REPORT #1
Gentlemen;
This Report is for the trading days beginning Wednesday, September 17, 2008, through Tuesday, September 23, 2008 (the Report Period). For the Period the major indices (Dow and S&P 500) were flat with the smaller capitalization issues falling about two tenths of one percent and small capitalization technology stocks falling close to 2% on average. However, a description of "flat" for the broader markets does not accurately describe the situation. By day the Dow was down 218, up 124, up 505, down 222 and down 196 to close the Period at flat. The tremendous volatility and position shifting underlying the market statistics are causing problems. In the data for all concerns this Period we are seeing position shifts as fund managers take their depository receipts from Merrill Lynch, Morgan Stanley and Goldman Sachs and shift them to other banks with the largest beneficiary being the various divisions of J.P. Morgan to include Bear Sterns.
This movement in the broader indices of course represents the panic in the early part of the week, the announcement of the 700Bn treasury plan and then the realization that things might not be so easy. The treasury plan and its implications are very broad and as of this writing remain uncertain. However a basic look indicates that despite the rhetoric and political posturing to the contrary, the bail-out is clearly targeted at stabilizing the CDS (credit default swap) market using mortgage securities as a fig leaf to gain congressional and public support for such a large sum. This is why for example the initial proposal did nothing about mortgage defaults and so on. We would also point out that this is not explicitly mentioned in the political debate primarily because what caused the loss of control in the CDS market was when Congress specifically exempted, by statute, the CDS market from any regulatory or monetary oversight whatsoever. Without commenting further on the situation at this time we would relay the best story thereabouts from a private client broker in Connecticut. On the day of the Senate hearings our broker was having a crown fitted at his dentist. Being in Connecticut the dentist had the Senate bail-out hearings on the radio. The broker described the situation of being in the chair with the dentist drilling while the radio was tuned to the hearings and remarked, "I don't know which hurt worse."
For the Period price support in XXXX shares was poor with the shares trading down $1.82 per share or about 7% to close the Period at $24.24 per share. Reported trading volume was 2,465,473 shares with intra-day clearing volume of 3,368,386 shares, weekly net clearing volume of 1,234,943 and 269,661 shares being delivered from registered to DTC. In checking our records we did not review XXXX'S registered shareholder list as part of our initial report as there were only 659,537 shares held registered. We assumed that there were unlikely to be major concentrations of shares in a block this small however unless these shares were newly issued option or warrant shares there appears to have been a tremendous concentration. Without the benefit of further knowledge we assume these delivered shares were option or warrant shares as they were clearly pre-sold into the market through the stock loan desk at UBS where they were delivered for immediate distribution. If the company has any information it can share on this subject as to who the owner of these newly issued securities was and whether they were option or warrant exercises that would be helpful.
While less than helpful for the price support over the week this type of activity indicates that certain investors are settling complex obligations in XXXX shares as we are hoping they will continue to do at an accelerated pace. On this note we would mention that the activity from many of the larger investors has been very small and we are a bit disappointed with this and attribute the lack of movement to broader market uncertainty. In particular Fidelity seems to be frozen at the moment. In a number of concerns we monitor, including XXXX, where Fidelity has large positions, they, and more importantly their hedge managers, have done nothing. Our modeling of their prior behavior indicates that this is unreasonable given the movements of some of the other share prices involved so we assume that the firm must be reevaluating its investment thesis at the highest levels.
Nevertheless, the clearing data does show position settling and acquisition by new investors and old investors as well. As to why the falling share price the clearing data indicate that we had unexpected sales by Dimensional Fund and Goldman International but the main driver for the Period was the number of investors that were selling the news of the product launch. As we were saying at the time, a product launch of this nature is much like a horse race in that it goes off at a set time, more or less, and is relatively binary in the outcome. Many investors took positions on that basis back in August at share prices between $22.00 and $24.00 a share and this week as the shares started declining back toward $24.00 a share many investors hit the stops and took the money off the table because of the broader market situation. To be clear we do not think that these investors have lost interest in the investment, it's just that the company's unqualified good news of late and the reflection in the share price has been tempered by broader market uncertainty and many of these investors calculate they have another bite at the apple. This is so because if the shares break support at $24.00 in any meaningful way through broader market malaise or for any other reason, the shares could fall closer to twenty before recovering. However if that happens at all, the company will be in a position to confirm the results from the product launch which would remove the last barrier to calculable recurring revenue and that would push the shares higher. Arguably higher than the $27.00 level reached on the announcement of product development completion accompanied by initial contracts. Again all this must be adjusted for whatever bank is failing that particular day and so on. While we have not done the research, it seems that there must be some expected value for the time it takes to certify a product of this nature and we can only assume that the more diligent of these investors are probably working against that estimate as a mean time estimate. If this is the case we would further expect that a number of your "supporters" that call the company for information are asking in one form or fashion about the company's quantification of this time value. It is in responding to questions like this that the company can subtly influence the timing of an investment decisions.
When faced with a question of this nature if the respondent makes some comment about the design of the product core and the routines embedded therein and how those should speed up the certification process and then says the company hopes to have that done "relatively quickly" without expanding on relative to what, then this has the effect or inducing the investor to take whatever position he is going to take sooner rather than later. If conversely the respondent says that the product core is such that it has to go through a series of calibrations before it can be certified and that that may "take some time" then this would slow the investment decision. Please notice that this type of message management only works on short term churn investors as longer term investors only wants the company to stay close to whatever schedule is put forward. We mention this because we assume based on our past experience that many of the faster trading investors are the ones concentrating on this type of information and are disproportionately calling the company masquerading as long term investors at this particular point in time.
As to the clearing data the company had a lot of trouble with investments held at Goldman Sachs this Period. The clearing data indicates that they are really in a tough position over XXXX. Their investment methodology is not necessarily one of betting against the company's performance but rather all the available evidence indicates that they are facing redemptions and movements of investors from their custody and clearing operations. This makes sense because as a commercial bank they are no longer able to legally float investments between Europe and the US relying on the regulatory disparities to leverage positions in rather creative ways. So as an institution we saw Goldman trade or transfer 1,050,398 shares this Period on a gross one way (only counting the lesser of dispositions or receipts) basis and 2,108,464 on a gross two way basis (counting both dispositions and receipts), with 213,368 in net additions and 251,833 shares in net subtractions. The pattern of the net trades is that the flows are coming out of the European trading and special purpose entities back to Goldman domestic indicating a de-leveraging on their part in the foreign swap market. This is sensible given the current situation.
As to what to expect going forward we are at somewhat of a loss. We would expect that the broader markets rally or at least try to rally Monday and Tuesday but after that things remain very uncertain. The reason this uncertainty is so large is because we have yet to quantify the mutual fund industry's exposure to counterparty defaults in the CDS market. If there is material exposure here then the timing of the loss recognition is critical when determining how much price support the shares will have. As to evidence one way or the other we would say that the slow pace of settlement of hedge and other positions in this and other securities is quite worrisome. If a long term holder was hedged against the product launch then one would expect that firm to begin reclaiming positions and taking down the insurance now that the product has been successfully launched. At a minimum, one would expect to see the counterparty to the hedge arrangement begin to tighten positions in anticipation of reduction in the total of outstanding hedges once the product is certified. We see none of this in this and other similarly situated shares we monitor. While we are unsure how to interpret this at this time it could be that the counterparties are illiquid because of the problems in the CDS market or convinced the market goes lower from here. If it is the case that this lack of movement is a CDS problem, then the collateral against the hedges is at risk and if for any reason there are material redemptions from long term holders such as mutual funds the losses would have to be recognized as the securities were sold to raise liquidity and that could potentially be a very large problem. After some study it is our opinion that this is the core reason for the bailout plan and explains the urgency for passage before September 30, 2008, to boost the markets before the Mutual Fund quarter ends September 30, 2008.
For the Period the largest (>= 20,000 share) changes in position were:
REGS (Registered share sale), (269,661) shares;
BOAF (New investment probably D.E. Shaw which began 09-08-08), 222,500 shares;
GLDM (Goldman domestic from foreign holdings after large churns), 213,386 shares;
PNCB (Dimensional Funds), (202,729) shares;
SSBT (SSgA and Pennsylvania State retirement pools), 194,776 shares;
BRST (North Pointe Capital and account transfers to JPM), 174,063 shares;
DEUT (Deutsche Bank investment Management & Schneider), 167,973 shares;
CITB (Principally Ashford Capital + sub-custodial shifts), (158,632) shares;
GSIN (Goldman International net), (156,300) shares;
USBK (New investment possibly Evergreen initiated 09-18-08), 105,230 shares;
MERR (BlackRock liquidity funds), 97,167 shares;
GSEL (Goldman short term leveraged trades opened 08-19-08), (95,533) shares;
UBSS (New investor at UBS initiated 09-17-08), 88,452 shares;
CSTT (Renaissance Capital continuing diminution), (73,291) shares;
BRWN (Fidelity core positions), (50,720) shares;
TDAM (Ameritrade retail short term speculative selling), (49,237) shares;
WELL (Labranch & Montgomery Securities retail), (48,330) shares;
JPMP (Short term trade initiated 08-18-08), (43,600) shares;
CITD (Citadel Trust), 43,343 shares;
BGIT (Barclay's Global), 43,106 shares;
CHSS (Charles Schwab retail accounts), (40,341) shares;
WELB (Wells Fargo Capital new position), 37,100 shares;
MELL (Sterling Johnson), (32,840) shares;
BKAM (Columbia Management), (24,258) shares;
MLSF (TIAA CREFF), (23,177) shares;
BCAP (Deep Value Capital Fund II), (22,010) shares;
FORT (Raffles Capital), 21,800 shares; and,
BOAC (Undetermined character new trade), 20,891 shares.
This Report is for the trading days beginning Wednesday, September 17, 2008, through Tuesday, September 23, 2008 (the Report Period). For the Period the major indices (Dow and S&P 500) were flat with the smaller capitalization issues falling about two tenths of one percent and small capitalization technology stocks falling close to 2% on average. However, a description of "flat" for the broader markets does not accurately describe the situation. By day the Dow was down 218, up 124, up 505, down 222 and down 196 to close the Period at flat. The tremendous volatility and position shifting underlying the market statistics are causing problems. In the data for all concerns this Period we are seeing position shifts as fund managers take their depository receipts from Merrill Lynch, Morgan Stanley and Goldman Sachs and shift them to other banks with the largest beneficiary being the various divisions of J.P. Morgan to include Bear Sterns.
This movement in the broader indices of course represents the panic in the early part of the week, the announcement of the 700Bn treasury plan and then the realization that things might not be so easy. The treasury plan and its implications are very broad and as of this writing remain uncertain. However a basic look indicates that despite the rhetoric and political posturing to the contrary, the bail-out is clearly targeted at stabilizing the CDS (credit default swap) market using mortgage securities as a fig leaf to gain congressional and public support for such a large sum. This is why for example the initial proposal did nothing about mortgage defaults and so on. We would also point out that this is not explicitly mentioned in the political debate primarily because what caused the loss of control in the CDS market was when Congress specifically exempted, by statute, the CDS market from any regulatory or monetary oversight whatsoever. Without commenting further on the situation at this time we would relay the best story thereabouts from a private client broker in Connecticut. On the day of the Senate hearings our broker was having a crown fitted at his dentist. Being in Connecticut the dentist had the Senate bail-out hearings on the radio. The broker described the situation of being in the chair with the dentist drilling while the radio was tuned to the hearings and remarked, "I don't know which hurt worse."
For the Period price support in XXXX shares was poor with the shares trading down $1.82 per share or about 7% to close the Period at $24.24 per share. Reported trading volume was 2,465,473 shares with intra-day clearing volume of 3,368,386 shares, weekly net clearing volume of 1,234,943 and 269,661 shares being delivered from registered to DTC. In checking our records we did not review XXXX'S registered shareholder list as part of our initial report as there were only 659,537 shares held registered. We assumed that there were unlikely to be major concentrations of shares in a block this small however unless these shares were newly issued option or warrant shares there appears to have been a tremendous concentration. Without the benefit of further knowledge we assume these delivered shares were option or warrant shares as they were clearly pre-sold into the market through the stock loan desk at UBS where they were delivered for immediate distribution. If the company has any information it can share on this subject as to who the owner of these newly issued securities was and whether they were option or warrant exercises that would be helpful.
While less than helpful for the price support over the week this type of activity indicates that certain investors are settling complex obligations in XXXX shares as we are hoping they will continue to do at an accelerated pace. On this note we would mention that the activity from many of the larger investors has been very small and we are a bit disappointed with this and attribute the lack of movement to broader market uncertainty. In particular Fidelity seems to be frozen at the moment. In a number of concerns we monitor, including XXXX, where Fidelity has large positions, they, and more importantly their hedge managers, have done nothing. Our modeling of their prior behavior indicates that this is unreasonable given the movements of some of the other share prices involved so we assume that the firm must be reevaluating its investment thesis at the highest levels.
Nevertheless, the clearing data does show position settling and acquisition by new investors and old investors as well. As to why the falling share price the clearing data indicate that we had unexpected sales by Dimensional Fund and Goldman International but the main driver for the Period was the number of investors that were selling the news of the product launch. As we were saying at the time, a product launch of this nature is much like a horse race in that it goes off at a set time, more or less, and is relatively binary in the outcome. Many investors took positions on that basis back in August at share prices between $22.00 and $24.00 a share and this week as the shares started declining back toward $24.00 a share many investors hit the stops and took the money off the table because of the broader market situation. To be clear we do not think that these investors have lost interest in the investment, it's just that the company's unqualified good news of late and the reflection in the share price has been tempered by broader market uncertainty and many of these investors calculate they have another bite at the apple. This is so because if the shares break support at $24.00 in any meaningful way through broader market malaise or for any other reason, the shares could fall closer to twenty before recovering. However if that happens at all, the company will be in a position to confirm the results from the product launch which would remove the last barrier to calculable recurring revenue and that would push the shares higher. Arguably higher than the $27.00 level reached on the announcement of product development completion accompanied by initial contracts. Again all this must be adjusted for whatever bank is failing that particular day and so on. While we have not done the research, it seems that there must be some expected value for the time it takes to certify a product of this nature and we can only assume that the more diligent of these investors are probably working against that estimate as a mean time estimate. If this is the case we would further expect that a number of your "supporters" that call the company for information are asking in one form or fashion about the company's quantification of this time value. It is in responding to questions like this that the company can subtly influence the timing of an investment decisions.
When faced with a question of this nature if the respondent makes some comment about the design of the product core and the routines embedded therein and how those should speed up the certification process and then says the company hopes to have that done "relatively quickly" without expanding on relative to what, then this has the effect or inducing the investor to take whatever position he is going to take sooner rather than later. If conversely the respondent says that the product core is such that it has to go through a series of calibrations before it can be certified and that that may "take some time" then this would slow the investment decision. Please notice that this type of message management only works on short term churn investors as longer term investors only wants the company to stay close to whatever schedule is put forward. We mention this because we assume based on our past experience that many of the faster trading investors are the ones concentrating on this type of information and are disproportionately calling the company masquerading as long term investors at this particular point in time.
As to the clearing data the company had a lot of trouble with investments held at Goldman Sachs this Period. The clearing data indicates that they are really in a tough position over XXXX. Their investment methodology is not necessarily one of betting against the company's performance but rather all the available evidence indicates that they are facing redemptions and movements of investors from their custody and clearing operations. This makes sense because as a commercial bank they are no longer able to legally float investments between Europe and the US relying on the regulatory disparities to leverage positions in rather creative ways. So as an institution we saw Goldman trade or transfer 1,050,398 shares this Period on a gross one way (only counting the lesser of dispositions or receipts) basis and 2,108,464 on a gross two way basis (counting both dispositions and receipts), with 213,368 in net additions and 251,833 shares in net subtractions. The pattern of the net trades is that the flows are coming out of the European trading and special purpose entities back to Goldman domestic indicating a de-leveraging on their part in the foreign swap market. This is sensible given the current situation.
As to what to expect going forward we are at somewhat of a loss. We would expect that the broader markets rally or at least try to rally Monday and Tuesday but after that things remain very uncertain. The reason this uncertainty is so large is because we have yet to quantify the mutual fund industry's exposure to counterparty defaults in the CDS market. If there is material exposure here then the timing of the loss recognition is critical when determining how much price support the shares will have. As to evidence one way or the other we would say that the slow pace of settlement of hedge and other positions in this and other securities is quite worrisome. If a long term holder was hedged against the product launch then one would expect that firm to begin reclaiming positions and taking down the insurance now that the product has been successfully launched. At a minimum, one would expect to see the counterparty to the hedge arrangement begin to tighten positions in anticipation of reduction in the total of outstanding hedges once the product is certified. We see none of this in this and other similarly situated shares we monitor. While we are unsure how to interpret this at this time it could be that the counterparties are illiquid because of the problems in the CDS market or convinced the market goes lower from here. If it is the case that this lack of movement is a CDS problem, then the collateral against the hedges is at risk and if for any reason there are material redemptions from long term holders such as mutual funds the losses would have to be recognized as the securities were sold to raise liquidity and that could potentially be a very large problem. After some study it is our opinion that this is the core reason for the bailout plan and explains the urgency for passage before September 30, 2008, to boost the markets before the Mutual Fund quarter ends September 30, 2008.
For the Period the largest (>= 20,000 share) changes in position were:
REGS (Registered share sale), (269,661) shares;
BOAF (New investment probably D.E. Shaw which began 09-08-08), 222,500 shares;
GLDM (Goldman domestic from foreign holdings after large churns), 213,386 shares;
PNCB (Dimensional Funds), (202,729) shares;
SSBT (SSgA and Pennsylvania State retirement pools), 194,776 shares;
BRST (North Pointe Capital and account transfers to JPM), 174,063 shares;
DEUT (Deutsche Bank investment Management & Schneider), 167,973 shares;
CITB (Principally Ashford Capital + sub-custodial shifts), (158,632) shares;
GSIN (Goldman International net), (156,300) shares;
USBK (New investment possibly Evergreen initiated 09-18-08), 105,230 shares;
MERR (BlackRock liquidity funds), 97,167 shares;
GSEL (Goldman short term leveraged trades opened 08-19-08), (95,533) shares;
UBSS (New investor at UBS initiated 09-17-08), 88,452 shares;
CSTT (Renaissance Capital continuing diminution), (73,291) shares;
BRWN (Fidelity core positions), (50,720) shares;
TDAM (Ameritrade retail short term speculative selling), (49,237) shares;
WELL (Labranch & Montgomery Securities retail), (48,330) shares;
JPMP (Short term trade initiated 08-18-08), (43,600) shares;
CITD (Citadel Trust), 43,343 shares;
BGIT (Barclay's Global), 43,106 shares;
CHSS (Charles Schwab retail accounts), (40,341) shares;
WELB (Wells Fargo Capital new position), 37,100 shares;
MELL (Sterling Johnson), (32,840) shares;
BKAM (Columbia Management), (24,258) shares;
MLSF (TIAA CREFF), (23,177) shares;
BCAP (Deep Value Capital Fund II), (22,010) shares;
FORT (Raffles Capital), 21,800 shares; and,
BOAC (Undetermined character new trade), 20,891 shares.
REPORT #2
Gentlemen:
This Report is for the trading days beginning Wednesday, September 23, 2008, through Tuesday, September 30, 2008 (the Report Period). For the Period the indices were down between 1.8% and 6% with the general rule being the smaller the capitalization and more speculative the company the worse the results were. Again, however, the description of down 1.8% for the Dow does not cover it. By day, the Dow was down 29, up 197, up 121, down 778 and up 485 to close the Period down 1.8%. If one considers the calendar week just past rather than the Period (which ended on Tuesday) it was by far the ugliest market week I have ever witnessed.
Since XXXX is a new client one of the principle reasons we consider what we do to be essential is because over the past 10 years there has been an increasing disconnect between share price levels and underlying enterprise value. In our opinion most of this divergence in liquid public markets has been accounted for by the unduly large monetary flows into and out of derivatives instruments. This week we have reached the point where the tail is wagging the dog. As of Friday of this last calendar week, relative share values were being almost completely determined by money flows and movements in the derivatives markets particularly the CDS market. In this situation, it is no wonder commercial banks will not loan any money, as they cannot reasonably assign any value to proposed collateral. The only thing that is readily valued at this point is cash and if one has the cash to repay the loan; one does not need a loan so the credit markets "freeze" up.
As to what to look for going forward we are hopeful that the situation will improve but it is still very risky. On the plus side, we have two factors. First, many cash rich concerns are stepping up to purchase large block assets for big money. Second, now that Secretary Paulson has the authority of the recently passed legislation it can be reasonably assumed that he will buy CDS instruments and then once the government is the owner of the CDS instruments the Treasury has the authority and legal standing to compel settlement of the outstanding CDS obligations against the asset. If one remembers that the CDS market operates on a leverage ratio of between 30 and 40 to one (the root cause of the current crisis) then 700Bn worth of purchased assets would force settlement of approximately $28Tr worth of CDS obligations. This would reduce the total outstanding CDS obligations by about half to a still excessive but much more manageable and less threatening $26Tr. Therefore, this will improve the situation.
On the risk side, there are two principal phenomena that could scuttle the effort. First the recent bankruptcy of some large banks has already compelled massive CDS settlement this last week and the counterparties to some proportion of the CDS obligations were found not to have sufficient real assets besides other CDS paper with which to settle. If the number of insolvent hedge fund counterparties is unduly high on all the remaining CDS obligations in circulation then the system could fail. Second and perhaps more important is the retail panic that is setting in. While the numbers for September are not out yet the clearing data and other data we monitor indicates that movements out of equities by mutual funds to cash based assets (at the explicit request of the retail account holders) is quite severe and appears to be accelerating. If this loss of confidence in mutual fund holdings continues and causes an enormously large movement of money out of equities or the markets altogether the system could fail.
We see all this in the trading pattern on any given day. If one noticed, the bleakest sign going forward was the market's inability to rally at the close of business Friday. On Friday the bailout bill passed the House, the markets were up and for psychological reasons many participants were doing everything they possibly could to close the market up or at least flat but it did not work. The disappointment was palpable. The reason they could not close the markets up even marginally or flat was twofold. One, mutual fund redemptions were mandating asset sales irrespective of price as retail account holders moved money to cash based assets (see the FX markets and the movement into dollars). Second, hedge funds that were having capital problems were on the phone all day trying to remediate the problem but when three o'clock came around the custodians stopped the discussions and started forced sales of the hedge fund assets. If either of these trends continue for any substantial length of time or markedly accelerate in magnitude then we could have an insoluble problem save some rather draconian alternatives that would encounter extraordinary ideological and political resistance. The fact that companies are starting to report for Q-3 next week is also ill timed. If the divergence between operating results and valuation is reinforced over the next two weeks then current emergency measures in place may be insufficient to stabilize the situation. As no one knows the answers here, we shall have to wait and see what happens.
Price support in XXXX shares was poor with the shares down $2.27 per share or about 9.4% to close the Period at $21.97 per share. Reported trading volume for the Period was 2,135,774 shares and the intraday clearing volume was 3,146,174 shares and the weekly net clearing volume was an especially heavy 1,842,403 shares. Many custody transfers pursuant to bank failures and reorganizations are still interrupting the clearing data for XXXX. More open cross-positions in the European market are closing as Goldman restricts that business and the company was affected by large institutional sales pursuant to the broader market conditions listed above. We would attribute the overall share performance to less repetitive buying and selling as those fast moving players that have dominated trading in the shares recently struggle with other positions. Given the reduction in this type of trading the slow but inexorable bleeding from the large mutual funds and hedge funds raising capital along with tepid buying was enough to move the price down. We would say that the current inability of the markets to make relative valuations is hurting XXXX particularly severely. We think people see that the company is progressing nicely but valuing the company on the revenue stream and other historical measures is not working right now. We would also note that on October second (outside this data Period), the company indicated the certification of the OOOO was progressing and in particular, all the major systems and subsystems have checked out apparently without major problems. That was good news that did not translate into share price support for broader reasons described above.
Once we strip out the custody transfers and repetitive trading then the largest seller over the Period was Putman Funds for 120,000 shares against concentrated buying from Perimeter Capital, which appears to have bought over 100,000 shares. We also had similar selling from BlackRock, Credit Suisse, Earnest and Citadel against no concentrated buying and that was enough to move the price. Nevertheless, we would say that XXXX fared much better in the fund redemption category than did many other concerns. In particular, we were surprised to notice an absence of movement of Fidelity shares as the clearing data for other concerns indicates that Fidelity is having customer redemption and reclassification problems. We doubt whether XXXX can escape this all together so we look for some diminution of that position next week. We would also note that XXXX seemed to be exempt from the investor controlled retail selling that we are observing in other companies as those investors are presumably waiting for the OOOO to go live and revenue to start to flow and we sincerely hope the valuation models are fixed by then to adequately reflect the change in position.
For the Period the largest (>= 30,000 share) changes in position were:
BCAP (Schroeder transferring custody positions), (778,785) shares;
MELL (Partial transfer from Schroeder), 426,742 shares;
PNCB (Dimensional Funds consolidating custody at PNC Bank), 319,515 shares;
BNPP (Dimensional shares to consolidated account), (269,460) shares;
GLDM (Goldman domestic received from Goldman International), 246,742 shares;
GSIN (Goldman International to Goldman domestic), (243,436) shares;
JPMC (Partial custody from Schroeder), 177,917 shares;
NRTH (Northern Trust reclaiming loaned shares on settling), 137,806 shares;
SSBT (Principally Putnam and other Mutual Fund selling), (119,137) shares;
UMBK (Perimeter Capital), 105,464 shares;
MERR (BlackRock Funds), (67,795) shares;
DEUT (Deutsche Bank Investment Management), 67,539 shares;
BNPP (North Pointe Capital), 59,460 shares;
CSEC (Credit Suisse managed Funds), (54,361) shares;
BKAM (Earnest Partners), (43,111) shares;
CITD (Citadel Trust), (42,260) shares;
BGIT (Barclay's Global), 38,632 shares;
FTBT (Ohio Teachers), 37,420 shares; and,
BCEQ (New Canadian position either Cannacord Adams or BC Equity), 31,199 shares.
This Report is for the trading days beginning Wednesday, September 23, 2008, through Tuesday, September 30, 2008 (the Report Period). For the Period the indices were down between 1.8% and 6% with the general rule being the smaller the capitalization and more speculative the company the worse the results were. Again, however, the description of down 1.8% for the Dow does not cover it. By day, the Dow was down 29, up 197, up 121, down 778 and up 485 to close the Period down 1.8%. If one considers the calendar week just past rather than the Period (which ended on Tuesday) it was by far the ugliest market week I have ever witnessed.
Since XXXX is a new client one of the principle reasons we consider what we do to be essential is because over the past 10 years there has been an increasing disconnect between share price levels and underlying enterprise value. In our opinion most of this divergence in liquid public markets has been accounted for by the unduly large monetary flows into and out of derivatives instruments. This week we have reached the point where the tail is wagging the dog. As of Friday of this last calendar week, relative share values were being almost completely determined by money flows and movements in the derivatives markets particularly the CDS market. In this situation, it is no wonder commercial banks will not loan any money, as they cannot reasonably assign any value to proposed collateral. The only thing that is readily valued at this point is cash and if one has the cash to repay the loan; one does not need a loan so the credit markets "freeze" up.
As to what to look for going forward we are hopeful that the situation will improve but it is still very risky. On the plus side, we have two factors. First, many cash rich concerns are stepping up to purchase large block assets for big money. Second, now that Secretary Paulson has the authority of the recently passed legislation it can be reasonably assumed that he will buy CDS instruments and then once the government is the owner of the CDS instruments the Treasury has the authority and legal standing to compel settlement of the outstanding CDS obligations against the asset. If one remembers that the CDS market operates on a leverage ratio of between 30 and 40 to one (the root cause of the current crisis) then 700Bn worth of purchased assets would force settlement of approximately $28Tr worth of CDS obligations. This would reduce the total outstanding CDS obligations by about half to a still excessive but much more manageable and less threatening $26Tr. Therefore, this will improve the situation.
On the risk side, there are two principal phenomena that could scuttle the effort. First the recent bankruptcy of some large banks has already compelled massive CDS settlement this last week and the counterparties to some proportion of the CDS obligations were found not to have sufficient real assets besides other CDS paper with which to settle. If the number of insolvent hedge fund counterparties is unduly high on all the remaining CDS obligations in circulation then the system could fail. Second and perhaps more important is the retail panic that is setting in. While the numbers for September are not out yet the clearing data and other data we monitor indicates that movements out of equities by mutual funds to cash based assets (at the explicit request of the retail account holders) is quite severe and appears to be accelerating. If this loss of confidence in mutual fund holdings continues and causes an enormously large movement of money out of equities or the markets altogether the system could fail.
We see all this in the trading pattern on any given day. If one noticed, the bleakest sign going forward was the market's inability to rally at the close of business Friday. On Friday the bailout bill passed the House, the markets were up and for psychological reasons many participants were doing everything they possibly could to close the market up or at least flat but it did not work. The disappointment was palpable. The reason they could not close the markets up even marginally or flat was twofold. One, mutual fund redemptions were mandating asset sales irrespective of price as retail account holders moved money to cash based assets (see the FX markets and the movement into dollars). Second, hedge funds that were having capital problems were on the phone all day trying to remediate the problem but when three o'clock came around the custodians stopped the discussions and started forced sales of the hedge fund assets. If either of these trends continue for any substantial length of time or markedly accelerate in magnitude then we could have an insoluble problem save some rather draconian alternatives that would encounter extraordinary ideological and political resistance. The fact that companies are starting to report for Q-3 next week is also ill timed. If the divergence between operating results and valuation is reinforced over the next two weeks then current emergency measures in place may be insufficient to stabilize the situation. As no one knows the answers here, we shall have to wait and see what happens.
Price support in XXXX shares was poor with the shares down $2.27 per share or about 9.4% to close the Period at $21.97 per share. Reported trading volume for the Period was 2,135,774 shares and the intraday clearing volume was 3,146,174 shares and the weekly net clearing volume was an especially heavy 1,842,403 shares. Many custody transfers pursuant to bank failures and reorganizations are still interrupting the clearing data for XXXX. More open cross-positions in the European market are closing as Goldman restricts that business and the company was affected by large institutional sales pursuant to the broader market conditions listed above. We would attribute the overall share performance to less repetitive buying and selling as those fast moving players that have dominated trading in the shares recently struggle with other positions. Given the reduction in this type of trading the slow but inexorable bleeding from the large mutual funds and hedge funds raising capital along with tepid buying was enough to move the price down. We would say that the current inability of the markets to make relative valuations is hurting XXXX particularly severely. We think people see that the company is progressing nicely but valuing the company on the revenue stream and other historical measures is not working right now. We would also note that on October second (outside this data Period), the company indicated the certification of the OOOO was progressing and in particular, all the major systems and subsystems have checked out apparently without major problems. That was good news that did not translate into share price support for broader reasons described above.
Once we strip out the custody transfers and repetitive trading then the largest seller over the Period was Putman Funds for 120,000 shares against concentrated buying from Perimeter Capital, which appears to have bought over 100,000 shares. We also had similar selling from BlackRock, Credit Suisse, Earnest and Citadel against no concentrated buying and that was enough to move the price. Nevertheless, we would say that XXXX fared much better in the fund redemption category than did many other concerns. In particular, we were surprised to notice an absence of movement of Fidelity shares as the clearing data for other concerns indicates that Fidelity is having customer redemption and reclassification problems. We doubt whether XXXX can escape this all together so we look for some diminution of that position next week. We would also note that XXXX seemed to be exempt from the investor controlled retail selling that we are observing in other companies as those investors are presumably waiting for the OOOO to go live and revenue to start to flow and we sincerely hope the valuation models are fixed by then to adequately reflect the change in position.
For the Period the largest (>= 30,000 share) changes in position were:
BCAP (Schroeder transferring custody positions), (778,785) shares;
MELL (Partial transfer from Schroeder), 426,742 shares;
PNCB (Dimensional Funds consolidating custody at PNC Bank), 319,515 shares;
BNPP (Dimensional shares to consolidated account), (269,460) shares;
GLDM (Goldman domestic received from Goldman International), 246,742 shares;
GSIN (Goldman International to Goldman domestic), (243,436) shares;
JPMC (Partial custody from Schroeder), 177,917 shares;
NRTH (Northern Trust reclaiming loaned shares on settling), 137,806 shares;
SSBT (Principally Putnam and other Mutual Fund selling), (119,137) shares;
UMBK (Perimeter Capital), 105,464 shares;
MERR (BlackRock Funds), (67,795) shares;
DEUT (Deutsche Bank Investment Management), 67,539 shares;
BNPP (North Pointe Capital), 59,460 shares;
CSEC (Credit Suisse managed Funds), (54,361) shares;
BKAM (Earnest Partners), (43,111) shares;
CITD (Citadel Trust), (42,260) shares;
BGIT (Barclay's Global), 38,632 shares;
FTBT (Ohio Teachers), 37,420 shares; and,
BCEQ (New Canadian position either Cannacord Adams or BC Equity), 31,199 shares.
REPORT #3
Gentlemen:
This Report is for the trading days beginning Wednesday, October 8, 2008, through Tuesday, October 14, 2008 (the Report Period). For the Period, the indices were down between 1.7% and 2.6% with poor performance being the rule irrespective of the capitalization of the stock at issue. The volatility involved in the trading Period and the last calendar week were both extreme. Overall, however, it is our opinion at this time that the macro signs point, in aggregate, toward more stabilization and decreasing volatility and fewer losses. However, the signs are still mixed.
Retail selling through redemptions of mutual fund and other shares continued to accelerate last week with total withdrawals surging to $63Bn from $44Bn the prior week. Additionally, mutual fund withdrawals started to become a problem for the first time in foreign markets particularly Canada and India. Monetary withdrawals from Hedge funds are also accelerating with October being projected to see between $65Bn and $80Bn in withdrawals compared to $44Bn for September. One also has to remember when looking at hedge fund withdrawals that it is always difficult and sometimes close to impossible to withdraw money from a hedge fund so one can assume that the underlying sentiment dwarfs the recorded numbers.
On the positive side there was enough buying on certain days to accommodate all this forced selling and move the markets up albeit temporarily. People like Warren Buffet were saying that domestic equity was looking attractive and generally some investors here and there were beginning to acquire share positions. The credit markets appear to be stabilizing with the LIBOR rate dropping to 1.67% from 5.09% the week prior, similarly overnight commercial paper rates fell to 1.05% from 3.50% and the spread between 3 month LIBOR and 3-month treasuries fell 100 basis points to 3.63%. The only problem in the bank data was the fact that that the long term spreads did not contract as much as the short term spreads indicating that people are still worried about the situation reversing over a three-month time frame, which in our estimation is a legitimate worry.
We have been suggesting for weeks that the short-term market drivers are the CDS settlements on the recently failed institutions. We predicted that the markets would remain under substantial pressure through Wednesday of this last week and so they were as people raised cash to settle Fannie, Freddie and Lehman Brothers CDS obligations. As a reminder this coming week Washington Mutual CDS obligation, go to auction October 23, 2008, with settlement due October 28, 2008, with the AIG CDS instruments still being held open by the United States Treasury with no auction date set at this time. While the Washington Mutual auctions are similar in magnitude to the Lehman auction the liability there is expected to be held by more traditional insurance and large pools so the selling effect is expected to be material and coming out of larger capitalization common equities with less of the exposure having been hedged.
Additionally this past week the disconnect between corporate earnings and share price performance continued unabated with firms like IBM, AMD and others recording good sales and profits only to suffer the consequence as soon as trading resumed. The press has been remarkably unhelpful as well concentrating on jobs and industrial output reports skewed by hurricane Gustav with no mention of the skewing as well as almost no mention whatsoever of the better than expected profits at concerns other than financial or retail.
So for what to expect going forward all the evidence points to another choppy week with a bias toward the upside early in the week and then a bias toward the downside late in the week once the WaMu CDS obligations are quantified. Further out we expect continued chop until the WaMu settlements are substantially paid by October 29, 2008, and then a rally beginning on or about the end of October, mostly due to psychological factors and one real effect. For the psychological reasons: one, October will be over. Two, the elections will be decided and three, Americans socialized after 1980 seem to be incapable of remaining gloomy for too long. The practical effect will be that the 700Bn in bailout funds and a further 1.3Tr in monetary accommodations will begin to stabilize the situation. As Dr. Kissinger remarked discussing the planned air strikes in the run up to the first Gulf War, "It is unreasonable to assume that we will hit nothing." The effects of the bailout and the monetization will be similar. Not completely effective but not ineffective either. All this of course assumes no new major bank or insurance failures triggered by WaMu settlements and assumes that treasury does not put the AIG CDS obligations on the block. Longer term, the situation remains highly uncertain until the international disparities find some accommodation or resolution.
For the Period, price support in XXX shares was tepid with the shares falling 46 cents to close the Period at 9.80 cents. The clearing data for the Period was constricted as Monday, October 8, 2008, was Columbus Day meaning that while markets traded there was no settlement as it was a bank holiday. Therefore, this week behaves like a holiday week. That said the clearing data indicate that the XXX share price declined in response to concentrated selling against very limited buying. The concentrated selling came from Banco D'Orsa, TIG Advisors, a.k.a. the arbitrage concern at Bear Sterns, Fidelity core positions, US Bank NA and Rockbay partners. The interesting thing about these sales is that the Banco D'Orsa sale, the TIG sale, the Fidelity sale and the US Bank NA sale were all capitulations and recognized losses. In the case of Banco ' Orsa the loss was particularly severe with the position only being acquired beginning in June at around $10.00 a shares. Behind these marquis sellers there was also selling from Sterling, Credit Suisse, money market concerns, SG America, Goldman, Swiss American and Dimensional. The selling from Dimensional, Credit Suisse, SG, Swiss American and perhaps Banco D'Orsa is related to the shares falling below a dollar as most of these banks begin to sell as a systemic risk policy when shares dip below the dollar level.
The buyers were a combination of deliveries from short positions and additional buying from new investors who typically acquired their shares sometime after September 15, 2008. Virtually the entire established shareholder base seems to have no enthusiasm for this security or more importantly belief in their own value proposition concerning this security. In this regard, we would again mention that the lack of information from the company for the last six months has in our estimation been unhelpful. We would once again urge management to establish some form of public value propositions and expectation as soon as possible. In this connection, we notice where the company will release earnings on November 4, 2008, but the company does not indicate that any kind of a call is scheduled nor provides an explanation as to why. With the uncertainly over the last six months we suggest a shareholder call is in order to provide some guidance and encourage management to schedule a call.
For the Period the largest (>= 50,000 share) changes in position were:
BDOR (Banco D'Orsa), (835,000) shares;
JPMB (TIG Advisors), (510,450) shares;
BGIT (Barclay's Global predominantly previously loaned shares), 476,665 shares;
TDAM (Ameritrade retail receiving previously loaned shares), 258,647 shares;
SSBT (State and other retirement pool receiving previous loans), 219,255 shares;
BRWN (Fidelity Core position), (210,629) shares;
MLSF (Merrill Lynch administered pools on prior loans), 163,034 shares;
USBN (US Bank NA & Rockbay), (135,102) shares;
JPMS (Longfellow), 108,319 shares;
MELL (Sterling), (95,528) shares;
SCTT (Scottrade retail receiving loaned shares), 90,476 shares;
INTB (Regional broker based retail accounts), 76,125 shares;
BNPP (BNP Paribas new account as of 09-18-08), 75,000 shares;
NFSS (The Prudential or prudential retail), 67,952 shares;
BCAP (New accumulation began 09-22-08), 62,427 shares;
PERS (Regional small funds and retail), 58,057 shares;
UNBK (Union bank of CA on previous loans), 55,900 shares;
BNBZ (Clearing position from last week), (53,246) shares;
INGL (Ingals & Schnyder), 53,000 shares; and,
CNTR (Clearing position), 52,900 shares.
This Report is for the trading days beginning Wednesday, October 8, 2008, through Tuesday, October 14, 2008 (the Report Period). For the Period, the indices were down between 1.7% and 2.6% with poor performance being the rule irrespective of the capitalization of the stock at issue. The volatility involved in the trading Period and the last calendar week were both extreme. Overall, however, it is our opinion at this time that the macro signs point, in aggregate, toward more stabilization and decreasing volatility and fewer losses. However, the signs are still mixed.
Retail selling through redemptions of mutual fund and other shares continued to accelerate last week with total withdrawals surging to $63Bn from $44Bn the prior week. Additionally, mutual fund withdrawals started to become a problem for the first time in foreign markets particularly Canada and India. Monetary withdrawals from Hedge funds are also accelerating with October being projected to see between $65Bn and $80Bn in withdrawals compared to $44Bn for September. One also has to remember when looking at hedge fund withdrawals that it is always difficult and sometimes close to impossible to withdraw money from a hedge fund so one can assume that the underlying sentiment dwarfs the recorded numbers.
On the positive side there was enough buying on certain days to accommodate all this forced selling and move the markets up albeit temporarily. People like Warren Buffet were saying that domestic equity was looking attractive and generally some investors here and there were beginning to acquire share positions. The credit markets appear to be stabilizing with the LIBOR rate dropping to 1.67% from 5.09% the week prior, similarly overnight commercial paper rates fell to 1.05% from 3.50% and the spread between 3 month LIBOR and 3-month treasuries fell 100 basis points to 3.63%. The only problem in the bank data was the fact that that the long term spreads did not contract as much as the short term spreads indicating that people are still worried about the situation reversing over a three-month time frame, which in our estimation is a legitimate worry.
We have been suggesting for weeks that the short-term market drivers are the CDS settlements on the recently failed institutions. We predicted that the markets would remain under substantial pressure through Wednesday of this last week and so they were as people raised cash to settle Fannie, Freddie and Lehman Brothers CDS obligations. As a reminder this coming week Washington Mutual CDS obligation, go to auction October 23, 2008, with settlement due October 28, 2008, with the AIG CDS instruments still being held open by the United States Treasury with no auction date set at this time. While the Washington Mutual auctions are similar in magnitude to the Lehman auction the liability there is expected to be held by more traditional insurance and large pools so the selling effect is expected to be material and coming out of larger capitalization common equities with less of the exposure having been hedged.
Additionally this past week the disconnect between corporate earnings and share price performance continued unabated with firms like IBM, AMD and others recording good sales and profits only to suffer the consequence as soon as trading resumed. The press has been remarkably unhelpful as well concentrating on jobs and industrial output reports skewed by hurricane Gustav with no mention of the skewing as well as almost no mention whatsoever of the better than expected profits at concerns other than financial or retail.
So for what to expect going forward all the evidence points to another choppy week with a bias toward the upside early in the week and then a bias toward the downside late in the week once the WaMu CDS obligations are quantified. Further out we expect continued chop until the WaMu settlements are substantially paid by October 29, 2008, and then a rally beginning on or about the end of October, mostly due to psychological factors and one real effect. For the psychological reasons: one, October will be over. Two, the elections will be decided and three, Americans socialized after 1980 seem to be incapable of remaining gloomy for too long. The practical effect will be that the 700Bn in bailout funds and a further 1.3Tr in monetary accommodations will begin to stabilize the situation. As Dr. Kissinger remarked discussing the planned air strikes in the run up to the first Gulf War, "It is unreasonable to assume that we will hit nothing." The effects of the bailout and the monetization will be similar. Not completely effective but not ineffective either. All this of course assumes no new major bank or insurance failures triggered by WaMu settlements and assumes that treasury does not put the AIG CDS obligations on the block. Longer term, the situation remains highly uncertain until the international disparities find some accommodation or resolution.
For the Period, price support in XXX shares was tepid with the shares falling 46 cents to close the Period at 9.80 cents. The clearing data for the Period was constricted as Monday, October 8, 2008, was Columbus Day meaning that while markets traded there was no settlement as it was a bank holiday. Therefore, this week behaves like a holiday week. That said the clearing data indicate that the XXX share price declined in response to concentrated selling against very limited buying. The concentrated selling came from Banco D'Orsa, TIG Advisors, a.k.a. the arbitrage concern at Bear Sterns, Fidelity core positions, US Bank NA and Rockbay partners. The interesting thing about these sales is that the Banco D'Orsa sale, the TIG sale, the Fidelity sale and the US Bank NA sale were all capitulations and recognized losses. In the case of Banco ' Orsa the loss was particularly severe with the position only being acquired beginning in June at around $10.00 a shares. Behind these marquis sellers there was also selling from Sterling, Credit Suisse, money market concerns, SG America, Goldman, Swiss American and Dimensional. The selling from Dimensional, Credit Suisse, SG, Swiss American and perhaps Banco D'Orsa is related to the shares falling below a dollar as most of these banks begin to sell as a systemic risk policy when shares dip below the dollar level.
The buyers were a combination of deliveries from short positions and additional buying from new investors who typically acquired their shares sometime after September 15, 2008. Virtually the entire established shareholder base seems to have no enthusiasm for this security or more importantly belief in their own value proposition concerning this security. In this regard, we would again mention that the lack of information from the company for the last six months has in our estimation been unhelpful. We would once again urge management to establish some form of public value propositions and expectation as soon as possible. In this connection, we notice where the company will release earnings on November 4, 2008, but the company does not indicate that any kind of a call is scheduled nor provides an explanation as to why. With the uncertainly over the last six months we suggest a shareholder call is in order to provide some guidance and encourage management to schedule a call.
For the Period the largest (>= 50,000 share) changes in position were:
BDOR (Banco D'Orsa), (835,000) shares;
JPMB (TIG Advisors), (510,450) shares;
BGIT (Barclay's Global predominantly previously loaned shares), 476,665 shares;
TDAM (Ameritrade retail receiving previously loaned shares), 258,647 shares;
SSBT (State and other retirement pool receiving previous loans), 219,255 shares;
BRWN (Fidelity Core position), (210,629) shares;
MLSF (Merrill Lynch administered pools on prior loans), 163,034 shares;
USBN (US Bank NA & Rockbay), (135,102) shares;
JPMS (Longfellow), 108,319 shares;
MELL (Sterling), (95,528) shares;
SCTT (Scottrade retail receiving loaned shares), 90,476 shares;
INTB (Regional broker based retail accounts), 76,125 shares;
BNPP (BNP Paribas new account as of 09-18-08), 75,000 shares;
NFSS (The Prudential or prudential retail), 67,952 shares;
BCAP (New accumulation began 09-22-08), 62,427 shares;
PERS (Regional small funds and retail), 58,057 shares;
UNBK (Union bank of CA on previous loans), 55,900 shares;
BNBZ (Clearing position from last week), (53,246) shares;
INGL (Ingals & Schnyder), 53,000 shares; and,
CNTR (Clearing position), 52,900 shares.