Tags: Hans | Parisis

Tread Carefully Before Investing in Big Banks

Monday, 11 May 2009 11:42 AM

The government has effectively said it wants banks to have Tier-1 common stock equivalent, which includes common and preferred shares, to 4 percent of risk-weighted assets.

So, investors will have to decide whether they have confidence in the risk weightings. They should take into account that Tier-1 measures of capital leave out certain unrealized losses on securities that could become real later. This risk factor is exposed in the Tangible Common Equities/Tangible Common Assets ratio (TCE/TCA).

Investors must now decide whether 4 percent, which in fact translates into 25-to-1 leverage, is safe for the highly uncertain environment we are and will stay in for quite some time to come.

I myself remain very skeptical. The Fed is way too optimistic on unemployment with their worst case scenario for 2010 at 10.3 percent unemployment when we are already at 8.9 percent and growing.

Remember, a healthy economy needs to create 250,000 new jobs per month.

I also don't take the Fed's estimate of an 8.5 percent commercial real-estate worst case loss rate while Branch Banking and Trust Company (BB&T) already takes into account a commercial real-estate worst case scenario of 12.6 percent.

When recovery comes, we will have to face a long, L-shaped recovery with persistent, very high unemployment, and we could easily stumble back into negative territory again before it's all over.

Everyone will have to decide for themselves before making investment decisions and must avoid getting trapped into wishful thinking or fabricated fairy tales. We will have to face a country and world as we have never known it until now.

Now, let's summarize the official bank stress test results:

  • The total loss rate for loans calculated by the regulators is 9.1 percent, a level that exceeded that seen in the 1930s.

  • Tier 1 capital ratio of 6 percent and Tier 1 Common capital ratio of 4 percent.

  • Estimated losses of $600 billion over 2009 and 2010.

  • Estimated revenues and reserves build over next two years to $415 billion.

  • Thus, an estimated need for additional capital buffer of $185 billion by the end of the fourth quarter.

    However, first quarter higher revenues and the new FASB accounting and reporting standards (which "improve profits" by 15 percent to 20 percent) allow additional total capital requirement to now total $75 billion, of which:

  • Bank of America: $34 billion

  • Wells Fargo: $13.7 billion

  • GMAC: $11.5 billion

  • Citigroup: $5.5 billion (after signaling already that it will request to convert the government's $45 billion preferred securities and trust preferred securities into common stock)

  • Morgan Stanley: $1.8 billion

  • PNC Financial Services: $0.6 billion

    Treasury's injected preferred equity stake is $218 billion. Remaining TARP funds available are $110 billion. Treasury expects $25 billion in TARP repayments soon.

    For comparative purposes, investors should keep in mind:

  • Using a similar methodology as the Fed, the IMF estimates that U.S. banks will take $1,050 billion in writedowns, including the current $580 billion. The IMF estimates in order to restore a TCE/TCA ratio of 4 percent U.S. banks will need $275 billion; for a ratio of 6 percent they will need $500 billion.

  • Nouriel Roubini calculates banks will need a total of $1,400 billion in order to establish an 8 percent total TCE/TCA ratio and $650 billion for a 4 percent TCE/TCA ratio. Please note: These figures mark loans and securities at market rather than book value and do not take into account banks' future retained earnings flow.

    Bottom line: Investors will have to calculate in advance the adequate leverage rate for the bank in which they want to invest.

    Now that the stress tests are finally out in the open, we all can see (if we want to) that the 19 so-called too-big-to-fail banks have too-low tangible common equity (TCE) ratios.

    Unfortunately, we all also now can see the regulators demonstrating, in my opinion at least, purely reckless behavior by ignoring this too-big-to-fail distortion that derives from excessively low capital ratios while not starting to ask these 19 systemically important banks to come up with additional capital so they would become able again to control this negative externality.

    (Note: Tangible common equity, also known as "tangible equity capital," or occasionally "tangible common book value," is the book value of the company minus the value of all assets that would be worthless if the company were to liquidate, as well as all preferred equity. Tangible common equity is equivalent to total equity minus intangible assets, goodwill, and preferred equity.)

    No wonder criticism continues about the degree of stress built into the "more adverse scenario" used by authorities to calculate the needed capital buffer.

    Looking at the stress test results, we see that the Fed estimates $465 billion total loan losses while the IMF already has estimated these loan losses at $602 billion. Take care, these losses could end up significantly higher in a weaker macro scenario.

    But, more importantly, the Fed estimates losses of $154 billion on securities while the IMF estimates these losses at more than $1 trillion. Obviously, they have very different opinions on what qualifies as "toxic" waste.

    Question is, who wants to sell what and to whom? Switzerland has already unilaterally imposed a 16 percent capital ratio for its systemically important banks to be phased in by 2013, a ratio that is double the Basel criteria of 8 percent for Tier 1 and Tier 2.

    It would have been appropriate for U.S. regulators to request a TCE ratio of at least 6 percent, not 4 percent, that would have been at least equal to the TCE ratio prevailing in the mid-1990s for all U.S. banks, and not just the 19 systemically important ones.

    The capital needs of all U.S. banks would have been an additional $225 billion when we us the IMF estimates, if the TCE ratio were to be increased to 6 percent.

    Abraham Lincoln is attributed as saying: "You can fool some of the people all of the time, and all of the people some of the time, but you cannot fool all of the people all of the time …"

    Of course, the equity needs for the 19 banks also depend on the net earnings before writedowns in 2009 and 2010, and that could be a negative, unless we have a miracle.

    The government has effectively said it wants banks to have Tier-1 common stock equivalent, which includes common and preferred shares, to 4 percent of risk-weighted assets.

    So, investors will have to decide whether they have confidence in the risk weightings. They should take into account that Tier-1 measures of capital leave out certain unrealized losses on securities that could become real later. This risk factor is exposed in the Tangible Common Equities/Tangible Common Assets ratio (TCE/TCA).

    Investors must now decide whether 4 percent, which in fact translates into 25-to-1 leverage, is safe for the highly uncertain environment we are and will stay in for quite some time to come.

    I myself remain very skeptical. The Fed is way too optimistic on unemployment with their worst case scenario for 2010 at 10.3 percent unemployment when we are already at 8.9 percent and growing.

    Remember, a healthy economy needs to create 250,000 new jobs per month.

    I also don't take the Fed's estimate of an 8.5 percent commercial real-estate worst case loss rate while Branch Banking and Trust Company (BB&T) already takes into account a commercial real-estate worst case scenario of 12.6 percent.

    When recovery comes, we will have to face a long, L-shaped recovery with persistent, very high unemployment, and we could easily stumble back into negative territory again before it's all over.

    Everyone will have to decide for himself before making investment decisions and must avoid getting trapped into wishful thinking or fabricated fairy tales. We will have to face a country and world as we have never known it until now.

    Now, let's summarize the official bank stress test results:

  • The total loss rate for loans calculated by the regulators is 9.1 percent, a level that exceeded that seen in the 1930s.

  • Tier 1 capital ratio of 6 percent and Tier 1 Common capital ratio of 4 percent.

  • Estimated losses of $600 billion over 2009 and 2010.

  • Estimated revenues and reserves build over next two years to $415 billion.

  • Thus, an estimated need for additional capital buffer of $185 billion by the end of the fourth quarter.

    However, first quarter higher revenues and the new FASB accounting and reporting standards (which "improve profits" by 15 percent to 20 percent) allow additional total capital requirement to now total $75 billion, of which:

  • Bank of America: $34 billion

  • Wells Fargo: $13.7 billion

  • GMAC: $11.5 billion

  • Citigroup: $5.5 billion (after signaling already that it will request to convert the government's $45 billion preferred securities and trust preferred securities into common stock)

  • Morgan Stanley: $1.8 billion

  • PNC Financial Services: $0.6 billion

    Treasury's injected preferred equity stake is $218 billion. Remaining TARP funds available are $110 billion. Treasury expects $25 billion in TARP repayments soon.

    For comparative purposes, investors should keep in mind:

  • Using a similar methodology as the Fed, the IMF estimates that U.S. banks will take $1,050 billion in write-downs, including the current $580 billion. The IMF estimates in order to restore a TCE/TCA ratio of 4 percent U.S. banks will need $275 billion; for a ratio of 6 percent they will need $500 billion.

  • Nouriel Roubini calculates banks will need a total of $1,400 billion in order to establish an 8 percent total TCE/TCA ratio and $650 billion for a 4 percent TCE/TCA ratio. Please note: These figures mark loans and securities at market rather than book value and do not take into account banks' future retained earnings flow.

    Bottom line: Investors will have to calculate in advance the adequate leverage rate for the bank in which they want to invest.

    Now the stress are finally out in the open, we all can see (if we want to) that the 19 so-called too-big-to-fail banks have too-low tangible common equity (TCE) ratios.

    Unfortunately, we all also now can see the regulators demonstrating, in my opinion at least, purely reckless behavior by ignoring this too-big-to-fail distortion that derives from excessively low capital ratios while not starting to ask these 19 systemically important banks to come up with additional capital so they would become able again to control this negative externality.

    (Note: Tangible common equity, also known as "tangible equity capital," or occasionally "tangible common book value," is the book value of the company minus the value of all assets that would be worthless if the company were to liquidate, as well as all preferred equity. Tangible common equity is equivalent to total equity minus intangible assets, goodwill, and preferred equity.)

    No wonder criticism continues about the degree of stress built into the "more adverse scenario" used by authorities to calculate the needed capital buffer.

    Looking at the stress test results, we see that the Fed estimates $465 billion total loan losses while the IMF already has estimated these loan losses at $602 billion. Take care, these losses could end up significantly higher in a weaker macro scenario.

    But, more importantly, the Fed estimates losses of $154 billion on securities while the IMF estimates these losses at more than $1 trillion. Obviously, they have very different opinions on what qualifies as "toxic" waste.

    Question is, who wants to sell what and to whom? Switzerland has already unilaterally imposed a 16 percent capital ratio for its systemically important banks to be phased in by 2013, a ratio that is double the Basel criteria of 8 percent for Tier 1 and Tier 2.

    It would have been appropriate for U.S. regulators to request a TCE ratio of at least 6 percent, not 4 percent, that would have been at least equal to the TCE ratio prevailing in the mid-1990s for all U.S. banks, and not just the 19 systemically important ones.

    The capital needs of all U.S. banks would have been an additional $225 billion when we us the IMF estimates, if the TCE ratio were to be increased to 6 percent.

    Abraham Lincoln is attributed as saying: "You can fool some of the people all of the time, and all of the people some of the time, but you cannot fool all of the people all of the time …"

    Of course, the equity needs for the 19 banks also depend on the net earnings before writedowns in 2009 and 2010, and that could be a negative, unless we have a miracle.

  • © 2017 Newsmax. All rights reserved.

    1Like our page
    2Share
    HansParisis
    The government has effectively said it wants banks to have Tier-1 common stock equivalent, which includes common and preferred shares, to 4 percent of risk-weighted assets.So, investors will have to decide whether they have confidence in the risk weightings. They should...
    Hans,Parisis
    2076
    2009-42-11
     

    Newsmax, Moneynews, Newsmax Health, and Independent. American. are registered trademarks of Newsmax Media, Inc. Newsmax TV, and Newsmax World are trademarks of Newsmax Media, Inc.

    NEWSMAX.COM
    MONEYNEWS.COM
    © Newsmax Media, Inc.
    All Rights Reserved