Sunday, November 23, 2008

Corporate Bonds, Citigroup & Robert Rubin, DKR

ADDED 5/15/09:  For any reader coming from a Google Search involving Hertz Bonds, I gathered my discussions together in a later Post, which can always be in the Gateway Posts near the top of my blog and by going to this link:

******************************Original Post:

The corporate bond market has not been a refuge from the deflation in asset values. As in the Great Depression, all asset classes other than U.S. treasuries have fallen sharply with commercial real estate bonds, rated AAA, trading at 60 cents on the dollar, down from over 90 cents a few weeks ago. The spread over treasuries for these securities have risen to 15% according to the WSJ. Corporate debt has not been as cheap as it is now even during the Great Depression compared to treasuries. Yields on high yield bonds have reached 25% and 8.2% for investment grade bonds.  

This article in the WSJ does not mention that Vanguard's Total Bond index fund is now positive for the year. Part of this out performance is due to including GSE and treasury debt in the index fund. There is an ETF for the Vanguard Total Bond index fund and it can be researched at the Vanguard web site. I have owned it (BND) and sold it earlier in the year. I am reluctant to buy it now due to its significant exposure to Fannie and Freddie debt, and I simply do not know what will happen when the conservatorship for these GSEs ends at the end of next year. I looked at the semi-annual report for BND and it had 70% of its assets in GSE and treasury debt.

However, most of that was in Freddie and Fannie debt, with only 22.7% of assets in U.S. treasuries. I would now prefer to avoid that ETF due to its exposure to the GSEs and buy SHY, an ETF for 1 to 3 year U.S. treasuries, a lesser amount in IEI, an ETF for 3 to 7 year treasuries, and to use LQD for corporate debt. All of these ETFs are low cost and Ishares is the sponsor. iShares ETFs for US investors - Exchange Traded Funds

I have not bought IEI. I am also using TIP, for U.S. Treasury inflation protected, and BWX for international treasury bonds. I am reluctant to add to my positions in U.S. treasuries since I believe that they represent merely the latest example in a long list of bubbles. I am no longer buying any mutual fund that invests in bonds and my experience with Loomis Sayles explains why.

In contrast to a low cost index fund for bonds, one highly touted bond fund, Loomis Sayles Retail Bond, LSBRX, is down over 29% year to date, a pathetic performance in an admittedly difficult market for corporate debt (this fund is still recommended by Morningstar and Kiplinger! Finance) Pathetic is way too kind to describe this year's performance of the Loomis Sayles retail bond funds.

In a rush to treasuries, the yield on the 3 month treasury has fallen to the absurd level of .015% and 2.05% for a five year note.

This is similar to the kind of yields from these instruments that were prevalent during the Great Depression.

Some investment grade bonds traded as Trust Certificates have risen recently to yields in excess of 15% as discounts to their par values have widened. I am going to limit myself to the TCs containing investment grade bonds since the non-investment grade bonds may just be too risky to buy for the next year. Two non-investment grade bonds that I own in TC form are DKR and PIS. Since I own DKR, I did review the earnings report from Hertz which showed a significant adverse impact from the slowdown.

The week earnings report from Hertz eventually sent the common stock to a buck and change by the end of last week and also impacted the value of the senior bond which is the underlying security in DKR. My position is small at 100 shares and I still plan to hold onto as a speculative bond position.

In addition to my previous extensive discussion on this TC, a failure of one or more of the U.S. auto makers would certainly be negative for Hertz as well as an acceleration of the downturn which will impact -severely -every heavily indebted company dependent on consumer & business spending. Many will not survive to be put in bluntly and the car rental companies fall into this at risk category.

Robin Rubin, the former investment banker, alleged wise sage, Obama advisor, former Goldman Sachs whiz bang, and Clinton's Treasury Secretary, got skewered in a Sunday New York Time's article about the downfall of Citigroup.

According the NYT, it was Rubin who pushed the bank to take on more risk by leveraging up to buy the toxic waste known as CDOs. As with the other financial institutions that have already failed, there was no meaningful risk management and an unbelievable lack of understanding about the risks assumed by what used to be one of the largest financial institutions in the world. After reading this article, you will understand why no one has any confidence left. Two of the individuals who brought Citi down, according to this article, made 20 and 30 million a year. Its chief executive did not even know the amount of the mortgage related assets owned by the bank, 43 billion, until he was told at a meeting in September 2007. What were these people really worth, including Rubin? Why did the CEO first learn about a 43 billion money pit when it was too late to do anything other than twist in the wind? How does someone who does not understand financial instruments like a CDO become head of one of the largest banks in the world? In each case of a financial firms meltdown, the number of people responsible could be counted with the fingers of one hand.

 In every case, these individuals were richly compensated for their incompetence, greed, arrogance and overall lack of knowledge, receiving tens of millions and even hundreds of millions of dollars. Part of their job appeared to be to undermine risk controls. Their penalty has not, and will probably never be, to return one cent of their ill-gotten gains, or to spend time in jail, but simply to find another job to ply their wares. How many people know the name of Thomas Maheras or Randolph Barker of Citigroup? Maybe if you rode the shares down from 55 to 3 you need to read about them in this NYT's article. The article also highlights that Prince, the former CEO, did not have a clue. If you ask me, the issue is not whether Maheras, Barker, Prince and Rubin were overpaid? The answer to that questions is of course they were. The real issue is to assign a value to them below what they were actually paid. I would say, and this is open to debate, that this fearsome foursome had a negative value of about 40 billion as sort of a bare minimum figure.

When you read all of the articles the NYT has written under the subject "The Reckoning" The New York Timesit is impossible to have any confidence, not even a smidgen, in any of the senior managers of our major financial institutions.  It is just really embarrassing that they are American.  

The WSJ and the NYT are both reporting tonight that the U.S. is engaged in yet another salvage deal, trying to save Citigroup before its failure causes a worldwide meltdown. The plan appears to be to create a bad bank out of this bad bank to hold the bad assets, like 50 billion of the trash and have the U.S. assume losses above a certain Citigroup My first suggestion is to first take it out of the hide of the Citi employees who were paid tens of millions each year to create this latest fiasco. I would hope Rubin would be fired along with any senior manager that came close to being responsible for this mess. The NYT article points out the culpability of the Board of Directors who should likewise be removed. Will any of that happen, probably not. Only those who did not receive anything will be punished. The people that caused the near collapse will keep their compensation for destroying the bank, the Board who authorized the leverage and risk taking will still be in charge, Rubin who facilitated the problems will remain, and the taxpayers will pick up the bill. 

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