How to Have a Bank Run

Modern history is littered with the corpses of collapsed banks. From the Great Depression in the 1930s to the financial crisis of 2008 banks have gone down, taking depositors’, lenders’, and shareholders’ funds with them as they fell. All too often they’ve taken the entire economy with them as well. This is the story of one bank’s failure — WAMU’s. We’ll use it to show how asset quality, capital, and liquidity worked together to determine WAMU’s fate. And we’ll see how WAMU’s experience applies to banks in general. At the end of 2007, WAMU was the 6th biggest bank in the United States, with $328 billion in assets, $250 billion in the form of loans. WAMU funded its assets mainly with $182 billion in deposits, $107 billion in debt, and $25 billion in shareholders equity. With a total regulatory capital ratio of 12.3%, the bank was officially well capitalized. WAMU’s loans were mostly higher-risk mortgages: 78% of loans were mortgages, and 67% of mortgages were higher-risk adjustable-rate and sub-prime loans. When home prices fell 10% from the start of 2007 through the first half of 2008, many of WAMU’s customers stopped making payments. The bank’s delinquent loans grew by 304%. That forced WAMU to take $12.5 billion in charges against the value of its mortgage portfolio. That in turn caused $4.5 billion in net losses, along with dividends and share buybacks, driving shareholders’ equity down by $6.3 billion, a 30% decline from 2007. The company had to raise $7.2 billion in new equity from a private investor in the second quarter of 2008 to make up for the loss...

Takata May Get Blown Away

Takata Corporation is a Japanese maker of airbags and other automotive safety devices that has had a bad accident. It is recalling 53 million cars to replace defective airbag inflators that have caused six deaths and over 100 injuries around the world. The cost will be somewhere between ¥12,400 and ¥18,600 per vehicle, according to industry experts. That means the company will have to come up with as much as ¥986 billion to pay for the recall. That’s a lot for Takata, whose entire revenue for the fiscal year ending in March 2015 was ¥643 billion. The question is where will Takata get the money? We think the best way to answer that question is to consider where Takata could raise funds (potential sources) and when Takata could get them (probable timing). The table below summarizes the approach we use. Let’s see how it works for Takata. Internal sources of funds are those the company controls, while external sources come from other firms. Immediate sources of funds are readily available – in about ten business days or less. Takata has ¥69 billion in cash and ¥22 billion in investment securities, which it most likely can access within ten days. It’s not a commercial paper issuer, and its latest annual report doesn’t mention any unused bank lines of credit. So we can’t know how much immediate external funding is available to the company. In this framework, near-term means funds that begin to become available about 11 – 120 days in the future. Internal sources include sale of assets that are not integral to the company’s strategy, which we call surplus...

Tesco’s in the Wrong Box

On January 8 Tesco announced more details of its plan to improve its competitive position in the UK, revive its profitability, and bolster its finances. It’s going to cut prices on popular brands, trim £250 million in operating costs, limit capital spending, stop the dividend, and sell assets. Some of the changes may already be working. The decline in UK sales is easing, with growth going from (5.4%) in the second quarter to (2.9%) in the third quarter to (0.3%) during the Christmas season. But January 8 brought more bad news as well. Moody’s downgraded Tesco’s credit rating to junk status (Ba1), and Standard & Poor’s did the same a few days later (BB+). Both agencies cited competition, profitability, and financial leverage as the reasons. Those are the risks we discussed in our January 5 blog post, “Testing Tesco.” But we think the rating agencies understate the risks. They don’t consider the difficulty of changing a company as large and as focused as Tesco. We see Tesco’s still unresolved financial reporting problems as symptoms of a damaged corporate culture that is likely to fight hard against change. The agencies don’t mention liquidity in their concerns about Tesco, but the declining trend in liquidity worries us at least as much as the increasing trend in leverage. The company’s liquidity position is at a four-year low, driven by growing current debt levels.   But our biggest worry isn’t any single risk or even the number of risks. It’s the compounding effects of Tesco’s risks, the way the company’s business and financial risks amplify one another. It’s common to think of credit risk in...

What’s That Burning at Tesla?

We blogged about Tesla just over a year ago, looking at what we called the company’s “liquidity burn.” We thought they only had about a year’s worth of liquidity left. Since then, burning through liquidity hasn’t been Tesla’s biggest problem. Instead, Tesla’s troubles have been with burning cars. Three of its sleek Model S cars have caught fire recently, and that may hurt sales or force a recall. Can Tesla afford it? A slowdown in sales or a recall would hurt cash flow, which has been improving lately. Free cash flow was $25.8 million dollars in the third quarter this year, driven by the success of the Model S. If cash flow falters, Tesla’s next line of defense will be its liquidity reserves, which also have grown a lot in 2013. Tesla used to keep about $200 million in liquidity in the form of cash and short-term investments. But in May 2013 the company raised $660 million in the convertible bond market and $617 million in the equity markets, using $452 million to repay its loans from the U.S. government and $178 million to hedge the convertible bonds. Tesla used the remaining $647 million to recharge its liquidity reserves. At the end of September 2013, they stood at $795 million. Is that enough? The size of a liquidity reserve should be based on the company’s ability to generate free cash flow and its vulnerability to event risk. Event risk is the unexpected need for cash caused by natural disasters, accidents, and product recalls. The cost to Toyota for its 2009 recall of 8.1 million cars for faulty break pedals was...

How Long Before Tesla Runs Out of Juice?

Tesla Motors has drawn a lot of attention for its sleek, high-performing electric cars. Its Roadster has been an enviro-celebrity favorite for several years, and its new Model S sedan is getting great reviews. The company has been trying to scale up to large-scale production since 2009, raising $226 million in the stock market and $465 million in Department of Energy loans. But there are growing concerns that Tesla might run out of cash before it can get into full production. The original plan for the Model S was to produce 5,000 in 2012, but the company recently cut that to 3,000. At that level of production, how long will it be until Tesla uses up its sources of liquidity? Over the last four quarters, Tesla’s internal cash flow deficit was $423 million. That was mainly the result of heavy start-up costs, which caused a $159 million shortfall in cash from operating activities, and from capital spending of $412 million. Unusually, cash flow from working capital was positive. Tesla has hardly any accounts receivable; instead, it charges customers a $5,000 deposit on each car they order. Customer deposits contributed $100 million dollars to cash flow through the last four quarters. How has the company recharged its cash batteries? From two sources: cash reserves and loans. Tesla has drawn $109 million from cash reserves and $298 million from the Department of Energy since June 2011. That left Tesla with $211 million in cash at the end of June 2012. As we noted in an earlier post about Kodak, “cash burn” is commonly defined as “the rate a company uses up...