The most taxing problem of our time

On the one year anniversary of the Lehman Brothers collapse, we put together a series of articles to mark the event and assess what problems still remained. The issue of banks that are 'too big to fail' but 'too big to save' remained unsolved.

This is our piece.

One year later we still don’t know if the regulators choice to sacrifice Lehman Brothers was the right one. But we do know they will do whatever they can to not have to make that choice again. Reports Jonathan Shapiro and Jane Lee.

In the final hours of the 158 year existence of Lehman Brothers, the ex-Treasury secretary and former rival banker Hank Paulson, Fed Chair Ben Bernanke, and NY Fed president Tim Geithner faced the toughest call of their lives.

Should they intervene and save the firm? And if they let it fail would the already brittle confidence of the financial markets withstand its collapse?’

While opinions are divided, the current version of history reads that the decision to let it fall was a catastrophic misjudgment. It’s a choice that the world wants to make sure never has to be made again.

The RBA governor Glenn Stevens concedes that managing the systemic risks posed by large bank failures is one of the defining challenges that regulators of his generation will face.

‘The most taxing problem of our time’

“The global policymaking community will have to grapple more effectively with the problem of entities that are ‘too big to fail’, but potentially ‘too big to save’, especially where their activities cross national borders. This is probably the most taxing financial regulatory problem of our time," he said recently.

Some believe that the problem of banks that are too big to fail will never go away.

"There will always be too-big-to-fail banks, no matter where the current debate leads us. When I say that banks’ balance sheets should be capped at $300 billion, I’m not for a minute saying that $300 billion is small enough to fail; I’m just saying that such banks are small enough to rescue,” says financial markets commentator Felix Salmon.

“Too big to fail we can cope with, by rescuing banks rather than letting them fail. Too big to rescue we can’t cope with. And right now, the big four banks in the US are too big to rescue. Which is scary," he said.

Stuff them with capital

One approach is to ensure big banks are more than adequately capitalised.

“If we cannot split banks up and cap the size then as a minimum we have to stuff them full of capital,” says Gary Jenkins, head of fixed income research at Evolution Securities in London.

"They just have to have lots of capital and we have to have much lower risk products being done by the banks and much less risk being taken so that they are much safer entities. And the only way you’ll do that is with regulation."

Others feel that being equiped to manage the failures, rather than preventing them is a more pragmatic approach.

"You’re not going to stop these things from failing, the best you can do is improve your ability to mop up afterwards. One of the big problems – and AIG illustrates it very clearly – is we’re still trying to regulate a global financial system with local rules. AIG was a classic example because as an insurance company it does not fall within central bank regulations. It does not fall under the transparency requirements of the central bank. And that was true of the investment banks too," said David Weiss, S&P's global chief economist.

Servant not master

Another way to manage the ‘too big to fail problem’ is reducing the importance of banks. Measures such as increasing the size and accessibility of capital markets so that businesses can lend directly from institutions is one such measure.

“In the same way that big companies can access funding directly from capital markets, by issuing bonds or commercial paper, I want to start creating a different financial model in the future, in which small companies get funding from sources other than banks,” said Chancellor Alastair Darling of the UK Treasury in a recent article.

“Our goal is to make finance the servant, not the master, of the real economy,” he says.

Jenkins shares a similar view on the role of the banking system.

“When you actually think about it what is a bank? What is it there to do? To oil the wheels of commerce. It being commerce itself is actually in some ways wrong,” he says.

He feels that the banking system should be a commodity or utility-like product, especially since it has become evident that the taxpayer has to stand behind it.

“That’s what it should be and that’s what regulators should want because if, at the end of the day, you have to bail it out - why on earth do you want it to be the main kind of money making machine in your economy? It doesn’t make any sense. They need to have a complete re-think about how the financial system should work. But I don’t think it will happen.”

Balance sheet overconfidence

A bit technical this one. Business Spectator column about the health of Australia's companies. All good...for now.

Balance sheet overconfidence

Corporate Australia's balance sheets are now showing virtually no vestige of the credit crunch, but they are by no means home and hosed.

Australia confirmed its status as the great escape artist in the most emphatic way this week. While most central bankers are still assuring their constituents that they had no immediate intentions to withdraw support measures, the RBA thrust us atop a pedestal by becoming the first of the G20 nations to lift rates.

But nowhere is the ability of the Australian economy to dodge a bullet more evident than in the financial metrics of Australia’s largest corporations.

Be it by good luck or good management, there are no remnants of the stress of the past two years in the sets of statistics presented by Fitch Ratings at a recent market gathering. The agency says that although gearing levels remain elevated, cash has continued to flow and credit metrics are healthier than during the last downturn in 1992.

Part of this perky outcome for Australia’s corporates is down to what Fitch calls "the residual positive impact of the resources boom" as China continues to scale up economic activity. Australia is well endowed and well positioned in the current circumstances and corporate balance sheets are benefiting.

The big get out of jail card dealt to local treasurers, and one which credit investors are grateful for, is our deep and liquid equity markets. While banks and bondholders ran for the hills, equity investors were happy to recapitalise those companies with stronger business models but whose financial profile was impaired by the downturn.

This cash injection, equal to over 10 per cent of total shareholder funds, pushed debt ratios back to 2006 levels. Without this backing, debt to earnings would have soared to a 1992 number.

With the help of the massive equity raising and a timely re-opening of bank and debt capital markets, treasurers have to some extent managed their liquidity profiles and ensured that most of their looming debt is refinanced.

But it is not time to celebrate. Finding bears at a credit rating agency gathering is not hard (it is the job of a credit analyst to fear the worst) and there is much for corporate Australia to be concerned about.

While the property sector has found its way back into favour, it continues to worry some. Commercial property values remain opaque due to a fairly dysfunctional market, while the inherent structure of AREITS means that companies are obliged to pay out most of their profits. The leverage of the sector becomes apparent when comparing like-rated corporates. While a firm like Foster's can easily pay back all its debt in several years, it would take Westfield – the most lauded of property firms – well over 20 years, even if it was allowed to halt all its dividends to clear its debt.

Another sector that has attracted attention is the energy and utilities sector. Steve Durose from Fitch ratings points out that firms in this sector are likely to need a combination of both debt and equity to meet the massive capital expenditure requirements to maintain networks' security of supply and to transition to a lower-carbon electricity generation mix. Expect to see deals done in both local and international capital markets to support the increased need for new funds.

Many of the other sectors should be alright and could benefit from the booming offshore bond markets. Borrowers in non-cyclical sectors are finding plenty of interest in their bonds. An Australian dairy firm recently tapped markets at margin that was almost half that paid by property trust Dexus, while demand for beverage companies’ bonds is said to be strong. In the domestic market, Wesfarmers has seen its bonds sought after, and perform much better than some of the other new issues, due mainly to its non-cyclical retail assets. And overnight, telco Optus priced ten year bonds 32 basis points inside of Commonwealth Bank, considered among the safest in the world.

Refinancing still remains an issue for many corporates. As James Wadell, director of capital markets origination at NAB noted: “The price that you pay on a bond issue is not important, it is the ability to access the market, and for some that access is still not there.”

Fitch estimates that over $A223 billion of refinancing needs to take place until the end of 2012, most of which is bank debt. More imminent, the ‘twin towers of debt’ loom with large spikes of corporate debt maturing in 2010 and 2011.

This massive task is for the most part expected to be handled. The figure is distorted to some extent by facilities that may never be used, and a winding down of capital expenditure in the material sector will increase the ability to pay down debt.

While the credit crunch doesn’t show in the aggregate stats, treasurers will be humbled by the experience. One lesson they would have learnt is that concentration of maturities and markets will cause headaches down the line. This could result in a strategy of tapping more markets, more frequently and in smaller amounts to smooth out debt profiles and avoid refinancing spikes.

And it is not only corporations that should be wary of celebration.

Despite the chest beating that this week’s rate rise brought, Fitch still has Australia’s foreign currency sovereign rating below AAA to reflect the reliance of our financial institutions on the continuous functioning of offshore debt markets.

Local corporates also face significant uncertainties in the context of the broader economy.

Sarah Percy Dove, Colonial First State’s head of credit research, comments: “We see the rally continuing across all risk assets until government stimulus is removed globally. There is a general acknowledgement among policymakers that it must be done. The unexpected consequences however remain to be seen.”

Derring Do Down Under

Business Spectator column on Australia's obsession with equities. There is a lot of press about Australia being 'the lucky country', I hope it stays that way but the strong weighting of the nation's retirement savings towards stocks suggests a hint of overconfidence.

In Like Flynn

Australia loves a punt. Between the pokies, the TABs, and two-up on ANZAC day, having a flutter is more than a hobby – it is almost a national imperative.

So it should come as no surprise that an OECD study conducted on pension fund allocation found that Australian retirement funds are by far the most aggressive among the 27 countries surveyed.

About 60 per cent of our retirement savings sit somewhere in the ‘global casino’, invested in local or international equities. The US and the UK are aggressive too – sitting fifth and sixth among the list in terms of stock allocation – but our Anglosphere mates are more gun-shy than us, to the tune of at least 10 per cent.

By way of comparison, German retirement funds have only a 10 per cent total allocation to stocks, while our fellow flag-bearers for banking conservatism, Canada, have 30 per cent in equities on the table.

Our bet is big. Not only is it the money we’ll be calling up for food and shelter when we’re too old to work, but the weight of savings in question amounts to more than the entire GDP of Australia.

So apart from the thrill of the bet, why are those entrusted with our nest eggs so gung ho by global standards?

Dr Stephen Nash, fixed income expert at FIIG Securities, has given the question a considerable amount of thought and has come up with a number of possible answers.

Firstly, a belief that those equities are able to provide a return that outperforms the erosive effects of inflation may pervade among local asset consultants. Dr Nash, however, dismisses this approach as weak at best, with better investment options available to guard against inflation.

Another reason is the nature of contributions in the superannuation industry. Because the law mandates that a set amount is contributed each year, as opposed to a set target returned on retirement day, there is a school of thought that pension funds may be a little more liberal in chasing returns and outperforming peers.

While that theory sounds good, there is little conclusive evidence to support the fact that a defined contribution pension is more risky, or has materially different asset allocations, versus a defined benefit pension. Data, admittedly from a few years back but at a time when defined benefit schemes were more prevalent, shows the same overall 60 per cent weighting to stocks in both pension types.

The long bull run also could have contributed to our bias towards equities. Our superfund trustees have become familiar with the returns that can be made with stocks, but have had few opportunities to become accustomed to the risks.

And by global standards, our punting club has had a good run. Australia was impacted by the ‘tech-wreck’ of 2000, but not nearly as adversely as the US technology stock-savvy investor, sucked into the market by ‘irrational exuberance’. Before then, US pension funds also placed 60 per cent in stocks, but the allocation has constantly fallen ever since. Around that time, Australia was on the cusp of a mining boom that has kept on going. Even this GFC hoo-ha has, for the most part, been wiped from memory as the commodities super-cycle continues to spin.

This love of stocks really is Australia-specific. As close as New Zealand, the punters lost their enthusiasm for the share market. The horrors of the ’87 crash saw NZ investors permanently put off stocks and is one of the reasons why their retail bond market dwarfs Australia’s, while the opposite is true of our respective stock exchanges.

Dr Nash also feels that a general lack of understanding, among Australians, about fixed income could be a factor.

An obsession with the stock market has long persisted, resulting in one the highest levels of stock ownership in the world. The infrastructure to access bonds is also simply not there. The man on the street will find it much easier to put his savings on an ‘exotic multi perm quinella’ at the trots than to buy a corporate bond, and it can probably be done in greater volumes. In the US, Europe and Japan the culture of bonds is far more prevalent, with thriving retail markets for fixed income securities.

While changing the equities bias within Australia’s investment community would be nothing short of a cultural revolution, there are signs that this is slowly getting underway. The early development of the retail corporate bond market may have been stunted by a renewed interest from wholesale investors and a recovery in stocks, but smaller deals by the likes of Heritage Building Society and Brookfield, and a order book of $A3 billion for the Commonwealth Bank’s new PERLS issue, shows that interest is piqued.

Dixon Advisory, a boutique investment firm that advises clients who self-manage their superannuation funds, has also seen overwhelming interest in its corporate bond funds. They’re close to locking up their fifth this year, with over $A200 million raised in their first four offers.

Regulators, too, are keen to see a market develop, as taskforces examine the workings of the superannuation industry and seek to ensure safer investment alternatives are available to retirees.

The form guide might not show it, but here’s a tip – the Australian public will be embracing bonds in 2010.

Beware the regulator

The fear of banks that are too big to fail, and to big to save has been perplexing global regulators for some time. How they solve this problem have a massive impact on global banking.

Beware the regulator

Hector Sants, the head of the UK market regulator the FSA, said recently that the market wasn’t scared enough of him. ‘We want people to fear us,’ he said.

Well, on Friday afternoon some Australian bondholders incurred the new-found wrath of the FSA when it told RBS to withhold the return of capital to investors of locally-issued junior bonds.

The FSA, rightly or wrongly, objected to the early redemption of the bonds on the grounds that the UK taxpayer had not tipped billions into the bank’s coffers for the benefit of yield-hungry Australian bond investors.

In truth, the secondary market valuations on these bonds anticipated this action to some degree, but it does show eagerness on the part global watchdogs to show their fangs.

If credit, equity and even commodities investors are not frightened, they will do well to pay careful attention to the behaviour of regulators as they seek to redraft the rules of global capital markets.

Deutsche Bank are attentive. This week the bank shut down a popular exchange traded oil fund because of ‘limitations imposed’ by the NY Mercantile Exchange. The fund used leverage and exposures to oil futures but could not generate returns because it was restricted from buying more contracts once it hit the regulator’s limits.

But it is in the global banking sector where the impact will be largest and there could much at stake depending on the direction and determination of global regulators.

With the Lehman’s anniversary approaching, they will more conscious of the financial reform ‘to do’ list. One item that policymakers will readily admit is too hard to solve, is the ‘too big to fail’ issue whereby financial institutions grew so large that their collapse would unravel the global capitalist system.

It’s been logged as a problem, but perversely some of the organisations that were deemed too big, have swelled even further.

The complex problem becomes even more perplexing when ‘the too big to fails’ extend across multiple jurisdictions.

“Basically it’s an elephant problem. You’ve got all these regulators, each of which controls a very small part of the overall animal. So one guy’s responsible for the trunk, one guy’s taking care of the tail, one is taking care of the left rear toenail, and everybody says, ‘Well my part of the elephant’s doing fine, but somewhere along the line the animal died and It’s not my fault,” explains David Weiss, global chief economist at Standard & Poor’s.

One of the very few ways to tackle the problem, according to Gary Jenkins, head of credit research at Evolution Securities, is to stuff these elephants full of capital.

“They just have to have lots of capital and we have to have much lower risk products being done by the banks and much less risk actually being taken so that they are much safer entities. And the only way you’ll do that is with regulation.”

The end result may be banking systems that are easier to patrol, given there are fewer but more solid institutions. But as Jenkins points out, regulation needs to be conducted on a global scale to be effective.

Regulatory steps in the direction of reducing the ability of big banks to take risks will, on the surface, play into the hands of lenders but reduce the opportunities to equity stakeholders. It may also create a nimble class of smaller banks with higher funding costs, but higher profit potential, operating alongside the caged elephants.

The central banks are the biggest banks around and while there are no imminent signs of their failure, some in the market are most fearful of how they might act.

A professional rate-watcher from a macro hedge fund sent us an observation from a blog.

“There's a large amount of money on sidelines waiting for investment opportunities; this should be felt in market when ‘cheerful sentiment is more firmly intrenched.’ Economists point out that banks and insurance companies never before had so much money lying idle.”

The quote appeared in the Wall Street Journal in August 28 1930 – reproduced in ‘newsfrom1930.blogspot.com’. If it sounds familiar it’s because it’s similar to comments heard recently, including this one from JPMorgan, published this week.

".. the amount of cash still sitting in money market funds and in bank deposits shows many have not enjoyed the rally this year. This suggests further upside from here if/when the economic data continues to be strong."

Our rate-watcher says it’s easy to see how, back then in the 30’s, the central bankers were fooled into thinking it was time to tighten monetary stimulus. He’s very scared they might make a similar mistake this time around.

Mock op/ed The future of finance journalism

Like most people, the subject matter that is of most interest to me, is well…me! I am essentially an online finance journalist and find the fate of the trade is fascinating. What is the purpose of financial journalism and in what form is it most valuable and commercially viable? Since I am stranded in the office by a Spring downpour, I’ve decided to write a mock-op/ed for the New York Times, even though I have plenty of real stuff to do…. (As if the NYT would give me over 750 words!)


Jonathan Shapiro’s Mock Op-Ed in the New York Times, October 10, 2009

Providers of financial news are at a critical junction as they march deeper into the online era. The decisions that executives make today will either ensure their prosperity or cast them into oblivion.

Finance news is somewhat different to other forms of news. News generally consists of items of interest. While in many cases finance news is interesting, it is crucially something else –it is tradable. How and when and what information is disclosed influences decisions and asset prices and is therefore inherently valuable. This will never change.

What has changed is how this information is delivered. The sheer importance of financial information has meant that it will always travel quickly but the median in which it is being delivered continues to evolve with technology.

News and finance information can be divided crudely into two categories. Information can be facts/developments and opinion/insight. In most instances, it is in the financial system’s broader interests to ensure facts are divulged democratically which offers little opportunity for one provider to differentiate itself from another.

The objective of opinion or insight is to either anticipate facts or developments or interpret their meaning. Opinions should not have the same limits applied to them, they are merely the beliefs of providers to other observers and generally it is the responsibility of the reader to determine and pursue the opinions deduced from public facts, he or she finds valuable

Broadly speaking the online and print media aim to deliver both the fact and opinion desired by readers.

As an online journalist, the ultimate embarrassment is to be beaten to a story by the print media. This means the print journalist has discovered a development, typed it up, had it edited and sub-edited, sent it off to the printers, who have run thousands of copies, sent them to the trucks and to the paper boys and newsagents, who have then delivered the paper to the doors and stores of the city before I’ve had any idea of the story. An online or wire journalist can publish the same story inside five minutes of finding out about it and a print scribe is at a clear disadvantage.

It’s clear then that the print format cannot compete in terms of timeliness breaking fact. So then what are the benefits of the clumsy old press? Well it’s not dead yet. Printing is an expensive and time consuming process which in itself acts as a quality control. To use an analogy, compare the last e-card you used against the last wedding invitation you received. The copy also has to carry resonance that lasts long enough for it to be edited, inked and delivered. Also for the price of a coffee, it’s the equivalent of a PA printing off all the best bits of the day and adding some pictures for you to read with your coffee. Not to be discounted is the value and prestige of physical permanence versus fleeting light.


Some things work for print but most things work against it. The challenge the print media faces, in addition to being easily out scooped, is to consistently match online copy for quality of insight. This is where economics comes into play . While the value of online advertising remains opaque, the revenue from print adverts can sustain the old model for the time being by essentially funding better quality. But for how long? It’s hard to envisage anything other than a slow decline in the print media as information is delivered faster and better.

Online news providers are gradually stumbling on the subscription model to supplement erratic advertising revenue. They have come to realize that consumer will always pay for something that they either need or see as ‘value’, and there’s value in swift access.

In fact, access will always have value on many fronts. A media provider that is able to find facts that no-one else can or provide unique and original insight. Access is a virtuous circle in that a wide reaching net incentives newsmakers to engage with one provider over the other. Insight is harder to erect barriers around, but more difficult to sift through amidst the infinite blogosphere.

So what is the essence of value in finance journalism? In my experience it’s a combination of timely fact and quality opinion, and ideally a combination - timely opinion. This is the future of finance journalism. Sharp and insightful comment and analysis that helps readers understand the facts with greater speed. It is where the virtues of print and online media meet.

Retailer bond batlle

Latest weekly column for Business Spectator...

Retailer bond battle - Business Spectator

Australia’s top retailers are not only squaring up to do battle on in the hardware front. Woolworths and Wesfarmers may be due for a face off in the corporate bond market.

The global financial crisis wiped some of the world's pre-eminent financial institutions off the planet and decimated the savings of millions. Some things however changed for the better, especially if you’re involved in buying, selling or arranging Aussie corporate bond deals (or writing about them for that matter).

Two years ago, bankers pitching the merits of the corporate bond market were politely ushered out of the offices of various corporate treasuries. Now, as this week has shown, even the highest and mightiest of our corporates are rolling out the red carpet.

“What has happened is that treasurers have said ‘We need an alternative source of funding. We can no longer just rely on the bank’. In the future, any company that is big enough to get a rating and has a borrowing requirement is going to have some sort of strategy that involves access to the capital markets,” says Gary Jenkins, head of fixed income research Evolution Securities in London.

“I’m not saying they all will access capital markets but they will have to at least consider it, and that’s very different to where we were even five years ago,” he adds.

While an appreciation of the corporate bond market was immediate for European and the US treasurers, Australian companies have dragged their heels to some extent.

With relatively strong balance sheets and attractive loan options being offered up by Asian banks, Australian corporates did not feel the same urgency as their offshore peers to issue bonds. There was some take up with a trickle of moderately sized deals from Tabcorp, CFS, Dexus and Leighton before Swiss cement maker Holcim’s $500 million bond issue showed the keenness of investors to support AUD corporate bond issues.

This week has seen a new phase in the local market’s growth spurt. For the first time in years, Australian bond investors are seeing the names that they desire, rather than the ones they merely tolerate, show an interest in the corporate bond market.

In the coming weeks, investment grade firms Wesfarmers and Woolworths plan to update debt investors. The meetings are not officially deal related but they are likely to be a signal of intention to issue notes at some stage in the future.

Wesfarmers recent experiences in the local bond market have been colourful. An unpopular decision not to redeem the Coles bonds in 2007 following the takeover got a number of large fund managers offside. The company however has since maintained a regular dialogue with investors and once the apologies were made, talk shifted to its diversified revenue sources, the progress of the Coles turnaround, and of course bond pricing.

Woolworths has always been at the top of bond fund managers’ shopping lists. A well managed, defensive and dominant household name, it meets all the criteria for a good fixed income investment. Unfortunately, a local bond issue hasn’t always been top of Woolworths’ priority list. Rumours are that the retailer was all set to go on a domestic bond issue earlier in the year but the terms of an Asian syndicated loan proved too attractive.

Flush with cash from the pockets of Australian consumers, in addition to its drawn funds from Asian lenders, Woolworths appeared uninterested in a bond deal, until now. The ‘A-‘ rated company, which has again reaffirmed a commitment to its credit rating, should see its bonds fly off the shelf should it choose to issue.

Other companies are also showing interest. With the stress of earnings season out the way, arranging banks are said to be inundated with requests from treasurers eager to either establish or consolidate their presence in the bond market. Mirvac and CFS have already held bondholder presentations while Stockland has explicitly stated its intentions to access the local bond market.

For all its potential however, the Australian corporate bond market does have its limitations.

Westfield is another name, whose paper local fundies would love to own. The property trust has always favoured offshore bond deals and this week’s dual tranche USD issue vindicated their faith in the depth of the US 144a market. Within 24 hours of releasing its annual earnings, it was able to launch and execute a $US2 billion bond offer of six and 10 year duration, inside of price guidance. Such a quick fire debt raising is unlikely to have been achievable in the local format.

The domestic corporate bond market might be some way off supporting Westfield’s high expectations, but the new found confidence in the local market, coupled with a desire from corporations to demonstrate access to alternative debt funding, bodes well for Australia’s corporate bond industry.

Trillion dollar confusion

Here is the latest piece to be published on Business Spectator. This looks at why credit and equity markets don't alway move in sync..Fascinating stuff !

Trillion dollar confusion

‘Corporate bond issuance hits new record’ ran the headlines on Wednesday. On Thursday however we were reading ‘Corporate bond defaults hit record.’ If you’re confused by news emanating from credit markets, don’t worry because you’re not alone.

Earlier in the week, data firm Dealogic reported that global corporate bond issuance had hit $US1 trillion for the year, the first time it had done so. With banks reluctant to lend and bond funds eager to invest at bargain levels, the result was a boom in bond issuance.

The volume and performance of corporate bonds masks the fact that 2009 is the worst year on record for bond defaults as 201 borrowers, with $US453 billion of debt, have hit a wall. The numbers look nasty but have, to a large extent, been priced in while restored confidence in the credit sector is allowing companies to re-finance, slowing the default count ticker.

It has however been a week of mixed signals as credit reached an ‘inflection point’.

Investors and traders are asking if the reversal in credit spread tightening is a sign of a healthy pullback or a precursor to a return of the bear market.

And it’s not only dealers who are debating but entire asset classes, with equity and credit markets agreeing to disagree. While stocks bounced back emphatically from a poor start to the week, credit indices have underperformed, trending lower.

There are a number of reasonable explanations for the disconnect. For starters, credit’s rally has been fiercer and faster than any in its history. Its current weakness may be reflecting a more profound correction relative to equities.

Another premise may be that credit markets tend to focus on suppressed economic fundamentals such as consumer spending, while equities have taken heart from what appears to be an improving corporate profit outlook.

It’s a natural bias given credit’s real gains from an economic revival are moderate compared to stocks, and the varying macro-economic views as to the shape of the recovery may be at play, resulting in divergent investment decisions by debt and equity investors.

There is a more elementary reason to explain why credit and equity markets move out of sync, however. It’s the classic conflict of interest between owners and lenders.

During the darker days of the crunch, credit and equity were in the trenches together, and both sets of investors demanded hasty deleverage.

But as the darkness lifts, the dilutive capital raisings have left shareholders with a smaller piece of a lower yielding pie. For bond investors, especially in investment grade corporates, the legacy of the credit crunch is a positive one.

This week’s set of corporate earnings highlighted the trend. Investment grade corporates such as Rio Tinto, Wesfarmers, Santos and the AREITS told investors that massive equity issues, dividend reductions and asset sales had significantly reduced their debt burdens.

But the leverage clock never stops ticking. As the environment stabilises, companies are once again seeking to appease their stockholders. This week saw a number of equity ‘deals’ with growth rather than capital management a motivating factor. There are also rumblings of some IPOs on the way, marking what would be the final stage of the recovery of our capital markets.

Blackstone's new deal

I've recently begun contributing to a far-reaching Australian finance website- 'Business Spectator' on a weekly basis, as part of our efforts to broaden the brand of our publication, which tends to be followed only by readers in debt markets.

The columns (I've always secretly wanted one!) are published on the weekends, posted after midnight on Friday and removed by 8am Monday morning for minimum exposure, but hopefully enough readers will come across them. The intention is to convey the events in credit markets for the week and their impact on broader markets.

Business Spectator - 15 August - Blackstone's new deal

Blackstone's new deal

Some say the top of the last bull market was easy to pinpoint. It was the day when the smartest deal makers in the world, known for cashing in by taking businesses private and reselling them to the public, sat at the end of a long oak table and told you to buy their own firm. That was the time to get out.

Private equity merchants Blackstone listed in a $US4 billion IPO in June 2007. The rest is black history. This week, Blackstone was back, tapping the bond markets for $US600 million of 10 year bonds, taking advantage of an incredible surge in demand for corporate bonds. Blackstone received over $US3 billion of bids as corporate bond investors scrambled for paper, allowing it to price well inside of guidance.

Time will tell if Blackstone’s deal was as ‘impeccably timed’ as its share offer was, over two years ago. It does, however, raise the question as to sustainability of credit’s rally and the window of opportunity to raise funds through a resurgent corporate bond market.

While Blackstone’s issue was well supported, there were some signs that demand for corporate bonds is waning. A single basis point slide in Merrill’s corporate bond index brought an end to a 23 day rally in cash bonds, while high yield bonds widened for three straight days after 16 positive sessions.

Credit indices also trended wider this week. The US’s CDX index was 10bps wider for the week by Thursday’s close while the Euro Main index was steadier trading around the 90 mark.

For the time though, the sector remains resilient with bearish traders too reluctant to bet against a general tightening bias. While the summer lull is slowing the supply of paper, those that do print deals are welcomed emphatically.

"I expect this risk rally to continue into – and maybe through – a large part of August. What happens after that? The next ugly leg of the bear market begins as we get into the July through September 'tipping zone', driven by the failure of the data to validate the V (shaped recovery) that is now fully priced into markets," said Bob Janjuah, RBS’s chief credit strategist.

Eye-catching rally

The performance of corporate bonds is attracting more widespread attention. Some equity analysts are watching for a slowdown in demand for corporate bonds, which has allowed companies to access funds at fair levels, for warning signs of a pullback in stocks. Plus credit markets have good brand as fortune tellers, having sold off sharply before equities came crashing down in 07.

The Bank of England has made a ‘mint’ from its corporate bond portfolio. As part of its quantitative easing initiative to boost liquidity, it piled into the sector in March and its portfolio is now up over 10 per cent prompting analysts at Evolution Securities to suggest it start operating as a hedge fund.

China however is perturbed by the rally which it says has made yields too low. It plans to set a minimum yield of 4.2 per cent for five year bonds to encourage investors to the market and wean companies off bank loans. There’s an idea.

Aussie credit still strong

The rally in Australian credit is showing few signs of weakness. While the Aussie iTraxx had snapped back to the 150 mark mid week, it recovered to trade back around 140bps. Corporate credits were helped by solid earnings from local market bellwethers CBA, BHP and Telstra who all reported multibillion dollar profits and strong capital positions.

New deals are continuing to come thick, fast and tight. This week saw two Kangaroo trades print well inside levels seen at the start of the year while Westpac raised a healthy $2 billion of five year senior debt at 35 basis points cheaper than they would have done a month ago.

The guaranteed space has also seen significant spread compression. Investors paid only seven basis points more for guaranteed bonds issued by 'BBB' rated Members Equity than they did for 'A' rated Citigroup. That premium is smaller than the 10bps investors demanded for bonds issued by Heritage Building Society versus like-rated regional Bank of Queensland. Both deals were printed in early July, and have since tightened by 20 to 25 basis points.

Domestically, the week ahead is another heavy one for corporate earnings but with corporate bond issuance all the range, we could start to see some of Australia’s top companies capitalise on credit’s incredible run.

Insto provides debt capital markets insight for their subscribers.

Snowmobiles on 1 April...

As the lawyers get smarter and the population gets dumber, The April Fools news item is a dying art. In the world of debt markets however, where the opposite is true, We thought we'd give it a go, telling our readers that Snowmobile deals would re-ignite our floundering securitisation market. It turned out to be one of our better articles and with abit of humour, we really engaged our readers. Even, the government's AOFM were good sports, providing us with a sharp, and funny response which they allowed us to publish.

***Snowmobiles to kick-start local ABS market***

A group of Australian investment banks are planning Australia’s first ever snowmobile
securitisation deal in an effort to revive the domestic asset backed securities market.

As demand for RMBS and auto loans has waned, banks are getting creative in attracting investors back to the ABS market and a securitisation of snowmobiles is seen as the perfect asset class to rev-up the market.

Investors have cited illiquidity in asset backed markets as the biggest stumbling block to the market’s recovery. Snowmobiles however operate better in less “liquid” environments.
Banks are eager to test investor enthusiasm for snowmobiles and are planning an off-road show for investors at Thredbo this coming winter. It is unclear as to whether the Australian Office of Financial Management will support the proposed issue, but given the snowfield’s proximity to Canberra, if the AOFM does come through as a cornerstone investor, it should be able to keep a close eye on its investment.

***Note on snowmobiles(1 April 2009)***

Some of our less astute readers may not have realised that the previous story "Snowmobiles to rev up local bond market" was nothing more than an April Fools Day fabrication.

While we have every faith in the recovery of the ABS market, we don’t believe it will be achieved via a snowmobile securitisation. In fact some suggested such a deal would receive an ‘icy’ reception, while others hinted that it didn’t have a ‘snowballs chance in hell’ of succeeding.

The AOFM issued the following statement:

“The AOFM is yet to receive a proposal regarding the transaction. As you are aware, the AOFM is only able to invest in prime RMBS. Therefore our initial thoughts are that only snowmobiles with an annex, canvas or plastic, capable of sleeping at least one person and able to be fully closed to the weather and permanently affixed to land could qualify. We are also concerned that the portfolio may have prohibitive geographic concentrations. The transaction is however not without merit. Accordingly, the AOFM thinks that an on-site due diligence over a long weekend in August is required, timing subject to the quality of the skiing conditions at that time.”

We hope you enjoyed the story. We apologise to any investors that raced out to do their credit work on the Australian snowmobile industry and to the irate bankers who rang around to find out why they were not on the deal.

Apart from one foolish email a year, Insto remains as committed as ever to timely, accurate and insightful reporting on Australian debt markets.

Becoming an Aussie Citizen

published 17 May 2005

By Johnny Shapiro

What does Australia expect of its new citizens? Would-be Aussie Johnny Shapiro gives Crikey readers a South African perspective on becoming an Australian citizen:

Advance Australia Fair...

Today is a significant day in my life. I am officially eligible to incorporate as an Australian entity ie. become a citizen of Australia. I have been notified by e-mail that my formal interview will take place on June 10th, by which time I should be aware of my responsibilities and privileges as an Australian citizen.

Lucky I've got over a month to learn them. Being the diligent applicant that I am, I've already come up with a handy anagram to help me remember my duties – DOSE – Defend Obey, Serve, and Enrol.

The first one “defend” has given me second thoughts – I am required to defend Australia – should the need arise. It means that if we're under attack, I would be expected, as part of an agreement with the state and in exchange for the privileges granted to me, to help fight off any external threats to the nation. Holy shit... I don't want to die for Australia – all I want is a passport, and the right to live and work here, and maybe running water. None of those are worth more than my life, well to me at least.

What if Australia is threatened? Suppose the mighty southern forces of New Zealand become antagonised about the quantity of sheep jokes directed at them and decide to launch a surprise attack on Port Botany? By virtue of my location in an urbanely renewed apartment – I'll be right there on the front line! I'll have to thwart the kiwi insurgency through Alexandria towards the airport and hold the strategic Surry Hill. But how? I have no military training; I'm shit scared of Maori warriors, they'll beat the crap out of me without knowing I was in their way.

I'm a lover, not a fighter – although the demographics of Surry Hills could make me the only thing preventing New Zealand Armed forces from reaching the CBD. They can have it. If we are attacked I'm putting on an All Backs jersey, a thick accent and crawling into a deep hole. Let's hope we stay friends with New Zealand and continue to allow their people to visit and claim unemployment benefits. Maybe it's all part of a plan to nullify the threat from the land of the short sharp vowel. I'll have to lie about promising to defend Australia, and hope that the Pacific and Indian Oceans, and our good terms with our neighbours continue to serve us well.

Okay so I won't defend Australia (unless its from the Solomon Islands) – but I guess I will have to “Enrol”. Enrol requires me to vote. Australia is a remarkable democracy that in the process of being democratic your civil liberties are abhorrently violated ... It's illegal not to vote – you have no right to not have a right. If you don't you get fined. If you're a motorist you are likely to get fined for waking up in the morning, but being docked wages for not giving a shit about politics is a tad harsh in my book.

The task is made more cumbersome by the fact that there is no one to vote for – my only viable choices are the right wing liberals – or the leftie labours, who does the middle of the road “corporates-are-evil-but-workers-are-lazy” vote for? I can't vote for the greens because with all the oxygen I inhale and all the Carbon dioxide I exhale, I'll feel like a hypocrite, and that's the only alternative I can think of.

Hopefully by the time I do have to cast a ballot there will be something worth voting for – I think Australia is more likely to be invaded by New Zealand.

“Obey” – I've got to obey Australia's laws and be a good citizen. That's the hardest one so far. I'm not doing so well as a resident. Australia was built by criminals and enforcement officers have been kind enough to make me feel very welcome. I am within 1 point of losing my license, and been fined over $800 in under a year of driving. Granted they were for deadly offences such as failing to buckle-up, not parking rear to kerb, and using a mobile phone while steering, but still – I've got to eat.

Perhaps I am being too sarcastic; I did attempt to pull off a ridiculous manoeuvre last July on a Sydney road and ploughed into another car, causing severe damage to both cars and my insurance premium. Woops. Sorry. My punishment ... 2 points and $60 fine. The traffic officer that saw me putting on my seat belt by Bondi beach must have known how light my punishment was when he docked half my license points and $240. I can obey from now I guess; I won t be able to afford my bus fare if I don't.

Finally I have to Serve, that's serving on jury duty if I am requested. As far as I know it means that at any time during my stay in Australia I could receive a call up to attend court and listen to evidence. This I have to do and failure will, I assume, make me liable for another hefty fine. I can't pay anymore fines – otherwise I will no longer be classified as a component of 'other' in the finance minister's revenue pie chart.

Hopefully I'll get a gory murder case or there'll be an attractive female in the jury that I can talk to about the legal system and politics, and wether or not Mrs Peterson did it with a candlestick in the library.

I used to only be a South African citizen, that was much easier, as long as you didn't wave the new flag before the old one was canned, or wave the old one when they made a new one – you were alright. “Defend” applied to your possessions, “Serve” applied to those who lived in the backyard of the house, “Obey” was optional and “Enrol” was as alien a concept as “legal system”.

So barring the reasonably likely event of my interview not going to plan, I'll be an Australian soon. I'll let you know how that goes.

Poker without friends - why poker is taking off again

published on crikey.com.au Feb 2005

Columnists

Jonathan Shapiro
Poker playing Crikey contributor

How cool is poker? Jonathan Shapiro sets out to find out what it is which attracts so many men and so many movies to glorify this seemingly seedy sport.

Even though the game of Poker is often associated with middle aged men donning peak hats and armbands, huddled around a green felt table in a dark smoke filled room, there is no doubting its sex appeal.

Hollywood doesn’t doubt it. It has cast two of its leading males, Mel Gibson in Maverick and Matt Damon inRounders, as wily and courageous characters with aptitudes for the game. Television has also played its part in glorifying poker. ESPN’s extensive coverage of the World Series of Poker has created new band unorthodox yet revered stars and SBS recently aired the tension filled Late Night Poker Series.

Poker is worthy of mass appeal- the game is simple yet compelling and requires skills on a number of levels; The mental ability to calculate odds and assess risk, The psychological skills to read opponents, anticipate, react, and manipulate their moves, the strength of character to remain calm and the conviction to make judgments and trust them. Poker demands speed of thought, cunning, and patience.

But Poker is most interesting when the stakes are high and small fortunes rest on the draw of a card. That’s where the romance lies. The skill level of a poker player can be determined by our most universal unit of measurement – cash. When money is involved Poker is very much a man’s game and not at all a gentleman’s game. Admitting you’re shit at poker is akin to admitting you’re crap in the sack –it serves as a concession of your manhood. It is an acknowledgment that you are weak-minded, cowardly, can be deceived and manipulated, and easily conned out of your money. This may be obvious to others but believing it yourself can be too shameful.

So you want to prove your manhood, your shrewd survival-skills, your courage, your nerve? It’s always good to start with a game amongst friends. Poker evenings that stretch deep into the night are as stereotypical as Sunday afternoons at the pub; a social environment with familiar faces is a good way to take the edge out of an often cruel game.

But what if you have no friends? Or if you have friends that do not enjoy playing poker? Or if you have friends that would not choose to play poker all day if they could?

The Star City Casino is always willing to cater to the changing needs of its customers. Encouraged by the ever-increasing popularity of poker, Star City has recently opened up public tables. They are almost always at capacity with many keen players waiting several hours for a vacancy. Unlike most games offered by the casino, players compete against each other rather than the almighty house; the casino’s intake is in the form of 75 cent ‘commission chips’, which each player must forgo to enter a hand. With each table seating 10 players, the casino pulls in a fixed amount of $7.50 per hand. The house’s profit is determined by the efficiency of the dealer; and not the looseness of the player’s pockets. Poker in this instance presents a rare case of socialist utopia in the heart of capitalist excess as each player represents only a seat; and is therefore valued equally by the casino.

The format of poker most favored by the Casino is the one preferred by ESPN and Hollywood- Texas Hold ‘Ems. This is considered the purest form of Poker – where more often than not, but not always, skill and cunning overcomes opportunism.

In Hold ‘Ems - each player must make use of two cards dealt to him downwards, and five ‘community’ cards which are placed upwards in the center of the table. Betting takes place at various stages of the dealing, the first round occurs before any community cards are dealt, and the final round commences after the last card is dealt. The reason this form is cherished by poker aficionados is because the majority of cards are shared, giving players a fair shot as assessing what their opponents may be holding. The various rounds of betting also give players the opportunity to speculate the strength of the other players by observing how they bet. The format is dynamic - many hands are snatched on the final card or the infamous ‘river’ where a weak hand can be instantly transformed into a winning one.

The World Series of Poker tournament held every year in Las Vegas is ‘no-limit poker’. In ‘no-limit’ you can bet as much as you have; with a single hand you can either double your money or be forced to mortgage your home. Here the art of ‘bluffing’ is employed. The boldest and best known poker move, ‘bluffing’ refers to a player holding a weak hand but behaving as though he has a strong one in the hope of forcing players with strong hands to concede. When the stakes are high, accurate character assessment skills and giant testicles are prerequisites.

Do not be frightened. The casino offers $5/$10 or $10/$20 tables for Texas ‘Hold Ems. This is a limited form of poker in which there are set levels of betting. In $5/$10, the first rounds of betting have a minimum bet of $5 and the final round has a minimum of $10. Raising and re-raising is allowed but betting is capped at certain levels for each round.

If you lack the self-assurance or hygiene to sit down with nine strangers at a casino and you have an internet connection and a credit card, you may prefer online poker. Be prepared for a few sessions of playing with demo money before your confidence is sufficiently marinated. There’s also an opportunity to sharpen those social skills between hands by chatting about the intricacies of ‘hold em’s’ with pokerdude212 and PocketRocketRob.

Online poker is much quicker than real-life poker. Calculations and assessments have to take place in an instant and decisions are often made by the gut. Nervous milliseconds are spent hoping and waiting for ‘CONGRATULATIONS’ to flash across the screen and the bits of chips to float towards the pimp-like character that PacificPoker.com has selected to be your graphic representation. Be warned - you can lose your money very quickly, but this may be more dignified than losing it slowly and being blood shot, covered in crisps and still in your pajamas.

Playing out of Australia does present an advantage in this form of the game. If you log on at 9 pm, you’ll be up against groggy compatriots partially covered in food on West Coast of America, and those knee high in crumbs at 4am in The East Coast. Be warned again –the best poker players are nocturnal creatures whose body clocks have long since abandoned hope of synchronizing with nature.

In the name of journalistic endeavor, I risked a small portion of my net worth and the danger of developing an addiction to cards to sample the options available to the poker enthusiast.

My online poker experience was unsatisfying and had it continued for more than one evening, it would have been expensive. Not only did I lose my entire bankroll, but I also beefed up my phone bill with international calls to the customer support team in India, pleading with them to reactivate my account.

I opted instead for the manual form on offer at the Star City –seeing someone take my money in the flesh would feel less like robbery than watching it vanish on a computer screen. I was also hoping for more personal interaction from a game in which human nature plays such a significant role. I was not disappointed. When I registered to play at the poker tables, I became a member of the Star City Poker community of oddballs, gamblers, bored businessmen, tourists, struggling magicians and support staff. I sat down amongst a cast of nine underworld characters I’d be happy to call my friends.

My warm welcome at the table was probably because I did not appear to be the best poker player in the world, and my appearance was justified. Poker nights with friends often finished early and my abilities earned me the nickname “unicef”, in reference to my charitable inclinations. I had since spent some time with my uncle, a futures trader who apparently as a youngster ‘invested’ large chunks of my grandfather’s money on his poker ‘tuition’. He was kind enough to dispense some of his knowledge, and vastly improved my understanding of the game. According to him, the key to winning at poker is to exercise patience and control ones emotion. In this game of men, testosterone is often ones biggest liability.

They say in poker, if you haven’t been able to spot the fool after the first ten minutes- then you’re probably it. ‘They’ of course refers to the mystical source of poker wisdom and poker wisdom, I’ve learnt, is generally acquired at great monetary cost. Fortunately, I could spot some fools. I was being patient and controlling my emotions - saving myself by folding, and betting heavily when I had strong cards. I won some hands and lost the odd few, but overall I was playing well. When I peeled myself from my seat after four intense hours, I had $600 in chips - a profit of $400.

Even though I had just spent the best part of a working world Monday in the casino, I felt great - winning and money tends to have that effect. I had just made more from playing cards than I would earn in a week working in a bank …and it was cash – instant cash! And it was fun! I began to wonder all sorts of things, like playing poker for a living, and paying rent in casino chips. My ego was slowly beginning to inflate. My poker career was doomed.

I returned a few days later. Ten minutes had elapsed and I had yet to identify the fool. A minute later I had inkling as to who it might be. Nevertheless I stayed around for a few hours, and paid $300 just to be sure.