Tuesday, 12 October 2010 15:35

As Earnings Season is Here, I Reiterate My Warning That Big Banks Will Pay for Optimism Driven Reduction of Reserves

As those that follow me know, I have been bearish on US banks since 2007. That bearish outlook resulted in massive returns ensuing years, just to have nearly half of it returned due to rampant shenanigans and outright fraud. Needless to say, it pissed me off - but it did much more than that. It created a re-bubble before the bubble that was bursting had a chance to fully deflate. As a result, what we have now is one big mess that is getting messier by the minute.

On Friday, July 16th, 2010 I posted "After a Careful Review of JP Morgan’s Earnings Release, I Must Ask – “What the Hell Are Those Boys Over at JP Morgan Thinking????”. The impetus of such was that this bank that all seem to be in awe of was taking a big risk in order to pad accounting earnings for a quarter or two. Below is an excerpt of my thoughts:

Trust me, the collateral behind many more mortgages will continue to depreciate materially as government giveaways and bubble blowing for housing fade!

The delinquency and NPA levels drifted down a bit, but they are still at very high levels. Charge-offs came down but the reduction in provisions has been quite disproportionate bringing down the allowance for loan losses. In 2Q10, the gross charge- offs declined 26.6% (q-o-q) to $6.2 billion (annualized charge off rate – 3.55%) from $8.4 billion in 1Q10 (annualized charge off rate – 4.74%). But the provisions for loan losses were slashed down 51.7% (q-o-q) to $3.4 billion (annualized rate – 1.9%) against $7.0 billion (annualized rate – 3.9%) in 1Q10. Consequently, the allowance for loan losses declined 6.2% (q-o-q) from $35.8 billion from $38.2 billion in 1Q10. Non performing loans and NPAs declined 5.1% (q-o-q) and 4.5% (q-o-q) respectively. Thus, the NPLs and NPAs as % of allowance for loan losses expanded to 45.1% and 50.7%, respectively from 44.6% and 49.8% in 1Q10. Delinquency rates, although moderated a bit, are still at high levels. Credit card – 30+ day delinquency rate was 4.96% and the real estate – 30+ day delinquency rate was 6.88%. The 30+ days delinquency rate for WaMu’s credit impaired portfolio was 27.91%.

While the lower provisioning was able to beef up the bottom line in this quarter, the same is not sustainable in the future as JPM cannot afford to reduce its allowance for loan losses substantially. This is a one shot, blow your wad and go to sleep deal!  There is no margin for error in the future, and one can only assume that the reason this was done was to pad accounting earnings and to take advantage of the extremely short term, and obviously naïve, memory of the financial media and retail/institutional investor. Given the high charge-off rates and delinquency levels, the provisioning will probably need to be bolstered again in the not too distant future.

Listen, even US Economic Cheerleader and Propaganda-in-Chief Ben Bernanke said it will be several years before growth and employment resumes. Sooooo…. What the hell are the boys (and girls) at JP Morgan doing????

Well fast forward three or four months and we get to see whether or not I had a point. You see, JP Morgan swallowed WaMu (who I warned would face peril in 2007) at a discount that is all but eaten up already as asset values continue to fall, and they swallowed Bear Stearns (whom I warned would fail in January of 2008) with government guarantees. Combine these with their own lending and you have a lot of potentially rotten assets smelling even more rotten. Now that the fraud which was mortgage paper keeping, transfer and assignment has come to light, it is just a matter of time before the even more material overstatement of values discussion becomes both commonplace and the subject of enough litigation to last several presidencies. Reference "The Robo-Signing Mess Is Just the Tip of the Iceberg, Mortgage Putbacks Will Be the Harbinger of the Collapse of Big Banks that Will Dwarf 2008!"

You see, JPM (and not to pick on them, so let's include their big bank brethren as well) so early stage delinquencies ameliorate, and as a result padded the lack of oomph in trading, asset management, core banking  and I-banking with the release of accounting reserves. Either they purposely were looking to deceive or the honestly didn't look at the amelioration in the larger context (or of course, I could just be wrong - but I seriously doubt so). If you remember, I issued an explicit warning regarding watching price without regard to economic activity in as well as paying heed to those who have vested interests in [youtube MutLxFck9Ec]

Below is a chart which illustrates the folly of excluding economic sales activity from your real estate based decision making.

Well, the big banks which include JPM that released reserves and provisions just did the same thing. They saw this...

... and apparently believed that a) this positive trend would continue (unrealistically optimistic, but possible),  b) collateral values will not collapse, c) this improvement was caused by organic means/economic growth and not government bubble blowing (and I am sure they knew better than that) and d) nothing else would or could go wrong. Well, all they had to do was to take a holistic view of the market before reducing provisions and they could have seen that although the credit metrics had improved slightly right after the government induced buyers to jump headfirst into a plunging housing market with suppressed mortgage rates and tax incentives, that the real world credit metrics were actually worse than they have been throughout this entire crisis due to the fact that economic housing sales have plummeted in relation to the deteriorating metrics, causing an increasingly large pipeline of bad assets to pile up on banks books. Just as an increasing price is misleading if you look at it in a vacuum, so are improving credit metrics. The NPA pipeline for the banks is not only getting longer, its the longest it has been since I can recall the data. This is a very bad thing.

Let's break this down...

The end result... Banks are becoming the country's largest REITs, sans the tax exempt trust part, and sans the expertise in managing properties.

As I anticipated way back in 2007, banks are becoming the largest homeowners in the country. Reference "Would you buy Countrywide if all of its bad mortgages were magically wiped off the books?" from December of 2007:

I know I wouldn't. I believe there are better investments out there from a risk/reward perspective. Countrywide is in a bit of a jam, and it is not just from bad loans on the books. Looking at the Countrywide Foreclosures Blog (yes, there actually is one), I found this article:14,196 Homes Offered For Sale on Countrywide Financial's Website. I browsed through some of the site, and the small sample of numbers that I looked at seemed accurately reported. It also seems to mesh with Housingtracker.net. Browsing through the comments, someone noticed that the bank and trust offerings were not included. I looked, and at first glance, it seemed like he had a point. Now,it is a lot of work to verify all of this, but if it does pay out (and it looks like it does), Countrywide has nearly 100% of it market capitalization outstanding as REOs – in a market where houses just aren't selling and property values are falling fast. This is totally discounting each and every under performing and underwater mortgage asset they have on their books.

Held by Countrywide Mortgage Co. $ 2,910,876,468
Held by Countrywide Trust and Bank $ 2,969,067,322
Total $ 5,879,943,790
CFC Market Capitalization $ 6,180,000,000
% market cap held as REO 95%

Just some food for thought.

Now, fast forward roughly 3 years, and after Countrywide and WaMu collapse (as we at BoomBust anticipated back in 2007), and you find the biggest and most respected banks in the country are suffering from THE EXACT SAME PROBLEM!!!

Banks balance sheets are getting stuffed faster than ever with bad loans and foreclosures because the bad loans and foreclosures are occurring faster than the market is absorbing them. This means that the REOs are building up on the banks balance sheets (whether they properly disclose this or not) and it also means that the Fraudclosure issue will significantly exacerbate the problem, and it also means this problem will get much worse as housing activity AND prices are on the downturn again.

These factors should have been taken into consideration before even thinking of reducing risk provision measures. Of course, then you have FraudclosureGate, which delays the foreclosure process, further stuffing the pipeline. The result of FraudclosureGate will be the mad dash to put fraudulent loans back the originator. None of these occurrences will be good for the banks, particularly those banks that swallowed the NINJA loan mills.

Look here for some more sobering views...

As of last quarter (when the effects of .GOV bubble blowing just started to wear off) housing related NPAs (or what will become housing related NPAs with honest accounting) have SIGNIFICANTLY outstripped housing sales in both growth rate and amount.

If you have read this far, then you undoubtedly have an interest in the mortgage and commercial banking space. I will be releasing to paying subscribers updated bank valuations and quarterly earnings opinions that FULLY reflect the data above, plus much more that I didn't have time to delve into today. Stay tuned for analysis of JP Morgan, Morgan Stanley, Goldman Sachs, PNC Bank, Well Fargo, and Sun Trust Bank. Others may follow. Subscribers can scan the subscription archives for previous quarterly opinions, stress tests and full forensic reports of all of the aforementioned bank (click here to subscribe). As a subscriber, you also have access to all of the data and analysis used to create these charts, in addition to a more granular application, by state in the SCAP template and by region in housing price and charge off templates – see

See the following posts for an extensive background on the topics discussed in the video:

[youtube iLKYxfxHpuY]

The full JPM Q2 review can be downloaded by subscribers (click here to subscribe) here: File Icon JPM 2Q10 review

Subscribers should also review our forensic valuation reports, which have (thus far) proven to be right on the money in terms of JP Morgan:

The JP Morgan Professional Level Forensic Report (subscription only)

The JP Morgan Retail Level Forensic Report (subscription only)

Those that don’t subscribe still have a lot of BoomBustBlog JPM opinion and analysis to chew on, including a free, condensed (but still about 15 pages) version of the forensic analysis above. You can find it below this pretty graphic from “An Unbiased Review of JP Morgan’s Q1 2010 Results Yields Less Roses Than the Maintream Media Presents“…

  1. An Independent Look into JP Morgan (subscription content free preview!)
  2. If a Bubble Bubble Bursts Off Balance Sheet, Will Anyone Be There to Hear It?: Pt 2 – JP Morgan
  3. Is JP Morgan Taking Realistic Marks On Its WaMu Portfolio Purchase? Doubtful!
  4. Anecdotal observations from the JP Morgan Q2-09 conference call
  5. Reggie Middleton on JP Morgan’s Q309 results
  6. Reggie Middleton on JP Morgan’s “Blowout” Q4-09 Results
  7. Is the US Government About to Forgive Mortgage Debt? Let’s Crowdsource Our Way Through a Scenario or Two!
  8. Pay Attention to the National Association of Realtors and Their Chief Marketing Agent At Your Own Risk!
  9. Why the Case Shiller Index, Although Showing Another Downturn Coming, is Overly Optimistic and Quite Misleading!
  10. Yes, Housing Prices Have Much Farther to Fall. We’re Talking Years…
  11. Because 105% LTV On Depreciating Property Wasn’t Good Enough for the US Taxpayer…
  12. I Told You Housing Was Going to Take a Downturn for the Worse. I’ll Tell You Something Else, We Are in a Housing Depression! It’ll Get Worse Until Market Forces Rule Over Government Bubble Blowing!
  13. As I Made Very Clear In March, US Housing Has a Way to Fall
  14. It’s Official: The US Housing Downturn Has Resumed in Earnest
  15. The Great Global Macro Experiment, BoomBust Cycles, and the Refusal to See the Truth: Bubble Economics in the Mainstream Media
Last modified on Thursday, 14 October 2010 01:34


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  • Comment Link Reggie Middleton Thursday, 14 October 2010 17:19 posted by Reggie Middleton

    As Tyler Durden reports from ZH, by way for Bloomberg:
    Even as JPM Jamie was crowing earlier about how great JPM's feces smell, and how the future is so bright, he's gotta wear Dimonshades, a little yet very important headline hit Bloomberg. To wit:



    Is JPM, with its massive cash trove, suddenly a little more nervous about the teeny, weeny foreclosure problem?
    Hey, don't say I didn't warn you well in advance! I'll see if I can get the JPM quarterly review up by tomorrow with the valuation up over the weekend. As a bonus, I have also calculated how long this mess will last given the variables as constant in this point in time. We're all looking pretty Japanese!!!

  • Comment Link macfly Wednesday, 13 October 2010 13:25 posted by macfly

    Another excellent report, Reggie howdo you manage to get such deep reports of so fast in such quick succession, each one seems like a thesis that would take most mortals months to prepare!

    I really wish you'd start a 'theoretical folio' as I would certainly subscribe to that - the only thing that stops me subscrbing to your full reports is I fear they may be over my head, and not give me the clarity I seek on my investments.

    Keep up the great work!

  • Comment Link macfly Wednesday, 13 October 2010 13:25 posted by macfly

    Another excellent report, Reggie howdo you manage to get such deep reports of so fast in such quick succession, each one seems like a thesis that would take most moral months to prepare!

    I really wish you'd start a 'tehoretical folio' as I would certainly subscribe to that - the only thing that stops me subscrbing to your full reports is I fear they may be over my head, and not give me the clarity I seek on my investments.

    Keep up the great work!

  • Comment Link john Wednesday, 13 October 2010 12:52 posted by john

    You can trade this market or you can sit in US$ cash, make a buy list of strong balance sheet companies that would still perform in deflationary enviroments and if the market does infact go down then you can put some of that cash to work as long as you buy said companies at a discount to their current assets.

    Timing is very difficult, shorting the market agaisnt the fed is very difficult, buying at a discount to current assets is a little easier but does not come around often and when it does the buy part is the hardest thing to do, you have consider market conditions and how the company will perform in said conditions.

    I have no time frames just preparation to act.

    If your not doing this full time then you need to stick close to some like Reggie who is.

  • Comment Link Reggie Middleton Wednesday, 13 October 2010 12:31 posted by Reggie Middleton

    IMO, yes. As stated earlier, big banks still have an implicit put option from the government. Until that is effectively removed, there is no reason for the banks to change their tune.

  • Comment Link pezhead Wednesday, 13 October 2010 12:27 posted by pezhead

    So, are we just seeing wacko, crazy exuberance

  • Comment Link Domarius Raines Wednesday, 13 October 2010 12:21 posted by Domarius Raines

    Good advice, so what's the time frame for the ponzi scheme to potentially implode? 6 to 24 months out? The market seems to defy logic right now. All points on reggies blog and others I read point to a lower stock market based on current fundamentals of the economy, history shows the stock market will continue on illogical exuberance only for so long.

  • Comment Link john Wednesday, 13 October 2010 11:39 posted by john

    @ DR, I'm with Reggie, stagflation or full out deflation. Personally I am all in US$ Cash..I have no Gold or silver

  • Comment Link Reggie Middleton Wednesday, 13 October 2010 08:06 posted by Reggie Middleton

    I believe we will have a stagflationary environment, if not full out deflation. search my site for stagflation for a lot of commentary on the topic.

  • Comment Link Domarius Raines Wednesday, 13 October 2010 07:57 posted by Domarius Raines

    So John if that is the case and the money does not circulate that could in tern lead to a deflationary environment right. And if so would an individual protect there assets buy silver and gold or short the market? Or just stay in cash?

  • Comment Link john Tuesday, 12 October 2010 23:16 posted by john

    Interest rates are at historic lows, inflation is mute let alone hyperinflation. QE is an asset swap with the banks, the fed buys the banks paper for cash, the cash is held in the nbanks accounts at fed reserve, no money is printed the fed just electronically credits the accounts and takes the paper. The private sector balance sheets need to be repaired before the money would be loaned out/put to work, even then there would have to be confidence in the market.

  • Comment Link Domarius Raines Tuesday, 12 October 2010 19:59 posted by Domarius Raines

    Hi Reggie excellent work.

    my question is if the fed continues to pump money into the banks and into the economy by implementing QE2 will this eventually cause hyperinflation?

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