Category Crypto Economics

An Alternative to the Order Book as the Market Design of a Crypto-Economic Trading Platform

In a crypto-economic trading platform:

  • “The network becomes the exchange”
  • Snapchat (ephemeral) bid-asks
  • User-defined smart contracts

The order book is a market design for the exchange of goods and assets.  It dates back to the European coffee houses of the late 1600s.  In London, Jonathan’s Coffee House was a significant meeting place for traders in London in the 1700s. It later became the site of the first London Stock Exchange.

In the late 1700s, in what later became known as New York City, Dutch traders met at a Buttonwood tree in lower Manhattan island to buy and sell goods coming into the port.   Now know as Wall Street, this location became the center of financial asset exchange in the United States.

Until the 1970s, stock exchanges were characterized by a market design involving traders gathering around pits with specialists manually matching bids and asks in paper order books (see below).

The great financial economist Fisher Black wrote a prophetic article in 1971 called “Toward A Fully Automatic Stock Exchange”   where he laid out the implications of the coming automation of the manual order book.  He speculated on what the computerization of the order book would mean for bidding mechanisms, liquidity and overall stock market efficiency.

Screenshot of Bid-Ask Order Book of Poloniex

Market design, indeed all design related to computers, is coupled tightly to the computer technology itself.  Just because one design is associated with a particular computer technology does not mean that the same design should be mindlessly carried over when the computer technology changes.

We recall the mindless carry over of the 80 character line limit established by IBM for punch cards in the 1920s to cathode ray tube (CRT) terminals in the 1970s.

There is a whole host of other instances of mindless carry over of designs when the technology changes.  One notable example is the organization of the factory floor after the conversion of machine power from a centralized shaft driven by water to decentralized electric power.

In the last several years, there has emerged a new decentralized, peer-to-peer (p2p) paradigm in computer architecture propelled by several trends — Internet of Things (IoT), autonomous vehicle-to-device (v2x) communication, and crypto.

This change demands a rethinking of the appropriateness of the centralized client-server order book market design in a crypto-economic platform.

The trend away from client server architecture is driven by a need to do more raw compute “at the edge” before sending data to the server for storage and higher order analytics.  This is known as “edge computing.”  The use cases for edge computing are Internet of Things (IoT) and autonomous vehicle-to-device (V2X) communication.

The trend away from client server architecture is also driven by the tremendous interest in Bitcoin, Blockchain and Ethereum.  Interest in crypto could be the start of a paradigm shift away client server financial intermediaries earning opaque rents and toward decentralized, trustless p2p protocols for validating and accounting for the exchange of financial assets.

A true true, decentralized crypto-economy involves not only a DLT layer but also high speed transaction layer. 

The thesis of this paper is that the time is now to consider a transaction layer with a true decentralized market design.

We believe that publish-subscribe will be the leading protocol of the transaction layer as it has already been deployed at scale an the platform behind several MMO games (from MZ) and chat platforms (WhatApp from Facebook, WeChat from TenCent).

 What is needed is an innovative p2p market design.  It could be along the lines a many-to-many, high frequency “take it or leave it” (TIOLI) publish-subscribe mechanism which could also be described as a discrete time, many-to-many, high frequency version of the Myerson auction.

Value Proposition:

  • user-defined contracts ( e.g. options with odd expiration dates, long-short pairs, straddles)
  • tokens earned by peers supplying liquidity spread contracts
  • elimination of latency rents going to HFT and server co-location fees going to exchange
  • elimination of “data ownership” rents earned by exchange

Specification suggestions:

  • high frequency, many-to-many, pub-sub protocol
  • messages in form of  Myerson “take it or leave it” (TIOLI) bid-asks
  • “serverless” with ephemeral matching with-in Redis-like in-memory data structure store, used as a database, cache and message broker.
  • ephemeral bid-ask data, only data “owned” is history of matches.
  • discrete time, batch process (i.e. events) following  Eric Budish’s work on continuous time design flaw in  HFT platforms 
  • third party AI bid bots
  • third party custodial services
  • settlement a function of DTL layer

Companies with pub-sub platforms

  • Satori (formerly MZ)
  • Facebook (WhatsApp)
  • TenCent (WeChat)
  • Google (Cloud Pub/Sub)

Some relevant URLs

Gabe Leydon, CEO Satori (MZ) TokenPost Interview During Korea Blockchain Open Forum,  July, 2018 https://www.youtube.com/watch?

Satori’s “AI Mesh network” transaction layer  stats — 500 Million “messages” per second or 1 million publishers sending 100 bytes a second 

Hadera Hashgraph’s DLT stats — 500,000 transactions per second with 100% consensus based on a “gossip of gossip protocol” and a consensus latency of 3.5 seconds.

Eric Budish, The Design of Financial Exchange, Some Open Questions at the Intersection of Econ and CS.  Simons Institute of Computing UCB, November 2015 https://www.youtube.com/watch?v=Rilv2AJ1TWM

Eric Budish, “Will the Market Fix the Market?”, AEA/AFA Joint Luncheon Talk, January 2017 https://www.aeaweb.org/webcasts/2017/luncheon

Albert “Pete” Kyle, “Continuous Auctions and Inside Trading”, Econometrica, November 1985   https://www.rhsmith.umd.edu/files/Documents/Centers/CFP/research/kyle1985.pdf

Albert “Pete” Kyle, “The Changing Nature of Trading Markets”, U of Maryland Conference,  May 2017 https://www.rhsmith.umd.edu/files/Documents/Centers/CFP/2017/kyle.pdf

Fisher Black, Toward A Fully Automatic Stock Exchange, 1971  http://17mj9yvb9fl2p5m872gtgax5.wpengine.netdna-cdn.com/wp-content/uploads/2017/07/Towards-a-fully-automated-stock-exhchange-part-1.pdf

 


The Missing Piece in Crypto Exchange: A Decentralized Alternative to the Order Book

In a crypto-economic trading platform:

  • “The network becomes the exchange”
  • Snapchat (ephemeral) bid-asks
  • User-defined smart contracts

Exchanges are regulated by the SEC and take years to gain approval.  Recently, the SEC has announced that all crypto exchanges are illegal unless they register with SEC.

There are two key design principles informing a market design presented below for a crypto-economy platform involving the exchange of digital assets including cryptocurrency deemed securities by SEC.

  • Eliminate enormous multi-million dollar rents captured by exchange intermediaries and front running HFT
  • Accept regulation by the SEC, but as an Electronic Communications Network (ECN) not an exchange. 

Traditional currency or asset exchange involve a two-sided auction market design better known as an order book.  Currently,  all crypto exchanges whether custodial, so-called “decentralized” exchanges (DEX), or relays with 0x smart contracts , still feature order books as a market design.

What we propose is a market design where “the network is the exchange”.  We strongly believe that this design would allow for registration with the SEC as a broker-dealer running an Electronic Communication Network (ECN) which is a subset of a Alternative Trading System (ATS) .  Getting approval for an ECN would be must faster than getting approval as an exchange.

Value Proposition:

  • user-defined contracts ( e.g. options with odd expiration dates, long-short pairs, straddles)
  • tokens earned by peers supplying liquidity spread contracts
  • elimination of latency rents going to HFT and server co-location fees going to exchange
  • elimination of “data ownership” rents earned by exchange

Specification suggestions:

  • high frequency, many-to-many, pub-sub protocol
  • messages in form of  Myerson “take it or leave it” (TIOLI) bid-asks
  • “serverless” with ephemeral matching with-in Redis-like in-memory data structure store, used as a database, cache and message broker.
  • ephemeral bid-ask data, only data “owned” is history of matches.
  • discrete time, batch process (i.e. events) following  Eric Budish’s work on continuous time design flaw in  HFT platforms 
  • third party AI bid bots
  • third party custodial services
  • settlement a function of DTL layer

 

Companies with pub-sub platforms

  • Satori (formerly MZ)
  • Facebook (WhatsApp)
  • TenCent (WeChat)
  • Google (Cloud Pub/Sub)

Satori is leading the integration of a pub-sub transaction layer with a DLT called Hedera Hashgraph.

 

 

The question is what will be the market design for the transaction layer?

Gabe Leydon, CEO Satori, TokenPost Interview During Korean Blockchain Open Forum, July 2018 https://www.youtube.com/watch?v=3Gc2wRk5WE4

Satori’s “AI Mesh network” transaction layer  stats — 500 Million “messages” per second or 1 million publishers sending 100 bytes a second 

Hedera Hashgraph’s DLT stats — 500,000 transactions per second with less than a second to 100% consensus based on a “gossip of gossip protocol”

Some URLs relevant to stock and asset market design choices:

Eric Budish, The Design of Financial Exchange, Some Open Questions at the Intersection of Econ and CS.  Simons Institute of Computing UCB, November 2015 https://www.youtube.com/watch?v=Rilv2AJ1TWM

Eric Budish, “Will the Market Fix the Market?”, AEA/AFA Joint Luncheon Talk, January 2017 https://www.aeaweb.org/webcasts/2017/luncheon

Albert “Pete” Kyle, “The Changing Nature of Trading Markets, U of Maryland Conference,  May 2017 https://www.rhsmith.umd.edu/files/Documents/Centers/CFP/2017/kyle.pdf

Albert ” Pete” Kyle, “Continuous Auctions and Insider Trading” Econometrica, November 1985 http://Albert “Pete” Kyle, “The Changing Nature of Trading Markets,

Fisher Black, Toward A Fully Automatic Stock Exchange, 1971  http://17mj9yvb9fl2p5m872gtgax5.wpengine.netdna-cdn.com/wp-content/uploads/2017/07/Towards-a-fully-automated-stock-exhchange-part-1.pdf

Target Markets:

continuous time order-processing client-server exchanges with massive multi-million dollar rents going to server owners and HFT snipers.

  • Pseudo-crypto DEX with client server order books
  • FOREX with tokenized fiat money
  • Swaps
  • Options
  • Dark Pools
  • Replace “book-maker” gambling with p2p gambling

 


An Outline of an Decentralized Alternative to the Order Book

In a crypto-economic trading platform:

  • “The network becomes the exchange”
  • Snapchat (ephemeral) bid-asks
  • User-defined smart contracts

The order book is a market design for the exchange of goods and assets. It dates back to the European coffee houses of the late 1600s.  In London, Jonathan’s Coffee House was a significant meeting place for traders in London in the 1700s. It later became the site of the first London Stock Exchange.

In the late 1700s, in what later became known as New York City, Dutch traders met at a Buttonwood tree in lower Manhattan island to buy and sell goods.   Now known as Wall Street, this location became the center of financial asset exchange in the United States.

Until the 1970s, stock exchanges were characterized by a market design involving traders gathering around pits with specialists manually matching bids and asks in paper order books (see below).

 

The great financial economist Fisher Black wrote a prophetic article in 1971 called “Toward A Fully Automatic Stock Exchange”   where he laid out the implications of the coming automation of the manual order book.  He speculated on what the computerization of the order book would mean for bidding mechanisms, liquidity and overall stock market efficiency.

Screenshot of Bid-Ask Order Book of Poloniex

Market design, indeed all design related to computers, is coupled tightly to the computer technology itself.  Just because one design is associated with a particular computer technology does not mean that the same design should be mindlessly carried over when the computer technology changes.

We recall the mindless carry over of the 80 character line limit established by IBM for punch cards in the 1920s to cathode ray tube (CRT) terminals in the 1970s.

There is a whole host of other instances of mindless carry over of design when the technology changes.  One notable example is the organization of the factory floor after the conversion of machine power from a centralized shaft driven by water to decentralized electric power.

In the last several years, there has emerged a new decentralized, serverless, peer-to-peer (p2p) paradigm in computer architecture propelled by several trends: Internet of Things (IoT), autonomous vehicle-to device communication (V2X), and crypto.

This technological change demands a rethinking of the appropriateness of the centralized client-server order book market design as the core of a transaction layer in a crypto-economic platform.

The trend away from client server architecture is driven by a need to do more raw compute “at the edge” before sending data to the server for storage and higher order analytics.  This is known as “edge computing.”  The use cases for edge computing are Internet of Things (IoT) and autonomous vehicle-to-device (V2X) communication.

The trend away from client server architecture is also driven by the tremendous interest in Bitcoin, Blockchain and Ethereum.  Interest in crypto could be the start of a paradigm shift away from client server financial intermediaries earning opaque rents and toward decentralized, trustless p2p protocols for validating and accounting for the exchange of financial assets.

A true decentralized crypto-economy involves not only a DLT layer but also a high speed transaction layer. 

The thesis of this paper is that the time is now to consider the possibility of pairing a transaction layer with a true decentralized market design with a decentralized distributed ledger technology (DLT).

We believe that publish-subscribe  currently is the leading protocol for the transaction layer as it has already been deployed at scale an the platform behind several MMO games (from MZ) and chat platforms (WhatApp from Facebook, WeChat from TenCent).

We believe that MZ’s recently spun-off subsidiary Satori is leading the integration of a pub-sub transaction layer with a DLT called Hedera Hashgraph. The question is what will be the market design for the transaction layer?

Some URLs relevant to Satori’s plans:

Gabe Leydon, CEO Satori, TokenPost Interview During Korean Blockchain Open Forum, July 2018

Gabe Leydon, CEO Satori (MZ) Fireside Chat Crypto Invest Summit, May 2018

CEO Gabe Laydon leaves MZ to focus on crypto — Venturebeat June 1, 2018

Gabe Leydon video at Hedera Hashgraph NY announcement April 18, 2018

Satori’s “AI Mesh network” transaction layer  stats — 500 Million “messages” per second or 1 million publishers sending 100 bytes a second 

Hedera Hashgraph’s DLT stats — 500,000 transactions per second with 100% consensus based on a “gossip of gossip protocol” and a consensus latency of a 3.5 seconds.

 

 

 

 

 

 

 

 

In a crypto-economic trading platform:

  • “The network becomes the exchange”
  • Snapchat (ephemeral) bid-asks
  • User-defined smart contracts

Value Proposition:

  • user-defined contracts ( e.g. options with odd expiration dates, long-short pairs, straddles)
  • tokens earned by peers supplying liquidity spread contracts
  • elimination of latency rents going to HFT and server co-location fees going to exchange
  • elimination of “data ownership” rents earned by exchange

Specification suggestions:

  • high frequency, many-to-many, pub-sub protocol
  • messages in form of  Myerson “take it or leave it” (TIOLI) bid-asks
  • “serverless” with ephemeral matching with-in Redis-like in-memory data structure store, used as a database, cache and message broker.
  • ephemeral bid-ask data, only data “owned” is history of matches.
  • discrete time, batch process (i.e. events) following  Eric Budish’s work on continuous time design flaw in  HFT platforms 
  • third party AI bid bots
  • third party custodial services
  • settlement a function of DTL layer

 

Companies with pub-sub platforms

  • Satori (formerly MZ)
  • Facebook (WhatsApp)
  • TenCent (WeChat)
  • Google (Cloud Pub/Sub)

Register with the SEC as an ATS or ECN not an exchange.

Targets — continuous time order-processing client-server exchanges with massive multi-million dollar rents going to server owners and HFT snipers.

  • Pseudo-crypto DEX with client server order books
  • FOREX with tokenized fiat money
  • Swaps
  • Options
  • Dark Pools
  • Replace “book-maker” gambling with p2p gambling

 

Abrams tweets on the need for decentralized market design as part of a true decentralized crypto-economics transaction layer

 

 


The Bancorp (TBBK): Another “Extend and Pretend” Loan To Avert a 1Q 2018 Loss

Postscript: June 29, 2018

The following sequence of events revolving around a single sale of a note made to a now bankrupt LLC is indicative of the shady way The Bancorp (TBBK) had handled the disposition of its commercial loan portfolio set aside as a discontinued operations three and a half years ago.

First, on April 27, 2018, The Bancorp announced that it had reached an agreement to sell a construction loan note due from a now bankrupt LLC.  The new buyer agreed to pay the bank the full principal of the loan, but this offer was likely made possible by the fact that the bank financed the purchase by taking new notes from the buyer.  In making the announcement, the CEO Damian Kozlowski said

“There was a lot of interest and value in the property”

implying that they did their due diligence and this was the best deal they could get.

Then, less than a month later on May 16, 2018, the bank abruptly announced in an 8-K the termination of the agreement.

Now, a month later on June 29,2018,  two days before the end of its 2Q18, the bank announced once again the sale of the note.  But,  this time the buyer paid all cash without bank-financing, but bought the note at a $1.9 Million mark-down from its principal, meaning the bank would be taking an equivalent $1.9 Million loss on sale.

Was this latest buyer involved earlier?  What might have changed in the last month to induce this new buyer to pay all cash?

Postscript: May 17, 2018

After The Bancorp’s annual shareholder meeting on May 16, 2018, the company filed a  Form 8-K announcing the termination of the loan discussed at length in this paper.

We can can only speculate that it was the new buyer who got cold feet and backed out, given the spate of lawsuits filed by lawyers representing Chinese EB-5 investors .

Below is the announcement.

The Company reports the termination of the previously-announced sale of a $36.9 million non-performing loan, which is collateralized by a hotel under construction and a parking lot in Florida. The loan became delinquent in the first quarter of 2018 and the borrower, a development corporation, subsequently declared bankruptcy. Based upon an independent first quarter 2018 appraisal, the loan to value is approximately 80% on an “as-is” basis, with personal guarantees of certain of the borrower’s principals.  The Bancorp Bank, the Company’s wholly-owned subsidiary, is pursuing collection and the Company currently believes that there will be no loss of principal.

 

Summary (originally published on May 2, 2018)

On March 7, 2018  two Florida LLCs filed for Chapter 11 bankruptcy to stave off foreclosure by The Bancorp (TBBK) on a $38 Million construction loan for a hotel in Ft. Lauderdale.

In an April 8, 2018 paper, we predicted that the bank would show a loss on its 1Q 2018 financials based on our estimate of an additional 20% mark-down of the troubled hotel construction loan.

However, literally “at the 11th hour” on April 26, 2018 on the night before TBBK announced 1Q2018 earnings, the bank signed a purchase agreement to sell the troubled loan with no loss due generous bank-financing coupled with a pre-packaged bankruptcy that subordinated other lenders to the LLC.

These other lenders were 60 Chinese investors contributing $500,000 each to gain priority status for a permanent residency visa under the controversial EB-5 program.

The new loan is still troubled due to uncertainty as to how much money is needed to complete the hotel plus lawsuits filed on behalf of the now subordinated Chinese EB-5 lenders.

As we have been saying in various papers over the past four years, The Bancorp still has continuing problems with its discontinued operations.

Disclosure

We have received no remuneration for this paper. We have never received any remuneration for any of our 6+ papers about The Bancorp’s “continuing problems with its discontinued operations.”  

Our financial analysis is often directed toward deceptive accounting practices of corporations.  But, it is against our nature to talk to, or work with opportunistic lawyers suing corporations.

We do not currently have a position in the Bancorp’s stock and do not intend ever to take a position in the stock.   Information in this paper, including forecast financial information, should not be considered as advice or a recommendation to investors or potential investors in relation to holding, purchasing or selling securities.

 

A Recap of The Bancorp’s Continuing Problems

The Bancorp (NASDAQ: (TBBK) is a publicly-held Philadelphia regional bank with a diversified loan portfolio.  It is also known for being one of largest issuers of reloadable prepaid debit and gift cards in the country.  

On October 31, 2014, The Bancorp announced that it was discontinuing its $1.2 Billion commercial lending operation.  It set aside this portfolio on its balance sheet, claimed it was marked-to-market, and that it was actively seeking buyers.  Since that announcement, the bank has had considerable trouble selling off the most troubled segments.

We have written a number of papers since early 2015 detailing “continuing problems with its discontinued commercial loan operations.” There have been two basic points we have tried to make:

  • The portfolio was not fairly marked initially because “fairly marked assets sell fairly quickly.”
  • Once the bank began to take additional markdowns, the hits to equity brought it close to going below the Dodd-Frank standard of a “well-capitalized bank.”

A full recap of The Bancorp’s problems can be found in our paper  “The Bancorp: ‘An Extend and Pretend’ Loan Operation That Will Never End”

 

The Bancorp’s Problems Continue into 2018

On March 7, 2018  two Florida LLCs filed for Chapter 11 bankruptcy to stave off foreclosure by The Bancorp on a $38 Million construction loan for a hotel in Ft. Lauderdale.

The unfinished Las Olas Ocean Resort at 550 Seabreeze Boulevard in Ft. Lauderdale, Florida.

We presented a detail account of this problem loan in our April 8, 2018 paper The Bancorp (TBBK): Will a Florida Hotel Loan Default Ruin Its 1Q18 Financials?

In that paper, we predicted that the bank would show a loss on its 1Q 2018 financials based on our estimate of an additional 20% mark-down of the troubled hotel construction loan.

After the market closed on Thursday April 26, 2018, what actually happened was that TBBK reported net income of $14.1 Million with no apparent negative effect from its discontinued loan operations in general nor from the troubled hotel construction loan in particular.

Based on summary financials, TBBK’s stock soared when the market opened on Friday April 27th…for the first hour.

After that,  the stock began to fall from an intraday high of $11.60 to close at $10.96 for a 5.8% decline.  The next day another 5.3% decline was tacked on.

 

What had happened was that institutional investors did not like what they heard on the call or read about a day later when the transcripts of the call were published on-line.

 

TBBK’s 1Q2018 Conference Call and Press Release

CEO Damian Kozlowski started the April 27th conference call, proudly claiming “..the first quarter was a great start to a new year”.   (The conference call has been transcribed and made available by Seeking Alpha.)

This statement was certainly justified given the summary financials disclosed the night before in a press release indicating a positive net income of $14.1 including a small net positive income of $156,000 from the discontinued operations.  

But, then CEO Kozlowski unexpectedly announced that a purchase agreement had been signed for the troubled loan collateralized by the unfinished hotel.

This was a quick sale all the way around —  just two months after the bank foreclosed and just one month after the borrower filed for bankruptcy. (See timeline below from our previous paper) :

 

 

CEO Kozlowski even revealed that the purchase agreement was signed just the night before,  just in time to deflect any concerns about the impact of the troubled loan on future profits.

“Last night, we signed a purchase sale agreement for the full principal amount and that transaction should close this quarter. So that’s good news on the credit side.”

“There was a lot of interest and value in the property. We are glad to in the last moment before we had this call to have a purchase sale agreement signed.”

Later on in the conference call,  CEO Kozlowski gave a rather confusing answer to an analyst’s follow-up question about the bank-financing of the loan sale.  

Matthew Breese

Understood. Now that’s very helpful. Okay. And then the hotel property with the purchase agreement, what was the size of that?

Damian Kozlowski

$38 million. Yes, there is a big loan in discontinued. We are working with the purchaser, so what will happen is about 18 million will come off, we will provide credit and that credit is not only going to be backed by all the collateral, but also additional guarantees by the purchaser. So it’s going to be a safe loan. We will go down about 13 million and then we will have a bridge loan in place for the acquirer if that will be extremely low risk.

Matthew Breese

Okay. 38 out of discontinued and then?

Damian Kozlowski

I’m not sure where you will put the 25 million, but the delinquency will end. So you will see that come off. You will see it go down by approximately 13 million and then we will have a new loan. I think it probably will be booked in discontinued, but it will be a safe and sound, it will be we believe a very safe loan.

It’s only up to a year, it’s only as a combination for them to finish and reposition the property. The people who are buying the property are extremely experienced and have great knowledge of the marketplace and knowledge of the hotel industry and they are and we are very excited and so is the town I think of Fort Lauderdale that they have decided to build the property.

Matthew Breese

Okay. And so that in combination with the mall, and we are looking at over the next six months potentially something like a 70 million coming out of discontinued right?

Damian Kozlowski

Well, yes 15 from the loan, 37, 38 from the hotel.

Matthew Breese

Okay, okay. Sorry my numbers are a little off there.

 

Reconstructing The Loan Financing and Cash Requirements of New Borrower

Based on the conference call exchange quoted above, here is how we saw the agreement:

Why would someone pay full value for this loan to a bankrupt LLC?  For one, it was completely financed by the bank.  But, more importantly, it turns out that the LLC and The Bancorp negotiated a pre-packaged bankruptcy filing that subordinated $30 Million in investments from other lenders.

This comes from a post by Vernon Litigation group representing those other investors.

Besides the $50 Million loan from The Bancorp less $13 Million unfunded balance, the bankrupt LLC received, and presumably already spent an additional $30 Million from so called EB-5 Chinese investors.  The EB-5 program gives priority status for immigrants applying for permanent residency visas if they invest at least $500,000 in a U.S. jobs creation project.

The Vernon Litigation Group found court documents indicating that the LLC bankruptcy was pre-packaged with clauses that “would subordinate or eliminate the debt owed to EB-5 investors”

Here is the full explanation:

“Perhaps the most troubling issue at hand, according to the Court Documents filed in Florida District Court last week, is the allegation that the EB-5 project principals Ken Bernstein, Eugene Kessler, and Jack Kessler allegedly proposed a plan to eliminate the investment made by foreign investors. Specifically, the 550 Seabreeze project principals allegedly sought the Lender’s support for a pre-packaged bankruptcy that would subordinate or eliminate the debt owed to EB-5 investors. In other words, under this plan allegedly proposed by the principals, investments made by the foreign investors through the EB-5 project could be effectively erased.”

Below is our estimate of the cash needed by the new borrower to finish the estimated 20% remaining to complete hotel,  and to complete the bankruptcy proceedings including a settlement with the now subordinated EB-5 investors.  The estimate also includes the payoff of a reportedly outstanding $5 Million construction lien.

 

An Estimate of Future Losses on TBBK’s  Discontinued Operations

Based on its 1Q18 financials, the Bancorp can be expected to produce a quarterly net profit on continuing operations of around $14 Million.

To his credit, CEO Kozlowski has introduced a level of transparency to the quality and accumulated markdowns of loans remaining in its discontinued operations.  Below is our summary of the lastest disclosure found at the bottom at TBBK’s 1Q18 financial PR referenced earlier:

 

 

 

 

 

 

 

 

 

 

 

At the very end of the 1Q18 financial PR, the bank was forthright in disclosing early on a new problem loan:

(1) Performing discontinued loans included a $17 million loan which was delinquent 60 days as of March 31, 2018. The loan is secured by multiple commercial real estate properties which cumulatively have a 95% loan to value.

Despite an ethic of transparency brought to the bank by CEO Kozlowski in mid-2016, we still question whether TBBK has adequate reserves to cover future loan delinquencies followed by borrower bankruptcies. We believe the bank when it says that current markdowns are according to GAAP.  But normal GAAP markdowns might not be sufficient to cover future markdown on the garbage left.

The bank has spent the last four year selling off the best pieces to other banks in the Mid-Atlantic region. In 2Q15, loans totaling $150 Million were “cherry-picked” by the Cape May Bank, NJ ($102M) and another unidentified bank.  In 3Q16, a loan package of $65 Million was “cherry-picked” by the First Priority Bank, Malvern PA.  

The rest no bank would touch without requiring The Bancorp to take a considerable loss on sale which would jeopardize their status as a “well-capitalized” bank per Dodd-Frank.

In addition, at least $300 Million in loans have come off the books as borrowers with low loans to values have been able to refinance at lower interest rates at other banks. What remains are likely “underwater” loans (loans to value > 100%) and “extend and pretend” loans featuring interest only payments with a large balloon payment at the end.

We estimate below that over the next two years, there might be as many as three quarters where TBBK would have to book additional markdowns whose size would cause an overall loss on their quarterly P&L.  

 

During the 3Q16 conference call, the new CEO Damian Kozlowski sought to reassure rattled analysts by claiming,

“We believe this (markdown) is not systemic. We believe this is a one-time item.”

At the end of this unusually long and testy 4Q16 conference call with analysts (a first!), CEO Kozlowski wearily pledged,

“I want to wind it down as quickly as possible…”

The year 2016 was a bad for investors in TBBK (see chart below) as the new CEO broke through the denial and booked additional markdowns.

Obviously, the CEO must have received a lot of criticism from the Board.  Maybe the criticism got to him as there were no major additional markdowns in 2017 and the stock more than doubled.

 

We do not believe that the mid-2016 Damian Kozlowski would have allowed the troubled loan sale to be rushed through at literally “the 11th hour” to avoid concerns about possible markdowns.  

He must be worn down with the clean-up of the “extend and pretend loan operation that will never end”.  

He must be tired of the “test the limits of GAAP” ethics of TBBK’s  Chairman Daniel G. Cohen and his cronies that make up a majority of the Board.  (See our accounting paper The Bancorp: A Test for Post-Enron GAAP)

 He is too good of a bank executive to be stuck dealing with problems created before his arrival.  It’s time to GET OUT!!!

 


The Bancorp (TBBK): Will a Florida Hotel Loan Default Ruin Its 1Q18 Financials?

Postscript: May 18,2018

Literally “at the 11th hour” on April 26, 2018 the night before TBBK announced 1Q2018 earnings, the bank signed an agreement to sell a troubled Florida hotel construction loan with no loss due generous bank-financing coupled with a pre-packaged bankruptcy that subordinated EB-5 lenders.  This last minute sale avoided the a 1Q 2018 loss that we predicted when this paper was first published on April 8, 2018

Then on May 16, 2018, The bank issued an 8-K announcing that the purchase agreement for the sale of the loan has been terminated.   We can can only speculate that it was the new buyer who got cold feet and backed out, given the spate of lawsuits filed by lawyers representing Chinese EB-5 investors .

Summary (originally published April 8, 2018)

The Bancorp still has continuing problems with a discontinued commercial loan portfolio first set aside on its balance sheet over 3 years ago.

The bank will likely book additional markdowns on a $37 Million loan made on a troubled Ft. Lauderdale hotel construction project with the developers finally filing for Chapter 11 bankruptcy protection in March 2018.

We estimate this additional markdown at $7.4 Million — sufficient to cause an overall loss for the bank when it reports its 1Q18 financials late in April 2018.  On the other hand, Wall Street analysts are forecasting a profit for TBBK averaging $.18 / share  or a profit of $10 Million.

 

Disclosure

We have received no remuneration for this paper. We have never received any remuneration for any of our 6+ papers about The Bancorp’s “continuing problems with its discontinued operations.”  

Our financial analysis is often directed toward deceptive accounting practices of corporations.  But, it is against our nature to talk to, or work with, opportunistic lawyers suing corporations.

We do not currently have a position in the Bancorp’s stock and do not intend ever to take a position in the stock.  Information in this paper, including forecast financial information, should not be considered as advice or a recommendation to investors or potential investors in relation to holding, purchasing or selling securities.

 

Introduction

The Bancorp (NASDAQ: (TBBK) is a publicly-held Philadelphia regional bank with a diversified loan portfolio.  It is also known for being one of largest issuers of reloadable prepaid debit and gift cards in the country.  

On March 7, 2018  two Florida LLCs filed for Chapter 11 bankruptcy to stave off foreclosure by TBBK on a $37 Million construction loan for a hotel in Ft. Lauderdale.

Note to analysts privileged to be in on TBBK’s quarterly conference calls:

  • Frank Schiraldi – Sandler O’Neill
  • William Wallace – Raymond James

Ask CEO Damian Kozlowski why a Philadelphia area bank has a history of making bad loans in Florida — this construction project in Ft. Lauderdale and the The Fashion Square Mall in Orlando, Florida discussed later)

During 2017, TBBK put together a string of four straight quarters of profits before deferred tax adjustments, largely because of no new material write downs on loans in its commercial loan portfolio set aside in late 2014 as a “discontinued operation.”  

CEO Damian Kozlowski stated in TBBK’s 4Q17 conference call :

While we may continue to have some gains or costs to resolve some of these credits, we believe that these portfolios are correctly marked, and that these adjustments will not significantly adversely impact our operating performance.

The purpose of this paper is to show that CEO Kozlowski is wrong.  TBBK once again has “continuing problems with its discontinued operations” that very likely will have a significant adverse impact on its 1Q18 financials.

 

The Timeline of the Las Olas Ocean Resort Loan

On January 25, 2018, The Bancorp (TBBK) filed foreclosure papers on two real estate LLCs in Florida Southern District Court.  

On March 7, 2018  the Florida LLCs filed for Chapter 11 bankruptcy protection to stave off foreclosure.

The Bancorp originated the loan in 2013 for $50 Million for the construction of a 12 story hotel called the Las Olas Ocean Resort at 550 Seabreeze Boulevard in Ft. Lauderdale, Florida.  This loan was part of the real estate loan portfolio set aside in late 2014 as a “discontinued operation.”  

Five years after the loan origination, the hotel was still unfinished and the loan balance was a reportedly $37 Million.

Below is a timeline of this loan.  At one time, we thought that the bank should have disclosed the January 25, 2018 foreclosure filing as a “subsequent event” on its FYE 2017 10-K filed in March 23, 2018.

In any case, we would be totally surprised if the bank failed to make special mention of this loan when it reports its 1Q18 financials sometime in late April 2018.

 

The South Florida Real Estate News  disclosed that financing for this hotel included $30 million in financing from Chinese investors via EB-5, a controversial Federal government program that fast-tracks 10,000 immigrant visas requests in return for at least $500,000 in qualified, job-creating investment

According to the publication, the project suffered numerous delays due to zoning problems and was unfinished at the time of the foreclosure…

“including have to wait nine months for a Broward County approval of architectural and engineering plans. Another six-month delay was in order to comply new Federal Emergency Management Agency flood plain requirements.”

The publication also reported that the lawsuit alleged that the developers

“… failed to finish the resort by its planned March 2017 completion date, failed to make its December 2017 loan payment…,”

The Unfinished Las Olas Ocean Resort in Ft. Lauderdale, Florida.

 

 

 

 

 

 

 

 

 

The Bancorp’s Continuing Problems with Its Discontinued Loan Portfolio

On October 31, 2014, The Bancorp announced that it was discontinuing its $1.2 Billion commercial lending operation.  It set aside this portfolio on its balance sheet, claimed it was marked-to-market, and that the bank was actively seeking buyers.  Since that announcement, the bank has had considerable trouble selling off the most troubled segments to third-parties.

We have written a number of papers since early 2015 detailing “continuing problems with its discontinued commercial loan operations.” There have been two basic points we have tried to make:

  • The portfolio was not fairly marked initially because “fairly marked assets sell fairly quickly.”
  • Once the bank began to take additional markdowns, the hits to equity brought it close to going below the Dodd-Frank standard of a “well-capitalized bank.”

A full recap of The Bancorp’s problems can be found in our  “The Bancorp: ‘An Extend and Pretend’ Loan Operation That Will Never End”

Throughout 2016, The Bancorp’s (TBBK) stock suffered a series of double digit declines on the day of quarterly earnings announcements dominated by new revelations about defaulted loans followed by foreclosure filing by the bank followed by bankruptcy by the borrower.   

In 2Q16,  it was the disclosure of a bad $30 Million loan to the owners of The Schuylkill Mall in Frackville, PA).  In 4Q16, it was the disclosure of a bad $42.2 Million loan to owners of  The Fashion Square Mall in Orlando, FL

Since a low of $5.01 per share on the day of the announcement of its 4Q16 and full year FY16 results in early February 2016, the bank’s stock has risen 119% to close at $10.99 a share on March 15, 2018.

In our opinion, this rise is largely due to an absence of new revelations about its discontinued loan portfolio rather than any fundamental improvement in its continuing operations.  

 

An Estimate of the Impact of $37 Million Loan Default on 1Q18 Financials

First, a single loan default, and subsequent foreclosure on a borrower who, in turn files for Chapter 11 bankruptcy protection, normally does not have a material impact on publicly-held bank’s quarterly earnings.

But, we think that in this particular loan default will have a material impact on 1Q18 earnings due to a combination of

  • A history of the TBBK under-reserving for its discontinued loan operations, and
  • A history of quarterly earnings from continuing operations coming in around $7 Million — tepid for a bank with $4+ Billion in assets.

First, we need to mention that there are two pieces to the bank’s discontinued loan portfolio.  The Bancorp peeled off one piece at the end of 2014 to an unconsolidated entity call Walnut Street LLC.  We have questioned TBBK’s election not to consolidate this LLC in our September 2016 paper The Bancorp: A Test for Post-Enron GAAP.

The other piece TBBK set aside on its balance sheet as a discontinued operation.

It took TBBK two full years to provide real color on the relative toxicity of the two pieces.  Even this was buried at the end of a press release announcing its 4Q16 results in February 2017.  The Bancorp finally disclosed how toxic unconsolidated Walnut Street LLC portfolio was relative to what was kept on the books.

Furthermore,  GAAP allows The Bancorp to value the two portfolios differently. For the portfolio still on its books, TBBK uses mark-to-market accounting with quarterly updates. The accounting is entirely different with the off-balance sheet Walnut Street LLC.

The LLC itself uses mark-to-market accounting internally per GAAP.  But because the LLC is unconsolidated and overwhelming financed by notes taken back by The Bancorp,  TBBK uses note valuation based on cash flow to account for the LLC’s portion of the loan portfolio. This gives them more of a cushion in accounting for changes in loan performance.

Below is our spreadsheet comparing the markdown of the two portfolios.  A more extensive comparison of the two portfolios can be found of in our 2016 paper  “The Bancorp: ‘An Extend and Pretend’ Loan Operation That Will Never End”.

The Bancorp has a history of  late accounting for losses on its discontinued loan portfolios. In 2016, TBBK P&L took a series of material hits to its P&L totalling $77.2 Million. 

While the bank does not name the specific loans associated with  markdowns / note write-offs, we believe that a majority of the $77.2 Million came from two loans where the borrowers eventually declared bankruptcy:

We believe that the majority of a 2Q16 markdown / note write-off of $31 Million came from Schuylkill Mall loan.  It was first significant loss the bank recognized since the bank first announced the discontinuation of commercial lending operations on October 30, 2014.

During the 2Q16 Conference Call, one analyst quipped, “.. maybe you guys ripped the Band-Aid off this quarter..” and went on to say he was unsure whether these losses were a one-time event or the beginning of a more forthright examination of the valuations of these troubled loan portfolios.

The bank’s history of catch-up loan reserve accounting support our belief that the bank will have to make additional mark-down in 1Q18.  Even with our estimated 41% markdown already booked on the Las Olas property, we think there will have to be more taken.

To be fair, the Las Olas hotel with its unfinished interior is still  salvageable and located on prime waterfront real estate whereas the Schuylkill Mall was not salvageable and torn done in 2018. The Orlando Fashion Mall was located in a prime area, but requires extensive redevelopment as a hotel and office complex.  

The figure for the estimated markdown at the time of the default — 41% — comes from the bank’s 4Q16 disclosure on average markdown of loans in its discontinued loan portfolio.

The figure for the additional markdown due to the default and subsequent Chapter 11 bankruptcy — 20% — is consistent with what we think TBBK took after 2016 Schuylkill Mall and the Fashion Square Mall loan defaults, foreclosures and subsequent bankruptcies.

 

 

 

 

 

 

 

 

 

 

Below is the history of TBBK’s net earnings for the past two years broken down into three components

  • Continuing operations less returns from unconsolidated Walnut Street LLC
  • Discontinued operations including markdowns
  • Returns on notes receivable from the unconsolidated Walnut Street LLC

Based on normal net income from continuing operations in 2016, we estimate 1Q18 net income from continuing operations at $7 Million.  Couple that with our estimated $7.4 Million additional markdown of the Las Olas property, we arrive at a $400,000 loss for TBBK in 1Q18.

Wall Street analysts currently are forecasting a profit for TBBK in the neighborhood of $10 Million.

This loss will be the first for TBBK in 4 quarters.

Given the toxicity of the loans remaining, we stand by our 2016 paper title: