Basel Liquidity Delayed, Weakened
by Jon Winick, President, Clark Street Capital
The Basel committee, a super-committee of global banking regulators, extended the deadline for banks to comply with international liquidity requirements for another four years.
Banks won the delay to fully meet the so-called liquidity coverage ratio, or LCR, following a deal struck by regulatory chiefs meeting yesterday in Basel, Switzerland. They’ll be able to pick from a longer list of approved assets including equities and securitized mortgage debt as they seek to build up buffers of liquidity for use in a financial crisis.
In our view, this was a strange development. In our view, banking regulators have been so focused on capital and raising capital standards, even though many of the largest banks that failed had strong capital levels – it was liquidity and asset-quality that did them in. Under the rule, banks are supposed to have a Liquidity Coverage Ratio of 100% for 30-days of outflows of deposits. By giving the banks until 2019 to comply and greatly expanding the definition of liquid assets, adding equities, and mortgage-backed securities to the mix, this makes banks more vulnerable to a liquidity squeeze.
Why are we tripling-down on bank capital, while we are loosening the liquidity requirements? A better solution is to reduce the direct and indirect dramatic increases in required capital, while keeping liquidity requirements high. This seems like another example of the banking industry hijacking the global economy (“we won’t lend unless you cave”) in order to get its way.
The other takeaway is that Basel is in trouble globally, as perhaps the committee has overreached, and did not adequately consult with the industry. Like the European Union, it is tough to keep these global accords together in a period of financial uncertainty.
After doing an independent review of foreclosures, the Federal Reserve and OCC settled with 10 banks for $8.5 billion. Many scoffed at the settlement as being too lenient, including the NY Times editorial page.
Not surprisingly, after spending an estimated $1.5 billion on consultants, the banks have found little wrongdoing and provided no meaningful relief. Equally unsurprising, regulators will let the banks off with a wrist slap for their failure to execute credible and effective reviews.
The editorial puts its hopes in the Consumer Financial Protection Bureau, to propose rules that will prevent the problems in the past.
GAO Report on Causes of Bank Failures
- The General Accounting Office prepared a report, analyzing bank failures in ten western, Midwestern and southeastern states. A few highlights:
- For banks less than $1 billion in assets, failures were driven largely by credit losses on commercial real estate loans. These banks also had pursued aggressive growth strategies funded by nontraditional funding, and had weak underwriting and servicing standards.
- Fair value accounting was not a major contributor to bank failures, as over 2/3ds of small failed banks’ assets were not subject to fair value
- Criticized the backward-looking current methodology for estimating credit losses, and praised the FASB proposal to move from incurred to expected losses
- The use of the loss share attracted more bidders for failed banks, and, while total loss-share payments were $16.2 billion through 2011 and expected losses should total $42.8 billion, the FDIC saved the DIF over $40 billion.
- Despite increased consolidation through failed banks, the GAO found only a limited number of metropolitan areas and rural counties that were likely to be significantly more concentrated; it was also noted that most acquirers of failed banks were out-of-market institutions anyway. Moreover, acquiring banks providing more net credit than the failing bank.
Attached is the complete report. This fascinating report is the most comprehensive publically available analysis of bank failures in this cycle and should be required reading for risk managers and board members everywhere.
OCC Semiannual Risk Perspective
The Office of the Comptroller of the Currency, the primary regulator for the majority of the US banking institutions, published its second edition of its “Semiannual Risk Perspective” last month. This report is a tremendous resource in identifying the hot buttons of bank examiners. No doubt, the concerns raised in this publication will show up in bank exams for years to come.
A few takeaways:
- Low rates, sluggish economic growth, and new regulations threaten business models of banks, the latter we thought was eye-opening from a regulatory agency. We’ve heard the comment (“the new regulations are killing my bank”) from many bankers.
- Underwriting standards are weakening due to the slow growth environment
- Credit quality improvement is stabilizing, i.e., bottoming out
- Net interest margins will continue to be under pressure as rates stay low and older assets are replaced by lower-yielding assets. For example, one large regional lender told us that their 5-year fixed rate loans originated in 2007-2008, are adjusting at roughly half of their previous coupons.
- Housing is getting better, and mortgage servicing has improved
- CRE shows improvements, but problem assets remain elevated. We have been arguing this point for some time now, but you are not going to see material reductions in problem assets without more bulk sales. On a side note, we noticed with amusement that 3 of the 4 bankers of the year from American Banker had done a bulk sale of non-performing assets in the last two years!
- Very worried about HELOCs, as payments will begin to spike as the draw periods end
Excellent report – will be interesting to see how these change from quarter-to-quarter as market conditions do.
Complete Sheila Bair Interview
Many of you enjoyed our three-part interview with Sheila Bair. Attached is the link to all three parts. After spending some time with Ms. Bair, we can see confidently that she was tremendously informed about all of the relevant issues today, including some details that you would not expect an executive to be on top of. While we do have some differences of opinion, her voice should be heard and we hope she continues to stay involved.
Additionally, if you know of industry experts that would be good interview candidates, please don’t hesitate to send them our way.
Clark Street Capital is a full-service bank advisory firm, specializing in the review, management, and disposition of complex loan portfolios. We provide customized solutions for our clients, leveraging our organic and deep understanding of banking, commercial real estate, whole loans, loan sales, and workouts.
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Bank Portfolio Management provides due diligence, valuation, and solutions for loan portfolios
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Bank Advisory helps banking organizations with capital plans, strategic plans, management and compensation studies, and asset disposition plans