Wednesday, March 25, 2009

US banks face big writedowns in toxic asset plan

From the Financial Times by Francesco Guerrera and Krishna Guha:

The government’s toxic assets plan will force banks such as Citigroup, Bank of America and Wells Fargo to take large writedowns on their loans, requiring them to raise more capital from taxpayers or investors, executives and analysts have warned.

Senior bankers say the authorities’ latest drive, announced on Monday, to cleanse financial groups’ balance sheets by encouraging investors to buy troubled residential and commercial mortgages will prompt banks to record losses on those portfolios.

The government will also use its “stress tests” to force banks to take more aggressive provisions on these loans, creating a stronger incentive to sell. This process will increase the pressure on banks that have large loan portfolios to raise fresh funds from investors or the government if capital markets remain frozen.

The possibility of further government injections is set to weigh on banks such as Citi, in which the authorities are about to buy a 36 per cent stake, BofA, Wells and other recipients of federal aid.

“The unspoken fear here is that selling off loan portfolios would lead to more government capital injections into major banks,” said an executive at a large bank.

Citi and BofA declined to comment.

Wells said it would support “any plan by the Treasury that helps financial institutions efficiently sell troubled assets while still providing an investment return to the US tax payer”, but said it had not seen all the details of Treasury’s proposals.

Accounting rules allow banks to carry loans on their balance sheets at their original value and set aside a percentage of the losses expected over the lifetime of the loan.

However, the government plan, which offers investors generous financing to buy banks’ distressed assets, will force institutions that sell loans at a discount to take a writedown equal to the difference between the original value and their sale price.

Some analysts believe the potential writedowns would deter banks from taking part in the plan, which was unveiled by Tim Geithner, Treasury secretary.

Richard Bove, an analyst at Rochdale Research, wrote in a note to clients: “[The plan] will not happen because it would destroy bank capital. It might cause a bank to fail the new stress tests under way. Banks will not take this risk.”

But while banks in theory have discretion over whether to sell loans, Sheila Bair, chairman of the Federal Deposit Insurance Corporation, said this decision would be made “in consultation with regulators” – a sign that the authorities might put pressure on banks to sell toxic assets.

Policymakers say the Geithner strategy is intended to fix the disconnect between the market and the banks by restoring investor confidence in their financial statements.

Outside investors and bank executives are miles apart in their assessments of the true capital position of the banks, making it impossible for them to agree a price at which to re­capitalise.

By forcing a more realistic and forward-looking assessment of expected losses on bank loans through the stress test, and creating a secondary market that establishes the expected credit losses on loan portfolios, the authorities intend to force banks to write down these loans.

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