Thursday, May 31, 2012

NY Times' Peter Eavis Part III: Shockingly, US banks are less than transparent on EU exposures

According to a New York Times Dealbook article by Peter Eavis, US banks have been less than forthcoming about their true exposure to the EU.

Call this yet another reason that the banks need to be required to provide ultra transparency and disclose on an on-going basis their current asset, liability and off-balance sheet exposure details.

Without this information, it is impossible for investors to assess the risk to these banks.

United States banks received a regulatory memo this year asking them to make clearer their public disclosures about their exposure to Europe’s troubled countries. Not all the banks bothered to comply fully, however. And this could backfire on them if financial conditions in Europe deteriorate further.
In January, the Securities and Exchange Commission requested that banks’ financial filings contain specific descriptions of loans and trading positions relating to Europe. But some large financial firms did not follow all the S.E.C.’s suggestions in their first-quarter reports. 
The agency’s memo was “guidance” and therefore not an edict that banks must adopt. Even so, with European leaders struggling to find solutions to the region’s problems, investors may not appreciate that banks chose to comply only in part.
Of course by not complying the banks send a loud message that says "WE HAVE SOMETHING TO HIDE!!!!"
One of the S.E.C.’s chief aims was to expand banks’ European disclosures so that outsiders can see what’s really packed inside them. 
The problem was that a bank might say it had total Italian trading positions of $3 billion, for example, but that might actually be a net figure that included hard-to-see offsetting items. 
Without such offsets, the “gross” Italian trading total may in fact be a lot higher. In its January memo, the agency made a point of asking banks to disclose gross figures, and then to highlight any offsetting items. 
The fear is that, in a crisis, a bank might not be able to collect all the offsets, so its true exposure may not be its net exposure.
Some banks nevertheless stuck with less transparent approaches. 
Please recall the Wall Street Opacity Protection Team.  Unless forced to provide more disclosure, Wall Street always provides the bare minimum.
One is Morgan Stanley, whose share price was pulverized last fall when investors worried about its exposure to Europe. In its first-quarter filing, the Wall Street firm’s disclosed an item called “net counterparty exposure,” a term that includes collateralized short-term loans and derivatives that don’t trade on exchanges.....
“Net counterparty exposure” is the largest component of Morgan Stanley’s troubled Europe exposure. But it could be bigger on a gross basis. A footnote to the item says it takes into consideration an undisclosed amount of collateral, the cash or assets that clients post with Morgan Stanley. 
However, if banks choose to include collateral as an offset, the S.E.C. asked them to quantify that collateral in a footnote. Morgan Stanley didn’t do that....
Bank of America also chose not to provide a gross total for all its Europe exposures. For example, the total for a $1.7 billion item called “securities/other investments” is reduced by an undisclosed amount of hedges and short positions, which are trades intended to go up in value if the underlying securities go down. 
“We believe that our disclosure is consistent with the guidance provided by the S.E.C.,” said Jerome F. Dubrowski, a Bank of America spokesman. “Each company will do this a little differently, but we believe this disclosure meets the criteria established by the S.E.C. If we are asked to provide additional information, we will of course comply.” 
The banks argue that offsetting items like collateral and hedges should not be ignored because they provide dependable protection. In certain stress situations, they will. 
But hedges may not work if European banks get into trouble. They may not be able to honor any payments they owe on trades American banks have made as a hedge. Morgan Stanley recognizes this danger. It doesn’t count hedges struck with banks in troubled countries in its overall total for European hedges. 
Another situation that could overwhelm banks’ strongest defenses is a dissolution of the euro
For instance, many of the banks’ hedges are credit default swaps whose prospective payouts would be in euros. What would happen to the value of a swap if its payout currency disappeared, or fractured into new currencies? ...
Even collateral, assets the banks already hold, may turn out to be worth a lot less than they had hoped for. Collateral often comes in the form of cash euros or European government bonds. 
For instance, one place banks receive and supply substantial amounts of collateral is at clearinghouses, entities that handle claims underlying trades. Indeed, the reason French exposure is high for Goldman Sachs and Morgan Stanley is that they both use a Paris-based clearinghouse for trades in secured short-term loans. But it’s common practice for collateral at European clearinghouses to take the form of cash euros or European government bonds. 
When asked whether this leaves them with vulnerable euro-based collateral, banks say they can swap such collateral into assets in other currencies. 
If things get worse in Europe, some banks may be pressed to include more countries – particularly France — in their troubled Europe disclosures. Bank of America, Goldman and JPMorgan all leave France out of those tables, though they reveal limited data about France in other places in their filings. The problem with the skimpier disclosures is that they don’t show how hedged any of those three banks are against French exposures. 
Perhaps it’s time for the S.E.C. to send another memo?
Yes, this time saying that the banks need to provide ultra transparency so all market participants have access to the information they need to truly assess the riskiness of each bank.

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