Level 3 Assets: Credit's Next Concern

[Green_Bear]

LEVEL 3 ASSETS (via Marketwatch.com) - Level 3 assets are those that trade so infrequently that there is virtually no reliable market price for them, and valuations for these assets are based on management assumptions.

Problems people! I’ve discussed many times in the past few months how the markets for these CDO’s, CMO’s, and other mortgage backed securities have seized up. There are just no bids and no volume, making no market!

Now, what we do know is that brokerages, banks, hedge funds, and other institutions are holding very complicated assets whose actual value has virtually vanished. The key word here is actual, or real market value. But these level 3 assets are NOT being marketed to the real market! They are being held, hidden on the books of major corporations and institutions, as management places their best-guess valuations that are almost always grossly overvalued!

Round 3 of the credit crunch will be the ‘coming out’ of sorts of the adjusted valuations of these level 3 assets leading to the uncovering of major losses to the most exposed corporations and institutions. I think this process will take months to play out and we are heading right into the heart of storm as November 15th approaches. >>>>

Level 3 Assets: Credit’s Next Concern
themoneyblogs.com/urbandigs/ … ncern.html

[Green_Bear]

Level 3 storm about to hit Wall Street
atimes.com/atimes/Global_Eco … 3Dj03.html

Auditors’ Challenge On Bank Assets
thebusiness.co.uk/news-and-a … sets.thtml

Goldman Sachs’s Level 3 Assets Were $72 Billion in Third Quarter
online.wsj.com/article/SB119202158945354654.html

Credit Crunch: More To Come
forbes.com/home/wallstreet/2 … 2citi.html

[Arthur_Daley]

@Green Bear

Credit Crunch: More To Come
forbes.com/home/wallstreet/2 … 2citi.html

Well old Charlie’s resignation tonight won’t help the mood much on the back of the merrill resignation earlier in the week.

[Green_Bear]

https://content.answers.com/main/content/wp/en/thumb/3/3b/300px-Classic_time_bomb.jpg

BOSTON (MarketWatch) – Citigroup Inc. in a quarterly regulatory filing Monday said its so-called level 3 assets as of Sept. 30 were $134.84 billion. Level 3 assets are holdings that are so illiquid, or trade so infrequently, that they have no reliable price, so their valuations are based on management’s best guess. The investment bank said its total liabilities related to level 3 assets at quarter-end were $40.36 billion, according to the Form 10-Q. Citigroup said it often hedges its level 3 positions.

Citigroup reports $134.8 billion in ‘level 3’ assets
marketwatch

We may be about to find out. From November 15, we will have a new tool for figuring out how much toxic waste is in investment banks’ balance sheets. The new accounting rule SFAS157 requires banks to divide their tradable assets into three “levels” according to how easy it is to get a market price for them. Level 1 assets have quoted prices in active markets. At the other extreme Level 3 assets have only unobservable inputs to measure value and are thus valued by reference to the banks’ own models.

Goldman Sachs has disclosed its Level 3 assets, two quarters before it would be compelled to do so in the period ending February 29, 2008. Their total was $72 billion, which at first sight looks reasonable because it is only 8% of total assets. However the problem becomes more serious when you realize that $72 billion is twice Goldman’s capital of $36 billion. In an extreme situation therefore, Goldman’s entire existence rests on the value of its Level 3 assets. >>>>>

The Bear’s Lair: Level 3 Decimation?
prudentbear.com/index.php?option … &Itemid=53

The $8.4 billion write-down announced by Merrill Lynch & Co. Inc. (MER) last week was just the latest in a series of similar revelations by Bank of America Corp. (BAC), Citigroup Inc. (C), The Bear Stearns Cos. (BSC) and Lehman Brothers Holdings Inc. (LEH). And it underscores the key challenge investors continue to face: You don’t know what a company’s assets are really worth, so a company’s portfolio can explode into a mushroom cloud of red ink at any given time. >>>>

Could Goldman Sachs Explode? How to Dodge the Ongoing Mortgage Mess
Moneymorning

[thewatcher]

Meltdown can’t be far off now.

What’s that old saying “when america sneezes the rest of the world catches a cold”

Well america is about to catch a serious dose !.

[Green_Bear]

Citigroup
Equity base: $128bn
Level three assets: $134.8bn
Level 3 to equity ratio: 105 per cent

Goldman Sachs
Equity base: $39bn
Level three assets: $72bn
Level 3 to equity ratio: 185 per cent

**Morgan Stanley **
Equity base: $35bn
Level three assets: $88bn
Level 3 to equity ratio: 251 per cent

Bear Stearns
Equity base: $13bn
Level three assets: $20bn
Level 3 to equity ratio: 154 per cent

Lehman Brothers
Equity base: $22bn
Level three assets: $35bn
Level 3 to equity ratio: 159 per cent

Merrill Lynch
Equity base: $42bn
Level three assets: $16bn
Level 3 to equity ratio: 38 per cent

From level three to cloud nine
ftalphaville.ft.com/blog/2007/11 … loud-nine/

[Green_Bear]

Standard & Poor’s said that a $1.5 billion CDO called Carina CDO Ltd. managed by State Street Global Advisors had started liquidating its assets. As a result, S&P slashed the ratings on Carina’s top tranches all the way from triple-A to junk double-B in one fell swoop. Subordinate tranches were cut as low as double-C.
Some 13 other CDOs have told S&P of default, a precursor of liquidation. The CDOs’ problems also reflect the ongoing contraction in the market for asset-backed commercial paper, a prime source of funding for SIVs (structured investment vehicles), which hold CDOs and other manner of alphabet soup.
And it’s only likely to get worse. In a report strikingly titled, “Staring into the Abyss,” RBC Capital Markets interest-rate strategist T.J. Marta says that additional write downs are coming, owing to a new FASB accounting rule, 157, that will force more financial companies to put prices on “Level 3 assets.” These assets have no active market, so they’ve been “marked to model,” based on their credit ratings, which are now turning out to have been faulty. FASB 157 is to take effect Thursday, Nov. 15.

Marta says RBC’s equity-strategy team says the U.S. banking sector is “embarking on its third major crisis since the 1920s.” He adds: “Not only have the ‘go-go’ days of structured products come to an inglorious end – at least temporarily – but vast swaths of the financial system lie in ruins,”
“Perhaps the most damaging aspect is the broken trust,” Marta continues. One of reasons U.S. financial markets were a magnet for the world’s capital was their reputation for transparency and trustworthiness.
“Now traders and investors complain that securities like CDOs have declined in value, but also no defensible value can be readily assigned. The U.S. dollar’s collapse in these circumstances is not surprising,” he concludes. >>>>

No End to the Bad News
Barrons

[tulip]

This new FASB rule will it not just mean that they’ll put the same price on the level 3 assets that they always had? If it doesn’t when will this new info be available to the public?

[yoganmahew]

@tulip

This new FASB rule will it not just mean that they’ll put the same price on the level 3 assets that they always had? If it doesn’t when will this new info be available to the public?

FASB 157 applies to the auditors, as far as I can see. They’ll have to value the investments themselves rather than just rely on the company’s say-so.

From here:
metrocorpcounsel.com/current.php?artType=view&artMonth=February&artYear=2007&EntryNo=6190

Editor: Please describe for our readers the new framework for measuring fair value that was created with the issuance of FASB 157.

Larsen: FASB 157 provides disclosure requirements and calculation requirements for the use of fair value wherever fair value is used in GAAP. FASB 157 was not specifically prepared for private equity and in many cases touches other areas of accounting to a greater extent. In principle, it does not change anything from a private equity fair value point of view. Before FASB 157, private equity funds were required to report on a fair value basis and they are still required to report on this basis. Conceptually nothing has changed - only the means for deriving fair value.

FASB 157 has increased the wattage of the light bulb shining on the fair value issue in private equity. Preparers of financial statements realize that FASB 157 is focused on fair value so they need to focus more keenly on how it is derived. In the future once a fund adopts FASB 157, there will be additional disclosure as to how the fund came to its fair value assessment for each of its investments. FASB 157 goes through a hierarchy of inputs to get these values. You then have to disclose the level of input used so that the reader of the financial statement can then assess the overall quality of the fair value determination.

Editor: What is the preferred methodology?

Larsen: There are several criteria: (1) if the company is a public company, quoted prices in active markets; for non-public companies: (2) cost or the latest round of financing may be appropriate to measure fair value for some period of time; thereafter (3) comparable company transactions; (4) performance multiples; (5) other relevant information. The technique least likely to be used and with caution is discounted cash flow.

Editor: Could you give an example of how a fund might value an investment?

Larsen: You have to look at it from two perspectives. If a company is in a buyout portfolio (usually meaning that it has earnings and is growing), in order to value that company you should first ask if it is publicly traded. If it is, you take the market price of its shares times the number of shares to get fair value. If it is not publicly traded, you look for a comparable company that gives an indication of value. You look at the market multiple for the comparable company, and if that multiple makes sense for your company, you use it in order to get a value - always in the context of the overall market and economy.

A venture-backed company that does not have earnings should be viewed in the same way. Is the company still on plan? Is the cash burn what was expected? You look at the goals and expectations set by the investor. You then look at similar companies and factor in the value of the market for that type of company and its product(s). Taking all of that into account, you make a determination of fair value. Often this is evaluated in the context of what was paid or the value of the last round of financing.

One of the interesting things is the comparative test. If someone else has written down the value of similar tier 3 investments with an illiquid market, then the auditors appear to be obliged to write down investments to this value. Could it result in predatory write-downs? (i.e. company x writes down it’s small amount of RMBS for Georgia mortgages because it knows company y is holding a big stack of them?).

[tulip]

thanks yoganmahew, so from tomorrow onwards we could start seeing large write downs. I’d say there’s some nervous people in the banks Greenbear has mentioned above. I wouldn’t like to be the auditor/accountant in charge of that.

[Green_Bear]

Rumour at the moment that “certain portions” of FASB 157 will be postponed, no link or confirmation yet…

[yoganmahew]

@Green Bear

Rumour at the moment that “certain portions” of FASB 157 will be postponed, no link or confirmation yet…

While FASB decided yesterday to to pospone the implementation of some parts of FASB 157, only non-financial assets (business combinations, etc.) have been excluded from this implementation; thus financial assets including asset backed securities and other illiquid financial assets will now have to be valued - whenever possible - using market prices or proxies of them rather than using voodoo-finance models and credit ratings (or better misratings) that don’t make sense.

rgemonitor.com/blog/roubini/226943