Vox Rationalis

Analyzing the U.S.'s Four Largest Banks

"Secondly I have grouped the 4 together for a number of reasons. Many investors like to invest in ETF's like the XLF and KBE and the 4 holdings are 37% of the XLF and 33% of the KBE."

If this was the reason you grouped these, why did you instead mention only the S&P 500 in your article? No mention whatsoever of why these should be grouped. But let's break this down a little further - current holdings of XLF:

1 JPMorgan Chase & Co. 12.61%
2 Bank of America Corp. 9.57%
3 Wells Fargo & Co. 9.32%
4 Goldman Sachs Group Inc. 6.48%
5 Citigroup Inc. 3.87%
6 U.S. Bancorp 3.35%

So why no GS, which makes up a much higher portion of the XLF? Or more importantly, why C at all, since its losses dramatically pull down all of your numbers while accounting for over 10% of the group's market cap?

"Now if you go to Value Lines 2010 estimates for the four banks and take out Citigroup from the picture you get a ROIC for the remaining 3 of 2.4% compared to 2.1% for the four, so the other three still do not inspire."

Wow. I hadn't even read to the end of your article: "I want to see at least 20% ROIC (return on invested capital) before I even think about investing a dime in any enterprise." You really have a complete lack of understanding about how banks work, and should have known better than to provide any advice without more study.

A banker is an intermediary who directs capital to where it can be put to good use. Take this function away, as you suggest by limiting banks to their deposits only (which, by the way, are borrowed funds with a different name), and capital no longer moves as efficiently, the cost of doing business increases, and economic activity and growth decline.

And so, since banks operate on the margin, that their returns are lower than other businesses is not just intuitively obvious to the casual observer, but NECESSARILY so. Dramatically simplifying, banks MUST be low-return businesses or other businesses couldn't afford to borrow money.

As an example, consider Hudson City Bankcorp, which Forbes named the Best-Managed Bank of the Year for both 2007 and 2008. Here are the ROIC figures, according to their annual report:

2007: 1.03%
2008: 1.27%

The big three banks have ROIC of 2.4%, much higher than the Best-Managed Bank in America, and you think they're dramatically too low? If your 20% were really a good yardstick for banks, do you think HCBK would be thought of so highly? I ran a screen just for giggles. Of the 38 large-cap banks (<$8B), only one -- Banco Bradesco -- had a ROIC higher than 10%, coming in at 11.4%. Most of the Canadian banks - which have been sailing through the trouble unscathed - run between 5% and 10% ROIC.

Banking is all about leverage and risk; if there were no risk, there would be no reason to limit the amount of money a bank borrows and then lends -- no need to limit leverage. Of course, risk is inherent in any borrowing, and the recent industry failure to manage risk is a big part of what we're all dealing with now. Do I want a banker who takes no risk? Of course not, because my returns as an investor or depositor would be surely reflect this risk intolerance. I want a banker who properly assesses risk. We pay for the banker's ability to assess and manage risk in a leveraged environment - not ROIC.

"So it seems from [2010 loan loss reserve estimates] that JPM might have a lot more bad loans on the books then the others and that C's situation may not be as bad as people think."

Man, this is just ignorance - you should follow the banks for a while before spouting advice on them. WFC has taken HUGE amounts of heat among analysts for not increasing its loan reserves more (WFC insists it is generating sufficient cash to cover its losses without adding to reserves). Citi really hasn't had to increase reserves as much as it should, because it's mostly government-owned anyway and needs every productive dollar it can get. Taking JPM's higher number as an indicator that it has more losses is just plain stupid - it could just as easily, and in fact far more likely, indicate that JPM is a more conservative operator.

Apologize to the nice people for wasting their time. DISCLOSURE: long WFC, BAC.

Analyzing the U.S.'s Four Largest Banks

Sorry, but there are big problems here. First off, source your data.

The clearest logical problem is the impact on the "analysis" of grouping these companies together. This only makes sense if one is considering buying the group as a basket. Strikes me that very few would consider this, and so it makes no sense to group them for any analysis; comparing them would be more useful.
JPM and WFC, by most accounts, are very well-run, and have done a much better job managing risk than most banks. BAC's purchases put very much it in a category of its own.

And as for C - does it make any sense whatsoever to group C with ANY other company? What happens to your numbers if you pull C from the discussion?

Today May Be Markets' Turning Point

I think the turning point is now. I mean now. Right... now. How about...now? Now? Maybe now. Now! NOW! Now now now now now...

Five Reasons the Market Could Crash This Fall

On Aug 04 09:59 AM The Goy wrote:

> I think you left out the fact that the US government is going to
> seriously raise taxes next year, so selling is going to happen this
> year.

This would make sense, except that there is likely a significant amount of capital losses carried forward from last year which will offset realized gains.

Weekly Unemployment: Lying with Numbers

On Jul 09 03:54 PM Mad Hedge Fund Trader wrote:

> ...we have fallen back to 2000 levels of total employment.

Complete and total nonsense. Look at ANY data on the subject.

> Only one out of 2.4 Americans now has a job.

Hogwash. With 300M people in America, this would mean 125M employed; the latest number is 140M. Which, by the way, means that a higher percentage of the population is now employed than at almost any time between 1970 and 1983. [ftp://ftp.bls.gov/pub...

> Stocks, real estate, and many other asset classes have also given
> up the decade’s gains.

Yes, the S&P 500's return in the last 10 years is -20%. Of course, this arbitrary sample starts pretty close to the peak of the dot-com bubble, doesn't it? Consider the returns for the four years prior to that ending 6/99: 30.2%, 34.7% 26%, 26.1%.

As for real estate, no way real estate's back at 2000 levels. The Case Shiller 20-city composite was 40% higher in April than January 2000.

Weekly Unemployment: Lying with Numbers

"Lying With Numbers" - Was this talking about the headlines, or this article?

"The critical fact is that that the number of non-adjusted new claims for unemployment insurance benefits rose by 175,834 claims year over year."

This is THE critical fact? Really? You think that the important analysis of unemployment claims is year-to-year? Why? Isn't a year an arbitrary number? Why not two years? Why not three? Your analysis is stunning - you're able to glean from your calculations that the economy is worse now than it was a year ago. Quick - somebody call the Nobel committee!

Let's just be clear about this - when December comes, and the unemployment rate is still rising, but year-to-year first time claims are lower, you'll be saying that things are getting better?

"...we have a catastrophic rise in the number of new claims for unemployment on our hands."

"Catastrophic"? Hyperbole much?

Citigroup's Horrible Conference Call

I'm not surprised that a new CFO would tend to speak in terms that only finance geeks would understand. I'd expect him to do much better next time after a round of criticism.

Though it doesn't appear to have been the goal of this column, I'd have preferred to see a translation of the discussion rather than a critique of it.

"Since the mark-to-market value of its liabilities is now lower, it’s allowed under US accounting rules to register a profit. But that’s not income as most people understand it."

This is the flip-side of write-downs. If these profits aren't income as most people understand it, so are the mark-to-market losses not actually losses, as most people understand them. These sorts of gains are exactly as legitimate as mark-to-market losses, as they are based on exactly the same accounting rules.

Annals of No-Comment, Meredith Whitney Edition

Dick Bove? Dick "Bank of America is, was, and always will be a great investing opportunity" Bove? If one keeps repeating the same thing over and over, I guess eventually you'll be right.

Bail Out for Dummies - Part I

growser7 wrote:

> You can tut-tut all you like...

Being critical of somebody pushing the notion that the ENTIRE banking system may be twice as damaged as the 1,000 or so S&Ls that failed is "tut tut"-ing? I guess I wasn't clear enough - I don't know how bad it is, but Durden's suggestion of magnitude is ludicrous. I don't know how big the largest gorilla in history was, but I'm pretty sure King Kong was fiction.

> You can conjecture all you like about toxic assets and the FDIC...

I'm not the one guessing about toxic assets, and my discussion of the FDIC (which, again, has nothing to do with bank assets) was purely fact-based.

> what I am seeing is the federal debt ballooning at a rate which will swamp us all.

Perhaps, but perhaps not. Remember that the debt burden at the end of WWII was more than 120% of GDP, well above where we will be in a few years, and Japan's is much higher still. That said, I'm right there with you when it comes to persistent, non-crisis mode deficit spending. One of the very important lessons I hope we the people are learning is that deficit spending during expansions is like a noose tightening around the nation's neck; it causes nervousness and it's a little uncomfortable -- until the bottom falls out.

Will we remember the lesson when the situation isn't so dire? I'm afraid we may be repeating ourselves; during the Carter administration, the national debt was perceived to be a real problem. But then, once the economy turned around during Reagan's term, we forgot all about it, and grew the structural, persistent deficit in unprecedented fashion. Let's hope that cycle doesn't continue.

> The real monster in the closet is a lot bigger than you think.

You don't have enough information to know what I think. All I've written is that Durden's guess about the government's assessment is implausible, and that Roubini's assessment is very unlikely to be greatly exceeded.

Bail Out for Dummies - Part I

This article’s like a child looking into a dark closet at night. We're pretty sure there's something in there, and it’s really scary. But some of the details our imagination is trying to explain here aren’t nearly as bad as we think.

There are three problems with this piece: omissions, logic, and math. Other than that, it’s just fine.

First, Durden doesn’t adequately describe the FDIC's role, and doesn’t differentiate between it and the many programs created to deal with this crisis. Deposit insurance has been around for 75 years, and the only recent change is the insured deposits limit increasing from $100,000 to $250,000. Big deal? Not really, since CPI has increased 150% since the $100,000 limit was instituted in 1980. Really, the new limit just catches up to the 1980 level. If it were not changed, large depositors needing insurance would simply have been forced to open accounts at multiple banks.

Worse, Durden’s statement that “the various Bail Out programs now support OVER 72% OF THE TOTAL LIABILITIES ON THE BALANCE SHEET” (my caps for his boldface)” doesn’t mention that 58% of the dollars in Durden's “support programs” are in the FDIC insurance, not in a “bail out” program.

“The implications… $3.6 trillion, or another $2.4 trillion to go... $3.1 trillion in total US losses, or another roughly $2 trillion to go. These provisions are optimistic. Why? BECAUSE THROUGH ITS VARIOUS IMPLICIT AND EXPLICIT GUARANTEES THE ADMINISTRATION IS SAYING THE TOTAL PAIN COULD POTENTIALLY REACH $8.8 TRILLION.”

Nonsense. These programs do not serve the same ends, some overlap, and the size of the largest is unrelated to the banks’ assets. The FDIC’s insurance provides no direct support of the banks, except that it boosts depositor confidence. But the size of this backstop is tied to deposits, not loans. By Durden’s reasoning, if insured deposits increased by $100 billion tomorrow, the government would believe losses could potentially be $100 billion more. Or, taken to extreme, if insured deposits increased by $10 trillion tomorrow, potential losses could be $10 trillion higher. This is, of course, nonsense, since massive increases in deposits would DECREASE the chances of any loss, including a major one.

Add to the logical problems a mathematical one. Durden writes that the government thinks the banks could lose $8.8 trillion for the simple reason that the maximum value of the various government programs he mentions is $8.8 trillion. But look at the assets: the banks and S&Ls held $8.07 trillion of loans, according to the Fed data Durden cites. Add in $1.3 trillion in munies, corporates, and foreign bonds, $83 billion of equities and mutual funds, and $2.44 trillion of unknown miscellaneous assets, and the TOTAL possible losses are $11.9 trillion -- IF THE VALUE OF EVERY ONE OF THESE ASSETS AT EVERY BANK FELL TO ZERO. Durden thinks “the administration is saying” this portfolio could lose 74% of its value? Really?

Durden then bemoans the fact that the least desirable assets are increasingly being used as collateral for Fed loans, but this couldn’t make more sense. If, in the future, the banks need to sell assets, clearly they should sell those that are the least distressed (those that are closest to their expected long-term value). By allowing lower-quality assets as collateral, the Fed increases the chances that banks survive. And since this is the Fed’s goal, it would make no sense to tie up the banks’ best assets as collateral.

“…as we head to the full funding capacity on all the Bail Out programs ($8.8 trillion), Zero Hedge expects to see as much (not necessarily the full amount) as $7 trillion more of new Treasury issuance as the true "worth" of the assets is realized.”

So you actually think the banks’ portfolio as described above is worth as little as 42% of face value? Really? It's worth noting that the cost to the government of liquidating failed S&Ls averaged about 30% of assets. And that's the assets of just the failed firms.

“The scale of the problem is simply insurmountable using current mechanisms in place.”

You just got through explaining that you didn’t expect the government to fully use the $8.8 billion of funding programs, but now you’re saying it isn’t enough? So where is the scheme lacking?

“The bottom line is that every dollar printed by the Treasury directly goes to fund a dollar in deposits, bypassing M1-M3.”

I guess you didn’t know that most of these deposits are included in M2, and all are included in M3.

“If the $8 trillion pool in total deposits realizes that it is supported by assets which even the government is saying are worth fractions on the dollar…”

Psst… FDIC. Some 65% of all deposits have no need to be concerned with bank assets – that’s the whole point. As for the other $2.8 trillion, suppose it’s all withdrawn from suspect banks. Where do you think it’s going? Unless it’s going into millions of mattresses, those dollars will make their way back onto banks’ balance sheets. The funds won’t disappear – they’ll find their way to productive use. Such is the magic of the market.

“...the risk of a wholesale systemic bank run becomes unstoppable even with all the government backstops in place, as the latter will be contingent on continued willing recipients of those rapidly devaluing pieces of paper known as U.S. Treasuries and once that assumption is questioned or outright proven false, all bets are off.”

Wow. Congratulations, you win the “most absurd alarmist claptrap of the day” award. Financial markets are forward-looking, right? Then why, oh why, is the “rapidly devaluing” 10-year Treasury yielding just 2.86%? What was it before this rapid devaluation? Let’s see, in the last couple of months it’s... pretty much moved sideways.

I mean, it’s not like you’re the only one who has access to this information. The market’s pretty good at discounting known information – why aren’t your prognostications of doom reflected in Treasury prices?

The thing in the closet is real, and it is indeed scary. But Durden’s description doesn’t make sense. I don't know how big it is, but the odds that it's much worse than Roubini says are smaller than tiny. We may not figure out exactly what’s in there until the light of a new day.

Warren's (Ridiculous) Prescription for Banks: Wipe Out Shareholders, Fire CEOs

"It would be easy to dismiss the woman as irrational..."

Would it have been as easy to write "it would be easy to dismiss the man as irrational"? It's kind of a strange sentence structure; usually (but not always) "woman" would be "her" or "Warren" if a writer was not making a point of highlighting the subject's sex.

Bank Liabilities: Why the Discussion Isn't Explicit

User 366653 wrote:
> First, I think "the market" is missing something: Trust preferreds
> have seniority over straight preferreds. Therefore, it would be hard
> to imagine that C or anyone else would orphan the trust preferreds
> by eliminating the dividend without offering the option of conversion
> to common as a way out.

Of course, Ford did just this last week - at the same time it offered a conversion of debt to common, it deferred payments to the trust preferreds. Different situation, of course, since I don't believe Ford has any straight preferreds, but relevant.

Bank Liabilities: Why the Discussion Isn't Explicit

On Mar 06 10:47 PM Nick Waddell wrote:
> Does anyone know if Canadian banks mark to market?

Sure they do. What they didn't do was lever up with absurd amounts of correlated risk, in no small part because the Canadian regulatory regime remained intact during the last ten years while ours turned into swiss cheese.

The $37B Roubini Forgot at Wells Fargo

Brown has totally missed reality here - the blame for the error lies with Time, not with Roubini. Here's the pertinent parts of the article:

"We relied on the loan-loss estimates of New York University professor Nouriel Roubini, a.k.a. Dr. Doom, who has been sagelike in his predictions about the credit crisis so far...

"Home buyers owe [Wells Fargo] $360 billion, up from about $150 billion just three months ago. Next, Wells has $154 billion in commercial real estate loans, as well as $200 billion in other types of commercial debt. Apply Roubini's overall 13% loss projection, and the conclusion is that Wells may be sitting on a $117 billion loss."

Roubini's not even quoted in the article. It is quite clear that any error here is not his.

An Obama Speech to Light Wall Street on Fire

Burke and Herbert is a local bank near Washington DC. It had record profits last year.

Record profits. In 2008. Not all banks have these problems.

Certainly there are thousands -- literally thousands -- of banks out there that did NOT overload on bad mortgages, that did NOT write CDS, that did not over-leverage themselves. Read your local papers, listen to your radio stations. You'll hear about them. They're the small banks that chose to really know their customers. They didn't fudge documents. They didn't sell and resell and resell option ARMs. They didn't try to make millions of dollars for their officers. They are responsible and their banks are in doing just fine.

By the way, there are some larger banks that are doing just fine as well. Their stock prices may not show it, but their financials do.

Don't you dare say that the big banks shouldn't bear the majority of the blame.