Swamp Report would not be the first to say “takes one to know one”. 24/7 Wall St. reports that Friday, May 1, JP Morgan issued a negative bank research call for the major money center and super-regional banks:
“Bank of America Corporation (NYSE: BAC), Citigroup, Inc. (NYSE: C), U.S. Bancorp (NYSE: USB), Wells Fargo & Company (NYSE: WFC), SunTrust Banks, Inc. (NYSE: STI), and others were all hit by the note. Analysts do not actually cover their own companies, but you can’t really get away from the notion that the analyst downgrade also throws JPMorgan under the bus as well.”
Effectively, JP Morgan has labeled several of its fellow money center banks as goats and contrary to 24/7’s opinion, wants us to think that JP Morgan is a sheep. Richard Ramsden of Goldman Sachs boldly called Citigroup a goat, er, sell on April 20, citing Citigroup’s looming credit losses. But of course, Goldman is a sheep, after all “we can sell bonds to suckers, er, public investors without government gaurantees”. An earlier, April 3 Bloomberg quote of Ramsden:
The relaxation of fair-value accounting rules won’t prevent bank shares from falling because growth in bad loans is accelerating, according to Goldman Sachs Group Inc. “Our core view is that banks will not bottom until underperforming asset growth decelerates,” Richard Ramsden, a New York-based analyst at Goldman Sachs, wrote in a report today. “Loans are going bad faster than banks earn money.”
Estimates of Ramsden from a still earlier Bloomberg report on April 1:
A March 24 report from Goldman Sachs Group Inc. analyst Richard Ramsden [ ] estimated that Bank of America Corp., Citigroup Inc. and JPMorgan Chase & Co. are all carrying commercial mortgages at 100 percent of face value. Yet commercial mortgages may be the next shoe to drop for banks. “Commercial credit losses are likely to be quite onerous during 2009,” Friedman Billings Ramsey Group Inc. analyst James Abbott wrote in a report this week. These losses “will be significantly larger than what most are expecting.”
Apparently, a sheep can call a goat a goat, but a goat can’t call itself a sheep, unless a bonifide sheep backs him up. The market didn’t really react on Friday to JP Morgan’s call… So, is JP Morgan a bonifide sheep? What about Goldman?
A Bloomberg report (or rather a Sueddeutsche Zeitung report) from April 24th deserves way more attention than it seems to have received. The key is that the leaked memo is true:
“German banks’ total risks from problem loans amount to 812 billion euros ($1.1 trillion) according to calculations by the BaFin financial-market regulator, Sueddeutsche Zeitung said, citing a confidential memorandum.”
With German banks needing to deal with $1.1 trillion, how much does that indicate for American banks, on a pro rata basis? Wait til there’s a similar “internal memo” leaked about American banks…
Rolfe Winkler has updated his estimates of Tangible Common Equity (rumored to be required by the FED to be at least 3%) for big banks . Some banks pass some fail. We suspect the government will change the definition of TCE so that it doesn’t even resemble Rolfe’s and all the banks pass. It should be emphasized that TCE will not tell us ANYTHING about off-balance assets and liabilities or funny accounting for certain assets.
24/7 Wall Street posts on the commercial real estate “land mine” banks have yet to deal with:
“The Financial Times recently reported on data about commercial real estate from Fitch, one of the three large credit ratings agencies. The paper wrote that “Fitch said properties were increasingly financed with no money down or even with loans for more than 100 per cent of a property’s value as owners borrowed greater amounts upfront to pay interest costs, betting that cash flows would improve quickly enough for the property to be self-sustaining.”
This means that what people did on a small scale with home mortgages they did on a larger scale with buildings and malls. General Growth has about $27 billion in debt. It is too early to say how much of that can be recouped though asset sales, but with commercial real estate defaults growing, all of the excess inventory will cause prices to drop, perhaps precipitously.”
Of course credit cards problems are just beginning too and residential has not bottomed either.
CNBC cites “sources” who tell them that the bank stress tests will require banks to have risk adjusted Tangible Common Equity equal to 3% of assets. This of course “sounds nice”. If assets weren’t so subject to “funny accounting”, it would be meaningful.
A Federal Reserve document obtained by the Associated Press indicates the government has decided to deflect the attention away from the big banks to smaller regional banks by focusing on loans rather than securities:
“That approach favors a few Wall Street banks while potentially threatening major regional players…
Some analysts said regulators are favoring the largest banks because if even one failed that would pose a severe economic risk. Banks that deal in securities are more interconnected to other corners of the global financial system.
Regulators also face pressure to highlight the weaknesses of some banks, or critics will dismiss the tests as a whitewash. That would undermine the goal of improving confidence in the financial system.”
In other words, the regionals are being sacrificed on the altar of the big banks that the government worships. We predict this will be treated as the scam it is by the market.
The IMF’s recent report on Global Financial Stability:
“Without a thorough cleansing of banks’ balance sheets of impaired assets, accompanied by restructuring and, where needed, recapitalization, risks remain that banks’ problems will continue to exert downward pressure on economic activity. Though subject to a number of assumptions, ourbest estimate of writedowns on U.S.-originated assets to be suffered by all holders since the outbreakof the crisis until 2010 has increased from $2.2 trillion in the January 2009 Global Financial Stability Report (GFSR) Update to $2.7 trillion, largely as a result of the worsening base-case scenario for economic growth. In this GFSR, estimates for write downs have been extended to include other mature market-originated assets and, while the information underpinning these scenarios is more uncertain, such estimates suggest writedowns could reach a total of around $4 trillion, about two thirds of which would be incurred by banks.”
In a new report, Fitch warns investors about CLOs:
“…given the evolution of leveraged loans from a relatively illiquid asset class at the inception of the CLO market to a more actively traded credit product, Fitch questions the practice of accounting for loans at par regardless of the discounted purchase price threshold. There are elements of the current loan market that are not directly addressed through Fitch’s rating criteria, but should not be ignored.”
Remember the recent rush by banks to buy discounted assets on the open market? Although this report was not specifically focused on how banks treat these assets on their balances sheets, if the CLO manager is a bank, it appears possible for the bank to buy-on-the-cheap loans and account for those loans at par rather than the price actually paid. Note that this activity would not be adjusting values due to the recent relaxation of mark to market by the FASB. This shenanigan is separate.
Fitch explains:
Discounted security purchases are generally permitted, but holdings beyond 5% of the portfolio notional balance are generally carried at their purchase price for purposes of overcollateralization (OC) tests.
This structural feature reduces the OC credit given to discounted securities and is intended to protect investors from the following:
• Egregious Par Building: Creating credit enhancement by measuring assets purchased at considerable discount to par at par value rather than their purchase price.• Adverse Selection: Accumulating assets with relatively weaker credit profiles as indicated by lower than average market prices.
While the intention of the discounted security adjustment has merits, Fitch has long identified issues with its practical application.In today’s environment, in contrast to the par loan market several years ago, almost all loans are trading below 85% of par. As such, most of the leveraged loan universe would be considered as discounted securities. Since managers account for discounted securities at their purchase price rather than par, there is a disincentive for a CLO manager to make substitution trades, which may be needed to improve the credit quality of the underlying pool of loans.
The big banks are announcing “record profits“, which are a sham. Time says the banking crisis is over. Goldman, the strongest of the bunch, is proposing to sell new stock to the public before the sham is completely disclosed. With the Treasury’s help, they may just pull the heist off, but it won’t change anything in the end. More losses loom. The big banks aren’t fixed yet and they will have to be, before recovery can take place.
F. William Engdahl at Financial Sense writes about the concentration of risk in the big banks:
“Today five US banks according to data in the just-released Federal Office of Comptroller of the Currency’s Quarterly Report on Bank Trading and Derivatives Activity, hold 96% of all US bank derivatives positions in terms of nominal values, and an eye-popping 81% of the total net credit risk exposure in event of default.
The five are, in declining order of importance: JPMorgan Chase which holds a staggering $88 trillion in derivatives (€66 trillion!). Morgan Chase is followed by Bank of America with $38 trillion in derivatives, and Citibank with $32 trillion. Number four in the derivatives sweepstakes is Goldman Sachs with a ‘mere’ $30 trillion in derivatives. Number five, the merged Wells Fargo-Wachovia Bank, drops dramatically in size to $5 trillion. Number six, Britain’s HSBC Bank USA has $3.7 trillion…
The problem is concentrated in these five large banks. The financial cancer must be isolated and contained by Federal agency in order for the host, the real economy, to return to healthy function.”
Mike Whitney at Counter Punch is equally pessimistic about economy because the big bank problems have not yet been contained:
“The S&P 500 has soared 23 per cent in the last four weeks, but the current bear market rally is misleading. The prospects for a quick recovery are remote at best. The fundamentals are all weak. Corporate profits are down, GDP is negative 6 per cent, housing is in a shambles, and the banking system broken. The Fed has increased the money supply by 22 percent, but economic activity is at a standstill. The velocity at which money is being spent is the slowest since 1987. Nothing is moving. The banks are hoarding, credit has dried up, and consumers are saving for the first time in 2 decades. The banks’ credit-conduit cannot function properly until bad assets are removed from their balance sheets. But the magnitude of the losses make it impossible for the government to purchase them outright without bankrupting the country.
Geithner’s plan does not fix the problems with the banks, it only delays the final outcome. The next leg-down in the recession will push many of the undercapitalized banks into receivership. Geithner’s PPIP won’t change that. As housing prices fall and foreclosures rise, the capital position of many of the banks will become untenable leading to a rash of bank failures.”
Meredith Whitney believes much more must be done to increase loss reserves at the big banks for real estate and mortgages:
“In Whitney’s narrative financial firms will relive the worst struggles of 2008 because housing prices in the major markets will fall much further than expected. Bank of America ( BAC – news – people ), HSBC ( HBC – news – people ) and even the resilient JP Morgan Chase ( JPM – news – people ) will have to increase reserves as real estate losses mount unabated. Home price expectations for the banking industry play a critical role in their entire accrual accounting methodology.
As home prices fall and as unemployment rises, banks will have to retain earnings to fund greater reserve funds as part of a cycle that Whitney says has “no end in sight as both forecasts continue to rise quicker than expectations.” It’s a “never ending game of catch up,” she says because the banks have been underestimating losses ever since the credit crisis began a year and a half ago. The average bank thinks the total decline in housing prices was going to be 30% at the end of the first quarter. Now, says Whitney, they’re thinking more like 37% — still behind reality.”
Whitney does forecast positive earnings for 4 of the 5 big banks for full year 2009, but is much more pessimistic than the consensus:
Bank Whitney’s 2009 EPS estimate Consensus
GS $8.55 $7.95
BAC $0.04 $0.38
C $(5.00) $(1.18)
MS $0.55 $1.85
WFC $0.65 $1.18
IRA has a great analysis of the PPIP. Their conclusion? Eventually we will pay the piper when the conflicting Mark to Fantasy rules and the Geithner/Summers plan both fail to cure the banks’ problem and liquidation becomes the new political expediency:
“When General Motors (NYSE:GM) is forced into an inevitable bankruptcy this June, however, doing similar for American International Group (NYSE:AIG) and the large banks will become a political inevitability and the notion of storing toxic waste will be shown to be a truly harebrained idea. As the Obama Administration begins to understand how deep the rabbit hole does indeed go in terms of subsidizing the continued existence of the growing collection of zombie financials, liquidation will become the most popular topic in Washington.
The tragedy is that the time lost between now and when the President realizes he is getting bad advice from Summers & Geithner could be the difference between a very bad recession and a crippling meltdown that is, in part, made worse by a PPIP that represents virtually no change from previous policy.”
