BBVA Reignites European Write-Down Fears

BBVA is Spain’s second biggest bank with activities also in the US, Latin America, Asia and China (15% stake in China Citic Bank).

Policy makers have long feared that European banks are failing to face up to their losses. BBVA‘s fourth-quarter results will hardly dispel those concerns. The Spanish banking group reported Wednesday that net income for the three months to December fell to just €31 million ($43.7 million), after taking an unexpected €1.4 billion of new provisions. This follows Societe Generale‘s surprise warning earlier this month that it faced €1.4 billion of fresh write-downs on its structured credit portfolios. As European banks kick off their 2009 reporting season, investors should brace themselves for further surprises. (…)

BBVA’s total nonperforming asset ratio may now be an eye-watering 4.3% — and 5.1% on its Spanish portfolios — but expected losses are now 57% covered by provisions. Meanwhile, BBVA’s capital position looks strong with a core Tier 1 capital ratio of 8%. The bank’s profitable emerging market operations, notably Mexico, provide strong capital generation. And BBVA’s focus on retail banking rather than risky trading activities makes it less vulnerable to new regulatory capital charges.

The higher provisions in the US were tied to commercial real estate loans.

That leaves BBVA still one of the most promising European banks, despite a 5% fall in the shares on the back of the results. A sustainable return on tangible equity of over 20% plus the potential to pay a generous dividend should support a share price in excess of the current twice tangible book value. But investors will now worry about other banks such as Barclays and Deutsche Bank whose balance sheet valuations have been regularly questioned. Policy makers did warn that investors were being too complacent.

Full WSJ article



Not a good month for housing. Existing home sales dropping, new home sales weak, and now more evidence that the shadow inventory is growing and spreading out, just when recent employment trends are turning weaker.

RealtyTrac®,  the leading online marketplace for foreclosure properties, today released its  Year-End 2009 Metropolitan Foreclosure Market Report, which shows that cities  in four Sun Belt states accounted for all top 20 foreclosure rates in 2009 among metro areas with a population of 200,000 or more, but foreclosure  activity showed signs of spreading into previously insulated areas as  unemployment became more of a driving factor.

While it was expected that cities from states with the highest levels of  foreclosure activity would top the charts, there is evidence that we’re  entering a new wave of foreclosures, driven more by unemployment and economic  hardship than what we’ve seen over the past few years.

Areas like Provo,  Utah, Fayetteville,  Ark., Portland,  Ore., and Rockford,  Ill., all posted foreclosure rates above the U.S. average in  2009. And markets like Honolulu, Minneapolis and Seattle saw  foreclosure activity increase at more than twice the national pace over the  past 12 months — although all three of those markets still had 2009 foreclosure  rates that were at or below the U.S.  average. (…)

Full RealtyTrac release


An Insider’s View of the Real Estate Train Wreck

John Mauldin posted this interview with a successful  insider of the real estate industry. Please read this informative piece, especially if you are positive about housing and commercial real estate, and …banks. (My emphasis).

(…) Back in 2007, however, what most intrigued me about Andy was that he had been almost alone among his peer group in foreseeing the coming end of the real estate bubble, and in liquidating essentially all of his considerable portfolio of projects near the top. There are people that think they know what’s going on, and those who actually know – Andy very much belongs in the latter category.(…)

As you’ll read in the following excerpt from my latest interview with Andy, who now spends considerable time each day helping the nation’s biggest banks cope with growing stacks of problem loans, he remains deeply concerned about the outlook for real estate.

No one has been more right on the housing market in recent years. So, what’s coming next? Some of the housing numbers in the last few months look a little less ugly. Could housing be getting ready to get well?

MILLER: I don’t think so.

For all intents and purposes, the United States home mortgage market has been nationalized without anybody noticing. Last September, reportedly over 95% of all new loans for single-family homes in the U.S. were made with federal assistance, either through Fannie Mae and the implied guarantee, or Freddie Mac, or through the FHA.

If it’s true that most of the financing in the single-family home market is being facilitated by government guarantees, that should make everybody very, very concerned. If government support goes away, and it will go away, where will that leave the home market? It leaves you with a catastrophe, because private lenders for single-family homes are nervous. Lenders that are still lending are reverting to 75% to 80% loan to value. But that doesn’t help a homeowner whose property is worth less than the mortgage. So when the supply of government-facilitated loans dries up, it’s going to put the home market in a very, very bad place.

Why am I so certain that the federal government will have to cut back on its lending? Because most of the financing is done via the bond market, through Ginnie Mae or other government agencies. And the numbers are so big that eventually the bond market is going to gag on the government-sponsored paper.

The public doesn’t have any idea of the scale of the guarantees the government is taking on through Fannie, Freddie, and FHA. It’s huge. If people understood what the federal government has done and subjected the taxpayers to, there would be a public outrage. (…) The government can’t keep doing what it has been doing to support mortgage lending without pushing interest rates way up.

Refinancings of single-family homes are very interest-rate sensitive. Consumers have their backs against the wall. They have too much debt. Refinancing their maturing mortgages or their adjustable-rate mortgages is very problematic if rates go up, but that’s exactly where they’re headed. So anyone who’s comforted by current statistics on single-family homes should look beyond the data and into the dynamics of the market. What they’ll find is very alarming.

On that topic, recent data I saw was that something like 24% of the loans FHA backed in 2007 are now in default, and for those generated in 2008, 20% are in default, and the FHA is out of money.

MILLER: Fannie Mae had a $19 billion loss for the third quarter of 2009, and they are now drawing on their facility with the U.S. Treasury. We have all forgotten that Fannie and Freddie are still being operated under a federal conservatorship. On Christmas Eve, the agency announced that they were going to remove all the caps on the agencies.

So what about commercial real estate?

MILLER: When I saw what was happening in the housing market, I liquidated all my multifamily apartments, shopping centers, and office buildings. I liquidated all my loan portfolios, and I’m happy I did.

Then it occurred to me in 2005 and 2006 that the commercial world had to follow suit. Why? Because it’s a normal progression. Obviously, when single-family homes decline in value, multifamily apartments decline in value. And when consumers hit the wall with spending and debt, that’s going to have an impact on retailers that pay for commercial space.

Furthermore, the financing for retail properties had gotten ludicrous. The conduits were making loans that they advertised as 80% of property value when they originated them, but in reality the loan-to-value ratios were well over 100%. And I say that to you with absolute, categorical certainty, because I was a seller and nobody knew the value of the properties that I was selling better than I did. I had operated some of them for 20 years, so I knew exactly what they were bringing in. I knew what the operating expenses were, and I knew what the cap rates were. And, you know, the underwriting on the loan side and the purchasing side of these assets was completely insane. It was ludicrous. It did not reflect at all what the conduits thought they were doing. They were valuing the properties way too aggressively. (…)

Right now there are an awful lot of banks that do an awful lot of commercial real estate lending, and for about a year now you’ve been telling me that you saw the first and second quarter of 2010 as being particularly risky for commercial real estate. Why this year, and what do you see happening with these loans and the banks holding them?

MILLER: It’s an educated guess, and it hasn’t changed. I still think that it’s second quarter 2010.

The current volume of defaults is already alarming. And the volume of commercial real estate defaults is growing every month. That can only keep going for so long, and then you hit a breaking point, which I believe will come sometime in 2010. When you hit that breaking point, unless there’s some alternative in place, it’s going to be a very hideous picture for the bond market and the banking system.

The reason I say second quarter 2010 is a guess is that the Treasury Department, the Federal Reserve, and the FDIC can influence how fast the crisis unfolds. I think they can have an impact on the severity of the crisis as well – not making it less severe but making it more severe. I will get to that in a minute. But they can influence the speed with which it all unfolds, and I’ll give you an example.

In November, the FDIC circulated new guidelines for bank regulators to streamline and standardize the way banks are examined. One standout feature is that as long as a bank has evaluated the borrower and the asset behind a loan, if they are convinced the borrower can repay the loan, even if they go into a workout with the borrower, the bank does not have to reserve for the loan. The bank doesn’t have to take any hit against its capital, so if the collateral all of a sudden sinks to 50% of the loan balance, the bank still does not have to take any sort of write-down. That obviously allows banks to just sit on weak assets instead of liquidating them or trying to raise more capital.

That’s very significant. It means the FDIC and the Treasury Department have decided that rather than see 1,000 or 2,000 banks go under and then create another RTC to sift through all the bad assets, they’ll let the banking system warehouse the bad assets. Their plan is to leave the assets in place, and then, when the market changes, let the banks deal with them. Now, that’s horribly destructive.

Just to be clear on this, let’s say I own an apartment building and I’ve been making my payments, but I’m having trouble and the value of the property has fallen by half. I go to the bank and say, “Look, I’ve got a problem,” and the bank says,
“Okay, let’s work something out, and instead of you paying $10,000 a month, you pay us $5,000 a month and we’ll shake hands and smile.” Then, even though the property’s value has dropped, as long as we keep smiling and I’m still making payments, then the bank won’t have to reserve anything against the risk that I’ll give the building back and it will be worth a whole lot less than the mortgage.

MILLER: I think what you just described is accurate. And it’s exactly a Japanese-style solution. This is what Japan did in ’89 and ’90 because they didn’t want their banking system to implode, so they made it easier for their banks to sit on bad assets without owning up to the losses.

And what’s the result? Well, it leaves the status quo in place. The real problem with this is twofold. One is that it prolongs the problem – if a bank is allowed to sit on bad assets for three to five years, it’s not going to sell them.

Why is that bad? Well, the money tied up in the loans the bank is sitting on is idle. It is not being used for anything productive.

Wouldn’t banks know that ultimately the piper must be paid, and so they’d be trying to build cash – trying to build capital to deal with the problem when it comes home to roost?

MILLER: The more intelligent banks are doing exactly that, hoping they can weather the storm by building enough reserves, so when they do ultimately have to take the loss, it’s digestible. But in commercial real estate generally, the longer you delay realizing a loss, the more severe it’s going to be. I can tell you that because I’m out there servicing real estate all day long. Not facing the problems, and not writing down the values, and not allowing purchasers to come in and take these assets at discounted prices – all the foot-dragging allows the fundamental problem to get worse.

In the apartment business, people are under water, particularly if they got their loan through a conduit. When maintenance is required, a borrower with a property worth less than the loan is very reluctant to reach into his pocket. If you have a $10 million loan on a property now worth $5 million, you’re clearly not making any cash flow. So what do you do when you need new roofs? Are you going to dig into your pocket and spend $600,000 on roofing? Not likely. Why would you do that?

Or a borrower who is sitting on a suburban office property – he’s got two years left on the loan. He knows he has a loan-to-value problem. Well, a new tenant wants to lease from him, but it would cost $30 a square foot to put the tenant in. Is the borrower going to put the tenant in? I don’t think so. So the problems get bigger.

Why would the owner bother going through a workout with the bank if he knows he’s so deep underwater he’s below snorkel depth?

MILLER: It’s always in your interest to delay an inevitable default. For example, the minute you give the property back to the bank, you trigger a huge taxable gain. All of a sudden the forgiveness of debt on your loan becomes taxable income to you. Another reason is that many of these loans are either full recourse or part recourse. If you’re a borrower who’s guaranteed a loan, why would you want to hasten the call on your guarantee? You want to delay as long as possible because there’s always a little hope that values will turn around. So there is no reason to hurry into a default. None.

So that’s from the borrower’s standpoint. But wouldn’t the banks want to clear these loans off their balance sheets?

MILLER: No. The banks have a lot of incentive to delay the realization of the problem because if they liquidate the asset and the loss is realized, then they have to reserve the loss against their capital immediately. If they keep extending the loan under the rules present today, then they can delay a write-down and hope for better days. Remember, you suffer if the bank succumbs and turns around and liquidates that asset, then you really do have to take a write-down because then your capital is gone.

So here we are, we’ve got the federal government again, through its agencies and the FDIC, ready to support the commercial real estate market. They’ve taken one step, in allowing banks to use a very loose standard for loss reserves. What else can they do?

MILLER: Well, obviously nobody knows, but I can guess at what’s coming by extrapolating from what the federal government has already done. I believe that the Treasury and the Federal Reserve now see that commercial real estate is a huge problem.

I think they’re going to contrive something to help assist commercial real estate so that it doesn’t hurt the banks that lent on commercial real estate. It’ll resemble what they did with housing.

They created a nearly perfect political formula in dealing with housing, and they are going to follow that formula. The entire U.S. residential mortgage market has in effect been nationalized, but there wasn’t any act of Congress, no screaming and shouting, no headlines in the Wall Street Journal or the New York Times about “Should we nationalize the home loan market in America.” No. It happened right under our noses and with no hue and cry. That’s a template for what they could do with the commercial loan market.

And how can they do that? By using federal guarantees much in the way they used federal guarantees for the FHA. FHA issues Ginnie Mae securities, which are sold to the public. Those proceeds are used to make the loans.

But it won’t really be a solution. In fact, it will make the problems much more intense.

Don’t these properties have to be allowed to go to their intrinsic value before the market can start working again?

MILLER: Yes. Of course, very few people agree with that, because if you let it all go today, there would be enormous losses and a tremendous amount of pain. We’re going to have some really terrible, terrible years ahead of us because letting it all go is the only way to be done with the problem.

Do you think the U.S. will come out of this crisis? I mean, do you think the country, the institutions, the government, or the banking sector are going to look anything like they do today when this thing is over?

MILLER: I know this is going to make you laugh, but I’m actually an optimist about this. I’m not optimistic about the short run, and I’m not optimistic about the severity of the problem, but I’m totally optimistic as it relates to the United States of America.

This is a very resilient place. We have very resilient people. There is nothing like the American spirit. There is nothing like American ingenuity anywhere on Planet Earth, and while I certainly believe that we are headed for a catastrophe and a crisis, I also believe that ultimately we are going to come out better.

John Mauldin can be reached at


Who’s Afraid of the Volcker Rule?

From Ft Alphaville

John Kemp, columnist at Reuters, admits there is no easy way of identifying how much money the major banks make from prop trading.

However, he points out there is a way to breakdown which banks depend most heavily on trading income rather than investment or commercial banking activities.

This, he says, is a clue to their prop trading revenues.

To wit, the following chart:

In which case, the two banks most exposed to a prop trading ban are: Goldman Sachs and Morgan Stanley.

Although Kemp does caution:

Not all those trading revenues are at risk. Many will be from “customer-related” activities. But if the administration’s proposed “Volcker Rule” separating banking from proprietary trading is enacted by Congress and enforced by bank examiners it is these banks that face the largest dent in their revenues, or at least the most intrusive regulation to ensure revenues really are customer-related and not speculation on behalf of the house.

A useful indicator nevertheless. And does this make Goldman the world’s biggest market-maker?



Not a great stat. The 20-City Composite is down 0.2% in November after being down 0.1% in October. This in spite of the tax rebate expiring in November and continued feet-dragging from banks on foreclosures.

“Only five of the markets saw price increases in November versus October. What is more interesting is that four of the markets – Charlotte, Las Vegas, Seattle and Tampa – posted new low index levels as measured by the past four years. In other words, any gains they might have seen in recent months have been erased and November is now considered their current trough value. On the flip side, there are still some markets that continue to improve month-over-month. Los Angeles, Phoenix, San Diego and San Francisco have seen prices increase for at least six consecutive months.

“To add more mixed signals, we are in a seasonally weak period for home prices, so the seasonally-adjusted data are generally more positive, with 14 of the markets and both composites showing improved prices in November. On balance, while these data do show that home prices are far more stable than they were a year ago, there is no clear sign of a sustained, broad-based recovery.”

And there will not be a broad-based recovery as long as the shadow inventories remain so elevated.


Full S&P; release



Lengthy piece by The Institutional Risk Analyst but well worth the time.

Watching the President announcing the proposal championed by former Fed Chairman Paul Volcker to forbid commercial banks from engaging in proprietary trading or growing market share beyond a certain size, we are reminded of the reaction by Washington a decade ago in response to the Enron and WorldCom accounting scandals, namely the Sarbanes-Oxley law. The final solution had nothing to do with the actual problem and everything to do with the strange political relationship between the national Congress, the central bank and the Wall Street dealer community. We call it the "Alliance of Convenience."

The basic problems illustrated by the Enron/WorldCom scandals were old fashioned financial fraud and the equally old use of off-balance sheet vehicles to commit same. By responding with more stringent corporate governance requirements, the Congress was seen to be responsive — but without harming Wall Street’s basic business model, which was described beautifully by Bernard J. Reis and John T. Flynn some eighty years ago in the book False Security.

A decade since the Enron-WorldCom scandals, we still have the same basic problems, namely the use of OBS vehicles and OTC structured securities and derivatives to commit securities fraud via deceptive instruments and poor or no disclosure. Author Martin Mayer teaches us that another name for OTC markets is "bucket shop," thus the focus on prop trading today in the Volcker Rule seems entirely off target — and deliberately so. The Volcker Rule, at least as articulated so far, does not solve the problem nor is it intended to. And what is the problem?

Not a single major securities firm or bank failed due to prop trading during the past several years. Instead, it was the securities origination and sales process, that is, the customer side of the business of originating and selling securities that was the real source of systemic risk. The Volcker Rule conveniently ignores the securities sales and underwriting side of the business and instead talks about hedge funds and proprietary trading desks operated inside large dealer banks. But this is no surprise. Note that former SEC chairman Bill Donaldson was standing next to President Obama on the dais last week when the President unveiled his reform, along with Paul Volcker and Treasury Secretary Tim Geithner.

Donaldson is the latest, greatest guardian of Wall Street and was at the White House to reassure the major Sell Side firms that the Obama reforms would do no harm. But frankly Chairman Volcker poses little more threat to Wall Street’s largest banks than does Donaldson. After all, Chairman Volcker made his reputation as an inflation fighter and not in bank supervision. Chairman Volcker was never known as a hawk on bank regulatory matters and, quite the contrary, was always attentive to the needs of the largest banks.

Volcker’s protégé, never forget, was E. Gerald Corrigan, former President of the Federal Reserve Bank of New York and the intellectual author of the "Too Big To Fail" (TBTF) doctrine for large banks and the related economist nonsense of "systemic risk." But Corrigan, who now hangs his hat at Goldman Sachs (GS), did not originate these ideas. Corrigan was never anything more than the wizard’s apprentice. As members of the Herbert Gold Society wrote in the 1993 paper "Gone Fishing: E. Gerald Corrigan and the Era of Managed Markets":

"Yet a good part of his career was not public and, indeed, was deliberately concealed, along with much of the logic behind many far-reaching decisions. Whether you agreed with him or not, Corrigan was responsible for making difficult choices during a period of increasing instability in the U.S. financial system and the global economy. During the Volcker era, as the Fed Chairman received the headlines, his intimate friend and latter day fishing buddy Corrigan did "all the heavy lifting behind the scenes," one insider recalls."

The lesson to take from the Volcker-Corrigan relationship is don’t look for any reform proposals out of Chairman Volcker that will truly inconvenience the large, TBTF dealer banks. The Fed, after all, has for several decades been the chief proponent of unregulated OTC markets and the notion that banks and investors could ever manage the risks from these opaque and unpredictable instruments. Again to quote from the "Gone Fishing" paper:

"Corrigan is a classic interventionist who sees the seemingly random workings of a truly free market as dangerously unpredictable. The intellectual author and sponsor of such uniquely modernist financial terms such as "too big to fail," which refers to the unwritten government policy to bail out the depositors of big banks, and "systemic risk," which refers to the potential for market disruption arising from inter-bank claims when a major financial institutions fails. Corrigan’s career at the Fed was devoted to thwarting the extreme variations of the marketplace in order to "manage" various financial and political crises, a role that he learned and gradually inherited from former Chairman Volcker."

As Wall Street’s normally selfish behavior spun completely out of control, Volcker has become an advocate of reform, but only focused on those areas that do not threaten Wall Street’s core business, namely creating toxic waste in the form of OTC derivatives such as credit default swaps and unregistered, complex assets such as collateralized debt obligations, and stuffing same down the throats of institutional investors, smaller banks and insurance companies. Securities underwriting and sales is the one area that you will most certainly not hear President Obama or Bill Donaldson or Chairman Volcker or HFS Committee Chairman Barney Frank mention. You can torment prop traders and hedge funds, but please leave the syndicate and sales desks alone.

Readers of The IRA will recall a comment we published half a decade ago (‘Complex Structured Assets: Feds Propose New House Rules’, May 24, 2004), wherein we described how the SEC and other regulators knew that a problem existed regarding the underwriting and sale of complex structured assets, but did almost nothing. The major Sell Side firms pushed back and forced regulators to retreat from their original intention of imposing retail standards such as suitability and know your customer on institutional underwriting and sales. Before Enron, don’t forget, there had been dozens of instances of OTC derivatives and structured assets causing losses to institutional investors, public pensions and corporations, but Washington’s political class and the various regulators did nothing.

Ultimately, the "Interagency Statement on Sound Practices Concerning Complex Structured Finance Activities" was adopted, but as guidance only; and even then, the guidance was focused mostly on protecting the large dealers from reputational risk as and when they cause losses to one of their less than savvy clients. The proposal read in part:

"The events associated with Enron Corp. demonstrate the potential for the abusive use of complex structured finance transactions, as well as the substantial legal and reputational risks that financial institutions face when they participate in complex structured finance transactions that are designed or used for improper purposes."

The need for focus on the securities underwriting and sales process is illustrated by American International Group (AIG), the lates
t poster child/victim for this round of rape and pillage by the large Sell Side dealer banks. Do you remember Procter & Gamble (PG)? How about Gibson Greetings? AIG, along with many, many other public and private Buy Side investors, was defrauded by the dealers who executed trades with the giant insurer. The FDIC and the Deposit Insurance Fund is another large, perhaps the largest, victim of the structured finance shell game, but Chairman Volcker and President Obama also are silent on this issue. Proprietary trading was not the problem with AIG nor the cause of the financial crisis, but instead the sales, origination and securities underwriting side of the Sell Side banking business.

The major OTC dealers, starting with Merrill Lynch, Citigroup (C), GS and Deutsche Bank (DB) were sucking AIG’s blood for years, one reason why the latest "reform" proposal by Washington has nothing to do with either OTC derivatives, complex structured assets or OBS financial vehicles. And this is why, IOHO, the continuing inquiry into the AIG mess presents a terrible risk to Merrill, now owned by Bank of America (BCA), GS, C, DB and the other dealers — especially when you recall that the AIG insurance underwriting units were lending collateral to support some of the derivatives trades and were also writing naked credit default swaps with these same dealers.

Deliberately causing a loss to a regulated insurance underwriter is a felony in New York and most other states in the US. Thus the necessity of the bailout — but that was only the obvious reason. Indeed, the dirty little secret that nobody dares to explore in the AIG mess is that the federal bailout represents the complete failure of state-law regulation of the US insurance industry. One of the great things about the Reis and Flynn book excerpted above is the description of the assorted types of complex structured assets that Wall Street was creating in the 1920s. Many of these fraudulent securities were created and sold by insurance and mortgage title companies. That is why after the Great Depression, insurers were strictly limited to operations in a given state and were prohibited from operating on a national basis and from any involvement in securities underwriting.

The arrival of AIG into the high-beta world of Wall Street finance in the 1990s represented a completion of the historical circle and also the evolution of AIG and other US insurers far beyond the reach of state law regulation. Let us say that again. The bailout of AIG was not merely about the counterparty financial exposure of the large dealer banks, but was also about the political exposure of the insurance industry and the state insurance regulators, who literally missed the biggest act of financial fraud in US history. But you won’t hear Chairman Volcker or President Obama talking about federal regulation of the insurance industry.

And AIG is hardly the only global insurer that is part of the problem in the insurance industry. In case you missed it, last week the Securities and Exchange Commission charged General Re for its involvement in separate schemes by AIG and Prudential Financial (PRU) to manipulate and falsify their reported financial results. General Re, a subsidiary of Berkshire Hathaway (BRK), is a holding company for global reinsurance and related operations.

As we wrote last year (‘AIG: Before Credit Default Swaps, There Was Reinsurance’, April 2, 2009), Warren Buffett’s GenRe was actively involved in helping AIG to falsify its financial statements and thereby mislead investors using reinsurance, the functional equivalent of credit default swaps. Yet somehow the insurance industry has been almost untouched by official inquiries into the crisis. Notice that in settling the SEC action, General Re agreed to pay $92.2 million and dissolve a Dublin subsidiary to resolve federal charges relating to sham finite reinsurance contracts with AIG and PRU’s former property/casualty division. Now why do you suppose a US insurance entity would run a finite insurance scheme through an affiliate located in Dublin? Perhaps for the same reason that AIG located a thrift subsidiary in the EU, namely to escape disclosure and regulation.

If you accept that situations such as AIG and other cases where Buy Side investors (and, indirectly, the US taxpayer) were defrauded through the use of OTC derivatives and/or structured assets as the archetype "problems" that require a public policy response, then the Volcker Rule does not address the problem. The basic issue that still has not been addressed by Congress and most federal regulators (other than the FDIC with its proposed rule on bank securitizations) is how to fix the markets for OTC derivatives and structured finance vehicles that caused losses to AIG and other investors.

Neither prop trading nor the size of the largest banks are the causes of the financial crisis. Instead, opaque OTC markets, deliberately deceptive structured financial instruments and a general lack of disclosure are the real problems. Bring the closed, bilateral world of OTC markets into the sunlight of multilateral, public price discovery and require SEC registration for all securitizations, and you start down the path to a practical solution. But don’t hold your breath waiting for President Obama or the Congress or former Fed chairmen to start that conversation.


The Warning Shot From Capital One

Capital One Financial just gored the bull-case for bank stocks. The credit-card lender’s shares plunged more than 12% Friday, far more than the wider bank sector, which fell around 3% on bank-overhaul fears.

The optimists have long argued that consumer-focused lenders will be the first to show a sustained earnings recovery, helping to ignite the mother of all bank rallies. But Capital One’s fourth-quarter results, released late Thursday, suggest that 2010 profits could disappoint at exactly the banks investors are most enthusiastic about.(…)


Capital One’s quarter reveals a less rosy scenario. Not only will loan growth be tough to achieve, it could also cost more than investors realize, especially in highly competitive areas, such as credit cards.

(…)One reason Capital One beat fourth-quarter earnings estimates was that it reduced its bad-loan reserve by a fair amount. But can the company keep making sizable reductions, given that it also said bad-loan losses "are stabilizing at relatively high levels"?

All banks currently face regulatory and political uncertainty. However, Capital One shows that, even once new rules are known, actually implementing them can cause upsets. For instance, new regulations that bring assets on balance sheet have been known for months. Yet Capital One only just estimated the dent to capital caused by the rules—and it was worse than many expected.

Full WSJ article. Pic and chart from Bloomberg News



(…) JPM beat market expectations regarding Q4 earnings, but came in a little light on revenues. We believe that "revenue lite" is going to be the story for the entire banking industry in 2010 in part because that is how bank customers are faring. The other theme is continued and perhaps sustained high loss rates.  We’ll remind one and all again that the industry lingered at peak loss rates for six quarters in the 1991-1992 credit trough.  We also lingered at zero default rates for years during the great land rush of 2004-2007, another nagging factoid which bothers us more than unusual.

This goes against Goldman Sachs more positive view: 

Both losses and NPAs fell 3% sequentially. That said, JPM sold $1.0 bn of NPAs this quarter; excluding this, NPAs would have been up 3%, which image was still very good vs. the 16% increase last quarter. By product, CRE appears to have deteriorated further, contributing to the big increase in commercial NPAs in 4Q. That said, JPM did not build reserves in this
segment this quarter.

Reserves are still building but at a more moderate pace and, with reserves over 5%, we may finally be at the end of the reserve building
cycle for JPM.

Back to IRA:

Now you understand that the Street was surprised by JPM’s results. The concept of weak revenue somehow does not square with 40% EPS growth in 2010. That’s where the Street is on JPM even now and even though it is pretty clear from management statements that the end of the pain is still ahead. We almost felt sad for the analysts who were actually hoping for a dividend increase. 

Ever hopeful, during the JPM call our colleague Meredith Whitney asked JPM CEO Jamie Dimon several times if there would not be some relief from Washington on those HELOC and other exposures, call it "HAMP II." Dimon denied any more knowledge than the analyst rat pack when it comes to future largess from Washington.  We think it will be tough for the banks to engineer a bailout while they are repaying the cost of TARP — and also filing in the hole in the Deposit Insurance Fund at FDIC.  Call the new tax load 15bp on net assets, with an even higher vig for the top 50 banks. 

IRA Bank Stress Index Rating – JPMorgan Chase – Q3 2009

IRA Letter Grade
Overall stress is slightly better than industry average.






Loan Defaults




Lending Capacity