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Steven Syre | Boston Capital

Is this a buying opportunity?

Email|Print| Text size + By Steven Syre
Globe Columnist / January 17, 2008

One reliable way to make an investment fortune involves buying stocks that have been absolutely pulverized by a stampede of fearful sellers and giving them time to return to their old prices. It requires good timing and plenty of nerve.

This is why bank stocks appear so tantalizing to many investors. Big names have fallen 40 percent, 50 percent, even 60 percent over the last 12 months. Some of those banks have attracted billions in fresh capital very recently to bolster their balance sheets, from presumably sophisticated investors around the world.

This moment in time is also intriguing. Banks are issuing their disastrous fourth-quarter financial reports this week. Most include gigantic write-offs that might lead you to believe the worst has been accounted for in dollars and cents. It may turn out to be the finance industry's worst earnings period since the Great Depression.

Finally, the Federal Reserve is about to lower interest rates again, and some economists think the next cut might be a whopping 75 basis points. Clearly the Fed is prepared to act more aggressively.

Could this be the bottom, the place to buy low and make serious money? As appealing as the opportunity seems, some people say that is mostly an illusion.

Bank stock analyst Gerard Cassidy of RBC Capital Markets thinks shares of many financial companies will begin to rebound soon for the reasons I've just mentioned. But he sees a short-term rally that ends badly as the banking business continues to deteriorate and those same stocks slump badly. "We think it's going to be a huge trap and a great time to sell into it," says Cassidy.

Brokerage analysts don't issue dire widespread warnings about the industries they cover every day, but Cassidy has a track record when it comes to sounding alarms. I first spoke with him nearly 20 years ago when he cautioned me that a giant local institution with seemingly manageable problems would have to fire its imperious chief executive, write off more than a billion dollars worth of loans, and eliminate its important dividend to have any chance for survival. I thought he was nuts.

The institution, Bank of New England, eventually did all three but still turned out to be the region's most spectacular bank failure ever. Other recommendations Cassidy made to sell bank stocks at the time, though not so dramatic, turned out to be contentious but important calls.

That doesn't mean Cassidy is right this time, but he's not alone and is worth hearing out. At the moment, he covers 24 different banks and doesn't recommend clients buy any of them.

"If this economy goes into a recession, the banking industry's problem assets will quadruple from here, and that's not priced into the current stock levels," he says. "Investors don't fully appreciate how different banks are and how the leverage [on their balance sheets] can kill you if you get in too early."

The threat of a recession is important to Cassidy's point of view. He thinks that kind of economic decline would hurt credit quality across the board but damage two loan categories in particular. Leveraged buyout finance, the money that fueled the private-equity business as it bought up companies on credit, would suffer. More importantly, construction loans will fall behind.

As damaging as subprime loans have been to banks, relatively few own them. More institutions own leveraged buyout loans. Many more still hold construction loans.

It's tempting to attempt to call the bottom for a stock or an industry, but you rarely get paid enough for the risk of perfect timing. Comeback stocks that start from such low points still offer plenty of profits for investors who wait a little longer to see more evidence.

Steven Syre is a Globe columnist. He can be reached at syre@globe.com.

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