A Concerned Investor

1 Comment

    • ON: Thu Jul 10th 14:09 PM
      Commented on:
      Risk/Reward of Owning REITs, Raymond James in this Boom Bust Cycle
      Your analysis of RJF makes very good points. As I assume your research indicated, there may be more issues than you had space to detail. Our analysis has turned up some questions as well.

      Raymond James Financial is viewed by most analysts as a brokerage firm but it is actually a thrift holding company, with its savings bank subsidiary now holding 45% of its assets, over which RJF has more leeway in mark to market reporting. The RJF management takes the position that the discounted Commercial Real Estate, Alt A I/O hybrids, and the other loans that are held in the RJBank subsidiary do not have to be marked to market. They seem to know the position is a bit shaky. As you probably saw in looking at the RJF press releases and SEC filings, RJBank announced in late March that it had increased the write-downs in the CMO portfolio you referred to from $3 million to $62 million, finally recognizing deterioration in market value of real estate assets. This was an admission that the real estate assets in the Securities portfolio had to be written down. The CEO went on to say, in so many words, that although logically this real estate mark down process should also extend to the bank loan portfolio, there are bank accounting rules that allowed them to not report the loans on a ‘marked-to-market’ basis. This forbearance of the accounting rules on mark to market and write-downs might make sense if RJBank actually were run as a normal bank, but in the RJF holding structure the bank is just a “holding pond” (a quote from the CEO in an Earnings call) for assets from the brokerage accounts where RJBank gets basically all its deposits like E*Trade did. RJBank has no checking or other bank services and only one branch. Does the argument they should get the benefit of bank accounting rules make any sense? If other brokerages like Bear Stearns (or a Merrill) had used the RJF savings bank subsidiary approach to buy its riskier assets and protect them from write-downs in a massive way like RJF did, then Bear or Merrill would not have had to write down their assets. Does it seem like RJF should get special treatment from regulators or auditors here? This inconsistency in treatment of brokerage structures and the ability of RJF not to mark to market does not make sense from either a regulatory or investor protection standpoint.

      On the other side, even if you say RJBank is a bank then there is still a strong argument that the accounting rules would not protect the Bank from a proper valuation and increased write-down or provisioning against its loans. Whether the RJBank loans should be marked down is a question that depends on whether the loans in its portfolio can properly be considered ‘temporarily impaired’. It would seem clear from the evidence that the loan portfolio is impaired and it is not a temporary condition. RJBank will have a difficult question to answer from the bank regulators. If RJBank is able to buy these loans at a discount from other banks like Citi whose risk managers have presumably required that the loans be categorized as impaired, marked down, and now sold off at ‘impaired prices’ months ago (and conditions have worsened) then how can RJBank continue to say the loans are only temporarily impaired.

      The regulators would seemingly also have to be concerned about the relatively low levels of reserves given the deterioration of the type of real estate assets that RJBank holds – a mere 26 bps for the Alt A hybrid loans where losses are projected at 5% to 7%, or even the seemingly higher 194 bps for the commercial real estate loans that the bank has probably been buying at a 500 bp or higher discounts. In the meantime, as you seem to suggest there might be a significant earnings benefit enjoyed by the bank on the loan purchases depending on the way they book these discounted loans.

      It seems clear why RJF is avoiding any suggestion of mark to market or impairment for as long as it can. A markdown of the loans would obviously result in a significant difference in the asset value of RJF and in its stock price. Under a strict mark to market, given the problems in the construction portfolio and where Alt A I/O and syndicated commercial real estate loans are now marked, the write-downs could be $450 to $500 million. You mention the CFO’s comment on the record level of earnings at the bank, and correctly question if that is really an accurate picture if delinquencies are coming, the loans are impaired and earnings not sustainable? A relevant question would also be aren’t bank accounting and SEC rules set up to make sure investors know more about the source and quality of bank earnings and the true valuation of the assets?

      You are correct in your short call if, as it appears, writedowns are inevitable; but more digging by you or other analysts, or more pressure brought by regulators, would hasten the process.
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