By Michael Rapoport And Ryan Tracy
Faced with new global regulations requiring them to strengthen
their capital, big lenders in the U.S. and Europe have turned to a
trading tactic that flatters their positions without actually
raising extra funds.
Banks that have done such "capital-relief trades" include some
of the largest in the world: Citigroup Inc., Bank of America Corp.,
Deutsche Bank AG and Standard Chartered PLC. But the Office of
Financial Research, a U.S. Treasury office created to identify
financial-market risks, is suggesting the trades run the risk of
"obscuring" whether a bank has adequate capital and pose other
"financial stability concerns."
The Securities and Exchange Commission and the Federal Reserve
also have also voiced concerns about the trades.
Capital-relief trades are opaque, little-disclosed transactions
that make a bank look stronger by reducing its "risk-weighted"
assets. That boosts key ratios that measure the bank's capital as a
percentage of those assets, even as capital itself stays at the
same level.
In a capital-relief trade, a bank can keep a risky asset on the
balance sheet, using credit derivatives or securitizations to
transfer some of the risk to a hedge fund or other investor. The
investor potentially gets extra yield and the credit risk of
smaller borrowers in a way it would be hard for them to get
otherwise, while the bank gets to remove part of the asset's value
from its closely watched "risk-weighted asset" count.
Banks say the trades help them manage their risk, even if they
don't go as far as a bona fide asset sale, and are just one tool
among many they are using to meet new capital requirements.
Some say the Office of Financial Research is mischaracterizing
the transactions, or that the trades didn't significantly affect
their capital ratios. Bank of America, for example, disclosed $11.6
billion in purchased capital protection in 2014 regulatory filings,
but said the impact of the trades on its capital ratios was less
than 0.01 percentage point.
Critics fear the trades can spread risk to unregulated parts of
the financial system--just as similar trades did before the
financial crisis.
"It just seems like another repackaging of risk to mask who's
holding the bag," said Arthur Wilmarth, a George Washington
University law professor and banking expert.
The trades are allowed under banking regulations and securities
laws, but recently have drawn attention in part because banks don't
say a lot about them. The financial-research office said in a June
report on the trades that banks should be required to disclose more
about them.
Banks have made significant progress in increasing capital
ratios to meet the new global requirements. This year, all 31 U.S.
banks the Fed surveyed under its annual stress tests stayed above
its minimum capital requirements for the first time, and the Fed
said the banks' core capital would have been 8.2% of risk-weighted
assets even under deep-recession-like conditions, up from 5.5% in
2009.
But they have more to do: The required capital levels for banks
will rise dramatically by 2019 as governments implement new
regulations known as Basel III. The Fed said in July it will
require still more capital at the biggest U.S. banks.
While some banks have reduced their risk-weighted assets this
year, 30 global banks that regulators label "systemically
important" reported that total risk-adjusted assets increased about
11% between 2012 and 2014, according to data provider Bureau van
Dijk.
The financial-research office said in the June report that 18
U.S. banks had disclosed in 2014 regulatory filings that they used
$38 billion in credit derivatives for "purchased protection" for
regulatory-capital purposes, up from 13 banks in 2009.
The Office of Financial Research didn't identify the banks, but
a review of regulatory filings by The Wall Street Journal indicates
that they include Citigroup, Bank of America, Goldman Sachs Group
Inc. and Morgan Stanley.
Some of the 18 U.S. banks say the trades weren't driven by a
desire to improve their capital ratios. "We don't enter into any
transactions for the sole purpose of artificially reducing
risk-weighted assets or increasing regulatory ratios," said a
spokesman for Citigroup, which had $16 billion in purchased capital
protection in the fourth quarter of 2014. He didn't specify the
impact of the trades on Citigroup's capital ratios.
Goldman Sachs and Morgan Stanley declined to comment.
Standard Chartered PLC has done 12 capital-relief trades since
2005. In one, a March 2014 trade that was part of a series dubbed
"Start," the bank transferred some of its risk on a pool of EUR1.5
billion ($1.67 billion) in loans to small and medium-size
companies. Deutsche Bank unloaded some of its risk on EUR2.35
billion in loans earlier this year with another variant of a
capital-relief trade, known as synthetic securitizations.
A spokesman for the Office of Financial Research said it is
possible the trades have only a "minimal effect" on capital ratios,
but the study showed the banks don't disclose enough information to
draw that conclusion.
The Fed in 2011 said capital-relief trades "can significantly
reduce a banking organization's level of risk" and has said in
recent years it scrutinizes the trades based on pricing, rationale
for the transaction, and other factors. Fed officials declined to
discuss specific transactions.
The SEC's concern is that some capital-relief trades might not
really get risk off a bank's balance sheet, said Michael Osnato,
chief of the complex financial instruments unit in the SEC's
enforcement division.
Wayne Abernathy, an American Bankers Association executive vice
president, says it is important to recognize the distinction
between "keeping the loan on your books without any cover, and
sharing the risk with somebody else."
Firms that advise on or invest in the deals include
Christofferson Robb & Co. and Ovid Capital Advisors LLC. "We
were attracted to transactions that transferred well-underwritten
loan risk," said Glenn Blasius, Ovid's CEO.
One worry about such trades is that they shift risk to funds and
other investors that aren't as closely regulated as banks. Before
the financial crisis, European banks bought $290 billion worth of
credit default protection from American International Group Inc.
for regulatory capital relief, the Office of Financial Research
noted. That protection likely would have proven worthless had it
not been for the bailout AIG received later.
Today's transactions are complex enough that regulators may miss
some of the risks, adds Thomas Hoenig, vice chairman of the Federal
Deposit Insurance Corp., who favors stricter and simpler capital
rules. "It's a little bit catch-as-catch-can," he said.
(END) Dow Jones Newswires
August 17, 2015 19:22 ET (23:22 GMT)
Copyright (c) 2015 Dow Jones & Company, Inc.
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