Friday, August 31, 2007

American Investment Banks "Shots In The Dark" Economist

I think that not even the best accounting magic can hide that the earnings and the balance sheet will take major hits down the road and have deteriorated significantly. There goes the low multiple....... This was always one of the main bull arguments, now they already had switch to book value (see comment further down), next......

Ich denke das nich einmal die größten Bilanzierungstricks verschleiern können das sich sowohl der Gewinnausblick als auch die Bilanzstruktur erheblich und wohl auch auf längere Sicht verschlechtert hat. Soviel zum niedrigen KGV das seit jeher als Kaufargument herangezogen worden ist. Nun wird bereits auf den niedrigen Buchwert hingewiesen (siehe Kommentar weiter unten), demnächst.......
Wall Street pays for its opacity

STOCKMARKET investors come in all shapes and sizes, but in the current turmoil they agree on one thing: if in doubt about a financial firm, shoot first and ask questions later.
> And when you have committed liquidity guarantees as shown in the table from the Handelsblatt to conduits/SIV´s it is no wonder that you dump the shares first.......
> Und wenn man Zweckgemeinschaften lt. dem Handelsblatt solch großzügige Liquiditätsgarantien gemacht hat würde ich auch schnellstmöglich meine Bankaktien auf den Markt schmeißen.......
> John M from Housing Doom has found this via Minyanville

Through the conduits’ convoluted structures, banks were able to “lend” huge amounts off-balance sheet and collect fees on no-capital-required lines of credit. No one - and I mean no one - ever expected these conduits to move from off-balance sheet back on-balance sheet and I don’t think the market yet understands the earnings, capital and liquidity impact of this migration.

If you figure you need anywhere from 6-8% capital per dollar of loans, then a move of $1.0 trln from off-balance sheet to on requires $60-80 bln in additional equity capital. I don’t know about you, but I don’t see this kind of free capital sitting around.

> Exellent find John M! Maybe we should forward this info to the rating agencies.... ;-)
> Nochmals besten Dank für diesen Fund an John M. Evtl- sollte man diese Erkenntnis an die Rating Agenguten weiterleiten....;-)
State Street, a big money manager, is the latest to stumble into the line of fire. Its shares slumped this week on unsubstantiated rumours that it faced big losses in asset-backed commercial paper.

> More details on State Street from Mish

But it is the investment banks that continue to take most of the bullets. They helped drag stockmarkets down on August 28th after Merrill Lynch downgraded a number of its peers, citing exposure to toxic credit, a day after Goldman Sachs had done the same. An unseemly squabble over jurisdiction in a bankruptcy case against two defunct Bear Stearns hedge funds ´probably didn't help to calm nerves. It hurts all the more to fall from a great height. Until a couple of months ago the investment banks were flying. Profit records were smashed quarter after quarter. Bonus pools looked more like lakes. Valuations climbed to three times book value, implying sustainable returns on equity of over 30%, when even 25% is rare in the industry.

As long as the money rolled in, no one seemed to mind that much of the business was cloaked in mystery.

Investment banks are now paying for that opacity, even though their management of risk has improved since the last credit crisis in 1998. They are suffering from their decision to do less moving and more storing of assets: they hold a lot more illiquid, hard-to-value paper these days, and have more capital tied up in lumpy private-equity deals. Worse, some of Wall Street's most lucrative recent creations, such as conduits and CDOs, are suddenly out of favour. This is part of what one analyst, Deutsche Bank's Mike Mayo, calls “dis-disintermediation”: the return of more traditional forms of finance, to the benefit of universal banks like Citigroup.....

Thanks to iTulip

All except Bear are still trading well above book value, the level at which they are generally considered cheap.
> Reminds me of the discussion from the "value" guys that came up with book value to measure the stock as dirt cheap... Until this sector turned to an impaired industry
> Die ganze Argumentation mit dem Buchwert erinnert mich sehr stark an dieselbe Diskussion mit den Homebuildern. Nachdem das KGV zu hoch war bzw. keine Gewinne mehr vorhanden waren kam plötzlich das Argument von sog. "Valueplayern" (LOL) das gemäß den Buchwerten die Aktien praktisch geschenkt sind.....Das war bevor der Sektor eine einzige Abschreibungsruine geworden ist......
Tellingly, while executives at other financial firms piled into their own shares in August, believing them oversold, there was scant buying among investment bankers.

The key now will be to reassure markets that the exotic assets on bank balance sheets are worth something. Investors are waiting with bated breath for Wall Street firms' third-quarter results, beginning in the second week of September. They may try to get as much bad news out as they can while sentiment is at rock bottom.

Mr Hintz sees it as an encouraging sign that none of the investment banks issuing bonds in the second half of August pointed to new “material” risks, as required when a company raises debt. This suggests that, while things are undoubtedly bad, the banks see no further nasty surprises in the short term.
bigger / größer
The debate over how to value elaborate securities, less pressing in good times, is now taking centre stage. Most credit instruments have to be held at the value a buyer might pay for them, not cost. But judging that is more art than science. The Securities and Exchange Commission, the investment banks' regulator, is examining the issue following rumours that Merrill Lynch and Goldman Sachs were too optimistic in their marking. “This is a chance for the SEC to show leadership on a crucial issue. We desperately need an umpire to ensure consistency and restore confidence,” says one senior banker.

At least investment banks are in better shape than they were going into past crises. Their capital structures are more stable: they increased long-term funding by $200 billion in the past year alone, making them less vulnerable when capital markets dry up. They are also more diversified. They have piled into commodities trading and wealth management, which remain attractive. Their proprietary trading desks, once predominantly credit-focused, now trade lots of equities too. All except Bear Stearns now earn roughly half of their non-retail revenues outside America. ....
Peter Nerby of Moody's, a rating agency, points to two further advantages (though his rivals at Standard & Poor's are not so sanguine). The banks have become better at making money in tough times, he says. Thanks to hedging, trading volume and volatility are now bigger earnings drivers than the level or direction of markets.
> Really? Wasn´t it just 2 weeks ago that the Fed bends rules to help two big banks that had to step in for their brokerage affiliates.... And when you look at the leverage the guy from Moody´s is overly confident. The bond market has a much gloomier view on Goldman & Co
> Wirklich? Ist es nicht gerade ein paar Tage her das die Fed Ihre Grundsätze über Bord geworfen hat um 2 Investmentbanken vor dem Kollaps zu retten.....Der Anleihemarkt sieht die Lage von Goldman & Co weniger entspannt...... Second, good first-half results will help to bail Wall Street firms out, as half of their accrued bonus pools can be taken back to cover second-half losses. A generous pay structure can come in handy if markets falter at the right time of the year.

Bear and Lehman Brothers are likely to suffer more than the rest, partly because they are smaller and partly because they are more exposed to asset-backed nasties (see chart). If conditions worsen, they may even have to buy back securities peddled to clients, as they are obliged to make markets in some of them.

The tables may yet turn. Merrill, Goldman and Morgan Stanley are more exposed than Bear or Lehman to the $300 billion overhang of unsold debt from leveraged buy-outs. This week the bankers fought back, forcing Home Depot to cut the price on the sale of its supply division and the trio of private-equity buyers to swallow higher interest rates on the debt. A bigger test of nerves will come in the next couple of weeks, when buyers are sought for more than $20 billion of loans to finance the takeover of First Data, a transaction-processing group. Were that or another big upcoming deal to collapse, the investment banks could expect a hail of bullets.
> And with appetite for junk like this coming to a halt it is likely that they will have to hold far more toxiy loans than planned.....
> Und nachdem der Junkmarket praktisch zum erliegen gekommen ist ist es sehr wahrscheinlich das die Banken einige ungewollte Kredite in Ihrer Bilanz behalten müssen......
Eleven junk-rated borrowers have sold bonds since the beginning of July, compared with an average of 41 a month in the first half of the year, Bloomberg data show. Three found buyers in August.
Some of them are desperately trying to find a way out..... But with onlyJust three of the 40 biggest pending LBOs have an escape clause that lets the buyer back out if funding can't be arranged this could be very expensive
Einige von Ihnen versuchen bereits verzweifelt sich aus einigen Deals freizukaufen..... Da aber nur 3 der 40 Deals eine Klausel beinhalten das man vom Kredit zurücktreten kann könnte das eine extrem teure Geschichte werden.....
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Blogger jmf said...

Russ Winter
has this to say

" from the Fed’s H8 release shows that from July 25 to August 15, bank credit grew by $81 billion as credit lines are tapped to make up some of the difference."

1:20 AM  
Anonymous Anonymous said...


Bush to Expand Government Role to Deal With Subprime

Despite all of the analysis, soon it could be a lot more painful to be short this market. Even the more than obvious reality that assets and equities have lost significant intrinsic value and have to be either propped up or bailed out by concerted central bank and government intervention will likely be spun as bullish. And if you are trading/speculating, what else is important other than the direction of the tape?

Will there ever be a day of reckoning/a real correction?

Mal sehen...


1:58 AM  
Blogger jmf said...

Moin Eh,

i agree.

That´s why i will wait after the first rate cut to add to my shorts.

I have closed lots of my trading positions but i´m still holding on to my longer term bets.

In addition i am long gold and the miners.

But i must admit that the move in gold so far is not what i´ve expected.

And i´m still trying to find a way to play the coming slump in the UK.

I´m not sure if the way to short the Pound vs the € is the right way

2:14 AM  
Blogger jmf said...

Don’t mention the… subprime exposure

Then yesterday, Bloomberg reported that DB was closing its London credit trading unit after large losses...

Frankly we just don’t know what Deutsche Bank’s exposure to the US subprime market is… They are the only major bank which hasn’t disclosed its exposure and this is obviously worrying some investors.

2:50 AM  
Blogger jmf said...

Barclays reassures after more emergency borrowing

Barclays rushed to reassure investors and depositors on Thursday night after it was forced by what it called a “technical glitch” to borrow from the Bank of England’s emergency reserves for the second time in just over a week.

The move came after it emerged Barclays had borrowed £1.6bn from the facility, which carries a penalty rate of interest, on Wednesday night. The episode follows an embarrassing dispute last week with HSBC over Barclay’s initial borrowing of £314m from the central bank’s facility. Separately, the FT reports that the Bank of England on Thursday warned financial institutions authorised to use its emergency facility not to discuss it publicly

3:11 AM  
Anonymous Anonymous said...


The Barclays story on the BBC site:

Barclays needs central bank loan

Barclays says that a "technical breakdown" in the UK's clearing system forced it to borrow £1.6bn from the Bank of England.

It is the second time this month that the bank has tapped into the central bank's emergency credit line, sparking fears it is facing a cash crisis.

But the UK bank insisted it was "flush with liquidity".

One is left wonder why, if they are really "flush with liquidity", the borrowing was necessary.


5:51 AM  
Blogger jmf said...



That´s the same bank that still wants to buy ABN Amro for over 60 billion.

ABN is leading the table with over $100 billion in potential SIV exposure....

You need an MBA or work for one of the rating agencies to understand the rational :-)

6:04 AM  
Anonymous Anonymous said...

Now it's clear how Barclays intends to use the money:

Barclays Plc, the U.K.'s third- biggest bank, will help rescue a $1.6 billion debt fund run by London-based asset manager Cairn Capital after it was unable to raise money in the credit markets.

Barclays's securities unit will provide a loan to refinance the fund's asset-backed commercial paper as it falls due, the London-based bank said today in a statement. The fund owns U.S. securities mostly backed by home loans.


7:33 AM  
Blogger Yogi said...

Is is just me, or do these off-balance-sheet financing games with SIVs remind anyone of Enron?

But, to quote Jeff Skilling, "I am not an accountant" :)

8:59 AM  
Anonymous Anonymous said...

Now this post is right where the money is? was? will be.

Hat tip Handesblatt/jmf. I hadbeen searching for this latest info. for a day.

3:27 PM  
Anonymous Anonymous said...

RE: Capital and ABCP liquidity facilities vs. on balance sheet

"The rule permits sponsoring banks, bank holding companies, and thrifts (banking organizations) to continue to exclude from their risk-weighted asset base for purposes of calculating the risk-based capital ratios asset-backed commercial paper (ABCP) program assets that are consolidated onto sponsoring banking organizations' balance sheets as a result of Financial Accounting Standards Board Interpretation No. 46, Consolidation of Variable Interest Entities, as revised (FIN 46-R). This provision of the final rule will make permanent an existing interim final rule.

The final rule also requires banking organizations to hold risk-based capital against eligible ABCP liquidity facilities with an original maturity of one year or less that provide liquidity support to ABCP by imposing a 10 percent credit conversion factor on such facilities. Eligible ABCP liquidity facilities with an original maturity exceeding one year remain subject to the current 50 percent credit conversion factor. Ineligible liquidity facilities are treated as direct credit substitutes or recourse obligations and are subject to a 100 percent credit conversion factor. The resulting credit equivalent amount is then risk weighted according to the underlying assets, after consideration of any collateral, guarantees, or external ratings, if applicable"

Full devilish details in this doc.
Comments/conclusions appreciated.

3:55 PM  
Blogger jmf said...

Moin Yogi,

i have thought the same thing.

Moin Anon,

thanks for the link. I´m not an expert but it looks like the banks have to set 10% of their usual capital when they act as "liquidity facility supporting ABCP" (until this guideline 0%)for ABCP under 1 year.

I think we can focus on the 10%/under 1 year ABCP.

All the trouble is coming from them.

Now we probably know why we are not seeing many SIV with ABCP over 1 year /50% credit "conversation" factor.

I´m not sure if this is the right paragraph that explains what is happening when the banks have to step in

For example, a capital charge would apply to an eligible short-term liquidity facility that provides liquidity support to ABCP where the ABCP constitutes less than 50 percent of the securities issued causing the issuing structure not to meet this final rule’s definition of an “ABCP program.” However, if a banking organization (1) does not meet this final rule’s definition of an “ABCP program” and must include the program’s assets in its risk-weighted asset base, or (2) otherwise chooses to include the program’s assets in risk-weighted assets, then there will be no risk-based capital requirement assessed against any liquidity facilities that support that program’s ABCP. In addition, ineligible liquidity facilities will be treated as recourse obligations or direct credit substitutes.

The resulting credit equivalent amount would then be risk-weighted according to the underlying assets or the obligor, after considering any collateral or guarantees, or external credit ratings, if applicable. For example, if an eligible short-term liquidity facility providing liquidity support to ABCP covered an asset-backed security (ABS) externally rated AAA, then the notional amount of the liquidity facility would be converted at 10 percent to an on-balance sheet credit equivalent amount and assigned to the 20 percent risk weight category appropriate for AAA-rated ABS.6

So once more the rating agencies seems to play a big role in how much they have to set aside.

Here is more

In addition, to qualify as an eligible liquidity facility, the agencies proposed in the NPR that, if the assets covered by the liquidity facility are initially externally rated (at the time the facility is provided), the facility may be used to fund only those assets that are externally rated investment grade at the time of funding. If the asset quality tests are not met (that is, if a banking organization actually funds through the liquidity facility assets that do not satisfy the facility’s asset quality tests), the liquidity facility will be considered a recourse obligation or a direct credit substitute and generally will be converted at 100 percent as opposed to 10 or 50 percent.

For these reasons, the final rule considers the practice of purchasing assets that are externally rated below investment grade out of an ABCP program as the equivalent of providing credit protection to the commercial paper investors. Thus, liquidity facilities permitting purchases of below investment grade securities will be considered either recourse or direct credit substitutes

"devilish details" indeed.....

11:44 PM  

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