Saturday, June 30, 2007

China approve bonds sale worth 1.55 tril yuan -Ministry of Finance will use proceeds to buy $200 bil foreign reserve from central bank(People's Bank of China) -Finance Ministry existing outstanding debt is 2.9 tril Yuan, 1.5 tril new issue 50% increase, curbing liquidity -Soaking up 1.5 tirl has the same effect as raising bank reserve requirement ratio 10 times with a magnitude of 0.5% each. -China Development Bank, the lender and the nation's biggest bond seller after the finance ministry, failed to sell 8 bil yuan asset-backed securities auction.

China bank systems vs China state organizations

-People's Bank of China is the central bank, formulating monetary policy and regulating financial institutions, regulating inter-bank lending, administrating foreign exchange and inter-bank foreign exchange market. -regulated under State Council (Guo Weu Yuan) -Bank of China is one of four state-owned commerical banks, Central Bank of China, Farmers Bank of China and Bank of Communications. -After the eruption of the financial crisis in the capitalist countries of Asia in 1997, in order to prevent and eliminate financial risks, the People’s Bank of China established a management system in 1998 to conduct independent management and supervision over the banking, securities and insurance sectors -Ministry of Finance (Cai Zhen Bu), formulating guidelines for the implementation of financial rules of finance corporations. -People organizations -Ministry and Finance and People's bank of Centeral are all directly under State Councile

China Central Bank System vs U.S Fed

When China's top policy makers set out to streamline the country's 57-year-old central bank system six years ago, they chose the U.S. Federal Reserve as a model. The government appointed a six-member board of governors for the People's Bank of China and merged 30 provincial branches into nine regional offices. Similarities mostly end there. The Fed, led by Alan Greenspan, 78, has been independent since the Federal Reserve Act of 1913. The People's Bank, headed by Zhou Xiaochuan, 56, needs the approval of Prime Minister Wen Jiabao and seeks consensus from at least eight government bodies. Investors seeking clues about whether China will raise interest rates again after its surprise October increase may be better off reading tea leaves. As part of the government bureaucracy, the central bank, based in Beijing, can only advise Communist Party leaders, said Huang Yiping, the chief China economist at Citigroup's global markets unit in Hong Kong. "The central bank will not do anything to guide expectations," said Huang. "If it recommends that rates should increase, it doesn't mean they will." While the People's Bank may be gaining clout as China's economy expands, that will not necessarily spell more transparency, said Wei Yen, 53, an analyst at the ratings company Moody's Investors Service in Hong Kong. The bank's lack of independence, coupled with China's collective decision-making system, can make economic moves even harder to anticipate, he said. "There's not a lot of consensus in the bureaucracy and there isn't much clarity until a decision is made," Wei said. A further complication: China has no fixed system to report monthly data such as inflation and trade performance. The People's Bank, for example, gives no warning that it will release information about the country's monetary supply. Each month, usually between the 10th and the 15th, the news is posted on the bank's Web site or carried by state-run media like the Xinhua news service. China started reporting M2, the broadest measure of money supply, in 1998. When the People's Bank got the go-ahead to raise benchmark lending and deposit rates for the first time in nine years on Oct. 28, the news was posted on its Web site at 6:14 p.m. The notice did not say if bank officials had met that day. When the Fed raised the U.S. federal funds rate Dec. 14 for the sixth time since June, it issued a statement immediately after its announced meeting. "China's central bank doesn't have a regular sequence of meetings," said Nicholas Lardy, a senior fellow at the Institute for International Economics in Washington. "Nobody knows weeks in advance if there will be a particular move or when it will be announced." Changes decided by the Fed's open market committee mostly are expected because the U.S. central bank signals markets as a matter of policy, said Huang of Citigroup. By contrast, China's leaders aim to avoid expectations as they try to manage a command economy in transition to free-market capitalism, he said. 'China's economy is still developing and the entire system is under reform," Xiao Geng, an economics professor at the University of Hong Kong, said. "Stability is the objective." Under the People's Bank Law of 1995, national debate about fiscal changes start at the central bank's monetary policy committee, a 13-member consultative group. Only four current central bankers sit on the committee, which meets quarterly, according to the law. Other delegates include the chairmen of the banking, securities and insurance regulators; the National Bureau of Statistics commissioner, the deputy finance minister and the deputy director of the State Development and Reform Commission, China's top state planner. Yu Yongding, who heads an economic policy unit at the Chinese Academy of Social Sciences, is also a member. The committee must submit the outcome of its discussion to China's highest administrative body, the State Council, according to the law. Members include the prime minister, vice ministers and the heads of various ministries. Wen bears responsibility for all policy decisions under Communist Party of China tenets. As China changes, the People's Bank is becoming a more influential voice in the administration, said Victor Shih, a professor of politics at Northwestern University in Evanston, Illinois. The bank's Fed-inspired makeover in 1999 was designed to sideline powerful provincial authorities, Shih says. The central bank also has become more communicative under the governor, Zhou, adding detail to its quarterly reports on money supply, interest rates and treasuries, Jonathan Anderson, the chief Asia-Pacific economist at UBS in Hong Kong, said. Governors now speak more openly about possible policy changes, he said. The signals are not always clear. The People's Bank deputy governor, Li Ruogu, said in the state-run Financial News newspaper Dec. 28 that China needed more time to evaluate the effect of interest-rate increases before deciding on any further moves. Seven days later, Zhou said the central bank should "fully take advantage" of interest rates to cap M2 growth at 15 percent this year, according to a statement posted on the bank's Web site. Zhou declined to be interviewed for this article. "A lot of what they're thinking about right now is how to telegraph to the market that everything is under control," said Marshall Mays, a director of Emerging Alpha Asset Management in Hong Kong.

Management of China's foreign reserve

-now $1.2 tril, will be $2.9 tril by 2010 -set up a state-owned investment agency -reserve now controled by SAFE, spevcial invsetment arm of central bank -the formation of a new agency breaks with the tradition dating from the birth of SAFA in 2003 when government went along with a central bank plan to infuse foreign cash into state-owned banks. The idea was to restructure poorly managed banks stuck in a muddy mess of non-performing loans. For example, SAFE Investments pumped US $22.5 billion each into the faltering Bank of China (BOC) and the China Construction Bank (CCB). The money came from a pool of US $60 billion it received from the central bank. The bailouts of state-owned commercial banks such as Bank of China, China Construction Bank and the Industrial and Commercial Bank also caused confusion. Later, SAFE Investments promised to stay clear of “commercial operations.” -Alternatives to setting up an investment agency including bailing out industries, stock strategic resources, reform health care and boost pension funds. -SAFE investment system followed Singpore's government investmnet company Temasek, but lacking the standards written in a charter -SAFE investment system lack regulation -If SAFE Investments survives, it will probably have to cut ties with the central bank. The bank, in turn, is expected to sell some foreign reserves to the finance ministry on behalf of the new agency. The ministry would raise capital for the purchase by issuing bonds, thus resolving controversies over foreign-reserve ownership and distancing the central bank from the new entity.

China Lawmakers Approve Interest Tax Cut, Bond Plans

-Central bank will sell $200 bond to government bond investors, including financial institutions -Elimnatining or cutting interest income taxes, introduced in 1999 by NPC to encourage consumption, will raise the real interest rate on deposits, shfiting money from overheated stock market. -now 1y deposite rate is 3.07%, lower than 3.4% inflation rate. -two more rates hikes of 27 bps each are expected if real interest tax is cut to 10%.

Friday, June 29, 2007

Economic Demand Side Analysis

Consumer less vulnerable -show hints of ciscipline -FR's household financial obligation ratio (FOR) mover lower in 1Q 2007 -Ratio of total household debt to personal disposable income (PDI) lower in 1Q 2007 -strong real income gains related to the job market are buoying consumer spending growth -however, consumers remain over levered Corporations more vulnerable - move in opposite direction -Debt-to-EBITDA and EBITDA-to-interest weakened -combined with sharply slower profit growth, increasing LBO and shareholder friendly management initiatives, rich valuations, and weakening credit metrics, the recent sharp rise in corporate debt growth argue that risks to credit fundamentals and market returns are skewed to the downside going forward.

When to trade borker-dealer credits

The best time to go long risk with respect to brokers in the last five years has been when spreads gap out on market fears. The trade worked earlier this yeasr: it worked when GM was downgraded, and it worke most reently when spreads gapped out due to fears of inflation. Will it work again this time when subprime market suffers(BSC hedge funds stumble).

subprime market is not just BSC problem, banks will suffer

Subprime is a WS issue -Ordinarily, WS would not shed tears if BSC is in trouble, they would pounce on its weakness. But much of WS is elbow-deep in the sme trouble securities, created by the height of mortgage boom. Now it is back to bite them. Last years, WS churned out around $550 bil so-called CDOs and they are hold some of them in their own balance sheet. -CIBC and Parbas all take a shock from the issues risks -CDOs are illiquid securities. Current accounting rule allow firms to peg CDOs at the price they paid for them. A shotgun sale of these securities will provide a true pricing for these securities. But no one dares to reprice it. -Another risk is that rating agency might downgrade these CDOs, marking down the value of CDOs. -the wild card is institutional investors, pension and hedge funds. If they rush for exist, they will create a downward spiral. -housing market might contribute to the downgrade of CDOs. According to Phoneix, houses enter foreclosures at a rate of more than 50 a day, up 60% than last year. The faster foreclsures rise, the more likely CDOs backed by these secs will be downgraded. Implication of CDOs meltdown -concerns are growing that subprime issue will spill over to junk bonds and leverage loans, draining leverage buyout deals and napping at WS banks profit.

Market review.... 06 29 2007

-Dow dropped a little bit, falling 13.66 to 13408 -concern about subprime market issue resurfaced -quarter-ending portfolio rebalance pushed down equity market and lifted bonds market -oil rose 1.1 to 70.68 a barrel -investors may want t olock in profits before the end of the quarter

Themes of second half 2007

New supply will be primary focus -given recent headline of the investors' pushback of leveraged loans, such as U.S Foodservcie, and loans with loose proections, it is helpful to view how investors confidence impact the demand for new issue supply Fed is on hold through year-end -Eco growth is slowing down, 0.8% in 1Q 2007 and 0.7% in 2Q and subprime has not spreaded into broader economy -Inflation is under contrain -No reason to cut interest rate soon Corp profit growth continues to slow -U.S. corp profit growth slowed sharply as highlighted by the deceleration of Y-o-Y growth from 18% in the fourth quarter to 6.5% in 1Q 2007. -But strong oversea profit growth and highe energy prices might offset profit weakness for big companies Housing weakness continue, consumer -2Y High mortgage rate (6.8%) -Rising deliquency rate in subprime (15%) and Alt-A(4%) -$500 mil subprime mortage need to be refinanced this year because their ARM terms expire -Housing bubble has accumulated for years given the magnitude of appreciation in real estate market. It will take a while to unwind the market bubble Global growth remains strong but hint of slowing by year-end -recent interest rate spikes along with slowing U.S. demand will cool foreign market Negative Credit Quality Events, Trends Continue, But No Credit Crunch Yet -with real borrowing cost still cheap historically, an abundance of debt capital still available, management will continue to pursure shareholder friendly initiatives that will leverage company BS. -Resistence from credit markets to blindly fund increasing corp borrowing will impose a discipline Credit derivatives growth slows, long only Investors re-emerg as a force -Rebounding profit growth and financial policy discipline following the credit marekt debt binge and implosion over the period 1998 through 2002 produced dramatic balance sheet deleveraging and restructuring that drove a nealy five-year bull market for crdit product. -the absence of new corproate debt to meet growing demand, U.S and global especially hedge funds, led to the use of credit derivatives to create synthetic corporate credit products.

investment banking business lines introduction

The main activities and units

The primary function of an investment bank is buying and selling products both on behalf of the bank's clients and also for the bank itself. Banks undertake risk through proprietary trading, done by a special set of traders who do not interface with clients and through Principal Risk, risk undertaken by a trader after he or she buys or sells a product to a client and does not hedge his or her total exposure. Banks seek to maximize profitability for a given amount of risk on their balance sheet[citation needed]. An investment bank is split into the so-called Front Office, Middle Office and Back Office. The individual activities are described below:

Front Office Investment Banking is the traditional aspect of investment banks which involves helping customers raise funds in the Capital Markets and advising on mergers and acquisitions. Investment bankers prepare idea pitches that they bring to meetings with their clients, with the expectation that their effort will be rewarded with a mandate when the client is ready to undertake a transaction. Once mandated, an investment bank is responsible for preparing all materials necessary for the transaction as well as the execution of the deal, which may involve subscribing investors to a security issuance, coordinating with bidders, or negotiating with a merger target. Other terms for the Investment Banking Division include Mergers & Acquisitions (M&A) and Corporate Finance (often pronounced "corpfin").

Investment management is the professional management of various securities (shares, bonds etc) and other assets (e.g. real estate), to meet specified investment goals for the benefit of the investors. Investors may be institutions (insurance companies, pension funds, corporations etc.) or private investors (both directly via investment contracts and more commonly via collective investment schemes eg. mutual funds) .

Financial Markets is split into four key divisions: Sales, Trading, Research and Structuring. Sales and Trading is often the most profitable area of an investment bank[citation needed], responsible for the majority of revenue of most investment banks[citation needed]. In the process of market making, traders will buy and sell financial products with the goal of making an incremental amount of money on each trade. Sales is the term for the investment banks sales force, whose primary job is to call on institutional and high-net-worth investors to suggest trading ideas (on caveat emptor basis) and take orders. Sales desks then communicate their clients' orders to the appropriate trading desks, who can price and execute trades, or structure new products that fit a specific need.

Research is the division which reviews companies and writes reports about their prospects, often with "buy" or "sell" ratings. While the research division generates no revenue, its resources are used to assist traders in trading, the sales force in suggesting ideas to customers, and investment bankers by covering their clients. In recent years the relationship between investment banking and research has become highly regulated, reducing its importance to the investment bank.

Structuring has been a relatively recent division as derivatives have come into play, with highly technical and numerate employees working on creating complex structured products which typically offer much greater margins and returns than underlying cash securities.

Middle Office Risk Management involves analysing the market and credit risk that traders are taking onto the balance sheet in conducting their daily trades, and setting limits on the amount of capital that they are able to trade in order to prevent 'bad' trades having a detrimental effect to a desk overall. Another key Middle Office role is to ensure that the above mentioned economic risks are captured accurately (as per agreement of commercial terms with the counterparty) correctly (as per standardised booking models in the most appropriate systems) and on time (typically within 30 minutes of trade execution). In recent years the risk of errors has become known as "operational risk" and the assurance Middle Offices provide now include measures to address this risk. When this assurance is not in place, market and credit risk analysis can be unreliable and open to deliberate manipulation.

Back Office Operations involves data-checking trades that have been conducted, ensuring that they are not erroneous, and transacting the required transfers. While it provides the greatest job security[citation needed] of the divisions within an investment bank, it is a critical part of the bank that involves managing the financial information of the bank and ensures efficient capital markets through the financial reporting function. The staff in these areas are often highly qualified[citation needed] and need to understand in depth the deals and transactions that occur across all the divisions of the bank. [1].

Technology Every major investment bank has considerable amounts of in-house software, created by the Technology team, who are also responsible for Computer and Telecommunications-based support. Technology has changed considerably in the last few years as more sales and trading desks are using electronic trading platforms. These platforms can serve as auto-executed hedging to complex model driven algorithms...

What do prime brokers service? Prime brokerage: generic term for bundled servcies by investment banks to hedge funds including custoday- clearing sec lending financing operational support - contact other brokers As hedge funds have proliferated globally through the 1990s and the current decade, prime brokerage has become an increasingly competitive field and an important contributor to the overall profitability of the investment banking business. As of 2006, the most successful investment banks each report over two billion dollars in annual revenue directly attributed to their prime brokerage operations (source: 2006 annual reports of Morgan Stanley and Goldman Sachs). Let's look at the GS prime brokerage.... It is classified into securities services Securities Services provides prime brokerage services, financing services and securities lending services to institutional clients, including hedge funds, mutual funds, pension funds and foundations, and to high-net-worth individuals worldwide, and generates revenues primarily in the form of interest rate spreads or fees. Business Segments The primary products and activities of our business segments are set forth in the following chart: Business Segment/Component Primary Products and Activities 1.Investment Banking: a.Financial Advisory • Mergers and acquisitions advisory services • Financial restructuring advisory services b.Underwriting • Equity and debt underwriting 2.Trading and Principal Investments: a.Fixed Income, Currency and Commodities • Commodities and commodity derivatives, including power generation activities • Credit products, including trading and investing in credit derivatives, investment-grade corporate securities, high-yield securities, bank and secured loans, municipal securities, emerging market and distressed debt, public and private equity securities and real estate • Currencies and currency derivatives • Interest rate products, including interest rate derivatives, global government securities and money market instruments, including matched book positions • Mortgage-related securities and loan products and other asset-backed instruments b.Equities • Equity securities and derivatives • Securities, futures and options clearing services • Specialist and market-making activities in equity securities and options • Insurance activities c.Principal Investments • Principal investments in connection with merchant banking activities • Investment in the convertible preferred stock of Sumitomo Mitsui Financial Group, Inc. • Investment in the ordinary shares of Industrial and Commercial Bank of China Limited 3.Asset Management and Securities Services: a.Asset Management • Asset management, advisory services and investment products (primarily through separate accounts and funds) across all major asset classes, including money markets, fixed income, equities and alternative investments (including hedge funds, private equity, real estate, currencies, commodities and asset allocation strategies), for institutional and individual investors (including high-net-worth clients, as well as retail clients through third-party channels) • Management of merchant banking funds b.Securities Services • Prime brokerage • Financing services • Securities lending

Goldman Sachs loses Asia Prime Borkerage Share

According to AsiaHedge magazine -MS overtook GS becoming No. 1 in term of share of Asia-Pacific prime brokerage market -GS share drop from 44% to 25%, MS increased 27% to 28%, UBS 7.2% -All increased their share of hedge funds asssets -Prime brokers earn some of their revenue from lending securitities to fund managers who then sell them, betting thy can buy them back at a profit - known as short selling.

Thursday, June 28, 2007

What is leverage buyout

The acquisition of another company using a significant amount of borrowed money (bonds or loans) to meet the cost of acquisition. Often, the assets of the company being acquired are used as collateral for the loans in addition to the assets of the acquiring company. The purpose of leveraged buyouts is to allow companies to make large acquisitions without having to commit a lot of capital. In an LBO, there is usually a ratio of 90% debt to 10% equity. Because of this high debt/equity ratio, the bonds usually are not investment grade and are referred to as junk bonds. Leveraged buyouts have had a notorious history, especially in the 1980s when several prominent buyouts led to the eventual bankruptcy of the acquired companies. This was mainly due to the fact that the leverage ratio was nearly 100% and the interest payments were so large that the company's operating cash flows were unable to meet the obligation.

Fed leave policy rate unchanged at 5.25%

-Fed only have two options now, leaving rate unchanged or lowering interest rate -inflation moderate, core inflation dropped from 2.4% in Feb to 2% in April. -subprime issue has not spreaded into broader economy, and subprime potential victims (around 30 million) only represent a small portion of whole population (400 mil). No season to put the interest of minority in front of that of majority -Economy is still doing ok, thought GDP is low -No reason to lower interest

Money Market funds vs ETF

Money Market Funds -a type of mutual funds investing in low-risk securities -usually treasuries, CD, and CP -total net assets $2.5 trillion ETF -fee-based accounts, annual fee fixed or based on assets -pegged to sales commissions asset or -liquidity is a concern, as one fund blow up, the whole industry will take a shock so everyone runs for exists. -ETF represents a significant portion of total trading volume on stock exchanges - 14% of the total activity -Bond ETF is also available, such as iShare from Barclays

Banks in 3Q forecast

-Banks will suffer in the second half of the year -Growth in retail-banking operation slow, household debt growth moved down based on Financial obligation ratio -Investment banking (underwriting) will take a hit due to bridge loans

WS Banks on Bridge loans

WS banks spent the past year relying on robust capital markets to offset losss in retail-banking operations. Now the revenue stream is going to dry up.

A sudden retrenchment in debt market is likely to nip at profits at the big banks that have been financing the leverage-buyout boom.

J.P. Morgan Chase & Co, Citigroup Inc. and Bank of Amrica Corp are the biggest players in the leveraged-loan business.

In the U.S., so-called covenant-lite deals accounted for about 26% of first quarter deals vs 4.6%in European leveraged-loan issues. The pace began to increase sharply in Europe in March.

Also, banks have provided $33.38 bil in bridge loans to leveraged-buyout deals, more than double last year's $12.87 billion.

Banks usually do not reveal details on revenue or fess from leverage loans.

China Plans Bonds for New Agency

BEIJING -- China plans to capitalize its new foreign-exchange-investment agency by issuing a local-currency bond valued at more than $200 billion, clearing a key hurdle for the sovereign-investment fund that will be formally established in coming months. China's Finance Ministry plans to issue 1.55 trillion yuan ($203.5 billion) in tradable bonds with maturities of at least 10 years in order to buy about $200 billion in foreign exchange, the official Xinhua news agency said. The Standing Committee of the National People's Congress began reviewing the proposal yesterday and is likely to approve the plan this week. Economists have said the massive bond issue will boost liquidity in long-term government bonds and build a better yield curve for traders to price debt, helping the country develop its nascent bond market. The new bonds could also serve another useful purpose for China -- draining liquidity from a financial system awash with funds.

Wednesday, June 27, 2007

The Fed Takes Subprime Woes in Stride Fed will leave the Fed rate intact at 5.25% Putting the Majority First By cutting short-term rates now, the Fed would run the risk of causing the financial markets to get frothy and the real economy to overheat. When the economy grows too quickly, demand exceeds supply and inflation sets in. That's intolerable to the Fed, whose main job is to keep the economy growing at a healthy pace with minimal inflation. Put it this way: The U.S. has a population of a little over 300 million. By comparison, there are a little under 10 million outstanding subprime loans, of which a little over 20% are delinquent or foreclosed on. Assuming typical household sizes, that's around 5.4 million people affected, calculates analyst Michael Youngblood of FBR Investment Management. By leaving interest rates where they are, the Fed is implicitly putting the interests of the majority ahead of the interests of the minority. Ironically, the best hope for subprime borrowers would be for the troubles in the subprime world to spread to the rest of the economy. A problem that became widespread and systemic would most likely jolt the Fed into cutting rates, helping relieve the pressure on subprime borrowers as well as on the rest of the economy. So far, though, there has been relatively little contagion from the subprime mess. On the whole, though, the U.S. economy seems to be rebounding from a weak first quarter, when growth was below a 1% annual rate. Action Economics is looking for gross domestic product in the June quarter, which is just ending, to rebound to a healthy 3.5% annual rate. Are people cutting back on borrowing—a classic sign of a credit crunch? Companies certainly aren't. Rotenberg and Yechiely note that corporate borrowing "has reached levels not seen since the late 1990s." Numbers that look frightening on the individual level seem less significant in the context of a U.S. economy that generates $10 trillion in personal income annually, which is what the Fed keeps its eye on. In a June 27 note, economist Edward Yardeni of Yardeni Research said that even if you buy Bank of America's (BAC) forecast that $500 billion worth of adjustable-rate mortgages are scheduled to reset this year by an average of 2 percentage points, that comes to only an extra $10 billion to $15 billion in interest payments. That's a tenth or so of 1% of total personal income. Yardeni's reaction was to quote the title of a classic Peggy Lee song: "Is that all there is?"

The housing mirage Like a mirage in the desert, the bottom of a housing slump seems to fade in and out of sight as the year progresses. Home sales jump, and there - you think you can make it out in the distance. Home sales fall, and it is lost in the haze. Spirits had been higher in April, when sales of new homes jumped 13%, as builders whittled away at huge inventories with aggressive pricing. The median price of a new home dropped 11% in April from the previous month, to $229,100, the biggest decline since 1970. In the last week of June, at the very end of what are traditionally the strongest three months for home sales, we learned that both existing- and new-home sales remained sluggish in May. On June 25, the National Association of Realtors said the rate of existing-home sales slipped 0.3% in May, to an annual pace of 5.99 million units, while supply climbed to 8.7 months, the highest reading since June, 1992. The next day, the U.S. Census Bureau said sales of new single-family homes fell 1.6% in May, to a seasonally-adjusted annual rate of 915,000 units. New-home supply edged up to 7.1 months from 7 months in April. The May home sales news, combined with homebuilder Lennar's (LEN) weaker-than-expected earnings announcement on May 26, dashed any remaining hopes of an imminent end to troubles in the housing market.

Bonds becoming a tougher sale Underwiters pull a $1.55 bi bondd offering by U.S. Foodservice, the nation second largest food distributor. When buyout firms stirke arranged financing with their bankders, they demand include terms the demand the underwriters provide "bridge" finanncing if a deal can not be sold to debt investors. -- Wall Streets will suffer from bridge loans. Also investors have rejected such as provisions as "payment in kind" which allow companies to put off debt payments to lenders (investors) if they run short of cash. If the latest stumblers worsen, they could make it harder for deals to get done at a time whne a mountain of borrowing is planned.

Tuesday, June 26, 2007

Behind Buyout Surge, A Debt Market Booms The corporate buyout boom of the 1980s was funded in large part by high-yield "junk" bonds. This time around, another financial product is supplying much of the fuel -- collateralized loan obligations. CLOs, as they're called, are giant pools of bank loans bundled together by Wall Street and sold off to investors in slices. They aim to spread default risk an inch deep and a mile wide. Last year, more than half of the loans behind the record wave of buyouts were parceled out to investors as CLOs, bankers say. As corporate borrowing soars, however, concerns are growing that CLOs have made it too easy for shaky or debt-laden companies to borrow money. If economic conditions deteriorate, those loans could sour and investors in the riskiest CLO slices could face large losses. That, in turn, could make it harder for buyout firms to borrow money. An index tied to non-investment-grade corporate loans fell all last week, according to Markit Group, its administrator. The index, LCDX, was launched one month ago and reached its lowest point yesterday. In late April, a Bank of England report noted parallels between the markets for subprime mortgages and for poorly rated corporate credit, heightening concern about the CLO market. CLOs are a form of collateralized debt obligation, or CDO. Besides corporate loans, CDOs often hold mortgage bonds and junk bonds. Borrowing by corporations has soared in recent years, and CLOs have played a big part. Since 2004, more than $210 billion of loans have been packaged into CLOs, up from $51 billion over the prior four years, according to data provider Dealogic. Investors searching for higher yields have put so much money into CLOs that even weak companies can get loans at relatively low interest rates. Last winter, for example, ailing Ford Motor Co. was able to borrow $23 billion in a matter of days, $5 billion more than it earlier planned. If loans in such pools go bad, the losses are initially borne by investors holding so-called first-loss tranches, which carry no credit ratings. Modest changes in loan defaults or even changes in market perceptions can lead to big swings in the value and yields of these securities. In exchange for bearing that risk, those investors stand to earn higher returns. Over the past two years, those tranches have returned more than 20% annually, according to Moody's Investors Service. Risk-averse investors can buy the more secure pieces, which carry investment-grade ratings, many of them comparable to the top ratings of U.S. Treasurys. Consequently, the yields on those slices are lower. These days, banks that arrange large buyout financings hold on to very little of the loans themselves. Bank underwriting standards have slipped as banks have become mere intermediaries, some executives at buyout firms contend. Banks enable and encourage private-equity firms to load up their companies with debt, these executives say. Most of the loan pieces ranged in size from $500,000 to $4 million. The CLO bought a portion of $1.8 billion in loans to Nasdaq Stock Market Inc., which the stock exchange had used to acquire a minority stake in London Stock Exchange Group PLC last year. It also bought pieces of loans that financed the buyouts of Neiman Marcus Group Inc., HCA Inc., Sungard Data Systems Inc. and Petco Animal Supplies Inc. Nearly all of the loans carry credit ratings that are below investment-grade, or "junk." The CLOs offered floating interest rates, which meant they would yield more if interest rates rose. CLOs have been lauded by former Federal Reserve chairman Alan Greenspan and others for dispersing risk. Michael Milken, whose underwriting of junk bonds at Drexel Burnham Lambert Inc. during the 1980s ignited that decade's buyout boom, has said that CLOs are among the most important financial innovations of the past quarter century. Over the past few years, buyout deals have been getting larger and larger, and companies have been piling on more debt in relation to the cash they generate. That leaves them especially vulnerable to rising interest rates and a slowdown in economic growth. The buyout of Univision Communications Inc. by a consortium of investors earlier this year, for example, left the broadcast company with a debt level of 12 times its annual cash flow, twice the norm in buyouts done over the past two years, according to Standard & Poor's. It's possible that even a small increase in defaults could have a big impact on CLOs, especially on the first-loss tranches. If investor appetite for these risky pieces diminishes, it could become harder for new CLOs to be issued, potentially choking off the buyout boom.

Monday, June 25, 2007

current housing market status ... 06 25 2007

In the day's major economic release, the National Association of Realtors said home resales fell 0.3% in May from April's pace. The median home price was $223,700, down 2.1% from a year ago; the inventory of homes for sale rose to a 15-year high. The news was hardly a shock to Wall Street, which long ago became inured to bad housing numbers.

Analysis of banks' income statements

Generally, operating profit before provisions, taxes and extraordinary items better reflect underlying profitability. Loan loss provisions are a financial outflow, although a non-cash expense. They are listed seperately from non-interest expense. Specific loan loss provisioning General loan loss provisioning Provisioning - income statement item Provision - cumulative, BS item Fundling liabilities can be broadly divided into customer deposits and purchased funds. Custoemr deposits reprsent retail deposits, while purchased funds are made up of commercial deposits(often in the form of large denomination certificates of deposit), and interbank and other borrowings.

Sunday, June 24, 2007

Wall Street Fears Bear Stearns Is Tip of an Iceberg When problems bubble up, the high-yielding securities are the first to falter. Hedge funds, insurances, even some big banks involved in buying subprime mortgages may have snapped up these bonds and could be at risk. Among the first of the big holders of these type securities are BSC. If problems in the mortgage industry worsen, high quality securities could suffer, as well, affecting more investors and drying up liquidity in the housing market. Many hedge funds and other institutions are paid in part on performance, so it is often in their interest to price, or "mark," their assets aggressively, attaching the highest possible value to them. The higher the value, the more compensation the fund manager receives from the fund's investors. Moreover, hedge funds typically don't keep investors abreast of the details of day-to-day trading. As a result, any losses the funds suffer may be significant by the time investors learn of them. That can be especially true for illiquid assets, which may not show much price movement for months and then dip sharply when confronted with the one-two punch of declining fundamentals and nervous investors. ... Still, the increase in illiquid investments raises concerns. For one thing, even in liquid securities like stocks, what can seem like a ready supply of cash can dry up quickly if investors get spooked. Those problems are heightened when leverage is used. Even if a fund plans to invest in an illiquid asset for the long haul, creditors can force its hand. If a leveraged investment racks up losses, the fund's lenders may demand more collateral, or even repayment of their loans. To meet those demands, the fund, whose losses are already magnified by leverage, could be forced to sell the investment well before the market recovers, adding to its burden. Figuring out the risk profile of illiquid assets -- and funds that invest in them -- can be tricky. Typical methods for assessing risk rely on measuring volatility -- the choppier returns are, the riskier the investment. But because illiquid assets don't trade regularly, marking to market -- or using recent sales prices to determine an asset's value -- may not be possible. In these cases, a fund manager may instead use a mathematical model to value an asset, a practice called marking to model. Such models tend to smooth returns, making an asset look much less risky, says Massachusetts Institute of Technology finance professor Andrew Lo, who is also a principal in AlphaSimplex Group LLC, an asset-management company that runs a hedge fund. Using broker-dealer quotes for illiquid assets can also damp volatility because they are often based on an average of bid and offer prices rather than actual sales prices. What's more, price quotes can vary widely from one dealer to the next. The Bear Stearns funds' situation demonstrates the considerable leeway funds have in valuing illiquid assets. The Enhanced Leverage Fund reported last month that it lost 6.75% of its value in April, but later put that loss at a far steeper 18%. CDS banks, hedge funds, and insurance companies have taken both sides of this trade. e.g BSC sustained losses, while Deustsche Bank and hedge funds such as Paulson & Co. and Balestra Capital have benefited by betting on higher defaults.

Analyze the individual banks first or the banking system as a whole?

The analyst confronts something akin to the chicken-and-egg problem. Since individual banks must be viewed in context, the banking system requires early attention. But the system or sector as a whole cannot be fully understood without knowledge about the problems and prospects of specific banks. In practice, gaining that understanding is an interative process. The analyst might begin with research into the structure of the system as a whole for background purposes. This might be followeed by a review of the major commercial banks. Then the analyst may return to a more "macro" perspective, preparing an analysis of the entire sector.

Bank Capacity to repay

cash flow: critical to debt repayment capacity liquidity: immediate access to cash or cash equivalents to fulfill current obligations. capital: reprsent owners' residual claims on a corporation's assets. collateral: assets pledged to the lender in case of default Traditional credit analysis: analyze collateral assets first Current approach: start with cash flow analysis and an evaluation of financial condition of the borrower. Elements of bank credit analysis Earnings capacity: ability to generate revenue and overcome difficulties Liquidity: bank's access to cash or cash equivalent Capital adequacy: caushion against its liabilities to depositors and creditors Asset quality: the likilihood that loans will be repaid. FI analyst: credit analyst + recommendations

Center of a Storm: How CDOs Work

Center of a Storm: How CDOs Work Mortgages are among the most widespread and simple forms of financing. How did a bunch of home loans caused the crisis that has gripped Wall Street for more than a week? Two BSC hedge funds bet heavily in complext financial instruments known as CDO, which performed poor when home-loan borrowers defaulted in record numbers. But fund's problem quickly developed into a broader market issue. Fear grew that other investors could suffer, causing a ripple that could crimp lending and curtail the flow of borrowed money that has fueled rallies in a variety of financial markets. What exactly are CDOs, the structures at the root of the angst. They are financial vehicles that bundle different kinds of debt -- ranging from corporate bonds, to securities underpinned by mortgages, to debt backed by money owed on credit cards -- and cut it into slices. These slices are sold to investors in the form of bonds. While the slices contain the same debt, they differ in terms of which pay the most interest and which are least at risk of losing money. Slices that pay lesser amounts of interest are the last to get wiped out by losses if there are defaults in the debt pooled in the CDO. Slices that pay more feel pain more quickly. In other words, the CDO slice with the lowest yield is at the front of the line on payday, but at the back of the line when pink slips are handed out. At the same time, CDOs use borrowed money to amplify returns. Fans argue that CDOs allow investors to buy into higher-yielding securities while taking on the same risk as they would with safe, lower-yielding securities. They also say that CDOs are another tool that allow financial markets to further spread risk so it isn't concentrated in the hands of a few players. But some investors think CDOs are an example of financial engineering gone haywire. CDOs are "more sleight of hand" than a sound way to generate diversified returns, said Brad Alford, founder of Alpha Capital Management, an Atlanta-based investment advisory firm that caters to wealthy families. "They're a method for Wall Street to repackage securities as a way to make more money." Indeed, Wall Street has made millions of dollars in fees in recent years by creating CDOs, selling them, servicing them and helping investors trade them. The vehicles are generally used by institutional investors, such as pension funds or hedge funds, not individual investors. CDOs have generated debate because they are complex, and pose a risk because they are several steps removed from the actual asset, or debt, that is being packaged. Consider a mortgage. Jane Sixpack borrows $100,000 from a bank to buy a house. The bank then pools Jane's loan with thousands of other mortgages. It then issues securities backed by this pool and sells those to investors. Jane keeps making her payments to the bank, but her mortgage is now owned by investors. An investment bank creates a CDO, which is really just a company. The CDO then buys some mortgage-backed securities, one of which holds Jane's loan. The CDO then pools these with other mortgage-backed securities and maybe some corporate bonds, slicing them up based on investor preferences for yield versus risk. The CDO manager sells portions of the package to other investors. In some cases, other CDOs are the buyers. There are even CDOs comprised of CDOs that have invested in CDOs. The bundling of different debts, along with the fact that the CDOs are a few steps removed from the debts they include, give rise to another risk. It's tough to get an accurate price for CDOs, which don't trade in active markets. When markets sour, the lack of available prices can make it even more difficult to value a holding, or to get out of it without taking a big haircut. So investors often have to estimate the value of a CDO and have a lot of leeway in how they do it. That's a worry for investors in hedge funds, big buyers of CDOs. Hedge-fund managers make most of their money through performance fees. This gives them added incentive to use price estimates that work in their favor, even if they might not reflect the price at which they could actually trade the CDO. Or it could mean that the managers themselves don't know exactly what their holdings are worth, because they are so far removed from the underlying investment. In the case of Jane's loan, that means the CDO buyer will have a tough time gauging whether she's a good risk or not. And if she defaults, it may take a while before that affects the value of the CDO, even though market conditions overall might have already changed.

Saturday, June 23, 2007

Bear Stearns Bails Out Fund With Big Loan

Bear Stearns Bails Out Fund With Big Loan?mod=hpp_us_pageone Quo Status of the crisis Bear Stearns Cos.'s dramatic decision to lend as much as $3.2 billion to one of its two troubled hedge funds staves off the risk of a fund collapse that could have damaged its position as a major Wall Street bond player -- and had the potential to ripple through a jittery subprime-mortgage market. The events have kept Wall Street riveted for two weeks because a lot of firms are deeply invested in the subprime sector -- which caters to borrowers with weak credit, and which has suffered in the housing downturn as delinquent loans have spiked. The firm, whose move helps preserve its reputation, eventually might even make some money from the struggling investments. Even if Bear is able to salvage one of its funds, the crisis is a black eye for the brokerage house, a rough-around-the-edges firm run by 73-year-old James Cayne. It may also end up being a financially costly gambit for the firm, whose performance is already feeling the pinch of the subprime woes. Prior to yesterday, Bear's financial exposure to the funds was largely limited to $40 million invested by the firm and its executives. Yesterday, Bear described the move as a responsible one for the market. "We're trying to deal with this problem in as forthright a way as we possibly can," Market insghts The clash provides a case study on the challenges that some big hedge funds face in navigating a world full of complicated financial instruments. Over the past decade or so, financial markets have grown substantially and have spread globally, leading to sophisticated and complex ways to place bets, often with large amounts of leverage. The past several years have been noteworthy because there hasn't been a major system-shaking financial problem, but with that has come a worry -- among regulators, scholars, central bankers and others -- that has led an ever-increasing appetite for risk that is bound to end badly for someone. So far, none of the hiccups has had a system-rattling effect: No major institution has collapsed, stock and bond markets have been buoyant. But each new episode renews worries that it will be the one to have ripple effects. The Enhanced Leverage fund's losses were magnified by the significant amount of borrowing it used to finance its trades. As of Jan. 31, it had $699 million in investor capital, but had over $12 billion in investments. A month later, its investor capital had dropped to $667 million, but its bets on the market had increased to $15 billion, according to documents reviewed by the Journal. With the funds' standing deteriorating, Bear also saw an opportunity: come in with a larger loan to prevent a fire sale of their assets. Such a move could help stabilize the assets' perceived value and prevent widespread markdowns of similar securities that would hurt Bear and others. Mr. Spector worked the phones Thursday afternoon, reaching out to various CEOs and senior Wall Street executives, according to a person familiar with the matter. The upshot: save the less leveraged fund that had better-quality assets and let the other fund collapse.

Thursday, June 21, 2007

ML backed away from a threat to dump BSC Hedge Fund collateral

ML backed away from a threat to dump $850 mil collateral. Inside news indicated that BSC might take over $3.2 bil of loans that banks and securities firms made to one of the hedge funds to prevent creditors from seizing more assets. My thought: Few investors are interested and are willing to pay at highly discounted price. So ML backed away and decide to reach a deal with BSC Balckstone raised $41.3 bil through IPO.

Bear's Woes Test Markets' Mettle

The near-collapse of two big Bear Stearns Cos. hedge funds marks an important test of the financial markets' resiliency. Stocks and bonds fell broadly yesterday as word spread that several investment banks were having trouble finding buyers for subprime mortgage securities they pulled out of the teetering hedge funds at the Wall Street firm. Meantime, market indexes that track the mortgage and corporate debt market fell as investors saw their risk rising. Securities and Exchange Commission Chairman Christopher Cox said the agency was tracking Bear developments, but didn't see systemic problems. Still, if recent history is any guide, the stock and bond markets might be expected to bounce back quickly. In just the past few years, the markets have been tested by turmoil in the automobile sector, rising global interest rates, a weakening dollar and the housing slowdown. They quickly bounced back after brief spasms of risk-aversion in every case. The last bout of jitters was just this past February, when problems in the subprime mortgage sector sparked brief selling. Ample amounts of cash in the hands of investors -- something investment pros call liquidity -- and a growing confidence in the market's resilience, have helped them to overcome worries. But some investors wonder if this case could be different.

Wednesday, June 20, 2007

LSE is in talk to merge with Italian Stock Exchange operator Borse Italiana

-combined vlaue will be $5.4 bil -30% in LSE held by Nasdaq, who might say no to the deal -Another hedge fund might blow off the deal, taken over not taking over -

MS 2Q earning commentary

-Theme diversification does matter 60% exposure to U.S and 50% revenue exposure to FI -Revenue related sell and trading FI securities increasd. drivers: Interest rate and currency trades. -Growth across all business lines except Discover. Revenue at Discover division dropped, company will spin off the division next week. 10% revenue. more like other four brokers.

Tuesday, June 19, 2007

BSC may shut down two hedge funds soon... 06 19 2007

Yesterday, BSC hedge fund came up with a rescue plan to inject new loans $1.6 billion from BSC and new equities capital worth of $500 mil from existing creditors, includign Citigroup and Barclays. You might think ML would hold its auction of seized BSC hedge fund collateral and the two funds might surve. But later today, ML decided to proceed with its auction, even more than originally planned, increasing from $400 to $850/800 mil, representing the entire collateral. The securites are mostly backed by mortgage and home loans, rated AAA and AA. The resuce plan included stiff requirements that creditors cannot initiate margin call in a 12-month period. That might prompt creditors like ML to cash out soon. The failure of the bailout plan might move two hedge funds to the brink of closing down, causing a wide-range consequences in the market. Implications -BSC suffer little tangible loss, but credit migh be destroyed -chill effect to the industry, UBS Dillon hege fund -ripple effct. BSC might come up with anothe bailout plan because the asset sales might cause the firm to revalue their own investments and those of other funds they lend to. Questions -why loan not equity from BSC Other: Two funds have swooned in recent weeks amid weakness in the market for subprime mortgages.

facts about BSC

1.used to be the largest under of Mortgage backed securities, surpassed by Leh Man this year 2.the largest broker for U.S hedge funds

why weaker banks would not fail?

While the free market theory of letting weaker firms to fail is generally sound, the special character of banks makes them an exception for nearly all government. Their unique roles - e.g supplying credit, functioning as a transmission belt for government moneytary policy, and as a payments mechanism - frequently persuades governmetns to view the troubled bank more sympathetically than they do the ordinary non-financial company that is experiencing difficulties.

The Money behind Private Equity Boom

It is the parterns, which include some of the world's largest and most powerful pension funds, that are funding the unprecedented boom in private equity. In some cases, these pension funds are making private-equity investments on their own, just as any other buyout fund would. The top quartile of funds outperform the public markets. Their returns are typically in 18% range, and some achieve 30% or more, industry insiders say. There is no evidence other PE firms, as a group, outperform the public market. Big pension funds need to put large chunks of capital to work. IT is inefficient to make smaller investments. As result, the big pension funds give money to the proven megafunds taht dominate the top quartile of PR firms. So the PE firms get bigger and bigger.

Monday, June 18, 2007

Hedge Funds vs PE funs vs Mutual Funds

Hedge fund investors can redeem their money on short notice if they don't like a hedge fund's results—putting immense pressure on fund managers to post good quarterly results. But private equity firms "lock up" their investors' capital for years at a time. A pension fund can't simply pull money out of a private equity fund whenever it wants, and that gives the buyout firm time to focus on troubled investments. It has never been more popular to bet against stocks. Once the realm of a few specialists, the financial alchemy of turning a garbage stock into gold by shorting it has moved into the mainstream: The strategy is now employed routinely by thousands of individual traders, hedge funds, mutual funds, and others. It's a simple concept, but relatively complex to execute in the real world—and an influx of competition is making the short-seller's life even more difficult. The number of short-sellers has multiplied dramatically during the last year, thanks to the rise of so-called 130-30 funds. These funds borrow against the money they have raised, enabling them to invest 130% of their capital in stocks. They borrow additional money so that they can invest the equivalent of 30% of their original capital by going short. But as short-selling has proliferated, it has become increasingly difficult to make money at the game. Whereas a profit-challenged enterprise may once have floundered until shutting down or filing for bankruptcy, many such companies are now targets for private equity firms that style themselves as turnaround artists (see, 10/8/06, "Private Equity Keeps Booming"). What's more, such firms are often willing to pay a rich premium to the market price for troubled outfits in which they see promise. As a result, fewer companies work as successful short plays, and the strategy has soured for many.

CBOT is the winner

CME have sweetened its offer twoice, may -ICE introduced 2.5 bil in cash and around 800k for each CBOT member, increasing 500k. -increase its bid to 11.7 bil from 10.1 vs 11.8 bil offer of ICE -485 mil dividend -won approval from U.S. Justice department antitrust regulations -combined future market Nasdaq might get LSE -Market indicated that NYSE Euronext tried to distance itself from LSE, derivatives, instead of equity, firepower has higher priority. -People familiar with the matter have said the among Nasdaq's reasons for buying Nordic exchagne operator OMX AB was that it would ease any move on the LSE, given they can talk of European synergies, and OMX can act as a go-between.

Hedge funds disintermediate Wall Street

Bad bets on mortgage have discouraged bankers from bidding for distressed loans (home loans), leaving industry veterans like Vranos to snap up home loans for at little as 30% on the dollar.... Wring returns from bad loans may get tougher as two dozen state lawmakers consider more than 70 bills to protect homeowners.... For now, bids from hedge funds may be helping Wall Street by preventing a deeper swoon... Markets for subprime home loans came almost to a standstill... Hedge funds may find themselves ensnared in the patchwork of federal and state regulations governing mortgage lending, especially on loans that may have been touched by fraud....

Leh surpassed BSC as the largest undweriter of Mortgage backed securities in 2007

gorwth of covenant-lite debt

SP said if sold without the protective covenants that used to be standard in this market, th ranks of covenant-lite debt will swell to 19% of the leveraged-lan market, up from 15%. The prevalence of covenant-lite debt illusrates how the high-yield loan market has become a riskier place to invest. IT is now dominated by buyers like hedge funds and managers of structured financial products such as CLOs, which allow some of the riskiest companies to raise funds at favorable terms. As of thurday, $356 bil in loand were issued year to date, compared with $79 billion of high-yield bonds. The erosion of covenants in the loan market has been a gradual one that has been accerlated since 2006, according to (SP) LCD's historic date.

ills deepen in subprime-bond arena - 06 18 2007

On Friday (06/18/2007), Moody's Investor Service slashed rating of 131 bonds backed by pools of speculative subprime loans because of unusually high rates of defaults and deliqneuencies among the underlying mortgages. The ratings company also said it is reviewing 247 bonds for downgrades, including 111 whose ratings it had just lowered. All the bonds were issued as recently as last year. The latest move by Moodys affaected around $3 bil worth of bonds, represenging less than 1% of $400 bil in subprime mortgage backed bonds. Moody's downgrades so far concentrated among bonds backed by second lien loans, which are taken out on homes that have already been pledged as collateral on another mortgage. Second-lien lenders stand at the back of the line; when borrowers default, it is highly unlikely the loans will recover any money. The housing market continue to deteriorate, and many economists see little hope it will recover before 2008. ABX (price based) tracking risky subprime bonds plunged to an all time low of 60.95. The ABX index was above 97 at the start of this year. Delinquency rate soared to 13.77% from 11.5%. For Bear, the trouble at one of the in-house hedge funds worsened significantly late last week. On Friday, lender ML announced plans to seize $400 mil in collateral from the fund, and auction off its seizure - which comprise mainly securities of CDOs. Analysts say the securities ML and the Bear funds are trying to sell aren't easily traded by investors. As such, they may draw bids that are signiicantly lower than what their sellers are hoping for. The asset sales this week will be closely watchded by WS, especially by hedge funds that hold similar bonds. The prices at which Bear sells its hedge-fund assets could impact how other investors price their own holdings. facts around $36.5 bil in securities backed by second-line loands were created by WS last year, less thaan 10% of the $483 bil in securitiese backe by subprime loands taht were issued. Most subprime bonds are backed by first-lien mortgages, which take a longer time to realize losses because their borrowers have to go through the foreclose proces. About 1.5% of bonds from 2006 that are backed by first-lien subprime mortgasges have been downgraded or are being reviewed by Moodys for downgrades.

Sunday, June 17, 2007

Analysts are more pessimestic

Buy recommendations slipped below holds as a percentage of total U.S. stock picks for the first time ever in February, and now trail 45.3 percent to 47.8 percent, according to data Bloomberg began tracking in 1997. Sells have increased to 6.9 percent from 1.9 percent in March 2000. The amount of shorting -- where traders sell borrowed stocks expecting to buy them back when prices fall -- jumped to 3.1 percent of shares listed on the New York Stock Exchange in May. That's the highest since at least 1931, according to Bespoke Investment Group LLC, a research firm in Mamaroneck, New York. So-called short interest on the NYSE rose to a record 11.8 billion shares as of May 15, 7 percent more than a month earlier, according to the NYSE, the world's biggest exchange.

Securitization as an alternative funding method

Securitization is the process whereby a financial institution that owns a loan portfolio and is looking at funding them through securitization will pool the assets, recognizing the ownership of the assets through classes of tranches. Generally it is more expensive for a bank to securitize assets against obtaining funds from the wholesale market. The extra cost can the 40 bps and above. Securization does have funding, liqudity, and asset liability management advantages. It increases the liquidity of some assets by creating a secondary market for them. Asset liquidity management is enhanced through transfering the risk of some of the assets to the market. Securitizing futures receivables is very advantageous for banks in countries whose sovereign rating is below investment grade.

Saturday, June 16, 2007

interest rate risk and BS matching

three factors a.interest rate risk use balance sheet stress test b.maturity match - use maturity profile c.currency matching long position: foreign currency assets > foreign currency liabilities. short position: foreign currency liab > foreign currency assets many banks in emerging markets strategically run short foreign exchange positions as part of their overall asset-liability policy. This is particularly the case where domestic interest rates are high or in high inflation economies, and thus funding locally through eithe deposits or the interbank market is expensive compared with low interest rates in hard currency economies. So they fund through foreign currencies.

Sources of funding for banks

The most sensitive funding sources are from the interbank market, whether it be domestic or foreign. funding from the interbank market can be both volatile and expensive. Many problems arise in emerging markets due to the tendency of banks to over rely on interbank funding. For instance, 1994 crisis in Turkey expose many Turkish banks' over reliance on internbank credit lines and bank-syndicated borrowings from overseas. When the country's sovereign risk rating was downgraded, sentiment changed as the economic crisis took hold. International banks cut credit lines, squeezing many domestic banks liquidity positions...Turkish banks realized from the crisis the advantage of possessing a good base of domestic deposit funding as it is the most stable source of funds for banks.

Friday, June 15, 2007

World exchanges are on fire

CMEH + CBOT or ICE + CBOT? CMEH sweetened for the second time its initial October bid for CBOT by adding 485 dividend to 10.1 bil acquisition proposal and pledging 333 mil more th help members of the Borad of Trade csah in on trading rights of disputed value they own at a seperate options exchange. The annoucement came on the heelsof a Justice Dep deicsion Monday to allow the Merc-CBOT deal to proceed without any changes. ICE has also sweetened th terms of its deal twice. It is on the border line....Merc officials believe that ICE stock reflects a takeover premium that assumes it will lose the CBOT deal but be snapped up by someone else. Nasdaq might get LSE Market indicated that NYSE Euronext tried to distance itself from LSE, leaving LSE one less way to avoid LT suitor NADAQ. NYSE Euronext think derivatives, instead of equity, firepower has higher priority. Nadaq has already batted off twice. Nasdaq has around 30% stake in the LSE, but under British takeover rules Nasdaq can not bid again until early next year. People familiar with the matter have said the among Nasdaq's reasons for buying Nordic exchagne operator OMX AB was that it would ease any move on the LSE, given they can talk of European synergies, and OMX can act as a go-between.

Tishman/Leh lower bid for Archstone Smith Trust

they lower the bid from 64 to 60.75, reflecting the concern in the commercial Real Estate wold that higehr interst rates are discouraging deals or causing prices lower.

Growth of three brokerage firms is slowing down - BSC, LEH, GS

2Q 07, 1Q 07 Leh, 24%, 34% GS 1%, 23% BSC 1%, 14%

Thursday, June 14, 2007

Comment about future of four brokerages

It is tied up the residential mortgage market Quo Status of Mkt deliquency rate (one-to-four-unit residential properties)drop 11 bps in the 1Q to 4.84% 2.Mortage rate is high, but not too high FNCR3030 Index now 6.686%, highest since 2005. still low compared to 99 or 2000 (8.5%) 3.Supply & Demand BB - ETSLTOTL Index go - exisitng home sales 5.99 mill in April, lowest in 3y, higher than 2000 and 2001 NHSLTOT - new home sales 981 thousand in April, 3y lowest, close to 2000 and 2001, higher than 95 and 96 Employment rate is the key -dropped to 4.5% since 2002

commentary of BSC, Leh, and GS

Until now, three brokerage firms have released 2Q 2007 earnings, and Leh and GS beat the estimate. The general theme is that if your business mix are diversified geographically and across different security assets, if you will do well. BSC miss the estimate because 1.higher exposure in FI assets -65% revenue related to FI products, around 50% for Leh and GS. -sales of mortage-backed bonds in U.S fell 19% in 2Q, -35% subprime, and -25% in Alt. BSC is No.1 in subprime and Alt-A mortgage origination. So BSC took huge loss in mortgage origination. 2.not internationally diversified ->80% revenue is from U.S, less than 60% Leh and GS -After Feb selloff, Europe vs Asia market has rebound dramatically. Euro and Aisan indices rebounded over 10% from Feb to end of May. So it miss chance to reap the benefit from favorable equity market. That partly explains why its growth of equity capital market revenue is negative where Leh can double. The dramatic loss of BSC also reflect a.revenue has recovere from loss -2% last qtr to 1% this quarter. b.the write down of specialist unit, Bear Wagner Specialist LLC due to shfit of NYSE to automated trading. is catching up as international player, long way to go

Mortgage Finance research sources and quo status

MBA market rates MBA - 30 y fixed rate 06/08/2007 6.61% 06/01/2007 6.35% Bloomberg FNCR3030 Index now 6.686%, highest since 2005. still low compared to 99 or 2000 (8.5%) Subprime Deliquency rate 13.77 in 1Q 07, hightest in 3y, lower than 2001 Supply & Demand BB - ETSLTOTL Index go - exisitng home sales 5.99 mill in April, lowest in 3y, higher than 2000 and 2001 NHSLTOT - new home sales 981 thousand in April, 3y lowest, close to 2000 and 2001, higher than 95 and 96 Equity Valuation BB - S15HOME, S&P sub-industry group $561.2, 3y low, higher tin 2002

Leh business segments description

1.Capital Markets - represent institutional client-flow activities, including prime borkerage, research, mortgage origination and securitization, secondary-trading and financing activities. The products encompase a a wide range ofd cash, derivative, secured financing, and structured instruuements. It also include proprietary trading activities and principal trading activities 2.Investment Banking - provides advice to corproate, institutional and government clients throughout thw world on mergers, acquisitions and otehr fianncial matters. services include M&A, restructuring, underwriting, leveraged finance, and private placement. 3.Investment Management - strategic investment advie and servcies to institutional and high-net-worth clients on a glboal basis. a.Asset managemnt - provides properietary asset management products across traditional and alternative assets classes, through a variety of distribution channels, to individual and insititutions. b.Private Investment Management - provides service to high net worth clients.

Overall Mortgage market condition barometers

1.Housing Starts (million) 2.Leading Indicators 3.Philadelphia Fed Survey

Wednesday, June 13, 2007

LEHMAN Conf Call takeaway

Market Conditions -global equity market rallied after Feb sell-off. Europe 8% in local currency and 5% in Asia. As a consequence, global equity trading volume increased 13% in dollar term. -Interest rate in U.S remains benight. .... -Subprime market remain challeng Net revenue in 1Q 2007 inceased 25% to $5.5 billion, 19% of the 1st 6 months Segments a.Capital Market +17% to $3.6 bil (68% pie) -Equity market doubled (94%) to $1.7 bil due to record overall consumer activities, equity derivative, and profitable trading strategies (principal trading) -FI failed 14% to $1.9 bil due to residential mortgage b.Investment Banking +55% to $1.2 bil (20% pie) -FI: record debt origination +87% to $540 mil -Equity: 60% to $333 mil -Advisory fee: 14% to $277 mil c.Investment Management -Asset Management: +33% to $460 mil -Private Investment Management: +26% to $308 mil

finance news review on 06 13 2007

-Leh combined two mortgage originator, BNC vs Aurora -both makes riky loans to borrowr not qualified for std loans, BNC Mortage LLC making subprime vs Aurora makes Alt-A -400 jobs cut ironically, in another article, CEO said "We've developed the culture and the trust with employees that lets us reduce pay when times are tough," O' Meara, 46, said "So we can avoid reducing payroll" Mortgage About 2.5 million people will buy homes for the first time this year, down from 3 million in 2005, said Gopal Ahluwalia, staff vice president for research at teh NAHB.

Facts about Brokerage

-largest underwriter of Mortgage Backed Bonds : Lehman -largest underwriter of subprime Mortgaged backed securities: Bear Stearns

Tuesday, June 12, 2007


-profit in 2Q increases 27%, $2.21 vs $1.69 -Equity trading revenue doubled, underwriting fees increased 76% -Investment Banking 55% to $1.5 bil, M&A fees 14% to $277 mi -48% revenue from Non-US vs 40% 1Q -FI trading revenue drop 14% to $1.89 bil (out of $5 bil) -Share price increase 0.4 to $76.06 -10y Bond (A), 110 bps FV

Monday, June 11, 2007

WS gets life from SEC rule

A new regulation relieving capital restraints may enable the biggest U.S. securities firms to make the rest of 2007 exceptional for shareholders. Alternative net capital requirements, passed in 2004 by SEC to keep WS firms competitive with their counterparts in European Union. U.S commercial banks are receiving a similar break from the Basel II agreement, set to take effect as early as next year. --- new capital adequacy standards. Under the old regime, securities firms had to reserve a set percentage of every dollar of capital ast risk to ensure solvency in the even of a market collapse or failure of a major event. The new rule takes a more nusanced approach. Reserves are determined according to a combination of risks including losses from credit deterioation, adverse market movements, inadequate internal controls and changes in legislation. They permit securities firms to use non-cash assets, such as derivative contracts, to offset risk. Most money freed up as a result might go toward trading or principal investments. Those business have fueled a tripling in WS earnings since the investment-banking slump of 2001 and 20023 and now account for about 50% revenue, up from 40% two years ago. They are using their own capital and increasing leverage and as long as funding costs are low, that's profitable.

NYSE relax rules

NYSE relaxed long-standing rules taht limited floor brokers to trade only Big Board listed shares. SEC approved change today, paving the way for floor traders to execute transactions on any exchange, inculding NASDAQ and ASE. The old rule was intended to guard against brokers exploiting information gleaned on the floor to execute trades in the OTC market.

Sunday, June 10, 2007

Financial Accounting Standards Board Meets with Accounting Standards Board of Japan to Discuss Global Convergence

Convergence—the development of a common set of high-quality accounting standards for both domestic and international use—has been a major initiative of the FASB and ASBJ. Working in partnership with the International Accounting Standards Board (IASB), the organizations believe that common global financial reporting across the major business and capital markets of the world is a critical component in providing credible, comparable, conceptually sound, and usable financial information They agreed that both Boards would continue to exchange views on longer-term issues and current concerns.

which industry will be impacted by higher intertest rate

Short financial and industries sectors, consumer discretionary, utilities. Long energy and food sectors. Many are also watching the housing market closely. With the sector already reeling from a glut of supply and falling prices, could higher rates slow home buying further? "The one thing the housing market had going for it was low rates," Evans says. Of course, Evans notes, even if rates rise, they're still low on a historic basis. Indeed, the news on rates points to problems, but it's no time to panic. "I don't think we want to paint some kind of gloom and doom situation," Evans says. "The economy has a way of working these things out."

Thursday, June 7, 2007

IRS tax loophole

-IRS moved to shut a corporate tax loophole last week, two days after IBM used it for stock repurchase. -Typially, a U.S company will be subject to double taxation mechanism when it repatriate earnings from overseas to U.S, one taxed by foreign government and one by U.S. At the same time, the company get tax credit from U.S to offset its payment for foreign taxes. The U.S tax rate is second highest, 40% for interests and dividends. -Through Trangular reorgnization, IBM set up a freign subsidiary in Netherlands. The subsidary borrowed monay and oversee earnings ($1 bil) to buy backed $12.5 billion (8% shares outstanding) without funneling money back to U.S (called Killer B). So it is not subject to U.S tax. Even more , IBM will use its oversea earnings to pay back loans ($11.5 bil). In this way, $12.5 bil earnings are immune from U.S tax. This explained its first quarter tax rate is only 29.5%. -The new regulation will treat funds use for buybacks as repatriated earnings, making them subject to U.S corporate tax rates. How did IBM make it -- accelerated share repurchase International Business Machines Corp. said it has spent $12.5 billion to buy back its stock in one of the largest uses of an "accelerated share repurchase," a tactic that allows a company to boost per-share earnings more rapidly than it would using a conventional buyback approach. In the complex deal, IBM created a Netherlands unit to finance the stock repurchase with overseas earnings and avoid having to repatriate funds, which would make them subject to higher U.S. taxes. IBM said it bought 118.8 million of its shares at $105.18 apiece from three investment banks that borrowed the shares from investing institutions, in a typical pattern for accelerated plans. The banks, in turn, will purchase an equivalent number of shares on the open market over the next nine months, and return the borrowed shares. IBM may pay more money to the banks if the average price of IBM stock rises during that period. The overseas element, lawyers said, is an unusual twist. IBM established a wholly owned subsidiary in the Netherlands, IBM International Group, to own its international operations and repay the loan taken out by IBM to buy the shares. IBM International will pay principal and interest on the loan with cash generated by IBM International outside the U.S. IBM treasurer Jesse Greene said the offshore tack, which he said has been used by "a few" other companies," will allow IBM to lower its taxes by using foreign units' funds without having to repatriate them to the U.S. Repatriation often results in a tax bill from the U.S. if the monies being returned are profits that have been taxed abroad at a lower rate. "There's an opportunity to use some of that cash overseas without being taxed again in the U.S.," he said. He declined to disclose the difference between IBM's U.S. and international tax rates. For the first quarter, IBM's world-wide tax rate was 29.5%. Accelerated share repurchases have become increasingly popular with big companies doing buybacks. The accelerated plans immediately reduce shares outstanding, increasing earnings per share. However, critics say the accelerated plans can hurt companies if the stock rises sharply, forcing them to pay more than expected later. The share purchases equal about 8% of IBM's stock outstanding and were authorized under a previously announced plan to buy $15 billion in shares. IBM said it borrowed $11.5 billion for the initial purchase from a group of banks and will pay $1 billion in cash. IBM announced the repurchase after the close of regular trading. IBM shares rose 73 cents to $105.91 in 4 p.m. New York Stock Exchange composite trading and another 8 cents to $105.99 after hours. IBM said that as a result of the stock buyback, it expects 2007 growth in earnings per share of 13% to 14% compared to the 11% forecast that it made when it reported earnings for the first quarter. It said the reduced shares will account for two to three points of growth, or 14 cents to 17 cents a share. Three cents of the benefit will occur in the current quarter with the remainder in the second half of the year. Mr. Greene said in an interview that IBM believes "we'll get a very similar result" to a traditional share repurchase program on the open market. He noted that IBM isn't spending all the authorized $15 billion, and he said it still has $1.4 billion available under a previous buyback authorization. IBM announced the planned buyback at its annual meeting in April, and the stock has risen since in anticipation of the reduced share float, analysts say. IBM touted the big buyback as a way to take advantage of its strong cash flow and return money to shareholders.

Wednesday, June 6, 2007

NYSE Euronext expand to derivatives trading

-NYSE said it may purchase an acquisition to expand into U.S derivative market. -Euronext NV is second largest derivative market. unlike other future derivative competitiors, such as CMer or Deutsche Boerse AG, it does not own a clearinghouse. -Bclear is just clearing service, taking care of administrative tasks and passing it LCH.Clearnet Group. -NYSE is losing market share to Nasdaq stock market...It wants to expand it detivative business. It is difficult to compete head-to-head -it will seek regulatory approval to give brokerages access to the Arca options market in Chicago -also seek regulatory approval to extend its Bclear unit to U.S from Europe

Bear Sterns is accused of market manipulation

Hedge funds accused Bear Sterns of maniuplating mortage market by buying underlying risky subprime loans to prop up its price. -Bear Sterns is the large mortgage backed security holder and is also one of the largest CDS players. Ususally as a protection seller, betting the credit condition will improve. If credit defaults increase, it will lose money. -As ABX dropped near the lowest level on Feb, its head Mortgage trader talked about propping up ABX index by longing some shakey mortage loans. New it has recovered a lot. Hedge funds suffer a loss because they are bearish on ABX. That is why they are accusing... -Legally it is ok. But it brings market ethic issue introduce language to give cover to market manipulation...

M&A deals in Exchange arena

NYSE Euronext is looking for for acquisitions of U.S exchange to expand its derivative trading business. Another deal by NYSE Euronext would add to the more than $64billion of acquisitions and joint ventures exchanges world widehave announced since 2005, according to Bloomberg data. Lastmonth, the NYSE's largest U.S. rival, Nasdaq Stock Market Inc.agreed to pay $3.8 billion for Stockholm-based OMX AB. In April,Euronext's chief rival in Europe, Deutsche Boerse AG, agreed topurchase New York-based International Securities ExchangeHoldings Inc. for $2.8 billion. The pace of consolidation among exchange has spured rival bids on deal. ICE is seeking to detail Chicago Merc's bid for Chicago Board of Trade. Synergy: technology sharing

what caused ghost towns in Spain

-Lower interest less than 3% -Rate increases have a more direct immediate effect on Spanish families because 96% of loans are ARM, compared to 20% in U.K and 12% in U.S

changing roles of financial intermediaries

traditional roles functions: create, distribute, and retain risks benefits: information asymetry, and save screening and searching costs investment banking: agents, create and distributing risks commerical banking: principals, deploy capital, monitor borrower, and retain some loans. Now with liquidity-fueled innovations lead to a conflation of the roles played by financial intermediaries. commerical banking: securitize loans through CLOS, no more holding but increasing distributing to hedge funds and investment banking entities. investmenting: increasingly ownning assets in portfolios because their advantage in gauging customers risk appettie and pricing expertise. challenge: commerical banks' increasing role as an originator and disbutors - and less as holder - of loans lessened their incentive to screen borrowers and monitor debtors. Notably, this incentive problem become more pronouced when they sell entire loan, as in mortgage securitization programs. Moreover, investment banks that pool and structure loans might have insufficient incentives to effecitively screen. After all, an borrower walks into a commerical bank for a loan, not into the invesment bank that package and distributes the loand through a structured vehicle. Greater liquidity or confidence does little to mitigate these problems; indeed, it could exacerbate them if confidence begets complacency. What if liquidity falter? well, consider the consequence if stock prices sold off globally, implied volatitility jumped, and record trading volumes overwhelmed the trading capacity on the stock exchange....Well it does not take a long memory to recall this scenario played out for a few days in the late Feburary. As you know, share prices recovered quickly, and implied volatitilifty reverted to near record low level. What lessons can be drawn from such an episode? Perhape because of more complete markets, shocks to liquidity are less likely to impose lasting damage. That hypothesis seems credible when the shock is based neither on rapidly changing economic fundamentals nor a genuine breakdown in market infrastruture. Or perhaps we have not witness a scenario that can subject financial innovations to a stringent stress test. Some high-leveraged private pools of capital may be unable to ride out bouts of high turnbulence if they are compellted to sell assets to meet margin calls, and by doing so, amplify the initial shock. Consequence is the losses will be sharper. Howevery, reductions in liquidity are unlikely to turn back the clock on financial innovations.

Tuesday, June 5, 2007

morning call ... 06 06 2007

-We have seen the PE firms keep hunting for public firms, and they have growed their war chests, pressuring public firms to take action to stay beyond the reach. -A typical approach is asset sales. E.g GE sell its plastic operation and Citigroup investors ask for more assets sale and cost cutting. -defense mechnism: By selling underperforming asset, their price will increase. -Citigroup might boost its price by 37%, $100 bil, by splitting up the entire company. -implications is PE effect further lever up company balance sheet, might have a macro impact.

Market Review as of June 5th 2007

Highlithts: Bernanke said on June 5th that core inflation remains elevated, though officials have seen a "gradual ebbing". He also said tighter lending standards for mortgages will trestrain housing demand... Why the market went down today? The service report (ISM non-manufacturing) shows that the economy is picking up. Last week, the unexpected job growth (non farm payroll) and higher-than-expected grwoth in manufacturing sector also suggested for a pickup. This reduce the chance of rate reduction in the near term future.

Monday, June 4, 2007

Loan Star acquire Accredit Home...

Accredit Home -pure player sepcializing in subprime mortgage running out of cash during the subprime market meltdown. face a cash crunch as creditors ask for loss recovery. -a good alternative to resolve financing issue and increase return for equity investors Question -why can not Loan Star wait until the the company condition get further worse. -the company had not release annual report and will delay its 1Q report. The company said it would suffer signicant loss because its loan origination volume was much lower than 1Q last year. -it means they see the sings of recovery in subprime mortage market. -CFC, 10y bond, tightened 30 bps since to 130 bps since March -key to survival is the source of their funding, -in April, Cerberus Capital Mg agreed to purchase H&R Block Inc's subprime-lending unit -in March, Chicago based hedge fund Citadel Invst Group LLC agreed to buy ResMae Mortgage Corp's mortgage lending unit for $22.4 million and loan 98.5 cents on the dollar for its loan portfolio - Accredited operates nationwide and ranked 14th last year among U.S. subprime lenders with $15.8 billion in loans and a 2.6percent market share, according to Inside Mortgage Finance, an industry publication.