virginCFAhooker Wrote: ------------------------------------------------------- > Why is this so hard to understand? > > If I sell a bond for $100 then I have a $100 > liability. > > If the market value for the bond falls to $50, do > I still owe $100? > > Accountants might say I do, but I’d be stupid to > pay it if I can just go buy the bond for $50! its questionable accounting, and that in itself is a cause for concern. also consider the fact that market values of bonds are highly volatile, unless you can access audited F/S in real time the reliability of the statements is highly suspect.
JoeyDVivre Wrote: ------------------------------------------------------- > Can you believe how it feels to be a US taxpayer > and read that crap? assuming they understood it… pretty sh*tty. But since most don’t we can get away with it.
What is key here is that you are also marking your assets to market. If Lehman Brothers has leveraged loans marked at 85 they show up on their BS at 85 no matter if they are still cashflowing. Therefore they mark their own debt the same way. Yes they still owe par at maturity but they will certainly collect assets at par before their debt matures. If you are writing down the value of your assets but not your debt, it distorts your IS.
naturallight Wrote: ------------------------------------------------------- > >>If the market value for the bond falls to $50, > do I still owe $100? > > Yeah, but the reason it falls is because people > are worried about YOUR credit quality. So your > poor performance helps you book a gain. That’s > what people are complaining about, I think. This may have some validity, but no one with substantial interest in your equity will view this as a gain because the higher forward looking cost of capital will dwarf the effect of nonrecurring income. In other words, this policy won’t give banks incentive to let their credit erode, because the forward looking ramifications for lower credit are much more significant than the backward looking small bump in revenue. Not that I’m an expert, but if this income is taxable, it will hurt net cash flow as they can’t recognize the income, but they have to pay taxes on it. I don’t think this helps them at all…
accountant23 Wrote: ------------------------------------------------------- > What is key here is that you are also marking your > assets to market. If Lehman Brothers has > leveraged loans marked at 85 they show up on their > BS at 85 no matter if they are still cashflowing. > Therefore they mark their own debt the same way. > > > Yes they still owe par at maturity but they will > certainly collect assets at par before their debt > matures. > Please tell me that you don’t believe that. Debt at 85 but no default risk, huh? > If you are writing down the value of your assets > but not your debt, it distorts your IS.
A bond manager I knew bought a bond this year at 70p. It defaulted 2 weeks later and he got back £1! Clever boy…
Is 70p < £1?
100p = £1. But you knew that and are being obtuse. Tut tut.
JoeyDVivre Wrote: ------------------------------------------------------- > accountant23 Wrote: > -------------------------------------------------- > ----- > > What is key here is that you are also marking > your > > assets to market. If Lehman Brothers has > > leveraged loans marked at 85 they show up on > their > > BS at 85 no matter if they are still > cashflowing. > > Therefore they mark their own debt the same way. > > > > > > > Yes they still owe par at maturity but they > will > > certainly collect assets at par before their > debt > > matures. > > > Please tell me that you don’t believe that. Debt > at 85 but no default risk, huh? > > > If you are writing down the value of your > assets > > but not your debt, it distorts your IS. I didn’t say all assets. The fact of the matter is that default risk doesn’t even have to be the issue. How many deals are on banks BS’s right now that are just simply underpirced for the current market environment. If you have an underpriced asset that trades with limited liquidity it may be marked in the 80’s for just those reasons. Default risk may not be the main issue.
Even if it’s limited liquidity (bonds at 85 because of liquidity problems doesn’t sound right to me) there is nothing like a guarantee that the company will receive par. You might have to liquidate the thing tomorrow. If the market prices it at 85 and you own it, a “fair value” guy like me would say you book it at 85. If you owe it, there is nothing like a guarantee that you can get out of it for 85. You owe par. What if a company says that the recovery value of this bond is 35 so in bankruptcy I just owe 35 so I’m going to book the 65 as profit?
I’m not saying you are guaranteed par. I’m saying if you are marking to market your assets, it makes sense to MTM your liabilities. I’m owed par, I owe par. In the meantime, a general widening of spreads should be relfected in both assets and liabilities. You have below market assets and below market debt.
accountant23 Wrote: ------------------------------------------------------- > I’m not saying you are guaranteed par. I’m saying > if you are marking to market your assets, it makes > sense to MTM your liabilities. I’m owed par, I owe > par. Except it’s not close to symmetric except in that rhetorical sense. You probably don’t get to MTM your own liabilities unless you go belly up. You owe par and as a going concern you are probably going to have to pay par. You are owed par but in many cases never expect to collect it. In the meantime, based on this rhetorical symmetry, you are marking up your equity because your credit has gotten pummeled. In some sense, it’s okay with me. This kind of accounting just marginalizes accountants and makes equity analysts the arbiters. > In the meantime, a general widening of > spreads should be relfected in both assets and > liabilities. You have below market assets and > below market debt. I’m just astounded by this kind of thinking. Nothing about this is symmetric. Do you personally think about your debts and your assets as similar obligations? Does your home mortgage provide a buffer to your worsening credit rating?
I’m not marking up my equity. If I issue 10 year debt at 4% and buy a 10 year asset at 4% and the credit quality of my company and my asset remain the same but spreads widen, I would MTM both my asset and liability by the same amount. My equity wouldn’t change. I don’t think in many cases people don’t expect to collect par. I don’t observe a market for my debt but if I did, it would make sense to me. If I sold $10 of assets I could repay $10 of debt regardless of what par is. That would be my economic reality.
The accounting is a bit funky, and certainly gains of this type lower the quality of earnings and are stripped out when analyst normalize things. That said, most people just see the headlines without knowing the full story (which is not unusual). It doesn’t get much airtime, but here is the argument the brokers use to justify this. I’m not saying I necessarily agree, but I thought it should at least be presented in the discussion. The liabilities that are held at fair value (and therefore marked-to-market when spreads widen) are by no means all of a firm’s long-term debt, rather they tend to be structured notes issued to high net-worth individuals and other “sophisticated” investors. There are a wide variety of these products out there, for example it could be a credit linked note whose performance references a basket of CDS contracts, or a synthetic note that provides 2x the inverse performance of the S&P500, or a currency note that is linked to the USD versus a basket of Asian currencies. Basically whatever someone will be willing to buy. Investors tend to purchase these not as a means of expressing a view on the issuing brokers credit profile, but rather to gain exposure to an asset class that may be otherwise inaccessible to them (the classic example is an insurance company that can only buy investment grade bonds but wants to play the FX or equity game). Of course there is a component of credit risk in these notes, but in more stable credit markets the performance is dominated by whatever indices or instruments are referenced in the structure. The view of the brokers is that these are trading instruments, and clients will trade them actively based on their performance. The typical means of exiting such a position is seeking a bid, at market value, from the issuing broker. Therefore, these notes are frequently taken out at market value as opposed to maturing at par. Plenty of counter-arguments can be made, but from their perspective this is somewhat more defensible than just marking all liabilities to market.
Excellent. So I issue debt which I originally call a par liability. Then my credit goes all to hell so I mark a gain on the debt. Geez, the market doesn’t think I will be able to pay all that back so that means I don’t have to. Of course, the real saving grace is that I sold this debt to people who will “trade them actively”. Unfortunately for them the only buyers out there are, um, me so I can offer them whatever I want. Fortunately, these are “sophisticated” investors who should have been able to find out for themselves that if they wanted to trade something actively they should have determined that there was a liquid market.
For the sake of discussion, corporate bonds rarely trade at 50. More like either 35 or 70. Only the company with bonds at 70 are going to be able to buy them back. I am also assuming that FASB is requiring a higher interest expense associated with the m2m on the liabilities. m2m the current market interest rate too. Is this what is going on?