Bear Stearns covered the air waves all of Friday, with its 'significantly detriorated' liquidity position and the early morning announcement of a NY Fed-JPMC liquidity support package. The Fed has gone a step further now after its 200bn TSLF announced the past week - its taking a direct risk on MBS-heavy instruments that it will bank on as collateral for the indirect funding to Bear Stearns. Its indeed a daring step considering the state of the debt markets. However, nothing short of this would have helped either - BSC going bust would have caused irreparable damage to the financial world and probably cause a market freeze. Despite the Fed-JPMC intervention, apparently some capital market players found the liquidity situation so demanding that they couldn't even borrow money on Treasuries...how worser could it get?
Now that a significant part of market confidence over the short-term would depend on how the BSC saga will unfold, its important to have a view on this story.
BSC's 9bn+ revenues in 2006 came from a mix which included 4+bn from Fixed Income, 2+ bn from Equities trading & research, 1+bn investment banking underwriting and advisory, 1+ bn from Global clearing services/Prime brokerage and another 0.5bn each from Private Client services & asset management. The most seriously affected portion of the business is obviously the Fixed income division, which is heavily exposed to residential MBS (including a good component of securitized ARMs). Most of its securities and fund loans to hedge fund providers would probably be significanly impaired in terms of liquidity. It has over USD 350+bn in assets/liabilities riding on a shareholder capital of just over USD 12bn...this leverage of over 32:1 with about 15+bn of its debt maturing in the next 4 quarters exacerbates the short-to-medium term liquidity position. However, its prime brokerage infrastructure, equities trading & research depth and private client advisory business would still command good value despite current market conditions. Considering that the Friday EOD stock price of 30/share is just about 1/3rd of its 85/share+ book value, there's probably still enough value in this stock considering that there's still good potential in divisions that account for over 50% of its revenue stream. However, with its over-leveraged balance sheet, true value depends a lot on mark-to-market valuation of its huge MBS and CDO portfolios.
BSC would definitely have enough willing suitors, though valuation range is an unknown factor at this point. JP Morgan, being BSC's clearing and settlement service provider, would be at the best position to judge the true value of its debt portfolio. Its probably for the same reason that JPM was the conduit for the Fed-sponsored bailout package, architected between Lazard, NY Fed and JPM Thursday night. Interestingly, NY Times already mentions JC Flowers and RBS as being potential suitors too. There is already talk of some kind of a long-term deal in the next 48-72 hours. However, my personal feeling is that this might eventually take longer to play out - most likely the key players would want BSC to regain some confidence with its pre-poned Monday earnings conference. If Alan Schwartz and Sam Molinaro are able to manage the call focusing on key fundamental strengths of their global equities & prime brokerage business, and also articulate clear short-term and long-term revival strategies, we should see some revival of market confidence in Bear. To draw a comparison, Etrade's Jarrett Lilien did a reasonably good job at this - focusing on fundamentals stregnths of their trading platform. If the Monday call pans out well, we could see some rebound in the stock, followed by a possible long-term deal announcement over the next 3-4 weeks.
***
This whole analysis above seems irrelevant and out-of-the-whack considering the latest developments on this front - JPM supposedly acquiring BSC for just over USD 2 a share! Ths situation on the ground at BSC was obviosuly far more grave than any one could ever imagine!
***
The whole BSC development poses an even more tough situation for the Fed ahead of this week's FOMC meeting. Its 200bn package and sustained inflation would have given its enoygh reason to avoid a major (50 bps+) rate cut; but the situation's now changed back to panic mode now. I would now reduce my bets on a 50bps or lower rate cut....unless Modnay turns out to be unusually good for the market. This Fed has been reacting to market pressures so far and its difficult to imagine them takeing a longer-term balanced (inflation Vs growth) in this post-Friday market situation.
Saturday, March 15, 2008
Tuesday, March 11, 2008
Fed's refreshing move
How can i not blog today?
We had the best day of the year by far, with Dow up more than 400 points! In a refreshing move at unleashing much-needed liquidity to the system, the Fed announced a Term Securities Lending Facility (TLFS), which provides for a line of up to USD 200 bn in treasury securities against collateral from its 20 prime dealers (banks, agencies etc) in the form of MBS and other AAA paper. What does this mean?
1) For starters, this is literally a stamp of assurance from the Fed that it does not see the MBS/ABS securities go to zilch in value (which is what the market seemed to think apparently, given the run on Financial sector shares)
2) This also means big players like C, GS, MER and even smaller players (including troubled ones like Thornburg and Caryle) can loan treasury securities by providing AAA MBS paper (this includes paper sold by banks, Freddie Mae, Fannie Mac) as collateral. They in turn can loan these treasuries to investors in return for cash...thus providing much needed liquidity to these players.
This has been by far the best move by a central agency to address the situation in a sane manner. Rate cuts won't take us far and would in turn put us in danger of a staglation. Subsidies to in-difficulty borrowers would address part of the issue, but in a non-meritocratic way.This brilliant move by the Fed was even more powerful since it was coordinated with the ECB, Bank of England etc...each of them provding additional liquidity building measures totalling over USD 45 bn. There might be some feeling this Fed move is again reactive, but no one has been anyway good at predicting the depths to which the MBS and ABS markets have fallen...even the larger debt market in general. Who would have imagined economic confidence in US waning to such an extent that default swaps on German bunds start getting priced lower than that on US treasuries?? We are in an abnormal economic situation; and any balanced moves by the Fed to address the liquidity crunch will help stabilize the market and bring credit and lendign back on track. This would not remove credit issues, but would at least provide more breathing room for the large players.
Financials were up big time, with Citi leading with a 9%+ gain. Troubled players like Thornburg also saw big upside moves. I feel most of the financials have enough momentum now to erase the near-term decline they had over the past 2-3 weeks. However, the FOMC announcement on rate cut next week might provide a damper - I don't think a sane Fed would try to appease the market with a 50 bps+ cut. This might cause short term negative momentum. I just hope the Fed plays the move along with good forward looking commentary to ease market jitters.
In addition to the good news from the Fed, consumer confidence index measures from Germany and supply/ manufacturing indices from Germany and Japan provided enough hint that all's not bad. Europe and Japan still seem to keep enough momentum - meaning well for most of the large global US corporations and money center banks. Bad for the dollar perhaps, since stregnth in Europe means ECB or Bank of Engalnd would not be forced to come down form their hawkish rate stances. However, once the Fed controls unbridled rate cut expectations next week, the dollar should rally back to 1.45-1.48 levels against the Euro again.
On the micro-side, if you had locked on to January calls at strike 25 for C early today, its difficult to imagine you would lose money by year end!
We had the best day of the year by far, with Dow up more than 400 points! In a refreshing move at unleashing much-needed liquidity to the system, the Fed announced a Term Securities Lending Facility (TLFS), which provides for a line of up to USD 200 bn in treasury securities against collateral from its 20 prime dealers (banks, agencies etc) in the form of MBS and other AAA paper. What does this mean?
1) For starters, this is literally a stamp of assurance from the Fed that it does not see the MBS/ABS securities go to zilch in value (which is what the market seemed to think apparently, given the run on Financial sector shares)
2) This also means big players like C, GS, MER and even smaller players (including troubled ones like Thornburg and Caryle) can loan treasury securities by providing AAA MBS paper (this includes paper sold by banks, Freddie Mae, Fannie Mac) as collateral. They in turn can loan these treasuries to investors in return for cash...thus providing much needed liquidity to these players.
This has been by far the best move by a central agency to address the situation in a sane manner. Rate cuts won't take us far and would in turn put us in danger of a staglation. Subsidies to in-difficulty borrowers would address part of the issue, but in a non-meritocratic way.This brilliant move by the Fed was even more powerful since it was coordinated with the ECB, Bank of England etc...each of them provding additional liquidity building measures totalling over USD 45 bn. There might be some feeling this Fed move is again reactive, but no one has been anyway good at predicting the depths to which the MBS and ABS markets have fallen...even the larger debt market in general. Who would have imagined economic confidence in US waning to such an extent that default swaps on German bunds start getting priced lower than that on US treasuries?? We are in an abnormal economic situation; and any balanced moves by the Fed to address the liquidity crunch will help stabilize the market and bring credit and lendign back on track. This would not remove credit issues, but would at least provide more breathing room for the large players.
Financials were up big time, with Citi leading with a 9%+ gain. Troubled players like Thornburg also saw big upside moves. I feel most of the financials have enough momentum now to erase the near-term decline they had over the past 2-3 weeks. However, the FOMC announcement on rate cut next week might provide a damper - I don't think a sane Fed would try to appease the market with a 50 bps+ cut. This might cause short term negative momentum. I just hope the Fed plays the move along with good forward looking commentary to ease market jitters.
In addition to the good news from the Fed, consumer confidence index measures from Germany and supply/ manufacturing indices from Germany and Japan provided enough hint that all's not bad. Europe and Japan still seem to keep enough momentum - meaning well for most of the large global US corporations and money center banks. Bad for the dollar perhaps, since stregnth in Europe means ECB or Bank of Engalnd would not be forced to come down form their hawkish rate stances. However, once the Fed controls unbridled rate cut expectations next week, the dollar should rally back to 1.45-1.48 levels against the Euro again.
On the micro-side, if you had locked on to January calls at strike 25 for C early today, its difficult to imagine you would lose money by year end!
Monday, March 10, 2008
As we move to FOMC time again!
While the broad market, especially financials, continue to tread unchartered negative territory, crude rose to a new high - at over $108 a barrel! Personally, i feel both are extreme reactions to market scenarios and not backed by fundamentals.
Starting with Meredith Whitney (Oppenheimer), almost every analyst covering C, JPM, MER, BS, GS have been cutting earnings estimates for the year drastically. The continued turmoil in the MBS and ABS markets, along with sustained uncertainty over bond insurers future butress the analyst speak and add more gloom to the market. However, i feel the financials would move upwards in the medium term - i had the same view early January and have been proven wrong by the market so far; but i hold on to my views. Credit-related losses definitely pose significant short-to-medium term earnings impact, but not to the extent reflected in stock prices - especially those of C and GS. Citi's market value is just a wee bit over USD 100 bn - as against over 250 bn less than 12 months back.
However, there might be more downward pressure as we near the FOMC meeting next week - i for one would strongly believe the Fed's going to limit its rate move to a maximum of 25 bps. And the market would obvisouly not react positively to this. On another note, if the Fed does indeed cut rates by 50 bps or more, i would call it suicidal long-term...staglation risks are serious at this point.
Starting with Meredith Whitney (Oppenheimer), almost every analyst covering C, JPM, MER, BS, GS have been cutting earnings estimates for the year drastically. The continued turmoil in the MBS and ABS markets, along with sustained uncertainty over bond insurers future butress the analyst speak and add more gloom to the market. However, i feel the financials would move upwards in the medium term - i had the same view early January and have been proven wrong by the market so far; but i hold on to my views. Credit-related losses definitely pose significant short-to-medium term earnings impact, but not to the extent reflected in stock prices - especially those of C and GS. Citi's market value is just a wee bit over USD 100 bn - as against over 250 bn less than 12 months back.
However, there might be more downward pressure as we near the FOMC meeting next week - i for one would strongly believe the Fed's going to limit its rate move to a maximum of 25 bps. And the market would obvisouly not react positively to this. On another note, if the Fed does indeed cut rates by 50 bps or more, i would call it suicidal long-term...staglation risks are serious at this point.
Saturday, March 1, 2008
Inflation worries continue to persist...
Back in January when the Fed went ballistic by announcing a 75 bps cut & then a 50 bps rate cut within a span of 10 days, i thought it was over-reaction to the market-psychology.(http://invest4tomorrow.blogspot.com/2008/01/should-fed-get-as-aggressive-as-market.html)
A slew of recent economic developments indeed point to the risks associated with an over-liberal monetary policy. Per the latest price index releases, wholesale and consumer price indices continued to tread dangerous territory in January. Year-on-year, the January 2008 numbers are 4.6% over 2007 numbers! Oil continues to tread the 90-100 dollar range per barrel, and this does not create any room for inflationary pressures to ease. To add to the woes, the Euro broke a psychlogical barrier of 1.5 against the dollar last week (possibly accelerated by level-trigerred program trading by currency desks though!)...which means imported crude oil turns even more expensive.
Finally, after a slew of such signals, there seems to be some voices of dissent in the Fed against a liberal interest rate cut policy. Vice Chairamn Kohn and Chairman Bernanke continues to opine that growth is indeed the highest priority; but on Feb 29, Chicago Fed President Charles Evans mentioned that growth 'insurance' (read rate cuts) need to be possibly reversed if inflationary concerns persist.
For one, the massive rate cuts in January did not do much to either ease credit availability or bring down market rates. Auction-rate bond failures highlight the fact that credit remains scarce - most of the big banks, including Citi & UBS shied away from such auctions, forcing most issuers to abandon the effort. Mortgage rates haven't softened either - 30-year rates have fallen as little as 27 bps bpS (!) from 6.07 to 5.80 over the past 6 months & 1-year ARMs have only dropped by close to 90 bps.
Credit and the cost of credit in the current market environment is more being dictated by lender worries. The biggest worry for all the big lenders at this point are a) potential write-downs in CDOs, MBSs, ABSs and other instruments which are either backed by sub-prime mortgages, ALt-A mortgages, risky retail instalment/revolving debt etc & b) potential risk associated with bond insurer downgrades and resultant massive write-downs in sub-AAA debt insured by them. The only way to tackle this is to use a double-pronged strategy of multi-party financial support for bond-insurers & incentive-driven/regulatory-driven measures to ensure continued credit availability. Sustained Fed rate cuts in such an environment may not work as much as expected.
As we wait for the next FOMC session on March 14, most traders are betting another 50 or 75 bps cut. Chicago Borard of Trade numbers already indicate a 72% probability of a 75 bps cut in March! And if January was an inidcation of how well the traders predict the Fed, we might very well be seeing that. Hopefully not - a more balanced view would mean the Fed looks in to Feb CPI numbers (which get released by March 14) and then weigh inflation risks with growth risks. Continued inflationary pressures will then dictate a lower cut of say, 25 bps. The market might react negatively to such a step; but how should it matter? Has the market gained any stability after the last instalment of liberal rate cuts...defintely not. In the current economic situation, the Fed should continue to focus on long-term economic fundamentals and not play in to market-psyche by announcing another 50 or 75 bps rate cut. Because that might just put us in a bigger probleme of prolonged staglation - making Fed monetaryt policy toothless.
A slew of recent economic developments indeed point to the risks associated with an over-liberal monetary policy. Per the latest price index releases, wholesale and consumer price indices continued to tread dangerous territory in January. Year-on-year, the January 2008 numbers are 4.6% over 2007 numbers! Oil continues to tread the 90-100 dollar range per barrel, and this does not create any room for inflationary pressures to ease. To add to the woes, the Euro broke a psychlogical barrier of 1.5 against the dollar last week (possibly accelerated by level-trigerred program trading by currency desks though!)...which means imported crude oil turns even more expensive.
Finally, after a slew of such signals, there seems to be some voices of dissent in the Fed against a liberal interest rate cut policy. Vice Chairamn Kohn and Chairman Bernanke continues to opine that growth is indeed the highest priority; but on Feb 29, Chicago Fed President Charles Evans mentioned that growth 'insurance' (read rate cuts) need to be possibly reversed if inflationary concerns persist.
For one, the massive rate cuts in January did not do much to either ease credit availability or bring down market rates. Auction-rate bond failures highlight the fact that credit remains scarce - most of the big banks, including Citi & UBS shied away from such auctions, forcing most issuers to abandon the effort. Mortgage rates haven't softened either - 30-year rates have fallen as little as 27 bps bpS (!) from 6.07 to 5.80 over the past 6 months & 1-year ARMs have only dropped by close to 90 bps.
Credit and the cost of credit in the current market environment is more being dictated by lender worries. The biggest worry for all the big lenders at this point are a) potential write-downs in CDOs, MBSs, ABSs and other instruments which are either backed by sub-prime mortgages, ALt-A mortgages, risky retail instalment/revolving debt etc & b) potential risk associated with bond insurer downgrades and resultant massive write-downs in sub-AAA debt insured by them. The only way to tackle this is to use a double-pronged strategy of multi-party financial support for bond-insurers & incentive-driven/regulatory-driven measures to ensure continued credit availability. Sustained Fed rate cuts in such an environment may not work as much as expected.
As we wait for the next FOMC session on March 14, most traders are betting another 50 or 75 bps cut. Chicago Borard of Trade numbers already indicate a 72% probability of a 75 bps cut in March! And if January was an inidcation of how well the traders predict the Fed, we might very well be seeing that. Hopefully not - a more balanced view would mean the Fed looks in to Feb CPI numbers (which get released by March 14) and then weigh inflation risks with growth risks. Continued inflationary pressures will then dictate a lower cut of say, 25 bps. The market might react negatively to such a step; but how should it matter? Has the market gained any stability after the last instalment of liberal rate cuts...defintely not. In the current economic situation, the Fed should continue to focus on long-term economic fundamentals and not play in to market-psyche by announcing another 50 or 75 bps rate cut. Because that might just put us in a bigger probleme of prolonged staglation - making Fed monetaryt policy toothless.
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