28 Feb 2010

Warren Buffett on foolish acquisitions

In his 2009 Letter to Shareholders the sage from Omaha says it better than we ever could: many acquisitions are value-destroying.

Overpaying for Acquisitions

We were quite staggered by the prices some Western Banks paid when they acquired banks in 'high growth potential markets' in Eastern Europe or other Emerging Markets. Case in point is Austria's Raiffeisen that supposedly paid nearly Euro 1 billion for Ukraine's Bank Aval in 2005. This represented nearly two thirds of Aval's balance sheet. Similarly high multiples were shelled out by other banks while we continuously advised that it would make more sense to plough the money into organic expansion. After all, the banks that were acquired were themselves only built up over a short time-span nor had they proven themselves through the business cycle.

How to regulate Derivatives

Warren Buffett famously described Derivatives as Weapons of 'Financial mass destruction' (2002 Letter to Shareholders of Berkshire Hathaway). While we think that this catchy phrase exaggerates the dangers of derivatives it has to be accepted that these contracts are essentially bets similar to futures contracts. As they are highly leveraged - in contrast to futures contracts there often is no margin at all - and no money may change hands when the initial contract is signed they are susceptible to outright fraud or abuse by overambitious traders and financiers. We would like to add to the debate by suggesting that all forms of derivatives are subject to meaningful margin requirements (including capital requirements in balance sheets of banks, insurance companies, corporations and public entities).

27 Feb 2010

Goldman and Greece: Barron's pullls no punches

Barron's Magazine is traditionally a magazine that defends free markets and capitalism. So it comes as a surprise when the Editorial Comment has a go at Goldman Sachs and Wall Street firms in general. When a stalwart of the business community like Barron's and not some leftist publication starts to call them 'Wall Street casino sharks' (sic) is it not time that these firms start to listen and change their business models?

24 Feb 2010

Poor Defense of Speculation

Darrell Duffie tries to revive well-worn arguments (Wall Street Journal, 24 Feb 2010) in defense of unrestrained speculation and does a disservice to free markets by leaving the door open for anti-market regulators. As a Stanford University professor one would expect him to show more awareness that certain speculative activities may well require more regulation in order to allow the rest of the financial markets to function without attracting counterproductive over regulation. Speculation may well serve a useful purpose - some times, maybe most times, but not always. For example, if speculators are allowed to buy insurance on my house (and even hire someone to burn it down in order to cash in on the insurance) then things have gone too far. But that threat exists when there is unrestricted speculation in short selling of shares, CDS contracts and distressed debt.

22 Feb 2010

The Donkey and BNP Paribas

Watching CNBC I could hardly believe my eyes when I spotted a middle-aged French lady rattling on about her life, that she dreamed of being rich when she was young. This was quickly followed by a rustic-looking chap from the West Bank who told us how happy he was to feed his donkey. The suspense built and I thirsted for the commercial break on CNBC to end so that I could find out which company was willing to shell out money for such incoherent testimonials. I expected it to be some charity, maybe linked to the United Nations. But the surprise winner was -- BNP Paribas! Having just closed today's Financial Times where a back page was adorned by the picture of Roger Federer it made it all-too-obvious that advertising has taken on a life of its own in the banking industry. Is it really all about image? Is it impossible to differentiate yourself by promoting a better product and outline the benefits it may bring to the customer? Does it really matter to a customer of Credit Suisse how many matches Roger Federer may have won? (650 in case you wonder). At a time when banking worldwide is an industry under siege - and we may not yet have seen the worst of the political onslaught - one would hope that managements put their advertising departments on a tighter leash.

Fraud Prevention - Banks walk on thin Ice

News that a subsidiary of Nord LB (Norddeutsche Landesbank) in Switzerland may have fallen victim to a fraud in its trade finance activities that may cost it up to Euro 130 million is a timely reminder that banking is a hazardous business where a premium should be put on credit and operational supervision and due diligence. All-too-often senior management is preoccupied with 'strategy' or political infighting and pays little or no attention to what is going on further down in the organisation or in outposts of a far-flung (overextended?) empire.

19 Feb 2010

BNP Paribas Compensation: A Model to follow?

BNP states that is will reduce its compensation-to-income ratio to 27 per cent for FY 2009. In doing so management claims to address public (political) concerns over excessive pay. BNP certainly seems to navigate successfully through the twin challenges of keeping regulators sweet and running the business smoothly while competitors stumble over PR gaffes or management mistakes. However, we do have a sneaking suspicion that pressure on compensation levels in the large investment banks will contribute to a revival of smaller competitors that are not in the limelight and are less subject to regulatory fervor.

18 Feb 2010

Goldman Sachs Business Principles

We still have the last edition of Goldman's phone directory that we received before moving on.

Point 1 states: Out clients' interests always come first. Our experience shows that if we serve our clients well, our own success will follow.

Point 2: Our assets are people, capital and reputation. If any of these are ever lost, the last is the most difficult to regain.

We hope that these points still feature prominently in the phone directory (which by now will probably be in electronic form only).

Greece: Why not declaring bankruptcy?

Martin Feldstein's piece in yesterday's Financial Times (Let Greece take a holiday from the Eurozone) caused us to send him a brief note and we will watch the reply of the sage with interest:

Dear Mr. Feldstein!

Your article - like most other articles concerning the Greek Debt Saga - tacitly assumes that one simple way to solve the problem is not feasible: a declaration of bancruptcy and subsequent resolution comparable to Chapter XI in the USA.

At present, the only two options that are being discussed are (1) a bailout by EU member states or (2) Greece leaving the Eurozone. Eliminating the option of bancruptcy from consideration creates an unproductive stalemate between two diametrically opposed viewpoints (aften aggravated by different ideologies regarding the philosophy behind the creation of the Euro).

Harmonised Stress Tests - Good in Theory

CEIOPS plans to introduce a harmonised stress test for Insurance companies in Europe. While this is a worthwhile project it will create one practical problem: what amount of stress will be applied to the balance sheets of the insurers? Well before the Credit Crunch started in the middle of 2007 we often asked the question: What would happen in the hypothetical case that all asset prices drop 20 per cent? would the banking and financial system in general be able to withstand such a shock - given that the margin of safety on a lot of lending was much less than that! We all know the answer to that question and I think that lessons still have not been learned. The problem is, that only by relying less on debt and debt instruments (in any form) and more on equity will the risk of a financial meltdown be successfully contained. Regulators will be hard-pressed to set the appropriate level of 'stress' in any test - too much and they regulate the insurance industry out of business, too little and the test becomes meaningless.

16 Feb 2010

Barclays Results - how good?

We are not running a financial research business but every so often we are tempted to comment on a company result when we can use it to pinpoint some interesting development in our patch - banking, securities and money management. The one detail that caught our interest in the Barclays results was the fact that actual return on shareholder's equity seems to be below the 10 per cent mark. While this is a respectable number - is has been produced during the second part of the Credit Crunch at a time when the sizable Lehman USA acquisition had to be digested - it puts into perspective the fact that the banking giants produce headline catching numbers (total compensation paid out, profits earned) but this has to be seen in proper perspective. Making that kind of return with a lot of tailwind from financial markets and ultra-cheap central bank money is no superhuman feat. Any new costly regulation may well put downward pressure on banking profitability in the future.

14 Feb 2010

Greece: Banks and Hedge Funds must watch out

The present crisis in and about Greece may look like a god-sent opportunity to make money but banks and hedge funds must be careful not to take too high a profile. Speculation against the Euro and Greece may well backfire if it turbo-charges downward pressure on the Euro and Greek bonds. The days when speculation was a cottage industry and could be ignored are long a thing of the past. Speculative moves do not reflect reality but they actually CREATE reality (a thankful nod to George Soros' theory of reflexifity). So this is not a harmless crap game but the lives of millions of citizens are at stake - and they will not tolerate for ever that a few make millions on the back of ordinary working people. Recent criticism (James Rickards in last week's Financial Times and today's Neue Zuercher Zeitung) pointed the finger at Goldman Sachs. But its competitors should not gloat but may well find themselves in the firing line as well. The New York Times points out that the same investment banks that now point the finger at Greek profligacy when they issue their research reports were more than willing to lead the country deeper into the debt trap. Can you really have it both ways? Even with the help of God?

12 Feb 2010

Bank Tax: Brown barking up the wrong tree

When statists sniff an opportunity to extract more tax from their subjects they usually find an excuse quite quickly. Gordon Brown certainly thinks that the solution to all of our problems is to invent a new tax. So it is no wonder that taxing banks is his solution to the global credit crunch. How that is supposed to absolve us from problems such as excessive borrowing, mismatch of maturities in balance sheets or simply bad lending is not explained to the public. In addition we have to expect the worst when it comes to disposal of the loot: will the tax money end up in some sort of reserve fund? or is it a pay-as-you-go scheme like the national 'insurance' or unemployment 'insurance' schemes that we are so familiar with?

EU Alternative Asset Management Regulation

The present plan to regulate the alternative asset management industry in the EU suffers from a number of serious deficiencies: Number one is the lack of a definition of the problem that it is supposed to solve. If there is no problem it is quite tough to design a proper regulatory regime. As far as we can see, apart from the usual rant from social engineers to the left (but also the authoritarians on the right) of the political divide there has not been a convincing proof that hedge funds or private equity funds pose a serious problem to anyone individually or to 'society' in general. So we are left with a legislative 'free-for-all' that gives underemployed and overpaid bureaucrats that represent no one but themselves (and their prejudices) carte blanche to cook up more schemes to make it difficult for ordinary citizens to make a living. As there is no clearly defined problem in the first place it is impossible to pass judgement whether or not the proposed measures are appropriate - an ideal world for the legislators as no one can call them to account or do a cost-benefit analysis of the proposed legislation. (As if anyone would to that in Brussels or any other capital). On the most basic level a major criticism has to be that it is not sensible to regulate hedge funds and private equity funds in the same law. They are similar in nature but it takes a bit of experience to understand that they are two very different animals. We rest our case as it is impossible to convince the average EU bureaucrat that he is barking up the wrong tree. Better to prepare for the wholesale decampment of the alternative investing industry to friendlier shores!

UK: is regulation 'clinically insane'?

The regulation may not be clinically insane (as per Jon Moulton) but it certainly requires a special individual to be able to find one's way through the thousand plus pages of the assorted rules and regulations passed by the FSA. One wonders how many of its staff would pass an exam that tests them about detailed knowledge of all the rules, - we would take bets that the present chairman would not be able to pass the exam. We do not even want to get into the question of democratic accountability as the British Parliament is not fit for the purpose it is designed for. There is no 'talk' (french: parler) as the stooges peopling its benches are basically told what to nod through by the government.

11 Feb 2010

Capital Ratios still at pathetic levels!

There is still more talk than action in banking reform. Volcker rule, Basel III, contingent capital - all these buzzwords are worthless if nothing gets implemented at some stage. News of generous bonus pools give the impression that all is back to normal in the banking world but when we had a look at the capital ratios of some large banks we were genuinely surprised - if not shocked - about the abysmal capital ratios that some of them reveal. Balance sheet totals seem to expand and the simple ratio of pure equity is in the low single-digits, and falling!

8 Feb 2010

Santander to float Bradford & Bingley?

It is just a bit over one year that the shareholders of B&B got expropriated by the British Government and saw control of the business handed over to Banco Santander shortly afterwards. So it may ruffle a few feathers among the investor community if there is talk that Banco Santander may float a stake in Bradford & Bingley or some other holdings in the UK on the public markets here. While Santander appears to be the laughing third party in this sorry affair one would hope that the effort of the previous owners of B&B to get satisfaction in the courts gets a boost from this slap in their face. After all, the situation at B&B cannot have been all that bad. Forensic accountants to the fore! And what about all that talk about 'Human Rights'?

AIG: Compensation Policy in Disarray

News that Peter Hancock is joining AIG with a compensation package worth up to $ 7.5 mio per year drives another nail through the credibility of the Obama administrations attempts to control pay in the financial sector - and in particular in the companies dependent on government support.