Lee Kuan Yew is Full Of Crap

Lee Kuan Yew is all over the news today, talking about GIC's 25% loss. In particular, he has been defending GIC's investments in the banks. I've written extensively about these investments, but MM Lee's latest attempts and defending GIC are some of the crappiest shit I've seen in a while.

Damn it - I'm just absolutely fed up with Lee's crap. For goodness sake already, just own up and admit that GIC did not have a clue.

MM Lee was quoted today in the Business Times, saying:

'We became cash-rich and when the market fell, we went into UBS and Citi,' he said. 'But we went in too early. That's part of the ride.'

...

'How could we have known this was the extent of the damage? You look at all the big-name banks - they have gone down, misjudged the situation, ruined their careers,' Mr Lee said.

Here's the octogenerian politician, trying to wriggle his way out by claiming that GIC could not have known the extent of the damage. He blames the big-name bankers for ruining their careers, and says its all "part of the ride".

Well, thats a bucketload of bullcrap.

You want to know how you could have "known the extent of the damage", Mr Lee?? I'll Tell You HOW!!!

GIC, UBS & Jim Rogers

Back on 10th December 2007, the following was reported on Channel News Asia regarding GIC's investment in UBS.

The Government of Singapore Investment Corp (GIC) is injecting 11 million Swiss francs, or nearly US$10 billion, into the troubled Swiss banking giant UBS.

This will give GIC an almost 9 percent stake in UBS.

The deal comes as UBS announced that it was making further multi-billion dollar writedowns for its US sub-prime exposure.

A few months later, on March 5th, 2008, the following was reported on many news sources, including reuters, about Jim Rogers' comments that Singapore was going to lose money on its investments in investment banks. (For those who don't know, Jim Rogers is one of the most successful investors of all time, and partnered George Soros when the two ran their Quantum Fund)

"It grieves me to see what Singapore is doing. They are going to lose money," he added, referring to investments by Government of Singapore Investment Corp and Temasek in Citigroup, Switzerland's UBS and Merrill Lynch.

Just today (April 1st, 2008) UBS has announced massive losses and is again trying to raise capital, just a few months after its massive capital raising exercise that involved GIC. Reuters reports:

UBS AG doubled its writedowns from the subprime crisis, parted company with its chairman and asked shareholders for more emergency capital on Tuesday in a second dramatic attempt to reverse its fortunes.

The Swiss bank wrote down an additional $19 billion on U.S. real estate and related assets, causing a net loss of 12 billion Swiss francs ($12.03 billion) in the first quarter, and said it would seek 15 billion francs through a rights issue of shares.

But what is interesting about GIC's 'investment' is that UBS has been characterised as requesting more 'emergency capital' to 'reverse its fortunes'. I'm not sure I'd really put money in such a company and call it an investment.

Well, of course, GIC and Temasek would say that their investments are 'for the long term' and that the performance of these investments cannot be evaluated simply on the basis of their performance in a few short months.

After all, a 40% drop in stock price in 4 months can't be that bad... right?

Well, in any case, it looks like Jim Rogers is far out in the lead in this race as to who will eventually turn out to be right (click for full images):

Babcock & Brown Structured Finance Fund

I was prompted to analyse the Babcock & Brown Structured Finance (BBSFF) Fund because of a OCBC brokerage research note I read on KEER's blog. It looked like an interesting proposition so I decided to investigate myself. I must say it has been a very challenging experience to analyse this fund and BBSFF is one of the toughest cookies I have encountered so far in my limited investing experience. So, here goes nothing.

Greater Yield – and Greater Risk

The BBSFF is a very unique investment on the SGX. It is a mutual fund that manages a portfolio of structured finance assets, including operating lease assets, credit derivatives in the form of CDOs/CLOs, and alternative assets such Biofuel-related loans and Music Copyright assets. The diverse portfolio of assets makes the analysis of the BBSFF quite a daunting task, and it is a challenging exercise to attempt.

During IPO, BBSFF was priced to yield a 9% return. This is higher than REITs which tend to yield about 5-7% and is somewhat similar to the yield of the shipping trusts. In order to return a higher yield, BBSF invests in assets that are riskier than prime real estate, the details of which I analyse below.

Diversified portfolio of risky assets

Operating Lease Assets

The current operating lease assets under the fund include aircraft assets and railroad assets (rollingstock). The fund also intends to acquire shipping assets when opportunities present themselves in the future. This class of assets has similar operating characteristics to the shipping trusts. Essentially the fund either owns the aircraft or stakes in entities that own aircraft/rollingstock and the assets are leased to airlines or railway companies.

What is notable about some of the operating lease assets is that these are not the most modern aircraft like the new A380 or the larger Boeing 747, but the aircraft include smaller and older models like the Boeing 757-200 which is actually out of production. The fleet of A320s, B737s, B757s and other aircraft are mainly smaller short to medium range aircraft probably used for intercity domestic flights in the United States.

Loan Portfolio and Securitisation Assets

The Loan Portfolio includes CDOs/CLOs that include packaged European and Australian non-conforming (U.S. equivalent is subprime) mortgages. This is the group of assets that has most recently been the centre of attention due to the recent American sub-prime crisis. Fears that the US subprime contagion would spread to Europe and other countries caused a significant sell-off in BBSF’s shares on the SGX. However, it appears that most of the CDOs and CLOs in which BBSF is invested consist largely of AAA-rated securities, with a small portion classified as A or BBB. A latest report by the company indicates that it has taken no losses in its credit derivative securities.

BBSF's exposures to Ancora securities (which are CDOs secured on Australian real estate) appear to be doing well. The Australian economy is powering ahead, largely unaffected by the American crisis (the Australian Central Bank recently raised rates yet again) and the US credit market correction has had little, or any, impact on Australian mortgages. A similar story is the case for BBSF’s exposures to UK and European CLOs and other securitization assets.

As disclosed by the fund, BBSF has no exposure to the US CDO market and so far has taken no damage to its portfolio because of the recent subprime crisis.

Alternative Assets

Alternative assets include loans made to biofuel production facilities, investments in music copyright assets, and a mezzanine loan made to the Paramount Bay project, which is an upscale residential development in the US. It is difficult to evaluate the risk of default or loss of these alternative assets, and I am not going to attempt to do so. I can only assume that these investments are of reasonable quality based on the judgment of the fund manager, and evaluate the financial returns as reported in the financial statements.

Accounting Quality

The level of disclosure in the prospectus and the financial statements is quite high, as would be expected of an Australia-managed company. However, there are a few things to note in analysing the company's financial statements.

1. There is no separation of assets into current and non-current assets, nor liabilities into current and non-current liabilities.
2. The cash flow statement is reported as a direct cashflow statement rather than an indirect cashflow statement. I attempted an indirect reconciliation between PBT and CFO, but the absence lack of separation between current and non-current assets makes the reconciliation difficult.
3. The financial statements amalgamate the results of the fund in 2006 since inception with 1H07 results, making the numbers slightly bloated for projections.

Financial & Profitability Analysis

As can be seen, there is a large gain due to foreign exchange exposure. This is an unpredictable and non-core operating item and I have made calculations excluding this number in order to make analysis more accurate.

As we can see from the ratios the fund is significantly leveraged with liabilities at 46% of assets. This is close to the fund’s loan covenant maximum of 50%, which means that there is little space for the fund to take on more leverage.

In terms of operating efficiency, it is hard to comment because of the lack of comparables. The fund’s ROE excluding forex gains is much lower than the ROE including the forex gain, similar for ROA.

Evaluation

10% yield at $0.95 stock price looks like a very attractive number, compared to other REITs and business trusts. However, there are several factors which make the attractiveness of BBSFF as an investment less clear.

a. At a P/B of 1.11, the market is saying that there is value in the fund that is not accounted for by its net assets. In other words, of the $0.95 per share, $0.09 comes from intangible value. My question is, where does this intangible value come from? The expertise of the fund manager? The value of the copyright assets? Where? It is not clear to me why this stock should be trading above NAV.

b. It would be much nicer for the investor if there was a clear mandate for its dividend policy. However, the prospectus only has this cryptic message about the dividend policy of BBSFF:

“Our dividend policy is to pay out the majority of the economic income received from our investments, after payment or provision for our operating and financing expenses. … Economic income is determined by our Company on the advice of our Manager. This determination involves an assessment as to whether distributions received on our investments constitute capital or income. In some cases, this determination involves an element of judgment by our Manager. In this regard we rely upon the experience of our Manager and its knowledge of our target asset classes to make the determination at the relevant time.” (Prospectus p57.)

In other words, much is left to the discretion of the manager and the investor can only assume that he will get what is due to him.

c. Many of the assets are difficult to understand. CDOs, CLOs, music copyright assets, mezzanine loans, and biofuels are difficult to analyse for someone who does not have significant experience in the field of structured finance. Much depends on the judgment and expertise of the manager.

With such a great information asymmetry and myriad of complex investment issues at stake, I think it would only be prudent to make an investment in BBSFF with a significant margin of safety. I personally am not prepared to risk my capital, and will only consider BBSFF if and when it trades near or below book value.

Bankers' Bonuses and Jobs at Risk

The recent subprime debacle and credit squeeze have put the pressure on bankers' salaries and jobs. The freezing up of the collateralised mortgage/debt market and other credit derivatives mean that investment bankers wielding their financial weapons of mass destruction will find much fewer opportunities to ply their trade as asset managers and other investors stay away from credit derivatives, structured finance vehicles, and related financial instruments.

A couple of articles talk more about the impact:

This article talks about a Top Barclays Banker losing his job.

This article talks about bankers being able to expect a much smaller bonus this year, if indeed they manage to keep their jobs.

I wonder what will the impact of the recent financial turmoil on this banker.

The Subprime Debacle and the Singapore Fallout

As the above chart reveals, the STI has been extremely volatile over the last couple of months. The index has rocked back and forth as events surrounding the US subprime squeeze unfolded. The US indexes fell and so did markets around the region, including Singapore.

What are the implications of this recent volatility?

A. Some think that the market is entering an extremely volatile phase. The prices of some stocks are violently fluctuating up and down, sometimes losing 50% in a day and gaining a similar amount back in another day. So because of this extreme volatility, one school of thought argues that it is better to stay on the sideline in cash or in a conservative position, until the market regains its composure and there is a better risk/reward situation available.

Because there is uncertainty surrounding whether the subprime fallout will have further implications on other sectors of the US economy, there is still a chance that the volatility in markets will continue as events continue to unfold. For such investors who would rather refrain from taking the risk, it is better to stay out of the market.

B. Another group of investors has simply been stopped out by the recent steep fall in stock prices. Margin calls have forced these investors to liquidate their positions at prices much lower than a couple of months ago.

C. A group of investors have found buying opportunities. They think that the damage has been confined to the subprime sector of the credit market and that the Federal Reserve has taken adequate actions to prevent the ripples from spreading throughout the economy. For these investors, the overall US economy is strong, and Asian economies are still in a position to deliver significant growth in the future.

For these investors, the sharp drop in prices in some stocks has presented a buying opportunity as they believe that the dip is only temporary and that prices will resume once the subprime issue passes and strong corporate earnings push stock prices to their previous highs and beyond.

I personally fall into category C, which category do you fall into?