Prospects for Banks and Financials

Readers of "A Dash" know that for the last year we have been contributing to RealMoney, a subscription service from (free trial available).  Before contributing, we subscribed for many years, finding the site to be a useful source of ideas and discussion.

One of the most helpful contributors is Bob Marcin, founder and General Partner of Defiance Asset Management.  Bob has a deep value approach and a nice recent hot streak.  He has advised against investment in financial stocks, while recommending early cyclicals which have been enjoying a rebound.

Bob is not one to go with the flow.  He writes authoritatively and forcefully, always bringing some good quantitative evidence to bear.

On Friday, he highlighted one of the key issues of the week, writing as follows:

Recently, Dick Bove wrote that financials offered an excellent long
opportunity, one of the best he has seen as an analyst. On Thursday,
Meredith Whitney did a piece on CNBC contending quite the opposite. I agree with Meredith.

Many are trying to bottom fish the debacle that is the financials.
That seems premature. Don’t take it from me, but from Whitney. There
many more write-offs and reserves boosts. There is a wave of
dividend cuts and dilutive capital raises ahead for regional and
money-center banks and brokers. That’s the fundamental situation.

With the stocks getting hammered, you would think the
businesses are cheap. Maybe not. Many financials still trade for 2-3
times tangible book, and that book is declining with higher loan losses
and charges. These stocks might represent value traps.

He went on to recommend that readers view the Whitney interview on CNBC.

Our Take

We certainly respect Bob’s conclusion and he has identified a crucial issue for the market.  We are concerned, as some writers like Megan Barnett of have noted, that financial analysts are engaged in speculation that might exceed their actual knowledge.

We were able to get the original reports from both analysts, and replied to Bob as follows:

Bob – I read Bove’s report and several of Whitney’s. I have also
watched interviews with both, including the one you cite. I agree that
people should watch it. I have no position in banks.

Here is the part I found troublesome. She believes that the she
knows the value of the assets better than the banks. She stated, "If
you are truly marking assets to market, you should be indifferent. Just
sell them." She says that banks have mistakenly waited and it will get
worse. The ratings agencies downgrade the assets and banks are required
to carry more capital.

The banks think that trying to sell into an illiquid market
would make matters worse. They believe the assets are under-priced
already. The various Fed lending facilities now allow them to make this
decision, something that was not the case during the fourth quarter

Whitney confidently states that the assets will have to be
sold eventually at a lower price, so banks should "take their poison —
er, medicine" right now. So if you believe that she knows the value of
the various exotic CDO’s and such better than do the banks, or that
prices like the ABX are accurate, her argument makes sense.

It is obviously much more complicated than this, but I am
trying to pull out the key assumption — and it is an assumption — in
her argument. Her reports project write-downs based upon the decline in
the ABX (for example) during the quarter. That did not really play out
for Lehman or Goldman, so who knows?


Reading sell-side analyst reports is a lot like reading seminar papers.  Over twenty years in the business we have read thousands of these reports, usually examining several on the same stock.  There is always evidence and logic, leading to conclusions.  There are also assumptions.  These assumptions relate both to facts and to methodology.  Sometimes the analyst has been pushed into unfamiliar territory.  It is always tempting to follow someone who has had a hot hand.

We have not yet reached a conclusion on this topic, but we are skeptical.  How can some analysts be so confident about the future performance of mortgage-related assets?  That is not their expertise, and it is basically unknowable.  Meanwhile, consumers of the research sell these stocks on each report and hedge fund managers pile on.  It is a crucial question that bears watching.  We have advised clients to avoid banks, and Bob Marcin has been even more aggressive (and right) in his recommendations.

[Disclosure –no bank positions, but long some other financial issues including Goldman Sachs (GS) and Merrill Lynch (MER).]

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  • alex morrow March 30, 2008  

    I believe the way to look at financials is through the windshield and not the rear view mirror. I agree with you on valuation. It’s impossible to place a value on many assets. The mark to market accounting valuation is not 100% accurate in the real world.(If I owned a printing company with a large paper inventory and my competitor goes under, has a liquidation sale and the paper goes for .30 cents on the dollar, why should I mark my entire inventory down by 70 percent. It makes no sense. I’m still in business and will sell based on what the market will bear).Financial businesses that have assets that were created to make money over some time frame, that plan to stay in business and have the financial wherewithal to do it should value assets accordingly.
    In any event, it’s tough for the outside observer to figure out these values.
    I think it’s safe to predict their will be more regulation which will place constraints on earnings power. There will be more limits on leverage employed. The too big to fail financial institutions will also be too big to take some of the risks that earned the most money.
    I’ve been focusing my efforts on hedge funds and financial businesses that will not be as regulated and will have the ability to make money by being entrepreneurial. These businesses have always had lumpy returns. This beaten down sector presents opportunity for those with a longer time horizon. In my opinion, now is the time to invest. If the prices go down, add to positions. The key of course, is to pick the right horse.

  • Mike C March 30, 2008  

    Well, if nothing else Meredith Whitney is certainly better looking then Dick Bove. 🙂
    Kidding aside, I’ve avoided banks and financials up to this point because they lie outside my “circle of competence” so I knew I couldn’t get a good handle on what their book value really was. A really smart money manager once told me, “it is ONLY WHAT YOU OWN that can hurt you”. Still, at some P/B multiple they become interesting.
    In terms of Whitney and Bove, I have ZERO doubt that their knowledge of financial companies and banks exceeds mine by a enormous margin. Having said that, if I was going to use their research to “get up to speed” who should I listen to? Who has been more right on how this would unfold since the beginning of this credit crisis in August? Should that matter?
    I remember Dick Bove swearing up and down unequivocally that Citigroup wouldn’t have to cut their dividend. Whitney said they would. What did Citigroup do? What other mistakes has Dick Bove made? What other things has Whitney been spot on right(writedowns)?
    Dick Bove says financials are an excellent long opportunity here, while Whitney says to expect more downside. Sometimes the best bet is simply to pass, but if forced to choose, it would seem going with Whitney is the better bet?

  • Mike C March 30, 2008  

    One more comment that applies to the asset writedowns.
    One recurring theme with respect to Fed analysis is this question of normative versus empirical analysis. The difference between what the Fed should do versus will do.
    Shouldn’t the same theme/concept apply to these writedowns? The focus of some seems to me to be reversed with the discussion being centered on the normative, how the assets *should be* marked, as opposed to the empirical of how they actually will be marked. Whitney in her CNBC interview lays out the chain of events for how these assets will be marked along with resultant cuts in dividends and necessary raising of capital.
    Will the assets ultimately be worth more then the marks? Maybe, maybe not. Should they be marked in some different method, other then mark to market? Maybe, maybe not. But if we are going to analyze the Fed with what is rather then what should be, I would think one should be consistent here.
    If ultimately more writedowns are indeed coming, leading to further substantial stock price erosion, then going long the names here because of how the assets ***should be*** marked is basically choosing to act/trade on normative analysis and a ticket to lose money.

  • Jeff Miller March 31, 2008  

    Mike C – I believe that I have been consistent in my approach. Investors are quite interested in whether there will be more write-downs and what inference to draw from that. Whitney seems to know better than anyone else the true value of the assets and also offers plenty of advice to bank executives on their mistakes and what they should do now.
    This article is all about looking at two analysts and evaluating their reasoning.

  • Ward March 31, 2008  

    I can’t speak for Dick Bove but as I understand his investment thesis it is that in the coming year or two banks who take deposits and make loans will be advantaged over the other financial institutions who lacked a deposit base and who obtained their funding from leverage and the derivatives markets. Right now everyone is suffering but it seems reasonable to me to think that the depository institutions may come out of the mess a bit stronger and the non bank financials weaker. On the other hand Ms Whitney’s research seems much more about playing who’s got the old maid and trying to get the next qtr right for a few points. I own some of both GS, WFC and some others but still a bit underweight the sector over all. Leaning in the Bove direction though.