Tag: Banks

Bolster the Economy: Lower Bank Capital Requirements for the Foreseeable Future $XLF $WFC $BAC $JPM

I think the bank stocks look cheap, as I highlighted with a few in a recent post. But there are issues with lending right now — and I am not even including the wave of defaults & impairments people expect or forbearance.

In the article in the WSJ titled, The Day Coronavirus Nearly Broke the Financial Markets, there is this scoop on what was going on in the market. Essentially, banks held interest rate hedges on it books and when rates went down, the hedges swung in the banks favor and out of companies favor who decided to hedge.

What is funny is that this was seemingly good thing for banks — they had a gain on their books — but actually restricted their ability to deploy capital:

So when Mr. Rao called senior executives for an explanation on why they wouldn’t trade, they had the same refrain: There was no room to buy bonds and other assets and still remain in compliance with tougher guidelines imposed by regulators after the previous financial crisis. In other words, capital rules intended to make the financial system safer were, at least in this instance, draining liquidity from the markets.

One senior bank executive leveled with him: “We can’t bid on anything that adds to the balance sheet right now.

Matt Levine summed up the intricacies well in his recap on this. This scenario plus consumers depositing a bunch of cash at the bank (due to fear in the market) resulted in an increase in the bank balance sheet, but also required additional regulatory restrictions with the balance sheet growth.

The Fed stepped in and said that, temporarily, they would ease these restrictions through March 2021:

Liquidity conditions in Treasury markets have deteriorated rapidly, and financial institutions are receiving significant inflows of customer deposits along with increased reserve levels. The regulatory restrictions that accompany this balance sheet growth may constrain the firms’ ability to continue to serve as financial intermediaries and to provide credit to households and businesses. The change to the supplementary leverage ratio will mitigate the effects of those restrictions and better enable firms to support the economy.

This is good and as I showed in my last post on banks, the amount of capital banks hold now is insane compared to what they had going into the Great Financial Crisis. The Fed agrees:

Financial institutions have more than doubled their capital and liquidity levels over the past decade and are encouraged to use that strength to support households and businesses. The Board is providing the temporary exclusion in the interim final rule to allow banking organizations to expand their balance sheets as appropriate to continue to serve as financial intermediaries, rather than to allow banking organizations to increase capital distributions, and will administer the interim final rule accordingly

Why did we tell banks after the GFC that they needed to increase their reserve requirements? So that they would be able to provide support in a crisis, not be a source of weakness. That is what is happening now.

I think we need to go a step further and actually lower the capital requirements for the foreseeable future. When you crimp credit, you crimp the economy. Lowering reserve requirements for some time would unleash significant amounts of capital into the system. So far the Fed has just said certain assets won’t count against the risk-weighted assets. With the rule expiring in 2021, it doesn’t really help banks feel super confident.

Here is the chart again of what banks capital levels look like – exiting 2019 with a median level of 12.8%.

Tier 1 Capital represents core equity capital to risk weighted assets and essentially represents the capital not committed to meeting the banks liabilities. The reason you have excess capital is to prepare for unforeseen events, which is why regulators require a minimum of 4%, but higher (6%) for large banks. Investors typically want to see 150% above the minimum.  That foots to 6% and 9% respectively… And the big banks were near 13%. The excess capital allowed banks to invest, conduct share buybacks or dividends.

But its clear to me that banks learned their lesson from the last crisis – they did not want to buy the cause again so they carried significant amounts of capital.

I think the Fed / Govt should lower the reserve requirement to unleash more capital into the system from banks, not just central banks. They clearly have excess capital, they just need to be encouraged to deploy it. Imagine how much capital would be deployed if banks went from 12% or 10% to 6%? We then could say they have to get back to 9% in 5 years.

 

Scary headline – Blackstone, others, tell portfolio companies to draw down revolvers

Boeing announced it would draw down its revolver (see what that means here), we are now hearing that major private equity firms are telling their portfolio companies to fully draw down on their revolvers.

It isn’t just Blackstone, it also is Carlyle, KKR and HIG. Why is this a scary headline for banks? These firms are huge and are likely invested in hundreds of companies each of varying size. I understand why a company would draw down revolvers now — it improves liquidity.

But so many at once it makes banks put capital to work all at once… banks typically need to have capital on the sidelines in case of very severe outcomes. You can’t predict everything, so when all these companies are drawing down on revolvers at the same time, it reduces capital available for other borrowers who need it.

This is similar to a run on a bank, except in this case it isn’t deposits trying to exit, its borrowers calling their capital.

All that being said, banks are extremely well capitalized this go around vs. 2008. And they must undergo significant stress testing. I think banks will be OK through this, but it shows how a virus can spread into something even more viral and squeeze the financial system.

JP Morgan put out this slide detailing that its CET1 ratio (i.e. the ratio meant to provide a backstop for banks headed into a recession) is still well above the minimum 4.5% level. This was after the massive loan loss provision they took, along with others.

Here’s a chart I found laying out the banks with the most comfort, little dated, but still shows solid cushion headed into this:

Statistic: Common equity tier 1 capital (CET1) ratio of selected large financial institutions in the United States in 2019 | Statista
Find more statistics at Statista

You could also see the Fed and ECB backstop the banks in funding more corporate loans or even lower the reserve requirement to stimulate loan growth.