Alex Dalmady's Blog

In Jefferies we Trust.

2011-11-17T08:55:00.001-05:00

With the Euro crisis as a backdrop, as opposed to the housing/mortgage crisis of 2008, this year's Lehman Brothers has been MF Global, a medium sized commodities broker-dealer, spun off from Man Group a few years ago and which had actually purchased the business from REFCO back in 2005.

REFCO, as many may remember was the subject of a famous meltdown of its own.

MF Global's demise came reportedly due to large leveraged bets on European sovereign debt which didn't pan out. That's tough for MF's stockholders and bondholders, who are probably looking at steep losses.

Here's the graph for MF's 6.25% 2016 bond, issued in August 2011, which basically fell off a cliff in two months.

Like Lehman, MF Global's debt was "investment grade" (Fitch, S&P and Moody's), right up until the nasty stuff hit the fan in late October. Of course, MF was just a triple B, as opposed to a Lehman's AA at the time of its collapse, so I guess we're getting better in the ratings biz. Off topic, this is why I really don't invest a whole lot in debt of financial companies. Very difficult to analyze and foresee these meltdowns.

Still, if it were just the stock and bondholders losing, no biggie. The problem is that the issue is affecting customers also. When brokers go down, customers don't normally lose their money or securities, because these assets are (or should be) segregated and separated from the broker's own. It can be a hassle to get everything set up again at new broker/dealer, but competing firms are normally more than happy to bring those customers on board. Sure beats wining and dining them.

The problem with MF is that apparently those customer funds were not well segregated. There is a reported $600 million "missing" from customer accounts. Big problem.

First off, this isn't supposed to happen. You'd figure that this was a lesson learned from the Madoff scandal (BLMIS was first and foremost, a broker-dealer). Second, this didn't happen with Lehman, where customers were taken over by Barclays and their assets were there. It didn't even happen with Stanford Financial's brokerage arm (other stuff happened there).

So, big black eye for regulators once again. Hopefully the money shows up, but this is kind of like with missing persons. After three weeks, the chances aren't good.

This leads us up to the old crisis equals opportunity adage and the title of this post: Jefferies (JEF). Jefferies is a mid-sized broker-dealer. Not a household name, but well known and regarded in the industry. While checking the company's Sec filings, an analyst at Egan-Jones noticed that the company was long European sovereign debt in an amount equal to close to 80% of JEF's equity and proceeded to downgrade.

The company said "Whoa, wait a minute. We make markets in those bonds and we're short (as in we have to deliver to clients) pretty much the same amount." (they didn't actually say THAT, but that was the message). JEF even went as far detailing positions and showing how they could change their inventory levels if the wish too. In short, JEF pretty much did everything right to control the damage. (Frankly, if you used this same yardstick, where does that leave every European bank?)

However, stock and bond traders have not been understanding and much less forgiving lately and JEF's securities have sold off sharply, opening up what appears to be an opportunity. On the very short end,

JEF's 7.75% 2012 bonds (due March 1) are trading below par, for what would look to be nice pickup for less than four months. On the other end, some of the longer dated maturities are yielding at or close to double digits. JEF is still "investment grade" (FWIW, I know).

While the selling could still get worse, I like the odds on this one and am willing (and have) put down some coins on JEF bonds. Drawing on the 2008 parallels, buying Morgan Stanley or Goldman Sachs bonds while Lehman went down in flames, proved to be an excellent investment. We'll see how this one goes. With 2012s, we'll know soon enough. For the long run, the broker-dealer business model is obviously "under review". Bear, Merrill, Lehman and now MF can't all be aberrations. For now, however, "In Jefferies we Trust".

Sino Forest Epilogue

2011-08-29T10:19:00.000-04:00

Since I already did two posts on Sino, might as well make it three and out.

Last Friday, the Ontario Securities Commission suspended trading in Sino Forest stock, alleging that the company may have defrauded investors by exaggerating its profits and assets.
Initially, the order also called for the resignation of the company's CEO Allan Chan and other officers and directors. That portion of the order was then excluded (apparently the OSC doesn't have such authority), but the CEO and several others resigned anyway.

This would appear to be the argument that ends the discussion concerning this case. But you never know, there are always dissenting opinions and conspiracy theorists. This announcement followed a flurry of news which included a very strange second quarter earnings report in which the company's erst-while rock solid operating margins evaporated, a three-month delay of the "independent review" and downgrades from the major ratings agencies.

Carson Block is looking like a champ. For his part, John Paulson took his lumps like a man. It was big loss for his fund, but he showed he could recognize when he was wrong.
I do feel for the analysts who came out to support the company. Lesson learned, hopefully. Don't trust everything they tell you, sometimes the numbers are simply a lie. Company officials are NOT your friends.

As for the bond angle, there is a bright spot. On Aug 17, Sino paid its 2011 bonds in full. So whoever took a flier on that trade I mentioned in my previous post, made out like a bandit. I wasn't that brave.

Sino stock may be suspended, but the bonds can be traded OTC, as far as I can make out.
My Bloomberg is indicating a 26 bid on the 2014's (the ones I luckily sold at 72). Ouch!

Battle Lines Drawn in the Forest

2011-06-15T08:30:00.010-04:00

It’s been almost two weeks since Carson Block's Muddy Waters report on Sino-Forest accusing the company of fraud.

I’ve been following the case even though I no longer have stakes in the game. There has been an interesting back and forth going on in the comment section of this blog and on other message boards. So here’s another post so that discussion can continue.

A few comments on where I think things stand.

1. The MW report

Substance aside, the report is poorly written. It’s self-serving. (Example: “Were Muddy Waters not to have come along, it is likely that this fraud could have continued for a few more years and billions of dollars more” – is this really necessary?). That lowers its value.

There’s information that is irrelevant to the company’s current situation. For example does some deal gone bad in 1994-96 have any bearing on the company’s value today? Probably not, it’s only there to establish a “pattern” of deceit. Lumping all this together in the report is confusing.

But the main elements of the fraud theory are there. The con itself: inflating profits and assets. The mechanism of that fraud: the use of opaque and undisclosed “authorized intermediaries” to fabricate transactions and profits, instead of selling directly (which would leave a paper trail). Finally, the cover up: a convoluted corporate structure to distract the auditors and manipulating the valuation process of its forests.

That’s MW’s theory. It’s not outlandish and certainly we’ve seen bolder scams go undetected for much longer. It could be wrong, of course, as is the case with every theory.

Now a lot of people are asking MW to “prove” their theory. That’s tremendously unfair. To do so, MW would have to have access to all of Sino-Forest’s records and books and be sure they were the “real” ones. That’s not going to happen.
They also can’t ascertain completely the scale of the scam, for the same reason. It could be that MW’s right and billions in assets are missing, or it could be more (or less).
The report says as much (“…without the aid of law enforcement, we will never really know how much money is there or where it went.”). You can’t fault them for that either.

What MW did was look at the evidence and put the pieces together for their theory (feathers, waddle, beak…hmmm).

Mr Block is being “made the villian” by those on the other side of the trade, which again, in my opinion, is unfair. Among other things there is a line of thought, that regardless of the outcome of investigations, Sino-Forest has been “mortally wounded” by his allegations.

Now, frankly the whole idea that you can “destroy” a company by spreading “false” rumors or information is hogwash. If the information turns out to be incorrect, then the company was what it said it was, and the markets will value it accordingly. If the allegations are true, a fraud has been exposed (hard to see the downside in that!). Even financial institutions, which are deemed to be more sensitive to “breaks in trust”, usually bounce back quickly once the air has cleared.
Sino-Forest’s stock has tanked. But lets be clear, a stock price does not a company make. Certainly not in the short run.

2. Company Rebuttal

After initially ignoring the allegations, the company took steps to address the situation. To look into the allegations they appointed an independent committee. That committee is only independent in the sense that it is comprised of “independent” (i.e. not working for the company) board members, but hardly “independent” in a third party sense, since those directors are probably still liable if fraud is present (self-incrimination, anyone?). The committee will be “assisted” by PriceWaterhouseCoopers, which is a good idea since using Ernst & Young, the company’s auditors, who also may be looking at some hot water, would hardly be independent enough.

Still, it’s important that PwC produce and sign off on any report for it to have any kind of credibility. Statements by the company or documents produced by the company without any third party independent (really independent) verification are automatically suspect.
The report is expected to take at least three months to complete.

The company also made some documents and information available to analysts and the public, but kept secret about others, such as its customers’ names and the location of its forests. That’s ok. They have no obligation to disclose this information to analysts or anyone else. When regulators and auditors come knocking, however, that’s a different story.

3. Others Chime in (or not)

The analyst at RBC Capital Markets, Paul Quinn, came out Friday (June 10th) with a very favorable opinion (Outperform – Evidence mounting in Sino’s Favour). Another analyst Richard Kelertas at Dundee (Canadian Firm, recently acquired by Scotiabank) called the MW report “a pile of crap” and was quite adamant in his support of the company (“we believe in the company, we trust the company). Of course, these guys have their reputation at stake since they have been following and recommending the stock for years. Since 2004 in Kelertas’ case and RBC has had an outperform on the stock since May 2009. Both firms reportedly did underwriting for Sino in its 2009 stock offering.

But they are not the only ones who did business with Sino. Credit Suisse, Merrill, Morgan Stanley and others were bookrunners on Sino bond and stock deals. So you can’t really use that as a rationale for the analysts’ positions. No, these guys truly believe what the company is telling them. I can relate. When I worked as an analyst there were some companies I followed for up to ten years and weren’t followed by anyone else. The execs knew me and I knew them. They’d show me the installations, tell me anecdotes and give me certain information that would never be “on the record”. Friends? Maybe. There was a certain empathy. The work’s easier when it’s not confrontational. But let there be no doubt about it, they would lie to my face if that’s what was their interest. And they did. After you get duped a few times, you learn to be a little less trusting and keep some distance.

Other analysts have been somewhat more skeptical. Annisa Lee, an analyst at Nomura Securities had put out a skeptical report already several months ago, well before the MW report. (and was reportedly cut off at today’s conference call). Morgan Stanley’s Vivien Gui also released a note (which didn’t get much press from what I see), which was called “my unanswered questions” and spotlighted doubts about the company’s scale, the location of its forests and the business model.

Then there is the enigmatic presence of Paulson with his large position. He is obviously attentive to what is going on, and reportedly has been supportive of the company. Unfortunately, he is “trapped” in a sense. Here’s why: my first impression was that Paulson should get his hooks in the committee and in the investigative process, to better assess where he stood. Ah, but by doing so, he would become an “insider” with the legal implications that that entails and thereby freeze his position. So, aside from laying blind bets in either direction, Paulson doesn’t really have any option but to wait.

At this point, the only ones who really know the situation are the company insiders. That is probably only a handful of execs. If there is fraud, the outside directors are probably clueless. (I’ve been on boards, the information you get is distilled more than a good scotch whisky). Ernst & Young, the company’s auditors, should know by now if they have been duped. You can bet that the first thing they did when this broke was to call in the Sino audit team and go over every sampling and every piece of independent verification that may be missing or suspicious. If something important got past them before, they now know what it was. Unfortunately since E&Y’s nuts are in the boiler, they won’t utter a word until they have checked and re-checked EVERYTHING. Don’t expect them to talk anytime soon. But they know…already.

4 The Bond Angle

Sino’s stock hit a new low today, but since I like to blog about fixed income and there aren’t a lot of bond blogs out there, I thought I’d chime in on some interesting movements in Sino’s bonds.

The 2014 bonds which my clients held (and the 2017s which they didn’t) have stabilized in the 60-70% range since their initial fall. One could interpret that as players assessing the best case scenario (no fraud full recovery) and the worst (partial recovery even if stock goes to zero) and looking for some middle ground.

2014 Bonds

The 2011 bonds, however, have rebounded sharply from a low in the 60% range to a recent price of around 90%. There would appear to be another dynamic weighing in this case. These bonds are due Aug 17 and there is only $87 million outstanding. Therefore, even if investigations finally reveal that Sino is a fraud, there’s a good chance these bonds could be paid before the results of those inquiries come to light. A play on the lack of expedience of the due diligence, if you will.

2011 Bonds

I’m not recommending it, but there’s is an alternative for Sino bulls to simply going long the stock, if you want to take it.

That’s where the Forest stands (or doesn’t) at this time. The other comment thread was getting too long, so please continue that fine discussion here. Go at it, just keep it civil.

Bitten by a Chinese Duck

2011-06-06T17:10:00.003-04:00

Sometimes you see a duck for what it is. Sometimes you take it for what it tells you it is.

The story of the week and perhaps the year is Sino-Forest. This is a Canadian-listed stock, but the company has forestry operations in the Peoples Republic of China.

Last Thursday, a research group called “Muddy Waters” put out a 39-page report on the company, stating in no uncertain terms that the company was a fraud. The company also has no qualms in saying that they are short the stock, and stand to gain financially if their allegations prove true.

Here is their website. You can download the report. Muddy Waters

This case got my attention for an obvious reason: I have stakes in the game. For disclosure purposes, a few of my clients owned some Sino-Forest bonds (10.25% 2014s). Bonds are rated BB by S&P, which makes them junk, but really good quality junk (two steps away from investment grade).

I went back over my notes to see why we bought these bonds back in 2009. Actually we didn’t buy these in particular, but received them in exchange for a shorter maturity paper. Anyway, at the time it looked like a good deal. The company had a very strong balance sheet including a great amount of cash, plus solid and consistent earnings. Those earnings are what struck me as the most positive, because I used to work for a paper company and I know a little about the industry. It’s a tough industry to make money in consistently. But Sino-Forest did and with very strong margins, so more power to them. Financials were audited by Ernst and Young, a big North American firm, so despite being a Canadian Firm born from a "reverse takeover, I thought it was ok. So I laid some coins down for my clients. Not a large bet, by any means. We always diversify a lot. Because stuff happens.

So now this report comes out. The stock plunged (although today it’s on the rebound). Bonds plunged. I downloaded the report and went over it on the weekend. I won’t lie and say I understand every detail. But there is a lot there. Mainly, an explanation of why those profit margins were so generous (they’re false!). Plus there are details about why certain representations that the company makes about its operations, such as size of the plantations, volume of sales, etc. are not realistic. It’s a very complete report.

The company is out today in full denial, offering details about their assets, including the original titles to their plantations. Questions have been raised about the authors of the report and their motivations.

After reading the report and looking over my notes, I fully expected to not being able to unload my clients’ bonds this morning. But lo and behold and bless the market makers souls, there was a market for them this morning, and I managed to unload them at 72%. Facing a possible total wipeout of the investment, this was a windfall for me and my clients. I am very satisfied. Of course, I could have held on and waited for explanations from the company or some sort of recovery in the case of bankruptcy. I preferred to accept that potential "duck bite".

There’s good reasons to give credence to the Muddy Waters report and I’ll give a few. I’ve been sort of in these guys shoes, so I can relate.

These guys are not hiding.

This is not a random anonymous blog or post on a message board. Serious time and money was put into this report and the research to make it happen. Please, let's focus on the “what” and not the “who”. When I was being questioned about that bank report back in 2009, the reporters seemed to be more interested in me than what my report was implying.

The analysts at Muddy Waters have a lot to lose if they are wrong. They face fines, jail time, etc. They are totally in the open on this. They also can't just go and cover their shorts now that they are on the record. They have more than money on the line. They are sure, very sure.

It’s a murky business.

“If it’s so profitable, why isn’t everyone doing it”. There are few competitors in the business, but Sino-Forest is the largest by far. Another company China-Forestry, turned out to be (surprise) a fraud. That said, if the business were so good, there'd be more competition and margins would drop at some point. Hasn't happened (according to the company).

Too good to be true.

Ah. Those profit margins. Yes, there is great demand for materials in China, and I’d assume that’s true for wood chips. But if your margins are this big, it has to be that you worked your forest for several years (grew/planted). But most of Sino’s forests were recently acquired. You can’t have you cake and eat it too. Either you worked the forest and are entitled to those large margins (the time factor, if you will) or you didn’t and the margins should be lower. You shouldn't be able to make this kind of money by just "flipping" a forest.

The Cash, the Cash!

One of the things that drew me to Sino-Forest bonds can also be a great litmus test. The cash. There is supposedly over a billion dollars in cash on the balance sheet. If Sino’s profits are false, that money is going to be missing somewhere. It’s either going to be in the value of the forests or in the cash balances (or both). Of the two, the cash is the easiest to check. If the cash isn’t there, we will know its all a lie. (Have these guys provide certified bank statements? I'd need to see those, ipso facto).

There is more than what is said.

Although the Muddy Waters report is extensive, it probably doesn't contain ALL of the analysts’ suspicions and red flags. That’s usually the case. You only put down on paper enough to drive your point and what has the best documental support. The research is much more extensive and probably includes a ton of anecdotal information which is not in the reports because you can’t really put down things that don’t “seem” or “feel” right or for which the evidence isn’t totally conclusive. Again, I can relate. That whole picture, however, is what allows them to be comfortable with their conclusions.

Of course, I don’t know anything for sure, since I didn’t do the work. You never know for sure. Analyzing from the outside is difficult, because you don’t have access to all the information that goes into putting out the company’s financials. You can’t really go asking the company for access either, as in “would you mind if I checked your books for fraud?”

Nobody likes to accuse anyone else of wrongdoing, even in the face of overwhelming evidence, for many reasons. It’s mean and most good people don’t like to appear being nasty or not giving the “benefit of the doubt” to the offender.

So here’s the question that I ask when a straight one way or another answer is required: “If your loved one’s life depended on your correct (not politically correct) answer, what would you say?”

With that on the line (which fortunately it is not), I’d lean towards calling Sino-Forest a Canadian/Hong Kong duck. If so, it will set a new standard for Asian Fusion fraud cuisine. We shall know soon enough.

This one bit me. Ouch.

From Russia with Bonds

2011-04-17T21:15:00.001-04:00

All investors have their favorite themes or "guilty pleasures". In my case, it's Russian bonds. Despite a troubled past and lots of questions about the future, I seem to feel at ease laying down cash on Russian names and enjoy the pickup over counterparts from other parts of the more "developed" world.

This affinity was only reaffirmed during the credit crunch of 2008-2009. When other countries were scraping for answers and cowering from creditors, the Russians showed some pride and put their reserves where their cojones were. Here's the graph:

During 2008, Russia went through about 40% of its international reserves. And while the financial press was portraying that as a weakness, it was quite the contrary. Russia was telling its local entities and companies: "look, if you need dollars to pay off your international creditors, come and get them". That's

kind of what international reserves are for, after all. They certainly gained the respect of this bond junkie.

The yield nowadays are nowhere near what they were doing the crisis, but I still feel comfortable with Russian bonds and will indulge in my "guilty pleasure" quite often.

For example, in the telecom space, instead of AT&T, Verizon (US) or Vodaphone, I'll take some Vimpelcom or Mobile Telesystems, thank you. With a nice pickup in yield, to boot. (Russians are more cellphone-maniacs than any other country, BTW).

In the energy realm, instead of thinking BP, Exxon or Chevron, how about some Gazprom, which is half owned by the Russian government anyway? Or Lukoil or TNK-BP?

Want something more exotic or risky? How about Alrosa (Diamonds) or Evraz (steel).

Here's a few individual bonds by these issuers.

Finally, here's an excellent clip portraying the history of the soviet union, to the music of Tetris.

Enjoy!

REG S'ed

2011-01-30T09:33:00.003-05:00

A couple of months ago, my wife came into the office to look for some files and thought I’d strike up a little conversation.

“Honey, did you know that Jordan is coming out with some bonds?”

I knew she’d be interested since we had visited Jordan in December 2009 and enjoyed the country very much.

“I’d like to buy some” she replied, even though I hadn’t told here what the terms were (not really exciting by the way).

“Sorry, but you can’t” I answered. “It’s REG S”.

It’s usually not a good idea to tell my wife she can’t do something, because she’ll just want to do it more. I knew I had to explain. (So here is kind of what I told her.

What happens is that in order to avoid going through the lengthy, complicated, bureaucratic and unpredictable process of registering a bond with the US SEC, many issuers will do what they call a private placement. They do it under REG S, basically promising that they won’t market or sell the bond to US Persons (citizens and legal residents). So the SEC leaves them alone.

“So I can’t buy it because I’m a US Citizen?” she said.

“Yep”

“That’s not fair” (you knew that was coming). “This is supposed to be the land of freedom” (and the capital of capitalism, I might add).

“Can I never buy these bonds?”

After a year you supposedly can, but good luck finding them or someone willing to sell them to you. Buying in an initial offering is normally a good deal also; the bonds routinely will trade a bit higher right after they’re issued. Sometimes the issuer will register the bonds with the SEC and make them available for trade on US markets, but they don’t have to.

“What about US companies? I can buy their bonds, right?”

No, not really. A lot of those, probably most, are REG S also. Even US companies figured out that it’s a lot easier to go that route and avoid dealing with the SEC.

I added that big US financial institutions could get in on most of these deals, even if my wife couldn’t, through a rule called 144A, which allowed “Qualified Institutional Buyers” or QIBs (not to be confused with Squibs, which are sons and daughters of magical parents who have no magical powers of their own), to participate in private placements also. So my wife needed not feel bad for Goldman Sachs or Morgan Stanley. They weren’t being left out.

By now my wife was very upset, she could do without buying Kingdom of Jordan 2015’s, but she did not like the to see her choices conditioned. In the world of investing, she was a second-class citizen, just for being a US citizen.

“I don’t understand. Why would the SEC do something that discriminates against US citizens?”

They do it to protect you. God forbid that Jordan or Dell Computer or someone else file their forms without all the right disclaimers, provisions and explanations that you are never going to read anyway.

“I’m really sorry I can’t give you a better reason.” I said as she left.

Of course, REG S, is just another example of regulatory patchwork, enacted in the 1990s to deal with exceptions and which ultimately became a rule. Along with security laws dating from the 1930s, which regulate markets and procedures inherited from the 19^th century and before, you could think that the whole system was due for revamping.

Maybe we could use something more atoned to a global marketplace where information flows almost instantaneously. Things have changed in the last century or so (you’d think).

Don’t hold your breath. The current system serves the financial industry well. Very well. The recent events concerning Goldman Sachs’ private equity investment in Facebook illustrate the point.

As you may recall, Goldman agreed to invest $500 million in Facebook, through an ad-hoc vehicle. Goldman’s clients would then be allowed to participate in that vehicle and hence invest indirectly in Facebook.

Sounds like something to “like”, right?

The SEC then decided they should look into this deal a bit closer and perhaps force open Facebook’s private “books”. Facebook wasn’t quite ready for that level of information sharing with the world, so Goldman said “REG S”, which translated means “SEC, bug off”.

Vampire Squids 1, Regulators 0. Regular investors: DNP. (Do Not Play).

(The photo is Vampyroteuthis infernalis or the vampire squid from hell. Unofficial mascot of Goldman Sachs).

State of the Junk

2011-01-15T13:31:00.002-05:00

Happy New Year to all. Two-thousand ten was a very good for junk bond investors like myself. Not as fantastic as 2009, but we’ll take this kind of performance any day of the week and twice on Sunday.

The FINRA-Bloomberg High Yield total return index was up 12.2%, for the year, on the heels of a 46% gain in 2009. Not bad.

There are numerous indices out there and this one just happens to be available and free. HERE

The equivalent Investment Grade index did quite well also, yielding 6.5%, even if it did give up some gains towards the end of the year.

For 2011 there are some things to look forward to and some issues to worry about.

Positive for junk: improving economies lowering default rates . Positive for bonds in general: rock-bottom short-term interest rates which continue to force investors to move up in risk to lock in yield.

On the worry side: Big Ben at the FED. Ben’s latest folly, called QE2, as in quantitative easing two or too (take your pick) is a fresh round of dollar printing from your favorite bearded guy.

Jon Stewart analyzed this to perfection last month, but here it is for those who missed it.

The Daily Show With Jon Stewart

Mon - Thurs 11p / 10c

The Big Bank Theory

www.thedailyshow.com

Daily Show Full Episodes

Political Humor & Satire Blog

The Daily Show on Facebook

I know there is a lot of debate over QE2, but I come from the third world, where we have been lectured for decades by first-worlders ad-nauseum that we can’t do this crap and get away with it unscathed.

Now, el Central Banker Numero Uno del Mundo is telling us that he can. Color me skeptical. This is going to come back and bite us and bond investors need to be aware.

When? Not Yet. How? Now sure. Stay tuned.

For now, it looks like us junk collectors will be fine in 2011, although it will be hard to keep up with the equity markets (so don’t try!). After that, it could be plan B time.

As for the photo: a cute little squid of the genus Stoloteuthis from the Indian Ocean.

Betting with Paulson

2010-10-27T14:11:00.001-04:00

At times, investing in the gaming industry can be a gamble (/corny opening line). Not that it really has to be that way. Like any addiction, gaming produces quite stable cash flows once the business is up and running and a customer base and a location has been established.

The threats are there, of course, with the expansion of licenses from revenue-hungry governments and the ominous Internet. Still, “if you build it, they will come” has worked relatively well in the past, so who are we to question its future applicability.

That said, gaming is a place where high yield thrives, since, not unlike gamblers, casino operators love to “double down” with plenty of leverage.

Where there’s leverage, there’s “credits” (as the pundits like to call bonds these days) and opportunities for bond investors (somehow credit investors doesn’t sound right) to throw some chips into the fray.

Start with MGM Resorts International, which owns a good chunk of the Las Vegas Strip (Bellagio, Mandalay Bay, Monte Carlo, Luxor, Grand, etc.) plus casinos and resorts around the rest of the world. Lots of property with a ton of debt, and booking substantial losses. Still, it’s a name I like, since the cash flow is good, and the company has shown financial agility. They have sold property to raise cash and recently announced they would issue new stock to the market. That’s always good for bond investors. In addition, Hedge fund manager John Paulson picked up a 9%+ equity stake earlier this year. Not fresh cash, but it’s always reassuring to have a guy like Paulson below you in the capital structure.

For MGM bonds, there are a number of choices, ranging from senior secured (the least risky in case of default) or the subordinated, which may not fare well in such a case. I listed a few on the table below. Personally, I like the subordinated 2013’s, because you might as well go “all in” if you think bankruptcy is looking like a long shot. But in any case, all these bonds have rallied over the last year and the easy money is over.

Second up is Harrah’s Entertainment, which is a behemoth like MGM, only larger and with less concentration in Las Vegas and more property in Atlantic City (not a good thing). Harrah’s was taken private in 2006 by private equity firms TPG and Apollo, which then proceeded to load it up with debt. That’s standard procedure in these cases. It’s also standard procedure for these takeover specialists to screw over those debt holders if necessary and convenient. That’s also not a good thing. Still, as we stated above, this is a business that generates cash, apparently even in Tunica, Mississippi (where Harrahs has THREE casinos).

Still, it’s not enough to make a bondholder comfortable (not that we ever are). So, once again Paulson to the rescue. Paulson’s fund(s) recently picked up a nice chunk of Harrah’s debt (over $800 mm) and agreed to exchange it for equity. For bondholders that’s a good thing since it means some deleveraging, if not a whole lot. Harrah’s LT debt is close to $20 billion. The company is planning to go public with its shares shortly, and from the preliminary prospectus, it appears they will be selling an additional $575 million in shares to the public. That would be a good thing, since it would mean more deleveraging.

Still, count me as a bit skeptical on Harrah’s, and I’d prefer the secured bonds, which still are offering a very hefty yield. That would make it good for a couple of chips.

Here's a BST oldie to get you in the gamblin' mood.

Converting to Solar

2010-06-28T19:21:00.002-04:00

Financial bubbles, not unlike supernovas, leave reminders of their explosions throughout the market Universe.

A bubble in alternative energy, and particularly Solar stocks grew quietly in 2006-2008 and burst pretty much in tandem with other bubbles such as the one in housing.

What were boom times have turned into dark times for solar companies, as competition is fierce and subsidies have been subsiding. Many of these companies are Chinese, so the Yuan’s recent revaluation has become a new concern.

But solar companies did take advantage of the demand for their stocks during the boom to raise capital and finance their activities, Solar panels may be shiny, but they don’t manufacture themselves.

During the brief boom, a very popular financing option for solar companies was issuing convertible bonds. Their stocks were on a tear, so the companies (wisely) decided to give up a bit of their potential stock upside for some cheap (low coupon) financing.

And so they did.

Fast-forward two years later and these convertibles are “busted”. That is, the market price of the underlying stock is so far away from the equivalent conversion price, that the convertible component of the bonds is practically worthless.

Nonetheless, they are still bonds, still pay a coupon and (fingers crossed) will repay principal at maturity. Now trading at discounts to par, the yields are enticing and these bonds have the added attraction in that a good portion of the total yield will come in the form of capital gains, which for many taxpayers implies a lower rate and pushing the taxable event a bit out into the future.

Here’s a table of some of the solar convertibles out there. Like always click to make it bigger.

With the exception of Trina Solar, whose convertible is in the money, the others are pretty much straight bonds now, so the main issue is whether or not they will be able to pay. In general, the prospects of that are not bad, since most of these companies are not excessively leveraged and could tap the markets for equity or new debt when time comes to roll over.

(As always do your own due diligence, and your mileage will vary).

Even Evergreen Solar, which appears to be the most vulnerable on the list, has a positive tangible equity in its books. Of course, ESLR has yet to make a profit, so keep that in mind.

My personal favorite is LDK Solar, which has been reporting profits and whose convertibles have a put provision that can shorten maturity by two years. Trading around 85% makes for a 26% yield in less than a year, if you exercise that put. Not very liquid, but if I managed to find some (and I did), they can’t be that scarce.

Energy Conversion Devices is another that looks “overlooked”. The company took a huge (non-cash) write-off recently, which affected the stock and general perception very unfavorably (some analysts consider their technology outdated). But there are believers and the company recently did some private debt/equity swaps with the convertibles (below the strike price, obviously). Although such an action is dilutive (and not great news) for stockholders, the more of those they do, they better chance bondholders have of collecting ultimately.

Of the others, JA Solar would seem to be the least risky and Suntech Power, the best value.

So, there you have it, a “green” alternative to my previous oily suggestions. May the daystar shine radiantly on your portfolios,

Spill Bonds

2010-06-13T19:12:00.007-04:00

It seems the whole planet has been watching the Gulf of Mexico oil spill. The world cup may provide a much-needed distraction from that unfolding disaster but in any event, analysts and traders are fast at work trying to find ways to make money in the oily turmoil, without appearing to be too oblivious to the plight of shrimp fishermen and seabirds.

Most of the work has centered on stocks, but like always, there is a bond angle to this also. Let’s “explore” and “drill down” to details.

First: the good guys, those trying to clean up this mess. Clean Harbors (CLH) is a name that comes to mind. Its stock is up over 20% since the spill. Its 2016 bonds, on the other hand, have traded flat. If you’re happy with a 7% yield on a BB- rated bond of a company whose prospects were fine and just got a lot better, there’s an idea for you. Clean and simple. The issue is a bit small ($300 mm), but it does trade (Reg S 144A only for now).

Now. the evil enviro-killers. BP jumps out first, of course, While much has been make of BPs stock slide, its bonds have sold off also. Here’s graph of the yield on BP’s 5.25% , 2013s as an example.

BP is still rated AA- by S&P, although we’d expect a downgrade at some point. In any case, the possibility that this spill will send BP into bankruptcy has to be extremely remote. The highest clean up cost estimate out there is $15 billion, which is huge amount of money. But BP can afford that, the company made $20 billion in profits last year.

At the bottom of this post there’s a list of oil spill bonds including some BP USD issues. BP also has issued bonds in Euros, Yens and Sterling, so the whole world can get clean up on what appears to be a temporary bargain.

BP may be the main target of the “spilling fields” disaster, but not the only one. Transocean (RIG) owns the Deepwater Horizon rig, which is leased to BP. Transocean will probably have a bill to pay in this fiasco too, but they too can afford it.

RIG bonds have been submerging also. Here is the yield on the 5.25%% 2013s. Quite a spike.

And there has been substantial “collateral damage also”. A company like Hornbeck Offshore (HOS), which doesn’t drill itself but operates supply vessels to the rigs has seen its stock and bonds hit. Several clients are reneging on their contracts alleging “force majeure” in the offshore drilling moratorium, but HOS isn’t buying that and is countersuing. The bonds have sold off and there is a nice buying opportunity, since the company’s balance sheet is still quite acceptable.

Then there are cases like McMoran Exploration (MMR) and Energy XXI (EXXI). These companies have operations on and offshore in the Gulf area, but the offshore ops are “shallow water”. Shallow water is a whole different animal when it comes to oil spill risk and the ban has been lifted for shallow water already.

Yet Another Update on My Wife's Junk

2010-05-09T11:58:00.010-04:00

Last year I blogged about the junk bond portfolio that my wife put together all by herself (mostly). LINK. I also ran an update on it later in the year. LINK.

This is what that portfolio looked like last time I updated: (click to enlarge)

A few things have happened since. First and foremost, everything went up. A lot. The portfolio gained 45% in 2009 and is up around 5% so far this year. Not that my wife was keeping count. She’s content to just clip coupons. I’m the one doing the counting.

Second there were corporate actions. Starwood Hotels (Sheraton) made a tender offer (accepted) and Jo-Ann Stores called its bonds.

In addition, the Alcoa and Seagate Bonds rose enough in price to trigger the “mortgage” sell signal. That signal basically states that if the bond pays less than our (tax-adjusted) mortgage rate, sell it and either buy something else or pay down the mortgage.

In any case, she decided not to pay down the mortgage, but rather to buy some more junk.
What to buy?

For starters, she selected SmithField Foods, a company I blogged about around Thanksgiving. That’s good because it means she actually reads my blog. When I mentioned that she already had two food companies in Dole and Chiquita, she said “What do Pineapples and Bananas have to do with Turkeys?” OK. Point Taken. Of course, coming from a vegetarian, who knows?

She did take my advice on her next purchase. I thought she could have an energy company in the portfolio, so I showed her several options. There are quite a few smaller oil and gas producers and refiners with bonds in the market at attractive yields. She chose Clayton Williams Energy, an oil and gas company with operations in New Mexico, Texas and Lousiana. Hopefully, for my sake, that well doesn’t come up dry.

Finally, she got motorized with her last two picks. First, Ford Motors, which has been doing much better lately and is benefiting from the troubles that Toyota is having. Ford bonds were huge winners last year, but still could have room to run.
Second, Avis-Budget Rent a Car, which is a highly leveraged situation, but my wife figures if they try harder they’ll pull through.

Here’s what the portfolio looks like now:
Click on the table to enlarge:

It’s a bit junkier, longer in duration and the overall yield is lower.

Only averaging about 7.56% now. But confronted with the alternatives: bank CDs at under 1% or taking her chances on the stock market, she says she’ll stick with her junk for now. She’s happy just to collect the interest. Market crashes? She's like "What me worry?"

That being the case, she should be able to sit tight and just clip coupons for another year and a half until her next bond matures. We’ll see what the world looks like then. Maybe it will be time to pay down the mortgage.

As for the photo. Yes, that is my wife. I married up, I know.

Getting up to speed

2010-04-22T08:14:00.003-04:00

I haven’t blogged for a while, so I thought we’d catch up on some things written about over the past year or so.

First, bonds in general. LINK. There is no doubt that corporate debt has been the asset star of the last year or so. While stocks have made their way back and are closing on their high-water marks, most bond portfolios and funds are hitting new highs.

The category is still very much in favor and there is some value still to be found. Don’t get too greedy and you’ll be ok. There are a lot of new issues coming to market both in the developed and emerging markets, so there is quite a bit to choose from. The big gains are over now, its coupon-clipping time.

As for more specific issues, our friend Borat must be happy. LINK. Kazakstan’s sovereign risk is now lower than many Eurozone countries. Not only Greece (duh), but Hungary , Portugal and almost Spain. The fact that Kazakh debt trades better than California’s was widely remarked in the press. LINK.

In Ukraine, things have calmed down. Elections were held in January/February and the pro-Russian candidate Victor Yankovych won a close second-round victory over Yulia Tymoshenko, despite her good looks. LINK. And so the “Orange Revolution” was reversed. Tension between Russia and Ukraine which contributed to the “gas war” between Gazprom and Naftogaz has come down dramatically and there are even talks of joint ventures. LINK. Russia has agreed to give Ukraine a price break on the gas it consumes, while Ukraine will extend Russia’s lease on its Black Sea Naval ports. LINK.
Naftogaz bonds, which defaulted briefly in October (swapped for new issue- LINK) are now trading at 108%. I remember an analyst stating that he “wouldn’t be surprised if the new Naftogaz bonds were trading above par in less than a year”. Oh wait, that was ME.
Isn’t it nice when neighbors get along?

As for corporate issuers: AIG and its subsidiaries are still current with their bonds all of which have rallied sharply. LINK. LINK. LINK. An important “turning point” was reached when airplane-leasing subsidiary ILFC returned to the bond market, thereby reducing the refinancing risk of its outstanding bonds. LINK.

Herrtz quietly dropped the suit against an analyst who had named the company as a possible bankruptcy candidate. They figured out it would only get them bad publicity. Took them a couple of months to figure that out. LINK.

Despite my skepticism, Kodak’s bonds and stock have rallied, as the company raises cash selling or licensing some patents and is trying to raise more by suing the likes of Apple and Research in Motion. I could have held on…oh well. LINK. LINK.

The price of Gold has stagnated, ruining a speculative gold trade I had set up, Sometimes investors DON”T go bananas. Especially when you expect them to. LINK.

Venezuelan bonds have rallied of late, but still yield much more than their credit rating would suggest. What good are the numbers if you can’t believe them? LINK.
Analysts are looking at a $1.5 billion bond maturity in August, as Central Bank reserves drop.

Blockbuster and Netflix continue their lopsided battle. The Hollywood studios have realized that Blockbuster’s survival is in their best interest. How much they will help keep Blockbuster away from bankruptcy remains to be seen. Anyway, the four trades proposed back in February are winners at this point. LINK. LINK.

Now that we’re up to date on these trailing issues, maybe we can move forward and I can get around to blogging more consistently.

Life After Japanese

2010-03-22T18:38:00.008-04:00

Not breaking news, but I wanted to mention that Japan’s population is shrinking. This is hardly unique in the world, since a number of other countries are also suffering from population decline, mainly in Eastern Europe. What makes Japan different and has demographers all over the world (all 25 of them) drooling in anticipation, is that they were expecting this, and there is really isn’t much Japan can do to avoid a dramatic depopulation in this century on a scale not seen since the bubonic plague ravaged Europe in the 1300s.

Here are the projections. It’s a really great graph, so click on it, put it in a big window and take some time to look it over.

The estimate is that by the year 2105, the population in Japan will have plunged from its current 127 million to around 45 million. A 65% drop for those keeping score. The action has only gotten started. Last year, the population decline was a modest 75,000, but by the end of this decade the yearly decline should be in the 500,000-1,000,000 range.

Driving the pop- drop is a fertility rate that has been in a steady decline for about 35 years, when it slipped beneath the “replacement rate” of 2.1 births per woman. It currently stands at 1.34, but even if it were to rise again, population decline would still occur since there are fewer and fewer women of childbearing age.

The social reasons behind the fall in fertility are basically that Japanese women don’t want to get married and much less have children. And who can blame them as one Internet poster put it:

“Fewer Japanese women having babies because they don't want to get married to childish Japanese men. Also, babies are expensive, and why bring a child into a world with a looming threat of Godzilla?”

Working women come home after 12- hour workdays to wait on their husbands and kids. Grandparents could babysit, if they weren’t busy taking care of their own parents.

For years, the central and local governments have been extending financial incentives for women to procreate. But you have to question the commitment when it wasn’t until late 2008 that childbirth was even covered by medical insurance (it’s not an illness).

Naturally, not everybody sees depopulation as a bad thing. Japan is still one of the more densely populated countries in the world and when they sought to “reach out” into the world for a little elbow room, the results weren’t pretty.
Still, the process is going to leave the country with a disproportionate number of elderly, and many are worried about that.

Immigration has been the answer for other societies in this pickle. But the Japanese seem to love their monoethnicity and a massive immigration program is unlikely to garner popular support.

Cruel and insensitive internet posters have suggested remedies such as subjecting Japanese males to “tenderization”, by forcing them to watch Sandra Bullock romantic comedy marathons Or spiking the water supply with ExtenZe. Very funny, guys.

Why am I blogging about this? It’s interesting and something to be considered when investing. When Japan’s population is headed for a fall off a cliff, one can hardly expect the Nikkei to bounce back to its 1989 highs (almost 40,000 then, it’s standing at 10,800 now). I know I’ll think twice about buying Toyota stock. (/Investment Theme Justification)

Rural Japan is already feeling the effects of depopulation. If you’re into this kind of thing, here’s a fine blog called “Spike Japan”, depicting the desolation setting in on the countryside. Great depressing stuff.
It’s almost like a preview from the series “Life after Humans.”
Enjoy.

Too Puny to Succeed

2010-03-13T23:32:00.004-05:00

Now that banking reform is beginning to be discussed in Washington, much of the conceptual discussion about new legislation surrounds “systemic risk” and “too large to fail” institutions.

Left behind is another structural challenge that faces regulators: “too puny to ever succeed”.

The FDIC puts out quarterly banking statistics, which are quite a good source for stat buffs like myself. LINK.

Here’s a tidbit: as of December, there were 8,012 banks in the US, with over $13 trillion in assets.

I know large numbers are difficult, so I’ll say it again: EIGHT THOUSAND BANKS.
That’s a lot of banks. I mean, how many banks do you really need? Obviously something very wrong happened on the way to industry consolidation.

The UK consolidated its banking industry in the early 20th century. Other countries, like Germany (with over 2,000 banks) have yet to see the shakeout. The US is on its way, with the total slowly coming down from over 14,000 in the 80s. But there is still a long way to go.

Here’s a pie chart with the banks by size.

What stands out here is that there are 2,845 banks with under $100 million in assets and almost 4,500 with under $1 billion. I know a billion sounds like a lot, but in terms of the total market, it represents less than 0.01%.

So we’re talking about a market where 92% of the market players are puny. Individually, they are tiny, minute, and perhaps insignificant. As a group, however, they control 11.5% of the system’s assets, including 17% of the real estate loans. (Can you say “systemic risk”?).

So what? You may say. More competition is great and it leads to greater efficiency. The fact is that in an efficient marketplace, these banks have no chance of long-term survival in their current form. Just think of the characteristics of the industry:

Retail banking has commoditized/standardized products and services. A checking account is still a checking account (even if people don’t write as many checks anymore).

Economies of scale exist. Processing two hundred transactions or whatever costs less per transaction than processing one hundred.

Technology has not only drastically reduced transaction costs (enhancing economies of scale), but is destroying the geographical barriers that protected the small fries. Let’s face it, do you really need to go the bank (branch) anymore? If a bank’s competitive advantage is being “close” to the consumer, how much closer than a click on your computer screen?

Close to 100,000 bank branches operate throughout the US, but although their number continues to grow (slower now), branches are shrinking in size and staffing. Last year, the WSJ reported that Bank of America was going to close 10% of its branches. The report was later denied by the bank, but you have to believe that the issue has been discussed in the bank.

BTW, just to get an idea, there are about 30,000 supermarkets in the US. Three bank branches for every one supermarket, seems a bit much, IMO. LINK

In any case, industry consolidation is now accelerated by the credit crisis. The FDIC can’t shut down these micro-banks fast enough. Of the 30 banks closed by the FDIC this year, 25 have total assets of less than $1 billion. Their challenge has been finding “less puny” and financially stable banks to absorb the operations of these failing banks.

So long Waterfield Bank, Marshall Bank, Evergreen Bank and Charter Bank (etc etc).
We hardly knew ye. You were too puny to succeed.

Whither Junk?

2010-02-21T13:08:00.005-05:00

The beginning of 2010 hasn’t been quite as smooth as most of 2009 was for the junk bond market. Some fear here and there, a pulled deal or two and risk spreads have widened a bit.

However, there is nothing really dramatic in this pullback. So far this year the FINRA-Bloomberg High Yield index is still up about 0.2%, but it’s 1.6% off the high achieved on Jan 11th. Compare that to some stock indices, a few of which (Spain) are down double-digits for the year and you’ll see junk has suffered only a “mild setback” in comparison.

Naturally, after a year that saw this index rise 44%, expectations might be a bit exaggerated not only from those riding the wave, but also from those anticipating a fall from those perceived “heights”

Still it’s always good to reassess one’s position. And mild or not, a setback is a loss and nobody wants to lose. So what now?

After thinking it over for about two minutes , I’ll be sticking with my junk for now thank you and here’s why:

1. The alternative is nothing. Not saying that there is no alternative, but if you’re
looking for something “safe” a 12-month FDIC insured CD at Bank of America is paying 0.80% APR. Two years: 1.11%. It’s quite ridiculous. Sure, bonds (and junk) aren’t really ‘safe”, but do you really want to give your money away to the big bad banks?

2. Money continues to flow into bonds. The Investment Company Institute tracks money flows into money market and mutual funds. During 2009, the net flow into bond funds was $374 billion dollars vs. a NEGATIVE flow of $9 billion for equity funds (which is pretty much a wash). Where is the money coming from? Money market funds (down $566 billion in 2009) and bank CDs (see point 1). Some money market funds are paying 0.01% because they can’t pay “negative” interest.

3. The boomers are getting older. The oldest boomers will be 64 this year and the youngest 46. E*Trade took a survey in 2008 (before the crash) and a majority of investors believe they are underweight in bonds and should be looking at allocating more. LINK.

4. Deleveraging continues. Despite the fact that credit is becoming easier, companies are looking to reduce debt, either by issuing equity or other means. LBO activity, which normally has the opposite effect (new issuing of debt to retire equity) has been very light.

Money flows and lack of attractive alternatives. This clip probably sums it up.

Internet Killed the Video Store

2010-02-08T18:17:00.013-05:00

The Internet has been a major disruptive force in business ever since Al Gore invented it a couple of decades ago (Al just can’t seem to remember exactly when it was).

Of course, of the assumptions we all made about it back then, many didn’t pan out, but others did, not necessarily in the immediate, cataclysmic fashion expected, but gradually and in some cases definitively.

In any case, battles between the “new” (Internet-based) and “old” (Bricks and mortar) abound and are ongoing, some having lasted for well over a decade now.

Today on the History Channel: The war between Intenet-based mail-order movies for home viewing and the video store. Netflix vs. Blockbuster.

This one, in particular has been raging for over a decade.

Essentially the war is over. Netflix won. In their latest quarter, the company reported excellent results and has accumulated over 12 millions subscribers. Netflix put together two things that worked relatively well: the Internet and the postal service, and with low overhead, provided a model that was hard to beat. More info HERE.
Check out the stock performance:

On the other hand, Blockbuster has had to deal with a model, which is outdated, but still has its followers. They operate over 7,000 stores in 25 countries. It used to be over 9.000 but reality has forced a round of closings and more are expected. They tried to beat Netflix at its own game with a mail-based system, but faltered and apparently are now losing subscribers. The estimates out there have them at between 1 and 2 million, far behind Netflix. And they have had to contend with a second battle front, from automated “kiosks” which rent out recent release DVDs for $1 per night. (Operated by Coinstar CSTR). To fight that, Blockbuster has set up some kiosks of its own (Blockbuster Express), but it’s a $1/day rental vs. a $4.99 2-day rental (what Blockbuster offers on new releases at the store), so that’s not going to be good for margins in the short run.
Here’s an interview with the CEO. Prepared to be unimpressed. LINK.

Don’t be sad, everyone dies sometime. With Blockbuster, it’s not a matter of “if”, but “when”. A competitor, Movie Gallery, operator of over 2.000 stores under the “Hollywood Video” brand, filed for bankruptcy last week, for the SECOND time in two years. LINK.

This was supposed to be good news for Blockbuster. I’d call it mixed at best, but most likely ominous.

With all that said, here come the investment ideas, starting with the winner: Netflix.

Idea # 1: Netflix bonds. In November, Netflix issued $200 million of 8.5% unsecured bonds due in 2017 (8 years). When you can find them, they trade somewhere around 102-104%, to yield around 8% to maturity. They are callable at par in 2015. This trade looks easy. Nice yield. S&P rates the issue at BB-, which is “junk” but only “a little junky”.
One concern perhaps is that the trend towards direct downloads could grow, overtake and overwhelm Netflix. Probably. But when? These things take time. Habits do not change overnight. The horse and buggy did not disappear once the car was invented. AOL STILL has dial-up Internet subscribers, people still buy magazines and so on. The bonds look safe to me for the next 5-7 years (which is all it will take). Netflix as a business, probably hasn’t peaked yet, so let’s not worry about its demise. YET.

Idea #2 Netflix puts. Instead of the straight equity play (buying Netflix stock), I prefer a more conservative approach. The stock has traded up a bit recently and the market isn’t looking so great. So the idea is to SELL Netflix puts 6 or more months away and at strike price lower than the current price (out of the money) The stock is at 61 right now, but you can get $2 or more for a Jun 50 put or $3.50 for a Sep 50 or $5 if you want to take it to Jan 2011. What this means (I know not everyone is an expert), is that if the stock goes below $50, which is 20% less than today, you will be assigned the stock (i.e. you must buy it at $50). If the stock doesn’t go under $50, you get to keep the premium. Sure, this is not an idea with a great upside and if NFLX goes to $100, you’ll still only get your $2-$5 in premium. So be it, I’m not greedy.

Now, lets go check out the unburied corpse (Blockbuster). Without getting too “numbery”, lets point out that the company last October issued $675 mm in new SECURED 2014 bonds to pay down its credit lines. At the end of the year, the company was said to have $247 million in cash. Leading us to…

Idea #3 Blockbuster secured bonds. Now trading around 71%, those secured bonds with a 11.75% coupon, yield over 27% to maturity…IF they pay. That of course, is the question. If and “how much?” or “how long?”. These bonds have an additional advantage, if you will, that they are a “sinking fund”, paying 3.33% back in principal each quarter.

If Blockbuster manages to stay out of trouble, you would have your 71 cents back in about three years counting interest and principal. Any payments after that, be it the result of normal operation, restructuring, reorganization or bankruptcy would be profit. There would still be 60 cents worth of principal outstanding on the bonds at that point.

Before you say, “they won’t last that long”, just look how long they HAVE lasted. And there are options for companies in these downward spirals: asset sales, cost-cutting, etc. I’m often amazed how long they can go on. Sometimes they even manage to “reinvent” themselves. Heck, Businessweek pronounced Apple dead over a decade ago. LINK.

There is a lot at stake, namely the CEO pulls in over a cool million a year and the top execs all over half a mill. I wouldn’t personally give that up without a good fight.

Bringing us to…

Idea #4 for the greedy and the optimistic. No, not Blockbuster stock. That’s for the foolhardy. This one is Blockbuster UNSECURED 9% 2012 Bonds (Maturity 09/01/2012), currently trading around 22% of par for a YTM of 93%. I guess it’s obvious that the market doesn’t expect these bonds to be paid in full and on time. Being unsecured, they are behind the secured bonds in a reorg or a bankruptcy and could come out of such an event with nothing.

But then again, 22% is pretty close to nothing already. There are many possibilities, not excluding the company tendering for these bonds (say at 30%...like Ford did early last year) or some sort of discounted swap. If Blockbuster can buy back or somehow write off part of its obligations at a deep discount, it can make the remaining debt more payable.
These kinds of maneuvers are what make investing in distressed assets interesting, and this is distressed for sure. Expect it to be interesting, in the Confucian sense (apparently he never said that…).

Ok, so there it is. I blogged a long blog this time. For those who didn’t bail halfway through: a thought. Think about these wars and those like them. The winners, the losers and the implications. Keep it in mind next time someone offers you some commercial real estate, a bookstore or a bank or gives you a DVD for Christmas.

Here’s a classic clip from “The Holy Grail”. Quite Appropriate.

My Neighbors’ Mortgage

2010-01-22T12:26:00.008-05:00

My neighbors are gone. They left several months ago. I didn’t realize exactly when, since I didn’t know them that well and frankly I don’t pay attention to those things.

There is a sticker on the front door, placed there by the homeowners association stating that “We have determined that this residence is abandoned and have contacted your mortgage lender”.

My curiosity was piqued. “What happened to these people?” A lost job, perhaps, or some other misfortune. Is the property for sale? Can I buy it dirt cheap? and so on.
I remembered that the property was up for sale for a short while, but then taken off the market again.

Well, the interweb is a wonderful and scary place and the answer was there. I looked up the county records and voilá:

I believe the table explains itself quite clearly, but in any case: they bought the property in 2002, with 20% down financing $205k for 30 years. Three years later, they refinanced for $342,400, probably at a better rate and pulled about $140k out. And then, only one year later, refinanced again with a $414,000 first mortgage and an $86,000 second mortgage tied to a revolving credit line (which I can only assume they used) and got themselves another cash-out for about $160k.

So basically, my neighbors bought their house with about $50k down, and pulled roughly $300k out of it in four years. We all know what happened to the real estate market and now the house is listed at zillow.com with a value of approximately $340,000, but no way it goes for anything like that in an auction.

I guess my neighbors just “walked away”. Can’t say I blame them. Sure their “credit score” will be shot, but that’s just “joining the club”. There are millions of Americans in the same boat. And it’s perfectly legal.

They will be liable for some taxes once the bank forecloses on the property and sells it (owner is liable for the difference between the loan value and the sales prices), But who knows when that will be. I went to the bank to find out about the house. I figured it would a nice way to add an extra bathroom (or two or three) or have a place to put my mother-in-law when she comes for a long visit (totally worth it) or simply make a deal.

From what I could gather, though, the bank has no idea the house is probably theirs, and very little interest in getting rid of it. They have not listed it in among their properties and I guess its not going to be on the market for a while.

So it sits there, deteriorating. The homeowners association mows the grass and cleans up the garden. The paper is still delivered and usually winds up on my driveway. The crack dealers are moving in (just kidding!).

One can only wonder how many more neighbors’ houses are still out there. Abandoned, but not foreclosed, sitting in residential real estate purgatory.

Time to sell my Bank of America shares.

It Ain't Me, Babe.

2010-01-20T20:18:00.003-05:00

Sorry to interrupt this blog, but I've been getting inquiries about the Venepirámides blog, which I have linked under "Blogs I read". It's not my blog. I don't write it or know the person who does. I read it, find it interesting and whoever runs it was kind enough to link this blog also and send some traffic my way.

When I was writing about Stanford, Venepirámides translated some of my posts into Spanish and published them there, for which I was and am grateful. I've also commented some of the posts there (using my name).

Recently, Venepirámides has been blogging about the Venezuelan financial system, which I lost track of like half a decade ago, and that has a number of bankers either nervous or upset or simply wondering about their classification in the rankings.
And they're calling and emailing me.

So to all the bankers, their friends and associates who are wondering...let me paraphrase Dylan.

But it ain't me, babe,
No, no, no, it ain't me, babe,
It ain't me you're lookin' for, babe.

I'm kind of partial to the Turtles' version (check out the go-go girls!)

Not a Prophet in Venezuela

2010-01-12T15:50:00.005-05:00

Analyzing Venezuelan bonds as an investment is a very sticky topic. On one hand, it’s very hard to be dispassionate about the issue, given the fact that I spent so many years in the country. On the other, there’s potentially good money in it, so one has to be practical and try to leave one’s emotions aside.

I will start with some advice: if you live in Venezuela or conduct a good amount of business there, you should probably NOT invest in Venezuelan bonds. Doing so would violate Dalmady’s first law of portfolio diversification: “Never put you nest eggs in the same basket as your cojones”. While this law may be a slight contradiction to Lynch’s axiom: “Invest in what you know”, ask any Enron ex-employee, who found himself simultaneously jobless and penniless (their 401ks invested in Enron stock), which precept is the more important one.

This is not to say one shouldn’t participate in the opportunities for participating in new offerings and quickly flipping these bonds for a profit, many of which have been good trades in the past few years. Those are arbitrages though, not really “investments”.

As for the rest of you (or us…but mainly you), here’s my take. Veni bonds have been on a tear lately, as you can see in the graph below of the benchmark Ven 27 bond (click on it to get a larger picture). In the last 30 days, that bond is up from 67% to around 83%.

There are a few explanations for this. First of all, Venezuelan debt was lagging in the credit market rally that began in late 2008. And it was lagging so badly that it was surpassed by the likes of Argentina and other lesser credits (not mention countries like Georgia, El Salvador, etc…which enjoy still much much better credit terms).

That fact wasn’t lost on the analyst community, which picked up on what they believed to be a bargain. Deutsche bank issued a note with a buy recommendation on PDVSA bonds several weeks ago and other analysts also gave their nod to Veni bonds. An analyst I spoke to at Credit Suisse was also very bullish on the bonds (while I shook my head in wonder). Analysts cite indicators, such as a relatively low Debt to GDP, Export Volumes, Substantial FX reserves, etc…which all seem to point out that Ven debt wasn’t as bad as its market price was indicating.

After Friday’s devaluation, even S&P got in the act, revising Venezuela’s credit outlook to “stable” from “negative”. JP Morgan upgraded the bonds yesterday also. So there is a lot of momentum riding on this trade and it could tick up even higher from here. If you’re riding this wave, congratulations, if you’re looking for some action there may still be some here. Double-digit yields are becoming an endangered species in the credit world and Venezuelan bonds still offer those.

Longer term, however, caution is the word. Although it’s hard, if not impossible to be a hometown prophet, I must point out the danger, Will Robinson. Buying Venezuelan debt is like lending money to a wealthy, eccentric and partly insane uncle. You kind of figure he’s good for it, but there’s a good chance he’ll blow his fortune buying real estate on the moon or something and leave you hanging out to dry.

That is the kind of uncertainty you must deal with if investing in Venezuela. Chavez regime’s economic policies are entirely idiot-logical (i.e. only make sense to an idiot). Electric shortages are fixed by shutting down shopping malls, agricultural policy proposals include “vertical chicken coops” on rooftops in poor barrios and consumption of scarce products and services is dissuaded by keeping their prices low. If money is tight, just take some dollars from the reserves at the Central Bank and/or devalue. What’s more, when devaluing the currency, book an exchange gain and spend that, too. What? still not enough? Nationalize a bank or two or ten. Ponzi banks? Bail them out and take them over. Need more money? That’s why we have the “Casa de la Moneda” (currency printing plant).

Corruption, deliberate misinformation and ineptness merge together to form an incomprehensible mess. There isn’t an official figure that can be trusted without an independent third-party verification. Inflation, unemployment, sure every country plays with those numbers…but also more basic, fundamental numbers are suspect in Venezuela. The “embellishment” of oil production figures has been well documented. But it could go deeper still. For example, the Central Bank puts FX reserves at $35 billion. Really? I’d need to see every single greenback to be convinced that that is the case. (Who audits the BCV? Think about that.)

I know what some of you may be thinking: “Dalmady’s just another Chavez-hater who wants the Venezuelan economy to fail and Chavez to fall with it”. Nah. I’m afraid Chavez is a given, he’s not going away anytime soon, so I’d much rather the country did well than not. Less than a decade ago, Brazil was considered a greater credit risk than Venezuela. Now it’s “investment grade”. Venezuela, on the other hand, competes with the worst of the worst. It’s disappointing, sad and no “trend change” is in sight.

It’s not like analysts aren’t used to uncertainty and contradiction, especially when dealing with government policy. Sure, measuring risk vs. expected return is how we handicap the game. In the case of Venezuela, IMO, there are just too many unknown variables and possibly disruptive scenarios to make an educated estimate. Expect the unexpected would have to be my best assumption. How do you put odds on that?

So, invest and play the game of chicken with fate, hoping to be able to bail out before the inevitable collision (Oh, yes…it WILL happen) or sit on the sidelines just for the satisfaction of watching the accident and saying “I told you so”. You could be waiting a long time for your shot at schadenfreude.

It’s a lose-lose proposition. I prefer to play some other game.

Resolutions

2009-12-30T07:21:00.005-05:00

Year end. Time for recaps and predictions. Looking back and looking ahead. Time for resolutions in the two senses of the word: those things that were resolved and those things we promise to address in the future.

Looking back, 2009 was a banner year for most investment categories. Financial markets recovered from the brink of despair, in a move so quick and furious that it offered great opportunity to those who remained alert, while those who passively stuck with their positions throughout could still find comfort in meaningful recovery. On the other hand, those investors who bailed out of the crisis at the wrong time, found themselves longing for those opportunities which passed them by, while they scoffed with skepticism or cowered with fear, unable to pull the trigger and return to the game.

Risk taking was richly rewarded, as the pendulum, which had swung high in favor of safety in 2008, came rushing back in the opposite direction. Playing defense was a losing game this year.

Two of my favorite categories: high yield fixed income and emerging markets, were the hottest tickets of the year. Russian Bonds, for example, with a little bit of both characteristics, were a great place to be.

On balance, it was terrific year for me personally also. My health improved, my family has been wonderful and Uncle Sam is going to smile when he gets my check next April. My clients are very happy to have heeded my advice. Vision and/or luck? A little of both perhaps, but does it matter?

I also had the opportunity to strike a few things off my “bucket list”. Check out the picture at the top. I’m sure you’ll recognize the place. (If not, please rent the whole Indiana Jones series).

The Stanford affair was perhaps the icing on the cake (my 15 minutes?). Aside from the excitement and the attention, it was a messy issue that helped put things in perspective for me. Everything can change in a minute, so don’t take anything for granted. I still follow the case but stopped writing about it. Maybe I’ll do a book about the whole ordeal some day. I certainly have enough material and it’s the only way I can think of to get on “The Daily Show with Jon Stewart”. Nowadays everyone writes a book. Even Sarah Palin!

Looking forward to 2010, challenges abound (there’s a cliché!). Starting with the markets, the easy gains have been made. I still see some opportunities in fixed income, because the dynamics of that market are still favorable. Low base rates, stingy banks, aging populations with more retirees (looking for income) and a few decades of “underhyping” of the asset class. Let’s face it, the media forgot bonds existed back in the early 80s (the 1780‘s) and are only now beginning to rediscover them.
Equity markets don’t appear so clear to me, although accommodative monetary policy lends little reason for selling. It’s a simple case of “what are you going to do with the money?” I have read a lot of research looking for enlightenment on the issue.

As for New Years resolutions, aside from the 20 pounds I vow to lose (this year I’m serious!), I will try my best to blog more. This humble little blog is receiving some pretty consistent traffic and when you have an audience, even a small one, you have an obligation to it. I’ll blog about the markets, investments and probably a lot about bonds and fixed income. It’s not the idea to “fixate” about fixed income, but while there are millions of blogs on stocks, there isn’t a lot of free commentary about bonds.
I’m going to try my best to make a least a post per week, which may not sound like much, but remember this is not my real job.

So, have a really peaceful and joyful rest of this holiday season, a great year in 2010 and thanks for reading my junk.

Online Junk

2009-12-15T12:48:00.005-05:00

Since I’ve written quite a bit about fixed income, I’ve gotten some inquiries (well, ONE) about how one goes about trading bonds as an individual investor.
I’ve looked around a bit for some family members and myself and I’d like to share some of those findings.

There are of course, the full service brokers: Merrill, Goldman, Morgan(s), European banks, Asian Banks/Brokers…etc. etc. If you have an account at one of these, you can usually call up your rep and get him/her to get you some bonds. They will mostly likely balk at your request for junk, trying to guide you towards some other lower-yielding safer fixed income alternative. Preferably one that makes more money for them. In the end, if you’re lucky, they will comply to your wishes, after telling you more than once that “the bank doesn’t recommend this” to cover their Armani-draped butts.

When you get your fill, you’ll pay a nice commission, but you may never know exactly what the bond actually cost, since the price was most likely marked up along the way, either by your broker or the dealer(s) through which the bond was bought.

I know this sounds like a rip-off, but dealers make their living working these sometimes illiquid markets and its only fair that they get some compensation for that and the risk of carrying inventory in some of these exotic assets.

Remember, however, that everything is negotiable and since there may not be a “market” per se, it makes no sense to place “market” orders. You can always haggle a bit or limit your bid. And you can always say no. Never forget to use this power.

That certainly sounds like a lot of work and hassle. But if the idea is to hold these positions for relatively long periods of time (years), it doesn’t turn into a job.
The back and forth can be a bit annoying and unless you have a Bloomberg or other access, your rep/broker will usually have a better beat on market conditions than you.

If you are like me, you tolerate this process, but you hate it and avoid it if possible. Which is why I buy my cars used at Carmax where the prices are fixed and I’m not locked into a battle of wits with a salesman, with his children’s new shoes at stake.

And it’s why I’ve been trading stocks online since the early ‘90s (CompuServe, remember that?). There is nothing I like better than a simple click, instead of having to chat for half an hour with some person over the phone, before you can get them to put in an order to buy 100 shares of IBM for the account (or something equally insipid).

Unfortunately, buying bonds online is not as easy as buying shares. But it can be done. If you have experience buying stocks online, you should be able to make the adjustments. If you have never transacted through an online broker, bonds are not the place to start.

For beginners, most of the online discount brokers get their offerings through a platform called “Bonddesk” (http://www.bonddeskgroup.com), which specializes in odd-lots (less than 1 million) offerings. They may include (or not) other sources. But if you look for a specific bond on several discount broker sites, you will likely find the same offers (amounts) and bids. Prices MAY vary as several of these online brokers add a markup (usually 0.5%) to the price they get through BondDesk.

What you will find are munis, corporates and government bonds. My particular interest is corporates, so I can’t tell you how the munis or government bond trading works (I’ll assume it’s similar).

The offerings are mainly US corporate bonds, although you may find some sovereign and foreign issuer bonds (yes, even Venezuelan Globals) sprinkled in. All in US dollars. You won’t find a Naftogaz or Hong Kong real estate companies’ bonds here (darn!). No Dubai. No Turmekistan.

Online brokers have search tools, with which you can narrow down the offerings. This is particularly useful, since you may be looking for a particular issuer (which has many bonds), maturity, yield etc. This is important, because it is not like stocks, there is not an offer on every single bond. Some things may not be available today (but maybe tomorrow).

There isn’t much room for haggling online, the price on the board is usually it, but some brokers will allow you to solicit an “ask” quote, which on occasion can be better than the executable price on the board. (Here’s a good description of the process. LINK).
If it is a bit complicated, you can call customer service and they will work you through the process of buying and selling.

Now here’s a rundown of the online brokers I’ve used or researched. Not supposed to be comprehensive or a plug for any one in particular and reader feedback is encouraged.

E*Trade Securities. I have been a client for years, so I’m biased, but this online broker has really gone after the retail bond investor and actually advertises the fact prominently on their site. No markups (from the BondDesk offerings) and commissions of $1/bond, with a $10 min and a $250 maximum. There are other brokers offering lower commissions, but not really low enough for me to switch.
The search tool is good and you can even access a particular bond's trading history with a link to the TRACE system.
Investment Grade, High Yield and even defaulted bonds are available for purchase.

Fidelity. From what I’ve seen on the “outside”, the workings of the fidelity online bond site is similar to E*Trades. The price is also $1/bond with a $250 max. Their fee schedule, however, states that below-investment grade bond trades must be placed through a representative, which defeats in part the whole online deal. Their search tool excludes D-rated bonds (defaulted), so these may not be available to trade. (Would you want to? Why not?). LINK

Schwab and TD Ameritrade limit online trading to investment grade bonds (BBB or better). Schwab marks up prices over the BondDesk ask price but has a similar commission schedule to E*Trade. ($1/bond, $10 min, $250 max). TD Ameritrade is just the markup apparently (I called them), but I was told elsewhere that there was a $3/bond commission also. FirstTrade also works on a markup basis.

OptionsXPress isn’t very expressive in the bond market. They offer the fixed income alternative, but at $5/bond with a $14.95 min, and a markup on the price, its obvious from their name what business they are really after. TradeKing is similar.

Interactive Brokers. This is one of best options in terms of commissions. The inventory appears to be BondDesk’s, but the commission is lower: $1/bond on the first 10 and $0.25/bond thereafter, with a $5 min. ($n250,000 is only $70 vs. $250 for E*Trade).

The “problem” with Interactive Brokers is that the interface is a complex trading station and it takes getting used to. Some bonds, which show up on the other brokers search tools may not show up here (I have not been able to find convertibles). And they expect you to trade; so if you don’t you’ll get a monthly charge assessed (not much, $10 IIRC).
For my Venezuelan friends, this is an option, since E*Trade no longer opens accounts for Venezuelan nationals. (They say they can’t verify identities…go figure).

Zion’s Direct is another alternative. They claim not to charge markups and there is a flat $10.95 per trade also using the BondDesk inventory. They call the service “Bonds for Less” and they seem to be interested in developing the niche. Only US Residents, however. LINK

A number of online discount houses don’t even bother with bonds: Zecco, First Trade, Sogotrade and others are not interested. They are after the stock day traders.

In conclusion, the retail investor CAN find a way to trade some corporate bonds online. It’s not easy, but it can be done.

The retail fixed income online trading landscape seems to be evolving and we should see changes as investor interest picks up. We could compare it perhaps to online stock trading circa 1992. Ah…who can forget those modem connection tones!
If so, we can expect it to evolve and the market for bonds and credits in general could become more transparent, liquid and accessible (although it may not be in Wall Street’s best interest).

One reader pointed out to me in my blog about my wife’s junk bond portfolio: Why bother? Just buy a bond fund and be over with it. Let someone else bother with defaults, tenders, calls, bid/ask spreads, credit ratings and the like. I promise I will get to that post. This one is already too long.

CIT: It Lives!

2009-12-11T10:40:00.007-05:00

Back in August, I blogged about CIT, the middle market financing company which was facing trouble funding its operations. It was a case of an apparently solvent company with a flawed business model.

LINK.

There was an interesting bond trade to be made, with CIT paper (many maturities and options) at below 70 cents on the dollar and as low as 45% for some maturities. It seemed like a decent wager at the time.

Well, after a relatively short 3 months, in which the company struggled with funding options, reorganization plans and dissident bondholders, and in the end settled for pre-packaged Chapter 11 bankruptcy, CIT emerged yesterday Dec 10 (after only 38 day in Chap 11). LINK.

My old bonds were replaced with new notes, laddered with maturities from 2013 to 2017 plus some NEW CIT shares. In all, the market value today of that package is about 80 cents of the original par value of the bonds. So, chapter 11 and all, if you tossed a few coins at this opportunity in August, today your bet is looking good.

However, if you opted for CIT shares, you came up with snake eyes. Those are worthless, as is the US government’s $2.3 billion TARP investment made in 2008. LINK.

And of course, if you are an original CIT note holder, you may not be happy looking at those 80 cents, but you’re still better off than having sold before Chap 11 and certainly happy you didn’t tender your bonds to Carl Icahn (who offered to buy them at 65 cents).

The point is that in bondland, default can mean many things, but not necessarily: “ you lost all your money”. So when you read about “default rates”, events may be included which may not be catastrophic. Chapter 11 can be a blessing.

Distress can be a synonym of opportunity, so don’t back down. But don’t be reckless and remember to spread it around.

Disclaimer: I already sold the shares, since I don't have a clear idea of how much the new reorganized company could be worth. The new bonds, which aren't your standard bonds (par value is $1 and interest is quarterly), have traded well, so I'll hang on to them for a while.

All that Glitters…

2009-12-03T19:17:00.008-05:00

…is a barbarous relic. In this case, one made out of shiny and precious gold. Gold has been in the headlines a lot in the past months and for good reason: its price has increased well over 30% this year and now stands at or very close to an all time record against the US Dollar (and other currencies as well!)

So just about everyone is saying what a great investment Gold has been or will be in the future. Before you go jump on the bandwagon and exchange your Euros, Swiss Francs or Bolivars for some shiny metal, take some time to read up about gold.

I’ll suggest the wiki page, which isn’t too long and quite informative. LINK.

Here’s my take:

Gold is the ultimate “want” material. Its demand is mainly from “want” and not from “need”. Gold’s limited industrial applications absorb around 300 tons of the stuff a year and it can be readily recycled and usually is, due to its cost. Total demand, however, is closer to 4000 tons a year. Most of that (over 80%) is for jewelry and almost a quarter of that is for India (800 tons). Gold is ideally suited for jewelry since it is attractive and highly malleable. It’s shiny.

However, despite arguments from my wife and Hindu brides-to-be, I think we can reasonably classify jewelry as a discretionary purchase. No one NEEDS jewelry.
Other uses include coins and bars. People buy these and stuff them in safe deposit boxes.

So basically, humans buy gold to hoard it. In jewelry boxes, in safe deposit boxes, in our temples, in our (OMG) central banks or buried under the sand on a tropical island.

An alien visiting our planet would find this behavior amusing (Spock says “illogical but fascinating”), but it’s something our cultures have been doing for centuries. National Geographic estimated that humans in our history have mined 161,000 tons of gold. It sounds like a lot, but since Gold is so dense, that’s only about enough to fill two Olympic sized swimming pools (again wikipedia is the source). It’s all hoarded or hidden somewhere.

Extraction of gold is running about 2500 tons a year, so there is a deficit of about 1500 tons a year, which is satisfied by recycling the gold in those two swimming pools. People (and I mean humans) will pull out their heirlooms, raid someone’s temple, find a buried treasure or simply sell their stash.

These market dynamics make Gold (and its poor cousin Silver), prime material for bubbles. Why? Because humans are greedy. Although the rational behavior of “homo economicus” would be to demand less gold when the relative price of it rises, many times it will be the opposite, the expectation of even higher prices will spur more demand and more hoarding.
Given the need for a voluntary recycling of gold stock to keep demand and supply in balance (and prices in check), small changes in behavior can cause major price swings.
Add in speculation, and you have all the ingredients for a bubble. One thousand tons of gold today are “worth” about $40 billion. A few hedge funds, some changes in allocation recommendation by some global players and you can add that kind of demand easily (or more). Gold futures allow mini-speculators like myself to control thousands of ounces without much collateral, not to mention what the likes of GOLDman Sachs can do.

In those circumstances, there is no upper limitation to price. Put enough players on the buy side of the gold trade and the result could be anything. Two thousand dollars, five thousand dollars. Whatever. Think Dot-Com circa 2000, Housing Circa 2007, Beanie babies, Tulips, etc. or….GOLD itself in 1979-80.

Goldbugs point to the metal as an “inflation hedge”. There is some logic to this rationale. Since the stock of gold is relatively stable, its value relative to other tradable goods (including stuff people actually NEED) should be relatively constant and unaffected by the high-speed currency printing presses flooding the world with their filthy “paper money”. (Here’s a good link about this).

This argument, however, assumes that people are rational in their trading of gold (sell high, buy low). But of course, if humans were totally rational, they wouldn’t hoard this stuff in the first place (or destroy the environment pulling it out of the ground).

Like it or not, Gold is destined for booms and busts.

Now that I have figured that out, the only rational recommendation would be NOT to invest in gold.

So, don’t INVEST in Gold. SPECULATE in Gold.

If humans are going to be irrational, herd-like and emotional, it would only be logical to try to benefit from that behavior. So trade the bubble.

How? First, forget physical gold. No coins, bars or heirlooms. The problem with these is that you won’t sell them when it’s time to do so. It will be stuck in box somewhere, and you’ll say “I’ll sell it when the market rebounds” or “I’ll get it tomorrow” and then you’ll fight with the dealer or jewelry shop guy over a few dollars. You’ll end up hoarding this stuff until the next bubble comes around, or maybe you’ll stuff it in your sarcophagus.

The other thing is that the gold rally didn’t start yesterday. The price has gone from around $300/oz in 2002 to $1200/oz today. Although I don’t think so, we could be nearing a top. But essentially, either it spikes further from here or it stops. If it stops, then why bother?

So, here is how I plan to play the gold bubble. Options. Normally I don’t buy options (I write them), but this is a place where I’d want to use them.

For example, September 2010 140 calls on GLD (a gold ETF aprox 1/10 price of gold), trade for about $5.75. I’ll buy 10 contracts for $5,750.

If all hell breaks loose on the gold market and everyone piles in, let’s say the price shoots up to $2500. I just turned those 10 contracts into 100 grand. If it all fizzles out, well there goes the Jamaican vacation. But that’s it and I won’t have to worry about finding someone to buy my Beanie Baby…er gold bar.
Classic high risk/high return bet. I like the odds better on this than eighteen red on the wheel.

Disclaimer: Caveat, Caveat. This isn’t investment advice and if you aren’t legally able to absorb it, please close your eyes and erase your memory.

Memory lane: you may have the impression that I don’t like gold. Not so. I made my first “killing”, if you will in the 79-80 bubble. At the time, I convinced my dad to buy some gold at $350/oz. in Sep 79 and piggybacked on the trade. A few months later the Russians, bless their souls, invaded Afghanistan and gold spiked. We cashed out in early 1980 at $620/oz, IIRC, after not selling at $800/oz or $720/oz or $680/oz. (ah… greed). I pretty much forgot about gold after that, but Dad lost precious time and money on silver mining companies and the like. (I lost my time and money elsewhere). Bubbles don’t grow again quickly after busting.

This one took 30 years!

Companies De-lever, Bonds De-liver

2009-11-17T08:25:00.011-05:00

Last week, retailer Dollar General joined a growing list of companies who have taken advantage of the recent strength in the stock market to issue stock, mainly to REDUCE DEBT.

These kind of deals are normally very well received by bondholders, since in most cases, they make the existing and remaining bonds more "payable" and therefore more valuable. They are often followed by a tender offer for the bonds or an upgrade by the rating agencies.

Of course, attention to detail is important. In DG's case, of the 34 million shares sold, 22 million were new shares while the rest were shareholder sales (KKR, which took the company private two years ago). So the company only received about $450 million (the offering priced at $21). But then, DG had paid a $239 million special dividend back in September. So, all-in, the increase in equity is only about $210 million. Still, for bondholders this is "free" money and they'll take it. The fact that the company is now public, also offers more financing options for the future. It could always issue more shares, if needed and if the buyout company (KKR) needs to realize their investment, they can always sell shares into the market instead of taking dividends out of the company.

As for other companies who have done the same, the list is long. Here are a few: Dole Foods, Gaylord Entertainment, Louisiana Pacific, Cemex, United Airlines, Brigham Exploration, E*Trade Financial, Saks, AMR (American Airlines), Heidelbergcement, Huntington Bancshares, Sonic Automotive, Smithfield Foods, Xinao Gas, Office Depot (preferred), Arch Coal, Marfrig...etc., etc.

Most of these bonds have performed quite well, pre and post stock offerings. The stocks themselves...a mixed bag. As for specific tips, one of our favorite de-leveraging plays is Smithfield Foods. The company has had its troubles (swine flu, hog oversupply, falling demand, etc.), but seems to be coming out of it.

This meat packer, owner of the "Butterball" brand of Turkeys has a variety of bond "flavors" for every taste.
There are the senior unsecured, with a mouth watering yield of over 10%, maturing in 2013 and 2017. There are the senior secured for those who are a bit "insecure" and need the extra guarantee and convertibles for those who want some equity taste spicing up their bonds.

Enjoy...Thanksgiving is next week!

Naftogaz Defaults, Bondholders Rejoice

2009-10-18T14:34:00.006-04:00

A little update on my post a few weeks back on Naftogaz. As "kind of" expected, the company failed to make the principal payment on its $500 million bond issue back on Sep 30, generating what the rating agencies called a "technical default".
They did come up with the interest coupon, however. LINK

Since then, and also as expected, the company held a bondholder vote, and with an overwhelming majority (92%), holders of Nafto paper agreed to swap their "defaulted" paper for the to be issued 9.5%, 5 year, govenment-backed bond that Naftogaz was offering in exchange. Even the dissident group went along. LINK

A few lessons here. One is that despite the showdown and drama that played out in the press, there was no real interest in any other outcome. Bondholders weren't necessarily obsessed with collecting their money, just getting a decent deal in the exchange (which they did). It's not like there are ton of better opportunities elsewhere.

The next lesson is that not all defaults are created equal. There is a huge difference between this "pseudo-default" (although it was defined as such for effects of making good on CDS), and defaults such as the Argentine default in 2001 and the recent Ecuadorian default. No one's going to lose money on this one, and I wouldn't be surprised if the new Naftogaz bonds were trading above par in less than a year.

Finally, if Ukraine wants to be a player in the capital markets, they really have to get their act together. This back and forth about paying or not paying and letting everything go down to the last minute (and beyond) was totally unnecessary and counterproductive. A little professionalism and foresight go a long way towards reducing country risk (and hence interest expenses). Ukraine could certainly take a lesson from Russia in this aspect, as much as it may pain them to do so.

The AIG Trifecta Part III – American General Finance

2009-10-10T15:20:00.010-04:00

Now, the last part to the seemingly endless AIG trifecta, brought to you by this blog, chock full of ideas that may or may not make you money. (Now you know why I never went into sales).

American General Finance. I wonder, who came up with that catchy name? In any case, its subsidiary of AIG and it also has bonds out in the markets with double digit yields on them.

Should you buy?

First of all, understand that AGF is a consumer loan company. They will give people loans to buy a refrigerator or send their kid to college or (drumroll) to buy a house. The get their money from the same “wholesale” model that we discussed here with CIT and ILFC. For those who haven’t been reading, that means they issued commercial paper and mid-term bonds to the market. They would then lend that money to individuals (as opposed to businesses for CIT and ILFC).

I’ll link to the 10-Q, but here are the basic numbers: a loan portfolio of about $20.7 billion, of which (yikes) $15.5 billion are real estate loans. On the other side about $20.9 billion of long and short term debt.

AGF has the same problem that CIT faces: they don’t have access to capital markets right now to roll over debt as it matures. They also have the additional problem that their real estate portfolio -well- is not great. About a third is “sub-prime” (FICO less than 619), another 20% is “non-prime” (FIC0 between 619 and 660) and the rest is “prime” as defined by these guys (FICO over 660). (Nowadays, TRY getting a loan with a 660 FICO score…)

Delinquency rates are up and the average yield on the portfolio (about 10%) is high, but can’t support higher funding costs.

Trying to not get too numeric, there is a real problem here.

Fortunately for AGF, there are some things they can do. First, liquidity. They are in “collection” mode, as in collecting more than they lend out, so they are generating some cash. They are cutting costs by closing branches, etc. Plus, consumer loans and mortgages, as maligned as they may be are still “pseudo commodities” and they can be packaged and sold or securitized and used as collateral for lower cost loans (and AGF has done so). As long as AGF can collect and sell assets, they can service debt as it matures (until they run out, but that could take a while).

Second there is support. This year, AIG came up with over $750 million in fresh equity for AGF. That’s money AGF does not have to pay back (unlike the money AIG lent to ILFC). A “bailout”, if you will. AGF could need more in the future. How much? I’d say about $2 billion tops.
Additionally, AGF has “lent” its parent AIG over $1.5 billion at low (Libor plus 50 bp) rates, but at an interest rate nonetheless.

The idea is not to dwell on these transactions between parent and subsidiary, but to understand that as AIG and AGF become more intertwined, they also become less separable. AIG has only formally committed to supporting AGF until Aug 15, 2010. But how do they cut loose, once they have intermingled the finances of parent and subsidiary? It’s not that simple.

So the credit holder in AGF is basically watching a game of chicken with the government “supporting” AIG (can they really cut loose?) and AIG supporting AGF. Methinks that if all it takes is another $2 billion of equity infusion in AGF, AIG (and the government) will prefer to pay it than deal with the public opinion consequences of an AGF failure.
And frankly, who is going to know? Like anyone noticed when AIG put $750 million into AGF to shore it up this year. Two billion is a drop in the bucket in the whole AIG mess.

So there you have it, your “bailout” opportunity number three. AGF bonds are available in a number of flavors. Here are a few options:

I’m not particularly partial to this particular AIG flavor (AGF), but if you understand the risks, well that’s what its all about. Potential double-digit returns do not come without some risks these days, even if a government bailout is involved.

Psst. If you ask me, I’d get the short dated paper (May 2010), at least AIG has committed to support through that date.

And so ends the AIG trifecta. Yes, there is still more to AIG, like AIGFP, which was an integral part of the financial meltdown mainly due to the CDS it wrote on CDOs, like RMBS and CMBS, leading to TARP, TALF and many, many more acronyms.
But no.

The AIG Trifecta Part II – ILFC

2009-10-05T12:12:00.005-04:00

As promised, the rest of the AIG trifecta. Part II is ILFC or International Lease Finance Corporation, an AIG subsidiary.

This part of AIG has been quietly “discovered’ by the mainstream press over the past year. So many of you may have read about it. LINK. LINK. (Very alarmist, not particularly insightful).

ILFC leases airplanes. Over 1,000 of them. They are the leaders in the business, which is dominated by themselves and GE Capital Aviation Services (a division of GE Capital).
Before you sigh and say “Oh no, the airlines are such terrible businesses, o dear me”, try to remember when they WEREN’T such terrible businesses. You can’t, can you? (unless you are really old, of course).

That’s why leasing exists and is so big for ILFC and GE. If the airline goes broke (as they periodically seem to do), the lessee takes its airplane back home and goes to play with someone else.

This has historically been good business. ILFC has been doing it since 1973, so they’ve been through ups and downs. This isn’t their first recession. The business is profitable: the company booked profits of $440 mm in the first half of 2009 and hasn’t registered a losing quarter as far as I looked back. LINK to 10-Q (if can you read these things).

So what’s the problem? Funding is the problem. ILFC would basically fund its operations two ways: commercial paper and notes (mostly medium term). It made sense, a typical airplane lease is three to five years, and so funding the purchases the same term is what would seem to be logical.
ILFC mid-term notes were even distributed on a retail basis as ideal investments for income-seekers looking for a bit more than the local bank offered (nothing strange with this, Ford, GMAC, GE, Dow and others do the same thing).

But when both the commercial paper and bond markets dried up, ILFC found itself in a bind. Notes were maturing at a quick pace and to boot they were a “part’ of AIG which was and to a point continues to be, financial caca (no touch!). The company was prepared (with credit lines) for temporary disruptions in the market, but this was and is and ongoing business. There were/are airplane orders in the pipeline, with which ILFC had to comply. These planes have airlines wanting them, but there is a cash imbalance in the process.

Mama AIG, now in government hands (kind of) has been both helpful and hurtful. On one hand AIG Funding lent ILFC $1.7 billion so it could keep up with maturing debt obligations and the purchase orders for new aircraft. (Taxpayer money? Not really, but the talking heads complain).

And AIG hasn’t been requiring dividend payments. But on the other hand AIG has been trying (unsuccessfully so far) to sell or otherwise dispose of this unit and that has undermined ILFC’s possibilities of obtaining stable (and inexpensive) sources of funding. Who is going to lend ILFC money (i.e. buy bonds), if they’re not sure what is going to happen to the company?

So there’s a kind of catch-22 going on with this. The press is focusing on the upcoming maturities as some kind of “impending doom”. Which I guess it could be. The notes are coming due constantly, as will the credit line (in 2010 and 2011).

However, if there is any rationality left in the market, this company should be able to come up with a solution, even if it is more stand-by financing by Mama AIG or even the government. AIG has committed to fund ILFC through August 2010.

A restructuring “a la CIT”, in which debt is capitalized wouldn’t seem necessary, since ILFC is far better capitalized than CIT. Not that it couldn’t happen, though. The ideal would be a return to the credit markets, which are thirsty for new paper. That return, however has been running into the concerns raised above about ILFC’s ownership.

The investment opportunity here is, of course, in ILFC notes and bonds, of which there many different options. The maturities are from now through 2013 and the yields currently around 11-13%. There are some large liquid issues, plus those retail “notes” that can sometimes be snapped up on the cheap, but which probably don’t have a good secondary market (so, you’ll have to hold them to maturity).

I’ve been a buyer, because frankly I can’t see a scenario where a Chap. 11 or a forced restructuring of this company makes sense. More likely they’ll come back to the credit markets sooner or later (as did Ford Credit) and get back to business.

It would be a shame that those shiny new 787 Dreamliners that Boeing is making should gather dust in the showroom.

Hertz: “We’ll come and get you” ®

2009-09-28T11:09:00.008-04:00

Sorry, for the interruption in the middle of my multi-part AIG analysis, but I just had to write this up.

Reuters is reporting that Hertz has decided to file a defamation suit against an Independent Research Firm, for suggesting that it might go bankrupt. This has to be the most outrageous thing I’ve read all year.

Hertz was included in a list of “Twenty companies most likely to go bankrupt” which was published and circulated by Audit Integrity, Inc, an independent research firm.

The outrage is not that Hertz may go bankrupt, (I have no idea) but that Hertz actually files this suit and considers it an “appropriate response”.

So now every time an analyst states something a company may not like, the “appropriate response” is to sue? Wow. Just Wow. (Any lawyers out there willing to represent me on the cheap?).

A research report is an opinion. Like…first amendment protected? Remember that? Opinions are an integral part of the market, without them we would not have two sides to a trade. Shut that down and we can say goodbye to any remnants of transparency. It was bad enough when everyone had to be “hush, hush” last year about the collapsing banks due to “public interest”. Now we can’t state an opinion about a car rental company’s prospects?

As for the report, I haven’t seen it, but Seeking Alpha has the list. I obviously don’t agree with it, since I own credits for a number of the names on the list (no not Hertz).

That is not the point. Obviously. I can only hope (because if I predict, I get sued), that Hertz gets this thrown out and Audit Integrity countersues and takes Hertz to the cleaners. Maybe it will throw the company into bankruptcy. LOL. (That was a joke, Hertz people).

I certainly KNOW which rental car company I won’t be using EVER AGAIN. I think that is an “appropriate response”.

Bailout Bonds or The AIG Trifecta (Part I –AIG)

2009-09-28T01:12:00.012-04:00

I got a ping on my Blackberry from a colleague/friend: “What do you think about AIG?” He was talking, of course, about AIG stock, which has been a trader's delight for much of 2009, from the short and long sides.

He might as well have asked me to tell him how general relatively is explained by string theory.

AIG is an analyst’s nightmare. Take one look at those financial statements and you can understand why the black hole that lurked within the company went undetected until it was too late.

Nowadays, even post-bailout, AIG’s 10-K (annual SEC report) is 344 pages long and its latest 10-Q (quarterly) is 221 pages strong. That’s without getting into the supplementary statements. To make matters worse, you can go through those reports with a comb and STILL not come away with an understanding of the company and much less a valuation of it.

You see, AIG is a holding company with different operating companies, all mainly in the financial area. To BEGIN to understand and value it, you’d have to go through all the main subsidiaries and drill down THEIR portfolios (now that we’re not sure of the value of anything) and businesses and add all that up.

Sorry, amigo, don’t have that kind of time. It also brings up the analyst’s conundrum: by the time the analyst has done the work, figured it out and written it up, the market has probably gone way ahead (perhaps on insider knowledge). So it’s not worth it. And as far as I have been able to find, there hasn’t been any deep research done on the company this year. Goldman Sachs, often fingered as the beneficiary of the AIG bailout lists the company as a “Not a GS-followed company”. (If someone can find a good report, send it my way, please).

I can’t say I blame them. I wouldn’t have an analyst spend time on unraveling the mysteries of the AIG universe, either.

Of course, you can read the WSJ and the Internet blogs. You’ll find outrage, opinions, conceptualizations, but very little in terms of hard numbers.

As frustrating as it may seem, sometimes you have to make use of less than perfect information and make some assumptions when investing. AIG and others like it, just stretch that reality a bit further than most.

With all those caveats, luck has it that that sometimes you can find tidbits of information that are particularly useful. Earlier this year I had been browsing through that mountain of AIG data, and I found this. LINK. Open it in a new window. Look it over, it’s important.

It is AIG’s post-bailout capital structure, explained by AIG itself. I know it may seem like Chinese to some, but basically this is the “pecking order” of AIG’s creditors, and bonds and shareholders.

First in line is the Federal Reserve Bank of NY, which basically has the first dibs on the sale/spinoff of several of AIG’s insurance businesses. AIG owes FRBNY over $40 billion.

Second is Senior Debt. Yes, Bonds. AIG has a number of senior debt issues outstanding.

Number three on the list is Junior Subordinated debt. Also bonds. A couple of these caught my eye. Will explain further down.

Four and Five is government bailout money and last on the list is the common stock.

So here’s how it works: if you were to value all of AIG’s assets (something I’m not going to do) and assign the value to the stakeholders in order of preference, there would certainly be enough for Level One. Also probably Level Two and probably Three. Levels Four or Five, not so sure. What’s more, we hear all the time that the government isn’t certain that they’ll get their money back. LINK. Well, until the gov is paid, there is nothing for level SIX.

How much is level SIX worth? No idea. If there are enough in assets and/or ongoing businesses to satisfy ONE through FIVE, level SIX is worth something. If not, it’s worthless. Right now, Mr. Market says that level SIX is worth $6 billion. Maybe it is. Maybe it’s worth 10 times that. Maybe zero.

I told my friend to trade the stock technically, if he was into that. What else can you say?

However, there is a lot to be said about Levels Two and Three. (Yeah, bonds). These guys collect BEFORE the government with its preferred stock. And so far, AIG has been making its debt payments on time and in full.

Not that this is secret to the bond market. Last year in the midst of the crisis, AIG senior bonds maturing in one year later (i.e. now) was trading at 50 cents on the dollar. Those brave enough to get in there, made their double. (Compare to those who dared to buy stock). (No, I wasn’t that brave).

Today AIG senior bonds are trading with yields mostly below 10%. They have been on a tear lately, since yields were in the high double digits only a few months ago.

Better returns are still available in the Level Three bonds, the junior subordinated ones. I’ve been able to get my hands on two different issues, the A-6, which matures in 2058 and the A-1, which runs through 2087.

The A-6 bond pays 8.175% coupon until 2038, when it changes to Libor plus 4.195%. Currently yielding about 14% until my kids inherit and something variable thereafter (which my grandkids might enjoy).

The A-1 is set up similarly, 6.25% until 2037, Libor plus 2.0568% thereafter until 2087. Trading around 50% currently, there’s some good interest payments left in those bonds until my great-grand kids collect the principal.

I was fortunate enough to get those bonds at a lower price, but would still consider buying them. AIG got its bailout, here’s a way get a bailout of your own.

As for the other two flavors of AIG. Next post. This is long already.

The Picture? Wayne Rooney. AIG used to be the sponsor of the Manchester United side. Ah, the good old days.

Update on My Wife’s Junk

2009-09-20T17:15:00.010-04:00

In one of those routine wanderings that people do while on the net pretending to be working, I waltzed over to Bank of America’s web site to check their CD rates.

One month: 0.30%
6 months: 0.50%
12 months: 0.95%
etc.

LINK

It only gets a bit better when you go out two to five years. (2 to 3%). Yes, FDIC insurance is included but only up to only $250,000.

BTW, notice how “interest checking” is accruing all of 0.01%. Seriously, how does BofA pay 0.01% and still call it “interest checking”?

Getting back to the rates, it’s got to be a tough pill to swallow if you’re a retiree or simply saving for something down the road and don’t want to risk it on the stock market.

Investors are moving into bonds. Can you blame them?

I’ve been harping on the issue for a while, I know. A few months ago, I ran a post describing my wife’s junk bond portfolio. It’s not the idea that those investments are specific recommendations. This was simply to show that a person with limited financial knowledge could put this together with a little help. So, other people can, too. (Notice I don’t say “anyone”, some people can’t or simply don’t care enough…but that’s for another post).

Here’s the link to that post. It’s not a long read.

My Wife’s Junk

Also, here is a table of what her portfolio looked like back then:

TABLE 1

A few things have happened between then and now. First of all, none of these companies has gone bankrupt (despite all the talk of “default rates”). Second, most of these bonds have moved up in price and there has been some corporate action. Third, my wife has made some necessary changes.

First she sold her Home Depot bonds (number 6 on the list) The yield on these came down to well under 3% and that is the “mortgage threshold” in this household (might as well pay down the mortgage). I had mentioned that she was thinking about doing this.

The Corrections Corp bond (number 4 on the list) was called. For the bond newbies (like my wife): some bonds have a provision that allows the issuer to pay them back before maturity. That one did. They paid back two years ahead of time. It doesn’t matter if you tell them nicely to keep your money. They still pay you, even if you don’t want them to.

The Owens-Illinois bond got a tender offer (see my post about Tenders...here). At 104%, for a bond with a year left, it was an offer she couldn’t refuse.

Here's the portfolio as of today. Click on the image to make it larger (and readable).

The new additions were as follows. The theme, is “flawed but fair”, as it should be with junk.

Interpublic 2014 6.25%. Interpublic is large global advertising company, whose claim to “shame” is being GM’s ad agency. The balance sheet checked out ok and, let’s face it, GM STILL needs to run ads. Now more than ever.

Dole Food 2013 8.75%. Food is stable business of course, but Dole was part of a leveraged buyout so it’s heavy on debt. But there is talk of taking the company public once again, which would improve the company’s balance sheet (and make the bonds less risky). S&P downgraded. Go Figure.

Continental Airlines 2011 8.75%. With this one, my wife kind of jumped right into the “risky” waters. Airlines are notorious for their tendency to go into bankruptcy and Continental has been in there –twice. But my wife figured, “hey, its only two years, Continental’s not doing that badly” and she has profits to fall back on. It’s always easier to take some risks when you’re already sitting on profits. S&P recently downgraded to CCC+ (from B-). The bond subsequently rose from 66% to 87%!

As for the rest of the portfolio, here is what it looks like now:

Advanced Micro Devices: This bond was downgraded from B to CCC+ by S&P in April. The bond has risen from 57% back then, to around 87% today. Thank you, S&P! In S&P’s defense, they are only assessing default risk, and not considering if the bond should rise in price. But seriously, do we really expect AMD, the world’s second largest microprocessor company, now with the backing of Middle East money, to go under?

Alcoa: Price is up, yield is down. Still beats the “mortgage benchmark”. So it stays.

Chiquita: Won’t go Bananas and sell now. S&P upgraded to B.

Davita: Has been stable, as expected. That’s why she bought it! (Dialysis Centers)

Jo-Ann Stores. This was upgraded to B- by S&P. This bond is going to a problem for my wife, because I believe it will probably be called next March. It’s hard to find, but if you want an easy 7%+ yield for about six months, I would recommend buying this (try to get it under par).

Seagate and Starwood. Nothing to say here. Just clipping coupons.

There it is, still short duration (average 3.35 yrs to maturity), still a decent overall yield (8.59%). A little riskier, perhaps (in S&P’s opinion). But my wife is still happy with it. And if she’s happy…well…you get the idea.

Note: comments now open to anyone. The death threats have waned. Just keep it on topic, ok?

The picture? Not my wife, but Ukrainian-born Olga Kurylenko, the latest “Bond Girl” (pun intended).

A Kodak Moment in Junkland

2009-09-17T20:10:00.005-04:00

Sometimes you make an investment and you feel uneasy about it almost immediately.
I had such a moment, a “Kodak” moment, back in January when I picked up some Kodak bonds.

These were 7.25% 2013s, yielding around 17% at the time and price of purchase. I had checked out Kodak’s financials and though they weren’t pretty, figured that the cash balance of over $2 billion would buy the company some time to get its act together. And it wasn’t a large investment. I was buying a lot of bonds at the time and trying to “spread it around”.

Yes, I was aware of Kodak’s problems. Bonds don’t get the “junk” label if they aren’t somehow flawed. But c’mon, it’s KODAK, the camera Dad used to take my baby pictures.

Then the First Quarter 2009 results came out (ugh) and later the second quarter performance was just as ugly. The cash balance was now down to $1.1 billion. Not unexpected, I guess, since there IS a recession going on (in case anyone on Wall Street forgot). This wasn’t just the recession, though; Kodak has been spiraling downwards for over a decade and now very sharply over the last five years. Sales for 2009 are likely to be approximately half what they were in 2004. Cash flow was negative. No tangible equity left on the books.

Consumer Digital Imaging Sales (i.e. Digital Cameras for us consumers) were down 33% Q/Q in Q2 09. And that’s the business that’s supposed to be a “keeper”. Kodak’s attempts to regain market share have been futile.
This was bad upon bad.

Despite a booming high-yield bond market; my Kodak bonds were floundering about where I had bought them. I pondered selling them, but the market was so good…maybe they’d catch up anyway.
But they sat there until about a week ago, when they jumped from the 65-70% range, to close to 80%.

Today I found out why. KKR will buy up to $400 million in SECURED senior bonds with warrants attached (maturity 2017) and Kodak plans to issue an additional $300 million in convertibles. This money comes at a hefty price. The KKR bonds haven’t priced yet (as far as I could see), but Kodak will pay KKR a 3% placement fee (for selling the bonds to itself, I guess) and the coupon is set at 10-10.5%. The details of the other issue (the convertible) haven’t been disclosed yet, but expect the financial cost to be high.

First order of business for these $700 million will be to pay off Kodak’s 3.375% 2033 convertibles, which have a put option (holders can and WILL sell them back to Kodak) in October 2010. That totals $575 million. Those bonds are trading close to par now (logically) after this announcement. LINK

So KKR’s deal bought Kodak some time and perhaps brought some frustration to stockholders who resent the possible dilution. Bondholders were mostly happy with the development (I sure was).
Who knows? Maybe Kodak will get its act together or develop some radical technology it can capitalize on. Or just survive to pay those 2013 bonds (all $500 million worth). These “maturing” companies sometimes decline gracefully. More often, they don’t, but still seem to find some nostalgia-filled white knight to give them a second, third or fourth lease on life. Not that KKR fits that bill, but…

I won’t hold my breath. My plan with most bond purchases is to hold until maturity and junk investors are optimists almost by definition. But when you make what you think is a mistake and you get a chance to correct it –at a profit- you have to take it.

So, with the bond trading up into the high 80s today, I’ll be looking for a chance over the next few days to sell these and let someone else enjoy a Kodak moment. Say CHEESE!

The Long and Short of Naftogaz

2009-09-15T12:50:00.011-04:00

Ukraine’s state-owned gas company is not usually at the top of the business news here in the Western Hemisphere. But there is a story to it, and like usual in this blog, an investment opportunity.

So here’s the short story and the long story.

The Short Version

Naftogaz, 100% owned by the Ukraine Government, is not in the finest of financial conditions these days. But as a government entity, the Ukraine government by way of subsidy or capital infusion has bailed it out, time after time.

The company has a series of loans and other debt obligations coming due over the next two years, which it wishes to reschedule. The total is $1.7 billion. The interesting part (for us) of these obligations is a $500 million bond issue coming due September 30. Two weeks from now.

All summer long, Naftogaz has fueled speculation about whether it would pay these bonds on time. At one point, it seemed they would pay. And then they’d be back in the “restructuring” mood.

Two weeks ago, they hired Credit Suisse to help them with the process, so the “restructuring” seemed to back on. LINK. Yesterday it was announced that talks with bondholders were beginning. Some tentative terms were leaked to the press. LINK.
Not everyone is happy with this, and there is a dissident group trying to block the efforts and make Naftogaz pay up on time. LINK.

Naturally, all this has bondholders quite nervous and that 2009 bond (with a 8.125% coupon) maturing in two weeks is trading at 85-86%.

The terms “leaked” about the restructuring are a coupon of 9.5%, an additional five years, an explicit government guarantee and possibly an upfront “consent” payment. If that’s it, sign me up.

Certainly, Ukraine is not an easy place to invest, and there is a rocky road ahead. But it’s not easy finding double digit yields anymore, not even in the emerging markets. This is a risk I can stomach. This isn’t Ecuador, who thumbed its nose at the international financial markets, recently. LINK.
Ukraine has a $16 billion program with the IMF established last year in the midst of the global crisis. You don’t sign on with the IMF, if your plan is to default a few months later. (You default FIRST, and THEN go to the IMF)

Now the LONG version
(more interesting…but well, LONGER)

The Ukraine and Russia have had a complicated relationship going back centuries. I’ll let you wiki that if you will, but here’s how it all relates to gas.

Russia has gas, with 25% of the worlds known reserves. Europe needs gas, since it gets cold in the winter (and at other times also) Since the 1970’s, the Soviet Union has been exporting gas to Eastern and Western European countries through a network of pipelines.

Here’s a great map of those pipelines. LINK. (Don’t you just love maps?)

I did write “Soviet Union”, but the USSR is no more and the main trunkline of the pipeline now goes straight through now independent Ukraine. That pipeline now belongs to Naftogaz. But the gas belongs to Gazprom (Russia).

If this sounds like fertile grounds for conflict, it has been. Through the 1990s, Ukraine and Russia quibbled about these issues and in particular gas debts, since Ukraine had the habit of getting behind on payments for the gas it consumed.

Not surprisingly, things really started to get testy after the Ukrainian “Orange Revolution” of November 2004-January 2005, from which a pro-Western government emerged with talk of joining the European Union and (OMG) even NATO.

So at that time, Gazprom figured out that it was about time to look at the easy terms (below “market”) that Ukraine was enjoying for the gas it consumed, and of course, Ukraine wanted more money for “transit fees” through its territory. Naftogaz admitted to “turning the valves” its way (diverting gas for domestic needs).

The dispute culminated with Gazprom turning off the gas for EVERYONE on Jan 1, 2006. The Europeans, not really enjoying the prospect of freezing in January, helped broker a deal and supply resumed. A similar spats over debts and prices resulted in a disruption in supply earlier this year, again with some Western European intervention.

At the moment, Naftogaz is current with its payments to Gazprom, but that probably doesn’t leave a lot of room for other creditors (hence the proposed restructuring). Add to this the fact that Naftogaz still subsidizes local gas consumption heavily (something the IMF isn’t particularly happy about) and Naftogaz’ financial situation is still suspect. But, as stated above, there is an “implicit” government backing and frankly for all practical purposes, Ukraine can not cut Naftogaz loose.

If all this weren’t convoluted enough, Ukraine is scheduled for presidential elections in early 2010. The incument president (Yushenko) AND primer minister (Tymoshenko) are expected to run, as well as former president (and loser in the “Orange Revolution”) Victor Yanukovych, (Putin’s favorite., BTW)

If all this is a little too complex for your stomach, well, maybe investing in the emerging markets is not your cup of tea. Personally, I love this stuff, especially when I’m sitting 6,000 miles away. I’ll take the Florida heat over the Ukrainian winter (with or without gas) anytime.

PS. The picture is of Prime Minister Yulia Tymoshenko, who has the Princess Leia look down pat. She appears to be Yanukovych’s (the pro-Russia ex-prez) strongest opponent in the upcoming elections. Incumbent President Yushenko, the Orange Revolution “Victor”, is nowhere to be seen in the polls.

Death of a Model?

2009-08-30T10:52:00.006-04:00

While the Chicken Littles of the financial world have been relatively quiet in the past few months, there continue to be pockets of anxiety. Perhaps the name most mentioned in the past few weeks is CIT.

This relatively obscure financing company deals in what they call “middle market business and commercial loans, financial services and solutions”. So we’re talking about Small Business Administration Loans, Factoring (lending with receivables as collateral), leasing, etc. Middle sized companies, like retail chains, service providers and specialty manufacturers turn to these guys for money. On the consumer side, they finance student loans.

So basically no “mortgage meltdown” here, although the recession has affected their loan and lease portfolio and write-downs put the company’s results into the red for the last few quarters (not unlike most financial institutions). CIT received TARP money last year (again…like everyone else).

The balance sheet appears to be solvent, with $64 billion in liabilities to $6.1 billion of equity. Hardly levered compared to most, you could say. Cash flow is quite positive.

Nonetheless, CIT tethers on the edge of bankruptcy. Why?

The problem is funding. For years, CIT has financed its operations by issuing notes and commercial paper to the “market” and then using those proceeds to lend out. They call it the “wholesale model”. Get money in the market at 4, 5, or 7%, lend it out at 9-12% effective rate. Live happy ever after.

Of course, something happened on the way to the bank (or middle market finance company). The credit freeze happened. All of a sudden the “market” for CIT’s paper was no longer there. CIT did a few things, like issuing commercial paper with a government guarantee (for a while) and converting to a bank holding company, which allows it to get FDIC-insured deposits. Additionally, CIT reduced its portfolio (essentially lending out less than it was collecting).

But it hasn’t been enough. Notes issued in previous years are coming due at a quick pace ($13 billion for the next 12 months). Funding has not been forthcoming quickly enough (deposits at the CIT bank are only $5 billion). At least not CHEAP funding.

There is a price for everything and CIT recently got a SECURED $3 billion credit line from Barclays and a syndicate of banks. But at a price: LIBOR plus 10%, with a 3% LIBOR floor. (That’s a 13% floor and there are other fees associated,too). They got some of the cost back buying back some notes at a discount, but it doesn’t offset that much.

This is obviously not a permanent solution. CIT can’t operate funding at over 13%. And of course, while its liquidity problems remain, it can’t fund cheaply. S&P already has them at CC.

It’s a catch-22. CIT can’t get the money it needs because it has no money. Rinse, lather, and repeat. Can the “wholesale model” escape this circle?

Of course, CIT itself is lobbying quite clearly for a bailout. Just check out its website. HERE. They have a point. How is CIT that much different from another banking holding company (Citi? Morgan Stanley?) or GE Capital for that matter (GE continues to get TALF support). On the other hand, shouldn’t the “market” have a market-based solution for this?

If CIT is indeed solvent as it’s balance sheet indicates (you can never be sure), shouldn’t there be a buyer for it? And also if so, shouldn’t CIT be able to return to its original business model (selling notes at “normal” yields).

Of course, there is an investment opportunity here. These “survival” plays tend to carry a very interesting risk/reward ratio. CIT’s stock has been volatile for sure. But a bailout could carry a hefty price in terms of dilution, so no simple solution there. Potentially large payout, however, CIT trades at a market cap of only $600 million (excluding the TARP money…which could convert).

And there are bonds, of course. Bets on “survival” generally have worked well since Lehman collapsed last year. Solvent companies with liquidity problems can find buyers (as was the case with Nova Chemicals) or a government hand if they are “too big to fail” (Banks, AIG and subsidiaries) or something in between (Ford Credit. GMAC).

In any case, CIT paper maturing in the next 2-4 months is trading at 60-70% of par. Putting down 60 with an upside of 100 in a few months, with only one major outcome in play (survival), is a tempting bet. In the case of bankruptcy, CIT’s long-term notes, trading at around 45-47%, would seem to indicate that the expectation of recovery is relatively high.
So overall, I kind of like those “pot odds”.

Fun with Standard and Poors

2009-08-21T15:18:00.005-04:00

On Tuesday (Aug 18) S&P downgraded the debt of homebuilder Beazer Homes (BZH) to “SD” or selective default. Two days later, the homebuilder’s credit (but not its bonds) was upgraded again to CCC, or basically where it was to start the week.

Before you say “whaaa”, lets just say that there is a reason behind the madness. What happened was that Beazer, seeing that its notes were trading below 50%, went out and bought a chunk of them back at those distressed levels. They invested $54 million to buy back $116 million worth of notes due in 2011-2016. Financially it makes a lot of sense, since they’re buying back bonds with yields of 30-50%. They’re not going to make that kind of cash building homes. Not these days, at least.

Well, S&P doesn’t like that very much. They call it a “selective default”. Basically, the company is taking cash on which all creditors have a claim and giving some bondholders (the ones selling) an early payment, while others get nothing. But you can also argue that by retiring debt at such a deep discount, the company puts itself into a better position to pay all creditors down the line. The market tended to agree with the latter assessment and Beazer bonds have rallied from as low as 22% at one time to 60-85% (depending on maturity).

As a (happy) holder of Beazer bonds, I don’t mind this kind of transaction, since it certainly beats other options available to distressed companies. Those usually involve issuing high-yielding secured debt, which basically puts itself in front of the creditor line and pushes us unsecured creditors down. S&P and Friends, on the other hand, don’t mind those as much.

Of course, S&P didn’t find out about these purchases until Beazer published its quarterly report (10-Q) a few days ago, and when they did, they proceeded to downgrade, but only for two days, since the fact is that the bonds outstanding are not really in default (and most probably are in a slightly better position to be paid).

This kind of thing happens in the strange world of debt and not only with obscure names such as Beazer. Earlier this year, Ford saw that its bonds were trading around 20% and instead of trying to purchase them in the market, decided to launch a tender at 30%. It was a total success with $9.9 billion in notes bought up by the carmaker. LINK. There was even a small arbitrage window, as those bonds traded around 20% for a few days AFTER the tender was announced (thank you, Ford!).

S&P weighed in to say “naughty, naughty”, but still had to reverse the downgrade a day later.

As for those bonds? Now trading around 70-75%. “Selective Default” indeed!

Disclaimer: I own Beazer and Ford bonds.

Love Me Tender

2009-08-18T16:43:00.003-04:00

It’s always flattering when someone comes up to you and makes an offer for something you own, even if you weren’t intending to sell it.

Well, bond investors are being flattered enough to blush lately as a spate of tender offers has hit the markets in the past few months.

Here’s what’s happening:

When credit markets “froze” up last year, so did the market for new bond issues. Companies, which were looking to refinance to improve their maturity profiles or simply raise capital for some corporate purpose, were essentially locked out. And we know what happened to the secondary market.
When your “old” bonds are yielding in double digits, who is going to buy some new, probably longer dated ones, at a lower rate. So very few new issues hit the market.

But as the markets have thawed, it has enabled issuers to come to market, selling new longer-dated bonds at “decent” rates and usually accompanying it with an offer to repurchase some outstanding shorter dated.

Just to name a few issuers doing this: International Paper (twice!), Owens Illinois, Corrections Corp of America, Centex/Pulte.

Now a couple of examples to understand that mumbo-jumbo.

Two weeks ago, Jabil Circuit issued $312 million of 7.75% notes at 96.143% (yield 8.50%). Here’s a Link.

At the same time, they offered to buy back the $300 million outstanding of their 5,875% July 15, 2010 (that’s less than 1 year) notes for a “total consideration” of 103.125%. That price is equivalent to a yield of only 2.45% for the remaining term of the bond. LINK.

As a happy owner of the 2010 notes, I was glad to turn them in a year before I expected to collect (2.45% doesn’t meet my yield threshold…might as well pay down my mortgage).

So why would Jabil issue notes at 8.5%, to buy back an equal amount of notes at 2.5%? Well, obviously they want to extend maturities. The market is quite open right now for new issues and they can’t assume it will necessarily stay that way. It’s an extra $18 million in interest expense for the year for a company that only earned $157 million pre-tax in its last full fiscal year. The comfort that liquidity offers comes at a hefty price.

The holders of the 2010 note had a relatively easy choice. Accept the attractive tender (98% did accept) or keep their 5.875 % note and collect the principal next June. There is little doubt they will be paid. The 2010 bond will obviously have reduced liquidity now, but frankly, most of these notes are bought to be held to maturity.

Of course, once Jabil pays for the tendered bonds, what do you do with the money? Well, the Jabil 2016 notes don’t look too bad (can you get me some?).

Another recent example is Brunswick Corporation (bowling, marine equipment). Brunswick, being heavily in the non-discrectionary consumer category, is having a hard time with the recession.

The folks at Brunswick sold $350 million of 11.25% SECURED (i.e. collateralized) notes due 2016 at 97.036% (yield 11.89%) and have tendered for $150 million of their 5% June 2011 notes. They’re offering 97% for the notes, plus a 3% “consent fee”, for a total of 100%. LINK

No premium this time, but I’ll be tendering happily again since this credit was making me a bit nervous. The terms that Brunswick has paid to make the new bond happen, clearly shows that others are a bit skittish also.

In any case, I can’t buy the new issue, since it is a Rule 144A/Reg S. Non-US persons can, but frankly I’m not recommending this risk right now.

Although at some times its hard to say goodbye to a bond for which a tender has been made, it also allows you to adjust your portfolio and move to a more profitable section of the yield curve. Selling those notes with 1 or 2 years left and where most of the profit has been made –with very little cost-, is a great deal.

So for now…keep ‘em coming. I’m loving these tenders. On the other hand, the bond calls…well that’s another issue. (and another post).

Too Good to be True?

2009-08-05T12:35:00.008-04:00

Corporate Bonds have gotten quite a bit of ink lately.

Here’s a link from Reuters “Nonstop corporate bond rally raises eyebrows"”and the more sensational headline from Bloomberg "Junk Bonds Make Loomis Sense Dot-Com-Like Danger”. Take some time to read those links.
Don’t panic, yet.

Basically, the storyline is “Hey, look at this great rally we all missed”. Since we all missed it, it has to stop. It’s a bubble, help us!

Or something like that.

As a confessed bond junkie (bond junker?). I’ll admit that things have been good. Unexpectedly good. Historically good.

Not unlike the equity markets, the rebound of the bond market has been fast and furious. Perhaps even more furious than stocks. According to the Reuters article July was the first month in many in which stocks outperformed bonds.

Here’s a graph from the St. Louis fed showing the yields of Baa rated (Moody’s – think BBB for S&P).

Since prices move in the opposite direction as yields, prices have been shooting up as those yields have collapsed. The move in junkier bonds has been even more dramatic.

Which is good, but it’s also bad because unlike stocks (remember the dot coms), bond prices are bound by rational limits. A risky (non-treasury) bond should not trade a yield below the corresponding treasury of the same duration. And of course, it makes no sense to buy a bond with a negative yield.

Treasury yields have trended up, as evidenced by this nice graph of the US yield curve.

Bond yields collapsing, treasury yields rising, spreads (the premium over the treasury yield) falling .we’re in for trouble, right?

Not so fast. Here’s a practical example. Let’s say back at the end of April you decided to buy some Alcoa 6% July 2013 at 92.75%, to yield a solid yet unspectacular 8.2%. Not bad for 4 years and Alcoa isn’t an extreme risk (BBB-, just what they call “investment grade). Good for you.
Today that bond is trading around par (100%), yielding 6% to maturity and you’ve made more in a single quarter (9.4%....the 1.5% coupon plus the price appreciation of 7.8%), than you expected to make on average in a year of holding the bond. Time to take profits and move on, right?

Well sure…you can sell. And do what exactly with the money? Put in in CDs? You’re lucky to get 1% on a three-month CD and 3% on a 5-year one. Treasuries? 2.63% for 5 years.
Less yield, lower risk.

You could increase risk, moving down in credit quality or longer in duration, looking for a bigger payout. Higher yield, higher risk.

Or you can stay put, which makes a lot of sense. First of all, because 6% YTM ain’t bad for 4 years and second because ot the shape of that yield curve.

The yield curve is seriously inclined and looks to continue to be that way for a while, even if it does move around a bit. For argument’s sake, let’s say that Alcoa’s spread vs. treasuries remains the same a year from now (330 bps) and that the three yield treasury remains at 1.66%. The bond would yield about 5% and trade around 102.75%.

So…it nothing changes and you wait a year on the bond, you’re looking for 6% in interest and 2.75% in capital appreciation over the next year. 8.75%!!! Not bad.
Sure, things can move, but as of now 8.75% is your base scenario for the next 12 months, not 6%.

That’s how powerful that incline in the yield curve is.

So, yes…this may be the beginning of a bubble. And yes, it the market has run quickly and far. And yes…this is like a bargain basement, all the good stuff gets picked up first (and is gone now), so you have to rummage through the bins to find value.

But when the yield curve is like now, think of how much fun it is to “slide down” as if it were a water slide.

So for now, I’m still buying bonds, and selling the bubble story.

Man of the Hour

2009-06-19T17:04:00.003-04:00

I'm told by a friend that the picture is of none other than Leroy King, the recently indicted, currently on paid vacation, head of the Financial Services Regulatory Commission of Antigua.

According to the criminal charges brought against him today, he would have received payment in exchange for looking "the other way" when reviewing Stanford's financials.

So I guess this would be Mr. King in his favorite pose.

Stanford: Circle of Trust

2009-06-19T11:38:00.010-04:00

As reported by just about everyone but very well by the Houston Chronicle (LINK), Allen Stanford was indicted by a Grand Jury in Houston. This came as a shock to only a very few “conspiracy theorists” out there who remain convinced that Allen was (and is) the victim of SEC overzealousness (or some other even further fetched concoction). A little reality check, please, people.

As for “what took them so long?”, I think it would be rather “how did they get this so quick?” It took about two years to get Ken Lay of Enron indicted. In any case, the indictment itself seems to lend some answers. Along with Robert Allen Stanford and CIO Laura Pendergest-Holt there were three others indicted: Houston-based accountant Gilberto Lopez; Houston-based global controller Mark Kuhrt; and Leroy King, a joint American-Antiguan citizen who was the head of the Financial Services Regulatory Commission down in Antigua.

Mr. King was the same one who in February declared that “everything was fine” in the morning, only to later say he would be “taking off the gloves”.
Apparently the US will try to extradite Mr. King from Antigua.

As for Mr. Lopez here's a cute comment from the Chronicle board"

I am oh so happy to see that they also picked up Gil "The World Revolves Around Me" Lopez. That man was as dirty as they come. Why don't they pick up his daughter Susan who also conveniently worked in the Accounting Dept. Oh, and his son Gil Lopez III who also had a high ranking position, for a contractor. We could all see if from the inside that it was a house of cards

Now this should be the answer of “what took so long”. CFO Davis, who apparently is being charged separately, and who has been cooperating with the authorities (i.e. singing like a canary) mostly likely had a good idea of “who knew what” and if he is trying to gain some favors with the authorities to see if they cut him some slack, well…you get the idea.

The authorities have to be frustrated with the Madoff case, where only Bernie sits in jail at this point. Davis’ insight may not help them recover more money (because there isn’t much more to recover), but he certainly has insights into who was in Stanford’s “Circle of Trust”.

These indictments are just the beginning. And here’s a tidbit I was sent, supposedly from a court document. If you have PACER access, maybe you can check is authenticity (at least if it was really filed as evidence). You know how it is with emails.

Additionally, the detailed recounts from Stanford executive meetings found in the SEC complaints are further evidence that not only Davis, but others have been “cooperating”. The authorities appear to be after the whole “circle” not just the main cogs.

Of course, all of this should give a certain relief to Stanford's thousands of victims, who may get at least some form of justice.
These developments, however, are likely to have little bearing on the ongoing receivership/liquidations processes, which are bogged down by in-fighting at the moment.

It's now up to the authorities to make these charges stick. Expect a very long and tedious (years) judicial process. The lawyers are licking their chops already.

UPDATE: Matt Goldstein at Reuters with another good take on the proceedings. Plus he uploaded the indictment. Good work!

UPDATE2: The SEC put its second amendment of its complaint up on its website. If you want the "juicy details" about how the books were cooked, this is a great read. LINK.

Kazakh Update

2009-06-10T11:28:00.006-04:00

Here’s a quick update for the nine readers of my post on Kazakhstan back in April. President Double N sees signs of stabilization, according to Bloomberg and that "there is a possibility to stabilize the economy at the end of the first half. The financial sector stabilized and the construction sector revived.”
The kind of thing we’d like to hear around these parts.

To make things better and to show how I called something right (for once), it seems that the IFC (international finance corporation – investment arm of the World Bank) is looking at a 10% stake in Bank Centercredit, the bonds of which we mentioned in our Kazakh post.
As reported by Rencap and Interfax.

Of course, Centercredit bonds are up sharply from when we mentioned them, but still yielding around 15%. The IFC endorsement would give it a huge credibility boost.

Borat would be proud.

The picture is a yak, of course.

First Stanford Book: Imperio de Papel

2009-06-09T08:56:00.006-04:00

To no one's surprise, books about the Stanford case are beginning to appear. This is the first one I've seen: "Imperio de Papel: El caso Stanford desde adentro" (Paper Empire: the Stanford case from the inside) edited in Mexico and as far as I can see only available in spanish for now.

It seems author Gabriel Bauducco sat down with a Mexican Stanford advisor (Hombre X) and turned it into a book. If I get my hands on it, I'll skip through to the end to see where the money is. Don't hold your breath though.

I'd expect a few more books to be on the way, now that we've already seen at least two TV specials (CNBC, BBC). Looks like somebody, aside from the lawyers and receivers, may make some money on this after all.

Stanford Venezuela Recapitalized

2009-05-09T11:32:00.004-04:00

The Venezuelan government announced that Banco Nacional de Credito (BNC) was the winner of the auction to control the assets and liabilities of Stanford Bank de Venezuela, a local commercial bank.

Although the press is characterizing this as a "sale" it was not really a sale, but rather a "recapitalization" and here is why:

In February, Stanford Bank de Venezuela, owned by Allen Stanford, was taken over by the Venezuelan government after the SEC filed a civil complaint that Mr. Stanford was running a ponzi scheme out of his Antigua bank.

Subsequently, the bank was declared insolvent and equity was written down to ZERO (declared lost). At that point it had NO capital and the owner was basically NOBODY.

An auction process to recapitalize the bank and assume the bank's liabilities (deposits) and assets was initiated and after two failed trials, BNC was declared the winner.

BNC will inject 240 million bolivars ($112 million at the official rate, $35 million at the rate everyone else has to use) to replish Stanford Bank de Venezuela's capital. This money will go into Stanford Bank de Venezuela, which will be then merged with BNC. BNC is basically paying to cover any further losses at what is now its own bank. The Venezuelan government gets NO money from this sale. Allen Stanford's "estate" gets NO money from this sale. The bank was basically given away to whoever put enough money in to recapitalize it.

For the depositors of Stanford International Bank in Antigua there is nothing to see here.

Stanford Bank de Venezuela reported a book value of Bs.88.3 million ($41 million official rate, $13 million otherwise) as of December 2008.

Economic Learnings of Kazakhstan for Make Benefit Glorious Investors

2009-04-30T22:03:00.010-04:00

My relentless quest for Junk takes me to the far corners of the earth. Figuratively, that is. Today’s subject of interest is Kazakhstan. A country I’ve had to learn about from wikipedia, since it didn’t exist when I was a lad. (and Borat).

Born (or reborn) in the breakup of the Soviet Union, It’s not hard to find on a map, since it is HUGE. It’s the eight or ninth largest country in the world, depending on your calculation method and sparsely populated with only 17 million inhabitants (about half Mulsim, half Russian Orthodox Catholics).

The place is a mineral treasure trove with practically every element in periodic table, including that ever-important U. Oil (about 3% of the worlds reserves) and gas, to boot.
(They need the gas…it gets REALLY cold in Kazakhstan in winter).

Sounds like a great place to invest, right? Well, that depends. Politically, it is led by a “demtator” Mr. Nursultan Nazarbayev since its breakaway in 1991. The constitution allows him to run for president as long as he lives, although future presidents will be limited to two five year terms (we know that can always change). Dissidence is not well tolerated. So keep that in mind

Unlike some of his South American demtator counterparts, however, Mr. NN has embraced market economics and the country has moved in that direction. The Heritage Foundation ranks it 83rd among nations in terms of economic freedom with a “moderately free” classification. (Venezuela is currently 174th, only surpassed by Eritrea, Burma, Cuba, Zimbabwe and North Korea). The economy has enjoyed stellar growth since 2000 until, well, recently (like everyone). Transparency International has Kazakhstan at 2.2 in the corruption scale. (0-10, 0 being the worst).

To his credit, Mr. N has done a pretty incredible foreign policy balancing act. He gets along well with the neighboring Chinese and Russians. He has visited Iran, which lies across the Caspian Sea from Kazakhstan, and still also enjoys relatively good relations with the US and Israel.

The country is facing an economic crisis, the onslaught of which was about a year ahead of the rest of the world (except perhaps Iceland). Banks are the center of the crisis, as local institutions, which financed domestic consumption and construction excesses with foreign capital (sound familiar?) find themselves in trouble.

A few weeks ago, fourth largest bank Alliance, found a $1.1 billion “surprise” liability and has defaulted. This week, the largest bank BTA, already taken over by the government in February, is facing the prospect of default and failure if it is unable to restructure its over $13 billion in foreign borrowings, despite receiving a $2 billion capital infusion from the government. LINK LINK2

In summary, it’s a mess, like everything else, except this mess is an 8-hour plane trip from civilization in every direction.

Invest? Sure. You could make your way down to the Kazakhstan Stock Exchange in Almaty or buy some bonds.

For the adventurous but risk-adverse, we offer Kazmunaigaz, the state-owned gas concern. Its 2013 bonds with a 8 3/8% coupon are trading at around 92%, yielding around 11%, while the 9.125% 2018s are around 87%, yielding close to 12%. Kazakhstan has $18 billion in reserves and I don’t think their gas company is going to default.

On the other hand, for those wishing to roll the dice a bit, we’ll make a suggestion in the banking sector. Not BTA and Alliance, although their bonds trading at 10-20% of par are enticing, restructuring and all. The one we like is Bank Centercredit, a smaller bank, whose largest stockholder (with 30%) is Kookmin Bank, the largest bank in South Korea.

BCCD’s 2011 bonds are trading at 61% to yield a whopping 41% to maturity, while its 2014 offering goes for about 50% to yield 28%. It may be a “coin flip”, but considering the backing, the chances for recovering the full amount at maturity look good enough.

There is a catch, however. If you are a US Person these bonds are off-limits. You can not buy them, you can not read about them. Please stop now before your eyes explode!

Why, you may ask? Well the US may enjoy economic freedom as far as the Heritage Foundation is concerned, but in terms of “investor” choice and freedom, its down by the bottom. Kazakhis can buy US bonds, but US investors cannot return the favor.

But that’s another story.

*demtator = democratically elected dictator. Dictocracy already has an entry in the Urban Dictionary and it means something else.

Stanford: Latin Parliament Weighs in

2009-04-23T09:12:00.005-04:00

Venezuelan daily Ultimas Noticias is reporting that the Latinamerican Parliament (also known as Parlatino) came out last week in Paraguay in defense of the Latin American depositors affected by the Stanford International Bank fraud case.

In their declaration of the the public service committee it was stated that "action was required by the US and Antiguan governments to preserve the rights of the depositors without privileges based on nationality" and that Parlatino would be "siding with the depostors affected by the this international financial fraud and demanding that those responsible be brought to justice".

Basically, Parlatino is weighing in on the receiver war between the British Accountants (Vantis) and the Texas Lawyer (Janvey).

A representative by the name of Correa proposed taking the declaration to other instances of Parlatino, so apparently this first declaration was just from the committee.

The picture is of Jorge Pizarro Soto from Chile, who is currently the President of Parlatino. (I didn't know that).

My Wife’s Junk

2009-04-22T13:04:00.011-04:00

In one of my posts (one of the non-Stanford posts a few of you read), I wrote of my wife’s no-hassle junk bond portfolio. And I also wrote a post about bonds overall. I’ll link to that.
If you’re new to this, start there. LINK.

Only us junkers have noticed, but JUNK has been ON FIRE lately, so this portfolio is up on average about 10% this year. A few of the bonds have become pricey over the last weeks.

But I still think it’s a good example for investors who may be new to bonds or junk bonds. Fixed income can be more than a CD. And should be. My wife put this together with a little help from me and as I explained she is NOT a financial expert. So with a little work (and money), you could too.
Click on the table to get a bigger version.

Here we go:

1. Advanced Micro Devices. This is actually a convertible bond with the “convertible part of it worth very little (convertible at 20…stock is around 3). So forget that. AMD is Intel’s only real competitor these days. Things aren’t that great for AMD these days with high debt and sales down,, but they have a solid backer in an investment firm from Abu Dabi. This is the high-risk play of the portfolio. A coin flip, if you will. But the wife thinks the odds of AMD of surviving are better than of it going under. So she made the call.

2. Alcoa. The large aluminum company. This bond is actually “investment grade” according to S&P. My wife calls this an industrial “too big to fail”. I thought the balance sheet was a bit heavy in debt…but they cut the dividend, so that means more money for bondholders.

3. Chiquita Brands. The longest maturity in the portfolio with 5 ½ years left. Bananas. My wife likes bananas.

4. Corrections Corp of America. These guys operate jails for a number of states. Anyone think that business is in a recession? Of course, there is no such thing as riskless. Nice short term bond.

5. Davita. I mentioned this bond in my J-Word Junk bond primer/rant. These guys operate kidney dialysis centers. As far as necessities go, that’s a service that is hard to do without.

6. Home Depot. It seems my wife single-handedly expects to keep these guys in business. She loves Home Depot. This is a bond that she might actually sell. It was bought below par and with less than 2 years left is at 102-104%. The highest graded bond in the portfolio at BBB+.

7. Jo-Ann Stores. This is an arts and crafts and sewing material retailer. Nothing is recession-proof, but these guys do ok when people make their own clothes or other stuff. The wife liked the stores, I liked the balance sheet. They have a credit line in excess of three times the bonds outstanding. And they have been buying the bonds back. S&P says CCC, the wife says…buy, buy, buy.

8. Owens Illinois. Only a year left on this one. Glass maker. Wife thinks they’ll make the payment too.

9. Seagate Technologies. Disk Drives. My wife takes WAY too many photos and has too much music. Always running out of space. Seriously though, business isn’t great, but these guys managed to issue new debt to the market so they should be able to refi by the time these bonds mature.

10. Starwood Hotels. Sheraton, Westin and several other brands. My figures that the collateral is good and if it comes to the worst we can turn in the bonds for a time-share or something.

That’s it. A nice little collection of junk, if you ask me. Short maturities. Somewhat diversified (no financials…hmmm) and a yield to maturity of 10.27% if nothing goes wrong. Too good to be true? The wife doesn’t think so, and neither do I.

Stanford: Vantis Does Dallas

2009-04-21T18:09:00.005-04:00

Law360 (subscription) and the Financial Times are reporting that Vantis has filed a petition for a Chapter 15 bankrupcty for the US assets belonging to Stanford International Bank Ltd. (SIBL).

A good explanation of what Chapter 15 means is HERE. What I undertand is that Vantis is looking for SIBL's direct investments in the US. That is: eLandia, HSSO, Forefront and the Majestic Grille in Memphis among others. They can do so because SIBL has already initiated the liquidation process in Antigua.

They will NOT be looking for Stanford Group Company or the advisors' commissions. SGC as we have noted before was the personal property of Allen Stanford, NOT SIBL's.

The turf war continues...now on US soil.

The Ecuadorian Two-Step

2009-04-20T22:49:00.005-04:00

The Ecuadorian government led by Rafael Correa has just launched a proposal to complete a quite impressive and unorthodox debt restructuring.

Ecuador is offering to repurchase its Global 2012 and Global 2030 bonds for cash at around 30 cents on the dollar according to this Bloomberg release.

It’s a great financial move, as the country will take advantage of the deep discount that its bonds are trading at and save a ton of cash going forward. Of course, the reason those bonds are trading so cheap is because they defaulted on them (failed to pay interest) back in November, not because they didn’t have the cash to pay, but because they claimed that the debt was contracted illegally.

These same bonds were trading close to par as recently as September 2008, so this chain of events has been quite shocking for holders of Ecuadorian debt.

Maybe its more shocking that people were actually surprised by all this. President Correa was voted into office with an anti-debt rhetoric, he created a commission to study the “legality” of the debt in 2007.

And in a complete shock said commission concluded that the 2000 restructuring in which the 2012 and 2030 bonds were born was an inconvenient and illegal deal for Ecuador, or pretty much the same conclusion that CORREA HIMSELF reached in this 2005 paper. LINK
(In Spanish…don’t bother reading, it won’t win a Nobel).

What is it with Latin American leaders? They TELL you what they plan to do, and people are shocked when they do just that.

So recapping…here is the Ecuadorian two-step:

1. Default on Debt
2. Buy it back on the cheap.

Repeat several times for best results.

Stanford Update

2009-04-17T11:30:00.012-04:00

I hate to leave the blog without any new material for so long, so a quick update on the Stanford issue. First of all, you can get exceptional extended coverage of the case at Venepirámides (in Spanish) or the Stanford Watch at the Houston Chronicle. Someone also set up a twitter. (Don’t ask me to explain twitter…I still don’t get the blogging deal).

Summing up. In Antigua the courts authorized that SIB go into liquidation and Vantis the receiver becomes Vantis the liquidator. Here’s a good link from the BBC. You can hear Vantis on Radio HERE. Scroll to minute 32 which is where the Stanford part starts.

The liquidator also had bad news for SIB depositors, confirming that SIB was in fact very much akin to a ponzi scheme. Since SIB is in liquidation, depositors have become creditors. No distributions are expected any time soon and the bank could take as long as 5 years to “wind up”. This is unfortunate and probably reflects that liquid assets have been scarcer than I believed and perhaps the only Tier II assets are those in the CS account that was frozen by the SEC. (see Begun,,,,).

It is also unfortunate because it hinders and delays other legal action that depositors could take against third parties. How can you sue for losses, until you know how much those losses actually are? (You can...but this is a bother) A quick wind up of SIB would have been ideal.

In the meantime, the Houston receiver Ralph Janvey, had his motions to control assets in Antigua quashed, but he still managed to sue 66 US advisors for over $40 million in commissions from CD sales. Normally I would link the complaint, but it lists these advisors’ home addresses and that really wasn’t a good idea if you ask me.

Also the first interest “clawback” was achieved as an investor accepted to put aside some $15,000 he had received in SIB CD interest in the past, in exchange for getting his brokerage account unfrozen. LINK

Oustide the US, the Panamanian Authorities were accepting bids for the local Stanford Bank. LINK. The results of the bids weren’t to be disclosed immediately. LINK.
The Venezuelan bank will go to auction again, after the first bidding process didn’t yield a result acceptable to the government. This time the government will not get a “premium” for the bank, all the money will go to recapitalizing the bank itself (so the investor is just paying himself and absorbing losses). LINK.
And count Mexican soap opera actress Laura Zapata among Stanford’s victims. LINK LINK.
Yes, that is her picture at the top of the post.

As for as the criminal case, Allen Stanford now has a lawyer, but he doesn’t expect charges to be brought for a couple of weeks. Oh…and the mother or his girlfriend defends his innocence. Shocking! LINK.

More interesting, however, is that David Finn, who is CFO Jim Davis’ attorney has a blog. Not really much case discussion, though…except for one little headline:
“My baloney has a first name..it’s A-L-L-E-N". LINK
Davis and Stanford were roomates at Baylor University back in the '70s.

I think this is the END of a beautiful friendship, Louis...I mean Allen.

Update: BW reports on SIB's accounting "multiplicity".

Tears For Tiers

2009-04-10T18:53:00.021-04:00

(I promised this explanation…here goes).

As has been reported in the SEC complaints, Stanford International Bank (SIBL), classified its investment portfolio into Three categories or “Tiers”.

Tier 1 was for cash and cash-like instruments (short dated paper, etc.). Very important Tier. It’s a well-known banking fact that you can run an insolvent bank for years, as long as you have liquidity. Knowing that, SIB maintained around 10% of its deposits in cash (Tier 1). This was an important pitch point for salesmen and officers, as in “The bank has never failed to pay in XX amount of years”. There was never a problem...until there WAS a problem.

In late 2008, as the bank faced an onslaught of redemptions, this cash balance was reported as low as $28 million, prompting management to seek funds from Tier 2.

Tier 2 was the actual portfolio. According to testimonies given to the SEC, it was worth a bit over $1 billion as of December 31, 2007 (instead of the $6.3 billion in the “books”) and had dwindled to $850 million as of June 2008 and only $350 million at year end 2008.
This portfolio was “overseen” (not actually managed) by Laura Pendergest-Holt and her team in Memphis.

Tier 3 was “everything else” and at the same time “very little”. Allen Stanford’s interview with ABC news gives a few clues about what exactly was and wasn't Tier 3 and how it was created. Here the interview again:

LINK

There are some great hints in his declarations. Forget about flying commercial or the Forbes list. He also said:

“Our returns in the “Boom Years” were lower than everyone else’s…No one is talking about that”

Ok. Let’s talk about it.

This goes straight to what was the Stanford “Business Model”. No Loans…just invest in securities. Back in the 90’s it was stocks and bonds (no hedge funds).
Here is what Stanford was talking about:

SIB’s average returns from 1992 through 1999 were 15% per year. That figure, believe it or not, is quite feasible for that period, since the S&P averaged 20% total return and the Nasdaq 30% in those years.
So SIB “underperformed”. That would also seem logical since SIB didn’t manage a straight equity or index portfolio. At the time they also invested in bonds.
Fifteen percent may sound like a lot, but in the late 90s, if that was all you were making…you were an “underperformer”.

AS has stated many times almost wistfully that the portfolio made “only” 14% in 1999, while others were making 30% and more…because his strategy was “conservative”.

Let’s assume, for the sake of the argument that the 15% is correct and it may well be. However, the “smoothness” of the numbers is very suspect, since as good as the market was, it was quite volatile also as returns on the indices reflect.

At some point, the portfolio made more…or more likely less than stated. Take 1994 for example, when the markets turned in a small loss and SIB stated a return of 13.9%. Perhaps it was only 5%.... but for the sake of continuing the business…they upped the number and created a “receivable” or something. Basically, they’d give it back when the market returned to normal.

AND THE MARKET COMPLIED. It was up almost 40% in 1995 and fresh money continued to come into the bank, so possibly they paid that “receivable” back with ACTUAL gains in excess of what was booked in subsequent years.
(As a side note…1995 and 1996 are the years with identical returns.).

So the numbers WERE being “managed” or smoothed out…if you will. Heck, even GE was “smoothing” its results, right? (GE was accused of doing JUST THAT back in those years).
And money was always coming in (deposits), so if the market bounced back, there was more “raw material” with which to recoup any “temporary” losses.

But then 2000 came around and it was bad. Especially bad for equity and incredibly bad for those high-flying internet and tech stocks that everyone was playing around with.
The Nasdaq lost 40% that year, but if you were in the wrong place you could easily have lost 80-90%. It wasn’t only the Nasdaq. The GE’s and IBM’s of the world were down sharply also.

SIBL claimed to have made 14.2% that year. That’s highly unlikely. Let’s assume that instead of that, SIB took a 20% loss. On a $600 million portfolio, you’re looking at about a $200 million difference and bankruptcy. But the common wisdom was “ the market always bounces back” and that had been the experience in the past. So a profit was booked where a loss should have been.

The problem with accounting for “fake” profits is that even fake accounting still has to do a double entry. So when you book that “fake” profit, you also book a “fake” asset. And this most likely how the TIER 3 investment category was born. "NOTHING was booked as an asset".

(Side note: Early this year, Satyam announced that $1 billion was missing from its cash accounts. No one “stole” this money, it was the result of booking false profits).

We know the story of course. The markets didn’t rebound until late 2002 and in the meantime more money entered into SIB, it was invested and lost. More “fake profits”…more TIER 3 Assets.

(Side note: I ran a simulation with a portfolio that was 30% S&P, 30% Nasdaq and 40% a bond composite. An “index” or average portfolio if you will. I used SIB’s deposit/expense flow. That portfolio racked up a $4 billion “shortfall” by the end of 2008. So most of Tier 3 was/is probably “NOTHING”, despite all the money that has entered the bank).

There was no easy way out of this “death spiral”, particularly because of the high cost of SIB’s deposits. Because of high rates and commissions, expenses were running at over 12% of deposits per year (very consistently from 2000 on). So, to make an example, if you had $100 worth of liabilities (deposits) and only $50 worth of productive assets, you’d need to make those assets yield 24% JUST TO BREAK EVEN. Practically impossible. Ah…but those halcyon days of the ‘90s gave them hope.

At some point, these guys figured that this wasn’t working and they needed a new plan. It was important to keep deposits coming in, to move the real portfolio/deposit ratio up and they needed something to provide better returns than the market was delivering.

Two strategies appear to have emerged. The first was “private equity”. A company by the name of Stanford Venture Capital Holdings was set up. Some of the investments were made through that vehicle. Others directly by SIBL.
Stanford’s website still has its “portfolio” of ptivate equity deals on it. These are all relatively small and almost without exception, terrible investments. As an example SIB sank $127 million dollars into eLandia alone during 2007 and 2008. Their remaining stake is TODAY worth less than $10 million. American Leisure Group is bankrupt. Health Solutions Systems seems to be heading to bankruptcy…and so on.

Where did the money for these investments come from? Book it to Tier 3. How much was it? It would be a matter of adding up, but $500 million, perhaps? How much is left? Not much. ($50 mm is my estimate).
But there is always the “Majestic Grille” in Memphis. Enjoy a “Majestic Mimosa” with Brunch on Sundays.

The other strategy was to build up financial businesses along what it considered its ‘area of influence.” Here we have the development of Stanford Group Company (US) and the franchises in Venezuela, Panama, Ecuador, Colombia, Mexico and elsewhere.
The important difference with the “other” strategy is that these banks and financial institutions were (are) NOT owned by SIBL and are NOT on SIBL’s books (any version).

These were (are) the property of Allen Stanford. That is why they are called “affiliated” companies. That of course begs the question; Where did the money to acquire these banks come from? SIBL NEVER paid a dividend. Allen Stanford did not have any other significant businesses. So the most likely answer has to be TIER 3. This could very well be the reason that there is supposedly a loan on the books to AS for $1.6 billion or so (although that could very well be something else).

Now in the cleanup of this mess, the liquidation of these institutions would provide money to Allen Stanford’s estate (which could then be theoretically used to satisfy SIBLs creditors). But they are also not worth much. We analyzed SGC in “Stanford vs. Stanford”. Probably worthless. Stanford Bank de Venezuela couldn’t be given away. Equity was declared “lost” and the bidder only had to put in capital (to the bank itself) and pay the government it's deposits. AS's estate will get nothing from that sale.
The situation was probably similar elsewhere. The problem was, that although they were “affiliated” these institutions lived off Antigua. SGC took in a large part of its revenues from sales commissions of Antigua CDs. And AS provided capital when needed ($7 million in early 2008 to SGC, for example). The Venezuelan bank gave out domestic loans with Antiguan CDs as collateral. Good luck collecting on those. Without the support of the "mothership" in Antigua, these outposts were unviable.

The other question would be why was AS the owner and not SIBL? The logical answer would be to avoid scrutiny. If SIBL were to buy or set up a bank in Panama, for example, the local regulators might want to look at the books from Antigua. That could lead to some embarrassing questions.

Just so some of the non-financial professionals understand. Nowhere on Earth is a bank owner allowed to take out a loan from his own bank. It’s fraud…defined.
What’s more, it’s common policy that bank officers get their personal loans elsewhere precisely in order to avoid such conflicts.

Once you’re on that slippery slope, anything goes. Personal expenses become “Image investments”. Cricket tournaments with $20 million prizes become “advertising investments”...etc. The WSJ in a 2002 article mentions a loan to the Antiguan government. Tier 3? Why not?

So if you kept up with all this, you should understand what Tier 3 contained: a few little somethings that were awful investments, some “anythings” that were definitely ill-advised, but mainly…a whole lot of “nothing”. But definitely NOT what was advertised in the financial statements.

You may also understand what AS was referring to when he mentioned “restatement” on the ABC interview. That will probably be his trial defense: “we messed up the accounting and should have “restated” our profits”. A seven billion dollar "OOPS"

You may also understand why he says “it wasn’t a ponzi”… because ponzis have no assets”. It didn't start as a ponzi. It was probably never really meant to be a ponzi, but it became one for all practical purposes.

Millennium bank was certainly more of a ponzi than Stanford and probably was never anything else. But SIBL was liquidating all its Tier 2 assets as it faced redemptions and was trying to pull cash out of its Tier 3 investments also. Had it been successful, it would have been left with NO assets. Then what would it have been?
Call it a PONZ if you like, or perhaps Ponzi without the dot on the i.

Stanford: “Begun, The Receiver War Has”

2009-04-05T23:24:00.009-04:00

(I said I wouldn’t write about Stanford anymore, but there is a lot of misinformation out there, so I couldn’t resist. I will try to ‘splain.)

You’d think that things couldn’t get much worse for those entangled in the Stanford Fraud saga, but it has. A nasty conflict is brewing between Antigua and Houston and in the immortal words of Yoda: “Begun, The Receiver War Has”.

In the RED corner: Vantis, the receiver in Antigua. Appointed by the Antiguan Government, they have been working at Stanford International Bank headquarters in St. Johns since Feb 22. They have control of SIB books (with all the “errors and omissions”) and have the list of depositors, which they have been checking, supposedly with depositors, if, when and where the mail service can find them and give them their statements. Vantis expects to have a web-based system for that soon enough, though.
They already have a preliminary total for the unpaid deposits at SIB: $7.2 billion.

This Monday (April 6, 2009), there is a hearing concerning the winding-up of the bank. “Winding-up” is British for liquidation. There isn’t a lot of information about that court proceeding in Antigua, but receivership isn’t eternal and a decision to wind up is required before anything can be distributed to creditors. (Receivers could also give the company back to its shareholder, but considering that they found a “significant shortfall” that’s not likely).

That doesn’t mean that Vantis (or whoever the liquidator turns out to be) will sell everything immediately, but winding up (or winding down) is the ultimate goal.

Aside from the “significant shortfall”, Vantis has found some money, mainly what is referred to by Stanford employees in the complaints as Tier 1 and Tier II assets. (We’ll get back to the tiers in another post).
BTW those complaints make great reading and are recommended for anyone interested in the case. In particular, those who still are wondering if fraud was committed (geez, get a grip, people). Link1, Link2, Link3.

Vantis, in some regard is the favorite in the receiver war because they control SIB’s books and have found the “easy money”.

Now, In the Blue Corner, Ralph Janvey, the Receiver in Houston. He took control of Stanford Group Company and its subsidiaries. This is the broker/dealer firm based in Houston. This is NOT a bank. What he found were 32,000 accounts there, which contained securities, and yes, some had Antigua CDs in them.

These holders of these accounts did not lose their securities, since these were held “separately” at third party custodians, but their accounts were frozen while Mr. Janvey looked for “clawback” opportunities. Some 4,000 remain frozen today, either because at some point they contained Antigua CDs or because they were related to Stanford employees or officers.

He has also found an assortment of loose assets (Sir Allen’s yacht, houses, golf course, restaurant in Memphis.), a number of listed and unlisted companies in which SIBL had a stake (eLandia, HSSO, Forefront…etc. etc.), nothing of which is really worth a lot. ($50 million at most and after a long, tedious liquidation process),

What he didn’t find was CASH. Fact is he had to get permission to access (not to say raid) Stanford Group’s escrow account at Pershing to get $10 million to fund his receivership. LINK.

And those frozen accounts are a HUGE headache. Basically, what they are trying to do is go back through time to see if some of those holders perceived “fraudulent” money. That’s interest on CDs, commissions in the case of advisors etc. But not few of those accounts also have unpaid Antigua CDs, so they have claims also. He is also probably finding that most depositors didn’t cash out their CDs…they rolled them over and over and over. In those cases, you can “roll back” the interest, but you can’t clawback anything.

In the end, if he manages to sort through all that, what he may recover won’t be much. Maybe, netting out some claims and clawing back $100 million at most with excruciating and extensive litigation (I’d say that’s probably optimistic). In the meantime, he even has a Nascar Driver mad at him. And in the Southern US…you don’t mess with Nascar.

If Janvey is frustrated, I wouldn’t be surprised. He also doesn’t have SIB’s books (any version) or a complete list of SIB’s depositors. He only knows about some of the CDs that went through SGC. The estimate is that only 20% of Antigua CDs were sold in the US.

But he does have Stanford Group’s creditors, employees, ex-employees, contractors, landlords, etc…probably calling him on a regular basis.

So explicitly or tacitly, Janvey is calling on the cavalry. Janvey may not have known where the Tier II money was, but he has the full weight of the US government behind him. Stanford CFO Jim Davis is reportedly singing like a canary and supposedly was aiding in the search for assets in Europe according to Bloomberg.

The first result of this cooperation would appear to be coming as Matt Goldstein at Businessweek reports that the SEC is asking the UK to freeze SIBL assets at HSBC branches in the UK and an investment account at Credit Suisse UK. These would be worth $10 million and $105 million respectively.
The motion is on the docket early Monday April 6 th (not before 11:30 UK) Court 37.

Great! Assets found! More money for Stanford’s victims. Right? WRONG! These are accounts belonging to Stanford International Bank. They weren’t LOST. Vantis knew where they were. Credit Suisse and HSBC are serious banks. There is no such thing as a hidden SIBL account at these banks. They people at HSBC and Credit Suisse read the newspapers (and they read Duck Tales…too!).

What is different is that now BOTH receivers are going after the same assets. And this can easily turn into a messy and costly “international” incident. Let’s not forget that Antigua and Barbuda is a sovereign country, although we may debate if it deserves to be one.
(and frankly Mr. Davis, let’s see some of Sir Allen’ accounts, not SIBL’s).

Why are they quarrelling? Well, it’s kind of like when burglars go though your house. They want the cash first, the jewelry next and they really don’t care about the stuff they have to put up on eBay.
The two receivers apparently held meetings this week in Miami. Hopefully some of the messiness can be avoided. But given Mr. Janvey’s record so far, messy isn’t something he avoids.

Who SHOULD get these assets? They are SIBL’s assets. The Antigua receiver should get them. Are Janvey and the SEC overreaching? Perhaps. But the Antiguans could be a little more forthcoming with information.

If I were a CD holder, whom would I root for? Once again, Antigua. The Antiguan government can’t be trusted, for certain, but…you CAN trust the IRS.
The estimated recovery (the whisper number) is about 5 cents on the dollar, or $360 million. If that money goes to Antigua…CD holders might see it. On the other hand, if it goes to the US, the IRS has a $227 million claim on Mr. Stanford, which comes first.
Five cents isn’t much, but two cents is lot worse.

Darn You, Yoda!
(I'll get back to the Tiers later...it's late).

UPDATE: SEC is granted asset freeze. LINK

UPDATE 2: Janvey's jurisdictional claims challenged (see bottom of article). Bloomberg

Quote Worth Mentioning "If an Antiguan court were to appoint a receiver for Bank of America and thrust it into involuntary receivership, the court would certainly uphold the United States’ own sovereignty and decline to recognize that order in any respect whatsoever,” Quilling said.

Quilling is representing investors looking to UNFREEZE SGC accounts.

Tax Tip for Losers

2009-03-31T16:02:00.006-04:00

OK. This one just for US Taxpayers (as far as I know).

There is a lot of talk about how the Bush-sanctioned cut in capital gains runs out in 2010 and rates go back up to their pre-2003 levels. Here’s a LINK. And ANOTHER.

However, what NOBODY talks about is that there are a lot of people out there who have tax LOSSES and not gains. Especially after that wonderful market performance of 2008. It’s not like everyone was short.

Capital Losses can be compensated with future capital gains or written off over time, but only at the rate of $3,000 per year. If we all knew how to generate capital gains every year, we’d all be happy and there would be no need for this discussion.

But let’s say you’re sitting on $100,000 of capital losses, because you believed in the stock market or you’re simply a lousy trader. You’ve sworn off stocks. It’s going to take you over thirty years to write off those losses on your 1040.
So you think: I have to generate some capital gains, to compensate this. Easier said than done, since you’ve sworn off the market and now your money is in CDs.

The interest from those CDs is NOT going to compensate your capital losses, since it is taxed as ordinary income.

Here’s where a BOND can help you. Coupon payments from bonds are ordinary income, but if you “sell” them for a profit, it’s a capital gain. Easiest way to get a capital gain from a bond is to buy it at a discount and get 100% at maturity.

So which bonds give you a good chance at that? Junk bonds, of course., but also CONVERTIBLE bonds. Especially if the Convertible feature is no longer worth much, since the strike is far out of the money. These “fallen” convertibles have low coupons and trade at discounts. Not all of them are risky.

Here are few examples of convertibles for LOSERS:

Flextronics 1% 08/01/10 ASK: 92 YTM: 7.4% BB
AMGEN 0.125% 02/10/11 ASK 94,75% YTM 3.1% A+
MEDTRONIC 1.5% 04/15/11 ASK 95.5% YTM 3.8% AA-
AMKOR 2.5% 05/15/11 ASK 82 YTM 12.4% B-
AMD 5,75% 08/15/12 ASK 49.5% YTM 30.9% B-

The coupon part will be taxable as ordinary income, but the capital gain portion (which is the main part in these bonds) will go to compensate your losses. The yields are in line with issuers’ other (non-convertible) bonds.

A broker or planner will normally look at someone in a high tax bracket and send them straight to the muni desk. But if you have losses, here’s a different option.

The Two Felixes and the Upside Down House.

2009-03-30T23:43:00.000-04:00

A few weeks ago, Felix Salmon brought up an issue at the heart of the housing mortgage meltdown mess, when reviewing the case of another Felix, whose plight was highlighted on CNBC.

Basically, poor Felix (the other one) is a bloke who bought a house for $600,000 and now finds that he owes $350,000 on a house he estimates is only worth $270,000. He is not in financial difficulty, but wonders if he should walk away from this negative equity (i.e. spare the $80,000).

The pundits at CNBC gave Felix the “if you can pay, you should stay” lecture, affirming he had a “moral” obligation to the house. Blogger Salmon, on the other hand, made the compelling argument that by turning in the keys Felix was indeed complying with the terms of the mortgage contract (giving the bank the agreed collateral) and he should AT LEAST use that leverage to negotiate better terms with the lender.

This analyst will side with Felix (the blogger) over CNBC on principle. However, I’ll take exception on the criterion used (home value vs. loan). And this is an important consideration for ANYONE facing a “negative equity” situation and perhaps a “rent” vs “own” decision. That is a LOT of people in the US these days.

Back to Finance 101, boys. They drill it into your head: if it’s not a cash item…it’s not relevant. And ALL attached cash flow should be considered. So the argument isn’t the $270,000 house vs. the $350,000 loan…it’s about the net present value cost of Felix’s need for housing.

So if we’re going to be technical, Felix has to estimate all the future cash flows derived from staying in his present house: mortgage payments, maintenance, property taxes, insurance and the (important) tax shield of his mortgage. If possible in different scenarios.

Felix’s mortgage financing is firmly attached to the “own house” decision. No one is going to give him 30 years at a tax-deductible 5% per annum without a house to back it up.

Then Felix has to determine a discount rate (his cost of opportunity) and find that NPV.
That can be tricky, given his outlook for the future and state in life (the cost of opportunity for a newly grad may not be the same as for a retiree, for example). But it’s not necessarily the rate on his mortgage, so the net present value of the loan is not necessarily that loan’s nominal value (the $350,000).

Repeat with all his other “housing” alternatives (buy something else, rent, move back with parents etc). They will all come back with different NPVs. Since they are also different “quality of life” characteristics, Felix has to determine which price (NPV) and quality (living arrangement) combination is the best fit for him. He may choose to pay a bit more (in NPV) to keep some privacy or luxury…for example.
To be exhaustive, all cash flow (or equivalent) items should be considered, such as the cost of moving his stuff, closing costs, deposits, etc, etc. Even the time to look for a place (if that time has an opportunity cost) should be considered.

Done this way, Felix may find that staying put could very well be the right financial decision, regardless of moral considerations.

And quite possibly another Felix in an upside down house in a what could seem to be a similar situation, should be making a completely different decision, given his own particular financial characteristics (tax bracket, opportunity cost and housing alternatives),

It’s all about the cash flow. Which is kind of ironic, because that was one of the mantras that fueled the housing bubble in the first place.

The J-Word

2009-03-29T21:03:00.000-04:00

(ED: A few days ago, I wrote about bonds, in general. Follow this link. It’s an easy read).

JUNK. JUNK. There…I wrote it. A financial slur. This one regularly tossed at “high-yield” bonds…those “outcasts” of the investment world.

And “high-yield” isn’t necessarily right, either, because the yield may not be THAT high.
The right term would be “low-rated”, because junk bonds are only “JUNK” because someone has deemed them to be such. That “someone” is none other than the rating agencies (i.e. masters of the universe – holders of the absolute truth), S&P, Moody’s and Fitch. Yes, these are the same people who told us that MBS (mortgage backed securities) were AAA and Lehman Bros was “investment grade” (until it wasn’t).

S&P Ratings Explained

The S&P rating system is simpler than it looks, think grade school: letters and pluses or minuses. A twist is that you can have more than one letter. Rules of thumb: Higher letter, better, more letters better; a plus sign beats no sign and minus is worse than no sign.
So A beats B; BB- beats B+; and B- beats CCC+. Get it? If not wikipedia will answer.
BBB- is the limit of respectability…everything below that is labeled with the J-Word.
D is for default and not death, because there IS life after default.

Why do they rate bonds as “junk?”

Usually, these issuers or bonds have some imperfection or flaw. Either the company is small or its in a tough industry, it might have a significant amount of debt or maybe it isn’t familiar or “American” enough. In other words, there is more risk that it may default (in the opinion of the credit agencies).

So what?

It’s just someone’s opinion, right? The same as if an analyst said BUY, HOLD or SELL on a stock, right? Unfortunately, NO.

The problem is t that the “junk” label is almost a curse. There are serious consequences to carrying it.

The media calls these bonds “too risky” and “only for pros”. Regulators tend to concur and it can be considered an “inadequate” investment for a conservative investor (advisors can be sued for recommending them). There are a considerable number of brokers/banks who REFUSE to offer “high-yield” bond recommendations. Additionally, junk bonds cannot normally be used as collateral for a margin loan, while any old stock over $5 will usually do. Only a handful of online brokers will offer them as an alternative to clients. Furthermore, a number of pension or retirement funds have statutory prohibitions concerning investing in “junk” while they can buy all the equities or leveraged hedge funds they like. More than a label, it’s a stigma.

This is incredibly unfair. Let’s not forget that bonds AS A CLASS are less risky than stocks. But the stock of the SAME issuer can be considered an “adequate” or even “conservative” investment suitable for everyone, while its corporate debt (bond) is deemed to be “junk” and only the “pros” are allowed to go near them.

Here’s a practical example, straight from my wife’s (junk) bond portfolio:

She holds Davita bonds carrying a 6.625% coupon, maturing March 15, 2013 (about 4 years), currently trading at about 97% to yield 7.3%. (high yield? hardly) These bonds are rated B+ by S&P, so they are not “borderline”, they are solidly in “junk” territory.

FYI, DAVITA is a company that operates kidney dialysis centers. It’s a stable business (if you need it, you need it) and sadly also a growing business. Recession-resistant? Probably. Doesn’t seem like a discretionary expense.
Notwithstanding, the company has a significant amount of debt (not unlike a utility) and default is always a possibility.

Oh...and Davita’s stock is also publicly traded (DVA). Currently at $43, it has weathered the crisis relatively well and is considered to be “defensive” for obvious reasons.
No broker or advisor would be open themselves up to liability if they recommended this stock to a conservative investor. But if they recommend (or buy) the bond…it’s junk and they open up a fiduciary can of worms (if it goes bad, of course).

For those who don’t get just HOW unfair this is; Davita STOCK would have to go practically to ZERO before default is a factor for the bonds. And EVEN in the event of default, bondholders can expect to come away with something. But Davita stock is “defensive” and you can use it for margin while its bonds are “junk” and worthless as collateral.

This is exactly what happens when regulators use a third party opinion (the credit agency) as the basis for policy. And investor “protection” takes on a whole new meaning when those investors willing or needing to take a little more risk for a higher return, end up invested in offshore CDs, hedge funds, REITS or high-risk equities…instead of some good old boring bond, which could have served them well. Just because somebody called it “junk”.
It’s financial bigotry at its worst.

So, as an equal opportunity investor…I like junk, I wish it were more available, had better markets and were easier to acquire and trade. It deserves a place on the menu and certainly a better rap.

And as a believer in free markets, I wish that some day, stocks and bonds -investment grade and junk (and even distressed)- along with derivatives of all kinds could join together and trade freely in more efficient and transparent markets, for the benefit of all.
Without the J-word.

Millennium Bank of Napa Valley?

2009-03-27T13:20:00.000-04:00

To no-one’s surprise the SEC came out yesterday and charged St. Vincent and the Grenadine’s Millennium Bank with being a Ponzi scheme. That’s because after the Stanford case broke, any good google search would come up with Millennium when looking for offshore banks. The blogs were all over it from the beginning. It even got TV time (Fox Business and perhaps othes) even before the SEC charged them yesterday.
I was asked about this bank several times, but there wasn’t much to say, these guys didn’t even bother publishing financial statements (false or otherwise).

So how did the SEC catch these guys? (They need hard evidence, remember).
They followed the money. It seems deposits to the bank, even those sent to St Vincent were FEDEXed back to Napa California where they would be put in a remote deposit machine to the United Trust of Switzerland’s account (Millenium’s holding company) at Washington Mutual. And they then paid everything from that account, including their own personal credit card expenses ($2.8 million), auto expenses $820,000 and wine $90,000. Airplanes? of course.

The defendants also paid out money to themselves. Some of it was more than they could spend, I suppose, so they set up investment Co’s. No news of “hedge funds” or if they had money with Madoff.
The take was at least $68 million, because that was the amount of cash deposited in the WaMu account. Millennium could have played this game in other jurisdictions also, since they catered to investors all over the world.

Big red face for WaMu compliance on this one. So much for the Patriot Act. Guess it doesn’t work well when the crooks are Patriots.

Bonds for Everyone

2009-03-26T20:46:00.001-04:00

I’ve checked this blog’s stats and people from 78 different countries have visited it. Obviously, most for the Stanford issue, but a number have been sticking around and reading the stuff and links I’m putting up here. And I put some ads on the site, which earned me a total of $0.01 yesterday, so this is a promising business for sure. LOL But other than the Stanford people and some of the media, I have absolutely no idea who is out there, what your degree of financial knowledge and what you want to read about. So I’ll take requests. And I’ll keep it simple, because I like simple.

First request is from a former Stanford Investor from Mexico, who was asking (aside from the Stanford stuff) for help with investing. I know a little about that, so here goes with the caveat of DYODDD (Do your own due diligence. dude), shamelessly stolen from a fellow blogger.
The lesson of the day is about BONDS, later we’ll get to JUNK bonds (my favorite kind).

Bonds are among my favorite investments. Junk bonds in particular. Here are seven reasons why I like them and why I like recommending them.

1. Bonds are simple.

It’s a loan. An IOU. This isn’t a bond primer, so here are few links if you are a total neophyte. LINK 1, LINK 2 and LINK 3. Things are defined and orderly. You know how much they should pay you and when they should ay it. They don’t call it “fixed income” for nothing. So you can plan around them and with them.
Like all loans, there are responsible payers, deadbeats and rip off artists. But the investor knows that these things exist (or should). The idea is to find an area or niche where you feel comfortable.

2. Bonds eliminate the middleman

I dislike middlemen between my investments and myself. So I COULD take my money to the bank, open a CD, get a low rate (or not), get a government guarantee (or not) and the bank would then turn around and lend the money to Dow Chemical, Procter & Gamble, the Republic of Kazakhstan, the US Treasury, or whatever. Or I could buy a bond and do the lending myself. I’m taking on a risk, no one will bail me out, but there is usually a reward associated with it (higher return).
It’s not the only way to eliminate the middleman. I could lend money to people also, with peer to peer systems like Prosper.com, but that is outside my personal comfort zone.

3. Bonds are more self-reliant

I hate relying on other people for things. That’s one of the issues I have with stocks. You can analyze them and find what looks like a great opportunity. But the way you make money is that someone else comes and buys that stock for a higher price than you paid for it. It’s frustrating for an analyst to see a great stock he bought cheap languish or decline, while “lesser” stocks flourish, particularly if all he predicted is coming true (company performance, etc.). But that happens…all the time. So you wonder “why doesn’t this stock go up?” and maybe it will and maybe it won’t and maybe in the end you were wrong. With the bond, the DD centers on one main issue: will these guys pay me back? If you think they will, or at least you like the odds (risk/return relationship), you can go ahead and buy. If you’re holding for maturity, you have your final buyer: the issuer itself (when they pay you back the principal).

4. Bonds don’t require much maintenance

People complain that investing is hard work and it is. You can work hard at your bond portfolio, if you want to…but if it’s hold to maturity you can let it go and let them work for you. Bonds pay YOU to wait patiently.

5. Bondholders get a little respect (not much…but a little)

CEO’s are always telling us that “they have a duty to shareholders, etc.”. To a point that’s true, I guess. But no one was asking Me about the CEO’s salary, bonuses and cutting the dividend, when I was holding stock (kind of, but not really). So, yeah, there is a duty to the stockholders, but the CEO and the board usually get to keep their jobs unless they really screw up (and sometimes even then).

With bonds, there is a “little” more respect because they’re a bit higher up in the pecking order, and you don’t care about the company’s performance that much, as long as they pay. The day they don’t pay or don’t want to pay, there can be consequences (Default), which more times than not involves these guys losing their jobs (unless you are the President of Ecuador, of course). Most of these guys really like their jobs. They’ll at least LOOK like they’re making an effort to pay.

6. My wife likes bonds

My wife is an extremely intelligent person (despite her marrying me). She knows a great deal about marine biology and in particular fish. But investing and finance is not her greatest interest (where I come in). However, being smart, she also realized I may not be around forever (women outlive men and her lifestyle is a whole lot healthier) and maybe leaving all the investing to me wasn’t the greatest idea either.

Long story short, we went a bond seminar at a local broker’s office. Two hours. She “got it”, of course, and I filled in the blanks. Not long thereafter, she set up a little low-maintenance bond portfolio with her sisters that is doing quite well. Not that she really looks at it. She doesn’t really have to. She knows when the bonds are due to pay interest and principal. Nothing too risky, but most of it is what is considered “junk” (which is an awful thing to call a bond, and I’ll get back to that later). I’ll describe the portfolio in another post, if anyone is interested. Expected return: about 8-10%, if things go reasonably well.
She’s happy with it and if she’s happy, I’m happy.

7. Brokers and advisors hate bonds

If they hate bonds, why should I like them? Well, they don’t really hate bonds as an asset class, but they’re not enthusiastic because there isn’t a lot of money to be made selling bonds retail. Especially, if the client is just going to sit on them. Don’t get me wrong: they WILL get their cut, particularly when you first buy. They’ll hit you with a commission and probably a “mark-up” (they go and “get” the bond in the market and sell it to YOU for more…crazy huh?). But that’s usually it. It’s a one-time thing and you can milk these bonds for YEARS. So they don’t like that. They will prefer to sell you a Bond “Fund”. That has its advantages. You get a quick diversification and “professional” management. It’s usually more liquid. You WILL pay these conveniences, as long as you hold the fund (management fee). You also won’t know necessarily what’s in the fund.

I, particularly, like knowing who owes me money and I buy my music, rather than renting it. So I BUY my bonds. But that’s me. And I don’t really like paying middlemen (especially when I’m doing the DD).

This post is running long…like a BOND. More on “JUNK” and the problems with bonds....later.

SEC getting it?

2009-03-26T11:27:00.000-04:00

Reuters is reporting that SEC Chairman Mary "Schapiro also said SEC lawyers are working on a plan to require investment advisers with custody of client assets to undergo an annual third-party audit, on an unannounced basis, to confirm the safekeeping of those assets"

Basically the idea is to crack down on operations like Madoff Securites, Westridge and countless others which would take a check from investors, claim it was buying securites, send them a false statement and doing whatever with the money.

You see the way things work today, you can give a RIA (Registered Investment Adviser) a check, and all he needs to send you is a quarterly statement with some numbers on it.

Of course, if that advisor has a third-party custodian (like Pershing..remember them?), the money and securities is out of the advisor's hands and you can get your info from that third party.

Eventually it would make sense to make every advisor use a third party custodian, but that's a transition that won't come quick or easy.

South Park takes on the Economy

2009-03-26T08:24:00.000-04:00

Last Night "South Park" took on the Economy. If you wondered about CDOs, MBS, TARP, Wall Street bonuses, etc. It is all explained in this episode called "Margaritaville".

The episode isn't on Hulu yet, but you can see it HERE. At least for now Click on the Margaritaville Episode - watch full episode.

It is irreverent and not politically correct,as usual, so if you are easily offended...well you shouldn't watch South Park...ever.

ED: Episode has been removed, hopefully it will be reposted at some time in the future.
ED2: Now its back up!...just try and see if it works.

FINRA on Scams

2009-03-24T20:38:00.000-04:00

The people at FINRA have gone to the trouble of putting up tips on their website about “Avoiding Investment Scams”. Here’s the LINK.
It’s quite a good explanation about the different types of common scams and the sales pitches used to sell them. Makes a good “educational” read.

They also have a SCAMMETER that you can run an investment proposal through, to see how many red flags it raises. And to top it off there is a RISKMETER, which is a self-test that measures how vulnerable you may be to a scam.

It’s work that is worth applause and probably about time. BUT, in the end, how useful is it? I ran the Madoff fund and a Stanford Antigua CD through the SCAMMETER and they came out ok. I wasn’t quite sure if Madoff was offering “high returns with low risk”, because it had such a track record, but that was never offered or guaranteed. In the Stanford case, the tough question was if it was actually a “high-yield” investment program, because the yields were good, but not extraordinary. But in any case, since these investments were coming from a licensed broker/dealer they STILL checked out ok on the SCAMMETER (even with the high yield or low risk offer).

Bank of America shares, on the other hand, which were selling at $3.80 when I picked some up on the advice of a blog (now $7.20 yippee!), gave me two red flags. One for being below $5 a share and the other for me not knowing the guy who writes the blog.
But I’m kind of liking that investment right now. (Target = $10).

So the scam meter is only good for the low quality scams (FINRA seems to admit it). The really good and really big scams we have seen lately, like Madoff, Stanford, and Westridge, were all pulled off by FINRA-licensees. So, run your advisor through FINRA to see if he might be part of a small scam (not licensed) or part of a multi-billion dollar one (licensed).

It’s nice that FINRA is trying to educate about fraud, but they shouldn’t try to tie some sort of moral or ethical value to the licenses they sell (and which are their raison d^etre), because they have none. These licenses also have a very relative “insurance” value. Investors do have the right to arbitration against their broker/dealer (if FINRA registered), but I’d hardly characterize FINRA as a “neutral” party to those disputes (guess who pays the bills?). And there is anti-fraud insurance through SIPC, but it’s limited in scope.

Is there some value to those licenses? Well, sure. The applicants normally have to pass a test, which requires some specialized knowledge and may include some ethics questions. But knowing the answers to those questions doesn’t make you ethical. And the questions themselves may not be the right ones. For example, in my recent Series 65 (Investment Advisor) test, I was asked “Under which of these circumstances can you take a loan from a client”. I was looking for “NONE”…but that wasn’t an option. So I guess I got it wrong. (Yes, I passed the test).

And herein lies the problem. The Securities Act of 1933 and the Securities Exchange Act of 1934 govern the US markets and the investment process. As good as these pieces of legislation may have been at the time, they are now celebrating their diamond jubilee. The world has changed a lot since then and version 2.0 is long overdue.

Just don’t make it like Vista…please.

Unmissable - Hey Paul Krugman!

2009-03-24T15:54:00.000-04:00

Don't know this guy...but the song is REALLY REALLY GOOD!

Mini-Madoffs

2009-03-21T23:44:00.000-04:00

They say there’s never only one cockroach. Or rat. Or Madoff. Especially when you start looking for them. The SEC has been looking and they have been filing complaints consistently so far this year. Some are calling it Ponzimonium. Or maybe it’s just a return to reality (or a return to “reality in returns”).

Here are a few from the SEC’s recent (three month) “Hall of Shame”

Joseph Forte of Philadelphia: ran a Ponzi scheme since 1995 trading S&P Futures contracts with reported annual gains of between 18% and 38%. Apparently Mr Forte actually traded; it just wasn’t his “Forte” (sorry, I had to). His only winning year was 2002, when he made $21,000. When his scheme was busted, investors had statements with $154 million on them, but there was only $146,814 in the account. Mr. Forte, of course, paid himself performance fees which supposedly were in the order of $10-12 million over the course of the scam. (The good old 2/20). He actually accrued $23 million in fees, so he didn’t even pay himself fully for his “false” profits. Scammed himself, if you will, along with 80 investors.
Forte’s company was a limited partnership and never registered with the SEC. Forté gave himself up, but only after he ran out of money and had even hit some friends up for personal loans to cover redemptions. Presumably he won’t be eating cheesesteak for a while.

James Ossie of Atlanta (CRE Capital), was promising 10% a month trading Yen futures. He actually traded those futures, losing about $12 million of the $25 million raised. CRE would get investors to “recruit” new ones, in classic pyramid style. 120 investors involved in this one, some of course, actually got to see that 10% a month.

Arthur Nadel was running six hedge funds in Sarasota, FL worth almost $500 million, when he mysteriously disappeared January 14th, leaving his fifth wife “Peg” with a note stating “withdraw as much cash as can” and “sell the Subaru if you need money”. He turned himself in two weeks later, attorneys at hand. The funds had only about $506,000 worth of assets in them, according to the SEC.
Nadel reportedly owned an aviation company, which had trained one of the 9/11 terrorists (not purposely of course). Also a shady past: he was allegedly disbarred in 1982 after defrauding clients to pay off debts to a loan shark. The rest…you guessed it…the one man show, the friendly CPA (unregistered since 1990). The green Subaru turned up at the Airport. Wonder if Peg will list it on eBay.

Gordon Grigg of Nashville took advantage of the “flight to safety”, by telling investors they were buying investments in the US government’s TARP program. The Program Relieved investors of their Assets, alright, but not their Trouble. $6.2 million was the reported “take” from 25 investors. The government-backed 12.5% notes offered only existed in Mr. Grigg’s fertile imagination. The pitch: this was a “private placement” the deal couldn’t be had anywhere else (right about that). Grigg had already been served with a “cease-and-desist” order in North Dakota for selling non-existent securities to a client in 2006. Maybe Grigg should be commended for actually finding SOMEONE with money in North Dakota.

Scott Ross of Gilbert Ill, was allegedly engaging investors to put their money in “life settlement contracts”. This is basically buying life insurance policies from people who expected to die soon (and really don’t need the money then, do they?). Mr. Ross who sold himself as a “sought-after expert on financial topics and strategies” (CNBC, anyone?) was using the money instead to “live it up” in a skybox in the new Colts stadium in Indianapolis and pay salaries and redemptions of his other funds. This scheme, which reportedly began in 2007, was tragically “short-lived” as the $2 million fund "expired".

Marvin Cooper (Billion Coupons, Inc.) of Hawaii was allegedly operating a Ponzi scheme among the deaf community on the islands. The complaint states that Cooper raised $4.4 million by holding investment seminars, offering 10-25% monthly returns trading Forex. Only $800,000 was actually invested, of which $750,000 was lost trading. Cooper allegedly spent $1.4 million, including buying a house and putting money down on real estate in Panama. In an email, Cooper wrote that down there he could “resume the OPM (Other People's Money) business without nasty headaches from those bastards from Wall Street and their cronies." Yeah, those bastards! Cooper, who is himself deaf, is still maintaining his innocence after the March 2nd “hearing”.

The SEC isn’t quite sure how much money James Nicholson of Westgate Capital (New York) was “managing” in his 11 funds. They think at least $100 million of investor capital was involved, and WC at some point claimed to have $750 million “under management” and at another it was only $200 million. But when two dozen investors’ reimbursement checks for over $5 million started bouncing in February 2009, it appears that true value of the assets was “materially less” (SEC’s words). Nicholson had been barred from the industry in 2001 and didn’t bother using a small accounting firm…he just made one up: “Havener and Havener”

On the other hand, in the case of Westridge Capital Management (something about the WEST, I guess), the accounting was much, much better. Mr. Paul Greenwood and Mr. Stephen Walsh are accused of misappropriating $293 million and $261 million respectively from their $667 million hedge funds. How do they know the “exact” amounts? Well, a Westridge “employee” would make these gentlemen sign a promissory note for the amounts they had “borrowed” every year. With this money the gentlemen and their wives (who are also named in the complaint) “invested” in a lavish life-style which included “multi-million dollar homes, a horse farm, cars, horses, and rare collectibles such as Steiff teddy bears worth $80,000 each.”

The hedge funds’ strategy was “enhanced equity index management”…and they of course, achieved those sought-after “smooth” high returns. The “target” client (or should we say “mark”) was college endowment funds and pension funds. There were only a few dozen clients, but they were big ones. Carnegie-Mellon University, University of Pittsburgh, Ohio Northern University, Bowling Green University, Iowa Public Employees, Sacramento Public Employees, San Diego County Employees Retirement Fund, North Dakota State Investment Fund (more money from North Dakota!) and others. All seemingly “sophisticated” clients, many of which actually got into Westridge through other “advisors”.
In the immortal words of Led Zeppelin “I’m gonna send ya…back for schoolin”. Maybe next time run the investment past one of your own finance or statistics professors? How about it?

North Hills’ Mark Bloom (NY) didn’t even bother running a hedge fund. He had a “Fund of Funds.” That “Fund of Funds” apparently only invested part of the $30 million it received in one fund: the Philadelphia Alternative Asset Fund, which turned out to be a fraud itself, uncovered in 2005. He did manage to “Fund” loans to himself for at least $13.2 million, including the purchase of a $5.2 million townhouse, which he transferred to his wife, who sold it four years after purchase for $11.2 million. (Nice trade, unfortunately not for his client). Bloom had learned from the best, since from 1992 to 2001 he was a partner of WG Trading Co, which was none other than “Westridge” (see above). North, West…Hills, Ridge…all the same thing.

Real Estate is safe, right? Not these days, and not for the investors in SunWest, which raised $300 million from 1300 investors to be invested in retirement homes with a safe and modest 10% annual return. They were told they were buying specific properties, when the money was going into one big pot, out of which the company paid everything. SunWest put that money down to buy the homes, but they didn’t do so well, and SunWest was paying returns from new investor money and mortgage refinancings. Payments ceased with the company couldn’t refinance anymore and lenders started to foreclose.
This was an industrial-sized version of the “house as an ATM” concept.

Hundreds of investors of LA-based “Diversified Lending Group” and “Applied Equities”, many senior citizens, bought $216 million worth of “Secured Investment Notes” supposedly backed by property and mortgage lending. These notes would pay a guaranteed 9 to 12% per annum
However, there was no such backing, since the SEC alleges that CEO Bruce Friedman used the money for other unrelated investments and diverted at least $17 million of that to “support his lavish lifestyle, including purchases of a luxury home, cars, vacations, jewelry, and designer clothing for himself and an alleged girlfriend, who is named as a relief defendant.” How do you freeze a Prada purse?

Finally, we have Investment Adviser Leila Jenkins of Locke Capital Management in Rhode Island. Ms Jenkins isn’t accused of misappropriating funds, but rather “making them up”. Having “only” about $165 million under management, she apparently “invented” a billionaire Swiss client to inflate her AUM numbers when soliciting prospective new clients. She also allegedly “invented” performance records in the past, including a certain period when she had NO clients.
Who says that you can’t claim a 30% return on a ZERO dollar investment? How much is 30% of ZERO? Right?

Stealing from the elderly, deaf, the dying, the charitable the college educated and the colleges themselves, the Mini-Madoffs have been very busy the past few years. You can only hope the authorities have raided the nest and the roaches are out, but you can only wonder.

Oh...and look out for names with “West” in them.

SEC Complaints/Press Releases

Forte
Ossie
Nadel
Grigg
Ross
Cooper
Nicholson (Westgate)
Greenwood and Walsh (Westridge)
Bloom
SunWest
Friedman
Jenkins

Starting Blog - No More Stanford

2009-03-21T13:07:00.000-04:00

This is my new blog.

The Stanford Blog entries have been moved to HERE

Este es el nuevo blog.

Los post sobre Stanford se han mudado a AQUI

Passing it On

2009-03-16T22:50:00.001-04:00

Today I received an email from a group called "Stanford Victims Coalition", whose purpose seems to be quite self-explanatory.

I went to their website and it seems to be free. I registered (also free). There are some discussion boards where many of the questions asked here, plus others are discussed and victims can rant and vent also, which can also be therapeutic.

Here's the Link. They also provided a list of victims who wish to talk to the press, so that's good place for the media to contact victims for their stories.

Maybe I'm naïve, but I didn't see a hidden agenda. So I'm passing this on.

Who needs a lawyer?

2009-03-11T12:43:00.001-04:00

(versión en español, en blog de venepirámides)
(Disclaimer: this is not legal advice…just my opinion)

I thought I was finished with this Stanford thing, but I have been getting emails with questions, so it’s better that I answer them here and everyone can read them. Let’s go case by case.

If you are the holder of an UNPAID Stanford International Bank LTD Antigua CD.

You do NOT need a lawyer. The bank in Antigua is in receivership and they are trying to collect as many assets as possible. The receiver in Antigua (Vantis) will be the one paying you eventually. You should keep track of the information that is coming out of Antigua and be patient. But please be realistic. There is not going to be much to distribute. My colleague at devilsexcrement had initially hoped maybe 10-20%, but now estimates 5% at most (more like 3%, if I read correctly). I’m afraid I must agree. The “investments” we know about aren’t worth much, and even if personal assets (jets, art, etc.) can be collected, much of it may go to fill in black holes elsewhere. For example, Stanford Financial may end up needing money, rather than supplying it. The bank franchises in Antigua, Venezuela and Panama have been taken over by the respective authorities. Even if they are re-sold, it is unlikely any money trickles back to the Antigua receiver.

Apparently the going rate for these lawyers is 40% of what is collected plus expenses.
Those expenses may turn out to be larger than any recovery. Some are going around claiming that they will be able to recover 40% of your investment. If they are so convinced, tell them to “buy” your claim for 20% and see the reaction. Not so enthusiastic anymore? I thought so.

In any case, ask what exactly do they plan to do. Sue SIBL? Sue your advisor? Sue the Antiguan Government? Maybe I’m missing something but I don’t see how a lawyer will put your claim ahead of the others.

The receiver in Antigua doesn’t think you need a lawyer either. Read the FAQ. Particularly the last one.

If you are the holder of a FROZEN Stanford Financial account and have never held an Antigua CD.

You do NOT need a lawyer. You need some patience. Your account will be thawed as soon as Mr. Janvey (the US receiver) verifies you have never had an Antigua CD. You do need to find a place to take your money because it can’t stay at Stanford, so start looking around.
If you want to sue Mr. Janvey for hardship, cost of opportunity, well go ahead. Remember that a judge has approved his actions.

If you are the holder of a FROZEN Stanford Financial account and have held an Antigua CD in the past.

You may think you were lucky to get out of Antigua, but unfortunately Mr. Janvey wants your money. If the interest you collected was part of Mr. Stanford’s fraud, you (according to this theory) are the beneficiary of “fraudulent conveyance” and need to return that “profit”. I’m not saying I agree with this, but apparently Mr. Janvey wants to do this.
If he does, you will be one of many affected. I would expect some sort of class action. You should probably join.

How far Mr. Janvey wants to take the “conveyance” principle is also a matter of speculation, because theoretically he could ask St. Jude Hospital to give back the Stanford donations or preferably for Mr. Stanford’s ‘acquaintances” or family to give back their Christmas presents. We’ll have to wait and see. For now he wants the Stanford accounts, because that is what is at his disposal. It may not be fair, but that is what it is.

If you are a past Antigua CD holder, lucky enough to not be anymore.

If you are outside of the US, you probably do NOT need a lawyer. I really don’t see how the Antiguan receiver can get at your assets for the “conveyance” thing, unless you have assets in Antigua. In the US, Mr. Janvey would have to find you first and unless the US firm has the records of all the Antigua CD holders, that won’t be easy to do.

Keep in mind, that people will be looking for money, and they may just want yours. So keep your options open, In any case, this will take some time, and no “conveyance” claims have been made yet in the Madoff case, as far as we know.

If you are a Stanford Advisor who didn’t sell Antigua CDs

You probably don’t need a lawyer, unless Mr. Janvey decides to collect those upfront “advances’ some of you received for bringing your business over to Stanford. I don’t see that case, but with these things you never know.
Keep your Rolodex, though. Good odds is that your clients may still like you and could even take their accounts to wherever you end up and keep you as an advisor.
If you find a new place, though…this time check it out better before signing on.

If you are a Stanford Advisor who sold Antigua CDs

You probably need a lawyer. Not to protect you from investor lawsuit, there is a 1994 Supreme Court decision that deals with that (or so I’m told). However, I could expect “fraudulent conveyance” to extend to the commissions and prizes that were paid for selling these CDs. If, on top of that, your assets are at Mr. Janvey’s disposal (frozen), I’d think he might want some of that. Besides a lawyer, maybe a career counselor would be good. There is a future for you in sales, but not so sure if in finance.
In any case, it always is a good policy to “know your client”, because they may be looking to know you better, after finding out that their Antigua CDs aren’t worth much anymore. Be careful.

If you are a Stanford Insider

You know you need a lawyer, but you already probably have the best other people’s money can buy.

Tell your tale of woe

2009-03-05T16:22:00.001-05:00

If you are a Stanford Antigua Investor and would like to talk about your troubles, the BBC is listening.

Here's an email so they can contact you for an interview: LINK. They asked me if I knew anyone, so I'm just passing this along.

Jon Stewart - Financial Analyst

2009-03-05T08:10:00.001-05:00

Mr Stewart has proven that not only is he a brilliant comedian, but an illuminated financial and market analyst.
Here is an invitation to watch last night's "Daily Show" (follow the LINK). It may be the best 21 minutes you ever invested.

LINK

You will understand WHY I am a fan.

(Oh...and Stanford is on it too)

Stanford vs. Stanford

2009-03-03T10:14:00.001-05:00

This is just to clear up some concepts, especially for the friends in media and some of the readers who may be confused. I really should be getting off the case, soon.
There are several “Stanford” institutions being mentioned these days, so it’s important to try to separate and clarify.

Stanford International Bank (Antigua) is the center of the controversy and where everything started. This is the “CD” issuer and where the $8 billion (more or less) portfolio seems to be missing. There are 28.000 account holders very upset at this bank.

Stanford Group Company, based in Houston, is NOT a bank. It (and its subsidiaries) is a broker-dealer and investment advisor, along the lines of a Raymond James (with our apologies to the good people at RJ). It also has accounts, about 35.000 of them.

SGC, however, does NOT have custody of the securities or cash in these accounts. These are kept at Pershing, J.P. Morgan Clearing and others. SGC and its team of advisors and brokers just “managed” these assets, that is gave orders to buy/sell or whatever.
So these assets are “safe” and the holders of these accounts (including Johnny Damon, my mistake) have not lost their money (unless they had Antigua CDs…of course). But these accounts are currently “frozen”, as in the holders can’t make withdrawals or shift their assets to a different broker/dealer (Merrill, Morgan Stanley, etc.) at this moment. This is a bother for these people, but it should be temporary.

The value of these assets is also a good question, since SGC has claimed to have $50 billion “under management”. Given the “numerical enhancement” ability of the Stanford PR team, that would seem to be an overstatement. Why is this important? Read on.

SGC is owned by Mr. Stanford directly, presumably bought or established somehow with money originating in Antigua (compensation or “Loans”, etc.). So if this business could be liquidated or sold somehow, that money could be used to compensate the Antigua CD holders (stress the could).
The ideal scenario: sell SGC to a competitor quickly, take that money and put it in the bank to pay those CD holders.

However, the SGC receiver, a Mr. Janvey is quickly finding out that SGC is a little black hole in itself. Being an analyst, we went to see SGC’s statements. Only a balance sheet is available (no P/L) and its from 2007. But that’s good enough.

First glimpse: $85 million in equity. Hurrah! However at second look, it is not so good. The cash and “equivalents” is listed at $48 million. Normally that would be good. But in the notes we see that Mr. Stanford made a capital infusion of $7 million in SGC early 2008. Why would a stockholder put in additional capital to this company, if it had $48 million in cash and was way over regulatory net capital requirements?
The $48 million may have been there, but it was more likely an “equivalent” than cash.
Receivables from Antigua? Perhaps.

The other item that stands out is $39 million in “Advanced compensation agreements” From what we gather, SGC would pay money upfront to investment advisors/brokers for them to bring their clients’ assets to SGC. These amounts would be amortized over time, as those assets would generate fees (supposedly) for the company. If the advisor/broker left, he or she would be on the hook for this money (look up “disgruntled ex-employees”).

Basically this is money that has already been paid and never gets collected, as long as the advisor/broker works at the firm. If the firm no longer offers them a job…well I guess they may not want to pay that money back. In the current situation, this item would seem to be worthless.

The buildings have mortgages, the equipment is leased, you get the idea.

How about the intangibles? Although numbers are lacking, referral fees from Antigua made up a good part of SGC income. It did generate income from its internal business, but that would not suffice to sustain its current structure. You may not be able to give the company away.

That leaves the 35,000 accounts and Mr. Janvey’s headache. He would love to be able to “sell” or assign this business to another broker/dealer investment advisor. But this isn’t quite as clear-cut as when Barclays purchased Lehman’s business. Who are those accounts really tied to? Stanford or the advisor? Or given what has transpired neither?. No one is going to buy a business that walks out the door the first chance it gets.

Time is of the essence; the longer the accounts are frozen the more likely they are to move away once thawed. There is little or no cash to pay employees to come in and work a transition.

And there is likely to be very little left for the US receiver to distribute back to Antigua (if any at all).

Of course, the good news (if you got all this) is that the fraud still stands at around $8 billion (not $50 billion).

EDIT: The "assets under management" were estimated by the receiver at $6 billion.

Get Your Fresh Duck Here! (El Pato Servido Aqui)

2009-02-28T11:44:00.001-05:00

Apparently the link to Duck Tales and El Pato, the original Veneconomy articles has now been restricted somehow, as bandwidth limits were exceeded.

So you can find Duck Tales and El Pato here, I guess until I see the bill for my server.

I also have the Stanford Annual Reports and at some time I will be posting those to the net, since for some reason the Stanford International Bank website is no longer showing them. But they are large...so I'll keep them on my hard drive for a while.

These are important historical documents and could be part of case study for accountants/auditors sometime in the future.

EDIT: Stanford International Bank Annual Reports and December Letter have been uploaded to SCRIBD and avaliable HERE.

In Defense of Stanford

2009-02-26T22:33:00.001-05:00

Several media outlets have now upped the tally on the alleged Stanford fraud from $8 billion (which is approximate) to $9.2 billion. We must come to the defense of Stanford on this one. It's really just $8 billion from the Antigua Bank (so far).

The other $1.2 billion arise from another part of the SEC Complaint which refers to a Mutual Fund Wrap program that Stanford Financial started in 2005. For those who don't know, a mutual fund "wrap" is like a Fund of Funds for mutual funds. Invest in one and you diversify over a series of mutual funds, each of which is supposedly also diversified. Double your diversification and double the fees you pay also.

Stanford Financial isn't accused of missappropriating (stealing) that $1.2 billion, but of misrepresenting the performance of the program. The program started in 2005, but Stanford already had a track record, which apparently was carefully "made up". And as they operated this program, they also "enhanced" the returns they were actually made. So the $1.2 billion should still be there for investors, but the $25 million they collected in fees...that maybe they shouldn't have.

This is also what the "disgruntled employees" were complaining about. (I was always wondering about that)

So why would Stanford set up a program like that and fudge the numbers to make a measly $25 million. Well, they brought a lot of advisors on board with it and those advisors were encouraged to...you guessed it...sell Antigua CDs.

I guess it shows where Stanford's real strength lied: in making up numbers.

Someone joked that the much ballyhooed "Stanford Investment Model" (SIM), actually stood for SIMulated.

Show Time

2009-02-26T12:57:00.001-05:00

I'm back to talking to the media. Thank you for your patience. I've already talked to some print and radio and will be doing CNN in a few mintues.
I've been trying to get back to everyone who emailed originally...and I really want to talk to some of the print people and internet blogs.

So here's an email: interview@dalmady.com, if you still want a piece of this story or if I left you out and that other email you sent was unaswered..
I know it will blow over soon enough and then we can all get back to our respective jobs.
Any help with Stewart is seriously appreciated.

28,000

2009-02-25T08:29:00.001-05:00

That's the approximate number of depositors who were left hanging in Stanford International Bank when it went into recievership by the Antiguan authorities. The receivers plan to get a statement out to every one of these clients so they can check their claim.

That's good news. It would seem that the data integrity has been preserved, at least on the liability side.
It tells us a few more things also. The bank was probably under some stress for redemptions and losing clients, as it had stated back in December 2007, that it had over 50,000 clients and as recently as December 2008 the figure was stated as "over 30,000".
You have to think if we can believe those numbers or not, but assuming they were correct you can see the drain.

What is now being determined is what remains on the asset side. At this point the receiver has already stated that there is "nothing like $8 billion" in the portfolio. Plus the fact that the bank was having trouble with redemptions, and scrambling for cash makes it clear that there weren't many liquid assets left.

But lies work both ways and one can only hope that the bank has some assets also "off the books" which can be seized and used to satisfy creditors. Even if they are illiquid ones. We know from SEC documents that the bank that "Doesn't do loans" actually had lent money to eLandia. There could be more of these deals out there.

Then of course, there are Mr. Stanford's assets, some of which have been seized or frozen. But there is a problem with that also. You see, Stanford International Bank never paid a dividend. So, if Mr. Stanford was receiving compensation from the bank in some other fashion, he needed to report that on his 1040. And while the IRS in normal circumstances can only go back three years to conduct an audit, if there is evidence of fraud, they can go back further. If Mr. Stanford owes US taxes (and apparently he does), the IRS gets first dibs on the seized assets. So, I'd say it's a pretty good bet that Mr. Stanford's filings are no longer gathering dust in the IRS's archives at this point.

Starving the Beast

2009-02-23T18:31:00.001-05:00

Ponzi schemes aren’t necessarily born that way. They can start off legit, as long as the model works. They can run with a gap between the value of the assets “in the books” and their “real” or “market” value (is the “market” really “real”?) for a while as long as the assets are performing and there is cash in the bank. For that to happen deposit growth only has to equal or exceed expenses minus investment income.
In a good year the gap may even narrow some. But there comes a point when the gap becomes too large, too obvious and it is filled in with a lie. And the “bank” becomes a beast.

The beast gets hungry. It needs money to cover the lie and it needs souls to bring it that food. So it stretches its tentacles into the world in search of the unsavvy, the trusting, the needy and food. More food. To enlist those souls it gives them what they crave: belonging, self-importance, and material wealth. And it becomes a cult. A cult with a leader, blind faith, and a golden shield.

On CNBC, analyst Mike Holland was reviewing Stanford material and said wisely “This doesn’t pass the smell test”. He’s right. It doesn’t. Mike’s a smart guy and knows this stuff. But the beast doesn’t want Mike’s money. It will never get Mike Holland’s money, so its tentacles never touch him. They go around him and find Johnny Damon. And Johnny isn’t stupid or foolish or even greedy; he doesn’t know what LIBOR is and he shouldn’t have to know; because he’s busy playing ball and earning his deserved rewards. So he sees the smartly dressed woman with the golden shield and the word “bank” and he signs the check. And the beast is fed.

So I wrote “Duck Tales” and I wrote it the way I did because it wanted it to be read. By Mike Holland. And Johnny Damon. And particularly the lost souls. To starve the beast. And maybe spare Mike or Johnny from this beast, or the next.

You see “Duck Tales” isn’t about Stanford or the SEC or how smart I am. It’s about forgiveness, and not judging, and about opening your eyes and seeing through the façade. Because we are all Mike Holland, and Johnny Damon and even Allen Stanford sometimes. So I wrote it for them. And I wrote it for me.

Dirty Job

2009-02-21T09:49:00.001-05:00

On “Discovery” there is a program called “Dirty Jobs”, where host Mike Rowe explores people who unblock sewers, shovel manure and other similarly distasteful ventures. It’s quite entertaining and I’ll watch as much as my stomach allows. Invariably, I come to the conclusion that it’s a job I DON’T want. But someone has to do it. Because if not, the sewers back up, the manure piles up, the roaches run free and things get messy and smelly real quick. The cleanup is normally costly and painful. So dirty as they may be, these jobs are important.

In the financial world, the dirty job is the auditor. He’s the maintenance man, he’s the cop. It’s the job I DON’T want. It’s the dirty job. But someone has to do it.

Drilling things down to basics, the auditor doesn’t do the books. That’s the accountant. The auditor checks things. That the money that’s in the books, is actually in the bank (Satyam – talking to you); that the inventory is IN the warehouse, that the portfolio actually EXISTS and so on. There’s a lot more to the auditor than just the accounting, so they’ll also check that the delivery guys don’t have a side business, that the purchasing guy is looking for the best deal out there and so on. You get the idea. They don’t only look for fraud, they also check that things are being done right, so they normally go around asking a lot of questions. Oh, and least I forget, the petty cash. These guys LOVE to check the petty cash till. It’s almost OCD. They usually work in teams, so one guy checks the other, and they rotate from task to task. You get the idea; no one gets too “chummy” or too familiar with any single aspect. It also makes it a bit more interesting for the auditors. They still do the petty cash thing, though.

One thing these guys love is third party confirmation, so they’ll send out little envelopes to the bank, the broker, clients, etc., just to make sure the bank and broker statements, the invoices and the delivery notes are actually correct and not some wild or fraudulent fabrication. Those little envelopes have to be sent back to the AUDITOR and not the company. The reason should be quite obvious, but they still put it all over those envelopes (and people STILL send it to the wrong place).

The “boss” auditor in the organization reports not to the CFO or the comptroller, but to highest level of the organization, usually the board of directors. I think we can understand why. They’re checking everybody else.

However, these guys usually don’t get paid like top-level executives, because it’s just a dirty job. They’re not out there making groundbreaking corporate decisions or on the front line with customers. Maybe it’s not fair, but that’s the way it is.

The “external” auditor checks that the things that the “internal” auditors are doing is right. And they’ll recheck stuff, usually the important stuff – money in the bank (PWC talking to you- Satyam), portfolio at the broker, etc. They do the little envelope thing, too.
And of course, the petty cash. They usually report back to the shareholders, which makes sense ‘cause that is one step UP from the board, in what is called an “audited” report.

They rotate “teams” from client to client and yes; it’s even a good idea to rotate external auditing firms every few years. You get the idea, fresh eyes, and fresh perspectives constantly.

When all this is working correctly, it’s like a smooth running machine humming the background.

Except for one thing: these guys are a PEST. They’re always snooping around asking stupid questions, wasting your time, sending those envelopes and checking the petty cash.
Managers and execs don’t report to these guys and most make a ton more money than they do. So when they come around, you’ll roll your eyes and think what do these guys want now? And you’ll make them wait outside, while you do your “real” job, the one they pay you to do, and the one that reports back to your boss and defines your bonus. Or you’ll let those stupid envelopes pile up on your desk, because you’re swamped and have better things to do. Most of the time this stuff doesn’t matter, just little blips in the background whirr.

So it’s humbling for the auditor, he knows his place in the pecking order and probably who makes what. So when the “big man” says “later” or “don’t worry about that” or “that’s the way we do things around here”, the auditor thinks “what the heck” or “it’s not really important” and “it’s their problem anyway”. And most of the time nothing happens, but sometimes stuff does. It happens. STANFORD happens.

So here’s the thing: auditor guy. It’s your job. It’s a dirty job. I don’t want it. But it’s yours. So do it. And do it well. And if you can’t do it: don’t do it. And if they don’t let you do it: QUIT. And if something smells funny: TELL. Be discerning though, you know what’s important. It’s not the account with $30 in it. Bug us with important questions, interesting questions. And knock it off with petty cash already (ok, ok, we’ll do it sometimes).

Because when the sewers back up and the manure piles up, and everything spills over, you’re going to know why. And you’re not going to like it.

So do your dirty job, do it with pride, do it with honor. It’s important. You guys are the front line of defense against the Stanfords of the world.

And clip this column and take it to your superior. This might be the time to ask for a raise.

P.S. Never been an auditor, so if I messed up the description, forgive me. But I still don’t want your job.

Shutting it Down

2009-02-19T15:12:00.001-05:00

Time for me to get back to work. Thanks guys. I'm declining all audio and video requests. That's radio, TV and telephone. I can't. It's too much. I know at this point I'll be getting questions that maybe I don't want to answer honestly or just can't answer 'cause I didn't do that part of the research. I'm a really bad liar.

I do want everyone who's interested to actually READ "Duck Tales", the first part much more than the second part. The second part we already know about. I didn't write "Stanford International is an $8 billion Ponzi" or "How to catch a thief"; I wrote "Duck Tales" and if you read it you will know the difference.

I'm going to pick up a nice copy of the "Emperor's New Clothes" and display it prominently somewhere around the house. I know I'm going to read it to my grandkids (not yet...PLEASE..LOL).

The story as far as I'm concerned is over. It's moved on. In a number of directions. If you want to read about the story, this is not the place to come. If you want to read some of the crap I've got going through my head, you're more than welcome. I've gotten some accolades for my writing these days (somebody actually called it a "gift" LOL), so that's something I will do. But not about Stanford, specifically. Other stuff. Related or not. It's my blog. LOL. I'll try to make it entertaining, Promise.

I'll also advise here when I'm going to be doing interviews, IF anyone is still interested after a while (I'm thinking a week). That will allow me to catch up on my work (did I say I love my job?) and why not...the story too. Then whatever.

The stuff on this blog, as far as I'm concerned is copyright-free. Feel free to use it. Copy/paste etc. I really don't know how that works. I don't know about the stuff that's linked out to other blogs, I'll check with my friends, new and old. Some will tell me I'm crazy, I guess.

I've found this to be a great way to communicate. I get to tell my own story...my way. Not within someone else's context. Personally, I think it's groundbreaking...and I hadn't realized up to now.
I will be writing about that.

I know you don't get opportunities like this in life very often. I really want to take advantage of it in a constructive way.

Shut Down...

P.S. But Jon...you know I'm waiting for you! (I am SO full of myself).

Media Blitz

2009-02-18T21:19:00.001-05:00

Calling all media. It's getting just a bit too much. I love you all, but you're getting a bit too close. Calling the home phone is a no-no and showimg up at my house is a huge no-no. Most of you have been real nice and I want to be really nice back. I'll figure something out and maybe the story will move on.

I've been trying to put things up here so people could understand. TRANSPARENCY. No secrets.

There's an email on the article. That's the way to contact me. Honest. I answer those emails. But the idea is that you READ the article first, please.

Except Jon Stewart, of course...he can have his people call my people. LOL. (this is getting SO ridiculous).

Stanford: Who Knew What When

2009-02-18T16:25:00.001-05:00

I hope this is my last “inside” story about Stanford. The story is moving ahead, as it should, and this is yesterday’s news.

I finally got around to reviewing the SEC complaint about the Stanford group and IMHO it is excellent work. It’s all there, the numbers add up, the language is unequivocally strong, and they have many facts I didn’t have. Plus there is a whole different angle to it also, with marketing and mail fraud, if I understand the complaint correctly (I’m not fluent in legalese). Please don’t discard that angle. Mail fraud is a serious offense and multiple counts will put you away for a long time. Those may turn out to be the only charges that actually stick. I think we all recall what Capone went down for. Does anyone have a problem with that?

So where and when they got their leads on this is irrelevant. They were obviously on to this operation in some form or fashion. If they were on to the Ponzi lead independently, kudos. If they plucked the “duck” off the net, recognized the value of the work I did, ran with it to complement their case in a few days, well double and triple kudos. Trolling for tips is exactly what these guys need to do. Kudos for that, too. There is a LOT of stuff going up right on the web right now. Pull it in, check it out, and get these guys.

Unlike Markopoulos, I did not take my data to the SEC. Hence; I have no grounds to judge their performance regarding the investigation. I threw it out there to see where it would stick and maybe save somebody some money or grief this time or next.

A few more issues here. This is NOT Madoff. Stanford International Bank is not a US company. They don’t list securities on US markets. They are not FDIC or SIPC insured.
They have NO obligation to file their financials with the SEC, as far as I know. And even if they do, the SEC cannot run an inspection in Antigua or request documents unilaterally. We’re talking borders, here, governments and jurisdictions. And even “cooperating” can be dicey, you don’t know who is with whom.

As it concerns my research, if SIBL hadn’t brazenly put their financials up on the web, I’d have nothing. There are actually banks out there that show nothing. Who knows what that is about? So transparency is the key to stopping these things.

Like all scams, there is KNOW, SAY and PROVE. I KNEW. I wasn’t just fishing out there with “Duck Tales”. I had what was there, which was plenty, but I also had lots of little subtle clues that didn’t go into the article. Stuff you get from reading hundreds of these things. I’m proud of that. I SAID, in my own ducky wimpy way, hiding behind Heisenberg. I’m proud of that. VenEconomy SAID without knowing everything I knew and that is why Toby Bottome is a great man. The SEC KNEW and moved to PROVE. That’s their job. Well done.
(I have a REAL problem with KNEW and SHUT UP, but that’s another rant).

The Madoff story blew the cover off all of our eyes. The SEC’s too. Maybe you haven’t noticed all the mini-Madoff’s running around out there and ditching their Cessnas to hide. I have. Who exactly do you think they are running from? It’s not from “disgruntled employees” I can assure you. Go get ‘em, guys.

These guys need help to whisk these guys out and clean this up. Sounds like a job program for ex-Wall Streeters if you ask me. Anyone see the epilogue to “Catch Me If You Can?”

P.S. Food for my big head. My daughter says I am now World Finance’s “Man of the Year”. Something about an “Elder Wand” that Harry Potter fans will get. LOL

Back Up and Running

2009-02-17T17:38:00.001-05:00

I'm back. Sorry I went down. I saw popups all over my page and freaked out. I promise I WILL get this blogging thing down (now more than ever).

I think this blog can be an important historical archive. Maybe I can field some questions too and write a few things if my day job allows it. I know a couple of things and people used to say I could explain complicated things in simple terms. I'll try.

As for now, I'm glad to see that some regulators and law enforcement "got it" as I thought they had and hopefully they find "Sir Allen" (when can we stop calling him "Sir"?), his inner circle and delve into his dealings. I'm pretty sure there is wide web of fraud and corruption. Please don't try to put ME on the record for it, OK? I took down the WSJ article. I don't take back a word I put there, but that wasn't me speaking, that was frustration and anger and the haunting pleas of that lady from Venezuela. I'm not like that. My wife called me out on it. I was almost thinking they were going to pin it all on the dead auditor and the press was part of the cover up. Paranoid, like Markopolous. I can relate.

I have not been swamped by Journalists. I have answered everyone who went through the appropriate channel. Those who didn't, I ignored. Thank you for the congrats...particularly those who actually READ my article. It's an honor to be called a "journalist" by people who really are...and put their cojones on the line for stuff more important than money. A Jamaican radio show wanted me on. I would have gone on...honest, but they wanted someone to talk about the investigation, and I'm just a guy who does numbers.

I've been invited to "guest-blog" at some very important blogs and I'll probably do some of that, especially at the blogs who backed me up during this thing.

The "Daily Show" hasn't called. DANG!

How I Know, What I Know

2009-02-16T13:25:00.001-05:00

You're probably asking yourselves how I know what I believe is going on in Antigua. I don't. But I do. That is nobody has spoken to me, but the numbers have. And here is why:

I established quite clearly in Duck Tales, SIBL has its own particular "business model". Investments, rather than loans. Highly liquid ones, supposedly.

Now if we all go to note 3.7 of SIBL 2007 financials (yes, the "official set"), called "liquidity risk" you will see that of $7.0 billion assets (the last column), $6.3 billion is listed as "up to 1 month assets". That's 90%, children.

What does that mean, boys and girls? Well if they have cash troubles NOW and even have to pull liquidity out of their investments like Transwitch (TXCC) (thanks Peabody...I'd link...but I'm a novice), they have no liquid assets. So figure it out...there's NOTHING (except those penny stocks and piecemeal here and there).

It also follows that it this wasn't a 2008 thing. Even if their portfolio was down 40% this year, according to model, they should have plenty of cash and be able to deal with redemptions.

So, our friends in Antigua are looking at the vault right now, and it's empty. Sorry kids.

Linking up and filling in the blanks.

2009-02-16T11:04:00.001-05:00

I'll make it easy for everyone by putting my stuff up on the web. Don't call me, I'm on the donotcall list and I will report you. LOL.

I promise to get this blogging thing better. My kids will help. Bear with me.

Here's the Original Article "Duck Tales". As I'm told it's already linked at Sir Allen's wiki bio. Quite poetic, I'd say.

Here's the inside story of "Confessions of a Reluctant Whistleblower" on DiabloCaca's site.

Here's the follow up: QUACK! on Inka Cola's site and QUACK! on DiabloCaca's site.

Let me fill in the blanks about me and the story. These are questions the reporters asked and are probably floating around anyway.

I'm 48. Happily married (sorry girls...and err you too, sir). I'm from Venezuela, but English is my first language (long story you don't need to know). I'm a financial analyst. They're writing "Florida-based" and "independent". Both good. I work out of my house. I like that a lot. I live in Florida and Yes I did come here LEGALLY.

About the story. I have NO inside information. I found out about this as stated in "confessions".

I'm not gruntled or disgruntled ANYTHING and Sir Allen doesn't owe me money. I don't know any Stanford employees past or present. I have NOT been contacted by regulatory or law enforcement agencies BEFORE or SINCE. I don't have a lawyer, though I'm told I might need one.

I don't know Mr. Markopolous, but from what I've seen he's a pretty smart guy. However, I would much prefer to party with Sir Allen.

I did not contact the Stanford group before writing "Duck Tales". A reporter actually asked me that. But I guess the fact that I'm not dead, maimed or suddenly filthy rich should clear that up.

I did not contact or try to file something with the SEC. After seeing Markopolous' deposition, that was probably the best. I can just imagine..."File this in triplicate...sign here, we'll get back to you after we check with the company".

Now I'll actually find some news to blog about. Like Joe the Plumber, and unlike Markopolous, I have an opinion about EVERYTHING.

Is anybody reading this?

Still on this Stanford Thing

2009-02-15T23:59:00.001-05:00

It’s Sunday night. Almost a week since DiabloCaca put “Duck Tales” up on the web. This should help get things out there. The bloggers and reporters are still finding details and new edges on stories. There’s the mistress CIO…a bunch of SEC filings to go through. There are some “whistles” from the past, which suddenly fell silent (jammed with benjamins?).

It’s over guys. Thank you all. It was over when the WSJ said “FBI”. Probably WAY before that. The FBI does not investigate “accounting discrepancies” or even “disgruntled employees”. The WSJ does not say “FBI” and “bank” in the same sentence unless they are sure. The FBI does not work 9 to 5 Monday through Friday. They have pulled files, put people on this. The same as the SEC. These guys have “expert” auditors who can sniff out schemes much more complicated than this one. They’re NOT STUPID, they just weren’t looking at this. Any 10-year old could read “Duck Tales” and tell something was fishy. Heck, “Duck Tales” is already linked on Sir Allen’s wiki bio.

The financial statements were on the website and still are. Let’s give these guys some credit. They’re on it and with a TON of face to save, so you can be sure there is some overtime and more than a few plane tickets to Antigua.

Today I stopped talking to reporters. I don’t want to seem rude or pretentious but...they need to take the story forward…not back. There are ton of angles. Some of you are a WEEK behind. Where’s Sir Allen? He’s already at least a week ahead of everybody. And he has his own means of transportation. Still reporting on that letter? C’mon, that was a “parting shot” to cover his retreat. Who are these directors? Where are they? They left that poor Mr. Bertsch behind to now “decline to comment”.
You’re a good man, Mr. Bertsch. I hope you find a job soon.

The odds of the bank opening for business tomorrow (or Tuesday, don’t know about the holiday) are not good. In Antigua, the PM is saying, “It is out there now that things may not be as rosy as they ought to have been with the Stanford Empire…” That’s Reuters reporting, not me speculating.

People are going to lose money. Some deserve to. I was told today of someone who sent $50k to Stanford Friday AFTER reading “Duck Tales”. Maybe that will make “Stupid investment of the week”. Many will be innocent. Some may never come forward admitting it was theirs. But if the hole is as big as I believe it is, we’re talking many times the GDP of Antigua (like 5). Antigua will NOT bail them out. They have no obligation to do so, either. Forget the US, too. That “Excess FDIC” insurance that SIBL talks about in its December letter? That’s for the Bank’s US deposits…not the money of depositors in SIBL. The money is NOT insured.

The hotspots will be easy to find. Just check the Stanford map at http://www.stanfordgroup.com/about/offices.aspx In the US: Florida, Texas, and most of the South, Montreal in Canada. The Caribbean, (of course). Venezuela, Colombia, Ecuador.

People are going to lose their jobs. Some deserve to. Some people are going to feel really bad about losing other people’s money. You know who you are. Think hard about it when you’re driving around in your Mercedes convertible. Think about what you really knew. But PLEASE, don’t do anything rash. Your life is valuable and you can turn it around.

All for now. I’m already worse than Joe the Plumber.

Patience. I will figure this blogging thing out.

Starting Blog

2009-02-15T23:18:00.001-05:00

I can't really depend on my friends' blogs forever. They have important issues to write about and I'm just going to blog a bit the Stanford case here until it winds down.

If I learn how to do this maybe I can post everything here and it can be an archive for future reference.

Alex Dalmady