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Been pretty quiet on the board for a while now, so I thought I would post my thoughts on a sector I believe I am knowledgeable about - banks!

Was a banker for 8.5 years at a small bank, the kind that takes deposits and loans the money back out with the occasional bond purchase.

I have been holding an oversized portfolio allocation of banks stocks for a while with mediocre results. I have thought that bank stocks represented a undervalued sector due to investor concern about a repeat of the GFC which I thought was unlikely to reoccur. As with most of you I didn't see COVID coming.

Many banks have reported 2Q earnings this week with the following recurring themes on the reported earnings:

1) Earnings down due to provisions to the ALLL (Allowance for Loan & Lease Losses). According to longtime and respected bank analyst Mike Mayo NEVER have banks provisioned so much towards ALLL in relation to actual losses (in the current periods) than in Q1 and Q2 of this year.

A little tutorial on ALLL. It is a contra asset account, like provision for bad accounts receivable. The provision hits earnings, total asset value and equity value on the balance sheet. On the balance sheet is is Gross Loans minus ALLL = Net Loans. One thing that needs to be remembered is that for the most part it is the gross loan amount that generates interest income. The act of making large provisions to ALLL does not decrease interest income.

Decreases in interest income normally occurs when a loan hits 90 days past due, although in a few instances they may continue to accrue interest, but generally when a loan hits 90 days past due interest income is only recognized as it is collected and not accrued. Loan losses, writing off loan balances and uncollected accrued interest, can occur before a loan hits 90 days or past due or later depending upon the bank and the situation with the specific loan.

Again Mike Mayo the well respected bank analyst is "estimating" that over the next two years loan write offs will be triple that of normal times. If he is correct, given the recent ALLL provisions and bank share prices, there are bargains in the bank sector, but the shares of every bank are not necessarily a bargain.

2) Deposits are exploding upwards. For Bank of America, they reported deposits of $1,719 billion at the end of Q22020 versus Q12020 $1,583 billion and Q22019 of $1375 billion. While BACs deposit increases my be more than the average bank, the average banks is seeing strong deposit growth.

In my words, never have banks had so much money and at a time there is not much they can do with it. They can't really buy bonds because the Fed has bought so many that they pay almost nothing.

They have to be very careful in making new loans as the possible rough economic times that could be ahead could lead to significant loan losses. IT IS AN EXCELLENT TIME FOR STRONG BORROWERS TO COME IN AND BORROW MONEY, but there are several factors that makes a borrow strong and one is that they don't have much debt a situation they are unlikely to change to any great extent during a possible financial crisis.

Banks can't repurchase much stock for the following reasons: 1) It is out of favor at least in the press and public attitude and doing so could create problems for them. 2) Bank examiners would be all over them. 3) With all the growth in deposits they may need to retain equity capital for capitalization requirements although this somewhat depends on what they do with those deposits.

COVID and Banking

COVID effects just about every business in some way, but its effects on bank operations should not be that great. It has little effect on the deposit side of bank operations as that is 98-99% electronic and for the cash side of the business there are ATM machines and drive through windows. Loan generation is a little more problematic, but my old bank has gotten pretty good at generating loans without the borrower ever entering the actual building - instructions are emailed then a folder gets to the borrower with tags everyplace the borrower must sign and date.

The biggest COVID problem for banks is the economic problems it generates which often decreases outstanding loan balance and almost always increase loan losses.

VM - Long BAC, C, CIT, PACW, HWC, FITB and most recently BK
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Thanks for the diversion from reit's which are not terribly inspiring these days. I don't understand banks but can't see how they will make money if rates stay in the cellar as I believe they will for the foreseeable future. As a novice, if I were buying one bank stock, it would have to be JPM.
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Is there a reason you do not hold any Canadian Banks? Such as BMO or BNS?

Chuck
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Thanks, VM! Illuminating for me. I used to own WFC as a turnaround play but lost faith in my investment thesis after they cut their dividend by 80%.

I do own an offshore bank (NTB) that is seemingly doing okay with what appears to be a sustainable, well-covered dividend.

I also own a small regional bank, TFSL, which seems to be doing well.

JPM looks to be the strongest in the BIG banks.

But overall, I do not find the sector to be that attractive.

David
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I like BAC and C. BAC has lot of potential to cut branches, reduce manpower, go more digital, this will allow them to increase the efficiency ratio and drive profits. Soon, the stigma around buyback will fade and banks will resume their buyback.

Mike loves Citi, of course for a reason. Citi has real potential to double when the COVID dust settles.
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In that the low end of the yield curve likely will stay very low, bank spreads and earnings can't be robust. Still, banks have good reserves & won't go bust.
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You have me interested, any thoughts on TD?
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Nice post.
Having been heavily into financials (including banks) for a long time, I began lightening my positions over the past 1-2 years. But then couldn't resist adding in March.

But I tend to concentrate on those outside of the primary nationals. I have exposure to those through my Berkshire and index holdings, of course.

I currently have positions in CFG, TFSL, COF, GS, INBK, and HDB.

Have been looking at PNC and PBCT recently.

(No overlap with your list!)

Given your comments re: not having much productive to do with their money, do you have any thoughts on positioning across the regionals, nationals, etc.?
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To coastal,

How will banks make money?

Well several ways.

1) Net interest income will still provide some revenue. Spreads or the NIM (net interest margin) will no doubt be compressed, but not eliminated. Banks will start paying next to nothing for deposits, some already are.

2) During the GFC, revenues on the deposit side crew significantly, mostly from the advent of debit cards. NSF fees are a major revenue source from the deposit side and there are other smaller sources. Even for 2019 the percent of revenues of most banks from the deposit had are greater than back in 2006/2007.

3) Larger banks have additional sources of income some considerable. That is one reason that I most recently bought BK as it is a bank focused on a customer base of the wealthy and the investment industry. It has a lot of fee revenue. Its largest revenue source is related to securities at $11.2 billion versus NIM of $3.2 billion. Making loans and holding bonds is a smaller part of BK than any other bank that I know of. While I believe that COVID will affect all businesses to some degree, BK will not be effected that much by either low interest rates or credit losses. Now security losses could be more problematic.

JPM

I owned JPM from 3/2008 to 1/2020. It is a good bank overseen by possibly the best banker today - Jamie Dimon. I think that is a well known fact and fully reflected in the price. When I sold JPM, I also owned BAC & C. They had all appreciated nicely, but JPM was selling at a premium to the other two and I figured better to sell before the market started to start guessing about how much longer Dimon would stick around.
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"do you have any thoughts on positioning across the regionals, nationals, etc.?"

Not really. Almost all banks share some characteristics, but they also have things that differentiate themselves from one another.

In March I was trying to stay away from banks with substantial exposure to the travel and energy industries. Today I would have much less problem with banks in the oil patch.

I looked at CFG and put an order in for it and several other banks. As my orders hit, I continued to lower my bids until I had all the banks I wanted then I cancelled all the remaining orders including the one on CFG. It reported better Q1 earnings than most, down a little, but not much. The problem was that it didn't provision much for its ALLL unlike most of the banks I looked at.
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Chuck,

I don't hold Canadian banks for the following reasons.

1) With its 25% withholdings on dividends, I prefer elsewhere.
2) Not that much diversification compared to other foreign countries.
3) While most banks share certain characteristics, I don't know much about the industry in Canada, beyond the banks up there are somewhat protected from foreign competitors, although that is one big plus in my opinion.
4) Steve Eisman, whom the character Mark Baum in the movie "The Big Short" is based on, has had some negative things to say about Canadian banks in general, although I do not remember the specifics right and since he spoke about them last year perhaps things have improved, assuming he was correct back then.
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Chuck,

Jim Gilles, who ran one of the very successful TMF managed portfolio services before it was shuttered, now works for TMF Canada. He is quite bullish on Canadian banks. After some exploration I purchased some Bank of Nova shares in a retirement account. Dividends are decent, Canadian banks in general have been run more conservatively and the dividends are not taxed if held in a tax deferred account.

This article is more than a year old but makes some of the same point Gilles makes in his pitch for Canadian banks.

https://realmoney.thestreet.com/investing/stocks/look-north-...

BNS does have exposure to some Latin American economies and in Canada, the real estate market. This more recent article by a TMF writer I am unfamiliar with outlines some of the risks and advantages.

https://www.fool.ca/2020/05/26/why-is-scotiabank-tsxbns-stoc...


If you have access to the MF live broadcasts, Jim Gilles has discussed Canadian Banks frequently. Unfortunately I haven't found a decent way to search the content of the live broadcasts

David
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Canadian banks in general have been run more conservatively and the dividends are not taxed if held in a tax deferred account.

Even if Canadian banks have been run more conservatively, I would be concerned about the Canadian economy with the continued closure of the US-Canadian border. According to this article https://www.thebalance.com/canada-economy-facts-and-outlook-... Canada's GDP in 2018 was $1.8T, of which $432B US ($584B CAD), or 24% was exports to the US. It doesn't look like the Canadian border will be re-opened until after the US gets the pandemic under control, and it doesn't look like the US is heading in that direction yet.

AJ
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