JasonC

BofA and Stating the Obvious About Bank Profits

The real story in the B of A report is they remain cash flow positive as they have throughout. They added another $2.1 billion to their loss reserves, matching the loss to the common pretty much. There was also the $1.8 billion item from writing *up* the value of debt issued by Merrill because its credit improved.

Trust me, they won't go bankrupt through an improving credit rating.

They tick over around break even until the credit loss rate turns, then they pop upward. The net cost of the entire crisis will be a dilution a bit under half, from being forced to issue lots of stock at lousy prices to maintain capital at the bottom. In return they will have Merrill and be a $2.5 trillion bank in the next up cycle.

Everyone reacting to it as some disaster is smoking something, it was a non-event report...

BofA and Stating the Obvious About Bank Profits

The Fed isn't going to lose anything buying agencies MBS securities. It is going to make somewhat more profit than it makes in treasuries.

Big Banks in Trouble: Huge Mortgage Write-Downs Seem Inevitable

The article contains the usual one-entry accounting error, confusing gross loan losses with net losses.

The IMF estimate of loan losses is a gross figure. In addition to capital raises, all net interest on all performing loans for the period is available to cover those losses.

The banking system has, to date, taken large write offs and raised large amounts of new capital, while simultaneously earning net interest on most of its loan book, recently at very high rates (because funding costs have cratered).

Fundamentally, banks are middlemen. When people do not repay their loans, savers do not earn anything on their deposits. Borrowers are charged far more than savers earn. The resulting wider spread covers loan losses. Until it does, the spread between rates charged to borrowers and rates paid to savers will widen and widen.

In fact they have already done so. Beyond subprimes, try to name a loan category for which the loss rate exceeds the rate charged on such loans. Yes, credit card loss rates around 10% are horrible and unprecedented, fine. But they are still much lower than the 13-18% rates charged on credit card loans. When funding costs are an immaterial 1-2%, that alone is enough to preserve capital (if not to earn anything).

The other usual doom mongering distortion in the article is to conflate deliquency rates with write off rates. Of course the former always run higher, frequently twice the latter.

Another way of analyzing the situation objectively is to look at cash fllow losses at banks since the crisis began. Additions to loan loss reserves and price mark downs are non-cash charges. Actual write offs of loans as irrecoverable are a different story. But those have basically been covered by net interest margin all along. Yes the banks have real losses compared to their previous accounting expectation from all of the above. But that is quite different from actual consumption of their capital. Cash flow can also forced toward a bank simply by running off its loan book.

It is really hard to run out of capital with a cash flow in your own direction of $45 billion per quarter.

Citigroup's Derivatives Reduce Bailout to a Non-Event

The article is nonsense. Read C's actual reports on its book, they disclose far more than anyone else, and the story is their net exposure is on the order of 0.5% of the gross notional numbers the hyperventilating short cites in the article. They hedge is existing risk in cash positions. C is incredibly liquid and a tank in hedging terms. It is also forcing a positive cash flow in its own direction to the tune of $45 billion per quarter - which is its market cap at these ridiculous levels. On any long term, forward basis the present price is going to work out to a PE between 2 and 3. It isn't going to fail, the authorities have made that abundantly clear. But the shark-shorts can't let go of their self-fufilling short-em-to-zero bone, and want to turn those machines back on. It isn't going to happen. Vols are back to half of the elevated levels of October and November. This too shall pass. And when it does, C is going to be an epic buy at these levels.

How Will We Finance the MBS Fix?

It is a fairer question than the comments realize. But here is the right way to do it --- not saying it is how they will...

First, the unmarketable tranche structure of existing MBSs needs to be wiped out. They lower tiers are not marketable in less than perfect conditions, ergo that whole model is dead. The way to fix this is to buy up all the subordinate tranches of existing mortgage pools and then combine them with ownership of the top tier, to recreate whole loans. An owner of all tranches is free to move what he likes among his various pockets, so all the subordination issues and cash flow ownership issues can simply be eliminated. The whole loan pool belongs to the entity that bought up the whole original lissue.

Second, simplest triage of the loans within the now-owned pool. First, all the performing loans become a full quality MBS, get an underwriting guarantee from GMNA, Fannie et al, and out the door they go. This brings in some cash from the investing community early in the process, to repay what was spent on the tranche buy-up. Since they now own a (1) transparent (2) whole loan consisting entirely of (3) performing loans with (4) a government guarantee underwriting it, this portion of the pool will be valued at a 5% cap rate or thereabouts. Which is much better than the secondary market for these things right now. The gain on that revaluation of the stable portion of the cash flows will fund a lot of the rest of it, though not all.

Then you have a big remainder left of non-performing loans. The remainder of the triage is to refinance loans that can remain performing on recent bailout terms, which need to "season" against re-default for up to a year before they can be added to an investment grade loan pool. And the third category, property already owned as a result of foreclosures plus additional loans that will foreclose. The best thing, if there were enough capital working this market, would be to auction off the latter two rapidly, but at the moment there isn't. Instead, use an auction procedure for bundles of the properties in the last category only.

The model for the auctions is the 1990s RTC and its handling of the assets of failed savings and loans. Announce pools of properties in the financial press and take bids on them. Yes, some will buy up a lot of property cheaply that way. Better to get it into hands of speculators making profits, than leave it zombifying banks treating it all as dead weight loss. The speculator-buyer has every incentive to turn the things he bought back into money as rapidly as he can, and to fix up things, and to hire efficient servicers, etc.

That is the way to get it to work.

And it is a problem, I can tell you. In real estate markets I actively track and bid within, the biggest remaining issue is no longer financing stuff. Rates at 5% for prime buyers plus most of the price adjustment already having happened, can deal with getting bidders, though low ball bids. No, the issue is getting anyone at a bank to even look at all their short sale offers and approve them. It can take months, and the entire time, the properties are sitting on the market at low asking prices without actually moving. They have to move. The issue it to restore liquidity, above all, and that can only happen if banks stop sitting on their short sale offers and just sell them all, instead.

Is there a need to police that pretty closely? Certainly. Otherwise sharpers will just stick banks with losses and keep properties they failed to pay for, by using cut-outs and the like. It will be work, a lot of it. And the original writer is correct, with tens of thousands of people in the industry let go in the last year or so as profits disappeared, the experience base to handle it all isn't working the problem yet. They need to end up rehired by loan-pool bidders and government contract servicers, etc.

Merger Arbs Balking at Merrill/BofA Deal

I am now up 44% on this position. The doom-mongering shorts miss again.

Merger Arbs Balking at Merrill/BofA Deal

Um, the CFC spread was 42%. Then it closed, at 0, on the stated terms.

Nobody is willing to take any risks at all, that is the only issue here.

Why Is Merrill Lynch Trading Significantly below BAC's $29 Offer?

Lewis says what he means and he means what he says. I made money on the CFC takeover and people said the same things about that one. The discount was 42% when I put the trade on, and it went through without a hitch in a matter of months.

The short sellers hate BAC because it pays fair prices for distressed companies instead of trying to drive everything to zero, and that squeezes them. But Lewis doesn't care. He has to work with the people at the companies he acquires. He treats them fairly, not like dirt. He buys at times when the market is already so distressed, BAC is getting a good price for the eventual future value of the companies he adds.

While one of these is in progress, the arbs will short BAC. It will stay down and the professional shorts will scream and try to scuttle it. But Lewis will ignore them and do exactly what he promises. His word at six months is the same as money, in my book.

Obviously there is a risk in all these trades. That is why they offer a return. Someone short BAC and long MER can lose on both ends if the deal fails apart. YMMV. But I consider MER an attractive way to add to my BAC position right now.

Lehman Bankrupt, Merrill Swallowed, AIG Wilting: What It All Means

The only moral hazard going on right now is the hazard that regulators listening to barking ideological moonbats will burn the world to the ground trying to save the taxpayer 25 cents.

The Fed had to inject $95 billion in funds today and the funds rate still closed at twice its target. The Europeans added another $50 billion. Financial institutions sought $400 billion from them. So to date, not having a "bailout" has cost 10 times what a bailout would have cost. And counting.

People need to stop worrying about who gets stuck with a loss and start worrying about how big the loss is.

The size of the lost is not fixed. It can and will and is, ballooning with the destruction of institutions and of confidence in counterparties. It can destroy 10s of trillions or it can destroy 10s of billions in the end. It will be the former, not the latter, if men continue fighting over who gets stuck with what piece of it, instead of stepping up and allocating the damn thing and moving on.

The Treasury's decision over the weekend was a breathtaking error of world historical proportions, and every commentator applauding it today out of ideological drivel deserves to lose their shirt and go out on the soup lines.

Four Questions About How We Got Here

"Oh, but the Fed just shouldn't have provided any extra funds". And short rates would be 6%, longer rates double digits. Also, half the banks in the country wouldn't have had sufficient reserves at the close, and would have been technically failed and subject to regulatory seizure. If you think that sounds like a bargain, wait until you see how rich you are when the banking system is gone completely. It'll be so grand and moral...

Four Questions About How We Got Here

lavalyn - it isn't at your expense! Jesu Christo, is there a single economist in the house? The economy is not a zero sum game. The aggregate value that exists to be shared out among all, depends on the existence of useful institutions and the state of confidence and the level of moral dealing between counterparties. Mad scrambles to shove losses onto others *destroy value* for everyone, and multiply economic losses that are already *inevitable*, by 10 to 100 fold.

To avoid a $15 billion bailout headline that would have enabled Barclays to liquidate Lehman, with the shareholders wiped out and all your precious incentives intact, the central banks had to lend the market, just today, $150 billion in fresh central bank credits. The markets actually sought $400 billion on the panic, to replace much of the $600 billion on Lehman's balance sheet as that was withdrawn from the market. They only got $150 billion of it and the Fed Funds rate closed at double the Fed's target. More huge loans will be required tomorrow.

Meanwhile, the Lehman bankruptcy means that guess what, its bankrupt, it isn't going to pay all its debts. Do its extra losses go away, therefore? Have you forced them to face up to them? Not at all. Instead they go careening around the rest of the system looking for a new home!

Merrill had to sell itself because Lehman was its counterparty on large portions of its swap book. AIG needs regulatory relief - endangering its policyholders - to the tune of $20 billion right off, to post enough collateral on its credit default swap book to stay in business another *day*, thanks to the huge spikes in loss rates due to the Lehman filing, and the direct losses on Lehman name CDSs.

Every company faces 1-2% higher funding costs which are the same as a huge Fed tightening in the middle of a deflation.

This was epic-ally stupid. 1932 deflate at the bottom stupid. And it is going to cost you 11 or 12 figures. Actually fixing Lehman might have cost 9 and it might have cost nothing.

Call it economy!

Ideological moralizing idiocy, is what I call it...

Four Questions About How We Got Here

The session was to net existing trades, thereby reducing the amounts that will go through the Lehman bankruptcy on both sides of the ledger.

The reason AIG became insolvant the instant the Fed let Lehman fail is AIG is the largest single writer of credit default swaps, and its book includes tons of guarantees on Lehman paper that Lehman clearing isn't going to pay. So did Merrill - it had many swaps with Lehman as the counterparty e.g., that is why it needed to merge with a strong counterparty the instant it became clear Lehman was going to fail.

As for how things can change so quickly for Lehman, um, does anyone here have the slightest idea what banking even is, anymore? Lehman has to roll over its debts continually. It was being asked to pay 15% and 20% on paper that a year ago cost 5%. You can't borrow at 20 and lend at 7 and make it up on volume.

As for how AIG is going to get money from the Fed without a bailout, it is simply calling the treasury's bluff. The Fed has a standing offer to allow any firm to borrow against decent securities collateral at affordable rates. It either means it or it doesn't.

Over the weekend, the Treasury secretary, listening to all the luddites baying for blood and the end of the west as a morality play, decided not to provide any guarantees on Lehman debts. If it had, they would not have cost anything in the end, and Barclay's would have bought the bank.

Now to save a headline about a bailout, instead the ECB just had to inject $43 billion, the Fed had to inject $25 billion, the Bank of England had to inject $9 billion, just to hold the line for today's close. Way to save money, brainiacs!

This will cost all of us an extra $500 billion easy, and probably more like an extra $2-3 trillion. It was world-historically stupid. Shrinking the money supply in 1932 stupid. It will be studied for generations as exactly the way *not* to run a lender of last resort operation.

The losses are already real, the issue is for the political system to rapidly and efficiently *allocate* them, so the financial system can get back to operating as normal. Instead we will have a mad scramble to get out of the way of losses that already exist, which will multiply those losses tenfold.

All the stupid ideologue moralizers saying "don't save him, he's not virtuous like me" are going to be buried in falling, burning timber. Earth to luddites - bankrupts don't pay their debts. Bankrupting your neighbors won't make you any richer - quite the contrary.

The entire lot of you should be ashamed of yourselves, and deserve whatever you get.

Top Market Cap U.S. Banks: A Long Term View on Value

Earnings of cyclical companies including banks need to be smoothed by using a 3, 5, or 7 year moving average for the denominator, to calculate PEs. Otherwise the PE only measures the volatility of the earnings themselves, and will be negatively, not positively, correlated with value.

As for which banks are the well run ones, there are two measures which are the best indicators of bank management quality. The first is the expenses figure - the leanest banks keep it down to 50% (USB is the only major that routinely posts numbers under that figure), and anything 60 or less is respectable. The second is an average return on assets over a full cycle. 1% is the requirement for a reasonably well run bank, while anything in the 1.5% range or higher is outstanding. You can expect a bank to average its leverage times that figure, plus a typical bond rate on its capital, long term.

All the well managed banks are exceptionally cheap right now. Consider foreign ones as well. While some of the European majors have typically had significantly higher expense ratios (and lower average ROAs because of it), the Barclay's and INGs are quite cheap right now, along with the 3 US banks the article mentions. JP Morgan should also be added to the list - it has navigated the present mess far better than most, and is in an excellent competitive position because of it.

More 'Workouts', But Will They Stem Foreclosure Tide? [Housing Tracker]

To Arnold - the robbers are the deadbeat borrowers who aren't paying current the paper they signed. Period.

On the original article - the foreclosure prices are the prices. Everyone else is in a fantasy-land of denial. The fair price of anything is the *clearing* price, where the number of buyers and the number of sellers are *equal*. There are tons more who want to sell than who want to buy, even at the foreclosure prices. Ergo, the clearing, that is the *fair*, price for these things, is lower than even the current market.

If you bought at the wrong price, then it sucks to be you, but you lost, not any of the rest of us. Take the hit or mail in the keys.