Monday, December 21, 2009
This is a good thing. Clipping off the low tail of a moribund system serves to eventually bring the overall industry up the quality tree. It's an example of a regulatory agency doing what it's supposed to. Yes I do hear those of you lamenting "if only we could do the same over in the large bank and investment bank segments of the system." True there's a lot more politics involved in arresting the risk shifting gamesmanship at the upper end of the spectrum to actually achieve some productive pruning. I'll take a little larger view though. The remainder of the banking system is being "trained up" by what the FDIC is doing and eventually this higher quality population of competitors will make their mark on the landscape. There may be some "mastodon stew" for these emerging hunter gatherers to feast on yet.
So here's the next installment of what I think will be a weekly forensic report by IRA. Your feedbck is important so let me know if you want to see more of these.
First Federal Bank of California, FSB Santa Monica, CA
Imperial Capital Bank La Jolla, CA
Independent Banker' Bank Springfield, IL
New South Federal Savings Bank Irondale, AL
Citizens State Bank New Baltimore, MI
Peoples First Community Bank Panama City, FL
RockBridge Commercial Bank Atlanta, GA
As you'll see in these forensic tables the IRA Bank Stress Index letter grading methodology picks up on the stresses with a fair bit of warning. More than enough to implement tactical plans to mitigate exposure and shift assets to more stable institutions.
IRA is taking a survey of how CFO's, Treasurers, bankers and bank counterparties feel about the current financial landscape. It's a short survey and we invite you to participate. If you'd like to take the survey please email Diana Waters before January 15, 2010.
Monday, December 14, 2009
So is it possible to see this kind of trouble heading towards a bank? And if so, how far in advance of disaster do the indications begin to reveal? That's the question that comes across my desk frequently. Everyone wants to know if the IRA Bank Monitor can see it coming. The direct answer is yes. IRA's A+ through F grading system was in fact developed specifically to illustrate these Bank Stress Indices or BSI's so as to begin warning early enough while there might still be time for bank directors and officers to attempt to avoid or mitigate a crisis that could result in regulatory action. But not all banks make it. For some, the fate of failure manifests. It is from these that it's possible to study the "What went wrongs?" so that the clues in the rubble can help others avoid the same fate.
On December 11, 2009 the FDIC closed three banks. The links point to IRA's Failed Bank History Report that shows the prior twelve (12) quarters of stress history for the failed institution. They are presented here as forensic examples.
in Overland Park, Kansas
Valley Capital Bank, N.A.
in Mesa, Arizona
Republic Federal Bank, N.A.
in Miami, Florida
I highly encourage serious students of banking and bank risk to study them. Reports on live institutions are available to subscribers at http://www.irabankratings.com/ .
Tuesday, December 8, 2009
I must say that I personally find the thought of a grassroots approach based on emphasizing small business recovery to be refreshing. The concept that "many hands make light work" makes good sense to me. The best of breed from the old ways will do well regardless. Encouraging and supporting smaller more maneuverable business to fill the needs voids will almost surely result in a revitalized and globally competitive United States of America. It's the kind of thing this country, encompassing all our political and cultural persuasions, is good at. It's certainly a more persuasive use of precious national wealth than continuing to prop up obsolescent "sucking sound" infrastructures. The question is of the new year will be can the Administration steer a course to the correct balance. I wish the President and his team the best in this effort.
The Flight to Quality, A Never Ending Journey
The impact on banks and businesses by what is about to unfold are many but ultimately it boils down to quality. The quality of the commercial and industrial entities that will seek and use business financing in 2010 and the quality of the banking institutions that will serve the new landscape. The banks will need to contend with two things to clear the way serving Main Street again.
First is completing the transition into a new reality that the country has moved into a post real estate boom phase. Shedding exposure is a tactical necessity. This means banks need to tend to their own health particularly with respect to the lingering cancer of losses from distressed real estate still in their bloodstreams. Projected real estate loan losses still to come are massive. The bulk of Option-ARM reset dates are in the still to come in 2010 and 2011 bucket. The reality is that these loans were never meant to survive the reset. Unless an alternative is created, the human pain and loss will be massive. The current loan modification program has an applicant failure rate of over 60% and the actuarial probability is that the remainder might just be a delaying tactic slowing the inevitable. Here's the truth. We have a lot of U.S. homeowners who can only afford to be U.S. renters. Until their relationship with finance and banking is morphed to reflect that truth the cancer will remain in the national bloodstream. Statutory loss reserves and FDIC insurance premiums will continue to suck discretionary capital away from new lending and a credit availability crisis will hamper the President's recovery agenda. Still, looking at the various piecemeal components of proposed solutions to this that have crossed my desk in the last year, I have a degree of belief there is a way to do this. It needs someone to architect it into a cohesive strategy then sell it to what is clearly still a weakened and hesitant hospital patient.
The second challenge to banks is to make the transition back to becoming a competitive marketplace for quality lending. Specifically, for the supporting the President's agenda, quality commercial and industrial lending. C&I loans and lines of credit are the fuel that grows economies. Targeted C&I for small firms may be forthcoming if the Administration follows through turning policy into substance. We should not be surprised if keen competition for the highest quality C&I customers will become all the rage next year. Indeed CFO's and Treasurers of well positioned firms should be insulted if they don't have several bankers knocking on your door courting their business accounts. There's some evidence of that happening already. Expect to see all kinds of spin about why your current bank is a pile of poop and you should become a client of bank X. It'll be all to the good because a competitive Main Street financing market is a sign of an improving economy. Don't believe bank advertising material on it's face though.
CFO's of commercial and industrial companies are well advised to exercise some "Trust No One Agent Mulder" prudence. We've seen a fair few "we're better than your old bank" pitches that turn out to have higher risk and stress ratings than a company's existing banking relationships. When asked we tell companies it's worth the peace of mind to obtain even the basic IRA report on one's bank and any bank pitching you for business. CFO's need an independent eye. Think of it as getting a "CarFax" before signing the papers. Making banks compete in the bright light of day could even sweeten the pot for a CFO particularly when being approached by equally good and competitively motivated banking alternatives. Finally, in these days of SOX compliance, it's also important to prove to the finance committee and to satisfy potential adequacy of internal controls challenges that one did use at least one independent criteria to base one's decision on.
In parallel, Treasurers need to look at their deposits placements and cash management strategies with a keen eye on bank quality. There are 8,500 or so active banks in the U.S. Not all of them are healthy. Some of them are "hazardous" and that's not a term I made up, it's a category they fall into based on business conditions exceeding regulatory criteria thresholds. And just relying on ladders and brokered deposit spreading isn't enough. Treasurers still need to pick one or more primary banking relationships where sizable balances may have to sit as part of enabling the smooth operations of the CFO and COO of the firm. The same reality that hit the Wall Street finance universe applies to industrials. Shifting risk is no substitute for reducing risk.
Sunday, December 6, 2009
The risk map at the end of September 2000 was as follows,
|IRA Bank Stress Grade Distributions|
And asset distributions are,
IRA Bank Assets Stress Distributions
The risk map is roughly identical from 2Q2009 to 3Q2009 give or take a little because of continued but now predictable hemmoraging. So where are America's challenges ahead?
Do we have the political will to do the right thing?
Bringing Wall Street back into the service of Main Street remains elusive. Finance remains a universe separate from the rest of our reality. The excesses of a decade and a half of "financial innovation" have been exposed but the inertia behind the collapse continues to fight on delaying the finance system's reintegration into mainstream society. What else can you say when you witness artifacts such as a stock market that pushes up prices on the arithmetic of expense management paid for by the unemployed and underemployed. Or a derivatives market so steeped in its' habits that it remains hell bent on preventing the kind of transparency that would help ensure the debacle we are living through won't happen again? These are not economic fundamentals, they are social and political risks that this nation cannot afford. The Administration and Congress are by now well aware of these forces and their effects. There is no reason the citizenry should not expect our leaders to do the right thing.
Refocusing industry incentives to make things right.
Just under 2/3rd's of the banking industry's assets lives in the A+/A/B stress range according to our calculations. The remainder have issues clearly requiring some degree of extraordinary administration. But so far, the remediation efforts of the United States remain piecemeal and nearest I can tell, overly focused on a few large entities that fall within the fashionable coverage limit of the major news bureaus. We have so far failed to systemically tap into the single largest source of recovery strength we have, the healthier banks. They are there but they are hamstrung from acting lumped in with the weaker and louder players who's calls for mercy and aid via taxpayer dollars retain our attention. In my job I see and talk to some of these A+/A/B banks and even some really smart C grade banks on the mend that struggle to take advantage of their positional strengths. But what should be a downhill run competitive advantage is an uphill struggle for the best of breed. So here's the challenge to our leadership. Refocus the process from a smattering of narrowly selective aid packages to a tidal of movement to change the nature of the industry so it gets back to an 80 good/ 20 bad ratio. This will involve a much larger shifting of impaired assets to sound foundations. It will undoubtedly manifest as a newsworthty mix of debacles and recombinations. But we need to return to a process of natural selection based on value instead of clout.
Make Main Street the political priority already.
We cannot make lemonade from rotting lemons. You can take comfort deluding yourself looking at day to day economic indicators but the reality is that as of September 2009 the total amount of bank balance sheet real estate loans outstanding by FDIC reporting banks was around $4.5 trillion dollars. That is about the same amount as it was in March 2007. It peaked at a high of $4.8 trillion in March 2008 just as the "crisis" was becoming common knowledge to America.
But here's the thing. In 2007 the annualized default rate on these loans was 11.8 basis points. Today it's 194.3 bp. Main street home ownership is struggling. Let's look at a few more then and now comparisons.
- In March 2007, 30-89 Day overdue loans was $43.7 billion. Today, it's $100.8 billion.
- Over 90 Day overdue loans were $11.2 billion in 2Q2007; today that figute is up to $88 billion.
- Non-Accrual residential real estate loans were $29.2 billion in March 2007; we are at $202 billion now.
- And bank real estate owned was $6.9 billion in March 2007. Today banks own $37 billion worth of real estate.
The challenge is pretty clear. The degraded real estate portfolio of America's banks massive and does not yet shows no signs of abating. Surrounding this challenging financial scenario is a loan modification program that by best estimates will work for no more than 1/3rd of the problem. An infrastructure solution needs to be found for the balance of the U.S. homeownership problem. Banks saddled with such problems cannot lend and therefore cannot help re-stimulate the economy. In economic terms this is a massive downward accelerating force if not dealt with. Numerous proposals surrounding this subject abound as we reach the end of 2009. None yet cohesive enough to represent anything amounting to a solution. We have a collective choice to focus on it or not.
Friday, September 11, 2009
Today I’m pondering next week’s expected beginning of the removal of government subsidies from the U.S. banking system. The stock market has been showing off its’ new found love for driving up equities regardless of the fact that computed stockholder’s equity numbers are now driven not by top line revenue improvements but by the modeled mathematics of cutting back on expenses. According to the Wall Street Journal, economists buoy about the world getting better. Exactly for whom I’m not quite sure because unemployment benefits are soon to permanently run out on people (and their families) for whom these same economists say no jobs are forthcoming for at least another year. I'm not sure I would advise the President to stand between the pitchfork wielding public and the “Black Swan” academicians with Christmas approaching.
And so into this "theoretically improving" world President Obama is expected to inform Wall Street next week that the one of the government's bank subsidy programs ends in October. The Troubled Loan Guarantee Program (TLGP) is a less well known subsidy vehicle than the Troubled Asset Relief Program (TARP) but it is nevertheless one of the pillars of the rescue plan that was put into place by the combined efforts of the Bush/Obama administrations.
TLGP is another one of those things that never really took off in the way people imagined it would. Like TARP it was meant to encourage banks to continue to lend under extraordinarily stressful conditions. However, we’ve all seen that credit availability dried up anyway because ultimately banks backed away from subprime lending as they collectively de-leveraged and shut down the exposure manufacturing aspects of their business models. So because there was no new lending the opportunities to make use of TLGP by the industry were relatively sparse.
So now here’s where it gets a little interesting.
Over the past year we’ve been tracking the system wide trends in defaults, non-accruals and finally other assets owned by banks and we’ve been seeing continued degradations in net lending assets quality. That means that the business need to eventually take advantage of trouble loan guarantees has been growing not receding. The TLGP concept may have been instituted before it’s time and that time may be still be in the future, probably not that far. One might ask, “are we pondering confiscating subsidy tools just as banks might be on the verge of using them?” And of course the even more fun questions "Why?" and “Is this a good idea?”
Of the 8,800 or so active bank units reporting to the FDIC around 3,500 or so have formally opted-out of the TLGP. Yes there’s a list floating around out there that has double that number but if you look real closely people that list has many banks listed twice, once under its’ FDIC Certificate ID and again under its’ Federal Bank Holding Company identifier. So that means 5,300’ish of the brethren have stayed silent on their intentions. This includes most of the bigger banks by the way. It they all activated under the program the Unites States government could quickly find itself running out of another kind of clunker money pool. TLGP extension by exception means a lot of case-by-case evaluation workload for the FDIC’s staff.
Could you put that in English please Mr. Santiago, "I think it means someone is setting up a high hurdle filter."
To be honest one can argue that banks have had ample time these past months to ponder their business positions and make their plans on how they will steer their way into the second decade of the 21st century. Apparently it’s time to test their mettle and let the forces of competition winnow the winners from the losers. If this is so, making TLGP extensions available only to those with true survivor potential as opposed to keeping the program open for zombies actually has national policy merit … as long as it’s applied objectively that is.
To me this means that the administration may be preparing to send a potentially uncomfortable message to Wall Street that it wants to begin to divert capital away from obsessing on artificially floating up the DJIA and redirect it back into economy building uses of private capital. By making it so that banks will soon need such private capital to survive the anticipated loss scenarios of 2010 it means that only collective and focused investment as a cadent nation of citizens can stave off the further withering of a weakened broader economy. It’s a glitch that changes the where and how the nation’s wealth reserves are to be employed. Pretty gutsy move. Wake up and smell that coffee!
“A déjà vu means they’ve made a change in the matrix.”
Monday, August 31, 2009
Unfortunately looking at the 2Q2009 industry stress distribution numbers based on the latest FDIC research master file the numbers tell a tale of doubt. Table 1 shows the population distribution of IRA bank stress indices computed over the weekend. The data includes every active bank in the United States for the end of 2Q.
|Table 1: IRA Bank Stress Index (BSI) Grade Distributions|
At first glance you might not see much change. The return to 2008 reveals dramatically looking at the asset values of the institutions in each stress bucket. One does indeed see a bump of improvement at the end of 1Q2009 no doubt due to the combined gallant efforts of the administration and the one before it. But I have to report with what I will admit is a sinking heart that it's all but evaporating according to the second quarter results. We are back to the stress patterns of 2008.
|Table 2: IRA Bank Stress Assets Distributions|
So where are we? Where are the big banks in all this one might ask? Generally, that would be them beginning to pile up in and around column B country. The regional and community banks remain split in a barbell pattern that's been emerging for some time.
Mission Element Need Assessment
Any analyst who isn't in complete denial about being on planet earth should clearly see at this point that a one size fits all unified theory of problem solving is a load of hooey. We now have on our hands a much more complex battle with at least three elements that need to be maneuvered cleverly if this is to turn out alright.
The A+/A's are our economy's anchor. We need to make sure they are advantaged to capture market share and rebuild our foundation to good operating standards. They aren't necessarily the politically connected. But I do not believe the other two legs of banking can survive without them. Left to me, this is where I'd design the most favorable incentives to encourage private investments. Why here? Because it creates implied financial forces to herd the other two groups towards safer and sounder outcomes.
The B/C banks are the one's still carrying excess leverage from the prior business cycle. We need to bring them back to earth in a controlled fashion. Destroying them is not an option. Though wounded, they are still a tool with a real purpose in our economic landscape. Rather, we need to mend and reposition them so that their penchant for chasing great opportunities can be recycled to help power the next leap of the American dream.
The D/F banks are the great turnaround opportunity of our economy. These are the institutions whose business models have become so mismatched to current conditions that it's showing in red ink net incomes, hazardous exposures to government advances, and unsightly loan loss scenarios. These are the banks that will require the iron hand of the Banking Act reborn to restore discipline to safe and sound principles. Turn them around we must for the sake of our own peace of mind. Mark my words, for each 5% of them we fix we'll feel a quantum of joy better about life in these United States.
The search for solutions goes on.
Monday, June 1, 2009
This observation about bank stress trends from the IRA Newsletter garnered some attention.
"At the current rate of deterioration, that could put the Stress Score for the entire industry over 10 by Q4 2009 or a full order of magnitude above the 1995 baseline. Such a worst case scenario suggests that we could see one in four US banks merged or resolved through the cycle. In the event, that suggests that over 2,000 institutions, large and small, will be resolved. Put that into context with the FDIC's "official" dead pool of 300 or so institutions and that gives you a tangible measure for how much "spin" might live within the official version of the problems facing the US banking industry."
One email from a respected reporter asked,
"Is this the same thing as saying one in four banks may fail? How realistic is it to assume what the data suggests? What specificially would drive so many banks out of existence? In other words, what's their Achilles heel in your judgment?"
When a bank fails it is resolved, that is, merged by government edict into another "healthier" institution. Yes it is possible that we will see a good portion of now weakened banks become the subject of a merger feeding frenzy later this year. This could indeed lead to the emergence of a smaller industry populated by larger more economically resilient and politically powerful companies. Some people believe that it's a good thing to concentrate banking power into a more consolidated industry. Me? I just see fewer banks charging higher fees for basic services.
What the IRA analyis of 1Q2009 FDIC data is saying is that lacking any improvement in the infrastructure that supports banking, our analysis indicates that the deterioration of the industry will continue to spread potentially affecting a larger population of institutions as the year progresses.
As has been stated in previous observations, banks have been migrating down the path towards weaker net incomes as a result of stalled lending engines and ballooning anticipated losses on existing loans. The pursuit of good lending begins to look more like balance transferrals instead of true blue new loans that expand the U.S. economy. Anything riskier carries the stigma of being just another balance sheet item eventually headed for the REO pile. It's not easy to make a living under such conditions and the biological sustainment capacity answer is that the population must shrink to equilibrate with the environment.
Dude I don't like that answer either. There's no reason why a country like the United States of America should "equilibrate" to a lower quality of life at this stage in our history. It just does not make sense to me that we'd let something like this happen when we have it in our power to create a different destiny.
The Achilles heel in this equation is the bastard cousin of banking ... finance. Finance is the leverage we create to make our money do more for us. It is a powerful and dangerous tool that can both create and be driven by good and evil. Behind banking's ailments is the fact that securitization, a central element in leveraging the operational processes of main street banking, is now dormant. Driven by greed and excess, it's caretakers have been driven into discredit and trust in it has evaporated. Entire industries that enabled it have ceased to exist in the last 24 months. What's left of it is stored in Federal financial toxic meat lockers. We've done all this at the very peril of our quality of life.
The fact of the matter is that unless we get the financial engines supporting our banking product inventory restarted in some rational fashion banking will continue to de-leverage. Does that mean giving the greedy back their licenses to steal candy from babies? Of course not. What I think it does mean is making a national effort to construct the apparatus to deliver a new range of financial vehicles to enable banking to do it's job again. And do it at a quality of life target design point at oh say "the pursuit of happiness" once more.
And so begins the search for a new dawn.
Wednesday, May 6, 2009
“Young man sometimes the only way to win is to lose gracefully.”
Gen. Bill Creech, Commander,
USAF Tactical Air Command
to Dennis Santiago years ago
Technology Innovation That Actually Works
We admire the Federal Deposit Insurance Corporation for many reasons. This month, we applaud them once again for the fine job they have done to bring the Central Data Repository (CDR) online in a way that serves the growing public demand for timely US bank data. Made operational just in January of 2009, we’ve just collected Q1 2009 CALL reports for over 7,600 reporting units, a goodly portion of which came out of submittal confirmation only a couple of days ago.
These CALL reports are submitted to the FDIC during a 30 day submission window beginning the first day of the quarter. We’ve been testing a variation of IRA’s ratings analyzer on these Q1 CALL’s since April 1st. The result is that IRA is now positioned to deliver preliminary bank stress estimates for the new quarter roughly two to three weeks ahead of the FDIC’s mid-quarter research master file release. Based on this maiden run, we are pleased to report that the FDIC’s CDR engine has the potential to enable a quantum leap in granularity looking at the U.S. banking industry.
Coupled with our analyzers, it’s possible to generate analysis on bank units as they file their CALL’s and, based our findings, generate a industry picture in around 36 to 48 hours after the close of the CALL submittal window. That’s pretty good!
Stable Pie Slices, But Dramatic Increase in Banking Industry Stress
Based on looking at sample set of around 91% of the test population used in Q4 2008, we observe that the distribution of IRA Bank Stress Rating grades for Q1 2009 retains the roughly 2/3rd to 1/3rd ratio of banks with A+/A grades versus elevated stress institutions IRA detected was characteristic of the banking industry throughout 2008.
|Q1 2009 Preliminary IRA Bank Stress Rating Grade Distribution|
(Based on data for 7,519 bank units from the FDIC CDR*)
Source: FDIC/IRA Bank Monitor
|IRA Bank Stress Grade||2009 Q1*||2008 Q4|
|There were an additional 108 banks in the initial data set that were found to have some holes in the data thus preventing computation for the preliminary analysis run.|
We see indicators of a continued migration of banks from the A+ range where stress fall below the index Dec-1995 = 1.0 start mark into the A range indicating more banks are now feeling the effects of economic conditions regardless of the business practice models they’ve had in place.
At this time we do not know what the disposition of the remaining 750 or so institutions that are not in the CDR as of 5/3/2009. We have not yet had a chance to determine who these missing units are.
|IRA Historical Bank Stress Grade Distributions|
based on FDIC Research Master Files
Source: FDIC/IRA Bank Monitor
At first glance the situation as of Q1 2009 may seem to be getting better. But it’s not. In prior quarters, banks wound up getting “F” grades because they were barely making money; that is, they had small but positive net incomes that produced ROE’s sufficiently below industry averages to indicate elevated business operating stress. A lot of these institutions were suffering due to mark-to-market accounting, goodwill write-downs and other ROE issues.
In Q1 2009, the data indicates a dramatic climb in the industry aggregate average Bank Stress Index from 1.8 at the end of Q4 2008 to a whopping 5.57 coming out of 1Q 2009 or half an order or magnitude above the 1995 benchmark. The reason for this is the number of banks who delivered negative net incomes in the first quarter of 2009, one thousand five hundred fifty-seven (1,557) of them as updated on our system after the data run on May 5, 2009.
Keep in mind what the Q1 2009 FDIC data is saying: Even with the change in the FASB rule for M2M accounting, and Fed liquidity programs, the leading factor driving higher industry stress scores remains ROE degradation, not charge-offs or operational factors such as efficiency. When charge-offs are the leading factor in the IRA Banking Stress Index, then the industry will be through the worst.
|Number of Bank Units with Negative|
Net Income in 1Q2008 by State
updated as of May 5, 2009
Source: FDIC CDR/IRA Bank Monitor
|* items updated since 5-3-2008. Please note that th FDIC CDR system continues to release data. The definitive lock down of quarterly numbers happens when the research masterfile is released later this month.|
The Q1 2009 results calculated by IRA are looking a little like a table from the CDC’s H1N1 confirmed laboratory cases page. Our overall observation is that U.S. policy makers may very well have been distracted by focusing on 19 large stress test banks designed to save Wall Street and the world’s central bank bondholders, this while a trend is emerging of a going concern viability crash taking shape under the radar.
We’ve noted in the past that US banks have been migrating down the quality slope taking an average of 9 months to complete the journey from “A” to “F” on the stress scale. The story is predictable. It begins with business losses and recriminations. This is followed by lending engine contraction as the propensity to create exposure narrows towards risk aversion and “quality lending” exclusivity. This is a rare diet to try to live on in these times. The bank, which makes its’ living wage from the interest it collects from its’ lending engine slowly starves.
At a certain point the carry cost of the infrastructure outweighs the earnings rate. Then you start to see strange shifts to seek incremental income from service fees, a move that often only serves to increase customer reluctance and mistrust. The end result is a stressed business model that can only be remedied by getting the core business, its’ lending engine, running again.
Counting the fourth quarter of 2007 when IRA’s data indicates this phenomenon began to emerge, we are now eighteen (18) months or one-half of a business cycle dragging this massive boat anchor the behind the US economy. We may have wasted valuable time trying to save Wall Street at the cost of Main Street.
At this point the reasons no longer matter. It’s time to win by thinking gracefully. The numbers indicate we need to seriously ask the question as to whether economic recovery for the United States can still come just from repairing Wall Street – or whether instead we should be worried about addressing the underlying loss rates that are driving the provisioning behind these poor ROE results. Has the time come to shift the policy focus away from the things that we love, namely big zombie banks, to tackle things that are truly hurting us?
Readouts on all 7,519 bank units collected by IRA to date are now available to our Advisory Clients. The Beta version of unit level preliminary indicators now appears in the IRA Bank Monitor for Professionals. Preliminary grade indicators appear in pink if available. It will begin to appear in the IRA Bank Ratings Service for Consumers as soon as Beta testing is completed. IRA is presently working on adapting the accompanying bank-holding company (BHC) extension of our ratings system to also feed from CDR collected preliminary data. We continue to support our “prime solution” philosophy that it takes everyone with fair, equal and transparent access to risk information to collectively guide our economy to recovery.
Friday, May 1, 2009
SEC's Schapiro Shows Little Interest in Cox's Pet Projects
Personally, I applaud SEC head Mary Schapiro's caution. Technology (old or new) is not a substitute for policy and it seems right that the SEC should pause and assess initiatives on an ongoing basis.
Supplement? Yes. Replace? That's a stretch.
While much work has been put into XBRL, stepping back given the present economic cycle, I can see no driving national interest why the United States needs to rush to catch up to a vision of replacing a body of material encompassing accounting, legal and forward looking commentary people can read with a narrower set of digital files as the primary evidentiary source for corporate reporting.
Proof of efficacy is essential. Within the SEC itself, has the question of the utility of this wonder tool been properly assesed? I respectfully submit that it's not unreasonable to demand that an investment of this magnitude must at least be shown to streamline and magnify effectiveness of the case load work within the Corporate Finance and Enforcement Divisions of the SEC as a stringent proof of concept. I mean is that kind of payback hurdle too much to ask of something that could impact corporate America like the second coming of Sarbanes-Oxley?
Does this mean XBRL won't happen? No. Does it mean that in the end it's just another data file format and not as some would hope a fundamental business language and process sea change? Speaking as both a CEO and a techie, I hope so.
Changing technologies, with regards to the internet versus the wire services, visceral reactions aside, it's likely best to consider all sides of the argument when it comes to the dissemination of corporate action data. Fairness is a process of constantly finding ways so that everyone gains access to information equally. Wire services, for all their synchronization, always reach professionals first. Enabling and encouraging pathways that allow individuals to negate this long time Wall Street advantage seems to be something always worth pondering. ... Tweet!
And finally, grander reporting and regulation topics seem ripe for one of those restart buttons like Secretary of State Clinton uses to manage foreign policy. The Obama White House has already stated its' intent to a process of review for financial markets regulation for the remainder of 2009. Make it so!
Monday, April 27, 2009
What is bank stress? The question is complex and anyone who attempts to simplify the answer probably is doing themselves more harm than good. There are operational stresses, financing stresses, and regulatory stresses that play like a noisy orchestra keeping bankers up at night and sadly sometimes driving them beyond the edge of despair.
In the U.S. government’s bank stress test, the question being asked is essentially “how well can a particular institution withstand the stresses of certain economic scenarios designed by the government”. As Fed Chairman Ben Bernanke stated in his testimony to Congress on February 25, these tests are not designed to pass or fail a bank. Rather, they are designed to help identify to what degree and in what areas each key institution participating in the stress process shows strengths or weaknesses so that the government can better determine how to use its’ resources to help alleviate the crisis.
That’s the plan and so far that’s also where the Federal Reserve and Treasury seem headed. We see no reason not to expect that a genuine attempt will be made to use the results of the stress testing process to help allocate government resources with greater precision.
Regardless, America and the world has a never ending obsession with picking winners and losers; or lacking closure, making odds. Right now if you want good odds probably better to place your bet on Susan Boyle. What follows is our response to the press asking for some way to shed a little more light on who likely stands where in the landscape.
Nothing in the list that follows represents an assessment by IRA as to how any of these institutions will fare with respect to the government’s stress tests. The question posed to us is how would IRA rank these nineteen banks relative to each other using our IRA’s independent benchmarking processes. It is quick analysis based on using some of IRA’s top level criteria to identify where these banks sit relative to each other in their ability to respond to the stresses we feel are of most concern under the current economic climate. At best, these figures could provide some visibility as to what the government may decide is the right individual prescription one by one.
Two Criteria, Three Buckets
For this we elect to focus on two criteria. The first is our IRA Bank Stress Index which is a measure of the operating stresses on a bank viewed as a going concern. The objective of this measurement is to identify whether an institution’s business model is working or potentially in need of adjustment. The criteria used are based on bank safety and soundness principles and have little to do with assessing the equity attractiveness of a bank. Remember only 900 or so banks are publicly traded out of the over 7,500 that report to the FDIC. The second criteria we focus on is financial leverage and for this we use another IRA proprietary measurement based on Economic Capital versus Tier One Risk Based Capital. The combination of the two gives a rough approximation of the business stresses a banker must contend with.
So from these two criteria we make three buckets – buckets that roughly align with the four buckets reportedly being used by regulators in the bank stress tests. They are:
• Upper Bucket – the institution metric measure well on both criteria.
• Middle Bucket – the institution is good on one out of the two criteria.
• Lower Bucket – the institution flags on both criteria.
We now present 4Q2008 information on 17 out of the 19 stress test banks. The arbitrary cut-off criteria for bucketing is the number 2. We did not have data for GMAC and American Express available for this snapshot.
Bank Holding Company
|IRA Bank Stress Index||IRA EC to T1 RBC Ratio||Is Stress Index > 2?||Is ECtoT1RBC > 2?||Probable Bucket||Simple Ranking via column B plus C|
|NORTHERN TRUST CORPORATION||0.66||1.484||No||No||Upper||2.144|
|SUNTRUST BANKS, INC.||1.49||0.885||No||No||Upper||2.375|
|PNC FINANCIAL SERVICES GROUP, INC., THE||1.36||1.576||No||No||Upper||2.936|
|BANK OF AMERICA CORPORATION||1.61||1.908||No||No||Upper||3.518|
|WELLS FARGO & COMPANY||1.47||2.146||No||Yes||Middle||3.616|
|CAPITAL ONE FINANCIAL CORPORATION||2.33||1.495||Yes||No||Middle||3.825|
|BANK OF NEW YORK MELLON CORPORATION, THE||0.81||3.963||No||Yes||Middle||4.773|
|STATE STREET CORPORATION||0.62||4.975||No||Yes||Middle||5.595|
|JPMORGAN CHASE & CO.||1.3||4.513||No||Yes||Middle||5.813|
|REGIONS FINANCIAL CORPORATION||21.11||0.715||Yes||No||Middle||21.825|
|FIFTH THIRD BANCORP||21.57||0.961||Yes||No||middle||22.531|
|GOLDMAN SACHS GROUP, INC., THE||20.6||7.905||Yes||Yes||lower||28.505|
Anyone familiar with the banking industry is unlikely to be surprised by the above relative positioning of these banks. Good operating performance combined with limited economic leveraging most likely translates into greater ability to withstand the stresses of economic shock scenarios. As combinations of leverage and operations positioning degrade there’s less business as usual wiggle room and thus greater need to implement more extensive strategies to respond to shocks. Do not count any of them out. All of these institutions are large businesses capable of a great deal of flexibility in responding to even the most massive business environment challenges.
Take Goldman Sachs. It sits at the bottom of the list because it’s a brand new bank holding company fresh from being an almost pure investment bank. It has little in the way of the kinds of classic bank operations that contribute to traditional operating stability and soundness measurements. More, it has no deposits to speak of and is entirely market funded, like American Express and Morgan Stanley. One could look at them and just as easily ask the question why they should be a BHC at all if they can find a business model that doesn’t require depositor backed lending engines to round out their operations.
The point is that the government is right to treat these institutions as individual cases each of which will have independent paths to journey their way back to being confident contributors to the economy.
Yes there will be commonalities and hopefully guidance templates that can use the information exposed by the process of close scrutiny to guide government policy with regards to other institutions beyond these nineteen few. That would be the best outcome of the process. We wish the government the best in their efforts and stand ready to assist in whatever way we can.
But if you plan to go long or short on any of the above, nothing in what you just read will mean much. Remember that at the start of this note that there were three stresses listed; operational, financial and regulatory. It’s the third one that’s the real wild card in the deck. Normal market forces are not the driving coefficient at the moment.
Tuesday, April 7, 2009
So here's a what if. What if the regulatory implentation of things like the PPIP were set up so that the government would only buy troubled assets from documentable non-speculators for say the first year of the program. This would focus taxpayer dollars towards flushing toxic assets from the operating institutions most in need of capital stress relief.
Then to further benefit the public what if the agency managing PPIP implementation followed a path where assets purchased for speculation would not be looked at until they seasoned a minimum 12-months holding period. This would allow truly skilled pool holders time to cherry pick promising items from the mix prior to disposal. The PPIP could also require the remainder collateral pool to be marked at the seasoning date prior to being purchased into the program. This would seem to be the right thing to do instead of relying on factors of a spreadsheet ... again.
Just thinking out loud.
Wednesday, March 25, 2009
In my comment on JJ's site I wrote, "There's absolutely no reason for a bank to retain TARP subsidies if they can effect a business strategy to configure assets and operations to go forward after paying them off. In fact I believe that's an essential mission challenge all banks that took TARP funds need to make part of their strategic planning. Banking is a highly competitive industry and global competition among the largest banks is hypercompetitive. That universe did not cease to exist when the United States legislated the current suite of laws into existence. Institutions saddled by government strings are disadvantaged in that universe. Mr. Lewis has his head on straight. An independent Bank of America is a better Bank of America. He's looking out for his shareholders and his depositors. If he can find a way to turn TARP into a short-term liability instead of an LBO more power to him."
Can Bank of America accomplish this? Based on the information we have in the IRA databases if any of the large banks can do this it's going to be BAC. It remains one of the strongest super-regional banks in our economy and we in our distillations of their Call Reports see the artifacts of an organized strategic plan to reign in their stray units quarter by quarter. Is it perfect? No. But what is in these times. Bank of America inherited some serious challenges as part of their 2008 acquisitions and Mr. Lewis is right to point out that there's some luck involved as to how the economy will evolve to making his dreams come true.
The bottom line is it's a plan that I personally believe benefits the National Interest. I wish you all the success in the world sir.
We respectfully suggest that other banks, particularly the better off mid-size and community banks, should take note of what Bank of America hopes to do. The next phase of this industry may not be centrally governed but instead highly competitive and possibly fratricidal. There's a lot of private capital out there just waiting to prove that the United States remains a nation with the means to pursue happiness. Speed and flexibility are strategic assets not to be underestimated.
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We also invite qualified parties to contact us about our Advisory Services at firstname.lastname@example.org.
Monday, March 23, 2009
During the second and third quarters of 2008, banks were shutting down new lending as defaults rose and fear gripped the new loan landscape. Stress scenarios computing Maximum Probably Loss (MPL) in turn force many to allocate heavily into provisions for loss reserves further tightening credit availability. The process took several months but the lack of new lending production is now beginning to manifest as degraded interest and fee earnings on loans. That’s the primary source of transaction revenue in the banking industry. So even though these banks have capital, they have no revenue.
Essentially these banks have slipped back into what is effectively a de novo start up configuration. It’s well known that new banks are capital rich and revenue poor. Their business model challenge is to grow lending to reach profitable operational returns. In the Institutional Risk Analytics (IRA) system this tends to make a bank display a bank stress rating we call a “start-up F.” The business stress is real. There’s tremendous pressure on the bank to get the lending engine up and running on a timely basis. Our system generates a special flag for this condition. The logic that triggers flag is appearing for these older banks that have anemic lending.
We have not seen many older strong capital banks drop down into this “de novo like profile” as a phenomenon until recently. But now we believe as much as one quarter (1/4th) of the low rating grades population in our system may be exhibiting signs of underperforming lending engine stress.
The condition is worrisome because during 2008 we saw a number of FDIC resolutions centered precisely around banks that were still capitally adequate but displayed worsening operational stresses. The banks the FDIC resolved often displayed adequate regulatory capital but weak income statements and deepening loan loss trends. We optimized the IRA system to detect the very real threat of regulatory resolution action around this degrading safety and soundness condition.
It’s clear that some banks avoided further loan losses by decreasing or ceasing new loan production. The result was the Fall/Winter 2008 credit squeeze. Time moves on and now the stress has morphed. All bankers know that growing one’s lending base is a tedious process. You make good loans one at a time. So the institutional risk question is can they get their loan engines moving again?
These banks must address the business issue of competing for new lending to bring net income back on stream before cost of capital catches up with them. The fundamentals say these banks need to begin aggressively competing for new loans in order to build up their interest and fees sources of income. We’ve heard a number of anecdotal cases of this beginning to happen. We have adjusted our automated detectors to indicate when a bank is exhibiting this “restart/de novo challenge” condition in our reporting.
Monday, March 9, 2009
But what is the real T.C.E. condition of these banks. An equity investor sees their investment through the eyes of the Securities Act. They buy stock through a market regulated by the Securities and Exchange Commission (SEC). They analyze their investments looking at the whole entity which in the most complex institutions is only partially a regulated bank.
For those of you who don’t know this, the regulated bank portion of your stock is overseen by an entirely different set of regulators operating under the authority of the Banking Act. The Securities Act and the Banking Act are immiscible. They do not interact. The identification numbers at the SEC and the FDIC are separate lists. There are 885 publicly traded banks and over 5,000 bank holding companies. So for over 80% of the banking industry, publicly traded stock price doesn’t figure anywhere in the analysis. And it’s the bank regulators who hold the power of U.S. law when it comes to capital adequacy. It’s their equations that govern what is enough, when prompt corrective action is required and when resolution is necessary. The computations are specific and they are not based on reading 10-K’s.
There are a number of T.C.E. figures floating around right now and we thought it would be a good idea to assess whether these are in fact helping public transparency or distorting it. The most common one we’ve found is the simplistic method. It’s,
T.C.E = (Common Equity less Intangible Assets) divided by (Total Assets less Intangible Assets)
These numbers are found in SEC 10K’s and are part of the standard 800 or so fundamental variables in all of the vended data feeds. It’s quick to calculate and it gives reasonable data for banks with business models that are primarily in the basic business of banking. It begins to distort as the bank participates in exposures to external risk sensitive activities such as trading and securities that are better tracked using Economic Capital (EC) analysis. And it can be as much as 200% to 400% off the mark for large complex multinational public companies with portfolios of operations that include significant portions of non-banking lines of business. For this last set of companies you really do have to separate them in to their bank and non-bank components and analyze the risk of each using differing techniques and then make the equity decision. Yes it’s more complex that quick glancing at the 10K and watching the price-volume but we’re in a brave new world and the winners are going to be the ones that figure out the new math.
Take poor Citigroup. I saw an article with a table indicating Citi’s T.C.E. was down to 1.8%. We ran the simplified formula for Citi and came up with 1.78% for 3Q2008 pulling figures from the 10-Q's matching the number from the source quoted in the articles. The figure is alarming because the conventional rule about T.C.E. is that it should be 3% of higher to be “adequate” from a banking safety and soundness perspective. The outcome of the equation puts quite a bit of “market” pressure on Citi to say the least. Adding insult to injury, it also opens up an arbitrage gap. The question in the end of course, is it real?
At the moment we’re not so sure at IRA because certain cross checks don’t fit. The three official tests of Capital Adequacy(1) for the Citi’s banking operations all show that this portion of the business is capitally adequate. Citi does carry a high degree of stress in our Bank Stress Rating system but it’s not because of any regulatory capital adequacy issues. Their loss provisions are in line with the Maximum Probable Loss (MPL) stress factors in our system so it looks like their operations scenario planning is being done properly as far as capital reserve positioning is concerned. So we ran a version of a bank operations-only T.C.E. and came up with a figure of 5.53% for Citi at the end of 4Q2008. This last figure for the bank portion of Citi agrees better with the regulatory indicators from the three official Capital Adequacy tests. We remain a little wary because the oddball number out of the lot is the simple calc TCE.
If all the numbers are true one thing it might imply is that the interests of the banking regulators, counterparties, et al and the interests of equity shareholders are not aligned by a conflict ratio of 3-to-1. That gets kind of interesting when the two become one.
I’m not saying that banks like Citi don’t have their share of challenges. They certainly do and yes they are scary daunting. But what I am saying is that they, the other banks, and this country’s economy do not need imaginary ones. In these times, we need to be sure the dots are connecting.
Note : The three official regulatory tests for bank capital adequacy are as follows,
a. Tier 1 Leverage Capital Ratio must be greater than 5%.
b. Tier 1 Risk Based Capital must be greater than 6% of Total Risk Weighted Assets.
c. Total Risk Based Capital must be greater than 10% of Total Risk Weighted Assets.
If you want to see IRA's Bank Stress Ratings reports you can buy them here. http://us1.institutionalriskanalytics.com/Cart/Request.asp.
Wednesday, March 4, 2009
Unknown voice: “Dennis if your numbers are correct it would mean that there’s no way some of these large banks could possibly stay in business.”
My response, “Yes it does indeed question their viability.”
Next question, “So will you change your numbers?”
Response, “No we will not. I believe the numbers are correct.”
I went on to explain that we had in fact “parametrically stressed” the Economic Capital factors as an exercise to locate the point where one would again get analytical indications of business viability for some of these larger vulnerable institutions. Our findings were that the allowable loss margin threshold needed to be raised to around 3,000 bp to make that happen. I reminded everyone that the cutoff between investment grade and junk was around 2,800 bp, the term toxic was not yet in vogue. This was simply not “real world viable” as a modeling ground rule. Doing so would imply that IRA would be buying into sanctioning operational and strategic policies saying a banking industry averaging at least as risky as a junk bond was "normal". That’s just far too much rope to give to banking institutions that are supposed to operate safely and soundly. The notion fails the common sense test.
Silence. That pretty much ended that phone call.
Now some stress testing numbers to keep in mind.
- There are rougly 885 publicly traded banks.
- There are around 5,000 regulated bank holding companies.
- There are 8,500'ish individual FDIC reporting bank units.
- IRA publishes a detailed Bank Stress Rating for every one of the above for every quarter going back to 1995.
- Each bank is tested using identical criteria.
- The most recent reports cover the operating period ended December 31, 2008. Anyone can buy one for $50.00 on our website.
- Our indexing methodology uses an analytical census of all active institutions in order to locate accurate behavior distributions.
Why bring this up?
The U.S. government is working on creating stress tests for a group of supposedly "mission critical" banks. There's a rule in analysis that when in doubt people do what they know. You have to watch out for that. Given the people working on this there's a good chance that the risk-stress methodology is likely unique per bank akin to the construction of an elaborate (that usually means opaque) boutique multi-asset class security with many of the risk inputs supplied by statistics provided by the bank being examined. Basel II called this type of thing the Internal Research Based (IRB) approach.
Some reminders are in order. IRB was meant for use by healthy institutions able to prove the empirical validity of their inputs and the stability and accuracy of their methods. Also IRB's are supposed to be accompanied by external research benchmarks and include an explanation of the differences, if any. The process is meant to promote counterparty confidence.
Wednesday, February 11, 2009
Alliance Bank was taken over by the FDIC last week and the assets sent to California Bank & Trust, a unit of Zions Bank. The Alliance case was typical case of a small institution that got trapped in the aftermath of a deflating bubble. It ended life the owner of a growing portfolio of foreclosed properties stemming from a lending default rate dragging operational earnings deep into the negative. Their Aggregate Loan Default Rate went from a miniscule 26bp (basis points) to 496bp and their Loss Given Default rate was 96%.
As it has been doing with regularity, the FDIC performed it's designated regulatory function taking the troubled entity into the arms of a better positioned and healthier financial institution. In fact, the degradation of Alliance's position took approximately nine months to gestate. The bank's overall stress ratings over time are shown below.
IRA Bank Stress Ratings: Alliance Bank, Culver City, CA
Sep-08 - F
Jun-08 - F
Mar-08 - B
Dec-07 - A
Sep-07 - A+
Like many other institutions who were caught in the bubble a migration of business from income producing to dead weight ensued. Non-Conforming assets went from $17.7M in Sep-07 to $96.5M in Sep-08. During the same time Real Estate Owned(REO) went from $1.1M to $16.6M.
Note: I was interviewed about Alliance on Monday by KNBC-TV Los Angeles. The segment aired on Tuesday Feb. 10.
Wednesday, February 4, 2009
Timing of production is keyed to the FDIC’s internal processing schedules. The FDIC holds release of the master dataset for each quarter’s filings for 45 days to perform internal cleaning prior to releasing it for analytics use. We get the data and process it to build the industry stress statistics typically just before the FDIC does its’ mid-quarter press conference. We try to release our reports to coincide with the FDIC conference date provided the FDIC arrived on time. An email is sent to all clients informing you that the reports have been updated.
FYI, catalogs of SEC filings for public companies are available on the IRA website. SEC filings contain top level information on companies aimed primarily at stock investors. They typically begin to appear just before the 30 day point after the end of the reporting period, hence the end of month follies in the markets. That’s a little ahead of the FDIC’s much more comprehensive data needed for safety and soundness analysis on banks to help assess the risk within a person/company’s cash and cash equivalents assets. Different portion of the wealth portfolio.
Wednesday, January 28, 2009
So here's one for you to ponder. The same colleges that train some of the best economists also train some of "the best" structured finance designers. It's the same math. I'm just sayin'.
Thursday, January 15, 2009
. The link takes you to an excel file containing four worksheets covering 3Q2008 and year-end for 2007, 2006 and 2005.
The technique for this requires rolling up the bank only assets of each of the units of a BHC to make the computation. We actually set the computers up to run the metric for all 5,000 or so bank holding companies for every reporting quarter we have in our databases. Naturally the popular press seems fixated on the top tier. The "Prime Solution" for the U.S. economy probably lies in deploying TARP money among the best of breed of the 5,000 though.
Enjoy the peek at the tip of the iceberg.
Tuesday, January 13, 2009
C - Capital adequacy
A - Asset quality
M - Management quality
E - Earnings
L - Liquidity
S - Sensitivity to Market Risk
CAMELS include privileged information on objective numerics, subjective discussion and judgement and external exposure analysis measures that help the regulator determine whether a bank is being run adequatetely or requires prompt corrective intervention.
Pattern Analysis to find "The Signal in the Noise"
IRA analysis uses publicly available information to perform similar analyses to the CAMELS process but using an outside observer approach. We opted to design a system that concentrates on bank stress indicators because this is what "main street Americans" actually worry about.
Unless one is a regulator, it's impossible to talk in detail to every bank in the United States. So we designed a more clinical statistical analysis approach to characterize behavior patterns at the census level (looking at all FDIC filers ... yes all!) to replace one-on-one subjectivity. The objective of our system is to allow a consumer to locate a bank's performance both in terms fundamental safety and soundness and in competitive context with its' peers. We believe this improves transparency for depositors as well as the decision matrix process for investors.
Why letter grades?
When we looked at how to set up the final grading scale we were sensitized to the need to make the grading system intuitive for consumers by the media. So instead of emulating the CAMELS 1 to 5 scale we opted for the more familiar report card of A to F letter grades.
In the CAMELS system a bank is considered well run if it has an overall CAMELS rating of 2 or lower and has issues if that rating slips to 3 or higher. Anecdotal comparisons to the IRA Bank Stress Index rating system indicate that one can expect the following,
IRA A+ generally finds banks with CAMELS 1
IRA A finds banks with CAMELS 1 and 2
IRA B finds banks with CAMELS 2 and 3
IRA C thru F corresponds to banks with CAMELS ranging from 3 to 5
CAMELS ratings seem to move more slowly than IRA Risk Ratings which are computed on a per period basis algorithmically. This makes sense given that CAMELS involve deeper private information examinations of an institution to complete.
We think the IRA rating may function like a leading indicator but it's hard to tell because one cannot get a look at all the CAMELS and their inputs unless one is at the FDIC. We do have the structure of the EXAM table in our computers, but not the content. Doesn't matter. If we did the law is such that we could only show the results to the regulators anyway.