Interesting last few trading days to say the least. First we had several banks report ugly earnings: Citigroup, Bank of America, J.P. Morgan, Wachovia, Wells Fargo, Washington Mutual, among others. Bank stocks are getting hit pretty hard. Since Citi is down over 24% YTD, Bank of America down 11% while the S&P is up about 7.5%. Both banks are down more than 7% since 10/15, when the MLEC plan was unveiled. The bank earnings seemed like non-news to me, at least in terms of the big picture. After all, what did we learn?
- Most complained that the liquidity crunch had harmed their results.
- Those involved in bridge loans took write downs.
- Most rose their loan loss provisions related to consumer loans.
- Their collective view of the housing market was poor.
None of this seems like new news to me. Plus we all know that when a public company is having a bad quarter, they usually go ahead and cram all the bad news into that quarter, so that subsequent quarters can look all that much better. And yet the market has taken it on the chin, both in credit and in stocks. And all the jobs report-driven euphoria of just two weeks ago has completely vanished.
Here are my takes. First, bank losses in sub-prime don't really worry me from a credit perspective. I think its relatively easy to get to the bottom on how much in sub-prime a bank has, and then you can make a reasonable judgment about how big a loss that might turn out to be. All of the large banks I mentioned above, yes even Washington Mutual, don't have enough direct sub-prime losses to add up to insolvency. And banks have a hell of a lot more access to liquidity, if for no other reason than the discount window, than straight finance companies like Countrywide or dare I say New Century.
If all you care about is survival, big banks are still a good bet. The stocks are a harder call, because stock investors need growth of profits and these banks are going to be more balance sheet focused over the next several quarters and less income statement focused. I can't really say at what prices the banks are a good buy, because I don't follow them closely enough to say at what price zero profit growth is priced into the stock.
However, the SIV problem is potentially a space-station sized issue. Citi is the headliner here, but even their supposedly $80 billion in SIV sponsorship can't possibly amount to insolvency. However, something is amiss. The MLEC idea seems like a solution to a non-existent problem, and doesn't seem to solve any actual problems. Just makes me wonder what the banks know that we don't know. I'm beginning to suspect that we're digging in the wrong place by looking at losses within the SIVs. Maybe the real problem is with bank money market funds. Banks don't want to ever ever ever break the buck. Remember, most banking services are commodities to consumers. If consumers lose even a small amount on their money market fund, the bank can kiss that relationship good bye. And yet, banks legally have a hard time making up for losses within a money market fund out of their own pocket. Has to do with recourse. Anyway, maybe the MLEC is designed to prevent defaults on CP held by bank money markets, in essence by passing the risk on from the money market fund to the bank itself. It's so crazy it just might work!
Disclosure: I own bonds for Washington Mutual and Wachovia through client portfolios.