By Sarah Morgan
Most banks are expected to pass the Federal Reserve’s latest “stress tests,” which measure their ability to withstand another downturn. But that doesn’t mean they’ll make the grade with investing pros.
Many investing pros and financial advisers have been avoiding banks as being too risky since the market meltdown of 2008. The Fed’s latest stress-test, the results of which will be released next week, is aimed at – at least in part – changing those perceptions by pointing out that most banks are healthier than they were a few years ago. But investing pros say the stamp of approval may not have the impact on bank shares some are hoping for. “There may be a little bit of a wiggle of market reaction when they come out,” says Tom Samuels, a managing partner at Palantir Capital. “But I think that people are properly focused on other issues.”
Topping that list of concerns is the European crisis. The balance sheets of American banks may be healthier than their counterparts on the continent, but they’re still not immune to the troubles there. Samuels says the ongoing crisis add “un-measurable” risk to large financials because the extent of their exposure to Greek and other sovereign debt is unclear. In particular, investors are unsure which institutions bought or sold credit-default swap contracts on troubled euro-zone countries. “To be invested in the big institutions right now is a leap of faith,” says Samuels.
It’s not just European debt that investors are worried about, says Rodney Johnson, the president of HS Dent: Banks still aren’t being fully transparent about the value of other assets on their balance sheets. They are not “marking to market,” which means they’re not reporting the current market value of assets like mortgage-backed securities. “If you’re not marking your securities to market, then I don’t know what they’re worth, and I don’t believe you when you tell me what they’re worth,” he says. Johnson doesn’t own any large financial stocks.
Given this lack of transparency, investors may be better off at smaller banks, advisers say. Small banks are not exposed to risk from credit-default swaps, Samuels notes. Since they’re exposed to risk when local businesses struggle to pay their bills, as the economy improves and the retail sector fares better, regional banks should benefit, Johnson says. Small banks also have shortcomings, Johnson says. They make a lot of commercial real estate loans, some of which were written with sub-prime-like problematic terms, he says.