BoA-M-L = LTSB-HBoS

Not exactly a palindrome, but a bull in a palindromic situation. BofA is to "pay $425m over toxic assets" as the FT words it; in fact of course this is an FDIC/Federal Reserve/US Treasury TARF scheme that starts just like a repo swap in the BoE/HM Treasury APS scheme, where LBG has agreement to repo swap £245bn or thereabouts (and RBS £325bn or so).
In the APS case there are delays while waiting for EC scheme & case approval, which everyone who looks into it assumes will come with requirements on LBG to restructure in alignment with Competition advice (the very same that was by-passed by an Act of Parliament to permit the Lloyds TSB takeover of HBoS). The US integrated multi-state regulatory supervisory system does not need to wait on a higher authority to validate the real economic value and competition issues involved.
In the US equivalent of the UK scheme, there is unlike in the UK case a speedy transition to the exit door marked TARF whereby US authorities provide soft loans to another financial institution or a groups of them, maybe hedge funds, to buy the impaired assets on soft (relatively risk-free) terms. Bank of America agreed late last night, after hurried discussion to dot and cross the terms, to pay $425m to federal regulators thereby to extricate itself from an agreement struck last December with federal authorities (involving probable repayment of protection subsidy) and to protect the bank from any further asset writedowns on $118bn worth of toxic assets, most of which came from Merrill Lynch (echoes of LBG's claim that most of its impaired assets come from HBoS). The terms 'toxic' and 'impaired' relate to assets that have fallen below book value, but can also mean simply assets that have an immediate downside of too high a risk weighting so that the amount of capital reserve required to support them (in addition to liability funding) costs more than the possible medium term upside.
By getting rid of $118bn toxics saves on the same again in liability funding at say 8% ($9bn) plus say $15bn in capital reserve. Then the other saves about $22bn in capital and perhaps another $100bn in liability funding = total of $53bn or 12.5% of the total assets. Assuming a 20% discount plus 5% fee means $80bn p/l writedown against net gain of $47bn = $33bn (new world according to GAAP), but gaining $319bn (less $45bn payback) in treasury bills at half the rate of funding gap funding worth say $10bn plus perhaps $10bn in annual net interest gain & fees from new business growth; net result = $-13bn + say 20% return on $21bn capital refershment = final cost of $7bn year 1 and $10bn profit year 2.
What do the authorities get? They get to expand the balance sheet by $319bn with enough head-room to issue the soft loan (more T-bills), which with roll-over after a year to keep everything off-federal budget, and then net $60bn profit + $45bn pay back over 2 years. The hedge funds or whoever contribute say $60bn and get a 30% return over 2 years of $20bn. Nice - everyone makes money including the taxpayers whenever the net proceeds are taken on budget, probably not in deficit reduction where the amount could pay for a month of Medicare etc., but by reducing the Federal debt by 1.5%.
The decision to pay the money to the US Treasury, the Fed and FDIC brings an end to one of BofA’s financial entanglements when it was aided to take over Merril-Lynch and lets the bank pay back $45bn in funds to TARP, freeing it to pay what bonuses it likes to top execs - maybe?
Just like when UK Government, Brown, Darling, Vadera & Mandelson acceded to, or actively encouraged, Blank & Daniels of Lloyds TSB to takeover HBoS, so had Paulson, & Bernanke enticed, encouraged or gone along with, Lewis & Thain to proceed with the BoA takeover of M-L. What no-one cared to worry about was that this scuppered attempts to save Lehman Bros. a year ago last week about which many are agreed was the funeral pyre worst moment of the Credit Crunch, a fire that consumed the independence of many firms, not least the two big Scottish banks. UK government stands to make considerably more out of its stakes in RBS & LBG than US federal authorities will make out of BoA-M-L, some of which it may book quite soon.
In the US case, the September 13th takeover was sweetened by a loan of $20bn in T-bills, on top of the $25bn already earmarked for BofA and Merrill, to make sure the transaction was consummated, plus a guarantee over $118bn worth of troubled assets (troubled = impaired = toxic = regulatory capital burden = writedown risks).
BofA, however, never formally signed a contract for the ringfence protection and in May decided against entering into the asset insurance programme. For the last quarter, the bank has been in negotiations with FDIC to determine fair value of the perceived insurance provided by the guarantee. That delay should have saved the bank maybe another $1bn or so in premiums?
Meanwhile in another part of the dark forest, the SEC says it is considering adding charges to its lawsuit against BofA for allegedly failing to give investors details on executive bonuses. The SEC’s statement that it would “vigorously” pursue the charges against BofA came after a federal judge refused to agree to a proposed settlement between the regulator and the bank. Whether the current deal gets BoA out from under that is unclear? In a scathing ruling only last week, the judge said the settlement made no sense unless the SEC identified the individuals who allegedly made false or misleading statements.
Separately, BofA on Monday named Charles Holliday, former chief executive of DuPont (also famous for its Du Pont ratios that formed the basis of Credit Risk Agency models, by the way, that have been such a massive bugbear on the credit crunch decades later, though no fault of Du Pont), as a director, furthering its effort to overhaul its board. The arrival of Mr Holliday means that six new outside directors have joined BofA’s board since the April 29 annual meeting, when shareholders voted to strip Mr Lewis of the additional role of chairman. Similar musical chairs have been played at RBS and LBG - more support for my prediction a year ago that by the end of this whole shenanigans no key executives in charge of the big banks before the Credit Crunch will still be in their seats by the end of it!

Trust versus Confidence?

an ATOMISER of the traditional kind.
Andy Haldane, the Bank of England’s head of financial stability, says enduring recovery depends on trust being restored to the financial system, and called for smaller and more diverse banks, and a return to mutuality. This may be a bit of a slap to the FSA for placing high hurdles in the path of a couple of dozen or so new banks seeking to form in UK o register branches or subsidiaries in the UK. Many banks want to do more to gather in retail deposits and the UK is a good place for that including the UK’s liabilities guarantee regime. Haldane attributes the slump in economy & credit in the financial system to a loss of trust between banks and households, among banks and between banks and investors over the past two years. “Loss of confidence” is perhaps a soft phrase for disdain, hatred and deep suspicion. “It is lack of trust – and hence credit – that may shape the recovery. Based on past evidence . . . we might anticipate a protracted period of repair,” he told his business audience in Leeds.
Recovery from past recessions in the UK, trust and credit for non-financial companies recovered well once the economy had started to grow. Actually there was always usually a 6 month delay before banks started to expand credit and trust in recovery. In the immediate future, Haldane accepts that trust in the financial sector has been substituted for by govrnment guarantees (insurance paid for by the banks) plus state intervention measures. He says, “Extending public sector credit on this scale relies on the deep pockets and prudence of our grandchildren. It can be no more than a stop-gap – a temporary bridge – until private sector trust can be restored.” I take issue with this. I expct the government’s measures to be highly profitable for taxpayers. Moreover, the vast bulk (let’s say all of it) is in fact off-budget (swapping short term treasuries for bank assets after large discount + fees) and therefore not involving taxpayers’ money. Taxpayers are exposed only via the fiscal deficit, hich I expect the profit on bank aid to recover at least 40% of.
He also called on banks to seek to rebuild trust in their activities without regulatory intervention, by insisting that banking should not be commoditised like car manufacture, and pressed the case for smaller, more local banks, pursuing diverse strategies. An examination of FDIC data on US 8,400 small banks may put this idea into perspective; just parcelling risk out ino smallest chunks (like how Lloyds of London disperses underwriting risk). Haldane says,
“If large-scale processing of loans risks economising on the collection of information, there might even be diseconomies of scale in banking. . . Within the space of a decade, banks went from monogamy to speed-dating and that big was not best.” He called for a return to greater mutuality in financial services to prevent shareholders pressing for too much risk-taking in the knowledge that taxpayers would stand behind losses. This is an attack on the FSA for having encouraged de-mutualisation on the basis that the market knows best how to value banks, and ensures banks can raise capital – a fine idea in mico-prudential terms, but not much good in a macro-prudential crisis. “I am happy to say that reports of the death of the building society sector are greatly exaggerated. Indeed, mutuality may do a better job of aligning stakeholder incentives than some alternative forms of corporate governance”, i.e. better than shareholders, but begs the question how do stakeholders or shareholders actually challnge excutive boards. Company La needs major changes in shareholder voting process and information rights and similarly in mutual society member comparable rights.
Alongside banks rebuilding trust in their own abilities, he said that a return of credit – which comes from the Latin word for trust – would also be helped by strict new regulations aiming to strengthen banks’ financial resources, their ability to spot and deal with severe risk including in their governance.
He argues that new regulations are unlikely to be the answer alone. “One reason why regulation might not be the whole answer is that trust in financial regulation is itself one of the casualties of crisis.” I think this is defeatist. The new Basel II Accord (FSA and CEBS responsibility at law) has hardly touched down. We need to give it more time to discharge all of its responsibilities onto the banks. Haldane says there is a difference between confidence, which he said had returned to the business world, and trust, “an altogether different animal”. “Moral compasses take rather longer to self-correct than magnetic ones. This has implications for the path of recovery in the period ahead.”
Lord Turner has had as much, in fact much moe to say recently, and thereby restored some trust in the FSA’s efficacy. The Bank of England by denigrating he role of regulation does not look as if it wants to embrace the FSA’s role and thereby end the UK’s tripartite regulatory system.