(Bloomberg View) -- Bank earnings.
In the great rivalry between Deutsche Bank's John Cryan and Credit Suisse's Tidjane Thiam over who can be more miserable, Thiam ... I guess lost a round?
Credit Suisse Group AG unexpectedly returned to profit in the second quarter, with all operating units contributing to earnings, as Chief Executive Officer Tidjane Thiam eliminated hundreds of jobs and cut costs.
Net income was 170 million Swiss francs ($172 million), the Zurich-based bank said in a statement on Thursday. While that’s a 84 percent drop in the year, it’s a reversal from a 302 million-franc loss in the first quarter, with analysts having forecast a loss in the three months through June.
No, that counts as a win. The goal, if you are the gloomy CEO of a universal-ish European investment bank in 2016, is not really to spread misery. It is to make your bank focused and profitable again. ("Since taking over a year ago, Thiam, 53, has reorganized Credit Suisse to scale back securities trading and free up capital for expanding the wealth-management business, following an approach used by Swiss rival UBS Group AG. ") But gloom and job cuts are your chief weapons, and they seem to be working now for Thiam. (Deutsche Bank is similarly glum, but its profit was down 98 percent year-over-year.) "'We recognise it’s only two quarters in and it’s only a start but it’s a good start against a very unsupportive market backdrop,' Mr Thiam told analysts," which is a real change in tone from his previous comments that "the horrible end is better than horror without end." A good start is even better than a horrible end!
Elsewhere, "Strong growth from fixed income trading at France’s BNP Paribas has offset a drop in domestic retail banking revenues in the second quarter, helping it to beat analyst expectations with a slight increase in net profit." In gloomier news: "Lloyds to Cut 3,000 Jobs in Expense Push After Brexit Vote." But: "Bank CoCo Coupon Payments Made Safer Under ECB Capital Rules."
White-collar criminal enforcement is so weird:
Christy Goldsmith Romero, the special inspector general, said in an interview that bank fraud at all levels of the industry still needed to be addressed. “If you have a banker, who when times were tough, was willing to cook the books and commit a crime to do that — maybe for the first time in their life or maybe they’ve been committing a crime and they haven’t been caught — we do not want that person not only in banking, we don’t want them on the streets,” she said.
Why would that be true? What would they do on the streets? Come up to you in a dark alley and lie to you about loan-loss reserves? If you start from the perspective that the U.S. puts too many first-time nonviolent offenders in prison for too long, I'm not sure why imprisoning first-time book-cookers for years would be your priority.
But that's not actually the popular complaint about the Special Inspector General for the Troubled Asset Relief Program. The complaint is that Romero is only putting people in prison who committed crimes, while she should be putting people in prison who ran big banks:
“Yes, if you break the law, you commit fraud, you should go to jail,” said Edward Mills, a policy analyst at FBR Capital Markets. “But to the extent that the only folks who get in trouble are the smallest guys that you’ve generally never heard of, that doesn’t help the narrative.”
One straightforward explanation is that big banks have smart people and good lawyers and rigorous compliance programs that, while they don't keep them out of "trouble" per se, at least keep them from committing provable felonies at their highest levels of management. Like, even if Jamie Dimon came to work one day and said "hey let's cook some books," he'd probably have someone to talk him out of it, or at least tell him how to get a similar result through legal methods. At smaller banks, who knows. So Sigtarp, an office that more or less grew out of public outrage at big banks, ends up mostly prosecuting people at small banks. It doesn't help the narrative.
I say unto you that criminal law enforcement is not a good tool for systemic financial regulation, or for political legitimation, or to "help the narrative." It always ends in disappointment. (It is also a moral disaster to imprison people for the sake of a narrative! But no one cares about that.) If you set up an agency to go after big-time crooks, you will mostly catch small-time crooks, because most crooks are small-time crooks, particularly the catchable ones. And then people will be mad at you for not catching big-time crooks, and your protestations that the big-time guys aren't crooks will ring hollow.
Elsewhere: White collar crime ministry.
It's apparently difficult being a hedge fund manager these days:
"Surging enemies forming a seemingly impossible perimeter, a crush of fellow soldiers on the field, arrows coming in overhead, and the need to avoid panic and deftly use sword and shield to fight your way out of a seemingly impossible situation is a good analogy for the emotional experience of managing assets since last summer," Loeb and Third Point wrote in the firm's latest letter to investors.
The way you manage a hedge fund is, you sit at a computer and type and talk on the phone. Sometimes you go to meetings in conference rooms. There are no arrows coming in overhead. (The conference rooms have ceilings, and air conditioning.) Yes, every so often a hedge fund will capture a hostile naval vessel, but that is very much the exception. But, you know, it's an analogy.
In private equity, things are also tough, though just in a regular low-returns way, not in a form-a-perimeter-wall-with-the-corpses-of-your-fallen-comrades way:
Carlyle Group LP co-founders William Conway and David Rubenstein on Wednesday said that soaring stock markets and intense competition for deals will make it harder for private-equity firms to reap big profits on leveraged buyouts in the foreseeable future.
“Right now, it is tough to earn returns of 20% or more in the private-equity business,” Mr. Conway said on an earnings call Wednesday, referring to the returns historically achieved by the industry’s top-performing funds.
Elsewhere, here are some interesting claims about active management and skill:
I find that 90% of active equity funds are skilled, with 80% able to more than cover their fees. Skill is not scarce, it is pervasive within the industry.
I also produce other results that run contrary to conventional wisdom. The best funds, those that are skilled with low portfolio drag, charge higher fees and are attracting new fund flows.
Truly active equity funds outperform. In these studies, the level of fund activity is measured by tracking error (the higher the better), benchmark R-square (lower the better), active share (the higher the better), and portfolio weighting best idea stocks (the larger the better), among other measures.
These results raise the question of why simply being more active allows the fund to outperform. If managers lack skill, as is so widely believed, then simply taking more high-conviction positions, for example, will not generate better performance. So, it must be the case that many managers are skilled stock pickers.
Before the Securities and Exchange Commission approved IEX's application to become a stock exchange with a 350-microsecond "speed bump," one popular prediction was that if IEX was approved, markets would get more complicated. Not just -- not even primarily -- because IEX's speed bump itself makes things more complicated, but because IEX's complications would be imitated and amplified by its competitors, who are not self-consciously in the business of making markets simpler and safer for long-term institutional investors. As I put it:
The big problem in the IEX application is that IEX are nice, so a lot of people want the SEC to let them do some new weird market-structure things. But the SEC is a general regulator, and if it lets IEX do those things, it sort of has to let everyone. And not everyone is so nice.
Anyway now IEX has been approved and "Nasdaq Inc. is talking with its customers about adding a 'speed bump' to delay orders for one or more of its U.S. markets." Don't focus on the speed bump idea here; focus on this:
“We are talking to customers about what they want and what they would like to see with respect to evolving market structure,” said Greifeld in an interview following the company’s quarterly earnings call. “So a speed bump is clearly one of the things we’re talking to them about.”
Oversimplifying only slightly, everything complicated and controversial in U.S. equity market structure comes from exchanges talking to their customers about what they want. (Or from SEC regulation I guess.) You don't like co-location and dozens of complex order types and direct feeds that are faster than the official feed? Those are things that some of the exchanges' best customers -- electronic trading firms that trade a lot of volume -- wanted, and that exchanges gave them. Since the SEC approved IEX's speed bump (and its own new order type), the established exchanges have more variables to work with, and now they are seeing which variables the customers want tweaked. Though any tweaks do need to go back to the SEC for approval.
Elsewhere: "Vanderbilt study debunks 'phantom liquidity' problem caused by high-frequency traders."
Here's a story about Jasmine Loo Ai Swan, a lawyer at Malaysia's 1MDB investment fund who has been mentioned in the U.S. government's effort to seize allegedly misappropriated 1MDB assets. Allegedly, $5 million of the $6 billion that Goldman Sachs raised for 1MDB ended up in Loo's Swiss bank account. And of that:
About a year after Jasmine Loo left the fund, people familiar with the matter said in interviews, she sent a six-figure sum to an account of Goldman Sachs’s Tim Leissner, who was the lead banker on the 1MDB bond sales.
Leissner, who also isn’t accused of any crimes, resigned from Goldman after he was placed on administrative leave in January. Neither he nor his attorney have commented since then. The transfer from Loo was an investment in a start-up company that Leissner was backing with her, one of the people familiar with the matter has said.
Disclosure: I used to work at Goldman Sachs, but I cannot recall a client's lawyer ever wiring me hundreds of thousands of dollars after I worked on a bond deal. I cannot say that Goldman covered itself in glory on the 1MDB deals, though it did make a lot of money. ("About $590 million in fees and commissions from the three 1MDB bond sales -- as much as 11 percent of the deal value in one case.") I guess that usually is the tradeoff, money versus glory.
I'm sure I've said this before, but the Harvard Business Review might be my favorite magazine. Here is a paragraph about ceremonies that starts corporate-bland but stick with it, it gets pretty hot:
Organizations, too, rely on ceremonies to anticipate new beginnings, demarcate endings, and help everyone understand or navigate the changes at hand. Remember how Howard Schultz launched his renewed vision for Starbucks when he returned to the company as CEO in 2008? Starbucks was coping with the global economic crisis and experiencing a rapid decline in profits. So, to align company leaders, Schultz gathered 200 senior managers from around the world, sent them out to local retail shops to better understand the customer’s point of view, and then brought everyone back together. He had planned to read the company’s new mission statement aloud as a way of reinforcing its renewed focus. But after he read the first line, without cue, a vice president stood up and read the next, followed by another vice president, and another. It was a ceremony with power — they all, one by one, pledged their commitment.
Did you get goosebumps? It's like Dead Poets' Society, but with Starbucks vice presidents. The rest of the article is not half-bad either; there is a corporate drum circle.
People are worried about duration.
I don't really want this to be a recurring section but, I mean, it has recurred. Anyway:
Investors in Japan’s 40-year bond have lost 24 years of coupon income in just three weeks as the rush into long-dated safe government paper went into sharp reverse.
This "highlights something dangerous at work in today’s markets: the scale of the risks investors are willing to take as they try to avoid anything that depends on economic growth." But your "avoid anything that depends on economic growth" could be my "insure my exposure to economic growth"; here is my new Bloomberg View colleague Tyler Cowen on negative rates as insurance premium:
Maybe it’s time we started thinking of negative securities as the equivalent of fire or earthquake insurance for that wealth. If there is truly $300 trillion in global wealth, is it so crazy to think that investors would pay a premium to buy $10 trillion dollars’ worth of insurance?
Lots of trades that look weird in isolation make more sense as a hedge to other trades; perhaps buying long-duration low-or-negative-yielding bonds is one of them.
People are worried about non-GAAP accounting.
Here's sort of a frustrating study of non-GAAP accounting at the 50 biggest S&P 500 companies:
Thirty-two included numbers not prepared according to standard accounting practices in their January-quarter announcements. (Those standards, called Generally Accepted Accounting Principles, give the numbers structure and consistency.)
When companies reported non-GAAP earnings per share, those numbers were almost always higher than the GAAP figures. Only three of the companies we examined reported a non-GAAP EPS number lower than their GAAP number.
Well yes but what one wants to know is: Are those non-GAAP numbers useful? It's one thing if a company reports "earnings before items we don't like" just to get a higher number; it's another if a company reports "earnings before genuinely weird non-recurring items" to give its shareholders a better sense of what its future business prospects are like. You'd want to look at non-GAAP earnings over a long time period and, for instance, see if non-GAAP income in Quarter 1 better predicts GAAP income in Quarter 9 than Quarter 1 GAAP income does. (There is some evidence for this.) Companies give reasons for reporting non-GAAP income. Many people doubt those reasons, and think that the only real reason for reporting non-GAAP income is to trick shareholders into thinking that income is higher than it is. (Why would that work?) But that seems like a proposition one would want to test.
People are worried about unicorns.
And if you're worried about unicorns, one thing you can do is sell your unicorn stock:
Startup investors are hitting the exits even as companies keep delaying going public.
According to a new report from Nasdaq Private Market LLC, Nasdaq Inc.'s platform that allows helps companies facilitate shareholder liquidity, the number of preferred shares sold on its platform in the first half of 2016 was higher than ever before.
"Preferred stock is typically held by venture capitalists and other institutional investors," so these trades -- 45 percent of Nasdaq Private Market's volume -- are venture investors, not employees, cashing out before the initial public offering.
Much of this is due to the private companies on the platform growing older, said Bill Siegel, head of Nasdaq Private Market. The average age currently sits at nine years, up from eight in 2015, and Seigel expects that number to continue moving higher. The continued IPO delay means we should see even more selling of preferred stock.
Nine years! Yahoo went through its entire life cycle -- as a tech startup, a public tech giant, a public tech afterthought, and now a soon-to-be Verizon subsidiary -- in 22 years, 20 of them as a public company. It used to be that the IPO marked the start of a tech company's rapid growth phase; in a few years, it will mark the end.
Elsewhere, it is really easy to get a cheap mortgage if you work at Google or Facebook or Apple.
People are worried about bond market liquidity.
Here's "Best Execution in Fixed Income: A Work in Progress" (also here), which I'm going to count, because liquidity worrying has kind of ... dried up?
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