US Banks: What a Difference a Year Makes

Although recent financial news has a decidedly cataclysmic tone, evidence continues to mount that things are improving frustratingly slowly and steadily, exactly as expected.



Today, the FDIC announced that US banks earned, in aggregate, 21.6 billion dollars in the second quarter of this year (FDIC). Though this is still well below historical standards, what is striking is that most banks (80% of them) have returned to profitability.

Back in May, when I first publicly recommended bank stocks (US Banks), headlines warned that the government might force banks to be broken up and sold, that financial regulation could destroy them, and that a new debt crisis (ex. Greece) might soon cripple them. None of these things has materialized.

Since May the US financials index (XLF) has nonetheless dropped from $15.36 to $13.44, despite quantitative improvements in all areas of banking: decreased leverage, reduced loan loss provisions, increased profitability, improved credit market stability, and more.

The new worries for banks include a flattened yield curve (making credit spreads less profitable), a potential double-dip in housing, and that Barack Obama is secretly a communist Muslim and/or Biblical Anti-Christ whose intention is to destroy the US financial system.

If you truly believe that the US economy will never improve, and that US families will never again buy cars or houses, use credit cards or keep bank accounts, you should definitely stay away from bank stocks.

If you believe that banking has a future in America (and that America has a future at all), this year’s prices may well mark the single greatest buying opportunity we will see in our lifetimes.
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"After 1929, so many people had been traumatized by the stock market crash that there was a lost generation."

Ron Chernow
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Disclosure and Disclaimer

Do not buy stocks, or take this or any other financial advice without doing your own analysis; including, but not limited to: reviewing business models, financial statements, management style and philosophy, recent developments, market macroeconomic analysis, and chart analysis. If you do not know how to do these things, you shouldn't be buying stocks in the first place. Seek the advice of professionals, as appropriate.
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Related amusement:

FOR and "The Spending Zone"

AND ITS IMPORTANCE TO THE US ECONOMIC RECOVERY





The FOR, or “Financial Obligations Ratio,” is a surprisingly overlooked indicator of a nations economic health; specifically, an indicator of the financial health of its citizens. If the US is to truly experience an economic turnaround, the FOR is the number to watch.

The Financial Obligations Ratio is a ratio of the amount of debt that citizens of the US pay in comparison to income. For example, an individual with an income of $4000 per month (before tax) that makes monthly payments (rent, car, credit card, and other payments) of $2000 has a FOR of 50% ($2000 / $4000). The “safe zone,” where living is easy and spending is comfortable, is a FOR or 40% or less, with 32-35% being optimal. The higher the FOR, the more difficult it will be for a person to save for emergencies, spend, or invest.

As we well know, during the boom ending in 2007 many US citizens overextended themselves. In some cases, people were running at debt levels of 50% of more – a completely unsustainable level. Sometimes this was to “get rich quick” by investing in real estate. In other cases it was merely to keep up appearances.

In 2008 - with the collapse of housing and the markets in general - people finally woke up to the dangers of borrowing and started paying off their debts. In some cases, credit was cancelled and they were forced to start paying off debts.

The FOR statistic, as reported by the Fed, is somewhat deceptive. Retired people who tend to have almost no debt whatsoever skew the reported numbers downward. Most people in the U.S. do not actually have a FOR as low as 16%, for example. In reality, the average working person runs at 30% - 45% (even though 40% is the maximum recommended).

The most important thing to know is that free cash flow (spending money) becomes vastly more available as FOR declines. Say, for example, that someone has an income of about $50K, or $4167 per month. If they have a FOR of 45%, they will have approx. $1000 spending money available per month after paying bills and taxes. That's $1000 for groceries, evenings out, vacations, clothes - everything. However, if they pay down their debts to get a FOR of 40%, they will have approx $1210 per month. That's a 21% increase in spending money from a FOR only 5% lower!

Economists - ignoring reality, as usual - refer to the process of people paying off their debts and saving money as “consumer weakness.” The media often laments the currently high US savings rate, saying that it is “bad” for the economy. I could not disagree more. In order to have a long-term, sustainable economic advantage, the US needs to be a creditor nation, whose people use debt wisely and sparingly.

After people started paying off their debts in 2007, dramatic things happened. The national FOR rate for homeowners has dropped from 17.64 to 15.93 – the lowest level since 2002.

Since debts have been paid down and savings increased, credit ratings have consequently improved. The media routinely tells us about the thousands of consumers whose credit has been ruined since the crisis, but they ignore the millions of consumers whose credit has vastly improved. Equifax Inc. (commonly known as “the credit bureau”) reported that as of July 2010, the average credit score of the US consumer rose to 704 – the highest level since 1998.

Once people pay off enough debt to get into the spending zone (15.5% average), they will have enough cash flow to simultaneously spend freely and save. In addition, they will have better credit ratings than at any point in the last decade. It is a pivotal point that will cause the economy to turn around faster than anyone expects.

If current trends continue, this magic 15.5% cash flow level will be reached by the end of 2010.

For additional information, see
The Federal Reserve - household debt
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"Never keep up with the Joneses. Drag them down to your level. It's cheaper."

Quentin Crisp, Raconteur