Given that that specific business area in the fixed-income markets is at the heart of the current credit crunch in the Capital Markets, many have asked more privately just what Lars has been thinking about the on-going market developments. Lars has specifically made a point (until now) on refusing to comment publically about Lehman Brothers and the recent sacking of his former boss, Joe Gregory, who until recently was the President of Lehman Brothers.
On Friday July 11th 2008, yet another contact queried what Lars thought about the on-going melt-down in financial equity securities, particularly those currently in the news such as Fannie Mae, Freddie Mac, Citigroup, Washington Mutual, Wachovia, Lehman Brothers, Merrill Lynch and Morgan Stanley. We talked through the various plus and minuses of these potential investments. This contact, who runs a multi-billion dollar portfolio on a leveraged basis, then asked Lars to put on his theoretical trading hat and suggest some specific trades. Lars demurred.
When pressed, Lars suggested that the pairs trade of long Lehman Brothers and short Fannie Mae on a proceeds basis at the then current prices of $14.00 and $10.00 respectively would be positive over the next month. As a result, we agreed to record this trade thought and to settle up one month hence. The winner will be entitled to a Starbuck's drink of his choice.
As Lars leaves for a combined business trip and some personal time in the Tetons mountains of northwest Wyoming, he is confident that Lehman Brothers CEO Dick Fuld will get that ship in order relative to the virtual black hole that is Fannie Mae. The next month certainly will be interesting as to whether this proposed trade ends up in the money.
Reader comments and thoughts are welcome.
]]>That both of these GSE's need to be supported in at least an oral sense is more than a ripple in the Capital Markets pond. It is much more like a major wave. Just what the final cost to tax payers will be remains to be seen. TCM suspects that the final bill will not be known until well after residential home prices stabilize and even begin to appreciate again. No doubt, though, the costs will be significant.
Lost in all of the GSE consternation is the lack of discussion about the critical policy decision on the future of mortgage finance in the United States. TCM has highlighted this critical issue before. Until the late 1980s, the S&L's were the primary holders of mortgage debt. Commercial banks also have owned some mortgage debt (with significant capital haircuts). The relatively lower capital requirements and the ability to "turn" the mortgage origination portfolios led to the rapid growth in securitization and the funding of mortgage debt through investors in the capital markets.
]]>That both of these GSE's need to be supported in at least an oral sense is more than a ripple in the Capital Markets pond. It is much more like a major wave. Just what the final cost to tax payers will be remains to be seen. TCM suspects that the final bill will not be known until well after residential home prices stabilize and even begin to appreciate again. No doubt, though, the costs will be significant.
Lost in all of the GSE consternation is the lack of discussion about the critical policy decision on the future of mortgage finance in the United States. TCM has highlighted this critical issue before. Until the late 1980s, the S&L's were the primary holders of mortgage debt. Commercial banks also have owned some mortgage debt (with significant capital haircuts). The relatively lower capital requirements and the ability to "turn" the mortgage origination portfolios led to the rapid growth in securitization and the funding of mortgage debt through investors in the capital markets.
As the credit crunch has evolved over the past eighteen months, many of the large institutional investors limited or even decreased their exposure to various mortgage debt instruments. Hence, to at least some extent, most mortgage originators have had to become portfolio lenders. Many of those originators are now reaching their portfolio holding limits and are ceasing to originate new mortgage loans unless there is near certainty that those loans can be sold in the secondary market(s). At present, this means selling the loans into either a FHA, FNMA or FHLMC pooled security.
Policy makers at present seem to be counting on the continued acceptance of these mortgage-backed securities with institutional investors. Have they considered what might happen if such investors "go on strike", especially if there is collective concern by debt investors about FHA, FNMA and FHLMC and their ability to make good on their contractual and implied obligations? Just where is mortgage debt going to be held and at what cost (especially regarding capital adequacy charges)?
Projecting out into the future a bit, does not this concern about the future of mortgage finance translate into higher mortgage costs? And those higher mortgage costs into less demand for residential housing which in turn also suggests a likelihood of further downward pressure on housing prices from reduced demand? Sadly, this probability makes TCM think that the credit crunch will be with the credit markets for at least another six quarters.
Reader thoughts and comments are welcome.
]]>Partly as a result of this announcement, Moody's Investors Service has put the ratings of Lehman Brothers under review for a likely downgrade. Lehman Brothers will be conducting a 10 AM conference call to discuss further this press release. From the press release, it appears that the fixed-income division had a net loss of approximately $5 billion, which is much larger than the losses that Lehman Brothers has announced in prior quarters.
Lehman Brothers in the past months has pledged to increase its transparency regarding its financial transparency. It certainly will be quite interesting to learn more about where these losses came from. Toomre Capital Markets LLC will post more about this company later in the day as further information becomes available.
]]>Partly as a result of this announcement, Moody's Investors Service has put the ratings of Lehman Brothers under review for a likely downgrade. Lehman Brothers will be conducting a 10 AM conference call to discuss further this press release. From the press release, it appears that the fixed-income division had a net loss of approximately $5 billion, which is much larger than the losses that Lehman Brothers has announced in prior quarters.
Lehman Brothers in the past months has pledged to increase its transparency regarding its financial transparency. It certainly will be quite interesting to learn more about where these losses came from. Toomre Capital Markets LLC will post more about this company later in the day as further information becomes available.
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Toomre Capital Markets LLC ("TCM") hopes that Lehman Brothers can succeed in placing the $5 billion in equity. While it will be highly dilutive to existing shareholders, such a capital raise should ensure that Lehman Brothers will be able to continue as an on-going entity, particularly in the fixed-income markets where their credit rating is critically important both for funding needs and the derivatives businesses. One might remember that a significant portion of the common equity currently is owned by the employees of Lehman Brothers who have seen the value of their holdings decline by close to fifty percent since the start of the year. Those employees might well be asking how Lehman Brothers allowed itself to get so off-sides to own some $80 billion odd in mortgages securities at the start of this credit crunch.
]]>Toomre Capital Markets LLC ("TCM") hopes that Lehman Brothers can succeed in placing the $5 billion in equity. While it will be highly dilutive to existing shareholders, such a capital raise should ensure that Lehman Brothers will be able to continue as an on-going entity, particularly in the fixed-income markets where their credit rating is critically important both for funding needs and the derivatives businesses. One might remember that a significant portion of the common equity currently is owned by the employees of Lehman Brothers who have seen the value of their holdings decline by close to fifty percent since the start of the year. Those employees might well be asking how Lehman Brothers allowed itself to get so off-sides to own some $80 billion odd in mortgages securities at the start of this credit crunch.
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Since last summer, we have lived through a severe and complex financial crisis. Why was the financial system so fragile? What can be done to make the system more resilient in the future?
The world experienced a financial boom. The boom fed demand for risk. Products were created to meet that demand, including risky, complicated mortgages. Many assets were financed with significant leverage and liquidity risk and many of the world's largest financial institutions got themselves too exposed to the risk of a global downturn. The amount of long-term illiquid assets financed with short-term liabilities made the system vulnerable to a classic type of run. As concern about risk increased, investors pulled back, triggering a self-reinforcing cycle of forced liquidation of assets, higher margin requirements, increased volatility.
What should be done to strengthen the system in the future? First, when we get through this crisis we have to increase the shock absorbers held in normal times against bad macroeconomic and financial outcomes. This will require more exacting expectations on capital, liquidity and risk management for the largest institutions that play a central role in intermediation and market functioning. They should be set high enough to offset the benefits that come from access to central bank liquidity, but not so high that they succeed only in pushing more capital to the unregulated part of the financial system.
Second, we have to improve the capacity of the financial infrastructure to withstand default by a big institution. This will require taking some of the risk out of secured funding markets, increasing resources held against default in the centralised clearing house, and encouraging more standardisation, automation and central clearing in the derivatives markets.
Third, the regulatory framework cannot be indifferent to the scale of leverage and risk outside the supervised institutions. I do not believe it would be desirable or feasible to extend capital requirements to leveraged institutiions such as hedge funds. But supervision has to ensure that counterparty credit risk management in the supervised institutions limits the risk of a rise in overall leverage outside the regulated institutions that could threaten the stability of the financial system. And regulatory policy has to induce higher levels of margin and collateral in normal times against derivatives and secured borrowing to cover better the risk of market illiquidity.
Fourth, we need to streamline and simplify the US regulatory framework. Our system has evolved into a confusing mix of diffused accountability, regulatory competition and a complex web of rules that create perverse incentives and leave huge opportunities for arbitrage and evasion. The blueprint by Hank Paulson, Treasury secretary, outlines a sweeping consolidation and realignment of responsibilities.
The institutions that play a central role in money and funding markets – including the main globally active banks and investment banks – need to operate under a unified framework that provides a stronger form of consolidated supervision, with appropriate requirements for capital and liquidity. To complement this, we need to put in place a stronger framework of oversight authority over the critical parts of the payments system – not just the established payments, clearing and settlements systems, but the infrastructure that underpins the decentralised over-the-counter markets.
Because of its primary responsibility for the stability of the overall financial system, the Federal Reserve should play a central role in such a framework, working closely with supervisors in the US and in other countries. At present the Fed has broad responsibility for financial stability not matched by direct authority and the consequences of the actions we have taken in this crisis make it more important that we close that gap.
Finally, we need a stronger capacity to respond to crises. The Fed has put in place a number of innovative new facilities that have helped ease liquidity strains. We plan to leave these in place until conditions in money and credit markets have improved substantially.
We are examining what framework of facilities will be appropriate in the future, with what conditions for access and what oversight requirements to mitigate moral hazard risk. Some of these could become a permanent part of our instruments. Some might be best reserved for the type of acute market illiquidity experienced in this crisis.
Authority to pay interest on reserves would give the Fed the ability to respond to acute liquidity pressure in markets without undermining its capacity to manage the federal funds rates in line with the federal open market committee's target.
The big central banks should put in place a standing network of currency swaps, collateral policies and account arrangements that would make it easier to mobilise liquidity across borders quickly in a crisis.
As we reshape the incentives and constraints for risk-taking in the financial system, we have to recognise that regulation has the potential to make things worse. Regulation can distort incentives in ways that may make the system less safe. One of the strengths of our system is the speed with which we adapt to challenge. It is important that we move quickly to adapt the regulatory system to address the vulnerabilities exposed by this financial crisis. We are beginning the process of building the necessary consensus here and with the other main financial centres.
On Monday, June 9th 2008, Mr. Geithner will be making a presentation to the same Economic Club of New York at which former Federal Reserve Chairman Paul Volker criticized the current Chairman Ben Bernanke. TCM wrote of Mr. Volker's comments in the post Volker Takes on Bernanke. Mr. Geithner's commentary and speech are no doubt in reaction to Mr. Volker's criticisms. TCM will write further of Mr. Geithner's speech contents once the text becomes available.
]]>Toomre Capital Markets LLC ("TCM") has previously written on the Bradley Birkenfeld case here. TCM wonders whether this delay indicates that United States prosecutors have entered into settlement discussions with UBS that no doubt will lead to the release of the customer list of wealthy Americans who used the services of the UBS private banking division. Certainly, if that were the case, prosecutors would not want Mr. Birkenfeld publicly naming names until a settlement with UBS was completed and further investigations were at least started. TCM will be keenly watching for developments in this and associated cases over the coming weeks.
]]>Toomre Capital Markets LLC ("TCM") has previously written on the Bradley Birkenfeld case here. TCM wonders whether this delay indicates that United States prosecutors have entered into settlement discussions with UBS that no doubt will lead to the release of the customer list of wealthy Americans who used the services of the UBS private banking division. Certainly, if that were the case, prosecutors would not want Mr. Birkenfeld publicly naming names until a settlement with UBS was completed and further investigations were at least started. TCM will be keenly watching for developments in this and associated cases over the coming weeks.
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Toomre Capital Markets LLC ("TCM") normally approaches such pronouncements from television pundits with a healthy dose of skepticism. However in this case, Jim Cramer is right on. The article continues:
]]>Toomre Capital Markets LLC ("TCM") normally approaches such pronouncements from television pundits with a healthy dose of skepticism. However in this case, Jim Cramer is right on. The article continues:
I explained that some stocks are neither longs nor shorts -- that, to me, is Lehman. There's no reason to short it, because I don't think it is going under but many are betting that way, and there is no reason to go long it, because the place is set up for a period of big fees from fixed-income products, from structured products, but clients have at last figured out that they will lose their jobs if they keep buying this nonsense.And that's really the rub. These places have oodles of high-priced salespeople, tons of them, and they are all being paid fortunes to sell products that don't work. They sell broken vacuum cleaners with no warranties.
It is that stark.
I know that anyone in brokerage is always reluctant to admit that structured products really have no value or are too risky, that they're just a way to figure out how to take a little extra per million -- a fraction, but they do add up. But that's what happened to a lot of these great firms that got fixed-income-heavy. There isn't enough money to be made selling regular commodity fixed-income products, so you have to talk people into buying things they shouldn't that they don't understand.
That game is over. But the people are still there, as is the overhead. Without this stuff, I don't know how you make a lot of money at an investment firm, particularly when you have decided to shrink your balance sheet and make fewer loans. Some can get away with it: Bank of America BAC, for instance, because it has a deposit base (same reason Wachovia WB is worth something, but I don't want to own it, either), doesn't need to rely on structured products to make some money.
LEH? I just don't see how they can deliver $5-6 earnings power anymore. Worse, I can't even figure out what they could earn in this environment. The franchise isn't too dicey, just the earnings estimates.
Jim Cramer puts much more bluntly what Toomre Capital Markets LLC has been struggling with as illustrated by the post Value of the Investment Banking Franchises?? Just what can these investment banking franchises earn in the post credit-crunch environment where there is limited demand for structured finance, mortgage securities, and complex derivatives and where they must operate with sharply decreased leverage and more limited proprietary trading operations? The regulatory changes that are going to be forthcoming as a result of the credit crunch are as of yet unknown. However, surely there will be increased capital charges under Basel II for what are classified as "trading positions."
Traditional stock and bond trading do not require as many people as currently are employed in the investment bank businesses nor do they produce the profits that will get paid such extreme compensation as paid during the housing bubble years. If the Capital Markets operations go back to the former and lower risk model of "client flow trading", surely there will be more layoffs and a lower rate of return for this industry.
The key to getting back to that more stable state will be to clean up and continue to sharply deleverage the various investment banking balance sheets. There probably will be some additional losses that will need to be recognized as part of that deleveraging process. Various capital market participants seem to be concerned about Lehman Brother's transparency in its financial accounting and how accurate the assets on its highly leveraged balance sheet might be marked.
As a former employee of Lehman Brothers, Lars Toomre is sad to see this investment bank go through its current travails. However, he is a bit surprised that the lessons from when he ran the mortgage structured product trading area have not been passed on. Apparently, Dick Fuld, Joe Gregory and others have forgotten that the true price of what an illiquid security or derivative is worth is where you can sell it to an independent third-party. A trader or desk might think that it is worth X. However, if the only other buyer in the market is willing to pay Y, it really is only worth Y and the difference (Y-X) is a loss. Any price above Y is only worth it if one can find another independent buyer.
The faster that Lehman Brothers and the other investment banks liquefy their balance sheets, the quicker the recovery will be in their economic fundamentals. Another item will be to increase their financial transparency. For instance, one item that Toomre Capital Markets LLC would very much like to see is information on the aging of the trading inventory, particularly with regard to the FASB 157 Level 3 assets. Old "aged" inventory that has not been traded in several months is more likely to be further from its actual liquidation value and (absent severe mark-downs that used to occur at some trading firms) is more likely to produce realized losses vis-à-vis the marks. If those aged positions also are in the Level 3 bucket, one has real reason to question just how accurate the market values of those positions are determined.
Thoughts and comments are welcome.
]]>The noteworthy fact that this article reveals "Under pressure from the authorities, UBS is considering whether to divulge the names of up to 20,000 of its well-heeled American clients, according to people close to the inquiry, a step that would have once been unthinkable to Swiss bankers, whose traditions of secrecy date to the Middle Ages. Federal investigators believe some of the clients may have used offshore accounts at UBS to hide as much as $20 billion in assets from the Internal Revenue Service. Doing so may have enabled these people to dodge at least $300 million in federal taxes on income from those assets, according to a government official connected with the investigation." [emphasis added]
If UBS were to reveal such a large list of wealthy Americans, there no doubt will be phenomenal anger directed against UBS and its CEO Marcel Rohner, who also just happens to be the head of the private banking arm when this supposed "wink and a nod" tax-avoidance activity supposedly occurred. Surely there will be considerable press coverage of this "tax scandal". There also no doubt will be considerable questioning by other UBS private banking clients about just what the value of supposed Swiss banking privacy truly is. This surely is to lead to some withdrawals and a likely decline in the UBS franchise value.
On the other hand, UBS could elect to fight the United States Justice Department. Of course, there likely then would be criminal charges against the institution itself to fight and the possible loss of United States banking and securities licenses. What the franchise value might be under such a scenario is anybody's guess. However, it is likely to be less than today's closing stock price. Would you want to own a deeply flawed investment banking franchise coupled with a disgraced private bank?
]]>The noteworthy fact that this article reveals "Under pressure from the authorities, UBS is considering whether to divulge the names of up to 20,000 of its well-heeled American clients, according to people close to the inquiry, a step that would have once been unthinkable to Swiss bankers, whose traditions of secrecy date to the Middle Ages. Federal investigators believe some of the clients may have used offshore accounts at UBS to hide as much as $20 billion in assets from the Internal Revenue Service. Doing so may have enabled these people to dodge at least $300 million in federal taxes on income from those assets, according to a government official connected with the investigation." [emphasis added]
If UBS were to reveal such a large list of wealthy Americans, there no doubt will be phenomenal anger directed against UBS and its CEO Marcel Rohner, who also just happens to be the head of the private banking arm when this supposed "wink and a nod" tax-avoidance activity supposedly occurred. Surely there will be considerable press coverage of this "tax scandal". There also no doubt will be considerable questioning by other UBS private banking clients about just what the value of supposed Swiss banking privacy truly is. This surely is to lead to some withdrawals and a likely decline in the UBS franchise value.
On the other hand, UBS could elect to fight the United States Justice Department. Of course, there likely then would be criminal charges against the institution itself to fight and the possible loss of United States banking and securities licenses. What the franchise value might be under such a scenario is anybody's guess. However, it is likely to be less than today's closing stock price. Would you want to own a deeply flawed investment banking franchise coupled with a disgraced private bank?
Toomre Capital Markets LLC suspects that this story is going to pick up a life of its own in coming days. With the American electorate entering the Presidential campaign season that is keenly focused on the economy and general tax policies, TCM strongly suspects that these rich Americans are about to be vilified as part of the contentious political season. UBS no doubt is going to receive plenty of bad publicity.
The interesting question, though, that TCM keeps on returning to is: What is the value of this institution in the sharply changed environment for investment banks? Surely, is it not over-valued because of very expensive operating costs relative to low transaction volumes? Does not this conclusion about investment banking profitability mean that operating costs need to come down further both through lower operating costs (particularly employee compensation and bonuses) and additional layoffs? And thinking through this line of thought further, does not this thought process imply that the urban centers of London and New York are going to be under further economic pressure? Thoughts and comments are most welcome.
]]>As Toomre Capital Markets LLC ("TCM") has written previously in the posts Value of the Investment Banking Franchises?? And Lehman Brothers Weighs Raising Equity Capital, TCM has been questioning what the on-going value of investment banking franchises will be in the post-credit crunch operating environment. That questioning assumes that one is able to work from "good" balance sheet data, which in the case of Lehman Brothers is being sharply called into question.
On Wednesday June 4th 2008, the Heard on the Street column in The Wall Street Journal is entitled Decision Time for Lehman. This article is well worth in reading in its entirety
]]>As Toomre Capital Markets LLC ("TCM") has written previously in the posts Value of the Investment Banking Franchises?? And Lehman Brothers Weighs Raising Equity Capital, TCM has been questioning what the on-going value of investment banking franchises will be in the post-credit crunch operating environment. That questioning assumes that one is able to work from "good" balance sheet data, which in the case of Lehman Brothers is being sharply called into question.
On Wednesday June 4th 2008, the Heard on the Street column in The Wall Street Journal is entitled Decision Time for Lehman. This article is well worth in reading in its entirety (as reproduced below):
HEARD ON THE STREET
Decision Time for Lehman
Balance-Sheet Woes Most Likely to Force Big Strategic Shift
By PETER EAVIS and DAVID REILLY
June 4, 2008
It is time to sort out the Lehman problem.
With its stock falling two days in a row, investors see Lehman Brothers Holdings Inc. as the latest firm weighing on financial stocks.
The problems in Lehman's balance sheet could force the firm to issue a large amount of equity -- or to sell part, or all, of itself to a larger financial firm.
While such options would be excruciating for the company's management and existing shareholders, that may be what it takes to bolster confidence in the investment bank -- and to stop concerns about the firm affecting the wider financial system.
Following an 8.1% drop Monday, Lehman shares slid 9.5% Tuesday. The latest decline came even though Lehman was buying back large amounts of its own shares. Tuesday in New York Stock Exchange trading, Lehman shares were down $3.22 at $30.61, 22% below their book value -- the measure of a company's net worth based on assets minus liabilities -- at the end of February.
The steep discount to book value apparently reflects investor discontent about the values Lehman has placed on its assets, many of which are backed by distressed real-estate loans. And the discount is also a sign that investors doubt management's ability to navigate this crunch.
Lehman is scheduled to report a loss for its fiscal second quarter, ended May 30, when it reports results the week of June 16.
Lehman's first option is to raise a large amount of capital. The Wall Street Journal reported Tuesday that Lehman was weighing whether to issue as much as $4 billion in new stock. But Tuesday's drop in Lehman's share price -- the stock was down about 15% at one point during the day -- makes it harder to sell new stock.
Selling at this level would be more expensive for the firm, especially if a buyer demanded a steep discount to the current depressed price. Lehman's market value has fallen to about $17 billion, so even a $4 billion capital raise is nearly equal to about 25% of the firm.
And investors may want to see Lehman raise even more than $4 billion to cover any future losses from marking down the value of its assets. Lehman is likely to report large losses on trades made to hedge assets in the second quarter. And critics argue that Lehman has lagged behind in marking down the value of assets backed with distressed residential and commercial mortgages.
There is another important reason why Lehman may need new capital: It likely needs extra cash to forestall another downgrade by ratings agencies.
Standard & Poor's Corp. Monday downgraded Lehman to single-A from single-A-plus, but kept the firm on negative watch. Lehman had indicated that such a downgrade could force it to post about $200 million in additional collateral to back derivatives trades.
Another downgrade could force the firm to post $5.4 billion in additional collateral, according to a note Tuesday from Brad Hintz, an analyst at Sanford C. Bernstein & Co. and a former Lehman chief financial officer.
Lehman's other option is to sell a stake to another firm or to sell out completely. The problem here is that the credit crisis has left few prospective buyers. So who might be left to step up?
At the right price, Lehman may make an attractive target for a private-equity firm or hedge-fund group that wants to add brokerage and investment-banking operations. Blackstone Group CEO Stephen Schwarzman is a Lehman alum who has long wanted to add more investment-banking businesses to his firm.
Citadel Group, a money manager with some sales and trading operations, may want to do the same. J.C. Flowers proposed buying Bear Stearns before its collapse, so interest from that buyout group wouldn't be a surprise.
A large commercial bank may also be drawn to Lehman at a discount to book value, especially if it gets time to go over the investment bank's assets to assess their value.
It is possible that Lehman, which survived the 1998 market meltdown and the credit crisis in March, can weather the latest storm. Lehman does have some time to work out if it wants to do something drastic, like sell out. Lehman can avoid a short-term funding squeeze since it can borrow directly from the Federal Reserve, but the Fed could get impatient if Lehman doesn't do something soon.
So, it can't put off the tough choices for much longer.
Lehman Brothers is scheduled to release its second quarter earnings report on June 16th. With its common stock being punished so in the last few days, that earnings release (and snap-shot of the balance sheet) cannot come soon enough. Hopefully, the Lehman Brothers management team also can address reports of why it was supposedly buying back common stock on June 3rd, whether it is true that the firm has sharply curtailed its proprietary trading activities, and just what is the heck is going on with its position in KSK Energy Ventures Ltd.
Toomre Capital Markets LLC for one is very curious about how a position purchased in January 2008 as part of a restructuring can result in a $400 million to a $600 million dollar gain at the end of February 2008 (end of Lehman Brothers first quarter). Then, of course, some insight into what is going on with their approximately $85 billion in mortgage portfolio and what might be the repercussions if the investment bank were to be downgrade again. There is a report from an equity analyst that such a downgrade would result in a need to post $5.2 billion in collateral against existing derivative and credit derivative swap positions.
Reader cooments and thoughts are welcome.
]]>However, on Tuesday June 3rd 2008, market participants woke to the news from The Wall Street Journal that Losses Push Lehman To Weigh Raising New Capital. As the article explains, the investment banking franchise known as Lehman Brothers apparently is "considering raising billions of dollars in fresh capital to help shore up its balance sheet, according to people familiar with the matter." This would be the first issuance of common stock by Lehman Brothers since it went public from American Express back in 1994. The cause of the stock issuance is what appears to be Lehman Brothers' first quarterly loss since it went public. The formal earnings announcement for Lehman Brothers is expected during the week of June 16th along with those from Goldman Sachs and Morgan Stanley.
This capital raise will be coming on top of six billion in capital Lehman Brothers raised during the past year including $4 billion in preferred stock raised after the forced sale of Bear Stearns to JPMorgan. The forthcoming earning report is expected to "show some fresh difficulties. The firm is saddled with billions of dollars in hard-to-sell commercial real-estate assets and leveraged loans and is expected to face further write-downs on these portfolios. That has led the firm to consider raising additional capital. Wall Street firms including Merrill Lynch and Morgan Stanley have also raised billions of dollars as losses from the mortgage meltdown have mounted."
The article concludes with information that Lehman Brothers was hurt by ineffective hedges. Specifically,
]]>However, on Tuesday June 3rd 2008, market participants woke to the news from The Wall Street Journal that Losses Push Lehman To Weigh Raising New Capital. As the article explains, the investment banking franchise known as Lehman Brothers apparently is "considering raising billions of dollars in fresh capital to help shore up its balance sheet, according to people familiar with the matter." This would be the first issuance of common stock by Lehman Brothers since it went public from American Express back in 1994. The cause of the stock issuance is what appears to be Lehman Brothers' first quarterly loss since it went public. The formal earnings announcement for Lehman Brothers is expected during the week of June 16th along with those from Goldman Sachs and Morgan Stanley.
This capital raise will be coming on top of six billion in capital Lehman Brothers raised during the past year including $4 billion in preferred stock raised after the forced sale of Bear Stearns to JPMorgan. The forthcoming earning report is expected to "show some fresh difficulties. The firm is saddled with billions of dollars in hard-to-sell commercial real-estate assets and leveraged loans and is expected to face further write-downs on these portfolios. That has led the firm to consider raising additional capital. Wall Street firms including Merrill Lynch and Morgan Stanley have also raised billions of dollars as losses from the mortgage meltdown have mounted."
The article concludes with information that Lehman Brothers was hurt by ineffective hedges. Specifically,
During the second quarter, Lehman was stung by hedges used to offset losses in real estate and other securities, according to people familiar with the matter. The firm bet that indexes tracking markets such as real-estate securities and leveraged loans would fall. If that happened, it would book profits that would make up some of its losses from holding these securities and loans.However, in an unexpected twist, some of the indexes rose, even as the assets they were supposed to hedge against continued to lose value or stayed relatively flat. Lehman's losses from both write-downs on assets and ineffective hedges will likely top $2 billion, people familiar with the matter said. Lehman will also realize additional losses related to its decision to reduce its work force, according to a person familiar with the matter.
The S&P downgrades came after the ratings agency completed a review of the entire securities industry. S&P said it believes Lehman and other securities dealers' revenues may decline more than anticipated based on the firms' still large exposures to illiquid and hard-to-value assets.
S&P analyst Scott Sprinzen said the Federal Reserve's decision to allow brokers to borrow money directly from the Fed, "gave us the comfort not to go further with some of the downgrades that we did," he says. "But we can't count on that indefinitely."
S&P cut Lehman's rating to A from A+, and also cut the ratings of Morgan Stanley to A+ from AA- and Merrill Lynch to A from A+. Despite the downgrades, the firms are still considered high-quality investment-grade credits. S&P affirmed Goldman Sachs's ratings at AA-, but revised its outlook of the firm to negative.
In recent weeks, David Einhorn of the hedge fund Greenlight Capital has been highly critical of what some refer to as the Lehman Brothers black box and the firm's lack of transparency in reporting what risks it takes to make its reported profits. Perhaps his criticism is biased by his admitted short position in Lehman Brothers' common stock. The key point of his short thesis on Lehman Brothers concerns FASB 159 (The Fair Value Option for Financial Assets and Financial Liabilities), a new accounting standard, which he called "Profiting from your own demise." This new standard allows companies to update the fair value of both their assets and liabilities. Previously, if interest rates moved, only the assets were revalued, so companies would report a gain or a loss based on that move. If your assets are properly funded by matching liabilities, however, both should move in lockstep and offset each other, so this new accounting standard seems to make sense.
Mr. Einhorn goes on to suggest that suppose a company's debt is being severely downgraded. Suppose further that the market hasn't changed, so the value of the assets remain the same. Now the company will record a gain and increase its apparent book value, or equity, when in fact it is in recognizably worse financial shape due to the downgrade. It is an entirely absurd outcome. According to Mr. Einhorn, the investment banks have been early adopters of this standard and this has had the absurd effect that the worse their credit, the more money they're making (because of the gain in book value that goes through the income statement). The logical extreme of this is that the most lucrative day in the history of your company will be the day you go bankrupt.
Mr. Einhorn suggests that the FASB 159 gains from marking down the value of Lehman's debt and gains from private equity marked up (but not sold) were the primary reasons that Lehman Brothers reported a first quarter profit. He further points to a portfolio of more than $6 billion in CDOs that were marked down only approximately $200 million during the first quarter. Given that a large percentage of the portfolio was below investment grade and how other below investment grade bonds widened substantially during the first quarter, he reasonably questions whether those assets were being correctly marked even in such a highly illiquid market environment.
Toomre Capital Markets LLC joins Mr. Einhorn is questioning the transparency of Lehman Brothers' financial disclosures. Perhaps the forthcoming second quarter earnings report will be particularly bad as Lehman Brothers corrects various biases that allowed the firm to report profits in past quarters? Maybe with a "kitchen sink" quarter, this investment bank will be able to go forward in the new environment of decreased activity, sharply lowered leverage and increased regulation? The interesting question is what the franchise value will be going forward. Yesterday, Lehman Brothers closed at $33.83 down $2.98 (or 8.10%) on the day. The 52-week low was $20.25 was hit around the time of the Bear Stearns crisis when the market participants were wondering if Lehman Brothers might be the next investment bank to succumb to the credit crisis.
One has to wonder with the forthcoming equity issue whether the Lehman Brothers common stock will trade down again to those lows. However, the real question is where is value with this investment banking franchise? Does anyone really know? Reader comments and thoughts are welcome.
]]>In the time since the Federal Reserve helped to broker the sale of Bear Stearns to JP Morgan (with some $29 billion dollars of potential assistance) on March 17th, the capital markets have stabilized. Credit default spreads have narrowed from extreme wide spreads. The equity markets rallied from the March lows. Also, in many fixed-income product sectors, spreads to risk-free securities have significantly narrowed from oversold conditions. In short, the massive oversold (or biased) positions in the Capital Markets have had time to return to more stable conditions.
Or at least that was the case until the last ten days or so when slowly conditions have started to deteriorate again. Are these deteriorating conditions indications of another wave of the credit hurricane about to hit the Capital Markets? Time will tell. TCM suspects that market participants are about to learn that various financial firms did not perform well during the second quarter and that there will be further asset write-downs in various portfolios where liquidity has been sharply curtailed due to the credit crunch. Such news will be no great surprise.
Amidst the turbulence of the various news reports about layoffs, resignations and common stock declines, TCM has begun to wonder just where is there value in the major investment banks [Goldman Sachs, Morgan Stanley, Merrill Lynch and Lehman Brothers] and their universal bank counterparts [Barclays, UBS, Deutsche Bank, and Credit Suisse]. What are these franchises really worth in a world of sharply reduced liquidity and where new regulations on risk and capital are likely to be imposed? Assuming that these institutions go back to the "old days" of client flow trading, aren't each of these franchises worth significantly less than their current market values? Reader comments and thoughts are welcome.
]]>In the time since the Federal Reserve helped to broker the sale of Bear Stearns to JP Morgan (with some $29 billion dollars of potential assistance) on March 17th, the capital markets have stabilized. Credit default spreads have narrowed from extreme wide spreads. The equity markets rallied from the March lows. Also, in many fixed-income product sectors, spreads to risk-free securities have significantly narrowed from oversold conditions. In short, the massive oversold (or biased) positions in the Capital Markets have had time to return to more stable conditions.
Or at least that was the case until the last ten days or so when slowly conditions have started to deteriorate again. Are these deteriorating conditions indications of another wave of the credit hurricane about to hit the Capital Markets? Time will tell. TCM suspects that market participants are about to learn that various financial firms did not perform well during the second quarter and that there will be further asset write-downs in various portfolios where liquidity has been sharply curtailed due to the credit crunch. Such news will be no great surprise.
Amidst the turbulence of the various news reports about layoffs, resignations and common stock declines, TCM has begun to wonder just where is there value in the major investment banks [Goldman Sachs, Morgan Stanley, Merrill Lynch and Lehman Brothers] and their universal bank counterparts [Barclays, UBS, Deutsche Bank, and Credit Suisse]. What are these franchises really worth in a world of sharply reduced liquidity and where new regulations on risk and capital are likely to be imposed? Assuming that these institutions go back to the "old days" of client flow trading, aren't each of these franchises worth significantly less than their current market values? Reader comments and thoughts are welcome.
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According to the press release, "No single precipitating event caused the board to reach this decision, but a series of previously disclosed disappointments and setbacks cumulatively have negatively impacted the company and its performance." One has to wonder though whether buying a large California thrift with an investment portfolio concentrated in negative amortization ARMs at the absolute top of the housing market had anything to do with his firing?
Or perhaps the recent regulatory sanctions had more of an effect than outsiders fully appreciate? Certainly having to settle charges about money laundering and needing to deal with possible collusion charges in the submission of municipal bond reinvestment hedges suggest that the bank did not have strong internal controls. Coupled with the recent OCC actions about its use of customer data with tele-marketing firms, one has to wonder what changed in approximately the last month since Ken Thompson was stripped of the Chairman role? Reader comments and thoughts are welcome.
]]>According to the press release, "No single precipitating event caused the board to reach this decision, but a series of previously disclosed disappointments and setbacks cumulatively have negatively impacted the company and its performance." One has to wonder though whether buying a large California thrift with an investment portfolio concentrated in negative amortization ARMs at the absolute top of the housing market had anything to do with his firing?
Or perhaps the recent regulatory sanctions had more of an effect than outsiders fully appreciate? Certainly having to settle charges about money laundering and needing to deal with possible collusion charges in the submission of municipal bond reinvestment hedges suggest that the bank did not have strong internal controls. Coupled with the recent OCC actions about its use of customer data with tele-marketing firms, one has to wonder what changed in approximately the last month since Ken Thompson was stripped of the Chairman role? Reader comments and thoughts are welcome.
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Since the Bear Stearns rescue effort unfolded in mid-March, there has been considerable criticism of the Federal Reserve and Treasury Department brokered sale of Bear Stearns to JP Morgan, particularly around the issues of moral hazard and the Federal Reserve's ability to act as an 'honest broker' in future financial crises. On the front page of the May 30th 2008 edition of The Wall Street Journal, there is an article written by Greg Ip entitled Fed's Fireman On Wall Street Feels Some Heat that summarizes some of the criticism still being directed at Timothy Geithner. The article contains the interesting reference that "As early criticism of the rescue swirled, the president of the Dallas Fed, Richard Fisher, sent Mr. Geithner an email in Latin: 'Illigitimum non carborundum,' along with his translation, 'Don't let the bastards get you down.' Mr. Geithner replied that his grandfather had the same slogan on his kitchen wall."
Toomre Capital Markets LLC for one is glad that Mr. Geithner pushed for the Federal Reserve to lend $29 billion to JP Morgan to facilitate the latter's takeover of Bear Stearns on Sunday, March 16th 2008. Although some rather ignorant Congressmen claimed that the Federal Reserve's participation "exposed the American taxpayers to unknown amounts of financial loss", TCM is sure that such politicians would have been singing a much different self-serving tune had Bear Stearns filed for bankruptcy early the next Monday morning. Many people who are not intimately involved with the Capital Markets do not appreciate how intricately the various investment and global commercial banks have become through derivative contracts and particularly what are known as Credit Default Swaps ("CDS").
]]>Since the Bear Stearns rescue effort unfolded in mid-March, there has been considerable criticism of the Federal Reserve and Treasury Department brokered sale of Bear Stearns to JP Morgan, particularly around the issues of moral hazard and the Federal Reserve's ability to act as an 'honest broker' in future financial crises. On the front page of the May 30th 2008 edition of The Wall Street Journal, there is an article written by Greg Ip entitled Fed's Fireman On Wall Street Feels Some Heat that summarizes some of the criticism still being directed at Timothy Geithner. The article contains the interesting reference that "As early criticism of the rescue swirled, the president of the Dallas Fed, Richard Fisher, sent Mr. Geithner an email in Latin: 'Illigitimum non carborundum,' along with his translation, 'Don't let the bastards get you down.' Mr. Geithner replied that his grandfather had the same slogan on his kitchen wall."
Toomre Capital Markets LLC for one is glad that Mr. Geithner pushed for the Federal Reserve to lend $29 billion to JP Morgan to facilitate the latter's takeover of Bear Stearns on Sunday, March 16th 2008. Although some rather ignorant Congressmen claimed that the Federal Reserve's participation "exposed the American taxpayers to unknown amounts of financial loss", TCM is sure that such politicians would have been singing a much different self-serving tune had Bear Stearns filed for bankruptcy early the next Monday morning. Many people who are not intimately involved with the Capital Markets do not appreciate how intricately the various investment and global commercial banks have become through derivative contracts and particularly what are known as Credit Default Swaps ("CDS").
Had Bear Stearns declared bankruptcy that next Monday morning, who knows what would have happened? Certainly, given the extreme negative sentiment that existed in the credit markets at that point, the equity markets could well have declined more than a thousand Dow points and various investment banking stocks like Lehman Brothers and Merrill Lynch likely would have declined precipitously. Who knows what would have happened in the much larger fixed-income markets that day as the approximately 5,000 Bear Stearns counter-parties scrambled to seize and sell various pledged collateral amounts. One might well to also recall that the fixed-income markets were virtually shut down the week before and that there likely would have been little or no bid for other fixed-income securities as everyone focused on self-preservation, just where they stood in terms of risk exposures and trying to fund themselves. Surely, the repo market would have seized up and the Federal Reserve would have had to pump many, many billions of liquidity into the financial system at who knows what eventual cost to American tax-payers.
Hence, while there may now well be more moral hazard risk in the American financial system, TCM strongly feels Mr. Geithner is a nod of a gratitude for preventing a complete systemic breakdown back in March 2008. Reader comments and thoughts are welcome.
]]>Late on the afternoon of Thursday May 29th 2008, The Wall Street Journal is reporting that Bradley Birkenfeld has apparently decided to change his plea to guilty. Apparently, in a federal court filing earlier in the day, a court clerk stated that Mr. Birkenfeld will change his plea at a hearing scheduled before U.S. District Judge William Zloch in Ft. Lauderdale, Florida on June 9th. He had previously pleaded not guilty.
The article continues "The former UBS banker is part of a larger probe that U.S. prosecutors are conducting into whether UBS advised wealthy American clients on ways to utilize complex corporate entities and off-shore locales to avoid paying U.S. taxes. The U.S. inquiry, which became public earlier this month, comes at a difficult time for UBS, which has written down some $38 billion in securities tied to subprime mortgage loans. A UBS spokesman wasn't immediately available to comment on Mr. Birkenfeld's court filing. Danny Onorato, a lawyer for Mr. Birkenfeld, said he could not discuss details of the agreement. A notice by the court clerk says the federal judge hearing the case 'will ask for a full confession' by Mr. Birkenfeld."
]]>Late on the afternoon of Thursday May 29th 2008, The Wall Street Journal is reporting that Bradley Birkenfeld has apparently decided to change his plea to guilty. Apparently, in a federal court filing earlier in the day, a court clerk stated that Mr. Birkenfeld will change his plea at a hearing scheduled before U.S. District Judge William Zloch in Ft. Lauderdale, Florida on June 9th. He had previously pleaded not guilty.
The article continues "The former UBS banker is part of a larger probe that U.S. prosecutors are conducting into whether UBS advised wealthy American clients on ways to utilize complex corporate entities and off-shore locales to avoid paying U.S. taxes. The U.S. inquiry, which became public earlier this month, comes at a difficult time for UBS, which has written down some $38 billion in securities tied to subprime mortgage loans. A UBS spokesman wasn't immediately available to comment on Mr. Birkenfeld's court filing. Danny Onorato, a lawyer for Mr. Birkenfeld, said he could not discuss details of the agreement. A notice by the court clerk says the federal judge hearing the case 'will ask for a full confession' by Mr. Birkenfeld."
According to a Bloomberg story on the same subject, "By changing his plea, Mr. Birkenfeld is signaling he will help prosecutors and identify other UBS customers who shielded assets to escape paying income taxes, said Eileen O'Connor, former head of the Justice Department's tax division. 'He's decided to cooperate,' said O'Connor, now a partner at the Pillsbury Winthrop Shaw Pittman law firm in Washington. The indictment, unsealed May 13, alleges Birkenfeld and Staggl attempted to sidestep rules in a U.S.-Switzerland tax treaty that requires information to be exchanged on some financial transactions. The pair -- and others not identified by prosecutors -- allegedly traveled to the U.S. to pitch their schemes." The Bloomberg article continues:
The billionaire beneficiary, unnamed in court papers except for his initials, has been identified as Igor Olenicoff, founder of Olen Properties Corp. He pleaded guilty in December to a charge of filing a false tax return and agreed to pay $52 million in back taxes, penalties and interest.Olenicoff was ranked 236 on the Forbes Magazine list of the 400 wealthiest Americans this year, with a net worth of $1.7 billion. He was sentenced to probation, 120 hours of community service and a $3,500 fine in April.
Birkenfeld, 43, and Staggl helped Olenicoff evade U.S. income taxes on about $200 million in assets, prosecutors said.
The case is U.S. v. Bradley Birkenfeld and Mario Staggl, 08- 60099, U.S. District Court for the Southern District of Florida, Fort Lauderdale. [A link to the indictment is here.]
Toomre Capital Markets LLC suspects that Mr. Birkenfeld has decided to "spill the beans" on other wealthy Americans who used the services of UBS to avoid paying taxes. The key question regarding UBS' potential liability is how full Mr. Birkenfeld's (and potentially Mr. Liechti's) still undisclosed "black books" are with American individuals who conspired to avoid paying taxes due. Certainly, if there are a number of such individuals, UBS will have much more negative publicity (and likely at least civil liability) around their private banking activities.
With UBS's demonstrated incompetence in the fixed-income markets and now this private banking scandal, one really has to wonder just where there is value in owning the common stock of this Swiss banking giant. Reader comments and thoughts are welcome.
]]>The ruling by U.S. District Judge Robert Sweet in Manhattan upholds a bankruptcy court's decision last year requiring that the funds be liquidated in U.S. courts. Holding the proceedings in the Cayman Islands, home to many hedge funds for tax reasons, could have shielded the funds' assets from some U.S. creditors. The ruling could have implications for other funds that seek protection under Chapter 15 of the U.S. Bankruptcy Code, which covers cross-border insolvencies. The judge upheld the bankruptcy court's finding that the funds' "center of main interests," as defined by Chapter 15, was in the United States.
"It is hoped that resolution of these issues may provide some aid to navigation in these uncharted waters," Sweet wrote in the decision, dated May 22 and made public on Tuesday.
"The process by which the financial problems of insolvent hedge funds are resolved appears to be of transcendent importance to the investment community and perhaps even to the society at large."
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The ruling by U.S. District Judge Robert Sweet in Manhattan upholds a bankruptcy court's decision last year requiring that the funds be liquidated in U.S. courts. Holding the proceedings in the Cayman Islands, home to many hedge funds for tax reasons, could have shielded the funds' assets from some U.S. creditors. The ruling could have implications for other funds that seek protection under Chapter 15 of the U.S. Bankruptcy Code, which covers cross-border insolvencies. The judge upheld the bankruptcy court's finding that the funds' "center of main interests," as defined by Chapter 15, was in the United States.
"It is hoped that resolution of these issues may provide some aid to navigation in these uncharted waters," Sweet wrote in the decision, dated May 22 and made public on Tuesday.
"The process by which the financial problems of insolvent hedge funds are resolved appears to be of transcendent importance to the investment community and perhaps even to the society at large."
Sweet said the liquidators did not adequately show that the funds had a sufficient connection to the Cayman Islands. At the time of the Chapter 15 petition, there were no fund assets in the Cayman Islands, the judge said.
Also, while the liquidators said that two fund directors resided in the Cayman Islands, "these directors have not been shown to have had any substantial involvement in the business of the funds," the judge wrote.
The liquidators, Simon Whicker and Kristen Beighton, of KPMG, had appealed a ruling by U.S. Bankruptcy Court Judge Burton Lifland in Manhattan last year.
Toomre Capital Markets LLC ("TCM") believes that this is a significant ruling that eventually will shed far more light on the murky activities surrounding these two Bear Stearns hedge funds whose collapse has marked the start of the current credit crunch. Whereas hedge funds prefer to operate in a world of restricted information and transparency, the United States Bankruptcy process is very transparent and much dirty laundry gets exposed in the process. Interested readers may want to check out the excellent article by Benjamin Feder on FinAlternatives.com entitled Reticent Hedge Funds Chafe Under Bankruptcy Code.
TCM certainly will be following with interest as information is finally revealed about just what Bear Stearns fund manager Ralph Cioffi did to get his two highly leveraged funds so off-sides that they collapsed in a matter of weeks. As this BusinessWeek article points out, the funds' investors have been quite stymied about getting any information about what really went on with this supposed professional hedge fund management firm.
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