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Bac, jpm, rbs, wfc, c etc.


Uccmal
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It looks as though these banks are going to be made part of SIFI - considered to big to fail.  If it comes to passing as written they will be required to have 2.5% more tangible equity to assets on their balance sheet, than average banks.  This is in the distance time wise but there is an assumption in the market place that these banks will experience lower returns as a result.

 

Now this is obviously logical since they have less leverage to use.  My thoughts around this whole game are that these banks and their 20 or so peers in SIFI have enormous negotiating power.  The assumption seems to that they will have lower returns.

 

I am not sure this is the case.  Having to hold that amount of equity may come with payoffs from repective governme ts to make up for the losses from reduced leverage.  I am willing to bet that when push comes to shove there will be other ways that governments assist these banks in making up the shortfall.

 

Thoughts?

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How about the fact that if I am carrying 9.5% equity/assets and Regions is at 7%, I'll put in every client presentation how I can survive any crisis while Regions/other midsized regionals with lower equity/assets cannot. The system will gravitate towards SIFI equity/assset levels. That is the true travesty...velocity of money will slow substantially. 

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I do not think Governments are going to make up for the reduction in leverage. I see the exact opposite via curbs on various fees and limitations on proprietary trading.

 

ROE = ROA x Financial Leverage

 

I think ROA is going to be lower than in the past - not just of the immediate past of 2000-2007 but also of 1990 onwards. This is due to a variety of factors: limitations on fees, limitations on many types of trading activity, elevated loan losses as consumer deleverages, etc.

 

Financial leverage is going down for sure from something like 15 to a 10. So the net effect should be much lower ROE for banks and I do not see any Govt help on the horizon that mitigates this.

 

This is coming from a guy who has a portfolio dominated by banks.

 

The flip side of reduced leverage is that it should result in much lower risk to the banks. This should feed into lower debt costs (which should add a modest amount to earnings) and hold your breath, higher earnings multiple or book value multiple. I do not base my investment case on higher earnings multiple but that is what I would think would happen if banks really end up with the capital ratios that are being talked about with Basel 3 and SIFI buffers.

 

Vinod

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At the end of the day I need to ask the question that I don't see asked.  The question is, so what?  What does it matter if they need to reduce leverage and will be less profitable?  So they will make less money than they did in boom times or perhaps less money than one might have thought they would make when the world improved.  They will simply be a bit less cheap than they are now, but still very cheap.  I think people focus on the wrong things.  Take BAC for example.  So what if they end up with 1% ROA/10% ROE instead of say 15% ROE?  Many of these banks are selling for well below book value now.  So instead of being worth 2-3x book in a few years or whenver, they'll be at 1.5-2x book.  Perhaps I am missing something, but other than the fact that as investments they are a bit less good than they were before, they are still good.  But if these banks can all regularly go back to churning out 1%/10%, they are still very nice investments here.

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Let me get this straight.  Restricting banks use of leverage to buy the riskiest and, ultimately, money losing investments will hurt their returns?

 

This is a very good point.  People have the chance to buy financial institutions that will be forced to be less aggressive, will be safer than perhaps at any time in the past, and will still make plenty of money and the prices range from around half BV to about 1x BV. 

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Here's a recent article on the sifi buffer: http://www.bloomberg.com/news/2011-11-07/citi-jpmorgan-may-face-highest-basel-surcharges-regulators-draft-says.html

 

If the maximum buffer above the Basel III requirements is 2.5%, then some banks will need 9.5% of capital.  The article suggests JPM and C might be in this group.

 

At a 1.5% return on assets, a bank could earn about 15.8% on capital.

 

The article mentions that it looks like Wells Fargo will only get a 1% sifi, which would put it at 8% capital.  A 1.5% ROA would mean that wells could earn 18.75% on capital. 

 

My guess is that US Bancorp will only need a 1% buffer at a maximum.  US Bancorp's Q3 ROA was 1.57%.  They're already looking really, really good.

 

I feel that after the next election in the U.S. (a year from now) banks will come out of the headlines no matter who wins the presidency and how the Congress breaks down. 

 

For banks like Wells and US Bancorp, I think the clampdown on leverage in this industry will actually be a boon as their competitors will be forced to be more rational in the areas that these two have always focussed on because their competitors can't make outsized returns in other areas.

 

Finally, I feel that the effect of the banking crisis has been to concentrate power (deposits) into a very small group of institutions and that this concentration has been intentional on the part of policy makers.  They have limited competition and have made regulation and oversight much more manageable.  Whether this is good for the country or bad, this is what I think they've done and why I think they've done it.  In exchange, the banks that made their money taking huge risks with lending and proprietary trading have seen their future returns brought down.

 

However, for banks that have always focussed on "basic banking" (like WFC and USB), this new scenario seems ideal.  If both of them only need 8% capital, they should be able to get very good returns on equity.

 

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All good points, thanks.  Kraven, no argument here and it certainly sounds like Vinod agrees.  I am Starting to dig at Jpm.  Have enough exposure to Wfc and Bac.

 

:) I just started digging into JPM as well. Had enough exposure to C and BAC.

 

Vinod

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Here's a recent article on the sifi buffer: http://www.bloomberg.com/news/2011-11-07/citi-jpmorgan-may-face-highest-basel-surcharges-regulators-draft-says.html

 

If the maximum buffer above the Basel III requirements is 2.5%, then some banks will need 9.5% of capital.  The article suggests JPM and C might be in this group.

 

At a 1.5% return on assets, a bank could earn about 15.8% on capital.

 

The article mentions that it looks like Wells Fargo will only get a 1% sifi, which would put it at 8% capital.  A 1.5% ROA would mean that wells could earn 18.75% on capital. 

 

My guess is that US Bancorp will only need a 1% buffer at a maximum.  US Bancorp's Q3 ROA was 1.57%.  They're already looking really, really good.

 

I feel that after the next election in the U.S. (a year from now) banks will come out of the headlines no matter who wins the presidency and how the Congress breaks down. 

 

For banks like Wells and US Bancorp, I think the clampdown on leverage in this industry will actually be a boon as their competitors will be forced to be more rational in the areas that these two have always focussed on because their competitors can't make outsized returns in other areas.

 

Finally, I feel that the effect of the banking crisis has been to concentrate power (deposits) into a very small group of institutions and that this concentration has been intentional on the part of policy makers.  They have limited competition and have made regulation and oversight much more manageable.  Whether this is good for the country or bad, this is what I think they've done and why I think they've done it.  In exchange, the banks that made their money taking huge risks with lending and proprietary trading have seen their future returns brought down.

 

However, for banks that have always focussed on "basic banking" (like WFC and USB), this new scenario seems ideal.  If both of them only need 8% capital, they should be able to get very good returns on equity.

 

I don't agree that WFC will be able to avoid SIFI stature as it continues to grow over time. Additionally, banking products are going to become more plain vanilla in time. BAC/JPM/MS/GS will reduce derivatives as capital rules make it too expensive for them to offer exotic derivatives that provide them an adequate return and provide enough value to clients to use a derivative versus buying or selling short some physical security/commodity,etc.

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I don't agree that WFC will be able to avoid SIFI stature as it continues to grow over time. Additionally, banking products are going to become more plain vanilla in time. BAC/JPM/MS/GS will reduce derivatives as capital rules make it too expensive for them to offer exotic derivatives that provide them an adequate return and provide enough value to clients to use a derivative versus buying or selling short some physical security/commodity,etc.

 

WFC will get hit by SIFI. 

 

The article suggested it might only be 1%. 

 

If you're saying that Wells' SIFI will be the same as JPM, C, etc. -- I wouldn't necessarily disagree but that's not what the article suggested was the preliminary result.

 

Your point about banking products becoming more plain vanilla is exactly what I'm saying as well.  That plays right into the hands of banks like Wells and US Bancorp.

 

 

 

 

 

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I don't agree that WFC will be able to avoid SIFI stature as it continues to grow over time. Additionally, banking products are going to become more plain vanilla in time. BAC/JPM/MS/GS will reduce derivatives as capital rules make it too expensive for them to offer exotic derivatives that provide them an adequate return and provide enough value to clients to use a derivative versus buying or selling short some physical security/commodity,etc.

 

WFC will get hit by SIFI. 

 

The article suggested it might only be 1%. 

 

If you're saying that Wells' SIFI will be the same as JPM, C, etc. -- I wouldn't necessarily disagree but that's not what the article suggested was the preliminary result.

 

Your point about banking products becoming more plain vanilla is exactly what I'm saying as well.  That plays right into the hands of banks like Wells and US Bancorp.

 

 

 

I distingush WFC and USB. USB's returns on risk weighted assets are much higher because they have more non-asset intensive businesses than WFC. WFC has historically had a better deposit franchise. I would argue today that WFC is much closer to a JPM, C, or BAC then a USB (especially post WFC's acquisition of Wachovia).

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Let me get this straight.  Restricting banks use of leverage to buy the riskiest and, ultimately, money losing investments will hurt their returns?

I highly recommend the last JPM annual as a reading material. The way they assume the consequences of such restrictions is discussed there in a really sensible way.

Sure those are only assumptions, yet a really great read.

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