US700 Billion Bailout

The startling thing about the US700 Billion Dollar bailout is the assumption that the Federal Reserve, the US Treasury and the folks on Capitol Hill have the patent on the solution. Despite so much incisive commentary in places like RGE Monitor by Nouriel Roubini, Money Morning and others, the bailout appears to be exactly that – a handout, albeit in tranches with Congressional oversight, whatever that means.

The Calculated Risk blog, in its posting for September 28 2008, sets out a summary of the proposals, via a document that emanated from the Office of the Speaker of the House, Nancy Pelosi. There are 3 critical components:

1. Re-invest in the troubled financial markets to stabilize [the US] economy and insulate Main Street from Wall Street

2. Reimburse the tax payer through ownership of shares and appreciation in the value of purchased assets

3. Reform business-as-usual on Wall Street through strong Congressional oversight and no golden parachutes.

There are repeated uses of the phrase “participating companies”. That’s a warning bell right there. If conditions (2) and (3) are taken at face value, those companies on the receiving end of government largesse, risk increased public interference at Board level, at macro and micro levels, including the scrutiny of executive contracts. Given the propensity in the US to unilaterally assume and extend jurisdiction wherever possible, SAW would not be surprised if, pursuant to the bail out, “participating companies” and not just the US Treasury would find themselves subjected to examination from the General Accounting Office (GAO). In the Pelosi document, the GAO is to have a presence at the Treasury, together with an Inspector-General. (No mention as to how much that would cost).

If anything, conditions (2) and (3) might later deter companies from participating in the bailout and send them down the road of a private re-structuring to maintain their independence, executive compensation and more importantly, the business-as-usual on Wall Street which condition (3) seeks to reform.

The reference to small and mid-sized companies is ominous: the Pelosi plan wants to help save small businesses that need credit by aiding small community banks hurt by poor quality mortgages, by allowing them deduct their losses by investing in Freddie Mac and Fannie Mae.

Why is it ominious? It implies that the smaller banks will be next to implode. That frustrates the intention to insulate Wall Street from Main Street. Secondly, it’s an open question whether the Federal Deposit Insurance Corporation is adequately capitalized to deal with the failure of a host of smaller banks. The irony is that the FDIC might need a bailout.

© 2008 Sanjeev Aaron Williams All Rights Reserved

Fannie & Freddie

Yet again, it pays to shut up.

For weeks.

Anyone who read the assertive and incisive comments over the last few months by Nouriel Roubini in the RGE Monitor, would have reacted with déjà vu on hearing about the impending implosion of the US organizations Fannie May and Freddie Mac.

In case you didn’t know, Fannie & Freddie are privately owned organizations operating under the mandate of the US Government. They perform a dual function.

Firstly, they provide funding for home loans, not by lending directly to the consumer, but by buying up tranches of mortgages from approved lenders, re-packaging them as investments and selling them off to Wall Street and internationally (sound familiar?).

Secondly, they are the guarantors of last resort of about half of all US home loans. That’s about US6 Trillion out of US12 Trillion at the moment. The figures start getting a bit silly at this level of debt.

The theory is that in their role as middlemen between mortgage lenders and investors, more money would be available at cheaper rates to allow people to buy their homes.

It’s their role as guarantors of an increasing number of crappy and defaulting mortgages that sent their share price plummeting, amidst fears that Fannie & Freddie would run out of cash. Both issued statements that their capital base is strong – although Freddie is scheduled to sell US3 Billion in short term debt right about now.

Predictably, the US Government made patriotic noises about how they must not be allowed to fail. Their line of credit was extended (about time too: Fannie has US800 Billion in debt, Freddie has US740 Billion in debt) and the US Treasury may even buy equity in them. It doesn’t get much sweeter than that. And who would ultimately be paying for all this? The dear taxpayer of course. And what would they get out of it? Nothing, except for continued intransigence and reluctance to lend to individuals and SMEs citing the “global credit crunch” as the excuse.

Problem was, as the New York Times pointed out, for years nobody in the US government would even acknowledge the existence of the line of credit, even though it amounted to an implicit guarantee that a Fed bailout would always be there, while in the meantime the Government didn’t have to show mounting losses on its Balance Sheet for what was in effect, a subsidy.

Again, as the New York Times put it on 13 July 2008:

The dominant role Fannie and Freddie play today is no accident. The companies, Wall Street firms, mortgage bankers, real estate agents and Washington lawmakers have built up an unusual and mutually beneficial co-dependency, helped along by robust lobbying efforts and campaign contributions.

Back in the real world of SMEs, there isn’t the luxury of government insulation that gives the business owner discounted rates on the money markets, covers up lousy management, arguably encourages “moral hazard”, imposed lax capital standards – which went unsupervised for years - and aided and abetted the packaging of toxic debt instruments to private investors. Since you can’t pay for lobbying, the best you can do is network.

Who really benefits from this? It ain't the consumer or the SME. It's those investors in collateralized debt instruments, originated by Fannie and Freddie, seeking to have their returns guaranteed by the state. Or, put it another way, a prime example in the sub-prime saga where profits are privatized and losses are socialized.

© 2008 Sanjeev Aaron Williams All Rights Reserved

What Lehman Did, You Can't

The Lehman Brothers saga in the US gets more interesting, although it’s unclear whether it’s a story in the making or simply rumour and innuendo attempting to create a story.

An online report by Randall W. Forsyth writing in Barron’s published on 4 June 2008, stated that less than 24 hours after the investment bank was reportedly mulling issuing US$3 – 4 Billion in common equity, it went into the market and bought back its shares.

The obvious question was asked: can a company be under-capitalized one moment, only to be over-capitalized the next? Not likely. Clearly something was going on. In certain situations where the stock price of a company is low and capital cannot be usefully employed for shareholder benefit, it might make sense to buy back the shares. The effect of a share buy-back is to stabilize or lift the share price. While that is what happened in LEH’s case, the stock still sits at its lowest level since August 2003.

SAW agrees with Forsyth’s view that it is arguable whether a share buy-back was the best thing to do, given that LEH’s Balance Sheet is purportedly riddled with (CDO-based?) assets of dubious value and limited liquidity. But, if, as it’s CEO is on record as saying, that LEH’s intention was to hurt those engaging in the short-selling of its shares, then a share buy-back using whatever liquidity a company has, would be a defensive move.

As a publicly listed company, LEH has the option of immediately going into the stock market and buying back its shares. They’re millions of them out there, they have an immediate market value and they’re liquid. Buying them back is a snap. If that’s what it takes to maintain a semblance of solvency and liquidity, so be it.

An SME faced with pressing liquidity and solvency issues as well as a Public Relations problem, does not have those quick options. As a private company, its shares are held by a handful of people, possibly a mix of family members venture capitalists or angel investors. There may be a Shareholder’s Agreement with rights and obligations, a mechanism covering notice of intention to buy back the shares, clauses covering how the shares are to be valued and an arbitration procedure if things get really ugly between a shareholder and the company.

Whilst it is possible for an SME to buy back its shares, it’ll take a while. Lehman still has billions of bucks worth of liquidity on its Balance Sheet and could afford to take an immediate bold move to spend some of that cash on a buy-back. The average SME with a looming cash flow problem, couldn’t do it. Either it has to deal with its Receivables properly, or tighten up on its debtors, or reduce the credit period currently extended to its customers, or get a bank loan (good luck with that, at the moment) or offer equity to outside investors.

Doing nothing will just erode shareholder value. And that opens another can of worms.

© 2008 Sanjeev Aaron Williams All Rights Reserved

Heard It Through The Grapevine

They’re baaa…cckkk…!! Lehman Brothers is back in the news. The Wall Street Journal of 4 June 2008 and one of SAW’s favourites, the Naked Capitalism blog, are reporting that LEH’s appears to be on track to report a quarterly loss larger than the US$300 million predicted by analysts.

And they’re not the only ones making predictions. Investors have bet huge amounts on puts that LEH is gonna sink,sooner rather than later. Their debt rating was downgraded and their stock downgraded to “underperform”.

And what’s LEH said to be doing? Looking for US$3 - 4 Billion worth of new capital to shore up its Balance Sheet.

Effectively, a tsunami of rumour and predictions are driving perception and behaviour. At least the big boys have PR departments, press statements and the luxury of resorting to slick financial euphemisms.

LEH’s denials that it had funding problems and that it did not borrow money from the US Treasury, failed to convince the market and its shares closed down 10%. Let’s not forget that it was in March 2008 that LEH raised US$3 Billion from investors in order to refute reports that it was in the same predicament as Bear Stearns.

For SMEs, any rumour and predictions by outsiders, or insiders, on solvency, are potentially fatal. If cash flow is erratic, intermittent or eroded and debt ratings downgraded in the face of contracting credit, expect to be doing what some SMEs in the US are already doing – taking their goods to the pawnshop in an urgent attempt to raise capital. (Or, to use a Wall Street euphemism, “to shore up their Balance Sheet”).

The problem with rumour is that it takes on a life of its own. For SMEs, even at the best of times, it’s a delicate balance between Accounts Receivables and Accounts Payable. Inevitably, the worst aspect of any rumour reaches the SME’s most intransigent creditors first and encourages the SME’s debtors to delay payments to the last. But the phone calls demanding an explanation keep coming thick and fast.

What a bind. Crippled cash flow in a hurricane of innuendo. What’s an SME to do?

Factor the Receivables immediately if possible – even just a portion of them.

Ironically, shoring up the Balance Sheet through Off-Balance Sheet financing (another term for Factoring) is the quickest way to get cash flow, without giving up equity or sinking further into debt.

One more thing. The reputable Factoring companies are acutely sensitive to outsiders’ perceptions of Factoring and adopt the role of Receivables Managers. It’s all part of the Factoring service. Their ability to make it clear to the SME’s creditors and ultimate debtors that the SME is raising working capital through ongoing cash flow management, often goes a long way in assuaging potentially suspicious parties.

© 2008 Sanjeev Aaron Williams All Rights Reserved

Passing The Hat Around

Whatever brave face that banks were putting on the sub-prime debacle when it first erupted i.e. it was only a small portion of their portfolios, has now all but melted. In the next few days it’s Earnings Reporting Time, specifically for the 4^th Quarter of 2007.

And it will not be a pretty picture. See the previous post, The Mushroom Cloud.

As Bloomberg pointed out in its online report dated 15 January 2008, the writedown on Citigroup’s losses are double what the company forecast in November 2007 and Citi has lost half its market value in the past year. Standard & Poor reduced Citigroup’s credit rating from AA to AA-.

But to put things in perspective, Citigroup’s capital base should not be an immediate issue (even though it did cut its dividend from 54 cents to 32 cents) It acted fast. In November 2007 it raised US7.5 Billion by selling a stake to the Abu Dhabi Investment Authority. It’s now slated to receive a further US12.5 Billion from the Government Of Singapore Investment Corporation, The Kuwait Investment Authority, its former Chairman Sanford Weill, Capital Research And Management (Citigroup’s biggest shareholder) and the New Jersey Division Of Investment – and not forgetting Prince Alaweed BinTalal of Saudi Arabia who’s been investing in Citicorp (as it then was) since the early 1990s and is investing more now.

And who else?

Oh yeah, Merrill Lynch is getting a further US6.6 Billion from the Kuwait Investment Authority, the Korean Investment Corporation and the Mizuho Corporate Bank. In December Merrill raised US5 Billion from Temasek Holdings of Singapore and US1.2 Billion from Davis Selected Advisors.

And these are only 2 banks on the list of The Mushroom Cloud looking for cash.

© 2008 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

Which Funding Source ? 3

The author prefers to deal with funding sources that offer alternative products. If a client turns out not to be eligible for factoring, the funding source can still add value by offering say, venture capital or equipment leasing. Everybody wins and it saves the client the hassle of looking for alternative funders.

Besides, just because the client isn’t eligible for factoring at the moment, doesn’t mean it won’t be eligible in the future.

© 2007 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

Which Funding Source ? 2

Since factoring is all about timely cash flow, the best factoring companies will be able to quote on the deal, or decline it, within 24 – 48 hours of a fully complete application being submitted. Note the operative words “fully complete application”. The author has seen enough companies whining to disclose the required information on the application form. It doesn’t help their case or the speed at which they might get the cash.

If a factoring company purports to charge an application fee when you’re submitting the initial paperwork, watch out. There are no grounds for it.

When the client accepts the quote, the factoring company will respond with a contract and supporting documents for the client’s signature. The contract is subject to due diligence. At that point, it is perfectly legitimate for the factor to request the due diligence fee from the client.

Some factors have preferred industries and will specifically exclude others. Others are more broadly based. Generally construction industry related factoring is a specialized niche and not all factors handle it – the risk element is highest in this sector.

Some factors have a monthly minimum value for a deal, below which, they will not fund. This is because the administrative costs of servicing the small account outweigh their returns on it. Hey, it’s business. Besides, there is a specialist market of “small factors” who will fund monthly amounts between $US2,000 – US$20,000. The author knows of some of them.

By contrast, other factors may not have monthly minimum values, but may have maximum monthly volumes, which can be increased on a case-by-case basis, or, syndicated between 2 or more factors.

© 2007 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

Which Funding Source ?

Straight up, this author will only deal with funding sources affiliated to the American Cash Flow Association (ACFA). Several times, clients have “insisted” that the author should contact this or that funding source which a friend told them about and negotiate for them.

Forget it.

Secondly, the author is not in the business of playing one funding source off against the other, merely at the behest of the client. Within the ACFA group of funders, word gets around pretty quickly as to what’s going on. The client shouldn’t be surprised if the funding sources flatly refuse to play his game and dump the company’s applications.

The funding sources of ACFA are inherently flexible, more so than others and exponentially more so than banks. If a business is turned down, it’s not for a lack of interest, but a lack of “fit” or the due diligence didn't pan out.

So, what goes into choosing a factoring funding source? That’s the subject of this and the next posts.

© 2007 Sanjeev Aaron Williams & Cashwerks All Rights Reserved