March 24, 2009 - Bank stocks are well off their bottoms. Bank Of America traded at $2.53 on Feb. 20 of this year. Now it's $7.90 as I check the latest quote. Wells, Fargo was down to $7.80 on March 5. You'll have to pay $17 as of this writing. JP Morgan touched $14.96 before bouncing to $28. And Citigroup (hopefully) bottomed at $.97 on March 5, then ran to $3 as I write this. Is it finally time to start buying bank stocks?

Of course, there are many programs waiting for a "Go" sign. The government just announced its latest plan to subsidize private investors for taking on toxic assets, most of them mortgages. That should stir interest. Some big players like Black Rock and Pimco are already sniffing around to see how bad the stench is. Both can buy billions of the stuff. If the big boys start buying bad assets, look for bank stocks to improve quickly.

With delinquent mortgages off the books, banks won't have to keep such a large loan loss reserve, a reserve that comes right out of earnings every quarter. With clean books, new, more stringent loans will be made to more credit worthy customers, requiring lower loan loss reserves going forward. The same is true for credit card loans: out with the bad, in with the new, better ones. Again, lower loan loss reserves required. Car loans the same thing.

Why would institutional investors buy these loans? Because not all of them will go bad. Some will pay off entirely. Some will go into foreclosure and sold. But if these very sharp investors buy these loans at the right price, they can still make money from them. For example, if they buy a loan at $50k that has a face value of $100k, and the house is foreclosed, then sold, there's a good chance the house will sell for $60k or $70k, putting a nice profit in the institution's pocket. These loans won't be sold at premium prices. There's going to be a fire sale or none at all.

That's another reason to wait. If the loans are sold at below levels where banks are holding them on their books, there will be more losses to record once the sales are done. No one knows what those losses will be. Can't even guess because the process hasn't started. I'd be very surprised if all loans on the major banks' books are at levels that reflect the real value of their loans. Many of the banks could be in for a nasty surprise when it's time to sell, taking more losses, and immediately upon sale, than initially expected.

Of course, no one is making them sell, but the pressure is strong. Every bank wants a clean balance sheet with a large equity position so it can get out and lend again. This time more wisely. So even if the pain is greater than they would like, expect banks to grit their collective dentals and sell anyway. The mess gets cleaned up, and the future's so bright they gotta wear shades.

One last indicator to look for before jumping back fully into the banking sector: they can raise equity. When institutions are willing to put their big money into banks at the equity level, then all's right with the world. They will scour the books of every bank that wants to offer stock, looking for any problems. If, after their due diligence, they buy stock, then you've got a pretty good indicator that the banks are back in business with a healthy balance sheet. That's when you can feel comfortable with the sector again.

In the meantime, if you want to buy bank stocks, buy only the best (JPM, WFC jump to the top) and buy only a little. Wait for the quarterly reports and the toxic asset sales, then finally the new equity offerings. Then the water will be much clearer...and safer..to jump into.

- Ted Allrich