Monday, October 12, 2009

Markets-Where Do We Go From Here?: Bank Earnings (BAC; C; GS; JPM)

Update below.
Original post:
We are sticking to our call for S&P 1125 sometime this month.
Back in December '08 we posted "Mom, Ben Bernanke Likes Bankers Better than He Likes You":
Savers are getting screwed as banks reliquify their balance sheets.
The ostensible reason short rates are now officially at 0.2% is to encourage banks to lend.

It's not going to happen. The banks are not taking on individual's or commercial's risk. Auto loans for a FICO score of less than 720 aren't being written.
So what are they doing? Carry-trade (say it like "Toga party").
For months, the borrow U.S. short, lend U.S. long has been used to rebuild banks balance sheets, destroyed by their former business practices.

Now with the Fed explicitly committed to lowering long rates (the 30-year trading at 2.63%, the 10-year at 2.144%), even borrowing at 0.2% doesn't give enough spread to run cash flow through the income statement and onto the bank's balance sheets.
What will the banks do? My guess is they will start buying sovereign debt for the yield, maybe even selling it to the Fed so they can take the money and do it all over again.
Right now Australian 15-years are priced at 4.20%.

Today, the American saver gets a pittance in a money market. It's really nothing but a wealth transfer racket.
Mom, we're going to Sydney.
Similar thoughts at "Investment Postcards from Cape Town":


The effects of this policy will become apparent this week as four of the big banks/investment banks report. Here's the calendar:
Wed., Oct 14: JPM
Thu., Oct 15: C; GS
Fri., Oct 16: BAC
They all report pre-market. Also this week, DJIA components IBM: INTC; JNJ; MRK andd GE will be reporting.
In September we pointed out the change in leadership the markets were experiencing, the bank sector which had led from the March 9 low were weakening. This has reversed in the last week and more particularly on Friday (KBW Bank Index [BKX] vs S&P):

Chart for KBW Bank Index (^BKX)

There is much handwringing about the bank's failure to lend.
Chairman Bernanke and the bankers are crying crocodile tears.

This is a deliberate policy. The banks get to play the U.S.'s do-it-yourself carry trade, borrow at an average .30% and lend at 4.00% (U.S. treasuries) 5.00% (mortgages) 10% (commercial loans), 12-28% (credit cards). They are literally printing money.

The Fed benefits by the banks buying treasuries because it allows them to perform their Quantitive Easing (monetizing the debt, i.e. printing money) in the mortgage market, cleaning up Fannie and Freddie's balance sheets. If the Fed didn't have the banks in the treasury markets interest rates would be considerably higher right now.
Everyone wins. If you forget about mom and pop savers.

Another wrinkle is the change the Financial Accounting Standards Board made last spring regarding how banks get to write down/write up their junk assets.
The new rules basically allow them to use whatever valuation they need to meet regulatory capital requirement. Cool huh?

Back when the FASB was considering the change we thought it was a big enough deal to put up multiple posts:

March 25
Banks to Write-UP Assets?
Following my mission critical (coffee a.m., lights p.m.) duties in importance is attempting to ascertain (sometimes feebly) regulatory impacts and how to make a buck off them. Here's one worth looking at, from the National Center for Policy Analysis:...
March 30
Mark-to-Market Lobby Buoys Bank Profits 20% as FASB May Say Yes
April 2
FASB Eases Fair-Value Rules Amid Lawmaker Pressure
April 2
Markets: Why the FASB Decision Matters

On Monday March 30 we posted "Getting Ready for the Wednesday/Thursday Market Pop":
As I said in the post immediately below, reality has attempted to intrude on the blogging.
I won't get all Fibonacci or 50-day on you, this decline has an odd feel to it. We might be setting up a nice mid-week run. The DJIA is currently down 307 at 7468 and the S & P is down 53.81 at 1491....
One of our rationales was the FASB move we'd been reporting was coming.
On Wednesday April 1 we posted "U.S. stock futures slip to start second quarter":

Great. Here I am calling for a midweek pop in the market and Dow futures indicate down 52.
Will this thwart my plans for world domination? In the words of Jimmy James (News Radio):

Mr. James:
"The original title of this book was 'Jimmy James, Capitalist Lion Tamer' but I see now that it's... 'Jimmy James, Macho Business Donkey Wrestler'... you know what it is... I had the book translated into Japanese then back in again into English. Macho Business Donkey Wrestler... well there you go... it's got kind of a ring to it don't it?

Anyway, I wanted to read from chapter three... which is the story of my first rise to financial prominence... I had a small house of brokerage on Wall Street... many days no business come to my hut... my hut... but Jimmy has fear? A thousand times no. I never doubted myself for a minute for I knew that my monkey strong bowels were girded with strength like the loins of a dragon ribboned with fat and the opulence of buffalo... dung. ...Glorious sunset of my heart was fading. Soon the super karate monkey death car would park in my space. But Jimmy has fancy plans... and pants to match. The monkey clown horrible karate round and yummy like cute small baby chick would beat the donkey."
-Episode #57 "Super Karate Monkey Death Car"
By way of
Well there you go. Pretty much says it all....
...By the bye, tomorrow the FASB will meet to decide whether to rescind mark-to-market accounting for the banks, see "Mark-to-Market Lobby Buoys Bank Profits 20% as FASB May Say Yes".
We gave you the rest of the story on May 30:
Thoughts on Markets, Investing and Life
The Dow Jones Industrial Average closed up 152.68 that day and a further 216.48. the next.
The run actually started a day earlier than I thought it would, with an 86 point advance on Tuesday.

Mom used to say, "It's great fun to fool around, just get your homework done first."
And there you go. One of the reasons we posted "Do not sell equities, Credit Suisse says" a week ago.
Update- one more thing to factor in, From Bloomberg:

Writedowns on Mortgage Servicing Make Even JPMorgan Vulnerable
The four biggest U.S. banks by assets may have to take writedowns on $55 billion of mortgage- collection contracts after marking them up by $11 billion in the second quarter, casting a shadow over earnings.

Bank of America Corp., JPMorgan Chase & Co., Citigroup Inc. and Wells Fargo & Co. wrote up the value of the contracts, known as mortgage-servicing rights or MSRs, by 26 percent in the quarter as mortgage rates climbed by about 0.35 percentage point. Net gains on the contracts added more than $1 billion to Wells Fargo’s record earnings in the quarter and $1 billion to JPMorgan’s first-quarter profit.

Mortgage rates fell about 0.26 percentage point in the third quarter, according to Freddie Mac, and servicing costs are rising, meaning the four banks, which handle collections on more than $5.9 trillion of U.S. mortgages, may face writedowns.

“We’re very bearish on MSR valuations,” said Paul Miller, a banking analyst at FBR Capital Markets in Arlington, Virginia. “They are overvalued. There are higher costs associated with the servicing, and we’re very concerned about it.”....

...Whether the banks will take losses as a result of any MSR writedowns in the third and fourth quarters depends on the level of their hedging. Bank of America, which lowered the value of its rights last year by $6.7 billion, still added $2 billion to its earnings as hedges outperformed the declines. JPMorgan’s hedges earned $1.5 billion more than the $6.8 billion it took in writedowns on its collection contracts in 2008....