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Bearish Signs for Regional/Non-TBTF Banks
The oligopoly in the financial sector consisting of the big TBTF banks (JPMorgan, Goldman, Citi, BofA, and Morgan Stanley hold a combined 96% of total notional derivatives exposure) has only gotten bigger since the financial crisis escalated because of the government response.
The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 amended the Bank Holding Company Act of 1956 to initiate the nationwide concentration limit for bank acquisitions:
The Board may not approve an application pursuant to paragraph (1)(A) if the applicant (including all insured depository institutions which are affiliates of the applicant)controls, or upon consummation of the acquisition for which such application is filed would control, more than 10 percent of the total amount of deposits of insured depository institutions in the United States.
.This is part of United States Code (12 U.S.C. §1842(d)(2)(A)) and as such is codified federal law. However, as a recent WaPo article explains, JP Morgan, Wells Fargo, and Bank of America each violated that contingency when they made their respective emergency acquisitions (Bear Stearns, Wachovia, and Countrwide Financial/Merrill Lynch).
The article goes on to say:
In Santa Cruz, Calif., Wells Fargo, Bank of America and J.P. Morgan Chase hold three-quarters of the deposit market. Each firm was given tens of billions of dollars in bailout funds to help it swallow other banks.
Not only is this possibly illegal given antitrust statutes, it chokes off competition and only increases moral hazard/systemic risk as each bank is that much more significant to the overall financial structure.
In addition, TBTF banks now have the built-in Bernanke/Geithner/Obama put, with implicit backstopping from the US government. This allows them to have access to much more/cheaper credit, as their solvency and credit risk is essentially equal to that of the United States of America because of implicit guarantees.
So, besides the American taxpayer who is on the hook for all of the asset losses/levering up/moral hazard, who does this consolidation hurt most directly? Regional banks.
These banks have commercial and residential mortgages on their books, too. But their losses aren't big enough to be backstopped by the Treasury or Federal Reserve. They are losing market share to the big banks at alarming rates as their deposits dwindle while their assets continue to decline in value. Unlike the TBTFs, regional banks' credit risk keeps rising dramatically as they don't have the US government backstopping them, and are finding it harder and harder to access cheap credit. As big banks raise rates and fees, the regionals are forced to be more prudent and are lowering them in the face of stiff TBTF competition. And perhaps most importantly, the regionals don't have the privilege of 42 $100MM+ trading days and a 97% win/loss ratio.
While big banks can "earn" their way out of some of their asset losses (once finally taken) through proprietary trading, investment banking/underwriting fees (equity and debt issuance in Q2 at record levels), and primary dealer benefits, regionals of course cannot. Which is why the FDIC's DIF ratio is down to 0.22%, a worse leverage ratio than even the Wall Street heavyweights. And why over 90 banks have failed in 2009 alone.
Regional banks, along with the rest of the financial sphere, have enjoyed a massive rally off March lows, with the Regional Bank Holders Index ($XRH) up around 160% since March lows. But the tide might be ready to turn. They seem to be in the process of forming the right shoulder to a head and shoulders pattern started last month, and big volume selling has been evident the last few weeks.
On Friday, put volume for many regionals surged, much of this volume coming in on front-month, out-of-the-money options, suggesting big bets/hedges for substantial downside in their stocks, very soon. BB&T (BBT) had strong activity at its $25 strike price for September expiration, with over 25,000 contracts traded at an open interest of around 3700. BBT closed the session at $26.77, and the 25 strike price for the September contract only a week away from expiration suggests substantial downside in the underlying equity. Keycorp (KEY) showed 27,000 contracts traded with an open interest of 15,000 for its $6 September put, which just turned into the money around 2:10 PM on Friday. Regions Financial (RF) showed 50,000 contracts traded against an open interest of 15,000 for its September $5 put, one strike price out of the money. Suntrust (STI)'s September $20 contract, two strike prices out of the money, had a volume of 18,000 vs an open interest of 8,000.
Looking forward, the increasing consolidation/oligopolization of the big banks and the technicals and options activity for regional bank stocks spells substantial downside. And given the near-term expiration of the contracts traded in volume, the large downside could start as soon as next week.
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quote
Regions Financial (RF) showed 50,000 contracts traded against an open interest of 15,000 for its September $5 put, one strike price out of the money.
End Quote
Someone help out a noob like me; who lost or made money on this RF? Also what is a "strike"?
Are these the next banks to fall? All of them show pretty large outstanding loans to commerical.
RF closed at $5.50 Friday. Nothing has been 'made' or 'lost' yet, but over the coming week the put buyer will gain if the equity of RF trades near / through the $5.0 handle. The strike price is where the option is set...ie, if I thought RF could trade higher than $6 I may trade a call option carrying a strike at $7. The buyer of put options thinks that RF will trade lower, so it's not a stretch.
Put options with a short expiry...someone is just surmising that a downtrend will hit this week, and the options are fairly cheap given expiration on Friday.
Long-term BBT should be fine, and also Suntrust. Using the share of national deposits is a more astute method to measure how much the TBTF 'own' of the national biz of banking.
What happened in local markets, as in the case of Santa Cruz, should be corrected. If i were a former bank exec locally based, I'd open a branch tomorrow. Most folks are despising the bank practices by the TBTF...
I'll try to provide a simplified answer.
Nobody has gained or any lost money YET. The purchaser of the 50,000 put contracts (a contract is 100 shares of stock) is betting that Regions stock will fall to $5 or less during the 5 trading days ending at Friday.
If the price falls below $5 during the week, the seller of the option theoretically has to buy 5,000,000 shares of Regions from the option buyer at $5 a share. So the option seller could lose up to 25 million if the Regions went to zero by next Friday. In realty, the seller hedged his bet and stands to lose much less money.
If the price stays above $5 for the entire week, the purchaser of the options could potentially lose the entire amount that he paid (circa $.15 per share plus $.50 per contract) - that he paid to buy the options. In reality, he is just hoping that Region's price will decline so that he can "sell to close" the contracts at a profit prior to market close on Friday.
Buying out of the money puts is basically a cheaper, lower risk alternative to selling short. Your loss is limited to what you paid for the put contracts. And you don't have to worry about margin calls or losing your borrow.
One other negative that will disproportionally hurt the Regionals and Community Banks is the dramatic increase in FDIC premiums. Quite ironic when you consider that the majority of these banks followed reasonable lending standards now have to compensate for the incompetence of their regulators and of course help out the TBTF bretheren.
Is this not a great country?
Already short some ZION (long puts against short calls). Prolly worth single digits. Level-3 assets nearly 50% of all assets, 79% (33Bln) of loans are commercial credits
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Nice crossover in the listed names here (August): http://www.bloomberg.com/apps/news?pid=20601039&sid=a04oVutXQybk
Seems like folks laying bets down on Failday.