It’s Not Over: Steer Clear of Banking Stocks

The U.S. banking sector remains in flux, highlighted by the underlying problems with The Bear Stearns Companies, Inc. (NYSE/BSC), which had been speculated to be on the verge of bankruptcy due to the credit market problems in the United States. As I have said in previous commentaries, the condition of the U.S. banking system remains characterized by uncertainties and sector risk.

On Tuesday morning, more bad news emerged from Switzerland- based UBS AG (NYSE/UBS). It expects to report a dismal first- quarter net loss of $12.0 billion and needs to retain another $15.0 billion in new capital. UBS blamed the subprime mortgage problems in the U.S. for its weakened state. Including $19.0 billion in additional losses and write-downs, UBS will have written down about $40.0 billion over the last nine months.

Deutsche Bank AG (NYSE/DB), the largest bank in Germany, also announced that it would report a first-quarter loss of about $4.0 billion attributed to “significantly more challenging” market conditions related to the U.S. subprime issues.

The reports from UBS and Deutsche Bank clearly indicate the vulnerability of foreign banks to the U.S. credit crisis and clearly support our reasoning for why we would steer clear of the sector for the time being.

Our view is to try to wait out the current turmoil and watch for things to improve in the banking sector before jumping back in. The inherent sector risk remains high and makes investments in banks vulnerable to above-average downside risk.

In my view, it could get worse, as the full extent of the financial impact of loans and mortgages may yet to be uncovered. This uncertainty makes financial stocks a very risky bet at this time. Some may view bank stocks as a dividend play at this time, but the truth is that the downside risk remains large and is an unnecessary risk to take.