Today, the Congressional Oversight Panel (COP) released its August report entitled The Continued Risk of Troubled Assets. The report “examines the economic implications of troubled assets and assesses Treasury’s strategy for removing these assets from bank balance sheets.” The COP report notes that the ability of banks to continue as going-concerns will be affected by (i) the future performance of the economy as a whole; (ii) the performance of loans and other assets on bank balance sheets; and (iii) the method banks use for valuation of these assets. The report also discusses the use of Troubled Assets Relief Program (TARP) funds to bolster the capital position of banks in the face of impending write-downs on troubled assets and to build regulatory capital reserves rather than remove such problem assets from the banks’ balance sheets.
The report states that the TARP “capital infusions have provided breathing space for banks to write-down many of these assets and to build loss reserves against future write-downs and losses.” Banks have, however, retained troubled assets on their balance sheets and, as the labor market and other economic conditions continue to deteriorate for borrowers, many of these loans will not be repaid. In some instances additional write-downs may be greater than originally expected. “If the troubled assets held by banks prove to be worth less than their balance sheets currently indicate, the banks may be required to raise more capital. If the losses are severe enough, some financial institutions may be forced to cease operations.”
The report also discusses some of the changes made to the traditional “mark-to-market” valuation method. “In response to the crisis, banks have been allowed greater flexibility in the way they value these assets.” Regardless of the valuation of these assets, however, the report notes that increasing uncertainty in the market has caused banks to build up capital reserves rather than increase lending to consumers – even credit-worthy borrowers.