Banks led us into this mess, and banks will lead us out

By Wade A. Barker, 19th Apr 2012 | Follow this author | RSS Feed | Short URL http://nut.bz/gm6lpede/
Posted in Wikinut>Business>Investment

Foreclosures caused worldwide weakness in the banking sector over the last several years. This sector needs to strengthen before wide spread economic expansion can exist.

Introduction
Interest Rates
Balance Sheets
Conclusion
Definitions

Introduction

In 2008, we started to see the banking sector have an erosion of their earnings due to the rise in foreclosures. Their balance sheets weakened substantially as more and more of their loans became questionable. The banks had to write these assets off their balance sheets at ‘fire sale’ values. As these loans became more and more delinquent, the bank was required to hold more cash in reserves. These reserves are money that the bank cannot loan out to individuals or businesses. Moreover, these banks were not making any profits on these delinquent loans and were becoming very cash strapped. One analyst commented that Bear Stearns had a very high Net Asset Value but was sold for a fraction of that Net Asset Value. I would argue that they had ‘dead assets.’ They had plenty of assets (they owned homes that they had foreclosed on) and therefore had a high Net Asset Value. However, these assets do not pay the bills. Cash pays the bills and these assets were not creating any cash. Therefore, these banks had plenty of assets but could not pay their bills and were essentially bankrupt.

Interest Rates

In addition, the Federal Reserve has lowered interest rates to the point that many banks are seeing an increase in mortgage applications. While some of these are to 'buy' a house, many of these applications are to refinance their existing mortgage. Nonetheless, this increase will help the banks create revenues and fees.

Balance Sheets

The balance sheet of banks should improve starting in the 2nd quarter of 2009 and improve going forward. FASB has changed the rules for how banks should account for their foreclosed assets. As previously discussed, the banks had to account for these assets according to ‘fire sale’ prices. Now a foreclosed asset can be recorded at its observable market price (or fair value of collateral). Therefore, because these assets are now going to be valued at a higher level, the balance sheet of many of these banks will improve.

Conclusion

Many of the large banks such as Goldman Sachs, JP Morgan, Citibank, Wells Fargo, and Bank of America have either shown nice profitability, or at least they have shown stability in their business. Most of these companies have seen nice improvement in their stock price recently. My opinion is that these stocks will continue move upward through the summer. Wall Street analysts will like to see the growth from last year and start upgrading the stocks. These companies will see improvement in their profitability due to low interest rates and individuals refinancing their mortgages. Lastly, the balance sheets of these businesses will improve so the companies will look more stable than they did last year.

Definitions

Glossary:
Fire sale: drastically reduces prices, the price you could get by selling an asset out on your lawn today.

Net Asset Value: the value of Assets minus the value of Liabilities

Dead asset: An asset or investment that is not creating any income or dividends. An example would be a rental property that has no tenant.
Balance Sheet: Assets minus Liabilities equals Owners’ Equity.

FASB: Financial Accounting Standards Board

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Meet the author

Wade A. Barker
Wade Barker has over 15 years of experience in the stock market, the U.S. and world economies. He worked for a technology fund of a large mutual fund company managing $11 billion.