We find that TALF 2.0 is likely to benefit securities with the least amount of writedowns and lowest haircuts —fixed rate bonds and long-reset hybrids should have the most upside. We estimate that banks will experience about $400bn more in losses, and stress tests will reveal the need for more capital for certain institutions.Among other things Jozoff points out is that banks will need to set aside an additional $215 billion in reserves against holdings of $2.1 trillion in residential loans not packaged into securities. As banks have taken only $85 billion in loss allowances as of Q4 2008, and Jozoff estimates the total expected residential losses at $300 billion (based on 12-16% losses on the total number mentioned above), banks will be hard pressed to fund this capital deficiency, especially now that each and every bank is rushing to repay the TARP that "it never needed in the first place." Continues Jozoff:
We expect that total losses could reach $1.3 trillion. Banks so far have taken writedowns and losses of $920bn, so they are roughly 70% through with total losses. Capital raised to date ($900bn, much of which came from governments worldwide) has been close to the amount of losses realized to date. Given the amount of losses still to come, we believe the system will need more government capital (although healthier institutions may not need more and may try to raise capital from the private sector). Bank earnings will also be a source of capital and some estimate that over the next two years, the largest institutions can see around $200bn of earnings (pre-tax, pre-provisions).Regardless of the validity of earlier "leaked" stress tests, this is likely a major sticking point for the administration which is currently beating its head on how to sweep these potential large future losses under the rug.
Going forward, the bulk of bank losses will come from loan books and less from securities portfolios, which have already gone through large writedowns. Most bank loans are not required to be marked-to-market, but, rather, reserves are set aside for expected loan losses to be realized in the next year or so. That is why reserve coverage ratios (reserves vs non-current loans) have plunged. In other words non-current loans are growing at a faster pace than reserves have built-up.
Even though banks don’t have to reserve for total cumulative losses today, the question is how much more reserves will they need over the next few years to cover loan losses. In the case of residential loans, if total expected losses are $300bn and banks have set aside $85bn in reserves for these loans, we estimate that there could be over $200bn left to go, or about half
of total projected losses across all assets.
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