S&P Downgrades Investment Bank for Being Too Good at Investment Banking

Includes: BAC, C, GHL
by: Kirk Shinkle

Want to know just how backward banking is right now? Analysts are downgrading financial institutions because they don't have enough exposure to bad assets!

Standard & Poor's cut its rating on merger advisor Greenhill & Co. (NYSE:GHL) to "strong sell" from "sell" on valuation. That's no big deal, but look at the reason. From S&P (bold is mine):

We think GHL is unlikely to benefit directly from recent government programs to stimulate credit markets since it lacks balance sheet exposure to risky assets. The firm should see some long term benefit if these actions improve the flow of credit, which could help to revive the stagnant M&A market, but near-term benefits are less certain. We believe GHL will be profitable in 2009, but we think the current valuation, which is more than 36X our '09 EPS estimate and well above our $42 target price, is inconsistent with the company's earnings power in this operating environment.

Is this S&P's not-so-loquacious way of telling us that the only short-term game in banking right now is getting in bed with the government? That makes some sense given the dearth of dealmaking, the slow economy and a trading landscape that hinges largely on whether or not the government can price and sell all of those toxic mortgage assets still on the balance sheets at the bad banks.

But wait a minute. Since we're in Bizarro Bank World, what are the banks who made all those bad bets doing now that the government bailed them out? Why, they're buying more risky mortgage securities!

According to the New York Post, Bank of America (NYSE:BAC) and Citigroup (NYSE:C), recipients of $45 billion in taxpayer cash each, are shopping in the secondary market for Alt-A and option ARM securities. From the Post:

"Our purchases in [mortgage-backed securities] increase liquidity in the mortgage market allowing people to buy a home," said BofA spokesman Scott Silvestri.

A Citi spokesman declined to comment, though people familiar with the bank say it argues the same point.

Citi's and BofA's purchases highlight the challenges both banks face while operating under intense public scrutiny.

While some observers concur that the buying helps revive a frozen market, others argue the banks are gambling away taxpayer funds instead of lending.

Moreover, the MBS market has been so volatile during the economic crisis that a number of investors who already bet a bottom had been reached have gotten whacked as things continued to slide.

It's a hint the banks think they know where the government is going to price all these toxic assets, but it's also the latest slap in the face to angry taxpayers as this shell game continues. The mind reels.