Institutional Investor's Alpha Magazine - March 2009 - (Page 31) and no company can continue to do that for very long. Once you see something like that, it’s pretty obvious that the stock is overvalued, and you can buy put options because you know that what they are producing is going to absorb cash very, very quickly. The company filed for bankruptcy shortly thereafter. Are there material differences between the U.S. and U.K. housing markets? Swallow: The U.K. real estate correction has been far take on the underlying assets, which are generally CDO assets, are going to be signifi cant — if not almost entire. If you’ve got between $10 billion and $20 billion of monoline-insured ABSs on your balance sheet as a European bank, and you’ve only written down about 10 percent of it, you’ve got a long way to go. How broad and deep is this problem? Lumsden: If the banks were to value their portfolios in quicker than the U.S. correction. If you look at the U.K. correction now relative to the early 1990s, it bears no comparison — we are now in the same position after one year, if not worse off, than we were after three years in the early 1990s. Lumsden: Absolutely, the decline in the U.K. from the peak has been quicker, although in absolute terms the U.S. decline still outstrips the U.K. The most concerning thing, to me, is that I fear we may have only just started to see the impact of people losing their jobs on that price depreciation in the U.K. — and if you look at the last recession, you could argue it wasn’t really the interest rates that killed people, it was losing their jobs. That is what made British homeowners give their keys back. That is only just starting to happen here, and it could accelerate in the months ahead. How would that affect U.K. banks? Lumsden: One of the problems, looking at the European line with our models, some would be multiple times underwater from an equity-valuation perspective. Swallow: This is arguably a highly politicized issue. On the one hand, you have large numbers of retail investors in the U.S. who hold monoline-insured municipal bonds, and on the other, you have European financial institutions with significant holdings of monoline-insured asset-backed securities. With so many different interests, maturities and timings of payments, any potential monoline insolvency would likely be messy, litigious and protracted. Do you see any opportunities on the long side? Lumsden: We are now facing a number of macroeconomic issues — it is no longer just a credit crisis. So I think where we go from here is going to be driven by the timing of any economic recovery, and that is a long-term issue. I don’t think we can expect the markets to do much over the coming year or so, but within that larger context, we are seeing some interesting opportunities — even on the long side, where we’re focused on shorter-duration, well- side now as well, is that everything is interconnected. So a lot of the German banks have had huge exposure to U.S. subprime through investing in CDOs and structured finance — but banks in mainland Europe don’t appear to have the same focus on mark-to-market accounting that exists in the U.S. The fact that those institutions may eventually have to realize the full extent of their losses will continue to impact lending in their own local markets. So it is a global problem, and what the U.S. has actually done very well is export a lot of its problems to the rest of the world. The net effect is arguably that the U.S. financial system may suffer less pain than financial systems in Asia and Europe, where some banks have invested in a lot of monolineinsured asset-backed securities and CDOs — all of these different structures. Where will the crisis strike next? Lumsden: The next big event is likely to be the mono- “With so many different interests . . . any potential monoline insolvency would likely be messy, litigious and protracted.” — STEVEN SWALLOW, CSQ ABS FUND lines’ eventual failure. And while you hear that most banks have taken that into account — and that may be true to some degree in the U.S. — there are a lot of European and Asian banks that are valuing monoline-insured books at very high levels relative to where they actually trade . . . Swallow: . . . and fundamentally where they should trade. When the monoline insurers eventually do default and you don’t have any ability to claim any cash at any meaningful level from them, the losses you are going to enhanced product with a large amount of subordination — product that will perform well across some pretty horrific scenarios where we see losses running at completely unprecedented levels. Swallow: While we are absolutely not willing to call the bottom of the market — because that is a fool’s game — I think we are in uncharted waters. Investors who have money to put to work can find tremendous value. We’re seeing more value at the top of the capital structure in the U.S. and in Europe, in deals that are of quite short duration — i.e., the actual tranches that have got cash flowing now and are paying principal, or very close to paying principal. MARCH 2009 • INSTITUTIONAL INVESTOR’S ALPHA • 31
For optimal viewing of this digital publication, please enable JavaScript and then refresh the page. If you would like to try to load the digital publication without using Flash Player detection, please click here.