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Five Things You Need to Know: Foreclosures Nearly Double; Capital .75 Financial; Private Equity Getting Cold Shoulder, or Cold Feet?; Bull Market Geniuses?; It's Buffett Time!


What you need to know (and what it means!)...


Minyanville's daily Five Things You Need to Know to stay ahead of the pack on Wall Street:

1. Foreclosures Nearly Double

The number of U.S. homeowners facing foreclosure nearly doubled in July as property owners with adjustable-rate mortgages saw their payments rise, according to RealtyTrac.

  • Lenders sent 179,599 notices of default, scheduled auctions or bank repossessions last month, a 93% increase from a year earlier, RealtyTrac said.
  • Forty-three states had year-over-year increases in foreclosure activity, RealtyTrac reported.
  • This, of course, adds to the overall supply of houses on the market.
  • The National Association of Realtors reported that in June the supply of houses on the market at the pace of sales was about nine months, double what it was two years ago.
  • "We are estimating that we will see about 2 million foreclosure filings this year,'' Rick Sharga, RealtyTrac's executive vice president for marketing, said.

2. Capital .75 Financial

Capital One Financial (COF) said yesterday that it would stop making residential mortgages and close GreenPoint Mortgage, its wholesale mortgage banking unit.

  • Well, that just goes to show you how serious this subprime mortgage debacle really is.
  • Except that this isn't about subprime mortgages.
  • The 31-branch GreenPoint Mortgage business specialized in Alt-A mortgages.
  • Alt-A mortgages generally occupy a space between Subprime and Prime, and are for people with good credit who don't quite meet Prime lending standards.
  • The closure will result In a loss of 1,900 jobs.
  • Gary Perlin, Capital One's chief financial officer, said weaker demand and pricing in the secondary mortgage markets had made it "difficult to operate our wholesale mortgage banking business profitably."
  • Well, at least Capital One gave running a mortgage business a good shot.
  • Capital One acquired GreenPoint as part of its purchase of North Fork Bancorp that closed last December... almost nine whole months ago.

3. Private Equity Getting Cold Shoulder, or Cold Feet?

An interesting piece by Andrew Ross Sorkin in the New York Times this morning wonders if private equity firms are going to be able to get out of all these leveraged buyouts. You know, all those bullish leveraged buyouts. The ones that were supporting the stock market by removing public shares from the market. Can all these private equity firms get out of them?

  • The article notes that SLM Corp's (SLM) shares are trading nearly 20% below the price offered by a consortium of buyers.
  • Texas Utilities (TXU) shares are trading about 9% below the buyout price.
  • Sorkin notes similar situations with Affiliated Computer Services (ACS), Ceridian (CEN) and United Rentals (URI).
  • "Private equity firms are being pushed to rethink deals by the banks that had committed to loan the money and are now expected to rack up billions in losses by selling the debt at a fraction of what they had planned," he writes.
  • Sure, that's one reason. We can blame it on the banks.
  • Private equity firms getting the cold shoulder.
  • Or, are private equity firms getting cold feet?
  • That brings us to today's Number Four...

4. Bull Market Geniuses?

We looked at this issue back in May in our special "What is Private Equity" edition of Five Things, but it's worth revisiting. Now, for millions of Americans who aren't intimately involved in financial markets on a day-to-day basis, "private equity" is code for "blah blah blahquity."

  • So what is this... how you say? - ah yes, "private equity" - anyway?
  • We can best discuss exactly what "private equity" is and does by using the classic "Lemonade Stand" example:

Unlocking Hidden Value

Suppose you run a Lemonade Stand that employs three people - you, the chief executive and operator; your mom, the one who makes the lemonade; your little brother or sister, the one who runs around the neighborhood telling everybody to come and buy your lemonade.

After a period of time, you realize you can expand to other corners only if you sell shares of your Lemonade Stand to the other people in your neighborhood, so you have a Lemonade Stand public offering.

Now, anyone who wants to invest in your Lemonade Stand can go to your next door neighbor Billy's backyard and trade shares of your Lemonade Stand. Meanwhile, as a "public Lemonade Stand," you take the capital from your investors and use it to branch out to three street corners. This allows you to increase overall profitability that the shareholders in your Lemonade Stand also enjoy via the dividends you pay.

Meanwhile, across the street in Johnny's basement, plotting is taking place. Johnny and his friends are pretty sure they know more about running Lemonade Stands than you do, ya friggin' bagodonuts ya.

"Look at you," Johnny says. "You're just a kid. What do you know about business? Nothing, that's what you know about it. Meanwhile, you got a bunch of bagodonut shareholders out there who can't see the hidden value they have under their noses! What's your plan for ice cream?" he demands to know.

"Ice cream?," you ask.

"You don't even know what I'm talking about do you," Johnny says, slowly shaking his head in disapproval. "When those ice cream trucks hit the street, your Lemonade Stand is history, pal. But look," he says, "you got a distribution network in place, a solid brand that could just use a little tweaking, you have a lot of hidden value. We can unlock the hidden value," he says.

Long story short, Johnny borrows money from his old man to take out the existing shareholders at a price they can't refuse. Ultimately, you have little choice but to sell your Lemonade Stand to Johnny, who quickly fires you and your employees, hires a team of Lemonade Specialists to run the stands, expands the offerings to include ice cream and candy, uses the increased sales and cash flow to borrow against the assets of the Lemonade Stand to expand and increase the capital repayments to himself so he can recoup his initial investment and pay back his old man.

The increased traffic and cash flow at the stands has the neighborhood wowed. They can't believe how Johnny has really turned around this flailing business!

"Hey Johnny, Billy asks, "can we buy back into this business?" "Sure," Johnny says. The IPO is expected to raise $4 billion, pricing in a range of $28 - $31.

  • OK, so now that things are a bit "distressed," this should be a perfect time for private equity firms to step in and scoop up a bunch of cheap companies to unlock their hidden value, right?
  • That's one way to look at it.
  • Another way to look at it, however, is that many of these private equity leveraged buyouts were not much different than condo flipping... on a larger scale.
  • The conventional wisdom (a year ago) was that subprime mortgage issues were "contained" because of the following (take your pick):
    a) People who bought homes with subprime mortgages were too stupid to know any better.
    b) People who loaned money to subprime quality borrowers were too greedy to bother to check lending standards.
    c) A combination of the above.
  • Implicit in those assumptions is the notion that just about everyone else obtaining credit was behaving appropriately.
  • And we do mean everyone else; prime mortgage borrowers and lenders, private equity firms, hedge funds, corporations themselves using borrowed money to repurchase their own stock, and on and on and on.
  • Here's an alternative view.
  • Subprime, the most vulnerable link in the credit chain, was simply the first to buckle.
  • To presume otherwise is to engage in some pretty hefty rationalizations that rely on a fairly rickety structure of race and class bias.
  • What if the same factors that led borrowers to demand credit, and lenders to meet those demands, at the subprime level, are precisely the same factors that led borrowers to demand credit, and lenders to meet those demands, at all other levels throughout the chain?
  • What if the factors creating an appetite for risk and driving credit demand at the subprime level are the same factors creating an appetite for risk and driving credit demand at all other levels?
  • Well, that would imply that the genius running a billion dollar private equity firm is driven to seek deals and obtain credit by the same risk-seeking desires and appetites that drive a building maintenance worker making $50,000 a year to buy a home and flip a condo.
  • And we certainly can't have that.

5. It's Buffett Time!

Sitting on what the Wall Street Journal refers to as "a war chest" of nearly $50 billion in cash, many are seeing Berkshire Hathaway (BRK) Chief Warren Buffett as one of the last buyers standing as the ongoing turmoil that began with the subprime mortgage market spreads.

  • These are happy days for Warren Buffett, the Wall Street Journal says.
  • While Berkshire has a long-standing policy of not discussing potential investment targets, it is a safe bet, the Journal say, that everyone from "beleaguered lenders hurt by the mortgage-backed and commercial-paper markets, to sponsors of private-equity deals that run the risk of falling through -- are reaching out to him."
  • Top on the list of Buffett-rescues? Countrywide Financial (CFC).
  • The Journal says Countrywide's debt-servicing business and investments in high-quality mortgages may be attractive to Berkshire.
  • Apart from the nearly $50 billion in cash and cash equivalents on its balance sheet as of June 30, Berkshire also holds about $74 billion in stocks and around $27 billion in bonds, the Journal says.
  • So, perhaps now is the time to take a look at your own portfolio and see if you, as an individual investor, have what it takes to follow Buffett's footsteps.
  • Fortunately, for you we have the following Tips for Individual Investors from the Oracle of Omaha himself.

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