Throwing Good Money After Bad

Bank of America continues to make dumb investment decisions with their latest master stroke to double down on their disastrous bet on Countrywide Financial. From Bloomberg:

Bank of America to Acquire Countrywide for $4 Billion

Bank of America Corp., the biggest U.S. bank by market value, agreed to buy Countrywide Financial Corp. for about $4 billion, five months after making a money- losing $2 billion investment in the unprofitable mortgage lender.

Bank of America will acquire Countrywide for approximately $7.16 a share in stock, the Charlotte, North Carolina-based company said in a statement today. The offer is 7.6 percent below Countrywide's closing share price on the New York Stock Exchange.

"I hope Bank of America isn't throwing good money after bad," said Eric Schopf, a fund manager at Baltimore-based Hardesty Capital Management LLC, which owns 216,000 Bank of America shares, before the takeover announcement. "They struck a deal that wasn't very attractive. Hopefully they can get it right the second time around."

Investors should beware when the word 'hope' is being thrown around by the so-called professionals. Remember what was said back in August when B of A paid $18 a share? Let's rewind:

"We hope this investment will be a step toward a return to a more normal liquidity in the mortgage markets," said Kenneth Lewis, Bank of America's chief executive, in a statement. "In the current turmoil the stock market has been underestimating the value in Countrywide's operations and assets."

The Wall Street lemmings are out in force claiming that B of A has had 6 months to look under the hood of CFC so they should know very well what the company is worth. I think that is a fairly reasonable view if you walk around with your head firmly lodged in your ass. Let's face it, B of A has no idea what Countrywide is worth. They paid $18 a share just 4 and half months ago. Apparently now $7.16 is a good price.

Countrywide, the largest independent U.S. mortgage company, gives Bank of America about 9 million borrowers and fees from servicing $1.5 trillion of mortgages.

No doubt there is value in Countrywide's extensive branch network. However B of A will also be taking on massive credit losses. Remember this chart?

This is clear case where the trend is not your friend. B of A says the deal is eps neutral for 2008 and will be eps positive in 2009. I doubt very much whether this deal will be eps neutral this year with the amount of forecast loan losses CFC is facing.

In the absence of this deal, CFC is bankrupt. CEO Angelo Mozillo's behaviour has been nothing short of criminal as he cashed in on options worth more than half a billion dollars whilst continuing to sing the company's praises when all the while the company was going down the gurgler.

In September I noted that B of A's intial stake in CFC was no bargain and this will turn out to be another poor investment that B of A shareholders will be paying for in the next few years.

More Signs Of US Recession

Just a few cut and pastes of stories that I believe are indicative of a slowing US economy and more specifically an ailing US consumer.

Capital One shows credit woes firmly hitting consumer

Credit-card shares were among the top decliners in the financial sector Thursday after Capital One Financial Corp. lowered its earnings outlook and raised its loan loss reserves, with increasing clarity that the credit crisis sparked by careless home lending has spread to the consumer sector.

As delinquencies on subprime mortgages surged this year, there were initially few signs that similar problems were leaking into the credit-card industry. However, that changed in recent weeks as evidence, like Thursday's news from Capital One, shows that consumers loaded up on credit-card debt to make up for a loss in the purchasing power they once wielded by refinancing mortgages during the real-estate boom.

Early Thursday, Capital One Financial Corp. cut its 2007 earnings view to $3.97 per share, below its previous forecast of $5, and said that it expects fourth-quarter earnings of 60 cents a share.

The McLean, Va.-based financial holding company said that the reduction was driven by increased provision expense and additional legal reserves established in the fourth quarter...

... Capital One said that the fourth-quarter 2007 provision for loan losses was approximately $1.9 billion. This is made up of approximately $1.3 billion in charge-offs and an allowance build of about $650 million.

"The allowance build reflects fourth-quarter delinquencies in the company's national consumer-lending businesses, continued deterioration in the approximately $700 million Held for Investment portfolio of Home Equity Lines Of Credit (HELOCs) originated by GreenPoint Mortgage, and expectations for a weaker U.S. economy in 2008, as evidenced in recently released economic indicators," the company said in a statement Thursday.

American Express Has $440 Million Charge for Quarter

American Express Co., the third- largest U.S. credit-card network, forecast first-quarter earnings below analysts' estimates and adopted a ``cautious view'' for 2008 because of a slowing economy.

The company will take a $275 million fourth-quarter charge as more cardholders fail to repay their debts, New York-based American Express said in a statement today. The company fell 7 percent in extended trading.

"We did see some negative credit trends among U.S. consumers during December, particularly in California, Florida and other parts of the country most affected by the housing downturn,'' Chief Executive Officer Kenneth Chenault said in the statement.

American Express said its first-quarter 2008 earnings from continuing operations will be less than the 90 cents a share in the same period in 2007, missing the 93 cent average estimate of 12 analysts surveyed by Bloomberg.

``Credit-card performance will noticeably deteriorate during the year, given spillover from residential mortgages, weaker economic trends, and higher levels of unemployment,'' Fitch Ratings said today in a report on the U.S. industry.

Weak holiday sales spark profit warnings


U.S. retailers reported disappointing holiday sales in December, sparking several profit warnings, as promotions, last-minute shopping and gift-card redemptions failed to turn around lackluster performance in the largest sales month of the year.

Retailers from Gap Inc. and Kohl's Corp. (KSS) to Limited Brands and Macy's Inc. (MC) missed analysts' forecasts.

Hot Topic (HOTT), American Eagle Outfitters Inc. (AEO) and Men's Wearhouse Inc. (MW) were among the retailers to lower their fourth-quarter profit forecasts.

No. 1 retailer Wal-Mart Stores Inc. (WMT) and No. 1 wholesale club Costco Wholesale Corp. (COST)were rare bright spots, benefiting from budget-conscious consumers seeking bargain electronics and buying bulk-food items. Off-price retailer Ross Stores Inc. (ROST) also benefited from shoppers seeking name brand products at a discount.

Two-thirds of retailers missed what were for many already lowered expectations, well above the long term average of 43%, according to Retail Metrics.

U.S. retailers reported a 0.4% gain in December, Retail Metrics said. Coupled with results from November, sales rose 1.7%, the worst performance since 2002.

More profit cuts expected

"Department stores and specialty retailers were among the losers in December, while discounters served as a relative source of strength," said Morgan Stanley analyst Michelle Clark. "Lackluster traffic levels in the weeks leading up to Christmas drove increased promotional activity."

Retail profit estimates appear to be at least 3 percentage points too high for 2008, the analyst said.

"We'll see a soft year in terms of consumer spending," said Stephen Hoch, Wharton School marketing professor.

According to ShopperTrak, retail foot traffic for November and December combined dropped 2.7%.

Possibly some of the worst data on the US consumer to date, yet the market rallied in anticipation of another interest rate cut. Despite the fact that 100bps of rate cuts have done nothing for the market and will do nothing for embattled consumers and declining company profits.

Initial Jobless Claims Contained ......for now

Weekly Initial Jobless Claims fell to a 2 month low of 322,000 in the week to January 5th. Investors may breathe a sigh of relief from the latest numbers but for how long? I suspect it will only be a matter of time before the 4 week moving average moves ticks up into the 350,000 - 400,000 danger zone. From the Department of Labor:

UNEMPLOYMENT INSURANCE WEEKLY CLAIMS REPORT

SEASONALLY ADJUSTED DATA

In the week ending Jan. 5, the advance figure for seasonally adjusted initial claims was 322,000, a decrease of 15,000 from the previous week's revised figure of 337,000. The 4-week moving average was 341,000, a decrease of 3,000 from the previous week's revised average of 344,000.

The advance seasonally adjusted insured unemployment rate was 2.0 percent for the week ending Dec. 29, a decrease of 0.1 percentage point the prior week's unrevised rate of 2.1 percent.

The advance number for seasonally adjusted insured unemployment during the week ending Dec. 29 was 2,702,000, a decrease of 52,000 from the preceding week's revised level of 2,754,000. The 4-week moving average was 2,701,750, an increase of 17,000 from the preceding week's revised average of 2,684,750.

Aussie Retail Sales Power Along in November

Australian retail sales continue to power along increasing a seasonally adjusted 0.8% in November. From the ABS:

SEASONALLY ADJUSTED ESTIMATES

• The seasonally adjusted estimate of turnover for the Australian Retail and Hospitality/Services series increased by 0.8% in November 2007. This follows a revised increase of 0.3% in October 2007 and an increase of 0.7% in September 2007.
• All states and territories had increases in the seasonally adjusted estimate, except the Australian Capital Territory (-0.3%). The largest increases occurred in Western Australia (+1.9%), the Northern Territory (+1.6%) and New South Wales (+0.8%).

ORIGINAL ESTIMATES

• In original terms, Australian turnover increased by 3.9% in November 2007 compared with October 2007. Chains and other large retailers (which are completely enumerated) increased by 5.2%, while the estimate for 'smaller' retailers (the sampled units) increased by 2.2%.
• Australian turnover increased by 8.4% in November 2007 compared with November 2006. Chains and other large retailers increased by 10.3%, while 'smaller' retailers increased by 5.8%.

A strong labour market and robust economy continues to underpin strength in retail sales. However recent interest rate rises, the threat of more to come in February and recent action by 3 of the big 4 banks to increase mortgage rates casts doubts over the ability of Australian consumers to keep up the pace of spending.

In the chart above the 6 month moving average of month on month changes in retail sales looks to be peaking however a significant slowdown in the economy and a sharp rise in unemployment would be needed to see that move down significantly.

AT&T Warn of Consumer Softness

The US Housing market collapse has not spread to the broader economy. This is the mantra still blindly repeated on Wall Street despite mounting evidence to the contrary. Yesterday AT&T provided added to the growing gins that things are not as contained as the so-called experts would have us believe. From Bloomberg:

AT&T Drops Most in 5 Years on Consumer 'Softness'

AT&T Inc. dropped the most in almost five years in New York trading after Chief Executive Officer Randall Stephenson said slowing economic growth led to "softness" in the home-phone and Internet businesses.

The shares fell 4.6 percent, helping to spark a broader decline in U.S. stocks, after Stephenson said San Antonio-based AT&T is disconnecting more phone and high-speed Internet customers who failed to pay their bills.

"We're really experiencing softness on the consumer side of the house from the economy," Stephenson said today at an investor conference in Phoenix.

The disconnections in the residential-phone business, which accounts for about a fifth of sales, have put more pressure on Stephenson, who became CEO in June. Last year, he relied on the popularity of wireless handsets such as Apple Inc.'s iPhone to fuel growth, helping to make up for losses of home-phone customers.

As mentioned here previously, as consumers cannot access the built in ATM on their front lawns any more many will turn to other forms of credit. Yesterday's consumer credit report confirms that this is the case.

U.S. consumer borrowing rose more than forecast in November as Americans used credit cards and auto loans to add to a record amount of debt, Federal Reserve statistics showed.

Consumer credit increased $15.4 billion for the month to $2.51 trillion, the Fed said today in Washington. In October, credit rose $2 billion, less than the previously reported gain of $4.7 billion. The Fed's report doesn't cover borrowing secured by real estate, such as home-equity loans.

The figures suggest Americans are relying more on credit cards and other short-term borrowing to maintain spending after the collapse in subprime lending made bank loans harder to get. An increase of 133,000 U.S. jobs in November and December was the lowest for those two months since 2002 and disposable incomes aren't keeping pace with inflation.

The fun is just beginning, wait until unemployment really tanks. Credit card delinquincies are already rising and will only get worse as the cash strapped Ameerican consumer finds it tougher and tougher to keep up their spending habits.

US Pending Home Sales Index Falls in November

From the NAR and the ever optimistic Lawrence Yun:

The Pending Home Sales Index,* a forward-looking indicator based on contracts signed in November, fell 2.6 percent to a reading of 87.6 from a strong upward revision of 89.9 in October, but remains above the August and September readings and indicates a broad stabilization. The index was 19.2 percent below the November 2006 level of 108.4. “Although there could be some minor slippage in the first quarter, existing-home sales should hold in a narrow range before trending up,” Yun said.

So Yun still sees Existing Homes rising in 2008, well eventually he'll be right but it won't be this year.

It's Solvency Stupid, Not Liquidity

The Financial media continues to drone on about the Fed and other central banks efforts to combat the liquidity problems in the banking system by injecting huge wads of cash. However as John Hussman has been pointing out for weeks it is little more than a simple magicians vanishing act.

I posted back in August that rather than bailing out financial institutions the Fed is acting as a pawnbroker. Temporary increases in the amount of cash in the form of repos are just that, temporary, very little new money has made it's way into the economy since August.

These temporary repos are just what the doctor ordered when it comes to addressing liquidity issues however liquidity is not the only problem nor the biggest one. As Nouriel Roubini and others have argued it is the problem of solvency or debt that is the bigger issue. Another excellent article on this issue appeared on Minyanville yesterday:

1. Debt Crisis Vs. Liquidity Crisis

Here is an interesting datapoint that many may not have noticed. Since the Federal Reserve Open Market Committee began lowering interest rates on Sep. 18, the S&P 500 has declined more than 7%. For those that have noticed the decline, particularly the decline in shares of Financial stocks as the PHLX Bank Index (BKX) has plummeted by 24% since Sep. 18 - a bear market by any measure - the most frequently asked question is "Why isn't the Fed's liquidity working?"

It's a reasonable question, after all, central banks in both the U.S. and Europe have said without equivocation that they will provide "as much liquidity as the market needs" to "fix" the problem. So why has this liquidity not been enough to maintain and support asset prices? Because this is not a liquidity crisis, it's a debt crisis. The difference is important, and grasping it can help us sort through a number of market actions that appear to be counterintuitive.

During a liquidity crisis, the issue is one of supplying money to those who, for whatever reason, have suddenly shortened their time preferences. Mr. Practical, writing on Minyanville's Buzz & Banter, characterized it this way:

Suppose there is a rumor that a large bank has made a bad loan. Because banks lend out more money than they have on deposit - this is called a fractional reserve banking system - if everyone goes to the bank and demands their money at the same time, a liquidity crisis can occur because the bank does not have enough cash on hand to satisfy the demand from its depositors. The Federal Reserve will then step in and provide liquidity, allowing the depositor demands to be satisfied. If the rumor of the bad loan proves to be false, then the issue is one of liquidity. Time preferences soon return to a more normalized state, depositors return, everyone feels better. But, if the rumor turns out to be true, it doesn't matter how much liquidity the Fed provides, the bank will go bankrupt.

Similarly, the issue today is not one of temporary liquidity, time preferences being shortened out of a temporary risk aversion. The issue is too much debt supported by too little value and income generation. As a result, time preferences are retreating, risk aversion is growing, and access to credit is diminishing.

The battle in financial markets is currently between reflation and deflation. The reason reflation is not winning is because the Federal Reserve is powerless to make bad debt good. The Fed can only provide liquidity, and then hope that liquidity spawns credit creation. The market is fighting this by taking that liquidity and using it to deflate, pay down debt.

Click on the link for the all of yesterday's "5 Things You Need To Know" and if you don't already you should check out Kevin Depew's 5 Things You Need To Know everyday for an easy explanation of some seemingly complex issues.