Archive for the ‘Finance’ Category

Government Complexity and the New Federal Healthcare Mandate

Saturday, October 30th, 2010

As a follow up to my last post (“U.S. government operations can be incredibly complex”), I wanted to provide a chart of the new U.S. health care system.  Healthcare represents 17% of the U.S. economy.  Unfortunately, Obamacare was passed with no one having actually read the bill.

Obamacare is modeled on Romneycare, the system in place in Massachusetts since 2006.  In the several years since Romneycare has gone into effect, healthcare costs have soared far beyond the national average.  Massachusetts now has the highest health insurance costs, the highest medical costs, the fastest rising costs and the longest waits for doctors in the nation.

Complexity itself is a major problem in organizational function.  The chart below does not bode well for the nation as a whole.  A larger version of the chart can be accessed here.

All About The Mortgage Process

Thursday, November 6th, 2008

Getting a mortgage can be a confusing process.  There’s a lot of paperwork and there are many loan programs to choose from.  In this post, I’ll provide an overview of the mortgage process and what you should expect from a mortgage consultant.

Goals

The mortgage process is substantially similar whether you are purchasing or refinancing a property. In both cases, your mortgage consultant should start by asking questions and listening to your goals.  That way, he or she can help you achieve your goals.  However, too many mortgage consultants start by telling you what to do based upon what is most profitable to them.

Your consultant should ask a number of questions, starting with, “What type of property would you like to purchase or refinance?”

  • If you want to make a purchase, your consultant will want to know…
    • What is your price range?   If you don’t know, he or should should be able to help you determine the price range for which you qualify.
    • How much money would you like to invest, if any?  Despite the credit crunch, there are still loan options that do not require significant down payments.
    • How much money do you have for closing costs and prepaid expenses, if any?
    • Is the monthly payment amount important to you?  If so, how much would you be comfortable paying on your mortgage each month?
    • How long do you intend to own the property?
    • Are you working with a real estate broker or sales agent?  If not, the consultant should be able to refer you to someone in the area in which you wish to purchase.
  • If you want to refinance, your consultant will want to know…
    • What are you trying to achieve in pursuing a refinancing?
    • How long do you intend to own the property?
    • What is the estimated value of the property?

By listening to your goals, your mortgage consultant can help you determine the loan programs best suited to achieve them and to meet your needs.

Prequalification and Preapproval

Prequalification and preapproval only occur in the purchase process, so if you are refinancing, you can skip this step.  In some locales, prequalification is the norm and in others, home sellers and real estate brokers and agents will require you to be preapproved.  You do not need to have a specific property in mind to get either a prequalification or a preapproval.  However, in both cases, your personal mortgage consultant sahould assist you.

  • Prequalification – Prequalification is an estimate of your purchasing power.  In short, it is an estimate of the price you can afford to purchase a property.  Your mortgage consultant will order your credit report and ask questions about your employment and income.
  • Preapproval – Preapproval means that based on the information you provide, a lender issues a loan approval with conditions.  Your mortgage consultant will order your credit report and ask questions about your employment, income and assets.  Depending on your goals, he or she may provide you with a checklist of information required for a preapproval.  Once your mortgage consultant collects the information, he or she then submits the information to a lender (or, if he or she works for a lender, it is processed through the lender’s system).  The lender will issue a preapproval with conditions that will vary depending on the property and on you and your circumstances.

Getting preapproved is a more thorough process than prequalification, but one is not numberswiki.com

necessarily better than the other.  It depends upon what is the norm in the place where you want to purchase a property.

Application

Your mortgage consultant will put together and submit a loan application and related documents and submit them to a lender.

  • If you previously have been preapproved to purchase a property, you’ll most likely only have to update the information you provided when you applied for a preapproval.
  • If you are refinancing or previously were prequalified to purchase a property, your consultant will ask you questions about your employment, income and assets.  Depending on your goals, he or she may provide you with a checklist of information required to complete the loan application.  Your consultant will order your credit report if it has not previously been ordered.

Depending on the type of property, the loan program and your personal circumstances, you may have to provide documentation supporting your income, assets or employment. Your mortgage consultant will advise you of the requirements. He or she should guide you along every step of the process and answer all your questions.

Processing and Underwriting

When your loan application and related documents are complete, the mortgage broker or lender’s processing center begins work on your loan.  This can include verifying your income and assets, ordering an appraisal of the property’s value and ordering a title search from the lender’s attorney to make sure the property has clear title, among other items.  If you’re working with a mortgage broker, the broker’s processors will transmit the loan package to the lender, who then begins the underwriting process.

In underwriting, the lender will evaluate the information that has been collected about you and your property.   Lenders have thousands of loan programs for residential and commercial purchases, refinances, construction or investment.  Therefore, the underwriting criteria will vary for each loan and according to your personal circumstances.  However, some factors the lender will consider in its evaluation are the value of the property and whether it believes you can repay the loan in a timely manner.

Upon making a satisfactory underwriting determination, the lender will issue a formal loan approval, known as a mortgage commitment letter or conditional approval letter.  The letter will state the terms and conditions under which the lender is willing to make the loan.  The conditions will vary depending on the property and your personal circumstances.  A typical condition, though, is that the property must have an appropriate amount of insurance.

The processor typically will work with your mortgage consultant and the lender to satisfy the conditions set forth in the commitment letter.  Once the conditions are satisfied, the loan will be ready for closing.

The Closing

At the closing, you will sign various documents that allow your loan to be put in place.  These include a mortgage (evidencing the lender’s interest in your property), a promissory note or mortgage note (your promise to repay the loan according to specific terms and conditions) and other similar documents.  If you are purchasing a property, the seller will transfer title to it to you at the same time.

At the close of the transaction, the mortgage is recorded in the land records of the city or county (Where the recording occurs varies depending on the state in which the property is located.).

Post-Closing

Good service does not end with the close of your transaction.  If you have any questions or concerns in the future regarding your mortgage, a good mortgage consultant will be there to assist you.

What is the VIX?

Wednesday, October 29th, 2008

The VIX is a measure of market risk, sometimes called the fear index.  It is used to gauge investor sentiment – whether the broad stock market in the United States is bullish or bearish.  VIX actually stands for volatility index.  it is the ticker symbol for one of the volatility indexes created by the Chicago Board Options Exchange (the “CBOE”).  In fact, the VIX is the most widely used volatility index, and was introduced by Duke University Professor Dr. Robert Whalley in 1993.

Volatility is the fluctuation in the market price of an underlying security.  The VIX measures market expectations of near-term volatility conveyed by S&P500 near-term options prices.  Specfically, the VIX presently is calculated by measuring the volatility of out-of-the-money put and call options on S&P500 stocks for the two nearest expiration months.  It anticipates the volatility of the S&P500 over the next 30 days.  A VIX of 30 means, roughly, that over the next 30-day period, the S&P500 will move 30% on an annualized basis (i.e., more info

8.66% over the next 30 days).

Typically, the VIX is inversely related to market tops and bottoms.  For example, a high VIX implies pessimism and usually means a market is bottoming.  Low values imply optimism.  However, using the VIX solely to determine a market bottom or top doesn’t work because the method isn’t foolproof.  However, there’s no cap on how high the VIX can go.  Historically, a VIX reading of 30 has been a high number. but the VIX has traded over 70 in October, 2008.   Consequently, It should not be used in a vacuum, but is best used with other indicators in order to provide investment guidance.

On March 26, 2004, the CBOE began offering futures contracts on the VIX for trading.  On February 24, 2006, the CBE listed options on the VIX for trading.

VIX and More is a blog that follows the VIX.  Volatility Trading is a new book with a CD-ROM on trading the VIX.

Foreclosure and Two Ways to Avoid Going Through It

Tuesday, October 21st, 2008

Foreclosure means that a borrower can not make the required principal and/or interest payments on a loan secured by an interest in property.  Because of the borrower’s default, the lender has a right to terminate the borrower’s interest in the property.  The procedures vary from state to state, but the end result is that the lender either can take ownership of the property or sell it and the borrower’s equitable or statutory right to redeem the property is barred forever.

Approximately 95% of all residential mortgages in the United States are being paid on time.  That means that there are problems with about 5% of mortgage loans.  If mortgagors (e.g., the homeowners / borrowers) do not pay their mortgage loans, they will lose their homes.

Two other options exist for those facing foreclosure.  First, the borrower can offer a deed in lieu of foreclosure.  This means that instead of waiting for the foreclosure process to occur, the lender consents to accepting the borrower’s property interest immediately.  If the value of the property is below the remaining mortgage debt, the lender usually agrees to forgive the difference.

The second option is known as a “short sale.”  In this case, the borrower sells the property for less than the remaining mortgage debt.  The lender’s consent is required and, as in a deed in lieu situation, the lender usually agrees to forgive the excess owed on the debt.

In both options, the homeowners lose their homes.  Yet, this still can be preferable than going through foreclosure.  First, it takes less time, so the home owner who knows there is no way he can keep his home can shorten the process and the pain.  Second, the home owner also will no longer be legally obligated to pay the debt.  Third, if a foreclosure occurs and the home is later sold for less than the amount owed on the debt, some states allow a lender to pursue the unpaid amount.  However, with deed in lieu or a short sale, the lender almost always consents to forgive any remaining debt.

Emergency Economic Stabilization Act of 2008

Tuesday, October 7th, 2008

Congress passed, and President Bush signed on October 3, the Emergency Economic Stabilization Act of 2008, H.R. 1424 (the “Act”).  The purposes of the Act are twofold:  It authorizes the Secretary of the Treasury (the “Secretary”) to restore stability and liquidity to the U.S. financial system and to do so in a manner that protects home values, college funds, retirement accounts and life savings; preserves home ownership and promotes jobs and economic growth; maximizes overall returns to American taxpayers; and provides public accountability to the exercise of that authority.

That’s a tall order.  The key provision involves a Troubled Asset Relief Program (“TARP”).  Under this program, the Secretary, through an office of Financial Security that is to be established, may purchase up to $700 billion in financial institution assets.  The assets must be residential or commercial mortgages or securities, obligations or other instruments relating to such mortgages originated on or before March 14, 2008 or other financial instruments that the Treasury determines necessary.  They may be purchased from all U.S. institutions of all sizes, including the licensed U.S. branches and agencies of foreign banks.  The Treasury can manage and sell the assets or enter into financial transactions regarding any purchased asset.

Some other provisions that sought to increase financial stability include an increase in FDIC deposit insurance from $100,000 per account to $250,000 per account until December 31, 2009 and an authorization for the SEC to suspend mark-to-market accounting.

The Act also included a number of unrelated provisions relating to tax relief, tax cut extensions, an R&D tax credit,  tax incentives, mental health and creating environmentally-friendly jobs, among others.

The House Majority Leader, Steny Hoyer, offers a section-by-section summary of the legislation here.

Real Estate Investment Trusts

Monday, September 15th, 2008

As a follow up to my last post noting that hard assets, such as real estate, tend to be good inflation hedges, I wanted to provide some basics on real estate investment trusts (“REITs”).  A REIT is an investment vehicle that owns either mortgage notes, real estate or a hybrid that both mortgage notes and real estate.

REITs came into being in 1960.  Most REITs at that time were mortgage REITS – they owned mortgage notes on real estate assets.  However, today, real estate and hybrid REITS are common.  Via securities, a REIT allows one to invest in large, income-producing real property.  That said, REITs come in a variety of flavors and can be sliced and diced a number of ways.

In the United States, three types of REITs as securities exist.  Publicly-traded REITs register with the U.S. Securities and Exchange Commission (the “SEC”) and trade on national stock exchanges.  The are also non-exchange-traded REITs, which also register with the SEC, but which don’t trade on a stock exchange.  Finally, private REITS neither register with the SEC nor trade on a stock exchange.

Additionally, REITs may be distinguished by the type of real estate they invest in.  This can be either broad or narrowly-focused.  For example, there are office REITs, multifamily property REITs, hotel REITs, shopping center REITs, warehouse REITS and storage facility REITs.

Another way a REIT may differentiate itself is for it to focus on a specific state or geographical region.

Companies must qualify to be classified as a REIT.  To do so, they must meet specific requirements of the Internal Revenue Code.  These requirements include the following:

* The REIT must be managed by a Board of Trustees or a Board of Directors.

* The REIT must be taxable as a corporation.

* The REIT must have 100 different shareholders.

* No more than 50% of the REITs shares may be held by five or fewer individuals.

* REIT shares must be fully transferable.

* At least 75% of the REIT’s gross income must be real estate-related, such as from rents or mortgage interest.

* At least 75% of the REIT’s total assets must be real estate assets.

* The REIT’s stock in its taxable subsidiaries may not be more than 20% of its total assets.

* A REIT must distribute at least 90% of its taxable income to shareholders as dividends.

These are some, but not all, of the main limiting characteristics of a REIT. A good book on real estate syndication in general, including REITs, is Samuel K. Freshman’s Principles of Real Estate Syndication.

Inflation and Hard Assets

Sunday, September 7th, 2008

We’ve had many years of low inflation in the United States.  In the past year, however, inflation has increased.  The U.S. economy is complex and many reasons are behind this acceleration.  For example, the industrialization of the economies of China and India have increased the demand for commodities, which are used to build infrastructure.  So the prices of commodities, such as steel and oil, have risen as demand has increased globally.

The law of unintended consequences also has played a part in inflation.  Congress passed and President Bush signed the Energy Independence and Security Act, which mandated a huge boost in the use of corn-based ethanol.  This occurred at a time when world grain stocks are at a 30-year low and prices at historic highs.  With more demand for corn, prices shot up.  Livestock producers and food processors incurred greater costs, as corn is a staple of livestock feed.  As a result, the cost of food rose and now, for example, eggs cost 40% more than they did a year ago.  In fact, even the prices for non-food crops rose as farmers switched from them to grain crops, which are more lucrative.

So what holds value during inflationary times?  Hard assets typically do.  One such hedge against inflation  is real estate.  Despite the housing downturn due to the subprime crisis and resultant credit crunch, real estate historically has been a good long-term investment when inflation accelerates.  Although the market is not at its peak, we haven’t seen a decline in U.S. commercial real estate comparable to the residential slump.  Good value may lie in commercial real estate investment over the next few years.

Capital Ratios of Financial Institutions

Thursday, August 14th, 2008

With the stocks of banks and investment banks imploding in 2008, there’s been much talk of capital ratios.  Regulators require banks to maintain minimum capital requirements.  The reason is to prevent them from failing due to overzealous lending during economic expansions that could result in financial setbacks when the economy turns down.  So just what are capital ratios?

In the United States, there are two primary capital ratios:  Tier 1 and Tier 2.  The Tier 1 capital ratio is the most important one, and that’s what I’ll focus on here.

The Tier 1 capital ratio consists of the ratios of the bank’s stockholders’ equity, preferred stock and retained earnings to its total risk-weighted assets.  Risk-weighted assets are calculated by putting each of the bank’s assets and off-balance sheet items into a basket and assigning a risk category to that basket.  Risk categories range from 0% to 100%.  If the overall risk is lower, then the bank is considered more stable for depositors and more conservative for investors.

The problem today is in determining both the valuation of and the risk relative to the assets.  Some, as I noted in my earlier posting on auction rate securities, are hard to value, but are less likely to default.  Others, such are a letter of credit, may be considerably riskier.  So actually determining the Tier 1 capital ratio involves art as well as science. Thus, bank stocks, which have fallen considerably this year, may still be overvalued.

Regulators use the Tier 1 capital ratio to segregate banks into five categories ranging from well-capitalized  to critically undercapitalized.

The Tier 2 capital ratio includes undisclosed reserves, general loss reserves, subordinated term debt, hybrid instruments, among other items.

Title 12 of the Code of Federal Regulations includes the regulations regarding minimum capital ratios.  A much more detailed compendium of what is included in bank capital ratios is available in Appendix A to Part 3.

Auction Rate Securities and How the Failure of One Market Can Snowball Into Other Markets

Thursday, July 31st, 2008

How can a failure in one market snowball and create failures in others?  Here’s a simplified example, in the case of auction rate securities (ARS).

Much has been written this year about the sudden illiquidity of the ARS market.  ARS are a product often used by companies to invest their excess cash.  The inability to properly value such securities led to problems because they need to be properly valued on a company’s balance sheet for financial reporting.  Additionally, when that cash was needed, reselling the ARS at what was their supposedly appropriate value was an issue, as they were trading at significant discounts because of market illiquidity.

An ARS is a debt security, most often a municipal or corporate bond, in which the interest rate is reset via a Dutch auction on each payment date.  Essentially, it is a long-term bond with a 20 or 30-year term, but with variable interest rate, so that it acts like short-term debt.  A Dutch auction, also known as a descending price auction, is the winning bid at which the lowest possible interest rate at which equilibrium occurs (equal numbers of buyers and sellers exist), such that all securities can be sold.  For ARS, the auctions to reset the interest rate usually are held every 7, 28 or 35 days.

In February, 2008, the market for ARS collapsed and more than 1,000 auctions failed.  This is because the ARS’ insurers were in financial difficulties because they previously had insured mortgage-backed securities that were now defaulting at higher rates.  Suddenly, the ARS were seen as riskier because the insurers backing them were less secure.  Although an auction may fail, the ARS’ rates do reset,  typically increasing to the maximum rate allowed for the issuer of that particular ARS.  Demand for the securities decreased.  The investment banks that make a market in these securities refused to act as bidders of last resort, which they previously had done.  Consequence:  the market for ARS froze.

Investment banks had pitched these securities as “cash or cash equivalents” to companies.  But cash and cash equivalents are considered liquid.  Suddenly, many companies which held ARS had to revalue their holdings, and some reclassified them as short-term investments.  These changes reduce cash holdings on the balance sheet.  In some cases, a company may technically default on its debt covenants based on the ratio of cash on its balance sheets.  Public companies with significant amounts of ARS as a percentage of cash could see a drop in their share prices.

Even if the issuer underlying a particular ARS is fine, the lack of liquidity and auction failure created problems for investors.  These problems, with began with the failure of mortgage-backed securities, spiraled into auction rate securities, affected companies’ balance sheets and perhaps, share prices.  This, simply put, is how the failure of one market can snowball into other markets.

A Management Flaw – and Financials Disasters That Shouldn’t Have Happened

Thursday, July 17th, 2008

One critical flaw that has hobbled and even killed companies is not managing growth.  Companies that don’t manage their growth produce unhappy customers, unhappy vendors, unhappy franchisees and sometimes, spectacular flame outs.  Why would a company put itself in this position?  Lots of reasons . . . attempting to grab market share, be the first into a new market and dominate a niche, management hubris or just plain greed.

Here’s an example of management hubris:  I interviewed for an executive position with a $700 million company that started growing extremely rapidly (It had doubled in the past 2 years.).  I spent 1.5 hours with their head of HR.  He told me, “We don’t have competition” and “I’d rather have someone do C+ work and get it done tomorrow than A work and get it done next week.”  Those sort of red flags say to me that when this company falls, it’s going to fall hard.

Two companies that should’ve been category killers, but ended up flaming out, are Boston Chicken (which changed its name to Boston Market) and Krispy Kreme Donuts.  Both had fanatics among customers and captivating products.  Both were loved by Wall Street.  In both cases, there was no dominant national chain in their niche, a la McDonalds in the hamburger category (KFC offered fried, not rotisserie, chicken.).  Both flamed out.

In Boston Market’s case, large loans fueled growth that occurred much too quickly.  Essentially, the company began to see itself as a financial, not food service, company, making money selling franchises instead of focusing on growing steadily and producing high quality meals.  The company failed to build a strong management team and had high executive turnover.  Food quality varied from unit to unit and even in individual units, depending on the time of day and number of customers.  Even its marketing strategy, with constant coupons, led to higher growth and lower margins.  Eventually, it filed for bankruptcy.

When Krispy Kreme opened in new areas, cars waited in long lines.  Although founded in 1937, its downturn came when it saw how lucrative franchising could be.  It sold its first franchise in 1995 and went public in 2000.  Its stock soared.  Yet it grew too rapidly without addressing a fundamental flaw:  stores that were too big – for selling just doughnuts – and cost too much to operate.  Some stores were too close together.  The company later began selling doughnuts to supermarkets, cannibalizing franchisees’ sales and flooding the market with product, lessening its cachet.  Franchisees paid high equipment and supply fees.  Ninety percent of sales were doughnuts, a much higher rate than competitors that diversified their offerings.  In other words, the company grew much too rapidly without first proving their franchise model.

On June 29, private equity firm MGL Asset Management Group LLC bid $7.25/share to take the company private.  But the company once traded at almost $50/share.

China and India Follow up – Investment and Economic Ramifications

Thursday, July 10th, 2008

A month ago, I wrote about the emergence of China and India in the world economy.  Their expansive growth, though, results in their being more greatly affected by global economic trends.  As Investor’s Business Daily notes in U.S. Slowdown Shows In Drop of China ETFs, lower consumer confidence and drops in spending among American consumers has hurt Chinese economic growth.  That’s because the U.S. is the largest export market for Chinese goods.

Technical analyst Michael Kahn, in his Barron’s column, What Happened to China and India?, states that both countries are in bear markets.  While the long-term fundamental stories are sound, there’s no technical reason to expect a recovery in the Shanghai “A” share index, the Bombay Sensex index or the iShares FTSE / Xinhua China 25 Index Fund (FXI) anytime soon.  The latter is a popular ETF that mirrors an index of the largest 25 Chinese mainland companies traded on the Hong Kong Stock exchange.  More information is available on the FTSE / Xinhua website.

Charting Publicly-Traded Securities

Saturday, May 31st, 2008

A great many resources exist for accessing information about securities that are publicly-traded. These securities can range from corporate equity to government debt to commodities futures. In general, if there is a public market, then a chart can be developed to track various aspects of a security.

Charting allows one to technically analyze different patterns in the security’s value and to attempt to predict what future patterns-and valuation-may occur. This is useful for everything from, for example, personal investment analysis and research to corporate due diligence and industry analysis for potential merger candidates.

Quite a number of charts allow you to customize parameters that include timeline, volume, comparison to competitors or benchmark indices, stock splits, dividend payouts, and the addition of various technical indicators.

Some useful websites that offer free charting, among other information, include:

* Finviz – This site offers a wealth of information, including a heatmap of the daily performance of individual equities and market sectors.

* BigCharts – Big Charts is one of the major charting engines and allows for easy customization.

* ClearStation – ClearStation is another site that provides a lot of information.

* StockCharts – StockCharts allows for a great deal of customization.

* Yahoo Finance – This very popular investment site has simple interactive charting options.

* Google Finance – Google has developed an interactive chart that allows you to drag the chart to quickly change time lines.

* MSN Money – These charts are easy-to-use and have good, simple explanations on changing chart parameters.

* Quote.com – This is another easy-to-use chart.

* Ask Research – Ask Research also allows for detailed customization of parameters.

Securities Offerings on the Internet

Wednesday, March 19th, 2008

In the 1990s, my colleague, Lou Turilli,* and I wrote an article for The National Law Journal about how the Internet might shape securities offerings. I followed that up with an article for Wall Street Lawyer, Securities Offerings Online By Small, Nonpublic Businesses. It specifically focused on whether small companies could viably offer and sell securities on their own via the Internet. I concluded that, “Clearly, selling securities online is a viable concept. Yet until fundamental issues such as the problem of gaining visibility, the lack of secondary markets, the arbitrary pricing and the disinterest of established investment bankers each are addressed, the opportunity for small businesses to raise capital in cyberspace will hold great promise as an idea, but be of limited practicality in the real world.”

I don’t think that my conclusion has changed. Distribution and pricing remain key obstacles for companies that want to promote their own online offerings. Marketing the securities is still a serious issue, and there are credibility concerns for the companies as well. Thus, serious companies will continue to pursue the traditional route.

* Lou and I practiced law together at Day, Berry & Howard. She recently was Vice President and General Counsel of Ryerson.

Fundamental and Technical Analysis

Sunday, March 2nd, 2008

Two analytical models exist to determine the appropriate price of an equity security.

Fundamental analysis focuses on analyzing a company’s financial statements and condition, its management, and its markets and competitive position.

Technical analysis focuses on studying a company’s market action via the supply of and demand for its securities in order to estimate future price trends. Michael Kahn writes for Barron’s Magazine and has an excellent blog, Behind the Headlines, that concentrates on the techinical analysis of securities and markets.