How Are Those Banks Doing? Depends Who You Ask

What is going on with the banks? What are they doing with all that government TARP money? Are they crumbling, are they lending, are they solvent, are the toxic assets causing them to fail or are they just fine? As usual the answer isn’t simple and depending upon who you ask, you will get a different answer. It all depends on your perspective.

As a bank executive your job is keep your bank alive. The primary reason companies fail is they spend more cash than they collect, In other words, they are cash flow negative. Based on recent financial reporting announcements, banks are cash flow positive due to increased fees from transactions they have facilitated and increased deposits. Many still have negative earnings due to write downs (on bad loans) but they can pay their bills and keep the lights on. So bank executives are relieved that the panic seems to be over and that their banks can remain viable ongoing concerns.

However bank executives aren’t happy that their pay has been limited by government regulation related to the TARP funds. They also don’t like being lumped in with big bad wolf - AIG (AIG). So they want to give the government back its TARP funds as quickly as possible. Bank execs could care less about lending more money and stimulating the economy because there few incentives to make a lot of new risky loans. From a bankers perspective it would be better to hold on to the cash and use it to pay back the government’s TARP funds.

To make matters worse for the bank execs, the government wants the banks to sell their troubled (toxic) assets in order to free up capital to make new loans. These toxic loans have not been written down to their current market price because execs view these prices as just a market glitch. The current market for these assets is essentially frozen. The few transactions that take place are at a greatly discounted price. Many of these securitized investments are receiving a large portion of the interest and principal payments on time. So bank executives see no reason to sell these assets for a loss when they are generating an adequate cash flow. Now that the panic in the credit markets has subsided, the bank executives see no reason to cooperate with the government if it is not in their best interests.

The government’s objective is to get the economy up and running. To do this they need the banks to be lending. It is the lack of liquidity in the markets that caused most of the panic. The banks were loaned the TARP funds to show the financial markets that the Treasury and the Federal Reserve had no intention of letting any more of the larger banks fail. In return, the banks were supposed to increase lending to consumers and companies, thereby stimulating the economy. However, the banks are not cooperating and lending has fallen. An analysis by the Wall Street Journal of Treasury Department data showed that the largest banks refinanced 23% less in new loans in February than in October 2008 when TARP was launched.

Supposedly the government is stress testing the banks to see if they can survive tough market conditions. However, it is not in the governments best interests to have any of the banks fail this test. If most of the banks failed the government would not be able to prop them up again. The stress test may only be a political tool the administration is using to make the banks keep the TARP funds.

The Treasury Department wants to avoid any political backlash stemming from reduced lending by banks. The Obama administration wants the banks more accountable. It wants them lending. Currently, the government has little say regarding how the banks operate due to how the TARP legislation was structured by former Treasury Secretary Paulson. Since bailout funds are dwindling the Treasury has few options and little clout with the banks. One option that the Treasury has begun to consider is turning the TARP loans into equity (stock in the banks). This costs the taxpayers nothing. The losers in all this will be the investors that own bank stocks. Investors will find their ownership positions diluted and the value of the stocks would fall substantially.

So how are the banks doing? It depends who you ask and what metric you use.

Comments

[RATHER FISH:]

You say the investors "WILL " be the losers!!! The investors have already lost BY taking the safe conservative route and advice from the very inept management who drove the country to this mess by GREED. These same managers now want to CHARGING YOU 28% ON MONEY YOU ARE LENDING THEM for 5%. What did P.T. BARNUM SAY?

Apr 26 06:39 PM

[Mental Block:]

And why shouldn't those investors have lost their money??

>>>>>&g...
One option that the Treasury has begun to consider is turning the TARP loans into equity (stock in the banks). This costs the taxpayers nothing. The losers in all this will be the investors that own bank stocks. Investors will find their ownership positions diluted and the value of the stocks would fall substantially.

Apr 26 06:42 PM

[mathgeek:]

Excellent article.

While it has become everyone's favorite sport to blame the bankers for everything bad in the world, I think this shows the dilemma they face.

Do you lend more? This reduces the capital cushion and makes it more likely you will fail the stress test. Banks have long been caught between conflicting pressures from Washington. (Lend more! Lend more cautiously! Lend more to lower income people! Keep your rates down! Keep more capital on hand! etc. etc.) TARP combined with the stress tests are merely a bit more blatently schizophrenic than usual.

I think that the insight that the stress test may be used to force banks to hold on to TARP funds longer is an excellent one... the question then becomes what is the government willing to do to try to force more of those funds to be lent? The real answer to that question may very well be nothing.... at least nothing beyond giving the media a few juicy soudbites about greedy bankers.

Apr 26 11:30 PM

[Steve W fro...:]

Yes some banks MAY face dilution but I believe the government is more interested in giving the banks time to earn their way out of the problem. BAC, for example, earned over 24B in the first quarter alone that was available for loan losses, future provisions and additional equity. Another couple of quarters of this and BAC won't need assistance. Many others posted similar results and IMHO the government will be smart to allow them the time to solve their own problems. The shock to the system of additional massive dilution to shareholders equity would be far more harmful and Geithner and Bernanke must know this.
After first quarter earnings like we just saw the risk of further dilution is receding rapidly. Barring further large deterioration in the economy we will not see the TARP funds converted.

Apr 27 12:40 AM

[William Cowie:]

The picture that has emerged is Paulson (a banker's banker) offered TARP to the banks as free money, with no strings attached. The American people, through Congress, attached strings in outrage. Then a funny thing happened. The moment the execs' pay got limited, all need for TARP disappeared, and they began falling over themselves to repay TARP money.

Does that mean the end of government aid to banks? Don't believe that for a second. All it means is the banks simply are telling our government to come up with a different program, not run through Congress and, most importantly, with no restrictions on their $60 million paychecks. Bye-bye TARP, hello PPIP. Now they can keep our tax dollars and don't have to answer to anyone for their compensation.

Welcome to the new America...

Apr 27 12:44 AM

[Old Trader:]

Steve,

Your premise of the banks "earning" their way out of their current hole would be realistic IF (please note the big "if") the bulk of the earnings you allude to weren't the result of one time items, and some dubious accounting.


On Apr 27 12:40 AM Steve W from Ford wrote:

> Yes some banks MAY face dilution but I believe the government is
> more interested in giving the banks time to earn their way out of
> the problem. BAC, for example, earned over 24B in the first quarter
> alone that was available for loan losses, future provisions and additional
> equity. Another couple of quarters of this and BAC won't need assistance.
> Many others posted similar results and IMHO the government will be
> smart to allow them the time to solve their own problems. The shock
> to the system of additional massive dilution to shareholders equity
> would be far more harmful and Geithner and Bernanke must know this.
>
> After first quarter earnings like we just saw the risk of further
> dilution is receding rapidly. Barring further large deterioration
> in the economy we will not see the TARP funds converted.

Apr 27 09:34 PM