Roughly two years ago, I penned a piece called How Greece Killed Its Own Banks! It outlined the end result of Greece attempting to hide sparse demand for its debt by forcing its banks to binge on it using excessive leverage. Of course, once you eat too much garbage, you start to stink, and eventually... Well, let's look at it from a visual perspective:
Greece and the ECB kicked the can down the road for two years, but as fate would have it... Reality rears its ugly head, as exemplified in today's MSM headline from CNBC: Record Losses at Greek Banks Show Pain of Bond Swap
Greece's top banks posted historic losses for 2011 on Friday, hit by a bond swap last month that blew holes in their balance sheets and nearly wiped out their capital base.
Together, National, Alpha, Eurobank and Piraeus, posted an aggregate loss of 28.2 billion euros ($37.3 billion), about 10 times their current market worth or 13 percent of the country's GDP .
The banks treated losses from last month's bond swap to cut the country's debts — part of a rescue package for Greece negotiated with the European Union and International Monetary Fund — as if they took place last year.
Inflicting real losses of about 74 percent on bondholders, Greece's debt swap proved a near fatal financial torpedo for lenders, crippling the sector's capital base.
From the big four banks, only Alpha spelled out clearly where this left its Core Tier 1 capital ratio. The other three reported where capital ratios would land after their use of standby funds provided by a capital backstop, the Hellenic financial Stability Fund (HFSF).
Alpha's core capital ratio (Tier 1) fell to 3 percent. Eurobank [EFG-FF 0.61 0.004 (+0.66%) ], the country's second biggest, did not disclose the figure but said the hit left it with total equity of 875 million euros.
National Bank [NAG-FF 1.73 -0.02 (-1.14%) ], the country's biggest lender with operations in Turkey, said its Core Tier 1 ratio would reach 6.3 percent, taking into account the use of a 6.9 billion euros standby facility provided by the HFSF fund.
Piraeus gave no Tier 1 figure but said tapping up to 5 billion euros of HFSF funds would boost its total capital adequacy ratio to 9.7 percent.
Greek bank shares have shed 74 percent in the last 12 months, underperforming the Greek stock market which is down 50 percent.
...Battered by a shrinking deposit base, rising loan impairments and unable to access wholesale funding markets, banks will need to fill the resulting capital shortfall and meet capital adequacy targets set by the central bank.
They face a core Tier 1 target of 9 percent by end-September.
... With the economy mired in recession...
I think its fair to say "depression' at this point. The destruction of the banking system is what pushed the US over the edge in the early 1900s, and it had a lot more going for it than Greece does.
... and unemployment at a record 21.8 percent, asset quality deteriorated, meaning banks' non-performing loans rose further — by 130 basis points to 12.9 percent of Alpha's loan book. Eurobank's bad debt provisions rose 4.7 percent last year.
Relevant BoomBustBlog research:
Those who follow me know that I have warned of this ad nauseum, through a variety of venues and media, focusing particularly on the destructive damage the bank collapses will bring, again...
This will be exacerbated by a re-default of the Greek debt that was designed to bail out the defaulted Greek debt. Why will this happen? Greece has severe, rigid structural problems that simply cannot (and will not) be solved by throwing indebted liquidity at it. As a matter of fact, the additional debt simply exacerbates the problem - significantly! This was detailed in the post Beware The Overly Optimistic Greek Speculators As Icarus Comes Crashing Down To Earth!
Two years ago in "Greek Crisis Is Over, Region Safe", Prodi Says - I say Liar, Liar, Pants on Fire! I compared the then Grecian situation to that of Damocles. Well, things have gotten much worse since then and I believe I was one of the most bearish (and accurate) at that time. Now, Greece resembles Icarus tumbling down from the skies, drenched in Hubris. Subscribers can download my full thoughts on Greece's sustainability post bailout here - debt restructuring_maturity extension blog - March 2012. Professional and institutional subscribers should feel free to email me in order to receive a copy of the Greek restructuring model used to create these charts and come to these conclusions.
Despite extensive, self-defeating, harsh and punitive austerity measures that have combined with a lack of true economic stimulus, Greece has (to date) failed to achieve Primary Balance. For the non-economists in the audience, primary balance is the elimination of a primary deficit, yet the absence of a primary surplus, ex. the midpoint between deficit and surplus before taking into consideration interest payments.
The primary balance looks at the structural issues a country may have.
Government expenditures have outstripped revenues ever since 2007 and have gotten worse nearly every year since, despite 3 bailouts a restructuring, austerity and a default!
This situation will simply get worse, considerably worse. I demonstrated in the post The Ugly Truth About The Greek Situation That'sToo Difficult Broadcast Through Mainstream Media that anyone who purchased the last set of bailout bonds from Greece will simply lose their money as well (that's right, just like those who purchased the previous set) since Greece is still running deep in structural problems and can't afford the interest nor the principal on its borrowing. It's really that simple.
Unlike as portrayed in the media, Greece is not a standout profligate child, but simply a microcosm of what is to come to a good portion of Europe. Just scan today's headlines for evidence of such.... German Manufacturing Shrinks Fastest Since 2009
Of course it did. Germany is a net export nation whose trading partners are dancing between hard landings, serial recessions, and outright depression! Exactly how does one expect this song to be sung? Let me count the ways for you, as Germany is currently the undeserved linchpin to what's left of EU fiscal integrity. Reference The Biggest Threat To The 2012 Economy Is??? Not What Wall Street Is Telling You...
I believe Germany poses the biggest threat to global harmony for 2012. Here's why...
... That's right, a 10% loss in bunds translates into a near 50% loss in tangible equity to this insurer, which would realistically be 60% plus as the rest of the EU portfolio will compress in solidarity. Combine this with the fact that insurers operating results are facing historically unprecedented stress (see You Can Rest Assured That The Insurance Industry Is In For Guaranteed Losses!) and it's not hard to imagine marginal insurers seeing equity totally wiped out. The same situation is evident in banks and pension funds as well as real estate entities dependent on financing in the near to medium term - basically, the entire FIRE sector in both European and US markets (that's right, don't believe those who say the US banks have decoupled from Europe).
Read the entire article, The Biggest Threat To The 2012 Economy Is??? Not What Wall Street Is Telling You..., to get the full picture.
Then there's my warnings on the foolishness of believing the Dutch economy will walk through this unscathed. The MSM headlines are awash with Dutch gossip:
- Dutch Face Political Crisis Over Austerity Budget
- Another One Down? Dutch Government Near Collapse: The Dutch government’s failure to reach an agreement in talks to achieve tough spending cuts could see nervous investors push up the country’s borrowing costs.
I have actually discussed the Dutch market in depth at the ING conference...
Yes, "The Real Estate Recession/Depression is Here, Eurocalypse Style". We have already identified a Dutch real estate short candidate - subscribers (click here to subscribe), please download Northern Europe CRE short candidate #1. This company is suffering from a variety of maladies that, on an individual basis, may not seem that bad but once aggregated put it on the same path that GGP was on. The difference? This is after the so-called economic recovery, in the conservative EU state of the Netherlands, and right before the massive rate storm that will bethe Pan-European Sovereign Debt Crisis that I have warned about since 2009. The result, many properties that will either be difficult or impossible to refinance or roll over. Again, subscribers, reference Dutch REIT Debt Analysis, Blog Subscriber Edition. This is a succinct illustration of how this company will not be able to rollover much of its debt, and the absolute lack of recognition of such by the markets. Of interest is the fact that the number 3 short candidate on our short list is over 50% owned by this company (which came in as #!). With friends such as that, who needs enemies!
Q&A and discussion, part 1
Q&A and discussion, part 2
A little more than a year ago I introduced the concept of the "Economic Circle of Life" in the post Do Black Swans Really Matter? Not As Much as the Circle of Life ... In said post, I posited the interference from the concerted efforts of the global central bank price fixing cartel has done significantly more damage than it has good - to wit:
I have always been of the contention that the 2008 market crash was cut short by the global machinations of a cadre of central bankers intent on somehow rewriting the rules of economics, investment physics and global finance. They became the buyers of last resort, then consequently the buyers of only resort while at the same time flooding the world with liquidity and guarantees. These central bankers and the countries they allegedly strive to serve took on the debt and nigh worthless assets of the private sector who threw prudence through the window during the "Peak" phase of the circle of economic life, and engaged in rampant speculation. Click to enlarge to print quality...
The result of this "Great Global Macro Experiment" is a market crash that never completed. BoomBustBlog subscribers should reference The Inevitability of Another Bank Crisis while non-subscribers should see Is Another Banking Crisis Inevitable? as well as The True Cause Of The 2008 Market Crash Looks Like Its About To Rear Its Ugly Head Again, With A Vengeance.
All four corners of the globe are currently "hobbling along on one leg", under the pretense of a "global recovery".
And in today's news... Rescue Plan Falters
Europe's bold program to defuse its financial crisis by cash into banks is running out of steam.
Go figure! Today's MSM commentary also features Print More Money? Central Banks May Have No Choice.
But wasn't this a a cause of much of the liquidity trap problem in the first place? Reference Portuguese Liquidity Trap: When You Add Too Liquidity to FIRE it Burns! The BofE agrees with this postulation, reference BoE Warns Inflation Could Run Into Medium Term. Of course, I have commentary on these guys as well... BoomBustBlog analysis: Subscription only - UK Public Finances March 2010
The only bright side to this is what I posted earlier today...
I'm still quite bearish on banks/sovereigns, but as history dictates the greatest wealth has been created during the greatest dislocations, not during the greatest bull markets as popular opinion would lead many to believe. Think of the robber barons after the Great Depression...
Elsewhere in today's news...
Spain's 10-year borrowing costs increased at its debt auction, reflecting concerns about its ability to cut its budget deficit amid rising unemployment and falling economic output. 5:26 AM
I went through this in explicit detail just 3 days ago in the post The Spain Pain Will Not Wane: Continuing the Contagion Saga. It is a highly suggested read. I have also warned on Spain thoroughly in the past. It has BIG problems firmly nestled in its property, banking and financial systems. Big Problems... Elsewhere in today's MSM fodder: Spanish Banks' Bad Loans Highest Since Oct. 1994
- Subscribers only - Spanish Banking Macro Discussion Note
As with Greece, Spain, Portugal and Ireland, I warned thoroughly and quite early that Italy will deliver a rash of broken promises in regards to it public finances leading up to a probably restructuring. Today's MSM headlines simply confirm more of the same, just two years later...
Italy will miss its budget deficit targets in 2012 and 2013 and its public debt will rise in both years despite the government's austerity measures, the International Monetary Fund forecast on Tuesday.
The IMF said in its Fiscal Monitor report that Italy's deficit would fall this year to 2.4 percent of output, well above Rome's 1.6 percent target, and would decline to 1.5 percent in 2013, when Italy is aiming to balance its budget.
The forecasts are a blow to Prime Minister Mario Monti, whose popularity is sliding and whose reform efforts are meeting rising criticism and resistance as the country's borrowing costs rise.
Italy's huge public debt, the second highest in the euro zone after Greece's as a proportion of GDP, will jump to 123.4 percent of gross domestic product this year, from 120.1 percent in 2011, and edge up to 123.8 percent in 2013, the IMF said.
Earlier on Thursday the IMF forecast the Italian economy would shrink by 1.9 percent this year and contract by 0.3 percent in 2013.
The Fund's forecast that Rome will significantly overshoot its balanced budget target next year will put pressure on Monti to adopt additional corrective measures, though the IMF itself has urged against this due to the weak economy.
Here are the first four pages of our subscriber research released in March 2010, sans the Italian crystal ball of course. Subscribers, please reference Italy public finances projection.
We should all keep in mind that Contagion Should Be The MSM Word Du Jour, Not Bailouts and Definitely Not Greece! The following are what we consider to be the focal point of sovereign debt stress if things continue to kick off.
- Report_122511 - Professional/Institutional edition (Insurers, Insurance & Risk Management)
- Report_122511 -Retail edition (Insurers, Insurance & Risk Management)
Bank report 170610 Retail07/07/2010
Bank Holdings_Report_04August2008 - retail09/16/2008
Just over two years ago I warned that Spain posed a significant threat to the EU area economies. This was a very unpopular stance, and since I'm more of a medium to long term strategist and Spain didn't experience any immediate pain, my stance was considered even more morose. Well, luckily, I supplied ample research to paying subscribers who were well prepared for what is now evidently coming down the pike.
CNBC reports: Spanish Bond Yields Top 6% as Debt Crisis Flares
Spanish 10-year government bond yields broke above 6 percent for the first time this year on Monday as concerns over the country's ability to keep its finances under control pushed debt markets back into "crisis mode".
Spanish yields were expected to rise further towards the panic-triggering 7 percent level beyond which debt costs are widely seen as unsustainable unless the European Central Bank resumes its bond purchases after a two-month break.
Yields on Germany's benchmark 10-year Bund, viewed as the euro zone's safest debt, hit a record low of 1.628 percent. The previous record was established in November 2011, at the height of the debt crisis before the ECB injected around 1 trillion euros of cheap three-year funds into the banking system.
"We're back in full crisis mode," Rabobank rate strategist Lyn Graham-Taylor said. "It is looking more and more likely that Spain is going to have some form of a bailout. Assuming there is not an (ECB) intervention you would not see a cap on Spanish yields, they would just keep increasing."
The latest blow to Spanish markets followed data on Friday that showed record borrowing by its banks from the ECB. Investors' main fear is that banks parked most of the funds in domestic government debt, making them more vulnerable to sovereign stress.
Spain faces a test of investor confidence this week with an auction of two- and 10-year bonds on Thursday.
Spanish 10-year yields rose 16 basis points at 6.15 percent, five-year yields topped 5 percent, while two-year yields spiked to 3.70 percent, all 2012 highs.
Six percent is psychologically important for markets as the pace at which yields rise has accelerated on previous occasions when that level was broken. Beyond 7 percent, Greece, Portugal and Ireland struggled to raise cash in the market and were forced to seek financial aid.
Underlining investor fears, the cost of insuring Spanish debt against default hit a record high of $520,000 a year to buy $10 million of protection.
Bloomberg reports: Europe Seeks More IMF Funds on Spanish Debt
Three weeks after European leaders unveiled emergency euro- area funding exceeding the symbolic $1 trillion mark, concerns about Spain’s position have ratcheted the nation’s borrowing costs to the highest levels this year. Crisis-fighting resources will dominate talks at the International Monetary Fund’s spring meeting in Washington from April 20-22.
While the U.S. insists that Europe can overcome the crisis using its own financial firepower, euro-area officials say they’ve done enough to trigger additional global assistance. The urgency was underscored last week as Spanish and Italian yields jumped, challenging assumptions among the region’s leaders that the worst of the fallout was behind them.
“After three months that were calmer than expected, the euro crisis is back,” said Holger Schmieding, chief economist at Berenberg Bank in London. “The speed of the recent surge in yields has elements of a renewed market panic.”
Spain’s 10-year bond yield climbed as much as 18 basis points today to 6.16 percent, the highest level since Dec. 1, before retreating to 6.06 percent at 2:45 p.m. in Madrid. That extended a rise of 19 basis points last week. Similar-maturity Italian yields rose 4 basis points to yield 5.56 percent. The 17-nation currency fell 0.2 percent to $1.3048 at 2:49 p.m. in Frankfurt, after sliding below $1.30 for the first time since January.
...The surge in borrowing costs prompted one of Spain’s deputy economy ministers, Jaime Garcia-Legaz, to call on theEuropean Central Bank to resume its direct intervention in the markets.
“They should step up purchases of bonds,” Garcia-Legaz said in an April 13 interview, wading into a debate that has split the ECB. While Executive Board member Benoit Coeure signaled April 11 the ECB may buy up Spanish bonds, his Dutch colleague Klaas Knot said two days later that the ECB is “very far” from reactivating the measure.
Professional subscribers can now actually download the original Spanish Bond Haircut Model that we used to calculate loss scenarios - Spain maturity extension_010610 (The Man's conflicted copy). Despite the fact I was probably the most realistically bearish out of the bunch, things have actually gotten materially worse since this model was constructed two years ago, hence it can use a refresh. Alas, it is still quite useful.
In the general subscriber document Spain public finances projections_033010, the first four (or 12) pages basically outline the gist of the Spanish problem today, to wit:
The stress caused by Spain breaking the central bank will bring to full fruition the theory behind our European Banking and Insurance research from the last few quarters. All would do well to remember (and re-read, if need be),
- Report_122511 - Professional/Institutional edition (Insurers, Insurance & Risk Management)
- Report_122511 -Retail edition (Insurers, Insurance & Risk Management)
Bank report 170610 Retail07/07/2010
Bank Holdings_Report_04August2008 - retail09/16/2008
Related Spain subscriber research from BoomBustBlog:
Last month I released an update to our Facebook IPO analysis (subscribers may download it here FaceBook IPO & Valuation Note Update). In its caveats section, I made pains to make very clear that one of the biggest threats to Facebook investors actually emanates from within, to wit:
Those who do not subscribe to BoomBustBlog yet purchased shares in the private (or soon to be public) market may be in for a rather disrespectfully rude awakening, as illu:strated in this piece from the NY Times - Face Time With Facebook CEO Stirs Concerns on Wall Street:
SAN FRANCISCO (Reuters) - Mark Zuckerberg wants at least $5 billion from Wall Street investors, but those investors will not be getting much face time in return.
The Facebook co-founder and CEO made that clear when he skipped the social networking company's first major briefing for analysts and bankers last week. The meeting was the first of many that will take place in the run-up to an IPO that could value the company at close to $100 billion.
Zuckerberg's dismissive approach is hardly unique among elite Silicon Valley companies, but it could become an issue with investors because of the enormous control he exerts over Facebook via special shares.
"We don't think that he should be hiding from the investors," said Carin Zelenko, the director of the capital strategies department for the International Brotherhood of Teamsters, whose pension and benefit funds have more than $100 billion invested in the capital markets.
Pissing off a $100 billion investor is an absolutely horrible way to kick off life as a public company. Suppose, just suppose, said investor becomes activist... Oh yeah, on that note...
According to Zelenko, the Teamsters will send a letter to the trustees of the various Teamster funds advising them to be wary of long-term risks associated with investing in Facebook as a result of its "anti-investor" corporate governance structure.
Maybe he should send BoomBustBlog subscriptions and custom advisory services to said teamster funds, eh? :-)
Two people who attended Facebook's March 19 meeting remarked on the young CEO's absence and privately said they expected at least a cursory appearance. One analyst asked how involved Zuckerberg would be in future. In response, the company said expectations should be set pretty low, according to one of the two who was at the meeting.
"Investors are crazy to want to get in bed with a company where the guy who controls it doesn't even pretend to care about the rest of the shareholders," said Greg Taxin of activist investment firm Spotlight Advisors, who will not buy shares. "That seems like a recipe for disaster."
And now is the time to pretend that investors prefer to consider what the best long term investment is as opposed to what the sell side peddles them???
As a private company backed by mostly venture capital, Zuckerberg enjoyed great leeway in choosing how to spend his time. But Zuckerberg will control 56.9 percent of post-IPO voting shares thanks to a dual-class stock structure and voting agreements with some early investors, and may face pressure to be more available to investors.
I think these guys are missing the most salient point. Zuckerberg IS the "investor[s]", at least from a control perspective. He just wants your capital, the actual control behind the capital is, and apparently will be for the foreseeable future, his! Will this be a good deal for the guys who part with their capital yet get no control or rights in return? Well, of course it is if Facebook goes to the moon and back in regards to growth and valuation. But will it???
For the moment, with investor enthusiasm for Facebook burning hot, the dual-class structure and Zuckerberg's lack of engagement are not likely to have a big impact on demand for the shares.
Of course Facebook enthusiasm is burning hot. The coals in the "investor" (and I put this lightly) fire are being stoked by none other than the sell side agents doing God's work, among others...
Professional and institutional BoomBustBlog subscribers have access to a simplified unlocked version of the valuation model used for this report, available for immediate download - Facebook Valuation Model 08Feb2012. The full forensic opinion is available to all subscribers here FaceBook IPO & Valuation Note Update. It is recommended that subscribers (click here to subscribe) also review the original analyses (FB note final 01/11/2011) as well as the following free blog posts on the topic:
- Facebook Registers The WHOLE WORLD! Or At Least They Would Have To In Order To Justify Goldman’s Pricing: Here’s What $2 Billion Or So Worth Of Goldman HNW Clients Probably Wish They Read This Time Last Week!
- Facebook Becomes One Of The Most Highly Valued Media Companies In The World Thanks To Goldman, & Its Still Private!
- Here’s A Look At What The Goldman FaceBook Fund Will Look Like As It Ignores The SEC & Peddles Private Shares To The Public Without Full Disclosure
- The Anatomy Of The Record Bonus Pool As The Foregone Conclusion: We Plug The Numbers From Goldman’s Facebook Fund Marketing Brochure Into Our Models
- Did Goldman Just Rip Its HNW and Institutional Clients Once Again? Facebook Growth Slows Pre-IPO, Just As We Warned!
- The World's First Phenomenally Forensic Facebook Analysis - This Is What You Need Before You Invest, Pt 1
- The Final Facebook Forensic IPO Analysis: the Good, the Bad & the Ugly
As most who follow Apple know by now, management has decided to return approximately $45 billion of cash to shareholders over three years. Of course, given Apple's recent historical free cash flow generating performance, this is not a very big sacrifice assuming Apple can continue its meteoric growth (which we actually doubt).
Observations and opinions of interest:
- Cook et. al. have made it abundantly clear that they plan to run Apple differently than that of Steve Jobs Company. This can be gleaned from Jobs insisting that Apple accumulate cash for a rainy investment fund as a growth company. This would have actually have been my preference as a shareholder, assuming I believe management had both the clarity and the vision to foresee new revenue streams as well as the managerial execution to see said revenue streams through. Under Steve Jobs' reign, Apple excelled in such. Under Cook's helm, I fear less so. Contrary to popular opinion, I don't necessarily believe that this is due to Jobs being materially superior to Cook in execution and/or vision, but due to the fact that Apple's primary revenue driving product lines are maturing and competition has increased immensely (read as Google, Samsung, HTC, etc.) in the very short period since Steve Jobs incapacitation.
- Apple's management as openly and obviously declared their days as a "high growth" company are most likely numbered. This is evident because Apple has made the managerial decision that best interest of the shareholders would be better served in returning a substantial portion of its cash horde than attempting to invest it directly in ongoing (or new) operations or M&A. In other words, they believe that investors could make more or better use of the money than Apple management can. This is typical behavior for maturing companies, those that are leaving the high growth stage and entering the mature corporate phase. What is not so typical is to have a company that has been growing at the rate of Apple make such a decision, unless of course I was correct in my assumption that Apple's growth will see material growth headwinds in the near to medium term. If that is truly the case, then Apple's management is doing (by far) the best thing as per the interests of the shareholders.
- If one has to return cash to shareholders, then the actual and explicit "return" of cash is the way to do it, ex. pay a dividend. Share buybacks, although hugley popular amongst the Fortune 500 crowd, is an ineffecient and in my opinion unproven method increasing shareholder value over the long term.
Listen up you Muppets!!!!! I'm rehearsing from my Goldman Interview, applying for retail stock broker, pushing Apple inventory :-)
The update to our Apple analysis is now available to subscribers Apple Margin & Valuation Note. This is a more comprehensive, more "scientific" update and approach to our piece from last year Apple - Competition and Cost Structure. Next week, pro subscribers will see a downloadable version of the model behind this that will deliver more Apple stuff than you can ever digest in one sitting. In review, it is interesting to note certain viewpoints in the previous Apple research note, particularly considering Apple's stratospheric rise in price, ex:
"At current price of $347 Apple trades at 2011 calanderised PE of 12x on our estimates and 14x on consensus estimates. Yes, we are more optimistic than consensus, but more realistic concerning future prospects as well."
We were considerably more bullish on Apple's fundamentals than the consensus, but alas we were off the mark, and Apple's share price has went stratospheric - stratospheric to the point that it deserves its own conversation (more on that later). But (yes, there always is a but), the hypothesis behind the afore-linked note still holds. As a matter of fact, not only is it as strong now as it ever was, it is actually playing out now as I type this. I will delve into this, but before I go on I must acknowledge that the mere topic of Apple seems to bring out the immature and impolite in the blogoshpere. So much so, many are literally afraid to mention anything that is no "Pro Apple". That's right, literally "AFRAID", as was pointed out in this recent WSJ article "Apple: Deutsche Dares to Doubt".
The subscriber document is evident on its face with a variety of valuation scenarios, an indepth that the original research document didn't have - an error in execution. So, for those that don't subscribe, let me toss out food for thought, and even more telling, proof that clearly proves the premise behind articles such as:
- How Google is Looking to Cut Apple’s Margin and How the Sell Side of Wall Street Will Enable This Without Sheeple Investor’s Having a Clue
- Sliced Apple Margins For Dinner?
- Steve Jobs Calls End Of the PC, We Call The End Of The Fat Margin Tablet – Including The Pretty iPad, With Proof!
What many fail to understand is that what Google as released with its reincarnation of Android is not a new mobile OS, or a flexible handheld technology, but an innovative business model that harnesses to open source software to profitability turn the suppliers and vendors of fat margined leaders against it - literally ingenious and very, very difficult to counter without compressing your own margins. Those interested in reading more can reference Looking at the Results of Google's "Negative Cost" Business Model Employed Through Android. So, let's get started by reviewing portions of my hypothesis from last year...
Did Android overtake iOS in marketshare and growth – Yes, Even With Apple’s Successful Launch On Verizon, Google Continues To Increase It’s Lead In The Smarthphone Space
Did Apple miss in 4 to 8 quarters – Yes, as a matter of fact, they missed exactly 4 quarters later. The Only, and I Mean the Only, Investment/Research House To Warn Of An Apple Miss Is Vindicated!!!
I've had many commenters say things such as "You've been crowing about Apple crashing for two years!" The fact of the matter is simply "no", I have never said such a thing. What I did say was that Apple will deliver an unpopular and unforeseen miss and margin compression due to competition. I said this in Oct. of ’10 live on CNBC, and I also said on BoomBustBlog that miss will occur 4 to 6 quarters. It is telling that they couldn't get anyone else to say what should be obvious (reference the fear and loathing surrounding the Deustch Bank analyst note, Deutsche Dares to Doubt). Well, they did miss and they are starting to feel the effects of margin compression from competition. this effect on margins is well hidden due to management's excellent execution (Kudos to you guys, btw) combined with the fact that the mobile market is growing so wide, fast and deep that it easily conceals margin compression behind massive unit sales. Although I did start to issue warnings in 2010 about Apple margins, but I made it very, very clear that this will occur over many quarters. I also made it clear I was not short at the time of the declaration. Short term traders were able to profit from my initial short notes with tight stops that I suggested...
.. but alas, the time to short was premature for a strategy guy (as opposed to a trader), and obviously so. That does not obviate the validity of the compression theory though.
From Hudson Square research:
This morning we spot surveyed 20 people at locations in Connecticut New York and found shorter lines than for the iPhone 4s or the iPad 2. We counted roughly 550 people on line at 5 locations combined, vs. the 2,300 people we counted in our iPad 2 survey last year.
I’m a fundamental and forensic strategist, not a short term trader. In addition, I run a subscription site, hence I do not – and will not – give valuation bands or price targets to the public for free – plain and simple. As a strategist, I make medium term projections, and they have been – on balance – rather accurate. This article started out with For some absurd reason, the mere topic of Apple brings up the most immature in the blogosphere. For instance, I started saying Greece would default considerably before I warned of Apple margin compression –both stances indicated that this would be a medium term occurrence. Well, exactly two years (8 quarters) later Greece defaulted, see Greece Is Trying To Convince Portugal To Make F.I.R.E. Hot!!! For some reason, that is a lot easier to swallow than waiting even less time for Apple margins to shudder, even though the miss that I called for came at the first month of the window that I anticipated and market share and margins are exhibiting behavior congruent to what I anticipated. Of course I know what the issue is, the share price has spiked. Alas so did Greek bonds at a point, and so did the shares of RIM, who faced the same margin compression scenario that Apple faces, see RIM Gets RAMMED! Again... Remember That Contrarian Call 1st Quarter of 2010. Apple's management is head and shoulders over that of RIMM's (who should have been replace two years ago, alas it's too late now), but compression is still compression.
Now, I hear many saying, "... but Apple's margins are at all time highs!!!" Really? Did iPad margins shrink due to competition – Yes.
Okay - This is the part that the immature are bound to ignore, so I can save some of you some time and you can stop reading now. Those who are actually curious about how I come up with margin compression while others state record margins...
As it stands now, Apple is rapidly (much more so than can be gleaned from sell side analyst reports and the media) losing market share in both tablets and smartphones!
As Apple loses market share, its costs to manufacture are actually increasing due to massive competition…
Apple's losing tablet market share faster than it lost smartphone market share
Android has moved to over 44% market share in tablets from less than 3% in less than a year and a half. That's amazing and much faster growth than it exhibited in smartphones – a category in which Android literally dominated in worldwide and US smartphone growth (as well as installed base re: US) in just a few short years. Apple dropped from just over 96% to just under 55% in the same time frame. Again, as with the smartphones, the Android tablet tech is superior to that of iOS products and as iOS normalizes the difference, margins will suffer. Margins will drop (is dropping) faster for tablets because prices are coming down as fast as tech is increasing.
Prices are dropping…
Costs are increasing…
So what does all of this add up to? Margins dropping!!! Just as I said last summer... Steve Jobs Calls End Of the PC, We Call The End Of The Fat Margin Tablet – Including The Pretty iPad, With Proof!
Hey, I would hope that I raised the specter of margin compression just now in all but the staunchest of fanboys, but why isn't it showing up in the reported numbers? Because Apple had what appears to be an unrepeatable blowout quarter that allowed them to shovel large quantities of deprecated iPhones to consumers at full price. In said quarter iPhones where just over half of the company revenue. With stiff competition from Android, they will have to show and prove in terms of R&D and/or discounted pricing and that's going to cost some margin reducing, real money. The upside? The iPhone 5 should be an amazing device. You see what a little competition provides?
Still, the iPad is 20% of revenues and if it grows, margins drop even more...
Have I been wrong on Apple? – Not yet, at least not any more wrong than I have been on Greece, or RIMM. Granted the share price has soared, but remained within 10% to 13% of the recommended valuation bands for about 5 months, with benefits to nimble traders (of which I am not). The stock price has performed well, but I never said the stock price wouldn’t do well. I don’t discuss stock prices outside of paid subscriptions. If or when I’m wrong, I’ll be the first to admit it. In 4 quarters if there’s no further sign of my thesis bearing out I’ll admit it, but guess what’s happening already….
Will I be wrong on Apple? Of course its possible, but things are looking like they are following the thesis rather well.
This is the story. Apple is a phenomenal story that makes a lot of money…. But… They make supranormal profits through supranormal margins in a highly competitive space wherein they have extremely competent competition since Google arrived on the scene. Until Google, everybody else was fumbling so Apple printed money Bernanke style!. Most importantly, though… They compete directly with their own suppliers! Does anybody who is not the staunchest fanboy truly believe their profit position is sustainable competing against the very same companies they have to rely on? They can still be wildly successful, and just have a normalizing of sales growth combined with a slip in margin and there goes the rosy share price projections. Is there a chance of this happening? Once more then, shall we
Well, they are currently losing marketshare (which the media never reports)
They are forced to drop the prices of their key products (which the media seldom reports).
They are losing margin (which the media never reports)
Despite this, the company is growing profits and revenues like bananas. Why? Because the market in general is growing like bananas. There’s a lot of risks to this growth though:
- Patent litigation (the company was forced to remover the iPhone from German shelves just a month or two ago, and got it overturned)
- Natural competition (should be self explanatory)
- Margin normalization (ditto)
- Direct competition with suppliers
- Heavy macro headwinds (high unemployment, Euro crisis, China hard landing) for its two primary products, both of which are essentially luxury products
Despite this. Apple as a retailer, now has a larger market capitalization (at $542 billion), than the entire US retail sector (as defined by the S&P 500), as per Zerohedge: It's Official - Apple Is Now Bigger Than The Entire US Retail Sector
Is Apple truly worth more than the entire retail industry in the 500 stocks of the S&P 500. Just sit back and let that settle right next to the margin compression theory. And in closing, also borrowed from ZH: Apple Responsible For 90% Of Intraday NASDAPPLE Gain
If the biz class 101 rules ring true, this could very ugly very fast... The Company had a slam bang quarter last, but much of that is essentially unrepeatable in the near term, reference Anecdotal Observations On Apple's Recent Quarter.
Greece will burn economically because of financially engineered, grifted ways and it most definitely will not be the only country in the EZ to do so. I have made this unequivocally clear since February of 2010, over two years ago - reference the Coming Pan-European Sovereign Debt Crisis.
So who is responsible for such a potentially cataclysmic event and what can be done about it? Well, amazingly, I'll answer it all in one post by combining a little reporting with some hardcore, truly objective, independent financial analysis. Ahhh, I love this new media blogging thingy! From Bloomberg:
You know, one sentence into this Bloomberg piece it already smacks of realism simply by indicating it was a mistake for an unsophisticated party to do business with Goldman. It's a damn shame that such a statement can be so believable on its face without even an ounce of justification provided yet. It goes to show you exactly how many feel, deep down, Goldman actually manages to outperform. It takes money from the foolish, as opposed to earning it by being the so called best of the best. It is the best, but the best had marketing and grifting - not necessarily engineering the best solution for its clients. You see, most of the time the best solution for your clients are antithetical to both your bonus pool and margin expansion.
On the day the 2001 deal was struck, the government owed the bank about 600 million euros ($793 million) more than the 2.8 billion euros it borrowed, said Spyros Papanicolaou, who took over the country’s debt-management agency in 2005. By then, the price of the transaction, a derivative that disguised the loan and that Goldman Sachs persuaded Greece not to test with competitors, had almost doubled to 5.1 billion euros, he said.
I hate to say it, but if you're foolish enough to listen to the most profitable bank tell you not to say thing to anybody else about said deal, then you may deserve what's coming to you. If there are any sovereigns or any other entities reading this and you find yourself in a similar situation, I suggest you simply contact me. For those who aren't familiar with me and my ability to sniff things such as these out, I urge you to ask the question, Who is Reggie Middleton? I'll independently review the deal for you and give you the T-R-U-T-H! You know, its been a while since I've seen that word in articles such as these. Another damn shame. There should be plenty of opportunity for me to discuss this, for Greece is definitely not the only European entity to be diagnosed with a chronic case of Goldman's financially engineered derivative product indigestion, reference Smoking Swap Guns Are Beginning to Litter EuroLand, Sovereign Debt Buyer Beware! So, I'll be looking forward to hearing from, and visiting you France, Spain, Italy, Portugal, Ireland, Belgium...
Papanicolaou and his predecessor, Christoforos Sardelis, revealing details for the first time of a contract that helped Greece mask its growing sovereign debt to meet European Union requirements, said the country didn’t understand what it was buying and was ill-equipped to judge the risks or costs.
“The Goldman Sachs deal is a very sexy story between two sinners,” Sardelis, who oversaw the swap as head of Greece’s Public Debt Management Agency from 1999 through 2004, said in an interview.
Righhhhht!!! Two sinners... How about an orgy in an economic brothel where financial syphilis was being passed around by the pimp who told all of the excited teenage boys who were about to get their cherry popped that they didn't need condoms, those little rubber things were for wimps. BTW, those pimply faced teenage boys who were convinced to get down without their intellectual/economic prophylactics had a much more diverse selection of accents than this story may lead one to believe - as excerpted from Smoking Swap Guns...
Moreover, one of the key reasons why such manipulations continued is the apparent ignorance of the EU's Eurostat, which knew enough about these deals to tighten the rules governing their accounting-albeit only after they had served their purpose - the Ponzi! When Italy's then-Prime Minister Romano Prodi miraculously achieved a four-percentage-point improvement in Italy's budget deficit in time to usher the country into the common currency, Italy's use of accounting gimmicks was widely discussed, and then promptly ignored. As at that time, everyone was only too eager to look the other way in the drive to get the single currency up and running.
It wasn't until 2008-a decade after the deals became popular-that Eurostat was able to revise its rules to push countries to include swaps in their debt and deficit calculations. Still, till date too little is known about countries' continued exposure to the deals that are already out there.
Overall, though there is less evidence to support that there are more such swap deals that happened during the late 90's till early part of this decade, the data below showing a sharp decline in interest payments as a percentage of GDP particularly for Belgium (apart from Greece and Italy), hints that there are considerably more of these deals to be discovered. The questions is, will they be discovered before or after the respective sovereign issues record debt to the suckers sovereign fixed income investors.
Notice the extremely supercalifragilisticexpealidocious reductions Belgium, Greece and Italy have made in their interest payments from 1993 to 2000 in this graphic made pre-2000. If one didn't know better, one would have thought theses countries actually used magic to make such reductions. Italy practically cut their debt service (projected, of course) in half. It really makes one wonder. I'm just saying...
BoomBustBlog subscribers (click here to subscribe) are welcome to download our contagion models which have been quite accurate thus far in mapping out where this has, and quite likely will lead us.
- Sovereign Contagion Model - Retail (961.43 kB 2010-05-04 12:32:46)
- Sovereign Contagion Model - Pro & Institutional
In Contagion Should Be The MSM Word Du Jour, Not Bailouts and Definitely Not Greece! I included sample output from the Model detailing the various paths of contagion that can be taken given default by "XYZ" country..
And back to the Bloomberg article...
Goldman Sachs’s instant gain on the transaction illustrates the dangers to clients who engage in complex, tailored trades that lack comparable market prices and whose fees aren’t disclosed. Harvard University, Alabama’s Jefferson County and the German city of Pforzheim all have found themselves on the losing end of the one-of-a-kind private deals typically pitched to them by securities firms as means to improve their finances.
Goldman Sachs DNA
“Like the municipalities, Greece is just another example of a poorly governed client that got taken apart,” Satyajit Das, a risk consultant and author of “Extreme Money: Masters of the Universe and the Cult of Risk,” said in a phone interview. “These trades are structured not to be unwound, and Goldman is ruthless about ensuring that its interests aren't compromised -- it’s part of the DNA of that organization.”
Nawwww!!! It can't be! Say it "Ain't True!" For those who haven't seen this VPRO special on how Goldman Sachs looted European countries years ago, it is literally a must see. The mayor of a small Italian village speaks candidly and openly to the audience. All it really takes is to hear it from the horse's mouth. If that's not good enough, you can always hear my 15 minute contribution, or that of Simon Johnson, or even Matt Taibbi. Yes, it's all here, complete with English translations where necessary.
A gain of 600 million euros represents about 12 percent of the $6.35 billion in revenue Goldman Sachs reported for trading and principal investments in 2001, a business segment that includes the bank’s fixed-income, currencies and commodities division, which arranged the trade and posted record sales that year. The unit, then run by Lloyd C. Blankfein, 57, now the New York-based bank’s chairman and chief executive officer, also went on to post record quarterly revenue the following year.
So Greece helped "grease' the FICC bonus pool under Lord Lloyd, eventually catapulting him up to the CEO position. Hmmm... Of course, you don't get something for nothing. Methinks Goldman et. al. may have a couple of bones stuffed up into thier closet as well. Speaking of FICC, reference this excerpt from So, When Does 3+5=4? When You Aggregate A Bunch Of Risky Banks & Then Pretend That You Didn't?...
Banks exposure to interest rate and foreign exchange contracts
With volatility in currency markets exploding to astounding levels (with average EUR-USD volatility of 16.5% over the past year (September 2008-09) compared to 8.9% over the previous year), commercial and investment banks trading revenues are expected to remain highly unpredictable. This, coupled with huge Forex and Interest rate derivative exposure for major commercial banks, could trigger a wave of losses in the event of significant market disruptions - or a race to the exit door of this speculative carry trade. Additionally most of these Forex and Interest rate contracts are over-the-contract (OTC) contracts with 96.2% of total derivative contracts being traded as OTC. This means no central clearing, no standardization in contracts, the potential for extreme opacity in pricing, diversity in valuation as well as a dearth of liquidity when it is most needed - at the time when everyone is looking to exit. Goldman Sachs has the largest OTC traded contracts with 98.5% of its derivative contracts traded over the counter. With the 5 largest banks representing 97% of the total banking industry notional amount of derivatives and most of these contracts being traded off exchange, the effectiveness of derivatives as a hedging instrument raises serious questions since most of these banks are counterparty to one another in one very small, very tight circle (see the free article, "As the markets climb on top of one big, incestuous pool of concentrated risk... ").
The table below compares interest rate contracts and foreign exchange contracts for JPM, GS, Citi, BAC and WFC.
JP Morgan has the largest exposure in terms of notional value with $64,604 trillion of notional value of interest rate contracts and $6,977 trillion of notional value of foreign exchange contracts. In terms of actual risk exposure measured by gross derivative exposure before netting of counterparties, JP Morgan with $1,798 bn of gross derivative receivable, or 21.7x of tangible equity, has the largest gross derivative risk exposure followed by Bank of America ($1,760 bn, or 18.1x). Bank of America with $1,393 bn of gross derivatives relating to interest rate has the highest exposure towards interest rate sensitivity while JP Morgan with $154 bn of Foreign exchange contracts has the highest exposure from currency volatility. We have explored this in forensic detail for subscribers, and have offered a free preview for visitors to the blog: (JPM Public Excerpt of Forensic Analysis Subscription 2009-09-18 00:56:22 488.64 Kb), which is free to download, and JPM Report (Subscription-only) Final - Professional, or JPM Forensic Report (Subscription-only) Final- Retail as well as a free blog article on BAC off balance sheet exposure If a Bubble Bubble Bursts Off Balance Sheet, Will Anyone Be There to Hear It?: Pt 3 - BAC).
Cute graphic above, eh? There is plenty of this in the public preview. When considering the staggering level of derivatives employed by JPM, it is frightening to even consider the fact that the quality of JPM's derivative exposure is even worse than Bear Stearns and Lehman‘s derivative portfolio just prior to their fall. Total net derivative exposure rated below BBB and below for JP Morgan currently stands at 35.4% while the same stood at 17.0% for Bear Stearns (February 2008) and 9.2% for Lehman (May 2008). We all know what happened to Bear Stearns and Lehman Brothers, don't we??? I warned all about Bear Stearns (Is this the Breaking of the Bear?: On Sunday, 27 January 2008) and Lehman ("Is Lehman really a lemming in disguise?": On February 20th, 2008) months before their collapse by taking a close, unbiased look at their balance sheet.
Subscribers, see WFC Research Note Sep 2009 2009-09-30 13:01:30 281.29 Kb, ~ WFC Off Balance Sheet Exposure 2009-10-19 04:25:53 258.77 Kb ~ WFC Investment Note 22 May 09 - Retail 2009-05-27 01:55:50 554.15 Kb ~ WFC Investment Note 22 May 09 - Pro 2009-05-27 01:56:54 853.53 Kb ~ Wells Fargo ABS Inventory 2008-08-30 06:40:27 798.22 Kb
Of course, this article is about Goldman right? In addition, exposure doesn't necessarily mean that the shit will it the fan, right? After all, it's different this time!!!
The interest rate storm is coming, that is unless Europe can maintain historically low rates as several countries default. Then again, they never default, right...
Don't believe me, let's look at history...
Again, click the little pics to make big pics...
So, as I was saying...
Hunting the Squid, Part2: Since When Is Enough Derivative Exposure To Blow Up The World Something To Be Ignored?
Goldman is much more highly leveraged into the derivatives trade than ANY and ALL of its peers as to actually be difficult to chart. That stalk representing Goldman's risk relative to EVERY OTHER banks is damn near phallic in stature!
Click those little pictures to make BIG pictures....
As opined earlier through the links "The Next Step in the Bank Implosion Cycle???"and As the markets climb on top of one big, incestuous pool of concentrated risk... , this is not a new phenomenon. Quite to the contrary, it has been a constant trend through the bubble, and amazingly enough even through the crash as banks have actually ratcheted up risk and assets in a blind race to become TBTF (to big to fail), under the auspices of the regulatory capture (see Lehman Dies While Getting Away With Murder: Introducing Regulatory Capture). So, what is the logical conclusion? More phallic looking charts of blatant, unbridled, and from a realistic perspective, unhedged RISK starring none other than Goldman Sachs...
And to think, many thought that JPM exposure vs World GDP chart was provocative. I query thee, exactly how will GS put a real workable hedge, a counterparty risk mitigating prophylactic if you will, over that big green stalk that is representative of Total Credit Exposure to Risk Based Capital? Short answer, Goldman may very well be to big for a counterparty condom. If that's truly the case, all of you pretty, brand name Goldman counterparties out there (and yes, there are a lot of y'all - GS really gets around), expect to get burned at the culmination of that French banking party I've been talking about for the last few quarters. Oh yeah, that perpetually printing clinic also known as the Federal Reserve just might be running a little low on that cheap liquidity antibiotic... Just giving y'all a heads up ahead of time...
... I'd like to announce to the release of a blockbuster document describing the true nature of Goldman Sachs, a description that you will find no where else. It's chocked full of many interesting tidbits, and for those who found "The French Government Creates A Bank Run? Here I Prove A Run On A French Bank Is Justified And Likely" to be an iteresting read, you're gonna just love this! Subscribers can access the document here:
Okay, now back to that Bloomberg article...
The Goldman Sachs transaction swapped debt issued by Greece in dollars and yen for euros using an historical exchange rate, a mechanism that implied a reduction in debt, Sardelis said. It also used an off-market interest-rate swap to repay the loan. Those swaps allow counterparties to exchange two forms of interest payment, such as fixed or floating rates, referenced to a notional amount of debt.
The trading costs on the swap rose because the deal had a notional value of more than 15 billion euros, more than the amount of the loan itself, said a former Greek official with knowledge of the transaction who asked not to be identified because the pricing was private. The size and complexity of the deal meant that Goldman Sachs charged proportionately higher trading fees than for deals of a more standard size and structure, he said.
“It looks like an extremely profitable transaction for Goldman,” said Saul Haydon Rowe, a partner in Devon Capital LLP, a London-based firm that advises global investors on derivatives disputes.
Goldman Sachs declined to comment about how much it made on the swaps. Fiona Laffan, a spokeswoman for the firm in London, said the agreements were executed in accordance with guidelines provided by Eurostat, the EU’s statistical agency.
Oh yeah, Eurostat! That bastion of Eurofellas who really, really know what they're talking about - as evidenced from Lies, Damn Lies, and Sovereign Truths: Why the Euro is Destined to Collapse!
and the EU on goverment balance??? Way, way, way off.
“Greece actually executed the swap transactions to reduce its debt-to-gross-domestic-product ratio because all member states were required by the Maastricht Treaty to show an improvement in their public finances,” Laffan said in an e- mail. “The swaps were one of several techniques that many European governments used to meet the terms of the treaty.”
The Greeks (again)...
According to people familiar with the matter interviewed by China Securities Journal, Goldman Sachs Group Inc. did as many as 12 swaps for Greece from 1998 to 2001, while Credit Suisse was also involved with Athens, crafting a currency swap for Greece in the same time frame.
Under its "off-market" swap in 2001, Goldman agreed to convert yen and dollars into euros at an artificially favorable rate in the future. This helped Greece to use that "low favorable rate" when it recorded its debt in the European accounts-pushing down the country's reported debt load.
Moreover, in exchange for the good deal on rates, Greece had to pay Goldman (the amount wasn't revealed). And since the payment would count against Greece's deficit, Goldman and Greece came up with another twist: Goldman effectively loaned Greece the money for the payment, and Greece repaid that loan over time. And the two sides structured the loan as another kind of swap. So, the deal didn't add to Greece's debt under EU rules. Consequently, Greece's total debt as a percentage of GDP fell from 105.3% to 103.7%, and its 2001 deficit was reduced by a tenth of a percentage point in GDP terms, according to people close to Goldman.
Another action that smacks of Hellenic manipulation, at least to the staff of BoomBustBlog: for years it apparently and simply omitted large portions of its military-equipment spending from its deficit calculations. Though, European regulators eventually prevailed on Greece to count everything and as a result, in 2004, there was a massive revision of Greek deficit figures from 2000 (a budget deficit of 2.0% of GDP in 2000 to beyond the 3% deficit limit in 2004), by then Greece had already gained entrance to the euro. As in my trying to prepare for the coming sovereign debt crisis, timing is everything, isn't it???
Cross-currency swaps are contracts borrowers use to convert foreign currency debt into a domestic-currency obligation using the market exchange rate. As first reported in 2003, Goldman Sachs used a fictitious, historical exchange rate in the swaps to make about 2 percent of Greece’s debt disappear from its national accounts. To repay the 2.8 billion euros it borrowed from the bank, Greece entered into a separate swap contract tied to interest-rate swings.
Falling bond yields caused that bet to sour, and tweaks to the deal failed to prevent the debt from almost doubling in size by the time the swap was restructured in August 2005.
Greece, which last month secured a second, 130 billion-euro bailout, is sitting on debt equal to about 160 percent of its GDP as of last year...
The derivative Loudiadis offered Sardelis in 2001 was also complex. Designed to provide a cheap way to repay 2.8 billion euros, the swap had a “teaser rate,” or a three-year grace period, after which Greece would have 15 years to repay Goldman Sachs, Sardelis said. All in, the deal appeared cheap to officials at the time, he said.
“We calculated that this had an extra cost above our normal funding cost on the yield curve of 15 basis points,” Sardelis said....
‘Very Bad Bet’
Sardelis said he realized three months after the deal was signed that it was more complex than he appreciated. After the Sept. 11, 2001, attacks on the U.S., bond yields plunged as stock markets sold off worldwide. That caused a mark-to-market loss on the swap for Greece because of the formula used by Goldman Sachs to compute Greece’s repayments over time.
“If you calculated that when we did it, it looked very nice because the yield curve had a certain shape,” Sardelis said. “But after Sept. 11, we realized this would be the wrong formula. So after we discussed it with Goldman Sachs, we decided to change to a simpler formula.”
The revised deal proposed by the bank and executed in 2002, was to base repayments on what was then a new kind of derivative -- an inflation swap linked to the euro-area harmonized index of consumer prices. An inflation swap is a financial bet that pays off according to the degree to which a consumer-price index exceeds or falls short of a pre-specified level at maturity.
That didn’t work out well for Greece either. Bond yields fell, pushing the government’s losses to 5.1 billion euros, according to an analysis commissioned by Papanicolaou. It was “a very bad bet,” he said in an interview.
“This is even more reprehensible,” Papanicolaou said of the revised deal. “Goldman asked them to make a change that actually made things even worse because they went into an inflation swap.”
And what the hell were they expecting? Didn't they realize that it was Goldman that was on the other side of the swap? Do you expect a wolf to turn down a pound of meat if he is asked if he wants it?
Greece was handicapped, in part, by the terms Goldman Sachs imposed, he said.
“Sardelis couldn’t actually do what every debt manager should do when offered something, which is go to the market to check the price,” said Papanicolaou, who retired in 2010. “He didn’t do that because he was told by Goldman that if he did that, the deal is off.”
Sardelis declined to comment about the analysis, as did Petros Christodoulou, director general of the debt-management agency since February 2010.
It isn’t unusual for dealers to impose confidentiality requirements on clients in complex transactions to prevent traders from using the information to front-run or trade against the bank arranging and hedging the deal, said a former official who analyzed the swap and asked not to be named because the details are private.
Personally, I dont care if it isn't unusual to impose confidentiality on complex deals. If you don't understand the deal, seek qualified, impartial assistance. If you're counterparty doesn't like that, then ever so politely tell them to f@ck off - PERIOD! If you enter into a deal that you don't understand, don't be surprised from that itchy/burning/stretched feeling you're bound to feel in your anus a few months into the deal.
Goldman Sachs’s initial 600 million-euro gross profit “sounds like a large number, but you have to take into account what the bank will be setting aside as a credit reserve, the cost to Goldman to fund the loan and the cost of hedging the currency component,” said Peter Shapiro, managing director of Swap Financial Group LLC in South Orange, New Jersey, an independent swaps adviser. “It’s hard to tell what the profit margin would have been.”
Hmmmm... Methinks I could tell that it would have been a lot higher than a plain vanilla loan's profit margin at prevailing rates, no?
The report Papanicolaou commissioned after taking over the agency showed the repayment formula meant that Greece would have to pay Goldman Sachs 400 million euros a year, he said. The coupon and the mark-to-market swings on the swap prompted George Alogoskoufis, then finance minister, to decide to restructure the deal again to limit losses, Papanicolaou said.
Loudiadis and a team of Goldman Sachs advisers returned to Athens in August 2005, according to former Greek officials. The agreement they reached to transfer the swap to National Bank of Greece SA and extend the maturity to 2037 from 2019, gave the Greeks what they wanted, Papanicolaou said.
The 5.1 billion-euro mark-to-market value of the swap was “locked in,” Papanicolaou said. It was that politically motivated decision to restructure and fix the increased market value that did as much damage as the original swap, said Sardelis, now a board member of Ethniki General Insurance Co., a subsidiary of National Bank of Greece.
“You can’t have prudent debt management if you change all the assumptions all the time,” he said.
Gustavo Piga, a professor of economics at University of Rome Tor Vergata and author of “Derivatives and Public Debt Management,” sees a different lesson.
“In secret deals, intermediaries have the upper hand and use it to squeeze taxpayers,” Piga said in an interview. “The bargaining power is in investment banks’ hands.”
Professor Gustavo Piga is the esteemed fellow who offered the nuggets of wisdom in the VPRO video above.
The nitty gritty on Goldman Sachs that you just won't get anywhere else...
If you haven't already, please do review the first four parts of this series, and if so skip past this break and into the nitty gritty--->
|I'm Hunting Big Game Today:The Squid On The Spear Tip, Part 1 & Introduction||
Summary: This is the first in a series of articles to be released this weekend concerning Goldman Sachs, the Squid! In this introduction (for those who do not regularly follow me) I demonstrate how the market, the sell side, and most investors are missing one of the biggest bastions of risk in the US investment banking industry. I will also...
|Hunting the Squid, Part2: Since When Is Enough Derivative Exposure To Blow Up The World Something To Be Ignored?||
Hunting the Squid, Part2: Since When Is Enough Derivative Exposure To Blow Up The World Something To Be Ignored?
Welcome to part two of my series on Hunting the Squid, the overvaluation and under-appreciation of the risks that is Goldman Sachs. Since this highly analytical, but poignant diatribe covers a lot of material, it's imperative that those who have not done so review part 1 of this series, I'm Hunting Big Game Today:The Squid On The Spear Tip, Part...
|Reggie Middleton Serves Up Fried Calamari From Raw Squid: Goldman Sachs and Market Perception of Real Risks!|
|Hunting the Squid, part 4: So, What Else Can Go Wrong With The Squid? Plenty!!!||
Yes, this more of the hardest hitting investment banking research available focusing on Goldman Sachs (the Squid), but before you go on, be sure you have read parts 1.2. and 3: I'm Hunting Big Game Today:The Squid On A Spear Tip, Part 1 & Introduction Hunting the Squid, Part2: Since When Is Enough Derivative Exposure To Blow Up The World Something To...
Reggie Middleton on Realism and being Offensively Honest
The many ways to reach Reggie Middleton:
Or simply email me.
In a discussion that I had over at ZeroHedge there came the topic of whether bank runs are possible in Europe. Well, I believe we've already had some devastating one's (ex. Northern Rock) but if one takes the continent only or the EZ in particular, we still have a significant systemic threat. The gist behind the argument is that if the true economic capital is weakened to the point that depositors/creditors/counterparties make a run for it, the sovereign nation in which it is domiciled will simply nationalize it. Hmmm... Let's take a look at how that might work out, as excerpted from Overbanked, Underfunded, and Overly Optimistic: The New Face of Sovereign Europe March 2010
I will attempt to illustrate the "Overbanked" argument and its ramifications for the mid-tier sovereign nations in detail below and over a series of additional posts.
Sovereign Risk Alpha: The Banks Are Bigger Than Many of the Sovereigns
Imagine the Swiss nationalizing just UBS and Credit Suisse, whose assets constitute 500% of the Swiss GDP. THAT'S JUST TWO BANKS!!! Imagine if the entire banking system got into trouble from daisy chaining European defaults???
This is just a sampling of individual banks whose assets dwarf the GDP of the nations in which they're domiciled. To make matters even worse, leverage is rampant in Europe, even after the debacle which we are trying to get through has shown the risks of such an approach. A sudden deleveraging can wreak havoc upon these economies. Keep in mind that on an aggregate basis, these banks are even more of a force to be reckoned with. I have identified Greek banks with adjusted leverage of nearly 90x whose assets are nearly 30% of the Greek GDP, and that is without factoring the inevitable run on the bank that they are probably experiencing. Throw in the hidden NPAs that I cannot discern from my desk in NY, and you have a bank that has problems, levered into a country that has even more problems.
If BoomBustBloggers remember, I went on a tear with my theory of European bank runs last summer. Reference:
- The Anatomy Of A European Bank Run: Look At The Banking Situation BEFORE The Run Occurs!
- The Fuel Behind Institutional “Runs on the Bank” Burns Through Europe, Lehman-Style!
- On Your Mark, Get Set, (Bank) Run! The D…
- The Mechanics Behind Setting Up A Potential European Bank Run Trade and European Bank Run Trading Supplement
I strongly suggest that any interested in the topic peruse the links above if they haven't already done so. They drive the point home. And on the topic of Greece and bank runs, ZH runs Greek Bank Deposit Outflows Soar In January, Third Largest Ever
According to just released data from the Bank of Greece, January saw Greeks doing what they do best (in addition to striking of course): pulling their money from local banks, after a near record €5.3 billion, or the third highest on record, was withdrawn from the local banking system. As a result, total bank cash has now dropped to just €169 billion, down from €174 billion in December, and the lowest since 2006. This is an 18% decline from a year ago, or €37 billion less than the €206 billion last January, and is a whopping 30% lower than the all time deposit highs from 2007, as nearly €70 billion in cash has quietly either left the country or been parked deep in the local mattress bank.
Were the big Greek banks effectively nationalized already? Don't the depositors and counterparties/creditors know that Bank of Greece and the ECB have their backs. I mean, come on now. Paranoia is simply going too far. MG Global account holders may be getting some of their monies back, as is somebody who had an account somewhere in Lehman. I remember when I made this warning about Bear Stearns back in January of 2008 (2 months before Bear Stearns fell, while trading in the $100s and still had buy ratings and investment grade AA or better from the ratings agencies). Nobody wanted to listen: Is this the Breaking of the Bear?
Once again, do I have a crystal ball??? Or just a spreadsheet??? After all, the ECB just injected a record amount of junk collateral backed, near ZIRP liquidity into the European banking system - Helicopter Ben style - a half trillion Euro worth, or 3/4 trillion dollars or so. And to think, many believe Hip Hop music and iPhones to be one of the biggest US exports:-) Of course, everybody on the sell side sees this as bullish - reference Cascade is to Domino as Greece is to Por… and Does Anyone See This Emergency As An Eme… for a more common sense approach to this ECB bailout of bailouts. As for just why such a massive liquidity injection was necessary? Well, as this excerpt from the subscriber edition of the BNP Paribas report is marked...
'Nuff said! Subscribers, as (not if, but as) this breaks, these are the companies trading at the valuations that are most shortable/profitable in my opinion...
- US REIT Fire Sale Scenario Analysis
US REIT Foreclosure Scenario Analysis
- US REIT Sample Property Valuation
- US REIT Cashflows and Debt Preliminary Analysis
European CRE (this one is a bit dated)
And the cat that was already let out of the bag...
Today's big headline from Bloomberg: Euro-Area Banks Tap ECB for Record Amount of Three-Year Cash
Euro-area banks tapped the European Central Bank for a record amount of three-year cash in an operation that may boost bond and equity markets.
The Frankfurt-based ECB said today it will lend 800 financial institutions 529.5 billion euros ($712.2 billion) for 1,092 days. Economists predicted an allotment of 470 billion euros, according to the median of 28 estimates in a Bloomberg News survey. In the ECB’s first three-year operation in December, 523 banks borrowed 489 billion euros.
So, basically, nearly twice as many banks are in trouble now as compared to just three months ago. This is bullish, right???!!!
“The astonishing number this time is the number of banks participating, which signals that a lot more small banks looked for the money and it is likely they will pass it on to the economy,” said Laurent Fransolet, head of fixed income strategy Barclays Capital in London, who estimates about 300 billion euros of the total is new lending. “So the impact may be bigger than with the first one.”
I'm not familiar with the quality and/or strength of the shit they smoke over there in London, but from the looks of things it appears to be potent enough. Let's take this bloke's comment to hear, "it is likely they will pass it on to the economy,” . Okay, now where do I begin? Exactly how much of first LTRO made it into the actual economy versus being hoarded by the banks? Is the "pass[ing] it on the the economy" the reason why there is now so much liquidity in European CRE? Here's a quick reminder of where I stand on this...
So, it's safe to say that all of those European REITs and real estate concerns with property mortgages coming up for renewal while underwater will definitively see most of that LTRO 2 money, right? Let's all take a deep breath and hold it as we wait for that one to happen. Ready? One... Two... Three...
What do you think, pray tell, happens when the liquidity starved, capital deprived, over leveraged banks fail to roll over all of that underwater Eu mortgage debt?
Investors seeking safety in Germany, the UK and France may truly be in for a rude awakening!
Reggie Middleton Featured in Property EU, one of Europes leading real estate publicatios
Those who wish to download the full article in PDF format can do so here: Reggie Middleton on Stagflation, Sovereign Debt and the Potential for bank Failure at the ING ACADEMY-v2.