Misc

07/14/09 - News Bits 15 Minute Reading

By: Jeremy Carpenter, MBA

We like to try new things here at Investor Solutions, so we are testing out a new article idea. It will give a brief summary of some of the more informative news stories of the last month that may have fallen through the cracks or just not come to most people’s attention because they don’t get the financial news channels’ hype. So, please give us your feedback and tell us whether or not you liked the idea and enjoyed the read.

Is an increase or extension in the home-buyer tax credit on the horizon? Currently, the Congress-approved tax credit for first-time home buyers sits at 10% up to a maximum of $8,000. Many are worried about the minimal effect this could be having on the industry. In fact, the Wall Street Journal has reported a new push in Washington for Congress to boost and extend the home-buyer tax credit. The current credit, which expires December 1, 2009 is thought to be too small to make an impact or spark the housing market. The Wall Street Journal has said the new push is for an increase back to the originally proposed $15,000 credit and to extend it to all home buyers.

The House of Representatives and the Senate voted in favor of a bill allowing the FDIC to borrow up to $100 billion from the Treasury Department while extending their deposit-insurance limit of $250,000 through 2013. At the end of 2009 it would have decreased back to the previous $100,000 limit. The move boosts the FDIC’s shrinking deposit-insurance fund, which has been depleted after 25 bank failures in 2008 and 45 so far in 2009. The bill also makes it easier for borrowers to participate in federal foreclosure-prevention programs and gives the government more powers to investigate how the Treasury and Fed use TARP funds.

Proving that the more you try to change things the more they stay the same, Wall Street, which burned thousands of investors with structured products that were supposed to provide healthy profits and limit losses, are pushing these high-fee products again with safety as the big selling point according to The Wall Street Journal. A structured product, as defined by Wikipedia, is usually a pre-packaged investment strategy based on derivatives. A feature of some structured products is a principal guarantee function which offers protection of principal if held to maturity. An example would be if you made a $100 dollar investment in a structured product. The issuer invests $80 in a bond that will mature to $100 in a given period. They put the rest of the money in an option or future or other derivative that satisfies the investment strategy. The risk for the “principal protected” product, that came to fruition, is that these products are not FDIC insured. They are only insured by the issuer, so a liquidity crisis or solvency issues would cause these products to lose their principal. Other products tend to have risks similar to those with options. Don’t be fooled by these gimmicks or the salespeople pushing them. Make sure you know exactly what you’re buying before you fork over your cash, or better yet, stick with the tried and true approach of long-term investing with index funds.

The Dow announced updates to its industrial index. The changes: Travelers (TRV) replaced Citigroup (C) and Cisco (CSCO) replaced General Motors (GM). Three companies left the Dow last year, AIG, Altria Group Inc. and Honeywell International Inc. and Kraft, Bank of America and Chevron Corp. were included. Those changes were the first since 2004.

According to Briefing.com, FBR Capital released a research report this past month regarding the deposit funding cost component of net interest income and its effect on bank earnings. Their analysis suggests that due to relatively low interest rates on bank deposits (and high associated costs) compared to rates on bank loans, there is a potential for the banking system to realize between $40 billion and $135 billion of net interest income. This represents a potential increase in spread revenue of 12% to 38% from current levels. They say that when the Fed begins tightening, because of economic improvement or to battle inflation, they expect significant margin expansion.

As defined by Wikipedia, net interest income (NII) is the difference between revenues earned on assets and the cost of servicing liabilities. All firms can divide the balance sheet into assets and liabilities. For banks, the assets are commercial and personal loans, mortgages, construction loans and securities. The liabilities are deposits from customers. In other words, the NII is the difference between the interest payments to the bank on loans and the interest payments by the bank to the customers on the deposits.

[NII = Interest payments on assets - Interest payments on liabilities]

The first financial companies took their turn, this month, repaying the TARP money they received from the government. USB redeemed the $6.6 billion worth of preferred stock it issued to the Treasury and intends to repurchase the 10-year warrant it gave the government under the same plan. BB&T will repay $3.1 billion to exit the TARP program. They will buy back all the preferred stock issued to the Treasury plus a dividend payment. Morgan Stanley confirmed that it paid back the $10 billion it received from the Treasury. JP Morgan repaid its $25 billion loan. Goldman Sachs bought back its preferred stock of $10 billion plus a one-time interest payment of $425 million. Bank of New York repurchased the 3 million shares of preferred stock it issued to the government. The liquidation value plus dividend payment resulted in roughly a $3.036 billion payment. BNY also intends to buy back, at market value, the warrant the Treasury holds allowing them to purchase 14.5 million shares of common stock in the company. American Express completed their repurchase of preferred shares for $3.39 billion. They are looking to repurchase warrants for 24.3 million shares of common stock as well. Northern Trust repaid its obligation of $1.576 billion back to the Treasury. They intend to buy back warrants issued for a little more than 3.8 million shares of common stock. Capital One bought back $3.57 billion worth of preferred stock. State Street repaid $2 billion in TARP funds, their full amount. They intend to repurchase the warrants they issued the government as well.

The government plans to unload these warrants rather quickly realizing that they have no place speculating on the future value of the financial companies. They want to leave the industry as quickly as possible and let it return to some state of normalcy. Banks will have 15 days after repurchasing all other government stakes in the company (i.e. preferred shares) to propose a fair market value for the warrants. Of the aforementioned 10 companies above, those who still have warrants to repurchase, the 15 day expiration will come after July 3rd. If government officials don’t agree with the proposed value, independent appraisers will help set a price. For banks who don’t want to estimate the value of the warrants, the Treasury will hire a firm to run an auction. The banks and anyone else will have a chance to buy them during this process.

On the downside, these repayments mean that the financial companies never did what they were supposed to do by receiving the TARP, which was meant to loosen up the credit markets and spur lending and in turn corporate and consumer spending. You can blame any number of people for messing that up, but in the end the firms thought the governments terms were too steep and didn’t want any part of the program. The good news is that the financial firms, and many other corporations in fact, were able to raise the money from the debt and equity markets. This is what the system is there for, so it’s a good indicator that the capital markets are healthy at least; although, arguably over supplied. Healthy markets mean less government intervention, which is a major part of this road to recovery. It will allow the government to concentrate on fixing the budget deficits and money supply, something that seems to be more of a threat to this economy now.