Basel III

  • 02 Apr 2013 at 11:58 AM

Prime Brokers Will Sell You Those Shares If You Want, But Wouldn’t It Be Cheaper To Rent?

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“Bucket shop” has become a general-purpose Wall Street insult – “don’t work at Blackstone, it’s a total bucket shop” – but it’s actually a particular thing, “[a]n establishment, nominally for the transaction of a stock exchange business, or business of similar character, but really for the registration of bets, or wagers, usually for small amounts, on the rise or fall of the prices of stocks, grain, oil, etc., there being no transfer or delivery of the stock or commodities nominally dealt in.”1 The “bucket” bit comes, I think, from the notion that your long order and someone else’s short order would be thrown into a bucket together, netting them out with the shop as a bookie, rather than being forwarded to the stock exchange.

These are illegal now in all sorts of ways, and when they existed in the olden days they seem to have been pretty shady, but I’ve always thought that as a concept they get sort of a bum rap. What’s wrong with giving people synthetic exposure to equities, particularly exposure with low initial margin requirements and limited recourse?

Anyway Risk has this truly delightful article today about synthetic prime brokerage: Read more »

  • 22 Mar 2013 at 1:20 PM

Everybody Wins With Bespoke Synthetic CDOs

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Bloomberg this week had an article about how bespoke synthetic CDOs are coming back in vogue, and various people have fretted about that, because synthetic CDOs are scary, financial crisis, etc. And, sure, it’s certainly possible that the next financial crisis will be exactly like the last, only with more Cyprus.1 But today let’s talk about something tangentially related.

If you require banks to have capital based on risk-weighted assets, and if capital is expensive (at least for bankers), then you’ll have banks who want to lower the risk weights of their assets. There are many ways to do this, including buying safer assets, selling riskier assets, monkeying with models, etc., but one popular way is to buy credit protection against risky assets. The reason that this is popular is because of regulatory discontinuities: if you have $100 worth of stuff with a 200% risk weight, then you have $200 of risk-weighted assets, but if you buy protection against the riskiest $10 of it then you might go from $200 of risk-weighted assets all the way to $6.30, because the safest $90 of it might have only a 7% risk weight.

That’s a big jump. If your aim is to have capital equal to 12% of your risk-weighted assets, then your capital requirements go from $24 to like 75 cents. If your cost of capital is 10%, then that jump saves you $2.32 a year. So you could pay, say, $2 a year to the protection provider and still be up a few cents, versus not buying credit protection – plus, of course, you’ve got credit protection (meaning that you get more money back if there are defaults). And if you pay $2 a year for five years to protect $10 worth of risk, then the protection provider should do that trade all day long: he’s getting paid $10 to take $10 of risk. At worst – if 10% of your stuff, or for that matter all of your stuff, defaults – he breaks even. It’s free money.

That’s oversimplified (time value, counterparty risk, whatever), but it’s kind of a thing. To some extent that thinking underlies things like the glorious Credit Suisse PAF2 trade, where Credit Suisse basically wrote credit protection to itself because doing so saved it so much on risk-weighted assets. But the folks on the Basel Committee on Banking Supervision don’t particularly like it, and so they released a document today yelling at banks about it. Read more »

  • 19 Mar 2013 at 1:46 PM
  • Banks

Banks Getting Less Risky And/Or More Tricksy

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It’s a good day to be wholly cynical about banks so let’s be mean to the Basel III monitoring exercise. This is a thing where periodically the BIS looks into how far away banks are from meeting their Basel III capital requirements, with about a nine-month lag. The answer is always “pretty far away,” which isn’t that big a deal since they have until 2019 to get there, but the good news today is it’s getting less far away:

On Tuesday, the Basel Committee said the average capital ratio of 101 large banks was 8.5%. In total, large banks—defined as having Tier 1 capital in excess of €3 billion ($3.89 billion)—need to raise €208.2 billion in capital to hit the ratio of 7%, which includes an extra buffer against financial shocks.

This shortfall has decreased by €175.9 billion since a similar test was conducted using data as of Dec. 31, 2011. The committee noted that these 101 large banks generated €379.6 billion of pretax profit between July 2011 and June 2012. Instead of being redistributed in pay and dividends, profit can be stored to boost capital reserves.

Yay. Here’s what that looks like as of June 2012 – again, this thing is on a nine-month delay for some reason, so that’s the latest: Read more »

  • 25 Jan 2013 at 11:16 AM

Basel III Liquidity Rules Already Making Banking Simpler And Safer

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Financial innovation gets kind of a bad rap, and one of my favorite parts of this job is when I get to celebrate it just for being itself. Sometimes this means breathtaking magic like the derivative on its derivatives that Credit Suisse sold to itself, or elegant executions of classic ideas like the Coke shares that SunTrust sold for regulatory purposes but not for tax purposes. Other times it’s a more prosaic combination of already-existing building blocks to allow people who were comfortably doing something to keep comfortably doing it in the face of regulations designed to make it more uncomfortable.

Yesterday a reader pointed me to a Bond Buyer article that, while perhaps neither all that scandalous nor all that beautiful, is sort of cozy. It’s about a new issue of callable commercial paper issued by a Florida municipal financing commission, and here’s the joke:

JPMorgan came up with the new product as a solution for variable-rate municipal issuers facing impending Basel III regulatory problems. The proposed regulations would require banks to have a certain higher value of highly liquid assets to be available to turn into cash to meet liquidity commitments that could be drawn within 30 days. Maintaining higher liquidity would be expensive for banks, which may try to pass on costs to its issuers, according to an analyst at Moody’s Investors Service. “What we did, starting over a year ago, is ask what we can do to change the product that will still work for all the players, including issuers, investors, and the rating agencies,” Lansing said. “And the ultimate result was this product.” The new product allows banks to continue to support variable-rate products after the regulations are implemented. The paper has a variable length of maturity, but always at least 30 days. Several days before the paper would have 30 days left to its maturity, the issuer calls the paper.

The joke isn’t that funny, though I giggled at the phrase “a solution for variable-rate municipal issuers facing impending Basel III regulatory problems.” Municipal issuers face no Basel III problems: municipalities are not subject to Basel III. Read more »

  • 07 Jan 2013 at 4:53 PM

Turns Out Global Regulators Are Fine WIth Using Credit Ratings To Decide What Banks Can Do

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It’s popular to say that financial markets and regulators have extremely short memories and so let’s say it about these new Basel liquidity coverage ratio rule changes out today. But not in an annoying sneery way. I mean, in an annoying sneery way, but not the obvious one.

The story is that among the post-2008 Basel mechanisms for keeping banks out of trouble is the required “liquidity coverage ratio,” which for each regulated bank:

  • tots up how much cash is likely to go out the bank’s doors in a crisis due to things like customers withdrawing deposits, derivatives counterparties terminating trades or demanding more collateral, corporate clients drawing down lines of credit, etc.; and
  • requires the bank to hold liquid assets that it could sell quickly in a crisis to meet those demands on cash.1

Virtually everything there is a term of art, but “crisis” and “liquid assets” are particularly squishy. When the LCR was first proposed it had rather harsh ideas of what sort of crisis might affect liquidity, and a rather narrow conception of what assets might be liquid enough to be sold quickly and economically in a crisis. The news today is that Basel has relaxed that approach in a number of specific ways described here and listed here; the brief version is that the types of assets that can be counted toward “high quality liquid assets” has been dramatically expanded to include a lot of corporate and RMBS debt, the assumed outflows in a crisis have been reduced, and the LCR is now being phased in from 2015-2019 instead of going into effect all at once in 2015.

A lot of people think this is a good thing, as it will reduce the already significant demands on “safe assets” and make banks a little more willing to use balance sheet to lend and stuff. As is true of everything that banks like, you can also if you are so inclined easily find people who think it’s a bad thing. There is no particularly Platonic right answer. Basically the exercise here is (1) imagine a bad situation and (2) see if the bank survives your imagined bad situation with a given mix of liquid assets; step (2) is a question of simple arithmetic while step (1) is determined entirely by the direction in which your imagination runs. There are good practical and social reasons for making your bad situation basically “2007-2008, but a little worse,” and so most of the debate is over translating that notion into liquidity outflows and asset haircuts, but if you think that that notion is conceptually suspect I can’t really prove you wrong. If aliens invaded France, SocGen’s liquidity reserve would probably not be suited to the situation.

But whatever. The jarring thing for me was this first bit of the changes to the LCR announced today: Read more »

  • 18 Dec 2012 at 5:45 PM
  • Banks

Banks Suffer From Too Much, Too Little Liquidity

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A thing that a bank does is take in short-term money in the form of deposits and lend out long-term money in the form of loans. Two things that you could want out of your banks are:

  • for them to lend out lots of their deposits in long-term loans, and
  • for them to keep lots of money in the bank to give back to depositors who want their money back at any particular time.

A thing two consider is that those two desires are (1) each perfectly sensible and (2) opposite. Another thing to consider is that everything that happens, someone can complain about.

So today we learn: Read more »

  • 29 Nov 2012 at 12:00 PM

Bank Of England, Everyone Else, Thinks Banks Are Lying About Capital

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Aaahhh I love the Bank of England’s latest Financial Stability Report. I mean: I haven’t read it, per se. But it follows the wonderful official-sector-report layout of blandly apocalyptic text running down the right side and lovely charts running down the left, so you can close one eye and it’s a delight. The charts are a nice mix of (1) visually displaying quantitative information and (2) not:

The gist of the report is, as the Journal puts it:

U.K. banks may be misleading investors over the true state of their financial health, the Bank of England said Thursday, in its starkest warning yet to banks to restore investor confidence and get credit flowing.

“One factor which may make stated levels of capital misleading is under-recognition of expected future losses on loans,” the committee said in the BOE’s twice-yearly Financial Stability Report.Banks may be further overstating their health by making “aggressive” use of risk weights used to determine how much capital different categories of loan require, officials added.

And here’s the bottom-line recommendation: Read more »

  • 12 Jun 2012 at 5:46 PM

Should You Mourn For JPMorgan’s Trust Preferred Securities?

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I spend a good 40% of my day mindlessly refresing JPMorgan’s page at the SEC hoping they’ve filed a new structured notes prosupp so I was excited to see this:

Following the Federal Reserve’s announcement on June 7, 2012 of proposed rules which will implement the phase-out of Tier 1 capital treatment for trust preferred capital securities, JPMorgan Chase & Co. announced today that each of the trusts listed below will redeem all of the issued and outstanding trust preferred capital securities identified below on July 12, 2012 pursuant to redemption provisions relating to the occurrence of a “Capital Treatment Event” (as defined in the documents governing those securities). In each case, the redemption price will be 100% of the liquidation amount of each trust preferred capital security, together with accrued and unpaid distributions to the redemption date. The redemptions will be funded with available cash.

You can go read the chart but there’s a total of just under $9bn of trust preferred securities with a weighted average interest rate of just over 7%, all being redeemed at par.*

These trust preferred securities are, to simplify ever so slightly, very long-term very subordinated debt securities that qualify as capital for JPMorgan: for the purposes of convincing regulators that JPMorgan is well capitalized, they were roughly as good as common stock, but they are cheaper for the bank because they cost only a 5.85 to 7% (tax deductible) coupon, vs. JPMorgan’s 16% trailing return on tangible common equity or its 13-ish% trailing earnings yield or however you want to compute the cost of its common stock. After last week’s announcement of revisions to the capital rules, these securities will (eventually) no longer qualify as useful ”tier 1″ regulatory capital. Under the terms of the securities, if they will no longer qualify as tier 1 JPMorgan has the right to get rid of them, since they were a capital-regulation arbitrage to begin with. And so they will.

WHAT COULD BE MORE BORING. Still, two idle thoughts. Read more »

  • 08 Jun 2012 at 1:17 PM
  • Banks

Let’s Talk About: Basel III

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The Fed last night unleashed eight zillion pages of Basel III implementation on the universe and I’m tempted to be like “open thread, tell us about your hopes and fears for capital regulation.” So do that! Or don’t because it is super boring, that is also a valid approach. Still I guess we should discuss.

Starting slow though. Banks have to have capital, meaning that they have to fund some of their assets with things that are long-lived and loss-absorbing, like common equity, rather than with things that have to be paid back soon and at face value. The reason for this is that the rest of banks’ assets are funded with things that we really do want to be paid back soon and at face value, like deposits, and if the value of those assets declines you don’t want those deposits to be wiped out.

The rules say that you need capital equal to a percentage of your assets. The game is deciding (1) what that percentage is, (2) what is capital (proceeds from selling common stock, and actual earnings, yes, but, like, deferred tax assets?), and (3) how you count assets (you might want more capital to shield you from losses in, say, social media stocks than you would to shield you from losses in Treasury bonds, so regulators use “risk-weighted assets,” so that $1 of corporate bonds counts as $1 of assets, $1 of Treasuries counts as $0 of assets, and $1 of Facebook stock counts as $3 of assets*).

Anyway, here are the required capital levels: Read more »

  • 12 Sep 2011 at 11:36 AM

Jamie Dimon Used To Live In America

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Over the years, Jamie Dimon has had a little bit of mild unpleasantness with banking regulators. But he’s always been bullish on America, which has formulated a secret sauce made out of “the best universities, best military, best rule of law, most innovation, the hardest working ethic of all.” Most important, America has this little thing called “freedom,” specifically Jamie Dimon’s freedom to run his bank for his shareholders, not for regulators.

That’s why it pains Dimon so much to have to tell us that our freedoms are slipping away into the clutches of some Swiss commies:
Read more »