bizzXceleration: Performance, Value and Profit

Finance Breakdowns

5 big losers in the banking crisis These financial companies have suffered serious, long-term damage to their businesses. They may not be going under, but their futures look grim. Right now every time a bank announces earnings that aren't quite as bad as Wall Street expected, its stock rallies. That market action actually makes a kind of perverse sense. These stocks have been beaten up so badly that any news that signals something less than the end of the world is good news. Citigroup shares were down 49% from the start of 2008 to the beginning of the July rally in financials. Bank of America shares were down 53%. These train wrecks make a great short-term trade -- if you can catch the bounce and avoid the next tumble. But in the long term, I think it's a very different story. The stocks that have taken the biggest beatings from the financial crisis are exactly those you want to avoid -- for anything other than a short-term trade -- because these companies have suffered large and lasting damage to their businesses. They aren't going under in most cases, but they will lose markets and market share to other, less damaged competitors. Some will wind up being sold to their rivals. What I'm going to call the losers of the financial sector have lost key people. They've had to sell off what once were key business units. They're undergoing reorganizations that will take years and will continue to distract management until they're completed. And, most important, because of their troubles, they're falling behind competitors that have been investing billions to seize new markets and lock up new customers instead of writing off billions in losses. Buy these beaten-up stocks for the bounce, by all means -- if you can get the timing right. But remember that these financial companies have suffered lasting damage, making them long-term losers. Which financial companies would I put among the losers? Here are five, in alphabetical order.

Why (and how) to bet against banks Financial stocks may bounce here and there, but the problems they face are almost too deep to fathom. You need to short them just to protect yourself. Almost without anyone noticing, last Wednesday financial stocks had their biggest one-day rally ever, with the financials in the S&P 500 Index ($INX) soaring 12.3%. With that, the group regained its status as the third-largest segment in the index, having slipped to No. 4 behind health care just the previous day. But it wasn't too long ago that financials were the index's largest sector, and despite last week's action, their prospects remain miserable. "We've seen unprecedented carnage in this sector, and there are no signs it is over," says Alec Young, an S&P equity strategist. "We would urge investors not to be too tempted in this area."I confess I have been tempted, arguing that because financials took the economy down, it will be up to them to lead it back. In February, my fundamentally bullish column on the group was headlined "Financial stocks: The stars of 2008?" The answer to that question so far: No. Events have been giving my optimism quite a thrashing. So today I'm going to suggest what I believe will be the smartest way to play this group for at least the next six to 12 months. That would be to short it, betting these stocks will fall even more.

5 big winners in the banking crisis Today's column is about the five financial companies that are best positioned to pick up the pieces. Each one is an intense rival of one or more of the five companies so damaged by the meltdown in the markets for everything from mortgages to credit cards to car loans to complex instruments that were supposed to take the risk out of buying debt. Each one of these winners is going to gain market share at the expense of its challenged competitors. It's pretty easy to pick up business against a competitor that's still firing people, selling off whole businesses and scrambling to find enough capital to keep regulators at bay. The issue for these five winners isn't whether they'll grab market share but how much they'll seize. My five winners from the financial crisis are ING Group (ING, news, msgs), JPMorgan Chase (JPM, news, msgs), Toronto Dominion (TD, news, msgs), US Bancorp (USB, news, msgs) and Wells Fargo (WFC, news, msgs). I've written about ING, Toronto Dominion and US Bancorp before. All three are members of my 'unfixed-income' portfolio, and US Bancorp is a current Jubak's Pick. But the two others are new to this column.

The death of value investing Sure, value funds are great for the long term. But in the long term, we're all dead. These days, value as an investing strategy is dead, too -- and you probably own a bunch of it. Boyar Value Fund (BOYAX) performed spectacularly during the previous bear market, beating the S&P 500 Index($INX) by 16 percentage points in 2000, 27 in 2001 and nearly 12 in 2002. But this time around it is getting creamed, down 25% in the 12 months that ended June 30. What changed? Well, during that 2000-02 cycle the financial sector was ebullient, beating the market nearly as much as fund manager Mark A. Boyar did. And Boyar is a huge fan of financials -- even now, when they are deep in the mud. They account for nearly 27% of Boyar Value assets. Value and financials are joined at the hip. The average value mutual fund has two times as much invested in the group as the average fund on the opposite end of the spectrum, growth. Academic research, including the Fama-French model that underlies modern portfolio theory, shows that value significantly outperforms over very long periods. Since its inception in 1998, Boyar Value has returned nearly twice as much as the S&P 500 Index despite the fund's recent underperformance. True, all true. And artifacts from the Titanic are worth more now than when the ship sailed, but you wouldn't have wanted to be holding them in your hand in the meantime. And the chances are, you've got value debris of Titanic proportions in your portfolio. Two of the 10 largest mutual funds and five of the largest 25 are value funds. Value did so well from 2000 through 2007 that it may by now dominate your 401(k) retirement nest egg, especially if you're drawn to top-performing funds. But that was then. Now, whether you want to own this stuff depends on what your meaning of "long term" is. If you mean two decades or more, you ought to be buying value with both hands. But if your time horizon is any shorter, you ought to let it sink into its grave.

Lehman Hardest Hit by Wall Street's Biggest Borrowing Cost Rise Since 2000 Bondholders are demanding the highest interest rates for Wall Street debt since 2000, threatening the industry's business model of acquiring assets with borrowed money. Lehman Brothers Holdings Inc. has seen borrowing costs for its five-year bonds rise to 7.7 percent, up from 5.2 percent six months ago, the biggest jump of the four largest U.S. securities firms, data compiled by loomberg show. The yield offered on Lehman's $1.5 billion of bonds maturing in January 2012 is 4.3 percentage points more than the yield for five-year U.S. Treasury notes, a premium almost double what it was in late January. Wall Street faced higher debt costs in 2000, when the U.S. Federal Reserve's base lending rate was 6.5 percent. What's different now is the Fed rate is at 2 percent, showing that elevated yields of bank debt are all related to risk premium, or the spread investors demand to lend to brokers rather than the government. Firms like Lehman also rely increasingly on access to capital these days, rather than on fees or commission income. ``This is almost self-induced balance-sheet destruction,'' said Joseph Balestrino, a fixed-income strategist at Pittsburgh- based Federated Investors Inc., which manages about $330 billion. ``This is far beyond just your basic slowdown.'' The last big gain in investment banks' credit spreads occurred in 1998 after Russia defaulted on its debt and the hedge fund Long-Term Capital Management LP collapsed. The yield on a Lehman note issued in April 1998 that matured in 2003 rose to 7.6 percent in October of that year from 5.89 percent in August, a 29 percent increase. Financing costs returned to normal within a few months. This time, interest rates are staying high for a longer period of time, threatening to undermine bank profits, even though the firms have been trying to reassure investors by selling assets they bought with borrowed money, a process known as deleveraging.

Merrill Sells $8.55 Billion of Shares as Thain Unloads Money-Losing CDOs Merrill Lynch & Co., the third- biggest U.S. securities firm, sold $8.55 billion of stock and will liquidate $30.6 billion of bonds at a fifth of their face value to shore up credit ratings imperiled by mortgage losses. The company sold 380 million shares for $22.50 each, data compiled by Bloomberg show. Merrill closed at $24.33 yesterday and fell $1.21, or 4.9 percent, to $23.12 at 10:04 a.m. in New York Stock Exchange composite trading. Temasek Holdings Pte., the Singapore-owned fund that became Merrill's biggest investor by acquiring shares in December, agreed to buy $3.4 billion of the new stock, Merrill said yesterday in a statement. The New York-based company is paying Temasek $2.5 billion to offset losses on its earlier investment. Merrill will also book $5.7 billion of writedowns in the third quarter. Almost $19 billion of net losses in the past year forced Chief Executive Officer John Thain to backtrack from assurances that the firm had enough capital to weather the credit crisis. Since taking the post in December, Thain has raised $30 billion in an effort to keep pace with mounting charges on mortgage bonds amassed by his predecessor, Stan O'Neal. Standard & Poor's cut the firm's debt rating last month and signaled that more downgrades were possible.

Citigroup Markdowns May Rise $8 Billion, Deutsche Bank Analyst Mayo Says Citigroup Inc. will probably write down the value of collateralized debt obligations by $8 billion in the third quarter, Deutsche Bank AG analyst Mike Mayo said, after Merrill Lynch & Co. said it will sell the firm's CDO holdings for 22 cents on the dollar. Citigroup values the securities, mortgage-related bonds at the heart of the credit crisis, at 53 cents, Mayo wrote in a report to clients today. Citigroup has $22.5 billion of CDOs and it may have another $7 billion in writedowns to come, Mayo said. That could force it to raise more money, as Merrill did today, he said. ``The decision about raising new capital may be closer than we previously thought,'' Mayo said in the report. He also expects the bank to write down an additional $1 billion because of its $2 billion in exposure to so-called monoline insurance companies.

Rinse. Lather. Repeat. A brief review of recent Merrill CEO statements:

1. We don't need capital;

2. We could use some capital, but we won't sell shares, we'll just sell some assets;

3. We need to sell shares and raise capital right away;

Where is Ken* when you need him? The financial firms obviously think investors are utter fools. And for a while, they were correct. They suckered people into buying into this mess the whole way down. Bottom calls each and every level -- all of which failed. Some analysts even called iBanks a "Generational Buys" -- 30% higher. Only not so much. Release earnings. Issue guidance. A few weeks later, lower earnings. A few weeks after that, take more write-downs. Raise more capital.  Start it all over again next quarter. Rinse. Lather. Repeat.The banks have adopted a Chinese water torture approach -- dribbling out the bad news in small doses over time. Its been working up until now, but I doubt it will keep working much longer. Can they keep fooling people much longer? Merrill issued quarterly earnings on July 17th, and then dropped this bomb shell on July 28th? They must really think we are idiots, and that the SEC is in their backpockets to even attempt getting away with this crap. Bill King writes that "Eventually a critical mass of investors and traders will become cognizant of the obvious scheme and distrust of financial firms’ results, guidance and motives will increase substantially. John Thain’s credibility is now an issue." I agree.

Merrill's $5.7B Write-Down, $8.5B Share Issuance I'm on an earlier than usual train home today, to take the missus out to dinner (she just flew back into NY today). Change at Jamaica, bump into a Natexis derivative trader I know from my old neighborhood. Our train comes, I sit with him, along with his pals from Merrill. We are talking cars when one of the Merrill guys' Blackberry goes off. He is a CDO manager, and he just got the IM that the big press release just hit the tape. The news about the write down and the new stock issuance is now public. He tells us about it -- Write-Down = $5.7B; Share Issuance = $8.5B -- and we all start talking about it.

My (naive) question: "Wait a second -- didn't Merrill just report last week? How did they not disclose a $5.7 billion dollar whackage?"Merrill guy's by-the-book-answer: "Earnings were the 17th; The decision had not yet been made to sell the ABS CDOs, or take the writedown, or issue more stock. That was done this week." I think:  "yeah, sure it was."  Frickin weasels. 

Other Merrill guy says: "Geez, the stock is gonna get hit tomorrow" (ya think?) The stock closed Monday at $24.33, down 55% year-to-date. Merrill woman: "When do we buy this?" CDO guy: "When it hits $15" Me: Ouch!

~~~

The Merrill announcement raises a lot of questions. Investors should be asking questions. If the SEC wasn't so busy chasing rumors, squeezing shorts, and otherwise wasting taxpayer money -- but not protecting shareholders -- they might consider some of the following questions also:

1. Why did Merrill fail to disclose this write-down to shareholders when they reported on July 17th? The stock was $30.73 then; everyone who bought since then just got totally sandbagged.

2. The Financials -- especially Merrill -- traded today as if many people knew this was coming. How much non-public information leaked in advance of this announcement? (Isn't non-public material inside information something the SEC used to care about?)

3. Who really thinks the worst of the write-downs, share issuance, and dilution is behind us? Anyone? Bueller? (These CDOs were       vintage 2005. That means we have 06 and 07 yet to go).

4. Anyone think Financials are cheap? You cannot trust the "E," and the "P" is obviously subject to change. Think they might get cheaper?

5. Who really thinks the Financials have put in a bottom?