Friday, October 30, 2009

The Duffman

Every once in awhile, when not busy crafting ridiculous headlines, Bloomberg actually writes fairly decent "exclusives" on interesting finance stories. Today's tasty treat covers Phil Duff, a finance whiz that flamed out in a rather large and embarrassing way in 2008. According to Bloomberg's account, Mr. Duff earned degrees from Harvard and MIT, became CFO of Morgan Stanley at 36, and was recruited as CFO to Tiger Management in 2000. Then, he founded his own hedge fund firm, FrontPoint Partners, which he sold to Morgan Stanley in 2006 for $400 million. So far, so good.

Not satisfied with this impressive winning streak, Mr. Duff decided to try to top himself. With much fanfare in March 2008, Mr. Duff founded Duff Capital Advisers LP, claiming it would be bigger than Tiger. He secured $100 million from Lindsay Goldberg, a $10 billion buyout firm in New York, and then promptly blew through all the money in under a year. Most hedge fund start-ups would consider $100 million in investment capital to be a gift worth investing right away, particularly during some of the most volatile and interesting markets we've seen in decades. But no, the $100 million was just working capital for Mr. Duff, that he used to create some fairly spectacular infrastructure for a massive fund, without really bothering to figure out how he was going to raise any capital. Mr. Duff signed a 15-year lease, costing $5.5 million a year, on 43,400 square feet of office space in Greenwich Connecticut. The new digs had a custom food court, two jumbo flat-screen televisions, showers, a boardroom table for 20 and a skylight with panes that filtered bright light to keep traders from squinting. Did I mention Mr. Duff's $39,000 desk? Mr. Duff hired approximately 104 employees and offered some of them lucrative pay packages, although several actually invested in the fund by purchasing shares.

Right before Lehman's collapse, Linsay Goldberg started asking some questions. Well, actually just one important one: Why are you spending so much money and not earning any? They eventually forced Mr. Duff to fire many of his employees and eventually forced him to hand over control of the firm. The firm was renamed Investment Risk Management Group and changed its focus to developing risk analysis tools. The company was strung along until May 21st, when Lindsay Goldberg finished raising its next private equity fund. Cause really, embarrassing failures like this need to be swept under the rug until new investment capital is raised. The private equity concern was forced to settle with some of the former employees over a pay contract dispute, but everyone signed NDAs, so nobody's talking.

Stories of hubris and excess like this sometimes make me thankful for the great recession of 2008. Anytime people begin to resemble cartoon characters, particularly from the Simpsons, you know we are due for a correction. Mr. Duff should've seen the writing on the wall when he ordered his $39,000 desk.

Thursday, October 29, 2009

GDP Finally Up

  • After a full year of wrenching declines, US GDP rose by a seasonally adjusted 3.5% annual rate in the third quarter. The gain was driven by consumer spending, which rose by 3.4% in the third quarter compared with a 0.9% drop in the April-June period of 2009. You can thank our federal government for cash for clunkers, the first time home buyer tax credit, and the piles and piles of stimulus cash showered on the economy. But with unemployment at 10%, and consumers continuing to shed debt, it seems unlikely that this sort of momentum can hold for a sustained period of time. Equity markets are not impressed, posting a meek rally this morning.
  • Another hedge fund scandal hits the tape, with the founder of K1 (no relation to K10, I promise) Helmut Klener arrested in Germany amid a fraud probe. The hedge fund is entangled in an international criminal investigation after banks including Barclays, JP Morgan, BNP Paribas and Soc Gen were saddled with $400 million in losses. Apparently the fund of funds deceived the banks when borrowing money to boost returns. Unheard of! In any event, details are forthcoming and likely to be juicy.
  • The Fed has finished purchasing its $300 billion in Treasuries, having met its quota, and grown tired of playing patty-cake with Treasury. The program has kept long term interest rates artificially low for the past seven-months, allowing lots of folks to refi into much lower interest rates on their mortgages. Lower rates have also led to a massive spurt of bond market issuance by firms, particularly since it's so tough to get a bank loan these days. The low interest rate mortgage boom, however, will continue as the Fed's much larger $1.25 trillion game of patty-cake with Fannie and Freddie goes on through March. Given how much money Wall Street dealers have made being the middle man between the Fed and Treasury and the Fed and Fannie and Freddie, it sort of makes you wonder why the Fed didn't cut them out and trade directly with the other government entities. In any event, rates are likely to head higher so get your refis done while you still can.
  • Here's a quick update on the Lembis, my favorite local real estate mogul family that punted generations' worth of real estate wealth in a few short years. Walter Lembi, managing director of the San Francisco based Lembi Group, is wanted for passing around $298,500 worth of bad checks at Caesar's Palace. Mr. Lembi was about as good at gambling away his money at the tables as he was with gambling away the real estate fortune that it took his family decades to build. Apparently, Mr. Lembi is no longer living in his Burlingame home, the address that was listed on court documents so authorities are having trouble tracking him down. Maybe they should check in one of his old apartments? Although judging from all the lawsuits, his tenants hated him so much, they're likely to rat him out.

Wednesday, October 28, 2009

Blackstone Hoping to Renegotiate Hilton Debt

I give Blackstone bonus points for attempting to fix its pesky $20 billion Hilton debt problem before the crud actually hits the fan. Apparently, the private equity group is hoping to convince holders of the debt to make some minor adjustments, like swapping their crappy debt for crappier equity, or extending maturities out even further, maybe until 2050 when the commercial real estate market starts booming again. Blackstone is even offering to contribute $800 million in additional equity to buy back debt at a discount. So many fancy accounting and financing tricks, so little time. The problem is it is hard to escape a turkey of a deal like the Hilton LBO, that was struck during the fairy tale days of the credit bubble. Unfortunately, it is hard for us to escape the Hilton LBO as well, for the Fed owns $4 billion in Hilton bonds, courtesy of Bear Stearns, via that awesome $29 billion risk-free loan the Fed gave to JP Morgan so it could purchase the more solvent portions of Bear. The only good news is that the terms of the debt limit Blackstone's ability to repurchase Hilton debt.

Blackstone is hoping to cut the debt load by $5 billion, as I'm sure that will make its equity portion worth more. After already writing off the investment by two-thirds, Blackstone needs all the help it can get to make its investors whole. I wish them luck with their negotiations. Personally, as a senior debt holder, I'd tell them to take a hike. Maybe cough up another $5 billion in equity? Then we can talk.

Mr. Bernanke is probably just getting a phone call right now from Steve Schwarzman asking him to take a haircut on the Fed's Hilton debt. Mr. Bernanke wonders out loud "How'd we wind up owning Hilton bonds?" An assistant whispers something in his ear. He sighs, then picks up the phone to call Blackrock, to find out what to do...

GMAC Needs More Dough. Again.

As if $12.5 billion weren't enough, GMAC is knocking on the Treasury's door, looking for another $2.8 to $5.6 billion. You know, just to tide things over until the next bubble kicks in. I'm still a bit perplexed as to why we are bending over backwards to keep GMAC afloat. Sure the auto finance concern has $181 billion in assets, but it can hardly be described as a systemic risk to the market. While it is true that GMAC provides crucial financing to the auto industry, which the government is now firmly invested in, I just don't understand why the bankruptcy option wouldn't work here. Essentially what we are doing is bailing out GMAC's creditors instead of forcing them to take a hit, like they should be doing for having made such a lousy investment.

What is so irritating about this particular bailout is that we have moved past the point of worrying about a global financial meltdown. The economy, although still fragile, seems to have stabilized, and now we're just randomly picking and choosing who deserves money from the government and who doesn't. Why is cheap financing for the auto industry more important that, say, providing cheap loans for small businesses? CIT was allowed to fend for itself and will likely wind up in bankruptcy soon. But GMAC, no GMAC, we have to continue to shovel money into because everybody has to buy cars. How on earth did it become a national priority that everybody needs cheap financing to buy a new car every couple of years? I know that in the grand scheme of things, another $5 billion or so is insignificant, but I still consider it to be a nice chunk of change that could be better spent on at least 50 other things that are more important for the future of this country.

Monday, October 26, 2009

Capmark Files For Chapter 11

Capmark Financial, one of the nation's largest property lenders with $20 billion in assets, has filed for Chapter 11 bankruptcy protection. Capmark used to be the commercial lending unit of GMAC, the residential mortgage lending arm of GM that has since received excessive amounts of government aid. Seems like everything that GMAC ever touched was bound to be a lousy investment. At least GMAC had a bit of foresight in spinning off Capmark in 2006 to KKR, Goldman Sachs Capital Partners and Five Mile Capital Partners, who paid $1.5 billion in cash to acquire the doomed commercial lender. I'll let you guess what that investment is worth today.

Capmark has a bank in Utah with $10 billion in assets that is not part of the bankruptcy filing. However, the bank has been warned by the FDIC that it needs to boost its capital levels. The bank makes and holds commercial mortgages making it a likely candidate for seizure by our friends at the FDIC. Speaking of the FDIC, it closed seven banks on Friday bringing the YTD total to 106. Now if that isn't bullish news for the stock market, I don't know what is. Otherwise, I have no explanation for this morning's rally.

Friday, October 23, 2009

Existing Homes Sales Boosted By Expiring Tax Credit

Existing homes sales were up a whopping 9.4% to a 5.57 million annual rate from 5.09 million in August. August was revised down slightly from down 2.7% to down 2.9%. The level of 5.57 million is the highest since 5.73 million during July 2007. So, the housing market is partying again like it's 2007. Sort of. The median price was down 8.5% year-over-year to $174,900.

In other encouraging news for housing, inventories declined to a 7.8 month level, down from 9.3 months in August. Furthermore, the percentage of distressed sales represented 29% of sales, down from 31% the prior month and 45% to 50% in late 2008 and early 2009. Huge volumes selling at rock bottom prices with inventories returning to relatively normal levels point very strongly to a bottom in housing, if it weren't for three nagging questions:
  1. What about the foreclosure pipeline? NODs, delinquencies and foreclosures are still rising, with mortgage mods merely delaying the inevitable.
  2. When the tax credit expires, are sales going to plummet again, similar to the expiration of the cash-for-clunkers program?
  3. What happens to interest rates when the Fed stops its unprecedented purchases of Treasuries and MBS? (hint: rates are going higher)

AMZN, MSFT Boost Nasdaq

Microsoft handily beat analysts estimates, posting first-quarter net income of $3.574 billion or $.40 cents a share, down from $4.373 billion or $.48 cents a share last year. Revenues for the quarter were $12.92 billion, down from $15.06 billion in the prior year's quarter. Better than expected but still down year over year. Nevertheless, the stock was up 10% on the open, but has given some of that back as the rest of the market is not participating.

Amazon, on the other hand, is up a whopping 20%, on some very robust earnings results. Third-quarter profits were up 69% helped by a 44% rise in sales of electronics and general merchandise. Net income for the quarter increased to $199 million, or 45 cents a share, from $118 million or 27 cents a share in the year ago quarter. Overall sales were up 28% to $5.45 billion. Amazon is forecasting sales growth between 21% and 35% for the fourth quarter, with net income projected to rise between 10% and 56%. Great numbers in the face of a tough retail environment, but the stock is now trading at a 74 p/e. A bit much perhaps?

Thursday, October 22, 2009

LTCM Take Three

John Meriwether is back. Remember him? The founder of Long Term Capital Management, the hedge fund that blew itself up in 1998 and almost took down Wall Street with it? Then there was JWM Partners, a vehicle he set up right after Long Term's collapse, a much more conservative fund that only lost 44% in last year's crisis. Mr. Meriwether wound that one down, presumably not thrilled about the prospect of having to work for free to get back to that high water mark again. Not one to rest on his laurels, Mr. Meriwether is launching yet another fund, this one to be called JM Advisors. Has he discovered some new money making scheme? Nah, he's planning to stick to his tried and true strategy of relative value arbitrage, aka "making a little money for a few years before you give it all back in one fell swoop." Anyone willing to invest in this new vehicle deserves exactly what they get. But pensions and endowments should not be allowed in.

Wednesday, October 21, 2009

Pay Czar Puts Down Foot, Sparks Sell-Off

Kenneth Feinberg, the Treasury Department's special master for compensation (aka "the pay czar") has used his new found powers to slash proposed compensation for the 25 highest-paid employees at the seven firms receiving extraordinary amounts of government aid. The firms include Bank of America, Citi, Chrysler, Chrysler Financial, GMAC, AIG, and GM. Mr. Feinberg will also demand a host of corporate-governance changes at those firms. He is set to lower total comp for 175 employees by a jaw-dropping average of 50%. The biggest cuts will be to salaries, which will drop 90% on average. Details are forthcoming but the person familiar with the matter who leaked the story to the press has revealed that no employee within the AIG Financial Products group will receive compensation of more than $200,000. Any ordinary American reading the news might shrug his shoulders and say "What's the big deal? That's still three times as much as I make." But the employees working for the unit are probably used to making much more and are currently in a state of shock. Will they all walk out on their jobs in protest? That's the interesting question. Will it matter one way or the other? Probably not. The government is not getting its money back on that turkey whether it pays top dollar for "talent" or not.

The market had an interesting response when the news hit the tape. All of the banks stocks sold off on the news. It is as if everyone panicked and said "Oh my God! All the talent is going to leave to start their own hedge funds because of the threat of comp getting slashed across the board." The funny thing is if all of the bank stocks actually slashed their comp expenses by 50%, that would be a huge boost for shareholders. Bank stocks should've rallied on the news. Goldman has set aside over $16 billion for compensation this year. Cut that down to $8 billion and the firm just made another $8 billion in profits, which is equal to more than the past two "record" quarters of earnings. Oh but right, if you cut comp by 50%, all the talent is going to scurry away and the firm will be left with a bunch of monkeys that buy MBS from Fannie and Freddie, finance them at zero percent interest rates and then mark 'em up and sell them to the Fed. And we can't have monkeys doing that kind of rocket science unless we pay them $700k a year. No, the smart folks will go to greener pastures at, I don't know, Citi? AIG Financial Products? Galleon?

Galleon to Liquidate After Redemption Requests

Say you have some money tied up in a hedge fund that has posted nice returns for some time. Then one day you pick up the WSJ and the founder is on the front page in handcuffs claiming he's innocent of the insider trading charges brought against him and the insider trading ring he was allegedly running with some of his good buddies from Wharton. Guess what? It turns out that some of the hedge fund guru's charitable giving was funneled to Sri Lankan rebels too. That's right about the point where you put the paper down, make a phone call, yank your money out and put it into some money market fund currently yielding .002%.

No surprise then that Galleon has been swamped by redemption requests and is liquidating assets in order to unwind. A buyer is even circling around the fund, looking to scoop up any remaining assets. Innocent or not, investors don't care to wait around to find out. Why would you? After all, the market's up, the fund has had good returns so far, and serious legal issues are never something that sharpen a money manager's investing acumen. Mr. Rajaratnam will be preoccupied defending himself for some time to come.

Tuesday, October 20, 2009

Housing, Apples and Guns

  • Housing starts climbed a less-than-anticipated 0.5% to a seasonally adjusted 590,000 annual rate compared to the prior month. August starts were revised lower to an increase of 1.0% from an initial report of a 1.5% increase. Building permits dropped 1.2% to a 573,000 annual rate. Permits were expected to rise by 2%. A slightly disappointing report for all those housing cheerleaders.
  • Apple posted a 47% quarterly profit jump on strong sales of iPhones and Macs. iPhone sales were up 7% year over year and Mac sales were up 17% year over year. Revenues were up 24% to $9.8 billion. Like Google, reporting a year-over-year increase in sales is rare and greeted with yet another pop in the stock price, even after strong run-ups in anticipation of good earnings.
  • The WSJ reports that Cerberus, everyone's favorite private equity group, is preparing to IPO its company called Freedom Group. Freedom is a combination of several gun and ammunition companies that Cerberus has been acquiring over the years, when it wasn't busy punting money on bankrupt automakers. Freedom is hoping to capitalize on a surge in gun and ammo sales this year and in contrast to most of its other investments, this one should actually be a winner for the beleaguered investment group. The article is accompanied by a photo of a girl who looks around 12 years old testing a Bushmaster rifle. Who says financiers don't have a humanitarian side?

Monday, October 19, 2009

Insider Trading is So 2008

Following on the heels of the arrest of Galleon Group co-founder Raj Rajaratnam, the Feds are finally threatening to crack down on insider trading. Anyone who regularly trades in the options market knows that this practice has gone on undetected and unpunished for years. Don't believe me? Here are just a few examples from the many I witnessed during my career as an options market maker:
  • A certain bio-tech stock which had fairly thinly traded options had a customer that always managed to buy out-of-the-money calls right before the company released positive phase three drug trials and FDA approvals.
  • Several really lucky options traders happened to buy a boatload of out-of-the-money calls for $.10 on a regional bank stock the day before expiration, which also happened to be the day before JP Morgan bought the bank for a huge premium.
  • My personal favorite was the purchase of loads of out-of-the-money puts in Merck for a $.05 the day before expiration, which happened to be the day before the company announced it was pulling Vioxx from the shelves. The stock dropped at least $10 on the news.
In fact, point to any M&A deal, and I'll guarantee that right before the merger is announced there is an unusually large amount of options activity. It starts with the traders who have the inside information making their bets. It is immediately followed by the piggy backers who assume that somebody knows something even if they don't so they'd better get involved. Finally, it ends with the traders who originally traded against the insider traders panicking to cover before their faces get ripped off when the actual news is announced. Is this really what we want when we talk about "efficient" markets?

Perhaps with the arrest of the billionaire Raj Rajratnam, pictured on the front page of the WSJ with Hank Paulson of all people, things will change. This particular alleged insider trading ring involved traders at hedge funds as well as executives from high-tech and health-care firms who gave them material non-public tips. The whole thing sounds like something out of the 80's but is probably far more commonplace than most of us would like to think. The ring is accused of making illegal profits of $20 million, but I'd wager it's far more than that given that Galleon was a multi-billion dollar hedge fund with decent returns. Authorities, however, only need to prove a few choice instances of insider trading to ruin the hedge fund and send the culprits to prison.

According to Bloomberg's story on the new hardline taken by Federal investigators on insider trading, the targets of the investigations, which have been going on for two years, include hedge-fund managers, lawyers and "other Wall Street players." Some probes rely on wiretaps, like the aforementioned Galleon case, while others depend on a "secret SEC commission data-mining project set up to pinpoint clusters of people who make similar well-timed stock investments." I guess the secret is now out of the bag. Who knows if any of these methods will catch another big fish? But perhaps all they need to do is scare investors into avoiding any suspicious looking activity. So next time you pick up the phone and Bud Fox tells you that "Blue horseshoe likes Andecott Steel" do yourself a favor and hang up.

Friday, October 16, 2009


We'll start with the lousy earnings news and work our way up:
  • Bank of America posted a net loss of $1 billion or 26 cents a share, compared with a profit of $1.18 billion a year ago. The loss was mostly due to $2.6 billion in write-downs from an improvement in credit spreads and a $402 million charge from a payment to the US government to get out of an asset-guarantee deal tied to the incredibly stupid and expensive purchase of Merrill Lynch. To add insult to injury, CEO Ken Lewis, who is stepping down at the end of the year, will receive no comp for this year and will be asked to refund the $1 million in salary he has collected for the year. This should be fairly easy to do as he is slated to receive around $69 million or so in retirement benefits.
  • GE, the finance firm that likes to pretend it is an industrial conglomerate, posted a third-quarter profit of $2.49 billion, or 23 cents a share, down from $4.31 billion or 43 cents a share. GE Capital's profits dropped by 87%, and will likely weigh on GE's earnings for some time, regardless of any improvements in the industrial part of the business. This is because GE Capital doesn't have to mark-to-market so its assets will just bleed to death rather than take large hits. But luckily, the company had the pleasure of issuing government guaranteed debt through the crisis to stave off a liquidity problem. The industrial side of the company seems to be doing well with an increase of 3% in its backlog of orders for big-ticket equipment, maintenance and other services.
  • IBM posted fairly decent numbers, although the market seemed not to like them enough to sustain the recent rally in the stock. Profits were up 14% on an increase in margins on a 6.9% decline in revenue. IBM also raised its full year guidance for next next year to at least $9.85 a share from its previous forecast of $9.70.
  • Google continues to impress. The highly profitable tech outfit actually had an increase in revenues of 7% from the year earlier quarter to $5.94 billion. Revenues were up 8% sequentially as well. Profits grew even faster as net income rose 27% to $1.64 billion. Google's stock is the only one up this morning after its earnings results.

Thursday, October 15, 2009

Goldman, Citi Temper Dow's Enthusiasm

While Goldman's earnings were better than expected, the stock has been unable to maintain its recent momentum. Although nearly anything impresses the equity market these days, beating earnings expectations when everyone is expecting you to beat earnings expectations is met with a ho hum reaction by investors. Go figure. Goldman posted a profit of $3.19 billion or $5.25 a share, up from $845 million or $1.81 a share a year ago. Revenues doubled to $12.37 billion. The best performing areas were the fixed income, currency and commodities trading group (once again, why on earth are investors and analysts not perturbed that the company lumps earnings from these units together?) and principal investments. Shocker that their principal investments rose when nearly every single asset class on the planet rallied in the third quarter. Little doubt, however, that these guys know how to make money when they are handed every opportunity on the planet by the federal government.

Citi, on the other hand, is still struggling under the weight of all of its bad lending and investment decisions during the credit bubble. The bank actually posted a profit, mostly due to an $851 million gain from its securities-exchange efforts in the quarter to convert the US government's preferred to common. Citi posted a profit of $101 million, compared with a year-earlier loss of $2.82 billion. If you include preferred dividends, which you should because that is cash out the door, the company lost 27 cents per share. Revenue rose 25% to $20.4 billion. One positive note is that cash and deposits jumped 17% during the quarter. However loans fell by 11%. Not good news for a weak economy that needs its banks to lend to spur growth. Just more evidence that the government's efforts to prop up the banks have only succeeded in propping up the market and banker's pay packages, and have not yet succeeded in feeding into the real economy.

Wednesday, October 14, 2009

Clock Ticking For Manhattan Apartment Complex

My vote for most preposterous real estate transaction of the bubble, Tishman Speyer's $5.4 billion purchase of Stuyvesant Town in 2006, is two months away from defaulting on its massive debt load. The problem? When the deal was put together, lenders were projecting that the complex's net operating income would triple to $336 million in 2011 from $112 million in 2006. Since net income is projected to be around $139 million this year, it's a bit of an understatement to say that rents are lagging. Meanwhile, that nifty $400 million interest reserve that was supposed to service the debt while rents skyrocketed to the moon was down to its last $33.7 million at the end of September. With a $16 million monthly burn rate, I'll let you do the math. A special servicer is taking over the handling of the CMBS, which is very necessary considering what a debacle this default will become once the various lenders begin to argue over who gets what when so little is left. A recent valuation of $2.1 billion on the properties would wipe out all the equity, mezzanine and some of the senior debt. The geniuses at Tishman, who put this deal together, don't seem to have too much on the line financially, as they left the honor of holding the bag to the folks like the retirees of California (via Calpers' $500 million investment), the Florida State Board ($250 million), GIC (the people in Singapore who probably don't know their government invested over $575 million in a crappy NY real estate deal) and the God-fearing folks at the Church of England (only $70 million but locusts and general pestilence might ensue at Tishman's headquarters.) Fannie and Freddie own $1.5 billion in senior debt. But at least it's senior, so the US government should recover significantly more than the aforementioned losers in this giant turkey of an investment.

JP Morgan, Intel Earnings Boost the Market

Who knew that force feeding banks free money, while allowing them to hike rates and fees and easing mark to market rules would provide such an earnings bonanza? JP Morgan didn't miss a trick this quarter posting a profit of $3.59 billion or 82 cents a share, handily beating analysts estimates of 52 cents a share. Revenues were up 81% to $26.62 billion. A sure sign that the bank's good fortune isn't necessarily being passed on to the rest of the economy is that loan balances continued to shrink despite a stabilization in assets and deposits. Credit-loss provisions which were $9.8 billion, up $3.1 billion from a year earlier and $100 million from the previous quarter painted a more sober view of the bank's business. Net charge-offs surged to 6.29% from 3.39%.

Meanwhile, in Techland, Intel, the chip giant, served up better than expected earnings as well, posting net income of $1.86 billion on $9.39 billion in revenue. Although these numbers were largely better than expected, revenues were still down 8% year over year. Intel also raised its revenue guidance for the fourth quarter to around $10.1 billion.

Now that everything is back to normal, and Wall Street is talking about doling out record bonuses again as if nothing ever happened and they didn't cause a financial meltdown that wrecked our economy and required government intervention, can we please ratchet back some of the crazy monetary policy the Fed is doling out? Please? Like maybe before the dollar goes to zero and gold goes to $5,000 an ounce and oil to $250 a barrel?

Tuesday, October 13, 2009

CIT CEO to Resign

With CIT's bankruptcy a near certainty after a failed attempt to swap crappy debt for longer dated, even crappier debt, CIT's CEO Jeffrey Peek thought it might be a good time to resign. Mr. Peek, as some might recall, left Merrill in a huff in 2003 after being passed over for the top job, a job I'm certain he would've been very good at. If anyone could've lost more money at the helm of Merrill Lynch than Stan O'Neal, it would've been Jeffrey Peek. Instead, he joined CIT, where he took a relatively conservative lender to small businesses, levered it up with short-term financing, and then loaded it up with subprime garbage. In comparison to Merrill, CIT only punted a cumulative $5 billion over nine consecutive quarters, a mere pittance, but it was enough to bring the lender to its knees, pleading for a debt swap with its lenders. In any event, a pre-packaged bankruptcy is likely in the cards soon. Too bad Mr. Peek won't be sticking around to clean up his own mess.

One would think that after all the high profile debacles of the past couple of years, where CEO after CEO has been forced out for making terrible mistakes or just not paying attention, that the cult of the CEO would be dying down a bit in the US and comp packages would be cut severely. Other than maybe Warren Buffett, Steve Jobs, Sergey Brin and Larry Page, is anyone else really worth all the money corporate boards throw at them? Ironically, the aforementioned CEOs don't even work for the money, they do so out of passion for their companies. But no, particularly at financial firms, you see a return to the mentality of "I'd better get paid alot of money because I'm the only talented person who can do this job." And boards buy into it every time. That's because it's easier to rubber stamp a high compensation package than it is to stop a CEO from putting a company on a path to ruin.

Monday, October 12, 2009

Earnings To Begin in Earnest

This week marks the beginning of a deluge in earnings reports. We'll hear from banking heavy-weights like JP Morgan and Goldman Sachs (both busy allocating bonuses), as well as lightweights like Citi (getting lighter by the quarter as it expected to post yet another loss.) In the meantime, here are some highlights from this morning's financial rags:
  • Potential bidders for one of the many half-built bankrupt Las Vegas luxury casinos, Fountainebleu, are attempting to decide whether it is worth paying anything to assume the liability of spending another $2 billion to finish construction. Penn National Gaming is supposedly expressing interest.
  • Foreclosures are hitting the high-end, with about 30% of foreclosures in June involving the top third of local housing values, up from 16% three years ago, according to This is likely due to the souring economy, as well as recasts on Alt-A and option arm loans that continued to be underwritten well after the subprime market came to a screeching halt.
  • Interesting article in the WSJ about venture capitalists shutting their doors, particularly in recent outposts like Dallas. Disappointing returns and an inability to attract money for new funds is causing many less established venture firms to wind down. CenterPoint Ventures was not able to raise a new fund in 2007 after investors demanded to see returns from earlier funds. The nerve of investors actually wanting to see returns before handing over more cash! Overall venture fund-raising this year is down sharply, with just 83 new funds totaling $8 billion raised in the US through the end of September, compared to 205 new funds totaling $30.5 billion in 2006.
  • KB Home is being investigated by the SEC for its accounting. Add this to the long list of scandals in KB Home's recent past, including accusations of stock option manipulation by its chief executive and federal charges that it engaged in improper mortgage lending.
  • The trial of former Bear Stearns hedge fund managers Cioffi and Tannin will begin in Brooklyn tomorrow. This one will be interesting.
  • The US Pay Tsar is cracking down on executive pay among lower level employees at AIG. Naturally everyone will leave if they aren't paid enough, except for the new CEO, who's allowed to keep his $7 million annual salary.
  • Citigroup was hit with a $600,000 fine for helping wealthy clients evade taxes through the use of total return swaps. Apparently this is merely the first in a wide crack down against Wall Street banks, most of which apparently use this strategy. I'm sure they're all quaking in their boots at having to take that $600k hit.

Friday, October 9, 2009

Citi Finally Does Something Right

No, I'm not talking about getting high marks for its managers from some bogus consulting firm that the board hired to conduct a government-mandated review. Although, according to the WSJ, Citi passed the preposterous test, which involved asking managers such tough questions such as "how effective are your colleagues?" No wonder the FDIC is skeptical about the rigors of the review.

What I'm giving Citigroup high marks for is offloading its Phibro unit to Occidental. Ever since the furor erupted over Andrew Hall's $100 million pay package, I have been advocating that the bank get rid of the unit. It's not that I don't think Mr. Hall deserves to get paid a boatload of money when he generates sizable profits. It's that I don't think anyone working for a firm that essentially went bankrupt and only has a pulse due to government assistance should be paying out those sums to anyone, no matter how profitable their individual unit was. Rather than deal with the political backlash of having to defend Mr. Hall's pay, it's just easier to get rid of the unit so the firm can concentrate on the more important business of managing its multi-trillion dollar balance sheet. Oh sure, Mr. Hall's unit made some money for the bank over the years, but it was a drop in the bucket compared to Citi's enormous losses. Furthermore, it is a proprietary trading business, which means the unit could easily misfire and lose a bunch of money too. Most importantly, the idea of bailing out Citi was to protect depositors and avoid the catastrophic consequences of the disappearance of a large lender to consumers and businesses. It was not to protect large pay packages to employees and support a commodities casino business. No, that was merely the government's intention when it bailed out Merrill...

Thursday, October 8, 2009

Noteworthy News and Economic Data

Some snippets of noteworthy news:
  • The FDIC's sale of the assets of Corus went off without a hitch. The winning bid of $2.7 billion was supplied by TPG, Starwood Capital and the FDIC, who bested seven other willing buyers of Corus' tasty pile of mostly defaulted construction loans. Of course, the FDIC is providing the dirt cheap financing (as in zero), and is taking a 60% equity stake. Essentially, the FDIC is selling the assets to itself, as well as an option to TPG/Starwood for all the upside. No wonder it got such a good price.
  • Consumer Credit declined by $12 billion, continuing its contraction streak for the seventh month. As I seem to point out every month when the number is released: this is good news for the long-term as consumers need to ween themselves off of credit, but short-term it doesn't help the recovery.
  • Jobless claims fell by 33,000 to 521,000, the lowest level since January 3rd. Continuing claims also fell by 72,000 to 6,040,000. The numbers are still very high, but still an improvement.
  • Alcoa kicked off the already hyped earnings season by posting an actual profit. It's been awhile since Alcoa has been able to pull off this amazing feat, three quarters to be exact. The company attributed the performance mostly to cost-cutting measures taken earlier in the year.
  • The strip mall vacancy rate hit 10.3%, the highest since 1992, which coincidentally may be the last time I actually went to a strip mall. This bleak report follows on the heels of equally lousy vacancy numbers released on offices and apartment buildings.

Wednesday, October 7, 2009

Fed Worries About Commercial Real Estate

Ok, so maybe it's a bit too late to start worrying about the impending commercial real estate crisis, since it's already begun. But at least one of our regulators has finally woken up and smelled the rot lying on our nation's banks' balance sheets. The WSJ reports that the Federal Reserve made a presentation to banking regulators last month that claimed that banks in the US "are slow" to take losses on their commercial real-estate loans that are being battered by slumping property values and rents (please see prior two posts.) The Fed document was prepared by an Atlanta Fed real-estate expert who is part of the central bank's Rapid Response program to spread information about emerging problem areas to federal and state banking regulators. While this is hardly a rapid response to a problem that reared its ugly head over a year ago, I'll give the boys at the Atlanta Fed bonus points for being ahead of the bank regulators, who allow reckless lending at a financial institution right up until the day the FDIC locks the front doors.

Banks with heavy exposure to commercial real estate loans set aside just 38 cents in reserves for every $1 in bad loans, according to an analysis by the WSJ. This is a sharp decline from $1.58 in reserves for every $1 in bad loans from the beginning of 2007. The WSJ's analysis included more than 800 banks that reported having more than half of their loans tied up in commercial real estate. To make a precarious situation even worse, many US banks have adopted a policy of extending loans when they come due even if they wouldn't make these loans now. It beats the heck out of going through the hassle of seizing the property, attempting to dump it on a market that has little appetite for commercial real estate, and taking a loss because the value of the property is below the loan amount. Best to keep your head firmly buried in the sand, and continue rolling that loan until everything returns back to "normal circa 2007." Another really ingenious tactic used by banks is the practice of using interest reserves to mask bad construction loans. When the loans are made, banks typically calculate interest that would be paid and set that money aside, paying themselves until the loan becomes due or the property generates cash flow. What happens when the developer is stuck with a half-empty building because he couldn't sell or lease the units and he can't get another loan at the same terms? That's when the bank finally takes the hit, even though all the clues were there to begin with.
How big is this problem? $3.4 trillion dollars of commercial real estate debt is outstanding, with more than half held by banks. Obviously not all of it is going to go bad, but much of the issuance from the past five years might unless a solution is found to the refinancing problem. With commercial real estate values already down over 30% and headed for steeper losses, nearly every property financed in the past few years is under water. Most commercial real estate loans are short-term in nature and investors just assumed they could refinance when the loans came due. Are they really going to cough up extra equity to hang on to buildings that they overpaid for? Or are they just going to hand the keys to the bank? Seems like banks need to beef up their property management arms because they are going to wind up owning alot of buildings. But don't worry, the Fed's Rapid Response Team is on it.

Office Rents Decline, Vacancies Rise

On the heels of yesterday's dismal news about apartment vacancies comes today's update on office space. Nationwide, effective office rents fell 8.5% in the third quarter compared with the same period a year ago, according to Reis. Companies returned a net 19.6 million square feet of space to landlords in the third quarter, slightly more than the second quarter. The net decline in occupied space totaled a record 64.2 million square feet, the highest negative absorption recorded by Reis since 1980 (excluding the 2001 terrorist attacks.) The vacancy rate hit a five-year high of 16.5%.

Declining rents and rising vacancies are a really bad combination, unless, of course, you are looking for new digs. The biggest office rent declines over the past 12 months came from New York, the epicenter of the financial meltdown. The highest vacancy rates, however, come from areas with poor housing markets and industrial cities such as Southern California, Las Vegas, Phoenix, southwest Florida, and Detroit. Of the 79 metro areas that Reis tracks, office vacancies rose in 72 of them and effective rents declined in 68 of them. Some charts from the WSJ below:

Tuesday, October 6, 2009

Apartment Vacancies Grow

US apartment vacancies hit their highest point since 1986, with the vacancy rate hitting 7.8%, according to Reis Inc. The rate is expected to climb further in the fall and winter when rental demand is typically weaker. Consequently, rents are down across the board, with the biggest declines in San Jose, New York and Orange County. The slump in rent and increase in vacancies is tied to rising unemployment, particularly in the under-35 age group. Reis anticipates that the vacancy rate will peak at well above 8% in mid-2010. Some charts below from the WSJ:

Monday, October 5, 2009

FDIC's Bair Gives "Secured" a New Definition

Bloomberg has an article this morning claiming that FDIC Chairman Shela Bair believes that regulators should consider making secured creditors carry more of the cost of bank failures. "This could involve potentially limiting their claims to no more than, say, 80% of their secured credits," Ms. Bair said yesterday while giving a speech in Istanbul, where hopefully nobody was listening. "This would ensure that market participants always have some skin in the game, and it would be very strong medicine indeed." I'll say. In fact, the medicine would be so strong that it might kill a few banks along the way. The whole point of secured financing is that secured investors can rely on being first in line to collect 100 cents on the dollar before anyone else gets a penny in a bankruptcy filing. If you are no longer assured of that outcome, you are no longer a secured investor. You are now "slightly secured and charging a much higher rate" or maybe "mostly secured and asking for WAY more collateral" or possibly "just not doing secured lending anymore." So, I'm thinking that cutting off secured funding on struggling banks is not going to help those banks stay alive, which is not going to help the FDIC's insurance fund, which doesn't really help Ms. Bair do her job of paying for bank failures.

Hovnanian Plans $775 Note Sale to Pay For Tender

First, let me just commend Hovnanian for still being in business. The beleaguered home builder is number one at the top of many investors' lists in the homebuilder death pool. The problem? The company took on too much debt to go on a land-buying spree during the boom and is struggling to pay off that debt while the value of its inventory has declined along with its revenues and profits. To solve the problem, the homebuilder came up with a brilliant plan. Hovnanian will buy back its debt that is trading at a discount, allowing it to book a profit. Of course, it doesn't really have the money, which is kind of the problem to begin with. But, no worries. They'll just issue some debt. Debt investors have proven time and time again that they are total suckers, so the plan should work well. Issue debt, buyback debt, book profit, stay in business a few more years. It's called kicking the can down the road.

Friday, October 2, 2009

On Jobs and Cars

Nonfarm payrolls declined by 263,000 in September, according to the Labor Department, bringing the total jobs lost since the recession began in December 2007 to 7.6 million. The unemployment rate climbed to 9.8%. Those cheery economists, all of whom have been busy ratcheting up expectations for growth next year, were only expecting a loss of 175,000 jobs. While a job loss of 263,000 is not half bad compared to some of the horrific numbers we were seeing earlier in the year, continuing job losses of this magnitude cannot possibly support the "green shoots" crowd's hopes for a V-shaped recovery.

Car sales didn't do much to paint a rosy economic picture either. US auto sales fell 23% in September after the end of the federal government's "cash for clunkers" program. Both GM and Chrysler's sales dropped precipitously, with GM's declining by 45% and Chrysler's by 42% while Ford had a better month, with sales only declining by 5%. It's really too bad that consumers didn't feel any sense of patriotism when they were picking out their new cars. After all, the government wrote them a check. The least they could do was support their investment in GM in Chrysler by buying their cars. But it was not to be. With total car sales declining back to a 9.2 million pace, roughly in line with the numbers we were seeing before the government's program, it appears highly likely that this stimulus measure was merely a temporary blimp that did nothing to jump-start demand for the longer haul. Hard to have demand for a new car when you can't find a job.

Thursday, October 1, 2009

Ken Lewis Steps Down

In what is being billed as a "completely surprising" move, Ken Lewis is stepping down as the CEO of Bank of America. What is most surprising is that he had the chance to voluntarily depart. While credited with building the behemoth into a large money-center bank, Mr. Lewis also nearly destroyed it by continuing his acquisition spree during the credit crisis. Purchasing Countrywide and Merrill Lynch may have been good "strategic" moves, but they would've been much better has he paid less for them. It is still hard for me to believe that anyone in their right mind would've offered to pay so much for Merrill Lynch when the investment bank wouldn't have lasted another week without some sort of financial intervention. Maybe he missed out on taking that negotiations class in business school?

It's unclear whether it was the investigation by the SEC, the House Committee on Oversight and Government Reform or the New York attorney-general finally got to Mr. Lewis. All we know from press accounts is that Mr. Lewis came back from an Aspen vacation with a beard and resigned to a very shocked board, who'd been sitting around doing lord knows what for the past several years. The board certainly didn't do anything to stop the ruinous acquisitions, or keep Bank of America from paying out huge bonuses to Merrill for pissing away $15 billion. Why would it have occurred to them that they might need to actually do some work, like find a new CEO? The FT speculated about a few likely successors, the most interesting of which was Bob Steele. Mr. Steele was the former Goldman Sachs executive who was recruited to save Wachovia when it was falling apart last year. He did a bang-up job of turning the firm around as it was eventually seized by the FDIC and auctioned off to Wells Fargo. But he did work at Goldman once, so he's obviously a genius and will probably get the job.