HJ

Thanks for sharing. Great job, Keith!

Bank loans these days are typically structured with LIBOR floors of 0.75% - 1%, so the loan coupon is max(LIBOR, LIBOR floor) + spread. For the first couple of rate rises, your loan coupon don't change. After LIBOR goes through the floor, your loan coupon then adjusts in accordance with LIBOR. BDC's stand for Business Development Companies. Basically a tax structure, similar to REITs, except they make loans to middle market companies, sometimes subordinated loans. In general these taker on greater credit risk than the "broadly syndicated loans" in these bank loan funds. They do yield more, and a lot of BDC's also invest in CLO equities. Their dividend is supposed to float, as most of their assets are floating rate based (also subject to LIBOR floor issue), but the manager will probably manage the actual dividend, so relationship between LIBOR and dividend yield is probably not 1:1.

They are mostly bank loan funds. Closed end funds all have a bit of leverage, call it 30%, but higher expense ratios, generically 2% +/-, they mostly trade at a slightly discount to compensate for that, also tend to have a small allocation to HY bonds. Liquidity is suspect, daily transaction dollar volume of a couple million, maybe more for the larger ones. Greater than that liquidity needs you need to potentially deal with higher discounts. The combination gets you to 6-7% dividend yield. Alternative is the ETF's, Invesco runs BKLN (Bank Loan), the biggest. Blackstone runs one for the Spider family, SRLN (senior loan). They generically have lower expense ratio, less than 1%, but no leverage. Less discount/premium issues to deal with, and can accommodate large sized liquidity needs. Then there are some open ended unlevered ones out there you can research, mostly retail mutual fund shops run those. Fidelity, Oppenheimer, etc. all have a version of these. They have expense ratio similar to, maybe a bit higher than the ETF's. Without leverage, the current dividend tend to be lower, 4-5%. Beware that most bank loans these days have LIBOR floors, so they don't really get the benefit of the first 75-100 bps of rate hike, if that's what you are gaming for. They will still be lower volatility than other fixed income alternatives. Asset class is quite homogeneous, not sure management adds that much. You are basically paying fees for access to the asset class. If you want to be more venturesome, you can try for higher leveraged / higher fee versions, CLO equity funds like OXLC, ECC (generically 10x leverage), but you pay fee on fee (fee to the manager, call it 40-50 bps on portfolio to manage the CLO (which is 4%-5% on your 10x levered equity), and fee to the closed end funds). The behavior of the asset changes as more and more leverage is added on to it. Alternatively go for the deeper credit versions, which are essentially the BDC's.

Inability for most active manager, value or otherwise, to outperform passive index over long enough horizon. Market is more efficient than most active managers would like to believe. What visually looks like value based on whatever metric, P/B, P/E, EV/EBITDA, etc., may well be simply higher risk.

There are certain business lines, (mostly investment banking businesses) where large banks are significantly more advantaged. But that's the business line that's most in question these days. Going back to the late 90's, the narrative is quite different about whether commercial banking or investment banking is the better business to be in. Today, everybody can't run away from IB fast enough.

I have long ago decided that I don't have a good handle on the Chinese market. I just thought these pictures are good for a chuckle. Don't know if you paid attention, but in the second picture, there is a Buffet picture. The Chinese next to the picture says the "Buffet Analytical System". And to the left of the picture, it says "100RMB, Understand it in one minute, Learn it in one minute".

http://photos.caixin.com/2015-06-08/100816899.html http://photos.caixin.com/2015-06-08/100816899_4.html Figure this topic is as good a place to post these as any.

At the enterprise wide level, there is a concept called "deposit beta" to measure the sensitivity of the rates banks pay on deposit vs. Fed Funds rate. in fact it's embedded in all the net interest margin disclosures in the K's of the financials. It's virtually impossible to disaggregate this information from typical statement of "in a parallel shift of 100 bps, our net interest income will increase/decrease by..". But for historical rules of thumbs, I've see people use something like 75% for the "super regionals", and as low as 60% for some of the more sticky deposit bases. But this is at the enterprise level, not just on demand deposits. It would imply something significantly lower for just the demand deposits. Backward looking number can be derived through study of the historical NIM disclosure in the K's. Things may be quite different in this cycle, as banks will be in general a lot less worried about the money market funds, so deposit beta arguably all shock to the downside, with banks passing through significantly less of the rate increases to depositors. In fact I would speculate for the first 25 bps, the banks will pass through virtually none of it. That's the reason they have been rallying every time people speculates that we are closer to that first rate hike.

Storage is THE PROBLEM to solve. But the interesting thing is it's exactly the function that fossil fuel does so well. Your body stores energy in the form of body fat. Some of the properties of oil are that it's highly compact in energy content, one drop contains a lot, it's liquid, so easy to transport. It replaces a previous generation of nature's battery, coal, where these properties are of greater importance. I do believe it's in the interest of humanity to solve the energy problem. But it's clearly debatable as to how the government should support this effort. Acting as if the government, out of all entities, already know what the future is supposed to be, is questionable at best..

These guys may be biased, but pre friends who live there, it is certainly true that German retail electricity prices are multiples elsewhere. http://instituteforenergyresearch.org/analysis/germanys-electricity-market-balance-must-pay-flexible-back-power/

The assumption is this will all be through cell phone, or whatever mobile device you carry that has sufficient computing power to facilitate processing at the backend. While the technological aspect of this whole discussion is interesting, the business aspect of it is perhaps more important, and your question kind of gets to it. How did we end up with the current payment system for all the various transactions in the society? With a mix of cash, card, mobile, Western Union, etc at the consumer level; through this whole DTC / Euroclear system in securities transactions, and ACH / bank wires, etc in other commercial transactions. Why was Paypal successful, for example, what purpose did it serve? Why does it seem like it's run to its limit, or maybe it hasn't? Seem to me it's invariably a combination of convenience, security considerations vs. cost, and ultimately, a trust factor which the banks inevitably underwrite at the back end. Most innovations so far (PayPal, ApplePay, etc) have chosen to ride the existing rails, and innovate on the edge, which seems to me, to be very well considered decisions.

One thing to think about is the fact that V and MA came to their current business form in unconventional ways. They were essentially cooperatives operated by the banks, and were able to leverage off the massive distribution power of the banks to make their services and products almost ubiquitous to the society, even though Diners Club, and then American Express had much earlier starts. Most normal businesses aren't built this way. In a way, it's kind of the triumph of the bank distribution power over alternatives. I would venture to guess that unless bitcoin gets the banks to be on its side, the moats of V and MA are quite secure.

Talks like this does make you feel like Google is a different sort of place. Thanks for sharing.

Evidence is anecdotal. But a lot of these activities are centered around the idea of synergy, aka job cuts. The hope is capital created this way may find its way into creating more productive activity. Nobody really tabulates statistics in this fashion, but the creative destruction process works in mysterious ways. On the margin, he could be correct.

Transcript of a talk he gave. http://images.businessweek.com/bloomberg/pdfs/BN_0850499D_041015_19334.pdf

The participants in this business are not just the lenders, but also the borrowers. And what I meant by the business molding the behavior of all participants is that the behavior of both groups mutually reinforce each other. The lenders behave a certain way because the borrowers behave a certain way, and vice versa. Reality is this becomes somewhat of a percentage issue. If only a handful of loan originators had some transgression in their behavior, I think most people would be willing to look beyond the couple of bad apples, and not blame the institutions. What makes this a lot more objectionable is when the percent of time this occurs is more than trivial. And when you deal with certain group of borrowers, this is exactly what happens and likely unavoidable. So what would you rather have at that point? No lending to that group at all? The former loan brokers who originate these loans will just transform into landlords, taking out the low interest loans, (which may or may not benefit from government policy subsidy at that time), and charge a rent equivalent of the 12% or whatever they would have charged on the loan as rent. Same problem will come with a different flavor. With few people having ownership interest in their own home, a community more easily deteriorates into a slum worse than the generic trailer parks. I think all of us feel an instinctive discomfort when reading about abusive behaviors, I just don't know the solutions to this is simply outlawing certain things. Most social experiments carry lots of unintended consequences.

In many ways this goes right to the question of whether sub-prime financing should exist at all. When you are dealing with a certain tier of borrower or consumer, some of the debt collection tactics or lending terms are almost unavoidable, because if the lender doesn't behave that way, he will be out of business in no time. 12% interest rate actually implies a population that's not quite that terrible, with default rate maybe in the low teens. I'm sure you can dig up many sympathetic cases against a company that's involved in this business for as long as they have. Also note that this came out not long after Buffet said on TV that "Elizabeth Warren would be more effective if she's less angry", a perfectly rational statement. From a policy perspective though, it's a more serious question. If you outlaw this sort of behavior, sub-prime financing go completely underground. These will show up as the same population that's abused by their landlords, or some local kin pin. Is this a more desirable outcome? To think that you can lend and service this population in the same way you do an American Express customer is too naive. I think Buffet stepped in this investment thinking he can be part of a better industry in the aftermath of the manufactured housing wipe out in the late 90's and early part of 2000's. But the nature of the business is such that it molds the behavior of all the participants and absorbs them, rather than the other way around. The way Elizabeth Warren's crowd want it, the only entity that can and will lend to this population becomes the government. And maybe that is the right solution for those moral purists. But I'm not sure it's the outcome that maximizes benefit to the society. But then again, efficiency was never the purpose of the purists. http://www.bloomberg.com/news/articles/2014-04-30/freddie-mac-to-start-filling-trailer-park-void-buffett-laments

Anther parallel can be found in FAST gross margin, way above distributors of other products. 10 points higher even compared with thier peer like a GWW. But GWW turns over their inventory more than FAST, all in a significantly less consolidated space. Convenience, a locked in client base, availability....

I agree with thepupil. The standard asset/liability sensitivity analysis doesn't lead to the conclusion that Prime/LIBOR spread, and therefore NIM, currently at historical wides, should be even wider in a rising rate environment. The statement that current LIBOR is negative out to 2 month is also not correct. USD LIBOR is positive across the curve. Otherwise, I happen to like the credit cad business a lot, in all its shapes and forms. According to Paul Volcker, "the single most useful financial innovation".

Not sure I understand why you believe extreme rising interest rates is beneficial to AXP. The economics of heavy spenders who pay off in full every month should be on the margin negative in that environment, because AXP has to front all the spending to merchants without getting paid any interest from the consumers?

http://www.bloomberg.com/news/articles/2015-03-12/billionaire-flies-on-amex-points-to-pay-45-million-for-artwork He must have earned a bit more than just a couple of plane tickets. But most of these guys probably don't fully redeem their points, especially if they have their private planes. I'm not very familiar with art auctions, but curious what percentage of transaction at Christies or Sothebys is done with credit cards. I did try to buy a car once on credit card, but the dealer wouldn't take it. He didn't want to pay 2% out of his margin to Amex,

Sure, PE is one way to think about it, they literally borrow money to buy stocks for a living, and plenty of one percenters came out of the process, granted that wealth was not well distributed across the society in this form. But I guess I think of leverage quite broadly. The operators of the cable / satellite business in the early days, for example, are in fact quite reckless with leverage. Same goes for the shale oil drillers of today, Las Vegas casino builders of yesterday, Ted Turner, the list goes on and on. The nature of the market economy makes it such that the good ones all compete very hard, and understand how to use financial leverage very well. I think that the money management industry caters to people and institutions who have plenty of money. The overwhelming desire to not lose it, or for that matter, the prudent man standard does a great job of ingraining the fear of leverage into people's psyche. But in reality, much of the new wealth of our society is created by people who embrace leverage rather than shy away from it.

I didn't mean to be argumentative. But certainly as it applies to my immediate surroundings (and it's a formerly well paid Wall Street fixed income crowd), I feel we were all so jaded with the financing process that we have plenty of "fearful when others are greedy", no where near enough of "greedy when others are fearful". Way too many errors of omission, with the artificial self imposed goal of zero error of commission. There is no one strategy that fits everybody's circumstance, but I felt there need to be some balance to the discussion rather than a one sided "don't borrow to buy stocks". Of course borrowing with mark to market triggers need to be done with extra caution. But people shouldn't just sit back and admire how Valeant became a 10 bagger in 5 years while failing to acknowledge the role leverage played in the whole wealth creation process. Deciding how to borrow, when to borrow and what terms to borrow on to acquire an asset is every bit as important as analyzing and understanding fundamental operating drivers of that asset. Even in the personal finance context, you can chose to be leveraged in a deep in the money call, for example. The public common equity world is almost too efficient to squeeze out any meaningful outperformance over time.

Make sense. Hope it's a negative yielder.

Isn't it also true that lots of people attribute their success to their business acumen and operating expertise, when leverage is an integral part of their success? (Read private equity shops, commercial real estate developers, cable company operators?)