I, Reggie Middleton, challenge the mainstream media to think independently. I challenge them to dig down, past the sterilized, politically correct soundbites proffered by popular corporate management, you know - the "in crowd". I challenge the MSM to pull out a calculator, run through the reported numbers, and actually ascertain if what is being proferred by managment actually correlates with the numbers offered to the regulatory agencies. I know some of the finance stuff can get arcane, but their are many objective parties to turn to for assistance. Unfortunately, they are very rarely consulted. I see the favored names in the media, but rarely do I see objective opinion.
Below is a snippet of headlines that I pulled from a Google news search for the phrase JP Morgan.
- msnbc.com - The market's expectations for bank earnings increased after JPMorgan set a high bar Wednesday with a surprisingly strong profit that helped propel the Dow ...
- JPMorgan scores big in latest quarter
- JPMorgan Chase Reports Strong Profit of $3.6 Billion New York Times - Oct 14, 2009: A year after the financial system was brought to its knees, a resurgent JPMorgan Chase reported a second consecutive quarter of surprisingly ...
- JPMorgan profits lift Dow past 10000
Two Reasons the Dow's Rally to 10000 Will Keep Moving Ahead - A blowout third quarter for jpmorgan Chase & Co. (NYSE: JPM) sent its shares and more than 600 other stocks 52-week highs. jpmorgan delivered its strongest ...
Keep these newsbites in mind as I go over what I gathered from JP Morgan's latest results.
JP Morgan - 3Q09 Results and Outlook
modelled results were pretty much on point with JP Morgan's actual Q309
reported results - see
- JPM Public Excerpt of Forensic Analysis Subscription (free)
- JPM Report (092209) Final - Professional (subscription)
- JPM Forensic Report (092209) Final- Retail (subscription).
The tough economic environment is still gripping the
traditional banking operations of US banks and JP Morgan's 3Q09 fail to provide
light at the end of the tunnel. As a matter of fact, if is arguable that for
those that do perceive a light, it is that of a freight train coming to run
over the observer. The credit deterioration impact on JP Morgan, however, has
been moderated by the gains from trading revenues which provided more than
adequate cushion to absorb the high credit losses from the traditional banking
major support for JP Morgan came from increase in revenues from principal
transactions (including trading revenues of investment banking and
corporate/private equity division) which led non-interest revenue to increase to
$13.8 billion in 3Q09 from $12.9 billion in 2Q09 and $5.7 billion in 3Q08. In
3Q09, non interest revenues accounted for 52.2% of the total net revenues
against 50.6% in 2Q09 and 39.0% in 3Q08.
This is part 3 in my quest for the truth in what lies off balance sheet of the big banks in America. Please reference If a Bubble Bursts Off Balance Sheet, Will Anyone Be There to Hear It? and If a Bubble Bursts Off Balance Sheet, Will Anyone Be There to Hear It?: Pt 2 - JP Morgan for the prequels. As was noted before, I also have a 30 part series on this Asset Securitization Crisis for those who are interested in my take on this from the beginning. It is a lot of reading, but it tells it like it is. Now, on to the bank to be owned by America - I'm sorry, that's Bank of America...
Bank of America Securitization Activities
Bank of America securitizes residential mortgages, commercial mortgages, credit card receivables, and home equity loans and automobile loans that it originates or purchases from third parties. As of June 30, 2009, the total principal balance outstanding of securitized portfolio was nearly 1.7 trillion (including 1.1 trillion of mortgage backed securities, securitized by Government sponsored entities). The total senior securities and subordinated securities held by BAC on its balance sheet amounted to about $27 billion (28% of tangible equity) and $10 billion (10% of tangible equity), respectively.
Note to readers: a formatting issue caused the 2nd half of this article to get cut off. I urge interested parties to reread the article to get the full message.
Since I write for a diverse audience, I will start this off with an overview of securitization. If you are in the industry or are just a smart ass dude, feel free to skip down to the JP Morgan specific section below. I also have a 30 part series on this Asset Securitization Crisis for those who are interested in my take on this from the beginning. It is a lot of reading, but it tells it like it is.
Securitization is still a very significant source of leverage and opacity in the US and European economies, in spite of its predominant role in the most recent global financial turbulence. It is a practice where loans and other debt instruments are aggregated in a pool and thereby used to issue new securities. Banks and financial institutions started establishing Special Purpose Vehicles (SPV) and Qualifying Special Purpose Entity (QSPE) under the FASB rules to securitized loans and thereby reducing, from an accounting perspective (but more accurately put), or transferring from an economic perspective, financial risks on their balance sheets. Although these new founded QSPE's were rated by rating agencies (Moody's, Fitch, S&P among the few) prior to the issuance of securities, the underlying ratings failed to capture the actual economic value of the underlying collateral. Furthermore, the ratings established by the rating agencies are an assurance of performance.
One of the quandaries of running a subscription service is that when you have some really juicy stuff, you inherently limit the audience that you are able to reach. Normally, this isn't that big a deal. When you believe that there is a mass cover up aiming to prop up the largest cadre of zombie, insolvent companies in modern history it becomes a much bigger deal. This leads me to distribute a significant amount of research for free. On that note, I have been following the breadcrumb trail of hidden (or more aptly put, concealed) corporate liabilities, and it has led me to (of all places) off the balance sheet of the big banks. I have spent a lot of time concentrating on exactly where the losses, if any, will come from in these banks. We have already established that the smaller banks had, have and will totally drain the FDIC's insurance fund over a year and a half ago (see As I see it, 32 commercial banks and thrifts may see the feces hit the fan blades Friday, 23 May 2008, notice how many of the banks have went under since then) in the post "I'm going to try not to say I told you so...
I would also like to add that I have raised the flag on this regional bank/commercial real estate issue many months before the sell side and the main stream media said a peep. This is not to brag or boast, for I am a fundamental investor and the market has definitively ignored the fundamentals for 7 months running. The point that I am trying to convey is that analysts in the big sell side banks work for their trading desks, underwriting and sales departments, and not for the investor (be it retail or institutional). Thus, proclamations of "Buy! Buy! Buy!" do not necessarily mean we have entered into a fundamentally firm area in which to buy stocks, bonds or any other risky assets covered by these guys. For a sterling example, see "The sell side is pushing with all of their might to inflate the market...".
As a matter of fact, I have also focused on those very same brokerages, banks, insurers and REITs that went bust, starting as far back as 2007, again before it was fashionable to do so (see Is this the Breaking of the Bear? January 2008, GGP and the type of investigative analysis you will not get from your brokerage house November 2007 to December 2008, A Super Scary Halloween Tale of 104 Basis Points Pt I & II, by Reggie Middleton circa November 2007, etc.)
Now, that everyone feels the coast is clear and we will be entering a new bull market amid a broad economic recovery sprouting green shoots all over the place, I am intent on quantifying what remaining risks there are - if there are any remaining risks I am also in the process of fine tuning the market neutral strategy that can produce profits up until and through the period that these banks bring the market and economy back down (see Option Strategy Analysis Update for the strategy analysis and their performance thus far).
For those that believe mark to market rules are useless (I know they make it hard to goose your share price in a deflationary market, see "Charting the Truth"), I bring you the collapse of a bank last week that wasn't even on the FDIC's troubled bank list. To add misty eyes to
misery, the mis-marking of the banks assets will cost the FDIC nearly a billion dollars. That's a lot for a bank that wasn't even on the watch list. If the banks were forced to carry assets at market value, REAL market value, these little surprises will not be allowed to sneak up. Investors, regulators, bloggers, etc. will be able to see them coming a mile away - or at least they should. Alas, I am able to see them anyway. Is it because I am hyper-intelligent, possessive of meta-human powers, or employ an army of elfin dwarves to hide in the boardroom duct vents to eavesdrop on the board meetings? No, its none of those. Its because I PAY ATTENTION, and odn't have any conflicts of interests and axes to grind that color my observations and analysis.
Subscribers should keep this in mind when reading about this big bank that has written a bunch (more than a quarter of its tangible equity) in naked, unhedged credit default and total return swaps - see "And the next AIG is....". Knowing what they have acquired as of late, and what their subsidiaires have been trying to unload, there is no telling what the hell the quality of the underlying is. One thing is for sure, it is probably not very pristine!
Before we move on to the Blooberg article that sparked this blog post, let's excerpt some key snippets from the latest FDIC memorandum to its Board of Directors. It is written in the coded language of regulator-ese, but I will translate for you in red font:
1. The FDIC not impose additional special assessments in 2009. Because we have hit them pretty hard already and they are already broker than we are!
2. The FDIC maintain assessment rates at their current levels through the end of 2010 and immediately adopt a uniform 3 basis point increase in assessment rates effective January 1, 2011.
3. In October 2008, the Board adopted a Restoration Plan to return the Deposit Insurance Fund (DIF or the Fund) to its statutorily mandated minimum reserve ratio of 1.15 percent within five years. In February 2009, given the extraordinary circumstances facing the banking industry, the Board amended its Restoration Plan to allow the Fund seven years to return to 1.15% percent. We're in trouble and need more time. We will crush an already insolvent banking system (despite the proclamations to the contrary by the government and bank management) if we attempt to return the fund to a prudent level in less than 7 years. Its getting worse quickly even as the bank stocks skyrocket over 100% - just a few months ago we throught we could do it in 5 years.
Pursuant to these requirements, staff estimates that both the Fund balance and the reserve ratio as of September 30, 2009, will be negative. This is techincially and effectively insolvent! This reflects, in part, an increase in provisioning for anticipated failures. In contrast, cash and marketable securities available to resolve failed institutions remain positive.
Staff has also projected the Fund balance and reserve ratio for each quarter over the next several years using the most recently available information on expected failures and loss rates and statistical analyses of trends in CAMELS downgrades, failure rates and loss rates. Staff projects that, over the period 2009 through 2013, the Fund could incur approximately $100 billion in failure costs. Staff projects that most of these costs will occur in 2009 and 2010. Approximately $25 billion of the $100 billion amount has already been incurred in failure costs so far in 2009. Staff projects that most of these costs will occur in 2009 and 2010. So, only 25% into this mess by the FDIC's own calculations, and they are already negative and insolvent. They believe the worst is yet to come (versus Bernanke, Paulson and Geithner saying the worst is behind us), and that worse will come rather quickly. To make things worse, as you read the article excerpted below, the FDIC doesn't even seem to have a firm graps on the risks, as they were blindsided by a nearly billion dollar failure that wasn't even on thier problem bank list, and this was last Friday! You all know who has been the most bearish on the financial sector through all of this.
If the Board imposes no further special assessments and leaves existing risk-based assessment rates in place, staff projects that the Fund balance would become significantly negative in 2010 and may remain negative until 2013. According to these projections the reserve ratio would not return to the statutorily mandated minimum reserve ratio of 1.15 percent until late 2018. 'Nuff said!
The projections in the preceding paragraphs address the effect of projected failures on the Fund balance (its net worth, which is assets minus liabilities), not the cash balance of the Fund, which provides needed liquidity. Staff has also estimated the FDIC’s need for cash to pay for projected failures. At the beginning of this crisis, in June 2008, total assets held by the DIF were approximately $55 billion, and consisted almost entirely of cash and marketable securities (i.e., liquid assets). As the crisis has unfolded, the liquid assets of the DIF have been used to protect depositors of failed institutions and have been exchanged for less liquid claims against the assets in failed institutions. As of June 30, 2009, while total assets of the DIF had increased to almost $65 billion, cash and marketable securities had fallen to about $22 billion. The pace of resolutions continues to put downward pressure on cash balances. While the less liquid assets in the DIF have value that will eventually be converted to cash when sold, the FDIC’s immediate need is for more liquid assets to fund near-term failures. Translation: We were forced to accept the trash assets from the fail banks that we could not convince the private sector to accept, as we mean (by using the term "less liquid claims") that these assets are effectively unmarketable, and must be traded at an extreme discount which renders them for all intents and purposes of the fund, effectively worthless in comparison.
Staff ‘s projections take into account recent trends in resolution methodologies, such as the increasing use of loss sharing—especially for larger institutions—which reduce the FDIC’s immediate cash outlays, and the anticipated pace at which assets obtained from failed institutions can be sold. If the FDIC took no action under its existing authority to increase its liquidity, the FDIC’s projected liquidity needs would exceed its liquid assets on hand beginning in the first quarter of 2010. Through 2010 and 2011, liquidity needs could significantly exceed liquid assets on hand. So, not only are we balance sheet insolvent, we will be cash flow insolvent within one quarter.
Imposing an additional special assessment as provided for in the May 2009 final rule would bring in approximately $5.5 billion in revenue to the Fund; imposing two (one at the end of September, one at the end of December) would bring in approximately $11 billion in revenue. Given staff’s projections, neither amount would prevent the Fund from becoming significantly negative or prevent the Fund’s liquidity needs from exceeding its liquid assets on hand in 2010. Even combining these special assessments with higher risk-based assessment rates would not solve these problems, unless rates were set very high or more was collected in special assessments. Furthermore, any additional special assessment or immediate, large increase in assessment rates would impose a burden on an industry that is struggling to maintain positive earnings overall. Translation: Damn, even if we hit the banks at the continuing rate that we have already elevated the special charges to, we are still insolvent. No matter if hit them much harder, insolvent we will still be. The only way out of this is the same accounting game that the banks pulled. Hopefully, we will be able to fool somebody. See below.
An alternative—borrowing from the Treasury or the Federal Financing Bank (FFB)— would also increase the liquid assets available to fund future resolutions but would not increase the Fund balance as there would be a corresponding liability recorded. Hey, wait a minute here. How is this any different from asking the banks to prepay thier insurace premiums. In the prepay scenario, there will be an increase in cash (an asset) as well as an associated liability (unearned insurance premiums). Do the FDIC folk believe me to be as dense as some of those bank investors that really believe that banking industry is solvent. I posit this query to all interested pundits: how can the banking industry be solvent if the banking industry insurance fund is insolvent, and by thier very own admission, very insolvent!??!!?!?!?!?!?!?!?
Staff projects that failures will peak in 2009 and 2010 and that industry earnings will have recovered sufficiently by 2011 to absorb a 3 basis point increase in deposit insurance assessments. Adopting a uniform increase in assessment rates of 3 basis points now, effective January 1, 2011, should ensure that the prepaid assessments would address current liquidity needs without materially impairing the capital or earnings of insured institutions. Advance adoption of the rate increase also should help institutions plan for future assessment expenses. So, whatcha sayin' is that we all know the banks are playing accounting games, we will just go along and play the games with them. Fu$% the economic earnings and cash, as long as we don't harm the accounting earnings, all will be fine. The problem with this is economic earnings actually mean cash and real capital. Accounting game or not, if you hit an insolvent bank hard for cash, it will give it to you and maybe even be able to gloss it over with pretty accounting tricks to make it look like its making some money, but in the end all you will be doing is using that money that you took from the bank to eventually take IT over. Garbage in, garbage out - old school programming! There is more, but I am sure you've got the message by now. Now, on to the article of the day...
Oct. 1 (Bloomberg) -- There was a stunning omission from the government’s latest list of “problem” banks, which ran to 416 lenders, a 15-year high, as of June 30. One outfit not on the list was Georgian Bank, the second-largest Atlanta-based bank, which supposedly had plenty of capital.
It failed last week.
The other shoe is dropping on the banking industry, and market reaction seems muted. This is interesting, for the demands of cash, deviations from expected returns (the technical definition or risk) and murkiness in realistic valuation of assets and liabilities are all converging to a point that bank insiders fear to tread.
First we will go through yesterdays news, then prance through some BoomBustBlog.com exclusives in a separate post...
For those that need a quick giggle, or a basic walk through of the basics, I bring you Street Cred - the tutorial. You can use the controls in the right pane to navigate at will. Feel free to pass it around. The links below are the blog posts that substanstiate the "tutorial". I will be releasing some juicy stuff on Wells Fargo a little later on.
Relevant links of interest:
- The Fed Believes Secrecy is in Our Best Interests. Here are Some of the Secrets
- Why Doesn't the Media Take a Truly Independent, Unbiased Look at the Big Banks in the US?
- As the markets climb on top of one big, incestuous pool of concentrated risk...
- Any objective review shows that the big banks are simply too big for the safety of this country
- The ARE trying to kick the bad mortgages down the road, here's proof!
- Why hasn't anybody questioned those rosy stress test results now that the facts have played out?
- A Must Read: An Independent Look into JP Morgan. This contains the "public preview" document (JPM Public Excerpt of Forensic Analysis Subscription), which is free to download.
The credit bust will be long lasting, and will harshly effect companies without strong business models - which is a lot more companies than many think due to the fact that a credit bubble has kept so many on life support. See Marginal companies with marginal business models are going to crack for my take on this.
Last month's BIS Annual Report states "Aggregate statistics show a sharp slowdown in the growth of credit to the private sector starting late in the first stage of the crisis." The delay in credit restriction was misleading to many and masks the full effect or credit restriction. The time lag stemmed from 1) forced balance sheet expansion due to off-balance sheet vehicle re-intermediation; 2) draw down of existing credit lines at favorable conditions by borrowers (these favorable conditions, and as a matter of fact the actual credit lines, are no longer availabe). The mounting and prospective losses that I have detailed in The Re-Release of the Open Source Mortgage Default Model and Green Shoots are Being Fertilized by Brown Turds in the Mortgage Markets outline (just in residential real estate lending, notwithstanding all other classes of lending) just how much more restrictive credit can get.
In following the CIT story in the media, I really wonder what makes anyone feel as if this company was actually rescued. It burned through 2.3 billion US dollars of federal bailout money in less than two quarters, is taking a $1.5 billion loss this quarter, has $10 billion of debt coming due, both the macro conditions that spawned its problems and its credit portfolio are still deteriorating. It then gets emergency financing from existing bondholders of $3 billion (which it is subsequently losing in real time due to operating and credit losses as well as near term debt rollover). To add misery to pain, the debt financing is at more than 25 times LIBOR, where the debt it is replacing is barely LIBOR plus a few basis points. Give a man dying of alcohol poisoning a shot of overproof rum and consider him saved!!! So, the company doesn't file for bankruptcy this month, but will be forced to file next month, and will have that much more debt to default on.
Pacific Investment Management Co., Centerbridge Partners LP and the four other bondholders that put up $2 billion in financing for CIT Group Inc. made an instant $100 million on an investment analysts say is almost risk free.
CIT, the 101-year-old commercial lender struggling to retire $1 billion of debt maturing next month, agreed to pay a 5 percent fee to the creditors and annual interest of at least 13 percent. On top of that, the New York-based company pledged assets worth more than five times the amount of the loan as collateral.
"The terms are egregious," said Dwayne Moyers, the chief investment officer at Fort Worth, Texas-based SMH Capital Advisors, which oversees $1.4 billion, including more than $70 million of CIT bonds. "They ripped the faces off everyone with these terms." Ripped the faces off???!!! What??? This is anus expansion to the nth Degree!
Do dogs have fleas? Do floozies jump bed linen? Finally, Do Wall Street banks that own data providers and a monopoly on CDS data have unfair access to said data?
July 14 (Bloomberg) -- The U.S. Justice Department is investigating the market for credit-default swaps, according to Markit Group Ltd., the data provider majority-owned by Wall Street's largest banks.
... The antitrust division sent civil investigative notices this month to banks that own London-based Markit to determine if they have unfair access to price information, according to three people familiar with the matter. U.S. lawmakers plan to regulate the $592 trillion over-the-counter derivatives market, which includes credit-default swaps blamed for helping worsen the biggest financial calamity since the Great Depression.