Nothing Is Ever Truly 'Off the Books' in the Financial World

Several articles came out last week pointing to Morgan Stanley’s (MS) purchase of a controlling interest in Citigroup’s (C) Smith Barney via a joint venture and Bank of America’s (BAC) purchase of Merrill Lynch as possibly misguided. Bank of America often called Merrill’s retail operation its crown jewel, and Morgan Stanley stressed the need for mass in wealth management. Despite Bank of America’s touting Merrill’s recent profits, the core profitability driver of full-service retail brokerage is waning.

The Wall Street Journal’s “Reconsidering Wealth Managers” reports that a Merrill Lynch Global Wealth Management and Capgemini Group survey showed that more than 25% of high net worth individuals withdrew funds or entirely closed their wealth management accounts. Wealthy clients have moved over half of their balances to simpler, lower margin investments such as cash and bonds. Smaller and regional banks were the beneficiaries. Capgemini says the business remains profitable as the full-service firms strive to increase assets under management.

The lifeblood of the retail operations is pumping highly profitable structured products to individual investors. Value adding through packaging and “access” to alternative investments had been the brokers’ mantra. It is here where the firms are trying to create an extraordinary resuscitation to again begin attracting both high net worth and institutional clients.

Bloomberg’s “Ambac Cut to Junk as Main Unit ‘In Runoff,’ S&P Says” suggests the market for structured products continues to be sick. The very same investment banks that are trying to retain investors’ interest in structured products are suing to prevent Ambac (ABK) and MBIA (MBI) from allocating capital to restart their municipal bond insurance businesses. The banks are scared the monolines won’t have enough capital remaining to back insured CDOs. The monolines are in turn suing the underlying mortgage originating banks for breach of warranties.

The Wall Street Journal’s “Repackaging by Banks Helps CMBS” reports that Bank of America, Citigroup and Morgan Stanley are repurchasing the highest tranches of unloved CMBS to sell them again with credit enhancement increased from 30% to 50%. They hope to rekindle institutional interest and make profit from a reduced spread over treasuries.

At the other end of the spectrum, the Financial Times’ “Banks rush to rescue of credit card trusts after record defaults” is reporting that American Express (AXP), Bank of America, Citigroup and JP Morgan (JPM) are buying the lowest tranches of credit card securitizations so they can absorb the first losses instead of investors. JP Morgan is even replacing some lower quality WaMu credit card loans with its own to reduce the loss ratio in certain trusts.

Keeping the credit card trusts viable is particularly important to banks because as consumers prepay balances, the trusts’ capacity is recycled into new loans. If losses reach a certain point, investors can accelerate payments reducing the capacity of banks to issue credit card debt. Banks are trying every manipulation possible to prevent that from happening.

Changes in accounting rules might force banks to include off balance sheet trusts (or securitizations) back on their books. The deciding factors include control and risk of loss. This could make all of these efforts to revive the shadow banking system irrelevant. Fed Chairman Bernanke should take note. Add to this the proposed Consumer Financial Protection Agency (CFPA) warning retail investors about the dangers of structured products and alternative investments.

Where does this leave our mega banks? Their investing banking businesses will become more dependent on traditional capital raising and trading, and their commercial operations will become more dependent on funds processing and traditional banking. When everything remains on the books, the whole operation becomes less profitable, including their prestigious retail wealth management chains.

Disclosures: Author is long ABK, BAC, C and MBI.

Comments

[Moon Kil Woong:]

We can only hope Michael Steinberg is right. Of course, re-instituting Glass Stegall would help seal this type of outcome.

"Their investing banking businesses will become more dependent on traditional capital raising and trading, and their commercial operations will become more dependent on funds processing and traditional banking. When everything remains on the books, the whole operation becomes less profitable, including their prestigious retail wealth management chains."

Jun 29 04:57 AM

[RiskAverseA...:]

The shadow banking system is as dead as Elvis and we probably have barely even begun to pay for the cost of the funeral...

Jun 29 07:56 AM

[KIT:]

If the Titanic was held off the books its stock would be rising now because the ship is sinking much slower. Maybe a Titanic ETF could be set up

Jun 29 11:04 AM

[Leftfield:]

For years I've assumed Wall St. knew their business even as I read about off-balance-sheet obligations and lots else they cook up. That's their business even though it sounded fishy to me. Now it's our business because these richest of the rich come to the pauperized former middle class for bailouts. We've paid for continued mega-pay employment on Wall St. so they can continue to create more "product" to hit the fan. They need a V-shaped recovery like our government for this stuff to actually work. Luckily for them it's always OPM.

Jun 29 11:27 AM

[D_Virginia:]

[insert obvious Titanic bailout joke here]

:-)


On Jun 29 11:04 AM KIT wrote:

> If the Titanic was held off the books its stock would be rising now
> because the ship is sinking much slower. Maybe a Titanic ETF could
> be set up

Jun 29 12:01 PM

[Sovestor:]

Off the book is a nice way to hide losses....but it will sooner or later blow up.

Jun 29 12:36 PM

[Alessandro:]

quoting from the article, "Keeping the credit card trusts viable is particularly important to banks because as consumers prepay balances, the trusts’ capacity is recycled into new loans. If losses reach a certain point, investors can accelerate payments reducing the capacity of banks to issue credit card debt. Banks are trying every manipulation possible to prevent that from happening."

--------

Wouldn't it make sense to waive all interest rate charges on aged consumer credit card debt that is older than three years? Wouldn't this help consumers pay down that almost one trillion dollars in credit card debt while at the same time returning cash back to the banks?

Is that a better plan than what Chase Bank is doing by trying to default over a million of their best, most loyal credit card customers by raising the monthly minimum payment an additional 150% above and beyond what it currently is.

And Chase Bank is not allowing for any kind of OPT OUT option either. talking about shooting fish in a barrel, the question is, why Chase Bank, why?

www.daily-protest.com

Jun 29 03:44 PM

[Snitzer:]

Like fledglings in the nest with their mouths wide open Main street continues to gobble down the crap that Wall street shovels in. Greed is the nature of the Street Beast, and the fledglings gawp, blind to the predator's strike. No matter how rigged the game is, it's big enough to allow the nimble to move between the shadows of the giants, feeding on the scraps. And you can have fun in the dark.

Jun 29 08:29 PM

[Illusional ...:]

As another human being, I think I know as much of what tomorrow will be as the guy on Wall Street...

There are things at the fat tail of the possibility curves, and simply, most people don't look forward to them...

On Jun 29 11:27 AM Leftfield wrote:

> For years I've assumed Wall St. knew their business even as I

Jun 29 09:53 PM

[sethmcs:]

It used to be a note to the financial statements "contingent liabilities" soon to be a line item. If something comes back to bite you than its not truely off the books.

Jun 30 12:45 AM

[User 305589:]

I agree with most of the article - though i can't make any sense of the author's long position in ABK. After taking massive hits from their misguided insurance on cdo and mortgage papers the monolines face a potentially terminal threat from quickly deteriorating municipal finances. No other than Warren Buffet stated just a few months ago, that he wasn't even sure whether the muni-insurance business would really be profitable in the long run. And he talked about his freshly started muni-insurance arm, which has charged far higher premiums than abk and mbia ever did! the common stock of the former monoline insurers are tricking time bombs that could implode anytime. It may pay off, to hold some of their bonds, but the common shares offer an awful risk-reward profile imho.

Jun 30 08:03 AM

[one eye:]

"Off the Books" is how the US Gov. has operated for decades.

The OMB's figures Vs. Congressional Disclosures.

Borrow from Social Security, leave IOU's behind. The Government has been caught "Cooking" the Books numerous times. They are still at it.

So if a "few" entities are nationalized, the Gov. will know exactly what to do.

Jul 01 05:36 AM