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UK banks to lose 100% of capital ("horror, the horror?" ...er No)

Not a surprise, after already having lost 100% of capital, UK banks losing the same again, approx. £130bn, this time in credit risk losses over “next few years” i.e. rest of the credit cycle, according to Moody’s yesterday. Moody’s neglect to say this is equal to the total of UK banks’ capital reserves.
It is always a bit of a cheek to make breathless shock-horror news out of what anyone who looks into the matter (like me) knows anyway, by reading the Bank of England and or FSA stability review reports, or just working it out as anyone can withoiut even needing to use a spreadsheet. So what almighty specially insightful analysis has Moody’s got that others do not – answer none really!
But when the ratings agencies are under extreme pressure to undress and let the regulators check their health right down to DNA gene-pool level before prescribing severely unpalatable medicines, it makes them feel good to kick & struggle by issuing warnings and downgrades all round, everything from government & country ratings to threatening banks with loss of unsecured borrowing grades.
In this prognosis on UK banks, Moody’s are not making it clear they are referring to gross losses i.e. default rates, not net economic losses after recoveries. Ratings agencies do not take account of loan collateral & other security, though they do seem this time to take some account of government guarantees on liabilities side of the balance sheet how do they do that – who knows – the regulators don’t know?
US & UK banking sectors have both seen their collective capital reserves fall to half despite government capitalisation assistance and then rise again with more assistance to get to target minima. That was help over the short fat tail of credit crunch shock. Next comes the long fat tail of recession – much easier to cope with because there is more time to do so.
Moody’s said UK banking sector had already absorbed losses on loans of around £110bn since start of 2007 by the end of 2008 and it raised or arranged around £120bn of new capital by mid-2009. Actually, fact is, that this is no different from the experience of US banks collectively (FDIC stress-tests showed the US commercial banks (current total capital $1.1tn) will need another $285bn in Tier 1 capital + $140bn (possibly $160bn) in economic capital buffers over the rest of the cycle (of which, $75bn this year), and that’s just for 10 of the top 19 banks.
And, more serious, but not mentioned, was the much greater loss of share equity in banks (US, UK, and in rest of EU) so that many or most banks fell below even discounted book value. US & UK banks lost nearly 1.5 times capital in fall in share values, of which nearly a third has been recovered since touching bottom in March, many major and medium sized EU banks similarly.
Moody’s claim that UK banks & building societies losses (approx. £130bn) from their loan books (from start of 2009) is based on forecasts of performance of key asset classes i.e. forecasting credit risk default trends. This is a little ironic since Moody’s had to admit in June 2007 that its ratings models for asset backed securities were insensitive to credit default rates (some amazingly buggy models!) and had not updated default data in the models anyway, not since 2003 – and subsequently had to down-grade several $trillions of ABS, by up to 17 notches, including many from AAA straight to ‘junk’!
Moody’s goes on to say UK banks’ losses could reach £250bn in a stressed case scenario if UK economic performance is worse than expected, and then it indicatd that worst-case is what it expects, maybe? What is of course interesting about the timing of this is that we are awaiting results (that will not be published in detail) of the EU’s stress-testing requirement on the EU’s top 49 banks sometime this month. Somewhat stung already by the IMF’s hard to justify assertion (except by comparison with US data) recently that EU banks have under-estimated losses to date by about half! But then we expct a traditional lag to operate between US and Europe – at least I do (historical experience).
The result of this is that despite signs of recovery Moody's (Investors Service division) said its fundamental credit outlook for the U.K. banking system is negative (weak economy & likely effect on banks' financial performance). This is quite cute since we know that UK banks have a high exposure to foreign markets (HSBC, RBS, Barclays, & Standard C especially that together account for more than half of the domestic banking). How sophisticated is Moody’s model? My guess is not very.
“Negative outlook” is a view of credit conditions in for the next 12 to 18 months, not a warning that ratings will be downgraded. Moody's says it does not expect “a large number of downgrades” in the next 12 to 18 months, which again is a cute threat since how many downgrades are needed to denigrate the sector, less than 5.
One reason for ratings stability is support from government (large capital injections, credit guarantees, support for depositors, SLS, then APS, plus BoE’s liquidity window). APS is subject to EC approval. If that approval is subject to lead to significant changes in the franchises of large banks (which means requiring Lloyds Banking Group to sell business units o reduce its market share), Moody's says it will change ratings of individual banks. That is an obvious dog & fire hydrant threat – very cheeky, and crudely insensitive to the precise details of the matter – bit Colonel Blimp-style ideology I suspect!
In expecting U.K. banks to see higher loan defaults, requiring bigger loan loss provisions & more capital, Moody’s cannot be factoring in positive underlying performance in traditional banking or factoring in confidence about debt recoveries (typically expected by current through-the-cycle ratios to be at least 50%).
Moody’s numbers include in its estimates the benefit of the UK government’s APS scheme (still awaiting EC approval) to quarantine over half a £trillion of LBG and RBS impaired assets (including US assets in RBS case).
Elizabeth Rudman, Moody’s lead analyst for the UK banking system said the agency does not expect further ratings downgrades over the next 12-18 months because of the stability provided by government support. Moody’s also expect
raised cost of funding (self-fulfilling prophecy by ratings agency) related to uncertainity over the effect of tighter regulation. This is of course absurd since tighter regulation should secure lower riskiness.
Lower interest rates eased the burden for some corporates (which have also deleveraged) but Moody’s still expects to see a sharp increase in banks’ corporate bad debts which it says are “typically lumpy” in nature, which presumes to know what banks will do or not do to support corporate clients.
Moody’s said it expected some of the highest loss rates for banks to come from commercial property lending as real estate values have fallen by 37% since they peaked in the second quarter of 2007 and says it expects property values to continue falling through 2010. This is also hard to square with the past historical experience of property values always falling in a recession to long term gowth rate, which means maximum 35-40% i.e. we are there now. So, this negs the question, what sophisticated additional insight has the Moody’s macro-model?
Further insight into the bleeding obvious, Moody’s state that most heavily exposed are RBS and LBG which had around 10 per cent of their loan book exposed to construction & property sector (shome mistake shurely, the actual %ages are higher than that!). It added that the commercial property exposure at some smaller building societies was a “particular concern”. Moody’s are borrowing the UK watch to tell us the time, and not adding any value at all, except being doomier & gloomier (or dumber & glummer) without a good or exclusive basis for doing so. Moody’s say UK consumers have a high level of debt and unemployment is rising (golly, who didn’t already know that?) and (shock!) such factors are expected to feed into higher losses on secured & unsecured lending. Well, fact is UK households also have higher net equity. (for more see http://lloydsbankgroup.blogspot.com/)