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Strategies & Market Trends : The Epic American Credit and Bond Bubble Laboratory -- Ignore unavailable to you. Want to Upgrade?

To: russwinter who wrote (58336)	4/16/2006 3:01:18 PM
From: ild	Read Replies (1) \| Respond to of 110194

Follow North Fork A. Gary Shilling, 04.24.06, 12:00 AM ET forbes.com The marriage of North Fork Bancorp (nyse: NFB - news - people )and credit card issuer Capital One Financial (nyse: COF - news - people ) looks like one made in heaven. It may be more accurate to describe the union as one made in desperation. Capital One knows that the salad days of the credit card business are over. The business is overcrowded, and the best lending risks have long since been solicited with hordes of new cards. Only subprime risks are left. Issuers say they can slice and dice credit profiles and calculate the delinquency and default risks to control losses--and charge high enough interest to cover both loan losses and the considerable expense of drumming up new business. But interest rates appropriate to cover costs for the subprime customers are already way high. So Capital One has been on an acquisition binge. It has moved into auto lending. Last year it went ahead with its agreement to buy Hibernia even after Hurricane Katrina visited large but unknown damage on that Gulf Coast bank's portfolio. Capital One wants North Fork badly, paying a 23% premium over its preannouncement stock price. It's willing to suffer an earnings dilution in the process. With Federal Reserve-led rises in short rates squeezing Capital One's lending margins, the company sees the deposits of rate-insensitive bank customers as a cheap source of funding. Capital One is not alone in its strategy of blending card issuance with retail banking. That, in fact, is how the card business started out, as a sideline for banks. Recently Bank of America (nyse: BAC - news - people ) bought MBNA; Washington Mutual (nyse: WM - news - people ) and Barclays (nyse: BCS - news - people ) shared the purchase of Providian Financial (nyse: PVN - news - people ); and HSBC Holdings Plc. bought Metris. Other than North Fork's three top executives getting a $288 million payday stemming from the sale, that bank has compelling reasons to do the deal. Its 355 branches are in the highly competitive New York City area. With its recent purchase of GreenPoint, a national mortgage lender, North Fork is heavily exposed to the likely collapse of the housing bubble. Until the takeover announcement, the stock had suffered a 17% decline from its peak in January 2004. Outside the mortgage area North Fork is basically a spread lender that borrows short term (mostly via deposits) and lends longer term. But the flat yield curve has slashed the profitability of that activity. So Capital One and North Fork both want to get into each other's business to water down the poor prospects of their own. Both can't be right. What should investors do? Steer clear of both. Capital One's stock fell 8% the day of the buyout news. And unless you expect a wave of takeovers of regional banks at big premiums, follow North Fork out the door and sell them. If you are daring, short the Regional Bank Holders Trust (148, RKH), an exchange-traded fund. The Fed's current interest-rate-raising campaign, like its predecessors, won't stop until something significant happens. That something could be a recession, a collapse in house prices or both. Central bankers aim for soft landings yet usually end up breaking many passengers' legs since they can't risk premature ease. They responded weakly to leaping inflation in the late 1970s and had to precipitate two recessions in the early 1980s to regain respect. That's why Fed-controlled short rates will keep rising. And don't believe the bulls bellowing that the Fed will stop while the economy is still strong. I, too, like a free lunch, but the central bank simply won't allow an economic feast without presenting the bill for it in the form of expansion-killing rate rises. Meanwhile, long Treasury yields will remain essentially flat, as they have since the Fed started to tighten in June 2004. Globalization, productivity-soaked new tech and other deflationary forces are keeping inflation low, outside of energy. And high petroleum costs are a depressing tax on users, not an inflation generator. In addition, bond investors sense that with high energy costs, Fed tightening and sliding housing prices, the economy is headed for weakness, if not recession and deflation. The current flat yield curve, which I forecast in my Apr. 11, 2005 column, will invert seriously as short rates rise and long rates don't. Bad news for regional banks, brokers, mortgage lenders, consumer finance companies, leveraged realty trusts and other spread lenders. North Fork's zeal to sell itself is telling you something. Pay attention. A. Gary Shilling is president of A. Gary Shilling & Co., economic consultants and investment advisers. Visit his homepage at www.forbes.com/shilling.