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Sahil Alvi is a management consultant, economist, intra-preneur, and writer. Sahil lives and works in Dubai. He is strategy consultant with a global consulting firm where he leads the firm’s strategic and business development initiatives including origination of strategies and opportunities for... More
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  • The Curious Case Of Credit Agricole - Part II

    Part II

    Macro-economic Maelstrom: Tale of Five Fat Tails

    The breathtaking disconnect between Credit Agricole's stock value and ground reality is particularly accentuated by what is happening right at this moment on just the macro-economic front (without even getting into the Middle Eastern and Asia-Pac geo-political escalations):

    1. France:

    S&P has recently downgraded French banks and put Credit Agricole on a "negative" watch.

    Meanwhile, as the German and French economies enter discernible slowdowns of their own, how much political capital do the leaders have left to thrust on their citizens any more bailout guarantees (de-facto wealth transfers) from creditor Eurozone members to a growing list of debtor nations with yawning deficits just to keep the current face of the Eurozone intact?

    2. Spain:

    France's Southern European neighbor is dragging its feet on an ECB intervention through the OMT program while the Spanish provinces threaten secession as a bargaining chip to change the fiscal balance-of-power between the federal and state governments. At the same time, the Spanish continue to lose precious time as state government bailout aid fund is all but spoken for and more requests are on the way. Bad loan provisions at banks continue to rise, unemployment is hitting Franco-era heights, yields are artificially in control (on the OMT promise and CDS bans), and the socio-political climate is about to explode (with suicides and evictions tearing at the core of this already strained society).

    3. Cyprus:

    The island's banks are practically insolvent and this tiny Eurozone member is expected to seek a bailout of 20 to 30 billion Euro of its own - mostly to keep, what else, the country's banks afloat and their rich Russian oligarch depositors liquid. While the bailout requirements are a small amount relative to the kinds of guarantees and disbursements already made by Eurozone members towards the likes of Greece, Ireland and Portugal, yet Cyprus might just end up beating Greece to the tape in the first full-fledged default of a Eurozone sovereign triggering an avalanche of bank-runs and defaults elsewhere in the Eurozone.

    4. United States:

    The 2012 sequel of the fiscal cliff-hanger starring President Obama and Speaker John Boehner has officially been released post-US elections. Regardless of the outcome, much drama is most assuredly going to unfold.

    5. Greece:

    Of course, the big elephant in the room is Greece tip-toeing again to the brink of another restructuring cliff (pardon the mixed metaphor). This time involving OSI (Official Sector Involvement) aka hard restructuring or debt forgiveness, and possibly, another round of PSI (Private Sector Involvement) who have already been arm-twisted to taking hair-cuts before. Wonder, what their hairdo will look like before the Greek saga comes to its long-winded end. Credit Agricole will be one of the lenders most impacted by any further restructuring, re-profiling, and the like. To state the obvious: the huge and real social pain being exacted by the downward debt-deflation austerity measures is reaching boiling point.

    The beginning of the end of the Eurozone (at least as we know it) is very near.

    Any of the above risks may very well be the trigger for a downward re-pricing of most capital markets that leading economist and fund manager Marc Faber mentions as the impending 20% correction. Which is just as well, because the current gap between the financial and real economies is getting to breaking point.

    Given the above tail-risks very much on the near-term horizon, does any responsible fiduciary, hedge fund manager or asset manager believe that Credit Agricole (or for that matter any other major Eurozone bank) needs to trade at or near its 52-week highs.

    Strange Price Behavior: Good News is Good News; Bad News is Better

    I do dozens of equity trades a month. Given my 'Short' position in Credit Agricole being my largest (long or short) in the portfolio, I have paid particular and real-time attention to its deteriorating fundamentals and its strange stock price behavior - particularly over the last two "eventful" months since the Draghi OMT announcement. Over the last couple of weeks, I took a significant loss on the position realizing after 3 months of wait that - despite the evidence - those "supportive" of the stock would remain relentless till they run out of dry powder to deploy towards propping up the stock price because the stakes were too high. This is a note of caution to those fundamentals-focused investors who view this as an attractive 'Short.' While the stock remains eminently "short-able," short-sellers' timing will have to be impeccable so as not to face significant draw-downs due to the unhealthy the dynamics at play behind this stock's price behaviour.

    Having reflected on Credit Agricole's price behaviour, I can plainly state that the stock price is tone-deaf, impervious and idiosyncratic (in a not so healthy way) to the banking group's astonishingly ugly and quickly deteriorating fundamentals - let alone - to the broader macro-economic and geo-political tail risks of a somewhat orderly Greek exit and subsequent disorderly Eurozone contagion; the rapidly contracting French economy and softening of the rest of the Eurozone core (Germany, Finland, The Netherlands, Belgium and Austria); the rising tensions in the Middle Eastern and Sino-Japanese conflict and of course; the forthcoming hairy, painstaking negotiations surrounding the US fiscal cliff.

    Management's lack of transparency regarding the entity's current core Tier 1 capital ratio, and absence of a fair and conservative assessment of its risk-weighted assets, is further exacerbated by the fact that stock has recently been trading at or near its 52-week highs - almost in spite of the "short sellers" who have been trying to wake the markets up from their QE and OMT-induced stupor.

    Upon touching a 52-week low of 2.88 Euro, the stock traded below 3 Euro for much of the summer 2012. Then, it started its somewhat inexplicably steep climb well before the ECB President Mario Draghi's so-called "game-changer" announcement of OMT aimed at bringing peripheral Eurozone bond yields down to more manageable levels. Of course, it's another story that a single shot is yet to be fired from Mr. Draghi's OMT bazooka since the early September, 2012 announcement of buying "unlimited" peripheral Eurozone sovereign bonds against "strict conditionality".

    After the OMT and QE-Infinity announcements, the stock went off like a rocket comfortably piercing its previous 52-week high of 6.29 Euro and setting a new 52-week high of 6.55 Euro. Arguably, part of the near vertical stock price climb could be explained by a "short squeeze" of investors who bet heavily during the summer that the long-anticipated break-up of the Eurozone was around the corner.

    Then, of course, came along the (un)expected wider-than-expected quarterly loss ending September, 2012 of 2.85 billion Euro for the group. The loss was merely greater by 1 billion Euro than the consensus estimate. Clearly, certain "recreational/medical" substances that were recently put to ballot in the US are already freely available and extensively used among the analyst community tracking this stock.

    Guess what the stock did on this "earth-shattering" earnings announcement:

    The young guns manning supposedly sophisticated artificially "intelligent" algorithmic trading machines initially had the audacity to fly off the handle (as is customary on most days), and take the stock higher than its opening price before reality began to sink in that, maybe just maybe in the face of this mind-numbingly large quarterly loss, this day was not a good day for such blatant exuberance toward the stock price - lest regulators get alarmed and other market participants feverishly start "raisin' cane" about the issue. Ultimately, on the day of this spectacular loss in earnings, the stock traversed a downward trajectory of 11% of rather vigorous trading activity through the day, and then within minutes very large blocks of shares pulled the stock right back up erasing half the losses. Such moves don't pass the smell test.

    Is it a case of putting lipstick on a pig with exposure to the PIIGS?

    On most other days, the stock defies gravity. There have been instances where the bank's "high beta" price behavior puts Silicon Valley small cap tech and bio-tech stocks to shame - rising (and a few times falling) as much as 5 to 8% on an intra-day basis.

    There seems to be significant amount of doubt and trepidation in the markets about the true and "fair" value of the stock.

    Then, there are days when the stock's high correlation breaks down vis-a-vis its two larger, better-capitalized, and profitable French banking peers: BNP Paribas (EPA: BNP) and Societe Generale (EPA: GLE). Predictably, more often than not Credit Agricole rises more than twice its two French peers or falls less than half vis-a-vis the other two. Such price action can mean one of two things: Either the market is placing greater value and confidence in Credit Agricole compared with its other two French rivals (hard to imagine). The other conclusion, obviously is, something smells fishy here. Imagination would come in handy as to who and why is behind such odd price behavior.

    Yet another example, on Nov 7, 2012, the Bid price (5.90 Euro) was higher by 2.1 cents than the Ask Price (5.921) for a good 5 minutes between 3.25 pm and 3.30 pm GMT, while the algos were busy "blindly" buying trying to prop up the stock price. Such dissonance has become a regular occurrence with this stock.

    Are those who are trying to prop the price of this stock over-playing their hand through their not-so-intelligent algos?

    Could it just be that certain vested interests are working hard to deploy cheaply accessed capital towards bolstering shareholders' equity - in the process boosting the bank's Tier-1 capital ratio and magically transforming an otherwise insolvent and illiquid bank seem solvent, liquid, and even attractive?

    Or is it that some large, powerful pools of capital are angling to gain from this speculative, high-beta play with a view that the French government will succumb to the "too-big-to-fail" card and back-stop the insolvency scenario for Credit Agricole?

    Wouldn't Mario Draghi, President - European Central Bank, be pleased to know that his LTRO-injected liquidity is being put to good productive use to prop up equity values of otherwise failed banks?

    Surely, Joseph Schumpeter's soul would be utterly amused that "creative destruction" of capitalism is being frustrated and obstructed right in his homeland: Europe.

    In the face of all the performance issues, market challenges, and macro-economic risks, in whose vested interest is it to keep Credit Agricole's equity price propped up at such a patently (un)fair value?

    Conclusion: Welcome to The Twilight Zone!

    Looking at Credit Agricole's long list of cardinal sins that it is yet to seek recompense for, it still appears that management of balance sheet/solvency risk, liquidity risk, and event risks seems like a novelty for lesser, more conservative, and faint-hearted banking cousins at the lower tier of the Eurozone banking pyramid, and not for this historic French banking champion.

    Its long list of "accomplishments" in banking over-reach and over-leverage can only be explained by the belief in certain investment management industry quarters that the banking group is systemic to the French economy, and therefore, it enjoys an implicit back-stop guarantee from the French republic. What such investors fail to appreciate (fully at least) is that such a back-stop would come with onerous costs. Nationalization and State intervention is a French tradition. Should the bank fail, current shareholders will get severely diluted or entirely wiped out. Junior bond-holders might follow close behind.

    Quoting an October 25, 2012 Bloomberg article on France's 60 billion Euro (thus far) assistance to its banking sector:

    "PSA Peugeot Citroen SA (UG)'s troubled finance arm brings the state's backing for the nation's banks to more than 60 billion euros ($78 billion).

    The government yesterday said it will guarantee 7 billion euros in new bonds by Banque PSA Finance, the consumer-finance unit of Europe's second-largest carmaker. The aid comes on top of support for Dexia SA (DEXB), the French-Belgian municipal lender, and for home-loans company Credit Immobilier de France.

    The French government is also providing a guarantee of about 28 billion euros to bolster Paris-based mortgage bank Credit Immobilier de France, or CIF, as it's known.

    France is already backstopping 36.5 percent of 73.5 billion euros of outstanding state guarantees on the debt of Brussels- based Dexia, which was the first victim of the sovereign debt crisis at the core of Europe. Belgium wants it to do more."

    These guarantees and capital injections cannot be generously dispensed ad infinitum without ramifications for France's own credit rating. So, as the French fiscal situation becomes increasingly vulnerable, the spigots are to be turned off fairly shortly.

    Investors beware. As leading Harvard and Stanford historian Niall Ferguson points out about empires, and I para-phrase: Collapses are never linear. Initially, they are slow and gradual and then they are swift and precipitous.

    Against the above discussed macro-economic and micro-economic backdrops, to see Credit Agricole go nearly vertical in the last few months, no one will blame you if you thought you were in the yesteryears' TV show: The Twilight Zone - where everything was topsy-turvy; everything was bizarre.

    Ultimately, certain laws of financial gravity are inviolable:

    1. We are the market.

    2. Market forces are irrepressible.

    3. All mis-priced assets have their day of reckoning; mean reversion is a reality.

    Profit from this one.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

    Dec 04 12:20 PM | Link | Comment!
  • The Curious Case Of Credit Agricole - Part I

    Part I

    Introduction:

    Every once in a while a trade comes along that defies all macro-economic logic, market fundamentals, valuation metrics, technical analyses, and good old common sense.

    Everything you ever held sacred, sensible, and proper about - admittedly somewhat "inefficient" markets - is left thoroughly violated.

    The third-largest French bank by market capitalization, Credit Agricole Group (EPA: ACA) (PINK: CRARY) is just such a study where laws of financial gravity don't seem to matter.

    Could Credit Agricole be an extraordinarily profitable "Short" trade?

    You decide based on the facts discussed below:

    Context: Treating a cocaine habit with more cocaine

    Over the last few years, while their US and British counter-parts have continued to undertake drastic measures to restructure their operational and financial foot-prints, Eurozone banks have levered up even further by buying hundreds of billions of Eurozone periphery sovereign, corporate and consumer debt. This disastrous move actually gathered momentum in late 2011 on the back of the 1 trillion+ Euro LTRO facility offered by the ECB to these very Eurozone banks who, by Q4, 2011, had lost credibility in international money markets and were asphyxiating from a lack of dollar funding. Like all government interventions, what LTRO injections generated as an unintended consequence was it discouraged the technically insolvent Eurozone banks from de-leveraging their balance sheets off the hundreds of billions in bad assets that should have been sold, restructured, written down, or written off several years ago. Cut to the present, an already untenable situation of bank illiquidity has definitively (and perhaps irreversibly) morphed into an insolvency problem for banks feeding on their own region's debt.

    To quote an Octo 3, 2012 Bloomberg article on French banks:

    "The investment-banking units of BNP Paribas SA (BNP), Societe Generale SA, Credit Agricole SA (ACA) and Natixis (KN) SA have 2.05 trillion euros ($2.64 trillion) in trading assets, including bonds, equities and derivatives, data compiled from the banks show. That's a 21 percent jump in the 12 months to June and a two-year high, just shy of France's $2.77 trillion gross domestic product.

    Trading in derivatives for BNP Paribas increased 48 percent to 446.1 billion euros in the 12 months through the end of June. For Societe Generale, it rose 38 percent to 242.8 billion euros."

    Through the LTRO (Long-term Refinancing Operations: a real liquidity injection program) and now OMT ((Outright Monetary Transactions: essentially, a liquidity injection announcement to buy unlimited sovereign periphery bonds), what ECB has done is take in a cocaine addict into rehab and provided the patient with even higher doses of cocaine so it doesn't go into withdrawals.

    While the remedy for this patient was a combination of medicines that were bitter and painful and would have included:

    a) restructuring irredeemable sovereign and corporate debt by letting errant financial institutions take the losses, i.e. debt forgiveness;

    b) consolidating, closing and re-capitalizing insolvent financial intermediaries;

    c) bring about gradual but strict fiscal discipline including change in policies as well as governance;

    d) reforming inflexible labor markets to boost competitiveness;

    e) privatizing inefficient and high-potential government assets,

    f) and most importantly, letting the debtor nations exit the Eurozone to regain competitiveness through issuance of their own currencies.

    By doubling down, however, a patient who could've been rehabilitated by Eurozone governments and the ECB is now terminally ill - and is about to die from off-the-charts toxicity levels (debt) that kept the patient even more high on cocaine than it was before coming into rehab.

    Why?

    Because it was politically unpalatable to let the Eurozone banks pay for their sins. The banks waved their considerable clout by pulling out the "systemically important" card.

    And the troika (IMF, European Commission, and ECB) buckled.

    Now, against this back-drop, let's drill down to Credit Agricole's health.

    Fundamentals & Valuation: Heavy Things Don't (and Shouldn't) Defy Gravity

    First, there's the minor issue of solvency and leverage.

    Despite being a heavily leveraged, highly unprofitable banking enterprise with subsidiaries and strategic investments in the choicest, most "eventful" of high-risk Eurozone markets such as Greece (Emporiki Bank), Spain (Bankinter), Italy (Intesa SanPaolo), and of course its home territory of France, this retail banking-focused group's stock price has perversely undertaken a parabolic rise -up 80% since the lows of this year and 66% in the past six months alone.

    Credit Agricole belongs to that rarefied top layer of a huge pyramid of financial services sector "Eurozone sinners," i.e. French banks, that together account for the largest private sector balance sheet exposure to the so-called "Club Med" European periphery sovereign, public and private sector debt.

    As early as the spring of 2010, The Economist estimated that French and German banks owned as much as 40% of all Eurozone peripheral debt that is estimated to run between 2 to 3 trillion Euro.

    As per the 2011 Eurozone bank stress tests, exposures to just Greek debt among four French banks were:

    • 1.7 billion Euro for BPCE,
    • 6.6 billion Euro for Societe Generale,
    • 8.5 billion Euro for BNP Paribas, and
    • 27 billion Euro for Credit Agricole (roughly 150% of the other three French banks combined).

    To quote Bloomberg on French banks' total exposure to Greece vis-a-vis its German and British counterparts:

    "French banks held $40.1 billion in Greek public and private debt at the end of June, or 55 percent of all foreign claims, according to data compiled by the Bank for International Settlements. German lenders had $5.5 billion in Greek debt holdings while U.K. banks held $5.6 billion, BIS data show."

    Putting the extent of French banks' precarious situation in context, should the $40.1 billion of Greek debt be written off in an entirely realistic scenario were Greece to default in the coming months, such an "event" will wipe out at least 40% of the market capitalizations of France's three biggest banking groups (BNP Paribas; Societe Generale, and Credit Agricole).

    How much of that Greek debt's been sold in the secondary market yet, and at what kind of write-downs is anybody's guess today?

    Coming down to balance sheet risk, Credit Agricole holds an eye-watering 136 times in assets (1.9 trillion Euro) vis-a-vis its equity value (13.9 billion Euro).

    To quote Jonathan Weil, Bloomberg View columnist:

    "Total assets at Credit Agricole were 1.9 trillion euros as of Sept. 30. Risk-weighted assets, however, were a mere 298.3 billion euros. In essence, we're supposed to believe that 84 percent of Credit Agricole's assets were riskless, even though that obviously is impossible.

    For a more realistic capital ratio, take tangible shareholder equity (which excludes intangible assets such as goodwill) and divide it by tangible assets. At Credit Agricole, the figure was 1.4 percent as of Sept. 30, which translates into leverage of about 73-to-1."

    To make a mockery of Basel III compliance, Credit Agricole refused to provide visibility on its current core Tier 1 capital levels (as a reminder, Tier 1 capital ratio principally comprises of common stock and earnings v/s risk-weighted assets).

    To quote Financial Times:

    "Mr Chifflet (Chief Executive) said the whole Crédit Agricole Group - the quoted entity and the regional banks - were on track to reach a core tier one ratio of 10 per cent by the end of next year (2013). The key measure of balance sheet strength is set at a minimum of 9 per cent under the incoming Basel III rules. The bank would not disclose a figure for the end of September."

    Credit Agricole's latest press release on Credit Agricole's website states that the banking group's core tier capital ratio is 11.3 per cent at 30 September, 2012.

    However, the Credit Agricole release goes on to say:

    "The Group also reaffirmed its target of a fully loaded Basel 3 Common Equity Tier 1 ratio of over 10% by the end of 2013, above regulatory requirements, integrating the necessary buffer to be constituted as global systemically important bank (1%)."

    So, the loaded question (pun intended) is, what does Credit Agricole Group consider as "fully loaded" Basel 3 Tier 1 ratio where the banking group is falling short right now?

    How is this "fully loaded" calculation different and more conservative from the 11.3% reported by the banking group that the management is not even willing to disclose the group's current standingon this metric?

    Such efforts by management to deliberately obstruct and obfuscate the true state of the bank's health is alarming, unhealthy, and frankly, can be construed as arrogant.

    After all, last time I checked, French capital markets reside within an advanced economy where management is accountable to public scrutiny - be it from depositors, investors, regulators, media, or citizenry.

    Moving on to impact on Credit Agricole's earnings from its Greek unit:

    Since 2008, Credit Agricole's Greek unit Emporiki Bank has generated losses to the tune of 4.42 billion Euro, and another 1.28 billion loss in the first six months of 2012.

    In the quarter ended September, 2012, Credit Agricole took a 2 billion Euro charge in order to let go off its disastrous foray into Greek banking through its subsidiary: Emporiki Bank. The Greek subsidiary was recently sold to Alpha Bank for the princely sum of 1 Euro, and the transaction is expected to close by end of 2012 (until its not). The deal could easily unravel if "Grexit" happens. In the event of a Greek sovereign default, Credit Agricole is expected to be on the hook for a number of contingent liabilities of Emporiki Bank (which would very likely go belly-up if "Grexit" comes to pass). In addition, to wash its hands off this cash-hemorrhaging misadventure, Credit Agricole has committed to a capital injection of 550 million Euro and convertible bonds worth 150 million towards the combined entity's equity - which incidentally would be less than worthless because all of Alpha Bank's equity owners (including Credit Agricole) would be on the hook for billions of Euro in additional liabilities should the combined entity come under stress or go under during the next Greek restructuring or outright default.

    For all the rhetoric surrounding the banking group's "adjustment plan" to de-leverage the entity off its massive balance sheet relative to its equity, let me quote Credit Agricole's most recent press release about its enormous Q3, 2012 loss:

    "The Regional Banks registered a 3.9% increase in revenues in the third quarter of 2012, while continuing to improve their loan-to-deposit ratio, which contracted to 126% from 127% at 30 June 2012 and 129% at 31 December 2011."

    A 300 basis point change over 3 quarters for a crucial chunk of the group's business is hardly an "improvement." It's the proverbial management fiddling away while Rome (or shall we say, Paris) is burning.

    The press release is available here: http://www.credit-agricole.com/en/News/Press-releases/Financial-press-releases/Third-quarter-and-first-nine-months-of-2012

    Quoting Bloomberg's article on the bank's most recent quarterly loss:

    "Credit Agricole recorded a 572 million-euro writedown mostly on its Italian consumer-credit business, a 181 million- euro loss linked to its sale of CA Cheuvreux, and a 193 million- euro accounting charge on its stake in Spain's Bankinter SA. Credit Agricole is selling Athens-based Emporiki for a token price of 1 euro to Alpha Bank, it said Oct. 17. The French bank will inject more funds into Emporiki, bringing the total capital boost since July to 2.85 billion euros, and buy 150 million euros of convertible bonds issued by Alpha Bank. Credit Agricole's corporate and investment bank had a 302 million-euro net loss in the quarter, hurt by own-debt charges and the cost of selling CA Cheuvreux. Excluding one-time items, the division's like-for-like profit fell 15 percent to 325 million euros, the bank said."

    The pattern that emerges from all of these exits is that these transactions are large, multi-hundred million Euro write-downs attributable to a de-leveraging process that can be described as nothing less than a "fire-sale". It begs the question: When does a business let go off assets at such deep discounts to book value?

    It is when the entity's finances are so depleted that it is fighting for its life, i.e. solvency.

    Then, there is the even more pedestrian issue of profitability.

    To quote Financial Times:

    "The French bank, which had prepared the market last month for bad news, reported a result that was about €1bn worse than expectations of a net €1.8bn-€1.9bn loss in the three months to the end of September, marking a sharp fall from the net profit in the same quarter last year of €258m. Revenues of €3.4bn were 32 per cent down on the third quarter of last year."

    Between Fiscal Year 2010 and 2011, Net Profits declined a staggering 72.4% from 4.09 billion Euro to 1.12 billion Euro. With 3 months to go in the current fiscal year (2012), Credit Agricole has recorded a net loss of 2.48 billion Euro thus far - and the full year numbers are likely to fall further for reasons discussed in this note.

    Fire-sale of assets can be expected to continue as part of the bank's "adjustment plan" - so more losses can be expected in the coming quarters. There's no way out to profitability for the short-to-medium term.

    Yet, what can only be described as an affront to the markets, the company is still contemplating whether it will pay out a dividend this year or not. You can't make this stuff up.

    To further quote Bloomberg on Credit Agricole's investment banking activities:

    Credit Agricole is also shutting its riskiest investment- banking businesses. The bank has stopped most of its equity derivatives and it has no proprietary trading activity, according to a Sept. 26 presentation. The lender is selling its brokerage CLSA to China's Citic Securities Co. in a transaction valued at $1.25 billion."

    Of course, the worst is yet to come.

    As the French economic indicators deteriorate (including 10% unemployment levels at a 13-year high), consumer and small business lending (Credit Agricole's forte) will fall further in the coming quarters - which will in turn impact net interest income and margins. With deep and wide provincial exposure through its regional banks, Credit Agricole's retail banking loan provisions are expected to rise significantly - much like their Spanish local lending counterparts or "Caixas". So, one can expect both a top-line and a bottom-line contraction in the coming quarters for Credit Agricole as well as for its peers. Crucially, Credit Agricole is expected to be impacted much more than its other two large French banking peers since the other two (BNP Paribas and Societe Generale) do have more income diversification through investment banking and trading lines of business while Credit Agricole is well on its way to exiting.

    To add fuel to fire, Francois Hollande, President of the French Republic wants to bring about a radical transformation of French banking sector with a view to ring-fencing riskier investment banking and trading activities from the more staid, low margin retail and commercial banking businesses. While the objective is admirable, the impact of greater (and no doubt more onerous) regulation and fragmentation of the French banking sector will raise the cost of doing business for French banks precisely at the worst time - thus putting liquidity, margin, and ultimately, solvency pressure on full service banks like the French triumvirate.

    Speaking of margins:

    Among its large banking peers around the globe, the bank's lack of profitability (Net Margins) at-4.0% can only be matched by industry laggards like Lloyds Banking Group (-4.1%), UBS (-1.2%) and Morgan Stanley (-0.8%). These are, might I add, the most dilapidated homes in a bad neighborhood where several other troubled Eurozone peers are generating double digit profits. For example: Banco Santander (17.4%), BBVA (14.2%), Natixis (13.0%), BNP Paribas (11.5%), and Commerzbank (11.6%). Along that sliding scale, even other large European players are eking out single-digit net profits: Deutsche Bank (9.2%), Banco Popular (8.7%), Caixabank (5.5%), ING (4.1%), Societe Generale (3.3%), and Credit Suisse (3.3%).

    Furthermore, at -5.2% Return-on-Equity, Credit Agricole is in the august company of "fallen angels" like Lloyds Banking Group (-2.2%), Royal Bank of Scotland (-6.9%), and Bank of Ireland (-9.1%) - each of whom required a full or partial government bailout wiping out much of existing shareholders' equity.

    So, there.

    End of Part I

    In Part II, I will cover the macro-economic tail risks that could re-price Eurozone financial stocks such as Credit Agricole dramatically lower in a matter of days or weeks. In addition, I will also discuss the strange stock price behaviour of Credit Agricole's stock in detail.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

    Tags: short-ideas
    Dec 04 12:20 PM | Link | Comment!
  • These times are about TIIMES: An investment thesis for managing “tail risks” in a period of secular economic instability by Sahil Alvi

    There is a confluence of several secular and cyclical factors that point in the direction of capital allocation rising in the Transportation, Infrastructure, Industrials, Materials, Energy, and Staples (TIIMES) sectors.

    Global scarcity of resources, protectionism and birth of new nations:

    These are times characterized by structural changes in the global economy as the clichéd economic weight of the world shifts back from the West to the East (for fifteen of the past eighteen centuries, such has been the status quo).

    These structural changes have only accelerated since the Global Financial Crisis. Since the ensuing Great Recession, United States – the wealthiest country in the world – has now approximately one in five of its citizens living in poverty. Unofficially, 16% of the workforce is unemployed or under-employed.

    The UK is squeezed from many sides: rising unemployment, surging entitlement requirements, declining tax revenues, increasing need for economic stimulus, falling industrial competitiveness, and a general economic malaise. The country has elected its first right-of-center government (with a leftist coalition partner) in over a decade.

    Portugal, Ireland, Italy, Greece, and Spain are all dealing with enormous fiscal problems threatening the very existence of the European Monetary Union. There is a good possibility that we have not heard the last or the worst of the Greek fiscal woes or the Irish banking crisis.

    Even hitherto fiscally robust economies like Austria and Belgium, are showing signs of economic strain.

    The historically liberal, left-leaning post-World War II Western Europe seems to be building up a rising appetite for anti-immigration, right-leaning, populist tendencies. Nationalistic, anti-immigrant sentiments are beginning to manifest in electoral politics as well as in government policy across liberal and/or socialist heartlands such as France, Germany, Sweden, Denmark, and The Netherlands.

    All of these are developed economies. All of these are some of the wealthiest societies in the world.

    In this environment, overt or covert forms of protectionism are only a matter of time. Such protectionism, however, tends to help those industries more which are resource and labor-intensive -- where jobs cannot be exported over a broadband connection.

    Historically, the world has dealt with scarcity for most of its existence. Make no mistake, despite armed conflicts in the past several decades not being as devastating or multi-lateral as World War II, the quest for resources continues to intensify among nations. In fact, one can argue that beneath all the cultural, religious, and linguistic differences that are offered up as the key bases for the independence struggles of various minorities, the central (although not always overtly stated) raison d’etre for new countries being carved out of existing ones is the notion of safeguarding ancestral, “sovereign” economic interests of a minority residing in a resource-rich territory within an existing nation.

    Right from the mid-twentieth century – when former South Asian British colonies became independent as India, Pakistan, East Pakistan (later Bangladesh) – the pursuit of economic self-determination has been as much a factor as the desire for political autonomy or social liberty in all independence struggles. Obviously, such a dynamic is not uniquely pertinent to the British empire either, the French relinquished their control over Indochina to give birth to three new nations for the same set of reasons - Vietnam, Laos, and Cambodia.

    Self-determination of political, social – and crucially – economic interests was the common thread across the founding fathers and the indigenous populations that catalyzed the break-down of the Soviet Union. Since the Communist union’s dissolution, a slew of new nations (many of which resource-rich) have come into being: Russia, Ukraine, Moldova, Armenia, Azerbaijan, Belarus, Estonia, Latvia, Lithuania, Georgia, Kazakhstan, Kyrgyzstan, Tajikistan, Turkmenistan, and Uzbekistan.

    East Timor became independent a few years ago fuelled by its quest for religious, cultural and economic freedom.

    As a matter of fact, there have been rumblings for independence in resource-rich Kurdish Autonomous Region of Northern Iraq (popularly known as Kurdistan) for quite some time. Yet another example of economic drivers playing a significant part in seeking autonomy and independence, many in the Flemish region of Belgium want to separate from Wallonia – in large part, due to the economic disparity and dispensation structure of state-provided welfare benefits.

    North and South Sudan may go their separate ways as early as January 2011. In addition to all the ethnic violence that has culminated in the proposed referendum for independence, South Sudan sits on over five billion barrels of proven oil reserves. Economics, again, becomes a critical consideration.

    Through the decades and across geographies, the ongoing march of societies, staking claim to resources they consider are rightfully theirs, continues to lead to conflicts.

    It is safe to assume, everyday, almost all of the seven billion people wake up wanting more than they already have. Some aspire for more luxuries; others seek more necessities; a vast under-class, just struggles for more dignities.

    More emerging and frontier market constituents are joining the growing global mainstream, of what constitutes as “middle-class consumers.” Global commerce is an agile, pragmatic force touching more and more lives.

    More food is being produced and eaten. More clothes are being bought, sold, and worn. More homes are being built and inhabited. More cars and trucks are being manufactured and driven. More energy is being produced and consumed. More roads, power plants, dams and bridges are being built and utilized. More paper is being used…and forests are felled. More minerals are being mined and processed. More manufacturing is being done and absorbed – on a net global production basis.

    It is an inexorable quest for more…and more…and more from a planet that has its very real physical limits.

    Resources are limited.

    Demand is rising. Supply is not. In fact, supply is diminishing for a wide variety of natural resources.

    It is that simple.

    The real, the tangible, the substantial: The World is Pyramidal

    Imagine Maslow's hierarchy of needs represented in a world that isn't round, ovular, or even flat.

    The world is a four-dimensional pyramid of time, population, demand, and supply.

    Due to the enormous pressure on resources owing to a rising global population, our times are characterized by exceptional change or instability underpinned by the triumvirate of: uncertainty, ambiguity, and complexity.

    What is also undeniable is: because of – or in spite of – globalization, the individual or family is much more disconnected from a social support structure. During earlier times in more settled communities, this support structure was taken for granted. With professional certitude and financial stability petering out, the individual or family is much more vulnerable to the financial consequences of the high-velocity change we experience today and can anticipate to experience for the foreseeable future.

    By mixing in the notion of rising demand and declining supply of natural resources, the concoction we have is a period that harkens back to our pre-historic ancestors’ times of operating in a hostile, uncertain, ambiguous, high-risk, constantly-evolving environment.

    It is only natural that a Darwinian “survivalist” instinct kicks in among us to seek safe havens.

    Investors are us: You and I.

    Quite obviously, our investment decisions are not disconnected from personal, social, economic, and financial choices.

    Therefore, what we find is a seamless connective tissue between our psychological makeup which may be in “survivalist” mode and our investment bias to seek a real, tangible protection from the real, intangible economic storm. It is this quest for the real, the substantial that has Gold breaching record highs on a regular basis. Silver is at a 30-year high precisely for the same reason.

    Prices for most commodities are on a secular upwards trajectory – due to demand-supply constraints. What, however, we are witnessing is something much deeper and more primordial. We have begun to witness a long-term, broad, global social, “survivalist” quest (beyond just the investment world) for the physical security of the real, the tangible and the substantial.

    This survivalist quest is a pragmatic quest.

    On the currencies front, most currencies will face a downward pressure but a few are expected to appreciate due to the “flight to safety” phenomenon:

    • currencies that have sound macro-economic fundamentals and fewer fiscal and monetary policy variables to contend with (Swiss Franc, Swedish Krona); or
    • currencies that are issued by large net exporters of natural resources (Canadian Dollar, Australian Dollar, Brazil Real, Russian Ruble, Norwegian Krone).

    Manifestation of individual and collective “tail” risks; particularly of the “fat” variety:

    The quest for financial security and a steady income at the expense of higher-risk, dividend income (or capital appreciation) is the underlying driver for fixed income security markets booming in most parts of the world.

    Baby-boomers in many ageing, developed economies of the West have had multiple setbacks in regards to their retirement savings and entitlements over the last decade. At the start of the millennium came the dot-com bust, shortly followed by the 9/11 attacks and the collapse of financial markets with a deep, ensuing recession. Barely recovering from that shock, the Credit Crisis came bringing along with it the worst recession since the Great Depression.

    As a result, a significant number of boomers have seen their nest eggs shrink just at the time when they have been made redundant or have had to accept lower paying positions with fewer benefits.

    Hence, the need of, and pursuit for, income security, reliability, and predictability is only going to strengthen in the coming years.

    It is in this setting that large, old-world behemoth corporations with steady cash flows and dividend payouts are expected to gain investor favor in the equity markets.

    It is for the same reason why even the convertible bonds asset class can be expected to perform better than pure equities across many industries – particularly, the services-oriented industries. It follows: various forms of capital structure arbitrage opportunities are expected to present themselves in abundance during this period of dislocation and change.

    Meanwhile, proprietary trading is on the way out for the money center banks and investment banks. Therefore, investment and corporate banking will become ever more consequential for generating profits for these institutions. This reduction and eventual evaporation of trading revenues will entail an aggressive pursuit for increasing lending and underwriting activities amongst the banks. Despite Basel III compliance obligations, banks are likely to loosen their lending requirements to win business in an environment that has a concentration of capital among the hands of relatively few, on the one hand. The real economy where real innovation happens and real jobs are created is diffuse and spread out, on the other hand.

    Leading up to the Global Financial Crisis, trillions of dollars worth of “intangible” securities had disastrously evaporated into thin air. During this Global Credit Crunch, we were all rudely awakened to the notion the “tail risk: Risk that lie outside the confidence interval of the expected range of outcomes on a normal distribution curve. Nicholas Taleb’s “black swans” do exist. In its aftermath, The Great Recession has also illustrated how our inappropriate or inadequate intervention (e.g. not intervening to save Lehman) of regular “tail” risks can allow them to morph into “fat tail” risks – unleashing a set of devastating, systemic, and inter-connected outcomes in what has come to be called The Great Recession.

    Even if “fat tail” risks do not actualize (or not as severely or frequently as in the recent past), our time is still to be characterized by an acute awareness of the possibility of “tail” risks in general, and "fat tail" risks in particular. Whether at the micro-economic (individual and family) level or at the macro-economic level, the notion of tail risks can be expected to play a significant role in the economic lives of nations, going forward.

    A future flush with capital:

    Post-Global Financial Crisis  (Global Credit Crunch) of 2008, whether due to genuine commitment towards the welfare of their constituents or due to political expediency or some combination thereof, governments have demonstrated a renewed sense of purpose to generate employment by investing in "energy security" and "infrastructure upgrade" projects for their respective economies. These investments are expected to be made through various fiscal measures such as:

    a)     shifting budgetary priorities away from defense, space and entitlements to sectors like energy and infrastructure projects,

    b)    launching deficit spending measures to invest in new infrastructure projects, and

    c)     raising taxes as well as growing the tax base, among other measures.

    Central Banks across most of the developed, and several of the consequential emerging markets, have progressively eased interest rates to near zero. In fact, the prospect (and eventual reality) of additional quantitative easing by the central banks seems another likely recipe to further increase money supply in the global financial system – particularly, in many of the leading developed economies including the US, UK, and Japan.

    In addition, private sector players such as banks, private equity firms, asset management firms and hedge funds are also expected to pursue their profit motive in this new phase of Keynesian-style, fiscal policy-driven expansion.

    Inorganically created trillions of dollars of capital (paper currency) is about to chase limited real resources and organically growing investment opportunities. The result: “Hard stuff,” i.e. real, tangible assets (Commodities, natural resources, plants and machinery, infrastructure and real estate) are to grow over a secular trend line for the foreseeable future – albeit with a higher degree of volatility. The “hard stuff” can be expected to out-perform the “soft stuff” (Software & Technology, Media, Entertainment, many parts of Financial Services and other Services sectors, among others).

    Hence, most of world’s reserve currencies (US Dollar, Euro, UK Pound Sterling, Yen) are to come under pressure in this monetary expansionary environment.

    Pursuit of yield and the resulting fixed income bubble:

    It may not seem like there is a profusion of liquidity in the general economy, yet the waves of capital are building up around the world and liquidity has already begun to creep into certain parts of the global economy such as a wide array of fixed income securities and emerging markets equities.

    There are already signs of a bond bubble building up on the horizon.

    Furthermore, central banks around the world are likely to continue to sustain a posture of extremely low interest rates to promote an increase in money supply thereby making a tight lending environment an unattractive proposition for banks and non-banking financial institutions. Government and corporate borrowings, on the other hand, will become ever more attractive to lending institutions’, corporations’ as well as institutional investors’, burgeoning balance sheets. The “promise” of a long-term steady yield would aggressively chase down returns in an otherwise uncertain environment. Therefore, fixed income instruments – whether sovereign debt, municipal bonds, or investment-grade (even high-yield) corporate debt – will increasingly become popular in this environment. Popularity, however, is not going to ensure high returns. Risk of a bond bubble is very real. Spreads – between high-grade and the enlarging pool of high-yield (aka junk) bonds – is expected to grow. Spreads – between fiscally austere and responsible governments vis-a-vis spendthrift economies, states and municipalities – is also expected to widen.

    In pursuit of yields, investor appetite for high-yield (read junk-bonds) has reached enormous proportions. This ravenous demand for high-risk fixed income securities, so recently after the Great Credit Squeeze, does not seem to abate even when it comes to high-risk sovereign debt such that of countries like Greece, Spain, Ireland or Portugal.

    It is noteworthy that, in early autumn of 2010, various Central Banks are still trying to fend off deflationary pressures both in word and in action – across many parts of the developed world.

    The Fed, for example, is indeed in a fix. On the one hand, the US economy remains sluggish despite interest rates near record lows inching closer to zero. On the other hand, unemployment rates continue to trend upwards over – what can now be considered – a secular trajectory rather than a cyclical one.

    Defensible (not necessarily, defensive) industries that get “hands dirty”:

    So, how can we confidently utilize the above analysis to:

    a)     preserve capital;

    b)    grow capital.

    It is quite straight-forward, really.

    One way is to listen to what legendary investor Jim Rogers professes in terms of the merits of investing in “hot commodities.”

    What companies would benefit from the "hot commodities" theme?

    Minerals, Basic Materials and Energy Producers:  BHP Biliton (BHP), Chevron (CVX), ConocoPhilips (COP), Exxon Mobil (XOM), LUKOIL (OTCPK:LUKOY), Newmont Mining (NEM), Rio Tinto (RIO), Petroleo Brasileiro (PBR), Royal Dutch Shell (RDS.A), Vale (VALE), Vedanta (VED), Xstrata (XTA), among others.

    Capital flows, and consequent capital appreciation, can be expected to occur in miners, producers, harvesters, distributors and traders of commodities. We can fully expect for producers and manufacturers of consumer staples (particularly those with a global reach), basic and intermediate materials, and various energy sources -- to see a significant increase in capital allocation as well. In the food and consumer staples space, companies like Kraft (KFT), Nestle (OTCPK:NSRGY), General Mills (GIS), Syngenta (SYT) and Monsanto (MON) are likely to do well in this period. If any of the food traders and distributors (Cargill, Bunge, Louis Dreyfuss) go public, they would be an attractive company in which to buy equity. Their debt would also be an attractive to gain exposure to the "food security" theme. Companies like Proctor & Gamble (PG), Unilever (UL), Johnson & Johnson (JNJ), among others are expected to show resilience in the consumer non-durables space.

    Our times, however, are not just characterized by rising values of “hard assets” such as: physical commodities, basic materials, and energy sources. Our times are not just about molecules found in nature. Our times will also re-discover the value of “hard-to-replicate,” “get your hands dirty,” industries like: infrastructure, industrials, utilities, telecoms, real estate, distribution and transportation.

    The Construction and Infrastructure sector (Building Materials Supplier, Construction and Heavy Equipment Manufacturers, Project Financiers, etc.) would be attractive investment destinations. Leaders in this space will continue to demonstrate their dominance: Alcoa (AA), Lafarge (OTCPK:LFRGY), Gerdau (GGB), ArcelorMittal (MT), POSCO (PKX) are all positioned well to benefit from global growth in infrastructure and real estate development -- particularly within emerging and frontier markets for years to come.

    In a world of rising telecommunications usage coupled with dramatic adoption rates of first-time users in vast expanses of the developing world, those companies which have a head-start in their respective telecoms (particularly mobile telephony) markets are poised for significant upside: Bharti Airtel (532454), Reliance Communications (532712), Brasil Telecoms Participacoes (BRP), VimpelCom (VIP), Turkcell (TKC), Vodafone (VOD), among others.

    Utilities and Distribution industries would benefit from a “flight-to-safety” phenomenon. They would also be viewed as defensible businesses that are hard-to-replicate overnight. Utilities like Pacific Gas & Electric (PCG), E.ON (OTCQX:EONGY), GDF SUEZ (OTCPK:GDFZY), Gas Authority of India (532155) are bound to perform well in an environment of rising energy consumption and high barrier-to-entry for a new distributor of energy to replicate the extensive distribution and transmission network that these enormous utility companies have laid out.

    Transportation sector – particularly – the one involved in movement of capital goods can be expected to retain resilient levels of demand and investment.

    In each of the above mentioned sectors, the companies (and their securities) of the following types are expected to do well: clear and diversified market leaders, or the ones which have significant exposure to emerging or frontier markets, or the ones with dominant or monopolistic  rights over raw materials, or those which are well-managed, low-debt, low-cost structures.

    Fundamentals of companies in the TIIMES space will point toward the best-performing equities and corporate debt -- as long as -- their securities are not over-priced vis-a-vis classic valuation metrics.

    It is against this backdrop, that investors can generate superior risk-adjusted returns by investing in industries encapsulated within the theme: TIIMES (Transportation, Infrastructure, Industrials, Materials, Energy, and Staples).

     



    Disclosure: Not Applicable
    Sep 25 11:17 AM | Link | Comment!
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