Back to their roots

[peterbirks]

You may remember sometime ago I wrote about the innocents abroad in Europe (mainly smaller co-operative banks) investing in derivatives, not being quite sure what they were investing in or how much risk they were taking on.

Interesting, therefore, to see that Austrian bank Bawag has agreed to pay at least $675m and to co-operate with prosecutors who are investigating the collapse of stock brokerage Refco.

The failure of Refco was in its own way somewhat tedious. Its CEO had "allegedly" hidden $430m in losses built up by a company under his control. To make matters worse, the company actually had an initial public offering, before collapsing somewhat spectacularly two months later.

Bawag, it transpires, lent Refco's CEO Philip Bennett between $250m and $300m every year between 2000 and 2005 to help him cover up his losses. When a company is floating and when the CEO received nearly a billion dollars from a leveraged buyout in 2004, even the most innocent bank abroad might think that loans of more than $200m a year might be considered relevant by the regulators. But not, apparently to Bawag, whose silence in the lead-up to the IPO might be described as "deafening".

The question that I can see forming on your lips is, "why?". Why would a bank hand out this kind of cash to help a CEO conceal losses? Ahh, well, it seems that some of Bawag's own investments were not going that well, and Bennett helped Bawag conceal the extent of these losses.

More will be heard of this, with several underwriters of the IPO likely to be facing investigation. But the whole caboodle makes you wonder how much you can trust any company's "official" figures. Bawag is no baby; it's a significan Austrian bank.

So, if a big institution seems to be making a lot of its money from a single place, make sure that single place is well-audited. After all, remember Barings.

Comments

Never Mind the Audits

[geoffchall.livejournal.com]

Well by and large, auditing is complete crap as a profession and as a security measure. It's what accountants who are gloomy/pessimistic go into since it's a form of saying 'you got that wrong' to people who were trying their best and saying 'this could go wrong' where it manifestly won't.

The knowledge that a set of books will be audited is a teensy protection against people who are going in for crass fraud but if you know how to ensure there is a decent audit trail, you can still defraud companies willy-nilly if you have your hands on the bookkeeping levers.

Of course the theory is that all these accountants groomed on learning audit and business systems then go out into the wider world and make British management the paragon of virtue it is today.

Re: Never Mind the Audits

[peterbirks.livejournal.com]

Much of the above was written in haste, but my point was not that the institution reporting the gains be well-audited, but that the place whence many of those gains are coming be well-audited.

Of course, you could say that the Barings operation in the far east was signed off by the accountants, but even a cursory look at the controls (not) in place would have made a seasoned investor suspicious. The same was the case with Independent Insurance, where nice and bright top line figures were never quite reflected in bottom line cash flow.

In other words, if any company anywhere seems to be relying on its profits from another, not very well-analysed income stream, then be seriously suspicious. I'm a great old fan of cash flow, personally. You can hide a lot in the figures, but you can't lie about how much cash has come in and how much cash has gone out. Actually, in Baring's case, I suppose you could, since Leeson actually DID lie about how much cash was coming in and how much cash was going out, but no-one saw fit to look at the bank statements.

PJ

Re: Never Mind the Audits

[geoffchall.livejournal.com]

Telling porkies about cashflow is easy, you just churn it in circles.

I currently have a chewy little number concerning a couple (Kath & Pete as it happens) who bought a house 10 years ago for around £350K with a £250K mortgage that by rights they couldn't afford on an income multiples basis. A decade on, they are about to try to increase their mortgage to £1.8M and once again I will be sent a letter asking me to reference their mortgage. I'll say what I always say - that they will probably be able to afford to make the mortgage payments (£7K/month) in the same fashion they have previously.

Of course the way they afford this is that they live spend £100K pa but have an income that barely reaches £40K. So they run up overdrafts, loans and credit cards to the point where they have to remortgage. From a credit scoring point of view they look great. Substantial loans and borrowings are repaid, no missing mortgage payments and in order to manage all of this debt spiral, they move money from one place to another quite fast.

So now they want a mortgage they can show that the turnover/cashflow on their main account is between £300 and £400K. Thus the bank give them a decent reference. The valuer for some reason reckons the place may be worth £1.9M now and I don't drop them in the shit (although I do tell them they're living their lives the wrong way). I'm lucky thus far that I haven't been asked anything more than I am and of course if anyone wanted accounts or tax returns, they'd kill themselves laughing.

So even on this minor scale, cashflow means little. Give me a detailed balance sheet over several years please. And even they can hide a multitude of sins.

Re: Never Mind the Audits

[peterbirks.livejournal.com]

Point accepted. Clearly things are not so utterly simplistic for me to say: "Oh, that company has $80m more than it had at the start of the year; it must be good" when said company raised $140m in a rights issue without buying anything tangible with it.

Similarly, "operating profit" can be misleading, since you can make a so-called cash gain while ignoring "one-off" non-cash write-offs that just happen to occur every year. As one analyst once said to me "How many one-offs is this company planning to have?"

PJ

Re: Never Mind the Audits

[(Anonymous)]

This raises an interesting question for me about the British property market. Just how much out-and-out lying is going on? I mean where people exaggerate their incomes and thus obtain mortgages they can only afford if nothing goes wrong.

If it's as widespread as I sometimes feel it is, then I wonder how fast the whole sector collapses once rates go up.

DY

Re: Never Mind the Audits

[geoffchall.livejournal.com]

How much blatant lying goes on like Pete & Kath? Not that much from my standpoint (and I see the truth of around 150-200 mortgage applications per year). There are a lot of people bending the truth a little bit to get where they want, but only total idiots behave like Pete & Kath.

The British property market continues to operate on the Bigger Fool theory, mildly underpinned by people's real need to have a house, but having been stable now for the best part of a decade (?) I wouldn't be too surprised to see a sharp correction at some stage.

Re: Never Mind the Audits

[andy-ward-uk.livejournal.com]

I was a little surprised when I explained my situation to the bank. I felt bad about getting a mortgage on the strength of my salary, in the full knowledge that I was about to quit.

When I told them this, they couldn't care less. I was paid X at the time I applied for the mortgage, and that was that as far as they were concerned. As long as I keep up the minimum payment, fine. If I don't, they get the flat.

As there are people contributing here who know 100x more than me about how banks and mortgages work, I won't speculate as to why !

Andy.

Re: Never Mind the Audits

[peterbirks.livejournal.com]

In simple terms, sometimes banks have money that they are desperate to lend, and sometimes they have absolutely no money to lend at all.

When there is an ocean of money looking for an investment opportunity, then people's standards tend to slip, either in terms of the return that they will accept for an equivalent level of default, or in terms of the chance of default for the same level of return.

Sometimes the standards can slip far enough to include even you, Andy. :-)

Well, I'm being unfair. All of this is automated these days. The office minnows punch in the numbers and it comes back yay or nay. If the answer comes back nay, and you really want to borrow the money, then you pay a 1% fee to a broker, who will either know a man who is prepared to lend you the money, or will know what answers can be "stretched" to obtain a yay rther than a nay.

All it comes down to is, are you a reasonable risk at the rate offered, given that it is a secured loan? In the US, the lender doesn't even worry about this, because your debt will be sliced and diced into different loan tranches and sold on to institutional investors. The "lenders" in the US aren't really lenders at all. In the UK there is at least an element of lending, since the bank is risking the exchange of a liquid asset (cash) for an illiquid one. Things only start to go seriously Pete Tong if there is a wave of defaults a la 1990 to 1992. In modern parlance, this would be called "a buying opportunity".

PJ