IndyMac has failed. Fannie Mae and Freddie Mac have been hobbled but kept alive by a government and Federal Reserve rescue.
All of this happened just weeks after President Bush and Treasury Secretary Hank Paulson claimed that the worst of the credit crisis had passed. Don't believe anyone who tells you that the worst is over until the banks, insurance companies, investment funds and mortgage companies that hold securitized debts fess up to what those securities are actually worth. The problem isn't that the securities are illiquid, it's that the prices should be lower than the financial institutions are willing to admit.
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Expect More Crisis
Ann Lee 07.17.08
IndyMac has failed. Fannie Mae and Freddie Mac have been hobbled but kept alive by a government and Federal Reserve rescue.
All of this happened just weeks after President Bush and Treasury Secretary Hank Paulson claimed that the worst of the credit crisis had passed. Don’t believe anyone who tells you that the worst is over until the banks, insurance companies, investment funds and mortgage companies that hold securitized debts fess up to what those securities are actually worth. The problem isn’t that the securities are illiquid, it’s that the prices should be lower than the financial institutions are willing to admit.
Probably by the end of the month, Goldman Sachs will auction off assets from a $7 billion structured investment vehicle that was previously owned and managed by Cheyne Capital Management, a London hedge fund shop that faced massive losses this summer when its commercial paper went illiquid. The Goldman auction might give us a clue about how inflated these assets are, despite the more than $400 billion in write-downs that banks have taken since the credit markets went south last summer.
Throughout the industry and around the world, investment banks and other financial companies that own structured mortgage securities have advanced the fiction that because the market for these securities is illiquid that they have no fair market value. Up until August 2007, when banks were able to sell these securities at attractive prices, they marked the securities to market, just as they would with a liquid stock. When prices plummeted, the banks ignored the inconveniently low “buy” prices and decided to price them based on their own secret algorithms. Mark-to-market has given way to mark-to-model.
Since every multinational bank is playing the same game, and every bank has a different model, we’re seeing banks give different prices for identical securities. What Morgan Stanley might say is worth $0.80 on the dollar could be worth $0.60 to Goldman Sachs. Who’s right? Nobody knows. But this is why LIBOR, the lending rate between banks, has shot up despite lower Fed Funds rates--the banks no longer trust one another, even on overnight loans.
The banks claim that since the securities aren’t trading, these models are appropriate. But even in the absence of a trade, bid/ask prices exist for all marketed products. A conservative firm will usually mark an illiquid position to an average of three “bid” quotes. The banks will counter that they don’t intend to sell these securities for the current bids. But they might not have a choice. A leveraged institution like a bank--and the investment banks have leverage in excess of 30-to-1--doesn’t always get to decide when it’s going to sell securities.
Marking-to-model is so subjective and secretive that it practically begs bankers to commit fraud. Traders who work on proprietary trading desks almost always report different prices for the same security that was being held in another department of the bank, such as the asset management department for a fund managed for clients. In some cases, a bank allows such inconsistencies because it has spent millions to hire a star trader and doesn’t want to look like an idiot for doing so.
Banks use third parties like State Street to build models for valuing these securities when they’re in client or mutual fund accounts. But sometimes clients or account managers disagree with their contractor. When that happens, the manager or client might push for a different valuation, and they usually get their way. The third party can only proffer a number; it can’t force anyone to accept it.
So long as the banks refuse to mark their securities to market (a task they claim is impossible), investors will have to blindly navigate the credit crisis. There’s too much fog for us to be able to tell if we’re on the near shore, the middle of the river or nearing the next bank. Definitely watch Goldman’s auction. It won’t change anything, but it will offer some clues as to how much more pain will have to be endured.
Feds fight the fear factor
But it’s hard to see how attempts to shore up investor confidence can work for long while home prices keep falling.
By Colin Barr, senior writer
July 17, 2008
NEW YORK (Fortune) -- Washington is tying itself in knots trying to shore up confidence in the financial sector.
In just the past week, officials have moved to curtail short-selling, promised a crack down on market rumourmongers and cooked up a rescue plan for beleaguered mortgage companies Fannie Mae and Freddie Mac - while taking pains to argue that the institutions are sound even as investors dump shares.
Trouble is, banks and brokerage stocks aren’t being done in by a cabal of bad guys on trading desks. Bankers who made increasingly reckless bets on the housing market engineered this train wreck. And the damage they wrought on their companies’ balance sheets is going to take time - and a lot more pain - to undo.
“This is the unwinding of our bubble economy,” says Euro Pacific Capital strategist Peter Schiff, a long-time critic of U.S. fiscal policy and credit market excesses. “Anybody can make loans. But banks are finding the problem right now is getting the money back.”
Cox on the case
The Securities and Exchange Commission stunned Wall Street this week with an emergency order that would limit short sales of 19 financial companies, including Fannie Mae and Freddie Mac as well as brokerage firms Merrill Lynch and Lehman Brothers.
In a short sale, an investor borrows stock, hoping the price falls so he can profit by returning the shares at a lower price. Until now, shorts have needed only to show they have made an effort to locate shares to borrow. Now they’ll need contracts for them.
The new rules, which would take effect Monday and last as long as a month, come on top of SEC Chairman Christopher Cox’s announcement Sunday that the agency would “immediately” find the source of untrue rumours about stocks. The basic message: the SEC’s cops on the beat will make sure no one is manipulating stock prices.
For now, Cox’s announcements seem to be working wonders. Financial stocks did indeed regain their stability Wednesday, soaring as short-sellers bought shares to cover their positions and Wells Fargo posted a stronger-than-expected second quarter. Hard-hit stocks such as Fannie, Freddie and Lehman surged as much as 20%, and the S&P 500 financial index posted its biggest-ever gain.
But the relief is likely to be short-lived.
Bank and brokerage stocks were at multiyear lows before Wednesday’s rally because their books are bloated with mortgage loans whose value will plunge as U.S. home prices continue to fall, and because many firms have borrowed heavily to make these bad bets, thus magnifying their losses.
Sooner or later, investors will turn their focus away from scheming short-sellers and back to crummy balance sheets.
Oppenheimer analyst Meredith Whitney, a long-time sceptic of the financial sector, has predicted that share prices will continue to fall, as firms struggle to sell assets and bring down expenses.
She wrote Tuesday that the industry’s failure to anticipate the steep fall of home prices could lead to “a material and protracted write-down and capital pressure scenario for the banks well into 2009.”
She doesn’t expect to see a rebound till banks “get real” about the value of the mortgage-related assets on their books.
Crisis? What crisis?
The banks aren’t the only ones that have failed to get real. Indeed, Cox’s offensive against short-selling can be seen as just the latest federal effort to downplay the depth of the credit crunch that started last summer.
Back then, Fed chief Ben Bernanke and Treasury Secretary Henry Paulson said the crisis - then linked exclusively to the collapse of subprime mortgage securities - would be contained without damaging the economy.
Since then, credit problems have gotten progressively worse. This spring saw the collapse of Bear Stearns, the mortgage-heavy investment bank that was rescued in a Fed-brokered sale to JPMorgan Chase, even as Cox said Bear had sufficient capital.
Then there was Paulson’s statement of government support for Fannie Mae and Freddie Mac over the weekend. Their shares had lost nearly half their value over the course of a week as investors fretted over their thin equity cushions and their hefty exposure to souring home mortgages.
The executive branch isn’t the only place Pollyannas reside, of course. “These institutions are fundamentally sound and strong,” Sen. Christopher Dodd, chairman of the Senate banking committee, said at a Capitol Hill press conference last week, in reference to the steep selloff in Fannie and Freddie shares.
Those who believe Fannie and Freddie are fundamentally unsound have no shortage of ammunition, however. Both firms have more than $800 billion in mortgage loans and other assets on their balance sheets. But Fannie has just $38 billion of shareholder equity - a measure of net worth - and Freddie $16 billion.
With the two companies and other mortgage industry players suffering heavy losses as home prices fall, it’s easy to see why some investors might be tempted to bet against the companies, whatever their motives.
National Debt Clocks: National Debt
by the Second.
"I place economy among the first and most important virtues, and public debt as the greatest of dangers. To preserve our independence, we must not let our rulers load us with perpetual debt." Thomas Jefferson, 1743-1826
Bull’s eyes on IPPs back
By ANITA GABRIEL
July 12, 2008
Frenzy best describes players in the power sector when they were hit with a windfall profit tax recently
IT’S been intensely hard to resist dipping into the honey pot of independent power producers, more so when the pot runneth over. Harder still when government coffers are shrinking, the threat of fuel poverty looms and higher power and living bills are posing major headaches for the public.
After all, what is a pound (or two) of flesh for a 200 pound gorilla?
The lucrative concessions accorded to IPPs during the early heyday of the privatisation of the country’s power sector will go down in history as one of the most groaned and moaned about deals in Malaysia and yet, all that harrumphing had done little to alter the status quo of the power players who, worth noting, include some of the country’s most powerful and successful tycoons – Tan Sri Syed Mokhtar Albukhary, T. Ananda Krishnan, Tan Sri Lim Kok Thay and Tan Sri Francis Yeoh.
Status quo got rattled and turned belly up two weeks ago. The Government imposed a 30% windfall levy on IPP’s audited returns in excess of 9% return on asset. Like a beat on ascending volume mode, corporate hissing in the power industry reached deafening levels over the week.
“It’s a punitive and oppressive formula not based on commercial realities,” hissed one player, referring to it as a “turbulence tax”.
Here’s the big question – is the windfall profit levy, which is essentially an excess profit tax, a whip to get IPPs, who have long and vehemently resisted compromise to get their act together and relent?
“It’s more than a whip. It’s a knife,” says an industry player. And it cuts deep because the levy has been passed and came into effect July 1.
But an observer quips: “A law that has been gazetted can still be degazetted ...”
Right or wrong formula – who knows?
At the centre of the apoplectic reaction from industry players is the simple formula that applies to all IPPs across the board – the ROA is derived based on earnings before interest and tax (EBIT) (as opposed to profit after tax (PAT)) divided by fixed asset (as opposed to total asset).
“If this is so, it would be extremely serious ... some IPPs could cease operations within three years,” says Penjanabebas president Dr Philip Tan.
The power business, which is a highly capital intensive business, has a high interest element and therefore, the formula which “disregards” the interest element appears to be painful for them to digest. “Any fiscal system has to take interest as an allowable expense. It cannot be disregarded. Otherwise, they are whacking into stakeholders who are providing capital,” says an industry observer.
Detractors of the proposal say that international accounting conventions take into consideration interest as a legitimate expense when imputing financial ratios such as ROA. Such a formula, says Tan of Penjanabebas, would have been “less onerous”.
Calls to tax experts reveal, however, that it is a highly arguable issue.
“Tax is a cost of doing business. So is interest. Therefore, a levy based on ROA on profit after tax makes it more neutral. But there are many financial ratios and formulas that use EBIT where tax is not viewed as a cost but an allocation to the Government and interest is viewed as not a common cost to all organisations,” says tax expert Dr Veerinderjeet Singh.
On the other hand, if the windfall profit levy was based on ROA derived from PAT over total assets, it would significantly lessen the pool of money that can be potentially tapped which defeats the Government’s purpose of plumping up its kitty during these tough times.
But a sharp banker points out: “The Government is expecting to raise some RM600mil from this exercise. At the same time, since the announcement, substantial value has been wiped out in terms of market value both in the equities as well as bonds market to the tune of billions. So, what is the point?” he says.
The stock of MMC Corp Bhd, which controls Malakoff Bhd, the country’s largest IPP, tanked to a year-to-date-low of RM2.72, losing just over RM1bil in market value since July 1. Similarly, the shares of YTL Power International Bhd dipped to a low of RM1.78, shaving off some RM330mil in value since the start of the month. Over at the bond market, yields of some of the debt papers, particularly that of Malakoff has been widening against falling prices.
To be noted is that the EPF holds a significant chunk of the debt papers issued by IPPs and more specifically Malakoff. However when contacted, EPF CEO Datuk Azlan Zainol stressed that the impact is “not significant.” “It will not effect us very much as we are long term investors of these papers. Even when we need to mark to market, it won’t see a significant impact on our investments.”
To put things is perspective however is that the levy is not imposed on total profit but on profit in excess of a certain threshold, and in this case, 9%.
“It’s hard to say really what is wrong or right. We are facing unchartered territories. There is no historical data to say what is wrong or what is right. But during difficult times, it is safe to say that when the people are nervous, it may be reasonable to expect those in lucrative positions to pay back,” says an observer.
Biggest loser of ‘em all
Ironically, what has long been touted as a badge of success, which is Malakoff Bhd’s status as the country’s largest IPP, is the very trait that makes the windfall levy the hardest to bear for the company which is 51% owned by MMC Corp Bhd, 30% owned by the Employees Providend Fund and 10% by Kumpulan Wang Amanah Pencen.
Recall that two years ago, MMC initiated an exercise to take Malakoff private in a RM16bil (including its RM7bil debt) takeover exercise.
An industry source points out that Malakoff will have to cough up some RM250mil annually for the levy, which adds salt to injury considering it’s highly levered state with a whopping RM16bil in total borrowings, saddled with RM1.2bil on annual interest expense.
“Malakoff will cease its business operations within 3 years due to the potential default of some of the group’s outstanding borrowings,” the source exclaims.
Another source estimates that Jimah Energy Ventures (50% owned by TNB and Malakoff each, and owner of the 1,400MW coal fired power plant presently under construction) will pay a total levy during the tenure of the PPA of RM1bil to RM1.5bil against projected profits of RM1.9bil. With that, the source says that it is likely to default on its financial obligation onto the fourth year of its operation.
“You can’t treat IPPs as a bunch of profiteers. There needs to be a balanced viewpoint. This is a call for survival or they will go under,” says an industry observer.
AMResearch says the windfall tax does not promote efficiency and could raise the cost of future privatisation projects: “Windfall tax is not only expected to elevate investment risks in existing IPPs but could raise the required rate of return of future projects to compensate for the possibility of such a levy in the future.”
Windfall? What windfall?
Windfall tax is essentially a tax levied by governments against certain industries who reap above-average or super profits due to an economic windfall for example, plantations companies when commodity prices are skyrocketing or oil and gas companies when oil prices are soaring.
For example, the government has also imposed windfall tax on plantation companies in the peninsula and Sabah and Sarawak when the crude palm oil (CPO) price hovers above the threshold level of RM2,000 a tonne.
However, in the case of IPPs, an observer points out that unlike producers of natural resources, a sharp increase in international price does not result in a burst of profits for IPPs whose profits are based on fixed terms and fixed tariffs. He points out that in Britain recently, windfall tax was proposed as IPPs in Britain have earned a sudden, unexpected “windfall” profit in carbon credits which bolstered their profits. “But this is not the case for Malaysia,” he says.
But while it is distinguishable, very few deny that the levy has been slapped on the IPPs as they have long been perceived to earn excessive profits. Based on that rationale, the levy could have been imposed much earlier, even before the high fuel price provoked anxiety instead of pouring so much time and resources into the tiresome, gruelling renegotiations of the PPAs which had failed to bear fruit.
So, why was the levy imposed now and not earlier? Perhaps for as long as the general circumstances were not compelling (as it is now), it didn’t seem like a necessity?
“The current structure of power generation is not really sustainable in the long run and more so, if we need to keep our electricity tariffs at fairly competitive levels. It is with this in mind, that over two to three years ago, there was an effort to renegotiate the PPAs. As it stands, electricity tariffs have gone up for the end users. Tenaga Nasional is also hit by higher fuel cost. The Government is bearing the burden of rising cost due to the subsidies. But, the IPPs – they are not sharing any of these burdens. It’s time for them to contribute,” says a source.
Another big worry
“The first guy to feel the heat from any adverse impact of the windfall tax would be the shareholders, followed by the junior bondholders and third and least of all, holders of the senior debt papers,” says a banker.
The “unexpected’ and “unprecedented” move however has left bondholders in a quandary. IPPs have issued RM23bil worth of debt papers to raise funds from the bond market. They represent some 10% of total outstanding bonds in the market.
“Those holding these papers are clearly looking to sell but there are no buyers and the trading volume is anaemic. But yields are widening,” says a bond trader. In layman’s terms, that means the value of the papers has dropped on a mark to market premise.
“After this, I doubt that any prudent investor will freely subscribe to any new bonds to be issued by infrastructure companies and power generation companies. Even if it is possible, we expect the interest rates would be very high to compute the risk premium,” says an observer.
RAM Ratings has yet to change the grades on the bonds. However, in a note sent out earlier in mid June it pointed out that the ratings of the subordinated debt issues would be among the first to be negatively affected while the highly rated senior bonds should be “adequately shielded.” “Having said that, prolonged imposition of the windfall tax could eat into the debt-protection reserves required for the ratings to be maintained,” it had said.
“I do not see an immediate default. But the buffers would be significantly reduced as a result of the windfall profit tax. In that case, we are anticipating some potential downgrades by a notch or two in some of the papers, more specifically the junior debt papers. There is already heightened volatility in the bond market due to inflation fears, potential hike in interest rates ... this has just added to it,” says a banker.
A whip by any other name...
Indeed, it is common the world over for windfall profit levies to draw feverish protest from affected industries. After all, who wants their profits crimped? But they do tend to quieten down eventually.
Most view the latest move on the windfall tax as a means to get the IPPs, who have long profited handsomely, to pay back during hard times. Others say it is simply a tool of persuasion for IPPs to relent to restating some terms in the PPAs.
So far, it appears to be working.
It is believed that the IPPs, through a meeting held early in the week with Energy, Water and Communications Minister Datuk Shaziman Abu Mansor, had made a plea for the tax grab to be postponed to enable them to assess the impact of the measure on their financial position as well as the implications for the bondholders.
Industry sources also say that during the meeting, the representatives of several IPPs have indicated that they were more open to making a “one off lump sum payment” to the Government but no amount was stipulated.
Is a U-turn on the cards for the windfall profit tax which was only recently gazetted? No one dares rule that one out.
Seven Questions: How Bad Will It Get?
July 2008
When William Poole warned in 2003 that Fannie Mae and Freddie Mac lacked the capital to weather a financial storm, his advice went unheeded. Five years later, the outspoken former president of the Federal Reserve Bank of St. Louis is far too polite to say “I told you so,” but he does have a message for the Fed: Wait too long to tackle inflation, and you’ll face an even worse recession in the years to come.
Foreign Policy: What’s your diagnosis of what happened to Fannie Mae and Freddie Mac?
William Poole: First of all, they had too little capital to withstand adverse circumstances. And the adverse circumstances were the severe downturn in housing, the decline in house prices, and the rising default rate on mortgages. I don’t know of anyone who early enough was saying that there would be a major national decline in house prices, so I can’t hold them to that standard, but I can hold them to a standard of holding adequate capital to be able to withstand unforeseen circumstances. That’s what capital is for.
FP: In 2003, you called for the government to eliminate its implied guarantee for Freddie Mac and Fannie Mae. Do you feel that Alan Greenspan, the Federal Reserve chairman at the time, didn’t listen to you?
WP: No. I never had any inkling that he disagreed with what I was saying. Greenspan was pretty much out in front also, saying we should try to scale back these companies and the implied guarantee—make them fully private companies so they’d be subject to market discipline. If Greenspan thought that I was way off base, he would have talked to me about it or had a staff member talk to me about it. That, I can attest, did not happen.
FP: Now, there has obviously been some turmoil in the banking sector. IndyMac, a regional California bank, collapsed last week. Analysts are wondering where the line is in terms of what banks are considered “too big to fail.” Where would you draw that line?
WP: I like the way that Greenspan used to put it and probably still does put it, that no firm should be too big to fail. Some might be too big to liquidate quickly and may require some support until they can be wound down, but there should be no firm too big to fail. We don’t know yet what the nature of the bailout of Fannie and Freddie is going to be, but I believe the plan would be to pay off at par all of the regular obligations. They are being turned into full faith and credit obligations of the United States government.
FP: So, what happens now?
WP: Here’s an analogy I like to use. In a formal bankruptcy, the court appoints a receiver. The receiver’s job is to, in some cases, reorganize a firm’s capital structure. Sometimes, the shareholders get wiped out and the bondholders become shareholders. Sometimes a company is liquidated and the creditors are paid according to certain legal rules. Depending on how particular credits are set up, a receiver’s job is to keep the company going long enough to obtain the maximum possible benefit for the creditors as a whole. In some cases, the company might be shut down quickly.
So that’s the analogy, and now the secretary of the Treasury is de facto in that position. But he’s operating under no established law. For the most part, everything that is now done to deal with Fannie Mae and Freddie Mac, to reorganize them financially or scale them back, is done now by negotiation between the secretary of the Treasury, Congress, and the companies. The companies have what you might call a “well-oiled political machine.” They have many members of Congress they talk to regularly who will represent their interests in this negotiation.
FP: NYU economist Nouriel Roubini, who has been sounding the alarm for quite a while, told Bloomberg News that we’re seeing the worst U.S. financial crisis since the Great Depression.
WP: I think that’s right, but let’s go back and revisit the Great Depression for a moment. In 1932, the economy was spiraling down and there were large numbers of bank failures. Eventually, in early 1933, various states started to declare banking holidays. They closed the banks and allowed them to continue to exist, but the depositors were not permitted to take any money out. They shut the doors.
When Franklin Roosevelt took office, he declared a national banking holiday. All the banks were closed, including the Federal Reserve banks. There was a total and complete collapse of the banking system, and the economy that had functioned on credit and deposits was suddenly left to function on hand-to-hand currency. We aren’t anywhere close to that and we won’t get close to that because of ample Federal Reserve resources and also intellectual understanding that would not permit that to happen.
FP: How bad will it get, then?
WP: We are going to have failures of large numbers of firms, financial firms in particular. A traditional important piece of business for community banks and regional banks are loans to real estate developers and builders. And now that some of those are going into default, it’s leading to failures of smaller commercial banks, and the ones that were the most heavily involved in real estate are the ones at the greatest risk. The longer these things go, the greater the depletion of capital. In time, the losses accumulate and exhaust capital and the firm fails, so the [Federal Deposit Insurance Corporation] shuts it down. It looks like there’s more of that to come, because there is no sign of a revival in home-building.
FP: Meanwhile, consumer prices are rising at their fastest rate in 17 years. Does that mean the Fed is running out of tools to keep growth going?
WP: All the financial turmoil that we’ve just been talking about—the tightening of credit, the fact that so many banks have impaired capital—that’s putting downward pressure on the economy, and the big increase in fuel prices is also putting downward pressure on real activity. You see that in transportation, the airlines, the auto industry—anything that has a big fuel cost. There is a growing amount of unemployment in those sectors, and the Federal Reserve is trying to support economic activity by holding the federal funds rate—the interest rate—at its current level. If the downturn in employment becomes much more severe, the Fed might even cut rates.
Now, to me, the inflation problem is actually part of what is depressing economic activity, because the generalized inflation that I think we have underway—although it’s not showing up in core inflation and wages just yet—is showing up in the depreciating dollar, and the depreciating dollar directly feeds through to increased energy prices and food prices. So, the depreciation itself is leading to depressed economic activity.
Moreover, if the inflation really starts to go into wages and into the core—the non-energy, non-food part—of the price indices, it will probably develop a fair amount of momentum and the Federal Reserve is not going to be able to reverse it even with a tighter monetary policy for probably a year or two, maybe even three. If the policy is too expansionary too long and we end up with a real inflation problem, all we’re doing is trading a bigger recession later for a smaller recession now.
William Poole is the recently retired president of the Federal Reserve Bank of St. Louis.
ASIA FOCUS
Regional wealth ranks swell
Asia Pacific millionaire bracket could surpass Europe's by 2012, reports Genevieve Cua in Singapore
June 28, 2008
Asia and the world's emerging markets captured the top 10 rankings in terms of the fastest growing wealthy population in 2007, with Singapore in sixth place.
The report by Merrill Lynch and Capgemini finds that the number of Singaporean wealthy individuals - defined as those with investible assets of US$1 million or more - rose 15.3% to about 77,000. The average wealth per individual is estimated to have risen from $4 million previously to $4.9 million. This is higher than the global average wealth per high net worth individual (HNWI) of about $4.04 million.
The Asia-Pacific wealth market is projected to grow at a 7.9% annual clip over the next five years to $13.9 trillion in 2012, according to Kong Eng Huat, managing director (South Asia) of Merrill Lynch. "[The region] will surpass Europe as the second wealthiest region after North America."
Merrill and Capgemini have forecast a growth rate of 7.7% for global wealth markets to a total $59.1 trillion by 2012, taking into account recent world developments.
Recent economic downturns in the United States have been shorter, it said, thanks to increasingly effective monetary policy. Emerging markets have also outpaced analysts' expectations. High net worth portfolios have also become more diversified and mobile.
"As growth in one region or market slows, HNWIs can move freely, reallocating their funds to other areas - often more quickly than the troubled market itself can react and recover. Ultimately, this evolution will make HNWI investments less vulnerable to market downturns," said the report.
Globally, the combined wealth of the world's high net worth individuals rose 9.4% to $40.7 trillion in 2007. This is a shade paler than the growth in 2006 of 11.4%, due partly to a slower pace of world economic growth. The world's real GDP expanded 5.1% in 2007, against 5.3% in 2006.
In terms of asset allocation, the wealthy have generally reduced their exposure to real estate, and moved to cash and fixed income assets. Asia's wealthy reduced their real estate weighting from 29% to 20%. Cash and fixed income have a combined 46%.
Mr Kong said: "The wealthy have retrenched to safer assets. Domestic market allocations also gained favour, which is a tactical move of caution as investors wait for movements in the global markets."
Stephen Corry, an investment strategist with Merrill Lynch Global Wealth Management, sounded a note of caution on rising inflation. Merrill's inflation expectations have been raised 190 basis points, and yet global interest rates have fallen from 5.5% to 5.1%. Even excluding the US, the increase in average global nominal rates is just 16 basis points.
"A lot of inflation is generated in Asia. Asia is growing too quickly but central banks are slow to move rates higher. ... You don't want to be in Asian bonds; be selective on Asian equities. The best bet is Asian currencies," said Mr Corry, who favours the Singapore dollar and ringgit.
This year's report included a highlight on "passion investments" including art, luxury cars, and wellness. Globally, luxury collectibles accounted for 16.2% of passion investments, and fine art 15.9%. Among Asians, however, the preference is for jewellery and watches, which took up 19% of their "passion" dollar.
Meanwhile, private bankers are optimistic about the continued growth of the Asian wealth market despite rocky stock markets, worries over inflation and slower economic growth.
"Our expectation for general growth continues to be around 15-25%. Business activity is still quite robust although [stock] markets have consolidated. Businesses and wealth creation are our leading indicators. We still foresee a fairly healthy continuation of growth," said Akbar Shah, head of mega-wealth (Asia Pacific) for Citi Private Bank.
UBS managing director Yeong Phick Fui said the fundamentals of continuing wealth creation, particularly in China, and the increased need for professional advice would continue to drive growth. "We believe that any uncertainty in the near term will be an aberration rather than a permanent deviation from the strong underlying trend."
Raj Sriram, head of private banking for RBS Coutts Singapore, said Coutts' business grew more than 50% in 2007, and he expected "healthy" growth in the medium term.
"We have been seeing continued growth in clients' funds under management despite market volatility, although growth is at a slower pace than previous years. At the macro level, wealth creation in Asia shows no signs of slowing."
Published in Business Times (Singapore) on June 26
Citi Posts Smaller-Than-Estimated Loss on Writedown
By Josh Fineman and Bradley Keoun
July 18 (Bloomberg) -- Citigroup Inc. reported a smaller- than-estimated loss by reducing mortgage-bond writedowns, eliminating jobs and borrowing money at lower rates.
Citigroup, the biggest U.S. bank by assets, rose in New York trading after the company said its second-quarter net loss was $2.5 billion, or 54 cents a share, because of $12 billion in writedowns and increased bad-loan reserves. Analysts estimated the New York-based bank's loss at $3.67 billion.
Led by Chief Executive Officer Vikram Pandit, Citigroup is the third major U.S. bank to beat analysts' predictions this week, after JPMorgan Chase & Co. and Wells Fargo & Co. Merrill Lynch & Co.'s results yesterday fell short of Wall Street's estimates. Pandit, who took over in December, reduced assets by about $67 billion during the quarter, making progress on the $400 billion he has targeted.
``Conditions have eased a little bit and at the same time they have been able to grow their top line,'' William Fitzpatrick, an equity analyst at Optique Capital Management in Milwaukee, which manages $1.4 billion, said in a Bloomberg Television interview. ``They haven't had a lot of clients run out the door. They have been able to maintain relationships. Now it's just a matter of being more profitable.''
Writedowns for subprime-related assets and debt linked to bond insurers totaled $7.2 billion. The bank's credit costs increased $4.5 billion from the second quarter of 2007, mainly because of bad consumer loans in North America and the company's credit-card business.
Writedown Estimate
Credit Suisse Group analyst Susan Roth Katzke predicted in a June 24 note that the company would have as much as $10 billion of writedowns.
Shares of the company rose to $19.29 in New York trading, from $17.97 at the close on the New York Stock Exchange yesterday.
Second-quarter revenue dropped 29 percent to $18.7 billion, compared with the average estimate of $17.3 billion among analysts surveyed by Bloomberg. Earnings in the same quarter last year were $6.23 billion, or $1.24 a share.
The U.S. consumer unit, which includes retail banking and loans to individuals and small businesses, had revenue of $7.89 billion, virtually unchanged from a year earlier. The global cards business rose 3 percent to $5.47 billion.
Tier 1 Ratio
Citigroup's Tier 1 capital ratio, a measure regulators use to monitor a bank's ability to withstand loan losses, rose to 8.7 percent at the end of the quarter from 7.7 percent in the first quarter and 7.1 percent at the end of 2007. The minimum for a ``well-capitalized'' rating from U.S. regulators is 6 percent. Citigroup sets its own target at 7.5 percent, partly to assure its AA- rating from Standard & Poor's.
Seven interest-rate cuts by the Federal Reserve in the past year have reduced the bank's borrowing costs and allowed it to trim the rates it pays depositors.
Revenue at Citigroup's corporate and investment bank plunged 71 percent to $2.94 billion. The wealth management division, which includes the Smith Barney brokerage, gained 4 percent to $3.32 billion.
Pandit, 51, put former Morgan Stanley colleague John Havens in charge of trading and investment banking, moved U.S. consumer head Steve Freiberg to oversee a new credit-card division and recruited former Wells Fargo executive Terri Dial to oversee consumer banking in the U.S.
Asset Sales
He also is taking steps to free up capital by selling assets. Under former CEO Charles O. Prince, Citigroup's balance sheet swelled by $689 billion, an amount larger than the entire balance sheet of San Francisco-based Wells Fargo, the fifth- biggest U.S. bank by assets. Citigroup's total assets stood at $2.2 trillion at the end of last year.
Citigroup slumped 39 percent this year through yesterday, reaching the lowest point since the bank was created a decade ago from the merger of Citicorp and Travelers Group Inc. The decline led to the ouster of Prince as credit-market losses piled up and Citigroup's market value fell below those of Bank of America Corp. and JPMorgan. New York-based JPMorgan reported second- quarter earnings yesterday of $2 billion. Wells Fargo's profit was $1.75 billion.
``We will continue to have substantial additional marks on our subprime exposure this quarter,'' Citigroup Chief Financial Officer Gary Crittenden said on a conference call last month.
Citigroup also wrote down the value of so-called monoline insurance companies including Ambac Financial Group Inc. after they were stripped of their AAA credit ratings.
Raising Capital
``All of the over $300 billion in capital raises worldwide have plugged holes,'' Oppenheimer & Co. analyst Meredith Whitney said in a Bloomberg Television interview earlier this week. ``They haven't funded new equity growth. You plug these holes and you are still in the same situation where you started off.''
The bank slashed the quarterly dividend by 41 percent in January to 32 cents a share, the first drop since the early 1990s. Analysts including Whitney have said the bank may have to cut the dividend again to bolster capital as losses escalate.
``They did not cut the dividend and many analysts were concerned that they might,'' David Dietze, president of Point View Financial Services, said in a Bloomberg Radio interview. ``Sequentially they made some nice improvements in terms of cost cutting.''
Pandit said in May that Citigroup will shed ``legacy assets,'' including real estate holdings and collateralized debt obligations, such as bonds backed by pools of subprime mortgages.
Revenue Target
Citigroup also plans to cut $15 billion in costs in the next two to three years, while aiming for revenue growth of 9 percent, Pandit said.
The bank said in January it would eliminate about 4,000 jobs in the securities division, and said two months later that the number had increased by about 2,000. Citigroup said in April it would slash 7,000 jobs outside the investment banking group over the next year, and executives have said further reductions are likely.
Citigroup agreed to sell its German consumer banking unit to France's Credit Mutuel Group last week for 4.9 billion euros ($7.7 billion). Capital freed up by that sale will boost Citigroup's Tier 1 ratio by another 0.6 percentage points, the company said.
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