The Case for (a Few) Banks

October 23, 2012

  • Don’t let 2008 scare you off, says Chris Mayer — who makes his very best case for a certain kind of bank stock
  • Fed policy backfires again: Income specialist Kelly Green on crazy amounts of corporate cash, and what it means for your dividends
  • Buying opportunity soon to emerge: Byron King unpacks an “informed rumor” in the energy patch
  • Stranded in Hawaii: Man mysteriously appears… and mysteriously disappears… from the feds’ no-fly list
  • A giant gold nugget (or a gold miner’s fish story)… the ugly realities of civil asset forfeiture… overwhelming police response… and more!

  “We Have More Ideas Than Money.”

“You don’t hear that much today,” Chris Mayer comments on PL Capital’s latest Financial Edge Fund presentation.

“Most of us have more money than ideas,” Chris goes on. “We live in a market where a potential crisis of one sort or another makes every idea look like a straw house in Hurricane Alley.”

Speaking of straw houses, “you probably know bank stocks have had a bad decade,” Chris writes. “You can’t tell by looking at Palmer’s and Lashley’s Financial Edge Fund. It’s beaten not only bank stock indexes, but the overall market by a wide margin.

“I spoke with John Palmer hoping some of this magic might rub off on me and that he would share some of his thoughts on investing in banks. I don’t know about the magic yet, but on the latter he did not disappoint.”

 We began by talking about all the challenges banks have to deal with. This leads to one inevitable conclusion — and a clear path to profit from the changes.

“First, those challenges,” Chris begins. “Today’s low interest rates squeeze bank profits.

“The bigger banks can handle lower rates and make a profit,” Mr. Palmer chimes in. “At the community bank level, we’re going to feel pain in our margins. I don’t think it is a lot of pain. Loans have been priced down again and again. I am not sure they are going to price down further.”

  Second, says Chris “the regulators are making it expensive to be a bank.”

Banks, Mr. Palmer explains, “are looking for layers and layers and layers of risk protection, which is expensive. I can’t tell you how many times I’ve had a CEO tell me, ‘Well, we didn’t want to make this loan because we know as soon as we make it we’re going to get criticized by the regulators.

“If you can’t grow your business,” Mr. Palmer goes on, “if you can’t grow profitability, then you are going to be forced into consolidation.”

100  “So what happens next?” Chris asks.

“Here we get to our inevitable conclusion. The smaller banks will consolidate into bigger banks. This way, they can spread those costs over a bigger asset base.”

And according to this chart from PL Capital, consolidation is past due for a rebound.

“The turn is at hand. Now what to do?” Chris ponders. “I say buy the smaller banks.”

As market forces slowly eat up small banks, “For now,” Chris writes, “you can get pretty good little banks for less than tangible book value per share. As they move up the food chain, your little bank stock could trade for 2 or 3 times book down the road as part of a much bigger entity.

“Small bank investing is a safe strategy too because banks have had five years to fix their problems and are in better shape today. Don’t let the ghosts of 2008 frighten you away from this opportunity.” Chris identifies a favorite in the current issue of Capital & Crisis.

  “The Fed’s policies are only causing more cash hoarding… not less,” says Kelly Green of our income desk — tracking another unintended consequence of Fed policy.

Apple reports earnings on Thursday. “So far this year,” Kelly writes, “it has consistently piled more cash into its coffers every quarter: $98 billion in the first quarter… $110 billion in the second quarter… now $117 billion in the third. Remember, this is the first year the company has paid a dividend — among the largest in dollar terms in the world. It is still making too much money to know what to do with. So it is just sitting on it.”

General Electric is in the same boat: It’s refinancing $5 billion in debt… even though it expects to build up to $100 billion in cash over the next four years.

“By the Fed’s own statements,” says Kelly, “you’d expect General Electric to be spending its massive cash pile on expansion, new hiring and acquisitions. That’s not happening.

“Many of these companies are filling their money pits as a cushion from another economic downturn,” says Kelly, identifying one factor at work. “But we suspect a great number of these massive corporations are waiting on a resolution to the big tax debate this winter.”

One huge unanswered question: Will qualified dividends continue to be taxed at 15%? Or will they be taxed as ordinary income?

If you’re in the right kind of dividend payers — the kind Kelly and Jim Nelson track in Lifetime Income Report — the blow from higher dividend taxes will be softened. Companies that grow their dividend each year will continue to deliver a growing stream of income: You can collect 8-10% pay increases every year. Where else in the private sector can you do that these days?

  The Fed “can’t print earnings growth,” reads a note this morning from Miller Tabak analyst Peter Boockvar… a reality that’s kicking the mucus out of the market.

Dupont disappointed… UPS fell in line with estimates but revenue came up short… 3M and United Technologies cut their outlooks. At last check, the Dow is down nearly 1.5%. The S&P’s been knocked back to 1413 — its lowest level since early September.
Meanwhile, Moody’s cut the credit rating of several provinces in Spain. So it’s a “risk-off” day among other asset classes, too…

  • Gold is back to a six-week low at $1,709. Silver has sunk below $32
  • Crude has slid below $87 for the first time since mid-July
  • The dollar index is back within sight of 80; the euro is a shade below $1.30
  • Treasury yields are sinking; the 10-year note is at 1.77%.

As we go to virtual press, the major economic number of the day also surprised to the downside: The Richmond Fed manufacturing index is back in negative territory. That’s three of the last four months the number has indicated contraction.

  Look for buying opportunities soon in the energy services sector, advises Outstanding Investments Byron King.

“Price competition is fierce in North America for fracking jobs,” says Byron, keeping his ear to the ground for “informed rumors.”

“The once-robust profits on frack jobs — injecting high-pressure fluids to break up deeply buried rock and liberate the ‘tight’ gas and oil — are tightening up due to a severe decline in gas drilling by operators across the spectrum.”

Here’s the background: “With the new oil and gas plays involving directional wells and multistage frack jobs, operators are putting more and more capital and services into wells that (for the most part) deplete faster than in the olden days.

“What used to be a $1 million well could now cost $5-10 million. Plus, it would deplete twice as fast. So five times the cost for half the oil or gas? You’re talking about an order of magnitude change in EROEI. Or another way of looking at it is that the overall economics of energy production are transforming before our eyes.

“Still, sometimes things can be evident, but not obvious. Right now, the profound nature of the world’s EROEI shift isn’t apparent to most people — not to most investors, not to a lot of alleged ‘energy analysts,’ not to most politicians and policymakers. But the new reality of EROEI is what the world looks like from the back side of the Peak Oil curve.”

Here’s what it means, short and long term. Start with slipping margins for the energy-services players, “which will translate into share price deterioration. For the long-term investor, it’s a chance to buy into great, global firms at a discount.

“Looking out into the future, the world will need the likes of these companies. Without the technical services they supply, you can kiss the oil (and gas) age goodbye.”

 Paradise turned prison?

“Hawaii is a paradise for most visitors,” says The Associated Press. “But it was Wade Hicks Jr.’s prison for five days.”

As our “War on You” file continues to grow… we’re becoming a little overwhelmed. What once was a small pile in the corner of our office is now overflowing out of filing cabinets and taking on a life of its own. Here’s the latest:

After hitching a ride on a military flight to visit his wife, a U.S. Navy lieutenant, Mr. Hicks found himself on FBI’s no-fly list during his layover in Hawaii.

“How am I supposed to get off this island and go see my wife or go home?” Hicks asked a U.S. Immigration and Customs Enforcement agent and bearer of bad news.

Her response? “I don’t know.”

“How could someone on a list intelligence officials use to inform counterterrorism investigations successfully fly standby on an Air Force flight?” AP asks.

How, indeed.

After confirming they had the right person and not being told why, Hicks “wonders whether his controversial views on the Sept. 11 terrorist attacks played a role,” AP writes. “Hicks said he disagrees with the 9/11 Commission’s conclusions about the attacks.”

The mystery may remain forever unresolved, as AP points out, “The government doesn’t disclose who’s on the list or why someone might have been placed on it.”

  “It’s scary to know that something like this can happen in a free country,” Mr. Hicks said.

“You’re not accused of any crime. You haven’t been contacted by anyone. No investigation has been done. No due process has taken place.”

Although Hicks wasn’t allowed to fly, he was able to score a hotel room at the Pearl Harbor naval base while he figured things out. A base full of submarines, cruisers and destroyers, mind you.

After considering private planes, cruise ships and even a fishing boat from Alaska, Hicks finally received a call five days later informing him he was clear to fly.

Before all is said and done, according to AP, Hicks “plans to seek to recoup his added travel costs from the government.”

Heh… good luck.

Before you get caught up in a Kafkaesque episode like Mr. Hicks, you might want to review Addison’s latest forecast.

  “If that is a 60 kilo chunk of gold, that is a significant find,” says Darren Seivwright of precious metals producer Gold Fields.

“If it is, I wish it were mine.”

A photo of large gold nugget believed to be found near Kalgoorlie-Boulder in Australia has surfaced and is causing a buzz in the gold mining circles.

Although, understandably, no one has claimed ownership, its estimated price tag sits around $1.6 million.

$1.6 mil? Not bad for a day’s work…“Rumors of big gold finds in the area are not uncommon, but rarely verified,” ABC News reports.

“However, in 2010, the Ausrox Gold Nugget, weighing more than 23 kilograms, was discovered with a metal detector in the Eastern Goldfields.”

Meanwhile, whether true or fiction, we’d imagine metal detector sales are going to see a spike in the near future…

  “If I’m reading Friday’s 5, right,” a reader inquires, “if someone wants to raise ‘wacky weed’ on the back end of my farm, without my even knowing it, and authorities happen to find it, then the government could confiscate my land!!??

“Sure changes my feeling about ‘pot’ laws. Hmmmm, maybe it would help my 71-year-old aching back.”

The 5: Believe it or not, the laws are better now than they were 15 years ago. The feds are held to a higher standard of proof under the Civil Asset Forfeiture Reform Act of 2000.

But don’t be lulled into complacency: “The forfeiture laws allow the government to seize any property that is connected to a crime or purchased with the proceeds of that crime,” writes the ACLU’s Denise Lieberman. “For marijuana growers, this can mean homes, farms and other items of real estate used in the cultivation or distribution of marijuana may be seized if the government can show that it was used to facilitate the crime or purchased with the proceeds.

“While innocence of the crime by the property owner is a defense for these forfeitures, the law generally places the burden of on the property owner to prove his or her innocence.”

Which is how Russ Caswell, discussed in Friday’s 5, is in danger of losing his motel.

  “The scary thing,” a reader writes, “about cases like Russ Caswell’s and all the other similar instances of the police state: IF IT HAPPENS TO ONE PERSON IN THE USA — IT CAN HAPPEN TO ANYONE.”

  “I’ve maintained for some time,” writes another, “that all governments are corrupt; it’s

just that some hide it better than others. To me, civil asset forfeiture laws are just another attempt to hide the corruption. ‘It’s not corruption, it’s the law!’

“Keep up the good work of bringing these things to more people’s attention.”

  I was foreman for a federal grand jury for the North Central District of Texas in the early 1990s,” writes a reader with another perspective. “The things you described were just begging to happen at that time. Except they were pretty well restricted to the federal segment of law enforcement.

“Believe me when I say I left my term terrified of my government at the federal level. However, I now am just terrified of all my government’s levels of law enforcement.”

  And I thought the local county sheriff’s department was the only one drunk on militarization and power to respond to an attempted suicide with the SWAT team,” writes an Ohio reader, reacting to a Pennsylvania reader’s story.

“Two weeks ago, the father of one of my employees became distraught and suicidal as a result of withdrawal of an antidepressant medication. When my employee and her mother called the police for help when he left the house with his shotgun and went out behind the barn, the county SWAT team showed up.

“Dressed in full combat gear including masks (!), they proceeded to set up surrounding the barn and closing off traffic on the road — even though the house and barn sat 200 yards off the road. They also brought the canine unit and a helicopter! These poor women were more traumatized by the police over-response than they were by the potential suicide. It appears that the police were looking for an excuse to gear up and go into ‘battle.'”

  “Was waiting at a red light late one Saturday night,” adds another. “Suddenly come police cars, lights blazing, speeding through the intersection. Several cars mind you, racing into the supermarket parking lot. A few cars circling the store with floodlights.

“We got curious and figured it was a shootout or a murder! I mean, close to a dozen police cars. So we sent a friend in to buy something and get the scoop. SHOPLIFTER !!!!

“Ten cars running red lights at high speeds for a grocery store shoplifter. really ?”

The 5: And your friend wasn’t arrested for “obstructing an officer”?


Dave Gonigam
The 5 Min. Forecast

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