RGE Monitor's Newsletter Good Morning!
Last week the FDIC released the Quarterly Banking Profile for the second quarter. FDIC chairman Sheila Bair sums the results up as ‘pretty dismal.’ In particular, Q2 earnings were 87% below the Q2 2007 level (i.e. $5 billion vs $36.8 billion) trimmed by sharply higher loan loss provisions (total $50 billion). Unfortunately, noncurrent loans have been growing even faster than the boost in reserves for the ninth consecutive quarter: the industry’s ‘coverage ratio’ fell accordingly to 88.5 cents of reserves for every $1.00 in noncurrent loans, a 15-year low. Banks have little choice but to build up loss reserves substantially in coming quarters, which occurs at the cost of earnings.
Whereas expected losses are booked against earnings in the form of loan loss provisions, unexpected losses result in capital writedowns. Already, global bank capital writedowns exceed $500 billion (out of the $1 trillion estimate for the entire financial system), the very number the IMF set as a ceiling for global bank losses in April. Far from being over, S&P acknowledges that “we’re at best maybe halfway through this cycle,” and therefore we may be navigating towards Nouriel Roubini’s $2 trillion global loss estimate. Interesting new research by the Federal Reserve Board shows that foreigners hold 39% of ABS backed by U.S. assets, meaning that 39% of associated mark-to-market losses will occur abroad. In numerical terms, and assuming a 20% markdown, this translates into roughly $475bn.
The 19 primary dealers on both sides of the Atlantic were at the forefront of the crisis so far and account for over 50% of writedowns. With equities and commodities following fixed income markets down there’s nowhere for investment banks to hide. Analysts are slashing the Q3 earnings outlook across the board and a recent survey among institutional investors reveals that another big financial firm is expected to collapse within the next 6 months.
Regional and smaller banks are vying with large banks and primary dealers for fresh capital ($350bn raised so far globally), but the window of opportunity is closing fast. The number of ‘dead men walking’ - in John Mauldin’s words – is rising quickly as is the number of banks on the FDIC list that are considered as troubled (i.e. 117 in Q2 up from 90 in Q1). Ironically, the FDIC might be itself on track to turn into one of the biggest casualties of this financial crisis. See “Can the FDIC Handle the Coming Banking Bust?”
A rather unexpected additional source of stress for banks are the GSEs. The FT last week reported that U.S. banks and insurance companies are the primary holders of Fannie&Freddie’s $36bn preferred shares. The latter were downgraded heavily in view of an imminent government intervention. The costs to the taxpayer of any government intervention are adding up accordingly from the initial $25bn CBO estimate to over $100bn among prime credit losses, preferred share and subordinated debt writedowns.
Turning to the non-bank sector it is clear that even the shadow banking system is in deleveraging mode. Hedge funds are closing in record numbers amid a dismal average performance especially in the past two months. Furthermore, cost efficiency considerations fuel a move towards ever higher asset concentration among the top 100 players. See “Shake-Out in the Hedge Fund Industry: Who Are the Haves And the Have-Nots?”
Some life has also returned to the heavily battered monoline insurer market. New York State Insurance Superintendent Eric Dinallo helped broker an agreement for MBIA to reinsure $184 billion in municipal bonds for the lower rated Financial Guaranty Insurance (FGIC). Analysts see the movement as a positive first step for all parties involved: MBIA, FGIC and the muni bond market. Recent deals with investment banks to relieve monolines –against a fee- from their CDO guaranty obligations are a further sign of the industry’s self-healing efforts.
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