If you’re expecting Mr. Market to ring a bell and call a bottom for you, get ready to miss the bulk of the move higher.

Right now, in certain financial stocks, there is a serious disconnect between a few companies’ current valuations and their future underlying business. We have recently seen a run in names such as Bank of America (BAC), National City (NCC) and Wells Fargo (WFC), but there are still plenty of plays out there.

We set up a portfolio at Stockpickr called Snapback Bank Stocks to reflect this. These are banks that are down substantially for the year but that have recently shown improving fundamentals.

Here are the requirements we used for the portfolio:

1. Heavy short interest in these stocks. We want the shorts laying all over these stocks, so when good news is announced, they will get caught in a massive short squeeze.

2.Declining nonperforming loans, or NPLs. We want companies that are actually experiencing a decline in defaults.

3.Decreasing capital reserves into the company’s loan loss provisions portfolio. This is similar to decreasing NPLs, because these companies believe the bulk of write-downs will be substantially lower in the future than in the past.

4. Trading at or below tangible book value.

5. Improving company credit and declining credit default swaps, or CDS, spreads.

First up are shares of First Horizon National (FHN), which are down about 70% for the year, from an all-time high of around $45 in March 2007. As of June 30, the company has a stated tangible book value of $12.52, with a short position of 33%.

First Horizon has been hit particularly hard because of its National Specialty Lending segment, which represents about 39% of total loans, with about 77% of these loans being defined as NPLs. The shorts have been right so far, but the company has taken substantial actions to improve the long-term quality of its business by:

1.Agreeing to sell its national mortgage platform to Metlife.

2. Issuing $690 million in common equity.

3. Replacing its quarterly cash dividend with stock.

4. Reducing its balance sheet by $1.7 billion in the first two quarters of 2008 -- with another $4 billion expected by year-end.

5. Writing down most of its nonperforming loans to net realizable values.

First Horizon’s 90-plus day home equity delinquency rate peaked in mid-April at 0.67% (it is now 0.48%). With improved reserves and loans, and the core businesses of regional banking and capital markets (i.e., fixed-income) still strong, First Horizon seems attractive. No wonder Goldman Sachs last week put First Horizon on its American conviction buy list.

Other names in the Snapback Bank Stocks portfolio include KeyCorp (KEY), which has a stated tangible book value of $16.60 and a short position of 6%; New York Community Bankcorp (NYB), which has a stated tangible book value of $12.8 and a short position of 11.50%; and SunTrust Bank (STI), which has a stated book value of $49.24 and a short position of 8%.

Remember: The key here is simply to not run out and buy all of these stocks hand over fist. If you do, you will get burned. Instead, look to buy these when there is maximum pessimism.


A note from James Altucher:

Every weekend I send an email to Jim Cramer and several hedge fund managers about the most interesting portfolios posted on Stockpickr that week. Usually those portfolios not only list stocks according to a theme but also offer significant analysis as to why the stocks are cheap.

Here are some examples:

Stocks related to drilling the Marcellus Shale

MLPS with yields above 7%

Microcaps trading for less than tangible book

Stocks that do well after Hurricanes

Here's the challenge: Build a portfolio at Stockpickr.com with great analysis, and send me the link. Each great portfolio (with analysis) will get posted on TheStreet.com with your byline (as a "Stockpickr Guest Columnist") and will be included in my email I send to Jim and the other
hedge fund managers on my list.


Published on July 31, 2008