ItsJustMe

UBS Plan Could Be the Road Map for Financials

PJ568, you're still dealing with market value however. Yes, spinning it off to a new company and selling that company to the general public will get it off their books. That will solve their liquidity problem but not their solvency problem. They will still absorb the exact same loss which is where people are getting confused.

If my $150 million of mortgage loans have a probable write-down of $50 million, then my IPO is only going to bring in $100 million unless you're assuming the public is a bunch of uninformed fools. In 2007, they (we) probably were. In 2008, we're not.

With all the horrible publicity they're getting, their IPO would probably be a disaster and bring in even less than the mortgages are really worth which is why the government will end up buying these bad mortgages.

Then at some point down the road, when workouts have been determined and the bad publicity has settled down, I agree that Newco could go public as a long-term mortgage company...

UBS Plan Could Be the Road Map for Financials

VoR, I was an auditor for over 10 years (currently a no longer practicing CPA). Like most CPAs, I'm well aware of Enron and their cozy relationship with their auditor. It brought down an entire multi-national accounting firm so getting another auditor to turn his/her head to a shell game is not likely in today's environment.

The total estimated writedown of sub-prime loans is $460 billion. That number comes from Goldman Sachs which one would think would have no incentive to drive down their own stock price.

The total estimated writedown of ALL consumer and commercial debt assuming a recession (which is no longer an assumption) is around $1 trillion. The banks are NOT writing down perfectly good paper to zero. They use sophisticated mathematical models based on the current default rate of a group of mortgages to project the future default rate and their writedown is based on that.

I agree with you that the Fed acted to avoid a panic. It was a good move on their part. I disagree that "Joe" is playing into anyone's hands by selling his stock. Joe NEEDS to sell his investment bank stock. The banks and hedge funds have been shorting their own stock (along with homebuilders) for a year now because they knew the housing bubble was collapsing.

That is why you're seeing investment bank and homebuilders surging now because the banks and hedge funds are having to buy that stock back to close out their positions and raise cash. As soon as their positions are closed and their buying has ended, it won't be pretty...

UBS Plan Could Be the Road Map for Financials

scittl, your plan depends on ultimately selling the loans for 100% of full value to "unsuspecting schmucks." That worked from 2002 through 2007. There aren't any unsuspecting schmucks now and even if there were, it's not worth the certain lawsuits that are going to come from even the earlier unsuspecting schmucks...

UBS Plan Could Be the Road Map for Financials

No, you're still missing it Todd. Let's say Wilbur Ross in your article above, wants to buy my $150 million in sub-prime loans. As a sophisticated investor, he knows as well as I do what they're really worth.

He's going to pay me $100 million for them and I'll have to recognize the $50 million loss. I just exchanged a $150 million loan receivable asset for $100 million in cash. The $50 million difference will be a loss on my income statement which then flows through to reduce my owners equity (capital) to zero.

The exact same thing happens if I spin off the $150 million loan receivable to a subsidiary. Instead of a $150 million loan receivable on my balance sheet, I now have a $150 million "Investment in Subsidiary." At the conclusion of that spinoff, nothing has happened to my total assets or equity.

However, since I own 100% of that subsidiary, the accounting rules state that whatever happens to the subsidiary also happens to me. If the subsidiary sells those loans to Wilbur Ross for $100 million, it will take a $50 million loss to its capital and the accounting rules force me to show the $50 million loss on my own books as a writedown of my "Investment in Subsidiary" from $150 million to $100 million.

There is no way for the banks to get rid of these bad loans without recognizing the losses. The accounting rules do not allow you to play smoke and mirrors with your financial statements by setting up subsidiaries. A bad loan is a bad loan and the only way you can get out of swallowing the loss is to either a) pretend it's not a bad loan and leave it on your books at full value which the banks have been doing, or b) sell it to a sucker who doesn't realize it's a bad loan.

Unfortunately, there aren't any suckers left which is why the large banks have reached desperation status. Quite frankly - and most people are stunned by this - if the projections of $1 trillion of write-offs by the end of the recession are accurate, the entire US banking system is insolvent.

That means that the losses will ultimately be more than the capital of ALL our banks combined. That doesn't mean that every single US bank is insolvent, but it does mean that the ones who are holding all of these NINJA and liar loans have significant negative equity.

That is why they are racing to raise capital. That is why Bernanke is making Fed moves unprecedented since the Great Depression. It's also why Bernanke looks scared to death and the politicians are asking what they can do to help rather than grilling him for risking billions of dollars of taxpayer money.

This is a VERY serious crisis and if the US banks start setting up subsidiaries, it is probably the prelude to a government takeover of those subsidiaries (at pennies on the dollar) rather than a means to get out of swallowing the losses...

UBS Plan Could Be the Road Map for Financials

A follow-up to my comment above. As a CPA, what seems common-sense to me about financial statements isn't always clear to non-accountants so I'll elaborate a little more on why UBS' spinoff strategy is just window dressing that won't change anything in terms of their capital problems.

Let's say I manage a bank which has $50 million in capital (owners equity) and $150 million in bad loans of which I think $50 million will eventually be totally noncollectable. If I admit to all the bad loans and write them all off, I'll have ZERO left in capital and a LOT of angry shareholders - and worse, frightened depositors.

However, let's say I take UBS' approach. I try to hedge and say that only $25 million is noncollectable so I write that off and spin the remaining $125 million of debt into a separate company. I'll now have $25 million in remaining capital and an asset on my balance sheet called "Investment in Garbage Subsidiary." (Okay, I'll probably name it something less honest to fool investors).

That investment asset will be on my books for $125 million, but guess what? When the auditors come in at year-end, they're going to audit the books of that subsidiary just as they audit my own books and they'll force the $25 million writedown in my subsidiary investment. I'm now left with ZERO capital and angry shareholders.

That is why UBS is out raising capital. The subsidiary idea is just window-dressing to get the garbage loans out of sight. No one is going to buy their new subsidiary for the same reason no one is lining up to buy their garbage loans now.

Don't be fooled by accounting tricks. The UBS spinoff is pretty meaningless...

UBS Plan Could Be the Road Map for Financials

Todd, there is no magic pill to get bad assets off your balance sheet to "preserve capital." Whether you spin them off or sell them, the resulting writedown is going to wipe out your capital and you will be forced to either go bankrupt or raise additional capital to keep operating. UBS is raising additional capital now and they'll likely have to do it again this year.

ALL of the investment banks will have to raise additional capital this year in order to stay solvent. It doesn't matter if they spin their bad loans into a separate company, sell them off one by one or build a pretty wrought iron fence around them on their balance sheet.

A bad loan is a direct charge against a bank's capital no matter what type of accounting wrapping you put on it...

Accounting Antics Lift I-Bank Earnings - Barron's

The quarterly financials are not audited so therefore you don't have pesky auditors asking uncomfortable questions about the likelihood of your mark-to-market assumptions. I suspect the analysts didn't anticipate the brazenness of the IB's since they were desperate to show positive earnings in the wake of the Bear Stearns bankruptcy.

Also, the likelihood of the IB's staying solvent (at least now with help from the Fed) is much greater than all the underwater homeowners eventually paying everything off. As a CPA and former auditor, I can tell you that writing down your own debt would not pass the smell test with me unless it came with a going-concern opinion.

I suspect their own CPAs will tell them the same thing come year-end unless they want to go the way of Arthur Andersen...

Stocks Rally on Financial Writedowns: Overly Optimistic?

taxfreelife is correct that the banks cannot just write everything down to where they "think" the bottom might be. They have to evaluate where they are each quarter based on the present loan delinquencies, conditions and trends.

If the worldwide economy continues to sink into recession as it appears, the writedowns will continue each quarter. Many reputable economists (and the banks themselves) are predicting that $1 trillion will be the eventual worldwide writedown of mortgage, business and credit card debt so as you can imagine, $19 billion is just another baby step on the way down.

There are so many investors that know this and are shorting the banks that as soon as any positive development hits (I guess $19 billion is better than $20 billion), they get caught in a short squeeze and the banks skyrocket as they scramble to get out.

What they should do, is simply buy some 9 to 12 month puts and wait patiently as the banks replace their current profit equity with billions of new shares until their book value per share is finally diluted down to a fraction of what they're showing now.

Bear Stearns value of between $2 and $10 per share is about right for most of the banks but the Fed is keeping the other banks liquid long enough that they can reach that value in an orderly systematic manner which could take a year or two...

3 Reasons To Be Bullish on the Investment Banks

Before his investment in Wells Fargo, Warren Buffet always advised investors to stay away from banks because it was too easy for them to hide their true liabilities. As a CPA, I can tell you that is especially true of the non-regulated investment banks.

I would hope that people finding out that 80 billion dollars in "pretend" book value didn't actually exist last weekend would have taught some lessons, but apparently not. When the Chase auditors spent the weekend looking over BSC's books, they found more scary liabilities than assets.

Not only did the other 2 institutions looking at their books that weekend not bid on BSC, but Chase finally had to be bribed by the Fed to buy the firm for a fraction of the worth of their valid REAL ESTATE assets.

Quite frankly, I suspect that all the investment banks and quite a few commercial banks are just as insolvent. That doesn't mean they'll all go under however. If the Fed continues to keep them liquid as they are apparently trying to do, then it is possible that over the next several years, the large investment banks (those that are too big to fail) can slowly deleverage and get solvent again.

However, Chase established their true market value last weekend. When their stock prices begin to get closer to that level - and I suspect they will over the coming year as reality sinks in - I'll consider catching them on the bounce since they'll be under new banking regulations by that point...

Tuesday Outlook: Market Manipulation?

What about that consumer price index last week that stated we had no inflation worries because energy costs were flat?