Banking Continues to Hold Caution Flag

 |  Includes: BAC, GS, KBE
by: Carlos X. Alexandre

Bank of America’s (BAC) earnings, or lack thereof, still prompted some to highlight the good news, considering that excluding charges, the bank earned $3.7 billion, or 33 cents per share. If John Doe didn’t have credit card debt and a mortgage underwater, he would be solvent -- that’s the analysis. It never gets old how the “one-time charges” are spun into meaningless events, although these events cost real money.

Certainly one can hope that the bottom has been reached, but the underlying economics do not bode well for the industry, which is the foundation of credit dependent global markets and, in turn, the core of our economic mechanism. As Bloomberg reported:

Expenses tied to soured home loans may total $20.4 billion in the second quarter, pulling the bank further from capital ratios demanded under new international standards, the Charlotte, North Carolina-based company said June 29. The gap may equal 2.75 percent of risk-weighted assets starting in 2013 -- at about $18 billion for each percentage point -- crimping Moynihan’s ability to raise dividends and repurchase shares.

As the Consensus EPS Trend chart below shows (courtesy of, one can only forecast based on what one knows, and the adjustments were made accordingly. BoA’s earnings estimate 30 days ago was for a real profit of 28 cents, mortgage write-offs included, although the stock has been in a freefall since January 14 when it closed at $15.25.

And that’s only what we can put our finger on. Couple that with the fact that just about every banking institution needs to raise capital on a global scale, while the financing of bad sovereign debtors is a simultaneous event, and I am not certain as to where all this money is coming from.

In a related topic, the shadow inventory of foreclosed homes is … well, in the shadows, while the “robo-signing” continues unabated, according to Seeking Alpha, potentially turning the legal field into the only growth industry well into the next century.

But the headlines this morning burst into a quasi celebration because Housing Starts grew by 14.6%, although the NAHB Market Housing Index increased a meager 2 points to 15, compared with a pre-crisis range of 60 to 70. Bloomberg summarized the data as follows, emphasizing the fact that rental units are on the front burner.

Construction of single-family houses increased 9.4 percent to a 453,000 rate in June, the most since November 2010, from the prior month. The monthly gain was the biggest since June 2009. Work on multifamily homes, such as townhouses and apartments, surged 30 percent to an annual rate of 176,000.

Obviously the building focus is shifting to accommodate increasing demand for apartments, further hampering the process of working through the housing inventory, and the unloading of foreclosed homes still held by the banks. The KBW Bank Index (KBE) has been preempting the financial trouble in the industry, and has declined 12.8% this year, as compared with a gain of 22.3% in 2010.

Lastly, word has it that U.S. banks have been selling Credit Default Swaps on sovereign debt. In simple terms, a CDS shifts risk from one party to another, just like an insurance policy. The Reuters article “Sovereign CDS volumes spike on cash market panic” published on July 15 adds perspective to the ability of risk evaluation, as if Greece’s austerity vote was a long-term, slam-dunk fix, although I can see the trade. Problem is that the CDS market can become illiquid in a heart beat, and if one is left holding the contract, one is left holding the proverbial bag.

"Some people had added risk after the Greek austerity vote and got caught off guard," he said. "Tuesday was one of the biggest volumes of the year on both CDS and cash. For the first time I really saw some genuine panic from clients looking to reduce risk, and at the same time some other guys thinking we're at the wides of the last year and there are opportunities."

The question is “Who’s holding what?” According to the Irish Times on May 7, one can deduce that some U.S. financial institutions have “Credit Default Syndrome.”

The IMF, which believes that lenders should pay for their stupidity before it has to reach into its pocket, presented the Irish with a plan to haircut €30 billion of unguaranteed bonds by two-thirds on average.

The deal was torpedoed from an unexpected direction. At a conference call with the G7 finance ministers, the haircut was vetoed by US treasury secretary Timothy Geithner who, as his payment of $13 billion from government-owned AIG to Goldman Sachs showed, believes that bankers take priority over taxpayers.

As Bank of America’s earnings forecast was reduced 425% from $0.28 to -$0.91 over the last 30 days based on new information, what else is out there that we don’t know? Maybe Goldman Sachs (GS) is providing further evidence by hitting a 52-week low.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.