RBS CITIZENS BANK and GREENWICH CAPITAL

The Royal Bank of Scotland (RBS) has legal battles all over it like a bad rash. It had to go to the government hospital for sick banks and now it's caught MRSA (Massive Regulatory & Statutory Arraignments). There are six class action on behalf of US shareholders and a handful of fund managements and institutional investors also suing the bank including in the UK. Municipals with statutory obligations have surely no choice but to sue, especially given the latest information. All suits are based on isuuing knowingly misleading statements and witholding information from shareholders and the markets. Now, following the scoop in yesterday's Daily Telegraph these cases are looking a lot sharper and the L-word is not permissable, 'they told lies'. If ex-CEO Fred Goodwin gets to keep the £2.5m of the signed for £16m pension pot he has drawn already, then there can be little doubt it will all 9and more) go to defence legal teams. Likewise, Larry Fish possibly and his $24m pension pot, ex-CEO of Citizens Bank (US 6th or 8th biggest bank), a fully-owned RBS subsidiary.
Statutory prosecution of bank execs in the UK would be a step forward. Ireland has already changed the law to allow the police to investigate Anglo-Irish Bank. But for RBS the main prosecutions may be in the USA, where we can surmise that Sir Fred is unlikely to travel to willingly. In the USA, already 2-300 bankers have been arrested and charged by the FBI. The main charge is saying one thing in private and the opposite in public, equivalent and comparable to 'insider trading'. The Telegraph article puts all this is into sharpest focus, headline, RBS traders hid toxic debt. Billions of pounds of “toxic” sub-prime mortgages were bought by Royal Bank of Scotland traders in a spree that was not disclosed to the bank’s board.
At first this sounds just like UBS where the structured products division trading and investing in over-valued securitisations and placing total return assets (buying toxic ABS 'income' and all the risk, but not the underlying instrument) into their pension customers investment account, which was in my opinion criminally inappropriate, and who then refused to expose their accounts to the board, or like Fortis where toxic assets were not, or could not, be properly accounted for in the bank's general ledger, or Bradford & Bingley where the execs deployed the excuse that they just didn't know because the accounting system didn't tell them! But the RBS case now goes further than that! One of the major issues in the credit crunch has been how quickly shareholders and markets disbelieved banks audited accounts. This is extremely serious both for the public companies involved and for the big 4 audit firms. Why did the auditors not forensically spot the truth of asset qualities? Their defence is that there are limits to how deeply they can investigate and their purview does not extend beyond 1 year solvency or to risk statements (Basel II Pillar III etc.) In RBS case the balance sheet expanded from £1.8tn to £2.4tn while fees to the auditor Deloitte grew from £31.4 million to £58.8 million. In 2007 Sir Fred was obsessed with buying ABN AMRO and part of that was an obsession to buy the bank's structured products holdings! On both RBS in America's toxic purchases and that of ABN AMRO the bank has had in each case write-down losses of at least £10 billions! And RBS didn't even manage to get hold of AAB's fabulous modern art collection! Fortis Bank, one of RBS's partners was equally purblind, perhaps Barclays also, so there may be some defense in numbers there? But, now we have a wholly different context where all-powerful governments call the shots. The UK Government first injected £20bn into RBS and provided over £1tn in additional support through loan and deposit guarantees, including guaranteeing the US balance sheet, and maybe £50bn into the SLS, and now, with new management in place under the impressive Stephen Hester, has most recently taken £325bn of somewhat impaired, or possibly quite toxic', assets into the Bank of England's APS (after a steep haircut of probably 25% in exchange for a BoE cheque kept on deposit at the BoE) plus another £12bn or so in fees taken as shares. £800m of this support has gone in to top up the RBS pension scheme that is £1.9bn under-reserved, a heady context for the issue of Sir Fred's and Larry Fish's golden-goodby pension bonuses!In raking-over the charred remains of the banking crisis, there is also much now being proposed for beefing up the power of non-execs and ensuring they challenge the executive and truly represent shareholders interests and oversee regulatory compliance and listen confidentially to whistleblowers. The latest RBS story also goes there by informing us that the non-execs were misled. That is something I think can be questioned, however. How is it possible they were blind to what RBS Greenwich Capital states proudly on its website (in the past and even still today about being a top player in sub-prime securitisations), or that there was a reason why 6 top managers were resigned at RBS GC in 2007, and how this cannot square with fred goodwin claiming he did not understand the fall in market value of Asset Backed securitisations (ABS) until early 2008 (a full year after the start of the crisis and more than 6 months during which ABS bonds risk gradings had been falling of the cliff once Moody's announced how flawed its risk-grading models had been)!
The telegraph story says, "Sir Fred Goodwin is under pressure to disclose what he knew of the sub-prime trading. Traders received multi-million pound bonuses after acquiring more than £30 billion of sub-prime assets during early 2007. Following these purchases the bank “didn’t stand a chance” of surviving unaided, one board director told this newspaper. The sub-prime assets are being blamed for causing the bank’s near collapse last year.
Last month RBS posted a loss of £28 billion – the largest in British corporate history...Sir Fred Goodwin, the former chief executive of RBS, is this weekend under pressure to disclose what he knew of the sub-prime trading. He repeatedly put out statements to the City saying that RBS “don’t do sub-prime” even though traders were buying the sub-prime assets. RBS board directors suspect he may have acted negligently. British taxpayers are being forced to underwrite the toxic loans bought undisclosed by executives working for RBS subsidiaries in America. In a series of interviews with RBS board directors and other senior insiders at the bank, The Daily Telegraph has discovered: Sir Fred did not tell the RBS board about the multi-billion pound decision to start buying sub-prime mortgages from other banks. RBS began buying up about £34 billion of sub-prime assets that US banks were offloading. RBS was unable to sell the assets on as planned, leading to the taxpayer bail-out. The system of annual cash bonuses encouraged bankers to buy up the assets with insufficient regard to the risks involved... Sir Fred told the RBS directors’ board in 2006 that the bank would not be moving into sub-prime mortgage lending... two senior RBS directors have claimed that the information provided by Sir Fred did not reveal the whole picture.
It is claimed that the former chief executive later disclosed that the bank had built up a multi-billion pound exposure to sub-prime mortgages during this period. Sir Fred is under pressure to disclose whether he sanctioned the hidden deals or whether he too was unaware of the strategy... A former RBS board director claimed: “Sir Fred told the board that the bank was not exposed to sub-prime. Only a year later did he inform the other directors that the bank had, in fact, built up a multi-billion pound exposure.” Another board director claimed: “Citizens Bank [a subsidiary of RBS in America] went and bought up packages of sub-prime mortgages. They didn’t go to the board for approval. That was a mistake. “People at Citizens were severely reprimanded for their actions, the board did not know. As soon as we knew, it was disclosed but it’s pretty stupid in retrospect. I don’t know whether Fred knew about the sub-prime deals.”
The disclosure raises serious questions over Sir Fred’s role in the decision-making process. The RBS board is legally responsible for scrutinising key decisions made by executives at the bank. If it is established that key information was not disclosed this could have legal consequences. The Financial Services Authority is this weekend under pressure to launch a full investigation ... The SEC.. has already launched an investigation into RBS’s involvement in the sub-prime market...Vince Cable, the Liberal Democrats’ Treasury spokesman, said last night: “It is very clear from the evidence that there was a major failure of corporate governance at RBS. We need a proper investigation into whether negligence was involved in the decision to build up all these toxic assets. The lack of criminal investigation in this country compared to America is very striking.” The Daily Telegraph has been told by several RBS executives that internal controls on the risks being taken by the bank were not adequate... During a board meeting in the summer of 2006, Sir Fred was asked by fellow directors whether the bank had any plans to move into the sub-prime market. He told the board that the bank would not move into sub-prime and that, as a result, “RBS is better placed than our competitors”. In the foreword to RBS’s 2006 annual report, published in April 2007, Sir Fred wrote: “Sound control of risk is fundamental to the Group’s business... Central to this is our long-standing aversion to sub-prime lending, wherever we do business.” However, RBS insiders acknowledge that these statements may not have revealed the full picture. On April 13 2007, New Century Financial, one of America’s largest sub-prime lenders which was facing bankruptcy, disclosed in a Delaware court that it had agreed to sell... sub-prime mortgages to ...RBS Greenwich Capital Financial Products. Another major US sub-prime lender, Fremont General Corporation, had a $1 billion line of credit extended to it by RBS around this time. Citizens Bank, RBS subsidiary, began buying up existing sub-prime mortgages from other banks from late 2006 – allegedly without seeking approval from the RBS board. It is claimed that it was not until the summer of 2007, as Northern Rock was facing meltdown, that Sir Fred told the board that RBS had, in fact, built up a substantial sub-prime exposure. Its investment banking division had some £20 billion of sub-prime assets. Citizens Bank had about £14 billion worth of sub-prime exposure. By the end of 2007, RBS was beginning to announce losses – or write-downs – on the value of sub-prime assets that had been secretly amassed. The majority of the bank is now owned by the Government. Last night, Sir Fred declined to comment as he is bound by a confidentiality agreement. A spokesman for RBS said: “The reality is that, like many others, RBS was heavily exposed to problems in sub prime markets via its own operations and those inherited from ABN AMRO. This is despite the fact that we did not engage directly in sub prime issuing. The Board was in possession of full information and the details provided to the market in all financial reporting reflected the Group’s honestly held opinion at the time.’’
What we have from this is that the board knew well from early 2007 that sub-prime securitised assets needed to be stringently avoided. When Sir Fred told the Treasury Committee House of Commons board of enquiry that he did not appreciate the dangers until early 2008, how can he square this. Can it be that he and other exec directors were misled by RBS Greenwich Capital (RBS-GC) and Citizens Bank?
Do the directors never read their own web-sites? RBS-GC made it banner-headline clear for years on its website, "We are an industry leader in the U.S. Treasury, agency and mortgage-backed securities markets, and in providing real estate and asset-backed financing." It is hard to be sure, but I reckon RBS-GC arranged and underwrote at least $1 trillion of securitisations, much of it of low quality. Market share and fees were pursued at the expense of quality and liquidity risk. Even today, under a picture of a leopard leaping over a chasm, in the RBS main website, the bit for Corporate and Institutional structured products, we read "... our structured credit online toolkit can help you to make the most of the structured credit derivatives market". The brochureware continues, "A streamlined, one-stop shop online solution, the toolkit delivers quality and transparency of workflow from start to end of the process, enabling you to pursue opportunities and efficiencies in credit risk.The toolkit delivers:Comparisons between credits/ Historical data and spread variation plotting / Spread analysis capabilities / Portfolio simulation/ Benefit from our structuring and distribution across a wide range of structured credit products from cash and synthetic CDOs to structured notes and exotic credit derivative products, including first to default baskets." Where was that toolkit when the board needed to us it for its own portfolio speculations in 2006, 2007 and 2008?

LLOYDS BANKING GROUP'S NATIONALISATION DEAL. BUT, IS THIS DONE WITH TAXPAYERS MONEY?

Today, Lloyd Banking Group, LBG, after a deal with officials and advisors of the HM Treasury Team (pictured), became a government controlled bank. The Treasury Team should never be under-estimated. These are heavyweights. If they were a rugby team they would look like a front row. If HM Treasury was a bank, and actually it is, arguably more of a bank than the Bank of England, it could be classed as the world's biggest after the US Treasury, including as it does the world's biggest commercial bank holding company, UK Financial Investments Ltd. (Assets about $4 trillions). But as in any bank's published accounts you will not find more than the tip of the iceberg of transactions data, and the big ticket items are off-balance-sheet. The media write of taxpayers money to bail out banks and taxpayers taking over Bank A or B and having the right to worry about that. But will this so-called taxpayers money appear in the budget plan and accounts to be presented to Parliament very soon - er, no! How should we understand this? Are taxpayers being burdened with financial risk or future long term debt, or not? Is taxpayers creditworthiness being leveraged, borrowed against, future revenue streams packaged up like securitised bonds have packaged up anything from mortgages and credit card receipts to insurance premiums and lease-finance hire-purchase payments? Is the money in some abstract way coming from 'the real economy' so-called, from real taxpayers, and are any gains or losses going to the accounts of taxpayers or somewhow to and from the whole economy? How can these numbers we read about grow to be the same size as GDP (annual National Income) or even be several times bigger? What is the real budget deficit, the real national debt today? It may sound irritating, amusing or churlish, but it would not be far-fetched, impractical, or unrealistic, to answer that actually all this is part of a 'parallel financial universe', certainly not directly part of National Income and Expenditure, not on the Government's HM Treasury budget, and only about as connected to taxpayers and the real or main economy as the huge turnover of financial transactions in the global financial markets churning through London are so connected. Most readers should at this point feel quite lost, as perplexed as they have a right to feel in front of a Picasso. Is this a global financial Guernica? Have we been bombed to shreds, or showered with money? Anyone who does not feel at least a bit lost, may I say you are uniquely strange, For more normal types, even all those working telephone numbers in banks, finding answers is surely like trying to find the light switch in a strange room. It's not by the door but under some elaborately fringed standing lamp by the Ming vase in the far corner, and to get there is an obstacle course of delicate groping in pitch-black by blind-touch through a treasure room of precious antiques! We have been living in a fiction for too long that everything government does financially is taxpayers income and expense. Er, sorry but no. Government is itself a financial behemoth, generating its own financial flows, its own output and income, with massive borrowing rights, enormous assets, huge creditworthiness. As taxpayers we are merely the equivalent of policy-holders paying our annual premiums, our daily and monthly duty-tax payments, and some of us making claims and all getting some services, access to roads, street lighting and sewage etc. sometimes cheques or giros in the post, and one in seven of us with jobs work directly for 'public services', most of those in education and health. Government is a 'mutual' financial institution and we are all, whether taxpayers or not, are policy and account-holders. And some of us are bondholders too. But we are not shareholders even if we do have shareholders votes every few years to appoint a new board or keep the existing one, and we get to appoint several hundred non-execs who we trust will do their best to hold the board to account. I can't decide if the democratic-taxpayer-fiction is also fact and should be cherished or challenged. But, I'm constantly being tasked at dinner parties or by friendly bar-flies with the question "well who's money is it then, where does it come from, are we paying for this or not?" The public interest takeover followed LBG's ill-fated (in the short term) takeover of HBOS. Agreement finalised late last night, friday, will see 'the taxpayer' (actually, Government’s “arm’s length” agency UKFI Ltd.) take an economic stake of around 77 % with 65% voting rights in return for insuring £260bn of toxic assets at a fee cost of about 6% and the same again annually, based on the current credit default rates that have spiked up to 6% where they were briefly when Lehman Brothers collapsed. Lloyds shareholders can clawback some of the new shares at 38.43p per share—a slight discount to Friday’s closing share price, which is half what it was only days earlier. Lloyds is clearly too cash-strapped to pay the fees for this in cash, which greatly surprises me and suggests that while the Asset Protection Scheme (APS) route is available to it (the so-called asset insurance option) the Bank of England’s Liquidity Window is not. It has also been stated that LBG is paying more than what RBS paid a few days earlier – possibly on the day CDS spreads were lower? Lloyds will issue non-voting, dividend paying B shares to the Treasury (taking economic ownership interest to 77%) just to cover its £15.6bn fee to join the government’s APS. The media dub this a scheme for insuring “toxic assets”. Are they ‘toxic’. I doubt that. I suspect they are, if toxic, mostly already written-down assets and otherwise they are bonded assets containing mostly high-rated regular customer loans – but that’s just a guess. The real purpose is to provide funding for the bank’s ‘funding gap’ that just this Month became suddenly very expensive (spiking just as last March and again in September when Lehman Brothers collapsed and credit insurance jumped dramatically for which the market proxy are Credit Default Swap spreads) and cannot be obtained from private funding sources, not cheaply anyway, only from government and central banks by swapping loan assets for treasury bills. But then the government is not offering a cheaper deal either? In fact, one irony is that the cost of insuring bank credit has jumped precisely because of political fears, the fear that government may force bank bondholders to swap their bonds for equity shares. Who or what has forced who into this deal is unclear. Maybe Lloyds found its access to the Bank of England (BoE) liquidity window for assets swaps for treasury bills is shut! Maybe the government needed to be seen to be doing something dramatic because CDS spreads have spiked up and therefore order Lloyds to the deal table by wielding a BoE stick and the only carrot being it was prepared to do a deal that in one go would supply the bank’s funding needs for all of 2009? But, where did the CDS spike come from? CDS spreads represent the cost of buyin insurance cover for loan defaults in CDO, but not entirely that. CDOs (bonded combinations of corporate debt instruments and other ABS) and Synthetic CDOs are markets also unto themselves, greatly exceeding in face value the underlying assets. These are tradable insurance policies that because they move up and down in price are speculations where for very little downpayment very large bets can be taken. The market prices spiked up on news of problems including possible partial nationalisations of Citigroup and Bank of America, and following the ham-fisted announcement that AIG had drawn down $55bn of its standby $80bn already authorised to cope with a quarterly, mainly paper, loss of $60bn. This is the downside of globalised financial markets, a panic reasction in America travels round the globe and forces UK government to nationalise Lloyds.
The prospect of increased government control will pile up resign pressure on Sir Victor Blank, the bank’s chairman and Eric Daniels, chief executive who orchestrated last year’s rescue deal to buy rival lender HBOS, which last week reported a £10.8bn loss. Removing Daniels and maybe his team would I judge be a disaster. These are bankers who very much seem to know what they are doing and have implemented an intelligent approach to restructuring their bank. But even they cannot it seems move fast enough to avoid nationalisation. They could perhaps have done more before the merger to securitise and swap more assets and build a large funding surplus last year when the SLS was open. But that now is merely hindsight.
One large investor said last week that Sir Victor should resign given the damage that the ill-fated HBOS takeover had wrought on Lloyds. That is poor if coming from institutional investors who supported the merger, some of whom were looking to buy parts of the new group cheap, and all of whom have ample analysis and research to back their judgements.
Lloyds admitted to thje Treasury Committee that it would not have needed any taxpayer money if it had not bought HBOS and that it could have done more due diligence? £150m and 3,000 man-weeks or whatever the resource committed was, was not enough? That I don’t buy! If anything, Sir Victor and Eric could rue that they did not agree to the merger being referred to the Competition Commission, which would have given months more of time to plan and re-structure. Eric Daniels told MPs that Lloyds had carried out ”three to five times” less due diligence than normal on HBOS’s balance sheet before agreeing the deal. That was probably true before 18 September, but should not have been true for the months thereafter. In any case, what we have here is further indictment of audit firms and annual and quarterly accounts presentations. Strictly speaking all that should be needed to know should be mostly gleaned from trustworthy published accounts.
The deal is will anger shareholders who believe buying HBOS severely damaged Lloyds like buying ABN AMRO damaged RBS. This is all true, except that Lloyds while not “directly” exposed to sub-prime and other toxic assets does have indirect exposures. These days bank CEOs have to become super-heroes, battling against time to save their banks and thereby save the world. Unfortunately ehat they have to say doesn't quite capture the excitement and drama of what they are up to. Daniels, the Spiderman of LBG, said: ”Our significantly enhanced capital position will ensure that the group can weather the severest of economic downturns and emerge strongly when the economy recovers. We believe this is an appropriate deal for our shareholders.” I agree and trust him on this, but the question for shareholders is can they afford to hang around that long? Will he have any left by then. Avoiding 100%nationalisation is important, if for nothing else than to be in the stock-market when recovery returns and thereby greatly boosting the equity of the bank, hopefully by leaps and bounds, and thereby also profitably rewarding Government and having a transparant and open and regulated marketplace for formally attracting private investment to replace Government backing.
Lloyds had, in recent years especially, been seen as a prudent and cautious bank, even deeply traditional and over-conservative, hich is not really true, just more fiction, but I believe Daniels on that score of being conservatively risk-averse when reading and listening to his statements about the bank’s risk policies.
Many shareholders believe that the toxic assets sitting on HBOS’s balance sheet threaten to poison Lloyds long, medium and short term. I don't agree at all. Except for corporate lending to property companies, I see no other evidence of that. Mostly what we are dealing with here is waves of loss of confidence washing across the pond from the USA. And if problems do not hit banks from one direction it will be afrom another direction. Banks of all kinds and in all states iof health have been variously damaged. Lloyds said on Saturday that APS scheme transfers significant risk away from shareholders and would significantly bolster its capital base. I think this is the wrong spin, far better to say it solves the funding gap refinancing problem! In time the HBOS deal will be a ”very good purchase” over time for the bank. I opposed this; after all what does any one bank matter in the wider scheme of things. What difference would it make if LBG is one bank or two banks? The only wider benefit is that one bank’s bad management is replaced with the combined bank’s much better management.
Daniels took a top-down very conservative view of the HBOS book which I find praise-worthy (see http://lloydsbankgroup.blogspot.com/2009/02/lbg-goodwill-hunting.html ).
Yet, the FT reports about the APS deal, “Details of the scheme show that around 83% of the assets which Lloyds plans put in the scheme are coming from the riskier loan books at HBOS. Lloyds said by putting the riskier HBOS assets into the scheme it has reduced the concentration of risk across the merged bank.” But, the total of HBOS assets deemed riskier than Lloyds would have permitted is only about £160bn of which £80bn is ‘bad bank’ work-out assets that are remotely ‘toxic’, according to the February published 2008 annual reports. If ‘toxic’ is used generally for any loans where defaults are expected to rise higher than where they are today, then all asset classes, all risk bucket, are ‘toxic’. But, the better definition of ‘toxic’ is sub-prime mortgage-related securities, bank and non-bank corporate junk bonds, their credit derivatives, and equity and mezzanine tranches of related securitised bonds. Taking that more precise classification, therefore how can 83% (£216bn) be deemed relatively toxic out of the £260bn APS total?
The 2008 annual reports were very conservative by using the worst M2M proxies of CDS spreads. Therefore, the underlying was probably not nearly so bad. All we really know is thatn around £74bn of the assets put into the scheme are residential mortgages, £18bn are unsecured personal loans, and £17bn is riskier Treasury assets linked to US sub-prime mortgages, or $109bn. £151bn - are corporate and commercial property loans written by HBOS’s corporate bank. That is what LBG inherited from Mr Peter Cummings' dealings (he also of multi-million salary and multi-million pension bonus) and is the total HBOS corporate loan book. Maybe shareholders should sue him? But, these loans are all mostly highly-rated regular quality assets, except for about £80bn that needs special attention, and let’s not kid ourselves about property and construction loans, many property developers always go bust in any property market crash. We all know that, don't we? banks know to take these hits and move on. Lloyds under the scheme (on the now classic SIV securitisation model) will absorb the first 9.6% (late 2008 sub-prime default rate in the USA) or £25bn of losses and will retain a further 10 % of further losses and Treasury 90 % of further losses. The Treasury is only going to have to pay up if the roof is totally blown off our economy. This is Tsunami or Hurricane insurance. To get there, to loan loss provisions that the Treasury will pay compensation for, requires 300% increase in current default rates, and a 600% rise in only a year before it makes a cash-flow accounting loss! Lloyds’ £15.6bn fee to the Treasury will be amortised over a 7-year period, and therefore any pay-out maybe can be too. The proceeds of the fee will be applied by the Treasury in subscribing for B shares which are non-voting equity paying a dividend of 7 %. This is generous to HM Treasury, and no doubt why Lloyds prolonged the negotiation to try to get a better deal. Amortising any outcome though must have looked OK. For fuller discussion including about Quantitative Easing and how Bank of England cheques will replace treasury bills in this asset for funds swap see http://monetaryandfiscal.blogspot.com/
At my dining table I've noticed HM Treasury officials getting more attention that investment bankers. As a sign of the times the latest James Bond, Casino Royale, features an HM Treasury agent, 'Vesper Lynd', assigned to supervise Bond and finance his poker table exploits. That sums up exactly what we want, someone to supervise our banks gambling habits. It is in this context we also have to understand the Asset Protection Scheme, APS. LBG is the second bank to take advantage of the government’s APS after RBS announced it was putting £325bn of assets into the scheme in a move which is expected to lift the state’s 70 % ‘economic stake’ in RBS up to as much as 95 %. The government’s voting stakes in both banks will be capped at 75 %, which is the threshold in the USA before the balance sheets come ‘on-budget’ of Federal finances, and may be the threshold operating in UK also.
Lloyds’ fee is high compared with the £6.5bn fee paid by RBS to insure £325bn of assets. Why? I do not believe that LBG’s assets are more toxic than RBS assets given RBS’s much larger US exposure especially via Greenwich Capital? I suspect it may reflect the innovative style of LBG’s risk accounting and its more conservative and global assessment than RBS’s accounting. If so, then that is an unfair and unreasonable penalty for being more risk averse and more honest about accounting standards! I suspect Daniels found himself unfairly cornered between ‘the fire hydrant’ and the ‘junkyard dog’ (my new kindly-meant terms for HM Treasury and the FSA). RBS will only shoulder the first 6%, or £19.5bn, of its assets defaults. This seems unfair. It may have something to do with differences between LBG’s SIV structures and RBS’s SIVs or covered bonds given that RBS’s US$ assets have the benefit of a 30% exchange rate gain against sterling with which to offset credit risk losses? However, unlike RBS, Lloyds is not giving up tax credits to help reduce its fee. RBS gave up £4.6bn of tax credits to help pay for the scheme. Also unlike RBS which raised £13bn of extra capital to help cover its first losses, Lloyds is not raising any fresh capital. Lloyds will also gain £194bn of expected risk weighted asset tax relief compared to £144bn at RBS because the riskier loans put into the scheme will have required Lloyds to hold a high level of capital against them. Lloyds said that as a result of the new B shares and conversion of preference shares, its core tier one capital ratio- a measure of financial strength - will jump from 6.4 per cent to 14.5 per cent. This is high. As part of the deal Lloyds has said it will increase lending to mortgage borrowers and small firms. It will offer a further £3bn of mortgage lending and £11bn of small business lending in the next 12 months. A further £14bn is committed for the 12 months thereafter. To my mind that seems not a lot of growth on the £1tn or so of assets left on the bank’s books! It might be something if despite all the restructuring this year the bank’s domestic loans will be £14bn higher at the end of 2009 than at the beginning of the year!

FSA OR A JUNKYARD DOG?

A supposed banking risk expert from group audit and other parts of his bank's senior-most management asked me today, "doesn't the FSA need a comprehensive rulebook, I mean something solid to supervise and regulate by?"
I know many people are asking such questions including the Treasury Committee, but I nevertheless fell off my Corney & Barrow barstool, or actually didn't, or did both, as I was clearly in a parallel financial universe. I said something sarcastically cutting and followed through with a description of Fred Shredinger's Paradox about whether ICAAP and SREP are in the structured product bucket or outside dead junk in the trading book, or both at once, and how he should remember what Neil Bohr said about how we can't use atomic particle physics to interpret what's really going on in the world, you know, Einstein or Newton or both? He nodded since that being what he'd studied at Cambridge before 2 years at the other Cambridge for a Harvard MBA. Of course the FSA has rulebooks, I said, spluttering on McFall's whisky, the FSA handbook of Rules and Guidance, the Prudential Rulebook and all the rules that are laws of the Capital Requirements Directive, the CRD, based entirely on Basel II with Solvency II, set out in 3 Pillars, thousands of pages, supported by hundreds of research papers, and tens of software systems in the IT market to implement this and that, and fulsome accounting formats and standards mandatory by law, IAS to IFRS... and, by the way, you need a super-computer to do it properly and a new general ledger system, and, above all, people who really know what they're doing, which over 90% involved in Basel II implementations don't much and care less, and some uncompromising know-all in charge with a seat in the boardroom!
The audit-jockey I was berating also moonlights as a rocket-science (crash 'n burn) fund manager, heavily invested in, while trading and short-selling, financial stocks, who thinks capital adequacy should have naff-all to do with his shareholder value, which he moaned seems to have eff-all to do with anything anymore, this 2 days after HSBC shorted 20% of its own shareholders, with another 20% to be sold short and only for the sake of $12bn acquisition funding, masquerading as 'new capital' to bolster the bank's capital adequacy reserves that are well upholstered already!
Anyway, somewhat un-phased, as only theoretical-mathematicians and geneticists can be, my bar-fly banker, who works managerially for group finance in treasury and for group risk with responsibility for Basel II MI, and on liquidity funding, and counter-party limit-settings, which combination, strictly-speaking, is illegal, but commonplace enough for him not to have to know that, starts telling me what's wrong with the FSA! He said he read and agreed with the view that the FSA approach is too light—touch, regulation by principle of negotiable guidance, not by "firm rules of laws" (sic), and while this "old-school tie, old boy, we're all members of the same British Bankers Club" (and him, double-Dutch), approach that once seemed so much more enlightened, but now when compared with the SEC’s lawyer-intensive way of sending in the FBI, and/or the armed terrorist wing of the IRS, at any opportunity to grab the files, and enforce through the courts if needs be every line of huge fat SarBox + B2 volumes of Germanic rules, shows that maybe the softly-softly British way is no longer appropriate in today's distressed and discredited markets - what did I think, I must agree with him, surely? GROUP RISK MANAGER
Apart from telling him he better pay for lunch or I'd throw him over the hurdle rate onto the ice-rink where he belonged, I explained without nuance that he was talking foolishly and if I was his boss he'd be sacked forthwith and sued to repay his last three years' bonuses! Such thoughts make one nostalgic for the good old days when that was, effortlessly, good management practise, but also, I knew, just the unkind sort of rough-play the Dutch take to like speed-skaters on thin ice. This delightful thought sent me off on another rant about today's HR sacking-culture - all about setting colleagues against each other, colleagues all to ready to re-play I Claudius and variously like so many Shakespearean Iagos determine who stays or goes under the ridiculous pretense that every department will face the same equitable %-cuts and can be trusted to sort that out sensibly themselves! Democracy is not something to be welcomed as a principle to be applied when determining which heads must roll! Modern madness, banks are never 'democratic' at any other time, and only pretend to be when making cost-savings! I told him that the FSA's rules are excellently documented but obviously not so that he can both read and understand them, and that they have the force of ARROW reviews, and that even the most under-stated, politest, kindest of warnings from the FSA should be heeded as if delivered with electric-shock stun-guns and cattle-prods, and thus responded to with all urgency, the best brains and highest seniority the bank can muster! But, such is the multi-cultural mix of The City, such perforce opinion is not clearly doctrinaire enough - I might as well have asked him about the risk-management of his ski holiday and whether he's planning to get his yacht out in April, or plans to leave it in the Adriatic near Split until the calmer seas of May, or what he thinks about Quantitative Easing, the QE of EQ without IQ, and its possible impact on interbank lending - answer, zero, he said - another foolish supposition I noted querulously. TRADITIONAL TRANSMISSION MECHANISM BANKING
He said, you know, clients used to think AAA meant something solid, when bankers were respected and respectable, and when central banks and Treasury officials seemed to know what they are doing. He had been at yesterday’s well-attended TSAM conference in London where some experts said they'd concluded, no doubt after long contemplation, that now it's time for the FSA to give up on principles and spend more effort to clarify the rules! I asked who where those, obviously self-styled, 'experts'. He said one is Tony Kirby, now of Ernst & Young, who said he'd "decided principles are a bloody mess. No one is quite certain how to put the principles into effect.” You run into problems of the Common Code vs. Code Napoleonic, among other problems. It's all just "guaranteed to keep the lawyers and advisors happily fat-fee-earning. We need clarity on what is useful, not just what are great debating points.” The other was Bob Gifford, a consultant and author, who chaired the session and who agreed that principles-based regulation created problems and its time is over. MODERN BANKING A LA JEAN TINGUELY, BASEL
I choked on my bearnaise, making the soggy pommes-frites soggier, and said they're talking aping gibberish; all the FSA's CRD principles are clause and sub-clause parts of statute laws (some of which will soon become part of case-law too) and all that differentiates principles from rules is that the former require the bank to invent its own way of implementing while the latter are laid down in precise equation detail. There are good reasons for this, and not just because the banks couldn't or wouldn't agree details in committees. Principles are neither optional nor any less mandatory just because they are not specified in precise atomic detail. Furthermore, if the principles were so defined the banks might foolishly imagine they can be dealt with in separate silos when all CRD principles require for their application to be across everything in the bank!
I said principles are macro-details and macro-definitions. They are the mainstay of Pillar II, SREP, ICAAP and scenario stress-testing to determine capital reserve requirements via economic capital models, with all data triangulated by conjoining different business perspectives, and forecast precisely, as best as can be done with the best resources, not powerpoints and spreadsheets, calculated for the coming months (short-term, <1 yr) and over the medium-term (>1 year/s) and they must be applied empirically top-down and bottom up and spread across all activities, business lines, and branches of the bank, to give both detailed guidance to all staff and holistic but precise in all directions for all senior management.
If a bank wants all that in firmest micro-detail it would require many time more volumes on top of the 20,000 or so pages of risk regulation already delivered! But, if the bank cannot translate such principles comprehensively, which obviously he and these experts' banks cannot, then they deserve to lose their banking licenses or get new management appointed!
I said, if you, your bank, and other banks, want the FSA to come down hard then why aren't you all saying so in consultative committees and to government. I'll tell you why, because you're trying to blame the FSA for your own failures at every level in implementing Basel II. It is not that the rules and guidance and principles are not clear and perfectly modulated and detailed insofar as any such human endeavour of such complexity has a right to expect to achieve at law, it is because it was so good that you failed to even read it, preferring the consultants' and audit firms' powerpoint slides, the comic-strip versions, and why that, because most of you so-called 'bankers' aren't; most of you haven't much of a clue, never been properly trained, don't know what a whole bank looks like, beyond your own little sordid bits of it. I said, you're so up your own and each other's end-of-year bonuses you can't take any responsibility for anything that is to do with the long term health and soundness of banking, nothing remunerative outside of your own personal income. Heads were turning, but few clapped as I called for brandies and cigars only to regret again for the millionth time that smoking is regulatory, legally, verboten!

BASKET CASE OF A BASKING SHARK: ANGLO-IRISH BANK

If investment banks were fishes they'd be sharks, never stopping in their search for profitable prey, ready to eat anything that looks or smells remotely tasty. But, if traditional banks were fishes they'd be toothless basking sharks, constantly hoovering up tiny payments and passing out loans through their gills. Anglo-Irish Bank, in these terms, called itself a basking shark, very common off the west coast of Ireland, but was it?
On the 9th September last, where else but at Lehman Brothers Financial Service Conference, Willie McAteer, Finance Director and Chief Risk Officer of Anglo-Irish Bank, presented a glowing account of his bank, watch-words, "balance sheet: old fashioned banking", "we lend against cash-flows not asset values", and with ratio statements like "customer loans €69bn, permanent funding €80bn" (Euro billions), customer and term funding = 116% of loans, "no requirement for external equity capital", core equity = 7%, "resilient and strong business model". McAteer also vouchsafed, "Significant market shift to “Balance Sheet lenders”, the upside from "Changed competitive landscape –exit of non-bank lenders", "25 years of performance through cycles –strong asset quality culture", a "Franchise strength with huge organic potential in existing markets" and a "Long established management team", that gives "Consistent delivery for shareholders". And the bank's strapline motto: "There is a difference!" The difference was that all the above statements were outright lies, and had been lies for years, and not just because of what happened later. Days later, the bank was staring at a run of Eur5bn in deposits heading for Eur12bn, when Lehmans went bankrupt, 3 days after its splendid conference, and Anglo-Irish had to be nationalised (of all banks in trouble after Lehman, only this one was 100% nationalised, and Fortis, except for parts to be sold to BNPP), after a short agonising debate within the Irish Government of whether to let the bank collapse or not. And, of course, all the shareholders were wiped out and the top executives and board terminated. A law was passed to allow criminal prosecutions and the Gardai (police) went in a few weeks ago.
Those of you who know about regulation will have spotted the obvious breach of CRD law that McAteer was both Finance Director and Chief Risk Officer! Pity the IFSRA didn't spot that one?
Let's now look at just why all the above statements by McAteer were blatent lies. The answers are to be found in a strictly private and confidential report for the IFSRA that has come into my hands today via the web-site of Anglo-Irish bank International. I've rarely had to read something so oddball as this PwC report in its reluctance to call a hook a hook, but it manages to show what the truth was, if you know how to read between the lines. Also, what is said of the bank in my opinion also clearly applies to HBOS's corporate loans property portfolio. The report implies Anglo was not risk-averse enough because the bank's business model seemed to perform well for years. It may have survived downturns before but was swimming into this one with foolish self-confidence.
Any risk-diversification in the bank's loans was merely by types of property, and property by business sector. Collateral was personal assurances & guarantees, but fallen in value. €2bn of treasury assets for sale alone needed writing-down to an extent that would wipe out at least 2 yrs profit. These Banking Book Assets (Available-for-sale) of RMBSs, ABSs, CDOs were €1.9bn difficult to value i.e. illiquid in current market. Impairments were absurdly recorded at below 1% of loans - easy to cover - probably because collateral had not been risk-checked and continued to be booked as of 'senior' high quality only. At the same time it was clear that the bulk of borrowers of big ticket loans are highly leveraged property developers, hence why the bank's covered bonds require 57-100% over- collateralization to get a AAA rating (400 loans at an average of €15m). By the 27 Sept. '08, Anglo forecast (a straight line 4 week projection) net negative cash-flow of €12bn by 17 Oct.'08. The reason was €10bn fall in corporate and retail deposits. PWC also says that in the last full week of September, customers withdrew €5.44 billion from the bank and the bank’s management was expecting a further €6.6 billion to be withdrawn by mid-October. This projection was based on €5bn fall in corporate deposits and €440m in retail deposits in the week Lehman Bros. failed? All the bank could do was hope to sell a securitisation of €2.2bn and to bid successfully in swapping assets for ECB treasury bills. Out of €70bn deposits, €20bn could be expected to be lost at a rate of €5bn per week for a month. The inter-bank and debt capital markets were effectively closed and projections had to assume they stayed closed, ushering in what we risk experts call "tail risk". So, on 28th Sept. Anglo phoned the central bank to say we're insolvent; you've got to help us and PwC was sent in for a 9 day high-level look-see. Pro-forma profit of €1.5bn was to be cut by half for impairments. Much of property development loans were non-performing currently. This was because interest was "rolled up" in many big loans to be paid from "future expected cash-flows". Is this what McAteer meant by lending on cash-flows, not assets? If so, he had taken a prudential risk mitigator and turned it into an extreme-risk speculative gamble. Anglo also lent on an interest-only basis against cash generative investment properties that depended on risk assessment of capital repayments from asset sales, or otherwise on roll-over refinancing. Hence Anglo's model was attractive to developers because they could roll debt from one project onto the next. In fact the model encouraged or even forced them to do so. Developers were forced to become sharks on Anglo's behalf. Anglo was a shark of sharks involved in direct commercial risk-sharing with its property developer customers.
This means Anglo would need long term capital sources.
The Annual Report for 2008, revealed that €451 million was advanced to 10 customers to buy shares amounting to 10% of the equity, which became available from the unwinding of a so-called contracts for difference stake, which was built up by billionaire businessman Seán Quinn. The bank said €83 million has been repaid but €300 million will be charged as bad debts in the interim accounts to March 2009, including a portion in respect of directors' loans. The "Golden Circle" of 10 investors, lent with less than 20% security and without recourse. Investment lending accounted for almost two-thirds of the bank’s loan book at 30 September 2008 of €74 billion with a geographical breakdown of €43.6bn in Ireland; €21.3bn in the UK (including N.Ireland) and €9.4bn in the US. Development & Land accounted for approximately a quarter of the total. The total amount lent to directors during the 2008 financial year was €255 million, of which €122 million was money lent to then chairman Seán FitzPatrick, who at the end of September 2008, for the eight time, hid his loans via an arrangement with Irish Nationwide Building Society.
In February, senior managers of Irish Life & Permanent, were forced to resign following a disclosure, that more than €7 billion had been placed on deposit at Anglo Irish in September, including €4 billion, which was lodged with Anglo Irish on September 30th, the last day of Anglo's financial year and the first day of the State bank guarantee. The deposit was treated by Anglo as a customer deposit to mislead investors and market analysts.
The report of extracts from reports produced by PwC, following the issue of the State guarantee to six Irish financial institutions on September 30, 2008, shows that Anglo Irish Bank had loans outstanding to about 15 customers in excess of €500 million each.
Apart from these outlandish relationship-banking deals, the margins it charged and factored in should have been high enough to cover the riskiness of its own model, not just the riskiness of the borrowers and their projects. The bank should have had extremely sophisticated property market analysis & forecasting. Did it? We know that the Irish central bank wrote papers in '05/'06 to show how extremely vulnerable the whole economy was to small rises in interest rates - these alone would trigger recession - had Anglo considered that context - had it any plan in place for cutting back its exposure, to become a lot less risky if it needed to - probably not. If anything it seems truly to have believed the next 10 years could and would repeat the past 10 years - hubris is not enough of a word to cover that? Development loans (no interest in the construction period, only a fat fee for the bonus money) are converted into investment loans when a property development is either sold or let and becomes revenue earning. The loans are retained on the Bank’s books post-completion of the buildings as not all get sold or tenanted and not all balloon-payments paid off, because then the outstanding loans are rolled over from one speculative project to the next project. This is an effective way whereby banks who lend like this are actually forcing up property prices and rents faster than the market would do so if the financing costs were not allowed to become cumulative from one project to the next and the next after that.
Banks who are thereby directly in property development business are effectively using the borrowers as high-earning front-men, and using the financing structure to push up property values! Equity-release is used to roll-over outstanding debt from project D to Project E to Project F so in time each subsequent project becomes burdened with more and more insupportable debt inherited from past chain of projects. This relies increasingly on property values and rents rising (even accelerating). Equity release loans include lending on the difference between past 'book-value' of land (price of bought with 'option') and current market values pre-development. Thereby, substantial collateral for loans can be based on an 'option' to buy, not on actual purchased land. This is equivalent to lending on derivative contracts and is a form of extreme leverage. In reality, land requires investment to justify its development land price, and at the very least the options should have been exercised. And of course the cost of putting infrastructure services into greenfield sites is usually enough to eat away most of that equity margin. Anglo built up strong relationships with its key customers. Anglo's now ex-management said that their strategy is deliberate one of developing deep relationships with who it deemed to be the strongest property operators. From PwC's review of the larger loans in the portfolio it is evident that a small number of key customers were involved in a large number of transactions and represented a "significant proportion of the loan portfolio" meaning too large, meaning "concentration risk". Anglo considered itself "able to attain a thorough understanding of its client’s business, finances and relevant risks, which are continually reassessed in face to face client meetings often held weekly", for which read great lunches somewhere nice, maybe at the Curragh or a yacht down at Dun Laoghaire or somewhere foreign much more jet-setting. These friends did not get put on the watch-lists. PwC noted that there are a number of customers which are not currently on the Bank’s watch0list, 'notable' or 'impairment' lists, "all of whom exhibit potentially serious short term liquidity issues".
This has the strong whiff of corruption! These 'relationships' were not subject to standard risk management, but privileged (an exclusive risk grade outside of any normal grading) by virtue of a mutual-interest collusion between bank and developers. But who were the Mr Bigs, the bankers or the developers? The watchlist was updated eventually only just before Anglo went to beg for help and mercy from the central bank. i quote, "...the Anglo model is dependent on customers’ ability to successfully refinance significant development and investment loan portfolios in the short to medium term. This is exacerbated where (i) Anglo is the lead bank in a wider syndicated loan (other banks can sue it for its underwriting assurance?) or (ii) significant additional debt funding would be required for the successful build completion to derive value from development land banks held by key customers. While the stress scenarios applied by management assume no new net lending for 2009 and 2010, it is assumed Anglo will successfully re-finance its own short term borrowings in that period." Note, by the way, that Anglo did participate in syndicated loans when McAteer implied it did not. It did, but as lead-bank, it sold syndicated loans. And, why, just to get in more to lend, not to spread the risk. "...carrying cost of assets may not exceed their economic value even if they are realisable and as a result the option of interest roll up may not be available to customers to the same extent as to date. In addition, while demographics remain favourable, the continued unavailability of mortgage funding and increasing unemployment may exacerbate already reduced demand for residential property resulting in a fall in price for units already built and less demand for new developments on the land banks held by Anglo’s clients. The retail trade is also struggling and if the difficult economic conditions continue into the medium term shopping centres and retail developments may begin to experience trading difficulties or not be developed. A number of Anglo’s customers have significant exposures to the retail sector ...accounting for (20%) ...of the Bank’s loan book ...may not lead to impairment in Anglo’s 2008 results, a further deterioration in market conditions could lead to a reduction in the discounted cash flow attributable to certain assets ... the Bank adopts impairment recognition policies as prescribed by ...(IFRS). The Bank has ...15 relationships in excess of €500 million. ...Bank considers that in all cases they are supported by diverse portfolios of assets underpinned by material contractual cash-flows and with significant personal/ corporate recourse."
These are not suddenly new risks - the bank should and probably did know. What this is trying to say is that Anglo was afraid to foreclose on borrowers for fear of a domino effect that would come back on the bank and expose its relationship-banking model. Even if LtVs are way above 100% of the net property portfolios, and or way above whatever the bank can get a hold off after tax authorities and others, it also means that Anglo could not just seize the cash-generating assets for itself in the event of default-risk and therefore the collateral. The security contracts were either not well-enough written and were therefore not worth the collateral value claimed? And these were borrowers who are almost always short-term cash-flow insolvent and in recent year or two already desperately trying to sell their properties and failing, into an increasingly illiquid market. relationship- - if a bank's officers and its customers are friends, but turn out also to be relatives or even same persons, then what? At least in Ireland when a bank collapses the regular depositors and household account holders are 100% protected. If the security on which some loans are secured was marked to market significant shortfalls would occur in line with the rest of the Irish and international banking sectors in current market conditions. Whilst the bank's lending model/underwriting standards rely in the first instance on contractual cash flows, collateral values are key in the event of default leading to a forced/ distressed sale. In accordance with IFRS, Anglo 'amortises' these cash-flow securities as IFRS does not permit a mark to market approach for such lending assets. The Bank has exposures to a number of customers who also have significant exposures to other domestic and foreign banks. There is a risk that (i) if other banks call in their loans customers may not have the resources to pay these and Anglo’s loans or (ii) these other banks may not participate in new rounds of refinancing. Anglo had a portfolio of available for sale financial assets with a fair value of €8.2 billion as at 30 September 2008 which reflected impairment and mark to market losses of €288 million in FY08. There was an AFS reserve of a negative €589 million held on balance sheet at 30 September 2008. The Bank use a number of sources to derive the fair value of the assets carried in the Available For Sale (AFS) balance sheet category. 75% of the prices for these portfolios come from Bloomberg with the remainder coming from external service providers and broker quotes. There is some uncertainty in the market about pricing for certain asset backed securities given market conditions. At 7 November 2008 the Bank was still seeking prices in respect of €978 million of AFS assets and expects to obtain third party prices for approximately 50% of these. Currently prices are based on the most recent counterparty prices.
But, the report is not explicit about Anglo's roughly €50bn 'funding gap'. Its roughly €50bn deposits may have evaporated by over half, hence it has a €75bn funding gap and only €8bn available for sale assets! So much for the "permanent funding! that McAteer claimed, a term that no-one would or should respect. Assume €50bn commercial development assets that have fallen 50% in market value the bank has a decade's worth of profit wiped out. The bank's assets were €101bn but RWA as high as €86bn! Top 70 borrowers = 17% or €12.6bn much of which are mothballed projects.
The state has nationalised something with a book of say €75bn that needs 100% refinancing and will cost €25bn to repay deposits. One strategy could be to hand over the deposits to other banks and give them €25bn of long term bonds secured on the rump of the bank, now deemed a 'bad bank' to be 'worked out' over 10 years, but nationalisation is only permitted by the EU for two years - that is a short time to redeem this bank's solvency?
Like fishes all banks swim underwater mostly all of the time. Solvency requires confidence. Can confidence be restored in 2 years for the bank to be wholly privatised - no. At best it will be sold off to another bank or only partly privatised at the end of 2010.