Bloomberg is reporting that homebuilders could be a buy now:
"Lennar Corp. and D.R. Horton Inc., the two biggest U.S. homebuilders, advanced after Citigroup Inc. said the industry's 50 percent decline this year has made the stocks attractive. Citigroup led financial shares higher after the largest U.S. bank said it expects 'a normal earnings environment' in the fourth quarter and former Federal Reserve Chairman Alan Greenspan said the credit slump may be ending."
Homebuilders are not buys right now. Not with this.
************************************************************
In the same day that Citigroup announces possible drops in future profits, the stock market surges with hopes that the credit crisis is over. Compare that with this:
"...the banks need to step into the confessional box and tell us just how much of the $2 Trillion drop in the value of US housing (so far) they are on the hook for. So far we’ve had a Billion here, a Billion there but the big boys have so far had their heads firmly in the sand and that means it’s time for a kick in the ass."
Ostriches, bulls...two names for the same animal? Currently, it seems that way.
Showing posts with label Banking. Show all posts
Showing posts with label Banking. Show all posts
Monday, October 1, 2007
Wednesday, September 26, 2007
Monday, September 24, 2007
The Goldman Sachs Lesson (as told by a professional)
As a follow up to this previous post, Mark Hulbert offers a great lesson regarding the Goldman Sachs' situation over the last couple of months:
"The time to buy, Nathan Rothschild famously said, is when the blood is running in the streets."
"For an answer you need look no further than what Goldman Sachs Group Inc. did in mid August, when it looked like the capital markets might dry up completely and the stock market appeared to many to be on the verge of a meltdown."
"The payoff? Its $2 billion investment has grown by a cool $320 million in the short time that has elapsed since then a 16% return in just one month, in other words."
Lesson learned. When the blood is flowing through the streets, make purchases or cover shorts.
"The time to buy, Nathan Rothschild famously said, is when the blood is running in the streets."
"But how to put this apocryphal advice to actual use? What does it look like in practice?"
"The blood most definitely was running in the streets."
"So what did Goldman do? It invested $2 billion (that's billion with a "b") of its own money in one of its hedge funds that was hemorrhaging." "The payoff? Its $2 billion investment has grown by a cool $320 million in the short time that has elapsed since then a 16% return in just one month, in other words."
Lesson learned. When the blood is flowing through the streets, make purchases or cover shorts.
Saturday, September 22, 2007
A Little Too Late...
I've been a bit predisposed the last couple of weeks, and in doing so, I've seen some profits dry up a little bit. At this point, I'm advising people to cover their shorts for Bear Stearns, Goldman Sachs, Citigroup, and JP Morgan. Closing prices for the respective corporations are as follows: BSC 117.32, GS 209.98, C 47.51, and JPM 47.13. I could have seen returns of 24 percent, 24 percent, 12 percent and 10 percent had I covered the shorts one month ago; but really, who expected the economic downturn to end in August? As it is, I'll still recognize some modest profits.
I still don't think we're at the bottom, but the recent rate cut from the FED has sparked a resurgence. I don't think it will last; Bernanke's just putting off the inevitable. But for now, cover your shorts...and be more observant than myself!
I still don't think we're at the bottom, but the recent rate cut from the FED has sparked a resurgence. I don't think it will last; Bernanke's just putting off the inevitable. But for now, cover your shorts...and be more observant than myself!
Thursday, August 23, 2007
And They Said it Wouldn't Spread...
Five articles of subprime spread.
The first: Subprime May Be Hitting Credit Cards, Too:
"Fallout from the mortgage mess and lower home prices may have started to creep into the credit card arena, judging from July payments and some initial moves by issuers to tighten the screws on cardholders."
The second: Mortgage Woes to Hurt Auto Sales:
"The ongoing slump in new-home sales and turmoil in the subprime mortgage industry will continue to hurt U.S. sales of light vehicles for the rest of the year and into 2008, according to an automotive market forecasting firm."
The third: Asian currencies led by rupiah dip as subprime losses spread:
"Asian currencies dropped yesterday on speculation global funds are exiting emerging-market assets as losses linked to US subprime mortgages spread."
The fourth: Layoffs Grow in Mortgage Industry:
"Brian Jurvis of Hazel Park wasn't surprised when he was laid off late last week from Countrywide Financial Corp.'s subprime lending division."
"Jurvis joined more than 25,000 workers nationwide who have lost jobs in the financial services industry since the beginning of the month -- more than half of them eliminated since Friday."
The fifth: Subprime pain spreads into office market:
"As business volume plunges for real estate firms hurt by the housing slump, they and companies that service them are abandoning office space and leaving landlords and surrounding communities suffering".
So far subprime problems have affected five other sectors or markets: consumer credit, auto industry, Asian markets, labor market, and commercial real estate.
Where else will this colossal problem rear its ugly head? Time will tell, but one thing is certain: the bubble is yet to burst. From Finance Markets.co.uk:
"In a recent CNN interview, Nouriel Roubini pointed out that current Federal Reserve estimates of the problem may be extraordinarily undervalued at $100 billion."
The first: Subprime May Be Hitting Credit Cards, Too:
"Fallout from the mortgage mess and lower home prices may have started to creep into the credit card arena, judging from July payments and some initial moves by issuers to tighten the screws on cardholders."
The second: Mortgage Woes to Hurt Auto Sales:
"The ongoing slump in new-home sales and turmoil in the subprime mortgage industry will continue to hurt U.S. sales of light vehicles for the rest of the year and into 2008, according to an automotive market forecasting firm."
The third: Asian currencies led by rupiah dip as subprime losses spread:
"Asian currencies dropped yesterday on speculation global funds are exiting emerging-market assets as losses linked to US subprime mortgages spread."
The fourth: Layoffs Grow in Mortgage Industry:
"Brian Jurvis of Hazel Park wasn't surprised when he was laid off late last week from Countrywide Financial Corp.'s subprime lending division."
"Jurvis joined more than 25,000 workers nationwide who have lost jobs in the financial services industry since the beginning of the month -- more than half of them eliminated since Friday."
The fifth: Subprime pain spreads into office market:
"As business volume plunges for real estate firms hurt by the housing slump, they and companies that service them are abandoning office space and leaving landlords and surrounding communities suffering".
So far subprime problems have affected five other sectors or markets: consumer credit, auto industry, Asian markets, labor market, and commercial real estate.
Where else will this colossal problem rear its ugly head? Time will tell, but one thing is certain: the bubble is yet to burst. From Finance Markets.co.uk:
"In a recent CNN interview, Nouriel Roubini pointed out that current Federal Reserve estimates of the problem may be extraordinarily undervalued at $100 billion."
"Instead, he points out that minority equity is bundled with debt, which is then leveraged against further higher debts, which can in themselves then be set up as collateral against even yet higher debts."
"Any loss of value on the original equity value - ie, sub prime mortgages - leaves only debt sustaining debt - a house of cards that we are only beginning to see unravel."Holy Deadly Debt, Batman! Does that mean we're in trouble??
Wednesday, August 1, 2007
Bear Stearns Has More Problems
In a shocking(?) turn of events, a third hedge fund managed by Bear Stearns is in trouble. Yesterday, they halted investors from bailing out:
"Bear Stearns Cos., manager of two hedge funds that collapsed last month, halted redemptions from a third fund after a slump in credit markets prompted investors to demand their money back."
Today, more Bear Stearns' hedge funds filed for bankruptcy:
"Two Bear Stearns Cos. hedge funds heavily exposed to the flagging mortgage industry filed for bankruptcy protection late Tuesday, two weeks after the company told investors one was essentially worthless and the other had lost more than 90 percent of its value."
"The funds were squeezed after Bear Stearns made wrong-way bets on the home mortgage market and was caught as loans to risky investors began to default."
"On Wall Street, Bear Stearns Cos., Lehman Brothers Holdings Inc., Merrill Lynch & Co. and Goldman Sachs Group Inc., are as good as junk."
"The highest level of defaults in 10 years on subprime mortgages and a $33 billion pileup of unsold bonds and loans for funding acquisitions are driving investors away from debt of the New York-based securities firms. Concerns about credit quality may get worse because banks promised to provide $300 billion in debt for leveraged buyouts announced this year."
I wonder what James Altucher thinks about all this? I bet he'll say that Goldman Sachs is a screaming buy.
"Bear Stearns Cos., manager of two hedge funds that collapsed last month, halted redemptions from a third fund after a slump in credit markets prompted investors to demand their money back."
Today, more Bear Stearns' hedge funds filed for bankruptcy:
"Two Bear Stearns Cos. hedge funds heavily exposed to the flagging mortgage industry filed for bankruptcy protection late Tuesday, two weeks after the company told investors one was essentially worthless and the other had lost more than 90 percent of its value."
"The funds were squeezed after Bear Stearns made wrong-way bets on the home mortgage market and was caught as loans to risky investors began to default."
"Bear Stearns is the nation's fifth-largest investment bank and specializes in mortgage-backed securities."
Is it only a matter of time before the company goes belly up? The more news that comes out, the more it looks that way. Meanwhile, investors have deemed other investment bank assets "junk":"On Wall Street, Bear Stearns Cos., Lehman Brothers Holdings Inc., Merrill Lynch & Co. and Goldman Sachs Group Inc., are as good as junk."
"The highest level of defaults in 10 years on subprime mortgages and a $33 billion pileup of unsold bonds and loans for funding acquisitions are driving investors away from debt of the New York-based securities firms. Concerns about credit quality may get worse because banks promised to provide $300 billion in debt for leveraged buyouts announced this year."
I wonder what James Altucher thinks about all this? I bet he'll say that Goldman Sachs is a screaming buy.
Monday, July 30, 2007
The Bears are Breaking the Banks
Forbes.com has a great article on the bears ruling banking stocks. Tom Van Riper makes some very sound arguments for that reasoning:
"Investors in major U.S. brokerage stocks haven't seen the last of the sell-off. Not with bank funding for merger deals slowing as credit gets more expensive. Wider spreads in the junk bond market, where so many deals are done, mean the costs of issuing securities are higher, as are the risks for doing so."
I cannot disagree with logic. And for just these same reasons, I'm waiting to see what happens before taking my profits. When Goldman Sachs fell below $200, I was tempted to cash out. Of course, I did not. And when Goldman Sachs broke through the $200 dollar mark last week, I was regretful. I waited and saw GS lose even more value. For that reason, I'm holding off on covering my short. I think we've got a ways to go before banking stocks begin a recovery. Mortgage rate resets have yet to reach a peak, while overall business credit is trending tighter and tighter. The Chrysler deal is a great example. With every new story coming out of the financial main stream media, psychological factors will push banking stocks lower. And if Hank Paulson has his way, the federal deficit will crowd private investment even more, but that's for a different post.
Of course there are some people who will disagree with me. Here, James Altucher of The Street wonders why Goldman Sachs is so cheap. He even goes so far as to say that the company might be subject to a private buyout. Here, Mr. Altucher continues his faulty reasoning by indicating that investors should buy Goldman Sachs, as well as JP Morgan, and Citigroup, all of which I've indicated at sell or short sell status. At least James didn't try and convince investors to buy Bear Stearns. Ha!
I may be wrong about this next point, and if that's the case, then call me out. I think the credit cycle is at least as easy to predict as the housing market. Why is this? Because the credit (ie: banking) industry moves at a pace that is similar to the housing market. Complete cycles in both sectors take years to complete. As soon as one realizes that the credit cycle downturn is beginning, a savvy investor would take bank stock shares from Mr. Altucher's account and sell them short. When the credit cycle peaks as high as it has this last go around, the drop should act in symmetry. What does this mean? Big money for "danger-seeking" investors who know how to play the game.
"Investors in major U.S. brokerage stocks haven't seen the last of the sell-off. Not with bank funding for merger deals slowing as credit gets more expensive. Wider spreads in the junk bond market, where so many deals are done, mean the costs of issuing securities are higher, as are the risks for doing so."
I cannot disagree with logic. And for just these same reasons, I'm waiting to see what happens before taking my profits. When Goldman Sachs fell below $200, I was tempted to cash out. Of course, I did not. And when Goldman Sachs broke through the $200 dollar mark last week, I was regretful. I waited and saw GS lose even more value. For that reason, I'm holding off on covering my short. I think we've got a ways to go before banking stocks begin a recovery. Mortgage rate resets have yet to reach a peak, while overall business credit is trending tighter and tighter. The Chrysler deal is a great example. With every new story coming out of the financial main stream media, psychological factors will push banking stocks lower. And if Hank Paulson has his way, the federal deficit will crowd private investment even more, but that's for a different post.
Of course there are some people who will disagree with me. Here, James Altucher of The Street wonders why Goldman Sachs is so cheap. He even goes so far as to say that the company might be subject to a private buyout. Here, Mr. Altucher continues his faulty reasoning by indicating that investors should buy Goldman Sachs, as well as JP Morgan, and Citigroup, all of which I've indicated at sell or short sell status. At least James didn't try and convince investors to buy Bear Stearns. Ha!
I may be wrong about this next point, and if that's the case, then call me out. I think the credit cycle is at least as easy to predict as the housing market. Why is this? Because the credit (ie: banking) industry moves at a pace that is similar to the housing market. Complete cycles in both sectors take years to complete. As soon as one realizes that the credit cycle downturn is beginning, a savvy investor would take bank stock shares from Mr. Altucher's account and sell them short. When the credit cycle peaks as high as it has this last go around, the drop should act in symmetry. What does this mean? Big money for "danger-seeking" investors who know how to play the game.
Wednesday, July 18, 2007
Fixing the Bond Market
When you don't like what you hear from one doctor, you get a second opinion. But how ethical is it to get a second opinion when you're talking about rating the creditworthiness of mortgage-backed securities? From Bloomberg:
"Moody's Investors Service has been excluded from rating 70 percent of new commercial mortgage-backed securities after toughening its guidelines. "
"'There's no doubt in my mind that it's because of the change' said Philipp, who included a chapter titled 'Rating Shopping is Alive and Well' in a report released today. 'Normally, we'd rate 75 percent of the issues, not 30 percent. I guess this is sort of like, no good deed goes unpunished.'''
Investors beware. You can put makeup on a pig, but it'll still be a pig.
"Moody's Investors Service has been excluded from rating 70 percent of new commercial mortgage-backed securities after toughening its guidelines. "
"'There's no doubt in my mind that it's because of the change' said Philipp, who included a chapter titled 'Rating Shopping is Alive and Well' in a report released today. 'Normally, we'd rate 75 percent of the issues, not 30 percent. I guess this is sort of like, no good deed goes unpunished.'''
Investors beware. You can put makeup on a pig, but it'll still be a pig.
Dow Drop Turns Into a Hiccup
The Dow dropped as much as a percent in early trading, before rebounding for a 0.38 percent loss. Over the last few weeks, we've had one trading day in which the market recedes from a subprime scare. In the previous weeks, the market has rebounded the following days. Last week, the market rebounded to post record highs. Will this week be the same? If the last half of the trading day is any indication, it could be.
One thing about trading today that made me scratch my head, is the minimal hit taken by Bear Stearns. If you'll recall yesterday, the company announced what the two troubled hedge funds were really worth: Zero, Point, Zero! Okay, actually one of the two funds is still worth nine cents on the dollar. But Bear Stearns didn't take the hit today. They lost less than half a percent. Goldman Sachs and JPMorgan, on the other hand, both lost two percent of their value; Citicorp lost one and a half percent; Merrill Lynch lost 3.25 percent.
The next two days should be telling as to what direction the market will turn. Will this be another hiccup, or the start of a correction period?
One thing about trading today that made me scratch my head, is the minimal hit taken by Bear Stearns. If you'll recall yesterday, the company announced what the two troubled hedge funds were really worth: Zero, Point, Zero! Okay, actually one of the two funds is still worth nine cents on the dollar. But Bear Stearns didn't take the hit today. They lost less than half a percent. Goldman Sachs and JPMorgan, on the other hand, both lost two percent of their value; Citicorp lost one and a half percent; Merrill Lynch lost 3.25 percent.
The next two days should be telling as to what direction the market will turn. Will this be another hiccup, or the start of a correction period?
Tuesday, July 17, 2007
Bear Stearns: WORTHLESS
It's being reported tonight that the riskier of the two Bear Stearns hedge funds is as good as worthless, while the other troubled fund is worth about NINE CENTS on the dollar. From the NY Times:
“'The preliminary estimates show there is effectively no value left for the investors in the Enhanced Leverage Fund and very little value left for the investors in the High-Grade Fund as of June 30, 2007,' according to the letter."
In a related story, Bloomberg reports that Goldman Sachs and JPMorgan are among a few bank who are unable to dump their debt:
"'The private equity firms, being very tough negotiators, are unlikely to let the banks off the hook,' said Martin Fridson, chief executive officer of high-yield research firm FridsonVision LLC in New York. 'They'll say that's your problem and that's why we're paying you: To take risk.'''
"'Those bonds are probably worth 94 cents on the dollar, or $43.5 million less than when they were sold on June 28', according to Justin Monteith, an analyst at high-yield research firm KDP Investment Advisors in Montpelier, Vermont."
I have a feeling that the faulty debt problems will be mostly contained within the banking industry. I can't see this affecting tech stocks very much, if at all. As for gold, these developments will only cause upward pressure on metal and metal stocks, especially if it gets bad enough for a federal bailout.
Investment banks beware. When the chickens come home to roost, the cock-fights will get bloody. Did you follow my advice? What about this? Are you covered?
(Edited 7/17/07 7:57 PM: edited to fix the NY Times link)
“'The preliminary estimates show there is effectively no value left for the investors in the Enhanced Leverage Fund and very little value left for the investors in the High-Grade Fund as of June 30, 2007,' according to the letter."
In a related story, Bloomberg reports that Goldman Sachs and JPMorgan are among a few bank who are unable to dump their debt:
"'The private equity firms, being very tough negotiators, are unlikely to let the banks off the hook,' said Martin Fridson, chief executive officer of high-yield research firm FridsonVision LLC in New York. 'They'll say that's your problem and that's why we're paying you: To take risk.'''
"'Those bonds are probably worth 94 cents on the dollar, or $43.5 million less than when they were sold on June 28', according to Justin Monteith, an analyst at high-yield research firm KDP Investment Advisors in Montpelier, Vermont."
I have a feeling that the faulty debt problems will be mostly contained within the banking industry. I can't see this affecting tech stocks very much, if at all. As for gold, these developments will only cause upward pressure on metal and metal stocks, especially if it gets bad enough for a federal bailout.
Investment banks beware. When the chickens come home to roost, the cock-fights will get bloody. Did you follow my advice? What about this? Are you covered?
(Edited 7/17/07 7:57 PM: edited to fix the NY Times link)
Saturday, July 14, 2007
Changing Course
As new information comes to light, I am forced to make adjustments to my portfolio. As much as I hate admitting being wrong, to do so is to learn and to grow. I was wrong on a few assumptions.
1. Merrill Lynch. Despite the fact that I think the subprime mortgage market is in huge trouble, I can't overlook this:
"Despite problems brokerage firms reported last month with the subprime mortgage business, analysts are more sanguine about results for Merrill Lynch, and they expect the firm to post a more than 20% rise from year-ago earnings per share."
You cannot ignore news items such as these. If you'll recall, Merrill took a very activist approach when it came to getting rid of subprime securities. While JP Morgan Chase was canceling auctions over fears that the entire subprime CDO market would be recognized for its true value, Merrill persisted. They rid themselves of highly risky debt obligations and by using an auction format, they were committed to doing so no matter the losses they'd incur. That, coupled with the news release, is my reason for changing course. If you shorted the company, buy enough stock to cover the short. If you sold your original stocks, too bad. I won't issue a buy for Merrill at this point because I think the banking industry is still due to take a large subprime hit.
2. Apple. The iPhone figures have yet to be released, yet the stock pushes upward. I'm not going to wait for it to hit $200 before I change course; I'm changing course now. Buy enough to cover any shorts and wait to see if the price comes down.
3. Google. This stock is the only one I'm reversing course on. From Marketwatch:
"Analysts polled by Thomson Financial expect Mountain View, Calif.-based Google to post a 44% gain in earnings from the period a year earlier, to $3.59 a share, while revenue is expected to grow 60% to $2.68 billion."
1. Merrill Lynch. Despite the fact that I think the subprime mortgage market is in huge trouble, I can't overlook this:
"Despite problems brokerage firms reported last month with the subprime mortgage business, analysts are more sanguine about results for Merrill Lynch, and they expect the firm to post a more than 20% rise from year-ago earnings per share."
You cannot ignore news items such as these. If you'll recall, Merrill took a very activist approach when it came to getting rid of subprime securities. While JP Morgan Chase was canceling auctions over fears that the entire subprime CDO market would be recognized for its true value, Merrill persisted. They rid themselves of highly risky debt obligations and by using an auction format, they were committed to doing so no matter the losses they'd incur. That, coupled with the news release, is my reason for changing course. If you shorted the company, buy enough stock to cover the short. If you sold your original stocks, too bad. I won't issue a buy for Merrill at this point because I think the banking industry is still due to take a large subprime hit.
2. Apple. The iPhone figures have yet to be released, yet the stock pushes upward. I'm not going to wait for it to hit $200 before I change course; I'm changing course now. Buy enough to cover any shorts and wait to see if the price comes down.
3. Google. This stock is the only one I'm reversing course on. From Marketwatch:
"Analysts polled by Thomson Financial expect Mountain View, Calif.-based Google to post a 44% gain in earnings from the period a year earlier, to $3.59 a share, while revenue is expected to grow 60% to $2.68 billion."
"Meanwhile, Cowen & Co. analyst Jim Friedland said in a note released Wednesday that he expects Google's share of its traditional search market only to grow ever-higher.
"'We believe Google will achieve a share of at least 90% of the search market over the next decade,' Friedland said."
If you shorted Google, cover your short. In addition, I recommend buying more shares. Google closed trading at the end of Friday at $552.16.
*************************************************************************************
Investing is about constantly re-examining your positions. Sometimes investment decisions are the wrong ones, while other times you'll be right on the money. For these three stock picks, I believe I made choices that were reckless, choices that were based on cursory research. I failed to use a proper amount of prudence. I shall try harder.
If you shorted Google, cover your short. In addition, I recommend buying more shares. Google closed trading at the end of Friday at $552.16.
*************************************************************************************
Investing is about constantly re-examining your positions. Sometimes investment decisions are the wrong ones, while other times you'll be right on the money. For these three stock picks, I believe I made choices that were reckless, choices that were based on cursory research. I failed to use a proper amount of prudence. I shall try harder.
Tuesday, July 10, 2007
S&P, Moody's to Downgrade Subprime Securities - World Stocks Falter
Well, it's about time. How long has it been since we've known about the risks? Months and months. Finally, the two credit ratings organizations are coming around:
"Credit ratings on 612 classes of residential mortgage-backed securities backed by U.S. subprime collateral have been put on CreditWatch with negative implications, S&P said. Beginning in the next few days, the agency said most of these classes will be downgraded."
"That covers about $12.078 billion in rated securities, or 2.13% of the $565.3 billion in U.S. RMBS rated by S&P between the fourth quarter of 2005 and the fourth quarter of 2006, the agency noted."
Meanwhile, in a related story:
"Moody's cut ratings on 399 subprime residential mortgage-backed securities, or RMBS, and said that it may downgrade another 32 because of higher than expected delinquencies on the underlying home loans."
I don't know how many more securities there are that are at risk, but I would bet there are more. Any literate investor should have known for weeks of the great risk associated with subprime mortgage securities; the looming interest rate reset will be devastating. Here's the simple picture:
Today, just one day after flirting with a record close, the Dow faltered by more nearly 150 points. Following the Dow decline, Asian markets followed suit. Something will act as the catalyst initiating a world-wide economic slowdown. It could be subprime, it could be something else. All that needs to happen is for a spark to start the wheel spinning. The next couple weeks should give us a decisive answer.
Meanwhile, in a related story:
"Moody's cut ratings on 399 subprime residential mortgage-backed securities, or RMBS, and said that it may downgrade another 32 because of higher than expected delinquencies on the underlying home loans."
I don't know how many more securities there are that are at risk, but I would bet there are more. Any literate investor should have known for weeks of the great risk associated with subprime mortgage securities; the looming interest rate reset will be devastating. Here's the simple picture:
"A lot of debt will be downgraded to junk status. A lot of that debt will have to be sold at fire-sale prices. A lot of pension funds and hedge funds that once thrived on the high returns they could get from investing in subprime junk will now lose a lot of money."
"S&P's announcement is a death warrant for the subprime industry. No longer will mortgage brokers be able to help buyers lie their way into a home. Fewer stressed homeowners will be able to refinance their mortgage, thus extending and exacerbating the housing bust."
Unwinding this tangled mess is taking time; along the way, it will affect more than just the mortgage industry. Of course it has already hurt the homebuild sector. Higher foreclosure rates have contributed to a rising supply of homes; also, looser loans standards helped fuel a housing boom which assisted in creating future projections that were grossly inflated.
And the subprime mortgage fiasco has not and will not be kind to the banking industry. Depending on who's holding what, investors could be rewarded greatly for making the right bets.
Another sector that could feel the hurt is retail. Fewer homeowners refinancing mean less being spent at home depot or at the mall. We've already seen home depot's hurt. Bed Bath and Beyond has also lowered it's expectations in the last few weeks. The housing downturn might be blamed as the number one reason, but subprime is not far behind. And as the noose tightens around lending standards, the infusion of cash that has helped fuel earnings in retail will evaporate.Unwinding this tangled mess is taking time; along the way, it will affect more than just the mortgage industry. Of course it has already hurt the homebuild sector. Higher foreclosure rates have contributed to a rising supply of homes; also, looser loans standards helped fuel a housing boom which assisted in creating future projections that were grossly inflated.
And the subprime mortgage fiasco has not and will not be kind to the banking industry. Depending on who's holding what, investors could be rewarded greatly for making the right bets.
Today, just one day after flirting with a record close, the Dow faltered by more nearly 150 points. Following the Dow decline, Asian markets followed suit. Something will act as the catalyst initiating a world-wide economic slowdown. It could be subprime, it could be something else. All that needs to happen is for a spark to start the wheel spinning. The next couple weeks should give us a decisive answer.
Wednesday, June 27, 2007
Exotic Security Classes, Balloon Payments, and Prepayment Penalty
This quote (from an article I referenced in my last post) caught my eye:
"CRL also found that more than two thirds of the subprime loans it looked at contained prepayment penalties. By charging borrowers up to six months of mortgage payments to retire mortgages, prepayment penalties lock borrowers into onerous loans by making it very expensive to refinance out of them and into a lower-rate fixed."
Prepayment penalties are a result of a CDO market making every attempt to minimize risk. Let's look at a couple of exotic securities available: IOs (interest only) and POs (principle only). Consider the following example: Bank 'A' created $100 million worth of mortgages. The mortgages are for 8 years at 8% with a balloon payment at the end. The bank takes those debt obligations, pools them together, and sells them to an intermediary who creates different asset classes depending on the cash flow expected from the borrower. The two equations below outline the yearly payment plan for two different asset classes. The top equation is the payment schedule for the investor who buys an IO security; the majority of their return comes from the interest paid by the borrower. The bottom equation is the payment schedule for the investor who buys a PO security; the majority of their return comes from the principle payment in the form of the balloon payment at the end of eight years.
You may have noticed that 43.5 and 55.7 is 99.2, not 100. In the example, the intermediary takes 0.8 as payment for administering the asset classes.
Prepayment penalties on mortgages are meant to reduce the risk. In our example, when borrowers refinance, the owners of the PO security class get their return without having to wait out the eight years, but the IO class is left with a bad investment as less interest is paid, causing a declining return on capital. Conversely, when the borrowers extend their loan, the IO class reaps the rewards as they continue to collect interest, while the PO class is forced to wait for their return.
What happens when the borrower defaults on the mortgage? A portion of the security becomes worthless. When there are record defaults, these securities will have big problems.
There's much more default risk undertaken by the PO class as 87 percent of their return depends on the balloon payment. There's default risk with the IO class as well, but that risk diminishes with each successive year.
There are some hedge funds that are heavily invested in these types of securities. The companies operating them will be the ones that suffer tremendously as foreclosure rates increase further, and they will. The beginning of the great mortgage reset has just begun and with more subprime mortgages being issued, the problem will continue.
At the beginning of this post, I referenced a CNN Money article that described a subprime mortgage market who hadn't learned their lesson. The lesson won't be learned until we reform the CDO market. Much like the illegal drug industry, as long as there is demand for these types of exotic investments, there will be a supply of exotic mortgages.
"CRL also found that more than two thirds of the subprime loans it looked at contained prepayment penalties. By charging borrowers up to six months of mortgage payments to retire mortgages, prepayment penalties lock borrowers into onerous loans by making it very expensive to refinance out of them and into a lower-rate fixed."
Prepayment penalties are a result of a CDO market making every attempt to minimize risk. Let's look at a couple of exotic securities available: IOs (interest only) and POs (principle only). Consider the following example: Bank 'A' created $100 million worth of mortgages. The mortgages are for 8 years at 8% with a balloon payment at the end. The bank takes those debt obligations, pools them together, and sells them to an intermediary who creates different asset classes depending on the cash flow expected from the borrower. The two equations below outline the yearly payment plan for two different asset classes. The top equation is the payment schedule for the investor who buys an IO security; the majority of their return comes from the interest paid by the borrower. The bottom equation is the payment schedule for the investor who buys a PO security; the majority of their return comes from the principle payment in the form of the balloon payment at the end of eight years.
You may have noticed that 43.5 and 55.7 is 99.2, not 100. In the example, the intermediary takes 0.8 as payment for administering the asset classes.Prepayment penalties on mortgages are meant to reduce the risk. In our example, when borrowers refinance, the owners of the PO security class get their return without having to wait out the eight years, but the IO class is left with a bad investment as less interest is paid, causing a declining return on capital. Conversely, when the borrowers extend their loan, the IO class reaps the rewards as they continue to collect interest, while the PO class is forced to wait for their return.
What happens when the borrower defaults on the mortgage? A portion of the security becomes worthless. When there are record defaults, these securities will have big problems.
There's much more default risk undertaken by the PO class as 87 percent of their return depends on the balloon payment. There's default risk with the IO class as well, but that risk diminishes with each successive year.
There are some hedge funds that are heavily invested in these types of securities. The companies operating them will be the ones that suffer tremendously as foreclosure rates increase further, and they will. The beginning of the great mortgage reset has just begun and with more subprime mortgages being issued, the problem will continue.
At the beginning of this post, I referenced a CNN Money article that described a subprime mortgage market who hadn't learned their lesson. The lesson won't be learned until we reform the CDO market. Much like the illegal drug industry, as long as there is demand for these types of exotic investments, there will be a supply of exotic mortgages.
Tuesday, June 26, 2007
Another quick look at CDOs
It's finally come. The SEC is investigating securities fraud stemming from the sub prime loan debacle. Finally some accountability, though perhaps it's too little too late:
"Last week, Cox revealed in an interview that the SEC was looking into the problems at the two Bear hedge funds. Bear said last week that it would provide up to $3.2 billion in financing for one of the funds after the investment bank discovered that the underlying value of the assets was much less than it had believed.
Collateralized debt obligations are extremely illiquid and have no true market price. The sellers value the securities based on models that use ratings from the credit agencies to judge the risk that they will go sour. Buyers have little idea what the underlying assets are, or what they should be valued at."
Ahh, I see. The article continues, mentioning Blackstone:
"In a wide-ranging oversight hearing before the House Financial Services Committee, Cox and the other four SEC commissioners defended the agency on a host of issues ranging from reform of the Sarbanes-Oxley corporate governance law to the approval of a public offering by Blackstone Group LLP".
I have been wondering why the Blackstone Group went public when it did. The market's much closer to the top than it is the bottom. Prior to going public, the company unloaded a whole helluva lot of real estate in the Chicago area as well as the Western region. I suppose they wished to reduce debt, which in turn would make them more attractive for their IPO. A more attractive IPO means a higher bid price, which means they raise more capital which means the principals of the company reap massive benefits. Right? And if this company were heavily invested in the subprime mortgage fiasco, going public would be the best thing for the principals as all that investment money coming in would create upward pressure on the initial price of the stock. Maybe we will see the shortest lifespan ever of a public company, but I don't know.
Yesterday, I wanted to lump Blackstone in with the other four investment firms I previously mentioned. I had a feeling that Blackstone would drop immediately, but then I thought: no, it's a new stock, people will buy no matter the price because it's *NEW*. I guess I should have followed my instincts. Despite being priced below their IPO price, I think the stock will rebound considerably, regardless of market conditions. But I do think this company is suspect. At this point, I do not think a savvy investor would sell or short Blackstone. It is one that I will watch closely and I will give you an update as soon as I've jumped off the fence.
"Last week, Cox revealed in an interview that the SEC was looking into the problems at the two Bear hedge funds. Bear said last week that it would provide up to $3.2 billion in financing for one of the funds after the investment bank discovered that the underlying value of the assets was much less than it had believed.
Collateralized debt obligations are extremely illiquid and have no true market price. The sellers value the securities based on models that use ratings from the credit agencies to judge the risk that they will go sour. Buyers have little idea what the underlying assets are, or what they should be valued at."
Ahh, I see. The article continues, mentioning Blackstone:
"In a wide-ranging oversight hearing before the House Financial Services Committee, Cox and the other four SEC commissioners defended the agency on a host of issues ranging from reform of the Sarbanes-Oxley corporate governance law to the approval of a public offering by Blackstone Group LLP".
I have been wondering why the Blackstone Group went public when it did. The market's much closer to the top than it is the bottom. Prior to going public, the company unloaded a whole helluva lot of real estate in the Chicago area as well as the Western region. I suppose they wished to reduce debt, which in turn would make them more attractive for their IPO. A more attractive IPO means a higher bid price, which means they raise more capital which means the principals of the company reap massive benefits. Right? And if this company were heavily invested in the subprime mortgage fiasco, going public would be the best thing for the principals as all that investment money coming in would create upward pressure on the initial price of the stock. Maybe we will see the shortest lifespan ever of a public company, but I don't know.
Yesterday, I wanted to lump Blackstone in with the other four investment firms I previously mentioned. I had a feeling that Blackstone would drop immediately, but then I thought: no, it's a new stock, people will buy no matter the price because it's *NEW*. I guess I should have followed my instincts. Despite being priced below their IPO price, I think the stock will rebound considerably, regardless of market conditions. But I do think this company is suspect. At this point, I do not think a savvy investor would sell or short Blackstone. It is one that I will watch closely and I will give you an update as soon as I've jumped off the fence.
Monday, June 25, 2007
Mortgage Rate Reset
It's amazing the way things are unwinding: very slowly and very predictable. This could have served as a warning of things to come for Bear Stearns:
"Bear Stearns Funds Own 67 Percent Stake in Everquest"
"Funds run by Bear Stearns Cos. own two- thirds of Everquest Financial Ltd., a firm that invests in debt backed by subprime mortgages and buyout loans"
On May 11th, the same day the article was published, Bear Stearns closed at $156.40. At the end of trading today, Bear closed at $139.10; Bear has lost 11 percent of it's value since May 11. It will continue to drop, we'll see where the bottom is. This chart, found on page 47, is dated March 12, 2007:
Looking at the graph, we can see that the fifth month, May 2007, was about the starting point to a rough time for homeowners with adjustable rate mortgages. As if on cue, foreclosures jumped 19 percent from April to May. If this chart is an indicator of times to come, the late summer will see another spike in mortgage resets, which should lead to an increased foreclosure rate.
Financial institutions and hedge funds that hold those mortgages should get hit harder in a few months than they are right now. This article (which I've referenced before), implicates JP Morgan Chase, Citigroup, and Merrill Lynch in the Bear Stearns fiasco, which is just picking up speed. I'm bearish on all four. I've already recommended selling Bear Stearns. Now I recommend selling the other three. This article implicates Goldman Sachs. Sell Goldman Sachs. There will be companies that will end up with the bad debt - it doesn't just disappear. A bailout from the government, a possibility depending on the severity of defaults, would be very beneficial for gold (which I've previously recommended buying).
Citigroup (C) ended trading today at $51.69. Merrill Lynch (MER) ended trading today at $83.98. JP Morgan Chase (JPM) ended trading today at $48.36. Goldman Sachs (GS) ended trading today at $216.74
"Bear Stearns Funds Own 67 Percent Stake in Everquest"
"Funds run by Bear Stearns Cos. own two- thirds of Everquest Financial Ltd., a firm that invests in debt backed by subprime mortgages and buyout loans"
On May 11th, the same day the article was published, Bear Stearns closed at $156.40. At the end of trading today, Bear closed at $139.10; Bear has lost 11 percent of it's value since May 11. It will continue to drop, we'll see where the bottom is. This chart, found on page 47, is dated March 12, 2007:
Looking at the graph, we can see that the fifth month, May 2007, was about the starting point to a rough time for homeowners with adjustable rate mortgages. As if on cue, foreclosures jumped 19 percent from April to May. If this chart is an indicator of times to come, the late summer will see another spike in mortgage resets, which should lead to an increased foreclosure rate.
Financial institutions and hedge funds that hold those mortgages should get hit harder in a few months than they are right now. This article (which I've referenced before), implicates JP Morgan Chase, Citigroup, and Merrill Lynch in the Bear Stearns fiasco, which is just picking up speed. I'm bearish on all four. I've already recommended selling Bear Stearns. Now I recommend selling the other three. This article implicates Goldman Sachs. Sell Goldman Sachs. There will be companies that will end up with the bad debt - it doesn't just disappear. A bailout from the government, a possibility depending on the severity of defaults, would be very beneficial for gold (which I've previously recommended buying).
Citigroup (C) ended trading today at $51.69. Merrill Lynch (MER) ended trading today at $83.98. JP Morgan Chase (JPM) ended trading today at $48.36. Goldman Sachs (GS) ended trading today at $216.74
Wednesday, June 20, 2007
More Mortgage Woes
Subprime mortgages claim another victim?
"Two large hedge funds managed by investment bank and brokerage Bear Stearns are close to being shut down as their complex mortgage-related bets have soured, the Wall Street Journal reported."
"More than 30 subprime lenders, including New Century, have gone bankrupt this year."
And I also found this:
"New Century is among more than 50 lenders that have halted operations, gone bankrupt or sought buyers since the start of 2006, according to Bloomberg data."
As if it weren't common sense, I recommend selling Bear Stearns (BSC). The stock is currently trading at $145.01, a loss of about one percent since the start of trading. To not see more of a precipitous drop is a case of blind bullishness.
Updated June 20, 2007 1:25 PM:
Bear Stearns closed the trading day at $143.20.
"Two large hedge funds managed by investment bank and brokerage Bear Stearns are close to being shut down as their complex mortgage-related bets have soured, the Wall Street Journal reported."
"The Journal said the two funds held over 20 bln of investments just a few weeks ago, mostly tied to risky securities linked to so-called subprime mortgages."
Twenty Billion in a matter of weeks...I'm sure the bulls will continue to look the other way; there will always be a tidbit of good news to blindly focus on. But this newest revelation is only a stepping stone on the way to more major problems. Just a few days earlier, I found this article which outlined a trend of rising delinquencies, particularly among ARMs. Here's the most disturbing part of the article (conveniently tucked down at the bottom):"More than 30 subprime lenders, including New Century, have gone bankrupt this year."
And I also found this:
"New Century is among more than 50 lenders that have halted operations, gone bankrupt or sought buyers since the start of 2006, according to Bloomberg data."
As if it weren't common sense, I recommend selling Bear Stearns (BSC). The stock is currently trading at $145.01, a loss of about one percent since the start of trading. To not see more of a precipitous drop is a case of blind bullishness.
Updated June 20, 2007 1:25 PM:
Bear Stearns closed the trading day at $143.20.
Subscribe to:
Posts (Atom)