really? nexTRADE!? <g>
great article by chris whalen on AIG v. CIT, while i'm not a fan of CIT, it becomes obvious that criminal markets get bailed out and rewarded, while pikers like CIT (and subsequent small businesses) can rot:
What Do AIG and CIT Have in Common? Asset Deflation
July 15, 2009
This week, we confirmed the coverage universe for subscribers to The IRA Advisory Service and included an upgrade of the Outlook for Goldman Sachs (NYSE:GS). This does not mean that we approve of the political machinations of the Boys on Broad Street. Quite the contrary. But our clients pay us to help them find value and GS is benefiting mightily from being among the last men standing - at least for now.
Along with JPMorgan (NYSE:JPM), GS has a near monopoly on trading and new issue underwriting, thus we expect strong operating results for 2009. As we told the folks on Fast Money on Monday, if you could buy into a hedge fund with access to the Fed discount window, subsidies from the US Treasury, and Ben Bernanke and Tim Geithner as your lobbyists in Washington, wouldn't you want a piece of that? But there are a number of firms looking to provide alternatives to GS. Even Wells Fargo (NYSE:WFC) has suddenly decided that capital markets is an attractive area for future business expansion, this after eschewing anything outside of its traditional banking focus. Go figure.
But remember, in order to hit those double digit returns with less leverage, risk must increase. See Jim Bianco's analysis of GS on The Big Picture. The more risk, the more chance of failure due to execution errors or simply bad market conditions. And the non-financial risk factors facing GS are growing with the firm's rising political profile. Indeed, perhaps the chief risk to GS remain the festering situation at American International Group (NYSE:AIG) and rising public angst focused on the surviving banksters.
If you have not done so, read our previous comment on AIG ("AIG: Before Credit Default Swaps, There Was Reinsurance"). We reported last week that the advisers working to raise cash via asset sales at AIG have been having little luck finding buyers for the firm's key units. The Wall Street Journal reports that the lead bidders for AIG's asset-management unit have dropped out of the auction process. But the key issue remains finding a buyer for the insuance business.
One source close to the matter tells The IRA that policy obligation guarantees (POGs) issued by National Union Fire Insurance Company of Pittsburgh, Pa (NUFIC) and American Home Assurance Company (AHAC), AIG's two most important insurance underwriting units, to various AIG affiliated insurers have effectively rendered these key operating units unsalable.
The source reports that the wording of the POGs is found in the notes to the 2007 NAIC Annual Statements for both NUFIC and AHAC. The quotes below are identical in both of the annual statements:
I. "The Company has issued guarantees whereby the Company unconditionally and irrevocable guarantees all present and future obligations and liabilities of any kind arising from the policies of insurance issued by the guaranteed companies in exchange for an annual guarantee fee."
II. "These guarantees are provided to maintain the guaranteed company's rating status issued by certain rating agencies."
III. "In the event of termination of a guarantee, obligations in effect or contracted for on the date of termination would remain covered until extinguished.
IV. The Company is party to an agreement with AIG whereby AIG has agreed to make any payments due under the guarantees in the place and stead of the Company.
Opines the source: "Generally, state laws do not allow an insurance company to issue unlimited guarantees that could potentially drain an insurer's entire policyholders' surplus, and further in this case, potentially drain all assets of an insurer. It is amazing that any state insurance department has allowed these guarantees to be issued and that they have been allowed to continue."
The source continues: "These POGs have been issued for a fee and that fee income should be reported as a liability and amortized over the life of the guarantee. In this case until the last policy, issued or in force on or before cancellation of the guarantee, has expired and all policy obligations incurred there under have been satisfied. It appears that no unearned policy guarantee fee liability has been established for the POGs."
Because of the web of POGs between the larger underwriters in the AIG group and other, inferior entities, our sources say it may not be possible to sell NUFIC and AHAC for any valuation that would significantly help to defray the cost of the AIG rescue.
Notice that we have not even mentioned the term credit default swap or "CDS." And yes, the announcement of the DOJ inquiry into CDS is another risk factor to keep top of mind for GS, JPM and the rest of the OTC dealers. More on that in a future comment.
We suspect that as the year progresses and if the promise made by Treasury Secretary Tim Geithner and Fed Chairman Ben Bernanke that asset sales would defray the cost of the AIG rescue are shown to be empty, AIG is going to be forced to go back to the US Treasury for additional funds. And the later in the year that such a request comes, the more angry will be the response from the Congress and the American people. Indeed, if our sources turn out to be correct, then AIG may well end up in bankruptcy after all.
One of the dirty little secrets of the AIG mess was that the "innovation" of guarantees, side letters and credit default swaps had the effect of entirely defeating state law regulation of insurers. The whole purpose of requiring insurers to maintain separate affiliates in each state where the insurer writes business was to prevent affiliated companies from weakening the ability to pay of the underwriter. The financial innovation at AIG has rendered such safeguards entirely moot.
As and when the bailout of AIG begins to unravel, the twin specters of market and liquidity risk may resurface. We told subscribers to the Advisory Service earlier this week: "More than anything else, the chief vulnerability of GS is liquidity. The market tremors being felt by talk of bankruptcy for CIT Group (NYSE:CIT) are mild compared to the major seismic events that could lie in store for all financials as the Fed and FDIC prepare to try - emphasis try - to withdraw debt guarantees and other subsidies extended to banks last year in the form of debt guarantees and repurchase agreements."
The troubles apparently faced in selling AIG's assets and the death struggle of CIT both illustrate a larger problem facing all financials, namely that with the cash flow from and value of the many financial assets falling, financing is unavailable and cash buyers of assets are very aggressive. We find it sadly amusing to see the Sell Side analysts laughing at the "systemic" impact of the failure of a small non-bank vendor like CIT. These same people won't be laughing when retailers and vendors in their communities shut their doors for good.
Fact is, commercial banks have been withdrawing from the factoring and receivables finance sector for more than 18 months, in part because these were never really traditional sweet spots for most commercial lenders. Like financing commercial real estate, providing debt working capital to small businesses is a risky line and one that demands deep channel knowledge and a tough approach to credit.
We heard about this "flight from risk" a few months ago during a colloquy with Senator Charles Schumer (D-NY), who related how a small oil company in the Bronx, NY, was no longer able to access financing for its inventory from a local bank. When we hear ratings sector colleagues like Sean Egan and David Hendle at Credit Sights talk about how easy it will be for small businesses to access financing from banks to replace non-bank lenders such as CIT, we wonder just which banks they have in mind.
BTW, click here to read the letter from IRA co-founder Chris Whalen to Senator Christopher Dodd (D-CT), responding to questions following the hearing on OTC derivatives that the Committee's Subcommittee on Securities, Insurance, and Investment held on June 22, 2009.
The impending collapse of CIT illustrates a key problem with Washington's response to the larger financial crisis, namely that rescuing the banks has not addresses the collapse of the non-bank financial sector, which at its peak accounted for more than half of all financing activity in the US economy. While CIT by itself may not be "systemic" in terms of causing the failure of other financial institutions, an eventual bankruptcy and liquidation for CIT may well mean a death sentence for thousands of private employers and the loss of many thousands of additional jobs.
Until about a decade ago, banks rarely played in the world of financing small businesses. Too much risk. The mortality rate of small businesses in the US is very high, in part because of their size and volatility. Smaller companies such as retailers, builders, food outlets and other types of service vendors lack the infrastructure and controls to satisfy the requirements of most bank lenders. In many respects, it is back to the future for the world of asset backed financing, a world that was once dominated by non-bank financial firms such as CIT.
In fact, most of the lenders with which we talk are avoiding any credit exposures that are not entirely money good and fully collateralized. Part of the reason for this is that the cash flows coming into the banking industry are falling almost as fast as the Fed is subsidizing their interest expense. While many of the larger players among the banks have reported gigantic increases in net interest margins during 2009, there are many more institutions whose gross yield, as we label it in The IRA Bank Monitor, is falling faster than interest expense. Like SunTrust Banks (NYSE:STI). We'll be profiling some of these institutions next week in The IRA Advisory Service.
BTW, we are in the process of transitioning the IRA Bank Monitor consumer ratings and related banking services to our new site, www.irabankratings.com and adding new functionality to the main URL. We welcome your comments.
us1.institutionalriskanalytics.co....
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