Research Zeitgeist: Bank Capitalization Concerns Heat Up

Concerns about bank capitalization came to the fore this week, most notably in the form of worries about Lehman Brothers (LEH). The investment bank is clearly not out of the woods, but at least has a few advantages that Bear Stearns did not.

Fears of a meltdown of the overall financial system have all but evaporated (for now) since the Federal Reserve-led rescue of Bear. And the Fed’s decision to open the discount window to investment banks, at least until September, gives Lehman some breathing room to get its house in order. In addition there seems to be more confidence that Lehman’s management can find a way through the storm than there was for Bear.

But concerns over bank capitalization remain. Moody’s warned this week that some big US banks remain undercapitalized, while the Institute of Institutional Finance notes that European banks are lagging their US counterparts in shoring up their balance sheets following subrime losses. The Financial Times reports that of the $387 billion in credit losses that global banks have reported since the start of 2007, $200 billion was suffered by European groups and $166 billion by US banks, according to the IIF. However, the data also show that European institutions have raised only $125.5 billion of capital to compensate for the losses compared with nearly $141 billion raised by their US rivals.

This discrepancy is likely to make investors scrutinise the balance sheet position of European institutions as it implies that European banks will either need to raise more capital or cut their lending.

Though banks seem to be working their way through their subprime losses, another potential iceberg may be lurking in the form of Alt-A loans. Fitch Research this week added more credence to concercns over these “not quite ready for prime” loans, noting that many Alt-A borrowers are looking more like subprime borrowers.

In the you-can’t-fool-the-market-for-long department, monoline bond insurers MBIA and Ambac were finally downgraded this week and…nothing much happened, as it clearly was already factored into the companies’ stock prices.

The stagflation conundrum also is rampant with concern over rising inflation worldwide set against weak growth and employment numbers in the US and elsewhere.

With Barack Obama finally anointed the Democratic Presidential nominee, the focus now switches to what he and John McCain plan to do about the thorny economic challenges.

Research Recap Quote of the Week

In Moody’s view, there are still (U.S. financial) institutions where capital levels may be insufficient considering their risk profiles.

Comments

[Reinko:]

Also of interest since the latest Z1 release of the Federal Reserve is out:

Total debt of the US financial sector still above one US GDP while the financial sector as a whole picked up about 200 billion US$ Q on Q in new debt in Q1 2008.

Compared with the first quarter after the credit crisis broke out (over 500 billion US$ new debt in Q3 2007) we see the credit crisis actually works: New debt availability is still on the decline and so the profits of the entire financail sector will follow suit.

Source:

www.federalreserve.gov...

Since it is anybodies guess how the financial sector is going to pay back the 16 trillion of outstanding debt, let alone pay for the interest on it, we aren't out of the woods yet.

2008 Jun 07 01:10 PM

[Reinko:]

And I forgot to mention that most US commercial bank reserves are not borrowed reserves;

They have negative real reserves and positive borrowed reserves, see the second column in the next file:

www.federalreserve.gov.../

The real reserves are now 130 billion US$ in the negative and what exactly the value of the pledged collateral is is not known right now.

Ha! In the past the Federal Reserve always did put a price on the pledged collateral but they now have programs where the primary dealers are placing a price on the pledged collateral...

All in all it still looks like the entire financial sector is sinking deeper and deeper.

In case how you want to see how all this pledging of collateral works on a day to day basis you can go to:

www.newyorkfed.org/mar...

In the last row you can find some links that track the daily details of the five 'providing liquidity' programs in place until now.

2008 Jun 07 01:18 PM

[SW Richmond:]

Reinko, thanks for the links...

It seems the banks are able to take their radioactive paper to the TSLF and exchange it for Treasuries, then take these Treasuries to the Discount Window, TAF, or PDCF and get cash. This way they can meet reserve requirements AND get bad paper off their books while bringing good paper onto their books, making them appear to be adequately capitalized. Pretty sweet deal. Until one realizes what it means about the banking system.

2008 Jun 07 02:30 PM

[crashof2008:]

Keep in mind however that these Fed facilities, unlike their BOE and European counterparts are only 30-day loans.

A loan is not a gift.

It must be repaid.

2008 Jun 08 09:41 AM