Description

I recommend a short position in PRK.  PRK is one of the most expensive regional banks at 1.9x tangible book.  This valuation ranks in the 95^th percentile of all banks.  Moreover, of banks with 15% loan exposure to Florida, PRK likely ranks as the single most expensive bank.  Based on this, one would assume that PRK has pristine credit quality and a superior management team.

Yet, PRK's loan book is seriously impaired and marked at clearly inflated values. PRK underwrote loans extremely poorly and aggressively with average LTVs (loan-to-value) at origination of roughly 90%.  Given the massive decline in residential and commercial property prices, current LTVs are well over 100%.  PRK was also a serial acquirer and has purchased 14 banks in the past 20 years.  PRK acquired perhaps the worst lender in Florida and southern Alabama (Vision Bank) at the peak of the real estate market in 2006.

I estimate cumulative losses could reach 68% of tangible book value.  Even after including 2 years of pre-provision earnings, losses could reach 41% of tangible book.  This would clearly necessitate a large capital raise by PRK.

VISION BANK (15% OF TOTAL LOANS)

Vision lent primarily in Florida and partially in Alabama. PRK acquired it at the peak of the real estate market in Sept 06. Vision was one of the worst underwriters in Florida, and this exposure alone will be devastating for PRK.

• Vision's loan book was underwritten extremely poorly and aggressively

The loan mix at Vision Bank is extremely risky with very high exposure to C&D (38% of total loans) and commercial RE and C&I (33%). 

Exhibit 1: Vision Bank Loan Mix

On top of this, Vision was an extremely aggressive underwriter.  From county records, I pulled roughly 20% of the Vision loan book in Florida (see Exhibit 2).  At origination, the LTV on these FL loans was 89% (this is based on the price paid by the owner).  Even worse, the median date of origination was mid 2005 (near the peak of the real estate market). 

Since the median origination date, residential property prices are down 25% in their counties in FL/AL and commercial RE prices are down 23% nationally (there are no regional comm. RE price indices).  Adjusting for these price declines, I estimate the current LTV (marked-to-market) at 109% for commercial RE and 153% for residential RE!

Exhibit 2: Vision Bank LTV Summary

Here are 2 telling quotes from commercial brokers based on several calls I made on PRK:

"If you couldn't get a loan from Vision, you couldn't get a loan from anyone"

"I'm sure they [Vision] would be gone if they hadn't been acquired"

Given the loose lending that took place in Florida, the first statement is amazing.

• The severity of realized losses will be extremely high for Vision Bank

Vision is one of the few banks that publishes its foreclosed loan list (REO) along with asking prices:  http://visionbankfsb.com/site/propertyforsale.html

Exhibit 3 shows loss severity on the first 5 foreclosed residential lots in Florida.  I did not cherry pick these loans and simply picked the first 5 on their list.  On 4 of the 5 loans, the loss severity is staggering, ranging from 48% to 61%. 

Importantly, these loss severities are based on PRK's asking price rather than the prices PRK could actually realize in the market today.  In several instances (see below in Exhibit 5), I believe their asking prices are significantly inflated; e.g., loans 4 & 5 are listed at a whopping $5.6-$5.8 million per acre for Florida panhandle beach front property.

Exhibit 3: Loss Severity of Vision REO Properties

• Estimated losses at Vision Bank alone are significant and could approach 15%-20% of total PRK tangible book value

Vision already has 22.9% NPAs (non-performing assets) to loans vs. the industry average of roughly 3%.  NPAs continue to grow at a significant rate and were up 37% YTD (Exhibit 4).

Exhibit 4: NPA Growth Rate for Vision Bank 

Assuming 50% severity on these NPAs (based on REO date above), total losses at Vision would equal 12%-30% of total PRK tangible book (see column 4 in Exhibit 5 below).  I include losses at several higher NPA levels as NPAs are likely to increase given the risk in the loan book.  This does not even include losses on the remaining 85% of the loan book.

Exhibit 5: Estimated Vision Losses as a Percent of Total PRK Tangible Book  

• Vision Bank clearly is delaying loss recognition and marking loans at inflated values

Here are the 3 largest REO (foreclosed) loans in FL/AL from Vision's website.  These 3 loans represent 30% of the value of all the REO at PRK.

Exhibit 6: Largest REO Loans at Vision Bank

Rather than sell these assets quickly like some banks, PRK has kept the largest foreclosed loan on the books for over 2 years (since July 2007).  The other 2 REO loans in Alabama have been held for about 1 year each.  According to brokers, PRK failed to auction the 2 loans in Alabama in Aug/Sept '08.  They received 1 offer on each at 82% and 60% below the asking price.  Yet, PRK continues to maintain the asking price at the inflated values.  My speculation is that PRK is delaying loss recognition given the large size of these loans.  Notice how the loan amounts in Exhibit 3 (where PRK is willing to realize ~50% losses) are all significantly small than the amounts in Exhibit 6.

Also, the extent of the over-building was so enormous that it is unlikely PRK will ever recoup the value on the 2 AL loans.  One commercial broker told me that: "Gulf Shores and Foley collectively have a population of 17K - at the peak of the boom, there were permits in place for 20K new residential lots in Gulf Shores and Foley"

Here is yet another example of a foreclosed loan that Vision Bank clearly has not recognized.  Vision lent $21 million for a water park/dolphin show/condo complex/retail center called 'Bama Bayou.  The following article discusses the foreclosure: http://www.al.com/news/press-register/metro.ssf?/base/news/12395278573090.xml&coll=3  Vision was the only bidder at auction and purchased Bayou for $103.M in April 09 (or a loss of $10.7M).  Yet, Vision did not charge off the loan in 1Q or 2Q of this year. Total Vision net charge-offs were only $8.0M and $6.7M respectively.  This would be a significant NCO for PRK overall as it would virtually double the annualized NCO rate in 2Q from the reported 1.08% to 2.03%.

I believe part of the reason PRK is able to hold these loans at inflated values and delay loss recognition is that their auditor is Crowe Horwath.  In case you haven't heard of Crowe Horwath, it's the 9^th ranked auditing firm in the country according to Accounting Today and is roughly 1/20^th the size of the Big 4 accounting firms.

PARK NATIONAL BANK (85% OF LOANS)

Vision Bank was not an isolated mistake. The core PRK market is in Ohio and includes numerous banks serially acquired over the years.  PRK was very aggressive underwriting the Ohio loan book. The loan mix is heavily commercial with 43% of loans to commercial RE and C&I and 7% of loans to C&D. 

Exhibit 7: Core Ohio Loan Mix

Exhibit 8 shows that the average LTV at origination was 93%. Conservative banks are typically in the 60%-70% range, especially on risky C&D and commercial RE loans. Since the median date of origination, residential RE prices are down 10% in their main counties and commercial RE down 6% nationally.  Adjusted for these price declines, the current LTVs are 92% for commercial and 110% for residential.  While the data in Exhibit 8 only represent 7.6% of the loan book in Ohio, it represents every loan I found over $500K for PRK.

Unfortunately, PRK does not disclose the REO loans in Ohio so it is difficult to estimate the loss severity on its loans with the same specificity as with Vision.

Exhibit 8: Ohio LTV Summary

CUMULATIVE LOSS ESTIMATE AND UNDER-RESERVING

I believe cumulative losses at PRK will be quite severe.  Under the "more adverse" case of the government stress test, PRK would see a 68% impairment of book value before any pre-provision earnings (column 3 in Exhibit 9).  The Fed did not disclose the loss assumptions for home equity and consumer loans so I made some estimates. 

Exhibit 9: PRK Stress Test Cumulative Losses

Analyst estimates of pre-provision earnings (after-tax) are roughly $105 million for 2009.  Even after including 2 years of pre-provision earnings, PRK would see 41% impairment ($197 million or $14/share) to tangible book value (Exhibit 10). This generously assumes PRK releases 30% of its reserves to 1.43% of loans; the 5-year industry average of reserves to loans was 1.43% (during the bull years of 2003-2007).  After 2 years, tangible common equity would decline from 7.0% of assets to 4.1%.  4.1% is clearly insufficient as regulators have suggested that required capital ratios will go up over time and a ratio of over 6% is more appropriate.  This would require a significant capital raise for PRK.

Exhibit 10: Reduction in Tangible Book Value

Given the extremely high valuation of its stock, one would imagine PRK has been aggressive in reserving against the loan book. To the contrary, I estimate the Vision loan book is currently marked at roughly 86% of book value (vs. my loss estimate of as high as 30% and BBT write-down of CNB's Florida-centric loan book by 37% this week). Vision includes just 5% of total reserves and 9% charge-offs through 2Q09. Vision reserves are clearly insufficient and cover only 20% of non-performing assets. The 2Q09 industry average according to the FDIC is 80%.  For all of PRK, reserves are only 42% of NPAs.  If PRK were to bring its reserves up to just the industry average, it would wipe out 14% of tangible book (~$4.80/share).

VALUATION

• PRK is extremely expensive compared to comparable regional banks with similar exposure to Florida.

Exhibit 11 below shows the price to tangible-book value of regional banks with exposure to FL.  The list is sorted from lowest to highest percent of total loans in Florida.  While this is certainly not a complete list, every bank with over 10% of loan exposure to FL trades at a significant discount to PRK and mostly below 1.0x book.  This is rightfully so as Florida is perhaps the second worst real estate market in the US.

Based on market cap, loan exposure and credit quality, WTNY is the most comparable bank and trades at a mere 0.9x.

Exhibit 11: Price-to-Tangible-Book Valuation for Banks with Florida Exposure

•   Why is PRK trading at such a premium to its comparables if there are so many problems?

PRK has a very high retail ownership and the dividend yield is artificially high. According to Bloomberg, 41.5% of shares are held by institutions including 17.2% held through PRK's trust and asset management arm for employees and others.  So excluding the trust shares, 71% of the shares (58.5% / 82.8%) are held by retail investors.  These investors likely find the 6% dividend yield appealing.

Yet, the dividend payout is extremely high at 94% of core earnings in 2Q09 (excluding one-time security gains).  As credit continues to deteriorate, PRK will have a tough time paying this dividend.  Management has openly stated that they will do whatever they can to maintain the dividend and would rather issue equity via the current ATM (at-the-market) offering than lower the dividend.  This is clearly not an optimal allocation of capital.

Catalyst

• Recognition of further credit deterioration
• Capital Raise. We believe regulators will require PRK to raise equity to shore up capital at some point over the next 2 years. PRK is currently trying to raise $70 million in an ATM offering (at the market). PRK announced the offering on May 27 and through July 20 was only able to raise $10.5 million at $61.18/share.
• Future dividend cut seems likely as credit continues to deteriorate