Noble Group: third degree treatment
The valuation of illiquid assets adds to the trading group’s woes
Investors are accustomed to the valuation problems exotic derivatives create in banks. It comes as more of a shock to find traders of commodities such as oil or iron, burdened with positions that are hard — some would say impossible — to value. Last week, Singapore’s Noble Group announced losses of $1.7bn for the second quarter and attributed the majority to impairments and reserves for so-called “Level 2 and Level 3” assets.
Simplistically, Level 1 assets have market prices, the worth of Level 2 assets can be extrapolated from those, while valuing Level 3 assets involves heavy guesswork. After the crisis, big banks had to add capital for Level 3 assets — or dump them. JPMorgan, for example, reduced Level 3 assets by four-fifths to $24bn in six years to the end of 2016. They now account for just 3.7 per cent of the bank’s total assets at fair values. The proportion at Noble was a quarter.
Last week’s loss included provisions for all $660m of its Level 3 assets. Critics have pointed to Noble’s accumulation of profits on commodity-based contracts in the five years to 2014. During that time, the company booked non-cash fair value gains of $4.6bn. Yet cumulative net income in the period was only $2.4bn. That may be because of large cash losses elsewhere. Another explanation could be that the non-cash gains were offset by losses on “readily marketable inventory”, as physical commodity stockpiles are known.
Cash outflows were a cumulative $1.5bn between 2009 and 2014. These were financed in part with new borrowings. Net debt was $2.7bn in March. Noble aims to cut that via the sale of the rest of its North American gas and power business. Moody’s says the group had $1.2bn of cash in March, but faces $2.1bn in debt maturity over 12 months.
The shares have fallen 96 per cent since 2014. Noble’s accounts are unclear and its finances are messy. Investments in Level 3 assets are implicated in the group’s problems. Regulation has reduced the financial complexity of banks only for it to balloon elsewhere. Noble is unlikely to be the last non-bank to struggle with the resulting woes.