Zombie Dance Party: Same Girls, New Music

rcwhalen's picture


"As long as the music is playing, you've got to get up and dance. We're still dancing.”

Chuck Prince

CEO, Citigroup

Bloomberg News reports that Bank of America Corp. (BAC), the best performer in the Dow Jones Industrial Average for 2012, has more than doubled since the start of the year “as the company rebuilds capital and investor confidence.”

My friend Meredith Whitney just upgraded BAC to a “Buy,” a call that is a little late given the stock’s performance to date.  But at just 0.5x book value, to be fair to Meredith, you could argue that the bank is still undervalued.  And many people do in fact believe this.  If we accept the basic bull market thesis for BAC being touted by Whitney and others, what is a reasonable valuation for BAC?  

Let’s set some assumptions.  

First, if you believe the bull market thesis for BAC, you must assume that the bank is going to prevail in the massive litigation it faces with respect to legacy mortgage securities.  This is a considerable assumption, but Whitney and the rest of the Sell Side analyst community seem to already have taken this leap of faith.  For the sake of their clients, let’s hope they are right.  

BTW, watch some of the more critical bank analysts ask BAC and other TBTF banks about the adequacy of reserves for civil litigation and put back claims by Uncle Sam in the Q4 earnings calls this January.  

Second and more important even than the litigation is the question of business model. Earlier this week, BAC CEO Brian Moynihan said that he was satisfied with a high single digit market share in the US mortgage sector.   Wells Fargo (WFC) is close to 40%.  BAC at < 10% market share nationally is perhaps a more profound assumption than the question of the BAC mortgage litigation.  BAC was once the dominant player in mortgage lending, both directly and through third part originations (TPO).  To have this bank’s huge balance sheet at such a low level of deployment is bad for the real estate market and for future earnings.  

Thanks to Senator Elizabeth Warren (D-MA) and the ill-considered Dodd Frank legislation, the TPO market has virtually disappeared.  The lending capacity once represented by Countrywide, WaMu and Lehman Brothers is gone.  BAC is still purchasing some production from outside providers, but the volumes are miniscule compared with the pre-2007 period. Thus the question comes: When Street analysts are showing a positive revenue growth rate for BAC and its peers, from where precisely is this revenue going to come?

Because of Dodd-Frank, Basel III and the Robo-signing settlement, the largest US banks are being forced out of the mortgage market.  Earlier this week, I talked about this dynamic on CNBC’s “Fast Money.” Suffice to say that analysts who assume that BAC will double in 2013 may not understand the new drivers – or lack thereof -- of revenue and earnings in all of the TBTF banks.

That said, I think it may be reasonable for BAC and even much maligned Citigroup (C) to double in the next twelve months, but not because of revenue or earnings growth.  If BAC hits street estimates for revenue in 2013 (+3-4%), is this a sufficient driver to justify a double in the stock?  No, but a doubling of the dividend is a good enough reason for cash starved investors.  In a very real sense, the biggest driver for stocks like BAC or C is not internal revenue growth but the zero rate policy of the FOMC.

During 2012, the preferred stocks of names like BAC and C have appreciated more than 15 points in price.  Yields for preferred issuers like the TBTF banks and General Electric (GE) have fallen by almost two points.  Is this because the revenue growth or earnings of these names have been growing?  No, these metrics are flat to down.  The appreciation of these securities has been driven by the FOMC and the Fed’s ridiculous zero rate policy.  ZIRP does not create jobs nor is it helping bank revenue.  

"Reduced expenses for loan losses and rising noninterest income helped lift insured institutions’ earnings to $37.6 billion in third quarter 2012," notes the FDIC in the most recent Quarterly Banking Profile.  "Two out of every three insured institutions (67.8 percent) reported year-over-year NIM declines, as average asset yields declined faster than average funding costs."  The fact that the TBTF banks are relying on fee income and line items like investment banking to hit revenue and earnings targets is very telling.  

So when you see Sell Side analysts like Meredith Whitney being so constructive on the TBTF banks, even with the poor operating performance, investors need to ask themselves a question.  Is the prospective appreciation of BAC and C the result of strong business fundamentals?  Or is the prospective appreciation of these stocks more a case of traumatized investors fleeing to the fantail of the Titanic to avoid the icy cold financial repression of zero interest rates?  Keep in mind that most of the improvement in earnings which seems to impress Whitney and other analysts has come as a result of expense reductions, mostly credit costs.  Efficiency ratios for the large banks are over 60%, of note. 

Even if you believe that BAC is going to escape the most horrific outcome in the mortgage litigation, the valuation target that is reasonable for this bank, C and the other TBTF institutions such as JPMorgan Chase (JPM) and WFC, is probably between 1 and 1.25x book value.  So yes, given that valuation framework, you can justify a doubling of BAC from current levels to say $20-25 per share.  But keep in mind that this stock was trading at $40 back in 2008 and over $50 in 2006 prior to the acquisition of Countrywide.   Are we likely to see BAC go to over 2x book value again?  Well, maybe, but not because of strong earnings or revenue growth rates.  

Should names like BAC or C manage to get above 1.25x book, it will be because of the Fed and ZIRP.  And as and when Fed interest rate policy changes, look out below.  As I noted on CNBC, without the benefit of a strong mortgage origination and securitization business, the TBTF banks are going to become far less volatile and far more boring.  Even the marginally higher capital levels of today, pre-Basel III, will imply lower asset and equity returns.  And this is not a bad thing.   

Yet investors are really not prepared mentally or emotionally for a market where the large banks are not delivering double digit revenue and earnings growth, whether organically or via M&A.  Most institutional investors, keep in mind, have no idea how the TBTF banks actually make money.  So when well-meaning Sell Side analysts predict wondrous stock price appreciation for the Zombie Dance Queens, the proverbial sheep on the Buy Side sing with joy -- and rush into the interest rate trap so lovingly constructed by Chairman Bernanke and the Fed.  Keep in mind that the corollary of ZIRP is massive interest rate and market risk on the books of all banks.  Think trillions of dollars in option adjusted duration risk.

Without the benefit of gain on sale from mortgage origination and securitization, it is difficult to construct a long term bull scenario for any US bank, large or small.  As and when the Fed normalizes interest rates, the business models of the TBTF banks are going to be far less exciting.  Mark-to-market losses on securities will wipe out stated earnings.  New and innovative ways of presenting “pro forma” earnings will appear on the scene.  The TBTF bank CEOs will rightly blame Washington.  

In this future banking market, names like C which currently trade on a 2 beta will have higher dividends, but relatively flat earnings and revenues.  Cost cutting, not growth, will fund these payouts to investors. Occasionally you will see big numbers from these names when the investment bankers have an especially good quarter.  But overall the TBTF banks are evolving into low growth utilities with nice dividends.  This is precisely the way banks used to be before President Bill Clinton’s “Great Leap Forward” in terms of housing and home ownership.   And, again, this is not a bad thing.  

But investors in the TBTF banks need to understand that the business model for this industry has changed.  The business model for banks is going to continue to evolve away from the high-beta, high volatility model of the 2000s to something that looks more like banking in the 1950s.  The action in terms of significant volume growth is in the non-bank sector.  Get used to it.  




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otto skorzeny's picture

meredith whitney-donkey punch-nuff said

TrumpXVI's picture

Good article, but I'm skeptical that the Fed will EVER normalise interest rates.  Interest rates will rise someday, but it will be because of a revolt in the fixed income markets.  Who knows when THAT will be?

Panafrican Funktron Robot's picture

Correct.  The Fed is merely attempting to slow the rate of collapse.  Jumps in interest rates accelerate the rate of collapse.  A slower collapse rate allows for a longer theft timeline. 

Gmpx's picture

All banks should be replaced with govt computer system - a money register. All people and companies should have accounts in the govt money register. They can transact (irrevocably) and they can keep money there free of charge without any interest or fees.

This is it. Then no banks ever needed. If you need a credit go to a credit company and they will give you credit for a fee or %%. But they will make the payment from they govt base accout to your govt based account.

You can call these credit companies banks but they will have no right to print money. Money is printed by the govt only.

CH1's picture

All banks should be replaced with govt computer system

Sure, give the state complete control over absolutely everything.

That'll work out just swell.

Statism is a persistent, cultivated delusion.

The state is organized crime, but with a giant intellectual class leading public worship for it.

Gmpx's picture

Money is a part of govt. Now it is a part of govt too, but it is subconracted to banks and allowed to be manipulated, mutiplied on behalf of govt. Now govt has to borrow money and tax you to pay their debt and expenses.

I simply offer that govt removes the parasite level (banks) and uses electrocnic register instead.

In my system there is no tax. If govt needs money it prints it.

Tax goes to history.

Louie the Dog's picture

They can transact (irrevocably) and they can keep money there free of charge without any interest or fees.

Is that something like "free" healthcare?

Gmpx's picture

Transactions are electronic and they cost nothing. Accounts are electornic records and they also cost nothing.

Panafrican Funktron Robot's picture

Yes.  Also, computer terminals, bandwidth, troubleshooting, design, audit, and data warehouses, cost nothing.

Gmpx's picture

There are no computer terminals - you use your computer to access the govt register.

Bandwidth is plain html, not video, so it is low.

The system is primitive compared to any bank.

Yes, there should be an IT team of 10 guys emloyed by the govt to run the ternical part of the system.

So the cost of the system per capita is almost nothing, less than a cent.

Please also note that the system I offer eliminates tax - govt prints money when needed.

Cursive's picture


I like your idea, but some entity has to create/issue/print the money and you chose the government, which again is probably the least bad alternative.  The power to create/issue/print money necessitates the need for a policy and I would suggest that the money supply be tied to population growth, i.e. the goal would be to fix monetary growth on a per capita basis.  You would also need to ban fractional reserve lending to avoid more credit bubbles from the legion of credit companies.

Kickaha's picture

Tying the amount of money to population growth makes good sense if you view money as nothing more than a medium of exchange.  But money is more than that.  It is also a store of wealth, or at least it can be used that way by savers, and it has been used that way for centuries. You could store your wealth in commodities, but they can be expensive to warehouse, can be illiquid to a considerable degree, and have transactional costs tied to their acquisition and sale.

The proper role of lending in a dynamic economy is to build societal wealth (as opposed to making bankers and Wall St. types obscenely wealthy).  Let's say I have a small plot of land with an old chicken coop teetering on it, but have no money and no chickens.  I go to the local bank and borrow $100.00 at interest for one year.  I fix up the chicken coop, buy some hens and a rooster, buy some chicken feed, and a year later I have sold so many chickens and eggs that I easily pay back the principal and interest on the loan to the bank.  After a year, I have a thriving chicken farm, a remodelled chicken coop, and some money in my pocket, all to the benefit of society.

Fractional reserve lending is not in and of itself evil.  But it seems to encourage bankers to start lending money to people who really have no intent to use that money to increase societal wealth in any way.  After a while, you run out of ideas for investing money in ways that actually increase real wealth, but the banks want to loan out the money anyway.   If the loans are made to people who squander the money rather than putting it to use in a true investment, the banks do not get paid back, and we end up in a banking crisis.

This is particularly true if the loans are made without adequate collateral.  Looking at the history of the current crisis, we have massive unsecured credit card loans, massive unsecured student loans, and a huge housing bubble resulting in massively under-collateralized mortgage loans, and massive margin accounts whose sole use is to gamble in financial markets.

I cannot agree that restricting banks to loaning only the money they have on deposit from customers or from bank capital reserves is the best and only alternative.  Tightening up loan standards so that adequate collateral is necessary to obtain a loan would act as a control on total lending activity and remind the borrower that the purpose of the loan is to increase real wealth and to avoid losing the wealth you already own.  Leverage should also be severely limited.  Maybe create $3 for every $1 held by the bank, rather than 33:1 or 40:1.

The full extent of the money supply should reflect not only the number of people, but also the total amount of real wealth.  Tying all lending activity more closely to collateral would go far to achieve that purpose.  

Giving trillions of dollars to people, whether it comes from banks loans clearly destined for default or government transfer payments, is FUBAR.  Loaning money to people who can evidence a clear ability to take that money and produce real assets from it in an amount far greater than  the amount of money loaned, plus interest, is the only way to produce real wealth for society.

Loaning unlimited amounts of money at zero interest in return for junk collateral to entitites with no plan to utilize the money productively to increase societal wealth is the apex of financial insanity.  Yet folks wonder out loud why things haven't really gotten any better since 2008, or, even worse, try to convince other folks that things really are better while we all distractedly slide into the abyss.

Gmpx's picture

Sorry, I disagree. Fractional reserve is a problem if it is only availble for a group of people.

Fractional reserve (money creation) should be allowed to all citizens equally or it should be removed.

If system allows a small group of people to multiply money on behalf of govt they become untouchable super humans.

Gmpx's picture

No fractional reserve! Money is govt. Govt is elected. If elected govt decides to print more money than needed - you deserve it because you elected the govt.

Govt does not give out credits, it only prints as much money as it considers right. Govt can hire a formed banker Lloyd and take his advice on how much money to print. But Lloyd should not be able to print money nor get any money from govt except salary.

If Lloyd wants to run a credit company it should accumulate money from selling shares. When his company has money he can give credit to anyone on any conditions he wants.

This is very very very simple. There is nothing difficult in how to organize money system. All the difficulty is created to defraud people.

Cursive's picture

Chris, congrats on heading up Carrington's investment banking.  Fine analysis as always, though I take exception to the "utility" part or lack of volatility.  Bank profitability is phony, but that's not a news flash.  All of these banks, particularly GS and JPM have prop trading desks that could destroy the bank in one bad quarter.  Of course, any of these banks will be bailed, so no biggie.  BernanQE has created an investment environment where buying stocks, and particularly big banks, is akin to the WWII-era patriotic duty of buying government bonds.

max2205's picture

It's a trade because they won't lose their way to insolventcy, or get sued out of existance, and there is always a bottom to trade.

What they won't survive is another crisis before they get right sized which may take 3 more years. No crisis in 3 years, that's the bet

fourchan's picture

all banks are insolvent as long as mark to market is suspended.


more dumb smart people missing the forest for the trees.

Kickaha's picture

I used to believe as you do.  Now I would like to see some facts.  Of course, no facts will ever be forthcoming, but with the Fed buying up paper spew at face value from its constituent banks at the rate of $85B per month, there is a good chance that all of the worst financial paper on the banks' balance sheets is now inside the stomach of the Fed.  There is a lot more for the Fed to swallow, but we very well may have passed the point where the majority of the banks listed assets might actually have some value in the current market, if only because you can transfer them to the Fed for a lot of fiat currency.

As for the business model that will produce profits for B of A, it's siimple.  Get money from the Fed at 0.25%.  Put it back on deposit at the Fed for 3.00% interest.  Diversify a little by having your proprietary desk invest in equities, which now only go up in value due to massively excess liquidity.  Loaning out money for mortgages or for any other reason has become irrelevant to the bottom line in the Age of ZIRP.

The crisis in 2008 was described as the imminent risk of a total collapse of the banking system.  The solution was to use a scheme too complex for the average person to understand to recapitalize the TBTF banks at the expense of everybody else.  If you are a banker, this makes perfect sense, because you truly believe the world would stop spinning in your absence.  If you are a politician, this also makes perfect sense, because you can reward your major campaign contributors without losing the sheeple votes you need to remain in office indefinitely, or until TSHTF, whichever comes first.



Hobbleknee's picture

Why would the banks evolve?  Everything is working fine from their perspective.  Profits are privatized and losses are socialized.  They commit fraud on a global scale without any negative consequences (to themselves) except for the occasional fine (pay-off) to the government (mafia boss). Bankster life couldn't be better. 

LongSoupLine's picture

Fucking spot on!

Only thing that can stop banks is outrage in revolutionary form from the people.
However, I have seen the "people" based on the last election, and have determined we are completely fucked. Hence, silver.

Hobbleknee's picture

If the people ever get enough balls to revolt, the propaganda machine will place blame on someone else and the sheeple will fall for it.  Not only will the bankers remain protected; they will also profit from the fake revolution on all sides.

fourchan's picture

the system of enslaving a free people to debt and capturing all assets is in full effect as it has been fo 98 years.


that is the fed res SYSTEM.