March 17, 2008 TCM Observations
Today is likely to be a memorable one in the story of the 2007-2008 credit crunch. As of 7 AM on March 17th, the Dow Jones Industrial Average ("DJIA") futures are already off 170 points as many people are simply in shock that Bear Stearns would agree to a JPMorgan Chase buy-out at $2 per share over the weekend. The Bear Stearns shares had closed at close to $30 per share on last Friday afternoon. Many people are having a hard time believing that Bear Stearns with a book value per share of close to $80 per share could be sold for such a low price. Here are some other thoughts:
- Last night Toomre Capital Markets LLC ("TCM") posted a note entitled Lehman Brothers Worried About Bear Stearns Fallout. That note explains that both the Federal Reserve and Lehman Brothers management are very concerned about the fallout from the Bear Stearns liquidity crisis.
- Lehman Brothers' equity price looks like it will be hard hit out of the box this morning. That stock closed on Friday March 14th at $39.26 per share. That was at a slight discount to book value of approximately $40 or so per share. As Lars Toomre types this note, Lehman Brothers is being indicated at a pre-open price of $27 or so.
- The earnings reports from Goldman Sachs, Lehman Brothers and Morgan Stanley this week are going to be critical to establishing some sense of stability in the global Capital Markets. Although the actual numbers from these global investment banks will be important, one must realize that they are already three weeks old. The accompanying commentary and statements about outlook will be critical, especially when compared to one another.
- There are tremendous amounts of rumors about UBS. Supposedly many counter-parties are backing away from UBS. Also there are comments that UBS did not in fact sell the $24 billion in Alt-A mortgages to Pimco earlier this month. One has to wonder where that pile of problematic mortgage securities will be valued at the end of this quarter. Will 70 cents on the dollar be rich or cheap for Alt-A mortgages?
- Lehman Brothers has shut down its European credit strategy team in London as part of its redundancy program. David Brickman, who was head of European credit strategy, and Ben Bennett, previously director, European credit strategy, stopped producing research last week, but may still be able to take up other roles within the firm, one of the people said. This news is quite telling. It suggests that Lehman does not foresee credit products returning to the Euro market in the near future and that much of the credit research can be covered out of New York.
- The New York Times has an article today entitled UBS Is Said to Consider 8,000 Layoffs. UBS' chief executive, Marcel Rohner, also told bankers attending the meeting, held in Berlin, that UBS was holding around 30 billion Swiss francs ($29.2 billion) worth of municipal bonds. These are highly rated assets, but the market for them has almost dried up in recent weeks. TCM wonders how of this block of paper will be funded with the Federal Reserve.
- The first post that TCM made this year was entitled Australian: Forget CDOs, It is Time for CDSs. Today Lars Toomre is reminded of the importance of Credit Default Swaps ("CDS"), especially when evaluating the cumulative market's sentiment about the credit risk of financial firms. As TCM wrote in the AMD white paper entitled Deriving Value in Credit Products, what makes CDS so important in the fixed-income markets is that they allow for speculation on the "short side" of commercial credits. These short sales of credit are the main causes of the widening in CDS spreads that are reported in the media these days. Lars Toomre is reminded how they are also excellent sentiment indicators of what larger (and perhaps more informed) credit market participants think and are willing to pay for a particular credit. Perhaps going forward for the next few weeks, TCM should put up a table of the major investment and global commercial banks that includes both their stock prices and their CDS prices when thinking of investment banking valuations?
- Bloomberg reports MF Global Shares Plunge on Concern Customers Are Pulling Funds: Apparently "MF Global Ltd., the largest broker of exchange-traded futures and options, fell as much as 80 percent in New York trading on speculation clients are pulling money and as financial shares dropped to their lowest level in almost five years."
- Yikes… At 1:30 PM, Lars Toomre checked the quote on Lehman Brothers again for the first time since about 10:30 AM. The stock price in the last hour has sunk below the $24.50 lows the LEH stock first experienced this morning. From the bounce back price of approximately $34, it has now plunged to a low of $20.25 and now is trading around $21.50. Wow… Wow… Wow… This plunge is after the news from Dick Fuld about how the investment banking liquidity issue was now off the table that circulated mid-morning today.
- Many wonder what Warren Spector and Ralph Cioffi have to say about the collapse of Bear Stearns.
- During the 1989-1991 time period, Lars Toomre headed up the Smith Barney Mortgage Trading department. Two of the key individuals at Smith Barney during that period were Jamie Diamond and Steve Black who acted as key lieutenants to the then Primerica CEO Sandy Weil. During the middle of 1989, Joel Kazis and Lars Toomre were brought in from Salomon Brothers and Lehman Brothers respectively to head up (and hopefully shake up) the Government and Mortgage Trading areas at the old sleepy Smith Barney. As a result, both Joel and Lars recruited a number of traders to join Smith Barney, all without any promise of guaranteed pay packages.
Then, during our time at Smith Barney, we witnessed the implosion of Drexel Burnham Lambert. Sandy Weil scooped up many of Drexel investment bankers. However, he neglected to tell the Capital Markets division that he promised a certain bonus pool to those bankers. Of course, when the firm's entire bonus pool for 1990 had to be smaller than he expected, the Capital Markets division suffered disproportionately and the short answer back from Jamie Diamond, Steve Black and others was a simple "Tough Luck! You people had no guarantees!" Today, someone who worked for me during the Smith Barney trauma commented that Jamie and Steve have continued Sandy's tradition of having a "two cent bid for dimes". That person continued about truly sad it was going to be for so many of the people in the Capital Markets areas at both JPMorgan and Bear Stearns as these firms are integrated. How very true…