Pat Dorsey: Hi I'm Pat Dorsey, Director of Equity Research at Morningstar. With the crisis of confidence in a global banking system once again reaching a crescendo after perhaps a fall stone a few weeks ago, I think it’s worth taking a step back and thinking about what is the possible end game here. What is it that’s stops the crisis of confidence in a banking systems and restores some model come of trust from investors. I’m happy to have with me Matthew Warren the Associate Director of Equity for our banking team. Thanks for joining me Matt.
Matthew Warren: Good to be here.
Pat Dorsey: So after the recent moves basically nationalization of a small Irish Bank well quality nationalization of a large English bank or RBS is worth thinking amount whether, that maybe part of the end game here in the US.
Matthew Warren: Yeah, I was force to think about it you know, you could see that in the market action today. A lot of investors are looking at what’s happening across the pond, you know they’re taking that as the foreshadowing of what could happened here and a lot of people are just selling you know and just going to ask questions later. It’s that worry about a zero that really draw out of the stock and were seeing that broadly across the banking sector. Especially in top to your banks people worry about the domino effect.
Pat Dorsey: Yeah, I was going to say that because there are two things that come to mind if you start putting nationalization of large US banks kind of the radio screen. One is the domino’s and then the others how that sort of somebody clips the competitive landscape on it’s head. On the domino side of things you know where do you draw the line from sort of the really bad, to the kind of bad, to the okay bad where does line happened?
Matthew Warren: Right, that’s extremely difficult so you know in our minds it seems like sitting here you know if they go back for a third bail out that might be it for them. Bank of America would be right behind them and then you know from there you’ve got this other large competitors like JP Morgan’s relatively better off right. But they some similar exposures they have I-Bank you know they’ve been strong while the others have been weak and they have been gaining from that position. If all of the sudden city and bank of America are full faith in credit US banks. Maybe all of the sudden JP Morgan goes from strongest to weakest among the large banks and so you know.
Pat Dorsey: If they had a landscape then basically flips on it’s head.
Matthew Warren: That could clearly happen so then you know you wonder how many dominos would fall but you know you would be the eye banking. The companies would be the large I-Banks would be—what are the key issues is as banks did amentia and bought troubled target. And you know—and people worried about that spreading to the host or what are the issues I mean that they’re several issues on the table but in terms of the dominos falling there is 8,000 banks in the country where does it stop.
Pat Dorsey: Because that’s an interesting I think point for most of our viewers to recognize which is a really very strange banking system here in the US in terms how fall mended it is. In most large countries if you would at a national has four or five banks that’s the whole banking system. You know, you have restored confidence that’s it right there. Whereas with 8,000 banks here in the US the essential of kind of where the domino style. And how you sort of draw this line between the banks that perhaps the US Government can take under it’s wing and you know operation you just you can take 8,000 under your bank.
Matthew Warren: Yeah, I don’t know how on earth we would manage that if that’s where we went to eventually. You know some people think that you know there is a distrust to government and people might still want to bank with their local banks that don’t have the trouble like securities in a more traditional loan book. So maybe they survive and it’s large banks that get in trouble.
Pat Dorsey: Actually let me explain for many, because the interesting maybe perhaps cultural difference here that you know the US has this long tradition of kind of perhaps less governmental involvement in the economy than other countries do. So it’s a little bit you know perhaps easier for the public to swallow in bank nationalizations and say what’s in Europe that it is in US. Do you think that could be an inexpedient to this or do you think that if has to happen it’s going to happen.
Matthew Warren: Both actually, so I think that’s why it doesn’t happen and it hasn’t been talked about very much until you know those concerns are getting amplified. Because what were seeing overseas, so that’s why we’ve been—the governments and Barry Radisson has even talked about it to you and go down that road. But really it’s you know it kind of waste on what your macro assumption is right.
So you know if you think that the asset prices continue to collapse the collateral values for this banks and if you think unemployment is going to double digit levels the earning will shift you all this capital. The banks are better capitalized than they were a year ago after taking all on this capital. But in that scenario the really ugly macro scenario that capital will be shoot through and—
Pat Dorsey: I think that that’s the big issue is that people, do the market is basically fast forwarding two to three quarters. Because if we take a snap shoot today to the ones are fine banks are arguably over capitalized. But what the market is doing its fast forwarding and assuming we have a lost courage continue to deteriorate right. If there was there on that—
Matthew Warren: And you know the forth quarter kind of marketed dramatic acceleration and loses because for 18 months what you saw is a loses running through the banks for mostly tied to the housing bubble bursting. So mortgage focus banks and banks that are in the worst region that is affected by that were the one seeing all the pain well now wearing on top of that. You have all the job loses started mounting the company is failing in the fourth quarter. All this things are starting the normal recession and everything granted their abnormally strong perhaps.
But those are being layered on top, so we really had the worst point in the curve and if you extrapolate that out. That that acceleration it draws a pretty nasty picture and I don’t think it’s very clear you know where that’s move out—you know there is a lot of people debating this all over the place and it’s not clear.
So I think people are voting with their feet with the banks, they’re afraid of that acceleration and people are afraid of the zero, they’re afraid of nationalization. And is it a realistic possibility that this could happen you have to say yes.
Pat Dorsey: Yeah, I mean that seems a question there at least it has to be discussed and that sort hive off. And this sort of thing we don’t talk about. And the one thing that might present perhaps a solution that other the nationalization is this alligator bank that’s been discussed. Which is basically taking all the bad asset of the balance sheets, ring fencing them and then leaving the big banks with presumably the less toxic assets. Is that a possible solution on your mind?
Matthew Warren: Yeah, it’s being discussed by various folks in the government now and there is a sense of urgency around it, it’s the original TARP program where I’m taking the trouble to liquid assets out and hoping that that taste on the dramatic mark downs of the liquid securities. So that you can see on normal loan curve and the UBS did it.
Pat Dorsey: I was going to say we do have an example a few word of example of this and this what’s this government did with UBS, correct.
Matthew Warren: Yeah, they took out the most troubled to liquid assets they did it quickly and they set them aside. So you could see the rest of the bank and what those earnings look like. This could help in the US if they need to do it quickly. That they need to go and grab this assets and set them aside. Ensuring them clearly doesn’t work they did with city and bank of America in terms of confidence it doesn’t work, the assets are still there. They still have first loss position and then shared loss that’s not doing the trick so far.
Pat Dorsey: And it couldn’t—we don’t have time for something like an auction process that allows things to drag on, it has to be basically something that’s quick, painful but done.
Matthew Warren: Yeah, take them close the marks are now were at a slight hair cut to that but just take them and get rid of this assets.
Pat Dorsey: Now in the end, it is a hard question to ask. But if you know this are two end games we can see here. maybe the side of the real bank impossible you know nationalization of one or several large banks are there other possible endings or they seem like the two most likely pass at this point?
Matthew Warren: Those are two likely scenarios if the—you know if the macro situation continues to deteriorate like it has. I mean obviously things could start to get better if the laws curves turn around, before the system has short circuited and before investors run for the hills, if you can see the lost curve start to get better then the banks will start to look over capitalized and that they you know they want too far perhaps. The problem is, is that that looks at least a couple several quarters off in my mind that, so our investors is patient enough I guess it’s the question there.
Pat Dorsey: So if you’ve had that handicap this most likely I’m getting is that what were talking about you know potential nationalization of one and more large banks versus the arrogation bank that would sort of take the bad assets. And allow us to see lost curves it sounds like you might think the ladder is more likely.
Matthew Warren: Yeah, you know I think with the new administration coming in I think they’re going to—the history so far is that they’re trying to have this off before it comes to crisis mode. And things are pretty tense now, I think they’re going to go and aggressively go after this bad assets and try and pull them off the bank balance sheet so you can see there aren’t curve like you mentioned. And not investors form of judgment based on that so that’s what I’m hoping to see.
Pat Dorsey: And that would be hopefully more rational judgment sort of based on the loss curve without this toxic assets as opposed to extrapolating the absolute loss.
Matthew Warren: Exactly because what you have is at the end of every corner people are trying to flush out this assets trying to sell him or her at forces. The marked down worst, so if you pull them off the bank balance sheet you can get out of that spiral and go back to actually learning curve.
Pat Dorsey: Excellent, thank you so much Matt.
Matthew Warren: Sure thing.
Pat Dorsey: I’m Pat Dorsey and thanks for watching.
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