Tuesday, December 4, 2012
Financial planning: What it's not and what it is
Recently one of our staff member within the Efinity Mortgage team asked what we felt was a fairly brave question during a meeting involving cross-platform personal (Insurance - Financial Services - Mortgage Lending). In short, she asked what our Licensed Financial Professionals did and was there a difference between financial "Planning" and "Advising". The answer was of course was clearly yes; there is a difference however the explanations which followed were a bit less clear. We felt this would be an excellent talking point within our firm. We set out to obtain Efinity's own definition of not only both terms "financial planning" and "financial advising" but offer some additional color on the subject. We found a commentary piece which largely outlined what we were interested in sharing. So in giving credit where credit is due, the below commentary is thanks to a Ryan Fox and Tim Maurer found at eveningsun.com back on 10/14/2012.
Financial planning: What it's not and what it is
Two of the terms in the financial services industry that are so often misused are "financial planning" and "financial advising." What is the first thing that comes to your mind when I ask, "What is a financial planning/advising?" My guess is that 65 percent of people assume the term is synonymous with the sales or management of investments with a stock broker. The other 30 percent probably think that it is the pursuit of finding the right insurance policy or policies. It may be generous to assume that 5 percent of people have been painted an accurate picture of what true financial planning or advising really is.
One thing that makes accurate discernment so difficult regarding this terminology is that financial planning does, indeed, include investment planning and insurance planning. But if the advice stops there, it's not genuine financial planning. The primary reason that financial planning has been viewed in such a modular fashion is that the behemoth financial industry realized before financial planning even became a thing that couching product sales in the appearance of sound planning and advice was good business. But, at the end of the day, financial planning with a brokerage firm inevitably leads almost solely to the sale of brokerage products; with banks, banking products; and with insurance companies, insurance products. Below you'll find a glossary with more complete definitions of the fundamental tenets of true financial planning and advice; what it's NOT and what it IS:
Investment planning - Is NOT merely the sales of stocks, bonds and mutual funds; it IS determining how all of the assets in your life-including stocks, bonds and mutual funds, but also real estate, commodities and entrepreneurial ventures-intersect with life and move you closer to your goals and objectives.
Insurance planning - Is NOT just about buying prescribed insurance products; it IS learning how to manage risk first through risk avoidance, risk reduction and risk assumption before transferring risk through insurance products.
Cash flow/budget planning - is NOT just for the under-resourced living paycheck-to-paycheck; it IS the engine of every household's sound financial plan, just as it is for every successful business.
Tax planning - Is NOT having your tax return prepared or jamming your numbers through Geitner's Achilles heel, Turbo Tax; it IS planning for the present, but also the mid-term and the long-term regarding payroll taxes, income tax, capital gains tax, tax deferral, gift tax, inheritance tax and estate tax.
Education planning - Is NOT sloughing a random chunk of money every month into an education savings plan to assuage your guilt that you're too busy keeping your own financial house in order to apply much thought to the cost of your children's education; it IS first developing a Family Education Policy (here's how much mom and dad are willing to pay and the terms you need to meet to receive that help) and then establishing a deliberate plan to meet those goals, some of which should be saved in a 529 education savings plan.
Retirement planning - Is NOT slaving away at a job you don't love so that you can shelve as much of your income as humanly possible in a 401k and IRAs to which you'll look for financial salvation in a retirement that can't come soon enough; it IS, first and foremost, finding a career that you can enjoy indefinitely so that you are always employable (the BEST insurance against running out of income in retirement), saving effectively for financial independence while also allocating dollars to enjoying life today and in the mid-term.
Estate planning - Is NOT sleeping through an expensive meeting with an attorney to have documents drafted that you don't understand; it IS examining the impact that you'd like to leave on this earth and implementing tangible plans - yes, through wills, powers of attorney, advance directives and occasionally other trusts, but also - designed to create a legacy, no matter what your age.
One of the reasons it's especially difficult to get complete answers about financial planning is because the purveyors of financial products - banks, brokerage firms and insurance companies - are working very hard to convince the public that they are to be trusted both as the advisor and the salesperson. Unfortunately, their economic bias - their financial conflict of interest - is so overpowering that the best advice is often tainted or watered down.
If Efinity Financial can bring some clarity to your financial goals, aspirations & questions we encourage you to reach out to one of our Licensed Financial Professionals - www.efinityfinancial.com
Monday, November 26, 2012
What Makes a Good Agent
As many of you know, within Efinity Group there exists a full service Insurance firm, Efinity Insurance. One of the questions we are often asked is; "What makes a good insurance agent?" It's an interesting question. We pulled the following information from the Independent Insurance Agents & Brokers of America website and believe it best represents both the expectations and professionalism one should expect from his/her personal insurance agent.
http://www.independentagent.com
When it comes to financial security and insurance protection, most people want a long-term relationship with a trusted adviser they can turn to many years into the future.
In fact, a survey by the Independent Insurance Agents & Brokers of America (IIABA) found that:
Three out of four insurance consumers use an agent when purchasing personal insurance.
More than half the respondents over age 55 have purchased insurance from the same agent for at least 20 years.
More than 60 percent say they value the opportunity to discuss insurance with a real person.
If you’re like most people, you want to develop a long-term relationship with an agent, too. So, how do you make sure the agent is professional and reputable? Here’s what to look for:
1. Independence. Independent agents represent an average of eight different companies-not just one. They can evaluate and compare the products of several insurance companies to find the right combination of coverage and value.
2. Licensing by the state.
3. Number and names of companies the agent represents.
4. Number of years the agent and agency have been in business.
5. The agent’s professional designations. For example, CPCU (Chartered Property and Casualty Underwriter) and CLU (Chartered Life Underwriter) are among the industry's most rigorous and prestigious designations.
6. Areas of specialization. Some agents and agencies have experience in specialized products, such as insurance for a farm, a classic car, or a home business.
7. Recommendations and referrals. How did you hear about the agent and the agency? Did someone you trust refer you? Ask the person for specific details about the experience.
8. Full-service capability. Is this a full-service agency for auto, home, health, and disability products?
9. Service representatives. Ask who will handle your account for routine updates and transactions.
10. Hours. Emergency numbers. Claims service. Ask if you can contact the agency after- hours for claims or other emergency needs.
11. Claims help. Ask if the agent plays a role in handling and tracking claims. Will the agent help resolve disputes that might arise with an insurance company, for example?
12. Policy review. Does the agency occasionally review and update policies to make sure your insurance is keeping pace with changes in your situation?
13. Community involvement. Does your agent participate in any local organizations, boards, volunteer activities, or other civic endeavors?
14. Industry associations. Does your agent participate in any local, state, or national trade associations? These activities often signify professionalism and a commitment to continuing education in the insurance field.
We hope you found some of this information valuable.
Thursday, April 12, 2012
Welcome to Spring - Home Buying Time!!
With Spring upon us, and new buyers out looking for houses, we thought today might be a good time to review the basics of what lenders look for as they decide to approve (or deny) mortgage applications. For at least the last two decades we have heard them called “The 4 C’s of Underwriting”- Capacity, Credit, Cash, and Collateral. Guidelines and risk tolerances change, but the core criteria do not.
CAPACITY
CAPACITY is the analysis of comparing a borrower’s income to their proposed debt. It considers the borrower’s ability to repay the mortgage. Lenders look at two calculations (we call ratios). The first is your Housing Ratio. It simply is the percentage of your proposed total mortgage payment (principal & interest, real estate taxes, homeowner’s insurance and, if applicable, flood insurance and mortgage insurance – like PMI or the FHA MIP) divided by your monthly, pre-tax income. A solid Housing Ratio (often called the front end ratio) would be 28% or less; although, at times loans are approved at a significantly higher number. That’s because your front end ratio is looked at in conjunction with your back end ratio.
The back end ratio (referred to as your Debt Ratio) starts with that mortgage payment calculation from the Housing Ratio and adds to it your recurring debts that would show up on your credit report (auto loans, student loans, minimum credit card payments, etc.) without taking into consideration some other debts (phone bills, utility bills, cable TV). A good back ratio would be 40% or less. However, loans sometimes are granted with higher debt ratios. Understand that every application is different. Income can be impacted by overtime, night differential, bonuses, job history, unreimbursed expenses, commission, as well as other factors. Similarly, how your debts are considered can vary. Consult an experienced loan officer to determine how the underwriter will calculate your numbers.
CREDIT
CREDIT is the statistical prediction of a borrower’s future payment likelihood. By reviewing the past factors (payment history, total debt compared to total available debt, the types of monies: revolving credit vs. installment debt outstanding) a credit score is assigned each borrower which reflects the anticipated repayment. The higher your score, the lower the risk to the lender which usually results in better loan terms for the borrower. Your loan officer will look to run your credit early on to see what challenges may (or may not) present themselves.
CASH
CASH is a review of your asset picture after you close. There are really two components – cash in the deal and cash in reserves. Simply put, the bigger your down payment (the more of your own money at risk) the stronger the loan application. At the same time, the more money you have in reserve after closing the less likely you are to default. Two borrowers with the same profile as far as income ratios and credit scores have different risk levels if one has $50,000 in the bank after closing and the other has $50. There is logic here. The source of your assets will be examined. Is it savings? Was it a gift? Was it a one-time settlement/lottery victory/bonus? Discuss how much money you have and its origins with your loan officer.
COLLATERAL
COLLATERAL refers to the appraisal of your home. It considers many factors – sales of comparable homes, location of the home, size of the home, condition of the home, cost to rebuild the home, and even rental income options. Understand the lender does not want to foreclose (they aren’t in the real estate business), but they do need to have something to secure the loan against, in case of default. In today’s market, appraisers tend to be conservative in their evaluations. Appraisals are really the only one of the 4 C’s that can’t be determined ahead of time in most cases.
Now, each of the 4 C’s are important, but it’s really the combination of them that is key. Strong income ratios and a large down payment with strong reserves can offset some credit issues. Similarly, long and strong credit histories help higher ratios….and good credit and income can overcome lesser down payments. Talk openly and freely with your loan officer. They are on your side, advocating for you and looking to structure your file as favorably as possible. We hope you find some value in this information as you elect to move up, move down or accross this great country of ours!
CAPACITY
CAPACITY is the analysis of comparing a borrower’s income to their proposed debt. It considers the borrower’s ability to repay the mortgage. Lenders look at two calculations (we call ratios). The first is your Housing Ratio. It simply is the percentage of your proposed total mortgage payment (principal & interest, real estate taxes, homeowner’s insurance and, if applicable, flood insurance and mortgage insurance – like PMI or the FHA MIP) divided by your monthly, pre-tax income. A solid Housing Ratio (often called the front end ratio) would be 28% or less; although, at times loans are approved at a significantly higher number. That’s because your front end ratio is looked at in conjunction with your back end ratio.
The back end ratio (referred to as your Debt Ratio) starts with that mortgage payment calculation from the Housing Ratio and adds to it your recurring debts that would show up on your credit report (auto loans, student loans, minimum credit card payments, etc.) without taking into consideration some other debts (phone bills, utility bills, cable TV). A good back ratio would be 40% or less. However, loans sometimes are granted with higher debt ratios. Understand that every application is different. Income can be impacted by overtime, night differential, bonuses, job history, unreimbursed expenses, commission, as well as other factors. Similarly, how your debts are considered can vary. Consult an experienced loan officer to determine how the underwriter will calculate your numbers.
CREDIT
CREDIT is the statistical prediction of a borrower’s future payment likelihood. By reviewing the past factors (payment history, total debt compared to total available debt, the types of monies: revolving credit vs. installment debt outstanding) a credit score is assigned each borrower which reflects the anticipated repayment. The higher your score, the lower the risk to the lender which usually results in better loan terms for the borrower. Your loan officer will look to run your credit early on to see what challenges may (or may not) present themselves.
CASH
CASH is a review of your asset picture after you close. There are really two components – cash in the deal and cash in reserves. Simply put, the bigger your down payment (the more of your own money at risk) the stronger the loan application. At the same time, the more money you have in reserve after closing the less likely you are to default. Two borrowers with the same profile as far as income ratios and credit scores have different risk levels if one has $50,000 in the bank after closing and the other has $50. There is logic here. The source of your assets will be examined. Is it savings? Was it a gift? Was it a one-time settlement/lottery victory/bonus? Discuss how much money you have and its origins with your loan officer.
COLLATERAL
COLLATERAL refers to the appraisal of your home. It considers many factors – sales of comparable homes, location of the home, size of the home, condition of the home, cost to rebuild the home, and even rental income options. Understand the lender does not want to foreclose (they aren’t in the real estate business), but they do need to have something to secure the loan against, in case of default. In today’s market, appraisers tend to be conservative in their evaluations. Appraisals are really the only one of the 4 C’s that can’t be determined ahead of time in most cases.
Now, each of the 4 C’s are important, but it’s really the combination of them that is key. Strong income ratios and a large down payment with strong reserves can offset some credit issues. Similarly, long and strong credit histories help higher ratios….and good credit and income can overcome lesser down payments. Talk openly and freely with your loan officer. They are on your side, advocating for you and looking to structure your file as favorably as possible. We hope you find some value in this information as you elect to move up, move down or accross this great country of ours!
Tuesday, January 17, 2012
How to ensure your home isn't under-insured
For many of our clients, the following information is view similarly to going to the dentist. That said, it's mission critical that your family review the following and please get with one of our agents for a policy review.
Fact is, most homeowners have insurance. All homeowners who have a mortgage must have insurance. The question is: do you have enough insurance? Will your policy cover you if the worst happens – if your house is totally destroyed and you need to rebuild?
According to the Insurance Information Institute’s 2011 Insurance Pulse Survey, nearly half (48 percent) of all homeowners in the U.S. believe the insured value of their home is linked to its market value.
“They are two different things,” says Michael Barry, the institute’s vice president of media relations. “When it comes to buying homeowners insurance, you have to look at the insured value – what would it cost to rebuild my home in its current location with comparable construction materials if I were to have a total loss? And that number does not represent the market value.”
With home prices in the flat, it’s easy to assume that you can save money by lowering the insurance coverage. Unfortunately, it doesn’t work that way. The cost of building materials – copper, lumber, steel, concrete – have all gone up dramatically the last few years.
“It’s truly unfortunate that people don’t understand market value versus replacement cost,” says Ned, the vice president of claims for a regional insurance company. He agreed to talk to me as long as I did not use his real name.
Ned told me about a recent claim for a house that burned to the ground and the homeowner was grossly under-insured. He had coverage for up to $350,000, but the estimated construction cost came in at $500,000. Ned says this customer was “one of the rare individuals who accepted responsibility” for the situation.
The insurance company did its best to help, but the new house did not have the quality of the original. The homeowner had to downgrade the kitchen appliances. Instead of granite countertops, he went with composite. He also had to settle for a lower-quality roof; one that was guaranteed for 30 years instead of 40.
Getting the right coverage is your responsibility. We advise reviewing your insurance coverage each year with our agents. Despite our reminders and email notifications, most people don’t do this.
Angie’s List recently polled its members and found that nearly one-third of those who responded hadn’t checked their home insurance policies for two years or more.
“This is your responsibility,” says Angie Hicks, the website’s founder. “Your insurance agent doesn’t know what you’ve done to your house. They don’t know if you added a deck or bought an expensive piece of jewelry. Only you know that information.”
So put this on your calendar to make sure you’re reviewing your policy at renewal time.
At the very least, you want to know what you have. Then you can tweak the policy or comparison shop. Make sure you don’t buy too much insurance. You don’t need to insure for the value of the land your house sits on.
According to the Insurance Information Institute, there are four elements that help you decide how much coverage to get:
- The cost to rebuild the structure.
- The cost to replace the contents.
- Additional living expenses if you have to move out during repairs.
- Your liability to others who might get hurt on your property.
If you’re looking to save money raise the deductible, don’t cut back on coverage. The Insurance Information Institute says increasing the deductible from $500 to $1,000 could reduce premiums by up to 25 percent.
Remember: the amount of money the policy will pay for contents and additional living expenses is typically based on the coverage of the structure.
It’s important to have a home inventory to show the insurance company if there is a loss. The free app MyHOME Scr.APP.book (available for iPhones and Android phones) from the National Association of Insurance Commissioners lets you quickly photograph, grab bar codes and serial numbers and store them digitally. There is also free software for your computer at knowyourstuff.org, a site run by the insurance industry.
We encourage you to spend time on both. It'll be time well spent.
Fact is, most homeowners have insurance. All homeowners who have a mortgage must have insurance. The question is: do you have enough insurance? Will your policy cover you if the worst happens – if your house is totally destroyed and you need to rebuild?
According to the Insurance Information Institute’s 2011 Insurance Pulse Survey, nearly half (48 percent) of all homeowners in the U.S. believe the insured value of their home is linked to its market value.
“They are two different things,” says Michael Barry, the institute’s vice president of media relations. “When it comes to buying homeowners insurance, you have to look at the insured value – what would it cost to rebuild my home in its current location with comparable construction materials if I were to have a total loss? And that number does not represent the market value.”
With home prices in the flat, it’s easy to assume that you can save money by lowering the insurance coverage. Unfortunately, it doesn’t work that way. The cost of building materials – copper, lumber, steel, concrete – have all gone up dramatically the last few years.
“It’s truly unfortunate that people don’t understand market value versus replacement cost,” says Ned, the vice president of claims for a regional insurance company. He agreed to talk to me as long as I did not use his real name.
Ned told me about a recent claim for a house that burned to the ground and the homeowner was grossly under-insured. He had coverage for up to $350,000, but the estimated construction cost came in at $500,000. Ned says this customer was “one of the rare individuals who accepted responsibility” for the situation.
The insurance company did its best to help, but the new house did not have the quality of the original. The homeowner had to downgrade the kitchen appliances. Instead of granite countertops, he went with composite. He also had to settle for a lower-quality roof; one that was guaranteed for 30 years instead of 40.
Getting the right coverage is your responsibility. We advise reviewing your insurance coverage each year with our agents. Despite our reminders and email notifications, most people don’t do this.
Angie’s List recently polled its members and found that nearly one-third of those who responded hadn’t checked their home insurance policies for two years or more.
“This is your responsibility,” says Angie Hicks, the website’s founder. “Your insurance agent doesn’t know what you’ve done to your house. They don’t know if you added a deck or bought an expensive piece of jewelry. Only you know that information.”
So put this on your calendar to make sure you’re reviewing your policy at renewal time.
At the very least, you want to know what you have. Then you can tweak the policy or comparison shop. Make sure you don’t buy too much insurance. You don’t need to insure for the value of the land your house sits on.
According to the Insurance Information Institute, there are four elements that help you decide how much coverage to get:
- The cost to rebuild the structure.
- The cost to replace the contents.
- Additional living expenses if you have to move out during repairs.
- Your liability to others who might get hurt on your property.
If you’re looking to save money raise the deductible, don’t cut back on coverage. The Insurance Information Institute says increasing the deductible from $500 to $1,000 could reduce premiums by up to 25 percent.
Remember: the amount of money the policy will pay for contents and additional living expenses is typically based on the coverage of the structure.
It’s important to have a home inventory to show the insurance company if there is a loss. The free app MyHOME Scr.APP.book (available for iPhones and Android phones) from the National Association of Insurance Commissioners lets you quickly photograph, grab bar codes and serial numbers and store them digitally. There is also free software for your computer at knowyourstuff.org, a site run by the insurance industry.
We encourage you to spend time on both. It'll be time well spent.
Monday, December 12, 2011
Securities Lending – Share Hypothecation
For the last several months, Efinity Finanical has quietly grown in the Dallas Fort Worth market. Those clients already presently working with our advisors are well aware of the weekly commentary we publish. Last week's was so good we felt it should repost here on the Efinity Report. Enjoy.
Securities Lending – Share Hypothecation
One of the main issues facing the financial world today is the difficulty investors have estimating the effect that a specific financial issue, such as a 50% haircut on Greek bonds, may have on the global or domestic financial and banking system.
So why can’t the people who run the European Central bank, the U.S. Central Banks Federal Reserve and Wall Street estimate the probability and effect of a bank going out of business? It looks like the reason some banks are classed as “too big to fail” is the fact that no one knows what will happen if they DO fail!
The reason is the financial system is based on everyone lending and making promissory contracts with each other. The system has evolved to a highly leveraged point where very little real cash or collateral exists. Looking at ‘cash in the bank’ has been replaced by credit ratings and rates as means to judge the fiscal security of a loan to a counterparty.
Unfortunately, these ratings and loan rates can change quickly; confidence is especially ephemeral these days. Take Italy, for example, whose cost of borrowing has nearly doubled in a period of weeks. This means the capital held by banks in the form of Italian bonds has shrunk by nearly 50%.
European banks are currently levered by approximately 30 to 1 – for every $1 they have in actual capital, they have $30 in borrowings. U.S. banks are current around half that level.
Shorting the System
Another reason for high volatility is the increasing ability of financial firms to profit from betting against markets - Shorting. Probably the most infamous example was Goldman Sach’s $550 million fine relating to fraud charges over the shorting of (seeking to profit from betting against) mortgage securities they had previously profited from by advising clients to buy. The fund was called Abacus.
Securities Lending
Securities Lending, a.k.a. Share Hypothecation, is a little known method for large financial firms to leverage the financial system - proponents call it the lubrication of securities markets. It certainly facilitates increased short selling activity. It is estimated that $1.9 trillion of securities are out on loan every day.
Securities Lending allows a Wall Street firm to loan shares to another firm in return for both a transaction fee and collateral to cover the loan. Although this may sound ‘normal’ among large companies, many Wall Street investor custody agreements include securities lending clauses allowing the firm to lend out shares owned by retail investors.
Yes, investment banks and the like regularly take their investors’ shares and loan them to companies looking to short the market.
For any financial relationship you have, check to see if the company participates in Securities Lending. If they do and the lender goes bankrupt, you will lose your shares!
Why Lend Securities?
Financial companies often “Lend” securities to facilitate short selling. Selling a stock “Short” means borrowing stock from a Lender for a period then selling the stock to a Buyer. At the end of the borrowing period, the Borrower has to give the stock back to the Lender.
If the price of the stock goes down during the lending period, at the end of the period the Borrower buys the stock in the market at the current reduced market price and gives it to the Lender. The Borrower therefore pockets the difference between the price they had originally sold to the Buyer at the start of the lending period and the price they had just paid for it at the end of the lending period.
If the stock rises in value during the borrowing period, the Borrower loses the difference in the original sale price and the price they have to buy it back to satisfy the loan. This practice avoids the short company for being accused of “Naked Shorting”, the practice of selling a stock short without owning the underlying stock.
Take a moment to think how frightening this concept is…in order to make a big negative bet against a company or country, all a Wall Street company has to do it find a counterparty who is willing to loan the representative securities for a nominal fee.
Even worse, the collateral to cover the trade is rarely “tangible”; it’s often other financial contracts. It is therefore very easy to see how confidence can rapidly evaporate in financial markets.
Company versus Country
One interesting result of the above is the changing risk/credit perception between many large corporations and a number of countries, chiefly those in Europe. Sovereign fixed income investments that were previously thought to be low volatility are now behaving like Tech stocks! At the same time, high yield corporate bonds are relatively stable.
Countries have been able to run whatever fiscal policy they wanted because their credit rating always allowed them to borrow and borrow at low interest rates. Companies generally had to maintain pristine balance sheets to enjoy anything like similar access to debt. Moreover, everyone assumed sovereign debtors were highly creditworthy whereas companies have to prove their creditworthiness on a quarterly basis.
Now that the confidence in the finances of many countries has disappeared, we are seeing massive swings in the prices of sovereign bonds; those securities that we all previously thought were very stable. Hedge Funds and short sellers are able to use leverage to bet against the debt of countries in the same way they contributed to the decline of Lehman Brothers.
In our opinion, large multinationals have managed their finances exceptionally well in recent years and their debt (Bonds) deserve the stability currently being shown. We have long stated that the world continues to grow in new areas and different ways. Companies and not countries seem to be doing much better at managing this change.
Securities Lending – Share Hypothecation
One of the main issues facing the financial world today is the difficulty investors have estimating the effect that a specific financial issue, such as a 50% haircut on Greek bonds, may have on the global or domestic financial and banking system.
So why can’t the people who run the European Central bank, the U.S. Central Banks Federal Reserve and Wall Street estimate the probability and effect of a bank going out of business? It looks like the reason some banks are classed as “too big to fail” is the fact that no one knows what will happen if they DO fail!
The reason is the financial system is based on everyone lending and making promissory contracts with each other. The system has evolved to a highly leveraged point where very little real cash or collateral exists. Looking at ‘cash in the bank’ has been replaced by credit ratings and rates as means to judge the fiscal security of a loan to a counterparty.
Unfortunately, these ratings and loan rates can change quickly; confidence is especially ephemeral these days. Take Italy, for example, whose cost of borrowing has nearly doubled in a period of weeks. This means the capital held by banks in the form of Italian bonds has shrunk by nearly 50%.
European banks are currently levered by approximately 30 to 1 – for every $1 they have in actual capital, they have $30 in borrowings. U.S. banks are current around half that level.
Shorting the System
Another reason for high volatility is the increasing ability of financial firms to profit from betting against markets - Shorting. Probably the most infamous example was Goldman Sach’s $550 million fine relating to fraud charges over the shorting of (seeking to profit from betting against) mortgage securities they had previously profited from by advising clients to buy. The fund was called Abacus.
Securities Lending
Securities Lending, a.k.a. Share Hypothecation, is a little known method for large financial firms to leverage the financial system - proponents call it the lubrication of securities markets. It certainly facilitates increased short selling activity. It is estimated that $1.9 trillion of securities are out on loan every day.
Securities Lending allows a Wall Street firm to loan shares to another firm in return for both a transaction fee and collateral to cover the loan. Although this may sound ‘normal’ among large companies, many Wall Street investor custody agreements include securities lending clauses allowing the firm to lend out shares owned by retail investors.
Yes, investment banks and the like regularly take their investors’ shares and loan them to companies looking to short the market.
For any financial relationship you have, check to see if the company participates in Securities Lending. If they do and the lender goes bankrupt, you will lose your shares!
Why Lend Securities?
Financial companies often “Lend” securities to facilitate short selling. Selling a stock “Short” means borrowing stock from a Lender for a period then selling the stock to a Buyer. At the end of the borrowing period, the Borrower has to give the stock back to the Lender.
If the price of the stock goes down during the lending period, at the end of the period the Borrower buys the stock in the market at the current reduced market price and gives it to the Lender. The Borrower therefore pockets the difference between the price they had originally sold to the Buyer at the start of the lending period and the price they had just paid for it at the end of the lending period.
If the stock rises in value during the borrowing period, the Borrower loses the difference in the original sale price and the price they have to buy it back to satisfy the loan. This practice avoids the short company for being accused of “Naked Shorting”, the practice of selling a stock short without owning the underlying stock.
Take a moment to think how frightening this concept is…in order to make a big negative bet against a company or country, all a Wall Street company has to do it find a counterparty who is willing to loan the representative securities for a nominal fee.
Even worse, the collateral to cover the trade is rarely “tangible”; it’s often other financial contracts. It is therefore very easy to see how confidence can rapidly evaporate in financial markets.
Company versus Country
One interesting result of the above is the changing risk/credit perception between many large corporations and a number of countries, chiefly those in Europe. Sovereign fixed income investments that were previously thought to be low volatility are now behaving like Tech stocks! At the same time, high yield corporate bonds are relatively stable.
Countries have been able to run whatever fiscal policy they wanted because their credit rating always allowed them to borrow and borrow at low interest rates. Companies generally had to maintain pristine balance sheets to enjoy anything like similar access to debt. Moreover, everyone assumed sovereign debtors were highly creditworthy whereas companies have to prove their creditworthiness on a quarterly basis.
Now that the confidence in the finances of many countries has disappeared, we are seeing massive swings in the prices of sovereign bonds; those securities that we all previously thought were very stable. Hedge Funds and short sellers are able to use leverage to bet against the debt of countries in the same way they contributed to the decline of Lehman Brothers.
In our opinion, large multinationals have managed their finances exceptionally well in recent years and their debt (Bonds) deserve the stability currently being shown. We have long stated that the world continues to grow in new areas and different ways. Companies and not countries seem to be doing much better at managing this change.
Thursday, November 3, 2011
Damn'd if you Do and Damn'd if you Don't
A state court judge has ruled that Illinois can move forward with a lawsuit alleging that Wells Fargo & Co. steered minority borrowers into risky mortgages at the height of the housing bubble. Important to note the court DID NOT find that Wells Fargo engaged in discriminatory lending but the Illinois action is the first fair-lending lawsuit brought by a state attorney general against a national bank to reach discovery, attorneys familiar with the case said. After discovery, Illinois may be able to bring the case to trial. We believe this is a poor decision.
Here are the underlying issues and possible ramifications for this. ALL residential mortgage lenders (BofA, Wells Fargo, Chase, Ally Bank even Efinity for that matter) had and have annual requirements and goals for community lending. Ten years ago, the push from Fannie Mae and Freddie Mac were to grow minority ownership. This was a directive from prior US President Bill Clinton during his presidency (1993-2001). A challenging task as these markets historically have been plagued with on-going credit and down payment issues. The "steering" as referred by the Illinois state attorney general will be difficult to defend as home loan underwriting requirements were much less focused on standard automated underwriting findings and subject to interpretation. Many of the loan programs available to mortgage lenders at the time were very lenient on income and employment documentation compared to the standard FHA loan programs. In addition, programs typically offered short term fixed payment durations lowering the starting rate and payment which many borrowers were attracted to. Add the year over year property increase assumptions, these underwriting decisions are now deemed discriminatory. Furthermore, what will be difficult to defend is the reasoning why those loan programs were selected. In many circumstances, borrowers fully intended to flip or move in a short time window making short term fixed duration loans preferable as the interested rates were significantly lower. Adding to the lack of clarity behind these transactions in question, no where within the application explains or supports the reasoning behind the transaction.
WF was "gently" pushed to lend in certain markets which conventional lending could and would not support. The transactional volume requirements demanded certain products which were available to the market place. Unfortunately while clients are usually always made aware of the risks associated with an adjustable mortgage product the purchase decision is usually made payment. Are there individual transactions where perhaps the risk/rewards were not fully vetted out 100%, perhaps but in this instance we believe individual borrowers are not taking personal responsibility for their decisions.
Here are the underlying issues and possible ramifications for this. ALL residential mortgage lenders (BofA, Wells Fargo, Chase, Ally Bank even Efinity for that matter) had and have annual requirements and goals for community lending. Ten years ago, the push from Fannie Mae and Freddie Mac were to grow minority ownership. This was a directive from prior US President Bill Clinton during his presidency (1993-2001). A challenging task as these markets historically have been plagued with on-going credit and down payment issues. The "steering" as referred by the Illinois state attorney general will be difficult to defend as home loan underwriting requirements were much less focused on standard automated underwriting findings and subject to interpretation. Many of the loan programs available to mortgage lenders at the time were very lenient on income and employment documentation compared to the standard FHA loan programs. In addition, programs typically offered short term fixed payment durations lowering the starting rate and payment which many borrowers were attracted to. Add the year over year property increase assumptions, these underwriting decisions are now deemed discriminatory. Furthermore, what will be difficult to defend is the reasoning why those loan programs were selected. In many circumstances, borrowers fully intended to flip or move in a short time window making short term fixed duration loans preferable as the interested rates were significantly lower. Adding to the lack of clarity behind these transactions in question, no where within the application explains or supports the reasoning behind the transaction.
WF was "gently" pushed to lend in certain markets which conventional lending could and would not support. The transactional volume requirements demanded certain products which were available to the market place. Unfortunately while clients are usually always made aware of the risks associated with an adjustable mortgage product the purchase decision is usually made payment. Are there individual transactions where perhaps the risk/rewards were not fully vetted out 100%, perhaps but in this instance we believe individual borrowers are not taking personal responsibility for their decisions.
Friday, October 14, 2011
Creative planning but ...
There are new developments between the Obama administration and a federal housing regulators who are considering a program to draw private investment back into the government-dominated residential mortgage market by having Fannie Mae and Freddie Mac sell slices of securities that wouldn't carry a federal guarantee but would pay a higher interest rate than current mortgage-backed bonds.
No decisions have been made, but officials believe a small pilot program could be rolled out sometime next year, according to people familiar with the matter.
Officials see it as a step toward reducing the $10.4 trillion U.S. mortgage market's dependence on government-controlled mortgage companies Fannie Mae and Freddie Mac. If the leadership in both groups believe this model would keep US residential mortgages affordable, we're all for it. However, we fear what this same leadership has not factored in is the "dramatic" increase private money would require in rate to not have government guarantee. The margins just aren't attractive to the everyday commercial investor and without attractive margins, rates to the consumer will surely rise.
No decisions have been made, but officials believe a small pilot program could be rolled out sometime next year, according to people familiar with the matter.
Officials see it as a step toward reducing the $10.4 trillion U.S. mortgage market's dependence on government-controlled mortgage companies Fannie Mae and Freddie Mac. If the leadership in both groups believe this model would keep US residential mortgages affordable, we're all for it. However, we fear what this same leadership has not factored in is the "dramatic" increase private money would require in rate to not have government guarantee. The margins just aren't attractive to the everyday commercial investor and without attractive margins, rates to the consumer will surely rise.
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