Highlights include Goldman Sachs Group, Inc. (GS), Bank of America Corp. (BAC), JPMorgan Chase & Co., Inc. (JPM) and Morgan Stanley (MS).

Some of the banks flexing their new profit muscles are showing extreme eagerness to repay TARP money “as soon as possible.” The managements’ comments range from “it is our duty to repay TARP,” to TARP being “scarlet letter” or even “destructive.” Many clarify that they did not ask for government money, but were forced by the government to take it.

At the same time, there are reports that the government is planning to convert the TARP preferred shares to common equity to shore up the banks’ capital levels without having to ask the Congress for more bailout money.

The fact is that these same banks are enjoying tremendous benefits from some
other lesser-known programs that come without any attached strings.

FDIC’s Guarantee Program

In October 2008, the FDIC had created a new program, TLGF (Temporary Liquidity Guarantee Program) through which it provides insurance on debt issued by the Banks, for a small fee. Banks have benefitted a lot as they are able to borrow cheaply and further the program was launched when the credit markets were virtually frozen.

During the last six months, Goldman Sachs (GS) has issued $28 billion in debt under this program while Bank of America (BAC) and JPMorgan Chase (JPM) have issued $40 billion each and Morgan Stanley (MS) has issued $23 billion.

Fed’s Lending Programs

During the past eight months, the Federal Reserve has pumped more than $800
billion of cash into the nation’s financial system. The central bank’s balance sheet now stands at $2.2 trillion, more than doubled since September, 2008, as the Fed continues to buy all kinds of securities. In all, the Fed has created 11 programs to combat the credit crisis.

The Investment Banks, which were earlier not eligible for borrowing from the Fed, were granted access to new discount window after Bear Stearn’s failure. Further, the identities of financial institutions that borrow from the Fed emergency lending program are kept secret to “avoid any stigma.”

During last week, commercial banks averaged $48.5 billion and Investment firms averaged $12.9 billion in daily borrowing from the Fed program.

Are All Profits Real and Sustainable?

The mega-banks benefited immensely from volatility and wide spreads, which resulted in huge profits in fixed income, currency and commodity trading. These conditions are not going to last forever.

The retail-focused banks made a lot of money in the mortgage originations. With mortgage rates at record lows, the surge in refinancing continues, but the other types of lending are going down as banks continue to be reluctant to lend to individuals and small businesses due to credit concerns.

Further, with capacity utilization at historic low of about 70%, the demand from the large businesses is not likely to pick up substantially any time soon, as the global slowdown continues.

And don’t forget Goldman’s missing month of December, (not reported in any quarterly results), which had resulted in a loss of a loss of $1.3 billion. Citi had a net income ($1.6 billion), only if we forget the preferred shares and the dividends thereon; after adjusting them, the bank had a loss of $0.18 per share. And the bank’s actual loss was much deeper if we remove the accounting profit of $2.5 billion resulting from widening of its credit default swap (CDS) spreads.

Similarly, Bank of America recorded $2.2 billion in gains related to mark-to-market adjustments on Merrill Lynch structured notes and other one-time gains during the quarter, which helped it to “beat the estimates.”

Losses Will Continue to Rise

All the banks have seen serious problems in their loan portfolios during the reported quarter. While there are signs of deceleration in the economic slowdown, the unemployment will continue to rise for coming month, and so will the losses on credit cards, home-equity loans and mortgages. We suspect that the at least some of the banks are not providing enough for future losses, which will eat into their earnings.

De-TARP Them but Do Not De-Regulate

The main problem that the banks seem to have with TARP funds is the restriction on executive pay and bonuses. An era of deregulation and a compensation structure that rewarded excessive risk taking created the financial mess that we are in.

Current administration is working on the overhaul of the regulatory structure. We should ensure that even if these big banks are allowed to repay TARP, they should be under greater regulatory oversight (including regulation of pay structure) as soon as possible — not only because these companies are still enjoying massive government support, but also, if in the future any one of them is in deep trouble, then taxpayers will have to again come to the rescue because of “too big to fail” systemic risks.

Zacks Investment Research

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