Smaller US Banks Need 24 Billion Extra

FT Reports:

Small and medium-sized US banks must raise some $24bn to meet the capital standards set by the government in its stress tests of large institutions, research for the Financial Times shows.

News of the potential capital shortfall could increase pressure on many of the 7,900 US banks that form the backbone of the US financial system.

As many as 500 more banks could close, according to investment bank Sandler O’Neill, which carried out the research.

So, the bigger banks which hold about two – thirds of the assets in the US banking system need 75 billion dollars and the smaller banks, which hold one – third of the assets need about one – third of that amount. Great research.

Industry Wide Deployment of Gross Bank Credit: India

From RBI’s website — here is a graph that states what everyone already knows, but still paints a very telling picture. The figures are in Rupees Crores and represent the deployment of gross bank credit.

The line that will catch your attention is — Construction. Any guesses on how fast this is going to fall from here on?

rbi-deployed-credit

Stress Test Results

The much awaited bank stress test results are finally out today and personally, the thing that interested me most was what they call — Buffer, in the report is exactly the opposite. I went to the tables first and got confused by that number, so, then had to read the report from the beginning.

The SCAP (Supervisory Capital Assessment Program) ran tests on 19 banks and came out with some numbers, which are not quite as bad as the IMF or the Roubini Estimates.

Of course, the Stress Tests are no longer “stress” because it is quite likely that the scenarios listed down while conducting the tests will play out and are no longer — worse case estimates.

Here are some numbers:

1. These  tests ran on 19 firms, which hold two thirds of the assets and more than one – half of all loans in the US Banking system.

2. The losses at the 19 banks for 2009 and 2010 under the “adverse” scenario could be $600 billion.

3. The bulk of these losses will come from residential related mortgages and consumer related loans (houses and credit cards).

4.  The 19 banks need to add $75 billion to their capital by the end of 2010 to reach their SCAP Capital Target.

5. 9 out of the 19 banks are good and don’t need to add any more capital.

6.. 10 of the 19 banks need to augment their capital (Tier 1) to reach the SCAP Capital Target.

7. These 19 firms have US Preferred Treasury Equity securities worth $216 billion dollars.

Here is a chart of the estimated SCAP Capital requirements for the 19 banks:

scap-capital

Japan Sets up 61.5 billion dollar scheme for Asia

After China; Japan seems to be making efforts to reduce its dependence on the US Dollar and promote trade in its own currency.

From Reuters:

Japan will establish a scheme to supply up to about 6 trillion yen ($61.54 billion) to Asian nations in the event of a financial crisis, Finance Mininster Kaoru Yosano said on Sunday.

The yen swap plan will be in addition to Japan’s $38.4 billion contribution to a $120 billion regional liquidity fund.

Both measures are aimed at supporting the region’s economies in a crisis, Yosano told reporters on the sidelines of the Asian Development Bank’s annual meeting in Indonesia.

“This brings our contribution to supporting regional liquidity to about $100 billion,” Yosano said.

Japan hopes the yen scheme will also promote the use of the currency in the region, business daily Nikkei reported.

Chrysler Bankruptcy

I found out about the Chrysler chapter 11 bankruptcy when I saw a friend browsing through its website looking for some sort of a fire sale. He said that he wasn’t looking at buying a Chrysler, but, if there was a good deal — he was game. I am not sure if others feel this way, but, I felt this was a refreshing take at things.

Fiat Comes In

WSJ reports that Fiat would initially take a 20% stake in the company, which could increase to 35% and even a majority stake, if the government’s debts are paid off.

The majority stake holder would be the Voluntary Employee Benefit Association,  with a 55% stake. The US Government would own 8% and the governments of Canada and Ontario would own 2%.

Cerberus Gets Wiped Out

Since Chrysler was 80% owned by: Cerberus — the wealthy Private Equity (PE) firm; I saw no reason for a bail out. It makes very little sense to give a hand out to wealthy PE investors and hedge funds, while asking the 54,000 employees and 115,000 retirees to make sacrifices.

I think the hedge funds were betting that the government would not risk a bankruptcy and would agree to their demands. I also have a sneaking suspicion that the banks were betting that the hedge funds would not be as generous as them. Both of them have lost their bets.

It Was Almost Bankrupt Anyway

I am glad they lost their bet because I have always felt that there is very little difference between a car company that may go bankrupt any time and a car company that is already bankrupt. Especially, when the US government is willing to back its warranties.

People who differed, compared it to a Honda and asked whether I would rather buy a Honda or a bankrupt Chrysler?

I feel that comparison is flawed.

What you really need to ask is whether you would buy a Chrysler or a Honda. If you would buy a Chrysler, then you need to ask yourself whether you would buy a Chrysler that may go bust any time or a Chrysler that’s already bust.

Till today; I wasn’t sure  of the answer, and I realized that was because the question was incomplete. To complete the question — you have to add another:

At what price?

When I asked that question — I started mulling various possibilities, and that should be heartening for Fiat and Chrysler.

They can make customers interested, if they are innovative enough with their offers, product line and marketing.

Fiat has a great opportunity to enter the US market; offer their line of small compact cars and open up a market which is not very big here. They have Chrysler’s vast dealer network to help them and a new management has a much higher chance of engineering a turnaround than the existing management.

One of my first bosses taught me that I should happy if a customer is yelling at me. He said that the fact that she is yelling, and has not gone to the competition means that I can still win her back. That’s why I say that people looking for fire sales is refreshing, because at least they have not gone to the competition.

US 2009 Q1 GDP Numbers

The GDP numbers released yesterday looked bad and marked the third consecutive decline in GDP. The economy shrank at 6.1% and the only glimmer of hope was — consumer spending.

When we entered this year, a lot of people expected recovery to begin in the second half of the year, but now it seems that the recovery is going to start only at the beginning of next year. This is what the IMF said some time ago, when they said that the global economy would shrink this year and then growth will only begin in 2010.

The only good news is that although the economy has done as badly, as it did in the last quarter — the declines came from diminishing inventories and investments, which adjust themselves to lower demand.

Here is a chart that compares how the two consecutive quarters fared.

The first three bars on this graph are consumer spending which fell rapidly during the last quarter and recovered in this quarter. Then the next two bars show business and housing investments, both of which were worse than last quarter.

Business investments fell because of the decline in consumer spending in earlier quarters and that makes the 6.1% – number a little less worse, than it appears. Since, consumer spending has shown sign of stabilization — business investment will also follow suit in the near future and stabilize quickly.

The fact that trade fell consistently is a really bad sign because countries use exports to claw their way out of a recession, but, if the whole world is struggling, then who can you export to?

I can’t wait for 2010 to arrive.

Citi and BoFA Fail Stress Tests: Time for Bonuses?

WSJ reported yesterday that regulators have told Bank of America and Citigroup that they would need to raise more capital based on the stress test results.

Obviously, this means that their current capital is not enough and they have failed the stress tests. What this also means is that the great first quarter results shown by Citi didn’t mean much and the noises made by Mr. Ken Lewis about asking for 20 billion instead of just 10 billion was not a “tactical mistake”.

Ordinarily, this would have meant huge bonuses for Citi and BofA executives, but, at least in the case of BofA — some people down at CalPERS don’t seem to agree. CalPERS is the biggest US Public Pension fund and holds about $176 billion dollars in assets. They own 22.7 million Bank of America shares and are going to vote against the re-election of Mr. Lewis and all other directors.

From their press release:

CalPERS contends that Lewis and other directors failed to disclose information to shareowners in connection with Bank of America’s merger with Merrill Lynch.  The pension fund also believes that the undisclosed payment of billions of dollars in bonuses to Merrill Lynch executives – before completion of the merger – warrants a vote against all directors.

“The entire board failed in its duties to shareowners and should be removed,” said CalPERS Board President Rob Feckner.  He noted the poor condition of the company, the failure by directors to disclose the extent of Merrill Lynch’s losses prior to consummation of the merger, the payment of billions of dollars to Merrill executives in bonuses for failure, and the failure of the board to act in the best interests of shareowners in overseeing management.

Citi is currently negotiating with the government to allow bonuses for its energy trading unit. You all know what a great quarter it just had.

This little piece from NYT sums it well:

One of the maneuvers, widely used since the financial crisis erupted last spring, involves the way Citigroup accounted for a decline in the value of its own debt, a move known as a credit value adjustment. The strategy added $2.7 billion to the company’s bottom line during the quarter, a figure that dwarfed Citigroup’s reported net income. Here is how it worked:

Citigroup’s debt has lost value in the bond market because of concerns about the company’s financial health. But under accounting rules, Citigroup was allowed to book a one-time gain approximately equivalent to that decline because, in theory, it could buy back its debt cheaply in the open market. Citigroup did not actually do that, however.

This is akin to negotiating with your credit card company; bringing your debt down from $5,000 to $2,500 — and then partying with the $2,500 dollar profits.

What party? — you ask.

Didn’t you hear about Wall Street compensation in the first quarter going back to 2007 pre – crash levels. I heard it when a Nobel Prize winning economist was griping about it.

So what’s going on here? Why are paychecks heading for the stratosphere again? Claims that firms have to pay these salaries to retain their best people aren’t plausible: with employment in the financial sector plunging, where are those people going to go?

No, the real reason financial firms are paying big again is simply because they can. They’re making money again (although not as much as they claim), and why not? After all, they can borrow cheaply, thanks to all those federal guarantees, and lend at much higher rates. So it’s eat, drink and be merry, for tomorrow you may be regulated.

Or maybe not. There’s a palpable sense in the financial press that the storm has passed: stocks are up, the economy’s nose-dive may be leveling off, and the Obama administration will probably let the bankers off with nothing more than a few stern speeches. Rightly or wrongly, the bankers seem to believe that a return to business as usual is just around the corner.

So, the banks are making paper profits and paying cash bonuses and yet their troubles don’t seem to end. What could they possibly do?

The answer is very simple — increase the Tangible Common Equity of banks and everything will be fine. Banks are not sufficiently funded, so if you fund them through this liquidity crisis — they will be just fine.

From Reuters:

Citi’s tangible common equity ratio was 1.66 percent at the end of the first quarter. Converting preferred shares into common, coupled with the $2.7 billion sale of a stake in Smith Barney brokerage unit into a joint venture with Morgan Stanley, should raise its tangible common equity ratio to 4.97 percent, Fox Pitt Kelton analysts wrote in a report two weeks ago.

So, even though they will not get any real cash, at least their books will look good. James Kwak made an insightful observation about TCE and preferred — common conversions a couple of months ago:

Because of the newly perceived need for TCE, the bailout plan under discussion is to convert some of the preferred stock into common stock. Citi wouldn’t actually get any new cash from the government, but it would be relieved some of the dividend payments (currently close to $3 billion per year), and of the obligation to buy back the shares in five years. (For the impact on Citi’s capital ratios, see FT Alphaville.) This is a real benefit to the bank’s bottom line, and hence to the common shareholders. At the same time, though, Citi would issue new common shares to the government, diluting the existing common shareholders (meaning that they now own a smaller percentage of the bank than before). In theory, the amount by which the shareholders in aggregate are better off should balance the amount of dilution to the existing shareholders.

So, even though banks have been doing pretty good when it comes to book profits and are doing equally well managing cash outflows; the situation doesn’t seem to improve.

Is it time to pause and rethink this whole thing?