Where is the US Consumer?--Part 2

Two pieces of news today that go along with my earlier post about the pressures families are facing in the United States. (http://seekingalpha.com/article/328252-where-is-the-u-s-consumer).   

First, “Home Prices Tumble.” (http://professional.wsj.com/article/SB10001424052970204652904577194752102528744.html?mod=WSJ_hp_LEFTWhatsNewsCollection) “For November, the Case-Shiller index of 10 major metropolitan areas and the 20-city index both fell 1.3% from the previous month. David M. Blitzer, chairman of the index committee at S&P Indices, also noted that 19 of the 20 major U.S. metropolitan markets covered by the indices in November saw prices decline from October…

The 10-city and 20-city composites posted annual returns of negative 3.6% and negative 3.7%, respectively, compared with November 2010.”

Second, “Consumer Confidence Unexpectedly Declines.” (http://blogs.wsj.com/economics/2012/01/31/consumer-confidence-unexpectedly-declines/)  “U.S. consumer confidence in January gave back some of the huge gains posted in the previous two months, according to a report released Tuesday. Views on labor markets darkened.

The Conference Board, a private research group, said its index of consumer confidence retreated to 61.1 this month from a revised 64.8 in December, first reported as 64.5. The January index was far less than the 68.0 expected by economists surveyed by Dow Jones Newswires.

Perceptions about the job markets worsened this month. The survey showed 43.5% think jobs are “hard to get” up from 41.6% saying that in December, while only 6.1% think jobs are “plentiful” down from 6.6% in December.”

These data are consistent with the material presented in the earlier post.  The United State consumer has lots to worry about and, for a large portion of this consumer base, spending is not expected to be very robust in future months.  And, their situation cannot be turned around soon by either monetary or fiscal policies. 

Where is the US Consumer?

“Rising Income is Saved, Not Spent,” reads the Wall Street Journal Tuesday morning. (http://professional.wsj.com/article/SB10001424052970204740904577192702993936344.html?mod=ITP_pageone_1&mg=reno-secaucus-wsj)

“Personal income increased 0.5% in December from November adjusted for seasonality, the largest monthly increase since March…but spending was flat over the month—actually fell when inflation is factored in.”

“The savings rate, around 5.0% for the first half of 2011, was near 4.0% for much of the second half of the year…. Economists warned that consumers would soon resume socking away cash at the expense of spending, and that appears to be playing out now.”

With unemployment still high and the housing market in the doldrums, consumers are reluctant—and in many cases unable—to increase their spending in a big way.”

The Federal Reserve’s recently released forecast projected unemployment rates remaining at high levels through 2014, declining only slightly throughout the next three years.  And, even worse, underemployment is also expected to remain high with the rate of underemployment staying near to one out of every five people of working age.  No help coming here.(

Furthermore, a large proportion of homeowners still find themselves “under water” with mortgages that exceed the market value of their houses.  This situation is not expected to improve in the near future.

Robert Shiller, the Yale economist, was just interviewed at Davos and responded to questions about home prices by saying that prices will probably continue to decline, although not at the rate they declined in recent years.  He added that even if housing prices did stop declining, there is no reason to expect that they would start to rise anytime soon.  In addition, he added, that even though housing prices were returning to something more like a “fair value” that historically, the tendency was for the market to “overshoot” the “fair value” until all the previous exuberance is wrung out of the market. (http://professional.wsj.com/article/SB10001424052970204740904577192702993936344.html?mod=ITP_pageone_1&mg=reno-secaucus-wsj)

A White House effort to lessen the impact of these homes that are “under water” seems to have failed in that the program developed by the administration has not reached enough borrowers to have much impact on the market. (http://www.ft.com/intl/cms/s/0/cf9fed00-4a89-11e1-8110-00144feabdc0.html#axzz1l2qSCMaM)

Even more chilling is the report released today by the Corporation for Enterprise Development (CFED) titled “The 2012 Assets & Opportunity Scorecard: How Financially Secure are Families?” (Go to http://cfed.org/.)   This study presents what it calls the households that are in “liquid asset poverty”.  A household is considered in liquid asset poverty if it owns a home, yet has no savings to speak of.  These people are just one significant emergency away from a real financial crisis. 

The emergency could take the form of a major car breakdown or a health problem.  Most of these people are earning a regular paycheck, CFED says, but they don’t really realize how close to the edge they are living.  Many have some other form of debt, but in an emergency would have to rely on very expensive sources of debt to try and carry them through the emergency. 

The study reports that 43 percent of the households in the United States are liquid asset poor.  This amounts to roughly 128 million households. 

Again, we seem to see the country bifurcating.  There are those households that are doing OK and are continuing to spend through these tough times.  Yet, there are a large number of people that have to watch out where every penny of their income is going.  This means that the economic recovery will not only remain week, but it will be fragile and susceptible to unexpected shocks.

Saving and deleveraging are still needed and being sought by many families, but this will just mean that the recovery will be missing any strong support from consumer spending in the near term.

And, it means that banks and other financial institutions cannot be sure of value of many of the assets on their balance sheets, both mortgages and consumer loans, but also face the fact that loan demand will also not be strong in the future.

We are still looking for where the surge in economic activity will come from.    

Corporate Confidence Continues to Wane

I closed my review of the 2012 prospects for mergers and acquisitions with this paragraph: “Let’s hope the boom in M&A business does take place. Let’s hope that the corporate cash and corporate borrowing do not go just to corporations buying back their own stock. Let’s hope that the unwinding and restructuring takes place because that is one prerequisite for business to get back to the capital investment activities that do drive economic growth.”

(http://seekingalpha.com/article/321037-the-outlook-for-mergers-and-acquisitions-in-2012)

However, at the end of January we see the headlines: “M&A volumes at lowest for a decade.” (http://www.ft.com/intl/cms/s/0/f23718f6-4a76-11e1-8110-00144feabdc0.html#axzz1kx2Cicvs) “Dealmaking has had its slowest start to a year for nearly a decade, as companies’ appetite for mergers and acquisitions remains suppressed by the uncertain outlook for the global economy.”

The deal volumes announced so far this year…about half the level of 2011 at this time according to S&P Capital IQ.

Additionally, we read “Hordes of hoarders,” concerning corporate cash hordes…with corporate entities holding onto well over $1.7 trillion at last count. “ (http://www.ft.com/intl/cms/s/0/4cd6cb8c-48e0-11e1-974a-00144feabdc0.html#axzz1kx2Cicvs) “At present, cash accounts for more than 6 percent of US non-financial companies.”

In one specific case, Apple has almost $100 billion in cash on its balance sheet, about level with the market value of firms like McDonalds, or ConocoPhillips, or Cisco Systems.

This pales against the cash holdings of US commercial banks who in January 2012 hold almost 13 percent of their assets in cash balances, up from 9.3 percent at the end of 2010.

I know that this is early in the year, but with everyone looking for positive signs that the economy is picking up steam we need to consider other signs as well. Furthermore, the current situation is not unlike the situation that existed at the start of last year…and the actual commitments never really came about.

The one word that seems to be on almost everyone’s lips concerning this situation is…uncertainty.

There is just so much uncertainty that exists in the world right now that people are unwilling to commit substantial resources to acquisitions…or capital investments.

Where is this uncertainty coming from?

In my mind this uncertainty exists from the lack of economic leadership in the world today.  Europe continues to dither…and so does the UK…and so does the US. 

No one seems to know where they are going…or where we are going. 

How can anyone commit in such an environment?

Who knows what economic policies are going to prevail in these areas over the next year or two…let alone the next three months?

Who knows how the people in these areas are going to react to whatever economic policies are going to be enacted by their governments?

We’ve seen how the governments have acted in the recent past…and these examples cannot give anyone much confidence.

Right now, I am concentrating on factors such as these to try and understand the state of the economy.  Business leaders may be prepared to commit in the future and certainly they have the means to borrow additional funds if they need them.

These leaders still face the following question: “Why should I commit to buy another company now when the economy could get worse and I could buy the same company for a lower price at some time in the near future?” 

Right now, the probability of this happening is still apparently large enough that it is causing these business leaders to hesitate to commit on acquisitions…or capital investment. 

I keep asking people to name one person in a position of political authority in the world that they would apply the title “leader” to…and I keep coming up with silence.

Unfortunately, I don’t believe that business leaders are going to commit resources until some sort of political leadership is forthcoming. 

I still believe that we can look at how corporations are using their “cash” as an indicator of future economic performance. 

For right now, though, the “cash” stays on the balance sheets!

Mr. Bernanke Gets His Way

Well, Mr. Bernanke has moved the Federal Reserve to a position of greater transparency. 

We now have projections of interest rates out until the end of 2014.  It is now believed by most members of the Fed’s Open Market that the Federal Funds rate will remain close to zero until the end of 2014.

What is the probability that the Federal Funds rate will be close to zero for the last six months of 2014?

In my mind, zero or close to it!

What is the probability that the Federal Funds rate will be close to zero for the first six months of 2014?

In my mind, zero or close to it!

What is the probability that the Federal Funds rate will be close to zero for the last six months of 2014?

You guessed it!

And, so on…

Seems like I don’t have a lot of confidence in these forecasts. 

What are these forecasts for, then?

I have already written my answer to this question.  These forecasts are to make Mr. Bernanke feel better. (http://seekingalpha.com/article/317453-bernanke-transparent-about-his-lack-of-self-confidence)

Mr. Bernanke doesn’t want to be misunderstood.  Apparently, in the past, Mr. Bernanke feels that he has been misunderstood.  Now, with the “new transparency” there should be no doubt where Mr. Bernanke and the Fed stand…and Mr. Bernanke should feel justified.

This is the first time in my mind that the Federal Reserve has done something of this magnitude so as to make the Chairman of the Board of Governors feel better.

I hope it achieves its goal because as far as I am concerned this new transparency program does absolutely nothing for me in terms of understanding where interest rates are going to be for the next two to three years.  It does absolutely nothing for me in terms of understanding what the monetary policy of the Federal Reserve is going to be for the next two to three years. 

If anything this new transparency program will assist, in the shorter-term, speculators in making lots of money.  George Soros, and others like him, loves a situation in which a government says it is going to maintain a price for as long as it can.  This type of government activity creates “sure thing” bets. 

The economy is in the condition it is in because there is still a lot of insolvency around.  By keeping short-term interest rates as low as they are helps financial institutions and other private or public organizations remain open hoping that they will be able to work themselves out of their insolvency. 

According to a report released Wednesday put together by the American Bankers Association and State Bankers Associations, thirty percent of the commercial banks reporting were under some form of written agreement with regulators.  A total of 1000 banks responded to the survey, so the study should be fairly representative.  Extrapolating this to the total number of banks in the banking system we would get some 1,900 banks under some kind of agreement with the regulators.   

This is when there are still some 864 commercial banks on the FDIC’s list of problem banks, which we know does not include all the banks under some kind of agreement with the FDIC. 

Many home owners still find the market values of their homes below the amount of the mortgage that exists on the property.  Commercial real estate loans are still defaulting at a very rapid pace and many businesses are declaring bankruptcy or are near filing for bankruptcy, especially small ones.

It is understood that the Federal Reserve must continue to protect against further economic deterioration and must continue to protect those individuals and institutions that are insolvent or near insolvency. 

Because of this and the consequent slow pace of economic growth the Fed must continue to keep the economy excessively liquid.

I don’t know that publishing interest rate forecasts for the next three years will convince us any more that the Fed is attempting to protect the banking system and the economy.  I guess it must help Mr. Bernanke to sleep better to know that he is releasing all this information even if it does little or nothing for anyone else.           

European Defaults: Portugal is Next After Greece

It ain’t over until it’s over…

The yield on the 10-year Portuguese government bond closed above 14.80 percent yesterday, a new record for the euro-era. 

“The markets are pricing in a Portuguese default with 10-year bonds trading at about 50 percent of par, a deeply distressed level in the eyes of many investors.” (http://www.ft.com/intl/cms/s/0/49916f7a-468a-11e1-89a8-00144feabdc0.html#axzz1kTbnc8Yy)

“Friday the 13^th may be an unlucky omen for Portugal.  On that day, almost two weeks ago, Standard & Poor’s became the last rating agency to downgrade Lisbon to junk, marking the moment for many investors when default looked inevitable for Portugal as well as Greece.” 

For more on this see my post on blogspot “Credit Downgrades and Europe” for January 16, 2012. (http://maseportfolio.blogspot.com/).

The downward spiral in defaults will continue as long as Europe fails to honestly face its problems. (See my post on blogspot for January 25, 2012 titled “How Long Will Europe Continue to Lie to Itself”: http://maseportfolio.blogspot.com/.)  

In the past, analysts, including myself, tried to explain what officials in Europe were doing by casually remarking that their actions amounted to “kicking the can down the road.”  Basically, the actions of the European officials were an effort to postpone dealing with the real issues, hoping that by delaying what was needed to be done the situation would eventually correct itself.

Now, it seems that the days of “kicking the can down the road” are reaching a climax. 

European officials hope to reach a deal on the Greek debt situation by the end of this month.  The current write down seems to be somewhere around 50 percent of face value, but there still remain issues to be decided like whether or not the European Central Bank will have to write down the Greek debt it has on its books. 

Bond markets have responded to this reality by dumping Portuguese debt.  Note that the yield on the ten-year government bond was about 10.40 percent (compared with 14.80 percent yesterday) around the middle of November, a time when it still seemed that maybe the European Union might be able to pull things together and avoid a Greek default. 

As the officials of Europe finally seriously travelled down the path to restructure Greed debt, the price of Portuguese debt started to weaken.  The price declines accelerated, as the possibility of a Greek write-down became more of a reality.  Today, the yield on the 10-year bond was around 15.00 percent.

I know that governmental officials hate to give in on these write-downs because they hate to concede to the “bond markets” and “speculators”. 

It is hard for governmental officials to admit that maybe the “bond markets” and the “speculators” might be right. 

It is a very difficult lesson for governmental officials to accept the fact that they cannot continue to cater to their constituencies with jobs and other benefits ad infinitum.  Over the longer-run, either taxes have to be raised or money has to be printed because the bond markets will not continue to underwrite debt that will be repaid, both principal and interest, by the issuance of more debt.

The economist Hy Minsky referred to this kind of debt financing as a “Ponzi” scheme.

 “Ponzi” schemes come to an end and the end cannot just be blamed on the “bond markets’ and the “speculators”.  In fact, the governments just line the pockets of the “bond markets” and the “speculators” by extending their uncontrolled spending until the collapse of the market becomes a “sure thing.” 

So the charade continues and Portugal seems to be next. 

Who will follow Portugal?  Spain…or Italy…who knows?

Yet, this is not the only concern that many of these officials are facing.  The austerity programs enacted by governments throughout Europe are not setting well with the people.  There is “discontent” and “upheaval” arising in many countries.

“The only consistent messages seem to be that leaders around the world are failing to deliver on their citizens’ expectations and that Facebook, Twitter, and other social media tools allow crowds to coalesce at will to let them know it.  That is not a comforting picture for the 40 heads of state  or leaders of governments who are attending the World Economic Forum (in Davos, Switzerland)…”  (http://www.nytimes.com/2012/01/26/world/europe/across-the-world-leaders-brace-for-discontent-and-upheaval.html?_r=1&scp=1&sq=across%20the%20world,%20leaders%20brace%20for%20discontent%20and%20upheaval&st=cse)

The situation is quite uncomfortable.  But this is what happens when you fail to deal with a problem…when you continually try to “kick the can down the road.”  The situation does not go away and the delay in dealing with the situation often turns out messier than if the situation had been dealt with earlier. 

The only way for the officials to resolve a condition like this is to get in front of it.  I don’t see anyone around in a position to do this.  The only real possibility is Merkel but the resentment that already exists against Germany makes it that much more difficult for her to achieve what is needed. 

If no leader arises then the defaults will continue…and the austerity will grow…as will the “discontent” and the “upheaval.” 

“Europe risks being handicapped if it doesn’t deal decisively with this challenge to democracy.”  Thought provoking way to end the New York Times article.    

How Long Will Europe Continue to Lie to Itself?

“Bank Seeks To Avoid Taking Loss On Bonds.”

So reads the headline for the New York Times article on the dilemma of the European Central Bank. (http://www.nytimes.com/2012/01/25/business/global/eu-officials-continue-to-press-for-a-quick-deal-on-greek-debt.html?_r=1&ref=business)

“European leaders have begun discussions with the European Central Bank on several options that might keep it from having to take a loss on its 55 billion-euro portfolio of Greek bonds.”

“The deal could address what has long been one of the more vexing questions in reaching a broad agreement on reducing Greece’s mountain of debt: how to get the central bank, the largest holder of Greek bonds, to participate in a debt restructuring without having to take a large loss that would have to be covered by European taxpayers, German ones in particular.

Private sector investors, including large European banks and hedge funds, have complained bitterly—and in some cases threatened legal action—over the central bank’s insistence that its 55 billion euros in Greek bonds were exempt from the loss that the private sector is facing, which some have estimated at 60 cents on the euro.”

The European Central Bank cries, “You can’t hold me responsible for my actions!”

There are articles all over the place on this issue. 

For example, on the front page of the Financial Times: “IMF urges ECB to take a hit on 40 billion-euros in Greek bond holdings.” (http://www.ft.com/intl/cms/s/0/74d2b31a-46b2-11e1-bc5f-00144feabdc0.html#axzz1kTbnc8Yy)

Greek debt will be written down…finally.

But, will people still be avoiding reality in some affected areas?

And, remember, this is all voluntary to avoid kicking off the credit default swaps outstanding…what a crock!

Still on the list of lies…Portugal…Spain…Italy…

Lies have a long life and can come back to haunt you in many…often, unfortunate…ways.  Just ask people up at Penn State these days. 

The resolution of a situation in which people cover up and try to avoid the truth never ends well.  The leaders (and I use this term lightly) of Europe that are perpetuating this comedy continue to draw it out as long as possible. 

The problem is that the European dilemma will continue to exist until it is dealt with.  For more on this see my blogpost “Credit Downgrades and Europe” posted on January 16, 2012 on my blogspot site (http://maseportfolio.blogspot.com/).  

The Outlook for Mergers and Acquisitions in 2012

The key issue in the area of mergers and acquisitions in 2012 is still uncertainty. There seems to be a lot of anticipation that the activity in this area could pick up during the year, but, like last year, there may be little to come of it. (http://www.ft.com/intl/cms/s/0/a29392 10-41d0-11e1-a1bf-00144feab49a.html#axzz1jqA4rKTp)

Many corporations still seem to have a “ton” of cash around.  Furthermore, the corporate bond market is flush; companies “sold $44.2 billion of both high- and low-rated corporate bonds this year, the highest on record for the time period….” Investors are “snapping up bonds…pushing the cost of borrowing for some issuers to record lows.” (http://professional.wsj.com/article/SB10001424052970203750404577171341742782200.html?mod=ITP_moneyandinvesting_3&mg=reno-secaucus-wsj)

“The yield on below-investment-grade, or ‘junk’ bonds fell to 7.93% Wednesday, the lowest since August 5 according to a Barclays Capital index.  An index for investment-grade bonds, which are of a higher credit quality, was at 3.62%.  In comparison, on Thursday the 10-year Treasury note yield rose to 1.972%.”

Funds are available. 

Corporate breakups are likely to continue or even accelerate in 2012.  Economic growth is not picking up speed.  Europe looks as if it is in another recession and this does not bode well for the rest of the west.  Companies are finding that the conglomerate structures they built up in recent are not very helpful in times like these, especially for those organizations that are suffering under the burden of too much debt. 

The western world is re-grouping from the excesses of the past ten to twenty years.  Those that still have the time to adjust are downsizing…laying off employees and discarding non-central businesses.  Those that don’t have this time are attempting to sell outright.

Those looking for deals have the ammunition to pull off these deals and they know that this is a “buyers” market with depressed valuations available.  They have the capability of being aggressive.   Whether or not they activate this aggressiveness is another question.

This is because a cloud remains over the M & A market, a cloud that kept many firms on the sidelines in 2011.  First off, a great deal of uncertainty exists with respect to the future of the economy.  Government stimulus policies, both monetary and fiscal, have not worked to any degree and it is debatable whether or not any additional actions will achieve much more.

In addition, Europe appears to be in recession right now and, given its sovereign debt crisis and the state of its banks, any recovery seems to be some way off.  It is uncertain how the situation in Europe might play out in the United States. (http://seekingalpha.com/article/317268-issue-number-1-for-2012-recession-in-europe)

Second, there is the upcoming election in the United States.  The uncertainty surrounding the policies of the American government with respect to business and finance over the past three years has been enormous…and largely uncalculable. At this time, we just don’t know how much the uncertainty in this area has retarded the recovery of American business and economic growth. 

Further uncertainties exist with respect to the impact of other actions of the federal government in areas like health care, the environment, and foreign affairs.  Some people are just learning about the expenses they are going to have to absorb with respect to Medicare, doctors fees, and health insurance.  As people learn more and more how their budgets are going to be affected, adjustments will be made to spending patterns and they won’t be up.

Third, in addition to the uncertainties created by new financial regulations and the complexity of these new regulations, there appears to be a growth in the government’s application of the anti-trust laws.  The recent treatment of the AT&T/T-Mobile merger is a case in point.  The government, ‘feeling its oats’ from this action, will probably step-up its aggressive behavior in this area, leading to even greater uncertainty relative to M&A activity.

Early in 2011, it looked as if there might be a big pickup in merger activity for the year.  Many of the same conditions we see today existed at that time.  And, what happened?

M&A activity did pick up in 2011 from previous years but we did not see the ‘big jump’ that many of us expected.  Instead of buying companies, many firms used their cash on hand or their ability to borrow at ridiculously low interest rates to buy back their stock.  This, of course, helped stock prices but it did not help the economy.

But, even a pick up in M&A activity will not do a lot to help the economy, especially in the short-run.  Buying companies outright or buying pieces of companies will initially result in efforts to achieve greater corporate efficiencies, higher levels of productivity, and will mean more reductions in employment.  This is a part of the “creative destruction” of a market economy.    

And, this should not be surprising.  The American economy has been subject to fifty years of credit inflation.  In such a time, among other things, businesses come to focus more on finance rather than production, they acquire other businesses that are not related to their core operations, and they hoard labor. 

The other side of the business structure created by credit inflation is the need to unwind and restructure what was built earlier.  That is what we face now. 

Let’s hope the boom in M&A business does take place.  Let’s hope that the corporate cash and corporate borrowing do not go just to corporations buying back their own stock.  Let’s hope that the unwinding and restructuring takes place because that is one prerequisite for business to get back to the capital investment activities that do drive economic growth. 

What's to Like About the United States Banking System?

I really don’t see much to like in the United States banking system. 

With interest rates so low across the board, commercial banks have very little interest rate spread to work with.

With Congress and the regulators so screwed up and yet so anxious to pass laws and regulate, the “regulatory risk” and the “complexity risk” facing the industry is enormous.

There is still plenty of evidence that commercial banks have a lot of unrecognized overvalued assets on their balance sheets. (http://seekingalpha.com/article/320370-bank-stress-tests-a-substitute-for-mark-to-market-accounting)

There seems to be growing interest in suing banks that are alleged of “making misleading public statements as the property market crumbled in 2007 to hide internal downgrades of loans from investors” (http://professional.wsj.com/article/SB10001424052970203735304577169360314402158.html?mod=ITP_moneyandinvesting_2&mg=reno-secaucus-wsj) or for other reasons that banks failed to appropriately disclose their financial condition.  There are also other settlements coming related to bank lending practices in the 2000s.

Bank earnings are a mixed bag, at best.  The larger banks are not performing well because trading profits and profits on many non-traditional banking operations are off.  (See JPMorgan and Citigroup)  The returns to trust banks (BNY Mellon, State Street Corp. and Northern Trust Corp.) are sagging because these institutions have taken a “defensive position” with respect to the financial markets and shifted a substantial amount of funds into cash and ultra-safe assets. (http://www.ft.com/intl/cms/s/0/140b9e70-41da-11e1-a586-00144feab49a.html#axzz1jqA4rKTp)

Only the banks that have stayed pretty much as traditional banks (like Wells Fargo, U. S. Bankcorp, and PNC Financial Services Group) have held up, profit-wise, in recent periods. This performance seems to be connected with some minor pickup in loan growth. 

Even in the case of loan growth, analysts are relatively pessimistic about the future.  “It appears that much of the commercial loan growth we have seen at the large cap banks is coming from large corporate syndicated lending.  Not all banks are players in this market.” This from Christopher Mutascio at Stifel, Nicolaus & Co.  Note that Mutascio is expecting “total loan growth and commercial loan growth” to slow in 2012.  No bounce here. (http://professional.wsj.com/article/SB10001424052970204555904577168510658669178.html?mod=ITP_moneyandinvesting_2&mg=reno-secaucus-wsj)

In my most recent blog I discussed the effort of BankUnited, a Florida-based bank, to sell itself because of the condition of the banking industry, especially in Florida.  BankUnited wanted to grow and yet could find no other banks to acquire…and they had looked at about 50 banks in the Florida region and elsewhere.  Because of the state of the banks available to acquire, BankUnited decided to sell.

Well, yesterday, BankUnited pulled itself “off the market”.  The bank had attempted to set up an auction for itself but only Toronto-Dominion Bank and BB&T Corp. submitted preliminary offers.  These offers did not come up to the price of that BankUnited received when it went public last year.  Thus, the bank withdrew its offer to sell. (http://professional.wsj.com/article/SB10001424052970203735304577169400198108514.html?mod=ITP_moneyandinvesting_1&mg=reno-secaucus-wsj)

Some of the banking statistics reflect the stagnant nature of the banking system as a whole.  For example, total commercial banking assets in the United States rose by about $700 billion last year. 

Note, however, that cash assets at commercial banks rose by about $515 billion!  That is, almost 75 percent of the growth in bank assets came from an increase in the cash holdings of the banks. 

Also, note that about 80 percent of this increase in cash assets at commercial banks in the United States occurred at foreign-related financial institutions. 

Furthermore, these foreign-related financial institutions increased their commitment to Net Deposits Due to Foreign-related offices by almost $650 billion.  Thus, these foreign related institutions took U. S. dollars and shipped them off-shore!  Thank you Federal Reserve System!

In all, the share of United States banking assets going to foreign-related financial institutions rose from about 11 percent to almost 15 percent from December 2010 to December 2012.  The largest twenty-five domestically chartered banks in the United States continue to account for almost 60 percent of the banking assets in the country.  The smallest domestically chartered banks (about 6,300 of them) continue to shrink as a proportion of banking assets. 

The American banking system is welcoming more foreign-related financial institutions to the ownership of its assets…note that one of the two bidders for BankUnited was Toronto-Dominion Bank…and is also seeing more and more of its assets being held by larger banks.

Right now, the commercial banking system seems to be going nowhere, just restructuring. 

This is just a very, very tough time for the banking system.  It is a time of transition.  The whole industry is changing. (http://seekingalpha.com/article/319449-the-banks-they-are-a-changing) But, then, the whole world seems to be going through a period of transition.  

Bank Stress Tests: A Substitute for "Mark-to-Market" Accounting?

“The FDIC Board yesterday issued a notice of proposed rulemaking that would require FDIC-insured state nonmember banks and state-chartered savings associations with more than $10 billion in total consolidated assets to conduct annual capital-adequacy stress tests. As of Sept. 30, 2011, the FDIC regulated 23 state nonmember banks with more than $10 billion in total assets. 

The Dodd-Frank Act-mandated proposal defines the term “stress test”; establishes methodologies for conducting stress tests that provide for three different sets of conditions, including baseline, adverse and severely adverse conditions; establishes the form and content of a stress-test regulatory report; and requires covered banks to publish a summary of stress-test results. 

The proposal is similar to one the Federal Reserve published in December.”  (Daily Newsbyte release of the American Bankers Association, January 18, 2012)

The commercial banking industry has not wanted to adopt “mark-to-market” accounting.  There are several reasons bankers do not want to do so, but, in my mind, the most prominent reason is that they don’t want to be accountable for taking on risk…both credit risk and interest rate risk.

Remember, I have been a banker for a large part of my professional life.   

Generally, you hear bankers complain about mark-to-market accounting after-the-fact.  That is, they complain when the value of their assets have declined.  The decline in the value of an asset has either come because the asset has “gone bad” (for whatever reason), or, because interest rates have risen and the price of a security has declined.  

In the first case, the argument forthcoming from the bankers is that either the asset needs time for the economy to recover or the asset needs time for the bank to help “work out” its problems.  In the second case, bankers argue that they will hold the asset to maturity so that no capital loss will need to be realized on the asset. 

Thus, the bankers have put on assets that have higher than average credit risk or long term assets that possess interest rate risk and have not had to account for any increase in the over all riskiness of bank assets until they either write off the asset or sell the asset for a price that is below its purchase price.

But, that can mean that there are a lot of “over-valued” assets on the books of the banks.

Because banks do not have to mark their assets to market, the banking system can have lots of “zombie” banks around, banks whose financial condition is unknown to their investors or depositors. (http://seekingalpha.com/article/319205-there-are-still-zombie-banks-around)

The presence of these banks, and not just the largest banks, can be noted in the Wall Street Journal article about Florida’s BankUnited. (http://professional.wsj.com/article/SB10001424052970203735304577167241414198390.html?mod=ITP_moneyandinvesting_0&mg=reno-secaucus-wsj) The BankUnited situation is unique in that it is a bank that was acquired by an individual, John Kanas, and a group of private-equity firms.  BankUnited was a failing bank that was purchased from the FDIC and made into a profitable organization, one that is well capitalized and growing. 

Yet, the desire was for the bank to grow more, and grow by acquisition, but this has not been possible because “other Florida banks are either too sick or too expensive…“Mr. Kanas’s team has examined more than 50 potential targets in the past few years but pulled the trigger on just one.” 

The banking system is still not healthy and when “outsiders”, like Mr. Kanas and his team, actually get to review the assets of a bank during a due diligence, they find out just how fragile the banking system is. 

The original acquisition of BankUnited was done in an assisted deal that “The FDIC estimates that the failure will ultimately cost its deposit-insurance fund $5.7 billion.”  Deals are still being made for “failed” or “troubled” banks, (there are still about 850 banks on the FDIC’s list of problem banks) but the efforts to complete them and the frustration connected with “the regulatory red tape that is increasingly gripping the industry” are costly and tiresome.

Mr. Kanas is in the process of selling BankUnited and is leaving the industry.  “’He is just tired,’ said a person who knows Mr. Kanas well.”

It seems to me that the imposition of “stress tests” on the banks with more than $10 billion in assets is a way to for the regulators to “mark-to-market” the assets of these banks!   The regulators are to see what happens to the value of the assets of a bank under “three different sets of conditions, including baseline, adverse and severely adverse conditions.”

These “stress tests” are just simulations, but, the purpose of the tests are on to determine how vulnerable banks are to changing market conditions.  In other words, are the banks sufficiently capitalized to withstand detrimental movements in financial markets.

This exercise basically “marks-to-market” the loans and securities held by a bank under different scenarios.  And, the exercise is conducted by the bank regulators and not by the banks themselves.  Furthermore, the Dodd-Frank mandate “requires covered banks to publish a summary of stress-test results.”  That is, the results of these tests cannot be hidden.

Because the commercial banks would not reveal their risk exposure voluntarily and of their own making, the regulators will now design the tests relating to the risk exposure of the banks and will force the banks to reveal the results of the tests publically.

One just wonders how long it will take for the regulators to extend these “stress tests” to all financial institutions with assets of $1.0 billion or more.  And, then...

I hope the bankers are happy with the consequences of their failure to disclose!