Word: loaned
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Dates: during 2000-2009
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...firms leading the charge to capital-light banking was Bank of America (BofA). Starting in 1993, a predecessor firm became one of the first banks to develop and embrace computer models that were supposed to improve a bank's ability to determine the risk of a particular type of loan. After a merger in 1998 that formed the bank, BofA officials often argued to investors and regulators that these new advanced risk controls meant the bank needed to carry less capital per loan. The officials also frequently fought regulations that would boost capital requirements for them and other banks...
...bank has $5 in capital and $100 in loans. Now the government gives the bank an additional $100 in preferred shares and says, "Go make more loans." Well, the bank might then have $200 in loans, but it still has only $5 in common shareholders' equity. The result: if just 2.5% of its loans go bad, the bank's shareholders are wiped out. Wisely, the largest banks in the nation lent less in the fourth quarter of 2008 than in the previous three months - a strategy that has drawn some complaints. But that hasn't removed the pressure on their...
...BofA wasn't alone. By early 2008, nearly all the big banks were poorly positioned to weather a downturn - particularly this downturn. Accounting rules demand that banks take a hit to their earnings by the value of a loan when it becomes clear a borrower is not going to pay it back. When a bank's loan losses are greater than its income, it has to take money from its shareholders' equity account to make up the difference. That's a big deal for a company's investors. If shareholders' equity is wiped out, their stock is effectively worthless...
...Miller looked at eight of the largest financial firms in the U.S. and determined that on average, if just 3.4% of their loans go unpaid, their shareholders will be wiped out. The good news is that these firms are so large that 3% of their loan portfolio is a really big number: some $400 billion. The timing of when the loans go bad matters too. If, say, 5% of a bank's loans go bad over 10 years, the bank will survive. It can cover the loan losses with the earnings it gets from all its paying customers. But given...
...switch to doing more lending through investment-banking operations has only made matters worse. For deposit-based loans, the banks have wide discretion as to when they record a loss. Some do it after a borrower misses his first payment. Other banks wait until the loan is 120 days past due. But for loans made through a firm's investment-banking division, the bank has to reduce the value of those debts according to what similar pools of loans are worth. This is known as mark-to-market accounting. And when investors grow increasingly nervous that borrowers will...