Category: Investing

“There are two requirements for success in Wall Street. One, you have to think correctly; and secondly, you have to think independently.”

~ Ben Graham

Credit crisis far from over: expert

Geoffrey Newman | May 02, 2008

A DERIVATIVES expert who two years ago warned of a potential meltdown in global credit markets has cautioned that the crisis is far from over, and has endorsed recent calls to relax controls on inflation and allow higher prices to help markets trade their way out of their problems.

Longtime critic of derivatives markets, Satyajit Das, says those who believe the US sub-prime loans crisis, and the drought in credit markets it triggered, are nearly over are wrong.

“I think the cycle has some way to run yet,” he told a Financial Services Institute of Australasia function in Sydney yesterday. “It’s a matter of years, not a matter of months.”

In particular, investors in the US stock market, which has climbed off its lows amid a growing mood that the worst of the crunch was over, were being too optimistic, he said.

The author of Traders, Guns & Money warned that many of the problem financial instruments were still hidden and the total amount of debt attached to them largely unknown.

Losses incurred by US banks were certain to rise as $US1 trillion ($1.06 trillion) in sub-prime housing loans was due to reset to higher interest rates in the next two years.

The use of credit card debt — now totalling $US915 billion — was cushioning US home owners. But, in an ominous sign, card issuers were rapidly increasing their provisions for bad debts, by as much as 500 per cent in the case of one bank.

The use of sub-prime debt structures was also a feature of other markets, such as private equity, where $US300 billion in loans were due to be refinanced in the next two years.

Mr Das said another $US1-$US5 trillion of assets would have to come back on to US bank balance sheets as a result of defaults on housing and other debts, and it was unclear how the banks could fund them — issuance of preference shares by US banks was already at a record high. He said losses at financial institutions from the credit crunch were likely to almost double to $US400 billion.

There were also second-round effects to come as the damage done to the real economy from financial sector losses fed back into further bank losses.
Mr Das said there needed to be a massive reduction in debt levels globally or a “nuclear deleveraging” before the crisis could be said to be over. That could be achieved through an economic crash “on the scale of 1929” but allowing inflation to rise would help to avoid that scenario. Higher inflation was a legitimate policy option since it reduced the real value of debt and gave companies and individuals breathing space to reduce their leverage by helping to put a floor under asset prices.

His comments come as some economists urge Australia’s Reserve Bank to relax its inflation targeting policy to help avoid a severe economic downturn.

He acknowledged that as inflation rose higher it was more difficult to control it, but noted the global economy was moving into a period of higher inflation anyway. “It could be the lesser of two evils,” he said.

http://www.theaustralian.news.com.au/story/0,25197,23631137-643,00.html

UBS Gives Haircuts
Vidya Ram, 03.28.08, 5:00 PM ET

LONDON –

In its advertising, UBS tells clients “it’s you and us,” but on Friday it told investors “you’re on your own.”

The Swiss bank told clients it was reducing the value of auction-rate securities in their accounts, by an average amount of 5%. It also refused to buy the bonds back from investors who bought the securities, thinking they were getting an easy-to-sell, higher-yielding alternative to money market funds but instead found themselves stuck with illiquid securities and capital losses, courtesy of the global credit crunch that began in the U.S. subprime mortgage market.

“This is the right thing to do,” said a UBS spokeswoman. “This is in the best interest in our clients regarding our accounts. Given the current market dislocation this the next logical step for any committed wealth manager.”

Auction-rate securities are long-term bonds issued by local governments, agencies, or corporations but sold in periodic auctions, say every 7 to 28 days, to set the interest rate. Firms that handle the auctions, like UBS and most of the big Wall Street concerns, used to step in an buy in the auctions if there weren’t enough bidders.

But that all went by the wayside in January and February as investors fled the bond markets. Auctions failed after no buyers showed up and the banks refused to step in as they had previously done. That meant the auctions failed, leaving brokerage customers holding the bag and issuers paying much higher penalty interest rates. The Port Authority of New York and New Jersey, for example, saw its rate skyrocket to 20% from 4% when its auction failed in February.

As a consequence of paying soaring penalty rates, many issuers are converting their auction rate bonds to fixed-rate bonds, putting more pressure on the remaining auction-rate securities that still haven’t started selling again. The bonds cost more than the issuers were paying on the auction-rate securities but yield far less than the penalty rates.

The banks backed off supporting the auctions because they didn’t want to risk taking more illiquid assets on their books after collectively writing off more than $100 billion in mortgage and credit derivatives. UBS has been among the hardest hit of the banks, already writing down $17 billion worth of credit holdings and facing another $11 billion in write-downs in the first quarter, according to analysts at Oppenheimer.

Its problems don’t stop there. Massachusetts securities regulators subpoenaed UBS, Merrill Lynch and Bank of America about their sale of auction -ate securities to customers, particularly bonds sold in closed-end mutual funds. The state is looking at what the banks disclosed about the possible risks of the securities.

“We received calls from a young saver whose house down payment is now frozen; two siblings whose family trust is now frozen; and small business owners who find their business interrupted because money they thought was liquid is tied up in these frozen securities,” said William Galvin, the Massachusetts secretary of the commonwealth, in a statement.

UBS wouldn’t say how much its brokerage customers own in auction rate securities, but the market is about $330 billion. The timing of UBS’s decision is perhaps telling. American investors are facing tax time, when many will need access to cash to pay Uncle Sam.

The Swiss banking giant previously told customers who were unable to sell the securities in scheduled auctions that the bonds would retain their full value and receive enhanced interest rates, according to TradeTheNews.com.

After falling 2.4% in Switzerland, to 28.98 Swiss francs, before the announcement, UBS American depositary receipts slid further in New York, dropping to $27.80, a loss of $1.33, or 4.6%, on the day. Less than a year ago, the stock had been above $66.

Investors who feel betrayed are likely to sue, adding to the pressures on UBS from the global liquidity crisis that began in the U.S. subprime mortgage market. UBS was the first major global bank to be hit by a lawsuit over losses related to the subprime crisis.

Singapore apparently paid Citi more when China refused
By MarketWatch
Last update: 9:25 a.m. EST Jan. 15, 2008
The Singapore government’s main investment vehicle agreed to increase the amount it planned to inject into Citigroup (C:C 26.24, -0.70, -2.6%) “apparently to cover” the approximately $2 billion Citi had unsuccessfully sought from the government of China, a person familiar with the situation said Tuesday.

During most of the day, Government of Singapore Investment Corp. (GIC) was committed to invest about $4.8 billion to $5 billion in Citigroup, but later in the day apparently told Citi it would “cover” the amount of money ($1.8 billion to $2 billion) the bank had hoped to raise from the Chinese government, the person said.

GIC’s decision partly reflected GIC’s long-standing relationship with the new CEO of Citi, Vikram Pandit, the person said. GIC was an original investor in Old Lane Partners, a hedge fund Pandit co-founded; it was later bought by Citigroup.

China Development Bank’s rejection of Citi’s request emerged Monday night.

The Singapore government would consider additional investments in Citigroup “if the opportunity and the need arises,” the person said.

Singapore has two sovereign wealth funds – GIC and Temasek Holdings Pte. – which have taken stakes in troubled financial institutions in recent months.

The terms of GIC’s purchase of $6.88 billion in Citi convertible bonds reflect the cash-strapped bank’s lack of leverage: GIC said the instruments will earn a hefty 7% non-cumulative interest, payable quarterly.

The conversion premium is a fairly low 20% and is “subject to adjustment in certain limited circumstances.” However, GIC noted these instruments give “appropriate downside protection.”
The press release didn’t give further details.

All told, GIC will own 4% of Citi as a result of the transaction; it already held 0.3% of the bank. GIC said it won’t “take” a board seat at Citi. Indeed, political sensitivities have prompted sovereign wealth funds providing financial infusions to U.S. and European banks to emphasize their intended roles as passive investors.

GIC pumps S$9.8b into Citigroup
By May Wong, Channel NewsAsia | Posted: 15 January 2008 1951 hrs

SINGAPORE: The Government of Singapore Investment Corporation (GIC) will soon have a bigger stake in US-based Citigroup.

GIC will pump in US$6.88 billion (S$9.8 billion) into one of the world’s largest banks. This is part of Citigroup’s bid to raise US$12.5 billion of capital to boost its financial position.

GIC is the hand behind the management and enhancement of Singapore’s reserves.

That is exactly what the company is doing with its latest purchase into Citigroup. The two companies took just eight days to seal the deal.

GIC’s investment is done through a financial instrument called convertible preferred securities. This will effectively give GIC some form of protection.

For example, if Citigroup’s stock price falls, GIC does not have to convert its securities into shares and will continue to earn dividends of 7 percent.

But such a prudent investment, with lower risks, will also mean that GIC will see relatively lower returns.

In a news release, GIC’s deputy chairman and executive director, Tony Tan, said the company looks for returns on a long-term basis. He believes GIC’s latest Citigroup investment will meet that objective.

Dr Tan said: “GIC is a financial investor seeking commercial returns on a long-term basis … We believe that the investment in Citigroup will meet our long-term investment objective in terms of risk and return.”

GIC now holds 0.3% of shares in Citigroup. The new deal will bring GIC’s stake in the bank to 4% if converted to shares.

The investment will make GIC, as a single entity, one of the top five investors in Citigroup. However, GIC says it will not sit on Citigroup’s board.

GIC’s latest investment comes hot on the heels of a major deal last month, when it pumped nearly S$14 billion into the Swiss banking giant UBS. – CNA/ir

Citigroup, Merrill Lynch Get $21 Billion From Outside Investors

By Yalman Onaran

Jan. 15 (Bloomberg) — Citigroup Inc. and Merrill Lynch & Co., two of America’s largest financial institutions, turned to outside investors for a second time in two months to replenish capital eroded by subprime mortgage losses.

Citigroup, the biggest U.S. bank, is getting $14.5 billion from investors, including the governments of Singapore and Kuwait, former Chairman Sanford Weill, and Saudi Prince Alwaleed bin Talal, the New York-based company said today in a statement. Merrill, the largest brokerage, said it’s receiving $6.6 billion from a group led by Tokyo-based Mizuho Financial Group Inc., the Kuwait Investment Authority and the Korean Investment Corp.

Wall Street banks have now received $59 billion, mostly from investors in the Middle East and Asia, to shore up balance sheets battered by more than $100 billion of writedowns from the declining values of mortgage-related assets. Citigroup was propped up in November by a $7.5 billion investment from the Abu Dhabi Investment Authority. New York-based Merrill was helped by a $5.6 billion cash infusion last month from Singapore’s Temasek Holdings Pte. and U.S. fund manager Davis Selected Advisors LP.

“The only reason the banks are raising capital from the Middle East and Asia is because those are the only people who have the excess capital to lend,” said Jon Fisher, who helps oversee $22 billion at Minneapolis-based Fifth Third Asset Management, which holds shares of Citigroup and Merrill.

Citigroup declined 68 cents to $28.38 and Merrill fell $1.25 to $54.72 in early New York trading.

The writedowns have reduced Citigroup’s so-called Tier 1 capital ratio, which regulators monitor to assess a bank’s ability to withstand loan losses. With today’s capital increase, the Tier 1 ratio would be 8.2 percent, Citigroup said, keeping it above the company’s 7.5 percent target.

`Capital at a Cost’

Morgan Stanley, UBS AG, Merrill Lynch & Co. and Bear Stearns Cos. also reached out to sovereign wealth funds or state- controlled investment authorities in Asia for money after bad investments depressed profits.

“It does show that investors aren’t completely ignoring the sector,” said Peter Plaut, a senior credit analyst at Sanno Point Capital Management, a hedge fund based in New York. “They are putting in capital but it’s at a cost. Now it’s up to the CEOs to be able to generate returns that exceed that cost of capital.”

The Kuwait Investment Authority, which invested in both Merrill and Citigroup, was formed by the Middle East’s fourth- biggest oil producing country in the 1980s to manage the nation’s wealth. Kuwait may have as much as $250 billion of assets, compared with about $875 billion for the Abu Dhabi Investment Authority, the world’s largest sovereign wealth fund, according to an estimate by Morgan Stanley analyst Stephen Jen.

Singapore, Alwaleed

The Government of Singapore Investment Corp. invested almost $7 billion in Citigroup convertible preferred securities and said in a statement today that it will own about 4 percent of the bank if the securities are turned into shares. With a 4 percent stake, Alwaleed has been Citigroup’s biggest individual shareholder since the early 1990s, when soured investments in commercial real estate left corporate predecessor Citicorp short of capital.

Singapore and Alwaleed, along with Los Angeles-based Capital Group Cos., the biggest U.S. manager of stock and bond mutual funds, Kuwait, the New Jersey Division of Investment and Weill, will receive a 7 percent annual dividend from the investment in Citigroup.

Merrill’s convertible securities will pay a 9 percent annual dividend on the securities until they automatically turn into Merrill shares in 2 3/4 years’ time. The group will get fewer shares if Merrill’s stock price climbs above $61.31 and more if it drops below $52.40, according to the company’s statement.

SEC’s Concern

Foreign investors whose stakes rise about 10 percent trigger a review by the U.S. Committee on Foreign Investment, which examines whether acquisitions by overseas buyers compromise national security.

U.S. Securities and Exchange Commission Chairman Christopher Cox said in December that the growth of state-run investment funds may lead to an increase in political corruption because governments might abuse the funds’ leverage over markets and companies.

While there may be “hand-wringing” in Washington over the investments, there won’t be an attempt to tighten rules on foreign investors, said Todd Malan, executive director of the Organization for International Investment.

“Congress realizes that we need this investment,” said Malan, whose Washington-based group represents 141 non-U.S. companies investing in the country.

The following is a table showing banks and securities firms that have sold stakes to shore up capital. All except Barclays Plc raised the cash after reporting asset writedowns and credit losses amid the collapse of the U.S. subprime mortgage market.

Firm Infusion Investor Stake

Citigroup $6.8 Government of Singapore 3.7%
Investment Corp.

7.7 Kuwait Investment Authority; not
Alwaleed bin Talal; Capital specified
Research; Capital World;
Sandy Weill; public investors.

7.5 Abu Dhabi Investment
Authority 4.9%

Merrill Lynch 6.6 Korean Investment Corp.; not
Kuwait Investment Authority; specified
Mizuho Financial Group

4.4* Temasek Holdings 9.4%**
(Singapore)

1.2 Davis Selected Advisors
(U.S.) 2.6%**

UBS 9.7 Government of Singapore
Investment Corp. 10%
1.8 Unidentified Middle Eastern
Investor 2%

Morgan Stanley 5 China Investment Corp. 9.9%

Barclays 3 China Development Bank 3.1%

2 Temasek Holdings 2.1%

Canadian Imperial 2.7 Li Ka-Shing; Manulife not
Financial; others specified

Bear Stearns 1 Citic Securities Co. 6%***
(China)
_____

TOTAL $59.4

* Temasek has an option to invest an additional $600 million.

** Estimate based on purchase price of $48 a share.

*** Citic has an option to increase its stake by as much as
3.3 percent.

Ten little Injuns standin’ in a line,
One toddled home and then there were nine;
Nine little Injuns swingin’ on a gate,
One tumbled off and then there were eight.
One little, two little, three little, four little, five little Injun boys,
Six little, seven little, eight little, nine little, ten little Injun boys.
Eight little Injuns gayest under heav’n.
One went to sleep and then there were seven;
Seven little Injuns cuttin’ up their tricks,
One broke his neck and then there were six.
Six little Injuns all alive,
One kicked the bucket and then there were five;
Five little Injuns on a cellar door,
One tumbled in and then there were four.
Four little Injuns up on a spree,
One got fuddled and then there were three;
Three little Injuns out on a canoe,
One tumbled overboard and then there were two.
Two little Injuns foolin’ with a gun,
One shot t’other and then there was one;
One little Injun livin’ all alone,
He got married and then there were none.

One little, two little, three little Indians
Four little, five little, six little Indians
Seven little, eight little, nine little Indians
Ten little Indian boys.

Ten little, nine little, eight little Indians
Seven little, six little, five little Indians
Four little, three little, two little Indians
One little Indian boy.