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Tuesday, September 30, 2008

Geldof launches "Bank Aid"

Newsbiscuit continues to outperform with the spoof story that Bob Geldof has launch Bank Aid following the meltdown in the financial sector. Full story here.

They have also revealed George Bush's latest attempt at a bailout plan here.

Hedge fund braced for large withdrawals

If Hedge Fund investors decide to lodge large redemption notices this week for the end of December [typical notice period is 3 months, assuming you are not in a lock-in period which is common in the early years of a fund], then we will see additional downward pressure on share prices and a considerable contraction in the trading capacity of funds.

Investor withdrawals are to be expected given a combination of fear about market risk, prompting a flight to safety and the neutralising of popular long/short hedge fund strategies by regulatory restrictions on short selling.

In many cases, the withdrawal of £1 is amplified by 10-20 times as a result of leverage. Hence, to realise cash to pay investors, a hedge fund will have to liquidate say £20 of assets in my example. Such forced sales will contribute to price depression and exacerbate illiquid markets. Depending on the scale of redemptions, some funds may find their funds wither to uneconomic levels i.e. fees generated on a small fund are insufficient to cover their costs, with the result that they are forced to close. In some cases, this could happen with redemption levels of only 40%.

Of course, Hedge Funds could do two things to discourage/stop exits. The first is that they could impose large redemption penalties i.e. heavily discount the price they offer to pay to repurchase units from investors - 25% or so. Secondly they could drop the "gate" on funds and suspend redemptions, which is a power funds often have to ensure an orderly operation of the fund - large exits destabilise a fund to the detriment of all investors.

Change in lending criteria for City workers will hit the property market hard

Salaries tend to represent a minority of the total compensation received by City workers, with the bulk coming from bonuses. The latter can be several times as large as the salary component.

Historically, bonuses have been a fairly reliable element of income with the result that mortgage lenders tended to include them for the purposes of assessing a person's mortgage capacity. However, the current chaos has prompted an apparent reversal of this policy by lenders who [rightly] consider that bonuses can no longer be assured and henceforth only salaries will be counted in the calculation.

This will dramatically reduce the ability of City workers to borrow. Setting aside any revulsion/envy you may have at seeing such figures, take the example of a banker earning a salary of £100,000 with a bonus of £300,000. Previously, they may have been able to borrow £1.2m, various things being considered. Now the same banker may be limited to £300,000.

Whilst this doesn't affect anyone in a property already, it will effectively stop them from moving or re-mortgaging, since the new policy would be used to calculate the mortgage limit on a new mortgage/property. At a stroke, the purchasing power of City workers, which has undoubtedly contributed to the property bubble, has been slashed. This will feed directly into the property market and push down prices at the top end of the market, by choking off demand.

First Fortis, now Dexia & 6 Irish Bank also get State suppport

The contagion continues to spread. After Fortis received an equity injection from three Governments yesterday, Dexia has followed suit except this time by France, Belgium and Luxembourg.

Ireland has also underwritten its' six largest financial institutions by guaranteeing deposits, covered bonds, senior debt and dated subordinated debt [nationalisation in all but name]. The institutions will be charged for this guarantee.

Hypo Real Estate, one of Europe’s biggest commercial property and public sector lenders, was handed a €35bn liquidity lifeline by other German private sector banks, the Bundesbank and the ECB. The lender is also selling €15bn of assets to cover its liquidity shortfall.

What is notable is that these institutions features at or near the top of a table produced by Cazenove analysts courtesy of FT Alphaville.

Ranking by ratio of debt to equity

Ranking by proportion of debt coming due in 2008/2009

It is notable that Dexia have relatively less short-term debt than others.

Monday, September 29, 2008

Easy come, easy go

A week last Saturday, the newspaper headlines were about the largest rise in a single day on the FTSE100 - up 8%.

Today, cumulative losses since then meant the FTSE closed lower than the point reached before the rally i.e. all those gains have been wiped away.

If someone gives you a firm opinion on the market today, as to where it is heading, they probably don't know what they are talking about.

Too worried to be successful

I caught up with a good friend from JP Morgan today who told me about the absurdity in the Bank, whereby huge amounts of business was flocking to their "safe harbour" but couldn't be landed because hiring restrictions, caused by fear about uncertain times, meant they didn't have sufficient staff to onboard the prospects.

Whilst they could pick & choose clients, internal capacity constraints meant they were turning away clients they would have delighted in winning 4 months ago.

Yet the opportunity to react and seize the moment by expanding capacity was being ignored because targets for the year (set in Jan) were being exceeded in 3 weeks.

Setting aside digestion concerns, which are important, one would have thought the top executives of the firm had shown enough of an example of opportunism of late to prompt staff to "seize the day".

Chi-X worries about fallout from Fortis problems

The problems which have prompted a bailout of Belgian Bank Fortis will have caused wider ripples amongst the European MTS platforms such as Chi-X.

Fortis, with its' attractive commercial offering, had become the central counterparty of choice for the new market entrants. Seen until recently as financially sound, it provided a reliable and respectable partner for an MTS wishing to quickly get customers onto their platform.

Whilst there is no indication that Fortis will retreat from this space, the concerns about its financial health, even after an injection of new equity by 3 European states, may give existing and prospective customers pause for thought about trading on the MTS platforms. After all, counterparty risk is effectively all with one counterparty. Whilst this is true in other markets with a CCP, as an example LCH operates a member default fund underwritten by other firms which provides a greater financial assurance than relying on the resources of just one firm.

Consequently, I imagine that the sales pitch of Chi-X, amongst others, will be under review on the slides/literature concerning its central counterparty arrangements. Likewise, trading volumes will be under close scrutiny, internally & externally, to detect if there has been any knock-on impact.

Already sensing blood in the water, European Central Counterparty Limited (EuroCCP), the European subsidiary of The Depository Trust & Clearing Corporation (DTCC) says it is ready to step into the breach and provide clearing services for European MTFs such as Chi-X, Nasdaq OMX, Bats and other new execution venues served by troubled Belgian bank Fortis.

More on this here: http://www.finextra.com/fullstory.asp?id=19056

Barclays trying to undermine Nomura

Image via WikipediaAfter buying the US arm of Lehman, Barclays looked over the European business but apparently declined to bid and so it was bought by Nomura. Buying all of Lehman in Europe was always going to less appealing to Barclays given the considerable overlap that would have existed between Lehman and Barclays Capital, especially in Fixed Income. However, demonstrating why Nomura had to put in place large retention payments for Lehman staff, Barclays has apparently been attempting to cherry pick staff in London - always a much cheaper alternate than buying a business.

Whilst perfectly legitimate, you could understand if Nomura might be irritated by BarCap's move. Whilst the acquisition was not altruistic, it has saved a considerable number of City jobs and will need the best talent to stay, if it is to rebuild the business.

Buy-to-let mortgages will be difficult to re-finance

The nationalisation of Bradford & Bingley will remove the largest provider of buy-to-let mortgages from the market, since it is highly likely that this will now be run as a closed book of business and run down over time.

In the current climate, it is improbable that many other institutions will be racing to fill the gap it is has left. As a consequence, existing buy-to-let mortgage holders who come to the end of early-years discount arrangements or similar, may find re-mortgaging a considerable struggle should they need to.

Whilst the rental market is proving very resilient, primarily because more people are choosing to rent than buy in a falling market, rental property owners are being hit with falling capital values which also depletes the collateral they can offer to banks for a mortgage. This may force such "investors" to sell their holdings, further depressing property prices.

Structure of Bradford & Bingley's nationalisation is clever

The manner in which taxpayers have been protected from Bradford & Bingley's ["BAD"] demise deserves applause.

The Financial Services Authority ["FSA"] deemed that the Bank no longer met the conditions for operating as a deposit taking institution, which invoked the provision of the Financial Services Compensation Scheme [ "FSCS"]. This scheme is funded by the banking industry and is designed to protect the first £35,000 of a customer's net deposits with an organisation, which I discussed previously here. This prompted a payout of £14bn to protect the assets of retail depositors to enable the deposits to be transferred to Abbey National plc. In addition, the Government backed up its' promise that no money will be lost by retail depositors i.e. unlimited guarantee by adding a £4bn to the pot that wasn't covered by the FSCS.

However, rather than drain other banks of cash to fund this payout, the Bank of England has lent the scheme the money on which it will charge interest [one-year LIBOR + 30bps], which will be converted into a three year loan by the Treasury. The Government also affirmed it stands behind the FSCS in meeting claims.

Hence shareholders will have borne the brunt of the collapse, followed by subordinated debt holders. Thereafter, the FSCS will absorb any shortfalls on assets, which the banking industry will be on the hook for. Only after each of these is exhausted, will the taxpayer be exposed.

Sadly, I haven't as yet figured out why they couldn't have done this with Northern Rock.

The Treasury statement can be found here.

Saturday, September 27, 2008

Nothing to do with me Guv.

Gordon Brown - World Economic Forum Annual Mee...

Image by World Economic Forum via Flickr

If the "age of irresponsibility is over" as Gordon Brown [GB Prime Minister] claimed on his trip to the USA and if the "advocates of light-touch regulation have been routed" as Ed Balls [UK Cabinet Minister] boasted, presumably they will be admonishing those in Government for the last 10 years who allowed this to happen........oh, that could be awkward.

UK Govt to nationalise Bradford & Bingley

News is emerging tonight that the Govt has decided to nationalise Bradford & Bingley using the legislation created for Northern Rock.

The Bank had teetered in recent weeks as concerns have mounted about its' lending book, which has about $41bn of mortgages classified as self-certified [income was not independently verified] or buy-to-let. These are considered highly susceptible to losses.

The likelihood is that the Treasury will split up the mortgage book and sell off the safer elements whilst retaining the riskiest mortgages referred to above, probably taking these into Northern Rock in order to merge the administration functions. It is conceivable that the branch network could be sold separately.

Job losses are inevitable adding to the huge numbers already lost in the financial services industry.

Friday, September 26, 2008

Michael Lewis on the $700bn rescue of Goldman

Image via WikipediaMichael Lewis, who wrote the excellent Liars Poker, is one of the better satirists on Wall Street related matters.

He has an amusing piece on the urgent need for intervention to protect the interest of Goldman Sachs, for the good on the USA. You can read it on Bloomberg here .

Here's an extract

The total collapse of the global financial system is one thing -- everyone at Davos in January saw that coming. But the shrinkage of the Goldman Sachs Group Inc. bonus pool is another. Whatever else the Treasury achieves it must know that if the employees of Goldman suffer any sort of pay cut, it will be judged to have failed. And our country may never recover.

AIG break the buck on their money fund

AIG Life (UK), part of the US insurance group rescued by the US Government, has advised investors in its Premier Bond enhanced money market fund that it will wind-up the fund in mid December and that investors should not expect to receive all of their capital back. The $5.8bn fund is already closed to redemptions after facing a deluge of withdrawal requests it couldn't meet.

Similar to other enhanced funds, the AIG had a heavy weighting in illiquid paper in order to generate higher returns. Illiquidity and depressed prices mean the fund will suffer losses by selling early rather than holding the paper to maturity.

More on this here and here.

The fund had been popular because AIG offered a rate which was 50 to 70 basis points better than deposits offered by rival providers. It did this through a wrapper which meant that tax on the interest payments could be avoided.

This fund almost certainly falls outside of the US announced scheme to underwrite money funds as this was not offered by one of AIG's US entities.

American Pie [re-mixed]

Thanks to Trader Daily for highlighting this excellent rewrite of Don McLean's "American Pie" that matches up nicely to our current circumstances.

Seems a long long time ago

I can still remember
How that trading used to make me smile
And I knew if I had my chance
That I could make that market dance
And maybe I'd be happy for a while

But January made me shiver
With all that Soc Gen could deliver
Bad news on the doorstep
I couldn't take one more tick

I can't remember if I cried
When I read about Bernanke's lies
But something touched me deep inside
The day the mistress died

So buy, buy, all those NASDAQ and SPYs
Called my broker and I told her
That I needed to buy
And them good ol bears will all be sellin and cry
Singing this'll be the day that I buy
This'll be the day that I buy

Do you have those shorts you love?
And do you have more offered above?
If your broker tells you so
Do you believe in buy and hold?
Can the fed save your mortal soul?
And can you teach me how trade real slow?

Well I knew that I'd be buying them
Cause I started fading that guy Jim
I kicked off both my shoes
Man I bought those NASDAQ and Spooz

I was a leveraged bullish trading buck
And I backed up that ol pickup truck
Then I hoped I wasn't out of luck
The day the mistress died

And they were singin
Buy, buy all those NASDAQ and SPYs
Called my broker and I told her
That I needed to buy
And them good ol bears will all be sellin and cry
Singing this'll be the day that I buy
This'll be the day that I buy

Now for five years we'd been on a roll
And moss grows fat on rollin stone
But that's not how it used to be
When the jester cried out on the TV
In a shirt he borrowed from Hank Green
And they took it all from you and me

Oh, and while the market was way down
The fed bought all those on the ground
The market had been spurned
No rally was returned
And while Paulson read a book of Marx
The trade pit looked so sparse
And bulls sang dirges in the dark
The day the mistress died

Helter Skelter in a summer swelter
The bears flew off to a fallout shelter
Eight point drop and falling fast
It never stopped, I lost my ass
The traders tried for one more blast
With the jester on the sidelines in a cast

Now the Globex move was sweet perfume
While bears all played their marching tune
They'd cover in a glance
Oh but they never got the chance
Cause the buyers tried to take the field
To straighten out all those bond yields
Do you recall what was revealed
The day the mistress died?

We started singin
Buy, buy, all those NASDAQ and SPYs
Called my broker and I told her
That I needed to buy
Them good ol bears will all be sellin and cry
And singing this'll be the day that I buy
This'll be the day that I buy

Oh and there I was ALL IN one trade
My profits all were lost in space
With no cash left to buy again
So come on Hank be nimble Hank be quick
Paulson bought that one real quick
Wall Street is the devils only friend

Oh and as I read another page
My hands were clinched in fists of rage
Corruption born in hell
Can't break that Satan spell
And as the Spooz climbed high into the night
To light the sacrificial rite
I saw bulls all laughing with delight
The day the mistress died

We were singin
Buy, buy, all those NASDAQ and SPYs
Called my broker and I told her
That I needed to buy
And them good ol bears will all be sellin and cry
Singing this'll be the day that I buy
This'll be the day that I buy

I met a bear who sang the blues
And I asked him for some happy news
But he just smiled and turned away
I went down to the sacred floor
Where I'd traded all those years before
But the man there said the limits wouldn't trade

And in the streets the bulls all screamed
The bears they cried and traders dreamed
But not a trade was broken
The church canes they weren't broken
And the three men I admire most
The father, son and Holy Ghost
They bought the last trade for the close
The day the mistress died.

And they were singin
Buy, buy, all those NASDAQ and SPYs
Called my broker and I told her
That I needed to buy
And them good ol bears will all be sellin and cry
Singing this'll be the day that I buy
This'll be the day that I buy.

AMEN

From one banking giant to another

Reuters has a profile on Jamie Diamond, saviour of Wall Street and CEO of JP Morgan. At the end of the piece they comment on his man-management style and the high regard he evidently has for his peers.

People who know him say Dimon cuts his peers no slack. On a conference call for Wall Street chieftains while JPMorgan was rescuing Bear Stearns, Dimon shot down a somewhat technical question from Citigroup Chief Executive Vikram Pandit, who has a doctorate in finance. According to published reports, Dimon told Pandit: "Stop being such a jerk."

Do you think he was subsequently visited by HR to discuss his "issues" and need for inter-personal skills training?

HSBC lays off 1100 investment banking staff

It keeps getting gloomier - HSBC has laid off a large number of staff from its' investment banking business including 500 from London. The cuts are across front and back office areas.

Thursday, September 25, 2008

Google Earth - messing about on the River [in Singapore]

A Computer Generated photo of what the Earth w...

Image via WikipediaI confess I don't use Google Earth very often, partly because each time that I do several hours slip by as I become so absorbed by the content e.g. tonight I've went wandering around Singapore where I used to live to see what had changed and 90 minutes had slipped by.

If you've never tried Google Earth, you absolutely must if only to be astounded by the awesome features of this free application.

In short, Google Earth lets you fly anywhere on Earth to view satellite imagery, maps, terrain, 3D buildings and even explore galaxies in the Sky. You can explore rich geographical content, save your toured places and share with others.

Touring locations around the world, your experience is dramatically enhanced with photographs and videos that can be called up from on the surface of the map [identified with small blue squares which you click on to view]. Equally stunning are the 3D building overlays that bring cities to life with real representations of cityscapes. But, you truly experience the magic of Google Earth when you "fly" through these cityscapes using features that allow you to turn your view point through 360 degrees, pan/zoom, and move in 3d through areas.

The latest version provides

Photo-realistic buildings from cities around the world
Dawn to dusk views with the Sunlight feature
Swoop navigation from outer space to street-level

Amazingly, many of the features of Google Earth are now enabled directly from within most popular browsers, once the requisite add-in has been installed.

There is also a huge community of Google Earth enthusiasts that have both identified interesting things on the satelitte pictures as well as having developed astonishing overlays e.g. population density maps, 3D cities, navigated tours of cities and countries. You can find some of those here and here.

Oh, and Google Earth now lets you pan around the Universe too!

Most importantly, let your kids play with it and enjoy their wonder too. You'll probably never pick up an Atlas again.

Vopium - VOIP service available on many mobiles

I was interested to learn about Vopium, which is a Danish startup that offers users a simple way to access cheap international telephony without changing their operator or sim card.

By using Vopium, people calling internationally can save up to 90% on talk time and texting.

Vopium provide a piece of software that installs on your phone and which will dynamically redirect calls through their gateways, thus giving you a cheaper rate. Very similar to what Truphone Anywhere does, when WiFi and 3G aren’t available.

They claim the software is compatible with almost 500 new mobile handsets that support various operating systems such as Symbian, Windows Mobile, Java and Blackberry. I installed it quickly and easily onto my Blackberry and found it integrated well with my contacts directory.

The software will try to route calls over wifi in the first instance, and in its' absence calls local gateway numbers with onward routing over the internet, so that you pay for a local call to your own operator and a reduce international tariff to Vopium. Oddly they don't make reference to using a GPRS or 3G connection.

I really like the idea that the application automatically intervenes when it detects an international call and provides a cheaper routing. Many company telephone networks perform low-cost routing in a similar manner and having this on your mobile is excellent. Whilst you could just switch to the application, it is something else you don't need to think about.

The service also offers a "Call me" service which allows you to call between two numbers cheaply, but which seemingly has to be accessed via their website. The cost applicable is best explained here.

However, where I think Vopium screws up is not the pricing but

a) the minimum balance to fund your account is GBP50, which is staggeringly large deposit for a service only charging a few pence per minute to many countries. This would deter me from using the service, since my experience with VOIP is that even GBP20 goes a long way. Of course, if you prefer to use your mobile for international dialling regularly rather than say a PC based VOIP client, it may appeal to you.

b) based on their "checkout" procedure and Help notes, they appear to operate separate account balances per product rather than a single overall account balance. Hence, if you wish to use several services, and if my understanding is correct, then you will need to fund each separately rather than having a single balance to draw against. If I'm wrong, then maybe they should look at clarifying their checkout process.

Still, you can try their service free with 30 free minutes + 100 SMS text messages without obligation.

Singapore F1 Grand Prix - virtual circuit tour

USGP 2007 - Lewis Hamilton - Victory Lap

Image by ChrisMRichards via FlickrI'm not a Formula One fan but love Singapore having lived and worked out there many years ago. Sadly I've not been back there for over 12 years and much has changed in that time. That said, I was astonished to learn that a Grand Prix was to be run around the streets of Singapore. Whilst many roads are quite wide, I couldn't visualise how a course might have been devised to provide enough passing room, run-off space, adequate turning space as well as pits.

I remember in my youth, the streets of Birmingham [UK] were turned over to Formula 3000 and it caused immense disruption because of the safety barriers that had to be erected weeks before, with the result that side-roads became inaccessible from major routes. In Singapore, I could imagine enormous difficulties arising.

Well, the race is on Sunday and will be the first race run at night under floodlights [Singapore doesn't do things by half]. To help visualise the track, you can check out a 3d tour in Google Earth or in your browser here.

Superb quote about Bradford & Bingley

An article about Bradford & Bingley in today's FT has a brilliant opening line.

"Bradford & Bingley has the classic balance sheet of a bank in big trouble. On the left side there is not much right, and on the right side there is not much left."

For the non-accountants in the audience, the left side refers to the balance sheet debits i.e. assets and the right side to the balance sheet credits i.e. liabilities

25 year old home owner found guilty of leverage

The media coverage of the financial crisis has introduced the public to bits of City jargon, commonly with a derogatory slant e.g. "short sellers" being bad and "leverage" being a dodgy scheme that caused banks to collapse.

Oddly, most home owners are as "guilty" of being heavily leveraged via the mortages. They have typically used a small deposit for a home and borrowed the rest, with the sum borrowed linked to their apparent ability to repay and their home pledged as security for the loan.

Speculation on the residential property market has been widespread, and for many years it has been seen as and genuinely been a one-way bet. Thanks to low interest rates and easy terms, people have been able to borrow ever greater sums thus giving them more purchasing power [in absolute terms] which has inflated the market. Large profits have been made by property buyers for relatively small financial investments of personal equity, the rest being borrowed on leverage of 9x or more.

Unfortunately, as interest rates have gone up so repayments have become a greater burden to householders; as property prices have fallen so the value of ther security has dropped. In such a climate, the impact is dramatic for individuals. In some cases, it will result in the home being repossessed and the home owner's personal equity in a property being wiped out, coupled with supplementary claims from the lenders for shortfalls on the security provided which failed to cover the loan.

Whilst on a massively greater scale and with far greater implications for the economy, the many leverage similarities between banks and individual homeowners are yet to be fully acknowledged by press, politicians and religious leaders alike or maybe they simply avoid unpopular themes. More significantly, it was and is the widespread belief that the property bubble is bursting, which is expected to lead to greater repossessions and losses on property related loans, that has contributed to the dramatic loss of market confidence.

Wednesday, September 24, 2008

A few good bond traders

The Big Picture has published an excellent email doing the rounds on Bloomberg email. Think Jack Nicholson on the witness stand in A Few Good Men replaced by a Head of Fixed Income at an Investment Bank.

Son, we live in a world that has bonds and those bonds need to be bought by men with balance sheets. Who's gonna do it? You? You, Lieutenant Fuld?

I have a greater responsibility than you can possibly fathom. You weep for Bear Sterns and curse the short sellers; you have that luxury. You have the luxury of not knowing what I know: that Lehman's death, while tragic, probably saved firms and that my existence, while grotesque and incomprehensible to you, saves markets.

You don't want the truth because deep down in places you don't talk about at parties you want me buying bonds, you need me buying bonds. We use words like TSLF, PDLF, Super SIV. We use them as the backbone of a life trying to defend something. You use them as a punchline.

I have neither the time nor the inclination to explain myself to a man who rises and sleeps under the blanket of the very freedom I provide and then questions the manner in which I provide it. I would rather you just said "thank you," and went on your way. Otherwise, I suggest that you pick a sub-prime option arm bond and pay par.

Either way, I don't give a damn what you think you are entitled to.

Shock news - people leave awful websites without buying

Tealeaf has published its fourth annual survey of online customers' experiences and found that though buying online is many people's preferred way of doing business, almost all still encounter problems.

The research found that 87% of the 2,000 people surveyed who buy online have experienced problems with online purchases, and four in ten of those abandon transactions or move to a competitor when problems flare up.

I'm amazed it's as low as 40%.

Tealeaf also highlight that consumers are now intolerant of companies' inability to make systems work. Tealeaf's research found that 84% of web users see no reason why web retail systems shouldn't work first time. "Most sites are not meeting those expectations," it said.

Scrip dividends - old fashioned arbitrage

One reason not mentioned in ISLA's paper for stock lending transactions is that stock is commonly borrowed by dealers to exploit the opportunity to arbitrage between the rate declared by a company for its' scrip dividend and the market price for shares when the election has to be made.

For example, a company may offer a cash dividend of £1 per share or 0.25 shares. This "conversion rate" between cash and scrip implies a share price of £4. An investor wishing to receive the cash dividend can enhance their income by agreeing to lend their stock to a dealer in exchange for a fee. A dealer hopes to exploit the benefit of the gap between the date the conversion rate is declared and the date that an election has to be made by the investor since the market price may be more than implied conversion price.

In my example, the dealer will wait until the last possible moment to see if the share price is above £4. If it is, they can source the stock from the company via the scrip dividend and immediately resell it at a profit. If the price is less than £4, they will opt for a cash dividend and absorb the small lending fee. In either case, the investor receives the cash dividend from the dealer.

A similar opportunity exists if the lender wishes to receive their dividend as scrip, except the dealer in that case is hoping that the market share price will be less than the conversion price, meaning they can buy shares in the market to give to the lender and make a profit by electing to receive the cash.

This practice shows up in the lending statistics for several banks including Standard Chartered and HSBC on the chart here with significant spikes around the dividend election dates.

Stock lending - is it evil and sinful?

Over lunch today with a friend from City circles, we briefly discussed short selling and he mentioned that Nicola Horlick had once opined from a conference platform that she thought institutional managers that lent stock to facilitate short selling were idiots as why would anyone lend stock to help others drive down the price of their holdings? This sentiment has been repeated many times recently.

One stock lending source is hedge funds! Hedge funds are not necessarily short sellers. Specifically, hedge funds that consider a stock to be undervalued will buy the shares and finance this by immediately lending them out.

For those unfamiliar with stock lending, this is how it works in a traditional form.

A borrower (e.g., a broker-dealer or bank) negotiates the terms of the loan with the lender to include price, rebate rate and in some cases, duration. This often involves an intermediary/agent acting for the lender.
The cash collateral is normally delivered at 102-105% of the market value of the stock lent
Securities are delivered to the borrower upon receipt of collateral.
The cash collateral received is invested by the lender to generate a return
A negotiated portion of the cash collateral interest earned on the reinvestment is paid to the borrower as a rebate.
The remaining portion of the cash collateral interest earned is retained by the lender as a fee [split if a lending agent is involved]
The market value of the stock lent is priced and marked to market daily to ensure full collateralisation
Stock is borrowed either for a specific term [overnight, week, month etc] or on open which means for an unspecified period with the option for the lender to recall it

For more information on the market and it size, see here, here and here.

In the long run, the market value of an equity security should not be affected by the lending of that security. Temporary buy / sell imbalances will not affect long term stock prices as they should ultimately return to their fair value - shares trading at a discount will represent a buying opportunity.

I have to readily acknowledge that most fund managers are closely attuned to their short-term performance and so will be concerned about prices, especially around quarter and year ends. Yet, importantly for pension fund trustees, they are looking at long term returns and income from lending has become an intrinsic part of the returns on the assets.

Back in June, the International Securities Lending Association responded to negative press comments about short selling and lending with a concise yet important set of counter-arguments here. The key points were

Some borrowing takes place in support of hedging activities e.g. when dealer go long in one instrument such as a CFD and hence go short in a related instrument namely shares. This provides liquidity in the market
Shares can be borrowed to ease settlement problems that would otherwise clog the system up i.e. a failure by a seller to deliver shares on settlement date may otherwise cause subsequent on-deliveries to similarly fail, an issue that stock lending can address

The paper also makes the key point that

Short sellers have no more influence over share prices than any other traders. If selling pressure caused a share price to fall below what other investors judged to be its fair value, they would buy and the share price would correct. Those who argue that short sellers can drive a share price below its fair value need to explain why other investors do not take that buying opportunity.

It added that short selling is not a one-way bet.

However, a greater authority than I has pronounced on the subject of short selling - The Archbishop of York. Sadly, the poor man is evidently a bit confused on the matter.

"To a bystander like me, those who made £190m deliberately underselling the shares of HBOS, in spite of a very strong capital base, and drove it into the arms of Lloyds TSB, are clearly bank robbers and asset strippers" Dr Sentamu told the annual dinner of the Worshipful Company of International Bankers according to the BBC.

The £190m profit to which he refers was allegedly made by people buying shares, not selling. Moreover, the story was subsequently debunked. Still, it shows the Archbishop must spend his Sabbath reading the Mail on Sunday.

Tuesday, September 23, 2008

FSA & Popular Press baffled by share price falls

Well that must have them confused. Short selling of financial stocks has been banned but prices have still fallen this morning.

Barclays -5.4%
RBS -6.8%
HBOS -11.1%
Lloyds TSB -7.6%
Standard Chartered -5.9%
Bradford & Bingley -13.3%

This can only mean one thing - potential buyers are forcing prices down by sitting on their hands and sellers are accepting the lower prices. To quote the Finextra blogger from yesterday, what a bunch of evil murderers.

Monday, September 22, 2008

For whom the bell tolls

Eli Lederman, CEO of alternate trading exchange Turquoise and formerly of the Morgan Stanley parish, stands proudly in the offices of his whizzy new execution venue but clearly harks for the past - he has bought a shiny bell declaring that "a real exchange needs a bell". That's what you call a competitive advantage with which to beat the opposition [or deafen them perhaps]. .

Viz character, Sid the Sexist, claims he is vindicated

At least I'm sure Sid the Sexist from the infamous adult comic, Viz, would claim he was vindicated were he to read the BBC News article here entitled "Men with sexist views earn more".

Reporting on a US study carried out over 25 years and published in the Journal of Applied Psychology, it found that "sexist men" will consistently out-earn more "modern-thinking" men.

It also noted that women with "traditional" views earned less than their "modern-thinking" female colleagues.

A topic for the next Girl Geek Dinner meetup, next dinner party or workplace discussion perhaps - light fuse and run.

Picture source Viz Comic Online

Short Selling - the witch hunt continues

I despair!

When even people within the industry jump on the "short selling is evil" bandwagon without offering any supporting facts, you have to have some sympathy with people who question the high salaries paid to City folks.

Today, a former City practitioner writing here on the Finextra website condemned short selling which is "being used by some very unscrupulous individuals and banks to manipulate the share prices that are bring down the great and the good in the market."

Unfortunately, the facts [missing from the Finextra article] don't support his case, as my recent posts have tried to illuminate with thanks to Data Explorer and Charles Stanley & Co. Moreover, HBOS has justifiably been under the spotlight for over 6 months amidst concerns about its' funding and mortgage book and the FSA found no case to answer re short selling.

But worse, the article goes all soppy and sentimental

"No more fine banking institutions should be murdered because of the ability of the few to use the many short selling derivatives instruments to create a false market."

Could it be that some of those institutions were "murdered" [or I suppose, more accurately, commited suicide] by their own use of derivatives in the first place, creating huge dents in their balance sheet and causing credit lines to be withdrawn? Might it be, for others, that their own profligate lending on ridiculous LTV ratios was at fault exacerbated by over exposure to an inflated property market, whilst running a challenging funding profile?

I'd have been delighted to add such comments to the Finextra article, but it apparently restricts those that may contribute to the discussion on the site.

I'm eagerly awaiting the follow-up article on Fixextra covering insider trading ala "Mail on Sunday" which headlined with City sharks made £190m killing in minutes before BBC report on HBOS takeover , a story quickly debunked here and which highlighted the ignorance of the popular press. As one comment on FT alphaville aptly put it in a related piece which I have modified for the purposes of the pubic at large, "STOP ....... forming so called "informed" opinions based upon READING THE DAILY EXPRESS, DAILY MAIL OR ANY OTHER PUBLICATION THAT CONTAINS, OR HAS CONTAINED AT ANY TIME A PICTURE OF A BIG BROTHER CONTESTANT.

Bradford & Bingley swaps bowler hats for tin hats

Hmmm, do you think the news that the FSA is preparing contingency plans for Bradford & Bingley ["B&B"] will increase confidence in the Company's future?

Having recently raised £400m extra capital and boosting its' Tier 1 capital ratio to 9.1%, you would think B&B would be in good shape. However, at issue is its' sizeable exposure to the UK mortgage market and more specifically mortgages that are considered most susceptible to bad debt e.g. buy-to-let market and self-certification mortgages.

B&B was downgraded by Moody’s last week, leaving its credit rating one notch above junk status. This downgrade would automatically cause other banks to reduce B&B credit lines. Most banks set internal credit limits to counterparties that are linked to ratings. Hence a downgrade reduces the credit line. Multiply this by each counterparty that B&B deals with in wholesale markets and this contracts the liquidity available to B&B to finance its' activities.

Yet the news will most probably cause retail depositors to be nervous or perhaps panic, regardless of the deposit protection scheme. This can only exacerbate problems facing B&B and drive it to seek safety with a buyer.

B&B management will be swapping bowler hats for tin hats this morning.

I'd like a Goldman Sachs cheque book

Image via WikipediaWith the news that Morgan Stanley and Goldman Sachs have converted their legal status into Bank Holding companies, they will be able to accept retail deposits.

Whilst it is unlikely they will, it might be a winner if they did, as there will be a certain snob value to having a Goldman Sachs cheque book and ATM card, which might pull in some image-conscious high net worth depositors.

Credit teams are the real villians of the financial crisis

Photo of Bank of America ATM Machine by Brian ...

Image via WikipediaWas it short sellers that prompted panic about bank collapses or might the withdrawal/reduction of credit lines from commercial banks played a greater part? Merrill Lynch confirmed that Bank of America had cut its' credit lines to Merrill in the week preceding its' acquisition.

Credit lines are an essential part of the liquidity portfolio for brokers and if they are removed that does two things

it immediately constrains the ability of the broker to trade and may force them to reduce positions at a time when forced sales will exacerbate their financial woes
it sends a clear message that confidence has been lost and that news travels fast, causing further "panic" and prompting either asset withdrawals by investors or tightening of credit lines by other firms, all concerned about being left with nothing

A weakened share price by itself does not cause a company to fail. However, the indirect effects are usually

it impedes the company's ability to raise further capital
it generates a loss of confidence in the company - a share price reflects views on a company, which in turn triggers more direct effects e.g. withdrawal of deposits
a re-examination of a company by a credit rating agency, which in turn may downgrade the company and prompt further problems

Had Lehman had an abundance of credit, it wouldn't have collapsed - it was its' liquidity [or lack thereof] that prompted the end of the firm.

In case you think I am picking on commercial banks, brokers have their own credit teams who do the very same thing and will readily cut the trading lines of a client if there is a hint of a problem.

2% of pound coins are fake

The BBC carries the story that the Royal Mint has been forced to acknowledge that about 2% of pound coins in circulation are fake - approximately 30 million counterfeits.

A video of how to detect a fake is here.

Sunday, September 21, 2008

Did John Mack, HBOS and FSA cry wolf?

Never let facts get in the way of a good story.

Paul Kedrosky highlights the extent of shorting on Morgan Stanley as a percentage of the market value of the company, using data from Data Explorer - I cannot attest to the accuracy of the numbers.

July 2008: 7% (peak)

Sept. 1, 2008: 2%

Sept. 16, 2008: 2.8%

Likewise, the FT also reports Data Explorer's data in relation to HBOS and highlights that bank’s market cap on loan this week was actually less than 3 per cent - nowhere the July high.

source Data Explorer

Finally, UK stockbroking firm, Charles Stanley has provided a table of shorting in UK.

Hmmmm. So where is the huge volume of shorting the drove financial stocks down? Might holders of the shares actually have been dumping the stocks in fear and the glut of sell order depressed prices? Evidently we need a new FSA rule to stop people selling for less than they paid for the stock and a market circuit breaker that precludes prices falling.

Better yet, perhaps the FSA could publish the numbers on which they based their rule change, or is it good enough that the market jumped by its' highest percentage gain ever to justify the change?

Saturday, September 20, 2008

US Cavalry rides to the rescue of Money Market funds

Image via WikipediaTiming is everything - no sooner had I written about the fallacy surrounding money market funds breaking the buck and the need for regulators to either require fund manager to set aside capital to cover their implicit guarantees or else increase the prominence given to risk warnings, than the US Treasury Secretary, Hank Paulson steps in to underwrite such funds with Government money.

According to Reuters

The Treasury said it would back money market funds whose asset values fall below $1 a share. Separately, the Fed said it would lend money to banks to finance purchases of certain assets from money market funds.
Set to last for at least a year, it is understood that the guarantee is unlimited, transforming US money market funds into a far safer haven than bank deposits, which is sure to delight the banks [NOT!]. Significantly, might this have the unintended consequence of starting a switch of funds out of bank deposits to this new safe haven for anyone with funds exceeding the existing FDIC limits of $100,000 per depositor per bank, especially since money funds typically pay higher rates than bank deposits? Act in haste, repent in leisure?

The Treasury clearly acted to stem a panic and sudden exodus from such funds, current estimated at $3.5trillion, which would have created further havoc in markets. According to reports citing the Investment Company Institute, money-market fund investors withdrew a record $169 billion during the seven-day period that ended Wednesday. This was causing funds to hoard cash and buy Treasury Bills, which drove their yields down to virtually zero. In shunning the commercial paper they typically buy, yields on these assets shot up to 8% and according to the Wall Street Journal, even firms like IBM were paying 6% for money.

Interestingly it is suggested that a fee is going to be levied for this guarantee, without clarifying from whom this is to be collected - fund managers or investors? Likewise, it is unclear whether any investment constraints will accompany the insurance but this would seem reasonable to assume since otherwise reckless funds might invest in excessively risky assets to increase returns, knowing such "bets" were underwritten.

Prior to the announcement, the LA Times reported that
Legg Mason Inc. said it would make $630 million available to its funds to guard against losses, taking a hit against quarterly earnings. The Baltimore-based asset manager had already injected $2.2 billion into seven funds since November to cover potential losses on debt issued by so-called structured investment vehicles.

source Wall Street Journal

Friday, September 19, 2008

Money Funds - the mythical damn weakens

I've written a number of times over the last year about money market funds [here, here, and here] and the myth surrounding "breaking the buck" i.e. the notion that they always return the capital invested and hence are safe. On a number of occasions during the last 12 months, Managers of money funds have been required to financially support them in order to preserve this fallacy i.e. directly top-up funds to maintain investors capital.

Money market funds invest in short-term money market instruments such as Govt Treasury Bills, Certificates of Deposit, and Repos. Such short-term horizons should minimise the likelihood of capital losses arising but cannot eliminate it and any losses directly impact the value of the fund.

As an industry, Money Market Fund Managers are very aware that if confidence in these funds were to be damaged and the illusion of safety to be impaired, the impact would manifest itself in huge withdrawals from a sector with trillions under management.

In 2008, the top ten Managers by funds under management were:

Fidelity $425.6bn
JP Morgan $267.9bn
Blackrock $259.8bn
Federated $231.1bn
Dreyfus $199bn
Schwab $194.4bn
Vanguard $191.4bn
Goldman Sachs $183.5bn
Columbia $146.8bn
Morgan Stanley $112.6bn

source FT.com

However, the fallacy was exposed this week when Reserve Primary's Money Market Fund was forced to announce that it had "broken the buck" - the fund was priced at 97cent following losses on Lehman short term debt. This is the first fund to actually price a fund at below $1 in 14 years, all other losses having been funded by the managers.

As I stated in past posts, most fund managers aren't capitalised sufficiently to provide such guarantees other than for small losses. It was for this reason that BNY Mellon and State Street both saw sharp falls in their share price, amidst concerns about potential money fund losses, with the former having admitted capital losses on one of its institutional money funds but confirming it would be supporting their net asset values.

At the same time, Putnam Investment decided to close it's money fund and return $12bn of funds to the investors. It did so not because of losses experienced, but because of the potential for losses especially after a period of heavy redemptions, when some assets may not have realised their value due to the need to sell them quickly to fund the said redemptions.

Given clear examples of implicit support by Managers, you would expect the regulator to either require these off-balance vehicles to be brought on balances or ensure risk warnings are given plenty of airing. Fund managers want neither of these, but unless something is done soon we may face a "mis-selling" scandal when a large fund encounters losses too great to be compensated by its' manager. Despite this, I doubt regulators will want to introduce any measures that could affect confidence in fund managers or the funds at present.

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