I’ve discovered an idea unique to this post-2008 world and perhaps one that will never repeat to quite this extent. I want to share this esoteric idea with you in what follows below.

I first saw it happen with a little bank stock I own personally. It announced earnings that were three times higher than expected because of “the reversal of the majority of its deferred tax asset (‘DTA’) valuation allowance.” The stock rose 9% in the next two trading days.

I decided to look into this wrinkle a little more. I found it happening in other places as well. Here are the biggest reductions in DTA valuation allowances this year with the return on the stock year-to-date. Once you see these figures, you’ll understand why this is a worthy inquiry:

An average portfolio gain of 73% for 2012 so far and only one loser! So what is this “DTA valuation allowance”? And how you can make a little scratch with it?

The DTA valuation allowance is a leftover from the crisis days when banks were losing money. Put simply, some banks had deferred tax assets. These assets were a kind of tax shield. But if you are losing money and unlikely to benefit from your tax assets, then accounting rules require that you take a DTA valuation allowance — in essence, you must mark down the asset.

This happened quite a bit back in the financial crisis when many banks lost money and it was uncertain when they’d turn it around, if ever. But now as the crisis is receding, banks are starting to reverse out these allowances.

But here’s the catch: It is not easy to reverse out the allowance. A management team has to prove to both its auditors and its regulators that its bank is back on the road to regular profits. When it does so, management can enact a reversal. The market takes such reversals to mean that a bank has turned the corner. The reversal means a bank’s problems are behind it. Stock prices jump as a result.

I decided to dig a little and come up with a list of banks with large amounts of DTA valuation allowances. Several of the banks I identified are still in really bad shape. Some even looked like they may not survive. In other words, no reversal is likely.

But several other banks are making money again. And they seem likely to do so in 2013 and beyond. These are good candidates for further research. The table below features six of the more interesting names that had huge DTA valuation allowances as a percentage of their current market caps:

Each of these is making profits now and expects to make profits next year. If these trends hold, a drop in the DTA valuation allowance is inevitable. And as you can see, the potential allowance reversals are big relative to the market caps of these stocks.

A few have high insider ownership positions from private equity players: UCBI (Corsair Capital, Fletcher Asset Management), FBP (Oaktree, Thomas H. Lee Advisors) and CPF (The Carlyle Group). I haven’t done all the work on how these ownership positions came about. I’ll guess that these players took their positions during the crisis and provided much-needed capital. I take their presence as a plus. As large owners, they are likely to keep management focused on delivering for shareholders.

If you are looking for banks with squeaky-clean loan books, these are not the ones. The trends, though, are good. I’m not officially recommending these stocks. I’m just sharing some interesting research as I go. We’ll see how this group looks a year from now.

Regards,

Chris Mayer
for The Daily Reckoning