Christopher Whalen: Massachusetts Mortgage Decision Could Kill Top Banks


The bank stress tests are back and you'll sure be hearing the phrase "Too Big To Fail" uttered over and over again.

The purpose of this test is to allow the 19 big banks to raise their dividends or repurchase stock. In order to get the approval they must submit their new capital plans to the Federal Reserve by this Friday.

It will be a big banking week with concerns about Portugal and on Friday, JP Morgan is set to report is earnings. I decided to speak with Christopher Whalen, Senior Vice President and Managing Director of Institutional Risk Analytics.

LL: Stress tests will be back on the big 19 banks before they can return capital back to shareholders. Which ones do you think will be the first ones to be able to do this?

CW: Depends on degree of regulatory capture. None of the top eight bank holding companies should be able to change dividends this year if we have regulators worthy of the description. Bank of America , Wells Fargo , JPMorgan, US Bancorp still have issues to address with mortgage servicing/securitization mess.

LL: Any concerns of banks failing this test?

CW: No. These tests are not meant to be failed.

LL: If these tests are not designed to truly test the banks, why do them? Is it just a pr measure to put investors at ease? How much credibility is in them?


CW: The stress tests are a marketing exercise by the Fed on behalf of its "clients" the banks. The head of supervision & regulation at the Federal Reserve Bank of New York refers to her large banks as clients. The stress tests have no credibility with Buy Side investors who really follow banks. They are simply a clever way for the Fed/Treasury to convince most investors that the too big to fail banks are solvent.

LL: Across the pond bank concerns continue. What is your outlook? Is Portugal the next to fail?

CW: I think the EU is going to gradually impose "burden sharing" on bond holders and large depositors of banks. They don't have money for subsidies. Ireland will be the test case.

LL: What inning are we in in the banking crisis in Europe?

CW: Fourth.

LL: Last week, the banks were impacted by concerns surrounding the mortgage repurchase risks following the settlement between BAC and the GSEs. How concerned are you?

CW: Not as much as everyone else about the lien/foreclosure issue. Very worried about investor issue. If you don't know Benedict v. Kapner (1925, Louis Brandeis), you need to do some reading.

LL: There is a lot of cash on balance sheets, do you expect any big M&A activity this year?

CW: Yes. Mostly medium size banks and funds buying fixer uppers. Think AmericanWest. Another court decision everyone in the M&A world needs to read is the bankruptcy court decision approving the Sec 363 sale of the bank in that transaction.

LL: How many bank failures?

CW: Hundreds.

LL: We are heading into the unofficial kickoff of Q4 earnings season,what is your outlook?

CW: We've seen revenues improving generally in the industry since bloodbath in Q3 2009. Question now is whether credit costs continue to drop or if a flat economy means that credit costs will plateau here.

I look for the positive names on our list to continue to improve, but the larger banks will have issues in terms of non-interest expenses for several quarters if not years. BAC expects to peak its ramp in terms of operational capacity to deal with foreclosures and reps & warranties claims Q3 2011.

LL: Who are the big winners?

CW: Investors with cash buying the assets/business of failed banks, companies. Huge opportunity. Almost all of our advisory work is focused on private transactions as opposed to public markets. The banks which are buying these assets are the ones to watch.

LL: Who are the losers?

CW: U.S. taxpayer. "Too Big To Fail" lives and Tim Geithner is spending tax dollars freely to subsidize the large banks.

LL: You are always looking ahead of the headlines, in fact you often predict them. What are you watching right now that others have failed to noticed?

CW: The MA decision is misunderstood. Homeowners are unlikely to win loan forgiveness as the result of errors in recording the lien on their home.

But investors in RMBS are facing hundreds of billions of dollars in losses on securities where the note was either not delivered or done so in a haphazard and negligent fashion. These claims could kill some of the top banks. But we should also remember that if the housing market continues to sink as we have predicted, then credit expenses will start to rise again. That is what Wall Street does not expect.

A Senior Talent Producer at CNBC, and author of "Thriving in the New Economy:Lessons from Today's Top Business Minds."


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