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December 16, 2022 | A number of observers are providing their prognostications about 2023, but we’d like to review what we learned in 2022 and then ponder what happens next. Along the way, we’ll take a victory lap or two for continuing to focus readers of The Institutional Risk Analyst on the actuals vs the often false narrative woven by the crowds of conflicted agents that populate Wall Street. And a big thank you and Merry Christmas to all of our readers!
It is important to remember that America is a commercial society, starting with the media. Everything you hear in the US media is driven by a commercial interest, either of the publisher or some large advertiser or corporate sponsor. And all retail communication, including Wall Street research, advice from financial advisors, and the opinions of credit rating agencies and other third-party service providers reflect a commercial bias.
One editorial objective of The IRA since its creation in 2003 has been to describe the difference between the hopes and aspirations of Wall Street as expressed by this chorus of conflicted agents and the actual results reported in the data. Sadly, most commercial vendors care less about quality and accuracy than one might hope. In this sense, in the decades we’ve worked as consumers of financial data, nothing has changed.
In June of this year we raised questions about how Wall Street data providers like Bloomberg don’t accurately resolve the charade of “non-controlling interests” in calculating equity market value and its derivatives (“Memo to Gary Gensler: Beware the “Non-Controlling Interest”). We wrote:
"The result of errors in calculation and/or presentation, however, can also allow issuers of securities to mislead investors. Just because the presentation of the data is allowed under GAAP or industry convention does not mean that it is not misleading. Whenever you simplify a piece of data by aggregating it into a derived metric like a P/E ratio or price multiple, fidelity and context is lost. And all too often the presentation of value is incorrect because the global providers of financial data are ignorant of context and the always moving target of GAAP accounting as interpreted by accountants and lawyers."
Today, for example, United Wholesale Mortgage (UWMC) and Rocket Mortgage (RKT) show MVE and price/book value ratios that are clearly wrong, yet despite several attempts by this terminal user, Bloomberg refuses to address the presentation error.
As a result of this blog post, The IRA was contacted by a senior columnist at The Wall Street Journal, who prepared an article based upon our comment. That writer confirmed our research that there are dozens of public companies using the non-controlling interest canard to mislead equity investors, a ruse that the major data providers refuse to address. Fact checking was done. Yet just hours before the article was to be published, it apparently was killed by the Journal’s editorial staff.
The lack of clarity and fidelity in published data on public companies helps issuers confuse retail investors, but the larger ebb and flow of interest rates and monetary policy has created some huge distortions in terms of equity market values. Add the techno babble of “fintech” which bloomed during the latest round of Fed bond purchases in 2020 and the stage was set for incredible volatility in stock prices.
At the end of 2021, we asked if Block In (SQ) was really worth 25x book value “Update: Block Inc. & Upstart Holdings.” At the time SQ was trading over $170, but today it is closer to $65. We focused on the financials, but provided context in terms of the impact of QE on this fintech name and the market more generally. SQ is down 62% YTD.
In January of 2022 we began to describe the post-QE deflation and how the process of ending the Fed’s massive open market operations would hurt equity market and bond valuations at the same time (“Powell, Yellen, Bernanke and Post-QE Deflation”). We wrote:
“It is becoming pretty clear that the FOMC has lost all credibility when it comes to financial markets or managing inflation. Market stability, lest we forget, has been a managed concept since 2009, thus when the FOMC decided to explicitly lean in the direction of "liquidity" (aka inflation) and forget the rest of the Humphrey Hawkins mandate regarding price stability, the cost was paid in credibility. Of course, there is a 1:1 correlation between the Fed's credibility and its loss of independence from the US Treasury, the primary beneficiary of QE.”
By February of 2022 we revisited Silvergate Capital (SI), a high-flying bank crypto stock that was trading at 12x book value in Q1 of 2021. Today the bank is down over 80% for the year and is at 0.45x book value. We wrote: “In the world of financials, Silvergate may be among the biggest meme stocks yet in the era of quantitative easing or QE.”
A little over a year ago, we profiled Raymond James Financial (RJF) for subscribers to our Premium Service. Since last year, RJF has been leading the group we lovingly refer to as the “asset gathers,” banks that focus on the investment advisory business, eschew credit risk and amass vast amounts of liquidity as a result. Even as most financials have given up significant ground in terms of valuation, RJF has managed to actually go up slightly in 2022.
Most recently, we focused our readers of the impact of the end of the Fed’s massive purchases of Treasury paper and MBS on book value reported by banks, REITs and other investors. In “Loan Delinquency, EBOs & Ginnie Mae MSRs” we described how rising interest rates were eroding stated book value and boosting the value of negative duration mortgage servicing assets.
Two weeks later, we published our look at the entire US banking industry, showing that once accumulated losses on available-for sale securities, and a mark-to-market is done on portfolio assets, the US industry is essentially insolvent to the tune of $1.9 trillion. When we asked “Is JPMorgan Chase Insolvent?,” the answer sadly is yes.
After the 2008 financial crisis, many banks and funds were effectively insolvent because the bid price on private mortgage assets had gone to zero. Even government mortgage assets were trading at distressed discounts. Banks were well-capitalized, but illiquid for a couple of years. The economy suffered through the 2010s as a result.
As 2022 comes to a close, however, the banking industry faces a different challenge, namely a vast wave of market risk created by the FOMC and quantitative tightening (QT). The amen chorus on Wall Street likes to repeat the phrase "banks are well capitalized." Maybe not. Those in the Buy Side chorus who are looking forward to lower interest rates in 2023 ought to instead be concerned that next year could really be about a bank solvency crisis.
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