Major bank failure seen as likely, survey shows

Investors believe such a collapse would pose a "serious threat" to global markets, writes Proinsias O'Mahony

NEARLY 60 per cent of institutional investors expect another major financial firm to collapse in the next six months and almost three-quarters believe a major bank failure within a year is likely, a new survey has found.

According to the Financial Times, the survey of 146 European, US and Canadian institutions by Greenwich Associates found investors believed such an event would pose a "serious threat" to global markets. Frank Feenstra, a consultant at Greenwich Associates, said "most institutions think we are currently in the most dangerous period for global financial services firms".

Investors were particularly concerned about "counter-party risks" on credit trades - the risk that the other party to a contract will default. Fear of a major chain-reaction of counter-party risk failures led to the Federal Reserve's bailout of Bear Stearns in March. The survey found that 55 per cent of those polled had stopped using one or more financial institutions as a counter-party on credit trades due to solvency concerns.

US institutions were very anxious in this area, with 85 per cent saying that counter-party risks posed a real threat.

The fragile state of global finance was in evidence again yesterday, with Switzerland's UBS and American bank JP Morgan announcing write-downs of $5.1 billion (€3.4 billion) and $1.5 billion respectively.

With total write-downs of $42 billion, UBS has been one of the biggest losers in the credit crisis, with only Citigroup ($47 billion) and Merrill Lynch ($46 billion) faring worse. Long known as the banker to the rich, wealthy clients have been deserting the troubled bank in droves, with money outflows of $41 billion in the second quarter.

JP Morgan has been lauded for avoiding the worst of the subprime excesses. Yesterday's warning that trading conditions in the mortgage market had "substantially deteriorated" in July, forcing it to write down $1.5 billion on mortgage-based assets, led many to think its more exposed rivals were likely to face further head winds in the coming weeks and months.

Wachovia, America's fourth-largest bank, said on Monday it was increasing its previously reported second-quarter loss to over $9 billion, adding that continued housing market deterioration necessitated further job cuts.

With defaults and delinquencies on home loans continuing to rise, banks have toughened up their lending standards. In its quarterly Senior Loan Officer Survey, the Federal Reserve this week reported that banks had "tightened their lending standards and terms on all major loan categories over the previous three months".

That's a far cry from the lax standards of the boom years. It was recently alleged that Richard Syron, chief executive of troubled mortgage provider Freddie Mac, was told in 2004 the firm was buying bad loans that posed "an enormous financial and reputational risk to the company and the country". His response, according to Freddie Mac's former chief risk officer David Andrukonis, was that "we couldn't afford to say no to anyone".

It's a different story now. Zillow.com, an internet provider of property valuations, yesterday said that almost one-third of US homeowners who bought in the last five years now owe more on their mortgages than their properties are worth. It said nearly a quarter of homes sold in the past year sold for a loss.

For banks, too, the fallout from the housing bust has been substantial, with global credit losses now exceeding $500 billion. US treasury secretary Henry Paulson has said that America's banking system "is a safe and sound one" and the list of "troubled" banks is very "manageable". However, there were 90 banks on the "problem list" of the US Federal Deposit Insurance Corporation (FDIC) in the first quarter of this year, an 18 per cent increase from the first quarter of this year.

That remains way below levels seen in the early 1990s, when 834 banks failed. Furthermore, the FDIC is quick to point out that a bank's inclusion on the list does not mean it is going to fail.

Still, Californian bank IndyMac, which became the third-biggest banking failure in US history when it collapsed last month, was not even on the FDIC list a week before it closed. IndyMac's failure erased as much as 15 per cent from the insurance fund.

Housing concerns refuse to go away. Yesterday, rating agency Moody's said that the number of UK subprime mortgages in arrears had jumped from 7.3 per cent last year to 10.2 per cent in the second quarter of this year.

US attention is switching to so-called prime mortgages, given to people with the best credit histories. "Prime looks terrible," JP Morgan chief executive Jamie Dimon said last month.

Prime loans account for most of the $12 trillion mortgage market, and delinquencies have doubled to 2.7 per cent over the last year. Trouble is also brewing in the Alt-A mortgage market. Alt-A mortgages were aimed at people with strong credit histories but whose risk profile was nevertheless high - for example, applicant's income was often not verified. Such mortgages tend to be regarded as riskier than prime and less risky than subprime. Alt-A mortgages in arrears quadrupled to 12 per cent in April from a year earlier.