Wednesday, 21 May 2008 01:00

Here we go with the investment bank shell game again

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Once again, as with Citigroup and several other large investment banks, we have a troubled entity that sells risky assets but fails to truly sell the full risks associated with them - presumably under the impression that we investors are not swift enough to cath which shell they have hidden that little red ball under.

UBS sold $15 billion of mostly subprime (junk) assets to Blackrock, while financing $11.25 of it (75%). So, the assets are gone, but the bank is still on the hook for $11.25 billion through the loan. If it is a recourse loan, they are using this depreciating stuff as collateral (some indirect market risk) and they have the credit risk of the counterparty. If it is non-recourse, well that speaks for itself. In addition, they probably sold it at a discount, hence took the loss there as well. I am not saying the deal will blow up, but the risk of the assets were not really transferred off of the banks books. Would UBS normally offer a loan of this type with these terms for subprime assets in this environment? I doubt so.

From CNBC:

UBS financed 75 percent of the funding used by U.S. asset manager Blackrock to buy a $15 billion portfolio of distressed U.S. real estate assets from UBS, the bank said on Wednesday.

UBS completed the deal by providing $11.25 billion in loans to Blackrock, the Swiss-based bank said in a statement.

Blackrock raised $3.75 billion in equity from investors to pay for the rest of the package, UBS said.

Investors have welcomed the deal as a way for the troubled wealth manager, the world's largest, to prune its balance sheet and shed the type of assets that made it Europe's biggest
casualty of the subprime crisis.

UBS said the vast majority of the positions sold to the Blackrock-led group were subprime assets -- the lowest quality of real estate loans, and so-called Alt-A assets -- ranked one step above subprime, in roughly equal parts.

The remainder was ranked prime.

By publishing the financing details and the composition of the assets, UBS is providing more clarity to investors seeking more transparency about the structure of the deal.

Further terms of the deal were not disclosed.

Wednesday, 21 May 2008 01:00

I warned you about the risk of those I Banks

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As far back as February I warned on the impending risks building up in the US I banks. From excessive counterparty and credit risk to imperfect hedges to dead and depreciating assets held off balance sheet:

Well, it looks like this quarter the chickens will start coming home to roost. Lehman, Goldman and Morgan Stanley have experienced (on a larger scale) similar issues that I have with my portfolio, albeit potentially with a less profitable outcome. Reliance on indexes really cannot serve as a true proxy for the actual underlying, and significant slippage is bound to result. That is why I don't use them. Now, I understand indexes may be easier when you are moving a few billion dollars, but where there is a will there is a way. I prefer to either deal direct with the underlying or with an exchange traded derivative of the underlying. See the following WSJ article.

This is another installment of my series on the US banking system and the Asset Securitization Crisis. As a recap, let's draw a map to where we are currently.

Sections 1 through 5 are background material that is probably known to the professional in this arena, but will make good reading for the lay person. I used it to make sure I made judgments based on observable facts vs. media representation and/or personal bias. I feel the section on counterparty risk should be required reading for everybody, though. The report on PNC basically outlines, in full detail, why I chose that bank out of 329 others, to initiate my short foray into the regionals. Part 2 of the municpal report will be coming soon.

  1. Intro: The great housing bull run – creation of asset bubble, Declining lending standards, lax underwriting activities increased the bubble – A comparison with the same during the S&L crisis
  2. Securitization – dissimilarity between the S&L and the Subprime Mortgage crises, The bursting of housing bubble – declining home prices and rising foreclosure
  3. Counterparty risk analyses – counterparty failure will open up another Pandora’s box
  4. The consumer finance sector risk is woefully unrecognized, and the US Federal reserve to the rescue
  5. Municipal bond market and the securitization crisis – part I
  6. An overview of my personal Regional Bank short prospects Part I: PNC Bank - risky loans skating on razor thin capital, PNC addendum Posts One and Two
  7. Reggie Middleton says don't believe Paulson: S&L crisis 2.0, bank failure redux

In the graph below, you will see that commercial banks have gorged themselves on consumer finance risk over the last 20 years. It is not just the investment banks that took chances with leverage and concentration.

Monday, 19 May 2008 01:00

A new look at the leverage on PNCs books

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At the end of 1Q2008, PNC’s leverage (total assets / total equity) stood at 9.7x against an average leverage of 10.0x for its peers (US regional banks). However, on adjusting for intangibles PNC’s leverage increases significantly to 25.7x and comprates negatively against its peer group average of 21.8x owing to a higher proportion of intangibles to its shareholders’ equity (around 65%). Take note that in our analysis we highlighted PNC’s poor regulatory capital ratios vis-à-vis its peers. If we were to exclude the intangibles for the entire peer group, PNC’s regulatory ratios would be even worse off in comparison with its peers due to its higher proportion of intangible to shareholders’ equity. This is simply an alternative way of expressing what I hope was thoroughly articulated in the PNC analysis, the adequacy of PNC’s capital is lacking.

Although in 1Q2008 PNC’s reported EPS of $1.10 per share compared to $1.26 in 1Q2007, PNC’s reported net income for 1Q2008 included several non-recurring gains, totaling $244 mn (including gain on sale of Hilliard Lyons of $114 mn, Visa redemption gain of $95 mn, BlackRock LTIP shares mark-to-market adjustment of $37 mn). Despite Mercantile, ARCS and Albridge acquisitions, PNC’s fee based income excluding the impact of extraordinary gains declined 19.1% in 1Q2008 over 1Q2007. Excluding the impact of these one time items, PNC’s adjusted EPS declined to $0.67 versus $1.26 in 1Q2007. Thus we believe that although PNC’s reported numbers represent quite the rosy outlook - an outlook which we failt to share, PNC’s core operating result remain under pressure.

Although PNC’s provisions at $188 mn and $151 mn for 4Q2007 and 1Q2008 were at low levels (which on its face seems to be a positive), expected higher charge-offs would warrant a higher allowance for provisions for PNC in the coming quarters since the bank’ has inadequate provisioning. In our analysis, we have commented on PNC’s inadequate provisioning for loan losses which seems a serious concern owing to expected rising NPAs/charge-offs