Sunday, May 31, 2009

Mortgage originators: it's time for a different kind of exam.

Tons of burdensome and populist regulation will probably hit the banking industry as a knee jerk reaction to this financial crisis. Here is one that is actually useful: mortgage originator rules and registration. Think about it. Securities and futures brokers/dealers/sales people have to be licensed. Here are the various certifications they have to pass (depending on the level and the area) - listed here to make a point:
  • Series 3 - National Commodity Futures Exam
  • Series 5 - Interest Rate Options Exam
  • Series 6 - Investment Company and Variable Contracts Exam (Mutual Funds/Variable Annuities)
  • Series 7 - General Securities Representative Exam (Stockbroker)
  • Series 11 - Assistant Representative - Order Processing
  • Series 15 - Foreign Currency Options Exam
  • Series 17 - Limited Representative (FSA registration)
  • Series 22 - Direct Participation (Limited partnerships) Exam
  • Series 30 - Futures - Branch Office Manager Exam*
  • Series 31 - Futures - Managed Funds Exam*
  • Series 32 - Futures Exam - United Kingdom Representatives*
  • Series 37 - Canadian Module of the General Securities Exam
  • Series 38 - Canadian Module of the General Securities Exam
  • Series 42 - Registered Options Representative Exam
  • Series 44 - NYSE Arca Options Market Maker Exam
  • Series 47 - Japanese Module of the General Securities Exam
  • Series 52 - Municipal Securities Representative Exam
  • Series 55 - Equity Trader - Limited Representative Exam
  • Series 62 - Corporate Securities - Limited Representative Exam
  • Series 63 - Uniform Securities Agent State Law Exam*
  • Series 65 - Uniform Registered Investment Adviser Law Exam (RIA)*
  • Series 66 - Uniform Investment Adviser - Combined State Laws Exam* (Combined 63 and 65)
  • Series 72 - Government Securities - Limited Representative
  • Series 82 - Private Securities Offerings - Limited Representative
  • Series 86 - Research Analyst - Securities Analysis
  • Series 87 - Research Analyst - Regulations
  • Registered Principal Level:
  • Series 4 - Registered Options Principal Exam
  • Series 9 - NYSE General Securities Sales Supervisor Exam - Options
  • Series 10 - NYSE General Securities Sales Supervisor Exam - General Module
  • Series 12 - NYSE Branch Manager
  • Series 14 - NYSE Compliance Officer
  • Series 16 - NYSE Supervisory Analyst
  • Series 23 - General Securities Principal (Upgrade from Series 9 and 10)
  • Series 24 - General Securities Principal Exam
  • Series 26 - Investment Company (Mutual Funds) Principal Exam
  • Series 27 - Financial and Operations Principal Exam
  • Series 28 - Financial and Operations Principal Introducing Broker Exam
  • Series 39 - Direct Participation Programs Principal Exam
  • Series 51 - Municipal Fund Securities Limited Principal
  • Series 53 - Municipal Securities Principal Exam
source: Wikipedia

Real estate brokers must have a license, so do accountants. But the guy/gal who sets you up with probably the riskiest financing that an individual/family can get (5:1 or higher leverage on your real estate investment - your house) didn't need anything. Most people will not end up without a home because of improper stock trades. But bad mortgages are doing it to millions.

So the various bank regulators are looking at a new proposal to deal with the issue. It will be bureaucratic and painful, but it's needed. Here is the overview:
"The OCC, Board, FDIC, OTS, FCA, and NCUA (collectively, the Agencies) are proposing amendments to their rules to implement the Secure and Fair Enforcement for Mortgage Licensing Act (the S.A.F.E. Act). The S.A.F.E. Act requires an employee of a bank, savings association, credit union, or other depository institution and their subsidiaries regulated by a Federal banking agency or an employee of an institution regulated by the FCA (collectively, Agency-regulated institutions) who acts as a residential mortgage loan originator to register with the Nationwide Mortgage Licensing System and Registry, obtain a unique identifier, and maintain this registration. This proposal implements these requirements. It also provides that Agency-regulated institutions must require their employees who act as residential mortgage loan originators to comply with the S.A.F.E. Act's requirements to register and obtain a unique identifier and must adopt and follow written policies and procedures designed to assure compliance with these requirements."
This document is dry and boring. It asks for inputs from the industry and regulators. It's a start.

Mr. Geithner goes to Beijing

With China now holding $1.55 trillion of US Treasury securities, Geithner must play nice. So far it's working. According to the fed's custody of foreign accounts, the non-US holdings of Treasuries continue to increase (see chart). These are not all the treasuries held by foreigners, but the trend continues to be on the upswing.

Foreign accounts holding Treasuries at the Fed

The US debt/GDP looks horrible relative to last year and the deficit is exploding (see table below). But part of the issue is the lack of alternatives. If you need some place to park your money, your alternatives are Japan, the UK, maybe Germany and France? The rest are just too small for somebody like China. Japan looks far riskier than the US. The UK is getting there as well. Maybe Bundesanleihen? Possibly. But the Chinese may want to hold a substantial amount of Treasuries in order to apply political pressure on the US. - Sure got Mr. Geithner attention.

Saturday, May 30, 2009

With Opel out of the way, uncle Obama becomes the proud new owner

Uncle Obama (with a mighty phone call) convinced the Germans that Opel is free from GM's bankruptcy - and off it went on it's own. So the Germans gave Opel a 1.5 billion Euro loan, as part of the sale to a Canadian parts manufacturer with the help of some Russians, and who knows who else. Real mess.

Some might remember Opels used to be popular in the US years ago (from Wikipedia).

Saab (that used to be owned by GM) went the same way. After getting some concessions from the union and freed from the messy European operations (see map), GM is ready to cross over into bankruptcy.

Until the last minute people hoped that the negotiations with creditors will succeed, potentially giving current shareholders some 1% of the new restructured GM. But it wasn't meant to be. The shares closed at 75c on Friday. It was amazing to see they actually had some non-zero value (possibly some short covering).

GM shares

Debt traded below 9c on the dollar. That's why in a rational world where contract law makes sense, equity should have no value when debt trades cents on the dollar. But in the don Rama Manuel's family business it's a different story.

GM Debt

Here are the new proud owners of GM. The greedy bond holders get what they deserve- how dare they ask for their money back. Shut up and take it from uncle Obama.

And when things get grim in the bankruptcy court and more jobs are lost, we can always go back to those happier times.

Barclays' cost of freedom

In late 2008 Barclays Bank raised some expensive capital (see story). That was the cost of avoiding nationalization by the UK government. £7.3 billion was the total capital raise with £4.3 billion in mandatory convertible notes.

The notes have to be converted before the end of June-09, creating a 10% dilution at 153 pp - about half the current level. Imagine an announcement that a company is about to issue 10% of additional shares at a 50% discount to market. Sounds like a signal to sell. The market seems to be ignoring it.

Barclays share price

The rest of the capital raise is quite expensive. £3 billion of 14% coupon notes going out to JUNE 2019 plus warrants. In total the new (mostly Middle East) investors will have an almost 32% stake in Barclays. It's amazing what it took to stay private in that dark October.

Friday, May 29, 2009

Consumer deleveraging - more pain to come

In its unprecedented effort to open up consumer lending, the Fed will be plagued by the over-leveraged consumer. Banks, unless absolutely forced to do so, will not lend to clients who are too leveraged. Unfortunately that happens to be a big part of the US consumers.

The latest McKinsey report shows there's a long way to go for consumer to de-leverage to reasonable levels. Here are some facts:

* The period of 2003 - 2007 saw US household debt nearly double to $13.8 trillion.
* During the same period household debt-to-income ratio has grown as much as it has in the previous 25 years.
* Since 2003 home equity loans and cash-out refinancings provided consumers with $2.3 trillion of financing. This was everyone's personal cash machine.
* Prior to the financial crisis, personal savings rate as a percentage of disposable income has fallen to nearly zero - the lowest since 1947.
* In 2008 household net worth relative to income has fallen to the mid-1990s level and household net borrowings turned negative (first time in the postwar period). De-leveraging has begun.
* We may need to see the consumer delever by another 27% before we get back to trend.

Consumer delevering is not limited to real estate based credit. It also applies to credit cards, auto loans, etc. Here is data from the Fed on non-real estate consumer credit.

Pequot giving up

I know people who are gloating over this. The media loves it - another high flyer going down. Another rich fund manager knocked out. Arthur Samberg deserves it. The SEC should hit them hard.

Actually it’s unfortunate. Not only will this create more job losses in the financial industry, but it’s another step toward general mediocrity in the asset management space. These guys were legends – 16.8% net annualized return over 22 years. These types of managers are disappearing, only to be replaced by large institutional mediocre players chasing AUM rather than returns.

Here is the last Pequot letter to investors:
Pequot Letter to Investors DealBook

Thursday, May 28, 2009

Baseball, Apple Pie, and Delinquencies

So far there is no end in sight for mortgage delinquencies. The latest data from the Mortgage Bankers Association is showing that over 9% of mortgages out there are now delinquent. This is unprecedented in recent history - see chart (going back to the 70s).

A popular myth out there is that it's the subprime defaults that are driving the rapid rise in delinquencies. Subprime mortgage delinquency rate has hit 25% based on the latest data. But the chart below shows the situation with prime mortgages.

Let them eat MBS... and now more notes and bonds?

Following up on our earlier discussion on Fed's mortgage securities purchases, a couple of items worth mentioning here:

1. The Fed is on target to take down roughly 2/3 of mortgage backed securities (MBS) supply this year (according to Goldman).

2. Given that the program of buying MBS is no longer having the desired effect (to bring down mortgage rates and stabilize housing), the Fed will move to buy more Treasuries - reducing (or attempting to reduce) yields.

Here is the Fed's securities holdings history (in millions):

Negative 30 year swap spread - a disappearing anomaly?

At the end of last year the 30-year swap spread (the spread between the 30-year interest rate swap fixed rate and they yield on the 30-year Treasury bond) turned negative. It reached levels as low as negative 60 basis points. It was a technical issue more than anything fundamental. Two theories persist as to what caused this anomaly:

  1. Institutions who owned fixed rate bonds (corporate and agency) had to sell to raise liquidity. Many had these fixed rate securities hedged with swaps. As they sold the securities, they had to unwind the swaps in size, diving down the fixed rate relative to treasury yields.

  2. Hedge funds got long swap spread when it tightened relative to historical levels, betting that it would widen. Then redemptions and margin calls forced them to unwind these trades forcing the spread to tighten and go negative.

Negative swap spread implies that at some point in the future bank lending rates (LIBOR) will be lower than government yields. This is impossible, given that one can not have a banking system that has better credit than the US government (or is it?). Nevertheless it’s a technical anomaly that is difficult to arb out. It would require purchasing the bond (on repo - in order to get leverage), swapping it into floating, and sitting on the trade for years. It has to be hard to get long-term committed capital these days that is not subject to redemptions.

Having said that, the spread has become significantly less negative - currently at 17 bp. If either of the hypotheses above are correct, any reversal of these trends (institutions buying more fixed rate assets and swapping them into floating or hedge funds putting the widening trade back on) would cause this.

2 months ago



Wednesday, May 27, 2009

Treasuries' fall starting to pressure mortgage rates

The rotation out of US treasuries (that we discussed earlier) is starting to pressure the broader market. Money is now moving out of agency paper as well, impacting mortgage bonds. Mortgage paper has been relatively stable until now (see chart below) driven by the Fed's aggressive buying. But "quantitative easing" is no longer having the desired effect.

Expect mortgage rates to jump in short order. That is starting to spook the equity market as a potential head wind for the supposed "green shoots".

Could the Nordic banking fix of the 90s work now?

In the early 90s the banking systems of the Nordic countries came under severe pressure, not too dissimilar to the experience of many large western institutions in 08. The governments stepped in with a somewhat haphazard approach and supposedly "fixed" the problem. Banks were stabilized and the economies recovered.

Below is some analysis from Capital Economics on the "lessons learned" from the Nordic experience. A few items from the analysis worth mentioning:

  • The governments stepped in to guarantee bank liabilities.
  • There is a common misperception that Nordic banks were nationalized. In fact bank nationalization was quite limited.
  • Iceland dodged the problem (just to get hit with a much more disastrous outcome this time around.)
  • The banking system was significantly smaller relative to countries' GDPs vs. today.
  • Nordic recession was regional, with the rest of the world in decent shape. That allowed for a reasonably quick recovery.
  • The paper points out that the Nordic approach is by no means a panacea to the current banking problems.

Tuesday, May 26, 2009

Steven Levitt - economics of crack dealing similar to McDondalds

This is a classic talk by Steven Levitt, the co-author of Freakonomics discussing the financial structure of a crack dealing gang. He shows similarities to the way McDonalds is organized and compensated (except for a few minor details such as life expectancy). Some amazing concepts observable in a drug dealing gang:
  • Franchising structure
  • Compensation similar to a corporation:
  1. $3.50/ for foot soldiers
  2. $100K/year manager
  3. $200K/year regional leader
  4. $400K/year board of directors
  • Cycle similar to the doc-com era. Earlier guys became wealthy - the rest just worked for "stock options" that never materialized.
  • "Compensating differential" concept works in drug gangs (during wars members get higher pay).
  • Game theory (Nash Equilibrium)
  • Gang leader gets paid even during worst times ("weak n' shit" hypothesis). Similar to corporate CEOs.
This is from Enjoy!

Accretable yield - accounting magic?

All of a sudden stories are popping up of banks turning purchases of “toxic loans” into profits. A good example of this is JPMorgan’s purchase of WaMu’s assets ($1.9 billion for all of WaMu’s assets). The mysterious accounting rule that banks are using to accomplish that is called “accretable yield”. Sounds like magic, right? That's what the mass media is insinuating - that this 2003 accounting rule is new (post-crisis), and somehow banks are "getting away with something".

What many people (even many of those in the financial services industry) don’t realize is that banks generally don’t mark originated loans to market. Most loans are part of what’s called the “banking book” (otherwise known as the accrual book). Let’s say the bank lent $100 MM at an average rate of 7%. The bank will then be taking into income $7 MM a year. If some loans become non-performing, the bank will take a provision (based on expected losses) against those loans and stop accruing interest on the non-performing loans. The rest of the loans will continue to accrue – no matter what the secondary market for such loans does.

So what happens when a bank buys a portfolio of loans from another bank at a discount? That’s when banks can apply the accretable yield methodology. Back to our example, the bank buys a loan portfolio with $100 MM face for $60 MM (60 cents on the dollar). Let’s say the bank believes that 85% of those loans will be repaid and the average maturity for that portfolio is 10 years. The bank expects to make $25 MM (expected repayment of $85 MM less the cost of $60 MM) of profits over 10 years and will therefore accrete $2.5MM per year. In addition it will accrue 7% x $100 MM x 85% (since only 85% of loans pay interest) = $5.95 MM of accrued interest. So the accretable yield on the portfolio is the total annual income over the purchase price = ($2.5MM + $5.95 MM)/ $60 MM = 14%. Magic? Not so much.

For those who absolutely love accounting and absolutely must know the language, here is the official pronouncement (2003) issued by the Accounting Standards Executive Committee:

SOP 03-3--Accounting for Certain Loans or Debt Securities Acquired in a Transfer

"This Statement of Position (SOP) addresses accounting for differences between contractual cash flows and cash flows expected to be collected from an investor's initial investment in loans or debt securities (loans) acquired in a transfer if those differences are attributable, at least in part. to credit quality. It includes such loans acquired in purchase business combinations and applies to all nongovernmental entities, including not-for-profit organizations. This SOP does not apply to loans originated by the entity. This SOP limits the yield that may be secreted (accretable yield) to the excess of the investor's estimate of undiscounted expected principal, interest, and other cash flows (cash flows expected at acquisition to be collected) over the investor's initial investment in the loan. This SOP requires that the excess of contractual cash flows over cash flows expected to be collected (nonaccretable difference) not be recognized as an adjustment of yield, loss accrual, or valuation allowance. This SOP prohibits investors from displaying accretable yield and nonaccretable difference in the balance sheet. Subsequent increases in cash flows expected to be collected generally should be recognized prospectively through adjustment of the loan's yield over its remaining life. Decreases in cash flows expected to be collected should be recognized as impairment."

The housing market - some sobering facts

The S&P/Case-Schiller housing data for Q1-09 was released today.
The US National Home Price Index was down 19% year-over-year. But beyond that here are a few items worth noting:
  • On an inflation adjusted basis (chart below) the index is down 36% from the peak.
  • To get to the last inflation adjusted bottom in housing prices, we have another 16% to go.
  • The previous correction that started in the late 80s and bottomed in the mid 90s was 16% (20% milder than the current correction thus far).
  • The previous correction took 7 years to hit bottom; we are 3 years into the current correction.
  • If you bought a house at the last peak (end of 1989), it took you over 10 years to get your money back (and you would be just above break even now - 20 years later).
  • On average if you bought a house any time after 2000, you've lost money (adjusted for inflation).

Monday, May 25, 2009

From short and shallow to V-shaped - just make the medicine go down

A year ago we had a great new expression to describe the recession we were experiencing - "short and shallow". Remember that? In the US we love coined phrases and images that help us sort through this confusing world. It's a truly great image - short and shallow, conjures up a stream. Just step over it - you may get a little wet, but it will be over soon.

It felt great. Here is a forecast from David Nichols from Seeking Alpha on April 17, 2008:
"... almost by definition, a widely-anticipated recession will be short and shallow, and over soon after it starts."
He then proceeds to say (now remember, this is April of 2008) that inventories are tight and a slight increase in demand will get things moving quickly:
"So the groundwork for a short and shallow recession -- and a quicker recovery -- is actually laid down by pessimism about the future. Wednesday morning we received word that housing starts are the lowest in 17 years, and that is clearly a good thing for a speedier recovery."
OK. So things didn't turn out to be short and shallow. But as social psychologists will tell you, when the forecast we love so dearly and our actual experience are quite distinct , we often experience what's called cognitive dissonance. We then try to explain away this uncomfortable feeling with a new forecast and new images.

These days the image is the V-shaped recovery. It's a nice picture - the economy went down, and now it's going up. IMF has a wonderful V graph GDP forecast for every country - see chart below.

It will be interesting to see what images will be served up to us next year. All that matters is that they make us feel better - and are easy to swallow. Nothing depressing or complicated please. Just the V-shaped green shoots please.

Sunday, May 24, 2009

Your Target should be managing risk

There is a different way for Target shareholders to manage what they own. It's called risk management. It's not a matter of which board will be "better" for the firm. It's the board that will be in a better position to manage risk - which is clearly Ackman's (Pershing Square) guys - that will make a differences for the shareholders.

Here is why. As a Target shareholder you thought you bought a retailer. But you actually own a retailer, a commercial real estate firm, and thousands of credit card loans worth billions. Is that what you really want to own in your portfolio - some CMBS and ABS? The chart below tells the story of risk. Over the past 2 years Target shares traded between Wal-Mart and a REIT ETF (ticker: ICF - a portfolio of real estate trusts). The violent downside moves of Target shares followed the volatility of commercial real estate. Wal-Mart shares showed a much more subdued correlation to real estate, achieving a better risk adjusted return.

Not a surprise. Target owns 96% of it's real estate, while Wal-Mart owns 58%. It makes sense to shave off some 30% of Target's real estate into a separate REIT. If the current shareholders want to keep the firm "intact", they can hold both the shares of the "new" Target and the new REIT. It also make sense to actively manage the credit card portfolio. Risk management after all is about holding exposures you want and reducing/selling exposures you don't.

Taxes are another reason to spin off the real estate. Target's tax liabilities would decrease significantly as it starts paying rent to the REIT. That should improve cash flow and increase earnings. The REIT on the other hand would be exempt from income taxes as long as it distributes 90% of it's income as dividend.

The only way to make the current board understand these issues is to simply replace some of them. They are enTRANCHEd fat cats afraid to rock the boat. Target needs more of that activist investor stuff.

Pershing Square proposal to the shareholders:

For the updated story see Bloomberg

Saturday, May 23, 2009

Martin Weiss: JPMorgan (and 14 other banks) will fail "objective" stress test

In his usual -let's try to freak everyone out to get more news letters out- style Martin Weiss gives this fairly dry but nevertheless worthwhile talk at the National Press Club. Below is the "press release" and the video link. A few highlights:
  • Bernanke's original prediction: expect $100 billion of losses at banks
  • IMF current estimate of actual losses is $1 trillion and further losses of $3 trillion.
  • 15 of the 19 institutions would fail the "objective tests"
  • His big focus is on JPMorgan, given their massive derivatives activity
  • He also slams Citi and Wells on their loan portfolios and super-regionals on their exposure to commercial real estate.
With regard to JPM, Weiss points to their counterparty exposure to other firms via derivatives positions. He seems somewhat fixated on that issue, putting JPM at the center of his "storm". It's worth exploring this issue a bit further.

The concern would be that those derivatives trades that are profitable (winning bets) or may become profitable in the future, are effectively loans by JPM to other firms. Simply put, if you make a bet with someone and win, but the other person doesn't have to pay you right away, you effectively have a loan out to the other person. Thus the size of JPM's "loans" to other firms is massive.

However what Weiss fails to mention is JPM's ability and willingness to call for and collect margin. A counterparty failure should not be a serious issue for JPM as their trading partners would generally post margin on trades that are profitable for JPM (while JPM would post to others on trades that have lost money for them). This is similar to the way futures exchanges have been operating (Chicago Mercantile Exchange for example began in 1898) in some of the most volatile markets without major issues.

As a great example of this, JPM's losses on derivatives due to hedge fund failures have been immaterial -all due to these margin mechanics.

Well, Dr. Weiss, JPMorgan may have other problems - we don't think derivatives is one of them.

The video link

Friday, May 22, 2009

CNBC plays the rumor mill game in helping bring down Bear Stearns

When it comes to this financial crisis, the mainstream media is often viewed as neutral - just here to report the news. The evil banks and hedge funds cause havoc and the media simply reports on it. Right. Here is an example of CNBC using a rumor to generate a sensation and exacerbate an already tense situation. It happened over a year ago as CNBC's David Faber set up Alan Schwartz on national TV.

Frontline captured it well (though they focused on the aftermath vs. the way it was handled).
Faber: "Mr. Schwartz thanks so much for being here this morning. ... So when I am told by a hedge fund that I know well that last night they tried to close a mortgage, a credit protection...". He then proceeds to insinuate that according to this hedge fund, Goldman is pulling Bear's credit lines.

What? He is talking about hearing something about a transaction from an unnamed hedge fund "he knows well". The hedge fund is probably short Bear and is feeding him the rumor to bring down the share price. Faber of course plays along.

He poses a question to which there is no good answer. If Schwartz says he knows the specific transaction, he's violating a bunch of confidentiality agreements/policies - both internal and external. Faber knows Schwartz will not discuss it. So Schwartz comes out looking like a bumbling idiot who is unaware of a large "problem transaction" and therefore is not fully in charge of Bear and unable to stem it spiraling out of control. Shares began to collapse shortly after.

OK, let's use a rumor from a conflicted unnamed fund to ask a leading question that can not be answered to create an impression of a CEO without a clue. Nicely done David!

Don't get us wrong here. Narrow Tranche has no particular love for Mr. Schwartz. He and his senior team are responsible for a number of key problems that brought down Bear and caused severe financial pain for thousands of hard working dedicated employees as well as the tax payer. But don't kid yourself, CNBC and other mass media made tons of money juicing up viewership through unethical tactics like this, hurting financial firms in the process. And in the process they also helped short sellers by playing their game of the rumor mill.

For those interested in the painful details of Bear's collapse and have tons of time on their hands here is a detailed story from Vanity Fair.

Banks getting relief from the market

LIBOR – OIS spread, and indicator of risk premium in the banking system continues to drift down.

A quick refresher:
* LIBOR is an indicator of average rate at which banks say they are lending to each other on a term basis (say for 3 months)
* OIS (overnight index swap) is the market for average of overnight rates over some term (like 3 months)
* In principle OIS and LIBOR should be the same over the same term because borrowing each night for 3 months at a fixed rate should be the same as borrowing once for 3 months. However during the crisis banks stopped lending to each on anything other than the overnight basis, LIBOR spiked (even if banks didn’t lend for 3 months, they would quite a higher rate), while OIS (the projection of the overnight - Fed funds- rate) was dropping (with the expectation of the Fed lowering rates).
* High LIBOR – OIS spread indicates lack of confidence in the system (little willingness to lend term).

Many argue that because LIBOR sometimes isn’t a reliable market rate (banks can for example manipulate it), this spread is not as meaningful. That’s possible. But there are other signs that financing for banks is opening up. The 3-day period of May-20th to May-22nd saw smaller banks around the world (particularly in Germany) come into the capital markets with debt issuance. Here are some of the issuers:

Norddeutsche Landesbank Girozentrale
DZ Bank
Landesbank Baden-Wuerttemberg
Norddeutsche Landesbank
Bankco Bilbao
National Ausralia Bank
Danske Bank
Royal Bank of Canada
Bayerische Landesbank
Landesbank Berlin Girozenrale
LfA Foerderbank Bayern
Bank Negara
One issuance failed: Vietnam Bank for Social Policies (state owned) was unable to place paper (their 4th attempt). Some of the issuance has been government backed. But this diverse mix of banks raising debt capital in a 3-day period is an indication that the confidence in the global banking system has improved significantly, opening capital flows. The question still remains whether this trend is sustainable.

Throw the rascals out

Angry about executive compensation? Well, don’t be. Because unless you are a shareholder, it’s none of your business. In the US if I start a company, hire somebody and decide to grossly overpay them, it really isn’t anyone’s business but the owners’. Being overpaid may be in poor taste, but it’s not against the law. This country is full of overpaid people and the public may think they do or don’t deserve it, but as long as it’s legal, there isn’t anything the public can do. Are we looking for Socialism to take hold in the US? No thanks. Executives ask for huge amounts of money, the owners (shareholders) pay them what they want, so why should others get angry?

Now if one is a shareholder, that’s another story, and one indeed has the right to be annoyed. But that anger should not be directed at the executives – they asked and they received. Instead it’s the board of directors that should be held accountable. Their responsibility is to provide oversight on behalf of the shareholders. And that’s where the problem has been. Directors have been ignorant, irresponsible, or conflicted. Time to throw these guys out and replace them with people the shareholders can trust.

That process of replacing puppet directors is about to get easier for shareholders. Shareholders can now nominate their own directors rather than just voting for them. Here is FT the story. And here is the overview.

“Under the proposal, shareholders who otherwise are provided the opportunity to nominate directors at a shareholder meeting would be able to have their nominees included in the company proxy ballot that is sent to all voters. Shareholders would also have the ability to use shareholder proposals to modify the company’s nomination procedures or disclosure about elections, so long as those proposals do not conflict with state law or Commission rules.”

So next time you get mad about some executive comp, or other stupid decisions a company makes, become a shareholder, nominate your guy/gal, and throw the rascals out.

Thursday, May 21, 2009

The Treasuries train. Hop on board.

It’s like a slow train wreck. You know it’s coming; you know it’s going to be bad, but there just isn’t much that can be done about it. Except maybe keep shorting Treasuries. Over 2 trillion of new supply of US Treasuries and only one major new buyer – the Fed. When the Fed first started the “quantitative easing”, Treasuries would rally every time the Fed was in buying. But the market is starting to ignore the Fed as the realisation of how massive the size of new supply sets in. It's also driven by the fact that traditional large buyers are struggling (such as Asian nations turning their foreign reserves inward.)
"May 21 (Bloomberg) -- Treasuries dropped after the Federal Reserve’s purchase of U.S. debt due in 2013 to 2016 as traders shifted focus to next week’s three note sales. "

Unlike other buyers who use existing cash to buy Treasuries (taking cash out of the system in the process), the Fed simply creates money. We all know what that means. Might as well give the US Treasury the “printing press” so that rather than borrowing from the Fed, it can “print” money when it needs it.

Proposed money market funds practices/regulation - about time!

In March-09 the Money Market Working Group released their report to the Board of Governors of the Investment Company Institute. This was meant to create a set of good practices before the SEC steps in and does something dumb. And by the way this is a a positive development to avoid disasters like this in the future: Press Release. No major surprises in the report, but a couple of items worth noting:

1. Less reliance on rating agencies. The recommendation seems to focus on having each fund's "committee" select their rating agency and encaurage competition. About time!

2. The SEC to monitor funds that significantly outperform their peers. This is probably the best signal that there may be a problem.

Here is the summary of all the recommendations:

"* Impose for the first time daily and weekly minimum liquidity requirements and require regular stress testing of a money market fund’s portfolio.

* Tighten the portfolio maturity limit currently applicable to money market funds and add a new portfolio maturity limit.

* Raise the credit quality standards under which money market funds operate. This would be accomplished by requiring a “new products” or similar committee; encouraging advisers to follow best practices for determining minimal credit risks; requiring advisers to designate the credit rating agencies their funds will follow to encourage competition among the rating agencies to achieve this designation; and prohibiting investments in “Second Tier Securities.

* Address “client risk” by requiring money market fund advisers to adopt “know your client” procedures and requiring them for the first time to disclose client concentrations by type of client and the potential risks, if any, posed by a fund with a client base that is strongly concentrated.

* Enhance risk disclosure for investors and the market and require monthly website disclosure of a money market fund’s portfolio holdings.

* Assure that when a money market fund proves unable to maintain a stable $1.00 NAV, all of its shareholders are treated fairly. For this purpose, a money market fund’s board of directors, or a committee of the board, would be authorized to suspend redemptions and purchases of fund shares temporarily under certain situations, and permanently for funds preparing to liquidate, in order to ensure that all shareholders are treated fairly.

* Enhance government oversight of the money market by developing a nonpublic reporting regime for all institutional investors in the money market, including money market funds, and encouraging the SEC staff to monitor higher-than-peer performance of money market funds.

* Address market confusion about money market institutional investors that appear to be—but are not—money market funds."

      The "green shoots" of unemployment claims

      One frightening statistic is the latest continuing US unemployment claims figure. This is the actual number of unemployed who are currently receiving unemployment benefits (filed for benefits at least two weeks ago.) It's at a historic high, but what's disturbing is the sharpness of the rise with no indication of any stabilization. See chart (source: US department of Labor).

      Now some will argue that the latest spike is based on a higher population vs. what we had say in the 70s, when things got really bad. Below is a graph of continuing claims adjusted for the US population. Green shoots anyone?

      Wednesday, May 20, 2009

      What's that loud noise they don't want you to hear? It's the screeching slowdown of China's economy.

      China's government and a number of talking heads on CNBC will have you believe that China will somehow manage to escape the global recession. By magic. They are just such a "powerhouse", they will pull the West out of this recession. Right. Here is a story on Taiwan. A quote:
      "Export-dependent economies across Asia have been roiled by the worst global slump since World War II. Japan’s economy shrank at a record 15.2 percent annual pace in the first quarter, data showed yesterday. Hong Kong’s GDP shrank 4.3 percent last quarter from the previous quarter, the biggest drop since 1990.

      A report tomorrow may show Taiwan’s unemployment rate climbed to 5.84 percent in April from 5.72 percent in March, according to a survey of economists."

      Yet somehow China is different? Maybe it's the half a trillion stimulus package that will keep them afloat. That assumes the stimulus rapidly and efficiently flows through China's economy. Really? Their banking system is notorious (see story) for lending to money-losing businesses and frothy real estate projects - often because the government tells them to do so. Sure you can grow on momentum for a while. But it looks like an artificial lag. The screeching slowdown is inevitable.

      The chart below shows the GDP comparison of HK, Taiwan, and Japan to that of China. China's economy can NOT be this insulated, not just from the West, but from it's key neighbors as well. Unless of course it's government is cooking the numbers, which is a possibility. Look out- a major drop in China's GDP is on it's way.

      The GGP case - a blow to CMBS

      The recent ruling in the General Growth Partners (GGP) bankruptcy case could cause some serious damage to CMBS structuring as well as the securitization market as a whole. As a lender to a "bankruptcy remote" vehicle I'd now be far more cautios. Collateral aside, the equity holder of the vehicle can potentially drag the vehicle I am lendng to into bankruptcy even if the collateral pool is perfectly fine. Then the bankrupt entity can suck cash (and possibly other assets) from the vehicle. Wait, that was supposed to be part of the collateral I was lending against! That's like lending someone money against their house and having the borrower sell a portion of the house to someone else. Ouch!

      So much for "bankruptcy remoteness" in the financing vehicles. If the rating agencies were on the ball, they'd be downgrading CMBS tranches where the equity holders may be in trouble.
      Here is the background story on this in the FT.

      The main argument against piercing the vihicles was provided by the Commercial Mortgage Securities Association and Mortgage Bankers Association. Here is the key quote presented to the court.

      GGP Amicus%281%29 zerohedge

      Tuesday, May 19, 2009

      Hedge funds vs. long equities - an uneven race

      You can say what you will about hedge funds’ “disastrous” performance in 08, but hedge funds as a whole continue to outperform the S&P500 (from 1993 to present), both on an absolute return basis (with an 18% outperformance in 08) as well as on a risk adjusted basis. The chart below shows this comparison, with the hedge funds universe represented by the Credit Suisse/Tremont Hedge Fund Index.

      Another comparison worth analyzing are the returns for hedge funds vs. a strong actively managed equity mutual fund. Here is a look at the Fidelity Contrafund. Absolute returns for the two are extremely close (see second chart). Hedge funds however clearly did better on a risk adjusted basis. Presumably with the hedge fund “asset class” one gives up liquidity for a reduction in volatility.

      Warren Buffett’s 10-year bet on S&P500 (see story in Fortune) against Protégé’s fund index should probably include the ability to liquidate 100% of the funds at the end, as well as a comparison of risk adjusted returns (for example Sharpe ratios).

      HFs vs S&P500 (below) and HFs vs. Fidelity Contrafund (lower chart)

      Construction without a floor.

      Housing supposedly led us into this recession and should therefore take us out? Maybe not yet. Housing starts hit another record low (see chart) with no sign of bottoming out. Some would argue this is a positive for the housing market as it shows reduction in inventories. Maybe. But it also shows job destruction in construction, which maybe more damaging in the long run.

      Talk to your forensic accountant lately?

      The utter destruction of trust in the asset management business due to several true sociopaths (even beyond Madoff), like Jim Nicholson of Westgate (more on that later), has significantly increased the barriers of entry for new asset managers to ridiculous levels. Here is a quote from a white paper from Huron Consulting:
      "It is becoming increasingly common for new investment managers to request an independent firm to verify the fund management track record. As an investor you should request to see a forensic audit of the returns. This audit should also include a benchmark to other investment managers’ performance as well as to the market."

      This is certainly quite useful, but given what has trinspired, this scrutiny should really apply more to existing managers who do have a long track record, rather than the new managers.

      Monday, May 18, 2009

      GLG - the "almost in the money" convert deal

      GLG, the publically listed hedge fund manager just recently placed some convertable debt with the conversion strike of 3.72. The shares closed today at 3.70 (see the chart below).

      Coincidence? Sounds like someone got themselves a sweet deal.

      "May 18, 2009 (FinancialWire) -- GLG Partners, Inc. (NYSE: GLG), the U.S.-listed asset manager, has completed its private offering of $214 million aggregate of dollar-denominated convertible subordinated notes due 2014. The notes bear interest at a rate of 5.00% per year and rank junior in right of payment to all of GLG's existing and future senior indebtedness.

      Noam Gottesman, chairman and co-CEO of GLG, Emmanuel Roman, co-CEO, and Pierre Lagrange, senior managing director of GLG Partners L.P. -- each a director of GLG -- purchased collectively $30 million of the notes from the initial purchasers as part of this offering, through certain of their affiliates.

      The notes are convertible, at the option of the holder, into shares of GLG's common stock at an initial conversion rate of 268.8172 shares per $1,000 principal amount of notes, subject to certain adjustments. The initial conversion rate is equivalent to a conversion price of around $3.72 per share.

      GLG used a portion of the net proceeds from the offering of the notes to acquire a portion of the indebtedness outstanding under its credit agreement in a transaction that closed concurrently with the closing of the note offering. Around $285 million of $570 million principal amount of loans outstanding under the credit facility were acquired at 60% of par value.

      The company said that any proceeds not used to acquire its outstanding indebtedness will be used by GLG for general corporate purposes to the extent permitted under the credit agreement.

      New York-based GLG Partners is a hedge fund manager that manages equity and fixed income portfolios and investment funds. The firm also invests in public equity fixed income, and in alternative markets through options, futures and convertibles. "

      Rating agencies are still at it.

      Here is a Deutsche Bank CLO - corporate debt collateral that DB is probably securitizing to reduce regulatory capital. A good guess is it was part of an unwound Total Return Swap they ended up stuck with.

      Fitch was able to rate the senior tranche AAA. The debt to equity ratio (AAA to sub) here is 2.5 : 1 - which is is quite a low leverage for a CLO. However if you look carefully, it's 67% unsecured debt (up to 75%). That seems aggressive. Possibly in 06 one could do a deal like this, but this is pushing it. Are the agencies pushing the envelope again?

      Pimco Total Return Fund - nice return

      PTTRX is up almost 5% year to date. Not bad for a conservative fixed income fund. A look inside reveals a large bet that paid off: agency paper. Tons of Fannie and Freddie debt. Unlikely they can do as well the second part of the year.

      India election - and reward

      Maybe the current US Administration can learn a thing or two from India about avoiding socialist/protectionist policies. Singh's victory gave India's equity markets a 17% pop in a day- almost 50% year to date (which by the way looks a bit frothy given global uncertainty). India under Singh as the finance minister and later the Prime Minister abandoned Soviet-style state planning and pushed for free-market reform quadripling the economy since 1991.

      leveraged loan market - rough road ahead?

      Let’s take a look at the US leveraged loan market. See the attached report from Markit. Looks like a 15%+ rally from the lows in mid Dec-05. Let’s see now:

      • 3.9% coupon (with LIBOR at ridiculously low levels and many loan facilities paying 1-month LIBOR instead of 3-months)

      • 4.4 years average life

      • $74 average price

      That corresponds to a 5.2% yield assuming par recovery. Why would anybody buy this stuff – junk ratings, high default rates, poor recoveries, 5.2% yield? Again this means if no defaults occur, one would get a 5.2% IRR. In the past the argument was that this asset class presented a better risk adjusted return opportunity. Now we know the asset class can have equity-like volatility. The Sharpe ratio is under 0.5 (depending on future LIBOR assumptions and what one thinks about future volatility). The only way buying these loans makes sense is in leveraged non-mark-to-market vehicles (cash flow CLO’s) that don’t care too much about volatility.

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