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What next for the banks?

Now that we have gone through the stress tests and the banks have been asked to plug their "worse-case-scenario" capital gap, what comes next?

The market has seen a bit of a relief rally as far as financials are concerned. At least, we now know the world is not coming to an end and none of these 19 banks are going to be allowed to fail. That presents a great opportunity for those willing to invest for the long haul. The question, however, is how long of a horizon should one invest for? As long as there is a substantial government investment in the banks, one does not have to decide in this quarter.

One thing the banks should do though is to shut up about making a fanfare of paying back the TARP. The truth of the matter is that none of these 19 banks have the money to pay back to pay back the TARP and that's why they have been rushing to the equity markets to hit up on private investors for the cash to pay off the government. In so doing the banks are likely to see significant dilution in the forseable future. That, with a pull back in credit and a slower growth going forward, means these banks are not going to be very attractive investments for a long time.

What is needed for these banks to deliver decent and respectable returns to shareholders in the next four quarters is some kind of a catalyst to get their earnings power to a believable level. The two things that need to happen are;

1) consolidation and further rationalization in the banking industry
2) shedding of underperforming and illiquid assets

The too-big-to-fail banks like Bank of America and Citibank should start selling assets to well-run regional banks to refocus their businesses and begin to come out of these crisis with increased odds to outperform.

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