Thursday, April 11, 2013 - Banks Behaving Badly

Banks Behaving Badly

by Sinclair Noe

DOW + 62 = 14,865
SPX + 5 = 1593
NAS + 2 = 3300
10 YR YLD - .01 = 1.79%
OIL – 1.15 = 93.49
GOLD + 1.70 = 1562.00
SILV + .01 = 27.76

The markets went up today because the market has been moving higher. Nothing in the news to derail the trend. Jobless claims fell far more than expected in the latest week, dropping to the lower end of the range for the year. Retail executives forecast improved same-store sales in April after mixed results in March. Other economic data showed import prices slipped 0.5 percent last month, in line with expectations, while export prices fell 0.4 percent, signaling inflation pressure remained tepid and would allow the Federal Reserve to continue with its current monetary policy. Most of the shorts in the market have been pummeled already; if you're waiting for a pullback, you've probably run out of patience. The trend is up; at least for now.

And we are in earnings season. I'm waiting for the big banks to post results. Right now the banks are generally trading below book. Citigroup trades at about 14 percent less than tangible book value,and Bank of America trades at a 7 percent discount to book value. JPMorgan, the biggest US bank by assets, and Goldman Sachs, the fifth-biggest, trade for 28 percent and 9 percent more than tangible book value, respectively. One of the concerns is that the banks still hold toxic assets on their books, and since counterparties don't know if they can trust those assets, the banks aren't receiving full valuation.

New legislation to impose higher capital rules on the largest banks, such as the proposal from Senators Sherrod Brown and David Vitter could possibly trigger a break-up of the largest lenders; however, it doesn't look like that legislation will go far. But, even if the politicians can't figure out a way to break up the big banks, the market might.

Analysts at Wells Fargo say shareholders should be demanding the big banks get broken down. “Given the challenges posed by increasing regulation, higher capital requirements, and well-publicized trading/market challenges, it’s not surprising that investors remain reluctant to assign a ‘full’ valuation to the universal banks,” the analysts wrote. “If regulators and/or legislators don’t demand it, shareholders could also intensify demands to ‘break up the banks.’ ”

The report says that if the banks are broken up, Citigroup should get a 24 percent premium, JPMorgan should get 69 percent and Goldman Sachs should be valued at 19 percent more than tangible book. Apparently the parts are worth more than the sum of the parts.

Of course, this is working on the idea that the banks won't implode first, due to their own bad behavior. The New York Times reports the big banks have been shedding risky assets to show regulators that they are not as vulnerable as they were during the financial crisis. In some cases, however, the assets don’t actually move — the bank just shifts the risk to another institution.

“This trading sleight of hand has been around Wall Street for a while. But as regulators press for banks to be safer, demand for these maneuvers — known as capital relief trades or regulatory capital trades — has been growing, especially in Europe.”

Apparently the Eurobanks are so large relative to GDP that their governments can’t credibly backstop the banking system so the banks are getting equity booster shots from hedge funds and pension funds:

Rather than selling the assets, potentially at a loss, the banks transfer a slice of the risk associated with the assets, usually loans. The buyers are typically hedge funds, whose investors are often pensions that manage the life savings of schoolteachers and city workers. The buyers agree to cover a percentage of losses on these assets for a fee, sometimes 15 percent a year or more.

The loans then look less worrisome — at least to the bank and its regulator. As a result, the bank does not need to hold as much capital, potentially improving profitability. Apparently, this move satisfies regulators, but it really doesn't change the risk, it just moves it around; it slices and dices the risk; it turns apples into applesauce, but it doesn't eliminate the risk. And if the assets default, then all the derivatives written to protect against risk, will become the most risky assets around. Unraveling these derivatives if there is a default is something like trying to make apples of the applesauce.

We frequently talk about the bad behavior of the big banks, but many of the smaller banks have been misbehaving as well. A government watchdog says that 137 community banks used $2.1 billion from a special fund aimed at boosting lending to small businesses to repay their bailouts from the financial crisis.

A report issued Tuesday by the special inspector general for the Troubled Asset Relief Program says the bailed-out community banks didn't step up their loans to small business nearly as much as other small banks that weren't rescued. Some banks that used the small-business lending fund to repay bailouts didn't increase lending at all, while others increased loans to small business by 25 cents for every $1 from the fund.

Congress created the small-business lending fund in 2010 to encourage banks with less than $10 billion in assets to expand their lending to small businesses. At a time of economic distress, the aim was to help small businesses get capital that had become difficult for them to obtain. The loan program charged the community banks lower interest rates if they used the money for loans to small businesses.

The Treasury Department was authorized to spend up to $30 billion on loans to small banks under the program. Only $4 billion was spent.. Of that, a total $2.7 billion went to the 137 bailed-out banks, which used $2.1 billion of it to repay the higher-interest rescue aid they had received from the government. For some small banks that received bailouts under the Troubled Asset Relief Program, the small-business lending fund "turned out to be little more than a TARP exit strategy," Romero said in a statement.

The law creating the special fund allowed banks to use money from that program to repay their bailouts. By repaying TARP funds, banks were able to escape limits on executive compensation and other restrictions.

We've talked recently about the Office of the Comptroller of the Currency, the OCC, and the Federal Reserve had conducted a review of abusive foreclosure practices by the big banks, and they were starting to send out checks to abused homeowners; a few checks for as much as $125,000, but the vast majority of checks for less than $300. The regulators conducted a case by case review of foreclosure abuses; well, not exactly. The regulators allowed the bank to hire private consultants to conduct the reviews, but it turned out to be too much work, so after a while they just threw up their hands and quit, even though they got paid $2 billion dollars to conduct the reviews. And the regulators just told the banks to pay some money; $3.6 billion to 4.4 million homeowners; without admitting wrongdoing, of course.

So, today, the regulators were on Capitol Hill to explain their actions, which were pretty much inexplicable. Among the inexplicable actions in the foreclosure abuse investigation is why the regulators did not immediately turn over case records of borrowers who maybe considering private legal action against the banks. It almost sounds as if the regulators were obstructing justice; actually, that's exactly what it sounds like – a specific decision to protect the banks but not to help the families who were illegally foreclosed on.