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This guest commentary was written by Christopher Whalen. It was originally posted on The Institutional Risk Analyst

Financials Climb the Wall of Worry - For Now - 6 5 2020 12 19 49 PM

Financial markets continue to predict a better economic recovery than is widely anticipated when speaking to business leaders.

With the notable exception of residential mortgage lenders, who are having a bumper year amidst the general economic carnage, most other parts of the economy remain disrupted and visibility on the financial cost of this huge dip in national wealth is limited.

Financials Climb the Wall of Worry - For Now - 6 5 2020 11 46 43 AM

We note that Amazon (AMZN) just raised $10 billion at crazy low rates.“The company raised $10bn in an offering that included three-year notes carrying an interest rate of just 0.4 per cent,” reports the Financial Times, quoting nameless sources.

But low interest rates aside, Barry Diller got it right on CNBC this AM when he said that “tremendous economic damage” has been done.

Meanwhile financials continued to move higher on hope of a quick economic rebound, but based upon little data. H/T to our Twitter pals for pointing out that the federal regulators have given banks an additional 30 days to file Q1 financials, yet public companies will be reporting earnings on time to the SEC.

What gives?

Most of the US banks have already filed electronically with the Fed, OCC and FDIC, so what is the justification for this delay?

No matter. Stocks climb walls of worry and don’t need inconvenient details like data to distract from the great work. We note that IRA Dead Pool founding member Deutsche Bank AG (NYSE:DB) is up 21% YOY just shy of $9.50, truly a remarkable and perhaps also troubling sign of the market froth.

The dearest valuation for a US bank still goes to American Express (AXP), at four times book value by far the segment leader. Next comes Charles Schwab (SCHW) at 2.3x book and First Republic Corp (FRC) a bit over 2x, which is also up for the year as of yesterday’s close. We bought some share of agency REIT Annaly (NLY) and more Citigroup (C) TRUPS over the past several days.

As good as things feel at present, we are still 30 days from Q2 2020 earnings and there remain an enormous number of unknowns in the world of banking and finance.

For example, we continue to learn new and interesting details about the busted, state-owned aviation company known as HNA, which for a time pretended to be the largest investor in Deutsche Bank.

A unit of China’s HNA Group reportedly failed to repay $750 million owed from its buyout four years ago of a US technology distributor Ingram Micro. In an announcement to the Shanghai stock exchange last month, HNA Technology Co Ltd reportedly stated that the missed repayment was on a $4 billion loan secured from lender Agricultural Bank of China in 2016 to finance the group’s $6 billion buyout of Ingram Micro.

Meanwhile U.S. Secretary of State Mike Pompeo Thursday warned American investors against fraudulent accounting practices at China-based companies, Reuters reports. Pompeo said the Nasdaq’s recent decision to tighten listing rules for such players should be “a model” for all other exchanges around the world. Ditto. Follow the rules or get out of the US market.

President Donald Trump is no doubt delighted to learn that US employers added 2.5 million jobs in May, a clear sign that the demand side of the economy is still quite strong. But we continue to see signs that the credit cost of the disruption in public activities and institutions is going to be vast and bigger than the 2009 default peak.

The fact that employment fell in May suggests to us that the credit picture, while still decidedly murky in commercial real estate and corporate credit, is improving on the consumer side, a nice surprise from a decade ago.

That roaring noise you can hear in the distance is the residential mortgage sector having another record month of origination.

Indeed, we offer as proof of the existence of a loving and merciful creator the fact that Impac Mortgage Holdings (IMH) has returned from the near-dead and is again originating government and conventional loans, National Mortgage News reports. “Impac Mortgage Holdings has resumed originating mortgages, but at this point will not be offering the non-qualified loan products it had previously focused on,” writes Brad Finkelstein.

Credit score limits imposed by lender banks led by JPMorgan Chase (JPM) are choking off government lending to lower income households and, for now at least, pushing production back into the conventional loan market. This means that credit quality of current vintages should be even better than recent years.

Meanwhile, everything else in the world of residential and small balance commercial mortgages is a cash only bid. Homes above $1 million are facing a bank-only market with little or no liquidity. We keep hearing about issuers such as FRC coming to market with single production jumbo offerings. Stay tuned.

Look for banks to continue to climb higher as investors cannot help but be impressed by a steepening yield curve. But remember that this time is very different from 2009 and credit losses at some banks, REITs, BDCs and funds with CRE and leverage loan exposures could be quite a bit larger than in 2009.

Look for financials to “extend and pretend” on a lot of poor credits in Q2 2020, but by Q4 we will be nicely positioned for the mother of all flushings in terms of taking bad assets to the curb. Remember, 2009 losses cost US banks over $120 billion or roughly total bank earnings for a year.

Buckle up.

ABOUT CHRISTOPHER WHALEN 

Christopher Whalen is the author of the book Ford Men and chairman of Whalen Global Advisors. Over the past three decades, he has worked for financial firms including Bear, Stearns & Co., Prudential Securities, Tangent Capital Partners and Carrington. 

This piece does not necessarily reflect the opinion of Hedgeye.