Commentaries

Rights and wrongs at Lloyds Banking

If you’ve ever wondered how the big-shot investment bankers “earn” their bonuses, the document launching Britain’s biggest rights issue will give you a clue. Lloyds Banking Group is issuing 36,505,088,579 new shares, to add to the 27,161,682,366 currently in issue.

The new shares will raise 13.5 billion pounds, of which 500 million pounds will disappear in the expenses of the offer. Much of this is paid to the banks which are guaranteeing that Lloyds gets its money, a reward for the risk they are taking that the shareholders will fail to take up their rights.

So just how big is this risk? Here’s one way to look at it. The rights price is 37 pence, and as long as the Lloyds share price remains above that, the risk is minimal. At 37 pence, engorged Lloyds, with 63,666,770,945 in issue, would be capitalised at 23.5 billion pounds, including the 13.5 billion pounds of new money. On Tuesday, the day the issue was priced, with Lloyds old shares at 91 pence, the business was valued at 23.5 billion pounds.

 In other words, for the underwriters to pay up, the value of old Lloyds would have to slump from 23.5 billion pounds to 10 billion pounds – and all by December 11, the day on which the new money is due.

Is UBS’s 8 million pound fine enough?

Not long ago, UBS was the pride and joy of its Swiss home. There it was, slugging it out with the big boys, and making a fair fist of joining the bulge bracket banks from New York.

That was before it all started to go wrong. The banking crisis produced a loss of $52 billion, but much worse has been the reputational damage done in that most Swiss of financial services, the discreet management of private fortunes.

The US authorities forced UBS to disgorge names of their citizens suspected of failing to pay enough tax on their hordes, squeezing a $780 million fine out of the bank in settlement.

Set next to that, the 8 million pounds that Britain’s Financial Services Authority has just extracted looks derisory. On Thursday the FSA revealed that UBS clients in London had lost 42 million dollars through the misuse of their accounts. The method was simple and old-fashioned; the employees would make a forex trade, and wait to see whether it was profitable before allocating it to an account. Heads they won, tails the client lost.

The bank has shut the stable door, and “deeply regrets” the affair (although not deeply enough to put a statement on its website). By 2007, when it took place, even the doziest compliance department should have long since ensured that this practice was impossible. Compliance at UBS was so fast asleep that they only woke up when a whistleblower told them. Bleating that the bank “has already taken full remedial steps” merely sounds pathetic.

Fining companies for the sins of their employees is always problematic, since the shareholders are footing the bill. In this case, the FSA might have insisted that UBS pursue the miscreants through the courts. That won’t bring back the $42 million, but it would force the bank to wash its dirty linen in public, as well as discouraging others who might be tempted to cheat this way elsewhere.

As it is, UBS is more likely to want to bury the affair with minimum publicity. A court case would cause even more of its valuable private clients flee to better-managed businesses, and who could blame them?.

UBS’ days of wine and CDOs

Expensive wines and toxic assets are rarely mentioned in the same breath.

But that was the talk at UBS during the summer of 2007, when the Swiss banking giant sold some $35 million in soon-to-be rotten collateralized debt obligations to Pursuit Partners, a Connecticut hedge fund, which is now suing the bank.

Last week, a Connecticut judge ruled that Pursuit had presented sufficient evidence that UBS sold the CDOs even though the bank had confidential information that Moody’s Investors Service was planning to slash its credit ratings on those subprime-backed securities.

The judge, in issuing a preliminary ruling against UBS, cited an internal UBS email that has received a fair amount of attention because a trader boasted: “Sold some more crap to Pursuit.”

But it’s the email exchange leading up to that trader’s comment, which wasn’t included in the judge’s decision but was obtained by Reuters, that may be just as revealing.

Much of the discussion between trader Evan Malik and a colleague concerns the amount of money they’d each spent on a 2000 vintage bottle of wine. The sale of the “crap” CDOs almost seems an afterthought in the email thread titled: “95pts Wine Spec. Best Tignanello since 1997.”

On the anniversary of the implosion of Lehman Brothers, it’s important to remember that the financial crisis really began a full year earlier — in July 2007 — with the collapse of two Bear Stearns hedge funds that had loaded up on CDOs.

Wall Street may find itself on the hook

Sometimes legal fishing expeditions pay off.

A year ago, a Connecticut hedge fund sued UBS, contending that it knowingly sold toxic mortgage-backed securities to institutional investors but never disclosed that information.

At the time, the accusation by the fund, Pursuit Partners, seemed intriguing. But because the complaint lacked any sign that it had the beef to back up its potentially explosive claim, the litigation all but fell off the radar screen.

Now, it appears the hedge fund managers were onto something, thanks to a Connecticut state judge’s decision to allow Pursuit’s lawyers to get limited access to some of UBS’ internal emails.

In some of the emails, the investment firm’s employees describe the $35 million in collateralized debt obligations sold to Pursuit in summer 2007 as “crap” and “vomit.”

At first glance, it might be easy to chalk this up as simply another case of Wall Street bankers peddling securities they privately thought were junk.

But the big revelation unearthed by Pursuit’s lawyers is the extent to which credit rating agency Moody’s Investors Service shared information with UBS about its impending decision to lower its ratings on some of the CDOs the firm was selling.

How global cities rank after the financial crisis

London, once one of the world’s most expensive cities, now ranks in the middle of the pack of European cities in terms of the cost of living. The sharp drop in the value of British pound largely is to blame for the decline of London’s ranking from the second priciest city three years ago to No. 22, according to a study of comparative purchasing power by UBS of 73 cities around the globe.

New York, Oslo and Geneva now have the highest living expenses in the world.  Excluding rent and energy, Oslo, Zurich and Copenhagen have the highest prices. Offsetting those costs, these cities also rank as having some of the highest gross wages in the world. Zurich, the headquarters of UBS, tops the scale in terms of gross wages, but also enjoys relatively low tax rates.

Currency devaluations meant prices slipped the most in Mexico City, Moscow and Seoul over the past three years. Eastern European cities in the European Union are 35 percent cheaper to live in than Western European ones.

TOP WAGES Western European workers make more than three times what Eastern European workers make in pay. Sofia, Bulgaria and Bucharest, Romania, which joined the European Union in early 2007, have wages comparable to Columbia and Thailand, the report notes.

Cities with the lowest wages include Delhi and Mumbai, along with Jakarta and Manila. These calculations were based on comparisons of wages in 14 different professions.

COST OF GOODS Tokyo pays the highest price for a basket of 39 food items at US$710, while Zurich is second at US$660. Food prices in Switzerland are 45 percent higher than the rest of Western Europe. Mumbai, on average, pays only one-fifth the cost of Tokyo for food.

Swiss score UBS share sale goal

After the debacle of UBS’s American tax row, Berne can chalk up a small victory.

That deal effectively blows a hole in the country’s vaunted bank secrecy, whatever the official bluster. However, the government can be proud of being the first European government to sell the equity stake it took to support its banking sector during the crisis.

Moreover, it is set to make a 20 percent-plus return on the deal. UBS was in deep water last October when the Swiss government said that it would invest 6 billion Swiss francs in convertibles, and now things are less fraught, it’s taking its profit. It will collect 1.8 billion Swiss francs, representing the present value of the 12.5 percent coupon that would have been paid before the notes expired in 2011.

The shares rose 3.6 percent in early trading, suggesting that the government will not have to take a big discount on its sale. Even assuming that the 332 million shares it will receive were sold at a 5 percent discount, it will raise 5.5 billion Swiss francs on the sale alone.

Overall, that is a 20 percent-plus turn since it put the money up in December. UBS gains too. It gets the government off the share register and will not be subject to so much political scrutiny as it rebuilds its battered franchise.

The deal will dent the bank’s tier 1 capital ratio by 60 basis points. However, this will almost be offset by a 50 basis point increase thanks to the Brazilian Pactual sale, leaving the bank with a solid ratio of over 13 percent.

Kaspar Villiger, the bank’s new chairman and a former finance minister, knows that Switzerland’s biggest bank still needs to tread carefully to rebuild its reputation, at home as well as abroad. He took care to thank the authorities “for their prudent and resolute course of action from October 2008 to this day.”

UBS settlement leaves Switzerland scarred

UBS, Switzerland and the United States can all claim a sort of victory from the settlement on Wednesday of their tax dispute.

UBS gets to avoid a fine that — according to the Swiss justice minister — would have threatened its existence. The Americans get the details of some 4,450 accounts that they say have held up to $18 billion, on which fat taxes may be payable. And the Swiss get to draw a line under a threat to their fundamental banking secrecy.

Even so, there will be many who want to keep their financial affairs private who will look for other homes for their cash.

The basics of the deal are as follows. The U.S. will drop its “John Doe” summons that looked for the names of as many as 52,000 Americans with accounts at UBS. This had prompted the Swiss to threaten that they would seize UBS’s data rather than accede to what they saw as a fishing expedition that they said would break Swiss law.

The Americans now say they were never looking for so many accounts, which would include many law-abiding citizens.

Instead, the Swiss will hand over details of 4,450 (the Americans say it could be more than 5,000) accounts of Americans at UBS. The bank, which is the world’s second-largest wealth manager, will write to affected account-holders urging them to take part in an American tax amnesty, if appropriate.

The Americans gain twice over. First, the affected account-holders will, unless they are stupid, cough up any outstanding tax before the amnesty expires on Sept 23. Anyone with accounts at other foreign banks is also likely to put their affairs in order before Uncle Sam forces them to. Moreover, Americans will in future will careful to comply with U.S. tax law given the reach of the U.S. justice department.

Time to get America’s Cup back on the water

Sometimes you have to wonder if it wouldn’t be better for everyone concerned if Larry Ellison and Ernesto Bertarelli slugged it out in the boxing ring rather than the courts to decide who should lift the America’s Cup.

Despite huge sums they’ve poured into designing, building and testing the most outrageously hi-tech sailing machines imaginable, there’s certainly no sign of the two billionaires getting anywhere near competing for yachting’s most prestigious prize on the water.

In the latest twist to the long-running legal battle between them, Bertarelli’s defending team Alinghi — which was until April this year sponsored by Swiss bank UBS (big thanks to Valencia Sailing for pointing this fact out and to UBS for confirming it) — announced that the venue for the 33rd America’s Cup would be the warm and sunny seas off Ras al-Khaimah in the United Arab Emirates.

For a few hours, sailing fans could dream of a sailing spectacular next February, when Ellison’s BMW Oracle team – sailing under the colours of the Golden Gate Yacht Club (GGYC) – is due to take on Alinghi in what has become one of the all time grudge matches in sailing.

But hopes of a trip to the beaches of the Gulf were swiftly dashed when — huge groan – GGYC put out its own statement:

San Diego, CA, August 5, 2009 – Golden Gate Yacht Club believes Société Nautique de Genève’s choice of this venue, without our mutual consent, is contrary to the Deed of Gift and the decisions and orders of the New York courts. We are reviewing our options.

The Deed of Gift — the oldest part of the rule book of the America’s Cup – makes for fascinating reading for Cup aficionados and is the life-blood of a generation of lawyers who are making their living from challenging each and every point.

from Neil Unmack:

Losses slow on UBS’ dodgy assets

Losses seem to be slowing on the 26 billion swiss francs of leveraged loans, asset-backed debt and other exotica UBS shifted last year from its trading to its loan book to avoid having to mark them to market.

UBS, Deutsche and other European banks made good use of this accounting trick introduced in October to avoid taking losses on volatile assets. The justification was that market dislocation exaggerated the assets' true risk. Of course, it was only a temporary dodge as assets still have to be written down over time as borrowers default or forecast cashflows decline.

UBS's second quarter results are encouraging. Credit losses on the reclassified assets fell to 208 million swiss francs, down from 565 million in the first quarter and 1.3 billion at the end of last year.

There is a downside to avoiding marking the assets to market. As the assets were already booked at prices above their market levels, UBS missed out on 1.3 billion swiss franc gain in the assets' fair value in the second quarter. Still, that's small beer compared to the 1.2 and 4.2 billion losses it would have taken in the first and fourth quarters had it not reclassified them.

from Neil Unmack:

Finance’s 80s experiment shows cracks

We may never see mullet hairstyles or other weird fashions again, but in finance, there is a 1980s revival.     The International Accounting Standards Board has gone back to the future, allowing banks to reclassify assets they previously had to mark to market as loans and receivables, valued at amortized cost. That effectively allowed them to avoid the embarrassment of mark-to-market and return to the historic cost accounting of a quarter-century ago.     The reasons are plausible enough: many asset classes were quoted at nominal, distressed sale prices only. But you ignore market prices at your peril: problems loans are left to fester, exposing investors to the cost of loan managers (understandably) taking a rosy view of advances they may have approved.     Many European banks took advantage of the IASB's lenience to whip doubtful assets off their trading books -- not just plain debt, but collateralized loan obligations, leveraged loans and other doubtful exotica. Now Deutsche Bank <DBKGn.DE> has indicated how this stuff is doing, and the answer is: badly.     Deutsche's pretty figures would have been quite spoiled had it taken a further 1.4 billion euros of unrealized losses on the 37 billion euros of assets it reclassified since last October.     The discrepancy between the carrying value and fair value shouldn't be a surprise -- that was the whole point of the changes. Unfortunately, the market is proving to have been right in pricing some of these assets as junk, because the losses in the reclassified book are starting to show.     More than half of Deutsche's 1 billion euro provisions for credit losses in the second quarter derived from these reclassified assets. Some 2 billion euros of the 3.2 billion euro rise in problem loans had previously been reclassified.     Deutsche is not alone. RBS' <RBS.L> impairment losses on reclassified assets rose to 747 million pounds in the first three months of the year, up from 466 million at the end of last year. UBS is carrying assets reclassified last year at 24.7 billion Swiss francs, versus the fair value of 20.6 billion.     The accounting changes are not designed to bamboozle investors, even though that is frequently the result. Losses may have been deferred, but they will happen. The question for banks is whether they can generate profits quickly enough to offset them. Market prices that seemed ridiculous in the depths of the panic may turn out not to have been the equivalent of the mullet after all.