Apparently everyone is very excited over the CDS rates being quoted upon a default of Berkshire Hathaway. Forbes has reported it and it appears to be talked about all over the blog world by numerous commentators.
But I have yet to see is any discussion about the yield on bonds of Berkshire Hathaway. We have to remember, there are various buyers in the market. A buyer of CDS insurance is not necessarily a buyer of their bonds, nor stock, etc. In fact, these are the types of things that are often most interesting to look for, a discontinuity in the marketplace. I have to say, this is a big one. Why?
A trip over to FINRA: http://www.finra.org will show people interested in this type of thing something far more interesting. The yields on the CDS's are about equivalent to the actual bonds themselves. So, an insurance writer can sit on the full amount of cash and get some amount of yield there, sell CDS protection on BRK, sell the equivalent amount of bonds and sit around and with the original cash balance at the RFR and sit with the cash from the short at the brokers cash rate. However, collecting interest on the two combined on top of the CDS while having 100% full protection from the short is a pretty compelling trade if you ask me. It's called free money. Real, economical, pure free money.
So, there are a few thing to ponder as we look at this discontinuity and whether or not BRK is truly in junk bond status. We need to try and come up with an answer as to which is right, the CDS market or the bond market, which presents the following questions:
1) Which is more liquid?
2) Which is in more turmoil?
3) Which has more questions over counterparty risk, making perhaps the number of acceptable sellers to be minimal and more valuable?
4) Which is in the midst of shriveling up because it needs to be moved over to an exchange before anyone will trade much anymore?
So as everyone freaks out over BRK CDS spreads, let's understand that just because it's a very disturbing and exciting thing to happen and thus seems very newsworthy, that in fact the analysis of what the CDS market says is stopping short of any sort of useful analysis at all. Perhaps this is the problem. Actually going through and pointing out that the bond yields say something very different might make the "oh my gosh" factor dwindle. Because maybe, just maybe, what's really happening is some huge institution probably has a big need to hedge out their risks and somewhere there are traders taking advantage of that. That's the way this game works. Forced buyers in illiquid markets get screwed, just as badly as forced sellers. Look at what happens to mutual funds at the end of every day they finally figure out how big their redemptions are going to be. Traders are sharks and the minute they smell blood, they will devour you. My guess is, someone really wants insurance and probably not because they own BRK bonds, perhaps they own some of those terrifying derivative positions Buffet wrote which have gone up in value.
So, looking at the bond market, it says BRK is one of the strongest companies around.... still. It trades lower than the average Moody's AAA rated company by what appears to be about 133 basis points. Now let's ponder what this says about what's going on in the rest of the market. It appears that this is yet another sign the world is going to end. But yet, the world is not going to end and the Great Depression is not here. The Great Depression required people to take all of their money out of the banking system causing a gigantic contraction in the money supply, causing a massive contraction in the economy.
So let's all ask ourselves.... do we really believe that everyone is about to put their money under a mattress, which is one of the core problems of the GD? We may move it from a weaker bank to a stronger, maybe even attempt to move it offshore (try Europe, I hear the banks are in great shape there too!!), but we are in far more danger of being Japan. But Japan started out being priced like the Nasdaq, with a bunch of not very compelling companies that don't allocate capital very well at all and have done nothing to rationalize their economy during the downward spiral and in fact have basically attempted to keep the status quo. Real GDP has in fact grown. So, the comparison doesn't really work completely since part of the problem of Japan is understanding the scale of the bubble and the mismanagement of the economy and capital allocation at a business level ever since. The similarity is that the US consumer is going to have a long time to have to repair their balance sheet and we may experience a defaltionary period. How the incoming administration behaves towards mimicking mistakes made in the GD and Japan are interesting possibilities. But that is about it. Deflation of -1% is a far cry from -10%. It won't happen.
The rates on CDS's should actually be a tip off that what's going on is pure mayhem. The markets are having trouble holding together. We can argue about whether or not that is a bullish or bearish sign. My bet is calmer days will eventually be seen.
Disclosure: As of today, long Berkshire Hathaway.
Friday, November 21, 2008
Thursday, September 25, 2008
Letter to my representative
This is a letter I am personally writing to my own representatives regarding the Treasuries $700 billion plan. I urge you to read it and if you feel similarly, to make some effort to contact your representatives. It appears now that there is some form of legislative agreement that is not published. This letter is based on the original proposal of the Treasury. While it appears that we already have new legislation and these comments may be old, they may help form the basis of commentary on the new legislation when the actual details of it arrives. If you don't like the legislation, let's try and stop it.
------
I am writing this letter to express my concerns about the recent legislative proposal from the Treasury Department for the authority to buy mortgage related assets. While I am very concerned about the health of our banking system and it is clear that a decision on how to most effectively deal with this crisis does need to be made rapidly to be effective, I can not support this legislation as written. The fact that time is of the essence makes the proposal given forth by the Treasury that much more galling. I would like to highlight my enormous concern over what has been proposed and offer a set of principals for gaining taxpayer support as well as ideas that could improve the situation.
First, this legislation is effectively a blank check for the Treasury to purchase $700 billion worth of mortgage backed securities with no oversight. This would put unprecedented power in the hands of the Treasury. I would like to highlight one of the most egregious parts of this bill:
Sec. 8. Review.
Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.
This section is enormously irresponsible and insulting to taxpayers to ask us for $700 billion with no oversight or possible review of actions, especially when many of the participants responsible for executing this legislation have potential conflicts of interest.
I would also like to highlight Section 3, which has two potentially conflicting statements:
Sec. 3. Considerations.
In exercising the authorities granted in this Act, the Secretary shall take into consideration means for–
(1) providing stability or preventing disruption to the financial markets or banking system; and
(2) protecting the taxpayer.
The problem with this section is not that there is a potential conflict between these two aims, but there is no information as to how the Treasury Department intends to resolve conflicts that will arise. The devil of this bill will be in the details and the Treasury has provided none. Taxpayers are being asked for up $700 billion. We have a right to have clarity and detail over how the Treasury intends to protect us. The Treasury has aired some ideas, but it is fair for taxpayers to ask for more than general ideas floated around and to demand that this legislation have those details explicitly stated within the text of the legislation.
I now want to highlight what I believe should be the roots of any forthcoming legislation.
1) The legislation should have a very clear intent of not providing solvency to institutions, unless the government receives a majority equity stake in the institution. What I want to make sure the legislation avoids and has explicit rules to ensure we are not doing, is an endaround to providing solvency by overpaying for assets.
2) If the government is the buyer of mortgage backed assets, the purchasing of assets should be done at penalty rates to ensure that the taxpayer is protected and that financial institutions seek other alternatives first. If banks don't want to participate with such demands, then this says something about how dire their needs are. We need to first understand that very sophisticated institutions are having a hard time identifying correct pricing for many of these assets. There is no reason to believe that the Treasury, given $700 billion with a stated goal to provide stability to the markets is going to be able to price them better than everyone else.
3) A large governmental entity buying bank assets may be necessary to help wind down insolvent institutions in an orderly manner and this is a reasonable use of taxpayer money.
4) I believe that if taxpayers are needed to fund a massive buyer of mortgage backed assets that the authority of this proposed institution should not be under the umbrella of the Treasury. It should be formed more in the mold of Resolution Trust Corporation, used to wind down the failed Savings and Loans institutions. As an asset management company, an RTC II can be given incentive of accruing profits to the taxpayer, like a normal asset manager and most importantly be setup as a fiduciary to the taxpayer with specific targeted investments it can make. Under the proposals given by the Treasury, it appears to me any such outside asset management firm would first work on the behalf of the Treasury, not the taxpayer. An RTC II could theoretically make equity investments into sound institutions without having political interference over such decisions and let unsound offers pass by. The current legislation provides no such guarantee as it simply gives a $700 billion check to the Treasury to do as it pleases. Since the stated goal of the legislation is to provide liquidity into the market, an RTC II does put a large buyer of mortgage backed securities into the market. Since this proposed institution would be motivated to buy assets at fair value in order to make profit, it would not have an incentive to overpay for those assets with taxpayer dollars. Adding another very large buyer in the market could help facilitate the return of other market participants who are too scared to put these distressed assets on their balance sheet. As a fiduciary to the taxpayer, we can be better assured that this entity is working on our behalf.
5) I urge you to not to add legislative riders about things like trying to fix corporate pay. There is plenty of time for well thought out legislation that would address these other issues. This legislation should be focused on doing what is necessary to help banks to move forward and resume lending as this is the immediate need. I fear that legislative riders will be made for political reasons and will not be well thought out even if well intentioned. There is a time and place for legislative proposals on banking regulation, etc. I believe this bill is neither the time nor the place for it.
Effectively, the Treasury’s proposal amounts to, "can I borrow $700 billion with no strings attached". There is no detail about how they will use it nor protect this massive sum of money. Not only are there are enormous potential conflicts of interest that are unaddressed as to how they will be resolved, but the Treasury has the gall to state: "Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency".
While I am very concerned about the current state of our world financial system, this legislative proposal is an insult. To receive such an unworkable piece of legislation under the time pressures we have, it says volumes about the complete lack of leadership we have in these trying times. I respectfully ask you to not allow this legislation to pass until it addresses the fundamental flaws in the current proposal.
Respectfully yours,
Greg Harris
------
I am writing this letter to express my concerns about the recent legislative proposal from the Treasury Department for the authority to buy mortgage related assets. While I am very concerned about the health of our banking system and it is clear that a decision on how to most effectively deal with this crisis does need to be made rapidly to be effective, I can not support this legislation as written. The fact that time is of the essence makes the proposal given forth by the Treasury that much more galling. I would like to highlight my enormous concern over what has been proposed and offer a set of principals for gaining taxpayer support as well as ideas that could improve the situation.
First, this legislation is effectively a blank check for the Treasury to purchase $700 billion worth of mortgage backed securities with no oversight. This would put unprecedented power in the hands of the Treasury. I would like to highlight one of the most egregious parts of this bill:
Sec. 8. Review.
Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.
This section is enormously irresponsible and insulting to taxpayers to ask us for $700 billion with no oversight or possible review of actions, especially when many of the participants responsible for executing this legislation have potential conflicts of interest.
I would also like to highlight Section 3, which has two potentially conflicting statements:
Sec. 3. Considerations.
In exercising the authorities granted in this Act, the Secretary shall take into consideration means for–
(1) providing stability or preventing disruption to the financial markets or banking system; and
(2) protecting the taxpayer.
The problem with this section is not that there is a potential conflict between these two aims, but there is no information as to how the Treasury Department intends to resolve conflicts that will arise. The devil of this bill will be in the details and the Treasury has provided none. Taxpayers are being asked for up $700 billion. We have a right to have clarity and detail over how the Treasury intends to protect us. The Treasury has aired some ideas, but it is fair for taxpayers to ask for more than general ideas floated around and to demand that this legislation have those details explicitly stated within the text of the legislation.
I now want to highlight what I believe should be the roots of any forthcoming legislation.
1) The legislation should have a very clear intent of not providing solvency to institutions, unless the government receives a majority equity stake in the institution. What I want to make sure the legislation avoids and has explicit rules to ensure we are not doing, is an endaround to providing solvency by overpaying for assets.
2) If the government is the buyer of mortgage backed assets, the purchasing of assets should be done at penalty rates to ensure that the taxpayer is protected and that financial institutions seek other alternatives first. If banks don't want to participate with such demands, then this says something about how dire their needs are. We need to first understand that very sophisticated institutions are having a hard time identifying correct pricing for many of these assets. There is no reason to believe that the Treasury, given $700 billion with a stated goal to provide stability to the markets is going to be able to price them better than everyone else.
3) A large governmental entity buying bank assets may be necessary to help wind down insolvent institutions in an orderly manner and this is a reasonable use of taxpayer money.
4) I believe that if taxpayers are needed to fund a massive buyer of mortgage backed assets that the authority of this proposed institution should not be under the umbrella of the Treasury. It should be formed more in the mold of Resolution Trust Corporation, used to wind down the failed Savings and Loans institutions. As an asset management company, an RTC II can be given incentive of accruing profits to the taxpayer, like a normal asset manager and most importantly be setup as a fiduciary to the taxpayer with specific targeted investments it can make. Under the proposals given by the Treasury, it appears to me any such outside asset management firm would first work on the behalf of the Treasury, not the taxpayer. An RTC II could theoretically make equity investments into sound institutions without having political interference over such decisions and let unsound offers pass by. The current legislation provides no such guarantee as it simply gives a $700 billion check to the Treasury to do as it pleases. Since the stated goal of the legislation is to provide liquidity into the market, an RTC II does put a large buyer of mortgage backed securities into the market. Since this proposed institution would be motivated to buy assets at fair value in order to make profit, it would not have an incentive to overpay for those assets with taxpayer dollars. Adding another very large buyer in the market could help facilitate the return of other market participants who are too scared to put these distressed assets on their balance sheet. As a fiduciary to the taxpayer, we can be better assured that this entity is working on our behalf.
5) I urge you to not to add legislative riders about things like trying to fix corporate pay. There is plenty of time for well thought out legislation that would address these other issues. This legislation should be focused on doing what is necessary to help banks to move forward and resume lending as this is the immediate need. I fear that legislative riders will be made for political reasons and will not be well thought out even if well intentioned. There is a time and place for legislative proposals on banking regulation, etc. I believe this bill is neither the time nor the place for it.
Effectively, the Treasury’s proposal amounts to, "can I borrow $700 billion with no strings attached". There is no detail about how they will use it nor protect this massive sum of money. Not only are there are enormous potential conflicts of interest that are unaddressed as to how they will be resolved, but the Treasury has the gall to state: "Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency".
While I am very concerned about the current state of our world financial system, this legislative proposal is an insult. To receive such an unworkable piece of legislation under the time pressures we have, it says volumes about the complete lack of leadership we have in these trying times. I respectfully ask you to not allow this legislation to pass until it addresses the fundamental flaws in the current proposal.
Respectfully yours,
Greg Harris
Saturday, December 22, 2007
JPM
The day before Jamie Dimon was on the front cover of Barron's, I had just entered into a smaller JPM position. For me, it was uncanny timing, however, it was a similar thought process that brought me to the conclusion and I figure "how to play the banks" is the exact same thought process that was going on over there and with me which drove the timing. I also figure that there are other people out there with similar thoughts, so I thought I'd write a bit about why I chose JPMorgan as my banking choice during this crisis.
Obviously, not all banks are well these days. Citi holds something like $43 billion of exposures to the "most senior" tranches of CDOs. Unfortunately, the value of the super senior part is really highly defendant on exactly what the quality of the paper is beneath it, because overcollateralization of zero (because it may be tranches of early exposures in the actual original securitization), is still zero and there's no way to tell unless you know what underlies the CDO. I'm sure it's probably not zero. The deeper question is how close to zero. They're also now bringing back onto the balance sheet god knows what because it hasn't been on the balance sheet and I'm usually pretty skeptical about the exact quality of items that are chosen to be held off the balance sheet. Thus, Citi is for me, impossible to analyze.
But just because I think that banks are in for a huge storm doesn't mean that simultaneously that you can look around and say that there is no value out there. One always has to remember that you should be willing to buy everything for some price because this is really a game of probability and understanding price implied expectations. If it will survive to produce cash in the future, it's worth a number. So I've gone on a quest for a position in a bank (other than my best, IMO, bank idea, BBNK - a much bigger sized position in my portfolio and maybe more on that in the future). So what is attractive to me about JPM?
Now, I do believe that at some point, I'm going to want to buy the weaker companies who have made it through the storm. But I don't think we're there yet. In fact, I think problems are going to last quite a while. Therefore, for now, I'm not looking for the screw ups. So the behavior of management leading into this situation to me is important. The balance sheet is extremely important. Questions like: How much subprime is sitting on the balance sheet vs. has been sold off? What kind of allowances are in the cookie jar to hold up in a storm? Exactly what kind of activities are going on off the balance sheet? How seriously do they take their capital ratios? How diversified are they away from mortgages? These are all important questions.
In JPM, there are some interesting answers. Dimon has claimed that they have about $1.5 Billion in CDO exposures and $6.8 B in warehouse holdings of the IB. None are collateralized by subprime. Taking a look at writedowns of subprime mortgages leads one to an estimate of about $10 billion total SP loans being held, which is peanuts for a company the size of JPM.
Taking a look off the balance sheet, we find exposure to multi-seller conduits. These are similar to a Structured Investment Vehicle, while simultaneously being pretty different. My understanding is that, SIVs are structured finance all over again, except it's an infinitely long lived investment vehicle instead of a security. The original securities are tranched by risk, maybe with some overcollaterization to possibly hide the quality of the underlying assets, maybe they're put in a CDO tranched by risk with some overcollateralization to hide the quality of the underlying assets (oops, I mean arbitraging extra spread) and maybe they're bought by an SIV which will structure itself all over yet again, to possibly hide the quality of the underlying assets (I mean arbitrage spreads), by which time, no one probably has any clue what the quality of the underlying assets are. But you know, it's all arbitraging value here, over and over and over again, so in actuality these things should be really valuable!! Or, turns out not so much, as the case may be. A conduit is a conduit, allowing participants to access the CP market to participate in the structured finance world as smaller players (at least this is my understanding). The assets are administered by JPM, who also provides credit enhancements, which appear to generally be in the form of liquidity agreements in say the case of disruptions in the commercial paper market. But these aren't entities restructuring all over again and there are real reasons to offer this structure to entities looking to sell assets into the conduit. One of the footnotes reads:
"The Firm views its credit exposure to multi-seller conduit transactions as limited. This is because, for the most part, the Firm is not required to fund under the liquidity facilities if the assets in the VIE are in default. Additionally, the Firm’s obligations under the letters of credit are secondary to the risk of first loss provided by the customer or other third parties – for example, by the overcollateralization of the VIE with the assets sold to it or notes subordinated to the Firm’s liquidity facilities."
While I do feel somewhat uncomfortable with this assertion, they are real and this isn't structured finance all over again, putting fuzzy math models into equations repeatedly, which ultimately casts quick doubts on the real underlying worth of the assets. There seem to be valid reasons why the structure exists. My belief (maybe call it hope) is, this will limit loss to liquidity agreements they may be forced to provide. Admittedly, I'm not 100% comfortable with this and is one of the reasons my position remains smaller.
Their Tier ratios are also, in fact the highest of any immediate peers I compared and their allowances are generally larger in comparison to ratios between chargeoffs and peer chargeoffs/allowances or NPA/allowances. So there's a bucket to take some heat for what's coming and a better bucket than most other banks deem necessary. So some things to quickly take away are that the management of JPM likes a big balance sheet, they've avoided the worst paper and off-balance sheet ideas, (they do have a bunch of LBO stuff hanging around though) and they take their provisioning seriously. These kinds of differences are big deals to me.
Digging down further, one begins to realize that JPM actually has pretty high levels of Tier capital in relationship to say BAC and C vs. their respective market caps (or previous market caps anyways). Now, there's a couple of things to intepret from this. One is that when looking at earnings levels, JPM comes out as an underperformer, that continues to perform better. At BAC, the difference primarily seems to relate to cost of funds (difficult to replicate and a huge competitive advantage for BAC) and non-interest expenses. But the expenses side of the ledger seem to have been improving at JPM in the last few years under Dimon and it seems like there's room to run. I'm not one much for turnarounds unless I really believe in management. This actually provides another interesting catalyst. Dimon is an extremely well regarded CEO at the helm of the slight underperformer. That means, that JPM, potentially has some water in the sponge that could be squeezed if management figures out how to get it out and the evidence is that they have been doing so. In fact, the distress in the credit markets may be an ultimate catalyst to make difficult changes to make it a top tier performer, though I believe this can only happen over a longer time frame. They also are quite diversified in their lending and the real outstanding issue of what's on their balance sheet appears to be their HELOCs and there is the matter of $40 billion in their trading portfolio labled "Other". But we also have an disclosure about what they believe is the worst paper (SP and especially CDO's backed by SP) that seems relatively limited. As well, I've modeled a fat tail credit event scenario that only a small number of banks seem to hold up well to (of which I'm sure there's no remote coincidence in that Buffett owns the ones that shine when you run these sims). But JPM holds up big time too. Taken together, the market therefore hasn't really tagged them. Which also gives them currency and that also gives Dimon the chance to go shopping for me as the wreckage unfolds.
So that's basically it. At some point, I'm going to want the weak survivors who are straggling up to shore. Until then, I don't. I want a management who hasn't been the dumb money. I want a big balance sheet and a bit of a war chest for allowances. Of course, this means their price hasn't gotten tagged like many of the others and perhaps is therefore offering less opportunity. But in an asset class that is dropping like stones, quality isn't such a bad thing. Because ultimately, JPM seems like a company I wouldn't have minded owning in the first place. All you have to do to understand that is to look through the paperwork at Washington Mutual and Countrywide. Even though I believe 50% of that equation will survive, it's hard to discount probabilities when you don't believe in management and the balance sheet and you can't help but think "Why other than the price do I want to own this company?".
Obviously, not all banks are well these days. Citi holds something like $43 billion of exposures to the "most senior" tranches of CDOs. Unfortunately, the value of the super senior part is really highly defendant on exactly what the quality of the paper is beneath it, because overcollateralization of zero (because it may be tranches of early exposures in the actual original securitization), is still zero and there's no way to tell unless you know what underlies the CDO. I'm sure it's probably not zero. The deeper question is how close to zero. They're also now bringing back onto the balance sheet god knows what because it hasn't been on the balance sheet and I'm usually pretty skeptical about the exact quality of items that are chosen to be held off the balance sheet. Thus, Citi is for me, impossible to analyze.
But just because I think that banks are in for a huge storm doesn't mean that simultaneously that you can look around and say that there is no value out there. One always has to remember that you should be willing to buy everything for some price because this is really a game of probability and understanding price implied expectations. If it will survive to produce cash in the future, it's worth a number. So I've gone on a quest for a position in a bank (other than my best, IMO, bank idea, BBNK - a much bigger sized position in my portfolio and maybe more on that in the future). So what is attractive to me about JPM?
Now, I do believe that at some point, I'm going to want to buy the weaker companies who have made it through the storm. But I don't think we're there yet. In fact, I think problems are going to last quite a while. Therefore, for now, I'm not looking for the screw ups. So the behavior of management leading into this situation to me is important. The balance sheet is extremely important. Questions like: How much subprime is sitting on the balance sheet vs. has been sold off? What kind of allowances are in the cookie jar to hold up in a storm? Exactly what kind of activities are going on off the balance sheet? How seriously do they take their capital ratios? How diversified are they away from mortgages? These are all important questions.
In JPM, there are some interesting answers. Dimon has claimed that they have about $1.5 Billion in CDO exposures and $6.8 B in warehouse holdings of the IB. None are collateralized by subprime. Taking a look at writedowns of subprime mortgages leads one to an estimate of about $10 billion total SP loans being held, which is peanuts for a company the size of JPM.
Taking a look off the balance sheet, we find exposure to multi-seller conduits. These are similar to a Structured Investment Vehicle, while simultaneously being pretty different. My understanding is that, SIVs are structured finance all over again, except it's an infinitely long lived investment vehicle instead of a security. The original securities are tranched by risk, maybe with some overcollaterization to possibly hide the quality of the underlying assets, maybe they're put in a CDO tranched by risk with some overcollateralization to hide the quality of the underlying assets (oops, I mean arbitraging extra spread) and maybe they're bought by an SIV which will structure itself all over yet again, to possibly hide the quality of the underlying assets (I mean arbitrage spreads), by which time, no one probably has any clue what the quality of the underlying assets are. But you know, it's all arbitraging value here, over and over and over again, so in actuality these things should be really valuable!! Or, turns out not so much, as the case may be. A conduit is a conduit, allowing participants to access the CP market to participate in the structured finance world as smaller players (at least this is my understanding). The assets are administered by JPM, who also provides credit enhancements, which appear to generally be in the form of liquidity agreements in say the case of disruptions in the commercial paper market. But these aren't entities restructuring all over again and there are real reasons to offer this structure to entities looking to sell assets into the conduit. One of the footnotes reads:
"The Firm views its credit exposure to multi-seller conduit transactions as limited. This is because, for the most part, the Firm is not required to fund under the liquidity facilities if the assets in the VIE are in default. Additionally, the Firm’s obligations under the letters of credit are secondary to the risk of first loss provided by the customer or other third parties – for example, by the overcollateralization of the VIE with the assets sold to it or notes subordinated to the Firm’s liquidity facilities."
While I do feel somewhat uncomfortable with this assertion, they are real and this isn't structured finance all over again, putting fuzzy math models into equations repeatedly, which ultimately casts quick doubts on the real underlying worth of the assets. There seem to be valid reasons why the structure exists. My belief (maybe call it hope) is, this will limit loss to liquidity agreements they may be forced to provide. Admittedly, I'm not 100% comfortable with this and is one of the reasons my position remains smaller.
Their Tier ratios are also, in fact the highest of any immediate peers I compared and their allowances are generally larger in comparison to ratios between chargeoffs and peer chargeoffs/allowances or NPA/allowances. So there's a bucket to take some heat for what's coming and a better bucket than most other banks deem necessary. So some things to quickly take away are that the management of JPM likes a big balance sheet, they've avoided the worst paper and off-balance sheet ideas, (they do have a bunch of LBO stuff hanging around though) and they take their provisioning seriously. These kinds of differences are big deals to me.
Digging down further, one begins to realize that JPM actually has pretty high levels of Tier capital in relationship to say BAC and C vs. their respective market caps (or previous market caps anyways). Now, there's a couple of things to intepret from this. One is that when looking at earnings levels, JPM comes out as an underperformer, that continues to perform better. At BAC, the difference primarily seems to relate to cost of funds (difficult to replicate and a huge competitive advantage for BAC) and non-interest expenses. But the expenses side of the ledger seem to have been improving at JPM in the last few years under Dimon and it seems like there's room to run. I'm not one much for turnarounds unless I really believe in management. This actually provides another interesting catalyst. Dimon is an extremely well regarded CEO at the helm of the slight underperformer. That means, that JPM, potentially has some water in the sponge that could be squeezed if management figures out how to get it out and the evidence is that they have been doing so. In fact, the distress in the credit markets may be an ultimate catalyst to make difficult changes to make it a top tier performer, though I believe this can only happen over a longer time frame. They also are quite diversified in their lending and the real outstanding issue of what's on their balance sheet appears to be their HELOCs and there is the matter of $40 billion in their trading portfolio labled "Other". But we also have an disclosure about what they believe is the worst paper (SP and especially CDO's backed by SP) that seems relatively limited. As well, I've modeled a fat tail credit event scenario that only a small number of banks seem to hold up well to (of which I'm sure there's no remote coincidence in that Buffett owns the ones that shine when you run these sims). But JPM holds up big time too. Taken together, the market therefore hasn't really tagged them. Which also gives them currency and that also gives Dimon the chance to go shopping for me as the wreckage unfolds.
So that's basically it. At some point, I'm going to want the weak survivors who are straggling up to shore. Until then, I don't. I want a management who hasn't been the dumb money. I want a big balance sheet and a bit of a war chest for allowances. Of course, this means their price hasn't gotten tagged like many of the others and perhaps is therefore offering less opportunity. But in an asset class that is dropping like stones, quality isn't such a bad thing. Because ultimately, JPM seems like a company I wouldn't have minded owning in the first place. All you have to do to understand that is to look through the paperwork at Washington Mutual and Countrywide. Even though I believe 50% of that equation will survive, it's hard to discount probabilities when you don't believe in management and the balance sheet and you can't help but think "Why other than the price do I want to own this company?".
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