Not As Short As This Fellow, But Owe A Few Shares

What do the following all have in common? The nation's largest boat builder awash in debt, a legacy airline hugely awash in debt and union issues, an tiny oil company with a huge market capitalization, a well regarded bank with a huge subprime portfolio, a fancy fitness club operating in a terrible industry, and a broad market index. They represent most of my short positions. They've provided a good hedge against my longer term holdings and have kept me from finding a high ledge.

Mid June is nearing and, as I mentioned in an earlier post, expect the media to feast on a California budget crisis as we near mid month. Comparisons to Greece will be rampant and requests for more Federal help will fill the front pages and cable shows. California will once again bring our over borrowing to the forefront. Sounds scary, so I would guess the markets won't like it even though they should already know its existence. I'd be surprised if my shorts didn't make me happy and my long positions cause me anguish. But I'll try to remember that I own stocks for a purpose and a long horizon. In the meantime I will borrow some more shares. Especially Brunswick as the California problems and Florida oilslick are not going to be conducive to sales of new boats.

Time to go tally today's damage and see if mama can buy new shoes.

More Bank Dilution Looms

Investors in financial shares have fared well this year as almost all are significantly higher than their March lows. Those that bought shares near the lows have obviously fared better than the original owners. But the time has come to be wary. Dilution looms, again, on the horizon.

Banks have had ready access to capital this year as they attempt to work through their myriad mistakes. First, the Government provided needed support, then hungry investors started lining up to buy financial secondary offerings. The result was the same: loans were written off, capital depleted, new capital acquired, and original investors diluted. Painful only for the original owners.

While mortgage and credit card loan delinquencies are still at record levels, commercial real estate lending was poorly underwritten and is now showing serious weakness, another capital consuming issue is raising its head. On January 1, 2010, FAS167 will take effect unless delayed. The effect will be that banks must set aside additional capital to support off balance sheet credit card receivables and other securitizations. Whether or not the assets are brought back on the balance sheet or not, more capital must be found to support the potential risk of implied recourse. The big credit card issurers, JPM,C,WFC,BAC,COF, to varing degrees, will be affected. Since current capital isn't plentiful, they will sell more shares and dilute the current base.

Several days ago, First National Nebraska, a moderate sized regional bank with a large credit card operation, filed to sell $250 million of new common and preferred securities. The major reason given for the decision was the need to support off balance sheet credit card securitizations. The decision to sell new shares was a difficult one for First National as it is owned, almost exclusively, by one family. They felt the need, and pressure, to dilute themselves to comply with FAS167. What do you think the professional, non-owner, managers will do? Yes, sell new shares to whom ever will buy them, Government or public.

Setting aside concerns about the remaining potential loan losses and adequacy of loan loss reserves, capital raising is coming again to the banks courtesy of the accountants and transparency. Bank shares will be worth less in 2010.

Credit Isn't The Only Thing Hurting Banks

I possess 20 years of commercial banking experience, 10 of those as CEO. Even though the industry has changed dramatically in the nearly 20 years I have been out of banking, I feel that I should be able to spot trends, analyze financial statements, and differentiate a good bank from a poor performer. This past year has shown that I can't.

Short positions on numerous financials made me a decent amount of money, but it could have been a fortune had I not always removed my position after a nice gain since they continued to trend downward. All the money I made on shorts, and then some, was lost on a bank turnaround that I was convinced I had figured out, National City. It's a long story, but suffice to say that I had twenty pounds of analysis that turned out to be faulty. 

Being a slow learner, I still follow the banks and look at opportunities. The sharp run up that the banks have experienced isn't sustainable. The yield curve is very lucrative at present and mortgage refinancing fees are plentiful. But in a de-leveraging economy good lending opportunities will be much scarcer than at peak earnings. Lower future earnings leads to lower P/Es and stock prices. Not to be forgotten are the huge loan losses that loom and the eventual dilution that will follow capital raising.

On top of the credit problems that bankers are dealing with, their buddies at the FDIC are adding to the banks misery. Since regulators have done such a poor job of controlling bank lending quality, on and off balance sheet, the FDIC Insurance Fund is in need of replenishment. Besides raising the deposit insurance fee, FDIC has levied a special assessment of 20 basis points. That is huge! At cocktails the other evening the president of a local 200MM bank told me his assessment was going to be $400,000! That is an immediate hit to earnings, or if the bank doesn't have earnings, book value.

Our banks will be earnings constrained for some time.

After all the stress test publicity abates and banks possibly enjoy an upward run, the trend is likely to be down. Since I have proven to myself that i know nothing about the industry anymore, I intend to short selected regional banks and stay with those positions. But for heavens sake, don't follow any of my advise when it comes to banks.