Equity Thursday : Systemically Importance Institutions Are Good
I really do not have too much to say about the state of equity markets right now floating in the whimsical highs of cloud number 9 which coincidentally is the month of September in our Gregorian calendar.
My mind is wandering these days to the price we are assigning to the institutions that are deemed too big to fail as we head into the month pre-ECB bank audit announcement, a process that has taken almost a year and a spate of tier 1 capital issues to the tune of USD 100 bio that is anticipated to hit the street (WSJ) as well as new swap margin rules coming soon (Reuters).
This is not mentioning Chinese banks coming out with their Tier 1 issues in the weeks ahead and a massive Alibaba ipo which has been quite an ill luck event after their past failed attempts, failing on a tanking market. And it looks like Alibaba must have gone all the way to heaven to consult the fengshui experts this time because it looks like nothing could derail their ipo this time.
My challenge is this. In the US, the regulators have identified a list of “too big to fails” (TBTF) and are constantly imposing new rules and heaping new regulations on them, besides the stream of fines, the chances of failure is highly marginalised.
I will not debate on the flaws of the system or try to ascertain the possibility of the impossible. The idea of TBTF suggests that the institutions can fall back on the government should anything go wrong and that is a form of “divine protection” which makes them infallible unless the government should fail, then heaven help Americans (and half the world along with them).
To date, there are 30 banks under the SIFI (Systemically Important Financial Instituion) supervision and 2 insurance companies, namely AIG and Prudential (Met Life is reportedly getting its verdict today). Hedge funds and asset managers are being evaluated too.
8 of the 30 banks are also listed in the GSIFI (Global Systemically Important Financial Institution) list. That means even more stringent requirements for them.
This is the list of the Global SIFIs taken from the FSB website.
I cannot but help but think we are in luck here.
Too Big To Fail = Cannot Fail At All Cost = Very Expensive To Maintain = Lower Profits
And the banks above are just about as credit worthy as their regulators which makes it a very expensive business to run for them i.e. expect low dividends because there will be a new rule tomorrow that will eat into their bottom line.
Banks are fighting back, hiring former FED officials and regulators to join their payrolls plus recruiting the top accountants around to make sure there is a new “reserve” to put in their books each year that will guarantee profits. Yet, I feel that there is quite a bit of profit to be made from this idea.
Take a look at US banks, their bonds and dividends.
For ease of work, I picked their latest perpetual “Coco” issue and for those without, such as the case of Capital 1 and PNC etc, I picked their 144A preferred shares or longest dated senior bonds in the cases of AIG, Metlife and Prudential.
The perpetual column gives an indicative yield of where their securities are trading.
I cannot help but feel that the table of GSIFIs or GSIBs could turn out to be a decent arbitrage eventually if we skip the equity dividends and head for the bonds. E.g. Goldman Sachs – equity gains + divds < perp yield.
Now, if we come closer to home, we note that the average Asian investor is already adopting this mindset.
Look at the latest bond issues. Companies affiliated with the government in whatever little way have done well. Eg. Kris Energy and Dyna Mac, both boasting Keppel stakes.
We have our TBTF banks here – all 3 of them which we can implicitly assume are safe. Within the TBTF banks, they will have their TBTF clients (corporates) which should be saved or the bank will fail along with them, so on and so forth.
If I had to choose, then I will pick the free loaders – the institutions or companies systemically important to the TBTF banks ie. their largest customers. The largest customers will enjoy free protection because the bank cannot let them fail whilst the bank is paying the price of protection to the regulators.
It is common sense that is almost too good to be true.
Will someone wake me up please ?