Is Marcus the new Soros?

On 27th September 2018, Goldman Sachs (Goldmans) launched its first foray into retail banking outside the USA with the establishment in the UK of its online savings account called Marcus. Offering an interest rate of 1.5% on sterling deposits, the account went straight to the top of the various, best easy access savings account tables.

Of course, older heads may remember the Icelandic and Indian banks offering market beating rates prior to the GFC, but this is Goldmans so it’s different this time!

Goldmans is no doubt pleased to be seen as the champion of the small saver in the UK. Savers in the UK have seen the base rate move from 0.25% in October 2017 to 0.75% in August 2018 but few if any institutions have passed on the 50bps uplift to their depositors. Indeed, the government’s National Savings arm has been lowering interest rates on its products, most notably removing the RPI linkage for its index-linked products from May 2019.

So the disruption to the traditional mainstream banking and building society structure has been welcomed by savers. In fact, so aggressive is the Goldmans offering that even the challenger banks cannot match the rate it now offers. Furthermore, the rate offered seems to be uncorrelated to the group’s credit rating.

 

The question no one seems to be asking is, “What is Marcus doing with the deposits”? Ford Money is raising funds but we know that within Ford there is a large vehicle financing operation. Similarly Tesco and West Bromwich have retail activities on the other side of the balance sheet.

In respect of Goldmans, there is no corresponding advertising of loan products, so what assets are Goldmans buying? Goldmans could simply be lending in the sterling interbank market but my feeling is that it is selling sterling and buying dollars, a nice carry trade as the USA has somewhat higher short-term interest rates as liquidity tightens as a result of the Fed shrinking its balance sheet.  

Goldmans alumni feature among noted EU “remainers” in the UK. Mark Carney, the Governor of the Bank of England is also a Goldmans alumnus. Brexiteers have feared that a financial crisis could be engineered to frustrate a Brexit on 29^th March 2019. They could be right. Some fear that the remainer Chancellor, Philip Hammond, would welcome such a crisis, if not actively engineer it.

George Soros famously shorted the pound in 1992 in anticipation of the UK leaving the ERM pegging mechanism. When it occurred in September that year, the BoE responded with higher interest rates to protect sterling. Perhaps Marcus is in the vanguard this time.

Notably, Goldmans didn’t launch Marcus until after Carney had agreed to stay on beyond 5^th June 2019 in order to steady the UK through the post-Brexit era. This decision mitigated Goldman’s risk with Marcus. Firstly, Carney is an arch rate dove and has not even considered normalizing UK interest rates even 10 years after the GFC. This means that a rise in interest rates after Brexit is unlikely, thus putting sterling at risk of declining further and enhancing any short sterling position. Secondly, Goldmans should be able to read the nuances better than most in the guidance given by their alumni. Therefore, they should be ahead of the game were the BoE to make any “surprise” moves. Of course, if, in the case of Marcus, it successfully corners the UK’s retail deposit market, then the BoE and the Government will be taking guidance from Goldmans!  

Apparently, the name Marcus was selected as it is the name of one of the bank’s original founders. Knowing how smug, investment bankers like to dream up codenames for the various deals they construct with an intellectual allusion, I suggest that Marcus is a reference to a character in Shakespeare’s Titus Andronicus.

 
At the end of the total carney (sorry carnage) in Titus Andronicus, Marcus is one of two adult survivors and thus in a position to install his brother as Emperor of Rome (the then EU). The twist in this case, which Shakespeare would have liked, is that dumb Brexiteers are probably putting the most shekels into Marcus and thus reducing the likelihood of the clean, "no deal" Brexit they so desire.

Will they TWiG?

Christine Tan’s Managing Asia series on CNBC is always interesting as it attempts to display Asia’s business at its best. The item shown on Sunday February 23rd, an interview with Taha Bouqdib (TB), the Co-Founder and President of TWG Tea, was more fawning than usual.

TWG Tea was founded by TB and Manoj Murjani, when TB came to Singapore in 2007. The tea business opened in 2008. So how has it been so successful in such a short time? Perhaps it’s all in the name.

Singaporeans love three letter acronyms or abbreviations be it HDB, PAP, CTE, AMK etc. There’s a world famous tea brand named after a Mr Twining. What if we take the three key consonants from that name, and start with the “T” and end with the “G”. Not to be confused with Twinings, of course, but let’s call it TWG.

Singaporeans are also suckers for brands - although they still have trouble distinguishing between fake and genuine Rolex watches or between real and rip-off Louis Vuitton handbags. So hopefully they will confuse TWG with Twinings.

To be a brand in Singapore, all you need is more than one outlet. So simply rent two or three shops from the start and in Singaporeans’ eyes, you are now a brand.

Trusted brands tend to have a long track record. Twinings was founded in London in 1706, over 300 years ago. How does TWG compete with that? Simple, just invent some heritage.

The oldest TWG can be is 1819, when Sir Stamford Raffles founded Singapore. OK, so let’s add a few years to that. How about printing 1837 on all our packaging and signage so that customers think we are steeped in tradition, dating back over 170 years?

Of course, Ms Tan didn’t actually address the choice of name or the implied provenance of the company in the interview. In fact, her best question to TB was, “How do you protect your brands from copycats in China?”.

I think she would have done better asking Twinings that.

Time for Zeti

One name that should perhaps be in the frame for the top IMF role is Dr Zeti Akhtar Aziz. She took over as the head of Bank Negara Malaysia in 2000, unusual given her gender. However, the appointment was a promotion, and recognised her skill at handling Malaysia's situation during and after the Asian financial crisis.
Whether or not she agreed with Dr Mahatir's metaphorical two fingers to the IMF rescue plan, I don't know, but the subsequent recovery of Malaysia economy is testament to a well-implemented policy.
Having trundled along in 2005/6 at around 2.50/$, the Ringgit declined in 1997 to 3.80/$ as its ASEAN neighbours felt the heat in H2 1997. In the first half of 1998the Ringgit moved lower to 4.40/$.
The capital controls introduced in September 1998 certainly shocked the market, as Dr M countered the Ringitt speculators. The Ringgit was pegged at 3.80/$, a stronger level than was perhaps expected. However, pegging the Ringgit ensured stability and meant that genuine investors had a base point for their future plans.
Coming off the peg was harder to judge. Hot money came into Malaysia in 2004 in anticipation of a de-pegging and a strengthening of the currency. Malaysia knows that it is part of the greater China region with respect to its trade and competitive position. China was under pressure from the USA to float its currency. When the Yuan FX rate was relaxed in July 2005, Malaysia quickly and quietly depegged the Ringgit while all the markets were focused on the Yuan. A lucky but nevitable break for Malaysia
Bank Negara adopted a managed float after depegging. Today, with the MYR at 3/$ compared with the peg of 3.8, the currency has clawed back much of Asian crisis losses.
Banks in Malaysia have had tricky times in the early 1990s and even Bank Negara struggled after some specualtive trades around that time. But since the crisis of 1997, BNM and Dr Zeti, in particular, have been performed well.
Apart from cocking a snook at the IMF and its one-size-fits-all policy, Dr Zeti has a good understanding of how Islamic finance can run alongside traditional banking.
At 64 years old she is a couple of years older the Strauss Kahn; furthermore, earlier this year,she was reconfirmed in her current job for the next 5 years so it might be that time is not on her side. Someone once told me that she was a gooner - not sure if that's true, but it is a slight blot on her otherwise impeccable credentials to be the new head of the IMF.

Nationwide clerical bungles, service gaps and waste

What’s up with the Nationwide? The back office is falling apart it seems. David Rigney and his operations managers, needs to start managing.

Two weeks ago I had a closure statement for a Capitalbond 92 account that I hadn’t even opened. Fortunately, there was no interest shown, but I would love to know where the phantom principal is.

Last week a family member received back her tear off slip in a window envelope, acknowledging that her bond maturity instructions had been received. Unfortunately, stuck behind her slip was a similar slip addressed to a Mr Alexander in Kilmarnock. The stray slip was handed in, same day at the local branch for forwarding to the rightful recipient. Staff at the branch at least took responsibility for sending it on, once I made it clear that it was nothing to do with me. So Sir, it should be with you soon!

And on Saturday, I eagerly opened a plain front envelope expecting a cheque for about 30p from Nationwide – more on this later. But the cheque was only for 2p and payable to a Mistry person. I will pass the wrong cheque to the local branch later today, so I hope the person who has my cheque will do likewise! Mistry will be 2p better off; but how much is First Class mail, even assuming Nationwide gets a bulk discount?

One of Nationwide’s problems is the internet offering. I can do transactions on the internet at home but can't send messages to Nationwide from home, without being timed out on the server. I therefore have to complain over the phone or via the terminal in the local branch.

As for the reason for the 30p cheque. There is a problem affecting people who have access to internet banking but who have not signed up for a FlexAccount. When an e-bond matures, it is automatically transferred into an e-bond maturity account if the final balance, is not reinvested on the bond maturity date. If a few days elapse before the reinvestment decision is made, the internet only gives the option to transfer the maturity date balance into a new account. The few days of accrued interest in the e-bond maturity account becomes orphaned. The actual amount of such interest is not however, displayed.

Nationwide advised me to use the close account option for the e-bond maturity account and the “hidden” interest would appear. Simple, you might think, but the balance from closing an e-bond maturity account can only be sent to a FlexAccount and not to an Instant Saver account, which is deemed to be a branch account. Therefore, on closing the e-bond maurity account, I was internet messaged to inform me that a cheque for the interest was being sent to me.

Why is Nationwide struggling? Are there too many ISA’s being opened now? Has the unemployment rate in Swindon suddenly fallen and they can’t get the staff? (I’ve been out of work for over a year now – I’d be happy to stuff envelopes)

Repo 105 vs FSA soft touch regulation 101

Two things strike me about the Lehman Brothers accounting for the over-collateralised repos. What did the counterparties do in respect of their own accounting treatments of the repos and what anti-money laundering investigations were made?

If Lehman's booked a sale, how did the counterparties such as Barcap, UBS etc, account for the repos? Were they purchasing the assets on an outright basis or did they regard these as normal repo transactions?

Unfortunately we'll never know. Lehman's year end was November while European banks have December, and Japanese banks March year ends, respectively. Thus banks can readily teem and lade assets and liabilities in order to help each other present the best balance sheet possible at the year end.

Perhaps as part of the global reform of the banking system, all banks should have the same financial year end.

The money laundering angle is simply the case that if I, as a customer of a bank, were happy to accept $100 for liquid assets clearly worth $105, such a suspicious contract should lead to the bank investigating me for potential money laundering.

But then the FSA withdrew its rule book on money laundering in early 2006, relying on banks to use their own code of practice for "know your customer" procedures based on a risk-based approach.

A typical in-house code would require a bank to investigate customers entering loss-making transactions where the loss is avoidable or transactions which have no apparent economic purpose. Also any suspicion of illegal activity or attempts to hide money from law enforcement and tax authorities should be followed up.

What the risk in the risk-based approach has come to mean, is the risk that the activity is found out or that the FSA will admonish the financial institution. The FSA's light touch has been a soft touch as far as the banks are concerned.

AA - desperation from the owners

Having failed to float the company on the stock market, Acromas the private equity joint venture (funded by debt of course) has decided to rake in the cash to help solve its GBP6bn debt problem.

As the very wise, Ian Griffiths pointed out, in a recent Guardian report, Acromas had negative net assets and pre-tax losses of GBP300m in FYE January 2009, but the auditors still signed it off as a going concern. The investment bankers behind the flotation presumably took a dimmer view of the situation or had seen preliminary figures for FYE January 2010.

As for raking in cash, I don't mean that the owners of Saga and the AA are widening the services on offer, such as the AA's home repair and maintenance offering currently mooted, or Saga's attempts to woo the over-50 semi-silvers, or the insurance arm is fighting hard to gain market share, I mean that the AA is top of the moneysupermarket.com best buy savings accounts for internet only banking and the five year fixed rate bonds.

The Icelandic banks also shot to the top of the savings charts before going down, as they tried to suck in as much money as they could before the inevitable crash. So why has the AA has gone for the top spot just after its latest financial year end?

Admittedly deposits in the AA accounts are protected under the FSCS arrangement as the AA uses the Bank of Scotland as its cover. But then if you already have savings in BoS, Halifax or Birmingham Midshires, your GBP50k protection limit under one deposit taker might be quickly reached.

The Lloyds Banking Group (as the owner of BoS) must be quite happy for the AA to steal the show. Lloyds, given its market share and credit rating, does not need to raise money at these unusually high rates. While banks as a whole are still too heavily supported by purchased funds, Lloyds can easily address its need for deposits over time. One is left wondering if Lloyds is a major creditor of Acromas by any chance?

The AA must be hoping that the full-silver haired, retired Saga punters will put their money into the AA account, (they've been reining in their spending horns due to the low returns on their savings until now) and that Acromas survives. Perhaps the old folk now know that if a deposit rate is too good to be true then someone else will pick up the pieces.

As for the home maintenance plan, Centrica, the last real money owners of the AA, didn't seem to think that was synergy between car roadside rescue and British Gas bolier repairs. Perhaps they saw that cars were getting more reliable; we've certainly seen the number of AA patrolmen reduced since 2004.

Finally, as the urbane Mr Peston notes in his recent blog, the remaining 5,000 AA men are seeing their pension benefits come under pressure as the Acromas management target savings. We taxpayers and pension fund members should worry about the GBP190m deficit in the AA pension fund as we know who will pick up the tab for that when the Acromas cambelt breaks.

QE and inflation denial

What's Mr Bootle taking? As a leading proponent of Quantitative Easing and one of the world's inflation deniers, his piece in yesterday's Daily Telegraph came as a shock. It seems that he feels that there is a risk of inflation in 2011 after all!

Better late than never, this shift of stance, but I would suggest that we are already past the "minor uptick" he refers to; RPI has run at an annualised rate of 3.7% since January. I don't expect today's figure to halt this trend.

A key plank of Mr Bootle's argument for persistent deflation, is that of "spare capacity" in the economy. Unfortunately, there are few idle machines because in a service-based economy, there were few active machines prior to the downturn.

The argument thus hinges on labour availability. I would suggest that employers have little demand for workers at the minimum wage of #5.80/hour and the associated red-tape headaches of employment, equal opportunity and anti-discrimination etc. legislation - (it's a miracle that anyone is employed). In fact they would rather employ immigrant "gang" or other cheap manual labour to staff the leisure and food production sectors or outsource the job overseas, if it is an indirect service.

The same service industry skew means that sterling weakness does not boost exports to any great extent compared with past crises. It may serve to increase tourism levels in the UK, if the elevated oil price doesn't deter potential visitors, but for all the imported food, goods and energy, sterling's weakness is inflationary.

Back to the spare capacity argument, what about the supply of labour at #5.80/hour? It is perhaps not that great after all. Many of the unemployed would seem to be better off on benefits at a higher equivalent hourly rate. Furthermore, despite the internet, the plethora of databases and employment agencies, the ability to match buyers and sellers of labour has not noticeably improved. Systemic unemployment may well be higher than many think.

On the other side of the inflation equation, I haven't seen anything to threaten the pricing power of retailers, energy suppliers or tax gatherers.

QE at #200bn will be about 10% of money supply as measured by M4. Unfortunately, M4 still hasn't grown to reflect the QE already smouldering away. It has been totally useless because unlike national stimulus schemes that have targeted the borrower, such as in Singapore and Australia, throwing money at the banking system will never work if their potential customers remain too scared to borrow.

So more QE and more loose money until after the election next May. But what if inflation takes hold and the world tires of sterling before then, will we get a rise in interest rates to defend sterling? What about the capital loss on the government's holdings of debt which will be dramatic given the long duration of their holdings?

So will it be an IMF rescue or a surge in UK interest rates? Probably both.

UK Financial mis-selling at its worst

I am one of 20 or so people who made written representations to the FSA after the members of the Britannia Building Society had voted to approve the merger of the society with The Co-operative Bank Ltd.

Setting aside that the transaction is strategically wrong – why does the UK’s #2 building society by assets need help when it complies with the FSA’s capital requirements? – the transaction was mis-sold.

The bulk of documentation and all the publicity surrounding the “merger”, referred to a merger between the society and Co-operative Financial Services Ltd. This is incorrect and misleading. The CFS is the owner of the eponymous bank, but as anyone in business knows, a holding company is a separate legal entity from a subsidiary. The transaction was described as a merger with the holding company; the vote was for a merger with its subsidiary.

Merger implies that the parties merging are broadly equal and that shareholders in each party will end up with an ownership interest in the merged entity. This is not the case here as Britannia members will have no interest in the enlarged bank. Society members are being offered membership of the Co-op Group but this is the holding entity for CFS. Returns to society members will therefore be diversified and diluted not only by the Insurance business of CFS but also by the returns from Somerfield/Co-op supermarkets, housing development, undertakers and pharmacies, to name but a few.

The accounting for the transaction is a straightforward transfer of the net assets from the Society to the Co-op bank. At the end of December 2008, the net book value of the Society was GBP881 million – and this, in effect, is simply being given to the Co-op Bank’s shareholders. I am not expecting a windfall payment but for the Society’s board to imply that giving away the Society at a cost of over GBP200/member (assuming 4 million members) was the best deal they could get, is suspiciously mendacious.

Of course the representations to the FSA will be considered – but ignored. The documentation for the deal was passed to FSA for its prior approval. But just in case someone there has forgotten the definition of mis-selling, I attach the link to the FSA’s website.
http://www.fsa.gov.uk/Pages/Library/Communication/PR/2003/052.shtml

Should it still be signed off by the FSA, it will no doubt be discussed at a higher place. The Treasury Select Committee will bare its teeth and get to the bottom of the matter and then, led by its Chairman, John McFall MP, decide that apart from a couple of slapped wrists, it is all hunky-dory.

Did I mention the Co-op Party? Society members after years of no political donations will now find that the new owners of their assets are funding the Labour party. The Co-op Party has 29 MPs who stand as Labour Co-op members.

Labour Co-op is abbreviated to Labour even on official documentation. How do I know? The published list of members of the Treasury Select Committee describes the following:- Rt Hon John McFall MP (Chairman), West Dunbartonshire, Labour.

Society members are being undertaken to the cleaners.

British Airways gliding to oblivion

I came away from yesterday's BA AGM feeling that this company is headed the way of the old US carriers. Its cost base is simply too high. It is the airline equivalent of GM; its pension liabilities (but a relatively modest healthcare liability) prevents it from competing effectively with its Asian counterparts or domestic greenfield operations. And this focus on the pension deficit and wage cost is almost to the exclusion of everything else, including ways that revenues might be increased.

BA provides nothing in the way of segmental financial information other than revenues by regional source. At least the monthly operating statistics split the world into four geographic area. No further disclosure is provided in case it is of potential help to competitors. So when asked at the AGM about the relative profitablility of its european and international operations, there was some obfuscation. There was no clear answer according to management, due to the high level of transfer traffic, up to 60%, filling the long-haul flights.

However, when the relative profitablility of Calcutta and Hyderabad services was discussed or the reasons for reducing flights to Poland, the Board claimed to have the numbers to know that they were doing the right thing.

If the transfer traffic muddies the revenue picture then BA's costs are equally shrouded in cloud as the variable element of total is relatively small compared with other airlines. Allocating fixed costs to particular routes or services becomes an art.

One shareholder suggested that BA should price closer to its marginal costs in order to fill its aircraft and at least get some contribution towards its massive fixed costs. Perhaps the problem here is that Ryanair and Easyjet are already pricing at these levels and making a profit. BA cannot compete with the low-cost carriers.

BA cannot sensibly compete with other premium operators. On page 21 of the latest annual report and accounts, there is a picture of an Airbus A380 in BA livery. The report notes that three airlines are operating this aircraft into Heathrow and that "the aircraft offers them the chance to enhance their products". But the picture is misleading; BA is not operating the A380. It is in fact delaying the entry into service by at least 5 months. When it eventually enters service in 2012, that will be a mere 4 years later than its key competitors on eastern long-haul routes.

So if the A380 is so good and BA wants to be a leader in premium traffic, why defer it? Why not instead sell some of the mothballed B747 and try and get some earlier slots on the A380 delivery schedule? It is a good passenger aircraft compared with the B747; in economy the seats are wider, legroom can be longer and cabin pressure higher (about 5,000ft equivalent vs 8,000ft). If the A380 is not as profitable as a B777-ER, for example, as may well be the case in the current market environment when bigger means harder to fill, then cancel the orders. If it is a viable proposition, buy it sooner rather than later. Even Singapore Airlines is now finding use for them on sub-four hour regional sectors in competition with LCCs.

In the current quest for revenue, as several shareholders pointed out, BA does a good job of scaring customers away. If it's not the unions threatening some action then it's Mr Walsh suggesting that the business might fail (make sure you buy tickets with credit cards if you have no trip insurance).

So what supports the great company. It doesn't believe in government subsidies but it is quite happy for other barriers to entry to persist such as landing rights or for others to build infrastructure on its behalf. BA are rightfully delighted with Heathrow Terminal 5 and the improvements in service levels are palpable according to their statisitcs. (I've not used T5. Since SQ introduced the A380 and coupled with a change in occupation, I've not flown with BA since 2006. Anyway pressure on T3 seems to have abated with the opening of T5). Furthermore, it is probably only BA that wants the third runway at Heathrow.

Nevertheless, BA's western long-haul business is also under the cosh. Following the end of the cosy foursome arrangement on the UK-US routes in March 2008, rival airlines are considering new point to point transatlantic routes or even new hub opportunities. Perhaps it is fortunate that the EU-US open skies agreement happened at a time of declining air traffic, making it more challenging for new players to start a new route, but it is once again forcing BA to look for a partner(s) such as American and Iberia.

As for the financials. For some reason shareholders were asked to approve special resolution 7, the allotment of new shares by placing or rights issue before special resolution 8 which created the headroom in authorised capital - cart before horse? Never mind, all resolutions were passed.

And the rights issue. The Board insisted that a rights issue was not planned and that a convertible bond was being considered instead with institutional investors. It seeks to maintain liquidity equivalent to 15% of revenues and it is already above this level. (1.38bn cash and equivalents at FYEMar09 vs revenue of GBP9.0bn.) However, the CB - diluting existing equity by no more than 7.5% if a shareholder meeting is to be avoided, would help to cover any further deterioration in operating conditions.

But 7.5% of the shares in issue is only 86.5million new shares. Based on a current share price of 128p, the conversion premium would need to be very large just to raise GBP200m. The issue of 9.75% convertible capital bonds (2005) in FY1990 raised GBP320m and represented a potential 18.3% of the then issued share capital. It looks like the proposed CB may need to be on a rights basis in order to raise a sensible amount of money at a sensible price.

But all is not well; we are still in a period of rising unemployment, rising oil prices and with BA's unions fighting to minimise job losses (3,700 further losses in the current FY). On top of that, there is the result of the triennial pension funds valuation after which the company's contribution level will be reassessed. The rating agencies are on top of the situation for once - both coming down a notch in the last few months to Ba1/BB. The company thinks the rating downgrades will have limited impact on its access to funds; it has committed facilities and adequate cash for 12 months of operations. However, the cost of hedging will now reflect a higher counterparty risk.

The company is in a stall but it is trying to regain control simply by pushing the cost stick forward. A stall can be recovered this way, but having a few revenue generating ideas to power the recovery might make the difference between meeting the ground hard and scraping the paint on the belly. Time to ring the broker and make sure that I'm not permitted to attend next year's AGM.

Avis Europe - try smarter not harder

Avis Europe - we try harder - but it's a dumb business model
I inherited a few shares in Avis some 8 years ago. Since then (FY 2000) Avis has managed to destroy value in spectacular fashion. Revenues have grown at 1.1% pa over this time, wage costs at 3.2% pa, staff numbers are now 2.3% higher and dividends declined prior to cessation in 2004. Debt continues to climb.
It's a relatively straightforward business which is why small, independent operators with a few cars and vans in their fleets can compete with the vast 100,000+ fleets of the big players - Avis, Hertz and Europcar.
In essence, Avis buys new cars and sells them a few months later at a loss. As all motorists know, you lose thousands of pounds the moment the car leaves the showroom, although one would expect Avis to get much larger discounts than most buyers, to mitigate the impact. In between it hires out the vehicles and seeks to make enough money to offset the asset depreciation, to cover the cost of finance and to cover staff and vehicle maintenance costs. It is the classic perishable goods business - so the ability to maximise revenue is crucial and yield management (charge out rates x utilisation) is key.
As part of its marketing, Avis has coat-tailed the major flag carrier airlines such as BA. Indeed almost one half of Avis’s business is derived from airports. However, the national, full-service airlines are being slowly massacred by the low-cost carriers, such as Ryanair and Easy Jet. Avis is unlikely to find a suitable way to work with these more aggressive airlines, so the slow death will continue.
Similarly its purchasing policy has been linked to the walking dead for much of this period. GM has now entered Chapter 11. Hopefully Avis is not too heavily exposed as a creditor of GM in terms of the residual value guarantees or vehicle buy-backs the manufacturer undertakes. Even if there is no monetary loss now, the depreciation costs on discontinued vehicles will need watching in the future.
Avis is broadly stuck with its 6 to 9 month holding period. Its customers want the new car smell, and beyond 9 months the pre-resale rectification work on the vehicles becomes more material in nature and cost. Furthermore, Avis may well need to pay extra mileage costs if the agreed limit with the manufacturer has been exceeded.
Meanwhile, our small operator with a dozen cars or so has flexibility on his car holding period and indeed on the marques he buys. If the local Nissan dealer has some sales targets to meet and wants to sell a few cars at a keen price, the independent operator can take quick advantage.
Similarly, in day to day operation, the small independent probably has a white board or production ticket arrangement to show him his vehicle status. Other than the accounts system and the website, there is no massive investment in IT.
In Avis’s annual report there are some data on market shares albeit untimely. In 2006, the share were Europcar group 23.7%, Avis 18.3% and Hertz 15.2%. In 2007, the figures were 25.6%, 17.7% and 15.3%, respectively. In the current year it claims to be maintaining market share. Let’s hope so.
So what works for Avis? The licensing income is small but growing. This are the fees paid by third party operators for using the Avis name and charged on top of any fees for using the Avis marketing system. Should the whole business go to an "asset-lite" brand management operation like a hotel? Do these licencees have the fire in the belly that the agent or corporate outlets perhaps lack?
Looking at the finances, the deterioration in the Parent Company P&L follows an impairment charge of GBP113m. This has reduced the P&L reserve to GBP11m as at FYE 2008 and we are almost headed for a re-run of mid-2005. In June 2005, a 4 for 7 rights issue at 35p raising GBP117m gross and a share premium release were needed to patch up the GBP335m deficit in the Parent P&L reserve following a GBP396m writedown in 2004 of Avis Parent’s investment in its subsidiaries.
The rights issue may not happen this time as the writedown is based on a discount factor applied to future cashflows. It’s great what you can do with discount factors to come up with the answer you want!
Debt-wise, there is nothing major to pay back until next year when the first USD48m tranche of US private placements fall due. The last four years have seen an increase in net debt from operating activities. In 2005, the reported EUR35m decrease in net debt was after tapping shareholders for EUR175m while in 2007, the sale of the Greek business released EUR196.7m, leading to an overall EUR27m improvement in net debt that year. Therefore, the only strategy for now is to reduce the fleet size in order to release cash, and to raise prices to maximise contribution.
Interestingly the covenants on the debt facilities are based on EBITDA interest cover and net debt to EBITDA. Given the high level of operating leases in the business and the scope for large variations in the level of profits on disposal of the vehicles, the ratios don’t seem to catch much at all. Some measure of fixed charge coverage to include the usual financial expenses plus the cash operating lease payments would seem more appropriate accompanied by some debt to total assets calculation.
What next? For the business, a healthy dose of inflation would help it reduce the nominal loss of value on its fleet transactions. As a shareholder, my hope is for the D’leteran group, the 60% shareholder, to put me out of my misery. Dealing charges would consume a large slug of my holding’s current value! It’s good to see Odey asset management taking an interest but with 3+% (as of March 2009) they cannot do much. Avis may be a global brand in some people’s eyes, but flipping a penny stock is probably the main route to a half-decent return for investors such as Odey.

Lloyds Banking Group - share offer: what to do as unconsolidated shareholders lose out again

Shareholders of both Lloyds and HBOS who have not consolidated their shareholdings of Lloyds shares post-takeover will lose out again.
You would have thought that the company, and Equiniti (the registrar), would want to minimise the cost of administering its large shareholder register. Apparently not; instead of searching out duplicate names and payment details on the register it is happy to let shareholders run two separate accounts. The reason is obvious - Equiniti presumably gets paid according to the number of names on the register and Lloyds gets the benefit of all the rounding down of entitlement calculations.
Shareholders in such a situation may have already lost a free share from the recent capitalisation issue of 1 new share for every 40 held. For example if you held 500 original Lloyds shares and then received 310 share in Lloyds in exchange for your HBOS shares you had 810 Lloyds shares in total. After the recent capitalisation issue you now have 512 + 317= 829 shares instead of 830 had your holdings been merged.
The current offer of 1 new share @38.43p based on 0.6213 shares for each existing share means you lose out again.
Our hypothetical 829 shares give us the chance to acquire 515 shares. However, split shareholders are offered fewer. Our 512 shares entitle us to buy 318 new shares and the remaining 317 shares means we can apply for 196 new shares. Net result - we can only get 514 new shares.
The application does give the shareholder the mechanism to combine and consolidate accounts for future issues but in this instance the total that can be applied for is the sum of the individual entitlement totals on each form.
Can anything be done?
I intend in my consolidation covering letter to apply for my extra share that I would have been entitled to had the consolidation of holdings occurred earlier.
I shall therefore send in a cheque for the amount on the forms plus an extra 38p for this lost share. I will also add a further 101p to this cheque to ensure that I get a refund of the overpayment - amounts for less than 100p are being retained for the benefit of the company.
Whether or not I get the share that is rightly mine is only part of the grievance. If it causes more stress and cost for Lloyds Bank then it will be a reminder for them that the acquisition of HBOS was the most obvious "no deal" of the bank's 300 year existence. This deal has caused stress for all its small shareholders who were incapable of outvoting the large investment fund managers. The latter are so closely associated to the investment banking salary gravy train that they struggle to think for themselves.
As for Equiniti, there will be even more rumblings of dissatisfaction among shareholders required to use this company's service once this administrative overload hits them.

Rating agencies - Reform can wait - we're busy right now

One of the main beneficiaries of governments' push for kamikaze interest rates and more credit in order to add to the mountain of toxic debt already built, are the rating agencies.
Far from being bypassed in the current new debt issuance bonanza, the rating agencies, who manufactured the structured finance ratings that propelled the credit crisis, are mainstream in the ratings of the various government-backed issues of new bank debt.
Instead of punishing the rating agencies for their past greed-induced blindness and insisting on fundamental changes to their business models, the desperation to create more money has led to the political expediency of doing nothing to change the agencies' flawed methods, for fear of delaying the issuance of the supposedly much-needed debt.
As for quantitative easing, will governments be buying unrated debt or will they too be demanding the illusory comfort of a rating agency prognostication?
Warren Buffet's fund which continues to hold over 20% of Moody's (MCO) seems to have correctly backed the embedded rating agencies over the interest-ridden, prevaricating politicians in the various public spectacles and recriminatory showdowns.
However, all it needs is for the SEC which, through its own laziness, started the process of hard-wiring the rating agencies into bondmarket regulation in 1975, to cut some of the wires. One example that springs to mind is that bonds issued by banks which carry full-faith government guarantees could be automatically designated by the SEC as risk-free and therefore not requiring of a rating. OK, so the rating agencies would then potentially seek to invoice the US government more for its sovereign rating but normally the agencies only charge against the traded liability - not against the contingent liability.
But this is not going to happen.
Rating agencies will not have to change; regulators cannot think of an alternative and who knows, the next quantitative black box models might get it right, so why bother looking for an alternative.
Meanwhile, investment managers are either mandated to follow ratings or potentiallly expose themself to legal challenge from their investors if they lose money on unrated transacations - how can that Catch 22 change?
So it's business as usual for the agencies with the added bonus of Basel 2 work to support their revenues and cement their position in the regulatory framework.

Quantitative easing - no -sell CDS

One thing governments are bad at is intervention in markets. The only success I can think of is the time when the HKMA bought a slug of Hang Seng index shares during the Asian crisis to put an end to the interest rate - property stocks shenanigans that were going on. What's more, after the crisis, the acquired shares were sold at a profit.

At the moment in the UK we have too much credit and not enough lending. At the same time interest rates have been cut and money market meddling undertaken in order to restart the lending process. The interest rate changes have had little impact - pushing on a string - as some commentators say. The reason for this failure of policy is that, thanks to the CDS market, the price of credit and the overall cost of borrowing have become detached.
So Mervyn King should step in and sell credit protection (CDS) in all the UK financial names.

This has many benefits and few drawbacks.
a) Selling reduces the price and so the cost of credit as measured by the CDS spread would decline. The lower CDS value would lower the cost of cash borrowings for these institutions.

b) It is so cheap - in fact selling means that HMG receives regular premiums from the buyer of the CDS protection. These are only a small percentage of the underlying notional debt but could be used to buy back cash debt in the underlying institutions or to buy their shares or for the money to be applied to whatever financial support measure the government has in mind. This would help close the gap between the cash and credit markets.

c) Unlike quantitative easing a) the impact of the CDS sales activities can be readily seen from market prices and adjusted more rapidly than interventions in the money market and b) there is no long-term such as hyper-inflation; once the CDS term is reached, the liability expires and the notional credit disappears.

d) By upsetting the players in the CDS market, the government might be able to bring to an end the derivatives monster. This is where all the credit is lurking and hence we have the paradox of seemingly too much credit in the system but not enough in the real world. Initially, the CDS sales are creating more credit but once the market has decided that it can't win against a sovereign that is backing the underlying credit, the CDS market would shrink. At this stage, the regulators can then step in to control banks' further exposures to derivatives by, for example, changes to the capital adequacy ratings for such instruments.

e) As CDS market players have found, you get a lot off bang for your buck. So don't waste money in cash bondmarkets, invest in derivatives where you can have some impact.

f) As CDS is essentially a form of insurance, HMG could reassess the level of guarantees it has set for the UK bank indebtedness. Maintaining a blend of CDS and guarantees would help bring equilibrium between the cost of credit, the credit risk of banks and the credit risk of the sovereign.

While the government has many consultants, I note that Mr Brown's key adviser is probably Baroness Vadera. Methinks her knowledge of day to day trading in CDS and cash bondmarkets might be limited, given that she left Warburg's in April 1999 - when CDS was the plural of compact disc and the Euro was only 3 months old!

But there again, is Dr Bernanke up to date? How much notional credit was wafting round the credit default swap markets in the 1930's? Is his study of the Great Depression that relevant or do we need the blend of barrow boys and quant jocks that got us into the mess to tap away on their laptops (another consumer staple of the 1930s) and find a way out?

Moore's Law and the Credit Crunch

Steve Lohr's comment in The New York Times on Tuesday November 4, titled "In Modeling Risk, the Human Factor was left out" makes for an interesting read. The blame for the financial meltdown is placed on those who thought they had covered all the angles in modelling financial markets, but who had forgotten the human factor.

However, he does not mention the providers of the technology. If guns had not been invented then people wouldn't get shot and without the development of computer technology and software, the financial engineering could not have taken place.

In 1987, the quant guys couldn’t handle massive, multi-variate models on their slow PCs, yet alone e-mail relatively small Supercalc spreadsheets to all and sundry.

Now SQL, SSPS and Excel, combined with Intel chips and the internet, give people tremendous computing power to produce models and an array of accompanying graphs to prove in glorious technicolor that all outcomes have been tested and therefore the computer’s output is right.

In addition, multiple recipients can now readily see these 50Mbyte models anywhere in the world on a 24/7 basis and be similarly enticed, thanks to e-mail, wi-fi and search engines.

As ever though, garbage in, garbage out or as Mr Lohr more accurately points out, not all the data to validate all the outcomes were input to these models despite the size of them. Forecasting, the daily returns of a large portfolio of multi-year mortgages would test even today’s laptops.

Perhaps the computer simply discourages critical, common-sense based thinking. People tend to believe everything they see on the internet. By contrast, a generation ago, people were told not to believe everything they read in newspapers.

But we've been here before. This financial crisis caused by misbehaving markets (as the models would have us believe) is a re-run of past crises of illiquid securities. The success of great minds and their models baffling mere mortals, was highlighted by the failure of LTCM which collapsed in 1998, just one year after two of its partners, Messrs Merton and Scholes got their Nobel economics prize for option theory.

Unfortunately, the financial regulators chose not to learn from this close call on the integrity of the financial system; financial engineering and its inherent weaknesses could continue unabated.

Now 10 years on from LTCM, and according to Moore's Law (chip capacity can double every 2 years) we now have around 2^5 the computing power that was available to the LTCM team. This should have given us the chance to make a 2^5 greater mess than the $4.6bn loss covered by the FED-orchestrated bailout in 1998.

So will we get away with just a 32x increase in bailout cost? It doesn't look like it at present, as markets talk in terms of trillions of dollars of CDS exposures and bank writedowns already total $702bn (Bloomberg).

But who knows, the net net cost might just be $117bn. In which case, if we escape with this low amount, then after the crisis, financial engineering can start again happy in the knowledge that in 2018, the cost of a bailout will be no more than 2^10 more than in 1998, at $4.7trillion.

ICICI Bank disingenuousness

ICICI is parading the fact that Moody's is rating its UK subsidiary at Baa1.
Two things strike me; a) it's Moody's, the same outfit that had Kaupthing at Baa3 until as recently as October 8th and b) the rating is higher than Moody's FC rating for the Indian parent.
So it looks like the Baa1 rating includes some support from a higher rated entity - presumably the UK government. But did anyone see ICICI UK Ltd on HMG's "chosen few" list of 7 banks and 1 building society?
And the other rating agencies - both have ICICI India at BBB-/stable, with an A3 short-term rating. Furthermore, bank strength ratings are in the order of C and C-; these are weak for a bank.
So thanks to Moody's JDA (joint default assessment) scheme, which gives the UK branch a better rating (neither Fitch or S&P rate the UK entity and why would ICICI buy an extra rating if it's lower?), the management are trying to imply that all is well. For some reason, ICICI Ltd in Singapore does not get any uplift and is Baa2 according to Moody's but that is probably down to the Moody's JDA black box expectation of support from MAS.
The move to seek reaffirmations of the ICICI ratings from Moody's and S&P over the weekend is an unusual move and almost certainly requested by the company. The hurriedness is reflected in the S&P statement referring to "Bakerie" rather than the Bakrie group.
In conclusion, things may be well with ICICI India but there is no guarantee for the UK subsidiary. Things may well be well for the UK subsidiary too, although it does seem to have been more exposed to the shenanigans of international derivatives than the Parent in India.
What is not so good is management's apparent misunderstanding of ratings and structural sub-ordination and the implications this has for the advice management is giving to the world at large about its relative credit standing.

Gordon Brown should copy HKMA

Given that the equity market is the most liquid, the most talked about and a key element in economic Lead Indicators, why doesn't HMG buy bank shares?
It can then make proper representation as a shareholder in the control of the business and can profit from its involvement.
Given that it is giving liquidity through the Bank of England, some equity upside is not too much to ask.
Unlike Mr Buffet, HMG should buy from the market and not take options on future performance. Furthermore, the preference share route is best avoided; these do not provide a cushion to a bank's equity price, but act as a penal charge on income. In the current environment of liability guarantees, the cushion to unsecured creditors afforded by the preference shares is simply not needed.
The common equity purchase plus judicious involvement in any rights issues or placings represent the best spur for confidence and allow the market to see the floor. All those investors now holding cash can then take a view.
In purchasing the equity, the trading criteria should be specific; e.g. it will be a potential buyer of bank shares if the price to book is say less than 0.35x and a potential seller if the price to book is over 0.65x. It will never sell more than 5% of its holding or 1% of the shares outstanding in the bank in any one day, and so on.
Does it work? Ask the Hong Kong Monetary Authority if their $15bn of share purchases on the Hong Kong stockmarket, over two weeks in August 1998, worked. I think it did, and they subsquently made a good profit. Perhaps there's some gecko lurking somewhere in Gordon waiting to emerge.

Debt for Equity - not liabilities to governments

There is a concern that banks have stopped lending. Is this because there are no solid borrowers or is it because lenders have lost faith as a result of arbitary changes to property rights and bankruptcy laws?
Banks will not advance money if they no longer see the equity of the borrower taking the first hit. If there is no first hit to be taken, then the banks must assume that they are pari passu with equity holders.
The main problem facing markets is that banks are facing immediate heavy losses arising from derivative financial contracts. Banks balance sheets are not designed for catastrophic losses of equity, but they can absorb up to 10% to 15% total losses on their loan book over say 5 years. This is equivalent to a 50% to 66% recovery on a bad loan book equivalent to 30% of the total loan book. Banks with non-performing assets = 10% of total assets will struggle. If the ratio reaches 20%, the bank will most likely fail.
For example, assume a typical bank with common equity of 6% of assets and a pre-tax, pre-provision ROA of 3.5%. If in any one year 15% of the loan book is non-performing then ppROA will fall to say 3%. Provisions and losses at 33% of these NPA reduce overall ROA to 0% and eat into equity to the value of 2% of assets, reducing equity to 4% of assets. The bank has an equity issue of say 1 new share for every one held but as the Price to Book Value will be <<1.0x, say 0.5x, the equity base only recovers to where it was before, at 6% assets.
If the same happens the following year, then shareholders will once again need to chuck money at the bank equivalent to 2% of the asset base until the problem eases.
But if I don't recover 67cents on the dollar and/or if the NPA ratio is higher, then the equity will be depleted by much more than 2% of the asset base. In addition, the ppROA will be adversely impacted by funding costs and the price to book ratio, ahead of the new share issue, will be even more bleak.
The forthcoming settlement of AIG, Fannie & Freddie, and Lehman CDS contracts means that we will get some market clearing prices on the bad assets. Then buyers and suppliers of capital will magically reappear because the calculations outlined above can be done with more certainty.
However, bank recapitalisation also requires time. As alluded to above, banks take the hits year by year and that is because the work out of loans or recovery of collateral are also time consuming processes. Furthermore, as these bad loans were "held to maturity" assets, and thus valued with some discretion, the banks had a chance to blend internally generated capital and external equity injections to restore the bank to rude health.

By contrast, the upcoming CDS auctions could be traumatic as we are trying to estimate in a few days the recovery value of the assets and the liabilities of four intertwined businesses. This is before the people now controlling the failed entities have barely started work on assessing the real assets of the businesses.

Unfortunately there is massively more value in the CDS being settled by auction than there is in the real assets of the business. Maybe 10x more derivatives traded than underlying assets, maybe much more. Mispricing the CDS values by 5cents on the dollar is equivalent to being 50% wrong on the value of the real assets.

But unfortunately the market price established will need to be used by the banks and this will almost certainly throw up some permanent impairments to their "held to maturity" loans. The chance for banks to smooth their way back to profits will have disappeared.

There seem to be three routes forward assuming banks remain in the private sector;
i) BIS and/or Fed relax the banks' capital criteria,
ii) another major overhaul of mark to market accounting is required or
iii) creditors take equity.

The purest route forward to offset the instant value destruction derived from the CDS auction would seem to be the creation of instant equity. In other words, there must be a mechanism for the instant swap of debt for equity.

But such changes cannot happen if governments have guaranteed all non-consumer deposits and liabilities, or if indeed the government has already split the balance sheet up.

As noted earlier, banks, in effect, already believe that they are no better off than equity holders which is why they are not lending. However, it is not the uncertainty of the credit market that makes holding equity unattractive but the unpredictability of government actions with respect to any holder of a bank liability.

At least with another bank's equity in their pockets, a bank then owns (albeit a very large amount) a homogeneous, transparently-priced security for which there is a liquid market - as long as the government doesn't interfere.

And finally, the conflict between going concern principles and fair value accounting can, in my view, best be resolved if liabilities are valued at the higher of par or market value. (Pension liabilities should be discounted at long-term government bond yields). There would need to be a balancing quasi-financial asset, but at least the ridiculous state of affairs where a struggling bank can show an enhanced equity valuation because the market discount to par of its own capital instruments are credited to equity, would disappear.

Invexit

Investment bank advice to Fed - SOS

Funny how, as the investment banks fell one by one, and as pressure mounted on Goldmans, the governments of the world suddenly took action. Just in time, as one of the most successful pedlars of derivatives and toxic debt products, and a master of trading and short-selling, might have gone bust.
Why governments seek advice from investment banks, the scourge of the modern world, is difficult to understand. For these banks there are yet more fees, coupled with ability to steer their clients towards maintaining loose regulation for their activities. But should not advice on the real economy, come from the commercial banks who handle real deposits and who make loans to material entities?
So instead of allowing their alma matere to be wiped out, to the future benefit of all, these government advisers decide it's time to get their political poodles to do something - save our souls.

(Invexit)

Singapore's recession reporting

Singapore has been in technical recession as of the end of March 2008 and based on this week's flash estimate of Q2, GDP will have shrunk again. So has the R word featured in the media?

Press releases from the MTI steer the journalists and market players to look at growth. The magic of seasonal adjustment makes the quarter on quarter numbers still look strong while the base effect impacting the year on year, quarterly numbers keeps the increment positive. Coupled with the government sticking to its 4% to 6% growth forecast for 2008 and everyone is happy. A cynic might ask if the focus on the incremental rather than the absolute GDP numbers is in some way related to the performance linked pay of Singapore's civil servants?

Back to the numbers ...
GDP at 2000 market prices in SGD million (source ESS)
Q2 2007 57,019.4, Q3 2007 58,842.3, Q4 2007 58,538.6, Q1 2008 58,362.7.

So Q1 08 is lower than Q4 07, which is lower than Q3 07. Technical recession?

And the "good news" flash estimate for Q2 2008 is growth of 1.9%. Based on Q2 07, this actually points to a further fall in output to around SGD58.1bn for Q2 2008.

The inflation rate has "arrested" some attention in the media, which at 7.5% yoy to May 2008 is uncomfortably high and this is despite a currency being held at the strong end of its trade-weighted range. Comments on the decline in labour productivity have been few and far between. The country wants the influx of foreign workers to continue; unfortunately they are failing to stimulate the economy.

Journalists are commenting on the very low interest rates in Singapore, mainly because savings rates for depositors are at derisory levels. With a full blown recession underway, low interest rates in Singapore are desirable. Despite the minimal cost of funds, the rate of monetary growth has been declining in recent months from the >20% levels seen in much of 2007 and was down to 9.0% in the year to May 2008.

So why is money attracted to Singapore? Is it the safe haven of the East? Property prices have had a good run supported by foreign investors, but at what stage, if at all, do the investors react to the weak growth and high negative real interest rates and dump SGD assets? Can energy-intensive Singapore survive in a world of high oil and food prices? While the great man is still with us, the chances are good.

Bradford & Bingley - stewards' enquiry needed

Never mind what Steven Crawshaw said to the markets on 14th April regarding the likelihood of a rights issue, what he said on the morning of 22nd April, in the interim management statement was even more misleading. In this he comments on the capital base and funding in the same sentence but with no mention of the capital ratios being at risk.
"The first quarter of 2008 has seen excellent growth in our retail deposit base. Bradford & Bingley has a strong capital base and has funded its business activities through 2008 and into 2009. We have a focused strategy, and a business model that is adaptable to changing market conditions."
Given the deep discount of the rights issue - the new shares offered at 82p compared with the prior close of 158p - one wonders why an underwriter is needed, especially as management gives the impression that capital is not urgently needed.
The recent price movements of B&B relative to those of the other financial desperados - A&L and Barclays - suggest that a bit of window dressing ahead of this rights issue might have been underway. Have the underwriters been earning their fees? A steward's enquiry would be most welcome.



The table above takes the daily price movement (ln (Px/Px-1)). It uses using prices from Yahoo and so ends on Monday 12th. Bank A is Alliance & Leicester, B is Barclays, C is Bradford& Bingley and D is HBOS - which of course already has announced a rights issue.
And the bank with the most price rises over the fourteen days - well B&B of course.