The Bankwatch

As the IndyMac failure is taken care of, attention is turning to the next round, and the focus is squarely on the smaller regional US banks. The good news is that this is not expected to be as bad as the rates of failure that occurred in the late 80′s early 90′s and that is based on the record of non-performing loans at Banks. Currently there are 90 Banks noted in the ‘problem’ category.

The key will be the strength of the economy, maintenance of employment levels, and continued ability to maintain debt payments.

FT.com / Companies / Financial services – Failure raises concern for regional banks

Analysts also have drawn up possible “who’s next” lists. Richard Bove, a banking analyst at Ladenburg Thalmann, said one way to determine which banks were most vulnerable was to look at the non-performing assets of an institution – including loans that are 90 or more days past due – and divide them by outstanding loans.

A ratio above 5 per cent suggests danger, and seven banks – including IndyMac – fell into this category, according to his analysis. But Mr Bove said that the system is “not anywhere near the danger” that existed during the savings and loans crisis in the late 1980s and 1990s.

Indeed, many experts have dismissed comparisons with that period when more than 1,000 institutions failed. The present number of so-called “problem” banks, which rose from 76 to 90 in the first quarter, is well below the record levels seen during the former crisis when one in 10 banks was in that category.

But regulators and analysts do expect more bank failures. John Bovenzi, chief operating officer of the ­Federal Deposit Insurance Corporation, said: “I don’t expect there will be large bank failures. There will be small bank failures.”

The combined debt load of the two mortgage holding companies is over $5 trillion, and equivalent to the entire US national debt.  To date the Fannie/ Freddie debt has been ‘off balance sheet’ and therefore not included in the national debt. 

Economist

They [Fannie Mae and Freddie Mac] hold or guarantee some $5.2 trillion of the nation’s $12 trillion of mortgages, backed by the thinnest wafer of capital, meaning their collapse would imperil the already paralysed American housing market. Yet as Joshua Rosner, an analyst at Graham Fisher, a research firm, points out, nationalising them, a stark choice for the government since their shares tumbled last week, would “result in a doubling of the federal deficit, a further collapse of the dollar and unthinkable implications for the Treasury’s cost of funding in the debt markets.”

Given the actoins on Sunday to back the beleagured companies, the US is a hair away from having to include the debt in their national debt.  This has implications for he value of the US currency, and therefore the inflation, and other economic impacts to Americans.  Economists, feel free to chip in with the impact and how that might play out. 

There will be all kinds of debate about this mortgage debt being secured, therefore not the same as traditional government debt which is issued on the name only of the government.  Nonetheless its no small leap to realise that the US government is now on the hook until the underlying asset value is clarified.

IndyMac is a deposit taking institution in the US, that only lends mortgages, and specialises in sub prime. Federal regulators took it over Friday, and it will re-open Monday under FDIC supervision.

IndyMac seized as financial troubles spread | Reuters

IndyMac joins top bank failures headed by the 1984 collapse of Continental Illinois National Bank & Trust Co.

The Office of Thrift Supervision (OTS) insisted IndyMac’s failure was the second-largest bank failure based on FDIC figures. But the FDIC said its data showed it was third behind the collapse of First RepublicBank Corp in 1988.

A highly telling and profound statement from Bernanke yesterday. While the notion of ‘public losses’ is not entirely clear, the second part that they will impose losses on shareholders, read Banks, is very clear. I read that a if a Bank is not viable it is not going to be saved, notwithstanding the crisis, and Bear Stearns albeit and investment Bank, is the best example so far. Which Bank will be the first?

FT.com / World / US & Canada – Fed ready to extend bank aid

“A bridge bank authority is an important mechanism for minimising public losses from government intervention while imposing losses on shareholders and unsecured creditors, thereby ­limiting moral hazard and mitigating any adverse impact of ­government intervention on market discipline,” Mr Bernanke said.

Nice crisp explanation of the cause of the sub prime crisis by Governor Frederic S. Mishkin of the US Federal Reserve. In particular I liked this quote “a global margin call on virtually all leveraged positions”. Later on I offer an observation on how social lending has a responsibility, and a role to play in all this.

FRB: Speech–Mishkin, Global Financial Turmoil and the World Economy–July 2, 2008

The subprime crisis exposed problems with the securitization of mortgages. In particular, it became painfully clear how poor the underwriting and credit-risk analysis were for a wide range of products. Some appraisers, brokers, and investment banks were motivated by transaction fees and had little stake in the ultimate performance of the loans they helped to arrange. Many securitized products were complex, and the ownership structure of the underlying assets was opaque. Investors relied heavily on credit ratings instead of conducting due diligence themselves, and credit rating agencies failed to fulfill their raison d’etre. The result has been rising defaults, particularly in the subprime mortgage markets, with losses to both investors and financial institutions.

The ultimate losses from the recent residential mortgage-market meltdown have been estimated by Wall Street analysts at about $500 billion–less than 3 percent of the outstanding $22 trillion in U.S. equities.² Why did a relatively small amount of losses on subprime mortgage loans lead to such broad-based financial disruption? After all, a 3 percent decline in stock market prices sometimes happens on a daily basis with hardly a ripple in the U.S. economy.

In part, the outsized impact of mortgage losses on broader financial markets probably stems from the fact that they exposed a more extensive set of problems in financial intermediation that were not limited to the original subprime loans. The liquidity shock that hit us in August has been described by one of my colleagues as a global margin call on virtually all leveraged positions.³ The liquidity shock quickly brought an end to the credit boom that preceded it, as a striking loss of confidence in credit ratings and an accompanying revaluation of risks led investors to pull back from a wide range of securities, especially structured credit products. Along the way, the inadequacies of the business models of many large financial institutions were exposed, and these models are now in the process of significant re-examination and rehabilitation.

However this statement, when the Governor spokeof the future, caught my eye. The agency problem he refers to, is the reliance on mortgage brokers, appraisers, and all catch points for mortgages. He explained earlier those agents had been motivated by mortgage volume, took their commissions, and ran. There was no incentive for those agents to offer quality, and in fact they were incented to offer volume, with poor or fictitious quality.

Although some of the most complex structured-finance products may be gone for good, securitization will only recover fully when new business models solve the agency problems that were inadequately dealt with in recent years

This highlights a market opportunity, where social lending can bring significant leverage to bear. In the speech, the Governor spoke of credit ratings failing, and he spoke there of the Moodys etc rating on the ABCP (Asset Backed Commercial Paper) market. There is another rating that becomes essential in all this, and that is the rating on the end borrower, the person who takes out the mortgage to purchase a home. The rating on that person must be complete, accurate, and transferrable. By transferrable, I mean it must be available for inspection, and due diligence up stream as the collaterisation process disseminates the mortgage into pieces that become CDO’s and other ABCP. Social Lending is not just about people lending to people. That is a great beginning, and offers the valuable inspection from the wisdom of crowds.

In the future the market may well see additional markets appear, and social lending must at a minimum outperform the old way of doing things.

I said I would stop commenting on the credit crisis, but just wanted to throw in a statement of the blindingly obvious …. confidence in Banks balance sheets is at a very low ebb, and its not clear when this will get better.

FT.com / Equities / Volatile market – Shares hit as fears grow over financial turmoil

Investors’ fears of prolonged financial turmoil deepened on Thursday as blue-chip downgrades sent European and US shares into a tailspin and oil prices jumped above $140 a barrel for the first time.

Incredible losses displayed in an Ontario court yesterday.

FT.com / In depth – Damage to securities revealed in court

Some securities have lost almost a third of their value – even
though many were considered to be so safe that they carried top-notch
ratings from the credit ratings agencies.

Meanwhile, some subprime mortgage-linked securities issued by groups such as UBS have lost almost 95 per cent of their value

In an ironic twist to the sub prime crisis, the big Banks are grouping together in an attempt to develop a solution for Ambac Financial.  The irony is that the Banks used Ambac to hedge their original risk in the bond market.  I believe the several of the Canadian Banks are also engaged with Ambac.

Risk managers at Banks must be pulling their hair out, as new risk elements appear almost daily.

FT.com / In depth – Banks link to solve bond insurers crisis

The group looking at supporting Ambac includes Citigroup, Wachovia, Barclays, Royal Bank of Scotland, Société Générale, BNP Paribas, UBS and Dresdner. The members of the group, which is being advised by Greenhill, were understood to be the banks most exposed to the insurer. Credit Suisse is advising Ambac.

Ambac, which has lost its Triple-A rating by Fitch, needs to raise at least $1bn, analysts say.

In the first report I have seen, Reuters notes that the credit market in Canada is tightening as we predicted a few months ago.  This is a result of the US Sub Prime crisis, and the participation by Canadian Banks.

More firms face growing demand pressure | Canada | Reuters

Sixty percent of firms said credit conditions had stayed the same in the fourth quarter compared to the previous quarter but 32 percent said borrowing had become even tougher.

A shift toward tighter credit was first noted in the third quarter, a reflection of the global credit crunch that began in August, but the Bank of Canada did not publish those results. It released the data on this question for the first time in Monday’s report.

An interesting fallout of the sub prime crisis is the sale of substantial stakes in Western Banks to Asian interests.  There have been a few to China, and here UBS is selling 9% to Singapore Government.

BBC NEWS | Business | Sub-prime woes continue for UBS

The bank wants shareholder support to sell a 9% stake to the Singapore government, and 1.5% to another buyer

In related news, the Chinese economy is expected to cushion the what is now being described as the worlds slump.

BBC NEWS | Business | China boom ‘cushions world slump’

Global economic growth will slow in 2008 as the credit crunch hits the richest nations, the World Bank says.

But the “resilience” of developing countries will cushion the slowdown, with China still booming, it adds.