Riddle me this.

An industry gets into trouble due to chasing fads, loading up on debt and overpaying for property. Many participants in said industry flirt with insolvency due to difficulty meeting debt service and asset values that have dropped below liabilities. This industry has been gifted with a special tax provision that allows them to pay no corporate taxes as long as they pay out 90% of their income to their shareholders. By now I am sure you have guessed the industry, but let's move on .

BoomBustBloggers have been on a wild CRE (commercial real estate) and residential rollercoaster ride over the last couple of years.

Keeping with this theme, the rabble rousing, digital rag known as ZeroHedge recent ran a couple of posts concerning the CRE crash and its effects on NYC hotels.

I'll coin this term in order to explain the travesty that is being allowed in the banking industry. Institutions are literally paying little old ladies' less than a half a percent on their life savings and using said funds to gamble in the risk fraught derivatives market, with the risk being totally underwritten by the government through the:

1. FDIC (deposit insurance and bond insurance - although to date this expense has been born by the industry, the FDIC is insolvent and may very well have to tap the Treasury, ie. the taxpayer: see I'm going to try not to say I told you so...),
2. Treasury (via TARP and associate measures, see America, You have been outright lied to! Bamboozled! Swindled! Hoodwinked! The Worst Case Scenario) and
3. Federal Reserve (ZIRP, QE, and a whole slew of programs I only wish I knew about - see The Fed Believes Secrecy is in Our Best Interests. Here are Some of the Secrets).

A perfect example of how the big banks are carrying this arbitrage out is outlined in "The Next Step in the Bank Implosion Cycle???", but the global economy risking behemoths are not the only one's that arbitrage bank deposit funds via FDIC guarantees. Earlier this year, I featured research on a smaller bank, Bank of Oklahoma (BOKF), which I found participated in some pretty suspect accounting moves. Despite these "gimmicks" the stock floated higher with the general market and particularly the banking sector. OF course, this does nothing to cure the ills that they have been papering over.

Of the many issues that I have been warning about concerning banks, their balance sheets and the risks that they take, one of the (and there are a few) most underappreciated is the currency risk of the "mother of all carry trades". See Roubini Not Alone in Fearing Dollar Carry Trade and Roubini Sees `Huge' Asset Bubbles Growing in `Mother of All Carry Trades'.

Investors worldwide are borrowing dollars to buy assets including equities and commodities, fueling “huge” bubbles that may spark another financial crisis, said New York University professor Nouriel Roubini.

You know, I happen to really, really appreciate the blogoshpere. There are a select handful of blogs that offer unique, insightful and very difficult to come by expertise, opinion and commentary. Much more so than the mainstream media and even more so than the more specialized media. Despite this, there are certain components of the MSM and corporate America that still do not respect the blogs. Now, why is that? Well, I dare you - no, I double dare you - to find an MSM outlet that performs investigative analysis at the level of the top blogs. I'm not even going to bother to mention who those blogs are (hint, hint), but just want to throw the challenge out there as I show how PNC may have possibly pulled the wool over the collective media, sell side and market's eyes.

Just a few hours ago, I posted my review of PNC's 3rd quarter earnings for 2009 (please look here to see the media, sell side brokerage and equity market's accolades for said results as well as my opinion). In that review, I actually gave management kudos what appeared to be operational excellence. While typing the review and pondering the data trends, that annoying thing called common sense kept nagging me. I thought to myself, how can their 90 day late loans and charge offs trend downwards after just buying one of the largest junk loan manufacturers in the country amid near record (and rising) unemployment? Even more to the point, why the hell didn't anyone else press this point? Well, I asked my analytical team to dig in a little deeper, and it didn't take long to come up with an answer...

PNC has reported strong accounting earnings for Q3-09 and lower charge-offs as well as lower 90 day lates. The press and the blogs were all over it as a news search in Google reveals:

PNC Financial Services profit jumps 88% - MarketWatch PNC Financial Services Group (NYSE:PNC) said that its third-quarter net profit jumped to $467 million, or $1.00 a share, ...

Reggie Middleton on Wells Fargo's 3Q09 Reported Performance

Results Review - 3Q09

Wells Fargo & Co. (WFC) reported higher-than-expected earnings for 3Q-09, beating consensus estimates for the second time in a row, primarily on back of increased revenues from mortgage banking. Although WFC's reported EPS at $0.56 was up 14.0% y-o-y, it declined 2.0% q-o-q in 3Q09. A y-o-y growth in earnings reflected strong growth in non-interest income (up 169.8% y-o-y) and net interest income (up 83.1% y-o-y) led by higher customer base and increase in product offerings to its existing customers, partially offset by increased provisions for credit losses (up 144.9% y-o-y and 20.2% q-o-q) during the same period. Excluding the impact of gains from mortgage servicing rights (MSR) and hedging gains (included in mortgage revenues and overall constituting a part of non-interest income), the Company's earnings declined in 3Q2009 on q-o-q basis. The contracting base of interest earning assets (q-on-q) along with higher loan losses provides a significant headwind to the company's valuation in the near-term.

We have taken a second look at the concerns raised by Ackman now that we have a copy of his short thesis on Realty Income (O) in PowerPoint and have come up with the following observations. For those who do not subscribe to my blog, I have decided to make a significant portion of my real estate analysis available to the public, so as to fully communicate the apparently unforeseen cash flow and valuation situations of some of these REITs. This is in anticipation of a slew of fresh REIT short candidates to be delivered to subscribers in the upcoming weeks. I feel the sector is ripe for a revisiting in terms of valuation, cash flow issues and macro outlook. For part one of my review of Ackman's "Realty Income (O)" opinion, click here (requires a quick, "free" registration).

To begin with, I have taken an earlier look at Realty Income, and while I agree that they may not be in the best shape and do not have strong macro prospects, I didn't see an absolute case for a short. I was then forwarded the full presentation given by Ackman, in which I was able to review more of his reasons for the short thesis. The following are my findings, followed by a detailed analysis of another REIT that, although may not be facing as stringent a macro dilemma, has a much more pressing cash issue at hand. Before we get to that, let's go over my second (albeit still relatively and admittedly cursory) review of the Ackman "O" short thesis. Keep in mind that Ackman and his crew probably took more time to review "O" and interact with its management than I did.

I have posted this warning of Bank of America's (BAC) naked swap writing to my subscribers a few weeks ago. Since BAC is reporting this week, I have decided to make my suspicions public. I have found evidence that this bank has $32 billion of naked (as in apparently unhedged) swaps on its books - just like AIG. The difference is this bank is bigger, probably has more exposure, and has already been bailed out - several times. Oh, did I mention the insured collateral is nearly half BBB rated or lower? How about extreme management issues at the top, and I mean all the way to the top (the CEO may actually bring down the ex-treasury secretary and maybe even the Fed Chairman). A trunk full of junk, surrounded by drama. It should be an interesting conference call today when they report, that is if anybody decides to ask the right questions.

As many of my subscribers and readers know, I have caught many companies on the short side as they imploded. One company that I did not get was American International Group. The reason it escaped me? I was too close to it. I have met Frank Tizzio (then president), Maurice Greenburg (then CEO and Chairman), and a several of their upper management to collaborate on deals, and was impressed with the way they ran their shop. Because of this, I didn't apply the same critical, skeptical eye that I used with the other prospects. Alas, because of such, I overlooked the inevitable, and in retrospect, the blatantly obvious.

One of the quandaries of running a subscription service is that when you have some really juicy stuff, you inherently limit the audience that you are able to reach. Normally, this isn't that big a deal. When you believe that there is a mass cover up aiming to prop up the largest cadre of zombie, insolvent companies in modern history it becomes a much bigger deal. This leads me to distribute a significant amount of research for free. On that note, I have been following the breadcrumb trail of hidden (or more aptly put, concealed) corporate liabilities, and it has led me to (of all places) off the balance sheet of the big banks. I have spent a lot of time concentrating on exactly where the losses, if any, will come from in these banks. We have already established that the smaller banks had, have and will totally drain the FDIC's insurance fund over a year and a half ago (see As I see it, 32 commercial banks and thrifts may see the feces hit the fan blades Friday, 23 May 2008, notice how many of the banks have gone under since then) in the post "I'm going to try not to say I told you so...

I would also like to add that I raised the flag on this regional bank/commercial real estate issue many months before the sell side and the main stream media said a peep. This is not to brag or boast, for I am a fundamental investor and the market has definitively ignored the fundamentals for 7 months running. The point that I am trying to convey is that analysts in the big sell side banks work for their trading desks, underwriting and sales departments, and not for the investor (be it retail or institutional). Thus, proclamations of "Buy! Buy! Buy!" do not necessarily mean we have entered into a fundamentally firm area in which to buy stocks, bonds or any other risky assets covered by these guys. For a sterling example, see "The sell side is pushing with all of their might to inflate the market...".

From Reuters:

Oct 6 (Reuters) - Pre-Paid Legal Services Inc (PPD) said it received a subpoena from the Division of Enforcement of the U.S. Securities and Exchange Commission (SEC) as part of a fact-finding inquiry, sending its shares down as much as 21 percent.

I have commented on the interconnected counterparty risks in the banking and shadow banking system. Tidbits are now coming out in the news. Any time a big lender defaults, another big lender (or three will be on the hook for it).

Goldman Owed $1 Billion if CIT Goes Bankrupt: Report

For those that believe mark to market rules are useless (I know they make it hard to goose your share price in a deflationary market, see "Charting the Truth"), I bring you the collapse of a bank last week that wasn't even on the FDIC's troubled bank list. To add misty eyes to misery, the mis-marking of the banks assets will cost the FDIC nearly a billion dollars. That's a lot for a bank that wasn't even on the watch list. If the banks were forced to carry assets at market value, REAL market value, these little surprises will not be allowed to sneak up. Investors, regulators, bloggers, etc. will be able to see them coming a mile away - or at least they should. Alas, I am able to see them anyway. Is it because I am hyper-intelligent, possessive of meta-human powers, or employ an army of elfin dwarves to hide in the boardroom duct vents to eavesdrop on the board meetings? No, it's none of those. Its because I PAY ATTENTION, and don't have any conflicts of interests and axes to grind that color my observations and analysis.

Subscribers should keep this in mind when reading about this big bank that has written a bunch (more than a quarter of its tangible equity) in naked, unhedged credit default and total return swaps - see "And the next AIG is....". Knowing what they have acquired as of late, and what their subsidiaries have been trying to unload, there is no telling what the hell the quality of the underlying is. One thing is for sure, it is probably not very pristine!

Any objective review shows that the big banks are simply too big for the safety of this country. That just about says it all. The only thing missing is that it doesn't tell you that the banks that are too big to ensure financial stability are still getting bigger, and riskier.

Before we go on, let's get a few things established for those who have not followed me regularly. Note to avoid redundancies: If you have not read me regularly, I suggest you peruse the "Credibility" side bar below. If you have not followed my recent banking articles over the last few weeks, then continue below. If you have been hanging off of my every word, then skip down to the "Break'em up, and break'em up now!" section, otherwise please read on. I strongly believe that the content of this article can change many a perception of the big banks in this country, and hopefully alert many to the risks that have been concentrated therein, even after the meltdowns that we have had to suffer at the collapse of Lehman Brothers and Bear Stearns. Things have not only not gotten better, they have gotten worse! Forward this article (or a summarized version of it) to your local congressman, senator, regulator or investment advisor, and ask them to respond to the assertions herein.

First of all, I would like to call attention to a well written article by J.S. Kim, The Coming Consequences of Banking Fraud. It just so happens to mirror my thoughts, exactly. Those who have been following my subscription services for a while, or even have just started, should realize that I have been quite accurate in my fundamental analysis. Although I am not always 100% on the money with everything, I am within the ballpark 80% to 90% of the time, give or take - which is quite a strong track record. The problem has been over the last quarter or two, that accuracy with the fundamentals has meant relatively little in terms of actual share prices. This means (it always has and always will) that we are in a severe speculative bubble (or conversely a fear driven post crash lull). I think we all know which one it is. It has even gotten to the point where some commenters on the blog claim "fundamentals no longer matter". The last time I heard that preached consistently was right before the dot.com crash, which was notoriously hard to time, but was clear as day in the ability to be seen coming by those who still counted profits and losses.

My research tells me that a large bubble has been blown again, even as the most recent one was still in the process of popping. Like Mr. Kim in the article above, I have found it quite difficult to time the coming if the anticipated bubble pop this 2^nd time around (I did successfully and accurately anticipate the bubble being reblown, but severely underestimated the extent, breadth and depth), thus have resorted to market neutral strategies to prevent loss of capital/profits while still keeping my finger on the bearish trigger (see In this difficult to trade market, you have to be more than just right... ). Don't get me wrong. I am not a doom and gloomer, or a permabear. I am a realist. I have absolutely no problem going net long (not market neutral) when I feel the time calls for it. The problem is that the issues that caused last year's market crash (which I pronounced loudly in 2007) have not even come close to being rectified, and as a matter of fact, are in many ways actually worse. In addition, the share prices of many of the companies that are laden with these issues have increased several hundred percent, with many currently hovering at pre-bubble burst prices. This is not the market for a fundamentals guy to go long in. Momentum investors and those who seek fads are currently having their time in the sun, but those who astutely followed the fundamentals are still significantly ahead of the game, by far. It is my belief that if a crash does come, and investors are significantly positioned, those windfall profits will return again, and be predictably manageable because fundamentals will come into play, and not the need to follow stories about high frequency trading, or to catch up with the rest of the market because you were on the sidelines while prices shot up.

In the initial revamp of the Doo Doo 32 bank list, our shortlisted banks were selected based on deteriorating fundamentals, and the idea at the time of screening was to review their solvency position, as we had screened the banks by applying filters similar to recently failed banks list.

Although widely accepted, computing adjusted P/B using the formula (tangible book + loan reserves - tax assets - fair value adjustment) could underestimate the multiple if a bank has high NPAs (non-performing assets) vis-a-vis loan loss reserves. If we want to add loan loss reserves to tangible book, we must deduct NPA as well. As a result, from a valuation point of view, conventional P/ TCE (tangible common equity) is more relevant.

JPM derivative and off balance sheet lending commitments and guarantees exposure

As we step through the various exposures that this most esteemed bank has, keep in mind that as of June 30, 2009 JPM's common shareholder's equity and tangible common equity stood at $147 bn and $79 bn, respectively. You tell me if the risk inherent in our banking system has been mitigated, please!

In following with my promise to call out the nations most insolvent, publicly traded banks, I am publishing part two of my short list of Doo Doo banks.

We have looked into 14 additional banks out of the group previous shortlisted from the original 869 bank scan (see the FDIC as a catalyst, or the new Doo Doo 32!) and almost all the banks in the additional list have better metrics compared with the original list of 8 banks published last week. We have selected two of the 14 banks analyzed recently based on the banks' loan and investment portfolio, operating metrics and valuation ratio.

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.

I have some good news and some bad news. The good news is that that market neutral strategy illustrated through my blog research is working like a charm (I will be posting some results soon). The market has been on a massive bullish tear, to the dismay of market bears.

Well, the new strategy works and it allows us to profit from both bullish and bearish moves. I have transformed my personal portfolio to the market neutral strategy.