Follow This Indicator To Gauge Financial Sector Health – And Grab Profits Smart Profits Report #527
by Karim Rahemtulla, Investment Director It’s one of the most important companies in America today… But like any company, it’s got its share of pros and cons. For example… Pr It holds the position of the largest private, non-governmental originator of mortgages in the US. Con: It also holds the dubious distinction of being one of the most blatant issuers of sub-prime paper. I’m talking about Countrywide Financial (NYSE: CFC) – the much-beleaguered bank and mortgage company. And there is an interesting trend occurring at the bank – one that bodes well for banks and the economy as a whole… The Importance Of “Average Joes” As a banking institution, Countrywide accepts deposits from individuals. While that’s an obvious point to make, it’s also a significant one, since this is the most important aspect of Countrywide’s business. Especially during the recent turbulent times. In order for Countrywide to loan money, it must do so using available funds from deposits, which it can then leverage into loans. It makes money from the positive spread between what the money costs (deposit rates on the money from you or I) and what it charges (loan rates to customers). Another alternative is to borrow funds from the institutional market and re-loan them. But since this requires a strong financial rating – something that Countrywide does not have at the moment – that idea is a non-starter. Now, about that trend I mentioned… What Countrywide’s Interest Rates Reveal About The Financial Sector’s Health Prior to the subprime mess hitting the fan, Countrywide’s deposit interest rate was as pathetic as those being offered by most large banks. However, once the subprime crisis and ensuing credit shortage gripped the market, Countrywide found access to easy funds very limited – meaning it could not borrow low and re-lend high. With institutional funding not an option, Countrywide mounted a full-court press on folks like you and me – yield hungry investors seeking higher returns on cash. And as an FDIC insured bank, the funds were pretty secure, provided they didn’t exceed the $100,000 threshold. And in January, it was evident just how tough a time Countrywide was enduring in trying to obtain funds to re-lend. The bank’s money market rates for a minimum $10,000 deposit were as high as 6% – significantly higher than the average bank. Even with the Federal Reserve in the midst of an aggressive interest rate-cutting program, Countrywide was still paying over 5%, while most banks were paying closer to 2%. Even Internet banks like ING Direct were paying 3% to 3.5%. The situation stayed this way until last month… Follow The “Countrywide Index” Just after the “tipping point” collapse of Bear Stearns on March 17, the subprime crisis began to ease. Around the same time, Countrywide finally started to lower its interest rates. Thursday's Countrywide deposit interest rates were under 4% – the high end of the deposit rate range. The days of grabbing high interest rates from troubled institutions may be over. Countrywide is not only finding money, it’s doing so relatively cheaply, considering its risky profile. While that’s not exactly great news if you’re looking for a higher rate of return on your deposits, on a broader scale, it does bode well for the US economy and banks in the long-term. After all, if a bank like Countrywide can borrow at lower rates, then the liquidity crisis that almost brought the financial system down is surely easing. For future reference, go to Countrywide’s website at: www.countrywide.com and keep an eye on the deposit rates. When they hit the same level at the major money center banks like JP Morgan Chase – or even close to the rates offered by Chase – then you’ll know that the financial crisis is almost over and the sector is ready to rally again in earnest. Karim Rahemtulla Smart Profits Notes: - Shares of Countrywide Financial (NYSE: CFC) soared Thursday after the company announced that shareholders on record as of April 28 will gather at the firm's HQ on June 25 to vote on the proposed $4 billion sale to Bank of America (NYSE: BAC). With the highly publicized deal having been struck in January, shareholders have had plenty of time to digest the plan and are expected to approve it. In response to the news, CFC shares jumped almost 10%. The deal is expected to close in the third quarter, with the main issue right now concerning whether Bank of America will take on all of Countrywide's considerable debt.
- Speaking of financial sector buyout approvals, Bear Stearns (NYSE: BSC) shareholders voted in favor of JP Morgan's (NYSE: JPM) $2.2 billion offer for the troubled firm. No surprise there. But what was a surprise to some who attended the meeting, though, was the speed with which proceedings were concluded. According to the Associated Press, the meeting lasted 10 minutes. Hardly worth the cab fare, really. In fact, given that it was held in Manhattan, the cab fare was probably more than the price of a Bear share (around $9.50). But as of today, Bear Stearns will officially be a part of the JP Morgan empire. The question now is: Can JPM make the marriage work? It's a massive task to integrate Bear's 7,000 employees, its various assets, its operational and technical systems, plus retain the firm's clients. But many financial sector economists believe the deal will work.
- As Investment Director of the Xcelerated Profits Report, Karim has put his money where his mouth is with regard to a rebound in the financial sector. While the comeback will take time and sector shares are still under pressure, he's positioned readers in two of America's biggest financial institutions that should be front-and-center when the rebound kicks in. Karim has a history of showing up early to "profit parties" - and his track record speaks for itself. He's aiming to do the same again here. What's more, shares in these firms are arguably even better value today than when originally recommended. To find out these picks, plus the team of professional traders' many other plays - and get a whole 12 months of recommendations - click this link.
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