Who's Next?
Due to a widespread lack of transparency and all sorts of behind-the-scenes maneuverings, its been hard to get a good grip on where all the dead bodies lie in the wake of the spreading meltdown in global credit markets.
The obvious casualties, of course, are firms that have already gone to the wall or that have been forced to throw themselves into the arms of vulture investors. More important, however, is trying to figure out who might be next or which firms could be at greater risk than others.
Unfortunately, in an environment where hard data is lacking, sometimes the best you can hope for are back-of-the-envelope-type calculations derived from snippets of publicly available information.
In an admittedly limited analysis, Peter Cohan, President of Peter S. Cohan & Associates and a contributor to BloggingStocks.com, asks "Could Citadel's Valuation of E*Trade's CDOs Wipe Out Capital at Three Big Banks?"
Last week, Citadel Investment Group, a Chicago hedge fund, bought E*Trade Financial (NASDAQ: ETFC)'s collateralized debt obligation (CDO) portfolio for 27 cents on the dollar according to The Wall Street Journal [subscription required]. If this price was applied to the Level 3 assets of nine of the largest banks, it would wipe out the capital of three of them.
It's important to point out, before presenting this analysis, that the 27 cents on the dollar price that Citadel paid applied only to E-Trade's CDOs. It may represent a worst case scenario price for these banks. Furthermore, the Level 3 assets of these nine banks include other illiquid securities besides their CDOs. Finally, the calculations I'll show are based on the most recent Level 3 assets and equity of these banks as of last month.
Having said that, here are the three banks whose capital would be wiped out if that 27 cents on the dollar valuation was applied to their Level 3 assets and written off from their most recent capital levels:
I'd like to think things are not that bad. (The portion of the ABX index tracking double-A-rated subprime bonds that is used by many investors as a proxy for determining the value of similar mortgage securities recently traded at 45 cents.)
Nevertheless, it would not shock me if these banks were scrambling behind the scenes to raise capital. But Level 3 assets are illiquid so when a market price like Citadel's comes along, bank audit committees have a hard time just ignoring it unless they can somehow justify why their computer models would set a far higher value.
I am not sure how long banks can delay the day of reckoning. But I think they should just get it over soon so the market can resume functioning.
(Hat tip to DealBreaker.)
(Disclosure: I am also an occasional contributor to BloggingStocks.com)
I remember when the Japanese banks lied, and kept on lying about non-performing loans in the books. It took years before they came clean. Because of their ownership of huge quantities of stock that the big four were illiquid if not outright insolvent at any given time during the demise of the Nikkei. I wonder how much toxic waste still remains.
I guess my point is that these back-of-the-envelope assessments can be pretty illuminating. My info about the Japanese bank situation, which was accurate over a period of years, came from just such an article in the WSJ sometime in 1997.
Posted by: Snappy Tom | December 04, 2007 at 07:25 PM
If you like please combine my two comments.
After thinking about it a bit I wondered how bad it had to be for the three banks to simply be insolvent e.g. -1b.
Morgan Stanley could receive as high as 41 cents on the dollar, Goldman 47 and Bear Stearns 30.
To me, these numbers are even scarier than the the E*Trade settlement because even at the ABX number Goldman is under water right now and Morgan darned close. Ironically Bear Stearns has a little breathing room.
Yikes.
Posted by: Snappy Tom | December 04, 2007 at 08:49 PM