Pondering 2H 2011 Bank Earnings
Institutional Risk Analyst
September 21, 2011
This week in the Institutional Risk Analyst, we do a short rant on the 2H 2011 outlook for financials and ask whether further deflation does not mean a mixed road ahead for some banks. To review, let's look at the Bank Stress Index (BSI) for the past several years in the box below. You can look up the rating for your bank on our retail web site, www.irabankratings.com.
Bank Stress Index |
Q2 2011 |
Q1 2011 |
Q4 2010 |
Q4 2009 |
Q4 2008 |
Q4 2007 |
Q4 1995 |
|
1.7 |
1.7 |
2.5 |
21.5 |
1.7 |
1.1 |
1 |
ROE |
2.5 |
2.4 |
5 |
100 |
3.3 |
1.4 |
1 |
Loan Defaults |
3.2 |
3.4 |
4.5 |
4.4 |
2.2 |
1.1 |
1 |
Capital |
0.8 |
0.8 |
0.8 |
0.9 |
1 |
1 |
1 |
Lending Capacity |
0.9 |
0.9 |
0.9 |
1 |
1 |
1.2 |
1 |
Efficiency |
1.1 |
1.1 |
1.1 |
1.2 |
1.2 |
1.1 |
1 |
Source: FDIC/The IRA Bank Monitor
We are barely two years removed from the Q4 2009 BSI score of 21.5 for the entire industry. Note especially the maxed-out 100 BSI score for ROE in that period as provisions expense peaked. That means that the stress on equity returns at the end of 2009 was two orders of magnitude above the stress level seen in 1995, the benchmark year for the BSI. And of course we changed the accounting rules as well at the end of 2009, thus the lower BSI scores in 2010.
Eric Dash of the NYT recently did a set up for Q3 2011 bank earnings and rightly focused on trading revenues, an important source of overall revenue for the large caps. But we have been following the carnage on the operations side, particularly the big retail houses. Look at the old Pru retail network convulsing with changes put in place by the enlightened managers at Wells Fargo ("WFC"/Q2 2011 Stress Rating: "A"). An exodus of talent and assets portends, but where will they go? UBS? Not this week.
Over at Morgan Stanley ("MS"/Q2 2011 Stress Rating: "A"), we read press reports of similar carnage, although in this case warfare between factions of investment bankers. To us, looking at MS, the big issue is the continuing indigestion of SmithBarney. At SB, like the old Pru retail business, the rules have just been changed by management seeking cost savings from every corner of the company. We have stated in The IRA Advisory Service and say again, watch for MS to spin its retail unit into a separate business. And MS will not be the only bulge firm following this example of accretive deconstruction.
All of the body language we see coming from operations and risk managers suggests a very lean 2H 2011 in terms of revenue and profits, in large part due to uncertainty about the US economy. The latest tax code gambit by Barack Obama to gain traction for the 2012 election has again thrown investors into uncertainty as to the rules of the game. Even as the White House has intensified its inaction regarding housing, resulting in the FOMC decision to twist longer duration Treasury debt, signs of growing deflation and dislocation abound. Does anyone at 1600 Penn notice?
People debate whether Barack Obama is Herbert Hoover or FDR, but in fact he is a little of both. President Hoover knew he had a problem, but believed the markets would correct themselves. In practical terms, Hoover's inaction is a good analog for the "do nothing" policy crafted by Larry Summers and Tim Geithner, and adopted by Obama.
Hoover created the Reconstruction Finance Corp in anticipation of some type of governmental action, but failed to use it effectively. Yet Hoover in his memoir pins the blame for the catastrophe from 1932 onward squarely on FDR, particularly on his attacks on business and attempts to forcibly regiment American society. These efforts, Hoover believed, drove the sharp drop in private capital invested in the US economy.
Obama, via his health care reform, soaring deficits and other clumsy policy initiatives, has eroded business confidence, one of the chief drivers of employment. The Sumer of 2011 budget fiasco was a bi-partisan achievement and not unlike FDR's deliberate fomenting of the banking collapse of early 1932. Hoover himself would confirm that when FDR famously said "we have nothing to fear but fear itself," he was exploiting fear he helped to exacerbate when banks closed from Detroit to New York.
Add to the bank earnings calculus uncertainty created by three years of Barack Obama the ongoing saga of the Eurozone, where the incompetence of the politicians is only exceeded by that of the central bankers. The ECB has consistently mismanaged its intervention in the bond markets, recently paying in the 80s for long-dated Italy bonds when the cash market is in the 30s. This sort of infantile tactical management of open market operations actually adds to market volatility.
In a recent post on Reuters.com, our friend Achim Duebel asked whether anyone understands "how distortive and damaging are the ECB interventions into periphery debt at 80 or 90 cents? The ECB bought Greek debt at those levels a year ago - average portfolio cost is estimated at 70-80 cents, where market prices are now 30 cents. Why are market prices now at 30 cents? Because the ECB had to stop buying. After looking into the abyss of Greek default, the ECB simply ran away."
"Now they are doing the same with Italian debt as they did with Greece, and of course the ECB will run away again," Duebel adds. "With the banks the intervention levels were far too high (haircuts too low), with the worst example of all being Ireland. In all these cases, ECB became an obstructionist force against restructuring, i.e. solving the problem."
We look for 2H 2011 to be eventful in a number of different ways, but it terms of the performance of the US banking sector we still have a long way to go before we again see in larger banks the sort of operational stability seen in 1995, the benchmark year for our bank index. The major factors affecting bank performance are largely economic as always, but the market value of the liquid, large-cap financials will be buffeted by the macro see-saw between the US and EU. We just hope that our BSI is not rising again by the close of 2011.
(c) Institutional Risk Analyst
www.institutionalriskanalytics.com
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