Traders Forecast Banking Stress to Last To End of 2010

The Financial Times reports that despite the snappy rally in bank stocks in the US, which may have been partly fueled by short covering, money market traders expect banks to face rough sailing till the end of 2010.

From the Financial Times:

Traders are betting that the credit crunch will still be hurting banks at the end of 2010 with financial institutions expected to be scrambling for cash to shore up their end-of-year balance sheets.

A popular so-called butterfly trade in the money markets is showing expectations of three to four times the stress at the end of 2010 as before the credit crisis started to bite last summer, although it implies the situation will have improved sharply compared with today.

Many executives are assuming the credit crunch will not carry on that long, although the majority of financial services senior managers believe it will take more than six months, according to a CBI/PwC survey last month.

Laurence Mutkin, head of European rates strategy at Morgan Stanley, said money markets were pointing to long-running financial strains. “The market expects that these stresses will persist,” he said. “It is saying the system survives but individual institutions will have to fight hard to be among the survivors.”….

Other measures of stress are running at high levels. The spread between the overnight index swap rate and Libor, the rate at which banks lend to each other, a spread seen as a pure measure of the risk, is seven to eight times as high as before the crunch. But it remains below the spikes prompted by fears of a complete collapse in the financial system last summer, at the end of last year and just before Bear Stearns was rescued in spring.

In case you took cheer from the Wells Fargo earnings report, which was the trigger to the rally in financials, consider this tidbit from Housing Wire:

Despite the optimism, a burgeoning portfolio of second-lien mortgages at Wells Fargo that had in recent weeks concerned analysts and investors hasn’t gone anywhere; and, if anything, Wednesday’s quarterly result also holds evidence that the credit losses in that particular portfolio have yet to fully reverberate throughout the bank.

Wells has a substantial $84 billion portfolio of home equity loans — and half of those are located in hard hit states like California and Florida; of that total, it has carved out the worst $11 billion for liquidation, with rest remaining as part of its “core” home equity portfolio.

In the second lien portfolio set up for liquidation, the percent of loans that saw borrowers miss two or more payments rose during Q2 to 3.6 percent, up from 2.79 percent one quarter earlier. The $73 billion “core” home equity portfolio saw a similar rise to 1.88 percent in 60 day delinquencies, compared with 1.71 percent in Q1.

So delinquencies continued to rise during Q2; net credit losses, however, did not. Charge-offs on second liens were actually down $104 million compared with first quarter 2008 — but don’t let that fool you. The improvement was primarily due to a change in how the bank handles its home equity portfolio charge-offs; earlier in Q2, the bank extended its charge-off policy from 120 days to 180 days, in an effort to give troubled borrowers more time to reach a loan workout (or to protect earnings, take your pick)…..

As second lien borrowers see equity in their homes evaporate due to price depreciation, second liens become extremely vulnerable to loss.

Which is why this stat matters more than most: approximately $35.6 billion of Wells Fargo’s $84 billion in home equity loans had combined loan-to-value ratios above 90 percent, according to the second quarter report. And that’s a figure based on automated value models, or AVMs, that were run in March 2008; were those AVMs run again today, it’s almost a sure bet that the number has gone up even further.

Of course, seconds are only one part of the equation here. Wells boosted its total loss reserves to $7.52 billion during the quarter, compared with 6.01 billion one quarter earlier; against that, overall non-performing assets (including seconds) rose to $5.23 billion, up from the $4.5 billion recorded during Q1. Which means that loss reserves are well ahead of NPAs, a good trend.

Maybe I am old fashoined, but I don’t see increasing a dividend when earnings are falling as a good move in general, and in particular in an environment as fraught as this one. Presumably, it was done with the intent of boosting the stock price. That gamble might pay off if it helps Wells raise equity this quarter. Otherwise, it looks to be an unnecessary risk.

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  1. Richard Kline

    Sooo the major ‘positive’ for Wells in Q2 is that they awarded _themselves_ a 60-day mulligan on booking delinquincies, if I read this. And the only minor positive is that they boosted loss reserves for equity seconds by a measly billion. Well, one wouldn’t want to scare off potential suckers, ahhhhh ‘investors’ during the all important courting season, now would one? Anyone wanting equity in Wells can buy it in six months for nickels and dimes to present face; why buy now, what’s the rush?

    On another note, I found the list of No-No Shorts put out by the Wealth Protection Squad at the SEC interesting: it announces in effect the nineteen international major lenders which are by consensus too big to fail. Interesting omissions from that were WaMu, Wachovia, and if I’m remembering HBSC, something I noticed but regarding which Mike Shedlock has popped up a post on as well. We can expect full public bailouts at many of the Sacred Nineteen in time to be at least proposed, but evidently the remainder have been left to the zombies. Nasty bit of triage, this.

  2. Ranger Turtle

    Wells Fargo isn’t even getting the protection that other banks are getting on the newly announced SEC Naked Short Seller Protection List!

    Goldman is protected but not Wells or Wamu or Wachovia.

  3. Anonymous

    “I don’t see increasing a dividend when earnings are falling as a good move in general.”

    Me neither. The market saw it as a strong statement of confidence — and it is. But managements have been mistaken before. COO Howard Atkins implied in a CNBC interview, using roundabout language, that Wells Fargo expected a bottom in housing not too long from now.

    Please tell me that Wells Fargo management didn’t grant themselves options with Tuesday’s close as the strike price!

  4. Hubert

    2 notes on that “Naked shorting short list”:

    How come nobody (except David Merkel) notes the irony that some of those 19 institutions are prime brokers which made a shitload of money by circumventing naked short selling rules?

    I am not an expert on this and I would welcome arguments on the short covering rush we see now:
    Even the people who borrowed the shares they sold short now are in trouble – there is no brokerage guarantee that the shares stay borrowable – and they now face competition from Naked shorts for their shares. Artificially compressed into a few days this is explosive stuff.
    I guess Richard Kline is right about the drift down but until option expiration tomorrow or early next week we could see fireworks on the upside thanks to skillfull manipulation.

  5. Anonymous

    Are you guys maybe too focused on Wells’s Balance Sheet? Even after a $3bn provision (including 1.5bn provision build) they still made almost $2bn. They have pre-tax pre-provision income of $5.6bn (over $20bn annualized). Yes, they do have alot of crappy loans. But they are also still making a crap load of money, even after amortizing all of those crappy loans.

    Anyone who thinks this goes to into the “nickles and dimes” is delusional. Buffett has a ton of cash ($40bn+) and he has a long demonstrated love affair with this bank. He’ll buy it all if it gets cheap enough.

  6. Andrew Clifford

    We keep seeing distressed companies pay dividends even though they desperately need the capital. Keeping the share price propped up ahead of any capital raising is a good theory. More pressing is that directors renumeration (bonuses and share options) are tied to share price. So they are incentivised to act in their own interests, against the interests of the company. Particularly if the company has been run into the ground and the game is almost up.

  7. Anonymous

    Money market rates and yields are very low today and with more bank consolidation, rates and yields will go lower, which will make extend time and challenge to obtain future cash flows. This is essentially a liquidity trap that will take several years to recover from.

  8. Anonymous

    If Wells Fargo gets cheap enough, we’ll all be able to afford it. It’s only the fourth inning in this financial debacle. The Fed and Congress are proving useless and, in fact, making things worse by throwing good money after bad.

    Wells Fargo is one of the better banks, but with no help from the government, the effect of a deep recession on employment and the consumer’s ability to pay, more subprime and ALT loans going bad, as well as A loans defaulting, due to falling property values (those who put down 10-20% will be walking next) increasing loan to value ratios, Wells Fargo will be in dire straits.

  9. Anonymous

    Maybe I am old fashoined, but I don’t see increasing a dividend when earnings are falling as a good move in general, and in particular in an environment as fraught as this one. Presumably, it was done with the intent of boosting the stock price.

    I disagree. The dividend increase was not that significant in dollar terms. However, it was significant for its shock factor.

    I think it was done with the intent of gaining market share while their competition is weak.

  10. Anonymous

    That’s the sort of thinking that has gotten the US in the mess it is in. Run companies on a short term basis, to please Wall Street, rather than do what is best for the business.

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