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Michael Baxter

Bull and Bear: Are banks’ profits being inflated?

Written by: Michael Baxter on November 19th 2012

Category: Bull & Bear, News

Bull and Bear – an optimistic and pessimistic view of investment news: Today’s stories: BP’s cunning plan, Are banks’ profits being inflated? SAS’s plan to save itself. Nintendo launches Wii 2

BP’s cunning plan

According to yesterday’s ‘Sunday Times’, BP  is considering spending a massive $3.7 billion on buying up its own shares. If this move goes ahead, shareholders will love it, or so goes the inference.

It is just that…

When you look into BP and the challenges it’s facing, you can’t help but feel a tad stressed.

First there is the fear of a takeover. Since the company’s shares are cheap, many think it may be targeted by another large oil company: Exxon Mobil, Royal Dutch Shell or Chevron perhaps. Can’t imagine a purchase by one of the US energy giants will go down well with the Brits. ‘Let’s sue the stuffing out of this British company, and when it is on the verge of collapse, pick it up on the cheap.’ Well, that account may not be how it really is, but that is how a purchase by a US company will be perceived.

Secondly, there is this issue that BP can’t be seen to do too well, because that would be like waving a red flag in front of the US bull. Alas there appears to be no toreador to come to the company’s rescue. So if the shares fall too low, the company may get bought out. If they rise too high, it may suffer an even bigger fine.

Thirdly, there is the potential fine relating to the US clean water act. The company has set aside $3.5 billion. Some reports suggest the fine may be nearer $20 billion.

Fourthly, there is the issue of trying to blame US firms. BP may or may not be totally at fault over the Gulf of Mexico oil spill, but should it try and divert attention to good old US companies, then the good old court of US opinion may not be too chuffed. One thing is for sure, that enormously popular (and all round nice guy, why he is practically a pacifist) US politician Dick Cheney, who once ran Halliburton, is not in any way trying to protect the good name of the US company, and he is doing nothing to try to ensure all the flak hits BP.

So BP is contemplating the idea of this huge pay-out to shareholders. Huge may seem like an odd word when you consider that BP’s costs relating the oil spill are around $40 billion (so far), but that is the word used by the ‘Sunday Times’ to describe the possible payment, so it must be right.

But here is the puzzle. According to Dominic O‘Connell in the ‘Sunday Times’: “Institutions like nothing more than cash returns.” So assuming, of course, that the US doesn’t notice, some kind of share buyback may lift the share prices, and help reduce the chances of a hostile takeover bid.

But why is it that “Institutions like nothing more than cash returns?” Right now, with oil still trading well over $70 and with lots of theories that we are running out of the black stuff, what companies like BP should really be doing is investing like crazy in exploration.

Not that it wants to find too much oil of course. BP doesn’t want to wave a red flag and get another fine. What it really needs is the possibility of finding more oil at a much later date. So spending lots of money on speculative exploration that brings in high returns in, say, ten years is probably what BP needs.

Alas, to keep shareholders happy it probably has to do the thing that isn’t in their best interests.

Are banks’ profits being inflated?

Mark to market. That phrase was being bandied about a lot a few years ago, but of late the noise has subsided. Now it’s back.

How should banks value their assets? Traditionally, accountants worked out how much had been paid, allowed for depreciation and voila, the valuation was the result.

Mark to market, on the other hand, values assets based on what the markets think they are worth.

The snag with mark to market is that asset values can rise and fall with the vagaries of the markets, creating massive volatility in valuations. There is also a view that market valuations can be inappropriate under certain circumstances, and that lack of information, over optimism or too much pessimism can distort true value.

Now a group of very powerful investors have got together and written to Vince Cable.

According to the ‘Telegraph’, which claims to have seen the letter, it stated: “The emphasis placed on mark-to-market valuations has, moreover, resulted in excessive volatility reflecting changing market sentiment, rather than economic fundamentals. The volatility clouds our view of performance and makes it difficult for us to determine reliably a company’s capital position.”

The letter said: “We believe that… the accounting and auditing systems in the UK are harming long-term shareholders by undermining our ability to reliably assess capital held by companies (especially banks); clouding our understanding of executives’ performance (and the relating problem of assessing remuneration); and by contributing to macroeconomic instability.”

Maybe this is the killer comment: “We have too often found ourselves in a position where executives are remunerated on the basis of ‘paper profits’ that were not actually earned.”

So there you have it: accountancy rules imposed by the regulator are distorting bank profits. That’s why banks are able to fork out such large bonuses and pay awards even when, in the real world, it feels as if banks are not actually contributing that much to the economy.

So, as some of us suspected all along, it’s all the fault of accountants. Let’s stop the bankers’ witch hunt, and seek out the accountants instead. Let’s make it a crime to be harbouring an accountant.

SAS’s plan to save itself

These days, we have become used to thinking if it’s from Scandinavia, it must be good– unless it is called Nokia, of course. But then Finland is different; the Fins speak an entirely different language from their Scandinavian neighbours, have a different name for their currency, and didn’t even send Viking ships out across the world during the millennium before last.

But it turns out the modern day equivalent of Viking long boats – SAS planes – are in trouble.

The Vikings are coming, screamed the bankers and insolvency experts.

The solution is to cut jobs, reduce wages for those who keep their jobs, and generally cut costs. And now the unions appear to be onside.  Maybe SAS can survives after all.

The snag is this. When a company responds to adversity by laying off workers and getting staff who stay on to accept pay cuts, that may help. But when this is the approach across the corporate world, the result is less demand, and more pay cuts follow.

Maybe SAS is an example of what is becoming known as a zombie firm. In the long run, jobs losses may be better than pay cuts, because at least those losing their jobs may eventually find an alternative form of employment.

Nintendo launches Wii 2

Nintendo went against the grain.

These days we have become used to US firms out-innovating Japanese companies. The real US triumph was with design.

Steve Jobs was apparently a fan of Sony. But Apple, as it were, out-Sonyed Sony.

But when Nintendo released its Wii a few years ago, it really did fell like a marketing/design masterstroke.

The Wii did not have the technical power of the Sony Playstation or the Xbox, but it did have those brilliant controllers.

These days, of course, smart phones and tablets have become – among other things – games machines.

And now Nintendo has launched the Wii U. By all accounts it’s a bold product. There is a small monitor on the controller and it shows graphics on the TV. So that’s two views – interesting idea.

A lot of rock and roll has gone into the system too. That is to say you have to roll and rock the games controller.

How will it do? No one knows. It may be that Nintendo has been too smart, and users will be confused by the product.

What is for sure is that the business in which Nintendo operates, being timid is not a viable strategy. Nintendo is not being timid. This does not guarantee success, but at least it does not guarantee failure.

These views and comments are those of the author alone and do not necessarily reflect the view of The Share Centre, its officers and employees

Tags: bank asset valuations bonuses, BP danger of takeover, BP potential bidder, BP share buy-back, Mark to market, Nintendo Wii U, SAS wage cuts union deal

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