Monday, November 1, 2010

Financials Under Stress

It's a bit pat to look at a sell-the-news down-move in stocks following what might be a major-league blowout election for the Repub side of the Republicrat/Demopublican Party and then the Fed meeting with potential friendly moves for financial assets, but more immediate adverse things are happening. A former blue-chip trust bank, Wilmington Trust (WL), more or less bit the dust today. It is of concern as a possible canary-coal-mine sign of lots more undisclosed problems with the asset base of other financial companies.
The details are a tad disturbing. The company announced quarterly results today, which revealed massive losses in its commercial real estate portfolio. Book value collapsed. The stock, which was $20 in the past year, is now at tangible book value under $4.

Simultaneously, an acquirer was found. This was not just any old acquirer. It was M&T Bank (MTB), which is 4.5% owned by Warren Buffett's Berkshire Hathaway (symbol BHK-A or BHK-B; BH for now). BH was a major beneficiary of the 2008 financial crisis, helping to bail out Goldman Sachs on much more favorable terms than the administration negotiated on behalf of the taxpayer. I suspect this was a political deal to quietly hand M&T to BH. Whether this was a favor owed by BH to Treasury and therefore was done above market value, or whether this was another gift to BH, or neither, cannot be known by yours truly.

Wilmington Trust has now collapsed below its bear market low. This is serious and so far as I know comes out of the proverbial nowhere. You may have noticed that Ambac is near bankruptcy as well, news that also broke today. The ticker symbol for Ambac is ABK. It might as well be BK!

Meanwhile, milder problems surfaced in the financial world. JPM is being scrutinized by the SEC regarding a mortgage securitization. The venerable Metlife has disclosed irregularities in its mortgage servicing division, and the division of Goldman Sachs that is a large mortgage servicer is on a credit downgrade watch.

Meanwhile, some measures of optimism about the stock market have reached very high levels just as insider selling has also reached extremes.

All this occurs as the 2-year Treasury yield is mired at new lows not only for this cycle but since the Great Depression at a Japanese-like 0.34%. I am told that this is more or less a free-market rate rather than one imposed by the Fed. Thus some very smart, large and serious money is leaving a lot of income on the table by hiding in 2-year Treasuries rather than buying the Dow at a much higher yield. Thus this vast pool of money at the very short end of the curve is implicitly saying that stocks are seriously overvalued, and that the dividend payout will largely be offset by price declines.

If one were to overlay the 5-year price charts of BofA (BAC), WL, and ABK, one might be interested to note that they have the same pattern as the chart of the 10-year bond.

When I discuss these matters with my financial professionals and the "investor on the street", the overwhelming consensus is that it the very long term Treasury bond is the riskiest and worst investment around. People are accepting gold more than the long bond.

What may well happen is that with WL stock collapsing overnight, it is clear that tangible book value in financial companies is meaningless. Thus there is no solidity to any banking company's valuation. All are suspect. We know that Citi was a goner in 2008 if not for the taxpayer, and BofA was close. The failure of the housing and commercial real estate markets to rebound mean that the real estate depression and the vast amount of securities tied to it looks to be acting as an undertow against the natural tide of economic expansion in a country with a growing population.

One has to be patient with macro events. ABK helped touch off the financial crisis in late 2007, when it and other similar companies were found to have insured garbage securitizations. Yet only three years later does it look to be dying.

GM was dying for years, but the final stock collapse came rapidly.

Ripeness may be all, but when will the fruit fall from the tree and then start rotting?

Dunno, but with regard to my contrarian speculative position in long Treasuries, I did see a headline I liked today on Yahoo's Finance section. It was the banner headline by the stock summary. It said something like: "End of the 30-year bond rally".
That might be like ringing a bell at the end of a move. The 30-year bottomed in yield in 2003, at the bottom of the short and long term interest cycle, at 4.10%. Sixteen or so months past the (alleged) end of the recession, it would fit my sense of symmetry if the yield, now at 4.02%, respected that 4.10% level as important resistance.

About a year ago, when long-term rates were much higher than now but ZIRP was well ensconced, I bought long bonds and commented to the broker to the effect that the Government wanted to run large deficits and would probably-- somehow-- engineer lower rates to help pay for them. Without knowing how, please look at this chart of the 30-year Treasury bond since inception in the late 1970s. Is it not possible that there has been an invisible hand leading the yield lower?
The current yield is seen to be around the downtrend line one's mind's eye can draw starting around 1981. (Click on the chart to enlarge.)

And with the 2-year Treasury having joined the 1-year note as well as the yet shorter-duration T-bill market at new lows for the cycle and showing no current signs of upward pressure, the outlier is the much smaller and volatile long bond market. Thus sentiment can change rapidly, because while we think we know the price changes coming down the pike the next few months, what happens years from now is pure conjecture.

All we need is one mini-crisis in the banking sector to drive yields a lot lower in the 10-30 year range; or, serious buying of the long bond by the Fed. Who knows, but the downside of holding said bonds to maturity is not the end of world unless the financial world actually ends via hyperinflation; and to that possibility I say: got gold? The upside of being correct on a bond purchase for a trade is however significant even if one simply has to metaphorically clip coupons for a year or five.

Copyright (C) Long Lake LLC 2010

1 comment:

  1. The only reason WL got away with dragging out their demise is because of friends at the DE DOJ.

    Hopefully, trust clients will transfer to another company before the merger takes place.