According to ProblemBankList.com (there really is a website for everything) details what a problem bank is:

The Problem Bank List is the FDIC’s internal list of financial institutions that the FDIC believes are in danger of failure.

Calculated Risk reader surferdude808 with the details:

The Unofficial Problem Bank List crossed a major threshold this week as 500 institutions are now listed.

The list grew by a net 18 institutions this week and nearly $44 billion in assets were added. Most of the increase comes is a result of the FDIC finally releasing its actions for September 2009. It will take another month to get their actions for October 2009.

And the chart...



Source: Calculated Risk

Lots of interesting information in the Office of the Comptroller of the Currency's Quarterly Report on Bank Trading and Derivatives Activities for the Second Quarter of 2009. Regarding Derivatives... risk is highly concentrated and banks are making a lot of money from them. In other words, not much has changed.

Most derivatives activity in the U.S. banking system continues to be dominated by a small group of large financial institutions. Five large commercial banks represent 97% of the total banking industry notional amounts and 88% of industry net current credit exposure.

The top five exposures (in order) are held at JP Morgan, Goldman Sachs, Bank of America, Citibank, and Wells Fargo. Looking at Table 4, we can compare the credit equivalent exposure of those banks' derivatives (equal to the netted current credit exposure and potential future exposure of those contracts) to the risk based capital of those banks (tier one plus tier two capital).



After the financial system blew up the global economy, the key question is why isn't the use and concentration by these large banks being reduced (we know how well the banks' controls worked out last year)?

I think this quote from Satyajit Das (hat tip Paul Kedrosky) sums it up nicely:

Warren Buffet once described bankers in the following terms: “Wall Street never voluntarily abandons a highly profitable field. Years ago… a fellow down on Wall Street…was talking about the evils of drugs…he ranted on for 15 or 20 minutes to a small crowd…then…he said: “Do you have any questions?” One bright investment banking type said to him: “yeah, who makes the needles?

Derivatives and debt are the needles of finance and bankers will continue to supply them to all the Dr. Jekyll’s and Mr. Hyde’s alike for the foreseeable future as long as there is a buck to be made in the trade.

Source: Treasury

Chris Whalen (via The Big Picture) provides an update of Institutional Risk Analytics latest bank stress test results. Before we dive in, here is a breakdown of what defines an A+ and an F bank (a full description of all ratings can be found here):

• A+ Overall: Banks with this grade tend to exhibit strong metrics across the board
• F: At this degree of stress, one or more of the key elements of the business model has reached failure mode. What concerns exist are probably already public

That comes out to 1.6 A+ banks for every F bank, up from 11:1 just three years back.

Source: The Big Picture

As an investor, would you want to be leveraged to loans taken out on this asset? Just saying.

The WSJ reports:

First lets rewind to see one of the ways Citi was able to turn a profit in its most recent quarter (per Calculated Risk):

Citigroup posted a $2.5 billion gain because of an accounting change adopted in 2007. Under the rule, companies are allowed to record any declines in the market value of their own debt as an unrealized gain.

Now lets take just one segment of the HUGE new U.S. Treasury issuance, the long bond (i.e. 30 year Treasury). According to data from Treasury Direct, the Treasury has had four 30 year auctions since last Fall.

30 Year Auctions


As a refresher, the price of a bond is inversely related to the interest rate (when interest rates go down, the coupons are discounted at a lower rate resulting in the higher price). The chart below details this phenomenon for the 30 year long bond for various interest rates. When the market rate (i.e. yield) is equal to the interest rate of the bond, the price of the long bond is PAR (i.e $100).

Price of a Long Bond at Various Interest Rates and Market Rates


The relevance? With 30 year rates spiking above 4.6% these bonds have lost a TON of market value. How much? Over 30% from their peak, but as much as 18% since February's auction.

Change in Long Bond Prices Since Issuance


That means February's $14 billion auction alone has already netted the government a cool $2.5 billion. Throw in the mass amounts the U.S. has made issuing 10 year bonds as low as 2.2% (now yielding 3.7%), thus making 15%+ profit as well, then according to "Citigroup accounting" we should be out of debt in no time...

The interesting takeaway of all of this... the U.S. doesn't need actual inflation to decay the value of the national debt.

The WSJ reports:

Banking trade groups are lobbying the Federal Deposit Insurance Corp. for permission to bid on the same assets that the banks would put up for sale as part of the government's Public Private Investment Program.

PPIP was hatched by the Obama administration as a way for banks to sell hard-to-value loans and securities to private investors, who would get financial aid as an enticement to help them unclog bank balance sheets. The program, expected to start this summer, will get as much as $100 billion in taxpayer-funded capital. That could increase to more than $500 billion in purchasing power with participation from private investors and FDIC financing.

The lobbying push is aimed at the Legacy Loans Program, which will use about half of the government's overall PPIP infusion to facilitate the sale of whole loans such as residential and commercial mortgages.

Federal officials haven't specified whether banks will be allowed to both buy and sell loans, but a list released by the FDIC and Treasury Department of the types of financial firms likely to be buyers made no mention of banks.

Allowing banks to have it both ways would give them added incentive to sell assets at low prices, even at a loss, the banks contend. They claim it also would free up capital by moving the assets off balance sheets, spurring more lending.

"Banks may be more willing to accept a lower initial price if they and their shareholders have a meaningful opportunity to share in the upside," Norman R. Nelson, general counsel of the Clearing House Association LLC, wrote in a letter to the FDIC last month.

Off balance sheet only frees up capital because it hides risks. This is absolutely mind boggling. Not the fact that they are asking, but how is this even a remote possibility?

Felix Salmon with the details:

Source: WSJ

Not sure of the accuracy of this, but Calculated Risk has a scorecard of stress test results / leaks to date. Here are those entities that need to scare up some tangible common equity as a percent of total assets.



Those entities that they have listed as not needing capital include:

• American Express
• Bank of New York Mellon
• Goldman Sachs
• JPMorgan Chase
• MetLife
• Morgan Stanley

Ahead of the announcement in 30 or so minutes, Option Armageddon (via Naked Capitalism) with details of the stress test. Reuters reports:

Lots of Testing, Not Much Stress

Back in October, Bloomberg reported:

FT Alphaville (via Zero Hedge):

Shows Goldman’s estimates for how banks are carrying assets like commercial mortgages and consumer loans on their books. According to the table, they’re carrying those assets at ludicrously optimistic averages of between 89 per cent and 96 per cent of their original purchase price. Yeah. Right.

That preposterous positivity has huge implications for Tim Geithner’s toxic asset plan, or PPIP.

The chart below details one such asset, commercial mortgages, are still priced at or near par, which I'll agree is a joke...



BUT, (fortunately or unfortunately), I don't think this will have any impact on the Public Private Investment Program "PPIP". Why? Because it turns out banks may have no intention of using the program for these assets. Dealbook with the details:

The Treasury Department recently unveiled its plan to lift mortgage-linked securities off banks’ balance sheets. But Citigroup and Bank of America have been buying those assets in a hurry from the secondary market, The New York Post reported.

The two banks, which have each received $45 billion in federal bailout money, have been buying up AAA rated securities, including some based on alt-A and option adjustable-rate mortgages, the paper said.

One trader told The Post that Citi and Bank of America were sometimes paying higher than market rate for the securities. A Bank of America spokesman said that the purchases would help increase liquidity in the mortgage market.

But does it even matter? Lets visit both sides.


"Yes... it Does matter!" Camp

Yves at Naked Capitalism has a view similar to my initial reaction:

It certainly looks as if Citigroup and Bank of America are using TARP funds, not to lending, which was one of the primary goals of the program, but to scoop up secondary market dreck assets to game the public private investment partnership.

And it fleeces the taxpayer a second way: the public has spent enough money on both banks so that in an economic sense, they ought to have been nationalized, yet for reasons that are largely ideological and cosmetic (the banks' debt would need to be consolidated were nationalized), they remain private. So not only are they seeking to extract far more than was intended even with the already generous subsidies embodied in this program, but this activity is also speculating with taxpayer money.

While I do understand why Yves is so critical and my personal distaste for the system (and banks in particular) is growing each and every day, lets go to the opposing camp as played by my alter-ego...


"Only Injecting Liquidity and Propping Up Prices" Matters Camp

According to the Treasury, the goal of the PPIP is:

To restart the market for legacy securities, allowing banks and other financial institutions to free up capital and stimulate the extension of new credit. The resulting process of price discovery will also reduce the uncertainty surrounding the financial institutions holding these securities, potentially enabling them to raise new private capital.

How can this be accomplished by banks selling legacy assets at above market value and not by banks buying assets at above market value, only to sell to investors at an even higher value (all made possible by subsidized loans)? My view is it works in either or neither scenario. In both cases the PPIP is able to transfer liquidity into the market, which props up asset prices. The main difference is whether the process is contained in the banking system or not. In the latter, if a pension plan and/or mutual fund can sell assets at an above market price to the banks, then those pension plans and/or mutual funds were provided "liquidity". If this results in a higher clearing price and additional cash to spend on new issues... great!

As detailed at the start of this post, in either scenario banks weren't going to sell assets held on their books for remotely their fair value. In the first scenario, the clear winners involved were:

• Banks (they were provided a way to recapitalize via selling assets at above market prices)
• Investment managers (they get to market a new revenue generating fund to investors)
• Wealthy investors (they receive a taxpayer subsidized loan - I say wealthy because like investing in a hedge fund, to qualify you will likely need to be wealthy)

It is clear who were not the big winners. The average investor who owns a lot of these "toxic assets" in their pension plan or in a mutual fund. They likely would have only seen the benefit if and when the PPIP helped increase the performance of the security via secondary effects to the broader economy.

In other words, this only shifts around when and where the money is going, not the mechanism created to add liquidity. Assuming the banks aren't just buying / selling from each other (I don't see the benefit of that), but accumulating these assets for the PPIP, then it may also result in the following:

1. The liquidity in the market increases (i.e. it becomes not only a one-way seller's market)
2. The market value of these securities increases (more buyers = increased demand = higher prices)
3. The banks will in turn sell these new assets at a premium through the PPIP to those that would not have been natural buyers of these securities
4. Rinse repeat, until asset values reach a new equilibrium price
5. Marginal assets previously overstated on balance sheets are now closer to the new equilibrium (refer back to #2)

Trust me, things will never work out this perfectly, but why should the banks and "wealthy" investors have all the fun?

The chart below shows the size of global capital markets in relation to the GDP leading up to the crisis. What's clear is that bank assets were a much greater percent of GDP in the EU than in the United States, explaining (along with currency issues) why the EU has been hit especially hard.

Chris Whalen (via The Big Picture) details his firm's (Institutional Risk Analytics) latest bank stress test results:

Notice the way in which the banking industry has shifted from a skew in favor of “A+” rated bank units at the start of 2006 – those with stress levels below the 1995 benchmark in the Stress Index – to a situation today where the number of “A+” rated banks has been cut in half and over 2,000 bank units now are rated “F”.

Being rated “D” or “F” does not mean that the institution will fail, but it does mean that the bank’ current performance in Q4 2008 was far above the industry’s elevated stress levels and thus the bank get’s a poor grade for this period. Indeed, in many cases institutions with relatively high levels of stress could be excellent value for investors.

As of the fourth quarter, IRA had JP Morgan, Wells Fargo, and Bank of America all at an A rating, while Citi was a resounding F. I wonder what kind of rating Bank of America has these days post-Merril acquisition...

Source: Institutional Risk Analytics

Bloomberg reports:

Federal Reserve Chairman Ben S. Bernanke rejected the idea that officials plan to use reviews of banks’ balance sheets as a pretext for government takeovers of the nation’s largest lenders.

The Treasury will buy convertible preferred stock in the 19 largest U.S. banks if stress tests determine they need more capital to weather a deeper-than-forecast recession, Bernanke told lawmakers in Washington today. The shares would be converted to common equity stakes only as extraordinary losses materialize, he said.

“I don’t see any reason to destroy the franchise value or to create the huge legal uncertainties of trying to formally nationalize a bank when it just isn’t necessary,” Bernanke said at the Senate Banking Committee hearing.

And financials roared....



Source: Yahoo

Top ten banks by market cap; then (October 31st, 2007) vs. now (February 20th, 2009):

By Rank


Maintaining Same Color


And this is AFTER the billions of dollars in government "investments".

Source: WSJ

By the fourth quarter of 2008, only Citigroup's Global Wealth Management Group was making any money (though those $29mm in earnings are too small to even see in the chart below).

Option ARMageddon via Infectious Greed reports:

As you can see, Morgan Stanley and Goldman have cut their leverage significantly. Citi is in worse shape. BofA and Chase are treading water. GE is the scary one.

December 30th’s was the first balance sheet the banks have published since they received TARP capital. Common shareholders are still in a first-loss position relative to the government, however, because TARP investments were in the form of preferred shares. So I have backed these out in order to arrive at the tangible leverage ratios above.

One BIG caveat with this calculation is that these companies carry “other assets” on the balance sheet, some of which might be intangible in nature. Also, each has significant risk exposure via off-balance sheet entities. The point is, even though these leverage calculations seem high, they actually understate the risks facing common shareholders…