1/28/09

Of Course The Banks Aren't Lending. There's A Depression On, Fool.

Yesterday, Kevin Depew of Minyanville wrote a column entitled Five Things You Need to Know: Under TARP, Neither a Borrower Nor a Lender Be. Depew discusses the lack of new lending by TARP (Troubled Asset Relief Program) recipient banks:

According to Bloomberg, 51 lenders who got TARP money reduced total loans by $92.9 billion, or 2.5 percent, in the fourth quarter from the prior quarter. Their smaller peers who didn’t apply for capital or declined cash infusions curtailed lending by $1.87 billion, or 1.3 percent, the article said. Fifth Third Bank (FITB), Capital One (COF) and KeyCorp (KEY) were among those receiving TARP funds that curtailed lending the most.

Depew goes on to say that this lack of new lending is "...puzzling the Fed, baffling Treasury and mistifying most economists." I doubt that the situation is quite as mysterious to the Fed and Treasury as Depew believes. Every Friday, the Federal Reserve Board releases an estimate of the aggregate balance sheet of US commercial banks flamboyantly known as "Assets and Liabilities of Commercial Banks in the US" or simply H.8. H.8 gives voluntarily provided data from the largest 30 US banks and statistical estimates from a sampling of smaller institutions. While I'm certain there is a fair amount of error in H.8 components, it should be sufficient for qualifying industry trends.

In bankworld, loans, securities, and cash are assets, deposits and borrowing are liabilities, and never shall the two meet. Below is a chart constructed from the historical H.8 data for all commercial banks:


It's important to note that equity in this context is more of an indicator of a trend in aggregate net worth, as opposed to capital adequacy. For example, the Federal Reserve Board does not include loan loss provisions in its asset tabulations. Nevertheless, a disturbing trend can be observed from September '08 until the present. It's readily apparent that liabilities have increased relative to assets. which can be seen below, in the complement of the above chart:


Considering that much of the TARP funds are booked as equity due to the fact that Treasury is buying preferred stock, the decline in bank equity becomes more interesting. Furthermore, loan defaults are almost guaranteed to increase as a result of the current unemployment levels, further reducing bank capitalization. Which finally brings me to my original point: Banks are hoarding their TARP proceeds due to adequate capitalization concerns. If I'm a bank president who is watching my capitalization ratios decline due to charge-offs and non-accruing loans, do I want some more of the hair of the dog that bit me? Nope.

I am certain the Treasury and the Fed are well aware of this. Nobody who is familiar with Fifth Third could honestly expect them to increase lending anymore than you would expect a drowning man to ask for barbells. Instead, I believe that these public complaints about the lack of new lending are merely a backhanded means of reassuring us of bank soundness. Who would ask a troubled bank to lend, right? Why Depew and other media types don't know this or won't say this is beyond me. More bad loans are precisely what we don't need. Instead, perhaps the media's efforts would be better spent looking at other bank indiscretions like jacking up interest on credit card debt, paying dividends with bailout proceeds and doing little to encourage savings.

1/20/09

The Gang That Couldn't Loot Straight

On Saturday, the New York Times ran an article, by Mike McIntire, discussing the progress of the $700 billion bailout plan, which received Congressional approval in October. The purported purpose of the bailout was to stimulate lending and to assist troubled homeowners. To date, approximately $350 billion or half of the approved funds have been disbursed. Essentially, the NYT reported that many of the banks who received the taxpayer funds have no intention of lending it. Per the NYT:

At the Palm Beach Ritz-Carlton last November, John C. Hope III, the chairman of Whitney National Bank in New Orleans, stood before a ballroom full of Wall Street analysts and explained how his bank intended to use its $300 million in federal bailout money. “Make more loans?” Mr. Hope said. “We’re not going to change our business model or our credit policies to accommodate the needs of the public sector as they see it to have us make more loans.”

In light of Whitney National's less than stellar performance over the last four quarters, Mr. Hope's unwillingness to lend may well be in everyone's best interest. Per the FDIC's Institutional Database:



As the above table demonstrates, charge-offs and non-accruals have skyrocketed over the last 4 quarters. Due to the recent deterioration of Whitney's loan portfolio, it's unlikely that additional lending was ever one of Hope's options. Whitney National's loans are a mix of commercial and residential loans that were originated in Florida, Alabama, Lousiana, Texas and other areas that have seen marked residential real estate value declines. Moreover, Whitney National has exposure to the flagging petroleum industry due to loans made to oil/gas exploration support companies. It's very likely that Whitney's real estate assets are overvalued, so it would be wise for Whitney to hoard the $300M to maintain the FDIC's required capitalization ratios for solvency in future quarters. As a taxpayer, the last thing in the world that I want is for Whitney National to make another loan. Well, it's almost the last thing. The only thing that would be worse is if Whitney did something completely irresponsible like paying a dividend that exceeded its net income for the quarter:




As the above excerpt from Whitney's most recent 10-Q statement demonstrates, this is exactly what they did. Now, I'm no banker, but if over 2% of my "assets" were in non-accrual status I'd be thinking about conserving every scrap of cash that I could lay hands on. Instead, Whitney National bank paid out nearly three dollars for every dollar it made it made in the third quarter. In other words, Whitney squandered the meager profit it earned in 3Q and then weakened itself further by dipping into reserves. In my opinion, this is recklessness bordering on retardation. If your house is on fire, do you water the garden?

To be fair, this dividend was paid out prior to Whitney National's receipt of the $300M bailout. However, it is difficult to fathom doing such a thing unless you expected some type of rescue. On November 19th, Whitney announced that they would be reducing their dividend for the 4th quarter to a mere $0.21/share, which is only a shade under double its Q3 EPS. Considering the economy is worsening daily and Whitney has to pay 5% on it's $300M bailout (about $0.06/share), it isn't likely that Whitney is going to double up on its net income. Thus, bailout money will be used to pay shareholders, which is a flagrant wealth transfer from the taxpayer to the investment class.

In summary, the NYT lambasted Whitney National Bank for proclaiming its unwillingness to lend the $300M provided by the US Treasury's bailout program. After closer inspection, it turns out that quality lending isn't exactly Whitney National's strong suit, so the public is best served by Whitney's inaction. However, Whitney National has blatantly abused its subsidy by paying dividends in excess of earnings and weakening its capital structure in the process. It is not the US taxpayer's, the FDIC's, or the Treasury's responsibility to protect shareholder's dividend streams, so if this doesn't constitute looting, I'm unsure what does.

1/14/09

Stay the course--Hit the iceberg.

Type the phrase "401k" into any news search engine and you will get the same results: An endless stream of articles advising you to the stay the course. In fact, it's the 401k industry's mantra. Yahoo! Finance has even started publishing a Fidelity-sponsored daily column called Focus on Retirement. Ad nauseum, the columns invariably tell you to do the following:

1. Avoid withdrawals and the associated 30% penalties.
2. Ignore market losses and don't reallocate your choices.
3. Maintain the same level of contributions, despite economic hardships or contribution match reductions.

They justify this advice by implying that you will miss the rally if you move/remove your retirement funds. You'll read how this is a "buyer's market" and that dollar-cost averaging will reduce the effects of any market downturns. In fact, you'll read it so often that you'll have trouble distinguishing one article from another. Now, if you're like most 401(k) participants, your account is probably down 30 to 50%. How did you get there? By staying the course, most likely. If you followed the above items during 2008, you got hurt and hurt badly.

Unfortunately, I have very little time this evening. In the future, I will post much more about defined contribution plans. In the mean time, in light of what appears to be another distinct stock market decline, I'd be thinking about reducing my retirement account's stock market exposure. The easiest way to do this is to reallocate your assets into the money market fund in your plan. This leads to the following possibilities:

1. I'm wrong and you will miss the end of the recession and the subsequent super-rally where the DJIA starts its return to 14,000 for it's current level of 8,200. It's possible, but judging by the death spiral our economy is in, it's not probable.

2. I'm wrong and the markets remain flat. You will remain at par with either option.

3. I'm right and you miss significant, additional losses as the markets probe new lows. Depending on your age and 401(k) assets, additional losses may become irreparable. In another words, it may be more desirable to risk missing a 10% gain than experiencing a 10% loss.

Obviously, the best thing for you to do is educate yourself on the details of your 401(k) and make your own decision. I urge you to do this and do it sooner than later. Good luck.


1/8/09

Game On

GMAC, the financing division of General Motors, has received a $5 billion bailout consisting of taxpayer funds. The terms of the subsidy stipulate that GMAC sell the US Treasury $5 billion in preferred stock shares which supposedly will pay an 8% dividend. GMAC is owned my Cerebus Capital Management and GM and provides automotive, residential, and personal consumer credit to the retail market. Prior to the current bailout, GMAC had applied to the Treasury to become a holding bank, so that it could become eligible to participate in the Troubled Asset Relief Program (TARP), due to significant losses incurred by reckless lending practices in the subprime residential mortgage market.

Two months ago GMAC wisely tightened their loan standards by refusing to lend to anyone with a credit score below 700. However, the day after they received their $5 billion of taxpayer funds, they loosened their credit standards to 621, which borders on subprime loan quality. Mark LaNeve, GM's vice president of marketing, stated that the looser standards will open the market from 40% up to 75% of American consumers. LaNeve went on to state:
"It will certainly signal that GMAC is back in the game, that your GM dealer is back in the game of financing vehicles. I think that's all positive."
The following points come to mind:

1. We, the public, are lending GMAC $5 billion at 8% interest. The likelihood of us ever seeing the principal, let alone the 8% interest, is sufficiently small that this could be considered a subprime loan.

2. The point of the $5 billion bailout is to stimulate lending to many people who probably shouldn't be lent to, considering the current economic environment. Obviously, this is how GMAC got into this position, but they're more than willing to take the ride again, so long as we buy the ticket.

3. Regardless of creditworthiness, how many people are going to buy from a company that probably won't be around 3 years from now?

It's my opinion that this "rescue" is little more than a glamorized pillaging of the treasury. However, I am inclined to agree with Mr. LaNeve's assessment of GM being "in the game." Unfortunately, the game is Ponzi and we are the marks.