Balance Sheet Stress and Vulture Buyers

MORE PAIN FOR BANKS IS COMING, as Reuters reports that UBS writes down $10 billion:

“After advising for weeks there were no huge charges on the horizon, UBS stunned the market on Monday with the massive write-down, saying it had obtained a 13 billion Swiss franc ($11.52 billion) capital injection from the Singapore government and an unnamed Middle East investor…

“UBS said the capital injection would enable it to raise its Tier 1 capital ratio to 12%, despite the hefty write-down of its exposures. Without the recapitalization, the $10 billion charge would have blown a hole in its capital base. Analysts say it is crucial for UBS to keep its Tier 1 capital in double figures in order to secure its franchise as the world’s largest wealth manager…

“‘UBS’ write-downs are large but conservative, and it has managed to find investors to take the risks,’ analysts at Dresdner Kleinwort said in a note to clients on Monday. ‘However, smaller groups may not have this luxury, and there is clear evidence of balance sheet stress emerging.’”

MBIA Receives $1 Billion Private Equity Bailout

Bloomberg reports that, seeking to avert a crippling reduction of its AAA credit rating, “MBIA Gets $1 Billion From Warburg Pincus”:

“Shares of MBIA, the world’s biggest bond insurer, soared as much as 27 percent after the company said it will sell $500 million of common stock to Warburg Pincus. The private equity firm will also backstop a rights offering of up to $500 million next year, Armonk, N.Y.-based MBIA said today. MBIA said it faces ‘significantly’ higher losses from a slump in the value of securities it guarantees.

“The added capital may help ward off a cut in MBIA’s top credit rating, which is under scrutiny by Moody’s Investors Service, Fitch Ratings, and Standard & Poor’s. MBIA’s AAA ranking stands behind $652 billion of state, municipal, and structured finance bonds, and losing the AAA credit rating would endanger those ratings, as well as cut off MBIA’s ability to guarantee debt, its main source of revenue.

“‘It’s a positive for the company,’ said Rob Haines, an analyst at CreditSights Inc. in New York. ‘It staves off the potential for a rating downgrade.’”

My Comment: A problem delayed is not a problem solved.

The insurers, led by MBIA and Ambac, are sitting on $100 billion of collateralized debt obligations backed by subprime mortgage securities. One billion dollars is peanuts, compared with their actual exposure. Bloomberg continues:

“Warburg Pincus, the New York-based firm started in 1971, will initially buy 16.1 million common shares, at $31 each. The firm will also receive seven-year warrants and have the right to appoint two directors… Mark-to-market losses will be more than in the third quarter, and the company will set aside as much as $800 million to cover losses it expects to take on securities backed by home equity loans, MBIA said…

“MBIA, in October, posted a $36.6 million loss because of write-downs on mortgage-related securities and halted stock buybacks to retain capital. So far this quarter, the company ‘has observed a further widening of market spreads and credit ratings downgrades of collateral underlying certain MBIA-insured CDO tranches,’ the company said in [its Dec. 10] statement.

“The fair value of the assets slumped by about $850 million in October, MBIA said. The company will have ‘significantly’ larger mark-to-market losses in the fourth quarter… ‘Given the magnitude of MBIA’s exposures, as demonstrated again this morning with UBS’ write-downs, I don’t see how $1 billion moves the needle,’ said David Einhorn, president of Greenlight Capital LLC in New York, which has a short position on MBIA.”

My Comment: Einhorn is clearly talking his book, but at least he admits it. Furthermore, I happen to agree with him. It took nearly all of that $1 billion, of which MBIA received only half so far, just to cover fourth-quarter losses. What now? The problem sure did not go away.

Bank of America Closes Institutional Fund

Denying a CNBC rumor of an asset freeze, Bank of America is closing its Columbia Strategic Cash Portfolio. Reuters reports:

“Bank of America Corp.’s Columbia asset management unit said on Monday it is closing a privately placed money-market fund for institutional investors.

“The bank’s Columbia Strategic Cash Portfolio fund, which has less than $11 billion in assets, has been closed to new investors, said Columbia spokesman Jon Goldstein.

“Goldstein denied a CNBC report that the fund had been frozen, saying that clients were being offered the option of cash redemptions or of switching their assets into other Columbia-managed funds.”

My Advice: Take the cash and run.

Minyan Peter on Vulture Buying

In response to Quint Tatro’s Minyanville piece on Monday, “Foreign Buyers at the Ready,” Minyan Peter wrote:

“While clearly foreign wealth funds and other offshore money is piling in to ‘bail out’ the capital infirmed, I would make a point about how these capital injections are being structured. Whether it is Citi, E*Trade, or UBS, new capital is coming in as either convertible debt or convertible preferred. Why? Because in liquidation, these new investments rank ahead of common shareholders when it comes to getting paid.

“As I have written previously, on the way down, vulture investors buy converts. At the bottom they go right for the common.”

Note: Peter is a former treasurer at a major U.S. bank.

Smack in the face of enormous losses at MBIA, with even bigger announced losses to come, the market is going giddy because MBIA received a down payment on a potential $1 billion max infusion. However, that infusion does not come close to covering MBIA’s subprime exposure.

The equity markets, in general, are acting as if all these problems are going to be solved by a one-time cash infusion from venture vultures and bailouts from oil producers.

Meanwhile, the credit markets have barely budged. LIBOR is down a mere one basis point from an extremely wide spread. LIBOR is suggesting banks still do not trust lending to each other, not even overnight.

The disconnect between the credit markets and the equity markets is simply staggering. Believe what you want, but the message from the credit markets is that a wave of bank failures is coming, and/or that balance sheet stress is going to get far worse before it gets any better.


December 12, 2007

The Daily Reckoning