The Great Deleveraging

[HenryTo]

Similar views from Peter Bernstein regarding our longer-term credit/economic outlook in this weekend's commentary:

http://www.investorsinsight.com/otb_va_print.aspx?EditionID=670

[rffrydr]

Fitch said that prime and subprime auto ABS performance indices produced higher delinquency and annualized net losses (ANL) in July. The ANL was 1.42% up 15% from June and 94% from a year ago. Subprime ANL were 6.56% in July up 16.5% m/m and 45% year over year. Delinquencies were up 30% from July. The wholesale vehicle market did show signs of stabilization in July, but Fitch was not expecting a structural improvement.
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Today is the Tomorrow you worried about Yesterday!

[rffrydr]

Don't like it? Wait a couple hours: the Korean/Lehman tie-up back on the table and RBA cut with the carry currencies taking it on the chin...almost two years carry in a few weeks. Throw crude down limit now.

Don't forget that the GSEs are now profit machines. Take away Oil and the Miners and money will HAVE to start flowing back to the financials. It pays not to forget the debt matures and HAS to be reinvested. There's alot coming in a couple of weeks. $80 dollar crude and many things will be forgotten.
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Today is the Tomorrow you worried about Yesterday!

[HenryTo]

Crude oil is down more than $6 as I am typing this and yet many developed and emerging markets have continued to take it on the chin. US futures are still down, while the Nikkei was down more than 250 points at last count. Korea has been and is still actively intervening in the FX markets to prop up the Won.

The bad thing is that there is still a lot of leverage within the global system - and this is further compounded by the fact that much of the world is still short the US Dollar and the Japanese Yen (e.g. Korean households that took out mortgages denominated in Yen or Chinese savers here in the US who bought New Zealand Kiwi dollar-denominated CDs) - two currencies which have exhibited a long strength over the last six weeks. Worse yet, there is still ample room for these two currencies to rise.

In order for the world to avoid a more painful episode of general deleveraging, the US and Japanese will need to supply more liquidity. As mentioned in this weekend's commentary, the "best bang for the buck" is still a bailout package for the GSEs. With respect to Japan, it now looks like the new PM (Taro Aso?) is more ready to feed liquidity to the Japanese economy than Fukuda. Both these events should be immensely bullish for the global financial markets - should/once they come to pass.

[HenryTo]

As discussed here many times before, look for banks' ROEs to decline dramatically and stay low going forward:
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Wed, 20 Aug, 14:54 GMT

ANALYSIS Banks' returns come back to earth, maybe for good

Fall of structured finance and regulatory pressure over capital reserves likely to mark end period of 20-30 percent ROE.

LONDON (Thomson IM) - A slump in lucrative structured finance business and regulators' demanding bigger capital reserves mean stratospheric profitability at banks is gone, possibly forever.

The credit crunch has hammered the return on equity (ROE) of many banks, particularly those in Europe and the United States, since the second half of 2007, and those returns may never recover to pre-crisis levels.

'Will the fantastic returns of 2006-early 2007 come back? It's really doubtful. It was a unique environment where each and every asset class appreciated so it was very difficult to do anything wrong,' said Bernd Ackermann, an analyst in rating agency Standard & Poor's financial institutions group.

In 2006, the top 10 banking ROEs ranged from 23.9 percent to 35.5 percent, with the average ROE at 13.6 percent, according to the Boston Consulting Group.

'Much of that (ROE levels) relates to capital ... what equity will be required in the next cycle,' said David Fanger, an investment banking analyst at rating agency Moody's.

Last year -- split neatly into a record first half and a sharply slowing second half -- banks' after-tax profits fell for the first time since 2003 and their average ROE declined to 13 percent, but that was propped up by exceptional returns at some banks, mostly from emerging markets.

'Until last year, we'd had a 25-year run of low interest rates, excessive liquidity, particularly post-9/11, low inflation and relatively good economic growth,' said Neil Dwane, chief investment officer in Europe for RCM, an investment unit of German insurer Allianz <ALVG.DE>.


REGULATION, REGULATION, REGULATION

Regulators will require banks to set aside more capital than before for risks other than that of default, such as potential losses due to a credit rating agency downgrade or due to a change in the price of an equity instrument.

'Does that permanently diminish ROEs? It may very well,' Fanger said.

The high ROE levels enjoyed by banks in 2006-07 are gone for good, Dwane said. 'In two-three years these businesses will be regulated and as exciting as utilities.'

Large banks across the world, such as Merrill Lynch <MER.N>, UBS <UBSN.VX> and Citigroup <C.N>, and other financial firms have written down $408 billion since the crisis hit, pressuring their ROE, a key benchmark for shareholders to measure profitability. [ID:nLC357494]

UBS's and Citigroup's ROE dipped into negative territory this year, compared to high positive returns last year. JPMorgan analyst Kian Abouhossein estimates that measure next year will still be considerably below the pre-crisis levels, or around 20 percent for UBS and around 11 percent for Citigroup.

According to S&P, Goldman Sachs <GS.N> posted ROE of over 30 percent in 2006. JPMorgan sees that figure at around 19 percent by the end of 2009.

ROE reveals how much profit a company generates with the money shareholders have invested. It is defined as after-tax profit divided by total equity -- so the higher the percentage, the more profitable the company.

S&P expects investment banking revenues to drop 20-30 percent this year on 2007, excluding writedowns.

'For 2009, I wouldn't say that this will improve dramatically,' S&P's Ackermann said.


FIASCO

Also pressuring slowing income at banks is the loss of a rich seam of revenue from structured products, which became a major contributor to the subprime fiasco because their complex nature made it hard to assess risks and value.

Demand has evaporated for asset-backed securities and collateralised debt obligations (CDOs), after the market for such debt repackagings froze in the wake of the blow-up in the market for U.S. subprime mortgages.

While structured finance may pick up in the future, products are likely to be simplified, subject to intense scrutiny and in all likelihood less profitable, analysts say.

And it is already costing banks more to satisfy investors as they look for higher dividends to compensate for the risks of investing in banks just as their share prices drop.

'Involuntary balance sheet expansion, higher funding costs and the need for stronger capital ratios are likely to result in a permanently lower return on equity for the industry,' Citi analysts said in a note on UK banks.

[HenryTo]

Deleveraging and real estate credit tightening also now hitting Houston, Texas - one of the major cities still (somewhat) booming due to its energy exposure:

http://www.chron.com/disp/story.mpl/front/5948418.html

[Odysseus]

Hi Diesel,

David really is one of the good guys. He has made lots of money and could with his rep danced his fund to shear more sheep. He did not. That is why I respect his observations.
His expectation for financials trading at half of book is a bit of a slippery slope. What he did not say but I understand is that book value can also be a function of future dilution for existing stockholders. In short, those with the ability to raise capital may eventually trade at diminished book. Those that cannot, will go BK at half of book.

The FASB has become another pawn/stooge in an accounting chimera that will give the banks and IB's a little time to recap. Jeff Skilling must be xxx on his guards and planning his appeal...

Tolstoi's great observation. "The threads of Mis-conclusions are woven into the fabric our lives."

I'm still trying to figure out how financials make money in the future. Their old models are broken. Historically ROE's were in the 8 to 10% ranges. Leverage was at best 12 to 1.

What I imply from David's analysis is that the next wave of troubled loans will be actual balance sheet loans for CRE, Alt-A's and eventually Primes.

Regards,

The crystal is broken. I need a broom and a dustpan.
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Psychic with Alzheimers. I can predict what I will forget.

[diesel]

Great interview. Thanks for the link.

[Odysseus]

There is a great interview on Bloomburg today with David Goldman of Asteri Capital.

David is one of the few hedge fund managers to close funds before he gets locked in and the markets unravel against him. He closed his fund in 98 before LTCM and gave back the money.

He recently closed again giving back the capital. His reasons for doing this are quite instructive.

If anyone wants an in depth primer on the state of the capital markets, I would suggest going to Bloomies and listen in. It is about a 20 minute interview.

David is one of the good guys. He is objective to a fault. The comment that most impressed me was that he believes that the credit crunch is only now beginning.

Worth a listen for those who wish to keep up with Henry's great de-leveraging thesis.

Regards

One scared MF.
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Psychic with Alzheimers. I can predict what I will forget.

[rffrydr]

Fed Credit Survey:

https://research.mfglobal.com/Dailyres/Financial/Eurobonds/12us_files/image002.jpg
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Today is the Tomorrow you worried about Yesterday!

[rffrydr]

Auto Leasing: the door to the candy store is slowly closing.

http://www.bloomberg.com/apps/news?pid=20601213&sid=aStq6nvSPVDw&refer=home

GM will need this to jumpstart the Volt.
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Today is the Tomorrow you worried about Yesterday!

[rffrydr]

Covered Bonds: after pulling teeth major banks making a show of it. Article touches on some of issues financial institutions might have with these. Obviously there is more to a market than just making a market. How much our "free world" depends on regulation:

http://www.smartmoney.com/breaking-news/smw/index.cfm?story=20080728042057
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Today is the Tomorrow you worried about Yesterday!

[rffrydr]

How much depends on trust...how much, now depends on punishment:

[HenryTo]

Unlike the failure of IndyMac, there's no deleveraging here, as all bank account holders were made whole:
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No angry lines of customers after bank takeover
Saturday July 26, 10:01 pm ET
By Amanda Lee Myers, Associated Press Writer
Bank customers unfazed as FDIC takes over 1st National of Nevada and First Heritage N.A.

PHOENIX (AP) -- Customers of two banks closed by federal regulators were assured that every penny of their money was protected, preventing lines of angry accountholders from forming Saturday.
The calm response was a stark contrast to the hundreds of angry customers who waited for hours earlier this month in Southern California to demand their money after IndyMac Bank's assets were seized.

The 28 branches of the 1st National Bank of Nevada and First Heritage Bank N.A. -- owned by Scottsdale, Ariz.-based First National Bank Holding Co. -- were closed Friday by the FDIC.

But Mutual of Omaha Bank bought all of the two banks' deposits, even those over the amount protected by FDIC insurance limits. IndyMac customers had to take a loss on whatever amount they had in the bank over the insurance limits.

One 1st National Bank of Nevada in downtown Phoenix didn't even have a note outside to tell customers about the trouble Saturday. But there were no customers outside to tell.

"I feel like the Maytag repairman -- there's just not much to do on the customer side of things," Federal Deposit Insurance Corp. spokesman David Barr said. "There's going to be no impact on the depositors whatsoever, except basically a name change," Barr said.

Insurance limits are typically $100,000, but some accounts, such as joint accounts, can have more money protected, Barr said.

On Monday, Mutual of Omaha will open the banks as its own branches, Barr said. During the weekend, accountholders can access their funds by writing checks or using ATM or debit cards.

Jeff Schmid, chairman and CEO of Mutual of Omaha Bank, said the acquisition of the new accounts aligns with the company's growth strategy to get aggressive with banking.

"We're very optimistic about these markets," said Schmid, who was in Scottsdale on Saturday to speak with his new employees. "This could be our finest hour."

Mutual of Omaha Bank has $800 million in assets and operates 14 retail branches in Nebraska and Colorado. It's a subsidiary of Mutual of Omaha, a 99-year-old insurance and financial services company with more than $19 billion in total assets.

The Office of the Comptroller of the Currency said in a news release that 1st National was undercapitalized and had experienced substantial dissipation of assets and earnings "due to unsafe and unsound practices."

Those practices "also weakened the bank's condition and seriously prejudiced the interests of the bank's depositors and the deposit insurance fund."

Another news release said First Heritage was critically undercapitalized and was likely to incur losses that would deplete all or nearly all of its capital.

As of June 30, the closed banks had total assets of $3.6 billion. That's down from $4.1 billion six months earlier. Most of the assets are in 1st National, while First Heritage N.A. accounts for $254 million.

The FDIC said the takeover of the failed banks was the least costly resolution.

Calls to 1st National executive vice president Joe Martony were not returned Saturday. No one could be reached at the First Heritage N.A.

1st National has 10 branches in Nevada and 15 branches in Arizona. First Heritage N.A. has three branches in Southern California.

[rffrydr]

[HenryTo]

Fed making incremental steps to allow private equity firms to invest in US banks in a substantial way:

http://www.bloomberg.com/apps/news?pid=20601087&sid=andzW.Pv3DjY&refer=home