The Problematic Banks

Recently, the Chairman of Sunturst Bank said lending institutions are not out of the woods yet and will probably continue to report losses on commercial real estate through 2010. Bank stocks dropped. This is a farce.

Many, if not most, lending institutions are facing the potential of dire straits for a variety of reasons, all centering around the fact that they still have massively overvalued loans and loan products, sloppily underwritten and unsecured (or under secured by deprecating collateral) during a time of high unemployment and weakening business conditions.

The complicity of US accounting authorities, regulators and government has not only kicked the can down the road, but has made the can a lot larger. I outlined this in The Folly of US Financial Political Games and pointed out the poignant comments that other have made on the topic as well (Interesting excerpt from Jeff Nielson, Banks are actually worse off now than they were before).

I called the collapse of the regional banking system about a year and a half ago with the Doo Doo 32 (As I see it, these 32 banks and thrifts are in deep doo-doo). Glancing at this list over a year later (no one thought the regional banks were even at risk when I came out with the list) in search of overlooked bear candidates, we excluded 6 banks which have been acquired or forced to close and excluded 13 banks with share price of less than $15. Of the remaining 13 banks, we looked deeper into six banks - BB&T Corp (BBT), Glacier Bancorp (GBCI), Sandy Spring Bancorp (SASR), M&T Bank Corp (MTB), TriCo Bancshares (TCBK), Zions Bancorp (ZION). Based on the comparative analysis of valuation multiples, past stock price performance, the bank’s loan and investment portfolio and operational performance (based on Bloomberg data and latest filings), I will produce the results of the analysis and the most Doo Doo bank for 2009 for subscribers over the next few days.

The WSJ referenced in The Folly of US Financial Political Games holds the key to what will bring many banks down, even the better run ones have invested in securities that are dropping in value by 20% to 50%, on a quarterly basis. To make things considerably worse, as also focused on in the political games article, the powers that be have actually endorsed the fraudulent reporting of said assets, essentially giving the ok to inflate the book value of this junk in order to create earnings and value where none is available. Of course, as can be seen in the graphs, the banks' share prices have responded accordingly, increasing by one hundred percent while the market value of their assets drop by 20 to 50%, taking humongous amounts, if not all, of the bank's tangible equity with it. In addition, the commercial real estate and construction sectors are looking to get much worse in terms of losses. Just ask Suntrust (STI).

If you don't believe him, just look at the implied leverage of some of these popular banks and imagine what happens to tangible equity when these investments drop in value (ex. some preferred trust and CDO portfolios have lost over 50% in market value this past quarter):

Bank	Investments/Common Equity
JPM Chase (JPM)	744% (Whoa - more on them in my next post)
Wells Fargo (WFC)	373%
Bank of America (BAC)	371%
PNC (PNC)	359%
Sandy Spring Bancorp	311%
BB&T Corp	245%
U.S. Bancorp (USB)	212%
SunTrust	200%

Still not convinced, let's look at how conservative select members of the surviving Doo Doo 32 are in terms of financial cushioning against further loss:

	Cushion (Reserve less NPA) as % of common equity
Bank
SunTrust	-23.3%
Sandy Spring Bancorp	-23.1%
Zions Bancorp	-19.9%
Glacier Bancorp	-9.6%
BB&T Corp	-8.3%
M&T Bank Corp	-7.8%
TriCo Bancshares	-7.6%

Do you still believe this to be a bank bull market in lieu of a bear market bounce fueled by legalized financial fraud? Well, let's pick a Doo Doo 32 bank and go through the books, shall we...

Zions Bancorp, a bank with about 4$4.5 billion of tangible equity, also has...

Investments
Level 1	267,044	6.7%
Level 2	1,826,631	45.9%
Level 3	1,888,828	47.4%

About half of this banks ENTIRE investment portfolio is not valued by market transactions, but marked to managements opinion, which of course is most rosy, to be sure.

Non agency mortgage backed securities as % of equity	51.1%
Non-agency MBS has the same value as used toilet paper in some circles...
Mortage loans as % of equity	654.4%

I think they over did it on the leverage front here.

So, exactly how is that investment portfolio doing?

30-Jun-09			Amortized cost	Fair value	Unrealized gain and loss
Available-for-sale
U.S. Treasury securities			25,113	25,845	2.9%
U.S. Government agencies and corporations:
Agency securities			290,504	296,378	2.0%
Agency guaranteed mortgage-backed securities			411,180	420,684	2.3%
Small Business Administration loan-backed securities			834,883	812,530	-2.7%
Municipal securities			251,029	252,833	0.7%
Asset-backed securities:
Trust preferred securities – banks and insurance			2,173,757	1,536,164	-29.3%
Trust preferred securities – real estate investment trusts			76,745	34,580	-54.9%
Auction rate securities			171,910	171,252	-0.4%
Other			161,983	107,329	-33.7%
Mutual funds and stock			246,300	246,300	0.0%
Total			4,643,404	3,903,895	-15.9%
Held-to-maturity
Municipal securities			671,671	671,399	0.0%
Asset-backed securities:
Trust preferred securities – banks and insurance			265,292	200,972	-24.2%
Other			32,486	18,717	-42.4%
Other debt securities			100	98	-2.0%
Total			969,549	891,186	-8.1%

Keep in mind that these losses are akin to the ones you and I would take in an institutional margin account. Zion's has a leverage ratio of 13x and investments to common equity of 189%. One dollar of investment losses equates to much more than one dollar of lost equity to this bank and its shareholders and investors.

If we look at the actual loan portfolio...

Commercial lending: (in million)			% of loan type	% of loan portfolio
Commercial and industrial		$10,588	53%	25.5%
Leasing		423	2%	1.0%
Owner occupied		8,782	44%	21.1%
Total commercial lending		19,793	100%	47.7%
Commercial real estate:
Construction and land development		6,848	50%	16.5%
Term		6,795	50%	16.4%
Total commercial real estate		13,643	100%	32.9%
Consumer:
Home equity credit line		2,086	29%	5.0%
1-4 family residential		3,781	53%	9.1%
Construction and other consumer real estate		599	8%	1.4%
Bankcard and other revolving plans		344	5%	0.8%
Other		342	5%	0.8%
Total consumer		7,152	100%	17.2%
Foreign loans		67	0%	0.2%
FDIC-supported assets		875	2%	2.1%
Total loans		$41,530	100%	100.0%

A full 1/3 is CRE, with half of that being construction. For those who don't know what that means... See "Who are ya gonna believe, the pundits or your lying eyes?" and "Who are you going to believe, the pundits or your lying eyes, part 2".

Another 17% is consumer with HELOCS (basically unsecured variable debt), residential 1-4 family and construction loans. All told this is 4x their tangible equity, and this is some of the worse lending categories to be in right now. I will expound on other banks, including the extreme risk that JPM and Goldman (GS) pose to the system in my next post (or two). In the meantime, here is plenty of related proprietary research and opinion on the banking farce and fake stress test material for any who are interested.

Disclamer: Not yet short all of the banks in this article, but actively working on it with option spread trades and straight short positions.

Comments

[Graham Jervis:]

I am long Zion Jan2011 $2.50 strike price puts for 15 cents, i can wait till Mr. Market realizes its folly. Your article emphasizes what Dan Ferris of Extreme Value has been saying all along with ZION, MET, and SMTB, however he actually shorted them and i decided to buy puts. If ZION continues to rise despite these fundamentals, then its a small loss for me, if it plays out the way it should then it should pay off reasonably well.

Dan Ferris also mentioned that four of Zions' eight banks have Texas ratios in the danger zone, putting the overall company in the danger zone. These four subsidiaries comprise approximately 73% of Zions' assets. When 73% of your assets are in trouble, your whole company is in trouble.

I am not seeing this bank going to Zero, but i don't see why its trading so high unless its short covering.

Aug 25 11:08 AM

[Duke Wong:]

I would like to find out: Asia's market had been hitted last couple weeks. Why asia market are getting trouble and US and Europe market are up? Is there nothing related?

Any one know, please post.

Aug 25 03:00 PM

[Stone Fox C...:]

If the assets are not market correctly, then the auditors still aren't doing their jobs. No way banks should be marking assets to absurd values that don't correctly value them. What good is that scenario?

Aug 25 05:44 PM

[John Lounsbury:]

Reggie - - -

Your bottom up micro analysis of banks and my 10,000 foot macro analysis are quite well aligned. Either a lot of the rest of the world is wrong or we have been smoking hallucinagens. I answered a the question: "Why are banks stocks still rising?" in an article on TheStreet.com last week with this: "It is a melt up, trying to regain the steep losses going to the March 9 bottom."

When a significant correction comes (September? October? Both?), the banks should be the biggest losers because their stock gains are the least deserved of any sector.

Keep grinding those numbers Reggie. It will pay off.

Aug 25 07:47 PM