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Vikram Saxena  

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  • Subprime Mortgage Losses: Not as Bad as Advertised [View article]
    The borrower who was sub-prime in 2006, is probably Alt-A right now. Two years of on-time mortgage payments can do wonders to your credit report. There are Federal programs which are helping these home-owners refi too. A lot of subprime loans were taken by single parents, minorities etc who had steady income but could not get the downpayment in place. As long as these folks maintained their jobs, they would not have a problem in getting a refi, especially when the system is working in your favor.
    Apr 23, 2008. 07:32 PM | Likes Like |Link to Comment
  • Subprime Mortgage Losses: Not as Bad as Advertised [View article]
    Great analysis. I have been predicting write-ups for some time. I expected that to happen in 2-3 years, but we might seeing them even sooner. As all the 2006 vintage is reset later this year, the losses sustained (or the lack of losses) will be obvious. So first and second quarter of 2009 might be the write-up quarter with banks booking big profits.

    That will work well for their bonus cycle also. Banks will wait till the end of the year before they start buying the 2006 vintage paper. The marks will improve in early 2009. Bankers will get the bonuses (typically stock) at depressed values, then start buying 2006 vintage paper to get their mark to fair value, and then announce billions of write-ups as their current distressed positions get marked up. The stocks should be rocking then and the value of their bonus suitably magnified.
    Apr 23, 2008. 08:32 AM | Likes Like |Link to Comment
  • How UBS Lost Money on Super-Senior Bonds [View article]
    CDOs split up the capital into different segments, with the lowest segment taking *ALL* the principal loss, before the next higher segment loses a penny. So if the lowest segment is the bottom 2%, then the CDO has to take a 2% loss before the rest of the 98% is affected.

    In UBS case they would have bought the tranche from 0-15%, and bought protection from 0-3%. As long as the losses were less than 3%, they would not have lost a penny.

    But then the bottom fell through the Subprime securities market and the losses, as marked to market, were significantly higher than the protection level.

    Think of a car insurance as an analogy. You write a policy with a $10,000 total value insured with a $500 deductible. If the loss is less than $500, you do not pay anything but once the loss goes above $500 you bear all the loss. This is what UBS did, sold insurance on a large chunk ($10,000), and bought insurance for the riskiest ($500 deductible) but then ended up with a huge loss since the loss was much more than the deductible.

    They are the only one to suffer. Many banks were short the worst sub-prime tranches and long the next level. They made money when the short got wiped out but did not anticipate the higher level tranche also getting wiped out; they underestimated the magnitude of the problem.
    Apr 23, 2008. 08:20 AM | Likes Like |Link to Comment
  • Google's EPS Beat Aided By Lower Than Expected Taxes [View article]
    This is a result of the high tax rates in the US. As Google's international presence grows, the tax rate will continue to come down. This was the first quarter where international sales were greater than US sales. Since all the earlier data had indicated that US was slow while the rest of the world, especially Europe was strong, this was not surprising. Expect more analysts to realize that now and also scramble to figure out why they were so wrong.
    Apr 18, 2008. 03:20 AM | Likes Like |Link to Comment
  • Housing, Credit, Economy: At an Inflection Point [View article]
    Kunst and ericinNE:

    Thank you for your comments.

    1. There are several federal programs in the pipeline which will help real home-owners who want to stay in their homes refinance to fixed rate products. This being an election year things are likely to move quickly in DC.

    2. A sub-prime home owner with a few years of steady mortgage payments will no longer be sub-prime. Credit scores do improve quite rapidly from the bottom for people with a good mortgage payment history.

    3. The other big factor in any debt crisis is time. With time wages and income creep up, improving the home owners ability to pay their mortgage. Time will also heal balance sheets, especially when the mark downs in banks have been extremely aggressive.

    Apr 15, 2008. 10:26 AM | Likes Like |Link to Comment
  • Housing, Credit, Economy: At an Inflection Point [View article]
    Basic Finance:

    Yes indeed. We are going to see more bad news.

    However the equity market is a future discounting mechanism. They will be priced based on what people see 6 to 9 months ahead. The underlying causes of this cycle's slowdown are gradually healing.

    That is why I feel that the low we will see in equities after this quarter's earnings would be very likely the low for this bear market.

    Apr 14, 2008. 09:53 PM | Likes Like |Link to Comment
  • Housing, Credit, Economy: At an Inflection Point [View article]
    My article clearly states that home prices will continue to fall at least till the end of this year and then form the bottom U over the next two years.

    The article you linked to does not take into account interest rates. Just because a mortgage resets, does not mean that the rate will go up. With LIBOR around 2.60%, the rate will go down after resets. This was different than much of 2006-2007 when LIBOR was 2-3% higher.

    Further, the ABS market has already priced in the 2006 and 2007 vintage which will reset in the future with a big discount.

    The AA tranche of 2007 vintages are trading at around 21c/dollar. That means that market expects a huge amount of principal loss on these mortgages.
    Apr 14, 2008. 05:35 PM | Likes Like |Link to Comment
  • Housing, Credit, Economy: At an Inflection Point [View article]

    As Arts pointed out, and I expanded upon in my comment, an inflection point is not the bottom. It marks a change in the rate (second derivative). That is exactly what I have written: that things will become worse before they get better and I expect the graph to look somewhat like the graph of x^3.

    Earnings are going to be bad this quarter and the outlook cautious. House prices will fall further as more sellers capitulate.

    However, the fundamental factors which caused these slides in the first place are showing signs of bottoming (sub-prime, credit crunch, lower wages etc.). It will take some time for the effects of these to go through.

    It is the gap between these two events, the potential washout after the earnings, and the recovery, which will be the best time to go long US equities.

    User169490: Though NAR has its own agenda, it is still worthwhile to compare the numbers, especially a derived number like affordability index which is based on publically available data. You can not dispute that home prices are coming down, the interest rates are much lower than an year ago, and nominal wages (not discounted for inflation) are up. The same NAR affordability index was flashing signs of distress during the peak of the boom.
    Apr 14, 2008. 11:48 AM | Likes Like |Link to Comment
  • Housing, Credit, Economy: At an Inflection Point [View article]

    Thanks for your comments.

    Things are going to become worse before they get better.

    I fully expect this quarter's earnings to be hurt by the credit crisis and expect some sort of capitulation in the equity markets (a big down day/a test of the lows).

    Similarly home prices are going to go down further, and faster as sellers start lowering prices after holding on for a long time and foreclosures dominate sales.

    However, both these actions are cathartic and will result in something similar to this curve:

    Apr 14, 2008. 08:27 AM | Likes Like |Link to Comment
  • Online Retail: Ready to Capture More Market Share [View article]
    Hi Chris:

    Thank you for your comments.

    The focus of my article was on how search engine marketing is cost effective for online retailers. It is especially useful since often it leads to the acquisition of new customeres, at a cost comparable to what advertising to existing customers costs. Specifically I feel that Google has a lot to gain from its dominance in that space.

    Brick and Mortar retailers will weather this downturn as all others before. The chains which are not well run or can not manage their inventory well will wither away. Retailers who offer a unique value proposition (e.g. An Apple Store, or Urban Outfitters) will prosper. Discount stores, especially warehouse stores will do well. General purpose department stores which do not offer anything unique will definitely suffer, especially those which compete with Walmart.

    Over the longer term, B&M retailers will have to distinguish themselves and their offerings to survive. Online retailing will thrive because of the convinience it offers. Amazon now has a subscribe and save service where you can sign up for delivery of staples at regular intervals, and get a discount. So if you have kids and use a lot of diapers or formula, you can sign up to receive the products at your door-step at a 15% discount! B&Ms who count on consumer staples for a bulk of their earnings will have to evolve to compete in the non-perishable segment.
    Apr 10, 2008. 10:52 PM | Likes Like |Link to Comment
  • Lehman's Preferred Offering: Bullish for Stocks [View article]

    Thanks for your comments.

    Again my point is that the Fed has significantly increased the profitability for IBs when the take risks so LEH is raising cash at a time when they can really profit from it. The market reaction on the day after I wrote this article seems to have vindicated my post.

    GSE spreads had really widened (when Carlyle failed) and the spreads are tightening, and much more likely to be tighter an year from now simply because the Fed backstop is now in place.

    A bulk of GSE backed paper continues to be prime/confirming/20% down. GSEs have been issuing bonds for a long time and the Alt-A/Subprime/neg-amo... boom is very recent. You have to look at it as a total percentage of GSE's outstanding debt. And even if the GSEs fail, it is the equity holders will be wiped out. The bond-holders are likely to be made whole by Uncle Sam simply because the fallout is going to be catostrophic. I continue to believe that GSE bond's defaulting is at least a 4 sigma event (I will give that to you ;) ).
    Apr 3, 2008. 07:23 PM | Likes Like |Link to Comment
  • Lehman's Preferred Offering: Bullish for Stocks [View article]

    0. I am not sure why the time I take to clarify an opinion or respond to a question is seen as an attack. Have I said something offensive?

    1. Your point about the original post not mentioning GSE's backed AAA is correct. I wish I could correct it.

    2. More important: do not miss the forest while looking at the trees. IBs are in the business of taking measured risk. They take it everytime they underwrite a deal, make a market in a particular security or take a prop position. Right now the Fed has made the profits from taking the risk significantly more than what it traditionally is. As a result an IB which has capital can profit from the environment. This is what makes the timing great.

    I gave an example of how leverage works using AAA MBS; IBs typically have a LOT more leverage than the 10x example I used. The Fed allows them use a 2% haircut for GSE backed bonds which can be used for 50x leverage.

    3. Modeling RMBS performance is a complex task with a LOT of assumptions about prepayments, and of late default rates for non-GSE backed bonds. However, even you agree that there is very little chance of principal loss on GSE backed bonds. Not to digress too much but let me address your questions about prepayment risk in the context of an IB:

    -> Prepayment happens is small steps; it is highly unlikely that an entire pool will be prepaid in a single month or quarter.

    -> Prepayment implies a return of principal. For example, as you pay off your mortgage, the note holder does not lose principal even if the value of the note goes down. Note that the market already prices its current expectations of prepayment/interest rate risk and its effect on the PV of the bonds cash flow; LEH is pretty good at it being the provider of a huge variety of tools used by buy side firms to model them.

    -> The IB can use that cash returned by prepayments to pursue what it deems is as the most profitable investment. The IB can reinvest it and buy more bonds or lend it at out at LIBOR which is still significantly higher than the borrowing cost from the Fed (look at TED spreads) or do whatever it wants with the new capital.

    -> For an IB, it is all about spreads. A buy and hold investor in RMBS has to consider the reinvestment risk since the prepayments increase at a time of low interest rates and change the traditional notion of a bond rising in value when interest rates fall. This affects the secondary market pricing of the bonds. However an IB primarily cares about is the:
    a) The spread between their borrowing costs and the coupon on the bond (which is heavily in the IB's favor). And the spread is so high that the IB can easily weather any UNEXPECTED prepayment related risk. The market will already price the expected prepayment risk in the current bond price.

    b) The spread at which the bond trades with respect to an index (say LIBOR or the treasury). Currently GSEs spreads have widened compared to historic norms so it is a great time to buy and park at the Fed, assuming that the spreads will eventually regress to the mean.

    There are several notes out there saying that it is a great time to invest in funds/ETF who buy GSE backed paper. Clearly these market observers do see something similar to what I have been saying.
    Apr 3, 2008. 06:46 AM | Likes Like |Link to Comment
  • Lehman's Preferred Offering: Bullish for Stocks [View article]

    1. My example was to illustrate how the Fed's inexpensive lending makes this the perfect time for IBs to raise new capital to work with.

    2. The link you posted is talking about private label Alt-A mortgages. These are neither prime nor are they backed by the GSEs; the market is treaging them like that. Private label Alt-A mortgages are trading at a huge discount; UBS sold them at 70c/dollar to PIMCO; subsequently Thornburg Mortgage's equity holders have been diluted by 20x after TMA was forced to raise capital to meet margin calls on Alt-A bonds they had purchased.

    To be eligible for GSEs the mortgage has to be to a prime lender, have a minimum of 20% down payment, and be conforming. GSEs backed mortgages used to trade at a very narrow spread to treasuries. The Fed is essentially backstopping them now with the TAF/TSLF; they could buy them in the open market as some observers have suggested but by using the TAF/TSLF they are letting the IBs take the spread. This is helping rebuild the IBs balance sheets and enhance their ability to lend again.

    Note that Caryle Capital's failure happened because GSE paper lost a few points last month. It was the widening of the GSE paper spread which prompted the Fed to act. The GSE spread is already tighening we speak and the IBs can also benefit from principal appreciation as the market unfreezes and spreads tightens further. The Fed will continue the lendng facility as long as the market is dysfunctional

    3. The GSE are government sponsored agancies with an implicit backing of the US Government. For the GSE AAA bonds to default, these GSEs will have to become insolvent and unable to fulfil their debt obigations. The US will not allow the debt obligations to fail that unless the Treasury itself is insolvent (the equity might be wiped out). With the Treasury's ability to raise money by increasing taxes and issuing treasury bonds, I feel that this scenario is truly a 5 or 6 sigma event. Given that the Roman Empire fell just 2000 years ago, I think it is highly unlikely that the United States too will fail ;).
    Apr 2, 2008. 11:00 PM | Likes Like |Link to Comment
  • Lehman's Preferred Offering: Bullish for Stocks [View article]

    What I have outlined is an example of how an IB can put the cash they have to use thanks to the low cost borrowing they get from the Feds. The reason the Fed is offering this facility is to encourage the IBs to take some risks and unfreeze the credit markets. That is why it was a great move for LEH to raise money right now.

    IBs are in the business of taking measured risks. They do well most of the time but mess up sometime. Right now we are in an environment where the Fed and Treasury has clearly announced their intention not to allow a meltdow. BSC was the sacrificial lamb; after that they will backstop the financial system.

    In this environment to expect GSEs to default on their bonds is like a 5-6 sigma event and banks will take their chances on that. If the GSEs default the entire global financial system is in touble, so there are greater things to worry about than LEH. The Fed has made it clear that they will continue the lending facility as long as the market is dysfunctional. This also means that LEH could buy the AAA GSE backed bonds at a much wider spread than the norm and profit from the eventual spread tightening. They will take comfort in the knowledge that the Fed will hold the bonds till the markets become fluid (and the spreads tighten).

    Apr 2, 2008. 08:57 AM | Likes Like |Link to Comment
  • Lehman's Preferred Offering: Bullish for Stocks [View article]

    The Fed has declared that they will continue to lend to the banks as long as the market is dysfunctional. The AAA bonds themselves are backed by the GSEs so unless they go under, the principal is safe. The only risk is interest rate movement which can be hedged.

    You borrow from Peter (Fed) to lend to Pan (the bond seller). Suppose the IB buys $10M bonds and puts $1M down. It needs to borrow $9M. It goes to Peter and deposits the AAA bonds and in exchange gets treasuries (with some haircut say 10%) worth $9M at a spread of 33bps. These treasuries are as good as cash and the bank pays Pan with the $9M in treasuries (or by selling them and generating cash) and $1M in their on equity. If there is a spread of 300 bps (5.6% AAA yield, 2.6% borrowing cost), the ROE on the 10% equity is 32.6%. The haircuts for AAA bonds are smaller than 10% so in principal the bank can leverage even more than 10x.
    Apr 2, 2008. 05:19 AM | Likes Like |Link to Comment