TRANSPARENCYTransparency of financial institutions during the Credit Crisis with two case studies Project work: Beya Noureddine Coviello Sofia Filippini Cristina Montermini Sonia Spocci Antonio
Summary • Definition of transparency, and the concept of “lack of transparency” • Lehman Brothers case study • Barclays case study • Balance Sheet and Income Statement Analysis
What Does Transparency Mean? The extent to which investors have ready access to any required financial information about a company such as price levels, market depth and audited financial reports. Classically defined as when "much is known by many", transparency is one of the silent prerequisites of any free and efficient market.When transparency relates to information flow from the company to investors, it is also known as "full disclosure"
TRANSPARENCY What is transparency? • Transparency is a concept strictly correlated to: -conflicts of interest -asymmetric information (A situation in which one party in a transaction has more or superior information compared to another). Information Asymmetry can lead to two main problems: 1. Adverse selection- immoral behavior that takes advantage of asymmetric information before a transaction. 2. Moral Hazard- immoral behavior that takes advantage of asymmetric information after a transaction
TRANSPARENCY LACK OF TRANSPARENCY • The major source of problems that contributed to the last (or actual?) crisis was the lack of transparency in major markets.
TRANSPARENCY LACK OF TRANSPARENCY • during the last ten years the market for credit default swaps (CDS) grew unregulated from almost zero to more than $44 trillion (more than twice the size of the U.S. stock market).
TRANSPARENCY LACK OF TRANSPARENCY • More importantly, the level of collateral posted for these contracts was very low or non-existent, generating the possibility of a systemic failure.
TRANSPARENCY LACK OF TRANSPARENCY • For example, in 2007 there were almost 6 trillion mortgage-backed securities outstanding. Most of these securities were issued under the 144A rule, with limited disclosure. This lack of transparency in the issuing process made it difficult to determine who owned what.
What to do? • Policy Makers have two ways to deal with the crisis: 1- Silence the problem to avoid an alarm to the public, media and investors 2- Be trasparent and accept the interference of Stakeholders, investors and Mass Media.
TRANSPARENCY TWO CASE STUDIES 1- Lehman Brothers 2- Barclays
Lehman Brothers • Lehman Brothers, an investment bank that dates back to 1850, was until its Chapter 11 bankruptcy filing on September, 15, 2008, the fourth-largest securities firm in the U.S. and a leading provider of financial products that let companies package and re-sell risk. • Lehman has a particularly strong history in fixed income, which is a broad term for any investment that yields a regular fixed return.
Lehman Brothers • In the years before the crisis, the firm has recognized its heavy reliance on fixed income as a source of revenue and has moved to diversify into other areas of finance such as investment banking and investment and asset management.
Lehman Brothers • Until the 2007 collapse of the U.S. subprime mortgage industry and resulting credit crisis, Lehman generated a significant portion of its revenue through the issuance of mortgage-backed and asset-backed securities.
The fall of Lehman Brothers • The demise of Lehman Brothers can only be understood within the context of the current financial crisis, the biggest financial crisis since the Great Depression. The roots of this crisis have to be found in bad regulation, lack of transparency, and market complacency brought about by several years of positive returns.
The fall of Lehman Brothers • When mortgage default rates began to rise and the demand for these securities began to disappear, Lehman was left with billions of dollars of rapidly depreciating securities on its balance sheet, forcing it to take large write downs and write-offs. Eventually, the company's efforts to shed risky assets proved unsuccessful, and investors sold off shares of Lehman in the fear that it wouldn't have enough capital to continue business as usual.
The fall of Lehman Brothers • On the 2nd of September 2008, the state-owned Korean Development Bank confirmed that it was in talks to buy up to a 25% stake in Lehman, though the deal eventually fell through. The following weekend, Lehman put itself up for sale, and the U.S. Federal Reserve called an emergency meeting of Wall Street executives to aid in the sale.
The fall of Lehman Brothers • The two main bidders, Bank of America and Barclays, dropped out on the same week-end after the federal government refused to absorb Lehman's future losses with taxpayer dollars. Left with no potential buyers, Lehman's board of directors decided to file for Chapter 11 bankruptcy protection on the September 15, ending the firm's 158-year history and claiming the title of the largest bankruptcy filing on record.
L.B.’s Transparency Repo 105
What’s Repo 105? Accounting maneuver where one company transfers an asset to another company in exchange of short-term cash, borrower will pay back the cash and take back the asset at a specific date, usually within a week or so.
L.B.’s misleading use of Repo 105 L.B. used repo 105 to get bad assets off books appearing to reduce its leverage and creating a misleading portrayal of its financial health. In fact instead of categorizing these transactions as a loan they described them publicly as a sale never disclosing that they had to pay back the cash that they borrowed for those assets. That’s not legal.
L.B. used repo 105 three times to improve its balance sheet during the issue of the quarterly reports: • Q4 of 2007 $39 b • Q1 of 2008 $49 b • Q2 of 2008 $50 b the effect was that LB had $50 b more in cash on its book and $50 b less in toxic mortgage assets.
TRANSPARENCY BARCLAYS • Barclays plc is a British financial services firm operating worldwide. It is a holding company that is listed on the London and New York stock exchanges, and was listed on the Tokyo Stock Exchange until 2008. • It is always been one of the most bank in the world.
TRANSPARENCY • This bank traces its origins back to 1690 when J. Freame and T. Gould started trading as goldsmith bankers in Lombard Street, London. The name "Barclays" became associated with the business in 1736, when James Barclayone of the founders, became a partner in the business. • In 1999 Barclays was the first bank to suggest an internet service called Barclays.net .
TRANSPARENCY • On September 16, 2008, Barclays announced its agreement to purchase, subject to regulatory approval, the investment-banking and trading divisions of Lehman Bros. Barclays absorbed $47.4 billion in securities and assumed $45.5 billion in trading liabilities.
TRANSPARENCY The Barclays’ rise • At the end of the october 2008, Barclays deny the govenement financial set in. • The money, more or less £3bn, was mainly raised from the investment funds of royal families of Qatar and Abu Dhabi (Qatar Holdings 12.7% - Challenger (Qatar) 2.8% - Abu Dhabi 16.3%).
TRANSPARENCY • The secures’ interests of Middle East was 14% while those of the governement was 12% • A direct financial aid from the governement mean a governement’s direct control from the inside • "The board believes that this maintains Barclays as a strong, independent and well-capitalised bank“, said Marcus Agius, Barclays chairman.
TRANSPARENCY • The government injected £37bn into RBS, Lloyds TSB and HBOS to avoid a collapse of the sector. • In return for the rescue, there may be restrictions on executive pay, bonuses and shareholder dividends
TRANSPARENCY • With this play, Barclays was still the UK's second largest bank by market capitalisation, worth almost £19bn, behind HSBC which was worth some £89bn. Lloyds TSB and HBOS was worth slightly over £17bn
TRANSPARENCY An exemple of good transparency • During the panic selling that was spreading after the Lehman Brothers’ fall, Barclays released an “unusual” open letter highlighting profits ahead of consensus • The letter was addressed to employees, customers, clients, and shareholders.
TRANSPARENCY • This is the most important points: «… Barclays has £36bn of committed equity capital and reserves; we are well funded, and we are profitable.» In 2008, although Barclays has made asset writedowns related to credit for a total of £8 bn related to exposure in the credit market«… it will close with report a profitwell above » of the 5.3 billion pounds expected by analysts' consensus
TRANSPARENCY «…these figures demonstrate that although we have been heavily impacted by the 2 credit crunch, our income generation was at a record level in 2008 and has enabled us to withstand this impact and still produce strong profits.» «…we confirm in this letter that we are not seeking subscription for further capital - either from the private sector or from the UK Government. »
TRANSPARENCY • On February 13, 2010 Barclays announced it would pay more than £2 billion in bonuses
Barclays’ Balance Sheet and Income Statement Analisys Excel files O.ROE = NOP/EC • NOP = Profit before tax and disposal of discontinued operations • EC = Total capital employed
O.ROE 2007 = 7076/32476 = 0.2179 21.79% • O.ROE 2008 = 6077/47411 = 0.1282 12.82% • O.ROE 2009 = 5331/58478 = 0.0912 9.12% Barclays’ ordinary performance diminished
ROE = NP/EC NP = Profit after tax • ROE 2007 = 5095/32476 = 0.157 15.7% • ROE 2008 = 5287/47411 = 0.111 11.1% • ROE 2009 = 10288/58478 = 0.176 17.6% Barclays’ total performance waved
Bibliografy • L.B. Transparency Repo 105: http://www.wealthdaily.com/articles/lehman-brothers-enron-accounting-gimmicks/2375 • Barclays’ Balance Sheet and Income Statement Analisys: http://www.barclaysannualreport.com/ar2009/index.asp?pageid=30 http://www.stockopedia.co.uk/shares/barclays-LON:BARC/balance_sheet/ • Ordinary information about Barclays: http://en.wikipedia.org/wiki/Barclays • Information about transparency: Frederic S. Mishkin, Financial Market and institutions.
Bibliografy • Barclays’ open letter is within Barclays’ websitehttp://group.barclays.com/cs/Satellite?blobcol=urldata&blobheader=application%2Fpdf&blobheadername1=Content-Disposition&blobheadername2=MDT-Type&blobheadervalue1=inline%3B+filename%3D26-Jan---Open-letter-from-Marcus-Agius-and-John-Varley.pdf&blobheadervalue2=abinary%3B+charset%3DUTF-8&blobkey=id&blobtable=MungoBlobs&blobwhere=1231864054593&ssbinary=true • Source of the Middle Est case from bbc new television web site http://news.bbc.co.uk/2/hi/7701405.stmhttp://www.bbc.co.uk/blogs/thereporters/robertpeston/2008/10/why_barclays_prefers_abu_dhabi.html • Source of the Middle Est case from the Guardian web site http://www.guardian.co.uk/business/2008/oct/31/barclay-banking1
Presentation by… • Beya Noureddine • Coviello Sofia • Filippini Cristina • Montermini Sonia • Spocci Antonio