Tuesday, December 11, 2012

US banks blindly bet on structured finance securities again

One of the unintended consequences of the Fed's zero interest rate and quantitative easing monetary policies has been to crush bank net interest margins.  As a result, banks are chasing yield and in particular have returned to blindly betting on the same opaque, toxic structured finance securities that were at the heart of the financial crisis.

What makes the banks blindly betting on these securities worse, is that the financial regulators do not see it as their responsibility to discourage this gambling.  If they did, sometime in the last five years they would have revised bank capital standards so banks have to hold 100% equity against any new purchases.

Regular readers know that because of opacity buying structured finance securities is blindly betting on the contents of a brown paper bag.  Simply put, the buyer does not know what they are buying because they do not know the current performance of the underlying collateral.

Knowing the current condition of the underlying collateral is important because if you don't know this knowable fact, there is no way to know how much cash the underlying collateral might generate.

Having a good idea of how much cash the underlying collateral might generate is what distinguishes investing from blindly betting.

As reported by the Financial Times,

US banks have increased their holdings of structured financial products to the highest level since 2009 in an effort to boost profits in the face of continued record low interest rates. 
Banks’ structured finance investments surged to $48bn in the third quarter of this year, according to data released last week by the Federal Deposit Insurance Corporation (FDIC). That is the highest since the FDIC began breaking out the investments in mid-2009, and a 25 per cent rise on the same period last year. 
Analysts say that banks have been snapping up higher-yielding structured securities to offset the effect of low interest rates. While banks’ total revenues have surged due to a boom in mortgage refinancings and loan sales, the interest the companies earn from their assets and loans has dropped sharply. 
The increase is likely to raise concerns that banks are assuming more risk to offset low interest rates – a situation which echoes the pre-financial crisis environment when banks made and bought billions of dollars worth of structured securities. 
“You’ve got to be on the lookout for riskier structures like asset-backed securities, or commercial mortgage-backed securities and maybe some other structured products,” said David Hendler, bank analyst at CreditSights..... 
The Office of the Comptroller of the Currency warned in the summer that banks might be tempted to take more risks to boost their profits..... 

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