Regional Banks: Too Small to NOT Fail

“Too Big To Fail.” We saw it with Countrywide Financial. We saw it with Bear Stearns. As the controversy expanded, there were more than a few smarties defending the need to save big financials because of the systemic danger their failure would inflict upon the world’s intertwined and complex financial structure. Chairman Bernanke suggested he really didn’t want to do what he did with Bear Stearns….only did it because of stuff associated with the “too big to fail” phenomenon... and doesn’t ever want to do it again. Personally, I doubt that Bear Stearns will be the only test of “too big to fail” before this mess is all over.

When I went through the charts this past weekend, I was struck by how many regional banks and S&L’s suddenly looked weak after some attempts at recent stabilization since mid-March. It caused me to think heavily about the other side of “too big to fail.” If the government is committed to only bailing out banks that would cause systemic national and international distress, then there is an inevitable concept coming that I call “Too Small To NOT Fail.” Okay, so National City (NCC) got about $1 billion of pseudo Private Equity money from JP Morgan Corsair. Washington Mutual (WM) got $7 billion from TPG et al.

There are rumors about other PE firms circling the S&L’s and regionals looking for opportunities. But the reality is there are thousands of these small financial firms and I suspect many of them are in big trouble. Their reserves for losses are insufficient. They need capital and some will get it. But there is not enough capital to cover it all and some of these banks will just not be appealing enough for new investors to put up the money.

In the early stages of the failures that will likely result, there won’t be a government bailout entity like we had with the S&L crisis. Instead, there will be a tough love stage where the banks will be allowed to fail. And then the politicos will start complaining why we could bail out the big guys on Wall Street at Bear Stearns (Too Big To Fail) and not the little guys on Main Street in small town America (Too Small To NOT Fail). Eventually, as the banks that could not obtain new capital topple, it will be tough to avoid small bank runs and then I expect that we will learn that even something small can lead to something big.

Comments

[Macroboyd]

Where are the facts to back up the statements in this article? What are the statistics that back up the statement, " But the reality is there are thousands of these small financial firms and I suspect many of them are in big trouble."

[fivedogs]

Mike,

Please share with us your ownership (or lack of) in the stocks NCC and WM.

[HingeFire]

A set of articles at HingeFire takes a look at the weakness in local banks. "Local Banks: Time to Short" (hingefire.blogspot.com...) evaluates the possible criteria for shorting small local institutions that trade publicly. "Just how bad is the situation with local banks?" (hingefire.blogspot.com...) provides a list of possible short candidates. "Weak Local Banks Retreating" (hingefire.blogspot.com...) takes a look at the short results after one month. As a set, the articles contains pointers to resources, information, and commentary about the FDIC's expectation of increasing bank failures.

[Bman]

Oh man...you really need to do your homework! The "too big" and "too little" comments are completely in error and miss the primary business drivers that lead to liquidity problems. IT'S LEVERAGE! Bear Sterns was 30:1...I have no idea what Countrywide had going from an actual ratio, but there model was on the high end of mortgage bank leverage.

Please get rid of your short positions so you can move on in your investment life.

[tcat92]

Where are the facts? More of the hysteria? This is the worst article I've read since this whole crisis started a few months back. The problems with writers is that sensationalism sells, mundane stories don't. The other problem is that if the writer is so knowledgeable about finance, they wouldn't be writers.

[Voice ofReason]

I question Seeking Alpha for allowing some the drivel that's been posted lately.

[View fromNYC]

This article is spot on. The facts are in the latest 10-Qs of the smaller regional banks and thrifts. The market has confirmed the facts by valuing some of the entities at less than book value and the options market has near term probabilities of failure for some smaller banks at 20%. While it may have been leverage that decimated the investment banks, it is going to be the bad real estate loans that are destroy this segment. The proposed legislation that will allow the FHA to buy mortgages after they are written down will only help the more conservative underwriters. The government is probably not going to step in and save a bunch of $50 million to $500 million market cap sized banks, and without any real franchise value, PE and other banks aren't going to be buyers either.