What's Wrong With Bank Stocks

Sure, State Street had horrible earnings and is getting taken out to the woodshed.  And yes, Meredith Whitney is bashing bank stocks again and who has been more right than her about the sector in the past year?  Not to be outdone, another two-bit, "me too" analyst from FBR is also out with some negative comments about the sector, but I can't imagine anyone cares what he has to say.  Because really, if you are choosing today as the day to inform the public that bank dividends might not be safe, and that Bank of America might need more capital, after it's already been bailed out by the government and is trading at $5, and you didn't even see that one coming, well, then anything negative you have to say about the sector should be deemed as bullish.  So what's the real story here?  Why are options traders paying through the nose to buy winger puts in every American bank stock on inauguration day?  The answer lies across the pond. 

Royal Bank of Scotland down 70%. Today.  Lloyds down 57%. Today.  Barclays, who snubbed its nose at government money a few short months ago down 40%. Today.  The UK's largest bank stocks are headed to zero as the market is anticipating a full fledged bailout of the banking sector.  I return to the same question that I asked the other day:  What, if anything, is bank equity really worth?  I don't know the answer.  I don't think anyone does yet.  But with the largest bank stocks trading like call options, investors are taking a good hard look around at the remaining banking landscape and asking why every bank stock shouldn't be trading in the single digits.  If it's still a $50 stock, look out below.

Barclays Spurns British Bailout Money in Favor of More Expensive Private Capital

Rather than face the indignity of a capital injection from its own government, Barclays chose instead to raise capital from Middle Eastern investors on more onerous terms.  Alphaville has a nice summary of the financing package it arranged with Qatar and Abu Dhabi and concludes that executives made these decisions in their own self-interest at significant cost to shareholders to keep the British government from meddling in their bonus pools and corporate governance.  Here's a quick summary of the terms:

• $4.86 billion paying a coupon of 14% until 2019, with in-the-money (as of Thursday's price) warrants worth around $1.2 billion.
• $7 billion billion short-term converts paying 9.75% until conversion (sometime next June) at a 25% discount to Thursday's close
• Assuming full conversion, Middle Eastern investors will own 31.2% of the bank.

Compare this to a 10-11% coupon for the British package with no warrants, with the caveat that the bank would have to issue a full blown prospectus and let the British government have a say  in compensation and the composition of top executives.  Shareholders will need to vote on this so the possibility exists of a shareholder revolt.  Barclays may find itself turning to the government, hat in hand, after all.   

Barclays and Lehman? Seriously?

I've heard some crazy Lehman rumors in my time, most of them true, but the rumor du jour circulating about Barclays evaluating a take-under of Lehman may take the cake.  Lehman received yet another drubbing in the market today for seemingly no reason, ending the session below $20, an eight-year low.  Bloomberg reported that this particular beatdown in the stock was attributed to speculation among traders that Lehman was going to sell itself at a below-market price to some bank.  Reuters claimed that one version of the rumor pointed at Barclays buying Lehman at $15.  Although referred to as a "take-under", if the stock continues its spiral downward at this velocity, $15 will appear to be a very attractive premium by the end of the week.

When I first hear a crazy rumor such as this one, I instinctively instant message or call every trader I know and ask if he's heard the rumor, thus contributing to the spreading of the rumor without really knowing the origin or having any facts to support the supposition.  As I spent all day today in a courtroom hoping I wouldn't end up as a juror on a one-month murder trial, I didn't have a chance to engage in any rumormongering.  Inspired by the strict instructions handed down by the judge for the murder trial, I have decided to look at the evidence before jumping to any conclusions:

• Barclays raised $8.9 billion from investors last week to raise its capital adequacy ratios.
• Lehman raised $6 billion three weeks ago, including $4 billion in common stock at $28.
• Lehman is a pure play US investment bank with significant mortgage related risks sitting on its balance sheet.
• Barclays is already in the US investment banking business.
  

I would like one of the rumormongers out there who actually believes this one to explain to me why a bank that just raised nearly $9 billion in capital because it had one of the lowest Tier 1 ratios of any European bank, would immediately spend that fresh cash to acquire a US investment bank caught in a vicious death spiral.  Barclays is already in the US investment banking business.  There is just too much overlap for the deal to make any sense from an operational perspective, which would imply that Barclays is interested in scooping up Lehman's assets at a discount.  Yeah, I thought that was funny too.  Who knows what those assets are really worth?  Maybe David Einhorn, but he's not telling until he's finished covering his short.  

From Lehman's perspective, it makes absolutely no sense that Dick Fuld would be looking for an opportunity to sell the bank at $15 a share a mere three weeks after he just raised money at $28 from a slew of supposedly savvy institutional investors.  That would absolutely put the final nail in Lehman's credibility coffin.  Because if Mr. Fuld was shopping the bank around at $15, the implication would be that Lehman is having counterparty or liquidity problems.  In that case, it would be better to wait for the opportunity to buy Lehman at $2 with the Fed promising to take the first $30 billion in losses.