C.M.O. 12.22.2009
Credit Market Overview
December 22, 2009
Winston Churchill served as Prime Minister of the United Kingdom from 1940 to 1945 and again from 1951 to 1955. He is probably most remembered for his leadership during WWII, pulling Great Britain and Europe as a whole through the fight as if by the sheer force of his grit and determination.
He was again elected PM in 1951 but by this point the British Empire was in decline and although he attempted to save it, the nation’s imperial prestige and power were waning.
Although not an elected official, Paul Volker used his position as Chairman of the Federal Reserve under Jimmy Carter and Ronald Reagan (8/1979 – 8/1987), to battle inflation with the same resolve and stood steadfast in the face of a Congress that would surely preferred that he went MIA.
Unfortunately the similarities between “Winnie” and Paul do not end there as Mr. Volker is once again in the economic lime light, albeit in a politically diminished role, as the Chairman of the President’s Economic Recovery Advisory Board (As I type all those words it brings to mind the theory about the length of someone’s title vs. the power they hold.) and as during Mr. Churchill’s second go ‘round it does seem as if the bloom is off America’s rose as calls for a new reserve currency and blame for the 2nd worst financial crisis in modern history batter this country’s preeminence as the world’s greatest economic super power.
Undaunted as both of these men are in the face of adversity, Mr. Volker has some strong opinions on ways of preventing the Great Recession 2.0 and they focus mainly on the role of the commercial banks in our financial system. In a recent interview in the WSJ he sums up his views on the myriad products that have been praised as financial innovation by saying that the only invention which truly deserves that acclaim is the ATM.
As a central banker Paul understands that one of they key roles played by the commercial banks is their involvement in the payment system that moves trillions of dollars between counterparties as well as providing depository outlets for businesses and individuals along with providing credit for small, intermediate and even some large companies.
This function, which PV sees as the true economic purpose of commercial banks, should be separated from the other activities they are involved in e.g. proprietary trading and underwriting securities, in his view.
After the carnage of the past two years there are four banks which Barron’s recently profiled, including them in a category they called “Big Four”. They are Bank of America (BAC), Citigroup (C), JPMorgan Chase (JPM) and Wells Fargo (WFC). The article quoted John McDonald, a banking analyst at Sanford Berstein, as saying “JPMorgan offers the best mix of offense and defense, its management has been able to focus. . . while other managements have been distracted”.
On the other end of the spectrum, it would appear from Andrew Barry’s analysis, lies Citigroup whom Mr. Barry describes as “the riskiest member of the Big Four, given its weaker near-term profit outlook and the challenge of its good-bank/bad-bank strategy of focusing on its desirable global consumer and commercial banking franchises (Thank you Mr. Volker) and its investment bank while divesting $600BN in assets”.
Of the two remaining, AB’s analysis states that BAC’s Tier One common equity ratio of 8% is higher than WFC’s 6.2% but that both appear to be adequately capitalized.
That there are only four banks that can now be called “big” brings to the fore the hotly debated topic of TBTF. What becomes a more important question is whether in protecting the last four does America take itself down in the process.
Maybe if Paul could channel Winnie we could the answers we need.
JPM closed yesterday at $41.90, the highest since 12/2 but possibly more significant was that it gapped higher on the open leaving a $0.60 difference between Friday’s close and yesterday’s opening. The CDS has been moving sideways to lower since falling precipitously after the abyss was missed in the spring. The 12/14 close of 46bps was the low for the year vs. last night’s 51bps close.
C also posted its CDS low close on 12/14 albeit at 136bps vs. JPM’s 46bps. The stock had closed at $3.20 on 12/17, a day after the equity offering that went so poorly even Uncle Sam decided not to join in. The stock has since recovered, closing at $3.42 yesterday with the CDS at 178bps.
That BAC and WFC repeat this same pattern with slightly different numbers should be no surprise as their inclusion in Mr. Barry’s “Big Four” means that while there will be some relative differences in performance, as wards of the government, there is little chance of them ever going away.
Enjoy the Holiday shortened week.
Jim Delaney
