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Friday, October 5, 2007

Non-Farm Friday

No posts the last two days. I’m feeling better now.

CNBC has the “SP500 is X points From Record Close sign front and centre. Futures are up on the non-farm payroll numbers.

U.S. Payrolls Expand in September After August Gain (Update3): “U.S. employment accelerated in September and revised figures for August showed an unexpected gain, easing concern the economy is headed toward recession.

Payrolls grew by 110,000 after an 89,000 increase in August, the Labor Department said today in Washington. Revisions added 118,000 workers to payroll figures previously reported for July and August.

More jobs and rising wages will help consumers weather falling home values, sustaining the spending that accounts for more than two-thirds of the economy. The report reinforces speculation that Federal Reserve policy makers won't need to lower interest rates again later this month.”

Most of the jobs were the result of government hiring. The ‘real’ economy continues to struggle.

“Most of the August revision came in government payrolls, which expanded by 57,000 during the month, reflecting hiring of teachers for the new school year. Previously, the Labor Department had reported a decline in government payrolls in August.”

While not a disaster, job growth is definitely slowing. Wage gains were surprisingly strong, and this does raise inflation concerns.

“Wages gained 4.1 percent in September from a year earlier, the biggest increase since February. Workers' average hourly earnings rose 7 cents, or 0.4 percent, after a 0.3 percent increase the previous month.”

Barclays Drops ABN Bid, Clearing Way for Royal Bank (Update2): “Barclays Plc abandoned a six-month battle to buy ABN Amro Holding NV after investors failed to back its bid, clearing the way for Royal Bank of Scotland Group Plc and two partners to complete the biggest banking takeover.

Investors tendered about 4.4 million shares to Barclays's 62.8 billion-euro ($89 billion) offer, the London-based bank said in a statement today, amounting to about 0.2 percent of ABN Amro's stock. Barclays was competing against a 71.8 billion-euro offer from Royal Bank, Banco Santander SA and Fortis.”

Barclays is admitting defeat, but getting away cheaply by avoiding both the costs and risks of executing this merger. Barclays will now have to look elsewhere for non-organic growth.

KKR, TPG Banks May Start Selling TXU Loan Next Week, People Say: “Bankers for Kohlberg Kravis Roberts & Co. and TPG Inc. may start selling loans to finance the $32 billion purchase of Texas utility TXU Corp. next week, people with direct knowledge of the deal said.

Citigroup Inc. and JPMorgan Chase & Co. will seek buyers for at least $5 billion of loans, according to three people, who asked not to be named because the terms haven't been set.

Banks are offering discounts of as much as 4 percent to sell some of the $300 billion of leveraged buyout financing they promised before losses on subprime mortgages shut down the market for high-yield, high-risk debt in July. Lenders syndicated $9.4 billion for New York-based KKR's purchase of First Data Corp. last week.”

If and how these TXU loans are sold will be an important indicator of the health of the debt market. Slowly the appetite for this kind of risk appears to be returning…

JPMorgan, Bank of America May Write Down Buyout Loans (Update1): “JPMorgan Chase & Co. and Bank of America Corp., the biggest arrangers of U.S. leveraged loans, may have combined markdowns of $3 billion in the third quarter, according to analysts at Sanford C. Bernstein & Co.

JPMorgan may have to write down holdings by about $2 billion, and Bank of America's markdown may be about $1 billion, Bernstein analysts Howard Mason and Michael Howard wrote in a note to investors today.

Rising subprime mortgage defaults in the U.S. have rocked credit markets in the past three months, leaving banks with losses on home loans and a backlog of about $370 billion in loans to fund buyouts. New York-based JPMorgan and Charlotte, North Carolina- based Bank of America between them shared 30 percent of the U.S. finance market this year, according to data compiled by Bloomberg.

Third-quarter earnings “for large banks will be dominated by the writedowns in leveraged lending and the loan warehouses,” the Bernstein analysts wrote.”

Assuming credit markets mend and that the housing situation doesn’t worsen, then the banks can work through this mess…

Bear Stearns to `Weather Storm,' Won't Need Infusion (Update6): “Bear Stearns Cos., the securities firm hit hardest by the collapse of the subprime mortgage market, said it will “weather the storm” and isn't looking for a cash infusion from an outside investor.

“Things are getting better” since the Federal Reserve lowered its benchmark interest rate on Sept. 18, Bear Stearns President Alan Schwartz said in a presentation to investors today. “Liquidity has improved,” said Schwartz, who was promoted in August when the company's stock fell to the lowest in two years.

Bear Stearns will make managing risks a priority over growth and is avoiding “big directional” bets after reporting its largest quarterly earnings decline in a decade, Schwartz said. The firm helped trigger declines in the credit markets when two of its hedge funds lost $1.6 billion of clients' money.”

Bear Stearns may survive, but will be ‘avoiding big direction bets’. If other major players act in similar fashion and become more conservative for the next while, then expect the significant underperformance of riskier assets as exposure is reduced and positions therefore undwound.

Ford, Chrysler Balk at GM Funding Level, People Say (Update1): “Ford Motor Co. and Chrysler LLC are balking at contributions as large as General Motors Corp.'s to create a union-run retiree health fund, five people with knowledge of the contract negotiations said.

The two U.S. automakers would benefit less from such a trust and are reluctant to match proportionately GM's $29.9 billion pledge to offload about $50 billion in retiree health-care costs, said the people. The companies also believe they can't afford job guarantees made by GM to the United Auto Workers, said the people, who asked not to be identified because the talks are private.”

The deal GM struck is an expensive one that requires massive cash outlays up front. Ford and Chrysler are a little hesitant and may try to squeeze out one or two more concession from the UAW.

Spain August Industrial Production Slows on Higher Credit Costs: “Industrial production in Spain slowed unexpectedly in August as rising credit costs curbed demand for Spanish goods.

Production at factories, farms and mines, which accounts for one-seventh of the economy, rose 0.6 percent from a year- earlier after adjusting for the number of days worked, following a 1.3 percent increase in July, the Madrid-based National Statistics Institute said today. Economists expected an increase of 2 percent, according to the median of six forecasts in a Bloomberg News survey.”

Slight hints of economic weakness are everywhere, but the Bulls are still firmly in control.

Tuesday, October 2, 2007

Another One For The Bulls

The DOW closed above 14 000 yesterday. As economic fundamentals continue to deteriorate and the credit markets continue to exhibit serious signs of distress, I simply cannot hold longs overnight. The NASDAQ, DOW and SP500 are fully stretched into overbought territory. I did notice the absence of volume yesterday on such a breakout which leads me to question the conviction and validity of this move.

Fed Fails to Restore Creditor Confidence, Pimco Says (Update1): “As far as the world's biggest bond investors are concerned, the Federal Reserve is failing to restore confidence in the U.S. credit markets.

Pacific Investment Management Co., TIAA-CREF and Insight Investment Management say the central bank's decision to lower the overnight lending rate between banks by half a percentage point last month won't prevent the economy from slowing or corporate defaults from increasing. Lehman Brothers Holdings Inc. strategists say last month's rally in high-yield corporate bonds, the biggest since 2003, may fizzle by year-end.

While indexes of derivatives that measure the risk of default show increasing investor confidence, the difference between the interest that banks and the U.S. government pay for three-month loans is wider now than a month ago. That's a sign the Fed's Sept. 18 rate decision has yet to persuade bondholders that lower borrowing costs will stop “disruptions in financial markets” from hurting the economy.

“The reality is the fundamentals haven't gotten any better, and, if anything, they've gotten worse,” said Mark Kiesel, an executive vice president at Newport Beach, California-based Pimco who oversees $85 billion in corporate bonds.”

So I sit in cash watching and waiting… unable to go long and hold overnight… and unable to go short again… yet.

Greenspan Sees `Rethinking' on CDOs After Losses (Update2): “Former Federal Reserve Chairman Alan Greenspan said there will be ``some rethinking'' of collateralized debt obligations after demand for them helped fuel the collapse of the U.S. subprime mortgage market.

“People always say it's the subprime market that created this crisis,” Greenspan told investors at an event hosted by Bloomberg LP in London. “It's the subprime asset-backed market'' which did, he said. “As a consequence of that there's going to be some rethinking about collateralized debt obligations.”

CDOs provide liquidity. That is their purpose. They free up cash in a company that would otherwise be tied up which is then recycled back into the economy by that company.

“The market for CDOs is already shrinking. Sales fell 54 percent in August to $17 billion from July, the lowest in more than a year, according to Morgan Stanley. CDOs are created by packaging bonds, loans or credit-default swaps and using their income to pay investors interest.”
The market is shrinking. Rapid and significant declines in CDO activity is the equivalent of suddenly employing a tightening monetary policy. Mind you, alone the impact is hardly large enough. But as banks hoard money to keep their conduits and SIVs from busting and raise their loan loss provisions, the cumulative effect IS significant.

Northern Rock Credit Risk Soars on Speculation of Break-Up Bid: “Northern Rock Plc credit-default swaps soared on speculation the U.K. mortgage lender that was bailed out by the Bank of England may be broken up and sold.

Contracts on the Newcastle-based bank increased 60 basis points to 200 basis points, according to Deutsche Bank AG. Credit-default swaps rise as perceptions of creditworthiness deteriorate.”

While this news isn’t unexpected and won’t have an impact, it is relevant. The (failed) business model of Northern Rock will now get picked up by those that gobble up the bank. Since we are still at the peak of this economic cycle, rather than the trough, this does not qualify as bottom fishing for undervalued assets and will almost certainly results in nothing but headaches Northern Rock’s new masters.

In the meantime, another point for the Bulls.

Monday, October 1, 2007

When Banks Start To Fail

This week is back end loaded with important data. The report everybody will be watching like a hawk is non-farm payrolls on Friday.

Citigroup Cuts Profit Forecast 60% on `Weak' Markets (Update1): “Citigroup Inc., the biggest U.S. bank, said third-quarter profit fell about 60 percent because of “weak” credit markets and losses on leveraged loans and mortgage-backed securities.

The bank will write down $1.4 billion before taxes on leverage finance commitments, Citigroup said today in a statement. The New York-based bank lost $1.3 billion on subprime assets and about $600 million in fixed-income trading. Higher loan-loss reserves contributed to $2.6 billion in credit costs in the consumer-banking business.”

This is not unexpected. However, this is the first of many weak quarters as the combination of realizing losses and slower future growth take full effect. The stock most likely does not yet accurately reflect this reality.

“Citigroup fell to $45.66 in early trading from $46.67 at the close on the New York Stock Exchange on Sept. 28. The stock has lost 16 percent this year.”

UBS Has Loss, to Cut Jobs, After Subprime Writedowns (Update4): “UBS AG, Europe's biggest bank, had an unexpected third-quarter loss and plans to cut 1,500 jobs after writing down the value of fixed-income securities by more than 4 billion Swiss francs ($3.4 billion).

The pretax loss, the first reported by any of the world's largest banks, totaled 600 million francs to 800 million francs, the Zurich-based company said today. Huw Jenkins, the head of the investment bank, will step down and become an adviser to Chief Executive Officer Marcel Rohner. Chief Financial Officer Clive Standish will retire. The shares fell.

UBS's announcement surprised analysts, who had estimated the company would earn as much as 3.3 billion francs, and contrasts with Credit Suisse Group, which said today it had a profit of about 1.3 billion francs in the quarter. A portion of UBS's writedowns are related to securities owned by Dillon Read Capital Management, the hedge fund unit that cost the company $300 million and former CEO Peter Wuffli his job.”

That analysts were surprised by these losses isn’t surprising. Seriously though, these losses are very real and, unlike its competition, UBS is motivated to report them to the fullest extent. Rohner, the new CEO, is taking this opportunity to start tabula rasa and sticking Wuffli, the former CEO, with all the losses. However, for the competition, it is currently in their self interest to minimize the appearance of losses. Therefore, UBS should by far have the worst numbers and the most accurate.

NetBank Closed by U.S. Regulators; ING Assumes Assets (Update3): “NetBank Inc., the online banking pioneer whose finances deteriorated with mounting mortgage losses, was closed by the Office of Thrift Supervision, becoming the first U.S. savings-and-loan to fail in three years.

The U.S. thrift watchdog, in a statement today, cited NetBank's losses from weak underwriting and failed business strategies and said the Federal Deposit Insurance Corp. would take control of the bank. Separately, ING Bank announced it gained FDIC approval to assume $1.4 billion of the failed bank's deposits and 104,000 of its customers.”

NetBank quietly failed on Friday. The media buried this one. Although the bank was already in trouble due to ‘high operating expenses’ it was the ‘significant losses from loan defaults, weak underwriting, poor documentation, lack of proper controls and failed business strategies’ that finally sucked them under. Put another way, wild speculation and lack of both respect for, and understanding of risk. The marginal players go first and while stronger, fitter competitors will surely survive they still get hurt and have to retreat to lick their wounds.

Recession Concern Spurs U.S. Bond Rally on Fed Ease (Update1): “For the first time since 1995, the U.S. bond market is rallying on the assumption that the Federal Reserve has relegated inflation to a secondary concern because the central bank views a recession as a much greater threat to the economy.

The bellwether 10-year Treasury note, which depreciated as its yield climbed at least a quarter-percentage point when the Fed began lowering interest rates in 1998 and 2001, won't be recoiling anytime soon after the Fed lowered its benchmark by half a point to 4.75 percent on Sept. 18, the first cut in four years. Instead, the 10-year yield will fall to 4.51 percent by year-end from 4.58 percent, according to the median forecast of the 21 securities firms that trade with the central bank.”

With gold at $850, oil $82 and the US dollar in free fall it would be almost foolish to believe rates could decline at the longer end of the curve. Think about it, would you want to buy a bond that yielded about 2.5% more than core CPI in a declining currency? At some point something has to give. Keep an eye out for the first silent signs of a quiet capital flight out of US treasuries…

European Manufacturing Growth Slows on Credit Costs (Update1): “Europe's manufacturing industry grew at the weakest pace in almost two years in September after the collapse of the U.S. subprime-mortgage market boosted credit costs, raising concern of a slowdown in economic growth.

Royal Bank of Scotland Group Plc said today its manufacturing index, based on a survey of purchasing managers, declined to 53.2 in September, the lowest since November 2005, from 54.3 in August. That confirmed a Sept. 21 estimate. A level above 50 indicates growth.

The data adds to evidence that fallout from the U.S. housing slump is spreading to Europe. The slowdown may spell the end of almost two years of interest-rate increases by the European Central Bank. Gains in oil prices and the euro's increase to a record already threaten to damp economic growth. A gauge of new orders slid to the lowest since August 2005.”

Of course it would spread. DUH. This IS a global economy.

Swiss Manufacturing Growth Slows More Than Forecast (Update1): “Swiss manufacturing growth slowed more than economists forecast in September as rising credit costs dim the outlook for European economic growth, a survey of purchasing managers showed.

An index of manufacturing fell to 57.6, the first decline since May, from 65.1 in August, said Credit Suisse Group, which compiles the report with the Association of Purchasing and Materials Management. A reading of above 50 indicates growth. Economists expected a decline to 63, according to the median of 15 estimates in a Bloomberg News survey.”

The Swiss are just getting started with their slowdown.

Russian September Manufacturing Growth Slows to Seven-Month Low: “Russian manufacturing expanded last month at the slowest pace since February as new orders from consumers abroad fell, a gauge of industrial production showed.

VTB Bank Europe's Purchasing Managers' Index declined to 52.2 in September from 53.1 in the previous month, the bank said in an e-mailed statement today. A figure above 50 indicates growth, below 50 a contraction. The bank surveyed 300 purchasing executives among Russian manufacturers.

“A fall in new export orders was the primary reason for the weakening in overall new order growth, a key component of the headline index,” Dmitry Fedotkin, an economist at VTB, said in the statement. The PMI index declined to the lowest level since February, when the index dropped to 52, this year's low.”

Who knows how accurate or how volatile the numbers are coming out of Russia, but the general trend remains: Manufacturing outside of Asia is definitely slowing.

U.K. August Mortgage Approvals Fall to Four-Month Low (Update2): “U.K. banks approved the fewest mortgages in four months in August as borrowing costs increased, a sign demand from buyers in the residential property market may start to slow.

Lenders granted 109,000 loans for house purchase, the least since April, the Bank of England said in London today. Economists forecast 110,000, according to the median of 24 estimates in a Bloomberg survey. House prices stagnated in September for a second month, a separate report showed.”

Considering the ridiculous speculation and price appreciation that has occurred in the UK real estate market, expect far far worse to come.