Tuesday, December 30, 2014

The Myth of Greek Democracy?

Renee Maltezou and Lefteris Papadimas of Reuters report, Greece faces early election after PM loses vote on president:
Greece heads to an early general election next month after parliament rejected Prime Minister Antonis Samaras's nominee for president on Monday, throwing the country into a new period of political turmoil just as it emerges from economic crisis.

Greek 10-year bond yields surged to a 15-month high and stocks tumbled after former European Commissioner Stavros Dimas fell short of the 180 votes needed to become president in the decisive third round of voting, triggering the dissolution of parliament.

Samaras set Jan. 25 as the date for a parliamentary election.

Opinion polls point to a victory by the radical leftist Syriza party, which wants to wipe out a big part of the national debt, and cancel the austerity terms of a 240-billion euro ($290 billion) bailout from the European Union and International Monetary Fund that Greece still needs to pay its bills.

While most Greeks do not appear to want elections, the terms of the bailout agreed by the Samaras government have imposed harsh sacrifices on many people and the signs of improvement in their battered economy have yet to show through clearly.

If Syriza is elected, it would be the first time an anti-bailout party determined to overturn the austerity approach prescribed since the start of the euro zone crisis comes to power in Europe.

"With the will of our people, in a few days bailouts tied to austerity will be a thing of the past," Syriza leader Alexis Tsipras said after the vote. "The future has already begun."

A defeated Samaras, who gambled and lost by bringing forward the presidential vote by two months, urged Greeks to vote for stability and vowed not to let anyone put Greece's place in Europe in question.

The result opens a new chapter of political uncertainty in the euro zone's problem child just as it appeared to be putting the worst of a six-year economic crisis behind it. After nearly crashing out of the euro in 2012, Greece this year returned to economic growth and ended a four-year exile from bond markets.

Syriza has held a steady lead in opinion polls for months, although its advantage over Samaras' conservative New Democracy party has narrowed in recent weeks. Weakness among potential coalition partners on both sides could mean that whichever party wins in January will struggle to form a government.

Failure to put together a government could leave Greece once again precariously close to a financial crisis since Athens will be without an administration to wrap up a final bailout inspection due to unlock over 7 billion euros in aid.

EU/IMF inspectors due to return to Athens in January will now resume discussions on concluding that review after a new government is in place, the IMF said, adding that Greece had no immediate funding needs.

Finance Minister Gikas Hardouvelis, who had been negotiating an early exit to the bailout program, said a new government would have to seek an extension to the bailout beyond its end in February. Although Athens had enough cash, it may have to issue more Treasury bills to cover funding needs in March, he said.

"There will be difficulty in negotiations because we need to have a government," Hardouvelis said.


Underlining the potential volatility facing markets, the main Athens stock market index fell as much as 11 percent before paring losses while Greek bond yields jumped above 9 percent. The main banking stocks index fell over 11 percent before recovering.

"The outcome of the final vote extends the political uncertainty for at least one month," said Theodore Krintas, head of wealth management at Attica Bank in Athens. "One cannot know if the result of early elections will be a viable government."

But unlike in 2012, markets elsewhere in Europe were rattled only a little by the latest upheaval in Greece, in a sign of increasing confidence within the euro zone that any contagion will be limited and can be contained.

In a bid to reassure markets, Tsipras has sounded more moderate lately, promising to keep Greece in the euro and negotiate an end to the bailout agreement rather than scrap it unilaterally. But he has refused to budge on reversing austerity.

Hours after the vote, German Finance Minister Wolfgang Schaeuble warned it would be "difficult" to help Greece if it veered off the path of reform and that any new government must stick to obligations signed up by the previous government.

On the streets of Athens, voters were worried that elections would put the sacrifices of the past two and half years at risk and threaten the country's future.

Stella Alipranti, 39, who runs a small tourism business, said she was disappointed and saw no advantage in an election.

"Things won't change just by changing the government because we have foreigners deciding for us," she said. "Having elections every two years certainly doesn't help the country."
Indeed, Greeks don't want or need another election but that's where they're heading yet again. Some see this exercise in democracy as positive. Economist Yanis Varoufakis posted a comment on his blog, Greece is about to give European democracy a chance:
Something is amiss in our Europe.

When the constitutional process of a proud European democracy seemed to be leading, quite properly, to elections (as was the case in Greece since the Fall), the European Commission, various governments and the commentariat-at-large intervened, presenting the prospect of elections (the crowning moment of the democratic process) as a disaster-in-the-making; as a calamity to be avoided at all cost.

When the elections became inescapable, the same power brokers began to lecture the citizens of this small, proud nation on how to vote. And when these voters seemed eager to vote differently, European Union authorities began to warn any new government that might emerge that it should consider itself a caretaker of the agreements that the previous government had struck with the European Union – that any thought of re-negotiating them should perish instantly.

Is this what our dreams of Europe have come to? Has Europe come to a point where elections are seen as a problem, rather than the source of solutions? Have Brussels-based government appointees grown so stupendously arrogant as to imagine that they can tell electorates how to vote? Have we reached a point when a people is told that if they vote in a government that seeks to renegotiate an asphyxiating international loan agreement, they face non-functioning ATMs within days?

There is, indeed, something amiss in our Europe and Greece, the proverbial canary in the mine, has brought it to the surface. Europeans from Helsinki to Lisbon and from Dublin to Cyprus must now make it their collective business to resuscitate that which once inspired us: a penchant for democracy.
I couldn't resist to post my thoughts on Varoufakis's latest:
"There is no democracy in Greece. It’s basically an oligarchy run by a handful of wealthy families controlling an ever shrinking economic pie. I have friends on the right that are actually fed up of Samaras and the coalition government because they squandered a real opportunity to finally cut the cancer that has plagued Greece for decades — a bloated, corrupt and inefficient public sector that continues to weigh the country down. Hardly any jobs were cut in the public sector in Greece over the last five years. The brunt of the massive job cuts was borne by the private sector. And the reason? Because Greek politicians on the Left and Right keep feeding the public sector beast to control votes, making promises the country simply cannot afford. So my friends on the right are fed up and want SYRIZA to win so it can “expedite the downfall of Greece and kill the public sector beast once and for all.” While I understand their exasperation, their logic is twisted and foolish. They should be careful for what they wish for because a SYRIZA victory will only extend Greece’s depression and quite possibly send the country back to the Dark Ages."
There is a myth in Greece that democracy is flourishing and the country will succeed in doing away with austerity imposed by troika and remain in the eurozone. This is absolute rubbish spread by SYRIZA's leader Alexis Tsipras.

If you want to really understand the Greek economy and the political theatrics being played out now, go back to read my thoughts from my September trip to the epicenter of the euro crisis where I painstakingly laid it all out. 

To really understand Greece, you have to understand that Greek politicians are blatant liars and corrupt to the bone. It's not just Tsipras. Successive governments from the Left and Right kept increasing the public sector to cement their political base and now that the country is bankrupt, they still can't cut the public sector beast because they fear political repercussions.

Economists will argue that Greece should exit the eurozone, reintroduce the drachma to devalue their way back to economic health. The problem with that logic is that all this will do is introduce rampant hyper inflation and nobody in their right mind will ever lend to Greece again knowing their debt profile will keep getting worse.

And as I've written back in 2012, it's time to look beyond Grexit because the cost of a Greek exit would be crippling not only for Europe but for the rest of the world. All this talk of "containing contagion" is pure fantasy. If Greece exits the eurozone, others will follow and it's game over for this fragile union.

Finally, Nick Maltouzis published a comment in MacroPolis, How snap elections in Greece fit into Samaras's strategy:
Snap elections in Greece have been on the cards for a while. Every move made by the government in recent months (negotiations with the troika in Paris, the early bailout exit plan, calling a sudden vote of confidence and moving the date of the presidential vote forward by two months) have been vain attempts to put off the inevitable. There was never a convincing case that the coalition’s candidate would be able to gather the minimum 180 votes needed and Prime Minister Antonis Samaras’s half-hearted attempts to offer a potentially game-changing compromise over the past week were far too little, too late.

Samaras’s decision not to meet other party leaders, regardless of the obstinacy of SYRIZA, Independent Greeks and Democratic Left, to discuss an agreed solution was less than his role as prime minister demanded. His decision to name his candidate at the last minute and for him to be the vice president of his own party, New Democracy, indicated that he had no real intention of building consensus. The premier’s admission in a TV interview on Saturday that snap elections would suit him perhaps inadvertently revealed that there was never any genuine attempt to elect a president.

There has been a distinct sense over recent weeks that the government has lost the appetite to see through the adjustment programme it has repeatedly argued is the only option for Greece to exit the crisis. The final troika review was meant to be wrapped up within a few weeks of the meetings in Paris in early September. However, as the review dragged on so it became apparent that the government did not have the political will (and perhaps the necessary votes in Parliament) to push things over the line. Each troika demand squeezed a little more life out of the coalition until it became clear that a new plan had to be devised.

At this point, Samaras made what was a deeply political calculation: He realised that passing the latest clutch of troika demands through Parliament would guarantee that his government had no chance of electing a president in February and would force it to go to national polls having only just approved a new round of unpopular measures. In these circumstances, bringing forward the presidential vote gave the coalition a slightly better chance of success or, if snap elections were not avoided, meant that a SYRIZA or SYRIZA-led government would be left with the task of closing out the troika negotiations.

Samaras will know very well that his chances of winning a snap election are slim. He will also be aware, though, that he can make life very difficult for SYRIZA. The polarisation of the political debate in Greece (in which the opposition has also played a significant part) has already led to the gap between New Democracy and SYRIZA narrowing. The less convincing a probable election victory is for SYRIZA, the more difficult the leftists will find it to form a government. They are highly unlikely to reach the 36 to 38 percent bracket they need for a clear majority. Meanwhile, fellow anti-austerity party Independent Greeks might not make it into Parliament or, if they do, will probably not have enough seats to help SYRIZA. An alliance with PASOK or centrist To Potami will demand a lot of bridge building.

So, if SYRIZA wins a January 25 election it will have around a month in which to ensure the election of a president, find political allies that do not yet exist, form a government for the first time in its history and reach some kind of settlement with the troika before the extension to the current bailout ends on February 28, leaving Greece in serious danger of being unable to meet its debt obligations over the next few months. Even if SYRIZA overcomes these hurdles, it will still have to put its demands for debt relief and economic stimulus to the country’s lenders, while running the risk of alienating them by fulfilling its pre-election promises of wage and pension rises.

This increases the possibility that a SYRIZA government would reach an impasse very swiftly. Any attempt to seek confrontation with the eurozone that could put Greece’s economy at risk would probably see its coalition partner(s) walk out, while a move to water down its austerity-reversing policies could cause a fracture with SYRIZA’s sizeable left wing. In the meantime, investors and depositors may have voted with their feet.

This would likely lead Greece to a new round of elections, with SYRIZA suffering the consequences of its swift stint in power and Samaras’s New Democracy cashing in. It is what has been come to be known in right-wing circles in Greece as the “Left Parenthesis” theory. Of course, it could play out a different way, with SYRIZA being unable to form a government and Greeks going to the polls for the second time around a month later, as they did in the summer of 2012.

It should not be forgotten that in those elections two years ago, New Democracy garnered an unthinkably poor 18.8 percent in the May vote (the lowest total in its history) but increased its share of the vote to 29.6 percent in June, having preyed on fears that Greece’s position in the eurozone would be at risk should SYRIZA win. It is this increase of almost 11 percentage points that is in the minds of those strategists who believe that Samaras might be better off playing the long game by allowing SYRIZA to make a mess of things and him coming back, almost saviour-like, with an increased majority.

It may sound like a far-fetched plan, which runs counter to Samaras’s insistence in Saturday’s interview that he was doing “everything possible” to ensure that presidential candidate Stavros Dimas would be elected, but there have been clear signs that snap elections have been on the prime minister’s mind. There is an old saying that you can tell a politician is lying just by checking to see if their lips are moving. There is a local variation to this: You can tell if a Greek politician is preparing for elections by checking if they are hiring public sector employees. A few days before Christmas, Parliament passed a government amendment to rehire more than 200 workers on the Athens metro.

If you were looking for a sign of whether Samaras and his government were preparing for elections, this was it. It is worth bearing in mind that these 210 workers were hired when New Democracy was in power in 2009, a few days before elections ushered in a PASOK government. A subsequent investigation led to charges being filed against 10 public officials and the workers losing their jobs as it was deemed that hiring criteria had been bypassed.

Apart from indicating that the government wrote off the possibility of electing a president, the decision to rehire these workers (following four previous attempts by New Democracy to do so) raises new questions about Samaras’s commitment to the principles of the adjustment programme he has spent the last 2.5 years implementing. The fact that SYRIZA also voted in favour of the amendment prompts doubts about whether the leftist party is doing anything more than paying lip service to the idea of breaking with the compromised political practices of the past. These issues would be something worth discussing in the upcoming election campaign.
Like I said, never trust Greek politicians, they always have something up their sleeve and keep buying votes by increasing the public sector even when troika demands they cut it. It's unbelievable but I'm so used to their lies that nothing fazes me anymore.

Below, Greece faces snap elections next month after Prime Minister Antonis Samaras failed in his third attempt to persuade parliament to back his candidate for head of state. Bloomberg’s Elliott Gotkine and Joe Weisenthal report on “In The Loop.”

Monday, December 29, 2014

Andurand Capital's Outlook on Oil

Kelly Bit and Sabrina Willmer of Bloomberg recently reported, Turmoil Boosts Hedge Funds That Bet Against Russia, Oil:
Randy Smith’s Alden Global Capital has been betting against the ruble for the past month and a half. Yesterday, it paid off when Russia’s currency fell as much as 19 percent.

Alden, a $1.8 billion New York-based hedge fund firm, is emerging as one of the winners from a recent spike in geopolitical turmoil.

Pierre Andurand, who foresaw the oil market’s peak in 2008, made an 18 percent gain for his hedge fund in November by predicting OPEC’s refusal to cut crude production and how that would strengthen the U.S. dollar against other currencies, including the Japanese yen, according to a letter to clients, a copy of which was obtained by Bloomberg News. Warren Naphtal’s $3.9 billion currency fund is up about 24 percent this year after recent bets on a stronger dollar, according to an investor report.

The hedge funds are making money from the trades at a time when many competitors are struggling to eke out a profit. This year’s more than 40 percent decline in oil prices has curbed global growth and hobbled Russia’s economy. Bill Gross, who ran the world’s largest bond fund at Pacific Investment Management Co. before joining Janus Capital Group Inc. in September, said an excess of leverage, or borrowed money, is making markets more volatile.

“When levered money moves and tries to seek a safe haven basically you have violent price movements,” Gross said in a Dec. 12 Bloomberg Surveillance interview with Tom Keene.

Emerging Markets

A $3.3 billion fund at Gross’s former firm has been one of those hit. The Pimco Emerging Markets Bond Fund (PEBIX) held $803 million of Russian corporate and sovereign bonds at the end of September, equal to 21 percent of total assets, an amount that’s more than double that of the benchmark it tracks, according to data compiled by Bloomberg. The fund has lost 7.9 percent in the past month, trailing 95 percent of its peers.

Alden, in addition to betting against the ruble, has also been profiting from a decline in Russian stock indexes, said two people familiar with the trades, who asked not to be identified because the information is private. Russian equities are down 42 percent in the past month and a half, according to the dollar-denominated RTS Index. (RTSI$)

Andurand, the 37-year-old London hedge fund manager, said earlier this month Brent crude will continue its collapse into next year as the Organization of Petroleum Exporting Countries stops balancing the global market. His firm’s bearish stance on oil in October helped his fund reverse losses in 2014 after Brent slumped during the month.

Oil futures continued their slide today after Russia, the world’s largest crude producer, said it would refrain from cutting supply to tackle the global surplus. West Texas Intermediate dropped 2.7 percent to $54.44 a barrel in New York. Brent crude for February settlement fell 1.7 percent to $59.02 a barrel in London.

Quant Funds

Naphtal’s Boston-based P/E Investments benefited indirectly from oil’s plunge as it bet on currencies with little exposure to commodities, according to two people familiar with the matter, who asked not to be identified because the information is private. The firm’s main fund, which relies on computer models to trade, rose 4 percent in November, helped by the U.S. dollar and by wagers against the Canadian and Australian dollar, the euro and the Swiss franc, according to one of the people.

The firm joins other quant funds in using computer programs to beat star managers this year, in part from the plunge in oil prices that some human traders dismissed. Hedge funds on average are trailing the Standard & Poor’s 500 Index for a sixth year. Hedge funds returned 1.7 percent this year through November, according to data compiled by Bloomberg, compared with a gain of 12 percent for the S&P 500.
Not all commodity funds fared well in 2014. In early December, Reuters reported, Oil's swoon on OPEC is rare boon for a few hedge funds:
OPEC's decision not to cut oil output despite a market glut gave a late-month boost to several energy hedge funds in November, pushing them toward double-digit gains in a year marked by commodity fund closures.

Greenwich, Connecticut-based Taylor Woods Capital Management, one of the larger U.S. energy hedge funds with nearly $1 billion under management, gained more than 5 percent last month and is up over 10 percent on the year, according to sources familiar with the firm's returns.

The fund, run by ex-Credit Suisse traders George "Beau" Taylor and Trevor Woods, runs a diversified energy-related portfolio, but the slump in oil prices to five-year lows after the OPEC meeting was a key driver, the sources said.

Pierre Andurand, founder of the BlueGold fund that had gigantic gains during the 2008 oil market slump, made 18 percent last month at his $350 million London-based Andurand Capital Management, which bet correctly on a dive in oil prices after the OPEC decision, the sources said. The November run extended the fund's annual gain to around 20 percent.

Crude oil prices have tumbled about 40 percent since June, the slump accelerating after the Organization of the Petroleum Exporting Countries decided last month not to cut production in spite of an oversupplied market - a decision that followed weeks of furious speculation and uncertainty in the market.

"Not everyone dared to put on heavy positions because no one really was sure what OPEC was going to do," said Tariq Zahir, managing member at Tyche Capital Advisors, a small-sized commodity trading firm in Hollow Way, New York. Tyche exited its crude oil positions prior to the meeting.

Andurand Capital could not be reached for comment. Taylor Woods declined comment.

Prior to November, Andurand Capital was up just about 2 percent on the year, according to the "The Nelson Report" on hedge fund performances, compiled by futures broker Newedge.

The Nelson Report's list of other well-known commodity funds that also trade energy and with annual gains through October includes the $1.3 billion SummerHaven Commodity Absolute Return Fund in Stamford, Connecticut, which rose 7 percent, and the $200 million Merchant Commodities Fund in Singapore, which was up 27 percent.

Those were rare bright spots in a commodity fund industry that's been steadily shrinking for several years.

Funds going out of business this year include Houston-based AAA Capital Management Advisors, which will shut its doors and return investor money by the year-end after lackluster returns. The fund, at its peak, managed more than $2 billion, but now has less than $540 million under management.

Brevan Howard, one of the world's biggest hedge fund managers, is closing its $630 million commodities fund, which was down about 4 percent through October, a source familiar with the matter said on Monday.
Over the weekend, I had a chance to exchange emails with Pierre Andurand, founder of Andurand Capital Management to discuss his market views. You will recall I discussed Andurand Capital when I reviewed Kate Kelly's book, The Secret Club That Runs the Word and in a follow-up comment where Andurand Capital responded to its critics, setting the record straight on its net performance and some of the wild claims made in Kelly's book.

My sources tell me Andurand Capital is up 14% net in December, bringing the YTD net performance to +36% and assets under management are now around $400 million. Moreover, BlueGold Legacy investors are up 25% in 2013 and 44% in 2014 to date (+33% net annualized since 2008).

In early October, Andurand Capital correctly predicted that it was highly likely OPEC would not cut or cut just a little amount, and that Brent would finish the year 2014 at $60 a barrel, and go down to $50 a barrel in Q1. 

I asked Pierre Andurand to share his market views with my readers. He responded:
I think Brent will trade down to $50/bl in q1 2015 and WTI down to $45/bl. After that we should be in a $50-$60 range for 6 months or so, and then go back up in 2016 to $70-80.

The oil markets were very stable between early 2011 and mid 2014 because the growth in US shale oil production was exactly offset by an equal amount of supply disruptions. This gave a false sense of security and balance to the market but it was actually just a coincidence.
Since summer 2014, we have had less supply disruptions (some oil come back from Libya and Iran, and even Iraq), while US supply growth stayed unabated, and demand growth ended up being much weaker than the market expected (700kbd vs 1.4mbd expected earlier in the year). All that moved the global S&D by 2mbd for 2h14 and 2015. The oil market suddenly got 2mbd oversupplied for 2015, and likely to start 2015 with high inventories.
That led to prices going down to rebalance the market as there is not enough storage capacity for inventories to rise 2mbd for more than 4-6 months. In the past, every time the market would get oversupplied Saudis/OPEC would reduce production to support prices, which brought a rising floor on prices (except late 2008/early 2009 because of the severity of the financial crisis). This time the Saudis decided for the first time since 1986 to defend its market share instead of prices with a view that the swing producers should now be the high-costs producers (Pre-Salt Brazil, Canada tar sands, US Shale oil etc).
Indeed in 2008, OPEC thought they would be producing 38mbd in 2014, and in reality because of lower demand growth than expected, and higher supply growth from non OPEC, OPEC ended up producing only 30mbd in 2014. The Saudis understood that it was a lost battle to support prices every time, as it would only encourage sub-trend demand growth, and high non OPEC supply growth at the expense of their own market share. Saudis/OPEC retreating from being the swing producer means much lower prices first in an oversupplied market, and then more volatile prices. We will see very large price ranges for oil prices, which will have an effect on many other financial assets too.

Much lower prices will slow down non OPEC production growth dramatically over time (but it will take some time and will be path dependant), and will lead to bankruptcies in the less efficient producers, and the most levered ones, it will bring a lot of M&A activity in the sector, and will put a lot of pressure on countries that are major oil exporters. I believe it will be a very eventful roller coaster.

It is interesting to note that speculative length hasn’t gone down since August but has actually gone up (in number of contracts), which means that the move down came mainly from more producer hedging, and more inventory hedging. When inventories go up, this lead to more selling of futures to lock in the contango. Specs don’t need to sell or sell more for prices to go down. I think if anything too many people are trying to play the eventual rebound way too early.
I then followed up with some questions and comments and Pierre was kind enough to respond (his response is in red):
  • You feel WTI might briefly go below $50, then stabilize around $50-$60 a barrel in 2015 and then eventually move higher to $70-$80 a barrel in 2016 but you do mention that demand growth has been weaker than expected. My own macro thesis has been that outside the US, global growth is much weaker than expected, and this can be a source of concern as the US dollar keeps rising, weighing down commodity prices and bringing global disinflationary/ deflationary headwinds to the US via import prices. If this happens, won't oil and other commodity prices stay low for many years? Brent going down to $50. I think WTI will be a few dollars less, ie $45. I agree with you that USD will likely get stronger and will create headwinds for oil demand and economic growth outside the US. Also as many emerging countries are abandoning price subsidies in energy, the demand response of lower prices will not be as large as people might expect. But I also think lower prices will have an impact on supply growth (much lower), and potentially bring revolution and destabilization in large oil exporting countries, and that will reduce supply, bringing higher prices back eventually.
  • Of course, if US growth keeps moving along at a nice clip and lifts the global economy out of its stagnation, then oil and commodity prices can rebound fairly quickly but I'm not sure this will happen as the euro zone, Japan, and China are slowing down considerably and seem to be stuck in a long period of deflation/ stagnation. Yes my thesis is not that much based on demand. I do believe lower prices will bring some incremental demand back as there will be less need for biofuels, alternatives, efficient engines, and people will go back to big cars consuming large amounts of gasoline, and also because overall I think it benefits world GDP growth. So I do think overall demand growth will be higher than for 2014, but probably lower than the average of the last 10 years. That’s why I am coming up with 1mbd demand growth worldwide over the next few years.
  • In my opinion, the Saudis didn't want to cut supply because they are worried about global growth and future earnings. High oil prices act as a tax on consumers so by holding production steady and lowering oil prices, they are effectively helping central banks ease financial conditions around the world. Any thoughts on this? Yes it is true and part of the equation (bringing oil demand growth back up). But they are also trying to lower supply growth in order to have higher prices later.
  • You are correct that much lower oil prices will slow down non OPEC production dramatically over time but you mention it's "path dependent". Can you elaborate on this? Here I mean the lower prices go, the higher they will go later. If they don’t go down enough, they will stay “low” for longer.
  • You see more volatility in oil prices going forward which will affect other financial assets (stocks and corporate bonds). I wrote a comment about howthe plunge in oil won't crash markets but others think otherwise. Where do you stand on this? Will markets decouple from oil prices in 2015 or will a further decline in oil "shock" markets into another crash? I do not have a strong view on that… It’s always hard to predict domino effects, so the best is just to be aware of the potential. Would a panic in energy high-yield bonds spread to all high-yield bonds? Will selling in oil exporting emerging markets spread to all emerging markets? Etc. I think that large moves in oil already have a direct impact on many currencies and will be the largest cause of currencies moves (RUB, Nigeria, Norway etc obviously, but also JPY, EUR because of the impact on inflation and the response of Central Banks). Same for emerging market equities. And it will also have an impact on certain high yield bonds. It will also obviously have an impact on companies that are oil price sensitive (producers, consumers, services, etc).

    I do not know yet if oil prices going down will crash markets. And that is where it is path dependent too. Lower prices are overall good for economic growth and risk assets in general as it puts more money in the hands of consumers who will spend it and support economic growth. But if oil prices crash too much, maybe it could have a negative psychological impact, and also lead to large oil exporting countries getting destabilized eventually? I do not think equity markets will crash next year because of oil. But maybe a large oil price move might force people out of their complacency?

    Also less petrodollars in the system will lead to less buying of financial assets than the last few years from the Gulf and Russia, and even selling of financial assets in order to raise cash to pay for budget deficits. This could have an impact on risk assets in general.

    On the balance though, I think lower oil prices are good for economic growth, and supportive of equities markets in general.
  • Your discussion on specs and hedgers is fascinating and I think you're right, many hedgers are trying to play the rebound too early. I remember Continental Resources CEO, Harold Hamm, was so sure oil prices would rebound fast that he publicly stated he wasn't hedging any longer. His stock kept plummeting after that along with those of other energy companies, especially oil drillers. I think hedgers had to hedge more and Hamm was the exception, and maybe since was forced to hedge recently? Banks must have pressured shale oil producers to hedge more in order to keep their loans. Specs have been net buying over the last 3 months! Too many are trying to play the rebound too early.
  • T. Boone Pickens came out recently predicting the return of $100 a barrel in the next 12 to 18 months, stating OPEC will slash production in the first half of 2015. He also stated you have to look at rig counts to predict oil prices. Do you use this metric as a forecasting tool? I don’t think OPEC will slash production. Saudis’ message is very clear and they can withstand the storm. It is wishful thinking from him. Yes I look at rig counts, and clearly lower prices will slow down production growth in US and Canada first, and everywhere else eventually. So far I only see vertical rig counts going down, which do not have too much impact on production growth. I think much lower oil prices will plant the seeds for the next big bull run, but I think it will be for 2017-2018. Eventually by 2018-2019 I think prices could make new all-time high. That is why I am optimistic about trading opportunities in oil markets, as there will be more volatility and larger moves than in the past thanks to OPEC letting prices balance the market.
  • Lastly, how would you respond to skeptical potential clients who think that you can't maintain or repeat your performance? I do not see why it will be hard or impossible to repeat it. My returns in 2014 were close to my average returns of the last 10 years. And I think there will be large moves in the next 10 years that will bring many opportunities. There will always be opportunities in the oil market. They cannot be stable for very long.
I thank Pierre Andurand for sharing his market views and as I stated in my comment when Andurand Capital responded to its critics, even though I foresee challenging times ahead for most commodity funds, investors shouldn't ignore active commodity managers, "especially ones like Andurand who have a proven track record in printing money."

My exchange with Pierre Andurand showed me a different perspective than that portrayed in Kate Kelly's book.  I find him highly intelligent, down to earth and an excellent trader who understands the oil market. He's definitely the type of manager that I would have allocated to when covering directional hedge funds at the Caisse and it's not just based solely on his performance.

Those of you looking to gain more information on Andurand Capital can contact Hakon Haugnes at hhaugnes@andurandcapital.com.

Below, Francisco Blanch, BofA Merrill Lynch Global Research, and Brian Belski, BMO Capital Markets, discuss whether it's time to buy energy sector given the disruption in Libya. I don't think it's a major turning point and would steer clear of energy stocks for the foreseeable future.

And Stephen Schork, editor and founder of The Schork Report, says the bottom on oi is unknown. "We don't know how much lower oil can go, it's similar to 2008 when we knew oil at $120, $130 and $140 made no sense, but high prices became the reason for higher prices. It's the same thing in reverse." Like I said, there will be short covering and relief rallies but the trend in the near term is lower for oil and commodity stocks in 2015.

Lastly, for energy prices to rebound, Saudi Arabia needs to change its rhetoric, says Jonathan Barratt, Chief Investment Officer at Ayers Alliance Securities.

Update: Bloomberg reports oil tumbled to the lowest level in more than five years on speculation a global supply glut that’s driven crude into a bear market will continue through the first half of 2015.

Friday, December 26, 2014

China to Overhaul Its Pension System?

CCTV reports, China to overhaul dual pension system:
China will reform its public sector pension system to reduce disparity between the public and private sectors, Vice-Premier Ma Kai said Tuesday at the bi-monthly session of the National People’s Congress Standing Committee.

Under China’s dual pension system, civil servants and employees in state agencies do not need to pay for their pensions — the government provides full support for them. But employees of private enterprises have to pay 8 percent of their salary to a pension account.

After retirement, private urban employees usually get a pension equal to about half of their final salary, but civil servants get much more without making any financial contribution.

"Some civil servants retire around the age of 50 but can get a pension of 5,000 or 6,000 yuan per month. I’m 70 years old now and I get 3,000 yuan per month. This is unfair," says a retiree in Guangzhou.

"My mother in law only has a monthly pension of 2,100 yuan. She worked for 30 years. I know many people have pensions of more than 10,000 yuan per month. That's a huge difference," says a Guangzhou resident.

The different methods of payment, accounting and management in China’s public pension systems have resulted in widespread disputes.

"Those who contribute a lot at work deserve high salaries. But after retirement there is no reason for them to get that much more than others. The government should call for fairness and not widen gaps. The five-times gap is huge," says Ding Li, research fellow in Guangdong Academy of Social Sciences.

And now the reform is coming. The aim is to build a system for Party, government and public institution staff that is similar to the one used by the private sector.

This move will affect around 37 million people: 7 million civil servants and 30 million public institution staff.

China has the world's largest number of civil servants and staff of publicly-sponsored institutions, and the national population is expected to reach 1.43 billion by 2020.

The State Council is making efforts to unify the nationwide management of the pension system to cover the entire population.
Telesur also reports, China To Expand Pension Coverage to Public Sector Workers:
Pension coverage for workers above the age of 15 has increased by 52 percent over the last four years.

About 40 million government, party, and public sector workers will be affected by the latest reform to China's pension system, a process that began in 2009.

"Next year, we will comprehensively deepen reform on social security regulations, and work out an overall reform plan to the pension system, as well as detail policies on unifying the national pension and completing personal accounts. It is expected to boost the level of pensions for both urban and rural residents," said Chinese Minister of Human Resources and Social Security Yin Weimin.

The latest proposals are part of China’s larger 12th Five Year Plan, which includes strategies to improve the social security system and expand the coverage of basic pension insurance to cover all urban and rural resident. The new reforms will go into effect January 2015.

During his address at the bi-monthly National People's Congress Standing Committee, Chinese Vice Premier Ma Kai said the government hopes to cover 900 million people by 2017, and 1 billion in 2020, raising the coverage rate from the current 80-95 percent.

Director of the International Labor Organization’s (ILO) Social Protection Department Isabel Ortiz praised the efforts by the Chinese government to expand pension and social welfare coverage throughout the country, stating, “China, for example, has achieved nearly universal coverage of pensions and increased wages.”

According to the ILO, pension coverage for workers above the age of 15 has increased by 52 percent over the last four years. By the end of 2013, 850 million people, nearly 75 percent of the population aged 15 and above, were covered under the four Chinese pension plans.

The Chinese National Social Security Fund currently stands at US$125 billion, which marks an increase of over US$93 billion in five years.

Despite important progress in expanding social security and pension system coverage, China has been urged to improve the protection of workers’ rights, labor conditions and the quality of collective bargaining.
After reading this, I decided to publish it as it was encouraging to see China moving ahead to improve pension coverage and to reform its dual pension system to make it more fair.

Under the current system, civil servants and employees in state agencies don't need to pay for their pensions. Instead, the government fully supports them. However, private sector employees have to pay 8% of their salary to the pension account.

After retirement, private sector employees usually get a pension equal to about half of their final salary, but civil servants get much more without making any financial contribution at all. The reforms are meant to cut these widespread disparities.

Of course, more reforms are needed if China is going to make these pensions sustainable over the long-term. They need to hike the retirement age, increase contributions, introduce risk sharing and more importantly, drastically improve the governance at all their public pensions, which isn't a given in a country where widespread corruption is rampant.

And these reforms can't come soon enough as China's state pension fund is set to grow just as the country is sliding into a pension black hole and is ill-prepared for the demographic challenges that lie ahead.

You can watch a CCTV report on why China is moving to overhaul its dual pension system. You can also watch a CCTV interview featuring Dr. Wei Nanzhi from the Chinese Academy of Social Sciences discussing pension reforms.

Below, a clip discusses why China's national pension is a time bomb. Watch this clip and keep in mind my comments on governance and reforms above.

Wednesday, December 24, 2014

OTPP and PSP Bet on Clean Energy?

The Ontario Teachers' Pension Plan just put out a press release, Ontario Teachers’, PSP Investments and Santander partner on global renewable energy and water portfolio:
Ontario Teachers' Pension Plan (Teachers') and the Public Sector Pension Investment Board (PSP Investments), two of Canada's largest pension funds, today announced an agreement with Banco Santander, S.A. (Santander) to jointly acquire a portfolio of renewable energy and water infrastructure assets. The assets, currently owned solely by Santander, will be transferred to a new company owned equally by all three parties.

The transaction, which is expected to close within the first half of 2015 subject to receipt of customary regulatory approvals, values the assets in excess of US$2.0 billion. Santander, PSP Investments and Teachers' intend to invest significant additional amounts in the new company over the next five years.

The portfolio includes wind, solar and water infrastructure assets located in seven countries that are operating or in development. The portfolio will be managed by an experienced team led by Marcos Sebares.

"We are excited about partnering with Santander and PSP Investments and look forward to supporting management in growing this company significantly in the coming years. This investment directly supports our focus on investing in platforms that provide access to development opportunities globally," said Andrew Claerhout, Senior Vice-President, Infrastructure at Teachers'.

"This investment fits well with our strategy of deploying capital in sizeable opportunities that offer long term revenues and growth potential along with solid partners. It also allows PSP Investments to continue to develop its portfolio of private energy assets while contributing to environmentally sustainable energy production," said Bruno Guilmette, Senior Vice-President, Infrastructure Investments at PSP Investments.

"Over the last seven years in Santander, the business has become one of the leading developers of renewables projects around the world, having invested over US$2 billion in renewable energy and water projects. A combination of Santander, which has consistently been voted the greenest bank in the world, and two investors, such as PSP Investments and Teachers', who have a long history of sustainable investing, marks the beginning of a new phase in the development of our company into one of the world's leading renewable energy investment companies. We have a strong balance sheet and long term investment strategy, with a mandate from shareholders to grow the new company over the next five years," said Marcos Sebares, CEO of the new entity.

Teachers' investment was led by its Infrastructure Group, which manages a global portfolio of C$11.7 billion of direct infrastructure investments, including water and wastewater, electricity distribution, gas distribution, airports, power generation, high-speed rail and port facilities.

PSP Investments' investment was led by its Infrastructure Group, which manages a global portfolio of C$6.0 billion of direct infrastructure investments, including power generation, airports, toll roads, port facilities, electricity and gas transmission, and water.

Santander's sale was led by its Asset & Capital Structuring (A&CS) team of 30 people specialized in infrastructure equity investments through its global footprint in Spain, Italy, UK, US, Brazil and Mexico. This team will manage the acquired portfolio and will lead investments in the new global renewable energy and water platform. Macquarie Capital acted as financial advisor to Santander.
This is a big deal and I expect to see more deals like this in the future as more European banks shed private assets to meet regulatory capital requirements. In doing so, they will be looking to partner up with global pension and sovereign wealth funds that have very long-term investment horizons. 

The Spaniards are global leaders in infrastructure projects (Germans and French are also top global infrastructure investors led by giants like HOCHTIEF and VINCI). When it comes to renewable energy, Spain is the first country to rely on wind as  top energy source:
Spain is the first country in the world to draw a plurality of its power from wind energy for an entire year, according to new reports by the country’s energy regulator and wind energy advocacy group Spanish Wind Energy Association (AEE)
Wind accounted for 20.9 percent of the country’s energy last year — more than any other enough to power about 15.5 million households, with nuclear coming in a very close second at 20.8 percent. Wind energy usage was up over 13 percent from the year before, according to the report.

The news is being hailed by environmental advocates as a sign that Spain, and perhaps the rest of the world, is ready for a future based on renewables. But the record comes at the end of a very rocky year for Spain’s renewable energy sector, which was destabilized by subsidy cutbacks and arguments over how much the government should regulate renewable energy companies.

Despite the flaws in Spain’s system, the numbers are promising for green energy fans. The renewable push brought down Spain’s greenhouse gas emissions by 23 percent, according to another industry report from Red Electric Espana (REE).

Spain also has one of the largest solar industries in the world, with solar power accounting for almost 2,000 megawatts in 2012. That’s more than many countries but still just a fraction of the energy produced by wind in Spain. In 2013, solar power accounted for 3.1 percent of Spain's energy, according to the AEE report.

By contrast, the U.S. produced only 9 percent of its energy with renewable sources last year, and wind accounted for only 15 percent of that.

But as the world reaches for more renewables, Spain’s record-breaking year is also a cautionary tale.

Going into 2014, it’s unclear how wind will survive steep government cutbacks.

At the moment, Spain heavily subsidizes its renewable energy sector, which costs billions of dollars in a country still in the depths of a financial crisis. When the country tried to raise individual rates for renewables, people complained bitterly and the government backed off, leaving the country with a nearly $35 billion renewable energy deficit.

The idea that renewables can’t survive without heavy subsidies might be cooling off the market in Spain and elsewhere, bringing the future of renewable growth into question. Global investment in renewable energy slipped 12 percent last year, despite the fact that the European Union and the UN have set ambitious energy goals for the next decade.

It remains unclear how the world will meet those goals given the spending-averse climate of most Western governments, but there’s no doubt they’ll be looking to Spain in 2014 to see if it can be done without going broke.
Indeed, over the summer, Spain's government dealt a death blow to renewable energy:
In the latest move to draw down Spain’s energy sector debt, Madrid unveiled a new clean energy bill this week that will cap earnings on power plants as well as introduce retroactive actions, earning a quick rebuke from the country’s already ailing renewable sector. According to a Bloomberg report, clean energy “generators will earn a rate of return of about 7.5 percent over their lifetimes,” adding that the rate may be revised every three years and is based on “the average interest of a 10-year sovereign bond plus 3 percentage points.” The new plan will be retroactively applied to programs active from July 2013.

The new plan was presented by Spain’s Industry Minister Jose Manuel Soria as a necessary evolution of the country’s renewable energy subsidy system, which he said would have gone bankrupt if no changes were made. Since taking over the country’s leadership in 2011, the right-leaning Partido Popular has continued to expand on earlier efforts to chip away at the country’s renewable energy support programs, which many critics have called unsustainable. Once hailed as one of Spain’s most viable sectors for strong growth, renewable energy has suffered under a steady restructuring of government support programs.

In addition to slowing the country’s solar and wind growth, the restructuring garnered legal action on the part of both international investors and domestic trade organizations, the latter of which has appealed to the European Commission for some level of protection from tariff and agreement reductions. Early cuts resulted in legal action against Madrid from over a dozen investment funds with stakes in the country’s solar market, adding to the unease of foreign investors.
I can tell you the cash strapped Greek government did the exact same thing on solar projects in Greece. One of the biggest risks in infrastructure projects is regulatory risk as these governments can change regulations at a moment's notice, severely impacting the projected revenues.

What are the other risks with infrastructure projects? Currency risk and illiquidity risk as these are very long-term projects, typically with a much longer investment horizon than private equity or real estate.

But both PSP and Ontario Teachers' are aware of these risks and still went ahead with this investment which meets their objective of finding investments that match their long-term liabilities. The Caisse has also been buying wind farms but I am wondering whether they're blowing billions in the wind.

Interestingly, this is the second major deal between PSP and OTPP this year. In November, I wrote about how they are nearing a $7 billion deal for Canadian satellite company Telesat Holdings Inc.

And on last week, Bloomberg reported that Riverbed Technology (RVBD), under pressure from activist investor Elliott Management Corp., agreed to be acquired for about $3.6 billion by private-equity firm Thoma Bravo and Teacher’s Private Capital.

In fact, Ontario Teachers' has been very busy completing all sorts of private market deals lately, all outside of Canada, which is smart.

Let me end with a story that inspired me this Christmas. I was struck by a CTV news clip last night, Hundreds rally to help paralyzed Alberta boy return home from hospital:
This holiday season, hundreds of people are donating money to help a paralyzed 13-year-old boy return home after months in hospital.

Lincoln Grayson has been at the Stollery Children's Hospital in Edmonton since a bicycling accident on July 4 left him paralyzed from the chest down.

"I'm grateful that my accident wasn't too severe that I don't have any brain damage," said Grayson who is one of seven children in his family. "I'd like to just be with the whole family."

The accident happened during a bike ride with his brother just six days after the family moved to Beaumont, Alta. from Lethbridge.

"We were just out exploring Beaumont," said Grayson's brother, McKay. "We just decided to go down a hill and it just didn't go so well."

Grayson flipped over the handlebars of his bicycle and landed on his face. The accident left him with several broken bones in his face and neck. Grayson, who was an athletic teenager, will likely never walk again.

"They said if he survived, he would be institutionalized for the rest of his life," said Carmen Grayson, the boy's mother. "I said no way. He's 13 years old, he's coming home."

But to bring him home, the family needs money to renovate their house to accommodate Grayson's wheelchair and other needs.

This is where family, friends, and hundreds of complete strangers have stepped in. In two weeks, Grayson's GoFundMe page has raised more than $40,000. Many of the donations have come from people in Beaumont and Lethbridge.

"It has meant the world to us," said Carmen. "We could not have done nor can we do what we're doing without the help of wonderful neighbours and friends."

For the first time since his accident, Grayson was able to spend the day at home on Saturday. His family hopes to take him home again for Christmas and eventually, on a permanent basis.

Renovations to the Grayson family home will begin in the New Year.

For now, Grayson is spending his time in hospital creating "Lincoln's 12 Days of Christmas." Each day, he films himself in his hospital bed talking about something he is thankful for, and then posts the video to his website.

"I want to share Christmas with everyone," Grayson said in his first video, struggling to speak because of the tube in his throat that keeps him breathing. "This year, my gifts will be gifts of gratitude."
Watch the CTV report and please donate to Grayson's GoFundMe page and help his family raise the funds they need to renovate their house. I wish all of you  a very Merry Christmas and Happy Holidays.

Tuesday, December 23, 2014

Oil Crash Slams Buyout Funds?

Oil Crash Wipes $11.7 Billion From Buyout Firms’ Holdings:
Oil’s plunge makes energy a great investment for the coming years, according to Blackstone Group LP (BX)’s Stephen Schwarzman and Carlyle (CG) Group LP’s David Rubenstein. For private equity firms, it’s also been painful.

More than a dozen firms -- including Apollo Global Management LLC (APO), Carlyle, Warburg Pincus and Blackstone -- have lost a combined $11.7 billion in 27 publicly traded oil producers since June, when crude prices reached this year’s peak before beginning their six-month slide, according to data compiled by Bloomberg. Stocks of buyout firms with exposure to energy have slumped, and bond prices suggest some closely held oil producers may struggle to pay for their debt.

“It’s been a really volatile period, and frankly that’s how Saudi Arabia wants it,” said Francisco Blanch, head of global commodity research at Bank of America Corp. “This is a battle of endurance.”

Brent crude oil slumped 47 percent to about $61 late last week from its high this year of $115 a barrel, dragging down energy stocks, as the Organization of Petroleum Exporting Countries sought to defend market share amid a U.S. shale expansion that’s adding to a global glut. The group, responsible for 40 percent of the world’s supply, will refrain from curbing output, U.A.E. Energy Minister Suhail al-Mazrouei said on Dec. 14.

Kosmos Energy Ltd., Antero Resources Corp., EP Energy Corp. (EPE), Laredo (LPI) Petroleum Inc. and SandRidge Energy Inc. (SD), each of which is backed by a buyout firm as its largest shareholder, fell by an average of 50 percent in U.S. trading from oil’s peak through Dec. 19 in New York. Warburg Pincus is the top stakeholder in Kosmos, Antero and Laredo; Apollo is the largest investor in EP Energy; and Carlyle, with a partner, owns the biggest piece of SandRidge, according to data compiled by Bloomberg.
Apollo, Carlyle

Apollo has $5 billion invested in energy debt and equity, including companies that are closely held. Carlyle has directed 10 percent of its $203 billion in assets into the industry. Blackstone, the second-biggest shareholder in Kosmos, has backed drilling projects off Ghana’s coast and in the Gulf of Mexico.

The deals highlight private equity’s role in the debt-fueled shale push, as hydraulic fracturing in search of oil and gas leads to higher production. After investing billions of dollars, the firms are preparing to step in with more cash to fund development when prices stabilize.

Carlyle increased its exposure to the industry in December 2012 when it invested $424 million to share revenue from NGP Energy Capital Management, an Irving, Texas-based investment firm that has stakes in at least six publicly traded exploration and production companies. NGP’s holdings include Memorial Production Partners LP, which declined 39 percent; Rice Energy Inc. (RICE), which fell 21 percent; and RSP Permian Inc., which dropped 17 percent.
Laredo, Kosmos

Warburg Pincus, the New York-based investment firm that hired former Treasury Secretary Timothy F. Geithner as president last year, saw its holding in Laredo decline 66 percent, while Kosmos, a West Africa-focused exploration and production company, has held up better, dropping 26 percent.

EP Energy was bought by New York-based Apollo and others for $7.15 billion in May 2012 and taken public early this year. Apollo and its clients, which put in about $1.8 billion of equity, are down about 20 percent on their initial stake, based on the latest closing share price. Apollo cited EP as a key contributor to a 2 percent decline in the firm’s private equity holdings during the third quarter.

“It could be worse from here,” Greg Beard, who oversees Apollo’s energy investments, said of oil producers at the firm’s investor day on Dec. 11. “When the market has been in excess like it is now, you see price declines. With a change in the stance of OPEC from one of price protection to the protecting of market share, we’re in excess for at least the next 12 months.”

Samson’s Bonds

The bonds of some closely held buyout-backed companies are falling as well.

Samson Resources Co.’s $2.25 billion of bonds due in 2020 dropped to 43.5 cents on the dollar from a peak of 103.5 cents in August. KKR & Co. and its partners acquired Samson in December 2011 for $7.2 billion, the most ever paid in a leveraged buyout of an energy producer, including $4.1 billion of equity.

Heavily reliant on natural gas, the Tulsa, Oklahoma-based company suffered big losses after the deal when prices for the commodity slumped. Standard & Poor’s and Moody’s Investors Service downgraded Samson’s junk credit ratings in the last two weeks.

Large buyout firms are emphasizing the opportunities that lower oil can ultimately create, rather than any immediate damage.
Few ‘Difficulties’

Blackstone, based in New York, is raising its second energy-focused fund with a $4.5 billion target. The firm, which owns stakes in startup Vine Oil & Gas LP as well as Kosmos, is weighted more toward natural gas and electric power than oil, Schwarzman said at a financial conference this month. The price drop “has not created a lot of difficulties for us,” Schwarzman, Blackstone’s chief executive officer, said at the New York event.

Henry Kravis, co-CEO of New York-based KKR, said at the same conference, on Dec. 10, that he welcomes the decline as a chance to fund cash-starved producers. Carlyle co-CEO Rubenstein said the next five to 10 years stack up “as one of the greatest times” to invest in energy.

“If you have an asset you already own, it’s probably going to go down in value,” Rubenstein said. If you have a lot of untapped money to invest, “it’s a great time to buy,” he said, adding that Washington-based Carlyle has about $7 billion to spend in energy.
Igniting Deals

Warburg Pincus raised $4 billion for energy in less than a year for its first fund dedicated to energy deals, which started investing this year. The firm, which had targeted $3 billion for the vehicle, has deployed more than $9.5 billion in energy-related companies since its founding in 1966.

“Dislocations create interesting investment opportunities, and we’re fortunate to have plenty of available capital,” Peter Kagan, who leads energy investing at Warburg Pincus, said in an e-mail.

Oaktree Capital Group LLC (OAK), the world’s biggest distressed-debt investor, is sizing up the bonds of struggling oil producers, Howard Marks, the Los Angeles-based firm’s co-chairman, told the conference. Marks sees the potential for oil’s decline to ignite a new debt crisis, he later told clients in a Dec. 18 letter.

“We knew great buying opportunities wouldn’t arrive until a negative ‘igniter’ caused the tide to go out, exposing the debt’s weaknesses,” Marks wrote. “The current oil crisis is an example of something with the potential to grow into that role.”
You should all take the time to read a note Oaktree's Howard Marks recently put out to clients, The Lessons of Oil. It's excellent and he rightly notes that DoubleLine's Jeffrey Gundlach was one of the few who got rates right in the last few years. (Interestingly, Bill Gross, the fallen bond king, loves TIPS while Gundlach hates them. I'm with Gundlach on that call).

Howard Marks is one of the best distressed debt investors in the world but I have to disagree with him, while I see the surging greenback and global deflation continuing to pound energy and commodity prices next year, I don't see the plunge in oil crashing markets. Markets will decouple from oil and melt up in 2015, led by tech, biotech, healthcare, financials and retail, but the biggest gains will be in tech and biotech.

However, as the article above demonstrates, there will be pain in the energy portfolios of public and private funds. Buyout funds are not immune to macroeconomic developments. They have suffered huge losses investing heavily in energy which is why you see their big wigs come out to state they see tremendous opportunities in energy.

Unfortunately, as Gundlach and others have explained, this time it's different, and there won't be any big rebound in energy and commodity prices. And god forbid deflation hits America, then it's going to be a bloodbath for energy and commodity related investments, regardless of whether it's in public or private markets. 

Importantly, all the risk departments at every pension and sovereign wealth fund should carefully tally up their exposure to public and private energy and commodity investments, including emerging markets like Russia, Venezuela and Mexico, as well as countries like Canada and Australia (Sober Look just wrote an excellent comment explaining why if energy prices remain at current levels, Canada's economy is in big trouble).

Public pension funds are feeling the pain of the plunge in energy and commodity prices through their public and private investments. Some will get clobbered while others who minimized their exposure to these sectors and understood the macro environment, will fare better.

Below, Mike Harrowell, Director of Resources Research at BBY, says oil prices could fall to $15-20 a barrel unless Saudi Arabia cuts output to restore market balance.

Also, take the time to read Gary Shilling's Bloomberg comment, Are You Ready for $20 Oil?. Clearly most of you aren't! Shilling recently discussed how the fall in the value of the ruble impacts the Federal Reserve and his call for global deleveraging. He spoke on “Bloomberg Surveillance.”

Monday, December 22, 2014

The $800 Billion Leveraged Loan Blacklist?

There's a Blacklist in the $800 Billion U.S. Loan Market and It's Not Illegal (h/t, Johnny Quigley):
What do Highland Capital Management, Fortress Investment Group LLC (FIG) and Cerberus Capital Management have in common? The firms, which manage some $110 billion among them, are on a list that says they can never invest in a $155 million loan that’s trading in U.S. markets.

RBS Holding Co., the owner of direct marketer Quadriga Art, banned the three firms and seven others last year from buying parts of the loan, according to two people with knowledge of the matter who asked not to be named because the decision was private. They were deemed, the people said, to be too demanding in debt restructurings, a fate that executives at RBS -- which has no relationship to the Scottish bank -- considered as Quadriga’s business faltered.

Unlike any other market in the U.S., the blacklist rules in leveraged loans. No regulator polices trading in the $800 billion market. Here, borrowers -- and the investors who control them -- choose who gets into the club. It would be as if Apple Inc. (AAPL) got to decide who could buy its stock.

“I really can’t think of a good example of another market where you really are selling to a lot of people but you still retain the right to keep some people out,” said Elisabeth de Fontenay, a professor at Duke University School of Law in Durham, North Carolina, and a former corporate lawyer.

While banks managing stock and bond deals can pick which investors are allotted securities in public offerings, anyone with enough money can buy the assets once they start trading in the market. Not so with loans. The lists prohibiting investors can last until the debt matures.

Booming Market

The practice poses risks to a market whose size has quadrupled from about $200 billion over the last decade as plunging interest rates fueled investor demand for securities that offer extra yield. Blacklisting reduces the number of potential buyers, which in turn makes the loans difficult to trade, and can exclude the savvier investors who are better able to fight for creditor rights in a default. 

“These types of limitations are tremendously detrimental” to the market’s quantity and quality of buyers and sellers, said Greg Margolies, a senior partner at Los Angeles-based Ares Management LP (ARES), which manages about $80 billion in assets including speculative-grade debt and real estate. “Ares will not invest in a name where secondary liquidity can dry up immediately because an issuer has decided to blacklist a number of market participants.”

Blacklist Defined

The Merriam-Webster Dictionary defines blacklist as “a list of persons who are disapproved of or are to be punished or boycotted.” In the loan market, there are three things that can warrant punishment: having a reputation for being a tough negotiator in debt restructurings, like Highland and the other firms in the RBS deal; having an affiliation with a borrower’s competitor; or simply being disliked.

“We protect the rights of our investors,” Jim Dondero, president of Highland, said in an e-mailed statement. “Sometimes we must pursue the ‘bad acts’ of management teams or sponsors. It stuns us that some managers are passive and never protect their investors.”

Mark Schulhof, chief executive officer of RBS, declined to comment. Gordon Runte, a spokesman for Fortress, and Peter Duda, a spokesman for Cerberus at Weber Shandwick, declined to comment.

Illiquid Assets

The lack of liquidity in speculative-grade debt has drawn warnings from regulators, including the Financial Stability Board and the U.S. Securities and Exchange Commission, as individual investors poured money into mutual funds and exchange-traded funds. The concern is that it’s become too easy to get into a market for people who don’t understand how tough it may be to cash out when sentiment sours.  

Trading is slow even in a bull market.

It took 20 days on average to complete a loan trade in the three months ending in June, according to data compiled by the New York-based Loan Syndications & Trading Association. That’s almost seven times as long as the three-day average in the corporate bond market.

Yet for all of the concern expressed by U.S. policy makers, none of them oversee the loan market. Its unregulated status traces back to securities laws that were drafted in the 1930s, when company loans were mainly private transactions between one bank and one borrower. These days, though, the debt is mostly sliced into pieces worth several million dollars and distributed to investors.

The SEC’s authority in this market is limited to loans that meet the legal definition of a security, which “depends on the facts, circumstances and economic terms of the loan or loan tranche,” according to spokesman John Nester. “The SEC is focused on the oversight of liquidity management in mutual funds and ETFs, and will continue to vigorously pursue violations of the securities laws within its jurisdiction,” Nester said in an e-mailed statement.

Bad Blood

Blacklisting is rampant. And growing.

Data gathered by Xtract Research show that 77 percent of all loan deals in the third quarter included provisions giving borrowers the ability to block individual lenders, up from 51 percent at the end of last year. The lists can often be updated to add new investors whenever a borrower wants.

The most common explanation given for excluding potential buyers is that they have an affiliation with rivals of the borrower. There’s private information that lenders get access to -- things like financial projections -- that the borrower doesn’t want them to see.

Robert Blank, head of leveraged-loan research at Xtract in Westport, Connecticut, calls those circumstances the most “reasonable” for justifying the blacklist.

Jonathan Kitei, head of U.S. loan sales and collateralized-loan obligation origination at Barclays Plc (BCS), said, though, that he’s seen personal animosity shape lists.

“Often times you see a sponsor put an investor on a blacklist because one partner at the firm doesn’t like the investor,” said Kitei, who is based in New York. “There are great inconsistencies in the use of blacklists.”

Leon Black’s Apollo Global Management LLC has blocked Highland from buying several loans of its takeover targets, according to a person with direct knowledge of the matter. There’s a history of feuding between the two firms: Highland sought in 2006 to stop a merger between Apollo-backed SkyTerra Communications and Motient Corp., triggering a series of court battles.

Highland, a Dallas-based money manager, was banned from deals including loans taken out by Caesars Entertainment Corp. (CZR), the casino operator partly owned by Apollo, according to the person, who asked not to be identified because the matter is private.

Charles Zehren, a spokesman for New York-based Apollo at Rubenstein Associates Inc., declined to comment.

‘Shindler’s List’

Blacklisting dates back to at least the late 1990s, when Nextel Communications Inc.’s then chief financial officer Steve Shindler penalized lenders who didn’t participate in the company’s new credit facility by banning them from buying the debt in the secondary market, according to industry newsletter Bank Letter.

It became known as “Shindler’s List,” reflecting Wall Street’s penchant for tasteless puns that twist history. The phrase is a reference to German businessman Oskar Schindler’s list of Jews to be saved from transportation to concentration camp Auschwitz during World War II, the subject of the Oscar-winning film of that name in 1993.

To this day, traders still use the name when talking about blacklists. Shindler, who is now chief executive officer of NII Holdings Inc., the bankrupt mobile-phone company that uses the Nextel brand in Latin America, declined to comment.
‘Disqualified Institutions’

“It’s anti-American,” Lee Shaiman, a senior portfolio manager with Blackstone Group LP (BX)’s credit unit GSO Capital Partners in New York, told the LSTA’s annual conference Oct. 23 when asked about the practice. “It’s anti-competitive.”

Some investors find out that they have been barred when they try to complete a trade and are turned away by broker-dealers. Others never know. Most lists are kept privately by the banks that arrange the deals.

Occasionally, they’re included in public credit agreements, like the blacklist orchestrated this year by a Goldman Sachs Group Inc.-controlled company named Interline Brands Inc. An addendum to a March 19 regulatory filing for the deal listed two names as “Disqualified Institutions” that couldn’t buy the loans: hedge funds Bulldog Investors and QVT Financial.

Andrea Raphael, a spokeswoman for Goldman Sachs, said the bank didn’t select the names on the list. Lev Cela, a spokesman for Interline, didn’t respond to e-mails and telephone calls seeking comment. A QVT representative declined to comment.

Phil Goldstein, the co-founder of Bulldog in Saddle Brook, New Jersey, was unaware for months that he had been banned. “It kind of irks you that there’s somebody saying you’re not good enough to do this or we don’t want you for that,” he said.

The whole thing is perplexing to Goldstein.

His fund, he said, doesn’t even invest in loans.
Welcome to the Wild West of credit markets, the unregulated, ever expanding U.S. leveraged loan market.

Back in July, Fed Chair Janet Yellen warned she sees signs of asset price bubbles forming in some markets such as those for leveraged loans and lower-rated corporate debt:
“We’re seeing a deterioration in lending standards, and we are attentive to risks that can develop in this environment” of low interest rates, Yellen said today in semi-annual testimony to the Senate Banking Committee.  
And in October, the Fed said it was stepping up its oversight of high-risk leveraged loans, shifting to a deal-by-deal review after its previous industry-wide guidelines were largely ignored by banks.

However, if the Fed sees a deterioration in lending standards and risks developing in the leveraged loan market, it didn't discuss them in its most recent deliberations where it basically committed itself to keeping rates low for considerable time longer despite the linguistic nuances in its text.

Financial Advisor reports the U.S. Treasury is also warning leveraged loans may be systemically risky:
Excesses in the buying of bank leveraged loans by asset managers from banks may be systemically risky, the Treasury Department’s Office of Financial Research said in its annual report Tuesday.

As banks moved to shrink their leveraged loan holdings to reduce risk and comply with the Volcker Rule, asset managers and pension funds have stepped in to buy.

The agency noted asset managers are purchasing an increasing share of leveraged loans on behalf of investors in hedge funds, high-yield bond mutual funds, and collateralized loan obligations.

“The growing role of asset management products in funding leveraged lending adds urgency to discussions about structural vulnerabilities, such as redemption, fire sale and maturity transformation risks in credit funds, and whether and to what extent they can contribute to financial stability risks,” the report said.

OFR added continuing concentrations of money market fund assets with a few large asset managers may require more intense monitoring of potential cash reallocation.
Increased scrutiny is impacting the leveraged loan market. Leveraged Loan Funds Seen Plunging 40% After Record Year:
Wall Street dealers are bracing for a steep drop in issuance of collateralized loan obligations after a record amount of the debt was raised this year, threatening to boost borrowing costs for the neediest companies.

Rules designed to limit risk-taking may mean CLO sales will be at least 41 percent less than the unprecedented $119.2 billion issued so far in 2014, according to the most pessimistic forecast by JPMorgan Chase & Co. (JPM:US) At least three other leveraged-loan underwriters are also projecting a decline even though the regulations won’t go into effect until at least 2016.

CLOs helped finance some of the biggest leveraged buyouts in history, and the outlook for a drop in issuance comes as prices in the more than $800 billion market for high-yield, high-risk loans are already near a two-year low. A BC Partners-led group of investors agreed to buy pet-store chain PetSmart Inc. for about $8.3 billion, the largest LBO for a U.S. company this year.

“The net result of the CLO market shrinking is that there will be less capital available for the leveraged-loan market and as a result borrowing costs will go up,” John Fraser, managing partner at 3i Debt Management U.S., said in a telephone interview. The U.S. debt-investment arm of the London-based buyout firm 3i Group Plc oversees $13.3 billion.
CLO Forecasts

Morgan Stanley predicts CLO issuance will fall to $75 billion to $85 billion in 2015, while Wells Fargo & Co. (WFC:US) sees a drop to $90 billion, according to research reports. Deutsche Bank AG says there may be $80 billion to $90 billion raised next year, according to a Dec. 10 report. JPMorgan expects CLO issuance of $70 billion to $80 billion, according to a Nov. 26 report.

CLO sales surpassed the previous 2006 high of $94 billion in October, according to JPMorgan. The growth has been a boon to lending with $485.8 billion of institutional loans issued in the U.S. this year, following the record $701.7 billion in all of 2013, Bloomberg data show. The debt is typically sold to non-bank lenders such as CLOs, mutual funds and hedge funds.

CLOs controlled 63 percent of the leveraged-loan market in the second quarter, according to the New York-based Loan Syndications & Trading Association. The funds purchase the speculative-grade debt and package it into securities of varying risk and return, typically from a AAA rating down to B.
Loan Prices

An investing arm of Zurich-based Credit Suisse Group AG (CSGN) issued a $685.8 million CLO this month, data compiled by Bloomberg show. The deal includes a $413.2 million portion rated AAA that pays interest at 1.48 percentage points more than the London interbank offered rate.

A reduction in CLOs would come when loan prices are falling as other buyers flee. Prices fell to 94.5 cents on the dollar today, the least since August 2012, according to the Standard & Poor’s/LSTA U.S. Leveraged Loan 100 Index. Investors pulled $1.05 billion from U.S. mutual and exchange-traded funds that buy leveraged loans in the week ended Dec. 10, a record 22nd straight week of withdrawals totaling more than $14 billion, according to Lipper.

The drop in prices may bode ill for Citgroup Inc., Nomura Holdings Inc., Jefferies Group LLC, Barclays Plc and Deutsche Bank, which, according to a company statement, have underwritten debt to back the buyout of Phoenix-based PetSmart.
LBO Loan

The financing for the deal announced Dec. 14 may be marketed to other lenders next year, according to a person with knowledge of the transaction, who asked not to be identified because the information is private.

The average yield for all loans rose to 6.01 percent in December from 5.84 percent in November, according to S&P’s Capital IQ Leveraged Commentary & Data.

New restrictions on CLOs are aimed at limiting excesses in the leveraged-loan market, where regulators have warned of froth. Investors piled into the debt in their search for yield as the Federal Reserve kept interest rates close to zero.

While the impending regulation hasn’t curtailed CLO formation in 2014, the cost to raise the biggest portions of the funds rose in November to an almost three-year high, according to Wells Fargo. The risk-retention rule, released on Oct. 21, is intended to make sure CLO managers are on the hook for at least a portion of their deals. It’s part of the 2010 Dodd-Frank Act enacted in response to the credit crisis that was fueled in part by securitized debt, particularly in the mortgage market.
What are the key takeaways for pension funds? While some firms defend the practice of blacklisting for competitive reasons, the more pressing issue is this market is growing by leaps and bounds and liquidity -- or lack of liquidity -- can come back to haunt investors.

More importantly, as the market grows, there are increasing systemic risks that can contribute to another financial meltdown. I worry about this now more than ever as there are delays and push back on banking regulatory reforms.

Does this sound familiar? Well, it should because it all happened in 2008 with toxic CDOs and CDS except the leveraged loan market isn't as big and doesn't pose systemic risk -- yet.

But as the hunt for yield keeps pushing funds back into CLOs, expect the exponential growth in leveraged loans to continue as more investors keep plowing into these funds ignoring the risks of leveraged loans.

And this isn't just a U.S. problem. Reuters reports that the European high-yield entering unknown territory:
The growth of European high-yield looked unstoppable until just a few months ago, but for the first time in years there is real uncertainty on where the junk bond market is heading.

While January is shaping up to be a busy month for primary activity thanks to a rush of M&A trades, with Altice alone set to issue up to EUR5.7bn equivalent, it is not clear if companies will continue to tap the market for opportunistic refinancings in droves.

"The wild card will be the market backdrop," said Nigel Walder, managing director, high-yield and loan capital markets and syndicate, EMEA at JP Morgan.

"There's a lot of event risk on the horizon, and we could see that impact high-yield next year."

At the start of 2014 the market was fixated on the threat of rising Treasury rates, with geopolitical concerns and credit risk largely ignored. But while rates rises were pushed out further on the horizon, political instability returned with a vengeance in the second half of the year and high-profile defaults such as Phones 4U wrong footed many.

In this fraught environment, whole swathes of the market that previously flourished have now been shut-out.

Greek corporates have tapped the market in droves since the start of 2013, but none has issued euro bonds since July. The same is true of European retailers, which following Phones 4U's demise in September, have seen some of the biggest price collapses in the secondary market.

While these shocks are far from over, as seen in the savage price action on German retailer Takko's bonds last week, it does mean that there is now some real opportunity for credit selection for investors.

"There's a lot of idiosyncratic risk in the retail sector, so you have to tread carefully, but if you're looking for value you can't ignore it," said Peter Aspbury, a high-yield portfolio manager at JP Morgan Asset Management.

"You could miss out on a lot of performance if Christmas trading is strong and lower oil prices start to feed through to consumer spending."


This scope for price appreciation was a missing ingredient in the European high-yield market for a long time.

Most high-yield bonds have embedded call options at set prices, which places a natural cap on how high the cash price of the bonds can rise. Until the sell-off began in earnest in September, the vast majority of European high-yield bonds were trading at their first call prices, which meant the only way they could go was down.

In the volatile conditions in the past few months, bonds without call options have fared better, which are overwhelmingly Double-B rated deals. Aspbury notes that the strong performance of Double-B credits caught many people by surprise.

"But many of the big names are now on the cusp of investment grade, and the vacuum created by these upgrades could create a natural bid for Single-B or Triple-C risk," he added.

"There's a lot of very beaten up names and any inkling of growth could spark a decent rally."

There are already tentative signs that buyers are willing to add risk to their portfolios once again. Siemens Audiology received strong demand for a Triple-C rated LBO bond earlier this month, which then traded up several points on the break.

The deal does also point to a potential threat to high-yield primary supply, however. The bond was downsized by EUR40m to EUR275m, after the loan portion of the deal was upsized by the same amount following incredibly strong demand.

While one of the main trends over the past few years has been loan-to-bond refinancings, the robustness of Europe's burgeoning institutional loan market could start tempting companies back.

For example, BNP Paribas credit strategists expect leveraged loan issuance to surpass European high-yield issuance for the first time since 2007.

Walder at JP Morgan said that investor demand for leveraged loans increased in 2014, and that the loan market is now much more liquid and a competitive alternative for deals.

"The technicals are still very good; there's a healthy new CLO pipeline and investors will have cash from the repayment of several large loans such as Boots and TDF," he said.
I don't want to sound the alarm on leveraged loans but I do want investors to be cognizant of all the risks that come with this unregulated market, especially systemic risk. As global leveraged loan markets balloon, I do worry that a fallout in this market has another 2008 stamped all over it.

Below, leveraged-loan investors can find themselves shut out of purchasing loans due to a blacklist restricting access tothe $800 billion loan market. Bloomberg’s Nabila Ahmed explains how it works and why it’s legal on “Market Makers".