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First off, let’s talk about the big news of the week: Federal Reserve Board Chairman Ben Bernanke came out yesterday and essentially told the marketplace to expect imminent interest rate cuts, saying:
“Financial and economic conditions can change quickly. Consequently, the Committee must remain exceptionally alert and flexible, prepared to act in a decisive and timely manner and, in particular, to counter any adverse dynamics that might threaten economic or financial stability”
Does that mean the bottom is in for the financials? Boy do I wish I had a dime for every time I heard someone ask that question in the past year! I’m not convinced we’re there yet.
Instead, what I see is America’s biggest financial institutions jet-setting around the world in a frantic search for capital to offset their mammoth — and rising — losses.
Merrill Lynch (MER) recently announced it would raise as much as $6.2 billion from Singapore’s government-backed investment fund Temasek Holdings. But Merrill reportedly needs another $3 billion to $4 billion. Why? It’s reportedly on the verge of announcing another staggering write-down — as much as $11.5 billion.
Citigroup (C) got $7.5 billion from the sovereign wealth fund in Abu Dhabi. It’s now looking for as much as ANOTHER $10 billion from foreign investors. Why? For the same reason as Merrill Lynch — more write-downs. We’re talking as much as $18.7 billion in one lousy quarter! That’s almost as much as the company earned in all of 2006.
Morgan Stanley (MS) sought out a $5-billion infusion from China Investment Corp and Bear Stearns (BSC) sold a stake of 6% to China Securities.
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Look, I’m no xenophobe. Foreigners should feel just as free to invest in our companies as we are to invest in theirs (with notable exceptions in some countries). But …
There Are Reasons to Think
Foreign Money Will NOT “Solve”
Our Financial System’s Problems
First, there are regulatory hurdles. If a single investor owns 5% or more of a bank’s shares, the Federal Reserve gains more regulatory authority. It can subject the bank to examinations and more careful capital scrutiny. Stakes of more than 10% or that involve board representation invite even more scrutiny from the Fed and the Treasury Department, as the Journal noted.
That means we can’t count on foreign money to bail us out forever. Eventually, important investment thresholds will be hit at large institutions if the need for capital continues to rise.
Second, there’s the possibility of political scrutiny. You probably remember how legislators went into an uproar when DP World — a state-owned company in the United Arab Emirates — tried to take over port management in six U.S. locations.
The more transactions we get, the higher the risk legislators will move to block a deal from getting done — sending financial sector stocks into even more of an uproar.
Third, if you’re a shareholder in these firms, you essentially get diluted each time your company raises fresh capital. In other words, you’re getting stiffed by all these deals.
And the biggest question, in my opinion, is …
Are These Foreign Firms Going to
Keep Throwing Good Money After Bad?
These international investors have deep pockets. In the Middle East, they’re flush with Petrodollars; in Asia, they’re flush with dollars raised from exporting to the U.S.
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But not one of the capital infusions to date has stopped the bleeding. Not one has turned around the targeted stocks for more than a brief time. And there is not one bit of evidence that the loan loss and write-down problems are going away.
In fact, losses keep mounting … charge-offs continue rising … and house prices are still falling, giving more mortgage borrowers a reason to walk away from their home loans.
Plus, the economy has started slumping toward recession, which is causing delinquencies on credit cards and auto loans to rise.
As the Wall Street Journal put it yesterday:
“The initial infusions were expected to quench the companies’ thirst for fresh capital. But mortgage-related write-downs have continued. And Citigroup last month bailed out seven affiliated investment entities, bringing onto its balance sheet $49 billion in new assets and further eroding its capital position.
“More bad news for banks could be around the corner. With the economy weakening, Citigroup and its peers are bracing for a new round of problems stemming from souring loans to consumers and businesses. Banks’ profit margins are getting pinched as they increase rates to lure depositors.
“The risk of credit downgrades to bond insurers could further imperil banks that have hedged their exposure to billions of dollars of bonds by buying insurance. The value of that insurance diminishes if the insurers are downgraded, making the bonds they have on their books fall in value.”
That all means foreign investors have lost a lot of money on the stakes they’ve taken already. What if they throw up their hands and say “We’re done. Solve your own problem?”
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I shudder to think what’s going to happen then!
What All This Means
For Your Investments
I’ve dubbed most of the financials and homebuilders “uninvestable” for a while. And just since I wrote to you last week:
Credit card, auto loan, and regional banking firm Capital One Financial (COF) laid an earnings egg. The firm said it would earn just $3.97 a share in 2007, well below its previous forecast of about $5. The company also announced a $1.9 billion provision to cover rising delinquencies, charge-offs, and legal expenses. Total expected charge-offs in 2008: Almost $6 BILLION!
The large regional bank Huntington Bancshares (HBAN) warned that it would lose 65 cents per share in the fourth quarter. The problems: $424 million in pre-tax charges tied to loans made to Franklin Credit Management, a subprime lender and investor … $64 million in pre-tax losses on loans held for sale, investment securities, and other assorted things … and $44 million in charges tied to an acquisition.
Meanwhile — and this is key — the bank said it is seeing “continued competitive pricing in our markets, mostly deposit related.” In plain English, banks are being forced to offer juicy yields to attract deposit holders. That’s putting even more pressure on profit margins.
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WCI Communities (WCI), a condo and single-family home builder, watched its shares tank by 53% in a single day due to bankruptcy fears. The company is trying to negotiate with its lenders over a $700-million line of credit and a $263-million bank loan. If it can’t get relief, WCI warned, it “could have a material adverse affect on the solvency of the company.”
Translation: The news flow is still negative. So I think you have to be defensive as an individual investor. China and Singapore may have tens of billions of dollars to flush trying to pick a bottom in U.S. financials. But I wouldn’t play that game right now.
In fact, if you’re going to invest in the financial sector, I’d turn the tables on these guys and put your money in overseas banks. Many of them are far outperforming ours. Ironic, isn’t it?
Until next time,
Mike
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