Big U.S. Banks Are Simply Un-Investible

Un-investible.

It’s an ugly word, but it’s exactly how I would describe the shares of major U.S. banks. If you own any of them — JPMorgan Chase (JPM), Bank of America (BAC), Wells Fargo (WFC), Citigroup (C) and others — you’re dooming yourself to underperformance in the best case, and potentially large losses in the worst.

Why? In my 15 years of following the bond, real estate and financial markets, rarely have I seen so many challenges facing the banking industry as I do now.

The six biggest U.S. banks have burned through more than $100 billion in legal costs tied to the mortgage and credit crisis.

You may know about my views on the interest rate market. Higher rates absolutely hammered the mortgage business at many of these companies in the most recent quarter. Wells Fargo’s mortgage originations plunged to $80 billion from $112 billion just one quarter earlier, while the pipeline of loan applications tanked 44 percent. Bank of America’s consumer real estate division lost a whopping $1 billion in the third quarter, and the company slashed more than 9,000 jobs.

Then there’s the problem of net interest margin, or NIM. NIM is a core profitability measure for banks of all types and sizes. It refers to the difference between a bank’s cost of borrowing money, and what the bank earns on that money.

Consider this simple example: Say a bank pays a depositor 3 percent in interest for the use of his funds. Then that bank turns around and lends that depositor’s money out at 6 percent to a corporate borrower. The difference between what the bank paid to get the money — and what it could earn on the money — is 3 percent. That’s the NIM of the transaction.

Now take a look at this chart of NIM at Wells Fargo:

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You can see the trend is unmistakable. The profitability of core lending has been going down the better part of three years now. And Wells Fargo is far from alone. I’ve seen this problem bedevil many banks in recent quarters.

Then there’s the relentless regulatory scrutiny, as well as civil and criminal charges and investigations. You can’t even turn on the computer these days without reading about another investigation, another multi-billion settlement, or another shady trader or corporate official being busted for ripping off clients or rigging the markets.

JPMorgan Chase is the biggest whale to get harpooned, reportedly agreeing to pay a record $13 billion to settle civil claims tied to its mortgage bonds. Those claims stem from actions that JPMorgan itself did during the housing boom and bust, as well as claims tied to Bear Stearns and Washington Mutual. The firm swallowed up those companies during the crisis.

Investors are reportedly seeking almost $6 billion in additional compensation from JPMorgan tied to lousy mortgage bonds that blew up in their faces. And that comes on the heels of a deal JPMorgan reached to pay a billion dollars to several regulatory agencies for shoddy derivatives trades.

JPMorgan isn’t alone. The government is reportedly after Bank of America as well, looking to squeeze out at least $6 billion. And Wells Fargo and four other large mortgage servicing firms were forced to settle with 49 states and the U.S. as part of a $25 billion deal. But that didn’t keep that institution out of trouble — New York just sued Wells for failing to live up to the terms of the bargain.

All told, the six biggest U.S. banks have racked up more than $100 billion in legal costs tied to the mortgage and credit crisis, according to Bloomberg. That’s a staggering figure. Furthermore, every time analysts and investors think the issues are settled, some new probe or lawsuit pops up.

Bottom line: If you’re looking to make money in an “up” market, or avoid the most painful losses in a “down” one, stay away from these losers. I’d much rather make targeted investments in select corners of the rate-sensitive portion of the stock market.

One of my favorite sub-sectors, for instance, has been the exchange operators — the companies that process and facilitate futures and options trading in a variety of capital markets. Those companies profit from the rising volatility we’re seeing in the interest rate, equity, currency and commodity markets — and they aren’t saddled with the legal, regulatory and margin issues facing the big mega-banks.

Start your research there if you’re looking for places to invest. Or if you need more guidance to all the latest twists and turns in the interest rate and related markets, give Safe Money Report a try. You’ll find my favorite investments, and specific “buy” and “sell” recommendations.

Until next time,

Mike

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