Banking bubble (charts)

Posted by Stacy-Marie Ishmael on Mar 31 18:24. 6 comments.

Warning: this post contains a bubble chart.

Citi’s European banks research team has come up with a fresh take on earnings and valuation bubbles across major markets.

Analysts led by Ronit Ghose compared the market value of banks to the size of the economies in which they are based – a measure dubbed ”penetration”. More…

Warning: this post contains a bubble chart.

Citi’s European banks research team has come up with a fresh take on earnings and valuation bubbles across major markets.

Analysts led by Ronit Ghose compared the market value of banks to the size of the economies in which they are based – a measure dubbed ”penetration”.

Methodological comment:

our calculation of bank system market value is based on the value of the quoted banks we cover, adjusted for their international businesses, and then grossed up based on these quoted banks’ share of national system loans and deposits.

For most markets, our analysis is based on an initial sample of over half the system. For Mexico and the UK, our analysis is based on only one quoted domestic bank (Banorte and Lloyds). For the US, to commercial banks we add investment banks, credit card and mutual fund companies.

From the note (click to enlarge the chart):

the most penetrated major market is China (c30% of GDP) and the least is Mexico (c8%). The old Commonwealth countries of Australia, Canada and South Africa — along with Brazil — follow
closely behind China, while Italy, Korea and Japan occupy the lower reaches of Figure 2. India and Turkey are mid-table.

And there’s more:

China has high penetration (bank market cap as % GDP) due to a high level of bank profits to GDP. But the PE multiple placed on its earnings is middle of the pack. So China has a high market value bank sector but does not have high valuation multiples relative to peers. The same — large relative market value, median PEs — is true of Brazil and South Africa.

Other high earning bank sectors can be found at opposite ends of the PE range, with Turkey (lowest 2011 PE of our sample) and Australia (one of the higher PE multiples in our sample). Turkey has one of the highest levels of
bank earnings relative to GDP, in line with Brazil. Australia’s bank sector earnings is the highest of the wealthy countries in our sample.

The note is worth reading in full (so many charts…), but for those of you with short attention spans, here’s the TL:DR summary:

whilst Australia – with a bank market value to GDP at a close 2nd only to China’s and banks earnings to GDP similar to Brazil – looks like a shining example of how to do banking and get a high multiple…turning Aussie won’t be easy: market structure, a robust economy and supportive shareholders all help explain Australia’s high earnings and valuation multiple…and while other developed markets like the UK could look to replicate the advantages of Australia’s oligopoly banking market, Australia’s commodity-driven strong economies may be harder to replicate…ditto for the investor base.

1. Investors looking for low-PE banking systems should focus on Turkey, Korea, and possibly Russia.

2. For low earnings relative to peers, Mexico screens best, as does India relative to other BRICs.

3. China and Brazil have large market values but the main risk is one of earnings sustainability not a valuation bubble.

4. For European banks the main investment take away is sticking with Standard Chartered and BBVA

Related links:
The terrorist model for banks – FT Alphaville
Bank picture du jour – redux – FT Alphaville
That JP Morgan picture – official redux – FT Alphaville

China May Face ‘Massive’ Bank Bailouts After Stimulus Program

By Bloomberg News

March 13 (Bloomberg) -- China may be forced to bail out banks that made loans for local-government projects under the unprecedented stimulus program unleashed in 2008, according to Citigroup Inc. and Northwestern University’s Victor Shih.

In a “worst-case scenario,” the non-performing loans of local-government investment vehicles could climb to 2.4 trillion yuan ($350 billion) by 2011, Shen Minggao, Citigroup’s Hong Kong-based chief economist for greater China, said yesterday.

“The most likely case is that the Chinese government will engineer a massive financial bailout of the financial sector,” said Shih, a professor who spent months researching borrowing by about 8,000 local government entities.

Chinese officials pledged this week to limit the risks posed by the investment vehicles, which circumvent restrictions on local-government borrowing to channel money into stimulus projects. Yan Qingmin, head of the banking regulator’s Shanghai branch, said March 5 that China plans to nullify guarantees provided by local governments for some loans.

Citigroup’s Shen said officials may keep monetary policy loose for longer than they should, boosting asset prices and building up overcapacity, to avoid the “squeeze” on investment vehicles that would trigger bad loans and bailouts.

“The risk is that inflation or asset bubbles force the government to withdraw their support to local governments much earlier than expected,” he said in a phone interview.

Stimulus Policies

In Shen’s worst case, commercial banks, lending because of explicit or implicit government guarantees rather than the quality of projects, see 20 percent of lending to the investment vehicles turn bad in 2011.

Premier Wen Jiabao is weighing when to exit crisis policies as property prices surge, inflation climbs and exports rebound, highlighting the risk of overheating in the world’s fastest- growing major economy, awash with cash from unprecedented lending in 2009.

Shih was more pessimistic than Shen in an interview on Bloomberg Television in Hong Kong yesterday. He said that if the central government stops lending to the entities now, the cost of a bailout may already be “in the neighborhood” of 3 trillion yuan.

The academic said that “the only credible action by the central government now is to allow a handful of these entities to go bankrupt -- so that the banks know that the central government means business when it says it’s withdrawing guarantees.”

‘Not So Serious’

In contrast, Jia Kang, the head of the research institute of China’s Ministry of Finance, said March 10 that the risks “may not be so serious as some people have claimed.”

Industrial & Commercial Bank of China Ltd. President Yang Kaisheng said March 7 that the lender had inspected loans it extended to the financing vehicles in 2008 and 2009 and “so far didn’t find many big problems.”

Su Ning, a deputy governor at China’s central bank, said March 8 that a “fairly high proportion” of total lending last year went to the funding vehicles. Chinese banks extended a record 9.59 trillion yuan of new loans in 2009. Su sees “a big risk” from local-government guarantees for money borrowed to fund infrastructure projects that may not generate returns, he said in Beijing.

The investment entities have played a key role in channeling money to stimulus projects, often for urban development, Citigroup’s Shen said.

Zhou’s Concern

Central bank Governor Zhou Xiaochuan said March 6 that while “many” of the financing entities have the ability to repay debt, two types cause concern.

One uses land as collateral, while the other can’t fully repay, meaning local governments may be liable, leading to “fiscal risks,” he told reporters in Beijing.

Regulators believe a few cities and counties may struggle with repayments in coming years because of debt ratios already exceeding 400 percent, a person with knowledge of the matter said in January. The ratio is of year-end outstanding debt to annual disposable fiscal income.

Chinese banks had 497 billion yuan of non-performing loans as of Dec. 31, accounting for 1.58 percent of advances, according to the banking regulator.

--Paul Panckhurst, Kevin Hamlin, Susan Li. Editors: Lily Nonomiya, Cherian Thomas

Overheating China – reaction

Posted by Neil Hume on Mar 11 10:40. 1 comment.

A bit more on the stronger than expected Chinese inflation data. Economists now expect further policy tightening measures and sooner rather than later.

Barclays Capital:
In view of the higher-than-expected inflation in February, More…

A bit more on the stronger than expected Chinese inflation data. Economists now expect further policy tightening measures and sooner rather than later.

Barclays Capital:

In view of the higher-than-expected inflation in February, we revise upward our projection of average CPI inflation for 2010 to 3.5% from 3.0%, which implies a rise in the headline rate to around 3.5% by mid-2010 and 4% by Q4. This is compared with the government target of 3% announced at the NPC meeting.

Consequently, we revise our call on the benchmark interest rate and now look for a hike in Q2; previously we expected rated to begin rising in Q3. We now project three increases of 27bp in the benchmark rates in 2010 – one in Q2 and the remaining two in H2. We maintain our projection of real GDP growth of 9.6%, but change from upside to balanced risks around the baseline, owing to the quickened pace of tightening

Morgan Stanley:

We continue to see multiple RRR hikes as necessary over the next few months to sterilize the liquidity impact from the BoP surplus, with the next RRR hike likely to be in the very imminent future. The first interest rate hike of 27 bps could come as early as April, in our view, followed by two more hikes in 3Q and 4Q. Nevertheless we stand by our call that Renminbi appreciation (against US$) will not resume until 2H10, although appreciation on a trade-weighted basis is already taking place given the US dollar’s recent and projected strength against other major currencies in the course of this year.

And finally, Goldman Sachs:

Although inflationary pressures remain moderate for now, we believe if there are no measures more decisive than the modest (although relatively frequent) RRR hikes, we are likely to see higher inflationary pressures. Recent comments by a number of policymakers that there are no signs of inflation yet are worrisome as it indicates a lack of willingness to take more decisive measures until higher inflation actually occurs.

Having said that, we still believe policymakers will take a combination of tightening measures in the coming months to prevent overheating. These measures are likely to be targeted at FAI-related areas given the government’s strong emphasis on stimulating private consumption and the unwillingness to fully utilize the exchange rate as a policy tool to influence exports growth. We expect these so called macro tightening measures to include a mixture of credit controls, further RRR and interest rate hikes, administrative controls on investment approvals and funding and other “industrial policies” to curb investment activities in sectors regarded as having problems such as overcapacity.

Melody's note, Comment from RBS (but its estimate for CPI, PPI n bank loan are all way wrong):

More concern about growth: property-sector FAI and export growth in 2H10
Returning to centre-stage, in our view, is the need to cement growth in 2010. While policy makers prefer stable to steadily rising property prices, these have seen nothing but extreme volatility. Combined with possible uncertainty about export growth in 2H10 and the close of the politically sensitive NPC session, we may have several months of relatively benign良性的 regulation of property, which may help property FAI. The risk is that if property prices start rising again, it may lead to greater social tension and more regulatory actions just as the supply of residential property increases in 2H10F.

A slight reversal of the exit/normalisation trade for several months?
We see 2010 as a year of ‘touching the stones to cross the river’ for policies in China, with the government reducing excess liquidity as the real economy improves. The implication is negative for asset plays and positive for transportation and industrials. Ranked by top-down incremental yoy growth, we prefer export-exposed sectors to consumption and FAI-related sectors. That said, in the coming months, we may see a slight reversal of the policy exit/normalisation trade. We believe the sectors that will benefit incrementally are property, energy, materials, cement and consumer discretionary. Defensives and agriculture inflation hedge may perform less well on postponed policy exit and reduced inflationary fear. The impact on banks should be positive on low valuations and reduced tightening fears.

Over to you, Chinese policy-makers.

Related links:
Roach: Pooh-pooh to Chinese bubbles - FT Alphaville
Chinese liquidity – and stocks – go BOOM! - FT Alphaville

JPMorgan, Citigroup Helped Cause Lehman Collapse, Report Says

By Linda Sandler, Bob Van Voris and Don Jeffrey

March 12 (Bloomberg) -- JPMorgan Chase & Co. and Citigroup Inc. helped cause the failure of Lehman Brothers Holdings Inc. by demanding more collateral and changing guarantee agreements, according to a court-ordered report on the biggest bankruptcy in U.S. history.

“The demands for collateral by Lehman’s lenders had direct impact on Lehman’s liquidity,” said Anton Valukas, the bankruptcy examiner, in a 2,200-page document filed yesterday in Manhattan federal court. “Lehman’s available liquidity is central to the question of why Lehman failed.”

Former Lehman Chief Executive Officer Richard Fuld, ex- Chief Financial Officer Erin Callan, former Executive Vice President Ian Lowitt and former Managing Director Christopher O’Meara certified misleading statements about the bank’s finances, according to the report. Fuld, 63, was “at least grossly negligent,” Valukas said. New York-based Lehman collapsed in September 2008 with $639 billion in assets.

In addition to his conclusions regarding New York-based Citigroup and JPMorgan, Valukas said of London-based Barclays Plc’s purchase of Lehman’s North American brokerage that a “limited amount of assets” belonging to Lehman were “improperly transferred to Barclays.” He added that the value of the assets may not be “material.”

Kerrie Cohen, a Barclays spokeswoman in New York, and Brian Marchiony, a JPMorgan spokesman, declined to comment.

Preliminary Review

Danielle Romero-Apsilos, a spokeswoman for Citigroup, said in an e-mailed statement that the bank is reviewing the report, and that a preliminary analysis shows the examiner “has not identified any wrongdoing on Citi’s part.”

Lewis Liman, a lawyer for Lowitt, who is now at Barclays, said in an e-mailed statement his client did nothing wrong.

“In the three months during which he held the job, Mr. Lowitt worked diligently and faithfully to discharge all of his duties as Lehman’s CFO,” Liman said. “Any suggestion that Mr. Lowitt breached his fiduciary duties is baseless.”

Barclays is Britain’s second-biggest bank. Citigroup is the third biggest U.S. bank, and JPMorgan is second. Bank of America Corp. is the biggest U.S. bank by assets.

Fuld was warned months before the bankruptcy by Treasury Secretary Henry Paulson that Lehman might fail if it continued to report losses without finding a buyer or formulating a survival plan, according to Valukas’s report.

‘Grossly Negligent’

Fuld was “at least grossly negligent in causing Lehman to file misleading periodic reports” while its risks were rising because of long-term assets financed with short-term debt, Valukas said in the report.

Lehman’s executives engaged in conduct ranging from “non- culpable errors of business judgment” to “actionable balance sheet manipulation,” as they used “accounting gimmicks” to move assets off the balance sheet without disclosing that to the government, rating-agencies, investors or Lehman’s board.

Fuld’s lawyer, Patricia Hynes, disputed the examiner’s allegation that the Lehman estate has a claim against him relating to transactions called “Repo 105 transactions.”

“Mr. Fuld did not know what those transactions were -- he didn’t structure or negotiate them, nor was he aware of their accounting treatment,” Hynes said in a statement. She also said none of Lehman’s senior financial officers, lawyers or outside auditors raised concerns about the transactions with Fuld.

Erika Burk, a lawyer who represents O’Meara in Lehman- related securities lawsuits, didn’t return a call seeking comment after regular business hours yesterday. Robert Cleary, a lawyer for Callan, said he hadn’t seen the report and declined to comment.

A Judge’s Son

Valukas, 66, a judge’s son, is chairman of the Chicago- based law firm Jenner & Block LLP, where his clients have included David Radler, Hollinger International Inc.’s former president. As U.S. Attorney in Chicago from 1985 to 1989, he was dubbed the Midwest’s Rudolph Giuliani for his hard line on white-collar crime, according to a 1989 New York Times profile.

In his report, he said that Ernst & Young LLP, Lehman’s auditing firm, failed to question inadequate disclosures by the Lehman executives.

The examiner said Lehman’s directors are “immunized from personal liability” concerning the way the company handled risk because management hadn’t presented any “red flags” to them.

“Our last audit of the company was for the fiscal year ending Nov. 30, 2007,” said Charlie Perkins, a spokesman for Ernst & Young, in an e-mailed statement. “Our opinion indicated that Lehman’s financial statements for that year were fairly presented in accordance with Generally Accepted Accounting Principles (GAAP), and we remain of that view.”

$38 Million

Valukas spent a year and $38 million producing the report. He interviewed more than 100 people including U.S. Treasury Secretary Timothy Geithner, Federal Reserve Chairman Ben Bernanke and former U.S. Securities and Exchange Commission Chairman Christopher Cox, and scrutinized more than 10 million documents, plus 20 million pages of e-mails from Lehman, according to filings in U.S. Bankruptcy Court in New York.

“There are a limited number of colorable claims for avoidance actions against JPMorgan and Citibank,” Valukas said in the report. He defined a colorable claim as sufficient credible evidence to persuade a jury to award damages at trial.

Barclays bought Lehman’s brokerage for $1.54 billion. Lehman has sued Barclays for at least $5 billion, saying it made a “windfall” on the purchase. Barclays responded that it’s owed $3 billion. A bankruptcy-court trial is set for April 26.

Improperly Transferred

The assets improperly transferred to Barclays included equipment with a book value of less than $10 million and customer information of “questionable value” that Barclays didn’t obtain in a “wrongful or unlawful” way, Valukas said. He found “limited colorable claims” against the bank for the transfers. The examiner found no evidence that any securities transferred to Barclays in the sale of the brokerage were owned by Lehman or its affiliates.

JPMorgan and Citigroup were two of New York-based Lehman’s main short-term lenders. On Feb. 24, Lehman said it settled with JPMorgan over the last of $29 billion in claims the bank filed against Lehman.

Citigroup, which handled currency trades for Lehman, received a new guarantee from Lehman when the now-bankrupt firm was already insolvent and didn’t give enough value in return, the report said.

“The examiner concludes that a colorable claim exists to avoid the amended guaranty as constructively fraudulent,” Valukas’s report said.

Lehman CEO Bryan Marsal said in an e-mail that he would “carefully evaluate” Valukas’s report to assess how it might help “ongoing efforts to advance creditor interests.”

The case is In re Lehman Brothers Holdings Inc., 08-13555, U.S. Bankruptcy Court, Southern District of New York (Manhattan).