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Category Archives: Corporate Governance

Guan Jianzhong, Chairman of Dagong Global Credit Rating Co. Ltd

Bloomberg reports that China’s Dagong Global Credit Rating Co. reduced its credit rating for the U.S. to A+ from AA citing a deteriorating intent and ability to repay debt obligations.

Having worked on both sides of the world, I have come to associate such statements with shortsightedness. My past experience as a senior research analyst for a brokerage firm in Asia-Pacific would suggest that we are going to see problems in China by 2012.

In this blog post we take a look at how consumers could cope with the Mortgage Mess. Yes, we need strong banks otherwise the Dagong rating will be fulfilled, but this economy is 70% consumer driven. We therefore need stronger consumers, as strong consumers underpin the health of the banks, and not the other way around. Using China as an example, as China’s income per capita rises its banks and financial services companies become more confident of themselves, therefore the Dagong ratings comment above. 

I want to inform our readers that QuantumRisk’s CMBS Property Risk Analytics promotion ended September 10, 2010 per an earlier newsletter. The new pricing, valid until March 2011, is available here.

Home Prices Sag in August 2010

The State of the Housing Market
In my August 2009 blog post Have we hit the Housing Bottom? I had suggested that the house prices will bottom in 1Q 2010. Given the graph, I must say that this was a pretty good estimate of timing. 

The second question I had attempted to answer then, was home price recovery sustainable? My answer at that time was that it was more likely not.

The economic analysis presented by HiddenLevers (see picture) suggests that house prices are struggling to maintain an upward momentum. 

Why? There are two reasons. First the glut in foreclosed homes (1 in 4 for sale are foreclosed) will keep supply substantially greater than demand. Second, 1 in 6 homes in foreclosure translates into 1 in 6 homeowners who will not be able to participate in homeownership for at least 7 years or a 15% reduction in demand.

The graph shows that house prices are now hovering in the 68% to 71% range of their 2006 peak values.  From an economic cycle perspective, the housing industry collapsed before the commercial property industry. Given a 15% reduction in residential ownership capacity, it is very likely that commercial property sector will recover before the residential sector does. That is, the trough in the residential sector will be longer than that of commercials.

What is not reported in the news is the residential vacancy rates. A friend of mine who works for a utility company told me a few weeks ago, this utility is seeing 1 in 7 homes vacant. This is 50% more than reported by US Census Bureau for 2Q. That means rental incomes will not increase in the medium term. It also means that utility revenues will fall by 14%.

Some other bank just increased the difficulty of Chief Executive Officer Brian T. Moynihan 'hand to hand combat' over mortgage disputes.

The Next Big Wave: Legal Risk
Most of us are focused on market, credit & operational risks, but the next big wave will be legal risk.

I recently found out that banks are selling the second mortgage on foreclosed homes to debt collectors. Sure this maybe legally possible but lets weigh the pros & cons. The pros. Maybe banks think they can get back they principal in the second mortgage by selling the second mortgage to a debt collector. Sounds great, high fives to the managers who thought up this one. And at worst you don’t even have to write it off your balance sheet just yet. Kudos.

But wait. Does anyone really think they can get their money back from homeowners who could not even pay their first mortgage? Especially if they are unemployed? It also raises another question, what was the function and scope of collateralization?

Now the cons. What this action has done is to clarify that in the event of a foreclosure / repossession, the bank recognizes that collateralized debt survives ownership and can be put back to owner / originators. (Check with legal counsel for an informed opinion.) In the United States one cannot have one set of laws for one group of people and another set for another group of people.

Therefore, investors who bought RMBS bonds can now recognize that their securitized bonds survive any asset ownership issues, and banks are now liable for securitized bonds because they survive ownership.

I found out about a bank’s access to your personal funds some years ago. When I contacted the FDIC about it they said they could not do anything about it. Some mortgage contracts include a single sheet document that states that the bank has the right to move your funds around to keep your mortgage current. This I believe is antithetical to the securities law because securities law does not allow financial services companies to move funds around for a client for the benefit of the company.

The problem here is given such a ‘contract’ will or does the bank have the right to reach out to your 401(k) or similar funds?

Prime fixed rate foreclosures jump

How Consumers Can Protect Themselves
There are several ways consumers can protect themselves from future messy mortgage problems:

 1. House Pricing: The graph above (picture in State of the Housing Market, above) suggests that with today’s market conditions a home buyer should consider as an upper limit a purchase price of about 70% of the 2006 appraisal. If the housing situation deteriorates, this 70% number will drop. Looking at CMBS for guidance, this number can get to be as low as 54%.

 2. Appraiser Selection: Before purchasing, get an appraisal of the property by an appraiser who does not have links to banks as this minimizes banker bias.

 3. Mortgage Origination: If you are purchasing a foreclosed property, it is not recommended that you get your mortgage from the same bank that foreclosed the property. Why? At least in theory, in the event that there are ownership issues, you have a different bank behind you. 

 4. Safeguards: Given the state of the housing market, it would be prudent for the home buyer not rush into a purchase as the housing market is not likely to recover anytime soon. If you do so, you would need to have staying power. Therefore, before making a purchase, here are some points you should consider:

 4.1 Title Insurance: Don’t sign an S&P if you cannot get title insurance.

4.2 Deposit: Make your deposit conditional upon getting a clean title.

4.3 Indemnification: Require that the seller and/or the mortgage provider accepts liability for any future ownership claims in the event of the failure of the title insurance company. The lesson of 2008 was that many securitized bond credit enhancements (credit insurance) turned out to be worthless when the economy as a whole turned south.

4.4 Survival: Require that in the event of a foreclosure/repossession that all collateralized claims (1st, 2nd & 3rd liens) cannot survive the ownership.

4.5 Delinquency: Require that the mortgage provider cannot start foreclosure proceedings until the mortgage is at least 90 days past due. In the state of Colorado there are no laws to prevent a lender from foreclosing on day 2. Yes, even I was surprised by this, and know of at least one recent case where the foreclosure proceeding was started on day 50. 

4.6 Miscellaneous Contracts: Do not allow the mortgage lender have access to your other funds. Remove all such ‘subcontracts’ from your S&P agreement.

 5. Walk Away: If there are any doubts about the price, property or claims on the property, walk away. This market in not going to recover any time soon, and there will be plenty of second chances.

 There are many really good managers in banks, but as a general rule banks rotate their managers. So the great manager you see today could be replaced by a rogue manager tomorrow. Therefore do not feel ‘uncomfortable’ including these conditions in your S&P. You may even have to hire your own legal counsel to protect yourself. Remember it is wiser to walk away then to be burdened by a debt for a property you no longer own.

Summary
The real sad story is that we will eventually see 1 in 6 families homeless. To put things into perspective, James Fry, founder of Mean Street Ministry, reports that when he started this ministry about 10 years ago, there were 2 suicides per year, today there are 2 a week. We as a family have known James Fry, his family & his ministry for many years. Let us in Thanksgiving help someone in return.

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Disclosure: I’m a capitalist too, and my musings & opinions on this blog are for informational / educational purposes and part of my efforts to learn from the mistakes of other people. Hope you do, too. These musings are not to be taken as financial advise, and are based on data that is assumed to be correct. Therefore, my opinions are subject to change without notice. This blog is not intended to either negate or advocate any persons, entity, product, services or political position. Nor is this blog post to be construed as investment advice. 

Contact: Ben Solomon, Managing Principal, QuantumRisk
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QuantumRisk looks at downside risk & lessons we can learn from industry failures. We don’t provide rosy scenarios of the future, that is better left to others. We neither negate nor advocate any persons, entities, products, services or political positions. Neither are we attorneys. Nor do we profess legal opinions on any subject.
 
However, as much as is reasonably possible we present opinions, information and facts that can be tested and verified by & for the benefit of our readers. In so doing, we explore downside risk, their consequences and how we could avoid these future scenarios. Sometimes, the conclusions arrived at may not be desirable but many times if we don’t look an undesirable outcome straight in the eye we usually cannot find a more amenable solution. 
 
An ideal outcome would be the rethinking of private & public policies that lead to a more secure future for all of us.

Goldman Sachs Senate Hearings
I had originally planned to write Part 2 of Loss Containment but realized that the Goldman Sachs Senate Hearings was more pertinent in this time frame. I will get back to Loss Containment next month, if something more pertinent does not surface.

On April 27 2010 the Senate Subcommittee on Investigations held a hearing in which current & former Goldman Sachs employees (including the CEO & CFO) testified. In all fainess we need recognize that many parties by ommission or commission share the blame for this financial crisis. I watched about 7 hours of the hearings, and have several observations:

1. More Main Street
Senator Carl LevinThe goals of these hearings (Goldman Sachs hearing was one of several) are threefold:
1. To construct a public record of the facts to deepen public understanding of what happened and to try to hold some of the perpetrators accountable.
2. To inform the current legislative debate about the need for financial reform; and
3. To provide a foundation for building better defenses to protect Main Street from the excesses of Wall Street.

Sen. Levin had repeatedly brought up the need to protect Main St. and therefore I infer that future regulation will be supportive of Main St. – Wall St. engagements and discourage Wall St. – Wall St. engagements. In this light, we recognize why Glass-Steagall worked at the operational level. It ensured that a substantial portion of the financial services industry was focused on the needs of Main St, and by use of barriers protected these segments of the industry from the influences of its more glamorous kin.

2. Discourage Non-Collateral Based Instruments
Senator Claire McCaskill“It’s gambling, pure and simple raw gambling” said Sen. Claire McCaskill.  This sentiment was echoed by Sen. Carl Levin and was repeated many times by the senators, suggesting that future financial regulation would some day discourage if not curb the development and use of financial instruments that are not directly identifiable with a real physical asset. That futures-like products are acceptable but synthetic-like products are not. This is going to be tricky to do but I infer that this will be the direction of future legislation.

With respect to Mortgage Backed Securities there are two possible requirements to ensure compliance with a possible collateral-based security requirement. First, that an analyst is able to follow the cash flow from the assset to the security, and show how a specific asset default, defeasance, or prepayment would affect the cash flow to a specific security. Second that the master or even the special servicer is able to do the same.

The first requirement is usually a given for straight forward/non-exotic deals, but the second is a problem even for some ‘basic’ deals as some of the data is missing. The MLCFC 2007 9 WF or GSMS 2007 EOP WF deals are good examples where the servicer has difficulty in providing some of the data. The slicing & dicing of some of the properties in these deals has no effect on the risk characteristics of the deals but has resulted in a breakdown in the servicers’ ability to provide current information right down to the property level.

3. Strengthening of Fiduciary Responsibilities
Sen Levin and his colleagues had repeatedly asked questions relating to clients’ interests versus company’s interests. Their focus suggest that future legislation will prevent a bluring of roles with respect to client versus company interests. Therefore we should expect a compartmentalization of financial services to protect the integrity of fiduciary responsibilities

Goldman Sachs Employees Testify (Fox News/AP Photo)

4. Individual Responsibility
Seven current and former Goldman Sachs employees including Chief Executive Officer Lloyd Blankfein testified at the Senate Hearings. First a disclaimer. My comments are based on my inferences as a management consultant working with teams and not as an attorney.

The fact that the Subcommittee required both current and former employees to testify before it suggests that individual employees cannot hide behind company policy or lack of, to defend themsleves against allegations of wrong doing. Further, everybody is doing it will no longer suffice as an acceptable defense or immunity for one’s actions.

Conclusion
History shows that financial regulation (Securities Act of 1933, Securities Exchange Act of 1934, Trust Indenture Act of 1939, Investment Company Act of 1940, Investment Advisers Act of 1940) spawned after the crash of 1929 took 11 years to formulate and implement. Similarly we can expect to see several more new or strenghtened regulations being formulated and implemented over the next 10 years. 
 
Future regulation will further compartmentalize both financial services (e.g. retail banking, investment banking, trading and public-type versus private-type fund management) and financial products (e.g. basic, middle and exotic products).   
 
There will be stronger, clearer guidelines as to how products can be structured. For example (and this is only a suggestion) basic products can be used to structure deals where AAA accounts for up to 90% of the deal. Exoctic products cannot have more than 25% AAA, and middle products cannot have more that 60% AAA

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Disclosure: I’m a capitalist too, and my musings & opinions on this blog are for informational/educational purposes and part of my efforts to learn from the mistakes of other people. Hope you do, too. These musings are not to be taken as financial advise, and are based on data that is assumed to be correct. Therefore, my opinions are subject to change without notice. This blog is not intended to either negate or advocate any persons, entity, product, services or political position. Nor is this blog post to be construed as investment advice. 

Contact: Ben Solomon, Managing Principal, QuantumRisk
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When I was at Texas Instruments, we were told that nobody is indispensable. If Dimon leaves JP Morgan and the bank’s share drop, then he did not do a good enough a job at succession planning at the bank.

The real issue is the rumored replacing of Tim Geithner. We need to ask ourselves why the rumor. It is because unemployment has exceeded 10% and still increasing, and this can allegedly be a liability to the Obama Administration in the coming elections.

However, if we look at history, neither the Democratic nor the Republican Administrations have in the past recovered from a similar unempolyment spike at an average rate better than 0.06% per month. Therefore, what is required is a collective change to historically untried policies rather than a change in personalities.

The problem then is if Dimon cannot solve this unemployment problem (and he won’t if he does not do something radical), who are the Democrats going to blame next?

 

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Disclosure: I’m a capitalist too, and my musings & opinions on this blog are for informational/educational purposes and part of my efforts to learn from the mistakes of other people. Hope you do, too. These musings are not to be taken as financial advise, and are based on data that is assumed to be correct. Therefore, my opinions are subject to change without notice. This blog is not intended to either negate or advocate any persons, entity, product, services or political position.

Contact: Ben Solomon, Managing Principal, QuantumRisk

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WSJ’s article Fed’s Tarullo Shakes Up Bank Rules states that: A regulatory clampdown could worsen the credit crunch or hurt the economy by excessively restraining Wall Street innovation.

Sorry I don’t buy that. The Wall St. crash of 2008 just blew away that argument. In my opinion subprime was not an ‘innovation’ we needed. Credit card rates at 30+% was not an ‘innovation’ we needed. And there are many more examples you can write down.

What was lacking was not the ability to innovate, but the willingness to innovate in areas where profits are sustainable.  For example, new technologies, new processes, new research, things that need real people to work on. Therefore to ensure that our financial services firms focus on economically sustainable endeavors we need regulations.

If you really believe that regulation will  hurt the economy by excessively restraining Wall Street innovation then look at Goldman Sachs. Their Tier-1 capital is now at 14.5% or about $1 for every $6 of assets . That is a serious amount of risk capital and they are not waiting for regulation, they have moved ahead of the regulators. So what is it they know, you and I don’t?

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Disclosure: I’m a capitalist too, and my musings & opinions on this blog are for informational/educational purposes and part of my efforts to learn from the mistakes of other people. Hope you do, too. These musings are not to be taken as financial advise, and are based on data that is assumed to be correct. Therefore, my opinions are subject to change without notice. This blog is not intended to either negate or advocate any persons, entity, product, services or political position.
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The Department of Labor statistics shows that the long term (1970-2008) annual unemployment is about 6.1%. Not good. 

USEconomicStatistics

Figure 1: Annual Unemployment & Annual GDP Growth. 

 

When Will Unemployment Return To Normal?
Using 6.1% as a bench mark this data show that the unemployment recovery rate after a peak, averages at 0.06%/month. From a May 2009 of 9.4% unemployment, it will take until November 2013 for unemployment to come down to 6.1%. Today’s (10/02/09) news Jobless Report Is Worse Than Expected; Rate Rises to 9.8% or 15.1 million jobless, suggest that it is more likely to be June 2014. Not good. Definitely not good.

 

What Does This Mean?
The US economy is 70% dependent on consumer spending, so we can expect GDP growth to much lower when this recession is over. The recession is expected to be over possibly this quarter 4Q 2009 or next quarter 1Q 2010. Then the “real” economic growth i.e. the job growth (job growth is what really counts) becomes the main driver and indicator of this economy. Without the job growths, mortgages are hampered, and banks, are constrained  and . . .

 

How Can Your Company Help?
1. Don’t downsize your jobs: Downsize your pay & benefits (temporarily) starting from the top.

2. Pay down your debt: This helps banks with their recovery.

3. Don’t ship jobs overseas: This is probably the single most important lesson from history. Jobs follow markets and markets follow jobs. Of course there are some jobs where the domestic-foreign pay diffference is so great that companies have no choice but to out-source overseas.

4. Invest, invest, invest: Good investments lead to better run companies. A good approach to becoming competitive with overseas costs is to invest in technology or capex that substantially increases productivity.

 

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Disclosure: I’m a capitalist too, and my musings & opinions on this blog are for informational/educational purposes and part of my efforts to learn from the mistakes of other people. Hope you do, too. These musings are not to be taken as financial advise, and are based on data that is assumed to be correct. Therefore, my opinions are subject to change without notice. This blog is not intended to either negate or advocate any persons, entity, product, services or political position.
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Well done Emanual Derman. At last someone is asking the right questions. I broke EMH, Portfolio Risk/Diversification and CAPM in my1995 University College Dublin 500-page Master’s thesis. I showed that,
1. Markets are only as efficient as the data reported.
2. Portfolios do not fully diversify away unsystematic risk.
3. CAPM is only valid within a 90-day range.

I published my thesis in 2002 as a 278-page book, titled “A Rational Approach to Unsystematic Risk, Re-Thinking Modern Finance” . You can still purchase it from http://www.quantumrisk.com/books.html while stocks lasts.

I too had a quick look at Andrew Lo’s AMH. It could be a good approach. However, being an engineer by training, I’m not keen to rush into more theory. In 1995 I had proposed how we could measure market efficiency (see table below). While I am not a whole hearted fan of EMH, I believe we should use metrics to measure market efficiency to monitor and improve markets. My 1995 results suggest that market volatility plays a part in market efficiency.

Stock Exchange Index Prob. of
Weak Form
Prob. of
Strong Form
Bangkok SET Index 100.00% 81.59%
Frankfurt DAX 87.29% 77.42%
Gold Gold Spot 100.00% 94.18%
Hong Kong Hang Seng 100.00% 90.49%
Kuala Lumpur Composite 83.40% 76.09%
Kuala Lumpur Emas 81.46% 66.15%
London FTSE 81.33% 71.33%
New York Dow Jones 84.13% 59.05%
New York S&P 500 84.20% 80.68%
Singapore All Share 76.26% 74.83%
Sydney All Share 100.00% 98.87%
Tokyo Nikkei 82.64% 76.79%

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Disclosure: I’m a capitalist too, and my musings & opinions on this blog are for informational/educational purposes and part of my efforts to learn from the mistakes of other people. Hope you do, too. These musings are not to be taken as financial advise, and are based on data that is assumed to be correct. Therefore, my opinions are subject to change without notice. This blog is not intended to either negate or advocate any persons, entity, product, services or political position.
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Your Business Model in 1-Hour! In 1-hr you will definitely learn to quickly fix your strategy problems. Register here for Aug 17, 18 & 19 2009. This is critical  knowledge in a recession. 2 presentation slides are shown below.
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Feedback of previous related seminars:
1. Great, very informative (DM),
2. Very well thought out, effective and practical (RS)

Premium Webinar: Your Business Model in 1-Hour!

Benefit: You will immediately learn,
1. If your business model works.
2. How to recognize useful industry metrics.
3. Determine what strategies work for your company.
4. Take away some strategy maps / frameworks.   .   .   .   .   .   .    Register here.

This is a practical short course on how to recognize the real strategies your business needs and how to recognize the industry metrics for you to stay on track. It demystifies the role of financial statements and gets you back on track with real industry data to manage your strategy. This seminar concludes with a set of quick checks for your business model.

 

Who Should Attend: CxOs, Corporate Managers, Consultants & Investors.

About Benjamin T Solomon: Managing Principal of QuantumRisk LLC, he has 28+ years working in multinational, national and regional companies (Texas Instruments, West Port, Capmark, Coopers & Lybrand …) developing IT systems, streamlining business processes, designing and implementing strategies, and extensive econometric & economic capital modeling in the CMBS/RMBS industry.

Registration: This will be a 1 hour webinar limited to 20 participants per session. Register here.

Dates: August 17, 18 & 19, 2009.

Notes:
1. You will be emailed a meeting key to join, and webinar link.
2. You will be provided a pdf copy of the slides, 7 days after the seminar.
3. Last Refund Date: No refunds after Aug 14 2009.
4. Refund Policy, here.

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2 Presentation Slides:

Slide32

An Example of a Process Framework

 

Slide33

An Example of a Format Framework

The Opportunity:
What would you pay to know the Black Swan of your CMBS deal risk?

Reverse that question!

What would a deal manager pay you to know the Black Swan of his CMBS deal?

The Need:
Inspite the bad publicity surrounding CDOs and structured finance the tranche strucutre is one of the most efficient methods of creating differentiated classes of assets, as The Committee on the Global Financial System explains:

A key goal of the tranching process is to create at least one class of securities whose rating is higher than the average rating of the underlying collateral pool or to create rated securities from a pool of unrated assets. This is accomplished through the use of credit support (enhancement), such as prioritisation of payments to the different tranches.

However, what really caused the market to substatially undervalue these assets was that the default rate and the severity of the loss was much greater than even the complex rating processes had estimated them to be.  Have you noticed that some (many?) of the AAA tranches had losses?

The Solution:
The answer is an econometric assessment of the default and loss distributions of CMBS assets. Note, not a single point value but the whole distribution. This distribution will provide the CMBS Deal’s 95% or 98% VaR and CVaR loss estimates.

From this distribution we can then recalculate the loss estimates for each tranche, and be pretty certain what the loss characteristics of these tranches are independently of the ratings assigned to the tranches. A backup second opinion, if you would.

Why would this provide better answers?
1. We know the assigned ratings did not cut it.
2. We know the vintage or triangular matrix method provided incorrect default and loss curves. I was the first & only person to correctly identify that a major tool, vinatges/triangular matrix method, used in the mortgage idustry was providing incorrect results. The link provides access to an Excel worksheet that allows you to confirm this for yourself. To understand the magnitude of this finding one only need to look at the vast array of mortgage analyses, from the Esaki-Snyder reports to the Wachovia 2008 CMBS Loss Study, that use this tool.
3. The DSCR loss model used in the CMBS industry does not match the historical data. I discovered this weakness in the method through extensive testing against the historical data. Do you know of anyone who has personally tested these tool against the historical data?

What would the solution look like?

The graph below is a simulated long term VaR & CVaR loss outcome for a simulated CMBS deal.

CMBSPartnership

This graph is based on a set of CMBS loss & default distributions, and provides a second method to evaluating bond pricing. After all at the end of the day, isn’t cashflow analysis and DSCR’s about bond pricing? Notice how VaR (green dash) consistently underestimates CVaR (purple dash). We can add in Black Swans into this report. Note that my initial assessement was that CMBS Black Swans are on the order of 20% to 80%.

Partnership:
I am seeking partnerships with banks/investment funds/ratings companies to fund the development of this econometric CMBS business, which I expect to be transferrable to the RMBS sub-industry.

Call me 303-618-2800 or email me at benjamin . t . solomon AT QuantumRisk . com if you are interested in this business.

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Disclosure: I’m a capitalist too, and my musings & opinions on this blog are for informational/educational purposes and part of my efforts to learn from the mistakes of other people. Hope you do, too. These musings are not to be taken as financial advise, and are based on data that is assumed to be correct. Therefore, my opinions are subject to change without notice. This blog is not intended to either negate or advocate any persons, entity, product, services or political position.
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Is Your Business Model Sustainable? In 1-hr you will definitely learn to quickly fix your strategy problems. Register at Events.
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I had a very successful webinar series Strategy In A Recession? in July. 

Feedback for this webinar:
1. Great, very informative (DM),
2. Very well thought out, effective and practical (RS), &
3. Interesting ideas about strategy (JH)

August Premium Webinar:
I will be conducting another premium webinar Is Your Business Model Sustainable?

Benefit: 
You will learn,
1. How to determine if your business model is sustainable.
2. How to determine useful industry metrics.
3. Determine what business forces / strategies work for your company.
4. Take away some strategy maps / frameworks.

This is a practical short course on how to recognize the real strategies your business needs and how to determine the industry metrics required to keep on track. It demystifies the role of financial statements and gets you back on track with real industry data that should be used to manage strategy. This seminar concludes with a set of easy checks that enable you to determine if you should need to change your business model.

Who Should Attend:
CxOs, Corporate Managers, Consultants & Investors.

About Benjamin T Solomon: Managing Principal of QuantumRisk LLC, he has 28+ years working in multinational, national and regional companies (Texas Instruments, West Port, Capmark, Coopers & Lybrand …) developing IT systems, streamlining business processes, designing and implementing strategies, and extensive econometric & economic capital modeling in the CMBS/RMBS industry.

 Schedule & Payments:
This will be a 1+ hour (>30 slides) $97 fee based webinar limited to 20+ participants per session. Schedule and payments here.

Dates:
August 17, 18 & 19, 2009. 

Notes:
1.You will be emailed a meeting key to join, and webinar link.
2. You will be provided a pdf copy of the slides, Aug 18.
3. Last Refund Date: No refunds after Aug 14 2009.
5. Refund Policy, here.

 

Ben Solomon

P.S. I changed the title of the webinar from Determining the Status of Your Company to Is Your Business Model Sustainable? after I received feedback that the subject was a lot more interesting than the previous title had implied.

If you remove the 5 worst cases, the top 100 TARP recipients data shows several inference quite clearly,

(1) TARP funding was allocated in a practical manner. Companies with larger assets were given more TARP. The graphical analysis shows that on average 2.69 cents of TARP was distributed for every $1 of bank assets.

TARP(1)

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(2)  There is no descernable relationship between Equity/Asset ratio (risk recognition) and Asset size. That means the Equity/Asset ratio must have been driven by some internal measure of risk or at least the perception of this risk. The large spread in the Equity/Asset ratio (4% to 17%) reflects a large variation in the banks’ opinion of the quality of the assets they had. 

TARP(4)

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(3) The negative slope shows that less TARP was given to banks that were better capitalized (absolute capital ratio) than to banks that were not. Also a desirable policy. The effect of the allocation scheme was to get the average bank risk capital up to 12.10%. This a huge jump from 4% of Tier 1.

TARP(2)

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(4) The positive slope shows that the more TARP a bank received as a proportion of its equity, the more TARP it recieved as a proportion of its assets. Remember that this is normalized data. That is the less risk capital (greater TARP/Equity) a bank had the greater the bank’s actual asset risk (TARP/Assets) or the poorer the quality of the assets. Or the greater the risk the less likely a bank would recognize its own risk.

TARP(3)

Why should this be the case, when all banks were supposedly similarly affected by the mortage mess? Apparently not. Some banks had more risky assets than others. In otherwords some banks were undercapitalized for the risk they were taking, and were not facing up to these risk. Note, this is an industry-wide behavior, as these inferences are based on the top 100 TARP recipients.

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There are two lessons here:

(1) It is surprising to find that professional bankers are more likely to underestimate their asset risk, the more risky the assets become.

(2) Regulatory capital allocation cannot be linear. It needs to be a non-linear scheme. That is the first x% of risk requires $y of risk capital. The second x% of risk requires $2y of risk capital, and the third x% requires $4y, etc.

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Disclosure: I’m a capitalist too, and my musings & opinions on this blog are for informational/educational purposes and part of my efforts to learn from the mistakes of other people. Hope you do, too. These musings are not to be taken as financial advise, and are based on data that is assumed to be correct. Therefore, my opinions are subject to change without notice. This blog is not intended to either negate or advocate any persons, entity, product, services or political position.
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