Standard & Poor’s today indicated that the Greek government has done enough for now to get its fiscal house in order and preserve the country’s credit rating, but at the same time the ratings agency downgraded the banking system and placed a negative outlook on several banks.
Key comments from S&P:
- We view the Greek government’s total package of deficit reduction measures as appropriate to achieve its 2010 fiscal target, given the deterioration in Greece’s growth prospects.
- We are affirming our ‘BBB+/A-2′ sovereign credit ratings on Greece and removing them from CreditWatch negative.
- The negative outlook reflects our view of the government’s ability to sustain reform momentum in the medium term.
S&P also:
- Revised its Banking Industry Country Risk Assessment (BICRA) classification and economic risk score on Greece to ‘5′ from ‘4′.
- Increased its estimate of gross problematic assets (GPAs) for the Greek banking system to 15%-30% of total credit, from 10%-20%.
- Affirmed its ‘BBB/A-2′ long- and short-term counterparty credit ratings on EFG Eurobank Ergasias S.A.(EUROB), Alpha Bank A.E.(ALPHA), and Piraeus Bank S.A.(TPEIR);
- Affirmed its ‘BBB+/A-2′ long- and short-term term counterparty credit ratings on National Bank of Greece S.A. (NBG).
- Removed the ratings on all four Greek banks from CreditWatch, where they had been placed with negative implications on Dec. 17, 2009. All outlooks are negative.
BICRA rankings summarize the strengths and weaknesses of a country’s banking system compared with those of other countries according to a scale ranging from Group 1 (the strongest) to Group 10 (the weakest). Other countries included in BICRA Group 5 with Greece are South Africa, Poland, Brazil, Malta, Kuwait, Oman, and Bahrain.
We believe that the Greek banking system’s economic risks have heightened, due to low economic growth prospects and structural weaknesses, higher vulnerability to capital outflows, and greater credit risk.
However, the banking system has coped with mounting economic challenges and remained broadly profitable, benefiting from its consolidated and modern structure and strong commercial franchises–which we view as main comparative strengths.
For details, see:
Research Update: Greece Sovereign Credit Ratings Affirmed At ‘BBB+/A-2′ And Removed From CreditWatch; Outlook Negative and
Greece BICRA/Economic Risk Score Revised To ‘5′ On Economic Risks; Bank Ratings Affirmed/Off Watch; Outlooks Negative
Technorati Tags: Alpha Bank, banks, EFG Eurobank Ergasias, Greece, National Bank of Greece, Piraeus Bank, PulseCheck, sovereign-debt
Guest Post by Oxford Analytica
While the crisis of 2008 was self-evidently a market failure, in terms of the mis-pricing of certain assets (particularly property), it was also a regulatory failure in three key respects:
- Regulators did not adequately consider the possibility that the short-term credit market could collapse, threatening several major financial institutions with insolvency.
- This was the by-product of an intellectual failure to keep abreast of how the macroeconomic framework was changing as a result of globalisation.
- While there was an arguably correct perception in the late 1990s that the 60-year-old Glass-Steagall framework was outdated, there was no effort to replace it with a 21st century successor.
In the wake of the crisis, political debate has focused on whether to return to the outmoded pre-1999 regulatory framework, rather than on how to adapt this model to address globalisation.
Glass-Steagall no panacea. Even a cursory examination of the old Glass-Steagall framework — which separated deposit-taking commercial banks from investment banks, or ‘broker-dealers’ (BDs) — indicates that it would not have been sufficient to prevent the 2008 crisis:
- Almost all of the banks that failed or were forced into mergers were either BDs (Lehman Brothers, Bear Stearns, Merrill Lynch) or purely commercial banks (eg Washington Mutual or the UK’s Northern Rock).
- The ‘universal banks’ created after Glass-Steagall did not perform noticeably worse — although a few (Citigroup, UBS) were in deep distress before being bailed out by governments. Indeed, some entered the crisis in relatively solid shape (eg JP Morgan Chase, Barclays) and have since benefited from the collapse or absorption of rivals.
Intellectual context of crisis. Thus, the crisis was not simply caused by deregulation, but by a deeper shortfall of risk comprehension in prevailing economic frameworks — which downplay such factors as shifting social contexts and changes in forecasting strategies that determine asset evaluation and market movements.
In other words, difficult-to-quantify human factors and the adaptive interactions of market players were downplayed by many economists and risk managers, who became enamoured of quantitative modelling:
- In the 25 years prior to 2008, academic economics became dominated by an emphasis on numbers — particularly quantitative modelling and statistics associated with ‘rational choice’ theory.
- This intellectual paradigm allowed neoclassical growth theorists to advance a framework with the premises that markets tend to equilibrate around efficient resource allocation and that government policy always does more harm than good in fostering economic growth. This increased the distribution of risk and reliance on complex quantitative modelling techniques to mitigate risk — with disastrous results.
Intellectual reaction. The crisis has significantly undermined this approach, although the economics discipline has been slow to adapt, with the initial impetus to fall back on a Keynesian framework. This reaction drove President Barack Obama’s embrace of the ‘Volcker Rule’ that would prohibit commercial banks from engaging in proprietary trading, and the Senate bill co-sponsored by Republican John McCain and Democrat Maria Cantwell that would reinstate Glass-Steagall in its entirety. However, in order to defuse incipient crises created by asset price bubbles, financial disintermediation and the attendant rise in systemic risk, any new regulatory paradigm would need to incorporate the insights that behavioural economists have developed since the 1970s — eg evolutionary models of how markets reach efficiency and group behavioural studies.
Outlook. Many economists still cling to the validity of their modelling techniques, which appear usefully predictive over the short term — but that are inaccurate as models of human behaviour over time. They tend to protest that improved modelling, rather than a wholesale re-evaluation of their approach, is apposite. This leads many to conclude that any re-regulation would be counter-productive.
However, this fails to account for innovative new research that has emerged from inter-disciplinary and behavioural economists in recent years. This includes the work of John Geanakoplos of Yale University on ‘leverage cycles’, which suggests that leverage cycles have observable and predictable characteristics, targetable by regulators.
Technorati Tags: banks, financial-markets, financial-regulation, Hedge-Funds, private-equity
But despite elevated losses from commercial real estate loans, Moody’s does not expect to make system-wide rating downgrades.
Moody’s estimates that rated U.S. banks hold 50% of total CRE loans and will incur CRE losses of $120 billion from 2008 through 2011. This sum represents a loss rate of approximately 17% on the banks’ year-end 2007 CRE loan balances. For both rated and unrated banks, total remaining losses on CRE lending may well exceed $150 billion.
“So far, Moody’s rated banks have incurred $43 billion of CRE losses through charge-offs and purchase accounting marks, leaving $77 billion — or close to 65% of our estimate — to be taken in the fourth quarter of 2009 and all of 2010 and 2011,” says the report’s co-author, Assistant Vice President Joseph Pucella. “Based on our forecasts and expectations for the CRE sector, however,” the analyst adds, “we see no need for further system-wide rating downgrades of U.S. banks beyond what we have already done.”
Outside of the rated bank universe, the analyst notes that the CRE problem is a more troubling issue.
A large number of smaller banks, which constitute just 15% of total system assets but carry 50% of all CRE loans outstanding, will likely continue to struggle under the weight of their CRE exposures, and many will collapse.
The cost of these failures will inevitably be borne by the entire banking system, but it is unlikely to be a ratings driver.
Moody’s estimates that high leverage and slack demand will cause property prices to ultimately drop 45% to 55% from their 2007 peak. Mr. Pucella explains: “We have periodically revised our CRE loss assumptions to reflect the worse-than-expected deterioration in the commercial property markets, and we have moved bank ratings down accordingly.”
Beyond U.S. banks’ ability to absorb CRE losses during the near term, Moody’s continues to have longer term concerns about the credit standing of those banks with outsized CRE concentrations. “Such institutions could find themselves with diminished franchises after the recession because CRE lending opportunities and the associated revenue have dried up,” Mr. Pucella points out, “which could then have major implications for the sustainability of their business models.” As a result of these franchise issues, a large CRE concentration could act as a constraining factor on bank ratings.
For details, see U.S. Bank Ratings Incorporate Continued High Commercial Real Estate Losses(Premium)
Earlier this week Standard & Poor’s said The Worst May Still Be Yet To Come For US Banks’ Commercial Real Estate Loans
Technorati Tags: banks, commercial-real-estate, regional-banks, U.S. banks
The fallout from Commercial Real Estate exposures for banks has yet to run its course, in Standard & Poor’s opinion.
Although many of the problems are already evident in the homebuilding sector, and are well underway in commercial construction, these are the smaller sectors, S&P says in an Industry Outlook. “We believe the problems in the larger mortgage and multifamily sectors are yet to be felt because for now low interest rates and still-adequate cash flows make debt servicing possible. As rates rise and rent rolls decline further, we believe that delinquencies will rise in this sector as well, and prices will fall further, complicating the refinancing of these portfolios.”
We see no reason to believe the impact of this credit cycle in CRE will be less severe in terms of losses banks incur than that of the 1990s.
“However, this time the smaller banks have the heavier concentrations in CRE. They also have healthier capital cushions that could help them weather the painful cycle. Our stress tests show that most rated banks are able to absorb the associated losses without eroding capital below 4% of tangible common to RWA, as long as the losses are spread over a few years. We believe that downward pressure on the ratings will continue, however, as the banks that appeared to be better positioned in terms of their portfolios or capital cushions prove to be more vulnerable, or fail to maintain their business-generating power.”
The report includes a table of the combined commercial real estate loans, CMBS and CRE equity investments shown as the banks’ exposures as a multiple of their tangible common equity. Below are the banks with TCE ratios in excess of 4%.
Even for the most heavily exposed banks, underwriting varies, S&P says. For example, New York Community Bancorp Inc. (NYB) focuses on rent-controlled New York City apartment houses, which produce steady cash flow and do not experience significant vacancies, and where nonperforming CRE loans were only 2% of CRE loans at Sept. 30, 2009. Synovus (SNV), on the other hand, with a high proportion of construction loans, has 10% nonperforming assets (NPAs). Some, banks such as Zions Bancorporation,(ZION) have portfolios whose average LTVs at origination were in the mid-50% area, whereas others aimed for 80%.
For details see: Industry Outlook: The Worst May Still Be Yet To Come For U.S. Commercial Real Estate Loans (Premium)
Technorati Tags: banks, CMBS, commercial-real-estate, New-York-Community-Bancorp, regional-banks, Synovus-Financial-Corporation, Zions-Bancorporation
Citigroup’s (C) reclassification last week of $75 billion of non-core assets as core assets amounts to little more than window dressing, in Moody’s view, and has no impact on its credit rating.
“In Citi-speak, this change in mind is expressed as a transfer of assets from Citi Holding to Citicorp with Citicorp being a business mix that the company wants to retain.”
All Citigroup is doing is reshuffling merchandise within the same shop window.
So called “core” assets and “non-core” assets are not within different legal entities funded by separate distinct creditors. Instead, they are all funded by the same legal entities, of which the primary ones are: Citibank N.A., Citigroup Inc., and Citigroup Funding Inc., which Citigroup guarantees.
Businesses in the core mix are regional banking predominantly in the U.S., Asia and Mexico, its North American card business (excluding private label), investment banking, and securities servicing. Also included in core activities are deposits, and currently, deposits far exceed “core” loans as well as total loans for the whole company.
Citigroup advertises its core business as its future. One of the results of the reallocation of assets to the core business is incremental spread income to that business mix. These incremental earnings comes at a time when it is saddled by large credit costs taken against its credit card portfolio and after it experienced a sharp decline in investment banking revenue in the fourth quarter. These incremental earnings will be at the cost of reducing income in the non-core segment. The reallocation will increase the balance sheet of the core businesses by approximately 6%.
For details, see CitiCore: A Notional Reshuffling of Assets (Premium)
Technorati Tags: (c), banks, Citigroup
As Goldman Sachs (GS) reports record earnings and other big banks announce quarterly results, we are pleased to offer a complimentary download of Plunkett Research’s Profile and Investment and Securities Trend Analysis 2010. In addition to identifying trends for the financial services industry, the 34-page report includes a review of recent developments and an extensive glossary of investment product facts.
Plunkett’s emerging trends to watch for:
- Greatly increased regulatory oversight will restrict investment companies and lenders of all types. Regulatory agencies such as America’s SEC, may get an overhaul. Investment companies, banks and insurance companies will brace for much higher levels of scrutiny.
Unfortunately, the outcome could easily err on the side of too much new oversight enforced by inefficient new bureaucracies.
- An era of much lower risk-taking by traditional lenders has begun that will last for years.
- The creation of higher-risk loans and investments will be taken over to some extent by hedge funds and private equity funds, accelerating a trend that has already been in place for some time, and replacing some of the former roles of commercial banks and investment banks.
- Alternative lending sources will be used to a growing degree by small businesses and some consumers who are unable to get loans elsewhere. For example, peer-to-peer lending companies are growing through enabling lending by and between members of lending clubs, or between friends and family.
- Virgin Money USA, for example, makes it easy for reliable small business owners to set up loans from friends. Prosper.com enables borrowers to apply for three-year, fixed-rate personal loans online by connecting borrowers with individual lenders. On the other end of the spectrum, small businesses that are unable to obtain or renew bank loans will turn to high-cost “factoring,” a method of borrowing against their receivables.
This report has been made available free of charge to Research Recap users for 30 days by special arrangement with Plunkett Research, an Alacra content partner. After 30 days, the report will revert to its regular Alacra Store price of $149.99)
For additional free research reports from the Alacra Store click here
Technorati Tags: Bank-of-America, banks, Citigroup, financial-products, financial-services, Goldman-Sachs, Hedge-Funds, investment banks, morgan-stanley, Virgin Money, Wells Fargo & Co.
Guest Post by Oxford Analytica
Banks in Latin America withstood the crisis and the downturn like few others in the global financial system. They financed loan growth with domestic sources of funding — such as deposits — and avoided many of the financial instruments that proved toxic in the developed world. Lessons learned from several past crises had also resulted in a healthy combination of well-capitalized banks and strict financial regulations and supervision.
However, banks did suffer in terms of loan growth, asset quality and profitability from the crisis and the downturn, even though many managed to grow their loan portfolios profitably while keeping bad loans under control. The notable exception was Mexico, where the deep recession saw lending contract and loan quality deteriorate sharply — especially in consumer lending and credit card financing.
Banks in several Latin American countries will enjoy double-digit loan growth this year as well as low levels of bad loans and strong profitability, making it an attractive sector for international investors.
Economic growth to spur lending. Most regional governments handled the crisis effectively and ratings agency Moody’s expects the region to expand 3.8% this year, after an estimated contraction of 2.0% in 2009. Latin American banking federation FELABAN sees the strong financial health of the banking sector as a key factor behind the region’s rapid recovery from the economic downturn. Regional growth this year will be positive for lending and other banking products and services as:
- consumer confidence and spending pick up;
- the employment situation improves; and
- more investments are made by both local and foreign companies.
Brazil and Peru are likely to lead loan growth this year among the region’s main markets as both these economies could expand around or above 5% in 2010.
However, loan growth will not return to pre-crisis levels in all Latin American countries this year as consumer lending, which drove much growth, was hard hit by the downturn.
Several large state banks gained significant market share last year — especially in Brazil and Chile — due to their active role in ensuring that financing was available at a time when private sector banks reduced their credit supply. Lending this year will again be led by private banks, now looking to take advantage of the region’s economic recovery and to regain terrain lost to state banks in 2009. Banks will also enjoy better asset quality this year as the payment capacity of individuals and companies improves along with the economic situation — which should contribute to stronger bank earnings.
Bank penetration advances. Despite favorable growth prospects for the region’s banks this year, access to basic financial services among the poor, small businesses and people in remote locations will remain at very low levels. It has been a permanent challenge over the years for banks and authorities alike to improve this situation, but progress has usually been slow. Last year did see some important advances on this front, especially in Mexico where a new distribution system is set to bring many low-income individuals into the financial system
Technorati Tags: banks, Brazil, Chile, Latin-America, Mexico, Peru
McKinsey makes the case for a “bad bank” solution to dealing with toxic assets in a new paper. However, the choices entailed are not straightforward.
McKinsey notes that after two years, the fallout from the financial crisis continues to afflict most banks, particularly those with significant levels of illiquid and difficult-to-sell securities—the so-called toxic assets, and especially collateralized mortgage obligations (CMOs), collateralized debt obligations (CDOs), and collateralized loan obligations (CLOs) With these assets still on the balance sheet, banks are finding it difficult to raise funds from wholesale markets or capital from equity investors. Short-term funding spreads are slowly returning to precrisis levels, but they are still well above the levels seen in the early part of this decade—this despite the still-significant support (including quantitative easing, repurchase programs, loan guarantees, liberalized collateral requirements, and so on) from the central banks.
Finding funds will soon get more difficult. Regulators are preparing new capital requirements and other changes that will impose fearsome new burdens on banks.
In response, banks are pursuing several channels. Most obviously, they are getting out of capital-intensive and structured businesses—in a word, deleveraging. They are pulling back from international operations to concentrate on domestic business. And they are dramatically overhauling their risk functions. All these steps are necessary and proper—but they may be insufficient. Capital is still scarce. Banks are still overleveraged, and unsalable assets still carry too much risk. Confidence is still wanting; so long as the illiquid assets sit on banks’ shelves, investors will be wary.
Hence the return of the bad bank. Dividing in two can help stricken institutions ring-fence their core businesses and keep them separate from the contamination of toxic assets. The separation allows the bank to lower its risk and to deleverage as first steps toward creating a sound business model for the future. A more efficient and focused management with clear incentives for portfolio reduction can maximize the value of bad assets. And the clear separation of good from bad can help banks regain the trust of investors, by providing more transparency into the core business and lowering investors’ “monitoring costs.” All these benefits do not, however, come for free: there are still economic losses and risks on the balance sheet that must be shared between the good-bank and bad-bank investors.
In sorting through the various structures banks are using today, we have identified five sets of choices that go a long way toward determining the bad bank’s structure and operations and eventual success. The paper explores each of these five variables here.
Technorati Tags: bad banks, banks, collateralized debt obligations, collateralized loan obligations, toxic asserts
The number of global corporate debt issuers poised for downgrades continued its decline this month to 824 issuers from 869 issuers last month, according to Standard & Poor’s. This is the lowest tally in the last 14 months. This decrease is largely because of an increase in the number of companies downgraded and assigned stable outlooks.
Potential downgrades are defined as entities that have either a negative outlook or ratings on CreditWatch with negative implications across rating categories ‘AAA’ to ‘B-’. This month, we note the following key points:
- The automotive and media and entertainment sectors showed the largest change in negative bias, narrowing 4% each since last month.
- Consumer products and retail and restaurants followed a similar trend, with a 3% decline in negative bias over last month.
- Although there were downgrades in all sectors, banks displayed the highest downgrade propensity, closely followed by media and entertainment, insurance, consumer products, and utilities.
For details see Credit Trends: Downgrade Potential Across Credit Grades And Sectors. (Premium)
Technorati Tags: automotive, banks, consumer-products, corporate-debt, Insurance, media and entertainment, rating downgrades, restaurants, retail, utilities
A new discussion paper from the Bank of England looks at the concept of increasing capital requirements on banks during market bubbles and reducing them in times of weak economic conditions when banks are typically reluctant to lend.
Excerpts from The role of macroprudential policy (free pdf download)
This discussion paper examines whether it would be practical to dampen cyclical overexuberance through a regime of capital surcharges on top of prevailing microprudential capital ratios. These surcharges could be applied to headline capital requirements or at a more disaggregated level (through so-called ‘risk weights’ on particular types of exposure). The sectoral approach might allow policy to be better targeted at pockets of emerging exuberance, but would also entail greater complexity. The appropriate level of disaggregation for setting capital surcharges would need to be considered carefully.
Increasing capital requirements in a credit boom would generate greater systemic self-insurance for the system as a whole and, at the margin, act as a restraint on overly exuberant lending.
Crucially, this mechanism could also operate in reverse: lowering capital requirements in a bust might provide an incentive for banks to lend and reduce the likelihood of a collective contraction of credit exacerbating the downturn and increasing banks’ losses.
Separately from seeking to address changes in risks through the credit cycle, capital surcharges could also be set across firms so as broadly to reflect their individual contribution to systemic risk. For example, as the FSA have discussed, surcharges could be levied based on factors such as banks’ size, connectivity and complexity. This would lower the probability of those institutions failing and so provide some extra systemic insurance. It would also provide incentives for those firms to alter their balance sheet structure to lower the systemic impact of their failure.
A big practical question is whether a macroprudential regime with aims of the kind described above could be made operational. Capital surcharges would need to be calibrated. That would ultimately require judgement, drawing on analysis, market intelligence and modelling. This discussion paper summarises, by way of illustration, a few of the indicators, quantitative and qualitative, that with further work could become useful inputs. They would largely be about the macroeconomy, and the financial system as a whole and the interaction between them.
It seems unlikely that macroprudential instruments could be set wholly according to fixed rules. Judgement may be needed to make robust policy choices. That would call for assessments of the resilience of the system, credit conditions, sectoral indebtedness and systemic spillovers — all of which vary over time and according to circumstances. All available evidence would need to be weighed, and policymakers would themselves need to adapt as they learn about the effects of their instruments on behaviour.
But it would be important that constraints were placed on a macroprudential regime to ensure transparency, accountability and some predictability. That would call for clarity around the objectives of macroprudential policy, the framework for decision-making, and the policy decisions themselves. It also suggests the need for robust accountability mechanisms. Such a macroprudential regime of ‘constrained discretion’ would share some similarities with macroeconomic policy frameworks.
Another important issue would be the degree of international co-operation. To be wholly effective, a macroprudential regime might require significant international co-ordination. But, even in its absence, appropriate macroprudential instruments might still be able to strengthen the resilience of the domestic banking sector.
Technorati Tags: banking-system, banks, financial-regulation
