Risk Rap

Rapping About a World at Risk

Good Bank Bad Bank Could Get Ugly

Bank Panic

Bank Panic

President Obama’s announcement that he intends to limit compensation for CEO’s of banks that accept TARP funds is only the tip of the iceberg. This one gives real meaning to the concept of Good Bank/Bad Bank and it could get ugly. As the government led economic recovery plan is implemented the banking system will still require massive capital infusions to maintain solvency. This will usher in far reaching structural and systemic changes in the banking system and capital market industries. Executive compensation is but a minor issue.

These structural changes risk creating a bifurcated banking system. The Bad Bank, so designated because it was placed into a timeout with a capital infusion by a benevolent state agency will be forced to change the banks demeanor and the manner in which it conducts business. These Bad Banks will become wards of a state intent on controlling behaviors by minimizing the risk posture these types of institutions can assume. Good Banks, so named because they remain above the need to accept the federal largess of TARP funds, will be free to conduct business without the additional cumbersome oversight of regulatory agencies.

What will the topology of a bifurcated banking system look like? A model that one may consider could be found in the People’s Republic of China where state controlled banking enterprises conduct business alongside emerging private sector banks that are mostly agencies of large global investment banks. In the US the history may be reversed; but the full or partial nationalization of weak banks will create a new institutional hybrid that will need to function under different ground rules then those imposed on fully privatized domestic banks.

The Bad Banks will become quasi-state run enterprises. Their business model and charter will be highly risk adverse forcing them to focus on mortgage related and low margin retail transactional type business. These banks will be required to maintain expensive brick and mortar branch networks to make sure that all sectors of society have access to the financial system. This might actually provide a growth opportunity for these types of banks because the “unbanked sector” of the economy remains large. A large and vibrant money services business (MSB) industry has flourished and thrived to serve the unbanked sector. The unbanked sector purchases banking services and it represents a significant expense burden on the underclasses and working poor who don’t have checking or savings accounts. Bringing this sector into the state banking system would also help to combat money laundering and the loss of tax revenues of cash based businesses. The sale of money orders, money transfer services and the sale of savings bonds and other fungible certificates will become a source of revenue dedicated to paying down the TARP debt.

The Bad Banks will not just become glorified MSBs. Bad Banks will need to focus on the stressed mortgage and credit card debt markets. These customer facing retail lines of business will offer a full line of workout resources to stave off the rate of home foreclosures and credit card delinquencies.

The Bad Banks will be capitalized with the Level III toxic assets that Hank Paulson so shrewdly purchased from the large investment banking institutions. The Treasury Department can dispense with FASB valuation rules and use these assets to value the collateral to maintain sufficient levels of capitalization in line with Basel II recommendations. Smoke and mirrors perhaps; but backed by the full faith and credit worthiness of the US government who can argue?

Equity shareholders in the Bad Banks can expect to see their shares underperform the market and its Good Bank peers. A balance sheet loaded with questionable asset quality, high debt to equity ratios, low margin businesses and high overhead due to excessive fixed costs all conspire against the Bad Banks shareholders potential of realizing a handsome return on their investment.

The Good Banks, liberated from the tyranny of balance sheets polluted with toxic assets and freed from the need of additional rounds of TARP funding will be energized with new entrepreneurial zeal. They will be free to ply their trade as evangelists of free market laissez faire capitalism. The Good Banks will be unencumbered by any new regulations federal agencies impose on the TARP dependent Bad Banks.

Unfettered from bureaucratic control, the Good Banks will be able to fulfill their mission of maximizing value for their shareholders. The risk profile of the Good Banks will be considerably different from that of the Bad Banks. The focus of their business will be on marketing higher margin and more risky financial products. They will offer investment banking and other transactional services and will command fees on scales radically different from the Bad Banks collecting two bits for each money order sold. The Good Banks will offer a full array of investment products and transactional services. Hedge funds, brokerage transactions and a full range wealth management services will be part of the product portfolios of Good Banks.

The Good Banks blessed with healthy balance sheets and strong cash flows from steady product sales into high net worth market segments will embark on aggressive acquisition programs of financial service providers. Healthy regional and community banks will be purchased on the cheap with the blessing of the acquired company’s shareholders who want to be freed from the tyranny of state control and TARP dependency. Good Banks will be the preferred bank for a vibrant and growing small business market and will command healthy fee income and sit on generous account balances this type of business provides. If a small business or retail customer account underperforms or becomes delinquent the account will be banished to the workout professionals eagerly waiting in the Bad Bank.

The Good Banks will be more like a giant private equity firm holding a vast portfolio of public financial companies and services providers. Good Banks will be nimble and voracious practitioners of free market capitalism. The accouterments of affluence like generous stock options, corporate jets, exotic junkets, splashy corporate parties will be in full swing. Larry Kudlow should have nothing to worry about. Free market capitalism as the only sure road to wealth and freedom will remain open to anyone as long as they have the means to pay the modest toll.

You Tube Video: Ennio Morricone, The Good the Bad and the Ugly

Risk: systemic, banking, market

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February 5, 2009 Posted by | banking, Basel II, credit crisis, FASB, government, hedge funds, private equity, recession, TARP | , , , , , , , , | Leave a comment

No Transparency from Corzine

Whats on Corzine’s Agenda?

Gov. Corzine is calling a meeting at NJIT of New Jersey’s best minds to deal with the economic crisis. The meeting will be closed to observers and to the public.

Corzine should open up a window of transparency. All these closed door meetings only serves to estrange the government from the public trust. Remember Cheney’s closed door meetings and the role it played in formulating the nations failed energy policy. All American’s paid dearly for that one.

The economic crisis will seriously effect state and local governmental institutions ability to fund and provide services. Its amazing the degree of involvement governmental agencies and officials are stepping in to manage the crisis. Mr. Cozine’s Goldman Sachs pedigree will serve him well. It seems the collegian club of GS alums are in control of everything.

Is Corzine meeting with friends to carve up state regulated banks and insurance companies that are on the brink of insolvency?

Is Corzine discussing the closure of the public school and transportation systems because the state has cash flow problems?

Is Corzine discussing the seizure of state pension fund assets to fund the current cash flow needs and further deplete the pensions assets?

Is Corzine finalizing a deal on the sale of the NJ Parkway, Turnpike, The Port Authority and the State College & University system to a syndicate of private equity funds lead by the Chinese Investment Corporation and other large Sovereign Wealth Funds?

We don’t actually know. Thats why Mr. Corzine needs to provide a little transparency and let the citizens of New Jersey know whats going on and how it affects them.

Risk: transparency, accountability, public trust,

Music: The Rays, Silhouette on the Shade

September 22, 2008 Posted by | China, credit crisis, government, pop, private equity, sovereign wealth funds, taxation | , , , , , , , , | Leave a comment

Private Equity: Source of Strength

It was a big day for banking news yesterday.

Bank of International Settlements issued its 78th annual report.

A quick read is a most sobering exercise. The world economy is at a tipping point. The credit market frenzy has lead to a major hangover for the global economy.  Unsustainability is the word that was prominently used and economic recovery drivers remain suspiciously absent from the world stage.

Speaking of banks SRZ issued a memorandum on private equity firm’s increased interest in acquiring bank assets. There are a number of regulatory issues concerning expanded investment of private equity firms in regulated banks; but the sector needs major capital infusion and a major shakeout and rationalization of the sector is inevitable.

With the disappearance of credit availability the sector is cursed with excess capacity. There’s blood in the water and private equity firms are starting to circle the regional and community banks looking for deals.

We post a lot about banks and the capital markets because we believe it represents one of the greatest risks to the economic security of our clients.

The banking industry and its role in the capital markets is undergoing a sea change.

I Want Money, by the Flying Lizards.

Risk: credit, market, sustainable business models, Basel 2, BIS, private equity, bank capitalization

July 1, 2008 Posted by | banking, Basel II, hedge funds, pop, private equity, regulatory | , , , | Leave a comment

Knowledge is Good

The state college and university system is confronted with mounting challenges as state and federal funding sources continue to trim budget allocations to these vital institutions. State funded college education is a critical social service and support institution that provides higher education opportunities to our lower and middle class citizens. The availability of affordable and accessible public education is critical to maintain an efficiently functioning democratic society. Education offers economically disadvantaged people the hope of social advancement, cultural assimilation and a chance to realize the greater aspirations of America’s promise.

As state funding for higher education decreases, consumers will have to pay more. Colleges will need to scale back offerings and will be required to become more of a market driven enterprise. They will also need to rely more on the largess of alumni and corporate support to remain economically viable.

Cutting state colleges loose to navigate the ebbs and flows of the market economy threatens institutional independence and moves state education services one step closer to privatization. On the positive side this will encourage and inform institutional development and program initiatives that address the needs of the diverse communities’ state colleges serve. This will tend to temper the “ivory tower” criticism of academic institutions; but they must not lose sight of state college’s principal mission to enlighten citizens, serve cultural needs, enhance economic advancement potential and advance the political liberties of citizens.

State colleges are not vocational schools. Nor are they pools of labor and intellectual capital created to support these requirements of capitalist enterprises. As state colleges become more dependent on private sources of funding, it risks that its institutional culture will assume characteristics and political biases to support and advance the interests of its funding sources. This is another dangerous example of how privatization is assuming control of functions previously considered the domain of the state. The privatization of certain military functions, administration of elections and leasing highway toll road administration to private interests signals the growing pervasiveness state capitalism and commercial control over social and governmental institutions.

A free society requires educational institutions to be free from the control of special interests. Partnerships between corporations and public education institutions are critical to the success and growth of both parties. Academic freedom and the protection of the marketplace of ideas must never be compromised for the want of funding and must be guarded at all costs.

“Eternal vigilance is the price of liberty” Wendell Phillips, the abolitionist wrote. Extra vigilance is required to assure that state education continues to be well funded and that the source of funds does not inhibit academic freedom and the ultimate liberty and freedom of expression of our citizens.

The challenge to maintain a standard of excellence, secure funding, maintain costs and create brand differentiation of the state college curriculum and service offering are keys to its survival. Like all market driven enterprises, state colleges need to create and market a unique value proposition. State colleges must balance course curriculum, services and institutional experience to equally serve its social constituents and commercial interests of its funding sources.

The experience of “No Child Left Behind” is a good example of a well intentioned policy that has harmed the primary education experience. NCLB’s places an emphasis on student’s ability to pass standardized tests. Test results are used as a metric to score the schools effectiveness and as a yardstick to reward good performance with additional funding. This program compromises the schools core education mission of instilling a love of learning to better prepare students to be productive members of society. NCLB more closely resembles a grant application process for capital funding that places the protection of the institution ahead of its mission to teach students.

Democracy requires citizens to possess an ability to question, reason and understand how dissimilar issues, events and disciplines intersect and connect in an increasingly complex world. State funded colleges are communities where these types of skills can be developed, nurtured and shared equally and dispersed widely to all members of the society.

That is what the original Lyceum was all about.

We close with a fight song from one of our great public universities, Hail to the Victors!

Risk: public education, civil liberties, informed electorate, participatory democracy, institutional bias, reputation risk, market risk

June 25, 2008 Posted by | education, government, pop, private equity, taxation | , , , , , , , , , , | 1 Comment

Let 100 Flowers Bloom

The FT reported that the China Investment Corp. (CIC) a Sovereign Wealth Fund with $200 billion in assets is looking to team up with the private equity firm JC Flowers to make acquisitions in the financial services industry. CIC has been somewhat active in acquiring financial services assets in the United States. CIC’s portfolio companies now include, Morgan Stanley, VISA and Blackstone Group.

After walking away from it’s commitment to buy Sallie Mae JC Flowers is loaded for bear and sees tremendous investment opportunities in the distressed asset valuation of financial services firms. It is a classic vulture fund mentality that sees great opportunity in the depressed equity valuations within a sector.

The US banking industry is ripe for rationalization. During the height of the credit marketing orgy, small banks were popping up like mushrooms after a soft summer rain. Cheap credit and funding sources flush with cash from the surging values in real estate and public equity markets put a banker on every street and an equity line of credit for every home. Risk aversion in the credit markets and dried up liquidity are changing the face of the sector and many of the publicly traded community banks need to attract equity capital to strengthen their balance sheets or merge with other banking institutions.

Vernon Hill, the former CEO of Commerce Bank, (recently acquired by TD Bank) has set-up a private equity fund to make acquisitions of small and mid-cap banks. The face and ownership of the banking sector is evolving. A drastic change in the systemic and regulatory structure of the banking industry is a welcomed inevitability. Global investors, regulators and industry executives will be hard pressed to balance the interests of bank stakeholders while serving the vital social function of facilitating commerce and finance for communities, corporations and consumers.

You Tube Video: Bird and Diz playing Hot House.

Risk; financial services, credit, regulatory, private equity, SWF, community banking

June 19, 2008 Posted by | banking, China, credit crisis, hedge funds, jazz, private equity, sovereign wealth funds | , , , , , , , , , , , , , | Leave a comment

InBev Looks To Chug a Few Long Necks and Knock Down Some Tall Boys

In a sign of the weak state of the dollar, the Belgian-Brazilian brewer, InBev has made an unsolicited takeover offer to acquire the leading American brewer and corporate icon Anheuser-Busch (BUD). The much beloved maker and marketer of America’s favorite beer, InBev’s $46.3 billion offer for BUD is indeed a tall drink to down but is the latest example of the growing thirst of foreign investors for cheap American assets.

InBev’s offer may raise the ire of patriotic beer drinkers. Many see the acquisition as another example of the decline of America’s industrial capacity. The acquisition has the potential of becoming an emotional issue for Americans because of the strong cultural and national identification of the brand with the American psyche. Busch Stadium the home of the baseball Cardinals in St. Louis, the Clydesdales delivering Christmas trees to snowed in rural homesteads, frogs incantating the BUD mantra in the bayous of the south and urban hipsters greeting homies with a “waz up”has thoroughly ingrained the brand identity and product consumption into the American experience.

America is up for sale at bargain basement prices. The rise of the EURO against the dollar, constrained domestic credit markets and free markets insatiable thirst for efficiency, rationalization and optimal returns are basic economic drivers of this Trans Atlantic-Pan American cross border acquisition.

It will become a prominent theme for American business for the foreseeable future. When you say Budweiser, you said it all.

Risk: dollar denominated assets, currency, brand marketing, American industry, M&A, foreign exchange, EURO, EU,

June 17, 2008 Posted by | economics, private equity, US dollar | , , , , , , , | Leave a comment

Capital Formation for SMB’s

CFO magazine ran an interesting but brief article on SEC plan to encourage and assist capital formation for small mid-size businesses (SMB’s).

In light of all the gyrations in the credit markets and the rush to aid investment and money center banks (see Risk Rap Post 4/10/08, SMB’s TBTF), it is heartening to know that the capital needs of our country’s most important economic sector is not being over looked by the government regulatory bodies.

The access to capital is critical for small businesses. The SEC plan to expand capital access to the segment will help SMBs cope with stringent credit policies, the effects of the economic downturn and the pressure on asset valuations due to the falling real estate and public equity markets.

An interesting side light to this initiative will be how community banks and private equity firms position themselves to take advantage of this SEC initiative. It bears watching and this could be an important program to align the interests of cash rich private equity firms and capital stressed community banks.

We’ll post more on this subject in the future.

Risk: SMB, Regulatory, Private Equity, Community Banks, Market, Credit

May 10, 2008 Posted by | banking, credit crisis, hedge funds, private equity, SME | , , , , , , | Leave a comment

TPG and WaMu WHOO HOO

Its starting and bears watching.

The reconfiguration in the banking market.

In this corner TPG, a bulge bracket private equity firm. Still flush with cash from the halcyon days of rich valuations and unlimited liquidity is looking to acquire some cheap dollar denominated assets at bargain basement prices.

And in this corner WaMu, a revenue challenged regulatory capital depleted, NYSE listed, consumer banking company that took a bad hit in its mortgage business and desperately needs to shore up its sinking capital ratios with a massive capital infusion.

The tension between unregulated private equity and regulated banking entities will become a major challenge that regulators, law makers and market participants will have to confront in the new economic landscape.

Much of the Basel II discussion centered on prohibiting the arbitrage of regulatory and economic capital within a banks own capital structure.

Like hedge fund managers, private equity bankers are the best and the brightest. They may perceive a cellar price to acquire large pools of regulatory capital. Might this be a form of economic/regulatory capital arbitrage?

Risk: Banking, Market, Systemic, Regulatory

You Tube Video: Tom Waits, Step Right Up

April 10, 2008 Posted by | credit crisis, hedge funds, private equity | , , , , , | Leave a comment