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Markets live chat transcript for the chat ending at 11:57 on 21 Aug 2007. Participants in this chat were: Paul Murphy (PM) Neil Hume (NH)

PM: We’re off!

PM: Welcome to Markets Live, Alphaville’s daily discussion of what’s moving and why.

PM: Neil is up and running — having taken the advice of one saga reader to long in to his system before 11.10

NH: it was still touch and go though

NH: logged in at 10.:50am. took 10 mins to boot up

PM: We are v much back from holiday — having missed all the fun, we are keen to catch up

PM: But let’s get straight into this v v v tricky market

PM: You know we are now in that Who The Hell Do You Believe phase of the cycle

NH: The WTHDYB Zone

PM: On the one hand we’ve got things like the monoline issue, where it looks like the whole structure for turning iffy speculations into investment grade paper might be coming apart at the scenes

PM: On the other hand we have people like Merrill Lynch, which have come out this morning to say that they have looked at all the downside risks associated with conduits, SIVs and pending LBO financing …

PM: … and decided that the problems are nothing for the banks to worry about.

NH: You’d better explain the monoline issue – you cant expect everyone to be experts on niche areas of the insurance industry.

PM: Look, everyone’s an expert on the insurance sector all of a sudden – even me!

NH: Ish. Having spent the last 24 hours trying to get up to speed on the transfer of risk from the banking sector to the insurance sector – and potentially back again.

NH: So, Monolines?

PM: Er, best go and read these two pieces for a fuller explanation….

PM: http://ftalphaville.ft.com/blog/2007/08/21/6597/bill-ackman-subprime-slime-and-the-bond-insurers/

PM: http://www.ft.com/cms/s/0/6de6c56c-4f65-11dc-b485-0000779fd2ac.html

PM: Basically, these are the entities that provide guarantees to structured securities such as asset-backed bonds and collateralised debt obligations.

NH: From what are relatively tiny capital bases, they insure paper worth….

NH: ….. wait for it….

NH: … $ 3,300,000,000,000

PM: They tend to insure only the top tier of risk, to which they are then able to attach AAA ratings. But there are still those who think they might be seriously at risk…

NH: But not Merrill Lynch.

PM: Well, ML are not talking specifically about monolines. But they are talking generally about the credit-related risks that have obsessed everyone over the past few weeks.

PM: This is a very long, detailed ML report, so will only be able to do a few extracts here, but our new Alphaville colleage, Sam Jones, is looking at doing a more detailed post a little bit latter.

PM: In this report we have reviewed the downside risks for the banks from conduits,
SIVs and upcoming LBO financing. Even on bearish assumptions, we estimate
the combined impact of these factors would be to reduce the average Tier 1 ratio
of the largest banks from 8.4% to 7.8%. This will not sink any banks covered in
this report. However, we do see some risks that share buy-back progammes
could need to be curtailed at Deutsche, HBOS, UBS and CS. The impacts on
valuation from these combined factors is also modest – equal on average to just a
2% downside risk to our estimated SoP valuations.

PM: The real swing factor is the macro outlook
Our strategists point out that no asset bubble has ever corrected in an orderly
manner. While we want to believe we are simply seeing a very bad case of the
“jitters” in financial markets, the risks are clearly growing that the after-effects
harm the real economy outlook for 2008. We have modelled the estimated
impacts of a normalising credit environment for the banks’ wholesale businesses.
On average, this suggests a 10% downside risk to our forecasts – far outweighing
the likely impacts of conduits etc. There is a wide dispersion around this average
figure – from a 2% risk to earnings at Intesa up to 20% at Deutsche and Natixis.

PM: Valuations are not compelling given the risks
If we stress our SoP valuations for the potential bad news on conduits, LBOs and
lower 2008 wholesale banking earnings, the upside in the sector declines from the
base case 25% to 14%. The sector has on average traded 10% below our SoP
valuations, so this figure of 14% is not compelling in our view, given the lack of
disclosures on most banks’ subprime and CDO exposures. We think disclosure
needs to improve significantly – hopefully with the Q3 results.

PM: Clear stock calls – Buy Unicredit & Danske
No matter how we cut the numbers, Unicredit and Danske look to offer compelling
upside potential of 20%+. By contrast Deutsche, HSBC and SEB look to offer the
least attractive relative value given the potential downside risks.

NH: That’s all very upbeat.

PM: Ah, but hang on – ML have a coupel of serious caveats…

PM: First, the disclosure from the banks on
their subprime and CDO exposures has generally been poor and unconvincing.
We think it needs to improve. Indeed the loss of liquidity in segments of the
interbank markets shows the banks have not even convinced themselves.
Therefore, we can not rule out “black holes” at certain banks. Second, the macro
outlook for 2008 is uncertain, with growing downside risks. Our strategists point
out that no asset bubble has ever unwound in an orderly fashion. We model a
tougher wholesale banking credit environment but do not stress the banks’ retail
portfolios or model a recession.

NH: Hmmm. Trust you not to miss the mention of “blackholes.”

PM: We should also stress at the outset that just because we model certain scenarios,
this does not mean we think they will necessarily occur. In particular, we believe
that many banks will disagree with our scenario under which we assume they
may need to fund their multi-seller and single-seller conduits. Yes, we agree
these vehicles should be relatively safe and that there is only a small likelihood
that the banks will need to fund these assets indefinitely. But with the CP markets
showing signs of severe stress (IKB, Canada, Golden Key, LB Sachsen) we think
it would be a reckless Treasurer who ignored the possibility. Our aim in this note
is to quantify the downside risks in a responsible manner, and draw valuation
conclusions. Banks which look inexpensive after throwing all these downside
risks at them should be offering compelling value, in our view. We present the
data in as full a manner as possible, which should allow investors to pick and
choose which assumptions they want to price in (if any).

NH: Oh, how big and responsible of ML. I like this next par:

NH: We are currently research restricted on ABN AMRO, Barclays, RBS, Santander
and Fortis. Hence, no analysis of their exposures is included in this report. This
might have had an impact on the conclusions of our study.

PM: That’s quite funny.

PM: I think ML have published their “Dont Panic” research about a month too early — if you ask me

NH: ah but the market are relatively quite calm this morning, giving the volatility seen on Wall Street overnight

NH: FTSE 100 has bounced in an out of positive terrority

PM: Currently down 17.8 points at 6060.3

NH: before we came on air it was around 5 points higher on some rumour that the Fed would cut interest rates later this week

NH: hang on, Paul will paste the bear bones of that rumour

PM: Yes, this went round one of the rumour wires…

PM: FED rumoured to further cut rates today.
Yesterday the New York Fed’s Open Market Desk announced that it will be
redeeming Treasury bills later this week. “On Thursday, August 23, 2007, the
Federal Reserve’s System Open Market Account (”SOMA”) will redeem $5 billion of
Treasury bill holdings,” said the New York Fed. Such a move might represent the
Desk’s attempt to better align the federal funds rate with the FOMC’s current
objective of a 5.25% target. The NY Fed added that the move is also aimed at
offsetting other factors, including “discount window borrowings”, that could be
a sign that the Desk expects increasing borrowing at the “new” discount rate.

PM: So the market rallied on that — but has slipped back again since

NH: there have been rumours of a problem in the insurance industry

PM: What was that?

NH: first up the rumour was that a british insurance company was in trouble

NH: attention focused on Brit Insurance because it sounded similar

PM:

NH: when that was played down attention turned to some payment protection company called British Insurance

PM:

NH: all rubbish of course but it gives an idea of how jittery things are

PM: We need a jittery icon

NH: in fact the only real news we have from the money markets this morning has come from the Bank of England

PM: Which is?

NH: that it lent £314m through its standing facility on Monday

PM: that standing facility? What’s that? Is it like the Fed’s discount window???

NH: yep

NH: allows banks to borrow an unlimited amounts but at a penalty rate of 100 basis points over the base rate of 5.75%

NH: Now, this is the first time in a month that someone has used the facility

PM: carlomagno is asking below whether this is really news — 314m being accessed thru the special facility?

NH: in these conditiions yes.

PM: Do we have any idea who it is??

NH: unsurprisingly the BoE won’t say??

PM: Hmmm

NH: but I have got a link that shows which banks have signed up to use the facility

PM: who are they??

NH: do you really want me to print it?? its quite long

PM: Yeah, go on

NH: Abbey National plc
ABN AMRO Bank NV
Alliance & Leicester plc
Allied Irish Banks plc
Anglo Irish Bank Corporation plc
Banco Bilbao Vizcaya Argentaria SA
Banco Espírito Santo SA
Bank of America NA
The Governor and Company of the Bank of Ireland
The Bank of New York
The Bank of Nova Scotia
The Governor and Company of the Bank of Scotland
The Bank of Tokyo-Mitsubishi UFJ Ltd
Barclays Bank plc
Bayerische Hypo-Und Vereinsbank AG
Bayerische Landesbank
BNP Paribas
Bradford & Bingley plc
Britannia Building Society
Calyon
Citibank NA
Clydesdale Bank plc
Commerzbank AG
Commonwealth Bank of Australia
The Co-operative Bank plc
Coventry Building Society
Credit Suisse
Danske Bank A/S
Deutsche Bank AG
Dexia Bank Belgium SA

NH: and

NH: Dresdner Bank AG
DZ Bank AG, Deutsche Zentral-Genossenschaftsbank
Fortis Bank SA/NV
HSBC Bank plc
ING Bank NV
Investec Bank (UK) Ltd
JPMorgan Chase Bank NA
Kaupthing Singer & Friedlander Limited
Landesbank Baden-Württemberg
Landesbank Hessen Thüringen Girozentrale
Lloyds TSB Bank plc
Mizuho Corporate Bank Ltd
Nationwide Building Society
N M Rothschild & Sons Ltd
The Norinchukin Bank
Northern Rock plc
Principality Building Society
Rabobank International (Coöperatieve Centrale Raiffeisen-Boerenleenbank B.A.)
Royal Bank of Canada
The Royal Bank of Scotland plc
Skipton Building Society
Société Générale
Standard Chartered Bank
Standard Life Bank Ltd
UBS AG
WestLB AG
Yorkshire Building Society

PM: Oh, hang on — if you’ve only got to “D” it really is a long list

NH: just got an email from a broker

NH: Northern Rock are saying it was not them who used the standing facility on Monday

PM: They are well and truly in the frame when any rumour flies at the moment –

PM:

NH: we should have a quick look at the NRK share price

NH: down 15.5p at 700p

PM: the back story here is that after the market closed last night, NRK issued a statement clarifying its exposure to CDO’s and US mortgage backed securities

NH: yep they did and it read well.

NH: NRK said it exposure was minimal and it also announced the planned sale of a second tranche of commercial secured loans to Lehman Brothers for £465m

NH: NRK said the loans had been sold at the expected price, although it declined to give further details

PM: So why are the shares lower this morning?

NH: well, analysts are saying that the key risk to earnings remains

PM: Which is?

NH: difficult funding conditions in the wholesale markets, an
issue on which there was no comment from NRK last night

NH: basically if funding costs continue rising then net interest margin and profitability will be squeezed further, it’s as simple as that.

PM: And there has yet to be any weakening in the three month libor rate has there?

NH: Not yet

NH: and if it stays where it is the profit forecasts for 2008 are going to have to come down by around. 15%

NH: although it is worth pointing out that some of this is already reflected in NRK’s share price, which has fallen 14% this month

NH: Actually, got an interesting note on the statement from Panmure Gordon

NH: says that the market was not expecting a UK mortgage bank to report any exposure tp US mortgage backed securities. As such it sees the Libor rate remaining where it is for the time being

NH: will just paste some highlights for you

NH: The other question concerns NRK’s US RMBS and CDO exposure, namely – why should a UK mortgage bank have any exposure at all to US mortgage-backed securities and CDOs?

NH: NRK state that it intends to hold to maturity the total £275m in exposure – this is
understandable given that recent disposals of US RMBS and CDOs have been reported at 5-20% discounts to book. A mark-to-market loss of, say, 10%, on the £275m exposure would have had a material downside impact on 2H07 earnings.

NH: We think the broader read-across is to LIBOR funding rates, which can be regarded as a proxy for the banks’ assessment of the risk of lending to other banks. We don’t think the inter-bank market was expecting a UK mortgage bank to report exposure to US RMBS and US CDOs, and we expect that this will result in 3-month LIBOR remaining pegged at 60-90bp over BOE Base Rate – with a correspondingly negative impact on NRK and its estimated 52bp spread business in 2H07.

NH: We put our forecasts and price target on NRK under review last week, and we continue with that given the market fluctuations, but this news adds to our perception of downside earnings risk.

PM: Ok, thanks for all that

PM:

PM: Just to return briefly to people using the Fed discount window — as raised by Carlomagno below…

PM: He/she has a point on this

PM: How on earth is it supposed to be “supportive” for Deutsche to use the facility — paying over the odds for money thru the Fed when it supposedly doesnt need to ?????

PM: It’s a childish idea — it’s as tho they were just checking the IT worked — the telecoms link — in case the bank needed to use the facility for real

PM: Also just wanted to say….

PM: on the caption compettion…

PM: I preferred “Thanks a billion!”

PM:

PM: Anyway — back to work…

PM:

PM: We need to turn to something a bit lighter

PM: Any suggestions Neil?

NH: Whitbread

NH: although it more gallows humour

PM: Go on

NH: Morgan Stanley has given the stock a push this morning

PM: Really?

NH: and WTB needs it

NH: stock has taken a real pummelling in the recent sell-off

NH: I’ll put that in perspective

NH: On July 11, Whitbread shares traded as high as £19.40 amid frenzied speculation of a bid from Starwood Capital

PM: Correct me if I am wrong, but weren’t we saying that that Starwood was seeking funding for a bid from RBS

NH: we did

NH: anyway last week Whitbread shares hit £14 as punters threw in the towel

PM: Threw in the towel! Not sure about that. Forced to sell is probably more like it - to meet big margin calls

NH: alright, alright

NH: anyway the point stands – this stock has been hammered and punters have lost a fortune on it.

PM: 25% if you bought at the top and were forced to sell at the bottom

NH: can we get back to the MS note please

PM: OK

NH: they reckon the stock has been oversold and now looks good value

PM: Hmm. There are quite a few stocks in that category at the moment

NH: there are

NH: Morgan Stanley makes the point that Whitbread is now trading at 10% discount to its peers, which it reckons is unfair given that 30% of the company’s market cap is effectively cash.

PM: OK, we had better see some of this note

NH: Upgrade to Overweight

NH: Persistent bid speculation and appreciation of freehold property drove the shares
to an all-time high in May, and these factors have
worked in reverse over the past few weeks as investors
have fled LBO targets and quasi-property. We see the
sell-off as overdone now, and think that the forthcoming
cash return will see investors starting to focus on
business fundamentals again. With a clean P/E of 17x
in 2007e falling to 14x in 2008e, Whitbread is now on a
10% discount to the peer group, and we see this as an
attractive entry point.

NH: Opco is now free

NH: There is nothing to stop Whitbread
replicating the Accor business model in economy hotels
(leased hotel estate) and the Wetherspoon model in
pubs (predominantly leased). Assuming a £3 billion sale
and leaseback (compared to £3.6 billion of fixed assets)
at 6% initial rental yield implies that the operating
company is worth just £200 million or 1x EBITDA.

NH: : We would not rule
out a takeover of Whitbread or a more aggressive
balance sheet structure. However, we would not buy the
shares for this reason, but would buy the company for its
increasingly strong fundamentals. Budget hotels are a
high-growth and high-return business, with compelling
rollout potential internationally. Pubs should see
double-digit profits growth driven by reinvestment in the
estate, and we expect a £800 million cash return this
year.

NH: Director buying suggests an opportunity. Chairman
Anthony Hapgood and FD Chris Rogers have bought a
total of £320,000 of shares in the last two months at
about £17 per share. We think that the market has
oversold the shares, and is ignoring the improving
fundamentals and significant asset backing.

PM: ah, its good to see that analysts are still pushing the op-co/prop-co stuff

NH: surprising if you ask me

PM: and a bit about a bid in there as well

PM: the bull market lives on!! — in some quarters

NH:

NH: some breaking news

PM: From china…..

PM: Chinese rates are on the move — upwards

PM: *CHINA CENTRAL BANK RAISES DEPOSIT RATES 27 BASIS POINTS — news wire snap

PM: *CHINA CENTRAL BANK RATE HIKE EFFECTIVE TOMORROW

PM: Maybe chinese investors might be tempted to join in the global market jitters

NH: or not

NH: did u see the Hang Seng overnight???

NH: screamed higher following news that the Chinese citizens will be able to invest directly in HK shares for the first time

NH: how has this Chinese rate news affected the market???

PM: Will Shanghai // HK closed, obviously, but UK…

PM: Footsie currently down 41.3 at 6037

NH: on the slide again

NH:

NH: just had some alarming news through on US housing foreclosures

NH: from a company called RealtyTrac

PM: Forwarded by a friendly — and v useful — broker

NH: Foreclosures up 93.4% from 1 year ago (July to July)

NH: The July2007 to June2007 change is up 9.1%

NH: The US average is now 1 in every 693 households in some stage of
foreclosure

NH: Top of the Flops;
Nevada 1 in every 199
Georgia 1 in every 299
Michigan 1 in every 320
Calif 1 in every 333
Colorado 1 in every 347

PM: So cheap housing available in Nevada, then

NH: if you want to live in Las Vegas

PM:

PM: Just to go to comments below …

PM: Greenback II — are you related to Greenback - the original?

NH: not sure we can read much into the meeting between the Fed chairman and Paulson

NH: not the first time they have talked in the past week is it???

PM: Hmmm — this market is suddenly feeling particularly jittery once more

PM: Interesting to see everyone — including ourselves — jumping at every rumour

PM:

PM: Ok, let’s get back to some stock specific stuff

NH: have you seen the share price of Cadbury???

PM: just looking — real dog again — down 19.5p at 533p — fall of 3.5%

NH: and have you seen the chart

PM: Bringing it up….

PM: Oh, dear!

NH: it’s a real shocker

NH: trading close to 700p in early June

NH: still at 680p in at start of July

PM: Now at 533p. ouch

PM: what’s spooked the stock?

NH: Two things

NH: first upmarket Swiss chocolate maker Lindt & Spruengli has warned that it will be increasing prices at the start of 2008 to counter high raw material prices

NH: and second there is a bearish note from Bear Stearns

PM: what does it say?

NH: assesses what the impact will be if CBRY has to demerge rather than sell its US soft drinks business

PM: Which is a very real possibility

NH: very,very real

NH: anyway BS has cut its earnings forecasts by average of 13.5% per annum through to 2010

NH: here’s some pars from the note explaining the downgrade

NH: Our downgrade relates to the over-proportional percentage of operating earnings (margins of 18.2% for U.S. Beverages against just 10.4% for Confectionery 2007E) and cashflows contributed by the Americas operations for which the remaining confectionery operations will receive interest on cash at an estimated 5% pre-tax.

NH: Our SOP is also impacted because we believe Cadbury’s best-case scenario could now be £6bn gross proceeds if it undertakes an IPO rather than the £7-£8bn we had estimated when we assumed a private equity transaction was more likely prior to the sub-prime market woes. We do not now have a ‘share restitution’ option as the company clearly needs the cash.

NH: Following our model changes, our valuation of Cadbury continues to look stretched, trading on 2008E 20.0x P/E,
11.5x EV/EBITDA and 1.8x EV/sales compared to a peer group trading on 16.4x, 9.7x and 1.7x respectively

PM:

NH: some amusing headlines going up on Bloomie about this BoE standing facility

PM: Go on

NH: The headlines suggest a journo is phoning round every single bank & building society trying to find someone to “fess up” to taking the loan.

NH: So far Nrk, B&B, Britania plus Yorkshire have all denied it is them.

PM: Hmm

PM: Interesting that all these are names are being pullied into commenting — especially when the number is so low, in relative terms

PM: Anyway — just pick up again on some of the comments below….

PM: There is clearly loads and loads of interest in the German Landesbanken situation

PM: I’m with the bears — these banks have been playing with cheap money and complex financial toys

PM: Which spells trouble.

PM: As for bailouts breaking EU rules….

PM: Think it depends on the threat to the financial system,..

PM:

PM: Ok, we are going to wrap up now

NH: the last point I would make is that volumes have been very low so far this morning

NH: doesn’t seem to be any real selling, yet.

PM: Interesting…

PM: Also — briefly note Carlomagno below — cant have a bailout without agreed reform programme for the german second tier banks

PM: Thanks for all the comments. Feel free to continue the conversation in our absence — will try and dip back in later.

PM: Next full session of Markets Live at 11am tomorrow

NH: in the meanntime hang on to your tin hats

NH: could be a volatile session ahead

PM: And sun glass — market is going up as we speak!

NH: bye