Toomre Capital Markets LLC

Real-Time Capital Markets -- Analytics, Visualization, Event Processing, and Intelligence

UBS: What's Another $10 Billion Dollar Loss Worth?

Like many other capital markets and fixed-income specialists, Toomre Capital Markets LLC ("TCM") has been shocked at how relatively "off-sides" various investment and global commercial banks had themselves positioned at the onset of the current subprime crisis and resulting credit crunch. What is now known as UBS and Citigroup are successor companies of brokerage firms that previously employed both Aldon Hynes and Lars Toomre in their structured finance areas. As it is said, ten billion dollars is more than a few shekels. How both UBS and Citigroup managed to lose more than TEN BILLION dollars from their CDO and sub-prime activities is truly amazing!

On Monday December 10th 2007, the Swiss banking giant UBS announced that it will write down the valuation of its CDO and sub-prime holdings by a further $10 billion dollars, likely leading to a loss for the fourth quarter and potentially wiping out all of its profits for the 2007 calendar year. To replenish its "Europe's largest bank by assets plans to raise 13 billion Swiss francs ($11.5 billion) selling bonds that will convert into shares to Singapore's Government Investment Corp. and an unidentified Middle Eastern investor, Chairman Marcel Ospel said on a conference call with reporters today." Market participants have speculated that the unidentified investor may be Abu Dhabi Investment Authority, which had also invested in Citigroup Inc., or the government of Oman.

The Wall Street Journal reports "'Our losses in the U.S. mortgage securities market are substantial but could have been absorbed by our earnings and capital base,' UBS Chairman Marcel Ospel said in a statement. 'Nevertheless, it is important to always maintain a notably strong capital position to support the continued growth of our wealth management business, which is the largest generator of value to UBS shareholders.'"

Marketwatch.com has further details on the UBS write-down. UBS CEO Marcel Rohner apparently said, "Conditions in the U.S. mortgage and housing markets have continued to deteriorate, and we have updated our loss assumptions to the levels implied by the current distressed market for mortgage securities… In the last several months, continued speculation about the ultimate value of our subprime holdings -- which remains unknowable -- has been distracting… In our judgment these write-downs will create maximum clarity on this issue and will have the effect of substantially eliminating speculation." Mr. Rohner also confirmed market speculation that the investment banking arm will focus more on supporting the asset and wealth management units. "In future, we will make certain that our investment banking operations grow by concentrating on serving the needs of institutional and corporate clients," he said.

Toomre Capital Markets LLC has one question though: Why the heck did UBS and Citigroup stray from their previous focus on serving customer needs? Were the enormous profits of Goldman Sachs (and the competitive need to keep up with the proverbial "Jones'es") so seductive that management threw all good judgment to the wind? Shareholders yet again are paying for the "heads management and employees win, tails everyone loses" behavior of Wall Street. Let TCM ask the question, "Is any young person (with less experience than a full economic cycle) really worth paying more than a few hundred thousand dollars per year?"

Lars Toomre had a mentor in Mr. Lewis Glucksman, the former mercurial Chairman of Lehman Brothers Kuhn Loeb, a predecessor firm to the current Lehman Brothers, who later in his career assumed responsibility for the Capital Markets division of Smith Barney for Sandy Weill and what then was known as Primerica. Lew was quite gruff and almost always had a quip when presented with an extraordinary opportunity. (There were plenty of such opportunities at the time as Lars Toomre was running the Smith Barney mortgage trading department in the midst of the savings and loan crisis and the liquidation with Resolution Trust Corporation.) Lew had been badly singed by the Penn Central Commercial Paper debacle and always stressed the importance of not only knowing the quality of a company's cash flow and earnings, but also the strength of the company's balance sheet. Hence, Mr. Glucksman was always high skeptical of any financial institution because of how opaque the balance sheet was reported and how the various assets and liabilities were valued.

As news spreads of the enormous subprime and CDO write-downs in the structured finance operations at Merrill Lynch, Citigroup, Morgan Stanley and now UBS, Lars Toomre can hear Mr. Glucksman chortling "See you never can trust these financial institutions… Who knows what the fucking balance sheet is worth? Would you buy the common stock of a blind pool? NO!!!!"

Needless to say, the Smith Barney mortgage department passed on many "extraordinary" opportunities back in the 1989-1991 mortgage crisis period and stuck to our core competency of serving our customers taking a relatively small spread from buying at X and selling to another investor at X plus delta X. Basic operational details were stressed, liking rigorously reviewing aged inventory reports and justifying the value of each and every position 90-days, 60-days and even 30-days old. As a result, the balance sheet was pristine and the profits were lower than they otherwise might have been (and certainly lower than our competitors). However, that brokerage firm never would have gotten itself into the position where the shareholders and employees were at risk for TEN BILLION dollar write-downs and the subsequent sharp decline in enterprise value.

Today UBS announced their economic losses as a result of truly poor enterprise risk management ("ERM"). No doubt further announcements will be made by Merrill Lynch, Citigroup, Morgan Stanley, Bank of America and other financial institutions. For investors in financial institution equity, a key question is whether the institution's management truly understands what enterprise risk management is and what it involves. Toomre Capital Markets LLC specializes in enterprise risk management and welcomes contacts from the potential clients, the press and other interested parties. Reader comments and thoughts are welcome.