Deutsche Bank: A Bogus Slight or Just Slightly Bogus??

Reuter's reported FDIC Vice-Chairman Hoenig's hyperbole regarding Deutsche Bank's seemingly poor capital position. This caused ZeroHedge, the Bête Noire of detached objectivity, to lavishly hyperventilate on the same without considered thought - with both  sufficiently retweeted to insure some nervous-nellies will be shorting DB stock or buying DB CDS protection, without delay.

I am no apologist for banks, least not for German Banks, who've rarely missed an opportunity to miss join a crisis. That said, I do reckon that these presumed obscene numbers and ratios are an artifact of their securities financing business (including liquid markets delta-one and all manner of back-to-back swaps as it is for MS, UBS, and CA). All such undertakings cause a balance-sheet gross up of assets, but take no account of margin or collateral that is the equivalent of (if not superior to) bank equity in regards to financed assets.

Consider, for example, if a DB customer deposits $100 at DB, and borrows a further $600 from DB to buy a total of $700 of bonds. DB's core equity is unchanged, but both the assets and liabilities on their balance sheet have increased. But the $100 of equity the client has deposited/pledged/posted is, to the bank, the equivalent (and I'd argue superior to)  $100 of core equity because under the terms of the loan, it is "first loss", where the bank maintains strict covenants over the type of collateral, minimum required margin in the acct, rights to liquidate under certain conditions, and so forth. So before the bank loses a penny, the margin must completely evaporate. In practice, demands for additional margin/collateral are issued as soon as agreed thresholds are perforated. Failure to perform triggers a liquidation of positions by the bank, NOT to the detriment of the bank, but to their customer who bears the equity-like risk of the positions. Moreover, it's contiunously marked-to-market, in contrast to a traditional bank loan that is typically unsecured and unmargined initially, slow-moving to reprice, not subject to variation margin, and difficult to call-in or on-sell.

But for all such securities companies who finance positions similarly, this equity/collateral of the client, this equity-like buffer upon which they lend against the entirety customers' position, doesn’t show up on THEIR balance sheet as equity, but rather as a liability, offset by the investment assets held on their clients behalf. No matter that, under the example above, the capital ratio is > than 15% with all the covenant cards proverbially-stacked in their favour. So, a 2% tier-1 to assets ratio is a rather meaningless measure of risk, loss or actual capital sufficiency in relation to it's positions. One would need to know the bank's tier-one equity PLUS customer equity and/or liquid-market collateral held in order to make a sensible apples-to-apples comparison before declaring them a hazard. 

Furthermore, financed positions like prime brokerage (as well as repo, delta-one) are typically liquid market instruments. No illiquids. No binary instruments like CatBonds. Sensibly large haircuts and low leverage for concentrated volatile positions (e..g. a Biotech portfolio), outsized position in relation to its historical liquidity, higher, but by no means stupid finance for liquid, well-hedged diversified stuff. Over two decades (speaking as a customer) they have all (DB, MS, GS, UBS, CA) extremely good risk management and control - much better in fact than the oversight of their own prop traders.  And they are positively draconian in comparison to the terms of an ordinary commercial bank loan.  

Vice-Chairman Hoenig is not the first to scare people with non-apple-to-apple comparisons that dramatically misunderstand the nature of these relatively prudent and well-risk-managed financing businesses (oh god, I know this sounds like an ass-lick straight from "Pseuds Corner" but its true!). Which is not to say they are without risk, but that this risk is not accurately reflected (i.e. severely overstated) in the too-often cited bogus ratios. There are lots of legitimate reasons to take aim at the banks in general, and Deutsche Bank in particular be it LIBOR manipulation, tax fraud, hiding losses, etc., but using a mis-specified capital-to-assets ratio, unfit for purpose, is disingenuine and not one of them - especially if one's purpose is to understand their actual capital position and consequential risk, free from hyperbole.

Deux Chevaux?

I'd long held, from a quick superficial point of view, that France Telecom was cheap. I thought so at 17. And at 14. Even more so at 10. And again at 8. I haven't had a position but have carried the thought nonetheless, and watched with some attention. The reason I've not taken a position is mostly because of my dislike of cratering revenues and earnings forecasts. While the stock has been ahead of the fundamental declines, opportunities have been fleeting, an little has changed to the fundamental scenario, though the stock is, again, in front of fundamentals.  Sumzero now thinks it is cheap too. 7x forecast. Outsized yield. Decelerating deceleration in revenues. Goliath status in local markets. Etc.

But before you back up your deux cheveaux (or park it front-wise since it's a rear-engine relic), it would be wise to consider this. I've been a good customer of Chez Orange for several years. Three analog landlines (inbound, fax, alarm circuit), Unlimited Broadband & Livebox TV, Video-on-demand, along with a digital telephone line (used for outbound), as well as two mobiles numbers with unlimited data, a few hours of talk time, and a heavily discounted foreign forfait. The monthly hit for this was roughly Euro160 plus whatever variable calls to daytime mobiles, foreign mobiles, or restricted regulated countries. My American friends tell me this is a serious bargain. My UK experience, and competitive observations suggested this was the wrong price.

So I ambled down to my local Orange kiosk where, despite the much-discussed low morale of engineers deskilled into clerical roles, I found a friendly salesman willing to tolerate my pidgin-French. I also had my trusty, enthusiastic, and more important, bilingual 10 year-old son. I told the Orange representative: "I think I'm paying too much. Let's negotiate". So we went back and forth. Discussed the various options, plans, and bundles. It turns out, France Telecom is keen to decommission the analog lines. If you can afford them, they ARE more reliable, and useful for fax and alarms, but the incentive to cut them is now simply too great. Mobile competitive pressures are finally being felt too. The result: massive, and I mean MASSIVE reductions.

After much discussion, we agreed: kill the analog lines. Move the permanent analog number to the digital line. Port the alarm to the digital line. Continue with unlimited broadband, Livebox WiFi and VoD, and with this package comes move 1 mobile to the bundle, and add the second mobile to the bundle for Euro 10. Total cost for year one: Euro 56/mo., stepping up to Euro61 when an applied discount rolls off. Wow! From Euro160/mo to Euro 55/mo!! OK, Small cuts to mobile minutes and an unobtrusive throttle on broadband for the mobile phones, and the small inconvenience of no fax line (must scan and e-mail), but these were inconsequential in the scheme of things.

Now, I realize that I am not the typical customer. But the revenue drop is eye-popping, and beyond my wildest imagination. And while one shouldn't extrapolate this throughout their businesses, the impact of similar blended revenue deflation is large and palpable and I am unlikely to be amongst the last customers to make such realizations and take action. France Telecom's debt, by contrast, is relatively fixed. And, for the first time in regards to FTE, firsthand, I witnessed how right the market had been fundamentally,and how little conviction I have that this is "in the price".

The stock IS likely ahead of revenue/earnings declines. And it may bounce. But continued revenue and earnings contraction and disappointments coupled with continued likely paring of the dividend means choppy trading and snuffed rallies before ratings will be view more positively.  That's my FTE anecdote of the day FWIW...

Valued Advice

Memorandum

To:         Bea Wethervane, Senior Consultant, Coxbridge Associates

From:     Hugh G. Shortphall, Florida University & College Teachers Pension Fund (FUCT)

Date:      31st May, 2013

Subject:  Hedge Fund Allocations

_____________________________________________________________

I've appreciated your valuable advice to our plan over the years. As you know, the path to changes in orthodox investment policy in a plan such as ours is often long and arduous, particularly when trustees and oversight committees are involved. Witness our struggle to add mortgage derivatives, or expand our equity allocations with a dedicated BRIC component which we finally received approval for, and implemented in 2007. Our campaign to add a GSCI Commodity Index component, as per your recommendation, was not easier, though with your help, we finally gained approval for and deployed it in mid-2008.  Your 2009 advice to implement a dedicated equity tail-risk program - one that we finally allocated to in Sep 2011 - was a big-step forward towards insuring our Board, Trustees (and plan members) could worry less about funding levels in the event of a market crash. 

Over the past few years, you've been tireless supporters of substantially increasing our hedge fund allocations, and, as you know, last year, we recently ramped up these allocations (taking funds from our long equity exposure).  I want to say, we trust your advice implicitly in this regard. However, we on the investment committee have been taking a lot of heat lately on this last decision - both at the tactical and the strategic levels. Not a day goes by without our Board and Trustees reading about overly-generous fee structures, poor manager and strategy performance, and asymmetrical division of the resulting aggregate investment return. As the chief internal supporter, I would be grateful if you could "do the rounds" with the Board and Trustees in order to reconfirm the thesis for this last decision in detail - something that would take the heat off me, and to the greatest extent possible, help you when Coxbridge's consulting contract comes up for renewal. In particular, they keep asking me "where are the scheme members' yachts (or Gulfstream IV's)", quoting figures that over the past decade, in aggregate, managers have pocketed $700 billion in gains whilst fund investors have gained a mere $12 billion net of fees. These concerns need to be addressed, and fears assuaged.

On a more positive note, I am pleased to say that as of the beginning of this year, we've finally completed the implementation of your advice to take replace more of our long-only equity with an allocation to several risk-parity managers. Indeed, as of January, levered bonds and reduced equity appear set to make a meaningful contribution to meeting the Plan's actuarial targets.   

HFM Advertising or How To Take The Management Out of Risk Management

I have advertising in my blood. One of my relatives invented the Coca-Cola's first brand extension. Yet another relation miraculously figured out how to convince housewives to buy boxes of ordinary baking soda and, quite literally, pour them down their drains and flush them down their shiny white toilets. Kerplooosssssshhh. He was paid handsomely for his efforts.   

Hedge Fund Management Companies, and their owners, must be salivating at the imminent opportunities advertising will afford their businesses (and please please please will dewey-eyed pseuds use the correct language:  'Hedge Funds' do NOT advertise; 'Hedge Fund Management Companies' are the not-so-altruistic interested parties here). 

Traditionally, Managers kept low profiles. They maintained anonymous sounding names, discreet offices, unpretentious business cards and few titles. They rarely gave interviews, to keep their secrets, well.....ummm errrr ....secret. But if you make a billion dollars in a single year, or, less discreetly, do it for several years in a row, it is, it must be said, rather hard to keep you (and your Gulfstream IV and your divorce) out of the limelight.

So as the business of Hedge Fund Management converges with Traditional Asset Management, Hedge Fund Managers must begin the arduous and fickle process of branding, identity, and positioning in what is arguably an increasingly-crowded space. Where does the successful manager start, without taking one's eye off the proverbial investment ball? Not being too mercenary here, I'd suggest you contact Cassandra, who has taken the liberty of conjuring (and be warned, copyrighting) some apt off-the-shelf tag-lines and slogans that capture the bona-fide essence of these truly unique entities that will shortly serve the other 99% of the investing public. (Please feel free to contribute your own in the Comments Section)   

     

Blackstone 

 "When Everything Is Not Enough"

Blackrock 

 "Have We Got The Trades For You!!"

Clive Capital 

"Working To Help You Try And Make it Back"

Zweig-DiMenna 

"Thank God For 'Dead Pet Trusts' "

Henderson (Absolute Return Fund) 

 "At Henderson, We're Redefining 'Absolute'"

Marshall Wace  

"The Closest [Legal] Thing to Getting The Call Before The First Call"

SAC Capital 

 "Systematically In Front" 

IKOS  

"Fighting For Return To The Bitter End" 

Bridgewater Associates 

 "We do it OUR way…(And it Works!!)

Campbell & Co 

"There are Leaders. And There are Followers. We are Followers."

Greenlight Capital 

"When We Talk Others Act. When Others Talk, We Act"

Paulson Capital 

"All It Takes Is One Big Trade"

or

"A Piece of Your Own Private Lottery"

Eclectica Asset Mgmt

"It's The Thought That Counts"

Pershing Square 

"'The Squeaky Bird Gets The Worm"

DE Shaw 

"We're So Annoyingly Smart…So You Don't Have To Be"

Blue Sky Japan 

"We Take The Management Out of Risk-Management"

Citadel Investment

"No Comments. Just Returns."

Appaloosa 

"Hedging is for Sissies" 

RAB Capital

Helping Investors Make a Small Fortune (Out of a Large One)

Hayman Capital 

 "Strong Conviction Walks the Line Between Brilliance and Ignominy"

ESL Investments 

"Redefining Concentration"

Highfields Capital 

"The Keys To Better Returns"

Winton Capital 

 "Making Trends Your Friends"  

Elliot Associates 

"We Are Paid To Be Greedy, And We Do Not Disappoint" 

Kynikos Assoc 

"[A Bit] Smarter Than The Average Bear" 

League of Extraordinary Gentlemen

I get depressed from time-to-time thinking about "The Edge" SAC and other "well-informed" investors can (and seemingly often do) achieve in comparison to an uninformed, but nonetheless reasonably systematic investor, such myself. Certainly, some of this is derived from good security analysis, and old-fashioned vision. But "The Edge" historically appears to be disturbingly pervasive across a variety of analysis such as the penchant for the slightly weaker of the highest momo stocks (many of which were formerly the highest momo stocks), but which haven't (yet) been torpedoed by preannouncements or estimate revisions to underperform their close highest momo kin, and have a meaningfully elevated probability of being torpedoed in the next interval. While there may be other explanations for this phenomena, Occam's law would lead one in the direction of selective disclosure and trading upon material non-public information. Not that one should be surprised at this.  The sheer number of people with privileged information is vast as is the trade in such information via "expert networks", even before considering friends, family, old boys' networks or similar networks of obligation and opportunity.exchange.

All this makes Porsche's Volkswagen ummm.... errrrr....call it a pecadillo, all the more incredible, and the losses suffered by the investment equivalent of "The League of Extraordinary Gentlemen" all the more schaudenfraudelicious. Larry Robbins prescient Glenview, David Einhorn's wily Greenlight, Halvorsen's mighty Viking, Singer's calculating Elliot Associates, Carlson's swaggering Black Diamond, as well as SAC, Tiger Asia, and Perry, and another more than forty, well-snookered, plaintiffs all got smoked. There were undoubtedly many more, who, like the guy who tried to open a bottle of Champagne with a corkscrew, were too embarrassed to put their name in the lights.    

Some think, and argue persuasively that Porsche is well-guilty of outright fraud. I am certainly not qualified to judge the legal merits, but as a detached observer, and one who tries hard NOT to be a

hypocrite, I am amused that the guys who persistently pursue, and often obtain,The Edge (by hook and/or by crook) are suing because they were, on this occasion, on the very wrong side of The Edge. Porsche managed to keep their intentions so private, NONE of The League had sufficient suspicions to prevent getting hammered. And impressively, there were no apparent leaks by Porsche's option counterparty banks, accountants, lawyers, or administrators. Or perhaps The League were just so overconfident in their fundamental assessments, they didn't feel that they needed to go the extra mile to obtain the requisite Edge.

So despite my opening lament, upon  reflection, I finish with a tad more optimism, knowing that The League are not infallible, and that they do, from time-to-time, get it horribly wrong. Maybe this should be Martoma's and SAC's defense ("what the hell! i was at RISK!! the Doc coulda been talking out his ass!!). But it also seems that in continuing to pursue the suit to the end that there is a fundamental asymmetry, a lack of sportsmanship in taking one's market lumps. One wonders if Martoma's expert network Doc WAS fabricating material non-public information...would he be sued?

Another One Bites The Dust (yet another update)

Things, people, and/or ideas believed to have integrity now seemingly compromised...(the second updated and expanded version)


Reinhart & Rogoff
Gold
Jérôme Cahuzac
Japanese Yen
Jamie Dimon/JP Morgan
Bitcoin
Banca Monte dei Paschi di Siena 
LULU
IKEA Meatballs


Wen Jiabao as "Humble Servant of The People
Lance Armstrong
Top Ten Lists
NYSE
Facebook
Austerity as an Economic Panacea
Harvard Students' Academic Honesty
BLS Statistics
Cyclical Recovery
Book Reviews
Strong Computer Passwords
Toyota
'Organic' Food
Money Velocity
Patents
Undecided Voters
Hospitals
The Food Pyramid
Purity of '.999 Fine Gold Bars
Penn State Football
"Top of the Pops" 
Fareed Zakaria
The "risk-free" rate
LIBOR as a Benchmark
Public Sector Pensions
HFT as a Beneficial Provider of liquidity
Diversifying properties of Hedge Fund's
Einstein's Theory of Special Relativity 
Celtic Rangers
Macroeconomic Forecasts
John Paulson
FRB Open Market Operations
Standardized Educational Testing
Swiss National Bank
A Relaxing Cruise
WTI as Oil Benchmark 
Olympus Corp.
TEPCO
Payment Protection Insurance
DSK
HM Revenue & Customs
Sony Playstation Network
Google
Privacy
Social Mobility
Actuarial Return Assumptions for Pension Funds
Marmite
Ryan Giggs
Acupuncture
USA Govt AAA
France   AAA
Voicemail
Boob Jobs
Snooker
David Einhorn
Nuclear Power
Deepwater Drilling
Tiger Woods
Professional Cricket
Sumo
Professional Cycling
High-Frequency Trading
Professional Baseball
FIFA
Professional Tennis
Municipal Bond Underwriting
The Catholic Church 
Track & Field Athletics
NCAA Sports
US Congress
UK Parliament
Analyst Research
Credit Ratings
Banks
Newtonian Physics
The Stock Market
The Food Pyramid
Incentive Stock Options
Reinsurance Brokerage 
Lou Dobbs
The Mortgage-Backed Securities Market
Hedge Funds
Social Security
Government Balance Sheets
Tooth Fairy


Errr ummm Professional Wrestling is starting to look good by comparison - at least it makes no pretensions to be anything other than it is. What's left?

In Search of Sonmi-451

I will gladly admit to anyone who asks that I adore the writing of David Mitchell.  He conjures like Murakami on steroids (unashamed of being influenced by the master's technique). And like Murakami, he is a masterful and imaginative storyteller, weaving wonderful tapestries of surreal sub-plots, and creating characters with voices that must make even the most accomplished of authors jealous. I suffered mild depression finishing the last of his novels, The Thousand Autumns of Jacob de Zoete, knowing there was nothing to (immediately) follow. I've been meaning to see the screen version of Cloud Atlas, but haven't quite got around to it yet, pre-occupied as I have been with markets and The Yen.

Indeed, on the latter front, Abe must presently be feeling rather good. Speculators have (to date) done all the heavy lifting - front-runing official intervention, thereby reversing half of the de-risking puke of carry-trades that vaulted the Yen from 115 to 85 back in 2008.  It is important to note that this move is convergence upon "normal" from its lingering (and rather dumb, stupid, ludicrous - choose your adjective) divergence caused by the Yen's safe-haven masquerade.  What is normal? Licking my finger and sticking it up on the air, I would offer that 105ish would hardly offend anyone official. But who knows. What I do know is that short yen is now the most crowded trade in the world. And if you recall in 1998 and 2008,  we all (or should) know how THAT worked out for those left holding the shitbag position. That said, the bank of Japan appears committed to taking everyone out of their positions this time. Or so the thinking goes. Perhaps that is what makes it (to them) such a proverbial lay-up? Short as many Yen as you want (with no cost of carry) and no matter what, the BoJ will allow you to "redeem" your position at a profit (provided you haven't done anything stupid with the proceeds, like, for example, buying French 10-years, or Gold - the former yet to egg investors' faces. But before, as The Cleaner (Harvey Keitel's "Pulp Fiction" character), uttered to Travolta & Samuel L., "Well, let's not start s*cking each other's d!ck$ quite yet!", it is worth contemplating the unpopularity of writing very large 10-digit checks (in dollars!) to hedge funds - many of whom have no qualms themselves using WWII market-torture techniques upon sovereign governments - which will be required for the franking and banking of Speculators paper gains on their aggregate monster positions.

Commentators have been using some rather big and important phrases to describe Abenomics. "....Biggest blah blah blah in generation...", "...blah blah commitment not seen before blah blah", "will ahieve their inflation target of blah blah blah" because blah blah it's different this time blah ..." (these are conjured and not verbatim, but you undoubtedly understand the rhetoric).  To be sure a weaker yen will flatter balance sheets from the ginormous overseas investments enterprises have made during the past two decades of industrial hollowing. And currency translation will make income statements look prettier too - both for exporters and those translating external sales and earnings. This will have some virtuous feedback effects as investors raise expectations that may impact stock prices, and even encourage some further investment on tghe margins. But, after all is said and done in whatever timeframe this feedback loop takes to work its way through markets, there is, and I believe, there will remain, a decided lack of demand for money to make physical investments in Japan as the demographic determinism that is Japan's irrefutable course over the next thirty years, bears down upon the population, economy and markets. It is an event that I have no recollection of ever having been witnessed as a result of something wholly voluntary, non-environmental, non-plague, non-externally-induced and non-military related. And to me, it is fast-approaching, coming into closer view like a large and solid rampart-of-a-wall, and printing money is like pissing on the wall in some Joshua-like hope this little stream of urine will bring it down.

Which brings me back to David Mitchell. What Japan needs is NOT monetization, nor Abenomics. What Japan needs is Clonenomics, or more specifically, what Japan needs is Sonmi-451 and her brothers and sisters. Not Asimo - which consumes not - but living, breathing, Clones. Or, if technology is still wanting, or morally repugnant, at least more babies and bodies - lots and lots of little Yoshi's and Kumiko's. New consumers to replace (and support) the old. Immigrants, BTW, work too. In the absence of a concerted policy to this effect, it is difficult (for me) to imagine how QE, or monetization, or any other policy will somehow spur the desired effect is sufficient size to overcome the demographic steeple. Try as I might, it remains, in my mind, fanciful to attach too-high a probability on a profound result. What is likely is that - as before - these attempts will find themselves goosing asset prices in unexpected places until .... the next puke.