Tuesday, 15 June 2010 12:42

The BoomBustBlog Pan-European Sovereign Debt Crisis Bankruptcy Search

One of the most apparent side-effects of the turmoil resulting from what I have coined as the Coming (now arrived) Pan-European (soon to be global) Sovereign (soon to be private as well) Debt Crisis is the spread of the awareness the markets have drastically undercharged for risk over the last 7 years or so. This, of course, is just a long winded method of saying bubble. Many companies, and some entire industries (ex. residential and commercial real estate [Commercial Delinquencies], banking, etc.) as well as entire nations (namely Greece [Calculate Your Haircuts Here] and Spain whose underestimated debt woes I just posted on yesterday[Spreads are Blowing Out]) have grown so used to this under-charging of risk that to wean them off of this cheap capital would be devastating. This means, in essences, the bankruptcies and restructurings are coming, and its not a matter of if, but when. This will probably portend a return to the 2008 lows, close to it, or worse, because in this global economic ecosystem you cannot have one part of the developed world's  import/export component do that bad without infecting the other components. This was explained in explicit detail in "Financial Contagion vs. Economic Contagion: Does the Market Underestimate the Effects of the Latter?" and modeled out to show which direction the chain reaction may push the dominoes, as well as which countries were at risk from whom in the BoomBustBlog Sovereign Contagion Model.

We can see the effects of contagion driving market rates higher already, even as central bankers set negative rate policies. Reference Spain T-Bill Yields Jump; Doubts Emerge over Rating and the (still 3 months too tardy) dropping of Greece's debt rating which exposes how politically exposed and potentially manipulable ratings agencies are even when they pussy foot around with should have been explicit downgrades months ago - reference EU Commissioner Attacks Moodys on Greek Downgrade.

It is only a matter of time (and I doubt it will be much time) before the popping rates of sovereign debt and the incessant demand from the market (or bailout vehicles to be funded in the market) start crowding out private debt consumers, and drive those rates higher. Those companies with weak balance sheet, minuscule margins and play-dough business models will crack like Easter eggs. The BoomBustBlog Bankruptcy Search Series will attempt to identify those companies before the market recognizes them and either warn our subscribers of the peril of holding said companies or allow them to potentially profit from their downfall. Let's start with the banks, which are a special case. You see, explicit bankruptcy (actually, regulatory receivership candidates) are often priced accordingly, but if you move one or two notches up the food chain, you can find a bevy of overpriced candidates that may not be ready to collapse immediately, but are priced as if they will continue forever. Add in a little sovereign malaise as a catalyst and boom, there goes the chemistry set!

There is a lot of banking research on the blog, but we decided to start from scratch with a fresh start and a tweaked set of criteria, which I have outlined below.

Stage Process
Initial List List of 229 banks in U.S with market cap greater than $100 mn
Step 1 Divided the banks into the following three sets to analyze each set individually
Set A Banks with Texas ratio of more than 50%
Set B Banks with Texas ratio of less than 50% but more than 30%
Set C Banks with Texas ratio of less than 30%
Step 2 Sub-divided each set further into three categories
1) Shortable set - Banks with share price of more than $10 and free float of more than 20 million shares
2) Banks with share price of more than $10 but free float of less than 20 million shares
3) Banks with share price of less than $10
INITIAL SCREENING - The selection criteria was to to find banks which continue to have high accumulated NPLs in the balance sheet and continue to record relatively high charge-off rates (loan losses), resulting in negative earnings and erosion of equity.
Step 3 In Set A and Set B , banks were selected in the first two sub-categories. In Set C, banks were selected only in the first category.
Major parameters used
a) Charge-off rates in the last quarter is higher than 2.5% of total loans
b) Loan loss coverage, i.e, Charge-offs/ (Pretax income + Provisions for loan losses) in the last quarter was less than 1.5x
c) Return on equity in the last quarter and on TTM basis is negative or extremely low
d) Coverage ratio (Allowance for loan losses to Non-performing assets) is less than 40%
e) Price-to tangible book value is more than 1.5x
Step 4 Banks selected in Set A, Set B and Set C in each sub-categories were consolidated to produce two separate lists
List 1 Selected banks in step 3 with share price of more than $10 and free float of more than 20 million shares
List 2 Selected banks in step 3 with share price is more than $10 but float less than than 20 mn shares
FINAL SHORTLISTING - The primary shortlisting criteria was to to find overvalued banks in terms of high 2011e P/E and high 2011 Price-to-tangible book value. Estimates for 2011e EPS and 2011e Tangible book value per share are based on consensus estimates sourced from Bloomberg
Step 5 Banks with relatively high 2011e P/E ratio while having weak fundamental were selected. A total of 13 banks have been finally shortlisted from the two lists
Final shortlisted banks Banks with high 2011e P/E as well as high 2011 Price-to-tangible book value are highlighted in green
Banks with high 2011e P/E but low 2011 Price-to-tangible book value are highlighted in blue

We have 4 banks that have returned to us from the original Doo Doo 32 list from two years ago (yes, many of those banks went bust, but there are still a few stalwart living dead traipsing around), while everyone else is brand spanking new to the watch list. All paying subscribers may access the live spreadsheet here.

For those of you who don't subscribe, here is a freebie. It's nowhere on top of the list, but it does provide food for thought:

Ticker Short name Price P/Tangible BVPS (2011e) ROE (based on 2010e earnings) ROE (based on 2011e earnings) Market cap Float (mn) Price as % of 52 week high Price as % of 52 week low 52 week high 52 week low P/B P/Tangible BVPS Tier 1 ratio Tangible Equity/ Tangible assets Loan-to Deposit ratio Texas ratio Coverage ratio Charge-off rate Provisions to charge-offs Loan loss coverage
Final shortlisted
PBIB US Equity PORTER BANCORP I 13.6 1.00 6.0% 7.8% 120 3.0 78.6% 128.1% 17.2 10.6 0.9 1.04 12.2 6.6% 91.6% 81.0% 23.2% 0.8% 105.3% 2.7
Last modified on Wednesday, 16 June 2010 11:50