The Problematic Banks

by: Reggie Middleton

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.

The complicity of US accounting authorities, regulators and government has not only kicked the can down the road, but has made the can a lot larger. I outlined this in The Folly of US Financial Political Games and pointed out the poignant comments that other have made on the topic as well (Interesting excerpt from Jeff Nielson, Banks are actually worse off now than they were before).

I called the collapse of the regional banking system about a year and a half ago with the Doo Doo 32 (As I see it, these 32 banks and thrifts are in deep doo-doo). Glancing at this list over a year later (no one thought the regional banks were even at risk when I came out with the list) in search of overlooked bear candidates, we excluded 6 banks which have been acquired or forced to close and excluded 13 banks with share price of less than $15. Of the remaining 13 banks, we looked deeper into six banks - BB&T Corp (NYSE:BBT), Glacier Bancorp (NASDAQ:GBCI), Sandy Spring Bancorp (NASDAQ:SASR), M&T Bank Corp (NYSE:MTB), TriCo Bancshares (NASDAQ:TCBK), Zions Bancorp (NASDAQ:ZION). Based on the comparative analysis of valuation multiples, past stock price performance, the bank’s loan and investment portfolio and operational performance (based on Bloomberg data and latest filings), I will produce the results of the analysis and the most Doo Doo bank for 2009 for subscribers over the next few days.

The WSJ referenced in The Folly of US Financial Political Games holds the key to what will bring many banks down, even the better run ones have invested in securities that are dropping in value by 20% to 50%, on a quarterly basis. To make things considerably worse, as also focused on in the political games article, the powers that be have actually endorsed the fraudulent reporting of said assets, essentially giving the ok to inflate the book value of this junk in order to create earnings and value where none is available. Of course, as can be seen in the graphs, the banks' share prices have responded accordingly, increasing by one hundred percent while the market value of their assets drop by 20 to 50%, taking humongous amounts, if not all, of the bank's tangible equity with it. In addition, the commercial real estate and construction sectors are looking to get much worse in terms of losses. Just ask Suntrust (NYSE:STI).

If you don't believe him, just look at the implied leverage of some of these popular banks and imagine what happens to tangible equity when these investments drop in value (ex. some preferred trust and CDO portfolios have lost over 50% in market value this past quarter):

Bank Investments/Common Equity


744% (Whoa - more on them in my next post)
Wells Fargo (NYSE:WFC) 373%
Bank of America (NYSE:BAC) 371%
Sandy Spring Bancorp 311%
BB&T Corp 245%
U.S. Bancorp (NYSE:USB) 212%
SunTrust 200%

Still not convinced, let's look at how conservative select members of the surviving Doo Doo 32 are in terms of financial cushioning against further loss:

Cushion (Reserve less NPA) as % of common equity
SunTrust -23.3%
Sandy Spring Bancorp -23.1%
Zions Bancorp -19.9%
Glacier Bancorp -9.6%
BB&T Corp -8.3%
M&T Bank Corp -7.8%
TriCo Bancshares -7.6%

Do you still believe this to be a bank bull market in lieu of a bear market bounce fueled by legalized financial fraud? Well, let's pick a Doo Doo 32 bank and go through the books, shall we...

Zions Bancorp, a bank with about 4$4.5 billion of tangible equity, also has...
Level 1 267,044 6.7%
Level 2 1,826,631 45.9%
Level 3 1,888,828 47.4%

About half of this banks ENTIRE investment portfolio is not valued by market transactions, but marked to managements opinion, which of course is most rosy, to be sure.

Non agency mortgage backed securities as % of equity 51.1%
Non-agency MBS has the same value as used toilet paper in some circles...
Mortage loans as % of equity


I think they over did it on the leverage front here.

So, exactly how is that investment portfolio doing?

30-Jun-09 Amortized cost Fair value Unrealized gain and loss
U.S. Treasury securities 25,113 25,845 2.9%
U.S. Government agencies and corporations:
Agency securities 290,504 296,378 2.0%
Agency guaranteed mortgage-backed securities 411,180 420,684 2.3%
Small Business Administration loan-backed securities 834,883 812,530 -2.7%
Municipal securities 251,029 252,833 0.7%
Asset-backed securities:
Trust preferred securities – banks and insurance 2,173,757 1,536,164 -29.3%
Trust preferred securities – real estate investment trusts 76,745 34,580 -54.9%
Auction rate securities
171,910 171,252 -0.4%

161,983 107,329 -33.7%
Mutual funds and stock 246,300 246,300 0.0%

4,643,404 3,903,895 -15.9%
Municipal securities 671,671 671,399 0.0%
Asset-backed securities:

Trust preferred securities – banks and insurance 265,292 200,972 -24.2%

32,486 18,717 -42.4%
Other debt securities
100 98 -2.0%

969,549 891,186 -8.1%

Keep in mind that these losses are akin to the ones you and I would take in an institutional margin account. Zion's has a leverage ratio of 13x and investments to common equity of 189%. One dollar of investment losses equates to much more than one dollar of lost equity to this bank and its shareholders and investors.

If we look at the actual loan portfolio...

Commercial lending: (in million) % of loan type % of loan portfolio
Commercial and industrial $10,588 53% 25.5%
Leasing 423 2% 1.0%
Owner occupied 8,782 44% 21.1%
Total commercial lending 19,793 100% 47.7%
Commercial real estate:
Construction and land development 6,848 50% 16.5%
Term 6,795 50% 16.4%
Total commercial real estate 13,643 100% 32.9%
Home equity credit line 2,086 29% 5.0%
1-4 family residential 3,781 53% 9.1%
Construction and other consumer real estate 599 8% 1.4%
Bankcard and other revolving plans 344 5% 0.8%
Other 342 5% 0.8%
Total consumer 7,152 100% 17.2%
Foreign loans 67 0% 0.2%
FDIC-supported assets 875 2% 2.1%
Total loans $41,530 100% 100.0%

A full 1/3 is CRE, with half of that being construction. For those who don't know what that means... See "Who are ya gonna believe, the pundits or your lying eyes?" and "Who are you going to believe, the pundits or your lying eyes, part 2".

Another 17% is consumer with HELOCS (basically unsecured variable debt), residential 1-4 family and construction loans. All told this is 4x their tangible equity, and this is some of the worse lending categories to be in right now. I will expound on other banks, including the extreme risk that JPM and Goldman (NYSE:GS) pose to the system in my next post (or two). In the meantime, here is plenty of related proprietary research and opinion on the banking farce and fake stress test material for any who are interested.

Disclamer: Not yet short all of the banks in this article, but actively working on it with option spread trades and straight short positions.