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No Green Today, Canny, Crash Monday JMHO

So, What Does This Obama Stuff Really Mean for the Big Banks? You Know, From a Fundamental Perspective
Reggie Middleton's picture
Submitted by Reggie Middleton on 01/22/2010 08:21 -0500

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Well, it looks like Blankein, Dimon, et. al. really should have tried harder to make that meeting with the President a couple of weeks ago. It appeared as if he may have had something important to discuss. As my readers and subscribers know, I have been very bearish on the big money center banks since 2007, and quite profitably so. The last 3 quarters saw a much larger trend reversal than I expected, that resulted in the disgorgement of a decent amount of those profits - a disgorgement that I am still beating myself up over. You see, as a fundamental investor, I don't do well when reality diverges from the fundamentals for too long a period. Luckily for me, fundamentals always return, and they usually return with a vengeance. To keep things in perspective though, I am still up on a cumulative basis many, many multiples over the S&P (which is still negative, may I add) as well as your average fund manager. Why? How was I able to do this? Well, its not because I am supersmart, or well connected. It is because I keep things in perspective. Those that look at the records that I publish say, "Well he was down the last couple of quarters, so..." while disregarding what happened the 8 or even 40 or so quarters before that. Such a short term horizon will probably not be able to appreciate the longer term perspective and foresight that enabled me to see this entire malaise coming years ago and profit from it. No, I am not perfect and I do mess up on occasion, but I also do pay attention to the facts.

These facts pointed to a massive overvalutation in banks throughout the bulk of last year, again! I made it clear to my subscribers that the banks simply have too many things going against them: political headwinds, nasty assets, diminishing revenue drivers, over-indebted consumers, and a soft economic cycle. I also warned explicitly that I didn't think Obama would be nearly as lenient on the banks as Bush was. Well, the headwinds are stiffening. On that note, let's take an empirical look at just what this means in terms of valuation (note, I will following this up with a full forensic re-valuation for all subscribers, incuding a scenario analysis of varying extents of principal trading limits). Some of these banks are I-N-S-A-N-E-L-Y overvalued at these post bear market rally levels considering the aforementioned headwinds. Methinks fundamental analysis will make a comeback in a big way for 2010 as it meets the momentum and algo traders in a mutual BEAR feast on the big investment banks cum hedge funds. I can't guarantee it will happen, but the numbers dictate that it should. We shall see in the upcoming quarters.

We have retrieved information about trading revenues for GS, MS, JPM and BoFA. We have also retrieved some balance sheet data to reflect the trend in investment holdings and the level of leverage, but I will address that in a future post for the sake of expediency. While the banks don't break out the P&L for principal trading, we can sort of back into it. Remember, traders are fed bonuses off of net revenue, not profit.



Goldman Sachs

Trading revenues accounted for more than 50% of the total revenues over the last 8 quarters. The impact on earnings is magnified with the total trading revenues amounting to more than 150% of the total pretax income over the last 8 quarters except for the last quarter in which the earnings were positively impacted by substantial decline in compensation expense which was negative 519 million in 4Q09 against 5.4 billion in 3Q09. The negative compensation charge during the quarter was owing to accounting adjustments

Principal investments which are purely GS proprietary transactions contribution ranged within 5% to 15% of the total revenues except in 4Q08 when the huge write downs in principal investments offset the positive revenues from other sources. Revenues from principal investments ranged within 15%-50% of the total pre-tax income except in 4Q08.

Click to enlarge.

image009.png

Note: In the GS income statement, revenues from trading and principal investments is the GS total revenues from trading activities. This revenue item comprises of two heads - trading and principal investments.

Revenues from proprietary trading in FICC (Fixed income, currency and commodity) and Equities is clubbed with the trading revenues earned on the transactions done on behalf of clients and is reported under the former head. In first nine months of 2009, nearly 41% of the trading revenues came from interest rate related transactions and 37% came from equities.

GS trading revenues break up (in $ million)


3Q09


% of total


9M09


% of total

Interest rates


3,928


58.6%


8,314


40.6%

Credit


2,022


30.2%


4,358


21.3%

Currencies


(3,617)


-54.0%


(4,038)


-19.7%

Equities


3,406


50.8%


7,515


36.7%

Commodities and other


964


14.4%


4,307


21.1%

Total


6,703


100.0%


20,456


100.0

The latter head primarily represents net investment gains/ losses from certain corporate and real estate investments and investment in the ordinary shares of Industrial and Commercial Bank of China Limited. Total principal investments amounted to 20.7 billion which is just 6-7% of the total investment portfolio of GS.

Thus, most of proprietary trading revenues is included the former head . However, it difficult to differentiate between proprietary trading and client related trading. Revenues from principal investments in case of GS and MS are not trading revenues but are write-ups/downs on certain illiquid investments which are segregated as principal investments. We have created various scenarios to demonstrate the impact of decline in trading revenues on earnings.



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More of Reggie on Goldman Sac

http://pajamasmedia.com/instapundit/92237/