Sunday, March 1, 2009

More Bank Bashing Fodder

When the execs of the biggest banks came to congress two weeks ago to be on the wrong end of some populist lynching, one of the questions asked was how much money had the banks earned by collecting underwriting fees by issuing FDIC-backed bank bonds, i.e. debt in which there is no risk. Intuitively this is a great question, as underwriters collect fees only when there is exposure risk, essentially they are paid to find buyers for a risky issue in which they are the primary purchasers. If there is no implicit risk, as in when they are issuing government backed debt and the bank is merely a pass thru of a government guarantee, it is mindboggling that banks should be compensated for this form of "underwriting."

The FT has done some investigative journalism into this topic. Turns out banks have pocketed nearly $1 billion in underwriting fees from placing government-backed debt. While European banks charge 0.15% on FDIC guaranteed bank bonds, their US counterparts demand twice as much or 0.3%. While at first glance this is a mere fraction of the fees that banks demand to issue Investment Grade and High Yield bonds, at 1% and 3% respectively, the numbers quickly start to add up when one considers the total size of the FDIC backed market. Morgan Stanley estimates that $634 billion worth of new bonds could be sold this year using European government guarantees. The situation in the US is likely comparable, implying over $1 trillion in FDIC debt is poised to come to market. If one assumes a blended 0.2% fee on this new debt, banks are set to pocket over $2 billion in fees for something which one can argue they should receive no fees for whatsoever, for two reasons: i) without these FDIC backed instruments, banks would likely not function at all as they would have no way to access the capital markets by traditional means and ii) the fees are going straight from the taxpayers' pockets to pad for bonuses for bond traders and salespeople in TARP-recipient banks, who are the largest underwriters of FDIC guaranteed bonds. Granted, the government does take a small portion off the top from banks selling guaranteed bonds, but it is nominal compared to the total potential and actual revenue stream.

The biggest abuser of this loophole is easily JP Morgan, which not only charges an arm and a leg for FDIC issuance, but also pockets fees for bonds that it itself issues! If there was ever a massive conflict of interest, this is it: apparently, the house of Dimon shared $123 million in fees with underwriters for raising $30 billion in debt. But as one bond banker said, the FDIC-backed asset class has become "one of the best fee-earners" for banks in recent months. It is likely that TARP recipients will fight tooth and nail from losing this one last remaining source of revenue against the worst underwriting and advisory investment banking climate of all time. Sphere: Related Content
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