The Second Wave of Bank Troubles

Floyd Norris notes that the S&P financials have sunk back to their mid-March lows. But although the index as a whole is back at its mid-March level, its components generally aren't. What we're seeing is pretty much what Mohamed El-Erian predicted in April: the second shoe dropping, and the bad news moving from the world of financial engineering into a much more real world of struggling businesses.

 During the next few months there will be a reversal in the direction of causality: the unusual adverse contamination by the financial sector of the real economy is now morphing into the more common phenomenon of recessionary forces threatening to undermine the financial system...

While the financial system has taken steps to enhance balance sheets, they speak essentially to addressing the consequences of excessive leveraging and imprudent financial alchemy. As such, the nasty turn in the real economy may fuel another wave of disruptions that, this time around, would also have an impact on mid-size and smaller banks.

So far, Wall Street still looks noticeably healthier than it did during the worst days of the Bear Stearns crisis. But Main Street, as exemplified by lenders in places like Ohio, looks much worse. Here are the biggest financial stock-price losers in the banking industry, from Norris:

• First Horizon (FHN), down 43 percent. (It is the parent of First Tennessee Bank.)
• National City (NCC), down 34 percent. Ohio's largest bank is under increased regulatory scrutiny.
• Wachovia (WB), down 21 percent. Its CEO was fired for losses.
• Huntington Bank (HBAN), down 21 percent. Also from Ohio.
• Regions Financial (RF), down 21 percent. It is based in Birmingham, Ala., where the county government may have to declare bankruptcy after getting caught in the derivatives mess.
• Fifth Third Bank (FITB), down 21 percent. Another Ohio bank.
• KeyCorp (KEY), down 19 percent. Another Ohio bank.

These aren't institutions which came unstuck when their leveraged super-senior trades imploded; these aren't banks which were lending billions of dollars to private-equity firms in the form of PIK-toggle bonds. Yes, they have real-estate exposure, but look at the states here: Tennessee, Ohio, Alabama. Not California or Florida, where the real-estate bubble burst most spectacularly.

Commercial banks are in many ways a leveraged play on the strength of their local economy. So while the March dip in the S&P financials was symptomatic of Wall Street's troubles, the June dip indicates something much broader.

Comments

[Alex_G]

The real casualty of the real estate bubble bursting is the small commercial banks, many of which have a fairly high exposure to builders, who borrowed to buy raw land and now can't get the funds to build. This is where most of the failures will happen, particularly in Nevada, Inland California and Florida.

[FXTrader40]

As far as I know, nobody forced the bank in Ohio (or Tennessee or some other relatively obscure place) to take on excess or unknown risk. If these banks genuinely served their local communities, they would not have come anywhere near the complex and absurd products wallstreet concocted. No need to. Example, but not in banking, Warren Buffet. No, what you have is many small players in banking that for some reason decided to gamble with the big boys, when the big boys owned the casino (example, Orange County). And we all know, the only way to make money in a casino is to own one (Donald Trump).

[Eagle-Chief]

Bear Stearns was a HUGE thing (at least we have been told this much). I am hoping that Bear Stears was not just a little "wave" on the ocean and that the next round of bank failures/bankruptcies does not becomes like the 2004 Indonesian Tsunami ! We should be prepared. A financial tsunami alert has been issued (BY ME). Maybe a tsunami will come; maybe it won't. Let us not get caught with our pants down, or without life vests on. And please, get far away from the beach !
This is serious stuff. Read what Nouriel Roubini or Meridith Whitney has to say about the credit crisis.

[Toeser]

We are at the early stages of this mess. The double Freddies are likely in big trouble, as are some banks and investment banks. Lehman announced today they will seek $6 billion in new capital. It will really hit the fan when the next big boy can't get new capital and goes under.

[OJO Zafado]

It's the math that does not make "cents". 18 months ago it was "we are heading for recession because of the inverted yield curve". Now we find the opposite. The Fed with it's rate at 2% and the banks offerring 3.5% on one year CDs, (both short term instruments) while these financials float out ever more subordinated debt at +8% (long term debt). Now these new preferreds are long term instruments but the gap is too wide to make economic sense. Unless... Merideth Whitney is probably right. Most common shareholders in even the top 4 banks are likely to see their diividends cut drastically. C and WB shareholders can just kiss the dividend on the common goodbye! With it's global platform the recent C-PM went out at 8.5% and ended last week at 8.7%. The real contest now is to see who will be the first to broach a +9% offering. Of course they are over subscribed! What will Lehman float out there to lure the fish? Have they said yet? The preferred share line cutters always make out. Too bad if you own any common shares in banks. The real bargains though are in these beaten down issues with near term call dates like FBF-PN (BAC) and USB-PE. How these banks can still sell CDs at what they are paying with 100% tax liability when stuff like the FNM-PP is out there paying +6.25% inflation protected at the 15% preferred tax rate on dividends is the math I don't get?

[tattors]

I would like to stress that Wachovia and Bank of America should be examined closely. They are run by greed drunken Frat Brothers who have encompassed many companies., Lowes, HD, ...
the Charlotte skyline is stricken with symbols of their excessive displays of egotism.... and now the NY banking cults are at war with these boys, as is Chicago... Hugh McColl and Ed Crutchfield made lots of opposition with their slashing and burning strategies... imo

[buyitcheap]

It goes back to Jeremy Grantham's letter some month's back, saying at least one big I bank will fail and that we may want to get reacquainted with being comfortable holding cash.

[francis schutte]

Looking at the lastest statistics of the Federal Bank of St-Louis: window borrowings from the Fed, net free or borrowed reserves of the financial instutions and total borrowings of financial institutions from the Federal Reserve ( see charts on goldonomic.com under academics and CDO), the peaks on the charts really give me vertigo. This kind of situation is unique. Looking at the 1920's it was just a blip compared to to huge spike we have today! I think these charts tell a book and they are really worth looking at and analyzing.

[Benl]

Sooner or later these banks become viable investments. The questions are when and which ones. Keep an eye on Wachovia and Fifth/Third. They serve very stable areas of the country which tend to resist recessions and maintain values.

[Skjellifetti]

NCC purchased two FL thrifts in 2006 in an attempt to enter the FL market. They overpaid and are (at least partially) in trouble due to subprime lending in FL.

Huntington Bank is down due to a purchase of Sky Bank which has cost it the usual merger/acquisition/int... stuff plus Sky had a link to Franklin Credit Management Corp. (NASDAQ:FCMC) which has forced Huntington to take a $500 million loan loss set aside on subprime mortgages related to the Sky acquisition.

[OJO Zafado]

The player to be named later by Lehman has been named. The $2 billion in new convertible preferred will go out at 8.75%. They are seeing the C-PM of 8.5% currently priced at 8.7% and raising them a full quarter percent. So this would lead to Wachovia or Fifth-Third comming to the market soon with an even better hand, raising the pot amnother quarter % to a full 9%. Somethin's happening here...? A bird in the hand is worth ???? ...

[OJO Zafado]

Another thought.

Does any one have an opinion of the ETF PGF? Starting to look like a dollar cost averaging candidate.

[barcswine]

CASH is always KING when the ugly head of GREED becomes
apparent as the consequences of it are emerging now.

That said, even this financial crisis will eventually pass as such have in the past.

The FEDS need to pass financial "transparency&quo... legislation to insure this kind of fiscal disaster never happens again; and if it does, those responsible go to prison for a long, long time.

Federal bailouts I guess are ok short term to keep the US economy on an even keel. However, very stiff Federal fines and long prison sentences are required to eliminate the kind of wholesale greed from adversely affecting the innocents (us) ever again.

[Vegasjoe]

FHN has cleaned up most of the mess, selling all the crap that got them into trouble in the first place, at a cost of 75% or more to existing shareholders! So what is their second shoe? And what are the odds BAC cuts its dividend and raises capital? And why did they close on $4 Billion CFC if it is all bad long term? What is long term? 3 quarters or 3 years? And what was WB thinking when it overpaid at $25 Billion for Golden West? Their current Board Chairman, and acting interim CEO, Smith, has presided over 20 years on the board of First Union's stalwart acquisitions, which led them to change their name to protect the guilty when they stole Wachovia. Infact, the only decent acquisition First Union has likely done is steal WB, but then they had to grease the palms of the outgoing CEO at Wachovia, Baker.

[Emerald]

Tattors got it right! Felix, please don't make the same mistake that so many members of the press make. No one, absolutely no one was "fired" for losses. The CEO's of Wachovia, Citi and Merrill were allowed to "retire" with full vesting and rediculous exit packages. Ther is no accountability and the Boards are rubber stamps. Caveat emptor!

[meatball]

On the money, Emerald. They should all be fired! No one in the companies stand up and make an effort to have an CEO eliminated. The Wachovia and Huntington mergers were of total ignorance and cost everyone in the company and the stockholders a lot of money. I wouldn't allow any CEO, making the money that they are, to make any kind of "woops" without reprecussions.

[messenger]

Agreed ---FHN-- Their blonder has cost the stockholders a fortune. Stock drops are normal if errors are made. Stockholder understand that, but to continue with the same CEO & CFO ( the protectors of stock holder money) is crazy. You don't have to be a financial wizard to see the stock drop from the 40.00s to 5.00 to understand their plans was only protecting officers. We hung in there thinking that the NEW officers were going to straighten the mess out. --- Well is it going to happen?