Prudent Speculations

One Final Post

2009-04-14T23:06:00.012-05:00

As many of you might have already guessed, I've concluded my writing here at Prudent Speculations. The keeping of this blog has been a wonderful experience; however, it has simply become too much of a time commitment. I believe that I have provided some valuable insights into the companies that I have chosen to write about and I invite those that have stumbled across this blog to search through and examine the initial articles on these companies, as I believe that many of the initial theses are still accurate.

I am particularly pleased with my articles on First Fed Financial (FFED) and PFF Bancorp (PFFBQ) which highlighted the problems these banks were facing while their stock prices were still trading in the double digits. In addition I am also proud of the various MLP articles that were posted as well as the articles that pertained to the credit crisis that were picked up by a variety of online news and commentary sites.

Should anyone wish to contact me I can be reached at:

prudentspeculations@gmail.com

Thanks for reading everyone.

Finding a Proper TARP Investment

2009-02-23T23:18:00.005-06:00

With the country's publicly traded banks set to undergo further examination in the weeks ahead it provides investors with the opportunity to examine how the market is valuing the publicly traded TARP banks and what future returns investors can expect. The simplest way to do this is to compare each of the bank's market caps with their respective TARP investments. The higher the percentage of TARP funds to the company's market cap, the more leveraged the company's stock price is to the government's investment. Conversely, the lower the percentage, the lower the bank's leverage to the government's TARP investment. In between these two wide ranges exists a group of banks with substantial leverage to TARP but with enough financial flexibility to take advantage of all the immense benefits that TARP leverage can provide to the right financial institutions. Below I have compiled a listing of the strongest, weakest and the what are likely the most attractive bank investments for those interested in exploring an investment in a bank that is fairly leveraged to the government's TARP investment.

Bank’s most leveraged to TARP investments:

(The Weakest TARP Banks)

Ticker - Company - TARP - Market Cap - TARP as a % of Market Cap

Bank’s with the least amount of TARP leverage:

(The Strongest TARP Banks)

Ticker - Company - TARP - Market Cap - TARP as a % of Market Cap

TARP bank’s with the best risk/reward profiles:

(The Most Attractive from an Investment Prospective)

Ticker - Company - TARP - Market Cap - TARP as a % of Market Cap

As Geithner Stumbles an Economic Recovery is Delayed

2009-02-11T16:59:00.004-06:00

Sometimes it just pays to say nothing at all. Secretary Geithner’s comments in front of Congress and in his department’s most recent press release in regards to their Financial Stability Plan show that the Treasury Department under Geithner has absolutely no business communicating with the financial community unless they are absolutely prepared to do so. In using a term like “stress test” and in failing to outline detailed steps that will be taken by the government to remedy the current crisis, Geithner leaves us wondering how he got such high marks as the President of the New York Fed. It is readily apparent that the markets need something big, in terms of government intervention, to get the credit market and the economy moving again. While the sheer size of the government’s program seems to fit the bill its effectiveness is far from certain.

When I first heard Secretary Geithner use the term “stress test” in reference to the need to thoroughly inspect the country’s largest banks in order to ensure their ability to lend, I assumed that the Obama administration had won out over the Treasury Department’s more market oriented philosophy. Fortunately, that appears to not have been the case, nevertheless, when someone uses the term “stress test” one can only assume that it will have significant consequences for our country’s banks. These consequences are surely closely related to nationalization and a general bleeding out of the poorly performing banks from our financial system. While nationalization would be a quick yet painful solution, a very public examination of the banks by federal regulators would almost certainly be a long affair that would allow the markets to continue down their current path of destruction. The government already has capital ratio requirements and regulations that force bank to describe the composition of their assets, these data points and ones similar to them, should be enough for the government and the markets to judge a bank on its viability.

While the TALF program is certainly a bold action, the majority of the Treasury Departments resources should be devoted to restoring confidence in the banks. Once confidence is restored in the banks, the American people can surely begin to have renewed confidence in the American financial system, helping to power the economy forward. Below I will outline several of the steps and programs that I believe the Treasury Department should initiate during TARP II.

- Mandatory Capital Injections: To be “well-capitalized” banks must have a tier 1 capital ratios of over 6%. In conversations with banks, the Federal Reserve and the FIDC have been trying to get banks to boost their capital ratios to over 8%. In order to restore confidence, the Treasury and the federal government should mandate that all banks with capital ratios of between 6-8% receive government investments. Banks with tier 1 capital ratios above 8% should receive incredibly attractive investments from the government to acquire banks with capital ratios below 6% and the weakest of the "well-capitalized" banks.

- Convertible Debt: As suggested by some, the Treasury Department should enter into convertible debt agreements with the nations largest banks. These investments by the government should provide for the governments debt interest to be converted to equity to ensure that the respective bank’s tier 1 capital ratio remains above 8%.

- A New Resolution Trust Corporation (RTC): Allow a new RTC to function like an old one but instead of taking over the assets of failed institutions, regulators should have it use the Federal Reserves balance sheet to purchase troubled assets currently held by viable banks. A return of the equity partnerships and multiple investor funds will help to bring private capital back into the credit market. Such an institution would supplement the expanded TALF program wonderfully.

- A National Moratorium on Foreclosures on Single Family Homes: This would be a bold and hope filled action, something that the Obama administration would be all to eager to go for, such an action would help to assure the American people that they have a little breathing room in case something goes wrong in their own lives. Such a plan would only be temporary but would hopefully get the American people spending again, helping to push the economy forward. While such a proposal is risky, the government could make it attractive for banks to delay foreclosures. It should be noted that investment, commercial and industrial foreclosures would still be allowed to go forward and that any national moratorium on residential foreclosures would only be temporary.

These are desperate times in America and it is time for a decisive and well thought out plan by the Obama Administration and Geithner’s Treasury Department to help prop up a failing American economy. With unemployment accelerating there is not much time for the government to act as the nations banks are dangerously exposed to increasing unemployment rates. We need an effective stimulus, a supportive regulatory authority for the financial markets, a significant amount of government capital and a return of public confidence in the American economy. All of these are possible but we need leadership, something that has been surprisingly lacking in Washington over the last several weeks.

For Further Review:

Treasury's Financial Stability Proposal

PSE's Perfect Timing of the Oil Market

2009-02-09T20:16:00.002-06:00

Nearly every oil company in America is struggling to deal with lower commodity prices. The majority of these companies have chosen to respond to declining commodity prices with severe drilling cutbacks and asset sales. However, Pioneer Southwest Energy Partners (PSE) is likely to stand out as an aggressive grower within the energy sector as it has the resources to continue its drilling programs and to purchase assets at below market prices. It is clear from recent statements by Pioneer that it is using its strong balance sheet to take advantage of the recent drop in oil prices and the corresponding drop in asset values across the sector. On Pioneer’s last conference call, management said they were negotiating a $200 million acquisition from the company’s parent, Pioneer Natural Resources (PXD); these assets will probably be centered in the Sprayberry field.

Pioneer’s timing could not have been better. Pioneer was formed in early 2008 through a public offering of units and a simultaneous purchase of about $220 million of developed oil producing assets in the Sprayberry field from its parent Pioneer Natural Resources. Pioneer promptly hedged the majority of its oil production in 2008-2011 at prices over $100. Even more astutely, Pioneer negotiated a $300 million credit facility at favorable rates before the credit crisis developed into its present form. Because of Pioneer’s strong hedges, management has said they can maintain their current distribution rate of $0.50 per quarter through 2011 regardless of the spot price in the oil market. This distribution offers investors a high degree of safety as they wait for the company to leverage its strong balance sheet to acquire depressed properties. In 2012, once the company’s current hedges expire, management has said that they need $80 oil to maintain their distribution with their current properties. While the current price of oil is significantly below that figure, I would not bet against oil rising to $80 yet again over the next several years. Fortunately, Pioneer is so heavily hedged that it is currently generating about $0.63 per quarter in distributable cashflow from which Pioneer will be able to build up quite a cash hoard that can be used to expand the company’s production portfolio.

With Pioneer now set to purchase another $200 million of oil producing properties in the Sprayberry from Pioneer Natural Resources at depressed prices it should be clear that the management team of Pioneer realizes the position they currently have as one of the more financially sound small cap limited partnerships. It should be noted that the purchase price between these two related company’s is being set at metrics similar to other recent oil property transactions in the industry. Management has said that it is their intention to leave the majority of the assets acquired from Pioneer Natural Resources unhedged so that unitholders can benefit from the rise in oil prices in the coming years. From this action, it can be concluded that Pioneer will follow a similar strategy following the acquisition of additional assets in the months ahead.

After Pioneers transaction with Pioneer Natural Resources, the company will still have almost $150 million of capacity available on its credit line for further acquisitions and drilling. In addition, unitholders can expect a substantial distribution increase following the transaction as the company’s leverage begins to grow.

There are only a few oil companies that have managed the downturn in oil prices as well as Pioneer. Linn Energy (LINE) and Exxon Mobile (XOM) are additional examples of companies that have done a good job of hedging their production and the timing of their capital expenditures. However, I know of no other company of similar size to Pioneer that is in such an excellent position to purchase assets in the oil sector at rock bottom prices.

Disclosure: Long PSE

Dark Skies Ahead for Big Oil?

2009-02-05T23:09:00.008-06:00

In what is likely to be one of the more interesting stories in 2009, the Financial Times on Wednesday discussed the impact that the falling price of oil will likely have on some of the world’s largest multinational oil companies. Despite having record breaking profits in 2008, 2009 looks to be a different story altogether as the decline in oil from $150 to $40 could lead to hard choices for oil companies. Particularly on whether or not to continue with their current level of capital expenditures, share buybacks and dividends or to reduce these expenditures to reflect their current cashflows and the price of oil. Below you will find a fascinating graphic from the Financial Times that breaks out the cashflows of six of the worlds largest oil companies and the impact that the fall in the price of oil will likely have on them.

The negative cashflows that will likely be achieved by BP, ConocoPhillips, Shell and Eni at $35 dollar oil will force these companies to either reduce their capital expenditures and shareholder payments or to borrow in order to continue with their current expenditure policies. While these companies have certainly built near fortress balance sheets, no management team enjoys shelling out more cash then what is coming in on unprofitable capital expenditures and through the return of capital to shareholders. In addition to the cashflows of the world’s largest oil companies being impacted by low oil prices their balance sheets are as well as the firms will likely have to take dramatic writedowns on assets that were purchased at premium valuations during 2008. A prime example of this occurring can be seen in ConocoPhillips most recent quarterly report in which it took a $34 billion dollar writedown.

Unlike their smaller brethren, BP, ConocoPhillips, Exxon Mobil, Shell, Total and Eni have held up fairly well given the recent swoon in the financial and commodity markets. This trend will likely not continue, as investors are likely to become increasingly skittish of these firms because of the ever increasing chance that they will be forced to take on substantial amounts of debt to maintain their current capital expenditures and shareholder return policies. Over the last year these six companies have performed as follows:

XOM: Down 2.8%

TOT: Down 25.3%

RDS: Down 26.4%

E: Down 28.0%

BP: Down 30.3%

COP: Down 38.3%

Of these six, it is clear that Exxon Mobil has significantly outperformed its fellow big oil peers. Despite having $31 billion in cash, the company’s quarterly earnings reports will likely be ugly going forward as the company’s free cashflow will undoubtedly comes under significant pressure. At its current price the company’s earnings multiple is 2-3 times its smaller mid and small cap peers. Despite its ability to radically reshape the oil and gas industry with its strong balance sheet, the stock should not be held at these levels given the current price of oil. The company's most recent quarterly report, and the ones that will come after it, will weigh heavily on the stock’s momentum investors, as they will become increasingly uncomfortable holding shares in a company with a deteriorating balance sheet and income statement. There are many other smaller oil and gas stocks that I would rather own over Exxon that have already fallen significantly and are now trading at levels much more reflective of the current environment within the energy markets. Unless oil returns to $70+ dollars per barrel, Exxon Mobil will more then likely come under significant pressure going forward as the gap between its valuation and that of its fellow big oil peers begins to converges.

For Further Review:

Financial Times Article on Oil Industry Cashflows

Financial Times Graphic

The Future Returns for FMD

2009-02-03T23:09:00.003-06:00

While the future is always uncertain, it is looking slightly brighter for First Marblehead (FMD). The company’s quarterly report last Monday shows a company that is striving to ensure that it is still an independent entity when activity in the credit markets returns. While the stock has been decimated and will likely never fully recover to its past levels it does nevertheless offer an interesting play on increased federal involvement in the private label student loan market and student loans in general. Going forward the company has two significant items going for it, namely its recent ability to significantly reduce costs and the expansion of the Department of Education’s asset purchase program.

During the quarter, the company managed to only burn through $14.3 million dollars, leaving it with $198.6 million in cash on hand, this dramatic reduction from the previous year is a testament to management’s strong desire to see the company through the current environment. This can be seen by the sixty percent reduction in non-interest expenses from the year ago period. While the company’s quarterly report was awful, the majority of the expenses were no cash charges related to a reduction in the value of the company’s residuals portfolio. While these charges will likely continue, they do not dramatically impact the company’s financial position.

The only significant concern that I had with the quarter was the sharp reduction in deposits at the company’s federally chartered thrift, Union Federal Savings Bank. With deposits declining by over $100 million, it is clear that the company does not believe that the operation of a thrift is in the best interests of its shareholders. This really does not make much since given the current credit environment and the added importance of having a secure liquidity source but I would imagine that the company was doing this so as to satisfy federal regulators. In 2008, I had argued for the company to dramatically expand its banking operations so as to secure adequate funding sources, as a result, I am rather disappointed in this unfortunate turn of events.

Nevertheless, the next major catalyst for First Marblehead is the upcoming implementation and likely expansion of the Department of Education’s Asset Based Commercial Paper Conduit program and the Loan Purchase and Participation Program. While only currently set up to deal with FFELP loans and a limited amount of privately originated loans, it is likely that this program will be expanded to purchase loans such as those currently being held and originated by First Marblehead. While the company’s future is certainly tied to an expansion of the Department of Education’s lending programs, the company will likely be able to make it through to a thawing of the credit markets with its large cash position and a greatly reduced burn rate.

Disclosure: Long FMD

For Further Review:

Department of Education PR

Dwindling Value in AIG

2009-02-02T23:53:00.006-06:00

The demise of AIG has been well documented in the business press over the last year. The company’s insatiable thirst for cash to satisfy its derivative contracts will likely become the stuff of legends in future business school case studies. While the company has survived in its pre-bailout form since September via the use of government funds, it has not been easy. The high interest rate on the government money has and will likely continue to make it difficult for AIG to operate in its current state for a prolonged period. Fortunately, AIG’s management team has vowed to take proactive steps to reduce the company’s debt level in 2009 via the sale of non-essential divisions. Unfortunately, these efforts have so far seen the company take one step forward while at the same time taking one step back. It now appears entirely possible that the valuations that the company’s assets deserve in the event of the sale will likely not be achieved during 2009. This is unfortunate, as it will likely put tremendous pressure on the company.

Over the last several weeks, investors have learned in greater detail how the company’s divestment activities are doing. While the disclosure that AIG could bring in over $8 billion from the sale of its International Lease Finance Corp. to a variety of sovereign wealth funds is certainly welcome news it is more then offset by another significant disclosure. Namely, the possibility that the company will sell its asset management division at a price that would have been absurd only a year ago. A significant driver of this reduced sale price has been the decline in assets under management. While a certain percentage is certainly as a result of the markets collapse, it is clear that withdrawals have soared. At the end of September, AIG’s asset management unit had over $676 billion under management; however, recent reports put this figure at only $210 billion. This decline, when coupled with a decline in valuations likely means that the unit’s current value to AIG has declined by over $10 billion dollars in only a quarter. This type of value erosion is an ominous sign as AIG seeks to sell other non-core assets.

Should the sale of AIG’s asset management unit go through, as rumored, it will be to the detriment of the federal government and AIG’s current shareholders. Despite a lack of divestitures of any significant foreign holdings, it is already readily apparent that the federal government must renegotiate its advance to AIG in such a manner so that it lowers the company's interest rate on its loan. This should give AIG’s management more time to sell off assets over the next several years, once asset prices and valuations return.

Disclosure: Long AIG

For Further Review:

Dow Jones Article on AIG's Potential Asset Management Sale

DOW to ROH: Sometimes Things Just Don't Work

2009-01-29T23:57:00.004-06:00

Last July I wrote a blog entry that discussed the possibility of margin and multiple expansion at Dow Chemical (DOW). The thesis of this recommendation centered around Dow Chemical’s acquisition of Rohm & Haas (ROH) and the company’s ability to pass on price increases and its ability to hold these price increases should the price of oil retreat. While I still hold shares in Dow Chemical, the investment story behind the company has clearly deteriorated. This has been caused in large part by the collapse of the company’s deal with Kuwait, further deterioration in the credit markets and by the U.S. economy’s significant turn for the worse. While I am thoroughly convinced that the company would have done quite well had economic growth only slowed and not collapsed and had the company been able to complete the sale of a select group of low performing units to the Kuwaitis, it is clear that the company is facing a completely different environment then it was six months ago.

Given how awful the earning reports from Eastman Chemical (EMN) and Nova Chemicals (NCX) have been, it is clear that Dow Chemical will likely not be able to fund the repayment of the debt taken on to complete the Rohm & Haas acquisition. Without the cash from the Kuwaiti sale, Dow Chemical simply cannot risk a purchase of Rohm & Haas in this economic environment. Should the acquisition of Rohm & Haas go through, the bridge loan that the company will be forced to take out will be crippling. It is clear that if Rohm & Haas had been trading freely, without Dow Chemical’s support, that it would be trading at a level well below its 52 week low of $44 dollars and no where near its current price per share. More likely then not, Rohm & Haas’ business has suffered a significant hit as its specialty chemicals, with their considerable ties to electronics, has likely been disproportionally impacted by a significant slowing of consumer spending.

Should the management of Dow Chemical still wish to complete the deal or if they are not able to escape the confines of their agreement with Rohm & Haas, it is evident that the purchase price must be significantly reduced. In addition, the terms of the deal must be changed so that a significant amount of the purchase is in the form of Dow Chemical stock instead of cash. The company’s dividend, while considered sacred by most because of the company’s ability to either raise or maintain it for the last 389 quarters will likely need to be cut in any event. However, if the Rohm & Haas acquisition is called off completely it will assuredly not need to be reduced to a mere pittance of its current value.

The deal between Rohm & Hass and Dow Chemical simply does not work in today’s world. The economic situation will likely prevent the combined company from paying back the bridge loan that would be needed to complete the purchase given the failure of the company’s deal with Kuwaitis. The management team of Dow Chemical and the company’s shareholders simply cannot want to be faced with the task of raising billions of dollars as the bridge loan approaches expiration, especially when the company’s core business is in a free fall. It is time for the company to hunker down, conduct small niche acquisitions, retool plants and pay down debt. A blockbuster acquisition cannot be supported given the current shape of the economy.

Upon the next quarterly report by Dow Chemical, we will likely see a company that has been battered by a slowing U.S. economy. The stock will undoubtedly come under significant pressure, when this happens it will be a clear buying opportunity as it will likely signify the abysmal shape of Rohm & Haas’ business and the subsequent calling off of the acquisition.

Disclosure: Long DOW

Is Liquidity Returning to the Energy Sector?

2009-01-28T23:58:00.004-06:00

There are signs that credit is flowing once again in the beleaguered energy sector and in particular within the Master Limited Partnerships (MLPs). MarkWest Energy Partners’ (MWE) announcement that it has successfully entered into a new joint venture with NGP Midstream & Resources and expanded its credit facility are tell tale signs that this illiquid corner of the energy sector is seeing a return of financing and investment. The new joint venture, when coupled with the increase in borrowing capacity, allows MarkWest to realign its capital expenditures to account for projects that it was required to undertake in the second half of the year. In achieving this, a significant overhang has been removed from the stock, as the company will likely not be forced to raise dilutive equity to undertake its obligatory contracts with Newfield Exploration (NFX) and Range Resources (RRC). These contracts, which were entered into prior to the credit crunch, mandated that MarkWest Energy Partners construct gathering pipelines according to what Newfield Exploration and Range Resources needed, regardless of whether or not MarkWest Energy Partners could effectively fund such projects.

While MarkWest Energy Partners will only own 60% of the combined venture with NGP Midstream & Resources, it will nevertheless no longer have to deal with an uncertain level of capital expenditures going forward into 2009 and 2010. The assets that were transferred into the joint venture were primarily in the Marcellus Shale, showing once again that western Pennsylvania remains one of the most attractive shale development plays in North America. NGP Midstream & Resources is at its core a private equity firm. Despite its relatively small size, its participation will likely serve as a harbinger of things to come, as cash strapped energy companies will be forced to turn to private equity firms and the plethora of cash that they are currently carrying to fulfill pre credit crunch commitments. However, even if private equity firms become increasingly involved in the energy sector through corporate/private equity joint ventures it is unlikely that any will ever rival Atlas Energy Resources' (ATN) universal cost advantage as derived from its partnership program.

Despite the resolving of its capital expenditure issues, MarkWest Energy Partners is still not a buy at these levels as the firm will be significantly impacted by sub $40 oil and an abnormally low NGL to crude ratio. As a result, unless there is a significant expansion in oil and gas prices, it is likely that MarkWest Energy Partners will not be able to cover its current distributions going forward.

For Further Review:

MWE Press Release

Finding the Next Consolidator

2009-01-26T23:57:00.002-06:00

The week got off to an improbable start on Monday with the announcement that Pfizer (PFE) had entered into a definitive merger agreement with fellow large cap drug maker Wyeth (WYE). Pfizer, like nearly every large drug company, has come under tremendous pressure in recent years to replace an aging pipeline with innovative new blockbuster products. Despite ambitious attempts by Pfizer’s management team and by all of the other drug makers in a similar position, the results have been dismal. As a result, these broken firms have been left with but with one quasi solution, and that is to merge with their rivals in an attempt to diversify and prolong the life of their pipelines. Such mergers cannot be faulted, as they are often one of the few options that corporate management teams have left open to them when faced with ineffective R&D spending and limited internal growth. Given the recent media speculation on a surge in deal making within the pharmaceutical industry it is interesting to ponder who will become a consolidator in the industry. While the growth through consolidation model clearly cannot work beyond a certain point it can be tremendously profitable until sheer size prohibits further profitable acquisitions.

Forest Laboratories (FRX) has been a tremendously well-run company over its entire history. However, like many of its peers it is facing an especially difficult environment going forward as it struggles to deal with stagnating sales and patent uncertainties. The company’s blockbuster depression and Alzheimer’s drugs have generated tremendous profits that have allowed the firm’s management to create the industry’s strongest balance sheet. By specializing in two areas, Forest Laboratories has managed to become one of the most profitable drug companies in America. This is a significant competitive advantage and will allow the company to conduct itself in a dignified manner as it races to morph itself into a truly multi-line drug company.

In looking at the company’s balance sheet, it is clear that it is in a position of strength and poised to acquire other drug manufactures in the next several years. The company currently has no long-term debt, $1.8 billion in cash and a tremendous amount of treasury stock that can be readily issued for an acquisition. These characteristics will allow Forest Laboratories to spend billions over the next several years to enter a world that is currently dominated by the likes of Eli Lilly (LLY), Schering-Plough (SGP) and Bristol Myers Squibb (BMY). In doing so it will be better able to compete for the small drug companies that will eagerly sell themselves to the titans of the industry in return for substantial monetary rewards. Forest Laboratories has done tremendously well for its shareholders over the last several decades but it is simply unable to compete and its dependency on key products will be the firm’s undoing unless it grows through acquisitions. The firm’s large cash flow, cash on hand and large borrowing capacity have the potential to make the company a deal maker in the drug industry.

Two potential targets exist that would allow Forest Laboratories to revolutionize itself. It has been readily acknowledged by most industry insiders that the drug companies that wish to prosper must participate in the world of biotechs, specialty pharmaceuticals and generics. That is why an acquisition of Mylan (MYL) and Endo Pharmaceuticals (ENDP) would go a long ways to truly diversifying Forest Laboratories while at the same time providing the company with exciting avenues for growth. The addition of Mylan would provide generic exposure to the company as well as prepare it for the loss of its two blockbuster drugs while at the same time positioning the company well in the exciting biogenerics field. While in acquiring Endo, Forest Laboratories would be adding increased exposure to pain management to its repertoire of branded drugs.

As it marches into the future, Forest Laboratories has the opportunity to build itself into a world-class drug maker thanks to its strong balance sheet and ability to purchase its competitors at rock bottom prices. If the company were to hypothetically buy a Mylan or an Endo, it would move much closer to the proven model of Teva Pharmaceuticals. Such a model is clearly successful and should be followed by all of the drug makers that are in search of a future that is better then the environment that they are currently immersed in.

For Further Review:

Forbes: "Pfizer Weds Wyeth"

Pipeline Troubles at Forest Laboratories

Fixing Financials

2009-01-25T23:58:00.004-06:00

Fred Joseph, co-founder of Morgan Joseph had some interesting commentary on the state of the financial industry on Bloomberg last week that I thought would be appropriate to discuss here. The interview with Joseph on Bloomberg can be found below. Joseph’s commentary is interesting as his firm, Morgan Joseph, is one of the more prominent investment banking firms that spends the majority of its time working almost exclusively with mid and small market companies. His discussion of how these companies are dealing with the turmoil in the credit markets clearly shows that there is still a tremendous amount of work to be done by the Federal Reserve and the Treasury Department in their fight to restore liquidity to the credit markets.

According to Joseph, the current state of government involvement in the operations of financial companies is the “best of both worlds” as it allows the companies to maintain their entrepreneurial spirit while at the same time allowing them to access capital that they desperately need and that would otherwise be unavailable. Such a statement is unequivocally true, as a straight out nationalization of troubled banks would likely trigger another crisis in confidence, similar to what was seen in the fall and in mid January. During his interview, Joseph also proposed government actions that would support mid and small market firms in their dealings with the credit market. While large market firms have access to the Federal Reserve’s commercial paper programs, mid and small market firms do not. This puts these firms in tight circumstances as they are essentially left with no funding sources. Such a program could easily be structured in such a manner as to allow the government to channel money through regional banks that already pay special attention to mid market firms, such as CapitalSource (CSE).

Joseph sees another difficult year ahead and believes that mid and small market firms will be forced to restructure, conduct equity for debt exchanges and undertake debt conversions in an attempt to improve their balance sheets. While companies will undoubtedly be pressed for cash in the year ahead, they will also have enormous opportunities to buy back debt at significant discounts, should they choose to use cash and or credit lines to repurchase debt that is trading at significant discounts to its par value. Overall it is an interesting interview and is worth listening to.

Disclosure: Long CSE

AIB: Tempting for Investors & Competitors

2009-01-22T23:59:00.004-06:00

The news out of Ireland has been rather depressing as of late as the country has found itself at the epicenter of the world’s financial crisis. Over the last several months, the Irish state has effectively guaranteed all of the country’s deposits, nationalized one of its more beleaguered banks and bought preferred shares in the remaining publicly traded banks. Such events, while concerning, should not exclude the country and its financial sector from one’s investment universe. Of particular interest is Allied Irish Banks (AIB), the diversified multinational bank holding company that I previously talked about here. Allied Irish Banks is without a doubt the strongest, largest and most diversified of the Irish banks as its relatively strong underwriting policies, aggressive deposit growth strategies, and diversified international investments have allowed the bank to become one of the more up and coming international banks.

With shareholder equity of 10.9 billion euros and a market cap of less then a billion dollars, Allied Irish is cheap and should be viewed as being not only attractive to investors but to its competitors as well. A sum of the parts evaluation reveals that Allied Irish is holding a significant amount of nonessential assets that could either be sold to bolster the company’s balance sheet or acquired by a competitor through an acquisition of Allied Irish. The company is essentially composed of five units scattered throughout the United States, European Union and the United Kingdom. The holding company has full ownership of the domestic operations within Ireland, First Trust Bank of Northern Ireland and Allied Irish Banks (GB) out of the United Kingdom, along with a 24.2% of M&T Bank (MTB) out of New York, 70.5% of Bank Zachodni WBK out of Poland and 49.99% of Bulgarian American Credit Bank out of Bulgaria. In addition to these investments, Allied Irish also has relatively minor investments in the U.S. and in the Baltic states of northern Europe.

These stakes could be unloaded in such a manner as to generate significant amounts of capital for the parent company. The sale of the company’s stake in M&T Bank would likely generate nearly a billion dollars, while the sale of the company’s stake in its Polish subsidiary would bring in well over a billion euros. In addition, a sale of the company’s stake in its Bulgarian and Baltic subsidiaries would generate at least a hundred million dollars while a sale of the First Trust division of Northern Ireland would bring in anywhere from 500 – 800 million pounds. In short, Allied Irish should be able to raise 3 billion euros fairly shortly if it felt compelled to boost its capital position. However, this will likely not be necessary as the banks tier 1 capital is now at 7.5% after receiving a non-dilutive preferred stock investment from the Irish government in late 2008. If the company were to sell the above-mentioned divisions, it could likely boost its capital ratio to at least 9.5%. When the value of these assets are coupled with the company’s ability to sell bonds backed by the Irish government, Allied Irish should be able to hold onto the majority of its subsidiaries until valuations rise in the future.

While loan losses are expected to be significant in Ireland the company should be able to add 1.5 billion euros in loan losses a year going forward, even with housing prices declining 30-40% and an unemployment rate that is significantly above the E.U. average. Allied Irish’s diversified lending portfolio in Ireland and stricter underwriting policies will allow the company to escape the pitfalls that its peers, who were more weighted towards residential lending, are currently experiencing. In addition, the company’s UK division has become a source of tremendous liquidity, as the deposit guarantee offered by the Irish government has proved immensely attractive for UK customers concerned about relatively paltry deposit limits at their country's own institutions. This arrangement will further strengthen the company’s funding options, making it an even more attractive acquisition target.

While Allied Irish Banks is clearly undervalued and represents an attractive opportunity to purchase a diversified international bank it is likely an infinitely more attractive investment for its U.S. subsidiary, M&T Bank out of New York. Allied Irish’s 24.2% stake in M&T Bank is likely concerning for the management team of M&T as it puts the bank’s status as an independent institution in doubt. Given the current environment, an acquisition by M&T Bank of Allied Irish makes perfect sense. In purchasing Allied Irish, M&T Bank would triple its balance sheet, gain international exposure to vibrant markets, retire a quarter of its outstanding shares and dramatically reduce the extremely high portion of its shareholder equity tied up in goodwill on its balance sheet. While M&T Bank’s capital ratios are not exceptionally high, the bank’s recent share issuance through the TARP program should provide the necessary capital to make a joint cash and stock bid for Allied Irish Banks. M&T Bank’s ability to masterfully navigate the credit crisis has left the bank in a position where it can provide long term and above average returns for its shareholders in the years to come, should it act decisively and acquire Allied Irish.

Allied Irish Banks recent decline has presented an opportunity to acquirer shares in a dynamic bank at bargain prices. Once the market recovers the stock will likely trade at significantly higher levels, especially if asset sales follow in the months ahead. If a bid from M&T Bank emerges or from some other aspiring bank it only serves as further upside for Allied Irish’s equity.

Disclosure: Long AIB

For Further Review

Article Discussing AIB's Polish Operations

AIB Press Release Discussing Government Share Purchase

Contemplating the Demise of BAC, JPM & C

2009-01-20T23:15:00.005-06:00

The collapse in the share prices of our country’s three largest money center banks over the last week has been truly stunning and is assuredly a crisis of confidence. What started out as a growing unease that the losses of the past year would continue into late 2009 and early 2010 for Bank of America (BAC), J.P. Morgan (JPM) and Citigroup (C) has now snowballed into utter fear that these banks, along with their European peers, could potentially face nationalization as government regulators strive to save a financial system that is still on the brink of cataclysmic failure. Bank of America, Citigroup and J.P. Morgan have all reported results over the last week and they have ranged from being appalling and awful to just plain bad. One bright spot has been that each of these banks appears to have reduced their exposure to various mortgage securities and derivatives to acceptable levels when compared to where they were in 2007; however, this has come at an enormous cost. Primarily in the form of vast infusions of dilutive government capital that these banks have been required to take since the passage of the first half of the U.S. government’s TARP program.

While losses associated with Bank of America’s, Citigroup’s and J.P. Morgan’s exposure to securities tied to the credit market has likely peaked, each of these banks still face enormous pressures from the rapid economic deterioration that has engulfed the United States and the world. In essence, the banks that toiled in credit market sensitive instruments are facing a double blow; as they must now deal with deterioration in the core of their balance sheets as loans to consumer across the United States begin to deteriorate in quality. What began with subprime mortgage backed securities and spread to the credit market and its alphabet soup of credit derivative products is on the verge of engulfing Main St. U.S.A. and the bread and butter of these institutions productive assets. Whereas the regional banks received TARP money to bolster their balance sheets for what was widely viewed as a coming storm, it is painfully apparent that the TARP money received by Bank of America, Citigroup and J.P. Morgan was only used to help the companies recover partially from the implosion of the credit markets. This has left them acutely exposed to a worsening U.S. economy.

As it stands now, the big three U.S. money center banks are clearly unprepared to deal with a severe and deep recession. Had Bank of America, Citigroup and J.P. Morgan found themselves in a position where they did not have to worry about a deteriorating macroeconomic environment the TARP money that they have already received would have been more then enough; however, this is not the case as December's unemployment data shows. With unemployment creeping up to 7.2% from 6.2% in September and with no sign of any improvement in payrolls we can be assured that the statement made recently by the Chicago Fed Board president that unemployment will rise significantly throughout 2009 and into 2010 is accurate. For Bank of America, Citigroup & J.P. Morgan such a rise will likely be a deathblow as their significant earnings power will be unable to catch up to surging defaults in their consumer banking divisions. Given their current reserves and their own acknowledged expectations for unemployment rates going forward the balance sheets of these banks will begin to become impaired yet again as the unemployment rate rises above 7.5% and it is likely that they will face near catastrophic stress should the unemployment approach 8.5% - 9%. As a result, it is without a doubt that a significant portion of the second half of the TARP will be designated to these banks, as their capital bases will likely become impaired beyond self-repair in 2009.

In September, J.P. Morgan stated that the bank would face nearly $56 billion in loan losses should unemployment rise to 8% and $42 billion in losses should unemployment rise to 7.5%, yet in its most recent quarterly report, J.P. Morgan stated that it is only likely to experience $32 - $36 billion in losses going forward. This is curious as such a loss projection pays little attention to their past expectations and most importantly to the recent surge in the unemployment rate. Instead of breaking out their losses in relation to the unemployment rate, as they did previously, the bank is now correlating their losses to a decline in housing prices. Such a correlation is surprising as home prices could easily stabilize before the unemployment rate. Given the bank’s $81 billon in tangible capital and $136 billion in tier 1 capital it is clear that it could survive under its current expectations but increasingly doubtful should the unemployment rate approach and pass 8.5%. If we use the bank’s September numbers as a guide, J.P. Morgan could face an additional $10 billion in losses for each .5% rise in the unemployment rate above 8%.

In looking at Bank of America and Citigroup, one must be a little more creative as neither of these two banks are as open as J.P. Morgan is about their balance sheets and their potential exposures to assets that are in danger of becoming impaired. As a result, we must look at their current loss rates on important sections of their loan portfolios. For Bank of America the key figure is the fact that the bank only had $1.3 billion of reserves tied to $255 billion in first lien mortgages or about .56%. Such a low reserve amount is shocking and will likely be the point by which Bank of America faces the worst pain going forward. The bank’s total managed consumer portfolio was better, yet still only had reserves of 2.83% on a $694 billion portfolio. In addition, its total commercial portfolio of $380 billion only had reserves amounting to 1.96%. In comparison, Citigroup sports a larger loan loss reserve pool that will be needed to support a portfolio that is performing significantly worse then either of its larger domestic peers. In a cruel twist of fate, Citigroup’s more global operations could very well prepare it better to deal with a surge in unemployment in the United States.

The future of Bank of America, J.P. Morgan & Citigroup is unquestionably tied to the rise of the unemployment rate in the United States. Should it peak at 8%, the current valuations on these companies make them the buy of a lifetime. On the other hand, should the economy deteriorate significantly and unemployment rise well above 8%, these three titans will become the primary recipients of the second half of the TARP fund. The United States, despite acting faster then its European peers to battle the credit crisis, is dangerously close to following them down the path of nationalization and must take whatever measures necessary to avoid such an event. With the inauguration of a new administration in Washington we can only hope that Obama’s massive stimulus plan will be expanded, that a national moratorium on foreclosures becomes a reality and that the idea of an “aggregator bank,” as proposed by the head of the FDIC, is given serious credence as these are likely the only steps that will limit federal ownership of Bank of America, J.P. Morgan and Citigroup to current levels.

Following the Money

2009-01-13T21:26:00.001-06:00

In a world where finding investment capital has become a fine art, Atlas Energy Resources (ATN) has shown its ability to do what no other energy company could even dream of undertaking in the current credit environment. Unlike any of its competitors, Atlas Energy operates a partnership program that allows private investors to participate in its drilling activities, in return for giving up a portion of its drilling rights, the company receives a huge cost advantage and management fees that are highly accretive, in addition to the portion of the drilling interest that it keeps for itself. In using other peoples money, Atlas Energy Resources is able to leverage its own capital position to garner projects that it would not otherwise be able to participate in if it were only operating off of its own balance sheet.

The company’s announcement this week that it has succeeded in raising over $201 million dollars in its end of year subscription program to investors shows that the company is poised to profit greatly from its competitors difficulties. As other seek to unload properties, Atlas Energy Resources will be there to scoop them up as it appears as if it will be largely unaffected by the credit crunch and the crises affect on the energy market. The most recent example of this occurring is the company’s recent deal with Aurora Oil & Gas (AOG). Such opportunities will continue to come the company’s way, as it is one of the few that is still willing and able to expand its operations. Atlas Energy Resources’ partnership program brought the company over $437 million dollars in 2008, 20% more then in 2007 and significantly below what 2009 will likely bring. As investors seek a relative safe haven for their investment dollars in 2009, there is no doubt that Atlas Energy Resources’ unique and revolutionary partnership program will stand out as a beacon of stability and opportunity in a sea of turmoil.

Given the company’s vibrant capital sources, an extensive drilling backlog and a massive position in the Marcellus Shale, it is clear that the company stands alone as the stock to own in the natural gas industry. While its competitors are fighting debt loads, desperately seeking joint ventures and unloading assets at fire sale prices Atlas Energy Resources is using an innovative funding structure to capitalize on the opportunities that the company currently has and those that will assuredly come its way.

Disclosure: Long ATN

For Further Review:

Partnership Press Release

Ten Stocks for 2009

2009-01-08T23:58:00.001-06:00

After taking a little holiday inspired break from Prudent Speculations, I have decided to rededicate myself as there are simply too many interesting things going on in the markets to stand idly by on the sidelines. Given how awful 2008 was, 2009 should be better as I doubt we can go any lower then the November lows that were set late last year. I still believe that when invested in the right companies investors should be able to beat the market. Below, I have compiled a list of some of the most interesting stocks for 2009 that I put together before the New Year but that I am just now getting around to posting here on the blog.

Allied Irish Bank (AIB)

An Irish bank with significant overseas assets in Eastern Europe, the U.K. and the U.S, when these assets are coupled with the company’s strong position in Ireland, the stock has a strong risk/return ratio going forward. The bank has been battered by financial market turmoil but the bank’s balance sheet appears to be in decent shape relative to its Irish peers. With newly added capital, Allied Irish should be able to hold onto its international divisions making it a rising international banking star.

CapitalSource (CSE)

One of the more fascinating financial plays, this former MREIT acquired a California state industrial bank this last summer, securing a funding source that it can control. The company has some of the highest capital ratios out there and limited exposure to the California residential mortgage market. As the company begins funding an increasing number of loans through its deposits as opposed to its credit lines, the company should see a dramatic decline in its funding costs. The bank’s large net interest margins will most likely become the stuff of legends, as its competitors will be unable to match its strong corporate client list.

The Bancorp (TBBK)

A Philadelphia bank with innovative deposit gathering techniques, strong management and capital ratios and a new subsidiary that will be taken public in the near future with a mandate to acquire other bank’s payment processing and technological infrastructures.

Dow Chemical (DOW)

With commodity prices declining, Dow’s costs have declined significantly. Given these declines, the company should be able to overcome any significant demand destruction that occurs during the recession. The stock’s recent decline should be alleviated by a new partner to replace the Kuwaitis and a lower offer for Rohm & Hass.

The Phoenix Companies (PNX)

An Insurance company and asset manager that is currently engaged in a restructuring that will result in a spin off of the company’s asset management division. This spin off should create immense value for shareholders and leave them with two companies that would both be ideal to own.

Rambus (RMBS)

I have been a longtime holder of the company and it finally appears that the patience that I have had with it is finally going to be rewarded. The company’s ability to defend its patents are going to dictate its future; however, substantial rulings against Hynix and Samsung should be handed down before a large patent trial commences in late January. I believe that the trial will amount to little, as the cartel lined up against Rambus will begin to settle over the next two weeks causing the stock to rocket higher. Given that the company is on the verge of a massive multi-billion dollar patent settlement with the world’s largest semiconductor companies, its current price is appalling and it likely represents the buy of the year.

21^st Century Holding Co. (TCHC)

A Florida insurer that should benefit from the dismantling of Florida’s state run insurance company and a general rise in rates. The company is cheap on all levels and a new management team appears to be running the company in a manner that allows one to realize how poor the prior management team truly was.

Chesapeake Energy Corporation (CHK)

Chesapeake’s large debt load, attractive properties and cheap valuation make it a definitive buyout target for any major produce looking to replenish dwindling reserves.

Sprint Nextel Corp. (S)

A Kansas City telecom giant trading at a relatively cheap valuation when compared with its peers, assuming the level of its customer defection has peaked. The company’s new management team appears to be making strong progress in turning around a long time laggard of the telecom industry.

Lorillard Tobacco (LO)

Lorillard is the cheapest of the big tobacco companies with the ability to buyback a significant amount of stock and raise its dividend substantially. In addition, it appears that the fear of a menthol ban is significantly overdone.

Best of luck to all in 2009 and remember to watch for the next bubble as there is far to much money floating around the system for one not to develop. My guess is that its going to show up in government bonds; however, should the economy continue to weaken all bets are off.

Quicksilver Gas Services Isn't Your Typical Gathering & Processing MLP

2008-11-28T11:44:00.002-06:00

In recent months many MLPs have declined in price as commodity prices have fallen. If you read my earlier article on midstream MLPs you know that some types of MLP assets do have commodity exposure while other types do not.

Quicksilver Gas Services (NYSE:KGS) is unique in that it is in the gathering and processing space but it does not have the commodity exposure of a typical gathering and processing MLP. This is because Quicksilver Gas Services charges Quicksilver Resources (NYSE:KWK) volume based fees. Typical gathering and processing MLPs make their money off of keep-whole or percent of proceeds contracts. However, Quicksilver Gas Services' volume based fee contracts more closely resemble those of a interstate gas pipeline contracts such as those used by Boardwalk Pipeline Partners (NYSE:BWP).

Quicksilver Gas Services is in an enviable position where its fee-based cashflows are increasing despite the poor margin environment that the rest of the gathering and processing MLPs are dealing with. The Barnett shale acreage that Quicksilver Gas Services services continues to be profitable to drill in the current gas price environment and the company said on their conference call that they expect the only draw $5 million on their credit facility to fund growth capex next year as Quicksilver Gas Services' quickly rising coverage ratio will almost entirely fund expected capex growth for next year.

Quicksilver Gas Services' volume based fee contracts mean that it deserves to be priced more like a company such as Boardwalk Pipeline Partners (NYSE:BWP). However, Quicksilver Gas Services should be able to grow much faster than Boardwalk Pipeline Partners with or without the return of access to capital markets. Quicksilver Gas Services' stable fee based contracts and sufficient access to liquidity should make its distribution safe even if processing margins and commodity prices remain low for a long time.

Disclosure: Long KGS

The Norwegians Are Coming!

2008-11-13T22:09:00.002-06:00

Earlier this week Chesapeake Energy (CHK) announced that the company was proceeding with the sale of a 32.5% interest in its Marcellus Shale development to StatoilHydro, the Norwegian oil giant. In return for its new interest in one of North America’s more interesting shale plays, StatoilHydro is paying $1.25B plus the guarantee that it will foot 75% of the expected drilling costs through 2012 for an additional $2.13B. Another Norwegian company, Norse Energy (NEC) has already built up a sizeable acreage position in the Marcellus Shale totaling somewhere around 175,000 acres. Given the interconnectedness of Norway it would not surprise me at all if the executives at Norse Energy and StatoilHydro had at the very least talked over the opportunities that the Marcellus Shale offers to natural gas prospectors. Nevertheless, the emergence of StatoilHydro as a passive foreign partner should serve as a reassurance to domestic gas produces in search of cash as the Norwegian giant is more likely then not only the beginning of wave of large foreign multinationals looking to diversify their production base via the acquisition of U.S. oil and natural gas producers in relatively low cost venues.

The purchase price Chesapeake received from the sale of this portion of its interests in the region amounted to a purchase price of nearly $5,800 an acre. This figure approaches the $6,000 an acre that some analysts had valued land in the Marcellus Shale, prior to the collapse of the credit markets. The deal is also significant in that it is the first large sale since July when Dominion Resources sold 205,000 acres to Antero Resources for $552 million or $2,600 an acre with Dominion reserving a future royalty rate of 7.5%.

Such a sale is good news for those companies looking to reduce their own leverage through asset sales. While still financially sound on a cash flow basis, countless U.S. natural gas companies have announced their intention to reduce their debt loads through asset sales as the country heads into an uncertain economic environment. Companies such as Quest Resources (QRCP), National Fuel Gas (NFG), Atlas Energy Resources (ATN) and EXCO Resources (XCO) appear to be especially well positioned to benefit from per acre prices that are above what should be expected given the freeze in the credit markets. In partnering with foreign investors in joint ventures, these companies will be able to use the proceeds from the sale of a portion of their interests in the Marcellus Shale to not only pay down debt but to also buy back their own stock which in nearly every case is trading at levels that would have been ridiculous only months ago.

For Further Review:

List of Marcellus Drillers

Chesapeake/StatoilHydro Article

Disclosure: Long QRCP, ATN, XCO

Mixing the Pickens Plan and a Auto Bailout

2008-11-11T20:47:00.003-06:00

With the automakers in such dire straits and in search of government funding for the second time this year it is only natural to assume that the federal government will be able to dictate terms to America’s once proud industrial titans. With the changing political climate, these new terms will be driven by Barack Obama and the congressional democrats. While the Big 3 are currently asking for over $50 billion, they have already received $25 billion to retool plants for more fuel-efficient vehicles. Such a large intervention should be used by the Obama administration to expand their own agenda while at the same time saving countless American jobs in the process.

Sponsored by oilman Boone Pickens, the “Pickens Plan” made its day view during the summer as an attempt to put the idea of energy independence back at the forefront of the political discussion in America. While displaced by the collapse of the financial markets in September, the Pickens Plan can be used by the Obama administration to bring about the achievements of some of its key objectives. While the details of the Pickens Plan are not entirely clear, the plan is centered around the construction of vast wind farms in the central United States that will be used to displace Natural Gas production which will then be switched over for automobile consumption. Such a plan would be beneficial to the United States because of its vast stores of natural gas, the relative cheapness of natural gas (it costs less then a $1 per gallon to fill up a car) and the significant environmental benefits of natural gas when compared to oil.

When preparing the various legalities of the bailout, Congress should put such stipulations in the agreement so that it forces the Big 3 to significantly ramp up their efforts to produce natural gas friendly vehicles as an intermediate solution to our country’s dependence on foreign oil. Such a stipulation would help provide cover for the unpopular bailout of the Big 3 while stimulating the economy, pleasing the environmentalist lobby of the Democratic Party and by helping to wean Americans off foreign oil. Given the surplus of natural gas production coming on in the next several years, excess natural gas supply should be enough to cover the initial consumption boost that would occur with the first generation of Big 3 natural gas based cars. In addition, the initial infrastructure spending that would be needed on the part of the federal government for a nationwide roll out of a natural gas system would provide an additional direct stimulus to the economy.

For Further Review:

The Pickens Plan

Auto Industry Bailout

$1 Per Gallon Natural Gas

Increased Government Support for Banks?

2008-11-03T23:52:00.008-06:00

The Wall Street Journal was out with an article on Monday stating that over 1,800 publicly traded banks would likely seek access to the Treasury Department’s rescue plan. While the total dollar figure being attached to the rescue plan is in excess of $700 billion, only $250 billion has been earmarked for bank recapitalizations. While this is a large sum, it is increasingly looking as if more money will be needed given the sheer number of banks that have not yet received government investments.

As we can see from the table below (via thestreet.com), nearly $170 billion has already been committed to supporting the institutions that control the majority of our banking system’s deposit base. However, this leaves only $80 billion in Treasury funds for the support of our country’s remaining 8,000 banks, most of which are private and state chartered. In other words, it’s going to get messy from here on out as the Bush administration will be forced to go back to Congress for more money, seriously reexamine the United States’ hybrid bank structure and be forced to develop an innovative method for delivering much needed capital to community banks. These community banks will prove difficult to deliver capital to because they are either too small or unwilling to become public, yet they nonetheless serve a vital part in the American economy and will need government capital in order to ensure the success of the Bush Administration's bank bailout. A simple division of the $80 billion dollars remaining among the 5,000 private and public banks likely to be working towards a government injection shows that they would on average receive a mere $16 million dollars, which is a surprisingly low figure and a cause for concern.

Banks Receiving Government Investments
Bank	Ticker	Amount (in billions)
JPMorgan Chase	JPM	25.000
Bank of America*	BAC	25.000
Citigroup	C	25.000
Wells Fargo	WFC	25.000
Goldman Sachs	GS	10.000
Morgan Stanley	MS	10.000
PNC Financial Group	PNC	7.700
US Bancorp	USB	6.600
Capital One	COF	3.550
Regions Financial	RF	3.500
SunTrust	STI	3.500
Fifth Third	FITB	3.400
BB&T	BBT	3.100
Bank of New York Mellon	BK	3.000
KeyCorp	KEY	2.500
Comerica	CMA	2.250
State Street	STT	2.000
Marshall & Illsley	MI	1.700
Northern Trust	NTRS	1.500
Huntington Bancshares	HBAN	1.400
Zions	ZION	1.400
First Horizon	FHN	0.866
City National	CYN	0.395
Valley National	VLY	0.330
United Commercial	UCBH	0.298
Umpqua Holdings	UMPQ	0.214
Washington Federal	WFSL	0.200
First Niagra	FNFG	0.186
Old National	ONB	0.150
First Community	FCBC	0.043
HF Financial	HFFC	0.025
Redding Bank	BOCH	0.017
FFW Corp.	FFWC	0.007
Saigon National	SAGN	0.001
Provident**	PBKS	0.000
TOTAL		169.832
Source: The Financial Services Roundtable, KBW Includes Merrill Lynch *Hasn't decided to participate

The government capital injections makes investing in banks difficult as it allows for an added variable that investors must take into account. Nevertheless, as the video below from Bloomberg discusses there are several metrics that can still be used by investors to gauge the risk of their bank investments. According to the commentator, tangible book value, normalized earnings and “excess” regulatory capital are all important characteristics that investors should be knowledgeable of when investing in banks. Even if his conclusions are poorly timed, the commentator does a nice job of laying out the framework needed for conducting bank investments.

As we saw in the forced National City sale, banks that have taken government capital should be viewed as having received a seal of approval from the government and can be considered by investors as safe havens in the financial sector and are more likely then not trading at once in a generation prices, regardless of the weakness in the economy going forward.

For Further Review:

Thestreet.com Bank List

WSJ Article

Atlas Pipeline's Processing Problems

2008-10-31T00:31:00.003-05:00

Atlas Pipeline Partners (APL) and Atlas Pipeline Holdings (AHD) have declined significantly recently over concerns about the margins at APL's processing plants. A large percent of APL's income comes from the sale of natural gas liquids that the company strips out of the natural gas that flows through its pipelines. At APL's processing plants unprocessed natural gas goes in and APL then burns a small amount of the natural gas to pull out the higher value natural gas liquids. APL then sells the natural gas liquids and has to pay for the amount of natural gas that has been burned up in the process. The problem APL has been facing recently is a rapid decline in the value of the natural gas liquids that it is selling. The price of natural gas liquids is highly correlated with the price of oil. As a result, as the price of oil falls APL's processing margins will decline. Since hurricane Ike, the price of natural gas liquids has fallen even further than the oil price as many refineries have reduced their purchases of natural gas liquids as a fair number of the refineries are undergoing repairs. Refineries are significant for the natural gas liquid market as they represent somewhere around 75% of the markets total.

When tracking APL's processing margins you need to look at two factors, the NGL-crude ratio and the price of crude. I generally place the NGL-crude ratio at around 55%, which is a bit low by historical standards but a bit higher than the ratio currently. As the impact of hurricane Ike wanes, I expect the NGL-crude ratio to improve back to around 55%.

The following table gives an example of what sort of distributions to expect at different oil prices.

Average Oil price	Annual APL Distribution	Annual AHD Distribution
$85	$3.96	$2.04
$70	$3.20	$1.60
$60	$3.00	$1.30

There are a few points worth making about this table. First, APL is hedged but APL is only partially hedged. In hindsight, APL picked a poor time to repurchase its crude oil hedges earlier this year, in doing so the company has worsened APL's exposure to dropping oil and NGL prices. On the way up crude outperformed NGLs and as a result APL's short derivative position were costing the firm a fair amount of money.

Another point worth mentioning is that AHD's distribution holds up well when APL's annual distribution rate drops from $3.96 to $3.20. This is because of how the IDR adjustment associated with the Anadarko purchase was structured. At $3.96 per year, APL is paying $9.3M per quarter on its IDRs. At $3.20 APL is paying $7M. This is because the IDR adjustment cancelled the IDRs between $7M to $12M per quarter. As a result, while APL is currently paying $9.3M per quarter it would have been paying $14.3M per quarter if not for the $5M per quarter IDR adjustment. An annual rate of $3.20 at APL puts its IDR payment at $7M. Below $7M per quarter, AHD's increased exposure is what you would expect.

If the price of oil averages below $85 for Q4, I would expect a cut in distributions at APL and AHD. When the oil price recovers you can expect APL & AHD to recover to the level of their past glory. Given time, AHD should return to being one of the fastest growing GPs as detailed in this article.

Another point worth mentioning is an issue Citigroup raised in a recent downgrade of APL. Citigroup believes that APL could be in danger of violating the terms of a credit agreement if the price of oil averages below $60 for "an extended period of time." This makes little sense to me, as even at $50 oil APL and AHD will continue to generate significant amounts of free cash flow. MLPs are required by their credit agreements to maintain hedges with those companies in their lending group to stabilize cash flows and any significant modification to those hedges would need to be run by creditors before it could happen. Even in a worst-case scenario, there is nothing preventing APL from maintaining a distribution significantly below its level of free cash flow and APL's partial hedge position should stabilize cash flow at a level that is capable of keeping its creditors happy. Unlike some MLPs, APL has more than enough capacity available on its credit lines to fund its business and all planned expansions. I expect management at APL to correct Citigroup on its credit agreement thesis at the next conference call.

Finally, Pioneer Natural Resources’ (PXD) option to acquire 14.5% of Midkiff-Benedum expires at the end of this year. APL's guidance is based on PXD exercising its option. However, in the current environment I wonder if PXD may choose not to exercise its option. PXD may be able to instead acquire assets at better multiples from other parties rather than by acquiring another 14.5% interest in Midkiff-Benedum at multiples determined before the credit crisis began. The best case scenario is for PXD to decline to exercise its option, as a result, guidance will likely need to be revised upwards. The worst case scenario is that PXD exercises its option and that APL receives $150M to shore up its balance sheet as a result.

In the short term, I see reasons to be bullish on oil. Longer term I think the fundamentals of the oil market will support significantly higher prices, once the economy recovers. If you think that oil prices will recover, than you may want to be a buyer of APL or AHD at these levels.

Is the Oil Market Reinflating?

2008-10-30T01:28:00.004-05:00

I have been amazed to watch the price of oil crash from its peak of $147 to its recent low of $62. If you read my prior article, you know that I believed that there were strong fundamental reasons that were driving the price of oil higher. After oil prices collapsed 57% from their peak the main reason given as an explanation for its fall was the decline of oil consumption as the economy began to slow. While this theory certainly holds true to some degree, I believe the driving factor in oil's decline has been the lack of liquidity in the marketplace rather than the declining consumption of U.S. businesses and consumers.

In the last six months, there have two major events that have impacted petroleum pricing. These two events were the bankruptcies of Semgroup and Lehman Brothers. As you can see from my chart Semgroup announced its bankruptcy on July 22, 2008. This was only a week after oil prices peaked. A few days before it declared bankruptcy Semgroup had a conference call with its creditors informing them of its problems. As knowledge of Semgroup's problems spread, anyone doing business with Semgroup took steps to cease any relationship with what was one of the nations largest energy marketers and traders. This counterparty risk created a bottleneck between energy producers and energy purchasers that prevented oil supply from reaching its end markets.

On September 15, 2008, we had our second major event, the bankruptcy of Lehman Brothers. This bankruptcy seemingly came out of nowhere because everybody had expected the Treasury to step in and broker a purchase of Lehman Brothers as it had done with Bear Stearns. Instead, the Treasury balked and allowed one of the nation's largest investment banks to fail. As a result, oil tanked the next day before rallying. Everything seemed fine for a couple of weeks as nobody could quite grasp the impact this would have on the US economy. Then a couple weeks later the flow of credit stopped as fear of insolvency had crippled the ability of almost every financial institution to function normally. Like all markets, the energy markets depend on credit to function, as most companies need credit to purchase oil inventories. With the credit crunch in full swing, many players began to have problems obtaining financing. This created yet another bottleneck in the nation's energy markets.

The ability of speculators and corporate entities to trade and own oil contracts was impacted by both of these events. It is clear that if speculators are forced to liquidate long positions then oil prices are going to drop and the same can be said for corporate entities. While the liquidity issue has become a major problem for the energy market the counterparty risk issue has also developed. With the Semgroup and Lehman Brothers bankruptcies, anyone owning contracts that Semgroup or Lehman Brothers were counterparties to was in trouble as they were more likely then not no longer safely hedged.

The first round of capital injections in the US banking system, while saving our nations banks will likely save the commodity market. The bailout should eliminate the problems that are preventing the normal functions of the oil market, whose disruption was caused primarily by the bankruptcy of both Semgroup and Lehman Brothers. So far, the behavior of the price of oil seems to be confirming this as the price of oil has rallied strongly from $63 on Monday. Looking back, it is clear that the capital injection is also the most logical explanation for not only the rise of the stock market but the commodities as well.

Disclosure: None

Don’t be Foolish: Buy National City

2008-10-26T18:48:00.004-05:00

PNC Financial’s (PNC) purchase of National City (NCC) is an absolute travesty for National City shareholders and for the banks that chose to forgo a purchase of the Ohio lender. The company’s recent quarterly report was fairly positive in my opinion as it showed a company that was well positioned to survive the current turmoil in the economy and the credit markets. Of all the majors, National City had the highest capital ratio, at 10.98% at the end of the September quarter. While loan losses were and still are a concern, the firm’s relatively strong capital position had caused me to believe that they would likely be one of the banking industry’s survivors and likely one of the new mega-regional banks to come out of the industry’s consolidation.

Unlike Washington Mutual (WM) and Wachovia (WB), National City has not experienced any deposit outflows and is still flush with liquidity, in fact, National City’s deposits actually increased in the most recent quarter when compared to the year ago quarter. When this is coupled with the bank’s relatively strong capital base and the company’s $3.8B in loan loss provisions to non-performing assets of only $3.5B, the choice to sell the bank becomes even more cloudy. Barring a run on the bank, National City could have continued on its own with current loss rates for another two years. However, this would likely be a worst case scenario as loan loss provisions have already begun to decline at many of America’s banks, including National City, which saw loan loss provisions decline 25% from the preceding quarter.

So why did National City sell? Because it’s likely that it believed that it had no choice. The Wall Street Journal does a wonderful job of providing a timeline of the National City sale and does a good job of alluding to the possibility that National City may not have been able to participate in the government’s capital injection program. The Wall Street Journal then alludes to the possibility that this caused the bank’s executives to fear that the company’s stock would collapse along with its deposit base as shareholders and customers scrambled to withdraw cash. Unfortunately, the government’s forced sale of National City succeeds in showing the investment community that it is taking its role as king maker in the banking industry too far. There are many other smaller regional banks in far worse positions that could have been dealt with first, including such abject failures as Downey Financial (DSL), Bank United (BKUNA), Flagstar (FBC), AmTrust Bank (AFSI), Guaranty Financial (GFG) and Colonial BancGroup (CNB). In forcing National City to sell itself, the government has shown the utterly arbitrary fashion by which it will decide who lives and who dies.

Fortunately, for National City and its shareholders, the company was not seized and given that the stock is trading at nearly 20% below PNC Financial’s offering price, management should cancel the deal and attempt to go at it alone. Given the bank’s large reserves and relatively healthy capital position, management would be negligent not to try, given the low offer from PNC Financial. I would personally rather have the bank seized and take a total loss on my holdings then have it sold to PNC Financial at $2 dollars and change. The bank’s large asset base, branch network, geographic concentration, Visa (V) stake, $6.6B in excess capital and $100B in deposits are diamonds in the rough and could if nothing else lead to a sale in several years for a much more significant sum then is currently being offered by PNC Financial.

In not purchasing National City, several banks are missing out on an acquisition that would be of tremendous benefit to their business models and their shareholders. Should management not renege on the merge agreement I would not be surprised to see U.S. Bancorp (USB), Regions Bank (RF), BB&T (BBT), TD Bank (TD) and Bank of the West (BNPQY) seriously look at National City. This will be especially true if the volatility in the financial markets decline in the weeks ahead.

The two most compelling names, of those listed above, are TD Bank (TD) and Bank of the West (BNPQY) as it would provide these two companies with the opportunity for national expansion via the National City name. Both BNP Paribas and Toronto Dominion have been looking at the U.S. for years and they would likely be able to pull off the acquisition without government assistance, which would be a boon for the Treasury Department. Given the incredible attractiveness of National City at these price levels, these two international power houses could offer between $3 & $4 dollars a share in stock and still make their shareholders very happy in the years ahead.

It is clear to me that the government’s botched involvement in National City is a sign of the dangers tied to the government’s bank bailout program. Before mandating future sales, the Treasury and its agencies need to outline and publicly release the key metrics that have caused the government to request the bank’s sale.

For Further Review:

WSJ Timeline of National City's Sale

National City's Visa Stake

National City 3rd Quarter Earnings

Disclosure: Long NCC @ 1.40 & Change

QRCP: At the Mercy of its Banks

2008-10-23T22:53:00.003-05:00

Much to my chagrin I have had the unfortunate pleasure of watching one of my favorite stocks absolutely collapse this fall. I first talked about Quest Resources (QRCP) back in May and have been positive on the company’s investment story since. While I am more then aware that investing in the financial markets is always a risky proposition, I strongly believe that investors shouldn’t have to take managerial fraud into account when computing the risk/return of various investments. For those who have not followed the company’s story, Quest Resources is the parent company of both Quest Energy Partners (QELP) and Quest Midstream (privately held), the company was generally doing well until its former CEO looted Quest Resources of over $10M dollars. His actions caused the stock to crash and for Quest Resources and it’s subsidiaries to go into technical default on their credit agreements. As a result, the Quest Resources story has turned into one that is focused entirely on liquidity and not the company’s underlying assets, which are primarily centered in the Cherokee Basin and the Marcellus Shale, I detailed these assets in May and June.

According to Quest Resources’ October update, the company has only a million dollars in cash and no available lines of credit. In addition, the company has $33.5M in term loans that likely need to be reconfigured as a result of the former CEO’s actions. Furthermore, the company is required to conduct $11M dollars in drilling before the end of the quarter or it will risk losing 15K acres of its 122K total acres in the Marcellus Shale due to lease violations. The company’s other primary but illiquid assets are its ownership of 100% of the general partnership of Quest Energy Partners and 57% of the company’s limited partnership units, in addition to, 85% of Quest Midstream’s general partnership and 36% of its limited partnership units.

Quest Energy Partners (QELP) is in slightly better shape as it has more financial breathing room. At the time of the October update the company had $9M dollars in cash on hand, $228M in debt and $7M in undrawn lines of credit. Unfortunately, the company is currently experiencing issues with its ability to sell the natural gas that it produces for a price that resembles those quoted in New York. This is likely as a result of the hurricanes, SemGroup’s issues and the fallout in the credit market as it relates to the hedging that companies can or cannot undertake with quality counterparties. I am hoping that the issue of pricing is resolved as we move into the fourth quarter.

Quest Resources’ second subsidiary is its midstream unit. The company had been planning to take this subsidiary public; however, with the markets what they are this will not be happening in the immediate future. As a result, Quest Resources has violated its agreement with its joint investors and could be forced to sell the unit. While this would not necessarily be a bad thing, it would disrupt the traditional MLP structure.

The one saving grace for the whole organization will be whether or not Quest Energy Partners is able to pay its third quarter distribution of $0.43 cents a unit sometime during the month of November. If the company can convince the banks to let it pay the distribution, the liquidity issues at Quest Resources will ease immensely. Should this distribution occur it will cause a significant turnaround in Quest Resources’ share price as it will signify to stockholders that bankruptcy and/or a highly dilutive capital raise is no longer on the table.

As I mentioned in an earlier article, the majority of MLPs can reduce their capital expenditures to next to nothing and essentially go into “run down” mode if they are unable to tap the equity and debt markets for capital to grow. I would hope that this is what all three of the Quest companies have already begun to do. If I were Quest Resources, I would feel more then comfortable losing the 15K acres in the Marcellus Shale if it meant that I could conserve $10M dollars that would otherwise go to drilling and instead use it to pay down debt.

The bottom line is this, if you do not already have a position, I would recommend researching it further so that you could potentially take a small speculative position. If you already own shares and feel comfortable buying more, I would take a look at the company's recent release and then decide if you were ready to lose your position entirely, should Quest Resources not receive its distribution from Quest Energy Partners.

For Further Review:

Quest Resources' Investor Relations

Disclosure: Long QRCP

Six Months of Prudent Speculations

2008-10-21T17:28:00.007-05:00

October 21^st marks the six-month anniversary of Prudent Speculations. It has been a great adventure and it has helped me to solidify my own personal investment thesis on many of the stocks that I personally follow. In the six months that I have been operating the blog I have had nearly 15,000 visitors from every state of the Union and from over 90 countries.

While it has been difficult at times to keep the blog as up-to-date as I would have liked with my commitments to the real world, it has nonetheless been well worth every ounce of my effort. Prior to starting Prudent Speculations, I had been a long time reader of financial blogs via SeekingAlpha.com and as a result I have come to greatly appreciate all the work that the bloggers in the investment community put forth so that we may all be a little more educated on the relevant topics of our times. For all those that have ever thought of starting a financial blog to talk about investing, the economy or their general opinions on the state of the financial markets, I would highly encourage it as we all benefit from each others efforts. Below I have compiled some of my favorite articles, for those new to Prudent Speculations, these articles would be a great place to start if you ever wanted to get a sense of the type of investor that I am.

Top Five Blog Posts by Number of Visitors

My Favorite Blog Posts

Notable Mentions of Prudent Speculations in the "Official" Media

In the next six months, I hope that I will be able to expand the number of postings that I have been putting up while maintaining the same kind of quality that I believe has been a characteristic of my postings during my first six months. To all of those that have subscribed by Feedburner, Email or SeekingAlpha, I want to let you know how much I appreciate you taking the time to read my ramblings on a semi frequent basis. Feel free to reach out to me at the blog's email, which can be found on the left sidebar.

Going forward, in an effort to provide a public forum by which my performance can be tracked, I have set up a virtual account at the updown.com, a widget can be found at the bottom of this webpage that should show the performance of this mock account. Generally speaking, I will divide the mock account into 20 separate holdings. These stocks will be ones that I have talked about in the blog and others that I find attractive. Please shoot me an email for the updated list of stocks in the mock account. Best of luck to all in these trying times and I hope that you continue to make Prudent Speculations a part of your investment research.

Buying the Market Bottom

2008-10-16T23:59:00.003-05:00

The intraday bounces that occurred on Friday the 10^th and on Thursday the 16^th have likely gone a long ways to forming a double bottom in the stock market. Should the markets be able to hold the intraday lows on these two respective dates in the coming days we will likely have established a near and potentially long term bottom in the stock market. Given the many opportunities that are available right now, investors would be remiss if they did not put some of their capital that is currently sitting on the sidelines into sound large cap value companies.

I know that we have been through a very rough month on top of an already rough year but the news stream and the realities of the world appear to be changing. In particular, something wonderful has begun to happen over the last several days in that it appears as if the financial news flow has shifted from a focus on the credit crunch to the worsening economy. This is a relief to me as it shows that we are moving past the crisis stage that was associated with the many near panics that occurred over the last several weeks. There are far fewer variables to account for in a worsening economy then with a collapse of the credit markets and I would much rather be investing in a poor economy then in one where the investment community is continually guessing which financial institution will fail next.

There are four companies that stand out to me as great investments during an uncertain economic environment. All of these companies are sound value investments with extremely low P.E. ratios, sound dividends and safe market positions.

The first company I have to recommend is Dow Chemical (DOW), I have previously given a detailed break down of my take on Dow Chemical and that can be found here. With the significant decline in the price of oil, Dow Chemical, as I suggested in my earlier post, should be doing quite well this quarter. While domestic demand destruction is a concern, higher prices, lower raw material costs and positive international growth should continue to drive the company going forward. With a P.E. of 8 and a dividend yield of nearly 7% it is hard to see this trade not being profitable over the long term.

The second company I have to recommend is AT&T (T), the company with its strong cash flow, healthy balance sheet and absolutely dominate market position is a perfect investment in times like these. With the beating that it has taken over the last several months the stock is currently trading at its lowest level since 2005 and with a dividend yield of over 6% and a P.E. of only 11 the stock is likely safer then Treasuries.

The third stock that I really like at these levels is CBS (CBS), the company will likely have significant advertising issues going forward but like my previous two recommendations it is an absolute steal at these levels. With a P.E. in the mid single digits and a dividend yield well above 10%, it’s hard to believe that this company is even a blue chip, but it is. With solid dividend coverage, ability to leverage up the balance sheet and the ability to sell off numerous assets to enhance shareholder value it’s hard to see how the stock could go much lower.

The final stock that I have to recommend is the defensives stalwart Reynolds American (RAI), the stock is not nearly as leveraged up as Altria (MO) giving it increased financial flexibility when it comes to share buybacks, dividends and acquisitions. With a P.E. of 8 and a dividend yield of 8 percent one is assured of above market returns for the foreseeable future.

In owning these names, investors will be able own four companies with an average P.E. of 8 and a dividend yield of nearly 8%. In addition investors will know that they are investing in companies that make up the backbone of the economy and that provide essential services that will likely not be trimmed by consumers and businesses during a recession, even if it should be severe.

For those interested, buysellshort.com does a nice job of discussing the technical aspects of the markets recent double bottom. The first three minutes of the video are the most relevant for our conversation.

Disclosure: LONG T, DOW & CBS