“FDIC-insured commercial banks and savings institutions reported $35.3 billion in net income for first quarter 2012. This represents a $6.6 billion (22.9 percent) improvement over first quarter 2011 results, and is the highest quarterly net income reported by the industry since second quarter 2007. The average return on assets (ROA) rose above the 1 percent threshold for only the second time since second quarter 2007 (third quarter 2011 ROA was 1.03 percent). Quarterly net income has now improved year over year for 11 consecutive quarters. More than two-thirds of all institutions (67.5 percent) reported year-over-year improvement in their quarterly earnings, and only 10.3 percent were unprofitable, the lowest level since second quarter 2007.” [FDIC]
The investment banking sector doesn’t seem to be doing too badly either, as the following two charts from the Wall Street Journal would indicate.
“The market for Mergers & Acquisitions (M&A) is clearly improving in valuations, financing availability, and deal volume and will continue to do so throughout 2012 according to a survey conducted by MBA students and Professor Kevin J. Mulvaney at Babson College in collaboration with members of The Association for Corporate Growth and Exit Planning Exchange.
Looming clouds on the horizon may include variations in the capital gains rate, estate changes, and uncertainty about economic growth and the effect of world events on the global economy. This is the 4th year of the Babson survey which has delivered “extremely accurate” projections in its previous years said Mulvaney.
Findings That Impact Business Owners
The environment for exit continues to improve. Valuations are rising and are projected to continue to rise. The market to sell a business or restructure capital is very good. Key is getting the company’s revenue growth and EBITDA (earnings before interest, taxes, depreciation, and amortization) to acceptable standards vs. the industry average and the expectations of the buyer.” [PRNewswire]
Note that one of the things that troubles the people engaging in the M&A trade is how much they might have to pay in capital gains taxes — let’s be clear — you don’t worry about capital gains taxation levels unless you stand to earn beaucoup bucks in investment banking.
So, if the commercial banks are experiencing the best profits since things on Wall Street started to unravel in 2007, and the mergers and acquisitions are doing nicely thank you very much — then why have the Financialists been so far behind the curve?
We’re learning more about the debacle at JPMorganChase, enough to know that their $2 billion and climbing blunder stemmed from a failure to learn some of the lessons of 2007. One lesson unlearned appears to be that price doesn’t always equate to value, and all the accounting treatments in the world won’t help you if one unit isn’t sharing accurate information with the others. To wit:
The JPMorgan Chase & Co. (JPM) unit responsible for at least $2 billion in losses on credit derivatives was valuing some of its trades at prices that differed from those of its investment bank, according to people familiar with the matter. [Bloomberg]
Recall, if you will, it was not so long ago the CEO of JPMorganChase, Jamie Dimon, was moaning loudly about the capital requirements under new regulatory regimes. In September 2011, Dimon “exploded” during an IMF conference about “growth killing capital requirements.” [BusInsider] This wasn’t Dimon’s first confrontation. He questioned Federal Reserve Chairman Bernanke about capital requirements in June 2011:
“The substantive issue that seems to be bothering Dimon is capital requirements, and particularly the news that the Fed is leaning toward making large banks, such as JPMorgan, hold a 3 percent capital “surcharge” (a complete misnomer; the requirement for more equity financing relative to debt would be a buffer against losses, and not a tax.)” [Bloomberg]
Lo and behold — what would have prevented the Balaenoptera musculus* sized losses at JPMorganChase? Reliance on larger capital reserves against risks.
“Those bets, which led to $2 billion of losses, wouldn’t have been necessary if JPMorgan did what banks once did: rely on bigger capital buffers rather than credit-default swaps to hedge against souring loans. One hundred years ago the equity of U.S. lenders was about 20 percent of total assets, compared with 9 percent now, according to data compiled by the Federal Reserve. For JPMorgan, it was 7 percent last quarter.” [Bloomberg]
One finance professor summed up the problem: “Only equity capital is the true protection against losses, whether from loans or other risks,” said Admati, who has written about bank capital. “Dimon and other bank CEOs lobby against rules that would force them to reduce leverage. Then they try to hide risks through derivatives that offer more ways to borrow and speculate.” [Bloomberg] (emphasis added)
Quick translation: Dimon and other bankers are lobbying against rules that would require their banks to maintain more capital reserves, and rely less on borrowing. Instead, they played in the Wall Street Casino hoping to cover potential losses in ways that would generate more revenue. It didn’t work. All it took was one London Whale to create a multiple billion dollar mess.
All the king’s Quants and all the king’s computer models couldn’t accurately value the risk JPMorgan was taking and without an accurate account of the risk, and without adequate capital reserves which would have obviated the need for the swaps dealing, the London Whale sank the bank to the tune of at least a tidy $2 billion. There’s nothing like a little obscurity to enhance the chances of exotic deals blowing up.
“The source of JPMorgan’s problems is an obscure group of indexes that track the performance of corporate bonds. One of the indexes, the Markit CDX NA IG Series 9 maturing in 2017, is essentially a portfolio of credit default swaps – basically contracts that protect against default by a borrower. This particular index is tied to the credit quality of 121 North American investment-grade bond issuers, including such names as Kraft Foods and Wal-Mart Stores . JPMorgan used that index, and others, to bet that credit markets would strengthen. Because that position is widely known on Wall Street, many traders are betting the opposite way in the hope of profiting as the bank’s losses increase. The index has been moving against JPMorgan in recent days.” [Guardian]
Surprise? If memory serves it was trading in exotic swaps that got several large financial institutions on Wall St. in a bit of trouble in 2008? And, why were they trading in exotic swaps until their wasn’t a single stand-alone investment bank left on Wall Street? Because they chose to hedge possible losses with swaps rather than maintaining higher capital reserves.
The merger & acquisition crowd may moan to the moon that such things as increased capital requirements are “growth killing,” BUT what really kills growth are investment banking practices which reward engaging in swaps dealing rather than more conservative practices like keep the piggy bank sufficiently filled to hedge against potential sour deals. Additionally, if we want another look at what’s really “growth killing” all we need is another Wall Street investment banking fiasco generated by banks that aren’t accurately calculating their risks and aren’t doing such a hot job of hedging them either.
In short, if they’re so rich — why aren’t they smart?