The past few weeks, make that days, have changed the face of US banking. Banks are now concentrated in 3 powerful entities: Citi, Bank of America and JP Morgan. The three biggest banks in the country are now bigger than ever, with a combined 31% of all U.S. deposits. Bank of America leads the pack with 10.99% of all U.S. deposits. J.P. Morgan trails only slightly at 10.51%. And Citigroup ranks as the only one of the big three below the 10% cap, with 9.8% of all U.S. deposits.
Now talk about too big to fail. Those banks will never be allowed to fail and they can take all the risk they want. But expect tighter regulation by the government to make them even quasi government entities.
Welcome to the Canadian banking model, where few banks monopolize the industry. Canadian have always called for deregulation to open up banking for outside competition but the government relented. The results higher fees, lousy customer service and high lending rates.
So to my friends in the US get ready for a lousy banking model.
September 30, 2008
September 27, 2008
Value Idea: Emerging Markets
I was working on this post all of last week but Barron's today has published a similar idea you can find it here: "Emerging Markets are cheap and they're the future". It is nice to get a verification of the idea.
Emerging markets (EM) equities and debt look very appealing, debt in particular. Emerging markets index has declined more than 33% this year, while EM debt spread have soared to 300 basis points over treasuries, its spread was 170 BPS in 2007.
Investors over the past few months have scaled down their holdings in emerging market equities and debt considerably. Capital flight from these markets was due to the credit issues faced by the developed world. Investors feared that credit issues will spread eventually to the Emerging Markets. EM funds have seen an outflow of $26 billion, compared with an inflow of $100 billion in the previous five years (source: Financial times, Economist).
I think the changed perception of EM risk is an opportunity. I see that a good risk/ reward proposition is in EM, debt in particular. Although perception of risk has changed, the fundamentals do not support the increased risk due to the following:
For sure emerging markets will slow down as a result of the rescission in the US; there is no decoupling ever and I am not arguing this. But the upward growth trend is not broken by the current credit crises.
First, Emerging markets economies are growing 4 times as fast as developed nation economies according to IMF. They no longer depend on foreigner to make capital investment; now they are capable of doing that on their own to spur growth.
Second, Emerging markets do not produce only cheap goods, but they have produced multinational companies that compete on the same level with developing nations companies. These companies will expand into developing economies to add markets and spurring growth. This will translate into higher job creation at home and higher wages.
Third, by the numbers emerging markets account for 80% world's population and 50% of GDP growth but only 8% of stock markets capitalization. The imbalance have to be corrected by owning more of the world's assets and occupying more in market capitalization.
Fourth, EM are cash rich and own a large portion in basic resources. As a group, they are in far better shape than ever before.
Many are commodity exporters and many commodities are at record highs.
Recently, crude oil is around $100 a barrel while
other commodities prices have also been increasing, although they came off their recent highs lately. Moreover, over the
past five years, many emerging market governments have taken steps to
insulate themselves from the effects of a global financial crisis.
EM governments are cash rich with reserves at record level. They are sitting at 75% of global cash reserves. Those reserves will support their currencies against the euro and dollar. Although currency appreciation is not the outcome those couturiers want to happen, there is no escaping it. The US dollar faces lots of head winds: ballooning trade deficits and ever increasing debt load. Treasury and the fed are continuing to pump dollars in the system debasing its value; it is astonishing that the dollar has not fell off cliff thus far.
This brings me to what will Sovereign Wealth Funds (SWFs) and cash rich countries do with this capital. The recent credit issues of US have given SWFs and cash rich countries pause and hesitance to invest in the US. These parties want to diversify away from the US to reduce their exposure. EM assets allows them to do just that, particularly EM debt.
My strategy is to be a buyer of EM debt and patient accumulator of equity, as it is highly correlated with global equity markets. I do not know when markets will recover therefore EM equities may languish a bit so I will cost average over the next little while. This strategy will provide me with the following:
Valuation
Now, emerging markets are trading once more at a significant discount. There
are some good reasons for this. The turmoil in states bordering Russia
suggests a rise in political risk. For example, stocks in the Ukraine
doubled in barely 18 months, but since January they have halved.
Next post I will discuss the risk associated with investing in EM also what type of instruments to use to monetize the idea.
Emerging markets (EM) equities and debt look very appealing, debt in particular. Emerging markets index has declined more than 33% this year, while EM debt spread have soared to 300 basis points over treasuries, its spread was 170 BPS in 2007.
Investors over the past few months have scaled down their holdings in emerging market equities and debt considerably. Capital flight from these markets was due to the credit issues faced by the developed world. Investors feared that credit issues will spread eventually to the Emerging Markets. EM funds have seen an outflow of $26 billion, compared with an inflow of $100 billion in the previous five years (source: Financial times, Economist).
I think the changed perception of EM risk is an opportunity. I see that a good risk/ reward proposition is in EM, debt in particular. Although perception of risk has changed, the fundamentals do not support the increased risk due to the following:
- future growth is much more solid in emerging markets with less structural issues and headwinds to limit its progress.
- emerging markets currencies will appreciate against the potential collapse in US currency due to current and trade accounts deficits.
- Developed economies are facing recession and credit risks while EM are facing one headwind in global recession. EM hold surplus foreign reserves as a result their credit situation is
much better than the US and Europe. Its ability to fulfill its debt
obligation is not impaired
For sure emerging markets will slow down as a result of the rescission in the US; there is no decoupling ever and I am not arguing this. But the upward growth trend is not broken by the current credit crises.
First, Emerging markets economies are growing 4 times as fast as developed nation economies according to IMF. They no longer depend on foreigner to make capital investment; now they are capable of doing that on their own to spur growth.
Second, Emerging markets do not produce only cheap goods, but they have produced multinational companies that compete on the same level with developing nations companies. These companies will expand into developing economies to add markets and spurring growth. This will translate into higher job creation at home and higher wages.
Third, by the numbers emerging markets account for 80% world's population and 50% of GDP growth but only 8% of stock markets capitalization. The imbalance have to be corrected by owning more of the world's assets and occupying more in market capitalization.
Fourth, EM are cash rich and own a large portion in basic resources. As a group, they are in far better shape than ever before.
Many are commodity exporters and many commodities are at record highs.
Recently, crude oil is around $100 a barrel while
other commodities prices have also been increasing, although they came off their recent highs lately. Moreover, over the
past five years, many emerging market governments have taken steps to
insulate themselves from the effects of a global financial crisis.
EM governments are cash rich with reserves at record level. They are sitting at 75% of global cash reserves. Those reserves will support their currencies against the euro and dollar. Although currency appreciation is not the outcome those couturiers want to happen, there is no escaping it. The US dollar faces lots of head winds: ballooning trade deficits and ever increasing debt load. Treasury and the fed are continuing to pump dollars in the system debasing its value; it is astonishing that the dollar has not fell off cliff thus far.
This brings me to what will Sovereign Wealth Funds (SWFs) and cash rich countries do with this capital. The recent credit issues of US have given SWFs and cash rich countries pause and hesitance to invest in the US. These parties want to diversify away from the US to reduce their exposure. EM assets allows them to do just that, particularly EM debt.
My strategy is to be a buyer of EM debt and patient accumulator of equity, as it is highly correlated with global equity markets. I do not know when markets will recover therefore EM equities may languish a bit so I will cost average over the next little while. This strategy will provide me with the following:
- income as EM debt spread is high for no fundamental reason
- hedge against US dollar decline
- appreciation once investors come back to the market
- improve my asset allocation by increasing debt portion in my portfolio.
Valuation
Now, emerging markets are trading once more at a significant discount. There
are some good reasons for this. The turmoil in states bordering Russia
suggests a rise in political risk. For example, stocks in the Ukraine
doubled in barely 18 months, but since January they have halved.
Next post I will discuss the risk associated with investing in EM also what type of instruments to use to monetize the idea.
September 21, 2008
Universal Banks | Is there a future? | The Economist
Is there a future for investment banking? | Is there a future? | The Economist:
Further commentary about the merit of supermarket banks, the one BofA trying to create with the purchase of Merrill Lynch.
"...... universal banks appear to offer clear advantages to both shareholders and regulators. Yet some of those advantages are illusory. For regulators, larger, diversified institutions may be more stable than investment banks but they pose an even greater systemic risk. “The universal bank is the regulatory equivalent of the super-senior mortgage-backed bond,” says one analyst. “The risks may look lower but they do not go away.” And deposit funding is cheaper than wholesale funding in part because those deposits are insured. Measures to protect customers may end up allowing banks to take on risks that endanger customers.
For shareholders, too, the universal bank may offer false comfort. A model that looks appealing in part because assets are not valued at market prices ought to ring alarm bells. Sprawling conglomerates are just as hard to manage as turbo-charged investment banks. And shareholders at UBS and Citi will derive little comfort from the notion that the model has been proven because their institutions are still standing. If the independent investment banks survive, they will clearly need to change. But they are not the only ones."
Further commentary about the merit of supermarket banks, the one BofA trying to create with the purchase of Merrill Lynch.
"...... universal banks appear to offer clear advantages to both shareholders and regulators. Yet some of those advantages are illusory. For regulators, larger, diversified institutions may be more stable than investment banks but they pose an even greater systemic risk. “The universal bank is the regulatory equivalent of the super-senior mortgage-backed bond,” says one analyst. “The risks may look lower but they do not go away.” And deposit funding is cheaper than wholesale funding in part because those deposits are insured. Measures to protect customers may end up allowing banks to take on risks that endanger customers.
For shareholders, too, the universal bank may offer false comfort. A model that looks appealing in part because assets are not valued at market prices ought to ring alarm bells. Sprawling conglomerates are just as hard to manage as turbo-charged investment banks. And shareholders at UBS and Citi will derive little comfort from the notion that the model has been proven because their institutions are still standing. If the independent investment banks survive, they will clearly need to change. But they are not the only ones."
September 19, 2008
Update to my Portfolio
It was a very interesting week. I have made few buys and some sells, here are the highlights:
What I bought on Wednesday during the market decline:
What I bought on Wednesday during the market decline:
- I added more of Brookfield Properties (BPO) at $17.50. I think BPO has unique assets in high barriers to entry markets. I ignored the noise of higher vacancy rates due to the turmoil on the financial markets and expected layoffs from banks. The company has good management and I think buying it at this time for the long term is worth of the risks.
- I added to the FirstService position. FirstService is commercial real estate service company that is trading now at less than the valuation one division of their holdings, which is residential property management. The company is mistook as a brokerage business and it is being punished because commercial real estate transaction are almost vanished. Sure its brokerage business will suffer but the residential business is solid. The company is being opportunistic and buying other businesses at the moment to position its business for the rebound. Its management is good and they are aligned with shareholders as they have an economic interest of about 25% of the company.
- I have added to Haliburton option position. I am under water on the position but I think HAL has room to run here and very attractive on a valuation basis.
- I sold US Bank corp into today's rally. I bought USB at $30 few months ago and it reached my valuation target I sold at $38, a return of 26% plus dividends received through the holding period. USB is very fine bank it avoided all the nonsense that is plaguing most banks today. It actually closed at 52 week high today. I think the bank is very solid with good management and focused on its core business with no ambition for empire building. But I got to get out right now on valuation basis.
- I sold United Rentals @ $17.45. I have lost on this position as I bought it at $21. I have entered into this trade to take advantage of a tender offer the company initiated but it did not work as I intended.
- Sold small position from my fixed income as yields have came down significantly during the panic. Prices of government bonds have went through the roof lately I am selling into that panic.
Bank of America & Merrill: Brilliant or Dissaster in the making
As you may have heard BofA is buying Mother Merrill. What to think of this move?Well, I am not enthusiastic. In the best of times large acquisitions like this have high probability of failure so I am not quite sure what is the situation in a troubled time like this. However this is far better than buying Lehman I must say.
I bought the shares of BofA because it is a retail bank with no exposure to investment banking, not a big one anyways. Now BofA is building an empire to reach all corners of US finance. I do not like the business of empire building. Just look at Citi business model of being a banking supermarket. It did not work. It was too difficult to manage and hid risks away from management.
BofA management are good and they have solid experience in integrating acquisitions. But this is an investment bank where its true assets and core competencies lie in its people and the relationship they build with clients. It is very different than a retail bank, which is about processes and customer service.Investment banking encourages the superstar while retail emphasize the system. It is a big culture clash.
I am mulling my position in BofA as I am not sure I can track it or follow it now due to the added complexity. I have not decided to sell yet, so I will keep running scenarios to the merit of the business.
Below is a good article about the marriage between BofA and Merrill that differ from all the typical media stance cheering the deal and celebrating Ken Lewis acumen of deal making.
The big question: In agreeing to buy Merrill Lynch, is Bank of America saddling itself with an unmanageable pile of toxic assets? While the potential long-term benefits for both firms are compelling, the short-term risks of doing such an enormous deal in the middle of a financial panic could end up being too much for BofA to handle.
If there were no credit crisis, the deal would appear to be a steal. For a mere $40 billion or so — the deal value has declined, along with BofA’s stock, from the initial $50 billion — BofA will be able to combine its giant retail-banking network with Merrill’s extensive network of personal financial experts. The cross-selling opportunities and the expected $7 billion in annual cost savings virtually pay for the deal.
Nevertheless, the price that BofA paid and the savings it promises to reap could take a back seat to its ability to support Merrill’s assets on its balance sheet.
BofA cannot use its large depository capital base to back up much of Merrill’s riskier assets, so it needs to be stocked and ready with cash. If BofA does not have the required amounts of capital to absorb these assets, some of which are particularly radioactive, it could find itself in the same boat as its broker-dealer rivals, begging for cash at a time when the world’s wallets are closed.
To complicate things, BofA is still in the process of absorbing the troubled mortgage lender Countrywide Financial, which it bought earlier this year. That deal will force it to put $172 billion worth of risky mortgage assets on its books. Countrywide is still hemorrhaging money and more write-downs are expected. About 35 percent of Countrywide’s subprime mortgages are said to be in default, and it could get worse.
Merrill Lynch still has $5.6 billion in subprime assets on its books, according to analysts at Oppenheimer & Company. That would combine with Bank of America’s $5.2 billion for a total of $11.5 billion in sludge. That is more subprime exposure than UBS, Morgan Stanley, Goldman Sachs and Wachovia — combined.
BofA says that the combination of Merrill and Countrywide’s assets on its balance sheet is expected to bring its Tier 1 capital ratio — a key measure of financial strength — down to about 7.4 percent. That would be the lowest of all the major financial institutions and not too far from the 6 percent mandatory level required by the government.
It could be worse: David Trone, an analyst Fox-Pitt Kelton, says he believes that BofA may have been using marks that overvalue some of its assets. He estimates that BofA’s Tier 1 capital ratio, after the acquisition, would be more like 6.65 percent if Merrill’s portfolio is marked to current market prices.
That would leave a thin margin for error, and there could be a rough road ahead.
Bank of America has billions in personal loans, credit card debt and car loans outstanding. If the economy continues to head south, more people will start defaulting on their commitments. That would burn through BofA’s loan-loss provisions and eat away at its profits. The result could be a tumbling stock price, which might require BofA to raise capital to fill the gap in its common equity. BofA could raise capital by cutting its dividend, but that would cause its stock to fall as well and send a negative signal to the market.
While other banks are deleveraging and selling their troubled assets, BofA is going the opposite direction and taking on more. If the credit crunch ends today, BofA could cross the finish line and make out like a bandit. But if it continues or gets worse, the nation’s largest bank could regret its impulsive wedding.
SEC issues temporary ban on short sales | Reuters
SEC issues temporary ban on short sales | Reuters
I am all for government intervention to stop this financial meltdown but banning short salling can prove to have unintended consequences.
Short selling provide liquidity and price discovery to the market. Without these two elements prices are distorted significantly and skewed. Moreover the move can shake investor confidence in market integrity and operations. I do not sell short but now I have less confidence in the market transparency and rules that I base my investment decisions on.
Enforce the rules on naked short selling that already exist. no one should be able to sell a stock that he/she does not own, that makes sense. Banning short selling altogether is a hasty move that can backfire.
I am all for government intervention to stop this financial meltdown but banning short salling can prove to have unintended consequences.
Short selling provide liquidity and price discovery to the market. Without these two elements prices are distorted significantly and skewed. Moreover the move can shake investor confidence in market integrity and operations. I do not sell short but now I have less confidence in the market transparency and rules that I base my investment decisions on.
Enforce the rules on naked short selling that already exist. no one should be able to sell a stock that he/she does not own, that makes sense. Banning short selling altogether is a hasty move that can backfire.
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