Posted tagged ‘Merrill Lynch’

Guest Post at Clusterstock

April 23, 2009

Hey, I wanted to let you, my loyal readers, know that I guest posted over at Clusterstock. The post, entitled “Investment Bank Scorecard” is my take on this past quarter as a whole. I think it’s worth clicking over and taking a look. I’d sum it up here, but, in all honesty, the value is in the nuances and small insights more than the general thesis.

Also, here is the chart attached to that post, in its orginal form.

Contrarian View: HR 1586 (T.A.R.P. Surtax Bill) will Create Millionaires

March 19, 2009

This is  just a  few quick thoughts, but I believe, in a few years, we’ll be able to take this bill and place it’s effects high on the list of unintended consequences. Let’s wonder what a reasonable firm would do in order to protect it’s people as much as possible from this legislation… I would put forth the proposal that a firm would give it’s employees the most “bang for the buck.” This seems to clearly be by paying in options. Now, I don’t know all the technical details behind how finance companies have to account for and value options given as compensation, but, using the CBOE option pricer and volatility from Morningstar, I get around $0.50 as the option price for a strike of $2.50 at the time Citi was giving bonuses out, around the time it was at $1.00. Or, if we use $2.50 for the equity price and the strike price, we get $1.62 option price.

Since those prices are per share for lots of 100 option, we get anywhere between 500,000 and 155,000 options, depending on when Citi’s rules would require it to re-cast it’s payments to employees. That’s obviously a huge range. However, for some context, when Citi was trading at $50 / share, having 500,000 shares would have meant you had $25 million in the bank. And 155,000 shares would have meant you had $7.75 million in the bank. However, let’s look at some more likely scenarios. Citi is currently trading at $3.00. As these options are longer dated (I believe the prices quoted above were for 3 year options), could one see a world where Citi is at $10, $15, or even $20 3 years in the future? I think so. So, 155,000 options would be worth between $1.55 million and $3.1 million.The other option is some combination of cash and restricted stock. As we see above, the total shares one would get, if merely receiving restricted stock (at the current trading level) is approximately half to two-thirds.

Now, obviously there are risks. Citi might not be around in three or more years–that is anyone’s guess! This assumes share price increases quite a bit (although the numbers look good even for more modest scenarios). However, all of these would be issues with restricted shares as well–which Wall St. heavily relies upon for compensation. Also, this is just for Citi, which is clearly in a more precarious position than some of it’s peers. For a firm like Goldman, Morgan Stanley, or even Merrill/BofA, the probability of defaulting is way lower. And, for those firms, volatility is lower, making options less valuable, and increasing the ratio of options to restricted shares. the purposes of comparison, Goldman is currently trading at approximately $100 and it’s two year volatility is around 60%. This yields an option price of around $39, or 3x as many options as restricted shares. So, for every $20 Goldman’s shares go up, one would make 3x as much if they had options.

You see where I’m going with this? Now, I don’t know the specific rules surrounding a firm’s ability to re-cast their payments once they’ve been made, or how they compute strike prices, restricted share award prices, or other details. But, I would bet that these firms go back to their employees and let them re-think some of their options (no pun intended).

Fun Super Irony Fact: HR 1586, in the 110th congress was the “The Death Tax Repeal Act of 2007”!!!

How to Fix the Crisis in Six Easy Steps

February 26, 2009

There is a lot of chatter about different plans, market anticipations, and pitfalls when it comes to “fixing” the economy and, specifically, nationalization. Despite the fact that I don’t have the same reach as several uneducated members of the media, I figured I’d share what I think the way forward is, regardless.

Step 1: Nationalize Citi and Bank of America. Let’s be honest, with recent talks of expanded stakes, ringfenced assets, and no end of the losses in sight, it’s probably time the U.S. Government came to grips with the fact that they already own the losses and the positive impact of letting shareholders keep the upside is nonsensical. Further, these institutions will need more money for a long time to come. And, if you’re paying attention, you know that the markets seem to twist and turn with the news coming out of financial institutions. Nationalization rumors depress the markets, talks of further government action scare away new capital, and the fundamental health of these firms makes current investors run.

Step 2: Begin lending. With so much chatter and anger about institutions not lending, it almost makes me wonder why there is such a deep lack of understanding. These sick institutions are trying to shrink their balance sheets and have a ton of souring assets on them. They have to raise capital to support their current asset base, so why do we really expect these banks and other firms to lend? Some would claim that lending for the sake of lending got us into this mess, but they are either telling only part of the story or don’t get it–excessive leverage and poor risk management got us to this point. In fact, I suspect that defaults on even the riskiest loans would be much lower if bank capital was free enough to continue making mortgage loans based on normal requirements for returns and risk/reward.

So, how do we begin lending? Simple, start a government bank. Well, not exactly, but the government now owns Fannie, Freddie, AIG, Citi, and BofA (see step 1). Clearly the government now (by step 2) has the infrastructure and technical know-how to manage the logisitical issues of setting up and running a lending platform. Now the government can lend directly and not wait for sick banks to do it. Further, they can underwrite to fairly normal lending standards and get a premium return on their capital. Also, rather than poaching the nationalized entitites’ “talent,” the government cam employ many out of work finance workers throughout the country (after all, lending in Missouri should probably be done by people in Missouri).

Step 3: Begin replenishing bank assets with new, cleaner assets. With all of these souring assets on the books of banks, their capital base being eroded, and leverage decreasing, TARP capital is probably being deployed very inefficiently and, obviously, conservatively. Well, since step 2 involves lending and creating assets, the government should then implement an auction process–all assets the government creates would then be auctioned off, much like treasury bonds are, to banks. Since the government would be lending based on normal underwriting standards (as compared to the previous paradigm of loan underwriting), these assets would have a strong credit profile and will likely perform much better than legacy assets. JP Morgan, for example, should jump at the chance to generate higher levels of retained earnings by buying assets when the rates it needs to pay are at historically low levels, once its capital frees up. This solves the chicken-and-egg problem of curing sick banks, hurting from consumer defaults and depressed economic activity, to free up the credit markets and getting economic activity to increase despite a lack of credit.

One could easily permute this plan in many ways. One possible way is to offer to swap new assets for legacy assets at current market levels to facilitate a much more immediate strengthening of the banks’ balance sheets. Another variation could include some partial government guarentee on assets it originates. I’m sure there are thousands more ways one could add bells and whistles.

Step 4: Broaden the Fannie and Freddie loan modifications and housing stabilization plan to the government’s new properties. I suppose this should be some sort of addendum to step 1, but it’s important enough to require some emphasis on it’s own. With Citi and Bank of America being so large, I’m sure the housing stabilization plan will have a much broader reach once those are wards of the state. We’ve all heard the arguments for stopping foreclosures and refinancing borrowers… When the house next door is foreclosed upon, your house loses tens of thousands of dollar in value, increases housing supply, etc.

Step 5: Break up the institutions that are owned by the government. Markets have been clamoring for Citi to be broken up for years. Bank of America shareholders probably want Merrill to be broken off A.S.A.P. (ditto for Countrywide). Chew up these mammoth institutions and spit out pieces that, in the future, could fail because they aren’t too big. This should be done to AIG, Citi, Bank of America, and both Fannie and Freddie.

Step 6: Immediately implement a new regulatory regime. This is pretty much a “common sense measure.” President Obama has begun to call for this, and it’s pretty clear that with no more major investment banks around, the S.E.C.’s role needs to be re-defined. I’ve already laid out my thoughts on what this new structure should look like.

Between all of these steps, we should have the tainted institutions out of the system, credit will start to free up, banks asset base will become more reliable, and systemic risks will go down as we significantly decrease the number of firms that are “too big to fail.” Seems logical to me…

Rick Santelli is a Lesson for our Children

February 21, 2009

So, by now you’ve heard of the rant of some guy I’d never heard of before (not to be confused with Barron’s Michael Santoli). Does anyone else find it amusing that Mr. Santelli was ranting on the floor of an “open outcry” trading pit? That’s right, he was ranting about wasteful spending to help homeowners while standing on a monument to the past of finance and inefficient execution.

Mr. Santelli, while I completely accept the fact that you are most likely compensated based on how many viewers you reel in and your entertainment value, and certainly not based on the quality of your journalism (this is CNBC after all, the house of Cramer), analysis, or even grasp of reality, you should still, every now and again, try reading something. From the details of the plan one could learn some simple things:

1. The plan is available only to those people whose mortgages are owned by Fannie or Freddie or those whose mortgages were backed by Fannie and Freddie and put into securities by them. Fannie and Freddie have strict limits on whose mortgages can go into those pools. They have to have high FICO scores, relatively low LTVs, and there is a maximum size allowed. Please note that this restriction, in and of itself, totally disqualifies sub-prime mortgage loans. Let me repeat: sub-prime mortgages and agency-backed mortgages are a totally disjoint set of mortgage loans–there is no overlap.

2. The program does not reduce principal owed. So, in essence, there is no forgiveness of debt, but only a reduction in interest rates and, perhaps, an extending of the term of the loan to reduce monthly payments. People still owe the same amount as before. Sounds like a welfare state to me…

3. The program doesn’t allow refinancing of second homes or investment properties. So all the speculators that own 3 houses on that were supposed to be flipped cannot refinance any mortgages except for the single first mortgage on the house they currently reside in.

4. Second mortgages aren’t covered under the plan. All the people who took out HELOCs to borrow money to buy stocks aren’t going to be bailed out either.

5. There is about $75 billion being used to help stabilize the multi-trillion dollar mortgage market. This number alone implied that there is some selection process to weed out unworthy people from being given government funds.

Look, I want the economy to improve as much as the next guy, but I think swelling the unemployment rolls by one idiotic reporter might be the kind of change I can believe in. Oh, and let’s finally close down the value-destroying open-outcry trading pits. Maybe removing that friction in our economy can help us save a few dollars.

I was going to stop here, but I’ll be honest… the complete and total stupidity of Santelli and those knuckle dragging dinosaurs who still use hand motions to make money, add trnsaction costs, and keep the computers at bay (not all of them, but most of them, I’m sure) on the floor of the C.M.E. are the reason middle America hates everyone in finance. Further, it’s the reason we need a bailout. How often did I hear “not my problem” or “because that’s where the market is” or any number of other, totally tone-deaf incantations from the mouths of people making seven-digit bonuses? Often. And, to be honest, do we have even single piece of tape with Mr. Santelli yelling about taxpayers paying for Citi? Bank of America? How about AIG? No? Well, we gave Merrill Lynch $15 billion and around $4 billion of that was immediately blown through to mint 696 seven-digit bonuses.

At least I can take comfort in knowing that Mr. Santelli will be forgotten in 100 years and that his rant likely has no lasting impact on our society–it showcases the worst, most base and uninformed stupididty. Children, pay attention in school or you’ll wind up working on the CME trading floor for CNBC.

All the Important Stories Without the Word “Commode” in Them

January 27, 2009

We learned a lot today, although tomorrow we might find that we learned completely different things. Here are the articles that prove the idiom, “When it rains it pours.”

1. Citi, in what can only be described as a series of epic P.R. fails, purchased a $50 million jet. Next in the series was this paragraph from DealBook:

A Citigroup spokesperson told DealBook that he could not confirm the reports that the bank was set to take control of a new jet, citing “security” concerns. “Executives are encouraged to fly commercial whenever possible to reduce expenses,” Citi said in a statement.

Seriously? Security concerns? Now, there are some rumblings that the jet was purchased two years ago. However, if there was ever a time to wage the P.R. war and risk getting sued to keep the big picture impression of your firm together, this was it. I can, without a doubt, say that if I were sitting in Vikram’s seat I would be refusing to pay for the jet or take delivery of it, and would be doing whatever I could to be sued. The headline, “Citi Sued for Failing to Honor Commitment to Purchase Corporate Jet” sounds like music compared to “Citigroup Likely to Face Criticism Over Jet” (the actual DealBook headline).

And in the end, they ceded the ground anyway.

2. Congratulations, you’ve hired some lobbyists! It turns out that a whole bunch of firms, including Citi, American Express, Capital One, Goldman Sachs, KeyCorp, Morgan Stanley, PNC and Bank of New York Mellon, all hired lobbyists. The whole notion of a company hiring a lobbyist, clearly, leads to obvious questions about companies representing their own interests and those of their shareholders instead of those of the people (who, now, are also their shareholders). I can’t possibly imagine what firms are thinking when they hire these lobbyists, except that they will “get away with it.” Absolutely ridiculous.

And, no sooner than I had noted this, newly confirmed Treasury Secretary Geithner cracks down on lobbying.

3. Apparently, Bank of America approved everything they used against John Thain when it came time to push him out. From the Elusive January 23rd version of the WSJ article:

Thain also left for a vacation in Vail, Colo., after the losses came to light, accelerated bonus payments at Merrill so they could be collected before the end of the year and scheduled a trip this week to attend the World Economic Forum in Davos, Switzerland […]

Vitriol between the Bank of America and Merrill camps also stemmed from the fact that Merrill had paid out bonuses much earlier than expected. A person familiar with Merrill’s bonus scheme said executives typically are told what their bonus will be by the second week of January and the payments are made in the second half of the month. Some people inside Bank of America believe Merrill accelerated the payouts to avoid having them cut amid a much-leaner plan at Bank of America.

(Emphasis mine.)

And, from the FT:

Ken Lewis, BofA’s embattled chief executive, ousted Mr Thain on Thursday after news of the bonus payments appeared in the Financial Times. BofA told the FT last week that Mr Thain had made the decision to pay bonuses in December instead of January and it had been “informed” of the move. The bank said Merrill was an independent company until the deal closed on January 1.

[…]

BofA yesterday confirmed there were conversations about the bonus payments prior to the pay-outs: “We never said we didn’t talk with them about it. But, in the end, it was their decision and they informed us of it.”

(Emphasis mine.)

Jeeze. Ken Lewis needs to go… His P.R. war to keep his job despite fleecing taxpayers is pathetic.

Why do the Articles about John Thain Change?

January 26, 2009

Okay, I really wanted to write something insightful about John Thain’s recent dismissal. There’s lots of information swirling around since the story caught fire and, especially with John Thain’s recent memo, I think there’s an underlying story emerging. However, the story keeps changing… Not just as new facts are revealed, but the actual article keeps changing! Let’s look at the timeline.

January 22nd — The narrative turns to John Thain’s excesses and the Ken Lewis flies to New York and dismisses Mr. Thain around 11:30AM.

Later Janaury 22nd — The blogosphere catches fire with the story. Mr. Blodget writes about it here (this link is extremely important later, we’ll come back to it). Deal Journal also dedicates a lot of ink to the events (the last link is great reading, btw). Felix also writes up his thoughts.

January 23rd — The Wall St. Journal sprays their pages with several articles about the situation. Deal Journal provides a nice roundup (note this link too).

January 26th (today) — There is more reporting about BofA’s role in the P.R. nightmare that is Merrill’s early bonus payments.

January 26th (today)– I try to go back and write about the entire incident. Wanting to ensure I catch the emotion and facts as they evolved, I try to go back to the original WSJ article.

The last step is the problem. The article from the 22nd, with all it’s anonymous sourcing and inflammatory language, is totally gone. In it’s place there’s an article dated the 26th, with some of the same information, but a totally different structure. Now, let’s examine the excerpt I was able to find, from Clusterstock (first important link):

Bank of America had lost confidence in Mr. Thain, this person said, after Mr. Lewis learned of mounting fourth-quarter losses at Merrill from the transition team handling the Bank of America-Merrill merger rather than from Mr. Thain himself. And when Mr. Lewis asked Mr. Thain what happened, the Bank of America CEO did not get a “good explanation for what was happening and why,” this person said.

The Bank of America CEO also concluded Mr. Thain has exercised “poor judgment” on a number of fronts. He left for a vacation in Vail, Colo., after the losses came to light, bonus payments at Merrill were accelerated so they could be collected before the end of the year and Mr. Thain had planned to fly this week to Davos, Switzerland, even though Bank of America had signaled that such a trip was not a good idea, this person said.

(Emphasis mine.)

This section appears nowhere in the new article from the WSJ. The entire article has been rewritten. Specifically, the charge about the bonuses being accelerated, emphasized above, is totally gone.

Now, I encourage you to see for yourself. Please don’t take my word for it.. Instead, go click on the links from the 22nd and 23rd, and follow the links to WSJ articles about John Thain being dismissed and see where the link takes you. I’ll even reproduce those here, in context. However, don’t feel shy about verifying!

Well, yes, of course he did.  And it’s apparently a common affliction at Bank of America (BAC). WSJ: Bank of America had lost confidence in Mr. Thain, this person said, after … (from Clusterstock)

Bank of America and Merrill Lynch arranged the deal in less than 48 hours, and the hasty work shows. Thain’s departure Thursday is the clincher… (from Deal Journal)

It was always a bit weird that John Thain was going to stay on at Bank of America, but as it turned out, he lasted less than a month before getting fired this morning by the equally-beleaguered Ken Lewis. (from Felix)

Amazing. Maybe someone has the original article so I can write about what’s been going on and in the public sphere of debate, instead of having to rely on revisionist history.

TARP Performance: Way Too Early to Judge

January 18, 2009

Felix has a post focused on some of the numbers in the CBO report on TARP. Specifically, it looks at subsidy rates (amount lost from various “bailouts” due to mark-to-market as a percentage of the original investment). First, I’ll note my strong objections to using mark-to-market at any given point in time as a true measure of what something has “cost” taxpayers. One issue that permeates this crisis is the government officials managing their response to (and this is borrowed from somewhere, but I simply cannot remember from where or find it) have something released before the asian markets open. Mark to market, however, is definitely the easiest to measure, hence the use of it. Things like economic activity, bank lending, credit rates for banks, etc. should be used as measures of TARP effectiveness.

Now, let’s move on to my other point–this is like calling the winner in the first few minutes of a game. Any analysis of the effectiveness of the bailouts is likely to be a bit skewed since what would have happened without them isn’t truly known. But drawing any conclusion on a five year investment less than three months after it was made is especially premature. The probability of taxpayers’  investments seeing an actual loss is, actually, quite low in my estimation. Why? These institutions were bailed out already, and that is, in some sense, an endorsement of not letting them fail in the near future. Be dismantled? Perhaps. Be sold? Possibly. But die, like Lehman did? Certainly not. In fact, if Bank of America and Citi prove anything, it’s that politicians are more likely to buy back into the game than face the taxpayers and explain how they lost tens of billions of dollars backing the wrong horse. Don’t get me wrong, I think there significant holes in the strategy for TARP.

This situation, of course, defines moral hazard when the current management is allowed to stay. Citi management can go around doing whatever they want to fix Citi, if they fail we pay. If they win, they look good. Same for Bank of America… Ken Lewis decides to acquire Merrill in a shotgun wedding and then plays chicken to get a subsidy. Did they lower the price of the Merrill acquisition? No. As a matter of fact, the government didn’t just have a right to put their boot on the professional throat of Ken Lewis, but they had a responsibility to–Mr. Lewis actually showed an active interest in leveraging the financial crisis and government strategy. But, I digress.

The point is we won’t know how our investments perform for quite some time, and if the strategy the government employs remains constant then taxpayers are unlikely to lose a dime. So, you won’t find me with a real-time accounting of the TARP investments in Bloomberg anytime soon.