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.
Now that the Robo-Signing scandals have achieved full notoriety through the media, it is time to address the real issues facing investors in bank stocks. We also believe that the media is staring at the wrong target. Each major media outlet is copying what is popular or what the next outlet broke as a story versus where the true economic risks actually lie - which is essentially the real story and where the meat actually is. This is what is truly at stake - the United States is now at risk of losing its hegemony of the financial capital of the world! Why? Because when we had the chance to put the injured banks to sleep and redirect resources to into new productivity, we instead allowed politics to shovel tax payer capital into zombie institutions as they turned around and paid it right back out as bonuses. As a result, significant capital has been destroyed, the original problem has metastized, and the banks are still in zombie status, but with share prices that are multiples of the actual values of the entities that they allegedly represent - a perfect storm for a market crash that will make 2008 look like a bull rally! For those who feel I am being sensationalist, I refer you to my track record in making such claims.
The Japanese tried to hide massive NPAs in its banking system after a credit fueled bubble burst by sweeping them under a rug for political reasons. Here's a newsflash - it didn't work, it hasn't worked for 20 years, and despite that Japan is embarking on QE v3.3 because it simply doesn't believe that it is not working. Here are the steps the US is consciously taking it its bid to enter a 20 year deflationary spiral like Japan, and may I add that these steps were clearly delineated on BoomBustBlog ONE YEAR ago (Bad CRE, Rotten Home Loans, and the End of US Banking Prominence? Thursday, November 12th, 2009), so no one can say this is a surprise.
Step one: Hide the Truth!
Is it possible for the US Government to choose to forgive mortgage debt? Sounds outrageous? Read on for the legal theory behind this claim and let me know what you think? I thought it was little esoteric as well, but as I looked deeper... Well, I'll let you be the judge.
A lot of attention accrued to Representative Grayson's calling out of foreclosure fraud, and for good reason. The story is absolutely amazing, and kudos to a member of congress that defends his constituency.
It's not as if other entities have failed to take notice. ZeroHedge has its usual witty commentary regarding the possibility of foreclosure transactions potentially being unwound due to fraudulent foreclosure activity. The NYT ran an article stating that Fitch will look into lowering the credit rating of companies that participated in the submission of inappropriate foreclosure paperwork, which apparently seems to include an awful lot of companies. It goes on to state (as excerpted by Zerohedge):
Fitch Ratings said that Wednesday it was asking mortgage companies about their internal processes for executing foreclosure affidavits. If it finds the processes lacking, Fitch will consider downgrading the company’s rating.
The agency also said if the issue is widespread, the resulting delays and extra costs to foreclose could increase losses related to residential mortgage-backed securities.
Here's the twist. A lawyer who happens to have followed my writings over the years has suggested that most are missing the big picture in focusing on fraudulent foreclosure documents. He contends (and I'm paraphrasing here, these are not my words, per se) "that since the U.S. has ownership interest in many (if not most) delinquent and distressed mortgages, this fact will be counted as policy in litigation. As a consequence it matters A LOT if you can say that your client has a Fifth Amendment Due Process right (or third party beneficiary Federal common law right) to a HAMP modification which is in FACT a minimization of the risk of default (not that flaky 31% number) BECAUSE, among other things, the U.S. has no economic incentive to foreclose". Now, I am no lawyer and thus the legal issues are beyond my domain, but I must admit I found the theory interesting. So, I've decided to crowdsource this one in anticipation that some of the more astute legal minds can shed some light on the validity of the theory. I'll supply the financial stuff in this post, and I'll rely on the legal eagles to peer review the theory.
I've been harping on banks a lot lately, so why give up a good thing. Next up, we have a "how to" manual for JP Morgan private bank salespersons to assist wealthy executives in insider trading and the liquidation and/or monetization of restricted stock. You see, this gets sticky because it very well may be against the law to put a hedging position on your restricted stock portfolio based upon non-public information. As a matter of fact, I'm pretty sure it is against the law. This is how JP Morgan presents it...
Much of the mainstream media has carried articles that were at least somewhat skeptical of the European bank stress tests. I think being "somewhat skeptical" is about 5 leagues below where they should be, but its a start. After all, the EU actually passed a bank that is literally insolvent. I don't want to pound on the actual insolvency of this German bank, since I already went into detail on this topic earlier, but it is imperative that my readers understand the depth and extent of the travesty (or lies) that are being promulgated in the name of "transparency". I ridiculed the basis of these stress tests last week (European Bank Investors, Don’t Look Now – You’ve Been Hoodwinked, BamBoozled…), but now it is time to show you that these tests which assume the biggest threat to the European banking system (sovereign default or restructuring) will not occur and capriciously passes banks that not only will be hampered in the future, but are actually quite insolvent (by nearly any realistic means measurable) now, have actually proven that the risks of restructuring and/or haircuts are virtually guaranteed. This leaves the results of the stress tests a farce, at best and an insult to capitalism and common sense.
The tests assumed that there would not be a sovereign default. The tests also refused to mark "hold to maturity" inventory to market, despite the fact that said inventory may be permanently impaired. The logic? Europe will not allow a default. But how about a restructuring? And how will Europe handle more than one sovereign coming to the restructuring trough? I've already demonstrated the damage that can be done in A Comparison of Our Greek Bond Restructuring Analysis to that of Argentina.
Price of the bond that went under restructuring and was exchanged for the Par bond in 2005
Price of the bond that went under restructuring and was exchanged for the Discount bond
Personally, I consider the European bank stress tests to be a farce; an attempt to Bamboozle, Hoodwink and Dis-inform any who would be naive enough to drink the Kool-Aid - not to dissimilar from the US bank stress tests (see You’ve Been Bamboozled, Hoodwinked and Lied To! Here’s the Proof). CNBC reports that "NO" default scenarios will be played out, which I find to be rather unrealistic since the reasons why the banks are enjoying restricted access to the capital markets is the fear of default! Think long and hard about this...
You are showing signs of HIV, and nobody wants to come near you, make love to you or lend long term to you due to the symptoms of this most unpleasant and deadly disease despite the many proclamations you have made to the contrary. You decide to set the record straight by visiting a prominent doctor to diagnose your issues and placate your associates. The doctor comes up with a prognosis, but simultaneously declares that:
- AIDS (the syndrome), and death have not and will not be considered because the doctor will not let any of his patients catch AIDS or die! Whaaatt!!!??? Does the doctor really have that much control over who catches diseases and who dies? [Analogous to refusing to even consider the potential for default on sovereign debt, as if no European country has ever defaulted before - many have, and many probably will in the future as well). This analogy actually serves us quite well for the ECB has very limited control over who gets sick and how the contagions (both financial and economic) are transmitted (see below).
- The patient will be assumed to operate between 96% and 57.8% efficiency. This is, of course, a problem if the patient truly is terminally ill, for his health should receive significantly more of a.... Well, a haircut.
- Only the patient's mucous membranes and other very short-lived tissue will be considered for examination, for the patience plans on keeping other body parts for the long term, hence they should not be affected by fluctuations by any potential illness. Yes, I know this statement doesn't make any damn sense, but then again neither does the ECB excluding hold to maturity and portfolio inventory from the stress tests either. It really doesn't matter how long you plan on holding said items, if they are permanently impaired in value, then they are permanently impaired, Right???!!! I know, we won't even consider a default scenario, but since countries do default.. If a default occurs, or more realistically a restructuring, then wouldn't longer term inventory be impaired - Permanently???!!! In the post A Comparison of Our Greek Bond Restructuring Analysis to that of Argentina I demonstrated how much damage was done to the Argentinian bond holders after their restructuring. Too bad the Argentinian investors didn't have the all-powerful ECB there to declare that restructuring and default are not part of the rules, hence not allowed. The following is the price of the bond that went under restructuring and was exchanged for the Par
From Reuters, by way of CNBC:UK Economic Slump Deeper than Thought
Britain's record recession was just as deep as we conservatively estimated it using realistic metrics even deeper than previously thought, and the economy could still have contracted in the first quarter of this year were it not for hefty government spending, official data showed on Monday.
The Office for National Statistics left its earlier estimate of first-quarter growth unrevised at 0.3 percent, giving an unchanged annual decline of 0.2 percent.
Britain faces mixed prospects for the second quarter, after data released at the same time showed that services output contracted 0.3 percent in April, the biggest fall since January.
During the first quarter, the biggest rise in government spending since the fourth quarter 2008 added 0.4 percent to GDP growth, alongside a 0.9 percent contribution from gross capital formation, which helped offset a drag of 0.9 percent from net trade. Imports rose and exports fell in roughly equal measure.
The figures suggest a major rebound in British exports will be needed to maintain growth when planned government spending cuts take effect from later this year.
On Wednesday, May 26th, 2010 I released "A Comparison of Our Greek Bond Restructuring Analysis to that of Argentina" in which I explicitly outlined the restructuring of Greek debt using the Argentina experience as a template (I suggested that mixture of zero coupon bonds and explicit haircuts would be utilized to re-wrap debt). During that time, many analysts and government officials at the time (and even now) said that I was totally unrealistic in expecting a Greek default or explicit restructuring (reference Greek Crisis Is Over, Region Safe”, Prodi Says – I say Liar, Liar, Pants on Fire!). Well, fast forward about 60 days, and voila, guess what the hell is going on??? Zero coupon bonds! Haircuts! Where have we heard this before??? Thanks and hat tip to BoomBustBlogger Shaunsnoll, "It’s no secret: Greece is restructuring debt" (via FT.com)
...consider the cost of sending lawyers and consultants – you could call them spies – to hang around Brussels and Frankfurt to assess the risk of a Greek default.
Yet simply by looking “on internet”, you could find out that Greece has already started to restructure its state debts. Look at the site for the Hellenic Association of Pharmaceutical Companies (www.sfee.gr), and you will find a link to a joint press release by the Greek Ministry of Health and Social Welfare and the Ministry of Finance. On June 9, unnoticed by most in the financial world, they stated: “The [Greek state hospital system] debts of 2007, 2008, 2009 amounting to €5.36bn [£4.4bn, $6.7bn] will be settled with zero coupon bonds.” The hospital debts lingering from 2007 will be paid with two-year zeros, 2008 with three-year zeros, and 2009 with four-year zeros.
There is some, actually a lot, of detail missing from the one page release, which presumably will be filled in by the legislation that will be introduced, and probably passed, to implement the restructuring. The release does say: “It is certain that the banks co-operating with the suppliers will show interest in prepaying these bonds, transforming the corporate risk undertaken on behalf of their customers – hospital suppliers – in credit risk against the Greek state, in the form of a bond which can be financed through ECB.” And, according to the release: “In case suppliers settle these bonds by January 2, 2011 . . . the above ‘discounts’ corresponds to a total percentage of about 19 per cent.”
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
From CNBC.com: Europe Double-Dip May Bring Correction: Roubini
Economic woes in Europe could spread to the U.S. and lead to a further correction in stock prices, Nouriel Roubini, chairman of Roubini Global Economics, told CNBC on Monday.
Hey, but wasn't I saying that since January of this year??!! Remember back February when the media and the sell side analysts said the Greek problems were soon to be solved and this definitely was not a "European" problem but rather a localized one?
BoomBustBlog, February 7, 2010: The Coming Pan-European Sovereign Debt Crisis – introduces the crisis and identified it as a pan-European problem, not a in localized one.
Sovereign Risk Alpha: The Banks Are Bigger Than Many of the Sovereigns
This is just a sampling of individual banks whose assets dwarf the GDP of the nations in which they’re domiciled. To make matters even worse, leverage is rampant in Europe, even after the debacle which we are trying to get through has shown the risks of such an approach. A sudden deleveraging can wreak havoc upon these economies. Keep in mind that on an aggregate basis, these banks are even more of a force to be reckoned with. I have identified Greek banks with adjusted leverage of nearly 90x whose assets are nearly 30% of the Greek GDP, and that is without factoring the inevitable run on the bank that they are probably experiencing. Throw in the hidden NPAs that I cannot discern from my desk in NY, and you have a bank that has problems, levered into a country that has even more problems.
Bloomberg has as a headline today: Stress Tests on European Banks Must Assess Sovereign Risks, EU Draft Shows. Duhhh! As if we should really ignore the biggest threat to the solvency of the the European banking system in a so-called "stress test". What is this, Geithner "lite"? Reference How Greece Killed Its Banks! to see exactly how much damage those who wish to ignore sovereign risks are trying to hide...