Bank mergers - what to expect now

A few months ago, I listed a few banks as targets in my post on betting on bank mergers. Things have changed quite a bit since then - and an update is due.

Most important change - interest rates have moved up and definitely going up in the short term (why not long term ? I think that the Fed will be forced to cut rates within the next 2 years to deal with the fallout of a housing slowdown or outright crash - not a conundrum, is it ?).

During the last great interest rate spike in the early 80's, a full 20% of small banks collapsed, and the Fed arranged for a bailout. This time around, it is supposed to be different - because of changes in regulations, reserve requirements and better hedging by banks. But if problems at Citibank and AIG are anything to go by, a few of the rules were being silently ignored. The effect of adjustable rate mortgages and massive carry trades will only be known when rates go up a few percentage points from current levels.

I am removing Washington Mutual (WM) from my takeover list. Since my position is small, I am not selling, but I would have cut my position by 70% if it had formed a larger part of my portfolio. Prospects for a takeover have fallen and risks from interest rates make it even worse. A European suitor now looks less likely given that European banks are more interested in going after other banks on the continent - there were 3 cross-border bank takeovers in the last month. (Another, more serious, question arising out of this - do European banks see more growth prospects in Europe than in the US over the next few years ? Is it time to bet bigger amounts on Europe ?). Another potential buyer, Citigroup, has been asked by the Feds to stop making acquisitions until it cleans up its control processes. This means that Citigroup is not buying anybody for a year or more.

So, are banks still worth betting on, as takeover targets ? Yes, but I now need even more insider buying activity and a good yield (2.5% atleast) to support any buying. I am also interested in much smaller banks or banks that have already tanked due to warnings.

Here is a short, incomplete list :

• LNB Bancorp (LNBB)
  
• KNBT Bancorp (KNBT)
  
• Epic Bancorp (EPIC)
  
• Doral Financial (DRL)
  
• Old National Bancorp (ONB)
  

I own LNBB, KNBT and DRL shares.