As the Pan-European ponzi scheme starts to unravel, I would like to take this time to remind all of the value of this new media, this medium of reporting and opinionated analysis known as the blogosphere. To my knowledge, there are very, very few public sources where one can the granular information that would allow one to not only identify, not only circumvent, but actually profit from global banking collapse. Yes, the mainstream media has its placed, burned permanently in the psyche of content consumers, but it is nigh time the blogosphere moved several rungs up the evolutionary ladder. If you recall, it was a (BoomBust)blog that warned of the pending collapse of Bear, Lehman, WaMu, and Countrywide.

And so it begins...

Last year I was invited to give the keynote speech at ING's Commercial Real Estate Valuation seminar in Amsterdam. The keynote was delivered in April, and let there be no mistake - I pulled no punches.

To give you an idea of the tone that I set in this very large European financial insitution, this was the opening slide to the presentation...

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Although this was a real estate valuation seminar, the premise was consistent throughout: A dearth of available financing through a weak banking system coming off of a real asset and credit bubble burst spells big trouble. The "big trouble" is much worse than many make it out to be. You see, the one thing that nearly all banks lend against is real estate, and the less banks lend against said real estate, the less said real estate is worth. A vicious, self-reinforcing circle of real asset price correction in an attempt to reach equilibrium.

So, what does this have to do with French Banks?

Well, the big thing in the media nowadays is the sovereign debt crisis. But this crisis is but one part of the solvency puzzle, albeit a big one. Basically, the banks are saying we have XX billion Euro on our balance sheets, when in actuality they have 80% of XX billion euro, at the same time asset values are steadily declining, chewing up equity along the way. I illustrated this in detail in the video above. You see, the concerted efforts of global financial central planners world wide have distorted the valuation and pricing of real asset markets. This distortion has led many to believe that the crash/correction of 2008 is over without us ever having to face true reversion to the mean. Let me be the one to tell you, that just ain't happening... Reference Do Black Swans Really Matter? Not As Much as ...

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 File Icon 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.

 I will go into the impending continuation of the real estate debacle in a later post, but the impetus behind the debacle is the topic du jour, Is Another Banking Crisis Inevitable?In said piece I made it clear that the global banking lie that the so called "risk free" assets carried on the books are not only far from "Risk free" but have wiped much, if not most of the tangible equity from banking books. When, not if, but when, these banks are forced to make a market price transaction, hell will break loose. My post last month, Eighteen Percent of the EU is Literally Junk, Carried As Risk Free Assets at Par Using 30x+ Leverage: Bank Collapse is Inevitable!!! basically says it all.

Referencing the material from the ING presenation..

Eurocalypse Cometh! Principal Haircuts, Serial Bailouts, ECB Insolvent! Disruptive Sound Of Dominoes In Background Going "Click, Clack"! BoomBustBloggers Instructed To Line Up Bearish Positions Again! 

If one were to even come close to marking the EU banks books to reality, market prices, or anything in between, the Lehman situation would look tame in compariosn! As excerpted from the subscriber document: File Icon The Inevitability of Another Bank Crisis

(click to enlarge) Even using overly optimisitic and much too rosy Eurostat numbers, the banks are sitting on top of a huge equity hole. The blue box below covers what we feel are the real numbers - a truly gaping hole!

And in the End, What Does It All Mean?

LGD 100+: What's the Possibility of Certain European Banks Having a Loss Given Default Approaching 100%?

It is not as if this wasn't foreseeable, for I have been warning of this hole since 2009/early 2010. In the BoomBustBlog subscriber document File Icon European Bank's Greece exposure, I gave the macro warning. I drilled down to more specifics namin the bank I felt was most at risk in this subscriber document. The follow up to this document was going to come out late today, but the CEO has let the cat out of the bag.

FT reports SocGen profit warning on Greek debt:

 Société Générale has warned that its profit target for 2012 will be “difficult to achieve” as a writedown linked to its Greek exposure weighed on quarterly results. 

...Frédéric Oudéa, chairman and chief executive, cautioned that the group’s €6bn net income target for 2012 looks hard to reach “within the scheduled time frame”.

...However, he said that second-quarter results demonstrated the “resilience” of Société Générale, despite the inclusion of a €395m pre-tax writedown due to Greek government bonds held by France’s second-biggest bank.

The writedown is due to Société Générale’s pledge to play a role in the Greek bail-out plan finalised in July in which all the Greek bond holdings of the French banks maturing before 2020 will be involved. BNP Paribas and Crédit Agricole have also made provisions concerning the loss to bondholders.

Société Générale has no bonds which mature after 2020, a spokeswoman said, adding that the writedown includes sovereign bonds held by Geniki Bank, Société Générale’s Greek subsidiary.

Net income in the three months to June 30 was below consensus analyst expectations at €747m on revenue down 2.6 per cent to €6.5bn, but including the impact of the writedown.

Net income for the first half declined 22.5 per cent to €1.66bn on revenue down 1 per cent to €13.12bn. The group posted half-year earnings per share of €2.05, down from €2.75 last year.

The bank’s shares fell 6.94 per cent to €30.25 in early morning trading.

Société Générale, which last year unveiled a plan to double net profit by 2012, said that targets had assumed a return to a normal economic environment which “has not occurred,” naming the recent eurozone and US debt crises, as well as the political turmoil in the Middle East and Africa as concerns.

I will have some more goodies along these lines that still HAVE NOT been broached by either the pop media or the sell side for BoomBustBlog subscribers very soon.

Tools for tracking the ever elusive path of contagion for BoomBustBlog subscribers:

More On My Observations Of The French!

Trading the BoomBustBlog Forensics: Observations From The Field

Unsurprisingly CAC had a plunge yesterday, one of the worst performers in all of the European markets - exactly as we have warned, reference Observations Of French Markets From A Trader's Perspective and excerpts from European Bank Run Trading Supplement Available for Download:

The Monthly chart, with only one more trading day left tomorrow [Friday] shows we are breaking the monthly trendline at 3910 THIS month (July), even though on a weekly basis, there were a few weeks this month where it was below already.

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That’s a quite NEGATIVE new development, with the 1st natural target being around 3600 (high above the trendline was 4200, break point  3900 - so a 300 point range) that 3600 level is the Nov10 low.

 Additional posts on the topic of Bank Runs

  1. The Mechanics Behind Setting Up A Potential European Bank Run Trade and European Bank Run Trading Supplement
  2. What Happens When That Juggler Gets Clumsy?
  3. Let's Walk The Path Of A Potential Pan-European Bank Run, Then Construct Trades To Profit From Such
  4. Greece Is Fulfilling Our Predictions Of Default Precisely As Predicted This Time Last Year
  5. The Anatomy Of A European Bank Run: Look At The Banking Situation BEFORE The Run Occurs!
  6. The Fuel Behind Institutional “Runs on the Bank” Burns Through Europe, Lehman-Style!
  7. Multiple Botched and Mismanaged Stress Test Have Created The Makings Of A Pan-European Bank Run
  8. Observations Of French Markets From A Trader's Perspective
  9. On Your Mark, Get Set, (Bank) Run! The D…


Published in BoomBustBlog

Here are a few updates supporting my thesis of the potential of a serial bank run (another one, that is) in Europe and the Eurozone. As was the case with Lehman Brothers and Bear Stearn (two of the biggest bank collapses that I have called during this "ongoing crisis), counterparties and funding sources get gun shy in the face of overvalued collateral and signs of insolvency - as well they should. Remember, we have identified banks that are at risk of Lehman 2.0, and for the exact same reasons that Lehman was at risk of such. Reference The Anatomy Of A European Bank Run: Look At The Banking Situation BEFORE The Run Occurs!, which I consider to be a must read!

Focusing on the most pertinent and contagious of the issues at hand leads us back to the initial premise of a European bank run. I laid the foundation for said topic discussion last Thursday in "The Fuel Behind Institutional “Runs on the Bank" Burns Through Europe, Lehman-Style" and the fear du jour is a European version of the Lehman Brothers or Bear Stearns style bank run. The aforelinked at explanatory piece is a must read precursor to this illustration of what can only be described as the anatomy of a European bank run - before the fact. Remember how the pieces of the puzzle were perfectly laid together for a Bear Stearns collapse in January of 2008, two months before the bank's actual collapse? Reference "Is this the Breaking of the Bear?" in which Bear Stearns collapse was illustrated in explicit, graphic detail. Lehman Brothers wasn't impossible to see either (Is Lehman really a lemming in disguise? Thursday, February 21st, 2008 | Web chatter on Lehman Brothers Sunday, March 16th, 2008).

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As excerpted from Let's Walk The Path Of A Potential Pan-European Bank Run, Then Construct Trades To Profit From Such:

The biggest European banks receive an average of US$64bn funding through the U.S. money market, money market that is quite gun shy of bank collapse, and for good reason. Signs of excess stress perceived in the US combined with the conservative nature of US money market funds (post-Lehman debacle) may very well lead to a US led run on these banks.

A trader that follows my work through the social media circles reports the pulling of even more liquidity from the eurozone area. This is a note that I received from him...

"US Money Market funds are aggressively w/ding from EZ bank comm paper and there is a HUGE shortage for dollars unfolding as we speak. Congress has warned the Fed not to go down the same path as 2008 (swap lines etc) so this will get ugly. As a trader, I'm not complaining, because volatility is my friend, but this is 1000x times worse than LEH/2008 (which at the time I was genuinely worried that the system might not make it). See, what made the depression so bad wasn't the stock market crash (bubblicious) but the sovereign defaults. Look at total bonds on NYSE listed at par from '25-'35, now imagine that on a world-wide scale. There are much larger dark pools of capital now than there were in the 20s and 30s and these players are trading CDS contracts on countries like a E-minis trader scalps the ES for 5-10 handles a day. Note: I almost have to get creative with my responses to your writings because you go so in depth and cover every dimension of the issue!"

Again, as excerpted from Let's Walk The Path Of A Potential Pan-European Bank Run, Then Construct Trades To Profit From Such:

If the panic doesn’t stem from the US, it could come (or arguably is coming), from the other side of the pond. The Telegraph reports: UK banks abandon eurozone over Greek default fears

UK banks have pulled billions of pounds of funding from the euro zone as fears grow about the impact of a “Lehman-style” event connected to a Greek default.

 Senior sources have revealed that leading banks, including Barclays and Standard Chartered, have radically reduced the amount of unsecured lending they are prepared to make available to euro zone banks, raising the prospect of a new credit crunch for the European banking system.

Standard Chartered is understood to have withdrawn tens of billions of pounds from the euro zone inter-bank lending market in recent months and cut its overall exposure by two-thirds in the past few weeks as it has become increasingly worried about the finances of other European banks.

Barclays has also cut its exposure in recent months as senior managers have become increasingly concerned about developments among banks with large exposures to the troubled European countries Greece, Ireland, Spain, Italy and Portugal.

... One source said it was “inevitable” that British banks would look to minimise their potential losses in the event the euro zone crisis were to get worse. “Everyone wants to ensure that they are not badly affected by the crisis,” said one bank executive.

Moves by stronger banks to cut back their lending to weaker banks is reminiscent of the build-up to the financial crisis in 2008, when the refusal of banks to lend to one another led to a seizing-up of the markets that eventually led to the collapse of several major banks and taxpayer bail-outs of many more.

Make no mistake - modern day bank runs are now caused by institutions!

 I have forensically stepped through the makings of a modern day global bank run in a series of informative articles - namely:

  1. The Mechanics Behind Setting Up A Potential European Bank Run Trade and European Bank Run Trading Supplement
  2. What Happens When That Juggler Gets Clumsy?
  3. Let's Walk The Path Of A Potential Pan-European Bank Run, Then Construct Trades To Profit From Such
  4. Greece Is Fulfilling Our Predictions Of Default Precisely As Predicted This Time Last Year
  5. The Anatomy Of A European Bank Run: Look At The Banking Situation BEFORE The Run Occurs!
  6. The Fuel Behind Institutional “Runs on the Bank” Burns Through Europe, Lehman-Style!
  7. Multiple Botched and Mismanaged Stress Test Have Created The Makings Of A Pan-European Bank Run
  8. Eighteen Percent of the EU is Literally Junk, Carried As Risk Free Assets at Par Using 30x+ Leverage: Bank Collapse is Inevitable!!! 
  9. Observations Of French Markets From A Trader's Perspective

In said articles, I made clear that continual back stopping of insolvent banks makes analyzing individual banks almost a moot exercise since the banks problems will invariably be hoisted upon the tax paying populace of the sovereign state that it is domiciled in, and in the case of the EU - the taxpayers of a collective of sovereign states. Thus, one should look at not only the solvency of the banking institutions (with full market to market on assets, reference subscription document The Inevitability of Another Bank Crisis), but the solvency of the domicile sovereign state as well and any possible contagion effects, post bank bailouts -reference subscription documents:

Greece, Portugal and Ireland are matters of potential contagion, but can potentially be funded by the EU for a few years. Italy and Spain simply can't be funded! Professional level subscribers can reference the debt default/restructuring worksheets online:

Again, I repeat, "Italy and Spain simply can't be funded!" BoomBustBloggers know that Italy is focal point that can quickly and quite destructively spread contagion to France, and via fiscal proximity, Germany. Reference Let's Walk The Path Of A Potential Pan-European Bank Run, Then Construct Trades To Profit From Such:

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CNBC reports: Italian Banks Slump After Bond Purchase Report

Italian bank shares were sharply lower in Wednesday morning trade after Reuters reported German Finance Minister Wolfgang Schaeuble said the euro zone's rescue fund should only purchase bonds on the secondary market in exceptional circumstances. Euro zone leaders agreed on a second bailout package for Greece last Thursday and said the European Financial Stability Facility (EFSF) bailout mechanism could buy bonds on the secondary market if the European Central bank recommended it do so.

"Even in the future, such purchases should only take place under very strict conditions when the European Central Bank deems there are exceptional circumstances on the financial markets and dangers for financial stability," Reuters quoted Schaueble as saying in a letter it obtained on Wednesday dated July 26. At 9:15 London time, shares in Intesa Sanpaolo were down 6 percent, while shares in Ubi Banca and Unicredit were trading just over 5 percent lower. Banco Popolare shares were off 5 percent.

This comes a week after releasing the very informative subscritpion document File Icon Italy Exposure Producing Bank Risk and a series of blog posts leading astute followers to the inevitable conclusion...

of The Inevitability of Another Bank Crisis. And like clockwork, the FT reports DB would have sold its entire 8bn holdings of Italian govt debt:

Deutsche Bank hedges Italian risk

Deutsche Bank cut its net exposure to Italian government debt by 88 per cent in the first six months of the year in a dramatic sign of international investors backing away from the eurozone’s third-largest economy.

Germany’s biggest lender disclosed with its second-quarter results that it had cut its net Italian sovereign exposure from €8bn at the end of 2010 to €997m by the start of July. Its overall exposure to what it called the “PIIGS” – Portugal, Ireland, Italy, Greece and Spain – fell 70 per cent to €3.7bn over the same period.

... Stefan Krause, Deutsche’s chief financial officer, linked the dramatic reduction in Italy to the first-time consolidation in December of Postbank, a German retail bank that had large Italian holdings. He added that Deutsche had bought credit default swaps – a form of insurance for investors – to hedge its Italian exposure in its trading book.

We went through this scenario for subscribers in detail, last year. Reference

... BNP Paribas, which has a large retail presence in Italy, expects to provide updated information on its sovereign exposures in next month’s results. But it does not anticipate them being dramatically different to the figures in the European stress tests, which revealed it increased its Italian holdings slightly last year.

Subscribers, see File Icon Italy Exposure Producing Bank Risk

UK banks are equally not expected to reveal such dramatic falls as most have already moved to reduce risk. Royal Bank of Scotland and HSBC have relatively small net positions, with less than €1bn of exposure to the country’s debt in their banking books. The comparable figure for Barclays is €2bn, according to data that accompanied the recent European stress tests.

...Deutsche’s disclosure came as it reported disappointing results, weighed down by difficult trading conditions in its investment bank.

We saw this one coming and BoomBustBloggers benefitted. Reference More On Trading with BoomBustBlog Research and the results after the face, BoomBustBlog Traders Armed With BoomBustBlog Research Caught ~10% Deutsche Bank Fall. All in all, quite prescient!

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According to data from Europe’s stress tests, Deutsche Bank had reduced its Italian government bond holdings by a third over the course of 2010 to about €5.3bn. The only bank that had reduced their holdings by more was Spain’s Santander, which cut them by 40 per cent to €261m.

As clearly articulated over a year and a half ago in Overbanked, Underfunded, and Overly Optimistic: The New Face of Sovereign Europe, the banking system is bigger than Europe itself and cannot be bailed out by the entities in which they are domiciled...

Sovereign Risk Alpha: The Banks Are Bigger Than Many of the Sovereigns

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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.

The discussion of a European bank meltdown

The next major article on this topic will discuss the issue that no one in Europe is broaching. With all of the stress in the banking system and so much CRE debt rolling over in the next 2 years, who will make these loans against drastically depreciated (from bubble highs) real estate approaching a bearish environment for CRE. More importantly, the unwillingness (or inability) of banks to lend freely against depreciating assets causes them to depreciate more - and faster, thereby exacerbating the problem since the banks have mucho CRE related products on the balance sheet. I will present my solution to this dilemma in detail, soon.

Institutional subscribers should feel free to reach out to me via Google Plus for video chat and discussion or via email. If you need an invitation to Google+ and are a subscriber, simply drop me a mail and I will give you one. I am always open to speaking engagements. Feel free to follow me on:

Published in BoomBustBlog

Although lengthy, this is a very important post that leads directly into the second of our trade setups based off of BoomBustBlog's fundamental and forensic European bank research (the first was Deutsche Bank, which paid off quite well). Please read through it in its entirety. The next post on this topic will be the actual trade setup itself.

20110725_-_CAC_Monthly

CNBC reports: Italian Banks Slump After Bond Purchase Report

Italian bank shares were sharply lower in Wednesday morning trade after Reuters reported German Finance Minister Wolfgang Schaeuble said the euro zone's rescue fund should only purchase bonds on the secondary market in exceptional circumstances. Euro zone leaders agreed on a second bailout package for Greece last Thursday and said the European Financial Stability Facility (EFSF) bailout mechanism could buy bonds on the secondary market if the European Central bank recommended it do so.

"Even in the future, such purchases should only take place under very strict conditions when the European Central Bank deems there are exceptional circumstances on the financial markets and dangers for financial stability," Reuters quoted Schaueble as saying in a letter it obtained on Wednesday dated July 26. At 9:15 London time, shares in Intesa Sanpaolo were down 6 percent, while shares in Ubi Banca and Unicredit were trading just over 5 percent lower. Banco Popolare shares were off 5 percent.

This comes a week after releasing the very informative subscritpion document File Icon Italy Exposure Producing Bank Risk and a series of blog posts leading astute followers to the inevitable conclusion...

  1. The Anatomy Of A European Bank Run: Look At The Banking Situation BEFORE The Run Occurs!
  2. The Fuel Behind Institutional “Runs on the Bank” Burns Through Europe, Lehman-Style!
  3. Multiple Botched and Mismanaged Stress Test Have Created The Makings Of A Pan-European Bank Run
  4. Eighteen Percent of the EU is Literally Junk, Carried As Risk Free Assets at Par Using 30x+ Leverage: Bank Collapse is Inevitable!!!

Many are missing the contagion link between these countries and the banks that are domiciled within them. I have put out significant research in an attempt to map the path of said contagion:

The question at hand is, "Can the EFSF outgun the global bond market in the pricing of insolvent nation, publicly traded debt?" I believe the answer is a resounding "NO!". Prices can probably be manipulated in the short term, but medium to longer term the global bond markes (particularly the 17 markets potentially covered by the EFSF) are simply too deep, too wide, too big to be centrally planned! We have seen an attempt at centrally planning large markets in the '90s when Soros broke the British Central Bank, as excerpted from The Fuel Behind Institutional “Runs on the Bank” Burns Through Europe, Lehman-Style!"

The portion about intervening in the secondary public markets brings one to mind of how the UK came to be outside of the EMU, and that is due to their hubristic mindset that they were bigger than the world's largest, deepest and most liquid markets as well in their attempt to manipulate the price of the pound upon (attempted) entry into the EMU. Speculators world wide, exemplified in the media by George Soros, apparently taught them otherwise. He became known as "the Man Who Broke the Bank of England" after he made a reported $1 billion during the 1992 Black Wednesday UK currency crises. Soros correctly speculated that the British government would have to devalue the pound sterling, as per Wikipedia:

Black Wednesday refers to the events of 16 September 1992 when the British Conservative government was forced to withdraw the pound sterling from the European Exchange Rate Mechanism (ERM) after they were unable to keep sterling above its agreed lower limit. George Soros, the most high profile of the currency market investors, made over US$1 billion profit by short selling sterling.

So, continuing with the thesis of EU officials attempting to ice skate uphill and consequently fostering a pan-European bank run in the process, I am posting the a followup discussion I had with Eurocalypse (click here for his background), the European CDS trader who is assisting in BoomBustBlog trade setups. This is a follow-up to the release of the subscription document File Icon Italy Exposure Producing Bank Risk.

I would like to comment on this as I ran an ALM [asset/liabiility management] department so I'm supposed to know what this is about!! I am not to say there is no "RUN ON THE BANK RISK", there ABSOLUTELY is, but this is not a feature of your featured bank only.

And I absolutely agree. Then again, two wrongs don't make a right, either. The ALM mismatch wasn't a unique feature to Bear Stearns either, but that didn't save them in the end, nor did it save Lehman. I would like to make it clear that the borrow short/invest long problem is truly not unique to our subject bank, but certainly adds to a plethora of issues weaken its position should things pop off. As a matter of fact, the prevalance of ALM mismatches will be the cause of serial bank run, if one were to occur. As a refresher, let's excerpt The Anatomy Of A European Bank Run: Look At The Banking Situation BEFORE The Run Occurs!

The subject of our most recent expose on the European banking system has a plethora of problems, including but not limited to excessive PIIGS exposure, NPA growth up the yin-yang, Texas ratios and Eyles test numbers that’ll make you shiver and razor thin provisions. Focusing on the most pertinent and contagious of the issues at hand leads us back to the initial premise of a European bank run. I laid the foundation for said topic discussion last Thursday in "The Fuel Behind Institutional “Runs on the Bank" Burns Through Europe, Lehman-Style" and the fear du jour is a European version of the Lehman Brothers or Bear Stearns style bank run. The aforelinked at explanatory piece is a must read precursor to this illustration of what can only be described as the anatomy of a European bank run - before the fact. Remember how the pieces of the puzzle were perfectly laid together for a Bear Stearns collapse in January of 2008, two months before the bank's actual collapse? Reference "Is this the Breaking of the Bear?" in which Bear Stearns collapse was illustrated in explicit, graphic detail. Lehman Brothers wasn't impossible to see either (Is Lehman really a lemming in disguise? Thursday, February 21st, 2008 | Web chatter on Lehman Brothers Sunday, March 16th, 2008).

I would also like to make it clear that it is my opinion that the EU leaders who insist on issuing "alleged" bank stress tests that assume its constituency are moronic simply add fuel to the bank run fire. The refusal to test for the concern that the entire bond market has simply feeds uncertainty in lieu of alleviating it, reference Multiple Botched and Mismanaged Stress Test Have Created The Makings Of A Pan-European Bank Run.

The "alleged" stress tests did not test for sovereign default and its effect on HTM inventory, which is already priced into the system and which is the primary worry of the markets. Thus, the stress test results are largely irrelevant.

It's as if I have AIDS and I go to the doctor and pass a test for measles... Does that make my multiple partners (counterparties , lenders and customers) more or less comfortable with my condition?

We have run our own numbers and produced alternative, more realistic scenarios including exposure, haircut assumptions and writedowns for individual countries. Specifically, we have applied writedowns on both banking and trading books with the results available in the subscription document File Icon The Inevitability of Another Bank Crisis? and well as File Icon European Bank's Greece exposure. In essence, after Lehman Brothers collapse, sovereign states appear to deem themselves obligated to bail out their respective insolvent banking systems, thus real stress tests should test both the banks' distressed portfolio carried at unrealistic marks and leverage and the sovereign's ability to aid said banks. Of course, this will be very unpopular from a political perspective because you will get a lot of nasty answers to the questions asked.

Below is a chart excerpted from our most recent work showing the asset/liability funding mismatch of a bank detailed within the report. The actual name of the bank is not at issue here. What is at issue is what situation this bank has found itself in and why it is in said situation after both Lehman and Bear Stearns collapsed from the EXACT SAME PROBLEM!

Note: These charts are derived from the subscriber download posted yesterday, Exposure Producing Bank Risk (788.3 kB 2011-07-21 11:00:20).

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Overnight and on demand funding is at a 72% deficit to liquid assets that can be used to fund said liabilities. This means anything or anyone who can spook these funding sources can literally collapse this bank overnight. In the case of Bear Stearns, it was over the weekend.

Now, back to the Eurocalypse discussion...

If you look at how they constructed this table, their (huge) deposit base under the heading classified as "Dette Envers la Clientèle" shows they are indeed funding long term assets with their retail deposits. There is regulatory ground for it and practical experience. I cant remember the exact rules, but by experience (ie. everytime, as long as there is no run) the retail deposits are stable, and typically in an ALM.

And therein lies the rub. Liquidity is always available, until it is needed. Ask Bear and Lehman, and Merrill, and Goldman, and Morgan Stanley, and... Well, you get the picture. I explained how this happened not once, but several times in the US just 3 years ago in "The Fuel Behind Institutional “Runs on the Bank" Burns Through Europe, Lehman-Style":

The modern central banking system has proven resilient enough to fortify banks against depositor runs, as was recently exemplified in the recent depositor runs on UK, Irish, Portuguese and Greek banks – most of which received relatively little fanfare. Where the risk truly lies in today’s fiat/fractional reserve banking system is the run on counterparties. Today’s global fractional reserve bank get’s more financing from institutional counterparties than any other source save its short term depositors.  In cases of the perception of extreme risk, these counterparties are prone to pull funding or request overcollateralization for said funding. This is what precipitated the collapse of Bear Stearns and Lehman Brothers, the pulling of liquidity by skittish counterparties, and the excessive capital/collateralization calls by other counterparties. Keep in mind that as some counterparties and/or depositors pull liquidity, covenants are tripped that often demand additional capital/collateral/ liquidity be put up by the remaining counterparties, thus daisy-chaining into a modern day run on the bank!

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I'm sure many of you may be asking yourselves, "Well, how likely is this counterparty run to happen today? You know, with the full, unbridled printing press power of the ECB, and all..." Well, don't bet the farm on overconfidence. The risk of a capital haircut for European banks with exposure to sovereign debt of fiscally challenged nations is inevitable. A more important concern appears to be the threat of short-term liquidity and funding difficulties for European banks stemming from said haircuts. This is the one thing that holds the entire European banking sector hostage, yet it is also the one thing that the Europeans refuse to stress test for (twice), thus removing any remaining shred of credibility from European bank stress tests. As I have stated many time before, Multiple Botched and Mismanaged Stress Test Have Created The Makings Of A Pan-European Bank Run!

The biggest European banks receive an average of US$64bn funding through the U.S. money market, money market that is quite gun shy of bank collapse, and for good reason. Signs of excess stress perceived in the US combined with the conservative nature of US money market funds (post-Lehman debacle) may very well lead to a US led run on these banks. If the panic doesn’t stem from the US, it could come (or arguably is coming), from the other side of the pond. The Telegraph reports: UK banks abandon eurozone over Greek default fears

UK banks have pulled billions of pounds of funding from the euro zone as fears grow about the impact of a “Lehman-style” event connected to a Greek default.

 Senior sources have revealed that leading banks, including Barclays and Standard Chartered, have radically reduced the amount of unsecured lending they are prepared to make available to euro zone banks, raising the prospect of a new credit crunch for the European banking system.

Standard Chartered is understood to have withdrawn tens of billions of pounds from the euro zone inter-bank lending market in recent months and cut its overall exposure by two-thirds in the past few weeks as it has become increasingly worried about the finances of other European banks.

Barclays has also cut its exposure in recent months as senior managers have become increasingly concerned about developments among banks with large exposures to the troubled European countries Greece, Ireland, Spain, Italy and Portugal.

... One source said it was “inevitable” that British banks would look to minimise their potential losses in the event the euro zone crisis were to get worse. “Everyone wants to ensure that they are not badly affected by the crisis,” said one bank executive.

Moves by stronger banks to cut back their lending to weaker banks is reminiscent of the build-up to the financial crisis in 2008, when the refusal of banks to lend to one another led to a seizing-up of the markets that eventually led to the collapse of several major banks and taxpayer bail-outs of many more.

Make no mistake - modern day bank runs are now caused by institutions!

And back to the Eurocalypse discussion:

We would make some stress scenarios. suppose deposits for example drop by 30% and look if there is a problem for short term funding,
basically they this would amount to -180bn, they need to be able to sell 180bn assets. There are 180bn of short term assets (less than 1 month)
they can sell, plus they probably can some of their trading book.

And this appears to be a weakness of modeling real life events. You see, by modeling just the effects of a 30% drop in deposits, you are ignoring the real world effect of counterparties pulling liquidity in tandem in an effort to minimize exposure -as detailed in the excerpt above. You are also negating the fact that much of the so called "trading book" is being carried on the books at prices that are significantly above what can be fetche in the market, which I illustriously detailed in the blog post Is Another Banking Crisis Inevitable? and whose empirical evidence was laid bare in the accompanying subscription document File Icon The Inevitability of Another Bank Crisis. I also went over this in detail at the large European bank, ING, as the keynote speaker at their CRE valuation conference in Amsterdam...

It looks like the subject bank is using 170bn of its deposits to fund its trading activities (this is the gap between asset and liabilities for undetermined maturities) and the rest of it to fund longer term assets (loans bonds etc...)

I'm not so shocked at the numbers, but its true European banks, and French banks in particular make money taking this liquidity risk. Basel III is designed to reduce this gap, at least up to 1 year through the DSCR ratio (implemented in 2018, they can still change their mind about it, because this is a big game changer for the industry forcing banks to have much more stable funding, which is difficult for non-retail banks and force them to reduce their assets or change them to "liquid" govt bonds, or secure more funding, but as all banks need to do the same, long term funding cost is going up, and it can't be known if there is sufficient demand for it... We're probably speaking trillions of euros.

This gap risk IS managed, even though the assumptions may prove one day too optimistic...

I prefer the term "unrealistic" as exemplified above...

Actually ALM managers have bad incentives to take risks, as traders... One way to do it, is assume deposits are stable. in practice, with the Fractional Reserve System, and Monetary aggregates growing together with (eligible or not) Total Oustanding Debt, Deposits have grown in rapidly in most financial institutions, boosting confidence among bankers to buy assets (they may think they're good because they get more deposits, but thats just a consequence of the monetary system !)

On that note, reference Fractional Reserve is Not the Problem...

By the way, the term "stable" refers to assigning a maturity to retail deposits. you have a client, he's not going to withdraw his money tomorrow. Maybe 10% tomorrow, and then 10% the 1st year, 10% of what is left the 2nd year etc.... basically every bank uses its own assumptions, but I would guess in the typical French bank, the average duration of a retail deposit would range between 4 to 10 years.
Using these assumptions, the ALM managers "hedges" accordingly the interest risk and liquidity risk. "Fair value hedge accounting" permits to receive fixed on swaps or buy bonds against those deposits without suffering the adverse Mark to Market of the hedge. which does make economic sense as long as the deposits stays indeed for (4 to 10) years on average.


Herein lies the rub. I went to pains to describe how patently unrealisiic the logic above is in a panic. Correlation comes close to 100% as depositors move in unison, motivated by the same impetus, and that is "to get the fuck out of dodge". In "The Fuel Behind Institutional “Runs on the Bank" Burns Through Europe, Lehman-Style", as referenced:

This phenomena essentially discredits the thinking at large and currently in practice that “since individual expenditure needs are largely uncorrelated, by the law of large numbers” banks should expect few withdrawals on any one day. The fact of the matter is that in times of severe distress, particularly stemming from solvency issues (read directly as the Pan-European Sovereign Debt Crisis, and Greece, et. al. in particular), the exact opposite is the case. Individual depositor and counterparty actions are actually HIGHLY correlated and tend to move in tandem, particularly when that move is out of the target fiat bank. They tend to take heed to the saying “He who panics first, panics best!"

Asset/liability mismatch can, at the margin nearly assure a Lehman-style fiasco in the case of an impetus that sparks herding mentality, whether it be among depositors/savers or institutional counterparties.

Back to Eurocaplyse:

French banks are among the ones most guity of playing this game, and they are among the ones pushing for accounting rules which are being revised, to still allow for this accounting procedure (typically American accountants were traditionally against this).

All in All, according to their "model" the subsctiption docs subject bank probably thinks they are fine, and in a liquidity crisis, they could stand up for several months, which is the time for a miracle, or rather the govt. and CBs to intervene. Of note 2010 and 2009 numbers for their gap look similar which is a clue for me that these are the numbers they are targetting.

That doesnt prevent systemic risk of course, and something worse than the worst scenario (and we know it can happen, of course), and given the subject bank owns subsidiaries in suspect PIIGS states, if there is a panic in any one of them, they could be identified as a risky bank (or on the contrary being seen by those PIIGS banking customers [as compared to from 100% local banks] as a "safer" bank and actually benefit from it ?)

Regarding the ALM gap, i think it would be very instructive to make comparisons within banks. it could be more telling than just marvelling at the subject bank's numbers. I would like to see whether the subject bank is more or less aggressive in its ALM exposure than other European banks or not.

We have done this, although the opaque reporting makes it labor intensive. Next up, we will be coming out with plenty of charts and trade setups for the subject bank.

Disclosure: Eurocalypse has no positions in the stocks referenced above, doesnt trade CDS, and doesnt intend to take positions in those financial instruments"
"Eurocalypse actually owns a small quantity of Italian (inflation-linked) bonds at its own risk. Please do your own due diligence and trade at your own risk 

Published in BoomBustBlog

Research in Motion has been one of the most successful tech shorts of this blog's history (thus far). We first recommended a short last year and reiterated it in the fist quarter of this year. Reference:

  1. BoomBustBlog Research Performs a RIM Job!

  2. BoomBustBlog's Fundamental/Forensic Analysis of Research in Motion Has Returned 2x-3x Original Investment This Year!!

 

This is a snapshot of RIMM as of the writing of this article...

image002

As you can see, the results have been spectacular, particular if well timed puts have been put to use. In January I posted:

I personally see a clear leader in mobile computing becoming visible in 2012. Using options, a minimum of 2012 expiration OTM and ATM contracts can be purchase at the most optimistic break points demarcated by the model above after being populated with assumptions you feel most valid. I will have a proprietary BoomBustBlog option model available for download to paying subscribers by the end of next week, at which time we will revisit the analysis above.

A 50% drop in price later... On that note, Bloomberg reports: RIM to Cut 2,000 Jobs as BlackBerry Loses Share to IPhone

Research In Motion Ltd., maker of the BlackBerry smartphone, plans to cut 2,000 jobs, or about a tenth of its workforce, as sales slow amid market share losses to Apple Inc.’s iPhone.

The reductions, across all functions, are part of a plan to “focus on areas that offer the highest growth opportunities,” RIM said today in a statement. The job cuts will leave the Waterloo, Ontario-based company with about 17,000 employees.

RIM predicted last month that sales this quarter may drop for the first time in nine years. The company is losing market share in the U.S. to the iPhone and handsets running Google Inc.’s Android software, in part because it hasn’t introduced a major new BlackBerry model since August. Cheaper Google phones are also making inroads in Latin America, Asia and Europe, threatening the popularity of less expensive BlackBerry models like the Curve.

... RIM fell 85 cents, or 3.1 percent, to $27.06 at 10:26 a.m. New York time in Nasdaq Stock Market trading. The stock had dropped 52 percent this year before today.

The headline grossly mischaracterizes RIM's problems. Google's Android has, by far, inflicted much more damage to RIM than Apple ever has. This was easily seen over 13 months ago, at least by BoomBust Bloggers, referencing BoomBustBlog Research Performs a RIM Job!...

Page 5 of our Research in Motion forensic analysis (released in the summer of 2010 - File Icon RIMM Forensic Analysis and Valuation – Professional & Institutional or File Icon RIMM Forensic Analysis and Valuation – Retail) clearly stated that while we expected RIMM’s handset shipments to rise as a result of a rapidly expanding smartphone market, it will lose considerable market share....

As it turns out, it appears that we were erred slightly to the optimistic side with an 18% market share estimate for 2010. By the end of the 3rd quarter, RIM has fallen to 15.3% according to information calculated from IDC, and its decent has accelerated far faster than even we (the bears) have anticipated – a full 350 basis points for the quarter. This is 6x the decent of last quarter and 7 x the decent of the quarter before that. It is quite safe to assume that they will be materially below this point at year end (the data that we crunch is lagged by a quarter). This market share loss is most assuredly caused by the outsized growth of Android, which I will demonstrate in a minute. Below are charts generated from an updated version of the subscriber document File Icon Smartphone Market Model – Blog Download Version:

As you can see above, for the full year of 2010 RIM has trailed smartphone market penetration growth and that trail has increased each and every quarter with the rate of decent rapidly increasing.

RIM’s share price has benefited from an increasing equity market as well as the announcement of new products. The Torch, although possessive of redeeming new qualities, is essentially still a generation behind Apple and 1.5 generations behind Android. See RIM Smart Phone Market Share, RIP?

Research in Motion is following the EXACT path we at BoomBustBlog had laid out for it since the 3rd quarter of 2010.

This story is far from over, primarily because we are just entering the chapter in which Android does what it does best, and that is compress margins. Due to the unique open source component of the Androd business model, it actually slashes prices and spikes the technology bar both simultaneously and quite rapidly. So rapidly that not only is it without precedent, but literally tramples all over Moore's law.

Moore's law describes a long-term trend in the history of computing hardware. The number of transistors that can be placed inexpensively on an integrated circuit doubles approximately every two years.[1] This trend has continued for more than half a century and is expected to continue until 2015 or 2020 or later.[2]

The capabilities of many digital electronic devices are strongly linked to Moore's law: processing speed, memory capacity, sensors and even the number and size of pixels in digital cameras.[3] All of these are improving at (roughly) exponential rates as well (see Other formulations and similar laws). This exponential improvement has dramatically enhanced the impact of digital electronics in nearly every segment of the world economy.[4] Moore's law describes a driving force of technological and social change in the late 20th and early 21st centuries.[5][6]

The law is named after Intel co-founder Gordon E. Moore, who described the trend in his 1965 paper.[7][8][9] The paper noted that the number of components in integrated circuits had doubled every year from the invention of the integrated circuit in 1958 until 1965 and predicted that the trend would continue "for at least ten years".[10] His prediction has proved to be uncannily accurate, in part because the law is now used in the semiconductor industry to guide long-term planning and to set targets for research and development.[11]

It is safe to say that Android chops the half-time to obselence implied by Moore's law by at least 50%, with a doubling of capabilities happening annually, and arguably even every two quarters. This has not gone unnoticed by those who are paying attention. The truly remarkable feat is that prices are simultaneously dropping towards zero out of pocket cost to the consumer. How does RIMM compete with that? Well, the same way all of Android's other competitos will if Android isn't significantly slowed down - again from Bloomberg's article:

‘Margin Pressure’

“Thorsten, with his Siemens background, is known as somebody who is exceptionally operationally efficient,” Shah said. “That’s a positive for the upcoming margin pressure that is likely.

You see, Bloomberg didn't go into detail regarding this phenomena, but luckily BoomBustBlog did more than just a little detail on the margin compression thesis, and for good reason. This will be the theme that will drive this industry to produce unprecendented functionality for the retail consumer and entperprise alike while simultanesouly putting those who can't compete at light speed with decreasing margins out back to the wood shed, metaphorically speaking, of course:

Those that chose to follow this short recommendation had plenty of tools to assist in the decision making:

RIM Model Assumptions

RIM Model Factors Driving Growth

After populating the assumptions tab, jump to the “Factors Driving Growth” tab and choose the player whose market share and penetration data you want to populate the valuation model for the sake of comparison. The choices are “Nokia”, “RIMM”, “Apple”, “HTC” and “Others”. This tab is annual data only.

RIM Model Quarterly Factors (driving growth)

On the next tab, you can do the same as the previous (this tab is quarterly growth). Each of the growth tabs has charts that are print and presentation quality. Just be sure to tell everyone where you got thesis, data and analysis from :-) .

Other tabs in the model…

RIM Model Income Statement

RIM Model Device Market Analysis

RIM Model Revenue Analysis

RIM Model Device Revenues

Valuation and Multivariate Scenario Output

Final output is RIMM’s valuation using our analytics and your assumptions as input in the assumption tab above, as well as a multivariate scenario analysis showing changes in quite a number of variables (assuming all others remain the same) and their effects on your base valuation, as well as the percentage upside/downside from the current price.

Published in BoomBustBlog

greek debt restructuring spreadsheet

It appears as if the EU politicking behind the bailout bonanza didn't yield everything they had hoped. I still believe they are going about this the wrong way, but they are obviously not paying close attention to my opinions - or are they? CNBC reports Moody's: Greek Default Is Almost Certain. Here's Why. It's nothing you haven't heard on BoomBustBlog before, but here's the synopsis...

Ratings agency Moody's cut Greece's sovereign debt by three notches on Monday to Ca, just one notch above default, saying the new bailout set a negative precedent for creditors of other debt-burdened countries.

For some reason, the EU leaders don't see this as adding to potential contagion, but I, Moody's and Fitch appear to differ. Since when do we agree? Why should any formally profligate state tighten its belt properly and risk the requisite political backlash when these bailouts are all but guaranteed to protect the German and French banks?

Euro zone leaders agreed last week to offer Greece debt relief through a new rescue package of easier loan terms, with private creditors shouldering part of the burden via a debt exchange. The downgrade means Greece now has the lowest rating of any country in the world covered by Moody's, which, like Fitch last week, said it would offer a new rating after the debt swap was completed.

Reference Multiple Botched and Mismanaged Stress Test Have Created The Makings Of A Pan-European Bank Run for my take.

"Once the distressed exchange has been completed, Moody's will reassess Greece's rating to ensure that it reflects the risk associated with the country's new credit profile, including the potential for further debt restructurings," it said. Last Friday, Fitch Ratings said Greece would be declared in restricted default due to the steps taken in the new euro zone rescue package but that new ratings of a low speculative grade would likely be assigned once the bond exchange is completed. Moody's said the combination of the announced EU support program and debt exchange proposals by major financial institutions implied that private creditors would incur hefty losses on their Greek government debt holdings.

Now the ratings agencies are getting seious and spitting the ugly truth. You see, the EU is attempting to paper over the losses with financial engineering and alternative names, but the fact of the matter is a loss, is a loss, is a loss. As excerpted from the afore-linked article:

Although the EU refuses to publish the truth, I have done so freely for blog subscribers and have available a detailed list, currently in its 3rd rendition, that explicitly walks though what will probably happen as any combination of the PIIGS group defaults.

Our most recent subscriber document explores the banking side of Greek failure - File Icon European Bank's Greece exposure, but I have put a significant amount of info into the public domain as well. If one were to even come close to marking the EU banks books to reality, market prices, or anything in between, the Lehman situation would look tame in compariosn! As excerpted from the subscriber document: File Icon The Inevitability of Another Bank Crisis

It said that while the overall package carried a number of benefits for Greece, including lower debt-servicing costs and reduced reliance on financial markets for years to come, the impact on its debt burden would be limited. The rating agency also warned that despite some debt reduction thanks to the new rescue package, the country still faced medium-term solvency challenges and significant implementation risks. 

This is EXACTLY what we said over a year ago, reference A Comparison of Our Greek Bond Restructuring Analysis to that of Argentina. The team was even able to ascertain which path the restructuring would take well in advance, as well as anticipatng the problem that Moody's is just now articulating. See What is the Most Likely Scenario in the Greek Debt Fiasco? Restructuring Via Extension of Maturity Dates.

"The announced EU program along with the Institute of International Finance's statement implies that the probability of a distressed exchange, and hence a default, on Greek government bonds is virtually 100 percent," Moody's said.

The IIF said that the bond-exchange deal would help reduce Greece's debt pile by 13.5 billion euros, and by offering a menu of new instruments it aims to attract 90 percent investor participation in the plan.

But Moody's noted that Greece would still have a mountain of debt to service after that"(Greece's) stock of debt will still be well in excess of 100 percent of GDP for many years and it will still face very significant implementation risks to fiscal and economic reform," it said.

Hmmm, like clockwork - as excerpted from What is the Most Likely Scenario in the Greek Debt Fiasco? Restructuring Via Extension of Maturity Dates dated Wednesday, 26 May 2010 02:07...

Greek Restructuring Scenarios

There are several precedents of sovereign debt restructuring through maturity extension without taking an explicit  haircut on the principal amount, and many analysts are predicting something of a similar order for Greece. This form of restructuring is usually followed as a preemptive step in order to avoid a country from technically defaulting on its debt obligation due to lack of funds available from the market. It primarily aims to ease the liquidity pressures by deferring the immediate funding requirements to later periods and by spreading the debt obligations over a longer period of time. It also helps in moderating the increase in interest expenditure due to refinancing if the rates are expected to remain high in the near-to medium term but decline over the long term.

However, the two major negative limitations of this form of restructuring if applied to Greek sovereign debt restructuring are –

  • It solves only the liquidity side of the problem which means that the refinancing of the huge debt (expected to reach 133% of GDP by the end of 2010) will be spread over a longer time period while the debt itself will continue to remain at such high levels. The sustainability of such high debt level, which is growing continuously owing to the snowball effect and the primary deficit, is and will continue to be highly questionable. Greek public finances are burdened by a very large interest expense which is approaching 7% of GDP. The government’s revenues are sagging and the drastic austerity measures need to first bridge the huge primary deficit (which was 8.6% of GDP in 2009), before generating funds to cover the interest expenditure and reduce debt.

Thus, even though the amount of funds required each year to refinance the maturing debt will be reduced by extending maturities, the solvency and sustainability issues surrounding Greece’s public finances, which were the primary reasons for it’s being ostracized from the market in the first place, will remain unanswered.

  • It will lead to decline in present value of cash flows for the creditors since the average coupon rate is lower than the cost of capital (reflected by the yields on the Greek bonds). The average coupon rate for bonds maturing between 2010 and 2020 is about 4.4% while the average benchmark yield for bonds with maturities from 1-10 years is nearly 7.5%. Also, as the maturity of the debt is extended, the risk increases and so does the cost of capital.

In order to assess the effectiveness of this form of restructuring for Greek sovereign debt, we have built three scenarios in which the maturities of the Greek debt is extended. These scenarios weren’t designed to be exact predictions of the future but to represent what may happen under a variety of highly likely scenarios (a pessimistic, base and optimistic case, so to say):

  • Restructuring 1 – Under this scenario, we assumed that the creditors with debt maturing between 2010 and 2020 will exchange their existing debt securities with new debt securities having same coupon rate but double the maturity.
  • Restructuring 2 – Under this scenario, we assumed that the creditors with debt maturing between 2010 and 2020 will exchange their existing debt securities with new debt securities having half the coupon rate but double the maturity.
  • Restructuring 3 – Under this scenario, the debt maturing between 2010 and 2020 will be rolled up into one bundle and exchanged against a single, self-amortizing 20-year bond with coupon equal to average coupon rate of the converted bonds.

image017

In all the three scenarios, we computed the total funding requirements and compared the same with funding requirements prior to restructuring. It is observed that restructuring will help in easing the immediate pressure of procuring funds to meet the huge funding requirements lined up in the next 5 years. However, it will also lead to substantial loss to creditors in the form of erosion of present value of cash flows. (Discount rate was the benchmark yields of Greek government bonds for similar maturity period).

Professional and Institutional level subscribers (click here to upgrade) may access the live spreadsheet behind the document by clicking here (scroll down after for full summary, spreadsheet and charts).greek debt restructuring spreadsheetgreek debt restructuring spreadsheetgreek debt restructuring spreadsheet

We will be running similar restructuring analysis for all of the PIIGS member that we have researched in thePan-European Sovereign Debt Crisis series.

Moody's added that while the rescue package for Greece benefited all euro zone countries by containing near-term contagion risks, the deal set a negative precedent. "The support package sets a precedent for future restructurings should the finances of another euro area sovereign become as problematic as those of Greece. The impact of Thursday's announcement for creditors of Ireland and Portugal is therefore likely to be credit-neutral," it said.

But economically, it is credit negative. Bondholders will be forced to realize significant losses on what was once held as "risk free debt" and "reserves". See the list of links below to ascertain the results of such, but first realize that those bondholders that will take said losses will not be able to collect on their CDS, of course sparking signficant litigation, and further losses.

Standard & Poor's and Fitch have downgraded Greece to CCC.

Derivatives body ISDA told Reuters on Friday that the IIF's plans for voluntary debt swaps and buybacks to help rescue Greece wouldn't trigger a "credit event" and payment of CDS contracts, limiting the fallout of any default rating. One condition for a credit event affecting CDS is that changes in the terms of debt must be binding on all holders, which ISDA said was not the case.

Then there's the obvious twists from other impetuses:

And in the End, What Does It All Mean?

LGD 100+: What's the Possibility of Certain European Banks Having a Loss Given Default Approaching 100%?

My next post on this topic will be a discussion of a technical trade set up using options (for pros/institutional subscribers) for the bank run candidate whose fundamental/forensic analysis write up I posted last week for subscribers, as well as an insiders (Asset/Liability manager department head) take on the situation for everyone. 

Professional and institutional subscribers will have access to our contributing trader’s trade setups and opinions within a week and a half. Institutional subscribers should feel free to reach out to me via Google Plus for video chat and discussion this and every Tuesday at 12 pm (please RSVP via email). If you need an invitation to Google+ and are a subscriber, simply drop me a mail and I will give you one. Feel free to follow me on:

Published in BoomBustBlog

image009

US and European markets are rallying once again on news that a new bailout agreement (think this is the 3rd, 4th or 5th, I lose count) has been reached. This one is unique in that it will allow/endorse a short term selective default and create a fund whose goal is actually to manipulate the debt markets and recapitalize banks! This news is quite timely for I have just released one of the banks that I believe are susceptible to a Lehman/Bear Stearns style "run on the bank". All paying subscribers, see icon Exposure Producing Bank Risk (788.3 kB 2011-07-21 11:00:20). Professional and institutional subscribers should feel free to contact me on this topic. I will be releasing additional info to Pro and institutional subscribers in the upcoming week. Now, from CNBC:

Minds have been concentrated by the danger that Europe's debt crisis could engulf the much bigger economies of Spain and Italy. Greece, Portugal and Ireland have already succumbed. The draft summit statement obtained by Reuters showed the EFSF rescue fund would be allowed for the first time to help states earlier with precautionary loans, to recapitalise banks and to intervene in the secondary bond market.

"To improve the effectiveness of the EFSF and address contagion, we agree to increase the flexibility of the EFSF," it said, listing those three key steps, all of which Germany had previously blocked.

... Dutch Finance Minister Jan Kees de Jager said a short-term or selective default for Greece, long vehemently opposed by the ECB, was now a possibility.

"The demand to prevent a selective default has been removed," he told the Dutch parliament. The chairman of the 17-nation currency area's finance ministers, Jean-Claude Juncker, also told reporters: "You can never exclude such a possibility, but everything should be done to avoid it."

According to the draft, the maturities on euro zone rescue loans to all three assisted countries would be extended to 15 years from 7.5 and the interest rate cut to around 3.5 percent from between 4.5 and 5.8 percent now.

The EFSF would be able to lend to states on a precautionary basis instead of waiting until they are shut out of market funding, and to recapitalise banks via loans to governments, even if they are not under an EU/IMF assistance programme.

It would also be allowed for the first time to intervene in secondary bond markets, subject to an ECB analysis recognising "exceptional circumstances" and a unanimous decision. Germany blocked all these measures when the European Commission proposed them back in February, at a time when the crisis was less acute, EU sources said. The wider EFSF powers could help deter or minimise any market contagion in case of a temporary Greek default.

In an apparent trade-off for Merkel's new willingness to embrace such bolder steps, Sarkozy dropped a French call for a tax on banks to help fund a second Greek bailout.

... The proposed expansion of the EFSF's role would have to be ratified by national parliaments, and could fall foul of critics in Germany, the Netherlands and Finland. Thursday's summit is very unlikely to mark a complete resolution of the crisis, as Merkel herself acknowledged earlier this week.

A second bailout may simply keep Greece afloat for a number of months before a tougher decision has to be made on writing off more of its debt.

I have yet to thoroughly vet the afore-referenced plan, but at first blush I tend to strongly agree with Merkel. This is but another stop gap, and an ephemeral one at that, to the road to Perdition, or at least that's what European appear to believe a true and actual default is. My opinion is that it is a necessary evil needed to purge unpayable debt and push the profligate EU states back onto the path of growth and prosperity.

The portion about intervening in the secondary public markets brings one to mind of how the UK came to be outside of the EMU, and that is due to their hubristic mindset that they were bigger than the world's largest, deepest and most liquid markets as well in their attempt to manipulate the price of the pound upon (attempted) entry into the EMU. Speculators world wide, exemplified in the media by George Soros, apparently taught them otherwise. He became known as "the Man Who Broke the Bank of England" after he made a reported $1 billion during the 1992 Black Wednesday UK currency crises. Soros correctly speculated that the British government would have to devalue the pound sterling, as per Wikipedia:

Black Wednesday refers to the events of 16 September 1992 when the British Conservative government was forced to withdraw the pound sterling from the European Exchange Rate Mechanism (ERM) after they were unable to keep sterling above its agreed lower limit. George Soros, the most high profile of the currency market investors, made over US$1 billion profit by short selling sterling.

In 1997 the UK Treasury estimated the cost of Black Wednesday at £3.4 billion, with the actual cost being £3.3 billion which was revealed in 2005 under the Freedom of Information Act (FoI).[1]

The trading losses in August and September were estimated at £800m, but the main loss to taxpayers arose because the devaluation could have made them a profit. The papers show that if the government had maintained $24bn foreign currency reserves and the pound had fallen by the same amount, the UK would have made a £2.4bn profit on sterling's devaluation.[2] Newspapers also revealed that the Treasury spent £27bn of reserves in propping up the pound.

...

The UK's prime minister and cabinet members tried vehemently to prop up a sinking pound and withdrawal from the monetary system the country had joined two years prior was the last resort. Major raised interest rates to 10 percent and authorised the spending of billions of pounds to buy up the sterling being frantically sold on the currency markets but the measures failed to prevent the pound falling lower than its minimum level in the ERM.

The Treasury took the decision to defend Sterling's position, believing that to devalue would be to promote inflation.[5] On 16 September the British government announced a rise in the base interest rate from an already high 10 to 12 percent in order to tempt speculators to buy pounds. Despite this and a promise later the same day to raise base rates again to 15 percent, dealers kept selling pounds, convinced that the government would not stick with its promise. By 19:00 that evening, Norman Lamont, then Chancellor, announced Britain would leave the ERM and rates would remain at the new level of 12 percent (however, on the next day interest rate was back on 10%). It was later revealed that the decision to withdraw had been agreed at an emergency meeting during the day between Norman Lamont, Prime Minister John Major, Foreign Secretary Douglas Hurd, President of the Board of Trade Michael Heseltine and Home Secretary Kenneth Clarke (the latter three all being strong pro-Europeans as well as senior Cabinet Ministers), and that the interest rate hike to 15 percent had only been a temporary measure to prevent a rout in the pound that afternoon.

Currency speculation

On September 16, 1992, Black Wednesday, Soros's fund sold short more than US$10 billion worth of pounds,[27] profiting from the UK government's reluctance to either raise its interest rates to levels comparable to those of other European Exchange Rate Mechanism countries or to float its currency.

Finally, the UK withdrew from the European Exchange Rate Mechanism, devaluing the pound sterling, earning Soros an estimated US$1.1 billion. He was dubbed "the man who broke the Bank of England."[31] In 1997, the UK Treasury estimated the cost of Black Wednesday at £3.4 billion.

On Monday, October 26, 1992, The Times quoted Soros as saying: "Our total position by Black Wednesday had to be worth almost $10 billion. We planned to sell more than that. In fact, when Norman Lamont said just before the devaluation that he would borrow nearly $15 billion to defend sterling, we were amused because that was about how much we wanted to sell."

Stanley Druckenmiller, who traded under Soros, originally saw the weakness in the pound. "Soros' contribution was pushing him to take a gigantic position."[32][33]

Hmmm! One would think maybe a statue should be erected of Druckenmiller and Soros in Trafalgar Square considering the euro state's current predicament, which is probably about to be made worse by trying once again to "out market" the market! On that note, let's explore what happens when true market participants - savers and instititutional counterparties - get the hint before governments, regulators and bank management.

Asset/Liability Funding Mismatches: The Major Cause of Institutional “Runs on the Bank”

Modern day banking business models (fiat banking system) fund business investment that often require expenditures in the present to obtain returns in the future (for example, spending on machines and buildings now for production in future years). Therefore, when businesses (banks included) need to borrow to finance their investments, they usually do so on the understanding that the lender will not demand repayment(s) until some agreed upon time in the future. Usually, the farther into the future, the more preferable, thus entities with exposures to business cycles (businesses) often prefer loans with a longer maturity. This longer maturity leads to lower liquidity, which is in the better interests of the borrower. This very same principle applies to individuals seeking financing on the purchase of big ticket items such as real estate, housing, boats, small businesses and cars. The flip side of this equation contains the primary funding source in the fiat banking system, the individual savers (both households and firms). These savers strive for relatively high liquidity due to shorter cycles in their (sometimes sudden) and considerably less predictable needs for cash. The products that serve these needs are the demand accounts that commercial banks use as their primary funding source.

Commercial and investment banks (as well as some broker/dealers) profit by acting as intermediaries between short term savers who prefer highly liquid demand accounts and borrowers who prefer to take out long-maturity loans with considerably less liquidity. When things are working as anticipated in the fiat banking system, banks acting as intermediaries profit by channelling capital from short term savers to long term borrowers, underwriting and eating the risk of this “asset liability funding mismatch”.

Banks also carry on their capital intensive businesses (ex. trading, market making, etc.) in a similar fashion by borrowing heavily on the short end of the yield curve on a relative sliver of equity and investing in the longer end of the curve or in more volatile, risky asset classes (i.e. public equities, private equity, real assets, commodities, etc.)

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The premise behind the fractional reserve (a system where only a fraction of deposits are required to be kept in house as reserves against deposit demands)/fiat banking system is that under ordinary circumstances, savers' unpredictable needs for cash are unlikely to occur at the same time. This premise has been justified by the theory that depositors' needs reflect their own and mostly unique individual circumstances. The fiat/fractional reserve banking institution, by accepting deposits from myriad and differing sources, assumes risk has been effectively diversified away, with the bank expecting only a small fraction of withdrawals in the short term at any given time. This is despite the fact that all depositors have the right to take their deposits back at any time. Adherence and acceptance of the logic behind the fractional reserve system allows fiat banks to make loans and investments over a long horizon, while keeping only relatively small amounts of cash on hand to pay any depositors (and counterparties) that wish to make withdrawals, capital calls or collateral calls.

Traditional views on this “bank run model” largely (or more aptly, only) consider individual savers in the form of depositors on the short side (liquid liabilities). It is a run such as this that caused the banking collapse during the US Great Depression. The modern central banking system has proven resilient enough to fortify banks against depositor runs, as was recently exemplified in the recent depositor runs on UK, Irish, Portuguese and Greek banks – most of which received relatively little fanfare. Where the risk truly lies in today’s fiat/fractional reserve banking system is the run on counterparties. Today’s global fractional reserve bank get’s more financing from institutional counterparties than any other source save its short term depositors.  In cases of the perception of extreme risk, these counterparties are prone to pull funding are request overcollateralization for said funding. This is what precipitated the collapse of Bear Stearns and Lehman Brothers, the pulling of liquidity by skittish counterparties, and the excessive capital/collateralization calls by other counterparties. Keep in mind that as some counterparties and/or depositors pull liquidity, covenants are tripped that often demand additional capital/collateral/ liquidity be put up by the remaining counterparties, thus daisy-chaining into a modern day run on the bank!

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This phenomena essentially discredits the thinking at large and currently in practice that “since individual expenditure needs are largely uncorrelated, by the law of large numbers” banks should expect few withdrawals on any one day. The fact of the matter is that in times of severe distress, particularly stemming from solvency issues (read directly as the Pan-European Sovereign Debt Crisis, and Greece, et. al. in particular), the exact opposite is the case. Individual depositor and counterparty actions are actually HIGHLY correlated and tend to move in tandem, particularly when that move is out of the target fiat bank. They tend to take heed to the saying “He who panics first, panics best!"

Asset/liability mismatch can, at the margin nearly assure a Lehman-style fiasco in the case of an impetus that sparks herding mentality, whether it be among depositors/savers or institutional counterparties.

Since banks both lend out and often invest at long maturity, they cannot quickly call in their loans or sell their investments. This scenario is exacerbated when said loan and/or investments have materially dropped in value causing a capital gap in between what said loans/investments can be called in for, and what is actually owed to the short term creditors. Again, this is a perfect example of what happened in the US with AIG, Lehman Brothers and Bear Stearns. Therefore, if a significant portion of depositors or counterparties either attempt to withdraw their funds or raise collateral/capital requirements simultaneously, a bank will run out of money long before it is able to pay all of its short term the depositors. The bank will be able to pay the first depositors who demand their money back, but if all others attempt to withdraw too, the bank will be realized insolvent and the last depositors will be left with nothing. It is for this reason that short term creditors tend to “panic first” in an effort to “panic best”, leading to a chain reaction that perpetuates a bank run. Essentially, the fiat/fractional reserve banking system creates a self-fulfilling prophecy wherein  each depositor/counterparty's incentive to withdraw liquidity and funds depends on what they expect other depositors/counterparties to do. If enough depositors/counterparties expect other depositors to withdraw their funds, then they all have an incentive to rush to be the first in line to withdraw their funds. “He who panics first, panics best!"

Next up on this topic I will discuss the sovereign states that I see exacerbating this risk through contagion, and will produce additional banks that are at risk to the big bank run for paying subscribers. In addition, I will post technical trade setups for Pro and institutional subscribers as well. After that, we will explore the effect that EVERYONE seems to be overlooking, and that is what happens to European CRE when that 70% of mortgage obligations come up for rollover in the next year and a half? There are basically ony two countries at risk, but they are at risk in a big way. Then again, if the excess funding (you know, to fill that equity gap formed by the devaluing real estate) fails to materialize on top of the expected funding needed just for the anticipated rollover, then lookout below in all of those countries whose CRE wasn't necessarily roaring to begin with. That would be basically... All of them! As all who attended my keynote speech at ING in Amsterdam know, I have proposed solutions for many and will make them part of the upcoming European CRE posts.

Feel free to follow me on:

Published in BoomBustBlog

rimm.goog.aapl

Apple reported blowout numbers and a record quarter yesterday. Not one, that's right, not one Wall Street analyst got it right! As a matter of fact, not only did no one get it right, they were all wrong to the downside - every single one! Doesn't that sound fishy after 11 previous quarters of analysts missing the mark to the downside? In a descriptive post yesterday, I detailed how I beat the street on Google's earnings, step-by-step by "thinking more like an entrepeneur and less like a Wall Street analyst".  In said missive, not only did I illustrate in relatively fine detail how the Street totally missed the massive value that Google is building, I also outlined in similar detail the voluntary game that the Street is playing with Apple and earnings guidance. Yes, it's a game, and an obvious one at that. Despite being so obvious, retail investors and institutions alike are playing along. Let me excerpt a few choice lines from said post:

 

Since I started covering mobile technology on BoomBustBlog, things have pretty much occurred precsiely as we anticipated - with Google, Microsoft, and Research and Motion (a 6x to 7x gain on select puts) following their prescribed paths...

Next up is Apple, whom we predicted our analysis would reach frutition in the 4 to 6 quarters. Apple reports today, and we fully suspect a blow quarter that (again, just like the last 12 quarters) surprise the unsurprisingly inept analyst estimates that somehow could not get it right for nearly 2 years straight see above). We also expect indications of our margin compression thesis to start peeping their little eyes out of the footnotes, of course to be totally ignored by the cheerleading sell side of Wall Street and pop tech and financial media, as the Apple lovefest marches on.

Hmmm! That was awfully prescient wasn't it? No! It wasn't. It was simply blatantly honest. Here is a further excerpt from a previous post describes in complete detailt the Analyst/Apple earnings game...

Yes, we are more optimistic on Apples' earnings than the sell side (reference page 16 in subscription document File Icon Apple - Competition and Cost Structure) Look to my writings from last summer to determine the common sense reasons why: .

Page 16 of the aforementioned document (which was released several months ago) pegged an uncannily accurate estimate of iPhone sales at 77 million for the year. Being that Apple sold ~20.3 million for the most recent quarter and said quarter was a company record, I think it's fair to say that we have a realistic grasp on Apple.

I syndicate my free content to several other sites, the vast majority of which are rife with Apple fanatics. These fanatics are literally incapable of parsing the logic of the preceding statement and the leading paragraph to this post. I have been more optimistic on Apple's nearer term accounting numbers than virtually the entire sell side, and have been proven accurate. As a matter of fact, this is actually a null feat that is absolutely nothing to brag or boast about since you simply have to look at the history of Apple's performance, guidance and analyst forecasts to see a needlessly consistent trend of error on the part of the sell side. Honestly, an elementary school student could have figured it out. I have also been correct on the underperformance and overvaluation of RIMM and the undervaluation and over performance of Google. Again, not a feat of superior intellect, but a much more mundane accomplishment of following the facts without bias and not having ulterior motives in producing analysis. In this case, an elementary school student may not have been able to do it, but I'm damn sure an astute high schooler could piece it together. In closing I will repost (for the 4th time) the earnings guidance snippet and challenge readers to possibility that we may have a very valid point.

In the meantime, sheeple-like investors are being hoodwinked by quarter after quarter of Apple blow out earnings. Don't get me wrong. I feel and fully acknowledge that Apple is executing on all 8 cylinders of a 6 cylinder engine, but it still has its real world limitations. Apple will start to bump up against these limitation over the next 4 quarters, and the signs of this bump are already apparent. Of course, the signs are being handily masked by the games that Apple management and the sell side analysts of Wall Street play, with the "Sheeple" retail and the lazier component of the institutional investors being put out to take the eventual bullet.

Riddle me this - If Apple can consistently beat the estimates of your favorite analysts quarter after quarter, after quarter - for 11 quarters straight, shouldn't you fire said analysts for incompetency in lieu of celebrating Apple's ability to surprise? After all, it is no longer a surprise after the 11th consecutive occurrence, is it? I would be surprised if my readers were surprised by an Apple surprise. Seriously! Apple management consistently lowballs guidance to such an extent that it can easily manage, no - actually create outperformance. This has has a very positive effect on their valuation. Of course, I do not blame Apple management for this, of they are charged with maximizing shareholder return. The analytical community and the (sheeple) investors which they serve is another matter though. Subscribers can download the data that shows the blatant game being played between Apple and the Sell Side here: File Icon Apple Earnings Guidance Analysis. Those who need to subscribe can do so here.

Below, I drilled down on the date and used a percentage difference view to illustrate the improvement in P/E stemming from the earnings beats.

In our analysis of Apple, we are using real world assumptions of future performance derived from backing in to the low balling this company is prone to. If you look at its history carefully you can gauge what management is comfortable with, hence what they may be capable of on the margin. Using these more realistic numbers, it is much more likely Apple will deliver a miss in the upcoming quarters in its battle with the Android! The following is the reason why...

Published in BoomBustBlog

First of all, congratulations to all BoomBustBlog subscribers that have recieved windfall profits on their researched Google positions for the second time in less than a calendar year. Google traded down to a 4 handle as recently as a couple of weeks ago and the January 880 calls (which I kept in inventory) were trading as cheap as 5 cents each. As I type this, those same options last traded at $1.40 each (now down to 1.05)- that's a 21x-26x return! 

Google's latest quarterly results should lead many - if not most - to believe Reggie Middleton and his team at the BoomBust bests ALL of Wall Street's sell side research. For previous examples (a lot of them), reference Did Reggie Middleton, a Blogger at BoomBustBlog, Best Wall Streets Best of the Best?

It is now well known that Google has once again knocked the ball out of park with their performance. Those who follow my blog know that I have been bullish on Google since the spring/summer of last year, with signfiicant profits being taken along the way. Many on the Street have turned rather negative on Google despite some of the most positive results and promising actions of its history, and in the industry! Why is that? How did I see so much value in Google while the Street was remiss, only to be taken totally and utterly by surprise? Let's take a historical traipse of my take on Google, but first we peruse the "short term-ities", looking forward only three months at at time mentality of Wall Street to ascertain why only Reggie Middleton's BoomBustBlog screamed on the The Gross Misvaluation of Google. [Subscribers, please follow along with the subscription documents - Google Q1 2011 earnings review - Google’s Q1 2011 Review: Part 2 Of My Comments On The Gross Misvaluation of Google and the subscriber forensic analysis (63 pg Google Forensic Valuation, to plug in your own assumptions see Google Valuation Model (pro and institutional).]

Larry Page did an excellent job on his first full debut performance as Google's new CEO during the conference call. One of his most important accomplishments? Convince the Wall Street crowd to realistically look at value creation and look away from short term, quarterly this-and-that-itis. A true high growth company is willing to sacrifice some margin to grow the business. This is Page on one of the most recent ventures, Google+:

I see more opportunities for Google today than ever before, because, believe it or not, we are still in the very early stages of what we want to do. Even in search, which we have been working on for 12 years, there has never been more important changes to make. They said there is no money to be made in search over and above a bit of banner advertising. Most new Internet businesses have had that same criticism. Fast-forward to today. It feels like we are watching the same movie again in slow motion. We have tremendous new businesses being viewed as crazy — Android. And actually have a new metric to report in Android of 550,000 phones activated a day. That is a huge number, even by Google’s standards. Chrome is the fastest growing browser. We have over 160 million users. Now people rightly ask, how will we monetize these businesses? Of course, I understand the need to balance the short-term with the longer-term needs, because our revenues and growth serve as the engine that funds our innovation. But our emerging high usage products can generate huge new businesses for Google in the long run, just like search. And we have tons of experience monetizing successful products over time. Well-run technology businesses with tremendous consumer usage make a lot of money over the long term.

Google+ is most likely a game changer and definitely has hurt those Goldman clients who allowed the Squid to convince them to fork over all of that money in a private offering, ex. Did Goldman Just Rip Its HNW and Institutional Clients Once Again? Facebook Growth Slows Pre-IPO, Just As We Warned! (more on that in a post later on today).

Google is a very aggressive Internet investment company who just so happens to operate its investments. Thus, it is a strategic acquirer. The problem with that, and the reason that there was a "Gross Misvaluation of Google" is that the Street cannot fully appreciate strategic investment when their entire world is measured 3 months at a time!!! In reference to aggressive investment, Page said:

Overall, we are focused on long-term, absolute profit and growth, as we have always been. And I will continue the tight financial management we have had in the last two years, even as we are making significant investments in our future. I would like to finish on our people. Great companies are no greater than the efforts and ingenuity of their people. We are continuing to hire the best. Keeping them happy and well-rewarded is crucial to our future. Many of you will be interested in hiring, whether we hired a few hundred more or less than you expected this quarter. But we will optimize headcount for the long term and the opportunities we see. It’s easy to focus on things that we do that are speculative, e.g., driverless cars. But we spend the vast majority of our resources on the core products. We may have a few small speculative projects happening at any given time, but we are very careful stewards of shareholder money. We are not betting the farm on this stuff.

Has Google given investors a reason to believe in Page's diatribe?

Reference the BoomBustBlog post, A Realistic Look At The Success Of Google's Investment History

As promised, I am presenting historical justification of the logic behind my call of absurdity in the drastic drop in share price after Google announces a redoubled effort in investment and marketing of its nascent businesses. I went into the logic in detail via our Google Q1 2011 earnings review - Google’s Q1 2011 Review: Part 2 Of My Comments On The Gross Misvaluation of Google. The following pages are excerpted the subscriber forensic analysis (63 pg Google Forensic Valuation, to plug in your own assumptions see Google Valuation Model (pro and institutional).

To begin with, Google apparently realized early on that it could better realize returns by investing shareholder capital through acquisitions. It has actually been quite acquisitive, making 88 purchases over the last 13 year. Last year was Google's most acquisitive year, ever!

While many of the referenced acquisitions have been to bolster existing products, several have literally become home runs - rising to the top of their respective categories and even threatening to go farther in that hey have the distinct potential to creatively destroy the status quo of several multi-billion dollar industries. Let's walk through a sampling.

Doubleclick + Youtube + Google TV (organically grown)

This combination is probably the closest thing to a direct replacement for TV as we know it. Even if Google TV does not succeed, YouTube is currently the most watched video site, by far and Doubleclick (for monetization, along with adsense style ads) is the 2nd largest display ad entity. Again, the potential to reconfigure the TV industry. Google is already seed funding original content and cutting licensing (streaming rental) deals with the large established studios. The ability to threaten TV as we know it was purchased for just over $1 billion. A pretty good investment, no? Would the NY Times parent co., Fox, Disney, NBC/Universal have considered this a wise purchase?

Admob and Android

For a mere $250 million (plus ongoing support and development costs and investments), Google now commands the largest global footprint of mobile phone OS, the fastest global mobile phone OS growth rate, the largest (by a very, very wide margin) mobile ad presence, and inarguably the most disruptive force in mobile computing. What tech, media, telecomm or strategic investment company would NOT by the Android/Admob combo now for 10xor eve 15x what Google paid for it? Microsoft, Nokia, Apple, Samsung, LG, RIM, Oracle, IBM, HP, anyone???

The list of strategic acquisitions that have paid off in spades goes on, as well as the requisite flops that go along with a high volume strategy.

So, assuming that Google has done a good job at spending its shareholder's money and sprouting several billion dollar businesses to assist in the diversification away from pure web search advertising - and realizing that last year was Google's most acquisitive to date, and realizing that Google is dumping more money into research, marketing, headcount and acquisitions now than in any time in its existence (including last year), should you be bullish on the stock? Three or four more Androids, YouTubes, Admobs and Doubleclicks to disruptively take over 5 or six more multi-billion dollar industries is a reason to lop 15% off of this stocks price (which currently barely accounts for just the search engine potential)???

As excerpted from Google’s Q1 2011 Review: Part 2 Of My Comments On The Gross Misvaluation of Google:

For the quarter ended March 31, 2011 Google reported gross revenues (before traffic acquisition costs) of $8.58bn, an YoY increase of 26.6% and QoQ increase of 1.6% while net revenues (after traffic acquisition costs) increased 29.1% YoY and by 2.6% sequentially to $6.54bn. The YoY growth in gross and net revenues was the highest at least since 2008 demonstrating a increasingly momentum in the growth of Google’s digital ecosystem. The increase in net revenues (after TAC) was actually stronger than the increase in gross revenues, indicating that Google has not only packed in growth but lowered aggregate top line expenses.

 However, despite a strong set of results the stock took a severe beating and was down c8% as the results were short of analyst expectations. The market’s reaction to Google’s numbers clearly reflects the very myopic view of US public markets wherein a stock is dumped if it fails to beat consensus – even when this view clearly overlooks the broader picture.

Google’s adjusted earnings came in at $8.08 a share below the $8.17 expected by the markets. However, a closer look at the results reveals that the perceived shortcoming was not a result of a revenue miss or margin compression but on account of Google’s entrepreneurial (and quite applaudable – at least from this investor’s perspective) endeavor to invest heavily in future projects. The miss was principally due to higher research and development expenses as the company continues to invest in new emerging businesses like Display, Mobile and Enterprise. Research and development expenses (including stock based compensation expenses) grew 50% YoY to $1.2bn and was 14.3% of gross revenues in Q1 2011 vs. 12.5% in Q4 and 12.1% in Q1 2O10. Had research and development expenses at 12.5% of gross revenues, the earnings would have been $8.51 per share, a clear beat to consensus and stock would have seen a roller coaster ride – despite the fact that future prospects would have been a fraction of that they are now due to lower investment in the future. Google has proven that their investments yield superior returns to that of cash holdings, ex. Youtube, Android, Admob, Google Voice, Teracent, etc. Instead, the stock was pushed down 8% as the shorter term players in the market reacted. Players such as sell side analysts whose employers benefit from the shorter horizon churning of stocks vs. a longer horizon and outlook, and traders who act on price movement and not value, were(are) clearly tangled between web of OPEX (ongoing cost for running a product, business, or system) and CAPEX (expenditures creating future benefits).

You see, the Street has become so accustomed to playing the earnings management game with their favored companies that most of them have actually lost the ability to ascetain true value outside of quarterly accounting earnings! Case in point - Apple's valuation

As excerpted from

Yes, we are more optimistic on Apples' earnings than the sell side (reference page 16 in subscription document File Icon Apple - Competition and Cost Structure) Look to my writings from last summer to determine the common sense reasons why: .

No, Google is not in the mobile space for search ads, it's looking to become the next Microsoft with Android as the next Windows. It is thinking big, simultaneously going after both the consumer and the enterprise space with cloud-based software and services - and advertising!

In the meantime, sheeple-like investors are being hoodwinked by quarter after quarter of Apple blow out earnings. Don't get me wrong. I feel and fully acknowledge that Apple is executing on all 8 cylinders of a 6 cylinder engine, but it still has its real world limitations. Apple will start to bump up against these limitation over the next 4 quarters, and the signs of this bump are already apparent. Of course, the signs are being handily masked by the games that Apple management and the sell side analysts of Wall Street play, with the "Sheeple" retail and the lazier component of the institutional investors being put out to take the eventual bullet.

Riddle me this - If Apple can consistently beat the estimates of your favorite analysts quarter after quarter, after quarter - for 11 quarters straight, shouldn't you fire said analysts for incompetency in lieu of celebrating Apple's ability to surprise? After all, it is no longer a surprise after the 11th consecutive occurrence, is it? I would be surprised if my readers were surprised by an Apple surprise. Seriously! Apple management consistently lowballs guidance to such an extent that it can easily manage, no - actually create outperformance. This has has a very positive effect on their valuation. Of course, I do not blame Apple management for this, of they are charged with maximizing shareholder return. The analytical community and the (sheeple) investors which they serve is another matter though. Subscribers can download the data that shows the blatant game being played between Apple and the Sell Side here: File Icon Apple Earnings Guidance Analysis. Those who need to subscribe can do so here.

Below, I drilled down on the date and used a percentage difference view to illustrate the improvement in P/E stemming from the earnings beats.

In our analysis of Apple, we are using real world assumptions of future performance derived from backing in to the low balling this company is prone to. If you look at its history carefully you can gauge what management is comfortable with, hence what they may be capable of on the margin. Using these more realistic numbers, it is much more likely Apple will deliver a miss in the upcoming quarters in its battle with the Android! The following is the reason why...

Of course, this inability of the Street to see the forest for the trees magically stops at the retail and insitutional customer. Once it comes to its own accounts, the Street miraculously start's to agree with Reggie's analysis... Miraculously! Reference: Goldman Sells Nearly Half $Billion Of Apple Stock Directly Into Their Client's Conviction Buy Recommendation: Guess Who Really Agrees With Reggie Now! and read very carefully!

Since I started covering mobile technology on BoomBustBlog, things have pretty much occurred precsiely as we anticipated - with Google, Microsoft, and Research and Motion (a 6x to 7x gain on select puts) following their prescribed paths...

Next up is Apple, whom we predicted our analysis would reach frutition in the 4 to 6 quarters. Apple reports today, and we fully suspect a blow quarter that (again, just like the last 12 quarters) surprise the unsurprisingly inept analyst estimates that somehow could not get it right for nearly 2 years straight see above). We also expect indications of our margin compression thesis to start peeping their little eyes out of the footnotes, of course to be totally ignored by the cheerleading sell side of Wall Street and pop tech and financial media, as the Apple lovefest marches on.

Published in BoomBustBlog

The first two European bank stress tests were simply jokes without punch lines. Failing to fully take into consideration sovereign default risks doesn't even illustrate How Greece Killed Its Own Banks!not to mention several other countries and the ECB. That was then, this now. Here are some factual BoomBustBlog tidbits to chew on:

 It is simply a damn shame that it has come to this. What the political powers that be in Europe have done in their grasp to disseminate obvious mis/disinformation is to sow the seeds for history's first Pan-European bank run! It is more than obvious to the entire world that Eighteen Percent of the EU is Literally Junk, Carried As Risk Free Assets at Par Using 30x+ Leverage. What is the purpose of attempting to conceal facts hidden in plain site?

Bloomberg reports: Stress Tests Compromised by Greek Non-Default

European regulators’ attempts to bolster confidence in the region’s banking industry today are being undermined by their unwillingness to test for a Greek default and a mutiny by Germany’s Landesbank Hessen-Thueringen.

The European Banking Authority will release the results of the stress tests for 91 banks as part of an effort to reassure investors the region’s banks have sufficient capital. Helaba, as the landesbank is known, refused to allow the EBA to publish its results in full, saying the EBA’s data “would lead to a halving of the core capital without legal grounds.”German regulator Bafin has also attacked the London-based EBA. Bafin Chairman Jochen Sanio said last month the watchdog lacks “legitimacy.”

The assessments are the first by the EBA since it was set up earlier this year. Last year’s tests by its predecessor were criticized for not being tough enough because banks were shown to need only 3.5 billion euros ($5 billion) more capital, a 10th of the lowest analyst estimate. The EBA can’t force banks to take part, and can’t test for a sovereign default, which policy makers are struggling to avoid. Greece has about a one in 10 chance of avoiding default, credit default swaps show.

“The EBA has no teeth,” Bob Penn, financial-services partner at Allen & Overy LLP, said in a telephone interview in London. It can’t “make requirements from any individual bank because the framework was set up to allow national regulators to keep supervisory powers,” he said. “This isn’t Helaba poking a stick in the eye of the EBA, it’s Bafin.”

...“The new authority has been struggling to have more severe tests than last year,” Charles Wyplosz, director of the International Center for Money and Banking Studies in Geneva, said in a television interview with Tom Keene on “Bloomberg Surveillance” yesterday. “Last year was recognized as a joke. The new authority wants to be tougher, but I don’t think they are tough enough to convince the market,” he said. “The real question is: do we assume there is a serious default on serious public debt?”

It is apparently not understood by this group that if you obviously attempt to hide the truth of a very strong likelihood of default, you lose credibility... thus destroying confidence. It is the lack of confidence that leads to bank runs. Just ask the management of Bear Stearns and Lehman. I warned of those events ahead of time as well. It is amazing that lessons have not been learned from the past.

‘Depth Charge’

“The sovereign debt default problem is the depth charge to the credibility of this exercise,” Penn said. “There’s nothing the EBA can do about that because it’s politically unthinkable.”

Yeah, politics, that's the problem. To bad it's not economically unthinkable!

Standard & Poor’s own stress test, published in March, found European banks would need as much as 250 billion euros in fresh capital if faced with a “sharp” increase in yields and a “severe” economic downturn. In contrast, a survey of 113 investors by Goldman Sachs Group Inc. last month showed they expect banks to raise 29 billion euros after the tests.

I have shown beyond a shadow of a doubt what happens in the case of Greek default, with specificity through several arenas...

Live, at one of the largest banks of Northern Europe

Through prominent European television and print media...

Amsterdam's VPRO Backlight and Reggie Middleton on brutal honesty, destructive derivatives and the "overbanked" status of many European sovereign nations

Amsterdam's VPRO Backlight and Reggie Middleton on brutal honesty, destructive derivatives and the "overbanked" status of many European sovereign nations

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.

And last but not least, through my own BoomBustBlog...

Although the EU refuses to publish the truth, I have done so freely for blog subscribers and have available a detailed list, currently in its 3rd rendition, that explicitly walks though what will probably happen as any combination of the PIIGS group defaults.

Our most recent subscriber document explores the banking side of Greek failure - File Icon European Bank's Greece exposure, but I have put a significant amount of info into the public domain as well. If one were to even come close to marking the EU banks books to reality, market prices, or anything in between, the Lehman situation would look tame in compariosn! As excerpted from the subscriber document: File Icon The Inevitability of Another Bank Crisis

Then there's the obvious twists from other impetuses:

And in the End, What Does It All Mean?

LGD 100+: What's the Possibility of Certain European Banks Having a Loss Given Default Approaching 100%?

Published in BoomBustBlog

Note: This may be it for posting for the next 20 hours or so, for I have found what looks like the next TWO (That's right! Two as in number 2) Lehman Brothers and Bear Stearns sitting right there smack in the middle of plain site in Europe and I will need some time to work on it with my analysts. The meltdown should occur just as it did here in the US save the world 2nd largest hedge fund probably will not have the resources to pull that funny little, furry financial creature from the family Leporidae out of their hat like the world's largest hedge fund did in the case of Bear Stearn's and Lehman Brothers. For those of you who do not know, I called the collapse of both Bear Stearns and Lehman Brothers months before the face while they were both trading at healthy stock prices, rated investment grade by "you know who" and rated "buy" by those whose name we shall not utter while still in the confines of downtown Manhattan!

bsc_vs_spx_for_reggie.gif

Bear Stearns collapsed in March of 2008, I first warned in September 2007, and gave explicit research and documentation to the public in January of 2008!

Correction, and further thoughts on the topic Posted on Sep 01, 2007 

Bear Fight - A most bearish view on Bear Stearns in a bear market:...at I did insinuate, or at least tried to, was that if real assets revert to mean valuations as I interpret them Bear Stearns will not be a prudent investment. As for institutions interested in portion... Sunday, 13 January 2008

 Here's the big Kahuna, Is this the Breaking of the Bear? January 2008


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Shortly after the "Bear fest", came the biggest foreeable bankruptcy in this nation's history. See "Is Lehman really a lemming in disguise?" and realize that this post was made on February 20th, when Goldman Sachs had a recommended price of about $55 while I warned that Lehman may be done for. This very similar to when I warned about the potential demise of Bear Stearns in January, when the rest of the Street had a "buy" at about $130 per share. Please click the graph to enlarge to print quality size.

Wait, there's much more...

Funny CLO business at Lehman .. loans into new securities. CLOs bought 60 percent of buyout loans before credit markets froze last year, said Mark Shafir, the global co-head of mergers and acquisitions at Lehman, in an ... Thursday, 03 April 2008

Lehman stock, rumors and anti-rumors that support the rumors... conspiracy, but if it pops 15% its due to ?????. Of course there are rumors and speculation floating around concerning Lehman, and I am sure a few short sellers may have whispered in someone's ear, BUT ... Friday, 28 March 2008

Of course, this all leads to the final conclusion, as illustrated in the seminal piece More on Lehman Brothers Dies While Getting Away with Murder: Introducing Regulatory Capture. Europe will soon learn a very, very valuable (albeit quite expensive and painful) lesson. That lesson is that lying is often really not worth it.

I will release preliinary findings on the suspect European banks in question, including names, prelimeary facts and figures to subscribers as soon as possible. This would make a very interesting topic for a FIRE sector compan annual board meeting as the keynote speaker, no? Now, back to our regularly scheduled programming of the mind and numbing of what was formerly called common sense...

Eighteen Percent of the EU is Literally Junk, Carried As Risk Free Assets at Par Using 30x+ Leverage: Bank Collapse is Inevitable!!!

So, the next domino falls in the Pan-European Sovereign Debt Crisis. As has been the casse for much of the Asset Securitization Crisis and the Pan-European Sovereign Debt Crisis, the ratings agencies have arrived to smoldering pile of ashes littered with charred bones and remnants of the putrid smell of burnt flesh with a fire hose and a megaphone yelling "Get out! We have word there may be a fire here!"

From Bloomberg: Ireland Debt Rating Cut to Junk, Adding Pressure for EU to Contain Crisis:

Ireland joined Portugal and Greece as the third euro-area nation to have its credit rating reduced to below investment grade as European Union finance ministers struggle to contain the region’s sovereign-debt crisis.

Moody’s Investors Service cut Ireland to Ba1 from Baa3, citing the probability that the country, which received a bailout last year, will need additional official financing and for investors to share in losses before it can return to the private market to borrow. The outlook remains “negative,” Moody’s said in a statement late yesterday.

Irish bonds dropped for a sixth day today after the downgrade, which came after European finance ministers failed to present a solution to the contagion that’s threatening to spread to Italy from the so-called peripheral euro-area states. Ireland’s debt agency said the downgrade will make it “more difficult” for Ireland to return to the market next year.

While Ireland “has shown a strong commitment to fiscal consolidation and has, to date, delivered on” the terms of its bailout, “implementation risks remain significant,” Moody’s said in the statement.

Irish 10-year bonds fell, pushing the yield on the debt up 31 basis points to 13.65 percent. The premium over German bunds widened 32 basis points to almost 11 percent. Italian yields were at 5.47 percent after surging above 6 percent earlier this week. The euro, which dropped to a four-month low against the dollar yesterday, rose 0.5 percent to $1.4049 as of 9:06 a.m. in London.

One must wonder what took Moody's so long to come to said conclusion. BoomBustBlog subscribers were well aware of Ireland's "Junk status" situation at least a year and a half ago. Outside of The Anatomy of a Serial European Banking Collapse nearly guaranteed scenario that I present last month, here are my thoughts starting July 2010:

For our professional and institutional subscribers, the Ireland Default Restructuring Scenario Analysis with Sustainable Debt/GDP Limits and Haircuts are available online. All subscribers have access tos the File IconIrish Bank Strategy Note which adequately warned before Irish banks dropped 85% in value. The File IconIreland public finances projections is also available to all paying members.

For those who don’t believe haircuts are possible, remember Denmark already took the clippers out. Ireland looks like they may be bluffing, but suppose their bluff is called???
From Bloomberg Today: Bondholder Haircut from Ireland May Shut Italy & Spain Out of Funding Markets

Ireland making good on its threat to impose losses on senior bank bondholders would precipitate a funding crisis for lenders across southern Europe, according to CreditSights Inc. “The fallout would be big and it would be bad,” said John Raymond, a London-based analyst at the independent research firm. “The senior unsecured market would shut down, at least for a while. Right now, the bigger and better Spanish and Italian banks can still access the market. That could end.”

... Pressure on bondholders to share the burden of banks’ losses is growing. In Denmark, the government inflicted so- called haircuts on senior creditors and depositors of regional lender Amagerbanken A/S, which failed after losing money on investments including real-estate loans. Moody’s Investors Service cut ratings of five Danish banks, including Danske Bank A/S, the country’s biggest, pushing up funding costs. Ireland’s government has similar powers to Denmark’s under the terms of its banking act.

And in other, seemingly forgotten news... Ireland Says Four Lenders Need $34 Billion After Stress Tests:

Irish regulators instructed four banks to raise 24 billion euros ($34 billion) in additional capital following stress tests on the nation’s lenders.

Of course, the most ironic point is that two of Ireland's big banks collapsed/were nationalized directly after passing the EU stress tests. Europe would be better off without the farce commonly known as stress tests for they simply undermine what very little credibilty TPTB (or at least the spokespersons for thesame) have left. 

And back to this most recent Bloomberg article...

Irish Bailout

Ireland was forced to seek an 85 billion-euro rescue from the European Union and the International Monetary Fund in November as a banking crisis overwhelmed the government.

The European Commission in Brussels said the downgrade “contrasts very much” with recent economic data and the “determined implementation of the program by the Irish government.” The Irish program is “fully on track,” it said.

Moody’s rationale for cutting Ireland echoed its review of Portugal, which was lowered to junk on July 5. European leaders may hold an extraordinary summit in two days in another attempt to stem the debt crisis, Greek Finance Minister Evangelos Venizelos and Irish Prime Minister Enda Kenny said separately yesterday.

Standard & Poor’s cut Ireland’s rating one level to BBB+ with a “stable” outlook on April 1. Fitch Ratings affirmed Ireland’s BBB+ rating on April 14 and removed it from “rating watch negative.” It said the outlook is negative. Both firms’ ratings are three levels above junk.

Ireland’s debt will rise to 118 percent of GDP in 2012 from 25 percent at the end of 2007, the European Commission has forecast. Taxpayers have pledged as much as 70 billion euros to shore up the country’s debt-laden financial system.

“Things need to get worse before they get better,” said Steven Lear, deputy chief investment officer at J.P. Morgan Asset Management’s Global Fixed Income Group in New York, who helps oversee $130 billion in assets. “There has to be a lot of pain before the alternative of pain seems palatable.” 

Oh, Mr. Lear, trust me, there will be plenty of pain to go around. The 2nd biggest hedge fund in the world (right behind the US Federal Reserve) is currently busting at the seems (literally) with junk! Think about it. There are 17 members of European Union, and 18% of those members are trading junk bonds as sovereign debt. These junk bonds (in some cases trading 50 cent on the Euro) are carried on HTM books at par, and have been purchased with 30x to 60x leverage. Care to calculate the losses, because I have. Once again, the endgame is The Anatomy of a Serial European Banking Collapse, but the prequel can be found in my many warnings that will lead up to that event, starting with the abject insolvency of the world's 2nd largest hedge fund - the ECB!:

Over A Year After Being Dismissed As Sensationalist For Questioning the ECB's Continued Solvency After Sovereign Debt Buying Binge, Guess What!

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Click, Clack, Click: The Sound of Falling Dominoes Behind The Door of the Eurocalypse!

UK banks abandon eurozone over Greek default fears

UK banks have pulled billions of pounds of funding from the eurozone as fears grow about the impact of a “Lehman-style” event connected to a Greek default.

 Senior sources have revealed that leading banks, including Barclays and Standard Chartered, have radically reduced the amount of unsecured lending they are prepared to make available to eurozone banks, raising the prospect of a new credit crunch for the European banking system.

Standard Chartered is understood to have withdrawn tens of billions of pounds from the eurozone inter-bank lending market in recent months and cut its overall exposure by two-thirds in the past few weeks as it has become increasingly worried about the finances of other European banks.

Barclays has also cut its exposure in recent months as senior managers have become increasingly concerned about developments among banks with large exposures to the troubled European countries Greece, Ireland, Spain, Italy and Portugal.

In its interim management statement, published in April, Barclays reported a wholesale exposure to Spain of £6.4bn, compared with £7.2bn last June, while its exposure to Italy has fallen by more than £100m.

One source said it was “inevitable” that British banks would look to minimise their potential losses in the event the eurozone crisis were to get worse. “Everyone wants to ensure that they are not badly affected by the crisis,” said one bank executive.

Moves by stronger banks to cut back their lending to weaker banks is reminiscent of the build-up to the financial crisis in 2008, when the refusal of banks to lend to one another led to a seizing-up of the markets that eventually led to the collapse of several major banks and taxpayer bail-outs of many more.

Eurocalypse Cometh! Principal Haircuts, Serial Bailouts, ECB Insolvent! Disruptive Sound Of Dominoes In Background Going "Click, Clack"! BoomBustBloggers Instructed To Line Up Bearish Positions Again! 

If one were to even come close to marking the EU banks books to reality, market prices, or anything in between, the Lehman situation would look tame in compariosn! As excerpted from the subscriber document: File Icon The Inevitability of Another Bank Crisis

Then there's the obvious twists from other impetuses:

And in the End, What Does It All Mean?

LGD 100+: What's the Possibility of Certain European Banks Having a Loss Given Default Approaching 100%? 

 

Published in BoomBustBlog