July 31, 2013

Banks BARE All

Where have I been?

Somehow, I missed the fun happening in SEC filings for large banks like Morgan Stanley, Goldman Sachs, JP Morgan, Credit Suisse and Deutsche Bank.

If you already know what BARES are – Buffered Accelerated Return Equity Securities, of course – goody for you, and you should’ve said something.

What first got my attention were big quarterly earnings this period for the banks. Strip out the Financials sector and S&P 500 earnings are measly. But banking is booming. Morgan Stanley reported a 66% jump in year-over-year quarterly net income “as the investment bank bounced back from a slump in trading revenue a year earlier,” said a Wall Street Journal story.

Wait a minute. Interest rates even after upticks since May 22 when Ben Bernanke offered an impression that the Infinite Money Theorem may in fact have a terminus are so low that inflation-protected notes guarantee buyers a loss even now. If banks rely on interest…well, you don’t expect big numbers, right?

Hang on now. Morgan Stanley said these results reflect trading gains. So I checked statistics at the Securities Industry and Financial Markets Association (SIFMA, where former Republican congressman Judd Gregg has just taken the helm).

Prepare for a small fusillade of data: Overall equity volumes are down 2% year-to-date compared to the same period in 2013. So that’s not it. Offerings of debt and equity are helping, certainly, with overall corporate underwriting up 14.7% from last year. Digging deeper, convertible debt is up 65%, mortgage-backed securities up 241%. But these are small markets, about $74 billion of a total $1.0 trillion of corporate financing so far.

For comparison, every month the US Treasury is issuing or refinancing over $600 billion-with-a-b of paper – bringing generous commissions to primary dealers like Morgan Stanley behind the bulk of them. But these levels are the same we’ve been seeing since 2009.

Why does this matter in the IR chair? Because these same banks drive big volumes and sellside coverage.

So what’s really juicing 66% earnings growth? Maybe the BARE facts. BARES are structured notes, a fancy term for a loan with a bunch of conditions making it something besides a loan. Big player HSBC says they offer an “alternative to traditional long-only investing and may out-perform a direct investment in the underlying asset” (ETFs, indexes, even individual stocks, HSBC says) when the environment is either moderately positive or negative. That’s because they include a downside hedge.

But investors can lose their entire investment too. Banks are offering these instruments by the truckload, Edgar suggests. Go to this link: http://google.brand.edgar-online.com/default.aspx?sym=ms. Change the last two letters to “gs” or “db” or “cs” or “jpm” or “bac.” Look for Forms FWP or 424B2.

Credit Suisse offers one maturing Aug 2, 2016 tied to the Russell 2000 with 19.5% interest unless the underlying index declines more than 20% during that time. By comparison, the Three-Year US Treasury is paying 65 basis points – 0.65%.

Read the prospectus and you’ll see Credit Suisse hedges – bets against the outcome it’s offering. If you can sell investors something to keep them out of markets, charge governments and corporations underwriting fees on record offerings, and put the proceeds to work trading on a riskless-principal basis to mitigate your risk, it’s a pretty good business apparently.

And it’s yet another reason why you need good data-analytics in the IR chair now. Your trading most times is not investment in the old-fashioned sense. We routinely see day-over-day changes of 20-50% in Hedging activity for household names. Understandable, when the facts are laid bare. So to speak.

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