Weak Economic Data Persists, Microsoft Surprises Market

Housing starts fell 15.5% to a seasonally adjusted 550,000 annual rate, after dropping 15.1%  in November to 651,000.  November was revised slightly higher from an original 18.9% drop, but seriously, who cares?  When the numbers are falling off of a cliff, does it really matter if the drop is 15% or 18%, the result is still the same: UGLY.  Year over year, housing starts were an astonishing 45% below the level of construction in December 2007.  Building permits decreased 10.7% to a 549,000 rate.  Economists were expecting permits to decline by .8%, so a huge miss in expectations.  As I've stated before, due to the significant supply/demand imbalance in the housing market, builders need to stop building houses for awhile until the housing inventory levels stabilize.  Go build a few bridges or fix an interstate.  Just stop building new houses.

Jobless claims jumped 62,000 to 589,000.  The four-week average of new claims remained unchanged at 519,250.  Speaking of people filing for unemployment, somebody at Microsoft had too much coffee this morning and decided to announce earnings before the opening bell, instead of after.  Microsoft announced it will cut as many as 5,000 jobs over the next 18 months.  Revenue for the quarter ended December 31 was up 2% to $16.63 billion, while earnings slipped to $4.17 billion or 47 cents a share, from year-earlier earnings of $4.71 billion, or 50 cents a share.  Analysts were expecting earnings of 49 cents a share on sales of $17.08 billion.  The company also neglected to offer profit and revenue guidance, citing market volatility.  In other words, much like everyone else, they have absolutely no idea what's going to happen in the coming year and don't even want to hazard a guess.  But just to be on the safe side, they are cutting costs.  Consequently, the stock is getting a beatdown.  

Apple Beats Earnings and Other Tech Highlights

Forget gold, the only store of value in this market is the iphone.  The economy can't be all bad if consumers are still choosing to spend hundreds of dollars on a fancy iphone when they can get a stripped down cell phone for free.  Apple gave a much-needed boost to the market by posting solid earnings and offering decent guidance for the current fiscal quarter.  The company reported net income for the quarter ended Dec. 27, 2008 of $1.61 billion or $1.78 a share.  Apple noted that it expects earnings of 90 cents to $1 a share on revenue of $7.6 billion to $8 billion, somewhat below consensus estimates, but not horrible, which is considered fabulous news in this economy.  Still, Steve Jobs' health problems are a big risk for investors, particularly as the company is now being prodded by the SEC for disclosure issues related to his health.  More than almost any company, Apple's success hinges on Mr. Jobs' unique vision and leadership skills.    

Meanwhile, over at Ebay, things aren't looking as rosy.  One would think that a brutal recession would cause more and more consumers to buy used crap from random people online rather than anything that's for sale at Neiman Marcus but Ebay shoppers are pulling back.  The company lowered guidance for the first quarter.  Revenues are now expected in the range of $1.8 billion to $2.05 billion, with earnings expected in the $.21 to $.23 range, far below analysts estimates.  Note to analysts:  Throw a few more darts at that dart board and try again. 

Intel and Microsoft announced cost cutting measures.  Intel plans to consolidate manufacturing and close 5 factories which will affect 5,000 to 6,000 employees.  Microsoft, set to report earnings today, is expected to announce cost cutting measures as well.  Analysts expect the company to reduce full-time positions and cut contract workers and outside vendors.  This from a company that has roughly 90% margins and massive cash pile-ups every quarter because it doesn't know what to do with all that money.  But that will be the theme for the year:  Cut some costs, hunker down, and try to survive the brutal downturn.  

Broadway Partners Defaults, Causes Turmoil in CMBS

The Wall Street Journal's Property Report has a great article today detailing how complicated (translation: ugly) a CMBS deal can get when a default is involved.  At the center of the new turmoil in the CMBS market is Boston's famed Hancock Tower and Broadway Real Estate Partners, one of the poster-children of the debt-fueled commercial real estate binge that based its investments on unrealistic cash flow assumptions.  I wrote about Broadway back in April 2008.  Broadway had extended its short-term loan on several properties and was looking for creative new ways to raise capital.  At the time, I enjoyed analyzing and speculating about the impending fissures in the commercial real estate market which was still viewed as immune to the credit crisis.  During the peak of the credit boom, I had often wondered why on earth anyone would buy an illiquid asset with a significant amount of short-term financing that carried much higher rates than the sub-3% cap rate from the property.  What was I missing?  Why did the math just not make sense to me?  Was my abacus just not calibrated correctly?

The answers to my crazy questions are quite clear now as deal after deal struck in 2007 is winding up in complicated angry negotiations with lenders and investors.  Broadway's recent default on the loan tied to the Hancock Tower, and other buildings, will certainly keep the lawyers gainfully employed.  Complicating the matter, the $700 million loan was securitized into mezzanine debt split between nine investors, including Five Mile Capital, BlackRock, RBS (now part of the UK government), Lehman (now bankrupt), and State Street (still kicking, just a really bad day in the market yesterday.)  At least State Street didn't buy the mezz debt because it thought it was a nifty investment, State Street seized the collateral from Lehman after Lehman defaulted on a repo.  What makes this whole kerfuffle somewhat interesting, particularly to the lawyers, is that the foreclosure process is not straight forward in a mezzanine deal.  The property is to be appraised and those investors who are the most junior according to the appraised value, get to decide whether to foreclose.  With commercial real estate values plummeting, and very little property actually changing hands due to a lack of financing, finding an appropriate valuation for the property that everyone can agree on is perhaps not so easy.  Consequently, determining who is the junior creditor who has control over the foreclosure is disputable.  And dispute they will.              

What's Wrong With Bank Stocks

Sure, State Street had horrible earnings and is getting taken out to the woodshed.  And yes, Meredith Whitney is bashing bank stocks again and who has been more right than her about the sector in the past year?  Not to be outdone, another two-bit, "me too" analyst from FBR is also out with some negative comments about the sector, but I can't imagine anyone cares what he has to say.  Because really, if you are choosing today as the day to inform the public that bank dividends might not be safe, and that Bank of America might need more capital, after it's already been bailed out by the government and is trading at $5, and you didn't even see that one coming, well, then anything negative you have to say about the sector should be deemed as bullish.  So what's the real story here?  Why are options traders paying through the nose to buy winger puts in every American bank stock on inauguration day?  The answer lies across the pond. 

Royal Bank of Scotland down 70%. Today.  Lloyds down 57%. Today.  Barclays, who snubbed its nose at government money a few short months ago down 40%. Today.  The UK's largest bank stocks are headed to zero as the market is anticipating a full fledged bailout of the banking sector.  I return to the same question that I asked the other day:  What, if anything, is bank equity really worth?  I don't know the answer.  I don't think anyone does yet.  But with the largest bank stocks trading like call options, investors are taking a good hard look around at the remaining banking landscape and asking why every bank stock shouldn't be trading in the single digits.  If it's still a $50 stock, look out below.

Merrill- Gone But Not Forgotten

Although the Bank of America/Merrill deal is done and should be old news, many angry questions remain about how this government-backed-merger-debacle was completed without informing stakeholders (i.e. BAC shareholders, Merrill's board, US taxpayers) of some crucial details.  For example, how is it that Merrill Lynch managed to lose $15 billion in the fourth quarter, but conveniently only after Bank of America shareholders approved the deal? Here's another good one:  Why did Mr. Thain waste Merrill's last board meeting on December 8th to plead for a $10 million bonus, when he perhaps should've mentioned the $15 billion hole in Merrill's finances?  Nevermind, that one was rhetorical.  Oh wait, I have another one:  Why, for the love of God, was J.C Flowers paid $20 million for his "expertise" to advise Bank of America on the Merrill purchase, when his "extensive due diligence" somehow overlooked said $15 billion in losses?  But wait, there's more:  How did the Fed get roped into guaranteeing credit derivatives positions as part of its $138 billion guarantee to Bank of America? How about:  Why did Bank of America learn of the losses from Merrill's transition team and not John Thain?  Better yet: Why does Bank of America care about retaining any of the senior clowns from Merrill?  Didn't they already run the company into the ground?  Are they really going to threaten to leave?  Who cares?  Let them go start their own business using their own money.  Some of these guys that have milked their free career calls to the max and bled shareholders dry in the process should have to go out on their own and risk their own capital for once.  

What I have the hardest time understanding as I read all of the gory details of what went down in the past couple of weeks that led to the government ultimately stepping in and allowing Merrill to live, is how on earth John Thain has not been hung out to dry.  Frankly, I couldn't believe how the press, shareholders and the SEC let Mr. Thain get away with virtual accounting fraud following the firm's second quarter earnings results.  For those who don't recall, Mr. Thain emphatically stressed that the street was grossly undervaluing Merrill's CDO portfolio.  Then, around 10 days after second quarter earnings, he announced another $5 billion loss for the third quarter and that Merill had "sold" the CDOs to an investment fund for 22 cents on the dollar plus 75% financing.  Clearly it was not the Street who was undervaluing Merrill's assets.  Why anyone trusted Merrill's marks on any of its portfolio after that kerfuffle is a mystery.

What happens next?  Will the angry mob force out Ken Lewis?  I, for one, hope not.  Why?  Because I really worry that somehow, Teflon Thain will wind up in charge.            

Administrative Note

I apologize in advance for the lack of posting today.  I had an unexpected personal matter pop up that I must attend to so I will not be blogging today.  Besides, nothing much going on today.  Citi lost another bucket of money ($8.9 billion), is going to split itself up (as if that fools anybody) Bank of America got its government bailout ($130 billionish,) and JPMorgan for some reason is getting pummeled again.  Just your ordinary run-of-the- mill trading day.  Market shrugs its shoulders and just moves on.  It is expiration Friday, of course, so you never know.  Things could get interesting...

Hedge Fund Outflows Pick Up Pace

Outflows from hedge funds were nearly $150 billion for the month of December, bringing total redemptions for 2008 to $200 billion and total assets under management down to $1 trillion from nearly twice the size.  Despite hedge funds' best efforts to put up gates, set up sidebars, drawbridges, electrified fences, (insert your favorite euphemism for "You can't have your money back.  Try again next month.") some investors still managed to pull out cash from their formerly-favorite, high-flying, status-wielding managers.  They were the lucky ones.  The unlucky ones were those investors who placed their funds with GoldenTree Asset Management.  Although GoldenTree claims to only be down 30% for the year, they have received redemption requests totaling 25-30% of the fund, which apparently they cannot meet with cash.  The managers have opted to repay investors "in kind" (i.e. with whatever they have sitting around the office that may or may not be worth something, CDOs, ABS, CDO cubed, and maybe the office stapler if we can get an appropriate valuation.)  Needless to say, investors who will be receiving these "in kind" securities are none too pleased.  Frankly, if these securities are illiquid and can't be sold at the moment, how are investors to know that the amount of securities is actually worth what GoldenTree claims they are worth?  No doubt, the lawyers will be working overtime on this one.  

Perhaps even more embittered than GoldenTree's clients are those invested with Citigroup's Corporate Special Opportunities hedge fund.  Citi is returning 3 cents on the dollar to investors.  Believe it or not, this is actually a huge windfall for investors, as Citi bailed out the fund which would have had negative equity if it weren't for Citi's capital infusion.  CSO, according to the FT, managed almost $4.2 billion at its peak but wound up with a net asset value of about $58 million and debt of around $880 million in November.  December's results, no doubt, didn't offer any improvement and will likely just show up in the negative column in Citi's earnings results to be reported tomorrow morning.  Special Opportunities indeed!