Archive for November, 2007

The "Subprime" Problem Means All Of Us.

9 comments Written on November 26th, 2007 by
Categories: Commentary, Subprime
In an excellent post titled "What is Subprime?", Tanta at the Calculated Risk blog talks about what "subprime" is, how it seemed to become a problem and how the current situation is a larger problem than "those subprime people".
That said, what it’s about is just working through the complexity of the variations on three things that have been the core of mortgage underwriting since roughly the dawn of time: the three Cs, or Credit, Capacity, and Collateral. Does the borrower’s history establish creditworthiness, or the willingness to repay debt? Does the borrower’s current income and expense situation (and likely future prospects) establish the capacity or ability to repay the debt? Does the house itself, the collateral for the loan, have sufficient value and marketability to protect the lender in the event that the debt is not repaid?

There is no New Paradigm, there was no New Paradigm, there is not going to be a New Paradigm. The Cs are the Cs. What we “innovated” was our willingness to believe that we had established the Cs with indirect or superficial measures (that are, not coincidentally, cheap and fast compared to direct measures).

...

What we call “prime” lending was based on the idea that all three C-questions had to get at least a minimally correct answer before proceeding. You had to be sufficiently creditworthy and sufficiently capable and have sufficient collateral before we made the loan. If you had, say, two out of three, you might qualify for a near-prime (like FHA) or subprime loan, depending on which two and by how far you missed the third.

The chilling part comes next: Why this problem is a bigger problem because it's deemed to be "subprime". Usually, says Tanta, loans that are "prime" (three Cs being fairly intact) slip into the subprime zone, due perhaps to temporary problems (like the homeowner losing a job) to a more sustained one (like the home market going down the wazoo). In other circumstances, subprime lenders jump in and say "okay dude(tte), we'll pay off your nagging prime lender and you pay US back instead, but (gleefully) at a higher rate of interest". When you want to save your house, you take this option.

The issue now is that subprime borrowers have bolted. The prime borrowers are slowly becoming subprime (home prices are already going down, remember) and when the term "subprime lenders" is slowly getting extinct, they have no refinance option. So the next step: They choose the foreclosure route. Default rates are up.

Read the article. And unlike me, read it slowly because otherwise, like me, you will have to read it again. We are all subprime now.

And what about us Indians? No, we're not the "brown" people mentioned there, but should we care about U.S. Subprime?

I would be kidding myself if I thought this is a U.S. only problem. Note that the European banks have suspended trading in mortgage bonds and China is worried about loss of US exports.

And India? First the software outsourcers have a lot to lose, considering they do a LOT of work with the financial industry all over the world. A dollar decline means a drop in exports so textiles is kaput. Liquidity constraints hit banks which "bank" on their ability to raise cheap money and deploy it for high returns. ECBs become more expensive as spreads abroad widen. Domestic consumption is driven by robust external demand as well, and to that extent asset prices will be hit if there is a global recession of sorts.

Of course I come across as bearish. But this has nothing to do with the stock market. It can continue to flourish, remember, and in the face of such data, it has in the past.

Posted in Commentary, Subprime

Sharekhan’s PMS performance

18 comments Written on November 21st, 2007 by
Categories: Moneyoga, PMS, Stocks

Sharekhan has released a newsletter depicting it's latest performance.

The Nifty Thrifty is an automated investment scheme where calls are generated by a computerised model. So no human intervention, and backtested for a while to ensure that the strategy stays statistically valid. But over this time period the results have been dissapointing.

Interestingly, the Nifty has done, er, phenomenally better. From Feb 1, 2006, the Nifty has moved from 2963 to 5907 (as on 31 Oct 2007, the date of the newsletter). That's a 100% gain nearly, but the Nifty Thrifty has only done about 34%.

It may not be a fair comparison to compare with the Nifty because of what they say:

Absolute returns? This needs to be highlighted because we do not intend to beat any particular index in a short period of time. We only intend to be able to generate absolute returns irrespective of where the market is heading by trying to capture trends based on technical analysis. So its more important to end the year with a profit than to compare that if the index was up 10% we should have also earned 10% or more. That is not the objective at all.

This is plain horseshit. Read on their portfolio management page that this is a "high risk, high return" kind of scheme, for which they pay high fees. And nowhere in the scheme's page does it say that the aim is capital protection - in fact your capital is not at all protected.

This graph shows you how the NAV behaved - and I hope this is after fees etc. (If it's not, the performance is considerably worse) Note that to protect capital the graph needs to be linear and pointing from bottom left to top right. But its not. Had you invested in this in December 2006, you would have lost money all the way till September 2007 (just about breaking even in May 07 and then dipping again). So your capital was not at all protected.

I would wager that a considerable proportion of the gains were skimmed off as performance fees, brokerage and transaction taxes. Meaning, the brokerage - Sharekhan itself - was the beneficiary of the fees and brokerage, while you underperformed the market. And they charge you the HIGHEST brokerage fee they offer - for retail investors they have options for fees lesser than the 0.05% they offer to their "premium" PMS customers. Meaning: Even if you lose money I don't care, I am going to take as much of your money as fees or brokerage.

The other scheme - a discretionary one this time - has done even worse. With the Nifty severely outperforming the scheme (Nifty went from 3908 to 5907, a 50% increase), the Star Nifty scheme returned a miserable 23%. Again, I don't doubt the manager's prowess - it could be that the lower returns are due entirely to fees and brokerage costs. But to you, the investor, how does it matter? Your money is gone anyhow.

What we should do is try and create a system which a) outperforms the Nifty on the way up (over a 1 year period or more) and b) looses less (or even gains!) if the Nifty goes down. In part b) one should note that all that matters is absolute returns - so preferably every single month or quarter (based on the timeframe of the model) should be positive in the absolute sense. (i.e. balance after the quarter should be greater than balance before)

I don't know if such a system exists and if it can be used. At Moneyoga, we are researching such systems and as we move along we will discover new opportunities and post them online. Given that the Nifty Thrifty is probably a trend-following measure maybe there is something we can check real fast. Watch this page.

Posted in Moneyoga, PMS, Stocks

So Exactly How Bad Is The Subprime Problem?

5 comments Written on November 20th, 2007 by
Categories: Commentary, Stocks, Subprime
Satyajit Das, who wrote the excellent Traders, Guns and Money, answers this question in an interview[Emphasis mine]:
I started by asking the Calcutta-born Australian whether the credit crisis was in what Americans would call the "third inning." This was pretty amusing, it seemed, judging from the laughter. So I tried again. "Second inning?" More laughter. "First?" Still too optimistic.

Das, who knows as much about global money flows as anyone in the world, stopped chuckling long enough to suggest that we're actually still in the middle of the national anthem before a game destined to go into extra innings. And it won't end well for the global economy.

Das is pretty droll for a math whiz, but his message is dead serious. He thinks we're on the verge of a bear market of epic proportions.

If Das is right - and I think he knows more than I do - the bear market that will follow will stick around for years. I think we would be kidding ourselves if we think this won't hurt us - but to be honest the first on the line to fall are exports. The fall out will be the financial market, and as a result of that, real estate, cement, auto, etc. will be hit. Some stories like Power, Infrastructure, Oil etc. may not be affected quite as much though.

The subprime crisis is fairly big, but we have to lose interest in it fairly soon so that it can hurt us when we are not looking. If history is a teacher, the lesson has been that markets hurt the most number of players when they are most vulnerable. What the US market is facing now is probably just a small tiny part of the eventual downturn - which could take years to unravel - and eventually we will also need to take some of that damage in our markets.

But does it mean the end of equities? To most of us reading this blog, it might seem like it. And when you come to the conclusion that "equities are dead", my suggestion to you is: think immediately about buying some.

Disclosure: Short Nifty, long RIL and some stocks not mentioned here.

Posted in Commentary, Stocks, Subprime

LIBOR is up to 6.45%

4 comments Written on November 20th, 2007 by
Categories: Commentary, Stocks, Subprime
It seems the subprime issues have started to affect LIBOR quite a bit. From the Telegraph:
Morgan Stanley said that the recent jump in the benchmark London Interbank Offered Rate, which yesterday rose to just under 6.45pc, was not merely a seasonal blip but a major warning sign of pain ahead.

It came amid further jitters in the banking sector, where many smaller, more indebted banks are struggling to find lenders to keep them afloat.

Libor rates, which indicate how willing banks are to lend to each other, have risen sharply during the past week, after spending almost two months close to the 6.3pc level - a worrying sign since it was Libor's increase in August that signalled the initial impact of the credit crunch.

Uhm, weren't a lot of Indian ECBs linked to LIBOR? Last I heard, LIBOR was around 5% or so. If we consider that most Indian ECB Loans are linked to LIBOR and that most were made earlier this year or last, when the LIBOR was about 5.3%, then there is an interesting problem. From RBI, As of March 31, 2007, nearly 72,000 cr. was in ECBs, and between April and June, a further Rs. 34,000 cr. was added. This is a net of Rs. 106,000 cr., which we can consider at a dollar rate of 42 or so, meaning they $25.2 billion. LIBOR on this has gone up 1%, which is an additional interest of $250 million dollars a year, or Rs. 1000 crores. Of course one might imagine that the dollar has reduced in value - but remember that the reduction has already been accounted for as "foreign exchange gains".

So who's affected? I don't know, but let me try and guess. Tata Steel for instance has a big loan for Corus, syndicated AFTER Jun 2007. This involves three tranches adding up to a total of 3.7 billion pounds. The effective rate is around LIBOR plus 200 points. For that loan, Tata Corus will end up paying an additional interest next year (if LIBOR stays this way) of about 1% higher - effectively around $80 million, or Rs. 300 cr. This is about 10% of Tata Steel's Net Profits annualized. (Of course if the pound goes down against the rupee further some of the losses may be recovered, but I doubt it will impact it as much as 300 cr.)

Who else? ICICI Bank seems to have a ton of them, according to this article. It has raised about $12.5 billion in the last two years, and these loans are all linked to LIBOR it seems. If LIBOR goes up 1%, their net payment is up about $125 million which is about 500 cr. That's again about 10% of profits.

Now I don't have all the information about how the ECBs are structured but on the face of it the LIBOR rise will affect every single ECB given. Companies like Reliance Industries, Reliance Communications, L&T, Bharti Airtel etc. have also got a lot of ECBs - the only company that will not show a serious loss is Reliance Industries as they have not booked forex gains for the gains in the dollar so far.

Given that with the subprime crisis the LIBOR may stay at this rate or go higher, and the impact may be quite heavy to some Indian companies. But some questions I have are:

  • Am I being too simplistic? Is this a valid concern at all?
  • Is there something called a fixed rate loan? Or if the loans say LIBOR+something they reset every x months as LIBOR changes?
  • Do you know a list of Indian companies with their ECBs, amounts and rates?
Will be interesting to probe this further.

Disclosure: Short Nifty.

Posted in Commentary, Stocks, Subprime

Moneyoga Release 2: A New Set of Screeners For You

5 comments Written on November 18th, 2007 by
Categories: Moneyoga
We've now added more features to Moneyoga.com. The list of new features are: Two of these,the Option Chains and the Market Metrics pages, have been explained by Kaushik.

Let me now tell you what we intend to do.

  • There are a lot of stocks traded daily.
  • If you had to go through each and every stock, you would have to spend an inordinate amount of time behind this, and yes it will get boring after a while.
  • Everyday, some stocks are moving, and moving fast. Some stocks are moving and have shown consistent growth. Yet others have done much better than everyone else in the past year.
  • You will hear about some of them - the RPLs, the RNRLs will all be immensely talked about in blogs, on TV and in the newspapers. Some of them you will never hear of because they are not quite that "hot".
  • We want to show you, through our "screeners", the stocks which show extraordinary strength or weakness, either in price or fundamentals.
So what do we have?

Top Gainers and Losers

A list of stocks that have done better than other stocks in various time periods: 1 day, 1 week, 1 month, and 1 year. You will find both gainers and losers, and you will find the stocks differentiated as those with F&O on them and those without.

The reason we keep them separate is that you can short F&O stocks on a position basis, and F&O stocks provide greater liquidity and volume which usually means that you don't have to worry about those stocks where volume is ridiculously low.

Note: Next to the code are figures in brackets, like ESSAROIL (2). This means ESSAROIL has been in this screen for two days consecutively. If we had run this screen yesterday and today, ESSAROIL would have occured in both. This is good to identify a one-off move versus a more sustained upmove.

New Highs and Lows

A list of stocks that have formed new highs or lows - the period for the "high" or "low" is of course different depending on your term, so we have lists for 1 month, 1 quarter, 6 months and 1 year.

Note: In a bull market you'll see many more new Highs and in a bear market, many new Lows. Yet, this can give you an indication of what is worth buying in a bear market and what is not in a bull market.

Stocks Above Moving Averages

A moving average is a smoothed curve of a stock over time. The moving average gives you an indicator of price strength - if a stock stays above its near and long term moving averages, it may be bullish.

Again, this is divided into stocks above 20, 50 and 200 day simple moving averages (sma). The "simple" is to differentiate it with an "exponential moving average" which is a curve that gives more weightage to recent data compared to earlier data, and those screens are useful for other purposes.

Volume Breakouts

When a stock is about to move higher or lower there may be a sudden spurt in volumes. This screener identifies stocks that have a much higher volume than the moving average.

Here we only consider those where the traded value (average) is at least 10 crores.

These are the list we have - we'll add more as we go on. Happy trading and investing! Oh yes, let us know what you think.

Posted in Moneyoga

NRIs/PIOs: Invest Directly In Indian Equities

4 comments Written on November 18th, 2007 by
Categories: Commentary
Non Resident Indians (NRIs) and Persons of Indian Origin (PIOs) can invest directly in the Indian markets.
NRIs and PIOs can open a demat account with any depository participant (DP). The NRI or PIO needs to mention the type and the sub-type (repatriable or nonrepatriable) in the account opening form collected from the DP. No permission is required from the Reserve Bank of India (RBI) to open a demat account. However, credits and debits from the demat account may require general or specific permissions as the case may be, from designated banks. Further, no special permission is required by a NRI for dematerialiation or rematerialisation of securities.
From the comments and emails I have received, a lot of NRIs seem to believe they can only invest in mutual funds or through Portfolio Management Services. I was also under the same impression. Now that the air is clear, I hope more NRIs and PIOs will come forward and invest directly; after all, investing in India is vogue and direct investment is perhaps better than investing through a fund, if you know what you are doing.

Tell me if you have problems going down this route - I hope that there is at least one brokerage that will let NRIs trade through an online account, let's see which ones create issues.

Posted in Commentary

Calculated Risk – A Brilliant Blog

6 comments Written on November 16th, 2007 by
Categories: Subprime
I've been reading Calculated Risk recently and man is it something. To get a better hold of the U.S. housing fundas, or to simply decipher the plethora of news you seem to hear, I cannot find a better place.

Today's picks from there: Goldman Sachs predicts a $2 trillion cut in future lending. What this means is - there may be a hit to banks' capital, which can take their capital down $200 billion (assuming just half of the total hits their balance sheets). If banks leverage their capital 10 to 1, they are going to stop lending to the extent of $2 trillion.

This is assuming that they can't find the $200 billion to recapitalise, (And $200 billion is not a small amount) and that there is no macho rescue event by the US Fed. And this is perhaps conservative as banks leverage higher than 10 to 1.

Another interesting piece, quoting from a Fed Governor's speech:

First, the bulk of the first interest rate resets for adjustable-rate subprime mortgages are yet to come. On average, from now until the end of 2008, nearly 450,000 subprime mortgages per quarter are scheduled to undergo their first reset, eventually causing a typical monthly payment to rise about $350, or 25 percent. Second, the weakness in house prices and the resulting limit on the build-up of home equity will hinder the ability of subprime borrowers to refinance out of their mortgages into less expensive loans; as a result, more borrowers will be left with a mortgage balance that exceeds the value of the house.
Very interesting conclusions further there. Good read.

Posted in Subprime

Dividend Reinvestment In TaxSaver Funds: A No-No

7 comments Written on November 15th, 2007 by
Categories: MutualFunds
A very large number of us, me included, have invested in ELSS funds (Taxsavers). All investments in these funds are locked in for three years.

Some of us, me included, have used the "Dividend Reinvestment" option when going into such funds. (An option you should never use anyhow)

Dividend Reinvestment in Taxsaver funds is especially bad; you can never get your money out completely, since each investment is locked in for three years. Every year the fund announces a dividend, and typically they keep it quite high so that people invest. You have about five days after the announcement of dividend to buy and get that dividend. Why is this good? Because you can get a tax deduction on the whole amount invested (under Section 80C) and then get a part of your money back.

(Ex. SBI Magnum Taxsaver announced Rs. 11 dividend when its NAV was 55, a 20% yield. If you had about 90,000 available in 80C, you could have invested it in the fund and instantly got back 18,000, but got a tax benefit on the full 90,000).

Now why are dividend reinvestment options bad here? Because every year the dividend will get reinvested and locked in for yet another three years. You will never be able to completely withdraw from the fund, even if it underperforms like crazy.

You might think: Well, let them reinvest it every year, what difference does it make? It will contribute to some part of my section 80C investment anyhow, no?

Consider this: What happens if the government withdraws the 80C exemption, or decides that ELSS funds will not be part of 80C? Every year you will be reinvesting and locking in your money for three years further and getting no tax benefit.

Further consider what else comes under 80C. Housing loan principal for instance. So if you take a loan to buy a house, and if the loan is above Rs. 20 lakhs, you are sure to pay more than 1 lakh principal per year through your EMIs. So you don't need another 80C investment. But the dividend reinvestment gives you no option but to keep investing and locking in your money.

Also under 80C is your childrens' education fees. Given what schools charge today, that might well cover your 1 lakh limit by itself.

One thing you can do is attempt to speak to the fund house and change from re-investment to payout instead. Some fund houses are ok with this, but I can't say for sure if all of them will agree.

And going forward, either invest in the dividend payout option or in growth - never the reinvestment option.

Posted in MutualFunds

« Older Entries