Pits, Pendulums and Perils: LEH, FNM, FRE and Other Walking Wounded
Well diving back into the on-going trials and tribulations of the Finance Industry wasn't today's strategic objective but with the industry ETF (XLF) up 3.3% and LEH closing up 7.4%, after being up over 11% on rumors of some sort of buyout, injection, something it seemed necessary. In a perverse way it pairs perfectly with the prior discussion of the dismal and deteriorating Retail outlook. The Finance outlook is much worse and the causes are linked - there's still more write-offs, the economic downturn will worsen loan losses and credit continues to tighten. In fact the spreads on some corporate bonds, discussed in the readings, are getting so bad that the credit markets are clearly anticipating a wave of bankruptcies in both the Finance industry and the general economy as the result of all this.
After the break you'll find the usual collection of readings. We want to couple those readings with an analytic review of the economy, monetary situation, the credit markets and the industry outlook. Which is far too much for one post so we're putting up this part with the readings and a few kickstart graphics and will plan to follow-up with the analytical dissection later. The readings are broken up into three clusters: some general stuff and examples, including some excellent BNN interviews which we've annotated a tad, some specifics on the disaster children (LEH, FNM, FRE) and some other exemplars (MER, AIG). The excerpts for the later, especially AIG, illustrate the pit fall trying to apply traditional analysis to companies facing these perfect storms of problems AND broken business models. On the other hand Dennis Berman's dissection of MER's stock float and the implications for the future is an excellent example of the kind of thinking that should go on. As is the BNN interview with Dick Bove where, among other bon mot gems, he points out that Dick Fuld of LEH has three days to pull the trigger or get bought in a hostile takeover. If not in so many words. The other thing that folks are missing, for all practical purposes, is that the Fannie and Freddie are effectively bankrupt with stock prices as close to zero as makes no never mind. What's going to happen when they have to be salvaged we wonder ? Talk about the collapse of Western Civilization if BSC was a threat this is the 8,000lb pre-historic ape in the parlor. We'll pick up the graphic with the next post but it shows a shrinking money basis as credit tightens and a rising yield spread between Fed Funds and 10Yr Treasuries. Most likely due to worries over the dollar and interest rates as the result of all this mess. Think about it in this context.
The Lehman Disaster
And then consider the accompanying LEH stock chart, which shows today's bump true enough. But also shows the implosion over the last year as all these problems eat away at it. Today's little bump up in this context doesn't mean so much does it ? Wonder how it managed to take the markets up with it ? The story is that all the folks approached by Fuld have been balking because he wants 20% over book value, i.e. a ~ $40 price. Instead he'll be lucky to get $15-20 and has destroyed his company by not dealing with these problems. As Bove points out.
The Fannie/Freddie Catastrophe
But whatever has been going on at LEH is nothing compared to FNM and FRE - which are central not just to the Housing market but to our economy. Talk about too big to fail ! The "funny" thing is that when you dig back thru it, like MER and Citi, most of the really bad crap they engineered for themselves was done in '06 and '07. In other words after the crisis in Housing was generally visible and should have been crystal clear to companies who's entire existence depended on understanding those markets and mechanics. Talk about your boiled frogs being flayed and displayed.
We dissected all that at great length in a prior post which you may want to review:
Bad Times, Really Bad Behavior, Bad Trouble: Fannie/Freddie and Perdition Road
Finance's Dismal Future
Wall Street, meet small street Storm-tossed financial firms are throwing their treasures overboard just to stay afloat. After years of rapid growth, the big players on Wall Street are downsizing. Stung by billions of dollars of losses and impoverished by plunging stock prices, firms from AIG and Citi to Goldman Sachs and UBS have been selling assets, laying off workers and mulling over possible split-ups. But with credit markets sending distress signals again, even a measured scaling-back may not be enough to see some firms through the next tempest. That's why, like Merrill Lynch before it, Lehman Brothers) is now considering jettisoning a prize asset in the name of raising cash. Indeed, investors have been consumed this year by uncertainty over the value of financial firms and their mortgage-heavy portfolios. One measure of that opacity lies in how much of a firm's asset base it designates as Level 3, signifying that the values have been assigned without any market input because none was available. Over the past four quarters, assets designated Level 3 by the eight biggest commercial and investment banks rose to $612 billion from $461 billion, according to investment strategist Ed Yardeni. While many of those assets no doubt have substantial value, the fact that no market exists to readily set a price suggests firms wouldn't be able to sell them to raise ready cash except at a steep discount. Beyond that, the sheer size of these illiquid asset stores is startling. Recent data show that both Lehman and Goldman Sachs have more Level 3 assets than they do tangible equity, a measure of the firm's value to shareholders.
- Market Lookahead BNN sets you up for your trading day with Bill Strazzullo, partner and chief markets strategist, Bell Curve Trading. [Worthwhile for the distinction between balanc sheet and income statement problems. Too optimistics on credit markets IOHO]
National City Bond Trades Show Looming Defaults KeyCorp Yields Can't Deny Never have regional banks been so disrespected by bondholders. National City Corp. Chief Executive Officer Peter Raskind says Ohio's biggest lender is the ``best capitalized of all major U.S. banks'' after raising $7 billion this year, yet its bonds show it's at risk of default. Cleveland-based National City's bonds have plummeted as much as 17 cents on the dollar since June and yield more than 10 percentage points above Treasuries, similar to Ford Motor Co. debt. KeyCorp, Comerica Inc. and Fifth Third Bancorp have also tumbled, falling as much as 14 cents. The declines underscore growing speculation among investors that the more than $500 billion of credit losses and asset writedowns sparked by the collapse of the housing market are nowhere near ending, and there is little Federal Reserve Chairman Ben S. Bernanke or Treasury Secretary Henry Paulson can do. ``It's like catching a falling knife and I'm not real interested in that,'' said Eric Johnson, president of Carmel, Indiana-based 40/86 Advisors Inc., which manages $25 billion in fixed-income assets. Until yields on corporate credit and mortgages stabilize, ``it's still going to be too early to buy.'' More than a dozen regional banks have been closed by state or federal regulators since 2007. The number of lenders on the Federal Deposit Insurance Corp.'s ``problem'' list climbed to 90 in the first quarter from 76 in the fourth quarter, the agency said in May, without naming the firms.
Bond yields hint at corporate bankruptcies AS RECESSION FEARS loom for the world's leading economies, analysts say a rise in corporate bankruptcies is inevitable over the next 12 to 18 months, and the banking sector could provide a larger-than-expected chunk of the proportion of companies that fail. According to the Merrill Lynch Corporate Master index, which tracks the performance of dollar-denominated, investment grade-rated corporate bonds, there are 72 bonds trading in distressed territory, 28 of which have been issued by banks. We are forecasting 110 banks with $850 billion in assets to fail by next July. That's eight times the FDIC's total reserves," says Chris Whalen, managing director of Institutional Risk Analytics. "The next president of the U.S. is going to have to create a vehicle to buy banks that we can't sell after they fail." The fallout from IndyMac has hit the broader banking sector hard, as evidenced in the option-adjusted spreads -- a measure of a security's extra yield over the yield of a comparable treasury security after accounting for any options or sinking funds -- on outstanding bank bonds.
The Evolution of Private Equity Despite the credit crunch some deals are getting done - but the amount of leverage is significantly less. BNN discusses the evolution of private equity with Howard Johnson, president, Veracap Corporate Finance.
Ron Insana's Hedge Fund Closure a Cautionary Tale Hedge funds used to be seen as a license to print money, but 2008 is shaping up to be the year the bubble burst. Earlier this month, former CNBC anchor Ron Insana folded Insana Capital Partners, the hedge fund he launched in 2006, while superstar investor Dan Benton announced that he's shuttering his $2 billion hedge fund Andor Capital Management in October. Our guest, New York Times M&A reporter Andrew Ross Sorkin, detailed Insana's travails on his DealBook blog, and goes into the finer points of the rash of hedge fund failures in the accompanying video.
Key Player Problems: LEH, FRE, FNM
Lehman On The Bubble Richard Fuld seems to be putting himself and Lehman Brothers into a corner. The embattled chief executive can't find willing investors, even overseas--perhaps because Lehman Brothers shares have tanked 61% since the last time the company raised capital. The $4 billion of common stock sold in June as part of the $6 billion total capital raised is now worth $1.8 billion. On Thursday, the Financial Times reported Fuld tried to convince the Korean Development Fund to buy 50% of his company last month and was turned down. The inability to raise cash, even from sovereign investment funds that have eagerly embraced U.S. investments since the credit crisis began, speaks to the difficult straits Fuld finds himself in. It's clear he puts Lehman's value well above where the rest of the market thinks it should be. Lehman's book value is $34 per share, but its stock trades at $13. Lehman's market capitalization of $9 billion as of Thursday is equal to the low end of the value attached to its Neuberger Berman asset management division alone. That implies the market values Lehman's remaining operations at zero. Richard Bove, an analyst at Ladenburg Thalmann, says this disconnect makes Lehman ripe for a hostile takeover. "It is possible that negotiations to sell a portion of the company to outsiders broke down because management was demanding to be paid book value or a premium to book value," Bove said Thursday. "So the market is at a standoff." Lehman is heading into another quarterly loss, according to analysts, whose views of the company's financial performance this summer grow increasingly pessimistic. That would be the second-straight loss for the bank, including an estimated $4 billion of additional write-downs.
- Pitfalls of a Lehman Sale Looking to sell its asset-management business sounds like a last-ditch move for Lehman Brothers, and any deal needs to be bold to clear the clouds hanging over the firm.
- Lehman Jumps After Korea Development Bank Says It's Considering Investment
- Lehman's Korean Suitor BNN speaks to Dick Bove, analyst, Ladenburg Thalmann. [This is the best discussion with insightful context from the anchor that we've heard]
Freddie Hunts for Cash Freddie Mac executives are talking to private-equity firms and other investors about the possibility of buying new common or preferred shares, but many investors fear their money will be lost if the Treasury bails out the companies. But that effort is running up against what may be an insurmountable hurdle: Many investors fear any money they invest now in Freddie or its main rival, Fannie Mae, will be lost later if the U.S. Treasury bails out the companies through a purchase of equity in them. Investors believe such a purchase would likely involve terms that would wipe out the value of previously issued shares.
Fate of Fannie and Freddie Hinges On $225 Billion Mortgage companies Fannie Mae and Freddie Mac are facing a $225 billion question. That is the amount of debt the companies need to refinance by the end of September. Thus far, they have had little trouble persuading investors to buy debt with maturities of a year or less. But investors say the mood could change as long as details of any potential government bailout remain murky. Shares of both companies have been hammered for weeks by fears they would no longer be able to function, a problem that would likely cripple the U.S. housing market. Last month, Congress gave the Treasury Department the authority to lend money to the firms or take an equity stake. Because investors have little idea how Treasury would intervene, they have become less enthusiastic about adding Fannie or Freddie debt to their portfolios, creating a potentially self-fulfilling spiral. For Treasury, which is mulling how to structure a rescue of the two mortgage companies, if necessary, the ability of the pair to keep turning over their debt is paramount. Treasury Secretary Henry Paulson has said the government has no plans to use its authority. But Treasury is developing a series of options that it could use to shore up the companies if a market seizure forced them to intervene, according to people familiar with the matter. The steps they take will depend on market conditions at the time and the needs of the firms, these people said. Among the options at Treasury's disposal is to make a large capital injection that would essentially result in a takeover by the U.S. government. Such a move wouldn't be undertaken lightly, these people said, and would be done as part of a broader plan to remake the companies. Among the issues being debated is whether to oust management and whether to treat both companies equally or devise a rescue for one and not the other. Treasury has no imminent plans to intervene, but a deterioration in the housing sector could force its hand if either company can no longer fund itself.
Other Examples: MER, AIG
Slim Pickings at Merrill Lynch What if you woke up one morning and had 615 million more mouths to feed? And your fridge? It's half-empty. This is the dilemma for Merrill Lynch Chairman and Chief Executive John Thain, who last week unveiled an $8.55 billion sale of new Merrill common stock. Coupled with other share offerings, previous Merrill holders will be diluted by 615 million shares, or roughly 38%. The market seemed to overlook this dilutive donnybrook, instead focusing on Merrill's other plan, to dump $30.6 billion in crummy derivatives. Mr. Thain tinkered with the timing of his problems: trading today's derivatives-pricing mess for tomorrow's earnings shortfalls. All this wheeling and dealing will soon leave Merrill with 1.6 billion shares outstanding. To return to an earnings-per-share level of $4.40 each, Merrill will have to produce annual net income of a little more than $7 billion. Right now, Street analysts are predicting median per-share earnings of $2.65 for 2009, or net earnings of $4.2 billion, according to Thomson Reuters. In other words, Merrill needs to come up with $2.8 billion in new profit -- not sales -- to get back to its 2004 per-share earnings levels. That's $43,000 in new profit for each of Merrill's 65,000 employees. Oh, and don't forget Merrill's dividend. Merrill continues to pay out 35 cents a share per quarter. Layer on 615 million more shares, and that's an additional $861 million out the door each year. That's precisely the problem. All those businesses have largely disappeared. That puts most of the earnings burden on Merrill's old-line businesses -- brokerage, asset management and investment banking. Mr. Thain embraces these units as Merrill's future, as well he should. But those new mouths are hungry. And the fridge is indeed sparse. Amid a flagging general economy, that leaves few options for Mr. Thain: Cut costs even deeper, hoping that the franchise can stay intact with ever-fewer employees. Somehow grab market share from other Street houses. Or, gradually, start to take on more risk on Merrill's trading desks, which produced the bulk of the $30 billion in losses over the past 12 months.
The Lessons of AIG From a high of $72 in early 2007, AIG has now collapsed to just $24.40. That follows an eye-watering plunge today, following dismal second-quarter results and some fears about the balance sheet. Mr. Greenberg, of course, retains a very large stake in the company. The shares he kept have, of course, plummeted along with everyone else's. But his sales still saved him, and his family, hundreds of millions in further losses. The unhappy investors who bought his shares aren't the only ones crying. AIG raised $20 billion in new money in May to shore up its balance sheet. That included selling new shares for $7.5 billion. Those who invested have already lost $2.7 billion, or more than a third of that, due to the collapse in the stock price. AIG has become blotting paper, soaking up investors' money. Over 10 years, they have actually lost half their stake. This is not a minor financial story. In sense, everyone in America is a loser. AIG is one of the most valuable companies in the world. If you have a pension plan or money in any stock mutual funds, the odds are strong that you have lost money on this stock. The question remains whether the latest plunge is the time to buy, or whether, in that unhappy Wall Street phrase, things are going to get worse… before they get even worse. And there's some reason to think shares have already baked a lot of further bad news into the cake. The latest plunge wasn't just about the dismal second-quarter earnings, and the further deep write-offs in the company's pile of bad mortgage-related investments. AIG management also added to the alarm with a PowerPoint slide suggesting future losses from its subprime and mortgage-related paper could reach another $8.5 billion. But if you listened to the conference call, that figure was based upon some very gloomy assumptions about write-downs and defaults.
Is Your Insurance Safe With AIG? For anyone who holds an annuity or other policy with insurance giant AIG, the current turmoil is surely both unnerving and frustrating. On the one hand, the news has been dreadful. The company has lost billions on bad investments due to the credit crunch. So far it has booked post-tax losses of more than $18 billion in the last three quarters, including $5.4 billion in red ink in just the last quarter. Wall Street has responded with alarm. AIG's stock price has collapsed by about two-thirds in a year, wiping more than $100 billion off the company's value. A former chief executive has already walked the plank. Meanwhile, the talk on has focused on the stockholders more than on policyholders. So is your policy, or annuity, safe with AIG? The good news is that there is no reason to be concerned, at least for now.