Monday, April 11, 2011

The Bank's Assets

You're thinking of investing in a business.  If the business owns, say, a locomotive, you know what it's worth: you can get a good guess out of a trade pub.  If the business went broke, you know you'd have a fair chance of selling the locomotive to somebody else.  But what if the business owns (be still my soul) "IP"--intellectual property, patents, copyrights, trademarks, trade secrets.  How do you know what they're worth?  There's nothing comparable--that's the point, they're unique.  Indeed, the real point of the IP is to prevent anyone from copying your gem of an idea.  In short, squishy numbers.

Comes now Greg Farrell, explaining how you've got a similar problem evaluating a bank:

A falling share price at an investment bank isn't just a measure of personal wealth for employees and a metric to use when senior executives wanted to figure out when they could retire.  When a bank hits hard times, there are no factories to sell or hard inventory that can be used as collateral toward a loan.  The assets of an investment bank are its loans, its funding commitments, and the securities it holds.  The share price represents the excess reservoir of capital that a bank can draw on aw a cushion against losses.  At the worst possible time in [the history of Merrill Lynch, the brokerage/bank] when it was holding more than $30 billion of toxic assets on its balance sheet--enough to wipe the firm out--a plummeting stock price was shrinking the firm's capital base.  It was yet another hole in the ship's hull.
Afterthought:  Or is there less here than meets the eye?  Farrell says that a bank's assets include "its funding commitments."  Then he says the share price represents "the excess reservoir of capital that a bank can draw on..." Are these two the same?  If so, the only (not very interesting) point is that the "funding commitments" probably don't show up as a balance sheet asset, even though they might be available as a matter of law.  Much different if "the excess reservoir of capital" is something more than its "commitments"--e.g., perhaps its prestige or power in the market place, such as to impel people to lend it money even though they may not be bound to do so as a matter of law.  

1 comment:

Anonymous said...

Its much worse than it seems.

The only real assets of an investment bank are its buccaneers. If you separate them from the bank, all you have is a balance sheet, which doesn't nearly reflect the profitability of the average investment bank.

In other words, even though the assets of an investment bank are (usually) liquid, the liquidation value of a typical investment bank is far less than its going-concern value.