Financial, Real Estate, Stock Markets Trends and Current Affairs

I always thought Paulson would eat those "worst is behind us" words. I wonder if he likes his verbs bland or spicey??? In today's news (and I mean early today, it is only1:44 am and already my puts are bursting at the seems with premium reading to match the week Bear Stearns went bust):

From Bloomberg:

Bradford & Bingley Plc, the U.K. lender struggling to raise cash in a rights offering, must honor a 2006 deal to buy about 2.1 billion pounds ($4.1 billion) of mortgages by the end of next year from GMAC LLC.

Customer payments are more than three months late on 5 percent of loans already purchased from Detroit-based GMAC, the car and home lender trying to avert bankruptcy for its residential mortgage unit. That's more than double the average rate for mortgagesheld by the Bingley, England-based bank, it said yesterday in a statement.

``This is what has spooked everybody,'' said Alan Beaney, who manages $2.1 billion of stocks as head of investments at Principal Investment Management in Sevenoaks, England. ``They are committed to keep buying these things.''

Rising loan defaults were ``by far the biggest factor'' in Bradford & Bingley's decision to sell a 23 percent stake to U.S. leveraged buyout firm TPG Inc., Chairman Rod Kent told analysts on a conference call. The bank fell 24 percent in London trading yesterday, the most since an initial public offering in 2000, after it slashed the price of the rights offering by a third and said the U.K. housing market is deteriorating.

The bank first agreed in 2002 to buy loans from GMAC. Steven Crawshaw, who stepped down June 1 as Bradford & Bingley's chief executive officer, renewed the deal in December 2006 and committed to buy as much as 4 billion pounds of loans a year through 2009.

Wachovia, Alt-A speculators , Countrywide, WaMu and Merrill weren't the only one's who binged on bad debt during the top of a bubble!

From WSJ:

Lehman Brothers Holdings Inc., set to report its first quarterly loss since going public, is considering raising billions of dollars in fresh capital to help shore up its balance sheet, according to people familiar with the matter.

The exact amount of the capital hike isn't known, but analysts and Wall Street executives estimate it is likely to be $3 billion to $4 billion. They said Lehman would probably announce the capital raising in conjunction with its quarterly results, due the week of June 16. The amount of new capital under consideration suggests Lehman's quarterly loss could be larger than the $300 million or so that some analysts have been expecting. Now I made it very clear that Lehman was guaranteed to take a loss this quarter because, they took an economic loss last quarter but covered it up with accounting shenanigans and smoke and mirrors. Lehman was one of the few companies that I shorted heavily despite not performing a full forensic analysis because they had too much smoke and too many inconsistencies. Starting in September of last year, I started uncovering a lot of Lehman lemmings. See my chronological smoke trail below.

On Monday, shares in the 158-year-old firm fell $2.98, or 8%, to $33.83 on the New York Stock Exchange after negative comments from two Wall Street analysts. The shares are down almost 50% this year compared with year-to-date drops of about 20% for rivals Goldman Sachs Group Inc. and Morgan Stanley. The Street's Riskiest Bank will have some surprises for us. Amazingly, S&P picked up on my view of riskiness with MS, I was shocked, and concerned to be in such company - considering their accuracy in these matters over the last year or two. The new capital would likely be raised by issuing common shares, diluting current shareholders, people familiar with the matter said.

Lehman is Wall Street's smallest independent firm now that the sale of Bear Stearns Cos. to J.P. Morgan Chase& Co. is complete (see Is this the Breaking of the Bear?). Lehman says it is well-positioned to weather the current credit-market turmoil, and its management has been aggressive at facing down its critics. Isn't that what Bear Stearns, Thornburg Mortgage, Indymac Bank and Countrywide said??!!! I am not one for litigation, but these guys seem to be pushing their luck!

In the past year, Lehman has raised $6 billion in capital, including $4 billion last quarter. The firm's financial position was further strengthened in March when Lehman, like all U.S. investment banks, was allowed to borrow directly from the Federal Reserve against a variety of collateral, which gives it ready access to considerable funding. The availability of Fed funding significantly reduces any worries that Lehman and other firms might suffer a cash crunch.

Nonetheless, some investors remain concerned that relative to its size, Lehman is holding more securities tied to both residential and commercial real estate than any other big Wall Street broker, according to Bernstein Research.

Mortgage Exposure

"Lehman still has a lot of exposure to the mortgage market, and they are going to need capital to get through it," said UBS analyst Glenn Schorr.

On Monday, Standard & Poor's cut long-term debt ratings on Lehman, Merrill Lynch& Co. and Morgan Stanley. The credit-rating agency focused in particular on Lehman, saying it expects a "relatively meaningful deterioration" in the firm's earnings for its second quarter, which ended May 31.

Also Monday, Merrill Lynch analyst Guy Moszkowski lowered his rating on Lehman stock to underperform from neutral. Oppenheimer & Co. analyst Meredith Whitney swung her earnings forecast to a loss from a profit. What took so long Meredith? You are usually lock step with me...

The immediate impact of the S&P downgrade will likely be minor, but the downgraded firms may face slightly higher borrowing costs. The cost of buying protection against a default at Lehman Brothers increased by $15,000 Monday, bringing the cost to $245,000 for five years of protection on $10 million of debt.

In contrast to Bear Stearns, Lehman has successfully raised capital, sold off risky securities and responded forcefully to rumors about its situation. After its most recent capital raising on March 31, its gross leverage ratio -- a measure of borrowing relative to assets -- fell to a more conservative 27.3 from 31.7 at the end of its first quarter in February. The figure is expected to be down to 25 as of the end of the second quarter. Semantics! There's more conservative, and then there is conservtive. None of the banks that use proprietay trading as a revenue source have conservative leverage ratios. In addition, I believe this reduction to be smoke in mirrors, in part because they have reduced the balanc sheet but retained the risk of the assets that that they shed, simply in another form. It can be seen as actually concentrating the risk in and attempt to placate naive investors (as in less knowing, not meaning to be offensive) shareholders. See the CLO funny business towards the end of the long list below.

In a statement, a Lehman spokesman said: "It is our clearly articulated strategy to reduce the size of our balance sheet this quarter." What you need to do is reduce the risk of your balance sheet, and make that your stated goal. No more smoke an mirrors.

Lehman's long-serving chief executive, Richard Fuld Jr., has experience in tough situations. In 1998, he fought off rumors about a cash crunch that were triggered by the near-collapse of hedge fund Long-Term Capital Management.

But Lehman's second-quarter results are expected to show some fresh difficulties. The firm is saddled with billions of dollars in hard-to-sell commercial real-estate assets and leveraged loans and is expected to face further write-downs on these portfolios. That has led the firm to consider raising additional capital. Wall Street firms including Merrill Lynch and Morgan Stanley have also raised billions of dollars as losses from the mortgage meltdown have mounted.

If Lehman proceeds with plans to raise capital, it is expected to do so by issuing common stock, the first such issue since it went public in 1994. In its earlier capital raising over the past year, it issued preferred shares, a stock-bond hybrid that doesn't dilute the ownership of common shareholders. D-I-L-U-T-I--V-E at a time when there are scant earning to go around to the shares that are already in existence. When will (foreign) investors learn that you are throwing your money down the tubes by funding these institutions at this point in the game. Just sit back and look at how much money was loss with the BSC, C, MS, and the whole list that is too long to run through, gamut of I-bank investments that were made over the past year. I don't want to hear that "this is a long term commitment nonsense either. Why don't you guys make your long term commitment at HALF the price by waiting until next year. Hey, I'm a long term player too. That doesn't mean I voluntarily burn my money like matchsticks.

While a common-share issue will hurt Lehman's already-suffering shareholders by diluting their ownership stake, rating agencies and regulators like to see a balance of common and preferred shares. That is why Lehman will likely go the common-share route.

Stung by Hedges

During the second quarter, Lehman was stung by hedges used to offset losses in real estate and other securities, according to people familiar with the matter. The firm bet that indexes tracking markets such as real-estate securities and leveraged loans would fall. If that happened, it would book profits that would make up some of its losses from holding these securities and loans.

However, in an unexpected twist, some of the indexes rose, even as the assets they were supposed to hedge against continued to lose value or stayed relatively flat. Lehman's losses from both write-downs on assets and ineffective hedges will likely top $2 billion, people familiar with the matter said. Lehman will also realize additional losses related to its decision to reduce its work force, according to a person familiar with the matter. I warned about bad hedges in February in the Morgan Stanley opinion: Street's Riskiest Bank .

The S&P downgrades came after the ratings agency completed a review of the entire securities industry. S&P said it believes Lehman and other securities dealers' revenues may decline more than anticipated based on the firms' still large exposures to illiquid and hard-to-value assets.

S&P analyst Scott Sprinzen said the Federal Reserve's decision to allow brokers to borrow money directly from the Fed, "gave us the comfort not to go further with some of the downgrades that we did," he says. "But we can't count on that indefinitely."

S&P cut Lehman's rating to A from A+, and also cut the ratings of Morgan Stanley to A+ from AA- and Merrill Lynch to A from A+. Despite the downgrades, the firms are still considered high-quality investment-grade credits. S&P affirmed Goldman Sachs's ratings at AA-, but revised its outlook of the firm to negative.

Now reflecting on why I haven't doubled down on Lehman more than the once or twice that I dipped in to the coffers... I am resource constrained. If I had more analytical firepower I would have really had a homerun position. I have hefty proportionate position as it is, but let's reminisce on the ruminations that was (notice the dates on each snippet while remembering that I started bloggin in September). Call this the chronological anatomy of a short selling blogger's tale of speculative anecdotal research and use the chart to peg the comments to Lehman's share price...

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This is the first of several drill downs into the list of 32 banks in deep doo-doo. Before I go on, let's outline the articles in this series thus far...

The Asset Securitization Crisis Analysis roadmap to date:

1. Intro: The great housing bull run – creation of asset bubble, Declining lending standards, lax underwriting activities increased the bubble – A comparison with the same during the S&L crisis
2. Securitization – dissimilarity between the S&L and the Subprime Mortgage crises, The bursting of housing bubble – declining home prices and rising foreclosure
3. Counterparty risk analyses – counterparty failure will open up another Pandora’s box
4. The consumer finance sector risk is woefully unrecognized, and the US Federal reserve to the rescue
5. Municipal bond market and the securitization crisis – part I
6. An overview of my personal Regional Bank short prospects Part I: PNC Bank - risky loans skating on razor thin capital, PNC addendum Posts One and Two
7. Reggie Middleton says don't believe Paulson: S&L crisis 2.0, bank failure redux
8. More on the banking backdrop, we've never had so many loans!
9. As I see it, these 32 banks and thrfts are in deep doo-doo!
10. A little more on HELOCs, 2nd lien loans and rose colored glasses
11. Will Countywdiw cause the next shoe to drop?
12. Capital, Leverage and Loss in the Banking System

Well, the first bank on the drill down list will also be 2nd of the banks that I will deliver a forensic analysis on (the first was PNC Bank). That bank is,,, (drum roll in the backgroud, crescendo.... I know some of you hate it when I do this........) Wells Fargo! I can hear a few of you naysayers cackling behind your computer screens as I type this. Wells Fargo is a big name brand bank (cackle, cackle)! Wells Fargo has Warren Buffet as its largest investor (cackle, cackle)! Wells Fargo this and that and blah, blah and (cackle, cackle).... All I can say is, beware of name brands (I actually felt compelled to address this in earlier posts). I have made more than a couple of dollars benefiting from name brand hubris and smaller investors who would rather be told what to do than read a balance sheet! Time will tell if I am right or not on Wells Fargo, just be forewarned - several of the banks on teh Doo-Doo 32 list have already taken a trip to the confessional! The score card for the credit crisis to date, Reggie Middleton - 10, big name brand investors - 0 (not to toot my own horn, I'm sort of a modest guy and I know I have a big mistake/loss coming soon, it just isn't going to be this one).

I actually have a lot of respect for Buffet, though. Hell of a fundamental investor and cash flow king, and charming public persona as well as being modest (at least he's got me beat). My appreciation differs from that of many, though. His investment track record is quite impressive for it stands the test of time as consistent. As a smaller, unknown investor, he was the most impressive, but now he is an icon and his very words and even a scent of investment from him actually moves markets. Even though he has a much larger capital base to work from (which makes it harder to generate large proportionate returns), his influence can be confused for investment acumen. All in all, he is one to be admired, but the investment results stemming from alpha have to be seperated from the ability to manipulate and move the market (unless that actual ability can be defined as alpha - topic for another day). We all make mistakes though, and Wells Fargo is a mistake waiting to happen. Let's walk through this company as I see it. Of course, since Wells Fargo failed to cooperate with me in releasing their numbers, I used statistical data to back into their probable delinquincies where they weren't directly available from their public filings.

Hat tip to Johnny Lay for pointing this out to me. From the Tom Brown's Bankstocks.com :

Permit me to point to some seemingly arcane (but in fact highly significant) numbers we have lately received as evidence that the worst-case scenarios concerning cumulative subprime losses being thrown around by the rating agencies, among others, are exaggerated.

Yes, you heard that right: the housing world has big problems, but it’s not coming to an end, after all.

The piece you are about to read is a follow-up to an article we posted here in February that noted, first of all, that if you want to get an early read on changes in credit quality in subprime, don’t pay attention to the number too many mortgage-industry watchers obsess over: the past-60-day delinquency rate. It is a lagging indicator of changes in credit quality.

Instead, look at two other metrics: 1) the inflows, in dollars, of newly delinquent loans, and 2) the roll-rates of problem loans from early-stage delinquency, to later-stage, to foreclosure. And on those numbers, I said at the time, the subprime picture seems to be showing signs of improvement. In particular, I made the point that dollar inflows to early-stage delinquency buckets had been falling for months.

One obvious answer to this dilemma in the "alleged" decline in subprime default metrics, as pointed out by Johnny Lay in his comment, is that "they just ain't makin' em (subprime loans) anymore". Duhh!

Well, make no mistake about my position. I am a super bear and a short seller, for now. I am also a full time investor. I will not short stocks that I feel won't go down in price. It's bad for the net worth, if you know what I mean. As for my opinion on Mr. Lay's opinion... Too many pundits harp on today's credit crisis being caused by the subprime debacle, or even worse yet calling it the "subprime crisis". It is far from such a thing. It is an asset securitization crisis, and far more shoes are dropping other than subprime. Thus, even if subprime were to get better, the banking industry will not, at least for the time being. See the full backgrounder on this top here:

Intro: The great housing bull run – creation of asset bubble, Declining lending standards, lax underwriting activities increased the bubble – A comparison with the same during the S&L crisis and here Securitization – dissimilarity between the S&L and the Subprime Mortgage crises, The bursting of housing bubble – declining home prices and rising foreclosure.

Now, as for the actual merits of the arguments set forth, I have found evidence to the contrary. Banks are not reporting late payments, delinquincies and charge offs at the rates that they were because, well,,,,, they are just not reporting them. That doesn't mean they are not occurring. The banks would rather not take the accounting and valuation hit. That does not make the bank more valuable for the loan is still defaulting, it is just that it looks a whole lot better on paper. Unethical??? Maybe. Factual??? You can bet your sensitive little tush!

Here is a little quip from the fine print in the reporting of my 32 bank Doo-Doo list : From April 1, 2008 onwards, "this particular bank on the doo-doo list has changed its home equity charge-off policy to 180 days from 120 days previously (the widely accepted industry standard). Amid current deteriorating credit markets with residential sector showing no signs of recovery, it is quite understandable that the bank has changed the policy in a bid to defer recognition of provision and charge-offs.

You see, sometimes you have to get past the indices, graphs and charts and dig down a bit deeper. My next post will be the start of the drill down into the banks of the doo-doo list. Stay tuned.

From the WSJ :

Already burned by bad mortgages on their books, lenders now are feeling rising heat from loans they sold to investors.

Unhappy buyers of subprime mortgages, home-equity loans and other real-estate loans are trying to force banks and mortgage companies to repurchase a growing pile of troubled loans. The pressure is the result of provisions in many loan sales that require lenders to take back loans that default unusually fast or contained mistakes or fraud.

[Chart]

The potential liability from the growing number of disputed loans could reach billions of dollars, says Paul J. Miller Jr., an analyst with Friedman, Billings, Ramsey & Co. Some major lenders are setting aside large reserves to cover potential repurchases.

Countrywide Financial Corp., the largest mortgage lender in the U.S., said in a securities filing this month that its estimated liability for such claims climbed to $935 million as of March 31 from $365 million a year earlier. Countrywide also took a first-quarter charge of $133 million for claims that already have been paid.

The fight over mortgages that lenders thought they had largely offloaded is another reminder of the deterioration of lending standards that helped contribute to the worst housing bust in decades.

Such disputes began to emerge publicly in 2006 as large numbers of subprime mortgages began going bad shortly after origination. In recent months, these skirmishes have expanded to include home-equity loans and mortgages made to borrowers with relatively good credit, as well as subprime loans that went bad after borrowers made several payments.

Many recent loan disputes involve allegations of bogus appraisals, inflated borrower incomes and other misrepresentations made at the time the loans were originated. Some of the disputes are spilling into the courtroom, and the potential liability is likely to hang over lenders for years...

... Repurchase claims often are resolved by negotiation or through arbitration, but a growing number of disputes are ending up in court. Since the start of 2007, roughly 20 such lawsuits involving repurchase requests of $4 million or more have been filed in federal courts, according to Navigant Consulting, a management and litigation consulting firm. The figures don't include claims filed in state courts and smaller disputes involving a single loan or a handful of mortgages.

In a lawsuit filed in December in Superior Court in Los Angeles, units of PMI Group Inc. alleged that WMC Mortgage Corp. breached the "representations and warranties" it made for a pool of subprime loans that were insured by PMI in 2007. Within eight months, the delinquency rate for the pool of loans had climbed to 30%, according to the suit. The suit also alleges that detailed scrutiny of 120 loans that PMI asked WMC to repurchase found evidence of "fraud, errors [and] misrepresentations."

PMI wants WMC, which was General Electric Co.'s subprime-mortgage unit, to buy back the loans or pay damages. Both companies declined to comment on the pending suit.

Lenders may feel pressure to boost reserves for such claims because of the fear they could be sued for not properly accounting for potential repurchases, says Laurence Platt, an attorney in Washington. At least three lawsuits have been filed by investors who allege that New Century Financial Corp. and other mortgage lenders understated their repurchase reserves, according to Navigant.

It is ashame this can be aired out in public and nobody even so much as winces:

From the FT Alphaville blog :

I never got a chance to perform a full forensic analysis of Lehman, but did put a fair size short on them a few months back due to their "smoke and mirrors" PR (oops), I mean financial reporting. There were just too many inconsistencies, and too much exposure. I was familiar with the game that some I banks play, for I did get a chance to do a deep dive on Morgan Stanley, and did not like what I found. As usual, I am significantly short those companies that I issue negative reports on, MS and LEH included. I urge all who have an economic interest in these companies to read through the PDF's below and my MS updated report linked later on in this post. In January, it was worth reviewing "Is this the Breaking of the Bear?", for just two months later we all know what happened.

I came across this speech by David Eihorn and he has clearly delineated not only all of the financial shenanigans that I mentioned in my blog, but a few more as well. Very well articulated and researched.

Here are a few choice excerpts:

"The issue of the proper use of fair value accounting isn’t about strict versus permissive accounting. The issue is that some entities have made investments that they believed would generate smooth returns. Some of these entities, like Allied, promised investors
smoother earnings than the investments could deliver. The cycle has exposed the investments to be more volatile and in many cases less valuable than they thought. The decline in current market values has forced these institutions to make a tough decision. Do they follow the rules, take the write-downs and suffer the consequences whatever they may be? Or worse, do they take the view that they can’t really value the investments in order to avoid writing them down? Or, even worse, do they claim to follow the accounting
rules, but simply lie about the values?

The turn of the cycle has created some tough choices. Warren Buffett has said, “You don’t know who is swimming naked until the tide goes out.” I do not believe the accounting is the problem. The creation of FAS 157 and other fair value measures has improved disclosure, including the disclosure of Level 3 assets – those valued based upon non-observable – and in many cases subjective – inputs. This has helped investors better understand the financial positions of many companies. For entities that are not over-levered and have not promised smoother results than they can deliver, when the assets have fallen in market value, they can take the pain and mark them down. It doesn’t force them to sell in a “fire-sale.” If the market proves to have been wrong, the loss can be reversed when market values improve. For levered players, the effect of reducing values to actual market levels is that the pain is more extreme and the incentive to fudge is greater. With this in mind, I’d like to review Lehman Brothers’ last quarter. Presently, Greenlight is short Lehman. Lehman was due to report its quarter two days after JP Morgan and the Fed bailed out Bear Stearns. At the time, there were a lot of concerns about Lehman, as demonstrated by its almost 20% stock price decline the previous day with more than 40% of its shares changing hands. In the quarter, bond risk spreads had widened considerably and equity values had fallen sharply. Lehman held a large and very levered portfolio.

With that as the background, Lehman announced a $489 million profit in the quarter. On the conference call that day, Lehman CFO Erin Callan used the word “great” 14 times, “challenging” 6 times; “strong” 24 times, and “tough” once. She used the word “incredibly” 8 times. I would use “incredible” in a different way to describe the report. The Wall Street Journal reported that she received high fives on the Lehman trading floor when she finished her presentation.

Twenty-two days after the conference call, Lehman filed its 10-Q for the quarter. In the intervening time, I had made a speech at the Grant’s Spring Investment Conference where I observed that Lehman did not seem to have large exposure to CDOs. This was true
inasmuch as Lehman had not disclosed significant CDO exposure.

Let’s look at the Lehman earnings press release (Table 1). Focus on the line “other asset backed-securities.” You can see from the table that Lehman took a $200 million gross write-down and has $6.5 billion of exposure...

... Now let's
look at the footnote 1 of the table, explaining Other
asset-backed securities:

The Company
purchases interests in and enters into derivatives with collateralized debt
obligation securitization entities ("CDOs"). The CDOs to
which the Company has exposure are primarily structured and underwritten by
third parties. The collateralized asset or lending obligations held by the CDOs
are generally related to franchise lending, small business finance lending, or
consumer lending. Approximately 25% of the positions held
at February 29, 2008 and November 30, 2007 were rated BB+ or lower (or
equivalent ratings) by recognized credit rating agencies... [emphasis added]

Last week, Lehman's
CFO and corporate controller confirmed that the whole $6.5 billion consisted of
CDOs or synthetic CDOs. Ms. Callan also confirmed that the 10-Q presentation was
the first time that Lehman had disclosed the existence of this CDO exposure.
This is after Wall Street spent the last half year asking, "Who has CDOs?"
Incidentally, I haven't seen any Wall Street analysts or the media discuss this
new disclosure.

I asked them how
they could justify only a $200 million write-down on any $6.5 billion pool of
CDOs that included $1.6 billion of below investment grade pieces. Even though
there are no residential mortgages in these CDOs, market prices of comparable
structured products fell much further in the quarter. Ms. Callan said she
understood my point and would have to get back to me. In a follow-up e-mail, Ms.
Callan declined to provide an explanation for the modest write-down and instead
stated that based on current price action, Lehman "would expect to recognize
further losses" in the second quarter. Why wasn't there a bigger mark in the
first quarter?

Now, I'd like to
put up Lehman's table of Level 3 assets (Table 3). I want you to look at the
column to the far right while I read to you what Ms. Callan said about this
during the Q&A on the earnings conference call on March 17.

[A]t the end of the
year, we were about 38.8 [billion] in total Level 3 assets. In terms of what
happened in Level 3 asset changes this quarter, we had net sort of payments,
purchases, or sales of 1.8 billion. We had net transfers in of

1.1 billion. So stuff
that was really moved in or recharacterized from Level 2. And then there was
about 875 million of write-downs. So that gives you a balance of 38,682 as of
February 29.

As you can see, the
table in the 10-Q does not match the conference call. There is no reasonable
explanation as to how the numbers could move like this between the conference
call and the 10-Q. The values should be the same. If there was an accounting
error, I don't see how Lehman avoided filing an 8-K announcing the mistake.
Notably, the 10-Q changes somehow did not affect the income statement, as there
must have been other offsetting adjustments somewhere in the financials....

... When I asked them
about this, Lehman said that between the conference call and the 10-Q they did a
detailed analysis and found, "the facts were a little different."

I want to
concentrate on the $228 million of realized and unrealized gains Lehman
recognized in the quarter on its Level 3 assets. There is a $1.1 billion
discrepancy between what Ms. Callan said on the conference call - an $875
million loss - and the table in the 10-Q, which shows a $228 million gain.

I asked
Lehman, "My point blank question is: Did you write-up the Level 3 assets by over
a billion dollars sometime between the press release and the filing of the
10-Q?" They responded, "No, absolutely not!"

However, they could
not provide another plausible explanation. Instead, they said they would review
the piece of paper Ms. Callan used on the call and compare it to the 10-Q and
get back to me. In a follow-up e-mail, Lehman offers that the movement between
the conference call and the 10-Q is "typical" and the change reflects
"re-categorization of certain assets between Level 2 and Level 3." I don't
understand how such transfers could have created over a $1.1 billion swing in
gains and losses...

---

I would like to add that Morgan Stanley is guilty of much of what Lehman is being accused of, and with much more net counterparty exposure and leverage to boot. See The Riskiest Bank on the Street and particularly Reggie Middleton on the Street's Riskiest Bank - Update. I would like to excerpt page 4 of that report here to see how similar the marketing (er, sorry about that again), I mean "financial reporting" of these two companies are:

Worsening credit market to impact Morgan Stanley’s financial position

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ABX BBB indices (September 26, 2007, toApril 2, 2008)Source: Marki.comtAlthough the ABX indices showed a slight recovery in March 2008, this is expected to be a temporary turnaround before the indices resume their downward movement owing to expected continuing deterioration in the US housing sector and mortgage markets. The following is a detailed, yet not exhaustive, example of Morgan Stanley's "hedged" ABS portfolio - Morgan Stanley ABS Inventory (1.65 MB).

"Hedged" is a parenthetical because we believe that large scale investment bank hedges are far from perfect. We discuss this later on in the report. These research reports were initially done in January and April, and I never got the chance to publicly release my thoughts on this hedging billions of dollars of specific risks with broad mathematical indices, marginal (at best) counterparties, and potentially litigous swap agreements, and such. Unfortunately, it looks like other investors/analysts may have beat me to the punch. Just remember, you heard it here first!

Once again, as with Citigroup and several other large investment banks, we have a troubled entity that sells risky assets but fails to truly sell the full risks associated with them - presumably under the impression that we investors are not swift enough to cath which shell they have hidden that little red ball under.

UBS sold $15 billion of mostly subprime (junk) assets to Blackrock, while financing $11.25 of it (75%). So, the assets are gone, but the bank is still on the hook for $11.25 billion through the loan. If it is a recourse loan, they are using this depreciating stuff as collateral (some indirect market risk) and they have the credit risk of the counterparty. If it is non-recourse, well that speaks for itself. In addition, they probably sold it at a discount, hence took the loss there as well. I am not saying the deal will blow up, but the risk of the assets were not really transferred off of the banks books. Would UBS normally offer a loan of this type with these terms for subprime assets in this environment? I doubt so.

From CNBC:

UBS financed 75 percent of the funding used by U.S. asset manager Blackrock to buy a $15 billion portfolio of distressed U.S. real estate assets from UBS, the bank said on Wednesday.

UBS completed the deal by providing $11.25 billion in loans to Blackrock, the Swiss-based bank said in a statement.

Blackrock raised $3.75 billion in equity from investors to pay for the rest of the package, UBS said.

Investors have welcomed the deal as a way for the troubled wealth manager, the world's largest, to prune its balance sheet and shed the type of assets that made it Europe's biggest
casualty of the subprime crisis.

UBS said the vast majority of the positions sold to the Blackrock-led group were subprime assets -- the lowest quality of real estate loans, and so-called Alt-A assets -- ranked one step above subprime, in roughly equal parts.

The remainder was ranked prime.

By publishing the financing details and the composition of the assets, UBS is providing more clarity to investors seeking more transparency about the structure of the deal.

Further terms of the deal were not disclosed.

For those that don't know, GGP represents one of my most
comprehensive research projects. Click here for a list of my work and here for reader commentary on potential shenanigans. For
everybody else, let's go through this and see if they did as well as
management preached...

FINANCIAL AND OPERATIONAL HIGHLIGHTS

• Core FFO
  is defined as Funds From Operations excluding the Real Estate Property
  Net Operating Income (NOI) from the Master Planned Communities segment
  (and WHY are we stripping this out???)and the (provision for) benefit from income taxes. Core FFO for the
  first quarter of 2008 was $226.6 million or $0.76 per fully diluted
  share as compared to $192.4 million or $0.65 per fully diluted share
  for the first quarter of 2007. Certain non-cash revenues and expenses
  included in Core FFO (This always raises suspicions. Instead of telling us what it is, they say "certain" items, and the fact that they were reduced compared to last year makes me even more curious) resulted in approximately $15.8 million or $0.05
  of Core FFO per fully diluted share in the first quarter of 2008 as
  compared to $29.0 million or $0.10, respectively, for the same period
  of 2007, representing a decrease of approximately $0.05 of Core FFO per
  fully diluted share. Minimum rent in the first quarter of 2008 includes
  approximately $21.0 million of lease termination income compared to
  approximately $3.7 million of lease termination income for the first
  quarter of 2007, representing an increase of approximately $0.06 of
  Core FFO per fully diluted share. Lease termination fees are not an ordinary income item in my book, hence they really cannot be replicated without volatlity for any length of time and should be stripped out as extraordinary or non-operating items, particularly when they are at these levels. More telling is the fact that they were actually included in the first place. The fact that you have a lease termination means that tenants are leaving, and they are leaving before lease maturity and willing to pay a fee for the pleasure. This screams bad macro scene to me. Take a look at the numbers and do the simple math - GGP is encountering a 568% increase in lease terminations, not expiries, but terminations. Should the prudent investor really expect such a significant jump in terminated retail shopping mall leases to be replaced by equal or greater revenue in the midst of a consumer led recession? As a matter of fact, would they be able to replace this income at all?
• FFO per
  share was $0.75 in the first quarter of 2008. FFO for the quarter
  declined to $223.2 million from $491.7 million in the first quarter of
  2007. The significant decline in FFO is primarily due to the
  approximately $298 million, or $1.00 per share, total tax benefit
  recognized in the first quarter of 2007 attributable to the tax
  restructuring of certain of our operating subsidiaries. Excluding the
  effect of such tax benefit, 2008 FFO increased approximately $29.5
  million, or approximately 15.2%, from 2007 FFO. Now,if you strip away the extraordinary/non-operating items (at least at these levels) called lease termination fees of $21 million, you will get a $8.5 million dollar gain. This $8.5 million gain came from several hundred million dollars of investment, such as the acquisition of the Homart properties mentioned below, among others. Hmmm. It doesn't look good here. I don't see how any banker could justify refinancing GGP loans when their real cash flow is on the fritz. In addition, the lease termination fees speak for themselves. The leases are terminating at a 568% y-o-y clip, which means vacanies will be rising quickly and significantly. Even if GGP were able to fill these vacancies quickly in a recession with retailers pulling back on all expenses (doubtful), they would be doing so in a much weaker leasing and rental market. Bad news no matter how pretty you try and paint it.
• EPS
  for the first quarter of 2008 were $0.03 per share versus $0.94 in the
  first quarter of 2007. Our first quarter 2007 EPS were significantly
  impacted by the tax restructuring, which increased net earnings, net of
  minority interest, by approximately $245 million or approximately $1.00
  per share.
• Core FFO per share guidance

SEGMENT RESULTS

Retail and Other Segment

• NOI
  for the first quarter of 2008 was $632.6 million, an increase of
  approximately 13.2% over the $558.7 million reported in the first
  quarter of 2007.
• Revenues from consolidated properties
  were $798.3 million for the first quarter of 2008, an increase of 18.3%
  compared to $674.6 million for the same period in 2007. The majority of
  this increase is due to the acquisition of our venture partner’s
  interest in the Homart I properties in July 2007, which resulted in the
  consolidation of 20 of the 23 properties in that portfolio that were
  previously reported as unconsolidated in our operating results.
  Excluding such acquisition, consolidated revenues would have increased
  by approximately $23.1 million or 3.4%. And if you strip out non-operating income such as the lease termination fees, revenue was flat year over year, and potentially negative if were to find out what those "certain" items are that were mentioned above.
• Revenues from unconsolidated properties, at the Company’s
  ownership share, declined to $146.6 million or 19.2% compared to $181.4
  million in the first quarter of 2007. The decline was due to the
  acquisition of our venture partner’s interest in the Homart I properties.
• Total tenant sales
  increased 0.2% and comparable tenant sales increased 0.9% in 2008, both
  on a trailing 12 month basis, compared to the same period last year. This figure would not encompass the effect of the recesionary slowdown
• Comparable NOI from consolidated properties in the first quarter of 2008 increased by 5.1% compared to the first quarter of 2007. Again, this is misleading because the amount of consolidated properties went up considerably. The properties performance seems to have the implication of deteriorating performance. You can't say I bought XXX% more in porperties but my NOI went up by X% and expect me to believe that all is rosy.
• Comparable NOI from unconsolidated properties at the Company’s
  ownership share in the first quarter of 2008 increased by approximately
  7.3% compared to the first quarter of 2007. This sounds good, but as you may have gathered, I am not a believer. Seeing is believing.
• Retail Center occupancy decreased slightly to 92.7% at March 31, 2008, compared to 92.9% at March 31, 2007. Wait until the effect of the 568% increase in lease terminations kicks in. If that trend continues in any meaningful fashion, the next few quarters will be ugly, whether they cure their financing problems or not.
• Sales per square foot for first quarter 2008 (on a trailing twelve month basis) were $460 versus $459 in the first quarter of 2007. Again this is a trailing indicator, and will not reflect what has happened recently.

Master Planned Communities Segment

• NOI in the first quarter of 2008 for
  the Master Planned Communities segment was a loss of $0.9 million for
  consolidated properties and income of $7.7 million for unconsolidated
  properties as compared to income of $3.6 million and $5.7 million,
  respectively, in the first quarter of 2007. The NOI loss in the first
  quarter of 2008 is due primarily to certain operating expenses which
  cannot be completely eliminated despite the significant reduction in
  current sales revenues. Oh, this is why they utilized the "Core FFO" nomenclature, to minimize the impact of this drop and loss. Unfortunately, you really cannot chop the unprofitable portion of your company off of the financial statement and call only the part that makes money "Core". Otherwise, my "Core" investment returns are 1,200 percent per year!!!
• Land sale revenues in the first quarter of 2008 were
  approximately $9.1 million for consolidated properties and
  approximately $23.1 million for unconsolidated properties, compared to
  $23.8 million and $13.4 million, respectively, in the first quarter of
  2007. Land sales continue to be at a very slow rate in 2008, a trend
  that is expected to continue into 2009. This is a big problem area for them. Think of the damage it has done to the homebuilders! Raw land is quite illiquid.

Alas, the conference call and the the 10Q should have more detailed information for us to sink our teeth into. I am under the impression that I am not welcome on the conference call, but I do know quite a few analysts follow this blog - so you guys know the pertinent questions to ask, ie. non-recurring revenue in lease termination fees, the family trust thing which looks very suspicious, and how GGP can post positive numbers in a recession with everybodey else posting negative. You may also want to inquire about their success in finding funding. I have had more than one set of potential GGP financiers and funding sources approach me about my opinions.

Just imagine a law suit that could make public the answers to all of those subprime questions you had about the Wall Street banks. Questions like that posed by the guy on Lehman TV ! This could be it. Reference the following press release:

Schiffrin
Barroway Topaz & Kessler, LLP and Labaton Sucharow LLP Filed a
Class Action Lawsuit Against Lehman Brothers Holdings Inc. -- LEH
Tuesday April 29, 6:19 pm ET

NEW
YORK, April 29, 2008 (PRIME NEWSWIRE) -- Schiffrin Barroway Topaz &
Kessler, LLP and Labaton Sucharow LLP filed a class action lawsuit on
April 29, 2008 in the United States District Court for the Northern
District of Illinois, on behalf of purchasers of the securities of
Lehman Brothers Holdings Inc. (``Lehman Brothers'' or the ``Company'')
(NYSE:LEH - News)
between September 13, 2006 and July 30, 2007, inclusive (the ``Class
Period''). The complaint names Lehman Brothers, Richard S. Fuld,
Christopher M. O'Meara, and Joseph M. Gregory as defendants
(collectively, ``Defendants''). The complaint alleges that during the
Class Period, Defendants violated the Securities Exchange Act of 1934
by issuing various materially false and misleading statements about
Lehman Brothers' financial well-being, business operations and
prospects, which had the effect of artificially inflating the market
price of the Company's securities.

If you are a member of this class you can view a copy of the complaint and join this class action online at http://www.labaton.com/en/cases/upload/Lehman-Bros-Complaint.pdf

The
complaint alleges, inter alia, that Defendants failed to fully disclose
the nature and extent of the Company's exposure to losses incurred from
trading in subprime mortgage-backed derivatives and that the Company
failed to timely writedown its positions in these securities. On July
10, 2007, Lehman Brothers announced that it had ``unrealized'' losses
of $459 million in the quarter ended May 31, 2007 from mortgages and
mortgage-backed assets in its inventory. On the same day, it was
reported that Standard & Poor's indicated that it may cut ratings
on $12 billion of bonds backed by subprime mortgages, a move that would
significantly cut into the Company's trading profits, since it is Wall
Street's largest underwriter of mortgage bonds. As a result of the
news, Lehman Brothers' stock fell $3.76 per share on July 10, 2007 on
unusually high trading volume. Throughout the remainder of the Class
Period, Lehman Brothers continued to downplay the risks associated with
owning these mortgage-backed securities, and the nature and true extent
of the Company's exposure to subprime-related assets and financial
positions. On July 26, 2007, it was reported by Bloomberg that the risk
of owning Lehman Brothers' bonds ``soared'' and its share price plunged
``as concerns escalated that investment banks will be hurt by losses
from subprime mortgages and corporate debt.'' The report detailed the
soaring cost of credit-default swaps used to bet on Lehman Brothers'
creditworthiness, signaling a significant deterioration in investor
confidence. On this news, Lehman Brothers' shares fell an additional
$3.16 per share on July 26, 2007, again on unusually heavy trading
volume. Finally, on July 31, 2007, Bloomberg reported that ``...Lehman
Brothers (is) as good as junk'' because the prices of credit-default
swaps for the Company equated to a Ba1 rating, implying that the
Company's credit ratings were below investment grade. On this news, the
Company's shares fell an additional $2.80 on heavy trading volume.

This came across my email inbox and I though I would share it with the blog.

A National Disaster

Rob Kirby

I was made aware of the existence of this article this evening. The author’s name is John Olagues. Here is his bio:

John Olagues is the owner and principal consultant for Truth IN Options and a recognized authority on listed and employee stock options.

After graduating from Tulane University (where he captained the baseball team and set many of Tulane's pitching records), John applied his B.A. in mathematics and his competitive spirit to the real world of stock options.

In 1976, John became a member of the Pacific Stock Exchange in San Francisco trading and managing options positions in scores of different stocks. John joined with Blair Hull to create Options Research, the first service to provide theoretical options values to market-makers and to the general public. In 1980, he became a member of the CBOE, where he personally traded more options in more diverse situations than any other trader.

After reading the piece, I contacted Mr. Olagues and asked for permission to repost his article with his bio. Additionally, I was curious, so I asked whether or not anyone from the mainstream financial press had contacted him regarding an interview or giving his article greater exposure?

His reply to me:

You can do with it what you wish. I have not had any calls or emails from the main stream media as they will not criticize the FED or J.P. Morgan. I am saying the J.P. Morgan essentially stole $30 billion from the tax payers through the FED and did a big favor for the short sellers, who probably made a few billion. From Cox to Bernanke, to Dimon and Cramer, they all played their roles.

This article is about how Bear Stearns stock was artificially collapsed so that illegal insider traders would make billions and J.P. Morgan would be paid $55 billion of US tax payer money to shore themselves up - and buy Bear Stearns at bankruptcy prices.

Massive buying of puts and shorting stock in Bear Stearns

On March 10, 2008, the closing price of Bear Stearns was 70. The stock had traded at 70 eight weeks earlier. On or prior to March 10, 2008 requests were made to the options exchanges to open new April series of puts with exercise prices of 20, and 22.5, and a new March series with an exercise price of 25.

Their requests were accommodated and new series were opened for trading March 11, 2008. Since there was very little subsequent trading in the call with exercise prices of 20, 22.5 or 25, it is certain that the requests were made with the intentions of buying substantial amounts of the puts.

There was in fact massive volumes of puts purchased in those series which opened on March 11, 2008.

For example: between March 11-14 inclusive, there were 20,000 contracts traded in the April 20s, 3700 contracts traded in the April 22.5s, and 8000 contracts traded in the April 25s. In the March 25s, there were 79,000 contracts traded between March 11-14, 2008.

Question: Why did the options exchanges not open the far out of the money puts for trading the first time that Bear Stearns stock hit 70, when the April and March options had far more time to expiration?

Certainly if the requesters were legitimate hedgers or speculators, their buying the March and April puts with 2 and 3 months to expiration was more reasonable.

Answer: The insiders were not ready to collapse the stock and did not request the exchanges to open the new series when Bear Stearns first hit 70.