Banco Popular de Puerto Rico

Receiving Wide Coverage ...ClusterSwap: European banks are even more exposed to the risk of government defaults than you think. According to a story in today's Journal, regulatory data released last week shows these institutions have been big writers of credit default swaps on government bonds of the continent's dodgier countries. And it's not just investment-banking-heavy multinationals like Barclays and Deutsche Bank that have been selling this insurance; smaller European institutions, like Landesbank Baden-Wurttemberg in Germany, have also been taking sovereign credit risk this way. Granted, CDS sellers typically hedge this risk by buying CDS on the same bonds. But as we've learned from the recent discussion of "gross" versus "net" exposure, those hedges are only as good as the counterparties behind them. And by and large the CDS-seller European banks appear to have bought their offsetting hedges from, well, other European banks. It is somewhat reassuring, though, to read this bit in the Journal story: "Some big banks … say they buy only from banks outside the countries in which they are seeking protection"; for example, "Deutsche Bank wouldn't buy Italian swaps from an Italian bank." No bank would do anything that foolish … right? Also in the Journal, the "Heard on the Street" column notes that the cost of a swap insuring against a default by Bank of America is higher now than it was in the dark days of early 2009. Moreover, there isn't as much difference between the cost of insuring B of A's senior and subordinated debt as there was then. These developments, the column says, suggest the market now believes two things: that the U.S. of A is less likely to stand behind B of A should the bank falter; and that regulators could well exercise their new resolution powers under the Dodd-Frank Act to wind down a giant institution, a scenario in which senior bondholders stand to lose money. Bottom line: "Investors aren't so sure 'too-big-to-fail' banks will always deserve that moniker." Lastly on the topic of CDS: it ain't exactly the smoothest five pages of text we ever read, but a new report by Nicholas Vause, a senior economist at the Bank of International Settlements, is worth the time. Data from June 2011, Vause writes, suggests that derivatives dealers have been transferring "multi-name credit risk" (the CDS market's equivalent of index funds, roughly speaking) to shadow banks (a broad category that includes insurance companies, pension funds and money market mutual funds, all of which lack the same public backstops and supervision of traditional banks). "These types of CDS can be difficult to value and have experienced significant price jumps in the past" (never a good thing if you've been a seller). Morning Scan translation: there may be more AIG-style blow-ups waiting to happen out there. Underscoring the aforementioned concerns about counterparty risk, Vause also writes that banks and security dealers have been net sellers of credit protection on financial-sector debt. "The risk of simultaneous default of protection sellers and reference entities is often higher when these institutions come from a common sector, rather than different sectors. As the financial sector is broad, however, this risk could have been mitigated by careful pairing of reference entities with counterparties." Morning Scan translation: let's just hope no one bought insurance against default by an Italian bank from another Italian bank. Or the same one.

Receiving Wide Coverage ...Fortress Fed: Ahead of the central bank's policy meeting today, the Journal has a lengthy feature taking stock of Ben Bernanke's six years as chairman. Among his current goals, the story says, Bernanke "wants to transform the Fed by making its murky decision making more transparent." He's already taken steps in this direction by initiating quarterly press conferences; potential strategies include disclosing the Fed's forecasts for short-term rates and adopting a formal inflation target. (There's also a sidebar with details on Bernanke's home mortgage.) Yet the Fed remains secretive in other ways. On the FT's "Money Supply" blog, Robin Harding writes that he made a Freedom of Information Act request for the Federal Reserve Board's reviews and examinations of the 12 regional Fed banks since 2000. The board rejected his request, arguing that the regional banks are "financial institutions" and thus information about them is confidential and exempt from FOIA. "This is a ludicrous catch-22 because the regional Fed banks are themselves financial supervisors of hundreds and hundreds of other banks," Harding writes. "Their performance in that role is a matter of public interest." Well said, and we might add that while confidentiality on bank-supervision matters may be necessary to avoid panics, it's hard to imagine a run on the New York Fed. We hope Harding appeals. On the other hand, Reuters' blogger Felix Salmon points out that other countries' central banks are even more opaque than ours. He cites a Bloomberg News story on the Fed's currency swap program, in which it has loaned dollars to foreign central banks to relend to local commercial banks. The Fed disclosed all the transactions with its counterparts, but even it may not know the identities of the ultimate borrowers; a Fed spokeswoman tells Bloomberg there's "no formal reporting channel" for it to get this information. And of course the foreign central banks don't publish it. At least the Fed is now bound by law - Dodd-Frank, to be exact - to identify borrowers from its discount window (after a lag of two years, to avoid stigmatizing them). God bless America, and good luck to Bernanke and Harding alike in their efforts to open more curtains at the Fed and let in that glorious sunlight.

Receiving Wide Coverage ...Fed Leaves Rates Unchanged: Recent data "suggests that the economy has been expanding moderately," the central bank said after the last policy meeting of the year, though it left its policy options open for 2012. A return to purchases of mortgage-backed securities remains a possibility, but for now the Fed will simply continue to reinvest principal repayments in new MBS. Wall Street Journal, Financial Times, New York Times, Washington Post

Receiving Wide Coverage ...Flight from Europe, to Safety: The stats in this morning's papers speak volumes: Three-month LIBOR hit its highest level since July 2009. (And if history is any guide, we gather some banks' actual borrowing costs could be worse than the index suggests.) The exchange rate for the euro fell below $1.30 for the first time since January. And cash on deposit at foreign-owned banks in the U.S. has fallen for six straight months, the first time this has happened in nearly a decade. The upshot of all this: confidence in Europe and in the global banking sector remains fragile, last week's accord among the continent's leaders notwithstanding.

Breaking News This Morning ...Hudson City Warning: The New Jersey bank expects to post a fourth-quarter loss after extinguishing costly debt.

Receiving Wide Coverage ...Capital Punishment: The Fed is expected to support the Basel Committee's plan to impose a capital surcharge on the biggest, most globally interconnected financial institutions, the Journal reports. A draft proposal could come before Christmas; JPMorgan CEO Jamie Dimon, whose bank would have to hold another 2.5% of extra capital as a percentage of risk-weighted assets (on top of the 7% required of all institutions) would probably prefer a stocking full of coal. Big banks have lobbied hard against the "G-SIFI surcharge," protesting it would dampen lending and hurt the economy. In another blow to the industry on this front, the European Union said Britain is free under EU law to impose extra capital requirements on her banks above and beyond what Basel calls for, the FT says. The U.K. government plans Monday to adopt that and most of the other proposals by Sir John Vickers' commission, including the "ringfencing" of retail banking from trading. Finally, Bank of America completed its previously announced debt exchange offer, generating $3.9 billion of capital that will count toward Basel III guidelines. The opportunity for banks to raise capital this way — by extinguishing debt at a discount to par — is an advantageous byproduct of bond investors' loss of confidence in the banks' credit. In an environment like this, you have to count your blessings wherever they come from.

Receiving Wide Coverage ...Less than a Lincoln: Bank of America’s share price fell below $5, as part of a broader selloff in financial stocks sparked by a warning from the European Central Bank about dangers for the Eurozone economy. The Charlotte, N.C., megabank’s shares closed at $4.99, the lowest level since March 2009. Mortgage-related litigation risk remains a dark cloud over the company, and $5 was a “bad psychological barrier” to break, an analyst tells the FT. Another analyst is paraphrased as saying that “some funds could become forced sellers of BofA shares due to pressure from clients and fund consultants, leading to further declines.” In a Bloomberg story picked up by the Washington Post, a money manager explains that the threshold is more than psychological: “We have screens that usually prohibit us from buying stocks under $5. If we own it, we would not kick it out automatically, but generally we tend to avoid stocks like that.” The trading-focused blog iBankCoin suggests those holding the stock may have an incentive to buy: “There have been reports that the $5 level in Bank of America’s stock must be defended by institutions in order for them to continue to hold the stock, else face forced selling.” And a finance professor quoted in the Bloomberg/Post story appears to damn Bank of America with faint praise. After saying the “real danger” for a public company is falling below $1 a share, which typically means delisting, he adds that in such cases “it is usually some fundamental problem with the business model and it may go to zero, but I think Bank of America is very different from your typical small failing company.” Quips the blog DealBreaker: “That’s Your Big Pump Up Speech?” Financial Times, iBankCoin, Washington Post/Bloomberg, DealBreaker

Receiving Wide Coverage ...The TBTF Quarantine: The Journal leads its story about that package of Dodd-Frank rules proposed by the Fed yesterday with one that came as a surprise to the industry: limits on the top six banks’ exposures to each other. Goldman Sachs’s net credit exposure to JPMorgan, for example, would be capped at 10% of the former’s regulatory capital, and vice versa. The story quotes an analyst as suggesting this may be “a back-door way” to shrink the banks’ capital-markets businesses. A shadow Volcker rule, if you will. (Or a stealth Glass-Steagall, perhaps. Maybe a veiled Vickers. How about a Trojan Tobin?) Restricting interbank credit among those with $500 billion or more in assets could, of course, hurt market liquidity, but this is a price the Fed’s willing to pay to reduce interconnectedness among the megabanks, and thus keep any one of them from threatening to “punch a hole in the fabric of the universe” (in Matt Taibbi’s memorable phrase) a la AIG. The FT’s story, however, notes two surprise concessions to the banking industry from the Fed, both in the area of liquidity. First, the Fed said it would rely on banks’ internal modeling, rather than its own, to gauge the banks’ liquidity needs. And the central bank proposed to allow Fannie Mae and Freddie Mac mortgage-backed bonds to count as “highly liquid securities,” alongside cash and Treasuries. This was notable, the FT says, since “global regulators sought to limit the amount of Fannie and Freddie securities that could be used to meet liquidity rules.” (Those bureaucrats must be anti-American! And anti-homeownership to boot. Figures, these fancy Europeans, renting cold water flats and living their entire lives inside the same square mile, running down the block once in a while for a bottle of wine and a baguette and parking their puny SmartCars perpendicular to the curb...) Where were we? Oh, right … As expected, the Fed’s 173-page proposal includes a capital surcharge for the top eight banks, consistent with Basel III. There’s a lot more in here, including ongoing stress tests and remediation requirements for banks that show lapses. Wall Street Journal, Financial Times, New York Times, Washington Post

Receiving Wide Coverage ...It's Not True, and If It Is, It's Not Our Fault: Bank of America agreed to pay $335 million to settle government charges that Countrywide overcharged minorities and steered them into subprime loans, in the largest residential fair-lending settlement in history. The bank denied the Department of Justice's allegations (we've seen the boilerplate "neither admitted nor denied" line in some news stories, but in the proposed consent order there's a flat-out denial right there on page 4). Yet at the same time B of A "took pains to distance itself from the accusations levelled at Countrywide," which it bought in 2008, the FT says. "Bank of America's practices are not at issue," a spokesman tells the paper. (The consent order includes an acknowledgment by the government that it's all about Countrywide.) This was the first steering case brought by the DOJ, but more are expected, the Journal says. The paper's "DealJournal" blog tallies all the various Countrywide-related settlements and other legal and credit costs B of A has incurred from the acquisition; they well exceed the $4 billion the bank paid for the mortgage company. And Fox Business/Dow Jones writer Al Lewis cites a separate, ongoing lawsuit against B of A from another arm of the government, the Federal Housing Finance Agency, which says that before the acquisition "the top executives of Countrywide...complained to each other...that BOA's appetite for risky products was greater than that of Countywide." Lewis is amazed: "Imagine that. Bank of America doing mortgage deals that even Mozilo found shocking. This would be like Frankenstein convincing Godzilla that he is the bigger monster." Wall Street Journal, Financial Times, New York Times, Washington Post, Los Angeles Times, Huffington Post, Fox Business,

Editor's Note ...Morning Scan is taking a break for the holidays next week. We'll publish next on Tuesday, Jan. 3.