Wanted to take a chance to highlight Goldman's thoughts on the "Bad Bank":
Industry context
The prospect of a government sponsored aggregator bank has sparked a major rally in bank stocks. Three questions need answers before we can assess the impact on equity holders:
1) At what price will assets be acquired? Market derived prices would destroy bank capital while buying assets at par puts losses to taxpayers. The distribution of losses between banks and taxpayers is critical in assessing the impact for common shareholders.
2) Who/what assets are eligible? Politically, it seems difficult to allow banks to sell assets to the government at a gain. Thus, brokers who mark to market would probably only benefit indirectly to the extent that fixed income markets rally. Asset purchases are likely to focus on whole loans given that restarting the flow of credit is key.
3) What strings are attached? TARP preferreds seemed attractive initially, but the perception changed as TARP was linked to new lending. Further linkage of federal assistance with policy measures (i.e., cramdowns) will be important.
Stock implications
Goldman's base case: banks do not bottom until non-performing asset growth decelerates. They view government intervention rallies as short term. That said, short term rallies can turn into real pain – i.e. last summer, banks rallied for two months.
As a result, they would recommend the following trades for those looking to
1) be less underweight, or 2) be hedged on a Cautious view:
1) JPM vs. USB: For large banks they would buy JPM or pair JPM vs USB. JPM has tangible common plus reserves of 5.0% which provide loss protection with or without a government bad bank, while valuation at 1.2X tangible book still preserves upside as the cycle turns. Conversely, USB trades at 3.2X tangible book and is actually slightly thinner on capital than JPM.
2) KEY vs. BBT: For regional banks they would buy KEY vs. BBT as KEY has tangible common plus reserves of 7.7% vs. 5.8% for BBT, while KEY trades at 0.6X tangible book vs. 1.5X for BBT. While BBT has more earnings power, credit issues are still ahead given a big construction book.
Notablecalls: FYI - While I agree with Goldman in part, I continue to stand by my thesis that the "Bad Bank" has put a stop to the slide. That's good enough for the time being.
There is not going to be any V-shaped recovery for the financials (or the whole global economy for that matter) but things are getting better. Blood will flow on the main street in 2009 but that's something we all have to deal with psychologically.
Industry context
The prospect of a government sponsored aggregator bank has sparked a major rally in bank stocks. Three questions need answers before we can assess the impact on equity holders:
1) At what price will assets be acquired? Market derived prices would destroy bank capital while buying assets at par puts losses to taxpayers. The distribution of losses between banks and taxpayers is critical in assessing the impact for common shareholders.
2) Who/what assets are eligible? Politically, it seems difficult to allow banks to sell assets to the government at a gain. Thus, brokers who mark to market would probably only benefit indirectly to the extent that fixed income markets rally. Asset purchases are likely to focus on whole loans given that restarting the flow of credit is key.
3) What strings are attached? TARP preferreds seemed attractive initially, but the perception changed as TARP was linked to new lending. Further linkage of federal assistance with policy measures (i.e., cramdowns) will be important.
Stock implications
Goldman's base case: banks do not bottom until non-performing asset growth decelerates. They view government intervention rallies as short term. That said, short term rallies can turn into real pain – i.e. last summer, banks rallied for two months.
As a result, they would recommend the following trades for those looking to
1) be less underweight, or 2) be hedged on a Cautious view:
1) JPM vs. USB: For large banks they would buy JPM or pair JPM vs USB. JPM has tangible common plus reserves of 5.0% which provide loss protection with or without a government bad bank, while valuation at 1.2X tangible book still preserves upside as the cycle turns. Conversely, USB trades at 3.2X tangible book and is actually slightly thinner on capital than JPM.
2) KEY vs. BBT: For regional banks they would buy KEY vs. BBT as KEY has tangible common plus reserves of 7.7% vs. 5.8% for BBT, while KEY trades at 0.6X tangible book vs. 1.5X for BBT. While BBT has more earnings power, credit issues are still ahead given a big construction book.
Notablecalls: FYI - While I agree with Goldman in part, I continue to stand by my thesis that the "Bad Bank" has put a stop to the slide. That's good enough for the time being.
There is not going to be any V-shaped recovery for the financials (or the whole global economy for that matter) but things are getting better. Blood will flow on the main street in 2009 but that's something we all have to deal with psychologically.
1 comment:
The bad bank should only be allowed to purchase whole loans, not securitized tranches. The "genius" in the securitization process is that the Wall Street wizards converted a block of assets now worth 80 cents on the dollar into tranches, 80% worth full value and 20% worthless. Principal is lost in foreclosure and short sales and it can never be recovered, the needle moves only one way on the tranches. Pretty soon, all that will be left from the securitizations will be the garbage. Historically, half the mortgages are paid off through home sale or refinance after about nine years, that's half of the securization paid in full. The senior holders get what cash comes from the foreclosures. You will have 2/3 of the homes sold but providing only 50% return of principal.
If the government ends up buying tranches, you can guess which ones will be sold, we can kiss our money goodbye.
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