Seeking Alpha
Long/short equity, deep value, value, special situations
Profile| Send Message|
( followers)  

It looks as if a BoomBustBlogger subscriber has made it into the news with a large option trade - STOCKS NEWS US-Bears flock to PNC Financial put options

PNC Financial Services fell 4.33 percent to $35.79. It reported a steep drop in quarterly earnings, hurt by credit losses and in its options, bears clawed at puts in the November contract, said Andrew Wilkinson, market analyst at Interactive Brokers Group. One player apparently enacted a ratio put spread in a bid to profit to the downside, he said. The Nov $36 strike had 20,000 puts bought for an average premium of $4.08 apiece spread against the sale of 40,000 puts at the Nov $31 strike for $1.97. The cost of the trade was 14 cents and yields maximum potential profits of $4.86 if shares fall to $31 by expiration. He also noted new put action at the Nov $29 strike and the $27.5 strike where 15,000 puts traded.

As subscribers know, we have determined that the overly lenient government stress tests (SCAP) will leave more than one bank requiring an additional capital raise before this credit malaise is all said and done. See The Re-Release of the Open Source Mortgage Default Model and Green Shoots are Being Fertilized by Brown Turds in the Mortgage Markets for our in depth take on loan losses to come for all banks who participated in residential real estate lending. These are the facts, unfiltered by green shoots mantra. PNC's government mandated $600 million capital raise was a joke, plain and simple. They will probably require multiples of that amount due to their National City acquisition and a careful glance at their balance sheet easily supports that assertion.

I have decided to show all a summary of what is arming subscribers to remain bearish against PNC, among other banks.

Below, please find a comparison between the government's stress test assumptions up to two years out, and our more feasible findings. Remain cognizant that the government's worst case scenarios under the SCAP stress test two years from now are on track to be pierced by the end of the quarter - unemployment, residential loan losses, consumer loan losses, etc. The stress tests were invalidated by real world data almost before they were completed. Prudently, it is already time for the banks to undergo another round of more realistically applied stress testing. Actually, the government is allowing banks to repay the TARP and take imprudent amounts of risk heretofore unheard of in regulated bank holding companies, ex. Goldman Sachs (NYSE:GS) and JP Morgan (NYSE:JPM). HMMM! What will it take for us to learn our lesson??

Gov 2 yr cumulative loss rate range Gov 2 yr cumulative average loss rate for US banks 2 yr cumulative loss rate for PNC
Base Case Adverse Case Base Case Adverse Case Fed's loss rate assumptions Realistic loss rate assumptions
First Lien Mortgages 5 – 6 7 – 8.5 5.5% 7.8% 8.1% 9.9%
Prime 1.5 – 2.5 3 – 4 2.0% 3.5%
Alt‐A 7.5 – 9.5 9.5 – 13 8.5% 11.3%
Subprime 15 – 20 21 – 28 17.5% 24.5% 12.7% Subprime losses not segregated in PNC reporting, Geo losses gross of recoveries est @ 38.7%
Second/Junior Lien Mortgages 9 – 12 12 – 16 10.5% 14.0%
Closed‐end Junior Liens 18 – 20 22 – 25 19.0% 23.5% 3.2%
HELOCs 6 – 8 8 – 11 7.0% 9.5% 3.7%
C&I Loans 3 – 4 5 – 8 3.5% 6.5% 6.0% 6.1%
CRE 5 – 7.5 9 – 12 6.3% 10.5% 11.2% 11.6%
Construction 8 – 12 15 – 18 10.0% 16.5% 21.5%
Multifamily 3.5 – 6.5 10 – 11 5.0% 10.5% 7.3%
Nonfarm, Non‐residential 4 – 5 7 – 9 4.5% 8.0% 6.9%
Credit Cards 12 – 17 18 – 20 14.5% 19.0% 22.3% 21.4%
Other Consumer 4 – 6 8 – 12 5.0% 10.0%
Securities (AFS and HTM)
Others* 2 – 4 4 – 10 3.0% 7.0% 2.5%
Total loan losses 7.3%
*including misc commitments and obligations

Drawing from data gathered from the FDIC and the NY Fed, we independently calculated the default, charge-off and recovery rates for various loan categories on a geographic, state by state basis. Below, you will find the states where PNC has the highest concentration of loans. Notice how much worse the historical numbers look using the government's own projected data (when not purposely scrubbed to was optimistic) as compared to the loss estimates used in the SCAP stress tests. Keep in mind that we are comparing three month old data with forward looking government projections, all the while acknowledging that we are on a downward sloping curve as it applies to housing prices and upward sloping curve in terms of unemployment. In other words, things are still getting worse, yet the numbers from 3 or 4 months ago already pierce the worst case scenario for up to two years into the future.

Primary geographies of PNC and National City 1Q-08 2Q-08 3Q-08 4Q-08 % change since 20008 Alt-A loss rate Sub prime loss rate
Pennsylvania 2.4% 1.2% -0.4% -0.8% 2.4% 14.3% 33.5%
New Jersey -1.5% -3.2% -4.8% -5.4% -14.1% 23.5% 43.4%
Washington 3.0% 0.5% -2.0% -3.8% -2.4% 11.1% 27.1%
Maryland -1.4% -4.2% -6.3% -7.7% -18.3% 18.8% 38.6%
Virginia -0.3% -2.6% -3.8% -4.6% -10.9% 21.2% 37.3%
Ohio 0.6% -0.3% -2.3% -1.9% -3.9% 15.6% 35.4%
Kentucky 2.8% 3.1% 1.7% 1.0% 8.8% 14.2% 34.7%
Delaware 1.0% -1.2% -2.0% -4.2% -6.3% 16.2% 39.1%
Florida -8.6% -13.0% -16.4% -19.5% -46.5% 37.1% 52.3%
Illinois 0.5% -0.6% -2.6% -3.0% -5.6% 22.9% 41.3%
Indiana 2.3% 1.6% -0.1% -0.5% 3.3% 16.1% 35.2%
Michigan -3.5% -5.2% -7.0% -6.9% -20.8% 22.5% 45.7%
Missouri 1.5% 0.6% -0.3% -0.6% 1.3% 13.4% 36.1%
Wisconsin 1.7% 0.8% -0.9% -0.9% 0.6% 17.8% 41.7%
Average (assuming equal weights) 0.0% -1.6% -3.4% -4.2% -8.9% 18.9% 38.7%
Overall U.S -0.2% -1.9% -3.9% -4.5% -10.1%
Price change relative to National Average 0.2% 0.3% 0.5% 0.3% 1.3%
Source: Federal Housing Finance Agency

Here is a table, fully laid out, illustrating the capital requirements for PNC under variety of scenarios. We are estimating a capital requirement of approximtely $4.1 billion, gross of the $600 million required by the government. There is no wonder why PNC has not repaid the TARP yet. As a matter of fact, no company should have been allowed to repay the TARP until a second, considerably more realistic stress test was applied. In addition, the stress test should be applied on a quarterly or bi-annual basis from now on.

Base Case Scenario

Min Tangible Equity Capital Ratio

Capital to be raised ($ mn)

TEC $ mn
(post add capital )

Tangible Assets
$ mn
(post add cap)

No of shares (mn)

Dilution Impact

2010 estimates

2.1%

0

4,963

237,010

0.0

0.0%

3.0%

2,213

7,177

239,223

52.4

11.8%

3.5%

3,453

8,416

240,463

81.8

18.4%

4.0%

4,705

9,669

241,715

111.5

25.0%

4.5%

5,971

10,934

242,981

141.5

31.8%

5.0%

7,250

12,213

244,259

171.8

38.6%

5.5%

8,542

13,505

245,552

202.4

45.5%

6.0%

9,848

14,811

246,858

233.4

52.4%

6.5%

11,168

16,132

248,178

264.6

59.4%

7.0%

12,502

17,466

249,512

296.3

66.5%

Base Case Scenario

Tier one Capital

Capital to be raised ($ mn)

Tier One Capital 2010 $ mn (post add cap)

Risk weighted Assets ($ mn)

No of shares (mn)

Dilution Impact

8.0%

0

24,612

237,010

0.0

0.0%

9.0%

0

24,612

237,010

0.0

0.0%

10.0%

0

24,612

237,010

0.0

0.0%

2010 estimates

10.4%

0

24,612

237,010

0.0

0.0%

11.6%

3,259

27,871

240,269

77.2

17.3%

12.4%

5,453

30,065

242,463

129.2

29.0%

12.8%

6,565

31,178

243,575

155.6

34.9%

The "lite" version of the "real" PNC stress test conducted in May by my staff and me is now available for public download. Notice how prescient it is now, and then, in light of PNC's recent earnings announcement - PNC profit down 87 pct, misses view on bad loans 23 Jul 2009.

PNC stress test write up - public lite 2009-07-27 02:37:11 193.21 Kb

Disclosure: I am short PNC and have been so on and off since the Spring of 2008. See "As I see it, these 32 banks and thrifts are in deep doo-doo!"

Source: More Reasons to Short PNC