Even as Sallie Mae settled one cause of speculation, option traders found something else on which to bet.
Background: On Friday, word that SLM Corp., better known as Sallie Mae, was in talks to be acquired drove trading in the stock and call options on the student lender. The company said yesterday it will be bought for $60 a share. Its stock rose $8.29, or 18%, to $55.05 in New York Stock Exchange Composite trading.
That is still about 8% below the deal price and reflects uncertainties about how quickly the acquisition will close and what regulatory hoops the buyers might have to jump through. If each of those questions is answered favorably over the coming weeks and months, the stock should rise to approach $60.
But some option traders saw an opportunity yesterday to try for a quick profit by speculating on what might happen to that so-called spread between the stock price and deal price, said Michael Schwartz, chief options strategist at Oppenheimer & Co.
How it works:
They did this by trading call options conveying the right to buy SLM shares for $55, in this case the April 55 calls, which expire in just four days.
Buying side: Buyers of these calls are expecting Sallie Mae shares to rise substantially past $55 in the next four sessions. They might be hoping for a rival bid to emerge, or just that once they have taken the time to think about it, stock traders will substantially adjust their view on how quickly the deal can close, Mr. Schwartz said.
Selling side: Much of the trading was also the work of sellers, who collect the option's price -- 50 cents by the end of the session -- and hope the stock won't remain above $55. Mr. Schwartz noted that either trade is fairly risky and likely the work of professional traders.
He also wondered if the call buyers were just redeploying a small portion of profits made in existing positions to take a shot that the stock could continue to rise. About 6,200 of the April 55 calls traded yesterday. They ended the session at 50 cents, up 45 cents.
Tuesday, April 17, 2007
Sunday, April 15, 2007
Cash Flows may be drying up: Buyback Alarm
Backgroud: One of the most enduring justifications for the current credit boom has been the idea that corporations continue to sit on healthy cash hoards.
The thinking: Robust cash flows, ------> help hold down the risk of default and imbue bond investors with the confidence that even their riskier holdings will hold up, at least in the short term.
Issue: But the underlying assumption that companies remain awash in cash may be eroding, and without many investors realizing it.
The thinking: Robust cash flows, ------> help hold down the risk of default and imbue bond investors with the confidence that even their riskier holdings will hold up, at least in the short term.
Issue: But the underlying assumption that companies remain awash in cash may be eroding, and without many investors realizing it.
- The most recent flow-of-funds data released by the Federal Reserve shows that free cash flow in the nonfinancial corporate sector plummeted late last year, according to Dominic Konstam, head of rates research at Credit Suisse. As credit spreads show signs of inching upward, a ramping up of corporate leverage at a time when cash is flowing to share buybacks could send bond spreads surging higher.
Free cash flow, calculated as internal funds less capital spending and buybacks, typically runs slightly negative and at most reaches about 2% of gross domestic product, according to Mr. Konstam.
- In the most recent flow of funds report, however, that figure plummeted to minus 5% of GDP, about as low as Mr. Konstam said he has ever seen it.
"I think it's alarming, and I think a lot of people are unaware," Mr. Konstam said.
Cause: The major culprit, Mr. Konstam said, is share buybacks.
- As risk premiums, or spreads over Treasurys, for corporate bonds hover near historic lows, companies have been able to borrow money at unusually low-cost interest rates. Many companies have then used their cash borrowings to repurchase stock shares, boosting the value of remaining shares.
- With this surge in buybacks, Mr. Konstam said, earnings growth has not been able to keep pace."Weak cash flow historically is not sustainable," Mr. Konstam said. "Either earnings must go up or investment or buybacks down."
- In fact, corporate investment poses another major concern, according to Tom Higgins, chief economist at Payden & Rygel. Mr. Higgins noted that companies are increasingly turning their backs on capital investment at a time when profits are peaking.
Given the general health of corporate credit, Mr. Konstam said that deteriorating cash flow is unlikely to produce sudden, catastrophic effects such as those seen when funding dried up in the subprime lending sector. Instead, he predicted a steady widening of spreads, one that he says has already begun.
Data: Treasury Prices Decline; Yield Rises to 4.761%
Treasury-bond prices ended lower Friday, with the yield curve flattening, as a Reuters/University of Michigan consumer-sentiment survey sparked a selloff in government bonds. The survey, indicating consumers' higher expectations for inflation,, was the last piece of data on the day, and for some bond traders canceled out an inflation-soothing producer-prices report of earlier in the day.
Option Strategy for Bearish Investor
Background: Earnings season, uncertainty about what the Federal Reserve's policy makers are thinking and broad issues such as the global economy are all making investors edgy these days.
"Over the next few months we expect markets to remain bumpy as investors digest ongoing news of slowing economic growth and weakening corporate profits growth," Bob Doll, global chief investment officer at BlackRock, wrote in his market comment this week.
Doll isn't so worried that he thinks the bull market is over, and investors who want to continue holding onto stocks but wouldn't mind carrying some insurance as well can turn to put options on the Standard & Poor's in case stocks stage a repeat of February's steep drop.
But rather than buying puts outright, Bud Haslett, director of option analytics at Miller Tabak suggests that investors consider a more complicated but lower-cost way of protecting the portfolio called a "combination bear spread."
Warning: The position will lose money if stocks rise much, so it isn't for someone feeling very bullish, and also "not for speculators," Mr. Haslett advised. Rather, "this is for someone who is getting a little bit nervous and doesn't want to just go out and buy puts."
Here's how it works:
"Put-Options Strategy May Be SalveFor Investors Nervous About Bears"
By MOHAMMED HADI April 14, 2007; Page B5
"Over the next few months we expect markets to remain bumpy as investors digest ongoing news of slowing economic growth and weakening corporate profits growth," Bob Doll, global chief investment officer at BlackRock, wrote in his market comment this week.
Doll isn't so worried that he thinks the bull market is over, and investors who want to continue holding onto stocks but wouldn't mind carrying some insurance as well can turn to put options on the Standard & Poor's in case stocks stage a repeat of February's steep drop.
But rather than buying puts outright, Bud Haslett, director of option analytics at Miller Tabak suggests that investors consider a more complicated but lower-cost way of protecting the portfolio called a "combination bear spread."
Warning: The position will lose money if stocks rise much, so it isn't for someone feeling very bullish, and also "not for speculators," Mr. Haslett advised. Rather, "this is for someone who is getting a little bit nervous and doesn't want to just go out and buy puts."
Here's how it works:
- With the S&P 500 near 1453, buy one June 1405 put option and sell one June 1375 put option. That combination costs about $5.
- To offset this cost, sell one June 1460 call and buy one June 1470 call, a move that nets a credit of about $4.
- Once combined the two positions will cost about $1
- It starts to profit once the S&P 500 falls about 3% to 1404 and continues to do so as it drops all the way to 1376. Buying the June 1405 puts outright, by comparison costs closer to $13.
Remember: the tradeoff is that the position will also eat into gains in your stock portfolio if the S&P 500 rises. It is also possible that, given that the trade has four pieces to it, commissions and margin requirement might not make it feasible for some traders.
"Put-Options Strategy May Be SalveFor Investors Nervous About Bears"
By MOHAMMED HADI April 14, 2007; Page B5
Citi's relentless pursuit of talent: $800 million
------------------------------------------------NYT-------------------------------------------
Annoucement: Citigroup bought a hedge fund today as part of a deal that would put a former top executive at Morgan Stanley, Vikram Pandit, at the head of its alternative investments group.
Title: Mr. Pandit would become chief executive of its Alternative Investments unit as well as a member of Citi’s operating and management committee.
Background: According to those close to the deal, Citigroup bought Old Lane, the hedge fund that Mr. Pandit helped found a little more than a year ago, as a way to bring him aboard. The Citi unit has been absent a full-time leader for over a year and is seen as a crucial part of Citigroup’s growth. The actual price for the fund will depend on performance, those involved said.
Advantage:
Annoucement: Financial services giant Citigroup Inc. yesterday unveiled its acquisition of Old Lane Partners LP, a hedge fund with $4.5 billion in assets under management and headed by Mr. Vikram Pandit.
Quote: Citi's top managment were quick to defend the critics of hefty price tage: $800 million. CEO Charles Prince: "an investment as much as it is an acquisition," referring to "world-class talent" of Mr. Pandit and his colleagues.
Snapshot: Citi's current alternative-investment unit has just $49.2 billion under management, with $10.7 billion of that from Citi itself. It includes a $3.3 billion private-equity fund launched in January and a $2.5 billion multi-strategy hedge fund.
Disavantage: There is a long tradition of companies engineering acquisitions as a way to win top talent. But it is a risky bet.
Profile & Background : Mr. Pandit grew up in Mumbai, India, and came to the U.S. in his mid-teens. After earning undergraduate and doctoral degrees from Columbia University, where he now serves as a trustee, he was a junior finance professor at Indiana University in the mid-1980s before joining Morgan Stanley. At the blue-chip securities firm, he became known for a soft-spoken, cerebral management style. While many Wall Street executives are known for schmoozing, Mr. Pandit rarely appears at high-profile social events. Though he joined a golf club in Purchase, N.Y., a decade ago to support John Mack, the current Morgan Stanley CEO who was recruiting members at the time, he rarely plays there, according to one of his colleagues. In the 1990s, he oversaw the firm's buildup of prime brokerage services catering to hedge funds, where it remains a leading player. He also pushed into electronic trading, keeping pressure on the major stock exchanges to keep a lid on trading fees.
At the peak of the dot-com bubble, Morgan Stanley had a commanding share of online stock issues based partly on its Internet analyst Mary Meeker. But just as those results propelled Mr. Pandit up the management ranks, the bursting of the bubble strengthened the fortunes of the firm's bond division. Mr. Pandit left the firm on the eve of a bruising battle waged by Morgan Stanley alumni who ousted Mr. Purcell in mid-2005. He left when Mr. Purcell promoted fixed-income chief Zoe Cruz to be co-president above him. His longtime colleague Mr. Havens soon followed Mr. Pandit out the door, along with a parade of other traders and bankers.
Though Mr. Pandit left quietly, Mr. Havens received a standing ovation from admiring colleagues as he walked off the trading floor.
------------------------------------------Point of View-----------------------------------------Andy: It's a showcase of how valueable an seasoned industry player along with his depth knowledge and experience in the market has become, amplifed by the example of the relentless pursuit by Citigroup with a tage price : $800 million. However, the action considers speculative as the company experiencing job cuts and major overhauls with emphasis on cost saving and revenue growth, given the short history with relatively poor performance.
Annoucement: Citigroup bought a hedge fund today as part of a deal that would put a former top executive at Morgan Stanley, Vikram Pandit, at the head of its alternative investments group.
Title: Mr. Pandit would become chief executive of its Alternative Investments unit as well as a member of Citi’s operating and management committee.
Background: According to those close to the deal, Citigroup bought Old Lane, the hedge fund that Mr. Pandit helped found a little more than a year ago, as a way to bring him aboard. The Citi unit has been absent a full-time leader for over a year and is seen as a crucial part of Citigroup’s growth. The actual price for the fund will depend on performance, those involved said.
Advantage:
- The appointment of a seasoned leader like Mr. Pandit would go a long way in helping the bank’s chief executive, Charles O. Prince III, overcome Wall Street’s perception that Citigroup has a leadership void as it undergoes a major overhaul. While Mr. Prince has dismissed the notion that he lacked a successor, Citigroup’s senior management team is seen as being too young and inexperienced for the top job. Although the recent hiring of Gary L. Crittenden as its new financial chief has bolstered the ranks, Mr. Crittenden has never run a big financial conglomerate.
- Mr. Pandit replaces Michael A. Carpenter who left Citi last May after more than a decade in executive positions to start his own venture. John Havens of Old Lane will be president of the Alternative Investments unit, and other colleagues also will be given Citi titles.
- For Citigroup, the purchase of Old Lane, which has a separate investment fund focused on real estate and infrastructure opportunities in India, may help fill other gaps.
- In order to capitalize on the meteoric growth in alternative investing. For the most part, the banks are seeking two things:
- access to the hedge funds for their private banking
- high net worth clients, and income from the gush of fees thrown off by hedge funds that do well.
Industry Reference: JPMorgan Chase blazed a path into hedge fund acquisitions in 2004, buying Highbridge Capital Management. At the time, rivals scoffed at the price and predicted the deal would fail. In fact, the fund has soared to assets of more than $17 billion this year from $6.6 billion.
Conclusion: Citigroup’s purchase of Old Lane is particularly spectacular considering Old Lane’s short and unimpressive track record.
Annoucement: Financial services giant Citigroup Inc. yesterday unveiled its acquisition of Old Lane Partners LP, a hedge fund with $4.5 billion in assets under management and headed by Mr. Vikram Pandit.
Quote: Citi's top managment were quick to defend the critics of hefty price tage: $800 million. CEO Charles Prince: "an investment as much as it is an acquisition," referring to "world-class talent" of Mr. Pandit and his colleagues.
Snapshot: Citi's current alternative-investment unit has just $49.2 billion under management, with $10.7 billion of that from Citi itself. It includes a $3.3 billion private-equity fund launched in January and a $2.5 billion multi-strategy hedge fund.
Disavantage: There is a long tradition of companies engineering acquisitions as a way to win top talent. But it is a risky bet.
- Performance: In the case of Old Lane, it is a newcomer to the hedge-fund game and has so far turned in a mediocre performance. The hedge fund has the backing of the Singapore Investment Corp. and the Harvard endowment. But it got off to a sputtering start last year when stock markets fell in May, and finished 2006 with a return of just 6%. So far this year, it is up about 4%.
- Clash over power for top spot: In addition, by luring Mr. Pandit and his team, Mr. Prince is risking the ire of his current cadre of capital-markets executives as a new group of capital-markets experts compete for top spots. The possibility of the kind of transplant rejection that occurred with Mr. Boisi at J.P. Morgan Chase arises because the Old Lane stars come from the same type of business as the two Prince deputies with the strongest credentials.
Those two executives, Michael Klein and Thomas Maheras, are co-heads of Citi's global markets and banking division and themselves earned their stripes at former Wall Street powerhouse Salomon Brothers, which was sold in 1997 to Mr. Weill's company.
The combination of the Salomon bond franchise with Citi's big lending platform has helped make Citigroup the top securities underwriter since 2002. - Unfit with Prince's turnaround strategy: the Old Lane executives' backgrounds don't fit neatly within the bank's top priorities outlined by Mr. Prince earlier this week -- bolstering U.S. consumer business growth, boosting the international share of top businesses, as well as expense and credit management. Investors want reassurance "that they won't spend too much on it," Mr. Mayo said.
Industry Reference: Wall Street history doesn't offer much encouragement either.
- In the spring of 2000, Chase Manhattan Corp. acquired Beacon Group LLC, an investment banking boutique, for about $500 million. Chase's goal at the time was to bolster its own banking ranks with a roster led by Beacon founder Geoffrey Boisi, the former investment banking chief at Goldman, Sachs & Co.
Two years later, Mr. Boisi left, after clashing with other top bankers after Chase merged with J.P. Morgan & Co. The Chase purchase of Beacon wound up being "a lot of money for not that many people," says Mike Mayo, an analyst at Deutsche Bank AG who covers banks and brokerage firms.
Profile & Background : Mr. Pandit grew up in Mumbai, India, and came to the U.S. in his mid-teens. After earning undergraduate and doctoral degrees from Columbia University, where he now serves as a trustee, he was a junior finance professor at Indiana University in the mid-1980s before joining Morgan Stanley. At the blue-chip securities firm, he became known for a soft-spoken, cerebral management style. While many Wall Street executives are known for schmoozing, Mr. Pandit rarely appears at high-profile social events. Though he joined a golf club in Purchase, N.Y., a decade ago to support John Mack, the current Morgan Stanley CEO who was recruiting members at the time, he rarely plays there, according to one of his colleagues. In the 1990s, he oversaw the firm's buildup of prime brokerage services catering to hedge funds, where it remains a leading player. He also pushed into electronic trading, keeping pressure on the major stock exchanges to keep a lid on trading fees.
At the peak of the dot-com bubble, Morgan Stanley had a commanding share of online stock issues based partly on its Internet analyst Mary Meeker. But just as those results propelled Mr. Pandit up the management ranks, the bursting of the bubble strengthened the fortunes of the firm's bond division. Mr. Pandit left the firm on the eve of a bruising battle waged by Morgan Stanley alumni who ousted Mr. Purcell in mid-2005. He left when Mr. Purcell promoted fixed-income chief Zoe Cruz to be co-president above him. His longtime colleague Mr. Havens soon followed Mr. Pandit out the door, along with a parade of other traders and bankers.
Though Mr. Pandit left quietly, Mr. Havens received a standing ovation from admiring colleagues as he walked off the trading floor.
------------------------------------------Point of View-----------------------------------------Andy: It's a showcase of how valueable an seasoned industry player along with his depth knowledge and experience in the market has become, amplifed by the example of the relentless pursuit by Citigroup with a tage price : $800 million. However, the action considers speculative as the company experiencing job cuts and major overhauls with emphasis on cost saving and revenue growth, given the short history with relatively poor performance.
Wednesday, April 11, 2007
The Future of Futures
The New York Stock Exchange and Euronext completed their debut as the first trans-Atlantic stock exchange last week, but the bigger news is what NYSE chief John Thain is promising next. The Big Board's quest to become a player in the derivatives business shows how global and competitive the market for these complex financial instruments has become.
Let's hope regulators are paying attention, especially as they weigh antitrust concerns surrounding two high-profile takeover bids for the country's oldest futures market, the Chicago Board of Trade. The CBOT is mulling offers from its Windy City rival, the Chicago Mercantile Exchange (CME), as well as from electronic upstart Intercontinental Exchange (ICE). In today's cutthroat world of global finance, exchange consolidation is more necessity than choice, and either tie-up would bring efficiencies and opportunity for investors.
* * *
You can bet the CBOT's competitors realize the stakes, which is why they've been fanning antitrust anxieties, hoping to scotch the deal and forestall a tougher competitor. Like Mr. Thain, they can follow the money. Stock markets are crucial to raising capital, but their growth is limited by the number of companies that choose to go public, the economic health of a country, and such regulatory follies as Sarbanes-Oxley.
Derivatives, by contrast, are limited mainly by a lack of imagination. These days, hedge funds and other traders make bets on everything from interest-rate movements to how much snow will fall during ski season. These contracts hold profit potential whether world stock markets are booming or swooning. Global stocks were worth about $50 trillion last year, and bonds $65 trillion. The global value of derivatives contracts? Some $450 trillion, and exploding.
Yet derivatives exchanges are also facing the same pressures as their equity counterparts. For decades, regional exchanges relied on gentlemen's agreements to defend their turf. But technology has hurdled these walls, allowing competitors to offer services from anywhere on the planet. Markets like the CBOT have had to transform -- from membership clubs with floor traders specializing in farm products, into high-tech, electronic exchanges that wheel-and-deal in Treasury futures.
This competition has brought extraordinary benefits to investors by lowering trading costs, but it has also meant exchanges must grow to provide liquidity, develop new products, and seek efficiencies. Also driving the merger wave is the cash that exchanges have mined by becoming public companies themselves -- an innovation that itself has brought more accountability. The Chicago Merc's trailblazing decision to go public in 2002 gave it a competitive edge over the CBOT, putting it in position to offer its $8 billion buyout.
The worry is that all of this will confuse merger regulators, who prefer to focus on local market share. In this case, they've been furrowing their brows over the number 85% -- the percentage of the market for exchange-traded U.S. futures contracts that a combined CBOT-CME would hold. The concern is that an exchange that large would be able to unilaterally raise trading prices. This fear has given some momentum to ICE's own $9.7 billion bid, because an ICE-CBOT tie up would have only 33% market share.
This sort of static analysis is better suited to yesterday's oil and steel trusts than today's global financial markets. Exchange-traded derivatives are still in their infancy. An estimated 80% of the global derivatives pie isn't even handled by exchanges but is orchestrated by banks in over-the-counter transactions. U.S. share is also a poor measure of market power because today's exchange competition is global. One of Mr. Thain's goals in buying Euronext was to get access to its derivatives business, Liffe, and make it more attractive to U.S. investors.
Different exchanges also specialize in different products. The CBOT thrives in Treasury notes, soybeans, wheat and corn. The Chicago Merc focuses on interest-rate, stock-index and livestock futures. ICE touts contracts in natural gas, oil and sugar. The combination of either exchange with the CBOT would be more complementary than monopolistic, giving traders access to broader ranges of products in one place.
New entrants still face challenges, in particular building liquidity. This was the wall the Deutsche Boerse hit when it launched Eurex US and attempted to poach Treasury futures away from CBOT. New players need a significantly better mousetrap if they want to quickly attract enough market-makers to create real liquidity -- and that can be difficult in established markets.
Yet it can happen, and new technology has lowered the barriers to entry. In equity markets, online exchanges like Archipelago began stealing business from the NYSE and forced modernization. The same is happening in derivatives, notably with the 2000 creation of the International Securities Exchange as the first fully electronic U.S. options exchange. ISE's cheaper and faster service allowed it to steal business from the manual trading floors of its stodgier competitors, and within a few years was competing head-to-head with the Chicago Board Options Exchange.
* * *
It's this potential that has older players looking to expand now, and the CBOT isn't alone in its merger ambitions. Mr. Thain is determined to grow his U.S. derivatives book and hasn't ruled out getting in on the Chicago action. The New York Mercantile Exchange, ISE, the Philadelphia Stock Exchange and the American Stock Exchange all have derivatives businesses that need to grow. European exchanges are also on the hunt for combinations, within their region or through deals in Asia, India or U.S.
All of which means that the best judge of the CBOT's competing merger offers are its own shareholders, not Beltway meddlers. Regulators may have the power to block a U.S. alliance, but they can't stop growth in exchanges across the world. They will merely impede the ability of U.S. companies to adapt and thrive in this new global marketplace.
Let's hope regulators are paying attention, especially as they weigh antitrust concerns surrounding two high-profile takeover bids for the country's oldest futures market, the Chicago Board of Trade. The CBOT is mulling offers from its Windy City rival, the Chicago Mercantile Exchange (CME), as well as from electronic upstart Intercontinental Exchange (ICE). In today's cutthroat world of global finance, exchange consolidation is more necessity than choice, and either tie-up would bring efficiencies and opportunity for investors.
* * *
You can bet the CBOT's competitors realize the stakes, which is why they've been fanning antitrust anxieties, hoping to scotch the deal and forestall a tougher competitor. Like Mr. Thain, they can follow the money. Stock markets are crucial to raising capital, but their growth is limited by the number of companies that choose to go public, the economic health of a country, and such regulatory follies as Sarbanes-Oxley.
Derivatives, by contrast, are limited mainly by a lack of imagination. These days, hedge funds and other traders make bets on everything from interest-rate movements to how much snow will fall during ski season. These contracts hold profit potential whether world stock markets are booming or swooning. Global stocks were worth about $50 trillion last year, and bonds $65 trillion. The global value of derivatives contracts? Some $450 trillion, and exploding.
Yet derivatives exchanges are also facing the same pressures as their equity counterparts. For decades, regional exchanges relied on gentlemen's agreements to defend their turf. But technology has hurdled these walls, allowing competitors to offer services from anywhere on the planet. Markets like the CBOT have had to transform -- from membership clubs with floor traders specializing in farm products, into high-tech, electronic exchanges that wheel-and-deal in Treasury futures.
This competition has brought extraordinary benefits to investors by lowering trading costs, but it has also meant exchanges must grow to provide liquidity, develop new products, and seek efficiencies. Also driving the merger wave is the cash that exchanges have mined by becoming public companies themselves -- an innovation that itself has brought more accountability. The Chicago Merc's trailblazing decision to go public in 2002 gave it a competitive edge over the CBOT, putting it in position to offer its $8 billion buyout.
The worry is that all of this will confuse merger regulators, who prefer to focus on local market share. In this case, they've been furrowing their brows over the number 85% -- the percentage of the market for exchange-traded U.S. futures contracts that a combined CBOT-CME would hold. The concern is that an exchange that large would be able to unilaterally raise trading prices. This fear has given some momentum to ICE's own $9.7 billion bid, because an ICE-CBOT tie up would have only 33% market share.
This sort of static analysis is better suited to yesterday's oil and steel trusts than today's global financial markets. Exchange-traded derivatives are still in their infancy. An estimated 80% of the global derivatives pie isn't even handled by exchanges but is orchestrated by banks in over-the-counter transactions. U.S. share is also a poor measure of market power because today's exchange competition is global. One of Mr. Thain's goals in buying Euronext was to get access to its derivatives business, Liffe, and make it more attractive to U.S. investors.
Different exchanges also specialize in different products. The CBOT thrives in Treasury notes, soybeans, wheat and corn. The Chicago Merc focuses on interest-rate, stock-index and livestock futures. ICE touts contracts in natural gas, oil and sugar. The combination of either exchange with the CBOT would be more complementary than monopolistic, giving traders access to broader ranges of products in one place.
New entrants still face challenges, in particular building liquidity. This was the wall the Deutsche Boerse hit when it launched Eurex US and attempted to poach Treasury futures away from CBOT. New players need a significantly better mousetrap if they want to quickly attract enough market-makers to create real liquidity -- and that can be difficult in established markets.
Yet it can happen, and new technology has lowered the barriers to entry. In equity markets, online exchanges like Archipelago began stealing business from the NYSE and forced modernization. The same is happening in derivatives, notably with the 2000 creation of the International Securities Exchange as the first fully electronic U.S. options exchange. ISE's cheaper and faster service allowed it to steal business from the manual trading floors of its stodgier competitors, and within a few years was competing head-to-head with the Chicago Board Options Exchange.
* * *
It's this potential that has older players looking to expand now, and the CBOT isn't alone in its merger ambitions. Mr. Thain is determined to grow his U.S. derivatives book and hasn't ruled out getting in on the Chicago action. The New York Mercantile Exchange, ISE, the Philadelphia Stock Exchange and the American Stock Exchange all have derivatives businesses that need to grow. European exchanges are also on the hunt for combinations, within their region or through deals in Asia, India or U.S.
All of which means that the best judge of the CBOT's competing merger offers are its own shareholders, not Beltway meddlers. Regulators may have the power to block a U.S. alliance, but they can't stop growth in exchanges across the world. They will merely impede the ability of U.S. companies to adapt and thrive in this new global marketplace.
When Investors Can't Leave
Lifecycle-fund investors were supposed to leave the driving to someone else. But many shareholders are grabbing the wheel.
These funds were designed to be the ultimate buy-and-forget investment. The notion: You purchase a lifecycle fund that targets your expected retirement date, and then sit back and let your money ride all the way to retirement and beyond.
But it turns out that lifecycle-fund investors have other ideas -- some good, some not so good.
• Adding on. Lifecycle-fund assets soared 61% in 2006, according to the Investment Company Institute. A big reason is 401(k) plans, where the funds are increasingly used as the default investment option.
Lifecycle funds are ideally suited to that task. Not only do they become more conservative as they approach their target retirement date; they also offer exposure to an array of stocks and bonds, thus providing one-stop investment shopping.
Many investors, however, aren't using the funds for one-stop shopping. According to 401(k) data from Vanguard Group, 69% of lifecycle-fund investors own at least one other fund in their retirement plan.
No doubt some folks are foolishly buying other funds, not realizing their lifecycle fund is already well diversified. But others may be consciously customizing their portfolio.
"I don't think we should conclude that everyone is making a mistake," says Stephen Utkus, head of Vanguard's Center for Retirement Research. "People might be juicing up or juicing down the risk" by adding other funds.
One sensible strategy: Stick maybe 80% of your retirement money in a lifecycle fund and then tack on smaller stakes in intriguing sectors such as emerging-market stocks, foreign small-company shares and high-yield junk bonds.
You might even buy more than one lifecycle fund. Suppose you plan to retire in 2017. You might purchase a mix of, say, Schwab Target 2010 and Schwab Target 2020.
"People will use a weighted average of two funds to dial into a particular year," says Jeffrey Mortimer, chief investment officer for equities in Charles Schwab's investment-management group. "I think that's pretty ingenious."
• Aiming elsewhere. Lifecycle funds were designed for retirement investors, who might draw down their nest egg over 20 or 30 years. But some shareholders are using the funds to amass money for a home purchase, where they will need their savings on a single day, or college, where costs should be over in just four years.
The problem: When lifecycle funds reach their target date, they typically have 50% to 60% of their money in stocks. "You run that horrific risk of having too much equity exposure when you get that tuition bill," Mr. Mortimer says.
Still, you could use lifecycle funds for these other goals. The trick: Buy a fund that reaches its target date 10 or 15 years before you will buy a house or pay for college. That will ensure you take a more reasonable amount of risk, because lifecycle funds continue to trim their stock exposure in the years after they reach their target date.
• Laddering funds. Some retirees are laddering lifecycle funds in the same way folks ladder individual bonds. This isn't a great investment strategy, because there's so much overlap between the funds' holdings, but it could help you manage your retirement spending.
Suppose you plan to quit the work force in 2015, when you turn age 65. John Haslem, professor emeritus of finance at the University of Maryland, says you might buy a 2015 fund to cover the first 10 years of retirement, a 2025 fund to pay for the years from ages 75 to 85, and a 2035 fund for your final years.
He suggests combining these three funds with an emergency reserve, which you could tap for income during rough markets. How you divvy up your money among the three funds and the emergency reserve will depend on your tolerance for risk and your life expectancy. "This allows people to segment the problem into manageable pieces," Prof. Haslem reckons.
These funds were designed to be the ultimate buy-and-forget investment. The notion: You purchase a lifecycle fund that targets your expected retirement date, and then sit back and let your money ride all the way to retirement and beyond.
But it turns out that lifecycle-fund investors have other ideas -- some good, some not so good.
• Adding on. Lifecycle-fund assets soared 61% in 2006, according to the Investment Company Institute. A big reason is 401(k) plans, where the funds are increasingly used as the default investment option.
Lifecycle funds are ideally suited to that task. Not only do they become more conservative as they approach their target retirement date; they also offer exposure to an array of stocks and bonds, thus providing one-stop investment shopping.
Many investors, however, aren't using the funds for one-stop shopping. According to 401(k) data from Vanguard Group, 69% of lifecycle-fund investors own at least one other fund in their retirement plan.
No doubt some folks are foolishly buying other funds, not realizing their lifecycle fund is already well diversified. But others may be consciously customizing their portfolio.
"I don't think we should conclude that everyone is making a mistake," says Stephen Utkus, head of Vanguard's Center for Retirement Research. "People might be juicing up or juicing down the risk" by adding other funds.
One sensible strategy: Stick maybe 80% of your retirement money in a lifecycle fund and then tack on smaller stakes in intriguing sectors such as emerging-market stocks, foreign small-company shares and high-yield junk bonds.
You might even buy more than one lifecycle fund. Suppose you plan to retire in 2017. You might purchase a mix of, say, Schwab Target 2010 and Schwab Target 2020.
"People will use a weighted average of two funds to dial into a particular year," says Jeffrey Mortimer, chief investment officer for equities in Charles Schwab's investment-management group. "I think that's pretty ingenious."
• Aiming elsewhere. Lifecycle funds were designed for retirement investors, who might draw down their nest egg over 20 or 30 years. But some shareholders are using the funds to amass money for a home purchase, where they will need their savings on a single day, or college, where costs should be over in just four years.
The problem: When lifecycle funds reach their target date, they typically have 50% to 60% of their money in stocks. "You run that horrific risk of having too much equity exposure when you get that tuition bill," Mr. Mortimer says.
Still, you could use lifecycle funds for these other goals. The trick: Buy a fund that reaches its target date 10 or 15 years before you will buy a house or pay for college. That will ensure you take a more reasonable amount of risk, because lifecycle funds continue to trim their stock exposure in the years after they reach their target date.
• Laddering funds. Some retirees are laddering lifecycle funds in the same way folks ladder individual bonds. This isn't a great investment strategy, because there's so much overlap between the funds' holdings, but it could help you manage your retirement spending.
Suppose you plan to quit the work force in 2015, when you turn age 65. John Haslem, professor emeritus of finance at the University of Maryland, says you might buy a 2015 fund to cover the first 10 years of retirement, a 2025 fund to pay for the years from ages 75 to 85, and a 2035 fund for your final years.
He suggests combining these three funds with an emergency reserve, which you could tap for income during rough markets. How you divvy up your money among the three funds and the emergency reserve will depend on your tolerance for risk and your life expectancy. "This allows people to segment the problem into manageable pieces," Prof. Haslem reckons.
Thursday, April 5, 2007
Intergration between Bank of America and U.S. Trust
The top executive at U.S. Trust, a private-banking operation being acquired for $3.3 billion by Bank of America Corp., has decided to quit this summer, dealing a setback to the big bank's ambitious push to become the leader in the lucrative business of managing rich people's money.
Bank of America has lacked a renowned private-banking name, and has struggled to persuade clients that its private bank offers the type of personalized service they expect. The Charlotte, N.C., bank pitches its size as a benefit, since it can approve large personal loans, but that heft also means clients often are steered toward a suite of the bank's own products.
U.S. Trust, founded in 1853, counts some of America's oldest dynasties among its clients -- including the Astors and Whitneys -- and requires a minimum of $2 million to open an account. The firm has about $93 billion of client assets. Bank of America's private bank has about $171.8 billion under management.
One of the biggest clashes between Mr. Scaturro and Mr. Moynihan revolved around investments. Mr. Scaturro wanted wealthy clients to have their own set of financial products, ranging from stock and bond portfolios to hedge funds and private-equity investments. Mr. Moynihan wants to centralize the investments to serve a broader group of bank customers.
Mr. Moynihan described the model in a February presentation to investors, breaking clients into segments with investable assets of $100,000 to $3 million, $3 million to $50 million and more than $50 million.
Mr. Moynihan described the model in a February presentation to investors, breaking clients into segments with investable assets of $100,000 to $3 million, $3 million to $50 million and more than $50 million.
Despite his decision to quit, Mr. Scaturro is entitled to a lump sum of $8.95 million in cash and shares valued at $3.3 million when the deal closes, according to his agreement with Schwab. Under Mr. Scaturro, U.S. Trust's earnings jumped to $190 million in 2006 from $146 million in 2005. Bank of America has described its private bank's earnings growth as "sluggish," and the unit's net income fell last year by 1%, or $6 million.
After announcing the deal, Mr. Moynihan told analysts on a conference call that the bank planned to "keep the U.S. Trust legacy, keep the identity," and to run a "unified business across the entire wealth spectrum under Peter's leadership."
But his and Mr. Scaturro's vision of how to treat this specialized clientele clearly differ. For one thing, Mr. Moynihan's mantra is "scale": Mechanization and a one-size-fits-all product suite has made Bank of America excel in such areas as branch and business banking, where products are commodities and where "customer delight" scores are scrutinized.
Mr. Scaturro, by contrast, preaches "specialized service" to millionaire and billionaire clients who demand constant attention and performance. The company's marketing events include intimate dinners for clients with top authors or politicians, private concerts and cocktail parties at its Manhattan townhouse.
Mr. Moynihan, according to people familiar with meetings held to orchestrate the banks' integration, viewed some of U.S. Trust's marketing events as overly costly and ineffective.
Bank of America, and its predecessor NationsBank, has been among the most aggressive at categorizing its "rich" clients -- from super-rich down to merely rich -- and tailoring services along those lines, which has meant some people accustomed to personal bankers end up steered to toll-free phone numbers for service.
Bank of America reached its unprecedented size through more than 20 acquisitions during the 1980s and 1990s. As the bank scurried from one deal to the next, it hemorrhaged customers of companies it had paid dearly to acquire.
Mr. Lewis has made integrating acquisitions a top priority in his six years at the helm, and Bank of America seems to have made progress in absorbing aspects of acquired companies' cultures. The bank boosted its share of New England customers after it bought FleetBoston Financial Corp. in 2004, in part because it adopted a popular integrated statement that showed all of a wealthy customer's accounts.
Still, Mr. Lewis remains leery of letting any unit operate under a different culture or name, and was loath to let U.S. Trust stand alone.
Islamic Finance---Malaysia
Now such innovation are not just commonplace in the Gulf, but also have become an important revenue source for Western financial giants with Islamic-banking division, such as Citigroup Inc. and HSBC Holdings PLC.
increasingly sophisticated Muslim communities in fast-growing Asian countries such as Malaysia are beginning to influence the Arab heartland, offering a vivid example that an embrace of the global economy can coexist with Islam.
Unlike oil-rich Gulf monarchies that rely on guest labor, Malaysia derives its prosperity from an educated work force and cutting-edge manufacturing. Electric and electronic goods such as mobile phones, semiconductors and computer parts account for about half of its exports.
The barrier that Islamic financial modernizers are trying to overcome is the Quranic prohibition on receiving or paying interest: "Allah permitted trading and forbade interest." While ignored by many secular Muslims and the conventional banks that operate in most Muslim nations today, this ban has long denied the benefits of modern banking to strict believers -- contributing, some say, to the Muslim world's relative decline after interest-based bonds and loans powered the West's Industrial Revolution. In Malaysia, Muslim distrust of conventional finance has also helped cement the historic domination of the country's economy by non-Muslim ethnic Chinese.
As Malaysia's government sought to lift the Malay majority out of poverty and promote native entrepreneurship, it focused on creating an Islamic financial alternative. Malaysia's government, by contrast, encouraged banks to replace interest-based transactions with arrangements that, while benchmarked to interest rates, are technically based on profit-sharing, leasing or trading -- all activities permissible in Islam because they involve entrepreneurial work rather than simply moneylending.
Malaysia also introduced the first sukuk, or Islamic bonds, years before Middle Eastern clerics accepted the practice.
Though rival Islamic banking and capital-markets centers have since sprung up in Dubai, Bahrain and London, Malaysia still accounts for two-thirds of the world's Islamic bond issuance. The country has achieved "the closest possible replication of conventional finance while giving it an Islamic label," says Mahmoud El-Gamal, Egyptian-born chair of Islamic finance and economics at Rice University in Texas.
One beneficiary is Azrulkhakim Suradi, the 31-year-old owner of a herbal-medicine business in the town of Shah Alam outside Kuala Lumpur. Mr. Azrulkhakim, who sports a shaggy beard and whose wife is shrouded in a black abaya, is a fervent Muslim believer and considers paying or receiving interest a grave sin.
Thanks to the availability of Islamic finance, Mr. Azrulkhakim became the first in his family to accept a bank loan. He has borrowed $43,000 from one Islamic bank to buy his dream car, a Mercedes-Benz C 200. He owes another Islamic bank $27,000 on a mortgage, and has just arranged financing for a second home. "I can sleep well at night," Mr. Azrulkhakim beams, "because I can be sure that everything my bank is doing conforms with the way of Islam."
Thanks to the availability of Islamic finance, Mr. Azrulkhakim became the first in his family to accept a bank loan. He has borrowed $43,000 from one Islamic bank to buy his dream car, a Mercedes-Benz C 200. He owes another Islamic bank $27,000 on a mortgage, and has just arranged financing for a second home. "I can sleep well at night," Mr. Azrulkhakim beams, "because I can be sure that everything my bank is doing conforms with the way of Islam."
Dr. Daud is unapologetic about the fact that many recent Islamic financial products, while technically based on lease or trade contracts, have become virtually indistinguishable from those offered by interest-driven Western finance.
"It's all about the journey you take to that destination," he says, drawing a parallel between financial gain and sex. A seeker of sexual pleasure, he explains, can get married or fornicate on the side -- just as a seeker of financial gain can profit from an Islamic sukuk or a conventional bond. "You'll have enjoyment in both cases," Dr. Daud chuckles, "but one is halal [permissible] and the other is not."
"It's all about the journey you take to that destination," he says, drawing a parallel between financial gain and sex. A seeker of sexual pleasure, he explains, can get married or fornicate on the side -- just as a seeker of financial gain can profit from an Islamic sukuk or a conventional bond. "You'll have enjoyment in both cases," Dr. Daud chuckles, "but one is halal [permissible] and the other is not."
Aware of this attitude, Malaysian banks in recent years have concentrated on crafting new structures based on leasing contracts, known as ijara, for global dollar-denominated sukuk marketed to Arab investors. The issuer of ijara sukuk places certain assets, such as a palm plantation or a building, in a special-purpose vehicle. In exchange for their cash, investors receive the right to the lease payments that the issuer makes to the special-purpose vehicle. The lease payments are usually set in advance and benchmarked to interest rates, making the investors' return comparable to interest from a bond.
The ijara principle was pioneered in corporate bonds in 2001, when Malaysian plantation company Kumpulan Guthrie issued the $150 million sukuk that were so controversial at the time. These days, almost identical ijara sukuk are commonplace in the Gulf. "If we persevere in educating the markets, eventually the markets will understand," says Badlisyah Abdul Ghani, the chief executive of CIMB Islamic Bank, one of Malaysia's largest. Mr. Badlisyah helped arrange the pathbreaking bond as an investment banker at Bank Islam.
Eager to educate oil-rich Gulf investors about such financial novelties, Malaysia's central bank, Bank Negara, is spending $57 million to invite Islamic scholars from around the world to Kuala Lumpur for a "Shariah dialogue" program. "To be an international financial center, you must allow a diversity of interpretations," says Bank Negara Deputy Governor Razif Abdul Kadir "This is our strength."
The ijara principle was pioneered in corporate bonds in 2001, when Malaysian plantation company Kumpulan Guthrie issued the $150 million sukuk that were so controversial at the time. These days, almost identical ijara sukuk are commonplace in the Gulf. "If we persevere in educating the markets, eventually the markets will understand," says Badlisyah Abdul Ghani, the chief executive of CIMB Islamic Bank, one of Malaysia's largest. Mr. Badlisyah helped arrange the pathbreaking bond as an investment banker at Bank Islam.
Eager to educate oil-rich Gulf investors about such financial novelties, Malaysia's central bank, Bank Negara, is spending $57 million to invite Islamic scholars from around the world to Kuala Lumpur for a "Shariah dialogue" program. "To be an international financial center, you must allow a diversity of interpretations," says Bank Negara Deputy Governor Razif Abdul Kadir "This is our strength."
Continued with CDO
Subprime lenders sell most of their loans to investment banks, which repackage them into mortgage bonds. Many of the riskiest slices of these end up in complex securities like collateralized debt obligation. Investors who then buy these CDOs are still trying to determine how much pain the subprime mess will cause, so they are not keen on buying new CDOs--even if the underlying loan quality is better.
Without the former CDO demand, mortgage lenders are having a harder time selling their loans at a profit.
Without the former CDO demand, mortgage lenders are having a harder time selling their loans at a profit.
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