The term thrown around lately to describe big U.S. financial institutions is 'zombie banks,' and the brand new cover story in this month's Atlantic, "What's Inside America's Banks?" does a great job demonstrating why.
A few of the key points: if even JP Morgan Chase, with its supposed fortress of a balance sheet, can lose $6-billion in one trade, when its value-at-risk for that portfolio was just $67-million in 95 per cent of likely scenarios, then anyone can. And after investing $1-billion in Citi, Bill Ackman lost $400-million and now vows to never touch another U.S. bank again because no one can decipher what's inside of them.
If you follow the banks closely, you'll already know a good chunk of the information laid out in the piece. But even to an educated investor, seeing all the problems compiled and then listed one after another makes quite the statement.
Here in Canada we often look south of the border at these facts and laugh, while at the same time praising the strength of our own financial institutions. But have you ever looked closely at their financial statements? Ever dug through the supplemental financial information packages? You'd be surprised at how little is in there.
Take the latest quarterly results from Bank of Montreal, whose capital markets division posted a quarterly profit of $293-million, its best in two years. The vast majority of this came from stellar trading activity. Yet the bank's supplemental financial package, which offers the most information about its financial performance, simply breaks down what types of trading contributed to this revenue (interest rate trading generated the most, with $159-million in revenue) and doesn't offer much more. Just big categories, no details.
Keep digging and you'll see that the risk-weighted assets on the bank's trading book amounts to $69-billion, but there's no breakdown of how that's comprised -- whereas when it comes to corporate loans, the bank breaks down exactly how much it has committed to every single industry, from agriculture to forest products.
To be fair, BMO does break out its derivative instruments, so you can see its gross assets in things like cross-currency interest rate swaps. But it's very hard for the average investor to tell what this exposure means, or if any of it is overly risky.
The same goes for Toronto-Dominion Bank, which prides itself on its investor relations. In its latest annual report, the bank simply states that "wholesale banking net interest income increased largely due to higher trading related revenue." Then in the section that is supposed to go into detail about where this profit came from, all you get is that "the increase was primarily in interest rate and credit portfolios and equity and other portfolios, partially offset by a decrease in foreign exchange compared to the prior year. The trading environment for interest rate and credit trading improved on tighter spreads and increased client activity in 2012."
That doesn't do much to explain how its income from interest rate and credit portfolios was $534-million this year, more than doubling 2011's profits from the same business.
This isn't meant to pick on these two banks specifically. The Big Six are all in the same boat. And that presents a problem: if it's hard to tell exactly where the banks made money from trading during a good quarter, when they're happy to divulge their good ideas, imagine how hard it will be to decipher what went wrong in a bad quarter.