What will be the result of this whole housing bubble blow up? I will try to describe the whole thing is very broad terms.
Around 2000, the demand for real estate started to increase rapidly. Demand for real estate comes from three different sources. First of all, a population increase can cause this. There can also be demand from people who want to own more than one house. There can also be a change in preference between renting and buying. The first reason, population increase, has been fairly steady over US history and are not the main driver of the recent housing bubble.
The demand for second homes certainly increased. People, in recent times, think of second homes as an investment. After the stock market crash of 2000, the dot-com blowup, people looked for alternatives to stocks. They noted the wonderful returns that they or their parents may have received by buying during or before the inflationary 1970s. This current demand was aided by the very low interest rates following the stock market crash. The two sources of this were Greenspan's Federal Reserve as well as the "vendor financing" resulting from the rise of the US trade deficit. In short, China sends us products, we send them dollars and they buy US financial assets such as US mortgages and US Treasuries. This helped keep interest rates down leading to a refinancing boom and a boom in first home purchases.
This was the first stage of the housing bubble. The number of homes of course didn't change as rapidly. This change in the supply-demand balance lead to the beginning of the price appreciation bubble. This of course feeds back and enticed more people to think of housing as a good investment which led to more buying.
The next stage of the bubble came from converting more renters into buyers. Traditionally people would rent while they were young and save money for a down payment on a home. This is what I learned when I was young. Typically this would be 20% of a house price. This was demanded from banks to create an equity cushion. Mortgages are non-recourse loans that allow the buyer to simply stop paying the mortgage and giving the bank the right, in turn, to foreclose or take back the collateral. The equity cushion provides the incentive for the buyer to do whatever it takes to avoid default. It also allows the bank to suffer as much as a 20% loss on resale without suffering a net loss.
Due to this dramatic run-up in house prices, the banks relaxed their lending standards to allow for lower down-payments. In addition, since house prices were rising rapidly, they were not too concerned about suffering any loss on the value of the collateral. There was no need for a 20% down payment if the house would be worth 20% more next year. Many of these loans were resold to investors anyway. So it would not be the problem of the originating bank or mortgage originator once it was sold off, if the payments were not made.
The worst of this was the subprime lending industry. Fueled by short-term loans from Wall Street banks, these lenders would give loans to just about anybody capable of fogging a mirror. The lenders were extremely profitable because they could sell off the loans very quickly. A 1% gain on a home loan isn't that great if it takes you a year to do it but if you can turn-over 10 such transactions in a year, that is a 10% annual gain on your capital. Better yet, if you can leverage up your assets to 10 times capital, that is a 100% return on capital. What a business model? So faster turnover from the buying mania and leverage created this wonderful business opportunity. However it depended on insatiable demand for houses as well as a plentiful supply of borrowed money from Wall Street and finally demand for these securitized mortgage products in the secondary market.
All this time, the homebuilders were ramping up their building. There was more demand for homes and so this resulted in higher profit margins. These profits created more capital that could be used to buy more land and build more homes. The end result would of course be a much larger supply of houses.
Home prices rose. Economic activity was vibrant with all this building and buying and selling. There were profits all around. Builders made a killing. Banks made a killing. Even the buyers made a killing if you counted the capital gains on the houses. All of these were extremely leveraged. The buyer bough with little or no money down. Putting down 5% (1/20th of the house) and getting a one-year appreciation of 20% meant a 400% return on invested capital. Who needs to work when you can get returns like that just by signing on the dotted line? Bank loans are always leveraged transactions. They are allowed to leverage their capital by about a factor of 10%. Builders were leveraged as well by borrowing from the banks.
Of course this all had to come to an end. Eventually prices got so high that most people simply could not pay the mortgage payment. They could not even pretend anymore. Monthly payments were as much as twice what it would cost to rent the same house. This was almost 50% of the average persons take home wages. The supply of people that could be converted from renters to buyers or single home owners to second home owners began to dwindle. The excess supply of new homes relieved some of the pressure on home prices.
So eventually home price appreciation stopped. Then the whole process which depended on rising home prices would come apart in dramatic fashion. Now we are in a period of falling prices. Now the total supply of houses is much larger than before. The supply of people willing to speculate on house prices has evaporated. The supply of banks willing to make low down payment loans has contracted. The fact that prices are clearly dropping removes any incentive to buy now. The deflationary mindset sets in. Why buy now when you can buy cheaper next year? The supply of houses for sale is even larger due to a massive wave of foreclosures.
What is the endgame for all of this? House prices will eventually bottom. They will do so when it becomes cheaper to buy then to rent. It will do so when a person can buy a home and rent it out for a profit. The trouble is that this break even point between buying and renting seems quite a ways off.
So who is the winner and loser from all of this? Like all bubbles, this has resulted in a miss-allocation of resources. This results in a inefficiency and so a decrease in GDP. Basically, houses will end up on the balance sheet of banks who will have to auction them off at a loss. So banks will have lost money which will easily erase all of the profits from the proceeding years. People who owned before the bubble will have seen their house value go up and down. Many of these will not be impacted. However, some of these may have borrowed against their home and now find themselves with a much higher debt/equity ratio. They may now have to work longer than they had planned in order to retire and so may spend less in the coming years. Again , this will reduce GDP.
Some people with good credit and secure jobs who bought near the peak will have to pay higher than normal mortgage payments for the rest of the life of the mortgage. Some people may have lost all of their net worth by having bought at the wrong time and now have to sell for whatever reason.
Who are the winners? For every losing speculator there is a winning speculator. Some people who bought and sold at the right time made a small fortune.
Young people and renters are winners. They will in the future be able to buy houses much cheaper. There are a lot more houses now and not that many more people.
Friday, February 29, 2008
Sunday, January 13, 2008
A good Zen koan for investing
Joshu asked Nansen, “What is the Way?”
“Ordinary mind is the Way,” Nansen replied.
“Shall I try to seek after it?” Joshu asked.
“If you try for it, you will become separated from it,” responded Nansen.
“How can I know the Way unless I try for it?” persisted Joshu. Nansen said, “The Way is not a matter of knowing or not knowing. Knowing is delusion; not knowing is confusion. When you have really reached the true Way beyond doubt, you will find it vast and boundless as outer space. How can it be talked about on the level of right and wrong?”
With these words, Joshu came to a sudden realization.
—“Ordinary Mind is the Way,” translated by Katsuki Sekida
This is one of my favorite koans. It also has an investing parallel. I have rewritten it as:
Joshu asked Nansen, “What is the way the make money in stocks?”
“Don't try to make money in stocks. Just invest wisely,” Nansen replied.
“Shall I try to seek after great returns?” Joshu asked.
“If you try for it, you will become separated from it,” responded Nansen.
“How can I get rich investing unless I try for it?” persisted Joshu. Nansen said, “The Way to riches is not a matter of trying to get rich or trying to keep from losing money. If you do that you will be bound with fear watching your daily net worth fluctuate wildly. Just invest wisely keeping true to your principles. If you do that you will be rich."
With these words, Joshu came to a sudden realization.
“Ordinary mind is the Way,” Nansen replied.
“Shall I try to seek after it?” Joshu asked.
“If you try for it, you will become separated from it,” responded Nansen.
“How can I know the Way unless I try for it?” persisted Joshu. Nansen said, “The Way is not a matter of knowing or not knowing. Knowing is delusion; not knowing is confusion. When you have really reached the true Way beyond doubt, you will find it vast and boundless as outer space. How can it be talked about on the level of right and wrong?”
With these words, Joshu came to a sudden realization.
—“Ordinary Mind is the Way,” translated by Katsuki Sekida
This is one of my favorite koans. It also has an investing parallel. I have rewritten it as:
Joshu asked Nansen, “What is the way the make money in stocks?”
“Don't try to make money in stocks. Just invest wisely,” Nansen replied.
“Shall I try to seek after great returns?” Joshu asked.
“If you try for it, you will become separated from it,” responded Nansen.
“How can I get rich investing unless I try for it?” persisted Joshu. Nansen said, “The Way to riches is not a matter of trying to get rich or trying to keep from losing money. If you do that you will be bound with fear watching your daily net worth fluctuate wildly. Just invest wisely keeping true to your principles. If you do that you will be rich."
With these words, Joshu came to a sudden realization.
Saturday, November 3, 2007
Why people lose money on fast growing companies.
Most people pick stocks like this. First they find what looks to be a "good company". A company that qualifies as a "good company" usually has a high growth rate.
For example people who call themselves "growth investors" will look for a company growing at 40% or so. Maybe it has only been around for two years but grew earnings at 40% both years. They say to themselves. "If it keeps growing at 40% for two more years (and why shouldn't it?) and retains the same valuation, then I will have doubled my money in two years."
Other people who would call themselves value investors or Warren Buffett inspired investors have read all the Buffett books. They take a variation on this. First of all, they look for high and stable return-on-equity, low debt, and a fairly high growth rate, say 20%. Then they look at valuation. They might be willing to pay P/E = 18 for a company growing at 20% and ROE=20% and no dividend. They might use DCF to get the "right" valuation.
Most of these "growth investors" and "value investors" don't beat the market.
The growth investor gets it wrong because they never really trust these growth predictions. They need to diversify into 25 growth companies because they have little faith in each one. Because of this, they do not know the companies very well. Sometimes there is not much to know. They may be speculative at best to begin with. Some do very well and keep growing quickly. Some slow down and lose their high valuation and some simply go bust. They get an average return over long time periods.
The "Buffett investor" gets it wrong as well. They also do not beat the market by much if anything. They may not get big losses because they avoid the speculative bubbles but may have some real dogs. Many of their "good companies" stop being good, drop in value and are sold. What went wrong? They read all the Buffett books. They made sure all had high ROE and therefore probably an economic moat.
What is wrong with the intrepid value investor? I first discovered it by reading this article over at Tweedy Brown, called "Great 10-year record = Great Future, Right?
(You might need to click around for it under research reports). It is a great article, a real eye opener for me. Many of these Tweedy Brown articles are great reads.
The gist of the story is that the earnings growth of companies over the proceeding 5-year period is uncorrelated with the earnings growth the preceeding 10 years. Similarly, the ROE is also uncorrelated. Companies with high ROEs over the 10-year period do not grow faster than the average company. And stock returns are not better for these high ROE companies.
What??!! You mean you can't turn Warren Buffett's performance into a simple formula based on high ROE? Sorry but no. Maybe that isn't surprising to you. After all, there are not many Warren Buffetts around despite everyone reading the books on how to emulate him.
Of course Warren never said it was that simple. He talks about many things including mangement, strong brands or economic moats. He talks a lot about fully understanding the business and being able to predict earnings. He talks about buying only cheap companies which he defines as companies selling below their intrinsic value.
I don't really think there is any great mystery to how Buffett does it. It is simply that he does it better than everyone else. When he says "really understand a business", he sets a higher threshold than most people. That is, he understands their competitors. He understands, whether their costs will likely rise or fall. He only buys companies for which he thinks he can undertstand what the demand for their products/services will be. He looks for companies that have little risk of underperforming his goals. It is these rare companies that he fully understands for which he can predict where they are going to be in 10 years. Once he knows this, he knows the value of the company and if it sells well below this value, it is a buy.
The bottom line is that Warren is hard to emulate because he does a lot of hard work that most people do not or will not do. It takes a long time to analyse an entire industry. Also, he has that rare constitution for investing. He doesn't get spooked out. He has confidence in what he is doing because he knows everything he needs to know. He doesn't get distracted. He doesn't violate his principles. He is of course the complete package, as Michael Jordan was the complete package in basketball. You can read books on how to be like Mike but that won't get you that far without talent.
One last thing about Buffett that I should point out. A rare quality he has is incredible patience. I see dozens of companies that I like and would invest in (and have invested in). Buffett aparently sees none. He has been sitting on $40B for several years and has invested very little of it. Clearly, his standards are much higher than most people. That kind of patience is incredibly rare among investors.
For example people who call themselves "growth investors" will look for a company growing at 40% or so. Maybe it has only been around for two years but grew earnings at 40% both years. They say to themselves. "If it keeps growing at 40% for two more years (and why shouldn't it?) and retains the same valuation, then I will have doubled my money in two years."
Other people who would call themselves value investors or Warren Buffett inspired investors have read all the Buffett books. They take a variation on this. First of all, they look for high and stable return-on-equity, low debt, and a fairly high growth rate, say 20%. Then they look at valuation. They might be willing to pay P/E = 18 for a company growing at 20% and ROE=20% and no dividend. They might use DCF to get the "right" valuation.
Most of these "growth investors" and "value investors" don't beat the market.
The growth investor gets it wrong because they never really trust these growth predictions. They need to diversify into 25 growth companies because they have little faith in each one. Because of this, they do not know the companies very well. Sometimes there is not much to know. They may be speculative at best to begin with. Some do very well and keep growing quickly. Some slow down and lose their high valuation and some simply go bust. They get an average return over long time periods.
The "Buffett investor" gets it wrong as well. They also do not beat the market by much if anything. They may not get big losses because they avoid the speculative bubbles but may have some real dogs. Many of their "good companies" stop being good, drop in value and are sold. What went wrong? They read all the Buffett books. They made sure all had high ROE and therefore probably an economic moat.
What is wrong with the intrepid value investor? I first discovered it by reading this article over at Tweedy Brown, called "Great 10-year record = Great Future, Right?
(You might need to click around for it under research reports). It is a great article, a real eye opener for me. Many of these Tweedy Brown articles are great reads.
The gist of the story is that the earnings growth of companies over the proceeding 5-year period is uncorrelated with the earnings growth the preceeding 10 years. Similarly, the ROE is also uncorrelated. Companies with high ROEs over the 10-year period do not grow faster than the average company. And stock returns are not better for these high ROE companies.
What??!! You mean you can't turn Warren Buffett's performance into a simple formula based on high ROE? Sorry but no. Maybe that isn't surprising to you. After all, there are not many Warren Buffetts around despite everyone reading the books on how to emulate him.
Of course Warren never said it was that simple. He talks about many things including mangement, strong brands or economic moats. He talks a lot about fully understanding the business and being able to predict earnings. He talks about buying only cheap companies which he defines as companies selling below their intrinsic value.
I don't really think there is any great mystery to how Buffett does it. It is simply that he does it better than everyone else. When he says "really understand a business", he sets a higher threshold than most people. That is, he understands their competitors. He understands, whether their costs will likely rise or fall. He only buys companies for which he thinks he can undertstand what the demand for their products/services will be. He looks for companies that have little risk of underperforming his goals. It is these rare companies that he fully understands for which he can predict where they are going to be in 10 years. Once he knows this, he knows the value of the company and if it sells well below this value, it is a buy.
The bottom line is that Warren is hard to emulate because he does a lot of hard work that most people do not or will not do. It takes a long time to analyse an entire industry. Also, he has that rare constitution for investing. He doesn't get spooked out. He has confidence in what he is doing because he knows everything he needs to know. He doesn't get distracted. He doesn't violate his principles. He is of course the complete package, as Michael Jordan was the complete package in basketball. You can read books on how to be like Mike but that won't get you that far without talent.
One last thing about Buffett that I should point out. A rare quality he has is incredible patience. I see dozens of companies that I like and would invest in (and have invested in). Buffett aparently sees none. He has been sitting on $40B for several years and has invested very little of it. Clearly, his standards are much higher than most people. That kind of patience is incredibly rare among investors.
Monday, October 29, 2007
The Global Housing Crash
I am a believer in the global housing crash scenario. Normally, I don't put much faith in economic forecasts. I think it is almost impossible to do it well. Alan Greenspan agrees by the way. He recently said on the John Stewert Show (of all places) that he hadn't seen any improvement in economic forecasting over his entire life. However, the housing situation is different. It is a matter of common sense. Logically, real housing prices should not change very much. Houses and the land they sit on are stagnant things like commodities. They do not produce cashflows other than by renting them out. But renting them out for an amount that doesn't cover the mortgage payment is a negative carry. They are clearly overvalued and must come down one way or the other. I won't go over the argument why they are overpriced and why they must come down. Rather, I want to focus on the consequences.
Lets assume that the following dire scenario happens:
House sales and prices continue to drop over the next two years. The subprime buyers cannot be kept in their houses despite much government interference. It simply isn't in their interest to stay. They foreclose and/or declare bankruptcy. However they aren't the only ones. Other "prime" homeowners with negative equity, negative net worth but otherwise good credit realize that they also have no incentive to stay in their homes. Many of them also join the subprime crowd. The negative feedback is obvious. More foreclosures lead to more inventory which puts more pressure on prices. The deflationary psychology sets in. People put off buying because prices are dropping so quickly. The Fed will do its best but can't force people to buy houses. Washington will do its best to pass legislation with incentives to slow the crash but with only mild effects. Prices drop by 10% per year for four years, a total of 35% and then start to decline another 2% for the next six years. The total 10 year decline is 42%. With 2% inflation, real prices have dropped by a factor of 2.
What would the consequences be?
I don't really know. But I think this would lead to many different crises, certainly a long recession if not a depression. Some of the milestones would probably include
In the end (whenever that is), houses are no longer sexy "investments". They become more affordable and necessary "expenses". They are just the place where you live.
As I mention above. I don't know how it will end or what will go right or wrong along the way but many of these things could happen. Many will only happen if house price declines cross certain thresholds. A 10% decline will be manageable. A 20% decline will be major pain. Beyond that, my above scenario is (I think) quite likely and I don't see what could cause prices to stop decling at only 20%. They will still be very expensive for most people and still a negative carry for renting out in most markets. I don't think most companies have a plan for 30% price declines.
Lets assume that the following dire scenario happens:
House sales and prices continue to drop over the next two years. The subprime buyers cannot be kept in their houses despite much government interference. It simply isn't in their interest to stay. They foreclose and/or declare bankruptcy. However they aren't the only ones. Other "prime" homeowners with negative equity, negative net worth but otherwise good credit realize that they also have no incentive to stay in their homes. Many of them also join the subprime crowd. The negative feedback is obvious. More foreclosures lead to more inventory which puts more pressure on prices. The deflationary psychology sets in. People put off buying because prices are dropping so quickly. The Fed will do its best but can't force people to buy houses. Washington will do its best to pass legislation with incentives to slow the crash but with only mild effects. Prices drop by 10% per year for four years, a total of 35% and then start to decline another 2% for the next six years. The total 10 year decline is 42%. With 2% inflation, real prices have dropped by a factor of 2.
What would the consequences be?
I don't really know. But I think this would lead to many different crises, certainly a long recession if not a depression. Some of the milestones would probably include
-
Lender failures -
Home builder bankruptcies -
Financial company impairments -
Credit crunch -
Failure of leveraged speculators - Major bank balance sheet impairments
- Recession in countries with housing crashes
- Recession spreads to most other countries
- Failure of mortgage insurance companies requiring Government bailout
- Near or complete insolvency of Fannie Mae, Freddy mac requiring Government bailout
- Investment bank failures
- Major bank failures
- Currency devaluation arms race
- Rise of protectionism
- Major inventory/capacity overhang in manufacturing/export countries like China
- Deflation in all major asset classes
- Flight to safety, US dollar?, blue-chips, health care, high cash-flow, recession resistant companies, Treasuries
- International goverment intervention in mortgage market and banking
- Panic, crises, unforseeable events and eventually resolution and recovery
In the end (whenever that is), houses are no longer sexy "investments". They become more affordable and necessary "expenses". They are just the place where you live.
As I mention above. I don't know how it will end or what will go right or wrong along the way but many of these things could happen. Many will only happen if house price declines cross certain thresholds. A 10% decline will be manageable. A 20% decline will be major pain. Beyond that, my above scenario is (I think) quite likely and I don't see what could cause prices to stop decling at only 20%. They will still be very expensive for most people and still a negative carry for renting out in most markets. I don't think most companies have a plan for 30% price declines.
Wednesday, October 10, 2007
Westernbank versus Inyx Timeline
This is a timeline to keep track of developments concerning the Inyx , Westernbank interaction
Feb 2005, Irish High Court bars Kachkar and Carrigan from investment and directorship positions in Ireland. (source: Carrigan testimony doc 191) |
March 31, 2005, Inyx and its wholly-owned subsidiary, Inyx USA Ltd. (“Inyx USA”), entered into a Loan and Security Agreement (as amended, the “USA Loan Agreement”) (attached Exhibit 1) with Westernbank. Fraud guarantees signed by "Inyx Operators" (source: RICO complaint) |
May, 2005, Inyx Pharma Ltd. (“Inyx Pharma”), which is also a wholly owned subsidiary of Inyx, signed an amendment to the USA Loan Agreement (attached Exhibit 2), and became a co-borrower under that Agreement. Inyx, Inyx Pharma and Inyx USA are referred to hereinafter as the “USA Borrowers.” loan $46M ($10M revolving and $36M in 4 term loans) secured by all assets (source: RICO complaint). |
July 2005 Jose Biaggi appointed CEO and President of Westernbank. |
August 30, 2005, Kachkar, Green and Goldshmidt each executed similar guarantees covering fraud, deceit or criminal acts by Inyx, the EU Borrowers, or any officer, employee or agent of Inyx or the EU Borrowers. (source: RICO complaint). |
On August 31, 2005, Inyx Europe Limited (“Inyx EU”) and Ashton Pharmaceuticals Limited, f/k/a Celltech Manufacturing Services Limited (“Ashton”), entered into a Loan and Security Agreement (as amended, the “EU Loan Agreement”) with Westernbank (attached Exhibit 9). Inyx EU and Ashton are referred to hereinafter as the “EU Borrowers.” Under the EU Loan Agreement, Westernbank agreed to lend up to $35.5 million, consisting of a revolving credit line of up to $11.7 million and term loans to Inyx EU in the aggregate amount of $24.8 million, pursuant to four promissory notes. Loans are now about $82M (source: RICO complaint also Montanez testimony). |
October 24, 2005, Inyx sought and received a $5 million Secured Over Formula Advance Loan from WBC for working capital to purchase new inventory. The loan was to be guaranteed by inventory one of the Inyx Companies was to purchase pursuant to existing purchase orders. The Inyx Companies, however, never reported such inventory to WBC, and the underlying purchase orders were fraudulent. In addition, while the loan has long since been due and owing, the loan has never been repaid. Loans now $87M (source: RICO complaint). |
Nov 2005, Another $10M in loans for revolver at Inyx Pharama Loans now $97.5M (source: Montanez). |
On or about August 1, 2006, a conference call was conducted among Westernbank employees and Handley and Hunter. During this call, Handley and/or Hunter falsely represented to Westernbank that most of the Inyx past due accounts receivable discussed on the call would be collected over the coming months even though they knew that most of these accounts receivable were fraudulent. This conference call took place over international wires (source: RICO complaint). |
On or about August 11, 2006, Kachkar, Green, Goldshmidt and other Inyx Companies employees traveled to Puerto Rico to meet in person with Westernbank employees. Among the topics discussed were Inyx’s aging accounts receivable. Kachkar, Green and/or Goldshmidt told the Westernbank employees that they should direct their questions to Handley and Hunter because they were the ones knowledgeable about the accounts receivable (source: RICO complaint). |
Sep 2006, Loans are up to $110M. Accounts receivables increasing, need more working capital. Added to revolver (source: Montanez). |
Starting in September 2006 and continuing through at least May 2007, the Inyx Operators repeatedly, misled Westernbank by advising it that the Inyx Companies and/or the Inyx Operators were finalizing arrangements with other sources of funding either to buy out or significantly pay down the Inyx Companies’ debt to Westernbank (source: RICO complaint). |
Oct 2006, Auditors cannot complete audit in UK. |
November, 10 2006 Jay Green says final stages of due dilligence with Goldman Sachs, Wachovia, Credit Suisse. Jay Green requests a waiver of financial covenants. They are writing off $37M in receivables and that they are pre-billings. "Raised a red flag". Contacted Kachkar who claims this is only GAAP accounting and that receivable are good (source: Montanez) |
November 17, 2006 personal guarantee from Kachkar and Benkovitch in the amount of $10 million (source: RICO complaint). |
November 20, 2006 Mike Vasquez sends letter acknowledging the $37M in pre-billings. (source: Montanez) |
Jan 2007 Last WHI Conference call. Stipes says Inyx is current and that it is not a bad loan. Might be acquired. |
Jan 17, 2007 Jack Kachkar offers $148.6 million to buy Marseille soccer team. |
Feb 21, 2007, Skepticism grows over Kachkar's funds Money laundering worries. . French Press says he has 386M Euros (same link). |
| Mar 2, 2007 Jay Green sends Westernbank a letter of commitment for financing from Pareto Securities. The letter turns out to be a forgery. |
| Mar 5, 2007 French Paper reveals that TRACFIN, the French agency that investigates money laudering is investigating Kachkar and Benkovitch. |
March 7, 2007 personal guarantee from Kachkar and Benkovitch in the amount of $8 million (source: RICO complaint). Loans at $120M (source: Montanez). |
Mar 14, 2007 Kachkar's claims to have purchased Grimaldi Castle exposed in Provence Paper . |
Mar 24, 2007 Robert Louis-Dreyfus decided not to extend a payment deadline for Kachkar to buy Marseille team. |
Apr 11, 2007 Jose Biaggi tenders his resignation as CEO and President of Westernbank and member of the BOD. |
In May 2007, Westernbank learned of a collateral deficiency under the Loan Agreements in excess of $80 million because of uncollectible accounts receivable. Various Inyx officers, including Kachkar, Green and Goldshmidt, thereafter gave false assurances to Case 3:07-cv-01606-ADC Document 3 Filed 08/23/2007 Page 32 of 54 33 Westernbank in June 2006 that the collateral deficiency was substantially less than this sum, the accounts receivable identified as uncollectible were in fact collectible, and/or that the collateral deficiency would be covered by other assets (source: RICO complaint). |
| May 2007, David Zinn says receivables probably not collectable (source Montanez). |
| May 14, 2007, Sahara Bank replies by SWIFT saying that it has no letter of credit from Qadahfi for Westernbank. |
| May 31, 2007 Meeting with Kachkar. He says receivables are good (source Montanez). |
June 7, 2007, Kachkar and Benkovitch executed an Amended and Restated Limited Guarantee (the “First Personal Guarantee”) (attached Exhibit 14) guaranteeing, with certain limits as detailed in the First Personal Guarantee, all obligations of the USA Borrowers and the EU Borrowers to Westernbank under both the USA and EU Loan Agreements (collectively, the “Loan Agreements”), up to $30.1 million. The First Personal Guarantee was given “in substitution” of earlier guarantees (source: RICO complaint). |
June 19, 2007 According to 8-K filed June 25, 2007, WB decides that the Inyx loan is impaired. |
June 20, 2007, Kachkar and Benkovitch executed an additional Limited Guarantee (the “Second Personal Guarantee”) (attached Exhibit 15) guaranteeing, with certain limits as detailed in the Second Personal Guarantee, all obligations of the USA and EU Borrowers to Westernbank under the Loan Agreements in an amount equal to the sum of $70 million plus the amount that the repayment obligations under the Loan Agreements exceeded $142.4 million. This Guarantee was “in addition to and not in substitution of” the First Personal Guarantee for $30.1 million, which remained “continuously in effect.” (source: RICO complaint). |
June 20, 2007, Kachkar and Benkovitch executed a Collateral Deficiency Letter (attached Exhibit 16), through which Kachkar and Benkovitch agreed to Case 3:07-cv-01606-ADC Document 3 Filed 08/23/2007 Page 12 of 54 13 provide certain collateral (the “Mining Collateral,” as defined in the Collateral Deficiency Letter) sufficient to cover the amount of the collateral deficiency under the Loan Agreements (source: RICO complaint). |
June 22, 2007 Montanez says "We became concerned on approximately June 22nd." because David Zinn reports missing $4.1M in receivables at Inyx USA and 28M sterling missing at Inyx Pharma and 51M sterling missing at Ashton. They contact Zinn who says they will never be collected. Zinn also says $14M in funds have been diverted from lock box (source: Montanez). |
June 25,2007 WB files the 8-K reporting the impairment. WHI stock falls. |
As of June 28, 2007, Westernbank had made loans to the USA and EU Borrowers in the amount of $142,778,299.77 under the Loan Agreements. As of that date, numerous Events of Default under the Loan Agreements had occurred (source: RICO complaint). |
June 28, 2007, administrators were appointed for Inyx Pharma and the EU Borrowers (source: RICO complaint). |
June 29, 2007, Westernbank sent a demand letter to the USA Borrowers (attached Exhibit 17). In that demand letter, Westernbank informed the USA Borrowers that (i) the amount of the outstanding loans exceeded the amounts available under the lending formulas and (ii) Westernbank was demanding, as entitled under the Loan Agreements and the Cross-Default Agreement, for the immediate payment of such excess amounts, totaling $87,282,422. The demand letter also informed the USA Borrowers that all other “Obligations” as defined under the Loan Agreements had become due and payable (source: RICO complaint). |
June 29, 2007, Westernbank sent a separate demand letter to Inyx Pharma and the EU Borrowers making the same demand as in the demand letter sent to the USA Borrowers but referring to the Obligations under the EU Loan Agreement that had become due and payable as a result of Event of Defaults under the EU Loan Agreement (attached Exhibit 18) (source: RICO complaint). |
July 2, 2007, Inyx USA, as well as another Inyx subsidiary named Exearis, Inc., filed voluntary petitions for relief under chapter 11 of title 11 of the United States Code in the United States Bankruptcy Court for the District of Delaware (source: RICO complaint). |
On or about July 3, 2007, Westernbank sent to Inyx, Inyx Pharma, Inyx EU and Ashton a “Notice of Default and Demand” (attached Exhibit 19). The Notice of Default and Demand stated that numerous defaults had occurred under the Loan Agreements (source: RICO complaint). |
On or about July 3, 2007, Westernbank also issued letters to the Inyx Operators demanding payment under the Fraud Guarantees (attached Exhibit 20). By these letters, Westernbank demanded payment from the Inyx Operators of at least $80 million (source: RICO complaint). |
On or about July 3, 2007 and on or about July 10, 2007, Westernbanki ssued letters to Kachkar and Benkovitch demanding payment under the Personal Guarantees and the furnishing of the Mining Collateral under the Collateral Deficiency Letter (attached Exhibits 21 and 22). Westernbank demanded from Kachkar and Benkovitch (a) payment in the amount of $30.1 million under the First Personal Guarantee, (b) payment in the amount of and $70,378,299.77 under the Second Personal Guarantee, (c) the furnishing of the Mining Collateral sufficient to cover the collateral deficiency under the Loan Agreements, and (d) compliance with and performance of their covenants under the Collateral Deficiency Letter (source: RICO complaint). |
July 26,2007 The Stipes Fights Back article published in Caribbean Business |
Sunday, October 7, 2007
A house is NOT an investment
People often get caught up in prevailing myths which provide a basis of belief which leads them to make poor financial decsisions. One of the biggest myths is the idea that buying a house is an investment. The way we talk about things often dictates the decisions we make. Investing money always seems more prudent than simply buying. Often it is said that buying a house is an investment. Is this true? That of course depends on what we mean by investment.
I think the best definition of investing is using ones savings to buy an asset which will provide real future returns in excess of the invested capital.
For example buying a factory with which you will produce marketable products is an investment. Even if you borrow most of the capital, you can pay the interest payments with the operating cash flows. If it is a good investment, you will have profits left over which you can put into savings. Over the long term, it is likely that you can pay off the mortgage and collect these cash profits. After say 30 years, you will have paid off the loan so that you own the factory, the cash flows that were produced as well as the future cash flows that will come in the future. If the real value of these things are greater than the real value of the invested capital, you have made a profitable investment.
I will use the term real value to mean inflation adjusted value. We can compare dollar amounts at different times by discounting them by the risk free return.
Other examples of investments are buying stock in a company, buying CDs from a bank, buying an apartment building which is producing cash flows in excess of the mortgage payment interest rates.
So, what about buying a house? Well, we all need a place to live. Our main choices are renting an apartment or buying a house (or condo). A similar decision to this is choosing what to eat. We all need food but we seldom talk about investing in our food. We consider it a necessary purchase not an investment. Buying a house should be considered the same.
It is possible to think of buying houses as investing. For example, if you buy a house for the purpose of renting it out, it can be an investment. If the rental payments are large enough to pay for the mortgage and also build equity in the house, this can be an investment. However this shows that it is only possible to make housing an investment if mortgage payments to rent are a low enough ratio. In fact this is the best way to value the price of houses. The price to rent ratio is similar to the price to earnings ratio for a stock.
During times of a speculative housing mania, the price of houses will be increasing. People buy houses with borrowed money and hope to make money simply from the increase in house price. If the house price is increasing faster than the interest rate of the borrowed funds then it may be the case that the rent is below the required mortgage payment but the appreciation of the house makes up for this negative cashflow.
However, this situation is unstable and cannot last for long. Eventually the house price will stop appreciating at these high rates and may even start deceasing. These people with negative cashflow will have to sell. This wave of selling will lead to higher inventories of houses for sale which will lower prices further. This kind of "investing" is better thought of as speculation. The profits depend on price appreciation and not positive cashflow. It is no different than speculating on the prices of gold, currencies or pork bellies.
Whether or not such housing speculators make money depends on when they got into the game. People who started early may come out with a profit. Those who started late will come out with a loss.
The housing industry is constantly promoting the idea that buying a house is an investment when this usually is not true. When you are buying a house to live in, this is simply a purchase to satisfy your housing needs. It is the main alternative to renting and often makes sense for people. If the payments on a traditional 30-year fixed mortgage are comparable to the payments that you would pay to rent the same house, then buying is probably a good idea. That is because you are paying a similar amount and are building equity in the house.
The housing prices in Los Angeles these days are so high that buying a house can only be thought of as irrational. Prices are way above any amount that is justifiable by rental cash flows. You will pay more on a interest only mortgage than you would pay to rent the same place. With an interest only mortgage, you are building no equity in the house. The no-money-down, interest-only-loan, which was so common these past few years can be thought of as renting money to speculate with infinite leverage on house prices. Most people would never borrow $20K and then buy pork belly futures but they actually undertaking something even riskier when they use these interest-only motgage products to buy a house. They are not actually buying a house- i.e they don't build equity-they are merely speculating on rates of appreciation. The only benefit over renting is that you get to profit from any appreciation of the house. However in a climate of falling home prices, this can only be a negative. Plus you need to pay all of the expenses associated with buying such as taxes, repairs and insurance. In such an environment prices have to go down since there is practically no financial incentive to buy at current prices. People who got in late may forclose and these forclosed homes will add to the inventory driving prices down further.
I think the best definition of investing is using ones savings to buy an asset which will provide real future returns in excess of the invested capital.
For example buying a factory with which you will produce marketable products is an investment. Even if you borrow most of the capital, you can pay the interest payments with the operating cash flows. If it is a good investment, you will have profits left over which you can put into savings. Over the long term, it is likely that you can pay off the mortgage and collect these cash profits. After say 30 years, you will have paid off the loan so that you own the factory, the cash flows that were produced as well as the future cash flows that will come in the future. If the real value of these things are greater than the real value of the invested capital, you have made a profitable investment.
I will use the term real value to mean inflation adjusted value. We can compare dollar amounts at different times by discounting them by the risk free return.
Other examples of investments are buying stock in a company, buying CDs from a bank, buying an apartment building which is producing cash flows in excess of the mortgage payment interest rates.
So, what about buying a house? Well, we all need a place to live. Our main choices are renting an apartment or buying a house (or condo). A similar decision to this is choosing what to eat. We all need food but we seldom talk about investing in our food. We consider it a necessary purchase not an investment. Buying a house should be considered the same.
It is possible to think of buying houses as investing. For example, if you buy a house for the purpose of renting it out, it can be an investment. If the rental payments are large enough to pay for the mortgage and also build equity in the house, this can be an investment. However this shows that it is only possible to make housing an investment if mortgage payments to rent are a low enough ratio. In fact this is the best way to value the price of houses. The price to rent ratio is similar to the price to earnings ratio for a stock.
During times of a speculative housing mania, the price of houses will be increasing. People buy houses with borrowed money and hope to make money simply from the increase in house price. If the house price is increasing faster than the interest rate of the borrowed funds then it may be the case that the rent is below the required mortgage payment but the appreciation of the house makes up for this negative cashflow.
However, this situation is unstable and cannot last for long. Eventually the house price will stop appreciating at these high rates and may even start deceasing. These people with negative cashflow will have to sell. This wave of selling will lead to higher inventories of houses for sale which will lower prices further. This kind of "investing" is better thought of as speculation. The profits depend on price appreciation and not positive cashflow. It is no different than speculating on the prices of gold, currencies or pork bellies.
Whether or not such housing speculators make money depends on when they got into the game. People who started early may come out with a profit. Those who started late will come out with a loss.
The housing industry is constantly promoting the idea that buying a house is an investment when this usually is not true. When you are buying a house to live in, this is simply a purchase to satisfy your housing needs. It is the main alternative to renting and often makes sense for people. If the payments on a traditional 30-year fixed mortgage are comparable to the payments that you would pay to rent the same house, then buying is probably a good idea. That is because you are paying a similar amount and are building equity in the house.
The housing prices in Los Angeles these days are so high that buying a house can only be thought of as irrational. Prices are way above any amount that is justifiable by rental cash flows. You will pay more on a interest only mortgage than you would pay to rent the same place. With an interest only mortgage, you are building no equity in the house. The no-money-down, interest-only-loan, which was so common these past few years can be thought of as renting money to speculate with infinite leverage on house prices. Most people would never borrow $20K and then buy pork belly futures but they actually undertaking something even riskier when they use these interest-only motgage products to buy a house. They are not actually buying a house- i.e they don't build equity-they are merely speculating on rates of appreciation. The only benefit over renting is that you get to profit from any appreciation of the house. However in a climate of falling home prices, this can only be a negative. Plus you need to pay all of the expenses associated with buying such as taxes, repairs and insurance. In such an environment prices have to go down since there is practically no financial incentive to buy at current prices. People who got in late may forclose and these forclosed homes will add to the inventory driving prices down further.
Sunday, September 16, 2007
Valuation of W Holding (WHI)
I have constructed a model for valuation of the W Holding company, a Puerto Rican bank (ticker: WHI). They are likely to suffer a one time loss over one or more bad loans this year. This model will assume that they have a fixed return-on-assets (ROA) over the immediate future. It assumes a fixed leverage, Assets/Equity. They have preferred shares and so pay a fixed dividend to preferred share holders. They also pay a common dividend. I will assume that this common dividend is a fixed percentage of net earnings (prior to preferred payments, common dividend and one time loss). I assume that common shareholders compound their dividends in a money market account. The following tables show the constants, the key variables, the expected yearly data and finally the results which include a valuation. We discount this to the present to get a Net Present Value which we can compare to today's stock price. All dollar amounts and share counts are in Millions.
Enjoy.
Enjoy.
| Name | Value | Description |
|---|---|---|
| NSHARES | 164.897 | Number of shares |
| ASSETS | 17894.0 | Beginning Assets |
| EQUITY | 1147.00 | Beginning Equity |
| PREF | 36.9120 | Annual preferred payments |
| LEVERAGE | 15.6000 | Leverage ratio, Assets/Equity |
| PREF_EQ | 530.800 | Preferred Equity |
| PRICE_NOW | 2.11000 | Today's Price per share |
| PE | 10.0000 | Price-to-earnings ratio for final valuation |
| PCB | 1.50000 | Price-to-common-book-value ratio for final valuation |
| DISC_RATE | 0.100000 | Discount rate to convert final value to present value |
| Name | Value | Description |
|---|---|---|
| ROA | 0.00800000 | Return on Assets |
| DIV_PAYR | 0.200000 | Dividend Payout Ratio, fraction of Net Income before one time loss and dividends |
| LOSS1 | 170.000 | One time after tax loss due to this years bad loans |
| BB_EQ | 50.0000 | Equity used to buy back stock in first year |
| PRICE_BB | 2.60000 | Average stock price for buy-back |
| Year | Earnings | E. Growth % | Dividend | Assets (end) | Equity | Com. Eq. /share | ROE | ROCE |
|---|---|---|---|---|---|---|---|---|
| 2007 | -26.8480 | -126.848 | 28.6304 | 15671.9 | 1004.61 | 3.25271 | -2.34071 | -4.35703 |
| 2008 | 125.375 | NA | 25.0751 | 16660.8 | 1068.00 | 3.68787 | 12.4800 | 26.4611 |
| 2009 | 133.286 | 6.30974 | 26.6572 | 17748.3 | 1137.71 | 4.16648 | 12.4800 | 24.8114 |
| 2010 | 141.987 | 6.52782 | 28.3974 | 18944.5 | 1214.39 | 4.69287 | 12.4800 | 23.3949 |
| 2011 | 151.556 | 6.73962 | 30.3112 | 20260.1 | 1298.73 | 5.27181 | 12.4800 | 22.1706 |
| 2012 | 162.081 | 6.94444 | 32.4162 | 21707.1 | 1391.48 | 5.90856 | 12.4800 | 21.1063 |
| Description | Value |
|---|---|
| Final number of shares | 145.666 |
| Ending common equity per share | 5.90856 |
| Total dividends received per share | 1.17726 |
| Total dividends compounded per share | 1.32790 |
| Price based on PE = 10.0000 | 11.1269 |
| Price based on PCB = 1.50000 | 8.86284 |
| Final Value/share = Av. Price + Total comp. dividend | 11.3228 |
| Net Present Value (discounted at rate = 10.0000%) | 7.03054 |
The key variable is ROA. I have assumed 0.8% in the example above which is quite conservative. The average ROA for W Holding since 1996 is 1.15%. The max was 1.147% (in 1997) and the min is 0.59% (in 2006). A more optimistic value for ROA would be 1% which would increase the Net Present Value to $9.5/share.
The main thing that I left out was share dilution from stock options which may be considerable. I would guess that there may be about 10 million shares created for management. This would lead to a dillution of 6%.
Saturday, July 7, 2007
W Holding and the Yield Curve
Here I will explain a bit about the yield curve and how it affects the profitability of banks with the focus on Puerto Rican banks and W Holding in particular.
The long term rates such as the 10 year or 30 year yields are determined by SUPPLY of savings and the DEMAND for long term loans. Essentially this is determined by the bond market and essentially is affected by everything that goes on in the world including the growth of the world economy, the savings rates, the inflationary expectations and world politics (i.e everything).
The curve defined by the yield of similar secutites (say US Treasuries) as a function of maturity is called the yield curve. Here is a webpage which will show you the shape of the yield curve at various points of time. You can check it daily as well as get some of the most insightful bond market commentary from PIMCO .
I won't go into the gory details of the yield curve and what it means in detail. It is quite a fascinating creature actually. It not only tells you about the present supply versus demand of loanable funds of various maturities but also tells you about the future expectation of changes in itself. In short, if you want to borrow (or lend) money for 10 years, you can do it in several different ways: one fixed 10-year loan or two 5-year loans or five 2-year loans. Global arbitrage will result in making the expected cost the same. This will presume the market assumption of what the 5-year yield will be in five years from now or what the 2-year will be at various points in the future. I like the quote from financial writer and former derivatives trader Frank Partnoy, "If you don't understand the forward yield curve, you're probably losing money to someone who does". Pardon the digression.
Generally banks borrow short term funds. For example they receive checking and savings deposits or issue CDs. They also borrow from each other at the Fed funds rate and if necessary can roll over these short term loans. Similar short term loans between banks are called repurchase agreements or repos. These are loans where the borrowing bank sends some collateral to the other bank such as bonds or some financial security. Funds from checking and savings accounts are the preferable way to borrow money since the interest expected on these is minimal. CD rates and in general the short term lending rates are largely determined by the Federal reserve. The Fed directly controls the overnight lending rate, the Fed funds rate, and all other short term instruments compete with this rate and so do not differ much from the Fed funds rate.
The difference between the long end (say 10-year yield) and the short end (the 3-month yield) is called the yield curve spread or simply the spread. This number is crucially important to the profitability of banks. This is because they typically borrow short and lend long. For example they issue CDs and take these funds and offer mortgages or business loans. When this spread is large, they can make a lot more money than when the spread is small. When the spread is negative, they are actually losing money by lending. This is one reason why the spread is typically positive. There is no incentive for banks to lend at rates that are lower than their borrowing costs. So they will refrain from doing so which will reduce the supply of loans and drive up the interest rate. Like all market rates, it is all determined by supply and demand. There is also the issue of risk spreads. Riskier loans require higher interest rates over the risk-free US treasuries. When these risk spreads are higher banks make more money. When they are tight (like now), banks have to take on risk without as much compensating profitability. These periods of low risk premiums do not usually last very long and frequently end in turmoil. As Greenspan put it, "...history has not dealt kindly with the aftermath of protracted periods of low risk premiums." Often they end in too many bad loans and not enough profit on the surviving loans to make up for it. In short, there is too much money and not enough good investments to make with it.
Let's get back to our bank in question, W Holding (ticker WHI), parent holding company to Westernbank of Puerto Rico. The defining feature of Puerto Rican banks is the lack of low cost deposits. Puerto Rico is quite poor. Although part of the US, they are as about as poor as Mississippi, the poorest US state. There is not a lot of money hanging around in checking and savings accounts. Instead these banks mostly rely on brokered deposits. In essense they have to buy their funds in the money market through CDs and repos and other similar short term instruments. Although this is usualy thought of as a dissadvantage, they have other advantages that can make up for it. The main one is the low tax rates. PR banks can register as an International Banking Entity (IBE). Because PR is not a state and doesn't have full representation, they are not taxed by the US government. Remember the whole "No taxation with representation" thing?. We take that pretty serious in the US (except for Washington DC). PR banks thus have lower tax rates and can offer slightly higher rate CDs and repos because they can earn slightly higher after tax returns by investing in US treasury securities.
These IBEs are typically divisions within the bank and when the yield curve spread is positive they become incredible cash machines with very little risk involved. The only risk is that the yield curve will flatten or invert, making them unprofitable or even loss producing. However these periods are usually not long lasting. If the flattening is due to rising treasury prices (falling yields) then they have made a capital gain on those bonds which make up for the fact that yields going forward are smaller. Rising Fed funds however are simply bad for IBEs and make this business difficult. Happily, these times do not last forever. The natural state for the yield curve is to have positive slope and so the natural state of IBEs is profitability.
There can be maturity mismatch. Much of this can be handled with derivative instruments such as interest rate swaps. Generally speaking, there are short term risks but over the long term they are great businesses. They can be run with very few employees and so are extremely efficient. WHI is one of the most efficient banks in the US.
This brings us to a rather simple point. The profitability of WHI is affected by the spread. The stock price is also affected by their profitability and so one would expect a correlation between the spread and the stock price. Lets look at a chart
The red is the yield curve spread with the scale on the left. The black is the stock price (scaled arbitrarily). One can see that there is a pretty good correlation. The stock price has a bit of a lag as investors don't seem to react until reported earinngs begin to decline. You don't want to be in WHI when the spread is huge (say 2004), profitability is large and investors think this will go on forever. However buying in the 2000 recession, before the fed cut, would have made you a four-bagger in three years. You want to be contrarian. You want to get in when things are bleak and the bank is simply skating by with low profit margins. The market is short term oriented. They won't wait for things to change. However a long term investor can simply buy in here and wait. Someday, things will change. The Fed will lower rates and the yield curve will steepen. The IBEs of Puerto Rican banks will become cash machines again and the banks will grow at growth rates of 20%+. The stock price will rise and continue to rise for years as the economy recovers until the Fed decides that it is time for a slowdown. You want to get out while the gettin' is good before a new crop of investors learn their lesson about the yield curve the hard way.
The long term rates such as the 10 year or 30 year yields are determined by SUPPLY of savings and the DEMAND for long term loans. Essentially this is determined by the bond market and essentially is affected by everything that goes on in the world including the growth of the world economy, the savings rates, the inflationary expectations and world politics (i.e everything).
The curve defined by the yield of similar secutites (say US Treasuries) as a function of maturity is called the yield curve. Here is a webpage which will show you the shape of the yield curve at various points of time. You can check it daily as well as get some of the most insightful bond market commentary from PIMCO .
I won't go into the gory details of the yield curve and what it means in detail. It is quite a fascinating creature actually. It not only tells you about the present supply versus demand of loanable funds of various maturities but also tells you about the future expectation of changes in itself. In short, if you want to borrow (or lend) money for 10 years, you can do it in several different ways: one fixed 10-year loan or two 5-year loans or five 2-year loans. Global arbitrage will result in making the expected cost the same. This will presume the market assumption of what the 5-year yield will be in five years from now or what the 2-year will be at various points in the future. I like the quote from financial writer and former derivatives trader Frank Partnoy, "If you don't understand the forward yield curve, you're probably losing money to someone who does". Pardon the digression.
Generally banks borrow short term funds. For example they receive checking and savings deposits or issue CDs. They also borrow from each other at the Fed funds rate and if necessary can roll over these short term loans. Similar short term loans between banks are called repurchase agreements or repos. These are loans where the borrowing bank sends some collateral to the other bank such as bonds or some financial security. Funds from checking and savings accounts are the preferable way to borrow money since the interest expected on these is minimal. CD rates and in general the short term lending rates are largely determined by the Federal reserve. The Fed directly controls the overnight lending rate, the Fed funds rate, and all other short term instruments compete with this rate and so do not differ much from the Fed funds rate.
The difference between the long end (say 10-year yield) and the short end (the 3-month yield) is called the yield curve spread or simply the spread. This number is crucially important to the profitability of banks. This is because they typically borrow short and lend long. For example they issue CDs and take these funds and offer mortgages or business loans. When this spread is large, they can make a lot more money than when the spread is small. When the spread is negative, they are actually losing money by lending. This is one reason why the spread is typically positive. There is no incentive for banks to lend at rates that are lower than their borrowing costs. So they will refrain from doing so which will reduce the supply of loans and drive up the interest rate. Like all market rates, it is all determined by supply and demand. There is also the issue of risk spreads. Riskier loans require higher interest rates over the risk-free US treasuries. When these risk spreads are higher banks make more money. When they are tight (like now), banks have to take on risk without as much compensating profitability. These periods of low risk premiums do not usually last very long and frequently end in turmoil. As Greenspan put it, "...history has not dealt kindly with the aftermath of protracted periods of low risk premiums." Often they end in too many bad loans and not enough profit on the surviving loans to make up for it. In short, there is too much money and not enough good investments to make with it.
Let's get back to our bank in question, W Holding (ticker WHI), parent holding company to Westernbank of Puerto Rico. The defining feature of Puerto Rican banks is the lack of low cost deposits. Puerto Rico is quite poor. Although part of the US, they are as about as poor as Mississippi, the poorest US state. There is not a lot of money hanging around in checking and savings accounts. Instead these banks mostly rely on brokered deposits. In essense they have to buy their funds in the money market through CDs and repos and other similar short term instruments. Although this is usualy thought of as a dissadvantage, they have other advantages that can make up for it. The main one is the low tax rates. PR banks can register as an International Banking Entity (IBE). Because PR is not a state and doesn't have full representation, they are not taxed by the US government. Remember the whole "No taxation with representation" thing?. We take that pretty serious in the US (except for Washington DC). PR banks thus have lower tax rates and can offer slightly higher rate CDs and repos because they can earn slightly higher after tax returns by investing in US treasury securities.
These IBEs are typically divisions within the bank and when the yield curve spread is positive they become incredible cash machines with very little risk involved. The only risk is that the yield curve will flatten or invert, making them unprofitable or even loss producing. However these periods are usually not long lasting. If the flattening is due to rising treasury prices (falling yields) then they have made a capital gain on those bonds which make up for the fact that yields going forward are smaller. Rising Fed funds however are simply bad for IBEs and make this business difficult. Happily, these times do not last forever. The natural state for the yield curve is to have positive slope and so the natural state of IBEs is profitability.
There can be maturity mismatch. Much of this can be handled with derivative instruments such as interest rate swaps. Generally speaking, there are short term risks but over the long term they are great businesses. They can be run with very few employees and so are extremely efficient. WHI is one of the most efficient banks in the US.
This brings us to a rather simple point. The profitability of WHI is affected by the spread. The stock price is also affected by their profitability and so one would expect a correlation between the spread and the stock price. Lets look at a chart
The red is the yield curve spread with the scale on the left. The black is the stock price (scaled arbitrarily). One can see that there is a pretty good correlation. The stock price has a bit of a lag as investors don't seem to react until reported earinngs begin to decline. You don't want to be in WHI when the spread is huge (say 2004), profitability is large and investors think this will go on forever. However buying in the 2000 recession, before the fed cut, would have made you a four-bagger in three years. You want to be contrarian. You want to get in when things are bleak and the bank is simply skating by with low profit margins. The market is short term oriented. They won't wait for things to change. However a long term investor can simply buy in here and wait. Someday, things will change. The Fed will lower rates and the yield curve will steepen. The IBEs of Puerto Rican banks will become cash machines again and the banks will grow at growth rates of 20%+. The stock price will rise and continue to rise for years as the economy recovers until the Fed decides that it is time for a slowdown. You want to get out while the gettin' is good before a new crop of investors learn their lesson about the yield curve the hard way.
Saturday, June 2, 2007
Where I get financial data
If I had lots of money I would pay Standard and Poor lots of money and I would get their Compustat database with some visualization software. However I don't so I have rolled my own. Here is a brain dump.
Where do you get financial data? Here is where I get mine.
1) Yahoo finance. http://finance.yahoo.com/
This is a pretty good site. I won't go into it in detail but you can find lots of financial data here as well as stock price charts and a message board (alas with too much spam). The problem with yahoo is that you can't get much for financial data from more than two year ago. It is good for short term info but not so good if your looking for 10 years worth of earnings data. You can also look up historical prices here. Other info you can find here are short ratios, EV/EBITA, Analyst estimates etc.
2) MSN Money
A good place for a 10-year history of profitability is MSN Money. For example, go here to get the 10 year profile for IBM.
The key things to note on here are the 10-year, net profit margins, return on equiy and assets.
http://moneycentral.msn.com/investor/invsub/results/compare.asp?Page=TenYearSummary&Symbol=IBM
When I want to look into a company that I know nothing about, I go here first. One glance at this table and I can see whether the company is profitable and stable or otherwise.
3) Morningstar
http://www.morningstar.com/
This is a great site for info about stocks. I pay $9/month or so for the premium membership. Here you can find loads of info about the companies. One of the best things are the analyst reports where you can learn a lot about the companies. They also gives recommendations for whatever that is worth as well as rate the management and tell you whether they believe the company has an economic moat (i.e. barrier to entry). Unlike bank analysts, they don't have conflicted interests. The other great thing is the stock screener. This is the best that I have seen. There are hundreds of parameters to screen on. You can even screene on things like their Morningstar management grade. You can also get 10-year financial data from the three financial statements. Highly recommended.
4) Scottrade
www.scottrade.com
This is the discount broker that I use. One of the things that I like about it is the access to Standard & Poor Stock Reports which are similar to Value Line reports. You can also buy these in book format from your bookstore . Obviously, I prefer the electronic PDF format. I can also save these to my laptop and use them as a database. They have 10 financial data and in a more useful format then most other places. Again, if I were more savy (or had more time), I would write some software to extract the data from the PSF files and store them in a more structured way. What I have been able to do is write a piece of code which prompts the user to highlight the table of 10-year financial data and cut and paste it into a file. Then it stores this into a simple text file and makes the following plot using Bed Bath and Beyond (BBBY) as an example.
I know that is a lot to take in at once but by looking at this, I get to see every financial aspect of a company in a single glance. Every box shows a 10 year history of some financial quantity. The top three (left to right) book value per share, earnings per share and cahsflow per share. In the sixth row you see the Returns on : assets, equity, invested capital, total capital, capital and tangible capital. I won't go into the details here about what the differences are. The three on the left of the bottom row are P/E, pretax earnings yield and free-cash flow yield. I can click on any box to see the growth rate calculations. I can also see the number of shares to see if the company has been buying back shares or diluting. This is extremely useful. I don't know of any other way to visualize this data without paying someone a lot of money to write some kind of software to do this. S&P also gives the stocks a rating 1-5 stars and over the past decade, this has proven to be market beating advice. Whether that will continue is anyone's guess.
5) National Association of Investment Clubs
http://www.better-investing.org
I decided to pony up $49/year to join this. I haven't explored here too much. I joined only to get a hold off their compustat database. You don't get the whole data base but you can search by ticker and get a complete financial history of a company. For example I can get the earnings for JNJ or GE all the way back to 1950. Pretty cool. I can save these html files with a simply keystroke. I wrote some software which then reads these html files. That way I can make a little database of companies that I haved looked up. If I were a bit more savy, I would be able to write a program which fetches this info without having to use a web browser. Maybe in the future. I also have written some code which makes plots of this data and calculates growth trends. For example this is one for JNJ.
This is very useful when you want to know the long term picture of the company. Unfortunately, this only gives you the long term picture of the PAST. The version which calculates the future earnings is still in development ;)
6) Insider trades.
You will want to keep track of insider trading (the legal kind). This is especially important with small obscure, out of favor or ignored companies.
http://www.secform4.com/top-lists.htm
7) SEC Edgar
Sometimes you need to get your hands dirty and read through anual reports like 10-K or the quarterly 10-Qs or other SEC filings. Go directly to the SEC page and search by ticker.
http://www.sec.gov/edgar/searchedgar/companysearch.html
8) Answers.com
Enough with financial data. There is more about companies than the numbers. I have mentioned two places already to get qualitative info. The morningstar and S&P analyst reports. But what if you want to read about the history of a company. You can find these at www.answers.com. They are written by Hoovers.com. I find these excellent places to read about the long term history of a company especially if they are not too well know. For example if the company is Bank of America, then there are many places to get info. For a company like this, you will find multiple books written on the company. However, for a less well know company like Graco (GGG) answers.com might be the best place to go. Wikipedia usally just has the same Hoover's histories.
9) Guru Focus
http://www.gurufocus.com/
This is a good site to find out where some of the world's best investors are putting their money. For example you might find out that Warren Buffet and Bill Miller both bought some stock which is now 20% lower than they paid. This may not lead you directly to riches but is still very useful info. If I am casually looking at a stock and I find out that a couple of these guys is buying it, then I might look into it in more detail. For example, seven of these value investing guru's have bough UPS. About 10 have bought Wal-Mart.
Where do you get financial data? Here is where I get mine.
1) Yahoo finance. http://finance.yahoo.com/
This is a pretty good site. I won't go into it in detail but you can find lots of financial data here as well as stock price charts and a message board (alas with too much spam). The problem with yahoo is that you can't get much for financial data from more than two year ago. It is good for short term info but not so good if your looking for 10 years worth of earnings data. You can also look up historical prices here. Other info you can find here are short ratios, EV/EBITA, Analyst estimates etc.
2) MSN Money
A good place for a 10-year history of profitability is MSN Money. For example, go here to get the 10 year profile for IBM.
The key things to note on here are the 10-year, net profit margins, return on equiy and assets.
http://moneycentral.msn.com/investor/invsub/results/compare.asp?Page=TenYearSummary&Symbol=IBM
When I want to look into a company that I know nothing about, I go here first. One glance at this table and I can see whether the company is profitable and stable or otherwise.
3) Morningstar
http://www.morningstar.com/
This is a great site for info about stocks. I pay $9/month or so for the premium membership. Here you can find loads of info about the companies. One of the best things are the analyst reports where you can learn a lot about the companies. They also gives recommendations for whatever that is worth as well as rate the management and tell you whether they believe the company has an economic moat (i.e. barrier to entry). Unlike bank analysts, they don't have conflicted interests. The other great thing is the stock screener. This is the best that I have seen. There are hundreds of parameters to screen on. You can even screene on things like their Morningstar management grade. You can also get 10-year financial data from the three financial statements. Highly recommended.
4) Scottrade
www.scottrade.com
This is the discount broker that I use. One of the things that I like about it is the access to Standard & Poor Stock Reports which are similar to Value Line reports. You can also buy these in book format from your bookstore . Obviously, I prefer the electronic PDF format. I can also save these to my laptop and use them as a database. They have 10 financial data and in a more useful format then most other places. Again, if I were more savy (or had more time), I would write some software to extract the data from the PSF files and store them in a more structured way. What I have been able to do is write a piece of code which prompts the user to highlight the table of 10-year financial data and cut and paste it into a file. Then it stores this into a simple text file and makes the following plot using Bed Bath and Beyond (BBBY) as an example.
I know that is a lot to take in at once but by looking at this, I get to see every financial aspect of a company in a single glance. Every box shows a 10 year history of some financial quantity. The top three (left to right) book value per share, earnings per share and cahsflow per share. In the sixth row you see the Returns on : assets, equity, invested capital, total capital, capital and tangible capital. I won't go into the details here about what the differences are. The three on the left of the bottom row are P/E, pretax earnings yield and free-cash flow yield. I can click on any box to see the growth rate calculations. I can also see the number of shares to see if the company has been buying back shares or diluting. This is extremely useful. I don't know of any other way to visualize this data without paying someone a lot of money to write some kind of software to do this. S&P also gives the stocks a rating 1-5 stars and over the past decade, this has proven to be market beating advice. Whether that will continue is anyone's guess.
5) National Association of Investment Clubs
http://www.better-investing.org
I decided to pony up $49/year to join this. I haven't explored here too much. I joined only to get a hold off their compustat database. You don't get the whole data base but you can search by ticker and get a complete financial history of a company. For example I can get the earnings for JNJ or GE all the way back to 1950. Pretty cool. I can save these html files with a simply keystroke. I wrote some software which then reads these html files. That way I can make a little database of companies that I haved looked up. If I were a bit more savy, I would be able to write a program which fetches this info without having to use a web browser. Maybe in the future. I also have written some code which makes plots of this data and calculates growth trends. For example this is one for JNJ.
This is very useful when you want to know the long term picture of the company. Unfortunately, this only gives you the long term picture of the PAST. The version which calculates the future earnings is still in development ;)
6) Insider trades.
You will want to keep track of insider trading (the legal kind). This is especially important with small obscure, out of favor or ignored companies.
http://www.secform4.com/top-lists.htm
7) SEC Edgar
Sometimes you need to get your hands dirty and read through anual reports like 10-K or the quarterly 10-Qs or other SEC filings. Go directly to the SEC page and search by ticker.
http://www.sec.gov/edgar/searchedgar/companysearch.html
8) Answers.com
Enough with financial data. There is more about companies than the numbers. I have mentioned two places already to get qualitative info. The morningstar and S&P analyst reports. But what if you want to read about the history of a company. You can find these at www.answers.com. They are written by Hoovers.com. I find these excellent places to read about the long term history of a company especially if they are not too well know. For example if the company is Bank of America, then there are many places to get info. For a company like this, you will find multiple books written on the company. However, for a less well know company like Graco (GGG) answers.com might be the best place to go. Wikipedia usally just has the same Hoover's histories.
9) Guru Focus
http://www.gurufocus.com/
This is a good site to find out where some of the world's best investors are putting their money. For example you might find out that Warren Buffet and Bill Miller both bought some stock which is now 20% lower than they paid. This may not lead you directly to riches but is still very useful info. If I am casually looking at a stock and I find out that a couple of these guys is buying it, then I might look into it in more detail. For example, seven of these value investing guru's have bough UPS. About 10 have bought Wal-Mart.
Wednesday, May 30, 2007
Valuation of RGFC.PK
The valuation of R&G Financial (RGFC.PK) which just sold its Florida Bank to Fifth-Third bancorp. I estimate it is selling at half its value and will probably double if/when it return to the NYSE from the pinksheets.
----------------
Shares
------------------------------------
21,559,584 Class A
29,561,190 Class B
-----------------------
51,120,774 Common shares
Liquidation value of Preferred stock
Series A 50,000,000
Series B 25,000,000
Series C 69,000,000
Series D 69,000,000
------------------------
total 213,000,000
------------------------------------
Equity (based on Bank Holding Company data, after restatement)
http://www.chicagofed.org/economic_research_and_data/bhc_data_2001_2006.cfm
-----------------------------------
544,945,000 As stated on BHC form
- 213,000,000 Preferred
---------------------
331,945,000 Equity for Common shares
- 118,569,000 Non-tangible servicing asset (though not worthless)
---------------------
213,376,000 Tangible Book Value
6.49335 Book value per share
4.17396 Tangible book value per share
3.02 Cohen (former analyst) estimate of Tangible book value per share
211,685,000 Other assets, probably mostly derivatives included in book value
Interest rate derivatives, probably OK
723,721,000 Listed on BHC as intangible and other assets
255,816,000 Listed on BHC as other liabilities
--------------------------
467,905,000 Diff between these two
------------------Changes with sale of Crown bank--------
Price payed
288,000,000 For crown bank
50,000,000 Paying off preferred shares
16,000,000 Real estate
-----------------------------
354,000,000 total payed
226,000,000 tangible assets of Crown bank
--------------------------
128,000,000 Gain in tangible assets for RGF common stock holders
213,376,000 Old Tangible Book Value
+128,000,000 Gain in tangible BV
---------------------------
341,376,000 New tangible BV
6.67783 New Tangible BV per share
----------------------------------
If Cohen's number is right
285,451,984 New tangible BV
5.58387 New tangible BV per share
----------------------------------
3.90 Price per share on May 30
69.84% Fraction of tangible BV
-------------------------------------
-------------Valuation----------------
Even a poor bank is worth about 1.5x tangible book value per share
Using TBV=5.58387
This is
Value = 8.3758
which is over twice the current price
Other scenarios:
The deal falls through. It needs to sell out like Doral to obtain cash. Value = 1.5 /share. Probability 10%
The deal goes through but tangible equity declines by $50M. Value = 6.0/share Probability 10%
The deal falls through and they fail. Value =0 Probability 5%
--------------------------------
Value = 0.75*8.4 + 0.1*1.5+ 0.1*6 = $7.05/share
I will take as my value 7.0/share which makes it a buy at 3.90 however with the risk involved I can only put a small amout of my money into it.
############## UPDATE #####################
RGF announces that the think the restatement will be about $240 million after taxes. They had figured $185-$200M previously. On their BHC form they listed -$264,637,000 as accounting restatement which is probably pretax.
So I think we subtract about $50M which gives us about 230-280 of tangible book or $4.5-$5.5/share. It is selling at
$3.95/share today. Still pretty cheap but worth the risk? Investors did seem to like Doral once it got an infusion. Maybe RGFC.PK is worth a few bucks. I think the chance of doubling is still very good and chance of failure small.
Also the $16M is not for RGF sharholders
8-K about FHA license being taken away. Hopefully temporary.
Price on July 23, $2.60/share WOW!!!
##################### Update ###########################
12/2007 Holding company report out
Common book value down to $125MM. There is $523MM in either 30 days late or non-accrual. They have recently said that they are probably not going to pay any more preferred dividends. They are now deteriorating quickly. It could be the end for RGF. They will likely need to sell the bank in order to avoid being seized by regulators. Yikes.
----------------
Shares
------------------------------------
21,559,584 Class A
29,561,190 Class B
-----------------------
51,120,774 Common shares
Liquidation value of Preferred stock
Series A 50,000,000
Series B 25,000,000
Series C 69,000,000
Series D 69,000,000
------------------------
total 213,000,000
------------------------------------
Equity (based on Bank Holding Company data, after restatement)
http://www.chicagofed.org/economic_research_and_data/bhc_data_2001_2006.cfm
-----------------------------------
544,945,000 As stated on BHC form
- 213,000,000 Preferred
---------------------
331,945,000 Equity for Common shares
- 118,569,000 Non-tangible servicing asset (though not worthless)
---------------------
213,376,000 Tangible Book Value
6.49335 Book value per share
4.17396 Tangible book value per share
3.02 Cohen (former analyst) estimate of Tangible book value per share
211,685,000 Other assets, probably mostly derivatives included in book value
Interest rate derivatives, probably OK
723,721,000 Listed on BHC as intangible and other assets
255,816,000 Listed on BHC as other liabilities
--------------------------
467,905,000 Diff between these two
------------------Changes with sale of Crown bank--------
Price payed
288,000,000 For crown bank
50,000,000 Paying off preferred shares
16,000,000 Real estate
-----------------------------
354,000,000 total payed
226,000,000 tangible assets of Crown bank
--------------------------
128,000,000 Gain in tangible assets for RGF common stock holders
213,376,000 Old Tangible Book Value
+128,000,000 Gain in tangible BV
---------------------------
341,376,000 New tangible BV
6.67783 New Tangible BV per share
----------------------------------
If Cohen's number is right
285,451,984 New tangible BV
5.58387 New tangible BV per share
----------------------------------
3.90 Price per share on May 30
69.84% Fraction of tangible BV
-------------------------------------
-------------Valuation----------------
Even a poor bank is worth about 1.5x tangible book value per share
Using TBV=5.58387
This is
Value = 8.3758
which is over twice the current price
Other scenarios:
The deal falls through. It needs to sell out like Doral to obtain cash. Value = 1.5 /share. Probability 10%
The deal goes through but tangible equity declines by $50M. Value = 6.0/share Probability 10%
The deal falls through and they fail. Value =0 Probability 5%
--------------------------------
Value = 0.75*8.4 + 0.1*1.5+ 0.1*6 = $7.05/share
I will take as my value 7.0/share which makes it a buy at 3.90 however with the risk involved I can only put a small amout of my money into it.
############## UPDATE #####################
RGF announces that the think the restatement will be about $240 million after taxes. They had figured $185-$200M previously. On their BHC form they listed -$264,637,000 as accounting restatement which is probably pretax.
So I think we subtract about $50M which gives us about 230-280 of tangible book or $4.5-$5.5/share. It is selling at
$3.95/share today. Still pretty cheap but worth the risk? Investors did seem to like Doral once it got an infusion. Maybe RGFC.PK is worth a few bucks. I think the chance of doubling is still very good and chance of failure small.
Also the $16M is not for RGF sharholders
8-K about FHA license being taken away. Hopefully temporary.
Price on July 23, $2.60/share WOW!!!
##################### Update ###########################
12/2007 Holding company report out
Common book value down to $125MM. There is $523MM in either 30 days late or non-accrual. They have recently said that they are probably not going to pay any more preferred dividends. They are now deteriorating quickly. It could be the end for RGF. They will likely need to sell the bank in order to avoid being seized by regulators. Yikes.
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