Shawn Baldwin from CMG in Chicago for the 2009 Critical Capital Management Series

FIG Leap



The market went on a tear for a six week rally and to some it signaled the return of the Bull. Was this the signal for static reinvestment? Unfortunately not, it was mainly driven on high hopes of ending the freefall with stabilization and buttressed with great results from Goldman Sachs (GS) and JP Morgan (JPM). Did the high margins from the aforementioned banks signal the imminent return of the bull market? Hardly, this was a bear market rally as I have stated from the start and as was evidenced by the precipitous drop in the Dow.


This is the time for trading.  We witnessed the chilly receipt of Bank of America’s strong results but smack down from investors. First allow me to say that the markets are not a Ken Lewis fan. Ken stepped into the shoes of banking giant Hugh McColl –who while small in stature, left giant footprints which still loom large in banking. Lewis has made the B of A institution larger and has arguably made great strides through acquisitions pre- Merrill Lynch. Lewis unfortunately doesn’t have the charisma of the old jarhead from North Carolina, which continues to cause B of A to under perform as a stock. If they get the old man out, the stock will surge on sentiment, this is a great weakness buy with a 12 to 18 month target, stress tests be damned!


The bear is far from being dead but we are seeing one of the last severe maulings. We are, however, a lot closer to the beginnings of a bull market and at this point there is a sector that we can start to making positions into with a (2) two quarter high-profit, return investment trajectory. That sector would be in Financial Investment Groups or FIG’s. This will be the area where investors can cover themselves and is the best place to leap back into the market for a long position. The FIG leap.



As we focus on investments we don’t want to invest in every area at one particular time. We want to target the market in sectors and focus on the institutional money inflows strengthening our investments. We are not focused on the retail investor, which usually tends to be a laggard. The strategy is to move along with the institutional investor, this will provide support to our investments and to use the laggard retail investor as our liquidity. This will allow us to exit with higher valuations and superior price. The institutions are much larger in size so they can’t exit as quickly, when a position begins to tank they will pile into it along with the other institutions to maintain their investment. These actions are masked as a “flight to quality” but are usually a result of little new ideas, trading opportunities and constraints due to their investment disciplines. These practices will create a high-return environment, the likes of which we won’t see for a long time again. There will be huge profits within the next 3 years. Now is the time to get in.


Please note that I am a FIG banker, so my analysis will be strongest for financial service providers: banks, insurance companies and REITS (Real Estate Investment Trusts).  This was the highest concentration of capital market transactions that I worked on-if there is an area that I know, this is it.


Let’s look at the numbers:



  1. From a macroeconomic position the case has already been made: From a global perspective, The FTSE 100 went 2.5% higher and was mainly driven by the FTSE banks 5% percent swell.
  2. The jobless rate up in 40 states, unemployment is almost 8.5% and will go over 10% next year (California is 11.2% already), this may seem like a harbinger of death but it isn’t—high numbers in unemployment signal a rebound because of capacity deficits.
  3. Consumer confidence rose 61.9% from 57.3%– which signals that the consumer who now are saving at alarming rates is feeling more secure consumer spend is 2/3rd of our economy—this is a highly critical number.
  4. The formerly all important Vix (the volatility indicator, a measurement of how much prices will go up and down) was down to 36, with demand pushing higher. The (2) two of these indicators suggest great insertion points. In the past, with the Vix this low, I would have jumped in fully with both feet. Since the Vix was compromised by the media and made its existence so pervasive, I’m not sure if it is not above manipulation and I won’t use it as the all important bell-weather. It is a great sign, though.


In the United States, pensions are under-funded by $1 trillion. They will invariably have to rebalance, which also means that they will reallocate. Since they will take on more emerging market allocations due to the high returns in those areas (although they will be late to the game as they always are), they will seek to stabilize the perceived risk with large positions into stable, financially secure institutions with long term viability, visibility and transparency—the beneficiaries of those investments will be the newly scrubbed and TARP heavy banks. This will allow them to smooth both risk and volatility in the portfolio.





If we are going to talk about financial investment groups we have to discuss General Electric (GE). GE is one of the largest clients to all financial service firms on Wall Street and it also has large businesses in the sector, it is highly important. GE had problems due to its venerable lending unit GE Capital and saw revenue fall 23% with profits falling off almost 60%. With profits of only $2.92B versus $4.51B which is roughly about .43 cents a share — a bad quarter for GE. The silver lining is that those losses were minimized by a $1.2B tax benefit. This unit will continue to give GE problems (please remember that I pointed this problem out and the direct correlation of the credit rating issue in previous commentary before it was a Wall Street Journal headline). Having said that, GE isn’t going anywhere. This is a weakness purchase with a 24 month target exit for the strong stomachs.


You won’t see it mentioned or spoken of but one of the main profit and cash generators GE used to create prodigious profits in the past was the “Honey Pot”. “The Honey Pot” referred to the vast real estate portfolio owned by The “Meatball” as it is affectionately called by GE’ers. GE could produce multiple hundreds of millions of dollars in profits by simply selling a building from it’s portfolio. This cash and profit spigot was shut off and it will now  become a drag to GE as it has a difficult time winding out it’s commercial real estate along with it’s businesses in credit cards and lending –wait a minute- those are all targets for the TARP and TALF aren’t they? Stay tuned for that. GE is a Street Beast and previously mastered both equity financing through spin-offs (selling off businesses through new stock sales) and debt financing with corporate bonds—very easy to do when you are rated Triple A ( the top bond rating a company can receive). To his credit, Jeff Immelt (my fellow Ohioan—he is from a small town 20 minutes from my home town of Dayton) reduced GE’s dependence on financing given the reductions in short term financings due to the credit crises. You can rest assure that GE will master TARP/TALF opportunities and will improve from these levels. If you can maintain a 24 month price target these prices are great, shorter periods are not so clear. There will be tremendous losses due to the credit card portfolio having late payments, charge-offs and personal bankruptcies. This is one only for the brave at this time; the complexity makes it choppy to navigate unless you are trading it. GE will eventually become dominant due to its complexity and exposure in areas where the TARP/TALF support will enhance its returns, just not yet.





The consolidation in finance has caused concentration of customers and capital. The (5) five largest banks have half of all the deposits, this is greatly accelerating profits. With deposits at all time highs and re-financings driven by low rates, profits are accelerating at record rates. Underwriting fees are running rampant due to the consolidation—both Bear Stearns and Lehman Brothers are no longer options and give tremendous pricing power to the survivors.


EQUITY UNDERWRITING: The richest fees are in the highly lucrative new issue underwriting business of initial public offerings (IPO’s) my particular specialty along with corporate bond underwriting—the priciest fees traditionally are in IPO’s (which is I why I pursued that line of business) . IPO issuance will come back within a 3 years to robust capacities because there is a substantial backlog of shelf registrations at the ready—meaning that there are a number of companies that have completed all of the necessary filings to list as a publicly traded company. The Rosetta Stone IPO helped to outline the pent up demand by investors for theses offerings. The pent up demand in combination with the super intense financial scrubbing and the ravenous hunger of institutional capital is going to make this area explode in a very similar fashion as it did in the period from 2002 to 2005. That demand and subsequent explosion in offerings was caused by 9/11. Look for it to happen again.


DEBT UNDERWRITING: Debt underwriting is surging due and the fees are double the normal prices, with over $97T to refinance you can believe that this will lead to dramatic profits. Bet on it—expressly bet on JPM, GS, MS they will continue to dominate this area—the first two are dying to get out from under the onerous yoke of inspection by the government and will be rewarded by the marketplace in terms of their ability to do so while those not so fortunate (i.e. Citi) will be punished. We will not play the bottom or weakness on these. We want to catch the momentum of the institutional buyer on this wave as they have to plow in and will do so on proper valuations.

(DIP) Debtor in Possession has been reinvigorated and will make a tremendous splash, William Ackmann through his activist hedge fund, Pershing Square, pressed the 2nd largest mall operator in the world, General Growth Properties into an incredibly lucrative financing for $375M which will sweeten his equity position and simultaneously create additional exits and future reduced equity acquisition costs. Nice. Ackmann seemingly has a focus for our Illinois companies and he always seems to do well. You may remember that he pressed McDonalds to sell their real estate business—McD’s is really a distribution and real estate play (separate commentary needed to explain—take my word for it) he determined that since REITS were doing so well that Mickey D’s should sell their real estate through an IPO, to stave him off the proprietors of Hamburger University IPO’d Chipotle and paid off Mr. Ackmann who went into the sunset with his sack of loot like the Hamburgular. Follow William as he prefers to be called (not Bill!) he is usually right and has an uncanny way of being prescient.



TRADING: Both JPM and GS had trading profits (of course a lot of their desks were shorting the market!) Make no mistake—trading still rules the day and it is the dominant revenue generator for the investment banks even though they are now BHC’s (Bank Holding Companies). JPM results were great with a 25% margin but were more diversified than those of GS, which still by all intents and purposes is a huge hedge fund. This is why the value at risk (VAR) jumped so high for Goldman: they are employing tons of risk so beware—this will mean that GS will be highly volatile.


Buying the shares of banks will be highly profitable because it will be difficult to buy a bank or start a De Novo bank; that is a company used as a shell or umbrella company for owning and operating a bank, especially with the regulators gone wild! This will assist in driving value (and price!) up. I clearly stated this in the September and it has become a hard fact.


REITS (Real Estate Investment Trusts) I have underwritten over $5B in REITS at my investment bank. These entities will follow the same trend as the banks and will greatly benefit from the government programs. The TARP will greatly assist these guys with cheap leverage for half of the profits. Sweeet! Of the 130 publicly traded REITS (that’s too damn many) most are trading incredibly cheap, nearly 1/3 below $5 –making 30% of the sector practically penny stocks. There will undoubtedly be some attrition, however the investment banks which took these entities public in the first place are avariciously eyeballing the sector so you can be sure that the presence of so many highly discounted stocks that there will be lots of M+A (mergers and acquisitions). The investment banks of course make fees for these! This is another strong buy signal for the banks, with $250B real estate debt coming to maturity their will be lots of action. The credit flow will free REIT’s up to acquire ravenously and accrete value. Mind the financing gap—it will be a huge opportunity.



I will complete our initial market analysis thesis we outlined in March with commentary next on Public Private Partnership and the PPIP influence followed up by Global Liquidity Solutions in which I will begin to explore Shari’ah finance and its applicability on a global basis.


From a practical standpoint, the next areas we will need to go over in depth are the secondary debt markets: these will be of grave importance and are the reason main reason that we are in a crisis at present. We will explore the entire alphabet soup from CLO’s, CDO’s, ABS, CDS and corporate bonds (internationally and domestically) because they will affect a portion of the market that is needed for hyper growth, activation and acceleration of lending. This will be key for the marketplace. In 2013 over $600B of junk bonds (non investment grade debt) will be due.


I will also go over the TARP/TALF plus propositions and how the new TARP master: ex Merrill Lynch alumni Herb Allison who became the head of FANNIE MAE during its nadir, will be a factor and how this might reduce the Goldman Sachs influence quotient in this arena. This area will be critical due to over $300B coming due in 2012 from the “take private” engorgement by private equity.



 It is really getting interesting now.


About the author

Shawn D. Baldwin is Chairman of the AIA Group (AIA), an alternative investment and advisory firm based in Chicago