Are big banks dead in the water?

morgan_stanley.gi.top.jpgBirds on a wire: Shares of Morgan Stanley fell on reports of a federal investigation similar to the one that's plaguing rival Goldman Sachs. By Paul R. La Monica, editor at large


NEW YORK (CNNMoney.com) -- Like sharks drawn to fresh blood in the water, it seems that federal regulators have a ravenous appetite and they are set to pounce on big banks.

According to a Wall Street Journal report, Morgan Stanley (MS, Fortune 500) is now the subject of an investigation over complex mortgage securities, just like Goldman Sachs (GS, Fortune 500). Shares of Morgan Stanley fell more than 3% Wednesday.

This has some wondering if Morgan is the next Goldman. But the scope of that question might be too narrow. A better one is this: Are all the big banks going to come under increased scrutiny from regulators?

It appears this might be the case. Interestingly though, shares of other large banks didn't get hit on the Morgan news Wednesday. Goldman's stock was up about 2% -- small consolation for investors considering that it's still down 22% since the SEC charged it with fraud in late April.

But shares of Citigroup (C, Fortune 500) and UBS (UBS) -- two banks mentioned in the report about Morgan as also having a role in marketing the mortgage investments in question -- were both up Wednesday morning.

Still, even if it turns out that no charges are ever filed against Morgan, it's clear that the SEC, DOJ and other federal agencies have found religion in going after the big banks.

Many politicians have also been intensely critical of the large financial firms as taxpayers continue to bristle about the bailout of the sector in 2008 and the quick return to profitability enjoyed by many of the banks that were propped up with government support.

The Senate is in the midst of debating a Wall Street reform bill and there are considerable questions about whether a new law may be passed that could have enough teeth in it to put a crimp in the industry's profits.

"Uncertainty is the biggest cloud. A lot of investors may stay on the sidelines until reform passes and we get that behind us," said Frank Barkocy, director of research with Mendon Capital Advisors, a Rochester, N.Y.-based investment firm that focuses on financial stocks.

Short sellers, investors that bet a security will go down in value, also seem to think that some of the big banks could fall further. According to the most recent figures released by the New York Stock Exchange, the number of Citigroup shares being held short surged 16% between mid-April and the end of the month.

Shorts also increased their positions in Bank of America (BAC, Fortune 500) and JPMorgan Chase (JPM, Fortune 500) during that period, albeit much more modestly.

Not everyone thinks that the banking behemoths are bad bets right now though. One money manger said that he still likes banks like JPMorgan Chase and Bank of America more than smaller banks that may face looming losses in real estate loan portfolios.

"The major banks are probably working their way out of the woods. But there are still a lot of regional banks with commercial real estate exposure. There are a lot of office vacancies around the country and rents aren't what they once were," said Doug Ober, chairman and CEO of Adams Express, a Baltimore-based closed-end fund that invests in U.S. stocks.

And in a report last week, analysts at Keefe, Bruyette & Woods wrote that the potential negative impact on earnings due to financial reform is already baked into Citi, Goldman, JPMorgan, BofA and Morgan Stanley.

But another fund manager isn't so sure that investors can safely assume that reform is priced into the stocks.

Chris Bingaman, portfolio manager with the Diamond Hill Financial Long-Short fund in Columbus, Ohio, said his fund owns JPMorgan Chase and BofA, but he's concerned reform will hurt them and other large Wall Street firms more than regional banks.

He did not rule out the possibility that headlines about Goldman and Morgan probes could lead to tougher restrictions on the industry's giants.

"They should be two different issues but regulatory reform may be influenced by what's going on with some of the investigations," he said.

For that reason, he said he's optimistic that superregionals like Wells Fargo (WFC, Fortune 500), U.S. Bancorp (USB, Fortune 500), BB&T (BBT, Fortune 500) and PNC (PNC, Fortune 500) won't be affected as badly by any legislation.

"Regulatory reform will impact revenue and earnings. The degree is the big question," Bingaman said. "The magnitude of the impact will be lower for banks with less of a capital markets and trading business and smaller derivatives books."

- The opinions expressed in this commentary are solely those of Paul R. La Monica.  To top of page

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