Whitney: TARP funds go down the downgrade drain

La lutte continue.

Forget the short-lived buzz of $300bn in TARP stimulus, pain for the banks is far from over. Real deleveraging is only just beginning to gather speed; the world economy has yet to enter its worst months, and there are certainly more writedowns to come.

Oppenheimer’s Meredith Whitney is – when it comes to banks’ capital positions – the analyst to turn to. And fortunately, she has a note out today:

We now believe that, at a minimum, capital ratios will be meaningfully lower in the fourth quarter versus post TARP pro forma levels. Aside from the greater than $40 billion in writedowns and provisions we expect for the group of bank stocks under our coverage, and earnings pressure related to chronic negative operating leverage, we also expect capital strains to become apparent from ratings change pressures. Accordingly, we maintain our cautious stance on our group.

The thrust of Whitney’s note is nothing new: she reiterates her “ring of fire” position, whereby ratings downgrades on securities owned by the banks punch huge holes in banks’ balance sheets thanks to onerous regulatory capital requirements. Lower rated securities require larger amounts of regulatory capital in reserve.

And for anyone sceptical as to the significance of that relationship…

rating downgrades versus capital infusions

The interesting part of the latest note comes in quantifying the scale of the rating agency downgrades so far – and more importantly, demonstrating that the worst of them have only just worked through:

Rating agency total downgrades

Clearly, Q4 of 2008 was the worst period so far in terms of security downgrades by a country mile:

rating agency downgrades

The effect of those Q4 downgrades, estimates Whitney, will be to more or less drain all TARP money pumped into the system so far. Expressed below as Opco analysts on upcoming writedowns for Wall Steet’s finest:

(Click on the image for a larger version)

Oppenheimer writedown estimates

Related links:
Citi of over-leveraging – FT Alphaville

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