Banks repaying TARP money - boost of investor confidence while diluting shares

JP Morgan was a reluctant borrower of TARP money, while others borrowed out of necessity. Now, JP Morgan, Goldman and Morgan Stanley as well as few others are lining up to repay TARP money. Government has announced rules on repayment - that the bank must be able to raise capital without Fed Guarantee.

1. Issuing of common stock
2. Converting preferred to common stock
3. Issuing non-FDIC guaranteed debt

All these have helped banks to raise capital, but have significantly diluted bank shares. However, it reinforces investor confidence.

Banks need to operate without the strings attached to hire and retain employees. This is certainly key to capitalism to return to normalcy.

Banks Raising Capital identified in Stress Test - Investor confidence regained

Many of the banks have raised money through selling common shares, converting preferred to common and selling debt to raise capital cushion identified by stress test. The speed at which the banks were able to raise capital is remarkable. Although that is not particularly helpful to the stock price due to dilution, it demonstrates the fact that the investors are confident in the capital markets. It is the most important part of the recovery.

Fed Bank Stress Test

Bank stress test has been completed. The results are withheld until earning season is over. The aggregated result may be released. This indicates that at an aggregate level, the stress test results reveal weakness vs. strength.

What if weakness is revealed?

It could force capital infusion. Where will the capital infusion come from? It could come through Public-Private-Investment-Program (PPIP) since the others have been exhausted.

What if strength is revealed?

Then, the banks can focus on serving customers instead of worrying about raising capital.

Liquidity vs, Credit Crisis

Liquidity - ability to turn an asset to cash.
Credit - Ability to borrow.

Liquidity Crisis - Inability to sell assets; such as, loan portfolio, asset backed security and CDO.

Credit Crisis - Consumer and business unable to borrow.

Economic Crisis, Recovery and impact on IT

Impact of Market Downturn on Hedgefund and Mutual Fund Industry

Both the industries have witnessed massive redemption. Their portfolios have shrunk due to the sudden fall in equities. Due to these, the overall portfolio sizes have shrunk. The industry will endure the following 5 changes.

1. Increase Fee Structure - Fees will rise to spread the cost to fewer investors.
2. Increased Consolidation - Industry will consolidate. Weak players will disappear. Weak Funds will disappear. strong funds and companies will strengthen.
3. Increase capital outflow and retail investment in stocks and bonds - With equities at decades low, retail investors are venturing into the stock and bond market in greater number.
4. Increased Regulation - Hedge fund industry has enjoyed relaxed regulation. That will be a luxury going forward. They will need to maintain higher capital to absorb risk. They will have to be more transparent with their methods. They will also be subject to more regulatory oversight.
5. Increased flight to ETF - ETFs are more tax efficient and regulated. Investors will fly to ETF to avoid the cost structure of mutual fund and hedge fund.

Fed Bond Buyback

Last week when Fed Chairman announced US treasury buyback, bond yield fell and soon after mortgage rates fell as well. Then, market digested the news. The next day the market sold off. When Secretary Geither announced the details of public-private approach to purchasing toxic assets, market reacted positively. Then, Treasury tried to buy bonds. It received lukewarm response. Then, it received massive response.

Overall, the investors are expressing confidence. Market seem to reinforce that. A week is too early to declare victory. But, given the rout in the stock market and the recent improvement, FED effects seem to be working in the right direction.