Too Much Supply, Too Little Support

Wow, this sounds pretty good!

WASHINGTON -- U.S. banks reported a first-quarter profit of $7.6 billion, buoyed by revenue at a few larger companies, but overall the credit picture remained grim as the number of banks in trouble continued to rise and borrowers increasingly fell behind on their loans.

Or is it?

Let's think. During that quarter AIG passed through some $100 billion plus from the taxpayer to the largest of these very same banks.

So the banks "made" $7.6 billion, but they had an "unearned gain" of over $100 billion. Let's call it an even $100 billion as some of it didn't stay here in the United States.

Now The WSJ claims:

Still, the latest results were an improvement from the industry's net loss of $36.9 billion in last year's fourth quarter.

They were? I guess if you can count robbery as an "improvement", ok. But let's look at this from a different angle - back out that "unearned" and illicit gain from the passthrough and they would have lost $92.4 billion dollars, or well more than twice last year's fourth quarter.

Heh, if I can steal making my numbers is easy! All you have to do is leave the bank vault open and promise me that there are no guards, no cameras and no guns! I will then march in and steal whatever I want, and of course will turn in respectable quarterly results.

The problem with the banks lies here:

Despite those actions, banks were increasingly unable to build their reserves fast enough to keep up with noncurrent loans. The ratio of reserves to noncurrent loans fell to 66.5% in the first quarter from 74.8% in the fourth quarter. It was the lowest level in 17 years.

To put this in a bit more simple form, this means that while the banks are claiming to be increasing loss provisions, loans are going bad faster than their provisioning is increasing - which means they're reporting "profits" that are false, as provisions for bad loans hit earnings. So we can take some more off those "reported earnings", as much as another $6-10 billion dollars.

Do those reported numbers still look ok?

What's worse is that the banks are charging off (that is, disposing as worthless) a huge amount and yet even that is not slowing down the bad loan count - they're going delinquent faster than the banks are charging them off.

That's not bullish folks.

Then there's this:

WASHINGTON -- A government program designed to rid banks of bad loans, part of a broader effort once viewed as central to tackling the financial crisis, is stalling and may soon be put on hold, according to people familiar with the matter.

The Legacy Loans Program, being crafted by the Federal Deposit Insurance Corp., is part of the $1 trillion Public Private Investment Program the Obama administration announced in March as a way to encourage banks to sell securities and loans weighing on their balance sheets to willing investors.

And this...

May 26 (Bloomberg) -- The highest-graded bonds backed by commercial mortgages may be cut by Standard & Poor’s, potentially rendering the securities ineligible for a $1 trillion U.S. program to jumpstart lending.

As much as 90 percent of so-called super senior commercial- mortgage backed bonds sold in 2007 may be affected as the ratings firm changes how it assesses the debt, New York-based S&P said today in a report. About 25 percent of the bonds sold in 2005, and 60 percent of those sold in 2006 may be cut.

The "CMBS", or Commercial Mortgage Backed Securities marketplace has seen an amazing contraction in spreads - that is, perceived risk - over the last month or so. Most of this has been due to the belief that The Fed would effectively monetize them (yeah, I know, they're claiming they aren't - riiiight!)

This change will drive a stake through the heart of that program - expect to see those spreads start to blow out again, and soon, as commercial real estate is in much more trouble than is being discussed openly.

Simply put there is far too much supply and far too many retailers that are or will go under to support it. There's no realistic possibility of fixing this problem and as a consequence the expectation has to be that we will see an all-on collapse at some point in the not-so-distant future in this marketplace as rent collections and therefore valuations collapse.

Now add a dose of panic in the Treasury market, and oh boy, things could get interesting fast, no?

Buckle up folks - this ride is likely to be a bit rough.

Disclosure: Lightly short the broad markets (SPX) at the present time.

Comments

[thiazole:]

I think if you wanted to blame a company for "stealing the money", it would be AIG. AIG stole it to pay off outstanding policies. the recipients of those policies didn't steal the money, though.

Not saying this is at all likely, but if AIG were to somehow pay back the government over say the next 20 years, would it still be theft?

May 28 02:11 PM

[Prudent Man...:]

There is no way the Federal Government and its regulators know what the banking system is worth and what their toxic assets actually are. They are waiting for the people who transacted these toxic transactions to tell them, which is crazy.

Anyone reading the news knows that foreclosures, hardly a lagging indicator, are increasing and will continue to do so as many of the large banks have not put their non-performing mortgages into foreclosure. They are waiting for a "short sale" but the borrower has walked. To do a "short sale" the borrower must sign over the deed and the banks can't find them. This is the dirty secret the regulators don't want to talk about and the media doesn't understand. Like a cancer it will grow until everyone involved gets out of denial and accepts the reality of asset write-downs.

If the government step aside an let the Free Enterprise System do its work this would be ameliorated in months and the problem solving can take place. As long as the politicians kick the problem down the street it will be with us in one form or another.

May 28 02:37 PM

[dcb:]

the reason these people should just stop paying. you can't foreclose if you can't show that you own the mortgage. the banks have no idea where the paper work is.


On May 28 02:37 PM Prudent Man CFA wrote:

> There is no way the Federal Government and its regulators know what
> the banking system is worth and what their toxic assets actually
> are. They are waiting for the people who transacted these toxic transactions
> to tell them, which is crazy.
>
> Anyone reading the news knows that foreclosures, hardly a lagging
> indicator, are increasing and will continue to do so as many of the
> large banks have not put their non-performing mortgages into foreclosure.
> They are waiting for a "short sale" but the borrower has walked.
> To do a "short sale" the borrower must sign over the deed and the
> banks can't find them. This is the dirty secret the regulators don't
> want to talk about and the media doesn't understand. Like a cancer
> it will grow until everyone involved gets out of denial and accepts
> the reality of asset write-downs.
>
> If the government step aside an let the Free Enterprise System do
> its work this would be ameliorated in months and the problem solving
> can take place. As long as the politicians kick the problem down
> the street it will be with us in one form or another.

May 28 03:09 PM

[Investor Nirav:]

On May 28 03:09 PM dcb wrote:

> the reason these people should just stop paying. you can't foreclose
> if you can't show that you own the mortgage. the banks have no idea
> where the paper work is.

can you expand on this?

May 28 03:31 PM

[Iconoclast421:]

Today Karl wrote that the curtains were on fire. Yesterday he used the phrase "ALL OF IT" in a title to one of his posts. The last time he used that phrase was in early March ("Whats Dead? ALL OF IT"). lol at that same time I was rolling my 401k from cash into the most aggresive fund I could. Apparently Karl has a way of marking the bottom, or rather marking when the market is going to lurch higher (I havent figured out which yet). All I know is that since the last time he used the phrase ""ALL OF IT" to this time, SPX is up 40%. Could Karl be signaling another 40% upward move? lol.

May 28 04:29 PM

[Alex Trias:]

Excellent article. This really sets the stage for "Credit Crisis Part II", which would make the first crisis look like it was for sissies. What the author is saying is that banks are becoming "more insolvent" than they already are, and that the only thing propping the credit markets up is the fact that men with printing presses are handing money over to banks - which, if the market decides to catch on - should really only be able to go on for so long.

May 28 04:30 PM

[Bill W.:]

Karl,

Excellent article, as usual! Just read some news the banks will be tickled pink to hear: The Government today announced that first time home buyers can, effective imediately, use thier $8000 tax credit to reduce the price of the home. So, instead of waiting until they get thier tax returns next year, the money will be used in the near term.

God help us all.

May 29 11:46 AM

[obewon:]

@Karl:
Thanks for a well written commentary. The "well-engineered" (i.e. rigged) rally is ending; now the manipulators will have to watch for the "unintended consequences" of their actions.


@Iconoclast:
Sure, if you want to lose all of what you have gained from the recent rally (which was rigged by the FED, Geithner's PPT, GS, and JPM), leave your money in stocks. If you wish to lose more, invest in L.T. treasuries.


On May 28 04:29 PM Iconoclast421 wrote:

> Today Karl wrote that the curtains were on fire. Yesterday he used
> the phrase "ALL OF IT" in a title to one of his posts. The last time
> he used that phrase was in early March ("Whats Dead? ALL OF IT").
> lol at that same time I was rolling my 401k from cash into the most
> aggresive fund I could. Apparently Karl has a way of marking the
> bottom, or rather marking when the market is going to lurch higher
> (I havent figured out which yet). All I know is that since the last
> time he used the phrase ""ALL OF IT" to this time, SPX is up 40%.
> Could Karl be signaling another 40% upward move? lol.

May 29 01:59 PM

[Old Trader:]

No doubt, the banks are feverently hoping things turn around so that they can stop, or at least slow down, the rate at which they're provisioning for losses. Additionally, I'm thinking that they're waiting with bated breath for a new government program that would either a) allow them of offload the "stinkers" at a higher price, so they can reverse some of those loss provisions and add them to future profits, or b) help owners of real estate become and stay current, which would have the same effect as "a", except that it would stretch out over a longer time frame.

May 29 07:03 PM