Banking Stocks: How Long Before Wall Street Stops Picking up Nickels in Front of Steamrollers?

Banking Stocks: How Long Before Wall Street Stops Picking up Nickels in Front of Steamrollers?

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JP Morgan's stunning two billion dollar trading loss, blamed on a hedging error, has renewed calls for tighter regulation on Wall Street. As a result, banking stocks are getting creamed, as investors take risk off the table ahead of a period of regulatory uncertainty.

But let's be honest. The time has come for Wall Street to look itself in the mirror, and make some big changes.

The main problem is that Wall Street has moved away from an investment-led model, to a gambling-led model.

"This was exemplified by the failure of [90s hedge fund] Long-Term Capital Markets (LTCM) which blew up unsuccessfully making huge interest rate bets for tiny profits, or “picking up nickels in front of a steamroller”, and by Jon Corzine’s MF Global doing practically the same thing with European debt (while at the same time stealing from clients)," writes the Azizonomics blog.

As Nassim Taleb described in his bestseller 'The Black Swan', the strategy of betting large amounts for small frequent profits is extremely fragile because eventually (and probably sooner in the real world than in a model) losses will happen. And if you are betting big, losses will be big, especially if you factor in the magnifying effects of leverage.

A gambling analogy might be useful to describe these effects:

Imagine going to the roulette table in Vegas, and placing a $100 bet on red (which pays out 2:1). If you lose, you double your bet to $200. If you win the second round, you receive $400 for a total of $300 invested. If you lose the second round, you double your bet again to $400, and so on.

The key idea here is that you're increasing the size of your bets to keep making a small profit relative to your overall position. For example, if you lose the bet 10 times in a row, your 11th bet would have to be for $204,800 to win back your initial stake of $100.

"That might well exceed the casino table limits," explains Azizonomics, and you'll be "left facing a loss far huger than any expected gains".

"The bigger point here is whatever happened to banking as banking, instead of banking as a game of roulette? You know, where investment banks make the majority of their profits and spend the majority of their efforts lending to people who need the money to create products and make ideas reality?"

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Luckily for investors, there are still many regional banks that are involved in more stable, traditional banking business models. What's more, it's quite likely these stocks will be unjustly dragged down by the overall sentiment affecting the financial sector.

All of the regional banks mentioned below have seen significant levels of insider buying over the last six months, which seems to counter the existing trend of significant insider selling in the broader market.

These banking executives seem to believe in the value of a more traditional banking model–do you?

Use the Turbo Chart to Compare the Performance of the First Two Companies in the List to the S&P 500:

“1. National Penn Bancshares Inc. (NPBC, Earnings, Analysts, Financials): Operates as the bank holding company for National Penn Bank that provides commercial banking products and services to residents and businesses primarily in eastern and central Pennsylvania. Market cap at $1.39B, most recent closing price at $9.10. Over the last six months, insiders were net buyers of 1,122,160 shares, which represents about 1.15% of the company's 97.52M share float.

 

“2. Cathay General Bancorp (CATY, Earnings, Analysts, Financials): Operates as the holding company for Cathay Bank, which offers various commercial banking products and services for individuals, professionals, and small to medium-sized businesses primarily in California. Market cap at $1.34B, most recent closing price at $16.99. Over the last six months, insiders were net buyers of 1,458,600 shares, which represents about 2.03% of the company's 71.80M share float.

 

“3. Sun Bancorp Inc. (SNBC, Earnings, Analysts, Financials): Operates as the bank holding company for Sun National Bank that provides a range of commercial and retail banking products and services in the United States. Market cap at $216.34M, most recent closing price at $2.52. Over the last six months, insiders were net buyers of 1,095,640 shares, which represents about 5.24% of the company's 20.91M share float.

 

“4. Guaranty Bancorp (GBNK, Earnings, Analysts, Financials): Operates as the bank holding company for Guaranty Bank and Trust Company that provides various banking products and services to consumers, and small and medium-sized businesses. Market cap at $201.67M, most recent closing price at $1.90. Over the last six months, insiders were net buyers of 746,787 shares, which represents about 1.05% of the company's 71.32M share float.

 

“5. Middleburg Financial Corporation (MBRG, Earnings, Analysts, Financials): Provides banking, fiduciary, and investment management services to individuals and small businesses. Market cap at $115.24M, most recent closing price at $16.44. Over the last six months, insiders were net buyers of 189,751 shares, which represents about 3.69% of the company's 5.14M share float.

 

“6. Cape Bancorp, Inc. (CBNJ, Earnings, Analysts, Financials): Operates as the holding company for the Cape Bank that provides a line of business and personal banking products to retail customers and small and mid-sized businesses primarily in Cape May and Atlantic Counties, New Jersey. Market cap at $107.81M, most recent closing price at $8.10. Over the last six months, insiders were net buyers of 120,100 shares, which represents about 1.52% of the company's 7.89M share float.

 

By Eben Esterhuizen, CFA. Short data sourced from Yahoo! Finance.

 

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