BANK RESPONSE TO LEGISLATION
According to a national poll in December 2009, 64% of Americans felt that bailing out banks was a mistake. Whether we like it or not, the fact of the matter is, banks have been bailed out for years, some restructure and rebound, and others fail and fall to the wayside. Banks are the target of massive legislation that is intended to make the banking sector safer. One example is the “Financial Crisis Responsibility Fee,” which is a levy on financial institutions to cover forecasted taxpayer losses from the TARP program. Each bank will pay into the FCRP 0.15% of its eligible liabilities, measured as total assets minus capital and deposits (A-C+D=L*0.15). As such, the banks with fewer deposits will be hit much harder than their larger counterparts. Agree or not, it is happening and any costs incurred by banks as a result will be passed on to the consumer in one form or another further angering public response to the banking sector while limiting available capital offered as loan funds.
CURRENT CONDITION OF INSTITUTIONS
Loan activity to individual consumers will remain weak for 16 months. Tougher rules on capital will hurt banks’ return on equity and could push them further out of profitability in some key areas. JP Morgan expects to incur a cost of $500 M in annual profit due to forthcoming credit card restrictions. Citigroup expects FICC revenues (estimated at $190 Billion in 2009) to be 15-20% lower this year. A further 15% of the pie could be lost if most over the counter derivatives migrate to exchanges. Any shrinkage in FICC will hit Goldman Sachs the hardest. Moreover, banks may be forced to reduce the principle on outstanding loans and they will struggle with maintaining interest-rate risk as rate cuts in 2007 and 2008 temporarily boosted bank profitability. When short-term rates start to rise again net interest margins will come under pressure.
I project therefore that the liquidity crunch will continue through 2010 and we will in fact see a recovery more resembling the “W” I spoke of in last month’s newsletter and not the “V” that many economists are touting. Banks will loosen liquidity in the 3rd quarter of 2011. Private equity firms, individual investors and venture capitalists will see a bevy of excellent deals this year and would be wise to take advantage of them during this window.