Clock is Ticking for Banks With Asset Quality Issues (Part II)

Back before Memorial Day, we looked at the stock price performance of the 302 publicly traded banks with assets between $1 billion and $25 billion after ranking them on five measures:  non-performing assets, reserve coverage, core earnings quality and exposure to construction and land development loans. 

In the second week of May, we noticed that the rate of decline among the stocks with poor fundamentals seemed to be accelerating relative to banks with better fundamentals (see table below). 

click to enlarge image

Back then the banks with the worst fundamentals were down 34% during earnings season when bad news was coming out.   But the banks with good earnings quality and fundamentals seemed to be holding up well: they posted a 2% decline during the same period.

Since then, we’ve seen IndyMac (IMB) close its lending operations, Freddie Mac (FRE) delay its capital raise in the face of a price decline to historic levels and BankUnited suffer a stock price decline 70% since launching its recap just to name a few issues.  Since we’ve entered a new era of investor skepticism and concern, we wanted to revisit the analysis to what trends it uncovered.

While almost all financial institution stocks have suffered greatly during the past month, the numbers continue to reflect the same trends we saw back in May.  The best of the bunch suffered price declines of 17% - but the worst group declined 40% in the past month, putting them down 83% year over year.  The market seems to be facing up to the reality that the most troubled institutions will fail or suffer massive dilution in recapitalization transactions. 

In our note May 24 (Seeking Alpha “The Clock is Ticking for Banks With Asset Quality Issues”), we pointed out that while it takes longer for banks to fail than their unregulated counterparts, they ultimately do if they have asset quality, management or other significant earnings quality issues.  We note that Fremont survived through April of this year despite having a lower quality loan portfolio than its unregulated peer American Home Mortgage (which suffered a liquidity crisis before failing during one week last August).

The banking system and the FDIC do a good job creating stability in the financial markets by providing liquidity to the industry, but they can’t let deeply troubled institutions survive forever absent a capital raise or other restructuring. 

Comments

[TheBookkeeper:]

Mindi did you ever consider that today's bank failures are brought on by bad bookkeeping. Are you aware that bookkeeping is a 650 year old language whose fundamental controls were abandoned when record keeping moved from paper and punch card systems to computer code? Do you know that accounting is a strategy run subject to that bookkeeping framework of rules? No accountant or economist that I know of, knows a proper bookkeeping's finely tuned rules. Bookkeeping is a piece of the banking story you would do well to consider.

2008 Jul 09 07:24 AM

[ETFnerd:]

Banks are in a world of hurt and will continue in that place for a while. Because investors in the market decided to close their eyes to being sold garbage because they were making money doing so, banks and unregulated lenders threw their underwriting standards out the window in order to churn out garbage in ever increasing quantities. The result is that investors don't trust the banks' underwriting any longer and refuse to buy any more garbage. In fact the baby gets thrown out with the bathwater, and investors refuse to buy regardless of whether the product is garbage or not. Thus we have the current liquidity crisis.

I think the question is not whether the banks have little time to right their business. That is only a concern for investment bankers like yourself wanting to sell these services to these banks so that they may be able to survive even if in moribund fashion. The real question is when will the banks regain their credibility with the buyers of their wholesale products. That ship is sunk and it's time to build a new one from scratch.

2008 Jul 09 10:31 AM