What Else Are the Banks Hiding? 25 comments
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The amount of credit risk that the banks have hiding in off-balance-sheet vehicles was a fairly big deal at the onset of the credit crisis. I haven’t seen much about it recently and assumed, mistakenly, that it had become a non-issue. Bloomberg has an article Thursday that suggests that isn’t the case at all.
David Reilly contends that the banks have a mountain of hidden assets that have to be accounted for sooner or later.
At the end of 2008, for example, off-balance-sheet assets at just the four biggest U.S. banks — Bank of America Corp., Citigroup Inc., JPMorgan Chase & Co. and Wells Fargo & Co. — were about $5.2 trillion, according to their 2008 annual filings.
Even if only a portion of those assets return to the banks - - as much as $1 trillion is one dark possibility — it would take up lending capacity the government is trying to free.
The hidden assets that may return to banks consist of mortgages, credit-card debts and auto loans, among others. Over the years, banks bundled them together and sold them to investors as securities.
Whether these assets are “troubled” or “toxic,” their return to bank balance sheets could slow efforts to get credit flowing again. After all, banks shed the loans to make their balance sheets look smaller, allowing them to hold less capital to act as a buffer against losses. Until a couple of years ago, that boosted profits.
According to Mr. Reilly, it is an open question at this time whether these assets must be brought back onto the banks balance sheets. The discussion regarding mark-to-market accounting also encompasses the accounting treatment of these vehicles. Since the thrust of the accounting changes as dictated by the Congress seems to be towards a system that papers over the current problems, the requirements to properly account for these assets will probably be watered down.
While the banks may be able to avoid consolidation, they cannot avoid the eventual necessity of recognizing the losses when they do occur. Based on the information in the article, there are probably some sizeable losses embedded in these portfolios. Some examples from Mr. Reilly include:
- $92 billion of credit card loans at Citigroup (C), $70 billion at JP Morgan (JPM), $114 billion at BofA (BAC).
- $355 billion of securitized commercial loans at Wells Fargo (WFC).
- $360 billion of securitized non-agency mortgage debt at BofA. Of that amount $58 billion are subprime loans and $138 billion Alt-A mortgage debt.
- BofA and Wells may have as much as $600 billion of assets that have to be consolidated.
What perplexes me is that we are still dealing with estimates, maybes and perhaps this will happen scenarios at this late date. Why? It’s a pretty universal principle that if you want to solve a problem, you first have to define it. If we don’t know at this late date the extent of the toxic assets for which the banks have to account how did the Treasury design a program that is reputed to be the solution?
The Fed and Treasury really do need to come clean about the extent of the problem. Their credibility is shrinking by the day. The Geithner Plan has received at best a lukewarm reception, probably because it is viewed as simply better than nothing. If the banks start replacing bad assets they sell to the public private partnerships with bad assets lurking in the shadows it is not going to sit well at all.
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I don't think we are going to see any significant new information on the off-balance sheet stuff until Q1 reports. At least where Wells is concerned we know they have hundreds of people working on cleaning it all up.
-Matt
As the bad assets come out over time they will be a drag on bank recovery.
Take Wells Fargo for example. Due to new government rules Wells was able to combine Wachovia's tax asset (tax carryover) with its own tax liability (taxes owed), turning something like a 4-5 billion tax bill into an 11 billion+ tax carry over that will zero out Wells Fargo's taxes for one to two years. It's right there in their 10-K.
Another example is the net interest margin. Big money center banks like Wells are increasing their deposit base by leaps and bounds. Those deposits cost the bank 1-2% in interest paid to depositors. At the same time the bank is turning around and originating mortgages at 4-6% with that money. Wells has one of the highest net interest margins in the business right now.
A third example would be mortgage refinances and originations. Refi activity is the highest ever recorded right now. Each refi brings in significant income in fees to the bank, removes the original loan from whatever securitzed vehicle it had been sitting in previously, and puts serious money in the pockets of large numbers of middle-class families which I guarantee you they will be spending at least some of. And we aren't talking about one-time here, we are talking about improved cash flow for millions of Americans.
The question has never been whether there would be mortgage losses or not. Everyone knows there will. The question has always been whether the banks can cover those losses with earnings. In fact, I think Wells has a pretty good handle on that, making it rather silly to price its stock as if it were going out of business.
Just looking at the negatives will not give you the whole picture. The media has been focused almost entirely on the negatives for the last 6+ months.
-Matt
I don't disagree with your points. In fact if you look at some of my other posts you will see that I subscribe to the position that the banks are generating exceptional amounts of net interest income (hard not to given the yield curve).
My concern is that the embedded losses in their balance sheets will overwhelm them before they can earn their way out. I think Wells is probably better than most of their peers but still questions linger. If more information was available -- reliable information not the banks' interpretation -- I could make a reasonable judgement.
As it is I remain hopeful and skeptical. Too many recent surprises that I just can't shake.
On Mar 26 10:44 PM MattZN wrote:
> The media tends to focus only on the negative aspects of the banks.
> They don't seem to be able to spend even 10 minutes reading a 10-K,
> so most people never hear about the positive aspects.
>
> Take Wells Fargo for example. Due to new government rules Wells was
> able to combine Wachovia's tax asset (tax carryover) with its own
> tax liability (taxes owed), turning something like a 4-5 billion
> tax bill into an 11 billion+ tax carry over that will zero out Wells
> Fargo's taxes for one to two years. It's right there in their 10-K.
>
>
> Another example is the net interest margin. Big money center banks
> like Wells are increasing their deposit base by leaps and bounds.
> Those deposits cost the bank 1-2% in interest paid to depositors.
> At the same time the bank is turning around and originating mortgages
> at 4-6% with that money. Wells has one of the highest net interest
> margins in the business right now.
>
> A third example would be mortgage refinances and originations. Refi
> activity is the highest ever recorded right now. Each refi brings
> in significant income in fees to the bank, removes the original loan
> from whatever securitzed vehicle it had been sitting in previously,
> and puts serious money in the pockets of large numbers of middle-class
> families which I guarantee you they will be spending at least some
> of. And we aren't talking about one-time here, we are talking about
> improved cash flow for millions of Americans.
>
> The question has never been whether there would be mortgage losses
> or not. Everyone knows there will. The question has always been whether
> the banks can cover those losses with earnings. In fact, I think
> Wells has a pretty good handle on that, making it rather silly to
> price its stock as if it were going out of business.
>
> Just looking at the negatives will not give you the whole picture.
> The media has been focused almost entirely on the negatives for the
> last 6+ months.
>
> -Matt
On Mar 26 10:44 PM MattZN wrote:
> The media tends to focus only on the negative aspects of the banks.
> They don't seem to be able to spend even 10 minutes reading a 10-K,
> so most people never hear about the positive aspects., etc.
>
>
If one were to start pointing fingers there's enough blame to go around, but people have already seemed to have forgotten that the massive ramp-up in sub-prime lending was not originated by the traditional banking industry. Unregulated non-bank entities were responsible for most of the volume, Wall street was responsible for most of the buying, other non-bank entities (now all out of business) were responsible for most of the CDO packaging, and AIG and others were responsible for writing CDS's without any risk controls (the banks, despite being hip-deep in the mess now, still had significantly better risk controls them companies like AIG which had basically none). Oh yah, and the government by 2008 was so dysfunctional that they couldn't regulate a 5-year old on a Popsicle binge, let alone anything real.
Fortunately sanity is slowly returning to the sector. Cry Wolf too many times without any real figures to back up claims and investors simply stop believing that the banks are the boogie man.
-Matt
Coconut Grove Bank has about doubled in size since then through service to a local community. What growth through service vs trader based acquisition can the big banks show the tax payer who is not big enough for an account but plenty big enough for a bailout?
The three C's of banking
Character (of customer) Capacity (to repay) Collateral (to cover risk) do not apply to big banks.
etfdesk.com
What you need to do to find out whether the SIV's portfolio will need to be consolidated is to read the agreements that were filed when the SIV was created. Those documents are all on the individual bank's SEC filings page. What you are looking for are provisions within the controlling documents that indicate under which conditions , and this is really important, "IF ANY", that would force the bank to make up for losses within the porfolio, and this is just as important, should those losses exceed the equity within the SIV. If the agreement is that the bank never needs to make up the losses, no matter what, than obviously, you can toss that SIV out and not worry about it - the investors and bondholders are on an island. It then becomes a grading/ranking of provisions within the remaining population - ie which SIV's have easy triggers to require the banks to pony up more collateral or equity vs which triggers are hard.
Obviously, its a whole lotta sluething, but that's why those wall street analysts get paid the big bucks.
Kind Regards
The fact is, buyers never examined what was in the pools, relying on the ratings agencies to do their homework. Of course, we'd all like "a Mulligan."
Ain't you glad we have 3 weeks of good news? 3 weeks we don't have to puke again and again? 3 weeks for our immune system to start getting accustomed to more than 18 months of trash assault?
Give it some rest.
We need to live like decent human beings again.
Stop digging more trash, we know there are lots more out there, but do we really have to dig all of them?
They're doing that because the present value of the income streams from these assets is greater than the market price by a large magnitude. These "bad" or "toxic" securities, as the media likes to call them, are still spinning off cash, just not as much as was originally thought when they were created. Compare the foreclosure rate to MBS prices. Their cash flows are too high to justify their pennies-on-the-dollar prices. The PV's of these securities might only be between 0.50 and 0.75 on the dollar, but that's a lot better than the 0.25 the market is offering. The banks' highest margin activity is finding a way to avoid selling these securities for pennies on the dollar, with returns from that activity much higher than what is available from originating new loans. GS will borrow from Warren Buffet at 10% to avoid missing out on those kinds of cash flows. Essentially, management is still operating on mark-to-model (or mark-to-cash flow) while the financial statements report mark-to-market.
----------------------...
"My concern is that the embedded losses in their balance sheets will overwhelm them before they can earn their way out."
----------------------...
Debt/equity ratios may continue to increase, and shareholders are very likely to be diluted, but the key fact is that the government has become dedicated to not allowing the failure of another big bank - or even insurance company. If debt servicing requirements became too burdensome, the Fed's loan window is open for business, although the bond and equity markets are increasingly looking like cheaper sources of capital. Of course I have to ask, is dilution really that harmful to existing shareholders if it props up the company and ensures its survival vs. bankruptcy?
Increasingly, it looks to me like all the big banks will survive, paying off their government debts with MBS cash flows, and some of those mark-to-market losses could someday return as unexpected mark-to-market gains.
The entire economy went "sub-prime"- covenenant Lite loans, leveraged buyouts saddling good companies with billions in debt, and TRILLIONS in derivatives with NOTHING behind them- not a house, not a shed. You have no idea (which is very profitable for me) what lurks off-balance sheet.
The reason we do not know how much loss lies in JPM's 80 TRILLION in (yes, I know, notional) is because if they told us the S&P would drop 60% overnight.
Let time tell which one of us is right. You keep trusting the Bankers- or is this Citi's PR dept. at work again?
On Mar 27 02:48 AM MattZN wrote:
> It's always a possibility that the losses will accelerate faster
> then the banks can handle, but it seems unlikely considering the
> moves the Fed made to force a bottom in home prices earlier and push
> out inflation a little further. Again, the media has done a very
> poor job on reporting. People still apparently believe that Bernanke
> is going to spend that 750B buying nothing but toxic assets. What
> he is actually doing is providing liquidity in mortgage-backed securities
> to allow banks, fannie, and freddie to ramp up origination and refi
> activity. Banks have to be able to securitize their originations
> or they hit a wall on available capital.
>
> If one were to start pointing fingers there's enough blame to go
> around, but people have already seemed to have forgotten that the
> massive ramp-up in sub-prime lending was not originated by the traditional
> banking industry. Unregulated non-bank entities were responsible
> for most of the volume, Wall street was responsible for most of the
> buying, other non-bank entities (now all out of business) were responsible
> for most of the CDO packaging, and AIG and others were responsible
> for writing CDS's without any risk controls (the banks, despite being
> hip-deep in the mess now, still had significantly better risk controls
> them companies like AIG which had basically none). Oh yah, and the
> government by 2008 was so dysfunctional that they couldn't regulate
> a 5-year old on a Popsicle binge, let alone anything real.
>
> Fortunately sanity is slowly returning to the sector. Cry Wolf too
> many times without any real figures to back up claims and investors
> simply stop believing that the banks are the boogie man.
>
> -Matt
On Mar 26 06:04 PM youngman442002 wrote:
> This is why I can't understand why their stocks are going up. How
> can anyone figure out what they are worth with this hiding in the
> shadows. And why is it "hiding" in the shadows...that is what really
> makes it stink. I know credit cards are not getting paid...neither
> are student loans..and soon Commercial real estate will be defaulting
> above the norms....it does not look that rosy to me..but then again
> if you have the Federal governement willing to give you anything..maybe
> it is Rosy...
On Mar 27 02:29 PM HBWOW wrote:
> I keep reading articles about the huge amount of derivatives in the
> world's market, ie "Central Banks in a Pickle" by Chris Laird article.
> He says that the world has well over $1000 trillion of derivatives
> out that are unregulated and deeply underwater. Most of the articles
> quote large numbers but I have yet to see a breakdown by country
> nor a breakdown of numbers held by our banks at any given time. Who
> started this insane gambling of unregulated, non descript, non monitored
> (by stock exchanges), non taxed (?), poorly or non recorded documentation
> type "investment"?
Hey let's all root for AIG to fail AFTER we already own them. That's like putting $500 on a 10-1 horse and shooting it in the leg before the race.