Thursday, September 30, 2010

The Revolving Door

Thought folks might enjoy this:

The Revolving Door

AIG Recapitalization Summary and Breakeven

Some snippets (and a summary) from AIG's recap transactions:

Repayment of FRBNY Credit Agreement:

At the Closing, AIG will repay to the FRBNY in cash all amounts owing under the Credit Agreement, and the Credit Agreement will be terminated. As of the date hereof, the total repayment amount under the Credit Agreement is approximately $20 billion. The funds for repayment are to come from net cash proceeds from the initial public offering of American International Assurance Company, Limited and the sale of American Life Insurance Company, which are expected to occur in the fourth quarter of 2010, and from additional funds from operations, financings and asset sales. 

Summary:  Okay, here AIG will repay the FRBNY credit agreement ($20B) by asset sales and cash from the business. Here's how:

 Repurchase and exchange of the SPV Preferred Interest:


At the Closing, AIG will draw down all amounts remaining available to be funded under the Department of the Treasury Commitment pursuant to the Securities Purchase Agreement, dated as of April 17, 2009 (the “SPA”), between AIG and the Treasury Department relating to AIG’s Series F Fixed Rate Non-Cumulative Perpetual Preferred Stock less up to $2 billion to be allocated to a new series of AIG’s preferred stock designated as the “Series G Cumulative Mandatory Convertible Preferred Stock” as described below. As of the date hereof, the total available funding under the Department of the Treasury Commitment is approximately $22.3 billion. AIG will use the Series F Closing Drawdown Amount to repurchase a portion of the FRBNY’s preferred interests in the SPVs corresponding to the Series F Closing Drawdown Amount and transfer the Transferred SPV Preferred Interests to the Treasury Department as part of the consideration for the Series F Preferred Stock.

Summary:  AIG draws down the $22.3B Treasury Securities purchase agreement (where the govt buys series F preferred stock from AIG) and buys FRBNY's interest in AILCO and AIA.  Interest in AILCO and AIA is then transferred to the Treasury.  This is how they fund the repayment of FRBNY credit agreement.

Now it gets fun, the exchanges of all outstanding preferred stock held by Treasury.

Series F preferred ($7B book value + $22B to be drawn):  they draw down Series F, buy the SPVs from the FRBNY and transfer AILCO and AIA to Treasury to repay the series F and exchange the remaining for 167MM shares of AIG..  Given the sales prices of AILCO ($15B) and what can be raised for AIA, I will call this paid.

Series G preferred (estimate $2B value):  Series G is created as part of the Series F drawdown up to $2B. This will be used to pay the FRBNY for any remaining interests it has in AIA and AILCO. Whatever is left at March 2012 will be converted to common stock.


Series C preferred ($23B book value):  At the closing, the Series C preferred stock will be exchanged for 562.9MM shares of AIG.

Series E preferred ($41B book value):  At the closing, the Series E preferred will be exchanged for 924.5MM shares of AIG.


The Treasury Department will then hold approximately 1.655 billion shares of AIG common stock, representing pro forma ownership of approximately 92.1 percent of the AIG common stock that will be outstanding as of the Closing.

Bottom line:  estimated $66B owed to Treasury, 16.55B shares held by Treasury = Treasury breakeven of approximately $38.  Share currently trade at $38.57Good luck.




Conditions to Close:

The parties will seek to promptly enter into definitive documentation to implement the Recapitalization and the other agreements described in the Summary of Terms. Among other closing conditions, it will be a condition to the Closing that AIG have sufficient cash proceeds available to fully repay all amounts owed under the Credit Agreement and that the FRBNY will not hold SPV Preferred Interests with an aggregate liquidation preference in excess of $6 billion immediately after the Closing. Additionally, AIG and certain of its key subsidiaries must have credit rating profiles, taking into account the Recapitalization, that are reasonably acceptable to the parties, and AIG must have in place at the Closing third-party financing commitments that are reasonably acceptable to AIG, the Treasury Department and the FRBNY.

Michael Lewis on The Mystery of Disappearing Proprietary Traders

Via Bloomberg (Lewis on Prop)

In the run-up to the vote on the financial overhaul bill, the big Wall Street banks squashed an attempt by Senator Carl Levin to pass a simple ban on any form of proprietary trading.

A Senate staffer close to the process told me the amendment was one of Wall Street’s highest priorities, spreading money around to exert as much pressure as possible
.
It worked: Levin’s amendment never reached the Senate floor for a vote. The final version of the bill restricts proprietary trading but allows big Wall Street firms to invest as much as 3 percent of their capital in their own internal hedge funds. How exactly the new rules are enforced is left to regulators inside the Federal Reserve, but it’s not hard to see how a wholly owned hedge fund might become a proprietary trading group, with a different name.


The 3 percent loophole amounted to an invitation for the big banks to keep on doing at least some of what they had been doing -- which is why Levin felt compelled to remove it, and the banks fought so hard to keep it.
Yet in just the past few weeks news has leaked that Morgan Stanley, JPMorgan and Goldman Sachs all intend either to close their proprietary trading units or to sell their interests in the hedge funds they control.

Obviously, something is wrong with this picture. Why fight for a right, and win, only to proceed as if you have lost? Why take prisoners only to surrender to them? Having preserved their loophole the big American banks now appear to be freely abandoning any attempt to exploit it. (Credit Suisse, on the other hand, just bought a stake in a hedge fund.)

Shark Watch

To see Wall Street turn its back on money is as unsettling as watching a shark’s fin veer away, and then sink from view. It leaves you wanting to know where the shark has gone, and why.

None of the firms have offered a good explanation for their new and seemingly improved behavior, but it’s not hard to think up several. From least plausible to most:

No. 1 -- Having not merely preserved but bolstered their place at the heart of capitalism -- with little banks failing everywhere, the big keep getting bigger and stronger -- the major Wall Street firms have experienced an epiphany about their relationship to wider society. They don’t need to screw people!

Newly able to raise their prices, they want to return to serving their customers, rather than exploiting them.
Whatever they lose from prop trading they will be more than compensated for through new and more trusting relationships with their clients -- who will now have no reason to suspect they are merely a tool for the firm’s trading desk.

Nice Guys

In a smaller and less competitive financial industry, it will pay to be the nice guy, and so Goldman Sachs now wants to play nice.

The only problem with this explanation is that I don’t believe it. More likely:

No. 2 -- The big Wall Street firms have looked anew at proprietary trading and seen a dying business.
For a start, their proprietary traders, put off by subpoenas and government inquiries and the new internal aversion to short-term pain on big trading positions, are fleeing for the privacy of hedge funds.
But the exodus of trading talent is only part of the problem. A general malaise has come over the world of big time financial risk taking. Everywhere you look hedge funds are either closing or shedding employees or, most shockingly, cutting their fees. At the bottom of this depressing new trend lies a deeper problem: a scarcity of suckers.

Find the Fool

The proprietary trading business turns in part on one’s ability to find the fool -- to find people willing to take the stupid side of the smart bets you are placing. One of the side effects of our seemingly endless financial crisis is to wash a lot of fools, many of them German, out of the game.

It’s as if a casino owner awakened one morning to find the tourists had all gone, and the only remaining patrons are pros counting cards at his blackjack tables. As he looked around his casino, for the first time in his life, he couldn’t find the fool. And the first rule of the casino business is: if you don’t know who the fool is, it’s probably you.

Prop trading isn’t as promising as it used to be. At the same time it’s a far greater nuisance than it ever was: The regulators might actually be paying attention to what your traders get up to; if they screw up the financial press is poised to write a story about them; and so on.

Not Worth It

It’s just not worth the trouble to prop trade, unless you can prop trade in some wholly novel way. Which brings us to a third possible explanation:

No. 3 -- Goldman Sachs, Morgan Stanley and JPMorgan are not in fact abandoning proprietary trading. They are just giving it a different name.

They are dismantling the units called “proprietary trading” and shifting the activity onto trading desks that deal directly with customers. (Which would explain why so few prop traders are being let go.)

After all, you don’t need a proprietary trading desk to engage in the two activities that any proprietary trading ban would seek to prevent: 1) running huge trading risks, and 2) taking the other side of the customers’ stupid trades. Goldman Sachs’ infamous Abacus program -- the one that talked American International Group into selling vast amounts of cheap insurance to offset subprime mortgage risk, and then shorted the instruments they themselves had created -- wasn’t dreamed up by the prop trading desk. It was the brainchild of what customers knew as the “Client Facing Group.”

In short, there are any number of explanations why Wall Street firms are all at once letting it be known they intend simply to walk away from what has been, until very recently, their single most lucrative line of work.

None of the Above

The answer may be none of the above or some mixture of the three. But what’s really striking is how little ability the outside world retains to find out what is going on inside these places -- even after we have learned that what we don’t know about them can kill us.

It would be nice to know, for instance, if the big banks are making these moves with the tacit understanding that the regulators, going forward, won’t be looking too closely at the activities of the “Client Facing Group.”

And yet news of the death of the Wall Street prop trader has been greeted with hardly a peep. And I wonder: is this the nature of our new financial order? Big decisions, in which the public has a clear interest, being made outside public view, with little public discussion or understanding.

If so, it isn’t a future at all. It’s just the past, repeating itself.

(Michael Lewis, most recently author of the best-selling “The Big Short,” is a columnist for Bloomberg News. The opinions expressed are his own.)

To contact the writer of this column: Michael Lewis at mlewis1@bloomberg.net

Jobless Claim Thursday

We all see the headline numbers, but if not, here's a snap:




Seasonally adjusted initial claims down 16k vs. prior week and 4wk MA down 6k vs last week.  Not bad (in other words, its not really bad).  But then:




Look at how high EUC and extended benefits are versus last year.  This is good?  Ummm, getting better?  Versus prior week, things are better.  How many of these folks are just running out of benefits.  Don't forget, folks just falling off the rolls is not better, it is worse - it just makes the numbers look better.

Have a great day.

GDP Thoughts

Looking at the US GDP release for some clues as to the corporate condition, I do not see much to be overly optimistic about.

1.    Profits from current production (corporate profits with inventory valuation and capital consumption adjustments) increased $47.5 billion in the second quarter, compared with an increase of $148.4 billion in the first quarter.  Current-production cash flow (net cash flow with inventory valuation  adjustment) -- the internal funds available to corporations for investment -- increased $61.1 billion in the second quarter, compared with an increase of $33.3 billion in the first.  The cash flow number looks pretty good.
2.Domestic profits of financial corporations decreased $3.4 billion in the second quarter, in contrast to an increase of $5.2 billion in the first.  Domestic profits of nonfinancial corporations increased $48.2 billion in the second quarter, compared with an increase of $117.2 billion in the first
3.    Profits before tax increased $15.3 billion in the second quarter, compared with an increase of $224.5 billion in the first.  The before-tax measure of profits does not reflect, as does profits from current production, the capital consumption and inventory valuation adjustments.  These adjustments convert depreciation of fixed assets and inventory withdrawals reported on a tax-return, historical-cost basis to the current-cost measures used in the national income and product accounts.  The capital consumption adjustment decreased $0.8 billion in the second quarter (from -$169.9 billion to -$170.7 billion), compared with a decrease of $106.9 billion in the first.  The inventory valuation adjustment increased $32.9 billion (from -$36.4 billion to -$3.5 billion), compared with an increase of $30.8 billion.


While Positive, we can see that corporate profit growth is slowing (as of Q2) and I would not be surprised to see it slow further in Q3.

Stocks are rallying on the news.  What exactly is there to cheer about?  The overall GDP number - +1.7% - was above expectations (+1.6%), but by no means strong. Prices are under control (+0.1%) and possibly heading lower (this, however, would not be good) and personal consumption was better (+2.2% vs +1.9% in Q1).  

Treasuries are rallying on the news (this I get), shaving a couple of bps off their yield.  10s are now 2.48%, 5s at 1.26%.

Yee haa, always moving.  Good hunting. 

Wednesday, September 29, 2010

Wednesday Market Review

Another day of light volume in the markets as participants digested statements by Fed members and data while taking a breather.  Risk traded lower (except HY) as a result.  Will have to see what impact the political posturing by the US towards China has on US markets tomorrow.

Fixed Income:


Investment grade turned in its first day of decliners outpacing advancers in a while at 0.90x on lighter volume.  HY advancers trumped decliners by 1.37x on better volume.  Bigger gainers today were BP, GE and AIG in IG space and Lehman, F and Clear Channle in HY space.
Pretty light new issue calendar today as well.



US Govvies sold off a bit today, despite the strong 7yr auction.  10s-30s curve flattened as 10s lost a bit more than 30s.  Elsewhere in the world Japan, the UK and Australian govt markets had a positive day, while German and Hong Kong markets lost ground.





Equities:

Primary indicies were down across the board today with concerns over the banks continuing and expectations of weaker growth.  I expect that this weakness will continue, although I have been proven wrong thus far.





IT the only sector to produce positive returns today.  Financials and materials lead the pack lower today.  What has changed in the last two days is beyond me.

Small caps outperformed today, turning in a modestly positive performance.  Growth continues to outperform value (no surprise).












Currency:


Another day, another kick in the face for the dollar.  The Euro continues to surprise me. While one might impulsively say it is dollar weakness not euro strength, the EUR/JPY and EUR/GBP pairs contradict this.  Also interesting is the decline of the Loonie despite commodity strength.


Commodities:

Its all good here.





Suggestions?  Thoughts? Comments?  Would love to hear them.  Am I missing something?  Anyone want to provide "boots on the ground" insight?  Come on, I know you're out there.


.

Airgas Covenants: Why Bother?

I was reading through the prospectus on the new Airgas 3.25% due 2015 to get a feel for the covenants offered to investors (yep, I am living right on the edge).  Here is the quick and dirty:

$101 change of control (COC).  The covenant has the standard verbage one has come to expect: 


Change of Control Triggering Event
Upon the occurrence of a Change of Control Triggering Event, unless we have exercised our right to redeem the notes as described under “—Optional Redemption,” each holder of notes will have the right to require us to purchase all or a portion (equal to $2,000 and any integral multiple of $1,000 in excess thereof) of such holder’s notes pursuant to the offer described below (the “Change of Control Offer”), at a purchase price equal to 101% of the principal amount thereof plus accrued and unpaid interest, if any, to the date of purchase (the “Change of Control Payment”), subject to the rights of holders of notes on the relevant record date to receive interest due on the relevant interest payment date.
“Change of Control” means the occurrence of any of the following:
(1) the direct or indirect sale, transfer, conveyance or other disposition (other than by way of merger or consolidation), in one or a series of related transactions, of all or substantially all of the properties or assets of Airgas and its Subsidiaries taken as a whole to any “person” (as that term is used in Section 13(d)(3) of the Exchange Act) other than a Principal or a Related Party of a Principal;
(2) the adoption of a plan relating to the liquidation or dissolution of Airgas;
(3) the consummation of any transaction (including, without limitation, any merger or consolidation) the result of which is that any “person” (as defined above) other than a Principal and its Related Parties, becomes the Beneficial Owner, directly or indirectly, of more than 50% of the Voting Stock of Airgas, measured by voting power rather than number of shares;
(4) Airgas consolidates with, or merges with or into, any Person (other than a Principal or a Related Party of a Principal), or any Person (other than a Principal or a Related Party of a Principal) consolidates with, or merges with or into, Airgas, in any such event pursuant to a transaction in which any of the outstanding Voting Stock of Airgas or such other Person is converted into or exchanged for cash, securities or other property, other than any such transaction where the shares of the Voting Stock of Airgas outstanding immediately prior to such transaction constitute, or are converted into or exchanged for, a majority of the Voting Stock of the surviving Person immediately after giving effect to such transaction; or
(5) the first day on which a majority of the members of the board of directors of Airgas are not Continuing Directors.
“Change of Control Triggering Event” means, with respect to the notes, the notes cease to be rated Investment Grade by each of the Rating Agencies on any date during the period (the “Trigger Period”) commencing 60 days prior to the first public announcement by us of any Change of Control (or pending Change of Control) and ending 60 days following consummation of such Change of Control (which Trigger Period will be extended following consummation of a Change of Control for so long as any of the Rating Agencies has publicly announced that it is considering a possible ratings change). Notwithstanding the foregoing, no Change of Control Triggering Event will be deemed to have occurred in connection with any particular Change of Control unless and until such Change of Control has actually been consummated.

Limitations on Liens (and sale/leaseback transactions).  This covenant made me laugh out loud.  Here goes (emphasis mine): 

Restrictions on Liens
We will not, and will not permit any Restricted Subsidiary to, Incur any Indebtedness secured by any Lien on any shares of stock, Indebtedness or other obligations of a Restricted Subsidiary or any Principal Property of ours or a Restricted Subsidiary, whether such shares of stock, Indebtedness or other obligations of a Subsidiary or Principal Property is owned at the date of the Indenture or thereafter acquired, without in any such case effectively providing that all the notes will be directly secured equally and ratably with such Lien.

Looks typical, right?  Has customary exclusions and a 10% of consolidated Net Tangible Assets carve out (issuer is allowed to lien 10% of CNTA without violating the covenant).  But then we read further and see what I feel has always been a sticky point:
Given the size of our operations, at any given time we expect to have very few or no Principal Properties and, accordingly, very few or no Restricted Subsidiaries.

Okay, so they cannot lien what they do not have.  Everything is fair game then.  This brings back memories of asking companies to tell me what their "principal properties" were and what they were carried for on the balance sheet.  The vacant stares and silence were almost amusing.

And finally, we have the


Consolidation; Merger or Sale of Substantially All Assets
We may: (1) consolidate or merge with or into another Person; or (2) sell, assign, transfer, convey or otherwise dispose of all or substantially all of our properties or assets and our Subsidiaries taken as a whole, in one or more related transactions, to another Person; if:
(1) either: (a) we are the surviving corporation; or (b) the Person formed by or surviving any such consolidation or merger (if other than Airgas) or to which such sale, assignment, transfer, conveyance or other disposition has been made is a corporation organized or existing under the laws of the United States, any state of the United States or the District of Columbia (any such Person, the “Successor Company”);
(2) the Successor Company assumes all the obligations of Airgas under the notes and the Indenture pursuant to agreements reasonably satisfactory to the trustee; and
(3) immediately after such transaction no default exists.
The Successor Company will be the successor to Airgas and shall succeed to, and be substituted for, and may exercise every right and power of, Airgas under the Indenture, and the predecessor company shall be released from its obligations with respect to the notes, including with respect to its obligation to pay the principal of and interest on the notes. Under these circumstances, if our properties or assets become subject to a Lien not permitted by the Indenture, we will equally and ratably secure the notes.
This is the successor obligor clause.  The company can be bought as long as the purchaser assumes the notes (downside somewhat limited due to the $101 COC).  Lets not forget the "all or substantially all" phrase.  This is a litigation phrase as there has been no "bright line" determined for what constitutes "all or substantially all".

Cross-default.  A default is deemed to have occured under the indenture if:
default under any mortgage, indenture or instrument under which there may be issued or by which there may be secured or evidenced any Indebtedness for money borrowed by Airgas or any of its Significant Subsidiaries (or the payment of which is guaranteed by Airgas or any of its Significant Subsidiaries) whether such Indebtedness or guarantee now exists, or is created after the date of the  Indenture, if that default (a) is caused by a failure to pay principal at its stated maturity after giving effect to any applicable grace period provided in such Indebtedness (a “Payment Default”); or (b) results in the acceleration of such Indebtedness prior to its express maturity, and, in each case, the principal amount of any such Indebtedness, together with the principal amount of any other such Indebtedness under which there has been a Payment Default or the maturity of which has been so accelerated, aggregates $100.0 million or more.
Bottom line:  The COC helps due to the Air Products (APD) bid (arguably a better company though, wouldn't mind seeing the debt travel), but everything else is worthless.

Not so for their credit line:
The New Senior Credit Facility contains customary affirmative and negative covenants, including a financial covenant whereby the ratio of funded indebtedness to consolidated EBITDA may be no greater than 3.5 to 1.0. The New Senior Credit Facility contains certain customary events of default, including, without limitation, failure to make payments, breaches of covenants, breaches of representations and warranties, certain monetary judgments and bankruptcy and ERISA events. The New Senior Credit Facility also contains cross-default provisions whereby a default under the senior and senior subordinated notes discussed below or the notes offered hereby would likely result in a default under the New Senior Credit Facility. In the event of default, repayment of borrowings under the New Senior Credit Facility may be accelerated.

Ever wonder why the banks always come out on top?  Are you still wondering?  I would call these covenants "let them eat cake" covenants.   We have learned nothing.

JPMorgan Finds Itself an Ally.

JPMorgan Chase reportedly is delaying foreclosure proceedings to systematically review documents after alerting attorneys that employees may have signed affidavits without personally reviewing the documents, the same issue that has plagued GMAC Mortgage (Ally).

"It has come to our attention that in some cases employees in our mortgage foreclosure operations may have signed affidavits about loan documents on the basis of file reviews done by other personnel – without the signer personally having reviewed those loan files," Kelly said.
Story here: Robo-signer

The implications of this are pretty big.  The bank cannot foreclose where affidavits are required and someone has not actually reviewed the file.  Think of the size of the foreclosure pipeline.  This will stall the process then clog the courts for some time.  Until this foreclosure process continues and the market is allowed to clear, housing cannot begin to recover.

What NOT To Say

Thought this was funny.  What would you say?

Killer interview question: Could you tell us something remarkable?

Sep 27, 2010
This question was asked at an interview for a junior-level position at an investment bank.

The background

It was a third-round interview and the panel seemed to have exhausted their questions. But as the interview drew to a close, the head interviewer said: “As we have five minutes left, could you tell us something remarkable?”

How the candidate responded

My mind was blank, but before I could stop the words leaving my mouth I said: “Well, I will tell you something remarkable. I have been dating my girlfriend for three years at university and have never once been faithful, and she has never once found out. That is remarkable.”

Did the candidate get the job?

I sat back to a strange silence, then the head interviewer lifted his head and said: “I cannot put this simpler: banking involves trust and integrity. You have just blown this interview.”

Stunned by my own stupidity, I stood up, shook hands and left.


What would you say?

Tuesday Market Recap

Another day mixed on risk today.  Market feels uncertain and is searching for direction.  So far a strong month, folks trying to digest the reason and create/modify expectations of Q4 performance.


Fixed Income:



Volumes were higher today as IG volume increased 15% and had an ADV/DEC ratio of 1.56x, which was lower than yesterdays 1.65x.  HY volume was 46% higher and the ADV/DEC ratio was 1.18x versus yesterdays 1.30x.  My read on this is that the market is taking a breath and some gains.  Econ data in the US and a continuation of European (read Ireland) fears constrained the risk trade.  Of note, RIG lost about 2 points in both the IG and convert space while the equity gained.

As well, corporate borrowers in the U.S. are squeezing investors as record-low interest rates and a lack of high-yielding alternatives force bondholders to accept the smallest concessions on new debt sales since March.
Yield on new bonds fell to within 15 basis points, or 0.15 percentage point, of existing securities on average last month, according to the most recent data from JPMorgan Chase & Co., the biggest underwriter of the debt. The so-called new-issue premium is approaching this year’s low reached in March, which was the least since the credit crisis began in mid-2007. Concessions


The yield curve was marginally lower today with the long end outperforming as data continues to show weakness and there are buyers-a-plenty.







Munis:

 Interesting news today:

Meredith Whitney, the superstar analyst who famously forecast disaster for America's big banks before the credit crisis struck, is now warning about another looming threat: The wreckage from over-stretched statebudgets.

Today, Whitney is releasing a 600-page report, colorfully entitled "The Tragedy of the Commons," that rates the financial condition of America's 15 largest states, measured by their GDP. Whitney claims that the study is the most comprehensive, in-depth analysis of the states' murky patterns of spending, revenues and benefits programs ever assembled by the government, foundations, or another research firm.

What Whitney found reminds her of the poor disclosure and arcane accounting rules that hid the fragile condition of the banks and monoline insurers that she unmasked. "The states represent the new systemic risk to financial markets," says Whitney. "I see a lack of transparency and an abundance of complacency on the part of investors and politicians, just as we saw before the banks imploded."

 Put simply, the study warns that the giant gap between states' spending and their tax revenues, estimated at $192 billion or 27% of their total budgets for the 2010 fiscal year, presents two dangers that investors are seriously underestimating. First, municipalities could start defaulting on their bonds guaranteed by the cities and towns themselves, an exceedingly rare event over the past three, mostly prosperous, decades.  "People keep saying it can't happen, just as they said national housing prices could never go down," says Whitney. "Now, it's a real danger."

On that note, the City Council of Harrisburg, Pennsylvania, capital of the sixth most-populous U.S. state, voted to hire lawyers to explore seeking bankruptcy protection.The City Council voted 5-2 to seek professional advice on bankruptcy or state oversight. Harrisburg, which needed state aid to avoid default on $3.3 million of bond payments this month, rejected hiring a financial adviser at Pennsylvania’s expense. The council opted instead to seek a new adviser and experts who can lay out the benefits and pitfalls of bankruptcy.

And finally, from the QSCB (affectionately Q SCAB) market (qualified school construction bonds):

The Pennsylvania State Public School Building Authority is selling $325.5 million of taxable qualified school construction bonds in the largest deal since the program began in February 2009. The securities, set for issue Sept. 30, will fund the renovation and building of schools in 46 Pennsylvania districts, improving energy consumption and laboratories. The bonds are ranked AA by Fitch Ratings and Aa2 by Moody’s Investors Service, both third-highest, according to preliminary offering documents. The school-bond subsidy is paid directly to the issuer, as is the case with Build America Bonds. The U.S. government subsidizes as much as 100 percent of the interest costs on the school debt and a fixed 35 percent on Build Americas.

But enough of fixed income already.

Equities:

Meager day in the equity markets today with the index gaining just shy of 50bps.  To reiterate the obvious, energy and healthcare lead the charge, while telcom and materials treaded water.  Is that a word, treaded?


I have been spending some time on looking at the growth/value and capitalization proposition, should have more on that tomorrow (cant wait, can ya?)
























Growth, its all about growth right now.




Currencies:

Dollar weaker today - again.  Unless something implodes in Europe (or rather, until), I cant see a reason to rally the buck.







That's all I have tonight.  Later.

Tuesday, September 28, 2010

Goldman Gives Absolute Zero Fed Funds a 25% Probability

The most likely scenario going forward is that the Federal Reserve keeps its key interest rate at the near-zero level of 0.25%... but according to Goldman's probability model, there's a not-insignificant chance (26%) that the Fed surprises the market with an interest rate cut to 0% itself.


Chart

If it doesn't happen in November, then it could still happen in December or January with a similar probability according to the above.
While this is far from the base case scenario for how things play out, it's far more likely than an interest rate hike (to 0.50%), whose probability is almost non-existent according to Goldman.

Personally, I don't see it as it accomplishes very little versus 25bps and has a very negative message.
 
 

Technology Review - Kalengo

I have recently been playing around with a portfolio analysis site called Kalengo (kalengo).  Essentially what this site does is serve as a portfolio analysis platform for investors.  The site is free and has some pretty interesting features.

Asset Correlation Analysis:  Based on user inputs of tickers, or loading in a portfolio that the user has created, the site will calculate asset correlations versus indices.  Here's a screenshot with some random tickers I selected:






















Portfolio Optimization (assuming you place value in the efficient frontier):  This feature takes your existing portfolio and your risk/return expectations (or it loads in its own) and optimizes the portfolio so that it will fall on the efficient frontier.


































Then we can move on to risk profile of the portfolio.The risk analysis looks at VAR, historical return and Sharpe ration, volatility and Beta.  This is an interesting approach as many sites won't calculate the VAR (as, to a degree, its assumptions can be questioned).  I have to look further into the algorithms to see how its calculated.












Finally, there is a returns based style analysis, which breaks your portfolio down into allocations by style:

















The site also allows people to follow your portfolio positions (if you allow it) and allows you to follow others.

All in all, I think this is a handy site that might be helpful to investors as they look at re-balancing their portfolios or adding additional securities.  I especially like the correlation data.

I would love to hear thoughts on the site as to shortfalls, likes and dislikes.

***I have no connection with or economic/financial interest in this site and no incentive to review it other than the dissemination of things I find interesting.

King Dollar - The Emporer Has No Clothes

The dollar is “one step nearer” to a crisis and a devaluation may be inevitable, former People's Bank of China advisor Yu Yongding says. “Such a huge amount of debt is terrible. The situation will be worsening day by day. I think we are one step nearer to a U.S. dollar crisis.” 











Once again, court jester dollar getting whacked.  If the deepest market on the planet doesn't like the dollar, does that forecast anything good for the US?

Monday, September 27, 2010

Monday Market Recap

Somewhat mixed day in the capital markets today.  Here is some data and thoughts:

Equities:


Equities tried to rally throughout the day, but just couldn't pull it off.  Financials got whacked as news of a breakdown in the MTD/STD merger hit the tape, European banks got hit (yep, another day in Ireland), and Citi found out the government might not be out by the end of the year.  Telecom and utilities pulled off positive performance due to the perceived safety of the sectors.

Like it or not, the near term trend continues to be up.  Tactical overweight.







Growth stocks continued to diverge from value as investors continued to jump on the equity gravy train.

Growth is where you want to focus a tactical overweight in equities.


Fixed Income:


Secondary IG market volume was low today compared to recent days and advancers outnumbered decliners 1.65x.  In the HY market, advancers outnumbered decliners 1.3x.

$13.5B priced new issue today, with notables being NBCU with $4.1B and Santander with $1.1B.



The yield curve steepened as 7s and 10s rose more than 30yr bonds.  Despite all the talk about "bond bubbles", I believe that treasuries still have some upside from here as there is a price insensitive buyer (I have heard instead of cash tax refunds, we could be getting treasuries).  Treasuries rallied on the back of a record setting 2yr auction.




Currencies:

Dollar continues to get beaten on as participants speculate that QE2 (or whatever the heck they will call it) is on the way, and rates in the US aren't attractive relative to most other currencies.







Bottom line today:  mixed on risk, still strong demand for govvies and credit and resistance against the leper formerly known as the dollar.

CIT Group - Tax Election Forecasting Agenda?

From CIT Group's (CIT) 8-k:
On September 15, 2010, CIT Group Inc. filed its 2009 consolidated federal tax return with the U.S. Internal Revenue Service. In connection with that filing, the Company elected to apply Section 382(l)(6) of the Internal Revenue Code of 1986 to the net operating losses and other tax assets that the Company had prior to its emergence from bankruptcy on December 10, 2010.
The Company’s 2009 reorganization constituted an ownership change underSection 382 of the Code, which places an annual dollar limit on the use ofTax Benefits. Section 382 contains two relief provisions for limitations onthe usage of Tax Benefits in Chapter 11 bankruptcy.
Under Section 382(l)(5), there is no annual limitation on the amount of Tax Benefits that the Company can use, but the aggregate amount of Tax Benefits is effectively reduced by deductions for certain interest expense with respect to notes that were exchanged for equity, and if the Company experiences an “ownership change” for U.S. federal income tax purposes within two years of its emergence from bankruptcy, the Company’s remaining Tax Benefits, if any, would be entirely eliminated.
Under Section 382(l)(6), the amount of Tax Benefits that the Company may use each year is limited, but there is no reduction in Tax Benefits, and there is no requirement to eliminate unused Tax Benefits upon a change in ownership within two years of the reorganization.
The Company amended its Certificate of Incorporation prior to emergence from bankruptcy to add Article Twelfth, which imposes certain restrictions on the transfer of the New Common Stock, in order to protect the Tax Benefits if the Company elected to apply Section 382(l)(5). In light of the Company’s election to apply Section 382(l)(6), the Board of Directors has determined that electing to apply Section 382(l)(5) is no longer in the best interests of the Company and its shareholders, and accordingly, Article Twelfth has no further force or effect.
In my humble opinion, the change in the tax code being used by the company serves two purposes: 1) protect the company's Net Operating Losses ($2.6 billion) by limiting their annual use, but extending the period in which they may be used, and 2) by allowing the Net Operating Losses to be used if there is a change of ownership, the Net Operating Losses may become a carrot to help the company sell itself.

As a finance company, CIT has to be able to fund itself in a cost effective manner. As the company has been changing the mix of their book, their investment yield has fallen while their funding cost has remained elevated. This leads to a NIM squeeze and declining profitability. The lack of investment grade ratings will keep the company from being able to fund efficiently - this is why there are very few stand alone finance companies (and why, at one point, the company sold themselves to Tyco (TYC)).

If the company is attempting to make themselves more appealing to potential suitors, it would want to retain the tax benefits of the Net Operating Losses and de-lever themselves (recall they have been paying down their term loans). Is Thain looking to flip the company into stronger hands? I wouldn't doubt it.

Personally, I like the company's loans and think there is some value there and the equity might be compelling if one has an eye towards an ownership change.


Disclosure: No positions

Sunday, September 26, 2010

Unilever Looking At Alberto Culver?

From the WSJ:

Unilever PLC, the Anglo-Dutch consumer products giant, is closing in on a deal to purchase Alberto Culver Co., maker of Alberto VO5 hair-care products, people familiar with the matter said. Precise terms of the deal couldn't be learned but Alberto Culver, based in Melrose Park, Ill., has a market value of $3.1 billion. With a typical takeover premium of 20% to 30%, it would fetch as much as $4 billion.
Alberto Culver's portfolio includes a number of well known hair care brands, such as TRESemme and Nexxus, in addition to Alberto VO5, and skin-care products such as St. Ives and Noxzema. The company, part owned by the family of founder Leonard Lavin and which dates its roots back more than 50 years, had sales of $1.4 billion in the last fiscal year, ended in September 2009.

Unilever currently sits on about $3.8B in cash and has a history of cash acquisitions.  Should the story be accurate, I would expect that they would come t the debt market for around $2B in debt, an easy sale for the company given their risk profile, debt metrics and (ugh, cant believe I am saying it) ratings.  Using an additional $2B in debt, we would get an adjusted debt to EBITDA (TTM for both companies) of 1.31x (up from 1.29x), which is easily manageable for their ratings.  At 19x EBITDA, I would think this acquisition would be somewhat expensive.

Saturday, September 25, 2010

3 Corporate Credit Unions Seized

U.S. regulators seized three corporate credit unions on Friday and will repackage about $50 billion in troubled assets from these and previous seizures to sell on the open market.
The National Credit Union Administration said the three corporate credit unions, which provide clearing services to retail credit unions, were critically undercapitalized.  Barclays Capital will manage the securitization plan, the regulator said. A securitization trust will be created to issue about $35 billion in guaranteed notes backed by the government, a process that will likely start in October, the NCUA said.  "This approach is best for taxpayers, consumers and credit unions," NCUA Chairman Debbie Matz said.
Matz said the agency also put in place on Friday regulations requiring corporate credit unions to hold higher levels of capital and setting risk limits. The institutions seized on Friday were Members United Corporate Federal Credit Union of Warrenville, Illinois; Southwest Corporate Federal Credit Union of Plano, Texas; and Constitution Corporate Federal Credit Union of Wallingford, Connecticut. Matz said combined they had about $16 billion in assets.  The seizures come after the NCUA last year took over two other such institutions: U.S. Central Corporate Federal Credit Union of Kansas and Western Corporate Federal Credit Union of California.
Corporate credit unions are the retail credit union's credit union, providing services including lending, and check and payment clearance services. The wholesale credit unions have experienced more troubles than their retail counterparts because they did not face the same restrictions on permitted investments, leading to big losses during the financial crisis.
The $50 billion in troubled assets comes from all five credit unions and is mostly in the form of mortgaged-backed securities. Matz said 70 percent of all assets held by corporate credit unions are now under conservatorship.  The seizure of the five firms will ultimately cost the industry between $7 to $9 billion, she said, and NCUA will collect this amount from credit unions over the next 10 years. Taxpayers will not have to foot any of the bill, she added.

Why do I bring this up, you ask?  I used to run money for Constitution Corporate.  Pretty straight forward stuff, short duration agency CMOs and vanilla asset backeds. We used to write CDs to member credit unions and reinvest those funds in the market - your basic spread game.  Looks like they changed direction over the last 12 years.

This will cost taxpayers which belong to credit unions money in higher costs, fewer services (depending on the size of the CU) and lower deposit rates.

Friday, September 24, 2010

Home Sales - Census Data

From the Census Bureau:

Sales of new single-family houses in August 2010 were at a seasonally adjusted annual rate of 288,000, according to estimates released jointly today by the U.S. Census Bureau and the Department of Housing and Urban Development.  This is unchanged (±16.7%)* from the revised July rate of 288,000 and is 28.9 percent (±11.0%) below the August 2009 estimate of 405,000. ,
The median sales price of new houses sold in August 2010 was $204,700; the average sales price was $248,800.  The seasonally adjusted estimate of new houses for sale at the end of August was 206,000.  This represents a supply of 8.6 months at the current sales rate.
Graphically:

So, this is what federally funded housing stimulus (yep, thats tax credits) and two crippled housing agencies gets us. 





The rest of this happy release can be found here:  Census Home Sales.

Its not getting better, is it.  Imagine if the shadow inventory started coming out.  Imagine if GMAC/Ally could continue foreclosing.  Its enough to make one shrug and crawl into a hole.  Soon, I will rant about housing and why I dont see what the big deal is.  Ought to be fun.

One last thing:  Without comments/thoughts/suggestions it feels like I am preaching to myself or there is complete agreement.  This is not what markets are made of.

Rare Earth, Getting Rarer - For Now

On the wire:

Akihiro Ohata, the Japanese trade minister, said Friday that his ministry was aware that Japanese traders were complaining of a halt from China of a crucial category of minerals and that the government was investigating the matter.
The Chinese Commerce Ministry has denied that it has halted exports of the minerals, known as rare earths and used in products like wind turbines and hybrid cars. And Mr. Ohata said the Chinese Commerce Ministry had also informed Japan that it had not issued a ban on exporting the minerals.
Eight executives, analysts and traders in the Chinese, Japanese and North American rare earths industries said that China had suspended the shipments Tuesday in response to a diplomatic dispute over Japan’s detention of a Chinese fishing trawler captain.
China mines 93 percent of the world’s rare earth minerals and more than 99 percent of the world’s supply of some of the most prized rare earths, which sell for several hundred dollars a pound.
Rare earths are used in a wide variety of industrial applications, including the manufacture of glass, batteries, catalytic converters, compact fluorescent bulbs and computer display screens. Demand has risen in the last decade for their use in clean energy applications, like generators for large wind turbines and lightweight electric motors for cars.
Rest of article here:  NYT Rare Earth

This is nothing more than leverage for the Chinese.  We have to realize that "rare earths" are not as rare as the name implies, but it is rare that governments allow for the mining of the minerals as the by-products can be toxic.

All of the world's heavy rare earths (such as dysprosium) are sourced from Chinese rare earth sources such as the polymetallic Bayan Obo deposit.  Illegal rare earth mines are common in rural China and are often known to release toxic wastes into the general water supply.

But fear not, my earth loving Prius driver.

The world’s two largest reserves of Rare Earth materials outside of China are in Mountain Pass, California and Mount Weld, Australia. Neither of these deposits are currently in production. Lynas Corporation (the current owners of the Mount Weld deposit), has begun development of a mine and concentration plant in Australia and a processing facility in Malaysia. Lynas has no announced plans to produce NdFeB magnets or intermediate materials. On the other hand, Mountain Pass, California possesses a mine that produced for 50 years prior to the suspension of mining operations in 2002.  MM LLC plans to restart mining operations and complete an extensive modernization and expansion of the related processing facility.  MM LLC further plans to broaden its operations to encompass the production of metal, alloys and NdFeB magnets. The initial planned production upon full restart in 2012 is 40 million pounds REO per year (almost 7 million pounds of Nd and Pr oxides).  This production can be achieved by using less than half the tons of ore that was required in the past to produce 40 millions pounds REO per year. 

More information on Molycorp here: Molycorp - I have no economic or financial interest in this company, just an interest in the industry.

Todays POMO - $3.9B

The Federal Reserve Bank of New York purchased $3.89 billion in Treasury debt maturing from 2014 to 2016 on Friday, part of officials' pledge to reinvest cash from maturing mortgage-backed securities and housing agency debt back into the bond market to support the economic recovery. Dealers offered to sell the Fed $15.85 billion in debt.

9/24;  $3.9B
9/22:  $2B
9/20:  $5B
Whats that, $11B this week?  Keep it up, someone has to buy it.

















POMO = Permanent Open Market Operation

Thursday, September 23, 2010

Irish Bonds - Not Again, Still.

On the wire:

Ireland proved unable to shake off rising sovereign-debt fears Thursday, with bond yields jumping as investors reacted to indications some Anglo Irish Bank bondholders may not get all their money back and official data showed the economy contracted unexpectedly in the second quarter.

The yield premium demanded by investors to hold 10-year Irish government bonds over German bunds topped 4.3 percentage points Thursday, the highest on record and up from around 4.1 percentage points on Wednesday. The cost of insuring Irish government debt against default hit a new record Thursday. The spread on five-year Irish credit-default swaps was seen at 490 basis points in late morning action, up from around 460 on Wednesday, according to data provider Markit.

Its like a car wreck, you don't want to look but are somehow compelled to.  The situation continues to deteriorate in Ireland and, ultimately, in PIIGS Europe.  As I have said, this is going to get worse before it gets better - and it will spread.  Sovereign spreads will be under pressure, pressuring the equity markets and push the currency lower.  While the chart below shows the recent strength of the Euro, I am expecting this to turn around.











That aside, I also read the following:

Analysts said a report in the Irish Examiner newspaper contributed to the latest round of concerns. The newspaper said Finance Minister Brian Lenihan had given a strong hint that the riskiest lenders to nationalized Anglo Irish Bank may not get all their money back.
The report said Lenihan explained that a bank guarantee program would be extended once it ran out at the end of September. The new measure, which was effectively passed by the cabinet earlier this week, would cover only deposits and not subordinated debt, the report said.
Here's a thought:  The bank failed!  As a subordinated holder you should not get your money back.  I realize that the bank was nationalized, but it would have otherwise failed and you would get nothing.  Trust me, I've been there.  Okay, extrapolating this would smack around FNM/FRE sub debt, but perhaps that is as it should be.  Ever read a prospectus on sub debt?  This is what it is meant to do - absorb losses so seniors survive (hopefully) in the event of a failure.  The more things change...

Qualified Dividend Income - On the Table?

On the tape today (Bloomberg):

 President Barack Obama, offering a consolation prize to high-income Americans whose taxes he wants to raise next year, is proposing to scale back a scheduled tax increase on their dividends. A budget law Obama signed this year may keep the Democratic president from meeting that goal. A cut in the dividends rate to its current 15 percent, from rates as high as 39.6 percent, was among tax measures enacted under Republican President George W. Bush. All those cuts are scheduled to expire Dec. 31, and unless Congress acts, the previous higher rates would return next year.
While Obama’s proposed 20 percent dividend rate is an increase from this year’s levy, it qualifies as a tax cut because it’s less than the rate scheduled to take effect for 2011. Under the budget rules, any tax cuts benefitting individuals earning more than $200,000, or couples earning more than $250,000, must be offset with new tax revenue or spending cuts elsewhere.
Passing Obama’s plan under the so-called paygo rules would require lawmakers to find a combination of revenue and spending cuts of about $100 billion over 10 years. This would be difficult to achieve in an election year, tax experts said. The alternative -- finding the 60 senators required to vote for waiving the budget rule -- would be equally challenging in the 100-seat chamber, they said.
Due to paygo, and a republican minority, I do not expect that QDI will continue to receive a favorable tax treatment.  As a result, dividend paying securities - primarily equity and preferred - will not have a relative advantage to their non-dividend paying peers.  While this reduces the relative attractiveness, I would not anticipate that it will materially reduce demand for these securities.  This is not to say I have lost hope that QDI will retain favorable treatment, just that it will be difficult.

Disclosure:  long various preferred stocks and dividend paying equities

Wednesday, September 22, 2010

Wednesday Market Recap

Uneventful day, all-in-all.  Here's some data and thoughts.

Bond market data and breadth (FINRA/TRACE):

Volumes were down approximately 12% today in  both IG and HY.  Advance/Decline issuer ratios were 1.43x and 1.02x for IG and HY, respectively.  Microsoft was one of the larger issuers today, doing $4.75B in 3s, 5s, 10s and 30s.  Microsoft sold $1B of the 3yr at a coupon of 0.875 percent, or +25bps, the lowest coupon in over 40 years.  Still think credit has legs and a little room for upside.  Until the change, clip the carry.

Some high yield info (new!):

As the KDP indices show, not much of a change in returns today.  Note the mid-grade index, this is high BB and low BBB names.  Historically I have liked the "5B" space as it is interesting in risk/return space and can help increase the average ratings of a high yield portfolio (or in the "old days", a CDO).  You can find this info here:  KDP Index


And the yield curve:


Govt debt had a good day today in the longer end as participants digested the FOMC speak and the weak mortgage/housing data released today.  I still think that risk free has more upside from here as rates are going nowhere fast from a policy perspective and inflation is nowhere in sight (despite the CAG and GIS statements).




Equities (table by S&P):


Domestic equities vacilated throughout the day as investors seemed to step back and take a breath from the recent market strength.  Housing and mortgage data certainly didn't help equities as it pointed to further economic weakness.  Utilities and materials showed the most strength, returning +64 and 36bps respectively (note commodity currencies as well when looking at materials).  International markets fared worse as investors pondered the various sovereign auctions and the outlook for the bloc.  So many mixed messages and data in the market (economy less weak, earnings okay, guidance not so good..) that it is difficult to ascertain value.  Trend is up near term though, which still warrants a tactical overweight.





Currencies (table byADVFN):

Dollar weakness was the theme in the currency markets today as participants traded out of the weakened currency (defecits will do that).  I personally like the commodity currencies (aussie, loonie and kiwi) as well as the swissie and the yen.  Cautious on EUR and negative on the pound and USD.


Bottom line:  mixed on risk, positive inertia on risk free and dollar weakness.  Taken as a snapshot (blinders to the trends) it would look like a transition away from risk - market and sovereign and into safer havens such as treasuries, utilities and commodity currencies (in itself a mixed cyclical message).

Would love to hear your thoughts.

About Me

A student of the markets that has held portfolio management, analysis and trading positions for over 15 years.