A few weeks ago we presented “Unwinding Planet Leverage” at the Spring CMRE dinner (http://www.cmre.org/) where I would say many were concerned about the ongoing credit fiasco. On the other hand, after countless capital raises, reassurances from commercial and investment bankers and the Bear Stearns rescue several months ago, sentiment has swung into bullish territory. Time after time I hear the same response from investors, “the Fed will not allow another large bank or investment bank to fail” or “I’m buying stocks since the Fed has things under control”. Oh really?
Today the Financial Times did a piece about potential accounting changes to off balance sheet entities created by our transparent bankers. Evidently, FASB wants to remove all conduits, SIVs, VIEs and any other form of off balance sheet activities consequently returning roughly $5 trillion to bank balance sheets – ouch!
Accounting changes could force US banks to take thousands of billions of dollars back on to their balance sheets in the coming months in a move that is likely to curb further their lending and could push them into new capital raisings, analysts have warned.
Analysts at Citigroup said a planned tightening of the rules regarding off-balance sheet vehicles would force banks to reconsider arrangements and could result in up to $5,000bn of assets coming back on to the books.
The off-balance sheet vehicles have been used by financial institutions to keep some assets off their balance sheets, thereby avoiding the need to hold regulatory capital against them.
Birgit Specht, head of securitisation analysis at Citigroup, said: “We think it is very likely that these vehicles will come back on balance sheet. “This will not affect liquidity because they are funded, but it will affect debt-to-equity ratios [at banks] and so significantly impact banks’ ability to lend.
In the past I’ve discussed leverage at various financial institutions which in some cases actually increased since the credit crisis began last Spring. For example, since the Bear Stearns funeral Citigroup actually increased their leverage from 18-1 to 19-1 while Lehman and Morgan Stanley shifted more of their level 2 assets to level 3. Adding additional pressure to an already strained banking system, the SEC will hear proposals regarding new credit rating systems, specifically asset backed securities.
The U.S. Securities and Exchange Commission may recommend this week that Moody’s Investors Service, Standard & Poor’s and Fitch Ratings include a new designation to the scale created by John Moody in 1909. The changes may force investors to reassess the way they gauge the risk of securities backed by mortgages, student and auto loans and credit cards, said one of the people, who declined to be named before the announcement. The action could force banks to add capital to guard against losses or curb lending.
To be considered “well-capitalized” under U.S. regulations, banks are required to hold five times as much capital against corporate debt than they are for commercial or residential mortgage-backed securities rated AAA and AA by S&P, Fitch
Ratings and Moody’s.
Should the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corp. order banks to hold more capital, investors in asset-backed securities may balk at buying, making mortgages more expensive, said American Bankers association executive director Wayne Abernathy.
Finally, the Bank of International Settlements is out with a warning on the global credit crisis implying a potential depression from the massive credit contraction.
In its latest quarterly report, the body points out that the Great Depression of the 1930s was not foreseen and that commentators on the financial turmoil, instigated by the US sub-prime mortgage crisis, may not have grasped the level of exposure that lies at its heart.
According to the BIS, complex credit instruments, a strong appetite for risk, rising levels of household debt and long-term imbalances in the world currency system, all form part of the loose monetarist policy that could result in another Great Depression.
The report points out that between March and May of this year, interbank lending continued to show signs of extreme stress and that this could be set to continue well into the future. It also raises concerns about the Chinese economy and questions whether China may be repeating mistakes made by Japan, with its so called bubble economy of the late 1980s.
My Comments: As planet leverage continues to unwind expect numerous rounds of toxic financing as regulators pressure banks and investment banks to raise more capital, diluting shareholders away in the process. Concurrently, regulatory pressure from the Fed will require banks and investment banks to meet margin calls as posted collateral via temporary lending facilities decline in value. Finally, our banking system will move closer to Japan circa 1991-1993.