Analysis shows megabanks have 23,000 times more exposure to credit default swaps than community Banks.
Healthy community banks unfairly impacted from financial adversity and consumers should heed the wake-up call.
As the economic crisis puts a spotlight on the obscure world of credit default swaps (CDS), an unregulated $62 trillion market that most people never heard of and even fewer understood, the fear of a CDS catastrophe is haunting the country’s largest banks, and the nation’s healthy community institutions and consumers are paying the price.
An analysis of FDIC data as of 12/2008 conducted by BancVue (www.bancvue.com, a leading provider of products and consulting to community banking institutions, shows that commercial banks $10 billion or larger have just over $24 worth of credit derivatives for each dollar of equity. By comparison, the rest of the industry has essentially one-tenth of a penny of CDS for each dollar of equity. Those numbers translate to the big banks having roughly 23,000 times as much credit derivative exposure versus all other community financial institutions.
This comes at a time when megabanks are already reeling from write-downs on mortgage-related securities. “These are the same institutions that themselves have either directly or through subsidiaries invested in the subprime market,” said Don Shafer, Chairman of BancVue. “After suffering losses all over the place, the megabanks are now waiting for the next shoe to drop. In the meantime, it’s placing an undue burden on healthy small banks and should serve as a wake-up call to consumers.”
Since the mortgage-backed securities that many swaps were supporting began to lose value in 2007, investors have feared that the swaps, originally meant as a hedge against risk, could suddenly become huge liabilities. While the CDS marketplace is completely unregulated and the swaps trade without a central clearinghouse, it’s known that commercial banks are among the most active participants. According to the Comptroller of the Currency, JP Morgan Chase, Citibank, Bank of America, and Wachovia were ranked the top four most active players.
In February, federal regulators facing a cascade of bank failures depleting the deposit insurance fund raised the fees paid by U.S. financial institutions. Although the FDIC intended on charging more from higher risk banks, they also suggested levying a hefty emergency premium in a bid to collect $27 billion this year. The higher premiums being assessed were originally set for 20 cents for every $100 of insured deposits levied equally on the 8,305 federally insured institutions. To put that in perspective, for a $250 million dollar community bank, the “one time tax” would constitute a $500,000 hit, which could wipe out 20% to 40% of a bank’s annual profits. At the Independent Community Banking Association Convention last week, FDIC Chairman Sheila Bair predicted that the assessment will probably be lower. She went on to say that the FDIC is seeking comments on whether the agency should use total assets or some other base for the special assessment, which would have consequences for how the burden is distributed.
“How about basing part of the assessment on the amount of credit derivatives a bank holds compared to their equity?” continues Shafer, referencing BancVue’s research showing the extraordinary exposure to CDSs of the megabanks versus the community financial institutions. “If you are going to unfairly burden smaller banks that played by the rules, the least the FDIC can do is base the levy on the banks that helped trigger the crisis.”
Even amidst this threat and turmoil among the megabanks, consumers are still trusting more than 70% of deposits in the U.S. to these large financial institutions. “Americans appear to be paralyzed in their banking relationship leaving so much of their hard earned cash in TARP and CDS-laden megabanks. It’s time for consumers to wake up and evaluate their banking options, particularly when community banks offer a less risky deposit alternative with better products and services,” concludes Shafer.