Killing it like a hooker in Hong Kong

Credit Suisse Bonuses: Better than a stock award?

The news that Credit Suisse is going to pay bonuses using its troubled assets has been viewed with glee, both restrained at the NYT and unrestrained at Dealbreaker. But I’m not totally sure that this actually disadvantages the senior bankers in anyway.

Here’s why. Let’s say that the troubled asset pool is currently marked at fair value on the CS balance sheet. Firstly let’s think about this, how do you identify high risk assets? Is it just the interest rate/risk premium on the asset? Nope, let’s say its trading at 30 cents on the dollar, but you bought it (or its marked on your book) at 15 cents on the dollar, then the asset is actually in the money, and hence not troubled. Now I doubt they know what the fair value of the assets really is, but let’s just assume management actually has genuine faith in the statements they’ve been putting out to the market saying that their marks are reasonable.

Now let’s compare handing out bonuses in terms of stock awards versus a slice of the troubled asset pool. What is stock? Shareholder’s equity is the residual value after all other claims have been paid. Hence if the firm were handing out stock awards, each recipient is receiving a portion of the remainder of the hypothetical value of the firm if all assets were sold and the proceeds used to pay off all liabilities.

Now if you hand out a slice of the troubled asset pool, what is the analogy? You look at the asset side of the balance sheet, identify the high risk assets, section them off, and hand them off to a trust to administer them. In theory, this is actually better for the recipients than the stock award. Why? Well let’s say the assets are valued at a distressed but fair market value. In effect what is happening is that a portion of the assets is getting carved out of the benefit of the recipients, who then have a collateralized position. Ie the recipients are actually now have a senior claim on the firm with reference to the shareholders. In the same theoretical value liquidation exercise, they will receive their money before shareholders do, and in effect this reduces the value of the stock.

This is even before the identification problem. How does the bank know which assets are troubled? Let’s say the bank has taken writedowns on its leveraged loans and these are piled into the bonus facility. But then perhaps the bank did not forsee a problem in the commercial mortgage market and leaves these on the balance sheet. The shareholders are still exposed to the commercial morgages as residual claimants, while the leveraged loans, if they have been written down far enough, might eventually be worth more than their written down value, and the shareholder no longer have a claim on them.

Of course most of us know that the assumption here is wrong. Those assets are not marked at fair value and CS knows it. Why no one calls them on this shit, I have no idea. Plus they’re supposedly providing leverage to the facility. So what they’re saying that the recipients are going to take first losses. Which means more of less that CS is paying bonuses using stuff that they already know is worthless.

Why an accounting or regulatory body doesn’t call these guys out on this shit is beyond me. But, Dealbreaker is right, CS bankers are getting screwed worse than their counterparts at any other bank.

December 19, 2008 Posted by | Uncategorized | , | Leave a comment