This is the timely insurance sector update for paying subscribers. The subject company of this update reports in a couple of days so I decided to issue an update to inform subscribers on where I stand in regards to this company's prospects. A more formal report will be issued once I have a chance to congeal my projections and assumptions with the company's stated results. One thing is for sure, things don't look good. They may be able to push off reporting the inevitable this quarter (although I doubt it), but they will have to pay the piper eventually since they are in the eye of the perfect storm.
This update also exemplifies the extreme value to be had in the professional subscriptions. I decided to dump a portion of my model's inventory markdown and calculation engine results into the pro addendum to exemplify and illustrate how much high level thought and resources go into the analysis of these various subject companies. Keep in mind this is just the inventory calcluation, which is included because althought operations and premium cycles are weakening singificantly, this company's Achille's heel is trashy investment inventory. The retail summary is 7 pages while the pro summary is 44 pages.
I will decide, after reviewing the reported numbers, whether I will pursue this company farther. Subscribers can access the research via the following links, Adobe v. 9+ required. Good luck!
I have performed some more digging in the insurance sector, basically looking for the next AIG, and although I am far from finished I thought I would drop a note to the professional level subscribers that extended the general insurance note that I released last week. You may download the note here:
pdf Actionable Item (189.75 kB 2008-10-17 11:26:41). pdf
Here are a few highlights (keep in mind that the details are reserved for the download):
As a result of the continuing financial crisis,
the company is recording significant unrealized losses as a result of mark to market
adjustment of the general account securities (the portfolio on which the
company assumes the credit and the market risk). The net unrealized losses on
these securities rose a deafening 550% to 5.2% of the cost as of June, 2008 against 0.8% as of
Dec, 2007. As of June 2008, the risky components of $77.6 billion dollar
portfolio included $2.04 billion of sub prime RMBS, $2.6 billion of equity
securities (79% relates to financial services sector), $15.7 billion of CMBS,
$11.7 billion of corporate bonds issued by financial services sector and
$2.9 billion of senior secured bank loans CLOs.
spent the majority of my Wednesday spreading my bearish positions
further around the European banks (the balance was catering to my beautiful, yet demanding 2 year old daughter). Let me give you a glimpse into some of the
reasons why. First a glance at the home page of Bloomberg.com yields...
1. U.S. Stocks Plunge Most Since Market Crash of 1987 on
Recession Concerns- Sounds like a market crashing to me.
VIX Index of U.S. Options `Exploding' Amid Growing Concerns
About Economy- Hey doesn't this hypervolatility almost always precede a major market crash?
Bernanke Says Fed May Take New Role in Trying to Curb
Asset-Price Bubbles - Which
contradicts the story below. If you want to prick asset bubbles, you
can start by not letting them form, such as in allowing banks to
conceal the losses of assets on their books - in essence inflating
those asset values.
SEC Clears U.S. Banks to Postpone Writedowns on Value of
And so it begins, the obfuscation of
true market values of assets held on bank's books. They can't fool me though.
Now, preferred stock is to be called debt. When is debt to be called preferred stock.
When are we going to be notified if or when the assets a bank is holding and
paid for with leverage have dropped in value by 70%. Doesn't that make the bank
worth less. Maybe not, after all stock is really debt, right?
S&P May Downgrade $280.1 Billion of Alt-A Mortgage Debt
Amid Delinquencies - But it doesn't really matter because
if you read the article above, banks don't have to write it down now. You know,
if I run into the middle of the highway, as long as I close my eyes so I can't
see the cars I'll be just fine.
Bush Says U.S. Taxpayers Will Get Back `Most' of Money Under
Bank Rescue- Of
course they will. Bush and his cronies have ever been the bastion of
credibility (Reggie Middleton says, "Don't believe Paulson": S&L 2.0 - bank failure redux, Is Paulson to be trusted, or is this Bush Administration Shock and Awe, 2.0? and Reggie Middleton asks, "Do you guys know who you're messin' with?"). Just look at bullet point one above: all of those levered equity
securities bought at the top of the stock bull run from 2003 to 2007 will
generate tons of return for tax payer as they overpay to buy them up.
What does all this have to do with my buying of the European banks bear positions? Well, most are still much, much too optimistic about the financial sectors prospects here. The Monday rally was an opportunity to go shopping, and shopping I did, for price and value diverged even farther. While I won't divulge what I bought, I will share a little anecdotal research (more empirical research on this may be available to professional level subscribers next week). Before we go on, if you haven't read Interesting Lehman email, it is must reading to fully grasp the weight of the rest of this article.
As a continuation of the
recent posts on credit default swap risks, I am releasing my
proprietary study of Lehman's counterparties. Please read "Interesting Lehman email" and "Do you who's going to screw who next week?" to get a clear background on the chain of posts (and the ample comments beneath the posts) that generated this one.
It would appear that I am on the right track, with extreme resources
being dedicated by already bankrupt companies to unwind trades that
were supposedly "netted out" already (Lehman Plans to Hire 200, Unwind Derivatives Trades: WSJ Link), monolines seeking government bailouts (Ambac, Bond Insurers Will Present Plan to Tap Treasury Funds, Callen Says), and hedge funds raising substantial amounts of cash in a hostile market:
- Hedge-Fund Clients Pulled $43 Billion Last Month,
- Hedge Funds May Cut 10,000 Jobs,
- Citadel Hedge Fund Falls 30% on Bond, Stock Losses,
- Morgan Stanley's Mack Says Some Hedge Funds May Fail,
- Concordia, GSA Capital Shut Asian Offices As Markets Slump Oct. 16 ...
- Highland Shuts Funds Amid `Unprecedented' Disruption
was very, very specific in my assertions that the hedge fund bubble has
burst, and I was even at risk of sticking my toe in the bubble since I
had my own vehicle primed and ready to go. The fund formation process
combined with my proprietary trading clued me in on the maelstrom well
before the media started running the stories. I urge all who have done
so, to please read " In the Great Global Macro Experiment, the next bubble to burst is...". It is quite tell tale and also reveals a lot about your author. Now, back to the topic at hand.
CDS exposure report was a quick and dirty overnight project and thus
not perfect, for I didn't want to distract my teams from their other
projects. I will offer most of it here for free, but the actionable
items are for paying subscribers (all levels) only. I stripped out the
companies that I felt were actionable in the near term to present it to
the general blog. This the process that was used to develop a list of companies with exposure towards Lehman's debt and equity.
We extracted data for individual companies (approx 100). Some of the
companies (in addition to the stated exposure herein) have also
disclosed expected losses or write-down on the corresponding Lehman
exposure. In cases where this information was not available we have
computed expected loss based on the recovery rate of 15 cents (US) on a
We then used the following process to come up with a shortlist of 9 companies which may find it difficult to sustain the pressure from expected losses as a result of Lehman's failure and inability to repay.
After computing expected loss on Lehman exposure we have computed
expected loss-to-shareholders' equity to determine the relative
magnitude of loss each company could undertake..
In addition to expected loss-to-shareholders' equity we have also
looked into factors like absolute share price, relative decline in
share price over various periods and price-to-book value to indentify
potential companies that are prone to trouble.
· Based on the factors above we have indentified a list of 9 companies (for subscribers) which meet each of the following criteria
1. Expected loss-to-share holder's equity =>1.0%
2. Absolute share price >$15
3. Share price decline is less than 30% in last 3 months and less than 60% decline in the last 12 months
4. Price to book value more than 1.0x
Subscribers may download the actual spreadsheet here: Lehman Brothers CDS exposure_impact (153.5 kB 2008-10-16 19:12:02), all others can see the sanitized list below in HTML. (Update 1 -
There is a typo in this dowload. We inadvertently included price for
AMG instead of AGM. Federal Agricultural Mortgage (AGM) should go off
the list since its share price is less than $15, a criteria we used to
shortlist the companies. However, the data on exposure to Lehman ($60
bn) is correct. This makes their exposure as % of shareholders equity
to 25% (on a base of $230 bn of equity), which is significant.
It is obvious that there are still too many media types who don't read Reggie Middleton. From teh UK Telegrah: Fears of Lehman's CDS derivatives haunt markets:
It is a full week after bankers gathered in New York to start sorting
out the derivatives mess left by the bankruptcy of Lehman Brothers. We
still do not know who is on the hook for some $360bn of default
insurance, or how much they will have to pay.
I recieved an email from a user which actually
struck a chord with me, since I did similar digging. I'm putting this
out here for discussion purposes only, and welcome all comments:
the research I have done I have found that most of the brokers
additional coverage on their customers cash accounts (the amount in the
excess of $100,000 covered by SIPC) is written with LLoyds. This is
the case with my account. Seeing that LLoyd's hit a new 52 week low
today when the market is up 500 points is not comforting to me - ticker
LYG (error on the part of the emailer, but his core point remains valid - see comments below). If things hit the fan (which anything goes in this environment),
do you feel LLoyd's could fail in their obligations to make good on
this insurance should we see more brokers fail? I am wondering if
Lehman was insured by LLoyd's to cover the $100k excess in their cash
accounts? This worries me and I'd like to know your thoughts on this
and who you feel the safest online broker is? And whether you think
LLoyd's is too big to fail? Is it a false since of comfort to feel
that we are covered beyond the $100k by SIPC?
From the Timesonline :
On Friday night, America’s chief accounting body, the Financial Accounting Standards Board, revealed that it would suspend the mark-to-market rules to take account of extreme market conditions. Institutions will be able to use their own estimates of an asset’s worth instead. The move follows pressure from the US Securities and Exchange Commission.
In a “position” statement, the board said: “In determining fair value for a financial asset, the use of a reporting entity’s own assumptions about future cash flows and appropriately risk-adjusted discount rates is acceptable when relevant observable inputs are not available.”
Now, it's all marked to "I wish it were". After caving to special interests pressure, we will have a significant relieft from accounting pressures (whoopee!) and an extreme downdraft in economic valuations. If you thinks things were a little negative last week...
Although FASB really didn't make any changes to the rules, they failed to tighten up the understanding, and left room for game playing. The level 3 category may prove to be the dumping ground now. The market won't go for it.
You see, smart investors don't count accounting dollars, they count economic dollars. It is really irrelevant what management says an asset is worth, what truly matters is what investors believe an asset is worth. Why don't our regulators get this? Do they really think all of us are that stupid? If you think we had a rough week earlier, you probably ain't seen nuthin' yet. As financials and shadow banks attempt to hide their losses behind the accounting shenanigan curtain, stage left, the market will respond to this ambiguity and lack of transparency the same it always responds in the face of opacity - with LOWER VALUATIONS!!! If the smart investor is really not sure of a price to be paid, he defaults to the lowest common denominator and works his way up from there. It may come to be that the mere increase of any level 3 assets will spell the death knell for a financial company.
I have been swamped lately, and the spreads on the instruments that I trade or extreme. This is not good for a person as stingy as I. Since the market is moving so quickly, and I have my teams spread so thin, I have decided to start instituting what I call "actionable items". These are things that I may have started taking positions in due to initial research in but have not performed enough analysis to come to a hard valuation. I will not do this often, since it may impede my development of an economical position, but if I feel it is worthwhile I will share my thoughts with my paying subscribers. I will even start including video and multimedia presentations in the notes.
I have just released two actionable item notes from my own trading activities, one for a company in the insurance sector and one REIT. Some may consider this time sensitive. So, paying subscribers, make sure you are logged in and look at the "Latest Subscription Content" area in the right margin, about half way down the page. This area is dynamic, and changes according to your subscription level. Even free subscribers have access to some of the content.
These reports require the Adobe Acrobat Reader version 9 or above. You can download it below. Please do not contact me about access without first downloading the most recent version of the reader. In addition, once you click the download links, you will be taken to the download interface where you must search for the files you are looking for. You may sort by aphabetical order, date, or popularity.
Enjoy, and be careful - it's rough out there!
We looked at Metlife last week as a potential short candidate. While there are certain observations (see below) on a negative side for the company, it is not in dire straights and is definitely not bankruptcy candidate material - although it is not a company that I would be willing to put my money in at this time. Following are some of our cursory observations:
My warnings on Goldman Sachs, Morgan Stanley, and CDS have born fruit, by the bushels, for those who have heeded it. The Doo Doo 32 and commercial real estate shorts will be revisited soon, for they are in for a round of hell after this malaise. My industrial shorts will follow, as well as my lesser known real estate and finance services positions and research.
Goldman is down over $50 per share (from about $185 to $134) since I issued my warnings and forensic analysis. Many thought they were too connected to fall with the crowd. That is not a scientific approach to these markets. It's simple math, they are at extreme risk and trade at a significant premium. For those who are hesitant to subscribe to my proprietary research, this trade (off of a relatively small commitment) would have paid the professional subscription for several years, with plenty left over. We have been hitting on all cylinders with the investment banks. I expect the Goldman trade to be more profitable than the Bear Stearns trade where the research came out at about $105 or so and eventually warned that a long would make sense at $3 and it was bought at $10 (see More on the accuracy of this blog's research and Performance of This Site for historical details of much of the research performance). The market is starting to see Morgan Stanley as the bastion of risk that I see it as, and it is paying off. I'll assume that there is no need to comment on how we did with the Lehman research and forewarning.
Reference the Moody's and S&P downgrades of AIG to see how my multiple warnings of the risks the CDS markets will pose come to pass. Bloomberg - AIG's Ratings Lowered by S&P, Moody's, Threatening Efforts to Raise Funds: