Saturday, May 29, 2010

Financials Update: House/Senate reconciliation process. FASB Rule Updates; JP Morgan Hates Spanish Banking Sector $STD $XLF

· Recall the group traded strongly last Fri (5/21) on the expectation that the House/Senate  reconciliation process will wind up softening the Senate Dodd version of financial regulatory  reform (investors had been valuing a lot of the financial space as if Dodd would be passed  into law verbatim as of Thurs 5/20). This hope remains a tailwind for the financials, although
the process will be a drawn out one and may not be wrapped up until Jul. The White House  this week sent more signals that it isn’t a fan of the Lincoln derivatives amendment, although
it will prob. let her runoff election get out of the way before making a push to have it taken
out of the bill. Just as the House/Senate regulatory overhaul process comes to a conclusion,
the FASB published its draft proposal this week concerning mark-to-market accounting. The
comment period for the FASB rules ends Sept 30 and it has promised that no changes will be
implemented before ’13. However, the ABA called the proposals some of the most dramatic
changes ever that will increase the pro-cyclicality of bank accounting (i.e. it will exacerbate
downturns and upturns in the economy rather than helping to soften swings). There is some
speculation that Congress could step in and provide more oversight before the rules are
implemented. Bank stocks held in OK despite the FASB worries as the industry already
discloses the market value of held-to-maturity assets in their statement footnotes; these
changes will move those footnotes into the statements themselves (although there could wind
up being changes made to capital; a Bloomberg article on Fri said that RF and KEY had
among the largest differences between their stated book value and market value of assets).
Despite the FASB accounting news, the big focus this week remains in Europe. Last

The Spanish government was forced to take over one of its local insolvent regional lenders after takeover talks fell apart; the St remains very worried about the Spanish banks in  general, esp. the local banks. JPMorgan’s European FI bank analyst (Roberto Henriques)  published a report this week that discussed the group – “Contrary to the rest of its European  peers, we think that the Spanish banking sector has a solvency crisis, particularly within the  savings bank sector”. In addition to the weekend’s seizure, the Bank of Spain this week  rolled out fresh provisioning guidelines for the country’s financial institutions which analysts
said would hurt the group’s ’10 earnings.
· Financials trading – the group underperformed the SP500 this week and in the month of
however, the group remains a big outperformer on a YTD basis (the BKX is still up
~17% YTD vs the SP500 being dwn ~2%; that said, the BKX was up ~30%+ at one point a
few weeks back). The Q1 earnings season was a major catalyst for banks as credit is showing
signs of finally reaching a positive inflection point and investors are looking forward to the
end of massive reserve builds. That tailwind remains in place and is helping the space,
although changes in Congress will wind up taking away some of this upside.

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