Coming Bank Themes: Whispers From the Confessional
What sort of themes can you expect to see coming from banks at the end of the quarter?
Minyan Peter, who has become quite popular around the 'Ville with readers and professors alike since his first letter, A Bird's-Eye View of the Credit Conundrum, and following pieces like Bank Earnings 101 and 102.
Thanks to the annual Lehman Brothers (LEH) Financial Services analyst meeting this week we have some early clues on banking results for the quarter. Based on the presentations I have read, as well as related press releases, here are some themes that I think you will see at the end of the quarter.
- First, expect a massive migration of "held for sale assets", particularly non-conforming mortgage assets, into "held for investment" or "loan" categories. Some may even, as Washington Mutual (WM) did, try to portray it as "opportunistic portfolio growth". But the reality is that the only way banks can avoid significant mark-to-market losses on mortgages they intended to sell, but can't, is to move them into portfolio. And, remember, once these loans are in portfolio, related loan loss provisions are required. So you should expect higher provisioning even without any deterioration in credit quality, just due to forced balance sheet growth.
- Second, expect fair value write-downs on assets held for sale. As I wrote in Banking 102: The Best of Times, The Worst of Times, please remember that these write downs won't flow through the income statement, but through Comprehensive Income. Look, too, for changes in the composition of banks investment portfolios. I expect that you will see highly liquid securities swapped for conforming mortgage securities. And with the run up in Treasury prices, I expect that banks with long maturity Treasuries in their investment portfolios have sold them wherever they can to book gains this quarter.
- Third, look for little if any securitization/asset sale gains. With the forced stockpiling of assets on balance sheet, gains will be small. And I expect you may also begin to see the downward revaluation of prior non-cash gains from earlier securitization due to higher than expected losses on previously sold assets. (Also a Comprehensive Income, not P&L, item.)
- Fourth, banks will go out of their way to emphasize the diversification of their earnings flow but at the same time tell you what lending businesses they have or are getting out of: subprime, second mortgage, alt-A, etc. Many will also emphasize their lack of involvement in anything that looks like asset-backed commercial paper, SIV's, CDO's etc.
- Fifth, capital management comments will focus on how they are "migrating toward the top end of [recommended capital] ranges" (National City). Mentions of stock buy backs will be few and very far between.
- Sixth, banks will emphasize how they are bolstering their liquidity, but many will also highlight the fact that their borrowing costs are rising and net interest margins are being squeezed.
Finally, expect higher provision forecasts due to both forced balance sheet growth and deteriorating credit quality. In many cases, though, you should expect little to know management recollection of prior credit forecasts.
For example, at the Lehman Conference, Washington Mutual announced that it now expects a $2.2 bln provision for 2007. $2.2 bln is $500 mln more than it forecast in July and well above the $1.3 -$1.5 bln it forecast in April when it said that its provision forecast was "our best thinking regarding trends in loan delinquencies, foreclosures and housing valuations at this time." WaMu's latest forecast is also almost 2.5 times what it shared in its 2007 earnings outlook ($850 -950 mln) in October 2006.
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