Capital Call
Insolvency is here, and not just in the United States. The rise in LIBOR and the increasing speed of issuing new shares point to the high probability of insolvency throughout the world’s major financial institutions.
LIBOR is skyrocketing despite central bank easing, and debt markets have completely frozen over. Besides being reluctant to lend to businesses or each other, major financial institutions the world over are raising capital at alarming rates to survive something that might wipe out many of them.
First, Citigroup did it. Fannie then stepped up to the plate. Northern Rock is being nationalized. And now, the Swiss giant UBS AG is following suit:
UBS AG, Europe’s largest bank by assets, said it will write down U.S. subprime investments by $10 billion and raise 13 billion francs ($11.5 billion) by selling stakes to investors in Singapore and the Middle East.
UBS expects a loss in the fourth quarter and possibly for 2007, the Zurich-based company said in an e-mailed statement today. Government of Singapore Investment Corporation Pte. will invest 11 billion francs through the purchase of mandatory convertible bonds, while an unidentified Middle Eastern investor will invest 2 billion francs, UBS said.
Ladies and gentlemen, this would be the third time that UBS has taken additional losses on their US investments. I reported UBS’s first writedown announcement under the heading “No bull to report today, as UBS decided to man up and take the pipe.” Turns out the b.s. never ends with these guys, as their losses far exceed what they reported. I think this will be the way the banks prefer to let out the bad news - in recurring increments. Get used to it. Goldman and JPMorgan haven’t reported any losses… yet. The first writedown will be the first installment in a long series of them.
It’s interesting how Singapore has no choice but to buy UBS shares. That sounds a lot like the recent Citigroup deal. What’s very interesting about these deals is that they are in the form of equity or mandatory convertible bonds, as opposed to senior debt.
Why is that? It could be that the risk premiums for bank bonds are rising and banks’ credit ratings are falling. Raising equity may be one way to reduce the cost of capital. Some analysts had computed that Citigroup’s cost of capital was at least 11%, and possibly up to the mid 20’s. If this is true, cost of capital is not the issue.
Maybe it is. Another possibility is that the debt market is completely frozen over. No debt issue of this size could possibly be sold now. Too bad, these guys didn’t issue the debt this spring when they could have gotten it for a 10-basis point spread above Treasuries.
Another alternative to consider is that equity may very well be the most practical financing for banks these days. You may be asking, “Why Juan Carlos, why?” Simple. The assets these banks own are far less than presumed, while the liabilities remain constant. That means the total equity is far less than reported in the most recent 10-Q. If you can sell more shares to new suckers, their claim to a smaller equity position has effectively enriched you and bamboozled them. With equity, you owe them nothing. Sure, you may be paying them a dividend now, but as Fannie Mae showed us, you can always cut or even eliminate the dividend altogether.
Compare that to debt. With their credit ratings in tatters in the frozen tundra of the credit markets, banks would have to pay a high default premium above the risk-free rate. Unlike dividends, the interest payments are mandatory unless you decide to retire the entire debt. That my friends is why bonds don’t make sense as a financing option in this environment.
In this environment, every bank is hoarding cash as evident in the high LIBOR. Bond financing reduces your cash. Equity financing gives you the cash from a new set of suckers. Your standard operating procedure tells you to always swindle the suckers, but survival demands that you now save the cash.
Bottom Line: If banks offer you the “opportunity” to buy new shares, tell ‘em Juan Carlos told you to just say “No, senor.”
UPDATE: Washington Mutual joins the feeding frenzy. Expect more to follow as they fight for survival:
Washington Mutual Inc., the largest U.S. savings and loan, will write down the value of its home lending unit by $1.6 billion in the fourth quarter and cut 3,150 jobs as losses in the mortgage market increase.
Washington Mutual also will cut its quarterly dividend to 15 cents a share from 56 cents and close 190 of 336 home loan centers, the Seattle-based bank said in a statement today. The company said provisions for loan losses in the quarter will be $1.5 billion to $1.6 billion, about twice as much as it previously expected.
Fitch Ratings downgraded the firm’s rating to “A-” from “A,” citing “worsening asset quality,” and “extremely challenging conditions in the U.S. residential mortgage market.” Washington Mutual said it plans to raise $2.5 billion to shore up its capital by selling convertible stock.
December 10th, 2007 at 8:01 am
[…] of Write downs Posted on December 10, 2007 by Admin Cutting The Bull › Capital Call Ladies and gentlemen, this would be the third time that UBS has taken additional losses on their US […]
December 10th, 2007 at 10:09 am
Sweep accounts gutted reserve requirements back in 1995. The only real limitation on banks creation of money (credit) is regulatory capital.
Regulatory capital is a measure of banks leverage. Of course, in good times less leverage means lower earnings. So once banks became “equity” constrained they found a way around it by creating off-balance-sheet SIVs and conduits.
These off-balance-sheet vehicles used subordinated debt (capital notes) and other credit enhancements (CDS) to get the AAA ratings they needed with a very small equity position.
As conduits and SIVs have collapsed banks have needed to use more of their tier 1 capital to roll those entities onto their balance sheets. Regulators are also increasing the amount of capital they must hold as securities on their balance sheet downgraded. It will increase again if the mono-line insurers (ACA, MBIA) collapse and the risk is forced back onto the banks balance sheet.
So, banks are hungry to increase tier 1 capital to survive (and even prosper) in the comming storm. Preferred stock or equity are the only options.
The Fed is unfortunately working from an out-dated play book that assumes that banks are reserve constrained. If the banks were still reserve constrained discount window operations would benefit banks. Discount window operations do nothing to add tier 1 capital to the banks balance sheets. In fact, discount window operations actually hurt tier 1 capital by reducing banks profitability.
December 10th, 2007 at 1:37 pm
“Preferred stock or equity are the only options.”
Even though Fannie did it, preferred stock may still be a cash drain with its bond yield type payment structure.
They are Fannie, though. Everyone else probably is going the equity route, or the mandatory convertible bond route.