JPM is leaving no stone unturned to prop up the operational performance and give out green signals, even if it involves the most unsustainable measures. While in 1Q10, trading income came to the rescue of the sagging core operations, in 2Q10, it was management’s over-exuberance (defying logic and rationality, to some extent) resulting in drastic reduction in loan loss provisioning and beefing up the bottom line. Although the credit quality has shown slight improvement (thanks to the enormous fiscal and monetary stimulus), it does not completely warrant for JPM’ unhealthy and hasty decision to substantially pare its loss provisions. I know many financial pundits second guess management as arm chair coaches, but when management error is egregious, well let’s let the numbers speak through graphics….
As Excerpted from As I Made Very Clear In March, US Housing Has a Way to Fall:
Trust me, the collateral behind many more mortgages will continue to depreciate materially as government giveaways and bubble blowing for housing fade!
In a nutshell, a cursory glance of JP Morgan's recent earnings announcement is middling, and that's putting it optimistically. Revenue and profits have fallen nearly across the board, and the earnings beat is a result of moving capital from reserves to the earnings column. Even this may be suspect, for while credit metric trends appear to be improving (largely a result of massive government stimulus), the core, underlying cause of this malaise looks to be on the move downward again. See As I Made Very Clear In March, US Housing Has a Way to Fall.
An Independent Look into JP Morgan (subscription content free preview!)
The JP Morgan Professional Level Forensic Report (subscription only)
The JP Morgan Retail Level Forensic Report (subscription only)
I wanted to share a series of negative news flow relating to the weakness in the core businesses of the investment banks owing to increased volatility in the capital markets over the last few months. This ebb from the sell side trails the opinion of BoomBustBlog research which forwarned of the same very early in the first quarter as well as last quarter of 2009l The news flow points out that the upcoming results of GS, MS and JPM might be disappointing or below expectations - as if we already didn't know this.
- According to some of the recent MSM articles, the recent surge in volatility has led to record low activity in the underwriting and M&A activity.
Global M&A value for the first half of 2010 grew 3% to $1.18 trillion, compared with $1.15 trillion a year earlier, according to Dealogic's figures. But while values were up against the year-earlier period, the $552.7 billion in value generated in the second quarter was down almost 7% compared with the first quarter of the year - WSJ.com.
Wall Street investment banks sold $1.36 trillion of stocks and bonds in the second quarter, down 33% from the second quarter of 2009 and the lowest quarterly total since the fourth quarter of 2008, according to Dealogic.
- Also, the capital markets volatility will have severe implications for the trading revenues of investment banks like GS and MS which derive substantial portions of their revenues from trading activities. Analysts have been downgrading earnings estimates for these banks and GS’s earnings have been particularly slashed since it generates nearly 60-70% of total revenues from trading.
Barclays Capital analyst, Roger Freeman, cut earnings estimates for Goldman Sachs Group (GS) and Morgan Stanley (MS) on June 23, 2010. Freeman slashed his second-quarter profit forecast for Goldman by nearly 64% to $1.95 a share from $5.35 a share. Freeman is expecting 40% lower trading revenues in FICC and equity segments in 2Q10 against 1Q10. His estimate for Morgan Stanley dropped 29% to 55 cents a share from 77 cents a share - WSJ.com.
Bank of America analyst, Guy Moszkowski, also slashed earnings estimates for GS and MS. He revised GS’ 2Q10 earnings estimates to $1.76 per share, 51% lower than the previous estimate of $3.57. The new estimates reflect a 45% decline in equity trading revenue and 40% drop in fixed-income trading revenue compared with the first quarter. MS’s 2Q10 EPS estimate was cut 35%, to 58 cents a share from 89 cents. The estimate on JPMorgan Chase & Co. was trimmed to 70 cents a share from 77 cents, and Citigroup Inc. was lowered to 2 cents a share from 4 cents - Businessweek.
I would also like to add that the recent volatility and market decline has also impacted the AUM of asset managers and there has been downward price revision by analysts. The assets under management of BEN declined 5% (m-o-m) in May, 2010 and the June figures are not yet out. Consequently, the target price estimates have been lowered by many analysts. In June, FBR Capital lowered its target for BEN to $105 from $118 and Barclays capital lowered its target for BEN to $125 from $133. Analyst at Goldman Sachs have also made significant downward revisions in this sector.
Now, the news flow in light of applied BoomBustBlog research:
The Asset Manager Trade is Printing Money Almost as Fast as Ben Bernanke
Who says only Americans are trying to delever?
Even with exposure to foreign events and insolvent counterparties at the top of every financial institution’s worry list for the rest of 2010, the microeconomic picture for debtors in the UK remains mediocre. Americans were not the only ransacked with debt during the past decade, as Brits watched their securitized debt levels rise to incredible rates. The Bank of England makes a point to state that without record low interest rates, defaults would be another issue for banks to look out for (interpreted: the Democratic People’s Republic of Korea will win the World Cup before the central bankers at the BoE even consider raising interest rates). Soon after, they state that it would be easier to raise rates in times of robust growth than the uncertainty of current conditions, which is absolutely novel.
- A majority of UK households have a large amount of equity in their home value
- Unsecured mortgages made up 2/3 of write offs since 2007, and even as they have stagnated, credit card write offs have increased to record highs
- The beginnings of a potential CRE resurgence in the UK have been limited to prime properties, with higher yield projects being shunned
- Even as prices are rising, they are still a third below 2007 peaks (and still probably overpriced if it is anything like the US CRE market)
- If tighter credit conditions prevent voluntary restructuring, CRE prices will fall further on corporate liquidations and forced foreclosures
One of the most apparent side-effects of the turmoil resulting from what I have coined as the Coming (now arrived) Pan-European (soon to be global) Sovereign (soon to be private as well) Debt Crisis is the spread of the awareness the markets have drastically undercharged for risk over the last 7 years or so. This, of course, is just a long winded method of saying bubble. Many companies, and some entire industries (ex. residential and commercial real estate [Commercial Delinquencies], banking, etc.) as well as entire nations (namely Greece [Calculate Your Haircuts Here] and Spain whose underestimated debt woes I just posted on yesterday[Spreads are Blowing Out]) have grown so used to this under-charging of risk that to wean them off of this cheap capital would be devastating. This means, in essences, the bankruptcies and restructurings are coming, and its not a matter of if, but when. This will probably portend a return to the 2008 lows, close to it, or worse, because in this global economic ecosystem you cannot have one part of the developed world's import/export component do that bad without infecting the other components. This was explained in explicit detail in "Financial Contagion vs. Economic Contagion: Does the Market Underestimate the Effects of the Latter?" and modeled out to show which direction the chain reaction may push the dominoes, as well as which countries were at risk from whom in the BoomBustBlog Sovereign Contagion Model.
We can see the effects of contagion driving market rates higher already, even as central bankers set negative rate policies. Reference Spain T-Bill Yields Jump; Doubts Emerge over Rating and the (still 3 months too tardy) dropping of Greece's debt rating which exposes how politically exposed and potentially manipulable ratings agencies are even when they pussy foot around with should have been explicit downgrades months ago - reference EU Commissioner Attacks Moodys on Greek Downgrade.
It is only a matter of time (and I doubt it will be much time) before the popping rates of sovereign debt and the incessant demand from the market (or bailout vehicles to be funded in the market) start crowding out private debt consumers, and drive those rates higher. Those companies with weak balance sheet, minuscule margins and play-dough business models will crack like Easter eggs. The BoomBustBlog Bankruptcy Search Series will attempt to identify those companies before the market recognizes them and either warn our subscribers of the peril of holding said companies or allow them to potentially profit from their downfall. Let's start with the banks, which are a special case. You see, explicit bankruptcy (actually, regulatory receivership candidates) are often priced accordingly, but if you move one or two notches up the food chain, you can find a bevy of overpriced candidates that may not be ready to collapse immediately, but are priced as if they will continue forever. Add in a little sovereign malaise as a catalyst and boom, there goes the chemistry set!
The global equity markets are in meltup mode again. I want to take this opportunity to reiterate that I am still quite bearish on much of the situation in Europe. Let's glance at the credit markets, major banks and the state of sovereign indebtedness in Spain.
As you can see, Spain's 3 yr CDS spreads are the highest they have ever been. They are significantly higher than they were during the entire Lehman fiasco, and they are even higher (or at least comparable) than they were right before the EU/IMF trillion dollar bailout package was announced in conjunction with threatening those who dared to speculate against Spain's fiscal health!
June 9 (Bloomberg) -- France and Germany called on the European Union to speed up curbs on financial speculation, saying some bets against stocks and government bonds should be banned as markets suffer a resurgence of “strong volatility.”
Relevant commentary from BoomBustBlog and sources throughout the Web on the accounting change that added 80% to the S&P since March 2009!!!
Warning Shots from the IASB: FT
- The IASB came under fire in the fall/winter of 2009 in regards to mark to market rules
- Banks wanted continued relaxation of valuing models in order to “smooth out volatility swings in asset prices”
- IASB and FASB plan to converge on mark to market ruling by 2011, both have stated a desire for more transparent financial statements, but have been politically compromised by bankers and commercial lenders
FASB Plan Would Force Banks to Report Loan Fair Value: BusinessWeek
- FASB is seeking to approve a proposal that would force banks to mark loans at market value by 2013, potentially having billions of dollars at risk for writedowns
- In April 2009, FASB gave significant leeway to banks in regards to pricing and modeling loan values, banking consultants are very opposed to a reversal of the measures
- Pension obligations and leases will be exempt from new measures
For those who have been following me in the Asset Securitization and Pan-European Sovereign Debt Crisis series this may be old news, but let's go through the exercise anyway. It looks as if we are back to those non-sense games being played by those that manipulate the market. Taking a look at Bloomberg.com's front page, you'll see "Stocks, U.S. Futures Rally on Economic Outlook; Yen Weakens, Bonds Decline" (hey, good times are here again) followed directly by "Banks Deposit Record $394 Billion With ECB, Avoiding Loans to One Another"(hey, isn't this the exact same environment wherein Bear Stearns, then Lehman Brothers collapsed leading the Treasury Secretary Hank Paulson to proclaim the end of the financial world was coming?). Then there's "Covered Bond Sales Surge; Transocean Tumbles: Credit Markets": Sales of covered bonds are accelerating as investors seek debt backed by collateral amid concern about the creditworthiness of governments and banks.
Okay, let's take this by the numbers....