bad and my money will not be in any of these for the time being.

  • Report this Comment On April 14, 2009, at 2:41 PM, Mosquito7778 wrote:

    Kahuna, you never cease to amaze me with your long winded pointless posts.

    Maybe you are trying to fight off the early stages of alzheimers by constantly reminding yourself and everyone else about your memories. I cant think of another reason why your long post about buying a car in 1972 has any thing at all to do with the artcle to attached it too. Best of luck to you.

  • Report this Comment On April 14, 2009, at 8:01 PM, sajenfool wrote:

    Look at 1998 price of the Financial Index XLF. It was tadeing at $24-26. This was before the housing bubble, CDS, derivatives etc After all the loans , derivatives and are all unwound , banks should go back to the normain say 10 days. That would be maybe 1998 levels. XLF now is trdaing at 10.25.

  • Report this Comment On April 14, 2009, at 10:08 PM, jesse2159 wrote:

    American banks have $3 trillion in bad assets that need to be absorbed by sell off's before they can make a profit. The banks announcments that they increased OPERATING INCOME is a false and misleading scale for them to use. It means that they made money from their current operations,..without mentioning the toxic assets that will bleed money from profits, day by day, week by week, month by month, for years to come. One step forward, two steps back is dancing, not advancing. Once the banks open their books on their bad assets, we might be able to value their shares. Until then, buy something else.

  • Report this Comment On April 17, 2009, at 2:53 AM, casalotta wrote:

    This is my question regarding C, my son is a Federal Employee and for years was given a government credit card issued by BOA, 2 months ago, the government pulled all Federal Workers BOA cards and reissued with Citi. How many Federal and DOD employees are there out there?!? This must be good for Citi because these cards will be paid by the feds as company expense cards for deployments, TDY and all other official government business. This should be billions in guaranteed credit card payments and revenue and a big loss for BofA

  • Report this Comment On April 17, 2009, at 12:19 PM, bigcat1969 wrote:

    Trillions. Someone correct me if I'm wrong, but haven't various branches of the de facto government given, loaned or promised to cover debts in the financial sector in the range of Trillions of dollars in the past six months. Isn't this why things are good again at the banks? With a 14 trillion dollar deficit is this federal aid sustainable? Can the banks survive without government handouts and zero interest? Is all this 'good news' simply spin from the giant government / financial conglomerate?

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