DJIA 7899.52 +167.61 (+2.17%) S&P 500 984.39 +24.95 (+2.60%) Nasdaq 1492.49 +73.37 (+5.17%) Value Line Index 730.83 +16.66 (+2.33%) 30-Year Bond 105 28/32 -1 27/32 5.11 Yield
Electronic connectors maker AMP Inc. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: AMP)") else Response.Write("(NYSE: AMP)") end if %> jumped $2 3/4 to $40 1/2 as AlliedSignal <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: ALD)") else Response.Write("(NYSE: ALD)") end if %> announced it was buying 20 million AMP shares at $44.50 a share in cash pursuant to its previously announced $9.8 billion takeover offer. At the same time, AMP also started its counter self-tender offer to buy back 30 million shares at $55 a share in cash. In response to AlliedSignal's original unsolicited bid, AMP shareholders had indicated that they were willing to sell 72% of the company's common stock to AlliedSignal. Despite vocal criticism from many of its major shareholders, including one of the firm's founding families, AMP's board and management have been fighting the takeover offer tooth and nail -- going so far as to urge lawmakers in AMP's home state of Pennsylvania to pass an amendment to that purpose. AlliedSignal has been trying to go around management's roadblocks by seeking written consent from AMP shareholders to place AlliedSignal officers and directors on AMP's board, but a U.S. District Court judge ruled yesterday that AlliedSignal nominees can't stand for election unless they declare a "fiduciary duty solely to AMP." AlliedSignal said it will appeal the decision. The saga continues.
Healthcare products maker and distributor Allegiance Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: AEH)") else Response.Write("(NYSE: AEH)") end if %> surged $9 7/16, or 41%, to $32 7/16 after agreeing to be acquired by the nation's second largest drug wholesaler, Cardinal Health <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CAH)") else Response.Write("(NYSE: CAH)") end if %>, for about $5.4 billion in stock and assumption of debt totaling $890 million. Allegiance shareholders will receive 0.415 of a Cardinal share for each Allegiance share, which values Allegiance at $38.47 a share, a 67% premium over Allegiance's $23 close yesterday. Cardinal Health, which sank $8 13/16 to $83 7/8 today, apparently was undeterred in its acquisition rampage, despite having its proposed acquisition of Bergen Brunswig <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BBC)") else Response.Write("(NYSE: BBC)") end if %> blocked by regulators on antitrust concerns in August. But Cardinal Health may get a green light this time. Unlike Bergen Brunswig, Allegiance isn't a direct competitor to Cardinal in the distribution of drugs to hospitals and pharmacies; instead, it is more focused on supplying medical devices and supplies. Cardinal expects the deal will not dilute per-share earnings and will yield cost savings in excess of $50 million within two years of completion. It predicts the combined company will grow at a rate of 20% or more per year.
After ending September at $23 15/16 a stub, United Rentals Inc. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: URI)") else Response.Write("(NYSE: URI)") end if %>, the largest equipment rental company in North America, has gotten mauled in every trading session since October began, closing at $12 7/16 last night. Today, however, boosted in part by the honor of attaining the status of "top pick" (up from "buy") at Donaldson, Lufkin & Jenrette Securities with a 12-month price target of $30 a share, United Rental regained $2 7/16 to $14 7/8. As with another gainer today, Amgen <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: AMGN)") else Response.Write("(Nasdaq: AMGN)") end if %>, one of United's key investment characteristics at the moment is its relative insulation from international turmoil (with most of its top line coming from construction and industrial segments). For a more complete look at United Rental, check out today's Fool Plate Special.
QUICK TAKES: After taking a beating over the last few days, PC makers and computer-related issues recovered some today on optimism that governments will be able to improve the global economy. Dell Computer <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: DELL)") else Response.Write("(Nasdaq: DELL)") end if %> surged $4 3/8 to $52 13/16, Compaq Computer <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CPQ)") else Response.Write("(NYSE: CPQ)") end if %> jumped $2 7/16 to $26 1/2, IBM <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: IBM)") else Response.Write("(NYSE: IBM)") end if %> added $3 13/16 to $127 5/16, Gateway <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: GTW)") else Response.Write("(NYSE: GTW)") end if %> was up $2 1/4 to $43 3/4, Apple Computer <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: AAPL)") else Response.Write("(Nasdaq: AAPL)") end if %> soared $4 5/16 to $35 1/8, Microsoft <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: MSFT)") else Response.Write("(Nasdaq: MSFT)") end if %> gained $5 11/16 to $96 7/8, Intel <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: INTC)") else Response.Write("(Nasdaq: INTC)") end if %> leapt $5 3/8 to $83 13/16, and Cisco Systems <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: CSCO)") else Response.Write("(Nasdaq: CSCO)") end if %> rose $3 3/8 to $50 1/16.
Enterprise software companies gained after Germany's SAP AG <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SAP)") else Response.Write("(NYSE: SAP)") end if %> pre-announced that Q3 revenues grew 43% despite the economic turmoil in Japan. SAP American depositary receipts rocketed up $4 1/16 to $36. Competitor BMC Software <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: BMCS)") else Response.Write("(Nasdaq: BMCS)") end if %> recovered $5 1/8 to $45 11/16 as Prudential Securities reiterated its "strong buy" rating. PeopleSoft <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: PSFT)") else Response.Write("(Nasdaq: PSFT)") end if %> rose $1 7/16 to $23 1/4, Compuware Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: CPWR)") else Response.Write("(Nasdaq: CPWR)") end if %> added $6 3/4 to $46 1/2, and J.D Edwards & Co. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: JDEC)") else Response.Write("(Nasdaq: JDEC)") end if %> gained $5 11/16 to $33 7/8... Ford Motor Co. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: F)") else Response.Write("(NYSE: F)") end if %> cruised ahead $3 1/8 to $44 1/4 as the No. 2 automaker named Pete Pestillo vice chairman of the company effective January 1, when William Ford, great-grandson of founder Henry Ford, takes over as chairman.
Banks also got a day of reprieve after being pummeled all week. Merrill Lynch <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MER)") else Response.Write("(NYSE: MER)") end if %> picked up $3 1/8 to $45 5/8, Morgan Stanley Dean Witter <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MWD)") else Response.Write("(NYSE: MWD)") end if %> advanced $4 1/8 to $45 3/4, J.P. Morgan <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: JPM)") else Response.Write("(NYSE: JPM)") end if %> was lifted $4 3/4 to $84 5/8, Citigroup <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CCI)") else Response.Write("(NYSE: CCI)") end if %> moved up $2 15/16 to $35 7/16, U.S. Bancorp <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: USB)") else Response.Write("(NYSE: USB)") end if %> regained $4 5/8 to $35 5/8, BankAmerica <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BAC)") else Response.Write("(NYSE: BAC)") end if %> gained $4 1/4 to $53 7/8, BankBoston <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BKB)") else Response.Write("(NYSE: BKB)") end if %> rose $2 5/16 to $29 15/16, Bank One <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: ONE)") else Response.Write("(NYSE: ONE)") end if %> tacked on $3 13/16 to $41 7/16, and First Union Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: FTU)") else Response.Write("(NYSE: FTU)") end if %> added $2 1/4 to $46 15/16... Biotechnology company Amgen Inc. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: AMGN)") else Response.Write("(Nasdaq: AMGN)") end if %> picked up $1 15/16 to $71 after Merrill Lynch raised its rating on the company to "accumulate" from "neutral," calling the company's earnings "highly reliable" because most of those earnings are based on the U.S. market, not on the international market.
Major pharmaceutical companies advanced today on expectations that they will report double-digit earnings growth in the third quarter. Pfizer <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: PFE)") else Response.Write("(NYSE: PFE)") end if %> rose $3 1/4 to $93, Warner-Lambert <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: WLA)") else Response.Write("(NYSE: WLA)") end if %> jumped $3 13/16 to $67 5/8, Bristol-Myers Squibb <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BMY)") else Response.Write("(NYSE: BMY)") end if %> gained $2 7/8 to $95 1/8, Eli Lilly <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: LLY)") else Response.Write("(NYSE: LLY)") end if %> rose $2 13/16 to $73 3/8, Merck <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MRK)") else Response.Write("(NYSE: MRK)") end if %> picked up $3 1/16 to $130 1/16, Pharmacia & Upjohn <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: PNU)") else Response.Write("(NYSE: PNU)") end if %> finished up $1 13/16 to $48 3/4, and Schering-Plough <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SGP)") else Response.Write("(NYSE: SGP)") end if %> put on $2 1/16 to $94 11/16... Desktop publishing software company Adobe Systems <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ADBE)") else Response.Write("(Nasdaq: ADBE)") end if %> moved up $1 7/8 to $33 1/2 as CEO John Warnock reportedly said the company is on track to meet analysts' fiscal Q4 estimates.
Forage and turfgrass seed company AgriBioTech <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ABTX)") else Response.Write("(Nasdaq: ABTX)") end if %> grew $1 1/8 to $10 1/4 after announcing late in the trading day yesterday that it has hired Merrill Lynch to help explore "strategic alternatives" -- meaning the industry consolidator is looking for its own buyer... Space and information systems company Orbital Sciences Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: ORB)") else Response.Write("(NYSE: ORB)") end if %> soared $2 to $23 after announcing it conducted another successful suborbital mission in late September, its 100th such mission... National Car Rental, Alamo Rent-A-Car, and AutoNation USA used car superstore parent Republic Industries <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: RII)") else Response.Write("(NYSE: RII)") end if %> sped up $1 5/8, or 14.44%, to $12 7/8 after announcing it has ended discussions with the Van Tuyl Automotive Group regarding a possible transaction due to current market conditions.
Financial guaranty insurance and reinsurance company Enhance Financial Services Group <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: EFS)") else Response.Write("(NYSE: EFS)") end if %> added $2 15/16 to $21 after the company said it is "comfortable" with analysts' Q3 EPS estimates of $0.54 to $0.55 and remains "confident in our prospects for continued strong growth and profitability"... Wheat gluten, premium wheat starch, and alcohol products maker Midwest Grain Products <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: MWGP)") else Response.Write("(Nasdaq: MWGP)") end if %> rose $1 3/4 to $13 1/2 after yesterday announcing that it anticipates returning to profitability in its fiscal first quarter ended September 30... Securities market maker Knight/Trimark Group <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: NITE)") else Response.Write("(Nasdaq: NITE)") end if %> gained $1 1/16 to $6 3/16 after announcing plans to buy back up to the greater of either $20 million in shares or a total of 3 million shares over the next 18 months. The company also said that it will "meet or slightly exceed" analysts' earnings estimates for the third quarter.
Aerospace and defense contractor Lockheed Martin <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: LMT)") else Response.Write("(NYSE: LMT)") end if %> took off for a $6 5/16 gain to $109 13/16 as late in the day it announced that it had been awarded a $1.3 billion contract modification to complete production of 40 Titan IV space launch vehicles and provide launch services.. Bankers Trust Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BT)") else Response.Write("(NYSE: BT)") end if %> gained $4 3/8 to $58 7/8 after The Wall Street Journal reported that it's expected to reduce the workforce at its BT Alex. Brown subsidiary by 5% to 10%... E-commerce software developer Sterling Commerce <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SE)") else Response.Write("(NYSE: SE)") end if %> jumped $2 3/8 to $25 after saying it was "comfortable" with analysts' expectations of $0.38 a share, before charges, for its fiscal Q4 ended Sept. 30... Biotech firm Chiron Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: CHIR)") else Response.Write("(Nasdaq: CHIR)") end if %> gained $1 3/8 to $20 as the company along with DepoTech Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: DEPO)") else Response.Write("(Nasdaq: DEPO)") end if %> resubmitted an application for FDA approval of a cancer drug that the agency declined to OK in May.
Discount retailer Dollar General <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: DG)") else Response.Write("(NYSE: DG)") end if %> was marked down $3 9/16 to $22 7/16 after BT Alex. Brown analyst Barbara Miller adjusted her near-term view of the company, even though she still has a good feeling about its prospects further out. The firm's "strong buy" rating was ditched in favor of a plain vanilla "buy," as Miller sees Dollar General's normal earnings growth rate slowing over the next three quarters as it transitions to a new headquarters facility in Nashville. Also, same-store sales growth rates in the months ahead will probably not top the high levels seen a year ago. Investors got a taste of this trend earlier this week when Dollar General reported an 8% increase in September comparable-store sales. While that's not shabby by any means, it was lower than the 9.9% same-store sales rise posted in September 1997.
Newmont Mining Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: NEM)") else Response.Write("(NYSE: NEM)") end if %> led a group of gold mining stocks downward today, falling $3 11/16 to $25 5/8. According to Bloomberg, Newmont Chairman and CEO Ronald Cambre told a mining investment forum in Denver today that lower gold prices will take a $25 million bite out of fiscal Q3 revenues. Newmont was able to use gold hedging contracts it picked up through its 1997 acquisition of Santa Fe Pacific Gold Corp. to its advantage in Q2, when it reported a $0.16 per share profit. Those contracts have expired, though, and Newmont now faces the prospect of lower second half earnings. Cambre also reportedly told the conference that he thinks the price of gold will rise in the months ahead. However, commodity traders apparently didn't listen to the tip, as the price of the December gold contract in New York fell $3.50 to $298.50 today. Homestake Mining <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: HM)") else Response.Write("(NYSE: HM)") end if %> lost $1 5/8 to $12 1/8, Placer Dome <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: PDG)") else Response.Write("(NYSE: PDG)") end if %> fell $1 5/16 to $14 13/16, and Getchell Gold <% if gsSubBrand = "aolsnapshot" then Response.Write("(AMEX: GGO)") else Response.Write("(AMEX: GGO)") end if %> slid $2 to $17 5/8.
QUICK CUTS: Vanstar Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: VST)") else Response.Write("(NYSE: VST)") end if %> sank $7/16 to $7 15/16 after agreeing to be acquired by Inacom Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: ICO)") else Response.Write("(NYSE: ICO)") end if %> in an estimated $479 million stock swap, creating the world's largest corporate distributor of IBM, Compaq, and Hewlett-Packard computers. Inacom fell $15/16 to $15 7/8 on the news. For more details, see this morning's Breakfast With the Fool... Telecommunications services company Sprint Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: FON)") else Response.Write("(NYSE: FON)") end if %> slipped $2 9/16 to $73 1/2 after The Wall Street Journal reported that the company told federal regulators that Tele-Communications Inc. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: TCOMA)") else Response.Write("(Nasdaq: TCOMA)") end if %> needs to sell its stake in the Sprint PCS venture due to TCI's proposed merger with Sprint rival AT&T <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: T)") else Response.Write("(NYSE: T)") end if %>.
Oil and gas and chemical piping systems maker Shaw Group <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SGR)") else Response.Write("(NYSE: SGR)") end if %> dropped $1 1/2 to $6 13/16 after saying weak results by its U.K. business will result in fiscal Q4 EPS between $0.02 and $0.05, missing the Street's mean estimate of $0.30... Indiana Energy <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: IEI)") else Response.Write("(NYSE: IEI)") end if %> dipped $2 1/8 to $23 1/2 after Merrill Lynch reduced the natural gas utility's near-term rating to "neutral" from "accumulate." The long-term rating was also cut to "accumulate" from "buy"... Truck and trailer bodies manufacturer Supreme Industries <% if gsSubBrand = "aolsnapshot" then Response.Write("(AMEX: STS)") else Response.Write("(AMEX: STS)") end if %> slid $15/16 to $8 following a Schroder & Co. downgrade to "neutral" from "buy"... Coronary stent maker Boston Scientific Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BSX)") else Response.Write("(NYSE: BSX)") end if %> sank $2 3/16 to $50 following a BT Alex. Brown downgrade to "market perform" from "buy."
Sealing products and specialty chemicals firm Wynn's International <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: WN)") else Response.Write("(NYSE: WN)") end if %> leaked $15/16 to $15 5/8 after saying it will report fiscal Q3 EPS of $0.30 to $0.31, which is short of the $0.33 the Street had been expecting... Schweitzer-Mauduit International <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SWM)") else Response.Write("(NYSE: SWM)") end if %> lost another $1 15/16 to $13 after the cigarette paper maker warned yesterday that its Q3 earnings will miss analysts' expectations... Israeli digital preprint and printing products developer Scitex Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: SCIXF)") else Response.Write("(Nasdaq: SCIXF)") end if %> slid $3 7/16 to $6 3/16 after saying delayed orders, global economic weakness, and a workforce reduction will result in a fiscal Q3 loss between $0.32 and $0.38 per share. The Street's mean estimate had called for earnings of $0.16 per share.
Financial printing powerhouse Bowne & Co. <% if gsSubBrand = "aolsnapshot" then Response.Write("(AMEX: BNE)") else Response.Write("(AMEX: BNE)") end if %> dropped $1/2 to $12 after saying a weak August and September will result in fiscal Q3 earnings below the $0.285 per share earned a year ago. The company's Q4 results may also see a year-over-year decline, the firm said... Titanium dioxide pigments supplier NL Industries <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: NL)") else Response.Write("(NYSE: NL)") end if %> fell $3/4 to $15 3/16 on reports that the market for titanium dioxide may have already seen its best days, which will have negative effects on the company's future financial performance... Homebuilder Kaufman & Broad Home Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: KBH)") else Response.Write("(NYSE: KBH)") end if %> lost $13/16 to $17 1/2 after Prudential Securities lowered its rating to "hold" from "accumulate."
Mortgage loan investment company Impac Mortgage Holdings <% if gsSubBrand = "aolsnapshot" then Response.Write("(AMEX: IMH)") else Response.Write("(AMEX: IMH)") end if %> tumbled $2 9/16 to $3 9/16 after saying it will report a fiscal Q3 loss of $0.70 to $0.93 per share (before charges), falling short of the Street's mean estimate of earnings of $0.48 per share... Outdoor and casual shoe maker Rocky Shoes & Boots <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: RCKY)") else Response.Write("(Nasdaq: RCKY)") end if %> was knocked down $1 1/16 to $5 3/16 after saying its fiscal Q3 revenues will be about $31 million, which is lower than the $31.6 million recorded a year ago... Defense electronics company Raytheon Co. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: RTN.B)") else Response.Write("(NYSE: RTN.B)") end if %> fell $1 7/8 to $55 1/8 after saying its fiscal Q3 earnings will be "slightly below" the Street's mean estimate of $0.90 per share, while Q4 earnings should be in line with the $1.08 per share expected by analysts.
FOOL
ON THE HILL
An Investment Opinion
by
Dale Wettlaufer
Asset-Backed Carnage, Part 2
On Tuesday, we looked at the bankruptcy of Criimi Mae <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CMM)") else Response.Write("(NYSE: CMM)") end if %> and the balance sheet issues that affected the company. The contention that the company was just fine and dandy except for getting shafted by its creditors and trading partners has been put forth, but that misses the point of the business model and the risk to investors. If you build your business model on making a spread on constantly turning lower-quality securities through your balance sheet, you end up down the creek without a paddle if you can't turn your balance sheet any longer.
One money manager sent me a note explaining the difference between now and the days when lots of businesses trading this sort of stuff got rolling. He explained, as a former credit analyst before going elsewhere in the investing world, that he covered "...high-grade financial services and CMBS [collateralized mortgage-backed securities] and asset-backed credits. Back in those days (1992 - 1995) the lower-rated CMBS tranches would trade at rich spreads with prepayment lock-outs and make-whole provisions to entice portfolio managers looking for bullet paper to buy this stuff. A BBB-rated CMBS deal with good property diversification and good geographic dispersion would trade at a spread premium to a liquid BB-rated high-yield deal. Thus you could buy higher credit quality at a larger spread than corporates. All the RTC deals that came to market in 1990 - 1995 were just fire sales and all this paper was stupid cheap. Anyway, I guess those days are gone."
Enter the real estate investment trusts (REITs) in the last couple years that couldn't come to market quickly enough. With the imprimatur of all the popular investment magazines and the image of stodgy investments for older folks, the outperformance and the high yield of these securities drew in momentum players and safety investors alike. However, many of these companies were like having your own personal trading desk. When things are going right, you're the rig. When they're not, you eat the diminishment in capital. In the case of Criimi Mae, the company's leverage didn't increase this year and, in fact, had dropped through the end of the first half of the year.
It wasn't so much leverage per se that killed the company. Leverage is a fine thing when assets are stupid cheap. But when your assets are growing at better than a 100% annualized clip and those assets are being acquired at super premium pricing (and thus a deteriorating margin of safety), all it takes is a downturn in the market for those assets to nuke your balance sheet.
One of the most interesting cases in the mortgage investment trust world this year is Redwood Trust <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: RWT)") else Response.Write("(NYSE: RWT)") end if %>, which has certainly had a rough go of it in 1998 but exercised admirable caution earlier this year when it said it didn't like what it was seeing in mortgage pricing. In the middle of a raging bull market in equities, it is pretty interesting to see a company pull back, sacrifice near-term earnings growth, and exercise some caution when it doesn't like what it sees. Not that Redwood Trust is out of the woods, but its credit quality is much different from Criimi Mae, which is loaded with subordinated credits that are priced in extremely illiquid markets.
But moving on to a different component of the asset-backed world, the last year has seen some spectacular blowups in the mortgage lending world as the result of what one could presume to be a more rational approach to pricing business models. Amazing how a liquidity crisis can force that rationality. Before we get to that kind of business model, we need to establish a framework for looking at lending in the late 1990s.
We already know that lending to plain vanilla mortgage borrowers is a tough game. If it were easy, then we would have never had S&Ls blow up in the 1970s, seek regulatory relief, get that "relief," and then blow up in the late 1980s and early 1990s. Anyway, you can't be a mortgage lender using just equity and expect to build shareholder value, because you'll never get the return on investment that equity investors demand. You have to use generous amounts of leverage to generate a return to equity holders, and there you get into the dangerous waters of interest rate risks, not to mention default risks. If you mismatch maturities and credit terms of your portfolio versus the terms of your liabilities badly enough, you can set a clock to the time expected for your equity to collapse.
So what's the best way to go about mortgage lending? That's right, get the government to insure it. Take the credit risk almost completely out of the picture, and you get Fannie Mae <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: FNM)") else Response.Write("(NYSE: FNM)") end if %> and Freddie Mac <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: FRE)") else Response.Write("(NYSE: FRE)") end if %>. You get a lower nominal interest rate on your mortgage, but you also get a larger federal budget and more taxes. What's the best way to offset the higher tax bill if you are an older person who has already paid off the mortgage? Invest in these government-sponsored entities. Yup, for every dollar of equity these companies have in use, they hold $25 to $30 in assets. No problem if you make $0.008 yearly for every dollar in assets, because with 25x to 30x leverage, that turns into $0.20 to $0.24 in earnings for every dollar of equity. Can't beat that, especially if you were smart enough to acquire these companies at a low multiple to book value.
OK, so you've got this huge force out there that acts as a lender to all the good credits in the U.S. and which can finance its operations through the securitization process. If you want to be a mortgage lender, there are a few options. You can run a plain vanilla business and have an extremely low overhead and generate a middling return on equity. Or you can run a plain vanilla business with low overhead and throw in some fee-generating services, generating a decent return on equity. Or you can build a huge infrastructure to originate the mortgages, earn a little money on the origination, get it off the balance sheet via securitization, and earn money by servicing those loans for the benefit of the investors buying into those securitization trusts. And then repeat ad infinitum.
You can also find some niches where this huge mortgage force doesn't operate. And you can go out on the credit quality spectrum -- anywhere from borrowers with a good credit history needing a high loan-to-value (the amount of the value versus the amount of the asset being acquired) loan all the way out to people with bad credit, bad prospects, and no collateral. But don't forget to charge them a huge interest rate.
We'll look at those scenarios on Tuesday in Asset-Backed Carnage, Part 3.
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Contributing Writers Yi-Hsin Chang (TMF Puck), a Fool Brian Graney (TMF Panic), Fool Two Alex Schay (TMF Nexus6), Fool, too Dale Wettlaufer (TMF Ralegh), Final Fool
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