Saturday, May 9, 2009
Muddling through – why the American banking system will not turn Japanese – Part II
Friday, May 8, 2009
Why American banks will not wind up looking like Japanese banks - Part 1
77 Bank has a very large market share (near 50%) in
Here is its balance sheet:
(click for a more detailed view).
Note that it has USD42.6 billion in deposits. This compares to $35.8 billion for Zions Bancorp – as close to an American equivalent as I can find. [Disclosure - I had been short Zions Bank at various times - but not for the great collapse in its local commercial property market. I lost money. I thought Zions modestly risky - but it wound up very risky.]
77 only has USD26.4 billion in loans though. If you take out the low margin quasi-government loans it probably has only USD20 billion in loans.
This bank seems to be very good at taking deposits – but can’t seem to lend money.
This is typical in regional
So – guess what. It sits there – just sits – with huge yen securities (yields of about 50bps) doing nothing much.
It’s a big bank. It has next to no loan losses because it has no lending.
Here is an income statement:(click for a more detailed view)
Profits were USD87 million on shareholder equity of 3251 million. You don’t need a calculator – that is a lousy return on equity for a bank without credit losses.
You might think that given that they have no profitability and no lending potential they might be returning cash to shareholders. Obviously you are new to
In a world where banks everywhere are short of capital 77 bank is swimming in it. Here is the graph of capital ratios over time:
This bank has an embarrassment of riches – and nothing to do with them.
Welcome to regional
An American Mirror
The title of this post was “An American Mirror”. And so far I have not mentioned
There are also mirror image lands – 77 is our mirror image.
Macroeconomic investing calls
We live in a world with considerable excess (mostly Asian) savings. Banks with access to borrowers made good margins because the borrowers were in short supply. Savers (or banks with access to savers) were willing to fund aggressive Western lenders on low spreads.
77 Bank has been the recipient of those low spreads. It has not been a fun place for shareholders as the sub 3% return on equity attests.
The economics of 77 Bank (and many like it) will change if the world becomes short on savings. There is NO evidence that that is happening now – and so 77 Bank will probably remain a lousy place for shareholders.
The market produces what the market wants
This is an aside really. We live in a world with an excess of savings. This is equivalent to saying that we live in a world with a shortage of (credit) worthy borrowers. So we started lending to unworthy borrowers – what Charlie Munger described as the “unworthy poor [whoever they might be] and the overstretched rich”. We know how that ended.
Unfortunately the financial system cannot make worthy borrowers. It can only lend to them when it can identify them.
This Subprime meltdown heralds the death (for now) of lending to the unworthy. The shortage of the worthy however is as acute as ever – and money for the worthy is still very cheap. [Money for the worthy is now difficult to obtain (at least outside Fannie/Freddie space), but still relatively cheap once obtained.]
The subprime meltdown does not solve 77’s problems.
John
One year later postscript:
The basic call that the global savings glut was not going away was right. The global glut of savings - which found its way into endless dodgy subprime mortgages and other problem loans - still exists. Chinese people still save to excess. Americans are saving more. The fundamental imbalance that drove the world financial crisis is still there. It is not obvious how that is fixed.
Japanese banks however have found that low margins are particularly dangerous - as there is little profitability to offset losses (even small losses). And Japanese banks are now having losses.
How might the BofA stress test work
THERE ARE ALL SORTS OF THINGS WRONG WITH THIS POST. BEST IGNORED. LEFT FOR POSTERITY...
There is a
But here is the guts of it:
The bank must be able to have 4% tangible common equity and a 6% tier one ratio by year end 2010 in the adverse macro (that is stress) circumstance. At bank of
The 19 Bank Holding Companies (including BofA) don’t need to meet the 4% test now – they only need to have enough capital now that they will in an adverse circumstance meet the 4 percent test later. In other words when counting the losses that they might have in an adverse circumstance they are also allowed to count the earnings they will receive in the adverse circumstance.
That is good for a few banks. Bank of America doesn’t meet a 4% tangible capital ratio now. Not even close. But its revenue is rising fast and it will be allowed to count three more quarters of revenue in its calculation.
Unfortunately they are not allowed to count anticipated near term increases in revenue (they are having them and in adverse circumstances bank revenue typically goes up). Presumably they are allowed to count revenue (net of “abnormal” trading gains and losses) at the run rate that they generated it in the first quarter – which is – as noted elsewhere on this blog – is a record..
There does not seem to be a provision against counting near term changes in pre-tax pre-provision earnings derived from cost changes. That means that Bank of America should be able to count the cost synergies but not the revenue synergies from the Merrill Lynch merger. That is about 6 billion per year – but probably only next year.
If a bank does not pass a stress test there are a few capital management options that are not open. The most important is to shrink the lending book. The stress test must be able to met whilst maintaining lending at prudent levels to keep the economy ticking along. I guess the government doesn’t want to discourage a crash by forcing lending down. They can however meet the tests by selling assets or raising third party capital or even (as is the shareholder’s greatest fear) by turning the preference shares that the government owns into new mandatory convertible preference shares as per the last Citigroup bailout.
Well everyone “knows” that the BofA shortfall is 33.9 billion. That number has been leaked widely – and is so precise that it would be embarrassing for the
Anyway I want to have a little think about what that number means…
Here is the balance sheet of BofA
The company has a total balance sheet of 2,322.0 billion – but only 977.0 billion of loans (less after provisions). By the time you add in an investment bank you get an awfully big number of assets (trading and other). But 86.9 billion in goodwill and 13.7 billion is other intangibles. The tangible assets are thus 2221.4 billion. 4% of this is 88.9 billion.
The shareholder equity is 239.5 billion but you need to subtract off the same intangibles. You then wind up with 138.9 billion in tangible equity. There is a whack of preferreds (including TARP) and you have 65.6 billion of tangible common equity. Prima facie the company has 65.6 billion in tangible common equity. The bank is prima facie short 23.3 billion of capital. I have put this in the following spreadsheet.
This number differs a little from the numbers in the last quarterly report. Here they are.
This suggests that we have a 3.13 percent tangible common ratio – and the difference is tax assets and liabilities associated with the intangibles – see the footnote. I am
Using that number we have 3.13 percent tangible capital, somewhat better than the 3.0 percent calculated above – and the shortfall is “only” 19.3 billion rather than 23.3 billion. The widely mooted current shortfall is about 20 billion.
But it is not the current shortfall that matters. It is the pro
Now suppose that BofA has zero growth between now and the end of next year. Then the required capital will not have changed – and the bank will have had some pre-tax, pre-provision earnings.
It will in fact have had a lot of them. Pre-tax, pre-provision earnings are running about 13 billion per quarter at the moment ($39 billion for the rest of this year plus another 52 billion next year for a total of 91 billion). It will also have a further 6 billion in “earnings” from the Merrill Lynch synergies.* So they will have 97 billion in earnings before losses.
But lots of losses – an amount that none of us really know. If they have 77 billion in losses they will still recover the 20 billion current shortfall and they will thus pass the stress test.
Now is 77 billion possible? Yes – but it is pretty bad if you think it has to come from the loan book. The loan book is 977 billion and already has 29 billion of provisions against them. The loan book might be that bad in an adverse circumstance – but frankly I doubt it. The actual losses last quarter were way less than that rate – though the company provisioned considerably more than they charged off and they pro
The non-loan book (and the off-balance sheet credit card book) could cause distress in the stress scenario. The particular issue is the credit card book – and I would expect profits to go away – but this is MBNA not Metris – and my guess is that the book will hurt but not kill. A credit card stress test here is solvable with 5mg of valium (a very small dose – read a mg for a billion dollars and you get it about right).
Far more problematic is the possibly they could blow up the (Merrill Lynch) trading book again. Merrills – rather than anything else is the black box at BofA. I suspect/hope that Bank of America has been steadfastly trying to de-risk the Merrill Lynch book. Sure they shouldn’t have purchased it – but they have taken a whack of charges against it and the trading book is likely – at least in the next thirty days – to show some reverses. After all –what were those year end charges about. And they can sell good slabs of this book reducing total assets and hence required tangible common equity. Still it is the trading book that is the black-box here and I have no idea how much valium is required to remove stress.
The best thing though about the non-loan book is that it is easy to liquidate. They can shrink it.
Indeed the easiest thing to shrink is the cash balance. I have pointed out that the cash balance of BofA is enormous – and in the stupid rule of the week the 4% TCE ratio includes 4% of cash. The rule is pretty clear – 4 percent on total assets including the huge excess cash balances BofA is holding. Just by increasing risk (through shrinking cash balances) BofA can solve $6 billion of its shortfall.
But in the end it comes down to the trading book which should, after some run-off, be shrinkable. The only question being how much do they lose by shrinking it? And that depends where it is marked. And to that – well I think you need to be an insider to know.
Disclosure: still long BAC.
John
*I think those earnings are as dodgy as they sound – but I think they can count them in working out stress test capital.
Wednesday, May 6, 2009
All lies and jest
Mr. Alphin said since the government figure [$34 billion] is less than the $45 billion provided to Bank of America, the bank will now start looking at ways of repaying the $11 billion difference over time to the government.
The real economy sucks
Tuesday, May 5, 2009
In an odd coincidence
Francesco Rusciano is out on bail – released to the custody of his parents who have put up their house to stop him fleeing.
This is a guy – who according to SEC filings – has been able to raise $30 million from 15 high net worth customers. [Maybe raising hedge fund money is easier than it appears to this start-up… however if any rich folk from
Anyway – the picture of Mr Rusciano with an unidentified female.
The report comes from a
In an odd coincidence, Rusciano was a sub-tenant of
(a) That Paradigm and Rusciano shared more than an office - they shared marketing arrangements and a phone number,
(b) the third party marketer in question (or at least its corporate office) was not licensed
(c) the third party marketer in question (or the individual in charge) had previously been a full time employee of Paradigm
(d) that this individual had caused their previous employer to settle claims for abuse of client funds in six figure amounts (whilst the marketer in question denied guilt)
(e) that the individual had also been suspended from the securities industry and sacked for allegedly fraudulently abusing the bonus system of a previous employer (and in this case accepted a fine but neither accepted nor denied guilt)
(f) that the third party marketer in question (company or individual uncertain) also introduced Paradigm to Alan Stanford’s organisation and that
(g) Paradigm thought sufficiently highly of the Stanford organisation that they had a cobranded product
To this we can add the following odd coincidences:
(h) that Paradigm had lent its name and reputation to another alleged fraudulent hedge fund – this one being Paradigm Global (
(i) that Paradigm claimed that it had 28 full time staff when very soon after it probably had less than ten
(j) that Paradigm similarly had offices in Monte Carlo and Tokyo whereas the only places I can find sales staff from the period are in Orlando Florida and similar and the Tokyo and Monte Carlo offices were rapidly closed
(k) that Paradigm until only a few days ago claimed on their website that they had never had a down year and they had decreasing volatility (a claim that disappeared only when pointed out on this blog)
(l) that Paradigm claimed in public documents to have over $1.5 billion under management when it (at least very soon after) had less than one fifth that amount, and that the decline happened despite the positive returns better than indices and with decreasing volatility
(m) that Hunter Biden and James Biden in sworn affidavits alleged that James Park (then the manager of Paradigm) was mostly absent and had a substance abuse problem but that all is well with James Park now as he is back at Paradigm
(n) that Hunter and James Biden in the same affidavits alleged that Paradigm had misrepresented their returns
(o) that Paradigm claimed its domestic outsource arrangements were with Global Fund Services LLC – a company supposedly in Atlanta but which is no longer in Georgia at Whitepages.com, (they do have some relationships with BISYS – now Citigroup)
(p) that Paradigm’s offshore fund administration is supposed to be at Folio Administrators and they claim in marketing documents that they have had that arrangement since 2002 whereas Folio Administrators in an email to me claim it only since 2004
(q) that on the SEC database exists an audit statement qualified as to the security of asset custody, and
(r) that Paradigm hired at least one other marketing staff member with long histories of alleged violations of broker conduct rules.
These odd coincidences were made clear on this blog. Full documentary backing for these coincidences is provided in this post – a post which almost nobody linked to or commented on – but which took a considerable time to write and which I largely researched before Ponta Negra was prosecuted by the SEC.
In an odd coincidence I am frustrated. Partly because it is all odd coincidences.
Mr LoPresti says that “Paradigm is not under investigation”.
In an odd coincidence I believe him. He is a lawyer and there is no reason why I should not believe him.
Monday, May 4, 2009
Stress test results: Who is leaking?
Paradigm Global, the Bidens and allegedly fraudulent hedge funds – a summary
- The Paradigm Hedge Funds had only between two and three hundred million dollars under management, which were leveraged to over five hundred million, not the more than $1.5 billion under management represented to us by Lotito and Fasciana.
- The returns on the Paradigm Hedge Funds were not as represented to us by Lotito and Fasciana; and
- The primary manager of the funds, Dr. James Park, had an apparent substance abuse problem and had been an absentee manager for several years...
Dear Fellow Investors:The global economic stress as measured by FX short term volatility, sovereign and corporate CDS spreads and VIXX indices persisted in the month of February, as the barrage of negative economic indicators remained unabated.Continued stress on the financial sector that peaked with the record quarterly loss of AIG and the collapse of Citigroup equity valuations has left policy makers and market participants perplexed as to how the current turmoil will be resolved.The month of February marked one of the most complex environments in foreign exchange that we have experienced since the inception of the Fund, as the ambiguity in governmental commentary on interest rate decisions and the measures being considered to aid the distressed economic climate caused abnormal gyrations in the G10 arena.We remain committed to our long DXY bias but as was mentioned in last month’s commentary, we have preferred to express this through a short EUR/USD bias and selectively partially imperfectly hedge it with a lower weighted long GBP/USD trade.We believe that the euro zone will continue to be weighed down by the massive 1.3 tn. EUR of outstanding debt of Eastern Europe that will be a challenge to refinance at reasonable yields in the current climate.The reversal of our short USD/JPY hedge was well-timed, as the announcement of the reissuance of U.S. Treasury samurai bonds to the Japanese marketplace has accelerated the upside momentum in USD/JPY. We have decreased the size of our short EM bias as commodity prices appear to have temporarily stabilized and we prefer to selectively express views through cross regional plays such as short EMEA/LatAm with underweights in HUF, PLN and overweights in CLP, BRL.We will continue to utilize low quantities of leverage and fewer numbers of intraday positions, as we anticipate the persistence of a high volatility marketplace into the end of Q1 2009.
Dear Mr. Hempton,I can confirm that Folio Administrators Limited are the appointed fund administrator for Paradigm Global Fund. Folio has been providing fund administration services to Paradigm's offshore funds since July 2004.Please let me know if you require any further information.Kind regardsWilliam HarrisDirectorFolio Administrators LimitedFolio HouseJames Walter Francis DriveRoad Town, TortolaBritish Virgin Islands, VG1110Tel: (284) 494-****Fax: (284) 494-****
Sunday, May 3, 2009
Another shameless plug for the Cooler Mr Hempton
Friday, May 1, 2009
What was it like to be a Stanford salesman?
Final postscript: I tracked Justin Hare down again. He appears to have taken an entirely honest sales job. It probably pays less - and it certainly does not come with trips to Antigua. I almost feel like taking this down now Justin is working an honest job for honest money. But hey - lets keep it here as a reminder for Justin.
General disclaimer
The content contained in this blog represents the opinions of Mr. Hempton. You should assume Mr. Hempton and his affiliates have positions in the securities discussed in this blog, and such beneficial ownership can create a conflict of interest regarding the objectivity of this blog. Statements in the blog are not guarantees of future performance and are subject to certain risks, uncertainties and other factors. Certain information in this blog concerning economic trends and performance is based on or derived from information provided by third-party sources. Mr. Hempton does not guarantee the accuracy of such information and has not independently verified the accuracy or completeness of such information or the assumptions on which such information is based. Such information may change after it is posted and Mr. Hempton is not obligated to, and may not, update it. The commentary in this blog in no way constitutes a solicitation of business, an offer of a security or a solicitation to purchase a security, 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.