The on-again, off-again, and suddenly back on-again trade with the nation's top lenders has pushed big banks to the top of the performance pile—at least for the moment. While recent declines by the year's hottest sector (XLF) have prompted some to double down, investors like Len Blum of Westwood Capital are steering clear, especially from what he calls the "Financial Costcos," saying they are just too hard to value.
"Their revenues are very, very difficult to predict and are based on a lot of things that have nothing directly to do with the bank's core franchise of lending and accepting deposits," says Blum in the attached video.
While he says the prospects for, and analysis of, the smaller banks is tied largely to the economy, he cautions that large banks earnings are still too dependent on things like trading, the ebb and flow of loan loss reserves, and accounting adjustments.
Despite these well-established and legitimate concerns, the KBW Bank Index (^BKX) is still up 20% this year. But Blum says he needs to see more than just share price gains to get in.
"I'd like to see some real transparency in the market values of the assets that banks are holding," Blum offers. Furthermore, banks are allowed to carry loans and mortgages at face value on their books—even if the collateral is worth dramatically less than the loan amount—and it creates mistrust of the numbers and pricing distortions. "That's one of the reasons you are seeing banks trade at 60% of tangible book value," he says.
Another headwind that is keeping him on the sidelines has to do with a threatened downgrade of 100 global banks by Moody's. Unlike other actions by ratings agencies that are widely ignored and discredited, Blum explains that this one would have actual financial implications, even if it doesn't have new informational content. He says because credit ratings are mentioned in financial contracts, an institution like Morgan Stanley (MS) would be forced to "take contractual actions, like posting collateral for derivative transactions" that would be very costly and hurt earnings.
"I think you're really taking a bit of a crap shoot," he says, of trying to gauge big bank results.