How to Eat a Bank
Financial Review by Sinclair Noe
DOW + 98 = 18,057
SPX + 10 = 2102
NAS + 21 = 4995
10 YR YLD – .01 = 1.95%
OIL + .99 = 51.78
GOLD + 13.80 = 1208.30
SILV + .34 = 16.59
For the week, the Dow is up 1.6 percent, the S&P is up 1.7 percent and the Nasdaq is up 2.3 percent. Both the Dow and S&P notched their second straight week of gains.
Oil posted its fourth consecutive weekly gain. The oil rally coincided with a stronger dollar, which weighs on dollar denominated commodities. In March, the prices the U.S. paid for imported goods and services fell for the eighth time in the last nine months, even though the cost of foreign oil actually rose for the second straight time. Import prices dropped 0.3% last month, or an even steeper 0.4% excluding fuel.
The sharply lower cost of imported goods is a double-edged sword. We may pay less for commodities and all sorts of goods such as cell phones and electronics; and that can stretch paychecks. Next Tuesday the Commerce Department reports on retail sales and we’ll find out if shoppers are in a spending mood or a savings mood. A strong dollar is also great if you plan to travel abroad; they say April in Paris is pretty nice. Yet the strong dollar also makes US goods and services more expensive for foreigners to buy, reducing demand for American-made exports. That’s cutting into corporate profits and could even cost American jobs, potentially slowing the nation’s pace of growth. The Labor Department will report on both producer and consumer prices next week, prices at the wholesale and retail levels. Economists expect both the CPI and the PPI to be up in March compared to February, but maybe not enough to move into positive territory.
Earnings season kicked off this week. The corporate earnings outlook for 2015 is ugly, as first-quarter earnings for the S&P 500 index are expected to come in 4.7% lower , while second-quarter earnings are expected to be 2.1% lower, according to FactSet. Meanwhile, Thomson Reuters says profits of companies on the S&P 500 are projected to have declined by 2.9% in the first quarter. So, that should give you a range.
The big banks start reporting earnings next week, with JPMorgan and Wells Fargo posting results on Tuesday. Mortgage lending is expected to prop up bank earnings, as lower mortgage rates have spurred applications to refinance home loans. Financials have the best outlook among sectors, with analysts projecting first-quarter 2015 earnings to have surged 10% from a year ago, according to Thomson Reuters data. Meanwhile, energy is expected to be the worst performing sector; companies may see first-quarter earnings plummet 64% from the same quarter a year ago.
If you were hoping to be one of the first people to sport the new Apple watch, yea, that ship has already sailed. At one minute after midnight, Apple started taking orders for delivery of the watches in June. Within 6 hours they were sold out. It’s hard to believe we’ve all survived so long without one of those watches.
Also this coming week, we might see a plea deal in the long running investigation into manipulation of the London Interbank Offered Rate, or Libor. The NY Times reports Deutsche Bank is close to a deal with New York financial regulator, federal prosecutors, plus regulators in Washington and London to pay a penalty (somewhere in the neighborhood of $1.5 billion) and accept a criminal guilty plea. The bank also faces investigations into currency manipulation and violations of United States sanctions against countries like Iran. Several other banks have already reached settlements on interest rate rigging, but Deutsche was a holdout.
General Electric plans to sell most of its $30 billion real estate portfolio over the next two years as it gets back to its industrial roots; GE also set a share buyback plan of up to $50 billion – the second-largest ever. Blackstone Group and Wells Fargo are buying most of the assets of GE Capital Real Estate in a deal valued at about $26 billion. GE said it had letters of intent to sell an additional $4 billion of commercial real estate to other buyers that it did not identify. The total deal is the biggest in the commercial property market since Blackstone’s acquisition of office landlord Equity Office Properties Trust in 2007 for $39 billion.
GE’s deal to sell off real estate and get out of most of the finance business will result in an after-tax charge of $16 billion in the first quarter, and up to $4 billion worth of taxes on repatriated earnings. Right now, US-based multinationals are not taxed by the US government on what they earn overseas, until they repatriate or bring that money back to the US. According to a report in March by Credit Suisse, the cumulative earnings parked by S&P 500 companies overseas is over $2 trillion, and there’s at least $690 billion in overseas cash. It’s not like the money is lost overseas; it is sometimes used for foreign acquisitions; another trick is to borrow against the cash pile to pay for dividends or share buybacks; not exactly a path to productive, organic growth.
To console investors about the costs, GE authorized one of the largest buybacks ever, second only to Apple’s $90 billion buyback plan. General Electric has the potential to return more than $90 billion to investors through 2018 in the form of dividends, buybacks and other measures. The exit of most of GE Capital businesses is expected to release about $35 billion in dividends to GE, which would be allocated to its planned $50 billion share buyback.
CEO Jeff Immelt has been scaling down GE Capital since the financial crisis, when GE Capital almost wiped out the entire company. What was once seen as a way for GE to help finance sales to its own clients had grown into a financial behemoth that stretched into subprime lending among other areas. For years, Jack Welch had used reserves that GE Capital maintained against problem loans to smooth out the books at GE; adding to reserves in strong quarters and reducing them in weak quarters, when the income was needed. GE Capital became a black box of financial complexity that baffled even experts but allowed Welch to “deliver” remarkably consistent earnings, almost as if he could produce numbers out of thin air. At the same time it managed to suck the life out of research and development at the parent company. Who needs research and development and innovation on the industrial side when you can cook the books on the financial side?
In September 2008, GE Capital was on the verge of collapse, only revived by an infusion of cash and confidence from Warren Buffett (and yes, Warren pulled down a sweetheart deal). That seems to have been the point where Immelt recognized the need for a new direction, back to its industrial roots. The only financial operations to be retained will be the leasing operations that are directly tied to GE’s manufacturing businesses, which make equipment ranging from aircraft engines to medical scanners. GE anticipates that the industrial operations will generate 90% of revenue by 2018.
The finance arm still has $500 billion in assets, making GE Capital the country’s 7th largest bank; that position also earned GE Capital the designation of a “systemically important financial institution” or SIFI. The designation as a so-called “SIFI” brings with it tougher oversight by the Federal Reserve. GE wants to lose the designation and the regulatory oversight that goes with it. They will still have a financing arm, but it will be greatly scaled down.
So far four non-bank firms, including GE Capital, have been designated as a SIFI. The others are insurers American International Group, Prudential Financial, and Metlife. Metlife is suing the federal government over the label. Just yesterday, Jamie Dimon of JPMorgan bemoaned the burdens of regulation. Some of the SIFI firms have privately griped that regulators haven’t provided them with a clear path on how to shed the designation. The Wall Street Journal calls it the “Hotel California” of Fed oversight; it’s a clever line, and I wouldn’t be surprised if the marketing team at Metlife or JPMorgan came up with it, but it is also incredibly stupid and a lie. It is easy to drop the SIFI designation; all a bank has to do is get smaller; sell off parts, spin off parts – simple. And the path was laid out in the Brown-Vitter bill. The legislation presented the mega banks “with a clear choice: Either have enough of your own capital to cover your own losses or downsize until you are no longer a risk to taxpayers.” The banks managed to squash that legislation because they still like the old business model of privatized profits and socialized losses.
For Metlife the whole idea of SIFI regulations was just too much to bear. When the insurer was designated too big to fail, they sued; because nothing says you are not big like taking on the entire US government. The Metlife argument might be better if the company didn’t tout, in its own advertising that it is indeed a huge, global company with tens of billion in revenue and trillions in life insurance in force. They just don’t want to be forced to hold extra capital in reserve because it might bring down their profits. So, Metlife thinks that is terrible. But the government thinks it might be a good idea to have some reserves just in case something goes wrong; it would be like a cushion against a catastrophe, some type of safeguard against disaster, some protection from a meltdown, you might even call it insurance.
So, what today’s deal shows is that there is a way out of the “too big to fail” problem with the mega banks; just cut them into small bite sized pieces that can be easily digested, and the American taxpayer need never be forced to choke on bailouts again. That is how you eat a bank. In that regard, the GE deal might be the most important restructuring of the American banking system to happen under the Dodd-Frank Wall Street reform law.