When it comes to bank earnings, so far so good. Now it's about the Treasury stress tests of the 19 banks.
And that ain't so good.
The markets got a look at profit figures and expectations from a number of big banks and companies this past week.
Wells Fargo says it expects a first quarter profit, JPMorgan Chase as usual didn't disappoint with decent earnings, and the beleaguered Citigroup's losses came in better than expected (chief executive Vikram Pandit is not getting the kudos he deserves for rightsizing Citi's ocean liner of debt and bad bonds).
And 'trades like a financial' General Electric's earnings for the first quarter were largely in line with analysts' expectations-even though a peek inside the biggest driver of the industrial conglomerate's profits, the black box that is GE Capital, shows a massive can of snakes, and also reveals that all of this finance unit's $1.1 bn in profit for the quarter came from a tax benefit of $1.2 bn (GE is not being stress tested).
But the stress tests of the 19 banks could result in the government yet again parking its ambulance in front of yet another bank with bags of more taxpayer money--or it may orchestrate another shotgun wedding, because it has said no bank will be allowed to go bankrupt.
And still the bank bailout meter ticks, as the government races to make the banks whole and not taxpayers, as the government has avoided a run on deposits with instead a run on taxpayers.
But a growing number of banks who took TARP money want to give that money back. Goldman Sachs is moving to raise $5 bn in common equity to pay back half of its $10 bn taxpayer loan. Wells Fargo, Bank of America, BB&T, all have indicated they want to pay back their TARP money.
However, not to sound too contrarian, and thinking this through--is that a good move? Why do I ask? Read on.
The White House Says "Ahead of Schedule"
It was also a week in which President Barack Obama marked the 2,000thtransportation project to be approved under his $787 bn economic relief package.
The government effort is "coming in ahead of schedule and under budget," the president announced.
But given that we are just 85 days into the presidency of Barack Obama, the question might rightly be asked:
Who did the president hire on this project? Edward Scissorhands? The Road Runner?
And isn't the president only talking about projects that have been approved, with shovels yet to break ground?
Stress Testing, One, Two, Three...19
In similar fashion, the markets seem to be expressing such Audacity of Hope when it comes to the stress tests of the 19 banks.
However, this is where the markets could really hit choppy seas.
Fears that the government would nationalize the banks after the Treasury announced its stress test plan in February drove the Dow Jones Industrial Average to a demonic 666 intraday low on March 6 (as economist Ed Yardeni tongue in cheek has noted) and to a dreadful close on March 9.
Fears that the banks would be run by a government that wouldn't think twice about upending contracts and siccing the IRS on banker bonuses--and anyone they do business with--sent the markets into a tailspin.
Which Banks and Companies are Getting Stress-Tested?
JPMorgan Chase, Citigroup, Bank of America, Wells Fargo, Goldman Sachs, Morgan Stanley, MetLife, PNC Financial, US Bancorp, Bank of New York Mellon, GMAC, SunTrust, State Street, Capital One Financial, BB&T, Regions Financial, American Express, Fifth Third Bancorp, and KeyCorp.
SunTrust, BB&T, Regions Financial, Fifth Third, KeyCorp, PNC Financial, US Bancorp, GMAC, all are being talked about as possible merger candidates--not that they will fail the stress test, because the government now says none of the banks will fail (given the way the automotive sector is headed, GMAC may be restructured through a bankruptcy as would one of its parents, GM--Cerberus, the vulture fund which owns Chrysler, owns 51% of GMAC).
How are They Being Tested?
About 200 bank examiners have taken to the banks on the list and are poring through their books right now.
The government is measuring their capital strength based on a number of different bad economic scenarios.
The baseline scenario assumes that GDP growth will be -2.1% in 2009 and 2% in 2010; that the unemployment rate will average 8.4% in 2009 and 8.8% in 2010; and that home prices will fall 14% in 2009 and 4% in 2010.
In another adverse scenario, the government assumes GDP growth will be -3.3% in 2009 and 0.5% in 2010; the unemployment rate is assumed to average 8.9% in 2009 and 10.3% in 2010; and home prices are assumed to fall 20% in 2009 and 7% in 2010.
Some results of the tests, intended to show whether major financial institutions need to raise more capital, are due to be released by the federal government on May 4th.
If a bank fails, it will have six months to raise capital. If they can't, they may get an infusion of taxpayer money. Or be subject to a government orchestrated shotgun wedding.
Colossal Juggling Act
The Treasury, Federal Reserve and FDIC will have a colossal juggling act next month, when it announces details of the stress tests. The size of the losses may be disclosed that's it. The balancing act is painfully difficult.
Government officials need to avoid a run on deposits.
They need to avoid a run on bank stocks.
And they need to avoid a run on the courts by plaintiffs attorneys itching to file lawsuits claiming failure to disclose material changes to a banks' profits, who could argue that not enough details were disclosed about the size of the losses.
The Great Disconnect
But there's a disconnect here---the anchors dragging down bank balance sheets will continue to sink bank earnings for some time to come.
The anchors still exist, even with the relaxation of the mark-to-market accounting rules, which effectively lets companies warehouse bad assets in the 'held to maturity' line item on the balance sheet, and not sock it to earnings.
Government officials have said they may need to spend another $2 tnon the bank bailout, a bailout that's looking more and more like Mr. Toad's Wild Ride.
Meaning, they believe there is a $2 tn hole still in the banks' books (at least).
But now the Treasury, the White House and the big banks are bruiting about that the banks are well capitalized.
What No One is Looking At
What measure is the government using to ascertain that a bank is well capitalized? There's Tier 1 capital ratios, that can include all sorts of junk in it like goodwill, which is basically the overpayment a company can make when it buys another company.
Also loaded in there are deferred tax assets, a sum which basically is a basket of losses that have built up, which a company can use to reduce the income taxes they owe to the IRS in future years--and in turn boost profits. But they have to report a profit to use that deferred tax asset, something that hasn't really been happening lately.
Or is the government using tangible common equity, a really tough gauge that strips out all sorts of junk and is basically a bank's net worth based on its hard assets?
By that measure "we'd all be insolvent," the chief financial officer of a major US bank tells me (now you know why the average tenure of a CFO is three years.)
Also, will there be a varsity capital reserve measurement used for bigger banks on the list, and a junior varsity gauge for the smaller ones?
Wells Fargo may need $50 bn in new capital due to writedowns, says Keefe Bruyette & Woods, which did its own stress test of the bank's balance sheet. Bank of America may need to raise tens of billions of dollars, too, other analysts note.
Has Your Head Exploded Yet?
I haven't written that subhed in a while. It makes me laugh.
Ok, $2 tn is about two-thirds of the tax revenue the federal government collects each year. A trillion is a thousand billion.
More of What Everyone is Ignoring
Morgan Stanley estimates that global wholesale banking revenues in 2010 will come in at about $220 bn.
However, the writedowns dwarf those sums. The IMF has figured that global credit losses from radioactive assets will amount to $4 tn. Banks worldwide to date have taken profit hits for about a quarter of those losses, or anywhere from $915 bn to $1.2 tn.
If you assume the $220 bn sales figure holds for years ahead, and using the $915 bn figure, the profit hits on the balance remaining equal 15 years of revenues.
We all know who we are talking about here. The 10 largest banks in the US hold three-fourths of the industry's assets, up from one-fourth 20 yrs ago, says Michael Mayo of Calyon Securities, whom many Wall Streeters believe to be the finest and sharpest bank analyst there is.
So, the name of the game then is to stall and delay writedowns for as long as possible.
Which means bank earnings could be hung up for some time to come.
Watch this: Other analysis from Tyler Durden at Zero Hedge (Durden is to be respected, he's a brilliant, formidable footnote digger) of Federal Reserve data shows that the banks have roughly $8.1 tn in loans and other assets, which include $5.3 tn in potential Kryptonite securities and other assets. Banks have written down only about $1.2 tn against these assets.
What Else is No One Paying Attention To?
And just take the Level 3 assets, the worst of the worst junk sitting on the balance sheets of the financials in the S&P 500.
Level 3 assets, which are mark-to-myth, totaled $537.4bn at the end of last year, or dangerously near the entire $598 bn market cap for the whole S&P financial sector at the end of 2008, economist Yardeni notes. Yardeni adds the government could have used the TARP program to buy the entire S&P 500 sector for $598bn.
And think about this: Enron-style off balance sheet vehicles house untold hundreds of billions of dollars in securitizations built on mortgages, auto loans, student loans, credit card receivables, you name it. Wells Fargo has about $105 bn in off balance sheet stuff. GE has at least $50 bn.
All of these assets and liabilities must be sluiced back onto the balance sheets for fiscal years starting after November 15 of this year, under new accounting rules.
Those sums will cause bank capital ratios to gyrate faster than a compass held over the North Pole.
Think the Treasury's trash removal plan to buy toxic assets will work?
My head really did just pop off my shoulders. It's flying down the hall, I have to go get it.
Keep Banks TARPed?
Best-selling author Michael Lewis, who wrote Liar's Poker, once said a conclusion is where the mind comes to rest. That might be true of letting the banks pay back their TARP money.
Should banks be allowed to pay back their TARP capital given that they are undercapitalized vis a vis the potential writedowns, and that their capital ratios must be boosted in order for lending to pick up?
And shouldn't moral hazard, desperately missing in all of this, be reintroduced here, meaning, the banks ought to be forced to hold onto this capital to pay taxpayers their dividends, meaning, interest on these TARP investments?
But here's the problem. Some banks didn't want the TARP money to begin with.
"If banks now claim they want to return the money because they don't need it, why do they have to raise new capital to replace the money from we the people in order to repay the government?" asks former Treasury secretary Paul O'Neill.
Mr. O'Neill rightly and smartly refers to a government rule that said in order to pay back TARP, banks had to do so via an equity raise. Which causes dilution of existing shareholders.
Turn Now to GE
GE Capital's tax benefit-driven first quarter profit hardly signals solid organic growth, and GE's infrastructure and industrial units are doing the heavy lifting. GE Capital's profits nosedived 58% and NBC Universal plunged 45% as a blisteringly bad advertising climate has torched all media companies, largely due to the cliff drop in ad spending as the automotive sector nears bankruptcy.
GE says its finance unit will still turn in $5 bn in profit this year, or a third of the parent's net income, down from 40% to 50% in prior years.
Though the Treasury is not stress-testing it, GE did do its own internal stress test based on various measures and came up with $18 bn in companywide losses.
Worth noting is that GE did not factor in at all any economic benefits from the government's stimulus spending.
However, Deutsche Bank's Nigel Coe, a notably sharp, shrewd bank analyst, did his own stress-testing of GE and figures that unrealized losses on the GE Capital's $436bn-worth of assets in real estate, loans and securities could hit $50bn this year, sinking the parents' numbers deep into the red.
And Steve Eisman of FrontPoint Partners, also one of the best analysts out there, says GE Capital has about $40 bn to $45 bn of embedded losses in the GE Capital portfolio. GE though has yet to turn GE Capital into a bank holding company, and instead funds itself with the Federal Reserve's commercial paper program and debt guaranteed by the FDIC.
$11 Trillion and Counting
That was the last estimate I saw for the cost of the bailouts.
I have yet to hear former President Bill Clinton say this: "Make inflation your friend."