Beleaguered Banks: Book Values, DVA's and The Potted Plant Strategy

It has been quite a year for the beleaguered banking sector and even more so in the last few months and weeks, with the European debt crisis and implementation of new U.S. banking regulations and legislative acts wreaking havoc with the industry.

There is so much ground to cover on recent developments and storylines that we think just bulleting some of the major points would be the best and easiest way to go. Let’s start with the most recent and more “actionable” items and then go from there.

• This weekend’s Barron’s cover story was titled “Buy the Banks”. To save you a lot of reading, the gist of the story is that the market has priced in too much negativity in the sector, with leading bank and financial indices down over 20% on the year and several leading names down over 40%. A core argument is that many “blue chip” banking names are trading at or below “tangible book value”.

• Then another Barron’s column asks: “Equities have Surged, Could Bank Earnings Stop the Momentum?” We need to be aware that this week is the Big Kahuna of financials/banking earnings releases: Citi, Wells Fargo, and First Horizon on Monday, Bank of America, Goldman Sachs, and State Street on Tuesday, and then Morgan Stanley, PNC, American Express, Bank of New York, US Bancorp and Blackrock on Wednesday, to mention just the real majors. The question is whether the market has priced in what are expected to be disappointing results.

• And finally, two other Barron’s columns are titled: “Just How Low Can Morgan Stanley Go?” and “Cheap Euro Banks Beckon.” Sparing you the details, the question asked again is whether or not “now is a rare opportunity to buy financials on the cheap?”

• The banking industry was also in focus last week as one of the targets of the “Occupy Wall Street” protests, which have now carried outside of New York City to demonstrations at bank branches, regional outposts and headquarters of banks around the U.S., Federal Reserve banks and financial centers in major cities. In New York, the residences of luminaries such as JPM’s Jamie Dimon were targeted for “picketing”.

• Speaking of Mr. Dimon, he has been all over the news on several fronts: his public and back channel railing against new banking regulations, the questioning of his ongoing support or not for Pres. Obama, and most importantly the release of JPM earnings last week. After a theoretical beat on earnings, investors sold the stock off by about 4%, due to some internal business groups’ results, year over year comparisons, some questions on accounting issues, and the outlook going forward. We were introduced to an acronym new to us, the “DVA”, which stands for Debit Valuation Adjustment. Hmmm, “a debit valuation adjustment (DVA) approach is applied to incorporate the credit risk in the fair value of uncollateralized negative replacement values for financial positions held by an institution where market observable inputs are not available.” Perfectly clear, we think and says to us “we will just wing it in guessing the value of certain risky assets”.

Hardest hit were results in investment banking, trading, and equity and fixed income underwriting for JPM. Dimon put the blame for some divisions’ results on volatility in the overall economic environment but said ‘the recovery is still here, although it has not really strengthened.”

• Then there has been the Bank of America flap over increasing debit card fees, much maligned across the board from a PR perspective and even attacked by Pres. Obama and Congressional figures, which we have commented on before. Jim Cramer went off on one of his rampages on the issue, asking if Washington was trying to start a run on the bank. Of course Cramer then later called his recommendation of BofA stock to viewers/subscribers “one of his worst calls ever” so we guess it is OK for him to start a run on the stock (in fairness he did say it is too cheap to sell here).

• All over the news toward the end of last week were ratings agencies’ downgrades and/or negative watch alerts on both European and U.S. banks with substantial European debt exposure. And then countless other stories on bank recapitalization plans, the depth of capital requirements and the very latest story on rumored G-20 recommended mandatory capital increases for up to 50 major banks.

• And lurking in the background always are the impacts of Dodd-Frank, the “Volcker Rule”, the Durbin Amendment and the Consumer Financial Protection Bureau (ok, this is severe headache time trying to keep all this on the radar screen and it is little wonder Mr. Dimon is so cranky). And it is also not terribly shocking that whispers are flying around about Goldman and Morgan perhaps looking to give up their “bank holding company status”, which was so fervently sought out during the last financial crisis.

• And finally, stories abound about the job layoffs in the financial services sector and a drive to cut back on discretionary expenses.

Most notable on the layoff front are the reports of BoA cutting as many as 30,000 jobs in the next few years. Of course, the drive for expense reduction did not stop two recently dismissed BofA execs from receiving a combined $11 million in severance. But rank and file BofA employees unfortunately had their annual “Field Day” cancelled.

On the same lines, The Royal Bank of Scotland has cancelled Christmas parties, Morgan Stanley has restricted Blackberry usage (of course RIMM does a pretty good job of that on its own), Barclay’s has cut back on taxi and limo expenses, and one major firm has reportedly downsized executive paper drinking cups. Our favorite though were the reports that two major banks have severely cut back on spending for “foliage and potted plants” in their offices.

What is next? Will Goldman Sachs execs be forbidden Double ShackBurgers and Triple Dip Sundaes for their cherished Shake Shack takeout lunches, having to make do with single burgers and only double dip sundaes?

Good Trading!
David W. (aka The Underground Trader)

 

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