Book Value

This is a very meaty piece, written for those who are serious about the true state of affairs in sovereign Europe as NOT reported in the mainstream media. Though not necessarily for freshmen, it is more than worthwhile for those who want to know what is not being said.

Economic contagion begets financial contagion, which will spread across much (if not most) of Europe, causing further economic contagion. This is what is written on the tea leaves in Ireland.

The maestro managed to run away from the old folks' bent on monetary destruction home just long enough to carry this amusing interview with Bloomberg TV's Al Hunt. Tomes (will) have been written about Greenspan's dementia, just as books will be available on the Kindle one day analyzing his successor's massive mistakes which are slowly but surely leading to an American day of reckoning, so we won't comment much, suffice to point out some of the key highlights in Greenspan's presentation. Most amusingly, note the escalating battle between Greenie and the Fed's new vice-chairman Janet Yellen, who blatantly contradicted Greenspan's that higher interest rates would have prevented a housing bubble. For all it's worth, Alan's response is actually quite interesting: "We tried to do that in 2004. We ran into a conundrum. For decades, every time the Fed raised its short-term rates, the 10-year note, which is really the proxy for mortgage rates, the yield went up with it. This time, it did not. And the reason it did not, is you cannot have the 10-year note determined both by arbitraged global finance and individual central banks. As a consequence of that…starting in the period where the sensitivity of the early stages of the bubble were building up, it was very clear that what was determining the rise in prices was movements in long-term mortgage rates going down, not the federal funds rate." In English, this is quite intriguing: China, which at about this time started running up massive trade balances, essentially became indifferent about US monetary policy, as it gobbled up everything east of 5 Years, with a preference on the 10 Year. The reason for this is the US consumer became the one driving force behind the massive Chinese economic expansion. With the consumer out, and with China set to report its first trade deficit in 6 years, and the Fed pulling out its support of mortgages, and the Chinese National Bank pulling liquidity, the move in 10 Year over the next few weeks is now more critical than ever, which is why the 10 Year - 30 Year MBS spread is paradoxically pressured at an all time tight spread, as all the early MBS shorts are covered, forcing pundits to say MBS are cheap as fighting momentum in this market is professional suicide. To be sure, this technical push down will soon end. And when this last coiled spring blows out, watch out below, first in housing, then in rates, in corporates, and last, in equities.

• Asian shares mostly down; India's RBI's rate hike dampens demand.
• Bernanke says taxpayers shouldn't bear cost of dismantling financial firms
• China cautioned US against citing its currency as a reason for imposing trade sanctions.
• Historic health overhaul bill passes; Democrats clinch win in 219-212 House vote.
• IMF's Lipsky says advanced economies are facing 'acute' debt challenges.
• Merkel: Greece doesn't need financial help.
• Aetna reaffirms 2010 targets, says 2010 results "are off to a good start."

Federated Investors' David Tice has a thing or two to say about the rally - "We've been the beneficiary of a massive credit bubble that we've not yet worked off the excesses... This secular bear market will not bottom until we get back until we get back below book value." In a portion of the interview not caught by the Bloomberg clip below, Tice says that the decline potential for the market is "huge." Don't tell that to the algos whose one and only program for the past month and a half is Buy.The.Dips.

It is difficult to get a man to understand something, when his salary depends upon his not understanding it.

A detailed overview of the current state of charge-offs, delinquencies and (yes) improvements in the mortgage industry - and most importantly what can be discerned from these trends...

A quick preliminary read of the Simon proposal to acquire GGP for $10 billion, via Bank of America, indicates a cap rate of 8% "assuming growth of 3.5% on top of the annualized NOI stream." The offer values GGP at $9/share, including $3 for the land business. As readers will recall there has been a difference in opinions between Hovde and Ackman on GGP's value, the first of which gets an "implied equity value of $5.73 per share at a 7.5% cap rate and negative $5.03 per share at an 8.5% cap rate which after incorporating the conversion of the unsecured debt into equity at price of $6 per share, the implied equity value is $5.94 per share at a 7.5% cap rate and $3.62 per share at an 8.5% cap rate," while Ackman is a tad more ambitious: "based on cash NOI (not adjusted for lease termination fees, tenant allowances, maintenance capital expenditure) for LTM ending Sep 2009, Ackman values GGP at $23.7, $32.0 and $41.6 per share at cap rate of 7.21%, 6.71% and 6.21%, respectively." Seems like Hovde is just a little bit closer in his valuation (assuming no overbid). The OCC supports the Simon offer as they get taken out at par.

We have so far avoided discussing this weekend's most tragicomic news, which undoubtedly is the Mortgage Bankers' Association selling their headquarters for a huge loss in less than two years. The building which was acquired for $76 million was sold to CoStar for $41.25 million. How the MBA is in any way supposed to provide insight on sentiment and market perspectives after a slap in the face such as this is beyond us. At best, they should start a $2.95 newsletter titled "How to top tick the market and never look back while waiting for the Dow 36k." The other implications of this transaction are self-explanatory. Yet courtesy of diligent readers, we have received some other very amusing information, which however focuses on the buyer in this transaction, specifically CoStar, which on its website brands itself as the "#1 Commercial Real Estate Information Company." Apparently the validity of this branding is only as good as the (un)solicited hot tips CoStar receives every day. A letter sent out earlier by an editor of CoStar's Watch List Group seeks to expand on the groupthink permeating the permabullish CRE investor landscape (we hope they approached Cohen and Steers with their query for an objective and unbiased perspective), with a set of questions that makes one question the validity of CoStar's self-branded imprimatur.

As mentioned in my previous posts, I have been engaged in a discussion of the valuation of Goldman Sachs and investment banks in general. Here is how it has played out.

It is no secret that SocGen's Dylan Grice has not been a big fan of the Japanese economy, or stock market for that matter. We have highlighted his perspectives on the island nation in the past, and his concerns about a likely demographic-induced funding crunch have been picked up by the likes of Hayman Capital's Kyle Bass. So when Grice comes out with constructive suggestions on how to play Japanese relative value, especially if it is based on liquidation value considerations, one would do well to listen.

A knowledgeable reader, who is currently a sell side analyst, questioned
me about using book value to value Goldman and investment banks in
general. He proposed using a formula that entails revenues as well due
to the fact that the main concern during the crisis was breakup value
while revenue visibility is clearer now that the crisis is over. While the crisis may be over, the root causes of the crisis have went nowhere, and the counter party risk concentration is actually much worse than before. In addition, not only is it political suicide to attempt to bailout another bank, I think it is poor economic policy as well. Combining these two assertions, it is not clear that we will not see anymore bank failures. The probability of such has dropped considerably though.

Before I get started, I want all to realize that this is not Goldman bashing piece. I think it is a [relatively] well run company, but its PR machine appears to be from Kindergarten land, and the aura of invincibility that it enjoys(ed?) is highly undeserved, as a consequence its historical "aura-based" premium is absolutely unjustified. Case in point...

Earlier Goldman issued a new report on the homebuilders (found here). Not much in terms of overall macro perspective change, however notable was that Goldman downgraded TOL as the firm "believes that outperformance will be limited in the first half of 2010." However, before TOL management decides it will no longer pick up phone calls by Goldman's Joshua Pollard, GS hedges with: "That said, we still believe that there is significant value in Toll shares for patient investors as Toll has one of the best franchises in homebuilding." So sleep confident dear hedge funds managers - Goldman should still be able to arrange private one on ones with the CEO at your leisure. As for the true reason for the downgrade, whether this is due to most shorts having cleared out of the stock already, much in line with keeping with Goldman's strategy of upgrading stocks that have a substantial short interest (ref. MGM), is unclear.

Two months ago Bloomberg's Jonathan Weil brought up the very relevant topic of fair value divergences on bank balance sheets courtesy of SFAS 107 and lax accounting firm standards (some more lax than others). Zero Hedge immediately followed up on this theme and presented a comparative analysis of various bank asset shortfalls, speculating that certain accounting firms are doing their best to do an Arthur Andersen redux for Generation Bailout.

On October 15 we said: "Just what about the economic environment has given Citi auditors KPMG the flawed idea that the bank's loan can be easily offloaded with virtually no discount? And just how much managerial whispering has gone into this particular decision. If one assumes a comparable deterioration for the Citi loan book as for the other big 4 firms, and extrapolates the 2.8% getting worse by the average 1.5% decline, one would end up with a 4.2% Book-to-FV deterioration. On $602 billion of loan at Q2, this implies a major $25 billion haircut. Yet this much more realistic number is completely ignored courtesy of some very flexible interpretation of fair value accounting rules at KPMG. Maybe Citi and its accountants should take a hint from Regions Financial CEO Dowd Ritter who carries the FV of his $90.9 billion loan book value at a 25% discount." Today, finally, after a two month delay, these two articles seem to have finally made the inbox of the financial gurus at the Wall Street Journal, which, in an article named "Accounting for the bank's value gaps," says: "can investors count on consistency when it comes to bank accounting? As many banks struggle with piles of bad loans, it appears some auditors are being stricter than others when assessing their true value." Way to be on top of that ball WSJ/Mike Rapaport. Nonetheless, we are happy that this very critical topic, is finally starting to get the due and proper, if largely delayed and uncredited, attention it deserves.

Regulatory capture has allowed what was just a bunch of stinky bank balance sheets to literally threaten the economy. Here is another shining (or stinking, depending on your perspective) example.