Mr. Mitchell: I think there are a lot of different ways to look at it. The primary focus is still on trends in real estate values. Particularly, I would guess within that framework - Arizona, Nevada and Southern California, up to and including the Central Valley areas that were really hot back in 2005, 2006 and 2007 in terms of rising real estate prices - both residential and commercial now of course have fallen the fastest. If you look at the individual franchises, we only cover a few banks that have a footprint in the region. Probably everybody in Arizona is having the same problems that Zions is having in Arizona. Probably everybody in Southern California is having the same sort of problems that City National has. Probably everybody who has the whole state of California to cover is going to have similar issues to what Wells Fargo has. To the extent that "geography is destiny" in the banking business, we think that concentrating on the areas that both had the most overbought real estate conditions and now are beginning to recover - or may be near the end of being the most oversold areas - are still where we would focus our attention.
Looking at banks these days, bank managements want us to think about everything except their credit problems. But their credit problems are really the only thing that matters in terms of valuing the stocks. What's really necessary is to answer the questions, "Is this a viable franchise that's going to continue? Does it have enough capital? Does it have enough reserves, and is the loan book sound enough that this company can emerge on the other side of the downturn with enhanced earnings power?" Those really are the $64,000 questions. In a surprising development, the fourth-quarter earnings were not really all that positive or benign with regard to trends in non-performing assets and troubled debt restructurings. The companies that have the weakest balance sheets are the ones where the stocks came out of earnings season with the best performance, and that's held up pretty well. In 2010 the riskier names are the ones that have been the best performers. That's been the case for a stock like ZION, a company that we think has a great long-term franchise but also still has considerable issues in its commercial real estate portfolio, and had a kind of a sizzling stock response to what was really a very subdued report. So it's hard to tell whether people are now starting to focus on who the takeover candidates will be in late 2010 or 2011 or 2012.
The U.S. banking industry, since the Bank Holding Company Act took effect in the late 1960s, has been in a long-term process of consolidation. Usually, 4%, 5% of banks are acquired every year. They didn't usually disappear because the FDIC took them over - that's the exception to the rule - but generally consolidation has been going on at a pretty good pace for about 40 years. So it's possible that some investors are already trying to position themselves in stocks of franchises that will get taken over one, two, three years from now.
Tickers included in this excerpt: BAC, BBT, C, CYN, FNM, FRE, JPM, SIVB, WFC, ZION
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