A blog milestone

This is the fiftieth blog post - a completely arbitrary milestone.

I look in wonder at long-time bloggers who are up to 6000 posts. I have already had to correct one decent mistake (that I have identified). If you can identify more I am very happy to issue corrections.

Since I started tracking visitor numbers we have had 3788 visits and almost 6000 page views. (I did not track readers for the first few weeks - so total visitors are larger.)

There have been just over 2000 absolute unique visitors. That means that most people visit once and do not return.

If you have visited more than twice you are likely to have visited more than 15 times. Also I have about 80 subscribers using feed-burner - so there are some loyal visitors. (The feedburner subscribers do not count in the visitor numbers unless they click through to something.)

Visits come from 672 "cities" in 58 countries. The cities are as defined in Google analytics and include what most people would call suburbs. The biggest concentrations of readers are in the United States, the UK and Australia in that order. Within the US the concentrations are New York, Connecticut, Chicago and New Mexico.

All of these numbers are beaten in a single day by popular blogs. I don't yet have a technorati rank - but Wikio ranks me as the 20,677th most influential blog on the web. There are relatively few investment blogs in the top 1000 but a lot of dodgy blogs have rankings very much higher than mine...

The most popular post is the first post on Barclays. Google correctly identifies that and links to it when you google Bronte Capital.

The second most popular post is the post about the fraudulent hedge fund in Santa Fe. As stated above I have a cluster of readers in New Mexico. Many of those readers lost money in the scam. Its been quite disconcerting to know how hard it is to raise hedge fund money as an honest hedge fund and how many people will willingly give their money to a total fraud. There is something there that I am learning about human nature.

I would like to know more about my subscribers and regular readers. Drop me an email.

And thanks for reading.

John Hempton

PS. There have been 7728 advert impressions served by Google on this blog. Only 32 of you have clicked. My impression - Google targets the adverts very poorly. More about that in a later post.

A correction on Sydney Airport

My post on Sydney Airport missed an important part of the capital structure.

Sydney Airport debt structure includes 1.45 billion in redeemable preference shares stapled to the ordinary shares (held by Macquarie Airports) and hence which are justifiably considered equity. Funnily I knew this from past looking at the accounts and had forgotten it. This is also very typical of Macquarie structures so I should not have missed it.

The coupon on those RPS is 13.5%. The negative cash flow of the airport is roughly the coupon on those debts. Indeed if you don’t include the coupon on the RPS as an interest cost then Sydney Airport was slightly cash flow positive including capex during 2007. That was also true in 2005 when the Airport did minimal capex.

If we were to restructure the RPS as equity (which is fair enough as it is subordinated and stapled to the equity) then Sydney Airport is solvent with flat traffic volumes for a few years. However to be worth anything to MAP holders it remains true that revenue has to go up and hence traffic volume has to rise for Sydney Airport to pay the coupon on the subordinated debt – let alone anything on the equity. It remains true that Macquarie has figured rising traffic volume over the long term into its thinking and it remains true that the oil price is causing them issues.

Sydney Airport will still be insolvent with a large fall traffic volumes but a few years of flat to slightly declining volumes is probably supportable provided that there are no short term maturities and the coupons on the subordinated debt get halted. (The listed entity - Macquarie Airports - would still get smashed under these circumstances - but the bond insurers would be OK.)

It also remains true that the debt of Sydney Airport has gone up more or less every year since the Macquarie takeover - and the distributions have been funded by debt.

That can't continue with (a) bad credit markets or (b) falling or even stable traffic.

So the weather channel is worth 3.5 billion

GE and partners (presumably knowledgeable partners) have purchased the Weather Channel for an undisclosed amount reputed to be $3.5 billion.

This is less than the $5 billion mooted before the credit crisis hit – but it seems an awful lot of for my beloved GE to pay.

I got one question: if the weather channel is worth that much what is this portfolio worth?

FOX Business Network
Fox Movie Channel
FOX News Channel
FOX College Sports
FOX Sports Enterprises
FOX Sports En Espanol
FOX Sports Net
FOX Soccer Channel
FOX Reality Fuel TV
FX
National Geographic Channel United States
National Geographic Channel Worldwide
Speed
Stats, Inc.

There is something wrong here. Either GE paid too much or News Corp is a steal at this price or both.

Pet suspicion: both.

Warning: see comment on News Corp in my first "things I stuffed up" post.

Weekend edition: having a whale of a time

On Sunday my wife and I walked from Bronte to Maroubra with a coffee at Coogee.

There was about 15 people on the headlands above Maroubra Beach with binoculars and a telescope. They were watching a large group of humpback whales.

The whales were the better part of a mile offshore and if you looked carefully the most that someone with my deficient eyesight could see was spray from their blowhole.

Here is a much magnified photo. It’s a smudge – but hey I am excited!

Mish comments on finance for machine tools

Mish has posted on his blog an email from a friend who is complaining about not being able to finance machine tools:

An emerging trend this year is the sudden scarcity of capital from banks & machine tool finance companies. We planned to purchase two new machine tools this year. It now appears that we can obtain financing for just one, in spite of a spotless corporate credit record and continued sales growth. The lenders seem to be over-tightening because of the recent credit crisis. As I told my banker, “You guys seem frightened of your own shadows!”"

Mish rightly points out that the main problem is not (as the email author suggests) that the banks are "frightened" rather the problem is that the finance companies can't finance themselves.

Now I might be a little dopey - but this looks awful good for a company that (a) makes capital equipment and (b) can afford to finance it.

Did anyone say General Electric?

Time to hide the valuables under the mattress and buy a shotgun

Dana Milbank of the Washington Post asked Phillip Swagel (US Assistant Treasury Secretary) whether it is time to "hide the valuables under the mattress and buy a shotgun". And Swagel did not hit it out of the park.*

At the same time we have the CEOs of major banks saying that they are profitable despite the headwinds.

With due respect - there is plenty of work in Washington for out-of-work CEOs good at spinning BS. Your country needs you.

The full video is here and is worth a watch. (Hat tip to the Big Picture.)

Memo to Phillip Swagel: practice saying the fundamental strengths of the United States are undiminished... even if you don't believe it. Its not good for someone in your position to talk down anything...

*My original wording was "Swagel does not hit it for six". But then I am Australian and therefore a cricket fan.

A not so encouraging dead link

I was doing a little research on Washington Mutual. In particular I was trying to work out whether the entire Long Beach Mortgage portfolio is as toxic as Mish's benchmark deal.

So I go through WAMU investor relations site - and looking for IR for fixed income. I get to this site. I click on the link to WaMu Asset Acceptance Corp (where all the Long Beach stuff resides).

The link is dead.

When major banks can't keep their IR page in order to give you credit data I can't blame people for being skittish.

Memo to WaMu: please fix.

Somthing to say for getting old - or just ignoring survival bias

Getting old is better than the alternative.

But Floyd Norris suggests that it seems to be better for your investing.

As I am getting older at the rate of one year per year Floyd's article should cheer me up. But it doesn't.

An article that suggests that older investors are less likely to be caught up in a bubble has a causality problem at its heart.

If you are likely to get caught up in a bubble you are unlikely to STILL be a professional investor by the time you are 50.

The article seems to suggest that age makes you wise.

But the alternative hypothesis is also possible: wisdom that allows you to grow old (and stay in business).

And if that is the case getting older at the rate of one year per year has fewer benefits than I hoped.

Things I once wrote

In my previous career (that is in May last year) I wrote a brief history of US finance since the 1970s. It explained our positions winning and losing. You can find it on the web here.

Before you read it though – read yesterday’s post on things that I stuffed up. The credit risk/interest rate risk. The conclusions to my article from last year seem wrong in several important ways.

Things I stuffed up – edition one - Interest rate risk versus credit risk

Anybody that trades stocks makes mistakes. I have made plenty. I would prefer sweep those under the carpet but a little bit of healthy self-flagellation is good for the spirit. Besides I hope it will make me a better investor. Besides I just posted that I purchased Ambac - something that could (easily) wind up as the next mistake. So you should know just how much I stuff up.

So this is the first of (almost certainly) many posts detailing things I stuffed up.

The list for the first choice is long. How about these?

(a) Believing that regional banks of Credit Agricole (which are very good) would offset the losses at the investment bank (which is very bad). Stock is down from 36 to 12.

(b) Believing that the mortgage insurers would blow up this cycle but the bond insurers would probably be OK. Ambac is down 90 to 1ish and is no longer writing much business. MTG (which was my favourite short) is down from 60 to 6 but is writing plenty of business. Got the wrong shorts… and didn’t short the bond insurers…

(c) Believing that the (seemingly extreme) valuation difference between News Corp and other media stocks would solve itself by New Corp’s stock price rising. It didn’t as a stock price comparison of Viacom, Time Warner and News Corp will attest. (It was a wash – all the stocks lost a little.)

(d) Buying Origin Energy at under $2 and selling it at about $4 on the basis that the utility parts of the business were fully recognised. I sold it despite loving the management. It is currently under hostile takeover at $15.60 – and the Aussie dollar in which it is priced has almost doubled. I didn’t recognise just how good the gas assets were. This was non-trivial as the fund I worked for owned almost 5% of the company – and left more half a billion dollars on the table and it was my fault.

Against this it should be pretty hard to tell what the worst intellectual error I made in the past five years is. But I have a candidate. I thought that the interest rate risk in US banks would blow up before the credit risk.

Background

The US has a very unusual mortgage market. Most mortgages have the peculiar term of being fixed rate when rates are rising – but being refinanceable if rates fall. This means that customers pay more for their mortgages than most jurisdictions – but that all the interest rate risks fall on the financial sector.

For instance in most markets the difference between central bank fund rate and the average mortgage rate is less (often much less) than 200bps. In the US it is unusual to get a conventional mortgage at under 6 percent – and the feds fund rate is 200bps. Mortgage margins in the US are more than double most countries.

For this however the system as a whole takes an awful lot of interest rate risk. If short rates were to go to say 8 percent there would be 5-7 trillion in mortgages that yield less than that. Individual institutions might say they were hedged – but the system as a whole cannot be hedged.

I spent an awful lot of time looking for banks and other institutions that were particularly levered to interest rate risk. WestAmerica Bancorp (an otherwise pristine bank) stood out. If you look at the balance sheet I linked in my previous post you will see that it contains $1.5 billion in fixed rate securities financed floating. That number is very significant compared to pre-tax income of 120 million or tangible book value of about 270 million. And WABC is by no means the largest offender.

My back of the envelope calculation was that the system had about 400 billion of pre-tax profits. That included all brokers, all banks, all insurance companies, fund managers – the works.

The US system had 7 trillion of interest rate miss-match. Almost half the profits of the entire US financial system could disappear in a 200bps rise in rates across the yield curve. And they would have disappeared without a penny of credit losses. A lot of institutions would lose their profits entirely. They would in my view all try to hedge simultaneously guaranteeing the dynamic hedging strategies that were in place did not work.

And I thought with Alan Greenspan setting the tone of the Fed the stuff up on inflation and hence interest rates was inevitable. Greenspan never saw a problem he could not fix by pumping more liquidity into the system. I thought Helicopter Ben was even more likely to use a little inflation to get the US out of its mess. Indeed that is where the “helicopter” moniker comes from – a speech to that effect. So essentially whilst I thought that credit problems were sort of inevitable – the US would inflate their way out – and hence the real manifestation would be an interest-rate-risk debacle.

So I spent a couple of years getting completely obsessed about interest rate risk. It led to some OK shorts (eg Fannie and Freddie) but meant I underestimated the credit story.

The credit risk I thought had been passed pretty heavily to the non-bank sector. It existed in the Europeans (I sort of knew about UBS). It existed in the investment banks (including Citigroup). It existed in some regional banks (I knew about Bank United). But I was stunned it wound up quite so bad at Fifth Third. Just stunned.

I thus covered a Fifth Third short many years ago. (Ooops.) I was short a bunch of interest rate risk sensitive banks (such as North Fork which was purchased by Capital One) and I didn’t short MBIA and Ambac. Indeed I was tempted to go long (but fortunately I did not). I made money on a few interest rate shorts – but altogether it was not a profitable activity.

A few years ago the short end of the yield curve was at about 1%. The long end in the 4s and quasi-government guaranteed mortgages were in the high 5s. Borrowing short to buy Fannie Mae backed mortgages was the seeming no-lose trade. Everyone was on it. It didn’t even carry much credit risk because everyone knew the government backed Fannie.

However it carried – and still carries – massive interest rate risk. Everyone seemed to ignore that. My usual reaction – if everyone is doing something then it will probably lose you money. I would rather be on the other side.

Still I remain convinced that this is a theme that will play out. Warren Buffett says inflation is heating up – and he doesn’t stretch the duration of his assets.

There are good people who think inflation is highly unlikely. Paul Krugman (who I admire) suggests that Bernanke should ignore the inflation naysayers. Mish writes for ever on how inflation is not likely – see here and here for examples.

I will get back to this shortcoming one day soon.

John