This is why GE and the few other remaining AAA rated financial companies are trying so desperately to maintain their rating. Once upon a time the interest rate charged a AAA company only varied a few basis points from that charged a AA- company (three steps lower), so the financial impact in terms of interest charges was relatively minimal. Well, that time is long gone and the difference now is a whopping 112 basis points (a basis point is .01 percent). For companies using massive amounts of debt, that difference can be tens of millions of dollars a year.
http://www.bloomberg.com/apps/news?pid=20601087&sid=a59gngOiy2c8&refer=home
So why such a spread today? That trust thingy explains a lot. Those still willing to lend need to be sure they will get repaid because there is virtually no secondary market for securitizing the loan. In other words, banks actually have to do some underwriting for a change because the loan will remain on their books. Accordingly, any variance from a perfect rating will cause lenders to charge a premium. There is also the supply/demand aspect to consider. Not a lot of lenders out there willing to lend at a time when there are a host of companies desperately needing to borrow. Those lenders still lending can afford to be picky and charge a premium for the privilege.
One reason banks are not lending money despite the hundreds of billions thrown to them by the U.S. is that they do not fully know how much they will need to use themselves to survive. As I have noted before, their business model is broken. All those fees they used to generate on complex financial transactions are now gone at a time when they are continuing to have building losses on loans, derivatives, credit cards and the like. If you are not making money and your losses are mounting you are not about to lend what you have to other companies that may not be able to repay you. Instead you hoard what you have until you are sure you will not need it, which could be years from now. Keep in mind that a lot of this money from the Fed is given to them as a loan that, absent them folding, will have to eventually be repaid to the Fed, so even when they do get back on their feet, they will have numerous lean years while they repay the loans. Don't look for banks to be posting good profits for some time to come.
http://www.nakedcapitalism.com/2008/12/banking-industry-sinking-faster-than.html
2009
I hope to post tomorrow some more thoughts on what 2009 holds for us. Not a pretty picture at the moment. Here are some thoughts from Wolfgang Munchau, at Financial Times, on what we should be doing in 2009. I agree with most of his thoughts (though not all of them as I do think spending on infrastructure and education makes sense). One particular point I like is that the financial industry is too large and we cannot and should not support it in its current form. Some of it needs to be broken up and wound down in an orderly fashion. I know this will have some unintended consequences, like in the CDS world, but we cannot support it all and need to use our money more wisely.
He also has a warning on things that might happen in 2009 to make matters much worse. Some of these are well within the realm of possibilities:
"It is not difficult to construct a plausible scenario of an economic catastrophe. Pick some of the following and you could end up with a depression that beats every modern record: a rise in global protectionism; competitive currency devaluations; a sterling crisis; social unrest in China, leading to political instability; a well-timed terrorist attack; continued refusal by eurozone leaders to co-ordinate; a payment default by a large sovereign in the eurozone; an acute emerging market crisis; continued lack of synchronisation of monetary policies, or a collapse of the CDS market. Obviously, the insolvency of a large global bank or the annihilation of the hedge fund industry would not go unnoticed either."
http://www.ft.com/cms/s/0/af4e7e40-d507-11dd-b967-000077b07658.html
You Can't Make This Stuff Up
Companies have variuos ways of financially benefiting their shareholders. One way is to pay dividends. The problem with dividends is that when you start paying them the expectation is that they should continue and never get reduced. Some companies this year are proving that expectation to be wrong, while others are struggling to maintain it.
Another way to benefit shareholders is through stock buybacks. Rather than just handing the money over to shareholders and building a dividend expectation in the future, some companies in good times will use some of the excess cash to rebuy shares, which should have the effect of increasing the share price for those remaining shares on the market. Note I emphasize excess cash as it makes no sense to buy back shares if you do not have the cash.
There is a good bit of controversy over share buybacks and whether they really make good sense for the company. While the logic of a buyback may be debatable generally, I think most would agree that using debt to finance a share buyback is right up there with subprime mortgages on the "ten stupidest things I did during the bubble" list. Seriously folks, how do you add value for shareholders by taking out a loan - on which you pay interest - to artificially inflate the share price with a buyback? I am sure some CFO got a nice bonus for coming up with that idea.
http://www.bloomberg.com/apps/news?pid=20601087&sid=aOW9ACek2RRg&refer=home
A third way to benefit stockholders is for the company to do a good job, spend its capital wisely, invest in prudent growth, avoid complicated financial instruments that no one understands and make a profit. Having excess capital sitting around is not a bad thing after all; just ask the companies that are now struggling to pay down debt. Indeed, those with a lot of capital now will undoubtedly get a host of investment opportunities over the coming months as competitors fail and sell assets at fire sale prices. Guess I am a bit old fashion here, but I like companies that benefit shareholders by being well run and prudent. Not all that exciting, I know, but if you want exciting you should go to an amusement park.
By the way, there is another reason why a company might do a share buyback that is worth noting. Buybacks can be done to cause a short squeeze. Just ask those that were shorting Volkswagen in late October when Porsche decided to execute on some options and increase its stake to 75%. The stock shot up 93% and the company for a while was worth more than Exxon. Talk about a squeeze.
http://benbittrolff.blogspot.com/2008/10/volkswagen-short-squeeze-hedgies.html
We Only Lost 38%!!
You know times are tough when a well run mutual fund that is closing in on the record for the most consecutive years for beating the S&P can boast that it only lost 38% this year. And, yes, that is a bit better than the S&P so far. I doubt this fact is being touted in their advertising materials but it is being touted by Bloomberg. I should note that my daughter's piggy bank is nicely beating the S&P this year, so if any Bloomberg writers are reading this, she does give interviews.
http://www.bloomberg.com/apps/news?pid=20601087&sid=aELpuqQko.Xg&refer=home
Go Figure?
Home prices in 20 major cities tracked by the S&P/Case-Shiller index dropped at a record rate, 18%, in the 12 months to October. All told, down 23% from the 2006 peak and still falling. The combination of tight credit, job losses and foreclosure sales will continue to pressure prices through 2009 and perhaps into 2010. Most predictions I have read by those that seem to be in the know are expecting the housing prices to drop 35-40% in total before all is said and done, so we still have another 12-17% or so to go. At the current pace, that is another 8-12 months before reaching bottom. We will see.
Another record also set today was in the consumer confidence index. Down to 38, which is the lowest since records began in 1967. Seems that people are realizing this recession is going to wear on for a while. There is also a lot of concern about jobs and unemployment, which is to be expected. In a word, it is dismal out there and the holiday retail numbers will reflect just how dismal.
So how does the market react to all this dismal news? Up nicely at the moment. Go figure? I guess some dismal news is already worked into the market at the moment, but we will see during the year-end reporting season coming up just how much. I still expect new market lows next year. The question is, how low?
http://www.bloomberg.com/apps/news?pid=20601087&sid=aquICb64DYOc&refer=home
http://www.bloomberg.com/apps/news?pid=20601087&sid=a1sbaSrZJxO8&refer=home
Rules To Live By
Robert Farrell, a long time analyst at Merrill Lynch (I bet they wish they had him back), developed a number of rules for guiding investment strategy. Some of these, like reversion to mean, I have discussed in some detail here. They are along the lines of my two-plus-two approach. Sooner or later we come out at four. I think these rules are all worth some consideration in these troubling times. The Big Picture recounts the 10 Rules here, with some good comments. Numbers 2, 5 and 8 are particularly worth noting at the moment.
http://bigpicture.typepad.com/comments/2008/08/bob-farrells-10.html
CRA Blame Game
Some people are seeking to blame the Community Reinvestment Act for the subprime crises. Now I know there is a logical and valid debate on whether the CRA has actually achieved its goal of ending a lending practice of redlining, i.e. not lending in poor areas, but to blame it for the current crises is ridiculous. The act itself calls for "sound" business practices and in no way, shape or form required banks to do liar loans, option ARMs, no money down or other junk loans that they were doing. Moreover, the CRA has been on the books for three decades but the current mess has largely been developing for less than a decade. Folks, there are plenty of scapegoats out there for this mess, but I hardly think the CRA qualifies. If anything the impact of the CRA has lessened under the current administration where agencies such as the OTS did little to enforce it.
http://baselinescenario.com/2008/12/16/community-reinvestment-act-housing-crisis-aei/
Here is a nice piece from the Washington Post (the first two of a three part series) on the arm of AIG that took it down, AIG Financial Services. Let me summarize what happened to AIG as best I can: GREED.
http://www.washingtonpost.com/wp-dyn/content/article/2008/12/28/AR2008122801916_pf.html
http://www.washingtonpost.com/wp-dyn/content/article/2008/12/29/AR2008122902670.html?hpid=topnews
Rick Rule Interview
Here is an interesting interview with Rick Rule (hat tip John), someone who knows commodities much better than your's truly. The part I find of interest is his discussion on oil. I noted yesterday I do not see oil prices escalating to any significant degree next year, and I am sticking with that (for now), but his point on where they might be in five years is well worth the read. He points out that a lot of the oil supply today comes from national oil companies, i.e. government owned. The governments running these operations are, generally speaking, running them into the ground. They are stripping the profits for social causes and/or their own use and not properly investing in new production or maintaining operations. This could lead to the destruction of 25% of today's supply in the years ahead. You might also have some tar-sands operations shut down, at least for now, as oil is well below where these operations are profitable. Ramping them back up could take some time. All things considered, $4 a gallon gas could sound rather cheap five years from now.
http://www.growthstockwire.com/interview/20081029_rickrule.asp
Disclosures: None
No comments:
Post a Comment