Tuesday, September 30, 2008

Selamat Hari Raya

TARPaulining All Over

I think they got the name wrong in the first place, that's why it did not get passed. TARP or Troubled Asset Relief Program, it sounded like tarpaulin, the heavy duty netting for lifting heavy goods onto the ships ... no wonder la, the safety net has too many gaping holes in them.

1) Seriously, this will bring back a tighter plan, one that is more accountable and responsible - so, gotta be good right.

2) The original plan did not specify at what price levels will the fund buy the distressed assets at. If they are buying at market, its no use to the banks and financials because it does not add to their capital base. Its the capital that needs to be enlarged. Hence they have to buy at higher than market prices for the whole thing to make sense, or don't buy the assets but give insurance for the assets as a major comfort factor.

3) The biggest obstacle has to be that the naysayers do not want the fund to buy these assets.

4) The release in batches is good to maintain a sense of integrity to the whole process. Shows that the team is managing the lending/injection well before given new parcels of fund. $250bn first, then another $100bn if results are positive. Plus the government will have the option to block the remaining $350m. This will send the message of more accountability at all levels.

5) The other message to the markets is that the US government will NOT just roll over in any future financial crisis. The major financial firms will now know that they cannot simply knock on the doors of Fed or Treasury to help them get rid of the mess they may create in the future. That is very clear.

6) There probably will be structured equity exposure to companies that take money from the fund as the fund is likely to be paying higher than market prices for the assets.

7) The mark to market accounting may be the pink elephant in the room. The rule may be suspended for the time being so that financials which sell those assets may not need to write down the full amount, which would have reduced their capital availability. The rule may be suspended till 2010 (when the fund expires) but only for those instruments affected and taken up by the fund. This seemingly inane accounting move actually may lift the gloom and difficulty of rescuing the affected companies brilliantly by just the stroke of an accounting entry.

All in, its actually not that bad that the bailout fund was voted down, although I did not expect that at all. A tighter second plan will send the right message and drill down on proper and responsible restructuring plans and ramifications. The fact that major equity markets may have lost 5%-8% may actually be good. When the second plan is approved, regaining just 3%-4% of what was lost may then be a big sigh of relief.
Still, its a very long road for equities in general. Not yet to get back in.

p/s photos: Mami Yamasaki

Oops, Iron Ore Dips

As I have highlighted a few times, iron ore prices, which are not traded on a daily basis, is a very good indicator of real demand and health of an economy, especially in property and construction. I was led to believe the trend is still firm when BHP and Rio Tinto got 93% year on year hikes for their iron ore a couple of months back. The recent deal signed with Vale caused me to change my views.

The head of China's leading steel company says the Chinese economy and steel industry are both "heading for a downward slide", as hopes fade that China can insulate Australia's resource-dependent economy from the widening global downturn. The comments by Baosteel's chairman, Xu Lejiang, coincide with new evidence that a contraction in Chinese building construction is seriously crimping demand for iron ore. "The economy is heading for a downward slide, so the steel industry is certainly heading for a downward slide," Mr Xu said at a Baosteel conference in Shanghai.

China recently emerged as the engine of the global economy after seven years of uninterrupted, accelerating growth. But severe credit rationing by the Chinese Government, which has helped to quell an inflation break-out, has coincided with the worsening global financial crisis to smash the confidence of Chinese real-estate investors and the building plans of residential construction companies. Residential construction accounts for about one-fifth of Chinese steel demand.

The research house Mysteel said yesterday the Chinese steel industry was in recession. Prices for steel products had fallen 15 to 20 per cent since July. The Tangshan spot market price for imported Indian iron ore has plunged below $US110 per tonne, down from $US195 in early July. Yesterday, the falling Chinese demand for imported iron ore had cut Australia-China bulk freight rates to as low as $US13 per tonne, from as much as $US50 midyear.

Reading the Chinese economy is even more complicated than usual because the Government shut down a large proportion of industrial and mining activity across northern China for the Olympic Games. But property sales have declined steadily since early this year and property developers are struggling to raise finance for new projects and to complete existing ones, while China's export sector has been weak since early this year.

Most seasoned analysts remain confident about China's long-term growth trajectory. But the next few months are likely to be bumpy, particularly for companies and sectors linked to its building industry. Mr Xu said he had no plans to cut production but warned that steel prices were "plummeting". "A very large number of small steel mills are cutting production," he said. For the first time in more than five years, Chinese buyers can purchase spot market Indian iron ore as cheaply as Australian iron ore on long-term contracts, including freight costs.

Some observers believe contract iron ore prices will fall next year, for the first time in seven years. When yearly contracts were made in February at an 86% increase on last year's prices, China's steel producers were flabbergasted but took the price hike. But that wasn't the end of it. Both Rio Tinto and BHP renegotiated their contracts a couple of months back for even higher yearly percentage increase. Has the tide changed?

The latest indicator was a couple of weeks back when steelmakers in China just announced that Vale, the world's largest iron ore producer, wants to raise prices only 13% above the company's 2008 contract prices. The tide has certainly changed. The critical part was that Vale's share price eased significantly following the news - indicating that demand and hike potential were lesser than expected. Chinese steelmakers are now buying their iron ore from Vale, not only at lower prices than Western companies were paying, but also at lower prices than Rio Tinto and BHP Billiton were charging. Very significant indeed.

While I think the mid term outlook for steel and materials prices would be affected on the downside, I do think that Beijing is turning on the tap as I expect a few rapid rate drops in SRR and BLR in the coming months. However, the whole process could take at least 6 months before projects get re-started and things get re-ignited there. Last word, stay out of building materials for the mid term.

p/s photo: Nguyen Thuy Lam

Sunday, September 28, 2008

Goldman Sachs & Nomura's Strategy

Finance Asia: As Goldman Sachs exits stand-alone investment banking, Nomura doubles down on the model by buying the Lehman Brothers franchise in Asia and Europe.

Who is taking the right approach?
Some observers argue that the high-leveraged investment banking era is over, and that Goldman Sachs has made a graceful exit from stand-alone investment banking to a bank holding company (BHC) model at just the right time. If they are right about Goldman, it would seem difficult to be bullish on Nomura’s expansion of that same investment banking model in Asia and Europe.
The weakness of the investment banking model embodied by Goldman Sachs and Morgan Stanley is nicely summarised in the September 20 issue of The Economist as stemming from: the higher risk of insolvency, due to higher leverage and the reliance on the short-term wholesale markets; the requirement to mark-to-market; and weaker future demand for their services, especially in structured finance.

Reiko Toritani, chief banking analyst at Fitch Ratings in Japan agrees: “investment banking is facing difficulties due to an overall reduction in risk appetite and a reduction in the leverage to stimulate returns. Morgan Stanley and Goldman have had to become more risk averse after being forced to change to bank holding companies (BHCs), and by more difficult markets," she says.

Goldman’s woes seem to reflect those problems. The bank has gone through an expensive capital raising exercise with Warren Buffett of Berkshire Hathaway. Buffett will invest $5 billion in perpetual preference shares with a 10% annual dividend and retain an additional $5 billion worth of warrants. And on Wednesday, the bank raised another $5 billion through an accelerated book-build.
BHCs are closely regulated by the Federal Reserve, and leverage levels will be capped closer to commercial bank levels (around 10 times for the sector, compared to 30 times for the non-commercial bank sector pre-crisis). That will make it hard to maintain previous earnings levels.

The exit of Morgan Stanley and Goldman leaves Nomura as the last major stand-alone investment bank in the world. Nomura is fiercely proud of its independence from Japan’s mega-banks, and it is likely that it is hoping its raid on Lehman Brothers will give it the international scale to sustain that independent model. The question is, has Nomura just put off the fateful day when it is wrapped in the arms of a mega-bank, or at least changes its status?

One sceptic of the stand-alone model points out how close even Goldman may have come to disaster, despite its high reputation.
“Goldman has a similar business model in many ways to Lehman and Bear Stearns. It’s a tribute to its franchise and mystique that it managed to retain investor confidence,” he says.

One could argue that Goldman played its cards wrong and that it could have avoided its exit from stand-alone investment banking by raising capital much earlier. Indeed, the firm famously made a lot of money shorting the mortgage-backed market in 2007 and early 2008. Goldman must have understood the negative macro-economic implications of the development of these instruments, and should have spent less money on the famously lavish bonuses, and more on plumping its equity cushion.
But, says a former Goldman banker “not paying bonuses (almost a year ago) would have resulted in people leaving the firm; raising capital would (even though it would have been cheaper then than now) have sent a danger signal to investors at a time when sentiment was jittery.

Raising money now from Buffett is the right thing to do, as is adopting the BHC model. People are more accepting of the need to do so, and it will help the firm ride out the downturn,” he says.
It isn’t clear if there is anything preventing Goldman from reverting to independent status when it finds the right moment.

In the meantime, over in Tokyo, Nomura has taken the opposite tack. It saw some investment banking assets going cheap and couldn’t resist. The $225 million Nomura reportedly spent on the Lehman operations in Asia, and the ‘nominal price’ paid (according to senior Nomura advisor Sadeq Sayeed, as quoted by Bloomberg) for its European operations, is low – and buying cheap is always the best hedge.

In addition, Nomura has bought people and IT platforms, and not assets or liabilities.
Yet the Nomura strategy looks paradoxical: it is buying into an investment banking model which has been abandoned by arguably its finest exponents. Can Nomura turn it around? That, says Takeo Sumino, a managing director responsible for private equity at Nomura Securities in Tokyo, is not the right question. “We are not trying to be like Goldman or Morgan Stanley. We are seeking to return to the days of the ‘independent, trusted advisor.’ We are emphasising the traditional investment banking model - before it was transformed by Goldman and others using high leverage and high risk.”

He’s not alone in this view. Says David Marshall, head of Fitch Ratings in Hong Kong: “securities brokerage and related services will still be needed in future, as will arranging sales of corporate debt and equity. Provided they maintain conservative balance sheets and plenty of liquidity - which in practice securities firms in Asia tend to do - they are much less vulnerable to liquidity problems than the highly leveraged US investment banks proved to be.”
Nomura’s Sumino reinforces his point by arguing that Goldman was moving its focus away from “the capital markets, advisory, and wealth/asset management business - those traditional investment banking businesses - and was increasingly focusing on the capital-intensive proprietary trading business, similar to the hedge fund and principal investment businesses, and also close to the private equity business. The consequences of that new strategy led to a relatively highly leveraged balance sheet.”

In addition, Sumino says “unlike US I-banks, we will not be trying to compete with hedge funds and the private equity funds and this should reassure our client base.” Sumino says that one of the main advantages of Nomura’s model is that “the role of the trusted advisor becomes all the more important at a time when commercial banks have investment banking operations. They can use their balance sheets to unduly influence their corporate clients. We can provide an alternative service and independent advice. As the last remaining independent investment bank, we can provide a special service to our clients.” A serious issue concerns the 5,000 new staff Nomura has acquired.

The Lehman staff, accustomed to the higher leverage, high-risk model may not take kindly to Nomura’s more conservative approach. Privately, sources at Nomura acknowledge this, but say they hope they can retain as much talent as possible, even if the Lehman staff find their trading capital cut back considerably. It is certainly difficult to see this marriage working easily.
Even granted Nomura (the plan is to drop the Lehman name) sticks to the ECM, DCM and M&A businesses, how profitable can it be in today’s environment? Those areas are all suffering in the ongoing credit crunch: indices across the region are falling and business activity is drying up due to a lack of positive news.

For Fitch’s Toritani, however, this is not a sign the Nomura strategy is bad. “It just means the payoff will take time. (It will come) during the next upturn, rather than immediately.”
One might argue that Nomura’s financial position is not that strong in the first place either, and it has $6 billion in subordinate debt and loans to service. Nomura lost $67 million last year, and its stock price has dropped by almost half from its 12-month peak. It can’t afford to lose money for too long.

However, Sumino counters by pointing out that Nomura is ‘well capitalised, with relatively low gearing and extensive foreign experience."
In addition, he believes synergies can be extracted from the combined business: “We have the best brokerage client base in Japan – and they have an appetite for uridashi bonds (foreign currency bonds held by Japanese investors) as well as foreign equity. We will, of course, explore cross-fertilisation between our domestic platform and our international platform.” Shinichi Tamura, banking analyst at Deutsche Securities in Japan sees other opportunities for Japanese banks in Asia. “The Japanese will likely not be replicating the ultra-high ROE (return on equity) model used by Western banks in Asia. Rather it’s possible they will acquire operations, as in the case of Nomura and Lehman, to service the international operations of their Japanese corporate clients. Japanese firms need to match assets and liabilities in non-Japanese markets and carry out M&A. Such an operation can help them do that.”

If Nomura becomes a successful and genuine ‘trusted adviser’ internationally, it will be ironic for Wall Street banks. Before the go-go culture emerged following the deregulation of the banking industry in the UK and the US in the 1980s, that was their role too. They then moved away from relationship banking to the more profitable (at least in the short term) transactional banking, as described in Jonathan Knee's 2006 The Accidental Investment Banker.

So who is smarter then? The question is tongue in cheek, of course. But at the moment, Nomura looks better placed. They are buying assets rather than trimming their balance sheets, and they are expanding their operations rather than laying people off. They have not made the profits of Goldman, but their long term strategy is clearly articulated. At the moment, that’s not the case with Goldman: Goldman has its reinvention to the next stage of investment banking still before it.

p/s photos: Hannah Tan

Saturday, September 27, 2008

Reassessing Indonesia (Part 1)

Malaysia and Singapore have a unique relationship. We are like squabbling in-laws, but we know we cannot and will never divorce each other.

You live with the tension and exchange of barbs. The ties between Malaysia and Indonesia are quite different. The animosity at times can boil over. Grudges are harboured and allowed to fester. There is a genuine fear of, and sometimes loathing for, each other.

Most of that is at the political and policy levels. Many Malaysians and Indonesians love to visit each other’s country. Indonesia to Malaysians in general, is a bit of an underachiever. Naturally, Malaysia to Singaporeans, is also a bit of an underachiever.

It’s time to reassess Indonesia. In many ways, the country is moving in the right direction business-wise.

Recently, Qatar and Indonesia set up a US$1bil fund to invest in energy and infrastructure. Qatar is the world’s largest exporter of liquefied natural gas (LNG), while Indonesia is third. Both countries are also members of the Organisation of the Petroleum Exporting Countries (OPEC), though Indonesia has just opted out.

Qatar will contribute 85% of the funds for the new fund and Indonesia the remainder. Qatar’s state investment fund, the Qatar Investment Authority (QIA), has teamed up with Abu Dhabi state enterprise International Petroleum Investment Co in March to launch a US$2bil fund.

The QIA has also set up joint funds with Oman and Dubai.

Indonesia is pro-Western, much like Malaysia, and could be a model for a modern Muslim nation, provided nationalist Islam (not radical Islam) doesn’t become too powerful a force in Indonesian society.

Following the aftermath of the Sept 11 attacks, many were outspoken on the various failings of Muslim nations. Indonesia is a dominantly Muslim nation, with the largest Muslim population in the world, but it also has small but strong Hindu, Christian and Buddhist communities.

Malaysia has generally enjoyed a better perception in the eyes of international travellers and global investors.

Indonesia has had to contend with thorny events such as the Bali bombings and the East Timor massacre. If investors are to be influenced just by these events, they would be doing Indonesia and themselves a disservice.

There is still pockets of “nationalistic fervour” among the political voices in Indonesia.

Health Minister Siti Fadilah Supari commented in April that regional governments in Indonesia should be on their guard whenever they dealt with international investment proposals.

She said the following should be considered by provincial governors and regents in respect of foreign investment plans:

· Would the international investors take control of Indonesian resources?

· Would the foreigners be prepared to be on an equal footing with Indonesian partners, or would they adopt a lordly, colonialist stance?

· Would a particular foreign investment benefit Indonesians or harm them?

· To what extent would Indonesians gain from the investment? Foreign investors often lie about this matter.

For example, South Kalimantan’s coal needs were less than 1 million tons per year and there was an electricity shortage crisis. Yet, at the same time, 70 million tons of coal was taken out of the province and sold internationally.

Indonesia has been beset by an autocratic regime for a long time. We need to reassess the country now as the country is certainly moving away from the authoritarian system to a more democratic one.

It is still taking baby steps but press freedom and the media’s brutal honesty and bravery has paved the way for a more civil society. This is an important aspect of a decentralised power system, which accords more voice to a wider spectrum of leaders and the disenfranchised.

Meanwhile, according to an AT Kearney study of the top 25 most attractive investment destinations in the world, Indonesia ranks 21st. The rankings for 2007 are based on a survey of 1,000 CEOs around the world. In 2006, Indonesia did not make the top 25. Thanks to a well-respected Finance Minister in Sri Mulyani Indrawati, there has been significant economic liberalisation.

Quasi-monopolies have not been protected and are expected to compete with new foreign companies.

The boom in commodities over the last five years has helped the country infuse more strength into its underlying economy. Indonesia is at or near the top in palm oil, rubber, base metals, coffee and cocoa.

Sustainability of global investments

Corporate investors across all regions are concerned about the sustainability of the global economic order. Is Indonesia the flavour of the month only because of the commodities boom? I think not, as most experts can see a sea of change enveloping the country.

The commodities boom only hastens the benefits of such changes.

The country is confident enough to implement several years of mandated increases in minimum wages. While some industries may have shifted or closed operations because of these new rules, these measures have also forced investors and businesses to move up the value-add curve.

There has also been a decentralisation of budgetary systems, which has allowed local leaders to better manage resources and spending to their localities.

Over the last three years, Indonesia has managed to enjoy more stability politically, in its currency and in economic viability. This lessens the discount on businesses in valuation models, thus resulting in better confidence among foreign investors going forward.

Corruption is still a problem but one can easily see a more transparent era for Indonesia. More bigwigs have been hauled up and tainted politicians have lost their seats with greater frequency.

Major business entities

Since beginning of 2007, there has been more than US$20bil in mergers and acquisitions and capital raising, which drove the corporate sector to new levels.

The corporate sector is no longer dominated by seasoned players from the Suharto era. If you put the top business groups next to Malaysia, the latter pales in comparison.

The Salim group tops the ladder with US$7.3bil (RM24.8bil) in revenues annually and is in agriculture, distribution, property management, financial services and telecommunications in Indonesia, Hong Kong, China and Singapore.

Next is the Sinar Mas group with revenues of US$4.77bil (RM16.2bil), which was forced to sell Bank Internasional Indonesia (BII) following the 1997 financial crisis but has since rebuilt itself in banking with the acquisition of Bank Shinta.

The Sinar Mas group can be said to have been most affected by the 1997 financial implosion as their Asia Pulp & Paper had a staggering debt load of US$14bil. Following years of negotiations and restructuring, the company has thrived. It is also the biggest national player in palm oil, with land bank of more than 1 million hectares.

I could go on and on, but a summary of local companies with annual revenue of at least US$1bil each would be better for now (major assets/annual revenues):

Salim: consumer goods, agriculture/US$7.3bil

Sinar Mas: pulp and paper, agriculture/US$4.7bil

Djarum: cigarette, Bank Central Asia, Cipta Karya Bumi Indah/US$3.7bil

Gudang Garam: cigarette, plantations, paper packaging/US$3.5bil

Bakrie: coal, Bakrie Brothers/US$3.1bil

Lippo: regional property developer, healthcare, financial services/US$2.7bil

Raja Garuda Mas: pulp & paper, plantations, energy/US$2.4bil

Triputra: coal, agro-industry, manufacturing/US$2.3bil

ABC: consumer goods, battery/US$2.1bil

Saratoga Capital: coal, Adaro, palm oil, infrastructure/US$1.9bil

Para: consumer goods, property, mining, financial services/US$1.6bil

Sampoerna: agro-industry, telecommunications, forestry and property/US$1.4bil

Ometraco: animal feed/US$1.2bil

Khazanah Nasional Bhd has a hefty profile in Indonesia. The businesses under Khazanah has an annual revenue of US$1.8bil. Its stakes include those in Bank Lippo, Bank Niaga, Excelmindo Pratama and infrastructure joint ventures (JVs).

Surprisingly, Temasek’s holdings in Indonesia has only a total annual revenue of US$1.5bil. It has stakes in Bank Danamon, BII, and various property and energy JVs.

Still, the key point here is the number of business entities that have substantial revenues. How many Malaysian businesses have combined revenue of more than RM3.4bil annually? Size matters, especially when they are headed in the right direction with the proper masterplan.

State-owned enterprises (SOEs)

The government has also planned to privatise a number of SOEs, which in itself is a grand plan to better manage resources, inject competition and promote efficiency in government. All in, 37 SOEs have been identified for privatisation and/or restructuring. There has been some delay in that certain factions of the government have been delaying the process.

Last year, 10 SOEs were scheduled for privatisation. However, only five are now ready to go to IPO this year: Krakatau Steel, Bank Tabungan Negara, and National Plantation Enterprises III, IV and VII. Needless to say, intense lobbying by the affected SOEs and maybe even “vested interests” must have been a large part of the delay.

Still, it’s hard to deny that the country is moving in the right direction.

p/s photo: Son Ye Jin

Friday, September 26, 2008

Financials Market Cap Decimated

Many of you would have received the "scary" email on how financials have been decimated in value. When there has been a bloody earthquake, its easy for bystanders to shout, "look at the many dead bodies". Is that a sincere warning, or just panic stricken obsevers talking? Gor those who missed the email, here's the gist:

Here's a list of the losses in market capitalization for 25 of the biggest financials since their rough peaks in October 2007. Keep in mind that these companies are not exactly emerging small cap coys but rather blue chips.

These losses include:

* A I G -Then: $178.8 billion... Now: $5.46 billion. Down 96.95%
* Bank of America -Then: $236.5 billion... Now: $123.4 billion. Down: 47.82%
* Citigroup -Then: $236.7 billion... Now: $76.34 billion. Down 67.75%
* Merrill Lynch - Then: $63.9 billion... Now: $30.2 billion. Down 52.74%
* Fannie Mae - Then: $64.8 billion... Now: $0.45 billion. Down 99.3%
* Morgan Stanley - Then: $73.1 billion... Now: $41.1 billion. Down 43.78%
* Wachovia - Then: $98.3 billion... Now: $19.44 billion. Down 80.22%
* JP Morgan Chase - Then: $161 billion... Now: $130.2 billion. Down 19.13%
* Capital One Financial - Then: $29.9 billion... Now: $16.9 billion. Down 43.48%
* Washington Mutual - Then: $31.1 billion... Now: $3.64 billion. Down 88.3%
* Lehman Bros. - Then: $34.4 billion... Now: $0.80 billion. Down 97.6%
* Goldman Sachs - Then: 97.7 billion... Now: $40.6 billion. Down 58.7%
* Wells Fargo - Then: $124.1 billion... Now: $111.25 billion. Down 10.35%
* National City - Then: $16.4 billion... Now: $2.8 billion. Down 83%
* Fifth Third Bancorp - Then: $18.8 billion... Now: $7.9 billion. Down 57.6%
* American Express - Then: $74.8 billion... Now: $37.5 billion. Down 49.87%
* Freddie Mac - Then: $41.5 billion... Now: $0.16 billion. Down 58.7%
* Suntrust Banks - Then: $27 billion... Now: $16.07 billion. Down 58.7%
* BB&T - Then: $23.2 billion... Now: $18.4 billion. Down 20.69%
* Marshall & Ilsley - Then: $11.6 billion... Now: $4.48 billion. Down 61.3%
* Keycorp - Then: $13.2 billion... Now: $5.68 billion. Down 56.97%
* Legg Mason- Then: $11.4 billion...Now: $4.96 billion. Down 56.49%
* Comerica- Then: $8.3 billion...Now: $4.74 billion. Down 42.89%
* Countrywide Financial: Then: $11.1 billion...Now: $0.00 billion. Down 100%
* Bear Stearns- Then: $14.8 billion...Now: $ 0.00 billion. Down 100%

Together these 25 companies alone have lost investors a total of $992,690,000,000 over the last 12 months... or nearly 1 trillion dollars. The email ends with the smart warning to keep buying gold and keep USD.

The above warning is too broad-stroke for my liking. Yes, we have seen great wealth destruction. The basis for the destruction are two-fold:

One, the leveraged exposure to derivatives relative to capital at risk. Some went as high as 25x leverage, hence when these instruments got whacked by 50% of more, your capital may almost disappear. Many of these are hard to mark to market, which again sent investors and analysts guessing the ultimate carnage.

Two, its a crisis of confidence as fellow financial firms do not even trust dealing with each other. There is still ample liquidity but no one is willing to lend to anybody, thus the Fed and Treasury had to step in, they did not want to, but they have little choice.

Are any of the major firms still in trouble or in danger of collapsing like Lehman and Bear Stearns? Well, many have missed a critical indicator. Back in September 14, 2008 ten of the world's largest banks will form a fund with a value of $70 billion, each putting in $7 billion to help restore lending to troubled firms. The banks are Bank of America (BAC), Barclays (BCS), Citigroup (C), Credit Suisse Group (CS), Deutsche Bank AG (DB), Goldman Sachs (GS), JPMorgan Chase (JPM), Merrill Lynch (MER), Morgan Stanley (MS) and UBS AG (UBS). You will find that many major banks did not participate. One can conclude that these ten banks are themselves most at risk - hence they are willing to pony up to shore up confidence and hope to buy time and save their own skins. Its actually not so altruistic but desperate.

If you want to know who might fail, well, look at the ten. Some are in more trouble and could not even participate to lend, such as Wachovia.
Of the ten, some are better placed because they have managed to sell more shares or have more capital injections. Goldman Sachs is safe for obvious reasons. JP Morgan is also OK and may actually be buying another firm or two for the right price. Merrill Lynch is now under Bank of America. Bank of America is not completely out of the woods as it now has Merrill's toxic assets, and will need to sell units and shore up capital, but still better placed than most. Morgan Stanley bought a lifeline by selling 20% to Mitsubishi UFJ, but also not entirely safe. Barclays is relatively OK and should be looking to buy one of the major distressed firms.

The European ones have been relatively quiet and may have escaped the carnage by being more global than the rest and having relatively low exposure to toxic US assets. The most at risk still should be UBS. Citigroup is a unique animal. I still think they have grave problems but their banking side is very solid. In fact, during the heightened uncertainty over the last 2 weeks, Citibank has seen an enormous jump in deposits as switched their brokerage accounts over to Citi's bank deposits. The bank is OK, its the investment banking side that is still up in the air.

Following is the list of 10 largest banks in the world in terms of market capitalization size, as released by Bloomberg on February 2008. Market capitalization is a way of measuring the corporate or economic size of a public listed company. The market capitalisation now may be significantly different since then but these are the banking giants. They are the new leaders, will they be able to grab the opportunities in front of them given the gaps created by the financial implosion?

Industrial & Commercial Bank of China, ICBC (China)

ICBC BankThe Beijing based ICBC Bank underwent one of the most remarkable faces of growth barely 2 years after going public, which gives a clear indication of investors’ preference in the emerging China market. ICBC offers a wide range of personal and corporate banking services which include loan, deposit, credit card, underwriting, trading and currency settlement.

ICBC was listed simultaneously on two exchanges - the Shanghai Stock Exchange and Hong Kong Stock Exchange in 2006, making it the first and only company to do so. ICBC has won numerous accolades and awards from various international magazines including Bankers, Global Finance, The Assets and Finance Asia.

Market capitalization - US277.514 billion.

HSBC Holdings (UK)

Earlier this year, HSBC was named as the world’s most valuable banking brand by The Banker Magazine. The bank was incorporated in England and Wales, with its main office located in London. In 1992, HSBC was involved in one of the world’s largest banking acquisition, after assuming full ownership of Midland Bank.

The merger also saw the beginning of HSBC setting up strong market presence, particularly in Europe. Apart from United Kingdom HSBC now also has significant operation in France, Czech Republic, Germany, Ireland, Switzerland, Turkey as well as Malta.

China Construction (China)

The bank was first established as the People’s Construction Bank of China and was changed to the current name in 1996. The bank’s rise to prominence is also helped with the involvement of Bank of America which injected some significant amount of investment for the past few years. In 2005, the China Construction bank landed into a scandal that involved the Chairman of the company, Zhang Enzhao.

Zhang was alleged to have received one million dollars bribe from an American company, which in return asked for an award of contract. Zhang eventually resigned from his post. The bank has more than 13,000 branches across its native country China, as well as active operation in Singapore, Hong Kong, German, Africa, Japan and Korea.

Market capitalization - US165.234b.

Bank of China (China)

Bank of ChinaThe third and final bank from China to make it to the top 10. In China, there is the term referred as the ‘Big Four’ banks and Bank of China is one of them.

Bank of China is the first bank established in the land of the dynasties. In the earlier years, the bank acted as the Central Bank but then its role was replaced and then converted into a full-fledge commercial bank. While the bank has overseas operation in Australia, United Kindom, Canada, United States, Brazil, Japan, Philippines, Malaysia and Korea, the overseas business only accounts for less than 5 percent of the company’s overall revenues.

Market capitalization - US165.087b.

JPMorgan Chase (US)

JPMorgan Chase BankJPMorgan Chase offers investment banking, financial services, wealth and asset management, and private equity. The current entity is a result of a series of mergers, with its original name did not sound anything like the current, which was the Chemical Banking Corporation.

JPMorgan is based in the downtown of New York, Manhattan. Additionally, the investment wing of the bank operates a number of offices around the world, with major presence in the United States, London, Tokyo, Singapore and Hong Kong. BusinessWeek ranked JPMorgan in the Top 10 Best Places to Launch a Career in 2006.

Market capitalization - US159.615b.

Banco Santander (Spain)

Banco Santander BankBanco Santander is the largest bank in Spain, and the second largest in Europe. The bank, which involves in retail banking, asset management and insurance, and global wholesale banking, employs more than 120,000 people worldwide, serving 68 million customers, a figure higher than the whole population of Spain.

Altogether, the group operates in more than 10,000 branches worldwide. The group is also one of the premium sponsors for McLaren-Mercedes F1 team. Banco has strong market presence in Portugal, United Kingdom and in Latin America including Brazil, Mexico, Chile, Argentina, Venezuela, Uruguay, Colombia, Peru and Puerto Rico.

Market capitalization - US109.862b.

Mitsubishi UFJ Financial, MUFG (Japan)

MUFG BankMitsubishi UFJ Financial groups runs The Bank of Tokyo-Mitsubishi UFJ, which is a result of a merger between The Bank of Tokyo-Mitsubishi and UFJ Bank Limited in 2006. The group, which is listed in five stock exchanges - Tokyo, Osaka, Nagoya, New York and London, is presently the largest financial services company in Japan in terms of size of assets.

Headquartered in Tokyo, Japan, the company holds a total asset of US1.2 trillion and is one of the biggest companies in the Mitsubishi Group. MUFG is now headed by the the President and CEO, Nobuo Kuroyanagi, an MIT business graduate.

Final word is that the "scary email" is too broad-stroke. In a proper restructuring process following a bubble implosion, we need to see companies failing. Why so scared? The gratifying thing is the speed with which this is happening, which will mean a swifter return to financial health. What you don't want to see is the Japanese experience where bad debts and bloated assets were not restructured since early 1990s. Till today Japan is still struggling with the "non-restructuring" dragging the economy along. Over the last 5 years we have seen a bit more restructuring in Japan. If only they did what the American are doing now, the economy would have recovered by 1995/1996 easily. It took them 18 years or so to get from 30,000 to 12,000. They could have gone from 30,000 to 10,000 in 2 years and get rid of the excesses and bad debts and recapitalise.

While many are harping on the $700bn fund and how the taxpayers are on the hook for it, taxpayers may actually benefit in two ways: better confidence so that the financial system works again thus eliminating the contagion effects spreading to other non-financial sectors which may result in even more staggering job losses for the broader economy; by pumping in capital now into troubled firms in exchange for higher rates and preference shares, the fund may actually make money after a few years when things normalise. We have to remember amidst all the carnage, a lot of the housing assets are trading at below replacement value, its just that there is no buyer now as fear grips everyone. While there had been a $1 trillion being wiped from the market cap of financials, there are also $7 trillion residing in money market deposits and checking accounts. Its a matter of ensuring the money cycle flows again. You don't want what the Japanese went through - till today there is still massive sums in deposits there, if it does not move (spend or invest) its brings everything to a halt. At the end, chances are good that the $700bn may actually make some money after 3-4 years.

While I think the Fed & Treasury have little choice but to go ahead with the plan, the negative is that we are seeing liquidity being pumped to arrest market falls, which will make us go through the cycle again of asset reflation. What can you do?

p/s photos: Song Jina

Wednesday, September 24, 2008

King Roubini Speakth

By Nouriel Roubini

Published: September 21 2008 17:57 | Last updated: September 21 2008 17:57

Last week saw the demise of the shadow banking system that has been created over the past 20 years. Because of a greater regulation of banks, most financial intermediation in the past two decades has grown within this shadow system whose members are broker-dealers, hedge funds, private equity groups, structured investment vehicles and conduits, money market funds and non-bank mortgage lenders.

Like banks, most members of this system borrow very short-term and in liquid ways, are more highly leveraged than banks (the exception being money market funds) and lend and invest into more illiquid and long-term instruments. Like banks, they carry the risk that an otherwise solvent but liquid institution may be subject to a self­fulfilling and destructive run on its ­liquid liabilities. (The known business model is that brokers-dealers run with a 25 to 1 leverage on capital to do their business. Following this debacle, we can expect a tightening on capital leverage, maybe down to 5-6 times. This will make it more difficult to generate fees on limited capital, and will limit the ability to fund deals. I expect the financial industry will be looking to rely more on SWF, private equity and hedge funds to fund any kind of substantial deals. No one can really hope to go it alone.)

But unlike banks, which are sheltered from the risk of a run – via deposit insurance and central banks’ lender-of-last-resort liquidity – most members of the shadow system did not have access to these firewalls that ­prevent runs.

A generalised run on these shadow banks started when the deleveraging after the asset bubble bust led to uncertainty about which institutions were solvent. The first stage was the collapse of the entire SIVs/conduits system once investors realised the toxicity of its investments and its very short-term funding seized up.

The next step was the run on the big US broker-dealers: first Bear Stearns lost its liquidity in days. The Federal Reserve then extended its lender-of-last-resort support to systemically important broker-dealers. But even this did not prevent a run on the other broker-dealers given concerns about solvency: it was the turn of Lehman Brothers to collapse. Merrill Lynch would have faced the same fate had it not been sold. The pressure moved to Morgan Stanley and Goldman Sachs: both would be well advised to merge – like Merrill – with a large bank that has a stable base of insured deposits.

The third stage was the collapse of other leveraged institutions that were both illiquid and most likely insolvent given their reckless lending: Fannie Mae and Freddie Mac, AIG and more than 300 mortgage lenders.

The fourth stage was panic in the money markets. Funds were competing aggressively for assets and, in order to provide higher returns to attract investors, some of them invested in illiquid instruments. Once these investments went bust, panic ensued among investors, leading to a massive run on such funds. This would have been disastrous; so, in another radical departure, the US extended deposit insurance to the funds.

The next stage will be a run on thousands of highly leveraged hedge funds. After a brief lock-up period, investors in such funds can redeem their investments on a quarterly basis; thus a bank-like run on hedge funds is highly possible. Hundreds of smaller, younger funds that have taken excessive risks with high leverage and are poorly managed may collapse. A massive shake-out of the bloated hedge fund industry is likely in the next two years. (This has not happened yet, and I suspect with the US$700bn facility, I doubt there would be a run on hedged funds' leveraged positions. We have to know that hedge funds have already seen an exodus by clients taking their money away from them for more than 6 months. The unwinding and so-called run have actually been happening in stages already.)

Even private equity firms and their reckless, highly leveraged buy-outs will not be spared. The private equity bubble led to more than $1,000bn of LBOs that should never have occurred. The run on these LBOs is slowed by the existence of “convenant-lite” clauses, which do not include traditional default triggers, and “payment-in-kind toggles”, which allow borrowers to defer cash interest payments and accrue more debt, but these only delay the eventual refinancing crisis and will make uglier the bankruptcy that will follow. Even the largest LBOs, such as GMAC and Chrysler, are now at risk. (I tend to disagree with Roubini here as I think private equity firms are actually going to come out on tops here. Yes, some of them have borrowed to the hilt to takeover companies and may be suffering now, but generally its the last few deals which look troublesome - such as GMAC and Chrysler, the majority are still OK and they won't be coming back to the markets till conditions have improved. PE firms will play an important role going ahead because they still have large pots of uninvested monies. As mentioned above, this type of capital is going to be seen in a more important light for funding purposes.)

We are observing an accelerated run on the shadow banking system that is leading to its unravelling. If lender-of-last-resort support and deposit insurance are extended to more of its members, these institutions will have to be regulated like banks, to avoid moral hazard. Of course this severe financial crisis is also taking its toll on traditional banks: hundreds are insolvent and will have to close.

The real economic side of this financial crisis will be a severe US recession. Financial contagion, the strong euro, falling US imports, the bursting of European housing bubbles, high oil prices and a hawkish European Central Bank will lead to a recession in the eurozone, the UK and most advanced economies. (I also doubt if a severe recession is in store if you note the billions they central banks are throwing at the problem. While I agree that its something the Fed/Treasury should do, I also think that it will actually maintain an excessive amount of liquidity in the world, which will rear its head in high commodity, high food prices, and reignite inflationary concerns... lesser of two evils?)

European financial institutions are at risk of sharp losses because of the toxic US securitised products sold to them; the massive increase in leverage following aggressive risk-taking and domestic securitisation; a severe liquidity crunch exacerbated by a dollar shortage and a credit crunch; the bursting of domestic housing bubbles; household and corporate defaults in the recession; losses hidden by regulatory forbearance; the exposure of Swedish, Austrian and Italian banks to the Baltic states, Iceland and southern Europe where housing and credit bubbles financed in foreign currency are leading to hard landings.

Thus the financial crisis of the century will also envelop European financial institutions. (Its bad, but not as bad as King Roubini makes it out to be. Global treasuries and central banks have never worked closer before. We should not underestimate the power of collusion. I also think Roubini still believe the economic engine and power of the world reside solely in the US and Europe, well not really anymore. If the last 5 years have shown us anything, its that the balance of economic power and engine for growth have shifted substantially to China and India, together with Latam, parts of Africa and most of emerging Asia. While the shift is not a tectonic shift, it is a substantive one. One which is altering the equation of global markets continually. The doom and gloom over USA and Europe painted by Roubini is correct, but don't miss the nice landscape and background of the other "bigger" emerging economies.)

The writer, chairman of Roubini Global Economics, is professor of economics at the Stern School of Business, New York University (The blogger is not a professor, not a graduate of economics, and although he enroled for a Masters course in business, he rarely attended classes ... and the closest he got to NYU is wearing the fake t-shirt he bought from Petaling Street)

p/s photos: Janice Man

Tuesday, September 23, 2008

Too Many USD Holders / Peg Revisited

Blogger Charles Chong said...

i don't fully agree on your statement. Mind you that China is a big adopter of US treasury bills, trillions of them. With China holding so much of US treasury bill, they will do their best to protect the value of USD, not to mention that HKD is in fact pegged to USD. China, being one of the wealthiest nation in Asia currently, will not allow their wealth to be swept away over night.

Comments: charles, we cannot hide, i mean the USA cannot hide behind the skirt that many countries are holding Treasuries hence they won't let the USD collapse... yes, politically, China and some of the Middle East nations have that objective as well... even China complained strongly on the GSE to paulson recently, basically hinting that they might STOP buying GSE debts if they do not go and rescue Fannie & Freddie... I ask you this, are the central banks in China, Japan, UK and US strong enough to stop a slide in USD ...think, I don't think they can, they may temporarily halt the slide with sentiment change n intervention... u cannot stop it if enough ppl think the same line ... if they can, u think the USD would have lose 30% in a few days back in 1987 ... if they can, u think the British pound would have lost 20% in a few days in the 90s... and thats with a lot of help from all major central banks

Blogger solomon said...

I do have the feel that the recent USD strengths and weaknesses are engineered by Central Bankers. Not quite sure whether it is for the bailouts, but they are tale signs about it, like dali's said.

How about reaffirming and applying the Brenton Wood II (renminbi - dollar peg) into more international currencies?

Having saying that, it reaffirmed my believe that the next target will shift to currencies speculation. The speculators(wolves) will camouflage behind the Central Bankers (tigers), you could hardly differentiate the currencies movements by who then.

My opinion is ringgit should consider the fixed peg to USD now. I am sure most of the local businesses will welcome this. At least, it have remove some business uncertainties in forex movement.

we should not go back to the peg because a peg gives a false sense of security ... you have limited room to move with monetary policy and yr fiscal policy are restricted... look at HK, they have a silly negative interest rate now, while their economy is tied to China, their monetary policy mirrors that of USA by virtue of the peg
most importantly a peg kinda stops a country and its industries from moving up the value chain in industrial efficiency and product competitiveness
you also want the country to benefit from a stronger currency for better purchasing power when the country does well
the peg would favour all exports again... and mostly very basic exports on the lower food and production chain, why debase our industries again ... i think the cpo planters and electronics exporters have had a gleeful run when the peg was instituted... looking at it another way, the rest of the country suffered but the these exporters were laughing, we had to contend with diminishing purchasing power and much of our loss went to support the bottomline of these exporters... thats why i think cpo buggers should be the first in line for a windfall tax...

p/s photo: Song Min Ji

Rebalancing The Twins

The first short position on oil was at US$139 (June 8, 2008), the double up position was taken at US$119.90 (August 5, 2008). The shorts were covered at US$112.90.

New positions (August 19, 2008)
Long oil futures $113.20
Long gold futures $802


The time has come to neutralise the oil position and take a small gain there. While I was bullish on oil, it was too much linked to the movements in USD.

I am very bearish on USD but I am more bearish on the destruction of demand from recent events. The liquidity injections from various central banks are good, but may not push oil past the US$115-120 region.

Sell oil futures $117.80 (gain 4.7%)

However I would be doubling up on Gold exposure. The destruction of wealth, and the reinjection of tons of liquidity by all central banks will stoke inflationary pressures again. In particular I am very much keen to be in real assets in this kind of era. I believe gold can even break US$1,000 this year and is headed for higher grounds. Key words, real assets.

Long gold futures US$900.60

(Double Long position in Gold with average price 900.6 + 802/2 -=

p/s photos: Pace Wu Pei Ci

Staff Cuts: Lehman Brothers, Asia Relatively Dicey

Finance Asia: Whitney Group is a global executive search firm focused exclusively on financial services, with offices in North America, Europe and Asia-Pacific. Russell Kopp, a Hong Kong-based director who heads the firm’s wealth management practice in Asia, shares his thoughts on the impact on Asia’s job market of the latest turmoil on Wall Street.

What do the Lehman layoffs and the consolidation of Merrill Lynch and Bank of America mean to the job market in Asia?

Lehman's demise is a serious hit to the markets in Asia. Barclays appears to be quite savvy in its approach, as in the US and Europe it's getting the pieces of the Lehman business it wants, without a black hole, and possibly with few liabilities at all. This should mean there is a fair amount of money set aside to lock in the Lehman employees that it ultimately hires.
However, it’s a different picture in Asia, as there are a multitude of legal entities and geographic operations which adds some major complexity to any potential deal. As much as every competitor is looking at the talent there, every person in the industry is 'feeling' for the Lehman guys, as it was a good solid shop in Asia and it apparently had a decent 2008 P&L. All of us just potentially lost a career option (as an employer) for some stage of our careers. In contrast, the Merrill Lynch and Bank of America combination is nothing but a trifle.

Does the turmoil present good opportunities for other banks and asset management companies to scoop up Lehman and Merrill talent?

As yet, we haven't seen large pools of talent come out of Merrill Lynch, but they and virtually everyone else will be trimming people before year-end. Yes, it helps to some degree, but the investment banking/capital markets/wealth management industry is always evolving. Sure, any large influx of talent helps those who are growing, but more importantly, the industry continues to evolve.
We saw all the British brokers – Barings, Jardine Fleming, Smith NewCourt, etcetera – disappear in the 1990s into global players, we saw the rise of the hedge funds over the past five years, and now we are starting to see other players grow. The Chinese and Korean brokers, the inter-broker dealers, a handful of boutiques, etcetera are all growing. On a longer-term basis, disintermediation will continue, Asian growth will propel the region's GDP, FX rates will loosen, interest rate policies will become more market driven and the financial markets will continue to broaden and deepen around the region. On a relative basis, much of the US and Europe is mature, so, there are still real opportunities for growth in Asia.

Will this mean compensation packages will be reduced?

Broadly, and on average, yes. However, there will always be pockets of the market with shortages of talent. In addition, niche product areas, and first movers will earn supernormal profits and senior players in these areas will not only be highly sought out, but highly paid - and likely, seriously guaranteed.

Which types of employees at Lehman will be able to find jobs more quickly here in Asia?

Clearly the Lehman people who will move quickly will be the ones who produce revenue, as no one's looking to add to their cost bases. Key investment bankers, traders, derivatives staff, etcetera are likely to be the most well bid. We'd also expect risk, compliance, COOs (chief operating officers), CAOs (chief accounting officers) and some IT people to be well bid. Although, Lehman staff in general are probably well above average, so hopefully, many will find new jobs.

Do you expect more of the people who have been laid off in the US to come knocking in Asia? Is there room for them here?

We continue to see a regular flow of candidates from both the US and Europe looking to come to Asia. Given the maturity of markets and the financial services industry fallout in both, it’s no surprise that we're seeing so many people turn up on 'spec' out here – both Asians wanting to return and Westerners looking for a better employment environment. There will be room for some of them, but certainly not all.

p/s photo: Andrea Fonseka

China's Base Building

The Standard: Many mainland investors are saying they will think twice before jumping back in to the stock market, despite the generous market-saving measures unveiled by Beijing last week. "It's good the government has come in to rescue the market, but I'm afraid that we haven't hit rock bottom yet," said Zhan Ye, a driver for a property company who used to order stock trades from his car as he listened to the radio news. "As soon as people see prices falling, they'll just get scared and pull their money out again." Middle-class dreams have been buried by the stock-market declines, according to Zhang Qi, an analyst at Haitong Securities in Shanghai. "Life savings have vanished just like smoke," said Zhang said. "Looking ahead, more family investors will stay far away from the stock market." Zhou Yu, 25, a Shanghai office worker, cashed his stocks in earlier this year, picking up a laptop, an iPhone and a camera with his profits. "I'm not planning to go back in right now," he said. "With the overseas market conditions ... who knows what the next big trouble will be?" To lure investors back, the government will have to offer even more sweeteners, some analysts believe. "How much confidence can be restored ... all depends on how generous the government will be," said Cao Xuefeng, an analyst at Western Securities in Chengdu.

Comments: Last week I have reiterated a couple of times that the Chinese stock markets could look very interesting over the immediate future. Once Beijing decides to do something, they will be very persistent to bring it to fruition. We should remember when the markets was above 5,000 and the way they have been raising SRR and interest rates to quash market activity. Safe to say, Beijing had been terribly successful at that. Hence when global event converge to further force Beijing's hand, I would side with Beijing.

The other major point to note is that market crashes are a bit different for China compared to other markets. Yes, the markets in China have a high percentage of individual participation, but that is much like the trend in most Asian markets. The good thing is that buying on margin is still in its infancy in China, which is good. There is still a lot of money in deposits. During crashes, many investors do not only lose their shirts but owe more than their net assets. This is not the case for the majority of share players in China. Yes, its painful, if you have 50,000 yuan and you lose 30,000 yuan it really hurts. In most other Asian markets if you have 50,000 dollars, chances are many will be losing all of that and more. In that sense, it is easier to rebuild momentum in China markets than you'd think.

I do think there will be a run even up to 3,000 level.

p/s photo: Taw-Natoporn Taemeeru

Monday, September 22, 2008

Staff Cuts: Merrill Lynch, Asia Relatively Safe

Finance Asia: The Bank of America-Merrill Lynch combine is forecasting US$7 billion of pre-tax cost savings over the next four years, representing 10% of the annualised expense base of the merged entity.

What does this mean for Merrill's people in Asia?
On a post-merger call posted on www.seekingalpha.com, Bank of America CFO Joe Price presented the US$7 billion cost reduction forecast to analysts, saying: “The savings would be centred in the areas you would expect with headcount reductions across both platforms including overlap and back office and support functions and processes, as well as vendor leverage.”

When pressed by analysts that the forecast cost savings seem very high, Price said BoA intends to be “very aggressive on the cost side or the efficiency side”.
Some specialists assume this will mean rounds of job cuts. Assuming simplistically that the 10% reduction in the salaries and wages is effected by cutting the same number of employees, this translates to 27,000 job cuts globally (Bank of America currently has 210,000 employees, Merrill Lynch has 60,000).

Obviously, given that salaries are only one element of costs, and further that salaries don't work on simple averages, the real numbers could be vastly different. But the fact remains that some rationalisation of staff seems likely.
Merrill has around 4,000 employees in Asia ex-Japan and another 1,500 in Japan, in total representing only 7.5% of Merrill’s worldwide headcount. One question doing the rounds is how many people in Asia will be deemed to “overlap”? The prevailing opinion on the street is that Asia seems better placed than a number of other regions because the duplication between BoA and Merrill Lynch is far less.

“I would be more concerned about Merrill Lynch employees if the firm was being acquired by HSBC, because there would definitely be a lot more job cuts,” says one source who suggests the minimal overlap between the two firm's businesses in Asia will be a factor limiting job cuts in the region.
BoA’s keen desire to build a global presence specifically in investment banking and wealth management – areas that BoA CEO Kenneth Lewis has maintained are driving the deal – corroborate that most Merrill bankers in the region should find a home in the new combined structure.

BoA's existing business in the region is largely retail and corporate banking focused.
Asia was home to some of the world’s fastest-growing markets for high-net-worth individuals in 2007, taking five spots out of the global top 10 for the third consecutive year, according to the 12th annual World Wealth Report released by Merrill Lynch and consulting firm Capgemini earlier this year. India was the world’s fastest growing HNWI market followed by China. Merrill has recognised the opportunity to capture private banking revenues in Asia and has invested time and resources to build a team to service the demands of this market. It has hired a slew of people from rivals such as Citi to build its presence and win clients. BoA is likely to value this team, which is now entrenched across a number of countries in Asia.

With regard to investment banking, BoA has tried unsuccessfully to grow organically in Asia in the past. In 2001 BoA shut down its investment banking business in Asia, a decision which affected 55 staff in Mumbai, Hong Kong and Singapore. In India, BoA had been successful in building a team of 12 people since it launched investment banking in 1997 and was in the midst of executing a pipeline of deals. The team was an attractive enough asset that ING Barings hired them en masse when BoA shut shop.
In 2004 BoA tried again to build an investment banking business, this time primarily in the US. In late 2007 it acknowledged that it had not been able to make significant strides in the business and started winding it down. But investment banking in Asia is increasingly becoming a balance sheet game as companies in the region expect their advisers to finance their growth ambitions, which in the current environment can be difficult for firms without large balance sheets and holding power.

Employees of Merrill Lynch’s India subsidiary DSP Merrill Lynch have expressed optimism that BoA could be just the fillip their business needs. Citi has been very successful in investment banking in India, partly because of the willingness of the US bank to lend balance sheet to clients. DSP Merrill, which is already in a top five position in investment banking in India in most products, is hoping the competitive advantages they gain post-merger will move them to pole position.

Whatever the case, the integration of Asia does not seem to be around the corner. When Royal Bank of Scotland acquired ABN AMRO in 2007, it focused first on integrating Europe and then turned towards Asia. In this case, the order is likely to be the US, Europe and then Asia. And maybe by the time BoA focuses its attention eastwards, financial markets everywhere will be showing some signs of recovery.

p/s photos: Isabella Leong

Sunday, September 21, 2008

Wither Dollar

Up until now, the dollar, in defiance of all expectations, has been strengthening against most world currencies. Even commodity prices had reversed their bullish trend. Maybe some of the long speculators on commodity reversed or deleveraged their positions to ride along side the US dollar reversal.

How could the dollar have risen in the face of overwhelmingly negative fundamentals? Some said the dollar had risen because Europe is following the US into recession. But, this proposition is ridiculous. No other nation has been as adversely affected by the credit crisis than America, where the mess had all began.

Some opine that Britain’s weakness is part reason for the US dollar’s strength. Yes, British economy is slowing and its property sector is facing a correction after years of bubble activity. But these are simply convenient reasons but hardly persuasive or convincing.

Deficit intact

Since 2002, the US dollar has lost more than 25% in real terms on a trade-weighted basis (or 28% in nominal terms). One would think that it would have gone some way to reduce its current account deficit, i.e. more competitive exports, lower imports, and a shift in consumer behaviour etc.

Truth is, the current account deficit has barely moved and is still at the 5% level.

According to the International Monetary Fund, a 10% depreciation in the US dollar will improve US’ current account deficit by one full percentage point.

Going by that rationale, the current account deficit should have been halved! Instead, over the period where the dollar lost 25% in real value €“ the US economy had to contend with higher oil prices, stronger competition from emerging countries and persistent war-related expenses.

(PS: A clear example of the US dollar losing 25% in real terms: a Middle East nation selling oil at US$100/b today is equivalent to them selling the oil at US$75/b back in 2002)

Noteworthy is that the US has spent the last 7 years in a silly war. China spent the last 7 years building infrastructure and planning for the Olympics.

Which country do you think frittered away resources, and which one tried to add value to her underlying economy?

The real reason

My prognosis for the US dollar strength is that it’s being engineered by major central banks with the main objective of halting the commodity price uptrend.

The stubbornly rising commodity prices was doing a lot of damage to inflationary figures and curtailing demand.

The Fed and Treasury are fully aware that higher commodity prices will not only curb demand, but will also result in higher interest rates (used to rein in rising prices for goods and services.)

But both these institutions NEED to keep interest rates low to proceed to save the financial institutions in the US.

They need to deal with Fannie Mae and Freddie Mac, Washington Mutual, and a whole host of regional banks.

They need a flattish and low interest rate regime to resuscitate and restructure desperate mortgages. They also need more stability in property prices.

Coincidentally (and smartly enough), a stronger US dollar and the planned bailouts do the trick nicely.

The ECB seems amenable to that strategy as a weaker euro stems the drop in exports. If you were to do a survey, the majority of economists agree that the ECB will not reduce interest rates until the second half of 2009.

That’s because the underlying strength in Europe is still strong and it needs to fight inflationary pressures from the high commodity prices more than anything else.

The jobs market in Europe is also still relatively strong. That scenario does not require a weaker euro.

In contrast, the US economy, continues to worsen. This even after the Fed slashed interest rates and the massive bailout plans for Fannie Mae and Freddie Mac.

The US overnight loan rate is less than half that of the ECB €“ 225 basis points lower. The US has a US$750bil per year current account deficit and rising.

It has huge federal and state budget deficits. Americans save less and spend more than any other people on earth. The US economy has been losing ground especially on the manufacturing side to emerging nations, transferring vital industries to them.

Fed’s deteriorating state

The American banking system is under dire circumstances.

More recently, Lehman Brothers buckled under pressure and filed for bankruptcy. I’m expecting a whole bucket load of regional banks to follow suit.

The Fed has already tainted its balance sheet with US$450bil worth of default-prone mortgage-backed assets from its favoured institutions.

This junk now amounts to almost half of the Fed’s balance sheet, yes the very thing that is supposed to back the US dollar.

In the face of these fundamentals, the US dollar has paradoxically appreciated against the euro, ruble, rupee, yen, real, Singapore dollar and almost all other currencies. How can this happen?

While China has been forcing its commercial banks to hold more dollars, there has also been huge buying, by other foreign central banks, of American treasury bills.

In August, the increase in Treasury bill buying far exceeded that which is needed to offset the huge US trade deficit.

The Treasury bill binge happened right before the surge of the US dollar. Doesn’t this hint of a concerted effort by most major central bankers to cooperate with the US Treasury and Federal Reserve?

The trigger-strategy

Prior to the intervention, most major American, European and Asian institutions held short positions in the dollar.

In order to kick off the dollar intervention, they needed a substantial initial pump. The first pump will be used to massively drain dollars from the world system, in order to forcibly raise its cross-currency value, above the first big stop-loss point.

These stop-loss points are well known to the Fed’s primary dealers.

Once the value was forced to the first major stop-loss point, a massive covering of shorts positions began. It was the biggest short squeeze in history.

The short position in the dollar was so enormous up until mid-July, that after the first stop-loss point was taken down, only minimal additional effort was needed to attack the next ones.

With a little added pressure, stop loss after stop loss is demolished, causing short sellers to desperately scramble to buy the dollar to cover what appears to be an impending catastrophic losses.

At some point, the dollar gained a momentum of its own. People who were previously short, and “stopped out”, decided that the wind was blowing in favour of the dollar.

These opportunists converted their funds to go long on the dollar and short on euros, yen, and so forth.

We are in the midst of this reversal right now, after the major part of the intervention has run its course. The powers-that-be are still intervening, to some extent, but they don’t need to use as much force, and have probably unloaded a lot of the long contracts already, at either a profit, or, at worst, a very small loss.

The carry trade

US Treasury chief Henry Paulson and the rest know that the yen carry trade has been fuelling commodity price spikes (borrowing in yen on low interest rates and investing in higher yielding assets).

They are aware that once the stop-loss levels have been triggered in an “unexpected rise in US dollar”, it would result in a domino-effect of investors closing out their yen carry trade positions.

Most of the funds in the yen carry trade were long in commodities, the euro, the Australian dollar and the New Zealand dollar. All spelt losses in those bets. However, the stronger US dollar also caused some of them to remain long instead in US dollar, even after the bashing they took in previous positions.

In the middle of the week, the dollar tumbled in Asian and European trading as a knee jerk reaction to news that the US credit crunch crisis is far from over, but climbed back up.

The markets have been very much herd-like for most of these twelve months, be it in oil or other commodity prices and similarly in the reversal of the US dollar. There is comfort in flying in flocks especially when the global financial markets are so tumultuous. This is not a period which rewards contrarian views.

Even those with contrarian views would be looking for better entry levels, after taking into account market psychology and sentiment. Now investors not only have to judge based on fundamentals and capital flows but also open interest in major futures contracts on various asset classes to get a gauge.

The dollar’s fundamentals are nothing to shout about. The fall of the dollar is a rational reaction to a massively mismanaged paper currency. When currency intervention ends, people will want out of the dollar.

Printing press

Private manipulation of oil, silver or gold markets is a felony but government intervention in worldwide currency markets is perfectly legal.

The bill for the nationalisation of Freddie Mac and Fannie Mae will add about US$6tril to the Federal deficit.

The US government will be forced to print from US$250bil €“ US$500bil new dollars to offset losses in the next 2-3 years.

In addition, it is likely that another US$500bil or so will need to be printed to bail out the FDIC insurance fund.

According to Nouriel Roubini, about US$1tril-US$2tril worth of “value” will have been removed from the system by those who eventually default.

Prior to the credit crisis, the Federal Reserve balance sheet amounted to about US$940bil worth of treasury bills.

This was the fundamental support for the “Federal Reserve Note” or better known as the US dollar.

That is also now lumped with about US$450bil worth of default-prone mortgage backed securities, thanks to efforts to bail out big banks from their even bigger mistakes.

This leaves the US dollar with less than US$500bil in solid support. Each additional new Treasury bill to support printing more money will tarnish the balance sheet.

Soon, global investors will start shouting that the US dollar is not backed by anything at all. If you are not going to revamp and restructure the economy and consumption patterns yourself, the rest of the world will do that for you.

Nearing the end

It’s really quite simple. There are potential trigger catalysts €“ maybe when investors start to add up the mind boggling funds required to complete the bailouts, or when fellow central bankers decide enough is enough with regard to joint intervention, or when the Fed has to cut rates, or when some critical Mid-East nation(s) decides to drop the peg to the US dollar.

Ultimately, the reserve currency status will only get you so far. Finances need to be shored up. Lehman being allowed to go into bankruptcy and Merrill Lynch giving up trying to stay afloat independently, had probably ended the US dollar uptrend.

US dollar will be on a downward pressure with the Fed having to lower rates in the months ahead, and more significantly, the imminent collapse of many more regional banks in the US now that both Paulson and the Fed’s Ben Bernanke have drawn a line on bailouts (not going to happen anymore).

Investors eager to swoop in on US dollar denominated assets may want to bear this in mind, be it stocks, bonds or property.

photo: Crystal Liu Yifei

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