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Earnings Without Revenue, Bubbles Without Credit Growth

rcwhalen's picture





 

 

“With fame I become more and more stupid, which of course is a very common phenomenon.” 

 

Albert Einstein (1879 - 1955)

 

Watching the denouement of Q1 2013 corporate earnings, one is tempted to pinch both arms in an effort to regain consciousness and perhaps an accurate perspective.   Maybe pinch is not the right term.  The world of finance is a very strange place at present, in part because traditional indicators of future earnings, revenue and growth seem to be completely divorced from reality – especially when it comes to the prices accepted by the financial markets. Global economies are weak and forward corporate revenues mostly invisible.  But financial markets are riding to new highs carried on a tidal wave of fiat money care of the Federal Open Market Committee and Bank of Japan. 

Since the trough of 2009, S&P 500 operating earnings have risen almost 100% from about $65 to almost $115, while revenue has increased about 26% from just a little over $910 to a little shy of $1,150 per share, according to the latest chart book from Yardeni Research. That is a 4:1 ratio between earnings growth and the increase in underlying revenue.  Or put another way, in 2009 there was $14 in revenue underneath every dollar in earnings in the S&P 500 vs. about $10 today.  

http://www.yardeni.com/pub/PEACOCKFEVAL.pdf

Of the 102 companies that have reported earnings to date for Q1 2013, 72% reported earnings above the mean estimate and 45% reported revenues above the mean estimate, according to FactSet.  

“Pricing power has been nonexistent [and] sales volume increases have been very limited so the only route to profit has been cutting costs. That has pushed profit margins to all-time highs,” Gary Shilling tells Bloomberg News.Shilling called the present market course “unsustainable,” a profound insight if you consider that layoffs and capital releases are the two leading components of increased corporate efficiency ratios.  Yet most of the major market analytics providers remain bullish.  

“The Financials sector has the second highest earnings growth rate of any sector at 7.1%. This marks a slight drop in earnings growth for the sector from the 16.6% growth reported in Q4 2012 and the 11.7% growth reported in Q3 2012,” FactSet continues. “… However, the first quarter is expected to be a trough in earnings growth for the Financials sector. Earnings growth is projected to return to double-digit levels for the remainder of 2013, led by companies such as Bank of America and Citigroup.”

http://www.factset.com/websitefiles/PDFs/earningsinsight/earningsinsight...

What is really interesting about the financials is that nearly 60% of the reporting companies came in with revenues below Street estimates, while almost 70% managed to beat earnings estimates on the upside.  FactSet notes that three of the bottom ten names in terms of percentage earnings misses were financials, including Bank of New York Mellon, BB&T and Bank America.   

The notion that financials can lead the way in terms of higher earnings in 2013 is more than a bit speculative, at least to this banking maven turned housing banker.  First and foremost, the US commercial banking sector has largely retraced lost ground in terms of regaining pre-crisis levels of operating income.  With ROEs in high single digits and little revenue growth, what mechanism will drive bank earnings in 2013?   And with a flat economy and so-so consumer spending activity, it seems a little exuberant to say that financials will continue to grow earnings as a multiple of flat revenue.  Indeed, volume growth is so poor in the banking sector that rising dividends are starting to actually result in negative retained earnings.

The chart below shows net operating income, dividends and retained earnings for all US banks at year end 2012, according to the FDIC.  Notice that banks are now paying out in dividends an amount that is in excess of NOI, resulting in negative retained earnings.  So much for all of that talk in Washington about higher bank capital levels.  If the largest banks are not able to grow revenues, then there is no way to build higher capital levels without radically shrinking the balance sheets of the banks.  

One of the biggest reasons that banks have been able to pay-out capital to shareholders via dividends is a general reduction in risk.  Risk weighted assets reported by the largest banks have been falling as have defaults and related loan loss reserves, resulting in higher capital levels – at least for now.  Off balance sheet leverage continues to run off with the non-agency mortgage sector.  The noxious combination of Basel III, Dodd-Frank and the state AG settlement also means that banks are providing much less credit to support the US economy.   You cannot have an asset bubble – or job growth -- in a classical sense without credit growth.  And bank lending volumes are actually falling.  Yes, falling.  Yet we have row upon row of Wall Street economists and analysts predicting near-double digit growth in bank earnings in 2013.  Hmmm.

These seemingly conflicting indicators, of rising earnings and flat to down revenues and credit volumes at banks, should be of concern to financial analysts and fiduciaries.  But since many of the prognosticators who contribute to industry earnings estimates are, in fact, economists, this is not a problem.   We can simply assume that bank earnings can continue to rise more quickly than bank revenues based upon cost cutting, layoffs and other short-term expedients.  Problem solved -- at least until the economist too joins the ranks of the “redunzl,” to recall composer Frank Zappa.  

Of course, with financials up double-digits for the year and the US economy showing signs of going into its now familiar fade after a strong Q1 performance, it is time to ask whether or not the gains should be taken from the table – with or without the Fed’s QE continuing.  Or imagine you have a 40% gain on an REO property you bought in 2009.  Do you take the cash off the table now or let it ride?

Since, as already noted, there is little or no net credit growth in the US economy, the efficacy of QE as a means for supporting higher GDP and job growth, and consumer activity and increased lending volumes, seems questionable. But of course even asking such a question is considered to be a sign of negative thinking.  Above all else we must be constructive.  After all, the first goal of FOMC policy is enhancing confidence rather than real economic activity. 

Indeed, to drive home the point about confidence, consider that one of the big drivers of performance in the financials in Q1 2013 was not the banks at all but rather non-bank financials.  The torrent of new issues for all sorts of non-bank strategies, many of these connected to the residential housing sector, has been the most interesting part of the financials complex for the past year or more.  And not all strategies are created the same.  

To that point, those selfless souls at Goldman Sachs wrote recently in a report on REO-to-Rent: “Rental yields on single-family homes, conditional on the current market prices, are compressed. Even among the 10 metro areas where our estimated 2013 rental yields are the highest, the average rental yield is only 5%.”  Goldman adds: “The REO rental yield assumes a 30% discount in acquisition price and $15,000 upfront repair costs.”   So nice to hear that caveat about expenses, especially compared with earlier GS tomes on the rent trade touting double digit returns without any mention of those pesky operating costs.

Of course, if you follow the US housing sector closely, you know that the “discount” in terms of pricing of REO vs. voluntary home sales has largely disappeared.   Like many of the opportunities for generating earnings and even revenue in the financials, the rally in home prices seems to be reaching a near-term peak – especially judging by the recent behavior of some of the shorter-duration professional strategies.  The fact of continued slack in the job market and in terms of consumer behavior also constrains the upside on housing.  The latest Case-Shiller data is more a function of short supply than a strong economic rebound, but does anyone care?    

When you look at some of the emerging alternative strategies and the agendas behind non-bank financials, you must ask yourself a question: Is an IPO for a firm that is primarily engaged in some aspect of owning and managing residential housing a bullish indicator?  Or rather is it an exit strategy for a savvy institutional investor?  More, if the total expenses on a given IPO reach well into double digits, is that a red flag from a risk management perspective? Does the prospect of a low single digit return on a hastily assembled rental strategy render a low double digit cost of capital problematic?  Hmmm

All of these questions and many others will be resolved in the fullness of time.  In the meantime, just remember that with the Fed and Bank of Japan buying nearly every government and agency security on the planet, even a completely rancid pile of bollocks might look and smell like a lovely red rose – at least until the rules of quantum mechanics are reinstated by our dutiful servants on the Federal Open Market Committee.  The tough part is discerning the median from the mean in this narrative, but that will have to wait until next time.

 


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Thu, 05/02/2013 - 09:05 | Link to Comment WhiteNight123129
WhiteNight123129's picture

There are two forms of payment, money and credit. You can have a bubble with credit or a bubble with money. Nothing surprising in having a bubble without credit growth when the bubble comes from money.. duh!!!

The difference is that when you pump assets with money, the risk is not a crash in asset prices (unlike with credit which a promise to deliver money). In a bubble pumped up by money, the risk is that money crashes (i.e. hyperinflation). However for that to happen you need a supply shock typically.

 

The notion that Bernanke wants to stimulate credit growth is misguided. What he does is replacing what is backing the currency deposits. Bank accounts are not "monetary aggregates" they are just currency deposits. So in order to avoid Cyprus, the fed if replacing crappy assets with base money as the backing of currency deposits in the commercial banking system. 

No need to create more credit and more currency deposits. What is needed is currency deposits to be spent, no more.

Go to the bank redeem your currency deposits for base money (100 USD bills) spend it all, and voila you have inflation with no increase in currency deposits, and no "multiplier".

The multiplier is reflecting nothing about inflation or deflation. It is reflecting that more and more Monetary base MB is backing currency M2, or stated otherwise, less and less bad credit is backing currency deposits in order to avoid a Cyprus where both the credit and the related currency deposits are wiped off.

Currency and money are different things.

 

 

Wed, 05/01/2013 - 01:34 | Link to Comment chart_gazer
chart_gazer's picture

"Since, as already noted, there is little or no net credit growth in the US economy, the efficacy of QE as a means for supporting higher GDP and job growth, and consumer activity and increased lending volumes, seems questionable. But of course even asking such a question is considered to be a sign of negative thinking." 

 

QE3 is a backdoor bailout for banks intended to move bad paper to the people. QE4 is needed to allow the government to deficit spend since there is no one else to buy the debt (also used to supress interest rates at auctions).  The stated objectives of the QE programs are bullshit, don't understand why more people don't call them on it.

Tue, 04/30/2013 - 14:57 | Link to Comment michigan independant
michigan independant's picture

He already went to the darkside guys move along. It pisses them off the Chicoms are already larger and all problems disappear with a phone call. WASHINGTON - The US Federal Reserve announced Wednesday its approval of China's largest bank to purchase a US bank and two other large Chinese banks to expand their business in US banking market. The Fed said in a statement that it has approved the Industrial and Commercial Bank of China Limited, China's largest bank, and two other Chinese investing firms to become bank holding companies by acquiring up to 80 percent of the voting shares of The Bank of East Asia USA., located in New York city. They own you inside out. The second natives lost. Currently the dhimmitude refers to non-Muslims being "allowed to retain their religious beliefs under certain restrictions and the Chicoms fighting over the rest. Yes that means here, not there.https://www.youtube.com/watch?v=G_R7bJahcwc

Tue, 04/30/2013 - 14:32 | Link to Comment CheapBastard
CheapBastard's picture

"Rancid"...good word to describe it.

Tue, 04/30/2013 - 14:17 | Link to Comment Kayman
Kayman's picture

steve from virginia

Well stated !

K

Tue, 04/30/2013 - 14:29 | Link to Comment Rustysilver
Rustysilver's picture

Kayman,

I second that Steve's comment from VA is solid.  Also, he said nothing about cars which again is +1.

Tue, 04/30/2013 - 13:50 | Link to Comment steve from virginia
steve from virginia's picture

 

 

 

@Chris Whalen, and:

 

Me ...

 

"The chart below shows net operating income, dividends and retained earnings for all US banks at year end 2012, according to the FDIC.  Notice that banks are now paying out in dividends an amount that is in excess of NOI, resulting in negative retained earnings."

 

If the banks don't pay the dividends they can't buy support in the stock market. The left hand steals from the right hand: they don't have a capital cushion, they are over-levered, consequently ...

 

" ... there is no way to build higher capital levels without radically shrinking the balance sheets of the banks."

 

Which means deleveraging ... and margin calls because all the Super-Bigs are trading. Here is a reason for the gold/silver price action last week: banks throwing assets into the fire to support their ownerships' eroding interests.

 

"One of the biggest reasons that banks have been able to pay-out capital to shareholders via dividends is a general reduction in risk"

 

Not really and you said so yourself. Dividends are the result of reduced headcounts. 

 

"Risk weighted assets reported by the largest banks have been falling as have defaults and related loan loss reserves, resulting in higher capital levels – at least for now."

 

Not when capital is bleeding out the door. Look ... the banks can either pay dividends or not. In either case there is capital diminution. What we are seeing in bank-landia is the onrunning consequence of the establishment trying to prop up ...

 

"Off balance sheet leverage ... with the non-agency mortgage sector."

 

The Super-Bigs are all zombies trying to keep from being sunk by their own dead-money misadventures. They are praying their new misadventures and central bank loans will save them ... the gold/silver margin calls suggest otherwise!

 

 "The noxious combination of Basel III, Dodd-Frank and the state AG settlement also means that banks are providing much less credit to support the US economy.   You cannot have an asset bubble – or job growth -- in a classical sense without credit growth."

 

C'mon Chris ... you're almost there! All so-called 'economic activity' is nothing more than credit growth.  The activities on the ground are theater, empty gestures designed to convice the 'rubes' there is something to our endeavors besides theft. The price we all pay is the wanton destruction of non-renewable capital.

 

Meanwhile, Basel III effects the EU-UK system more than the US, Dodd-Frank is a poxy mess  and AG Settlement did the banks a favor. Sometimes a cigar is just a cigar ...

 

"And bank lending volumes are actually falling.  Yes, falling.  Yet we have row upon row of Wall Street economists and analysts predicting near-double digit growth in bank earnings in 2013.  Hmmm."

 

Earnings grow until the banks run out of people to fire ... both in the banks themselves and in the companies that are the banks' clients. Lending volumes shrink b/c there is nothing to lend to ... economic activity or 'productive output' is a lie ... all that remains is to lend so as to service dead money debts.

 

"These seemingly conflicting indicators, of rising earnings and flat to down revenues and credit volumes at banks, should be of concern to financial analysts and fiduciaries.  But since many of the prognosticators who contribute to industry earnings estimates are, in fact, economists, this is not a problem.   We can simply assume ... "

 

... a can opener. We live in wishful-thinking-land and will continue to do so until the roof caves in ... and it's caving right now under everyone's noses.

 


Tue, 04/30/2013 - 12:50 | Link to Comment Kayman
Kayman's picture

One of the biggest reasons that banks have been able to pay-out capital to shareholders via dividends is a general reduction in risk

= Bernanke buying your shit paper.

Notice that banks are now paying out in dividends an amount that is in excess of NOI, resulting in negative retained earnings.

And why would a TBTF bank want an increase in Retained Earnings ?

1. Ben stands ready to save them. Hank Paulson #2 is waiting in the wings.

2. An infinite ROI is achieved as your Retained Earnings approach zero. 

Chris, I always enjoy your articles; they are usually full of solid information. Nevertheless you often seem conflicted.  Inutitively, you must know all paper rents have to be anchored in the real economy at some time.

 

Tue, 04/30/2013 - 12:30 | Link to Comment Bam_Man
Bam_Man's picture

In a world of ZIRP and legalized accounting fraud, bank "earnings" can be anything they want.

Tue, 04/30/2013 - 11:03 | Link to Comment Downtoolong
Downtoolong's picture

Is an IPO for a firm that is primarily engaged in some aspect of owning and managing residential housing a bullish indicator?  Or rather is it an exit strategy for a savvy institutional investor?

It’s neither. It’s not about a long term investment opportunity. It’s about desperate attempts to avoid the shit pie that traditional investing has become. It’s either this or reaching for Spanish junk bonds and subjecting yourself to HFT beatings in the stock market just to get the kind of yields once available in CD’s and Treasury’s. But, that doesn’t make every alternative investment good by comparison. Most of these too are just short-term financial plays to make a few insiders filthy rich by cashing out just before the whole thing collapses. There is more than one Angelo Mozilo out there. 

Tue, 04/30/2013 - 10:21 | Link to Comment RaceToTheBottom
RaceToTheBottom's picture

Banks are not the solution, they are the problem.

Tue, 04/30/2013 - 12:26 | Link to Comment dontgoforit
dontgoforit's picture

And these $$ bills are getting mighty thin!

Tue, 04/30/2013 - 10:00 | Link to Comment fonzannoon
fonzannoon's picture

Cursive don't waste your time with this author. He is the worst. You can watch him fluff Bob Doll's balls once a month on CNBS.

Tue, 04/30/2013 - 10:17 | Link to Comment Cursive
Cursive's picture

@fonzannoon

I actually followed Chris for a long time.  He generally has good analysis.  I think the problem that he and others are having is that they are trying to operational or tactical analysis to a strategic problem, i.e. not seeing the forest for the trees.  Our problem is not that banks aren't lending, our problem is that banks have lent too much for too long and the debt has to be cleared now.  System Reset, bitches.

Tue, 04/30/2013 - 10:17 | Link to Comment fonzannoon
fonzannoon's picture

I genuinely liked Chris's analysis. He made me ill the last few times I saw him on TV. I am sure he has to tow a certain line but he ate the matrix steak clearly.

Tue, 04/30/2013 - 10:22 | Link to Comment Cursive
Cursive's picture

@fonzannoon

He recently joined Carrington (a mortgage investment firm), so that's his angle now.  I wrote a lot when I could have just said he's talking his book (in this case profession and his company).

Tue, 04/30/2013 - 10:42 | Link to Comment illyia
illyia's picture

Sometimes reading the comments first saves time... just the headline, then.

Tue, 04/30/2013 - 09:46 | Link to Comment Cursive
Cursive's picture

Basel III is noxious?  You might as well have said that MtM is noxious as well.  The banks skirted good business practices and the regulatory structure for decades, now we all have to deal with the consequencs.  FASB proved it is nothing but a political puppet and suspended MtM, therefore the banks won't clear the deadwood from the books to make way for organic growth.  Until the banks are truly recapitalized, there is nothing to this so-called "economic recovery."  Of course, at this juncture, the best way to recapitalize is to nationalize, but the banksters will have none of it.  So, that's the conundrum.

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