Troy Racki's  Instablog

Oh great, here we go.  When you do it for one, err two, then you have to do it for all.  But can you really blame investors when the rules of the game have changed?  All they are seeking is equal opportunity to profit.

This week potential buyers looking to acquire BankUnited (BKUNA) have asked the FDIC to put the bank into receivership prior to selling its assets.  This comes after BankUnited failed to raise sufficient capital to meet a $1 billion injection requirement by its May 4th deadline, prompting a warning by the Office of Thrift Supervision.  Now the vulture capitalists are circling in the hopes that the FDIC will put a bullet to the bank and hawk off the assets at a rock bottom price.

Such a move would wipe out shareholders and place creditors on uncertain ground.  This would not be the first time.

BankUnited shares ended Friday at $.79, similar in price to the $.75 low Wachovia (WB) set on September 29th, 2008 when the FDIC announced that it would facilitate an "open bank" transfer of company ownership to Citibank (C).  The deal was valued at $2.2 billion, or $1 a share.  Just a year earlier Wachovia Bank shares had rested in the mid to low $50s, a testament to how rosy the market had become.  The announcement drew criticism that the deal's price was too low.  Institutional investors had little choice however.  If they did not agree the FDIC would have placed Wachovia into receivership and their $1 a share price would have gone to $0.

However on October 3rd, Wells Fargo (WFC) stepped in and announced that it would acquire Wachovia for $15.1 billion in an all stock swap.  This was a significant improvement over the price the FDIC had brokered, which saved taxpayers and institutional investors a lot of money.  Had the original deal gone through the FDIC was prepared to absorb 87% of Citibank's losses on Wachovia's $312 billion loan portfolio, assuming the worst case scenario.

Regardless of either deal, Wachovia's bondholders faired well, receiving par on their $54 billion of bonds.  This prompted outrage from some.

Bondholders in the case of Washington Mutual were not so fortunate.  On September 25th 2008, the FDIC seized the bank and sold its $307 billion balance sheet to JP Morgan Chase (JPM) for $1.9 billion.  During this process $38.9 billion of senior and subordinated note holders were wiped out.  Additionally $3.5 billion in preferreds and 1.7 billion common shares that had closed at $2.62 the day prior were also zeroed.  All those losses added up to $46.8 billion for anyone aligned with WaMu.

The FDIC's actions at eliminating this many creditors would seem to have benefited JP Morgan which reported that its total mortgage losses would be only $39 billion in a deep recession, according to the recent stress tests.  So given the worst case scenario it appears that JP Morgan has profited by $5.9 billion by letting the FDIC do its thing.

Consequently bidders for BankUnited want a similar deal.  Rather than getting into a price war and acquiring the bank prior to receivership, by waiting until the end bidders can eliminate creditors from the equation.  Then if the FDIC sells the bank for less than market value the acquirer pockets the difference.  Given that this has happened already for JP Morgan, and almost happened for Citibank, will it again?

Currently the FDIC has extended BankUnited extra time, allowing for bids until May 19th, making it more likely the bank will find a buyer prior to receivership. 

But will it?  The banking environment is looking more like a high stakes poker game.  What if all the bidders call the FDIC's bluff?  Has the FDIC's previously poor judgment created a new environment where none will bid until the risk is eliminated by axing the creditors?  Is this fair to creditors or is it simply the new rules of doing business?

As investors in a new environment the safest course of action would be to withdraw from the financials until the rules of the game have been well established.  Of course if you do that you might miss out on some wonderful gains, as seen in the spike in prices of such financials as Bank of America (BAC).  But is the risk of being seized and the creditors negated worth the reward?  Another move may be to just purchase the winners from these deals, both past (JP Morgan and Wells Fargo) and future and avoid the rest. 

Just hope that what goes around does not come around.

Disclosure: WFC long.

The author has received no compensation for their publication.

Parents, next time little Johnny asks you what they should grow up to be, a lawyer, a fireman, or a doctor, just tell them to become an auto worker.

Seriously.

If you sit down and do the math you will discover that an 18 year old high school graduate who remains with the UAW for 30 years will have the ability to earn 10% more than a 22 year practicing pediatrician.  How is this so?  Are we really paying our auto workers the equivalent of a physician?

According to the United Auto Worker's website, an entry level position with the union pays about $33,420 for the year.  This includes their starting salary of $14.20/hour, a 6.4% retirement, a $1/hour payment to their health care fund, and a generous national PPO health insurance plan.  Meanwhile our pediatrician earns $0/hour working towards their degree while simultaneously taking on school loans.  The following year the union employee receives a pay increase of at least 3.75%.  With that in mind and fast forwarding through time, the UAW worker will earn approximately $304,463 over the next 8 years.  Meanwhile, according to the American Medical Association the average medical student will be $139,517 in debt upon receipt of their degree.

Considering a 25% federal income tax rate, and a 4.35% Michigan state income tax rate, our UAW employee will have taken home $215,103 in compensation for their 8 years.  The difference in net worth between the auto worker and the doctor would stand at $354,620.  If the auto worker invests their $215,000 at a modest 5% return, that amount will balloon to $350,380 in 10 years while the doctor's loans will end up costing $227,258 after 10 years at a 5% student loan rate.

This massive difference of $577,638 of net worth is why the doctor can never surpass the line worker.  It's not until their 10th year that the starting pediatrician actually earns more than the line worker at their $30.065/hour average ($80,664 vs. $60,130), because most two year residencies pay less than the UAW.

In year nineteen of the calculations, the UAW worker will earn $63,130 in salary, $23,819 in retirement benefits value, and $18,366 in interest off the compounded value of their first eight years of work.  The amount of $105,315 is nearly equal to the pediatrician earning their salary of $108,289, which typically has few benefits for the solo practitioner.  While over the next 11 years the pediatrician will earn more than the line worker, they will never achieve a net worth greater than the UAW worker in part because of the generous benefits and the initial 8 years earnings which will have compounded to $629,232 by year 30.  Total benefits to the worker during that time will amount to $352,805.

At year 30, the UAW worker will have achieved a net compensation of $2,447,597 versus the pediatrician’s $2,216,378, a winning margin of about 10%.

So we ask ourselves: Can America afford auto doctors?

With Chrysler in surgical bankruptcy, General Motors (GM) flirting with it and Ford Motor (F) trying to keep its head above water, these days there's one abbreviation upon many lips, the UAW.  Between the bondholders and the UAW, these two factions hold the future of the Big Three in the palm of their hand.  Reducing liabilities to both are necessary for the continuation of the American automobile industry.

Currently things are not looking so good for the bondholders.  Right now it appears that they will receive just 10 cents on the dollar according to the Wall Street Journal.  This return of their principle will come in the form of common stock.  Meanwhile current share holders will be hit with a 100 to 1 reverse stock split, putting their ownership of the company at just 1%.

But what about the UAW, what are they going to give up?  So far concessions made by the union appear to be few and far between, forcing massive layoffs.  President Obama currently appears to have the UAW's back, after all the 721,025 active, retired, and spouse members of the UAW voted for him.  Currently GM is offering the UAW $10 billion in preferred stock at a 9% yield, along with $10 billion in cash, in exchange for $20 billion in obligation forgiveness.  Is 100 cents on the dollar really fair when bondholders are getting just 10? 

Honestly, the UAW should be giving up more, and we as a society should be asking for just that.  Do we really consider a line technician of equal compensation as an experienced physician?  A physician's decision can determine life or death.  Is that equivalent in importance to putting a wheel on an axle?  Regardless of the answer, that's how we are currently compensating our auto workers. 

Why is the government satisfied in making the creditors eat the lion's share of the loss?  Those nearly worthless GM bonds are held by mutual funds that represent many American retirees who need the steady income a bond provides.  What about the $13.4 billion in loans the taxpayer gave GM?  Why should half of it get swapped into common when the UAW gets preferred?

Even if GM avoids bankruptcy and continues on to 2010, paying and promising our auto workers a compensation level equivalent to our physicians is simply unsustainable.  If America wants to continue to produce cars, it needs to be more innovative and competitive on the world's stage in the terms of price and quality.  Otherwise evolution, the survival of the fittest, will dictate the eventual extinction of the big three.  The UAW should be mindful of this when it comes to the bargaining table, otherwise it will end up killing the goose that laid their golden egg.

Disclosure: F long.

If you think our financial regulators need more authority, then you may want to reconsider.  Over the past eight months, pieces of a concerning puzzle have begun to come together.  One of these pieces surfaced in October when the FDIC seized Wachovia Bank and tried sell the company to Citibank for pennies on the dollar.  Many considered it a steal of a deal.  It turns out Wells Fargo was thinking the same thing and days later offered seven times more than Citibank, and more specifically, without taxpayer concessions.  SmartMoney magazine wrote a piece on the matter stating:   

"Then Wells came on the scene. It offered to buy Wachovia for $7 a share and told the FDIC that it didn't need any investment or any guarantees. Believe it or not, Citi had the gall to sue to block Wells' offer even though in every dimension it was superior for Wachovia stakeholders and for the American taxpayer." 

"You have to wonder what the FDIC was thinking in the first place. Citi had to take two huge capital injections from the U.S. Treasury under the TARP program in order to survive, and it had to have the Federal Reserve guarantee $300 billion of its toxic assets. So what was the point in having a bank that screwed up take over Wachovia?" 

(www.smartmoney.com/Inv...) 

Then in December at Bank of America, CEO Ken Lewis was considering dropping out of the Merrill Lynch merger after billions more in losses had been taken by the investment brokerage since the deal’s original announcement.  But when Mr. Lewis considered pulling out Ben Bernanke and then-Treasury Secretary Henry Paulson pressured him to hold his tongue and follow through, as reported by CNN. 

(money.cnn.com/2009/04/...)   

Because of this Bank of America had to swallow those losses, meaning you the taxpayer, through TARP, are the ones left holding the bag. 

Meanwhile a perfectly sound private bank worth $250 billion was told by the FDIC and the Treasury that it had to accept TARP money or face the humiliation of having its books dragged across the public stage, as told on air by Fox News.  While its books wouldn't have lost a page, just the act of being in the public eye would have set its business aflame as potential clients would have bailed from a supposed sinking ship.  The on air judge stated that the action taken by the government was extortion.  Besides the government not only earning a tidy 5% return on their money, now the government's 2% stake means it can tell the bank how to run their business.  Should not a well operated business have the right to run itself without government intervention? 

(http://www.youtube.com...)  

Well FDIC chairwoman Sheila Blair doesn't agree.  She wants more power.  As reported by the New York Times, besides overseeing the banks themselves, Blair now wants the authority to take over troubled insurers, bank holding companies and other financial institutions deemed by the FDIC as insolvent.  

(http://www.nytimes.com...) 

As both taxpayers and private investors we should be concerned. Giving the FDIC the power to declare more businesses insolvent, such as Wachovia, and then pass them along to whomever they please, such as Citibank, is a frightening proposition.  As seen by the inability of the FDIC to gauge true market value, one could predict that the FDIC could pass unjustified billions from one entity to another, whether accidentally or not, all while granting guarantees compliments of the taxpayer. 

If Chairwoman Blair does receive this vast power, investors are likely going to withdraw from related financial institutions because of the fear for possible abuse.  This would result in a very significant and wide spread pullback in the market.  For example, General Electric would apply to Blair's reach through its GE Financial arm.  In fact, the government has thousands of publicly traded businesses classified as being "financials".  When a temporary ban on the short selling of financially listed companies was issued in September 2008, the depth of this list became quite clear.  Some of those companies on the list included the more obvious names like American Express in addition to more than a few surprises, such as Sears.

Should the FDIC be given more authority when there are significant concerns regarding its track record?  Does the Treasury have the public’s interest best in mind?  Is either the FDIC or the Treasury trying to protect the investor?  Relaxing our sense of caution and ceding more freedom, whether in good times or bad, is a recipe for disaster.  Giving our regulators more authority, when they have proven there should be significant concerns on their judgment, is just cause for alarm.

Disclosure: Long WFC.