Thursday, September 25, 2008

Barclays Mops Up Lehman Brother’s Business In North America

Barclays, the major Global Financial Services Provider Company, took over bankrupt Lehman’s business in North America. More than 10,000 employees of Lehman Brothers, engaged in different capacity will now be employed in the amalgamated company of Barclays & Lehman. The Court of Bankruptcy, having given green signal to the takeover, Lehman’s North American business comprising of Fixed Income, Equity Sales, Selling & Distribution, Research, Investment Banking etc, will now run in full swing. In a statement, Barclays stated that though the amalgamated business will now run in the name of “ Barclays Capital”, but since Barclays has already purchased the goodwill name of Lehman, it can use that name as & when it deems fit.

Contributed By:
Prof. Jayanta Mitra
(Globsyn Business School)

Tuesday, September 23, 2008

The AIG Incident: WHY??

Given the crisis on Wall Street and the focus on American International Group Inc., one of the world's largest insurers, everybody is suddenly talking about counterparty risk.

What is counterparty risk, and why is it now an issue?

In the simplest terms, counterparty risk is the chance that the person on the other side of a deal - the counterparty - won't be there when it's time to pay up. Take an example most people can relate to: Selling a home. There's always the chance that when it comes time to close the deal a month or so down the road, the buyer won't show up or won't have the money.

In financial markets, traders and banks are constantly thinking about counterparty risk. When they make a deal to buy or sell, they often look at the credit rating of the party on the other side of the transaction. If the credit rating is high, they will go ahead with the deal. If the credit rating isn't so hot, they might ask for additional guarantees or collateral. Or maybe they won't do business with the counterparty at all, which is what happened to Lehman Brothers and Bear Stearns in their last days.

How does that relate to what's happening at AIG?
As an insurer, AIG expanded into the business of selling insurance against bond defaults, probably figuring it wasn't that much different than underwriting life or home insurance. AIG provided the insurance through derivative contracts known as credit default swaps. The problem for AIG is that it looks as if there could be a lot of claims at once because of a wave of defaults on mortgages and also by companies such as Lehman Brothers, Fannie Mae and Freddie Mac. By some estimates, the firm could face losses of $25-billion (U.S.) on the swaps.

How does a credit default swap work?

Credit default swap is like an insurance policy. In fact, it is an insurance policy. Suppose you own bonds issued by XYZ Corporation and you want to hedge against the possibility of a default. The credit default swap market has developed over the years to allow you to do that. You would enter into a contract with say an insurance company that would sell you a "policy" that would make you whole if XYZ defaulted. The contracts usually run for five years and you pay an annual premium for the coverage. AIG is a big insurance company and they issued a lot of these contracts. They allowed their customers to "swap" to them the risk of XYZ defaulting.

If XYZ's situation worsened, be it real or imagined, a new credit default swap would cost more to enter into and the value of the existing one would change. The issuing company has to mark the value of the existing contract to the current market and that is one of the reasons why AIG has taken such huge markdowns the past few quarters.

And these markdowns are just that, markdowns. If XYZ doesn't default during the life of the insurance policy, then the markdown will be marked back up. AIG has said that the economic risk they see is much smaller than the markdowns they have taken. That may be but I don't know they have any more insight into the fortunes of a GM, Lehman, Merrill or Washington Mutual than the rest of us ( I don't know if AIG has written contracts on these companies. Using them as examples only.) This was probably a poor business decision to enter this business. There really isn't a bad risk in the insurance business. There is bad pricing of that risk.

How did AIG end up in this situation?

The company worked through the weekend to raise capital by selling subsidiaries, but ended up rejecting bids from private equity firms and instead appealed to the U.S. government for a loan. The government said no and told AIG and the rest of Wall Street to seek a private sector solution. Banks such as Goldman Sachs Group Inc. have been asked by the U.S. Treasury to try to come up with as much as $75-billion to lend to AIG, but there are questions about the feasibility of that plan. That pushed the ball back into the U.S. government's court and it was seeking a solution last night.

Why would a failure at AIG potentially be more trouble than at Lehman?

For the world financial system, AIG is a powder keg because of its CDS contracts. Lehman was a big player in the market, but it was both a buyer and a seller, so its net exposure is relatively small as many contracts cancel one another out. AIG is primarily a seller of credit default swaps, meaning there are many players who are depending on AIG's ability to pay up on insurance policies

Contributed By:
Arjun Pal
(Knowledge Cell - Globsyn Business School)

Friday, September 19, 2008

Bank of America Takes Over Merrill Lynch

Bank Of America Corporation has agreed to acquire Merrill Lynch & Co. Inc for US $ 44 Billion in a deal, that will give the US Bank the world’s largest brokerage. Recently Merrill had been hit hard by the Credit Crisis & has written down more than US $40 Billion. Bank of America is paying US $ 29 a share price, 70 % premium to Merrill’s share price on 12.09.2008, although Merrill’s shares were trading at US$ 50 in May and over US$ 90 at the beginning of June2007.The deal had been approved in the last year by the Directors of both the Companies. Merrill Directors will join the Bank Of America Board. It is quite likely that after this Take Over, the Market Participants will gradually lose interest in other Investment Banks.

Contributed By:
Prof. Jayanta Mitra
(Globsyn Business School)

Tuesday, September 16, 2008

Lehman Brothers Bankrupt - End Of A 158 Years Old Company

US Investment Bank Lehman Brothers Holding Inc said that it plans to file for Chapter 11, i.e. Bankruptcy. But the Chapter 11 filing will not include its Broker –Dealer operations & other units, including Neuberger Berman. Recently, Lehman Brothers were facing utmost difficulties in tiding over situations relating to Mortgages & Asset Backed Securities of $ 46 Billion, Low Credit Rating, problems in raising Capital and last but not the least lack of Investors confidence. Lehman Brothers, which stood firm in the financial crisis of World Wars, succumbed to the Global Credit Crunch. European Share Prices are bound to go down following Lehman’s Bankruptcy. US Dollars went down 2.3 % to 105Yen, from 107.86 late on 12.09.2008. While the Euro dropped to 152.26 Yen from 153.43.To curb the situation that may arise from collapse of Lehman, the Federal Reserve launched a series of emergency measures on 14.09.2008 to calm down the trading discrepancies in the Financial Markets. Nearly 3000 Employees of Lehman Brothers in Asia, excluding the Indian Back office, are waiting anxiously & nervously to hear their fate. A Lehman executive, in Singapore, who did not want to disclose his identity, told Reuters over telephone “I guess we will have to wait for the marching orders.”

Contributed By:
Prof. Jayanta Mitra
(Globsyn Business School)

Monday, September 15, 2008

Emerging Real Estate Markets

Despite worldwide spiral inflationary trends and economic turmoil in the USA, emerging Real Estate Markets are experiencing growth like never before. On 2ND December 2008,Investors, Developers & Planners are invited to discuss the opportunities in emerging markets. Leading Experts in Real Estate Investments will speak at the “ Real Estate in Emerging Markets Forum”, on that day at the Harmonie Club in New York City. Real Estate Investment Experts predicts the following: -

  1. Emerging Economies account for 30% of World GDP & by 2015 they will account for 50%.
  2. Emerging Markets had a Current Account Surplus of more than US$600 Billion & total Foreign Exchange Reserves exceeding US$ 2.7 Trillion
  3. Young Professional Workforce, Rising Income & an expanding Middle Class is driving urbanization beyond the Traditional Metro Cities.
  4. China leads the way experiencing nearly 10% growth, India follows closely with about 8%, Russia about 7% and Brazil at 4%.
  5. It is anticipated that over the next decade, US$ 22Trillion will be spent on Infrastructure in the emerging markets, as accelerating urbanization creates demand for power, electricity, water & transport networks.

Contributed By:
Prof. Jayanta Mitra
(Globsyn Business School)

Wednesday, September 10, 2008

Retail Loans: The Major Concern for banking industry

Bankers anticipate a rise in bad loans, especially in the retail segment after the latest bout of interest-rate tightening. Senior bankers are bracing for higher delinquencies in the personal and consumer loan portfolio of banks besides credit cards, as the impact of higher interest rates start to bite. The burden of repayment is expected to hurt those who have taken small-ticket loans.

Recently, credit rating agency Crisil had warned of a rise in delinquencies in the retail portfolio of banks, with rising interest rates. Higher rates could lead to a slowdown in lending. It is too early to comment on whether interest rates have peaked and may taper off in the near term, rising interest rates will certainly impact the growth of the lending business, but may not impact the quality of credit. Credit is expected to grow by 15% this year, of which, retail loans are expected to rise only by 5-10%. However, corporate credit will continue to grow at a significant pace.

The Indian economy would grow at 7.5-8%, which is still quite robust compared with other countries. Not only this, such a growth rate is sustainable for Indian economy and there is an opportunity for this to rise further. The first lot of delinquencies may be felt in the unsecured loans portfolio, including credit cards, personal loans and consumer durable finance. It may be seen in mortgage loans and loans given to small-and-medium enterprises in the next phase.

The other issue worrying bankers now is the possibility of a single-borrower defaulting across multiple banks. Higher interest rates are causing individuals to borrow from several lenders at the same time and there is a high possibility of them defaulting too. The next 8-12 months may see this phenomenon rising, especially in the personal loan segment.

According to a recent report by credit rating major Crisil, the asset quality of retail loans extended by commercial banks in the country is set to deteriorate. The report said that bad loans, or non-performing assets (NPAs) in retail loans will rise to 4% of the total loans over the next two years, from 2.7% as of March 2007.

The increasing exposure to higher-risk customers is mainly through personal loans and credit card receivables, it has said. These are unsecured in nature and now form 17% of the total outstanding retail loans in March 2007, up from 6% in 2004. Housing loans constitute over half of the total retail loans in India. Bad loans in home loan portfolio increased to 2.2% of the total loans in March 2007, from 1.8% in 2005. These are expected to increase to 2.7% in the financial year 2008-09.

Car and commercial vehicle asset segments comprise one-third of the total retail loans. Crisil estimates that gross NPAs in these segments have increased to 2.3% and 4%, respectively, as of March 2007, from 0.9% and 3.2%, respectively, in 2005. In 2008-09, these numbers are seen at 3% for car loans and 5.5% for commercial vehicles. The slowdown in recovery efforts, following the controversy over recovery methods of some players, resulted in a sharp spike in delinquencies during September-October 2007.

Contributed By:
Arjun Pal
(Knowledge Cell - Globsyn Business School)