Big Banks Tumble Again: Financial Losers

NEW YORK ( TheStreet) -- Bank of New York Mellon ( BK) was the loser among the nation's largest banks on a rough day for the stock market, with shares falling 3% to close at $29.01.

Another mixed batch of economic reports underscored investors' concerns over the timing of the Federal Reserve's inevitable curtailment of its monthly purchases of $85 billion in long-term securities. The Fed has kept the short-term federal funds rate in a range of zero to 0.25% since late 2008. The central bank's bond buying is meant to keep the squeeze on the rate curve, by holding long-term rates down.

The market had been anticipating a slowing of the Federal Reserve's balance sheet expansion, sending the yield on 10-year U.S. Treasury bonds up by 44 basis points from the end of April to Tuesday, when the market yield was 2.14%. Investors on Wednesday pushed the yield on the 10-year down to roughly 2.11%.

The broad indices all ended with declines of over 1%. The KBW Bank Index ( I:BKX) was down 2% to close at 59.95, with all 24 index components showing declines.

Big banks with stocks showing 2% declines included Goldman Sachs ( GS), with shares closing at $158.30; Citigroup ( C), closing at $50.03; Bank of America ( BAC), at $13.09; Capital One ( COF), at $60.19; JPMorgan Chase ( JPM), at $53.03; and State Street ( STT), which closed at $64.88.

Mixed Economic Reports

The ADP private payroll employment for May showed U.S. private sector employment rose by 135,000 in May, which was quite an improvement from a downwardly revised 113,000 increase for April. Still, the May number was significantly below the average estimate of 165,000 among analysts polled by Thomson Reuters.

ADP said "a gain of 5,000 jobs in the construction industry during May was offset by a decline of 6,000 lost jobs in the manufacturing industry," which fits in with a weak set of recent manufacturing reports.

The Census Bureau on Wednesday reported that factory orders rose by 1% during April, after a 4.7% decline during March. Economists had expected factory orders to increase by 1.5% in April.

On a more positive note, the composite index from the ISM non-manufacturing survey showed an increase to 53.7 in May from 53.1 in April. A figure above 50 indicates expansion. The May number came in ahead of an expected reading of 53.5 among economists.

The Federal Reserve in its Beige Book report on Wednesday said "overall economic activity increased at a modest to moderate pace since the previous report in April across all Federal Reserve Districts except the Dallas District, which reported strong economic growth. The manufacturing sector expanded in most Districts since the previous Beige Book.

Also on Wednesday, the Bureau of Labor Statistics made a huge downward revision, saying that unit labor costs during the first quarter declined at an annual rate of 4.3%. The initial reported figure was an increase of 0.5%. The revised figure provides some comfort to investors that inflationary pressures are controlled and that the Federal Reserve may not need to quickly rein in its monetary stimulus.

Fannie and Freddie

Common shares of Fannie Mae ( FNMA) and Freddie Mac ( FMCC) pulled back significantly for a second straight session. Fannie's shares were down 19% to close at $1.81, while Freddie's shares were also down 20% to close at $1.75.

Fannie and Freddie are known as the government-sponsored enterprises, or GSEs, and hold roughly $5.2 trillion in mortgage loans and mortgage-backed securities. The GSEs were taken under government conservatorship at the height of the financial crisis in 2008, but remain crucial to the U.S housing market, purchasing roughly 90% of newly originated mortgage loans in the United States.

The U.S. Treasury holds $117.1 billion in Fannie Mae senior preferred shares and $72.3 billion in Freddie Mac senior preferred shares, for bailout assistance provided to the companies. With both GSEs now profitable, they have paid or announced dividends to the government totaling $131.6 billion. But no matter how profitable the GSEs get, they aren't allowed to repurchase any of the government-held preferred shares.

Long-term investors holding GSE common shares and junior preferred shares expect a political settlement that will allow Fannie and Freddie eventually to repay the government and go on operating, or a dissolution of the GSEs that includes an eventual payout to investors.

Bloomberg on Tuesday reported that Senators Bob Corker (R., Tenn.) and Mark Warner (D., Va.) are drafting a bill to dissolve Fannie and Freddie over a period of five years, while having the U.S. Treasury take over the GSE's mortgage loan guarantees. The GSEs would, in part, be replaced by a new government agency.

The expected Corker-Warner bill signals a change of attitude in Washington, because it will give consideration to junior preferred shareholder of the GSEs, as well as to their common shareholders.

In a note to clients on Tuesday, FBR analyst Edward Mills wrote "while this legislation faces significant hurdles and GSE reform is still a long ways off, this legislation is significant as it marks the most constructive bipartisan effort yet to move Fannie and Freddie beyond conservatorship."

A Petition On Behalf of GSE Shareholders

A petition to "restore fairness to Fannie Mae and Freddie Mac common shareholders" was created at the White House's website on Saturday, requesting the government "provide fairness and protection to GSE shareholders." According to the petition, "just as the Federal government made available funds and guarantees to assist the recovery of American International Group ( AIG) and Citigroup and as a result, provided fairness and protection to their shareholders, similar provisions should reasonably be made to protect the Fannie and Freddie common shareholders."

American International Group was able to move past its epic government bailout in part because the Treasury converted its preferred AIG shares to common shares, after which AIG made a series of share repurchases from the government. The repurchases and other sales of converted shares enabled the Treasury to claim a profit of $5.0 billion from the AIG bailout, with the Federal Reserve also claiming profits from assistance to the insurer.

A large portion of government held preferred shares in Citigroup were also converted to common shares, helping the banks in its efforts to exit the Troubled Assets Relief Program, and also resulting in a profit for the Treasury, as Citi's common shares recovered.

The petition appears to be aiming for a similar mechanism for Fannie and Freddie to escape the crippling dividend payments being made on government held GSE senior preferred shares.

The petition Wednesday afternoon was very far from its goal of 100,000 signers, with only 1,205 signatures at 4:00 p.m. ET.


-- Written by Philip van Doorn in Jupiter, Fla.

>Contact by Email.

Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.

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