By Richard Smith, a capital markets and IT consultant
There was some really strange stuff going on last week.
First, Citi got in a right old tangle.
Monday: Citi announce share sale. Pretext: TARP escape.
Wednesday: the share sale falls through.
Wednesday: it also emerges that the IRS has been quite kind (or at least 2/3rds kind since USG owns a third of the stock) about Citi’s deferred tax assets – they will be allowed to keep them – and they count as Tier 1 Capital under Basel II).
Thursday: Basel II bins deferred tax assets as regulatory capital , so Citi face the prospect of raising another $40Bn in addition to the shares they didn’t sell on Monday. And they are still stuck in the TARP.
Now, the conspiracy theorist interpretation of this is that Citi or US Treasury got a whiff of the Basel III rulings, tried to get a sale away, (before investors realised that if they bought in they’d be diluted yet again as some point by the fundraising required when the DTAs get binned), and then got snubbed by equally well informed investors on Weds. Kind of self-cancelling insider trading.
Second, banks will soon have a VERY big equity hole!
Haven’t seen any analysis of how the new Basel bank capital calculations would affect US bank regulatory capital but if Credit Suisse’s back of an envelope calculation is right for Eurobanks (they will need EUR 1.1 Trillion of extra capital of one sort or another), then a crude read-across is that American banks need another $400Bn of capital, of one sort or another. I am ignoring ridiculous basket cases like Citi. This is based on Eurobanks representing about 50% of the world banking asset base, with US banks acounting for another 15%, and on the assumption that US and Eurobanks have been gaming their capital requirements so the same overall extent. (Yves comment: the assumption in the US is that US banks are further along on their writedowns than the Eurobanks are, but given that the US banks just got an expected break from the FASB re not having to implement a rule change that would have required them to consolidate their off balance sheet entities, that cheery assumption may not include those lovely “qualified special purpose entities”).
In another part of the Basel III forest, the document is very keen for OTC derivatives to be traded on an exchange. It doesn’t distinguish between CDS and other derivatives such as swaps, so I take this as an implicit admission that the entire OTC market was a crap idea – rather radical and smack on from my perspective.
At the same time as this push to exchanges is announced, the FSA tossed their own spanner into the works, with their rather Yvesian argument that derivatives clearing may in some cases (and I assume they mean CDS) will be just as ropey and bailout prone as the OTC market. Or more cynically, they are introducing the same loophole to derivatives regulations as we saw in the US!
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the Basel III changes regarding tier 1 capital are not suggested to be implemented until the world economy recovers, that is what i read last week along with the actual proposal. until then, banks will be hit by the CRE and Option-ARM storms, so their capital adequacy is still subject to plenty of changes.
i personally expect the banks with the lowest LTVs to perform best and need least further recapitalization, because their borrowers will have most incentives to service their loans.
In europe it is expected to be in 2011 with a possibility of some grandfathering. AT the moment it is still in consultation so some watering down is expected. Some european banks will fair better than others, but next years profits will most likely be taken up boosting capital requirements as a result. Many of the South Med banks look to be hit hardest under the current suggestions.
Mark to Market is still in there but higher capital is required for risky assets. Tier 3 disappears and all off balance sheet assets have to be brought back on. Many of the tax fiddle loopholes are closed including defered tax. I have not seen any analysis yet on the impacts of Basel III on US banks, but my rough calculation suggests that it will not be implemented in the US for a much longer period. Despite US banks being much further along in right downs, it does look like hitting some US banks very hard.
Brick, I read that too, but I am wondering whether it means a) that 2011/12 is the intended date for the final set of Basel III standards, or b) the date by which local European regulators will adopt them as local standards. Do you know?
Irrespective of that, I wouldn’t be holding my breath in the US: Basel II went live in 2004 but wasn’t adopted over there (for international banks) unitl 2008.
Excellent analysis and discussion and I thank you all for this.
I had missed the Basel ruling on the suitability of the DTA’s.
Dodgy market, explains the weakness in their offering. Word must have been out on that.
Anyways, thank you.
Are you sure that Basel was the reason for the share sale?
USG was keen to get WFC and Citi out of TARP before the end of the year and made it obvious that the TARP money had to show a “profit”. Even if they had to add a favorable tax ruling giveaway to Citi in order to do that.
I think the likely explanation is that the first order of business in the new year will be the new financial regulations. Whilst the new laws are being debated they wanted all the big banks out of TARP with a “profit”.
The whole of 2009 has been about the replacement of the explicit TARP with hidden subsidies in the form of superlow interest rates, artificially low mortgage rates via FNM/FRE and Fed mortgage buying, tax breaks and changes to mark to market accounting. USG and the banks do not want new financial regulations discussed with a backdrop of anger about TARP.
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