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MTM and loss reserves


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I can't understand why it would make sense for a bank to be required (as some people advocate) to mark their loans to market -- wouldn't that implicitly provide a loss reserve (embedded in the market price).  So theoretically wouldn't the bank then be justified to operate without a loss reserve?

 

Just a passing thought.  Sometimes these thoughts don't amount to much -- but every now and then I see somebody advocate a mark-to-market model for banks and it makes me think of this double counting of anticipated loss in the loan portfolio.

 

 

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Well, I could think of one reason...

 

Loss reserves should usually lag the market. Bringing MTM would force banks to act faster on a change of market.

 

You are right, if a loan portfolio is valued at MTM then it should not have a loss reserve. Unless the bank is begin extra conservative or knows something the market does not.

 

BeerBaron

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MTM is raised because Auditors dont want to think and want less liability. It has nothing to do with investors inmo.

 

I think banks should choose MTM or Quarterly stress test with reserves test. The stress test could be based on loan location or delinquencies.

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Banks are required to mark the Held For Sale portfolio to market with the mark going directly to income. You hold these things for trading, so if you screw up - you take the P&L hit & reduce your equity immediately. The value of the loans is what someone else is willing to pay for them, not what you'd like it to be.

 

I sell you my bad loans for X, & agree to buy your bad loans for X. We both have a valuation sale & no cash changed hands, but neither of us will trade as we dont believe each other. Instead we'll each sell some of our bad loans to the fed in return for cash & slightly better quality bad loans. The fed takes the bottom tranche of credit risk & pushes out cash that gets reinvested in T-Bills. Each banks average loan quality & T-Bill holding rises, which reduces their capital requirement & leverage ratio. Deleveraging.

 

If the banks take a collective material writedown (ie: foreclosure mess) the process stalls & leverage ratios abruptly climb. To get the ratio back down, the banks need a collective equity issue equal to writedown.

 

SD

 

 

 

 

 

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Banks are required to mark the Held For Sale portfolio to market with the mark going directly to income.

 

I was looking at the Citigroup "Special Asset Pool" -- this is where they put their junkiest non-core assets that they are selling and running off.  The size of the pool is down to $94.8b in Q3 2010, vs $162.5b in Q3 2009.  38% of the pool is marked-to-market (including the "available for sale").  

 

What's interesting is that tje available for sale assets are marked at 90% of face value, but their held-to-maturity assets are marked at 69% of face value.  You are saying that available for sale is marked-to-market -- it just surprises me that market is 90% of face value I guess, whereas the hold-to-maturity is marked much lower.  Sort of counterintuitive to me.

 

page 9:

http://www.citigroup.com/citi/fin/data/p101022a.pdf?ieNocache=309

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HTM are bonds valued at cost + any ongoing amortization if you're holding zeros (or coupon bonds no longer paying interest). There is only a gain/loss when the bond matures at 100, or the bond is sold/transferred to HFS (deemed sale).

 

The HTM portfolio probably exchanged the better quality bonds for whatever the HFS couldn't dump, & restructured whatever was about to default bonds into long term zeros. The HTM number is probably high relative to what it iniatially was. The HFS is high because it has the best of both portfolios in it.

 

Were there a 10% drop in the HFS portfolio, the whole delta would hit their P&L immediately.

A hit big enough to really screw up their day?

 

SD 

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Were there a 10% drop in the HFS portfolio, the whole delta would hit their P&L immediately.

A hit big enough to really screw up their day?

 

It would wipe 3 months of Citicorp's earnings, and would slow the ongoing de-leveraging perhaps enormously as it would be more painful to move more assets to HFS.

 

People have been focusing on QE2 in terms of how much wealth effect it generates and how much GDP it will translate to.  But I don't think that's what QE2 is for -- if you look at what the banks need to sell in order to deleverage (top dollar for low quality bonds) then QE2 begins to make sense -- get the banks deleveraged as fast as possible and we've got a fighting chance (I think that's Ben's mentality).  Unless of course one believes it doesn't matter when banks have their capital tied up in illiquid assets.  Otherwise, I'm at a loss to understand what the real strategy is.

 

 

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People have been focusing on QE2 in terms of how much wealth effect it generates and how much GDP it will translate to.  But I don't think that's what QE2 is for -- if you look at what the banks need to sell in order to deleverage (top dollar for low quality bonds) then QE2 begins to make sense -- get the banks deleveraged as fast as possible and we've got a fighting chance (I think that's Ben's mentality).  Unless of course one believes it doesn't matter when banks have their capital tied up in illiquid assets.  Otherwise, I'm at a loss to understand what the real strategy is.

 

QE2 is not money printing as everybody says it is: it is an asset swap from higher duration assets to lower duration assets. In effect it does have a minor deflationary effect because it takes away interest baring assets and replaces them with assets without payment coupons. There is no new money in the system!

Now I believe that your thoughts are going to the right direction: it is very probable that QE2 is an additional bank bailout and a way to keep borrowing costs lower so as to allow people to refinance and borrow long term at lower rates. In essence it is targeted at a slowing housing market and may be a preemptive bank bailout. Bernanke must be freaking out at what he sees developing!

It doesn't seem to work however because rates are starting to shoot up as people are focusing on assets they can resell to the FED. Moreover it brought a frenzy of speculator that are betting on inflation expectations which is having enormous consequences around the globe. QE2 may be backfiring bad and one wonders why the FED is not letting congress and government do the job because they are the ones that should be doing it in a modern monetary system like ours. Bernanke probably saw the political stalemate developing early...

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The media plays up commodity price movements, but they are unreliable indicators of inflation. If the general economies don't also adopt those inflation expectations, with the accompanying investment and consumption that seems to be the goal of QE2, then we get another 2008 experience in the commodity markets. It's true that we get real trouble if the fast growing countries decouple their growth rates from the U.S. and cost-push us to stagflation, but that doesn't seem to be a near term scenario.

 

The Richmond Fed president gave a speech today in which he reviewed monetary actions in response to the 1960-61 recession. He noted that, rather than adhere to a rigid unemployment target, the Fed should be ready to react when the economy shows signs of moving under its own momentum.  ???... If the Fed is trying to coerce the public into building vision boards with expectations based upon artificially low interest rates, then how easy will it be to distinguish between natural momentum and the monetary push? Lockhart referenced some of the issues that made monetary looseness so sticky in the 60s and the 70s, but he didn't address how exactly the current Fed would act differently.

 

 

 

 

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