Wednesday, 17 July 2013

Bits from a changing world . . .

One of the features of the reporting season in the US so far has been weakness in the North American consumer banking divisions of those financial institutions that have reported. At Citi, whose numbers are generally positive on the back of asset sales from its' "bad bank" division, North America consumer banking revenues were down 1 per cent at $5.1bn, net income in the division fell 4 per cent to $1.1bn. There was a similar story at J P Morgan and Wells Fargo.

In the pure investment banking sector Goldmans as usual have led the way reporting numbers above expectation. Net income for the period was $3.70 a share, up from $1.78, a year earlier and beating the $2.89 estimate. There were a couple of stories from within those numbers. They tripled profits from debt investments for example and increased profits from fixed income from 12%. The stock dropped nearly 2% after the numbers and this was partly because of the tax rate dropping from 32% to 27%, thus bringing into question the quality of the returns. The CFO admitted that the drop in tax rate was a one off. Crucially, especially if you're investing in companies such as Morgan Stanley compensation at GS increased 27% to $3.7 billion or 43% of revenue for the quarter, down from 44 percent a year earlier. The ratio was 38% for all of 2012. That suggests to me that the "foot on throat" cost cutting is ending. Finally RoE was 10.5% in the quarter, up from 5.4 percent in the year-earlier period and they repurchased $1.6 billion of shares during the quarter. All of this tells me that the stock looks fine while rates are low, but like so much else in the banking world once the Fed starts to taper then 10.5% RoE will look less enticing to shareholders and to management. I'll tip that GS significantly increases it's risk taking (watch their trading revenue numbers in the following quarters) in order to account for the switch away from bonds and into equities.

There's a back to the future feel in banking these days primarily because of the regulatory uncertainty gripping governments and boardrooms. Barclays poached JPM's head of finance to help them re-orientate the business. Barclays can probably see managing asset sales as being a primary driver for the coming couple of years in Europe. Take for example their arrangement of the Commerzbank sale of the is' Eurohypo UK property portfolio. Readers of these blog will know that I've been following this one closely and have advised investors to take a look at whats available since the sale was first put in the market. Wells Fargo with Lone Star have pulled the trigger at a less than bargain price of book value minus 3%. I reckon thats a great sale even though from all accounts the loans and property in the book have been performing extremely well, probably reflecting the prime nature of the core holdings in the portfolio. At this price you have to wonder whether Commerzbank would have kept the portfolio but for pressure from Berlin (who owns 17% of the bank) to de-leverage the balance sheet making a sale of that holding easier and at a better price.

I've been surprised at how long it's taking to make asset sales in this environment. Clearly banks because of the "unlimited" nature of the ECB liquidity advances have been able to hold on until they could squeeze prices back to holding vales. You can't argue with their execution, but possibly it didn't serve the system as well as it could have because it essentially transferred the risk to governments and created an asset bubble. Look at Citigroup and the way that the current CEO ran the "bad bank" assets expertly and delivered increasing capital adequacy ratios. You can't argue with that, but you might argue that the result from a regulatory point of view is an emboldened group of "still too big to fail" banks that may come back to haunt tax payers in years to come. As an investor you need to continue to monitor these asset sales and make comparisons between them and your own portfolios in order to properly assess your value. Right now I'd feel pretty good about central London property and in the longer term the GBP. You were warned.

There's been talk about the leverage in Asia post the crisis. Various credit agencies are looking closely at Singapore and starting to warn that because of their relationship to the USD that things may not be so rosy as they seem. Yesterday we heard Singapore non-oil exports fell 8.8% in June (v 5.8% exp.). This is probably a reflection of USD strength and a slowdown in demand for higher end electronics. Investors sitting on profits in core Asia might consider switching out of positions at this stage knowing that eventually economies will have to fight the Fed taper and China slowing.

And finally to the China story. I'm baffled by the mixed signals we're getting out of Beijing. The slip by the finance minister on Friday that the country is now aiming for growth of 7% being the latest example. We know that we're already at 7.5% which remains the official target for the year and so further drops now look likely, but what are we seeing. The Iron Ore price remains above USD 120, which seems totally out of line with the GDP growth rate and what the AUD is telling us. I can only surmise that the 120 level in iron ore is illusionary.

It was interesting to see that emerging markets (mainly China) short selling research house Muddy Waters Research released it's first report on a US company. I've never heard of American Tower, but the operator of cell-phone antenna has seen it's stock almost triple since 2008. American Tower is the second-biggest U.S. REIT by market value and MWR is as usal raising concerns about some of the accounting policy the company employs. The example they give is the revaluation of cell towers they own in Brazil. The company restated book value by positive $250m dollars recently on the back of no asset sales by itself. This is what I mean when I warn investors about looking at book values. In the case on the Commerzbank UK sale we have some real data both on total value and if you drill down on the rents and associated performance of leases in terms of arrears etc. Maybe American Tower has something similar for these Brazilian properties, but if it doesn't they'll be a raft of short sellers trawling through each holding one by one. Be very cynical about perceived market value and actual market value as an investor.

Le Tour is entering its' final stage and I'm off to the new Rapha Shop (they call it a Cycling Club) here in Sydney tonight to watch the double climb of Alp d'Huez. It was nice to get an invitation after dropping in their to pick up a new long sleeve jersey and another pair of their classic bibs. I'm looking forweard to climb now not so much as a race, but rather for the scenery as Chris Froome will basically have to fall off and break a leg to lose the tour from here on in. The coup d'grace he delivered on Mt Ventoux the other day sealed it in my mind and without something extraordinary from Contador we'll be seeing Froomes emaciated body on the podium in Paris.

I'm not sure the Tour is 100% clean, but humans can do amazing things when tested. I just hope this all ends well and we don't have to revalue the books after the fact. Maybe American Tower can put a cell phone station at Alp d'Huez and revalue it as priceless . . . because it is.


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