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I'm going to try not to say I told you so... 11 comments
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
More Doo Doo Banks Available to the Public: These are publicly traded banks with a high probablity of an FDIC takeover
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, its none of those. Its because I PAY ATTENTION, and odn'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 subsidiaires 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!
Before we move on to the Blooberg article that sparked this blog post, let's excerpt some key snippets from the latest FDIC memorandum to its Board of Directors. It is written in the coded language of regulator-ese, but I will translate for you in red font:
1. The FDIC not impose additional special assessments in 2009. Because we have hit them pretty hard already and they are already broker than we are!
2. The FDIC maintain assessment rates at their current levels through the end of 2010 and immediately adopt a uniform 3 basis point increase in assessment rates effective January 1, 2011.
3. In October 2008, the Board adopted a Restoration Plan to return the Deposit Insurance Fund (DIF or the Fund) to its statutorily mandated minimum reserve ratio of 1.15 percent within five years. In February 2009, given the extraordinary circumstances facing the banking industry, the Board amended its Restoration Plan to allow the Fund seven years to return to 1.15% percent. We're in trouble and need more time. We will crush and already insolvent banking system (despite the proclamations to the contrary by the government and bank management) if we attempt to return the fund to a prudent level in less than 7 years. Its getting worse quickly even as the bank stocks skyrocket over 100% - just a few months ago we throught we could do it in 5 years.
Pursuant to these requirements, staff estimates that both the Fund balance and the reserve ratio as of September 30, 2009, will be negative. This is techincially and effectively insolvent! This reflects, in part, an increase in provisioning for anticipated failures. In contrast, cash and marketable securities available to resolve failed institutions remain positive.
Staff has also projected the Fund balance and reserve ratio for each quarter over the next several years using the most recently available information on expected failures and loss rates and statistical analyses of trends in CAMELS downgrades, failure rates and loss rates. Staff projects that, over the period 2009 through 2013, the Fund could incur approximately $100 billion in failure costs. Staff projects that most of these costs will occur in 2009 and 2010. Approximately $25 billion of the $100 billion amount has already been incurred in failure costs so far in 2009. Staff projects that most of these costs will occur in 2009 and 2010. So, only 25% into this mess by the FDIC's own calculations, and they are already negative and insolvent. They believe the worst is yet to come (versus Bernanke, Paulson and Geithner saying the worst is behind us), and that worse will come rather quickly. To make things worse, as you read the article excerpted below, the FDIC doesn't even seem to have a firm graps on the risks, as they were blindsided by a nearly billion dollar failure that wasn't even on thier problem bank list, and this was last Friday! You all know who has been the most bearish on the financial sector through all of this.
If the Board imposes no further special assessments and leaves existing risk-based assessment rates in place, staff projects that the Fund balance would become significantly negative in 2010 and may remain negative until 2013. According to these projections the reserve ratio would not return to the statutorily mandated minimum reserve ratio of 1.15 percent until late 2018. 'Nuff said!
The projections in the preceding paragraphs address the effect of projected failures on the Fund balance (its net worth, which is assets minus liabilities), not the cash balance of the Fund, which provides needed liquidity. Staff has also estimated the FDIC’s need for cash to pay for projected failures. At the beginning of this crisis, in June 2008, total assets held by the DIF were approximately $55 billion, and consisted almost entirely of cash and marketable securities (i.e., liquid assets). As the crisis has unfolded, the liquid assets of the DIF have been used to protect depositors of failed institutions and have been exchanged for less liquid claims against the assets in failed institutions. As of June 30, 2009, while total assets of the DIF had increased to almost $65 billion, cash and marketable securities had fallen to about $22 billion. The pace of resolutions continues to put downward pressure on cash balances. While the less liquid assets in the DIF have value that will eventually be converted to cash when sold, the FDIC’s immediate need is for more liquid assets to fund near-term failures. Translation: We were forced to accept the trash assets from the fail banks that we could not convince the private sector to accept, as we mean (by using the term "less liquid claims") that these assets are effectively unmarketable, and must be traded at an extreme discount which renders them for all intents and purposes of the fund, effectively worthless in comparison.
Staff ‘s projections take into account recent trends in resolution methodologies, such as the increasing use of loss sharing—especially for larger institutions—which reduce the FDIC’s immediate cash outlays, and the anticipated pace at which assets obtained from failed institutions can be sold. If the FDIC took no action under its existing authority to increase its liquidity, the FDIC’s projected liquidity needs would exceed its liquid assets on hand beginning in the first quarter of 2010. Through 2010 and 2011, liquidity needs could significantly exceed liquid assets on hand. So, not only are we balance sheet insolvent, we will be cash flow insolvent within one quarter.
Imposing an additional special assessment as provided for in the May 2009 final rule would bring in approximately $5.5 billion in revenue to the Fund; imposing two (one at the end of September, one at the end of December) would bring in approximately $11 billion in revenue. Given staff’s projections, neither amount would prevent the Fund from becoming significantly negative or prevent the Fund’s liquidity needs from exceeding its liquid assets on hand in 2010. Even combining these special assessments with higher risk-based assessment rates would not solve these problems, unless rates were set very high or more was collected in special assessments. Furthermore, any additional special assessment or immediate, large increase in assessment rates would impose a burden on an industry that is struggling to maintain positive earnings overall. Translation: Damn, even if we hit the banks at the continuing rate that we have already elevated the special charges to, we are still insolvent. No matter if hit them much harder, insolvent we will still be. The only way out of this is the same accounting game that the banks pulled. Hopefully, we will be able to fool somebody. See below.
An alternative—borrowing from the Treasury or the Federal Financing Bank (FFB)— would also increase the liquid assets available to fund future resolutions but would not increase the Fund balance as there would be a corresponding liability recorded. Hey, wait a minute here. How is this any different from asking the banks to prepay thier insurace premiums. In the prepay scenario, there will be an increase in cash (an asset) as well as an associated liability (unearned insurance premiums). Do the FDIC folk believe me to be as dense as some of those bank investors that really believe that banking industry is solvent. I posit this query to all interested pundits: how can the banking industry be solvent if the banking industry insurance fund is insolvent, and by thier very own admission, very insolvent!??!!?!?!?!?!?!?!?
Staff projects that failures will peak in 2009 and 2010 and that industry earnings will have recovered sufficiently by 2011 to absorb a 3 basis point increase in deposit insurance assessments. Adopting a uniform increase in assessment rates of 3 basis points now, effective January 1, 2011, should ensure that the prepaid assessments would address current liquidity needs without materially impairing the capital or earnings of insured institutions. Advance adoption of the rate increase also should help institutions plan for future assessment expenses. So, whatcha sayin' is that we all know the banks are playing accounting games, we will just go along and play the games with them. Fu$% the economic earnings and cash, as long as we don't harm the accounting earnings, all will be fine. The problem with this is economic earnings actually mean cash and real capital. Accounting game or not, if you hit an insolvent bank hard for cash, it will give it to you and maybe even be able to gloss it over with pretty accounting tricks to make it look like its making some money, but in the end all you will be doing is using that money that you took from the bank to eventually take IT over. Garbage in, garbage out - old school programming! There is more, but I am sure you've got the message by now. Now, on to the article of the day...
From Bloomberg:
Oct. 1 (Bloomberg) -- There was a stunning omission from the government’s latest list of “problem” banks, which ran to 416 lenders, a 15-year high, as of June 30. One outfit not on the list was Georgian Bank, the second-largest Atlanta-based bank, which supposedly had plenty of capital.
It failed last week.
Georgian’s clean-up will be unusually costly. The book value of Georgian’s assets was $2 billion as of July 24, about the same as the bank’s deposit liabilities, according to a Federal Deposit Insurance Corp. press release. The FDIC estimates the collapse will cost its insurance fund $892 million, or 45 percent of the bank’s assets. That percentage was almost double the average for this year’s 95 U.S. bank failures, and it was the highest among the 10 largest ones.
How many other seemingly healthy multibillion-dollar community banks are out there waiting to implode? That’s impossible to know, which is what’s so unsettling about Georgian’s sudden downfall. Just when the conventional wisdom suggests the banking crisis might be under control, along comes a reality check that tells us we’re still flying blind. You can't say I didn't warn you at least two years in advance:
The cost of Georgian’s failure confirms that the bank’s asset values were too optimistic. I have been alleging this for some time now, see "Is JP Morgan Taking Realistic Marks on its WaMu Portfolio Purchase? Doubtful!". It also helps explain why the FDIC, led by Chairman Sheila Bair, is resorting to extraordinary measures to replenish its battered insurance fund.
...As recently as its March 31 report to regulators, Georgian said it met the FDIC’s requirements to be deemed “well capitalized.” By June 30, that had dropped to “adequately capitalized,” after a $45 million second-quarter net loss.
Georgian also reported a 12-fold jump in nonperforming loans to $306.4 million from $24.7 million three months earlier, mostly construction loans. Again, you can't say I didn't warn you well in advance:
Georgian’s numbers made it seem as if the surge arose from nowhere. On its March 31 report, the bank said just $79.1 million of its loans were 30 days or more past due. That included the loans it had classified as nonperforming.
Survival Mode
Georgian’s new CEO, John Poelker, downplayed any concerns. “Whether there is enough capital for the bank to be a survivor isn’t an issue,” he told Bloomberg News for an Aug. 5 article.
What wasn’t made public until Sept. 25, the day it closed, was that Georgian Bank had agreed to a cease-and-desist order with the FDIC on Aug. 31 after flunking an agency examination. The 19-page order described various “unsafe or unsound banking practices and violations of law and/or regulations,” including failing to record loan losses in a timely manner. Again, something that I have sounded the horn on, see "They ARE trying to kick the bad mortgages down the road, here's proof!". Georgian neither admitted nor denied the allegations.
The FDIC updates the public about the number of banks on its problem list once a quarter. An FDIC spokesman, David Barr, said Georgian was added to the FDIC’s internal list in July. He said the agency adds banks to the list based on exam ratings, not the data in their financial reports.
As for the 416 banks on the list as of June 30, up from 305 a quarter earlier, the FDIC said their combined assets were $299.8 billion. (The FDIC didn’t name the banks, per its usual practice.) If Georgian’s experience is any guide, the real-world value of those assets probably is much less.
Rising Losses
That might help explain why the FDIC keeps increasing its estimates for the losses it’s anticipating from future bank failures. In May, the agency said it was expecting $70 billion of losses through 2013. This week, it bumped that to $100 billion. The agency also said its insurance fund would finish the third quarter with a deficit, meaning liabilities exceed assets.
The FDIC, backed by the full faith and credit of the U.S. government, will get whatever money it needs to protect depositors. For now, it plans to raise $45 billion by collecting advance payments from the banking industry. Those payments will cover the next three years of premiums that the banks owe.
In effect, the FDIC is taking out a massive, no-interest loan to cover its bills. Borrowing from the future won’t improve its insurance fund’s capital, however, only its liquidity.
The big question is what the FDIC will do next time, should its loss estimates keep rising -- and there’s no reason to believe they won’t. By statute, the insurance fund is supposed to be funded solely by the banking industry. The FDIC could keep borrowing from the banks, directly or through more advances. No it can't. The industry doesn't have the money.
The agency could tap its $500 billion credit line with the U.S. Treasury. It still would have to pay back the money with fees from the industry, assuming the banks can’t persuade their minions in Congress to change the law. As it stands, the only way to boost the fund’s capital immediately is by charging the banks a lot more money for their insurance premiums.
Given the odds that other surprises like Georgian Bank are lurking, the FDIC will have to bite this bullet eventually.
Disclaimer: I am most likely short every single ticker or public bank mentioned in this article.
Instablogs are blogs which are instantly set up and networked within the Seeking Alpha community. Instablog posts are not selected, edited or screened by Seeking Alpha editors, in contrast to contributors' articles.
This post has 11 comments:
its good to have people like you out there, cause if one was to listen to the mainstream media, one would think all is well out there, when clearly its just a big smoke screen and lots of hope in trying to hope away these problems, LOL. It seems all these banks are HOPING things will change, its hilarious.
As for your hating,.. Don't hate the player, hate the game. It's called math!!!
Take a close look at my track record. You can even look at the past 160 or so articles on SA or better yet go to my site and get the source. I have been right 90% or the time. Stock prices are not the final arbiter of the truth, my friend, but over time they do tend to fall in line. It hasn't failed yet, just ask Japan.
Just because major institutions, millions of sheep (I don't know why you are saying this since volume is at a historical low for a rally of this magnitude), and what you consider the greatest investors in the world are buying banks, doesn't mean they were right. How many of those guys accurately called the downfall in residential and commercial real estate, banks and insurance, the stock and bond markets?
If all those millions jumped off the Brooklyn Bridge, would you follow them???
... and stop hating. Peace and love.
Great post, again. It's all about "mark to magic" and when that doesn't work "mark to fantasy".
Larry Doyle, a new SA contributor, has a nice article on the Georgian Bank situation, just posted: seekingalpha.com/artic...
You might want to look at that and maybe leave a comment. Larry did a good job on the article.
Unlike you, I am not a trader. I don't have the labor or bandwidth to get in or out of complicated positions. Most of my profits have been in companies that have folded (at least on the short side). Traders, and others, who truly don't think one of the anointed big banks will not fail (again, and again) have another think coming. The system is in much worse condition than is generally accepted, and the only way out of it is to flush the trash out of the system. The only variable is whether we do it the hard way or the harder way.
I offer fundamental analysis, I don't offer investment advice or buy and sell signals. That is what the trader blogs are for.
SA wants a short disclaimer, I give it to them. Its their blog! If you want a more detailed view of how I have hedge during the rally, do a search on my site for "market neutral option strategies".
BTW, it is my belief that we are in for a doozy of a fall. Although it is hard to be bearish against the crowd, the fundamentals call for it. Look at a chart of the S&P from 9/07 till present and tell me which account would have more money in it, a net short account or a net long account. The recent rally, although quite aggressive, has only returned roughly half of what was lost - and I think we will be giving that back plus some.
The problems that caused this mess had nothing to do with economic indicators but stemmed from bank practices, credit and real asset bubbles and balance sheets. Looking at economic indicators to guide you to the long side is like looking at a road map to fly a space ship.
Spring through early fall have been challenging for the last two years but fall through winter have seen fundamentals prevail.
@buyitcheap: thanks. since you agree with my outlook, you must be outlandishly intelligent :-)
The key that has helped me was not to gamble (as in going long just because everybody else was long, refusing to take profits, etc.). I shorted Bear Stearns at $185 and published research as to why. I eventually went long at about $1.65 and it went up to $10. BSC was an obvious short from their balance sheet. The same with Lehman, GGP, WaMu, etc. I took incremental profits, and sometimes just left the original basis in the position after 100% or so profits in speculation the company would totally collapse, which many did. Once profits start ramping up I very rarely go less then 50% cash and make heavy use of options.
I don't give investment or trading advice, so although I understand your stated position, it doesn't apply to me. I offer only fundamental analysis and opinion.
They exact same scenario that caused the other big banks and cos. to fail last year is extant now with many of the banks that people say are too big to fail. They are not too big to fail. Banks have been failing for thousands or years, and life has still went on. It is a myth to believe that the world will come to an end if JP Morgan fails. Jamie Dimons deferred comp may come to an end, but that just leaves a space for smaller more entrepenurial firms to take JPM's place and get their chance to grow into large behemoths who may themselves be at risk of being replaced if they can't compete in a competent fashion. This, my friend, is called capitalism. By propping up insolvents, even for fear that the world will come to an end is not only erroneous, it is anti-capitalistic and will significantly prolong the economic downturn.
Even if the government attempts to save the big banks (which they can't save them all), they will probably not be saving the equity investors. Reference Fannie and Freddie for prime examples.
@Anand: "I disagreed on the premise that a favored bank like jpm willl go under after the gov't handing them bear sterns assets and wamu on a platter and making them the "model institution.""
The gov. used JPM to absorb distressed assets. It wasn't necessarily on a silver platter. If you read my report, JPM is already underwater on its highly discounted WaMu assets, and we are not even half way through this mess yet.
"Why can't they save them all in combination with those banks abilities to raise capital lately... if bac can raise capital months ago at $12 a shares they sure as hell can today... I"
So would you buy a 2nd BAC secondary offering now? If not, what makes you think everyone else would? Even if they do raise capital, the subscribers to my site know that the capital that they have raised pales to the capital lost and the capital at risk. The government helped engineer a bubble to capitalize the banks, it is not something that can happen on a regular basis. BAC stock was trading above the secondary offering price, even Lewis couldn't believe it.
"As for equity investors fannie and freddie had very a different urgency and they needed to be in conservatorship for the govt to manipulate."
And what was the difference??? A lending institution with the implicit/explicit backing of the government that was stuffed to the gills wtih bad mortgages and derivatives in a deflationay, deleveraging environment with decreasing demand. That description could easily fit Freddie, Fannie, LEH, JPM, C or BAC. The only difference between now and then is the government backed liquidity, and modicum of more capital but not nearly enough to justify the risks. It appears that very few people realize that none of the core problems that caused this mess have been addressed, hence there is no practical reason to believe that more bank failures are not eminent.
" sure as hell hope you didn't go long in 2000... and if you did I hope you avoided tech! The s&p got cut in half two years later so you must have been an incredible stock picker in 2000..."
I went long, highly leveraged into distressed real estate in 2000 and started selling off in 2004 and 2005 in anticipation of an obvious popping of the bubble which happened in the 2nd half of 2006. I shorted everything real estate related in 2007. Practically all of the problems in 2007 and 2008 are in existence in 2009 thanks to a combination of ignorant investors believing that the problem was solved and a government that is too entwined with a lobbying financial sector to force it to take the bitter deflationist medicine that needs to be swallowed.
"Why can't I find this article in your profile under recent articles... I have to go through my comments to find it... strange."
You are not trying to find my stuff very hard if you have not been to my blog. That is where all of my original content is to be found. I have no control of the editorial stuff on SA. As for your other comments, come on over to the blog and lets have that discussion there.
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