Britannia Radio

The Massive Problem Facing Big Banks By Frank Curzio, editor, Penny Stock Specialist Friday, April 15, 2011 In July 2010, one of the biggest financial regulatory reform bills became law. It's called the Dodd-Frank Wall Street Reform and Consumer Protection Act. The new bill included 240 new rules. These rules are supposed to improve transparency in our financial system. More important, these rules call for banks to shrink their balance sheets – so no one company in the sector is "too big to fail." Since the Dodd-Frank Bill became law, large-cap banks have underperformed the overall markets. Below is a chart comparing the iShares Dow Jones U.S. Financial Services Fund to the S&P 500. The S&P 500 has outperformed the large-cap bank fund by roughly 7%. This underperformance is no surprise. Imagine if your company received over 1,000 pages of regulatory proposals at once. Then imagine you have to restructure your entire company under the microscope of the media and politicians. Banks are not focused on creating new products and revenue-generating ideas right now. They're looking to get their regulatory issues in order. You might think this underperformance creates a buying opportunity in big banks. But I'd avoid these stocks… You see, banks are shrinking their operations. They'll have trouble growing revenue over the next few years. This may not seem like a big deal… until you analyze the data. According to Thomson Reuters, the four largest banks in the world (JPMorgan, Citigroup, Bank of America, and Wells Fargo) are expected to grow earnings by more than 30% a year over the next three years. But these banks are only projected to grow revenue by an average of 2% a year until 2013. To put this in perspective, large-cap banks are projected to grow earnings faster than almost any sector in the S&P 500. But analysts expect earnings to grow despite nearly zero revenue growth over the next 18 months. To meet Wall Street's aggressive earnings estimates, banks will have to raise fees. Consumers will likely see higher ATM fees, higher credit card fees, higher checking account fees… And institutions will likely see higher investment banking fees. It's become the norm these days to see companies pass on their higher costs to consumers. However, large-cap banks may have a tough time following this trend. Politicians have their eyes on the banks right now. Higher credit card or institutional fees will likely be widely criticized – especially in the early stages of the presidential campaign. With these headwinds, earnings estimates for large-cap banks are too aggressive. Estimates will have to come down sharply in future quarters – and that's not factored into current stock prices. I'm not saying large-cap banks will never be a buy. In previous essays, I've told you to buy big banks if you can get them below tangible book value. That's a way to limit your risk in this sector. Today, none of the big four are trading below tangible book value. The smart move is to stay away from large-cap banks right now. Good investing, Frank Curzio