Best idea I've heard in months
Yesterday, I ran a screen on my Bloomberg terminal. It was very simple, one of the simplest I've ever run. I asked for all the publicly traded banks with Tier 1 Capital ratios of 20% and greater.
Tier 1 Capital is like the safety buffer a bank keeps to absorb losses. The banking rules say you need 5% or more to be a "well-capitalized bank." So 20% is four times the regulatory minimum, indicating a very safe bank.
Just 17 publicly traded banks have 20% or more Tier 1 Capital. Of those 17, I've already recommended three. I recommended two in the most recent issue of Extreme Value. And I recommended another one, Banco Latinoamericano de Comercio Exterior, S.A. (BLX), way back in 2004. BLADEX, as it's called, invested in none of the subprime or other nonsense that nearly destroyed the U.S. financial system and which will certainly cause the failure of hundreds more banks in the U.S. in the next couple of years. Since then, Extreme Value readers have made more than half their BLADEX purchase price in dividends.
Most of the remaining banks on the list are too small and illiquid to write about. But I found one more that's big enough. It's located in one of the eight worst states for bank failures... which is a prime spot to grow a bank via FDIC-assisted failed bank deals.
The bank I found is trading for 1.4 times book value. That's a little too high. It'll have to come down some to be an Extreme Value buy. I doubt I'll recommend it this month, but I'm still going to put it on my list of banks that could see triple-digit returns in the next year or two, due to FDIC-assisted failed bank deals.
In a failed bank deal, the FDIC lets a good bank buy a failed bank's loans and foreclosed real estate for a discount to fair value. Then, it promises to pay the good bank an 80% share of all the losses... but the good bank usually pays 80% or less of fair value to buy them, so it's like a government-guaranteed profit for banks and their shareholders. The assets could go to zero, and they would still be worth 80 cents on the dollar to the bank and its shareholders, courtesy of the FDIC.
On top of that, the good bank can also buy the failed bank's deposits, usually for a tiny 1% premium. That's 1% for all the future earnings from lending those deposits out. Could you imagine someone agreeing to take 1% in return for 100% of his future earnings? Only a government agency would do a deal like that! Either way, a well-capitalized small bank can make a lot of money and grow rapidly if it can participate in just one or two failed bank deals. The deals have little if any downside, and potentially huge upside.
I expect to add at least one or two more of these banks to the Extreme Value model portfolio. This is the best idea I've heard in a long time. Currently, I think it's the best way to double or triple your money over the next two years. To get access to Extreme Value and our two recent small bank picks, click here.
Last fall, OBAMA!'s administration pledged $75 billion in taxpayer funds for a mortgage foreclosure program to help save 7 million borrowers. So far, only 231,000 homeowners have completed their modifications (21% of the 1.2 million borrowers who began the program). Another 158,000 who signed up have dropped out, either because they couldn't pay or they didn't complete the necessary documents. That's up from 90,000 a month earlier.
The private sector tried a mortgage modification program in late 2008 with similar results – 60% of the modifications were in default a year later. Why are these programs such a failure? Two reasons... First, the people entering the modification program don't only have a mortgage to worry about. They have credit-card debt, auto debt, etc. Even after the modification, $61 of every $100 earned by the borrower goes to servicing debt. Second, when people don't have jobs, they can't cover their debts. The unemployment rate is still 9.7%, and initial jobless claims today rose 24,000 to 484,000. You can decrease interest and principal all you want, but if cash isn't coming in the door, the mortgage isn't getting paid.
The government can only prop these people up for so long. Eventually, the majority of these underwater homeowners will default on their mortgage. And the foreclosures will begin en masse. Already, U.S. home foreclosure rates increased by 35% in the first quarter – the biggest jump in five years. In all, 900,000 households, one in 138 homes, received a foreclosure-related notice.
According to mortgage-market expert Mark Hanson, known by many as "Mr. Mortgage," 8.4 million homes are in some stage of foreclosure in the U.S. He expects foreclosures to double, hitting 180,000 next month. At that rate, it'll take 47 months, nearly four years, to burn through them. Hanson doesn't think the housing market can take 2.2 million foreclosures a year. "If foreclosures stay right here at record highs of 91k per month, it will take 7.6 years to clear," he said. "I think it is safe to say this will be with us for a while longer."
Of course, it could get uglier sooner if the U.S. loses its ability to print ever-increasing amounts of money to fund boondoggles like loan modification. That fate depends mostly on China. China has already started buying huge quantities of gold and other commodities, in part because it needs them for infrastructure and growth, and in part as a means to exit the dollar. Today, news came out that China held 1.3% fewer Treasuries in February than in January – the fourth consecutive monthly decline. I guess China is allowing Treasury bonds to mature without replacing them, rather than actively selling, but I don't know how to tell for sure. It hardly matters. When your No. 1 customer stops buying, you have a problem. Japan is the No. 2 foreign Treasury holder in the world, and it too held fewer Treasuries in February.
New highs: Powershares Dynamic Biotech Fund (PBE), Financial SPDR ETF (XLF), ConocoPhillips (COP), Visa (V), San Juan Basin (SJT), Altria (MO), Intel (INTC), St. Joe Company (JOE), Banco Latinoamericano (BLX), Markel (MKL), W.R. Berkley (WRB), Prestige Brands (PBH), Portfolio Recovery Associates (PRAA), WD-40 (WDFC), Akamai (AKAM), Brady Corp (BRC), Dana Holding (DAN), Carpenter Technology (CRS), DirecTV (DTV), Entegris (ENTG), Teleflex (TFX), Westport Innovations (WPRT), Rowan Drilling (RDC), United American Indemnity (INDM).
In the mailbag... reader advice on surviving a crisis... and grad school. Send your e-mail to feedback@stansberryresearch.com.
"First buy guns and plenty ammo so you have any chance at all. Then purchase all the land you can, so you have a place to survive. Buy gold when you can. Be an Alliance member with Stansberry as soon as you can afford it. (I can't afford it, spent it all on guns and ammo.) But follow their advice to the 'T' and then you'll be set for the rest of your life." – Paid-up subscriber Fred
"You're spot on in your response to Ian, but you forgot to warn him about that miserable MBA that he wants to do and the fact that they are going to teach him the Efficient Market Hypothesis in this MBA as though it was the god given truth. There is a special place in hell reserved for professors that preach this sort of thing to young minds." – Paid-up subscriber Humphry Hamilton
Regards,
Dan Ferris and Sean Goldsmith
Medford, Oregon and Baltimore, Maryland
April 15, 2010