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Tag Archives: TARP

I am very pleased to see that Michael Corkery of the Wall Street Journal’s Deal Journal has similar views to a blog I posted TARP’s Possible Role in Jobs Growth.

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Disclosure: I’m a capitalist too, and my musings & opinions on this blog are for informational/educational purposes and part of my efforts to learn from the mistakes of other people. Hope you do, too. These musings are not to be taken as financial advise, and are based on data that is assumed to be correct. Therefore, my opinions are subject to change without notice. This blog is not intended to either negate or advocate any persons, entity, product, services or political position.

Contact: Ben Solomon, Managing Principal, QuantumRisk

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To get jobs growth going, maybe what is required is a business solution and not an economic solution.

The exceptions are people like Ben Bernake who did a marvelous job of reducing the severity of this recession. Even then Bloomberg reports (05/29/09) that Bernanke’s efforts to bring down borrowing costs to revive the housing market and help the economy are stalling.

Let’s review TARP to find some answers. TARP, issued as preferred stock in the banks’ balance sheet, is tax payers’ public funds used to cushion private shareholders bank balance sheets so that the difference between the banks’ assets and liabilities does not fall below a specific value (at best) or go negative (at worst); because Assets – Liabilities = Equity.

As reported by the Washington Post (07/20/09), the special inspector general overseeing the government’s financial rescue program said that “many of the banks that got federal aid to support increased lending have instead used some of the money to make investments, repay debts or buy other banks”.

What TARP was meant to do was to give banks time to fix the Asset side of the Balance Sheet. If banks had to mark to market, my guess would be that their Assets were about 25% smaller than on July 2007. This suggests that at the worst period during the recession some banks would have had an insignificant or negative equity on the Balance Sheets.

With hind sight this inference makes sense for 2 reasons. (1) There was a huge outcry around April 2009 by the banking industry to move away from mark-to-market rule. (2) The special inspector general report mentioned earlier.

Therefore, we see that the role of TARP was to ensure that bank Equity would remain positive and above a specific Asset % and nothing more.

Now what the banks did with TARP makes business sense too, because TARP increased some banks’ Equity in such a manner that they needed to adjust the Asset – Liabilities side of the equation; that meant reducing Liabilities or “repay debts” and increasing Assets or “make investment” and “buy other banks”.

Could we blame the banks for making “good” business decisions to secure their own safety having received so much cheap money with no strings attached? Let’s flip sides, would you as a banker give free money to your customers?

Let’s think about this some more. The only way banks are going to stay profitable in an underperforming economy is to (1) shed more banking jobs, (2) close more branches, (3) foreclose more properties & (4) reduce risk of lending by reducing lending. All are undesirable outcomes. I suspect that even banks forget that they too need a functioning economy to be profitable.

It appears that the previous Treasury Secretary Paulson’s primary objective was to save the banking system, not the economy, and therefore did not attach any conditions to the TARP funds. I believe the thinking was that this was to be a financial transaction only, to save some banks.

By the time Secretary Geithner took over, some of the initial panic had subdued. There did not seem to be the need to push for more conditions. Even if one wanted, what additional conditions would one attach to the TARP funds? This was a new situation and everyone was learning on the job.

Looking back we can clearly see that TARP’s weakness lay in not aligning the banks’ interests with the tax payers’ interests. Banks are the primary source of credit for a functioning economy, and if after they were rescued, they continued to withdraw credit from the economy then something is amiss. Fed’s Non Revolving Credit Outstanding shows that until recently non-revolving credit had been shrinking. But the recent blimp could be due to the clunkers and other such programs and not so much a revival in bank lending.

Do you remember “what is good for GM is good for America”? We should not make that mistake with the banks either.  Now this is our challenge, aligning banks’ interest with America’s.

The banks’ balance sheets provide an answer as to how to align the banks’ interest with America’s interests. Monitor banks’ business loans and mortgage assets and implement an additional TARP condition that banks cannot return their TARP borrowings until their business loans and mortgage assets have increased by 25% (or some percentage the economist feel safe with). By this rule the government does not tell the banks how to run their business. It tells the banks that the government only recognizes that the banks are healthy functioning members of the economy when they have shown that they can increase these critical assets by 25%.

This rule will immediately stop banks from adjusting their balance sheets by raising capital without growing their business. Raising capital is equivalent to substituting TARP dollars for private money and does not prove that banks will avoid previous mistakes. This rule will (1) cause banks to focus on their critical role of credit provider for the economy. (2) Buoy home prices because spatial correlations dictate less foreclosures will put less downward pressure on neighboring home prices. (3) Facilitate a greater tolerance for mortgage delinquencies for those who have lost their jobs for reasons beyond their control, and therefore fewer foreclosures.

We need to take into consideration that most banking practices are derived from experience in a functioning economy, when everything else is going good. This recession is the exception to those practices and needs to be viewed in a different light.

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Disclosure: I’m a capitalist too, and my musings & opinions on this blog are for informational/educational purposes and part of my efforts to learn from the mistakes of other people. Hope you do, too. These musings are not to be taken as financial advise, and are based on data that is assumed to be correct. Therefore, my opinions are subject to change without notice. This blog is not intended to either negate or advocate any persons, entity, product, services or political position.

Contact: Ben Solomon, Managing Principal, QuantumRisk

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The New York Times reported Goldman Earns $3.19 Billion, Beating Estimates and this on a Tier-1 capital ratio of 14.5%. Goldman has the second highest Tier-1 capital ratio after State Street. Most banks are now in the 10%-12% range with US Government assistance. This is a far cry from the original Basel II requirement of 4%, and Tier-1 capital ratios of 14.5% would have been considered insane in the pre-2007 days.

Goldman Sachs is sending important market signals:

1. Well managed banks can make good profits in spite of “insane” Tier-1 ratios.

2. My guess is that Goldman Sachs is expecting a second asset value collapse soon as this firm has been steadily increasing its Tier-1 ratio and its risk adjusted capital since 2008. See my post  Quant Error! Goldman Sachs Success.

What does all this mean? Well lets look at all the facts.

1. A total of 106 regional banks failed in the United States this year, a figure not seen since 1992.

2. 15.1 million people are unemployed and counting coupled with a jobless recovery. That means prime mortgages are defaulting at unprecedented rates.

3. Many banks are in denial about their current viability and are resorting  to giving incorrect information to their customers. In particular:
3.1 These banks’  credit card operations are telling their customers that they are not part of the banking business and therefore did not receive TARP, when the banks did receive TARP.
3.2 Some banks are telling their customers to take out loans on the other collateral they have and use it to pay off their existing loans.
3.3 Other banks are telling their customer that they have no access to TARP funds or any government assistance and therefore have to foreclose on their customers’ properties.

Points 1, 2 & 3 by themselves just show that the mortgage mess is pretty bad. But add that to what Goldman Sachs is doing – Tier-1 of 14.5% – then that, in my opinion, suggests that Goldman Sachs does not have much confidence in the economy. I hope I’m wrong but it is better to be aware of the downside risk then to walk around in rose tinted glasses.

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Disclosure: I’m a capitalist too, and my musings & opinions on this blog are for informational/educational purposes and part of my efforts to learn from the mistakes of other people. Hope you do, too. These musings are not to be taken as financial advise, and are based on data that is assumed to be correct. Therefore, my opinions are subject to change without notice. This blog is not intended to either negate or advocate any persons, entity, product, services or political position.
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Has S&P tightened their ratings methodology? The TARP+Equity Risk Capital stacks up quite favorably in comparison with the S&P downgrades.

Today Reuters reported that S&P cuts ratings on 18 US Banks. I will show how the TARP+Equity Risk Capital stacks up in comparison with the S&P downgrades.

Symbol Company TARP / Equity TARP / Assets(%) Equity / Assets(%) TARP+Equity(%) TARP ($millions) Assets ($millions) Equity ($millions)
WFC Wells Fargo 52.12% 4.10% 7.87% 11.98% 25,000 609,074 47,964
CMA Comerica Incorporated 45.26% 3.48% 7.70% 11.18% 2,300 66,003 5,082
C Citigroup 36.66% 2.38% 6.49% 8.87% 50,000 2,100,385 136,405
BAC Bank of America 32.27% 3.06% 9.48% 12.53% 52,500 1,716,875 162,691
FITB Fifth Third Bancorp 31.62% 2.96% 9.35% 12.31% 3,400 114,975 10,754
WL Wilmington Trust Corporation 30.95% 2.72% 8.79% 11.51% 330 12,133 1,066
KEY KeyCorp 28.72% 2.46% 8.57% 11.04% 2,500 101,544 8,706
SNV Synovus Financial Corp. 28.23% 2.83% 10.02% 12.84% 968 34,227 3,429
WTNY Whitney Holding Corp 25.36% 2.72% 10.74% 13.46% 300 11,016 1,183
ASBC Associated Banc-Corp 22.30% 2.35% 10.55% 12.91% 525 22,303 2,354
HBAN Huntington Bancshares 21.94% 2.53% 11.53% 14.06% 1,400 55,334 6,381
WBS Webster Financial 21.14% 2.29% 10.82% 13.11% 400 17,479 1,892
CRBC Citizens Republic Bancorp 19.41% 2.28% 11.74% 14.01% 300 13,170 1,546
SUSQ Susquehanna Bancshares 17.48% 2.22% 12.71% 14.93% 300 13,505 1,716

 

Two points are worth noting. First, with the exception of Citigroup (8.87%) the TARP+Equity of these banks ranged between 11.04% and 14.93%.  Second, the TARP/Equity ratio for downgraded banks is > 17.48%.

In my earlier blog TARP, a Post Event Risk Capital I had suggested that 25% (or 1/4) would be a good benchmark to separate risky banks from ‘safer’ banks. The S&P downgrade suggest that S&P is using a stricter rule that is equivalent 16.7% or 1/6.

This would suggest that we can expect more bank downgrades in 2009.

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Disclosure: I’m a capitalist too, and my musings & opinions on this blog are for informational/educational purposes and part of my efforts to learn from the mistakes of other people. Hope you do, too. These musings are not to be taken as financial advise, and are based on data that is assumed to be correct. Therefore, my opinions are subject to change without notice. This blog is not intended to either negate or advocate any persons, entity, product, services or political position.
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The New York Times article, Regulators Feud as Banking System Overhauled, presented an interesting insight into the regulatory world. In essence the opposing points of view are,

(1) John C. Dugan, the Comptroller of the Currency, blasted a proposal to impose stiff new insurance fees on banks as unfair to the largest banks, which he regulates.
(2) Sheila Bair, chair of the Federal Deposit Insurance Corporation, says that the large banks had wreaked havoc on the system, only to be bailed out by “hundreds of billions, if not trillions, in government assistance.” Sheila Bair regulates the smaller banks.

In my blog post, We Need a Non-Linear Risk Capital Scheme, I showed that the Obama Administration had indeed allocated TARP funds fairly uniformly at 2.69c of TARP per $1 of bank assets across the industry. However, the banking industry like many industries is relatively opaque. What the TARP allocation allowed us to infer was that professional bankers tend to underestimate their risk as these risk increase.

These inferences taken with my earlier blog post, TARP, a Post Event Risk Capital, shows that the 20 biggest TARP recipients received more TARP than the 20 smaller TARP recipients when normalized for risk capital or equity. The biggest recipients received on average $15.9 billion TARP each, or 54%.77 of their equity, while the smaller recipients recieved on average $0.12 billion or 24.94% of equity.

The hard data shows that Sheila Bair is correct, that big banks were undercapitalized for the risk they were taking compared to the smaller banks. This does not mean that the smaller banks were risk averse, just that the bigger banks were more risk seeking than the smaller banks. And this makes logical sense because the bigger banks could better afford to pay for resources to delve in and exploit exotic (with hindsight) high risk instruments.

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Disclosure: I’m a capitalist too, and my musings & opinions on this blog are for informational/educational purposes and part of my efforts to learn from the mistakes of other people. Hope you do, too. These musings are not to be taken as financial advise, and are based on data that is assumed to be correct. Therefore, my opinions are subject to change without notice. This blog is not intended to either negate or advocate any persons, entity, product, services or political position.
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If you remove the 5 worst cases, the top 100 TARP recipients data shows several inference quite clearly,

(1) TARP funding was allocated in a practical manner. Companies with larger assets were given more TARP. The graphical analysis shows that on average 2.69 cents of TARP was distributed for every $1 of bank assets.

TARP(1)

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(2)  There is no descernable relationship between Equity/Asset ratio (risk recognition) and Asset size. That means the Equity/Asset ratio must have been driven by some internal measure of risk or at least the perception of this risk. The large spread in the Equity/Asset ratio (4% to 17%) reflects a large variation in the banks’ opinion of the quality of the assets they had. 

TARP(4)

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(3) The negative slope shows that less TARP was given to banks that were better capitalized (absolute capital ratio) than to banks that were not. Also a desirable policy. The effect of the allocation scheme was to get the average bank risk capital up to 12.10%. This a huge jump from 4% of Tier 1.

TARP(2)

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(4) The positive slope shows that the more TARP a bank received as a proportion of its equity, the more TARP it recieved as a proportion of its assets. Remember that this is normalized data. That is the less risk capital (greater TARP/Equity) a bank had the greater the bank’s actual asset risk (TARP/Assets) or the poorer the quality of the assets. Or the greater the risk the less likely a bank would recognize its own risk.

TARP(3)

Why should this be the case, when all banks were supposedly similarly affected by the mortage mess? Apparently not. Some banks had more risky assets than others. In otherwords some banks were undercapitalized for the risk they were taking, and were not facing up to these risk. Note, this is an industry-wide behavior, as these inferences are based on the top 100 TARP recipients.

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There are two lessons here:

(1) It is surprising to find that professional bankers are more likely to underestimate their asset risk, the more risky the assets become.

(2) Regulatory capital allocation cannot be linear. It needs to be a non-linear scheme. That is the first x% of risk requires $y of risk capital. The second x% of risk requires $2y of risk capital, and the third x% requires $4y, etc.

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Disclosure: I’m a capitalist too, and my musings & opinions on this blog are for informational/educational purposes and part of my efforts to learn from the mistakes of other people. Hope you do, too. These musings are not to be taken as financial advise, and are based on data that is assumed to be correct. Therefore, my opinions are subject to change without notice. This blog is not intended to either negate or advocate any persons, entity, product, services or political position.
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The table below show the top 100 TARP recipients (out of 137) for which I could find the complete data. This 100 accounts for $337.553 of the $444.933 billion or 76% of TARP.

Data Sources: Forbes & ProPublica.

Symbol Company TARP / Equity TARP / Assets(%) Equity / Assets(%) TARP ($millions) Assets ($millions) Equity ($millions)
FRE Freddie Mac 391.57% 5.77% 1.47% 50,700 879,043 12,948
FBNC First BanCorp 184.61% 15.26% 8.27% 400 2,621 217
OCN Ocwen Financial Corporation 110.84% 26.51% 23.91% 659 2,486 595
AIG AIG 89.39% 6.71% 7.51% 69,800 1,040,000 78,088
FNM Fannie Mae 82.96% 3.86% 4.65% 34,200 885,918 41,226
HMPR Hampton Roads Bankshares 74.74% 9.50% 12.71% 80 845 107
WFC Wells Fargo 52.12% 4.10% 7.87% 25,000 609,074 47,964
PNC PNC Financial Services 50.30% 5.32% 10.58% 7,600 142,771 15,108
LION Fidelity Southern Corp 49.55% 2.71% 5.47% 48 1,778 97
TAYC Taylor Capital 47.34% 2.82% 5.95% 105 3,719 221
CMA Comerica Incorporated 45.26% 3.48% 7.70% 2,300 66,003 5,082
VCBI Virginia Commerce Bancorp 40.49% 2.67% 6.60% 71 2,655 175
PVTB PrivateBancorp 37.77% 3.26% 8.63% 244 7,479 645
CIT CIT Group 37.37% 2.62% 7.01% 2,300 87,819 6,155
LKFN Lakeland Financial Corporation 37.09% 2.49% 6.71% 56 2,249 151
MCBI MetroCorp Bancshares 36.96% 2.85% 7.71% 45 1,578 122
C Citigroup 36.66% 2.38% 6.49% 50,000 2,100,385 136,405
OSBC Old Second Bancorp 36.48% 2.47% 6.77% 73 2,956 200
HTLF Heartland Financial USA 35.88% 2.42% 6.74% 82 3,379 228
OZRK Bank of the Ozarks 35.56% 2.45% 6.89% 75 3,062 211
FFCH First Financial Holdings 34.58% 2.22% 6.43% 65 2,924 188
SIVB SVB Financial Group 34.30% 3.21% 9.37% 235 7,310 685
WIBC Wilshire Bancorp 34.23% 2.64% 7.70% 62 2,359 182
CLFC Center Financial Corp 33.71% 2.59% 7.68% 55 2,126 163
GSBC Great Southern Bancorp 33.70% 2.33% 6.92% 58 2,487 172
COBZ CoBiz Financial 33.51% 2.53% 7.55% 65 2,548 192
FRME First Merchants Corp 33.39% 3.03% 9.09% 116 3,822 347
WTFC Wintrust Financial Corp 33.38% 2.52% 7.55% 250 9,923 749
FBC Flagstar Bancorp 33.26% 1.83% 5.49% 267 14,606 802
BANR Banner Corp 32.51% 2.67% 8.23% 124 4,636 381
BAC Bank of America 32.27% 3.06% 9.48% 52,500 1,716,875 162,691
FHN First Horizon National 32.12% 2.44% 7.59% 867 35,550 2,697
ABCW Anchor BanCorp Wisconsin 31.87% 2.14% 6.70% 110 5,150 345
FITB Fifth Third Bancorp 31.62% 2.96% 9.35% 3,400 114,975 10,754
OKSB Southwest Bancorp 31.23% 2.62% 8.39% 70 2,671 224
WL Wilmington Trust Corporation 30.95% 2.72% 8.79% 330 12,133 1,066
PFG Principal Financial Group 30.21% 1.32% 4.37% 2,000 151,527 6,620
CVBF CVB Financial 29.94% 2.01% 6.73% 130 6,454 434
NARA Nara Bancorp 29.43% 2.60% 8.85% 67 2,574 228
FFIC Flushing Financial Corp 29.22% 1.96% 6.70% 70 3,573 240
FFBC First Financial Bancorp 29.06% 2.31% 7.96% 80 3,460 275
KEY KeyCorp 28.72% 2.46% 8.57% 2,500 101,544 8,706
SNV Synovus Financial Corp. 28.23% 2.83% 10.02% 968 34,227 3,429
UCBH UCBH Holdings 28.00% 2.34% 8.37% 299 12,743 1,067
NBBC NewBridge Bancorp 27.91% 2.54% 9.10% 52 2,063 188
STI SunTrust 27.36% 2.76% 10.10% 4,900 177,233 17,907
LBAI Lakeland Bancorp 27.25% 2.29% 8.42% 59 2,572 217
ABCB Ameris Bancorp 27.01% 2.37% 8.78% 52 2,193 193
FMBI First Midwest Bancorp 26.66% 2.32% 8.71% 193 8,311 724
WAL Western Alliance Bancorporation 26.64% 2.68% 10.07% 140 5,219 525
CPF Central Pacific Financial Corp 26.62% 2.39% 8.97% 135 5,650 507
ZION Zions Bancorp 26.55% 2.56% 9.65% 1,400 54,631 5,274
SBCF Seacoast Banking Corp 26.29% 2.18% 8.28% 50 2,297 190
TBBK The Bancorp 26.18% 2.69% 10.29% 45 1,677 173
IBNK Integra Bank Corporation 26.17% 2.46% 9.39% 84 3,401 319
MI Marshall & Ilsley 26.10% 2.65% 10.14% 1,700 64,260 6,514
SASR Sandy Spring Bancorp 25.95% 2.63% 10.12% 83 3,164 320
CATY Cathay General Bancorp 25.94% 2.39% 9.20% 258 10,812 995
STSA Sterling Financial Corp 25.72% 2.39% 9.28% 303 12,700 1,178
PCBC Pacific Capital Bancorp 25.45% 2.41% 9.48% 181 7,485 710
WTNY Whitney Holding Corp 25.36% 2.72% 10.74% 300 11,016 1,183
SRCE 1st Source Corp 25.25% 2.48% 9.82% 111 4,478 440
BPOP Popular, Inc. 25.23% 2.24% 8.89% 935 41,679 3,706
STBA S&T Bancorp 24.79% 2.50% 10.07% 109 4,354 438
WSFS WSFS Financial 24.25% 1.64% 6.78% 53 3,198 217
BPFH Boston Private Financial Holdings 24.00% 2.14% 8.93% 154 7,183 642
CYN City National 23.99% 2.45% 10.21% 400 16,339 1,668
FNBN FNB United Corp 23.97% 2.51% 10.46% 52 2,055 215
LNC Lincoln National Corporation 23.81% 1.36% 5.70% 2,500 184,281 10,498
VLY Valley National 23.65% 1.73% 7.32% 225 12,988 951
FULT Fulton Financial Corp 23.63% 2.34% 9.92% 377 16,058 1,593
TRMK Trustmark Corp 22.97% 2.31% 10.05% 215 9,315 936
MBHI Midwest Banc Holdings 22.88% 2.28% 9.95% 85 3,727 371
FPFC First Place Financial Corp 22.86% 2.18% 9.55% 73 3,341 319
COLB Columbia Banking System 22.34% 2.43% 10.86% 77 3,170 344
MBFI MB Financial 22.32% 2.33% 10.45% 196 8,407 878
ASBC Associated Banc-Corp 22.30% 2.35% 10.55% 525 22,303 2,354
TFSG South Financial Group 22.25% 2.48% 11.16% 347 13,977 1,559
GRNB Green Bankshares 22.15% 2.40% 10.81% 72 3,019 326
HBAN Huntington Bancshares 21.94% 2.53% 11.53% 1,400 55,334 6,381
IBOC International Bancshares Corp 21.83% 1.96% 8.99% 216 11,011 989
UCBI United Community Banks 21.48% 2.18% 10.14% 180 8,264 838
MSFG MainSource Financial Group 21.26% 2.25% 10.56% 57 2,539 268
WBS Webster Financial 21.14% 2.29% 10.82% 400 17,479 1,892
DFS Discover Financial Services 20.51% 3.51% 17.09% 1,200 34,234 5,850
WABC Westamerica Bancorporation 20.39% 2.00% 9.80% 84 4,189 410
HIG Hartford Financial Services 20.21% 1.02% 5.04% 3,400 333,840 16,824
BTFG BancTrust Financial Group 20.19% 2.36% 11.67% 50 2,123 248
SUPR Superior Bancorp 19.78% 2.27% 11.47% 69 3,040 349
PNFP Pinnacle Financial 19.72% 2.31% 11.73% 95 4,106 482
BUSE First Busey Corporation 19.47% 2.34% 12.04% 100 4,265 514
CRBC Citizens Republic Bancorp 19.41% 2.28% 11.74% 300 13,170 1,546
RF Regions Financial Corp. 17.76% 2.42% 13.65% 3,500 144,436 19,708
SUSQ Susquehanna Bancshares 17.48% 2.22% 12.71% 300 13,505 1,716
PRK Park National Corporation 17.30% 1.47% 8.48% 100 6,820 578
UMPQ Umpqua 17.22% 2.57% 14.91% 214 8,346 1,244
NPBC National Penn Bancshares 14.33% 1.62% 11.32% 150 9,241 1,046
WSBC WesBanco 12.85% 1.42% 11.07% 75 5,271 583
FNB F.N.B. Corporation 10.88% 1.24% 11.36% 100 8,096 919
MTB M&T Bank Corporation 9.20% 0.91% 9.89% 600 65,893 6,519

 

This data does not include 37 companies (below) for which data was missing/incomplete/could not be identified correctly. If you note any mistakes please let me know, I will correct them.

Company TARP ($millions)
General Motors 50,700
Chrysler 15,500
GMAC 12,500
Chase Home Finance 3,600
GM Supplier Receivables, LLC 3,500
Wells Fargo Bank, NA 2,900
CitiMortgage 2,100
Countrywide Home Loan Servicing 1,900
Chrysler Receivables SPV LLC 1,500
Chrysler Financial Services 1,500
Bank of America, NA 799
Aurora Loan Services 798
GMAC Mortgage 633
Saxon Mortgage Services 407
Select Portfolio Servicing 376
Wilshire Credit Corporation 366
Home Loan Services, Inc. 319
East West Bancorp, Inc. 307
First Banks, Inc. 295
New York Private Bank & Trust Corp 267
Carrington Mortgage Services 195
Green Tree Servicing 156
Provident Bankshares Corp. 152
Dickinson Financial Corp II 146
WTB Financial Corp 110
Nationstar Mortgage 101
Plains Capital Corp 88
Liberty Bancshares 79
TowneBank 77
Independent Bank Corporation 72
Alpine Banks of Colorado 70
First Bancorp 65
Standard Bancshares 60
Union Bankshares 59
Home BancShares, Inc. 50
State Bankshares 50
BancPlus Corporation 48

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Disclosure: I’m a capitalist too, and my musings & opinions on this blog are for informational/educational purposes and part of my efforts to learn from the mistakes of other people. Hope you do, too. These musings are not to be taken as financial advise, and are based on data that is assumed to be correct. Therefore, my opinions are subject to change without notice. This blog is not intended to either negate or advocate any persons, entity, product, services or political position.
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As someone who had reported to the CFO of a financial services firm, I spent some years building economic capital models to understand and allocate risk capital.

My point with SOX (that financial statements are true and correct) was if Wall St. really did understand the risk they faced they would have had to allocate risk capital which they did not. The TARP borrowings – in actuality a post event risk capital – shows that financial services firms, for what ever reason, did not understand their risk, as measured by TARP dollars.

As a quick study, I generated 2 tables of TARP recipients, one for the Biggest Recipients & one for Smaller Recipients (received <= $200,000,000). (This was based on complete data I could find easily, so some of the biggest recipients are missing.)

We can infer several points from these two tables (below):

1. On average, the biggest TARP recipients received 2x more TARP funding than the smaller recipients (54.77% of equity versus 24.94%). There are 3 possible interpretations.
(a) That TARP allocation was biased towards the bigger institutions.
(2) That the biggest institutions had substantially more risky assets than smaller institutions.
(3) A combination of both.

2. On average, the smaller TARP recipients were better capitalized (9.47%) than the larger recipients (8.68%), suggesting that smaller institutions were more conservative in their risk management.

3. Freddie Mac (391%), Fanny May (83%) & AIG (89%) received substantially more funding than the other recipients, as measured by the percentage of their June 2008 equity, i.e. without TARP these companies were insolvent. This says that these companies and many banks did not understand the concept of economic capital.

4. Equity as a percentage of assets is too gross a risk measure to inform investors of the downside risk. For example 7 of the biggest recipients and 8 of the smaller recipients had more than 10% equity. This points to
(a) Insufficient or incorrect allocation of risk capital due to significant underestimation of risks associated with these assets.
(b) More importantly the dire need to report risk capital by asset type.
(c) The (unpopular but) dire need to allocate risk capital for all types of assets classes (past, present, future, balance sheet & off-balance sheet).

5. TARP can be considered a post-event risk capital, in that it enabled these institutions to remain solvent i.e. the risk capital (TARP+Equity) that should have been in place to handle the 2008 mortgage mess. Using this concept we see that the risk capital that all financial services companies require to remain solvent in a downturn is on the order of 12%.

6. If we set 25% TARP/Equity ratio as a benchmark for the institutions’ risk management culture, then we can infer that 16 of the biggest recipients and 10 of the smaller recipients had an excessive risk seeking management culture. One could use any other benchmark, 35% or 10%. In my opinion, 25% is a good ballpark benchmark.

7. In my opinion, institutions that received more than 25%  TARP/Equity should not be allowed to return their TARP without showing a substantial change in their management culture.

For Business Process Review or Statistical Modeling advice, please contact Ben Solomon at QuantumRisk LLC. (Note fix email address)

Data source: Forbes (June 2008 Balance Sheets) & ProPublica

Biggest Recipients of TARP 54.77% 3.22% 8.68% 11.90%
Symbol Company TARP/
Equity
TARP/
Assets
Equity/
Assets
Risk Capital
FRE Freddie Mac 391.57% 5.77% 1.47% 7.24%
AIG AIG 89.39% 6.71% 7.51% 14.22%
FNM Fannie Mae 82.96% 3.86% 4.65% 8.51%
WFC Wells Fargo 52.12% 4.10% 7.87% 11.98%
PNC PNC Financial Services 50.30% 5.32% 10.58% 15.91%
CMA Comerica Incorporated 45.26% 3.48% 7.70% 11.18%
C Citigroup 36.66% 2.38% 6.49% 8.87%
BAC Bank of America 32.27% 3.06% 9.48% 12.53%
FHN First Horizon National 32.12% 2.44% 7.59% 10.03%
FITB Fifth Third Bancorp 31.62% 2.96% 9.35% 12.31%
PFG Principal Financial Group 30.21% 1.32% 4.37% 5.69%
KEY KeyCorp 28.72% 2.46% 8.57% 11.04%
SNV Synovus Financial Corp. 28.23% 2.83% 10.02% 12.84%
STI SunTrust 27.36% 2.76% 10.10% 12.87%
ZION Zions Bancorp 26.55% 2.56% 9.65% 12.22%
MI Marshall & Ilsley 26.10% 2.65% 10.14% 12.78%
LNC Lincoln National Corporation 23.81% 1.36% 5.70% 7.05%
HBAN Huntington Bancshares 21.94% 2.53% 11.53% 14.06%
DFS Discover Financial Services 20.51% 3.51% 17.09% 20.59%
RF Regions Financial Corp. 17.76% 2.42% 13.65% 16.07%

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Smaller Recipients of TARP 24.94% 2.26% 9.47% 11.74%
Symbol Company TARP/
Equity
TARP/
Assets
Equity/
Assets
Risk Capital
TAYC Taylor Capital 47.34% 2.82% 5.95% 8.77%
FRME First Merchants Corp 33.39% 3.03% 9.09% 12.12%
BANR Banner Corp 32.51% 2.67% 8.23% 10.90%
ABCW Anchor BanCorp Wisconsin 31.87% 2.14% 6.70% 8.84%
CVBF CVB Financial 29.94% 2.01% 6.73% 8.74%
FMBI First Midwest Bancorp 26.66% 2.32% 8.71% 11.03%
WAL Western Alliance Bancorporation 26.64% 2.68% 10.07% 12.75%
IBNK Integra Bank Corporation 26.17% 2.46% 9.39% 11.85%
PCBC Pacific Capital Bancorp 25.45% 2.41% 9.48% 11.89%
SRCE 1st Source Corp 25.25% 2.48% 9.82% 12.30%
STBA S&T Bancorp 24.79% 2.50% 10.07% 12.57%
MBHI Midwest Banc Holdings 22.88% 2.28% 9.95% 12.22%
MBFI MB Financial 22.32% 2.33% 10.45% 12.78%
UCBI United Community Banks 21.48% 2.18% 10.14% 12.32%
WABC Westamerica Bancorporation 20.39% 2.00% 9.80% 11.80%
PNFP Pinnacle Financial 19.72% 2.31% 11.73% 14.05%
BUSE First Busey Corporation 19.47% 2.34% 12.04% 14.38%
PRK Park National Corporation 17.30% 1.47% 8.48% 9.94%
NPBC National Penn Bancshares 14.33% 1.62% 11.32% 12.95%
FNB F.N.B. Corporation 10.88% 1.24% 11.36% 12.59%

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Disclosure: I’m a capitalist too, and my musings & opinions on this blog are for informational/educational purposes and part of my efforts to learn from the mistakes of other people. Hope you do, too. These musings are not to be taken as financial advise, and are based on data that is assumed to be correct. Therefore, my opinions are subject to change without notice. This blog is not intended to either negate or advocate any persons, entity, product, services or political position.
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Paul Krugman’s blog post Bailout for Bunglers was instructive. I particularly liked the end:

“There’s more at stake here than fairness, although that matters too. Saving the economy is going to be very expensive: that $800 billion stimulus plan is probably just a down payment, and rescuing the financial system, even if it’s done right, is going to cost hundreds of billions more. We can’t afford to squander money giving huge windfalls to banks and their executives, merely to preserve the illusion of private ownership.”

Though I agree with Paul Krugman, I think somethink is missing. We need to identify the cause of the recession before we can put forward a recovery package.

From the perspective of business and economic processes, two processes collided in 2005-2008 time frame that resulted in our current recession. The first was the bursting of the house price bubble, and the second was the oil price spike.

The figure below depicts US Home prices up to 2005. House prices peaked in 2006 and started to decline.

shiller_ie2_fig_2-1

Source: Robert Schiller’s United States Housing Bubble (Wikipedia)

The two figures below show average monthly oil prices (Dec 07 to Jan 09) and average yearly oil prices (1967 to 2009).

yearlyavgoilprice

monthlyavgoilprice

Source: OPEC


Conference Board tells us that the average per capita discretionary income in 2006 was $9,148 or gasoline cost was went up from 11.5% (2005) of discretionary income to 26.9% ( 2008 ) (using 2006 discretionary data for all years). A sizeable increase. But this does not tell the whole story.

For households with incomes of $50,000 or less, i.e. small business employees, the 2006 discretionary income was $1,900 for the whole family of 2.7 people. That is, gasoline costs went from 55% (early 2005) to 90% (mid 2006) to 130% (mid 2008). Definitely not sustainable.

Given that the initial toxic mortgages were Alt-A/Subprime loans, and my guess, is that most of these borrowers were small business employees, the gasoline price spike would have killed off these borrowers’ ability to service the loans. No payments resulted in deliquencies, defaults, suffocated demand and finally home price depreciation, and further time-lagged domino effects that scuttled the banks and the rest of the economy.

House prices only started to fall in 2006 when gasoline prices had become unsustainable.

Looking at the graphical data, we can now infer that gas prices at the pump must remain below $2.00/gallon, if the US economy is to come out of this recession any time soon. This is a very important lesson, gasoline prices wiped out a substantial portion of the discretionary income of about half of the US working population.

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Disclosure: I’m a capitalist too, and my musings & opinions on this blog are for informational/educational purposes and part of my efforts to learn from the mistakes of other people. Hope you do, too. These musings are not to be taken as financial advise, and are based on data that is assumed to be correct. Therefore, my opinions are subject to change without notice. This blog is not intended to either negate or advocate any persons, entity, product, services or political position.
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In my previous post Mortgage Spreads too High? I had used the formula: 

53% * 2,000,000 * $250,000 * (35% + 20%) = $145.75 billion

Let me explain. This is a standard expected loss formula adapted to our current situation. It takes the form:

Expected Loss = Prob of Default *  Severity of Loss

Given no reworking of loans, the probability of a default is 53%. The Severity of Loss is the average loss as a percentage of the loan, in this case 35%, multiplied by the average loan value. Depending on which paper you read, the average residential mortgage loss varies between 20+% to 60+%. The generally accepted figure is 35%. 

Given that a very large proportion of the loans are subprime, one can expect a Loan-to-Value (LTV) ratio of 100%, i.e. the average loan amout was the value of the property or $250,000.

I added an additional 20% to the loss as on a 100% LTV the unrecoverable loss needs to include the depreciation in house prices of 20%. This is appropriate as average losses are monotic and subadditive.

There is an important lesson here.

The formula tells us that if banks foreclose on a property they will have to realize the additional loss from the 20% house price depreciation. If banks have the capital to hold on to these foreclosed properties until the economy revives and house prices appreciate, then these banks do not require the government bailout funds, and should not be allowed access to the bailout funds.

This raises the question, how are banks using the bailout funds? If the bailout funds are being escrowed into reserve accounts for when a foreclosure is realized, then expect further deterioration in the mortgage markets in 2009; because the bailout funds are being used to stopgap bank losses but not to address the cause – the real economy.

If the funds are used to rework and rewrite mortgages so that 85% of the toxic mortgages are now viable, then we can expect a recovery in the mortgage market in 2009, because banks are addressing the problems in the real economy.

Now we know why Sheila Bair of the FDIC proposed a workout of 2,000,000 residential mortgages. In the long run it will actually help save the banks.

Unfortunately, as Paul Kruger pointed out in his New York Time’s blog, the spreads have increased to unprecedented highs. So don’t expect a recovery in the real economy of the mortgage markets until mortgage spreads come back down.

Benjamin T Solomon
QuantumRisk LLC

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Disclosure: I’m a capitalist too, and my musings & opinions on this blog are for informational/educational purposes and part of my efforts to learn from the mistakes of other people. Hope you do, too. These musings are not to be taken as financial advise, and are based on data that is assumed to be correct. Therefore, my opinions are subject to change without notice. This blog is not intended to either negate or advocate any persons, entity, product, services or political position.
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