Over the last few weeks I have been taking advantage of the rally in financial stocks to accumulate a short position in SunTrust Banks. My average price is $42.93, but I do plan to short more shares if the price continues to rise. As I have explained previously, US banks are facing a massive credit bust that will lead to hundreds of institutions becoming insolvent. To profit from the situation I am shorting some of the banks which I think have a high probability of failing. Washington Mutual is one. SunTrust is another.
SunTrust’s core market is the US Southeast, namely Florida and Georgia. Florida is right up there with California as having the worst housing markets in the country. I believe SunTrust’s exposure to Florida real estate along with its thin capital cushion will cause it to struggle to survive. In particular, the bank has a huge portfolio of construction & development loans amounting to 115% of its tangible equity.
Already SunTrust’s loan portfolio is showing a disturbing trend. Below is a chart of SunTrust’s Texas Ratio, which is calculated by dividing non-performing assets including loans more than 90 days delinquent by the bank’s tangible equity plus loan loss reserves.
The following is my estimate of the writedowns that SunTrust will have to take over the next two years. The economic environment that I have assumed is one in which the US will fall into a prolonged recession marked by unusually high numbers of personal and corporate bankruptcies.
If SunTrust were to lose $10 billion, it would be left with little tangible equity. But before its tangible equity gets to close to zero, regulators would force it to raise capital. Since this would be very dilutive to existing shareholders, the stock would sell off sharply making any possible offering so dilutive that it would be nearly impossible. This would be a similar situation to what Freddie Mac faced and what Lehman Brothers and Washington Mutual currently faces. If SunTrust is unable to raise capital then at some point depositors will get nervous and pull their funds, thereby creating a liquidity problem for SunTrust and forcing it to be taken over by the FDIC.
To summarize, I think betting against banks is a good speculation in the current climate and SunTrust is, in my opinion, one of the weaker institutions.
