Seven Deadly Sins

Well we added 100 shares of SKF at $85.65 today on a technical basis though there is some question how well technical analysis fares in a market as badly rigged as this one, but it looks like at least one notable fundamental analyst is in the same camp. The bad bank bad mouthing man is Mike Mayo formerly of Deutsche Bank. These days his employer has changed, but his message on the banks remains the same.

…there’s another bank slayer in town, and his name is Mike Mayo.

The former Deutsche Bank analyst has re-launched his coverage of the sector at his new employer, CLSA, with a note titled the ‘Seven deadly sins of banking’.

And Mayo, who was a virulent critic of ex-Merrill boss John Thain and anathema to Chuck Prince,  can barely find a positive thing to say about the sector. Of the 11 banks he is now following all are rated either “sell” or “underperform” and his forecasts are also mostly below consensus.

He sees the sector lurching from one crisis (capital market losses) to another, more serious one (loan losses).

The impact of excessive risk, while already seen, still has more to go in our opinion, especially given a rolling recession by asset class. While mortgage losses may be half way to the peak, card and consumer losses may only be about one-third of the way and industrial and commercial real estate problems (except construction) seem in the early stages. Loan losses, as a percentage of loans, will likely pass the level of the Great Depression. Other pressures to income should include lower revenues (less loans and fees), higher expenses (more oversight costs), and dilution of shares outstanding (insufficient capital), likely leading to ongoing earnings shortfalls through 2010. Per the balance sheet, banks will likely need a permanently higher capital and reserve levels, implying lower ROEs and less reserve releases when the cycle is over.

The losses  are, of course, a consequence of the ‘Seven deadly sins of banking’, all of which Mayo says were committed, sometimes on an unprecedented scale, by US banks over the past 10-15 years.The seven deadly sins of banking are ways that US banks increased risk to generate revenues. These actions front-loaded earnings and back-ended costs, the brunt which is being felt today. These “sins” were not created in a day but typically over 10-15 years. In almost each case, the extent of the transgression, meaning excessive risk, could be described as somewhere between the worst in a decade and the worst ever.

Below is our list with a summary of the issue:

Greedy loan growth - once in a generation excess.

Gluttony of real estate - historic asset concentration.

Lust for high yields - loan losses exceed Depression (est.)

Sloth-like risk management - highest ever consumer debt.

Pride of low capital - lowest level in 25 years.

Envy of exotic fees - exotic turns toxic w/$400 billion of charges.

Anger of regulators - consequences of past lobbying.

Mayo says atonement is possible for the sinners, but it will mean banks embracing lower levels of risk, leverage, growth, returns and maybe even size.

Over the long term there is a real possibility that the regulatory pendulum swings all the way back to 1934, whether via a reenactment of Glass-Steagall, a new way of measuring market concentration (not only deposits), or other moves that lead to a break-up of certain large banks. Even short of this, there is a chance that banks move in the direction of becoming more akin to large public financial utilities.