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AG SETTLEMENT: BAD FOR CREDIT CARDS, GREAT FOR SERVICING BANKS

A Year in the Making ...

The long-rumored servicer settlement details are out at last, with a final announcement expected later today.  We've dug in to the details, and it looks like a strong win for the banks.  Of the $26B total value (per the WSJ), only about $5B is in the form of cash payment.  The balance is from principal write-downs and economic benefit of refinancing. That's a sweetheart deal, especially considering that the principal write-downs can involve mortgages that the servicers don't even own.  For details, see below. 

 

Quick Take on the Details:

- $26 billion settlement, including CA & NY (WSJ)

- $4-5 billion in cash payments by the banks to foreclosed homeowners

- $21-22 billion in principal forgiveness and underwater refinancing assistance

- Of the $21-22 billion, $17 billion will apply to mortgage-backed securities investors, having no impact on the banks.

- The remaining $3-5 billion will be principal forgiveness and underwater refinancing

 

AG SETTLEMENT: BAD FOR CREDIT CARDS, GREAT FOR SERVICING BANKS - servicer settlement share

 

Principal Write-Downs: Banks must effect $17B of principal write-downs for current borrowers.  

Hedgeye: Banks are using the best kind of money to pay for these principal write-downs: other people's money. Yes, this $17B will come out of the pocket of private label MBS investors.  Haven't PLMBS investors suffered enough?  In all seriousness, are there any accusations of wrongdoing against PLMBS investors?  Why are they bearing the cost?  If the argument is to help the broader housing market by helping underwater borrowers, this is a drop in the bucket.  Estimates of the total underwater balance of US borrowers are in the $700B - $750B range.  $17B barely touches that. 


- Payment to borrowers:
 According to the WSJ and FT, borrowers will receive payments totaling $4.2 - $5.0B.  The WSJ reports that $1.5B of that will go to borrowers who were foreclosed between September 2008 and last December.  

Hedgeye: This makes little sense to us. If a borrower wasn't wrongfully foreclosed on, why do they get any monetary settlement?  And if a borrower was wrongfully removed from their home (as happened in certain cases), then a $1,500 payment hardly constitutes justice. What's more, the time frame is odd. Did the banks change their practices at the beginning of 2012?

 

 

Refinancing: Banks must provide $3B worth of benefit to borrowers in the form of refinancing.

Hedgeye: This is once again other people's money, except to the extent that banks are refinancing loans that they own.

 

Liability Waivers: Banks are freed from further liability from the AGs or regulators around foreclosures. However, they don't gain liability waivers around MERS (NY AG Scheiderman's suit will proceed) or around securitization (Schneiderman again, along with the FHFA).   

Hedgeye: That's a pretty good deal on foreclosure wrongs - some states have serious penalties for wrongful foreclosures, and the servicers escape the threat of all of that.  Waivers on other elements would be a real gift.

 

 

Implications of Rising Foreclosures - Bad News For Cards

We wrote extensively on the negative implications of a servicer settlement for the credit card operators back on 7/11/11. But to recap our thoughts we offer the following summary. Clearing the legal morass around foreclosures will cause them to re-accelerate.  The chart below shows the swift drop-off in foreclosure filings when the robosigning scandal broke in October 2010.  While reformed practices may slow the timeline somewhat compared to the pre-scandal time period, and increase in the pace of foreclosures from current levels is very likely.  This has several implications:

 

1) More pressure on home prices: More low-level transactions in the distressed market pulls the home price indicators lower.  Extremely low comps can also pressure non-distressed transactions.

 

2) More bankruptcies: As we showed in a prior research report, foreclosures are highly correlated with bankruptcies.  Although the causality isn't always from foreclosures to bankruptcies, it often is: a bankruptcy filing can serve as a last-ditch effort to save a home.  Increasing bankruptcy filings is a negative for the credit card issuers.  We believe that part of the very low credit costs at the card names for the last five quarters is due to the artificial suppression of foreclosures.  Because bankruptcies flow straight to charge-offs without spending time in delinquent status, the increase in credit costs could hit very quickly.  This would be a negative for the pure-play card names (COF, DFS, AXP) and would slightly offset the benefit for the moneycenters.

 

AG SETTLEMENT: BAD FOR CREDIT CARDS, GREAT FOR SERVICING BANKS - foreclosure filings

 

AG SETTLEMENT: BAD FOR CREDIT CARDS, GREAT FOR SERVICING BANKS - bankruptcies and foreclosures

 

Joshua Steiner, CFA

 

Allison Kaptur

 

Robert Belsky


THE HBM: DNKN, YUM, PNRA, BWLD

THE HEDGEYE BREAKFAST MONITOR

 

MACRO NOTES

 

Consumer

 

Initial jobless claims came in at 358k versus expectations of 370k and 373k the week prior (revised from 367k).

 

THE HBM: DNKN, YUM, PNRA, BWLD - initial claim

 

 

SUBSECTOR PERFORMANCE

 

THE HBM: DNKN, YUM, PNRA, BWLD - subsec

 

 

QUICK SERVICE

 

DNKN: Dunkin’ Brands U.S. comparable store sales were up 7.4% and Baskin-Robbins U.S. comparable sales were up 5.8% as the company reported 4Q EPS of $0.30 versus consensus $0.28.

 

YUM: Yum Brands was upgraded to Neutral from Sell at Goldman.

 

NOTABLE PERFORMANCE ON ACCELERATING VOLUME:

 

PNRA: Panera Bread declined 7.2% on accelerating volume following disappointing earnings.

 

 

CASUAL DINING

 

BWLD: Buffalo Wild Wings was cut to Market Perform by Raymond James.

 

NOTABLE PERFORMANCE ON ACCELERATING VOLUME:

 

BWLD: Buffalo Wild Wings led the space, gaining 17%, following much stronger than expected earnings.

 

THE HBM: DNKN, YUM, PNRA, BWLD - stocks

 

 

Howard Penney

Managing Director

 

Rory Green

Analyst

 



Early Look

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Bad Macro

“The macro is so bad everywhere.  In America, our political leadership is doing nothing to help us get out of the current situation.  Worldwide, Europe is just in a state of financial collapse.  I think we are in plenty of trouble and have to watch ourselves closely.”

-Julian Robertson on CNBC, September 13th, 2011

 

While Julian Robertson is retired from managing other people’s money, prior to his retirement he established probably the best long term record of any money manager with a reported annual return of north of 30% from 1980 to 1998.  More impressive to me has been his ability to mentor, train, and seed successful money managers after retiring from the business himself.

 

I’ve had the pleasure of meeting Mr. Robertson a number of times.  The most notable for me was while I was attending Columbia Business School  and took a class called, “The Analyst’s Edge”, which was taught by John Griffin, founder of Blue Ridge Capital and the former President of Tiger Management.  This class offered me, and my fellow students, a crash course in analyzing companies from the practitioner’s perspective.  In lieu of a final exam, our final grade was based on pitching a stock to Julian Robertson in the Tiger Management boardroom. 

 

Not only was the situation itself intimidating, but the company I had spent the semester researching was Ace Aviation, more commonly known as Air Canada.   As background, in 1999, the year that Tiger Management dramatically underperformed the SP500 and eventually shut its doors, U.S. Airways was purportedly Tiger’s largest equity holding and a key reason for the underperformance.  So, yes, I was pitching an airline to Mr. Robertson, even though it was the industry that had burned him a few short years before.

 

Shockingly, despite my somewhat sweaty palms, the pitch actually went relatively well.  Mr. Robertson was very thoughtful in his questions as it related to my thesis, which was primarily based on a sum-of-the-parts analysis, and seemed very intrigued by the idea.  Now, of course, he may have just been trying to be polite, but I think the better answer is that a key reason he was, and remains, one of the world’s great investors, is his ability to have an open mind and change opinion.  In effect, he showed incredible mental flexibility.

 

I highlighted the quote above to flag the simple fact that Mr. Robertson went on CNBC to emphasize how negative the macro was at the literal 2011 bottom of the stock market.  In fact, since September 13th, 2011 the SP500 is up more than 15% and the Euro Stoxx 100 is up more than 23%.  On an annualized basis, those moves would equate to some of the best annual equity index returns in the last hundred years.  So, was Julian Robertson wrong based on his dour September 13th, 2011 macro outlook?  Well, that ultimately depends how his portfolio was positioned for the last four months.  My guess is that Mr. Robertson and his protégées managed the environment quite effectively and kept their feet moving.

 

Interestingly, on September 13th our CEO Keith McCullough (he is on the road today in Boston) wrote the Early Look and while we shared an eerily similar fundamental view as Mr. Robertson, Keith wrote the following that morning:

 

“Great short sellers in this game have one thing in common – they know when to cover . . . I’ve written 2 intraday notes in Q3 of 2011 titled “Short Covering Opportunity” (one on August 8th and one yesterday). Yesterday’s call to cover shorts generated as much questioning and feedback as any time I think I have ever made a call to cover shorts since the thralls of early 2009. This is an important sentiment indicator.”

 

In hindsight, making the aggressive short covering call on September 12th of last year was the correct call.  Some might call it luck, but for us it was born out of our global macro process.  Now, arguably, we probably should have gotten even more aggressively long.  As always though, the first step in the stock market business is to not lose money.

 

Coming into 2012 we were as bullish as we’ve been in awhile.  One of our key 2012 macro themes was that the rate of global growth slowing would bottom.  In our macro models, marginal rates of change in growth are critical, but as critical is monetary policy, which influences growth.  On January 25th of 2012, the FOMC released the policy statement post their December meeting, with the key line being:

 

“In particular, the Committee decided today to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that economic conditions--including low rates of resource utilization and a subdued outlook for inflation over the medium run--are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014.”

 

So, in one fatal swoop, The Bernank extended the Federal Reserve’s depression level monetary policy out another year.  Monetary policy influences our outlook on inflation, which influences our outlook on growth and equity returns.  Hence, we reversed course following the FOMC policy statement noted above.  Now, maybe that’s Bad Macro, or maybe it’s smart macro.  The data suggests it’s the latter.

 

In the Chart of the Day, we’ve attached an analysis that looks at inflation versus the price to earnings ratio of U.S. equities from 1978 to 2008.  The r squared between CPI, the proxy for inflation, and P/E is very highly correlated at 0.76. As the curve demonstrates, inflation is bad for equities.  That’s not a guess, that’s a fact based on the data and underscores our shift in outlook post the FOMC statement in January.  Some call this mental flexibility, for us it is process. So far, by the way, we’ve been wrong on U.S. equities in the shorter term duration.  That said, fighting the Fed worked in 2011.

 

While I am on the topic of Julian Robertson this morning, I would like to give him credit for more than being one of the best money managers of our time and an incredible mentor of young money managers. I would also like to acknowledge his leadership in philanthropy.  As Albert Einstein said:

 

“The value of a man resides in what he gives and not in what he is capable of receiving.”

 

Indeed.

 

Our immediate-term support and resistance ranges for Gold, Oil (Brent), EUR/USD, US Dollar Index, and the SP500 are now 1717 – 1761, 113.42 – 118.27, 1.31 – 1.33, 78.51 – 78.94, and 1330 – 1360, respectively.

 

Keep your head up and your stick on the ice,

 

Daryl G. Jones

Director of Research

 

Bad Macro - EL Chart 2 9

 

Bad Macro - VP 2 9
  


THE HEDGEYE DAILY OUTLOOK

TODAY’S S&P 500 SET-UP – February 9, 2012


As we look at today’s set up for the S&P 500, the range is 30 points or -1.48% downside to 1330 and 0.74% upside to 1360. 

 

SECTOR AND GLOBAL PERFORMANCE

 

THE HEDGEYE DAILY OUTLOOK - 1

 

THE HEDGEYE DAILY OUTLOOK - 2

 

THE HEDGEYE DAILY OUTLOOK - 3

 

 

EQUITY SENTIMENT:

  • ADVANCE/DECLINE LINE: 480 (91) 
  • VOLUME: NYSE 765.35 (4.99%)
  • VIX:  18.16 2.89% YTD PERFORMANCE: -22.39%
  • SPX PUT/CALL RATIO: 1.40 from 3.12 (-55.13%)

CREDIT/ECONOMIC MARKET LOOK:

  • TED SPREAD: 43.69
  • 3-MONTH T-BILL YIELD: 0.08%
  • 10-Year: 2.00 from 1.98
  • YIELD CURVE: 1.75 from 1.73

MACRO DATA POINTS (Bloomberg Estimates):

  • 6:30am: OPEC monthly crude output report
  • 7am: BoE announces interest rate decision; est. 0.50%, unchanged
  • 7:45am: ECB announces rate decision, est. 1%, unchanged
  • 8:30am: Initial jobless claims, week of Feb. 4, est. 370k (prior 367k)
  • 8:30am: WASDE
  • 9:45am: Bloomberg Consumer Comfort, week of Feb. 5 (prior -44.8)
  • 10am: Freddie Mac 30-yr mortgage
  • 10am: Wholesale Inventories, Dec., est. 0.4% (prior 0.1%)
  • 10:30am: EIA natural gas storage
  • 1pm: U.S. to sell $16b 30-yr bonds

GOVERNMENT/POLITICS:

  • President Barack Obama meets with Italian Prime Minister Mario Monti in Oval Office, TBA
  • U.S. Postal Service, which may run out of money this year, reports quarterly results after 8:30am
  • Conservative Political Action Conference begins in D.C., with speakers including Mitt Romney, Newt Gingrich, House Speaker John Boehner, Sen. Marco Rubio, Gov. Bobby Jindal, Sarah Palin
  • House, Senate in session:
    • House meets at 9am to consider amendments to bill on insider trading
    • Senate Judiciary marks up bill on televising Supreme Court proceedings, votes on federal judge nominations, 10am
    • House Energy and Commerce holds hearing on proposed generic, biosimilar user fees, drug shortages, 10am
    • Mark Zandi, chief economist at Moody’s, testifies before Senate Banking on housing market, 10am
    • Senate Budget hearing on inequality, mobility, 10am

WHAT TO WATCH: 

  • Greek finance minister heads to Brussels after politicians failed to finalize new austerity measures needed to secure $173b bailout package
  • Southern Co. gets regulator vote on bid for first permission in 30 years to build nuclear reactors in Ga., noon
  • Pepsi releases earnings; watch for commentary on restructuring, strategic shifts following business review
  • President Barack Obama’s advisers have grown more confident about U.S. economic growth this year
  • Bank of England, ECB issue rate decisions; both estimated to keep rates unchanged.
  • Diamond Foods ouster of CEO, CFO, restatement of financial data, imperil Pringles deal with P&G
  • USDA Wasde report, 8:30am
  • BP said to be negotiating with U.S. to settle pollution claims over the 2010 Gulf of Mexico oil spill
  • Credit Suisse posts unexpected 4Q loss, hurt by “adverse” markets and reorganization costs
  • California, New  York said to agree to join more than 40 other states in a nationwide settlement that seeks to end abusive bank foreclosure practices

EARNINGS:

    • Precision Drilling (PD CN) 6 a.m., C$0.34
    • Alexion Pharmaceuticals (ALXN) 6:30 a.m., $0.34
    • Bunge Ltd (BG) 6:30 a.m., $1.53
    • Coca-Cola Enterprises (CCE) 6:30 a.m., $0.36
    • Flowers Foods (FLO) 6:30 a.m., $0.21
    • Teradata (TDC) 6:55 a.m., $0.62
    • Philip Morris International (PM) 6:59 a.m., $1.09
    • BCE (BCE CN) 7 a.m., $0.66
    • CBOE Holdings (CBOE) 7 a.m., $0.35
    • Dunkin’ Brands Group (DNKN) 7 a.m., $0.28
    • Fortis (FTS CN) 7 a.m., C$0.47
    • International Flavors & Fragrances (IFF) 7 a.m., $0.71
    • Lorillard (LO) 7 a.m., $1.96
    • PepsiCo (PEP) 7 a.m., $1.12
    • Sirius XM (SIRI) 7 a.m., $0.01
    • Thomson Reuters (TRI CN) 7 a.m., $0.56
    • Brookfield Infrastructure Partners (BIP) 7:30 a.m., $0.36
    • Husky Energy (HSE CN) 7:30 a.m., C$0.55
    • Noble Energy (NBL) 7:30 a.m., $1.16
    • Och-Ziff Capital Management Group LLC (OZM) 7:30 a.m., $0.02
    • Sealed Air (SEE) 7:30 a.m., $0.49
    • Sigma-Aldrich (SIAL) 8 a.m., $0.89
    • Manulife Financial (MFC CN) 8:04 a.m., C$(0.10)
    • Canadian Tire Ltd (CTC/A CN) 8:05 a.m., C$1.85
    • Shoppers Drug Mart (SC CN) 10:30 a.m., C$0.82
    • Great-West Lifeco (GWO CN) 12:05 p.m., C$0.50
    • Expedia (EXPE) 4 p.m., $0.52
    • Nuance Communications (NUAN) 4:01 p.m., $0.36
    • Pitney Bowes (PBI) 4:01 p.m., $0.60
    • XL Group (XL) 4:01 p.m., $0.15
    • Lions Gate Entertainment (LGF) 4:02 p.m., $0.11
    • LinkedIn (LNKD) 4:02 p.m., $0.07
    • Activision Blizzard (ATVI) 4:05 p.m., $0.56
    • Republic Services (RSG) 4:05 p.m., $0.45
    • Cameco (CCO CN) Post-Mkt, C$0.40

COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)

  • Hedge Fund Snaps Seven Annual Gains in ‘Ugly Year’: Commodities
  • Oil Rises an Eighth Day in London on Euro Optimism, Cold Snap
  • World Food Prices Rose Most in 11 Months on Oilseeds, Grains
  • Copper Swings Between Gains, Losses on China Inflation, Stocks
  • Cocoa Falls After Exporters Agree on Ivorian Rules; Coffee Gains
  • Gold May Gain as Dollar’s Decline Spurs More Demand for Metal
  • Wheat May Fall as Australian Exports Increase; Corn Declines
  • India to Sustain Rice Sales to Iran, Seeking to Boost Trade
  • BP Said to Seek U.S. Settlement of Gulf Spill Pollution Claims
  • Rio Tinto Swings to Second-Half Loss on Aluminum Charge
  • Refinery Closing Threatens Virgin Islands’ Debt, Employment
  • Japan Offers $65 Million in Subsidies to Cut Rare Earth Reliance
  • Europe Coal Loses to South Africa on Renewables: Energy Markets
  • North Dakota Oil Boom Brings Bakken Price Bust: Chart of the Day
  • Gazprom Yields Soar as Tax Plan Spooks Investors: Russia Credit
  • Glencore Price for Xstrata Rises Amid No Vote Threat: Real M&A
  • Rabobank May Boost Global Farmer Funding 20% to Offset Europe

THE HEDGEYE DAILY OUTLOOK - 4

 

 

CURRENCIES


THE HEDGEYE DAILY OUTLOOK - 5

 

 

EUROPEAN MARKETS


THE HEDGEYE DAILY OUTLOOK - 6

 

 

ASIAN MARKETS


THE HEDGEYE DAILY OUTLOOK - 7

 

 

MIDDLE EAST


THE HEDGEYE DAILY OUTLOOK - 8

 

 

 

The Hedgeye Macro Team

 


WEEKLY COMMODITY CHARTBOOK

Strong employment trends and favorable weather versus last year has translated into strong top line trends in 4Q and 1Q to date for companies across the restaurant space.  As the benefit of weather fades and compares become more difficult from a top-line perspective as we move through the year, we would expect commodity costs to play a greater role in stocks with exposure to certain commodities.  On aggregate, 2011 was a year where the restaurant space was under pressure from a commodity inflation perspective but strong sales helped most companies leverage COGs.  With overall commodity inflation abating in 2012, and sales trends remaining strong, many expect restaurant companies to continue to post impressive earnings growth.  We agree with that view but think that there are companies that are facing significant exposure to protein costs that may pressure profit margins for FY12 more than expectations are anticipating. 

 

WEEKLY COMMODITY CHARTBOOK - commod

 

 

SUPPLY & DEMAND

 

Beef – WEN, JACK, CMG, TXRH

 

Beef prices are a factor for most of the restaurant companies we follow but WEN (20% of food and paper spend), JACK (20% of commodity basket), TXRH, and CMG are especially exposed.  The chart of live cattle prices, in the “charts” section of this post, below, shows just how far prices have run. Grain prices are holding up at current (elevated) levels and that does not bode well for those hoping for beef prices to snap back.

 

SUPPLY

 

The U.S. cattle inventory is down 1.9% from a year ago and 6% from the January 2007 peak.   While a decline in cattle numbers from a year ago was expected, the drought of summer 2011 that affected the cattle industry added to the liquidation and inventory came in even lower than expectations.  Jim Ross, of the Livestock Marketing Information Center, said in an interview with CattleNetwork that he expects no significant increase in U.S. beef production until at least 2015 as other countries are only beginning to cut production now. 

 

DEMAND

 

Increasing export demand from emerging markets remains supportive for beef prices.  We will be watching broad economic trends and the U.S. dollar to assess how demand is likely to impact beef prices.  Supply, at least recently, has been the most important factor in driving such high prices over the last nine months.

 

 

Coffee – SBUX, PEET, DNKN, CBOU, THI, MCD

 

Coffee prices gained 2.8% week-over-week but are almost 11% below last year’s levels.  SBUX has its coffee costs locked through most of 2013.  The company is past the peak of the inflation seen in coffee prices, according to management commentary on its most recent earnings call (1/26).  Coffee costs have impacted PEET heavily and, as of the company’s most recent earnings call on 11/1/11, inflation had gotten ahead of pricing.  While coffee prices have come down, it seems that supply and demand dynamics are likely to support prices or, at least, make a drastic decline from here unlikely.

 

SUPPLY

 

Global coffee production for 2011/12 will be 130.9 million bags, down from last month’s estimate of 132.4 million bags, according to the International Coffee Organization. 

 

DEMAND

 

Coffee shipments from Brazil, the world’s largest producer and exporter, fell 26% in January from a year earlier. 

 

Global coffee consumption for 2011/12 will be 136.5 million bags versus 135 million bags in 2010 due to increased demand from emerging markets, according to the International Coffee Organization.

 

 

Chicken Wings – BWLD

 

Commodity cost inflation for BWLD will step up in 1Q with 2Q being the most unfavorable compare if prices remain elevated, as wing prices bottomed in 2Q10.

 

SUPPLY

 

The six-week moving average egg sets number declined sequentially from -5% for the week ended 1/28 to -5.3% for the week ended 2/4.  This is a bullish data point for chicken wing prices.

 

DEMAND

 

As beef prices go higher, we expect the food service industry to shift focus to chicken to alleviate cost pressures.

 

WEEKLY COMMODITY CHARTBOOK - egg sets

 

CORRELATION TABLE

 

WEEKLY COMMODITY CHARTBOOK - correl table

 

 

CHARTS

 

Coffee

 

WEEKLY COMMODITY CHARTBOOK - coffee

 

 

Corn

 

WEEKLY COMMODITY CHARTBOOK - corn

 

 

Wheat

 

WEEKLY COMMODITY CHARTBOOK - wheat

 

 

Beef

 

WEEKLY COMMODITY CHARTBOOK - live cattle

 

 

Chicken – Whole Breast

 

WEEKLY COMMODITY CHARTBOOK - chicken breast

 

 

Chicken Wings

 

WEEKLY COMMODITY CHARTBOOK - chicken wing

 

 

Cheese

 

WEEKLY COMMODITY CHARTBOOK - cheese

 

 

Milk

 

WEEKLY COMMODITY CHARTBOOK - milk

 

 

Howard Penney

Managing Director

 

Rory Green

Analyst


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