By RGE Monitor
According to preliminary results leaked to the New York Times, all 19 banks with assets above $100 billion that are subject to the Treasury’s “stress test” are bound to pass the test. The official results are due by the end of April but the upbeat mood in the banking sector was already reflected in the 30% stock price rally in the run up to the Q1 earnings season.
The major three commercial banks had already noted that they were profitable in the first two months of the year, and Wells Fargo announced that it expects to post a record net income of $3 billion when it reports results on April 22 (with combined net charge-offs of $3.3 billion for both Wells and Wachovia from $6.1 billion in the fourth quarter). Meanwhile, Goldman Sachs reported larger than expected Q1 earnings (ex December loss due to earnings calendar move) while at the same time raising fresh capital through a $5 billion stock sale in order to pay back the $10 billion in TARP money received last year.
A look below the surface reveals some caveats to this positive picture. As Nouriel Roubini points out in a recent writing: “In brief, banks are benefitting from close to zero borrowing costs and fewer competitors; they are benefitting from a massive transfer of wealth from savers to borrowers given a dozen different government bailout and subsidy programs for the financial system; they are not properly provisioning/reserving for massive future loan losses; they are not properly marking down current losses from loans in delinquency; they are using the recent mark-to-market accounting changes by FASB to inflate the value of many assets; they are using a number of accounting tricks to minimize reported losses and maximize reported earnings; the Treasury is using a stress scenario for the stress tests that is not a true stress scenario as actual data are already running worse than the worst case scenario.”
Other commentators also point to the fact that many of these banks were among the main recipients of AIG bailout funds in previous months, e.g. Goldman Sachs ($12.9 billion), Merrill Lynch ($6.8 billion), Bank of America ($5.2 billion), Citigroup ($2.3 billion) and Wachovia ($1.5 billion), according to New York Times data. The firms involved dismiss this factor as immaterial for Q1 earnings. Nevertheless, the US Government Accountability Office (GAO) noted in a report at the end of March that Treasury should require that AIG seek additional concessions from employees and existing derivatives counterparties.
Meanwhile, in the real economy credit growth to the private sector has continued to slow at a fast pace in the US as well as in Europe, while US credit card charge-offs rose to an all-time high in February at 8.82%. Moody’s predicts the charge-off rate index will peak at about 10.5 percent in the first half of 2010, assuming a coincident unemployment rate peak at 10 percent. In turn, Fitch warns that credit card delinquencies point to record defaults ahead. Keep also in mind that global high-yield defaults are expected to reach 15% by the end of 2009 and that the commercial real estate market has just turned.
According to recent press reports, in a report next week the IMF plans to raise its global loan and securities loss estimate to $4 trillion by the end of 2010, including about $3.1 trillion in US originated losses (up from $2.2 trillion estimate as of January) and $900bn in European and Asian originated losses. Compare these numbers with US originated loan and securities losses of $3.6 trillion as estimated by RGE Monitor in a January report. As outlined in our report, $1.8 trillion are expected to fall on US banks alone.
Eurozone banks are also exposed to the US downturn, especially through expected losses on securities holdings. Adding the expected losses on Central and Eastern European exposures, as well as domestic originated loans and securities losses, a first back of the envelope calculation suggests combined losses of about 11% to 15% of GDP compared to the 12.6% of GDP calculated for the US.
How are eurozone governments responding to their toxic asset overhang? Both the ECB and the European Commission were reported to be working on consistent draft guidelines for “bad bank” while leaving each country its own strategy.
The rapidly worsening situation in Ireland – the Economist defines it as a depression – for banks, despite liability guarantees, forced the government on April 8 to introduce its nationwide “bad bank” scheme. In particular, the Irish solution envisions the government buying certain toxic loans at a discount from banks’ balance sheets in return for government bonds. Importantly, the assets will be transferred at an appropriate discount, thus forcing the current stakeholders to take a haircut. Moreover, the government requires the banking sector to cover any losses the toxic asset management company incurs at the end of its mission. While RGE thinks this is an efficient approach, the necessary upfront outlays to capitalize the investment fund weigh further on the country’s strained public finances and funding costs.
The German proposition, on the other hand, aims to distinguish between temporarily illiquid as opposed to toxic assets. According to press reports, the idea is to guarantee the illiquid assets in separate but still bank-affiliated vehicles with EUR200 billion in government funds. Press reports point to a far more radical solution in the making for problem banks, such as Hypo Real Estate (HRE), some state banks, as well as Commerzbank. A final decision is expected by April 21.
Source: RGE Monitor, April 8, 2009.
