Atlas Pipeline's Processing Problems

Atlas Pipeline Partners (APL) and Atlas Pipeline Holdings (AHD) have declined significantly recently over concerns about the margins at APL's processing plants.  A large percent of APL's income comes from the sale of natural gas liquids that the company strips out of the natural gas that flows through its pipelines.  At APL's processing plants unprocessed natural gas goes in and APL then burns a small amount of the natural gas to pull out the higher value natural gas liquids.   APL then sells the natural gas liquids and has to pay for the amount of natural gas that has been burned up in the process.  The problem APL has been facing recently is a rapid decline in the value of the natural gas liquids that it is selling.  The price of natural gas liquids is highly correlated with the price of oil.  As a result, as the price of oil falls APL's processing margins will decline.  Since hurricane Ike, the price of natural gas liquids has fallen even further than the oil price as many refineries have reduced their purchases of natural gas liquids as a fair number of the refineries are undergoing repairs.  Refineries are significant for the natural gas liquid market as they represent somewhere around 75% of the markets total.

When tracking APL's processing margins you need to look at two factors, the NGL-crude ratio and the price of crude.  I generally place the NGL-crude ratio at around 55%, which is a bit low by historical standards but a bit higher than the ratio currently.  As the impact of hurricane Ike wanes, I expect the NGL-crude ratio to improve back to around 55%. 

The following table gives an example of what sort of distributions to expect at different oil prices.

Average Oil price	Annual APL Distribution	Annual AHD Distribution
$85	$3.96	$2.04
$70	$3.20	$1.60
$60	$3.00	$1.30

 

There are a few points worth making about this table.  First, APL is hedged but APL is only partially hedged.  In hindsight, APL picked a poor time to repurchase its crude oil hedges earlier this year, in doing so the company has worsened APL's exposure to dropping oil and NGL prices.  On the way up crude outperformed NGLs and as a result APL's short derivative position were costing the firm a fair amount of money. 

Another point worth mentioning is that AHD's distribution holds up well when APL's annual distribution rate drops from $3.96 to $3.20.  This is because of how the IDR adjustment associated with the Anadarko purchase was structured.  At $3.96 per year, APL is paying $9.3M per quarter on its IDRs.  At $3.20 APL is paying $7M.  This is because the IDR adjustment cancelled the IDRs between $7M to $12M per quarter.  As a result, while APL is currently paying $9.3M per quarter it would have been paying $14.3M per quarter if not for the $5M per quarter IDR adjustment.  An annual rate of $3.20 at APL puts its IDR payment at $7M.  Below $7M per quarter, AHD's increased exposure is what you would expect.

If the price of oil averages below $85 for Q4, I would expect a cut in distributions at APL and AHD.  When the oil price recovers you can expect APL & AHD to recover to the level of their past glory.  Given time, AHD should return to being one of the fastest growing GPs as detailed in this article.

Another point worth mentioning is an issue Citigroup raised in a recent downgrade of APL.  Citigroup believes that APL could be in danger of violating the terms of a credit agreement if the price of oil averages below $60 for "an extended period of time."  This makes little sense to me, as even at $50 oil APL and AHD will continue to generate significant amounts of free cash flow.  MLPs are required by their credit agreements to maintain hedges with those companies in their lending group to stabilize cash flows and any significant modification to those hedges would need to be run by creditors before it could happen.  Even in a worst-case scenario, there is nothing preventing APL from maintaining a distribution significantly below its level of free cash flow and APL's partial hedge position should stabilize cash flow at a level that is capable of keeping its creditors happy.  Unlike some MLPs, APL has more than enough capacity available on its credit lines to fund its business and all planned expansions.  I expect management at APL to correct Citigroup on its credit agreement thesis at the next conference call.

Finally, Pioneer Natural Resources’ (PXD) option to acquire 14.5% of Midkiff-Benedum expires at the end of this year.  APL's guidance is based on PXD exercising its option.  However, in the current environment I wonder if PXD may choose not to exercise its option.  PXD may be able to instead acquire assets at better multiples from other parties rather than by acquiring another 14.5% interest in Midkiff-Benedum at multiples determined before the credit crisis began.  The best case scenario is for PXD to decline to exercise its option, as a result, guidance will likely need to be revised upwards.  The worst case scenario is that PXD exercises its option and that APL receives $150M to shore up its balance sheet as a result.

In the short term, I see reasons to be bullish on oil.  Longer term I think the fundamentals of the oil market will support significantly higher prices, once the economy recovers.  If you think that oil prices will recover, than you may want to be a buyer of APL or AHD at these levels. 

Is the Oil Market Reinflating?

I have been amazed to watch the price of oil crash from its peak of $147 to its recent low of $62.  If you read my prior article, you know that I believed that there were strong fundamental reasons that were driving the price of oil higher.  After oil prices collapsed 57% from their peak the main reason given as an explanation for its fall was the decline of oil consumption as the economy began to slow.  While this theory certainly holds true to some degree, I believe the driving factor in oil's decline has been the lack of liquidity in the marketplace rather than the declining consumption of U.S. businesses and consumers.

In the last six months, there have two major events that have impacted petroleum pricing.  These two events were the bankruptcies of Semgroup and Lehman Brothers.  As you can see from my chart Semgroup announced its bankruptcy on July 22, 2008.  This was only a week after oil prices peaked.  A few days before it declared bankruptcy Semgroup had a conference call with its creditors informing them of its problems.  As knowledge of Semgroup's problems spread, anyone doing business with Semgroup took steps to cease any relationship with what was one of the nations largest energy marketers and traders.  This counterparty risk created a bottleneck between energy producers and energy purchasers that prevented oil supply from reaching its end markets.

On September 15, 2008, we had our second major event, the bankruptcy of Lehman Brothers.  This bankruptcy seemingly came out of nowhere because everybody had expected the Treasury to step in and broker a purchase of Lehman Brothers as it had done with Bear Stearns.  Instead, the Treasury balked and allowed one of the nation's largest investment banks to fail.  As a result, oil tanked the next day before rallying.  Everything seemed fine for a couple of weeks as nobody could quite grasp the impact this would have on the US economy.  Then a couple weeks later the flow of credit stopped as fear of insolvency had crippled the ability of almost every financial institution to function normally.  Like all markets, the energy markets depend on credit to function, as most companies need credit to purchase oil inventories.  With the credit crunch in full swing, many players began to have problems obtaining financing.  This created yet another bottleneck in the nation's energy markets.

The ability of speculators and corporate entities to trade and own oil contracts was impacted by both of these events.  It is clear that if speculators are forced to liquidate long positions then oil prices are going to drop and the same can be said for corporate entities.  While the liquidity issue has become a major problem for the energy market the counterparty risk issue has also developed.  With the Semgroup and Lehman Brothers bankruptcies, anyone owning contracts that Semgroup or Lehman Brothers were counterparties to was in trouble as they were more likely then not no longer safely hedged. 

The first round of capital injections in the US banking system, while saving our nations banks will likely save the commodity market.  The bailout should eliminate the problems that are preventing the normal functions of the oil market, whose disruption was caused primarily by the bankruptcy of both Semgroup and Lehman Brothers.  So far, the behavior of the price of oil seems to be confirming this as the price of oil has rallied strongly from $63 on Monday.  Looking back, it is clear that the capital injection is also the most logical explanation for not only the rise of the stock market but the commodities as well. 

Disclosure: None

Don’t be Foolish: Buy National City

PNC Financial’s (PNC) purchase of National City (NCC) is an absolute travesty for National City shareholders and for the banks that chose to forgo a purchase of the Ohio lender.  The company’s recent quarterly report was fairly positive in my opinion as it showed a company that was well positioned to survive the current turmoil in the economy and the credit markets.  Of all the majors, National City had the highest capital ratio, at 10.98% at the end of the September quarter.  While loan losses were and still are a concern, the firm’s relatively strong capital position had caused me to believe that they would likely be one of the banking industry’s survivors and likely one of the new mega-regional banks to come out of the industry’s consolidation.

Unlike Washington Mutual (WM) and Wachovia (WB), National City has not experienced any deposit outflows and is still flush with liquidity, in fact, National City’s deposits actually increased in the most recent quarter when compared to the year ago quarter.  When this is coupled with the bank’s relatively strong capital base and the company’s $3.8B in loan loss provisions to non-performing assets of only $3.5B, the choice to sell the bank becomes even more cloudy.  Barring a run on the bank, National City could have continued on its own with current loss rates for another two years.  However, this would likely be a worst case scenario as loan loss provisions have already begun to decline at many of America’s banks, including National City, which saw loan loss provisions decline 25% from the preceding quarter.  

So why did National City sell?  Because it’s likely that it believed that it had no choice.  The Wall Street Journal does a wonderful job of providing a timeline of the National City sale and does a good job of alluding to the possibility that National City may not have been able to participate in the government’s capital injection program.  The Wall Street Journal then alludes to the possibility that this caused the bank’s executives to fear that the company’s stock would collapse along with its deposit base as shareholders and customers scrambled to withdraw cash.  Unfortunately, the government’s forced sale of National City succeeds in showing the investment community that it is taking its role as king maker in the banking industry too far.  There are many other smaller regional banks in far worse positions that could have been dealt with first, including such abject failures as Downey Financial (DSL), Bank United (BKUNA), Flagstar (FBC), AmTrust Bank (AFSI), Guaranty Financial (GFG) and Colonial BancGroup (CNB).  In forcing National City to sell itself, the government has shown the utterly arbitrary fashion by which it will decide who lives and who dies.  

Fortunately, for National City and its shareholders, the company was not seized and given that the stock is trading at nearly 20% below PNC Financial’s offering price, management should cancel the deal and attempt to go at it alone.  Given the bank’s large reserves and relatively healthy capital position, management would be negligent not to try, given the low offer from PNC Financial.  I would personally rather have the bank seized and take a total loss on my holdings then have it sold to PNC Financial at $2 dollars and change.  The bank’s large asset base, branch network, geographic concentration, Visa (V) stake, $6.6B in excess capital and $100B in deposits are diamonds in the rough and could if nothing else lead to a sale in several years for a much more significant sum then is currently being offered by PNC Financial.

In not purchasing National City, several banks are missing out on an acquisition that would be of tremendous benefit to their business models and their shareholders.   Should management not renege on the merge agreement I would not be surprised to see U.S. Bancorp (USB), Regions Bank (RF), BB&T (BBT), TD Bank (TD) and Bank of the West (BNPQY) seriously look at National City.  This will be especially true if the volatility in the financial markets decline in the weeks ahead.    

The two most compelling names, of those listed above, are TD Bank (TD) and Bank of the West (BNPQY) as it would provide these two companies with the opportunity for national expansion via the National City name.  Both BNP Paribas and Toronto Dominion have been looking at the U.S. for years and they would likely be able to pull off the acquisition without government assistance, which would be a boon for the Treasury Department.  Given the incredible attractiveness of National City at these price levels, these two international power houses could offer between $3 & $4 dollars a share in stock and still make their shareholders very happy in the years ahead. 

It is clear to me that the government’s botched involvement in National City is a sign of the dangers tied to the government’s bank bailout program.  Before mandating future sales, the Treasury and its agencies need to outline and publicly release the key metrics that have caused the government to request the bank’s sale.   

For Further Review:

WSJ Timeline of National City's Sale

National City's Visa Stake

National City 3rd Quarter Earnings

Disclosure: Long NCC @ 1.40 & Change

QRCP: At the Mercy of its Banks

Much to my chagrin I have had the unfortunate pleasure of watching one of my favorite stocks absolutely collapse this fall.  I first talked about Quest Resources (QRCP) back in May and have been positive on the company’s investment story since.  While I am more then aware that investing in the financial markets is always a risky proposition, I strongly believe that investors shouldn’t have to take managerial fraud into account when computing the risk/return of various investments.  For those who have not followed the company’s story, Quest Resources is the parent company of both Quest Energy Partners (QELP) and Quest Midstream (privately held), the company was generally doing well until its former CEO looted Quest Resources of over $10M dollars.  His actions caused the stock to crash and for Quest Resources and it’s subsidiaries to go into technical default on their credit agreements.  As a result, the Quest Resources story has turned into one that is focused entirely on liquidity and not the company’s underlying assets, which are primarily centered in the Cherokee Basin and the Marcellus Shale, I detailed these assets in May and June.

According to Quest Resources’ October update, the company has only a million dollars in cash and no available lines of credit.  In addition, the company has $33.5M in term loans that likely need to be reconfigured as a result of the former CEO’s actions.  Furthermore, the company is required to conduct $11M dollars in drilling before the end of the quarter or it will risk losing 15K acres of its 122K total acres in the Marcellus Shale due to lease violations.  The company’s other primary but illiquid assets are its ownership of 100% of the general partnership of Quest Energy Partners and 57% of the company’s limited partnership units, in addition to, 85% of Quest Midstream’s general partnership and 36% of its limited partnership units.    

Quest Energy Partners (QELP) is in slightly better shape as it has more financial breathing room.  At the time of the October update the company had $9M dollars in cash on hand, $228M in debt and $7M in undrawn lines of credit.  Unfortunately, the company is currently experiencing issues with its ability to sell the natural gas that it produces for a price that resembles those quoted in New York.  This is likely as a result of the hurricanes, SemGroup’s issues and the fallout in the credit market as it relates to the hedging that companies can or cannot undertake with quality counterparties.  I am hoping that the issue of pricing is resolved as we move into the fourth quarter. 

Quest Resources’ second subsidiary is its midstream unit.  The company had been planning to take this subsidiary public; however, with the markets what they are this will not be happening in the immediate future.  As a result, Quest Resources has violated its agreement with its joint investors and could be forced to sell the unit.  While this would not necessarily be a bad thing, it would disrupt the traditional MLP structure. 

The one saving grace for the whole organization will be whether or not Quest Energy Partners is able to pay its third quarter distribution of $0.43 cents a unit sometime during the month of November.  If the company can convince the banks to let it pay the distribution, the liquidity issues at Quest Resources will ease immensely.  Should this distribution occur it will cause a significant turnaround in Quest Resources’ share price as it will signify to stockholders that bankruptcy and/or a highly dilutive capital raise is no longer on the table.   

As I mentioned in an earlier article, the majority of MLPs can reduce their capital expenditures to next to nothing and essentially go into “run down” mode if they are unable to tap the equity and debt markets for capital to grow.  I would hope that this is what all three of the Quest companies have already begun to do.  If I were Quest Resources, I would feel more then comfortable losing the 15K acres in the Marcellus Shale if it meant that I could conserve $10M dollars that would otherwise go to drilling and instead use it to pay down debt.

The bottom line is this, if you do not already have a position, I would recommend researching it further so that you could potentially take a small speculative position. If you already own shares and feel comfortable buying more, I would take a look at the company's recent release and then decide if you were ready to lose your position entirely, should Quest Resources not receive  its distribution from Quest Energy Partners.      

For Further Review:

Quest Resources' Investor Relations

Disclosure: Long QRCP

Six Months of Prudent Speculations

October 21^st marks the six-month anniversary of Prudent Speculations.  It has been a great adventure and it has helped me to solidify my own personal investment thesis on many of the stocks that I personally follow.  In the six months that I have been operating the blog I have had nearly 15,000 visitors from every state of the Union and from over 90 countries. 

While it has been difficult at times to keep the blog as up-to-date as I would have liked with my commitments to the real world, it has nonetheless been well worth every ounce of my effort.  Prior to starting Prudent Speculations, I had been a long time reader of financial blogs via SeekingAlpha.com and as a result I have come to greatly appreciate all the work that the bloggers in the investment community put forth so that we may all be a little more educated on the relevant topics of our times.  For all those that have ever thought of starting a financial blog to talk about investing, the economy or their general opinions on the state of the financial markets, I would highly encourage it as we all benefit from each others efforts.  Below I have compiled some of my favorite articles, for those new to Prudent Speculations, these articles would be a great place to start if you ever wanted to get a sense of the type of investor that I am.

Top Five Blog Posts by Number of Visitors

1. Resource America: Unfairly Punished by the Credit Crunch
2. Finding Value in Atlas America (ATLS)
3. Finding Morgan Stanley’s Suitor
4. The “Texas Ratio” and FirstFed Financial
5. Multiple, Margin Expansion at Dow Chemical    

My Favorite Blog Posts

1. What Have You Done Jamie Dimon?
2. Midstream MLPs: Defensive Sector Crashing with the Market
3. Defining the California Ratio
4. Quest Resources: A Marcellus shale Sleeper Play & More
5. Understanding First Marblehead’s Bank
6. From Blue Chip to Mediocrity: The AIG story   

Notable Mentions of Prudent Speculations in the "Official" Media

1. Portfolio.com’s WaNo
2. Portfolo.com’s All the Way to the Banks
3. Thestreet.com’s Is Cramer Underestimating Atlas Energy?
4. Yahoo Finance’s The Week’s Best Stock Blogs

In the next six months, I hope that I will be able to expand the number of postings that I have been putting up while maintaining the same kind of quality that I believe has been a characteristic of my postings during my first six months.  To all of those that have subscribed by Feedburner, Email or SeekingAlpha, I want to let you know how much I appreciate you taking the time to read my ramblings on a semi frequent basis.  Feel free to reach out to me at the blog's email, which can be found on the left sidebar.  

Going forward, in an effort to provide a public forum by which my performance can be tracked, I have set up a virtual account at the updown.com, a widget can be found at the bottom of this webpage that should show the performance of this mock account.  Generally speaking, I will divide the mock account into 20 separate holdings.  These stocks will be ones that I have talked about in the blog and others that I find attractive.  Please shoot me an email for the updated list of stocks in the mock account.  Best of luck to all in these trying times and I hope that you continue to make Prudent Speculations a part of your investment research.  

Buying the Market Bottom

The intraday bounces that occurred on Friday the 10^th and on Thursday the 16^th have likely gone a long ways to forming a double bottom in the stock market.  Should the markets be able to hold the intraday lows on these two respective dates in the coming days we will likely have established a near and potentially long term bottom in the stock market.  Given the many opportunities that are available right now, investors would be remiss if they did not put some of their capital that is currently sitting on the sidelines into sound large cap value companies.   

I know that we have been through a very rough month on top of an already rough year but the news stream and the realities of the world appear to be changing.  In particular, something wonderful has begun to happen over the last several days in that it appears as if the financial news flow has shifted from a focus on the credit crunch to the worsening economy.  This is a relief to me as it shows that we are moving past the crisis stage that was associated with the many near panics that occurred over the last several weeks.  There are far fewer variables to account for in a worsening economy then with a collapse of the credit markets and I would much rather be investing in a poor economy then in one where the investment community is continually guessing which financial institution will fail next.

There are four companies that stand out to me as great investments during an uncertain economic environment.  All of these companies are sound value investments with extremely low P.E. ratios, sound dividends and safe market positions.

The first company I have to recommend is Dow Chemical (DOW), I have previously given a detailed break down of my take on Dow Chemical and that can be found here.  With the significant decline in the price of oil, Dow Chemical, as I suggested in my earlier post, should be doing quite well this quarter.  While domestic demand destruction is a concern, higher prices, lower raw material costs and positive international growth should continue to drive the company going forward.  With a P.E. of 8 and a dividend yield of nearly 7% it is hard to see this trade not being profitable over the long term. 

The second company I have to recommend is AT&T (T), the company with its strong cash flow, healthy balance sheet and absolutely dominate market position is a perfect investment in times like these.  With the beating that it has taken over the last several months the stock is currently trading at its lowest level since 2005 and with a dividend yield of over 6% and a P.E. of only 11 the stock is likely safer then Treasuries.

The third stock that I really like at these levels is CBS (CBS), the company will likely have significant advertising issues going forward but like my previous two recommendations it is an absolute steal at these levels. With a P.E. in the mid single digits and a dividend yield well above 10%, it’s hard to believe that this company is even a blue chip, but it is.  With solid dividend coverage, ability to leverage up the balance sheet and the ability to sell off numerous assets to enhance shareholder value it’s hard to see how the stock could go much lower.   

The final stock that I have to recommend is the defensives stalwart Reynolds American (RAI), the stock is not nearly as leveraged up as Altria (MO) giving it increased financial flexibility when it comes to share buybacks, dividends and acquisitions.  With a P.E. of 8 and a dividend yield of 8 percent one is assured of above market returns for the foreseeable future.

In owning these names, investors will be able own four companies with an average P.E. of 8 and a dividend yield of nearly 8%.  In addition investors will know that they are investing in companies that make up the backbone of the economy and that provide essential services that will likely not be trimmed by consumers and businesses during a recession, even if it should be severe.   

For those interested, buysellshort.com does a nice job of discussing the technical aspects of the markets recent double bottom.  The first three minutes of the video are the most relevant for our conversation. 

Disclosure: LONG T, DOW & CBS

US Capital Injections Place Banks on Solid Ground

The U.S. government's capital injection into our country's banking system via the government's purchase of preferred shares of publicly traded bank holding companies will prove to be a significant event in the historical timeline of the current financial crisis.  It will mark the point at which our financial system was saved from certain self inflicted destruction by a government unwilling to usher in a prolonged dark era in the economic development of the United States.  The government's initial $250 billion dollar investment in the countries largest banks will be significant in that it will dramatically strengthen the balance sheets of the companies that hold the vast majority of the banking systems assets and deposits. Nevertheless, Treasury officials should move quickly to boost the capital levels at the country's regional and foreign subsidiary banks as they are likely more challenged by liquidity issues then their larger money center peers.  In looking at the country's largest banks and thrifts by total assets as of 6/30/08 (the most recent date that the data is available from the FDIC) we can see that the country's 100 largest bank holding companies had over 9.8 trillion dollars in assets at their bank subsidiaries.  In the second chart you will see the remaining banks after the various subsidiary companies are accounted for and consolidated into their parent companies and finally I will turn to a discussion of the country's regional banks that are included in the FDIC's list of the top 100 banks and thrifts in the U.S.   

Top 100 Banks & Thrifts
As of 6/30/2008
100 Total Banks

Institution Name	Ticker	Total Assets($000)
JPMorgan Chase Bank	JPM	1,378,468,000
Bank of America	BAC	1,327,429,079
Citibank	C	1,228,445,000
Wachovia Bank	WB	670,639,000
Wells Fargo Bank	WFC	503,327,000
U.S. Bank	USB	242,307,928
HSBC Bank USA	HBC	177,466,246
SunTrust Bank	STI	171,500,853
FIA Card Services	BAC	165,349,652
National City Bank	NCC	151,164,598
Regions Bank	RF	139,353,930
State Street Bank & Trust Co.	STT	138,858,742
Branch Banking and Trust Co.	BBT	132,884,104
RBS Citizens	RBS	132,050,955
The Bank of New York Mellon	BK	130,062,000
PNC Bank	PNC	128,348,405
Countrywide Bank	BAC	116,384,145
Capital One	COF	108,520,315
TD Bank	TD	98,855,014
Keybank	KEY	98,047,883
ING Bank	ING	79,464,958
Sovereign Bank	SOV	79,189,002
Wachovia Mortgage	WB	76,795,109
Citibank (South Dakota)	C	75,004,087
Chase Bank USA	JPM	74,462,629
LaSalle Bank	BAC	68,378,716
Fifth Third Bank	FITB	67,272,497
Comerica Bank	CMA	65,961,348
The Northern Trust Co.	NTRS	65,199,779
Manufacturers
& Traders Trust Co.	MTB	65,079,643
Bank of the West	BNPQY	63,262,439
Compass Bank	BBVA	61,067,148
Union Bank of California	MTU	60,227,793
Merrill Lynch Bank USA	BAC	58,042,116
M&I Marshall and Ilsley Bank	MI	57,686,276
The Huntington National Bank	HBAN	54,842,484
Fifth Third Bank	FITB	54,160,865
Hudson City Savings Bank	HCBK	49,149,097
E*TRADE Bank	ETFC	46,708,354
Deutsche Bank Trust Co.	DB	46,071,000
Harris	BMO	41,592,254
Mellon Bank,	BK	39,476,494
Bank of America, Rhode Island	BAC	39,211,041
Morgan Stanley Bank	MS	38,530,000
Citizens Bank of Pennsylvania	RBS	38,174,843
LaSalle Bank Midwest	BAC	37,642,708
First Tennessee Bank	FHN	35,286,528
GMAC Bank	GM	31,935,992
USAA Federal Savings Bank	-	31,539,259
Capital One Bank (USA)	COF	31,301,809
RBC Bank (USA)	RY	31,263,091
Merrill Lynch Bank & Trust Co.	BAC	31,094,658
Discover Bank	DFS	30,501,647
Wells Fargo Bank South Central	WFC	29,769,000
New York Community Bank	NYB	29,006,619
Wachovia Bank, FSB	WB	27,992,417
UBS Bank USA	UBS	27,316,033
Banco Popular de Puerto Rico	BPOP	26,101,000
Colonial Bank	CNB	25,986,562
Goldman Sachs Bank USA	GS	25,726,832
American Express Centurion Bank	AXP	25,348,661
American Express Bank, FSB.	AXP	25,024,015
Associated Bank	ASBC	22,059,071
Charles Schwab Bank	SCHW	21,608,387
Astoria Federal
Savings & Loan Association	AF	21,598,603
Zions First National Bank	ZION	20,195,316
Citicorp Trust Bank, fsb	C	19,634,564
Bank of America California	BAC	19,469,401
People's United Bank	PBCT	18,734,368
Firstbank of Puerto Rico	FBP	17,841,107
Webster Bank	WBS	17,351,831
TD Bank USA	TD	17,329,254
Westernbank Puerto Rico	WHI	17,081,956
TCF National Bank	TCB	16,468,963
State Farm Bank, F.S.B.	-	16,152,741
Bank of Oklahoma	BOKF	16,092,004
City National Bank	CYN	15,970,869
Guaranty Bank	GFG	15,937,098
AmTrust Bank	AFSI	15,898,116
Commerce Bank	CBSH	15,592,314
GE Money Bank	GE	15,392,648
Chevy Chase Bank, F.S.B.	-	14,913,528
Flagstar Bank, FSB	FBC	14,567,785
Wells Fargo Bank Northwest	WFC	14,470,000
MidFirst Bank	-	14,217,588
BankUnited, FSB	BKUNA	14,200,460
Carolina First Bank	TSFG	13,937,707
The Frost National Bank	CFR	13,796,772
First-Citizens Bank & Trust Co.	FCNCA	13,539,818
BancorpSouth Bank	BXS	13,394,684
First Hawaiian Bank	BNPQY	13,026,627
Valley National Bank	VLY	12,965,879
Banco Popular North America	BPOP	12,871,285
United Commercial Bank	UCBH	12,851,854
Bank of America Oregon	BAC	12,721,850
Downey Savings and Loan Assoc.	DSL	12,630,056
Citizens Bank	RBS	12,372,252
Sterling Savings Bank	STSA	12,215,752
Amegy Bank	ZION	12,135,590
Washington Federal Savings &
Loan Association	WFSL	11,794,035

______________________

Top Banks After Parent-Subsidiary Consolidation & Recent Mergers

As of 6/30/08
73 Total Banks
Institution Name	Ticker	Total Assets($000)
Bank of America	BAC	1,856,253,965
JPMorgan Chase Bank	JPM	1,452,930,629
Citibank	C	1,323,083,651
Wells Fargo Bank	WFC	1,322,992,526
U.S. Bank	USB	242,307,928
RBS Citizens	RBS	182,598,050
HSBC Bank USA	HBC	177,466,246
SunTrust Bank	STI	171,500,853
The Bank of New York Mellon	BK	169,538,494
National City Bank	NCC	151,164,598
Capital One	COF	139,822,124
Regions Bank	RF	139,353,930
State Street Bank and Trust Co.	STT	138,858,742
Branch Banking and Trust Co.	BBT	132,884,104
PNC Bank	PNC	128,348,405
Fifth Third Bank	FITB	121,433,362
TD Bank	TD	116,184,268
Keybank	KEY	98,047,883
ING Bank	ING	79,464,958
Sovereign Bank	STD	79,189,002
Bank of the West	BNPQY	76,289,066
Comerica Bank	CMA	65,961,348
The Northern Trust Company	NTRS	65,199,779
Manufacturers and Traders Trust Co.	MTB	65,079,643
Compass Bank	BBVA	61,067,148
Union Bank of California	MTU	60,227,793
M&I Marshall and Ilsley Bank	MI	57,686,276
The Huntington National Bank	HBAN	54,842,484
American Express Bank	AXP	50,372,676
Hudson City Savings Bank	HCBK	49,149,097
E*TRADE Bank	ETFC	46,708,354
Deutsche Bank Trust Company	DB	46,071,000
Harris National Association	BMO	41,592,254
Banco Popular de Puerto Rico	BPOP	38,972,285
Morgan Stanley Bank	MS	38,530,000
First Tennessee Bank	FHN	35,286,528
Zions First National Bank	ZION	32,330,906
GMAC Bank	GM	31,935,992
USAA Federal Savings Bank	-	31,539,259
RBC Bank (USA)	RY	31,263,091
Discover Bank	DFS	30,501,647
New York Community Bank	NYB	29,006,619
UBS Bank USA	UBS	27,316,033
Colonial Bank	CNB	25,986,562
Goldman Sachs Bank USA	GS	25,726,832
Associated Bank	ASBC	22,059,071
Charles Schwab Bank	SCHW	21,608,387
Astoria Federal	AF	21,598,603
Savings and Loan Association
People's United Bank	PBCT	18,734,368
Firstbank of Puerto Rico	FBP	17,841,107
Webster Bank	WBS	17,351,831
Westernbank Puerto Rico	WHI	17,081,956
TCF National Bank	TCB	16,468,963
State Farm Bank	-	16,152,741
Bank of Oklahoma	BOKF	16,092,004
City National Bank	CYN	15,970,869
Guaranty Bank	GFG	15,937,098
AmTrust Bank	AFSI	15,898,116
Commerce Bank	CBSH	15,592,314
GE Money Bank	GE	15,392,648
Chevy Chase Bank	-	14,913,528
Flagstar Bank	FBC	14,567,785
MidFirst Bank	-	14,217,588
BankUnited	BKUNA	14,200,460
Carolina First Bank	TSFG	13,937,707
The Frost National Bank	CFR	13,796,772
First-Citizens Bank & Trust Co.	FCNCA	13,539,818
BancorpSouth Bank	BXS	13,394,684
Valley National Bank	VLY	12,965,879
United Commercial Bank	UCBH	12,851,854
Downey Savings and Loan Assoc.	DSL	12,630,056
Sterling Savings Bank	STSA	12,215,752
Washington Federal
Savings and Loan Association	WFSL	11,794,035

In addition to consolidating the 100 largest banks with their respective parent companies, we must also remove from the list the foreign bank subsidiaries that are operating in the United States as it will likely be more difficult for the Treasury to take preferred share positions in them then U.S. domiciled regional banks.   Of the banks that compose the 100 largest U.S. banks by assets, the 13 foreign banks on the list account for a over 1 trillion in assets.  While these banks should be in sound shape as a result of their separate capital structures and parent companies that are once again healthy they will likely still need the assistance of the U.S. government to navigate the credit crisis as they were some of the biggest buyers of mortgage backed securities.  As a result of the complexities that come along with investing in foreign subsidiaries the Treasury should turn its primary attention and the majority of the its pocketbook to purchasing preferred stock in the countries largest regional banks.   After the removal of domestic subsidiaries and foreign bank subsidiaries we are left with the country's 49 largest regional banks with total assets of over $2.3 trillion, the list of these 49 regional banks can be found below the list of the foreign bank subsidiaries, which is below.  It should be noted that the list of the U.S.'s 49 largest regional banks excludes the banks that have already received capital injections from the government.      

Foreign Bank Subsidiaries As of 6/30/08
13 Total Banks

Institution Name	Ticker	Total Assets($000)
RBS Citizens	RBS	182,598,050
HSBC Bank USA	HBC	177,466,246
TD Bank	TD	116,184,268
ING Bank	ING	79,464,958
Sovereign Bank	STD	79,189,002
Bank of the West	BNPQY	76,289,066
Compass Bank	BBVA	61,067,148
Union Bank of California	MTU	60,227,793
Deutsche Bank Trust Company	DB	46,071,000
Harris National Association	BMO	41,592,254
Banco Popular de Puerto Rico	BPOP	38,972,285
RBC Bank (USA)	RY	31,263,091
UBS Bank USA	UBS	27,316,033

______________________

Consolidated Public, Non-Foreign Banks, With No Government Capital Injection
As of 6/30/08
49 Total Banks

Institution Name	Ticker	Total Assets($000)
U.S. Bank	USB	242,307,928
SunTrust Bank	STI	171,500,853
National City Bank	NCC	151,164,598
Capital One	COF	139,822,124
Regions Bank	RF	139,353,930
Branch Banking and Trust Co.	BBT	132,884,104
PNC Bank	PNC	128,348,405
Fifth Third Bank	FITB	121,433,362
Keybank	KEY	98,047,883
Comerica Bank	CMA	65,961,348
The Northern Trust Company	NTRS	65,199,779
Manufacturers and Traders Trust Co.	MTB	65,079,643
M&I Marshall and Ilsley Bank	MI	57,686,276
The Huntington National Bank	HBAN	54,842,484
American Express Bank	AXP	50,372,676
Hudson City Savings Bank	HCBK	49,149,097
E*TRADE Bank	ETFC	46,708,354
First Tennessee Bank	FHN	35,286,528
Zions First National Bank	ZION	32,330,906
GMAC Bank	GM	31,935,992
Discover Bank	DFS	30,501,647
New York Community Bank	NYB	29,006,619
Colonial Bank	CNB	25,986,562
Associated Bank	ASBC	22,059,071
Charles Schwab Bank	SCHW	21,608,387
Astoria Federal	AF	21,598,603
Savings and Loan Association
People's United Bank	PBCT	18,734,368
Firstbank of Puerto Rico	FBP	17,841,107
Webster Bank	WBS	17,351,831
Westernbank Puerto Rico	WHI	17,081,956
TCF National Bank	TCB	16,468,963
Bank of Oklahoma	BOKF	16,092,004
City National Bank	CYN	15,970,869
Guaranty Bank	GFG	15,937,098
AmTrust Bank	AFSI	15,898,116
Commerce Bank	CBSH	15,592,314
GE Money Bank	GE	15,392,648
Flagstar Bank	FBC	14,567,785
BankUnited	BKUNA	14,200,460
Carolina First Bank	TSFG	13,937,707
The Frost National Bank	CFR	13,796,772
First-Citizens Bank & Trust Co.	FCNCA	13,539,818
BancorpSouth Bank	BXS	13,394,684
Valley National Bank	VLY	12,965,879
United Commercial Bank	UCBH	12,851,854
Downey Savings and Loan Assoc.	DSL	12,630,056
Sterling Savings Bank	STSA	12,215,752
Washington Federal	WFSL	11,794,035
Savings and Loan Association

JPMorgan, Bank of America, Wells Fargo, Citigroup, The Bank of New York & State Street, with combined assets on 6/30/08, including their recent acquisitions, of 6.1 trillion represent the backbone of the American financial system.  Their 6.1 trillion in total assets clearly represent the majority of the assets of the American banking system, especially when compared to the 2.3 trillion of assets held by the country's 49 largest U.S. domiciled regional banks.  While this raises significant concern of deposit concentration, as I talked about here, it shows us how far we have come in the last week to now be able to say that our country's six largest financial institutions are now completely and utterly sound with the explicit backing of the world's most influential financial backer and lender of last resort.  In expanding its preferred share purchases to the regional banks the U.S. government can succeed in bringing about one of the greatest rallies in the financial markets of all time as a hand cuffed economy begins to come back to life, driven by banks willing, eager and capable of providing the credit needed to drive the economy of America.

In order to ensure that these preferred purchases will not be viewed as a sign of weakness for the regional banks that take the governments money, Paulson & Co. must mandate that all of the 49 largest regional banks and if possible the 13 largest foreign subsidiaries all sell preferred stakes to the government.  If this display of unity were to be taken it would not be surprising at all to see a further rally in the market as it would show to the investment community that all of the U.S.'s 100 largest financial institutions composing the vast majority of the country's total banking assets are completely sound.   

For Further Review:

NYT's Article on Capital Injection

FDIC's Website

Disclosure: Long NCC

Midstream MLPs: Defensive Sector Crashing with the Market

As we all know, the entire market has been crashing in recent weeks.  The price action in the MLP sector has been no different.  However, unlike many sectors that have been crashing the businesses of Midstream MLPs are very defensive in nature.  Midstream MLPs can be characterized as having stable cashflows that are backed up by either fees based an the volumes of oil, gasoline or natural gas moved through pipelines or hedges that are used to stabilize the fairly stable cash flows of processing plants.  Under even a severe recession people will still need to drive to work, heat their homes and turn on their lights.  Midstream MLPs will continue to serve this need by transporting the energy we need to survive.  This idea was recently confirmed by the management of Crosstex Energy LP (Nasdaq:XTEX) on October 2 during their conference call to discuss the impacts of Hurricane Ike.  Below is management’s statement on the matter:

"We think that we have a great set of assets in a diverse area in the best of producing areas and those assets are going to continue to perform well. We’re still serving a necessary piece of the industry. We’re getting gas to market. The market is going to continue to demand this gas supply with a link to the source. So we feel good about that"

The one Achilles heel of midstream MLPs is that they are highly dependant on the capital markets to finance growth projects.  But midstream MLPs are not dependent on capital markets to operate their assets.  This was recently confirmed by management of Crosstex Energy LP (XTEX).  Here is what Crosstex's management said about this issue.

"We think Wall Street is doing a poor job of distinguishing between companies that need capital to execute a growth plan versus those that need capital to survive. We are clearly in the former group."

Once pipelines, processing plants or storage tanks are in place the amount of capital required to operate them is very low.  Most midstream MLPs continue to have significant amounts of their credit lines undrawn but they will nonetheless likely be deferring growth projects in the current environment as the long-term credit markets are no longer functioning.  Nevertheless, there will continue to be a large need for new midstream infrastructure in the United States, as significant new infrastructure is needed to support the production growth of the North American shale plays.

Midstream MLP cash flows fall into one of two groups.  Fee based contracts and price based contracts.  While both groups are defensive in nature, some types of midstream assets produce cash flows that are more secure than others are.  Pipelines with fee-based contacts are oil pipelines, gasoline pipelines and large interstate or intrastate natural gas pipelines.  These fee based contracts charge based on the volume of product that they transport, not the price.  These fees are raised every year based on the Producer Price Index.  These companies can be considered the toll roads of America’s energy infrastructure.  

Oil and refined product pipelines have a little economic exposure as the consumption of gasoline has dropped between 3%-4% over the last year.  Whether this trend continues now that gasoline prices have dropped is unknown but a recession certainly will not help gasoline consumption.  Fortunately, the annual rate increases have more than made up for the slight drop in volume.  Under normal circumstances, rate increases result in steadily increasing cash flows.  Under these circumstances rate increases are keeping cash flows stable for oil and gasoline pipelines. My favorite pick in this area is NuStar GP Holdings LLC (NYSE:NSH) with a 10% yield.  Under normal circumstances, I would expect NSH to be able to grow distributions at 20% per year for the next few years.

Intrastate natural gas pipelines are the most stable type of asset in the midstream MLP universe.  Natural gas consumption is still rising as the United States slowly migrates towards generating more of its electricity from natural gas and less from coal.  There is a shortage of this type of pipeline as in many areas of the United States as natural gas is essentially trapped in producing basins with a lack of pipeline capacity to transport it out.  Interstate natural gas pipelines also have annual rate increases based on the producer price index so this type of asset should continue its cash flow growth even during a severe recession.  My favorite pick in this area is Energy Transfer Equity (NYSE:ETE) with a 12.5% yield.  Under normal circumstances, I would expect ETE to grow its distribution 20% per year for the next few years.

The final area within fee based contracts is storage assets.  Oil or gasoline storage cash flows are very similar that that of oil or gasoline pipelines.  Natural gas storage cash flows are similar to those of natural gas pipelines.  Storage assets also have rates that adjust for inflation.  Even during the best of economic times, storage assets typically have little growth.

The third type of assets are natural gas gathering and processing assets.  These assets have some commodity exposure as cash flows are tied to the price of natural gas or natural gas liquids.  Gathering pipelines charge a percent of the value of the natural gas they move, as a result they are long natural gas.  While processing plants burn some natural gas (methane) to extract the natural gas liquids (propane, butane, isobutane etc.), which they keep and sell, processing plants must then purchase the amount of natural gas (methane) they burned during the processing.  So processing plants are long natural gas liquids and short natural gas.  The pricing of natural gas liquids is highly correlated with oil prices.  Midstream MLPs hedge the cash flows of gathering and processing assets with derivatives for what is typically a rolling three-year period.  If gas and oil prices are significantly lower three years from now, these assets will continue to be profitable, as the costs of operation are very low but they will be less profitable than they are today.  My favorite pick in this area is Markwest Energy Partners (NYSE:MWE) with a 14.8% yield.  Markwest Energy Partners has been guiding for 15% to 20% distribution growth over the next 12 months.

Recently Warren Buffett purchased preferred shares of General Electric (NYSE:GE) and Goldman Sachs (NYSE:GS) that yield 10%.  The median Midstream MLP yield is somewhere around 12%.  Given their general stability, I view MLPs as better defensive holdings when compared to these two companies.  Typically, midstream MLPs retain a portion of the distributable cash flow to ensure stable distributions and most MLPs only distribute between 70% to 90% of their available distributable cash flow to ensure that they have this margin of safety.  In addition, it is important to remember that if inflation picks up in the future MLPs may do much better than Buffett's GE or Goldman preferred shares as MLPs have the ability to pass any inflation through to the rates they charge, whereas Buffett's preferred shares have fixed dividends.

So, you are probably asking if midstream MLPs are so stable and defensive why are their yields so high and why have unit prices declined with the rest of the market? Citigroup Global Markets addressed this question in a recent report on October 8.  Here is Citigroup’s statement on the subject:

"This type of volatility in a sector with defensive characteristics leads us to believe that fundamentals and valuations are being completely ignored in the near term as fear and forced liquidations by distressed hedge fund investors seem to be the primary drivers of recent unit price performance." 

Wachovia Capital Markets and Lehman Brothers (now owned by Barclays) have also reached the same conclusion.  Jim Cramer has also recently recommended Kinder Morgan Energy Partners LP (NYSE:KMP) and Enterprise Products Partners LP (NYSE:EPD) as defensive stocks that pay high dividends in comparison to their underlying asset value.  On October 8, Kinder Morgan Energy Partners raised its distribution 3%, suggesting that MLPs truly are defensive investments in difficult times.  Here is what the firm’s Chairman and CEO Richard Kinder had to say about the business environment.

"While no company is 100 percent immune to external conditions, KMP continues to demonstrate that our diversified portfolio of stable assets is capable of generating consistently strong cash flow even in extremely difficult market conditions"

ONEOK Partners LP (NYSE:OKS) TEPPCO Partners LP (NYSE:TPP) Enterprise Products Partners LP (NYSE:EPD) and Global Partners LP (NYSE:GLP) have all raised their distributions and made similar comments in the past week.  As I write this there have only been five midstream MLPs to announce distributions so far this quarter and all have increased their distributions.  In the coming days I expect announcements of distribution increases and similar comments from virtually all midstream MLPs as the economic downturn should have little effect on cash flows in the sector.

For Further Review:

Citigroup Report