Today, my colleagues and I received many calls regarding the new FDIC-Guaranteed Goldman Sachs three-year bond. There seems to be some confusion about the structure. Let me try to make sense (that sounds familiar) of the structure.
Goldman Sachs issued a three-year note with an explicit FDIC guarantee. This means that the bonds a directly and explicitly backed by the U.S. government. Although this is an attractive feature, the guarantee comes at a price. In this case, the price is a relatively-low yield. The bond carries a coupon of 3.25% and was trading around +190 basis points over the current three-year treasury note (about 3.20%) late this afternoon. This was shocking to many financial advisers and their clients. After all, three-year CDs are offering yields approaching 4.00%. Put a half of a point sales credit on top and the Goldman bond yields approximately 2.90%. Why does the FDIC-guaranteed Goldman bond trade at yields which are far below CD yields? It is a function of the market.
The Goldman bond was an institutional deal. Institutions do not purchase CDs as their trade sizes (5mm, 10mm or more) are well beyond the FDIC limits (now $250,000). Since, in the case of the Goldman issue, it is the bond and not the investors which is insured, size does not matter. This makes yields in the low 3.00% area attractive for institutions with conservative risk tolerance levels.
More deals are in the pipeline. GE, JPM MS and a certain large bank are said to be poised to enter the market with FDIC-backed bonds. Look for yields to be unattractive versus CDs. Also, do not expect to receive allocations when indicating interest in these deals in syndicate. Institutions will have these oversubscribed well before price guidance is posted. Also, in the cases of JPM, MS and that certain large bank will likely run their own books as Goldman did. This means that institutional clients of the issuing firm will receive preference.
Yesterday, I mentioned that FDIC-guaranteed corporate bonds carry a stronger government guarantee than Freddie and Fannie bonds and that could divert investment dollars from the GSEs to the new FDIC-backed corporate bonds which could increase GSE borrowing costs and, therefore, mortgage rates. Today the government responded. The Federal Reserve Bank will purchase up to $100 billion in direct obligations (agency bonds) of FHLMC, FNMA and FHLB. It will also purchase up to $500 billion of mortgage-backed securities issued by FHLMC, FNMA and GNMA.
Finally, the Fed is addressing the real problem. Banks cannot lend unless they can securitize the loans and recoup capital to continue lending. This cannot occur if buyers for MBS are scarce. The Fed's stepping in for buyers could be a win / win situation. Banks can begin lending again as they have buyers for their MBS and the Fed owns MBS consisting of GSE-conforming loans which are not laden with hidden land mines. This could be a money-maker for taxpayers.
The Fed is also going to institute a $200 billion program which will purchase receivables consisting of consumer debt and business loans. This collateral is as safe as GSE-conforming mortgages, but the higher coupons and straightforward structures could also be money makers. This should have been among the earliest actions by the Fed. Fed Chairman Bernanke actually discussed such programs when outlining possible Fed responses to a financial crisis when he was a Fed governor six years ago. What took you so long, Ben?
Tuesday, November 25, 2008
Monday, November 24, 2008
Now Wait A Minute
Goldman Sachs is first to market with an FDIC-guaranteed bond. No price guidance has been given and it will probably be oversubscribed before that occurs. As with nearly every part of the government's relief efforts, the law of unintended consequences is in force. New corporate bonds for which the issuer pays for the FDIC guarantee may be considered to be more secure than GSE debt.
How can that be you say? FRE and FNM debt DOES NOT carry an explicit government guarantee. Their charters have not been changed. The guarantee is still implied, but is now stronger. FHFA chief Lockhart called the guarantee "affective". Compare that to the FDIC guarantee of corporate debt. That guarantee is explicit (of the FDIC). This could divert investment dollars from GSE bonds (which is sorely needed to restart the mortgage market) to FDIC-guaranteed corporate bonds. The government is about to find out that it can't have its cake and eat it too.
How can that be you say? FRE and FNM debt DOES NOT carry an explicit government guarantee. Their charters have not been changed. The guarantee is still implied, but is now stronger. FHFA chief Lockhart called the guarantee "affective". Compare that to the FDIC guarantee of corporate debt. That guarantee is explicit (of the FDIC). This could divert investment dollars from GSE bonds (which is sorely needed to restart the mortgage market) to FDIC-guaranteed corporate bonds. The government is about to find out that it can't have its cake and eat it too.
Sunday, November 23, 2008
Ch-Ch-Changes
Last week, the Detroit Three CEOs flew into Washington DC (in comparative style) to beg for money. To justify federal aid, Detroit executives were prepared to do, well not much of anything. The CEO consensus was that the Detroit Three are teetering on the brink of bankruptcy because of the credit crunch. Boys, boys, no one is going to buy that. Yes, the credit crunch may have accelerated your demise, but Detroit has been losing market share for 35 years. Few will contest this fact, not even pro-union politicians.
Since last week, Democratic legislators, including Nancy Pelosi and Harry Reid, have called on the Detroit automakers to come back with restructuring plans if they want federal aid. This may not sit well in the Motor City, with management and labor alike. Even President-elect Obama's adviser, David Axelrod is telling Detroit CEOs that plans to return the former "Big Three" to profitability are needed in order to receive taxpayer dollars. This does not bode well for Ron Gettelfinger and the UAW. It may not bode well for GM bondholders either.
There may be a revolt at General Motors. In spite of CEO Rick Wagoner's statements that bankruptcy was not an option, GM's board of directors said that it will consider all options including bankruptcy. This is a vote of no confidence in Mr. Wagoner, in my opinion. Truthfully, it is not likely for GM bondholders to be made whole, regardless of the restructuring plan. Whether it is a Chapter XI filing or a government-led restructuring, bondholders will likely suffer. Bondholders may not be completely wiped out,but will receive (yet-to-be-determined)cents on the dollar. This compensation my not be in the form of cash. New bonds and / or new shares will likely make up most if not all of bondholder recovery.
GMAC bondholders could be made whole, but it is tricky. A GM Chapter XI "could" lead to a GMAC bankruptcy filing, but GMAC could receive TARP funds if it is approved as a bank holding company. If GM is to survive and emerge from bankruptcy, a viable finance unit is a must.
Remember, GM NEVER guaranteed GMAC bonds or vice versa. The same is true of Ford and Ford Motor Credit. Also, all GMAC and Ford Motor Credit Preferreds are actually $25.00 par bonds and rank pari passu to other bonds of equal seniority. Conservative and moderate investors may want to consider exiting GM, GMAC, F and FMCR bonds. Aggressive investors (speculators) should consider the auto finance companies rather than the manufacturers. Equity investors may want to consider swapping into the $25 par bonds to climb higher on the capital structure.
Since last week, Democratic legislators, including Nancy Pelosi and Harry Reid, have called on the Detroit automakers to come back with restructuring plans if they want federal aid. This may not sit well in the Motor City, with management and labor alike. Even President-elect Obama's adviser, David Axelrod is telling Detroit CEOs that plans to return the former "Big Three" to profitability are needed in order to receive taxpayer dollars. This does not bode well for Ron Gettelfinger and the UAW. It may not bode well for GM bondholders either.
There may be a revolt at General Motors. In spite of CEO Rick Wagoner's statements that bankruptcy was not an option, GM's board of directors said that it will consider all options including bankruptcy. This is a vote of no confidence in Mr. Wagoner, in my opinion. Truthfully, it is not likely for GM bondholders to be made whole, regardless of the restructuring plan. Whether it is a Chapter XI filing or a government-led restructuring, bondholders will likely suffer. Bondholders may not be completely wiped out,but will receive (yet-to-be-determined)cents on the dollar. This compensation my not be in the form of cash. New bonds and / or new shares will likely make up most if not all of bondholder recovery.
GMAC bondholders could be made whole, but it is tricky. A GM Chapter XI "could" lead to a GMAC bankruptcy filing, but GMAC could receive TARP funds if it is approved as a bank holding company. If GM is to survive and emerge from bankruptcy, a viable finance unit is a must.
Remember, GM NEVER guaranteed GMAC bonds or vice versa. The same is true of Ford and Ford Motor Credit. Also, all GMAC and Ford Motor Credit Preferreds are actually $25.00 par bonds and rank pari passu to other bonds of equal seniority. Conservative and moderate investors may want to consider exiting GM, GMAC, F and FMCR bonds. Aggressive investors (speculators) should consider the auto finance companies rather than the manufacturers. Equity investors may want to consider swapping into the $25 par bonds to climb higher on the capital structure.
Thursday, November 20, 2008
I Can't Get No Private Capital
When Hank Paulson shocked and surprised me by wiping out GSE preferred dividends. Although I was wrong about "Hammering Hank" wiping out the GSE preferreds, my prediction that it would wipe out the new issue preferred market was right on, unfortunately. The inability for banks to raise Tier-1 capital may be at the root of the selloff of financial stocks. I am not alone in this opinion.
Paul Miller of Friedman, Billings and Ramsey believes that the U.S. government may need to infuse $1.2 trillion into U.S. banks because private investors will not take risk. Adding fuel to the selloff if the lack of transparency regarding banks exposures to bad assets. Mr. Miller writes: "The sheer size of the capital deficiency, coupled with the opaque nature of credit risk, will keep private capital sidelined."
Few financial institutions have been exempt from the recent selloff. Some firms have seen share prices fall to levels which may necessitate a merger or a sale of some divisions. What could possibly be driving this selloff?
Financial institutions have been reluctant to disclose their exposure to toxic assets. No one is quiet sure what assets are held by each bank and what they are worth. Adding to the jitters has been the practice of some banks of labeling toxic assets a "Level III" Level III assets are not marked to market. When banks move assets to the Level III bucket (for a variety of reasons, none of which anyone believes), the assets do not have to be marked to market (or at all). One bank recently move $10s of billions to Level III. That firm's stock price has gotten crushed. My prediction is that by Monday 11/24/08, Wall Street will look very different.
Not surprisingly, GMAC has applied to become a bank holding company. If approved, GMAC would be able to tap TARP. That could give bond holders a stay of execution. Short-term (months) bonds would likely be money good of approval was granted, but unless GM is able to build and sell cars, GMAC's long-term prospects are bleak. There is something else to consider. The FDIC may be reluctant to grant bank holding company status to GMAC before a GM rescue is finalized. This is because if a bank holding, a GMAC failure would be the FDIC's problem. Stay tuned.
Lastly, when commodities prices were roaring and inflation was on the rise, TIPs were a popular investment, even though we would need Carter-esque inflation for TIPs to outperform treasury notes. Now that inflation has dissipated and deflation may be on the horizon, no one wants TIPs. However, now is the time to buy TIPs. I would buy five year TIPs. Break-evens are sufficiently attractive versus the five-year treasury note to make five-year TIPs attractive investments even if we experience muted or even, negative inflation in the near-term.
Paul Miller of Friedman, Billings and Ramsey believes that the U.S. government may need to infuse $1.2 trillion into U.S. banks because private investors will not take risk. Adding fuel to the selloff if the lack of transparency regarding banks exposures to bad assets. Mr. Miller writes: "The sheer size of the capital deficiency, coupled with the opaque nature of credit risk, will keep private capital sidelined."
Few financial institutions have been exempt from the recent selloff. Some firms have seen share prices fall to levels which may necessitate a merger or a sale of some divisions. What could possibly be driving this selloff?
Financial institutions have been reluctant to disclose their exposure to toxic assets. No one is quiet sure what assets are held by each bank and what they are worth. Adding to the jitters has been the practice of some banks of labeling toxic assets a "Level III" Level III assets are not marked to market. When banks move assets to the Level III bucket (for a variety of reasons, none of which anyone believes), the assets do not have to be marked to market (or at all). One bank recently move $10s of billions to Level III. That firm's stock price has gotten crushed. My prediction is that by Monday 11/24/08, Wall Street will look very different.
Not surprisingly, GMAC has applied to become a bank holding company. If approved, GMAC would be able to tap TARP. That could give bond holders a stay of execution. Short-term (months) bonds would likely be money good of approval was granted, but unless GM is able to build and sell cars, GMAC's long-term prospects are bleak. There is something else to consider. The FDIC may be reluctant to grant bank holding company status to GMAC before a GM rescue is finalized. This is because if a bank holding, a GMAC failure would be the FDIC's problem. Stay tuned.
Lastly, when commodities prices were roaring and inflation was on the rise, TIPs were a popular investment, even though we would need Carter-esque inflation for TIPs to outperform treasury notes. Now that inflation has dissipated and deflation may be on the horizon, no one wants TIPs. However, now is the time to buy TIPs. I would buy five year TIPs. Break-evens are sufficiently attractive versus the five-year treasury note to make five-year TIPs attractive investments even if we experience muted or even, negative inflation in the near-term.
Wednesday, November 19, 2008
It's The End Of The World
Time is running out for the Detroit Three, especially GM. Without some form of financial aid, GM may not survive until Congress reconvenes in January. The clock may have struck twelve for GM today as the Senate announced that a vote on aid to the Detroit Three this week.
Up until now I was of the opinion that GM would get some kind of rescue and although GM bondholders may not be made whole, GMAC bondholders may me made whole or, at least receive a recovery at similar levels as recent trading levels. Now I am not so certain. There is too much inflexibility on all sides. Congressional Democrats what the Detroit Three to come back with a plan which returns them to profitability, but preserves all UAW jobs and a mandate to build so-called "green" cars, consumer demand be damned. Detroit CEOs want no meaningful change to their corporate cultures and the UAW will make no further concessions of wages, benefits and job cuts.
Owning GM bonds may be a play on bankruptcy recovery. Owning GMAC bonds is a bet that GM continues to build cars, inside or outside of bankruptcy. What should investors do? If I owned GM bonds I would sell. If I owned GMAC bonds, I would hold on and pray. If I was at or near retirment age, I would drive away laying rubber all the way.
Up until now I was of the opinion that GM would get some kind of rescue and although GM bondholders may not be made whole, GMAC bondholders may me made whole or, at least receive a recovery at similar levels as recent trading levels. Now I am not so certain. There is too much inflexibility on all sides. Congressional Democrats what the Detroit Three to come back with a plan which returns them to profitability, but preserves all UAW jobs and a mandate to build so-called "green" cars, consumer demand be damned. Detroit CEOs want no meaningful change to their corporate cultures and the UAW will make no further concessions of wages, benefits and job cuts.
Owning GM bonds may be a play on bankruptcy recovery. Owning GMAC bonds is a bet that GM continues to build cars, inside or outside of bankruptcy. What should investors do? If I owned GM bonds I would sell. If I owned GMAC bonds, I would hold on and pray. If I was at or near retirment age, I would drive away laying rubber all the way.
Monday, November 17, 2008
Now Wait A Minute
Earlier this year, when the idea of rescuing troubled mortgage borrowers was first bandied about, I questioned the morality and legality of doing so from the standpoint of investors. The vast majority of mortgages are not held by banks, but have been securitized (MBS) and sold to investors. In many instances, banks are merely mortgage servicers.
Investors are questioning the morality of changing the terms on mortgages for which they are creditors. Investors believe that the decision is there's not the banks. I questioned a friend who is a mortgage expert about the legality of banks changing mortgage terms without the consent of investors. He told me last week that most mortgage contracts provide for such changes. An article in today's Wall Street Journal discusses this topic.
The Journal states that a provision known as delegated authority. Unbeknownst to many investors, banks can change the terms of a loan without the consent of investors, who are the actual creditors. Investors believe they should have been consulted nonetheless.
Banks may have the legal right to change the terms of mortgages. Such changes my ultimately benefit investors in the long run, but I am willing to wager that such provisions will keep many investors away from the private label MBS market.
Why just private label MBS? With agency-backed MBS, the agency involved guarantees the return of principal (explicitly government guaranteed with GNMA and implicitly guaranteed by FNMA and FHLMC). With private label MBS, the issuing / servicing bank is not responsible for the return of principal to investors. If enough mortgages default to return 60 cents on the dollar to investors, so be it. Banks to not guarantee their MBS in any way.
As with non-cumulative preferred stock, private label MBS may be another dead market.
Investors are questioning the morality of changing the terms on mortgages for which they are creditors. Investors believe that the decision is there's not the banks. I questioned a friend who is a mortgage expert about the legality of banks changing mortgage terms without the consent of investors. He told me last week that most mortgage contracts provide for such changes. An article in today's Wall Street Journal discusses this topic.
The Journal states that a provision known as delegated authority. Unbeknownst to many investors, banks can change the terms of a loan without the consent of investors, who are the actual creditors. Investors believe they should have been consulted nonetheless.
Banks may have the legal right to change the terms of mortgages. Such changes my ultimately benefit investors in the long run, but I am willing to wager that such provisions will keep many investors away from the private label MBS market.
Why just private label MBS? With agency-backed MBS, the agency involved guarantees the return of principal (explicitly government guaranteed with GNMA and implicitly guaranteed by FNMA and FHLMC). With private label MBS, the issuing / servicing bank is not responsible for the return of principal to investors. If enough mortgages default to return 60 cents on the dollar to investors, so be it. Banks to not guarantee their MBS in any way.
As with non-cumulative preferred stock, private label MBS may be another dead market.
Oops I Did It Again
I have written, many times, that banks are not using capital raised earlier this year to lend to consumers, but to repair their balance sheets. I have also commented on how companies which are unable raise money in the capital markets have been taping bank lines of credit. CIT Group was one notable institution to do this earlier this year. Genworth Financial did the same last Friday. Although these backstop provisions are beneficial to the borrowers, they are putting already battered banks under even more stress. Although I failed to make the connection between reduced consumer lending and corporate lines of credit, an article in today Wall Street Journal has not.
The article details how corporate backstop facilities are putting banks under pressure because banks cannot securitize these loans. The capital markets are dysfunctional at this time. The author makes the case that the government's attention should focus on repairing the capital markets. This is easier said than done at this point in time.
Why is it so difficult? First, the media and certain government officials have made the crisis a battle between Wall Street and Main Street. What many of our leaders do not understand (or won't admit) is that Wall Street and Main Street intersect. Shut down Wall Street and business shuts down on Main Street. The country needs functioning markets.
Secondly, government actions (halting GSE preferred dividend payments, the ever changing TARP plan and inconsistent dealings with troubled institutions, etc.) have only helped to shut down the capital markets to companies needing funding, especially financial institutions.
I agree with the Journal that corporate backstop financing is helping to prevent banks from lending, but this is a result of the credit crisis not a cause. If banks did not have many billions of writedowns from bad assets, the credit markets would not have seized and these corporate loans and lines of credit never would have been tapped. Until the capital markets are unfrozen the crisis will continue.
How to we unfreeze the markets? Here is a crazy idea. Why not insist that banks receiving TARP funds use the funds to pay preferred dividends, bond interest payments and loan to companies needing capital, but which cannot access TARP themselves. After all, not every company can become a bank holding company, although they will try.
Da Do Ron-Ron
UAW chief Ron Gettelfinger announced over the weekend that the UAW will make no further concessions, its workers earn about the same as those working for foreign companies in the U.S. and GM's problems are not the result if the UAW OR management. Rather, it is the result of higher fuel prices (until recently) and the Wall Street credit crunch.
That's right Ron, GM, which has lost money for the last several years and which has been on the decline for over 30 years is in trouble because it cannot issue more debt and afford more 0% financing. Toyota, Honda, Nissan, Subaru, Hyundai, Mercedes and BMW, all which build vehicles and components in the U.S., do not appear to have such problems. The problem, Ron is that UAW workers have benefit packages which far exceed those of workers at foreign-owned factories, GM is saddled with legacy costs (pensions, retiree benefits, etc.) and stupid ideas such as the Jobs bank, which pays workers not to work.
Agreeing to the aforementioned compensation packages is the fault of GM (and Ford and Chrysler) management. GM culture is that the company is THE U.S. automaker and that it will regain market share. I don't think executives get out of Michigan much. Although Detroit vehicles may rule the road in and around Detroit, the are not as dominant in other areas of the country. Many people get by just fine without a mammoth SUV.
Detroit's bloated corporate structures, generous labor agreements and ostrich-like behavior with regards to its competition is dooming Detroit to fail. When one needs to sell small or mid-size car for at least $24,000 (GM's figure as of 2005), one cannot make money in today's environment. The Detroit Three have not made money on passenger cars for many years. The only reasons Detroit continued to build cars along with trucks is because the needed fuel-efficient, albeit obsolete, cars to bring their Corporate Average Fuel Economy (CAFE) numbers down to government-mandated levels. That is right boys and girls, the Detroit Three are forced to build vehicles which are unprofitable to meet government mandates. That and the fact that it would have to pay assembly line workers not to work if car plants were idled force Detroit to build unprofitable cars. If one is not going to profit any way, why bring them up to Toyota or Honda standards. In a perverse way of thinking, it is more cost-effective not to invest in passenger car technology.
Many people have asked me what to do with their GM bonds. As they are trading at prices in the $20 area, I do not think investors are harmed by waiting to see how the situation plays out. However, I do not see any disadvantage to selling now. Sound confusing? Let me explain.
The street is essentially telling us what to expect from bankruptcy recovery. However, in a bankruptcy, bondholders may not receive cash. In a bankruptcy, creditors may receive cash, new stock, new bonds or a combination thereof. Investors wanting cash may want to sell now.
What about a government bailout? Even a government bailout does not guarantee that investors receive par or receive cash. In a bailout, investors will still probably receive cents on the dollar for their bonds and probably will not receive much, if any, cash. Investors may receive more GM bonds and stock in a bailout than they would receive in a traditional bankruptcy, but they may not. What about the government just giving GM (and Ford and Chrysler) cash? Since that doesn't fix the problem, I would recommend that any investors still holding GM bonds to sell into any rallies.
What about GMAC? GMAC has no cross-default responsibilities with GM. There was never any, even before the 51% spin-off to Cerberus (the same is true of Ford and Ford Motor Credit). I am cautiously more optimistic about GMAC. Why am I more optimistic? If there is any hope of rebuilding GM, there needs to be a viable and functioning finance company to fund the purchase of vehicles. GMAC COULD become a bank holding company, but that probably would not happen until (unless) GM is saved in some form. After all, why make GMAC a bank holding company just to have the FDIC (or the OTS if it becomes a thrift) if GM collapsed leaving GMAC without vehicles to finance.
My opinion for GMAC bonds is similar to that for GM bonds with one caveat. I think that GMAC will be in business. As long as GM is producing vehicles (whatever its corporate condition), GMAC should receive TARP money and will make good on its obligations.
What if I am wrong? Those investors who cannot risk a GMAC failure should cash out now, especially into any rallies. The one exception may be GMAC Smartnotes. GMAC Smartnotes (which are senior notes) are trading 10 or more points below other GMAC senior notes. This is due to the lack of liquidity which is a result of small deal sizes. Since Smartnote holders would receive the same recovery as larger senior notes in a bankruptcy and the market is pricing (possible bankruptcy recovery estimates) large senior note issues 10 or more points higher than Smartnotes, investors may wish to ride this out. As always, investor suitability should reign supreme.
The article details how corporate backstop facilities are putting banks under pressure because banks cannot securitize these loans. The capital markets are dysfunctional at this time. The author makes the case that the government's attention should focus on repairing the capital markets. This is easier said than done at this point in time.
Why is it so difficult? First, the media and certain government officials have made the crisis a battle between Wall Street and Main Street. What many of our leaders do not understand (or won't admit) is that Wall Street and Main Street intersect. Shut down Wall Street and business shuts down on Main Street. The country needs functioning markets.
Secondly, government actions (halting GSE preferred dividend payments, the ever changing TARP plan and inconsistent dealings with troubled institutions, etc.) have only helped to shut down the capital markets to companies needing funding, especially financial institutions.
I agree with the Journal that corporate backstop financing is helping to prevent banks from lending, but this is a result of the credit crisis not a cause. If banks did not have many billions of writedowns from bad assets, the credit markets would not have seized and these corporate loans and lines of credit never would have been tapped. Until the capital markets are unfrozen the crisis will continue.
How to we unfreeze the markets? Here is a crazy idea. Why not insist that banks receiving TARP funds use the funds to pay preferred dividends, bond interest payments and loan to companies needing capital, but which cannot access TARP themselves. After all, not every company can become a bank holding company, although they will try.
Da Do Ron-Ron
UAW chief Ron Gettelfinger announced over the weekend that the UAW will make no further concessions, its workers earn about the same as those working for foreign companies in the U.S. and GM's problems are not the result if the UAW OR management. Rather, it is the result of higher fuel prices (until recently) and the Wall Street credit crunch.
That's right Ron, GM, which has lost money for the last several years and which has been on the decline for over 30 years is in trouble because it cannot issue more debt and afford more 0% financing. Toyota, Honda, Nissan, Subaru, Hyundai, Mercedes and BMW, all which build vehicles and components in the U.S., do not appear to have such problems. The problem, Ron is that UAW workers have benefit packages which far exceed those of workers at foreign-owned factories, GM is saddled with legacy costs (pensions, retiree benefits, etc.) and stupid ideas such as the Jobs bank, which pays workers not to work.
Agreeing to the aforementioned compensation packages is the fault of GM (and Ford and Chrysler) management. GM culture is that the company is THE U.S. automaker and that it will regain market share. I don't think executives get out of Michigan much. Although Detroit vehicles may rule the road in and around Detroit, the are not as dominant in other areas of the country. Many people get by just fine without a mammoth SUV.
Detroit's bloated corporate structures, generous labor agreements and ostrich-like behavior with regards to its competition is dooming Detroit to fail. When one needs to sell small or mid-size car for at least $24,000 (GM's figure as of 2005), one cannot make money in today's environment. The Detroit Three have not made money on passenger cars for many years. The only reasons Detroit continued to build cars along with trucks is because the needed fuel-efficient, albeit obsolete, cars to bring their Corporate Average Fuel Economy (CAFE) numbers down to government-mandated levels. That is right boys and girls, the Detroit Three are forced to build vehicles which are unprofitable to meet government mandates. That and the fact that it would have to pay assembly line workers not to work if car plants were idled force Detroit to build unprofitable cars. If one is not going to profit any way, why bring them up to Toyota or Honda standards. In a perverse way of thinking, it is more cost-effective not to invest in passenger car technology.
Many people have asked me what to do with their GM bonds. As they are trading at prices in the $20 area, I do not think investors are harmed by waiting to see how the situation plays out. However, I do not see any disadvantage to selling now. Sound confusing? Let me explain.
The street is essentially telling us what to expect from bankruptcy recovery. However, in a bankruptcy, bondholders may not receive cash. In a bankruptcy, creditors may receive cash, new stock, new bonds or a combination thereof. Investors wanting cash may want to sell now.
What about a government bailout? Even a government bailout does not guarantee that investors receive par or receive cash. In a bailout, investors will still probably receive cents on the dollar for their bonds and probably will not receive much, if any, cash. Investors may receive more GM bonds and stock in a bailout than they would receive in a traditional bankruptcy, but they may not. What about the government just giving GM (and Ford and Chrysler) cash? Since that doesn't fix the problem, I would recommend that any investors still holding GM bonds to sell into any rallies.
What about GMAC? GMAC has no cross-default responsibilities with GM. There was never any, even before the 51% spin-off to Cerberus (the same is true of Ford and Ford Motor Credit). I am cautiously more optimistic about GMAC. Why am I more optimistic? If there is any hope of rebuilding GM, there needs to be a viable and functioning finance company to fund the purchase of vehicles. GMAC COULD become a bank holding company, but that probably would not happen until (unless) GM is saved in some form. After all, why make GMAC a bank holding company just to have the FDIC (or the OTS if it becomes a thrift) if GM collapsed leaving GMAC without vehicles to finance.
My opinion for GMAC bonds is similar to that for GM bonds with one caveat. I think that GMAC will be in business. As long as GM is producing vehicles (whatever its corporate condition), GMAC should receive TARP money and will make good on its obligations.
What if I am wrong? Those investors who cannot risk a GMAC failure should cash out now, especially into any rallies. The one exception may be GMAC Smartnotes. GMAC Smartnotes (which are senior notes) are trading 10 or more points below other GMAC senior notes. This is due to the lack of liquidity which is a result of small deal sizes. Since Smartnote holders would receive the same recovery as larger senior notes in a bankruptcy and the market is pricing (possible bankruptcy recovery estimates) large senior note issues 10 or more points higher than Smartnotes, investors may wish to ride this out. As always, investor suitability should reign supreme.
Saturday, November 15, 2008
I Can't Stand It
Ron (don't blame us) Gettelfinger, of the UAW, has publicly stated today that the UAW will make no further concessions with regards to a Detroit bailout. In a noticeable change of rhetoric, Mr. Gettelfinger is not blaming Detroit management either. Instead, Mr. Gettelfinger's bogey men are Wall Street and high gasoline prices. Never mind that GM has not made money from U.S. automotive operations in years, instead relying on foreign sales and profits from GMAC. GM was forced to resort to 0% financing in 2002, before high fuel prices. Some may argue that the economy was sluggish in 2002. OK, What about 2003 to 2006? The economy was booming, borrowing costs were low and fuel prices, although somewhat high, were no higher than today's prices and much lower than their peak earlier this year. What about the fact that Detroit's domestic competitors are weathering the storm just fine.
No the bottom line is that the Detroit Three, for years, caved in to UAW demands for ever-higher wages and better benefit packages. To pay for these union contracts, the Detroit Three were forced to depend on high-margin vehicles such as trucks and SUVs. For years, experts were concerned that the Detroit Three were too dependent on one kind of product and did not have the needed flexibility to successfully meet changing consumer demands. They were right. Today's Detroit dilemma is complete the fault of Detroit management and the UAW. If they remain rigid they will die. If not now (government money), then down the road when irate customers join he millions of customers who have already left the Detroit Three forever. This Detroit vehicle owner is poised to do the same.
Here is a CNN / Money story from January 16th 2002:
http://money.cnn.com/2002/01/16/companies/gm/
No the bottom line is that the Detroit Three, for years, caved in to UAW demands for ever-higher wages and better benefit packages. To pay for these union contracts, the Detroit Three were forced to depend on high-margin vehicles such as trucks and SUVs. For years, experts were concerned that the Detroit Three were too dependent on one kind of product and did not have the needed flexibility to successfully meet changing consumer demands. They were right. Today's Detroit dilemma is complete the fault of Detroit management and the UAW. If they remain rigid they will die. If not now (government money), then down the road when irate customers join he millions of customers who have already left the Detroit Three forever. This Detroit vehicle owner is poised to do the same.
Here is a CNN / Money story from January 16th 2002:
http://money.cnn.com/2002/01/16/companies/gm/
Thursday, November 13, 2008
Shut Up-A You Face
Yesterday, Treasury Secretary Hank Paulson (A.K.A. Mr. Flip Flop) announced that he was cancelling plans for the Treasury to buy troubled assets from banks. The markets were shocked by the sudden change of heart. I was not.
Although I was surprised by his timing (middle of a trading session with no warning, I was not surprised by the change of plans. After all, banks are not going to sell assets at 50 cents on the dollar (they may as well write them down and hope for some degree of recovery) and the Treasury was not going to pay par (or anything close to it) to assets which glow in the dark. The TARP plan was still-born. However, following the markets' negative reaction and criticism from Congress, Mr. Paulson stated today that purchasing troubled assets are not off the table.
Please Mr. Paulson, do not open your mouth until you are certain of what you speak. I appreciate that we are in uncharted territory and that Mr. Paulson and Mr. Bernanke often have to make things up as they go along, but opening one's mouth and unnerving the markets when one is not sure is counterproductive. Mr. Paulson is scaring market particpants and he must stop now!!!
I do not envy Mr. Paulson. He is dealing with the most severe financial crisis since thhe great depression, but his policy reversals (the GSEs) and inconsistencies (Bear Stearns, Lehman, AIG, etc.) have the markets frightened instead of calmed by his actions.
I am frightened. After being blown up by Mr. Paulson's handling of the GSE preferreds, I am determined not to be burned again. In my opinion, investors looking to buy into firms receiving government capital injections would be better served by buying trust preferreds or bonds rather than common equity or preferred stock. The government's level of investment is equal traditional non-cumulative preferreds and senior to common. In other words, Mr, Paulson can wipe out the dividends on common and preferred stock if he deems it necessary. He needs only to order banks not to pay the government the dividends on the government's preferreds. Securities of equal and lower ranks would also have to have dividends suspended. This coupled with the strong possibility of having the 15% tax on dividends raised makes traditonal preferreds unattarctive in my view. Trust preferreds and bonds are senior to the government's claim. Stay senior to Hank!!!
Although I was surprised by his timing (middle of a trading session with no warning, I was not surprised by the change of plans. After all, banks are not going to sell assets at 50 cents on the dollar (they may as well write them down and hope for some degree of recovery) and the Treasury was not going to pay par (or anything close to it) to assets which glow in the dark. The TARP plan was still-born. However, following the markets' negative reaction and criticism from Congress, Mr. Paulson stated today that purchasing troubled assets are not off the table.
Please Mr. Paulson, do not open your mouth until you are certain of what you speak. I appreciate that we are in uncharted territory and that Mr. Paulson and Mr. Bernanke often have to make things up as they go along, but opening one's mouth and unnerving the markets when one is not sure is counterproductive. Mr. Paulson is scaring market particpants and he must stop now!!!
I do not envy Mr. Paulson. He is dealing with the most severe financial crisis since thhe great depression, but his policy reversals (the GSEs) and inconsistencies (Bear Stearns, Lehman, AIG, etc.) have the markets frightened instead of calmed by his actions.
I am frightened. After being blown up by Mr. Paulson's handling of the GSE preferreds, I am determined not to be burned again. In my opinion, investors looking to buy into firms receiving government capital injections would be better served by buying trust preferreds or bonds rather than common equity or preferred stock. The government's level of investment is equal traditional non-cumulative preferreds and senior to common. In other words, Mr, Paulson can wipe out the dividends on common and preferred stock if he deems it necessary. He needs only to order banks not to pay the government the dividends on the government's preferreds. Securities of equal and lower ranks would also have to have dividends suspended. This coupled with the strong possibility of having the 15% tax on dividends raised makes traditonal preferreds unattarctive in my view. Trust preferreds and bonds are senior to the government's claim. Stay senior to Hank!!!
Tuesday, November 11, 2008
Come To Butt-Head
In my previous post, I advocated that GM consider a pre-packaged bankruptcy. In an example or great minds think alike (or maybe it is fools never disagree), noted hedge fund manager Bill Ackman apparently agrees with yours truly and also advocates a pre-packaged bankruptcy for GM. Mr Ackman states:
"It (GM) has been hamstrung for years because it has too much debt and
it has contracts that are uneconomic. The way to solve that problem is not to lend more money. They should do prepackaged bankruptcy."
Nancy Pelosi has other ideas. She wants to throw money at the so-called "Detroit Three". Her idea to protect taxpayers is to limit executive compensation, but will not ask the UAW to give any concessions. Although I am no fan of Detroit mismanagement, UAW contracts are way out of line with the rest of the country and need to fall in line. Ideology aside, the Detroit Three's labor costs are not mathematically feasible. There is no way around the math, like it or not. Look for a big fight in DC with GM's life on the line. The fight could change the nature of all government bailouts. Ding, round one!
"It (GM) has been hamstrung for years because it has too much debt and
it has contracts that are uneconomic. The way to solve that problem is not to lend more money. They should do prepackaged bankruptcy."
Nancy Pelosi has other ideas. She wants to throw money at the so-called "Detroit Three". Her idea to protect taxpayers is to limit executive compensation, but will not ask the UAW to give any concessions. Although I am no fan of Detroit mismanagement, UAW contracts are way out of line with the rest of the country and need to fall in line. Ideology aside, the Detroit Three's labor costs are not mathematically feasible. There is no way around the math, like it or not. Look for a big fight in DC with GM's life on the line. The fight could change the nature of all government bailouts. Ding, round one!
Friday, November 7, 2008
American Leyland
Today, GM reported huge losses ($2.5B in the third quarter) and stated that it burned through $6.9 billion. According to the company, its cash reserves now stand at $16.2B. GM says that it needs between $11 billion and $15 billion to fund operations. The company expressed concerns that it may not have enough cash to survive the balance of the year, which has just over a month and a half remaining. GM needs help (as do Ford and Chrysler) and it needs it now!
The way which is probably preferred (to varying degrees) is throwing cash at the Detroit Three is an attempt to weather the storm to maintain the status quo in Detroit. In exchange for this cash infusion, it has been suggested that the government could take an ownership interest in the Detroit automakers. This hearkens back to the thrilling days of British Leyland.
British Leyland was formed in 1968 by combining Britain's automakers. I was partially nationalized in 1975 in an attempt to keep its unionized workforce employed. Strikes, mismanagement and high labor costs eventually doomed British Leyland. Companies such as MG, Austin Healey and and Triumph passed into history and iconic brands such as Jaguar and Land Rover were sold to foreign automakers. It was an unmitigated disaster. This is probably fate which awaits a merged Detroit Three with a semi0nationalization thrown in for good measure. All is not lost however. There are ways to save the Detroit Three.
The fact of life is that Ford and GM are too big. They need to downsize and trim their labor forces. All of the Big Three need to adjust their compensation structures, both blue-collar and white-collar, to resemble those of employees of foreign manufacturers in America. After all, Toyota, Nissan, Honda, Hyundai, Subaru, BMW and Mercedes build cars and components in the U.S.
The easiest way would be to either de-unionize or reach an agreement with the UAW to restructure compensation packages. However, this is unlikely and GM is in such dire need of cash, it may be too late for mere concessions. The best answer for GM (and possibly Ford and Chrysler as well) may be a prepackaged bankruptcy.
The criticism of filing for bankruptcy is that potential car buyers may stay away out of fear that their warranties may not be honored and parts availability and service may be compromised. A prepackaged bankruptcy solves this problem.
In a prepackaged bankruptcy, a company reaches agreements with its creditors, suppliers and labor unions prior to filing for bankruptcy protection. The company will also obtain Debtor In Possession financing to pay for any restructuring costs. A company can go in and out of bankruptcy almost instantly.
One obstacle (apart from the UAW) is that few if any investors would be interested in providing DIP financing. Here is where the government can help. If the government merely provided the DIP loans (similar to Chrysler in the late 1970s, although Chrysler avoided bankruptcy, such a deal could be done. GM could be out from under billions of dollars of debt, it would be smaller, leaner and have more manageable labor agreements and be a healthier customer for its suppliers. This is the best way to preserve the Detroit Three and save as many jobs as possible.
Unfortunately, the UAW and its allies in DC would probably shoot this idea down (they don't see labor as a commodity whose demand can wax and wane along with compensation levels). At worst, GM and, maybe Ford and Chrysler as well, will fade into history. At best, we will have "American Leyland" and the U.S. auto industry's demise will be further prolonged.
The way which is probably preferred (to varying degrees) is throwing cash at the Detroit Three is an attempt to weather the storm to maintain the status quo in Detroit. In exchange for this cash infusion, it has been suggested that the government could take an ownership interest in the Detroit automakers. This hearkens back to the thrilling days of British Leyland.
British Leyland was formed in 1968 by combining Britain's automakers. I was partially nationalized in 1975 in an attempt to keep its unionized workforce employed. Strikes, mismanagement and high labor costs eventually doomed British Leyland. Companies such as MG, Austin Healey and and Triumph passed into history and iconic brands such as Jaguar and Land Rover were sold to foreign automakers. It was an unmitigated disaster. This is probably fate which awaits a merged Detroit Three with a semi0nationalization thrown in for good measure. All is not lost however. There are ways to save the Detroit Three.
The fact of life is that Ford and GM are too big. They need to downsize and trim their labor forces. All of the Big Three need to adjust their compensation structures, both blue-collar and white-collar, to resemble those of employees of foreign manufacturers in America. After all, Toyota, Nissan, Honda, Hyundai, Subaru, BMW and Mercedes build cars and components in the U.S.
The easiest way would be to either de-unionize or reach an agreement with the UAW to restructure compensation packages. However, this is unlikely and GM is in such dire need of cash, it may be too late for mere concessions. The best answer for GM (and possibly Ford and Chrysler as well) may be a prepackaged bankruptcy.
The criticism of filing for bankruptcy is that potential car buyers may stay away out of fear that their warranties may not be honored and parts availability and service may be compromised. A prepackaged bankruptcy solves this problem.
In a prepackaged bankruptcy, a company reaches agreements with its creditors, suppliers and labor unions prior to filing for bankruptcy protection. The company will also obtain Debtor In Possession financing to pay for any restructuring costs. A company can go in and out of bankruptcy almost instantly.
One obstacle (apart from the UAW) is that few if any investors would be interested in providing DIP financing. Here is where the government can help. If the government merely provided the DIP loans (similar to Chrysler in the late 1970s, although Chrysler avoided bankruptcy, such a deal could be done. GM could be out from under billions of dollars of debt, it would be smaller, leaner and have more manageable labor agreements and be a healthier customer for its suppliers. This is the best way to preserve the Detroit Three and save as many jobs as possible.
Unfortunately, the UAW and its allies in DC would probably shoot this idea down (they don't see labor as a commodity whose demand can wax and wane along with compensation levels). At worst, GM and, maybe Ford and Chrysler as well, will fade into history. At best, we will have "American Leyland" and the U.S. auto industry's demise will be further prolonged.
Thursday, November 6, 2008
Don't Stop Believing
I have had many questions asking why the markets, especially financial bonds and preferreds, have not responded more positively to the government's rescue plans. My answer has been that the market does not trust that the government will infuse money and take a passive role. Recent comments from legislators have only heightened these fears. Some of my readers have doubted my belief that the government (thanks to its treatment of the GSEs and Lehman) has caused more fear instead of easing investors concerns. Maybe the following excerpt from the Wall Street Journal is more convincing:
"A survey of more than 400 firms by Sifma and other financial-industry trade groups found that a large percentage of financial firms would be reluctant to participate without more details about any potential program. More than nine in 10 said they were less likely to participate in the so-called Troubled Asset Relief Program because of a "lack of clarity." Nearly the same number expressed reluctance if Treasury requires firms to issue warrants in return for taking assets from them."
No one trusts the government, not the banks and not investors. Banks want the government to buy toxic assets at reasonably high prices without becoming beholden to the government. Investors want to be assured that banks have accounted for all of their toxic assets and that the government will not force a suspension of dividends or other actions which would be negative for their investments.
What is frightening to me is that the banks are so adamant that the government get these assets of their books. They don't want accounting rule changes. They don't want cash infusions due to preferred or warrant sales. They want the government to take bad assets at good prices. Oppenheimer's Meredith Whitney may frighten the heck out of us, but I believe her to be on the money. Look for more pain down the road.
"A survey of more than 400 firms by Sifma and other financial-industry trade groups found that a large percentage of financial firms would be reluctant to participate without more details about any potential program. More than nine in 10 said they were less likely to participate in the so-called Troubled Asset Relief Program because of a "lack of clarity." Nearly the same number expressed reluctance if Treasury requires firms to issue warrants in return for taking assets from them."
No one trusts the government, not the banks and not investors. Banks want the government to buy toxic assets at reasonably high prices without becoming beholden to the government. Investors want to be assured that banks have accounted for all of their toxic assets and that the government will not force a suspension of dividends or other actions which would be negative for their investments.
What is frightening to me is that the banks are so adamant that the government get these assets of their books. They don't want accounting rule changes. They don't want cash infusions due to preferred or warrant sales. They want the government to take bad assets at good prices. Oppenheimer's Meredith Whitney may frighten the heck out of us, but I believe her to be on the money. Look for more pain down the road.
Tuesday, November 4, 2008
Sweet dreams and flying machines in pieces on the ground.
Election day is finally here. Both candidates have seen fire and rain throughout the contest. Voters have endured much as well. Depending who wins the election, some of my readers may feel as though the future appears bleak. Let's put things into proper perspective. We are choosing between two candidates, elected democratically, who will (in their own way) preserve the freedoms to which we are guaranteed. We need not worry about a despot assuming power or a rolling back of our civil rights. Compared with much of the rest of the world, we do not have much about which to worry. Our problems and concerns are trivial to that of much of the world. We may have much to lose, but this is only because we have so much to lose.
Enough with the civics lesson. Tomorrow we all have to make a living and protect our clients. Depending on which candidate wins and how much of a Democratic majority of Congress, there could be more government intervention or influence on banks, lenders and insurance companies.
Ever since Treasury Secretary Paulson (with pressure from Barney Frank and Chris Dodd), wiped out the GSE preferreds, the markets have been very wary of government "help" My concern is that the next administration and Congress may change the rules of the TARP plan.
The government has the power to dictate how government funds are used by the banks. This includes forcing banks to use funds to issue more loans and force banks to suspend dividends on common and preferred equity. It is because dividends of assisted institutions will be paid only with the blessing of the government, I suggest buying trust preferreds, which have a debt component, rather than DRD/QDI preferreds. Because of their debt component, trust preferreds are SENIOR to the preferreds being purchased by the government. If you trust the government, feel free to buy non-cumulative preferreds. I would rather stay senior to Uncle Sam, thank you.
By the way, I am not alone with my concerns about the Government intervention. The following is from an article in today's online Wall Street Journal:
"Any expansion would likely prompt calls by U.S. lawmakers to attach more conditions. Members of Congress have begun pushing Treasury to force banks to lend the money they've received, complaining to Mr. Paulson that they're sitting on the cash or using it to fund acquisitions and pay dividends."
Caveat Emptor!
Enough with the civics lesson. Tomorrow we all have to make a living and protect our clients. Depending on which candidate wins and how much of a Democratic majority of Congress, there could be more government intervention or influence on banks, lenders and insurance companies.
Ever since Treasury Secretary Paulson (with pressure from Barney Frank and Chris Dodd), wiped out the GSE preferreds, the markets have been very wary of government "help" My concern is that the next administration and Congress may change the rules of the TARP plan.
The government has the power to dictate how government funds are used by the banks. This includes forcing banks to use funds to issue more loans and force banks to suspend dividends on common and preferred equity. It is because dividends of assisted institutions will be paid only with the blessing of the government, I suggest buying trust preferreds, which have a debt component, rather than DRD/QDI preferreds. Because of their debt component, trust preferreds are SENIOR to the preferreds being purchased by the government. If you trust the government, feel free to buy non-cumulative preferreds. I would rather stay senior to Uncle Sam, thank you.
By the way, I am not alone with my concerns about the Government intervention. The following is from an article in today's online Wall Street Journal:
"Any expansion would likely prompt calls by U.S. lawmakers to attach more conditions. Members of Congress have begun pushing Treasury to force banks to lend the money they've received, complaining to Mr. Paulson that they're sitting on the cash or using it to fund acquisitions and pay dividends."
Caveat Emptor!
Subscribe to:
Posts (Atom)