Wednesday, April 30, 2008

Fed Eases, Then Confuses

The Fed lowered the fed funds target to 2%, then issued a policy statement that may as well have been written in Urdu for all of its clarity. "The substantial easing of monetary policy should help to promote moderate growth over time." Then they say "financial markets remain under considerable stress and tight credit conditions and the deepening housing contraction are likely to weigh on economic growth over the next few quarters." Followed by: "The committee expects inflation to moderate in coming quarters..." but "It will be necessary to continue to monitor inflation developments carefully." Also, they claim that uncertainty about prices "remains high." Let me summarize what Bernanke is trying to say: The economy is likely to grow moderately, unless the market crashes in which case growth will dramatically decrease. Inflation may go lower but could possibly go much higher and frankly, we have no idea what's going to happen. Why'd I take this job? Why?

GDP Up 0.6%, Federal Government Owed Thank You Note

GDP rose at a seasonally adjusted 0.6% annual rate in the first quarter. This is the first estimate of first quarter GDP from the Commerce Department, so I'll be waiting for some revisions down the line. Although I am most definitely not an economist, a few interesting numbers in the report caught my eye. Consumer spending was weak, rising a meager 1%, the smallest increase since the second quarter of 2001. Purchases of durable goods fell 6.1% in the first quarter, residential fixed investment dropped by 26.7%, and business spending fell by 2.5%. Inventories, on the other hand rose, causing real final sales of domestic product (GDP less the change in private inventories) to decrease by 0.2%. What is offsetting these abysmal numbers? It appears to be the federal government, which increased spending by 4.6% after a meager 0.5% increase in the fourth quarter of last year. Any actual economists out there want to throw in their two cents?

GM Posts $3.25 Billion Loss, Analysts and Investors Cheer

General Motors posted a $3.25 billion loss for the first quarter, a loss acquired in a multitude of creative and interesting ways. The following is a direct quote from the Reuters link "GM on Wednesday posted a first-quarter loss due to a costly supplier strike, waning demand for its most profitable vehicles and charges related to struggling former subsidiaries, although results beat Wall Street expectations." In summary, costs rose, revenues declined on lack of demand, and it had to take huge charges on its investment in GMAC, the finance unit. Perhaps the market is cheering that GM only owns 49% of GMAC having spun the balance off to Cerebrus Capital in a very well-timed move in 2006. That spin-off was initially orchestrated to protect GMAC's credit rating from GM's deteriorating financial situation, since GM cannot sell cars without offering financing to its customers. Ironically, GM has stabilized somewhat, while GMAC has been dragged down by its residential mortgage lending unit. Perhaps the market is celebrating the fact that GM's overseas sales were better than expected, although I'm certain this was due mostly to a weak dollar. Whatever the reason, GM is up on the news. Maybe by the end of the day, investors will notice that beating analysts estimates of some "core earnings excluding everything" number that may not even include car sales, is really not such a lofty achievement.

Tuesday, April 29, 2008

Citigroup Raising More Capital. Again. For the Last Time. No, Really.

Citigroup is selling $3 billion $4.5 billion in common stock, raising the total amount of capital the company has scraped together to more than $30 billion since December. Although it had been at least two weeks since the company delivered its miserable earnings report which was greeted with cheers by the market because "the worst was behind us", Citi was back in the headlines with more embarrassing news today. The Wall Street Journal reported this morning that Citi is attempting to avoid being sued by reimbursing Smith Barney clients who were invested in two hedge funds that suffered horrendous losses. If you think you are reading old headlines about Citigroup bailing out its own hedge funds, think again. Citi stabilized another fund called CSO Partners back in February. Today's news dealt with two hedge funds called Falcon and ASTA/MAT that lost 75% and 90% of retail investors' money. It takes a significant amount of investing acumen to lose that kind of money in about three months. It would take me at least six months to rack up losses of those magnitudes. Needless to say, this news didn't help Citigroup's tarnished reputation which Vikram Pandit is desperately trying to restore. Mr. Pandit, I believe, currently has the toughest job in America. Can you imagine having to sit through a risk meeting at Citigoup? I can. It might go something like this:

Vikram Pandit: Okay, let's start with the good news.

Complete Silence

Vikram Pandit: Okay, let's move on then. Any bad news?

Sallie Krawcheck: Vikram, we need to bail out our retail investors who put their money in the Falcon and ASTA/MAT fund.

Vikram Pandit: Bailout? What are you talking about? We don't have any money. All the money we've raised is covering mortgage and credit card losses and that other hedge fund that blew out last November.

Sallie Krawcheck: Vikram, they're going to sue our pants off.

Vikram Pandit: Fine, Fine. Bail them out. Do we still have Chuck Prince on retainer? Maybe he can be our legal council. Also, somebody issue a press release that we're going to issue a convertible.

Gary Crittendon: We already did a convert last November with Abu Dhabi, remember?

Vikram Pandit: Convertible preferred then.

Gary Crittendon: We did that too.

Vikram Pandit: Bond issuance?

Gary Crittendon: Check

Vikram Pandit: I guess we have to do common. Ok, how are the marks doing on our fixed income portfolio? Spreads have come in. How much have we made?

Head of Fixed Income: Based on the marks we have made up, we should only lose another $5 billion.

Vikram Pandit: Fantastic! How are we doing in reducing the size of our derivatives portfolio?

Head of Derivatives: Great! We've whittled it down to about $34 trillion from $35 trillion at year end.

Vikram Pandit: Good work. Clearly the risk has been contained. By the way, has anyone talked to the Wall Street Journal about replacing that stock photo of me where I'm grinning like a buffoon right next to stories about how much money we keep losing?

PR Guy: I'm on it.

Vikram Pandit: What about lunch?

Hot Dog Guy: I brought the hotdogs, but you've got to pay me cash. I don't take your credit.

Earnings and Economic Numbers 4/29/2008

Deutsche Bank reported a net loss of 131 million euros after taking 2.7 billion in write-downs. In other, equally shocking banking earnings news, Countrywide lost another bundle of money, attempting to prove to the world that WaMu and Wachovia had nothing on them when it came to lack of underwriting standards. Countrywide lost $893 million, or $1.60 a share. Although the Bank of America takeover appears to be on track, Countrywide's losses could easily blow through the $4 billion that Bank of America paid for it in about three more quarters. Furthermore, GMAC posted a $589 million loss due to $859 million in losses in its ResCap mortgage lending unit. Another fine example of great timing by Cerebrus Capital, who took a large stake in GMAC at the peak of the market. Need another? Chrysler's losses led to a 32% decline in Daimler's net income. Cerebrus paid $7.4 billion for its 80% stake in Chrysler just a year ago. That investment has been a real performer.

If you are confused about the horrendous numbers posted by the financial firms, a peek at a couple of economic reports should help explain the situation. The S&P Case-Shiller Home-Price Index fell 12.7% from a year earlier. Nineteen of the twenty cities in the index showed declines, Las Vegas leading the pack with a 23% price slump. Charlotte, the lone holdout posted a meager increase of 1.5%. Then again, I don't ever remember reading about frantic condo-flipping in Charlotte. Also, US foreclosure filings doubled in the first quarter, led by Nevada. Interestingly, Las Vegas is in Nevada, which leads me to suspect that there is a very interesting correlation between foreclosures and slumping housing prices. Maybe everyone will use their $600 rebate checks from the government to buy a house out of foreclosure. If that happens, I'd consider being bullish again on financials. In the meantime, I'm buying more bags of rice on the downtick.

CALPERS' Chiefs' Resignations Ignite Suspicion

Just days after Russell Reed announced his departure from the post of Chief Investment Officer of the California Public Employees' Retirement System, Fred Buenrostro, the CEO, followed suit. Two months ago, Christianna Wood, Senior Investment Officer of Global Equities resigned. All of the above claim to be pursuing greener pastures in the private investing community. It is undoubtably true that they will be paid far more for their services in the private sector, but I have to wonder if their concurrent departures were somehow linked to CALPERS' investment performance. CALPERS put up very nice performance numbers through the last fiscal year, which ended June 2007. Unfortunately, we have no numbers since then and June 2007 was right before the credit markets began to melt-down causing losses to reverberate through nearly every single asset class. CALPERS is a noted investor in alternative investments, so I have to wonder how much performance has been dinged by the turmoil in the markets since June 2007. With only two months to go before the next fiscal year end, if I had to report lousy investing performance to a bunch of angry state employees who are depending on me for their retirement incomes, I'd be going where the grass is greener too.

Monday, April 28, 2008

Kerkorian Accumulating GM Ford

After trying to unsuccessfully enact changes at GM three years ago, Kerkorian has turned his attention to Ford, acquiring a minority stake and bidding for 20 million shares at $8.50. This is arguably even better news than Ford's shareholders received last week when the company unexpectedly reported a meager profit of $100 million. Just the thought of Kerkorian's interest can cause a spike in the stock price, as some hedge funds learned the hard way when Kerkorian wreaked havoc on their bets by bidding for a stake in GM in May 2005. Hedge funds were long the bonds and short the stock in leveraged bets that were skewered when GM's stock unexpectedly spiked on news of Kerkorian's stake just a few days after GM's bonds were downgraded to "junk" by the rating agencies. Imagine attempting to explain to your investors how this "arbitrage" trade went awry.

Investor: How'd you lose all my bleepin' money?

Hedge Fund Manager: Um, So I was long the bonds and short.. oh never mind. We got kicked in the nuts and punched in the head at the same time.

Investor: Ok, yeah. That makes sense.

Kerkorian's interest in the auto industry isn't new or even recent. He was a big investor in Chrysler as well. He's been at this game a very very very long time. In fact, the most bullish part of this story is that Kerkorian is a nonagenarian who still wakes up every morning thinking about his next big deal while drinking his prune juice. I challenge you to find anyone who has more experience chasing auto deals than this guy. What does this mean for Ford investors? At a minimum, a short-term boost for investors that have had very little to cheer about in recent years.

Continental and United Abandon Merger Talks, Analyst Discovers Link Between Oil and Airline Losses

In actual airline news, Continental has abandoned merger talks with United, thus turning its back on the typical airline strategy of "if we get bigger, we can lose more money faster, go into bankruptcy sooner and get bailed out, again." Now that UAL has been jilted, it can begin its desperate search for another merger partner. This should give analysts plenty of material for guessing which airline will make a bid for UAL.

Speaking of useless analyst research, some crack analyst at Soleil-Solebury, just noticed an intriguing negative correlation between the price of oil and airline earnings. Perhaps he was too busy calculating WACC and forecasting top line revenue estimates to notice that oil has been on a tear for the past, I don't know, four years. Maybe he takes public transportation and hasn't noticed that it costs him $4 to fill up his tank? Apparently today was the first day that he decided to actually do the math to calculate how many times an airplane needs to refuel its enormous gas tank before every single flight? The good news is, he has finally taken some action and lowered his lofty price targets on four airlines despite keeping "buy" ratings on three of them. The bad news is that he did it about a week after all the airlines were crushed when Delta and Northwest reported staggering losses. I guess you can't expect much more out of Soleil - Solebury, a company that sounds like a fish and steak outfit. But maybe next time he could just issue an apology instead.

Yahoo Ignores Ballmer's Tough Talk

Jerry Yang countered Steve Ballmer's tough talk with silence this weekend, as the deadline to accept Microsoft's bid for Yahoo passed unanswered. Most analysts seem to believe that Microsoft "needs" Yahoo to better compete with Google in the lucrative internet search and advertising business and will raise its bid in order to ensure that the deal is done. The way I see it, Yahoo was an $18 stock before Microsoft's bid, giving it a $25 billion market cap. Microsoft said it would pay $40 billion for the company. If Microsoft pulls its bid, Yahoo will be forced to go it alone in its battle for web dominance against Google, unless, of course some other white knight comes along. Unfortunately, not many strategic buyers are running around with $40 billion handy and problems in the credit markets make a deal this size unlikely for a financial sponsor. Perhaps only Google could digest an acquisition this size. If you ask Sergey and Larry what they think about making a bid for Yahoo they'd probably reply solemnly with: "Too many antitrust issues," before breaking out into hysterics and adding "Are you kidding? We're crushing those guys!" Does Microsoft really need Yahoo or does Yahoo need Microsoft? This question will be answered within the week. I'm betting on the latter. Feel free to mock me if I'm wrong.

Friday, April 25, 2008

Consumer Sentiment Index Declines To 1982 Levels

US consumer sentiment fell more than expected to levels not seen since 1982. Are things really as bad now as they were when Olivia Newton-John's hit "Physical" was the number one song? It's true that it if you are an average American, the value of your house has declined, it costs you $3.50 to fill up your gas tank, and Costco just put the kabosh on your plans to pay the bills by stocking up on extra bags of rice and flipping them to your neighborhood Asian restaurant with a 50% mark-up. But 1982? Come on! Let's just get a bit of perspective. Interest rates in 1982 were in the double digits. Inflation was running at 6.16%. The first CD player was sold in Japan. And Times "Man of the Year" was THE COMPUTER. We didn't have personal computers, cell phones, voice mail, text messaging or DVD players. Al Gore hadn't even invented the internet. What did people do all day? I, for one, was playing Michael Jackson's "Thriller" album over and over again. Would anyone else like to share a touching personal story?

Ex-Trader Charged With Spreading False Rumors

Ripples of terror reverberated around Wall Street trading desks yesterday when the SEC accused a former Schottenfeld Group trader with spreading false rumors about Blackstone's proposed takeover of ADS. The SEC demonstrated firmly that it is not messing around with rumor-mongering by going after this pea-shooter whose total profits on the offending trades were $25,000. It is certainly true that Mr. Pea-Shooter (aka Paul Berliner) did make up rumors about a supposed meeting that never took place between Blackstone and ADS. He then forwarded those rumors to 31 of his closest friends ( who are all brokers) through instant messenger. He also shorted the stock at around $77 and watched it fall in response to the spreading of his rumors. However, those who listened to Mr. Pea-Shooter and sold their stock in a panic, or even shorted it, should send this guy a thank you note. The Blackstone/ADS deal never happened and ADS is now a $57 stock.
There are many who believe that Wall Street is built on a firm foundation of rumor-mongering. If traders didn't spend all day making up rumors to support their trading positions, their productivity levels would drop markedly. Within many of these rumors, however, lies a kernel of truth. Finding that kernel is considered part of the game. Were traders spreading rumors about Bear Steans going bankrupt? Absolutely. But Bear Stearns was eventually forced to find a white knight to rescue it. Will the SEC go after those rumor-mongers? Or is it not illegal if the rumors become a self-fulfilling prophecy? Every investment bank relies to varying extent on borrowing in the money markets to finance its trading positions. Theoretically, any investment bank can go bust over a crisis of confidence. Lehman, who was also apparently the target of viscous rumors during the height of the panic in the credit markets, emphatically put its foot down and raised capital to avoid winding up like Bear. Does the SEC go after those who spread rumors about Lehman but not Bear just because Lehman's management did a much better job of dispelling the rumors of its "potential" insolvency? The answer is obviously not straight-forward. But whatever it is, you didn't hear it from me.

Thursday, April 24, 2008

Broadway Partners Honored With "Mini-Macklowe" Award

Broadway Partners, a New York real estate investor, is coming dangerously close to emulating its apparent hero Harry Macklowe, the New York real estate developer who defaulted on his debt obligations earlier this year. According to the Wall Street Journal's Property Report, (which requires a subscription so I cannot link) Broadway Partners, an extremely aggressive office property investor, is currently peering down from the top of the commercial real estate ponzi scheme and realizing that it may be the greatest fool. Apparently, Broadway acquired billions of dollars worth of office properties using short-term debt near the peak of the credit cycle and is now desperately trying to avoid handing over the keys to the trophy properties it has acquired over the years. The investment partnership will try to raise equity from its investors to buy back debt at a discount from the debt-holders. Furthermore, it is attempting to offload several properties in Houston and San Francisco in order to raise cash. Will Broadway be able to pull all of this off before the first portion of the short-term debt comes due in January 2009? That depends on how much the credit environment improves in the next six to nine months.
When I read stories like these in the press (please see my previous post about Frank Lembi for another example of a real estate titan who is punting properties after a debt-fueled buying spree), I start to wonder what all of these supposedly experienced and brilliant real estate investors were thinking when they paid sub-3% cap rates to buy investment properties. I understand that some markets are better than others. It is certainly the case that you should see 10% cap rates in a crummy market like Detroit that has horrible fundamentals and significantly lower cap rates in markets with strong fundamentals like San Francisco or New York. But why would anyone ever pay a cap rate that is less than the 10 year note for an illiquid asset? I was recently told by a real estate broker when comparing higher cash flows in a different city to properties in San Francisco that "San Francisco is not a cash flow market. It's an appreciation market." That has certainly been the case for the past few years and could continue indefinitely if investors weren't buying properties with enormous amounts of leverage, particularly short-term debt. This is how San Francisco became a "Negative Cash Flow Indefinitely, GET ME A BID FOR THIS BUILDING!" market.
While I'm busy honoring Broadway Partners for its real estate folly, I might as well hand out another award. This one goes to Sam Zell. I'll call this award: "I sold the high! Ha ha, suckers!" Sam Zell, for those who don't know, sold his REIT Equity Office Properties for $36 billion in early 2007 right before the credit markets took a dive. That's some good timing!

New-Home Sales Dismal, Nobody Drinking Macchiatos

New home sales fell 8.5% to an annual pace of 526,000, the lowest since October 1991. The median price fell 13.3% from the same time last year and inventories rose to 11 months. Anybody counting on a rebound in new home sales, (which did not include any economists, all of whom forecasted a drop in new home sales albeit not as sharp) may be sorely disappointed. The homebuilder stocks, showing a complete disregard for reality, are rallying.
In completely unrelated news, SBUX disappointed investors with another lousy quarter coupled with a reduced forecast. Apparently, stretched consumers are starting to wake up to the fact that you don't actually have to pay $2 for a cup of coffee. You can make it at home for pennies. The stock has been pounded in the past two years, almost completing its transformation from a growth stock to a value stock. Pretty soon, it may be cheaper than a caramel macciato.

Earnings Roundup 4/24/2008

After the close of trading yesterday, Apple and Amazon both reported solid earnings. Apple's earnings rose 36%, handily beating wall street forecasts. Amazon's earnings also rose 29%. Were either of these stocks up 20% like Google when it reported a 30% rise in earnings? Sadly, for shareholders, the answer is no. Although the real losers today may be the owners of the options on Apple and Amazon's stock who were pricing in a large move. Volatility in the options will more than likely get crushed today.
In what may be viewed as the most shocking earnings news of the day, Ford actually posted a profit for the quarter. What? A US automaker posting a profit? Before everyone runs out to start a car company to compete for fat profits, I'd like to point out that Ford only made a measly $100 million on $45 billion in revenues. Not the greatest margins in the world. But at least they've managed to stop the bleeding.
Credit Suisse continued the parade of embarrassing losses posted by financial firms. The company lost over $2 billion on a $5 billion write-down. The stock apparently rallied in European trading because the company claimed they did not need to raise capital. So, if the company raises capital it's bullish. If the company doesn't raise capital, it's bullish. Curious indeed.
Motorola posted a wider loss than expected on plunging sales of its Razr phones. MOT forecast a second-quarter loss, disappointing analysts who were expecting the company to return to profitability. I recently replaced my lousy motorola phone when it fell apart after 1 year, with an iphone. I fully understand why MOT is losing the cell phone wars.

Sam's Club and Costco Limiting Rice Purchases

Two big warehouse chains are restricting rice sales per customer to limit hoarding of the precious commodity. The recent sharp increase in rice futures has created significant challenges for a large portion of the world that relies on rice as a diet staple. Governments around the world have begun banning rice exports in a desperate attempt to ensure that enough supplies remain within their borders. One of the most useful things I ever learned in an economics class is that price caps and trade restrictions create shortages and exacerbate an already difficult situation. Jimmy Carter demonstrated this quite effectively in the 70's (let's hope he does better with solving the Middle East peace crisis.) At any rate, the price of rice continues to surge and threatens to cause panic in parts of the world where people could possibly starve without it. However, the US is not part of that world. Thankfully, if Sam's Club runs out of rice, it may cause problems for Asian-themed restaurants, but nobody in America is going to starve. Our grocery stores are stocked with a dizzying array of substitutes. While it is certainly true that food prices are increasing across the board, we have yet to reach a state where we need to ration our staples. So I find this move by Sam's Club and Costco to be rather bizarre and somewhat irresponsible as it could create a panic where one need not exist.

Wednesday, April 23, 2008

Ambac CEO Claims "Worst May Be Behind Us."

In an attempt to calm investors' nerves after posting $1.6 billion in losses on $3 billion in write-downs, Ambac CEO Michael Callan jumped on the bandwagon with all of the other financial company CEOs by implying that the credit crisis was past its nadir. "The worst may be behind us," Callan stated during the company's conference call. He further clarified his point by saying "Worst is a big black bear that is chasing us so everybody RUN FOR YOUR LIVES!" This last quote is actually not true, but that should not take away from the comical nature of the CEO's actual comment. Ambac has a $400 million credit line that is currently in violation of its net worth covenants. Furthermore, the company is seeking shareholder approval to increase its shares by 350 million in order to raise cash to shore up its balance sheet. However, given that the stock is now trading at $3.50, the capital infusion may not be enough. According to the Bloomberg article, the CDS on Ambac has widened by 90 basis points to around 793 but my inside sources claim it is actually trading at 1018 right now, meaning the bond market has its doubts about Ambac's ability to remain in business.

In a related article, Ambac's lawyers are investigating the contracts on 17 transactions. The company is attempting to figure out how losses on underlying collateral with Bear Stearns that were originally projected at 10% morphed into 81.8% default rates. Sort of makes me wonder how bad Ambac's projections are on the rest of its deals. The worst is behind us? That had to have been a joke. But shareholders aren't laughing.

Delta and Northwest Lose $10.5 Billion Combined

Both Delta Airlines and Northwest posted significant losses due to a sharp increase in fuel costs. $6.1 billion of Delta's total loss of $6.39 billion was due to a non-cash charge related to accounting for its exit from Chapter 11. Northwest Airlines lost $4.1 billion. What I've noticed recently is that there is an interesting negative correlation between the price of crude oil and the amount of losses at airlines. Crude oil goes up, airlines lose more money. Has anyone else noticed this curious phenomenon? In all fairness, both companies do hedge a portion of their fuel consumption, but sky-rocketing fuel costs really hurt their bottom-lines.

I am certainly not an expert on the airlines, but I have always found it hard to stomach the idea of investing in an industry that seems to go into bankruptcy every few years. Despite a history littered with former carriers forced out of business, new "discount" carriers pop up out of nowhere to try to steal market share, thus causing everyone to lose money again until they are on the brink of bankruptcy again. Airlines have so many complicated and expensive issues to deal with such as labor, maintenance, and safety. This doesn't even take into account the fact that terrorists like to use planes to advance their horrifying agendas. In summary, the airline industry is tough. Will the merger of two of the largest airlines (Delta and Northwest) really help alleviate any of these problems? It may help them stay in business a bit longer, delaying the next round of bankruptcies for at least another couple of years.

Ambac Posts $1.66 Billion in Losses

Ambac reported a net loss of $1.66 billion, or $11.69 a share, thus outsmarting all of those analysts who were expecting losses of about a third of that number. This is quite a feat by Ambac, considering that ABK was a $6 stock yesterday. I'm sure many companies wish they knew the secret to losing twice their market capitalization in one quarter and remaining in business. Since Ambac insures about $524 billion in bonds, this news should not be greeted with exuberance by the credit markets, although I would guess the credit markets were not expecting uplifting news out of Ambac. But can all the equity bulls who think the worst in the financial morass is behind us continue to ignore news like this?

Tuesday, April 22, 2008

Citigroup Seeks Advice From HP

In what is perhaps the most curious headline in the financial news today, Citigroup is asking HP for advice on reviving its fortunes. Apparently, Citigroup sees similarities between its current situation and HP's back in 2005 when Carly Fiorina, the former CEO was forced out and replaced by Mark Hurd. Although I only report what I read in the financial press, I can only surmise how the conversation went after Vikram Pandit dialed Mark Hurd's number:

Pandit: Hello Mark? This is Vikram Pandit.

Hurd: Who?

Pandit: Vikram Pandit, the CEO of Citigroup.

Hurd: I think you have the wrong number. This is Hewlett-Packard, the computer company in Silicon Valley.

Pandit: Yes, yes. I know. I want to talk to you about fixing some of the problems we're having with the bank.

Hurd: I don't need a loan or a new credit card.

Pandit: No, no. You misunderstand. I'm looking for advice on how to get through this difficult time without breaking up the company.

Hurd: Hmmmm. Did I mention we're a computer company?

Pandit: I know. I'm just looking for general strategy.

Hurd: Maybe you should introduce a new line of ink jet cartridges. The margins are great. Oh, wait. Nevermind. Forget I said that! The margins are terrible. You should maybe try to spin off a business or two? Then you could charge yourself some investment banking fees and book them as revenues!

Pandit: But you didn't spin anything off.

Hurd: True, true. Maybe what you need to do is telegraph the fact that you are fairly certain, although not entirely, that the credit crisis may possibly, although not definitely, be nearing an end?

Pandit: Oh yes! Yes of course! What should I say?

Hurd: Make a good sports analogy. Like we're entering the fourth quarter.

Pandit: I think Blankfein already said that.

Hurd: Have you tried baseball?

Pandit: Morgan Stanley's Mack already talked about being in the final inning.

Hurd: What about the third period of a hockey game?

Pandit: Nobody watches hockey. What if I just say we're more than half way through the credit crisis?

Hurd: Weak, but it's better than nothing.

Pandit: Would you be interested in making an investment in our esteemed firm?

Hurd: Um no. And stop sending me all those damn credit card offers.

Results of the TAF Expose True State of the Money Markets

The Fed posted the results of the Term Auction Facility, the 28-day term loan it offered to dealers today. The stop-out rate was 2.87%. Eighty-three bidders submitted a total of $88 billion in bids for the $50 billion in loans awarded. Demand continues to exist for financing from the Fed for unwanted collateral, as the rate is significantly higher than the fed funds target of 2.25%. However, the results were about 2.5 basis points lower than one-month libor, which is currently at 2.895%. This indicates that dealers consider trading with the Fed a privilege rather than a stigma. Although conditions in the credit markets have improved significantly in the past month, as evidenced by a reduction in swap spreads, the persistently high spread between libor and fed funds points to significant fears of hidden credit problems that have yet to be exposed. If banks were not afraid to lend money, they would be closing the gap between libor and fed funds by putting on massive arbitrage positions. If you told a bank a year ago that it could borrow at 2.25% and lend at 2.90% short-term, without taking any interest rate risk, it would've responded with "How many trillions of times can I do that trade?" These types of anomalies have never existed for such a prolonged period of time. It's just too juicy of a trade to go unexploited. So what is the story behind the persistence of this wide spread? I can only hazard a guess: Banks are still very nervous about the next shoe to drop.

Earnings Update 4/22/2008

The Good:
AT&T posted a 22% increase in profits and 6% increase in revenues.
McDonald's reported a 24% increase in profits on a 6% increase in revenues.
Dupont's profits rose 26% on 9.3% increase in sales.
Lockheed's first-quarter earnings rose 5.8% on a 7.6% rise in sales.

The Bad:
United Airlines said it's first-quarter loss widened to $537 million.
UNH posted a 7.2% increase in net income, missing analysts estimates and reducing forecasts for 2008.

The Really Ugly:
RBS wrote-down another $11.7 billion in mortgage-related assets and plans to raise $24 billion in new capital through a rights issue.

In summary, if you are in the business of providing telecom services for the iphone, you had a good quarter. If you sell burgers around the world where the dollar is worthless, you're doing very well. If you are selling seeds during an unprecedented spike in agricultural commodities prices, you're printing cash. Furthermore, if you continue to provide defense services to a country at war, more power to you.
On the other hand, if you have to buy fuel to operate your business, $118 oil is killing you. If you are in the health insurance business, the skyrocketing cost of medical care is not helping your business. Furthermore, if you happen to be a large UK bank that overpaid for a huge acquisition, not to mention a boatload of mortgages at the peak of the boom, you are totally screwed.

Monday, April 21, 2008

CIT Announces Common and Convertible Preferred Stock Issuances Totaling $1 Billion

Joining the chorus of financial institutions desperate to beef up capital in today's uncertain markets is CIT, who announced concurrent offerings of common stock and convertible preferred today after the close of trading. The funniest thing about this offering (I'm sure you never believed there could be humor in a stock offering) is that CIT is using some of the net proceeds from the sale of the common to pay dividends to the outstanding preferred stock holders as well as interest to the outstanding junior subordinated notes. So, if you're actually buying into this stock offering, the company is taking your money and handing it out to other investors before it begins to deal with its major liquidity issues.

Nevertheless, issuing gobs of common, convertible, or preferred stock is the current thing to do as evidenced by:
1.) Citigroup, who plans to sell $6 billion of hybrid bonds.
2.) NCC, who is raising $7 billion, as noted below this morning.
3.) JPMorgan, who issued $6 billion of hybrid bonds.
4.) Wachovia, who raised $8 billion in common and preferred stock.
5.) Washington Mutual, who raised $7 billion.
6.) Lehman who issued $4 billion in convertible preferred stock, and UBS who is planning a major rights issue.
7.) Did I forget someone? I'm sure I did. Oh, that's right. My mother. I called my mother and told her that investors were dying to throw billions of dollars at any financial institution, even if it was carrying tons of assets it doesn't know how to value. So she's opening a bank, collateralized by some old shoes and is issuing a $2 billion convertible preferred. Give her a call if you're interested.

Ofheo Settles With Former Fannie Mae Bosses

Federal regulators settled with former Fannie Mae executives accepting far less in fines than they had originally requested. Former CEO Franklin Raines agreed to donate $2 million to charities and give up stock options that are currently worthless. If my dog dropped a big one in the middle of the living room, I would probably dole out harsher discipline than Ofheo dealt to Franklin Raines. Ofheo initially talked a big game, seeking over $115 million in returned compensation when it went after Raines and his cohorts for allegedly tinkering with FNM's accounting in order to hit certain earnings targets that would trigger fat bonus payments. FNM had to restate earnings for several years, posting huge losses, and the company paid about $400 million in fines. Seriously, the next time I see some CEO compensation consultant on TV justifying enormous CEO signing bonuses and prearranged severance packages because the CEO position contains significant "risks," I'm going to track him down and punch him in the face. Here is a perfect example of how the CEO position is all upside with zero risk. FNM's former executives committed accounting fraud. They paid themselves bonuses on earnings that didn't exist. The company paid a huge fine, the stock was annihilated, and the insurance is going to pay the former executive's fines. Who took all the risk? The shareholders. That's precisely why shareholders should get a say in how much they decide to fork over to their CEOs in compensation. It seems as if public opinion is finally moving in that direction, which may make being a shareholder in a US public company a bit more appealing in the future.

Bank of America Disappoints Investors, National City Raises Money

Bank of America reported net income of $1.21 billion on revenues of $17 billion. This represents a 6.3% decline in revenues and a sharp 77% drop in net income, due to about $2 billion in asset write-downs and an increase in provisions for credit losses of about $4.5 billion. Given the market's reactions last week to similarly upbeat news from the banks and dealers that reported earnings, I would've expected the stock to be soaring. However, it appears as if investors are finally beginning to actually notice the minus signs in front of some of the bleak earnings numbers as Bank of America's stock is actually trading down before the opening bell.

In other banking news, National City has located some chumps willing to lend it $7 billion in order to stay in the banking business. According to Bloomberg, Corsair Capital is leading a group of investors that will pay $5 a share for the stock. Needless to say, current investors who certainly paid more for their shares, are none too pleased, as the stock is now getting pummeled before the open. Despite the 40% discount to the market price of NCC, I still have to wonder if this is a good investment for Corsair. NCC is based in Cleveland, where I'm fairly certain banks will pay you money to take foreclosed properties off of their hands. Furthermore, NCC made a few very expensive acquisitions in Florida, of all real estate hotbeds, near the height of the boom. What else lurks on NCC's balance sheet? You'd have to pay me $5 to find out.

Friday, April 18, 2008

K10 Discovers True Link Between Testosterone and Traders

A study linking elevated levels of testosterone to profitability in traders was published a few days ago in the Proceedings of the National Academy of Scientists. Much has been made of the results of this study which concluded that traders with the highest testosterone levels in the morning were the most likely to make money that day. I have read a few different interpretations of the results, some claiming testosterone was also to blame for excessive risk-taking, with others claiming that traders who were identified as sissies should be injected with testosterone in the morning. I, on the other hand, refuse to read too much into a study conducted on 17 traders for eight consecutive business days on one trading desk in London. This is due to the fact that I have conducted my own studies (purely anecdotal as they may be) on the effects of testosterone on traders. The results of my unscientific study conducted on over 200 traders over the course of every business day for about 12 years have produced the following conclusions:

1.) Elevated Levels of Testosterone Cause Traders to Throw Phones
What is interesting about this discovery is that it doesn't actually matter what type of phone is thrown. Any phone is fair game. For example, I have witnessed traders with elevated levels of testosterone break very expensive equipment on sophisticated desks of upstairs trading floors at banks as well as $50 cell phones on a filthy options exchange floor. The following is a key event which led to my conclusion. Names have been changed to protect the innocent. Some dialogue has been altered to keep this blog family friendly.

Broker: Can you give me a quote on blah blah (a very unusual complicated spread)?

Trader 1: I'm busy! Go away!

Broker: I really need a quote. It's for a good customer.

Trader 1: I'm at blah blah (accidentally messes up the math)

(Broker relays quote to customer on the line, then gets very excited.)

Broker: You're done on 500,000!

(Trader 1's testosterone starts to rise as he realizes he gave the wrong quote)

Trader 1: No, Wait. You're not done on 500,000. I did the math wrong. He's not done.

Broker: You gave me a live quote! You're done on 500,000!

(Trader 1's testosterone explodes. Please note reaction.)




(Trader 1 grabs phone out of brokers hand and hurls it at the broker, Naomi Campbell-style. Due to increased testosterone, Trader 1 temporarily loses vision in one eye thus causing him to miss his target. The phone shatters when it hits the floor causing a large piece to bounce into the air, hit Trader 2 in the eye, thus breaking his glasses.)

Trader 2: Ow! My eye!

2.) Elevated Levels of Testosterone Cause Traders to Abuse Clerks
As a trading assistant, new employees are generally expected to tolerate a significant amount of abuse from traders who are supposedly teaching them the ropes. Here is a good example of what is going on currently on most trading desks:

Trader: Did you put the tickets in? Where's my BLEEPIN' coffee? Have you put in our lunch order yet? How am I supposed to think when I'm so hungry? Why am I losing money today? You must've put something in wrong! Can you figure out what's wrong?

Assistant: Yes. I haven't had time. No. I'm not sure. I don't know. I don't think so. And I'm working on it.


3.) Testosterone Causes Traders to Fight About the Same Things Every Single Day
There is a natural tension on a trading floor between trading and sales. Traders are paid on profits while those in sales are paid on commission. As a consequence, traders always think that salespeople are trying to "screw" them just to print a ticket and collect commissions. Salespeople just think traders are jerks. Despite the fact that these things are known, traders insist on picking fights with brokers and salespeople every day accusing them of trying to "pick them off." Please observe the following example:

Broker: Can I get a quote on the blah blah?

Trader: Who's the customer? Is it the Bleeps at Bleep Bank? I'm not giving them a quote.

Broker: Yes, that's the customer. Can I get a quote please?

Trader: Are they trying to pick me off?

Broker: Can I please just get a quote?

Trader: I'm at blah. But I'm only good for a 1-lot.

Broker: Ok. Done. Can I do 100,000 there?

Trader: No! I can't believe you picked me off! You BLEEP BLEEP BLEEP!
(Trader throws phone at broker. Repeat this conversation every business day for the rest of eternity.)

I'm thinking I might team up with a neuroscientist and have my study published in a scientific magazine.

Google and Citi, A Tale of Two Economies

Google posted a 31% jump in profits for the first quarter, dispelling the rumors that had been circulating about the slow-down in the economy affecting the company's ability to continue to grow at a torrid pace. If you happened to check the stock after hours yesterday, you may have thought for a moment that you had stepped through a portal in time and traveled back to 1999. It's rare to see a $75 surge in a stock's price these days, although on a percentage basis a 17% move isn't that hard to believe. What is interesting is how mispriced the options on Google were relative to the jump in the stock price. The options market is generally good at jacking up the implied volatility in the options to anticipate a stock's move on earnings news. But given that Google reported the day before options expiration, getting the pricing right was particularly difficult this time. If you were a betting fool and felt like taking some serious one-day risk, you could've purchase the april at-the-money straddle for roughly $30 yesterday and printed cash today. It's rare to see a stock blow through eight strikes on an expiration friday. In any event, there are some fairly significant profits and losses out there today, which should make for interesting trading.

Citigroup, on the other hand, lost $5 billion in the first quarter on a massive $15 billion in write-downs. Revenues, although down by 50%, did not decline as much as analysts expected, which got the market very excited. Why does this also remind me of 1999? Because back then internet companies with negative margins would claim "we're losing money on every product we sell, but we'll make it up on volume." And the stocks would rally. Once again, the chorus of "the worst is behind us" continues. I still don't believe it given how the overhang in the credit market persists and Citi remains an owner of $2 trillion in assets, but it's tough to fight a market that loves to rally on such dismal news.

Thursday, April 17, 2008

Welch Retracts Credibility Statement, Now Claims Immelt Going to Hell

Wait a minute. What? He said he's a "hell of a CEO?" Oh. I'm sorry. I guess I must've misinterpreted his statement. Just like Welch claims he was misinterpreted when he announced to the financial universe yesterday that Immelt had a "credibility problem" on live television. I'm guessing GE stopped paying for Welch's use of a good PR agent when it redesigned his retirement package after it was leaked to the media during his highly publicized divorce. However, it's nice of GE to give Welch more airtime to apologize for bad-mouthing the CEO for being honest with investors. Who has the credibility problem now?

Earnings Update 4/17/2008

Merrill Lynch reported stellar earnings. Its net loss was only $1.96 billion after taking a $6.5 billion write-down. The most interesting part of this earnings report is not the write-down, which even my cab driver the other day was estimating at around $6 billion, but the precipitous declines in all of Merrill's other businesses. Debt and equity underwriting dropped by 61% and 45% respectively. Underwriting is supposed to pick up the slack when trading suffers, but apparently, that doesn't always work. Thank goodness John Thain was given $78 million in pay last year for starting in December (according to the Wall Street Journal's CEO compensation report.) Can you imagine how much Merrill would've lost if Thain wasn't "adequately motivated?"

In other finance news, SLM reported a loss of $.28 a share. The company wants you to ignore the loss and pay attention to its "core earnings" which were $.34 a share. The loss, apparently, is supposed to be one of those "one-time" things, that has happened to SLM three quarters in a row now. Given the incredible turmoil in the student loan market, it is hard to imagine that SLM will ever rise to its former glory when JC Flowers was willing to pay $60 a share for the company very recently. It may not ever rise to its former glory of $45 a share, the price SLM paid to buy back its own shares after Citi exercised the puts SLM had sold against its own stock. SLM then had to issue stock at $20 to fund the buyback, locking in a $1 billion loss. More importantly, SLM said it cannot issue any more loans until liquidity improves. What this means is that the company is just sitting on about $155 billion in loans with shareholders equity of $5 billion. Time will only tell what will happen to delinquency rates in student loans when students are no longer receiving 50 offers a week in the mail to consolidate or refinance their loans.

If you haven't already jumped out the window after reading this depressing report of the state of our financial institutions, there is some good news out there. Both INTC and IBM reported solid earnings yesterday, so all may not be lost. Google's earnings are probably the most anticipated in the tech world. Options traders will tell you with confidence that they have no idea what Google's earnings are going to be, but the stock is going to make a $50 move in either direction.

Wednesday, April 16, 2008

Former GE CEO Welch Advises Immelt to Manipulate Earnings

Jack Welch was on CNBC this morning criticizing Immelt, claiming that he had a "credibility issue." Welch asserts that Immelt promised to deliver strong earnings three weeks ago and he didn't deliver on that promise. I believe what Welch is saying is that Immelt should have used some fancy accounting tricks to artificially boost earnings in order to satisfy Wall Street analysts, just like Welch did when he was CEO. Ever wonder how GE beat earnings by a penny for many years under Welch's reign and achieved spectacular returns? It under-reserved insurance reserves for years, thus artificially boosting earnings. Welch conveniently retired, taking an egregious retirement package which became public during divorce proceedings from his second wife who he left for a much younger woman. Immelt then had to boost reserves to an adequate level in order to sell the insurance arm, basically wiping out most of the earnings gains from Jack Welch's last five years in office.

Although GE's earnings were a disappointment, and Immelt should've been more conservative when giving guidance, he did the right thing by reporting lousy earnings. I'm not a huge fan of GE in particular, but I actually believe that Immelt is a much better CEO than Welch ever was. Welch was lucky, and crafty. In my opinion, he is also mostly responsible for the absurd CEO packages awarded to CEOs for doing mediocre work. When GE was picking a successor for Welch, Welch made certain all three contenders for his job received enormous retention bonuses at GE, thus forcing other companies who wanted to hire the losers to offer absurd guarantees. Who was one of those contenders? Our friend Robert Nardinelli, who was recently forced out of Home Depot with $200 million in pay that he felt he deserved. Shareholders and the board disagreed. Maybe it is Immelt who should be giving Welch some much-needed advice: Get a hobby and stop telling me how to do my job.

Economic Headlines 4/16/2008

Housing starts plummeted a whopping 11.9% in March from February. This was only a surprise to the analysts who had forecast a 5.2% drop. The homebuilders said "Are you kidding? Have you seen my inventories? You're lucky it didn't drop 100%" Meanwhile, CPI rose .3% in March, but only .2% excluding food and energy. This puts the annualized rate at 4.0%, and 2.4% excluding food and energy. Remember when Bernake first took office and said he was going to target a band for inflation? I'm pretty sure we've blown through the high band at this point and the guy is easing. This should clearly explain why a.) the dollar continues to get destroyed and b.) the price of oil, gold, copper, silver, and everything in my cupboard is skyrocketing.

In earnings news, JPM matched analysts estimates by posting a 50% drop in net income. Fabulous. Wells Fargo beat analysts estimates by posting an 11% drop in net income, a modest drop considering that Wells is a large mortgage lender. Hats off to Wells Fargo for not getting sucked into the no-doc lending frenzy and avoiding the CDO debacle. There's a good reason why Warren Buffet loves this stock. Because when everybody is blowing out, the few who are still standing get to reap the benefits of the recovery.

Tuesday, April 15, 2008

State Street Boasts Higher Profits, Ignores Losses

State Street beat earnings estimates handily this morning by posting profits of $530 million. The stock rallied nicely until the conference call when the company mentioned that its investment portfolio had $3.16 billion in unrealized losses. The company's claims that the losses were most likely temporary ("See? They're unrealized losses! They don't actually count!") failed to impress investors when it dawned on them that State Street may actually fail to realize it has losses. How many of those losses will turn into impairments is anybody's guess, but something tells me the answer in definitely not close to zero.

BBI Bids for CC, Everyone Scratches Head

In the most unexpected news to hit the tape since the Bear Stearns implosion, Blockbuster is bidding for Circuit City. I can't think of a stranger marriage proposition since that old guy tied the knot with Anna Nicole Smith. Why would Blockbuster, a business that is slowly bleeding to death, make a play for Circuit City, a business that is quickly bleeding to death? Only Carl Icahn knows for sure, as he is expected to help finance the acquisition. M&A is all about "synergies", so if anyone out there actually understands the synergies of this bizarre deal, feel free to explain it to me. My personal view maintains that BBI and CC are attempting to streamline their bankruptcy paperwork by submitting one bankruptcy filing, rather than two.

Economic Headlines 4/15/2008

If you weren't depressed enough writing out checks to the IRS today, these economic headlines should do the trick. In inflation news, US PPI rose by 1.1%, twice as much as expected. Core PPI, excluding food and energy, was up by a more modest .2, as expected. Luckily, I don't know anybody that actually buys food or consumes energy, so this was actually very good news. US foreclosure filings jumped 57% in March. According to Realty Trac, one in every 538 households was in some stage of foreclosure. Furthermore, about $460 billion of adjustable-rate loans are scheduled to reset this year. The Fed's interest rate cuts should help alleviate some of the pain, however, it is unclear how many of the adjustable loans had very low teaser rates that must adjust higher regardless of the Fed's cuts. On the corporate side, US corporate bankruptcies are accelerating as borrowers are having difficulty refinancing. The amount of distressed corporate bonds (those yielding more than 10%) jumped to $206 billion on April 11, 2008 from $4.4 billion in March of 2007. Remember March 2007? My nine month old could've crawled into a branch of Countrywide and received a $2 million, no money down, interest only loan. My baby knows those days are over. I'm pretty sure that's why she was crying yesterday.

In a rare bit of good news, J&J reported strong earnings. Revenues were up 8% and earnings increased 40% from a year ago. Also, the NY Fed Factory Index unexpectedly rose in April. Of course, futures are higher because everyone knows inflation and bankruptcies don't matter, but an incredibly volatile measure of manufacturing in NY does.

Monday, April 14, 2008

The Stock Buyback Scam

One of the great lessons future business leaders learn in business school is that stock buybacks are great. It is hammered into their skulls in class after class. It's tax efficient! It counteracts dilution! Blah blah blah. I propose that, on the contrary, stock buybacks are terrible for long term stockholders because they temporarily prop up the price of the stock so that insiders can sell at more favorable prices. Furthermore, companies tend to buy more stock in good times, thus paying a premium for their own shares. In fact, companies are locking in enormous losses in their stock trading. Washington Mutual just issued 176 million shares of stock at $8.75. In 2006 and 2007 WM purchased approximately 150 million shares of its own stock at an average price of $43.48. The company just punted $5.2 billion dollars trading its own stock. Wachovia's 10K shows it spent approximately $8.4 billion purchasing its own stock in the past three years for about 150 million shares. A bit of simple math shows that Wachovia paid around $52 on its own stock. Today it announced it was issuing shares at $24 for a loss of $4.2 billion. Let's see, buy at $52, sell at $24. Even my nine month old baby knows that's a bad trade, and she tries to eat her socks.

The stock market is littered with companies that are being forced to issue shares at enormous discounts to where they purchased shares a year ago. In Barron's this weekend, there was a small blurb that noted the $589 billion in buybacks companies engaged in last year. Furthermore, S&P was quoted as saying that buybacks would continue to be strong in 2008. I beg to differ. Take the stock issuance frenzy in financials, add one part freeze in current buyback programs, add another part major problems raising capital due to credit market fiasco and what do you get? I'm certain you don't get strong buybacks in 2008. In fact, I would have to ask if the guys at S&P are smoking crack! Even Whitney Houston can tell you that S&P is dead wrong, and she's the most public crack smoker I know, although I hear, she's finally laid down the pipe. I predict that 2008 will be the year of the backlash against stock buybacks.

Wachovia Issues Debt, Cuts Jobs

According to CNBC, Wachovia has announced the terms of its anticipated capital infusion. The company will issue $3 billion in common stock at $24 and $3 billion in a convertible with a 7.5% coupon and 30% conversion premium. Since I can't post a link to the TV, I will wait until a respectable news outfit reports the news before posting a link. Wachovia also announced that it will cut jobs and slash its dividend by 41%. Furthermore, if all of that news that wasn't thrilling enough, it is reporting a loss of $350 million in the first quarter, due to $2 billion in asset write-downs.

Wachovia's stock closed at $27.81 on friday so the common stock issuance was theoretically supposed to be offered at a 12% discount. Great deal right? Maybe Wachovia was hoping for the rally Lehman's stock received on the news of its 7.25% convertible, which everyone and their mother wanted in on? The stock is currently trading at around $24.85 before the open, so possibly investors are beginning to realize that a hugely dilutive stock offering isn't incredibly bullish.

Friday, April 11, 2008

GE Drops the Bomb

GE shocked the market with a lousy earnings report, sending its shares down 10% and taking the rest of the market down with it. Analysts were shocked, absolutely shocked to discover that GE is really just a large financial company masquerading as an industrial titan. Earnings from GE's financial services arm were down 20%. According to CEO Immelt "The financial services environment was very difficult and became even more difficult late in the quarter." No surprise to anyone except for the Merrill analyst who upgraded this stock to a "buy" on March 20th. The stock actually rallied 5.3% on the upgrade, as the analyst claimed confidently that GE would not suffer from the difficulties in the credit markets. Maybe the cheery upgrade was in response to GE buying Merrill's consumer finance unit in December, helping Merrill free up some much needed capital? This is just pure speculation on my part as equity analysts don't have a history of conflicts of interest. The moral of this story is never take stock advice from a company who is about to post yet another $6 billion or so in further write-downs.

No Money, Just Linens 'N Things...

Linens 'N Things is expected to file for bankruptcy on Tuesday. Separately, and yet entirely related, Apollo is going ahead with its IPO plans, despite the turbulent market. How are these two stories related? Because Apollo, the highly regarded private equity firm run by Leon Black, took LNT private in February of 2006 in a $1.3 billion buyout. Maybe Mr. Black thought he could get his firm's IPO out the door before the LNT bankruptcy filing in order to cash out before returns in his funds suffer? I'm just speculating, of course.

Who on earth could've seen the surprising news of LNT's bankruptcy coming? Did the news of LNT's $154 million loss in 2006 not ring a bell for investors and cause them to view other similarly debt laden deals with caution? No. The private equity boom continued for at least another year. But perhaps it is finally starting to dawn on people that not every company in America needed to be loaded up with debt and taken private, unlike the definitive claims of all of those nauseating editorials I had to read in the Wall Street Journal during the height of the boom about how private equity "creates efficiency." Maybe, just maybe, the whole boom was based on financial engineers taking advantage of the tax benefits of issuing debt and temporary insanity in the debt markets. Perhaps, private equity players are starting to think "hmmm, maybe piling a ton of debt on a bunch of highly cyclical businesses (hello Freescale and Chrysler) five years into an economic boom was perhaps idiotic." Yeah, if I were Mr. Black, I'd be planning my IPO too...

Thursday, April 10, 2008

Goldman's Blankfein Says End to Credit Crisis is Near..

Blankfein claims we are in the third or fourth quarter of the credit crisis, although he hedges by saying that the fourth quarter of most sports events tends to be the longest. Separately, yet totally related, Goldman punted $500 million of Chrysler bonds for $.63. So, let me get this straight, the credit crisis is almost over, yet GS is puking bonds at $.63. That's a mighty big discount if this credit crisis is really just a mark-to-market phenomenon and not indicative of future defaults. In Blankfein's defense, it is his job as CEO to try restore confidence at a meeting of GS shareholders. Furthermore, I'm certain that every dealer involved in the bond syndication of this deal knew it was a turkey at the time, but the capital markets shut down abruptly before they could offload any of the bonds.

Just how big of a turkey this deal would turn out to be didn't start to dawn on anyone until, oh I don't know, maybe three days after the deal closed. Was it the $2.7 billion in losses that Chrysler reported immediately following the buyout that gave it away? Or maybe it was the move by Cerberus, the PE firm who took Chrysler private, to hire Robert Nardinelli, a non-car-industry executive to run Chrysler? Robert Nardinelli, for those who don't recall, is the genius who was sacked from Home Depot after six years of below average performance (the stock declined while rival Lowe's rose significantly), because he wouldn't take a pay cut. I guess no CEO can be expected to live off of less than $200 million. At any rate, if I were GS, I'd be looking to hit the next bid behind that $.63...

Pain in the Money Markets Continues

The spread between overnight central bank rates and three month libor hit 77.5 in the US and 95.45 in the UK yesterday, getting dangerously close to levels seen when the crazy rumors about Bear's imminent bankruptcy were flying around. As it turns out, those crazy rumors were true, so banks are expecting something unexpected to hit. They may not know what it will be, but it's going to be really bad. They don't want to lend to each other. Again, the implications of this, if it continues, are far and wide. The less lending banks do to each other, the less avenues banks have to finance their inventory, leaving them unable to make new loans or buy new securities. An inability to obtain loans by consumers through mortgages, home equity loans, credit cards or auto loans puts a big damper on consumer spending. Consumer spending is 70% of GDP. The preliminary reports from the retailers this morning aren't looking too hot. Other than Walmart and Costco, other retailers reported sharper declines than expected in March. Everyone shopping at Walmart and Costco instead of the Gap and Limited? I think that's because you can't find bags of rice for hoarding at the Gap. If I were the Gap, I'd look into maybe supplementing my clothing line with a rice aisle. You know how Williams Sonoma puts the $40 bottle of olive oil next to its beautiful salad bowls to try to trick you into forgetting that you can get a bottle of olive oil for $5 from Walmart? It would be like that.

Wednesday, April 9, 2008

No Price? No Problem. GS Creates Pricing.

Goldman Sachs Level 3 Assets Rose to 39% to $96 billion in the first quarter. It's headlines like these that make me doubt the positive earnings reported for the first quarter. According to recent accounting changes, dealers have to classify their assets into three categories, Level I (mark-to-market, or securities that have a price in the market), Level II (mark- to- model, securities that have no current price in the market but are marked based on known inputs) and Level III (mark- to- I-have- no- idea, I'm- just- making- it- up.) The fact that GS moved around $36.4 billion of its assets from another category into Level III means that they have no idea what those assets are worth and are just guessing at their value. That, my loyal readers is precisely why I can't buy into this idea of the worst being behind us. In fact, on this headline alone, I just upped my mattress allocation in my portfolio to 60%.

Tuesday, April 8, 2008

Top Five Reasons to Be Really Bullish

5.) Pending Home Resales Fall More Than Expected
4.) Former Hedge Fund Greats Getting Clocks Cleaned
3.) Citi and Wells May Loan Less Money to Preserve Capital
2.) Last Large SIV Facing Blowout By September If It Can't Refinance
1.) Student Loan Insurer Files For Bankruptcy Roiling FMD Investors

In summary, the pace of home sales is still shrinking, banks are restricting lending, investors who used to make money are getting housed (consider this a pun if you'd like), and students are about to find it even harder to borrow money. In defense of the market, it is actually down on the day, so maybe for once, it is interpreting bad news as bad news.

Wa Mu Raises Money to Last Seven Quarters...

In case you haven't heard the news, Wa Mu is getting a $7 billion capital infusion from TPG, the big private equity group. WM is selling 176 million common shares for $8.75. So if you are buying the stock right now for $12.50 or so, you're a chump! Separately, yet somehow strangely related WM reported a "preliminary" first quarter loss of $1.1 billion. Initially, TPG's capital infusion was rumored to be around $3 billion. Then the number went up to $5 billion. Now it is $7 billion. I guess TPG wanted their investment to last at least seven quarters, so they could collect some management fees from their investors. Seriously, this may prove to be a very good investment for TPG, but it's difficult to know at this point. WM holds $58 billion in option arms in its $110 billion loan portfolio. Furthermore, WM has $60 billion in home equity loans as well as an addition $20 billion in subprime home loans and home equity loans. We'll see how many of those option arm borrowers pick the option of walking.

IMF Wants New Role as Equity Analyst..

Taking its lead from bank analysts, the IMF has decided to enter the How-much-will-this-credit-debacle-ultimately-cost-the-universe guessing game. The IMF's estimate is $945 billion. What I don't like about this estimate is that it is not a nice round number. Why didn't they just round up to $1 Trillion? Since they have no idea and are just guessing, why not make a much bolder statement? What, all of a sudden, makes the IMF an expert on the mortgage market? Although I would wager that the IMF doesn't have any experienced MBS analysts on their staff, they are experts in lending money to institutions who consistently default on their loans. So maybe $945 billion is the right number.

Monday, April 7, 2008

Profits? We Don't Need No Stinkin' Profits!

One question I like to ask frequently without ever receiving a satisfactory answer is the following: Where will future profits in the banking industry come from? Forget about all the write downs, despite the fact that they still aren't completely behind us, why should I buy any financial stocks now? Global debt issuance has plunged is all areas of the debt markets. According to the Financial Times, total debt issuance volumes were down 48% from a year ago. Down $1 TRILLION. That's with a capital T! Total syndicated loan volumes were down 47%. Structured finance was down 89% (ouch.) Debt underwriting was a large profit center for banks and brokers and that was just cut in half. With the Fed's frantic efforts to bail out the banks, one can make the argument that these markets will improve. But will they get back to prior levels? I don't know. Ask investors who are holding AAA CDO's trading at pennies on the dollar if they're ever going to buy another CDO again?

Meanwhile, speaking of $1 trillion dollars, primary dealer fails surged to $1 trillion for the week ending march 26th, up $804 billion from the prior week. What does this actually mean? Let's assume that all the fails happened to one dealer (Dealer X.) Also assume that Dealer X has $1 trillion in inventory owned at an average rate of 5%, all treasuries, that he finances every day in the repo market which ordinarily trades around fed funds. The dollar value of a basis point on $1 million overnight is $.28. So every day, the dealer earns the difference between the interest he collects on his inventory ($1 trillion x 500 basis points x $.28 x 1 day=$140 million) = less what he pays to finance the inventory ($1 trillion x 225 basis points x $.28 x 1 day = $63 million.) Assuming no mark to market changes in his inventory, he should collect $77 million a day in carry. This is why banks love a steep yield curve. They can buy long-dated securities at a high rate, and finance them at a lower rate short term in the repo market, using very little capital. However, if a dealer fails to deliver collateral into a repo (which requires delivery versus payment), he is still obligated to pay the interest, even though he never actually gets the loan. This leaves the dealer no choice other than to take out another loan to finance the securities that he failed to deliver, thus essentially doubling his financing costs. Assuming Dealer X failed on his entire inventory, his financing charges just doubled reducing his profit in the above example to $14 million a day. This example is merely meant to explain the mathematics of fails and how excessive fails can cost dealers significant amounts of money. Furthermore, it is meant to show how great the dislocations are in the financing markets and that the Fed absolutely needed to intervene to swap treasuries for MBS to help alleviate some of the strains.

A closer look at the Fed report shows that the difference between reverse repos and repos for mortages, agencies, and corporates is approximately $1 trillion (total reverse repos for MBS, agency and corporates = $600 billion while repos = $1.6 trillion). So if dealers attempted to reduce their financing needs by not renewing any of their reverse repos in non-treasury securities, and merely focused on financing their inventory, they would be left with $1 trillion dollars to finance. That's with a capital T. And that's why dealer financing at the discount window has soared to $38 billion. Add this to the hundreds of billions lent by the Fed through the TAF and TSLF and the $30 billion loan to JP Morgan to buy Bear. Clearly, dealers really need the Fed, as other sources of financing for the $1 trillion in inventory has disappeared. The Fed is cooperating, which is good. Is it enough? If it were, would the fed funds rate have had an 8.5% trading range on 4/4/08, topping out at 10%? This debacle will only be over in my book, when dealers can get financed themselves without a crutch from the Fed. In the meantime, the world will continue to unwind its loser bets from the glory days of 2005-2007. And profits at dealers will suffer because they have nowhere to turn to sell their products. Can they make it all up in carry from the Fed's easy monetary policy? It's what the bulls think and it's why they all think the worst is behind us. But I'd bet against it.

Carlyle wants back in!

What do you do immediately following an incredibly embarrassing blowout of one of your funds? Raise a new one! Carlyle announced it has raised $1.35 billion for a distressed debt fund. I can't imagine being the tool at Carlyle tasked with calling all the investors to say "yes, yes, I know, you're never gonna see that money again. But have I got a deal for you today!" Wouldn't you just hang up the phone? But no, someone with money to burn said "Here, take $1.35 billion! Go buy back all that debt you had to puke to meet margin calls! We'll make it back! I know we will!" I'm not saying I wouldn't give $1.35 billion to a distressed debt fund. It's probably a great idea right now. I'm just saying I wouldn't give it to the guys who just BLEW OUT LAST MONTH! I'd give it to Paulson. Or Warren Buffet. But Carlyle? No.

When Bad News is Good News

The employment report was a bit of a disappointment, showing cracks in the "strong job market" argument that bulls had been using to justify their buying. Nevertheless, the market managed to come back from a loss to finish roughly unchanged on Friday. Meanwhile, in related news, anecdotal evidence is popping up everywhere I turn that inflation is about to bust out and rear its ugly head in the US. Commodities prices continue to roar and post new highs. Gold and oil are on the rally train again. "Bah! Who cares about gold and oil?" say the bulls, "you can't eat it!" Well, check out the commodity that 3 billion people depend upon for nourishment. Rice prices are soaring, causing major calamities all over the globe for developing nations. Every day I read something new about some part of the world that is experiencing growing inflation. The BRIC's are starting to have problems with inflationary pressures.The middle east is experiencing high inflation due to the weak dollar that is causing a surge in commodities prices. Although all the stats in the US point to low inflation, with the rest of the world experiencing problems and the US still hugely reliant on imports, how soon before it hits us too? The stock market loves all this news. We are again on the "all the problems are behind us, you've got to buy stocks!" train. Call me crazy, but I still think bad news is bad news!

Thursday, April 3, 2008

Late Payments on Consumer Loans Harken Back to 1992

Late payments on consumer loans are the highest since 1992, according to the ABA. If you look back to 1992, there wasn't alot of good news to be found. War broke out in Yugoslavia. Riots were plaguing LA. The US economy was in a recession. Kurt Cobain and Courtney Love were married. Worst of all, "All 4 Love" by Color Me Badd was the number one song. There isn't much of 1992 that we'd want to revisit, least of all, the economic conditions. I, for one, would still rather bust out the Color Me Bad and reminisce about the music...

Senate to Bailout Homebuilders

Our hardworking Senators (just back from a break during the largest global financial crisis we've seen in awhile) have furiously crafted a plan to help homeowners struggling to stave off foreclosure. Of the $15 billion allocated towards saving the housing market, $6 billion has been tagged to save the ailing American Homebuilder. Homebuilders will now be allowed to carry back losses 4 years instead of 2 in order to get tax rebates to the tune of $6 billion. Because really, of all the poor suffering Americans who need help getting out from under the suffocating mound of negative equity, the homebuilders should be our first priority. Let's just review exactly what the homebuilders did during the boom. If you look at their balance sheets and cash flow statements, you will see that the majority of them borrowed heavily to finance purchases of land so they could build spec houses to capitalize on the frenzy in the housing market. They made oodles of money, their executives were paid handsomely, insiders sold their stock and of course, they paid taxes. Management chose to ignore the well-known fact that homebuilding is an extremely cyclical business and they decided to make the most money they could possibly make, leveraged to the hilt without any thought to what would happen in the downturn. My question to my loyal readers is the following: What exactly is wrong with letting some of these jokers go out of business? Honestly, if our government had an extra $6 billion sitting around, maybe I'd be okay with giving them a tax break. But we don't, so our government needs to start prioritizing. I, for one am writing my Senator! Needless to say, this is not the first time she's heard from me.

Wednesday, April 2, 2008

MBA index tumbles back to lows

Mortgage application volume tumbled from the prior week. For the technical analysts out there, that would be a thud, followed by a meow, followed by another thud. Apparently, application volume had surged the previous week, but then gave back those gains this week to sit close to its lows. So, despite the discount in houses, folks aren't rushing out to buy them. Please see post below and add to my list of things that aren't helping the housing market or banking industry.

Some Thoughts on Housing

There is a great chart in the WSJ today (which requires a subscription so no link for now) highlighting the 10 US metropolitan centers with the highest percentage of homes in foreclosure in January of 2008. Cape-Coral-Fort Myers, Fla holds the title with 5.8% of the homes in foreclosure, followed by Port St. Lucie, Fla with 3.9%. The list goes on and ends with Naples-Macro Island, Fla. which has 2.7% of its homes in foreclosure. The article is actually about the Senate's attempt to come up with a solution to the crisis but the chart is more interesting. The Senate is not getting any help from FNMA, who announced today a tightening in its lending standards for home mortgages it buys or guarantees. FNMAwill now impose a minimum credit score of 580 for most loans. FNMA did not have a minimum prior to this change. Furthermore, FNMA will increase the period to reestablish credit history after a foreclosure filing from 4 years to 5 years. This is more than likely in response to a rise in delinquencies of FNMA's portfolio. To recap, foreclosures are surging, home prices across the US are falling, lending is tightening. Also, what about all of the home equity loans on banks' books that are 90% LTV? Banks have frozen access to home equity loans, presumably because they feel it's not such a great business in a declining market, they have no room remaining on their balance sheets, and they anticipate taking write-downs on loans they already carry. The home equity loan problem is sure to be the next crisis. Although there are so many crises going around, it's hard to predict what's next.

Tuesday, April 1, 2008

Some Good News and Some Bad News...

Lehman had no trouble selling its convertible preferred stock. They opted to raise $4 billion instead of the initial $3 billion due to excessive demand for the issue. According to the press release, the convertible preferred will pay 7.25% and will be convertible at any time into 20.0509 shares of Lehman's common stock, which represents an initial conversion price of approximately $49.87. The market likes this news as Lehman is up $3 in pre-market trading. While this should help squash rumors of liquidity problems at Lehman, it makes me wonder why they would borrow 7.25% money when they can get unlimited amounts from the discount window at 2.5%? But they don't call me a skeptic for nothing.
Thornburg managed to price the $1.35 billion it promised to raise to meet margin calls to its other lenders. This is actually only marginally good news. While the money will help the company stave off bankruptcy, it will cause the common shareholders to end up owning only around 5% of the company. So instead of paying $1.5 for the stock, you'd probably have to pay me to buy it.
That is most of the good news I see. In the bad news department, UBS will take a $19 billion write-down and can its CEO. Meanwhile,Deutsche Bank is writing down $3.9 billion and stating that "conditions have become significantly more challenging during the last few weeks." Futures are up so the market is back on "the crisis is over" mode. We'll see how long it lasts this time...