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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 Essentialist by Sahil Alvi
  • The Curious Case Of Credit Agricole - Part II 0 comments
    Dec 4, 2012 12:20 PM

    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 (NASDAQ: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.

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