Barclays in denial

There is a lovely article in the Daily Telegraph about Barclays being in denial about the size of the losses that it needs to take.

One thing that caught my eye was the following:

It has even been suggested that Barclays chose not to offload its Alliance Boots debt, when others in the banking syndicate took a 10 per cent valuation cut to get the assets off their books, because Varley and Diamond wanted to protect the minimal writedowns on leverage loans.

Well you might say that. I couldn't possibly comment.

Anybody looked lately at their consumer lender exposure in Japan? I couldn't possibly comment.

How about just the almost total absence of losing trading days in the investment bank. I couldn't possibly comment.

Anyone you know carried an 800 billion pound investment bank portfolio and not lost money on at least some days... I couldn't possibly comment.

How about the LBO exposures. Well apart from Boots I cannot possibly comment.

Stephen Cooper - a follow up

I didn't need to look for impropriety at American Home Mortgage to guess that it should be considered if you were to make an investment in their defaulted paper. They appointed Stephen Cooper CEO. Stephen Cooper is who you appoint when you do not want the bankruptcy management looking at your past. See my last post.

The Wall Street Journal has however beaten me to the story. In an article about two Bear Stearns executives that face indictment is this little throw-away:

Federal prosecutors in Brooklyn are investigating whether the Swiss bank UBS AG improperly valued its holdings and whether the collapsed mortgage lender American Home Mortgage Investment Corp. of Melville, N.Y., engaged in accounting fraud, people familiar with the matters have said. Prosecutors in Manhattan and Los Angeles are respectively probing whether mortgage lender Countrywide Financial Corp. engaged in securities fraud or loan fraud. None of the companies have commented.

Some things are so predictable...

Stephen Cooper's Business: The past is prologue

Stephen Cooper runs companies in bankruptcy or financial distress. Past clients include Enron, Krispy Creme, and Collins and Aikman.

Current clients include American Home Mortgage as this press article indicates.


So how does Stephen Cooper get all the best clients?


Well he is competent in business administration even if he thought he could make a viable business of Enron.

But there are plenty of people competent in business administration and they didn't think that they could recover anything viable from Enron. Krispy Kreme (another Cooper business) has not turned around even though Stephen Cooper collected his "success fee". In that case - and I am not kidding - Stephen Cooper's definition of success was the elapsing of sufficient time.

There is however a simple way that Stephen Cooper gets his business. He never sues past management.

When he was appointed to the Enron position he simply disavowed any responsibility to sue past management. The New York Times article cited above quotes as follows:

But Mr. Cooper emphatically refused to speculate on what brought Enron down.

''It's literally of no interest to me,'' he said. ''I'm not going to spend time here looking in the rear-view mirror.''

This was despite the fact that one of the best avenues for recovery for Enron creditors was to chase past management - some of whom were never prosecuted and have huge fortunes. (See for example Lou Pai who is reported to have well over $100 million and married his stripper girlfriend.)

There were similar failures to even consider prosecuting past management in the Krispy Kreme case (even though there were plenty of allegations of impropriety).

Indeed Stephen Cooper is who you appoint if you have something to run from. Whilst the past is of no interest to him - it is prologue for anyone who is a creditor or shareholder in a Stephen Cooper run shop.

The saga of how Cooper got to this position is well told in this book by Lynn LoPucki.

Given that liquidation is a big business - and some of us want to make money buying the defaulted paper of firms in bankruptcy - its worth understanding Stephen Cooper.


The Marsh & McClennan connection


Stephen Cooper has now sold his business (even though he remains the CEO). The owners are Marsh, Mercer, Kroll - part of the Marsh & McClennan empire.

The busienss of selectively electing not to sue past management may be legal (I guess - though I am not a lawyer). However it is not obviously in the interests of creditors and I would have thought that the administrator has to act in the interests of creditors.

Nobody I know has taken the step of suing Marsh & McClennan (NYSE:MMC) for the behaviour of their subsidiary. Again I am not a lawyer - so maybe it is not actionable.

All I want to comment on is despite broker commissions kickbacks exposed by Spitzer, paying the CEO of the NYSE too much money (exposed by Spitzer) and late trading at Putnam (exposed by Spitzer) it is possible that not all was done.

Someone needed to look into the Kroll, Zolfo, Cooper subsidiary.

Spitzer may have been caught after his pants were down - but in my view he was caught before he finished the job.

Short post today: Barclays and fraudulent hedge funds

This is just a short post - to tie in some loose ends I have.

I wrote yesterday about Barclays Global Capital.

I have written twice about a fraudulent hedge fund (New World Capital management) - see here and here.

Barclays has developed quite a business marketing hedge funds. They compile a ranking of hedge funds. Here is the current ranking of their currency funds.

Now here is my sting: at one stage New World Capital Mangagement was ranked Number One on Barclays Hedge fund rankings.

Barclays - strange, stranger and truly opaque

Barclays is the financial institution in the world that most scares me. Indeed it petrifies me. It is huge (currently the second biggest institution in the world and substantially larger than Citigroup). It is highly levered. And it is in all the places you don’t want to be at the moment.

Barclays may be “too big to fail” but it is also probably “too big to bail out”.

You will have to forgive me a long post but this is one of the most important stories in the world today – and I am groping a little in the dark. Wall Street is currently (correctly) obsessed by Lehman Brothers – but they should be similarly obsessed by Barclays Global Capital. Barcap is a far more interesting and important beast. Moreover the standard hypothesis these days is that Barclays will buy Lehman. See this press report for an example.

If you follow Lehman you should also follow this – just to see how strange this hypothesis is.

I posted my old notes on Northern Rock to warm you up for this. If you haven’t read them read them before reading this.

What went wrong in UK Banking!

UK banking has been a true disaster. Far worse than the US – or even than the much maligned UBS. The stock price of Royal Bank of Scotland for instance has been much worse than UBS. The stock price of Barclays is not quite as bad – but is still ugly. That is despite the UK banks not declaring substantial losses. Quite strange.

The origins of this disaster lie in the collapse of UK mortgage margins. UK mortgage margins have fallen and fallen. The different banks had different responses to this fall. Halifax – which was originally a pure mortgage bank – made the most sensible call of all – which was to buy Bank of Scotland. It hasn’t saved them entirely from the crunch – but the shareholders of Halifax have done far better with BOS than they would have done alone. RBS purchased lots of businesses in the US (with which came a subprime problem). One kind way of describing their behaviour was that they were last seen standing by the side of the road with a sign that read “anywhere but here”. Abbey National gave up and sold itself to Santander. Northern Rock decided to make up the margin collapse with more volume – and we know where that got them.

Barclays decided to become a debt trading investment house. About half of its profits now come from the sort of activity that Lehman does.

This market is hostile to pure debt trading investment houses. Barcap should be having a truly awful time. But the remarkably the management are quite upbeat - declaring their investment banking division profitable - this quote headlining the 15 May trading statement (my emphasis):

“Our 2008 performance continues to benefit from the diversification of our business in recent years. In Global Retail and Commercial Banking, our UK businesses performed well. There was very strong profit growth in Barclaycard and we continued to expand our international businesses rapidly. Our Investment Banking and Investment Management businesses were profitable in challenging market conditions. ”

Pay up for talent

Barclays did not buy an investment bank. There were persistent rumours that they would buy Lehman – but it never happened. The way that they built the bank was to steal whole teams from lots of investment banks – offering what investment bankers respond best to – lots of filthy lucre.

One year they put on a thousand staff at over 250 thousand pounds average salary. That seemed like an aggressive hiring spree to me. The next year they doubled it and I think (but cannot confirm) they continued to expand on this pace. This is a lot of cost base to add to a retail bank with declining margins.

I know they offered guaranteed bonuses – so when they slow this beast down the staff costs do not go away.

Barclays has some good businesses – notably the i-shares that are so beloved of hedge funds. But most of what they do is just looks like a standard debt driven investment bank.

Steroids got nothing on this growth – lets look at gross derivative exposures

Having employed all these people and told them to trade. Unsurprisingly they did. Now I am just going to extract a few things from the annual reports. Here is the derivatives exposure from the 2007 annual:

I encourage you to click for detail.

These numbers are as they seem. The total gross derivative exposure is 29 trillion pounds. I deal with banks – but I am not used to dealing in trillions of pounds. I don’t think anyone is.

The gross credit swaps are 2.4 trillion pounds – but mysteriously the fair values (both assets and liabilities) are low. Only the fair values go in the consolidated balance sheet so if you were to mark these like some people do the balance sheet would be much larger. (There is mismarking in someones book - but it may not be Barclays).

The CDS are up from a mere 1.2 trillion at year end 2006.

The scale of the growth is best seen by looking at the same disclosure in say the 2003 table (snipped from the 2004 annual report):

Again I encourage you to click for more detail.

In four years our derivative exposure (total face) has gone from 5.9 trillion pounds to 29.2 trillion pounds. Our credit derivative exposures have gone from 43 billion pounds to 2.4 trillion pounds. [I keep needing to watch myself when I type this. I am not use to this many zeros – and I deal in Japanese banks which account in yen.] Anyway this is about 50% annualised growth - reflective of the great Barcap hiring spree.

It is not just the derivatives that they grew. The on balance sheet exposures grew to astronomical size too. Here is the summary from the Barclays annual report of Barcap.

Lets stress how weird this is. You have 3.8 billion pounds of “trading income” and only 42 million pounds of “value at risk”. The balance sheet however – and this is ON BALANCE SHEET exposure is a mere 840 billion pounds. That is about the same size as the whole of Citigroup! In the income statement they took a net 795 million pounds of charges against US subprime exposure. That is 19 times their value at risk.

Oh, and you got all this income with a trading team you hired with guaranteed bonuses into the most crazy-for-talent market that has ever happened. When I saw the bonuses some of my friends were being promised - well I wondered why I wasn't going to Barclays.

They were pretty good traders all up too. Unlike anything I do they made money almost daily. Below is the value at risk over 2005-2006 with the number of positive and negative trading days.



I love this - almost EVERY day they made money.

It was a little rougher in 2007 - as the 2007 annual makes clear

Analysis of trading revenue

The histograms show the distribution of daily trading revenue for Barclays Capital in 2007 and 2006. Revenue includes net trading income, net interest income and net fees and commissions relating to primary trading. The average daily revenue in 2007 was £26.2m (2006: £22.0m) and there were 224 positive revenue days out of 253 (2006: 243 out of 252). The number of negative revenue days increased in 2007 largely as a result of volatile markets in the second half of the year. The number of large positive revenue days also increased but these were spread across the year

Oh well - in bad times you get some losing days at Barclays.

Of course it all depends on how you mark the exposures. Barclays held - and continues to hold lots of nasty stuff. Their marks on the super-senior CDOs are implying only a fraction of the problems at Ambac or AIG. How do I put it? When is it mark to model and when is it mark to myth?

They put out a interim trading report. Its here. You look at the marks - and see if they make sense to you. The statement is here (warning pdf).

They got the true subprime thing happening here. They own Equifirst - a true subprime lender. Or at least it was a true subprime lender - it now does FHA loans and the like. They purchased in March 2007 when it was early in distress. They got a few billion pounds of loans with the acqusition that they meant to securitise if the market reopened. Oops.

They got the lot. Just read the appendix to the trading statement. And compare to AIG.

I got much more on this thing. But this is a blog and meant to be light hearted. Enjoy.

John

You must forgive me my tactlessness: New World Capital Management - a follow up

Short post - and an apology. I previously posted on Fun and games in hedge fund land. That post was about a fraudulent (and now disappeared) hedge fund.

The title of the post was needlessly offensive. What New World Capital did was not fun and games. I have been contacted by someone who lost a considerable part of their net worth in that fund. To them it is a tragedy.

Greg Duran (the guy who ran New World) took real money which was the embodiment of real people's financial aspirations - sending their kids/grandkids to college etc.

This blog is read primarily in hedge fund centers. My readers are clustered in New York, Connecticut, San Francisco, London. There is also a cluster of readers in Santa Fe and Alberquerque. [I am using Google analytics to map my readers.]

The readers in Santa Fe stay longer than the ones in New York - and they all read the post on New World. They are in pain. I posted as if New World was just an interesting scam. I guess it is until you are actually scammed.

To those readers - please accept my apology.

John

Australia is different: Macquarie Bank edition

Macquarie Bank runs a "wrap" product by which Australian retail investors can invest in a range of funds and have all their tax compliance done for them. The website describing this product is here.

Customers naturally enough carry some cash. The cash has traditionally been managed in a AAA rated fund holding mostly government and quasi-government and other short-dated high rated securities. The Macquarie cash fund behaved quite well - unlike say Macquarie Fortress.

But Macquarie has pulled a bait-and-switch. The attached newspaper article tells the story:

http://business.smh.com.au/macquarie-finds-1b-under-nose-20080609-2o13.html

I have repeated the first part of the article here for your edification:

MACQUARIE GROUP just found a cool $1 billion under its bed to address the high price of debt - or actually, under the beds of pensioners and superannuation investors.

With little fuss, Macquarie has converted the cash accounts of investors in its super manager and pension manager "wrap" investment products into deposits in Macquarie Bank.

Investors with a total of $1 billion in cash accounts have been given little choice in the matter: the switch occurred in May whether or not the investors wanted to make the move.

Or, as Macquarie told its investors in a leaflet about the change: "No action is required from you."

Investors have been swapped from the AAA-rated Macquarie Treasury Fund - which invests in a variety of money market products - into a deposit with Macquarie Group's banking division, which is rated two notches lower at A-1.

Investors have to deliberately opt out of the move by switching their cash into another cash fund if they do not want to become a depositor with the bank. Even then, they will have to maintain a minimum of $2500 in the cash account as a deposit in Macquarie, as part of their participation in the "wrap" investment platform.

For a bank, more deposits are a bonus because they are a cheaper source of funding than is available on the wholesale debt-funding market.

I don't want to breach copyright - so for the rest of the article you will need to click through to the Sydney Morning herald. Here is a link.

My old notes on Northern Rock

In 2005 I travelled to the UK to study the UK banks. I should have shorted the lot of them. But I didn’t. But for the record here are my notes – written on a slow English train – about Northern Rock – and never finished. I have edited it only to remove references to my actual sources.

I put this up not to gloat (but its nice). Rather I am going to do an expose of another UK bank shortly.

I cannot gloat too much - because whilst these notes are amazingly prescient I did not make a fortune on the stock. I predicted rain - but its making an ark that counts!

===================================================

Quote:

Northern Rock – leverage mortgages to the max

Northern Rock is a very simple bank. It has only one strategy and it makes no bones about taking this strategy to its absolute limit. They are completely non-forthcoming about where the limit of this strategy might be – but we will see that later.

The strategy of Northern Rock is to grow the mortgage book. Fast. All decline in margin is to be made up by volume growth. They are absolutely explicit about this – the corporate objective is:

• Grow the asset base by 25 per cent per annum plus or minus 5 per cent
• Grow earnings by 15 per cent per annum plus or minus 5 per cent.

It is pretty clear that they have even de-emphasized the old building society funding base which is I think might be actually shrinking before “hot money” high rate deposits and foreign deposits[1]. At the conference they told us how they were still concentrating on the deposit base but it had the tone of protesting too much. Besides its clear that rating agencies and bond markets want some deposit based liquidity.

I am also not exaggerating in the slightest about what the corporate strategy actually is. The management must have used these two bullet points five times in my presence (and I was not with them long).

Well it is pretty clear that growing the balance sheet by 25 per cent per annum grows risk by something near 25 per cent per annum (the company will deny this – more on that later). Growing profits by 15 per cent per annum means that capital will wind up growing by 15 per cent per annum (give or take a little).

If you grow risk by 25 per cent and profits and capital by 15 then either

• You will run out of capital and the regulators or rating agencies or bond markets will not allow you to fund your growth – in which case the growth fizzles out at best, or

• You will eventually be taking so much risk that the return on capital will not be rational in an ex-ante basis. Some point ex post you will blow up, possibly spectacularly.

If you think I am exaggerating what this strategy is then here are the five year summary numbers from the annual report. Ten year numbers were reported at the conference and they had pretty well the same appearance.

INSERT [sorry I wrote this on the train and had a hard copy of the annual. I never bothered putting the actual table from the soft copy in the report]

Note there is no credit data here. Nowadays credit losses are negligible in UK mortgage banking.

Obviously you should notice the massive expansion of leverage in this book. The asset number to look at is the “total assets under management”. This number includes securitised mortgages where the residual credit risk is at Northern Rock. (The main buyer of this paper are Japanese banks both major and regional.[2]) The total leverage of book has moved from 27 times to 42 times. Obviously this can’t go up for ever but I suspect it can go for quite some more time. (You will see that 43 times leverage is not unusual for a UK bank.)[3]

When I was with the company I tried to explore the limits to the strategy and got nowhere useful. It would be nice to know though because when the company reaches the limit of its leverage it would be a safe short (unable to grow and possibly facing further margin erosion). Until then its probably a better long then a short as there seems no impediment to earnings increasing at at least the teens and the PE is only XXX now.

That said – here goes for my discussion about the limits to Northern Rock’s growth. The company told everyone at the conference that mortgages were safer than conventional loans probably deserving a 33 per cent risk weighting. In Australia and the US the standard is 50 per cent risk weighting for mortgages with no insurance less than 80 per cent loan to value (LTV ratio) so by international standards 33 per cent is aggressive.[4] That said Northern Rock suggested that there mortgages were substantially safer than the average (measured delinquency at about half the market rate) and hence they should have half the risk weighting – call it 17 per cent. They even went as far as to say that the regulator agreed with them. [Some comments have been removed here because they report indirect comments from regulators. I cannot vouch for them on this blog.]

Now if your mortgages require only a 17 per cent risk weighting then you can be 84 times levered with a Tier One ration of 7 per cent. [Figures: 1/(.17*.07)]. If a third of your tier one capital is subordinated debt (not uncommon in banking these days especially in the UK) then your total leverage ratio might be well over 100. I did this calculation for them and they were quite uncomfortable – because they are hardly wanting to telegraph to the rating agency that they will one day be 100 times levered. (It would increase the cost of their funds now and hence further compress their margin.)

I did not get any useful feed on where the limits to growth are. However looking at the other banks (discussion later) I suspect that the limit is roughly 60 times levered. That would suggest (growing capital at 15 and earnings assets at 25) that there are four to five years left. However by that point the bank has almost ₤200 billion in assets – large compared to the UK mortgage market. Its funding would be totally ridiculous. [Comment deleted because a senior executive of another UK bank thought Northern Rock would go bust in 2007. I just do not want to dump him in it.] Something will crack – but in five years earnings could double again and the stock could be an abysmal short.

If you look at the five year summary above you will notice that the mortgage originations in any year the gross lending is substantially larger than the net lending. In 2004 gross lending was GBP23 billion - about 45 per cent of the total managed book at the end of 2003. Asset growth is only about 45 per cent of net lending.

This leads into the way that the lending is done. Its TEASER RATE lending. In the UK new mortgages (especially from this bank) tend to have a “teaser rate” which applies for two to three years (mostly two years). The fashion of late is to have two year fixed rate loans on very low spreads (the yield curve is flat in the UK) and to offset the spread a little bit in up-front fees. The loans revert to old fashioned (and fat margin) standard variable rate (SVR) at the end of the teaser rate period. The profitability of this business is determined by how many of the loans you manage to keep on your books after the teaser rate wears off and on any incidental products you might sell to the mortgage holder. If the loan comes in through a branch rather than an IFA the loan might be more profitable because it does not cause a broker fee. Internet channels are also relatively profitable.

The way that Northern Rock grows so fast is that it is the king of the teaser rate. It has however very poor retention. Bradford and Bingley told me that Northern Rock would boast about their 400 retention staff (they will cut your rate if you ring up because the alternative is for you to go elsewhere and a cut rate loan is more profitable than a new brokered loan). The competition also target Northern Rock customers. Natwest (HBOS) have regular advertisements on TV showing people on a rollercoaster with very low mortgage rates about to swing up wildly (and quite graphically make them sick). They suggest that you are nuts if you take this swing up and offer you GBP100 if you are an Alliance & Leicester or Northern Rock customer (not a B&B customer) and your rates refinance and you do not want to pick a Natwest mortgage. Its clear that Natwest however is trying to get people through the (lower cost) direct channels. (This sort of competition exists in deposit pricing too.)

There is a test as to whether all this teaser rate activity produces long term customers. Just look at the implied fall off in loans versus the originations two years ago. In 2004 it appears that over GBP10 billion repaid. Gross lending two years ago was 12.5. There is clearly some but quite limited success in retaining the customers. When pushed on accurate data on this issue Northern Rock were simply not forthcoming.

There is one more thing that is quite revealing about Northern Rock – and that is the effect of International Accounting Standards (IFRS) on balance sheet and profitability. UK companies are being forced to adopt IFRS and whilst it is an issue with a lot of noise for many companies the differences are small. They are not small at the Rock. In particular IFRS requires that income and expense charged as a fee but which relates to some period gets amortised over the period. Now remember that the shift in the market has been from floating rate teaser products to fixed rate teaser products with high fees. The Rock has been booking those fees up front inflating earnings and book value. IFRS will (under the guidance given at the conference) reduce book value and earnings by about 10 per cent. (Leverage is probably closer to 47 times – and using a sixty times limit the company probably has only three years rather than five.) The company seems to think that IFRS is a bad idea (aren’t the fees cash). But I am never quite sure whether the mix of fees and spread has shifted driven by accounting considerations or whether its driven by the realisation that churn is going to remain incurably bad or get worse. (Obviously enough up front fees are a good idea if you are scared of churn.)

All of this was enough to make me pretty bearish on the stock. But it got worse. They simply stretched numbers to say what they do not. If it were not for the low standards of America I would say they lied – but I suspect just being economical with the truth was closer. I have referred above to the notion that their delinquency is half the industry average and therefore (as they argue) they deserve only half the regulatory capital charges of the competition. The problem is that a delinquency rate simply does not make sense when your growth has been as rapid as the Rock. I tried to tease out of them the notion of a “growth adjusted delinquency rate”. No luck. I tried to work out what the delinquency by age of mortgage was so I could do the numbers – no luck. They simply were not forthcoming and even attempted to mislead me.[5]

The place however they misled most blatantly was on the margins both historic and prospective. The company stressed that I should not just look at interest margin – rather I should look at fees plus margin over assets – especially as they had shifted to fixed rate low margin loans with relatively high fees. Ignoring the IFRS issue (as they did) the average margin on the book is 125bp and it has fallen every year – most notably during 2004. They wanted to tell me that the INCREMENTAL margin was 110-120bp. This is much higher than the competition tell me the margin is (40-80bps) and simply cannot be squared with the margin figures in the above table. The problem is that they will soon hit limit leverage constraints (but they would not tell me what those constraints were) and were aware that their margins (hence earnings and ROE) would continue to drop once they hit those limits.

As for credit risk. The company told me that they had a position in the broker market as offering the cheapest loans to the best credit. I have one reason to disbelieve them. The Rock has a lower rating and hence a higher funding cost than several competitors – and hence would naturally have a relative advantage further up the risk spectrum (its hard to do good credit well with a low rating). Also they told me in another breath that they had industry leading margins (which did not reflect in the accounts). Stuffed if I know. They seem to think that they will be alright with a 20 per cent fall in the property market. They seem to get concerned when you talk about a 30 per cent fall – and they seem to think that a 35 per cent fall is impossible. I heard all the old hoary clichés: “they are not making any more land in the South East” etc. I should get the stock brokers to organise me some chats with mortgage brokers and IFAs. But I am – until that – inclined to believe that the threshold for pain is about a 30 per cent fall in the property market – and that falls beyond this range could lead to a wipe-out because the loan book is new (hence has not had the chance to get much appreciation into it) and is so levered. [Ok – I was wrong here – they went bust on funding.]

You do have to give the bank credit for one thing though. They have got their costs quite low – 38bp of assets and probably lower under IFRS. This is one of the lowest cost structures in the world. The management will point this out as almost their crowning achievement. They had to do it (had they kept their old cost structure the squeeze in margins would have wiped them out). It does however look difficult to keep reporting lower costs – this looks a lean operation.

Do I want to short it? I wouldn’t object – but I suspect we can do better with timing. The investment bankers are convinced that if something went wrong it would be purchased at 80 per cent of book on the way down. Maybe that is true now – but it will not always be so. I was staggered by the lack of sophistication of the staff – I met the CFO and he was either dumb or a liar or just assumed I was dumb. This company is totally dependent on the goodwill of financial markets. I put to them that they were dependent on the kindness of strangers – and they bristled. They thought that people invested in UK mortgages because they were good investments. Why – so they thought would you invest in Italy?

For discussion.

---

[1] The shrinkage does not show in the numbers – but the deposit base includes €2.5 billion in French deposits which are really hot-money commercial paper and some Japanese deposits. The claimed retail deposits in the five year results page I reproduce (17239) does not match the balance sheet (20342) and I am assuming the difference is roughly the above €2.5 billion and other quasi wholesale money. I can’t tell how much “hot money” there is but Northern Rock were pretty keen to advertise a 5.4 per cent rate. The shrinkage is a guess – but the company was not far from admitting the same when pushed on the issue.

[2] Amazingly the CFO was prepared to name the six Japanese banks which purchased the paper. I told him we had an interest in the Japanese banks and it would help me understand their books. He did not remember their names but he had been on a roadshow to Japan. I have virtually never had a company volunteer this sort of information. Its pretty naïve to do so as there is more than one way to interfere with a banks funding. If he had thought about it clearly it was just as likely I was short Northern Rock than long it. It was part of a general attitude I came across in Britain (nobody appears at all concerned about the vulnerability of funding bases). I pretty well floored Michael Oliver (the very experienced IR guy at Lloyds TSB) when I told him this when I took him out to dinner.

[3] The US tends to have a regulatory limit on leverage at 20 times. Any further and the informal rule is that you can expect an intrusive visit from the regulator. [Some comments deleted here.]

[4] [Regulatory footnote removed – partly because it is wrong – and I am embarrased.]

[5] On the train between Leeds and Leicester I chatted to a woman in her fifties about the banks. She had a mortgage on SVR (an old high margin mortgage) with Lloyds TSB. I asked her why she did not refinance it and she told me a story about weakened credit. Her husband no longer worked and her income paid the mortgage and supported the family. She had plenty of equity in the house but she (erroneously) thought that she could not refinance. Refinance would have saved her GBP500 per year. It was an easy decision had she been informed. Lloyds is hardly going to inform her. But there is a lesson here – the back book are going to have higher delinquency than the front book but without necessarily worse credit. It self-selects this way in part. The comparison that Northern Rock had on their delinquency rate was at best grossly misleading. (There is a possibility that they believed it though which would suggest incompetence. In this case they misled so transparently they might well just have been dumb.)

Its a sh-t business - but hey - the dollar is falling

I subscribe to the GE Press release/blog. Indeed they have a nice page of ordered feeds to become part of your Firefox bookmarks.

Many of the releases are seemingly inconsequential - at least in a company the size of GE. Here is an example in which GE (through its Jenbacher Engine business) turns farm waste (ie sh-t) into electricity.

The individual project is inconsequential - a megawatt of capacity - so probably couple of million dollars powered by - and I am not kidding - 20 cubic metres (700 cubic feet) of cattle effluent and 50cubic metres (1700 cubic feet) of other biomass daily.

Its good to know that GE sales and development staff have their hands in the muck.

What is consequential about this project is that it is not in Iowa. It is in Italy.

The competitors to GE in Italy would have mostly Euro costs. This may be (literally) sh-t business, but it is certainly more attractive when your costs are in dollars and your competitors costs are in Euro.

Places to be bullish

One way of interpreting the current financial crisis is as the first stage of the huge current account adjustment that the US is going to have to go through. Consumers in the US have had high levels of borrowing. These were mathematically unable to be sustained indefinately - but they could be sustained for a long time.

The subprime crisis is - in one view - the first indication that a long time has passed. Endless consumer lending is no longer good business. The US current account (which ran somewhere near 6%) will reduce (over time) to a more standard 2%.

This will involve a lot of movement from domestic sectors (housing, retail, medical, domestic finance) to export orientated sectors. If this adjustment happens slowly you will get what the press refer to as a "soft landing". If it happens fast you get a recession. If it happens very fast you get a true crisis (as per Argentina where the Peso almost became worthless).

If you want to get bullish about the US you want to be bullish about the sectors where the economy will be moving to - export or import replacement orientated. The current account deficit is nowhere near 2% now - and so this trend has years left to run.

The places with the best long term trends are products that America does well - that the Chinese need - and where the competitor is European and has Euro costs and US dollar sales.

Did anyone say aeroplanes, jet engines etc? Well Boeing hasn't been a bad stock over five years though it has been a bit rough of late. But even better is the technology that involves saving energy - or shifting stuff around more efficiently. And has anyone noticed that GE engines tend to be better at that than most the competition?

If you want to get bullish about the US these are the places to get bullish - really bullish. The problem with GE is that they have domestic businesses. Medical business is doing relatively poorly in the last result on domestic performance - and NBC - which is purely domestic has results that suck. The domestic part of the finance business is not doing great either - but it is doing much better than it would have done had Immelt not pruned it so hard.

But for the moment lets wallow (if that is not too graphic) in the good stuff - in American knowhow turning Italian cattle-crap into electricity.


J

Joe Gutnick: a first follow up OR Why pay stock shills when you can have News Corp for free

Joe Gutnick plans to list his Legend Mining in Australia. And THE AUSTRALIAN (News Corps orignal flagship newspaper) has taken his numbers at face as shown in this linked article.

Which leads to an interesting question: why bother paying stock shills USD2500 when the News Corp will take your adverts without payment?

The article of course makes it plain:

The company sees a local listing as logical, considering the operations will be based in Queensland.

But this would involve trading existing shares -- there are no plans for any immediate capital raising here.

So Joe is going to sell existing shares in Legend to the Aussies. The $2500 stock shilling in my last post is the pump. The sale to Australian fund managers is - well a way of getting some cash into existing shareholder pockets. Maybe its a good deal for all. After all Joe has struck gold and diamonds before. Still paid stock shills do not in general outperform.

Now Bronte Capital has always had the best interest of Australian Investors at heart. So - seeing this as we do - we have have purchased the Google search terms "Joseph Gutnick", "Joe Gutnick" to link to this blog.

My adverts will cost a lot less than $2500.