Week of February 8, 2010
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Risk News Archive
Credit Risk
Credit Outlook for U.S. Diversified Financial Sector Mixed
Bankers: Officials Getting in Way
White House Proposes Increase in FDIC Deposit Insurance Fund
Economist Sees Slow Revival in Commercial Real Estate
REITs: Better but Not All-Clear
Congress Worries About Commercial Real Estate
Banks Not Loosening Credit Yet, Fed Reports
Commercial Real Estate to Continue to Drag Economy, Experts Predict
Banks Report Slowing CRE Loan Charge-Offs
Distressed Assets Hit $170B
U.S. Commercial Mortgage Lenders Shun Loans in Need
Market Risk
Centralized Clearing of OTC Derivatives, Devil in the Details
Bernanke's Exit Strategy: Tighter Reserve Requirements
Operational Risk
Sources: Dodd, Shelby Negotiations Breaking Down
Volcker Urges Senators to Adopt Obama's Rules on Banking
Wall Street Toughens its Rules on Clawbacks
Enterprise Risk
Online Consumers Seek Out Stronger Security
Heartland Moves to Encrypted Payment System
Federal Reserve Banks Announce New Studies to Examine Nation's Check and Electronic Payments Usage
Securities Lending
Northern Trust Faces Lawsuit Over Securities Lending Losses
Consumer Lending
How Banks Can Win from Being Second
Home Lenders See Regs Raising Their Expenses
More U.S. Consumers Pay Credit Card Before Mortgage: Study
Another Source of Woe in FHA: Builder-Run Lenders
Lenders Pursue Mortgage Payoffs Long After Homeowners Default
Mortgage Bulls Bid Fed Fond Farewell
Respa Rule Delays Many Mortgages, Torpedoes Others
Housing Momentum Builds but Perils Persist
Credit Risk
Credit Outlook for U.S. Diversified Financial Sector Mixed
RiskCenter (02/04/10); Bertsch, Brian
The ratings outlook for securities firms and investment management firms is stable for 2010 as those firms increase liquidity and capital and reduce risks, according to Fitch's "U.S. Diversified Financial Services" report. However, the ratings firm says that U.S. diversified financial services sector's outlook is mixed even as these firms seek out opportunities to generate revenue. On the other hand, finance and leasing firms have negative credit outlooks due to credit deterioration, funding and liquidity concerns. Fitch does suggest that the sector's ratings could stabilize in the second part of 2010 if the economy and credit markets improve. As the economy improves, Fitch expects stronger firms to take advantage of the market conditions and bolster their balance sheets and acquire new business and possibly competitors.
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Bankers: Officials Getting in Way
Las Vegas Review-Journal (02/05/10); Edwards, John G.
At the recent Mortgage Bankers Association Commercial Real Estate Finance/Multifamily Housing Convention, Mutual of Omaha Chairman and CEO Jeremy Schmid said that despite the official policy of U.S. banking regulators, examiners are making it tough for community banks to originate loans. "I think there's an absolute and complete disconnect between what Washington thinks is happening and what their examiners are doing," he said. Meanwhile, Charles Fedalen Jr., executive vice president at Wells Fargo Bank, noted that examiners regularly monitor operations but overburdened bank watchdogs have not scrutinized the company like they did in the early 1990s.
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White House Proposes Increase in FDIC Deposit Insurance Fund
Washington Post (DC) (02/02/10); Appelbaum, Binyamin
The Obama Administration's 2011 budget proposal calls for an increase to the U.S. Federal Deposit Insurance Corp.'s (FDIC) insurance fund for depositors of failed banks. Banks would be required, under legislation to be drafted by Congress, to pay higher fees into the fund, which should translate into fewer risks and a better financial safety net. With the number of failing banks on the rise in the last two years, the FDIC fund has dwindled significantly, forcing the agency to raise fees and impose special assessments on banks. According to the budget proposal, "It may be appropriate to consider raising the target to a level above 1.5 percent [of insured deposits] in order to maintain positive fund balances during future downturns." Sources indicate the FDIC supports the idea.
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Economist Sees Slow Revival in Commercial Real Estate
Charleston Regional Business Journal (SC) (02/04/10); Fitts, Ricky
Grubb & Ellis chief economist Robert Bach expects commercial real estate markets to bottom out in 2010 as the slow pace of deals will begin to revive. While values and prices might still descend further, he remarks, the worst of the damage has likely been done. Bach quips, "This is the year when people will be peeking out of their bunkers." Bach further expects lenders to extend loans to existing customers as opposed to taking over properties in such a market. Credit will remain a major problem, however. Office vacancy rates nationally are hovering around a two-decade high and will likely peak this year. Bach further expects rents will continue a gradual decline. Looking at the Columbia, S.C., market, office vacancies are on pace to peak by midyear. Bach concluded that a revival in employment and wage growth is necessary to get consumers back into spending. When they do return, retailers will be buoyed by the renewed demand. Bach states, "My sense overall is that the economy will make it through this."
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REITs: Better but Not All-Clear
Wall Street Journal (02/01/10) P. C10; Troianovski, Anton
Analysts report that there are some signs emerging of an end to the beating taken by commercial real-estate valuations. Still, it's a bit premature for investors to go shopping for REITs in droves. Equity values could still be hit by higher interest rates and the increasing correlation of real-estate stocks with the broader market, even if the price of underlying property held by REITs stabilizes in price. In addition, REITs still face declining rents and occupancy levels from a cash-flow perspective. Most important, REITs have already skyrocketed from their lows. The Dow Jones Equity All REIT index, after losing 75 percent of its value from February 2007 to March 2009, has doubled since spring. Green Street Advisors estimates that REITs now trade at a 20 percent premium to the net value of their real estate. Moving forward, any ongoing correction in the broader market would likely have a negative effect on REITs. A rise in interest rates could also hurt. Meanwhile, commercial landlords who were able to cover interest payments because of falling interest rates will find operating harder as floating rate debt gets more expensive and rents remain weak. Finally, there is still little in the way of any concrete proof that prices have actually bottomed. Because office leases often run five years or more, rental accords signed during the frothy market are just beginning to roll over.
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Congress Worries About Commercial Real Estate
New York Times (02/01/10); Sanati, Cyrus
U.S. Reps. Paul Kanjorski (D-Pa.) and Ken Calvert (R-Calif.), along with more than 70 other House members, sent a letter to the U.S. Treasury Department and the Federal Reserve on Feb. 1 urging those agencies to take an active role in maintaining the health of the commercial real estate market. Lawmakers are concerned that the $6.7 trillion commercial real estate market could hamper economic recovery if it falters financially. The agencies were encouraged to make public statements that urged lenders to continue issuing credit for performing assets even if property values have declined. Kanjorski said, "In order to safeguard the businesses operating on Main Street and protect the millions of jobs depending on commercial real estate, the Treasury and the Federal Reserve now must take needed and urgent action to stave off a potentially devastating wave of commercial real estate foreclosures and bank losses." With about $1.4 trillion in commercial mortgages due by 2013 and 65 percent of those transactions experiencing reductions in property values, refinancing is essential to stabilize the market.
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Banks Not Loosening Credit Yet, Fed Reports
MarketWatch (02/01/10); Nutting, Rex
According to a recent U.S. Federal Reserve survey of senior loan officers at 55 U.S. banks and 23 foreign banks operating in the United States, the net percentage of banks tightening credit standards is close to zero, but the flow of credit to consumers and businesses still has not been increased. Banks cited concerns about the economy, lower liquidity in the secondary markets, reduced risk appetites, and a desire for additional bank capital as reasons why they continue to tighten lending standards. Although banks do not expect higher loan losses in 2010, they predict asset quality will stabilize. However, commercial real estate loans and other lines of credit could deteriorate in quality this year. More than one-quarter of banks surveyed tightened standards on commercial real estate loans, and 25 percent of banks indicated that demand for CRE loans had diminished.
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Commercial Real Estate to Continue to Drag Economy, Experts Predict
Buffalo News (02/01/10); Hall, Kevin G.
Experts from Moody's Investors Services, Fitch Ratings, the Urban Land Institute, and the Mortgage Bankers Association all expect the performance of commercial real estate loans to continue to erode in the near term. "We've seen delinquency rates increasing; we've seen by a whole variety of measures increased stress in the commercial real estate market," acknowledges Jamie Woodwell, MBA's vice president of commercial real estate research. At the same time, the commercial property sector appears not to be hurting the economy as much as feared, with earlier warnings of default rates of 60 percent or more fading.
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Banks Report Slowing CRE Loan Charge-Offs
CoStar Group (01/27/10); Drummer, Randyl
CoStar Group is reporting that a number of major regional banks recorded a general slowing in the rate of deterioration of their commercial real-estate (CRE) loan portfolios in this year's fourth quarter. Several reported early indicators that credit quality and portfolio performance are stabilizing. Regions Financial Corp. President and COO Grayson Hall, states, "We are encouraged by some of the recent trends but remain cautious about the pace and substance of improvement. We clearly see improvement in our credit quality metrics but remain measured in our forecast regarding the pace of improvement." However, he and other bank executives concede that non-performing CRE loans continued to mount within their portfolios. More than one-third of the nearly $270 billion in commercial real estate loans maturing in 2010 are reportedly backed by property worth less than the loan balance—a level that will likely increase among loans coming due in 2011 and 2012.
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Distressed Assets Hit $170B
GlobeSt.com (01/26/10); Morphy, Erika
Delta Associates reports that the level of distressed commercial real estate assets has increased to $170.1 billion. The pain is being felt even in historically stable markets such as Washington, D.C., where the growing level of distressed office assets is now clocking in at $1 billion. Delta Associates CEO Greg Leisch comments, "It was bound to happen. We have had a couple of national players with significant assets here that are distressed, such as General Growth Properties and Tishman Speyer." Such companies flocked to Washington because the area was perceived to be stronger and safer than most others in the country. Leisch notes, "Some of them invested unwisely as a result." Nationwide, the level of distressed assets has increased nearly 21 percent since November and a whopping 49 percent since August, according to Delta. The firm based its findings on data provided by Real Capital Analytics.
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U.S. Commercial Mortgage Lenders Shun Loans in Need
Reuters (01/20/10); Yoon, Al
Bankers attending the recent Commercial Mortgage Securities Association conference said they are willing to offer more loans for apartment building owners and other borrowers with solid cash flow and low debt, but are unwilling to offer additional liquidity to those borrowers with maturing loans at the top of the market. Citigroup reports that refinancing problems are likely to get worse as $29 billion in fixed-rate loans in CMBS mature, which is fivefold higher than that of 2009 and is likely to grow 33 percent in 2011. Unless maturing loans can reflect the lower property values and revenue seen in the market, lenders are likely to remain cautious about offering financing help. Investors at the conference suggest that the market has between $10 billion and $20 billion in available capital for 2010, but unless investors locate safer deals, they are unlikely to take the plunge. Meanwhile, the market has seen about $96.4 billion pulled from the market by major resources of commercial mortgage lending, including banks, bond insurers, and insurers.
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Market Risk
Centralized Clearing of OTC Derivatives, Devil in the Details
RiskCenter (02/05/10); Weber, Joan
A recent Greenwich Market Pulse survey indicates that about 80 percent of financial firms and other companies favor moving over-the-counter (OTC) derivatives to a central clearing system would reduce counterparty risk, and 51 percent believe the shift would reduce market-wide systemic risks. However, these same firms remain cautious about current proposals to create a central clearing system for these derivatives, noting that little has been examined about how switching to a new system would impact market liquidity and costs and the ability of firms to hedge risks. Corporates believe that notional trading volumes of OTC derivatives would decline under a mandatory centralized clearing system, while 44 percent of financial firms believe that notional trading volumes would increase. Some of the negative consequences cited by survey respondents included a rise in costs related to margin requirements and an increase in transaction costs. Corporates also are concerned that standardized contract could reduce flexibility and generate mismatches in positions and possibly disqualify trades from hedge accounting. Meanwhile, about 47 percent of survey respondents indicate that they are unaware of clearinghouse proposals and are less knowledgeable about the details of those proposals.
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Bernanke's Exit Strategy: Tighter Reserve Requirements
Wall Street Journal (NY) (02/04/10) P. A19; Kessler, Andy
With the confirmation of U.S. Federal Reserve Chair Ben Bernanke to a second four-year term, speculation continues about what the next moves will be for the central bank to ensure economic recovery. Former hedge fund manager Andy Kessler says that the best option for the central bank is to increase reserve requirements to limit leverage, which often fosters economic bubbles. Historically, the Fed seeds the market, and Wall Street firms take each dollar of that money and create $20, while at the same time banks take each dollar and create $10. Bernanke, according to Kessler, needs to prevent this phenomenon of creating money out of "thin air." He suggests an increase in the 5 to 1 leverage limit by 1 percent annually until it reaches 20 percent in 2020.
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Operational Risk
Sources: Dodd, Shelby Negotiations Breaking Down
Roll Call (02/04/10); Palmer, Anna; Brady, Jessica
Sources indicate that negotiations on financial regulatory reform between U.S. Senate Banking Committee Chair Chris Dodd (D-Conn.) and the committee's ranking Republican member Sen. Richard Shelby (Ala.) have started to fall apart. Both senators continue to disagree on how to best handle consumer protections, but despite hints of a standoff between the lawmakers, sources indicate both are still willing to try and form a consensus on the issue. Democratic staffers warn that some rumors abound that the negotiations are breaking down, but those claims could be because the people saying them do not like portions of the bill under discussion. Both Shelby and Dodd do not prefer the Obama Administration's proposal for a separate consumer protection agency, but they are in disagreement about how much power to provide a consumer protection division. Sources indicate Dodd could issue a moderate bill as soon as the week of Feb. 8.
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Volcker Urges Senators to Adopt Obama's Rules on Banking
Washington Post (DC) (02/03/10) P. A11; Dennis, Brady
During a U.S. Senate Banking Committee hearing, former U.S. Federal Reserve Chair Paul Volcker encouraged lawmakers to adopt the Obama Administration's latest proposals limiting financial firms' speculative investments using their own capital. The proposals would prevent banks from owning hedge and private equity funds and from using capital for speculative investments. However, U.S. Senate Banking Committee Chair Chris Dodd (D-Conn.) warned that these additional proposals could derail progress already made in the Senate on financial regulatory reforms. Meanwhile, U.S. Treasury Deputy Secretary Neil Wolin said, "The goals of financial reform are simple. To make the markets for consumers and investors fair and efficient, to lay the foundation for a safer, more stable financial system less prone to panic and crisis, to safeguard American taxpayers from bearing the risk that ought to be borne by shareholders and creditors, and to end once and for all the dangerous perception that any financial institution is too big to fail." The committee is expected to hold a second hearing on the proposed rules on Feb. 4.
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Wall Street Toughens its Rules on Clawbacks
Wall Street Journal (NY) (01/27/10) P. C1; Sidel, Robin
Morgan Stanley and JPMorgan Chase & Co. are just two of the financial firms tightening their compensation clawback practices. JPMorgan recently revised its rules allowing the firm to take back compensation from any employee who has stock as compensation should their decisions lead to excessive risk-taking or fraud. Compensation experts have pushed hard for clawback provisions as the public becomes increasingly fed up with the excessive pay at financial firms. However, Harvard University Law Professor Lucian Bebchuk warns, "Firms have not been providing outsiders with the information that is necessary to assess whether the clawbacks are meaningful and effective or merely cosmetic." Experts wonder if clawbacks have loss thresholds embedded in them or if only the employee placing the bet is penalized even though superiors would have had to approve the transaction. University of South California Finance Professor Kevin Murphy says, "When we pay a bonus based on certain performance metrics, we want to have the ability to, if that metric turns out to be salacious or inaccurate, to recover money from the employee later. But there isn't a lot of case history on seeing them being implemented." Since firms would find it difficult to clawback compensation on which employees have paid taxes, many of the new policies only apply to stock awarded as compensation but that is vested over several years. Boards continue to struggle with finding a balance between offering appropriate compensation to retain talent and preventing them from "gaming" the system.
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Enterprise Risk
Online Consumers Seek Out Stronger Security
Computer Weekly (01/20/10); Ashford, Warwick
Most users of online services want stronger forms of encryption, according to a worldwide RSA survey of online consumers. In the past, service providers were often hesitant to implement higher levels of authentication because they were afraid of scaring off users, but 90 percent of those who took part in RSA's survey said they would use stronger forms of authentication if they were available. Among those who use online banking services, 80 percent say they want stronger forms of authentication. Users of government Web sites, health care services, and social networking sites also called for better security measures. Given this strong desire for better forms of authentication, security is now seen as a proven competitive advantage for service providers such as financial institutions, says RSA's Mark Crichton.
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Heartland Moves to Encrypted Payment System
IDG News Service (01/20/10); Jackson, Joab
Heartland Payment Systems plans to switch to an end-to-end encryption system for payment transactions, says CEO Robert Carr, who notes that the system is "a good way to mitigate the risk of having the kind of compromise that we and hundreds of other companies have had." Previously, Heartland followed most companies in its encryption of card number databases, responding to a 2003 California statute requiring the public disclosure of data breaches. However, the numbers were decoded for use in other applications, where they were vulnerable to interception by hackers. Voltage Security's Terrence Spies says Heartland's new end-to-end encryption solution will offer retailers the ability to encrypt cards so they themselves will not store the numbers on their systems at all. The system involves the installation of a tamper-resistant security module at the point-of-sale system. The module encrypts a card's number with a public key using Identity Based Encryption when the card is swiped, and then the number is transmitted to the Heartland gateway. The encrypted numbers rather than the original numbers will be used in other database systems as identifiers through the format-preserving encryption method.
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Federal Reserve Banks Announce New Studies to Examine Nation's Check and Electronic Payments Usage
Federal Reserve Board (01/20/10); Savage, James
The U.S. Federal Reserve Banks are planning a new series of studies to examine the use of checks and electronic payments. The studies will build on data gleaned from similar studies conducted in 2001, 2004, and 2007. "The Fed's 2010 Payments Study is a continuation of an ongoing effort by the Federal Reserve System to measure trends in noncash payments in the United States," says the Federal Reserve Bank of Atlanta's Richard Oliver. The studies were commissioned to calculate the U.S.'s yearly number, dollar value, and composition of retail noncash payments. Collectively the studies supply aggregate estimates and present trends in U.S. consumers and businesses' employment of noncash payment techniques. Earlier studies have indicated a continuing reduction in the use of checks and the expanding use of electronic payments such as credit cards, debit cards, stored value cards, automated clearinghouse, and electronic banking transactions. The preliminary results of the study should be disclosed by late 2010.
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Securities Lending
Northern Trust Faces Lawsuit Over Securities Lending Losses
Pensions & Investments (02/02/10); Burr, Barry
The Chicago Public School Teachers' Pension and Retirement Fund and the City of Atlanta Firefighters' Pension Plan have filed a joint federal lawsuit against Northern Trust, claiming it breached fiduciary duty in managing their assets in securities-lending programs. The suit accuses Northern Trust Investments NA and its parent, Northern Trust Co., of “breaches of contract and fiduciary duty” in managing assets for the funds related to securities lending. The complaint charges that rather than invest securities-lending collateral pools for the Chicago and Atlanta funds “in conservative, highly liquid, ultra-short-term investment funds” Northern Trust, “instead locked those funds into risky, long-term investments - including hundreds of millions of dollars of unregistered, illiquid securities that plummeted in value.” The suit cites warnings of Northern Trust's chief economist, Paul Kasriel, including one in 2006 “that the U.S. housing market was in a ‘recession' and that the housing market would ‘pull the economy down' in 2007.” The Chicago and Atlanta funds participate directly in the securities-lending program and cash collateral pools. The Chicago fund also participates indirectly through its investment in a Standard & Poor's 400 midcap index fund, managed by Northern.
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Consumer Lending
How Banks Can Win from Being Second
Wall Street Journal (02/04/10) P. C10; Eavis, Peter
First mortgages take priority over junior mortgages, which theoretically should shoulder a loss first in any workout aimed at saving a borrower from foreclosure. Yet federal programs meant to make first mortgages less burdensome have left second-lien loans mostly unmodified, essentially giving the junior lender a free pass in some cases. This is a dilemma for the White House, as the performance of its Making Home Affordable program could improve if second mortgages took more of a hit. The median debt-payments-to-income ration of program participants winning a permanent modification is 55.1 percent—which is still high and could result in a high redefault rate—but slashing the junior debt could significantly lower that ratio.
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Home Lenders See Regs Raising Their Expenses
American Banker (02/03/10) P. 1; Berry, Kate
Mortgage origination costs have risen by hundreds of dollars per loan as a result of changes to the Real Estate Settlement Procedures Act that were implemented on Jan. 1. Given that lenders generally include compliance costs in other expense categories, it will be difficult to track the costs associated with RESPA. "[Any new regulation] first goes to the legal folks, who dissect it and figure out what they need to change in terms of business processes, then it goes to operations, who have to train underwriters and closers, and they need to change technology and protocols," says Marina Walsh, associate vice president of industry analysis at the Mortgage Bankers Association.
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More U.S. Consumers Pay Credit Card Before Mortgage: Study
Reuters (02/03/10)
New research from TransUnion shows that the share of consumers delinquent on mortgages but current on credit cards climbed to 6.6 percent in the 2009 third quarter from 4.9 percent a year earlier. According to study author Sean Reardon, "This goes against conventional wisdom and that has always been that, when faced with a financial crisis, consumers will pay their secured obligations first, specifically their mortgages." Conversely, the survey shows that the percentage of consumers behind on their credit cards and current on their home loans decreased to 3.6 percent in last year's third quarter from 4.1 percent in the first three months of 2008.
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Another Source of Woe in FHA: Builder-Run Lenders
American Banker (02/01/10) P. 1; Horwitz, Jeff; Berry, Kate
With HUD planning regular reviews of FHA loans, the financing arms of several home builders are being scrutinized because of default rates significantly higher than the national average. Some believe the poor performance speaks to the fact that these lenders are run by firms whose sole mission is to sell homes, while others blame seller-funded down-payment programs and builders' presence in overheated housing markets. Regardless, observers say HUD's plans to eliminate lenders from the FHA program if their default rates are more than double the regional rate and higher than the national rate mean that all lenders will find it difficult to continue writing FHA mortgages.
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Lenders Pursue Mortgage Payoffs Long After Homeowners Default
BusinessWeek (01/28/10); Howley, Kathleen M.
Lenders increasingly are seeking to collect unpaid mortgage balances through deficiency judgments against borrowers who foreclosed or secured short sales. The FDIC reports a 48 percent surge in mortgage recoveries to an all-time high of $1.01 billion and a nearly twofold increase in home-equity loan recoveries to $392 million between January 2009 and September 2009 from a year earlier. Real estate attorneys say the main targets for deficiency judgments are borrowers who were current on their payments but abandoned their homes because their loans were underwater.
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Mortgage Bulls Bid Fed Fond Farewell
Wall Street Journal (01/28/10) P. C1; Gongloff, Mark
While many fear that the end of the Federal Reserve's $1.25 trillion mortgage-buying spree will have dire ramifications for the U.S. housing market, a growing number of investors are confident that mortgage rates will not skyrocket when the central bank leaves the market in a couple of months. The optimism is grounded in the belief that the government will retain a major presence in the market, both via its mortgage-backed securities holdings and the generally held belief that it could step in again if the market stumbles. If this view is correct, the end of Fed purchases will have little to no effect on interest rates on mortgage-backed securities and will likely mean mortgage rates will stay fairly low.
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Respa Rule Delays Many Mortgages, Torpedoes Others
American Banker (01/27/10) P. 1; Berry, Kate
Lenders are having problems providing borrowers with good-faith estimates, now that new RESPA disclosure rules are in effect. Some report trouble with certain items such as the first month's interest paid in advance, title insurance premiums, and state transfer taxes; and some are now relying on quality-control and back-office personnel to review loan applications. Closing is likely to take longer and purchases are likely to be delayed or to collapse because of the rule, and lenders acknowledge that they are listing the highest fees possible in order to avoid a penalty.
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Housing Momentum Builds but Perils Persist
Wall Street Journal (01/27/10) P. A2; Hagerty, James R.
The Wall Street Journal's quarterly housing survey offers new evidence that the market is healing after a four-year downturn, but weakness in the employment sector is keeping the threat of more price drops alive. Inventories of for-sale homes are down sharply, triggering bidding wars in some jurisdictions. Moody's Economy.com reports that fundamental market drivers look fairly healthy in Minneapolis, Raleigh, Dallas, Houston and D.C.—five markets where mortgage default rates are below the U.S. average and local job markets are likely to outperform the country. However, areas with weak employment prospects—among them Las Vegas, Jacksonville and Tampa—posted some of the highest rates of defaulting borrowers among the 28 markets tracked.
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