These 32 Commercial Banks and Thrifts May See the Dung Hit the Fan

I have identified 32 banks that are $@%%. It's really as simple as that. I have been publishing the research that I used to build my investment thesis. Thus far we have:

1. Intro: The great housing bull run – creation of asset bubble, Declining lending standards, lax underwriting activities increased the bubble – A comparison with the same during the S&L crisis
2. Securitization – dissimilarity between the S&L and the Subprime Mortgage crises, The bursting of housing bubble – declining home prices and rising foreclosure
3. Counterparty risk analyses – counterparty failure will open up another Pandora’s box
4. The consumer finance sector risk is woefully unrecognized, and the US Federal reserve to the rescue
5. Municipal bond market and the securitization crisis – part I
6. An overview of my personal Regional Bank short prospects Part I: PNC Bank - risky loans skating on razor thin capital, PNC addendum Posts One and Two
7. Reggie Middleton says don't believe Paulson: S&L crisis 2.0, bank failure redux
8. More on the banking backdrop, we've never had so many loans!

I am almost prepared to start listing more of my commercial banking shorts, but before I do I want to delve even further into the educational realm so there is no doubt as to why I am as bearish as I am. For those who can't wait to see my ultimate shorts, I will give you the complete list of what I call the "Deep Doo-Doo Banks". These are the banks that are steeped pretty deep in it. Are you ready? Can you handle the pressure? Okay, here we go!

Wells Fargo (WFC) - Popular Inc (BPOP) - SunTrust (STI) - KeyCorp (KEY) - Synovus Financial Corp (SNV) - Marshall & Ilsley (MI) - Associated Banc (ASBC) - First Charter (FCTR) - M&T Bank Corp (MTB) - Huntington Bancshares (HBAN) - BB&T Corp (BBT) - JPM Chase (JPM) - U.S. Bancorp (USB) - Bank of America (BAC) - Capital One (COF) - Nara Bancorp (NARA) - Sandy Spring Bancorp (SASR) - PNC (PNC) - Harleysville National (HNBC) - CVB Financial (CVBF) - Glacier Bancorp (GBCI) - First Horizon (FHN) - National City Corp (NCC) - WaMu (WM) - Countrywide (CFC) - Regions Financial Corp (RF) - Citigroup (C) - Wachovia Corp (WB) - Zions Bancorp (ZION) - TriCo Bancshares (TCBK) - Fifth Third Bancorp (FITB) - Sovereign Bancorp (SOV)

Now, I already released some of my work on one of the banks, chosen due to paper thin capitalization - along with a different view on leverage. Keep in mind, for the purposes of this blog, I'm just a resourceful individual investor - albeit one that is very lucky to date (this post was before Bear Stearns dropped 98%). Therefore, no one, and I really mean no one, should be taking my opinions on this blog as investment advice. It is not intended as such and should not be percieved as such.

Before we focus on which banks I am shorting, let's explore the current banking environment. I aimed my team at banks that have high concentrations in risky products, risky geographic areas and low tangible and regulatory capital. There were a lot to choose from. So, to narrow down the list, I had everybody enter the 12 step program - after reading my tutorials above, of course.

2nd lien products in high LTV states that have rapidly declining housing values proffer the opportunity for 100% losses with no recoveries.

Above is a list of states and the home equity and 2nd lien defaults for said states. For those who don't know, 2nd lien loans (of which include HELOCS, piggy backs, home equity loans, etc.) are 2nd in line when it comes to liquidation rights under foreclosure. If the loan was made with a high LTV (let's say 90% combined LTV, with the first loan made at 85% LTV), in an area that has even a modest (these days, anyway) decline in value of 10% year over year, then you effectively have a 100% loan with not equity. Every dollar after this that the house drops is a permanent loss from the bank's loan. Factor in the costs of deed transfer, mortgage tax, utilities, upkeep, brokers commissions and legal fees (about 7.5%), and the bank now get's nothing, even if it can move at auction. When I say nothing, I mean nothing. Not just an NPA on its books, but absolutely not way to recover any value from the home. I can hear the blog readers now saying, "Well, what are the chances of that happening?". Stay tuned, and we will assuredely find out.

The graph above shows a subsection of my 32 bank Deep Doo-Doo list who sport:

1. HELOC portfolio exposures with high average LTVs that increase the risk of the whole portfolio
2. HELOC portfolio exposures with full 100% LTVs or close to it consisting of a very large portion of the total portfolio
3. HELOC exposures with very high, but not quite 90% LTVs consisting of a large portion of the total portfolio

For those that really wondered whether the scenario that I outline above could really take place - well, wonder no more! We have a whole smorgasbord of banks in that position. The key is, which of these bank have loans in the aforementioned areas detailed in the first graph. I know you know that I know the answer to that question. I'm even going to tell you for free, but before we go there let's cover some additional background material. I want you to pay particularly close attention to who is leading the pack in high LTV concentrations. I was short this bank and WaMu since last year, and have since covered both short positions in the single digits are close to it. As a rule, I rarely ride a stock past $10 on the way down because zero is but so far away and the risk/reward ration is rarely justifiable (the two monolines that I have covered in detail are an exception to this rule). In this case, I covered both too early, particularly Countrywide. The moral to the story here is that many of these banks are not too far behind Countrywide, with the largest difference between CFC and them being CFC's piss poor public relations ability. WaMu is right there too, as well as some big name banks with some big name investors behind them. I will end my bank series with a full scale forensic report of my number one short in the sector and I am sure it will shock many of you who like to buy into brand names.

In order to determine how likely the aforementioned event is, let's create a metric by which Reggie Middleton measures risk. This metric will be units of risky or non-performing assets as a percentage of statutory equity. This, of course, can be refined by removing goodwill, Bullsh1t, and the various accounting pollutants to plain old economic earnings, but less just start with this. When applying Reggie's Risk Metric to the graphs above, we can identify more banks.

Looking at risk from this perspective, we not only see who has no clothes on when the tide goes out, but also how well (un)endowed they are in addition.

Please keep in mind that some loans and banking products are much riskier than others. Due to this, I have culled what I believe to be the riskiest products to short list the banks. We have already addressed 2^nd lien loans. There is also construction and development (C&D) loans that are still on the books that are by far, much riskier than the conventional commercial loans - which are risky assets themselves in this environment. An off the cuff, anecdotal assumption would be that 20% of these loans will be in default in many areas, with greater numbers the newer the vintage. For a category such as high rise condos, they are usually 24 month, interest only, 20-30 year amortization. The intent is to have them refinanced into permanent loans upon construction completion, which is difficult for projects such as condos. Construction costs have spiked, supply is up and demand is down. Those banks with high LTV C&D loans (ex. Corus Bank) and any 2^nd lien loans over 90 LTV should be high on the short list.

One to four family properties are also quite risky, for amateur (and not so amateur, actually) investors bought buildings without a firm (or even loose) understanding of cash flows, cap rates, and rental yields - aided and abetted by the banks which apparently missed out on the cash flow valuation memo as well. Well, those who overshot the predictions of rent rolls, undershot the estimation of expenses, or took out volatile ARM products ended up not only underwater, but with negative cash flow as well. It is much easier to walk away from an investment property than it is to do so from your home. As you can see from the graph below, my assertions seem to be ringing true. The rate of change in delinquencies in these are SKYROCKETING!

I am going to cut this short here, and will continue this series in 24 hours or so. I have quite a bit of information, so the series will be at least 4 or 5 additional parts. I also need to post my homebuilder updates (remember I broke the secret on the industry's secretive JV accounting) and Muni default ->CDS failure connection research as well. So much to do, so little time. I do hope you guys appreciate this, for I don't know where else to find it on the net. As if this disclaimer is necessary: I am short, or in the process of accumulating bearish positions in most if not all of the companies detailed in this article.

Comments

[User 198682:]

Squeeeeeezzzzzzeeee!!!

Guess what... the market is forward looking. it's known about everything in this posting since November. Being short these names now is like being long last July.

Good luck sir

2008 May 23 12:04 PM

[siegfried:]

agree--the home equity crisis is a ticking time bomb. now take your list and cull it for banks that have already taken the hit, raised additional equity and moved on, then adjust the remainder for banks "hidden assets" like the KO stock on STI's balance sheet that will add $1 billion of equity this quarter and then cull out the banks operating in geographies that have not been hard hit. You will get banks like CMA, BBT, and SNV. Still trading above book and still under reserved. Then its a race--will they have to write down before the recession turns. If the recession lasts through the year and they have to do year end house cleaning (again) then they will trade down 20% to 30% from here. If not, then you are stuck with watching them trade between their 50 day MA and their 200 day MA for the next 2 quarters.

2008 May 23 12:12 PM

[Ebuddy:]

Look back on this article in about 18 months and it will personify the adage that even a blind squirrel finds a nut once and a while. While the author clearly makes some salient points he has selected some very large banks (USB, WFC, KEY and BAC to name a few) that are much more complex than simply their home equity portfolio. In addition, institutions with highly conservative underwriting strategies with regard to credit, BB&T and US Bank come to mind, are more resistant to the housing value downturn. As long as the customer can afford to pay their first and second mortgages and has a propensity to do so (good credit), risk from LTV alone is almost immaterial. In addition, conservative lenders will have been less likely to sell negative-amortization products which further dilutes the risk of default due to payment shock. Inevitably, by selecting 32 medium to large size banks the author will get some correct but he gets a “C” for research.

2008 May 23 12:36 PM

[Citibanker:]

You are way off the mark. But I do like your attempt at scholarship.

2008 May 23 12:38 PM

[Reggie Midd...:]

You guys are funny. This is one of a 15 part series, and each and every point you have made has or will be covered in complete detail. Do you guys mean to tell me that you have read all of the links and text in the article before you posted these comments?

There is much to learn. Be sure you come by the blog for the last five installments.

2008 May 23 02:21 PM

[kurt walter:]

BAC buying CFC is the old story of throwing more good money into a bad initial investment. I am always amazed how often this happens. Poor management caused the current mess. The vast majority of those HELOCs (also know as home ATM money) are worthless. No value. Poof.

2008 May 23 04:19 PM

[jimmy46:]

You didn't mention FBC, they're under $5 now and claim they didn't write sub prime.
Bargain or trap?

2008 May 23 04:30 PM

[Will Smith 000:]

Some regional banks are doing well. For example, GBTS. They have no subprime exposure.

2008 May 23 06:30 PM

[drmalaka:]

Reggie, as always a great article. You have so much back up information that those who throw barbs at you just do not want to do the work and understand what is really happening.

Ebuddy, Reggie did not say sell all those stocks, he has more articles and will select the best shorts. Your points are correct, so the answer might be that those are not on the short list.

The first comment is just a stick your head in the sand attitude. Trust the market, they know. First, don't forget the lowlife scumbags you are trusting. Second, how forward looking was the market in Q3 07 when it ran to new highs? What about NASDAQ in March 2000? To blindly follow that is idiotic, at least take a moment to listen. Read what Reggie and others have to say and then decide who you agree with.

There is very little room in these banks for defaults, it is not like they have a gross margin of 50% so a few defaults would mean nothing. Generally speaking, I would figure that losing all the principal on one loan would cancel out the profits of twenty five or thirty loans at least. If they lent out money at 10% interest the interest payments on ten loans of equal value would cover one complete loss. Then you have to factor in that they only make the spread between what they borrow for and they lend out. Add in overhead and costs and I might be underestimating the number of quality loans one complete loss cancels out.

Reggie you are spot on. If a bank holds a high percentage of these potentially zero value loans (and I agree with your hypothesis that a lot of these will be zero) then that bank is going to be in trouble. I love how you are going about this.

All those above who are so positive on this sector, do you really believe that housing will come back by the end of the year or early next? 11 month supply of houses compared to a usual 5.

2008 May 23 06:57 PM

[Rhett:]

"This is one of a 15 part series, and each and every point you have made has or will be covered in complete detail."

What kind of investment advice is it that tells you to depend on the advisor to back up his analysis in the future? Gads!

2008 May 24 04:53 PM

[TA:]

Alright you got me - I'm sure you have 14 worst case scenarios to parade in front of us in the coming weeks.

I called Buffett and told him I'm selling my WFC and he should do the same. Meredith told us a few weeks ago and we didn't listen and here you are telling us the same.

In fact I will sell my Canadian banks too(I live in Canada) just in case(they aren't on your list but every US bank is so it must be that you aren't including International banks in your analysis).

What a fool I've been - thanks for clueing me in.

2008 May 25 12:48 AM

[TA:]

Honestly Reggie, ignore the fools who bring up the fact you are telling us this 9 months after everyone else - better late than never I say!

Hindsight is number #1 in investing! Yah hindsight!

2008 May 25 12:57 AM

[Joe E:]

The continuing decline in house and condo prices is a serious worry for banks with a lot of residential real estate (and related construction loans) on their books. Nobody wants to buy real estate right now because of the possibility of looking stupid later when (if) prices go down further.
Even the best capitalized major banks are in no position to withstand a serious recession at this point, at least without seriously diluting shareholders. The brands can survive, but current shareholders may see their stakes diluted enormously. This means lower stock prices. However, a coming recession is not certain and the big banks have lived through tough times in the past. They also have the Fed as their friend.
If the economy holds up, then your analysis might look too pessimistic later. If the economy, especially employment, gets worse to a significant degree, then your analysis will seem brilliant.
I also think that there will be some relaxation of the mark-to-market rule for banks which has caused much of the recent markdown activity and depressed earnings/capital. ACAS gave an example of a debt security they were forced to mark as worth $11 million dollars even though it produced and is producing $8 million in cash flow each quarter. The fed has made a start on this for banks by accepting non-treasury securities as collateral for some loans. The Fed is unlikely to let major banks go under because of a new and arguably flawed accounting rule change. This by the way is not meant to contradict your analysis but just to mention a possible counterforce.

2008 May 25 08:05 AM

[SW Richmond:]

If one examines macro indicators of the health of financials, they have never been poorer. Never. Never has such massive intervention been needed to keep them (ostensibly) afloat. Never have they gone to Congress hat-in-hand begging for hundreds of billions of dollars of free money. Never have they lobbied for relaxation of accounting standards so that they can continue to appear solvent. The fundamentals for financials going forward are fricking horrible. Everyone knows that it's darkest before the dawn, but we haven't really gotten to "darkness" yet and dawn is quite a few years away.

Those among you who are fooled, or are trying to fool us, should join Karen Finestein on CNBC and load up on Citi. As for me, I loaded up on SKF all the way down, after Dick Bove's insane bottom call.

2008 May 25 08:31 AM

[CrossProfit_:]

Some pretty harsh comments above, hew! We're sure Reggie appreciates the comments as at least he's been spared the usual name calling.

So far the series has been very good, pointing out various subtleties that are usually overlooked. As soon as Reggie named the banks there was bound to be fireworks. Well, we're joining the show and listing, for the record, our take on the 32 to be checked over the next 3, 6 and 12 months in relation to Friday's close - 05/23/2008.

* PC = premium content, undisclosed.

ASBC PC
www.crossprofit.com/vi...
BAC UP
www.crossprofit.com/vi...
BBT UP
www.crossprofit.com/vi...

BPOP PC
www.crossprofit.com/vi...
C FLAT to DOWN
www.crossprofit.com/vi...
CFC UP
www.crossprofit.com/vi...

COF FLAT to UP
www.crossprofit.com/vi...
CVBF Unrated
FCTR PC
www.crossprofit.com/vi...

FHN FLAT to UP
www.crossprofit.com/vi...
FITB FLAT to UP
www.crossprofit.com/vi...
GBCI Unrated
HBAN FLAT (new evaluation line to be posted soon)
www.crossprofit.com/vi...

HNBC Unrated
JPM FLAT
www.crossprofit.com/vi...
KEY UP
www.crossprofit.com/vi...

MI UP (new evaluation line to be posted soon)
www.crossprofit.com/vi...
MTB FLAT
www.crossprofit.com/vi...
NARA PC
www.crossprofit.com/vi...

NCC High Risk
www.crossprofit.com/vi...
PNC UP
www.crossprofit.com/vi...
RF FLAT to UP
www.crossprofit.com/vi...

SASR PC
www.crossprofit.com/vi...
SNV UP
www.crossprofit.com/vi...
SOV UP
www.crossprofit.com/vi...

STI FLAT
www.crossprofit.com/vi...
TCBK Unrated
USB FLAT
www.crossprofit.com/vi...

WB See chart
www.crossprofit.com/vi...
WFC UP
www.crossprofit.com/vi...
WM See chart
www.crossprofit.com/vi...

ZION FLAT to UP
www.crossprofit.com/vi...

CrossProfit

2008 May 25 10:56 AM

[Lawrence Kl...:]

I am wondering why no one with credibility has not even touched upon the possibility that this is much, much deeper - due to a planned and very coordinated attempt - to bilk the gullible public out of billions of dollars by the bankers themselves. It is inconceivable that all this "sub-prime" lending went on without their tacit approval. I put forth the CEO of Country Wide as a perfect example. Not only is this a national epidemic but also an international problem, when German and British banks become so heavily involved. Am I a conspiracy nut? Maybe so. But doesn't it strike anyone but me as strange that over one weekend everybody can come together to "save" Bear Sterns- we are talking HUNDREDS of BILLIONS here - and then shove the bill onto the dumb taxpayer? The mantra has - and always will be - get away with what you can, plead innocent to the government, they will bail you out and then you are home free. If I am wrong on any of this then why do these "CEOs" take home hundreds of millions of dollars in cold, hard cash for trashing their own companies, and leave the taxpayers and the employees who worked for these companies for years holding the bag. As far as my research has shown ALL the CEOs in the above mentioned banks have received tremendous compensation packages for a job not even close to being well done. Please tell me which bankers are going to prison versus those who are just going to retire to their private mansions - as We The People pick up the tab?

2008 May 25 01:50 PM

[CrossProfit_:]

Reggie,

In 2006 the FDIC had 50 banks on its watch list and 3 defaulted in 2007. In 2007 the FDIC had 76 banks and institutions on its watch list. It doesn't mean that all 76 will default. In fact, most won't as there are numerous solutions before forcing a closure. This is out of over 8,000 banks/institutions/thr... etc., that are supervised by the FDIC. Keeping things in perspective is very important.

The FDIC does NOT disclose the names of the banks that are on its watch list. However, there are five private companies that list and grade banks in an effort to emulate the FDIC standards.

One free service, yet considered less reliable, can be found here:
www.bauerfinancial.com...

The free 'star rating' is what you are looking at. The additional reports for a fee you can compile on your own...buy one and see how they do it etc.

Good luck,
Saul Sterman
CrossProfit

2008 May 25 04:29 PM

[ed auerbach:]

Reggie: On a spec I just bought CRBC (not on your list of 32 dogs). Take 5 minites and tell me what you think. Much appreciated.. [e-mail]...

2008 May 25 06:14 PM

[Stewie:]

Nice work..............I have to love the fools who bought financials already. Did you clowns not look at the dismal economic forecasts for 2009-2010. This thing is far from over, and probably will end is a flurry of takeovers at or around net tangible.

Hey fools maybe you should quit taking advice from fund managers on CNBC, when is the last time one of those toadies had a negative opinion of the market.

2008 May 27 07:34 AM

[Big Al45:]

Don't know enough about most of the banks cited in your article, but think you are right about PNC.

Their financials aren't great and you can't trust them anyway. PNC caught pulling an Enron move about 5 years ago - creating an off balance sheet entity to hide factoring losses.

Perhaps most telling - the COO's 2008 bonus calculation (see pages 48 and 49 of the 2008 proxy). Demchack will get 100% of his bonus even if PNC's Asset Liability Management unit's performance is 25 basis points lower than its peers. In 2007, payment of the bonus required ALM to perform at the same level as its peers.

As soon as I read the proxy, I dumped the stock (at $68) and haven't looked back.

2008 May 27 01:41 PM

[David Hunkar:]

Glacier Bank may come out fine out of this mess since they operate in states like Montana,Wyoming,Dakota... etc.The stock is holding pretty good when compared to other banks of similar size.So far they havevn't announced huge losses and their loan portfolio is ok.

2008 Jun 01 03:13 PM