Thursday, February 26, 2009

A series of quarterly numbers

Here is a series of quarterly numbers

Quarterly  
   
12/2008 13,106 
09/2008 11,642 
06/2008 10,621 
03/2008 9,991 
12/2007 9,164 
09/2007 8,615 
06/2007 8,386 
03/2007 8,268 
12/2006 8,599 
09/2006 8,586 
06/2006 8,630 
03/2006 8,776 

Obviously this number has been getting bigger over time – and very dramatically bigger this year and particularly in the fourth quarter.

So what is it?  The credit loss series for a bank?  No – but it is a bank.

It is – wait for it – the quarterly net interest income for bank of America measured in millions of dollars.  

It’s a good number to be big – and it is getting bigger rapidly now.

The fee income is also growing but only if you net out trading losses.

Felix Salmon objected (quite strenuously) to my pre-tax provision number in the long post.  His objection is here.

Well here is the oddity.  Other than for banks with substantial trading income (or losses) the fourth quarter has been an absolute record at just about every bank I am looking at.  Sure if your losses are huge then your net interest income could be going backwards (as per Corus bank).  But that is the exception.  If this trend continues (and I think it will) then my pre-tax, pre-provision estimate in the long note is dramatically low whereas Felix was sure it was high.

Saying something nice about banking is certainly not the common parlance in the blogosphere.  Yves at Naked Capitalism for instance commented on this section – quoting from a WSJ article:

From the Wall Street Journal:  Citigroup executives are attempting to strike a seemingly impossible balance: Run the business in a way that will please their new federal masters, but also help the bank rebound from $28 billion in losses over the past five quarters.

Yves: That is another company-serving bit of spin. Does anyone think, with pretty much all advanced economies contracting and deleveraging likely to continue, that there are great profit opportunities out there? 

Well yes Yves.  Even with pretty much all advanced economies contracting there are opportunities in banking.  

Indeed provided you can maintain access to funding the opportunities in banking are the best that they have ever been in my life.  The margins are massive.  Many people want (even need) to borrow money – and if you have money to lend you can select on the absolutely best credits.  Your risk is much lower than it was on the average loan in the boom.  The implied return on equity is much higher.

Happy days.

Of course they are happy days only if can maintain your funding (far from being a given) and you do not have losses so big from the boom that you will be wiped out (also far from being a given).

But in the past most banks that have got into trouble have been recapitalised by pre-tax, pre-provision earnings.  And at the moment pre-tax, pre-provision earnings are going up.

For the record this is very different to Japan.  In Japan bank spreads collapsed to 30bps.  They did this because of the vast excess deposit bases at zero interest rates.  But I cannot find another banking crisis in which bank spreads have fallen.  Does anyone else know one?



John 

10 comments:

jonathan said...

there is very simple possible explanation. on bac's balance sheet for end 08 and end 07 i c about 750bio of borrrowings (short term + long term). its a bit smaller for 06/05 but only down to 550bio. over the whole period they've got about 400-500bio of short term borrowings. for simplicity lets just assume all the non-deposit funding needs to get rolled every quarter.

the us govt is now facilitating the bank borrowing short term at the treasury rate. bac cds was about 125bp average about a year ago. 125bp on 750bio for one quarter is ~2.25bio usd. their cds is now about 250bp, so 5.5bio subsidy vs where they would be ex govt assistance. yes i accept this last calculation is v v crude and bac cds would surely be much wider without any govt program -- but thats a moot point as there would probably be no bac either.

this sounds pretty consistent with many of the views you have espoused on your blog before. the govt is guaranteeing funding so the bank can grow its way out of trouble. fair enough.

but then dont say "the implied return on equity is much higher" -- its only higher as long as you believe the government subsidy will continue (i.e. the government wont take a big equity stake). if they take equity their just underpaying themselves for insurance.

im not arguing with your conslusions, i just think there is less here than meets the eye not more. govt subsidizing existing institutions, partially via non-transparent mechanisms. next.

John Hempton said...

Absolutely agree. The revenue is rising if and only if you can maintain access to funding.

The better your funding the faster your revenue is rising.

Plenty of opportunities - if you have access.

If the government is going to give you that acesss... then you have access...

Anonymous said...

The other important reason is write downs. When a fixed income instrument is impaired (OTTI) the cost basis is changed and a corporation gets to consider the new amortization schedule for calculating interest income. Big write downs = big future interest income for performing securities.

Elwood Anderson said...

It sounds like the oligarchy is doing just fine as long as they are using our tax dollars. What would those income figures look like if they had to finance those loans from private sources of capital?

Charles Butler said...

Kudos for this one.

David Pearson said...

John,

What you call "access to funding" is nothing more than a taxpayer subsidy in the form of deposit guarantees, FDIC debt guarantees, the TAF, etc.

You aim to show that in the worst of times, banks have franchise value. In reality, you show that in the worst of times, the value of banks arises entirely from taxpayer subsidy. The difference between the two is subtle, but significant. In the first case, the banks should not be nationalized, but should be helped to "grow their way" out of their problems. In the second case, there is an argument to be made for taxpayer ownership of bank equity, as it would better reflect the true source of franchise value.

You could argue the value of the taxpayer guarantee declines over time, and therefore is not significant over the term of a DCF. I disagree with that view. The damage done to these mis-managed franchises, in the absence of a guarantee, would be long-lasting. In effect, lending spreads would be depressed for years as depositors would not trust the banks. Alternatively, the banks could jack up loan rates to compensate, and that would depress volumes and raise required provisioning (as losses are higher in a credit-starved economy).

In answer to your question, show me a country without deposit guarantees, and I'll show you an example of a country where lending spreads collapsed in a crisis.

John Hempton said...

It is not just guarantees - because banks without guarantees around the world have had widening lending spreads - albeit not as sharply widening.

If you simply have a good deposit base then your lending spread has widened.

In fact almost whatever you do your lending spread has widened.

J

David Pearson said...

Argentina may be a good example. I'm not sure what kind of guarantees they have, but lending spreads mask the woeful lack of banking intermediation in the economy. Lending is limited and provisioning is high. So yes, many of these countries may show positive spreads, but the underlying trend is for lending to become "subprime", with lower volumes and lower absolute profits.

In any case, do I hear you arguing that today, in the U.S., bank franchise value would be positive in the absence of taxpayer guarantees? So you think deposit rates would be...Lower? Equal? Slightly higher? Massively higher?

David Pearson said...

BTW, an instructive fact about Brazilian banks is how over-capitalized and under-levered they were during the 90's. Loan to deposit ratios were only 60% -- the rest of the balance sheet was in local currency, s.t. gov't debt. This low-risk lending could account for respectable deposit rates and therefore good lending spreads. Basically, the banks were in the business of lending s.t. to the government, and depositors gauged the risk of this lending to be acceptable. Decent loan spreads do not tell the whole story.

Blank Xavier said...

Adam Smith wrote that as the amount of stock available to be lent decreases, the rate at which it is lent necessarily increases (e.g. reduction in the competition to lend).

But isn't the rate at which banks lend effectively controlled and set by the Fed? or do the Fed only set a lower bound?

General disclaimer

The content contained in this blog represents the opinions of Mr. Hempton. Mr. Hempton may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Hempton's recommendations. The commentary in this blog in no way constitutes a solicitation of business or investment advice. In fact, it should not be relied upon in making investment decisions, ever. It is intended solely for the entertainment of the reader, and the author.  In particular this blog is not directed for investment purposes at US Persons.