Security’s Beta – an indicator of systematic risk

Assessment of creditworthiness of financial institutions or financial instruments is one of the supervision measures. Standard & Poor downgraded the long-term credit rates for major financial institutions including Bank of America, Goldman Sachs, Barclays and HSBC on 30 November. On16 December, Fitch reported the rating cuts for seven largest banks: Bank of America, Goldman Sachs, BNP Paribas, Barclays, Deutsche Bank and Credit Suisse and Citigroup. Even though the downgrades reflect the assessment of the enhanced rating methodologies those involve systematic risk analyses based on macro indicators, industry and regulatory environment, will the valuation reinforce the discipline of the financial performance and reduce systematic risks?

According to the Rating Methodologies for Banks prepared by the Frank Packer and Nikola Tarashev and published in BIS Quarterly Review, June 2011, the assessed tolerance of complex financial instruments, evaluated trends of credit growth and the increase of asset prices as well as greater focus on high quality capital would have provided an important information about the stability of entity during the pre-crisis period. As the intermediation role of banking sector is significant and financial stability is essential for economy’s development, public authorities commit to support banks by additional capital injections, asset purchases or liquidity provisions. Consequently, rating agencies use “stand alone” and “all in” ratings those reflect the financial strength of the institution without the support and with the sovereign and international institutions interventions.

Capital strengthening through the retained earnings is one of the most efficient ways to enhance the resilience of financial institutions during financial shocks. However, financial institutions commit to dividend payments as long as retained earnings are essential to attract investors.

The Goldman Sachs Group, paid dividends on all series of preferred stock on the 10th of November for the following series of its non-cumulative preferred stocks: $239.58per share of Floating Rate Non-Cumulative Preferred Stock, Series A; $387.50 per share of 6.20% Non-Cumulative Preferred Stock, Series B; $255.56per share of Floating Rate Non-Cumulative Preferred Stock, Series C; and $255.56per share of Floating Rate Non-Cumulative Preferred Stock, Series D.

Barclays paid 1p per ordinary share and 4p for America Depository Security which represents 4 shares on 9 December 2011.

Bank of America Corporation announced about regular quarterly dividend of $18.125 per share on the 7.25 percent Non-Cumulative Perpetual Convertible Preferred Stock, Series L.

HSBC declared that the third interim dividend of $0.09 per ordinary share will be paid on 18 January, 2012, the dividend of $0.45 per American Depositary Share, which represents five ordinary shares will be paid on 18 January 2012, the dividend of $0.3875 per Series A American Depositary Share was paid on 15 december, 2011.

The Board of Directors of Credit Suisse most likely will suggest dividends for financial year 2011 with the results of the fourth quarter of 2011 on February 9, 2012.

Moreover, majority of banks were downgraded because of the challenges in the financial sector, id. est. systematic risks those affect financial stability. Security’s Beta describes the sensitivity of its return to the systematic risk, the average change in the return for each 1% change in the return of market portfolio. Deutsche Bank’s Beta is 2.20, Beta of Bank of America is 2.19. So, those banks are more vulnerable that HSBC, Credit Suisse and Goldman Sachs. Beta of HSBC presents 1.19, Beta of Credit Suisse amounts 1.38 and Beta of Goldman Sachs is 1.39.

Consequently, securities’ Beta should be involved in the assessments of systematic risks and factors those reduce securities sensitivity to the portfolio fluctuations could be explored further.