The Banking Winners And Losers

The government is helping to create a two-class system of banks - winners and losers.

Despite their protestations to the contrary, the bailout efforts of the Federal Reserve and the Treasury Department have helped fuel big gains at certain institutions; while their reluctance to prop up others has lead to their near-demise.

Look no further than the huge divergence between Goldman Sachs (GS) and CIT Group (CIT).

Goldman was backstopped several months ago, with the government allowing it to convert to a commercial bank charter with little review and a very short timetable. It received a large shot of TARP money and was allowed to raise cheap money in the debt markets with an FDIC backstop.

Result: The firm had the financial wherewithal to swing for the fences in the markets. It generated a record profit of $3.44 billion in the second quarter thanks to big gains in commodity, interest rate, and stock trading.

That’s pretty surprising when you think about it. I mean, here we are just a few quarters after the worst meltdown in the financial markets ever - one fueled by massive, excessive risk-taking by the country’s biggest commercial and investment banks. And now, Goldman is taking the most trading risk in the firm’s history.

Goldman generated record profits in the second quarter. Now it’s taking the most trading risk in the firm’s history.

The evidence: Goldman’s Value-At-Risk, or VAR, surged to a record $245 million in the quarter. (This indicator purports to measure how much money a given firm can lose in a single day of trading.)

Meanwhile, the large commercial lender CIT was left to twist in the wind. The government refused to allow it to sell backstopped debt via the Temporary Liquidity Guarantee Program. CIT almost tumbled into bankruptcy before a group of bondholders agreed to bail it out with a $3 billion infusion.

Goldman shares have surged 89 percent this year. CIT shares have plunged 78 percent. Now that’s a divergence!

Major Divergences Also Showing Up in Loan Performance Data!

The banking industry as a whole is getting pounded by rising consumer loan delinquencies, rising mortgage delinquencies, rising commercial real estate losses, and more. The average bank had about $2.44 of nonperforming loans (meaning loans that are no longer accruing interest or have been restructured) for every $100 in total loans at the end of the first quarter.

But there are a few banks that avoided taking on too much risk … that didn’t plow headlong into the commercial and residential real estate markets.

Consider, for example, a decent-sized bank in the Midwest that recently reported earnings. It had a nonperforming loan ratio of just 0.33 in the most recent quarter - only 33 cents in bum loans for every $100 outstanding.

That contrasts sharply with a major Alabama-based bank that reported earnings a few days ago. It has operations throughout the Southeast, and it’s getting hammered because of its exposure to home builder loans, home equity loans, and retail and commercial lending. Its nonperforming loan ratio (excluding loans held for sale) jumped to 3.17 percent in the second quarter from 1.65 percent a year earlier.

Result: The first bank’s shares are essentially unchanged in the past two years. The second bank’s stock price has plunged 89 percent to less than $3.50 a share.

Many Foreign Banks Are Pummeling Their Domestic Competitors

If you expand your horizon to some of the overseas institutions, you see even more severe divergence in performance. While some of the U.S.-based regional banks appear to be going the way of the Dodo, some of the foreign bank stocks I watch are flying.

Many banks in emerging markets are busting at the seams with fresh cash … and their stocks are set to skyrocket.

The biggest lender in Latin America, as measured by assets, has seen its shares surge 47 percent this year. A leading Chinese bank that’s traded in Hong Kong has soared 74 percent. One of the leading Indian banks I watch is up 69 percent.

There’s a very simple reason for this outperformance: Many of these foreign economies are in better shape than ours. In a real turnaround from past history, “emerging” market countries like Brazil and China have huge war chests and great growth prospects. Developed countries like the U.S. and U.K., on the other hand, are borrowing hundreds of billions of dollars from foreign creditors to prop up their sagging economies.

Right now, many of the past winners are greatly overbought and pricey. But I’m watching this divergence very carefully. If I see new opportunities, I’ll do my best to let you know.

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