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Day of Atonement: Al-Chet for Risk Managers

YomKippurTNToday is Yom Kippur.  It is the Day of Atonement.  The Jewish faith marks this day each year as a day to reflect on our sins and shortcomings we have committed during the past year.  It is a day of personal assessment.  Calling all to examine how we have failed to live a life in conformance to our highest aspirations and ideals.  It is customary to recite an Al-Chet confession prayer.  The Al-Chet is a confession of a persons past year sinful behavior. It is hoped that this admission of sin leads to  reconciliation with the aggrieved and an awareness that helps to establish a pattern of improved behavior in the future.

It is good that we commemorate such a day and use it to a constructive purpose.  After all, how many among us are without sin?  How many of us have achieved a level of perfection that obviates the need to reflect on how we can improve and make amends to those we may have hurt?   To be sure, even the best among us have fallen short of the glory of God.  A Higher Power surely keeps mere mortals rightsized and humble when our egos and perception of ourselves grows too large and burdensome.  The need to keep a strong self will from running riot is critical.  It is particularly dangerous when a person or corporation is unaware and ambivalent to the collateral damage its actions  spawn through the naked pursuit of self interest and ambition. In a sense, God is the ultimate celestial Chief Risk Officer that keeps wanton will in check.

The Day of Atonement is an important day because it is a day of transformation.  It calls for self examination and transformation.  Once we have learned the nature and extent of how our actions and inaction have negatively impacted ourselves and others,  we are called to make amends to set things right.  It is a day that requires considered action to improve ourselves so we can become a positive force for change in the world.

Considering the year that just transpired in the financial services industry, I wonder what an Al-Chet confession for risk managers would include.   We need a strong dose of atonement so we don’t repeat the egregious mistakes we committed last year.

An Al-Chet for Risk Managers:

I was not strong enough to stand up to my boss

I put selfish gain ahead of ethical considerations

I falsified or hid data to conceal results

I failed to be objective

My risk model was too subjective

I ignored warning signs

I was in over my head

I did not understand all the risk factors

I failed to get an outside opinion

I was beholden to monetary gain

I was victim to group think

I placed institutional interest ahead of ethical considerations

I  failed to admit I was wrong

I was not honest with regulators

I was not honest with shareholders

I looked the other way

I failed to act

I conveniently overlooked infractions / irregularities

I made exemptions

I did not understand the depth of the problem

I know there are many more.

Please help me to uncover, understand, make right and overcome.

Shalom

You Tube Music Video:  Aretha Franklin,  I Say a Little Prayer

Risk: compliance, reputation, catastrophic risk, moral hazards

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September 28, 2009 Posted by | banking, corruption, credit crisis, regulatory, reputation, reputational risk, risk management, sustainability | , , , , , , , , , , , , , , , , , , | 6 Comments

As Bank Failures Rise, FDIC Funds Sink

fdic-cartoon-2-2The FDIC has reported the failure of 77 banks so far this year.  It is the highest rate of bank failures since the height of the Savings and Loan crisis in 1992.  The cause of the failure for many of these banks are mounting loan loses on commercial loans made to commercial real estate developers and small and mid-sized businesses (SME).   This is dramatically different from the banking crisis that unfolded in the later part of 2008.  Bank solvency was threatened due to high default rates in sub-prime mortgage loans and the erosion of  value in residential mortgage backed securities (RMBS) held by larger banking intuitions. This led to the TARP program that was created to purchase distressed assets and inject much needed capital into struggling banks.

Most of the bank failures are the result of the macroeconomic factors spawned by the recession.  High unemployment and tightening credit availability has stressed many consumer oriented businesses.  It has led to alarming bankruptcy rates of SMEs.  This has hurt community banks who have a significant portion of their commercial lending portfolios exposed to commercial real estate dependent on a vibrant SME segment.  Bank failures remove liquidity from the credit markets.  As more banks fail funding sources and loan capital are withdrawn from the system.  This is yet another dangerous headwind c0nfronting SMEs  as they struggle with a very difficult business cycle.

The FDIC is growing increasingly alarmed about the solvency of its insurance fund and its ability to cover depositors of failed banks.  This years largest bank failure, Colonial Bank Group is expected to cost the FDIC insurance fund$2.8 billion.  Its a large amount for the  stressed fund to cover in  light this years high number of bank failures and an expectation that failures will continue to rise.

According to Forbes online, the FDIC has indicated concern that the Guaranty Financial Group Inc., a Texas-based company with $15 billion in assets that racked up losses on loans to home builders and borrowers in California, and Corus Bankshares Inc., a $7 billion Chicago lender to condominium, office and hotel projects are also at risk of failing.  Each failure will place a added  strain on the FDIC insurance fund. The costliest failure was the July 2008 seizure of big California lender IndyMac Bank, on which the fund is estimated to have lost $10.7 billion.

The FDIC expects bank failures will cost the fund around $70 billion through 2013. The fund stood at $13 billion – its lowest level since 1993 – at the end of March. It has slipped to 0.27 percent of total insured deposits, below the minimum mandated by Congress of 1.15 percent.

The FDIC has a huge challenge on its hands.  It needs to maintain the orderly working of the banking system to alleviate the waning confidence of consumers and shareholders.  Recently it was announced that restrictions on private equity firms purchasing banking companies will be relaxed to assure that the industry remains sufficiently capitalized.  Regulators will need to increase oversight of community banks risk  management controls.  The added transparency may be resented by bank management but it may help to stem the tide of accelerating bank failures as the difficult conditions in the commercial real estate market persists.  In any case bankers should expect to see an increase in FDIC insurgence premiums to recapitalize the depleted fund.  Unfortunately bank customers will be burdened with rising fees banks charge for services as they seek ways to cover the rising expense of default insurance.

Bankers must become more vigilant in their assessments to determine the credit worthiness of SMEs. Sum2’s Profit|Optimizer is helping bankers assess small business credit worthiness; leading to lower loan defaults, higher profitability and more harmonious client relationships.  The Profit|Optimizer is also available for purchase on Amazon.com.

You Tube Music Video: Ray Charles, Busted

Risk: FDIC, banks, credit,

August 22, 2009 Posted by | banking, credit, credit crisis, economics, FDIC, private equity, real estate, recession, regulatory, risk management, SME, Sum2, TARP, Uncategorized | , , , , , , , , , , , , , , , , , , , , , , , , , | Leave a comment

Avoiding Bankruptcy

bankruptcyThe soft economy, the rise of inflation and the curtailment of credit is having a dramatic effect on small businesses. Annual bankruptcy rates among small businesses is sky rocketing. As the recession continues small business bankruptcy will continue to rise.

Bankers are undertaking a comprehensive review of their small business loan portfolios to enhance risk mitigation programs. They are increasingly driven to engage their small business clients to determine if they can detect any problems that is affecting their clients financial health. Poor operating performance leads to a distressed condition that can ultimately lead to insolvency.

Banks are becoming more proactive. Small business managers need to take action to uncover the factors that are damaging the business.  They must recognize the early warning signs of an emerging distressed condition to remain in the good graces of bankers by honoring the parameters of existing loan covenants.

Banks are taking the lead.  Bankers are initiating an effective engagement process by conducting business reviews  that disseminate information and provide tools to help businesses identify sources of risk in clients business operation. It is incumbent on small business managers to understand how changing market dynamics and operational risk factors are impacting their business and more importantly demonstrate a willingness to take steps to mitigate these factors

The problems posed by curtailment of credit and rising unemployment pose acute threats to small businesses. This is particularly true for businesses that cater to retail consumers. The erosion of consumer buying power due to loss of income and evaporation of customers credit lines means that they won’t be purchasing goods and services offered by small businesses.  Small business sales and profitability evaporates due to exposures to these risk factors.  Small businesses must devise strategies to address these types of risks.

Bankers need to be involved with their small business clients to determine how these risk factors are affecting business profitability and what steps need to be taken to temper their effect.  This a great opportunity for bankers to enhance their engagement level with small business clients. The exercise will preserve relationships, mitigate potential credit defaults and build the banks brand as an effective and involved partner to small businesses.

Sum2 provides a series of risk assessment products that assist companies to chart paths to profitability and growth.  Please visit our website to learn more about the Profit|Optimizer, a unique risk management and opportunity discovery tool that can help you more effectively manage the challenges posed by the recession.

You Tube Video:

risk: credit, bankruptcy, banking, SME

August 20, 2009 Posted by | commerce, credit crisis, recession, SME, unemployment | , , , , , , , , , , , , , , | Leave a comment

$700 Billion is a lot of Guacamole!

paulsonAn article in today’s  Forbes online entitled Trouble with TARP,  reports a growing concern by the Congressional Oversight Panel (COP) about the effectiveness of the $700 billion program.  The COP reports that the effectiveness of the program is difficult to determine due to lack of transparency of how funds were spent.  The COP report also states that the absence of any reporting guidelines for TARP participants impedes effective oversight.

The 145 page report starts with a retelling of the extreme conditions confronting the banking sector as the credit crisis exploded last autumn.  It also outlines the choices confronting regulators, legislators and industry executives as the crisis deepened.  We were led to believe by Treasury and Federal Reserve officials that the global banking system was in imminent  danger of collapse.  Nothing less then immediate and drastic measures taken by sovereign government officials and industry executives would prevent the catastrophic consequences of global economic carnage.  The report makes it clear that these market conditions were so extreme that regulators were navigating through uncharted waters.  Any remediation measures taken had little historical precedence to guide actions.  Hence Paulson was given carte blanche to handle the crisis with unprecedented latitude and executive facility.

As this blog reported earlier this week, the TARP was originally designed to acquire troubled assets from banking institutions.  TARP funds were earmarked to purchase mortgage backed securities and other derivatives whose distressed valuations severely eroded capital ratios and stressed banks balance sheets.  Hank Paulson later shifted the strategy and decided to inject TARP funds into the banks equity base.  This has done wonders for the shareholders of the banks but troubled assets remain on the banks balance sheet.  As the recession continues,  unemployment, home foreclosures, SME bankruptcies and the looming problem with commercial mortgage backed securities  (CMBS) are placing a new round of added strain on the banking system.

The TALF program is designed to draw private money into partnership with the government to acquire troubled assets from banks.  So far the program has received a tepid response.  I suspect that the principal factors inhibiting the expansion of the TALF program are numerous.  Chief among them is the inability of FASB to decide upon valuation guidelines of Level III Assets.  Banks holding distressed securities may also be reluctant to part with these assets because they have tremendous upside potential as the economy improves.

The COP also questioned the effectiveness of TARP because stress tests were only conducted on 19 banks.  The report states that additional  stress tests may be required because the previous tests failed to account for the length and depth and length of the recession.   Community banks are also of concern.  They face a perfect storm in challenging macroeconomic conditions.  Of particular concern is commercial real estate loans.  Many economists are concerned that high rate of loan defaults in commercial loan portfolios pose great threats to the community banking sector.

Though interest rates remain low due to the actions of the Federal Reserve,  lending by banks still remains weak.  SME’s are capital starved and bankruptcy rates are quickly rising.  SME’s are critical to any economic recovery scenario.  A strong SME sector is also crucial for a vibrant and profitable banking system.  Perhaps a second round of TARP funding may be required to get more credit flowing to SME’s.  If banks start failing again it would be devastating.  The Treasury and the Federal Reserve don’t have many bullets left to fire  because of all the previous expenditures and a waning political will of the people to continue to fund a systemically damaged banking system.

Risk: banks, SME, economy, credit, market

You Tube Video Music: Billie Holiday with Lester Young, Pennies from Heaven

August 13, 2009 Posted by | banking, credit crisis, economics, FASB, Paulson, real estate, recession, regulatory, SME, TALF, TARP, Treasury, Uncategorized, unemployment | , , , , , , , , , , , , , , , , , , , , , , , , , | Leave a comment

Waiting for the Other Shoe to Drop

TALF_MainAccording to a recently published report by a Congressional Oversight Panel reviewing the effectiveness of the Troubled Asset Relief Program (TARP),  many banks  remain vulnerable due to questionable commercial loans  still held on their balance sheets.  This is  a looming problem for community and smaller banking institutions.  Smaller banks are being adversely effected by the the rise of commercial loan defaults.  Many community banks have large loan exposures to shopping malls and other small businesses hard hit by the recession.

The report states,  “Owners of shopping malls, hotels and offices have been defaulting on their loans at an alarming rate, and the commercial real estate market isn’t expected to hit bottom for three more years, industry experts have warned. Delinquency rates on commercial loans have doubled in the past year to 7 percent as more companies downsize and retailers close their doors, according to the Federal Reserve.

The commercial real estate market’s fortunes are tied closely to the economy, especially unemployment, which registered 9.4 percent last month. As people lose their jobs, or have their hours reduced, they cut back on spending, which hurts retailers, and take fewer trips, affecting hotels.”

Defaults in sub prime and other residential mortgages precipitated last years banking and credit crisis. The TARP program succeeded in stabilizing a banking system that was teetering on collapse.  The $700bn infusion into the banking system appears to have buttressed depleted capital ratios and severely stressed balance sheets of large banking institutions.  But many banks are still carrying troubled assets on their balance sheets.  Commercial Mortgage Backed Securities (CMBS) values are tied to the cash flows generated by renters and lessors of the underlying mortgaged properties.  As occupancy rates of commercial properties fall cash flows dissipate.  The market value of these securities plummets creating a distressed condition. This places additional strain on the banks balance sheet driving capital ratios lower and places a banks liquidity and ability to lend at risk.

The TALF (Term Asset Backed Loan Facility) was instituted in March to extend $200bn  in credit to buy side financial institutions to purchase troubled assets and remove them from banks balance sheets.  So far only $30bn has been allocated through the program.  Clearly banks balance sheets remain at risk due to their continued high  exposure to this asset class.

A strong economic recovery will address this problem.  A prolonged recession will resurrect the banking and credit crisis we experienced last autumn.  It would appear that TARP II may be a necessity if more private sector investors don’t step up to the plate and participate in TALF.

You Tube Video: David Byrne, Life During Wartime

Risk: CMBS, commercial real estate, banks, credit risk

August 11, 2009 Posted by | banking, commerce, credit crisis, economics, government, private equity, real estate, recession, risk management, SME, TALF, TARP, Uncategorized, unemployment | , , , , , , , , , , , , , , , , | 2 Comments

Drivers Wanted!

fuel efficientThe cash for clunkers rebate program is a great success.  The first $2. billion allotted to the program was spent within two weeks.  The recently approved additional allocation of $1 billon for the program will no doubt be taken advantage of by consumers.   American’s are always keen to do a deal and can’t wait to drive away in a brand new ride unwritten in part by our most favorite relative, Uncle Sam.

The government’s goals of the cash for clunkers program are being achieved.  The program  will have a positive environmental impact as more fuel efficient vehicles replace the old gas guzzling clunkers.  The program has also allowed car manufacturers to liquidate 2009 inventories that were piled high due to tepid demand borne from the recession and credit crisis.  The program may also help cure consumers recession psychology and their new found aversion to purchasing new stuff.

It is hoped that this boost to car manufacturers may kick start the economy.  Ford Motor Company’s  recent positive earnings announcement and GMs and Chrysler’s arrest of declining quarterly sales are one of the “green shoots” of recovery pointed to by politicians and economists.  However a huge question remains concerning how to incubate long term sustainable drivers that will end the recession?  The $600 tax rebate checks sent out by Paulson last year provided a temporary boost to the economy.  Its effects did little more then forestalling the more deleterious effects of the growing recession.  See The Charge of the Light Brigade.  Hopefully cash for clunkers will help to kick start some recovery momentum to an economy aching for relief from systemic malaise.

The US economy has grown overly dependent on a few industry sectors that include services, real estate, banking and construction.  The SME service sectors have been devastated by the contraction of credit, unemployment and the curtailment of consumer demand brought on by the recession.  During the good times, these sectors were driving economic growth and expansion.  Unfortunately these sectors remain conspicuously absent as leading drivers in the new emerging  economy.

Macroeconomic factors unpinning recovery continue to be negative for these sectors.  Hi tech and manufacturing seen as critical to a lasting recovery have also been a bit lethargic.   These industries are capital intensive and with the capital markets still seeking a firm recovery footing these sectors will remain weak.   Health care and pharmaceuticals are key sectors in the US economy, but political uncertainty around reforming industry practices and much needed restructuring hampers the sectors ability to assume a leading position in recovery scenarios.

Last year Sum2 published The Hamilton Plan, a Ten Point Program to incubate small midsized enterprise (SME) manufacturers.  At its core, the plan seeks to encourage capital formation initiatives from public and private sources.  Manufacturing is key to any sustainable economic recovery.  Our ability and desire to link manufacturing to the entrepreneurial capabilities and business skills of SME’s to address targeted needs could well be the drivers that finally steer us out of the recession.

Risk: recession, SME, manufacturing

August 10, 2009 Posted by | commerce, credit crisis, economics, Hamilton Plan, manufacturing, private equity, psychology, recession, SME, sustainability, Uncategorized | , , , , , , , , , , , , , , | Leave a comment

An Evening with Ed Altman

Last night Sum2 had the distinct pleasure of attending Prmia’s History Making Series lecture that honored Edward Altman at the Deloitte and Touche Conference Center in NYC.

Mr. Altman, The Max l. Heine Professor of Finance at the Stern School of Business at NYU, was honored for his life long contribution to the study and development of credit risk analysis. His foremost contribution is the development of the Z Score which uses financial ratio benchmarks within an industry segment to determine corporate financial health. He has made many contributions to the study of credit risk, corporate finance and investment analysis of debt securities.

His presentation covered the development of credit risk analysis since his first published work concerning the Z Score in 1968. Mr. Altman was funny, intelligent and very engaging and he raised some dire concerns about the current credit market environment and what it may forebode. To be fair to Mr. Altman, he pretty much stuck with the subject of the development of the discipline of credit risk analysis and like Alan Greenspan went very light on market prognostications.

Some brief highlights of Mr. Altman’s presentation:

Stressed the importance of a healthy corporate credit culture and its neglect has contributed to the current crisis.

Bankruptcy workout and recovery rates will suffer due to current state of credit market.

Lenders need to combine quantitative and qualitative factors to determine loan default probabilities.

Risk managers need a better understanding of the correlation of debt ratings and corporate performance.

Mr. Altman also stated that corporate bond defaults could approach 11% next year and that other securitized asset classes are under severe pressure.

Mr. Altman also opined about the etymological origins of the phrase, “waiting for the other shoe to drop.”

Music Video: The Credit Crunch Song

Risk: credit market, research, economics, corporate finance

October 17, 2008 Posted by | credit crisis, economics, investments, risk management | , , , | Leave a comment

Level Three Sinks Lower at GS

Interesting piece at CFO Magazine concerning fair value deterioration of Level Three Assets at Goldman Sachs during the month of August. Goldman Sachs reports that valuation of Level Three Assets dropped by 13%. It would be interesting to understand the impact of this collateral erosion had on GS’s largest counter-party AIG?

Was this the trigger that precursors the radical interventionist moves by the Treasury to purchase a controlling stake in AIG?

This insight will become most constructive as the Treasury begins its purchase program of toxic level three assets. Hammering Hank has hired Neel Kashkari one of his mentees from GS to head up the repurchase program. Mr. Kashkari is said to be a quantitative wiz kid and a real life rocket scientist to buy Level Three Assets from GS and other banks and create and manage a portfolio of toxic assets on behalf of the American taxpayers.

The CFO article can be viewed here.

You Tube Video: Goof Troop Level Three

Risk: collateral valuation, counter-party default,

October 8, 2008 Posted by | banking, credit crisis, EESA, FASB, TARP, Treasury | , , , , , , , , , | Leave a comment

Conference Call with Hank

National Federation of Independent Business (NFIB) members had an opportunity to participate in a conference call with Secretary of the Treasury Henry Paulson. Mr. Paulson was keen to solicit the support of NFIB members for the passage of the Emergency Economic Stabilization Act, (EESA).

NFIB members are small business owners who are generally very conservative, free market advocates who vigorously support tax relief, oppose regulatory oversight and large governmental spending programs. NFIB member firms are the entrepreneurs, shopkeepers, service providers and small business risk takers who populate the small stores and office space on Main Street USA.

Small business owners are a politically vocal and influential constituency whose support proponents need to gain passage of EESA. Last night EESA passed the Senate. It will now return to the House of Representatives for a vote. Secretary Paulson asked NFIB members to contact congressmen, senators and media to urge support of EESA passage.

Key points raised were as follows:

FDIC deposit insurance limit was raised to $250,000

EESA Bill included riders with tax cuts and other rebate incentives

EESA has a recoupment provision “put” that allows Treasury to sell assets back to banks at a previously agreed upon price

Failure of EESA will curtail community bank lending activity to small businesses

Large businesses and municipalities dependent on credit markets for short term funding will scale back purchases with small businesses

Current Treasury tools are not sufficient to deal with problem

EESA funding (Federal Budget program cuts) will need to be addressed in next budget cycle

Regulatory frameworks of financial services industry need to be streamlined, strengthened and reformed

Mark to Market of toxic bank assets will help to temporarily address bank solvency and capitalization ratios

Music Video: Blondie, Hangin on the Telephone

Risk: bank solvency, credit, interest rates, recession

October 2, 2008 Posted by | credit crisis, EESA, Paulson, TARP, Treasury | , , , , , , | Leave a comment

Existential Valuation

Charles Ponzi

Many pundits blame the banking crisis on people taking out mortgages they could not afford. I place it at the feet of the investment banks that funded the sub-prime mortgage products.

Michael Lewis’s book Liars Poker details how Salomon Brothers business exploded during the late 1980’s as the mortgage market began to grow. Salomon Brothers since acquired by Citigroup was an early innovator in the creation and sales of mortgage backed securities (MBS). Without MBS the necessary funding that fueled the exponential growth of mortgage finance, construction, home finance lending and equity lines of credit could not exist.

This innovation drastically altered the nature of the banking industry. Bank’s at one time loaned out money from their own capital. But this changed with the advent of MBS type products. Structured products allowed local banks to access funding from many sources and changed banks into credit channels that marketed credit products financed by third parties. Since it wasn’t their capital at risk, risk management and due diligence suffered.

The great innovation of MBS was that it added leverage to the credit markets. As investment banks and buy-side investors grew rich on the cash flows provided by MBS the investment banks began to invent new financing products. CMOs, CLO’s, ABS securitized cash flows and other exotic derivatives like CDS came onto the scene to provided investor protection in the event of a counter-party default. These products levered up the debt positions of corporations, consumers, investors and governments. It created an economy overly dependent on an unsustainable credit marketing industry. As is the case with all Ponzi schemes, as the low man on the totem pole began to default on the usurious rates charged for sub-prime loans the entire house of cards collapsed.

As leverage in the credit markets grew to fantastigorical levels these non-market traded products became more sophisticated and esoteric. These products were structured to address investment requirements of institutional investors. Since they were non-exchange traded securities sold directly to investors the ability to value these securities was exceedingly difficult. As the market developed further the Financial Accounting Standards Board (FASB) had to create rules and asset classifications of these securities so that they could be properly valued for reporting purposes. FASB solution was to classify these assets as Level Three.

See May 17 Risk Rap Post on FAS 157

Herein lies the rub for these Level Three assets. Maybe the dismal science can wave a magic wand and make these assets double in value, disappear or perhaps quarantine these securities in accounting purgatory waiting for better times and future Treasury Secretaries to offer absolution and full redemption for the past sins of our fallen Masters of the Universe.

But just because we say it ain’t so bad don’t make it so good. The Basel II global banking guidelines for capital adequacy insist on transparency on asset quality. The world central bankers have agreed on a formal regulatory methodology to determine asset valuation, solvency conditions, collateral management practices and acceptable ratios of economic and regulatory capital requirements necessary to protect against defaults in the credit markets. What a thought! The US banking industry should stop dragging its feet on its adoption and start implementing the recommended strict disciplines it advocates to protect the solvency of our banking system.

No more voodoo economics, asset valuation slight of hand or accounting convention tricks and balance sheet gymnastics. We need fiscal disciplines, transparency and accountability based on sound economic and generally accepted accounting principles. We need to develop an economic infrastructure that is based on the creation of value and equity not an economy based on creation of collateral and deepening debt.

Music: Cab Calloway and the Nicholas Brothers Jumpin Jive

Risk: bank solvency, pariah nationhood, FASB, Basel II

October 2, 2008 Posted by | banking, credit crisis, FASB | , , , , | Leave a comment