Thursday, July 31, 2008

GMAC Racks Up Another $2.5 Billion in Red Ink

GMAC posted its fourth consecutive quarterly loss of $2.5 billion in the second quarter.  The bulk of the losses, $1.86 billion, came from ResCap, the mortgage lender who has announced it has suspended almost all production outside the US.  Last month Cerberus, GMAC's private equity majority owner arranged a $60 billion debt refinancing package to stave off a bankruptcy filing of ReCap.  As much as I like to mock the clowns at Cerberus for making two of the worst possible private equity investments in the history of investing (the other being Chrysler), I have to hand it to them for having the energy and desire to concoct complicated financing deals to prolong the agony for investors.  Frankly, I'd have thrown the towel in a long time ago, buried my head in the sand, and prepared for a protracted legal battle in bankruptcy court.  So I give them bonus points for sticking it out and attempting to turn things around.  It doesn't mean I think they will succeed with either investment.  If GMAC isn't eventually torpedoed by ResCap, there's a good chance it succumbs to the precipitous decline in automobile sales.  The automotive finance unit of GMAC reported a loss of $717 million in the second quarter.  Furthermore, GMAC will stop subsidized auto leasing in Canada and is reducing new leases in the US which will not help GM sell more cars.  The decision to reduce leasing perhaps stems from the $716 million in impairment charges the company took from the declining value of leased vehicles.  GMAC has $30 billion in leases which includes $12 billion in SUVs and $6 billion in trucks.  Something tells me this is not the last impairment charge it will be taking on its SUV and truck leases.  The good news is, Cerberus can always pump up its profits again by using its precious cash to buyback GMAC's debt, which is trading at a discount.  After all, that has been a nice boost to earnings in the past.  How much longer investors will be willing to extend financing for this type of financial engineering remains to be seen.  Tomorrow, we'll see what type of financing package Cerberus can renegotiate with Chrysler's irritated lenders.  Will the negotiations succeed?  The only thing I know for certain is that Chrysler's borrowing costs aren't going lower.        

Wednesday, July 30, 2008

Fed Extends Lending Facilities

The Fed announced it was extending investment banks' access to the discount window (the primary dealer credit facility) until January 30,2009.  The program was originally set to expire in September.  The Fed is also extending the Term Securities Lending Facility through January.  The TSLF has provides $200 billion in 28-day loans of Treasuries in return for other unsightly types of collateral.  The Fed is also authorizing auctioning of options of up to $50 billion on the TSLF for exercise in advance of periods where funding pressures are elevated (i.e. quarter ends).  The Fed will begin auctioning loans to commercial banks lasting 84 days in addition to the Term Auction Facility, which will begin August 11 and will alternate with the $75 billion in existing 28-day loans.  The total credit under that program will be $150 billion.  Furthermore, the Fed is increasing the size of a swap line with the ECB due to significant demand for dollar funding from the Fed.  Detailed explanations of all of these facilities (in addition to a very handy mortgage map) can be found here at the New York Federal Reserve's website.  In summary, funding problems persist in the money markets and the Fed believes it has to be a lender of last resort to ward off potential liquidity issues that could lead to banking failures.  That is the optimistic viewpoint.  The pessimists would say that the Fed is taking on the funding risks of a fragile US banking system.  If the liquidity issues wind up becoming solvency issues then the Fed and US taxpayer is on the hook.  I'll let you decide which side of the fence you land on this debate.  

President Bush Signs Massive Housing Bill Into Law, Hopes For the Best

The parade of lousy news for the housing market continues unabated.  The MBA's mortgage applications index dropped 14.1% last week to an eight year low indicating that sales and refinancing activity continues to be sluggish.  Yesterday, the Case-Schiller home price index showed a 15.8% decline from a year earlier, showing little respite from sagging home prices across the country.  Meanwhile, in depressing homebuilder news, Centex reported that its fiscal first quarter net loss widened to $150.1 million, on a revenue decline of 41%.  Average prices for Centex homes in the first quarter fell 10%, the number of homes fell 35% and new orders fell 35%.  This was on the heels of Pulte's $158.4 million loss a week ago.   
I suppose President Bush decided that this was as good a time as any to sign a major housing bill into law.  President Bush signed the massive homeowner bill into law this morning.  The President had threatened the measure with a veto over a measly $3.9 billion provision that provided grants to states to purchase and spruce up foreclosed properties.  Given our President's propensity to spend billions at the drop of the hat, I found it very ironic that he would threaten a veto over a measure that was so innocuous.  Perhaps this provision just needed some better marketing, a fancy title like the "Repossess-Our-Homeland Security Provision" or the "Weapons of Homeowner Destruction Act".  Thankfully, our crafty Treasury Secretary, Hank Paulson, more than likely calmly explained the gravity of the situation using a slide show with a few charts and graphs detailing the recent stock performance of Fannie Mae, Freddie Mac and rest of the US banking sector.  The stock market's reasonably healthy performance during the latter half of President Bush's term had been the last remaining portion of his legacy that wasn't embarrassing.  So Mr. Bush picked up his pen, and signed the bill into law.  Now we wait.      

Tuesday, July 29, 2008

Merrill Marks CDOs to Market, Other Banks Cringe

During Merrill Lynch's earnings report on July 18th, CEO John Thain claimed that buyers were offering prices for the $19.9 billion in CDOs remaining in its inventory that were too low to justify a sale.  At the time, I argued that he was admitting that the assets were marked too high on Merrill's balance sheet and that it would required further write-downs.  I didn't realize it would happen within two weeks.  I find it extremely disturbing that the report of Merrill's CDO sale and new capital infusion came so close to the second quarter earnings report.  Frankly, it implies that the company's earnings report was a sham.  Nothing happened in the past two weeks that caused CDO prices to fall.  Merrill consciously chose not to mark the securities to market, arguing that the market was wrong and that its models were right.  It seems very hard to believe that the deal to sell the $11 billion in CDOs to a Lone Star affiliate, while providing the financing, was scraped together in two weeks.  It had to have been in the works and it implies that Merrill deliberately marked the CDOs at a higher price than where they were ultimately sold.  Had Merrill marked the CDOs to the price where it sold those assets a mere two weeks later, it would have reported a net loss of $10 billion rather than $4.65 billion.  That number may have proven too high for investors to stomach and would have spoiled the plans for the equity issuance.  Perhaps Merrill had to wait for the SEC to put a clamp on short selling first before announcing the deal?  Maybe Merrill thought it would sound better splitting the loss into two chunks?  I'm just making educated conspiracy theory guesses but something smells very fishy here.
Furthermore, now that Merrill has traded these assets at a price, and that price is roughly 20 cents on the dollar for "super seniors", they have marked the entire market.  Anyone holding CDOs of any variety will need to reference this trade when marking their assets until someone comes along and trades them at a different price.  Before yesterday, there was no price because there was no market.  Dealers could claim they were doing their best to supply a price.  I smell a slew of write-downs to come.  But no worries, only 20 cents to go before they go to zero, and then, we can safely say that the worst is over.   

Monday, July 28, 2008

Merrill Raising $8.5 Billion in Equity, Punting CDOs, Settling Dispute With SCA, Having Busy Day

SEC Chairman Christopher Cox was preparing to give himself a big pat on the back for rooting out those evil "naked" shorts and causing a monster rally in financial shares.  Now that the GSE's are getting a government guarantee and shorting has been all but outlawed, financial stocks can only go higher because they were so darn cheap to begin with, right?  The decline in financials in the past few trading days has perplexed those who really believed that the worst was behind us, for sure, and this time they really meant it.  Unfortunately, neither the SEC, the Fed, nor the Treasury Secretary can do anything about the deteriorating assets at banks, brokers, insurance companies, or any financial institution that paid no attention to declining underwriting standards in the past three years.  Take Merrill Lynch, for example.  After reporting abysmal earnings and selling its valuable stake in Bloomberg just a few short weeks ago, the company has outlined plans to raise $8.5 billion via equity issuance.  Merrill announced a slew of other measures in the press release.  I will focus on the most crucial components.  
Most importantly, Merrill announced a "substantial sale of US super senior ABS CDO securities resulting in an exposure reduction of $11.1 billion from June 27th, 2008."  Furthermore, Merrill has terminated some hedges with XL Capital.  This is really fabulous news!  The company is punting $11 billion of its most toxic garbage and settling the acrimonious dispute with XL.  If you scroll down a bit, you get to the not so good news.  The company needs to take a pre-tax write-down in the third quarter of 2008 of approximately $5.7 billion.  "The write-down is comprised of a $4.4 billion loss associated with the sale of CDO's, a $500 million loss on the termination of hedges with XL Capital and an approximately $800 million maximum loss related to the potential settlement of other CDO hedges with certain other monolines."  Scroll down even further and you get to the really juicy part about the CDO sale.  First of all, Merrill is selling $30.6 billion in gross notional amount of CDOs which were carried on Merrill's books at $11.1 billion at the end of the second quarter.  Merrill is selling these CDO's for $6.7 billion to an affiliate of Lone Star Funds.  But that's not all!  It is providing financing to the purchaser for 75% of the purchase price.  Better yet, the recourse on the loan will be limited to the assets of the purchaser and the purchaser will not own any assets other than those sold in this deal.  Got that?  Basically, Lone Star set up a fund with around $1.65 billion in capital.  It borrowed the rest of the money from Merrill to buy the $6.7 billion in CDOs.  If this really is the bottom, Lone Star gets all the upside.  If the CDOs go to zero, Merrill will lose $5 billion because it can't go after Lone Star's other assets, it only has recourse to the CDOs.  Although technically it looks like Merrill is getting rid of the assets, it still retains risk that the Loan Star affiliate will default or will be unable to meet margin calls and then Merrill will seize the collateral and be stuck with the ensuing losses.  This deal smacks of desperation, but Merrill is in fact desperate to put this mess behind it and move on.
As for the stock offering, Temasek Holdings, the Singapore investment fund has agreed to purchase $3.4 billion in Merrill's offering.  Temasek, if you recall, thought $48 was a great price for Merrill back in January, 2008 when the investment fund took a $4.4 billion stake in Merrill.  If you loved it at $48, you might as well buy more at $24.  Unfortunately, this will require regulatory approval as Temasek's stake was close to 9.4%.  Furthermore, Merrill has agreed to pay Temasek $2.5 billion due to certain obligations under reset provisions contained in Temasek's earlier investment, which Temasek will reinvest in the offering.
If you were wondering why Merrill's shares were taking such  beating in the past few days, even relative to its broker dealer friends, this is the news you've been waiting for.  Whoever knew about the common equity issuance did a fairly decent job of telling a few of his closest friends without having it wind up in the mainstream press (as a few of the untrue Lehman rumors did).  What do you call a rumor about a common equity issuance that turns out to be true?  That, my friends, is called insider trading.  Where's Christopher Cox when you need him?

Chrysler Caught in Catch-22

Chrysler has to refinance $30 billion of its lending arm's working capital by Friday.  However, the automaker has to offer financing to sell its vehicles, but has been losing money on leased cars as resale values have plummeted on SUV's.  What do you do when you need to offer financing to your customers to sell cars but you depend on your lenders to stay in business and they're not happy that you're losing money?  Chrysler has chosen to stop offering auto leases through Chrysler Financial beginning in August.  This drastic move is more than likely meant to placate Chrysler's lenders as it attempts to renegotiate its credit facility.  Not surprisingly, the terms on the new credit facility will be much less friendly to the automaker, in the neighborhood of roughly 2% over Libor (about three times higher than last year when it was originally negotiated.)  In summary, a combination of reduced sales from its inability to offer leases and significantly higher borrowing costs seem likely to torpedo the company in the very near future.  Not good news for Cerberus Capital, the private-equity firm that is attempting to bring the US automaker back from the brink, or its investors.  Nor is this positive for consumers who liked the idea of leasing so they could trade in cars every couple of years.  This may be even worse news for investors in Chrysler's debt as it does not bode well for the company's ability to generate revenues to cover its debt service.  Maybe if Cerberus wants to keep Chrysler afloat it should just start buying its vehicles in bulk.  That seems to be the only way out of this pickle. 

Friday, July 25, 2008

Can't the CFTC Find a Bigger Fish to Fry?

The CFTC has taken a civil action against Optiver Holding, a Netherlands-based oil trading firm and three employees for allegedly manipulating crude oil prices.  According to the CFTC's allegations, the traders attempted to manipulate the price of different types of oil during 11 trading days in March 2007.  This manipulation led to staggering profits of $1 million!  Other firms had to be involved given the gargantuan size of the profits.  I'm certain that the CFTC is on the verge of uncovering a collusive oil market manipulation scheme run by many firms that will all split up that $1 million profit.
Given how much attention has been paid to the idea that evil speculators are behind the spike in oil prices, I can understand that the CFTC has to appear as if it is attempting to discipline traders.  Otherwise, it will risk the suffering the same fate as Fannie and Freddie's soon-to-be former regulator OFHEO.  Unless the CFTC gets its act together and starts disciplining the speculator community, Congress with make up a new regulator and replace the CFTC.  So the CFTC pointed its finger at Optiver and its measly $1 million in trading profits.
Maybe a little simple math will help explain how ludicrous it is that the CFTC chose to go after these pea shooters first.  Crude oil futures trade on the Nymex.  One futures contract is equal to 1,000 barrels of oil.  Therefore, if you own 1,000 futures, if the price of oil goes up $1, you make $1 million.  So far today, according to the Nymex website, nearly 51,000 of the September crude oil futures contracts (the current front month) have traded.  The open interest on the September contract is 316,031 contracts.  The total notional amount of the 51,000 contracts that have traded today, using $123.86 as the price of oil, is $6.3 BILLION.  The notional amount of the open interest is $39 BILLION.  Hypothetically speaking,  if you bought all 51,000 of the contracts that traded today, with crude oil down $1.63, you would be looking at losses of $81 million.  Frankly, given the size of the market, I don't understand how anyone could or would attempt to manipulate oil prices to make a measly $1 million.  
The Wall Street Journal has quotes from two congressmen applauding the CFTC's action as some sort of useful measure in clamping down on manipulators.  The irony is that according to the complaint, the traders are accused of "banging the close" or trying to force the price down in the last seconds of trading.  The traders were quoted with saying things like "just whack the oil."  Congress has been beating the drum about manipulators forcing prices higher and the first case the CFTC brings is about traders attempting to manipulate prices to do down?  Perhaps the two congressmen quoted in the Commodities Report section of the Wall Street Journal didn't actually read the allegations before applauding the action.  
A far more interesting story would be to attempt to figure out what happened at SemGroup.  SemGroup declared bankruptcy on Tuesday after posting $3.2 billion in oil trading losses.  The company was short oil futures as a hedge against its physical assets.  Speculation is mounting that the liquidation of its oil futures positions may have led to some of the recent volatility in oil prices.  Here we're talking about billions of dollars in losses taken by a firm that was only trying to hedge its oil production.  Maybe something fishy was going on here?  If I were the CFTC, I'd focus on the billions in losses rather than the $1 million in profit.  Why?  Because if there really is manipulation going on in the oil markets, the manipulators reading the headlines think this is funniest joke they've heard in a long time.

Durable Goods Rise Unexpectedly, Foreclosure Filings Triple

In the ever-confusing world of conflicting US economic reports, today proved to be no exception.  New orders for US-made capital goods rose an unexpectedly healthy .8% in June, the Commerce Department reported.  Economists' forecasts were fairly wide of the mark as they were expecting a decline of .3%.  Excluding the volatile transportation component, orders were up 2.0% in June.  We can confidently put this report in the "good news" column for the US economy and the timing of its release could not have been better.  It should help to buffer the sting from the always-dreaded release of RealtyTrac's quarterly report on foreclosure filings which was flat-out terrible.  A total of 739,714 foreclosure filings were recorded during the second quarter, an increase of 14% from the first quarter and 121% from the same period in 2007.  Furthermore, bank repossessions were up as a proportion of total filings, representing 30% of the notices issued during the quarter.  California's Central Valley had the highest rate of foreclosure filings, one out of every 25 homes.  Riverside/San Bernardino had one filing for every 32 households.  Las Vegas, Bakersfield and Sacramento rounded out the top five.  The new home sales release is due out in a half an hour.  I'm no economist, but I'm guessing the number will not be pretty.  

Thursday, July 24, 2008

Sales of Existing Homes Nonexistent

Sales of US existing homes fell 2.6% to an annualized rate of 4.86 million from a 4.99 million pace the prior month.  Existing home sales are down 16% year-over-year.  The median home price dropped 6.1% from June of last year to $215,100.  Sales declined in three of four regions with only the West showing an increase in sales of 1% with the median price dropping by a whopping 17%.  This is perhaps indicative of the steep markdowns going on in California as lenders try to dump properties they repossessed as the result of foreclosures.  Inventories of unsold homes rose to 4.49 million from 4.482 million in May.  This represents an 11.1 month supply at the current sales pace.  Apparently, about a third of last month's sales were foreclosed properties.  According to the perennially cheerful chief economist of the National Association of Realtors Lawrence Yun "There are signs of pent up demand."  I'm not sure where he's been looking for all of that pent up demand.  Does he have potential buyers locked in his hall closet?  If so, for the love of God, let them out!  It seems hard to believe that there is any pent up demand with sales and median home prices declining month after month.  What is more than likely happening is that the market is adjusting to reflect actual demand by people who can afford houses based on reasonable lending terms.  We will not return to the free-wheeling days of 7.25 million existing home sales per year, the peak reached in September 2005, unless every single subprime and Alt-A lender that has gone bust is resurrected and resumes lending no-doc, negative am, option arm, cash-out loans.  And that is a reality that homebuilders, mortgage lenders, and investors must face before conditions improve.  

Update:  Freddice Mac's 30 year fixed rate mortgage average was up to 6.63% from 6.26%.  That is a mighty big leap in one week, due to both rising treasury yields as well as widening spreads.  Anyone who can tell me how this will affect next month's existing home sales numbers gets a gold star.

Qualcomm, Amazon, and BIDU Reward Investors, NCC and Ford Disappoint

First the good news:  Amazon, Qualcomm and BIDU are partying like it's 1999.  Qualcomm, announced it had settled a legal spat and reached a licensing agreement with Nokia after three years of litigation.  The company also raised its full year guidance by, what looks like two cents.  In June, Qualcomm forecast full-year earnings of $2.09 to $2.13 a share and it raised guidance to $2.11 to $2.13.  This was apparently worth over $10 billion in additional market capitalization.  Go figure.
In other happy technology news, Amazon and (touted as China's Google) both posted solid earnings results.  Amazon's earnings doubled, although some of the boost in earnings came from favorable exchange rates.  Although North American sales grew 35% over the prior year, down from a 38% growth rate in last year's second quarter, international sales jumped 47% compared to 31% last year.  Media sales accounted for 59% of the company's total revenue compared to 64% last year, indicating that the company is becoming more diversified. said second-quarter profit soared 87% over the year-earlier period on healthy growth in the number of marketing customers and revenue per customer., known as China's Google is actually besting Google on its home turf, with 60% of China's internet search market.  Apparently China has 221 million people online.  Potential growth in China, if all the billion or so people decide to come online is clearly awesome.  This is why is such an exciting stock to many investors.  The stock also routinely makes $40 moves, which makes it a favorite among traders with strong stomachs.
In horrible earnings news, Ford posted a second-quarter loss of $8.7 billion as it wrote down the value of truck plants and loans to buyers of pickups and SUV's by $8 billion.  Even excluding the unexpected writedown, Ford lost 62 cents a shares, nearly triple what analysts were expecting.  The company is "confident" it has enough liquidity.  But the company was also confident it would become profitable this year a mere three months ago before vehicle sales fell off the cliff.  
National City, reported a $1.76 billion loss, or $2.45 a share for the second quarter.  The company increased its provision for loan losses due to a surge in delinquencies, charge-offs, and non-performing assets.  You can read the gory details here.   

Wednesday, July 23, 2008

House Passes Legislation to Bailout Fannie, Freddie, Homeowners, Everyone

Landmark housing legislation sailed through the House today and is expected to pass through the Senate, bypass a Presidential veto and become law in a few days.  The bill amounts to a host of last minute measures cobbled together that throw money at several disparate housing problems.  The hope is that maybe one or two of them will actually solve a problem.  Most importantly, the bill gives Treasury Secretary Hank Paulson the power to inject capital into Fannie Mae and Freddie Mac and appoints a new regulator for the GSEs.  As I have noted before, I think it is appropriate for the Treasury to make their guarantee explicit given how the markets were in a complete panic a week ago.  A certain measure of confidence has been restored in the banking sector now that investors are less preoccupied with Fannie and Freddie's failure.  That confidence alone can ensure that the Treasury never has to inject capital.  Given their bloated balance sheets and huge amounts of leverage, Fannie and Freddie will need more capital if delinquencies and defaults rise (as they most certainly will given the absence of a bottom in housing).  But with a government guarantee in place, the firms will most likely be able to raise cash from the private sector.  Furthermore with a strict new regulator, theoretically we won't find ourselves in the same boat again.  I say "theoretically" because this is the Government we're talking about.  Lawmakers tried to appear as if they cared about limiting losses to taxpayers by tying any bailout of Fannie and Freddie to the federal debt limit.  Then they went and raised the debt ceiling by $800 billion.  
The portion of the bill that I am most skeptical of is the $300 billion Barney Frank brainchild that has been floating around for some time.  What Representative Frank proposes is that the FHA refinance up to $300 billion in mortgages of borrowers who cannot afford their current mortgage, into a more affordable mortgage.  Not only would the rate be lower but the principal would be reduced by a "significant amount," forcing the lenders to write down the value of the loan on their books, and extinguishing all second liens.  The borrower would then share in any appreciation in equity 50/50 with the government, assuming he lived in the house at least five years.  If he refinances or sells the property before five years, the government gets an even larger share of the equity (100% in the first year, 90% in the second, phasing by 10% until it hits 50%).  Presumably, if prices go lower, the homeowner will have all the incentive in the world to walk and leave the government with the bill.  There is no reason to believe that borrowers will default at a lower rate to the FHA than they would to a private mortgage lender.    
One major flaw in this bill is the idea that any American would give up his God given right to the equity in his home.  Owning a home in the US was touted for too long as the surest way to build wealth.  In parts of the country where home inventories are still very high and prices continue to drop, it seems unlikely that anyone would chose this option.  The logical choice would be to default, hand the keys back to the bank, go back to renting, wait 5 years or so for your credit to improve and buy another house where you get 100% of the equity.  While the bill claims that this will help 400,000 homeowners, my guess is that it will be far fewer than that.  You can read the rest of the 687 page document here if you're having trouble sleeping.  Trust me, it works.  I'm going to bed.

Tuesday, July 22, 2008

Wa Mu: What's Another $3.3 Billion?

Washington Mutual proved yet again that it could extract more value from its operations by firing everyone except a few beefy guys to shovel deposits into an incinerator.  Can a handful of former bankers work fast enough to incinerate $3.3 billion in a quarter?  It seems unlikely.  However, the bank had no problem burning through another $3.3 billion on its lousy portfolio of assets.  The Seattle thrift reported a net loss of $6.58 a share, which included a charge related to the $7 billion capital raise the company announced in April.  Excluding the charge, WaMu reported a loss of $3.34 a share.  Apparently, analysts, if you still care what they think, were expecting a loss of $1.05 a share on this basis.  Naturally, the stock immediately ripped higher after the earnings report.  Why?  I haven't a clue.  I suppose the same reason that Wachovia rallied nearly 30% after reporting an $8.9 billion loss before the open.  If anyone out there knows the reason, feel free to enlighten the rest of us.  In the meantime, I'll be scratching my chin until I come up with an explanation.        

Wachovia Issues Abysmal Earnings, Admits Golden West is Somewhat Impaired

I'll give Wachovia a bit of credit for warning investors that its earnings were going to be dismal.  When you are a week away from posting a nearly $9 billion loss, and the boneheaded analyst community is still anticipating a profit, it's wise to issue a press release.  Despite the warning, investors were a bit flummoxed by the bank's eye-popping loss of $8.9 billion.  Wachovia posted a loss of $4.20 a share compared with net income of $2.3 billion or $1.23 a share a year earlier.  Wachovia also slashed the dividend to a meager 5 cents a share from 37.5 cents and plans to fire 6,350 employees (updated to 10,750 employees in later news reports).  If you think this is all the bad news Wachovia will report, you haven't read the fine print.  Apparently Wachovia's $8.9 billion loss did include a $6.1 billion impairment against goodwill due to its acquisition of Golden West Financial. (please see updated note below) According to my calculations, however, Wachovia still needs to take at least an additional $9 billion to writedown the full $15 billion in Goodwill it holds against Golden West acquisition.  The inability of the company to face the reality that its ill-timed $25 billion acquisition of Golden West Financial was a complete mistake, is a sign that management is clearly still smoking crack.  14% of Golden West's $121 billion in Pick-A-Pay loans, 70% of which are based in declining housing markets of California or Florida, have zero or negative equity.  According to my calculator, that is $17 billion.  For more Pick-A-Pay ranting, please click on the link to all my prior Wachovia bashing.   
Above and beyond the Pick-A-Pay mortgage fiasco, Wachovia did include a $4.5 billion reduction in the value of commercial loans, plus $597 million in investment-banking assets.  So if you thought its lax underwriting skills were confined to residential mortgages, you were sadly mistaken.  As it turns out, the bank is pretty lousy at underwriting loans across the board.  Furthermore, it paid $144 million in legal settlements related to telemarketing and $975 million due to an adverse tax court ruling on lease transactions.  The really good news is that Wachovia was also raided by regulators last week in a probe tied to auction rate securities.  I'm sure that's not going to be expensive either.  Anyone who believes that this is the kitchen sink quarter and the company will start to post earnings again needs to lay the crack pipe down.

Update:  My original post did not include the $6.1 billion in goodwill impairment because the Bloomberg report I based it on has erroneously reported that the company was NOT taking a goodwill impairment charge.  My apologies for the confusion.  For an updated news report, here's the link to's story.

Monday, July 21, 2008

American Express Spoils the Finance Party, Apple Nosedives After the Close

American Express proved to be the finance party pooper after posting a 38% drop in quarterly profit following the close on Monday.  The company reported earnings of $653 million or 56 cents a share, compared to $1.057 billion, or 88 cents a share.  Analysts were expecting earnings of 83 cents a share and boy were they angry to find out how wrong they were.  They must've promptly called every investor on their speed dials and urged them to dump the stock as the shares fell over 10% after the earnings report.  Although investors have been greeting profit declines from all the banks with a cheer since the middle of last week, for some reason, American Express' disappointment was deemed atrocious.  Perhaps investors were angry that the company did not warn analysts of the coming miss so that they could have slashed their earnings estimates the week before the report to appear as if they served some sort of useful purpose in society?   Finding out in the earnings report is down right embarrassing.  Having to use forecasting skills to determine that the high end consumer is being affected by the slump in the economy, depressed stock market, and credit squeeze, well, that's just too much to ask of anybody.      
Speaking of the high-end consumer, Apple said on Monday that its current-quarter earnings would be well below Wall Street targets.   While Apple's earnings were respectable, with net income totaling $1.07 billion or $1.19 a share, forecasts of $1 earnings per share for the September quarter were below Wall Street's target range of $1.13 to $1.41.  The company shipped nearly 2.5 million Macs, up 41% from a year ago and 11 million iPods, up 12% from a year ago.  Apple sold 717,000 iPhones, more than double the amount a year ago when the product was introduced.  Although the company is clearly experiencing strong growth in all of its products, so much is baked into the stock price that it is difficult to keep pace with investors' expectations.  Apple's shareholders are facing a fate similar to what Google and Rimm's shareholders experienced before: a very strong performance in a difficult economic environment with a stock price that is priced for perfection.
Fear not for tomorrow brings a host of earnings news both before and after the close.  Sandwiched in between the news will be a full day of trading where investors will digest the earnings data and decide whether financials are a screaming buy, techs are a sell, neither or both.  Of course, if they decide that financials are a sell, they can't actually short the stocks or risk angering the SEC.  If only there were some other way to express a short position.  Maybe I'll give Black or Scholes a call, see if they can think of something creative that the SEC has never heard of.  In any event, with Wachovia earnings due before the bell and Washington Mutual after, something tells me the volatility is far from over.

Bank of America and Genentech Lead Market Higher

Bank of America gave yet another boost to financials following less than catastrophic earnings results from the large money center banks last week.  It says alot about the market we're in when a stock can rally 10% on news that it will not need an FDIC bailout this week.  Bank of America's net income declined 41% to $3.41 billion from $5.6 billion a year ago.  What investors were really cheering was the announcement by the bank that the Countrywide acquisition will supposedly add to profit this year.  I suppose that California regulators read that comment and began to salivate as they have now expanded their suit against Countrywide.  The California Attorney General is now alleging that the company handed out bonuses to its loan officers to steer borrowers into the riskiest mortgages possible.  I'm sure this comes as a complete shock to everyone.  I smell a very expensive settlement with the government in the making.
The most interesting part of Bank of America's earnings report was the fact that net charge-offs were up 33% from the previous quarter to $3.62 billion yet the provision for future bad debts fell 3% from the first quarter to $5.8 billion.  Thankfully, net charge-offs and the provision for loan losses are never correlated so it shouldn't be a surprise that the bank's charge-offs increased significantly without a corresponding increase in the provision for future losses.  Oh, wait a minute.  Nevermind.  
Meanwhile, in Biotech Land, Swiss drug maker Roche offered to pay $43.7 billion for the balance of Genentech.  Roche already owns 54.9% of the US biotech and is clamoring for control of the R & D.  Perhaps this signals the return of the buyout boom?  I suppose if Roche was a private equity firm and Genentech was a car company it might be a positive sign for buyouts.  But since Roche is a drug company and Genentech has the closest thing to the cure for cancer, I can safely say that this is probably just a one-off deal.  As long as the front page of the Wall Street Journal continues to contains stories such as the one today detailing the significant problems Cerberus is encountering in its attempts to refinance Chrysler's $30 billion in short-term debt, the private equity bust is far from over.  More importantly, as long as companies and consumers who benefitted from overly easy financing in the past couple of years continue to have problems refinancing their debt, the market malaise is sure to continue.      

Friday, July 18, 2008

Meanwhile, In Techland, Microsoft and Google Disappoint

Google and Microsoft both disappointed investors with weaker than expected earnings.  Google's earnings missed analysts' estimates, although profit rose to $1.25 billion from $925.1 million from the prior year.  Excluding some items, Google's earnings were $4.63 a share.  The stock is taking a bit of a beating today, essentially reversing the gains it took the last time Google reported earnings that surprised to the upside.  The company admitted that a pullback in the economy was affecting the rate of "paid clicks" on search advertisements that generate revenue.  The paid-click rate decreased 1% from the previous quarter but grew 19% from the same period a year earlier.  Clearly, the stock is slumping because investors expect surprises to the upside from Google, something the company has been able to deliver consistently.  The perverse logic of today's market indicates that it is better to lose $2.5 billion when investors are expecting losses of $5 billion, rather than make $1.25 billion when investors were expecting profits of $1.26 billion.    
Microsoft, on the other hand, posted profits of $4.3 billion, a 42% increase from the prior year's second-quarter on revenues of $15.8 billion, an 18% increase from the previous year.  Because Microsoft missed estimates by a penny and issued a weak outlook, the stock is down 5%.  While we're on the topic of Microsoft, I'm going to weight in on the Microsoft/Yahoo kerfuffle.  Back when every analyst in America was going on and on about how Microsoft desperately needed to pay upwards of $37 a share for Yahoo, I wrote a skeptical piece.  It was very hard for me to believe that Microsoft did not have the upper hand in negotiations.  After all, Yahoo was trading at $18 a share before Microsoft launched its initial bid that caused Yahoo's stock to rally to $28.  In the interim, talks have fallen apart, resumed, fallen apart again, resumed again,  and fallen apart....again.  So where do they stand now?  Microsoft wants Yahoo's search business, but it has made it perfectly clear that it is not going to pay a penny more than it believes the business is worth.  Yahoo's board is now facing a major uphill battle in an attempt to convince its shareholders that it can extract more value independently.  The market doesn't seem to believe that Yahoo's current board can organically grow the business, as the stock has slumped back down into the low $20's since Microsoft withdrew its bid.  Microsoft's latest blow came when it said it is no longer going to engage in negotiations with Yahoo's current board.  I believe that Yahoo's board will be given the boot by shareholders and Microsoft will claim its prize.  Microsoft may even win Yahoo (either in part or in whole) at a lower price than it originally anticipated.  Why?  Because we're in a bear market, Microsoft has cash and nobody else can afford to offer a counter.  Call me crazy and feel free to mock me if I'm wrong...       

Citigroup Earnings Better, Merrill Earnings Worse

Merrill's $4.65 billion net loss reported yesterday afternoon was a shock even to the most pessimistic analysts, who had all been caught up in an earnings estimate slashing frenzy for the past couple of weeks.  The investment bank posted a $9.7 billion write-down which was somewhat offset by the $4.43 billion sale of its stake in Bloomberg.  The company's second quarter loss was actually higher than its first quarter loss.  Apparently, the worst was not over for Merrill then.  Is it over now?  Frankly, it is a really bad sign when a company begins to sell its valuable assets while burying its head in the sand on its real problem.  Merrill's remaining CDO holdings fell to $19.9 billion at the end of June from $26.3 billion at the end of March.  Mr. Thain claimed that buyers are offering prices for CDO's that are too low to justify a sale.  What does this statement really mean?  They have these assets marked too high on their balance sheets and will need to take further write-downs.  Unless of course, the CDO market magically reinvigorates and buyers emerge out of the woodwork.  
The interesting thing is that sentiment has improved so much in the past two days that Merrill's bleak earnings report did not dent its stock price much for a very peculiar reason.  Citigroup, in a real shock to the market, reported a mere $2.5 billion loss.  The company only posted $7.2 billion in write-downs on its exposure to bond insurers.  Of course, Citigroup's assets remain at $2.2 trillion.  If I could get my hands on the current copy of the balance sheet, I would consider spending my weekend attempting to determine what future surprises lie buried in the morass of Citi's assets.  But I suppose I'll have to wait another 45 days for the 10-Q like everyone else and join in the current euphoria over a non-catastrophic earnings report.  It will give me some time to figure out how Freddie Mac plans to raise $10 billion in equity when its market cap is only $5.39 billion.

Thursday, July 17, 2008

CIT Losses $7.88 a Share, Stock Rallies to $7.64

While it's true that investors were anticipating a huge loss from the company due to the sale of its home lending business, you still have to hand it to CIT for beating estimates from analysts.  The beleaguered commercial lender lost $2.07 billion in the quarter.  Excluding the losing sale of the home lending business, the lender had a profit of $48.1 million.  The company increased credit losses by $60 million and spent $15 million more on interest costs (despite a lower interest rate environment).  Furthermore, the company spent $17 million on severance and $69.1 million to exit some real estate deals.  CEO Jeffrey Peek, claimed the results were "quite respectable."  I'd hate to see what he considers a weak quarter.  While investors seem to be willing to put the lender's dismal past behind them, the increase in delinquencies may be of concern.  Commercial borrowers who were at least 60 days behind on payments rose to 2.43%, compared with 1.7% in the first quarter.  If the company was out of the woods, the trend for delinquencies would be heading in the opposite direction.  But perhaps the stock is attempting to rally to $7.88 a share so that the math makes sense.  After all, can you lose $7.88 a share if you are only a $7 stock?  

Marginal JP Morgan Earnings Vs. Lousy Economic Number, Who Will Win Battle?

Yesterday's marginal earnings results from Wells Fargo (down 23% but exceeded estimates!) beat out a jarringly high CPI report and record low homebuilder confidence to propel the Dow up 276 points.  Not to be outdone, JP Morgan followed Wells Fargo with its own middling earnings report of a profit decline of 53% from the prior year that the market absolutely loves enough to ignore the abysmal housing starts number.  Housing starts rose due to a technical change in the way the index is calculated, but otherwise remained at 17 year lows.  The market is higher on what is perceived to be non-catastrophic results from two of the largest money center banks, which has caused a huge relief rally in the entire financial sector.  One has to wonder if the market is getting ahead of itself for a few important reasons.  First of all, we have yet to hear from Bank of America, Merrill Lynch, Wachovia, or Citigroup.  Merrill's decision to sell its Bloomberg stake for $4.5 billion, less than what it had initially anticipated is a sign that they are desperate for cash and are willing to part with some valuable assets (as opposed to perhaps the garbage that may still lurk on the balance sheet.)  
Most importantly, when banks report earnings, they do not supply a balance sheet.  In my opinion, it is nearly impossible to gauge a bank's financial condition without looking at the balance sheet.  Specifically for commercial banks, a line item called OCI (other comprehensive income) includes profits or losses taken on the bank's available for sale portfolio that the bank may deem as "temporary."  For some reason, investors seem to overlook this item, despite the fact that in times when spreads in the credit markets are at their widest levels in years, significant losses may be hiding in OCI, perhaps enough to wipe out reported earnings.  In any event the market seems to like the news for the time being.  We'll see how long this bear market rally lasts.   

Wednesday, July 16, 2008

WFC Earnings Vs. CPI, What Matters Most?

Wells Fargo released earnings that beat analysts estimates giving a much-needed boost of confidence to financials.  The company also increased its dividend by 10%.  Although Wells Fargo earned $1.75 billion, a 23% decrease from the prior year, revenues were up 10.3%.  You can read more specific details of their earnings here.  Wells Fargo's stock is up on the news, as are the stocks of other large money center banks in the hopes that things maybe won't be so bad when they report earnings in the next couple of days.  In this environment, a plus sign in front the net income column is greeted with huge cheers.  Can BAC with its Countrywide acquisition, JPM with its Bear acquisition, and Citigroup with its asset-puking do the same?  I'm skeptical, as usual.
Meanwhile, in economic news, the CPI report was none too friendly.  The headline number was up a whopping 1.1% and the core was up .3%.  The CPI release knocked Dow futures back down to earth after they had leapt on the WFC news.  The market is flat, while investors duke it out over what is more important: surging headline inflation?  Or the fact that maybe a bank or two might be left standing after the worst is over?  If the worst really was over, it would be easier to tell.

SEC Attacks Short Sellers, Subpoenas Rumormongers

The SEC, tired of being left out of the regulatory party, has launched a few initiatives this week to punish those who are responsible for the current credit crisis: short sellers and rumormongers.  Did you think it was irresponsible lending coupled with a lack of the most basic regulatory oversight of an industry gone mad with greed?  Nah, it was the short sellers.  They must be stopped!  Forgetting that Regulation SHO already exists, which stipulates that short sellers must confirm with their clearing firms that they can borrow shares before they short a stock, the SEC is still claiming that "illegal naked shorting" exists and is now forcing investors to actually borrow the shares before shorting a stock.  My question to the SEC:  If you think Regulation SHO is being violated, why not go after the firms who are in violation?  
The SEC has also subpoenaed several securities firms and more than 50 hedge fund advisors  seeking communications data related to short-selling and options trading in Bear Stearns and Lehman Brothers stock.  Good luck to them in determining who was shorting these stocks based on a genuine understanding of the enormous risks inherent in their businesses, or an attempt to manipulate their stocks by spreading bogus rumors.  The important thing is that the SEC looks like it is actually doing something.  In times of financial turmoil it is important to look very busy, or risk having your budget cut at the next congressional get-together.  Whether you are actually accomplishing anything useful is apparently not important.     

Tuesday, July 15, 2008

Can Anything Stop the Market's Downward Trajectory?

Back on March 31st, when Mock The Market was a mere one-month old, I wrote a post entitled "Are We In a Bear Market?"  Since I had virtually no readership at the time, I had to answer my own question, which was a resounding "yes."  Now that the market is down significantly since then, and everyone is clear on the fact that the worst is most definitely not over, what happens next?  What is going to stop the market from continuing to puke on itself like a three month old baby every single day?  Of all companies, GM finally did something that may be a step in the right direction.  GM eliminated the dividend.  This is a step that virtually every single bank needs to take to bolster confidence.  Any company that has significant liabilities supporting assets of an even marginally questionable nature absolutely cannot and should not pay a dividend until it is very clear that the US economy has stabilized.  Shareholders should understand the risks of purchasing stock and that a dividend is never a guarantee.  
After Bear Stearns failed, some pundits claimed that it was safe to buy stock in commercial banks and thrifts rather than investment banks because they funded their assets with deposits rather than less reliable borrowings in the money markets.  IndyMac's failure, however has now caused significant concern among investors that even institutions with a large deposit base are not safe if depositors panic and seek to withdraw money.  This is a particularly thorny issue for banks that hold a significant amount of illiquid assets.  If depositors rush for the exits and the bank does not hold sufficient amounts of liquid assets then the FDIC will have to step in again.
This brings us to the much bigger question that goes far beyond the average bank shareholder's suffering:  How much bailing out can the US government withstand?  What are the consequences of bailing out Fannie and Freddie and a host of other banks that are more than likely going to fail as the economy suffers?  Will the government also have to bailout GM?  What about the airlines?  Where do we draw the line and how bad is this really going to get?  Predictions range from the optimistic to complete and utter despair.  My opinion is that the eventual outcome will fall somewhere in the middle.  As I have stated many times before, I believe that many regional banks, specifically those that did significant amounts of construction lending in boom-to-bust areas will fail.  I also believe that some homebuilders will fail as well as some thrifts.  It is likely that another investment bank will need to be taken over.  But despite all of this, I still believe that it is a very positive sign that banks are facing the music, taking write-downs, and hopefully slashing dividends within the next few weeks.  It is what differentiates the US from Japan in the 90's. 
I think Paulson's plan to open the discount window to Fannie and Freddie is a very good idea.  It restored confidence in Fannie and Freddie's debt, which is crucial to the functioning of capital markets.  I am less crazy about the idea of the government taking an equity stake in Fannie and Freddie, but that alternative is much better than fully nationalizing the mortgage lenders.  Although the stocks of Fannie and Freddie have not reacted positively to the news, the alternative of doing nothing would have caused the market to be down significantly yesterday.  The upside to all of this is that stocks are cheaper.  They may not have bottomed yet but if you loved buying stocks last year when the Dow was at 14,000, you have to love them even more at 2005 prices.  Furthermore, unemployment is still low (remember when 6% was considered "full-employment?")  So maybe, just maybe the US economy is going to make it out of this mess very battered and bruised, but intact, and we aren't all going to have to move into our crazy uncle's bomb shelters.  That is my hope, at least.  If you've met my crazy uncle, you'll know exactly what I mean. 

Monday, July 14, 2008

Cerberus Newest Fund Down 1%?

According to Bloomberg, Cerberus Capital Management LP's newest fund is down 1% since inception in November 2006.  The $7.5 billion Cerberus Institutional Partners Series Four lost $32 million on $3.3 billion in investments through March 31, according to a copy of the investor presentation that Bloomberg News obtained.  Although this only includes results through March 31, I am going to have to call them out on that one.  There is no way that fund is only down 1%, given that it has huge stakes in Chrysler and GMAC, both of which are teetering on the brink of bankruptcy.  Let me be clear that I have absolutely no inside knowledge of the situation.  I barely have any outside knowledge.  I only know what I read in the financial press.  I know, for example that Cerberus led a group of investors that paid $7.4 billion for a 51% stake in GMAC in 2006.  I also know that GMAC completed a very complicated $60 billion restructuring to avert bankruptcy on June 4th due to its ailing ResCap mortgage unit that is bleeding cash.  I'm thinking, maybe, just maybe, they've lost a bit more than $32 million on just the GMAC investment?  Call me a crazy skeptic....  

Treasury and Fed Promise Bailout for Fannie and Feddie, SEC Crack Down on Rumors

Regulators worked overtime this weekend to concoct some sort of plan to stem a potential full-blown market collapse following a pummeling in financial stocks all week that culminated in IndyMac's failure on Friday afternoon.  The good news is that they seem to have been successful in implementing some level of confidence as futures are up this morning.  The bad news?  The prospect of the government shoveling tax money into Fannie and Freddie in the form of debt and equity financing could possibly turn into a very expensive proposition over the long term, depending on how poorly Fannie and Freddie's assets eventually perform.  Of course, the US government can print unlimited amounts of money to prop up the housing market, that is if nobody minds that a head of lettuce is going to cost $5 more in the afternoon than it did in the morning on any given day.  We won't even get into what it may cost to fill up your gas tank.

Sunday, July 13, 2008

What IndyMac's Failure Portends For the Market

Friday afternoon, Alt-A mortgage lender IndyMac was seized by the FDIC after panicked depositors withdrew funds totaling $1.3 billion within a few days.  The bank did not have adequate liquidity to continue to meet depositors demands for withdrawals and was forced to shut down.  The FDIC will now take over and attempt to perform an orderly liquidation or a sale.  The Office of Thrift Supervision (OTS) pointed the finger at Senator Charles Schumer accusing the Democratic Senator of causing the panic by leaking a letter to the press expressing concerns over the bank's solvency.  Mr. Schumer defended his actions claiming that the OTS should have done a better job of policing the thrift.  While Mr. Schumer has a point, I'm going to have to side with the OTS on this one.  What exactly is the point of sending an incendiary letter in a time when investors and markets are in a complete panic over the solvency of the US banking system?  What was Mr. Schumer doing when IndyMac was busy handing out no-doc loans in the housing frenzy of 2005-2007?  Holding hearings over baseball steroid abuse?    Yes that was a far more important issue than investigating significant anecdotal evidence of rapidly deteriorating lending standards in the mortgage industry.  
The failure of IndyMac was preceded by a week of extremely volatile trading in financial stocks.  By "volatile," I mean financials were on an incessant downward trajectory with barely an uptick.  Stocks of investment banks, thrifts, commercial banks, as well as Fannie and Freddie were all pummeled relentlessly on what some attributed to "malicious rumors" spread by short-sellers.  While perhaps rumormongering always persists in periods of tremendous uncertainty, I firmly believe that the plunge in financials was due more to mounting realization of the possibility of some very frightening scenarios.  Many have questioned Fannie and Freddie's solvency in the past, but for the first time last week, investors started to believe it and headed for the exists en masse.  The failure of Fannie or Freddie has massive implications for Wall Street, as well as Main Street.  It is why the government won't allow it.  Central banks are huge buyers of Fannie and Freddie's debt as are investment banks.  Investment banks also securitize Fannie and Freddie mortgage loans into MBS and trade derivatives with the housing behemoths.  I don't even need to mention that Fannie and Freddie guarantee nearly half of all mortgages outstanding.  If Fannie and Freddie weren't buying conforming mortgage loans right now, nobody could buy a house, unless you happen to have the cash for a 100% purchase.  Without financing, the housing market would collapse entirely.  
Arguments that the selling was overdone and the evil short-sellers should be prosecuted by the SEC fell flat on their face after the close Friday when IndyMac was seized by regulators.  The fears of bank failures are clearly not unfounded.  Many banks are still staring large losses in the face and will more than likely need to raise additional capital.  It is impossible to raise capital if investors are in a panic.  Confidence needs to return to the market before buyers will step in again.  The risks of a rapid failure of any financial institution is just too high for many to wade in to the market.  What will it take to restore confidence?  I have a few ideas:
  • Fannie and Freddie have to halt all dividends to common shareholders.  They must appear as if they are if they are actively preserving capital and not just issuing pointless press releases claiming they are adequately capitalized.  The market doesn't believe them.
  • The Fed should make a formal announcement that Fannie and Freddie can borrow from the discount window if necessary.  Why?  Because the stocks rallied significantly when this rumor reverberated around Wall Street on Friday and then fell when the rumor was debunked.  Any step that can restore a measure of confidence in the market should be taken.  The mere possibility of borrowing from the discount window has kept Lehman from succumbing to Bear Stearns' fate for the past three months.  Who knows what Lehman's future holds, but the discount window staved off sheer panic for at least three months, buying the company time to raise more capital and shed assets.  Lehman's chances of survival improved markedly because of this. 
  • Regulations should change to allow private equity to take larger than a 10% stake in banks without coming under regulatory scrutiny.  There are many good reasons why this regulation is in place, but most of the reasons are superseded by the fact that banks need capital and private equity has hinted that they are willing investors.  I have expressed much cynicism towards private equity here at Mock The Market, so perhaps some of my regular readers wonder if I've changed my tune.  Not exactly.  I'm still skeptical of the business model of piling loads of debt onto any company just because foolish lenders are willing to lend you money to lay off employees and pay yourself a dividend.  However, the market has clearly changed.  Dividend recaps are a things of the past, and private equity will really need to roll up their sleeves and enact real changes to turn the banks' fortunes around.  Frankly, if they have the money, are willing to take the risk, and want to work hard, I say let them.  The reality is, the alternatives are just too frightening.       

Friday, July 11, 2008

GSE's Rumored to Be Eligible for Discount Window

According to CNBC, the Fed is opening the discount window to Fannie and Freddie to help alleviate concerns about liquidity.  While this doesn't address questions about Fannie and Freddie's solvency, which is at the heart of the market panic, it does put an end to speculation that Fannie and Freddie won't be able to meet their financing needs.  The market is snapping back from the lows on this news, as it is indeed bullish, at least in the short term.  

Update:  My apologies for initially reporting this as news even though it was on CNBC.  Apparently, this is just a rumor, which explains why the market has turned around and gone back down.  In light of this error, I'm going to call it a day before I get accused by the SEC of spreading unfounded positive rumors that cause the market to rally!

Market Takes a Dive, Again

The market is tumbling again on very little hard news.  Fannie Mae and Freddie Mac are down 43% and 49% respectively on rumors of an imminent government bailout which would essentially wipe out shareholders.  Treasury Secretary Hank Paulson will be speaking at some point today to address concerns about Fannie and Freddie.  Frankly, I'm not sure how much this is going to help the financials.  I must express my surprise again that Fannie and Freddie are going to zero before the other broker dealers, given how much investment banks depend on Fannie and Freddie for business.  But the market is always full of surprises.  For example, why did everyone decide this week that Fannie and Freddie were basically insolvent?  Everyone already knew how leveraged they were and that they would need to raise capital to withstand further write-downs from the deterioration in their mortgage holdings.  But somehow, this week, people threw up their hands, decided enough was enough, and started blasting their holdings.  I would actually believe this was capitulation, except that when you're talking about highly leveraged players, capitulation isn't over until the stocks trade at zero.

Thursday, July 10, 2008

US Foreclosures Rise 53% in June, Doomsday Predictions Come out of the Woodwork

Foreclosure filings rose 53% in June from a year earlier and repossessions almost tripled, according to RealtyTrac.  Nevada retained its title as the Foreclosure Capital of America with one in every 122 households in some stage of foreclosure, more than four times the national average.  California and Florida came in second and third respectively.  California had seven of the 10 US metro areas with the highest rates, including the top three: Stockton, Merced, and Modesto.  
Needless to say, this data should help clear up any confusion over whether housing has bottomed.  It hasn't.  Foreclosures continue to rise, putting further pressure on prices which leads to homeowners walking away.  Banks repossess properties, sell them at a loss, forcing them to write down the value of their assets.  Banks are leveraged, so the write-down of assets necessitates a search for new capital which dilutes their existing shareholders and causes equity values to decline.  The vicious cycle continues until home prices reach an equilibrium point where buyers return to the market because houses look fairly valued.  The question investors have to ask themselves is: How many homebuilders, banks, lenders, and mortgage REIT's will go bust before we reach that equilibrium point?  In any major pricing correction, the highly leveraged players are always the first to go, unless of course they have an implied government guarantee, in which case they may be the last to go, but they will still go.  We've already witnessed most of the subprime lenders go belly-up followed by several hedge funds, a major investment bank, and a few Alt-A lenders.  But we're not done yet.  If you don't believe me, maybe you'll listen to a few sources with more credibility.  Former St. Louis Federal Reserve President William Poole believes that Fannie and Freddie are insolvent.  Coincidentally (or maybe not) credit default swaps widened again on Fannie and Freddie's debt this morning to levels not seen since March.  This on the heels of a serious bludgeoning of the stocks in yesterday's market meltdown.  Even the Wall Street Journal reported that the Bush administration is preparing a contingency plan in the event that the companies falter according to three people familiar with the matter.  The President was so desperate to appear as if he was up on the matter that he forced three sources to leak the news!  He may have even been heard saying "Can we out a few CIA operatives?  Maybe go to Defcon 9?  Orange Alert?  Do you think that would help the uh...situation?" before Paulson steered him back in the right direction.  In any event, the government is on alert.  Maybe we'll all get another $600 in the mail in a few months.  If you were too rich to get one last quarter, chances are you might be poor enough this time around.   

Wednesday, July 9, 2008

Wachovia Warns of Large Losses, Hires New CEO

Wachovia expects to post losses of at least $2.6 billion when it reports earnings July 22nd.  This equates to around $1.25 a share.  Analysts were expecting earnings of 16 cents a share, but I'll get to the part about how useless analysts have been in a minute.  The forecast includes a $4.2 billion pretax charge to build loan-loss reserves, $3.3 billion of which are related to "Pick-A-Pay" loans, which I have mocked relentlessly ad nauseam here at Mock the Market.  Furthermore, Wachovia expects to incur a goodwill impairment charge, the amount of which is still being determined.  Still being determined?  I sincerely hope that they did not pay Goldman Sachs a bunch of money to help them calculate a goodwill impairment charge that my next door neighbor's crazy cat could've coughed up with her next fur ball.  You don't need an abacus to do the math on this one.  They paid $15 billion more than book value for Golden West Financial.  Write the whole damn thing down already!
On to the analyst bashing.  On Thursday, June 26th, I wrote a piece about the speculation surrounding potential suitors for Wachovia and did a very quick analysis of the bank's financials.  I noted that Wachovia had $90 billion of option arms concentrated in California and Florida and $3.5 billion in deferred interest (interest they had booked as income that they had yet to collect from borrowers since borrowers were choosing to make minimum payments) as of the March 31, 2008 quarter end.  I also noted that Alt-A performance had deteriorated significantly in May. (Indymac's demise is further proof of this phenomenon.)  I went on to say that the company had yet to take any impairments against the Golden West financial acquisition and that it would need to take a significant write-down.  Frankly, I spent a couple of hours looking at the company's 10-Q and 10-K before I came to these conclusions.  The jokers aka analysts, who get paid gobs of money, spend all day looking at financials and somehow were expecting the company to post a profit.  How and why?  Because the worst is over?  If you read a major financial publication, have taken a basic accounting class and spent about 20 minutes looking at the company's financials, you could've easily concluded that they were going to lose money.
Wachovia made one other significant announcement:  The company hired Treasury Undersecretary Robert Steel as CEO.  This is actually a very positive development, not because he's a GS alum but because he has Hank Paulson's phone number.  It's always a good idea to know how to get in touch with the US Treasury Secretary.  Particularly if you are bank that may need a bailout in the near future.     

Indymac Out of Mortgage Business

Monday afternoon, Indymac Bancorp, announced it would exit the mortgage origination business and lay off 4,000 exmployees.  The company stated it was unable to raise additional capital or sell assets and had no choice but to shutter its lending operations.  Indymac claimed that no bids existed or bid/ask spreads were too wide on its mortgages so it was unable to raise cash in that manner.  Tuesday, Indymac agreed to sell its retail mortgage branches to Prospect Mortgage.  The company went on to say that it was facing "elevated levels of deposit withdrawals".
Indymac's decline has not been terribly surprising, given that most of its rivals have either gone bankrupt (New Century, American Home Mortgage,) faced near-death (Thornburg) or were forced into a merger (Countrywide.)  What this news triggers should be more fear about what risks remain on the balance sheets of all US mortgages lenders.  If Indymac couldn't sell assets because no bids existed for the mortgages, what does this portend for Washington Mutual and Wachovia, who are stuck with multi-billion dollar portfolios of option arms?  What about Fannie Mae and Freddie Mac?  The issue aggravating the market is not whether Fannie and Freddie will need to raise $75 billion due to an accounting change.  It is whether Fannie and Freddie's assets will deteriorate markedly due to surging defaults.  Do they have adequate capital to cushion against unprecedented levels of stress on their portfolios?  With banks and lenders going belly up at every turn, it's no wonder that the market is starting to panic.  After all, the Fed can't bailout everyone.

Tuesday, July 8, 2008

Bernanke Wants More Control of Investment Banks

In a speech delivered this morning, Federal Reserve Chairman Ben Bernanke stated that the Fed may extend the direct lending facility to investment banks into 2009 as long as emergency conditions "continue to prevail".  Continued access to the window, however, will have significant consequences for investment banks.  Bernanke once again defended the Fed's bailout loan to Bear Stearns in the face of the investment bank's imminent bankruptcy, and outlined a few strategies for avoiding future investment banking bailouts.  These strategies included the Fed having control over investment banks' capital, liquidity holdings and risk management.  Furthermore, in case the Fed proves not to be a much better risk manager than the financial firms, the Fed will put procedures in place to enact orderly liquidations of investment banks in the event that they fail.  Will the banking sector be a safer place with Bernanke running the show?  I would bet a few dollars on that, but only because my dollars are fairly worthless these days...   

Monday, July 7, 2008

Fannie Spanked, Freddie Pulverized on Lehman Analyst Note

Fannie and Freddie refused to take a breather from their heated race straight to zero.  Freddie won today's sprint with an 18% drubbing, while Fannie fell a mere 16%.  As if the recent horrible housing and economic news wasn't bad enough, a couple of Lehman analysts, hell-bent on dragging the entire financial sector into the toilet along with their employer's stock,  decided to put out a research note today claiming that an accounting change may force the two beacons of housing finance to raise an additional combined $75 billion in capital.  The analysts clarified that the companies would probably get an exemption from the rule making their research note entirely irrelevant, except for the part about $75 billion being a very large and headline grabbing number.  This is exactly the kind of skittish market where you can make a real name for yourself by issuing press releases touting large numbers for effect.  If I worked for Lehman, I would definitely be looking for every opportunity to get my name out there in the event that any of the 500 rumors floating around about my employer's possible liquidity problems turns out to be true.  
On May 14th, the day that Freddie Mac released earnings that "beat" expectations, I wrote a story about Freddie Mac increasing its Level 3 Assets by $127 billion.  I found this news to be incredibly alarming and was amazed that the stock ripped up to $27 on the news.  How can anyone possibly care about a $151 million loss that is "less than estimated" when $157 billion of Freddie's assets are being priced God knows where?  This from a financial firm that just had a major accounting scandal just a few years ago?  Investors chose to ignore the news about the increase in Level 3 assets and lapped up the new offering of common and preferred at prices roughly double today's prices.  Now investors are pounding the stock on a Lehman note that frankly isn't saying much of anything.  Spreads on Fannie and Freddie's debt are out at their widest since "the worst was over" in March.  This means more bad news for borrowers as rates are spiking again.
Fannie and Freddie won't fail.  If the Fed bailed out Bear, you'd better believe they'll bail out Fannie and Freddie for not only do they have an implied government guarantee, but they really are too interconnected to fail.  They also have combined debt of $1.6 trillion, with a capital "T" which is owned by investment banks and central banks all over the world.  No, they won't fail, but it doesn't mean the stocks can't go much lower.  And if Fannie and Freddie keep going lower, Lehman will be right there keeping the pace.        

Ambac Authorizes $50 Million Stock Repurchase Program

Investors in Ambac Financial have watched their investment fall off of a cliff in the past year, amid constant speculation about the bond insurer's solvency.  What does the board do to improve morale?  Authorize a $50 million share buyback, of course.  The good news is, you can buy truckloads of Ambac stock with $50 million dollars, as the stock is currently trading at around $1.35.  The bad news is, the company cannot begin to repurchase shares until the March offering of shares is completed by the underwriters.  For those who don't recall, Ambac issued 170 million shares of common stock in mid-March for $6.75 a share.  It also issued equity units with a distribution rate of 9.5% at an 18% premium to Ambac's stock price at the time.  I'm not sure what the hold-up is with the March offering (underwriters stuck with a bunch of underwater stock perhaps?), but if you bought in at $6.75 and are looking for a buyer, the company will gladly take if off your hands for $1.35.  Nice. 

BCE Buyout Back On! For Real.

In the on-again off-again world of stalled buyouts stuck in credit crisis purgatory, the BCE buyout has emerged relatively intact.  Somehow, despite litigation that threatened to derail the deal, the company has struck a compromise with its private equity buyers and lenders to reach a deal.  The purchase is due to close by December 11, essentially giving the lenders an extra three months to sell the debt used to finance the LBO.  BCE has agreed to suspend the $900 million dividend, effectively lowering the private equity buyers' costs.  This is much needed good news for the beleaguered buyout industry which is now littered with the corpses of busted deals and LBO debt trading at a significant discount to face value.  BCE stock is up smartly on the news, with investors assuming that this is a done deal.  But is it really?  Although the breakup fee was raised to C$1.2 billion, if equity markets continue to take a dive, the fee may start to look cheap relative to a completion of the deal.  Furthermore, the lenders still have to sell $34 billion in bonds and loans to finance the deal.  Although the banks have an extra three months to pull off this herculean feat, one has to wonder if any investors out there are clamoring for buyout debt in the current environment.  If the sale of the debt begins to look unlikely, the lenders may try to find another way out if legally possible.  Those sneaky lenders will do whatever it takes to avoid ending up saddled with even more assets they can't sell.  Somehow, I suspect this is not the last chapter in the BCE buyout saga.

Thursday, July 3, 2008

Penn National Gaming Pockets $1.475 Billion On Cancelled Buyout

The $6.1 billion leveraged buyout of Penn National Gaming by Fortress Investment Group and Centerbridge Partners has been cancelled. Penn will receive $225 million in cash from the termination fee. Additionally, the company will receive $1.25 billion from the purchase of Penn's redeemable preferred equity by Fortress, Centerbridge, Wachovia and Deutsche Bank.

The company said in a statement that the proposed transaction could not be completed without significant litigation. It went on to say that "A re-negotiated, reduced purchase price was not a viable option." Perhaps everyone involved read Monday's cover story in the Wall Street Journal entitled "Debt-Laden Casinos Squeezed by Slowdown". Actually, they didn't even need to read the story. Just the headline was enough to cause them to scrap the planned deal. Furthermore,the headline must have scared Penn so much that the company plans to use the termination fee to pay off debt. Penn National's CEO Peter Carlino expressed disappointment that the company's shareholders would not receive $67 a share from the merger. However, he stated "We may be in the gaming business, but we would never gamble the Company's future." Clever Man.

Lehman Celebrates Banner First Half By Awarding Bonuses

Lehman Brothers has opted to issue shares to all employees representing 20% of their equity compensation for the year.  According to the Financial Times: "The early partial payment of annual bonuses follows demands from employees who believe the stock, hammered this year during the credit crunch, is likely to rise significantly in value."  Let me get this straight.  Employees think the stock is too low, they are mad, so they asked to be paid bonuses right now.  The company, who worries about "talent" fleeing to competitors, decided to pay its employees part of their bonuses now, rather than waiting until the end of the year.  Do I have that right?  A few minor facts seem to be missing from the above interpretation, the most important being that the company is losing buckets of money and suffering from a major crisis of confidence.  I have a much better idea.  How about awarding bonuses after the company has dug itself out of the hole?  After all, bonuses are discretionary (although rare instances of guarantees exist).  Everyone gets a nice fat salary.  Nobody is going to starve without a bonus.  Furthermore, anyone out there that can name a single investment bank that is hiring more employees than it is sacking gets a gold star.
I understand that Lehman has a serious morale problem.  I certainly get that employees are really angry, particularly those that were going about their business slaving away in departments unrelated to the mortgage crisis.  However, that is one of the risks of choosing a career in investment banking, as opposed to something a bit more stable.  The money is good in good years because banks make oodles of cash.  In bad years, you should expect to get paid less and possibly lose your job during a big downsizing.  It happens every six to eight years, so I'm not sure why employees feel they are entitled to a bonus when their employer is getting absolutely annihilated.  If you want a steady, guaranteed income, go work for Proctor and Gamble.  Otherwise, how about socking away money in the good years so that when you think the stock is cheap, you can go buy some.  
Please address all hate mail to K10.

Wednesday, July 2, 2008

Merrill Analyst Says Buy GM at $40 and Sell It At $11

A Merrill Lynch analyst put out some groundbreaking research on GM this morning claiming that bankruptcy was an option for the auto company.  He reversed his prior buy recommendation (issued in February 2007 when the stock was at $40) and cut the stock to an "underperform" now that it is trading below $11.  I'm not quite sure what caused the analyst to change his formerly bullish opinion.  Perhaps it was based on one of the following reasons?
Since he didn't issue an apology with his downgrade to make up for being so incredibly ridiculously behind in following the GM headlines, I'm assuming he's not the least bit sorry for losing so much money for investors.  What I find even more absurd is that the stock actually sold off an additional 8% on the downgrade.  Who are the investors that use Merrill Lynch as their sole source of news?  How can anybody still be surprised by a report that claims that GM could go bankrupt?  Did someone actually receive this research report and then call every one of his brokers and scream "Sell all my GM!  All of it!  My analyst told me it might go bankrupt!"  It is price action like this that makes me a serious doubter of the "efficient market" hypothesis.  How on earth can all the negative news be priced into stocks when somebody actually thinks an analyst's opinion matters?     

JP Morgan Analysts Say "Worst is Over" For Banks

Bank stocks are experiencing a dead-cat bounce today on an analyst note issued by JP Morgan claiming that the worst of debt-related losses and write-downs are over for European banks.  Hmm, that refrain sounds awfully familiar, but I can't quite put my finger on where I've heard it before.  But since a bank analyst said it, it must be true.  Those guys are never wrong about anything.  Incidentally, analysts are currently predicting an earnings increase of 7% for S&P 500 companies for the full year of 2008 over 2007.  This would imply a very large bounce in earnings in the second quarter.  Even my one year old thinks that is a bit farfetched, and she spends most of her day repeating her mantra: "gum gum gum."  
In other bullish banking news, UBS Chairman, Peter Kurer said the bank won't be asking investors for new funds.  Well, that's a relief.  If the Chairman says they won't raise anymore money then it definitely must be true.  After all, UBS hasn't screwed up anything important in the past six hours or so.  Maybe Mr. Kurer has yet to factor in any of the cash the company is going to have to shell out to cover the settlements with the various regulatory agencies it is entangled with.  Even bear markets experience the occasional bounce, so I'll let the Bulls take over for the morning.  We'll see how long this rally can last. 

Tuesday, July 1, 2008

UBS Mess Gets Extra Stinky

Anyone who thought keeping up with the rumors swirling around financials was tough, should try keeping up with the actual news.  The banking sector is caught in a heated race to determine which bank can destroy its reputation the fastest.  It is hard to pinpoint an exact winner of the negative publicity wars, but UBS, for now, seems to have surpassed Citibank and Lehman to become the new Britney Spears of the financial world.  Every day begins and ends with some story about a loss, or enforcement action, much like Britney's every absurd move was documented until the extent of her carelessness turned the world against her.  Here are a few interesting parallels:
How much more painful news can a bank take before private banking customers start fleeing for the exits?  It's hard to say.  The public can be incredibly forgiving.  After all, Britney was invited to perform at the VMA's long after it was crystal clear that she was a complete train wreck.  Private client customers have yet to move their assets en masse.  But then again, where are they going to take their account?  Citi?  It is becoming increasingly clear that if you had significant assets you wanted to preserve, UBS knew how to keep them from being depleted by taxes.  It's what the Swiss are born and raised to do.  Unfortunately, regulators are not keen on tax evaders.  As it happens, attorney generals dislike fraud and investors hate to lose money.  Did these guys do anything right in the past few years?  They had very nice commercials.  U and US, UBS.  Very clever.  Although it appears as if they need to change their slogan to U and US PLUS the IRS.   

Wachovia Discontinues "Pick-A-Pays", Waives Prepayment Penalties

Wachovia has finally admitted that allowing borrowers to decide their own mortgage payments through its "Pick-A-Pay" loan product was completely idiotic.  The beleaguered lender announced yesterday that it was discontinuing the now world-famous "Pick-a-Pay" loan.  Wachovia also announced that it would waive all prepayment fees associated with its pick-a-pay mortgage to "allow customers flexibility in their home-financing decisions."  I must take a moment to comment on Wachovia's generosity.  After years of waiving principal and interest payments on its loans, it is now waiving the prepayment penalties!  I suppose Wachovia believes that waiving the prepayment penalties will encourage all of the borrowers currently trapped in pick-a-pays to refinance.  However, many of the current pick-a-pay borrowers have opted to pay just the bare minimum allowed, while their principal balances balloon and housing prices fall.  59% of them live in California, 10% in Florida.  Can any of these people actually qualify for any other mortgage currently offered?  If not, do any other lenders still offer option arms?  If so, give me a call, I have a few more puts to buy.  This brings me back to the question I pondered last Thursday in my last story about Wachovia: What is the $120 billion portfolio that Wachovia hired Goldman to "evaluate" actually worth? I'm guessing these loans aren't trading at par.  How big of a discount the loans would garner in the marketplace is a very serious question.  If it is anything higher than 50 cents on the dollar, I will be genuinely surprised.  Judging from the recent price action in the stock, investors are not waiting around for an answer.