Andre J. Peschong

That is the current mantra for banks as it portends to their portfolio of commercial paper.  The banks cannot afford to have the level of delinquencies on their commercial paper turn into a massive capital call and thus stay in the TARP money conundrum.  In speaking with some very high level management at major banks they are all concerned with the health of their commercial portfolios: off the record of course.  I am hearing from these people that approximately one third of their portfolios are in some form of default while another third is currently distressed or substantially out of covenants.  When I heard this I was mortified!  What can be done to stave of this impending financial Armageddon?  In the next 12 to 18 months there will be approximately $800 billion worth of commercial loans coming due and with the economy still in a very fragile state this could really become a catalyst for the second bottom.  The banks, with a lot of help from the administration, are methodically going through their respective portfolios and figuring out a way to put the commercial loans back into covenants.  What this really amounts to is a massive billion dollar loan modification program.  If the banks can “modify” or extend most of these loans,  so that it is back to a conforming piece of paper, they will not have to take a haircut or write down which protects their capital requirements.  The net effect is it allows the banks to shore up their loan portfolios with the stroke of a pen, which in turn enables them to go to the street and raise new investor capital.  Case in point this week, Citigroup and Wells Fargo each raised billions of new capital so they can do what?  Repay the TARP money, which on the face of it should be good news.  Well it is certainly good news for the Treasury Secretary and the administration because the taxpayer money is coming back and the banks appear to be healthier which codifies the administration’s position that we are out of the recession and a new period of growth starts.  That makes me feel all warm and fuzzy but the real motivation for the banks to repay the TARP money is to have the government oversight off their back and it lets them get back to their old school bonus programs.  This is a potential win-win scenario; for the administration it is a fabulous PR feather in their cap and for the banks with a stroke of the pen they are getting these loans back into covenants thus creating the illusion of a stronger bank which in turn allows them to raise capital in the open market, repay TARP and preserve their bonuses.  This entire farce is what I like to call extend and pretend.   The banks extend the loans and change the covenants and then they pretend everything is great!!  The article that best sums up this position was put out this morning on Tech Ticker and is called American Kabuki.  It is definitely worth a read and distills from the experts exactly where the banking system currently stands.

I will be following up on this subject matter with another key philosophical discussion regarding the question of a company or an industry being too big to fail.

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