Bank customer service – some follow up

Felix Salmon has made the correct observation about bank customer service and private banks. His analysis:

Big retail banks tend to look at their high net worth clients and see lots of profits. So they try to pamper those clients as much as they can, with personalized service and dedicated phone numbers and, very often, lots of salespeople pushing some kind of equity derivative or other.

But their org chart, their IT system, their DNA -- it's still Big Retail Bank. If a private-banking client phones up and asks for something they can call up on their computer, then no problem. But ask for something which might be slightly different -- and you run into a brick wall.

In a real private bank, one which is built upwards from a rich client base rather than being built by skimming off the richest clients of a much broader client base, such things are much less likely to happen. In a real private bank, the client has a private banker -- a human being with first-hand knowledge of his client and the ability and authority to make things happen.

Well eventually National Australia Bank has promised precisely what Felix Salmon suggested should have happened in the first place. I wonder a little if being the writer of a well read financial blog had something to do with it. But if people have found NAB private bank helpful please mention it in the comments and I will publish. A good turn is a good turn and should be acknowledged.

More generally I have received a bit of email about bad bank customer service. Several pieces were about Royal Bank of Scotland. RBOS has done well over 100 acquisitions – and getting customer service right throughout that is difficult. However Fred Goodwin (who I think is a truly dreadful CEO) has one genuine claim-to-fame – which is that he meets his post-acquisition cost targets. He might do this at the expense of customer service – but at least he does it.

I got a general comment that regional banks (especially small town banks) are better than big city banks. They are just helpful. However its friendly but not that much fun when a staff member at a regional branch of Chase spends 15 minutes trying to solve a problem on an internal phone centre number. I guess it works – and keeps the customer happy – but it is not great customer service.

I have one email about good customer service at Fifth Third. That meets my preconceptions. I have blogged about Fifth Third here and here. However there was a comment contrary to this on Seeking Alpha when I wrote about Fifth Third there.

Finally I received a few emails about banks with financial problems solving them by cutting back on staff and hence annoying customers. I have no corroboration so I will not publish names. Mostly you could guess - and if you want to email me I am very happy.

John Hempton

PS. I also received one negative comment about Danske's merger with Sampo in Finland. That surprises me. I have held out Danske as a bank that does this particularly well. Annecdotes contrary to my thinking are much appreciated.

Epistemology for beginners:

As regular readers probably have worked out I am getting obsessive about what constitutes enough evidence to have a bet on a stock long or short. [We can and will be wrong often.]

I have seen a lot of crap written about what we know and how we know it. This blog post is both funny and useful. (HT to Felix.)

Google – the evil identity theft company

I use GMAIL and it worries me that all my life is stored on some server in the Googleplex. But I guess I trusted a company whose motto was “DON’T BE EVIL”.

Now I have just installed Chrome – the new and very slick browser from Google. Call me an early adopter!

It will not become my favourite browser until I have a feeds extension as per Firefox.

But one thing has really got me. Go to options on the tool menu on the right side and you can make all saved passwords visible. Oi – this is in an age of identity theft where I travel globally with a laptop! And I run finances from this laptop.

Firefox also has such an option – but at least you can hide it with a master password. Microsoft – for all their reputation for security flaws are just not that stupid.

If this keeps up the boys from Redmond will find their reputation restored – Vista notwithstanding.

John Hempton

PS. I have a cynical take on this. This is a browser with a really neat incognito feature. It allows you to visit sites without leaving any trace on your computer. A porn feature if you will. Google is encouraging pornography.

So you can be secure from your wife when you are checking out the internet sites of escort agencies. But you can't secure your financial passwords! Tells you about Google's priorities.

Obvious reason: Google makes lots of money on advertising sexual services. They don't lose lots on identity theft. People - even those that profess not to be evil - act according to the incentives given them.

Suing Dell – a follow up

I wrote earlier about my own experience with Dell and warranty issues.

For those that want to know – Dell folded and fixed my computer at no expense.

Background: I purchased a Dell XPS M1330 online through Grays Online – an auction system where Dell gets rid of its excess inventory.

The inventory is marked as either faulty or working. The computer I purchased was not marked as faulty.

The XPS M1330 had a fault which was widely reported – and indeed reported on Wikipedia. The fault was to do with inadequate cooling on the graphics chip – and indeed Dell changed the chip from January 2008.

I purchased the computer in March 2008 – but they had the old motherboard/faulty cooling system in the computer and did not indicate in the auction that the computer had a known fault.

I sued Dell – and the main argument came down to the fact that they sold me a computer with a motherboard/cooling system that they knew was problematic. It was thus misrepresentation.

I paid for repairs – and the repairman gave the game away. He didn’t even bother to turn the computer on to check out the fault. He just started unscrewing it and replaced the relevant bits. He then turned it on and it worked. He told me that he had done more than 50 of these computers – all the same fault, none of which was produced after late January 2008.

Dell is panned for customer service issues – but in my case the customer service issue was faulty design. If there had been no fault there would be no customer service issue. The great internet unwashed knew about this well before Dell did – with articles on the web about how to fix Dell’s design fault.

As it turned out Dell folded. They agreed to refund my repair costs and the legal costs without appearing at court. It wasn’t much money – and they probably knew they had a problem.

Dell probably should have known that I was serious when on the phone I indicated that I was going to sue them. If they thought I was bluffing they lost.

It is sure better to keep the customer happy. But much better would be to produce equipment that is not faulty.

And in that my repair-man – a nice young man from India who talked with pride about his soon-to-be-arranged marriage gave me some hope. He knew of no current Dell consumer product that had this sort of manufacturing/design problem. So maybe – just maybe – Dell is getting ahead of the game.

John

Bank customer service

Banks are notoriously bad at customer service. They know they have customer lock. People are less likely to change banks than get divorced according to the oft-cited dictum. [I do not know the original source and can't vouch for the data.]

But today I am having one of those “bank customer service days”. I am a customer of National Australia Bank private bank. Private bank is an area walled off for the "important" customers.

I need something very simple. I need a set of interest statements for my own account and the family trust for the 2006-07 tax year – and I need them in a simple form.

Surprisingly the bank cannot deliver.

This seems odd.

Moreover I am starting a hedge fund. I need to choose banking arrangements – and failure to deliver simple things to a private banking customer would rather mitigate against choosing National Australia as a service provider of any kind to a hedge fund.

So the lack of customer service is a mechanism for shooting yourself in the foot. [Banks have plenty of ways of doing that.]

For the past year all people have talked about is bank balance sheets. When insolvency beckons customer service comes second.

But if anyone notices their bank is improving their customer service let me know. Its always interesting to find a bank which retains its customers by making their life better rather than by offering looser credit terms or higher term deposit rates. Besides such banks are likely to work better for shareholders as well as customers.

John Hempton

Explaining the brokers – Part III

This is proving to be a hard series to write. The brokers are complex. To really go through the Lehman 10K is a schedule clearing event. (The same is true for Barclays and other institutions I have made the attempt on.) But I hope I have painted the world appropriately.

In Part I I described just how big the brokers have got. Enormous. Some criticisms said that I was overstating the case because I compared US brokers to possible US assets – but the brokers were global. However that criticism is unfair – I did not include the foreign investment banks which are just as big – note UBS (which long had the biggest balance sheet in Europe), Barclays (the second biggest balance sheet in the world), SocGen (which has about half the trading revenue of Goldman Sachs), BNP Paribas and Calyon (both also large), Deutsch Bank and Nomura.

In Part II I explained just why there was such a glut of excess savings in the world – and why those savings are in such a risk-averse form.

My assertion is that the brokers – more than any other institution – have become the intermediaries between the Anglo/American (and Spanish) economies and copious pools of savings.

The first way they did this was through the now thoroughly discredited securitisation market. What securitisation did was take pools of assets (some junky, some good) and create AAA rated securities by segmenting and selling off the most senior cash flows. This left equity tranches (which had high returns and natural owners) and BBB tranches which were waste at the end with no natural owners.

So investment banks worked out a trick – which was to wrap the BBB tranches up into “collateralised debt obligations”. The purpose of these was to make the BBB bits go away. They would tranche the BBBs and produce some more AAA (which was sold to “natural owners”) and some more BBBs and equity tranches.

Never failing to do something to excess Wall Street then tranched the BBB bits of CDOs to produce the notorious (and mostly worthless) CDOs of CDOs or CDO Squareds. Surprisingly they sold some of these as AAA (admittedly with a few billion of guarantees from the monolines).

Some brokers (notably Goldman and Deutsche Bank) were pretty darn good at avoiding holding the “super senior” crap at the end of this. “Super senior was a euphemism to hide the fact that the AAA stuff was really contingent on BBB stuff that was already levered.” Other brokers (notably Merrills and UBS) were particularly bad at ducking this stuff. Similarly poor were National Australia Bank in my home market. [See the forthcoming Part IV.]

None of this explains why the broker balance sheets are so big (other than UBS and Merrills). The brokers don’t need to hold the assets for any length of time to securitise (though sometimes they did). The securitisation business is “moving business” not “storage business” and assets that are held when the music stops are ubiquitously bad – but are not necessarily huge in number. [The losses from holding assets at the end however will total tens of billions – maybe even 100 billion if you count all investment banks.]

It’s the “storage business” that fascinates me. They call it “trading” which implies a “moving business” but trading as done by most investment banks involves considerable storage.

The strangest thing about it is that the people actually doing the trading had no idea the economic function that they were performing.

Put yourself in the shoes of some prop trader. Some of them do “risk arbitrage” on takeovers and the like (see the description of Goldies trading business in Robert Rubin’s “In An Uncertain World” ]

What I think the traders did – and I would love some trader to confirm or deny this via email – is sit there and say “I can buy this security, sell this security, buy this interest rate hedge, buy this credit default swap and I am balanced”. So he did it.

And over time he kept putting the positions on one way – he went long the exotic instrument (say a mortgage or a piece of credit card or CDO paper), purchased a CDS or a monoline guarantee or some other credit protection, and funded this by shorting a vanilla instrument (some AAA paper – especially a Treasury).

And as they did it the balance sheets got bigger and bigger and bigger.

The economic function that the trader was performing was turning exotic instruments issued by the West into vanilla instruments favoured by the East. They were intermediating on the trading floor. And they were the biggest intermediators in town.

Goldies prop trading profits got to 30 billion dollars. If you added up the prop trading profits of the street – and they were always profits until recently – the numbers were well over 70 billion and probably over 100 billion (depending on who and what you counted). There are approximately 110 million households in America (sorry I have not checked that number for a while) and maybe that again in the indebted developed world. The trading profits were say 500 dollars per household.

Well if they were profits to Goldies et-al they were losses to someone – somebody paid $500 per household. And struggle as I may the only service that I can think that is worth $500 per household that was provided by the trading desks of investment banks was intermediating debt. So that is what they did. The “losing side of the trade” saw the 70 billion plus paid to the trading floor of investment banks as just something embedded in their monthly interest payments. The trader saw it as a mathematical game – but it was just service provision.

Now the reason this post is hard is that the data to support this proposition is thinner than I would like.

At a first cut if the trading was really just the bring-forward mark-to-market of the book then the trading revenue as a proportion of assets should fall each year.

When I first studied this (a few years ago) that was true. But it is no longer true. Trading revenue as a proportion of assets was particularly high in 2006. One person I talked to suggested that was just because the broker balance sheets just grew faster than ever – they just did it on the OTC market and didn’t actually need to back anything with the physical. I don’t know about that – and I do not have the data to either prove it or not.

But here is a simple model which details my quandary. In it I assume Goldies balance sheet would shrink by 30% each year just through natural attrition (loans repay etc). Then I look at the addition to the balance sheet and trading revenue as a percentage of additional revenue.

This seems to suggest that trading margins (ie a bring forward of all the profits) seems to be about 6% of incremental assets added. It’s a nasty profit front load if the business shrinks because you need to hold capital based on the whole balance sheet. 2006 looks to be a particularly good year.

But finding enough data to support this thesis generally I am finding hard to do.

If anyone has a better explanation I would love to hear it.

John Hempton

From the comments - believing in Magic

Bondinvestor (whoever they may be) left a reasoned piece in the comments. It disagreed with my position on Magic outlined in this post.

I like people that disagree with me and I would love BondInvestor to get in contact...

bondinvestor said...

MTG, PMI, RDN and even ORI and GNW are all buys.

the best way to think about MI conceptually is as a bridge loan. if home prices collapse or the borrower loses a job in the first 3 yrs, the loan goes bad. otherwise, it's a solid investment.

the critical question to getting these stocks right is the level of cumulative defaults on 06/07 flow business. 05 is bad, but not catastrophic. the bulk business has already been written off. therefore, the only lingering uncertainty is what the level of defaults on 06/07 will be.

here is how to answer the question. MGIC's total claims paying resources (investments + collateralized reinsurance recoverable + the present value of installment premiums) is roughly $13B. that is 24% of the total risk in force. the subprime debacle (for which you were right to short the stock) will end up costing them about 8% of risk in force on a cash basis. that leaves 16% of risk in force (roughly $9B) available to satisfy claims on 06/07 business.

that leaves roughly 2/3rds of the claims paying ability ($9B) available to satisfy losses on flow business. the problems are concentrated in 06/07. the total risk in force on 06/07 is roughly $20B (may be high). so in order for MGIC to go bust, roughly 4/10 06/07 vintage loans must go belly up.

so how likely is that? well, if you obtain copies of MI annual statements, you can recreate loss triangles by accident year. they will show you that, over time, the cumulative default rate on a flow book is around 2%. it also demonstrates that by year 3, somewhere between 30 and 50% of lifetime defaults have been recognized.

you can use the loss triangles and historical seasoning curves to develop a rough model of what lifetime defaults will be on the 06/07 books, given the experience to date. they suggest cum defaults in the range of 10-15%. now, 06/07 only accounts for 40% of the flow book, so the total contribution to loss frequencies will probably by somewhere in the 4-6% range.

this analysis suggests that, far from being insolvent, there is actually tremendous value here that has been unrecognized by the market. the stocks are 10-20 baggers over a 5 year time frame.

that being said, i think all parts of the capital structure of these companies are interesting. for those who are intrigued by the analysis, but scared to own the equities, i'd point to RDN and PMI holding company debt. you are getting 13-25% YTM (face value 55-80% of par) for a senior interest in the holding company that owns the regulated MI subsidiary.

August 29, 2008 10:54 AM

My objections to this are that I am not sure that the bulk book is fully written off, nor am I sure that the book in 2007 will look anything like any previous year - as the last refinance of my rolling loans was onto Magic's book.

My further objection is that statutory capital deficiency happens way earlier than this - and stat capital deficiency will close the business as per TGIC.

But I remain to be convinced otherwise - and I have had a go at reconstructing Magic's loss triangles (with help from a reader) and we got not very far (probably because we gave up early).

If Bond Investor would like to share with me I would much appreciate it.

Thanks.

John

Ripping off two charts – Moodys mid year residential mortgage backed security performance update

Moodys has published a short report entitled U.S. RMBS Mid-Year Performance Update: H1 2008. This post will shamelessly rip off a two charts from it. The entire report is absolutely consistent with the data summary that I have been giving on this blog. Its really annoying to do all this work eyeballing hundreds of MBS pools and then find a really neat 8 page paper that does it all for you…

I would quote the report more broadly except that I do believe that they have some copyright issues. You might find someone to kindly send you it. Or you can buy it on the web here at an outrageous price. [If the price were one tenth the price listed here I would recommend it…]

But given that I do not own the research I will limit myself to a review.

The review goes through different types of collateral and different loss curves. I will not go through all of them for copyright reasons.

The first picture I will extract is cumulative losses on Subprime RMBS by year of origination. This is one of those “no hope” charts because losses are trending upwards fast with no obvious signs of stopping.

The picture makes it look like 2005 looked nasty and stabilised (something I have been saying for a while) but that the 2006 and 2007 pools have no hope. The 2007 pool is worse than the 2006 pool. [This should sound familiar to regular readers of this blog.]

The second chart I think makes the story a little clearer:

The 2005 pool had a delinquency hiccup – but is now back in the fold. I think we can safely estimate losses on 2005 subprime pools now and they are not that bad. The 2006 pools looked like they were stabilizing – and I blogged to that effect. The data in the last month however has given me some pause – hence my depressing thoughts post. Any light at the end of the tunnel in the 2007 pool looks like an oncoming train.

The same trends exist for Alt-A generally – but I am not going to extract all the data from the Moody’s report as I respect their copyright. I should say with Alt A the 2007 pools are not modestly worse then 2006 pools they are immodestly worse.

This is consistent with my rolling loans thesis. The loans could never be repaid but they could be refinanced. They kept getting refinanced to later pools and the last pool contained the detritus.

The 2006 Alt A delinquencies also looked to be stabilising but with a hiccup in the last month. The hiccup in the last month was worse than the subprime pools. 2005 is right back in the fold as with subprime.

Moodys then break the Alt-A into conventional adjustable rate mortgages (ARMs) and Option Arms. It seems there is almost no last-month kick up in delinquency for conventional arms but a big kick-up for option ARMS. This suggests the problem is Option ARM resets and confirms the analysis of many of the people who have commented on my blog. [Dear readers – a lot of you are very smart - indeed the great joy of this blog is what it delivers to my inbox.]

They then do cumulative losses on jumbos. Similar trends – but there is a kick down in last month delinquency. Does anyone know why jumbo credit looks to have got better very quickly. I have no idea.

They then do subprime Closed End Seconds and HELOCs (something I have studied at great detail). There is MUCH more stabilisation in CES – even the 2007 pools appear to be stabilising, however HELOCs, which are generally more prime than CES are not showing the same stabilisation.

Also with PRIME CES the 2005 pools look awful, with subprime CES the 2005 pools look good. In general 2005 mortgages are only bad if they are prime. [That should confuse most of you - but I think its because in bad poosl the really bad loans rolled out into 2006 and 2007 pools but prime people did not roll their loans.]

I would go further than the Moodys report and note that more generally the better the credit the worse the trend, or the worse the credit the better the trend. But nonetheless the Moody’s report is accurate, neat, short and should be got by anyone with decent access. The expensive source I link to is probably too expensive – but that is your choice.

If you are really maniac you can take this data and recalibrate Bill Ackman's open-source model of the bond insurers. I have done that - but my estimates are probably not much better than anyone else who does it with some integrity.

J

Reducing post frequency

I started doing this blog with the idea of two posts per week, but it somehow morphed into one per day. I had a lot to say and somehow had found an outlet.

I was however chewing considerable human capital - having developed ideas over a long period of time. [I do not generate ideas as fast as I have put out posts.]

So it is time to face reality and drop the post frequency to one per week - somewhere near the level that I consider sustainable.

If given a choice between quantity and quality I will chose quality. I hope my readers are not too disappointed.

J

Counting and double counting – a comment on losses and accounting standards esp FAS 159

Warning: Wonky accounting alert. Don’t bother reading this if you are not interested in wonky accounting issues

Last post I asked if anyone had a decent list of the losses so far realised. The problem was double counting – which is pervasive if you do this sort of thing. Aaron of the HF implode meter (who is usually acute about these things) made a comment which misses the point entirely – but it required a little thinking – and I admit I missed it at first. Here is his comment –

Then again, some gains aren't really gains, like the gains counted on the financial co's own collapsing bonds. Sure, they could buy those back, if of course they weren't already in hock for cash...

I will get back to Aaron’s comment later…

The gains from debt forgiveness in tax

In the US if you have a debt forgiven that is income for ordinary tax purposes. It sounds quirky – but its not.

If a bank lends company A $100 and they haven’t paid it back then the bank has clearly lost $100. Company A has lost $100 too – but that loss ultimately did not come out of Company A’s pocket – it came out of the bank’s pocket.

Unless you are very careful though the tax law is going to allow both company A and the bank to claim $100 in tax losses. That is a good way for the tax system to collapse because Company A could lend to Company B who could lend to Company C and so on and a single $100 loss could theoretically produce thousands of dollars in tax losses. Those losses could wipe out the tax base of any respectable country.

Fortunately (or unfortunately depending on your point of view) the people who draft tax law in most countries are not that stupid. [I started my career doing this stuff at the Australian Treasury – so it was once an area of expertise for me. We had terrible trouble in those days with cascading tax losses in trusts…]

What most countries do is that they have provisions against “loss cascading” or the like. They fix this up ultimately by taxing gains from debt forgiveness.

When it is finally clear that Company A in my above example will not have to pay back the said $100 it gets assessed on a “gain from debt forgiveness”. The idea is that if you borrow $100 and don’t have to pay it back that is a gain of $100. It offsets the loss of $100 above.

Gains from debt forgiveness in GAAP

The accounting rules do the same thing. When Conseco (a company I knew extremely well) completed its bankruptcy it compromised a few billion in debt (mostly preferred shares). The $2 billion or so it did not have to repay was a gain for accounting purposes – and the “New Conseco” published accounts reflecting that gain.

There were similar adjustments for the removal of Conseco Finance from the balance sheet.

Done properly these gains will remove double counting of losses from the accounting system. If you add up the losses made by Conseco and the losses made by the preferred stockholders without assessing the gain from debt forgiveness you get double counting.

Accountants rightly get concerned about double counting. But the accounting answers questions in a way that might be misleading to investors.

Typical question:

How much did company X lose doing that stupid lending:

Two possible answers:

(a). $2 billion dollars

(b). $500 million dollars [but we have ignored the $1.5 billion more borne by debt holders but ultimately forgiven].

The accounting answer is technically correct but doesn’t really get to the guts of why the lending was so stupid.

Now accountants are often pedants and investors should be practical people. And I have never seen a place of more vociferous disagreement than the disagreement over FAS 159.

FAS 159 says (roughly and in this context) that if a company is using mark-to-market accounting on its assets and its liabilities it should also use mark-to-market accounting on liabilities whose market value is affected by their own credit worthiness.

To take a real example, Ambac is a bond insurer which is showing in its accounts about 7 billion in derivative losses. During the last quarter they booked about a billion in gains because the market assessment of their credit worthiness went down and so the market value of Ambac’s derivative liabilities went down. Had the accounts been measured a month later Ambac would have booked over a billion in losses on the same transactions. The result was that during the last quarter Ambac’s profit was approximately equal to its market cap. It will reverse that profit this quarter.

That profit of course was meaningless for an investor assessing Ambac stock. [I own Ambac stock - purchased at $1.30.] I don’t think the FAS159 movements make any difference in assessing Ambac. I ignore them. I think Ambac’s results were not great but they showed stabilisation which was enough given the stock price.

David Einhorn – a man considerably smarter than me - put it this way in a speech (“FAS 159: Profiting From Your Own Demise”)

If your own credit spread widening counts as revenue...

... and you pay compensation as a percent of revenue ...

... the most profitable and lucrative day in the history of your firm will be...

THE DAY YOU GO BANKRUPT!

Ok – so let’s ignore FAS 159 assessing Ambac, investment banks and the like. And the results are much worse than the headlines. The underlying of the investment banking industry sucks.

When you shouldn’t ignore FAS159

In once sense what FAS159 does is it brings forward the gains from debt forgiveness. If the price of repurchasing Lehman’s debt falls then Lehman has made a gain which it is hard for shareholders to profit from. If Lehman goes bust and has its debts forgiven Lehman has also made a gain – but it’s the same gain recognised on a mark-to-market basis as its credit worthiness collapses. [Its also hard for the shareholders to benefit from this gain.]

This is of course a problem with mark-to-market accounting generally. Mark to market accounting brings forward profits. It also brings forward losses. It’s a darn stupid way to run an investment bank when you pay cash on profits that are not realised but just bought forward. It’s a darn stupid way to invest when the profits being bought forward are the profits from total collapse and debt forgiveness.

But if you are adding up losses then the gains from debt forgiveness are a necessary part of ensuring that you don’t double count.

Likewise – in a mark-to-market world if you are adding up losses then the gains on FAS159 are a good thing to include.

Now let me bring back Aaron’s comment:

Then again, some gains aren't really gains, like the gains counted on the financial co's own collapsing bonds. Sure, they could buy those back, if of course they weren't already in hock for cash...

Aaron bought this up in the context of double counting. But this is the one context when those gains really are gains. Aaron is thinking like an investor – and I love him for it. But just for once I wanted someone thinking like an accountant.

J