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An Evening with Ed Altman

Last night Sum2 had the distinct pleasure of attending Prmia’s History Making Series lecture that honored Edward Altman at the Deloitte and Touche Conference Center in NYC.

Mr. Altman, The Max l. Heine Professor of Finance at the Stern School of Business at NYU, was honored for his life long contribution to the study and development of credit risk analysis. His foremost contribution is the development of the Z Score which uses financial ratio benchmarks within an industry segment to determine corporate financial health. He has made many contributions to the study of credit risk, corporate finance and investment analysis of debt securities.

His presentation covered the development of credit risk analysis since his first published work concerning the Z Score in 1968. Mr. Altman was funny, intelligent and very engaging and he raised some dire concerns about the current credit market environment and what it may forebode. To be fair to Mr. Altman, he pretty much stuck with the subject of the development of the discipline of credit risk analysis and like Alan Greenspan went very light on market prognostications.

Some brief highlights of Mr. Altman’s presentation:

Stressed the importance of a healthy corporate credit culture and its neglect has contributed to the current crisis.

Bankruptcy workout and recovery rates will suffer due to current state of credit market.

Lenders need to combine quantitative and qualitative factors to determine loan default probabilities.

Risk managers need a better understanding of the correlation of debt ratings and corporate performance.

Mr. Altman also stated that corporate bond defaults could approach 11% next year and that other securitized asset classes are under severe pressure.

Mr. Altman also opined about the etymological origins of the phrase, “waiting for the other shoe to drop.”

Music Video: The Credit Crunch Song

Risk: credit market, research, economics, corporate finance

October 17, 2008 Posted by | credit crisis, economics, investments, risk management | , , , | Leave a comment

Conference Call with Hank

National Federation of Independent Business (NFIB) members had an opportunity to participate in a conference call with Secretary of the Treasury Henry Paulson. Mr. Paulson was keen to solicit the support of NFIB members for the passage of the Emergency Economic Stabilization Act, (EESA).

NFIB members are small business owners who are generally very conservative, free market advocates who vigorously support tax relief, oppose regulatory oversight and large governmental spending programs. NFIB member firms are the entrepreneurs, shopkeepers, service providers and small business risk takers who populate the small stores and office space on Main Street USA.

Small business owners are a politically vocal and influential constituency whose support proponents need to gain passage of EESA. Last night EESA passed the Senate. It will now return to the House of Representatives for a vote. Secretary Paulson asked NFIB members to contact congressmen, senators and media to urge support of EESA passage.

Key points raised were as follows:

FDIC deposit insurance limit was raised to $250,000

EESA Bill included riders with tax cuts and other rebate incentives

EESA has a recoupment provision “put” that allows Treasury to sell assets back to banks at a previously agreed upon price

Failure of EESA will curtail community bank lending activity to small businesses

Large businesses and municipalities dependent on credit markets for short term funding will scale back purchases with small businesses

Current Treasury tools are not sufficient to deal with problem

EESA funding (Federal Budget program cuts) will need to be addressed in next budget cycle

Regulatory frameworks of financial services industry need to be streamlined, strengthened and reformed

Mark to Market of toxic bank assets will help to temporarily address bank solvency and capitalization ratios

Music Video: Blondie, Hangin on the Telephone

Risk: bank solvency, credit, interest rates, recession

October 2, 2008 Posted by | credit crisis, EESA, Paulson, TARP, Treasury | , , , , , , | Leave a comment

ADP Job Report Minus 8000

Nonfarm private employment decreased 8,000 from August to September 2008 on a seasonally adjusted basis, according to the ADP National Employment Report®. The estimated change in employment from July to August was revised down from a decrease of 33,000 to a decrease of 37,000.

September’s ADP National Employment Report continues to offer evidence of a weak labor market. Note that this month, the ADP Report does not reflect two special factors that might have further depressed employment in September. These are the strike of some 37,000 machinists against Boeing, and job losses related to hurricanes that struck the Gulf Coast.

This month’s employment loss was driven by the goods-producing sector which declined 72,000 during September, its twenty-second consecutive monthly decline. The manufacturing sector marked its twenty-fifth consecutive monthly decline, losing 48,000 jobs. These losses were somewhat offset by employment gains in the service-providing sector of the economy which advanced by 64,000.

Details on the ADP Report can be found here.

Music: The Silhouettes- Get A Job

Risk: unemployment, manufacturing, job loss, recession

October 1, 2008 Posted by | recession, unemployment | , , , , | Leave a comment

Too Much Sugar

I’ve heard that too much sugar can lead to diabetes. If you take too much of it over a long period of time it alters your body chemistry and produces an imbalance that leads to this dangerous and life threatening disease. Once you have contracted the disease and if it remains untreated it takes an awful toll on your body. As the disease progresses doctors start to cut off fingers and toes to try to arrest a growing gangrene. In its final stages of the disease, the diabetes sufferer sacrifices legs and arms to the surgeon’s knife in order to keep the body alive. Its a terrible disease and it leads to an ugly death.

I believe that the disease of diabetes is a fitting metaphor for our current economic crisis. The last 20 years have been a sweet run for our nation. We denied ourselves nothing. The economic and political powers let us eat cake. They never asked or suggested that maybe we need a diet or should alter our consumption because of our overindulgence and our inability to stop. The large financial institutions were never asked to stop taking great risks and vigorously fought oversight and regulation. Our elected officials never denied themselves a privilege or opportunity to serve the interest of their paymasters.

This nations citizens over indulged and gorged themselves on unbridled consumerism fueled by the perception of an infinite credit limit and an insistence on a sense of entitlement. People believed that the rampant acquisition of houses, cars, cloths, gadgets and leisure accoutrement’s had no limits and the party would never end. Hell as the Iraq War developed W insisted it was a patriotic duty to run up our credit card balances at the Mall Of America.

The Masters of the Universe on Wall Street set another dangerous example for the world to follow. They too indulged in an orgy of speculation that created unimaginable levels of riches for themselves. They gave no thought to the extensive collateral damage their financial transactions and structured products would create. They truly believed that everyone could live in a McMansion if only they had more faith in free markets.

Our elected officials believed the highest expression of patriotism would be to send tribute to finance their reelection. They prostituted themselves to any special interest lobby group for as little as a cheap junket to the nearest exotic offshore isle. They sold their votes and sold out their constituents to line the pockets of special interests with taxpayer money. Party leaders like Tom “The Hammer” DeLay is actually on trial for money laundering. DeLay now claims that he was unfairly victimized by the anti-money laundering provisions of the Patriot Act. Its either a supreme sublime irony or a startling cosmic karmic correction depending on your political bias.

So here we sit today. Rudderless, bereft of political leadership. Waiting for the next cut. Everyone should start searching the deep recesses of their sofas to look for some loose change. We might need it to help get us through this crisis. I fear it won’t be enough to avoid the next slash of a surgeons knife to cut out the growing gangrene metathesizing in our body politic.

Music: Eurythmics, Sweet Dreams Are Made Of This

Risk: depression, existential dread, consumerism

September 30, 2008 Posted by | credit crisis, economics | , , , , , | Leave a comment

Job Loss Up / Economy Down

The erosion of jobs continues as the economic malaise seemingly deepens in the United States.

Today the Labor Department issued its employment report for August and it points to a weakening economy and an unemployment rate at a 5 year high.

We cannot detect any sector recovery drivers in the US economy. Global drivers are also slowing down as demand from the worlds largest market continues to abate.

One silver lining of the global economic downturn is the slowing of inflationary pressures. This might provide the impetus for the Treasury to send out another round of tax rebate checks. Don’t count on it though.

Hedge funds are deleveraging market positions and raising cash. This may impact market liquidity and contribute to extended market softness.

Yesterday on CNBC Bill Gross, CEO of PIMCO indicated that banks need additional $400 B infusion by the Fed to maintain sufficient capital levels to assure credit availability and market liquidity. Hedge funds and SWF’s are waiting for this demonstrated commitment by the Fed before they can feel confident about a strengthening economy and a more favorable investment environment.

The Hamilton Plan outlines a program to reignite economic growth for a moribund economy.

Music: Stevie Ray Vaughan and Jeff Beck: I’m Goin Down

Risk: recession, banking, unemployment, credit crisis, banking

September 5, 2008 Posted by | Hamilton Plan, recession, unemployment | , , , , | Leave a comment

National Small Business Summit and the Credit Crisis

Sum2 will be participating in this year National Small Business Summit in Washington DC.

The summit sponsored by the National Federation of Independent Businesses, calls together NFIB members and friends to examine and discuss pressing issues and concerns that affect small businesses.

Sum2 will voice a shared concern of many of its clients about the necessity of small businesses to be assured that access to capital during this credit crisis not be threatened. Community banks have an important role to play and government representatives need to be aware of their significance as a primary credit channel for small and mid-size businesses.

Leaders from the world of business and government will be brought together so that a concerted voice that represents the interests of small business can be heard by our elected representatives in the congress and senate.

This years conference will feature key note addresses by, Senator John McCain, Senator John Kerrey, former Press Secretary Tony Snow, former ebay CEO Meg Whitman and Hall of Fame Quarterback and business person Rodger Staubach.

The full summit’s agenda can be viewed here.

Sum2 is a recognized leader in providing risk management innovative solutions to small and mid-size businesses. We are very pleased to be participating in this event and look forward to voicing the concerns of our clients, partners and friends to the elected officials of our representative democracy.

If you have any ideas or suggestions that you would like us to raise please send us a note.

We look forward to hearing from you.

And we’ll keep working for you and our shared interests.

You Tube Video: Vanessa Williams, Work To Do

Risk: small business, political, credit, community banking, representation

June 5, 2008 Posted by | commerce, credit crisis, risk management, SME, Sum2 | , , , , , , | Leave a comment

Macroeconomic Risk Impacts SMEs

Small and mid-size enterprises (SME) are acutely susceptible to the negative impact of macroeconomic risk factors. Macroeconomic risk factors such as inflation, interest rates, market cycles, market regionalism, credit and labor availability, and fuel costs conspire to drain profitability and financial health of small and mid-size businesses.

Though issues of scale are principal culprits that enhance the negative impact of macroeconomic factors on SME’s, other factors such as risk concentration in product markets, clients, and supply chain; silo business functions and lack of specialized treasury functions to hedge risk and maximize capital allocation returns also contribute to enhanced macroeconomic risk profile of SME’s.

To help SME’s to better understand and manage the impact of macroeconomic risk factors on their business; Sum2 is providing the Profit|Optimizer Macroeconomic Test to small business owners and managers at no charge. The test is a module from the Profit|Optimizer product which provides a thorough risk assessment and opportunity discovery review of a small business enterprise.

The test can be accessed by clicking this Profit|Optimizer hyper link.

We hope to be of service. Take the test.

You Tube Video: Charley Brown

Risk: SME, Macroeconomic Risk, Inflation, CRG, Risk Management

May 31, 2008 Posted by | risk management, SME, Sum2 | , , , , , | Leave a comment

Reinventing Community Banks

Community Banks have been profoundly affected by the current crisis in the credit markets. Many will need to reposition their market focus and adopt innovative growth strategies to build its capital base and sustain profitability if they wish to remain independent.

Community banks have confronted drastic market challenges in the not to distant past. During the 90’s community banks dominance of the small and mid-size business (SMB) market began to erode. The dynamics of the banking industry changed rapidly. Large money center and regional banks leveraged technology, operational and balance sheet scale to provide access to inexpensive credit products bundled with cash management tools. They were armed with huge marketing budgets and became adept at selling a growing array of transaction services that met the growing sophistication and business needs of the lucrative SMB market. The current banking crisis forebodes yet another drastic alteration in the structure, regulatory and businesses practices of the industry. The current banking crisis will forever alter the face and scope of community banking sector.

The challenge for the community bank will to reinvent itself. Community banks must decide who its customers are and target the market with focused precision. Community banks need to recognize its strength by leveraging its natural geographic advantages and sell products into markets that transcend local limitations. Community banks need to offer products that help SMBs manage cash flow and liquidity, make informed decisions on capital allocation initiatives, decrease cost of capital and products that facilitates transactions and fosters new customer acquisition.

Community banks must also begin to farm new liquidity pools. Securing funding sources in a world of limited liquidity will be the greatest challenge for community banks. Overcoming regulatory hurdles notwithstanding, branding community banks as a consistent, trusted and efficient delivery channel of credit products is an important ingredient for its survival. The community bank must recognize how it adds value in a complex and expanding delivery chain. The failure to secure funding sources will only accelerate balance sheet erosion that results in merging with another institution or liquidation.

The community bank must assure its funding sources, equity holders and regulators that it truly knows and understands its customer’s market and growth potential. This KYC goes deeper then determining an acceptable FICO score, Federal ID verification and passing an OFAC screen. Employing risk management and opportunity discovery exercises with SMB prospects and clients are principal business drivers that provide critical disclosure information to funding sources that address risk aversion concerns.

Funding sources and other stakeholders must be secure in the knowledge that the community banker understands the peculiar risk characteristics of the SMB’s strategy, business model and governance and risk management acumen to provide investors and lenders exceptional returns on investment capital and lines of credit. The banker then becomes an effective risk manager whose vigilance and considered business judgment provides a fair return to funding sources, assures regulators that capital ratios remain strong and reward shareholders with appreciating equity valuations.

Community banks are just one of the many expanding choices an SMB has to provide banking and financing services. Community banks must create a compelling brand identity and articulate a differentiated value proposition with focused product marketing to regain its market dominance with SMBs.

You Tube Video: The Beatles, Money

Risk: Credit, Market, Banking, Small Business, Recession, Marketing,

May 30, 2008 Posted by | banking, credit crisis, SME | , , , , , , , | Leave a comment

Capital Formation for SMEs

CFO magazine ran an interesting but brief article on SEC plan to encourage and assist capital formation for small mid-size businesses (SMB’s).

In light of all the gyrations in the credit markets and the rush to aid investment and money center banks (see Risk Rap Post 4/10/08, SMB’s TBTF), it is heartening to know that the capital needs of our country’s most important economic sector is not being over looked by the government regulatory bodies.

The access to capital is critical for small businesses. The SEC plan to expand capital access to the segment will help SMBs cope with stringent credit policies, the effects of the economic downturn and the pressure on asset valuations due to the falling real estate and public equity markets.

An interesting side light to this initiative will be how community banks and private equity firms position themselves to take advantage of this SEC initiative. It bears watching and this could be an important program to align the interests of cash rich private equity firms and capital stressed community banks.

We’ll post more on this subject in the future.

Risk: SMB, Regulatory, Private Equity, Community Banks, Market, Credit

May 10, 2008 Posted by | banking, credit crisis, hedge funds, private equity, SME | , , , | Leave a comment

Corporate Credit Markets Redux

This morning I attended a Standard and Poors presentation on Emerging Issues in Fixed Income Market. It was extremely well done. The presenters offered some interesting data and insights concerning the health of the corporate bond markets.

Key Takeaways:

  • Tighter lending conditions spell heightened risk of defaults
  • Two-Thirds (66%) of Non-Financial US Corporate Bonds are Speculative Grade
  • A spike in lower grade new issues from 2004 through 2007 will feed default supply
  • Consumer Discretionary Market Sector is weakest (media/entertainment, consumer products, retail)
  • Corporate defaults will escalate in late 2008 through 2009 and will trough in 2010.
  • This year’s baseline default rate forecast is 4.7%, with a high of 8.5% and a low of 3.7%

What interests me is the degree to which these prognostications may reflect similar default and business distress rates in the small and mid-size business market (SMB). My initial guess is that SMB’s will not experience a similar level of default. I don’t believe that SMB’s are as leveraged as public companies. But credit risk remains a pressing problem for SMB’s and the dramatic curtailment of bank lending heightens default risk.

SMB’s that sell to public companies should take time to study the financial condition of these corporate accounts. Defaults are painful for investors and creditors. Having a large unmet receivable exposure can seriously damage the financial health of an SMB.

I do believe that the forecast for the consumer discretionary sector is very relevant for SMB’s. SMB’s in this sector will not escape the pressures of the economic downturn. High fuel costs, consumer spending capability and inflation will dramatically hurt this sector and may result in increased defaults as the economic slowdown takes hold.

We highly recommend that SMB’s purchase the Profit|Optimizer to mitigate the effects of these risks.

You Tube Video: Louis Jordan, Let the Good Times Roll

Risk: Credit Risk, Corporate Defaults, Consumer Product Market, Small Mid-Size Businesses

May 2, 2008 Posted by | banking, credit crisis, recession, SME, Sum2 | , , , , , , | Leave a comment