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Friday, April 24, 2009

Fed's White Paper: More Should be Released

by Calculated Risk on 4/24/2009 10:04:00 PM

Note to the Fed: Clearly some analysts have the 12 categories and related indicative loss rates. To be fair, the Fed should release this additional information ASAP.

A few analyst quotes via Bloomberg: Rosner, Davis, Investors Comment on Fed Model for Stress Tests

“The anticipation over the white paper appears to be much ado about nothing. The most significant numbers provided by the Fed in the paper appear to be the page numbers.”
Josh Rosner, an analyst at Graham Fisher & Co. in New York.

“[C]ompletely worthless. We were looking for the translation of the economic forecasts to loan losses and we didn’t get that.”
David Trone, an analyst at Fox-Pitt Kelton Cochran Caronia.

“The assumptions the regulators have used here seem to imply that they’re anticipating a bottoming out of the economic downturn. The momentum in the economy might potentially make the alternative more adverse scenario the baseline scenario.”
Jeff Davis, director of research at Howe Barnes Hoefer & Arnett in Chicago.
Each analyst makes a key point.

I think the only interesting number in the white paper was "12"; the Fed noted that the banks were "instructed to project losses for 12 separate categories of loans".

Based on how the Fed reports Charge-off and Delinquency Rates, we can guess the 12 categories (Update: these are listed in the appendix):

  • Residential real estate first liens, three categories: Prime, Alt-A, Subprime.
  • Residential real estate 2nd liens, two categories: closed end juniors, HELOCs.
  • Commercial real estate (CRE), three categories: Construction & Development (C&D), Multi-family, and other (nonfarm, nonresidential) Note: this is how the Fed breaks up CRE.
  • Consumer Loans, two categories: Credit Cards, Other.
  • Commercial & Industrial (C&I)
  • All other (agricultural, leases).

    As David Trone noted, why didn't the Fed provide the "translation of the economic forecasts to loan losses"? The Fed noted that the banks "were provided with a range of indicative two‐year cumulative loss rates for each of the 12 loan categories for the baseline and more adverse scenarios." Why not provide these indicative loss rates?

    Heck, the WSJ has leaked some of these loss rates:
    The Wall Street Journal released details of a confidential document that the Federal Reserve gave banks in February. The document provided details about the formulas regulators used to assess loan losses in a worsening economic environment.
    One scenario that assumed a 10.3% unemployment rate at the end of 2010 required banks to calculate two-year cumulative losses of 8.5% on mortgage portfolios, 11% on home-equity lines of credit, 8% on commercial and industrial loans, 12% on commercial real-estate loans and 20% on credit-card portfolios.
    Stress Test Losses Click on graph for larger image in new window.

    Under those assumptions, 13 of the banks undergoing the stress tests could be hit with $240 billion of losses, according to Westwood Capital LLC.
    Clearly Westwood Capital has the indicative loss rates - doesn't that create an unfair playing field that some people have the information and others do not?

    And finally, as Jeff Davis noted (and I've been writing for some time), the "more adverse" scenario is the new baseline.