The Soundness of Banking

Good article here with perspective and touches on the core aspects of banks & the commercial real estate situation, not the recent earnings hype or short term trade tendencies. Click here.

Evansville screwed the system (update)

In a previous post (saved under the label "banks"), you can click on the "bank" label on this post to get to it, I noted how an Evansville, IN bank was the first to repurchase stock warrants and how taxpayers may have gotten the raw deal.

Here's an update to that story - which confirms that, yes, the Evansville bank won and we, the taxpayers, lost in that situations and a few others thus far.

"Cut" it out. Banking on the slide? (CONTENT ADDED)

June 17th the S&P decided to listen to TSM and cut its rating on 18 banks while also lowering its outlook on 4 others. We've said all along (despite bear market rallies up and gains of 100 or more percent - playing trends and recognizing overall macro-economic pictures for long-term investing are two different things) that banking is bad and staying bad and will get worse than where their stocks currently sit. We hope you made some fast money on them because they're going back down and may take your profits with them if you dont watch out! Here's the CNBC link:

http://www.cnbc.com/id/31406152

What more could you need than the TSM approval call to sell banks? How about Meredith Whitney - the bank-know-all, know-how woman - who said June 15th that toxic assets have yet to wreak their havoc on banking balance sheets, earnings reports and stock prices.

Bloomberg made some interesting comments recently and pointed out that during the 1Q of 2009:

1) Net Income of $7.6 Billion Is Less than Half Year-Earlier Level; 2) Noninterest Income Registers Strong Rebound at Large Banks; 3) Aggressive Reserve Building Trails Growth in Troubled Loans; 4) Industry Assets Contract by $302 Billion; 5) Total Equity Capital Increases by $82.1 Billion, mostly for TARP recipients. 6) Number of problem institutions: 305 with $220bn in assets--> insurance fund fell to $13bn from $17.3bn in Q4 2008. The FDIC imposed an emergency fee to raise $5.6 billion to rebuild the fund, with more assessments possible this year. The agency forecasts failures will cost $70 billion through 2013.

In considering mark-to-market accounting rule changes for banks... starting Q1--> Robert Willens (former Lehman): rule change could boost capital balances by 20 percent and earnings by as much as 15 percent. Edward Jones: Under the new rules banks will also be allowed to exclude from net income any losses they deem “temporary,” making it easier to provide a flattering earnings picture

There's no place like home?

Mortgage applications plunged to their lowest levels since December 2008 (down 15.8%) while refinancing activity dropped 23.3% this past month. The obvious culprit = rising 30 yr rates from banks. As TSM stated before, its a consensus opinion that any rate above 5% for a 30 yr mortgage or refi SERIOUSLY dries up the housing interest. Couple that with the fact that the first-time home buyer credit expires at the end of November 2009 and you have a situation where even if housing does bottom, the existing inventory may well sit there for long periods of time. That means a very slow housing recovery, along with depressed (altho maybe now accurate) home prices. So maybe the surge in new home starts and building permits last month ISNT a good sign?

What else - well think about what drives mortgage rates. They typically have a 150 basis point spread against the 10 year treasury. Nowadays its closer to a 200 basis point (2%) spread. Rates have jumped last month on (1) belief that the market is recovering and people are moving into stocks that offer higher returns, so treasury rates have to go up to compensate and be appealing; and (2) belief that federal government measures are inflationary and may be so in the midterm future. It appears that both of those underlying currents are ahead of their time and may back track. So rates could be heading below 5% again. Recently, they hit 5.72% and today they stand at 5.36%. I don't know, but even if it does go back down, I'm not sure sub-4% is in the cards and so I think housing could be a slow drudge. Which only hinders the economic recovery that much more.

PS, also keep in mind that recent bank "profits" came partially from refi activity. Doesn't look so good for them going forward now.

Evansville screwed the system?

After a 4:30am nite at work I'm too tired to really attend to the blog, but then I saw the articles today about 10 banks repaying TARP funds and had to write a little something - I mean, it does involve Evansville, IN for crying out loud. How you might ask? Well, although this will be understating things a bit, it basically goes like this - when a bank repays its TARP funds, it kind of buys back "warrants" that the Treasury took in the company. Now these warrants must be paid for based on a fair market value formula -- so this is how the government said the taxpayer would make money on the deal. The Treasury got in when values were low, then the idea is that banks stabilize and increase in value and their fair market value then increases(and the warrants increase in value as well).

The question lies in whether the formula is accurate enough. Old National Bank of Evansville, IN is the only bank to actually have paid the government for its interest/warrants thus far. ONB paid $1.2 million for warrants that were worth between $1.2 million and $5.8 million according to estimates (the wide range indicates how poor the formula may be or how hard it may be to "fairly" value these warrants). Assuming the warrants are actually worth $5.8 million, that means ONB would have secured nearly 80% of the taxpayers profits on the deal!

So what the big deal - we're talking 4 million dollars for 300 million taxpayers/people. Well, consider that Goldman Sachs, Morgan Stanley, and JP Morgan are looking to buy their warrants from the Treasury. If the same formula is used, then they may only end up paying $1 billion for warrants that are worth $4 billion.

The numbers and exact formula aren't so important here as the fact that banks are making money (potentially) on a program that was intended to benefit taxpayers. Politically that stinks. But I dont care about that as much as the fact that this means that the government continues to find ways to spend without being reimbursed and/or cutting costs. That means more national debt and more concern about financial stability.

Throw in the fact that the Supreme Court is reviewing the Chrysler bankruptcy sale and you get a potential major flaw in the recovery playbook. These are the measures and actions that stabilized and calmed the frantic situation previously. These are also the measures that have given way to optimism and hope that have served as the grounds for the recent/current bear market rally. If these disappear or prove faulty (along with the bank stress tests - which the Congressional Oversight Panel (COP) today said weren't tough enough and needed to be done again), no I dont think we go back to fear and armageddon, but I think that it really makes you wonder what we're rallying on - if those are the base measures for dealing with these fundamental problems, then where are we if those measures are faulty? Not to mention (although I now will) that TARP hasn't actually succeeded in getting bad/toxic assets of bank balance sheets (which was the program's purpose). It's 'succeeded' in capitalizing the banks to cover losses -- at our expense. These aren't sound fiscal measures, responses or programs. And without the like, you can't build sound fiscal futures.

BANKS & STRESS TESTS

May 18 -- While the scale isn't quite as big, an interesting stat/report came out this morning. The stress tests were limited to the top 19 banks in size (needing about $75 billion in additional cap). If the test were applied to the next 200 biggest banks, 38% of them would face capital shortfalls. The report indicates that that amounts to a need for an additional $16 billion in capital. Now just like with the stress tests, that number may be too low because of inadequate assumptions. And while that numbers isn't likely to "break the bank" or banking system, it does continue to underline how widespread the ripple effect of the situation is. Nearly 40% of the top 200 banks don't have enough capital. Whether this recession "recovers" anytime soon or not is one thing, but even if it does, it's becoming abundantly clear that what we "recover" to will be far from strong growth known in days past and more like a sludging growth that might still feel like a recession.

May 4 -- Good news is banks are staying alive, for now. There are questions about the assumptions of the stress tests but we'll just have to wait and see how bad credit losses prove to be. So the bottom (conservative) line here is don't play the banks. And if you do, go purely best of breed. I'm talking Goldman and JP Morgan here. There might be more rewards elsewhere but more risks too, especially with questionable accounting practices, unforeseeable and unknown future credit losses, and the TARP hands of the government involved in daily affairs. I do disagree with folks that say we now have weak banks and strong banks. I think that there will always be investors and they look for banks that have risk without serious risk of failing. I dont think the government will let these guys fail. they might take'em and reorganize or recapitalize them but not totally fail. so basically, investors see these banks not as weak, but as plays for quick money and trades....which is exactly why I don't think they fit for someone's investment portfolio given I view investments as a long-term (3-5-10 yr) horizon.

Bad news = Apparently Citi - which only needs $5 billion of capital raising according to stress test results - really needs $35 billion and its amount was reduced only after getting regulators to count future assumed capital gains as legit. Such reductions were not limited to Citi. As a whole for the 19 tested banks, the same logic was used to reduce the overall amount of capital needed from $185 billion to $75 billion. Assuming future gains during such serious and speculative times = risky in my opinion.

More bad news = if you recall stories about how banks got in this problem with excessive leverage ... lending out 30 or 40 dollars for every 1 dollar they had in the bank. Well that leverage was excessive in comparison to the average banks used to run in the mid 90s...around 15 or 20 bucks to every 1 they had in capital/on hand. The stress test assumptions of a 3% tangible common equity ration would mean that banks would have a leverage degree of 25:1. Not really going all the way back to the safe old days, are we? As you can imagine, requiring 6% or more tangible common equity would mean lower leverage, but it would also mean the banks would need to raise more on hand capital... so those lower stress test results numbers would jump and scare everyone again.