2008 in Review

At the end of each year, I like to re-visit my hits and misses. Let's start with the misses.

My biggest mistake was thinking we didn't need any capitulation (July 25, 2008). The market hit the skids shortly thereafter. At the time I made the call, the S&P 500 was 1,257--now it's 869. That's a loss of around 30%. (Not as bad as Hilary Kramer, but too close for comfort.)

Of course, the market did capitulate later on, and on September 18, 2008, I said it was a good time to slowly re-enter the market. Unfortunately, the S&P 500 was 1206 on September 18, 2008--now it's 869. That's a loss of around 28%.

I also had a near-miss. On July 30, 2008, I praised Garmin when it was selling around $36/share. Fortunately, less than a week later, on August 5, 2008, I sold my shares, writing, "I sold Garmin (GRMN), taking a [small] loss. I violated the rule of never catching a falling knife." Garmin is now around $19/share.

My top hits in 2008?

1. Not only did I predict Longs Drugs would be bought out, I also identified the eventual buyer:

Longs is going to be a good company and attractive takeover target...CVS is going to be knocking one of these days.

I made the call on May 29, 2008. On August 12, 2008, CVS announced it was buying Longs Drugs.

2. On September 19, 2008, I correctly said that Transmeta (TMTA) was trying to conserve cash to become more attractive as a buy-out candidate.

TMTA looks like a company trying to conserve cash to survive. If you're looking for a growth story, this isn't it; however, as long as its patent portfolio remains viable, TMTA may be a potential takeover target or value play at the right price.

On November 17, 2008, Novafora bought Transmeta.

3. I correctly called a short-term bottom in banking stocks and Colonial Bancgroup (CNB) shares. My joyful reaction at making the correct call is here.

4. I called MGM overpriced and told the CEO at MGM's shareholder meeting he was propagating unrealistic expectations:

[Despite your rosy outlook] you're basically telegraphing that you're going to lose money because you're expanding and spending money while entering a recession...

In the same post, I wrote,

Overall, I believe MGM will not be able to replicate its record in 2007 and will make less money in the short term.

At the time, MGM was selling for around $52/share. Now it's at $12.74/share.

If you read the full post, you will see that I disliked the CEO at the time, Terrence Lanni. Mr. Lanni recently resigned after the WSJ reported that he had falsified his resume.

(By the way, the only other CEO who rubbed me the wrong way was Trimble Navigation's (TRMB) Steven W. Berglund. Let's see what happens with him and his company in 2009 and beyond.)

5. Recently, I called the drop in the Canadian dollar overdone. So far, it appears I accurately called the bottom.

6. I called GE a good buy when it was around $14.66 a share. It closed today at $15.66. GE's current dividend yield of 7+% shows it is willing to pay investors to wait until better times.

My favorite "hit," however, had nothing to do with a prediction. At the Yahoo shareholder meeting, I told Chairman Bostock to stop talking about Microsoft, comparing his repeated and unnecessary public proclamations to words from a jilted ex-girlfriend. I also politely suggested Mr. Yang go on a sabbatical. We haven't heard a peep out of Bostock for months now, and Mr. Yang has gracefully exited. Meanwhile, Yahoo stock has quietly made a comeback from around $9/share to around $12/share.

Aside from hits and misses, what was my biggest lament? That this article wasn't more popular among my regular readers. I don't think we're going to see the end of "OCM," so perhaps the article will gain more popularity with time.

As for my thoughts on 2009, I am looking forward to it. I think the S&P 500 will hit 1012 in 2009, but whether it stays there is anyone's guess. Here's the annual Barron's challenge if you're into forecasting.

My riskiest 2009 stock is Maxim (MXIM). I am hoping it will go to $14.90/share by early 2010. I started buying Maxim shares at around $12/share and have been averaging down. Maxim closed today at $10.98/share. If I'm right, my Maxim shares will appreciate 30+% in around one year.

The market's gyrations notwithstanding, it's important to remember that most Americans enjoy one of the highest standards of living in the world. If you disagree, may the new year bring you knowledge and a much-needed passport.

The information on this site is provided for discussion purposes only and does not constitute investing recommendations. Under no circumstances does this information represent a recommendation to buy or sell securities or make any kind of an investment. You are responsible for your own due diligence.

Colonial Bancgroup (CNB) and How to Value a Bank

A reader made a comment to the post below, indicating that CNB might be worse off than its total debt and total cash numbers indicate. He is correct--almost all banks are difficult to value today, because it is almost impossible to determine what percent of the debtors will be able to pay back their loans. The reader pointed me to the following link:

http://yahoo.brand.edgar-online.com/displayfilinginfo.aspx?FilingID=5754137-104895-280327&type=sect&dcn=0001193125-08-037476

He believes that CNB is a risky investment because much of its debt is mortgage-related. Banks hold many different classes of assets--student loans, mortgage loans, small business loans, life insurance policies, home equity lines, and so forth. His analysis relies on an assumption that today, any bank holding significant mortgage-related or property-related loans in markets such as Florida, Nevada, and California will be distressed. I don't dispute that analysis; however, I also do not believe CNB deserves to be trading at 3 dollars a share, even with its risks. CNB will probably not collapse and as a result, five years from now, when property values recover, CNB will be lauded for being in high-growth areas.

In any case, CNB accelerated its earnings release to July 16, 2008. We will have a better idea of where the bank stands tomorrow. I can't imagine CNB would have accelerated its earnings release if there was worse-than-expected news involved, but common sense doesn't always apply in this panicked market.

Colonial Bancgroup (CNB) Recap

One day after calling a bottom in well-capitalized banking stocks, Colonial Bancgroup (CNB) and First Horizon (FHN) increased 16% and 30%, respectively (at least as of 10AM PST on July 15, 2008).

I was able to make a short term trade on XLF as well--I put a limit order to buy last night, and when I woke up, it increased 4.3%, so I sold. I can't do a full stock update just yet, as the market isn't yet closed, and I will wait at least three weeks so I can get a better picture of how my stock picks are doing. In three weeks, most of the major companies will have released earnings.

For now, my main holdings are as follows, in descending order of worth: PFE, INTC, CNB, and DBV.

The information on this site is provided for discussion purposes only and does not constitute investing recommendations. Under no circumstances does this information represent a recommendation to buy or sell securities or make any kind of an investment. You are responsible for your own due diligence.

Colonial Bancgroup (CNB)

Correction Note (on July 15, 2008): an astute reader from Seeking Alpha pointed I was misusing accounting terminology in my posting, namely how debt is characterized on a balance sheet. When a bank makes a loan, it becomes the creditor. As a result, its balance sheet lists the loan/debt as an asset.

In my article, I used Yahoo Finance's "total debt" and "total cash" figures, which do not appear to include loans as "assets." The "total debt" and "total cash" statistics provide some holistic insight into how much a bank might be over-leveraged. At the end of the day, the ability of debtors to pay their debts is paramount, not "total debt" or "total cash," and everyone is currently dealing with bankers' black boxes of credit quality. But I was able to call at least a short-term bottom--both FHN and CNB, jumped by around 30% and 16% (see full day's chart for July 15, 2008), respectively, one day after I called a bottom in well-capitalized banking stocks. My full article, published yesterday, is below:

I am calling a bottom in well-capitalized regional bank stocks. When the New York Times publishes an article titled, "Analysts Say More Banks Will Fail," (by Louise Story) we have a good contrarian indicator. But here's what makes me angry: the reporter cites Richard Bove in her article as support for her thesis that despite being better capitalized in general, more banks will collapse. Take a look at this Nightly Business Report link to an interview with Mr. Bove:

http://www.pbs.org/nbr/site/onair/transcripts/080714c/

He expressly says he believes regional banks are in good condition:

"I think that the regional banks are actually in relatively good condition...I think if you look a year from now, the prices of bank stocks will be considerably higher than they are today."

Of course, he also says it is risky to bet on bank stocks now, in a time of panic, but overall, the clear sentiment is that the overwhelming majority of banks are healthy. The article itself states that 150 out of 7,500 banks might fail--or just 2%.

I have been very disappointed in my own stock picking ability because I bet on Colonial Bancgroup (CNB). While I bought almost all of my shares at under 5 dollars, the market has decided that CNB is worth only 3 dollars a share. I continue to believe I am correct, and the market is being irrational. The question is whether I can stay solvent until the market becomes rational again.

Bank stock financial data are abstruse because they defy normal value analysis. Usually, value investors like myself look at a company's total cash and total debt. My own personal yardstick is to deem a company undervalued if its net cash exceeds 10% of its market capitalization. For example, Intel has a market cap of 108 billion. Therefore, I want its net cash to be at least 10.8 billion before I view it as undervalued. Intel has about 11 billion in net cash, passing my test (I own shares in Intel).

Banks, on the other hand, cannot be analyzed in this way, because they make money through loans. As a result, Shakespeare's advice, "Neither a borrower nor a lender be," doesn't apply. In addition, a bank having more debt does not necessarily denote irresponsible spending. Indeed, as an investor, you want your bank to have more debt, because banks make money by loaning to others, not by keeping their cash. The problem lies in evaluating whether a bank's debt (or, in accounting terms, its assets, because they are technically the creditor) is likely to be repaid by its debtors. As debtors default on loans, they cause an immediate downward spiral: the bank that loaned them money has to stop lending others as much money; perhaps raise the rate on its CDs to attract more money; and take other steps that decrease its ability to take advantage of normal business conditions. What we forget is in a non-panicked world, banks have the easiest job: they get money from the Fed Reserve or their depositors at 2.25%, and then loan out the money at 5.5% or more. They make an automatic 3.25% just for being a middleman. (You can see why online banks are even better--they eliminate the fixed costs of a bank, like its numerous tellers/employees, ATM machines, and physical structures, and just get paid for being a middleman, minus the normal overhead. That's why an online bank like ING can offer higher CD rates.)

Having established that a bank's financial data cannot be analyzed in the same way as a non-bank's, how do we ascertain whether a bank might go under? One informal measure might be to measure the amount of total cash vs. total debt. It's a similar analysis as above, except that in these precarious times, if a bank has too much debt relative to its cash deposits, it is more likely to collapse. All figures are from Yahoo Finance's "Key Statistics" pages as of July 14, 2008:

IndyMac, which has collapsed, had about 2 billion in total cash and 11 billion in debt. That's a 9 billion dollar difference.

Washington Mutual has 15 billion in total cash and 97 billion dollars in total debt. That's an 82 billion dollar difference.

Regions Financial has 5.5 billion in total cash and 29.5 billion in total debt, a 24 billion dollar difference.

M&T Bank, considered to be a healthy, well-capitalized bank, has 2 billion in total cash, and 16.8 billion in total debt, a difference of almost 15 billion.

US Bancorp has 7.3 billion in total cash and 72.6 billion in total debt, a 65.3 billion dollar difference.

Wells Fargo, considered to be a conservative lender, has 25 billion dollars in total cash, and 157 billion dollars in total debt, or a difference of 132 billion. This high level of debt is very surprising. Warren Buffett extolled the virtues of Wells Fargo in a recent annual shareholder letter, and Mr. Buffett is the classic value investor. Wells Fargo might have a high debt load because it didn't sell off its loans to Wall Street and held them on its own books instead, but I am just speculating. As a direct holder of the debt, Wells Fargo can hold it till kingdom come, and would have no external pressure to dump loans at a discount. In some ways, its refusal to spread its risk creates an advantage. (I own some shares in Wells Fargo.)

Now we come to Colonial Bancgroup, or CNB. CNB has 2.5 billion in total cash and 5.3 billion in total debt, a 2.8 billion dollar difference. It has the lowest total debt of any other bank above, and plenty of cash relative to its debt.

Whatever you may think of banks collapsing, CNB probably won't be among them--its debt load just isn't high enough to make a collapse imminent. At 3.36 dollars a share, if you have an iron will, you may want to consider buying 1000 shares and leaving it alone for a while. A prudent investor would probably wait until after July 21, 2008 to buy, because CNB reports earnings on July 21, 2008. I will hold onto my 1100 shares of CNB and be patient--like Wells Fargo, I can wait a long time, but I hope next week brings good tidings and immediate vindication.

The information on this site is provided for discussion purposes only and does not constitute investing recommendations. Under no circumstances does this information represent a recommendation to buy or sell securities or make any kind of an investment. You are responsible for your own due diligence.

Stocks Update

The WSJ mentioned Colonial BancGroup (CNB) in an article today titled, "Small Banks Get Tempting." Author Peter Eavis said that CNB was an "intriguing prospect," but it would probably take two to three quarters (9 months) before the stock would rebound. He mentioned that the bank's charter had changed from federal to state, "allowing it to replace the Office of the Comptroller." I don't think anyone quite understands that all banks are regulated by the Office of the Comptroller if their funds are FDIC-insured. Either I'm wrong, or financial journalists aren't doing their homework.

Pinnacle Entertainment (PNK) took quite a beating today and yesterday. I only have 100 shares, and won't add anymore just yet, but I am surprised the stock is down this much. As Mr. Eavis might say, PNK looks like an "intriguing prospect" at these prices.

Open Positions
CNB = -2.51
EQ = -2.15
EWM = -3.61
GE = -6.00
IF = -8.04
PFE = -7.84
PNK = -13.72

Average of "Open Positions": losing/negative average of 6.27%

Closed Positions:
Held more than seven days but less than one year:
PPS = -2.8
WYE = +2.4%

Held less than 7 days:
ICE (+2.0%), MMM (0.5%), MRK (0.1%), PFE (1.3%), SCUR (15%) (Overall record in this category is a 3.78% average gain)

Daytrades:
PFE = +0.5%

Average of "Closed Positions" sub-categories, except for Daytrades: up/positive 2.09%

Combined Total Averages, excluding Daytrades: losing/negative 4.18%

Compare to S&P 500: losing/negative 5.15%
[from May 30, 2008 (1385.67) to June 24, 2008 (1314.29)]

The information on this site is provided for discussion purposes only and does not constitute investing recommendations. Under no circumstances does this information represent a recommendation to buy or sell securities or make any kind of an investment. You are responsible for your own due diligence.

Stocks Update

I don't usually like giving a Stocks Update right before the market closing, but I have some more closed positions I wanted to add (ICE and WYE). I couldn't handle ICE's volatility, and WYE went up 4% today. But as you can see, CNB has been a major disappointment today. I picked up another 250 shares, bringing my total to 750 shares. It's not a major investment, and most of the regional banks went down today (e.g., Regions Financial, etc.), but for the first time, I am starting to have doubts about CNB. It is quite possible it will need to raise more capital due to its mid-2007 acquisition of Citrus & Chemical Bancorporation, Inc. Where is Citrus Bank located, you might ask? (Cue ominous music...) Lakeland, Florida, one of the states affected most by the subprime mess. In any case, my only "major" position continues to be PFE.

Remember the days when banking and pharma companies were "widows and orphans" stocks? Grandma could buy some shares, not expecting any major upswing in price, but collect a consistent dividend check. The banks looked out for the savers back in the day, knowing how many shareholders were depending on their dividends. Now, this unusual economic environment has made savers into buffoons, and speculators into heroes. More important, how long will this unusual market continue? The theoretically risky stocks--like technology, where a company product can become worthless overnight due to failure to innovate--are safe havens, and the theoretically necessary stocks--like banking and medicine--are the most dangerous. There's only one explanation for this--the technology companies, like Intel, acted liked conservative banks, saved their profits and now have very healthy balance sheets. Meanwhile, the banks went loco and decided they were growth companies, Grandma's dividend check be damned. And so it goes.

Update: for what it's worth, here is CNB's response to an email I sent their Investor Relations:

We acquired Citrus and Chemical Bank in December of 2007. As part of the purchase accounting, at the date of acquisition, the assets and liabilities are marked to fair value. This mark would have happen in December of 2007 and therefore has been reflected in our capital ratios for two quarters now. Our board of directors meets in mid July at which time they will vote on the dividend. At this point, we have enough capital to maintain the dividend at its current level of $.095/quarter. We filed an 8k a couple of weeks ago which shows our excess capital and good liquidity position. This material can be accessed from our website at www.colonialbank.com.

Open Positions
CNB = -11.53
EQ = -3.19
EWM = -0.45 (excluded from totals due to insignificant gain or loss)
GE = -4.52
IF = -6.24
PFE = -7.74
PNK = +4.74
PPS = 0 (excluded from totals due to insignificant gain or loss)

Average: losing/negative average of 4.74%

Closed Positions:
Held more than seven days but less than one year:
WYE = +2.4%

Held less than 7 days:
ICE (+2.0%), MMM (0.5%), MRK (0.1%), PFE (1.3%), SCUR (15%) (Overall record in this category is a 3.78% average gain)

Daytrades:
PFE = +0.5%

Average of all sub-categories, except for Daytrades: up/positive 3.09%

Colonial Bancgroup Inc. (CNB) Bolstering its Dividend?

[Note on November 13, 2008: this post was popular because it was published during an extremely volatile time in CNB's stock price. CNB stock has since declined along with the rest of the market, and I sold my shares at a profit. Readers who followed this blog and bought on the way down had a brief opportunity for out-sized gains. See this 07/16/08 entry (CNB Entry), just one month after the 6/15/08 entry below.

Note on August 28, 2009: what a long, strange ride it's been for CNB. The bank became insolvent, and the FDIC brokered a takeover by another bank, BB&T. CNB shares now trade only on the OTC market under the symbol CBCGQ.PK.]

I was immediately attracted to Alabama's Colonial Bancgroup Inc. (CNB), because its stock symbol reminds me of "CMB," or Cash Money Brothers, from the classic film New Jack City (where Chris Rock played a crack addict a little too well). Acronyms aside, CNB recently indicated it might switch from a national charter to a state charter. What does that mean? For reasons discussed below, I believe this is good news for people like me, who bought CNB stock for its dividend.

First, it is generally less onerous to operate as a state chartered bank than a federally chartered bank. For example, a state chartered bank can more easily pay dividends than a federally chartered bank. To understand why, we need to go back in American history. Many of the Founders of the United States viewed the notion of a federally-supervised banking system with skepticism. They had just come from a centralized, tyrannical British system and did not want to grant their federal government equivalently broad powers in the form of money-monopoly. But Alexander Hamilton pushed for a central banking system and in 1791, help set up the First Bank of the United States in Philadelphia, as well as the U.S. Mint (also in Philly). Perhaps because of the initial difficulty in setting up a centralized banking system, the federal government later passed laws that forced federally-chartered banks to operate under more strict arrangements, creating an Office of the Comptroller and other regulatory banking agencies.

The restrictions on a national (or federally chartered) bank’s ability to pay dividends arise from two statutes: 12 U.S.C. § 60(b) and 12 U.S.C. § 56.

12 U.S.C. 60(b) states:

Approval required under certain circumstances:

A national bank may not declare and pay dividends in any year in excess of an amount equal to the sum of the total of the net income of the bank for that year and the retained net income of the bank for the preceding 2 years, minus the sum of any transfers required by the Comptroller of the Currency and any transfers required to be made to a fund for the retirement of any preferred stock, unless the Comptroller of the Currency approves the declaration and payment of dividends in excess of such amount.

In short, a national bank has to get approval from the federal government if the total of all dividends it declares is more the total of its “net profits,” including net profits from the last two years, and excluding any required transfers to maintain liquidity and pay off higher priority creditors. The point is that there is a restriction on paying dividends that doesn’t necessarily exist under a state charter.

12 U.S.C. § 56 (titled, “Prohibition on withdrawal of capital; unearned dividends”) states:

No association, or any member thereof, shall, during the time it shall continue its banking operations, withdraw, or permit to be withdrawn, either in the form of dividends or otherwise, any portion of its capital. If losses have at any time been sustained by any such association, equal to or exceeding its undivided profits then on hand, no dividend shall be made; and no dividend shall ever be made by any association, while it continues its banking operations, to an amount greater than its undivided profits, subject to other applicable provisions of law. But nothing in this section shall prevent the reduction of the capital stock of the association under section 59 of this title.

Basically, if a federally chartered bank ends up with bad loans, they cannot exclude those loan losses when determining their “net profits.” This accounting restriction affects its ability to pay dividends and attract shareholders, who typically buy bank stocks for their dividends. In contrast, if a non-federally-chartered bank is losing 100 million dollars because of bad loans but makes a profit of 99 million dollars elsewhere, they might not be forced to mark-to-market their bad loans, meaning they might be able to report a net profit of 99 million dollars (oh, pro forma, how Wall Street loved you). However, a federally chartered bank, under that simplified scenario, could not pay any dividends whatsoever. This § 56 accounting restriction means that in bad years, federally chartered banks would probably have to reduce or eliminate their dividends. In addition, because a federally chartered bank has to pay dividends from “net profits,” rather than some other capital account (“prohibition on withdrawal of capital”), a bank with two consecutive bad years might not be allowed to pay any dividends at all for a long time, even if it is financially healthy overall.

What does this mean now that CNB’s application to become converted into a state chartered bank has been approved? I interpret it to mean the relatively hefty dividends are going to keep coming. In the absence of financial irregularities--never a sure bet these days--the state conversion application should be good news for Cash Nabob Bulls, er, CNB shareholders (sorry, Mario van Peebles--I couldn't resist, especially not when you have an economics degree from Columbia University.)

The information on this site is provided for discussion purposes only and does not constitute investing recommendations. Under no circumstances does this information represent a recommendation to buy or sell securities or make any kind of an investment. You are responsible for your own due diligence.