Citigroup’s chief financial officer, Garry Crittenden, was nothing if not candid when questioned yesterday about whether the extra $8bn to $11bn (£3.8bn to £5.3bn) in sub-prime write-downs announced over the weekend would be sufficient. “We’ve taken what we think is a reasonable stab,” he said. Reasonable stab? Well that really is reassuring.
Yet his candour raises an important issue about the way banks account for any meltdown in their credit quality. As Mr Crittenden intimated, in the end it comes down to a question of judgement, which is why nobody has any faith in the numbers now being reported and why banking shares remain in freefall.
In an increasingly transparent world, the reporting of bank profits remains one of the last bastions of creative accounting. Some forms of accounting for credit are based on market prices, others not, but the bottom line is that there is virtually no consistency on how these matters are resolved, even within national banking communities, let alone internationally. This helps explain why there can be several different views within both Merrill Lynch and Citigroup as to the damage. The only consistency seems to be that with each successive estimate, the diagnosis gets worse.
Different banks have startlingly different attitudes to how the same credits are assessed, with some banks choosing to take 100 per cent write-offs, others lesser amounts, and still others optimistically thinking that they can ride the storm and record no bad-debt experience at all. In Britain, there appears to be no obligation on UK banks to mark to market their exposure to collaterised debt obligations and other forms of questionable debt. This may help explain why no UK bank has so far detailed its sub-prime losses.
Nor is it just in the accounting of profit and loss that banking is deeply unsatisfactory. The capital adequacy rules applied by regulators for solvency purposes seem to be up the spout too, with the whole system relying substantially on the now-discredited assessment of assets made by credit-rating agencies.
The recently enacted Basel II solvency regime, billed as a progressive modernisation of the international framework, is a complete joke when it comes to the way capital is allocated to mortgages. Sheepishly, I have to admit to having in the past given Northern Rock a positive write-up on the basis of the amount of capital Basel II would release for repayment to shareholders.
Despite all the historic evidence to the contrary, mortgage lending was judged by the designers of this accord to be virtually risk-free. This in itself may have encouraged a rush into mortgage lending, helping to create the very risk that Basel II said didn’t exist. We now know differently.
Yet it is self-evidently the case that most mortgage lending is indeed relatively safe. Default rates tend to be low compared with other forms of lending. With Northern Rock, for instance, there appears to be no problem with the quality of the loan book. This is where banking crises normally begin.
Yet it in this case, it is on the funding, rather than the lending, side of the balance sheet that the difficulty has occurred. Banks have been hoarding cash to pay for any problems the credit crunch may throw at them, which in turn means they have stopped lending to anyone regarded in present circumstances as remotely risky, including Northern Rock. In the meantime, we are all at sea in trying to understand who has lost what or, even when banks do come clean, whether their “stab” at the problem is remotely credible.
Sainsbury: Qatar’s irresponsible bid
Both the Qatari Investment Authority and its private equity partner, Paul Taylor’s Delta Two, have quite a bit of explaining to do after so unexpectedly pulling out of their bid for J Sainsbury.
I say unexpectedly, but it will have come as little surprise to readers of this column. I’ve long been sceptical about the deal’s deliverability. None the less, the bidders seem to have led everyone up the garden path in persisting with the endeavour with such evident determination, when all along there now seem to have been problems.
Both Mr Taylor and the Qataris emerge with their credibility shot to bits. Nobody had ever heard of Mr Taylor before the Sainsbury bid charade came along. He’s had his 15 minutes of fame and now looks set to vanish into the obscurity from which he came.
By contrast, it doesn’t seem to me that the Sainsbury board can likewise be faulted. They never particularly liked the proposition – a highly leveraged takeover in an intensely competitive sector – but they liked the price, which the great bulk of shareholders was keen to accept.
The Qataris had bought 25 per cent of the company, they appeared to have fantastically deep pockets, and they seemed genuine in wanting to buy the business. Nobody would have taken Mr Taylor seriously by himself, but the Qataris gave him credibility. The board had every reason to believe they were serious. Nor on this occasion can the Sainsbury family be blamed for obstruction. Through gritted teeth, they in the end went along with the deal, subject to various safeguards being put in place for the business and its pensioners. These were satisfied.
The pension fund cannot be blamed either, although, somewhat disingenuously, yesterday’s Delta Two statement refers to this as a continuing issue. In fact the pensions problem was settled to everyone’s apparent satisfaction about three weeks ago.
The continued deterioration in credit conditions plainly has been a factor. Both BAA’s and Alliance Boots’s refinancings have run into trouble.
Even so, Delta Two has known about the headwind it was up against from the moment it announced its intentions back in July, yet still it persisted. The fact that it didn’t begin its due diligence until a month ago is entirely its own fault. It took Delta for ever to get the primary financing into a state where the board could reasonably give access to the books.
Mr Taylor also spent weeks of fruitless endeavour trying to sign up the existing Sainsbury management to new contracts. This was always a non-starter because of the conflict of interest it would have placed on Justin King, the chief executive, and others the Qataris wanted on board.
Nor, too, is it reasonable to cite the extra £500m of equity Delta Two at the last minute announced it would need for working capital purposes. This was not something the board had set as a condition for recommendation, but rather it was a condition that Delta Two itself came up with after due diligence. It’s obviously a lot of money, but in the context of a £13bn bid not so large as to be thought a deal-breaker.
None of the reasons given for pulling out look persuasive. In these circumstances, it is only possible to speculate on why the Qataris got cold feet. Is it a political problem with the chief executive of the QIA, who also happens to be the Prime Minister of Qatar? Perhaps he’s fallen out with the Emir. The Sheikh and the Emir have long been thought to be at loggerheads.
The problem with sovereign wealth funds is that you are never likely to know the answer to such questions. They make secretive private equity investors look like paradigms of transparency by comparison. Whatever the explanation, investors are going to be doubly sceptical next time they come calling. Delta Two seems to have acted recklessly.
Where does all this leave Sainsbury? The strategy and targets for the next three years look credible enough, and, whereas he’ll no doubt be disappointed not to have crystallised his options, the chief executive is fully committed to the task in hand.
More worrying is the share register, with the Qataris sitting on 25 per cent, which they say they won’t sell, the family on 18 per cent, and Robert Tchenguiz with a further 10 per cent, on which he’ll be showing a big loss. They all seem to want different things from the company. That scarcely makes for a happy ship.Reuse content