Thursday, 07 January 2010 00:00

Someone Is Paying a Lot for High Priced Doo Doo ^Featured

Written by Reggie Middleton

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In reviewing the banks that were originally included in the Doo Doo 32 (a list of likely doomed banks created in the spring of 2008), I decided to have a team take the devil's advocate perspective (an exercise that we normally pursue) and attempt to build a bullish case for the sectors that I viewed bearishly yet have outperformed the S&P and escaped profitable shorting during the last three quarters. The results are illuminating.

Below is a list of shortlisted banks that have reported higher returns relative to S&P 500 between the period March 9, 2009 and January 5, 2010 - the bear market rally of 2009. The methodology that we followed for this short listing is as follows:

· We took out a list of banks that are domiciled in the US and have market capital of more than $500 million and current share price of more than $10.

· Next we calculated returns for each bank and S&P 500 between period March 9, 2009 and January 5, 2010.

Clic Click any graphic to enlarge

· I shortlisted banks that reported higher return than S&P 500 and prepared matrices with various key parameters like q-o-q growth in NPAs, Texas ratio, Efficiency Ratio etc. over the last four quarters.

· We then highlighted the positive and negative parameters for various quarters and parameters using different conditions for each parameter (please see row 2 and 3 in the attached spread sheet model below).

Conclusions

· We have highlighted four banks that have reported relatively (this term must be stressed, for even these banks are giving up significant amounts of common shareholder equity to non-performing assets) sound fundamentals over the last four quarters which could justify the increase in there share price to certain extent. This statement is actually quite the stretch taking into account the banks that have shown more blue highlights than orange (see the attached spreadsheet, free registration required - Banks that outperformed the S&P 060110 2010-01-07 02:42:42 1.21 Mb). More focus has been on q-o-q growth in NPAs and the Texas ratio to choose the banks that have increased in relative health. As you can see from the graphic below, nearly all banks that have shot up in price have at the same time rapidly trended down in fundamental performance and credit quality. The screen is comprehensive as well. We included the following fundamental and credit quality metrics in the scan:

Tier 1 ratio
Q-o-Q growth in NPAs
Texas ratio
NPA as % of loans
NPA as % of common equity
Provision as % of loans
Provision as % of common equity
Reserve for loan losses as % of loans
Cushion (Reserve less NPA) as % of loans
Cushion (Reserve less NPA) as % of common equity
Loan loss coverage
Net interest margin
Efficiency ratio
Q-on-Q growth in net interest income (before provisions)
Net Interest Income as % of revenues
Q-on-Q growth in non interest income
Return on assets
Return on equity

Clu Click to enlarge a partial screenshot of the model

· Though we have selected four banks, overall the shortlisted list of banks have performed quite poorly over the last four quarters. When NPAs as a percent of common equity are taking into consideration, those four banks are on the downtrend as well.

· Only one bank I would consider relatively clean (that is, without significant caveats, although its metrics are deteriorating), and that bank's share price has went relatively nowhere in comparison to the rest of the bunch who are giving up massive amounts of common equity to credit losses, and whose metrics are deteriorating in nearly every conceivable category used to measure bank health.

What is truly interesting is that this very poor showing of asset and credit quality, as well as fundamental value trends is quite evident AFTER the government has dumped hundreds of billions (if not more) into bank rescue plans and FASB has basically given the green light to go ahead and lie about asset values. See the effect this has had on not only bank stocks but the broad market as well.

For more on this, see "How Regulatory Capture Turns Doo Doo Deadly".

It should be clear to all who study this model that banks stocks have become trading vehicles and not representative slices of future income or indicative of future asset values. On top of this evidence of fundamental implosion, the macro seen looks absolutely HORRIBLE!

Residential real estate prices are trending down in the face of hundreds of billions of dollars of bubble blowing, (see"If Anybody Bothered to Take a Close Look at the Latest Housing Numbers...").

Residential loans are still on a steady path of implosion - getting worse, not better (see "The Truth! The Truth? Banker's Can't Handle the Truth!!!"). The interesting issue is that all of the categories are at currently a level that scream solvency alert!

Commercial Real Estate Losses are REALLY ramping up, and this is just the beginning! See CRE 2010 Overview.

While you're at it, check out "The Latest REIT Updates are Now Available" for added measure.You can see that not only is the collateral behind the failing residential loans imploding at an unprecedented rate, but the stuff behind the failing commercial loans make residential housing look downright rosy in comparison. Compare and contrast how fast the CRE values are falling against those of the residential values that get much more press and airtime in the mainstream media...

See CRE Consulting for more info on CRE trends.

Tell me, dear readers, are we in Japan yet???!!! Don't let those who don't run the numbers tell you otherwise. We are following damn near (save some differences in structural rigidity) lockstep in their path. Okay, I'm busted! Not exactly lockstep. Our property decline is probably STEEPER! Look at the second leg.

"Wait a minute buddy!" is being shouted at me from behind the Internet pundit's bullish keyboard. We are in the midst of a recovery, and GDP is forecasted to increase. You know, forecasted by the same guys who somehow missed the biggest stock market and economic drop of a lifetime. Yeah, I know... The GDP thang! Well, wasn't GDP humming right along when all of this mess started. This is about assets and liabilities, not revenue inflows and outflows. I hope you guys have been practicing the use of your chopsticks, cause here we go, GDP increase and all!!!

Practically all of Japan's global banks are no longer global. All as a result of the silly, unsustainalbe, and guaranteed to fail game of "Hide the Sausage" and "Extend & Pretend"!

Click to enlarge...

Source: Cap Gemini Banking M&A

I have been fairly accurate in observing this mess for the last 10 years. I had a rough 3 quarters but hey, nobody's perfect. One thing I can say for sure, the signs pointing to significantly further asset declines are much clearer now than they were over the last ten years. Take it from someone who has bothered to stop and read the signs.,,

Understanding my proprietary investment style

I took a loss for the year (primarily due to Doo Doo being bought at insane pricess as their business deteriorates, ex. market manipulation) bringing my total gains down for the Asset Securitization Crisis (yeah, go ahead and click it - the entire crisis has been documented in real time, and some pretty nifty macro calls/observations as well), but am still up deep into the three digits since the crisis started and considerably more if you count the starting point of the bubble. I'm thoroughly pissed at myself nonetheless, but we must keep things in perspective, (see "Year End Note to BoomBustBlog Readers and Subscribers". The boom/bust cycle continues for this BoomBustBlogger, though!

Case Shiller index has been amplified by a factor of 10x for the sake of comparison to the S&P 500.

Hey, buddy! Ya' have any overpriced bank stocks to sell me in this new bull market for the new millenium? I heard the sell side banks on Wall Street are pushing banks and REITs. You know how they protected us in the first half of this downturn. Ya' think they'll do just as good a job in the second half?

See the following for a backgrounder on my opinion before we move on to the risks emanating from other parts of the world stimulated by our number one export from the "Too Big To Fail, but Too Big to Let Survive Intact" club: