Tanya Azarchs

Long only
Tanya Azarchs
Long only
Contributor since: 2011
I was intrigued by your calling out two factors in your analysis, the decline in velocity and rise in credit. It seemed to me to be contradictory. Velocity is falling because the increase in money supply, mainly deposits, appears to be held by the banks in excess reserves at the Fed (due to new regulatory liquidity requirements) instead of being lent out to those who will invest and spend it. Certainly not a robust sign of economic growth. However, you also show that total credit is expanding. I went to FRED graphs to do a breakdown of which sectors could possibly be borrowing. It was not the financial sector, nor the household, corporate or local government sectors. They have been delevering, in fact. It turns out that what is driving your graph of total credit is federal government debt. That is still credit growth but a different implication for corporate profit sustainability.
As to your thoughts on money supply growth driving GDP growth, if you turned your statement around, you could equally say that given that velocity had slowed, if money supply had not counterbalanced that decline there would have been a fall in GDP. The only danger is if velocity picks up and the Fed does not reduce money supply, inflation could ensue. That would be an amateur failure for the Fed.
I would challenge your fundamental assumption that banks with high levels of interest rate swaps would necessarily be more exposed to rising rates than others. You are right that there is very little one can tell from the reports of notional amounts other than volume. What you can glean a little from is the quarterly change in the net amount of swap assets and swap liabilities. That is essentially the income they earn from swaps--the change in the market value of the swaps. The market value represents the present value of the difference in the income stream (or expense stream) between the party paying fixed rates and the party paying variable rates (in the case of a fixed/floating swap which is the most common type). As rates change, the present values change. If the bank is hedged (for example matched as to how often it is fixed payer versus floating payer), the marks to market cancel out. The changes in the net amount of assets and liabilities will be very small. The way the bank makes money is on what is essentially the bid/offer spread on the contracts. Conclusion: if GS is hedged, it will be neutral on rising rates. If not, they will suffer trading losses on their derivatives as well as the rest of their fixed income inventory. You can't conclude much from the reported numbers.
Nor is it particularly logical to think of their reserves as providing some sort of offset. They are regulatorily mandated at this point to satisfy liquidity requirements. Risk management systems do not typically include those in the equation on interest exposures. Rising rates would negatively impact their bond trading inventory. In general, however, a stable, steeper yield curve is a positive for securities firms because they finance their bond inventory with cheaper shorter term funds.
I would also like to correct the history on 1994 for Banc One, PNC and other regional banks. They had tried to hedge against, or buy insurance against, the possibility of a falling rate environment when checking account deposits cannot lower the interest rates they pay in tandem with lower rates received on floating rate commercial loans because the deposit rates are already at "0". This is the very environment we have today. They tried to hedge by buying more longer term assets in the form of MBS and synthetic MBS, ie swaps. This is a perennial fundamental structural problem for banks. You can't really hedge against it, only buy insurance, and when the scenario you fear does not transpire, you lose on the value of your insurance cost.
You're right. I was conservative partly because I don't see NIM improving at all for a good while, basically until short rates rise (affecting Libor-based loan pricing). The NIM each bank can achieve is going to be different based on their balance sheet mixes. For example a bank with lots of high rate credit card loans and interest free checking accounts can get over 4%, while a bank with large investment banking operations and lots of government bonds may not get much over 2% (the new regulatory liquidity requirements don't help here either). In addition, the higher NIMs in 2010 also included consumer fees that can no longer be charged, so we not see a return to those levels.
I might point out that Merrill is owned by BAC and therefore its capital trust certificates (quasi preferred instruments) carry the same risk as BAC's preferreds.
While this analysis is correct, investors should be aware of the special risks of investing in preferred stocks of banks, namely that regulators have the power to dictate an interruption in dividend payments if earnings are impaired, and the "bail-in" policies of the regulators could mean heavy losses if the bank is ever seen to be in danger of insolvency.
This is really good stuff. Truly insightful.
I believe it is problematic. Usually in this part of the credit cycle (positive trends) you would expect to see mergers as uncertainly over potential hidden loan portfolio problems diminishes. However, the ultimate impact of regulatory changes (Dodd-Frank, Basel III) should keep the potential acquirers distracted and unsure of capital impacts of mergers. Also, becoming larger now has real capital and regulatory penalties. In thinking about the potential for break-ups and divestitures versus mergers and acquisitions, the divestitures seem more likely.
You may be right. However, C this time pretty well nailed the stress estimate, meaning that they were one of those that the Fed said really understood the process this time, implying that some did not. Their conservative request is understandable given past experience, but may also be a better read of Fed mood, especially with regard to banks that needed more bailout than others.
Yes, hopefully the CCAR process will bring other factors to bear in the decision. However, the Fed will have to manage public perceptions about caving in to bank requests...
It depends on what you mean by "good for". Clearly the Obama administration has been good for the supply side -- that is how we turned around the import reliance. But that is "bad for" the pricing aspect. So it seems we should stick with the industrials part of the S&P index. Also, if independence is going to really happen then it means NG infrastructure will have to develop to absorb the production. Does anyone have an opinion on attractive NG infrastructure plays?
Is there not a difference between rules based and principles based law? Putting back a loan on a technicality of underwriting is not an issue if the loan turns out to be good. Banks generally have the liquidity to carry such loans. But if the put-back is prompted by a perceived deterioration because of changed personal circumstances for the borrower--e.g. job-loss, divorce, health (all common issues)--can you really blame that on faulty underwriting? or is the issue really the turn of the wheel of fortune?
Somehow, it seems that legally speaking, Countrywide has been more integrated into BAC's operations than ResCap was into Ally Bank's. Hard to see but that's the way it goes.
I think BAC will take the biggest write-offs (thanks to Countrywide), and don't believe that they can win a fight with the GSE's. But I think that JPM will have a little catching up to do since they under-provisioned this quarter. The others are chugging along at a pace that will likely need to be sustained for a while longer.
I agree with you completely. This is a test of the power of the rating agencies, and one day into it, it seems that the market has blown them off. However, it is still too early to say that there won't be a real impact to the availability of funding. And on BAC, their liquidity is partly a function of their shrinking balance sheet. How that intersects with the downgrades and the truly enormous legal issues will be "interesting" to watch in the Chinese sense of the word.
I am no friend of VaR models. They are at best a final check for a risk manager to get a daily snapshot of positions on some kind of an integrated basis, and a way of communicating complicated issues to senior management. They must always be taken with a grain of salt: that their predictive value is based on an assumption of steady state markets, which at best may continue for a day or two. They should never be a basis for long term capital allocation. At worst, they are merely an exercise in regulatory compliance.
The big HOWEVER here is that they were not the issue in JPM's losses. Those who think they are ignore a few basic facts:
1. VaR measures are only one of a plethora of risk measures used to set trading limits. They are a final check and never the main check.
2. VaR is not a "predictor" of risk but only a backward-looking measure.
A deal would clear the air and lift a meaningful pall of uncertainty from the big five mortgage lenders. That should be very positive for the stocks. The important thing to watch will be how much indemnity from further litigation the banks extract. The other consideration is whether the markets have adequately discounted the impact of the settlement on the banks' financials (see US Banks Third Quarter Earnings here at Seeking Alpha for my estimates). Litigation reserves are unlikely to be sufficient especially for Bank of America, which should also be the hardest hit. Citibank may surprise by being less hit.
Tim
The markets seem to agree with you today. But why do you think they did not realize the inadequacy of the summit resolutions right away on Friday?
Yep, these are mostly mortgages (except for Citi) that I just think of as a 4-5 year cleanup process. A slow drip of losses. The Trups repurchases will only happen if they would mean a big improvement in ongoing interest expense, so an upfront loss for longer term benefits. Some of the Trups are relatively cheap funding and so will remain.
Basically, a lot of negatives have already been priced in (witness yesterday's rally). To your two points:
1. I don't think there are so many assets that can't be priced. The legacy assets are if anything being marked up as they run off. If you mean mortgage loans, they will just need to be chewed through, taking the writeoffs as borrowers actually default--so no need to actually anticipate that other than through a drag on earnings for the next 3-4 years. The real, great unknown is the extent of litigation. I can think of another one, too: depending how the housing issues are dealt with, there could be increased prepayment risk in the MBS portfolios.
2. The cost of TRUP redemption is matched at least on a PV basis with cost savings, as the only TRUPS that will be redeemed will be those that are high cost funding.