After a huge fall off in credit consistent with the fall in nominal GDP, we are seeing credit stabilise at a lower level. Debt to GDP ratios may not be lower, but as GDP is lower, so too is credit in the system.  Yet there is a large difference between the haves and the have-nots, largely due to a difference in which banks received government largesse and which did not.

Bank analyst Don Coxe puts this in perspective for us:

A sustained U.S. economic recovery is unlikely until all banks, and not just the big institutions bailed out with government funds, start to recover from the effects of the financial crisis, according to longtime investment strategist Don Coxe.

Many banks that got funding from the government have seen their shares soar, while smaller, regional banks have not.

That’s a sign that investors believe the smaller banks are less well placed to participate in, and contribute to, the economic recovery, said the chairman of Coxe Advisors LLC in Chicago, who advises clients of the BMO Financial Group.

Think big banks – big business, small banks-smaller business.  In effect, the credit flow for large multinationals is now back to normal.  However, like consumers, small and medium-sized enterprises (SMEs) are finding a tougher reception. Revolving credit lines are being cut and loans are harder to come by (one reason Warren Buffett and Goldman Sachs are stepping into this space in this crucial holiday season).

This is a case of supply and demand constraints. One the one hand, credit supply is constrained because regional financials are loaded down with bad debts and have not received the same measure of bailout money that big banks have.  On the other hand, SMEs are having to downsize and are demanding less credit.

"The thousands of regional U.S. banks on which an economic recovery depends have not participated in the sudden explosion of trading profits" of the biggest five U.S. banks, he said.

The state aid granted to large banks during the financial crisis has convinced investors the government will step in again in future to save the behemoths if needed. That has helped pull share prices back up from the 12-year lows hit in March.

By contrast, as more commercial real estate loans turn bad in the still-feeble economy, regional and community banks are struggling.

A key gauge of the gulf between big banks and smaller lenders is the KBW Regional Bank Index exchange traded fund (KRE.P). The ETF’s recovery has lagged the rebound in shares of the biggest five U.S. banks, said Coxe.

"There will not be the kind of sustained U.S. economic recovery that will drive a sustained U.S. bull market until the shares of the Main Street (KRE) banks begin to outperform" both those of the biggest five banks and the S&P 500 index .SPX, he said.

Small bank index suggests recovery is elusive – Reuters

Related posts:

• More warnings on regional banks
• Regionals are exposed to credit crisis
• Michael Panzner: regional banks in trouble
• Relative value in financial services
• Fifth Third takes on assets of Freedom Bank

You are a teacher at a local primary school. Each school day you and some of your colleagues watch over the children at the school playground to make sure all of the children follow the rules and keep their hands to themselves. Your role is to keep the children safe. Mind you, this is a Montessori School where the philosophy is to let children explore within set boundaries.  But, if a child hurts another or a child’s behavior poses an immediate risk to others, you always step in.

In fact, one child, Charlie has been a bit of a problem recently. Charlie is one of the biggest kids at the school, a boisterous sixth grader who likes to push and play with matches. Last July 4th, it seems he got a hold of a video on the Internet blog Credit Writedowns on how not to use fireworks.  Contrary to the video’s intention, he rather liked seeing things blow up and courting danger. You see Charlie is a bit of a pyromaniac. You have repeatedly had to stop Charlie from bringing matches to the playground and lighting things on fire. But, recently you have had to confiscate firecrackers and suspend him from school.

But, one day a new headmaster comes to the school. He doesn’t believe much in the need for teachers to monitor the children. The children can monitor themselves. Unfortunately, Charlie has a bit of a following at school and before you know a lot of the kids are lighting firecrackers on the schoolyard. No one gets seriously hurt – just a few minor burns here and there. So Charlie ups the ante to M-80s like he saw in the video. There was a serious close call when he put the frog in a jar with the M-80, but self-monitoring has worked pretty well and there have still been no major casualties.

That’s when little John comes up to you and asks, “Ms. Watkins, why does Charlie have lit dynamite?”

In case it’s not obvious:

• Charlie is a too big to fail bank.
• The matches are debt, the firecrackers are derivatives, the M-80s are asset-backed securities and the dynamite is OTC derivatives.
• You (Ms. Watkins) are Brooksley Born
• The headmaster is Alan Greenspan
• Little John is another smaller community bank
• The other children are banks and citizens of the broader economy
• The frog-glass incident was LTCM’s collapse
• The lit dynamite incident was Lehman Brothers

In the past, I have likened regulators to referees or playground monitors to illustrate why the concept that markets are self-regulating is absurd. In the last post, “Frontline – The Warning: Who Knew About the Looming Financial Crisis?” Alan Greenspan was at war with regulator Brooksley Born over this concept of self-regulation. Born believed that regulation was a necessity in any financial market. Greenspan believed that markets are inherently self-regulating. Even fraud was self-regulating through market discipline in his view. I believe he has now repudiated this. However, Born lost that battle with ugly consequences when the market she wanted regulated, OTC derivatives, blew up via AIG.

Self-regulation is to regulation as self-importance is to importance.

Note: Even though, I am pointing to Buiter’s piece here, I am not a believer in regulation-heavy in the least. Nevertheless, his ideas do merit consideration.

Related posts:

• Deregulation efforts from the late 1990s were blocked
• A conversation with Richard Posner on Charlie Rose
• Greenspan: financial crisis ‘will happen again’
• A conversation about AIG on Charlie Rose
• Forstmann on Charlie Rose: easy money caused crisis

We are a few weeks into earnings season and it should be abundantly clear that financial institutions are firing on all cylinders.  In fact, financials are leading the broader market for the first time since 1993.  Yet, loan losses have been absolutely enormous.  What gives?

The Great Giveaway is the essence of recent market performance in a nutshell.  Let’s look at U.S. Bancorp for a second as an illustration.  In March, Warren Buffett mentioned in some CNBC interviews that he felt the underlying earnings power of his major holdings in financial shares, Wells Fargo and U.S. Bancorp, was pretty robust.  Both have come out with some pretty bullish announcements since then.  U.S. Bancorp announced its earnings yesterday.  This is how Deal Book reported the event.

U.S. Bancorp, one of the 10 largest U.S. banks, reported higher-than-expected quarterly earnings on Tuesday on record revenue from mortgages, sending its shares up almost 21 percent, Reuters said.

The strong mortgage activity helped to offset losses from lease financing, construction and development loans, and credit cards.

The bank also put aside $1.3 billion for loan losses, $833 million more than a year earlier, as declining home prices affected both consumer and commercial loan portfolios. Chief Executive Richard Davis expects to set aside similar amounts in the next two quarters, before loan losses start to moderate toward year end.

“I don’t expect us to stop reserve-building until which time we see strength in the reduction of (losses),” he said on a call with analysts.

Shares soared on the results to finish up 20.9 percent at $19.27.

“Our credit costs are elevated like the rest of the industry but we were able to offset that with our core businesses,” Chief Financial Officer Andrew Cecere told Reuters in an interview.

The bank in November took over failed California lenders Downey Financial and PFF Bancorp, with support from the federal government.

“I would expect to see more of the same, but nothing large,” Mr. Cecere told Reuters, when asked about future acquisitions.

First-quarter profit for common stockholders fell to $419 million, or 24 cents per share, from $1.08 billion, or 62 cents per share, a year earlier.

Analysts on average were expecting the Minneapolis-based company to earn 20 cents a share.

Like Wells Fargo and JPMorgan Chase, which both reported last week, U.S. Bancorp saw record mortgage production revenues from new applications and refinancing.

But broader interest in loans started to decrease in the second half of the quarter, Mr. Davis said on the call, attributing this to customers becoming more careful.

“There are a number of customers who are neither as qualified as they were a year ago, nor are they interested in (more) debt,” he said.

U.S. Bancorp received $6.6 billion in taxpayer funds under the U.S. government’s Troubled Asset Relief Program last year, and TARP recipients have been under fire for not extending this money to customers.

“We have not denied a single credit-worthy customer since the beginning of this downturn,” Mr. Davis said. The bank hopes to repay the $6.6 billion once regulators approve, he said.

What you should have noticed is this:

1. There were massive loan losses at U.S. Bancorp (”The bank also put aside $1.3 billion for loan losses, $833 million more than a year earlier, as declining home prices affected both consumer and commercial loan portfolios. Chief Executive Richard Davis expects to set aside similar amounts in the next two quarters, before loan losses start to moderate toward year end.”)
2. So what.  U.S.  Bancorp made a lot of dosh anyway.  How? “Like Wells Fargo and JPMorgan Chase, which both reported last week, U.S. Bancorp saw record mortgage production revenues from new applications and refinancing.”
3. But, what’s more, they received $6.6 in bailout funds AND they got to pickup a few assets like Downey Financial’s carcass courtesy of the FDIC. (”The FDIC and U.S. Bank entered into a loss share transaction. U.S. Bank will assume the first $1.6 billion of losses on the asset pools covered under the loss share agreement, equal to the net asset position at close. The FDIC will then share in any further losses.”)
4. And, finally U.S. Bank is getting massively subsidized debt issuance courtesy of every big bank’s new friend, the former Grim Reaper FDIC (”Fitch Ratings has assigned ‘AAA/F1+’ ratings to debt issued by U.S. Bancorp (USB) through the FDIC Temporary Liquidity Guarantee Program (TLGP). Specifically, USB issued $750 billion of 2.25% senior notes due March 13, 2012.”)

So, what you are seeing at U.S. Bancorp are real profits coming courtesy of Federal Government largesse. Now, I happen to believe that U.S. Bank is one of the better big banks in the U.S. But for the sake of argument, let’s assume they were in dire straits and were on the verge of collapse pre-TARP.

That’s not a problem now.

Lots of revenue. The Fed has engineered low long-term interest rates by buying into the treasury and MBS market with money they created out of thin air. The result has been a lot of refinancing and new mortgage applications. Check.

Lower liquidity constraints and unimpaired assets. The FDIC has given U.S. Bank the deposits of Downey after it was bankrupted, much as Wells Fargo got Wachovia and JPMorgan got Washington Mutual. These deals were done on extremely favourable terms because many of the losses will have been recorded before the takeovers. Therefore, U.S. Bank, Wells and JPM are getting huge deposit bases and a large asset book without most of the losses the legacy organizations would have carried in a merger. That means they all get low-cost funding not subject to rollover risk (the wholesale market which bankrupted Northern Rock) and relatively unimpaired assets. Check.

Capital injection. U.S. Bank also got a big fat check for $6.6 billion under the TARP. This should go a long way toward helping recapitalize the bank and insuring it as a safe counterparty and depositary institution. Check.

Low-cost funding. Finally, U.S. Bank is getting FDIC-subsidized funding. It’s kind of like the kind of sweet deal Fannie and Freddie have gotten in that investors felt agency debt was implicitly backed by the Federal Government.

The long and short, there fore is that U.S. Bank is getting a huge helping hand from the government. Even if it had been impaired beforehand, it would look much better now. The fact that their earnings STILL fell some 60 percent, gives you an insight into the magnitude of the problem i.e. loan losses.

The conclusion I have drawn from this is that the big banks will be earning a lot more money than had been anticipated before Q1 results were released. Nevertheless, continued problems in the prime mortgage and commercial real estate markets will be a drag on earnings as indicated by the huge writedowns at U.S. Bank and other banks like BofA. You should also note that credit card delinquencies are equally problematic. The regionals, with their construction loans and CRE exposure, are going to be taking it on the chin here.

Until and If these headwinds become insurmountable, big banks will be making money. Regional banks and local banks, not so much.

Sources
U.S. Bancorp Posts Higher-Than-Expected Profit – Deal Book
Fitch Rates U.S. Bancorp’s FDIC Guaranteed Debt ‘AAA/F1+’ – Market Watch

Related posts:

• Wells Fargo to buy Wachovia
• The FDIC acknowledges it is to run out of money
• Bloomberg: $500 billion in writedowns by firm
• Bankruptcies: US Bancorp takes over at Downey and PFF
• What the stress tests reveal about Obama’s thinking on banks

The Bloomberg video below makes it seem that Whitney believes the stress tests are a sham. She says the tests are a theoretical exercise whereby banks ask: “what will our earnings power be in two years after we sell off these ‘toxic’ assets?” She goes on to suggest that the answer to this question will be a self-serving, upbeat response not wholly reflective of the real dangers lurking.

In reality, much more capital is still going to be required.  Some of this will happen via asset sales, as she suggests.  However, one should anticipate a real need for yet more capital still.

You should also note she says the regionals will struggle because they have A LOT of commercial property (CRE) exposure – something I mentioned quite often in 2008. Case in point is Zions, which had a horrendous earnings announcement just yesterday.

“Zions’ capital position will come under significant pressure in the short-term because of its large commercial real estate lending concentration and collateralized debt obligation portfolio,” Moody’s said. “Future credit costs in Zions’ residential construction book and CDO portfolio cause a significant risk of the firm becoming undercapitalized.”

The long and short is: it is good to be a “too big to fail” big bank. It is not so good to be a regional or local bank.

Related posts:

• At least six banks need more capital under stress tests
• What the stress tests reveal about Obama’s thinking on banks
• Stress tests reveal Citi and BofA need more capital, but you knew that already
• Is Meredith Whitney bullish now?
• Ackman and Stigliz talk Stress Tests with Charlie Rose

Recently, I posted a Wall Street Journal article that suggested smaller banks and new banking enterprise can supply the lion’s share of additional credit needed for the U.S. banking system. While President Obama is off meeting the heads of the big banks, we should keep in mind that there are other institutions out there that can bring the U.S. credit markets back to life.

I am not the only one making this case. Meredith Whitney has also been vocal about the need to start focusing on community and regional banks.

Below is a CNBC video with Frank Sorrentino, the North Jersey Community Bank chairman/CEO lamenting the lack of attention they are getting.

Also see this video of Meredith Whitney talking about her view of the future of the banking industry, the demise of big banks and the rise of small banks. Great stuff. (PS. – the associated article also quotes me, so, of course I like it!).

Related posts:

• Meredith Whitney seems onboard with the fake recovery
• Bill Miller and Meredith Whitney: The Bull and the Bear
• Meredith Whitney says nationalization is wrong and banks will lose money
• Mortgage insurers will trigger further writedowns
• Regional banks: examples of risk from SoCal

As you know from reading my blog, I am expecting a lot of writedowns from regional banks as real estate loans sour.

In fact, I expect a number of bankruptcies because of defaults in commercial property where much exposure is hidden.  This is an issue I have been writing about since May. Many of the larger regionals, which have already received TARP funds will suffer large writedowns despite having low subprime exposure.

Below is a clip of Bain Slack of Keefe Bruyette & Woods, who has a few words to say about the regionals, especially in the Southwest.

Take a look.

Related posts:

• Gateway Financial and Midwest Banc have one-third of capital in Fannie and Freddie Preferreds
• Regional banks: examples of risk from SoCal
• More warnings on regional banks
• Wave of regional bank write-offs?
• Regional banks are suffering

This past weekend, the FDIC closed yet another bank, Freedom Bank of Bradenton, Florida. The bank had total assets of $287 million and total deposits of $254 million. Super regional Fifth Third, based in Cincinnati, Ohio will take over the insured deposits of the institution and all Freedom branches have opened today as Fifth Third branches.

What is most significant about this announcement has nothing to do with Freedom and everything to do with Fifth Third. In the aftermath of the U.S. treasury’s TARP bank re-capitalizations, we should see this announcement as an endorsement of the beleaguered super regional.

Freedom Bank, Bradenton, Florida, was closed today by the Commissioner of the Florida Office of Financial Regulation, and the Federal Deposit Insurance Corporation (FDIC) was named receiver. To protect the depositors, the FDIC entered into a purchase and assumption agreement with Fifth Third Bank, Grand Rapids, Michigan, to assume all of the deposits of Freedom Bank.

The four branches of Freedom Bank will reopen on Monday as branches of Fifth Third Bank. Depositors of the failed bank will automatically become depositors of Fifth Third. Deposits will continue to be insured by the FDIC, so there is no need for customers to change their banking relationship to retain their deposit insurance coverage. Customers of both banks should continue to use their existing branches until Fifth Third can fully integrate the deposit records of Freedom Bank.

Over the weekend, depositors of Freedom Bank can access their money by writing checks or using ATM or debit cards. Checks drawn on the bank will continue to be processed. Loan customers should continue to make their payments as usual.

As of October 17, 2008, Freedom Bank had total assets of $287 million and total deposits of $254 million. Fifth Third agreed to assume all the deposits for a premium of 1.16 percent. In addition to assuming the failed bank’s deposits, Fifth Third will purchase approximately $36 million of assets. The FDIC will retain the remaining assets for later disposition.-FDIC

If you recall, Fifth Third has been one of the regional banks under greatest scrutiny and selling pressure along with NCC, Zions, Wachovia, Regions Financial and KeyCorp. Recently, the bank had expanded well beyond its core regional base into Florida and has seen a significant increase in non-performing assets.

Yet, it is now deemed safe enough to take on the assets of failing institutions in Florida. To my mind, that is a green light for Fifth Third investors. It says that regulators see the bank as more of the solution than the problem. Granted the FDIC has focused only on smaller institutions given its limited capital to back failing institutions. But, ultimately regulators had the opportunity to use a number of banks to take on these assets, but it chose Fifth Third.

That must be seen as very good news to any Fifth Third depositor or shareholder.

Related posts
Does the FDIC have enough money?
Regional banks are suffering
Fifth Third looking to sell assets
Fifth Third to raise $2 billion
What’s happening at Fifth Third?

Sources
Fifth Third Bank Acquires All the Deposits of Freedom Bank, Bradenton, Florida – Press Release, FDIC

Related posts:

• FDIC moves in at Great Basin Bank
• Westsound Bank seized by FDIC
• Last bankruptcy tonight: America West Bank
• SunTrust Bank receives insured deposits of Omni National Bank
• FDIC Friday Night Special: Lincolnwood

As with everything else, the bailout of the U.S. banking system is going to have unintended consequences. One of them seems to be giving exactly those firms that wasted billions of shareholder money a chance to double down. Flush with government money, these busted financial companies may just go on a shopping spree sponsored by Uncle Sam. Local banks are not too pleased.

Camden Fine, the chief executive of the Independent Community Bankers of America, said it was unfortunate that the U.S. treasury had imposed few conditions on the way the money was used, other than a stipulation that dividend payouts to shareholders must not rise.

“When you have taxpayers’ money used by larger banks to purchase otherwise healthy banks, that just promotes the kind of consolidation that got us into this mess in the first place,” said Fine.

“These taxpayer funds are intended to unfreeze the credit markets and to open up local economies — not to help investors in one bank buy out investors in another.”
-Guardian

Well said.

Related posts:

• Government banking Irish edition
• How Goldman profits from the credit crunch
• Automakers likely to be bailed out
• Some banks not paying TARP dividends
• CIBC to write down another $1B: analyst

PNC, down only 13% this year-to-date, very good for a bank stock, is acquiring beleaguered Ohio bank NCC for $5.5 billion. The price represents a huge discount to the prevailing market price before open today and NCC was down 34% in early trading. PNC is issuing $7.7 billion in stock and warrants to the U.S. government under TARP. PNC expects National City merger costs of about $2.3 billion.

The Treasury money gives the new entity about 10% in Tier 1 capital. “The acquisition of National City will increase our core deposit base to $180 billion, making PNC the fifth largest U.S. bank by deposits. At a time when core funding is key, we see our deposit strength as an important success factor,” PNC said in a press release. NCC has no statement on its website as of 940AM ET.

National City posted a huge loss, put aside more money for losses and announced plans to eliminate 4,000 jobs. Its third-quarter loss came to $729 million, up from $19 million a year earlier.

This has to be a very good deal for PNC and its shareholders. It is a good deal for NCC’s depositors as it avoids bankruptcy but its shareholders are getting killed. In my opinion, this is further proof that U.S. Government officials are willing to pull out all the stops to keep the financial sector from collapsing. But, it also shows that manybanks are effectively bankrupt and that their shares are absolutely worthless.

More details to follow. See NCC-related writedowns and stories at the credit crisis timeline.

PNC Statement

PNC to Acquire National City

Merger will create fifth largest U.S. banking deposit franchise PNC to further strengthen capital position

PITTSBURGH, Oct. 24 /PRNewswire-FirstCall/ — The PNC Financial Services Group, Inc. (NYSE: PNC) and National City Corporation (NYSE: NCC) today announced that they have signed a definitive agreement for PNC to acquire National City for $2.23 per share, or an aggregate fixed amount of approximately $5.2 billion in PNC stock. Additionally $384 million of cash is payable to certain warrant holders. Total consideration approximates National City’s market capitalization as of the close of business on October 23, 2008. National City shareholders will be entitled to 0.0392 share of PNC common stock for each share of National City.

  (Photo: http://www.newscom.com/cgi-bin/prnh/20081024/NEF023 )(Logo: http://www.newscom.com/cgi-bin/prnh/20000307/PHTU015 )

PNC plans to issue to the U.S. Treasury $7.7 billion of preferred stock and related warrants under the TARP Capital Purchase Program subject to standard closing requirements. The U.S. Treasury Department approval of PNC’s participation enables PNC to further strengthen its capital position, resulting in an estimated pro forma Tier 1 capital ratio for the combined company of approximately 10 percent.

“The acquisition of National City will increase our core deposit base to $180 billion, making PNC the fifth largest U.S. bank by deposits. At a time when core funding is key, we see our deposit strength as an important success factor. Upon closing the transaction, we will implement our successful business model and execute our strategies for managing risk, achieving cost efficiencies and growing high-quality revenue streams,” said James E. Rohr, chairman and chief executive officer of PNC. “We believe this strategic combination will continue PNC’s efforts to build capital strength and shareholder value. We are also gratified that we have been selected to participate in Treasury’s Capital Purchase Program, which has helped to put this transaction on a very solid footing.”

The transaction has an estimated internal rate of return to PNC of more than 15 percent and is expected to be accretive to PNC’s earnings in the second year. PNC’s fair value adjustments and provisions for future losses of National City’s current loan portfolio will bring the cumulative impairment of these loans to approximately 17.5 percent. PNC will continue to liquidate non- core and impaired loans.

“The combined company will have greater scale and scope, enhancing service to our customers and communities and providing greater opportunities for our employees. This transaction is about two companies that fit well together in terms of geography, products and services,” said Peter E. Raskind, chairman, president and chief executive officer of National City.

Upon closing the transaction, Raskind will be appointed a PNC vice chairman, and one National City director will join the board of the combined company.

In addition to ranking fifth nationally in deposits, the combination with National City is expected to place PNC fourth among U.S. banks in number of branches. It will give PNC the No. 1 deposit share position in Pennsylvania, Ohio and Kentucky and will rank the company No. 2 in Indiana and Maryland.

PNC expects to incur merger and integration costs of approximately $2.3 billion. The transaction is expected to result in the reduction of approximately $1.2 billion of noninterest expense through the elimination of operational and administrative redundancies.

Under terms of the agreement, PNC will acquire all outstanding shares of common stock of National City in a stock-for-stock transaction, which has been approved by the Boards of Directors of both companies. In connection with the transaction, National City has issued to PNC an option to acquire 19.9 percent of National City’s common stock that becomes exercisable under certain specified circumstances. Corsair Capital, LLC, which owns approximately 7.8 percent of outstanding National City common shares, has agreed to vote all National City common shares it owns in favor of the deal and otherwise support the transaction. After closing, PNC intends to merge National City’s banking affiliates into PNC Bank and they will assume the PNC Bank name. The merged entity will have its headquarters in Pittsburgh.

Based on PNC’s closing NYSE stock price of $56.88 on October 23, 2008, the transaction values each share of National City’s common stock at $2.23. The aggregate consideration is composed of a fixed number of approximately 92 million shares of PNC common stock. Additionally $384 million of cash is payable to certain warrant holders.

The transaction is currently anticipated to close by Dec. 31, 2008. The merger is subject to customary closing conditions, including both PNC and National City shareholders and regulatory approvals. Citigroup Global Markets Inc., JPMorgan Securities, Inc. and Sandler O’Neill + Partners, L.P. acted as financial advisers to PNC, and Wachtell, Lipton, Rosen & Katz acted as its legal adviser. Goldman Sachs acted as financial adviser to National City and Sullivan & Cromwell LLP acted as its legal adviser, and Cravath, Swaine & Moore LLP acted as legal adviser to the Board of Directors of National City.

Related articles
National City has big loss, to cut 4,000 jobs

Source
PNC to Acquire National City – PNC Website

Related posts:

• National City gets approval to raise cash
• FDIC Friday Night Special: First National Bank of Anthony
• Gateway Bank sold, hurt by Frannie preferreds
• AIG down; Lehman and WaMu looking to be sold
• Citigroup and Morgan Stanley: the City Morgue is now open

Spanish banking giant Banco Santander has pulled through the credit crisis with a much higher profile than ever before. I was initially skeptical that the firm was hiding huge losses at it had exposure in Spain, the UK and the US, all terrible bubble markets. Yet, it has seemed to come through swimmingly and is using the current market turmoil to consolidate its overseas positions.

The latest move by Santander is its merger discussions with Sovereign Bancorp, the beleaguered U.S. regional bank based in Philadelphia. Regional banks in the U.S. have suffered more because mark-to-market rules under accounting rule FAS 157 has put off foreign buyers afraid of significant credit writedowns applicable under a merger due to the FAS 157 rule. Rumors have circulated that Canadian banks have avoided the U.S. for just this reason.

With Santander looking seriously at Sovereign, this should put the likes of NCC and Fifth Third into play as well. I reckon this news will further fuel a massive rally in financial shares come Monday morning.

Banco Santander of Spain is in advanced talks to acquire Sovereign Bancorp for virtually no premium, people briefed on the matter said, as the acquisition of weakened banks continued apace in another hectic weekend.

Santander is likely to pay $3.81 a share for Sovereign, a savings and loan that has been hobbled by bad mortgages. That would mean buying Sovereign for about $2.53 billion, these people said.

The move would bolster Santander’s footprint in the United States, something the Spanish bank has desired for some time. Unlike other banking giants throughout the world, the firm has been largely unhurt by the global credit crisis, having foregone trading in subprime mortgages and other risky debt that have since imploded.

Santander has been considered a logical white-knight for Sovereign, ever since it took a nearly 25 percent stake in the bank three years ago and filled three seats on its board. By buying out the remaining shares, Banco Santander will be able to put Sovereign on stronger financial footing. It also would reduce the chance that its original stake would be wiped out as Sovereign’s prospects soured.

Shares in Sovereign have plunged 77 percent over the past year, but closed up 16.9 percent on Friday.

As other Spanish banks are deluged by losses, Banco Santander has been one of the more robust players to emerge from the credit crisis. It steered clear of many of the problems tied to American subprime mortgages and other complex investments, and is now seizing opportunities on a global stage. On Friday, it completed its bargain-basement 1.3 billion pound purchase of Britain’s Alliance & Leicester. And it had been among the early bidders for Washington Mutual and Wachovia in the United States.

The bank is no stranger to mergers: Its current form was born in 1999 by the merger of Banco Santander and Banco Hispano, giving it big presences in Europe and Latin America. In 2004, Santander bought Abbey National of Britain for $15.6 billion.

Along with Banco Bilbao Vizcaya Argentaria, Banco Santander has been seeking gain a bigger foothold faster-growing American markets, especially places like Florida, Texas, and Arizona that have strong ties to Latin America where it also has expanded.

Sovereign, a Northeast regional player based in Wyomissing, Penn., outside suburban Philadelphia, has suffered mightily as the housing crisis worsens. After barreling into new markets in the southeastern and southwestern United States, it became swamped by mortgage and home equity losses as home values in those regions collapsed.

The bank has also been hit hard large auto loan portfolio and big holdings of Fannie Mae and Freddie Mac preferred stock, which have effectively been wiped out. As a result, it has sharply pulled back from making new loans.

Source
Santander In Advanced Talks to Buy Sovereign – Deal Book

Related posts:

• Banco Santander is very confident
• Santander buying Alliance & Leicester for £1.3 billion
• Santander: US, Spanish and UK mortgage exposure
• Spain: savings banks suffer while BBVA and Santander expand
• Spain’s BBVA making a push in the US

Updated 535PM EST on 16 Sep 2008 to reflect information from this press release:
National City Completes $7 Billion Capital Raise

While all eyes were focused on Lehman Brothers this weekend, many other players were making their moves to shore up their own balance sheets in order to avoid the critical situation which felled Lehman. Merrill Lynch is the obvious example of shrewd moves in the wake of the Lehman fallout.

However, National City Corp (NCC), based in Cleveland, OH, has made its move as well. It has received shareholder approval to raise as much as $7 billion in new capital.

National City Corp, a U.S. Midwest regional bank battered by mortgage losses, has won stockholder approval to authorize new shares to allow for a $7 billion capital infusion, the bank said on Monday.

The Cleveland-based bank said shareholders authorized an increase in the maximum shares outstanding to 5 billion from 1.4 billion. Shareholders also approved the conversion of some convertible debt into common stock, and the exercise of some warrants. These actions were related to a capital raising plan announced in April, in which National City raised dilutive capital from Corsair Capital LLC and other investors.

The new capital gives National City “the necessary flexibility to address current market challenges,” Chief Executive Peter Raskind said. He added that the bank has no exposure to Lehman Brothers Holdings Inc, the Wall Street bank that filed for bankruptcy protection, and has routine derivatives contacts with Lehman’s broker-dealer unit.
-Reuters

The moves by National City have to be a relief for shareholders as NCC was one of the regional banks most under scrutiny for its exposure to additional real estate related losses. However, one must not this authorization is only the first step; the next step is actually getting the money.

The moves by National City have to be a relief for shareholders as NCC was one of the regional banks most under scrutiny for its exposure to additional real estate related losses. Although the move, has meant serious dilution for National City, it is a relief to know that bankruptcy is less likely in the wake of the largest Chapter 11 filing in U.S. history.

Related posts
Regionals options suffer due to accounting rules
National City Faces `Informal’ Probe Tied to Lending
What if a large U.S. regional bank goes to the wall?
Market turmoil confirms FDIC’s tough position
Does the FDIC have enough money?
National City is on probation

Related posts:

• National City is on probation
• KeyCorp to raise $1.5 billion, cut dividend 50%
• National City Faces `Informal’ Probe Tied to Lending
• National City sold
• Regional banks: examples of risk from SoCal

In case you missed it, the financial system in the U.S. is near collapse. This weekend was unbelievable. Lehman Brothers filed for bankruptcy. The world’s largest insurer AIG is looking for the Fed to help it avoid collapse and Merrill Lynch was forced to close a deal with Bank of America to save it’s own hide.

Just another day at the office? Hardly. Dow Futures are down 350 points and the FTSE in London is already off nearly 5%. So get ready, this is going to be a very, very difficult day in the markets. Here’s the news of importance:

It all started on Monday last week. In the aftermath of the Fannie and Freddie bailout, market nerves were not calmed. Washington Mutual fired its CEO and announced it had an ominous agreement with the OTS (Office of Thrift Supervision).

Meanwhile Lehman Brothers released an early third quarter earnings report that was widely panned by analysts.

Then, it became obvious that some major losses in the Credit Default Swaps (CDS) market were in the offing due to the takeover of the GSE’s by the government. That was going to hit companies like AIG, which had a huge exposure to the CDS market.

The result was a meltdown in shares of WaMu, Lehman and AIG on Friday.

The Fed called an emergency meeting to deal with Lehman. No agreement was found and Lehman declared bankruptcy early this morning. They have assets of $500 billion

AIG dealt with three buyout shops to shore up its capital base but rejected an offer and went hat in hand to the Fed instead. They have assets of $1 trillion.

WaMu has not seemed to do anything. But rumors are swirling and they will come under great pressure this morning. Oh, and they have assets of $300 billion.

Merrill Lynch was the coup of the day. They struck a deal with Bank of America at a significant premium to both book value and the prevailing market price of their shares. Given what we are likely to see today, Merrill Lynch and its shareholders have to be very very happy. They can say, “thank you very much, John Thain.” Oh, and they have a assets of $1 trillion.

So, we’re talking about combined assets of $2.8 trillion here.

Conclusion
So, the day begins with one company gone (Lehman). Two companies under heavy selling pressure (AIG and WaMu) and one company loving life (Merrill Lynch). Who else should we watch?

All the regional financials, the home builders, and the Commercial Real Estate REITs are all going to be under heavy selling pressure.

Brace yourself!

Related posts:

• Mea Culpa: I was too bullish on the BofA-Merrill deal
• Why Lehman failed
• AIG down; Lehman and WaMu looking to be sold
• SEC charges BofA of lying to investors over Merrill but settles
• Merrill – Bank of America deal

Seven years ago, I was involved in a merger that was the last proposed under the old pooling of interests accounting rule that was phased out after June 30, 2001. This methodology was great because it didn’t necessitate acquiring companies to re-mark assets on the companies balance sheets to reflect impairment of intangible assets.

Needless to say, the accountants got rid of this method of accounting after the halcyon tech bubble and AOL-Time Warner merger days. The result was huge impairment charges as many had overpaid for the purchased companies. Vodafone and Time Warner are two companies that were hit by this rule in particular.

Now, a new rule on the horizon is creating more headaches for companies looking to avoid writedowns: FAS 157. For regional banks this may be a problem.

I wrote about the problem with FAS 157(named for the Financial Accounting Standards Board, which governs U.S. accounting standards) two months ago saying:

Smaller regional and local banks are still involved in mortgage lending and lending too for real estate construction and commercial property. However, they hold most of these loans on their balance sheet at book value. They have not re-distributed the risk of these loans in the securities markets as much as the money-center banks.

What’s noteworthy is that these loans are held at book value meaning that they are on the balance sheet as if there has been no impairment to the loans. So, you ask, how could that be when big players have been writing down hundreds of billions? The answer lies in FAS 157. This rule does NOT apply to bank loans. It only applies to freely traded securities. Translation: there are enormous hidden losses on the balance sheets of most regional and local banks from these loans.

Translation: if you have bank loans, all is fine and well — don’t mark to market. But, as soon as an acquisition occurs, if you have significant writedowns to assets — intangible, goodwill or otherwise — that are unaccounted for, these must be reflected in the post-merger accounts. It’s basically marking to market, which is what has killed the money-center banks as they have had to writedown their CDO and Asset-backed security investments.

One reason you haven’t seen many companies stepping up to the plate to buy the likes of WaMu, NCC, Zions, Fifth Third and all the other U.S. regional banks is that they have tons of assets sitting on their balance sheet that would, if marked to market today, in this environment, mean huge losses.

Now, if you need some serious net operating losses (NOLs) as a tax shield (as Bank of America apparently needed in its acquisition of Countrywide Financial) that’s just great. You can goose future profit by carrying forward these NOLs. But most acquirers don’t want to do this. Rumor has it the Canadian banks have been scared off for just this reason.

Washington Mutual Inc. Chief Executive Officer Alan Fishman, who sold the last bank he ran, may not be able to repeat the feat because new accounting rules for devalued loans are driving away buyers.

At least three potential acquirers ended talks this year to buy either Seattle-based WaMu or Cleveland’s National City Corp., according to two bankers involved in the talks. A sticking point, they say: a rule change that will force acquirers to compute a target’s assets at market prices instead of deriving values from measures including the purchase price.

The Financial Accounting Standards Board’s change, effective in December, may delay consolidation in an industry saddled with more than $500 billion in writedowns and credit losses. Loan prices may drop by about 30 percent from their valuation at maturity, said Robert Willens, a former Lehman Brothers Holdings Inc. accounting analyst and executive who teaches at Columbia Business School.

“The new rule will curtail M&A by making it too expensive,” said Willens, who also runs a tax consulting firm in New York. “With loans fetching their greatest discounts since the Great Depression, it sharply reduces the value of a target’s assets. That will force an acquirer to raise additional capital in this very difficult environment.”

Brad Russell, a spokesman for Washington Mutual, declined to comment on potential acquirers and the FASB rule, as did Kelly Wagner Amen at National City.

`Fragile’ Market

The new rule isn’t the only obstacle to bank mergers. Plunging home prices and rising defaults have punctured mortgage securities, forcing lenders to conserve cash. U.S. markets remain “volatile and fragile,” and bankers are reluctant to lend because of increased risk, Deutsche Bank AG Chief Executive Officer Josef Ackermann said at a Sept. 5 conference in Canada.

Fishman, for that matter, said in an interview that a sale isn’t in the bank’s future. “You don’t build a company to sell it,” the 62-year-old lifelong New Yorker said in a Sept. 8 interview. Fishman, who replaced ousted predecessor Kerry Killinger, 59, was CEO of Brooklyn’s Independence Community Bank Corp., which was sold to Sovereign Bancorp in 2006.

Others aren’t so sure.

Whatever the reason for suitors to be gun shy, this limits options for the likes of NCC and Washington Mutual in the future.

Related posts
The regionals versus money center banks

Source
WaMu, National City Lose Suitors on Accounting Rule – Bloomberg

Related posts:

• The regionals versus money center banks
• FASB: Mark all financial assets at fair value
• What Home-Loan Banks reveal about the effects of mark-to-market
• $35 billion in missing writedowns
• What is a credit writedown?

National City is one of the regionals under the greatest pressure and scrutiny. This Friday afternoon announcement has to make deposit- and shareholders alike very nervous.

National City Corp., Ohio’s largest bank, said the U.S. Securities and Exchange Commission started an informal probe into the company’s lending and the sale of its subprime home unit to Merrill Lynch & Co.

The bank was asked in June to provide the regulator with “certain documents concerning its loan underwriting experience, dividends, bank regulatory matters and the sale of First Franklin Financial Corp.,” Cleveland-based National City said in a filing today. First Franklin was sold to Merrill Lynch in December 2006 for $1.3 billion.

“We are voluntarily cooperating with the SEC,” said spokeswoman Kristen Baird Adams in an interview. “Given the volatility in the market and certainly in our stock price in particular, the action is not surprising.”

The notice adds another layer of scrutiny for National City, which said in June said it had signed an accord with the Office of the Comptroller of Currency tied to capital, risk and liquidity management. The bank wouldn’t elaborate. National City has been the worst-performing stock tracked by the 24-company KBW Bank Index this year, losing almost 70 percent.

-Bloomberg, 8 Aug 2008

Related posts:

• National City is on probation
• National City gets approval to raise cash
• National City sold
• FDIC Friday Night Special: First National Bank of Anthony
• SunTrust Bank receives insured deposits of Omni National Bank

I fully anticipate this will happen, so the question becomes: what will the Fed do?

The FDIC stepped in at two banks over the weekend, 1st National Bank of Nevada and First Heritage Bank. These banks failed as a result of construction loans in real estate bust regions of the US. No, surprise there. This is to be expected in a downturn and the FDIC was prepared.

But, the regional banks have been absolutely crushed over the past few months. Judging by their stock prices, equity investors expect some of them to go bankrupt. Fifth Third, Washington Mutual, National City, Huntington Bancshares, and KeyCorp are all down over 80% to mention a few names. The group as a whole is in deep trouble.

What’s more is the full brunt of the downturn has yet to be felt. In particular, souring commercial real estate and construction loans are going to be a theme oft-heard in the coming weeks and months. One other theme barely broached is land prices. Home builders have bought massive parcels of land in anticipation of an ever-increasing demand for housing. With house prices dropping dramatically, those purchases have devalued considerably, sometimes as much as 60-70%. Who do you think loaned the home builders money for these purchases? Regional banks.

So the stage is set for a major failure in the regional banking cohort — which brings us to the question of policy response. None of the major regionals has an explicit or implicit backstop from the U.S. Federal Reserve like the golden list of 19 do. Therefore, should a major regional bank go to the wall, it cannot expect a government guarantee like Freddie and Fannie. It should not expect the kid gloves treatment of Bear Stearns because systemic risk is less of a question. The best it could expect is an FDIC asset seizure, wiping out shareholders, but protecting insured deposits.

On the other hand, uninsured bank deposits are still at risk. Recent share weakness has been precipitated by rumors that Washington Mutual’s uninsured creditors are quietly pulling money from the company, weakening its liquidity position. Were WaMu to fail as a result of these liquidity concerns, a large chunk of the FDIC capital base would need to be used to fund the bank’s seizure as this would be the largest FDIC seizure by an order of magnitude. Therefore, it is likely that the FDIC would ask for more funds from taxpayers in order to shore up its own balance sheet. I fully anticipate that the FDIC will lack adequate capital to take over the banks which will fail over the next few years.

So, a regional bank will not get an explicit or even implicit backstop from the government and taxpayers. However, the magnitude of the problem is such that eventually the taxman must come calling for more money. Those individuals still under the impression that banking writedowns will not be nationalized in some form have a long overdue date with reality coming. Despite its free-market bluster and rhetoric, America is not so different from Japan.

Related posts:

• Michael Panzner: regional banks in trouble
• Regional banks: examples of risk from SoCal
• WaMu on the brink of disaster: has agreement with regulators
• Fifth Third takes on assets of Freedom Bank
• More warnings on regional banks

1st National Bank of Nevada and First Heritage Bank, operating in Nevada, Arizona and California were taken over by the FDIC on Friday. They always wait until Friday night to do their business. This marks the first FDIC closure action since the FDIC closed the much bigger IndyMac.

Bad loans to developers and home builders in Arizona and Nevada led to the failure Friday of an Arizona company’s two banks, including First Heritage Bank in Newport Beach.

The Federal Deposit Insurance Corp. seized the banks late in the day and turned over operations to Mutual of Omaha Bank, part of the large Mutual of Omaha insurance company.

All depositors, including those with deposits in excess of the FDIC’s insurance limits, will have their accounts switched to Mutual of Omaha Bank and will be covered for all their funds, the federal agency said.

“Customers should just think of it as two banks merging,” said FDIC spokesman David Barr.

Ten banks and thrifts have failed in the last 18 months, mostly because of the collapse of real estate markets inflated by years of easy-money lending by mortgage originators. The largest specialist in so-called alt-A loans — made to borrowers whose risk profile fell between prime and subprime — was IndyMac Bank, which collapsed this month and is being operated by the FDIC.

First Heritage and First National of Nevada were owned by First National Bank Holding Co. of Scottsdale, Ariz.

First Heritage, established in 2005, was mainly a deposit-taking franchise, specializing in homeowners associations, property managers such as condominium companies and similar enterprises.

-LA Times, 26 Jul 2008

This sort of thing is going to make people a bit more panicked about where they put their money. At least the FDIC has a ready made solution here.

The last three bank failures demonstrate that hot regions like Arizona, Nevada and California should expect to see a lot of failed banks associated with construction loans.

I’ve added them to my list of Bankrupt Global Financial Institutions.

Update: 509 EDT 26 Jul 2008 – Past FDIC closures of this ilk demonstrate that insured depositors do not have to worry about losing money. Whether taxpayers have to eventually top up the FDIC’s resources is another question altogether. But, some previous articles from TheStreet.com point out the pitfalls and benefits. For instance, ING acquired NetBank’s assets when it failed. But it did NOT acquire the uninsured deposits.

NetBank’s Failure Is Proof That Ratings Matter, The Street.com, 1 Oct 2007
Losing Half a Million on NetBank’s Fall, TheStreet.com, 3 Oct 2007
Ohio Bank Fails, TheStreet.com, 4 Oct 2007
Bad Management Sinks Bank, TheStreet.com, 28 Jan 2008

When a merger partner is found, that’s the best case scenario. But, as the NetBank case shows, that’s not always a happy solution if yo have more than $100,000 tied up in a bank. When an IndyMac-style closure happens, uninsured depositors should be frightened as well. This link shows you who is protected and who isn’t.

Related articles
Two More Banks Fail, WSJ
Mutual of Omaha Bank to Acquire Deposits of Failed First National Bank, Market Watch
Regulators Close Two More National Banks, Washington Post

Related posts:

• FDIC moves in at Great Basin Bank
• Two more FDIC Friday Night Specials brings total to 55 failed banks
• Banks seized by FDIC in Nevada and Illinois
• Silver State Bankruptcy: Another FDIC Friday Night Special
• FDIC closes banks in Michigan and California

Recently, the SEC restricted short selling on a list of 19 stocks because of turmoil following the Fannie-Freddie worries last week. In effect, the SEC was signaling that these institutions are too big to fail because a number of these companies were not subject to rumors of massive losses while a number of institutions not on this list were. Obviously, then, this begs the question as to what financial institutions are too big to fail.

My subjective opinion is based on asset size. Here is a list of the top banks by assets from infoplease.

United States’ Largest Banks
(in millions of U.S. dollars)
Rank	Name (city, state)	Consolidated
		assets
1	Citigroup (New York, N.Y.)	$2,199,848
2	Bank of America Corp. (Charlotte, N.C.)	1,743,478
3	J. P. Morgan Chase & Company (Columbus, Ohio)	1,642,862
4	Wachovia Corp. (Charlotte, N.C.)	808,575
5	Taunus Corp. (New York, N.Y.)	750,323
6	Wells Fargo & Company (San Fransisco, Calif.)	595,221
7	HSBC North America Inc. (Prospect Heights, Ill.)	493,010
8	U.S. Bancorp (Minneapolis, Minn.)	241,781
9	Bank of the New York Mellon Corp. (New York, N.Y.)	205,151
10	Suntrust, Inc. (Atlanta, Ga.)	178,986
11	Citizens Financial Group, Inc. (Providence, R.I.)	161,759
12	National City Bank (Cleveland, Ohio)	155,046
13	State Street Corp. (Boston, MA)	154,478
lass="xl26" style="border-top: medium none; height: 25.5pt; width: 56pt;" num="" width="75" height="34">14	Capital One Financial Corp. (McLean, Va.)	150,608
15	Regions Financial Corp. (Birmingham, Ala.)	144,251
16	PNC Financial Services Group, Inc. (Pittsburg, Pa.)	140,026
17	BB&T Corp. (Winston-Salem, N.C.)	$136,417
18	TD Bank North, INC. (Portland, Maine)	118,171
19	Fifth Third Bankcorp (Cincinatti, Ohio)	111,396
20	Keycorp (Cleveland, Ohio)	101,596
21	Northern Trust Corp. (Chicago, Ill.)	77,480
22	Bancwest Corp. (Honolulu, Hawaii)	74,808
23	Harris Financial Corp. (Wilmington, Del.)	69,172
24	Comerica Incorporated (Dallas, Tex.)	67,167
25	M&T Bank Corp. (Buffalo, N.Y.)	66,085
26	Marshall & Ilsley Corp. (Milwaukee, Wis.)	63,432
27	BBVA USA Bancshares, Inc. (The Woodlands, Tex.)	59,953
28	Unionbancal Corporation (San Fransisco, Calif.)	57,933
29	Huntington Bancshares, Inc. (Columbus, Ohio)	55,985
30	Zions Bancorporation (Salt Lake City, Utah)	53,597
NOTE: As of May 30, 2008.
Source: Federal Reserve System, National Inform ation Center.

I have highlighted the first 9 banks with assets over $200 billion as banks I reckon the Feds would not allow to go under. Below that line, what the Feds would do is unclear. But certainly, banks with assets less than $100 billion are not going to be bailed out.

Some of these companies are subsidiaries of foreign banks, so the U.S> would not be the place to look for bailouts. These institutions include Taunus (part of Deutsche Bank), HSBC, BBVA, and TD Bank North (Part of Toronto-Dominion).

However, this list does not include investment banks like Lehman Brothers, Goldman Sachs, Morgan Stanley, and Merrill Lynch or Insurance companies like AIG, MetLife, Prudential and Berkshire Hathaway or other financial institutions like American Express and General Electric, all of which are to big to fail. Nor does it include Fannie Mae and Freddie Mac, which we have seen are definitely too big to fail.

Conclusion
So, who would I put on my list? I would at least put the 7 banks I mentioned with assets over $200 billion (not including Taunus or HSBC). I would add Freddie and Fannie, plus the major Investment Banks: Lehman Brothers, Goldman Sachs, Morgan Stanley, and Merrill Lynch. As far as other institutions go, AIG, MetLife, Prudential, Berkshire Hathaway, GE and AMEX would be on that list as well.

Obviously, most of these institutions are in no way imperiled, Berkshire Hathaway being the most obvious example. And there are lots of examples of institutions with over $200 billion in assets like The Hartford, which I have not put on the list. None of the brokerages like Schwab and T. Rowe Price are on this list. But, on the whole, this covers most of the institutions the Feds are interested in saving.

So, this is a backstop for 19 U.S. financial institutions to match the SEC’s list of 19. That’s my list.

What’s yours?

UPDATE: 1324 EDT
WaMu is not on this list because they are a savings and loan. But, they do have more than $300 billion in assets. So, for consistency sake, I’d have to add them. But I think Washington Mutual is the prime example of a financial institution which did NOT receive SEC help from short sellers, but that would need it more than the likes of Goldman.

WaMu really shows how unfair the list of 19 is. Regulation on the fly, in crisis is never pretty

Related posts:

• FDIC list of problem banks
• WaMu on the brink of disaster: has agreement with regulators
• Question: How is Fannie Mae a AAA company?
• IndyMac: Another Banking Bankruptcy
• FDIC steps in at two more failed banks

In the aftermath of the Meltdown of the GSEs and the heavy-handed regulatory solution used to stem the tide, regional banks are in focus for investors as they stand to the take the brunt of short-selling.

There were five earnings reports from regionals today. I will highlight them here. NCC has yet to report and is due to report this Thursday.

Wachovia
Wachovia is the biggest and the worst of the lot, recording a nearly $9 billion loss for the quarter. The company slashed its dividend and is going to cut 6500 workers from its payrolls. Clearly, Wachovia is in a world of hurt.

Wachovia’s goodwill impairment charge didn’t include its Golden West business “due to the value of the retail banking franchise,” the company said. The impairment included $4.5 billion in reduced value of commercial loans, plus $597 million in investment-banking assets……..

The outlook for housing worsened in the second quarter, Wachovia said. Twenty-five metropolitan areas account for 90 percent of the option ARM historical losses with 22 of those markets in either California or Florida, the bank said. The exceptions include Washington D.C., Phoenix, Arizona and Las Vegas.
-Bloomberg, 22 Jul 2008

Need I say more? Wachovia looks dreadful.

Regions Financial
The Alabama-based regional slashed its dividend too. But, at least it made a profit.

Net income fell by half to $206.4 million, or 30 cents a share, from $453.3 million, or 63 cents, a year earlier, the Birmingham-based bank said today in a statement. Excluding merger-related charges, Regions earned 39 cents a share, missing the 43-cent average estimate of 19 analysts surveyed by Bloomberg.

Regions joins at least 16 other U.S. financial firms that cut their dividends this year, exceeding the previous five years combined, as companies hang on to capital to absorb soaring loan losses. Regions said the cut in the quarterly dividend, to 10 cents a share from 38 cents, would save $780 million a year.

This is Alabama’s biggest bank. But, they have gotten themselves in real trouble by expanded out into Florida, which has been hit hard by the housing downturn.

SunTrust
SunTrust is looking a lot better than Wachovia. If you recall, SunTrust and First Union were in a tussle over a Wachovia takeover back in 2001. First Union won and proceeded to take on the risks that SunTrust has since avoided, Golden West Financial, a top-of-the-market acquisition included. Clearly, SunTrust has been battered, but it has better managed risk than the new Wachovia (which is really First Union).

SunTrust Banks Inc., the largest bank based in Georgia, said second-quarter earnings dropped 21 percent as more real estate loans went sour. The shares rose 4 percent in early New York trading after SunTrust said it won’t sell new shares or cut the dividend.Net income available to common shareholders fell to $535.3 million, or $1.53 a share, from $673.9 million, or $1.89, in the year-earlier period, the Atlanta-based company said in a statement today. Earnings excluding gains from selling stock in Coca-Cola Co. were 78 cents a share, exceeding the average analyst estimate of 66 cents.

-Bloomberg, 22 Jul 2008

Fifth Third
Relatives close to me own shares in this bank, so I have been watching them closely. They have really taken it on the chin with all the other regionals in the Midwest. Fifth Third, like Regions Financial, got into trouble by expanding into Florida, a big mistake. Things in the Midwest are bad enough without moving into unknown volatile markets. Stick to your knitting I say.

Fifth Third Bancorp, Ohio’s second- largest bank, posted its first loss in at least nine years as the lender set aside more money to cover bad debts in distressed housing markets including Florida and Michigan.The net loss was $202 million, or 37 cents a share, compared with a profit of $376 million, or 69 cents, in the same period a year earlier, the Cincinnati-based company said today in a statement. The bank had a profit of 5 cents a share excluding a tax charge related to leveraged leases. Last month the bank forecast earnings of 1 to 5 cents.

Chief Executive Officer Kevin Kabat braced Fifth Third for further losses last month by slashing the dividend 66 percent and announcing plans to raise $2 billion selling shares and subsidiaries. The bank tripled its charge-offs for loans it expects won’t be paid back, and boosted its provisions against future bad loans sixfold to $719 million.

-Bloomberg, 22 Jul 2008

KeyCorp
Key rounds out our five here. Yet another company that moved into unknown boom markets at the peak of the housing bubble. This is clearly a mistake. These regonials were chasing the hot deals and looking to make a fortune in markets they had no business entering. Now, they have egg all over their faces. Look to CRE (commercial real estate) loans in the future as the key (pun intended) to the company’s fortunes down the line. Despite the Bloomberg story about a one-time loss, Key is still heavily exposed to future losses due to its construction and CRE exposure.

KeyCorp, Ohio’s third-largest bank, reported its first unprofitable quarter since 2001 as the lender lost a tax case tied to leasing and set aside more money to cover bad loans. The shares fell 12 percent in early trading.The second-quarter net loss was $1.13 billion, or $2.70 a share, compared with a profit of $334 million, or 84 cents, a year earlier, the Cleveland-based bank said in a statement today. While the cost of the tax case was less than the bank forecast, the cost of uncollectible debt was higher than expected, said Jeff Davis, an analyst with FTN Midwest Securities.

“More important is going to be what happens to credit quality,” Davis said in an interview today. “It’s about asset quality, and where does capital stand at this point in time.”

Chief Executive Officer Henry Meyer has stopped lending to builders in places where the bank has no community banking operations after defaults in states including Florida and California that prospered during the housing boom. KeyCorp raised more than $1.7 billion in the quarter selling convertible and common stock and halved its dividend after losing the tax case.

-Bloomberg, 22 Jul 2008

Comment
Basically, the regionals have no Fed, Treasury, or SEC backstop like the golden list of 19. If any of them gets into trouble they will fail. I reckon at least one of the major regionals will fail by early 2009 and see this group of banks as particularly toxic. They all got into areas they had no expertise in and made huge losses there. This is a classic case of why tighter regulation was necessary in boom times to prevent these companies, important in their respective regions, from over-extending themselves outside their areas of expertise. SunTrust looks like the brightest bulb in the pack.

For other posts on the regionals, see the tag ‘regional banks‘.

Related posts:

• KeyCorp to raise $1.5 billion, cut dividend 50%
• Wave of regional bank write-offs?
• KeyCorp craters after dividend cut
• Quality financials are out there
• No one gets a bonus at Commerzbank and no dividend either

As financial shares take a beating, it is a good opportunity to highlight the differential treatment of accounting for loans and for debentures and securities because this bodes ill for regional banks.

FAS 157
The crux of the difference in how loans are treated for accounting purposes and how debentures/securities are treated comes from FAS 157. This was an accounting promulgation issued by the Financial Accounting Standards Board (FASB), the body that makes the rules for how U.S. companies can comply with Generally Accepted Accounting Standards (GAAP).

FAS 157 addressed the issue of fair value measurements. And it was designed to mark to market all tradeable securities, so that the balance sheets of financial firms reflected the true state of their financial position. FASB’s own words as to its rationale are as follows:

Prior to this Statement, there were different definitions of fair value and limited guidance for applying those definitions in GAAP. Moreover, that guidance was dispersed among the many accounting pronouncements that require fair value measurements. Differences in that guidance created inconsistencies that added to the complexity in applying GAAP. In developing this Statement, the Board considered the need for increased consistency and comparability in fair value measurements and for expanded disclosures about fair value measurements.

The net effect of FAS 157, which went into effect at the worst possible time in November 2007, is that it has forced most institutions with tradeable Mortgage-backed securities (MBSs) and derivatives to write down the value of their assets. If a debenture is trading at $90 when par value was $100, that $10 loss must be taken down and run through the income statement as a credit writedown.

Needless to say, financial companies are getting their clocks cleaned by having to write down massive quantities of tradeable securities to fair value. And there has, therefore, been pushback.

A Financial Accounting Standards Board member encouraged the rule-setting body to consider modifying a new standard aimed at getting financial companies to value assets at market prices in light of investor concerns that firms aren’t disclosing enough about their complex securities.

FASB member Thomas Linsmeier today urged two investor participants to convey their criticism of corporate disclosure to the accounting group’s staff at a Securities and Exchange Commission conference held in Washington.

The investor concerns relate to how the so-called fair-value rule, or FAS 157, has been implemented since it went into effect last November when the collapse of mortgage-backed bonds caused firms like Citigroup and Merrill Lynch to take massive writedowns.
-Financial Week, 9 Jul 2008

Translation: securities firms are lobbying FASB to rescind FAS 157 now. The thesis here is that marking to market leaves the securities firms vulnerable to wild swings in the market value of their tradeable assets and, therefore, makes them more volatile and more risky. There is a lot of truth to this statement. However, what is really hurting the industry is the timing of the measure — right when the housing bubble collapsed and writedowns had to be taken on a gargantuan scale. No one would be crying if they were forced to write up their securities due to gargantuan gains in asset value.

Differential treatment of loans
Here’s where additional writedowns by regional banks come into play. When it comes to Mortgage-backed securities and derivative instruments like CDOs, it is the big global financial institutions that play the leading roles. Regional financial institutions are only bit players in this pool of investments.

Smaller regional and local banks are still involved in mortgage lending and lending too for real estate construction and commercial property. However, they hold most of these loans on their balance sheet at book value. They have not re-distributed the risk of these loans in the securities markets as much as the money-center banks.

What’s noteworthy is that these loans are held at book value meaning that they are on the balance sheet as if there has been no impairment to the loans. So, you ask, how could that be when big players have been writing down hundreds of billions? The answer lies in FAS 157. This rule does NOT apply to bank loans. It only applies to freely traded securities. Translation: there are enormous hidden losses on the balance sheets of most regional and local banks from these loans.

Conclusion
The hope was that as the housing market reached bottom and turns up the regionals and local banks would be protected from the type of massive writedowns that the larger security firms have had to do. On the other hand, what if the credit crisis and housing downturn last much longer? Well, then, we have only begun to see the writedowns and many are to come from local and regional financial institutions.

Oh, and they can’t count on being to big to fail and the Fed bailing them out. Maybe that’s why they are selling off.

Related posts:

• Paulson’s Economic Patriot Act is about marking to market
• FAS 157 and the significance of distress versus bankruptcy
• Regionals options suffer due to accounting rules
• What Home-Loan Banks reveal about the effects of mark-to-market
• New Crisis Threatens Healthy Banks

Looking at today’s selling wave, a number of bank shares are down over 10% including Washington Mutual (WM), National City (NCC), Wachovia (WB), Zion (ZION). Many other shares are trading well into negative territory with share prices below $10 including KeyCorp (KEY), Fifth Third (FITB), Dearborn (DEAR), and Huntington Bancshares (HBAN). These are very large banks looking at considerable losses in equity value after a supposed backstop by the Treasury was supposed to calm the markets. Instead selling pressure has accelerated for the regionals and those heavily exposed to Alt-A mortgages like WaMu.

• Are any of these companies on the FDIC watch list?
• How will depositors act?
• What will Congress due to prevent a 1930’s style wave of bank runs?

The FDIC simply does not have enough capital to be an adequate backstop for the aforementioned companies. This is turning into the a re-run of last summer. However, this time the economy and financial institutions both are on shakier ground. We need a market-stabilizing solution fast.

Related posts:

• FDIC steps in at two more failed banks
• Does the FDIC have enough money?
• What if a large US regional bank goes to the wall?
• FDIC Friday Night: Silverton Bank is seized
• Two more FDIC Friday Night Specials: Franklin and Security Pacific

Troubled regional Financial Fifth Third is looking to sell assets along with cutting its dividend and raising capital in order to shore up its balance sheet. The company announced it was looking into asset sales when it announced its dividend cut and capital raising intentions. However, Barron’s has a piece today speculating on just which assets those could be.

Last week, Fifth Third Bancorp announced several initiatives intended to strengthen its capital position, including the potential sale of certain noncore assets.

Although probably speculation at this point, we believe Fifth Third’s processing-solutions segment, which includes Fifth Third’s merchant-acquiring franchise and the Jeanie electronic funds transfer (EFT) network, could certainly be considered an asset that is not being fully valued by the market, whose value could be monetized through either a sale or some kind of equity offering.
-Barron’s, 25 Jun 2008

Expect to hear more specifics in the future about Fifth Third’s plans.

Related articles
More Bank Bailouts Ahead?, WSJ, 23 Jun 2008

Related posts:

• KeyCorp to raise $1.5 billion, cut dividend 50%
• Fifth Third to raise $2 billion
• Bank of America cuts its dividend
• Lloyds has a decent first half
• HBOS to raise new capital

This from the Financial Post.

The note from Blackmont analyst Brad Smith followed news late on Friday that Moody’s Investors Service had downgraded XL Capital Assurance. CIBC has exposure to XL Capital since the bond insurer provides it with guarantees on some investments.

“Based on this downgrade and XLCA’s credit default swap spreads … we expect CIBC will write off its remaining fair value exposure to XLCA in its Q3/08 results,” Mr. Smith wrote in the note.

According to Moody’s, the downgrade reflected XL Capital’s impaired financial flexibility and its proximity to minimum regulatory capital requirements.

CIBC took a big loss in the second quarter, after taking additional charges of $2.5-billion for U.S. structured credit securities and other positions hurt by the credit crunch.

-Financial Post, 23 Jun 2008

To date, writedowns by Canadian banks have been rather limited. As a result, the likes of Royal Bank of Canada have been posited as suitors of struggling U.S. regional banks. However a blog entry from Calculated Risk makes me question this possibility:

… regional banks which may find it difficult to find suitors since accounting rules require that a takeover target’s portfolio is marked to market at the time of acquisition …

And that might just leave FDIC receivership as the only option for many banks. From the WSJ:

There is often only one option left for a capital-starved U.S. bank that can’t attract a suitor — receivership under the auspices of the Federal Deposit Insurance Corp. While hardly ideal, that works fine as long as only a few banks stumble. But if the pressures of the credit crunch cause too many to fail, the FDIC could be overwhelmed. … No wonder FDIC Chairwoman Sheila Bair has said bank problems are giving her heartburn.

-Calculated Risk, 23 Jun 2008

It will be quite interesting to see how the regionals fare as real economy effects in credit cards, commercial real estate and auto loans take hold. For now, the CIBC’s and RBC’s of the world may be a bit gun shy.

Related Posts
Royal Bank of Canada: time for takeover talks
New Crisis Threatens Healthy Banks

See: Credit Crisis Timeline for a full list of writedowns and capital raising by institution and a timeline of the credit crunch.

Related posts:

• More warnings on regional banks
• KeyCorp to raise $1.5 billion, cut dividend 50%
• Another massive write-down: Deutsche Bank
• What if a large US regional bank goes to the wall?
• Global Bank write-offs and failures

The Washington Post has a story on regional and healthy banks that I highly recommend. Essentially, we are past the first wave of writedowns and are moving into phase two where it won’t be about derivatives and RMBS’s as much as underlying loan losses and collateral damage in commercial property and construction loans. In the U.S., this puts the regionals front and center

The one and only reason I would support bailouts or nationalization of mortgage debt is because of systemic risk. I am very dubious on the bailout plans presented to date.

Ultimately, when good companies go down with the bad, as happens in a recession, it is a shame. But, there comes a point when systemic risk threatens to paralyze an economy. It is still early days. Nevertheless, we should keep this in mind as the credit crisis unfolds.

Increasing struggles by consumers and businesses to make payments on a variety of loans, not just mortgages, are setting off a new wave of trouble in the financial sector that is battering even institutions that had steered clear of the subprime-home-loan debacle.

Late payments on home-equity loans are at a record high, according to fresh data from the Federal Deposit Insurance Corp. The delinquency rates on loans for cars, small businesses and construction are spiking to levels not seen in a decade or more.

Unlike last year, when soaring mortgage defaults sparked a crisis of confidence in the financial system, the root of these problems is the downturn in the broader economy. Simply put, consumers and businesses are strapped for cash with job losses growing and retail sales falling, economists said.

“We are not finished with the mortgage problem, but you are starting to see increased delinquencies in other forms of consumer debt,” said Paul Kasriel, an economist at Northern Trust Securities. “We are in the eye of the hurricane. We had the first wave of the credit crisis, and it was quite damaging. But there’s another wave coming, and it’s likely to be as destructive.”

The institutions most at risk in this new phase of the credit crisis are regional and local banks, many of which stayed away from subprime mortgages. These firms are key drivers of economic activity in communities across the country. Without them, consumers would lose a source of personal loans. Small businesses would struggle to stay afloat. Construction companies often can’t finance local projects without these banks.

Because they have fewer options than big Wall Street firms for raising emergency funds, these regional and local banks tend to be more vulnerable in a crisis.

In the Washington area, the stock prices of several local banks have already plummeted, with shares of Virginia Commerce Bank falling nearly 50 percent and Alliance Bank dropping about 45 percent since the beginning of the year.

-Washington Post, 22 Jun 2008

See: Credit Crisis Timeline for a full list of writedowns and capital raising by institution and a timeline of the credit crunch.

Related posts:

• More warnings on regional banks
• Wave of regional bank write-offs?
• The regionals versus money center banks
• Regionals are exposed to credit crisis
• $35 billion in missing writedowns

and cut dividend.

Regionals across the country are now suffering. The second leg down for financials has truly begun. I warned on Fifth Third this past Thursday in What’s happening at Fifth Third?

See new story here.

Update:
9:19 EDT
Fifth Third to raise $2 billion in capital, replaces chairman, MarketWatch, 18 Jun 2008
Fifth Third Cuts Dividend, Looks to Raise New Cash, WSJ, 18 Jun 2008
Fifth Third to raise $1-billion, Globe & Mail, 18 Jun 2008
Fifth Third to Raise $2 Billion on Share, Asset Sales, Bloomberg News, 18 Jun 2008

See also: Credit Crisis Timeline for a full list of writedowns and capital raising by institution and a timeline of the credit crunch and Capital Raising for a total amount of all capital raising done.

Related posts:

• KeyCorp to raise $1.5 billion, cut dividend 50%
• HBOS to raise new capital
• RBS takes an enormous hit
• KeyCorp craters after dividend cut
• $35 billion in missing writedowns

From Bloomberg News:

Regional Banks Tumble

Zions, the lender with operations in 10 Western U.S. states, tumbled 10 percent to $33.44 for the steepest decline in the S&P 500. “Weakness” in residential construction and land values in the Southwest will harm loans and is “expected to persist into 2009,” the lender said in a presentation attached to a regulatory filing today.

This dragged other regionals down. As of 1:00PM EDT, regionals looked like this:

Related posts:

• Revisiting regional banks
• Regional banks: examples of risk from SoCal
• Michael Panzner: regional banks in trouble
• Regional banks are suffering
• Financial shares now diving