Q2 profits a false dawn for banks, Moody's says

Although the past week has seen several banks report strong second-quarter results, the crisis is by no means over, according to a report published yesterday by credit rating agency Moody's. Jean-Francois Tremblay, a senior analyst in the agency's global financial institutions group in New York, predicted the last few months of 2009 will see banks fall back into the red.

"In the US, we estimate rated banks will incur approximately $470 billion of losses and writedowns in 2009 and 2010, which may cause many banks to be unprofitable during that period," he wrote. The losses would be augmented by the effects of planned accounting changes, which will force banks to take billions of dollars worth of off-balance-sheet assets back on to their balance sheets. The upshot is, Tremblay added, that US banks have yet to record the bulk of their losses.

Though the financial markets appear to have returned to something like normality in the past quarter, this is an illusion, he believed, claiming banks' stability is underpinned by massive amounts of government support, and this is set to be withdrawn over the next few years.

Federal Reserve Board chairman Ben Bernanke is set to testify before Congress later today, but outlined his exit strategy in an article published this morning: the Fed could tighten the money supply by raising the interest paid on reserve balances, discouraging low-interest lending, implementing reverse repo agreements to reduce bank reserves, selling more Treasury bills and potentially selling off its securities holdings – all of which would raise short-term interest rates and limit credit growth.

After the withdrawal of support, banks would face the need to replace government-backed funding with more expensive unguaranteed funding, and would also face a 'cliff' of maturing short-term debt in the next three years, which would need to be replaced with increasingly expensive longer-term borrowing.

"We expect the convergence of this debt rollover and increasing long-term benchmark rates to exercise upward pressure on funding costs. This problem may be compounded by initiatives that are under way internationally to require regulated financial firms to build larger capital buffers," Tremblay warned.

His colleague Craig Emrick, a US banking analyst, added there are still considerable downside risks to the US economy, which could blow through existing capital stocks. The sentiment echoed comments made earlier this week by the Treasury's inspector-general, Neil Barofsky, who warned in a report on the Troubled Assets Relief Program that the economy was performing worse even than the Treasury's own adverse-case scenario in terms of both GDP growth and unemployment rates. Macroeconomic problems would again make it impossible for banks to raise capital in the equity markets, the report predicted.

European banks also face more losses, the report said. "Most European banking systems are still harbouring a significant amount of unrealised non-performing assets. The delay in recognising these losses may lie in the timing of deterioration of different asset classes. For instance, commercial real estate often leads other asset classes such as residential prime mortgages."

Johannes Wassenberg, a managing director in Moody's European, Middle East and African banking team, warned it was "very likely" more European banks would collapse as a result.

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