The Worst Banks in South Florida (MiamiHerald.com)

Company name City Total assets(in millions) Must capital ratios be raised? Enforcement action
1st National Bank of South Florida Homestead 321,271 Yes Cease and Desist
Bank of Coral Gables Coral Gables 145,320 Yes Cease and Desist
BankAtlantic Fort Lauderdale 4,424,565 Yes Cease and Desist
City National Bank of Florida Miami 3,861,652 No Formal Agreement/Consent Order
Coconut Grove Bank Miami 615,282 No Formal Agreement/Consent Order
Eastern National Bank Miami 427,616 No Formal Agreement/Consent Order
Executive National Bank Miami 285,467 No Formal Agreement/Consent Order
First East Side Savings Bank Sunrise 81,591 Yes Cease and Desist
Gibraltar Private Bank & Trust Coral Gables 1,654,974 No Cease and Desist
Great Eastern Bank of Florida Miami 62,757 Yes Cease and Desist
Great Florida Bank Miami Lakes 1,516,057 Yes Cease and Desist
Home Federal Bank of Hollywood Hallandale Beach 81,082 Yes Cease and Desist
Intercredit Bank Miami 258,268 No Formal Agreement/Consent Order
Landmark Bank Fort Lauderdale 316,166 No Formal Agreement/Consent Order
Ocean Bank Miami 3,590,044 Yes Cease and Desist
OptimumBank Fort Lauderdale 183,601 Yes Cease and Desist
Pacific National Bank Miami 348,912 No Cease and Desist
Professional Bank Coral Gables 124,016 No Cease and Desist
Regent Bank Davie 487,796 Yes Formal Agreement/Consent Order
Security Bank North Lauderdale 113,404 Yes Cease and Desist
TransCapital Bank Sunrise 244,993 Yes Cease and Desist
Valley Bank Fort Lauderdale 124,427 Yes Cease and Desist

Type of Enforcement Action

Order to Cease and Desist:

An order issued when a bank is engaging or has engaged or is about to engage in an unsafe or unsound banking practice or a violation of law. The bank must follow certain requirements or take specific actions.

Formal agreement/Consent Order:

A formal agreement between a bank and the FDIC. The agreement states that certain actions be taken and/or certain activities are prohibited, or else the bank will be subject to a cease and desist order.


• Written agreement/Consent Order: A formal agreement between a bank and the FDIC. The agreement states that certain actions must be taken and/or certain activities are prohibited, or else the bank will be subject to a cease and desist order.

South Florida banks under scrutiny
.Many financial institutions in South Florida are operating under regulatory directives, working to put themselves back on sound footing.

By Ina Paiva Cordle
icordle@MiamiHerald.com
Hit hard when the real estate bubble popped in 2007, many South Florida-based community banks are still reeling from the aftershocks.

Over the last few years, past-due loans have mounted, funds required to offset loan losses have skyrocketed, and real estate has been repossessed and marked down, leading to a flood of red ink and a drain on capital.

All the while, regulators have been keeping a close watch.

In fact, of 240 Florida-based banks and thrifts, 78 — 32.5 percent — are currently operating under severe regulatory enforcement actions, including prompt corrective actions, cease and desist orders, formal agreements and consent orders. The actions are among the tools regulators use to work with banks to correct deficiencies and make sure they are on sound financial footing, and following safety and soundness guidelines and regulations.

That’s a higher proportion than in most, if not any, other state, banking experts say, and it reflects the current economy.

“It’s just only natural to see the increase in actions when the economy does go down,’’ said David Barr, spokesman for the Federal Deposit Insurance Corp. “It happened in the last crisis, in the late ‘80s and early ‘90s. And during the good times, there were considerably fewer.’’

Florida led the nation in bank failures in 2010, with 29 statewide. And one-third of all U.S. bank failures were in two states: Florida and Georgia, said Ken Thomas, a Miami-based independent banking consultant and economist. With 10 failures to date — including Palm Beach-based Lydian Bank on Aug. 19 — he anticipates a total of at least 15 bank failures in Florida this year. That would be on par with 2009, when 14 banks failed in the state, following two failures in 2008 and none in 2007 or 2006, before the crisis, when the number of banks in Florida topped 300.

The impact on the local economy of a bank seizure and sale to a stronger institution is hard to measure, Thomas said. Senior staff may well lose jobs, and if the new owners close branches, other employees may be out of work as well.

The successor bank may be stricter in its lending practices. Customers sometimes find themselves stripped of long-time working relationships and the accumulated good will that came with them. Though deposits are protected, bank closures may heighten anxiety about the overall economy.

A regulatory action doesn’t necessarily mean a bank is heading into failure; many are issued to banks that recover and thrive. Still, all but two of the 37 Florida banks and thrifts that have failed since Jan. 1, 2010 had a severe enforcement action in place, according to SNL Financial, a data and analysis firm.

“Many of the institutions cited by regulators may correct their infractions, yet others may be forced to raise capital, merge with a stronger peer, or see their bank seized by regulators,’’ SNL said in a report.

Without a doubt, South Florida holds the largest concentration of banks operating under regulatory directives within the state. Of the 78 community-based banks in Florida under such directives, 22 are based in Miami-Dade or Broward Counties, SNL data shows.

Requirements may be both strategic and operational. Some banks are instructed to engage their board of directors more actively in decision-making; others are told to bring in experienced senior managers. Some are told to create formal ethics policies, formalize anti-money laundering procedures, raise credit standards, increase loan-loss funds or write off bad loans. Most significant are directives to boost capital to meet higher capital-to-asset ratios required by regulators .

BauerFinancial, which rates banks nationwide on a five-star scale — two or fewer stars are classified as “troubled and problematic’’ — counts 19 problem banks in Miami-Dade and Broward, based on March 31, 2011 financial statements.

“Capital, profitability and asset quality, or non-performing or delinquent loans — those have the most impact’’ on the bank’s rating, said Karen Dorway, president and director of research for Coral Gables-based BauerFinancial.

Almost all the banks deemed “troubled and problematic’’ by BauerFinancial are also those operating under regulatory orders.

But consumers need not worry.

“As long as their money is insured by the FDIC, there are a lot of other things they need to worry about than the safety of their money,’’ Barr said.

REAL ESTATE SPILLOVER

Florida and South Florida have been hit harder than other markets because of the severity of the real estate downturn and our location as the epicenter of the housing crisis, Thomas said.

“The fortunes of most Florida banks, especially here in South Florida, are tied to the real estate market, both the residential and commercial sides,’’ he said. “And as it has collapsed so too have the fortunes of our banks.’’

While some indicators suggest local real estate values may soon be on an upswing, experts agree that the banking recovery will still take more time.

“It took us six years to blow up the bubble. It’s going to take five to six years to get out of this mess. And we’re now entering the fifth year,’’ said Ben Bishop, chairman of Jacksonville-based Allen C. Ewing & Co., an investment banking firm that specializes in banking.

Recent turmoil in the global economy has renewed fears about the health of the national banking system. Still, Bishop believes the worst is over for Florida. As long as the economy does not dip into another recession, next year will be the first full year of the recovery for Florida community banks, he said.

“Two-thousand-twelve is the first year that will see the loan loss provisions for banks start to decline, and that means earnings are right around the corner,’’ Bishop said. “They may not make a lot of money, but they will lose a whole lot less in 2012.’’

In the meantime, many South Florida banks operating under regulatory actions are working hard to correct their issues, including raising capital.

CORRECTING ISSUES

Here are the stories of seven such banks and the steps they say they are taking to meet regulators’ requirements.

• U.S. Century: In June, Doral-based U.S. Century Bank signed a consent order with regulators that cited issues with asset quality, management, earnings, capital, liquidity and sensitivity to market risk. The order was released by the FDIC in late July.

“The problem you will find with most banks is devaluation,’’ said U.S. Century Vice-Chairman, President and Chief Executive Octavio Hernandez. “When you have properties that have lost 50, 60, in some cases 70 percent of their original value, it is very difficult not to have capital issues, because when new appraisals come in, you have to adjust your books accordingly.’’

So far, the nine-year-old bank has made strides in disposing of some of its problem loans, which are mostly related to commercial real estate.

With $359 million in delinquent loans, U.S. Century sought to dispose of at least $25 million in loans in the second quarter, and it succeeded in selling off $38 million, said Abel Montuori, first executive vice president and senior lending officer. The goal for the third quarter is to dispose of another $71 to $80 million in loans, he said.

U.S. Century also recently hired the Japanese investment banking firm Nomura Securities to raise at least $150 million in private equity funds, said Hernandez. Last week he flew to New York to make presentations to potential investors. U.S. Century currently has $1.6 billion in assets.

“Our focus right now is on two things: raising capital and reducing our classified assets, and we have beefed up that department significantly,’’ Hernandez said. “All the attention of the bank is there and on the effort to raise capital, and meeting all the other areas of the consent order. We’re focused on that, and hope to have all that resolved quickly to regulatory satisfaction.’’

• Ocean Bank: Miami-based Ocean Bank, which previously had been asked to correct deficiencies, signed its most recent consent order with regulators April 28. The directive required stricter capital ratios and anti-money laundering controls and cited weaknesses in asset quality, management, earnings, liquidity and sensitivity to market risk. The bank, with $3.5 billion in assets, was founded in 1982.

Ocean Bank President and Chief Executive A. Alfonso Macedo said the bank has invested in new anti-money laundering systems and training and has put together a new team of experts.

Ocean Bank also has reduced its delinquent loans by half, from more than $770 million to $324 million.

“That’s been our biggest focus, because the more we improve our asset quality, the better we’re going to look and the more profitable we are going to be,’’ Macedo said.

To boost its ratio of capital to assets, since 2007 Ocean Bank reduced overall assets and has raised $100 million from its current shareholders. The company is now seeking additional capital from both current shareholders and outside investors. But it has not yet met an early July deadline for raising its capital ratios to the required level.

“We have a very good relationship with regulators,’’ Macedo said. “We are working closely with them and they know what we are doing.’’

• Great Florida Bank: Miami Lakes-based Great Florida Bank, which previously was served with a cease- and-desist order, received its most recent directive in April. It also was instructed to increase its capital. The bank, founded in 2004, has $1.4 billion in assets.

“We have entirely focused our plan on making sure we manage our risk, which we have, and making sure our risk does not deteriorate, and that our ratios improve, which they did over the last quarter,’’ said Great Florida Bank President and Chief Executive Mehdi Ghomeshi.

Trying to improve its capital ratios through internal measures, since late 2010 Great Florida has shrunk its balance sheet by 7 percent; reduced its non-performing loans by 8 percent; decreased its interest expense by 26 percent; and cut its overall expenses by 16 percent, Ghomeshi said.

“When the investors gain confidence in the economy and the banking sector, we will be able to raise the capital [from investors],’’ he said. “Unfortunately right now, investors are investing in bonds.’’

• Professional Bank: Coral Gables-based Professional Bank, which agreed to a consent order in December, just satisfied one of regulators’ primary directives last week by hiring an experienced president and chief executive, Raul G. Valdes-Fauli. Most recently president of the South Florida market at CNL Bank where he managed the tri-county region, Valdes-Fauli was previously president and CEO of commercial banking for Miami-Dade County for Colonial Bank.

Other issues — such as creating a business plan, a blueprint for earnings, and creating policies for lending, loan losses, ethics and interest rate risk management — have either been addressed or are in the works, said Valdes-Fauli, who started his job Aug. 15. The bank, founded in 2008, has $126 million in assets.

“We have a detailed business plan that is addressing all the issues raised in the order,’’ he said. “And we’re making wonderful progress in hopefully showing examiners we have everything buttoned up.’’

Other South Florida banks say they have already been successful in correcting every issue cited by regulators.

• Fort Lauderdale-based BankAtlantic was issued its most recent action, a cease and desist order, in February 2011, requiring, among other issues, that the bank raise its capital.

“What led to the C and D was that our non-performing loans ballooned because we’re a Florida bank, and many of our commercial real estate customers were having trouble, and as a result, the regulators required us to have even higher capital than we currently had,’’ said Alan Levan, chairman and chief executive of BankAtlantic Bancorp, the parent of BankAtlantic.

“We understood the rationale for it, and they gave us to June 30 of 2011 to increase the capital ratios, which we did,’’ he said. The ratios now meet regulators demands and are the highest capital ratios since the bank was founded in 1952, Levan said.

BankAtlantic raised its ratios through several methods, including selling its branches in Tampa; completing a stock offering to existing shareholders; reducing its concentrations of loans; and restructuring its balance sheet. For the quarter ending June 20, 2011, the bank, with $3.8 billion in assets, showed a profit for the first time since the second quarter of 2007.

“We believe that we have met everything that was required of us in the C and D,’’ Levan said. Typically, it takes regulators months to reexamine a bank and lift any enforcement actions.

• City National Bank of Florida, co-founded in 1970 by Leonard Abess and sold by his son Leonard Abess Jr. in 2009, signed a formal agreement/consent order with regulators in April 2010. The order cited City National’s anti-money laundering procedures as well as its concentration of real estate risk.

“Like most community banks we had a high percentage of real estate assets on our books,’’ said Jorge Gonzalez, president and chief executive of Miami-based City National Bank, which has $3.9 billion in assets and is now owned by Caja Madrid, the third largest financial services company in Spain.

“So we cleaned up all the assets that were underperforming, and we reduced the amount of real estate concentration,’’ he said. The bank’s nonperforming assets now represent 1.3 percent of total assets, and its capital ratios are above required levels, Gonzalez said. He expects the regulatory action to be lifted by the end of this year.

• In March 2010, Coconut Grove Bank signed a formal agreement/consent order that cited concerns found during a March 2009 examination, said Lynn M. Cambest, chief financial officer and treasurer.

“By the time we signed the agreement we literally had substantial compliance with all the issues raised in the letter, with the exception of raising capital,’’ Cambest said. Among those issues were board oversight, credit risk management, funds for loan losses, and improvement of assets and investments.

On June 24, Miami’s oldest continuously run bank — founded in 1926 — completed its last requirement, raising $32 million in a private placement, funded by 33 local investors, including Ivax Pharmaceuticals-founder Dr. Phillip Frost. It now has $648 million in assets.

Frost is now the bank’s largest individual shareholder, with more than 20 percent of the bank’s shares.

Other experienced businesspeople — including TECO Energy Executive Chairman Sherill Hudson — have recently joined the board.

As a result of the private placement, Cambest said Coconut Grove Bank’s capital ratios at the end of the second quarter were more than in compliance with regulatory directives.



Read more: http://www.miamiherald.com/2011/08/21/v-fullstory/2369351/south-florida-banks-under-scrutiny.html#ixzz1VmU8xVPP

The Bailout Banks - How are They Doing (Barrons)

Home > News & Commentary > This Week's Magazine > Features
MONDAY, MAY 11, 2009
FEATURE



After All That Stress, a Hugh Sigh of Relief
By ANDREW BARY

Now that the leading financial companies have passed their stress tests, investors are eager to buy bank stocks again. But which ones?

WALL STREET CHEERED THE GOVERNMENT'S EAGERLY awaited release last week of stress tests on 19 leading financial companies. Bank stocks gained 36%, extending a furious rally that has produced a 135% gain in the widely followed KBW Bank Index from its March lows.

Investors viewed the stress tests as showing that the major public financial companies can handle potential loan losses even in a draconian economic scenario with a manageable amount of new equity capital -- or no new capital at all. The big fear had been that banks would have to resort to capital raising that would massively dilute existing common shareholders.

Now institutional investors are eager to buy financial stocks. Morgan Stanley and Wells Fargo took advantage of growing institutional demand for new stock issues immediately after the stress-test results were released Thursday.

"A lot of money managers were underweighted in bank stocks relative to their benchmarks, and they've been panicked buyers because of what they see as an inflection point," says John McDonald, banking analyst at Sanford Bernstein.

There were broad gains through the sector. Fifth Third soared 120% to $8.49; PNC Financial rose 40% to $53.08; Bank of America gained 63% to $14.17, and Wells Fargo gained 44% to $28.18, helped by a plug from Warren Buffett, whose Berkshire Hathaway is Wells' largest holder.
Credit-card specialists American Express and Capital One were strong; AmEx shares rose 17% in the five sessions to $28.40, and Capital One gained 81% to $31.34. Because the stress tests took a rosier-than-anticipated view of potential credit-card losses, AmEx and Capital One weren't deemed to be capital-deficient. Many on Wall Street had expected that Capital One would be forced to boost capital.

Analysts saw room for further gains in the sector, but investors need to recognize that profits for this year are likely to be weak, and that 2010 earnings may continue to be depressed by elevated losses on commercial-real-estate mortgages and on home-equity and credit-card loans.
Investors are starting to look at what analysts call "normalized" earnings, or what banks can earn in a more benign economic and credit environment, which may not come until 2011. Banks are generally trading for four to nine times those normalized earnings.

Those potential profits, however, are subject to a host of variables, including the economy, interest rates, bank capital requirements and asset returns. McDonald favors some of the stronger banks, including JPMorgan Chase and PNC. JPMorgan, which rose 20% to $38.94 last week, now is valued at around seven times normalized earnings of more than $5 a share.

UNTIL RECENTLY, INVESTORS FEARFUL about earnings power tended to value banks on tangible book value, a conservative measure of shareholder equity. "Two weeks ago, the only thing people cared about was price to tangible book," says Barclays Capital analyst Jason Goldberg. "Now it's price to normalized earnings. Two weeks from now, who knows what it will be?"

Goldberg favors Bank of America, whose shares were up sharply despite needing to raise an industry-leading $33.9 billion. The stock trades for less than five times Goldberg's estimate of normalized earnings of $3.47 a share. Wall Street believes BofA can raise required capital without much dilution. The bank said it plans to sell 1.25 billion of common shares and convert some of its preferred stock to common -- and to sell some non-core assets, including the Columbia investment-management business.

Bank of America's $33 billion of preferred stock offers a high-yielding play on the bank's revival. The Series J 7.25% preferred trades around $15 (60% of face value of $25) for a yield of 12%. A former Merrill Lynch preferred issue, now called Series 5, trades for just $9, a fraction of its face value of $25. It has a yield of 11%. The BofA preferred dividends now look more secure, and the common yields next to nothing.
One of best plays for fans of beleaguered Citigroup is its $15 billion of preferred stock, which is due to be converted into common shares in an exchange offer to get under way soon. Citi's Series P preferred traded Friday around $22.50, enabling investors to buy Citi common at around $3 a share, considerably below Citi's close of $4.02. Each preferred share is likely to get 7.3 common shares. The opportunity exists because arbitrageurs can't close the currently wide spread between the preferred and common, with Citi shares virtually impossible to short.

Citi's trust preferred, which is senior to the regular preferred, also could be appealing. Some probably will be converted to common to meet the need for $5.5 billion of additional capital called for in the government stress tests. Citi's Series W trust preferred trades around 15, for a yield of 10%.

Citi's common is a dicier bet because the company's plan to convert more than $50 billion of preferred stock to common to boost key capital ratios could balloon its share count to 23 billion from the current five billion, permanently capping its earnings power. Moreover, the government likely will emerge as a major shareholder, leading to further potential meddling in Citi's business. With Citi's business mix shifting, it's tough to peg normalized earnings power, which could be anywhere from 50 cents to $1 a share.

--------------------------------------------------------------------------------

from CNBC, Current Opportunities in Corporate Bonds

Forget Stocks: The Real Rally Now Is In Corporate Bonds

Posted By: Jeff Cox | CNBC.com
CNBC.com | 25 Mar 2009 | 02:45 PM ET
While stocks have been rallying lately, the big investing story these days may be corporate bonds, where soaring yields are drawing strong interest.


Many corporate bonds, particularly those in the financial field, are offering double-digit yields, while the Dow Jones Corporate Bond Index is just above 7 percent. The gaudy yields are a strong enticement even though the threat of defaults makes the bonds highly risky.

"Credit markets aren't working properly so investors don't want to take the risk. To attract investors they have to keep pushing up the yield," says Heater Errigo, managing director at Lynx Investment Advisory in Washington, D.C. "At some point the yield spreads have to narrow back in ... but right now it's a great opportunity. You can buy some high-quality corporate bonds that can give you some great yields."

Spreads between corporate bonds and Treasurys have hit about 4 percentage points, a trend stimulated both by a rush to the safety of government issues and a drop in demand for corporates on fear that the companies issuing them may not make good on their debt.

At the same time, the surge in stocks, while pronounced, still leaves the major indexes well off their highs for 2009, and the past two days have seen the market wobble. That has sent investors looking for returns elsewhere.

Investors can buy bonds either directly, using a manager, or through funds, with a surge of activity particularly in exchange-traded issues. An initial direct investment into corporates usually requires at least $5,000 but the amount varies, while ETFs can be purchased as easily as stocks.

"They're always a legitimate investment opportunity. You just have to be selective at what you buy," says Dennis P. Barba Jr., professor at the Weatherhead School of Management of Case Western Reserve University. "Do some research into the company and have a reasonable sense that they're going to be solvent."


But for retail investors the calculus is difficult, and some investment pros are loathe to recommend corporates.

"For income, bonds are great, but you better know the risk factor," says Bill Walsh, president of Hennion & Walsh Asset Management in Parsippany, N.J. "If we had a client right now that has to buy corporates because they want that extra yield and understand the risk, what we would suggest is instead of taking that one corporate, use a professional manager."

Managers have taken a liking to ETFs that track the performance of indexes measuring corporate bonds.

The iShares iBoxx Investment Grade Corporate Bond fund has seen strong money flows over the past week though it is down about 7 percent for 2009.

Another of the more popular ETFs for the group, the iBoxx High Yield Corporate Bond , is off nearly 8 percent this year but has gained about 12 percent in the past two weeks.

Another of the more actively traded ETFs in the group is the SPDR Barclays Capital High Yield Bond , which also has gained 12 percent since March 9.

Enthusiasm From Money Managers

Indeed, the demand for corporates is on the brink of bullishness.

The Investment Manager Outlook, a quarterly survey of investment pros conducted by Tacoma, Wash.-based money manager Russell Investments, found 67 percent of managers bullish on corporate bonds and 61 percent bullish on high-yield bonds in general. Both categories were more popular than stocks.

"In this environment of caution and realism, managers are finding opportunity in spreads between high-quality corporate bonds and Treasurys that are at historic levels," Erik Ristuben, Russell's chief investment officer, said in a statement.

"Managers also see attractiveness in high-yield bonds, which may constitute a very good value compared with a possibly even more volatile equities market, especially for those managers who can discriminate and effectively pick the winners."


To be sure, the other end of the double-edged sword in the corporate yield surge is an uncertainty over the future of equities.

Stocks have staged an impressive rally this week, but the Dow industrials are still 13 percent below their January peak after the post-election rally.

Investors are pricing in a five-year default rate of 40 percent for corporates, according to Deutsche Bank, indicating that a sustained run higher in stocks could be difficult amid all the troubles companies will be facing in the days ahead. The number also serves as reminder of how important it is to pick the right bonds.

"A trend upward is not going to happen until the corporate market goes back to normal," Lynx's Errigo says. "We have to have lending go back to a normal level before the equity markets are going to have a sustained rally. It's definitely a reflection of the uncertainty in equity markets out there."

The Russell survey also has found sentiment declining for stocks, even though a 57 percent majority still finds the market underpriced.


"Managers want to know that the economy is functioning properly again and believe that the credit situation is the key to understanding when the economy and markets are set to recover," Ristuben said.

Until the equity markets stabilize, investors will have to decide just how much risk they're willing to take. Those with a high appetite could find a nice reward in corporate bonds.

"My discussion with the retail investor would be: Do you know the risk and do you want that risk, and if you do is there a way to diversify that risk?" Walsh says. "I don't know if I believe the reward is worth the risk at this point for an individual investor."

© 2009 CNBC.com
URL: http://www.cnbc.com/id/29877394/

Citi Preferreds Exchange Terms (marketwatch)

Citi gives public preferred 5%-15% conversion haircut

By Marshall Eckblad
Last update: 7:52 a.m. EST March 3, 2009(This article was originally published Monday.)
NEW YORK (MarketWatch) -- Owners of publicly traded preferred stock in Citigroup Inc. will take a haircut of 5% to 15% when they exchange their shares into common stock of Citigroup at $3.25 per share.
The discount imposed on public preferred shareholders values the shares above the market price at which the preferred shares were trading before the deal was announced. Still, the pricing of the exchange, disclosed Monday, reveals that some preferred shareholders are more preferred than others in the deal.
Holders of the private preferred, who are getting a better price, include the U.S. and Singaporean governments, as well as Saudi Arabian Prince Alwaleed Bin Talal. Those investors will exchange preferred shares at par value, or the shares' original purchase price.
Citi had indicated Friday that, in contrast to owners of privately placed preferred stock, the public preferreds wouldn't get to exchange for Citi stock at their preferred shares' par value. Citi said only that the final price would be at a yet undisclosed "premium to market," and some investors anticipated facing a steeper discount to the shares' original purchase price.
Charles Lemonides, chief investment officer of ValueWorks LLC, a New York money manager, was worried Friday that Citigroup was going to shortchange retail investors, offering them inferior terms if they converted their preferred shares to common stock. But the details of the offering, which Citigroup disclosed in a regulatory filing Monday, turned out not to be so bad. The terms are "awfully close to fair and nothing to make hay over," Mr. Lemonides said.
A source who requested anonymity said the U.S. Treasury asked Citi to discount the value that public holders would receive in order to get the most out of its taxpayer-funded investment to bail out Citi.
A Citi spokesman couldn't promptly comment for this piece.
Shares in Citi were recently trading down 14% to $1.29. Citi preferred shares mostly fell Monday, reflecting the decline in the underlying common stock.
Citi will convert all the applicable preferred shares into common stock at $3.25 apiece. A person familiar with the matter said the price was calculated using a 20-day moving average price.
Citi said today in a filing with the Securities and Exchange Commission that holders of Series F, Series AA and Series E preferred stock - representing about $11.8 billion of the total - will be offered 95% of the liquidation value, while Series T holders - representing about $3.2 billion - will be offered 85%.
In treating its preferred shareholders differently, Citi, and even the U.S. Treasury, may be signaling that it will give better terms to private investors willing to take a large stake in recovering financial firms. At the same time, the relatively small haircuts may be an effort to show investors in preferred shares that they will not suffer dire consequences should the government purchase common stock in a firm.
Other reasons for treating the different shareholders differently may include ensuring the cooperation of the private holders, which would leave the government with a smaller stake.
The U.S. government struck a deal with Citigroup last week to convert a large portion of its preferred shares in Citi into common shares. The government will own about 36% of the New York bank.
On Friday, Citigroup said it would offer to exchange up to $52.5 billion of its existing preferred shares for common stock worth $3.25 each. In order to induce investors into exchanging preferred shares into common shares, the bank said it would suspend all dividends paid to common and preferred shares, with the exception of trust preferred securities.
-Contact: 201-938-5400

Warning on Hybrid PreferredStocks - Financials (Fitch)

PRESS RELEASE: Fitch On Bank Hybrid Capital In 2009



Fitch Ratings-London-04 February 2009: Fitch Ratings says that the risk of deferred interest payments on bank hybrid capital instruments (which share characteristics of debt and equity) has increased materially for the banks most under pressure in the current financial crisis, due to significantly lower operating earnings, or losses, combined with high levels of government support, according to a comment published today.

"Central to this matter is the question of the extent to which the government support that has flowed - and will, in Fitch's opinion, continue to flow - in the world's banking systems can be relied upon to extend to existing holders of deeply subordinated bank capital instruments," says Gerry Rawcliffe, Group Credit Officer in Fitch's Financial Institutions group.

Fitch does not believe investors should view such support as continuing endlessly. Absent evidence of a normalising of operating conditions, regulators may well exhibit some bias toward protecting taxpayer funds. This could include looking to put hybrids into deferral.
"In certain cases the investment risks faced by investors in these instruments is sufficiently material for Fitch to view them as not being of investment grade," says Rawcliffe

Fitch's hybrid capital rating criteria (July 2005) do not assume that government support would be forthcoming for these instruments, and that the key driver of hybrid capital ratings is the stand-alone strength of an institution, as expressed in its Individual Rating. Fitch believes that the current exceptional circumstances merit a conservative application of the existing criteria, especially given the uncertainty and opaqueness surrounding the regulatory considerations in respect of hybrid capital.

In response to the heightened risk of hybrid coupon deferral and, in extreme cases, outright principal loss, Fitch has already taken rating actions that have widened the number of notches between the Issuer Default Rating (IDR) and the rating assigned to the hybrid and preferred instruments for select issuers. Given that the deferral decision process potentially involves both regulatory and political considerations, and the possibility that the situation regarding bank hybrid capital could change very quickly, Fitch expects to maintain downgraded hybrid capital instruments on Rating Watch Negative. For instruments with low investment grade ratings, the Rating Watch Negative indicates that a move into sub-investment grade is a real possibility.

Fitch regards a deferral on a hybrid instrument as non-performance from a ratings perspective. Deferral will lead to the assignment of instrument ratings consistent with non-performing obligations, typically in the low 'B' to 'CCC'- 'C' range. Loss expectations will be derived from a combination of the expected duration of the coupon deferral and the cumulative versus non-cumulative nature of the instrument.

The full comment, "Fitch Sees Elevated Risk of Bank Hybrid Captial Coupon Deferral in 2009", is available on the agency's subscription website, www.fitchresearch.com.

When the Sky Falls - Ben Stein in the NY Times

October 26, 2008
Everybody’s Business
You Don’t Always Know When the Sky Will Fall

By BEN STEIN
NOW, as the great Phil Rizzuto used to say, for “some high hops and short stops” — only not in sports, but in finance and life.

First, I get a certain amount of mail asking why I was unable to spot the stock market crash in advance, sell short and become rich. And why was I unable to foretell the future, so my readers could avoid losses and make money?

Well, I am just a person. I don’t have any magical powers to foresee the future. In this case, I did not foresee the catastrophic mistake, as I view it, by Treasury Secretary Henry M. Paulson Jr. to allow Lehman Brothers to fail. That failure left a gaping hole in the financial services industry, and blew away confidence that the Feds knew what they were doing.

Months ago, one of the greatest of American economists, Anna Jacobson Schwartz, who was co-author with the late Milton Friedman of “A Monetary History of the United States,” accurately said that American banks did not face a liquidity crisis, but that they might soon urgently face a solvency crisis. In other words, banks would have ample reserves to lend but might lack assurances that they could meet all their financial obligations if those loans went bad. She was right. In fact, bankers have had so many losses and faced so much uncertainty that they dared not lend, for fear of killing their banks with bad loans — so we have actually had a solvency crisis.

(By the way, it’s a disgrace that Mrs. Schwartz, a mainstay of economic insight since before World War II — as well as my late mother’s college roommate at Barnard — has not been a Nobel laureate. That hints at a dismal sexism in the dismal science.)

The solvency crisis exploded when, in mid-September, Mr. Paulson allowed Lehman Brothers to die a sudden death. I would never have believed that it could happen, which shows one of my many limitations as an economist and a human being. I assume that the future will be much like the past, but sometimes it isn’t.

After Lehman, I felt sure that the government would realize its mistake and issue blanket solvency guarantees to banks. But that didn’t happen, the stock market fell apart, credit went icy cold and the wheels started to come off the economy. This also took me by surprise.

The failure of government to limit the loss possibilities from credit-default swaps has also been a mystery to me. And credit-default swaps themselves are something of a mystery. They are derivative instruments that supposedly insure a bond or similar entity against default. In fact, they are a wager about the possibility of default of anything, and the potential payouts for the wagers that have been made are many times larger than the value of all the subprime mortgage bonds that ever were.

The need for the government to take action seemed so clear — and still seems so clear that I cannot believe a day passes without its happening. But the days pass, nothing happens, and I am proved wrong again. And I lose some of my life savings and it hurts.

Now let me move to another point: all of the recent misery, including the stock market’s plunge, the disasters at Fannie Mae and Freddie Mac, the loss of retirement savings. These did not happen out of the blue. The catastrophe of giving bonds ratings far higher than they deserved did not happen by chance. And endlessly rosy reports from banks and investment banks about their health did not result from a butterfly flapping its wings in China.

Human beings did these things. The harm to the American people and to the world has been substantial. There has been real pain here. Why is it taking so long to find out who did what and whether laws were broken? That’s what prosecutors are for.

And, closer to home, a talented makeup artist who works with me almost daily in my TV appearances asked what happened to people in a recession. (She is young.) I said that fear and insomnia happened to most people but that a few million would actually lose their jobs and millions more would lose income.

“What do they do?” she asked, looking worried.

“They find other work or live off their savings,” I said. “They certainly cut back on their spending.”

“What if they don’t have any savings?” she asked. “I don’t have any savings,” she said. “No one I know except you has any savings.” She looked extremely worried.

This is perhaps the main lesson of this whole experience. It is basic but still unlearned: human beings must have savings. This is not just a good idea. It’s the difference between life and death, terror and calm. So start saving right now, and don’t stop until you die.

FINALLY, I’ll turn to the oil companies. When crude was skyrocketing, the beautiful people wanted to beat Exxon Mobil, Chevron and BP into a pulp. Many people assumed that oil barons controlled prices, made “obscene” profits and made life difficult for ordinary citizens. But the price of oil has fallen by more than half from just a few months ago. Gasoline prices are at levels no one thought we would ever see again. Very expensive projects that the oil companies commenced, like extracting oil from tar sands in Canada, may now be major money losers.

What do you say, folks? Let’s acknowledge that we were a bit hasty. The oil companies are just corks bobbing up and down on the ocean of worldwide demand and supply, exactly as the oil companies said they were. They are not going to be starving, but they are clearly not the invincible demons that their enemies said they were. Now that we see how vulnerable they are, is there any reason to hit them with a surtax?

Will we ever learn that they are just dust in the wind, like the rest of us? Probably not.

Ben Stein is a lawyer, writer, actor and economist. E-mail: ebiz@nytimes.com.

The Lehman Legacy (from Financial Times)

The Lehman legacy: catalyst of the crisis
By Aline van Duyn, Deborah Brewster and Gillian Tett

Published: October 12 2008 19:26 | Last updated: October 12 2008 19:26



On September 15, Catherine Naud checked her Washington Mutual bank account before she began a 10-day road trip across Utah, Arizona and several other states. On her return to New York, Ms Naud, a scientist at Columbia University, logged on to her bank’s website. “I got a message that I was now a JPMorgan customer, that Washington Mutual no longer existed,” she says. “I was shocked.”

It is a reaction many other policymakers and investors would now echo – not just in relation to last month’s demise of WaMu, the largest US savings and loans association, but also to the wider financial crisis that is convulsing the global economy. After all, when the credit turmoil began just over a year ago, many bankers and policymakers maintained it would be over in a matter of months, since the losses could be easily “contained”.

While this view proved over-optimistic, a few months ago it did seem as if the worst of the financial panic might be ebbing away. More specifically, when Bear Stearns, a large US stockbroker, imploded back in March, some thought that might be the biggest upheaval the crisis would bring – not least because the markets rallied after Bear was acquired by JPMorgan Chase.

Instead, the sense of panic has escalated in the past few weeks, creating a fresh wave of bank failures. Consequently, as global leaders scramble to introduce emergency measures – including the prospect of governments taking direct stakes in banks – the question many non-bankers such as Ms Naud might ask is: why has all this become necessary? What has caused the resurgence in financial panic, in a manner that has apparently left global leaders so scared?

The catalyst arguably came four weeks ago on Monday, just as Ms Naud was setting off on her holiday. In the early hours of September 15, Lehman Brothers, the 158-year-old Wall Street institution, filed for bankruptcy. Despite round-the-clock talks with banks and investors over the preceding weekend, US financial authorities decided not to step in to prevent the collapse. “I never once considered it appropriate to put taxpayer money on the line in resolving Lehman Brothers,” Hank Paulson, Treasury secretary, said the day after Lehman’s demise.

Six months earlier, the Federal Reserve and the Treasury had stepped in to prevent the rival Bear Stearns from filing for bankruptcy. After that, officials came to take the view that dealers and investors had become well aware Wall Street banks were no safe bet. These hopes were misplaced. The Lehman bankruptcy set in train a series of damaging events in an unexpected quarter: the $3,500bn (£2,055bn, €2,590bn) US money market fund industry, used by banks and companies across the world for their short-term financing needs.

The day after the bankruptcy, the $62bn Reserve Primary Fund, the country’s oldest money market fund, posted this sombre statement on its website: “The value of the debt securities issued by Lehman Brothers Holdings (face value $785m) and held by the Primary Fund has been valued at zero effective as of 4pm New York time today.”


THE TRANSATLANTIC TUSSLE

“Horrendous.” The terse description by Christine Lagarde, French finance minister, of the decision to let Lehman fail is one echoed by many other European policy makers and investors.

A crucial question still baffling observers is why the US allowed the collapse. Did officials not foresee the consequences? Or were they just determined to make a policy point – or unable to prevent it?

In Europe some blame the decision on ideology, claiming that Hank Paulson, US Treasury secretary, refused to offer aid to avoid accusations of moral hazard. Others wonder if officials were overwhelmed by the speed of events.

US officials dismiss claims of ideology or complacency; they insist that the Federal Reserve was keenly aware that the broker’s collapse could spark chain reactions. However, Washington effectively ran out of options because events were moving so fast – and its hands were tied by a pernicious combination of UK and US laws.

This legal saga started on the Thursday before Lehman failed, when it became clear it was close to collapse. At that stage, the Fed believed that it could legally only extend support if this was either secured against quality assets, or if it was part of a deal to help a willing buyer.

In the subsequent case of AIG, the Fed decided that the insurer had plenty of good assets. But with Lehman, the Fed was horrified at the size of the hole in the bank’s books. The Fed and the Treasury decided they had no legal mandate to risk extending a loan without a buyer (a situation which, crucially, no longer applies since the $700bn bail-out package).

Bank of America initially expressed interest in Lehman – but when it saw the books it demanded so much support that officials balked. Focus turned to Barclays which, it was thought, could do a deal without support. And even though the UK bank later asked for aid, its request was modest enough that many US officials thought a deal could be done – until Sunday.

What changed all this was a transatlantic tussle. The Barclays deal could only work if Lehman’s trading positions were guaranteed when markets opened on Monday. Other Wall Street banks were unwilling to do this. While Barclays appeared willing to offer some pledge, it became clear that UK listing rules prevented it from offering this without getting shareholder approval – an impossible task at such short notice.

In desperation Mr Paulson, called his British counterpart, Alistair Darling, and other UK policymakers. But London refused to waive the rules. Some US officials suspect that British regulators were reluctant to let Barclays proceed; UK officials argue that tearing up listing rules would have created more confusion and fear. Since Lehman was American, they argued that the onus was on Washington to be creative, most notably by providing a temporary government guarantee.

Either way, these discussions took place at such a late stage that by Sunday afternoon Washington felt it had no choice but to let Lehman go.

This pushed the value of the assets in the fund to below their $1 per share face value. In other words, the fund had “broken the buck” – an event greatly feared by regulators and fund managers since the start of the credit crisis more than a year before. “Lehman’s bankruptcy was so significant because it led a fund to break the buck,” says Deborah Cunningham, chief investment officer at Federated Investors, one of the biggest money market investors. “Lehman would probably not have had more of an effect on markets than any other bank collapse if it had not been for this tag-on effect in the money markets.”

Money market funds’ popularity rested on their reputation for being almost as secure as bank deposits. Marketers of the funds had long emphasised that only one small fund had ever “broken the buck”, and that was 14 years before. The fear was that once one fund showed that investors could lose their principal, the damage to the industry would be severe.

These concerns proved well founded. As word of the Reserve Fund’s predicament spread, investors fled. By that weekend, more than $200bn had been pulled from money market funds, by both retail and institutional investors. When other short-term funds, such as prime funds, are included, the amount that was taken out of short-term investments quickly reached $400bn.

That shift brought the funds under heavy pressure to sell into an illiquid market, simply to ensure they had enough cash to pay investors withdrawing their money. For banks, heavily reliant on these investors for their funding needs, it created a spiral of liquidity crises. “It was the straw that broke the camel’s back,” says Joe Lynagh, a portfolio manager at T. Rowe Price, an investment company.

To assure retail investors, the Fed quickly lined up a liquidity facility for money market funds, allowing them to sell short-term debt backed by assets. However, that was not enough. Last week, the Fed started buying commercial paper in an attempt to break the impasse, but it was too late for some banks faced with billions of dollars of short-term funding needs and nowhere to raise the money.

“The impact of the investor pullback is borne most heavily by banks that are predominantly reliant on wholesale funding, a group that includes many European banks,” says Alex Roever, analyst at JPMorgan. “This investor pullback from the secured dollar bank commercial paper market is a contributing factor in the recent wave of liquidity issues at European banks.”

Should this have been foreseen? There were plenty of market indicators suggesting Lehman could default – mainly the soaring cost of insuring in the credit derivatives market against that eventuality. Yet most investors holding cash bonds did not appear to be mentally or practically prepared for a default.

“Prior to Lehman, there was an almost unshakable faith that the senior creditors and counterparties of large, systemically important financial institutions would not face the risk of outright default,” notes Neil McLeish, analyst at Morgan Stanley. “This confidence was built up ever since the failure of Continental Illinois (at the time the seventh largest US bank) in 1984, a failure in which bondholders were [fully paid out].”

For months, regulators including the Bank of England as well as the Fed had been putting pressure on banks to prepare for a default by a big market participant. The risk of a bank collapsing under the weight of overvalued and illiquid mortgage backed securities and a funding crisis had been demonstrated by the fate of Bear Stearns.

With Wall Street’s big broker-dealers involved in millions of derivatives trades, which feature in contracts from basic hedges on oil prices to complex structured debt securities, regulators were worried that the unravelling of such trades could be the downfall of the financial system.

Yet it now seems that, with all the emphasis on limiting the fallout on markets such as derivatives, a more straightforward consequence of a bankruptcy was overlooked: the pain it imposes on creditors.

First, Lehman hurt its bondholders. Lehman was a very large borrower, with around $130bn in debt outstanding. The expected losses on these bonds spiralled swiftly. In early September, they were trading at 95 cents on the dollar but by the Monday after bankruptcy had fallen to around 40 cents – and last week to 10 cents. Its short-term debt – as the Primary Reserve Fund found – was essentially worthless.

Second, investors such as hedge funds, which had money or assets held at Lehman, were hurt, too. Hedge funds that were using Lehman as a prime broker found that their collateral was frozen as its complicated bankruptcy process got under way – which in turn effectively left many of these funds frozen as well.

“A lot of people did not understand the implications of Lehman’s default,” says a chief executive of a large hedge fund. “Whether it is a misimpression or bad assumptions, the fact is, as a hedge fund with balances at Lehman, you lost access to those balances when it went bankrupt. Hedge funds have joined the list of unsecured creditors and many were not prepared for this.”

To make matters worse, the fragmented legal infrastructure in Europe, combined with differences in bankruptcy laws with the US, left even expert lawyers uncertain about exactly how a bankruptcy might proceed. Many experts predict it could take years to unwind Lehman, the world’s biggest ever corporate bankruptcy case.

Hedge funds, like money market funds, have therefore shied away from an exposure to bank debt. “People are rightly a lot more conservative in their assumptions about credit risk,” says Ms Cunningham.

“After the failure of Lehman Brothers ... institutional investors have said that they would prefer to stay home,” says Bill Gross of Pimco, the bond fund manager. “Instead of risking their money [it] goes into that figurative mattress.”

Getting the money out of the mattress and back as a source of financing for banks is one of the biggest tasks now facing politicians. “With financial markets worldwide facing growing turmoil, internationally coherent and decisive policy measures will be required to restore confidence in the global financial system,” the International Monetary Fund said last week, warning that a failure to do so would be “costly for the real economy”.

Policymakers will on Monday be watching the markets closely in the hope that the weekend meetings on both sides of the Atlantic aimed at tackling the crisis will start to restore confidence in the global financial system.

But with so many professional investors having run for the exits, the key now is also to ensure people like Ms Naud do not become so worried that they take their money out of their newly renamed banks and place it under a rather more literal mattress.

Copyright The Financial Times Limited 2008

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Information for AIG Policy Holders (from www.aigag.com)

Q. American International Group, Inc.’s (AIG) CEO announced a plan for the company’s future, which includes the sale of the AIG American General insurers.
Why did AIG make the decision to sell its domestic life insurance business?A. Quite simply, because the domestic life insurance business is valuable. The proceeds from a sale of these assets can be used toward paying off the two-year $85 billion secured credit facility issued by the Federal Reserve Bank in September 2008 to help AIG with its short-term liquidity needs.

Q. What does a sale mean for policyholders?
A. First and foremost, we want to assure you that your policies are safe and secure. The insurance policies written by one of our insurers are the direct obligations of that underwriting company -- not AIG or any prospective buyer. The sale of an insurer does not change its obligations to its policyholders.
Our commitment to customer service remains the same, and we continue to strive to exceed your expectations in everything we do. Our customer service centers are available to assist you with questions or policy maintenance issues.

Q. Can you tell me more about how policies are protected?
A. Insurance is a highly regulated industry. All insurance companies doing business in the United States are regulated by state law, and required to maintain enough capital and surplus to satisfy their obligations to their policyholders. The type and quantity of investments in which insurance companies may invest surplus capital is also limited by state law. Although various companies owned by AIG are part of a larger insurance holding company system – including AIG American General insurers – each company is individually responsible for the liabilities associated with the business that it sells. In addition, each insurer is individually regulated by its state of domicile for compliance and financial solvency independent of its parent or affiliates. This includes ongoing financial reporting to the regulator and undergoing periodic financial examination.
In accordance with state insurance requirements and investment guidelines, an insurer’s general account is primarily invested in high-quality investment grade fixed income securities (bonds). The investment objective of the general account is to optimize yield, adjusting for credit risk, liquidity and liability characteristics.
State insurance regulations are substantial and are designed to preserve and enhance the solvency of the general account and to assure that the contractual obligations to our policyholders are fulfilled. These regulations, along with the conservative investment requirements, help to safeguard policyholders.
It is important to note that the guarantees related to individual AIG American General insurers life policies and annuity contracts are backed by the general account of the respective issuing companies. These general accounts support only the obligations of AIG American General life insurance companies and are not obligated to support any other AIG businesses.
If you would like to see what the state insurance regulators and the National Association of Insurance Commissioners have to say on this matter, please go to www.aigag.com and click on the main banner for more information.

For more detailed information on specific insurer ratings visit www.AIGAG.com/ratings.

Q. Someone has approached
me about surrendering my
AIG American General insurer policy or annuity contract.
What should I do?
A. Please be sure you have all the facts before making a decision. Visit www.aigag.com for more information.
Q. Who are AIG American General’s re-insurers?
A. AIG American General companies utilize many re-insurers. The major companies are Swiss Re, RGA Reinsurance, Transamerica Reinsurance, Munich Re, and Gen Re.
Q. Are policies insured under
the FDIC?
A. No. The FDIC insures bank accounts – checking, savings, trust, certificates of deposit (CDs), IRA retirement accounts held at the bank and also money market deposit accounts. All of these bank accounts generally are insured by the FDIC up to the legal limit of $100,000.
The FDIC does not insure products such as mutual funds, annuities, life insurance policies, stocks and bonds.
AIG American General, www.aigag.com, is the marketing name for the insurance companies and affiliates of American International Group, Inc. (AIG), which comprise AIG’s Domestic Life Insurance Operations. Information regarding American International Group, Inc. (“AIG”) or AIG American General presented in this brochure is for informational purposes only and represents combined statistical information of the member companies of AIG or AIG American General. Neither AIG nor AIG American General underwrites any insurance policy described within this brochure. The licensed insurance company underwriting the product is solely responsible for its own financial condition and its contractual obligations.

Business Week on Getting Out Now

Investing October 2, 2008, 5:00PM EST

Why You Shouldn't Bail on Stocks Now
Today's bunker mentality has the stock market looking cheaper relative to Treasury bonds than it has since 1978
by Roben Farzad and Tara Kalwarski

To many panicky investors, it feels like financial Armageddon. But decades worth of investing precedent suggest otherwise. And investors who bail on stocks now might come to regret it.

Make no mistake: The freeze in the credit markets is frightening. "People don't have any experience with this kind of thing happening," says Martin Barnes, managing editor of Bank Credit Analyst. "People can't look back at previous episodes and take comfort and say, 'I've been here before.'" And so, almost by default, we are given to extreme bearishness—invoking the Great Depression and Japan's lost decade is all the rage. "Sure, these things are possible," says Barnes. "But not likely."

Sept. 29's 778-point drop on the Dow doesn't even rank among the top 10 in percentage terms—it was 7%, compared with 22.6% in 1987. Yet the very system that rewarded risk taking for years is now holed up in the closet under a security blanket. Hedge fund traders, banks, individual investors, small businesses—you name it—have been piling into ultrasafe short-term Treasuries, which now yield close to 0%.

We've felt the sky was falling before. Recall that one-day panic on Oct. 19, 1987, or the savings and loan crisis of the early 1990s, or the Asian meltdown in 1997, when Koreans lined up on the streets of Seoul to donate jewelry to shore up their currency. The markets took big hits in all of those cases, but ultimately bounced back. By the beginning of 1989, for example, the Dow had returned to its pre-crash levels.

The smart money knows that banking crises are par for the course. According to the International Monetary Fund, the past quarter century has seen at least 124 banking crises around the world. "It is important to recognize that this isn't the first time the U.S. financial system has experienced—and survived—a financial crisis," says Eric Bjorgen of Minneapolis-based Leuthold Group, an investment research firm.

BARGAIN INTERNATIONAL STOCKS
The time to panic, if there ever was one, was a year ago, when stocks were hitting their highs—not now, when they are hitting their lows. Today's extreme bunker mentality has the stock market looking cheaper relative to Treasury bonds than it has since 1978.

That's precisely the environment in which savvy, patient investors make their fortunes. Case in point: legendary cheapskate Marty Whitman of Third Avenue Funds, an octogenarian who lives for volatile times like these. "Right now is a time when deep value investors excel," he says. "People like myself got rich in '74 and '87, unlike those who tried to pick bottoms." The common stocks of companies that need access to capital markets are "toast," he says. "The common stocks of companies that can finance themselves have never been more attractive."

Whitman says that many international shares in particular have never looked so cheap: "There are unbelievable bargains. It's terrific for us." Stocks he thinks are especially cheap include Hong Kong-based real estate investment holding companies, including Cheung Kong Holdings, Hang Lung Group, Henderson Land Development, and Wharf Holdings.

Even Rob Arnott, chairman of investment advisory firm Research Affiliates and a bear long before it became fashionable, says the current panic "is creating some really spectacular opportunities for those who are nimble and weren't overly aggressive." The reaction in financial-services stocks is overdone, he says. "We have an anti-bubble—when a sector of the market falls to levels that no plausible scenario would justify." Arnott also sees "great bargains" in convertible bonds and says the debt of "many emerging markets is more creditworthy than U.S. Treasuries". The broad U.S. stock market, however, has a chance of falling further as consumers begin tightening purse strings, he says. Arnott thinks investors should lower their long-term expectations of stock returns to about 6%.

Of course, bargain-hunting always sounds great in theory. But people have shown time and again a predilection to sell low—just as they tend to buy high. Princeton economics professor Burton Malkiel, author of the best-seller A Random Walk Down Wall Street, notes how much hot money piled into equity funds in early 2000, just as the market was about to peak. Then, as stocks were nearing the bottom in the third quarter of 2002, that money fled in droves. The timing couldn't have been worse. "One of the things we know about individual decisions in markets is that people generally do the wrong thing," he says. "I know money is coming out now. I don't know whether this is the bottom. But taking money out now, when things look horrible, is almost always the wrong thing to do."

A Good TIme to Be Careful - some tips from Motley Fool

Why You Should Fear the Future
http://www.fool.com/investing/value/2008/10/03/why-you-should-fear-the-future.aspx

Richard Gibbons
October 3, 2008


Remember when everyone was quoting Baron Rothschild, saying, "Buy when blood is in the streets"? Well, this is it. We're in the Wall Street equivalent of Kill Bill meets Jurassic Park. It looks like it's all over but the spurting.

Warren Buffett knows how to play this game. He's buying, and he says that in five or 10 years, "we'll look back on this period and we'll see that you could have made some extraordinary buys."

But when the market drops 9% in a day, it's hard to react logically, like Buffett -- and not, say, curl up into a quivering, sniffling ball. Here are five ways to help you achieve your goal.

1. Be afraid -- be very afraid
Instead of looking at how much you can make by buying a stock, examine all the ways that you can lose. Bruce Berkowitz, who manages the Fairholme Fund, swears by this strategy. He tries to think of every possible scenario that can kill a company -- and if he can't find any, then he'll buy.

Even ridiculously paranoid scenarios deserve consideration. A year ago, it was inconceivable that a handful of the nation's biggest banks would go out of business and that credit markets would essentially freeze. But just because it was inconceivable, that doesn't mean it couldn't happen -- and it did.

In this environment, where no one is lending, you should be especially paranoid about debt covenants and maturing debt. Even if a company is profitable, a large debt maturity that it can't roll over could drive it into bankruptcy. With economic conditions as they are, companies are making moves they wouldn't have considered if the market were better, like General Motors (NYSE: GM) drawing down its credit lines and issuing equity to pay off debt.

2. Avoid black boxes
Be suspicious of companies you don't understand or whose financials are opaque. In fact, unless you understand the business model, don't buy it at all.

Sure, Buffett has invested in Goldman Sachs (NYSE: GS), and it will probably turn out like many other Buffett investments. But unless you fully understand Goldman's investment portfolio -- which seems almost impossible right now -- it's difficult to be confident that the business is rock-solid.

The same sort of reasoning applies to retail banks such as Citigroup (NYSE: C) and bond insurers such as Ambac (NYSE: ABK). If you can't assess the risk, you can't be confident in the investment -- especially when blood is flowing like water.

3. Invest only money that you don't need soon
Assume that the near-term market will remain volatile -- even after it smoothes out. That approach will prevent you from investing money you need in the near term, and thus protect you from losses you can't sustain.

Think of it this way: Suppose that you do find one of Buffett's extraordinary buys and are brave enough to pick it up. Then you're set, right? Well, not entirely. You can still lose if you're forced to sell. Remember, Buffett isn't saying these stocks will become 10-baggers tomorrow, or even next year. He's talking about five or 10 years.

So when you buy, don't buy with money you'll need soon, and definitely don't use margin. If you're forced to sell at a bad time because of a margin call, then you could lose money even if you've successfully identified a stock that goes on to become a 10-bagger.

For instance, immediately after the 9/11 tragedy, you could have bought Boyd (NYSE: BYD) at a cheap $5 per share. But a few days later, it traded at $3.50. If a margin call forced you to sell at that price, then you would have missed the stock rising above $50 over the subsequent five years. Ouch.

4. Ease in
And all of that means you should be suspicious of how your chosen investments will perform initially. When the market's this volatile, don't put all of your money into a stock all at once. Instead, put a portion in when you see an attractive opportunity, but save some cash to buy more if it falls.

Some people buy in thirds on the way down so that they have two chances to average down without becoming overexposed to the stock. I recommend buying enough that you'll be happy when your stock goes up, but little enough that you'll also be happy if it falls significantly and you can buy more. I originally purchased Legg Mason (NYSE: LM) in the mid-$60s. The descent hasn't been fun, but it's easier to handle knowing that I can buy shares at an even lower price now. And I have.

5. Buy at a discount
Of course, the whole reason you're trying to buy when there is blood on the streets is that that's when stocks are trading at big discounts to their fair value. Those discounts can propel your portfolio to extraordinary returns -- the bigger the discount, the bigger the potential return. Plus, a good understanding of a stock's intrinsic value can give you the confidence to hold in today's volatile market.

But make sure you're buying shares that are actually cheap. Many companies are trading at prices far lower than they were a year ago -- but that doesn't mean they're cheap. Fannie Mae (NYSE: FNM) had fallen a lot by mid-August, but it was still expensive.

The Foolish bottom line
There's blood in the streets, so if you can handle the volatility, it really is a great time to invest -- but invest suspiciously and fearfully. It will do your portfolio good if you do.

The Long View - Ask a Seasoned Investor (from Portfolio magazine)

Talking to Chuck
by Portfolio Staff October 2008 Issue

Charles Schwab says investing is boring. That's why the practice has become a lost art—and a national emergency.


At age 71, Charles Schwab has seen his share of stock market slumps. In 2003, he stepped down as C.E.O. of the Charles Schwab Corp., the San Francisco-based brokerage house he’d founded in 1973, but returned to his role in 2004, when the company was getting pounded during a down cycle. Since then, not only has the company gotten back on track but its bottom line seems to be benefiting from the current turmoil as well. Schwab himself is almost evangelical about the importance of investing—despite an economic slump he says will still take months to run its course.


Where are we in this down cycle?The market probably hasn’t reached the bottom yet. I would expect that to happen between now and just past the election. The overall economic slowdown probably won’t subside until sometime in 2009. But that’s okay. Markets move in anticipation of economic moves. You can see the market beginning to reach its bottom—it’s going past the threshold. There’s still more ugly news coming out, I’m sure.

How will we know when we’ve hit the bottom?
That’s the challenge. You don’t know until you see it in the rearview mirror. There’s no way to know even when it’s arrived. That’s all the more reason successful investors have the confidence to stick to their plan and ride through the ups and downs—and even to invest when there is the possibility of a drop in the short term. It’s the long-term trend they’re after.

What do you expect will be the lag time between when the market turns and when the economy responds?
I expect it’s probably about six months. That would be consistent with other periods in the past.

Your company talks to thousands of investors every day. How scared are they?
They sound scared every time we have a market that’s going nowhere. It’s not pretty. Most people you meet live for today. Thinking and planning for tomorrow is almost impossible. Investing is such an abstract notion that most people really have a tough time grasping it until they’re way
far gone: “My God, I’ve got to save for my future—what in the world am I going to do?”

So you advise people to invest in a market like this one?
This is a fantastic time, frankly, for people who are just starting to invest. Prices are low.
In investing, you’ve got to have some confidence that stock market cycles will be no different in the future than they have been in the past. The market will recover.

Yet investors are reluctant.
We want to enjoy everything we see advertised, and there’s nothing about saving or investing that gets our juices going. Investing is a very abstruse, intangible concept. It’s what economists talk about. How many people have taken a class in economics? The literacy around this concept is woefully low, but it’s amazing how essential this boring concept is. We say the same thing about good health: You don’t really become aware of it until you’re sick. Then you realize there really is some limitation on the strength of your body. Being a saver always means the same thing: spending less than you earn. That never changes.

How did we end up here—with saving and investing being such a low national priority?When I was a kid, we were coming out of the Great Depression and World War II. All you talked about in families was the lack of money and the desire to save and make life better. The past 20 years have been bountiful, but we’re moving through a big crack now, from the subprime thing to everything else. I’d be willing to bet in five years’ time, maybe 10 years, the pendulum will swing back to a much more conscientious rate of personal savings. What we’re going through now is cathartic, but it’s very painful. One of the key things to understand in a free society, which I wish we didn’t have to face, is that there are cycles. It never goes in a straight line. It’s a fundamental fact that market systems go up and down. Life goes up and down. And that’s okay.
I’ve heard you call for a national effort to boost the savings and investment rate. Why is that?
We have a huge national problem. Our savings rate is zero or below zero. It’s a disgrace.

We have to have a national program to launch the savings rate to 10 percent. It almost has to be as important as going to the moon.

You’ve contributed money to John McCain. Does he support such an effort?
This isn’t a political thing. We’ve just got to get some shock component to this. I haven’t found a good way to awaken people at an earlier age to the fact that they have to save and invest.

What percentage of the ­population does what you suggest?
Between 2 and 5 percent of the population invests as it should. It’s shocking to meet people who simply haven’t put aside anything for the future, and they’re now approaching 50. You tell them it’s never too late to start, but, man, deep in your soul, you say, “What has this person been doing?”

Where should people begin if they’ve never invested before?
New investors should be assembling a diversified portfolio. An investor with a smartly diversified portfolio of stocks should expect something like a 10 to 11 percent return per annum. Your money should double every seven years.

All of a new investor’s money should go into stocks?
If you’re younger, it should all be stocks. If you’re over, say, 55, your portfolio should be more diversified—some international stocks, small-cap stocks, low-cost mutual funds, fixed-income investments, some money-market funds—and you should expect an annual return of 8 percent.

What’s an easy rule of thumb for how much to invest, as a percentage of income?
It depends on your age, how much you’ve already invested, and other factors. But a good rule of thumb, if you’re just starting out working, is to put aside 10 percent of your income each year and stick with that over your working life. If you wait until later in life, you’ll need to increase that considerably. At age 62, your life expectancy might be 30 more years.

How much should most investors be actively trading? How often should they rebalance their portfolios?
Certainly some investors trade very actively. There’s no formula for the right number of trades
in their case. But our average client trades only a few times a year. For most of us, the rebalancing is
the important part, and that should be looked at on an annual basis—but also if major changes
in the market occur or if your objectives change. With a portfolio of mutual funds, which is the best way to get diversification, the process is much simpler.

And you don’t advise going it alone.
No, you’ve got to get some professional help. No matter how much I have looked at this issue, I have to say with a great amount of discouragement that not more than 2 to 3 percent of our population wants to think about any of this. The rest of us need good, ethical, cost-effective assistance.
Why does your company do well when the market is down?
We’re a well-established, well-regarded company. People gravitate to us. At a time when people are very worried about the news on the front page and various economic crises, that tends to make them more fearful.

What’s the biggest miscon­ception about investing?
Many people confuse investing with big short-term hits, “the next great thing.” That’s not investing; it’s gambling. Bad advice feeds on that, by trying to sell us the next great thing. It’s okay if investing is a little dull, as long as it’s doing what it’s supposed to be doing, which is to help you build financial independence.

What should people be investing in?
I don’t believe that sector investing—picking investments by industry—is a wise move for the average person. If you were smart enough to move into oil, will you be smart enough to move out? Nobody’s really that smart.

Look, I’m the biggest advocate of entrepreneurial people making speculative moves. But you don’t want to be making those moves with your investment.

So if I call one of your advisers and ask which companies to invest in, they won’t give me names?
They’d better not. They’ll encourage you to have five to 10 sectors in your portfolio. When you buy a great index fund, that happens anyway.

You’ve been consistent about the need to stay the course, even in down cycles. In a market like this, should investors do anything different at all?
There’s no harm in taking the opportunity to think about whether your portfolio is structured the right way. If it is, and it doesn’t need rebalancing, it’s not a time to be making big changes. But again, down markets are an opportunity to invest at a discount. That’s hard for most of us to do, because the chances are good that we could go further downward. And that’s a tough emotional ride.

What’s the best piece of investing advice you ever got?
Start saving today and start investing tomorrow.

And the worst?
You should get out of the markets now.