Surprise! Investors have little faith in numbers provided by banks

As bank earning season approaches, the NY Times ran an article documenting that investors have little faith in the numbers provided by banks.

This is a very big problem.

A loss of faith in the numbers provided by the banks is nothing less than a loss of faith in the ability to independently assess the risk of and value the banks.  Investors learned from the subprime mortgage securities that if you cannot independently assess the risk of and value a security not to buy the security.

Investors also learned from the financial crisis that began on August 9, 2007, that bank regulators should not be relied on for an accurate assessment of the risk of the banks (remember the comments about how the subprime problem is contained).

In short, given what investors have learned, the question is how much longer can the market function without faith in the bank balance sheet numbers and when will the global orderly sell-off in bank stocks become a more frantic activity?

There is only one way to solve this problem of a lack of faith in the numbers provided by a bank.  That is disclosure of each bank's current asset and liability-level data.  With this data, market participants can independently assess the risk of and value each bank.

The protesters who have gathered for weeks near Wall Street and the highly paid investors and analysts in the buildings that surround them don’t agree on much. 

But when it comes to the nation’s biggest banks, they have a lot more in common than you would think. Both are deeply frustrated with financial institutions in general and have little faith in the message coming from bank executives. 

... Senator Richard J. Durbin of Illinois, the No. 2 Senate Democrat, took the unusual step of denouncing Bank of America on the Senate floor [over its monthly charge for debit card use], urging customers to “vote with your feet, get the heck out of that bank.” 

Investors certainly have. Bank stocks are at lows not seen since the wake of the financial crisis, and shares of Bank of America, the nation’s biggest bank, are down more than 50 percent since the start of the year, while Citigroup is down more than 40 percent....

And in a kind of unusual convergence, protesters and bank analysts alike have had it with bank management....

“There is a huge skepticism, that goes way beyond normal healthy doubt, about how reliable their numbers and guidance are,” said Chris Kotowski, an analyst with Oppenheimer. “People who were bullish are frustrated and beaten down.” 

Michael Mayo, a longtime financial services analyst, ... argues there is so much pressure on loans, margins and revenue that even at these depressed levels, American bank stocks are too richly priced. And the political and financial uncertainty in Europe makes the sector even more risky. “Underweight bank stocks and put more of your money elsewhere,” he advises. 

Mr. Mayo is not alone...

Analysts expect that auto, credit card and corporate lending will have inched upward in the third quarter, and lower credit losses could mean the release of several billion dollars’ worth of past reserves that will be counted toward current profits. 

But these days, investors are ... increasingly focused on the consequences of prolonged unemployment of around 9 percent and an almost daily drumbeat of other grim economic data. 

What is more, worries are rising that the debt troubles in Europe could infect the balance sheets of American financial institutions. 

Even though the banks insist their exposures are not a cause for alarm, investors have so little faith in the numbers banks have provided that their first reaction is to sell shares first, and ask questions later. 

The credit default swap market provides one clue of how deep those fears run, as the cost of buying insurance against the default of billions of dollars’ worth of bank debt has surged since mid-July. 

Rates on credit default swaps for Morgan Stanley now stand at 420 basis points, while Bank of America’s rate was 379, and Goldman Sachs was at 351. That is equivalent to the cost of insuring junk bonds issued by companies whose credit rating is below investment grade. 

Among the major banks, only JPMorgan Chase and Wells Fargo fare better, with rates at just above 150 basis points.