Using Veritas to Construct the "Per…

29-04-2017 Hits:85784 BoomBustBlog Reggie Middleton

Using Veritas to Construct the "Perfect" Digital Investment Portfolio" & How to Value "Hard to Value" tokens, Pt 1

The golden grail of investing is to find that investable asset that provides the greatest reward with the least risk. Alas, despite how commonsensical that precept seems to be, many...

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The Veritas 2017 Token Offering Summary …

15-04-2017 Hits:80012 BoomBustBlog Reggie Middleton

The Veritas 2017 Token Offering Summary Available For Download and Sharing

The Veritas Offering Summary is now available for download, which packs all the information about Veritas in a single page. A step by step guide to purchasing Veritas can be downloaded here.

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What Happens When the Fund Fee Fight Hit…

10-04-2017 Hits:79872 BoomBustBlog Reggie Middleton

What Happens When the Fund Fee Fight Hits the Blockchain

A hedge fund recently made news by securitizing its LP units as Ethereum-based tokens and selling them as tradeable (thereby liquid) assets. This brings technology to the VC industry that...

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Veritaseum: The ICO That's Ushering in t…

07-04-2017 Hits:84351 BoomBustBlog Reggie Middleton

Veritaseum: The ICO That's Ushering in the Era of P2P Capital Markets

Veritaseum is in the process of building peer-to-peer capital markets that enable financial and value market participants to deal directly with each other on a counterparty risk-free basis in lieu...

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This Is Ground Zero for the 2017 Veritas…

03-04-2017 Hits:80891 BoomBustBlog Reggie Middleton

This Is Ground Zero for the 2017 Veritas Offering. Are You Ready to Get Your Key to the P2P Capital Markets?

This is the link to the Veritas Crowdsale landing page. Here is where you will be able to buy the Veritas ICO when it is launched in mid-April. Below, please...

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What is the Value Proposition For Verita…

01-04-2017 Hits:83138 BoomBustBlog Reggie Middleton

What is the Value Proposition For Veritas, Veritaseum's Software Token?

 A YouTube commenter asked a very good question that we will like to take some time to answer. The question was, verbatim: I've watched your video and gone through the slides. The exchange...

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This Real Estate Bubble, Like Some Relat…

28-03-2017 Hits:54149 BoomBustBlog Reggie Middleton

This Real Estate Bubble, Like Some Relationships, Is Complicated...

CNBC reports US home prices rise 5.9 percent to 31-month high in January according to S&P CoreLogic Case-Shiller. This puts the 20 city index close to an all time high, including...

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Bloomberg Chimes In With My Warnings As …

28-03-2017 Hits:82274 BoomBustBlog Reggie Middleton

Bloomberg Chimes In With My Warnings As Landlords Offer First Time Ever Concessions to Retail Renters

Over the last quarter I've been warning about the significant weakness in retailers and the retail real estate that most occupy (links supplied below). Now, Bloomberg reports: Manhattan Landlords Are Offering...

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Our Apple Analysis This Week - This Comp…

27-03-2017 Hits:82124 BoomBustBlog Reggie Middleton

Our Apple Analysis This Week - This Company Is Not What Most Think It IS

We will releasing our Apple forensic analysis and valuation this week for subscribers (click here to subscribe - lowest tier is the same as a Netflix subscription). As can be...

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The Country's First Newly Elected Lame D…

27-03-2017 Hits:81993 BoomBustBlog Reggie Middleton

The Country's First Newly Elected Lame Duck President Will Cause Massive Reversal Of Speculative Gains

Note: Subscribers should reference  the paywall material here for stocks that should give a good risk/reward scenario for bearish trades. The Trump administration's legislative outlook is effectively a political desert, with...

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Sears Finally Throws In The Towel Exactl…

22-03-2017 Hits:88018 BoomBustBlog Reggie Middleton

Sears Finally Throws In The Towel Exactly When I Predicted "has ‘substantial doubt’ about its future"

My prediction of Sears collapsing once interest rates started ticking upwards was absolutely on point.

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The Transformation of Television in Amer…

21-03-2017 Hits:85893 BoomBustBlog Reggie Middleton

The Transformation of Television in America and Worldwide

TV has changed more in the past 10 years than it has since it's inception nearly 100 years ago This change is profound, and the primary benefactors look and act...

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From Bloomberg:

Treasury Secretary Henry Paulson and New York Federal Reserve Bank President Timothy Geithner met this evening with Wall Street executives to discuss this week's slump in the financial markets.

Securities and Exchange Commission Chairman Christopher Cox also took part in the discussions, New York Fed spokesman Andrew Williams said in a statement. The talks with ``senior representatives of major financial institutions'' were held at the Fed's New York district bank, he added, declining to identify the executives.

The Wall Street Journal reported earlier that Morgan Stanley Chief Executive John Mack (HMMMM!!!!) and Merrill Lynch Chief Executive John Thain participated in the discussions with Paulson, Geithner and Cox.

The New York Fed meeting came as Lehman Brothers Holdings Inc. continues to seek a buyer or buyers for the investment bank that lost 77 percent of its value this week.

We all know what is happening to Lehman, and if you followed this blog you knew it about 7 months ago. We also know why Thain from Merrill was at that meeting. But why was John Mack there??? Well, registered users and subscribers know from the readings in the sidebar.

 Banks, Brokers, & Bullsh1+ part 1

Wednesday, 19 December 2007 | Reggie Middleton

A thorough forensic analysis of Goldman Sachs, Bear Stearns, Citigroup, Morgan Stanley, and Lehman Brothers has uncovered...  Last week, Morgan Stanley called Citibank the “short play of...

The Riskiest Bank on the Street
(Archived/Reggie Middleton's Boom Bust Blog/MyBlog)

Key highlights of my research on the "Riskiest Investment Bank on the Street": The Riskiest Bank on Wall Street – Morgan Stanley has US$74 billion of Level 3 assets, over 200% of its eq
Monday, 11 February 2008
A closer look at the exposure of the other brokers
(Archived/Reggie Middleton's Boom Bust Blog/MyBlog)
...- Who has the most of their assets tied up in illiquid Level 3 as a proportion to tangible equity? You guessed it, The Riskiest Bank on the Street. Now, they do have a decent amount of liquidity the ...
Sunday, 16 March 2008

19. On the insolvencies of non-bank financial institutions
(Archived/Reggie Middleton's Boom Bust Blog/MyBlog)
...Bullsh1+ part 1 Banks, Brokers, & Bullsh1+ part 2 Money Panic Bear Fight The Breaking of the Bear The Riskiest Bank on the Street Here comes the CRE Bust (Quip on Lehman Brothers)...
Tuesday, 18 March 2008

20. Quick Morgan Stanley update from my lab
(Archived/Reggie Middleton's Boom Bust Blog/MyBlog)
  This is a refresher to the The Riskiest Bank on the Street piece that I posted a few months ago on Morgan Stanley. Let me get straight to the salient points. High exposure to lev
Thursday, 20 March 2008

21. Early morning scan of events
(Archived/Reggie Middleton's Boom Bust Blog/MyBlog)
For those that haven't noticed, I've begun sharing my early morning news and data routine with the blog. Here goes Monday moring EST. Is the Fed running out of ammo? Reserve
Monday, 31 March 2008

22. Reggie Middleton on the Street's Riskiest Bank - Update
(Archived/Reggie Middleton's Boom Bust Blog/MyBlog)
This is the update to my forensic deep dive analysis of Morgan Stanley. It is still, in my opinion, the "riskiest bank on the street". A few things to make note of as you browse through my opinion a
Sunday, 06 April 2008

23. Banks, Brokers & Bullsh1t 3.0: Shenanigans at Morgan and Lehman
(Archived/Reggie Middleton's Boom Bust Blog/MyBlog)
I've been promising to give an illustration of the shenanigans being played by the commercial and investment bank's for some time now, but I've been quite busy working on my entrepeneurial pursuits
Wednesday, 16 April 2008

24. I warned you about the risk of those I Banks
(Archived/Reggie Middleton's Boom Bust Blog/MyBlog)
...ive counterparty and credit risk to imperfect hedges to dead and depreciating assets held off balance sheet: The Riskiest Bank on the Street Is this the Breaking of the Bear? Banks, Broke...
Wednesday, 21 May 2008

 

For those who are not part of the inner caucus:

Morgan Stanley has US$74 billion of Level 3 assets, over 200% of its equity, which is the highest amongst its peers. Although the Level 3 assets have declined from the previous quarters owing to huge writedowns, the reclassification of assets from from Level 2 to level 3 category continues as the liquidity for the troubled mortgage paper drys up.

Increasing level 3 assets likely to cause further losses: Morgan Stanley’s hard-to-value assets, represented by level 3 assets have grown persistently, rising from 4.3% of the total assets in 1Q2007 to 7.0% in 1Q2008 partly off the transfer of assets from level 2 to level 3 due to unobservable market inputs. As liquidity crisis and credit spread widening continues to hamper the global financial markets, we expect the increasing proportion of level 3 assets in Morgan Stanley’s balance sheet to translate into higher losses and asset write-downs for the company. Also noteworthy is the fact that Morgan Stanley’s level 3 assets as a proportion of its shareholders’ equity are the highest in its peer group which makes it one of the most vulnerable companies to be hit by continuing credit market turmoil. 
 

Morgan Stanley’s significant level 3 exposure and high leverage remain a cause for extreme concern

Large write-downs likely due to level 3 assets exposure: Morgan Stanley’s level 3 asset exposure, which stood at 261% of its equity as of February 29, 2008, is likely to cause a significant drag on its valuation in the near future. These assets, for which the bank uses proprietary models to gauge their value, will witness the largest write-downs of all asset categories amid the current credit market turmoil. When compared with other leading investment banks, Morgan Stanley clearly stands out to be the most vulnerable to falling values in these hard-to-value assets. It is worthwhile to mention that Bear Stearns, which last month witnessed significant erosion in its market capitalization, had level 3 assets equal to 239% of its equity, next only to Morgan Stanley. Although the Fed has mitigated liquidity concerns of investment banks in significant part, the balance sheet solvency is a far more difficult problem to address – and one in which Morgan Stanley leads the pack. 
 
 
Bank Level 2 Assets Level 3 Assets Shareholder Equity Total Assets Level 2 Assets-to-Equity Level 3 Assets-to-Equity Leverage (X)
Citigroup $934 $133 $114 $2,183 822% 117% 19.21
Merrill Lynch $768 $41 $32 $1,020 2405% 130% 31.94
Lehman Brothers $177 $39 $26 $786 687% 152% 30.59
Goldman Sachs $277 $72 $47 $1,120 586% 153% 23.71
Morgan Stanley $226 $74 $31 $1,045 723% 236% 33.43
Bear Stearns 227 $28 $12 $96 1926% 239% 8.15
 
Based on latest quarterly filings and transcripts 
 
Let's pay close attention to the chart above. Bear Stearns flamed out in March. I warned you twice that they were going to flame out in January. Stearns is the only company that has (had) a higher L3/equity ratio than Morgan Stanley. The next runner up after Morgan is Lehman Brothers. 'Nuff said. Then after Lehman we have Merrill, the Street's latest whipping boy. Who sports the highest adjusted leverage on the Street (includint what was Bear Stearns)? I'll give you two guesses... 
 
Also, the growing proportion of level 3 assets in Morgan Stanley’s total asset exposure is raising investors’ concerns over expected write downs in the coming quarters. The bank’s level 3 assets have increased partly due to re-classification of assets from level 2 to level 3 on account of unobservable inputs for the fair value measurement. During 4Q2007, Morgan Stanley re-classified $7.0 bn of funded assets and $279 mn of net derivative contracts from level 2 to level 3. Morgan Stanley’s level 2 assets-to-total assets ratio declined to 5.2% in 4Q2007 from 8.9% in 1Q2007 while its level 3 assets-to-total assets increased to 7.0% in 4Q2007 from 4.3% in 1Q2007 indicating growing uncertainty associated with valuation of assets not readily marketable. The trend can be expected to continue in the coming quarters as uncertainty associated with realizing values from illiquid assets continues to grow.  The following is excerpted from a post that I made in April - most prescient. Remember, back in April most sell side houses had buy recommendations on Morgan AND Lehman with targets in the 60 dollar range. With friends like those, who needs enemies.
 

On a different, but related, note we seem to have Lehman playing hide the sausage with losses.

The most recent 10Q has a realized gain of $695 million in the Corporate Equities line for Level II assets, (see Banks, Brokers, & Bullsh1+ part 1 for bullsh1t updates - I just knew I would get to use this link againCool). Comparing this to prior quarters shows a significant jump, averaging considerably less that $70 million, with the largest being $135 million. This is even more fishy considering equities on a global basis were trending downward for the reporting period at hand. I know that level III is supposed tto represent assets with no observable inputs, but come on now, where were these equities as the global markets sank, Mars? Okay, maybe Pluto since Mars may be a little less hospital to financial entitiy life forms.

We also have gains of approximately $550 million from proprietary investment activity. I read this as benefits from playing with adding assets to level three at values they "think" are higher than last reporting period since there are no observable inputs to tell them otherwise (except for a global drop in fixed income and equity prices - but why let that rain on the parade). We now have a new meaning for the term prop desk.

These unrealized Level III equity asset gains were millions of dollars more than what Lehman reported as pretas income for the quarter. That should scare anybody long in the stock. If it it doesn't make you wet your pants, just remember that they also booked about $600 million in FAS 159 gains to arrive at about a $500 million profit for the quarter. FAS 159 gains are for the most part phantom gains (this was addressed in detail in the Reggie Middleton on the Street's Riskiest Bank - Update, and I will excerpt it llater on in this missive as we illustrate MSs games). Take these two tidbits of data in perspective, and Lehman took a very deep loss last quarter, and rallied hard on the their results, on top of it. I believe they were a good short before the price pop, and they are an even better short with the stock 20% higher. I  may even consider welcoming an SEC investigation against me for shorting the stock. We can open my trading books, research and blogs, and in exchange we can also open Lehmans books to see if my research, observations and assertions had any merit or empirical standing - Uh Oh! Here comes that Jack Nicholson effect again, after all, all we want is the truth. "The TRUTH! The TRUTH! YOU CAN'T HANDLE THE TRUTH!!!" I love that scene...

Lehman and it's MSRs: Multiple Statutory wRightups!

With Bear Stearns gone (Is this the Breaking of the Bear?), Lehman is the undispute king of MBS on the street. They are, as a result of being so involved in the industry, rich in MSRs (it really stands for mortgage servicing rights, I was just being an asshole in the subtitleFoot in mouth, or was I?). Lehman wrote UP the value of these assets. Granted, with the current financing home sales market slowing to a crawl, prepayments have dropped considerably, giving a plausible gain to these rights since they will not be eliminated through loans being retired, but their amortization rates fell below the reduced (by one third) long term assumptions. Thus, they are not only kitchen sinking for this quarter, but this is a) a non-cash gain (yeah, like the level III hide the sausage game and the FAS 159 benefit - so "Where's the cash?"), and b) supposedely a hedge (albeit an imperfect one) against Alt-A impairments - we may see some horrow related to this in the future.

Morgan Stanley guys teasing the Lehman guys - "My sausage is bigger than yours..."

 The Reggie Middleton on the Street's Riskiest Bank - Update piece was posted right before Morgan reported. No need to fret though, there were no surprises and they are still the riskiest bank on the street. I would like to not that many sell side instutions have buys on Lehman and Morgan - some with price targets of $65! Whaaaatttt???!! Methinks someone may be sniffing the ink off of the analyst reports before it dries... Since I am just a neophyte individual investor and blogger, I will try not to be intimidated by the big boys, but I must disagree. Consider me the diminuitive captain contrarian.

In the recent 10Q, Morgan's gains from level III assets were exactly 100% more than the level III asset gains for ALL OF LAST YEAR! This was during the roughest and most illiquid structured product, fixed income, and most volatile equity quarter in recent history, if not ever. Hmmmm! I wonder... Oh yeah, they get to determine the values of level III assets, not the market (Banks, Brokers, & Bullsh1+ part 1) - and did they need to do some constructive determining this quarter. Instead of going into MS assets indepth, I will defer to the full report: Reggie Middleton on the Street's Riskiest Bank - Update, but will point out a few interesting tidbits. The report shows a constant trend of shifting assets from Level II to Level III, presumably as they become impossible to value due to illiquidity, in other words - are worth less - this increase is despite impairments incurred in extant level III assets. It appears that as these assets are shifted from level II to III, they may also be revalued to the upside.

This may look pretty on MS income statements, but from an investor's and an economic perspective, this bodes ill. Even if they did some how trade some of this stuff profitably, much of the gains were in derivatives such as CDS what could have a reversal that would wipe out these phantom gains in the future, reversing to a significant loss. This speculation is unnecessary though, since most of it was not cash or real. I am working on regional bank shorts now, but when I'm finished, I will have my analysits revisit this in detail and I will share my results. MS sports the highest concentration of level III assets to tangible equity of any bank on the street save Bear Stearns, and we all know what I thought would happened to the Bear in January (Is this the Breaking of the Bear?).

Pretty reporting with more input from the public relations and marketing departments than the accountants actually caused Morgan Stanley's price to pop, just like Lehman's. When reality (bullsh1t) hits the fan, they will have that much farther to fall.

 

FAS 159, translated to mean FSA 101 (Fudging to Save our Asses)

Excerpted from Reggie Middleton on the Street's Riskiest Bank - Update:

Since most of these securities are not traded in the secondary market, it would be difficult for Morgan Stanley to translate these accounting gains into economic gains by purchasing them at a discount to par during a widening credit spreads scenario. To explain in simpler terms, marketable securities can be purchased at a discount to par if credit spreads increase as MS debt is devalued. Thus, theoretically, MS can retire this debt for less than par by purchasing this debt outright in the market, and FAS 159 allows MS to take this spread between market values and par as an accounting profit, presumably to match and offset the logic in forcing companies to market assets to market via FAS 157. In reality, only marketable securities can yield such results in an economic fashion, though companies that would be stressed enough to experience such spreads probably would not be in the condition to retire debt. In Morgan Stanley's case, these spreads represent non-marketable or minimally marketable debt to a great extent - such as bank loans, negotiated or OTC /structured borrowings and deposits. These cannot be purchased at less than par by the borrower, thus any accounting gain had through FAS 159 will lead to phantom economic gains that don't exist in reality. For instance, a $1 billion bank loan will always be a loan for the same principle amount, regardless of MS?s credit spreads, unless the bank itself decides to forgive principal, which is highly unlikely. It should be noted that Lehman Brothers actually experienced an economic loss for the latest quarter of about $100 million, but benefitted by the accounting gain stemming from FAS 159, that led to an accounting profit of approximately $500 million. This profit, which sparked a broker rally, was purely accounting fiction. Similarly, Morgan Stanley (in economic profit, ex. "real" terms) overstated its Q1 '08 profit by approximately 50%. This overstatement apparently induced a similarly rally for the brokers. Quite frankly, we feel the industry as a whole is in a precarious predicament due to dwindling value drivers, a cyclical industry downturn, a credit crisis and a deluge of overvalued, unmarketable and quickly depreciating assets stuck on their balance sheets. Their true economic performance is revealing such, but is masked by clever, yet allowable accounting shenanigans. 

Below are snippets from my proprietary Morgan Stanley model that was designed to illustrate the potential benefits of the use, misuse, and absue of FAS 159. I am currently working on regional bank shorts, but when I am finished I will have my analysts scour the most recent 10Qs for things that I missed and report back.

Morgan Stanley, De-shenaniganed by Reggie Middleton:


  Q1 08 Q2 08E Q3 08E Q4 08E Q1 09E
Benefit From FAS 159 Subtracted from Net Income 547.00 148.72 147.41 87.67 58.14
Adj. Earnings / (loss) applicable to common shareholders 987 -1214.67 -297.04 397.40 -82.57
Adj. EPS              0.97            (1.19)          (0.29)            0.39          (0.08)
Cumulative effect of adoption of the fair value option          
 % of liablities 3.13% 0.88% 0.88% 0.53% 0.35%
Widening of credit spreads  95 bps   25 bps   25 bps   15 bps   10 bps 

 

 For the fiscal year ended November 30, 2007, the estimated changes in the fair value of the Company’s shortterm and long-term borrowings, including fair value option was elected  that were attributable  to changes in instrument-specific credit spreads  were gains of approximately $840 million

We have computed fair value adjustment relating to Morgan Stanley's liablities under the FAS 159 based on expected movement of spreads. We expect Morgan Stanley to record $383 mn gain for reminder of 2008 and $116 mn for 2009 under FAS 159 due to expected widenind of spreads. In 2010 and 2011, we expect Morgan Stanley to report $290 mn and $118 mn loss under FAS 159 due to spreads compression on its liabilities.

 In 1Q 2008, Morgan Stanley recorded $527 million benefit from the impact of widening credit spreads on firm issued structured notes.

Now, if we take the FAS 159 adjusted income and plug it into a P/E model to run the comps...

 

    Price Shares o/s   EPS          
        2008 2009 2010   Thomson mean for MS - EPS
Morgan Stanley MS 43.5 1104.6 (0.12) 2.47 5.41 5.65 6.63 7.78  
Bear Stearns BSC 10.7 118 6.48 8.95 9.63   Thomson mean for MS - BVPS
Goldman Sachs GS 176.5 395 16.59 20.70 21.80 33.77 38.76 43.95  
Merrill Lynch MER 45.9 969 3.95 5.73 5.83        
Lehman Brothers LEH 43.3 554 4.88 6.75 7.06        
                     
                     
Company Market Cap
(US$ mn)
  P/E              
    2008E 2009E 2010E            
Morgan Stanley       48,074  NM          17.64        8.04 . 
Bear Stearns         1,266        1.65            1.20        1.11  
Goldman Sachs       69,749      10.64            8.53        8.10      
Merrill Lynch       44,468      11.62            8.01        7.87            
Lehman Brothers       23,991        8.88            6.42        6.14            
Industry Average   8.20 6.04 5.80            
Excluding Bear Sterns   10.38 7.65 7.37            
                     
                     
Current share price 43.5                  
                     
                     
P/E approach                    
P/E           7.65                  
EPS (2009) 2.47                  
                     
Estimated Price         18.87                  
Upside (downside) -56.6%                  

 
We have excluded Bear Sterns from the peer average owing to the recent liquidity crisis faced by the firm in the repo market.We belive that recent initiatives by Fed to open the discount window to prime brokerages firm will help them manage their short term liquidity and they will be able to avert a similar repo crises. That does not mean that I feel they are out of the water. Another bank very well may fail, as the pop media pieces excerpted above regarding LIBOR clearly indicate that the large money center banks certainly agree with me. The next shoe to drop, IMO is the CDS and counterparty credit arena, where the Fed has much less control. This is in essence what happened to Bear Stearns, but on a smaller scale. I think that once the CDS market (or any other market with lax counterparty credit controls) starts to unravel, all hell will break loose. This is essentially what the Fed was trying to prevent in the rescue of Bear Stearns.

As you can see, my forensically cleansed version of Morgan's valuation is significantly different from both the sell side consensus and the current market. Time will tell if this is the collapsing of the House of Morgan as well.

And some more from the Riskiest Bank on the Street series written originally in January and updated in March:

 
 
image0121x.gif
image014x.gif
 
High leveraging could hinder capital raising abilities: While expected asset write-downs could continue eroding Morgan Stanley’s equity at least for the next few quarters, the company’s higher-than-peers leverage levels could prove to be an impediment in raising additional capital to maintain its statutory capital levels. Morgan Stanley’s leverage (computed as total tangible assets over tangible shareholders’ equity) stood at 37.3X as of February 29, 2008, while the bank’s balance sheet size had been reduced to $1,091 bn as of that date from $1,182 bn on November 30, 2007. The bank’s leverage is the highest among its peers which could be a cause of concern amid falling income levels and tight liquidity conditions in the financial markets.
image0121.gif
 * Adjusted assets / adjusted shareholder's equity 
 
Morgan Stanley taking initiatives to “de-risk” its balance sheet: In the wake of issues underpinning the current crisis in the markets, Morgan Stanley is making continued efforts to “de-risk” its balance sheet by reducing its exposure to risky credit positions. Morgan Stanley’s total non-investment grade loans decreased to $26 bn in 1Q2008 from $30.9 bn in 4Q2007. In addition Morgan Stanley reduced its gross exposure towards CMBS and RMBS securities to $23.5 bn and $14.5 bn, respectively, in 1Q2008 from $31.5 bn and $16.5 bn, respectively, in 4Q2007. 
 
 
Highly leveraged balance sheet could hinder capital raising: At 37.3x Morgan Stanley’s adjusted leverage ratio (a measure of the extent to which the company relies on borrowed money) is the highest among its peers. Morgan Stanley’s high leverage could hinder the company’s ability to raise capital to maintain statutory capital levels in future (or at the very least make the cost of said capital extreme) and take advantage of any near-term business opportunities amid tight credit conditions. 
Continued asset write-downs to impact profitability: While the financial sector continues to clean its balance sheet by writing off bad assets, the global credit crisis doesn’t appear to have subsided. UBS and Deutsche Bank expect $19 bn and $3.9 bn of write-downs, respectively, for 1Q2008. Morgan Stanley’s $9.4 bn asset write-down in 4QFY07 was followed by a $2.3 bn mortgage-related asset write-down in 1Q2008. Amid continuing housing sector problems and credit spread widening, financial sector could see further write-downs in the coming quarters.  The following charts attempt to outline what we see as a potential downside to commercial (retail) and residential property values, respectively. According to these charts, companies such as Morgan Stanly, which hold significant securities and related assets written at the top of the real estate and credit bubble with high leverage, have quite some way to fall before equilibrium (ex. a bottom) is reached, and when that point arrives, history portends that we will coast along the bottom in lieu of experiencing a “V” shaped curve where asset values immediately bounce upwards – further lending to illiquidity in the said markets.

 

Declining ABX index indicates troubled times are not over yet Morgan Stanley used the performance of the ABX index as one of the benchmarks to writedown US$9.4 billion in 4Q 07. As this index continiues to witness downward trend, we believe that the asset writedown done so far, may not be sufficient.

Forensic Accounting of ABS Assets yields more woes - a security by security accounting of MSs ABS inventory shows at least 30% and probably 56% in additional losses coming down the pike, as well as tests to its excessive exposure to the anemic capital reserves of its counterparties, namely monoline insurers and hedge funds.

Losses from unconsolidated VIEs of $38 billion can wipe out almost half of the company’s total equity Morgan Stanley has $20 billion of its unconsolidated VIEs assets in credit & real estate portfolio where the company expects a maximum loss ratio of 65%. Considering the worsening real estate markets, we believe that the company will incur huge losses on this portfolio. In addition, the company has $7 billion towards MBS & ABS portfolio and $10 billion of strucutured finance products.

Exposure toward Bond Insurers/private funds raises counterparty risk The failure of bond insurers, on whose shoulders lie the rating of $2.4 trillion of bonds, raises a serious doubt about a systemic failure in the U.S. financial services industry. Morgan Stanley’s exposure of $3.6 billion toward just the two major bond insurers may result in unforeseen losses for the company. The company has a counterparty credit risk exposure of $13.9 billion toward parties rated BBB and lower.

Morgan Stanley Issued Securities with Exposure to Ambac and MBIA

Morgan Stanley has exposure to bond insurers through bonds insured by them and their status as counterparties to derivative contracts. The inability of bond insurers to pay claims has become a serious concern for parties exposed to such firms.

The significant concentration in subprime home equity lines, who are subject to playing 2nd fiddle to the primary lender in first position in terms of claim on the what is increasingly highly encumbered property, leaves MS open to unprecedented losses - losses that can extend significantly past the next two quarters.

Deal Type

Min Rating

Sum of Par Amount

Sum of Potential Losses

CDO

A

$37,800,000

$0

 


AA

$15,000,000

$0

 


BB

$4,000,000

$0

 


BBB

$8,000,000

$0

CDO Total

 


$64,800,000

$0

CMBS

A

$238,297,455

$0

 


AA

$166,048,000

$0

 


AAA

$700,924,635

$0

 


B

$21,323,450

$0

 


BB

$79,302,500

$0

 


BBB

$629,817,177

$0

CMBS Total

 


$1,835,713,216

$0

Home Equity

A

$3,734,303,697

$1,679,091,758

 


AA

$3,045,402,787

$779,963,597

 


AAA

$398,260,933

$0

 


BB

$5,144,130

$5,144,130

 


BBB

$11,919,038,778

$9,239,733,896

 


CCC

$704,192

$225,201

Home Equity Total

 


$19,102,854,518

$11,704,158,582

RMBS

A

$251,756,751

$106,291,080

 


AA

$487,871,361

$98,398,644

 


AAA

$886,227,100

$0

 


BB

$6,442,461

$0

 


BBB

$254,936,389

$79,764,450

RMBS Total

 


$1,887,234,062

$284,454,174

(Other)

A

$20,000,000

$0

 


AA

$45,500,000

$0

(Other) Total

 


$65,500,000

$0

Grand Total

 


$22,956,101,796

$11,988,612,756

 

 

Counterparty credit exposure (in $ million)

 

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Source: Company data