Retail investors may soon purge their portfolios of the shares of underperforming banks.
For the investors, the end-of-year sales would represent a tax strategy; accepting losses from underperforming bank stocks could offset gains made in other sectors of the economy.
But for the struggling banks in question, especially those with less than $2 billion in assets and not much liquidity, such moves could further cripple their ability to attract badly needed funds.
"The liquidity discount associated with tax-loss selling is forcing those stocks to trade at an even larger discount to book," said Lauren Pettit 3rd, who manages the community bank portfolio at Anderson & Strudwick in Richmond, Va. "This is awful for these banks right now, because it just makes the problem even worse in terms of raising capital."
Though tax-loss selling is a typical year-end ritual, much of this year's activity was delayed as people waited to see if the Bush-era tax cuts would be extended. A deal unveiled this week, which would keep a 15% capital-gains tax, should soon activate transactions, analysts said.
Financials are singled out as they underperform the market. A report issued last week by KBW Inc.'s Keefe, Bruyette & Woods Inc. said that while the Standard & Poor's 500 index rose 5.9%, as of Dec. 1, the S&P 500 Financials Index edged up 0.2%. KBW's Mortgage Finance Index, Bank Index and Regional Banking Index all lagged.
"If you're looking for areas where investors might have some ability to take a tax-loss sale, it would be in a sector that lagged the market, and financials were the most obvious of those," said Melissa Roberts, KBW's senior vice president of quantitative research.
The KBW report found that underperforming companies with big retail investor bases — more than 33% of all investors — that have exhibited year-to-date stock losses are those most likely to feel the impact of such selling.
The report identified several vulnerable companies, including First Bancorp of San Juan, Puerto Rico; Superior Bancorp in Birmingham, Ala.; and Cascade Financial Corp. in Everett, Wash.
Some industry observers see the sell-off as a buying opportunity.
Mark Fitzgibbon, an analyst at Sandler O'Neill & Partners LP, said the sell-off is likely to create volatility across the banking sector. "That creates opportunities for investors to sift through the rubble … and identify some names that maybe get oversold," he said.
For banks susceptible to tax-loss selling, activity could make bad situations worse. Many face delisting for low bid prices or market capitalization. A sell-off would take another bite off their market caps and could may provide more evidence of separation occurring between what Fitzgibbon called the "haves" and the "have nots."
"For the haves, those companies are seeing a turn in credit quality and are starting to show improved earnings and better profitability, and their stocks are rising nicely," he said. "Then you have some of the have-nots, where one problem is compounding the other."
While retail investors are typically more patient than institutional investors, some can no longer afford to stand pat.
Pettit said some investors his firm has worked with — including lawyers and small-business owners — have been hard hit in the downturn. Others have enjoyed a decent recovery in other sectors and are looking for a tax loss to offset gains from the past year.
Meanwhile, the base of small institutional investors and private funds investing in community banks, which had built up during the 1990s and early 2000s, has all but disappeared. "It's the perfect catch-22," Pettit said. "It creates a nightmare for the banks that right now need the equity capital."
The tax compromise unveiled by the White House this week is not set in stone, said Ted Kovaleff, an analyst at Horwitz & Associates. If Congress fails to approve the extension — and the tax cuts expire — investors may take the opposite approach.
"That is to say, you'll have tax-gain selling to take advantage of the favorable tax treatment of capital gains," Kovaleff said. "And the tax loss will become much more valuable come January."
