Every once in a while I almost write “I don’t envy big bank CEOs,” and then I consider my own finances and the mood passes. But it does seem hard, no? The job is basically that you run around all day looking at horrible messes – even in good times, there are some horrible messes somewhere, and what is a CEO for if not to look at them and make decisive noises? – and then you get on earnings calls, or go on CNBC, or sign 10Ks under penalty of perjury, and say “everything is great.” I mean: you can say that some things aren’t great, if it’s really obvious that they’re not. If you lost money, GAAPwise, go ahead and say that; everyone already knows. But for the most part, you are in the business of inspiring enough confidence in people that they continue to fund you, and if you don’t persuade them that, on a forward-looking basis, things will be pretty good, then they won’t be.
Also, when you’re not in the business of convincing people to fund you, you’re in the business of convincing people to buy what you’re selling and sell what you’re buying, which further constrains you from saying “what we’re selling is dogshit.”1
Anyway I found a certain poignancy in Citi’s correspondence with the SEC over Morgan Stanley Smith Barney, which was released on Friday. Citi and Morgan Stanley had a joint venture in MSSB, and MS valued it at around $9bn, and Citi valued it at around $22bn, and at most one of them was right and, while the answer turned out to be “neither,” it was much closer to MS than C. Citi was quite wrong, and since this was eventually resolved by a willing seller (Citi) selling to a willing buyer (MS) at a valuation of $13.5bn, Citi had to admit its wrongness in the form of a $4.7 billion write-down, and the stock did this: Read more »
A value-at-risk model basically works like this. You have some stuff, which is worth X today. Tomorrow it will be worth X + Y, where Y ranges from more or less negative infinity to positive infinity. Y is a function of a bunch of correlated random variables, rates and credit and stock prices and general whatnot. You look at a distribution of moves in those variables and take (usually) a 2-standard deviation daily move; if 95% of the time rates move by -10 to +10 basis points, your VaR model will assume a -10bp or +10bp move, whichever is bad for you. You take the 95%-worst-case, taking into account correlation etc., and tot up how much you’d lose in that case. Then you write that number down and feel a bit better, since you’ve sort of implicitly replaced “we have $X today and will have some number between negative and positive infinity tomorrow” with “we have $X today and will have some number between ($X – VaR) and positive infinity tomorrow,” though of course the first statement is true but unhelpful and the second is not true and also unhelpful.
But that aside! You get your VaR from a distribution of your variables, but the obvious question is what distribution. A good answer would be like “the distribution of those variables over the next three months,” say, for quarterly reporting, but of course that is only a good answer because it begs the question; if you knew what would happen over the next three months you would, one assume, always end those three months with more than $X and this VaR thing would be moot or moot-ish.1
So instead you look at things that you think will allow you to predict that future distribution as accurately as possible, which is epistemically troubling since VaR is a measure of how inaccurate your predictions might turn out to be. Anyway! You pick a distribution of variables based on the sort of stuff that you always use to estimate future distributions in your future-distribution-estimating business, which could mean distributions implied by market prices (e.g. option implied vol) but which seems to mostly mean historical distributions. You look at the last N days of data and assume that the world will be similarly distributed in the following M days, because really what else is there to do.
Picking the number of days to use is hard because, one, this is in some strict sense a nonsense endeavor, but also two, the world changes over time, so looking back one year is for instance rather different from looking back four years. Here is how different: Read more »
I don’t have much insight into Citi’s earnings but I do enjoy the reporting of them. When a car or Facebook company reports earnings you basically ask questions like “how many cars or Facebooks did it sell?” and “how much money did it make on each one?” and those questions are kind of answerable and their answers give you a sense of how you should feel in your heart about the company. When a bank – like, a bank bank – reports earnings you can ask “how many mortgages did it sell?” and “how much money did it make on each one?” and those answers will be useful to you too, though there will be murky liquidity and valuation overhangs that will reduce their usefulness.
If you asked those questions of Citi, you might or might not get answers that might or might not be useful, but you’d be hard pressed to translate them into the headlines on Citi’s earnings. Big banks are not primarily engines for selling products and collecting a margin on them; they are bundles of accounting decisions, and this is never more apparent than at earnings time. This is pretty far removed from economic activity in the world:
Citigroup Inc.’s third-quarter profit fell 88% as the bank took charges tied to the value of its debt and the sale of a stake in its brokerage joint venture …
Others chose to emphasize economic activity in the world, at the cost of, y’know, GAAP: Read more »
Buried in a footnote1 a while back I ruminated on the fact that, in the deal where Morgan Stanley bought a chunk of its Morgan Stanley Smith Barney brokerage JV from Citigroup, Morgan Stanley got a sort-of-free option to buy the rest of Smith Barney, and how that option is (1) valuable and (2) sort of cheap funding. That was basically all wrong, sorry! The lesson is, never read footnotes.
Charlie Gasparino is reporting that “Morgan Stanley chief James Gorman is making a full-court press with regulators to expedite the purchase of the remaining piece of the Smith Barney brokerage firm from Citigroup, moving up the buyout date as much as two years ahead of schedule,” so I guess Gorman puts the time value of that option at zero or less. As for cheap funding, Goldman had a research note this week saying that they met with Morgan Stanley and heard the same story, and also that:
At the margin, full MSSB ownership should have a meaningful impact on ROE as: 1) MS is still paying Citigroup a portion of earnings from the JV despite holding capital to support the entire business, 2) synergies with the Institutional Securities business will grow (i.e. client flow routing), and 3) the funding profile and client product offering mix will improve.
I think the second two things say something like “Citi won’t appreciate us shoving all of our MSSB customers into high-margin Morgan Stanley products, so we have to get rid of them before doing that,” though you could read them otherwise. The first thing calls the cheap-funding argument into some doubt, though maybe not that much doubt; Morgan Stanley’s capital is by some metrics cheaper than Citi’s, while its (credit market) funding is more expensive, so maybe this is still a good deal.
Anyway here’s what Gasparino has to say about the delay: Read more »
Here’s an interesting set of slides that Morgan Stanley CFO Ruth Porat presented at the Barclays conference today. For some reason this one struck me:
Morgan Stanley: basically a mutual fund! Half a mutual fund. Really barely at all an investment bank, which I guess is the way of the world for investment banks, but still sort of stark to see it there in black and white, er, navy and yellow. And Morgan Stanley will be shifting even more toward wealth/asset managing after today’s hotly negotiated purchase of Morgan Stanley Smith Barney.1 As Reuters puts it: Read more »
There’s been sort of an impromptu referendum on whether the big US universal banks should be smashed into itty-bitty pieces, and how itty-bitty, and which ones should be smashed first, and for some reason the leading contenders seem to be Citi and Morgan Stanley. Those two seem uninterested in that free advice, though, since they’re now hagglingover the price of Morgan Stanley Smith Barney, the joint venture that is slowly migrating from Citi’s bloated clutches into Morgan Stanley’s also apparently bloated clutches. Whee.
Morgan Stanley owns 51% of this wealth management venture, while Citi owns 49%, and MS is looking to exercise an option to buy 14% more at a contentiously negotiated price. Citi carries MSSB on its books at a $22bn valuation and wants Morgan Stanley to pay a bit more than that to buy another chunk of it, while Morgan Stanley carries it at something like a $14bn valuation and wants to pay $9bn for it.* I submit to you that that bid/ask spread is not well calculated to make you feel good about (1) the intellectual rigor and independence of Citi’s and/or Morgan Stanley’s investment banking valuation work or (2) the balance sheet transparency of major banks. Thing (1) is I guess why the parties hired Perella Weinberg to be their neutral appraiser.** Thing (2) sparked Citi to put out an 8-K last week saying “oh btw we might have a huge hit to earnings when we mark down our ‘reasonable and supportable’ $22bn valuation to whatever Perella Weinberg finds,” which would not be great for earnings or Basel I capital or general confidence in Citi.***
Morgan Stanley has announced that it will be buying 14% of its Morgan Stanley Smith Barney joint venture from Citi in a sort of glacially negotiated way. MS currently owns 51% of MSSB (plus $5.5bn of preferred interests), and Citi owns the other 49% (plus $2bn of preferred). You can read how they’re going to figure out the price here. Basically they each hire an advisor to value MSSB like a public company, and then get together and see how close they are. If they’re within 10% of each other, they average their prices; if not, they hire a third advisor to figure out who got closer to the right answer. Don’t get too excited about pitching to be one of those advisors, though, at least not in the first round:
Morgan Stanley and Citigroup each will engage one investment bank or financial advisory firm of national standing and with experience in the valuation of securities of financial services companies (an “Appraiser”) for purposes of estimating FMV. All fees and disbursements of the first two Appraisers shall be the responsibility of the party that engaged such Appraiser. Either or both of the first two Appraisers may be an affiliate of the party engaging such Appraiser, and Morgan Stanley has engaged Morgan Stanley Investment Banking as its Appraiser.
MSSB’s net income was about $300mm last year*, and recent Morgan Stanley Investment Banking valuation precedents suggest about a 100x P/E, so I’ll go ahead and predict we’ll see a $30bn-ish valuation from them, no? (Too easy? Actually, ha, it’s not that wildly off; press reports suggest a $15bn bid from MS and a $23bn offer from Citi.) Here’s how they’ll do their math: Read more »
Despite telling Morgan Stanley’s legal counsel that he and Anna Gristina/Scotland were merely “friends” as opposed to partners in a whorehouse that he was supposedly trying to help her line up financing for, broker David Walker, who has not been charged with anything, has been put on administrative leave “until the Manhattan district attorney’s office concludes its investigation.” [FBN, earlier]