Saturday, October 11, 2008

Mass and personal hysteria are rampant

All of my remaining stock positions have been killed over the past several weeks. They’ve fallen faster and more severely than I would have imageined. Gold, inverse 10 year treasuries, and inverse nasdaq were not able to compensate for the swoon in equities. National City is the position that concerns me the most because it contains the most risk and has developed into a large position. So I’m going to talk to myself and see if I can continue to convince myself that I’ve made a smart investment.

I remain convinced that NCC has adequate capital and liquidity at the holding company. The major risk is a bank run and so far, so good. The bank has lots of crappy loans, but the capital, reserves, and earnings to work through those---if there isn’t a large deposit run.

The financial press was active Thursday and Friday talking about NCC selling themselves to PNC, BNS, or someone else. Nothing could be confirmed. If there is a deal, will it be a market oriented transaction or a FDIC forced marriage? Obviously I’m praying for the former.

NCC now seels for $2. It has a $9.50 book value per share and another .50 per share in Visa; so let’s figure on a BV of $10 per share. they have another $2 per share in their loan loss reserve. That’s $12 per share to handle bad debts. They have a $20B liquidating portfolio [ NCC’s definition for lines of business they are no longer active in ]. The entire portfolio is not poor credit although that is where the bulk of their credit risk resides. On a per share basis, they have $10 per share segregated here. They are not going to lose the entire amount of each loan. If they were to lose 1/2, and that would be 4 times what the bank thinks they will lose, that is $5 per share. That still leaves $7 per share of value, or $14 billion of capital to face the recession and any weakening of the remainder of their loans. Unless a sale is a FDIC forced shotgun wedding, the price is going to be closer to $7 than $2.

Beyond the back of the envelope math above, there are several other influences at work that encourage a deal. they are:
1.The new TARP bailout bill now allows acquiring banks to use write-downs of an acquired bank’s portfolio to eliminate taxes on the combined operation rather than just adjusting the balance sheet under “purchase accounting.” Just like Wells Fargo was able to make Wachovia work without FDIC assistance, someone can see the logic in acquiring NCC as long as the acquirer maintains a good, profitable business.
2. The Treasury is exploring its new authority to make direct investments in banks. These investments, most likely prefered stock, will give banks the strength to survive, rebuild earnings, and eventually redeem the government’s preferred securities. This option is a new one that could be attractive to NCC should it determine that it needs more help. Acquirers know that the possibility exists for Treasury money so they need to hurry and bid correctly if they want to expand their footprint.
3 Believe it or not, there are still some banks that sell at prices greater than book value. PNC and BNS are two of those. there are others. These guys could do aall stock deal, at an attractive price to NCC, and since they were paying with paper do well for their shareholders, especially with the new tax rules. If an all stock deal happened, i wouldn’t hold the stock for long. Today I’m not sure I would hold on until I hit the capital gains 12 month threshold.

I still nervously prefer for NCC to ride it out, but would thankfully accept a decently priced buyout. The past several weeks have been scary and taking a gain would be soothing in these stressful times.But I sure don’t want them to give the bank away and I don’t think they will. The Corsair group didn’t put $7 billion, at $5 per share, in for grins. They too were looking to make multiples of their investment, not a paltry return. But in these times even Corsair could be convinced that a $7+ deal makes their $5 April investment look acceptable. Plus, as part of a larger, stronger bank their stock position can still grow dramatically as the economy improves.

I’m guessing a deal happens and am hopeful that my analysis is correct on pricing. I can make a case for quite a bit more in the deal price, but I am also aware of the risks involve and the times we live in. I’d take $7 and run like I stole something.

Happy Columbus Day.

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