Friday, June 13, 2008
Short post today: Barclays and fraudulent hedge funds
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.
Thursday, June 12, 2008
Barclays - strange, stranger and truly opaque
Barclays may be “too big to fail” but it is also probably “too big to bail out”.
What went wrong in
The origins of this disaster lie in the collapse of
Barclays decided to become a debt trading investment house. About half of its profits now come from the sort of activity that Lehman does.
“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. ”
I know they offered guaranteed bonuses – so when they slow this beast down the staff costs do not go away.
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):
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
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 revenueOh well - in bad times you get some losing days at Barclays.
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
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.
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
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
Tuesday, June 10, 2008
Australia is different: Macquarie Bank edition
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.
Monday, June 9, 2008
My old notes on Northern Rock
In 2005 I travelled to the
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
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
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
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
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
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.
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
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
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
[3] The
[4] [Regulatory footnote removed – partly because it is wrong – and I am embarrased.]
[5] On the train between
Its a sh-t business - but hey - the dollar is falling
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
Friday, June 6, 2008
Joe Gutnick: a first follow up OR Why pay stock shills when you can have News Corp for free
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.
Thursday, June 5, 2008
A colourful charachter stoops to paid stock shills
Here is a lovely profile from Forbes Magazine which in 1996 described his fortune and his (major player) status in Israeli politics.
In the article it was pretty clear that the relationships Diamond Joe had were mutually beneficial. Joe spent his money on conservative Israeli causes and famous conservative New York Rabbis and Israeli Prime Ministers promoted him and his stocks.
Joe's fame does not end there. He was the target of a purported (but real) al-Qaeda assassination plot. Indeed his name turned up in the notebook of an al-Qaeda operative on trial in France as recently as last year.
I have to be careful about what I say about him though. He sues people so this will be a post lacking in colour. He famously sued Dow Jones (ie Barrons) in the Australian courts for something they put on the internet about his business interests. He won. The High Court of Australia (equivalent to the US Supreme Court) judgement is here.
Barrons has removed the story - so I can't even link it.
Joe Gutnick has run several gold and diamond exploration companies - with some success and some failures. He spent 9 years on the BRW Australian rich list though unusually for a successful miner he has dropped off. At other times ventures have become very problematic - as this story about the insolvency of Centaur mining will attest.
He received the "Diggers Award" at the (famous) Kalgoorlie Diggers and Dealers conference.
The Rabbi/shills even went so far as to predict where he will find diamonds and/or gold. Australian fund managers were once accused of taking those predictions too seriously - because they were often right. Yes - he did actually find diamonds. And his gold companies actually produced gold proving Mark Twain wrong. (Twain's definition of a gold mine: a hole in the ground with a liar on top.)
Investing with Joe is speculative - but he has form both as an explorer/miner and as a stock promoter.
So imagine my surprise when I find that Diamond Joe's latest venture is being promoted in PAID penny stock adverts. I have a junk email address which I use to subscribe to dodgy stock emails. I don't look at it much - as there are literally thousands of emails in the box. But this one caught my eye:
So far nothing unusual - but the contact detail really caught my eye:
Legend International Holdings Inc Mr. Joseph Gutnick, +011 613 8532 2866 Chief Executive Officer Fax: +011 613 8532 2805 josephg@axisc.com.au or New York Office General Manager Business Tel: 212-223-0018 Fax: 212-223-1169 legendinfo@axisc.com.au
Visit Legend International Holdings Inc.
Website: www.lgdi.net
And the last disclaimer
This email was sent to you from STOCKGROUP's Newshotline. If you wish to take yourself off from the subscription (Investor), please use this link to cancel future deliveries. Thank you. The Information in a Stockgroup Media Inc. Newshotline is A PAID ADVERTISEMENT and is for the viewers information only. Legend International Holdings Inc. has paid a fee not exceeding $2500.00 in cash or stock to have their corporate information featured. The corporate information is purely and solely the responsibility of Legend International Holdings Inc. and it is neither commented upon, researched, or in any manner the responsibility of Stockgroup Media Inc, whose only function is as a supplier of media facilities. Any information provided by the advertisers of Stockgroup Media Inc., through its media services, is not to be construed as a recommendation or suggestion or offer to buy or sell securities, but is provided purely as an informational media service. Stockgroup Media Inc. makes no warranties or undertakings as to the accuracy or completeness of this information. All due diligence should be done by the reader or their financial advisor. Investing in securities is speculative and carries risk. Persons who wish to buy or sell securities should only do so in consultation with their registered securities advisers.
Oh how times change. Once Diamond Joe could get an Israeli Prime Minister to shill for him. Now he is stuck using StockGroup's News Hotline as a PAID ADVERTISEMENT.
(Disclosure: no positions.)
Wednesday, June 4, 2008
Will General Electric get its advanced materials back?
Tuesday, June 3, 2008
Australia really is another country: Part 2
John
[Second disclosure: no interest in any stock mentioned.]
General disclaimer
The content contained in this blog represents the opinions of Mr. Hempton. You should assume Mr. Hempton and his affiliates have positions in the securities discussed in this blog, and such beneficial ownership can create a conflict of interest regarding the objectivity of this blog. Statements in the blog are not guarantees of future performance and are subject to certain risks, uncertainties and other factors. Certain information in this blog concerning economic trends and performance is based on or derived from information provided by third-party sources. Mr. Hempton does not guarantee the accuracy of such information and has not independently verified the accuracy or completeness of such information or the assumptions on which such information is based. Such information may change after it is posted and Mr. Hempton is not obligated to, and may not, update it. The commentary in this blog in no way constitutes a solicitation of business, an offer of a security or a solicitation to purchase a security, or investment advice. In fact, it should not be relied upon in making investment decisions, ever. It is intended solely for the entertainment of the reader, and the author. In particular this blog is not directed for investment purposes at US Persons.