Quite a few people have been emailing me about my opinion on the bank bailout deal. I do not think Obama will go the Bush Route and favor Wall Street over Main Street. It is just not a wise move. Alas, I've been wrong before, but if I am wrong about Obama's politics, I still will not be wrong about bank finances. Exactly how well did all of the other bank (and insurer) bailout plans work? I don't recall any of them resulting in a sustained increase in banking shares. As a matter of fact, I observed just the opposite. I really like Obama (contrary to most finance folk), but the man (and his staff) can't work miracles. Mother Market will have her way one way or another. Let me walk you through an example of how expensive it is to save the banks (this is a continuation of Is JP Morgan Taking Realistic Marks on its WaMu Portfolio Purchase? Doubtful! which itself is a continuation of

Re: JP Morgan, when I say insolvent, I really mean insolvent
).

Much of the data below came from the Wells Fargo Forensic Analysis that I released exactly 8 months ago, before I started charging for premium content. It appears the report has been quite prescient. There is ample evidence in that report to indicate that WFC is due for a downfall, but strong institutional coverage and media favoritism, plus the brand name effect (see my take on Brand Names and those that follow them), seems to have kept the price elevated for some time. That is alright, though, I have a lot of patience. I would like to make clear, contrary to popular (albeit, probably just current) belief, that I cannot predict the future. I can count my ass off, though, and that's how I find companies that eventually tank, and often tank hard.

wc_share_price_-_8_mos_to_22009.png

Keep in mind this is OLD data from last year, before the employment bust, before the steepening of housing price depreciation, before the other big bank failures, and most importantly - before the assinine acquisition of Wachovia and its poisonous option ARM, HELOC and 2nd lien mortgage portfolio that it shouldn't have been able to GIVE away at cost. The excerpt from the report:

The states of California,
Nevada and Florida reported the steepest y-o-y drop in home prices. Wells Fargo,
with large construction loans exposure in all of those regions, is highly likely
to be negatively impacted.

Wells Fargo’s Loan Portfolio

image002.gif

Source: Company data

Rising defaults in home equity
portfolio could result in higher losses

During the housing boom, Wells Fargo expanded its real estate portfolio
and avoided making option Adjustable Rate Mortgages (ARMs) or negative
amortizing loans. Despite avoiding these riskier loans, Wells Fargo’s home
equity portfolio is deteriorating due to rising defaults and declining home
prices. Consequently, the bank segregated US$11.5 billion of home equity loans
into a liquidating portfolio, representing approximately 3% of total loans
outstanding in 1Q 08. These home equity loans that are concentrated in the
California, Florida and Arizona markets accounted for a significant portion of
credit losses. The liquidating loan portfolio is mainly confined to geographic
markets that have witnessed the steepest decline in home sales and housing
prices. The liquidating portfolio resulted in an annualized loss rate of 5.58%
for 1Q 08, compared to 1.56% in the remaining core home equity portfolio.

Wells Fargo’s home equity losses are concentrated in the third-party
correspondent channel. Approximately 55% of the liquidating home equity
portfolio of US$12 billion has a combined loan to value (CLTV) of 90%. Such a
high LTV will likely result in major losses for the bank in this liquidating
portfolio. The core home equity portfolio was worth US$72.1 billion in 1Q 08. Of
this, approximately 45% of the exposure was in the states of California,
Florida and Arizona (36%, 4% and 5%, respectively), representing nearly
70% of the bank’s shareholders’ equity
. The worsening housing
scenario in these markets as prices continue to tumble and defaults rise, is
expected to result in higher losses in the near future.









Home equity portfolio – geographical breakup

image006.gif

Source: Company data


Now, since I had nothing else to do, I decided to sit up for two nights in a row to calculate more realistic marks by hand, using the Case-Shiller index which any who follow me know that I feel this index is much too optimistic when dealing with urban areas (see

Is JP Morgan Taking Realistic Marks on its WaMu Portfolio Purchase? Doubtful!
). Below you will find various categories of 2nd lien loans with various CLTVs over various LTV primary loans.

Markdown
on 0.85 CLTV 2nd lien over an 0.8 LTV primary mortgage




Average Markdown, Case-Shiller WFC Inventory Weight Adjusted Markdown
Others ~ Comp 20 -38% 0.44 -17%
Texas 0% 0.04 0%
Minneapolis -55% 0.06 -3%
Florida -67% 0.04 -3%
California -89% 0.37 -33%
Arizona -83% 0.05 -4%
Appropriate Mark -60%





Markdown on 0.9 CLTV 2nd lien
over an 0.8 LTV primary mortgage




Average Markdown, Case-Shiller WFC Inventory Weight Adjusted Markdown
Others ~ Comp 20 -78% 0.44 -34%
Texas 0% 0.04 0%
Minneapolis -96% 0.06 -6%
Florida -79% 0.04 -3%
California -93% 0.37 -34%
Arizona -87% 0.05 -4%
Appropriate Mark -82%





Markdown on 0.95 CLTV 2nd
lien over an 0.8 LTV primary mortgage




Average Markdown, Case-Shiller WFC Inventory Weight Adjusted Markdown
Others ~ Comp 20 -80% 0.44 -35%
Texas 0% 0.04 0%
Minneapolis -100% 0.06 -6%
Florida -80% 0.04 -3%
California -93% 0.37 -35%
Arizona -87% 0.05 -4%
Appropriate Mark -83%





Markdown on 0.95 CLTV 2nd
lien over an 0.9 LTV primary mortgage




Average Markdown, Case-Shiller WFC Inventory Weight Adjusted Markdown
Others ~ Comp 20 -80% 0.44 -35%
Texas 0% 0.04 0%
Minneapolis -100% 0.06 -6%
Florida -80% 0.04 -3%
California -93% 0.37 -35%
Arizona -87% 0.05 -4%
Appropriate Mark -83%





Markdown on 1 CLTV 2nd lien
over an 0.9 LTV primary mortgage




Average Markdown, Case-Shiller WFC Inventory Weight Adjusted Markdown
Others ~ Comp 20 -100% 0.44 -44%
Texas -60% 0.04 -2%
Minneapolis -100% 0.06 -6%
Florida -80% 0.04 -3%
California -100% 0.37 -37%
Arizona -93% 0.05 -5%
Appropriate Mark -97%

No matter which way you slice it, Wells Fargo has to take a significant hit to its equity if these loans are marked any where near market. Mar-08 (dated) shows net tangible assets at $35,011,000,000. The average writedown here is about 81%, times the 19% of loans the OLD WFC had (which is about $500 billion, I haven't looked it up) and you have just about wiped Well's Fargo's tangible equity right off the table. These numbers are not even close now, due to the Wachovia acquisition, but they will be looking a lot worse, not better.

I am going through all this to illustrate a point. Let's suppose the government decides to over pay for the asset by 30%, that still leaves a gaping whole in the equity of this bank, and that is not taking into consideration the massive amounts of other debt that is going bad in the bank. This is just one subclass of residential real estate lending. If you go through the Wells Fargo Forensic Analysis you will see a plethora of other problems that will need to be bought out. Long story short, the US does not have the capital to support these rotting assets. They will fall one way or the other.

Now, let's suppose that the US just prints enough to buy the assets. Well, there is still a loss there. The loss was purchased from the banks and passed to the US taxpayer, who will bear the loss in higher taxes which will come out of that tax payers discretionary consumption which then comes out of industries revenues which dampens demand for bank services (or which there are still too many banks anyway). Again, long story short, there is no way out of this other than to let the truly insolvent banks fail. It's just a matter of whether they fail now, or later - but it will happen.

Unfortunately, I had to write this at 3 am, so I will go back and correct lapses in logic and typos withing 24 hours.

Published in BoomBustBlog

I decided to make this post in response to the discussions in the comment thread of "Investment Advice in the MainStream Media: Hedge against Success???" For those don't know, the JPM discussion started due to this insolvency post: Re: JP Morgan, when I say insolvent, I really mean insolvent (a must read for anyone with economic interest in JP Morgan). WaMu, which was recently purchased by JPM, was the leader in Option ARM sales, and (from personal experience) has one of the most convoluted, inefficient and error prone 2nd lien underwriting processes out there. I explained the Option ARM dilemma in "The banking backdrop for 2009". To make a long story short:

Option ARMs to Reset Earlier than Expected

In 2009 and 2010, loans with 2004 and 2005 vintages would be recast. Besides these vintages, loans with negative amortization are expected to recast early. With more than 65% of borrowers electing to make Minimum Monthly Payment (reaching a staggering 85% for 2006 and 2007 vintages), loans which recast on account of negative amortization caps are expected to increase drastically.

The problem ahead: According to Fitch, of the nearly $200 bn of option ARMs outstanding, roughly $29 bn of loans are expected to recast by 2009. Of this $6.6 bn constitute 2004 vintage (that would be recast as a result of completion of the end of five-year term in 2009) and $23 bn constitute 2005 and 2006 vintage loans that would recast early due to the 110% balance cap limit.

Further an additional $67 bn is expected to recast in 2010 of which $37 bn belong to 2005 vintage (that would be recast as a result of completion of the end of five-year term in 2010) and the balance $30 bn consist of 2006 and 2007 vintage loans that would be recast early due to the 110% balance limit cap.

The potential average payment increase on the loans recast is 63%, representing an additional $1,053 due each month on top of the current average payment of $1,672. These large payment increases could cause delinquencies to increase, and increase dramatically, after the recast. The fact that only 65% of borrowers have elected (or are able) to make only minimum payments underscores the magnitude of the potential problem. The potential payment shock combined.

Other Blogs are reporting Reserve requiring downgrades: "Wednesday's downgrade of 2,446 classes of mixed RMBS caught traders off guard - even though it was viewed as an eventuality. While the market had largely priced in below-investment grade ratings to alt-A bonds following Moody's Investment Services' announcement that it would increase loss assumptions, the swiftness with which the rating agency acted has traders bracing for even more supply.

While the market was already trading bonds to these higher loss assumptions, the banks and insurance companies that own this paper are now going to have to hold more capital against these assets, and the increase given that these bonds are now junk [rated] is not a small matter," said one trader. . .

Moody's warned in a report last week that loss assumptions would be increased for RMBS and that downgrades could be expected. Moody's is projecting that alt-A deals originated in the second half of 2007 will experience 25.5% losses of original balance, compared to 23.9% of 1H07 deals, 22.1% for H206 deals and 17.1% for 1H06 deals. The rating agency in May expected average losses for 2006 and 2007 vintage deals to reach 11.2% and 14.7%, respectively.

Massive selling is not expected immediately though it is only a matter of time before a substantial portion of the downgraded bonds are put out to bid, a second trader said ..."

with the continuous deteriorating outlook for home prices and lack of refinancing opportunities could be a negative cause of concern for investors in Option ARM securities. Even more ominous, is pall cast upon the banks that hold these assets and are additionally exposed to other forms of consumer credit, ie. HELOCs, credit card debt and other unsecured loans (remember the links from the Asset Securitization Crisis above).

Alt-A

What bank has that"Other forms of consumer credit" exposure stated above? JP Morgan who doubled up on the exposure when it bought Washington Mutual, the Option ARM king.

We will get back to Option ARMs and what they will do to JPM in a later post. For now, let's realize that the JPM/WaMu combo has the highest concentration of 2nd lien loans (and Option ARMs) in the absolute worse housing areas in this country, CA, FL, and NV. Keep in mind that 2nd lien loans have diminished priority in terms of claims on assets, so if a house sells for 70% of its previous sales value, and there was a 70 LTV loan combined with a 80 CLTV (combined LTV) HELOC on top, the HELOC lender takes a 100% loss. Let me repeat that, "a 100% loss". How likely is this to happen JPM? Well, let's investigage a little further, shall we? JPM currently has these impaired loans from WaMu marked down 25%, and is currently not classifying them as non-performing even thought the mortgagees are not paying. Let's take a visual tour across the land to see if this 25% mark is realistic.

Well, now we know that there is a high concentration of 2nd lien loans on the books. A very high concentration, leveraged up nearly 200% (we're not even going to broach the topic of C&D and CRE loan risk).

Geographic and/or Product Concentration is a Bad Thing. WaMu has both

Do you see the two states that have been in the news the most lately have big spikes in my pretty little graph.

Now, if we drill down into those two big stalks we see above and observe who has the most concentrated exposure there, we see the following...

The JPM/WaMu combo has TWICE the California 2nd lien exposure as Countrywide, and we all know what happened to Countrywide! And in Florida, the condo capital of world, we have...

The JPM/WaMu combo is 2nd only to Suntrust. This is how I feel about Sun Trust: Sun Trust Forensic Analysis. Don't take this lightly, my triple digit returns didn't just pop out of thin air. I do my homework and can boast a pretty strong track record. Remember, concentration is a very risky thing in investing. You can hit a home-run short term, but long term the odds will catch up to you and hurt a lot. These banks rolled the die, and crapped out. The shareholders just don't know it yet. Below, I put a FICO score chart in just for the fun of it. FICO scores are a lot less relevant than many believe. They are still useful, but far from the be all and end all that they were marketed as.

Guess who has the 3rd lowest aggregate FICO out of the crew. Now, the bank at the lower and of the 2nd lien FICO graph has bought what is probably the most troubled large mortgage lender in the world in what is probably the worst macro environment in the last 7 decades. We can now see how that is ending. The 3rd lowest scorer is dragging down the bank who bought the most poisoned of the Investment banks, albeit with ample government assistance. Hmmmm... Was that smart???

As someone with direct experience in the residential lending arena can tell you, there is a big difference in the quality of loans written directly versus those sourced from a third party, ex. a broker. The reason, obviously, is that the brokers don't (didn't) have any skin in the game in terms of risk retention, and have significant incentive to "fudge" the numbers in order to push loans through (that is how they are paid). Then we have glorified brokers who post margin, got a warehouse credit line and call themselves "mortgage banks". These guys are just brokers with a fancy credit card that they parked loans on till they could sell them off to investors. The problem is, this forced minimum risk retention, but enough to drive 100's out of business when the market collapsed in 2007. Long story short, it is much more dangerous to rely on what you hope to be prudent underwriting from a brokered loan than from a direct channel loan. Amazingly enough, we had the exact same problem with brokers in the S&L crisis. I guess 1,200+ lending institution failures wasn't enough to teach a lesson that lasted more than 15 years. For more on this, see A comparison with the same during the S&L crisis.

Well, you see who has been relying on the brokers. "Nuff said. Don't be fooled by large asset bases and big brand names either. Bear Stearns was a big brand name, and Citigroup had the largest asset base out there.

So, all of this stuff ultimately leads to loans not getting paid. When loans don't get paid, foreclosure occurs. We can fairly easily map out what will happen to the JPM/WaMu/Bear Stearns combo when the foreclosures start hitting (which is right about now), using the widely followed Case-Shiller index. Let me warn you right now, though, these numbers will be highly optimistic due to the fashion in which the index is put together. It is an econometric marvel, yes, but it excludes so much economic reality as to be misleading in a fast trending market. See "A reminder concerning popular housing indices" for more on this topic.

Now, keep in mind that I am using optimistic numbers in these calculations and graphs, and then take a gander at the sharp drop in housing prices that have already occurred in the problem areas identified as JPM/WaMu/Bear Stearns hot spots. That is one hell of a roller coaster ride.

Now, in Re: JP Morgan, when I say insolvent, I really mean insolvent (a must read for anyone with economic interest in JP Morgan) I made clear (through the subscription content portion) that JPM has taken 25% marks on its WaMu credit impaired portfolio. Is that enough? Let's walk through the high concentration areas using this overly optimistic numbers that are 3 months old (the more recent numbers look worse since the housing price slide, foreclosure rate and unemployment is increasing in velocity and volume, not to mention the coming Alt-A debacle described earlier).

Assume the typical property in these hot spot areas had a 70% 1st lien mortgage (that means that the buyers put 30% down in cash - and we all know better than that!) and then somewhere along the line in 2007 to 2007 the homeowner took out a mere 10% home equity loan, which brought the CLTV (combined loan to value) ratio up to 805. These are very conservative numbers, for I know for a fact and through personal experience that these banks gave 90, 95, 100, and 110 LTV loans out like it was candy. Some loan packages were underwritten outright at those very high LTVs, while others had very optimistic, no SUPER OPTIMISTIC (if you know what I mean) appraisals that effectively put the true LTV way over 100%. It is an academic argument though, for as you can see, JPM/WaMu takes a total loss using the most conservative numbers imaginable.

CA-Los
Angeles
CA-San
Diego
CA-San
Francisco
FL-
Miami
FL-
Tampa
Composite-
10
Composite-
20
Decline from 2 years ago (2/2007) -35% -35% -37% -39% -30% -26% -24%
Assumed loss on 1st lien 0.7 LTV -5% -5% -7% -9% 0% 4% 6%
Assumed loss on 2nd lien 0.8 CLTV HELOC on top of 0.7 LTV 1st -105% -105% -107% -109% -100% -96% -94%

As you can see, the marks on the HELOC's and 2nd lien loans should be 100%, not 25%. Even using the 10 and 20 city composite index, once you factor in the cost and expenses of foreclosure, holding and remarketing the property, you will have close to, if not greater than a 100% loss. If one were to factor those 100% marks into the entire portfolio, would you come up with an average of 25%? Subscribers should reexamine the sensitivity analysis that we did here JP Morgan Forensic Highlights 2009-01-06 19:18:08 133.34 Kb, here JP Morgan Q408 Quarterly opinion with sample trades - Professional & Institutional 2009-01-22 08:48:02 211.69 Kb (retail users, click here JP Morgan Q408 quarterly valuation opinion - Retail 2009-01-22 08:49:26 79.24 Kb) remaining cognizant that the base case valuation numbers and the call on JPM's insolvency was based on a mere 40% mark down. That is not taking into account the massive negative amortization and/or the expiration of teaser rates coming off of the Option ARMs described earlier. Let's take another look at that graph...

Starting right about now (February), the negative amortization recast should start to bring in a rash of Option ARM foreclosures as the housing values shoot downward, and the amounts owed on the houses actually shoot upwards. A nasty combination, indeed, and one in which JPM will suffer.

Now, let's take a look at the first liens that were written on what was the customary 10% down payment.

MONTH CA-Los
Angeles
CA-San
Diego
CA-San
Francisco
FL-
Miami
FL-
Tampa
Composite-
10
Composite-
20
Decline from 2 years ago (2/2007) 35% 35% 37% 39% 30% 26% 24%
Assumed loss on 1st lien 0.9 LTV -25% -25% -27% -29% -20% -16% -14%
Assumed loss on 2nd lien @1 CLTV HELOC on top of 0.9 LTV 1st -125% -125% -127% -129% -120% -116% -114%

As you can see, JPM's 25% mark is rather aggressively optimistic for 1st lien loans, and that is using numbers from 3 months ago before the unemployment and foreclosure wave of the quarter hit. When combined with the extremely large 2nd lien loans, the mark should be more like 125% instead of 25% (I'm being a smart ass here, since it must be capped at 100%, but there is more to this 125% number, as we will see in a minute).

Now, these numbers are entrenched in the past, we are living in the present, and any additional marks are contingent upon future price movement. What does the future hold? Considerably higher marks, that's what.

Even using the highly optimistic Shiller index, we are in for a very pessimism generating fall, as can be seen from the graph in "When someone tells you they are seeking stabilization in the housing markets, show them this graph!"

I figure, we are about 50% through the housing price downfall cycle. That means there is a lot, and I mean a lot, more devaluation once it comes to residential housing prices. This doesn't even begin to scrape the surface of JPM's problems, either. Commercial real estate loans, consumer finance loans, credit cards, commercial leasing and business loans, leveraged loans, private equity loan - it doesn't look rosy going into a depression or severe recession. How many loans do you ask? Well, I pointed this out over a year ago...

  1. More on the banking backdrop, we've never had so many loans!
  2. The consumer finance sector risk is woefully unrecognized, and the US Federal reserve to the rescue
  3. Reggie Middleton says don't believe Paulson: S&L crisis 2.0, bank failure redux

Before I go, I just want to let all know that as pessimistic as all this sounds, it is actually optimistic. If I were to be a realist, I would have mentioned that many of the mortgage assets that JPM bought/owns are highly leveraged derivative assets. These numbers in the article are referencing WHOLE loans, not loan derivatives. That means that the numbers mentioned here, both positive and negative, have to have a multiple applied to them. I believe JPM to be insolvent simply by examining the portfolio as if it contained all whole loans, which we all know it does not. If factor in the reality of the leverage, illiquidity, and murkiness in pricing of their leveraged mortgage derivatives.... Well, I think you guys are smart enough to figure out the rest.

Published in BoomBustBlog

Better late than never, here is the Macro Spanish bank research. Due to the time and resourced that the hacker caused me, I fell behind in both research, strategizing, and publishing to the blog. Since this piece is not as timely as it could be, I am making it a freebie - all you have to do is register. This is a whopper piece of research as well, including sample currency hedging/speculating samples, a full macro analysis, and my usually rigorous forensic analysis of the company itself. Let this serve as an example of what subscribers get at the pro and institutional level.

Reggie Middleton on Banco Bilbao Vizcaya Argentaria SA (BBVA)

The current financial crisis, being proclaimed as the worst since the Great Depression, has virtually pounded financial systems across the world. Fear of a global crash amid a worsening macro-economic environment and mounting loan losses have hampered nearly all efforts to restore calm in the global markets as the exposure of leading banks became unmanageable. Declining housing and stock prices, and rising unemployment levels are squeezing consumer wealth globally and are expected to weigh heavily on the banking system in the form of rising loan defaults. Until very recently, the global banks have experienced most of the impact in the form of distressed securities, capital shortages and funding problems, however the problems have now started to engulf their consumer and commercial loan portfolios as well.

In Spain, BBVA, the second largest domestic bank, could see a massive deterioration in its real estate and consumer loan portfolio. The Spanish real estate sector is making a high horsepower a U-turn after years of a massive housing bubble that has burst - culminating in an unemployment rate that has risen to an outrageous 13.4% level. The power skid is showing no signs of reaching an inflection point, and we believe is only in the beginning throes of a sharp downturn. In addition, the banks' other key growth areas including Mexico, the U.S and South America are witnessing a slowdown in economic activity, restricting BBVA's growth prospectus amid the current turbulent environment. With increasingly challenging economic conditions in each of these economies, BBVA's asset quality has deteriorated sharply with non-performing loans rising to 36% of its tangible equity without corresponding (equal) increase in provisions. As the bank deals with these tough times ahead, we expect BBVA's bottom line growth to remain subdued due to a slower credit off-take and higher provisions in the coming quarters.

Key Highlights

Sharp slowdown seen in Europe - According to the European Commission forecasts, the European economy is expected to contract 1.9% in 2009 with a modest recovery in 2010. Spain, in particular, is expected to be one of the worst hit due to the humbling of its housing sector which had, for several years, been a significant contributor to the country's economic growth. This will impact BBVA by slowing down its credit and loan growth in addition to significantly deteriorating the credit quality of its loan portfolio.

BBVA's asset quality is set to deteriorate rapidly as Spain enters recession - Problems in Spain are more pronounced than in most of its European counterparts. The Spain's budgetary deficit has already crossed the 3% threshold limit set by the European Commission and is expected to cross 6% by 2009, only behind Ireland. The unemployment has reached a 12-year high of 13.4% in November 2008, the highest in the Euro zone, while the real estate sector bubble (particularly residential vacation homes purchased by foreigners), the pillar of economic growth engine, has burst. BBVA, with nearly 40% of its total loan exposure tied to real estate & construction loans and individual loans in Spain could see massive deterioration in its asset quality.

Besides Spain the bank has to deal with other challenging economies including Mexico and the U.S - In 3Q2008, U.S and Mexico contributed nearly 29% and 16% of total revenues, respectively. The downturn in the U.S economy is showing no signs of stabilization, with an unabated fall in housing prices and frozen credit markets continuing to shatter consumer confidence. Recession in the U.S has also led to a sharp slowdown in Mexico which is highly dependent on US for exports and remittances. The slowdown in both of BBVA's key markets will not only impact the pace of BBVA's growth but also augment the risk profile for the bank as it now has to deal with vagaries of these economies to navigate itself in these turbulent times.

BBVA's NPAs have skyrocketed on back of economic slump - Since January 2008, BBVA's non-performing loans have increased 92% to €6.5 bn. As at the end of 3Q2008, BBVA's loan losses as a percentage of tangible equity stood at an astonishing 36%. Eyles test, a measure of banks' delinquent loans (net of reserves) as percentage of its tangible equity, has increased to 12% in 3Q2008 from 4% in 2Q2008. This sharp rise in the bank's NPA levels, particularly in context of its lower equity cushion, could substantially erode shareholders' equity.

Inadequate provisioning to impact BBVA's bottom line - Owing to deteriorating loan portfolio, BBVA's NPAs have almost doubled to 2.0% of the total loans in 3Q2008 from 1.1% in 3Q2007. Despite an increase in NPAs, the bank's provision has declined to 2.3% of the total loans from 2.4% a year ago. As loan losses are expected to increase in the wake of economic slowdown, BBVA will have to increase its provisions considerably, denting its near-to-medium term net income.

BBVA's valuation at... Register (for free) and download the full report pdf Banco Bilbao Vizcaya Argentaria SA (BBVA) Professional Forensic Analysis 2009-01-28 16:04:04 439.80 Kb

For those who haven't been to the Spanish coastal areas to see for themselves or are not familiar with the Spanish situation, I have included random research on Spain from pundits around the Globe!

  1. Spain Facing 'Exceptional' HardshipEU Observer
  2. Spain: Overall analysis ( 369,54 KB ) la Caixa
  3. The economy in 2009: out of The Twilight Zone ( 160,73 KB )
  4. Spain: Dies Irae; Beyond the real estate crisis Société Générale Economic Research
  5. The IMF on Spain
  6. An adjustment in Spanish saving has begun - JP Morgan
  7. Economic Survey of Spain 2008 - OECD
  8. Spain: The Worst Is Yet to Come - Morgan Stanley Global Economic Forum
  9. Spain: First GDP contraction in 15 years (-0.2% q/q in Q3 2008) - BNP Paribas
  10. Quarterly Report On The Spanish Economy: Spain's GDP Contracted 0.2% in Q3 Compared to Q2 - The Bank of Spain
  11. Inflation Is Dead In Spain, Fasten Up Your Seat Belts For A Sharp Dose Of Deflation - A Fistful of Euros
  12. Spain: External imbalances persist, fiscal surplus disappears - European Commission Autumn 2008 Forecast
  13. Macro: Construction Correction Driving Economy Down - Morgan Stanley - Global Economic Forum

I've also decided to include some illustrative hedging/speculative samples that I will intermittently include in future reports, time and resources permitting. I will be releasing a timely report on a UK insurer in 24 to 48 hours to subscribers. The insurer still has a little meat left on the bones. BBVA, due to the recent and uncalled for run-up in banks may be for the risk takers in my constituency, though.

The Spanish Bank Short Arbitrage View

Below is an illustrative analysis for investment in BBV put options along with different hedging scenarios. These examples are for the purposes of illustration only, and are not in any way to be considered, or intended to be construed as, investment advice. I want it to be know that this work sample has not been proofread, and to be honest I probably may not have the time to do so. Continue at your own risk. The Pound and Euro trade now has a diminished risk/reward proposition from a speculative perspective (not so as a hedge). Those of you who attended the BoomBustBlog Boat rides should have heard me express my opinions that I believed the Pound, Euro and oil would all head sharply southward. That was 7 months ago, and this is now. I still have opinions on the aforementioned, but they haven't been thoroughly and empirically vetted. I have included the currency argument in the downloadable PDF located at the end of this article, for any who may be interested.

BoomBustBlog boat ride 1.0:

BoomBustBlog Boat Ride 2.0, on the MotherLand!:

In the current working model we have taken at-the-money put options for BBV (with strike price of $12.5) and at-the-money EURO options (with strike price of 1.365). According to information available on NYSE and Bloomberg BBV had option series for January, February, April and July. We have conducted analysis for February and July expiration series for above at-the-money options. (However my proprietary model - not to be confused with commercial models that I may use and are available through popular vendors - is built dynamically to change strike price, premium and the hedge ratio (currently 3:1) in the highlighted orange cells to conduct similar analysis for any other option chains). We have sourced option pricing data for BBV from Bloomberg and Currency Options from CME Group.

This sample assumes the following:

Spot Prices
BBVA € 9.0
BBV $11.96
EURUSD $1.364
At expiration
Expected change in underlying -15.0%
Expected change in currency -15.0%
BBV Put Option EURO Put Option (long) EURO Call Option (long)
Spot Price $11.96 1.3644 1.3644
Srike Price $12.50 1.365 1.365
Premium $1.60 0.0347 0.0391
Expiry date Feb-09 Feb-09 Feb-09
At expiry BBVA in Euro € 7.7
EURO at expiry 1.160 1.1597 1.1597
Price at Expiry ($) $8.89
Lot Size 100 10,000 10,000
Contract value per lot $1,250
# of contracts 5.00 1.00 1.00
Pay off at expiration (per unit) $2.008 $0.171 -$0.039
Per contract $201 $1,706 -$391
# of contracts $1,004 $1,706 -$391
Unhedged ADR put $1,004
ADR + Put $2,710
ADR + Call $613
ADR + Put + Call $2,319
Initial Investment
Unhedged ADR put $800
ADR + Put $1,147
ADR + Call $1,191
ADR + Put + Call $1,538

We have conducted scenario analysis for change in underlying BBVA (in Euros) and change in currency based for four hedging circumstances -

Position Currency Risk

•1) Un-hedged BBV Put Options - Appreciation of Euro (thru ADR)

•2) BBV ADR Put with Long EURO Put - Appreciation of Euro (on ADR as well as loss of put premium)

•3) BBV ADR Put with Long EURO Call - Appreciation of Euro (thru ADR) however offset by Euro Long Call

•4) BBV ADR Put with Long EURO Put and Long EURO Call (Straddle) - Appreciation of Euro (thru ADR)

•5) Un-hedged Short BBV - Appreciation of Euro (thru ADR)

•6) Short BBV with Long Futures - Hedged position

The payoff matrix for each of the position is given below.

BBV ADR Put with Long EURO Put, and Un-hedged BBV put options would provide same pay-off matrix (in terms of direction). However with depreciation of Euro strategy with long Euro Put would provide better returns to investors. On other hand BBV ADR Put with Long EURO Call would provide more diverse risk exposure compared to BBV ADR Put with Long EURO Put. The above strategy would provide returns when BBVA underlying declines (investor will only lose call premium) and would also provide returns when Euro Appreciates (investor will only lose call premium). The last strategy BBV ADR Put with Long EURO Put and Long EURO Call provides pay off similar to strategy with BBV ADR Put with Long EURO Call except that it would provide lower returns in exchange of added diversification.

Net Payoff Matrix
(US$ return):

Position : Undhedged ADR PUT (% return)

Change in underlying (in Euros) at expiration

Change in currency at expiration

-25%

-15%

-10%

-5%

0%

5%

10%

15%

25%

-25%

249%

191%

162%

133%

104%

76%

47%

18%

-40%

-15%

191%

126%

93%

60%

27%

-5%

-38%

-71%

-100%

-10%

162%

93%

58%

24%

-11%

-46%

-80%

-100%

-100%

-5%

133%

60%

24%

-13%

-49%

-86%

-100%

-100%

-100%

0

104%

27%

-11%

-49%

-88%

-100%

-100%

-100%

-100%

5%

76%

-5%

-46%

-86%

-100%

-100%

-100%

-100%

-100%

10%

47%

-38%

-80%

-100%

-100%

-100%

-100%

-100%

-100%

15%

18%

-71%

-100%

-100%

-100%

-100%

-100%

-100%

-100%

25%

-40%

-100%

-100%

-100%

-100%

-100%

-100%

-100%

-100%

Net Payoff Matrix
(US$ return):

Position : BBV ADR Put / long Euro Put (% return)

Change in underlying (in Euros) at expiration

Change in currency at expiration

-25%

-15%

-10%

-5%

0%

5%

10%

15%

25%

-25%

441%

282%

202%

123%

43%

22%

2%

-18%

-58%

-15%

401%

236%

154%

72%

-11%

-34%

-57%

-80%

-100%

-10%

381%

213%

130%

46%

-37%

-62%

-86%

-100%

-100%

-5%

361%

191%

106%

21%

-64%

-90%

-100%

-100%

-100%

0

340%

168%

82%

-5%

-91%

-100%

-100%

-100%

-100%

5%

320%

145%

57%

-30%

-99%

-100%

-100%

-100%

-100%

10%

300%

122%

33%

-40%

-99%

-100%

-100%

-100%

-100%

15%

280%

99%

19%

-40%

-99%

-100%

-100%

-100%

-100%

25%

240%

79%

19%

-40%

-99%

-100%

-100%

-100%

-100%

Net Payoff Matrix
(US$ return):

Position : BBV ADR Put / long Euro Call (% return)

Change in underlying (in Euros) at expiration

Change in currency at expiration

-25%

-15%

-10%

-5%

0%

5%

10%

15%

25%

-25%

134%

95%

76%

57%

37%

75%

113%

150%

226%

-15%

95%

51%

30%

8%

-14%

20%

56%

91%

186%

-10%

76%

30%

6%

-17%

-40%

-7%

27%

71%

186%

-5%

57%

8%

-17%

-42%

-66%

-34%

14%

71%

186%

0

37%

-14%

-40%

-66%

-92%

-43%

14%

71%

186%

5%

18%

-36%

-63%

-91%

-100%

-43%

14%

71%

186%

10%

-1%

-58%

-87%

-100%

-100%

-43%

14%

71%

186%

15%

-21%

-80%

-100%

-100%

-100%

-43%

14%

71%

186%

25%

-60%

-100%

-100%

-100%

-100%

-43%

14%

71%

186%

Net Payoff Matrix
(US$ return):

Position : BBV ADR Put / long Euro Call / Long Put (% return)

Change in underlying (in Euros) at expiration

Change in currency at expiration

-25%

-15%

-10%

-5%

0%

5%

10%

15%

25%

-25%

303%

185%

125%

66%

7%

35%

65%

94%

153%

-15%

273%

151%

89%

28%

-33%

-7%

21%

48%

121%

-10%

258%

134%

71%

9%

-53%

-28%

-1%

33%

121%

-5%

243%

117%

53%

-10%

-73%

-49%

-12%

33%

121%

0

228%

100%

35%

-29%

-93%

-56%

-12%

33%

121%

5%

213%

83%

17%

-48%

-100%

-56%

-12%

33%

121%

10%

198%

66%

-1%

-55%

-100%

-56%

-12%

33%

121%

15%

183%

49%

-11%

-55%

-100%

-56%

-12%

33%

121%

25%

153%

33%

-11%

-55%

-100%

-56%

-12%

33%

121%

Download the full addendum here: pdf Banco Bilbao Vizcaya Argentaria SA (BBVA) Addendum - Pro 2009-01-28 17:48:27 569.55 Kb

Published in BoomBustBlog

666. That's the sign of the beast. It's also representative of that big bank that is buying that other big bank's brokers. They put a sell out on HSBC. That's cool! I agree, except for the fact that it is over 6 monts late, nearly 60% in value decline later (not quite, but it does fit into the catchy title), and the last 6 is the IQ of anyone who leaves their money with these buffoons. I know that's a little harsh, but come on now. I warned explicitly (as in 20 pages explicitly) back in August. January 75 puts were trading at $6.99, now they are about $33.50. Whose money am I taking? Morgan Stanely clients, that's who! The same can be said for Bear Stearns, Lehman, GGP, GS and even Morgan - the riskiest bank on the Street. I had sell and collapse (that's right, I told you that Lehman and Bear would fail at least 3 to 6 months before hand see research & performance) calls on these stocks early last year while these brokerages were pushing buys and holds. Come fellas! Now that I think of it, buffoon is really not that harsh. For more on this, see Super Brokers form to push Super Broken products to make those with High Net Worth Super Broke!

hbc.png

A glance at HSBC - Did the market miss this one?
(Archived/Reggie Middleton's Boom Bust Blog/MyBlog)

I have started looking into HSBC. The bank has significant exposure to risky assets and incurred huge losses in the personal finances division in the US last year. Despite this, there has not been mu
Monday, 07 July 2008

1. Part one of three of my opinion of HSBC and the macro factors affecting it
(Archived/Reggie Middleton's Boom Bust Blog/MyBlog)
HSBC Holdings, one of the largest global banks, has remained relatively unaffected by the ongoing credit turmoil and housing downturn in the US until now. The bank has outperformed its peers, most of
Thursday, 14 August 2008

2. HSBC 1H 08 results update
(Archived/Reggie Middleton's Boom Bust Blog/MyBlog)
Decline in net income HSBC’s net income fell 29% y-o-y to US$7.72 billion (or US$0.65 per share) in 1H 08 from US$10.9 billion (or US$0.94 per share). The bank’s prof
Thursday, 14 August 2008

3. LTTP (Late to the Party), pt 4
(Reggie Middleton's Boom Bust Blog/MyBlog)
From Bloomberg : HSBC Holdings Plc, Europe’s biggest bank, may seek to raise about $14 billion as increasing bad-loan provisions erode profit, CLSA Asia-Pacific Markets said.
Tuesday, 16 December 2008

4. The name brand contrarian plays have bore sweet fruit
(Archived/Reggie Middleton's Boom Bust Blog/MyBlog)
For those who were doubtful of my research and stated positions in the big name brand banks, I think a recap is in order. I have taken strong bearish positions on a few of the most revered name bran
Monday, 10 November 2008
Published in BoomBustBlog


As I sit back and look at the market go through its bear rally, performing a myriad of what if scenarios on my various bearish positions and generating cash where feasible by selling off profits, I revisited the Doo Doo 32 and a few big name banks. I say to myself, "This year will not be as easy as last year, now that nearly everybody should be aware of the extent of the problem, and the violent bear market rally/option spreads that makes shorting and put buying very expensive." Then I listen to talking heads in the media and the "everbull", long only professionals. I ponder, "Hmm, maybe there is a little low hanging fruit to be had after all". To be sure, we will have to sit through this bear market rally which has to hurt anybody not in all cash or hedged, and there seems to be a willingness of traders to push this one relatively far. The FACTS still remain though, if the stocks of the BoomBustBlog bear targets move much farther, this could very well be another repeat of last year's triple digit performance. Yes, it's risky, but risk is the price of reward, isn't it.

With that disclaimer espoused, let's look at how accurate my longer term thesis have fared. The graph below was taken from the Doo Doo 32 article.


In order to determine how likely the aforementioned event
is, let's create a metric by which Reggie Middleton measures risk. This metric
will be units of risky or non-performing assets as a percentage of statutory
equity. This, of course, can be refined by removing goodwill, Bullsh1t, and the
various accounting pollutants to plain old economic earnings, but less just
start with this. When applying Reggie's Risk Metric to the graphs above, we can identify more banks.

image006.png

Looking at risk from this perspective, we not only see who has no
clothes on when the tide goes out, but also how well (un)endowed they
are in addition.

Now, compare the companies from the Doo Doo 32 article and the allocation of the TARP program below (sans the companies that have already failed or have been driven into other firms), and you will see that I am on to something. After all, the Doo Doo 32 article was penned on

The credit crisis is (not) waning

Reggie
Middleton says don't believe Paulson: S&L crisis 2.0, bank failure
redux
)

Allocation of TARP Capital Injections ($ billions) 100% = $250
bn

Others (201 in total count)

$ 48

Citigroup

$ 45

AIG

$ 40

Bank of America/Merrill Lynch/CountryWide

$ 25

JP Morgan Chase/Bear Stearns/WaMu

$ 25

Wells Fargo

$ 25

Godlman Sachs

$ 10

Morgan Stanley

$ 10

PNC

$ 8

US Bancorp

$ 7

Sun Trust

$ 5

Unallocated

$ 3

Now "the worst is behind us" Secretary Paulson wants to claim the balance of the TARP that is not already spent. WHY??? Well let's look at it visually.

Big on this list are the recipients of much of my research from early last year. Never let it be said that I don't have a clue about what's going on.


Well, I have some other thoughts on certain financial institutions, the first of which is available below (with at least one other following). Subscribers can view my opinion here. I trust you will find the inconsistencies that I have found to be quite interesting. You will also be wise to beware of those "name brands" that are "too big to fail"! Keep the recent post, "
The banking backdrop for 2009 " in mind as you read the following:

pdf JP Morgan Forensic Highlights 2009-01-06 19:18:08 133.34 Kb

Published in BoomBustBlog

In an election year, what normally would be an important topic of
debate becomes a debatable topic of nill importance. Case in point: As
the public strives to understand the root causes of the economic
crisis, politicians and partisan media have refined their talking
points. Unfortunately, many are quite focused on creating a wedge
political issue, truth be damned. This is an excerpt from a blog post
called the The CRA Talking Point
and it is well worth the read. Basically, it illustrates a shift of the
blame for the current financial situation from those who probably
deserve it to those who can't defend themselves when accused. Granted,
there is enough guilt to go around, but the Community Reinvestment Act
really has nothing to do with this. Actually, it is the conservative
Republican party that seems to be trying to fit a square peg in a round
hole. Hmmm! The geometrically challenged. Here are a few quips from a
recent Bloomberg article :

Federal regulators directed Fannie Mae and Freddie Mac
to start purchasing $40 billion a month of underperforming mortgage
bonds as the Bush administration expands its options to buy troubled
financial assets and resuscitate the U.S. economy, according to three
people briefed about the plan.

Fannie and Freddie
began notifying bond traders last week that each company needs to buy
$20 billion a month in mostly subprime, Alt-A and non-performing prime
mortgage securities, according to the people, who asked not to be
identified because the plans are confidential. The purchases would be
separate from the U.S. Treasury's $700 billion Troubled Asset Relief Program.

Published in BoomBustBlog
Wednesday, 08 October 2008 02:00

Regarding the recent rate cuts...

We've been through this before (4 months ago, actually) and I have shown that it is not helping the banks. See The Anatomy of a Sick Bank!
(Archived/Reggie Middleton's Boom Bust Blog/MyBlog)

So, how safe is your Doo-Doo? This installment of Reggie Middleton on the Asset Securitization Crisis (part 17) is more consumer orientated, and attempts to reveal who the riskiest banks are in the
Monday, 09 June 2008 {reademore}
Published in BoomBustBlog

This bank is in big trouble. Notwithstanding their own credit issues, a slowing business cycle, and horrible macro conditions, they actually paid $100 billion for acquisitions in the last 5 quarters. This company wasn't even (IMO) worth $100 billion in the last 5 quarters. Talk about subprime borrowing!

Two of those acquisitions were the largest companies in their respective industries, along with the largest problems caused by the Asset Securitization crisis (or one could say caused by them). Merrill Lynch led Wall Street in asset value writedowns, and I don't think they were really all that aggressive in doing so. Countrywide is a gaping radioactive cesspool of liabilities and underwater assets (see the posts below from LAST YEAR). They actually have practically as much in REOs (dollar value) as performing mortgages. This makes them effectively a real estate company - against their will. The legal liabilities appear to be near limitless. What the hell was Ken Lewis thinking when he bought these two companies? Integrating a large acquisition is hard enough, doing 5, with 2 being the largest in their respective (very large) industries during the worst credit and real estate downturn since the Great Depression, as your own credit and earnings metrics deteriorate in the face of nearly $10 billion + worth of legal liabilities seems to be a form of corporate hari kari. Then again, what does a lowly blogger know about the intricacies of high finance and corporate machinations...

Published in BoomBustBlog

The Asset Securitization Crisis: Part 26

This is part 26 (and we're not even finished) of the macro updates that drive my ever-developing investment thesis. Click here for the current performance of this thesis as applied through a public research model.

Fannie Mae & Freddie Mac - Who will finance their future?

Fannie
Mae and Freddie Mac were formed as government agencies to expand home
ownership and provide stability and liquidity to the secondary mortgage
market. The continued decline in housing prices in the US has resulted
in huge write downs in the residential mortgage backed securities
market. The S&P Case Shiller home price index has been declining
consecutively for the last 23 months; it fell 0.5% in July 2008. The
imminent threat to Fannie Mae's and Freddie Mac's combined debt of
US$1.59 trillion, and lack of financing options have raised doubts
about the viability of mortgage companies. Their net worth has been
eroded significantly due to huge losses. It stood at US$54 billion as
of June 30, 2008. The underwritten or owned mortgages by these two
entities comprise about 50% of the US mortgage industry (worth US$12
trillion). These two large mortgage giants faced a liquidity crunch,
due to large write downs that amounted to US$14.9 billion in the last
one year. Fannie Mae has raised more than US$14 billion in capital
since November 2007, while Freddie Mac raised US$6 billion in the same
period to offset write downs on mortgages it owns or guarantees.
Consequently, to avoid a severe mortgage market crisis if they failed,
they were taken over by the US government on September 7, 2008. The
government has decided to take charge of the beleaguered mortgage
companies through Federal Housing Finance Agency (FHFA), a government conservatorship,
and rescue them from the current situation. The government would back
the debt underwritten by these two companies. FHFA, formed by the
merger of Federal Housing Finance Board (FHFB) and the Office of
Federal Housing Enterprise Oversight (OFHEO), would supervise the two
mortgage giants and have the powers of the Board and management. The
Chief Executive Officers for both companies have been replaced. Mr.
Herb Allison and Mr. David M. Moffett are the current CEOs of Fannie
Mae and Freddie Mac, respectively.

Published in BoomBustBlog

Ban on short-selling

US: The Securities and Exchange Commission on Friday issued an emergency order temporarily banning short selling in the shares of 799 financial institutions until midnight on October 2, 2008. The SEC said it may extend the order if it's necessary to protect investors, but it won't last more than 30 days. In a pre-trading market GS and MS have gained 10%.


The U.S. Securities and Exchange Commission may require hedge funds to disclose their short-sale positions and plans to subpoena the funds' communication records. The SEC would hedge funds and investors managing more than $100 mn to publicly report their daily short positions. SEC has also made it a securities fraud when sellers deceive brokers about delivering shares to buyers. The SEC would also impose penalties on brokers if their clients haven't delivered shares to buyers within three days of a short sale. The SEC also approved a rule drafted in March 2008 that it would amount to be a fraud for investors to lie to their brokers about locating shares to be sold short. Currently, brokers rely on their customers' assurance that they had located shares that could be used to cover a sale.

UK: Britain's Financial Services Authority has imposed temporary ban on investors from taking new short positions in financial stocks from midnight on Thursday, September 18. The ban has been imposed until January but would be reviewed each month.

Published in BoomBustBlog