Proof Of Another Big US Bank Collapse? Investment Banks Rated "Buy" By Other Banks? What Does It Take For Investors To Learn?

Reggie Middleton's picture

On February 10, 2008, I created an extensive blog post, explicitly labeling Morgan Stanley as "The Riskiest Bank on the Street!" To my knowledge, I was the only one to make such a blatant accusation. Of course, months later Morgan Stanley and all of its brethren started collapsing. Many attributed this to the overall market malaise, I didn't.

In September of 2008, 7 months after the first bearish report, I penned "As I said, the Riskiest Bank on the Street", which essentially compared my opinion, analysis and most importantly accuracy, to that of the Street's sell side, as excerpted...

For all of those who had/have a buy on Morgan Stanley, contact me for a special institutional subscription to the blog. I have said Morgan Stanley is a very strong short candidate (for about 9 months now).

Wall Street has said the following (from Zacks.com, ABR = average broker recommendation): 

MORGAN STANLEY
(NYSE) $21.75

Current ABR

2.27

ABR (Last week)

2.27

# of Recs in ABR

11

Average Target Price:

$51.60

LT Growth Rate

10.40%

The average broker recommended price for that period (and this period as well) was/is absolutely absurd, and has no grounding whatsoever in reality. This is what my report said in 2008:

We value Morgan Stanley at US$20.76 per share, 58% lower than the current market price – We have analyzed Morgan Stanley exposure toward the Level 3 assets and its exposure to unconsolidated VIEs. To value Morgan Stanley, we have used the Discounted Cash Flow (DCF), Price-to- adjusted book (P/BV) and Price-to-Earnings (P/E) multiple methods. Based on our weighted average valuation, we arrive at a fair value of $20.76 which represents a downside of 57% from current levels of $48.25.

Look at graph below to determine who was closer to the truth, Reggie Middleton and his team, or Wall Street - all of Wall Street!

Does this make you wonder why create posts such as Did Reggie Middleton, a Blogger at BoomBustBlog, Best Wall Streets Best of the Best? It should be blatantly apparent that anyone who follows Sell Side researh over that of BoomBustBlog is at best taking extreme risks with their capital, and more realitically headed for disaster and deserving every bit of it along the way. The telling portion of this tale is today's Bloomberg article ilustrating a fact which we suspected, but which no one really knew for sure except Wall Street banking insiders, and that was that MS took $107 in loans from the Fed during 2008. More than any other entity in the history of the Fed, more than all of the banks who had both larger balance sheets and asset basis' than MS, more than anybody. So, was I right? Was MS truly the The Riskiest Bank on the Street? We shall delve into the Bloomberg article, but first, a few more excerpts from the aforementioned blog post of January 2008:

"Worsening macro and market conditions to restrict revenue growth – Financial services industry witnessing its toughest times in recent history faces a tough task of getting things back to normal. The deteriorating macro environment coupled with flagging confidence among investors/customers alike, things are more likely to get worse than better."

"as tests to its excessive exposure to the anemic capital reserves of its counterparties, namely monoline insurers and hedge funds."

Now, from Bloomberg: Morgan Stanley at Brink Got $107B From Fed:

As markets convulsed in September 2008, Morgan Stanley (MS) Treasurer David Wong briefed the Federal Reserve on a “dark” scenario in which the U.S. firm would need at least $10 billion of emergency loans from the central bank.

It got 10 times darker by month’s end. Morgan Stanley borrowed $107.3 billion, the most of any bank, according to data compiled by Bloomberg News using information released in response to Freedom of Information Act requests, related court orders and an act of Congress.

Morgan Stanley’s borrowing -- more than twice the amount all banks got from the Fed in the market squeeze that followed the Sept. 11 terrorist attacks -- peaked after hedge funds pulled $128.1 billion from the firm in two weeks, documents released by the Financial Crisis Inquiry Commission show.

The first comprehensive examination of the Fed’s emergency lending reveals how close the New York-based bank came to running out of cash because of a run on its prime brokerage, the unit that finances hedge funds’ trades and holds their cash and securities. The Fed loans also show the degree to which Morgan Stanley and other banks depended on such brokerage accounts for funding, even though clients could close them on short notice.

“These were like hot-money deposits that could flee in an instant,” said Tanya Azarchs, a former Standard & Poor’s analyst who covered Morgan Stanley during the crisis and is now a consultant in Briarcliff Manor, New York. The firm “never thought that the hedge funds would get that spooked.”

Wow! Pretty damn prescient? Or just observant? I'll let you be the judge, but here's a hint: you don't have to be prescient to see any of this coming, and I'm no more special than any other Joe Schmoe on the Street - outside of being a lot less conflicted! Of course, it doesn't end there. Let's take a look at the Golden Boys from that same post back in September of 2008 ("As I said, the Riskiest Bank on the Street"):

Look at what I said in Reggie Middleton on Goldman Sachs Q3 2008 vs what the guys that most retail investors and family offices give their money says about Goldman Sachs... 

GOLDMAN SACHS GROUP INC
(NYSE) -114.50
Current ABR 2.96
ABR (Last week) 2.79
# of Recs in ABR 12
Average Target Price: $200.91
LT Growth Rate

17.40% 

 

Again, the average broker consensus is an absolute joke. Subscribers and long time readers know my price targets for Goldman were much more pessimistic. Who was right? I refer you to What Do Goldman Sachs and B.B. King Have in Common? The Thrill is Gone…:

GS’s considerable leverage provides a means (the lever) of high returns to shareholders when asset prices are appreciating but the same becomes a very material economic concern when the asset prices lose value. With low trading revenues, GS has little cushion to absorb write-downs on these assets, leading to erosion of equity. As of March, 2010, the GS’s investments portfolio amounted to $339 billion (nearly 566% of the tangible equity). Referencing my previous posts, “Can You Believe There Are Still Analysts Arguing How Undervalued Goldman Sachs Is? Those July 150 Puts Say Otherwise, Let’s Take a Look” and “When the Patina Fades… The Rise and Fall of Goldman Sachs???“, we can reminisce over the fact that Goldman BARELY earns its cost of capital on an economic basis, and that’s before considering the potential horrors which may (and probably do) lay on the balance sheet (for more on BS horror, referenceReggie Middleton vs Goldman Sachs, Round 2.

As for the Street and mean analysist estimates, this is the verbage (that's verbage, not garbage) that accompanies these reports via hyperlink:

Recommendations Research Page

Brokerage Research firms spend over a billion dollars a year to fully analyze and recommend stocks to their clients. Most of that expense is paid out as compensation to a group of highly intelligent, and well compensated, equity analysts. It is usually in your best interest to know what these Wall Street heavy weights think about your stocks before you make buy, hold, sell decisions. And there is no better place
to gather that information than on the Recommendations research pages on Zacks.com.

Okay bloggers and bloggettes, this doesn't make any damn sense.Why would anyone not want to subscribe to truly independent research is beyond my reckoning. Mediocre independent research is better than top notch biased research any day. Just imagine what mediocre biased research will offer you.

I know I may be a little biased on this topic because I may stand to gain from selling subscriptions, but let me make
this very clear - I am an investor first and foremost. That is what I do all day, everyday. The blog always has, and probably always will, operate at a significant loss.The only reason I am bothering to make this post is because I am absolutely awed by the stickiness engendered by the sell side brokerage marketing machine. One would think that this site (or any independent research site) would be oversubscribed, if anything just because there is chance they may be trying to tell the truth. Okay, rant and rave is now offline...

So, to recap, I have accurately called the fall or collapse Morgan Stanley (The Riskiest Bank on the Street and Reggie Middleton on the Street's Riskiest Bank - Update), Lehman Brothers (Is Lehman a Lying Lemming?), and Bear Stearns (Bear Fight - A most bearish view on Bear Stearns in a bear market and Is this the Breaking of the Bear's Back?), Goldman as well (Goldman Sachs Snapshot: Risk vs. Reward vs. Reputations on the Street and Reggie Middleton on Risk, Reward and Reputations on the Street: the Goldman Sachs Forensic Analysis) as well as very recently the French bank run (The French Government Creates A Bank Run…) and Wall Street's sell side opinion still regulalry runs diametrically opposed to mine. I pray thee tell me, who has truly earned their stripes through these rough times? I query, because I have recently picked out another potential failure and we shall see how serious this one is taken this time around. To refresh everyone's memory...

The Squid Is A Federally (Tax Payer) Insured Hedge Fund Paying Fat Bonuses That Can't Trade In Volatile Markets

Trade setups on the Squid coming up next for paying subscribers. This one will be tricky, for valuations tell an incomplete story which is the reason why I announced this one publicly. You simply cannot profit off of the ancillary Squid news.

And in closing, for anyone who is interested...

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Key highlights of my archived research from 2008 (before the crash) on the "Riskiest Investment Bank on the Street":

The Riskiest Bank on Wall Street – Morgan Stanley has US$74 billion of Level 3 assets, over 200% of its equity, which is the highest amongst its peers. Although the Level 3 assets have declined from the previous quarters owing to huge writedowns, the reclassification of assets from from Level 2 to level 3 category continues as the liquidity for the troubled mortgage paper drys up.

Declining ABX index indicates troubled times are not over yet – Morgan Stanley used the performance of the ABX index as one of the benchmarks to writedown US$9.4 billion in 4Q 07. As this index continiues to witness downward trend, we believe that the asset writedown done so far, may not be sufficient.

Forensic Accounting of ABS Assets yields more woes - a security by security accounting of MSs ABS inventory shows at least 30% and probably 56% in additional losses coming down the pike, as well as tests to its excessive exposure to the anemic capital reserves of its counterparties, namely monoline insurers and hedge funds.

Losses from unconsolidated VIEs of $38 billion can wipe out almost half of the company’s total equity –Morgan Stanley has $20 billion of its unconsolidated VIEs assets in credit & real estate portfolio where the company expects a maximum loss ratio of 65%. Considering the worsening real estate markets, we believe that the company will incur huge losses on this portfolio. In addition, the company has $7 billion towards MBS & ABS portfolio and $10 billion of strucutured finance products.

Exposure toward Bond Insurers/private funds raises counterparty risk – The failure of bond insurers, on whose shoulders lie the rating of $2.4 trillion of bonds, raises a serious doubt about a systemic failure in the U.S. financial services industry. Morgan Stanley’s exposure of $3.6 billion toward the bond insurers may result in unforeseen losses for the company. The company has a counterparty credit risk exposure of $13.9 billion toward parties rated BBB and lower.

The riskiest bank on Wall Street – High exposure to Level 3 assets despite significant write-downs

Need to raise additional capital if current crisis worsens – Morgan Stanley raised $5 billion from China Investment Corp to maintain its capital ratios as it reported huge losses in 4Q 07. Going forward, as the credit market environment, the housing and real estate markets continues to crack, the company will likely report huge and may have to raise additional capital.

Worsening macro and market conditions to restrict revenue growth – Financial services industry witnessing its toughest times in recent history faces a tough task of getting things back to normal. The deteriorating macro environment coupled with flagging confidence among investors/customers alike, things are more likely to get worse than better. Furthermore, the decline in structured product revenues, risk averse nature owing to recent turmoil and the less active M&A environment will exert pressure on the company’s revenue growth in the coming quarters.

We value Morgan Stanley at US$20.76 per share, 58% lower than the current market price – We have analyzed Morgan Stanley exposure toward the Level 3 assets and its exposure to unconsolidated VIEs. To value Morgan Stanley, we have used the Discounted Cash Flow (DCF), Price-to- adjusted book (P/BV) and Price-to-Earnings (P/E) multiple methods. Based on our weighted average valuation, we arrive at a fair value of $20.76 which represents a downside of 57% from current levels of $48.25.

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icon Morgan Stanley (287.96 kB 2008-02-11 12:49:56)