Monday, July 6, 2009

Dick Bove on CNBC

"In the 1st quarter of this year the 8426 banks in the US generated $ 80 billion in pre-tax cash profit. That was the highest number that this industry has generated ever." - Dick Bove on CNBC (June 26, 2009)

Doesn't seem to get much coverage. The current cash earning power of banks right now remains extremely strong.

There will be large write-offs for the banks over the next couple of years but the system continues to have significant capacity to absorb those write-offs and build capital through earnings over time.

During a downturn, the short run earnings are often understated while banks are booking loan loss provisions to build reserves in anticipation of future losses. Non-cash expenses in GAAP* can easily be misunderstood. What they mean in the long-term may be far less significant than they seem in the near-term. Getting the interpretation mostly right and understanding the inherent limits of accounting is key.

For any bank it comes down to sound assets, smart credit analysis and underwriting, reasonable leverage/capital levels, sufficient liquidity and, ultimately, the quality of earnings. A bank with the lowest cost deposits has a huge advantage in the long run. Current GAAP earnings alone do not tell you very much about the dynamics of a bank.

Where investing in banks gets tricky is when they are required by regulators to raise capital to meet capital requirements when the stock price happens to be low. When this happens, it may not make sense (or even be fair) economically but as Clint Eastwood said in the movie Unforgiven: "Deserve's got nothin' to do with it."

Fair or not, the dilution still has a very real negative impact on investor returns.

A lot of pain lies ahead for the banks but the survivors should turn into solid long-term investments. Those that buy a high quality bank now -- and have the stomach to ride out the storm -- will likely do just fine over the next 10 years even if some dilution occurs.

Adam

* Generally Accepted Accounting Principles
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