Bank of America, Citigroup, JP Morgan and Wells Fargo Stocking Up on Liquidity

Geithner’s Treasury and Congressional politicians are telling banks publicly to expand lending and boost the economy. At the same time Bernanke’s Federal Reserve is telling banks to increase liquidity as the banks see little loan demand from qualified borrowers.

Adequate capital and adequate liquidity are two completely separate concepts as Bear Stearns and Lehman found out the hard way. Capital is purely an accounting concept, generally consisting of common and certain preferred equity. Liquidity on the other hand is the cash either available or that can be generated to meet funding obligations in the event of deposit withdrawals or a freeze in short-term credit.

Bloomberg’s “Bank of America Joins China as Buyer of Treasuries” and “Pandit ‘Near Death’ Cash Hoard Signals Lower U.S. Bank Profits” explore how bank fears and regulatory pressures are moving banks counter to the economic recovery. Liquidity is generally defined as cash, deposits at other banks and any debt securities that the Fed will accept as collateral for overnight loans. Citigroup (C) only earns 0.63% on liquid assets vs. 7.2% it could earn on loans.

Bank of America (BAC) September liquidity stood at $422.6B, 19% of assets; Citigroup $450.3B, 24% of assets; JP Morgan (JPM) $453.6B, 22% of assets and Wells Fargo (WFC) $201B, 16% of assets. In cash alone, JP Morgan is holding $80.7B and Citigroup an amazing $245B. The big four banks are claiming that they are protecting themselves from adverse conditions. None of the banks reported regulatory pressure.

Wells Fargo claims that it has less need for liquidity than its other top rivals. In the ratio of deposits, long-term debt and equity to assets; Wells Fargo stands at 92% compared to Bank of America at 75%, Citigroup at 72% and JP Morgan at 63%. From the exposure to short-term funding risks, JP Morgan is showing its investment banking characteristics far more than the others.

Whether JP Morgan is more or less risky than its big four peers might be judged on the quality of its assets. The term risk weighted assets is often thrown around when discussing adequate capitalization of the banks. Each category of asset is weighted from 0% risk for treasuries to a very high weighting for leveraged loans and risky consumer finance. Then the weighted assets are summarized and divided by the various capital definitions.

The level of haircut the Fed takes on collateral is probably similar to risk weighting for regulatory purposes. The trouble is that the risk weighting is credit based and does not take into account interest rate risk. So too liquidity has an interest rate risk in all but the shortest term assets. Therefore, a bank’s liquidity could shrink with a rise in interest rates.

With this heightened emphasis on liquidity, it is interesting that banks are holding only a composite $125B or about 1% of assets in treasuries. Barclays (BCS) says that the norm after recessions is for banks to hold an average 8.5% of assets in treasuries, giving them the capacity to hold up to $1T. Barclays believes that banks will jump in as the Fed has quit quantitative easing (monetizing the debt). This might be a stretch as the interest rate risk in treasuries is especially high and banks have used Fannie Mae (FNM) and Freddie Mac (FRE) debt as higher paying 0% risk weighted alternatives.

Treasuries still have the role as the main currency on Wall Street. So demand will always exist for the short-term near zero rate instruments. Bank of America is holding $31B in treasuries and Citigroup has $17B in treasuries “available for sale.”

Given that investment grade corporate bond yield fell from a post Lehman average 7.96% to an average 5.06%, the Fed has certainly created a bubble. Perhaps this is why our big four banks are willing to forgo earnings to keep such a large percentage of their liquid assets in cash. In essence, returning money to the Fed for nearly free to forgo interest rate risk.

I like the new emphasis on liquidity by the top commercial banks, but caution that it might not provide as much security as it appears. Former Fed Chairman Greenspan is already warning that excess bank liquidity is unsustainable with market expected bank profits, economic growth and that tainted word "innovation."

Bloomberg’s “Private Equity IPOs Slump as Goldman, Citigroup Can’t Sell AEI” is reporting additional difficulties on the investment banking side. Institutional investors are not willing to accept IPOs with less than stellar balance sheets. Goldman Sachs (GS) and Citigroup were unable to float AEI, a former Enron power plant and natural gas pipeline operator, at any price. That is not good for IB fees and a sign of continuing trouble for private equity.

The consumer business is getting tougher; credit card reforms and other consumer protections will soon start taking their toll on profits. The mortgage origination business could also begin to falter when the Fed starts easing its purchases of Fannie and Freddie securities, interest rates climb and the pool of qualified home buyers shrinks.

All told the best that I can say is banks are on the road to lower, steadier earnings. I like my banks becoming utilities; that’s why I am staying clear of the “unbanks” Goldman Sachs and Morgan Stanley (MS).

Disclosures: Author is long BAC, BCS, C and WFC.

Comments

[bbro:]

Good article....banks (large banks) are solvent and very liquid but
unprofitable ( for the moment)...preprovision earnings is the way out of
the wilderness....

Nov 03 04:54 AM

[User 350850:]

This is a balancing act for sure - increased liquidity is required for unexpected adverse events, but it can also create a false sense of security as it may hinder loan activity. Without increased loan volume in the small to medium sizes businesses, we will be stalling the recovery and letting good ideas go to waste.

Banks need a new model to deal with this kind of "mezzanine risk", one that fits somewhere between venture funding and traditional asset based lending. I believe it is the right thing to do and would give the economy a shot in arm.


On Nov 03 04:54 AM bbro wrote:

> Good article....banks (large banks) are solvent and very liquid but
>
> unprofitable ( for the moment)...preprovision earnings is the way
> out of
> the wilderness....

Nov 03 08:21 AM

[perceptions...:]

You gotta wonder -
1) Why these banks are hoarding cash, if the recovery is underway?
2) Why these banks are showing such reluctance to get into US Treasuries?
3) How much in hidden losses would be revealed, if Mark to Market rules on accounting for assets, such as Residential & Commercial Real Estate?

Nov 03 09:05 AM

[AndrewBaker:]

Banks should be split apart to separate the basic banking of deposits, loans and mortgages from the gambling side of derivatives and other trading strategies. This would mean that the "too-big-to-fail" aspect would apply only to the basic utility type banking, and the racier stuff can be done with private money, letting such a bank fail due to losses if that's the way it pans out. That way, taxes and public money are not at risk to support activities that should fund themselves from private sources of finance.

Nov 03 09:12 AM

[RiskAverseA...:]

How can one not perceive a greater measure of bank balance sheet fakery when even the long-term solvency of the U.S. Treasury increasingly is being called into question? Indeed, this might be one reason why Treasury holdings among banks are so low. When the whole thing is set to blow, why not improve momentary appearances of solvency squeezing yield further out on the risk curve? It seems that, despite last year's near meltdown of the money market, those who chase yield even among what are widely perceived "safe instruments" (agencies) either have not learned a thing or the present moment is a ruse whose intention falls under "all things are not what they seem."

Nov 03 09:37 AM

[jbde:]

The large banks are preparing for the day of reckoning [wrecking]. They are hording liquidity because they know what is about to happen. They are hiding the losses and when they are forced to mark to market [by liquidating housing and commercial assets], the losses will pour.

Confidence in the banks will wane to zero and we will see bank runs. Expect the government to test its new 'not too big to fail' rules by breaking up Citi. BofA can avoid this by spinning MER off.

We are in a period of deflation that will start to spiral downward. There are no more piggybanks for consumers; and when you have to by oil or gas to heat your house, you will sell anything you can for whatever you can get.

Instead of giving 'stimulus' money to municipalities, the money should have been spent on creating jobs to old fashion way - work programs! Bridges, roads, grid, solar, nukes, wind. How many urban planners do you need writing reports? Get rid of the waste. The bloated positions added over the boom years need to go - instead they keep them and axe the teachers.

Nov 03 10:45 AM

[rennert:]

Everything horrible again?? Whose wheels are being greased this time.
The ones who profit from low zero interest rates that is who paying these folks to scare us to death. 90% of our people are working. These clowns are all coming on to scare us into accepting low, low interest rates. They are making Wallstreet and all the Multinationals happy with their scare munger talk.
On TV also all I hear is talk about 10% unemployment, so what ? 90% are working. Everyone on my street here in Florida is working. Milk at 8.50 a gallon, Fed needs to raise at lest 1%, that will not derail us. But it would make Wallstreet and The MultiNationals wish they had Diapered up before leaving home.

Nov 03 11:00 AM

[Steve J:]

the article should probably include within its analysis the amount of "agency mortgage backed securities" each company holds as part of its interest rate risk.

The credit risk is low, interest rate risk is moderate which gets hedged the same as if they were treasuries, however the difference comes with any difference in liquidity of agency mbs'.

What truely must be considered is where do the banks hold their cash? My understanding is the Federal reserve is paying out .63% . If this is true then why should a bank invest into a 3 month treasury?

Thanks for the article, very good topic, good facts and enjoyable to read.

Nov 03 02:35 PM

[bassmaster17:]

I'd be weary of following Dick "multigenerational buying op Bank of America at 38" Bove and shorting WFC. It seems as if they are vulturing the good CIT loans not to mention other bankruptcies.

Nov 03 03:55 PM

[geewow:]

Right! Bernanke is suggesting the mega investment banks continue their liquidity accumulation because the dollar will fall even further, and once that happens they can write off their toxic losses at rock bottom dollar values, while sitting on a huge pile of taxpayer supplied zero percent liquidity as the real economy falls further in the pit.

This is no economic recovery strategy, but more of the same bankster theft.

eye-on-washington.blog...

Nov 03 07:04 PM

[muellship:]

Looks to me like the huge cash infusions to the banks were to serve one purpose only: Stop deflation while discouraging lending or even tying bankers hands to keep cash on the books. In this way, solvency is buttressed but inflation is theoretically kept low and circulating money supplies increase little. In the event that money does make it out and there is inflation, then all of these bad loans are reduced by decrease in the value of the dollar through a dilutional effect. That being said, inflation remains a better option than deflation and so far, it has worked. But what about unintended and unanticipated consequences? Stay tuned....

Nov 03 10:23 PM

[bbro:]

If want a mark to market valuation read the banks' 10q and find
the Fair Value for FInancial instruments....the irony is that the Tarp
infusions in large part were unnecessary if you look at the Banks'
Tangible Common Equity + Preprovision earnings - the differential in Fair value.....

On Nov 03 09:05 AM perceptions_now wrote:

> You gotta wonder -
> 1) Why these banks are hoarding cash, if the recovery is underway?
>
> 2) Why these banks are showing such reluctance to get into US Treasuries?
>
> 3) How much in hidden losses would be revealed, if Mark to Market
> rules on accounting for assets, such as Residential & Commercial
> Real Estate?

Nov 04 03:43 AM

[bbro:]

You through the word solvency around like it was candy .....what is
your definition of solvency???

On Nov 03 09:37 AM RiskAverseAlert wrote:

> How can one not perceive a greater measure of bank balance sheet
> fakery when even the long-term solvency of the U.S. Treasury increasingly
> is being called into question? Indeed, this might be one reason why
> Treasury holdings among banks are so low. When the whole thing is
> set to blow, why not improve momentary appearances of solvency squeezing
> yield further out on the risk curve? It seems that, despite last
> year's near meltdown of the money market, those who chase yield even
> among what are widely perceived "safe instruments" (agencies) either
> have not learned a thing or the present moment is a ruse whose intention
> falls under "all things are not what they seem."

Nov 04 03:44 AM

[bbro:]

You seem to have little undrstanding of accrual accounting versus
fair value accounting....


On Nov 03 10:45 AM jbde wrote:

> The large banks are preparing for the day of reckoning [wrecking].
> They are hording liquidity because they know what is about to happen.
> They are hiding the losses and when they are forced to mark to market
> [by liquidating housing and commercial assets], the losses will pour.
>
>
> Confidence in the banks will wane to zero and we will see bank runs.
> Expect the government to test its new 'not too big to fail' rules
> by breaking up Citi. BofA can avoid this by spinning MER off.
>
> We are in a period of deflation that will start to spiral downward.
> There are no more piggybanks for consumers; and when you have to
> by oil or gas to heat your house, you will sell anything you can
> for whatever you can get.
>
> Instead of giving 'stimulus' money to municipalities, the money should
> have been spent on creating jobs to old fashion way - work programs!
> Bridges, roads, grid, solar, nukes, wind. How many urban planners
> do you need writing reports? Get rid of the waste. The bloated positions
> added over the boom years need to go - instead they keep them and
> axe the teachers.

Nov 04 03:45 AM

[bbro:]

Again show some understanding of accrual accounting...


On Nov 03 03:55 PM bassmaster17 wrote:

> I'd be weary of following Dick "multigenerational buying op Bank
> of America at 38" Bove and shorting WFC. It seems as if they are
> vulturing the good CIT loans not to mention other bankruptcies.

Nov 04 03:46 AM

[greaterdepr...:]

No, JPM BAC C are insolvent-Bankrupt, if you will. JPM has over one Trillion in losses hidden off-balance sheet. See Reggie Middleton's great work on this.


On Nov 03 04:54 AM bbro wrote:

> Good article....banks (large banks) are solvent and very liquid but
>
> unprofitable ( for the moment)...preprovision earnings is the way
> out of
> the wilderness....

Nov 04 09:33 AM

[greaterdepr...:]

Is that the kind of accounting used to hide insolvency?


On Nov 04 03:46 AM bbro wrote:

> Again show some understanding of accrual accounting...

Nov 04 09:36 AM

[bbro:]

Reggie Middleton has demonstrated very little understanding of balance sheets but has made a nice name for himself in this crisis....his time has passed...

On Nov 04 09:33 AM greaterdepression wrote:

> No, JPM BAC C are insolvent-Bankrupt, if you will. JPM has over one
> Trillion in losses hidden off-balance sheet. See Reggie Middleton's
> great work on this.

Nov 04 12:49 PM

[bbro:]

Again read a 10q....


On Nov 04 09:36 AM greaterdepression wrote:

> Is that the kind of accounting used to hide insolvency?

Nov 04 12:50 PM

[Graham and ...:]

Banks need to get back to "banking" (taking deposits and recycling them into loans), and out of "trading" (derivatives and other items).

Building cash by letting the proceeds of "other" activities "run off" is a good first step.

Nov 04 02:03 PM