IMF Cuts Forecast for Global Losses to $3.4 Trillion

By Timothy R. Homan and Sandrine Rastello

Sept. 30 (Bloomberg) -- The International Monetary Fund cut its projection for global writedowns on loans and investments by 15 percent to $3.4 trillion, citing improvements in credit markets and initial signs of economic growth.

The tally, released in a semiannual report today, was based on a new methodology after criticism of an April estimate of about $4 trillion. Banks’ losses on bad assets are projected to increase from July 2009 through next year by $470 billion in the euro area, $420 billion in the U.S. and $140 billion in the U.K., the report said.

As firms from Bank of America Corp. to BNP Paribas SA repair their balance sheets, the report said banks that already have written down $1.3 trillion may have another $1.5 trillion in toxic debt on their books. The result will be impaired credit markets that may stifle the recovery through next year and require sustained attention from policy makers to avoid reigniting the crisis, the IMF said.

“Systemic risks have been substantially reduced following unprecedented policy actions and nascent signs of improvement in the real economy,” the IMF said in its Global Financial Stability Report. “Even so, credit channels are still impaired and the economic recovery is likely to be slow.”

For the period from 2007 through 2010, banks’ writedowns on nonperforming assets will be $2.8 trillion worldwide, with $1 trillion originating in the U.S., $814 billion in the euro area and $604 billion in the U.K.

Losses

The IMF said U.S. banks have recognized about 60 percent of their expected losses, compared with 40 percent in both the euro area and in the U.K. Bank earnings will not be enough to offset future losses, the IMF said in the report. It added that the euro area needs to raise more capital than the U.S. or U.K. and “further reforms may be needed to strengthen banks before central banks can fully exit from extensive liquidity support.”

While raising capital should be a priority, preserving funds on hand is equally important, said Jose Vinals, director of the IMF’s monetary and capital markets department. “Capital conservation is something that is very important at this stage,” Vinals said today at a news conference in Istanbul.

In a category called “other mature Europe” that includes Denmark, Iceland, Norway, Sweden and Switzerland, bank writedowns may increase by $120 billion by the end of 2010, the report said.

Banks have already written down $610 billion in the U.S., $350 billion in the euro area and $260 billion in the U.K., the report said.

IMF Estimates

The overall loss projection, which includes pension funds and insurance companies’ potential losses, was lower than an initially projected $4.1 trillion announced in April, attributed to improved economic and financial conditions, the IMF said.

After some European officials complained five months ago about IMF estimates for the region’s banks, the fund’s report today said a different approach was used to estimate future loan and securities losses. The new measure links regional economic forecasts and credit developments to project writedowns. The previous method did not take into account geographic differences.

In the U.S., consumer loans “remain the worst performing segment,” and residential and commercial mortgage charge-off rates are expected to increase in the second half of 2010, the report said. In the euro zone and U.K., “muted economic activity and rising unemployment are expected to push up loan losses,” it said.

Market Collapse

The financial crisis stemming from the collapse of the subprime mortgage market in the U.S. wiped 44 percent off the MSCI World Index, erasing about $24 trillion from the value of global equities in the 12 months to the end of March. Financial companies worldwide have recorded $1.6 trillion in writedowns and losses, according to Bloomberg News data.

“There’s still a lot of impaired assets on the balance sheets of the banks,” IMF Managing Director Dominique Strauss- Kahn said in a Sept. 21 interview. “A lot has been done, but there’s still a lot to do.”

The MSCI World Index has rallied about 64 percent from this year’s low in March.

While signs of improvement in the economy and “reassuring” bank stress-test results have relieved some of the immediate pressure to deal with toxic assets, addressing them remains a “a policy priority and a challenge,” the IMF said in the report.

Hurdles

In the U.S., the Public-Private Investment Program “has faced significant hurdles,” and authorities could adjust it to encourage banks to participate more in the initiative, according to the report.

In Europe, programs to establish “bad banks” to hold impaired assets are still in the early stages and “show promise,” the IMF’s report said.

The Swiss government last year invested 6 billion Swiss francs ($5.8 billion) in mandatory convertible notes to help Zurich-based UBS AG split off toxic assets.

BNP Paribas, France’s largest bank, earlier this month said 2009 provisions for bad loans will be between 7 billion euros ($10.2 billion) and 8 billion euros, lower than analysts’ estimates.

Still, the report mentioned “a concern” about Germany’s plan, which instead of demanding upfront recognition of losses, allows banks to spread them over 20 years.

A leverage ratio for banks, which would manage holdings relative to total assets, will be added to the existing Basel II capital rules, which all members of the Group of 20 advanced and emerging economies will adopt by 2011.

Capital

The U.S. has pumped capital into banks with a $700 billion Troubled Asset Relief Program in the past year. Citigroup Inc., Bank of America and American International Group Inc. were among the top recipients.

The IMF estimates that credit constraints, while easing in most regions, still pose a threat to the recovery. That’s because overall demand will not slow as fast as supply because governments need cash to finance their stimulus plans and their growing deficits, the IMF said.

“Our scenarios envisage the supply of bank credit falling for the remainder of 2009 and into 2010 both in the United States and Europe,” according to the report. “Western European banks appear able to absorb deteriorating credit conditions in emerging Europe, but may lack sufficient capital to support a recovery in the region.”

At the same time, the IMF said, “sovereign issuance will effectively compete with -- and possibly crowd out -- private- sector credit needs.”

The IMF dismissed the notion that a temporary rise in sovereign debt issuance by advanced economies can hurt emerging market debt. Such a scenario would occur only, the IMF said, if widening deficits in industrial nations were sustained.

Governments need to commit to medium-term plans to ensure fiscal sustainability and avoid an increase in long-term interest rates, the lender said. The IMF predicted that financing an increase in budget gaps of 5 percent to 6 percent of gross domestic product may raise long-term borrowing cost by 150 to 200 basis points.

To contact the reporters on this story: Timothy R. Homan in Istanbul at thoman1@bloomberg.netSandrine Rastello in Istanbul at srastello@bloomberg.net