Should BMO Be Worried About Moody's Valuation of Its SIV Exposure?

Moody’s was one of the credit rating agencies Moody-Ratings-Fiasco Sep-2007 that enabled the subprime mess, then snoozed as the underlying values plummeted last summer. In an effort to burnish its reputation, Moody’s appears to be getting ahead of the curve in tackling the values of the large Structured Investment Vehicles [SIV], one of which is managed by the Bank of Montreal (BMO).

BMO is the agent on the $22 billion “Links Finance” SIV (see prior post “The self-serving but sensible ‘bailout.’“ October 16-07), and would likely have benefited from last Fall's push to create an international Jumbo SIV, and it would have consolidated the SIV managed by multiple banks, including Citibank (C) and HSBC (HBC). Once that effort died, Citibank took about $47 billion of these assets onto its own balance sheet. Then, it proceeded to write down billions of these very same assets, which forced it to raise another $14.5 billion of new equity a few weeks later. As a result, Citibank shareholders own less than 85% of their bank than they did prior to this mayhem.

Here in Canada, CIBC (CM) has written off C$3.5 billion as a result of their “exposure” to subprime loans, which led to this week’s C$2.75 billion equity offering. CIBC’s shareholders own ~12% less of the bank than they did a few months ago.

Which brings us to Moody’s analysis of the SIV universe, and the impact this could have on BMO. According to a Wednesday morning Bloomberg article, SIV bond values are down 47%:

Bondholders in structured investment vehicles, caught in the collapse of the subprime mortgage Bear-Stearns-Troubles Nov-07 market, suffered a 47 percent drop in the value of their investments, according to Moody’s Investors Service.

The net asset value of SIVs, funds that use commercial paper and medium-term notes to buy higher-yielding debt, tumbled since July, when subprime-related losses contaminated credit markets. Investors who own the funds’ lowest-ranking bonds, called capital notes, would receive 53 percent of their money should the SIVs be forced to liquidate, the ratings company said in a report today.

SIVs sold $55.6 billion of holdings between June and November because investors stopped buying their commercial paper, debt due in less than 270 days. Five of the funds have gone out of business or are winding down and total assets in these companies have dropped to $300 billion, Moody’s said.

SIVs with high net asset values may "see sharp declines as contagion spreads across different segments of the credit markets," Moody’s analysts led by Henry Tabe in London wrote in the report. “Managers and sponsors of SIVs now acknowledge that the senior debt investor base is unlikely to return to the sector in the absence of fundamental changes to the business model.'’

In its Q4 press release, BMO advised that it had invested $1.25 billion of new cash into its Links SIV in the Sept.-Dec. 2007 period. According to Moody’s, none of the SIVs they reviewed had completely held their value:

Net asset values declined to as little as 27.6 percent, while the highest for the 25 SIVs rated by Moody’s was 80.3 percent.

The questions for today are pretty clear:

Does the Moody’s calculation have any bearing on what is going on at Links?

Which 3rd party firm is providing NAV testing of the Links SIV, so that shareholders can know that BMO’s C$249.9 million “Aggregate Market Value Exposure and Earnings Volatility for Trading and Underwriting and Structural Positions,” is accurate?

Was that C$1.25 billion of new money advanced at an old or current valuation of the Links vehicle?

Does BMO have any intention of taking Links onto its own balance sheet, just as HSBC and Citi have done with their vehicles?

If that were to happen, how much new equity capital, if any, would BMO need to raise given the size of the SIV ($22 billion) relative to BMO’s C$15.3 billion of shareholders equity?

Given CIBC’s horrible disclosure process around its subprime “exposure” (see prior post “When $330 million of subprime becomes $1.7 billion at CIBC,“ November 13, 2007), let’s hope the rest of the banking fraternity will recognize that the word “exposure” refers to “the potential losses we could experience,” rather than how the CIBC used the word last summer when the bank said that it had just $330 million of exposure to the subprime market. Perhaps the bank was thinking current mark-to-market values, rather than the Oxford definition of exposure.

As CIBC shareholders know all too well, that seemingly modest $330 million ultimately turned into a C$3.5 billion writedown. Let’s hope BMO has done a better job assessing and outlining what its absolute potential losses are, rather than the “death by 1,000 cuts” approach that CIBC has taken; and the requisite 30% drop in CIBC’s share price that has resulted.

Disclosure: The author owns BMO.

Comments

[Ginger Yellow:]

There's a fundamental misunderstanding here. NAV does not mean the value of the SIV's assets. It means the amount the assets exceed senior liabilities, expressed as a percentage of capital. A NAV of 50% can mean a decline in asset value of only 2%, because SIVs are highly leveraged.

Secondly, the $1.25bn BMO invested was senior debt, not capital notes. The NAV calculation is relevant, because it provides a measure of the credit enhancement for senior debt, but it does not serve as a proxy for the value of the senior debt (whereas it does for the value of the capital notes).

2008 Jan 17 11:44 AM