Variant Perceptions

Month: November, 2010

CMBS delinquencies slowing down

More good news in the commercial real estate front. Bloomberg not only mentions the stabilization in bank CRE loans that we discussed a couple of days ago.

U.S. commercial real estate loan delinquencies and default rates continued to march toward new records in the third quarter, but the pace of growth slowed, in yet another sign of a nascent industry recovery.

The default rate on commercial real estate mortgages held by U.S. banks in the third quarter rose by 0.9 percentage point, one of the smallest increases since the downturn began, according to a report released on Monday by Real Capital Analytics.

Commercial real estate mortgage payments that were late by 90 days or more rose to 4.36 percent in the third quarter from 4.27 percent in the prior quarter, according to U.S. Federal Deposit Insurance Corp figures.

but also highlights that commercial mortgage backed securities (CMBS) are also showing signs of stabilization with a sharp slowdown in the increase of delinquencies,

The report was the latest evidence of stabilization in the U.S. commercial real estate market. Credit rating agency Standard & Poor’s said on Monday the delinquency rate for loans behind commercial mortgage-backed securities (CMBS) rose 3 percent in the third quarter, down a jump of 14.1 percent in the second and 30.2 percent in the first. A loan is considered delinquent if it is more than 30 days late.

At the end of the third quarter, $46.8 billion in CMBS loans were delinquent, or 8.32 percent, S&P said. The National Association of Realtors said that overall vacancy rates across most types of commercial real estate likely have peaked and may show small improvement by year end.

I am not going to deny that delinquencies of 8.32% are high but they are not the end of the world either. Especially considering that their securitization isolated commercial banks from the worse CRE lending. Not only that, but these securities that were considered toxic waste are now being targeted for growth with their better underwriting conditions as we mentioned in a previous post.


Two more Japan charts

For those that like to talk about Japan lost decades, you may consider it only one lost decade. After solving the banks nonperforming loans problem, the Japanese sustained a very strong recovery on a per worker basis – that accounts for Japan’s demographic handicap -.

And Japan achieved this despite mild deflationary headwinds. If people wants to compare the current US economic situation to Japan, it seems like 2002-2008 might be a better fit than the 90s lost decade, quantitative easing included.

All of these graphs are from the excellent Adam Posen presentation at the London School of Economics from May this year.


I am having the fun of a lifetime with the BBC Sherlock, so my apologies if you do not like the arrogant and obnoxious new header of the blog. It will stay there for a couple of weeks as an experiment. And any suggestion that this show inspired the most recent banking post is probably right.

PS: I am on the fence on the Asperger or Sociopath debate, it is just a good show

Holding banking doomsayers accountable

Third quarter 2010 earnings are out and with several banks revisiting one year lows you would think that the credit situation is getting worse. That is simply wrong.

The New York Times finally started following the story with its Friday’s article “Banks Start to Dig Out From Troubled Loans“. My only complain is the use of the word start, why journalists not only are late to stories but then downplay them. And do not take my word for it, the same New York Times printed a graph that shows troubled loans peaking almost a year ago.

Some will say that those numbers are still high but before you jump into conclusions let me make a couple of points.

First, the USA is not Japan

It took more than 10 years after the bubble burst for Japan non performing loans to peak at close to 10% of total loans and only then government pressures pushed banks to deal with the zombie keiretsu borrowers. In the US instead, non performing loans were recognized faster, peaking at  7% in less than 3 years. Not to mention that the Japanese real estate bubble was crazier with much higher loss severities. And even after all that, when the Japanese finally decided to deal with their issues the banking sector NPLs decreased rapidly and stock prices recovered.

The second point is that American banks are very well capitalized (equity plus reserves) to handle the non performing loans even at this high levels. For illustration purposes lets bring back our old tool the Texas Ratio courtesy of updated for Q3 2010 that keeps improving from already manageable levels.

So what is going on. My impression is this just is another installment of the Fear of the Dark, Fear of Death series. Human beings do not react well to uncertainty and banks are part black box so it is easy to say “there are many things to worry about banks”. I have no problem with that, everyone is in his right to invoke the not-in-my-circle-of-competence amendment. What disturbs me is that it usually comes with a litany of measurable and testable arguments that when proven wrong are just simply set aside to be replaced by the next litany that justifies the preconceptions.

For example, in this blog we have been very sceptic of the Commercial Real Estate is the next shoe to drop argument. Has anyone care to see its recent performance, well here it is. Already in the third quarter of 2009  CRE NPLs hit the second derivative and are stabilizing at less than 5% of total CRE loans well below the real issues: mortgages and construction NPLs.

Do you feel the fear? That is Elizabeth Warren probably around February 2010 when it was already clear that things were improving on the CRE front. Lucky for us she is more of a analytical doomsayer so she tried to support her points of view with a congressional oversight panel report. And surprisingly,  it is a very good report with very interesting data.

What made me skeptical of her conclusions was how easily she mixed and confused CRE construction and development loans, a real problem, with income producing CRE loans, a much smaller problem. Mixing both had the consequence of exaggerating the scale and scope of the problems.

This wrong thinking has been repeated again and again during the crisis. The confusion of resets with recasts was another one. Were not option ARMs and other recasts supposed to explode more than a year ago bringing down the banks with them? That must have been one of the most silent explosions I have ever heard.

As soon as one of the issues is proven wrong, the discussion moves to the new flavor of the month. Now the new issues are:

  • Europe: can somebody explain me the contagion mechanism, maybe not because there is no contagion mechanism this time.
  • Putbacks that even the worst loss estimate is less than one year of earnings
  • Foreclosure mess: that the banks badly mishandled. However, that has been usually the case in every real estate bubble in history and every time the banks managed to get their foreclosures.

Doomsayers sound smart and professorial but their ability to predict has been abysmal even for forecaster standards. Why? Partly because markets adapt, people adapt, and capitalist economies grow solving a lot of issues in the process. But hey, the bogeyman and hell are just around the corner.

I sometimes miss people like John Templeton  and Peter Lynch in 1989, right in the middle of the S&L crisis, sharing their optimistic long term perspective while grounded in the difficulties of investing. They were not just smart but wise. Instead we are now at the end of the beginning for banks and these celebrities keep playing on our fears without checking their thinking and numbers.

I am not going to say that some of these issues could not become real, even data driven people like myself are susceptible to over confidence. I prefer to be detached with an open mind since banks are still somewhat opaque and their issues in other situations are real, just look at Ireland or some specific American banks like Flagstar Bancorp that is going through their third capital injection.

However, when you see one hit wonder celebrities that have been all wrong since October 2008 jumping to the new thing that confirms their preconceptions -and I think you know who I am talking about – take a pen, a napkin, run some numbers, but specially check the logical steps. Even with the more professional and less self promotional, like the excellent and bearish Chris Whalen, you should do so because there is no substitute to thinking independently and thinking correctly.

Update: Premier Exhibitions

Recent Mark Sellers interview where he comments on his plans with Premier and his life after Sellers Capital.

“In retrospect, I wish I hadn’t ever gotten involved in the company,” Sellers said. “If I can get out of it and break even or better, I’d have to say that’s a big victory.”

But it’s not that simple. At Friday’s closing price, $1.92, Premier’s market capitalization was about $89 million — far less than the appraised value of its Titanic holdings, which Sellers said is more than $145 million. Sellers said his fund’s investment in Premier is almost at break even.

But liquidating all that stock — the rough equivalent of about a year’s worth of trading volume — isn’t an option, since it would drive the price lower.

Key to Premier’s future and Sellers’ eventual exit from the company: monetize the Titanic.

With the 100th anniversary of the storied liner’s 1912 sinking coming up, timing is key. A well-publicized expedition to the wreck site in August helped stoke interest. A federal court ruling in August also provided some assurance that Premier couldn’t simply be stripped of its salvage rights to Titanic without a payment of about $110 million from the U.S. government.

“My plan is to make sure that the Titanic assets are well taken care of,” he said. “Whether they are held by Premier or held by someone else, I feel as though it’s almost a larger duty that I have. It’s an international treasure. I don’t want someone to piece them out and sell them on eBay or put them in a private collection never to be seen again by the general public.

“So I’m going to stay involved until there is some certainty about what is going to happen with those Titanic assets.”

Today, Sellers Capital controls 46 percent of Premier shares, representing the hedge fund’s only current investments. Once the Premier investment is sold off — Sellers makes no bones that selling the stock at a profit is his end game — Sellers Capital will cease to exist.

David Tepper at Carnegie Mellon

And concluding the series on David Tepper, a small surprise: a 40 minutes presentation he did probably around November 2007 at Carnegie Mellon, more specifically at the Tepper School of Business [add favorite Argentinians joke here]. It shows another side of him instead of the loud and profane publicized by the media. Specially interesting are his lessons from

  • the Russian crisis, bomb threats included
  • politics at Goldman Sachs, and his love affair with Jon Corzine
  • the use of cash as a hedge, actually the best hedge.

And it is time to go back to company analysis…

[ ?posts_id=4427617&dest=-1]

RR: The video was removed but here is a transcript thanks to Santangel’s Review

David Tepper on investing under uncertainty: practice

We discussed how David Tepper protects his positions. However, at the same time when have your heard a value investor saying anything remotely like this:

We’re not afraid to lose money. Hence the plaque. I should say, we’re not afraid to make money – David Tepper

The thing that comes to mind with him is not his defense. In complete contrast to Seth Klarman for example his record is consistently inconsistent … as he would be the first to recognize. He has several years of average or below average returns punctuated by home runs every five years or so. As Seth Klarman is the master of being fearful when others are greedy, you could say that David Tepper is the master of being greedy when others are fearful… an important ability to learn if you ask me.

All the points that we discussed on how he protects his downside came into fruition in his now famous March 2009 trade:

Tepper was sitting on a pile of cash, having sold out of most of his positions in the spring of 2008, and didn’t have any debt. So when the U.S. Treasury put out a white paper in February 2009 announcing its Financial Stability Plan, which included the Capital Assistance Program designed to shore up the capital of banks, he took his time and read the fine print.

The white paper and term sheet said the preferred stock the government was buying in the banks would be convertible to common shares at prices far above current trading levels at the time — which meant it was indeed a time to buy, buy, buy.

So he did. The fund began amassing sizable positions in bank-related securities: common and preferred shares, and junior-subordinated debt, to be exact. His targets, Bank of America and Citigroup in particular, as rumors circulating that the banking behemoths would be nationalized in early 2009 edged the stocks to near collapse.

Tepper was able to buy Bank of America preferred shares at just twelve cents on the dollar and Citigroup bonds at just nineteen cents. As those stocks rallied by the end of 2009, Appaloosa raked in the billions.

Appaloosa also was able to buy about a billion dollar’s worth of AIG’s commercial mortgage-backed securities at nine cents on the dollar. Currently trading at about ninety-three cents, the “AIG ace” was a major coup and contributor to the firm’s success in 2009.

“Most of the upside was on the preferred and debt side, “ he says. “That’s perhaps why so many people missed this trade. They just couldn’t see it.” – NetNet profile

Let me emphasize this last point: most of his bets on banks and AIG  were on the preferreds and debt side.

He also  bought substantial stakes in common and preferred equity in several zombie REITs (NCT, GKK, MPG). We discussed one of these REITs and I hope to have showed that it had a margin of safety.

This is a sample of other moments:

  • 1989 Junk Bonds Collapse: “After the market imploded in 1989, most banks dissolved their high-yield trading desks. But Goldman’s survived, in part because Tepper, who had worked his way to head trader, helped take the edge off with a canny move: purchasing underlying bonds in the financial institutions that had been crippled by the crash. When the banks emerged from bankruptcy and the market picked up again, the value of the bonds soared.”
  • 1998 Russia: “Tepper bought a bunch of Russian debt on the assumption that the Russian government wouldn’t default. When it did and the ruble collapsed, it cost his fund hundreds of millions of dollars. But even as the market tanked, Tepper kept buying the ever-cheaper bonds, and a few months later, his tenacity paid off: The fund went up 60 percent.”
  • 2002 Junk Bonds Collapse Again: “when the junk-bond market collapsed for a second time. Tepper lost 25 percent, but made up for it the following year, when bonds he’d purchased in bankrupt companies went up 150 percent, Tepper’s big score in 2003. Tepper had purchased the distressed debt of the three then-largest bankruptcies in corporate history: Enron, WorldCom, and insurance giant Conseco. When they emerged from bankruptcy and the debt appreciated, Appaloosa went up a whopping 148 percent.”
  • 2010 Quantitative Easing: “You talk about when you get moments, this might be one of those—kind of (…) Either the economy is going to get better by itself in the next three months…What assets are going to do well? Stocks are going to do well, bonds won’t do so well, gold won’t do as well. Or the economy is not going to pick up in the next three months and the Fed is going to come in with QE. (…) What, I’m going to say, ‘No Fed, I disagree with you, I don’t want to be long equities?’ Sometimes is that easy, not all investment decisions are difficult ones”


David Tepper on investing under uncertainty: theory

Much like Eddie Lampert was able to see value in Kmart when everyone else wrote the company off. Tepper is great at identifying the true value of a company when the company looks like it is worthless- David is able to extract value where others cannot see or understand. And the exit strategy is simple thereafter! – Frank DeRose, Ferrata Capital

David Tepper is not the investor most easy to understand: media shy and does not like to talk about specific positions. His is a bond shop so the 13Fs only show a small part of his portfolio. Incredibly, Appaloosa’s offices are in New Jersey overlooking a mall parking lot. Even in politics he keeps his cards close to the chest: tell me the rules, just make them stable and certain.

Nevertheless, I decided to dissect the few resources available and see if there was anything to learn from him. The reason? over the last two years it was very surprising to me how often sectors, companies and even specific ideas that got my interest were part of his portfolio. Only that his results, given the size of his portfolio, were nothing short of amazing and I usually was one step behind.

He was a boundary-pusher, loud and profane, and a know-it-all – NY Magazine Profile

Some of you may wonder on what could be the use of investigating the habits of a former trader? David Tepper’s education was trading at Goldman Sachs but I take issue on that he is just a trader. His public equity positions have been medium to long term -Bank of America and other banks securities were bought in March 2009 and  still has them- and  has been active in several situations looking to improve companies finances -ie: Delphi and General Motors-. And that combination makes him interesting and someone from whom to learn a couple of tricks.

Distressed debt is Tepper’s specialty. He has mentioned that distressed is very similar to risk arbitrage. Actually the much descredited but still interesting Robert Rubin, who was head of Goldman’s risk arbitrage some time ago, was somewhat of a mentor so why not pick Rubin’s book and see what he says of this discipline:

In arbitrage, as in philosophy, you analyze, look for holes in the analysis, and seek conclusions that hold together. However, while analytical rigor may be sufficient for philosophy, it’s not enough for arbitrage -as in policy making- you also have to be able to pull the trigger, even when your information is imperfect and your questions can’t all be answered. You have to make a decision: Should I make this investment or not? You begin with probing questions and end having to accept that some of them will be imperfectly answered -or not answered at all. And you have to have the stomach for risk. – In an Uncertain World, Robert Rubin

Some would say this is reckless, and profane Tepper would probably interject balls to the wall. However, if you look more deeply he protects the downside and lives to fight another day when he is wrong.

  • Bond shop: he looks to the whole capital structure for opportunities for the best risk/reward tradeoff. Bonds and preferreds provide better protection, and in times of panic their rewards can still be substantial.
  • Themes are macro but investments are micro: He has a view on the financial difficulties and perspectives of a country, but the quality of the specific ideas he finally invests in provides another layer of protection.
  • Do not fight the government: And that means not just the FED. In March 2009, he trusted a federal government document detailing the banks bailout. You wonder if this only works in the USA, I am sure I would not trust other countries governments not to brake the law.
  • Sell fast if you make a mistake: probably a heritage of his trader days, he is willing to recognize he is wrong fast and close his positions. This sometimes has put him in awkward situations like Delphi: “pushed, with the grace and diplomacy of a battering ram, to play a central role in the reorganization of the company, only to turn tail and manufacture an excuse once they lost interest.”
  • Do not use leverage: for Russia 1998 he had leverage, but it was low and he learned his lesson. If his recent results are any evidence, leverage is not needed for high returns.
  • Hedge: if there is a possibility to filter the thesis in a pure way, hedge. At the end, was not this what hedge funds were about?
  • Markets adapt, people adapt: And if all that does not work, markets tend to heal themselves

I got a headache because I was listening to one guy talking about how there’s gonna be hyperinflation. And then after him there was some guy telling me there’s going to be a depression and deflation. Neither—neither—is most likely going to happen. The point is, markets adapt, people adapt. Don’t listen to all the crap out there – Ira Sohn conference May 2010

But the one thing that I would like to emphasize, and this comes straight from Rubin’s book, is the importance of scenarios, probabilities and downside for distressed investing and we are going to look next some of his famous moments to see how this all works… do you think you can make decisions with trees?