Monthly Archive for October, 2009

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The Land Standard

Posted on October 12, 2009, 9:00 pm. 0 Comments

There were other reasons for high Japanese land prices. Punitive capital gains taxes—designed by the bureaucrats to encourage “long-termism”—taxed short-term property gains at 150 percent of profits. By discouraging the sale of land and creating an illiquid property market, the fiscal system actually stimulated land speculation.…

Between 1956 and 1986, land prices increased 5,000 percent, while consumer prices merely doubled. During this period, in only one year (1974) did land prices decline. Acting on the belief that land prices would never fall again, Japanese banks provided loans against the collateral of land rather than cash flows. Towards the end of the 1980s, they increased lending against property, especially to smaller companies. The rising value of land became the engine for the creation of credit in the whole economy. Tochi-hon’i sei, the land standard, had arrived.

Quote taken from page 293 of Devil Take the Hindmost: A History of Financial Speculation by Edward Chancellor, published 1999.

I’m sure readers of this blog will recognize the parallels between Japan’s experience and America’s own recent experiences. Rising land prices, government intervention helping create a future problem, and serious lapses in loan standards. This has all happened before and we have all suffered for it, so why did we think it would be different this time?

I continue to think that the financial industry (and the world) would be better served by more students of history rather than more students of math, business, or economics.

Republic Bank: From Fourth to First in Kentucky

Posted on October 11, 2009, 9:26 am. 1 Comment

Republic Bank (RBCAA) is one bank that has interested me a good deal, mostly because of its amazing growth story and its ability to remain very profitable in a tough environment due to its good credit culture. Republic is based in Louisville, Kentucky and has went from fourth largest to the largest Kentucky-based bank over the past decade. The bank has $3.1 billion in assets and has three operating divisions: traditional banking, mortgage banking, and Tax Refund Solutions. Republic says it is the 4th largest processor nationwide of electronic tax refund products, which I think is definitely a niche for Republic.

Republic has some outstanding metrics: ROA 1.04% and ROE 12.58%, which are both extremely high for any bank at the moment. Republic has been recognized as the 10th best performing bank in the country by Bank Director Magazine, rated 15th best performing bank in the country by ABA Banking Journal, and 32nd best performing bank in the country by US Banker Magazine. Also, insiders own 55% of the company.

The following are the notes I took during my reading of Republic’s annual reports.

2000 Annual Report

In previous two years repurchased 440,000 shares. Announced purchase of 1 million shares of company stock through Dutch auction tender offer.

Credit culture: “We remain committed to our time-tested lending standards in the face of competition that can be quick to sacrifice credit quality in return for growth.”

Investing in efficiency can lead to profits and better relationships:

“Another initiative for 2000 was to increase the Company’s efficiency while maintaining a high level of personal client service. We achieved this in our lending function through our centralized loan operations. This area provides consistent, uniform underwriting, processing and servicing of our loans, while maintaining personal client service at our retail banking centers by leaving authority to approve loans with our experienced lending staff.”

On commercial lending: management focuses on quality loan underwriting.

Tax Refunds: For the year ended December 31, 2000, Refunds Now generated over $2.1 million in pre-tax earnings for the Company.

2001 Annual Report

No real mention of underwriting or credit culture. 2001 seems to have been a year of great expansion.

2002 Annual Report

Again, no mention of credit culture or underwriting in letter to shareholders. Another record year.

Refunds Now generated $6.5 million in revenue.

2003 Annual Report

Republic continues to expand: executives with hardhats and shovels in front of a unbuilt bank branch. Republic has become the 2nd-largest independent bank holding company in Kentucky, up from 4th-largest.

“Our goals remain lofty for 2004 despite a projected downturn in secondary market lending and its contributions to the Company’s bottom line. Our traditional banking strategies in 2004 will be simple and time-tested. In commercial banking, the focus will be to grow the balance sheet through the commercial lending and commercial cash management areas without sacrificing the credit quality we hold so dear.”

2004 Annual Report

Some shareholder friendly quotes in the letter:

“Throughout our history, asset quality has remained a primary focus of senior management. We believe there is no greater measure to the long-term success of a financial institution than asset quality.”

“Our focus on controlling non interest expenses was very successful in 2004. Non interest expenses increased only 5% for the year despite twelve full months of overhead associated with our newest banking centers. Cost containment will remain a focus in 2005; however, the Company remains steadfast in its resolve to avoid sacrificing long-term shareholder value in order to benefit from short-term economic gain.”

Cognizant of risk:

“Our non traditional business lines – Tax Refund Solutions and Deferred Deposits – continued their solid performance in 2004. These products have enabled us to profitably expand our customer base by fulfilling consumer demand for convenient and timely short term funding. We remain dedicated to providing customers with the products they desire at pricing that is appropriate for the risk involved and service required.”

2005 Annual Report

“The Company’s historically exceptional asset quality continued throughout 2005. In our opinion, no other factor determines the long-term success of a financial institution more than its asset quality, and at Republic outstanding asset quality is a way of life.”

Republic exited the payday loan business.

Says deposit-gathering remains a challenge: “We believe our deposit gathering function must grow in order for us to continue the success we experienced in the past.”

2006 Annual Report

$3 billion in assets and became the largest Kentucky-based bank holding company. Acquired a Florida bank and also created a “Private Banking” division. I like the fact that Republic has more stringent requirements for the loans its Florida bank makes as compared to the loans the Kentucky banks make.

Credit quality:

“It is important to note that we were able to achieve solid loan growth during 2006 while maintaining our strict underwriting standards. Entering 2007, we remain committed to maintaining exceptional credit quality standards and to never sacrifice these standards for the benefit of the short-term gain associated with higher loan volume.”

2007 Annual Report

The credit culture seems to be conservative and strong:

“We are pleased to report that our overall asset quality remains solid, with nonperforming assets less than 1/2 of 1 percent. While many institutions lowered their underwriting standards during the last few years due to pressure to produce higher volumes, Republic chose to maintain its traditional high credit quality standards. We have steered clear of the unsustainable returns of sub prime mortgage loans and this strategy has positioned us for continued success for years to come. As loan losses continue to grow at many banks across the country, our asset quality further underscores our value as a safe and sound, long-term investment option for our shareholders.”

3-year partnership with Jackson Hewitt announced for tax refund solutions.

2008 Annual Report

2008 seems to have been an amazing year for Republic mostly because the financial crisis basically highlighted Republic’s strengths: its credit culture, focus on prudent underwriting and credit quality.

“We attribute much of our success to the strength of our core operations and our business model, which is built on a cornerstone of prudent underwriting standards. For over 25 years, the foundation of our success has been built on a strategy of not only maintaining exceptional credit quality but a business strategy of never sacrificing long-term shareholder value at the expense of short-term gains.”

Continued to express interest in reducing and moderating overhead costs especially in light of the increased costs associated with opening new banking centers.

The New Yorker Profiles Martin Armstrong, the Man Behind the Pi Cycle

Posted on October 10, 2009, 12:18 pm. 0 Comments

The ContraHour blog points out that the New Yorker has a recent article profiling Martin Armstrong. It’s a very interesting article that informs the reader of Armstrong’s background, his beliefs regarding cycles, and how he got himself thrown in jail. The article also does a good job in discussing some of the behavioral biases of humans and whether or not the cycles we see are truly there or whether the human brain is just doing its job and desperately trying to identify patterns where none exist.

Armstrong began to observe that many things worked like this—that occasionally a contagion, of indeterminate origin, passed through the system, hitting one asset class after another. One summer, his father took him to Europe, and the web of foreign currencies gave him a tactile sense of interconnectivity and the oscillations that might come of it. The following year, Armstrong’s high-school history teacher showed his class the 1937 film “The Toast of New York,” about the Black Friday panic of 1869 and the gold speculator and con man Jim Fisk, with a young Cary Grant as Fisk’s accomplice. At one point in the film, Fisk quotes gold at a hundred and sixty-two dollars and fifty cents an ounce. Armstrong, aware that the price, in 1966, was just thirty-five dollars, assumed that the line was Hollywood nonsense. Prices could not possibly have fallen so far over the span of a century. He went to the library, however, and found, on microfilm, a contemporaneous reference in the Times to a gold price of a hundred and sixty-two dollars. It further demolished his youthful assumption that assets gradually appreciated over time—that markets were linear.

One day, in a newspaper, he came across a list of financial panics that occurred between 1683 and 1907. On a lark, he divided the span (two hundred and twenty-four years) by the number of panics (twenty-six) and found that, on average, there had been a panic every 8.6 years. As he read more, he began to suspect that 8.6 was a highly significant number. He discerned a recurrence of major turning points in the economy and in world afairs that followed a distinct and unwavering 8.6-year rhythm. Six cycles of 8.6 years added up to a long-wave cycle of 51.6 years, which separated such phenomena as Black Friday and the commodity panic of 1920, and the Second and Third Punic Wars.

asset class after another. One summer, his father took him to Europe, and the web of foreign currencies gave him a tactile sense of interconnectivity and the oscilla-tions that might come of it. The follow-ing year, Armstrong’s high-school history teacher showed his class the 1937 ?lm “The Toast of New York,” about the Black Friday panic of 1869 and the gold speculator and con man Jim Fisk, with a young Cary Grant as Fisk’s accomplice. At one point in the ?lm, Fisk quotes gold at a hundred and sixty-two dollars and ?fty cents an ounce. Armstrong, aware that the price, in 1966, was just thirty-?ve dollars, assumed that the line was Holly-wood nonsense. Prices could not possibly have fallen so far over the span of a cen-tury. He went to the library, however, and found, on micro?lm, a contemporaneous reference in the
Times
to a gold price of a hundred and sixty-two dollars. It further demolished his youthful assumption that assets gradually appreciated over time—that markets were linear. One day, in a newspaper, he came across a list of ?nancial panics that oc-curred between 1683 and 1907. On a lark, he divided the span (two hundred and twenty-four years) by the number of pan-ics (twenty-six) and found that, on aver-age, there had been a panic every 8.6 years. As he read more, he began to sus-pect that 8.6 was a highly signi?cant number. He discerned a recurrence of major turning points in the economy and in world a?airs that followed a distinct and unwavering 8.6-year rhythm. Six cy-cles of 8.6 years added up to a long-wave cycle of 51.6 years, which separated such phenomena as Black Friday and the com-modity panic of 1920, and the Second and Third Punic Wars.

Read the whole article. I thoroughly enjoyed it.

Contango’s Prospects: Dude, His Dudeness, El Duderino

Posted on October 9, 2009, 9:30 pm. 0 Comments

Contango Oil & Gas recently won its bid on its third prospect, “His Dudeness.” Additionally, I highly recommend checking out Contango’s recent presentation, entitled “The Big Lebowski and Zen of E & P.” Contango has a great set of core beliefs and is likely the most value-minded and shareholder-friendly drilling and exploration company in America.

Number of Banks Not Making TARP Payments Increases

Posted on October 3, 2009, 10:16 pm. 0 Comments

Via The Business Insider:

The number of banks that didn’t make their monthly dividend payments on TARP funds skyrocketed to 29 in August, up from 18 in May. Banks can choose not to make payments during a given month, allowing the dividends owed to accumulate unpaid.

Failure to pay may be a sign of financial distress. Obviously banks that are short of capital may decide to retain funds rather than pay off the TARP.

Here’s the complete list of banks that didn’t pay in August:

AIG

Anchor Bancorp Wisconsin

Central Pacific Financial Corp

Centrue Financial Corp

Citizens Bancorp

Citizens Bank & Trust Co

Commerce National Bank

Commonwealth Business Bank

Dickinson Financial Corp

First American International

First Banks

Georgia Primary Bank

Grand Mountain Bancshares

Idaho Bancorp

Lone Star Bank

Midwest Banc Holdings

One Georgia Bank

One United Bank

Pacific Capital Bancorp

Pacific City Financial Corp

Pacific International Bancorp

Patterson Bancshares Inc.

Peninsula Bank Holdings Co.

Premier Service Bank

Royal Bancshares Corporation of Pennsylvania

Seacoast Banking Corporation of Florida

Sterling Financial Corporation

UCBH Holdings Inc.

United American Bank

An 11-Year Old Perspective on AIG

Posted on October 3, 2009, 8:44 pm. 0 Comments

With the ominous title “A Darkness on the Edge of Town,” David Schiff wrote in October 1998 about the singular popularity AIG had maintained among Wall Street and how AIG enjoyed an unjustifiably high multiple for an insurance company. Keep in mind that the insurance industry is supposed to be cyclical, is basically a commodity business, and has low barriers of entry.

Though there is no hint in the article that Schiff that AIG would fail in spectacular fashion, what I found interesting is that a full decade before AIG’s spectacular collapse, there was at least one person questioning AIG’s ability to command outlandish multiples and also questioning Wall Street’s belief that AIG’s consistent earnings would never disappoint. Below is just a snippet of the article:

Although Warren Buffett has said that he prefers a lumpy 20% return to a smooth 15%, many investors apparently prefer just the opposite: they prize consistency and predictability (or what they perceive as such), and are willing to pay more for it. Because AIG is a fine company with a powerful global presence, and because its earnings have compounded at a 14% rate over the past decade, investors believe it’s a perpetual money-compounding machine. They have bought the theory that AIG is a “growth” company (rather than a cyclical insurance or financial company) and as such deserves a significantly higher multiple than would otherwise be accorded. Although AIG’s stock has retreated from a recent high of 102 5/16, it’s still trading at 24 times earnings and more than three times book value….

Investors justify these multiples on the grounds that AIG is “safe”: its earnings won’t disappoint stockholders. In buying AIG, money managers are, in effect, paraphrasing an old expression once popular among purchasers of data-processing equipment: “Nobody ever lost his job buying AIG.”

Despite AIG’s achievements, two questions are worth asking: 1) What will happen to the company when Greenberg, who is 72, is no longer there? 2) How has AIG generated such consistent earnings growth, and what is the likelihood that this consistent growth will continue?

Obviously, no one knows the answer to the first question. It turns out that no one quite knows the answer to the second question, either. Some who follow AIG have told us that they can’t really analyze it. Others have said that they don’t even spend much time trying to do so-that, to a larger extent than they would for other companies, they take AIG’s numbers on faith.

Yes, a full decade before AIG’s collapse, analysts following AIG could not analyze AIG. They simply took AIG’s numbers on faith. This worked out for a while, but when it became clear that AIG’s own managers could not understand their own company in 2008, that should have been the clear signal to exit from the stock and issue that rare “Sell” recommendation.

An Illustrated History of U.S. Banks Net Interest Margins

Posted on October 2, 2009, 7:47 pm. 2 Comments

Below is a chart I created showing the net interest margin of U.S. banks (click for larger image):

NIM-2009

As you can see, the blue line is the net interest margin for all U.S. banks. Glancing at the data, you can see the net interest margins peak sometime in 1993 and from that point on, net interest margins have been in decline. Gee, I wonder if that has anything to do with total consumer credit beginning its 15-year long march upwards? (See my previous posts on consumer credit: What Portion of Past Economic Growth Was Debt-Fueled? and Predictably, Consumer Spending Declines).

Bank net interest margin peaking in 1993 I feel is more evidence that late 1992 and early 1993 was a real economic turning point for this country. People started to borrow and spend without abandon based on rising productivity, increased incomes, increasing asset prices, increasing home and land values, etc. I can only surmise this meant there was a lot more money out there in the economy, competition between banks for that money was fierce, and therefore net interest margins for the banks began to decline.

Another thing I find interesting is that the “small” banks with average assets under $1B seem to always have had a much better net interest margin than the “large” banks with average assets greater than $15B. The graph below shows the difference between the small and large bank net interest margins (click for larger image):

NIM-spread-2009

Since 1984, the average net interest margin spread between small and large banks has been 112 basis points. Another interesting thing is that the spread seems to fall a good deal during and after a recession, but once the economy gets going again, the spread then widens again. Perhaps this is because the large banks have usually been the ones to benefit most from government attention and from their closer relationships with the Fed and Treasury? Being too big to fail probably has its competitive advantages in moments of economic instability or crisis…

Update to Nintendo Owner Earnings

Posted on October 2, 2009, 9:10 am. 0 Comments

A reader of the blog contacted me regarding my previous post on Nintendo. What he had to say was helpful and most importantly he pointed out my likely double-accounting error:

As I recall, what I wanted to say about Nintendo is that I think you may be making a double-counting error in calculating your owner earnings estimate 2. Generally, cash from operations (CFO) consists of net income + depreciation expense and other addbacks for working capital adjustments. Since no business can survive without maintenance cap-ex, which depreciation expense relates to, it does not really make sense to subtract depreciation if one wants to know what owner earnings are. It is therefore an OK method to take CFO – depreciation to calculate owner earnings. Another method might be to take CFO minus capital expenditures on property, plant, and equipment, which will be found under the cash from financing activities line, below CFO. This does not separate cap-ex into maintenance and non-maintenance, however, but it may be rougly right.

However, in your second owner earnings calculation you subtract R&D and advertising from CFO. This may be double counting because, presumably, Nintendo’s net income already is net of R&D and advertising expense, and since net income is an input into CFO and since CFO does not add back R&D or advertising, you have already considered them in your CFO figure.

The possibly exceptions to this are if either R&D or advertising are capitalized / amortized over a period of time. Some companies do this for advertising, typically if their customers sign long-term contracts or buy multi-year subscriptions. I don’t think Nintendo would do this. If R&D and advertising expenses are already fully reflected in net income and CFO, then you needn’t subtract them a second time to get owner earnings. That means your first owner earnings figure is likely the correct one, and that Nintendo at a current market cap of $35.78B and 2009 owner earnings of Y440B or $4.89B is trading at < 8x earnings. Not bad.

Indeed. The possibility of purchasing Nintendo at less than 8 times earnings sounds pretty good to me. As always, do your own due diligence when making an investing decision and do not rely upon the work of others as they may have committed errors (like I did) or what they may have said is just false and misleading.

Canada’s Largest Ponzi Scheme

Posted on October 1, 2009, 9:34 am. 0 Comments

When the money dries up and the tides go out, you begin to see who was swimming in the nude and who was not. Canadian authorities in the past several weeks have arrested the two individuals responsible for the largest Ponzi scheme in their country’s history.

Back on September 14 was news of the first arrest:

Two Alberta men face charges for allegedly diverting more than C$100 million ($92 million) from Canadian and international investors in a Ponzi scheme.

Milowe Allen Brost, 55, of Chestermere, Alberta, and Gary Allen Sorenson, 66, of Calgary, were charged today with fraud and theft, Canada’s Royal Canadian Mounted Police said in an e- mailed release. Brost was arrested and Sorenson is probably out of the country, police said.

Brost and Sorenson created Syndicated Gold Depository SA, which had agreed to lend money to Merendon Mining Corp., with the promise of tax breaks and high rates of return to investors, police said. The two men raised more than C$100 million from 1999 to Dec. 31, 2008, from investors in Alberta, Canada, the U.S. and elsewhere, police said.

The second accomplice, Sorenson, was arrested by the mounties upon his arrival at the Calgary airport. For some strange reason, Sorenson left his mansion in Honduras to face his charges:

Gary Sorenson left behind a sweeping, multimillion-dollar mansion in the hills of Honduras and boarded a private plane.

When it landed yesterday morning at the section of the Calgary airport where the city’s oil elite meet their sleek jets and skirt security lines, he was greeted by four RCMP members. The alleged mastermind of Canada’s largest Ponzi scheme, accused of defrauding $400-million from 4,000 investors, was handcuffed and whisked away to face the charges.

It was a brazen step, even for a man police believe oversaw a scheme that worked to curry investments from professional football players and once advertised on a chuckwagon at the Calgary Stampede.

Why Mr. Sorenson left Honduras – a country that has not signed an extradition treaty with Canada – is a question that even those tasked with bringing the man to justice can’t quite answer.

Though different in geography and appearance, this Ponzi scheme was functionally no different than America’s largest Ponzi scheme with Madoff.