risk

What went wrong at Merrill Lynch?

Jim Kim — Sun, 09 Nov 2008 09:35:00 -0500

The New York Times offers a long narrative about the fall of Merrill Lynch. The basic story line is that "two indispensable members of (Stan) O'Neal's clique"--Osman Semerci, who, among other things, ran Merrill's bond unit, and Ahmass Fakahany, the firm's vice chairman and chief administrative officer--helped O'Neal tailor dubious risk practices. Those practices allowed the firm to build up the CDO portfolio that would eventually topple the firm, forcing it into the hands of Bank of America. That it ended up holding so much of its product seems shocking. You would think it would want to offload the product as soon as they could create it. My sense is that they were probably forced to hold the senior portions because they couldn't sell it; people wanted the higher yielding stuff back then. In the end, perhaps, there is some poetic justice to choking on your own food.

For more:
- here's the article

Congressmen criticize credit rating agencies

Jim Kim — Wed, 22 Oct 2008 16:02:25 -0400

You know a hearing is going bad when a congressman start reading instant messages between two of your employees that goes like this:

          Official 1: By the way, that deal is ridiculous
          Official 2: I know, right. The model definitely doesn't capture half the risk.
          Official 1: We should not be rating it
          Official 2: We rate every deal. It could be structured by cows and we would rate it
          Official 1: There is a lot of risk associated with it. I personally don't feel comfy signing off as a committee member.

A cow? Half the risk? One witness, prosecution friendly so to speak, told how he requested underlying loan data to rate a CDO. His boss at Standard & Poor's responded in an email that the request was "totally unreasonable." Obviously, S&P, Moody's and Fitch have some PR work to do.

For more:
- here's a New York Times write up

Talks stall, fate of bailout unknown

Jim Kim — Thu, 25 Sep 2008 18:23:03 -0400

At one point, it looked there would be an agreed-upon bailout plan. But then it all fell apart, leaving the fate of the plan up in the air. The combatants will try again today. At the White House, a surprise proposal was floated by John Boehner of Ohio that featured a smaller role for government. After that, the optimism that a deal could be reached seemed to fade.

According to the New York Times, Treasury Secretary Henry Paulson literally kneeled by House Speaker Nancy Pelosi and asked for her support. It seems that most participants in these talks are supportive of a mechanism that will allow the government to limit executive pay at participating companies, and gain an equity stake in some cases. But there are some huge issues still outstanding.

When you get right down to it, the biggest issue remains valuation. At some point, the folks over at the Treasury will have to decide how much they are going to pay. They may seek some outside consulting with this complex task. Bill Gross? There are many securities out there that conceivably could be purchased. You have to wonder if any negotiation will be allowed. Banks will want as much as they can get, in part to avoid writedowns (depending on how they are valuing the debt currently). The government certainly runs a big risk of capital losses, though equity stakes ameliorate that risk a bit. All in all, it's fair to say that success is not guaranteed. On top of all that, it will be interesting to see if any controls on Treasury are built into the system.

For more:
- here's a New York Times article

Regional banks at risk due to GSE preferred stock

Jim Kim — Tue, 09 Sep 2008 11:13:37 -0400

The bailout of Fannie and Freddie has been a rank disaster for common shareholders of the two companies. They are clearly the big losers. The preferred shares are not as widely owned, but regional banks tended to be big owners. Hey, they sounded like a great idea when people assumed that Fannie and Freddie would live forever. According to a table from Goldman Sachs posted by the Financial Times, tiny Gateway Financial has 22 percent of its "tangible equity at risk" in GSE preferred shares. Midwest Banc Holdings is at 20 percent. The biggest regional banks with the most exposure are Westamerica and Sovereign; they have 10.6 and 8.5 percent of their respective tangible equity at risk in these securities. As the FT notes, the big question is Wells Fargo, which has not disclosed how much GSE preferred shares it owns. But it did say it will take a charge for the third quarter.

For more:
- here's the post

Long-short funds really delivering?

Jim Kim — Thu, 04 Sep 2008 13:36:39 -0400

The conventional wisdom at the moment is that long-short funds are in heavy demand. According to Morningstar, about 90 money management firms offer more than 200 products applying a 130/30 or 130/30-like approach to a host of products, hedge funds, mutual funds, SMAs, exchange traded funds and others. But a Morningstar analysis has also found that some funds are taking on a lot of risk for mediocre returns. The study analyzed the returns of 40 different 130/30 strategies over a 12-month period, and found a beta range from 3.5 to a negative 1.25, reports Investment News. Of course you would want a beta in line with the appropriate index. So the message here is that not all 130/30 funds were created equal. There is a lot of leeway, and managers that fall behind may be tempted to catch up with some additional risk.

For more:
- here's the article

Pension view: Risk is good

Jim Kim — Tue, 19 Aug 2008 12:54:16 -0400

We've noted that pensions aren't bailing out on hedge funds and private equity funds. In fact, they continue to embrace them. That has made life a little more of an adventure for some pension overseers. Portfolio profiles Bill Clark, who oversees a $77 billion investment portfolio for New Jersey workers. In search of higher returns, the fund voted to diversify out of stocks and bonds and into alternatives. It has a goal of 19 percent in such vehicles; it's at about 12 percent now. But what has really put Clark "out there" was the decision to invest in Merrill Lynch, Lehman Brothers and Citigroup--only to watch them all tank. The Merrill deal fortunately came with some anti-dilutive provisions that have kept the state from taking a big bath. Clark remains undeterred. His search for alpha continues, though you have to wonder if at some point people in New Jersey will grow uncomfortable.

For more:
- here's the Portfolio article

Hedge fund launches getting harder even for big names?

Jim Kim — Wed, 06 Aug 2008 13:49:58 -0400

We've noted that while the hedge fund industry is thriving, the barriers to entry seem to be rising. Launches are down, and the myth that just anyone can start one has evaporated. We're now seeing some big names--names that can command assets--struggle to launch. Dow Kim certainly qualifies as a big fish. But the former co-head of trading and investment banking at Merrill Lynch has nixed plans for Diamond Lake Investment Group after investors pulled about $1 billion in commitments. Kim may have been tainted a bit, fairly or not, by his role in powering Merrill Lynch to the top of the CDO tables, notes Breakingviews. This is yet another sign that despite the hedge fund industry's strength, the market has changed a bit, with investors gaining the upper hand. They wanted various assurance on risk and other issues.

For more:
- here's the Breakingviews article

Banks bet on stadium sponsorships

Jim Kim — Fri, 25 Jul 2008 08:00:45 -0400

Does Citi Field have the same ring as Shea Stadium? Well, it likely depends on who you are. Mets loyalists may grumble. But for the bank, it's a nice, albeit expensive, marketing move. Business Week notes some think that Citigroup could use the $20 million a year the sponsorship cost in other areas right now. But such deals are currently popular among commercial banks. Citi seems to have paid a premium. Bank of America bought the rights to the Carolina Panthers' stadium in Charlotte for $7 million a year. Other banks paid even less. M&T, PNC and Comerica have also bought stadium naming rights. For banks, such deals amount to a low-cost way to burnish their brands with the public and associate with a professional team. I'd like to see how the ROI is actually measured. There's risk on both sides. Recall the Houston Astros got stuck with Enron.

For more:
- here's the Business Week article

Ratings agencies' practices under more fire

Jim Kim — Wed, 09 Jul 2008 07:44:18 -0400

In its probe of credit rating agencies' practices, the Securities and Exchange Commission collected and reviewed more than 2 million emails and instant messages. Whew! It has uncovered a bevy of "evidence" that reveals some analysts to be very skeptical, even uncomfortable, with the ratings they were handing out. It recalls the probe into tainted Wall Street stock analysts, some of whom were against all those buy ratings on flimsy Net stocks. One email noted by the Financial Times: one product did not capture "half" of the deal's risk, but "it could be structured by cows and we would rate it". Another one referred to an "even bigger monster--the CDO market. Let's hope we are all wealthy and retired by the time this house of cards falters." The big three have agreed to remedial action. But you have to wonder if enforcement action is coming.

For more:
- here's the article

Wall Street boards to change with times?

Jim Kim — Wed, 02 Jul 2008 12:31:33 -0400

We noted recently that the credit crunch has not given rise to a lot of board turnover at hard-hit banks. Some boards, such as Washington Mutual's board, seem bent on change. But the groundswell of shareholder anger some expected never quite materialized. Well, we may see some fireworks yet. The UBS board has announced that four of 12 directors will not be back. UBS of course has been one the biggest casualties of the crunch in Europe, and the board was obviously feeling pressure to do something. The Financial Times reports that the board wants to beef up expertise in critical areas: audit and risk, for example. I'm sure other boards are thinking about this. My guess is we'll see some very diplomatically announced turnover over the next year or so.

For more:
- here's the Financial Times article