Regional Banks: It's All About Credit

Loan losses have been at the forefront of the news reports these days. What asset classes are most concerning for the regional banks?

Lot loans, constructions loans, second-lien home equity, especially brokered home equity and second-lien home equity in vacation or stressed markets.

Those markets that were the growth markets are now the stress markets. There was a lot of leverage in the system that is being unwound in terms of housing and borrowing on housing. We think that ... Florida and California, [as well as Nevada, Arizona, the Midwest and other rising unemployment areas will take several more quarters, if not two more years, to recover].

The issue is when the banks finally foreclose, they start putting [real estate] back on the market. That's going to have a negative impact, because you're dumping more inventory at lower prices back onto the market. So it's going to be a cycle. It's got to work through. What we haven't seen yet are the vulture funds coming in with higher bids. They're still very aggressive in terms of their [low bid for] for properties from the banks. We're looking at nonperforming assets growing on an absolute basis with very little loan sales and recoveries coming in to mitigate [nonperforming assets] and charge-off growth. When we start to see loan sales happen that will start to be the beginning of declines slowing of the growth of nonperforming assets. We haven't seen it yet, but there is a lot of liquidity out there on the sidelines.

What are your initial earnings expectations for the second quarter? Which issues will investors be focusing on the most?

I am expecting the banks to rally into earnings at this point. If you asked me to make a trading call I would be buying the banks here, going in, because I think the short interest is excessive and the bad news is in there. If the banks come out with anything in terms of earnings that is less bad you could see a pretty good rally. Now does that hold over the long term? I think at some point the negativity will come back in this group, because the recognition is we still have another couple quarters to get through, but the banks are getting closer to giving the market some comfort. They at least know where the problems are and are dealing with them. So we will have spots -- names that investors will be able to pick better -- after this quarter in terms of owning some financial exposure.