capital

  • 03 May 2013 at 3:23 PM

Fed Governor Wants Everyone To Remember That It’s Not Just Banks That Are Too Big To Fail

By

One reason that a lot of people are enamored with the Brown-Vitter approach to bank regulation is that it’s very simple, and everyone deep down sort of thinks that the simple answer has to be better than the complicated one. “You don’t need risk-based capital or stress tests or liquidity coverage ratios or VaR models or multiple tiers of capital or bail-in debt,” Brown and Vitter promise. “You just need to make sure that big banks don’t have assets of more than ~6x their common equity.”

Some people disagree1 and by all means feel free to question those people’s motives. Certainly some people benefit from complexity, bankers above all but also banking regulators, former regulators, and I suppose me too. Simple banking seems really boring, though maybe Brown-Vitter simple banking wouldn’t be.

Anyway that seems like the background to this interesting speech by Fed governor Daniel Tarullo about financial stability, which you could if you like read as sort of the Fed’s initial response to Brown-Vitter. And it’s not not that; the speech engages with Brown-Vitter on the capital stuff, basically defending the status quo of risk-based regulatory capital while conceding a little to Brown-Vitter’s call for higher capital.2

But he seems at least as focused on another source of systemic risk: not banks but wholesale funding markets, not capital but liquidity. You could see why the Fed might be focused there. Read more »

  • 01 May 2013 at 5:22 PM

Bill To Make Banking Boring Actually Might Be Kind Of Fun

By

There are a lot of things you can read about the Brown-Vitter bill recently, though it’s a really nice day out and you probably shouldn’t. It’s not … it’s not like a real thing is it? When the text of the bill, which would raise the equity capital requirements on big banks to ~15% on a non-risk-weighted basis and forbid U.S. regulators from implementing Basel rules, first leaked, I sort of assumed it was a temper tantrum not intended to become law, and the fact that its official title is the “Terminating Bailouts for Taxpayer Fairness (TBTF) (Get It?) (GET IT?) Act of 2013″ doesn’t exactly change my mind.1

I seem to have company in that view. Here you can read Jesse Eisinger (pro-Brown-Vitter) saying it’s a “barbaric yawp” that “probably won’t get passed.” Here you can read Davis Polk (anti) agreeing. Here you can read Matt Taibbi (very pro) saying that it might.2 So you figure it out.

Here’s one thing though, which is:

  • Here you are with $100 in Pretty Safe Assets funded with like $5 of Capital and $95 of Debt.
  • Suddenly you need $15 in Capital.
  • You’re not going to take that lying down.
  • You sell the Pretty Safe Assets to Quintilian Regulatory Fucking-About Partners, a hedge fund, for $100.3
  • You buy a call option on the Pretty Safe Assets from QRFAP, struck at say $70, which has a fair value of about $30 since it’s way way way in the money and the Pretty Safe Assets are, by hypothesis, not that volatile.
  • Your sources and uses are: Read more »
  • 29 Apr 2013 at 4:14 PM
  • Banks

Deutsche Bank Goes Back To Improving Its Balance Sheet In The Traditional Ways

By

I’m beginning to get the hang of how Deutsche Bank works, which seems to be:

  • When they lose money, that strengthens their capital position, and
  • When they make money, that weakens their capital position, requiring them to sell shares.

Maybe? Three months ago we talked about how … well, I said “Deutsche Bank Improved Its Balance Sheet By Losing A Lot Of Money,” which I guess seemed funnier at the time, but to be fair (1) Bloomberg said “Deutsche Bank ‘took pain’ in the quarter by booking a loss to boost its capital ratio without selling shares,” which is about equally funny or unfunny, and (2) Deutsche did in fact have a 4Q loss of €2.2bn and yet increased its Tier 1 capital ratio by 90bps.

Today, on the other hand, Deutsche pre-announced – good! positive! €1.7bn! – first-quarter earnings and also:

The Management Board of Deutsche Bank AG resolved today, with the approval of the Supervisory Board, to execute a capital increase, which is intended to raise gross proceeds of approximately EUR 2.8 billion. The purpose of the capital increase is to strengthen the equity capitalisation of the bank. Read more »

  • 08 Apr 2013 at 3:20 PM

Senate Bill May Solve Too-Big-To-Fail By Shrinking Banks By 70%

By

The Brown-Vitter bill, which two senators plan to introduce in an effort to dramatically raise bank capital requirements, has caused a range of fairly predictable reactions, and a few strange ones. Here, for instance, is a lobbyist complaining about “raising required capital to comically high levels,” but the comedy is perhaps elusive. But one stylized fact about bank capital that I find a little funny is that it is always the same; after a certain number of drinks this chart is hilarious:

What that says – perhaps a bit unclearly – is that if a bank is going to add some assets, it will do it by taking on debt; and if it’s going to reduce its debt, it will do so by selling assets; and the one thing that it won’t ever do is change the amount of equity it has. Capital ratios change, but capital amounts basically don’t (except to grow verrrrrrry slowly and steadily over time); all the action is in the denominator.

Consider what that chart means for Brown-Vitter: on Friday I calculated that the bill would require adding, in round numbers, $1.2 trillion of capital at the top 6 banks, all at once.1 But that holds bank assets constant, which is not how it generally works. Of course it’s possible that this new law would break the pattern of banks always having the same amount of equity and just adjusting their debt, and cause them to actually increase their equity dramatically; I suspect that’s roughly speaking the intention.

Another possibility is that banks would keep doing what they’ve always done and bring up equity ratios by reducing assets; the amount of equity would remain constant, as it has in the past. On that math, the six big banks would have to reduce assets by $7 trillion. Out of a total of $9.5 trillion currently. So like a 72% reduction in bank lending and investing and what-have-you.2 Eep?

Perhaps there is comedy there though I’m not sure. That chart has been floating around various places but I swiped it just now from this paper,3 by Tobias Adrian of the NY Fed and Hyun Song Shin of Princeton, musing about why it might be. Or, rather, they just assume the constantness of bank equity, and question why amounts of bank debt change. What they come up with is that leverage moves inversely to value-at-risk, which you can sort of see in this chart: Read more »

  • 05 Apr 2013 at 5:46 PM
  • Banks

Some Senators Think Big U.S. Banks Could Use An Extra Trillion Dollars Or So Of Capital

By

There’s a surprisingly large and vocal group of people who think that capital ratio requirements for large banks should be much higher than they are now (like, 15+%), and that those ratios should be based on total assets rather than any sort of regulatory risk-weighting. It’s surprising not because those are especially bad or counterintuitive ideas, but because who would have guessed a year ago that that would be a thing that people talked about? Good work, Admati & Hellwig.1

Anyway the latest is a bill that Senators Sherrod Brown and David Vitter are planning to introduce, which you can read about at Bloomberg, and read the draft of on Quartz. The gist is:

  • Every U.S. bank would have to have a minimum 10% capital ratio,
  • The biggest banks – those with over $400 billion in assets – would have to have up to 15%,
  • The ratio is just (Tangible Common Equity) ÷ (Total Assets plus some off-balance-sheet things including lending commitments); i.e. it’s not risk-weighted at all, and
  • “the [Federal Deposit Insurance] Corporation, the [Federal Reserve] Board, and the Comptroller [of the Currency] shall be prohibited from any further implementation of [Basel III].”

This feels like it may not be intended all that seriously, but whatever, let’s do the math and see what it gets us. Roughly speaking, it gets us the following:


Read more »

  • 22 Mar 2013 at 1:20 PM

Everybody Wins With Bespoke Synthetic CDOs

By

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

By

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 »

  • 01 Mar 2013 at 1:07 PM
  • Banks

Goldman Analysts Hint That Deutsche Bank Should Consider Just Packing It Up And Going Back To Germany

By

I realize it doesn’t actually work this way but I always imagine that sell-side analysts at big banks who cover other big banks enjoy sabotaging each other a little. “Take that, you Deutsche Bank jerks!,” Jernej Omahen might have thought as he hit send on this one:

Deutsche Bank AG fell the most in more than five months after Goldman Sachs Group Inc. cut the company to sell from hold, saying it may have to transfer $13 billion to its U.S. unit under new capital rules.

Deutsche Bank slid as much as 6.2 percent, the biggest intraday drop since Sept. 26, and traded at 33.07 euros at 1:40 p.m. in Frankfurt [closing at 33.66 / down 4.6%]. The stricter requirements may hurt profit at Europe’s biggest bank by assets and require it to ask shareholders for more money, Goldman Sachs analysts including Jernej Omahen wrote in an e-mailed report from London today.

Goldman’s note addresses two impacts of recent Fed moves to make international banks’ US operations safer: the capital impact, and the funding impact. The capital stuff is wholly imaginary, though I guess the economic consequences might be real enough. Start with this chart, and note that “Taunus” is basically shorthand for “Deutsche Bank’s US operations”:

If GS is right – I have no idea, I’ll just assume they are, but there are some assumptions and guesses here – the problem with Deutsche’s U.S. operations isn’t that they’re undercapitalized; it’s that they have negative capital. Read more »

  • 27 Feb 2013 at 1:23 PM

Mourn For The Derivative On Its Derivatives That Credit Suisse Wrote To Itself

By

You may not believe this, but a few weeks ago I spoke to a business school class about the financial industry, and a student asked me “what would you say to someone who’s considering a career at an investment bank?” Somehow it did not occur to me to congratulate her on her humanitarian impulses. Instead, I suggested that there are two possible futures for the big banks. In one, the various efforts to “make banking boring” – more onerous capital and liquidity regulation, clearing and futurization of derivatives, bans on prop trading, calls to break up big banks, and so forth – would create amazing opportunities for people with the intelligence, motivation, and shall we say aesthetic sensibilities to find new ways to accomplish their non-boring goals within a shifting framework. Just like changes in the tax code create work for smart tax lawyers, so changes in banking regulation and structure create opportunities for smart bankers to steal a march on their competitors.1

In the other possible future, banking would be boring.2 Today is a dark day: Read more »

  • 31 Jan 2013 at 6:14 PM

When No One Else Would Invest In Barclays, Barclays May Have Just Invested In Itself Itself

By

We’ve talked a lot about bank capital today but there’s still time for one quick addendum. First, though, two rough-and-ready equations:

  • Capital = cash paid in by shareholders plus retained earnings
  • Capital ratio = capital divided by assets

The first equation explains my puzzlement at the claim that Deutsche Bank “book[ed] a loss to boost its capital ratio without selling shares;” it’s arithmetically impossible to boost your capital by losing money, though you can (separately) boost your capital ratio by fiddling with the denominator.

The important thing about the second equation is that, for banks, the ratio is well under 1. So if your capital ratio is a relatively robust 10%, that means that 90% of your total assets are funded with borrowed money, and 10% are funded with cash from shareholders and retained earnings. Some people dislike this system.

Anyway there are various semi-magical ways to monkey with the denominator but there is one simple and obvious way to monkey with the numerator – the actual amount of capital that you have – and it is this:

  • Take some money,
  • dress it up in a fancy costume, and
  • issue some new shares to the the now-cleverly-disguised money.

You have magically transformed Assets (money) – which, remember, are 90%+ funded with borrowed money – into Capital. This has perpetual-motion-machine properties,1 so it’s pretty good.

Also it is, like, wildly wildly wildly illegal. Or, I mean, it’s pretty illegal as I just outlined it above, but if you put a fancy enough costume on the money maybe that makes it okay.2 Anyway draw your own conclusions about this: Read more »

  • 09 Jan 2013 at 11:03 AM
  • Banks

Survey: Investors Expect Banks To Meekly Over-Comply With Regulations Without Pushing Back On Anything

By

On Monday, as a bevy of banks were settling a zillion dollars of mortgage lawsuits and putting themselves on a path to (1) certainty and (2) giving money back to shareholders, Goldman released a research note with the results of a survey of investors’ expectations of bank capital return.1 Here is what some sample of investors expect:

Total payouts are expected to increase to an average of 58% post-CCAR/CapPR from 43% in 2012. … The survey results suggest the biggest increases in dividend payout ratios will be for Citi and Capital One, while PNC and Morgan Stanley are unlikely to meaningfully move higher. For buybacks, investors expect the biggest increase for BB&T and JP Morgan (vs. their actual buyback, not vs. 2012 approval levels), while there is little change expected for Morgan Stanley, Bank of New York and Northern Trust. … Many of the banks with the most variability of responses are those that are coming off subdued capital deployment levels in 2012, including Capital One, Bank of America, Citigroup and Regions. Given the lack of consensus, it seems that regardless of the announcement, the market is likely to be “surprised”.

I too prefer to order my life so that I’m surprised by everything.2

Anyway the interesting/disappointing part for me is what investors thought about what GS calls the “Mulligan rule.” This refers to the fact that, in the 2012 bank stress tests, banks asked regulators for approval to return an amount of capital, and if the regulators said no then the banks basically couldn’t do anything (ex regular dividends etc.) for another year, but in the 2013 tests if the regulators say no the banks can go back and ask once more for another, lower amount of capital return. I was pretty bullish on this: the do-over gives you a chance to be more aggressive once, and scale back if regulators say no, so you’d think that at least some banks would be aggressive and get away with it, while others will be too aggressive and have to cut back to a more moderate capital return but still no harm no foul. Or so I would think. I am in the minority:

And here, conveniently, is why banks wouldn’t be aggressive – because their own shareholders would get mad at them for being too aggressive: Read more »