Note: I took some short cuts to make this simple - think of this emconceptually/em. I’m intentionally mixing financial institutions. For commercial banks, the FDIC stopped the bank run by upping the FDIC insurance. For investment banks, the Fed provided the liquidity. Please think of this conceptually or I’ll have to write 100 pages …br /br /This post looks at a bank balance sheet and a liquidity crisis. In a subsequent post, I’ll look at a solvency crisis and two possible solutions.br /br /emA special hat tip to This American Life’s Alex Blumberg and NPR’s Adam Davidson who presents some of the same ideas (although I’m going to go further). Here is the a href=”http://www.kcrw.com/events/planet_money”website/a for their presentation./embr /br /a onclick=”window.open(this.href, ‘_blank’, ‘width=580,height=750,scrollbars=yes,resizable=yes,toolbar=no,directories=no,location=no,menubar=no,status=no,left=0,top=0′); return false” href=”http://4.bp.blogspot.com/_pMscxxELHEg/SfSMo_MyxFI/AAAAAAAAFGo/z6RAhzPjGLo/s1600-h/BBS1.jpg”img style=”BORDER-RIGHT: #000000 1px solid; BORDER-TOP: #000000 1px solid; FLOAT: right; MARGIN: 10px; BORDER-LEFT: #000000 1px solid; BORDER-BOTTOM: #000000 1px solid” alt=”Bank Balance Sheet” src=”http://4.bp.blogspot.com/_pMscxxELHEg/SfSMo_MyxFI/AAAAAAAAFGo/z6RAhzPjGLo/s320/BBS1.jpg” border=”0″ //a ibspan style=”font-size:78%;”Click on graph for larger image in new window./span/b/ibr /br /If you watch the Planet Money a href=”http://www.kcrw.com/events/planet_money”presentation/a, they explain the basics of a bank from a balance sheet perspective. It doesn’t matter if the left scale is in dollars or billions of dollars - the structure is the same.br /br /Capital is the amount of money investors put into the bank plus any retained earnings. Liabilities is the money the bank borrows from depositors or other sources. And assets are loans that the bank makes (and a little cash and other assets). (see Alex and Adam’s presentation to make this clear).br /br /The balance is: Assets = Capital + Liabilitiesbr /br /Banks make money by lending at a higher rate than they borrow. In the Planet Money example, the banks borrowed at 3%, loaned the money at 6%, for a spread of 3%. The difference between 6% and 3% is called the “net interest spread”.br /br /Banks report something a little different called the “net interest margin”. The difference between the “spread” and the “margin” is because not all assets are loans (some might be held as cash for regulatory reasons). Net Interest Margin (NIM) is the interest earned, minus the interest paid, divided by total assets. As an example, Wells Fargo just a href=”https://www.wellsfargo.com/press/2009/20090409_Prelim_Earnings”reported/a a net interest margin of “approximately 4.1 percent”.br /br /Now look at how profitable a bank could be. If this bank had $100 billion in assets, and a NIM of 4.1% that would be $4.1 billion in annual profits before expenses and charge-offs - on just $10 billion in capital (Note: The diagram shows 10-to-1 leverage; many banks were levered 30-to-1 or more).br /br /Of course the bank has expenses (all those nice buildings and employees) - and there are always charge-offs for loans that don’t get repaid, even in good times. For reference, the Federal Reserve tracks the charge-offs by loan category a href=”http://www.federalreserve.gov/releases/chargeoff/chgallsa.htm”here/a.br /br /Banks have two main risks: interest rate risks and credit risks. Since banks mostly borrow short and lend long, they are exposed to increases in short term interest rates, and this would lead to lower NIMs. The credit risk is that too many of those assets will go bad (more on credit risks in the next post).br /br /a onclick=”window.open(this.href, ‘_blank’, ‘width=580,height=750,scrollbars=yes,resizable=yes,toolbar=no,directories=no,location=no,menubar=no,status=no,left=0,top=0′); return false” href=”http://1.bp.blogspot.com/_pMscxxELHEg/SfSY9oFYgTI/AAAAAAAAFGw/Zkg5ow7GeY0/s1600-h/BBS2.jpg”img style=”BORDER-RIGHT: #000000 1px solid; BORDER-TOP: #000000 1px solid; FLOAT: right; MARGIN: 10px; BORDER-LEFT: #000000 1px solid; BORDER-BOTTOM: #000000 1px solid” alt=”Bank Balance Sheet” src=”http://1.bp.blogspot.com/_pMscxxELHEg/SfSY9oFYgTI/AAAAAAAAFGw/Zkg5ow7GeY0/s320/BBS2.jpg” border=”0″ //a Not all liabilities are the same. The second diagram shows three categories of liabilities: 1) Long term bank debt, 2) commercial paper (called CP, this is less than 270 days duration, and usually much shorter), and 3) FDIC insured deposits. br /br /Each category has advantages and disadvantages. br /br /Commercial paper is usually the lowest interest rate, but it is the shortest duration and has the highest interest risk. Usually the bank pays the highest interest rate on long term debt, but there is no interest risk for the duration of the security. Most banks have a mix of liabilities.br /br /Now imagine the bank starts reporting higher than expected credit losses - or at least depositors believe the bank will start reporting huge loses. br /br /a onclick=”window.open(this.href, ‘_blank’, ‘width=580,height=750,scrollbars=yes,resizable=yes,toolbar=no,directories=no,location=no,menubar=no,status=no,left=0,top=0′); return false” href=”http://4.bp.blogspot.com/_pMscxxELHEg/SfSasPsZ80I/AAAAAAAAFG4/ayXL3gdunJk/s1600-h/BBS3.jpg”img style=”BORDER-RIGHT: #000000 1px solid; BORDER-TOP: #000000 1px solid; FLOAT: right; MARGIN: 10px; BORDER-LEFT: #000000 1px solid; BORDER-BOTTOM: #000000 1px solid” alt=”Bank Balance Sheet” src=”http://4.bp.blogspot.com/_pMscxxELHEg/SfSasPsZ80I/AAAAAAAAFG4/ayXL3gdunJk/s320/BBS3.jpg” border=”0″ //a Here the bank has lost $5 billion, and the capital has been cut in half.br /br /Fearing further losses, the commercial paper (CP) investors run for the hills and refuse to reinvest again when their short term paper matures.br /br /The FDIC insured depositors run (or amble) towards the hills too. A classic bank run.br /br /The long term debt holders are stuck. They can sell in the market, but at a lower price - and that doesn’t impact the bank’s balance sheet (OK, there are some accounting issues here that I will ignore).br /br /To stop the bank run, the FDIC stepped up and a href=”http://www.fdic.gov/news/news/financial/2008/fil08102a.html”increased/a the guarantee on FDIC insured assets to $250 thousand. But this did nothing for the commercial paper investors. br /br /a onclick=”window.open(this.href, ‘_blank’, ‘width=580,height=750,scrollbars=yes,resizable=yes,toolbar=no,directories=no,location=no,menubar=no,status=no,left=0,top=0′); return false” href=”http://2.bp.blogspot.com/_pMscxxELHEg/SfSdBjj1_-I/AAAAAAAAFHA/dibNnBcvbxU/s1600-h/BBS4.jpg”img style=”BORDER-RIGHT: #000000 1px solid; BORDER-TOP: #000000 1px solid; FLOAT: right; MARGIN: 10px; BORDER-LEFT: #000000 1px solid; BORDER-BOTTOM: #000000 1px solid” alt=”Bank Balance Sheet” src=”http://2.bp.blogspot.com/_pMscxxELHEg/SfSdBjj1_-I/AAAAAAAAFHA/dibNnBcvbxU/s320/BBS4.jpg” border=”0″ //a Next the Fed steps in and replaces the commercial paper liability as it matures.br /br /If this was just a panic, and the bank was actually fine, the commercial paper investors would return (or the bank could sell more long term debt), and the Fed would be replaced by private debt.br /br /However this is not just a liquidity crisis, and the Fed is still providing liquidity to the banks. br /br /This doesn’t work long term because the Fed requires the banks to over collateralize any money borrowed from the Fed. As the long term debt starts to mature, those investors will follow the commercial paper investors to the hills - and the Fed will have to provide more and more liquidity. And eventually there will not be enough collateral to borrow from the Fed. Here is an example of the a href=”http://www.frbdiscountwindow.org/announcement090330.cfm”Collateral Margins Table/a for the discount window.br /br /Next I’ll discuss the solvency issues (not as easy to fix).div class=”blogger-post-footer”img width=’1′ height=’1′ src=’http://res1.blogblog.com/tracker/10004977-8801696459558471884?l=www.calculatedriskblog.com’//div
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centeremFiduciarybr /A strange word to bankersbr / Result: …takeover./embr /by Soylent Green is People/centerbr /br /a href=”http://www.fdic.gov/news/news/press/2009/pr09057.html”From the FDIC/a: Bank of North Georgia, Alpharetta, Georgia, Assumes All of The Deposits of American Southern Bank, Kennesaw, GeorgiablockquoteAmerican Southern Bank, Kennesaw, Georgia, was closed today by the Georgia Department of Banking and Finance, which appointed the Federal Deposit Insurance Corporation (FDIC) as receiver. To protect the depositors, the FDIC entered into a purchase and assumption agreement with Bank of North Georgia, Alpharetta, Georgia, to assume all of the deposits, excluding those from brokers, of American Southern Bank.br /…br /As of March 30, 2009, American Southern Bank had total assets of approximately $112.3 million and total deposits of $104.3 million. Bank of North Georgia paid a premium of 0.003 percent to acquire the deposits of American Southern Bank.br /…br /In addition to acquiring $55.6 million of the failed bank’s deposits, Bank of North Georgia agreed to purchase approximately $31.3 million in assets. The FDIC will retain any remaining assets for later disposition.br /br /The FDIC estimates that the cost to the Deposit Insurance Fund will be $41.9 million. Bank of North Georgia’s acquisition of all the deposits of American Southern Bank was the “least costly” resolution for the FDIC’s Deposit Insurance Fund compared to alternatives. American Southern Bank is the 26th bank to fail in the nation this year and the fifth in the state. The last bank to fail in Georgia was Omni National Bank, Atlanta, on March 29./blockquote It is Friday!div class=”blogger-post-footer”img width=’1′ height=’1′ src=’http://res1.blogblog.com/tracker/10004977-7721032460129708536?l=www.calculatedriskblog.com’//div
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From Floyd Norris at the NY Times: a href=”http://www.nytimes.com/2009/04/24/business/economy/24norris.html”Subprime Loans, Corporate-Style, Will Fuel Defaults/a blockquoteIt appears that defaults on leveraged loans and corporate bonds will soon rise to levels not seen since the Great Depression.br /…br /The default rate on leveraged loans and speculative grade bonds is rising rapidly. “We expect the default rate to get to the range of 14 percent by the end of the year,” said Kenneth Emery, a senior vice president of Moody’s. That compares to peak default rates of 10 to 12 percent during the last two recessions …br /br /How did we get into this mess? The story is remarkably similar to the tale of subprime mortgages./blockquoteJust another area with rapidly rising defaults. Norris also discusses toggle-PIKs (kind of like Option ARMs for corporations).br /br /Note: span style=”font-size:85%;”PIK stands for Payment-in-kind (i.e. pay interest with more debt). These were used in the ’80s LBO craze with predictable results (high defaults). Toggle means the borrower has the choice of paying in cash or PIK./spanbr /br /There were negatively amortizing loans everywhere: Option ARMs for homeowners, toggle PIKs for corporations, and of course interest reserves for Construction Development loans (always common, but are blowing up on lenders).div class=”blogger-post-footer”img width=’1′ height=’1′ src=’http://res1.blogblog.com/tracker/10004977-5655803277139635066?l=www.calculatedriskblog.com’//div
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From HotelNewsNow.com: a href=”http://www.hotelnewsnow.com/Articles.aspx?ArticleId=1014″STR reports U.S. data for week ending 18 April 2009/a blockquoteIn year-over-year measurements, the industry’s occupancy fell 10.7 percent to end the week at 57.4 percent. Average daily rate dropped 10.3 percent to finish the week at US$97.25. strongRevenue per available room [RevPAR] for the week decreased 19.9 percent/strong to finish at US$55.83.br /span style=”font-size:78%;”emphasis added/span/blockquotea onclick=”window.open(this.href, ‘_blank’, ‘width=1055,height=815,scrollbars=yes,resizable=yes,toolbar=no,directories=no,location=no,menubar=no,status=no,left=0,top=0′); return false” href=”http://4.bp.blogspot.com/_pMscxxELHEg/SfCs_N7dF6I/AAAAAAAAFFE/T29pDzn0ROU/s1600-h/HotelOccupancyApril23.jpg”img style=”BORDER-RIGHT: #000000 1px solid; BORDER-TOP: #000000 1px solid; FLOAT: right; MARGIN: 10px; BORDER-LEFT: #000000 1px solid; BORDER-BOTTOM: #000000 1px solid” alt=”Hotel Occupancy Rate” src=”http://4.bp.blogspot.com/_pMscxxELHEg/SfCs_N7dF6I/AAAAAAAAFFE/T29pDzn0ROU/s320/HotelOccupancyApril23.jpg” border=”0″ //a ibspan style=”font-size:85%;”Click on graph for larger image in new window./span/b/ibr /br /This graph shows the YoY change in the occupancy rate (3 week trailing average).br /br /The three week average is off 11.1% from the same period in 2008.br /br /The average daily rate is down 10.3%, so RevPAR is off 19.9% from the same week last year.br /br /When the Q1 advance GDP report is released on Wednesday (April 29th), I expect to see a sharp in decline in non-residential structure investment. The underlying details will be released a couple of days later, and I expect investment in lodging to be hit especially hard. Why build new hotels when the occupancy rate is 57%?br /br /centerData Source: Smith Travel Research, Courtesy of a href=”http://www.hotelnewsnow.com/”HotelNewsNow.com/a/centerdiv class=”blogger-post-footer”img width=’1′ height=’1′ src=’http://res1.blogblog.com/tracker/10004977-7388745186822066807?l=www.calculatedriskblog.com’//div
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I’m surprised this is playing out in public …br /br /First the government offered $1.0 billion, and no equity interest in the new Chrysler, to a consortium of debtholders (mostly banks with pier loans: JPMorgan Chase, Goldman Sachs, Morgan Stanley and Citigroup).br /br /The banks a href=”http://www.calculatedriskblog.com/2009/04/chrysler-pier-loans.html”countered/a with $4.5 billion, and a 40% equity interest.br /br /From CNBC: a href=”http://www.cnbc.com/id/30357028″Treasury Raises Offer to Chrysler Lenders/a blockquoteTreasury has offered the lenders $1.5 billion of first-lien debt and a 5 percent equity stake in a restructured Chrysler …/blockquote It will be interesting to see if the banks budge (and by how much). They claim they can get more than 65 cents on the dollar in liquidation - or $4.5 billion. Just 7 more days …div class=”blogger-post-footer”img width=’1′ height=’1′ src=’http://res1.blogblog.com/tracker/10004977-8320621592359576093?l=www.calculatedriskblog.com’//div
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Pier loans: Bridge loans that couldn’t be sold.br /br /From the WSJ: a href=”http://online.wsj.com/article/SB124034225632440083.html?”Bankers Rebuff U.S. on Chrysler Debt/a blockquoteChrysler owes … lenders, which include banks such as Citigroup Inc. and J.P. Morgan Chase Co., about $6.9 billion. But President Barack Obama and his auto team had demanded that the banks cut that to $1 billion, while gaining no equity stake in a restructured Chrysler.br /br /In their five-page counteroffer, the lenders said they are prepared to cut Chrysler’s first-lien debt by $2.4 billion, or down to about $4.5 billion, in exchange for a minority equity stake, likely to be 35% to 40% … br /br /The lenders have told Treasury … they could recover at least 65% of their loans to the company if it is liquidated in bankruptcy./blockquote Chrysler is probably worth more dead than alive - at least to these debt holders. That complicates the negotiations.br /br /Nine days to go …div class=”blogger-post-footer”img width=’1′ height=’1′ src=’http://res1.blogblog.com/tracker/10004977-5209024290396806318?l=www.calculatedriskblog.com’//div
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From the LA Times: a href=”http://www.latimes.com/business/la-fi-commre20-2009apr20,0,784017.story”Southern California office market is hammered by recession/a blockquoteVacancy in Los Angeles County reached 14.3% in the first quarter, up from 11.2% a year earlier, according to a report released last week by Cushman amp; Wakefield. In Orange County, where demand has been dwindling for more than a year, vacancy ticked up to nearly 18% from 15%.br /br /Among the hardest-hit markets are the Inland Empire, Irvine and north Los Angeles County, all of which have been wracked by the losses of tenants in the troubled industries of mortgage and finance. Vacancies in all three areas have surpassed 20%, a sign of a very weak market. In Ontario and the area around Los Angeles International Airport, vacancy tops 30%./blockquoteAnd the following is … amusing: blockquoteIn West Los Angeles, owners are steeply discounting the monthly cost of an office — cutting rates that, ironically, grew so high during the boom years that many companies were forced to move out and find cheaper digs./blockquoteI saw this in my community too. Leases expired. Landlords raised the rents sharply. The long term tenants moved out. Real estate related businesses moved in. And now the buildings are vacant!div class=”blogger-post-footer”img width=’1′ height=’1′ src=’http://res1.blogblog.com/tracker/10004977-715544433001395863?l=www.calculatedriskblog.com’//div
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Note: I will be at this event tomorrow night.br /br /From Tom Petruno at the LA Times: a href=”http://latimesblogs.latimes.com/money_co/2009/04/fans-of-nprs-alex-blumberg-and-adam-davidson-who-produced-the-award-winning-housing-crisis-explainer-the-giant-pool-of-money.html”NPR’s ‘Planet Money,’ live from Santa Monica/a blockquoteFans of NPR’s Alex Blumberg and Adam Davidson, who produced the award-winning housing-crisis explainer a href=”http://www.thislife.org/radio_episode.aspx?episode=355″”The Giant Pool of Money,”/a will want to tune in to a href=”http://www.kcrw.com/”KCRW/a on Sunday from 6 to 7 p.m. PDT: The two will be broadcasting their “Planet Money” show live from the Broad Stage in Santa Monica.br /br /Following on the success of “The Giant Pool of Money” in May 2008, Blumberg and Davidson launched a href=”http://www.npr.org/blogs/money/”Planet Money /ain early September to blog on the nation’s economic crisis. Their timing was perfect: Planet Money began on Sept. 7 — the day the government seized Fannie Mae and Freddie Mac, the first dominoes to fall in the financial-system collapse./blockquotediv class=”blogger-post-footer”img width=’1′ height=’1′ src=’http://res1.blogblog.com/tracker/10004977-4192649665406312012?l=www.calculatedriskblog.com’//div
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First, Citi has committed to “tell the market strongexactly/strong” the results of the stress tests:blockquoteem[I]t made sense to delay the launch of the exchange offer until strongwe could tell the market exactly what the results of the stress test are/strong./embr /Citigroup, April 17, 2009/blockquotea onclick=”window.open(this.href, ‘_blank’, ‘width=1080,height=820,scrollbars=yes,resizable=yes,toolbar=no,directories=no,location=no,menubar=no,status=no,left=0,top=0′); return false” href=”http://4.bp.blogspot.com/_pMscxxELHEg/SeiJIW-Q-oI/AAAAAAAAFCk/gxCz_kO3gr4/s1600-h/CitiNCL.jpg”img style=”BORDER-RIGHT: #000000 1px solid; BORDER-TOP: #000000 1px solid; FLOAT: right; MARGIN: 10px; BORDER-LEFT: #000000 1px solid; BORDER-BOTTOM: #000000 1px solid” alt=”Citi Net Credit Losses” src=”http://4.bp.blogspot.com/_pMscxxELHEg/SeiJIW-Q-oI/AAAAAAAAFCk/gxCz_kO3gr4/s320/CitiNCL.jpg” border=”0″ //a And from the a href=”http://www.citigroup.com/citi/fin/data/p090417a.pdf”investor presentation/a:br /br /ibspan style=”font-size:85%;”Click on graph for larger image in new window./span/b/ibr /br /Note the rapid rise in card NCLs. NCLs jumped from 8.04% in Q4 to 10.18% in Q1 2009.br /br /Mortgage NCLs are rising sharply too.br /br /a onclick=”window.open(this.href, ‘_blank’, ‘width=1080,height=820,scrollbars=yes,resizable=yes,toolbar=no,directories=no,location=no,menubar=no,status=no,left=0,top=0′); return false” href=”http://1.bp.blogspot.com/_pMscxxELHEg/SeiLMhawwUI/AAAAAAAAFC0/Ejt0mdEYNMM/s1600-h/NCL1stMortgage.jpg”img style=”BORDER-RIGHT: #000000 1px solid; BORDER-TOP: #000000 1px solid; FLOAT: right; MARGIN: 10px; BORDER-LEFT: #000000 1px solid; BORDER-BOTTOM: #000000 1px solid” alt=”Citi Mortgage Net Credit Losses” src=”http://1.bp.blogspot.com/_pMscxxELHEg/SeiLMhawwUI/AAAAAAAAFC0/Ejt0mdEYNMM/s320/NCL1stMortgage.jpg” border=”0″ //a The second graph shows the 90+ Days Past Due (DPD) trend for 1st and 2nd mortgages, and the Net Credit Losses. br /br /The 90+ DPD is increasing rapidly for 1st mortgages - jumping from 5.71% in Q4, to 7.15% in Q1 2009.br /br /Credit losses are still rising rapidly at Citi.div class=”blogger-post-footer”img width=’1′ height=’1′ src=’http://res1.blogblog.com/tracker/10004977-7529708091876194163?l=www.calculatedriskblog.com’//div
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From South Florida Business Journal: a href=”http://www.bizjournals.com/southflorida/stories/2009/04/13/daily53.html”BankUnited given 20 days to strike deal/a (ht FFF) blockquoteIn a prompt corrective action directive, posted on the Office of Thrift Supervision’s Web site Thursday and issued two days earlier, Florida’s largest bank was ordered to submit a binding merger or acquisition agreement to the OTS within 15 days …br /br /BankUnited’s $5.89 billion in option ARMs accounted for 51 percent of its loan portfolio on Dec. 31.br /br /The bank ended 2008 with $13.95 billion in assets, 1,098 employees, $8.61 billion in deposits in 86 branches, and 11 percent of its loans noncurrent./blockquote Here is the corrective action: a href=”http://files.ots.treas.gov/enforcement/97100.pdf”PROMPT CORRECTIVE ACTION DIRECTIVE/a br /br /Just a tease for BFF (Bank Failure Friday).div class=”blogger-post-footer”img width=’1′ height=’1′ src=’http://res1.blogblog.com/tracker/10004977-5200480635668312797?l=www.calculatedriskblog.com’//div
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