ACE was up today as was XL. Now XL was up even with a ratings downgrade so must be on sale talk. ACE file a mixed shelf today. So here is my speculation, ACE is going to buy XL and issue common to do so. The price will be close to today's price, and ACE will take a huge mark on the investment securities, so Xl's book value will be written down to pretty much nothing. They get XL's platform some good teams, and very large cost savings, and take out a major competitor. If the securities are not that bad, and they should not be, they get upside on the securities, as the majority of those should come back. They can issue equity above book, so this deal will be accretive on book, and massively accretive on earnings.
You heard it here first! or maybe this is the talk of the town, but i am cut off, sorry.
Monday, December 15, 2008
WABC - a short idea
Just did some work on WABC. Basic thesis very good bank but priced to perfection in an unfortunate location, and will not escape unscathed. Analyst estimated for losses are way too low:
WABC is a very well run institution with conservative lending standards, and a more than adequate capital cushion. The company trades at a significant premium to its peer group (Bloomberg) at 3.4X Price/Book, and 5.25X Price/Tangible Book vs. peers at 1.16X and 2.24X respectively. Other bank indices are trading at even lower multiples, with the Nasdaq Bank index at 1.03X Price/Book, and the KBW bank index at 0.74X Price/Book. The company’s sole area of operations is Northern and Central California, and as the research indicates, estimates for 2009 are significantly too high, as loan loss provision assumptions are much too low. Downwards estimates revisions will lead to significant multiples compression for this institution that is priced to perfection.
In addition, the significant valuation premium (41% deposit premium) makes it very unlikely that WABC is acquired and significantly reduces the likelihood that this stock will lead any bank sector snap-back.
Based on my earnings assumptions and using a modified dividend discount model, WABC should trade closer to 1.9X BVPS, still well above its peer group. This would result in a $27 share price. Given the volatility of bank sector earnings, Price/Book is a more appropriate metric at present.
It is clear that WABC’s credit metrics have been very solid. The company has also largely avoided the most problematic areas: C&D loans are a small part of the portfolio, the company maintained standards on home mortgages (no sub-prime, 80% LTV and full documentation), and has minimal 2nd lien exposure. That being said, CA is the epicenter of this economic downdraft, and conditions have worsened significantly since the end of Q3. Home prices have declined 48% since the peak, making even 80% LTV loans underwritten back in 2005 underwater. Office vacancies are increasing rapidly, unemployment in the State is now at 8.3%, retailers are under severe pressure, and the state is in fiscal crisis. CRE prices are also declining reducing collateral protection in that asset class. This points to increased pressure in CRE, both owner occupied and non-owner occupied, as well as growing pressure on C&I loans. At a recent conference in San Francisco, it was disclosed that pools of performing CRE loans were receiving bids of $0.80-$0.85. Commercial property prices are down 15-35% in the San Francisco/Northern California area.
The consumer portfolio is largely auto loans, and though WABC had solid underwriting, auto prices are down 12% according to the Manheim index. This will lead to a higher severity of loss in that portfolio.
High unemployment and talk of raising the sales tax in California to offset a massive fiscal deficit will put great strain on the C&I portfolio which consists largely of small businesses.
The current CEO has been running WABC since 1988 so a historical look back is worthwhile. NCOs peaked at 0.65% back in 1993. Assuming NCOs peak in 2009, provisions will be highest this year. My loss estimate for the portfolio has NCOs peaking at 1.5% in 2009, and staying high at 1.4% in 2010. The company has stated a desire to keep the allowance over 2% given its geographic concentration, and the allowance peaked at 2.45% during the early 90s. Macro conditions are significantly worse this time around and WABC will surely be impacted to a greater extent than in 1993. Assuming NCOs are closer to the 1993 peak vs. my estimate, will still lead to a greater than 10% shortfall in EPS.
With net interest margin peaking, and a shrinking balance sheet, pre-provision earnings are likely to be flat at best. WABC is no longer buying back shares, and it is hard to see how the company can keep EPS flat to slightly up y/y as according to consensus.
The company’s efficiency ratio is already at 40%, and it is unlikely that the firm can reduce operating expenses to offset the impact of increased provisions and a shrinking balance sheet.
Recent results:
WABC reported GAAP EPS of $0.00 but excluding the impairment on FNM/FRE preferreds, an operating EPS of $0.78 excluding the $0.81 impact of the FNM/FRE charge and $0.03 tax benefit. WABC was able to expand net interest margins by 85bps y/y offsetting the impact of a 12% reduction in earning assets. Total revenues fell 2% linked quarter however, as 3bps of net interest margin expansion was more than offset by a 3% decline in earning assets. Fee income was down 4% from the prior quarter offset by a similar reduction in operating expenses. The company’s efficiency ratio is an impressive 40%.
Valuation:
Street estimates for 2009 of $3.10/share are too high. I forecast $2.37/share Analysts reach that number tweaking several different factors:
1. Continued net interest margin expansion: Most foresee continued net interest margin expansion. Given the already low rates, and increased competition for deposits, it is unlikely that WABC will be able to expand margins further.
2. Street analysts forecast continued reduction in operating expenses. This is unlikely given the already efficient operation that WABC is running.
3. Balance sheet growth: WABC is forecasted to grow its balance sheet, even though the company has explicitly stated its cautious outlook, and has shrunk earning assets by 12% y/y.
4. Drawing down loss reserves: some analysts foresee a reserve drawdown where NCOs exceed provisions. This is highly unlikely when the company has explicitly targeted a 2%+ allowance ratio, competitors are scrambling to increase reserves, regulators are pushing for conservatism, and the economy is declining at a rapid rate.
5. Loss provisions: this last point is the most crucial. Apart from one outlier that is forecasting $20M in provision expense, the street is clustered around a provision expense in the low single digits. Not only does this indicate no deterioration of credit, but also the street, as mentioned above, is factoring a drawdown in the allowance. Both conclusions are very hard to see in this economic environment. My analysis of potential embedded losses in the portfolio point to significantly higher losses. I see charge offs peaking in 2009 at 1.5% of average loans, and provisions in 2009 of $38M or 1.6% of average loans. WABC will likely build the allowance, provisioning more than charge offs in this environment, and losses embedded in the portfolio are likely to be significantly higher than in the early nineties. As previously mentioned, charge offs peaked at 0.65% in 1993. The current environment points to significantly higher severity of losses across the board, and increased frequency.
· It is also unlikely that WABC grows its loan portfolio, as it is more likely to conserve capital against any unexpected losses, particularly from its investment portfolio. Based on my earnings expectations of $2.37/share, WABC should trade closer to 1.9X to 2.0X BVPS. This would still confer a significant premium to its peer group. On a tangible book basis, the $27 target would equate to 3.0X tangible book still at a large premium to its peer group. On a PE basis, 11.2X 2009E is appropriate, given the earnings shortfall and the limited visibility in this environment. Smaller regional banks with limited exposure to capital markets and sub-prime lending have significantly outperformed their larger peers. However as we have seen in the past, the credit crisis began in sub-prime mortgages but expanded to hit other sectors. At present, prime mortgages are under pressure, CMBS pricing points to significant deterioration in CRE loans, and C&I loans are bound to be impacted. Accounting and loan composition have shielded some of the regional banks to date. WABC valuation will appear even more stretched, if its peer group multiples compresses to closer to some of the larger regional banks. Eventually all institutions, even the most conservative will be affected. Though not factored into the analysis, WABC will also have to bear the cost of a proposed sharp increase in FDIC insurance premiums (expected to rise 5bps for WABC, $0.06 impact).
· WABC’s significant premium to the sector makes it an unlikely acquisition target, and its defensive characteristics make the stock unlikely to lead any market snap back. Both attributes provide investors with downside protection.
WABC is a very well run institution with conservative lending standards, and a more than adequate capital cushion. The company trades at a significant premium to its peer group (Bloomberg) at 3.4X Price/Book, and 5.25X Price/Tangible Book vs. peers at 1.16X and 2.24X respectively. Other bank indices are trading at even lower multiples, with the Nasdaq Bank index at 1.03X Price/Book, and the KBW bank index at 0.74X Price/Book. The company’s sole area of operations is Northern and Central California, and as the research indicates, estimates for 2009 are significantly too high, as loan loss provision assumptions are much too low. Downwards estimates revisions will lead to significant multiples compression for this institution that is priced to perfection.
In addition, the significant valuation premium (41% deposit premium) makes it very unlikely that WABC is acquired and significantly reduces the likelihood that this stock will lead any bank sector snap-back.
Based on my earnings assumptions and using a modified dividend discount model, WABC should trade closer to 1.9X BVPS, still well above its peer group. This would result in a $27 share price. Given the volatility of bank sector earnings, Price/Book is a more appropriate metric at present.
It is clear that WABC’s credit metrics have been very solid. The company has also largely avoided the most problematic areas: C&D loans are a small part of the portfolio, the company maintained standards on home mortgages (no sub-prime, 80% LTV and full documentation), and has minimal 2nd lien exposure. That being said, CA is the epicenter of this economic downdraft, and conditions have worsened significantly since the end of Q3. Home prices have declined 48% since the peak, making even 80% LTV loans underwritten back in 2005 underwater. Office vacancies are increasing rapidly, unemployment in the State is now at 8.3%, retailers are under severe pressure, and the state is in fiscal crisis. CRE prices are also declining reducing collateral protection in that asset class. This points to increased pressure in CRE, both owner occupied and non-owner occupied, as well as growing pressure on C&I loans. At a recent conference in San Francisco, it was disclosed that pools of performing CRE loans were receiving bids of $0.80-$0.85. Commercial property prices are down 15-35% in the San Francisco/Northern California area.
The consumer portfolio is largely auto loans, and though WABC had solid underwriting, auto prices are down 12% according to the Manheim index. This will lead to a higher severity of loss in that portfolio.
High unemployment and talk of raising the sales tax in California to offset a massive fiscal deficit will put great strain on the C&I portfolio which consists largely of small businesses.
The current CEO has been running WABC since 1988 so a historical look back is worthwhile. NCOs peaked at 0.65% back in 1993. Assuming NCOs peak in 2009, provisions will be highest this year. My loss estimate for the portfolio has NCOs peaking at 1.5% in 2009, and staying high at 1.4% in 2010. The company has stated a desire to keep the allowance over 2% given its geographic concentration, and the allowance peaked at 2.45% during the early 90s. Macro conditions are significantly worse this time around and WABC will surely be impacted to a greater extent than in 1993. Assuming NCOs are closer to the 1993 peak vs. my estimate, will still lead to a greater than 10% shortfall in EPS.
With net interest margin peaking, and a shrinking balance sheet, pre-provision earnings are likely to be flat at best. WABC is no longer buying back shares, and it is hard to see how the company can keep EPS flat to slightly up y/y as according to consensus.
The company’s efficiency ratio is already at 40%, and it is unlikely that the firm can reduce operating expenses to offset the impact of increased provisions and a shrinking balance sheet.
Recent results:
WABC reported GAAP EPS of $0.00 but excluding the impairment on FNM/FRE preferreds, an operating EPS of $0.78 excluding the $0.81 impact of the FNM/FRE charge and $0.03 tax benefit. WABC was able to expand net interest margins by 85bps y/y offsetting the impact of a 12% reduction in earning assets. Total revenues fell 2% linked quarter however, as 3bps of net interest margin expansion was more than offset by a 3% decline in earning assets. Fee income was down 4% from the prior quarter offset by a similar reduction in operating expenses. The company’s efficiency ratio is an impressive 40%.
Valuation:
Street estimates for 2009 of $3.10/share are too high. I forecast $2.37/share Analysts reach that number tweaking several different factors:
1. Continued net interest margin expansion: Most foresee continued net interest margin expansion. Given the already low rates, and increased competition for deposits, it is unlikely that WABC will be able to expand margins further.
2. Street analysts forecast continued reduction in operating expenses. This is unlikely given the already efficient operation that WABC is running.
3. Balance sheet growth: WABC is forecasted to grow its balance sheet, even though the company has explicitly stated its cautious outlook, and has shrunk earning assets by 12% y/y.
4. Drawing down loss reserves: some analysts foresee a reserve drawdown where NCOs exceed provisions. This is highly unlikely when the company has explicitly targeted a 2%+ allowance ratio, competitors are scrambling to increase reserves, regulators are pushing for conservatism, and the economy is declining at a rapid rate.
5. Loss provisions: this last point is the most crucial. Apart from one outlier that is forecasting $20M in provision expense, the street is clustered around a provision expense in the low single digits. Not only does this indicate no deterioration of credit, but also the street, as mentioned above, is factoring a drawdown in the allowance. Both conclusions are very hard to see in this economic environment. My analysis of potential embedded losses in the portfolio point to significantly higher losses. I see charge offs peaking in 2009 at 1.5% of average loans, and provisions in 2009 of $38M or 1.6% of average loans. WABC will likely build the allowance, provisioning more than charge offs in this environment, and losses embedded in the portfolio are likely to be significantly higher than in the early nineties. As previously mentioned, charge offs peaked at 0.65% in 1993. The current environment points to significantly higher severity of losses across the board, and increased frequency.
· It is also unlikely that WABC grows its loan portfolio, as it is more likely to conserve capital against any unexpected losses, particularly from its investment portfolio. Based on my earnings expectations of $2.37/share, WABC should trade closer to 1.9X to 2.0X BVPS. This would still confer a significant premium to its peer group. On a tangible book basis, the $27 target would equate to 3.0X tangible book still at a large premium to its peer group. On a PE basis, 11.2X 2009E is appropriate, given the earnings shortfall and the limited visibility in this environment. Smaller regional banks with limited exposure to capital markets and sub-prime lending have significantly outperformed their larger peers. However as we have seen in the past, the credit crisis began in sub-prime mortgages but expanded to hit other sectors. At present, prime mortgages are under pressure, CMBS pricing points to significant deterioration in CRE loans, and C&I loans are bound to be impacted. Accounting and loan composition have shielded some of the regional banks to date. WABC valuation will appear even more stretched, if its peer group multiples compresses to closer to some of the larger regional banks. Eventually all institutions, even the most conservative will be affected. Though not factored into the analysis, WABC will also have to bear the cost of a proposed sharp increase in FDIC insurance premiums (expected to rise 5bps for WABC, $0.06 impact).
· WABC’s significant premium to the sector makes it an unlikely acquisition target, and its defensive characteristics make the stock unlikely to lead any market snap back. Both attributes provide investors with downside protection.
Thursday, December 11, 2008
CMA and others
Was just gearing up to do some work on banks and CMA tanks. Oh well, my basic thesis is that C&I delinquencies and losses have lagged but this will be the first big quarter. Most bank valuations are very low, and with federal funds they may well be able to avoid dilutive capital raises, and be able to wait a few years before raising common. There are some banks that are still trading very rich. WABC is over 5X tangible book. I have to check that one out, because one slip and it will be cut in half. I am sure it has strong capital ratios, but it can still go to 2.5X book.
CMA has been one of my short ideas since summer. Of course the change of rules in september would have killed that position, but in the end they did cut their dividend and will have to do so again. they have grown in TX, but that state is not immune and will be dragged into things. They also have midwest exposure and construction loans, but I am waiting for C&I to fall off a cliff. I think this quarter but Q1 at the latest.
CMA has been one of my short ideas since summer. Of course the change of rules in september would have killed that position, but in the end they did cut their dividend and will have to do so again. they have grown in TX, but that state is not immune and will be dragged into things. They also have midwest exposure and construction loans, but I am waiting for C&I to fall off a cliff. I think this quarter but Q1 at the latest.
Monday, December 8, 2008
SLM calls
I just bought some January SLM calls at $10 strike. Now I know the volatility is high, but I think there is a big catalyst with the ABCP renegotiation which will happen prior to expiration. With a little christmas rally in the mix (a necessary component unfortunately), I could be money good.
We shall see.
We shall see.
Random musings
NDX down 82% peak to trough, XLF down 77% peak of 38 in 05/2007, and trough to date on 11/21/08. Looks like financials bubble just as powerful as TMT. Unfortunately much more pervasive and interwoven with macro.SPX down 47% peak to trough 2000-2002, SPX down 49% peak to trough to date. Multiples were 2X as high entering last correction, so there is leeway fro even more significant earnings cuts. Based on long term average of 14-15X, looks like $60 for SPX is being build it. That seems reasonable.If credit markets normalize, and massive fiscal stimulus comes through paired with continued monetary creativity, we could be approaching a bottom.. though recovery will likely be slow and painful for broader economy.What do you think?
Still scanning for fresh ideas.
Still scanning for fresh ideas.
Wednesday, November 26, 2008
Checking results
My ACE long WTM short call posted on this blog from 10/29 is up 3.5% from that date, but a lot more from mid-october when I first made the call (actually up 31%).
I also pushed long MA short GPN up 15% since my post on October 30th.
SLM is up since my work on the 15th, but of course the market is up big.
IAP on the other hand I believe is down.
Enough pats on the back (actually I doubt anyone is reading anyways). My work on AOC is progressing. Defensive name, good management, will outperform in a down market for sure, but is certainly not a beta name. Kinda boring but boring is nice. They do have integration of Benfield.
I also pushed long MA short GPN up 15% since my post on October 30th.
SLM is up since my work on the 15th, but of course the market is up big.
IAP on the other hand I believe is down.
Enough pats on the back (actually I doubt anyone is reading anyways). My work on AOC is progressing. Defensive name, good management, will outperform in a down market for sure, but is certainly not a beta name. Kinda boring but boring is nice. They do have integration of Benfield.
Saturday, November 15, 2008
SLM
I am returning to SLM. I think there is clearly upside for the stock. I get $14 in a runoff scenario, with $12 from the loan portfolio, with fairly elevated private credit losses (2% per annum on the whole portfolio, not just in school). I also get $14/share or 1.7X BVPS of $8.37. Current quarter run rate eps of $0.36 still translates to a 17% ROE, which correlates to a 1.7X P/B. One would assume that a run-off scenario would be a bottom for the stock, however it is currently at $7.45/share below book.
In this situation, I think more time needs to be spent on the things than could go wrong. Why such a large discount to "intrinsic" value.
Clearly, the #1 concern is rolling the ABCP facility. Unfortunately for SLM, collateral in the ABCP is marked to market, focing SLM to inject additional equity (extra collateral) in the facility. As of Q3 SLM had $29.1B of assets at book value backstopping $24.7B in liabilities. The facility is supposedly non recourse, but with such a large variance between assets and liabilities, if the facility was terminated, SLM's equity would basically be wiped out. Another interesting point on this facility is that SLM reduced the borrowing terms. However, my sense is that this was forced on SLM. The new limits are $21.9B for FFEL with a maximum borrow of $20.8B, and for private $3.6B with a maximum borrow of $3.2B. On the NNI call, NNI disclosed that their FFEL loans are currently mark to market at $0.83/$1 in their warehouse line, with significant deterioration in October. If SLM's FFEL were marked at NNI's level, that would be an additional $2.8B of collateral, that SLM would need to post. Moreover, the private loan marks would have deteriorated even further.
Signs of the impact of this ABCP vortex are evident with unencumbered FFEL loans declining from $14B to $9B sequentially, and unrestricted cash falling $3B sequentially to $4.7B ($1.4b of that cash is collateral for derivatives gains). Net liquidity declined $12B in one quarter. The saving grace here, is the new directive from the DOE that sets up a means to offload Stafford loans back to May 2003. This would provide a funding source for $16B, and would help SLM reduce its ABCP draw by double digit billions. The DOE will provide a liquidity backstop in the form of a forward purchase agreement to the ABCP investor. According to NNI, the set price should be close to or at par. I think this facility will give significant benefit to SLM. However, until that facility is renewed, there will be doubt, as banks, should they decide to play hardball, can get a great deal on these loans (can sell them to the FED at $0.90 for example).
#2 is the lack of funding for private loans. SLM has ramped up deposit gathering, and was able to do a term loan earlier in the year, and though this is something, it is certainly not ideal in terms of matched funding. As SLM cannot pass along its cost of funds to consumers, it has opted to improve returns by seeking lower credit costs with a much higher level of co-signers, as well as higher credit scores. Still at this point, the economics, or the form of private student loan market is in doubt. There is talk of increasing Stafford loan limits in a 2nd stimulus package, which would relieve pressure, but also reduce the size of the private loan market.
#3 is private loan credit. Though the company notes that charge-offs have been inline, the company did increase provisions in Q3 with expectations of further deterioration from the economic situation. Delinquencies for traditional private loans rose to 6.3%,and total delinquencies were at 9.4%. However forbearances were down, so the total bucket was only up slightly. A significant deterioration would impact earnings and could impact capital levels.
#4 is the FFEL program beyond 2009-2010. What is the plan beyond 2010? Will SLM retain servicing when it puts the loans to the DOE? Will there continue to be a shift to the Direct loan program? Will further chances to the SAP be made in the future?
#5 is the APG purchased paper program. SLM took a large impairment this past quarter, but additional impairments are possible - leading to further capital strains.
#6 slower prepayment speeds could impact cash flow needed for debt paydown if capital markets remain closed.
#7 Residual interests have been marked down largely due to higher discount rates. SLM has $2.3B in residual interests on balance sheet. This is another source of potential capital strain.
#8 Rating agencies and capital requirments for private loans, and for FFEL. There may be pressure for SLM to hold more capital vs. managed assets. Will SLM participate in TARP, will the government pull a AIG in a worst case?
#9 Future of the wholesale funded model? can SLM compete as a standalone, what form will the ABS market return in and when.
All these concerns are weighing on the stock. However, they fall into two buckets. Can the company survive without additional capital? what is the future earnings power of SLM? If the answer to question #1 is yes? then the stock should trade in the mid-teens. If we get reasonable clarity on #2, then we could have a recovery to the 20s. As the source of earnings growth in the past few years has come from private loans, a resolution there is key. Continued cost cutting provides opportunities, and SLM has opportunities in servicing, including the 2010 contract for servicing the direct loan portfolio for the DOE.
I need to see if this liquidity extension back to 2003 is working, but the big question is this ABCP facility. I think it will get renewed in a slimmed down fashion. I also think that pricing for FFEL loans will improve slowly further reducing strain going forward. That makes me a buy on the stock at this price. With that being said, it seems that NNI is in a more enviable position. Yes they have a warehouse line that is causing them similar angst, but they are in discussion with BAC to amend it. And yes Moody’s downgraded Nelnet’s senior unsecured debt to Ba1 from Baa2,with review for possible further downgrade. Nelnet has $275 million of unsecured debt
maturing 2010. The ratings downgrade resulted in a 30 bp step-up in cost of Nelnet’s
$750 million unsecured credit line. However, they have limited private loans ($1B of a $26B portfolio) so the tail of credit risk is not there, and have a larger fee component from non- FFEL related programs. That stock is also trading below book value per share, and may well be better value than SLM.
This new funding facility, where the government is providing a liquidity backstop but not directly purchasing the loans, may well be a model for the future. It could result in lower funding costs but also in retained servicing since the loans are not sold to the government at any point. Looks like the structure is for cash for 97% and the lenders financing the other 3%. Much better than the curent situation, but still worst than the past. If lenders cannot sell the lower tranches and have to retain them going forward, then capital needs will have to go up.
In this situation, I think more time needs to be spent on the things than could go wrong. Why such a large discount to "intrinsic" value.
Clearly, the #1 concern is rolling the ABCP facility. Unfortunately for SLM, collateral in the ABCP is marked to market, focing SLM to inject additional equity (extra collateral) in the facility. As of Q3 SLM had $29.1B of assets at book value backstopping $24.7B in liabilities. The facility is supposedly non recourse, but with such a large variance between assets and liabilities, if the facility was terminated, SLM's equity would basically be wiped out. Another interesting point on this facility is that SLM reduced the borrowing terms. However, my sense is that this was forced on SLM. The new limits are $21.9B for FFEL with a maximum borrow of $20.8B, and for private $3.6B with a maximum borrow of $3.2B. On the NNI call, NNI disclosed that their FFEL loans are currently mark to market at $0.83/$1 in their warehouse line, with significant deterioration in October. If SLM's FFEL were marked at NNI's level, that would be an additional $2.8B of collateral, that SLM would need to post. Moreover, the private loan marks would have deteriorated even further.
Signs of the impact of this ABCP vortex are evident with unencumbered FFEL loans declining from $14B to $9B sequentially, and unrestricted cash falling $3B sequentially to $4.7B ($1.4b of that cash is collateral for derivatives gains). Net liquidity declined $12B in one quarter. The saving grace here, is the new directive from the DOE that sets up a means to offload Stafford loans back to May 2003. This would provide a funding source for $16B, and would help SLM reduce its ABCP draw by double digit billions. The DOE will provide a liquidity backstop in the form of a forward purchase agreement to the ABCP investor. According to NNI, the set price should be close to or at par. I think this facility will give significant benefit to SLM. However, until that facility is renewed, there will be doubt, as banks, should they decide to play hardball, can get a great deal on these loans (can sell them to the FED at $0.90 for example).
#2 is the lack of funding for private loans. SLM has ramped up deposit gathering, and was able to do a term loan earlier in the year, and though this is something, it is certainly not ideal in terms of matched funding. As SLM cannot pass along its cost of funds to consumers, it has opted to improve returns by seeking lower credit costs with a much higher level of co-signers, as well as higher credit scores. Still at this point, the economics, or the form of private student loan market is in doubt. There is talk of increasing Stafford loan limits in a 2nd stimulus package, which would relieve pressure, but also reduce the size of the private loan market.
#3 is private loan credit. Though the company notes that charge-offs have been inline, the company did increase provisions in Q3 with expectations of further deterioration from the economic situation. Delinquencies for traditional private loans rose to 6.3%,and total delinquencies were at 9.4%. However forbearances were down, so the total bucket was only up slightly. A significant deterioration would impact earnings and could impact capital levels.
#4 is the FFEL program beyond 2009-2010. What is the plan beyond 2010? Will SLM retain servicing when it puts the loans to the DOE? Will there continue to be a shift to the Direct loan program? Will further chances to the SAP be made in the future?
#5 is the APG purchased paper program. SLM took a large impairment this past quarter, but additional impairments are possible - leading to further capital strains.
#6 slower prepayment speeds could impact cash flow needed for debt paydown if capital markets remain closed.
#7 Residual interests have been marked down largely due to higher discount rates. SLM has $2.3B in residual interests on balance sheet. This is another source of potential capital strain.
#8 Rating agencies and capital requirments for private loans, and for FFEL. There may be pressure for SLM to hold more capital vs. managed assets. Will SLM participate in TARP, will the government pull a AIG in a worst case?
#9 Future of the wholesale funded model? can SLM compete as a standalone, what form will the ABS market return in and when.
All these concerns are weighing on the stock. However, they fall into two buckets. Can the company survive without additional capital? what is the future earnings power of SLM? If the answer to question #1 is yes? then the stock should trade in the mid-teens. If we get reasonable clarity on #2, then we could have a recovery to the 20s. As the source of earnings growth in the past few years has come from private loans, a resolution there is key. Continued cost cutting provides opportunities, and SLM has opportunities in servicing, including the 2010 contract for servicing the direct loan portfolio for the DOE.
I need to see if this liquidity extension back to 2003 is working, but the big question is this ABCP facility. I think it will get renewed in a slimmed down fashion. I also think that pricing for FFEL loans will improve slowly further reducing strain going forward. That makes me a buy on the stock at this price. With that being said, it seems that NNI is in a more enviable position. Yes they have a warehouse line that is causing them similar angst, but they are in discussion with BAC to amend it. And yes Moody’s downgraded Nelnet’s senior unsecured debt to Ba1 from Baa2,with review for possible further downgrade. Nelnet has $275 million of unsecured debt
maturing 2010. The ratings downgrade resulted in a 30 bp step-up in cost of Nelnet’s
$750 million unsecured credit line. However, they have limited private loans ($1B of a $26B portfolio) so the tail of credit risk is not there, and have a larger fee component from non- FFEL related programs. That stock is also trading below book value per share, and may well be better value than SLM.
This new funding facility, where the government is providing a liquidity backstop but not directly purchasing the loans, may well be a model for the future. It could result in lower funding costs but also in retained servicing since the loans are not sold to the government at any point. Looks like the structure is for cash for 97% and the lenders financing the other 3%. Much better than the curent situation, but still worst than the past. If lenders cannot sell the lower tranches and have to retain them going forward, then capital needs will have to go up.
Wednesday, November 12, 2008
Compare and contrast
I have always been leery of life insurers, and have always preferred P&C companies. A traditional P&C company does not have liquidity issues. Of course if there is a massive CAT, then the company has to pay claims, but if there is a ratings downgrade, customers may opt to not renew their policy but they cannot claim collateral, or demand payment etc... I like that. I went to a Fitch seminar a long time ago, and one sentence stuck in my mind: P&C companies fail because of problems on the liability side (under-reserving, adverse development) and a life company fails because of problems on the asset side (poor investment choices). This is because life companies liabilities are much longer in duration, leading to much higher asset to equity ratios. Realized impairments are therefore magnified on the equity line.
All of this was before the new guarantees on variable annuities, which have added a further layer of complexity to analysing these companies. Life companies also stretch for spread with GIC products, fixed annuity products and funding agreements. These products can not only lead to asset-liability mismatches but also push the insurer to stretch for yield. Hence more private placement debt, whole loan mortgages, CMBS, high yield, alternatives etc...
Bearing all that in mind, let's take a look at HIG. HIG stock has cratered. Why? first because the company has suffered massive realized and unrealized losses from its investment portfolio. The company has $15B of CMBS exposure and an overweight on the corporate side to financials. It also owned equities in financials (RBS and Barclays to name a couple) that are not coming back fast. WE are talking about $5.1b of realized capital losses in the first 9 months. With all this the company was buying back stock through the first half of the year, but then the second shoe dropped. As equity markets fell, guarantees on variable annuities went in the money, and not only does HIG suffer from lower fee income, but WORST, statutory capital requirements increase dramatically as this obligation needs to be covered. The company estimated that it would need an additional $2.5B of capital if equity markets were to hit 800 (30% down from Q3). This number would rise exponentially beyond that. So no surprise that it raised capital from Allianz. No surprise that the stock is trading at 0.25x BVPS, as no-one including management knows how much capital they need. Additional impairments are possible in the investment portfolio, rating agencies are getting nervous (downgrades would impair the institutional business first), and equity markets could drive capital needs even higher.
By the way, company always said the the risk in the variable annuities was hedged - apparently not enough! so what do you have now, a stock with a beta of 3. LNC and other annuity writers are also at risk. THAT is why, I never liked these guys. AND HIG and others will need to take large DAC write downs (basically the profitability of the business is less than they thought). Disturbing to me, is the explicit assumption of 8-9% market return built into these VA products by life companies. We have the S&P flat past 10 years.
Now let's turn to ACE. I just read the Q, and I like it. The one risk is 8.7B of corporate fixed income securities. There could be losses there in a big downturn, but manageable. ACE actually reinsures some variable annuity contracts but only GMDB and GMIB contracts. Risks are manageable (Max loss on GMIB at present is $539M, but nothing before 2013), and the company has stopped writing the business to keep within preset limits. As I said above, it is the liability side that gets P&C companies in trouble. ACE is releasing reserves, and has been more conservative than others. To be honest I have not done a reserve study recently, given the recent hard marke, but ACE is the only Bermuda to offer global loss triangles. ACE has asbestos exposure (was a big deal in 2002) but that is dormant right now. ACE is also very well positioned to take advantage of turmoil at AIG, XL and others. Result a stock trading above BVPS, and outperforming on big down days. This is my favorite stock in the balance sheet risk category (MA is my pick for income statement risk, and AOC is my most defensive name). Another good one would be CB.
All of this was before the new guarantees on variable annuities, which have added a further layer of complexity to analysing these companies. Life companies also stretch for spread with GIC products, fixed annuity products and funding agreements. These products can not only lead to asset-liability mismatches but also push the insurer to stretch for yield. Hence more private placement debt, whole loan mortgages, CMBS, high yield, alternatives etc...
Bearing all that in mind, let's take a look at HIG. HIG stock has cratered. Why? first because the company has suffered massive realized and unrealized losses from its investment portfolio. The company has $15B of CMBS exposure and an overweight on the corporate side to financials. It also owned equities in financials (RBS and Barclays to name a couple) that are not coming back fast. WE are talking about $5.1b of realized capital losses in the first 9 months. With all this the company was buying back stock through the first half of the year, but then the second shoe dropped. As equity markets fell, guarantees on variable annuities went in the money, and not only does HIG suffer from lower fee income, but WORST, statutory capital requirements increase dramatically as this obligation needs to be covered. The company estimated that it would need an additional $2.5B of capital if equity markets were to hit 800 (30% down from Q3). This number would rise exponentially beyond that. So no surprise that it raised capital from Allianz. No surprise that the stock is trading at 0.25x BVPS, as no-one including management knows how much capital they need. Additional impairments are possible in the investment portfolio, rating agencies are getting nervous (downgrades would impair the institutional business first), and equity markets could drive capital needs even higher.
By the way, company always said the the risk in the variable annuities was hedged - apparently not enough! so what do you have now, a stock with a beta of 3. LNC and other annuity writers are also at risk. THAT is why, I never liked these guys. AND HIG and others will need to take large DAC write downs (basically the profitability of the business is less than they thought). Disturbing to me, is the explicit assumption of 8-9% market return built into these VA products by life companies. We have the S&P flat past 10 years.
Now let's turn to ACE. I just read the Q, and I like it. The one risk is 8.7B of corporate fixed income securities. There could be losses there in a big downturn, but manageable. ACE actually reinsures some variable annuity contracts but only GMDB and GMIB contracts. Risks are manageable (Max loss on GMIB at present is $539M, but nothing before 2013), and the company has stopped writing the business to keep within preset limits. As I said above, it is the liability side that gets P&C companies in trouble. ACE is releasing reserves, and has been more conservative than others. To be honest I have not done a reserve study recently, given the recent hard marke, but ACE is the only Bermuda to offer global loss triangles. ACE has asbestos exposure (was a big deal in 2002) but that is dormant right now. ACE is also very well positioned to take advantage of turmoil at AIG, XL and others. Result a stock trading above BVPS, and outperforming on big down days. This is my favorite stock in the balance sheet risk category (MA is my pick for income statement risk, and AOC is my most defensive name). Another good one would be CB.
Thursday, November 6, 2008
More on MA
MA Q3 well ahead of expectations, though the company did guide to lower topline for next year below their 12-15% long run goal. However based on the tremendous leverage the company has (76% incremental margins) and variable operating costs (largely advertising and personnel), MA believes it can hit 20-30% EPS growth with high single digit topline (at constant currency, a strong dollar is a negative for the numbers).
Current consensus is at $10.50 which is below 20% growth. Of course consensus is coming down. My realistically pessimistic take on 2009 gives $10.08. This still has 6% topline growth and y/y operating margin expansion (1.5% increase in expenses). Management believes that the company can hold the line on expenses and given its composition I think that is very likely. Even with flat transaction and GDV growth I get EPS above $9.20. There would still be some topline due to pricing and lower rebates as volume targets are not met.
A conservative DCF well below management expectations of margin expansion and topline growth gives $268. Given the lack of visibility, I think the value of the DCF at present is lessened, however it does capture the longer term value of the company. MA is a FCF machine with a very stable franchise, a very good candidate to apply a DCF towards. Of course the DCF does not account for legal, regulatory or some technological shift that would damage the franchise but it is a very good datapoint.
MA currently at $140/share is trading at 14X my 2009E EPS estimate. Can the stock go lower, clearly it can, however I am quite certain the MA will continue to trade at a significant premium to the market. Even after this period of hyper EPS growth subsides (next 3-5 years as company expands margin), MA should still be able to post low double digit EPS growth ( the usual levers, some topline, some margin expansion, and share buybacks). Given the global franchise, the balance sheet strength, the high returns and cash flows, the future MA would still have a 18X multiple similar to over global brand stocks like KO. Currently KO is trading at 13.3X 2009 exactly the same as MA (on $10.50 consensus). MA's growth profile and margin expansion opportunities are significantly greater.
Current consensus is at $10.50 which is below 20% growth. Of course consensus is coming down. My realistically pessimistic take on 2009 gives $10.08. This still has 6% topline growth and y/y operating margin expansion (1.5% increase in expenses). Management believes that the company can hold the line on expenses and given its composition I think that is very likely. Even with flat transaction and GDV growth I get EPS above $9.20. There would still be some topline due to pricing and lower rebates as volume targets are not met.
A conservative DCF well below management expectations of margin expansion and topline growth gives $268. Given the lack of visibility, I think the value of the DCF at present is lessened, however it does capture the longer term value of the company. MA is a FCF machine with a very stable franchise, a very good candidate to apply a DCF towards. Of course the DCF does not account for legal, regulatory or some technological shift that would damage the franchise but it is a very good datapoint.
MA currently at $140/share is trading at 14X my 2009E EPS estimate. Can the stock go lower, clearly it can, however I am quite certain the MA will continue to trade at a significant premium to the market. Even after this period of hyper EPS growth subsides (next 3-5 years as company expands margin), MA should still be able to post low double digit EPS growth ( the usual levers, some topline, some margin expansion, and share buybacks). Given the global franchise, the balance sheet strength, the high returns and cash flows, the future MA would still have a 18X multiple similar to over global brand stocks like KO. Currently KO is trading at 13.3X 2009 exactly the same as MA (on $10.50 consensus). MA's growth profile and margin expansion opportunities are significantly greater.
Tuesday, November 4, 2008
MA
MA up big today. Have not read transcript but I would wager they reaffirmed longer term targets just like V, and highlighted the resiliency of the franchise in case of a downturn. Price had gotten way cheap for a unique franchise, even if numbers were not going to be so fantastic.
I will update my model on this one and put in some bearish assumptions especially on cross border and we shall see. I will note that the company got a 5% boost from pricing - who else has pricing power? Of course that is unlikely to continue but points to the robust franchise.
Debit purchases up strongly in the US compensating for weakness in credit.
This is one of my favorites, even at $160. At $120 it was as steal
.
I will update my model on this one and put in some bearish assumptions especially on cross border and we shall see. I will note that the company got a 5% boost from pricing - who else has pricing power? Of course that is unlikely to continue but points to the robust franchise.
Debit purchases up strongly in the US compensating for weakness in credit.
This is one of my favorites, even at $160. At $120 it was as steal
.
WSJ article
WSJ article today mentions potential government participation in other finance companies such as bond insurers but also specialty finance companies. Given the political importance of student lending, I would imagine that SLM is also on the list. Not knowing the form of a government infusion, it is hard to tell if this will be positive for the stock. With regards to SLM the government has other levers to pull to make their life easier.
Having the hand of government tilting the scales makes investing in financials very difficult at present as there is no clear set of criteria regarding the basis for intervention and the form that intervention will take.
Having the hand of government tilting the scales makes investing in financials very difficult at present as there is no clear set of criteria regarding the basis for intervention and the form that intervention will take.
Sunday, November 2, 2008
Voice brokers
Very interesting comment from ICE CEO (one of the industry's most dynamic and respected figures). ICE is about to roll out a clearing solution for the CDS space, which will lead to greater standardization and electronicfication of trade execution. However Sprecher believes there will be a strong role for the voice brokers:
"I also think that the voice broker business as a whole, that surrounds the CDS business, will do well. I think that is a view that may not be shared looking at the stock prices of some of the pure CDS brokerage companies. But I think that what you will see is a need for voice brokered structuring, and options, and other things, just like you have around the standardized energy business"
Now the leading voice broker (for CDS) GFIG is currently trading at 3.5X EPS (no bberg yet so this may be stale), at $3.11/share (was as low as $2.60 at one stage on friday). If Sprecher is correct, and bear in mind ICE is an exchange (though it does own Creditex), then GFIG is crazy cheap. I have favored IAP.LN because of its greater product diversity, and stronger electronic platforms. However, GFIG is also worth taking a look at. Hopefully will have a chance to do work on that name as well. I have the GFIG transcript, so will take a look.
"I also think that the voice broker business as a whole, that surrounds the CDS business, will do well. I think that is a view that may not be shared looking at the stock prices of some of the pure CDS brokerage companies. But I think that what you will see is a need for voice brokered structuring, and options, and other things, just like you have around the standardized energy business"
Now the leading voice broker (for CDS) GFIG is currently trading at 3.5X EPS (no bberg yet so this may be stale), at $3.11/share (was as low as $2.60 at one stage on friday). If Sprecher is correct, and bear in mind ICE is an exchange (though it does own Creditex), then GFIG is crazy cheap. I have favored IAP.LN because of its greater product diversity, and stronger electronic platforms. However, GFIG is also worth taking a look at. Hopefully will have a chance to do work on that name as well. I have the GFIG transcript, so will take a look.
Friday, October 31, 2008
AOC
Let the record show that I was talking about AOC before today. Stock is up nicely on earnings. Will take a look and see. Of course in this market up 7% is peanuts, and it could be down a bunch before end of day.
Key point of interest is if they echo comments from insurers on maket conditions, and update on Benfield acquisition.
Update: reading transcript of AJG call, management did not point to any price increases apart from marine. So that is a bit of damper on the hard market hypothesis.
Key point of interest is if they echo comments from insurers on maket conditions, and update on Benfield acquisition.
Update: reading transcript of AJG call, management did not point to any price increases apart from marine. So that is a bit of damper on the hard market hypothesis.
Thursday, October 30, 2008
LM
LM is up almost a 100% since it bottomed at $11 probably a few days ago. I had not been following the stock closely but reading the transcript, valuation metrics were eye popping cheap. 0.25% AUM for example.
Concerns are around capital to absorb SIV issues, but this is a stock that bears watching as a market rally will provide jet fuel to this one given valuation.
One to watch. I will try to look more deeply into this one. I should be getting laptop tomorrow and then access to bloomberg. I may have to shop around for Excel but will be up and running next week. Hopefully will also have my files etc.
Concerns are around capital to absorb SIV issues, but this is a stock that bears watching as a market rally will provide jet fuel to this one given valuation.
One to watch. I will try to look more deeply into this one. I should be getting laptop tomorrow and then access to bloomberg. I may have to shop around for Excel but will be up and running next week. Hopefully will also have my files etc.
Investing in financials
Clearly the financials landscape still has many pitfalls, just look at HIG today. Have not heard the earnings call, but clearly concerns must center around either further significant dilutive capital raises and/or liquidity/ratings agency actions. Down 33% wow!.
So, my focus at present is not to be a hero and avoid the riskier names. Clearly if you bought a basket of those some will have stupendous upside, but it does seem casino like at present.
With that said, one still either has to take some balance sheet risk with most likely relatively stable earnings (ACE, CB, TRV), or avoid balance sheet risk but accept greater EPS volatility (TROW,BEN, MA). A group that I believe has neither balance sheet nor much EPS volatility are the insurance brokers (AOC, MMC). Both also have cost cutting opportunities and will be beneficiaries if insurance rates stop declining. Of course, valuation is not super cheap. I will be doing more work on those names.
Another stock that i like is IAP.LN, the largest interdealer broker. Clearly the OTC market is in disrepute and there is no visibility at all at present, but this is one to watch as well. As an aside Deutsche Borse has had a huge rally from way low numbers. I wonder if this is due to the VW action. That stock is also interesting.
I would like to start thinking of banks at some stage, but the regulatory and capital uncertainty is so high that picking winners at present seems quite foolhardy.
I had GPN as a short vs. MA (MA very solid franchise, with too much priced in, and GPN only gts paid when MA gets paid
Of course, my resources are limited, access to street and management curtailed, and I have to search for a job, so this blog could end up being overly ambitious.
So, my focus at present is not to be a hero and avoid the riskier names. Clearly if you bought a basket of those some will have stupendous upside, but it does seem casino like at present.
With that said, one still either has to take some balance sheet risk with most likely relatively stable earnings (ACE, CB, TRV), or avoid balance sheet risk but accept greater EPS volatility (TROW,BEN, MA). A group that I believe has neither balance sheet nor much EPS volatility are the insurance brokers (AOC, MMC). Both also have cost cutting opportunities and will be beneficiaries if insurance rates stop declining. Of course, valuation is not super cheap. I will be doing more work on those names.
Another stock that i like is IAP.LN, the largest interdealer broker. Clearly the OTC market is in disrepute and there is no visibility at all at present, but this is one to watch as well. As an aside Deutsche Borse has had a huge rally from way low numbers. I wonder if this is due to the VW action. That stock is also interesting.
I would like to start thinking of banks at some stage, but the regulatory and capital uncertainty is so high that picking winners at present seems quite foolhardy.
I had GPN as a short vs. MA (MA very solid franchise, with too much priced in, and GPN only gts paid when MA gets paid
Of course, my resources are limited, access to street and management curtailed, and I have to search for a job, so this blog could end up being overly ambitious.
SLM
This stock has been one of my bete noirs so to speak. I recommended it in the teens and clearly it has not done well. Various parties have come at around $20 for a runoff scenario on the stock. However this analysis assumes no dilutive capital raise, loss estimates on private student loans that are inline with the past, and clearly a more normal spread between LIBOR and CP.
Do I think SLM will need to raise capital, no. Are there scenarios where they would have to, yes.
The scenario that the market has focused on is the linked to the renewal of the ABCP facility. This facility is due in February and though it is non-recourse, it is over-collaterized. Moreover loans in the portfolio are marked to market, so the need for additional collateral increased in this wild environment. As of last month, according to the company, SLM had 2% of capital against FFELP loans in the facility and 10% vs. private loans. Capital targets for the company as a whole are 50bps vs. FFELP and 8% vs. private loans. Thus if those loans were put back to the banks, it would create a significant capital drain for SLM. Is this likely, no but can it be ruled out completely? In these times nothing is impossible. There is talk of the DOE expanding their CP+50 program to include eligible loans back to the 2003 time period. Such action will allow SLM to refinance loans and shrink the ABCP facility significantly. This would be a positive both from a balance sheet risk perspective as well as from a net interest margin perspective, as the cost of the facility is significant.
SLM also has this purchased paper business (buying distressed paper both mortgage and other), that is in runoff but has led to charges the past two quarters. This should just be an incremental negative, but it does add additional capital strain. On the plus side, capital requirements for this business is high and as the portfolio runs off, capital should be released.
If loss expectations on private student loans deteriorated significantly, a large provision could deplete capital. I think this is the biggest unknown at present. Q3 numbers did see a pick up in delinquencies, and a long recession will certainly cause strain on the portfolio. Private loans are a relatively new product, and there is no historical stress scenario.
There are other issues affecting the company but are more growth oriented ( can the company fund private student loans effectively, what is the future of the FFELP program in a democratic administration, will SLM retain servicing if it puts loans back to the govt). However, these are not really relevant at present given that the stock trades at 50% of a run-off scenario.
Is this stock a buy? Wow, the whole wholesale funded model is in disrepute right now, and I guess having been burned before, I would wait for some tangible progress; namely either a renewal of the ABCP facility or at least an execution of a FFELP ABS transaction. This may mean buying the stock in the mid teens, but that would still leave decent upside, while hopefully providing a clearer understanding of the downside.
Do I think SLM will need to raise capital, no. Are there scenarios where they would have to, yes.
The scenario that the market has focused on is the linked to the renewal of the ABCP facility. This facility is due in February and though it is non-recourse, it is over-collaterized. Moreover loans in the portfolio are marked to market, so the need for additional collateral increased in this wild environment. As of last month, according to the company, SLM had 2% of capital against FFELP loans in the facility and 10% vs. private loans. Capital targets for the company as a whole are 50bps vs. FFELP and 8% vs. private loans. Thus if those loans were put back to the banks, it would create a significant capital drain for SLM. Is this likely, no but can it be ruled out completely? In these times nothing is impossible. There is talk of the DOE expanding their CP+50 program to include eligible loans back to the 2003 time period. Such action will allow SLM to refinance loans and shrink the ABCP facility significantly. This would be a positive both from a balance sheet risk perspective as well as from a net interest margin perspective, as the cost of the facility is significant.
SLM also has this purchased paper business (buying distressed paper both mortgage and other), that is in runoff but has led to charges the past two quarters. This should just be an incremental negative, but it does add additional capital strain. On the plus side, capital requirements for this business is high and as the portfolio runs off, capital should be released.
If loss expectations on private student loans deteriorated significantly, a large provision could deplete capital. I think this is the biggest unknown at present. Q3 numbers did see a pick up in delinquencies, and a long recession will certainly cause strain on the portfolio. Private loans are a relatively new product, and there is no historical stress scenario.
There are other issues affecting the company but are more growth oriented ( can the company fund private student loans effectively, what is the future of the FFELP program in a democratic administration, will SLM retain servicing if it puts loans back to the govt). However, these are not really relevant at present given that the stock trades at 50% of a run-off scenario.
Is this stock a buy? Wow, the whole wholesale funded model is in disrepute right now, and I guess having been burned before, I would wait for some tangible progress; namely either a renewal of the ABCP facility or at least an execution of a FFELP ABS transaction. This may mean buying the stock in the mid teens, but that would still leave decent upside, while hopefully providing a clearer understanding of the downside.
Wednesday, October 29, 2008
ACE call
I am still waiting for files and models to be sent to me from my prior firm.
In any case, I am going to wait to get my model before doing any valuation work but key issue on the ACE call was Evan calling the end of the soft market. This has been echoed by PRE, and Munich Re as well as Berkely. The thesis is that investment losses, the difficulties at AIG, XL, and other market participants, increased cost of capital and reduced risk tolerance should lead to prices hardening. All of the above is true. In the minus column, a severe recession will lead to reduced exposure, and ACE and others are still releasing reserves. Typically a hard market will be signalled by adverse development. The fact that companies still have favorable reserve releases makes me less enthusiastic about getting on board the hard market train.
In ACE's case the company has begun releasing reserves on casualty lines pre 2004. ACE is one of the last guys to start significant releases in the casualty lines, and the firm probably still has significant excess reserves in those lines. Moreover, a good chunk of the unrealized losses on the investment side will eventually flow back. The duration of the investment portfolio is 4 years so these securities will eventually accrete back to par. All this to say is that the printed Book value per share of $46 is low, and I think $60 is a no brainer on this stock. Now if this signals the beginning of a hard market, well we could go higher, but $60 is there even in this environment.
Still like the stock even after the move today.
One could pair it against WTM if you wanted to be defensive, but that is also pretty cheap.
Off to Costco for buying cheap booze.
In any case, I am going to wait to get my model before doing any valuation work but key issue on the ACE call was Evan calling the end of the soft market. This has been echoed by PRE, and Munich Re as well as Berkely. The thesis is that investment losses, the difficulties at AIG, XL, and other market participants, increased cost of capital and reduced risk tolerance should lead to prices hardening. All of the above is true. In the minus column, a severe recession will lead to reduced exposure, and ACE and others are still releasing reserves. Typically a hard market will be signalled by adverse development. The fact that companies still have favorable reserve releases makes me less enthusiastic about getting on board the hard market train.
In ACE's case the company has begun releasing reserves on casualty lines pre 2004. ACE is one of the last guys to start significant releases in the casualty lines, and the firm probably still has significant excess reserves in those lines. Moreover, a good chunk of the unrealized losses on the investment side will eventually flow back. The duration of the investment portfolio is 4 years so these securities will eventually accrete back to par. All this to say is that the printed Book value per share of $46 is low, and I think $60 is a no brainer on this stock. Now if this signals the beginning of a hard market, well we could go higher, but $60 is there even in this environment.
Still like the stock even after the move today.
One could pair it against WTM if you wanted to be defensive, but that is also pretty cheap.
Off to Costco for buying cheap booze.
Mission statement
Hello, I have just lost my job at a long/short firm, so I have time on my hands. In fact I will probably be unemployed for a very very long time. This blog is a tool for me to stay sharp regarding the investment world, as well as an outlet for thoughts on my job search, geopolitics, and my personal obsession: snow and snowstorms.
One of my favorite companies, ACE reported today. I listened to the call, evan's voice is quite soothing as is their financial strength. I will have more comments after I get my hands on the call transcript. the first adjustment to losing one's job is the sudden cutoff of information. Bloomberg will apparently extend for 2 months access to account holders who have lost their job. That is great news and as soon as I get my super cheap laptop I just purchased, I will have some bloomberg access. In the interim, a shout out to my buddies who will provide me transcripts etc...
On the job search front... Well as this is the first week, we are still in the optimisim camp here. Eventually even your friends will not take your calls, but we are not there yet. I guess all I can do is try and connect to as many people as possible. Nobody is hiring, or at least very few are hiring.
One of my favorite companies, ACE reported today. I listened to the call, evan's voice is quite soothing as is their financial strength. I will have more comments after I get my hands on the call transcript. the first adjustment to losing one's job is the sudden cutoff of information. Bloomberg will apparently extend for 2 months access to account holders who have lost their job. That is great news and as soon as I get my super cheap laptop I just purchased, I will have some bloomberg access. In the interim, a shout out to my buddies who will provide me transcripts etc...
On the job search front... Well as this is the first week, we are still in the optimisim camp here. Eventually even your friends will not take your calls, but we are not there yet. I guess all I can do is try and connect to as many people as possible. Nobody is hiring, or at least very few are hiring.
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