Low-hanging fruit in the oil patch…

Low-hanging fruit in the oil patch…

This story is about oil drilling components.

More than that, however, it’s about how energy companies are trimming the fat in some of the most basic ways possible – by standardising subsea drilling components, engineering contracts, even light bulbs. It’s at once an indictment of the oil industry, and the amount of fat that still has left to be trimmed after a period of excess, and an illustration of the degree to which technological revolution beyond shale drilling is now bringing down costs – in some cases by as much as two thirds.

… While the specs for Norwegian Sea drilling might provoke reactions akin to the oil field’s name—the Snorre—such standardized pipes and casings could hold the key to a pervasive mystery about today’s energy market: Why is everyone still drilling when prices are in the basement?

Even as oil producers have planned $1 trillion worth of spending reductions between 2015-to-2020—cutting staff, delaying projects, and squeezing contractors—they’ve continued to green-light new wells from the Norwegian Sea to Brazil, and from Uganda to the Gulf of Mexico. Those initiatives mean oil production will continue to grow, adding to the supply glut and putting downward pressure on prices.

It’s a development that has both baffled and frustrated the world’s biggest producers of crude, who have been waiting for lower prices to force a rollback of global production. They have largely blamed the resilience of the world’s oil drilling on U.S. shale producers, as well as efforts to maintain market share, but the Snorre and other projects like it suggest there may be another–much more boring–culprit at fault …
Read the rest of ‘How Actual Nuts and Bolts Are Bringing Down Oil Prices’ over here.
The AAA bubble, deflated

The AAA bubble, deflated

Half a decade ago, I wrote a post with a rather eye-catching lede. “This, we think, could well be the most important chart in the world right now,” it said.

AAAratings
It went on to discuss the disappearance of triple-A rated securities in the aftermath of the U.S. housing bubble and trillions of dollars worth of downgraded mortgage-backed securities. The disappearance was short-lived, however. By 2009, highly-rated government debt had more than filled the hole left by increasingly scarce AAA-rated securitizations.

“The AAA bubble re-inflates and suddenly sovereign debt becomes the major force driving the world’s triple-A supply,” said the 2011 post, written when worries over the eurozone debt crisis were in full swing. “It’s one reason why the sovereign crisis is well and truly painful.”

Frances Coppola has a much more recent post that reminded me of this.

It features a chart from the rating agency Standard & Poor’s, which forecasts that triple-A rated sovereign debt will essentially become an endangered species by 2050 thanks to a rise in government borrowing.

sandp

Coppola makes a good point here. “It’s a great chart. But what it is really telling us is that S&P’s way of assessing the creditworthiness of sovereigns belongs to a bygone age. In the new world, junk is safe, debt is an asset and investors fear governments. So ratings will be meaningless in future, and ratings agencies, redundant,” she concludes.

That said, I do wonder about the need and ability of the financial industry to re-engineer ‘safe’ securities with top-tier credit ratings, given the degree to which such ratings are still (incredibly!) embedded in our financial system – from liquidity buffers to central bank asset purchase programmes. For this reason, I would dearly love to see an updated chart encompassing all fixed income.

Update: A few days after this post, Gary Gorton and Tyler Muir published a related BIS paper on collateral shortages. Check out the write-up here.

Peer-to-Fear

Peer-to-Fear

In January of this year I resurfaced some of my older reporting on the peer-to-peer, or marketplace, lending industry and wrote this line in the first article about Lending Club raising interest rates for the riskiest borrowers on its platform:

It’s worth recalling the words of some investors at the time who criticized LendingClub’s lofty $8.9 billion valuation—reached partly because of overwhelming enthusiasm for all things tech-related.  “These companies are really specialty finance companies, but look at where specialty finance companies trade in the public markets,” said one major marketplace lending investor at the time [of LendingClub’s late 2014 IPO].

It’s a point that, like much of my coverage, has been oft-repeated since – especially in the wake of recent news that Renaud Laplanche, LendingClub’s CEO, resigned following allegations of internal control issues and a rather sloppy ABS deal with Jefferies. My interest in marketplace lending has always been its overlap with traditional finance and the degree to which – as I’ve often written – the disruptive sector has been  co-opted by the very thing it sought to disrupt. In fact, one of the earliest enterprise pieces I wrote on the nascent industry, from January 2013, included the following gems:

“The one thing about peer-to-peer lending is it’s still a relatively manual process. This business needs a lot of scale to be profitable,” said a P2P analyst.

“In order to grow this business one must really have made relationships on the institutional side,” said a P2P CEO.

“On the surface it really almost comes across as too good to be true,” said a P2P institutional investor.

More than three years later and the pressures of scaling a ‘technology’ business that still relies on direct mail for advertising, and which derives much of its value from avoiding the legacy costs (including regulation) of traditional banks, seems to have come to a head viz LendingClub’s apparently lax internal controls, funding and securitization processes.

For those interested, here’s my more recent coverage of the industry’s travails.

When credit market concerns arrive at the marketplace lenders, January 2016 – Recall that the bear case for marketplace lenders was always a turning of the credit cycle that would either produce a rise in borrower defaults or result in a dearth of funding as skittish investors cut their lending on the platform. At the beginning of this year, credit markets spasmed,and LendingClub raised rates on lower-quality loans on its platform by about 67bps as it sought to better compensate nervous investors.

More trouble in bonds backed by peer-to-peer loans, March 2016 – A rating agency slapping a credit rating on a securitization only to downgrade it eight weeks later because of faster-than-expected-delinquencies seems … reminiscent of something.

A new class action suit wants to treat peer-to-peer lenders like mobsters, April 2016 – A scoop about a class action suit that strikes at the heart of the marketplace lending model and came on top of the already troublesome Madden vs Midland Funding decision, completed the ‘doomsday duo’ of funding concerns and regulatory scrutiny for the industry.

LendingClub is turning out to be anything but a direct lender, May 2016 – The resignation of Laplanche sent LendingClub shares plunging and, more significantly, exposed one of the biggest oddities at the center of the company’s business model. While promising to democratize finance by using new technology to directly match borrowers with lenders, LendingClub has turned to a complicated network of middlemen and professional investors to fund its rapid expansion and disintermediate traditional banks.

And the latest edition of our Odd Lots podcast, which sums up some of my thoughts on the matter:

Welcome to the Age of Asset Management

Welcome to the Age of Asset Management

This was a wide-ranging discussion that I was fortunate enough to moderate at the most recent Milken conference.

I’m told that this post on cross-border deleveraging, combined with some previous work on asset managers, was the inspiration for it. In any case it was a pleasure to discuss everything from capital controls to passive investing and, of course, market liquidity with David HuntJim McCaughanHilda Ochoa-BrillembourgRonald O’Hanley, and Nouriel Roubini.

Related link:
It’s the cross-border deleveraging, stupid! – Bloomberg

It SIVs! It SIVs!

It SIVs! It SIVs!

These are the kind of stories I love to write. The creators of the first structured investment vehicle (SIV), a type of shadow bank that eventually went on to wreak havoc during the financial crisis, are staging a comeback with a plain old vanilla bank.

I’m sad to say though, that First Global Trust Bank does not have the same mythological ring to it as Gordion Knot.

Per the Bloomberg story:

Nicholas Sossidis and Stephen Partridge-Hicks, the bankers who created the model for structured investment vehicles that later collapsed during the global financial crisis, are back.

Sossidis and Partridge-Hicks own First Global Trust Bank Plc, a London-based firm that was authorized to provide banking services a month ago after a three-year approval process, U.K. Companies House and Financial Conduct Authority records show. The new lender is funded by Gordian Knot Ltd., their firm that once managed billions of dollars through a SIV until that vehicle’s 2008 collapse, the documents show.

“FGTB is a simple, narrow wholesale bank,” the lender’s website says. “We will only accept deposits or investments from professional, wholesale investors. Our business model doesn’t cater for retail deposits or current accounts….”

Read the whole thing here.

Allen Stanford, revisited

Allen Stanford, revisited

One of my favourite financial scandals of recent years was the $17 billion ponzi run by Sir Allen Stanford, a knighted Texan who had previously achieved some notoriety for attempting to export an altered game of cricket to the U.S. and who ran the 20/20 tournament in Antigua.

I got a chance to revisit the topic on the latest edition of the Odd Lots podcast, when we interviewed Alex Dalmady – the independent financial analyst who helped blow the whistle on Stanford by publishing a now famous ‘Duck Tales’ note on Stanford International Bank.

Have a listen below, and steep yourself in some post-financial crisis nostalgia with the below FT clipping.

twenty1

Bad time to be a bank

Bad time to be a bank

Bank stocks have plunged in the new year, surprising a number of analysts and investors who had hoped that the long-awaited rate rise by the Federal Reserve would (finally!) help boost financials’ collective profit margins. Instead, the market seems squarely focused on the turning of the credit cycle and the idea of losses yet to come.*

On that note, I think it’s worth reiterating where the froth on bank balance sheets lies.

I’m willing to bet it’s about to get interesting to be a banking reporter again.

Fierce battle for corporate loans sparks US bank risk concerns (May 2013, Financial Times) – US banks were sharply increasing loans to big and small businesses in the aftermath of the financial crisis. In itself, the move to more business lending was not necessarily a bad development for the wider economy, or for the banking system. But the worry, as ever, was that intense competition to extend more commercial loans combined with a desperate need to boost return on equity, could spur banks to offer money at dangerously low rates and on far too loose terms.

Regulators on alert as US banks boost commercial loans (May 2013, Financial Times) – Companion piece to the above. This part proved rather ironic in the wake of collapsing oil prices: “Dick Evans, the chief executive of Texas-based Frost Bank, remembers the recession that hit the Lone Star state in the 1980s: banks that had been lending to booming energy groups suffered when the price of crude collapsed. Then, he says, it was real estate lending that banks turned to in an effort to replace some of their lost returns from commercial lending. Three decades on, that history may be reversing across the US [as banks trade real estate lending for commercial loans].”

Wall Street trades home mortgages for corporate credit – (July 2014, Financial Times) – Home mortgage lending stagnated as banks and other lenders grappled with new rules and the continued fallout from the biggest housing crash in US history. At the same time, lending to many American companies surged, helping shift Wall Street’s once-dormant securitisation machine into gear, while the market for corporate bonds also boomed (with much of that money flowing into the energy sector). Where once the origination and bundling of home loans was big business, corporate credit has for the past few years been the thing keeping banks and other financial institutions busy.

Commercial credit is the new mortgage credit – (September 2015, Bloomberg) – Key sentence: “Whether the surging popularity of commercial credit in all its forms results in the same kind of bust that overtook the housing bond market remains to be seen. Plenty of analysts, investors and regulators have certainly expressed concerns about an asset class that is being chased by so many yield-hungry investors, and pitched by so many profit-hungry financial institutions.”

All that commercial lending by banks suddenly isn’t looking so hot – (January 2016, Bloomberg)  – Written a day or two before the beginning of bank earnings season, this post pointed out that financial institutions; commercial and industrial (C&I) loan portfolios were showing signs of cracking. Sure enough, the fourth-quarter earnings season yielded a bunch of big-name banks setting aside more loan loss provisions to cover soured energy loans, which fall into the C&I classification.

*And I haven’t even mentioned the impact of negative rates, which wreak havoc on the business model.

The oil bubble?

The oil bubble?

There are perhaps, two hallmarks of an asset price bubble. Both happen after the fact, or as the bubble is bursting. Actually, one could easily argue that bubbles only ever materialize after they burst; only then is the bubble that inflated under everyone’s eyes transformed into something other than a really “good bull run.”

Back to the hallmarks. The first is that the majority must agree it was a bubble. The second is public outrage and regulatory actions that arise as unsound business practices built on flimsy assumptions begin to unravel (think, for instance, of the collapse of Bernie Madoff’s ponzi scheme in the aftermath of the 2008 financial crisis).

Neither of those has materialized just yet when it comes to the energy sector, but it feels like they are getting closer.

To wit, the subtle change in the narrative regarding oil prices – not from how much further they will fall but to why did they get so darn high in the first place?

Read More Read More

Ding dong, the DVA is dead

Ding dong, the DVA is dead

Debt valuation adjustments, otherwise known as the bane of every bank reporter, analyst and investor relations’ team existence, are finally being phased out.

I don’t have much new to add so here, other than I wonder whether we’ll see any impact from the withdrawal of fake and flimsy – but countercyclical – capital).

In the meantime, and in memorium, here’s an old thing from 2012 that I wrote on the subject.

Banks face profits hit as fog descends

It’s the attack of the accounting quirk.

One day into bank earnings season on Wall Street and we have already seen the dreaded “debt valuation adjustment”, or DVA, wallop JPMorgan , knocking $211m off the supersized bank’s $5.7bn of third-quarter profits.

DVA is the flipside of the recent rally in bank debt. While investors have been clamouring for the extra yield on offer from banks’ bonds, pushing up prices, they are now experiencing the counter-factual of narrowing bank debt spreads.

That’s because the accounting option known as DVA effectively gives banks the ability to book profits when the value of their bonds decreases, but also requires them to record losses if the value of their debt increases.

The motivation behind the option, the US accounting standards board says, was “to reduce both complexity in accounting for financial instruments and the volatility in earnings caused by measuring related assets and liabilities differently”.

The ultimate effect of the standard, issued in 2007, was the exact opposite. When the value of banks’ own bonds fell precipitously during the financial crisis, banks used the accounting option to record significant profits. Lehman Brothers, for instance, posted a more than $1bn DVA gain just days before it filed for bankruptcy.

In early 2009, when banks were publishing results from the dark days of the 2008 fourth-quarter, DVA reached new heights of absurdity as financials, en masse, reported stellar profits based on the plummeting value of their bonds. Between 2007 and the first quarter of 2009, US banks posted DVA that averaged 10-20 per cent of their pre-tax earnings, but reached as much as 200 per cent, according to research by specialists at UBS.

When the value of their bonds recovered in later years, they were compelled to post losses. Now, with the price of the bonds having surged in recent months, the accounting quirk is about to eat into banks’ third-quarter results once again.

It’s an impressively counter-cyclical accounting standard, but one that does nothing to shine a light on the already impenetrable thicket that is bank earnings.

There is an added complexity in that some banks have not been content with the weird and wacky world of DVA. To help hedge – or offset – the profit and loss swings caused by the value of their own debt, some have taken to selling credit protection on correlating banks. In late 2008, for example, some banks were said to have sold protection on Lehman as a hedge against their own DVA gains.

This creates another baffling dynamic; banks may record losses as the value of their own bonds increases, but not to the extent that they have hedged that loss and profited from the rising value of credit protection written on other banks…

More here, here, here and here.