Wednesday, May 28, 2008

Don't Mess With Texas

We've frequently discussed how abysmally banks have been performing and their continued overvaluation by the market despite a propensity for lying about their assets and exposures. An excellent article detailing the return of retired FDIC experts was in this weekend's Furthermore, something called "The Texas Ratio" was outlined by Gerard Cassidy of RBC Capital Markets. "The ratio is calculated by dividing a bank's non-performing loans, including those 90 days delinquent, by the company's tangible equity capital plus money set aside for future loan losses. The number basically measures credit problems as a percentage of the capital a lender has available to deal with them." When that ratio reaches 100%, banks generally tend to go kablooey. For reference, IndyMac has a ratio of 140% and is currently dying. NCC, a strangle I am currently playing, has a ratio of 40, up from single-digits just 2 years ago....

In accordance, I've come up with a list of cheap out-of-the-money puts on some potential belly up banks:
Synovus SNV 1/09 7.50s .2-.45
Corus CORS 1/09 2.50s .25-.5
East West Bancorp EWBC 1/09 10s .4-.6
Colonial CNB 12/08 5s .8-1

The Wells Fargo Credit Quality report for May is both an oxymoron and hilarious. It succinctly fleshes out what I've been preaching for 6 months. To quote a fellow iTuliper babbittd, "Consumer credit outstanding rose $15.3 billion in March (chart 1). Revolving debt, which includes credit cards, rose $6.3 billion, more than the $3.9 billion increase in February. Non-revolving debt, which includes auto loans, jumped $9.0 billion following a $2.6 billion increase in February. Falling home prices and slowing job growth are squeezing household wealth (chart 2). Thus, consumers are increasingly turning to credit cards and other forms of debt to finance their purchases.

Real consumer spending growth had been trending down for two years before credit card use ramped up and saved the day, at least for awhile (chart 3). However, over the last six months, spending growth has slowed even further, suggesting credit card use has not been able to fully compensate for slowing home equity withdrawal and job growth. The jump in credit card use amidst a slowing economy has led to rising delinquency rates on credit cards (chart 4)."

Capital One, anyone?

Lauren LaCapra of notes used auto loan rates are going through the roof....insult to injury.

May 2008 Credit Quality Report from Wells Fargo


Anonymous said...

It would be nice to actually calculate the Texas ratio on the banks you think are going belly up.
Just listing cheap puts does not mean they have a bad Texas ratio. Perhaps the author is trying to short some stocks.

Tiger Coach said...

What you are failing to mention is that the reasoning in this article is fundamentally sound. The fact that banks would break long-established rule of thumb type measurement systems in light of the current liquidity crisis of lending institutions is plain negligent.

Ax... It is safe to assume that the jump in revolving debt is heavy exposure to credit card debt. The fact is that 90 days out from this day (5/28) would literally jack up someone's credit if they are failing to make even the minimum payments. Legislation here, and tighter underwriting scrutiny may well be a case of shutting the barn door after the horse has escaped.

What's in Your Wallet?

Anonymous said...

Tiger Coach. I guess you failed to understand my post. I did not debate the merits of the Texas ratio. The author failed to do his homework by listing several belly up candidates with no mention of their respective Texas ratios.

AX said...

Anon, I'm with TC on this. Considering you don't have the balls to buy individual stocks, let alone options, why should I do the work for you? You have the formula, why don't you post the results? Google's up $36 since we spoke 5/27....

Perhaps a good first step would be having the courage to at least use a pseudonym. Here is some recommended listening for you to get you pumped up:

Extreme Ways-Moby (Theme from Bourne Supremacy)
Burning Man-Third Eye Blind
Ring of Fire-Johnny Cash or Blondie

AX said...

Wow, my apologies to the new anonymous. TC and I were under the impression we knew you, as we have a frequent anon commentor here.

I would still recommend the songs, and unfortunately you didn't know me 3 days ago when I recommended Google at $540, today $585!

Sincerely, apologies as I appreciate the viewing and comments. Tell you what, I'll work on Texas ratios for those stocks this weekend.

However, on my own site I have no need to pump or berate stocks indirectly. I just come out and tell you what I'm doing. As I mentioned, I have a strangle on NCC right now. If you look at past posts, you'll know I've been short COF for a long time and have shorted several financials in the last 6 months.

Anonymous said...

I used to be a bank examiner and I have calculated the Texas ratio on EWBC which is a stock I own long. After reading the earnings transcripts the last 2 quarters I feel management is proactive and they are addressing the problems. We should know how well they are doing when they report earnings for the second quarter sometime around mid June. If they take a $20 million charge and their non-performing loans do not increase they should be out of the woods. They could post earnings of .50 per share which could give them a P/E ratio of about 7. They also recently had a $200 million capital injection recently raising their capital to slightly over 12%. I found the conclusion that EWBC could be a good belly up candidate laughable.

AX said...

Anon, thanks for responding. Can you list the Texas ratio for EWBC? Perhaps this bank should be in a totally separate category from the others. But it was not picked at random. Referencing the MarketWatch article from the post, you'll see that is was chosen for its high exposure to C&D loans (25%), an area that may begin defaulting at much higher rates soon. Colonial was also plucked from the same article,whose TR has gone from 1.5% to 25%.

Corus, a company I discussed a few months back, left their core strategy of regional backing to get huge subprime exposure in Florida. They have gotten hammered as the stock has gone from $30s to $5 and still has risky loans out.

Synovus was taken from the following article on Florida's highly leveraged banks:

Any other candidates you can think of?

Anonymous said...

EWBC's Texas ratio is .10. Historically they have had low non-performng loans. I would not be putting banks on a pre failure list until their Texas ratio reaches .50. 74,467+52,952 divided by 1,157,000 + 117,100. Note their reserve for loan losses is close to equaling their entire level for non performing loans + 90 day past due loans.

Anonymous said...
There are a lot of financial companies that are non banks on this site. This is a useful site to get some of the larger small banks. The weaker banks will remain weaker as it is a reflection of weak management. The banks will have to earn their way out of their problems. While calculating the Texas ratio is helpful also look at the (Earnings before tax + the quarterly provision for loan losses)divided by the number of shares outstanding to get an idea of the banks earnings power. 8 to 10 X this number(depending on growth rate) on an annual basis should give you a reasonable projected value for a bank stock.

AX said...

Anon, thanks for the added input. It occurs to me that the TR can be thrown off by both the underreporting/underaccounting for delinquent loans (we've seen quite a bit of this) and under-reserving for loan losses. Maybe you can comment on how prevalent this still is in your opinion and the difference in banks like Wells Fargo who traditionally have over-reserved versus other banks, large or small.

Anonymous said...

WFC and your smaller banks are 2 different animals and should not be compared. WFC has mortgage backed securities and CDOs that are booked similar to bonds and are marked to market, model or what ever they want. This is where the problems lie with big banks as no one knows what their portfolios are really worth. I feel games are being played at the big banks and I do not invest in them! The smaller banks are easier to understand and after a bank examination the problem loans will be properly reserved against either by management or by the bank examiners.

It is my opinion that the bigger banks have more risk as getting a value for their portfolio is much harder. Why would you want to invest in something that you cannot value? The problem with WFC is they think they have properly reserved or over reserved but with their portfolio no one really knows. Banks like C are most likely worse than anyone knows. If you do not understand it or cannot value it do not invest in it.

AX said...

The question for me is not whether I should be investing in them, but betting against them despite the continued market optimism for a financial rebound. What do you think of Lehman as a potential BSC like candidate given Einhorn's continuous shorting of their stock? It seems you're wary of short-sellers, but his track record, like his mentor's Ackman, is a good one.

Anon, can I also ask how you heard about my blog? Was it simply by searching for references to EWBC?

Anonymous said...

Buffet likes to buy companies that he understands. LEH is one I do not understand. It seems like the big brokers make a lot of money and give it to their top 10 or so employees. In bad times the shareholders get 90% of the losses. Management does not know what their portfolio is worth and if they did I think they would wait until after their bonuses are paid to tell the truth. This is not a good risk reward ratio for the shareholders. I agree the best way to play LEH may be to short it. I would rather invest in something else. After all if you limit yourself to a narrow group of the S&P 500 stocks there are about 490 other stocks from which to choose.

I found your blog from a pre set search for EWBC from google. If you would like to contact me directly my e-mail is

QAS said...

AX - Samir here interesting blog good stuff..i've just read some interesting info in Barrons regarding Amylin (AMLN) regarding Carl Ichan's aquiring >5% of outstanding stock including 2 million + call leaps that expire in 2010. What do you think about this investment a good bandwagon to jump on. I use to work for lilly and the way they work is that they partner for about 2 yrs with a company and then buy them out like they did with ICOS. Would you be willing to put some money on the table for these leaps?

AX said...

Samir, your point is well taken about Lily's strategy. The "Whale watching" strategy as with Icahn can also be effective. However, beware. Icahn with his infinite wealth can afford to expose himself to Black Swan type events on many levels. He can afford to lose $190 million. We have to be much more selective. The 1/10 calls don't look very cheap to me. There is always the possibility of takeovers/blockbuster drugs in your industry, that's why volatility is so high.