Many people are suspicious of the rally in U.S. bank stocks. Some even go so far as to suggest the market is being manipulated to allow insolvent banks to recapitalize by issuing new shares to investors.
Francis Chou, manager of Toronto-based Chou Funds, has in the past not been a fan of financial stocks. During a previous rally, he warned unitholders to stay away from them because of the DROP principle (D is for dribbling out the bad news slowly, R is for raising money, and OP is for dishing out the most optimistic projections). Once the money has been raised from investors, these companies will announce a few months later the big drop that is, to take a big writedown, he wrote.
Chou is not as negative on the current rally in bank stocks. When he coined the DROP principle during a previous rally,he was trying to alert unitholders to the dangers of toxic assets in the balance sheets of financial companies. They were not written down and the financial companies may try to raise capital before they had to declare the true extent of their losses in toxic assets .That is not applicable now because of the cataclysmic losses they reported in 2008.
He adds: Banks that have not been affected by the financial crisis will do quite well in the future. With the governments driving the treasuries to yield nearly 0%, the spread between what the banks are paying for deposits and borrowings in the market (like FDIC insured), and what they can lend at is enormous. For the first time in many years, banks are being paid handsomely for the risks they are taking.
Which banks have come through the crisis relatively unscathed? Royal Bank of Canadaand other Canadian banks have. In the U.S., big banks that got through the crisis without government funds were (according to an IMF chart in this document):
JP Morgan Chase ( JPM) Wells Fargo ( WFC) US Bancorp ( USB)