Make That $60B?
The New York Post is out this morning saying that the servicing settlement will be much larger than previously reported. The settlement will be $55-60B, not the $20B previously rumored, according to "sources close to the discussion" cited by the Post. The money would be applied to restitution for harmed borrowers, civil penalties, and 51 funds - one for each state plus a national fund - for regulators to use at their discretion. These discretionary funds could be used to do principal reductions, although the banks and some AGs worry that principal reductions for delinquent borrowers will create a moral hazard for borrowers who are still current.
We have used the top five servicers' market share to determine their possible liability. The chart below shows the mortgage servicing market share of the top five banks, which collectively control 60% of the market, as of 2009. BAC is the largest servicer, with Wells Fargo in second place. For purposes of this calculation, we are assuming that the settlement amount is $55B and is split on a pro rata basis according to market share among the top five servicers.
To put these levels in context, a $18.5B settlement from BAC is equal to 14% of their tangible book value, while WFC's penalty would be 17% of tangible book. That said, it's likely that any penalty would be due over a period of time, rather than in a lump sum. It's also likely that national regulators would be partially motivated by safety and soundness of the financial system, and would be averse to a settlement so punitive that banks would require recapitalization.
Joshua Steiner, CFA
Our weekly roundup of key commodity price action and company-specific food cost commentary.
There was an interesting divergence over the past week between milk and cheese prices. Cheese prices have flat-lined since early June while milk prices have continued on an upward trajectory. Whether or not dairy prices are set to continue higher or flat-line, the current, historically high, level of dairy prices is sure to weigh on margins for CAKE, DPZ, and PZZA. Grain prices, while still at elevated prices, and up significantly year-over-year, declined last week as warmer weather in Canada and the U.S. may help the development of the spring crop. Despite declining on two of the past three days, coffee costs are up over 4% week-over-week.
Coffee prices have been pressuring the coffee retailers into raising prices over the past couple of quarters and, as the chart below indicates, it will likely be some time before year-over-year inflation in coffee markets subsides. On two of the past three days, prices have come down thanks to reduced concern that frost may damage crops in Brazil – the top coffee producing country. Below is a selection of comments from management teams pertaining to coffee prices from recent earnings calls:
- PEET (5/3/2011): We believe we're better off lowering our earnings guidance by $0.10 this year and continuing with the plans we have in place than we would be curtailing spending activity or taking extraordinary pricing action that would be inconsistent with our long-term business interests, and the more sustainable long term cost of coffee we foresee. As a result, you will see throughout our call today that we have a very strong performing fundamental business, but we have to buy some unusually high priced coffee in the short term, then we're not going to do unnatural things in reaction to an unnatural market environment short term.
- Hedgeye: prices were sliding as the dollar caught a bid but, over the last couple of weeks prices have swung higher again. While it seems that prices may have been “unusual”, this elevated level of pricing may persist for longer than expected.
- GMCR: (5/3/11): Before closing, I also want to touch on rising coffee costs and the effect of our business. Like others in the industry, we are closely watching coffee prices. When we announced our last price increase in September of 2010, coffee prices had increased roughly 30% from $1.45 to $1.90 per pound over the course of roughly three months. Since then, costs have continued to escalate, recently hitting historic highs of more than $3 a pound, a nearly 60% increase since September. In attempt to offset rising green coffee costs, as well as increases in other input costs, we are currently in the process of raising prices for all packaged types. We expect that consumers will see an increase of approximately 10% at the point-of-purchase as the result of this price increase. We expect to see the full benefit of this price increase during our fiscal fourth quarter of 2011. We generally fix the price of our coffee contracts three to nine months prior to delivery so that we can adjust our sales prices to the marketplace.
- Hedgeye: Coffee has backed off the “historic” high of more than $3 per pound but is still at $2.60 plus and up over the last couple of weeks. Demand remains strong; without a rising dollar, expect price to continue to pressure retailers.
- SBUX (4/27/11): Regarding coffee costs, as I have indicated previously, we have fully locked our coffee costs for 2011 and are price-protected for a couple months into fiscal 2012. As we progress through the balance of 2011, we will progressively take actions to secure our coffee needs and lock coffee costs for additional months into 2012. While we expect that the costs we pay for coffee may be higher in '12 than they are in '11, we remain confident that we can offset those increased costs and preserve our long-term earnings growth targets.
- Hedgeye: SBUX is confident that it can pass on price and offset coffee inflation with other efficiencies. It is interesting that it expects higher coffee prices in 2012 than in 2011, which would somewhat contradict PEET’s assertion that in May that prices at the time had been unusual. SBUX expects worse prices to come.
Wheat costs declined 4.1% week-over-week, bouncing over the past couple of days as buyers (China is said to be one) took advantage of the dip in price. The initial decline was widely attributed to easing concerns surrounding supply given signs that the global economy may slow. In addition, Russia, once the world’s second-largest shipper, will lift an export ban on July 1, adding to speculation that global supplies will be ample. Below is a selection of comments from management teams pertaining to wheat prices from recent earnings calls:
- MCD (4/21/11): And so if the commodity markets move significantly from here and the main ones obviously looking at beef, looking at corn, wheat, coffee, et cetera, our guidance reflects where the markets are today. If they stay around these levels, the 4% to 4.5% [commodity guidance for 2011] should be locked in. If they move dramatically up or down, then we'll have to reflect that as we move forward.
- Hedgeye: inflation guidance may have to be adjusted higher.
- PNRA (4/27/11): In this expense line, we expect margin unfavorability to continue to grow on increased all-in cost inflation throughout the year -- and because we haven't taken and we don't currently plan to take pricing in our dough sales for franchisees this year.
- Hedgeye: wheat inflation could possibly subside in the back half of the year as comparisons become less unfavorable for buyers. This will be more likely, of course, if the dollar strengthens.
- DPZ (3/1/11): We’ve got wheat locked down for the year.
Chicken wing prices are continuing to tick higher, rising 2.5% last week. BWLD is a name we are cooling on (not based on COGS!) but the next quarter, we expect, will still be strong. Below is a selection of comments from management teams pertaining to coffee prices from recent earnings calls:
- BWLD (4/26/11): For cost of sales, the traditional wing market continues to be favorable and the price of chicken wings for the first two months of the second quarter is averaging about a $1.02 per pound, which is lower than any quarterly price since 2003. It compares to last year’s average price for the second quarter of $1.51. Our Boneless Wings contract is extended through March of 2012 at flat pricing to 2010.
- Hedgeye: Traditional wings count for 20% of restaurant sales and boneless wings count for 19%.
Notable news items and price action from the restaurant space as well as our fundamental view on select names.
The main commodity data points this morning are wheat and coffee prices declining. Warmer weather may aid wheat spring prospects and easing fears about frost damage in Brazil is causing coffee prices to decline.
French newspaper Le Figaro is claiming that French lawmaker Bernard Reynes is proposing an increase in the value-added tax on soft drinks from 5.5% to 19.6% to help finance assistance to agriculture.
- CMG, it emerged yesterday, invested $2.5m in Soul Daddy, the winner of the America’s Next Great Restaurant television show. $2.5m is equivalent to $0.08 per share for CMG.
- SONC has introduced a line of sundae shakes and a new spicy hot dog option.
- PZZA was cut to “Neutral” at SunTrust Robinson. The stock closed down -4.7% on accelerating volume yesterday.
- CBOU, PEET and SBUX all gained on accelerating volume as coffee prices came down.
- DRI was raised to “Strong Buy” at Raymond James. The PT is $62.
- RUTH, BJRI, and BWLD gained on accelerating volume.
TODAY’S S&P 500 SET-UP - July 6, 2011
As we look at today’s set up for the S&P 500, the range is 35 points or -1.71% downside to 1315 and 0.91% upside to 1350.
SECTOR AND GLOBAL PERFORMANCE
- ADVANCE/DECLINE LINE: -39 (-2012)
- VOLUME: NYSE 906.95 (+4.84%)
- VIX: 16.06 +4.84% YTD PERFORMANCE: -9.52%
- SPX PUT/CALL RATIO: 1.87 from 1.30 (+43.98%)
CREDIT/ECONOMIC MARKET LOOK:
- TED SPREAD: 23.56
- 3-MONTH T-BILL YIELD: 0.02%
- 10-Year: 3.16 from 3.22
- YIELD CURVE: 2.72 from 2.72
MACRO DATA POINTS:
- 7 a.m.: MBA Mortgage, prior (-2.7%)
- 7:30 a.m.: Challenger job cuts, prior (-4.3%)
- 7:45 a.m./8:55 a.m.: ICSC/Redbook Weekly Sales
- 10 a.m.: ISM non-manufacturing: est. 53.7, prior 54.6
- 11:30 a.m.: U.S. to sell $28b 4-wk bills
- 4:30 p.m.: API inventories
WHAT TO WATCH:
- President Obama will take questions today in what White House officials are calling his first Twitter town hall
- IMF Managing Director Lagarde to hold news conference in Washington at 9:30 a.m.
- Greek banks are willing to roll over their government bonds as part of a European Union aid plan, Finance Minister Evangelos Venizelos said; debt-holders meet in Paris today
- Allen & Co. conference continues in Sun Valley; watch for developments on Hulu talks
- Facebook to make announcement; reports from TechCrunch, others have indicated it’s a video-chat partnership with Skype
COMMODITY HEADLINES FROM BLOOMBERG:
- Rice Futures May Help Tokyo Grain Exchange Break Even After Run of Losses
- Crude Oil Declines as Portuguese Debt Downgrade Sparks Demand Concern
- Wheat Drops as Warmer Weather May Aid Spring Crop Prospects; Rice Gains
- Coffee Falls for a Fourth Day as Frost Concern Eases; Sugar Prices Slide
- Cotton Poised for Further Declines on Fibonacci Levels: Technical Analysis
- Copper May Drop, Risking Longest Winning Streak of 2011, on Debt Crisis
- Gold May Climb for Third Day as European Debt-Crisis Concern Spurs Demand
- U.S. Farmland Boom May Peak in 2011 After Five-Year Surge, Rabobank Says
- Oil Supply Falls Fifth Week in Survey on Refining, Imports: Energy Markets
- Kodak Default Odds Reach 74% After License Suit Delays: Corporate Finance
- BASF Said to Consider Ending Genetically Modified Crop Research in Germany
- Coal of Africa Climbs Most Since 2008 in Johannesburg on Project Approval
- Australia Ends Month-Long Suspension of Live Cattle Shipments to Indonesia
- Oil Tanker Rentals Seen Sinking to the Lowest Since 1997: Freight Markets
- EUROPE: markets fall after 7 days of gains.
- Moody’s downgraded Portugal’s credit rating to junk on Tuesday
- Spain and Italy this morn -both markets down hard and broken TRENDs, while Germany continues to look great.
- Germany May industrial orders +1.8% m/m vs consensus (0.5%) and prior revised +2.9% from +2.8%
- UK June Halifax house prices +1.2% m/m vs consensus +0.0% and prior +0.1%
- ASIA: looks better and better by the day with both the KOSPI and Sensex breaking out above Hedgeye’s immediate-term TRADE lines