Sizing Up Level 3 Assets
A: Another day, another bite from the credit monster. Lets keep the credit discussions going as this is by far the most important macro economic news going on right now, with $95 oil a close second, and the free falling US dollar an even closer third. Here are todays credit crunch headlines as well as the latest 'level 3 assets' disclosures as filed to the Securities & Exchange Commission.
First, lets size up what we know (which is already outdated) as disclosed in filings to the SEC for level 3 assets exposure by major banks and brokerages; again, this is important because these numbers will likely have to be revised higher once the new accounting change takes place on Nov. 15th.
Source: FACTBOX: Sizing Up Banks' Hard To Value Assets (Reuters)
MORGAN STANLEY (NYSE: MS) -----> $88.21B as of August 31st
GOLDMAN SACHS (NYSE: GS) ------> $72.05B as of August
LEHMAN BROTHERS (NYSE: LEH) ---> $34.68B as of August 31st
BEAR STEARNS (NYSE: BSC) --------> $20.25B as of August 31st
CITIGROUP (NYSE: C) --------------> $134.84B as of September 30th
MERRILL LYNCH (NYSE: MER) ------> $15.39B as of September 28th
BANK OF AMERICA (NYSE: BAC) ----> $21.64B as of June 30th
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TOTAL = $387.06 Billion of Level 3 Assets Known So Far
Now, the $250 Billion dollar question is how will these numbers be revised in future filings after the accounting change takes place on November 15th? Note that these are not losses, they are the total assets deemed by the company to fit into the category of un-tradable assets because not enough liquidity exists in the marketplace to get a true price value on the securities; so instead of marking them to market they are marking the asset values to models. In other words, the firms use these in-house valuation models to put a price tag on what these assets might be worth if they could be traded. Needless to say, you can see the problem with certainty here and why future write downs and losses are likely as the secondary mortgage markets continue to be seized up!
Today's credit crunch headlines:
Wachovia Sets $1.1B in OCT Losses (AP)
Wachovia Corp. said Friday the value of collateralized debt obligations in its portfolio fell about $1.1 billion in October, making it the latest financial institution to warn of sharp losses last month in the credit markets. The company also said it plans to boost its allowance for loan losses in the fourth quarter due to expected credit deterioration in the housing market in certain regions. The provision is pegged at $500 million to $600 million in excess of charge-offs in the quarter.Barclays Denies Speculation About Write-Downs (Bloomberg)
Barclays Plc, Britain's third-biggest bank, denied speculation that it will announce a substantial writedown in the value of its assets after its stock fell as much as 9.1 percent.HSBC Exits Mortgage Securities (NY Times)"There is absolutely no substance in these rumors," spokesman Alistair Smith said. He also denied speculation that Chief Executive Officer John Varley may step down.
HSBC Holdings, the British bank, said it had stopped sales and trading of mortgage-backed securities in the United States after the collapse of the subprime market forced it to close two lending units.On The Subprime Endangered List (BusinessWeek)The bank will keep its asset-backed business both globally and in the United States, Mr. Goad said, including securities backed by non-United States mortgages.
Which CEO will be catching subprime heat next now that Citigroup's Chuck Prince is out? It will likely come down to whose losses are biggest. Bear Stearns' James E. Cayne may be the most vulnerable CEO.Those last two sentences are why I included this in today's discussion! Especially the very last sentence: "That, in turn, could make it harder and costlier for Bear to borrow the money it needs to run its day-to-day operations." Keep in mind that as this credit crunch evolves to future phases, ratings downgrades become more and more likely and that in itself can cause more problems. The vicious credit cycle feeds on itself.Bear's biggest problem may be its so-called Level 3 assets. That risky group includes all securities that require a lot of guesswork to value - such as mortgage-related debt and assorted corporate loans. Those hard-to-trade assets are susceptible to markdowns - and Bear has $20 billion worth. Bear has offered little hint about the type of Level 3 assets it holds, but analysts think the bulk are mortgage-related. In its recent conference call, Bear said it had $2.4 billion in subprime exposure.
For a company of Bear's size - its market value is roughly $15 billion, vs. $165 billion for Citi and $45 billion for Merrill - a $3 billion-plus hit would be disastrous. It would be nearly triple the $1.1 billion in net income Bear generated in the first nine months of the year. And it would likely tarnish its credit rating, signaling to lenders that the firm has a thinner cushion against potential losses. That, in turn, could make it harder and costlier for Bear to borrow the money it needs to run its day-to-day operations.
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Comments (6)
Where are u getting these numbers from? Bill Gross said sub prime related market is approximately 1 trillion USD. Per your calc approximately 400 are out in the open what about the remaining? Are funds going to be hit?
Posted by Anonymous | November 9, 2007 11:49 AM
I got these #'s from the reuters article I sourced in the post. Bill Gross speculated on that $1 trillion dollar number I believe. I think he expects $250-350B in actual losses. So far we have about $50B in losses, $90B if you include GM's..So we have some more to go.
The point I am trying to get across is that WE DONT KNOW! This level 3 assets accouting change makes this uncertainty even deeper!
Posted by Noah | November 9, 2007 2:12 PM
Everyone is making an assumption that these are mostly mortgage related figures... but I'm thinking that is a bad assumption.
Posted by spaceboy | November 10, 2007 1:37 AM
Noah - a technicality: the companies that are disclosing Level 3 assets have already early adopted FAS 157...prior to adoption of FAS 157, sorting assets into buckets and disclosing Level 1/2/3 was not required. So while it is true that the numbers you quote are outdated, the mandatory implementation date of Nov 15th shouldn't have any effect on these companies. Thanks for all the great insights into our markets that you provide!!
Posted by anon | November 10, 2007 10:01 AM
anon's post is correct- a technicality, but nevertheless correct. The large banks, like Goldman, has already adopted the new rule in Q1 07 actually, so the exposure amount isn't going to change drastically, unless of course, they did shady accounting back then and will have to come clean now- an unlikely event.
The REAL issue is now, they will have to mark their exposures down more and more as market pricing data become available. Also, smaller banks etc. which have not adopted the new rule will provide an aggregate exposure that will be high as well.
Here's an easy to read summary:
* CFO Magazine has an article titled, "FASB 157 Could Cause Huge Write-Offs."
* Why? Because under the new provisions firms are forced to whenever possible use "observable inputs" in pricing their Level Three assets.
* In somewhat overly simplified terms, Level Three assets are those that may rely on mark-to-model inputs since they so rarely trade.
* In may cases there is no way to price the securities. This gives the firms a lot of leeway in determining their value.
* But when something does trade, under the new rules it forces that asset out of Level Three based on the pricing data that becomes an "observable input."
* "It you think banks are writing off large amounts of assets now, wait until new accounting rules take effect this month," the CFO article says.
* But Goldman Sachs (GS), Merrill Lynch (MER), JP Morgan (JPM), Morgan Stanley (MS) and Citigroup (C) already adopted early implementation of FASB 157 beginning in the first quarter of 2007.
* Still, we keep reading vaguely grim predictions of looming disaster beginning on November 15.
* What gives?
* We think there may be confused causality here.
* Firms such as American International (AIG) in their 10Q said they are "currently addressing the effect of implementing this guidance."
* A lot of firms out there are in this boat.
* Meanwhile, Wall Street's major firms are about the only firms that have already adopted the FASB 157 provisions.
* The issue is not increased writedowns based on this FASB 157 "implementation date."
* The issues remains the fear of forced sales creating "observable inputs" at distressed prices that will force assets to be valued at starkly lower levels.
Another important stat is not only their exposures, but the ratio of their exposure to their capital. Like Goldman, which is over 180% even if their exposure is on the lower side. Using this kind of info, Merrill actually is safe compared to the rest.
Cheers and keep up the good word!
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