Skip to content

Link to Book \"Stories in Credit Analysis\"

Link to our views on the use of advanced math in credit pricing:

The Debt of Ghost Towns & Ghost Countries

The population of the US city of Detroit peaked in 1950 at 1.8 million. In the census of 2010, the population, at 700,000, was barely 40% of the 1950 population. Skilled labour, which helped in causing the debt load of Detroit to zoom, had moved out, leaving the poorer and unskilled lot to face the music of debt servicing. The city is now on the verge of defaulting on its debt and its pension obligations to poorer citizens.

About a year ago, in a piece The Moral Hazard of Open Borders On Sovereign Creditworthiness (, we had predicted that skilled labour will flee the indebted countries of Europe into the welcoming arms of Germany. That is precisely what is happening. Spain’s engineers are fleeing to Germany to escape unemployment at home. This benefits German companies while hurting the ability of the government of Spain to repay its debt.

Over the next few years, we will see more and more sovereign/sub sovereign debt that will have to be written off as skilled labour flees those debt holes into oasis’ that welcome them. They would have helped create the debt, but will not be involved in debt servicing- leaving that task to poorer citizens who do not have the skills to emigrate.


The FDIC discovers that Deutsche Bank is “horribly undercapitalized”

Late last week, the Vice Chairman of the US’ deposit insurance agency, the FDIC, said that Deutsche Bank is “horribly undercapitalised” . That should not be news to readers of this blog. However, when the regulator made this claim, he did not take into account the issues given below- else he would have added one more adjective to the description (awfully, horribly, undercapitalised?).
1) The Vice Chairman assumes that the value of assets, as stated in the balance sheet, is true. This is being too generous- particularly concerning its Level III assets which the bank is valuing in a “mark to myth” fashion. Fiddling with accounts is not new to Deutsche. At the height of the credit crisis, Deutsche misplaced $12 billion of asset valuation, for which it is being investigated by the Bundesbank. Again, in 2010, the bank is alleged to have fiddled with its computer models.
2) It is understating its legal liabilities in the US from the sub prime crisis.
3) It is understating the volatility of its trading book. After all, capital is necessary to cover unexpected losses in its trading book too.

CARE Strikes Again!

Just when we were beginning to fear that CARE Ratings was losing the ability to amuse and amaze the Indian debt markets, CARE has struck again.  The reason for our fear was simple- it has been almost a month since CARE published a truly idiotic rating.  Today CARE downgraded Educomp, a company on which CARE had a high single A rating until recently, to D.  As usual, CARE was late to the party- the default had occurred sometime back.   But have no fear- CARE has several tricks up its sleeves to amuse and amaze us!

Gold Backed Loans: Creditors be Comforted-the Weak Hands in the Gold Market are out!

Lenders who have given out loans collateralised with gold must have experienced some heart stopping moments during the last few months as gold prices sharply cracked. We would not be too concerned about taking credit exposures to gold loan companies (provided the LTV of the loans is 60% or below).

Gold is passing from weak hands (leveraged players, speculators and hedge funds) to strong hands (Indian, Chinese and Vietnamese housewives etc). The speculator such as Soros has to close out his position at some point. The gold that goes to an Asian housewife is forever removed from the market unless there is a deep financial crisis in the family.

Gold demand in India, the world’s largest buyer, is heading for a quarterly record after prices slumped to a two-year low in April, the World Gold Council said. India’s gold imports will be 300 to 400 tonne in the second quarter, almost half total shipments for all of last year. Gold auctions run by the State Bank of Vietnam were fully subscribed and some retailers in Japan ran out of stock. Weak hands sold 477.7 tonne valued at about $21 billion from exchange-traded products this year. The buyer was the strong hand. Throw in the demand from central banks of countries running current account surpluses (again strong hands, as opposed to weak hands running current account deficits), we would be sanguine about gold’s long term prospects. And the creditworthiness of lenders whose business model is built around lending against gold.

Carson Block shorts Standard Chartered Bank’s Debt

The famous short seller, who identified basket cases such as Sino-Forest announced yesterday that he is short Standard Chartered Bank’s debt. The reason he is short is because of the questionable quality of the bank’s loan book- particularly its mining sector exposure.
Readers of the book Stories in Credit Analysis would recognize that we have never been fans of this bank and never bought the bank’s emerging market story. Most recently, its earnings have been driven by underprovisioning. We have also highlighted the bank’s poor internal controls (which has resulted in the bank paying huge fines to regulators in many countries- the most recent episode being payment to US regulators for money laundering). The root of Standard Chartered bank’s problems is the bank’s management structure. The CEO is a non-playing captain who operates out of London, while the different emerging market units do pretty much what they like. Now non-playing captains are alright for a country’s Davis Cup tennis team- not for an international bank.
For the same reason, we have deep doubts about the sustainability of HSBC’s earnings and fear an orgy of explosion of contingent liabilities into actual liabilities

Risk : First Principles

am thinking of putting together a collection of essays on Risk Management from first principles. The essays would have minimal quantitative application and maximal use of common sense. Readers of this blog are requested to contribute.

Earnings, EPS and Falling Credit Quality of US Companies

Equity analysts in the US are gushing about the recent trend of buoyant earnings per share (EPS) of US companies. Unfortunately, that is not something for creditors to cheer about. The rising EPS, in many cases, is not due to strong operating earnings, but due to share buybacks which reduce the number of outstanding shares. The buybacks in many cases have been funded through debt. These shenanigans effectively make equity senior to debt and creditors who are sleeping on the wheel are in for a nasty surprise.

Finally S&P puts Deutsche on RWN

Deutsche Bank’s A+ credit rating from S&P has finally been placed on rating watch with negative implications. The points highlighted in the S&P release are some of the points we had highlighted exactly two years ago in our detailed piece on Deutsche Bank ( But not all the concerns we had raised have been addressed in S&P’s review and the rating agencies continue to be woefully behind the curve. We would go so far as to say that Deutsche Bank, through its global linkages, is the biggest risk to the global financial system. Not the Italian banks that will soon fail. Or the doddering Spanish and UK banks.

Institutional Structures are Useless for Creditors in a Crisis

One of our key assertions on sovereign credit assessment in the book Stories in Credit Analysis is that a creditor should not draw comfort from the protection afforded by institutional structures in a country. Institutional structures will fray during a crisis. We had asserted that is better for creditors to forecast the likelihood of a crisis occurring than trying to forecast what happens after that- things will not go as per the script. This thesis has been amply confirmed by the happenings at Cyprus. Creditors who drew comfort from the institutional mechanisms of the EU would have been shocked to see a solemn contract in the form of deposit insurance being torn apart during the current crisis. The same thing happened in the US when the US government screwed the creditors of General Motors during the GM bankruptcy episode. Noble notions such as “property rights” were given a quiet good bye.

Hence our quarrel with rating agencies who in their sovereign rating exercise give considerable weightage to the institutional framework of a country. Our belief: it does not matter if the country is the US or China- when a credit crisis happens, creditor rights will be chipped away. So, instead of drawing foolish comfort from institutional structures, a creditor is better off predicting the likelihood of a crisis happening and basing his investment decisions based on that assessment.

No more Stress Tests Please! Can we have more Bank Disclosures?

Many moons ago, we had expressed skepticim at the Federal Reserve’s bank stress tests ( The latest stress test just confirms that these stress tests are pointless Keynesian hole digging. The stress tests are based on a scenario prevalent during the credit crisis of 2008. The next credit crisis will be very different. Assets that were most liquid during the last crisis (US government securities) will not be so during the next crisis. To satisfy various liquidity requirements, banks have accumulated government securities, which they will all try to sell at the same time, thus making them illiquid.

How much better it is to force the banks to disclose far more on the true state of their loan, trading and the investment books? Market players can then conduct their own stress tests under scenarios which they deem likely. Based on actions of informed market players, through the share price, a quick feedback is provided to bank management. Without these disclosures, big bank stock valuation of the brokerage houses is a wierd guess at best and fraudulent at worst.

%d bloggers like this: