Bank Banks: Fed Fear Losers

NEW YORK ( TheStreet) -- Nearly all stocks of large U.S. banks were down on Tuesday, as investors continued to worry over a possible curtailment of bond-buying by the Federal Reserve.

The Dow Jones Industrial Average was down 0.5%, while the S&P 500 ( SPX.X) and Nasdaq Composite each saw declines of 0.6%.

The KBW Bank Index ( I:BKX) pulled back 1% to close at 61.00, with all but three of the 24 index components showing declines. Big banks with shares declining over 1% included Bank of America ( BAC), which closed at $13.36; Citigroup ( C), closing at $1.40; Fifth Third Bancorp ( FITB), at $17.92; Regions Financial ( RF), at $8.98; and Goldman Sachs ( GS), which closed at $161.68.

The market has taken a three-day pause amid a remarkable run for bank stocks. The KBW Bank Index is up 19% this year, following a return of 30% during 2012.

With a conflicting batch of recent economic reports, as well as contradictory statements in recent speeches by Federal Reserve chairman Ben Bernanke and other members of the Federal Open Market Committee, investors continue to worry that the central bank may curtail monthly purchases of $85 billion in long-term securities.

The Fed's massive balance sheet expansion is meant to hold down long-term rates. The central bank has also kept long-term rates at record lows for over four years, keeping the federal funds rate in a range of zero to 0.25% since late 2008.

The market always anticipates changes in monetary policy, and has pushed the yield on 10-Year U.S. Treasury securities to roughly 2.13% Tuesday from 1.70% at the end of April.

One of the more negative recent economic reports came from the Institute for Supply Management, which on Monday said its ISM manufacturing survey for May fell to 49 from 50.7 in April. This was the first time the figure was below 50, indicating contraction, since November.

In a note to clients on Tuesday, UBS economist Maury Harris wrote that "the latest manufacturing ISM data continued to be inconsistent with generally lower jobless claims and higher consumer confidence. While this inconsistency means we are not yet very worried about the US economy, there are enough ambiguity and crosscurrents in recent data reports to likely keep the Fed from dialing back on quantitative easing anytime soon."

"We still do not expect reduced Fed securities purchases until early next year," Harris Wrote.

Fannie and Freddie

Common shares of Fannie Mae ( FNMA) and Freddie Mac ( FMCC) pulled back on Tuesday, following two days of very strong gains. Fannie's shares were down 11.5% to close at $2.24, while Freddie's shares were down 11% to close at $2.18.

Fannie and Freddie are known as the government-sponsored enterprises, or GSEs, and hold roughly $5.2 trillion in mortgage loans and mortgage-backed securities. The GSEs were taken under government conservatorship at the height of the financial crisis in 2008, but remain crucial to the U.S housing market, purchasing roughly 90% of newly originated mortgage loans in the United States.

The U.S. Treasury holds $117.1 billion in Fannie Mae senior preferred shares and $72.3 billion in Freddie Mac senior preferred shares, for bailout assistance provided to the companies. With both GSEs now profitable, they have paid or announced dividends to the government totaling $131.6 billion. But no matter how profitable the GSEs get, they aren't allowed to repurchase any of the government-held preferred shares.

But investors holding GSE common shares and junior preferred shares are expecting some sort of political settlement that will allow Fannie and Freddie eventually to repay the government and go on operating, or a dissolution of the GSEs that includes an eventual payout to investors.

Bloomberg on Tuesday reported that Senators Bob Corker (R., Tenn.) and Mark Warner (D., Va.) are drafting a bill to dissolve Fannie and Freddie over a period of five years, while having the U.S. Treasury take over the GSE's mortgage loan guarantees. The GSEs would, in part, be replaced by a new government agency.

While it is still only a draft proposal, the Corker-Warner bill appears to be a political watershed, because it will give consideration to junior preferred shareholder of the GSEs, as well as to their common shareholders.

In a note to clients on Tuesday, FBR analyst Edward Mills wrote "while this legislation faces significant hurdles and GSE reform is still a long ways off, this legislation is significant as it marks the most constructive bipartisan effort yet to move Fannie and Freddie beyond conservatorship."

-- Written by Philip van Doorn in Jupiter, Fla.

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Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for TheStreet.com Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.

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