We didn't think there was an honest banker left in America. But we forgot about Andy Beal...
Bull markets can make a fool look like a genius. But only real geniuses can survive and prosper during bear markets.
Our friend Cactus Schroeder is one of only a handful of Texas wildcatters who stayed in business despite the '85 slump and the '98 slump – wipeout markets for small American crude producers. Our friend Rick Rule – the leading investment banker in the world for mineral-resource companies – earned his place in the industry by simply surviving the 22-year bear market in precious metals from 1980 until 2002. Ted Bywater spent his entire 40-year career in commercial real estate in Florida – and never went bankrupt. When these men talk about their industries, we listen. Closely.
Andy Beal – founder and chairman of Beal Bank – is the only banker we know of who was actively shrinking his asset base from 2004 to 2007. He virtually stopped making loans during the period – and only bought some loans because federal regulators insisted he do so. Instead, he allowed his loan book to run off, shrinking his assets from $7.7 billion to $2.9 billion. He didn't only reduce the size of his loan book; he also raised additional capital, selling $74 million of preferred stock.
Because he wasn't making new loans, there wasn't much work to do. He laid off about half his employees and starting working half days. By September 2007, Andy Beal had enough cash to pay off all of his depositors. If there had been a run on the banks, Andy Beal was probably the only banker in America who would have survived. So... who do you think the bank regulators attacked?
Says Forbes magazine: "Then came a shocker: Amid one of the most reckless lending sprees in history, regulators focused on the one bank that refused to play along." The FDIC came after him. The IRS came after him. The credit-rating agencies threatened to downgrade his ratings.
If you have ever had any doubt about the real purpose of regulators – which is to protect the largest corporations from competitors like Andy Beal – you should study what happened to Beal Bank during the last four years. The only diligent, careful, and wise banker in America was nearly forced out of business by the people who are supposed to be "protecting" me and you – all while the country's biggest banks made the most reckless lending decisions in history.
And here's the best part of the story: Beal is lending again – aggressively. He plans to grow his loan book from $3 billion to $30 billion over the next few years. Once Wall Street got desperate to raise capital – when Bear Stearns failed – they finally agreed to start selling individual loans again, loans Beal himself could analyze.
He bought $1.8 billion of whole single-family residential loans in 2008. He's hired 450 new employees to service these mortgages in-house. Since last November, he's added another $2 billion in carefully selected mortgages. He's now building 28 branches to help raise new deposits. While every other bank in the country is at risk of going out of business, Beal is thriving. And guess what his only problem is now? That's right – the government, again.
The government is dumping billions into the same banks that caused the crisis, but not giving Beal a penny. The Troubled Asset Relief Program (TARP) gives out capital based on 3% of 2008 assets. So if a bank had done far too much lending between 2004 and 2007, it can get money. But bankers like Beal, who were being prudent, won't qualify.
Worse, by keeping his competitors afloat, the government is preventing the market from working. Says Beal, "Banks are on a prayer mission that somehow prices will come back and they won't have to face reality." He says half of America's banks – 4,000 of them – would go bust if they marked their assets to what a real buyer would pay today.
Speaking of the bad banks and their inflated assets... there's yet another twist to the ongoing accounting rule changes designed to hide the poor condition of their books. The Treasury Department wants to make sure that if the new public-private bailout plan doesn't work, the banks won't be forced to mark the assets on their books to new, lower prices generated by that auction.
At the market peak, these banks were levered over 30 to one. That is, the banks had about three cents of reserves against their loans. Let's assume total losses on these loans ends up being around 10% (the number is probably actually much worse). With losses at about 10% of assets, banks would require more than three times as much reserve capital has they held in the fall of 2007 simply to cover their losses. We wish the Treasury luck.
Famed bank analyst Mike Mayo – who recently left Deutsche Bank for Calyon Securities – agrees the change in mark-to-market (MTM) accounting will do little to save the banks. He released a new report saying banks' loan losses will exceed those during the Great Depression. According to Bloomberg, Mayo "expects loan losses to increase to 3.5 percent by the end of 2010. Mortgage-related losses are about halfway to their peak, while credit card and consumer losses are only one-third of way to their expected highest levels."
The changes to MTM accounting will alter banks' balance sheets by only one-third or less and will have no impact on "the economics of bank troubles." Especially considering that loans have been marked down to only 98 cents on the dollar, on average.
This is sad. In a last-ditch effort to fend off bankruptcy, General Motors has turned to selling its prized classic car collection. In the latest auction, the company is selling some 100 of its antique and show cars, like a 1978 Corvette Indy 500 pace car (one of four made).
In an earlier auction this January, GM raised $9 million selling cars like the 1998 Cadillac "Popemobile," which transported Pope John Paul II, and a 1996 presidential limo. This auction is a good show of faith but insignificant, considering GM's $13.4 billion government loan and over $30 billion in existing debt. The auction is scheduled for this Thursday in Palm Beach, Florida.
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New highs: none.
In the mailbag... some of the angriest letters we've ever received. Apparently, some readers think it's our fault GM went bust – as if our writing somehow was more powerful than 20 years of capital deficits, 40 years of unaffordable union labor, and 10 years of the most inept corporate management in history. Right or wrong, we like hearing what you think about our work. Send your opinions here: feedback@stansberryresearch.com.
"Porter you arrogant little twit... I have absolutely had it with YOU and ANYTHING TAINTED BY YOU. What happened with you and GM? Did your tranny blow up because you FORGOT to service it? Or do you just LOVE JAP cars. And don't tell me again and again and again and again (oops, too late) that GM is the worst run company on the face of the Earth. S&A is worse, much worse, because with your personal vendetta against GM how can I have ANY FAITH in anything you say or write? There is no place in investment newsletters for this sort of blatant personal attack. No one else on the staff does this, just you. There is NO EXCUSE FOR YOUR BEHAVIOR!!!!!!!!!!!!!!!!!!!!!!! I am a retired GM engineer, chemist and statistician and the main problem with GM is that 'Americans' walked away from a perfectly good 100% AMERICAN manufacturer of automobiles for a few percentage points in total defects. What a shame, because now the whole country will suffer, and you seem to enjoy watching it unfold, doing your little play-by-play. How sick – how very, very sick. REMOVE MY NAME IMMEDIATELY FROM ANY AND ALL PUBLICATIONS FOR WHICH YOU WRITE TODAY... I don't want to see your name ever again!!!!!!!!!!!!!!!!!!!!!!!!!!!!!" – Paid-up subscriber Victoria Smith
Porter comment: OK.
"I, for one, thoroughly enjoyed the SUCR farce and must admit I was completely duped – until the April Fool's salutation at the end. Thanks for showing that bit of mercy at least, or I'd have been going nuts trying to search for this fool's gold. Then, I got to thinking how well it had been written and had thoughts along the lines of RR – but thought his comments about arrogance and writing bullsh*t were unwarranted. Sour grapes or potshots of jealousy that you're succeeding, perhaps? Me thinks he doth protest too much? Then to find that he is an MD... I can tell you a very competitive and jealous bunch. I know. I am one. Probably the most narcissistic, competitive, emotionally stunted assemblage in the world. And arrogant, yes. So much so, that tired of dealing with them daily and taking a clue from Michael (Jordan), I exited the game at my peak 5 years ago at age 45 (following one or two false starts, again just like Michael) to enter the world of capital gains, where I set my own hours and there's very little night and weekend call. Or MD's to deal with. Society seems to value it more highly as well, since they tax it much less and no one wants to sue you and take everything you have (generally). Anyway, I digress, as my point is to write and thank you for ALL the help you provide we developing investors. I'm a happy and paid up Alliance member (probably the best deal on earth) and use some of ALL the things you publish. I feel your pain as some of the least popular stuff is some of your best stuff, and don't understand why the horses won't drink it. Keep up the good work, keep leading them to the water, and keep up the humor." – Paid-up Alliance subscriber SB
"As an Alliance member I have received the Put Strategy Report from its start. Prior to its publication I had sold only three naked puts. It wasn't fear that kept me from emphasizing the strategy; instead, it was insufficient knowledge of the opportunities and the lack of attention and motivation to check out this part of the market. For me, your recommendations serve as examples of what is out there. The newsletter has opened up that world, and I have gone far beyond its specific suggestions. This has been a near-perfect period for naked put selling, and we may not see the likes of it again (I hope we don't!). I am not going to give any numbers, but the percentage returns have been phenomenal. Thanks for the newsletter; It's great. Best of all, it opened my eyes." – Paid-up subscriber BW
Regards,
Porter Stansberry
Baltimore, Maryland
April 6, 2009