Last week a friend raised the questions on the subject of subprime loan problems in the US. He asked me why the problems were so serious and said crisis of such size to the financial markets had not been seen for many years. Also, he was amazed why the big names like CitiBank and many other, though reluctant, have to go overseas to seek for capital injection. Also, Bear Stearns bailout by JP Morgan Chase had surprised many.
Though related, I try to avoid discussing on the advanced credit risks models such as JP Morgan Creditmetrics model, Credit Sussie's CreditRisk+ model or Merton's KMV model. It is because they are too complicated and too quantitative for most of my readers to understand. Also, this topic and their extension to the regulatory capital and economic capital of a bank are so wide that a blog is too short for it.
Instead, my blog this time will focus on the qualitative side of the credit risk management. There are five main causes that I think of which account for 85% of the crisis.
The first one is superstitious. There was no real downturn of real estate market since the Second World War. It is because of this long perception, most people believe that the direction of the real estate market is only up and no down that made the bankers were very relaxing in their mortgage lending.
The next is the culture. The shareholders and Institutional Investors of the Banks have a high demand for short term performances. These gradually changed the landscape of lending cultures of the banks by emphasising on short term return and tolerating higher risks on the long end of the balance sheets.
Thirdly is the incentive packages to the bankers. The bonus is normally tied to the performances, while higher returns are commensurate with higher risks. So, to aim for bigger bonuses, the bankers are encouraged to go for higher risks business at the expenses of the shareholders.
Fourthly, most banks are relying on the external rating agencies to assist them in rating the Mortgage Back Securities (MBS) and Collateralized Debt Obligation (CDO)in their investment portfolios. So, if there is a lending problem, it is not just a one to one single problem but it is a problem for all the banks at the same time.
Lastly, the credit derivative markets such as credit default swaps and credit spread options etc have been expanding so fast that the contagion is easily get out of hand. The domino effect could spread quickly from one bank to another which could easily collapse a financial system. That was why the Federal Reserve had to take quick actions to stem the spreading by involving into the deal of Lehman Brothers, yet risking the allegation of encouraging moral hazard among the banks.
Though the subprime problems are still overhanging the financial markets, I think we have seen the worst already. It is a painful experience to learn from it but it does help the bankers to minimize committing the same mistakes again.
6/26/2008
If to bet with Stanely why not join his flagship
Sociedade de Jogos de Macau (SJM) is about to launch the third largest IPO so far this year in Hong Kong. It is not a name known by all, but for Stanely Ho, the owner of SJM, is certainly recognized by most of our Hong Kong people. Also, its 19 out of 29 total casinos in Macau and their 1,100 mass market gaming tables and 3,700 slot machines are certainly places that we left some money before leaving this little enclave.
For this overdue IPO, I do not try to restate the facts in the prospectus but do want to highlight the price range values the company at 10.1 to 13.4 times its predicted 2008earnings, which is much cheaper than its major competitors. US-listed Las Vegas Sands is currently trading at 82 times 2008 estimates, and MGM and Wynn are trading at 22 times and 29 times respectively.
I am not asking my readers to risk their money in this stock or saying it is a sure win on the first day of debut but to advise those if to plan for a trip to Macau and try their lucks, why not use the stakes to apply for this IPO. I am always of opinion if to gamble why not to invest, particularly when the counterparty is the same.
For this overdue IPO, I do not try to restate the facts in the prospectus but do want to highlight the price range values the company at 10.1 to 13.4 times its predicted 2008earnings, which is much cheaper than its major competitors. US-listed Las Vegas Sands is currently trading at 82 times 2008 estimates, and MGM and Wynn are trading at 22 times and 29 times respectively.
I am not asking my readers to risk their money in this stock or saying it is a sure win on the first day of debut but to advise those if to plan for a trip to Macau and try their lucks, why not use the stakes to apply for this IPO. I am always of opinion if to gamble why not to invest, particularly when the counterparty is the same.
For envy, do you know there is a ratio?
Sometimes, I wonder the people are so good at picking names or phrases to catch your eyes or attention. You must be of interest to know what is an envy ratio if you come across this term.
This ratio is used in the private equity acquisition.It is calculated between the price paid by the management team and that paid by the investing institution (usually private equity) for their respective share of the equity in a management buyout/in.
For example if a private equity firm paid $30m for 75% of a company's equity and management paid $5m for 25%, then the Envy Ratio would be 2x.
30/75 / 5/25 = 2x
So, the higher the ratio, the more envy will be.
It has been used in London, but it now seems to be catching on in Asia. Anyway, it is a term worth to remember. It is not surprise if to hear happy ratio, sad ratio or even hungry ratio in the future.
This ratio is used in the private equity acquisition.It is calculated between the price paid by the management team and that paid by the investing institution (usually private equity) for their respective share of the equity in a management buyout/in.
For example if a private equity firm paid $30m for 75% of a company's equity and management paid $5m for 25%, then the Envy Ratio would be 2x.
30/75 / 5/25 = 2x
So, the higher the ratio, the more envy will be.
It has been used in London, but it now seems to be catching on in Asia. Anyway, it is a term worth to remember. It is not surprise if to hear happy ratio, sad ratio or even hungry ratio in the future.
6/24/2008
Why Price Book Ratios are used for Bank Acquisition?
With the opening up of the Financial Markets in the aftermath of the admission of China into WTO, there were increased cases in merger and acquisition in the Banking Sector either in Hong Kong and China which poised opportunities to the investors. The valuation methods used for Banks are based on market price against book value ratio (Price/Book) rather than using Price against Earning (P/E) ratio, why is it and what is the rationale behind it?
First of all, what is meant by book value. Book value is equal to total assets minus total liabilities. Since most of the assets and liabilities items on the balance sheet of a bank are monetary items which are highly liquid that can be converted easily into cash if to sell them in the Capital Markets. The market value of these items can be easily identified either by mark to market or mark to model. That is why the Price Book valuation is more appropriate for valuing a Bank than Corporations in other industries. Theoretically, a bank can sell all the assets and paid all the liabilities at market value. The balance of such is equal to the net worth of a bank. So, if there is an acquisition, the minimum price to pay must be at least equal to the net worth of the Bank, otherwise the acquired Bank would prefer to break up the balance sheet and sell them on a piecemeal basis that could ultimately give better value to the existing shareholders rather to sell it to the acquirer.
Hence, in order for an acquirer to succeed the deal, minimum price to pay must be at least equal to the net worth of the acquired bank. How much to pay above the net worth will depend on how much synergies that can be created from the combined Bank. Of course, there are other factors need to be considered such as competitive bids and the level of premium to tempt the shareholders to sell it to the acquirer.
If we take Wing Lung Bank as an example, the 2.9 price book ratio seems quite high but for the acquirer China Merchant Bank (CMB), it may be another story. The price paid by CMB might take into account of growth, synergies and other strategies that the outsiders might not be easily quantified. On the the hand, for the late privatization of CITIC International Financial Holdings (CIFH) , you might be surprised why the price book is 1.6 only if to compare 2.9 above. It does not mean the price is wrong instead it tells us another story. Since the control has been in the hands of Citic Group before the privatization, there is no need for Citic to pay too much premiums for the balance of the purchase. Whether 1.6 is fair will depend on the whole structure of deal such as exchange of shares etc.
As there are many different types of business combinations, it is natural the price book ratio for each deal transaction could be quite different from one another.
First of all, what is meant by book value. Book value is equal to total assets minus total liabilities. Since most of the assets and liabilities items on the balance sheet of a bank are monetary items which are highly liquid that can be converted easily into cash if to sell them in the Capital Markets. The market value of these items can be easily identified either by mark to market or mark to model. That is why the Price Book valuation is more appropriate for valuing a Bank than Corporations in other industries. Theoretically, a bank can sell all the assets and paid all the liabilities at market value. The balance of such is equal to the net worth of a bank. So, if there is an acquisition, the minimum price to pay must be at least equal to the net worth of the Bank, otherwise the acquired Bank would prefer to break up the balance sheet and sell them on a piecemeal basis that could ultimately give better value to the existing shareholders rather to sell it to the acquirer.
Hence, in order for an acquirer to succeed the deal, minimum price to pay must be at least equal to the net worth of the acquired bank. How much to pay above the net worth will depend on how much synergies that can be created from the combined Bank. Of course, there are other factors need to be considered such as competitive bids and the level of premium to tempt the shareholders to sell it to the acquirer.
If we take Wing Lung Bank as an example, the 2.9 price book ratio seems quite high but for the acquirer China Merchant Bank (CMB), it may be another story. The price paid by CMB might take into account of growth, synergies and other strategies that the outsiders might not be easily quantified. On the the hand, for the late privatization of CITIC International Financial Holdings (CIFH) , you might be surprised why the price book is 1.6 only if to compare 2.9 above. It does not mean the price is wrong instead it tells us another story. Since the control has been in the hands of Citic Group before the privatization, there is no need for Citic to pay too much premiums for the balance of the purchase. Whether 1.6 is fair will depend on the whole structure of deal such as exchange of shares etc.
As there are many different types of business combinations, it is natural the price book ratio for each deal transaction could be quite different from one another.
6/22/2008
Who is greedy?
The Secretary for Food and Health, Chow Yat-ngok York has done a great job to stage a multi billion-dollar buyout of Hong Kong's poultry industry in an historic move that may spell the end of the territory's live chicken trade. The proposed ban on keeping live chickens overnight and recalling of the live poultry licenses, to my opinion, are effective measures to control the deadly virus. The potential economic consequences would be huge if one day there is an outbreak in Hong Kong.
No matter what, the health of the Hong Kong citizens should be put in the first place. Given the virus strains could be changed rapidly, it is right for the Government to step up measures before the fatal virus find their ways to hit into the territory. I feel sympathy to those who worked in the poultry industry, but for the compensation amount of 3 bio demanded by the poultry industry were far too high to be accepted by the taxpayers.
It is hard to find a business in the world that the owners can only enjoy the upside profit while the downside losses are left to the others. It is totally unreasonable. For the three years compensation offered by the government, as far as I can see, is a very generous offer. For the demand of 3 bio is too greedy to be accepted.
No matter what, the health of the Hong Kong citizens should be put in the first place. Given the virus strains could be changed rapidly, it is right for the Government to step up measures before the fatal virus find their ways to hit into the territory. I feel sympathy to those who worked in the poultry industry, but for the compensation amount of 3 bio demanded by the poultry industry were far too high to be accepted by the taxpayers.
It is hard to find a business in the world that the owners can only enjoy the upside profit while the downside losses are left to the others. It is totally unreasonable. For the three years compensation offered by the government, as far as I can see, is a very generous offer. For the demand of 3 bio is too greedy to be accepted.
6/19/2008
Some thoughts after reading Freakonomics
Being tempted by the " Freakonomics" is one of the best selling books and discussed widely by circle of friends, I borrowed the book and spent few hours here and there last week to flip through if I can get something out from it.
Those who have read the book mostly share the view that " Economists earn more than mathematicians?".
When we look around, those who can earn big bucks need not to be meticulously accurate. So, why bother to be a Rocket Scientist if your ultimate aim is for the dollar and a better life.
If we have to wait for everything to be exact before carryig out our investment, I dare to say most of the time we will miss the boat. Having said that, prudence and reasonable care are words that we should never forget when we put the money into the market.
Those who have read the book mostly share the view that " Economists earn more than mathematicians?".
When we look around, those who can earn big bucks need not to be meticulously accurate. So, why bother to be a Rocket Scientist if your ultimate aim is for the dollar and a better life.
If we have to wait for everything to be exact before carryig out our investment, I dare to say most of the time we will miss the boat. Having said that, prudence and reasonable care are words that we should never forget when we put the money into the market.
6/17/2008
Why still we have to invest in the derivative warrants?
While the stock market is quiet, I would like to put some time before lunch to ask the investors in our stock market how many have lost their money in the investment of equity warrants for the last couple of years. I can almost guarantee the number of losers must far exceed those who can win from it. I am pretty sure the big winners are the issuers of these warrants. It can be easily implicated from their advertisements that can be seen everywhere either from TV, Posters or Radio Broadcasting. They are so penetrating that you can feel it anywhere you go. Why, the issuers play the trading and listing rules to their maximum advantages.
We all know the beauty of equity warrants is that small capital outlay can bet for big returns while the downside is limited to the initial capital. Though sound appealing, wonder how many investors really knew or understood the rules governing the issuance of the equity warrants in Hong Kong.
According the consultation paper issued by SFC in 2006, for the derivative equity warrants, no quota system be for both further issues and identical issues. Also,the processing time by SFC was to reduce from the previously 4 days down to 2 days. The objective of this proposal was said to minimise price anomalies caused by shortages in supply of a particular derivative warrant.
In the other words, the supply of same identical warrant or similar warrant could be increased in size any time without limits and down to the market in just two days time. You can imagine how the prices are affected apart from the movement of the underlying. What on earth the game is so one sided that the risk return is out of balance for small investors.
Hong Kong stock market thrives on the derivatives for number of years and now pleased to say to top the world in its volume. Personally, for Hong Kong to be a successful Financial Center, we are not just aiming for the volume. While we let the crocodiles to move around, also fair rules of games have to be set up to protect the investors.I know most big issuers are coming from big houses and have the resources to have bigger say to affect the rules set by the SFC, but wonder if the views of the general investors should also be weighted.
For comments: Please to schan033@gmail.com
We all know the beauty of equity warrants is that small capital outlay can bet for big returns while the downside is limited to the initial capital. Though sound appealing, wonder how many investors really knew or understood the rules governing the issuance of the equity warrants in Hong Kong.
According the consultation paper issued by SFC in 2006, for the derivative equity warrants, no quota system be for both further issues and identical issues. Also,the processing time by SFC was to reduce from the previously 4 days down to 2 days. The objective of this proposal was said to minimise price anomalies caused by shortages in supply of a particular derivative warrant.
In the other words, the supply of same identical warrant or similar warrant could be increased in size any time without limits and down to the market in just two days time. You can imagine how the prices are affected apart from the movement of the underlying. What on earth the game is so one sided that the risk return is out of balance for small investors.
Hong Kong stock market thrives on the derivatives for number of years and now pleased to say to top the world in its volume. Personally, for Hong Kong to be a successful Financial Center, we are not just aiming for the volume. While we let the crocodiles to move around, also fair rules of games have to be set up to protect the investors.I know most big issuers are coming from big houses and have the resources to have bigger say to affect the rules set by the SFC, but wonder if the views of the general investors should also be weighted.
For comments: Please to schan033@gmail.com
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