READINGS ...

AM | @agumack

"We're not making any idea that pops into his head" — Marcus Lemonis

 . Fintech & securitization. Two interesting pieces on the role that Fintech could play in terms of securitizing loans to small businesses. "The idea of securitising loans to small and medium enterprises (SMEs), many of which are heavily reliant on bank lending in Europe, is particularly appealing ...  [The] new risks have to be weighed against the desperate need for credit in Europe" (*).

(*) Thomas Haile: "Does securitisation of online loans have a future in Europe?", Financial Times, 10 May 2016 and "Funding circle to tap securitisation market", Financial Times, 14 april 2016.
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. Inventory management at micro-caps. On CNBC.com, Marcus Lemonis gives some priceless advice on managing inventories at small businesses. "If you can't track what's selling or not selling, [then] you can't do any forecasting to build inventory. You can't even monitor trends or customer behavior. You have no shot at success" (*).

(*)  Zack Guzman: "The Profit' star Marcus Lemonis: Making these inventory mistakes could be disastrous", CNBC.com, 1 September 2016.
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 . Bloomberg & Brexit. Well done Bloomberg! There is now a Bloomberg Twitter account that provides "Full coverage of Britain’s exit from the EU, by @business teams in London, Brussels and around the continent" (*). Very usefull indeed!

(*) @Brexit
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. Chouinard on Venture capitalists. "Venture capitalists are such assholes", says Yvon Chouinard, the founder of Patagonia, as he briefly discusses the case of Diamond Equipment in a captivating piece by Nick Paugartner for The New Yorker (*). By the way, Prof. Damodaran has two recent pieces on VCs: a blog post under the title "Venture capitalists don’t value companies, they price them" [see], and a VIDEO [see].

(*) Nick Paumgartner: "Patagonia's philospher-king", The New Yorker, September 19, 2016.
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. Paul Krugman: Brexit and the Pound. Paul Krugman on the weakness of the pound: "We face the prospect of seriously increased transaction costs between Britain and the rest of Europe, which creates an incentive to move those services away from the smaller economy (Britain) and into the larger (Europe). Britain therefore needs a weaker currency to offset this adverse impact" (*).

(*) Paul Krugman: "Notes on Brexit and the Pound", The Conscience of a Liberal, October 11, 2016.
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. Vladimir Putin. The Economist is out with a special report on what it calls "Putinism". The gist: "Institutions that would underpin a prosperous Russia, such as the rule of law, free media, democracy and open competition, pose an existential threat to Mr Putin’s rotten state." I think I'm going to buy this one (*).

(*) "The threat from Russia", The Economist, 22 October 2016.
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UPDATING SOME VERY IMPORTANT DATA ...

AM | @agumack

When governments and companies are able to sell bonds in their own currencies, it means that the quality of governance is improving. You can have enormous amounts of local-currency debt, but the source might be state-onwed banks (like in China). Alternatively, governments and companies can issue large amounts of bonds ... in US dollars (or euros). That is why I take the ability to issue local-currency bonds as the litmus test of the quality of governance. I want to thank Prof. John D. Burger at the Sellinger School of Business (Loyola University Maryland) for sending me the revised calculations of the stock of local currency bonds in terms of GDP for a number of countries [1]. The new calculations update the data from one of my favorite articles, published in 2006 [2].

                                                              * * *

Speaking of local-currency bonds, there are some interesting news coming from Argentina: the government has just issued a 10-year bond in pesos. While the yield looks pretty high (15.5%), it shows the impact of renewed confidence in the ability of the Argentinean central bank to deal with the country's perennial inflation problem [3].

[1] John D. Burger, Rajeswari Sengupta, Francis E. Warnock, Vernica Cacdac Warnok: "Us Investment in Global Bonds: As the Fed Pushes, Some EMEs Pull", Economic Policy, October 2015.

[2] John D. Burger & Francis E. Warnock: “Local Currency Bond Markets”, IMF Staff Papers, Vol. 53, 2006. This is one of the most striking findings from the paper: "To gauge the importance of various factors, our estimates in column 1 of Table 3 imply that (other things being equal) if Brazil had Denmark’s rule of law, its bond market as a share of GDP would be 43 percentage points higher"

[3] Nicolás Dujovne: "Menos inflación y crédito más barato, claves del porvenir", La Nación, 17 October 2016.
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WELLS FARGO: THE ETHICS ANGLE

AM | @agumack

The (ongoing) Wells Fargo story is just a gold mine from the perspective of a course on Ethics in the Financial World, which I will be teaching in the Fall Semester. I using this post to collect the necessary information. Ideas for debate and conclusions will follow in futher posts.

- General information. A timeline of the Wells Fargo scandal [see].

. On September 8, 2016, the alleged misconduct was revealed when the Consumer Financial Protection Bureau (CFPB), the Los Angeles City Attorney and the Office of the Comptroller of the Currency (OCC) fined the bank $185 million, alleging that more than 2 million bank accounts or credit cards were opened or applied for without customers' knowledge or permission between May 2011 and July 201 [see].

. "In his testimony, Mr. Stumpf gave details about steps the bank has taken to address the problems and to regain customers’ trust. He said that starting in 2013, the bank analyzed questionable behavior related to account openings at its branches and strengthened internal oversight to fix the problems uncovered. The company had already said, following the announcement of the enforcement action, that it was eliminating sales goals for retail bankers for all products. “We should have done more sooner to eliminate unethical conduct and unintended incentives for that conduct to occur,” Mr. Stumpf said. (20 September 2016)" [see; includes VIDEO].

- Reputational risk. Compare the amount of the fines imposed to the loss in market capitalization.

. Bigcharts price quote [see]. Ticker symbol: WFC. Number of shares outstanding: 5.046 billion [see]




- Cost of capital/cost of funding. Credit rating agencies have reacted to the news.

. "Moody's did not signal it would review Wells Fargo's current rating, but said it expects "some immediate damage to Wells Fargo's reputation from this embarrassing episode." However, the Moody's note said Wells Fargo will eventually have a "more durable sales and marketing model" due to expected changes to its sales practices and incentive structures" [see]

. Fitch lowers Wells Fargo's credit outlook to negative: "The outlook revision reflects potential damage to the firm’s franchise and earnings profile following recent regulatory actions regarding improper unauthorized account openings, Fitch said Tuesday in a statement. Fitch reaffirmed the San Francisco-based lender’s rating of AA-/F1+. The ratings company said that even as “customer damages appear limited," the scandal could pressure the bank’s earnings. While WFC emerged from the financial crisis in a much better position than similarly sized peers, Fitch believes this issue creates reputational risk given the issue and allegations are understandable to the general public, in a way that misdeeds at other banks are not, Fitch said, using the lender’s stock symbol [see].

- Clawbacks. Executives have agreed to forfeit part of their pay. Note: it's the Board of Directors, led by its independent members,

. "In seeking to defuse the firestorm over its sham accounts, Wells Fargo & Co.’s board turned to an old, but obscure gambit – getting its top leader to pay up. John Stumpf, the bank's chairman and CEO, will forfeit about $41 million of unvested stock awards and forgo his salary while the company investigates its retail banking sales practices. Carrie Tolstedt, Wells Fargo's former head of community banking, also will forgo her unvested equity stock awards, valued at $19 million, and will not receive retirement benefits worth millions more. Neither Tolstedt nor Stumpf will receive 2016 bonuses. Under the leadership of Stumpf and Tolstedt, hundreds of thousands of sham accounts were opened by employees to meet their sales targets, enraging the customers and triggering ongoing federal investigation. And the bank may not be done with "clawing back" -- as the practice is often called -- the executives' pay. “The independent members of the board will take such other actions as they collectively deem appropriate, which may include further compensation actions,” Stephen Sanger, Wells Fargo’s lead independent director, said Tuesday in a statement" [see].

- Corporate governance. Activist investors push for a shake-up at the top.

. "Banking industry scandals and problems have put a focus on the combined chairman and chief executive role in the past. In 2009, when Bank of America’s Ken Lewis was under fire for his handling of the acquisition of Merrill Lynch, investors voted to separate the roles, in effect stripping him of the chairmanship. Jamie Dimon of JPMorgan Chase defeated proposals to strip him of one of the roles in the wake of the “London whale” trading fiasco. Earlier this year, 17 per cent of Wells shareholders backed Mr Armstrong’s proposal for an independent chairman, the highest level of support since 2013. The activist has presented the proposal for an independent chairman each year since 2012" [see]



- Whistleblowers. Did Wells Fargo fire the whistleblowers?

. "CNN Money has found multiple whistleblowers from Wells Fargo who were willing to go on the record and report that they were fired in retaliation for coming forward to report the massive fraud in which Wells Fargo employees opened up 2,000,000 fake accounts in their customers' names, raiding their real accounts to open them, then racking up fees and penalties, and trashing their customers' credit ratings.CNN also spoke to a former Wells Fargo HR manager who explained how the retaliatory firings worked: employees who blew the whistle would be monitored closely for minor infractions (e.g. being two minutes late for work), then fired "with cause."[see]
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FINTECH

DOCUMENTS: STANDARD & POO'S 'INSITUTIONAL' CRITERIA FOR SOVEREIGN RISK

AM | @agumack

The material from this post (including the tables) comes from Standard & Poor's document Sovereign Credit Methodology, published in December 2014. Note the importance attached to the notion of checks and balances. For an attempt at measuring the strength of checks and balances worldwide, I have proposed an Index of Checks and Balances in my other blog (in Spanish). You can see it here. Broadly speaking, 'checks and balances' refers to the distribution of political power within a nation. Nobody denies the need for a strong executive power, but that strength should be (at least partially) balanced by the existence of other political institutions that are independent for that power. The legislative and the judiciary obviously come to mind, althought in some well-run parliamentary democracies, the executive is taken from members of the legislative body itself. This is why, in my own index, I give paramount importance to survey-based measures of judicial independence. My index also gives some weight to central bank independence—but this a matter to be discussed separately.

Material for Standard & Poor's
The sovereign rating methodology (we use "criteria" and "methodology" interchangeably here) addresses the factors that affect a sovereign government's willingness and ability to service its debt on time and in full. The analysis focuses on a sovereign's performance over past economic and political cycles as well as on factors that indicate greater or lesser economic policy flexibility in future economic cycles. The five key factors that form the foundation of our sovereign credit analysis are:
Institutional and governance effectiveness and security risks (reflected in the institutional assessment).

. Economic structure and growth prospects (economic assessment).

. External liquidity and international investment position (external assessment).

. Fiscal performance and flexibility as well as debt burden (fiscal assessment).

. Monetary flexibility (monetary assessment).

The institutional and economic profile reflects our view of the resilience of a country's economy, the strength and stability of its civil institutions, and the effectiveness of its policymaking. It is the average of the institutional assessment (see Paragraphs 30-42) and the economic assessment (see Paragraphs 43-53). Very high institutional risk and high debt burden. A sovereign with an institutional assessment of '6' cannot be rated higher than 'BB+', regardless of any potential upward adjustment for a large asset position (see Paragraph 25). The track record of sovereign defaults suggests that institutional risks are among the main causes of the poor economic policies that lead to default, which is why the institutional assessment receives this particular weight. A sovereign with an institutional assessment of '6' and a debt assessment of '5' or '6' (see Table 7) cannot be rated higher than 'B+', given the heightened risks such a combination entails. The institutional assessment comprises an analysis of how a government's institutions and policymaking affect a sovereign's credit fundamentals by delivering sustainable public finances, promoting balanced economic growth, and responding to economic or political shocks. The institutional assessment captures these factors:

. The effectiveness, stability, and predictability of the sovereign's policymaking and political institutions (primary factor).

. The transparency and accountability of institutions, data, and processes as well as the coverage and reliability of statistical information (secondary factor).

. The sovereign's debt payment culture (potential adjustment factor).

. External security risks (potential adjustment factor).


Effectiveness, stability, and predictability of policymaking, political institutions, and civil society. The criteria analyze the effectiveness, stability, and predictability of policymaking, political institutions, and civil society based on:

. The track record of a sovereign in managing past political, economic, and financial sector crises; maintaining prudent policymaking; and delivering balanced economic growth. This includes a timely implementation of various reforms (such as to health care or pensions, to ensure sustainable public-sector finances over the long term), prudent monetary policy management, and effective management of external pressures.

. The predictability in the overall policy framework and developments that may affect policy responses to a future crisis or lead to significant policy shifts.

. Actual or potential challenges to political institutions, possibly involving domestic conflict, from popular demands for increased political or economic participation, or from significant challenges to the legitimacy of institutions on ethnic, religious, or political grounds.

. The cohesiveness of civil society, as evidenced by social mobility, social inclusion, prevalence of civic organizations, degree of social order, and capacity of political institutions to respond to societal priorities.

Effective policymaking and stable political institutions enable governments to address periods of economic distress and take measures to correct imbalances. This helps sustain long-term growth prospects and limit the risk of sharp deterioration of a sovereign's creditworthiness. Stable and well-established institutions generally ensure a certain degree of predictability in the general direction of policymaking, even when political power shifts between competing parties and policy details change as a result. Conversely, succession risks, a high concentration of power, and potential or actual challenges to political institutions are factors that can pose risks to institutional stability and, in turn, lead to substantial policy shifts and affect the continuity of key credit characteristics. The analysis of the risk of challenges to political institutions is based on the history of internal political conflicts, including extra-constitutional changes of government.

The accountability and transparency of institutions, data, and processes are based on the analysis of the following:

. The existence of checks and balances between institutions.

. The perceived level of corruption in the country, which correlates strongly with the accountability of its institutions.

. The unbiased enforcement of contracts and respect for the rule of law (especially in the area of property rights), which correlates closely with respect for creditors' and investors' interests.

. The independence of statistical offices and the media, as well as the history of data revisions or data gaps, as measures of the transparency and reliability of the information.

The transparency and accountability of institutions bear directly on sovereign creditworthiness because they reinforce the stability and predictability of both political institutions and the political framework. They do this even though they may not reinforce the stability of a ruling political class or party. In addition, transparent and accountable institutions, processes, and data are important because they enhance the reliability and accuracy of information and help make known in a timely manner any significant shifts in a country's policymaking or the occurrence of risks relevant to sovereign credit risk.
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Document. Standard & Poor's downgrades Poland (January 2016) [see]

This is the part of the statement that refers to political institutions.

The downgrade reflects our view that Poland's system of institutional checks and balances has been eroded significantly as the independence and effectiveness of key institutions, such as the constitutional court and public broadcasting, is being weakened by various legislative measures initiated since the October 2015 election. Poland's new ruling party Law and Justice (PiS), which holds an absolute majority in the parliament (Sejm) and the senate, has set out to make fundamental changes to Poland's institutions. For example, the constitutional court's ability to work efficiently and independently will likely be undermined, in our view, by changes to the court's composition and decision-making process. The government's new media law, as another example, gives the government extensive powers to appoint and control the directors and supervisory boards of public broadcasters. A third law terminates contracts of all current senior, career civil servants and removes a constraint regarding previous party membership, therefore enabling the new government to change the structure of the civil service. In our view, these measures erode the strength of Poland's institutions and go beyond what we had anticipated regarding policy changes from the general election.
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Document. Standard & Poor's downgrades Saudi Arabia (October 2015) [see]

This is a reference to Saudi politics:

We analyze Saudi Arabia as an absolute monarchy in which decision-making resides with the king and the ruling family. In our view, reconciling intrafamily issues around sucession could make the kingdom's policy decisions more challenging and difficult to predict. Two new councils, the Council for Political and Security Affairs and the Council for Economic and Development Affairs, have been created to form government policy more efficiently. Power is devolved to the crown prince and deputy crown prince, who respectively head these two bodies. The king approves the decisions of the councils. Broader institutional checks and balances are still at early stages of development.
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Document. Standard & Poor's downgrades Russia Foreign Credit Rating (January 2015 [see]

This is a reference to Russian institutions:

We view Russia's institutional and governance effectiveness as a rating weakness. Political power is highly centralized with few checks and balances, in our opinion. We do not currently expect that the government will be able to effectively tackle the long-standing structural obstacles (perceived corruption, the weak rule of law, the state's pervasive role in the economy, and the challenging business and investment climate) to stronger economic growth over our 2015-2018 forecast horizon.
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PROF. DAMODARAN ON 'BOTTOM-UP BETAS'

AM | @Mackfinance

"I'm actually wedded to bottom-up betas" — Aswath Damodaran

I have recently decided to devote more attention in class to what Prof. Damodaran calls 'bottom-up' betas. Students seem to find it interesting too. Here's some video material with the explanations:

1. Identify the business or businesses that make up the firm whose beta we are trying to estimate.

2. Calculate the levered betas of other publicly traded firms that are primarily or only in each of those businesses. Use regression analysis. In most businesses, there are at least a few comparable firms and in some businesses, there can be hundreds. Begin with a narrow definition of comparable firms, and widen it if the number of comparable firms is too small. Consider the possibilities of widening your search globally to get more firms in your sample. Do hundreds of regression! [TABLE]

3. Calculate the average of levered betas for each relevant sector.

4. Use the average debt-to-equity ratio (D/E) for each sector [this information will be provided] to ‘unlever’ the average beta with the formula: βU = βL / [ 1 + (1 – t) (D/E)]. This is the average unlevered beta for each division.

5. Calculate the bottom-up unlevered beta of the firm as a weighted-average of the unlevered betas for each division. But what weights do we use? There are two possibilities: use the proportion of the enterprise value of the businesses relative to the total enterprise value of the firm (enterprise value = market value of debt + market value of equity – cash). Or you could just use the revenues (sales) by sector.

6. Use the debt-to-equity ratio of the company to arrive at the levered beta, using the formula: βL = βU [ 1 + (1 – t) (D/E)]. That’s it!
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LEHMAN BROTHERS & THE EFFICIENT MARKETS HYPOTHESIS

AM | @Mackfinance

"A generalised mutual suspicion" — John Plender

There is a new book out on the Lehman Brothers crisis. The author is Oonagh McDonald. There is much praise for the book from the Financial Times' reviewer John Plender, although he complains about MacDonald's "harshness based on hindsight" (*). The most interesting part comes from the critique of the Efficient Markets Hypothesis:

MacDonald examines how, one weekend in September, Lehman went from being valued by the stock market at $639bn to being worth nothing at all. It did not require much to make Lehman go up in smoke. At the end of its last financial year, it was so highly leveraged that its assets had only to fall in value by 3.6 per cent for the bank to be wiped out. The response of these Wall Street wizards to the credit crunch that began in mid-2007 was pure hubris. Having survived episodes of financial turmoil when many expected the bank to fail, Mr Fuld and his colleagues decided to take on more risk. Meanwhile, they neglected to inform the board that they were exceeding their self-imposed risk limits and excluding more racy assets from internal stress tests.

The board, conspicuously short of expertise in risk management and financial plumbing, enthusiastically endorsed the policy. A strength of McDonagh’s book is that it recognises that this was really a property-based crisis. Much of the decline in the value of Lehman’s assets came from direct exposure to property. Because Lehman brought other banks into these transactions, word about the deterioration in the quality of its assets quickly spread. A generalised mutual suspicion about the value of other banks’ assets became a hallmark of the crisis. 

But the conclusion is a broader, provocative exploration of the concept of market value, in which McDonald tilts at the efficient market hypothesis that underlay much of the thinking in finance ministries, central banks and regulatory bodies before the crisis. This incorporates the notion that competition between market participants will ensure that prices reflect all publicly available information. It leads to the conclusion that bubbles do not exist, which in light of the crisis many find absurd.

(*) John Plender: "Lehman Brothers crisis: A crisis of value. By Oonagh McDonald", Financial Times, 15 February 2016.
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SOME ARTICLES ON BASEL, SYTEMIC RISK

AM | @Mackfinance

"A large range of uncertainty" — The Bank of England

. John Vickers: "The Bank of England must think again on systemic risk", Financial Times, 14 February 2016.
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NOW EVERYBODY TALKS ABOUT THE YIELD CURVE!

AM | @Mackfinance

"Curve inversion will come quickly" — Harvinder Sian

The yield curve, one of our favorite indicators, is making an astonishing comeback. Now everybody seems to talk about it! Here are some links to recent articles on the yield curve.

. Robin Wigglesworth: “Yield curve recession indicator sends warning on US economy”, Financial Times, 13 February 2016.

. Robin Wigglesworth: “US yield curve narrows to 8-year low”, Financial Times, 10 February 2016

. Bloomberg: “Citigroup: The Best Predictor of a U.S. Recession Will Resurface Sooner Than You Might”, 2 December, 2015

. Dean Croushore & Katherine Marsten: “The Continuing Power of the Yield Spread in Forecasting Recessions”, Federal Reserve Bank of Philadelphia, Research Paper No. 14-5, February 2014


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BUSINESS TO BUSINESS IN ASSET MANAGEMENT: INDEX PROVIDERS

AM | @Mackfinance

"Profits generated by index providers have risen significantly" — Chris Flood

. Chris Flood: "Profiting from passive aggression", Financial Times, 16 November 2015.
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THE ETF REVOLUTION: SOME NUMBERS

AM | @Mackfinance

"The growth is scary" — Anonymous ETF provider

. New record. The ETF market has set a new record for global asset gathering (inflows): some $372bn for 2015. In December alone, ETFs posted net inflows of $55bn, marking the 23rd consecutive month of positive net flows, according to research firm ETFGI. Over the past five years, the inflows reach $1.5tn after growing dissatisfaction with the high fees and widespread underperformance of actively managed traditional mutual funds.

. Total ETF assets. Total assets stand at $2.99tn—a figure consultancy PwC expects to hits $5tn by 2020.

. The Big Three. BlackRock, Vanguard and State Street Global Advisors together control more than two-thirds of the ETF industry's global assets and in 2015 grabbed 55% of the new cash allocated by investors to ETFs, according to ETFGI.

. Others. Some of the notable beneficiaries of investors' growing interest in ETFs include WisdomTree and Deutsche Asset Management, which both saw inflows to ETFs more than triple in 2015 compared to the previous year.

. Minimum size. ETFGI estimates that more than 6,100 ETFs are now available to investors globally, but around 70 per cent of those funds have less than $100m in assets, the minimum level generally regarded as necessary to break even.

. Innovation. Providers have to strive to be different. It is vital to have the right products in an increasingly crowded market place, to build ETFs that meet specific client needs. WisdomTree, the New York based manager, runs a pair of currency hedged European and Japanese equity ETFs that were two of the fastest growing products globally in 2015.

. Japan. Figures released by the Japan Exchange Group in February 2016 put the combined January trading value of all ETFs at record Y7.94tn—a 100% increase on the same period last year and a 53.4% month-on-month rise from December 2015. The increase in ETF traded volume was even more marked, jumping 128% year-on-year. (Note the role of the BoJ).

 Sources. ETFGI; PwC: "ETF 2020: Preparing for a new horizon"; Leo Lewis: "ETFs set Japan record", Financial Times, 3 February 2016; Chris Newlands: "Is it time to halt the rise of the ETF machine?" and Chris Flood: "Dominance of big three forces wave of innovation", Financial Times, 1 February 2016.
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PASSIVE ASSET MANAGEMENT: SOME NUMBERS

 AM | @Mackfinance

"The rise of passive managers continues unabated" — John Authers

Most active fund managers do not beat their benchmarks: nine out of ten actively managed European equity funds failed to reach their performance goals over the last decade. In the US, around 80% of large-cap equity managers fell short of their index targets over the same period. These statistics have helped fuel inflows into index-tracking funds, including Exchange Traded Funds (ETFs).

. In the US, 32.4% of long-term funds' assets are managed passively, with $4.52tn under management, against $9.44tn managed actively. The share has roughly tripled since 1998.

. In 2015. Within equities, $169bn flowed out of actively managed funds, with $102bn of that finding its way to passive managers.

. In 2015. Vanguard pulled in $221bn, while BlackRock, including the iShares division, took in $103bn. Most of the traditional active managers suffered big outflows.

. Most funds are actively-managed. Only 15% of fund assets globally are managed passively, but there is an accumulation of data showing that investors face disappointment with active managers.

. Massive under-performance in emerging markets. Fewer than one in five UK small-cap and sterling-denominated emerging market fund managers beat their benchmarks over 10 years. Almost 98 per cent of euro-denominated emerging market funds underperformed over the same period. Fewer than half of the 489 UK equity funds and 1,192 European equity funds that were launched 10 years ago have managed to survive.

Sources. John Authers: "Passive asset managers are good corporate stewarts", Financial Times (21 January 2016); Chris Flood: "Nine out of ten active funds underperform benchmark", Financial Times (25 October 2015).
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THE ECONOMIST ON EUROPEAN BANKS

AM | @Mackfinance

The Economist argues that US banks have cyclical problems, but European banks have structural ones. This is the article:

FOR those who worry that a repeat of the crisis of 2007-08 is imminent, this week brought fresh omens. Shares of big banks tumbled; despite a mid-week rally, American lenders are down by 19% this year, European ones by 24% . The cost of insuring banks’ debts against default rose sharply, especially in Europe. The boss of Deutsche Bank felt obliged to declare that the institution he runs is “absolutely rock solid”; Germany’s finance minister professed to have no concerns (thereby adding to the concerns). This is not 2008: big banks are not about to topple. But there are reasons to worry, and many of them converge on one country.

Start with the better news. Banks are more strongly capitalised than they were. Even in Europe, where lenders have been slower than their American counterparts to raise capital, banks have plumped up their core equity cushions from an average of 9% in 2009 to 12.5% in 2015. Managers at European banks are making a renewed effort to adjust to the post-crisis landscape. New rules on everything from capital to liquidity are forcing them to change. John Cryan, Deutsche’s newish co-chief executive, was brought in to trim its investment bank. He is jettisoning whole divisions, and suspended the dividend this year and last. Credit Suisse is undergoing similar surgery. Just now, this is weighing on the banks’ share prices. Yet, however painful for investors, the sensible goal is ultimately to create slimmer, safer, more profitable outfits.

Also salutary, if painful, is how investors in bank debt are coming to understand that they bear greater risk than they did. New European rules that came fully into force at the start of this year stipulate that troubled banks must deal with capital shortfalls by “bailing in” holders of bank bonds before any call is made on the taxpayer. The chance that bondholders might lose money suddenly seems more real. The turmoil at Deutsche this week stemmed partly from fear that the bank might struggle to pay interest next year on a type of bond that is designed to act as a buffer in a crisis. There are some design flaws in the bail-in regime, but the possibility that European banks are at last repairing themselves at a cost to their investors is the silver lining to this week’s spasms.

The clouds, alas, still loom. One source of anxiety is the health of the world economy. The factors that spook markets more broadly—the slowdown in China, plunging commodity prices and indebted energy firms, political upheaval from Greece to New Hampshire—all weigh heavily on banks in particular. Banks do well when the economies they serve are growing, and miserably when they are not. The receding prospect of higher interest rates leaves American banks with less hope of widening the margin between the rates they pay depositors and what they charge for loans. In Japan, where bank shares have fallen by 24% this month, and Europe central banks have imposed negative rates, in effect levying a fee on some reserves—one that banks have not yet been able to pass on to depositors. With the economic outlook growing gloomier, margins being squeezed and restructuring costs still hitting profits, investors have good reason to fret.

Worse, some countries appear to have taken so long to deal with their banks that they will now struggle to clean them up at all. The IMF reckons that the total amount of non-performing debt in Europe was around €1 trillion ($1.13 trillion) at the end of 2014. Bail-in is an especially ugly prospect in countries where bank debt is owned not only by diversified financial institutions but also by local retail investors. Under such conditions, politicians may find that they cannot force the cost of cleaning up balance-sheets on voters without causing uproar.

Rome is where the hurt is
No country is more impaled on this dilemma than Italy. The gross value of non-performing loans makes up a whopping 18% of their total lending; retail investors own some €200 billion of bank bonds, equivalent to 12% of GDP. A government plan to buy bad debts from the banks at close to face value would fall foul of European rules against “state aid”. But selling the loans at a significant discount would force Italian banks to recognise losses, some of which could be borne by retail investors. The prime minister, Matteo Renzi, headed down this road late last year, when the efforts to save four small banks clobbered the savings of individual Italians and seemingly resulted in a high-profile suicide. He will not want to do so again.

The European Union and the Italian government recently agreed on a half-baked alternative to bail-in, though few think it will cleanse banks’ balance-sheets. Instead Italy seems trapped between the rock of hurting small savers and the hard place of a banking system strangled by bad debts. If Mr Renzi cannot negotiate his way round the new rules on bail-in, Italy’s banks and economy risk years of more stagnation, poisoning relations with the EU. Behind this week’s banking headlines is the threat of something very bad coming out of Italy.
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SUPER-BOWL ADS: DATA POINTS

AM | @Mackfinance

"Adverstisers should consider doing strong digital marketing during that period" — Anne Lewnes

There is a guaranteed, built-in audience that will be not only watching the game, but talking about the advertising. Consumers recognise that, historically, advertisers have upped their game during the Super Bowl, that they will pull out all the stops to try to entertain them and that they’ll get to see something new. This year 40 brands will be doing just that, having bought airtime from CBS for a slot in Super Bowl 50 and they will all be jostling for the public’s attention. “Culturally, the Super Bowl may be the one time a year when advertisers are actually invited to the family rooms of American households. Ads become central.

Consumers knows the ads will be new and entertaining and also understand the high costs for each commercial creating added interest,” added Bill Tucker, executive vice president at the Association. “The Super Bowl serves as the centre of gravity and grand finale of extensive integrated cross platform marketing programs that includes promotion, in store marketing, advertising and social buzz with huge extensions leading up to the game. The return on investment continues to be heavily analysed by advertisers and is paying off for them.”

Some data points about Super-Bowl ads (*):

. $10 million for one minute. When is 30 seconds worth $5m? That is the question facing Super Bowl advertisers as they gear up for February 7, the biggest day in US marketing. The price tag that broadcaster CBS is charging for a television commercial for this year’s National Football League championship game is double the average $2.5m price a decade ago, according to Kantar Media.

. $5.9bn spent. According to Advertising Age companies have spent $5.9 billion on commercials since the first Super Bowl in 1967.

. 110 million viewers expected. Last year’s clash, where the New England Patriots snatched victory at the death from the Seattle Seahawks, attracted the biggest television audience in American history, 114.4 million viewers and was watched in 71 per cent of homes. By the time of the winning touchdown, there were more than 120 million people glued to their screens.
 
. 114 million viewers in 2015. But the game regularly breaks US TV viewing records, with 114m people tuning in last year. This Sunday’s pie will be even bigger, as CBS will for the first time make its livestream of the game and all national commercials available over internet TV boxes including Apple TV and Roku. Advertisers are already teasing their ads well before game day, using digital channels to extend their reach.

. 14 million hours of Super-Bowl ads. YouTube touts its metrics which show that advertisers that put up their ads early on its AdBlitz site get twice the views and three times the social shares as those that wait to release their ads during the game. Last year, people watched 14m hours of Super Bowl ads on YouTube, with 60 per cent of viewers tuning in on mobile phones. “We have stopped thinking about the Super Bowl as a one-day event. Our campaign starts when the NFL season starts,” says Ram Krishnan, chief marketing officer at PepsiCo’s Frito-Lay, maker of Doritos and other snacks.

. 60% jump in website traffic. Adobe, the software maker, estimates that brands that advertise during the Super Bowl see traffic to their websites jump more than 60 per cent, a boost that can last for more than three weeks after the game.

. 25 days of viral afterlife. “Advertisers should consider doing strong digital marketing in that period,” says Ann Lewnes, chief marketing officer. The most popular Super Bowl ads have a viral afterlife on social media that lasts on average 25 days, she added.

 

(*) Shannon Bond: "Super Bowl ads capitalise on bumper day with new angles", Financial Times, 6-7 February 2016. David Millward: "Superbowl: the biggest advertising show of all", The Telegraph, 7 February 2016.
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SUPER-BOWL ADS: U2 & BANK OF AMERICA

AM | @Mackfinance

"An example of creative capitalism" — Bill Gates

A sign of the times: between 2008 and 2013 there was not a single Super-Bowl ad from a financial services companies. In 2015, US insurer Nationwide was the second-most mentioned brand on Twitter during the game, according to Salesforce Marketing Cloud. But three-quarters of those conversations were negative as viewers vented their disgust with Nationwide's ad about a dead child, and the insurer had to issue an apology. The company is sitting out this year's game.

The 2014 ad from BankofAmericaMerrill Lynch is particularly interesting; it is about cause marketing or cause sponsorship. As such, it contains no information at all about financial services. This is from the Financial Times in early 2014 [1]:

The BoA ad will declare that for 24 hours everyone can download a new song from U2, ‘Invisible’, for free. The bank will then donate $1 for every download to a global fund to fight Aids, organized in association with Red, the philanthropic group co-founded by Bono. This comes on top of a $10m ‘simple’ donation from BoA. Brian Mynihan: ‘This is an advdertisement but it’s not really an ad … The aim is to create heat and energy’. Banks such as BoA have strong motives to ‘engage’ in innovative ways. A poll by Edelman, the public relations company, suggests that half of all consumers distrust banks.

The philanthropic sector is under pressure to become more innovative too. Government aid budgets are being cut and the attention span of consumers –or donors- is becoming more fickle. Of course this approach is not without risks for both sides. Bono, for example, admits that U2 was initially wary about embracing a bank. Bono: ‘When we looked at BoA and go to know Mr. Moynihan, we saw that values were important to them and they were trying to compensate for the financial mess’. There are more rumors at Davos that more deals are being discussed.

Recently, the FT came back to this topic with a Bono interview about 'conscious consumerism':

It is a decade since the star went to the WEF to launch Red, the brand campaign that began with the aim of ending the transmission of HIV/Aids from pregnant women to their unborn children. Described by Bill Gates as an example of “creative capitalism”, Red’s early partners included Starbucks, Apple and Nike, which made products under the Red brand and donated proceeds to the fight against Aids in Africa. The campaign has over the past 10 years raised more than $350m. “Corporate social responsibility is a phrase that is in common usage now but it wasn’t back then,” Bono says, speaking to the Financial Times on the telephone from “bubblin’ Dublin”, the day before flying to Davos.

An aim of Red, which he dreamt up with Bobby Shriver, a US lawyer and nephew of John F Kennedy, was to engage companies, and their customers and employees, in the fight against Aids, encouraging them to make and market Red-branded products, rather than just write a cheque. “Red understood early on that corporate social responsibility was not just for how companies gave their money but also for how companies make money.” Now, the challenge facing Bono and Red is the next decade. New partners have signed up, notably Bank of America, which in 2014 pledged $10m to Red, donating $1 for every free copy of the U2 track “Invisible” downloaded the day of that year’s Super Bowl. The bank recently pledged another $10m and has embarked on initiatives that include displaying at its ATMs images shot by the photographer Rankin of HIV-positive mothers and their children, who were born HIV-free thanks to their mothers taking antiretroviral medication.

“If we can get these drugs consistently into the hands of these mothers they will not transmit [the disease] to their children and we can cut off its growth,” says Brian Moynihan, Bank of America’s chief executive. Bono says the money Red has generated is “critical to the people whose lives it is saving”. As important, he says, “is the heat, the excitement”, the campaign has generated in terms of enlightening people who may never have thought twice about the Aids epidemic. “You can go to a Bank of America ATM now in Toledo, Ohio, and see a picture of children born without Aids because of Red. That has an effect.”

[1] Gillian Tett: “How Bono and B0fA made sweet music”, Financial Times, January 31, 2014. Note that the article appears in the very same issue of the FT where BofA’s $8.5bn settlement is discussed! 

[2] Matthew Garrahan: "Bono surveys a Red decade of conscious consumerism", Financial Times, 21 January 2016.
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CLOSET TRACKING

AM | @Mackfinance

This is quite an interesting story, with many different angles to it: asset management styles (passive v. active), legal risk, ethics, etc. More material to be posted soon! The Aberdeen Asset Managament story is particularly noteworthy; close tracking or not, active asset managers find themselves under a lot of pressure.

. Madison Marriage & Attracta Mooney: “EU probe into asset managers uncovers potential mis-selling”, Financial Times, 2 February 2016. 

. Madison Marriage: "Watchdogs attempt to force trackers out of closets", Financial Times, 16 November 2016

. David Rockets: "Name closet trackers, European regulator told", Financial Times, 8 February 2016.

. Attracta Mooney: "Aberdeen cuts fees on emerging markets fund", Financial Times, 8 February 2016.

. Lex: "Asset managers: out of the closet", Financial Times, 22 January 2016.

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FOUR STORIES ON VALUATION

AM | @Mackfinance

[1] Stocks are risky! The key take-away from the market turmoil so far in 2016 is a reminder that stocks are risky (*). Indeed! Here's Prof. Damodaran:

The global equity markets collectively lost $5.54 trillion in value during the month, roughly 8.42% of overall value. The global breakdown of value also reflects some regional variations, with Chinese equities declining from approximately 17% of global market capitalization to closer to 15%. The good news is that there have been dozens of months that delivered worse returns in the aggregate. In fact, the US equity market's performance in January 2016 would not even make the list of 25 worst months in US market history. What I learned from January 2016 is that stocks are risky (I need reminders every now and then), that market pundits are about as reliable as soothsayers, that the doomsayers will remind you that they "told you so" and that life goes on. I am just glad the month is over!

(*) Aswath Damodaran: "January 2016 data update", Musings on markets, 1 February 2016
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[2] Platform companies. Morgan Stanley analyst Kate Huberty recenly argued that Apple would command a forward P/E multiple of 18x if valued as a "large-cap platform company across industries"; however, the forward P/E multiple would tumble to 13x if the company were to be valued as a large-cap IT harware vendor. But what is a platform company? The FT has been publishing some interesting articles on this topic: "In its simplest form, a platform company is one that expands by constant acquisitions, usually powered by huge debt ... basically a company dependent on acquisitions for growth, taking advantage of cheap borrowing costs to buy up businesses to expand quickly. The recent travails of hedge fund manager Bill Ackman (of Valeant fame) has led him to admit: "We believe 'platform value' is real, but, as we have been painfully reminded, it is a much more ephemeral form of value than ... other assets" (*).

(*) Arash Massoudi, Miles Johnson & Dan McCrum: "Platform party topples over into hangover" Financial Times, 2 February 2016.
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[3] Platform companies & short-sellers. Short-sellers, understandably, do no like platform companies. Here's Jim Chanos: "They're investment banking-driven. Those roll-ups are just huge fee payers to Wall Street". This is from the FT (*):

Valeant Pharmaceuticals, Altice, Platform Specialty Products and Nomad Foods have all grown rapidly by making a string of big acquisitions facilitated by record-low interest rates. That activity has placed these platform companies among the leading participants in the overall mergers and acquisitions boom. Since August, shares in each of the four have fallen by more than 50 per cent, as investors began to take fright at their heavy debt burdens and ability to grow without further deals. Valeant, Altice, Platform Specialty and Nomad have a collective debt burden of $78bn at a time when the cost of corporate debt has been rising. The $1.1bn in fees paid by the four companies since 2013 is a significant revenue source. The figure is roughly equal to the amount of fees paid by Swiss based corporations in 2015 and close to the total fees made from South and Central America over the same period. Valeant has paid $398m in total investment banking fees since 2013, a figure which includes payments to banks that helped fund, advise and underwrite its debt-backed expansion. The largest recipients of fees from Valeant were Goldman Sachs and Deutsche Bank, which received $60m and $48.5m respectively, according to estimates from Thomson Reuters and Freeman Consulting.

(*) Arash Massoudi, Miles Johnson & Dan McCrum: "Wall Street the winner as four 'roll-ups' spend $1bn on investment bank fees", Financial Times, 2 February 2016.
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[4] Accounting reforms. A new IASB financial reporting standard is likely to have implications about the way revenue and leases are accounted for:

All will have an impact on investors, as they have the potential to affect lending arrangements, dividend policies, tax planning and share prices. They also represent a step up in regulatory co-operation between the US and international standard setters. Converging the different corporate reporting frameworks has been fraught. While the two regulators were largely able to agree on the revenue recognition and lease accounting standards, attempts to agree a common base for assessing financial instruments failed in 2014 ... However, it is the new standard for accounting for leases — known as IFRS 16 — that is arguably the most important, because it ends a practice that investors claim has hidden assets and liabilities from plain sight (*).

(*) Kate Burguess & Harriet Agnew : "Accounting’s big shake-up to bring more transparency", Financial Times, 21 January 2016
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ETHICS IN THE FINANCIAL WORLD: ARTICLES, LINKS

AM | @Mackfinance 

. Tom Mitchell: "Chinese police need diggers to unearth 'Ponzi scheme' that that took alleged $7.6bn", Financial Times, 2 February 2016
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. Pan Kwan Yuk: "Wells Fargo to pay $1.2bn over loans case", Financial Times, 3 February 2016

Wells Fargo had been in talks with the US Department of Justice, the Department of Housing and Urban Development, the US Attorney in the Southern District of New York and the Northern District of California for more than a year over allegations that it improperly certified certain mortgage loans that did not qualify for insurance under the Federal Housing Administration (FHA) between 2001 and 2010. The government alleges that Wells Fargo should not have received insurance proceeds when some of the loans later defaulted.
________

. Laura Noonan: "JPMorgan pays almost $2.5bn to settle legal disputes", Financial Times, 26 January 2016.
 
 JPMorgan Chase will be left almost $2.5bn out of pocket after the US bank finally settled two of its biggest legal headaches left over from the financial crisis. Insurer Ambac said on Tuesday that it would receive almost $1bn from the bank to settle a long-running lawsuit about the sale of mortgage-backed securities. The news came just hours after court filings revealed that JPMorgan would pay $1.42bn to end most of its remaining disputes with the estate of the defunct Lehman Brothers. The bank issued stock exchange statements saying that neither settlement would “materially” affect earnings for the first quarter. The Ambac lawsuit centred on mortgage-backed securities sold by an arm of Bear Stearns, which JPMorgan acquired in 2008. Ambac alleged that the Bear Stearns unit misrepresented the securities. Court documents showed one Bear Stearns employee referred to some of the securities as a “sack of shit”.

Note 1: on January 24, FT informs that Goldman Sachs paid a $5.1bn penalty for "mis-selling mortgage-backed securities".

Note 2: example of a 'shitty loan'? Quicken Loans was sued on claims that it had fraudulently originated loans: "...abuses such as Quicken endorsing a loan from a borrower who requested a refund of the $400 application fee so she could afford to feed her family. She ultimately made only five mortgage payments before defaulting, costing the government about $94,000 in insurance claims" (Peter Rudegeair: "At Quicken Loans, a Will to Do Battle", Wall Street Journal, 16 June 2015)
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. Gina Chon: "JPMorgan fined $330m for misleading clients", Financial Times, 19-20 December 2015.

JPMorgan Chase has been ordered to pay a $307m penalty for failing to disclose to clients that it was steering them to the bank’s own investment products rather than those offered by rivals.The bank agreed to pay $267m to the Securities and Exchange Commission and admitted wrongdoing in settling charges, which found JPMorgan failed to disclose conflicts of interest to wealth management clients.
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. Joseph Cotterill: "KKR pays $30m to settle disclosure charges", Financial Times, 30 June 2016

The firm “thus, breached its fiduciary duty as an investment adviser”, the order added. “This resolution, which relates to historical expense allocation disclosures and policies and not to any current practices, allows us to focus on delivering value for those who invest with us,” KKR said in a statement. “We take our fiduciary responsibilities seriously and have strived to adapt our policies and practices to the changing nature of the industry, market and our business,” it added.
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BOOKS. CORPORATE GOVERNANCE & THE VALUE OF INDEPENDENCE

AM | @Mackfinance

Andrew Hill, from the indispensable Financial Times, publishes a review of sorts of Jeff Gramm's book Dear Chairman. Board Battles and the Rise of Shareholder Activism (New York: HarperCollins, 2016) (*). Gramm —a hedge fund inversor and a professor at Columbia Business School — tells the story of shareholder activism in the US from the 1920s to today. Hill singles out the battle between GM CEO Roger Smith and independent director Ross Perot about the ill-fated acquisition of Hughes Aircraft; he puts forward "the value of true director independence". From the editors:

A sharp and illuminating history of one of capitalism’s longest running tensions—the conflicts of interest among public company directors, managers, and shareholders—told through entertaining case studies and original letters from some of our most legendary and controversial investors and activists. Recent disputes between shareholders and major corporations, including Apple and DuPont, have made headlines. But the struggle between management and those who own stock has been going on for nearly a century. Mixing never-before-published and rare, original letters from Wall Street icons—including Benjamin Graham, Warren Buffett, Ross Perot, Carl Icahn, and Daniel Loeb—with masterful scholarship and professional insight, Dear Chairman traces the rise in shareholder activism from the 1920s to today, and provides an invaluable and unprecedented perspective on what it means to be a public company, including how they work and who is really in control.

Jeff Gramm analyzes different eras and pivotal boardroom battles from the last century to understand the factors that have caused shareholders and management to collide. Throughout, he uses the letters to show how investors interact with directors and managers, how they think about their target companies, and how they plan to profit. Each is a fascinating example of capitalism at work told through the voices of its most colorful, influential participants. A hedge fund manager and an adjunct professor at Columbia Business School, Gramm has spent as much time evaluating CEOs and directors as he has trying to understand and value businesses. He has seen public companies that are poorly run, and some that willfully disenfranchise their shareholders. While he pays tribute to the ingenuity of public company investors, Gramm also exposes examples of shareholder activism at its very worst, when hedge funds engineer stealthy land-grabs at the expense of a company’s long term prospects.

(*) Andrew Hill: "Lasting lessons from smug CEOs and somnolent shareholders", Financial Times, 2 de febrero de 2016.
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SOME ESG-RELATED LINKS

 . Financial Supervisory Board announces membership of Task Force on Climate-related Financial Disclosures [see]

. Mike Scott: "Investors seek ethical benchmarks", Financial Times, 16 November 2015. 

. Attracta Mooney: "Sweden to force disclosure of climate impact", Financial Times, 23 November 2015.

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CME Group Ads

CME Group ads

P2P LENDING: RESOURCES, LINKS, ARTICLES

Company websistes

. Imagine Bank (CaixaBank)

. Spotcap


General Fintech stories


. FinTechExchange 2016 [see]

. Laura Noonam: "Fintech developers seek place on global map", Financial Times, 27 January 2016

. Ben McLannahan: "Lending Club grapples with rise of rival disrupters", Financial Times, 27 January 2016 [hard copy]

. Gillian Tett & Isabella Kaminska: "Blockchain eclipses Basel III as fintech sets Davos abuzz", Financial Times, 22 January 2016 

. Martin Arnold: "Caixabank launches mobile-only service for millenials", Financial Times, 15 January 2016

. The Financial Brand: "The 10 Most Popular Digital Banking Articles of 2015" 

. Kadhim Shubber: "The former big beasts of Wall Street who are shaking up banking with fintech investments", Financial Times, 15 December 2015 [hard copy]

. Morgan Stanley: "Can P2P Reinvent Banking?", 17 June 2015


On P2P Lending in China:

. James Kynge: "China’s P2P lending risks ripple through the economy", Financial Times, 1 February 2016

. Gabriel Wildau: "Shanghai P2P lender Lufax raises $1bn", Financial Times, 19 January 2016 [hard copy]

. Don Weiland: "Chinese companies turn to internet and P2P lending to auction bad debts", Financial Times, 29 January 2015 [hard copy] 

. Gabriel Wildau: "Democratizing finance: China's P2P industry attracts scammers", Financial Times, 28 January 2015

. Tom Mitchell: "Chinese police need diggers to unearth 'Ponzi scheme' that that took alleged $7.6bn", Financial Times, 2 February 2016 


On Fintech and Ethics:

. Sohpia Greene: "Quants are the new ethical investors", Financial Times, 25 January 2016

. Burton G. Malkiel & Adam Nash: "Creative Destruction at America's Brokerages", Wall Street Journal, May 4, 2015 
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