Is the Threat to the Banks Over? Implied Volatility Says So

By: Reggie Middleton | Fri, Apr 2, 2010
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Implied volatility for the big banks is down across the board, just about where it was before the system went into convulsions. This implies the coast is clear, as do the share prices of many banks.

Hard core forensic and fundamental analysis implies otherwise. So does the Fed's actions, which still incorporates ZIRP policy, as well as the waffling at FASB. We will either have smooth sailing from this point on out or there is a nasty surprise waiting (on and off balance sheet) for bank investors in the near future. I invite readers to weigh in with their opinions.

Average 3-Month Implied Volatility of GS, JPM, MS, BofA, WFC, STI and PNC

As you can see, we are just about where we were in 2007 in terms of average volatility.

Increase/Decrease of 3-Month Implied Volatility of GS, JPM, MS, BofA, WFC, STI, ans PNC over the Last 3-Months, 6-Months, 1-year, 2-Years, and 3-Years

The decrease in volatility has been extreme. On that note, it would be a good time to revisit the FASB argument: About the Politically Malleable FASB, Paid for Politicians, and Mark to Myth Accounting Rules

S&P500 Index 2008-2009

It would also be a good time to revisit the derivative exposure and concentration argument as well...

JP Morgan's Notational Derivatives versus Worldwide 2008 GDP

Cute graphic above, eh? There is plenty of this in the public preview. When considering the staggering level of derivatives employed by JPM, it is frightening to even consider the fact that the quality of JPM's derivative exposure is even worse than Bear Stearns and Lehman‘s derivative portfolio just prior to their fall. Total net derivative exposure rated below BBB and below for JP Morgan currently stands at 35.4% while the same stood at 17.0% for Bear Stearns (February 2008) and 9.2% for Lehman (May 2008). We all know what happened to Bear Stearns and Lehman Brothers, don't we??? I warned all about Bear Stearns (Is this the Breaking of the Bear?: On Sunday, 27 January 2008) and Lehman ("Is Lehman really a lemming in disguise?": On February 20th, 2008) months before their collapse by taking a close, unbiased look at their balance sheet. Both of these companies were rated investment grade at the time, just like "you know who". Now, I am not saying JPM is about to collapse, since it is one of the anointed ones chosen by the government and guaranteed not to fail - unlike Bear Stearns and Lehman Brothers, and it is (after all) investment grade rated. Who would you put your faith in, the big ratings agencies or your favorite blogger? Then again, if it acts like a duck, walks like a duck, and quacks like a duck, is it a chicken??? I'll leave the rest up for my readers to decide.

As excerpted from As the markets climb on top of one big, incestuous pool of concentrated risk...

As a result, we have looked into derivative exposure of top commercial banks to determine if they are hedging with each other to an extent that engenders systemic risk. We have sourced the data from OCC report (attached for your reference, see occ_q1_2009_derivatives 10/09/2009,01:37 190.49 Kb). Overall derivative products in U.S have grown at a staggering pace rising from $41 trillion by 2000 year end to $202 trillion, or nearly 14.0x of U.S GDP as of March 31, 2009. Of the $202.0 trillion notional value of derivatives in United States, top 5 banks alone account for 96% of the total industry notional amount The high concentration of derivatives among the top five players strongly suggest (this actually being politically correct, realistically it practically assures us) that they may be subject to extreme levels of counterparty risk towards each other. JPM is the largest player in derivative markets accounting for approximately 40% of total notional value of derivatives in U.S. JPM's notional value of derivatives as of March 31, 2009 stood at 39.0 times its total assets and 959 times its tangible equity.

Company Notional Value of derivatives % of Total Notional Value Implied market value using JPM's actual as template Implied hedged amount using JPM's actual as template Total Assets Notional Value of derivatives / Total Assets Tangible Equity Notional Value of derivatives / Tangible Equity Implied Counterparty Exposure of Derivatives as Multiple of Tangible Equity
JPMORGAN CHASE & CO. 81,161 40.2% 1,798 1,700.05 2,079 39.0x 84.65 958.8x 20.1x
BANK OF AMERICA CORPORATION 38,864 19.2% 861 814.06 2,323 16.7x 65.66 591.9x 12.4x
GOLDMAN SACHS GROUP, INC., THE 39,928 19.8% 884 836.34 926 43.1x 41.91 952.7x 20.0x
CITIGROUP INC. 29,619 14.7% 656 620.41 1,823 16.3x 29.67 998.4x 20.9x
WELLS FARGO & COMPANY 1,870 0.9% 41 39.17 1,286 1.5x 30.33 61.6x 1.3x
HSBC NORTH AMERICA HOLDINGS INC. 3,454 1.7% 76 72.35 402 8.6x 66.23 52.1x 1.1x
Total 201,964 100.0% 4,316.48 4,082.37          
*all data as of 1Q09.
** JPM had additional collateral at the initiation of transactions of 18,500

Notice how all of the banks on this list probably have at least 100% of their tangible equity exposed through counterparty exposure to, at the most, 5 other highly concentrated, highly correlated and highly incestuous counterparties. Most of the banks have between 12 and 20 times their tangible equity concentrated into this close knit pool. That, my friends, is excessive risk waiting to implode. I am sure there are some of you saying "Well, you don't know that they are actually using each other as counterparties". Yeah, right! Who the hell else would they be using? Tell me what group of companies will be able to absorb $4.1 trillion dollars (That's TRILLION with a "T" of MARKET VALUE carried on the balance sheet, NOT notional value) of counterparty risk??? These are the top derivative holding banks here in this list.

Maybe it is also a good time to review the risks of the Pan-European debt crisis roiling the fixed income markets. After all, if we have massive defaults (virtually guaranteed), some banks will be caught out there, particularly the ones who hold a lot of the debt, and those who were used to hedge the risk of that debt. As illustrated above, the pool of banks large enough to hedge is really not that large in the US, where the largest banks reside. Hey, everything is kosher. After all, everybody is hedged, right?

1. The Coming Pan-European Sovereign Debt Crisis - introduces the crisis and identified it as a pan-European problem, not a localized one.
2. What Country is Next in the Coming Pan-European Sovereign Debt Crisis? - illustrates the potential for the domino effect
3. The Pan-European Sovereign Debt Crisis: If I Were to Short Any Country, What Country Would That Be.. - attempts to illustrate the highly interdependent weaknesses in Europe's sovereign nations can effect even the perceived "stronger" nations.
4. The Coming Pan-European Soverign Debt Crisis, Pt 4: The Spread to Western European Countries
5. The Depression is Already Here for Some Members of Europe, and It Just Might Be Contagious!
6. The Beginning of the Endgame is Coming???
7. I Think It's Confirmed, Greece Will Be the First Domino to Fall
8. Smoking Swap Guns Are Beginning to Litter EuroLand, Sovereign Debt Buyer Beware!
9. Financial Contagion vs. Economic Contagion: Does the Market Underestimate the Effects of the Latter?
10. "Greek Crisis Is Over, Region Safe", Prodi Says - I say Liar, Liar, Pants on Fire!
11. Germany Finally Comes Out and Says, "We're Not Touching Greece" - Well, Sort of...
12. The Greece and the Greek Banks Get the Word "First" Etched on the Side of Their Domino
13. As I Warned Earlier, Latvian Government Collapses Exacerbating Financial Crisis
14. Once You Catch a Few EU Countries "Stretching the Truth", Why Should You Trust the Rest?
15. Lies, Damn Lies, and Sovereign Truths: Why the Euro is Destined to Collapse!
16. Ovebanked, Underfunded, and Overly Optimistic: The New Face of Sovereign Europe
17. Moody's Follows Suit Behind Our Analysis and Downgrades 4 Greek Banks

The EU Has Rescued Greece From the Bond Vigilantes,,, April Fools!!!

More banking opinion and analysis:
  1. The Fed Believes Secrecy is in Our Best Interests. Here are Some of the Secrets
  2. Why Doesn't the Media Take a Truly Independent, Unbiased Look at the Big Banks in the US?
  3. As the markets climb on top of one big, incestuous pool of concentrated risk...
  4. Any objective review shows that the big banks are simply too big for the safety of this country
  5. Why hasn't anybody questioned those rosy stress test results now that the facts have played out?
  6. Banks Swallow Another $30 billion or So in More Losses as Their Share Prices Surge (Again)

You can download the public preview here. If you find it to be of interest or insightful, feel free to distribute it (intact) as you wish.

JPM Public Excerpt of Forensic Analysis Subscription 2009-09-18 00:56:22 488.64 Kb



Reggie Middleton

Author: Reggie Middleton

Reggie Middleton

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