Investment Basics

On Friday, November 5, 2010, the Associated Press published an article about the record number of bank failures since the Savings and Loans crisis. As of the date of publication, the 141 bank failures in 2010 has exceeded the 2009 figure of 140, suggesting that bank failures remain a growing part of the financial services sector. However, the number alone does not tell investors a whole lot except that there are more failures than in 2009. Digging a little deeper, we see that the value of those failures is less than half of what it was in 2009, suggesting that the smaller and weaker financial services firms are the ones bringing those numbers higher.

Although numbers have indeed surpassed the prior year's total number of failures, investors should look at whether or not the system is actually improving. Since the FDIC is having to incur much less of a deficit for those 141 failures than it had to incur for the 140 for all of 2009, the bottom line is that the financial services system is actually in recovery mode. This is an important turning point because finance-related recessions (or recessions that are caused by financial services firms) typically take much longer to end, making the recovery process a longer and often more painful one.

In addition to failures costing less, the FDIC has also been rebuilding its deposit insurance fund. Before the financial crisis, it held a surplus of $50 billion; after 2008, it had a deficit of $21 billion. The Economist points out that after the first 140 failures, the deposit insurance fund had reduced its deficit to $15 billion, a sign that the financial services firms that have survived up until now have been helping to rebuild that fund fairly aggressively (to compare apples to apples, imagine reducing your debt load by roughly 30% in less than 1 year... this is what the FDIC has essentially done).

The point of taking note of these bank failures is not just about pointing out that the system continues to have its flaws (or just cheaper flaws), but to point out that as these last few remaining, troubled financial institutions disappear under the wings of the FDIC, the larger and stronger financial services firms stand to benefit. There are many ways these survivors can get stronger, including acquisitions of the highly discounted assets of the troubled firms. But most importantly is that these surviving firms, whose capital base is just strong enough already, will start to see a growing customer base as further evidence of economic recovery push people through their doors for the services they provide.

Ultimately, financial services firms are not to be avoided by investors. To the contrary, these historic numbers (of failures) make the case for greater investor interest before the price for these stocks gets too expensive.

--> See what Equity Funds hold Financial Services at MutualFundSite.org.

Chris has more than 17 years of financial services experience. He is a regular contributor to the Mutual Fund Site, where a review of the Third Avenue Value Fund was recently published.