More Trouble Brewing for Banking Sector?

The financial shares that were in the deepest trouble in February have also rebounded the most with the powerful surge in stock markets from their low in March 2009 (+60% in Europe and the U.S.).

Banks whose solvency ratios dipped to dangerously low levels have enjoyed spectacular rallies: Bank of America (BAC) +610%, Citibank (C) +400%, RBS (RBS) + 475%, Barclays (BCS) + 640%, Fortress (FIG) +650%.

While these financial institutions have not returned to their pre-crisis market caps, they have been riding a steep yield curve, while benefiting from seamless support from governments (the Lehman shock more than ever) and reduced competition, and are now being valued on the basis of marked upsurge in structural profitability.

Check out this NY Times article, which traces the evolution of the major banks.

However, the newsflow in recent days argues for a more discriminatory uptake on the situation of banks, some of which are having a hard time keeping their heads above water, and, in general, on new regulations governing bank profitability.

Lloyds (LYG) and RBS, for example, would like to reduce their exposure to APS (the government’s Asset Protection Scheme). The shareholder investment plan would prevent the government’s stake in the bank from rising further but it would lead to a substantial dilution of the existing share base in favour of the issuance of new shares for UKFI to remunerate the government for providing this guarantee. This will entail asset disposals, required by Brussels, anyway, given the government support, and new share issues.

But Spanish banks are also in the news. For the time being, they have skirted the worst of the crisis, but many analysts are surprised by their resistance, given the collapse of the real estate sector on the Iberian Peninsula.


BBVA (BBVA) is reportedly ready to sell and lease-back 1,350 branch offices to a Deutsche Bank (DB) infrastructure fund. The move would generate a gain of €1.2bn. Santander (STD) would raise €5bn (i.e. twice the initial figure) by selling 13.21% of Banco Santander Brasil via an IPO. Bear in mind that the Spanish banks’ loan default rate totalled 4.73% in July, i.e. €87.5bn, or double the figure for the same period last year! With unemployment at 18.5% and a still troubled real estate sector, this ratio could double again.

Moreover, certain banks are hindered from smoothing losses over time due to their practice of making debt to equity swaps with their stressed clients, thereby converting them into shareholders of major real estate developers and building societies or direct owners of land and buildings.



In a country which has as many homes for sale as the United States, despite having one-sixth the population, and where real estate debt to banks totals €470bn, this is looking more and more like a Japanese scenario for our Spanish friends.

On the other hand, Mr Stark might say that, since the country represents a mere 10% of European GDP, there is no risk of deflation or credit crunch on the zone…


As for the United States, this article from the Wall Street Journal explains how the new bank capital requirements to diminish leverage will have an average 25% impact on their profitability.


What is incredible is the totally pro-cyclical aspect of these measures. It would have made much more sense to institute these moves when former Citigroup CEO Chuck Prince carried on like he was the captain of the Titanic, with his statement that, “As long as the music is playing..."

The big question now is, how will banks be able to reconcile the following constraints?

- Lower their leverage, either by increasing their capital or by lowering their exposure.

- Continue to help finance the economy by increasing lending, as regularly demanded by political officials who want to see their aid translate into a real recovery in lending.

- In Europe, the need to replace part of their hybrid capital by core capital.

- In the U.S., the need to contribute to the replenishment of FDIC funds, which will undoubtedly soon draw on its credit line at the US Treasury ($500bn), if the scenario of Institutional Risk Analytics proves to be clairvoyant.

While the FDIC has “only” 400 banks on its short watch list, IRA has given an F, its worst rating, to 2,256 of them. As such, it estimates that the FDIC’s cumulative losses could climb to $400bn to $500bn, while its security cushion has contracted from $60bn to $10bn since last autumn.

Considering the hue and cry raised by the association of U.S. banks when the FDIC imposed a “special” contribution of $5bn, we can only imagine what would happen if the IRA’s estimates of funds that will need to be recovered turn out to be true.

As for Debt Deflation, check out this article in the Telegraph on the situation with our Baltic friends. Swedbank reports that 30% of the mortgages in Estonia are in negative equity, where GDP is set to contract 14.5% (i.e. twice the decline in Iceland!).

Lucky that Mr Weber recognised this morning that inflationary risk is unlikely in the near future …

Disclosure : Long 20 years OAT 0% Coupons, EDF Corp 5 Years 4.5%.

Comments

[PastTense:]

The trouble the banking sector has is the continuing massive losses in residential mortgages, commercial real estate, credit card debt, etc. While they don't have to recognize these losses because of accounting gimmicks they are very real. See Calculated Risk:
www.calculatedriskblog.../

Sep 21 07:50 PM

[Judit:]

Please, no more negativity toward banks...they are here to say as much as you'll wake up tomorrow. So we better deal with the fact that they will turnaround, and will serve hundreds of millions of customers, like always...

Sep 21 08:49 PM

[miolaman:]

everyone is so eager to see the recession end and their 401k's improve that no one is paying attention to reality. consumers are going to save more and spend less as unemployment continues and increases, home equities decline for years, and commercial real estate tanks over the next 18 months. this all reminds me of the rhetoric we heard from obama for 18 months to get elected. there was no substance to him or his experience which is painfully being exposed now in just 9 months in office. folks like it or not we are in for several very lean years and this recent stock market rally is built on spin from washington and elsewhere to get people back in the market. there is no free lunch. you show me anywhere that we have signs of a real return to even 25% of the economy we had in 2005 (which was based on credit,credit, and more credit), and i will eat my hat etc. my advice is pay off debt, save money and pray!!!!!!!!!!!!!!!!

Sep 21 09:15 PM

[highlarche:]

This government will not tolerate huge unemployment. They will spend spend and spend to fight it. I say buy gold and silver.

Sep 21 10:14 PM

[Mad Hedge F...:]

int Try in commercial real estate. The vultures are circling the embattled commercial real estate industry, ready to swoop down and devour the carrion before it’s dead. A trio of REIT IPO’s have hit the market this week looking to buy real estate for pennies on the dollar, as well as the bargain basement debt of other troubled REIT’s. JP Morgan, Citibank and Barclay’s launched their Apollo vehicle (ARI). Bank of America and Morgan Stanley came out with a new security called Foursquare (FSQU). Not to be outdone, Bank of America, Merrill Lynch, Goldman Sachs, and UBS followed up with their Colony (CLNY) instrument. This is a classic example of new equity coming in and taking ownership of assets where the previous owners have gone to money Heaven. Commercial real estate lending exploded from $1 trillion in 1988 to $3.5 trillion in 2007, and some $2 trillion of that has to be refinanced this year. Takers are few, with banks reeling in leverage ratios, insurance companies gun shy, and the collaterized debt markets in intensive care. The TALF is expiring at year end. Did I hear someone shout “Bail Out?” Many listed REIT’s will only survive because their rules limited them to mere 2:1 leverage, and were able to raise $16 billion in new equity since March. That has helped propel the Dow Jones REIT Index ($DJR) up 84% from the lows. More highly leveraged private investors and regional and community banks not so constrained are choking on their holdings, and many are limping on by letting mark to market rules fall by the wayside. This is why I am not recommending bank stocks or REIT’s at these levels. The new vulture issues may be another story. I was involved in a strategy at Morgan Stanley to Hoover up Houston office buildings on the cheap in the wake of the early eighties oil bust. The lucky investors got a tenfold return on their capital.

Sep 21 11:30 PM

[Nettligent:]

Bank of America paid $3.6 billion in bonuses to near bankrupted Merrill before the acquisition was completed.
Bank of America management paid themselves another billion in bonus and compensation for billion in losses.

SEC will back them up. Government will bail them out again.
Why would Shareholders and Taxpayers are always victims? Where was the justice?

Sep 22 03:56 AM

[george archers:]

Bank's capital for every dollar,they loan out 10 dollars.What an easy way to make money.Better than growing them dollars on trees.
In Canada,it's 5 banks starte at $1 to 13,then $1 to 353, now $1 to unlimited.
Canada's sole fat 5 banks are in the business of buying up many of them failing US banks. Here in Canada,your lucky to get .047% on savings
Don't worry, be happy, it's all monoply money :^/

Sep 22 08:52 AM

[geewow:]

I agree with miolaman, but judit doesn't get it yet:

"Please, no more negativity toward banks...they are here to say as much as you'll wake up tomorrow. So we better deal with the fact that they will turnaround, and will serve hundreds of millions of customers, like always..."

Pay off debt, and save your precious cash! You may need it! Downsize your lives and live more simply. Give up the consumer desires and buy what you comfortable need. Take a risk with your cash if you can create a widget of some sort that will supplement your earners.

The banks have been recapitalized off the backs of our working people. Monetized Treasury bonds and bills are being converted into debt that has been freely passed out in abundance without careful scrutiny or oversight. Bernanke does not even know the where, who and how his loans to foreign central banks have gone. And if so, won't say. He dishes out threats of market instability if he reveals his loan recipients. This is an economic crime syndicate!

Zero percent interest loans to banks and broker dealers, which then turn around and buy Treasuries for a profit and gamble in the market protecting Bernanke's ass have been jacking up stock and commodities prices (manipulation). This has been Bernanke's backdoor deal. There is plenty of liquidity but it is being used for the banker's personal use.

So, don't complain about the banks because they are here to stay? What a "cop-out". That is like saying don't go to a doctor because eventually you'll die. These banks need controls, supervision, and oversight. Bernanke needs to be audited and this action of the government selling off our nation's wealth to the Fed, turning it into unregulated monetized debt, so we can buy it back with interest is a complete dope-slap.

I say get the hell out of the market and teach these jerks a lesson. Take your cash out of the manipulated game, and place it in your local and regional banks. Pay off your debts! These market manipulators (Bernanke, Geithner and Obama) will then see exactly that the average investor means business when he/she demands reform NOW.

eye-on-washington.blog...

Sep 22 09:49 AM

[Curtis Forbes:]

Banks need to shed their foreclosed houses and condos in a structured way that will increase their capital position and keep the homeowners in their homes building equity.
www.azcentral.com/memb...

Sep 22 01:04 PM

[jackooo:]

Yeah!! Save your cash so you can earn .50% on it. What fool would do that? You are forced to invest or lose out to inflation..

Sep 22 01:13 PM

[Bad Dog:]

But they are tolerating huge unemployment and will continue to do so.


On Sep 21 10:14 PM highlarche wrote:

> This government will not tolerate huge unemployment. They will spend
> spend and spend to fight it. I say buy gold and silver.

Sep 22 01:38 PM

[User 422955:]

Mad Hedge: Your comments are mostly interesting. In this case, however, you've jumped the gun. As of Tuesday 22 Sept 6:30 pm (CDT), none of your three new symbols has yet made its IPO. There is some scepticism about these new REITs, which helps to balance your optimism See . . . .

www.reuters.com/articl...

Sep 22 07:41 PM

[MSimon:]

Banks ARE here to stay. Just not the same ones currently in operation.

Sep 23 05:36 PM