There was a lot of uproar back in March when the Fed arranged the deal for JPMorgan to buy troubled investment bank Bear Sterns. The deal, which pissed off a lot of taxpayers, put up 30 billion taxpayer dollars up to cover Bear’s risky investments losses.

More recently the Fed moved to bail out mortgage purchaser and guarantors Fannie Mae and Freddie Mac – yet let the fourth largest investment bank in the country, Lehman Brothers, fail. Now the Fed has arranged a two year, 85 billion dollar loan (of taxpayer money) to American International Group. My opinion- this loan was absolutely necessary and anyone who wants to complain about how the government is “privatizing gains and socializing losses” should first look at the terms of the deal and then look at what would have happened if AIG went bust.

The Terms of the Deal- Hardly a Bailout
AIG will receive up to $ 85 billion from the Federal Reserve Bank of New York. The funds are being lent at LIBOR plus 850 basis points (not very favorable loan terms from the viewpoint of the borrower). The Fed is also getting a controlling 79.9 percent of AIG’s equity interest, and will have the right to veto the payment of dividends to common and preferred shareholders. The deal will give AIG time to sell some assets, while still remaining solvent.

If AIG Had Gone Bust
I am certain there would be international financial bedlam. AIG is the world’s largest insurer by far, and has a very integral CDS ( credit default swap) business. Without AIG we would see the credit markets seizing up worse than Caesar in Act I scene ii. With that tightening credit would have come a wave of investment bank defaults. Eventually the mayhem on Wall Street would have spilled over to Main Street and who knows where the trouble would end. If AIG had failed I don’t think it is unreasonable to think that the US and perhaps even the world, could have entered into a multi-year long economic downturn.

In conclusion, I am more than satisfied with the bailout; the terms were reasonable, and the steps taken were necessary.

Disclosure- Long AIG.

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I get a lot of questions about bank stocks- have we seen a bottom? Is it safe to start nibbling? What bank is the cheapest? And while the financials are not my favorite sector right now, I think that if you have a longer term investment horizon – JP Morgan is the bank stock that should take a look at.

Just an aside

There seems to be a lot of confusion about what it means for a stock to be “cheap.” People often say things to me like – “but WaMu is trading at 4 dollars, don’t you think it is really cheap right now?” First of all the nominal value of an individual stock has nothing to do with how cheap or expensive a stock is. This argument cannot even be made from a market cap perspective as a lower share price does not mean a “smaller” company because the number of share outstanding varies greatly from stock to stock. If you are going to talk about how cheap a stock is you need to base that argument on a comparable metric -such as P/E, fP/E, P/S, P/BV, ROE, etcetera- and then look at that metric with regards to how risky the stock is. So the per share price has nothing to do with how “cheap” a stock is. I know why so many people think this – in the real world it is perfectly logical for someone to consider a pen that costs 4 dollars to be cheaper than one that costs 200 dollars. But that is the type if thinking that will get you in a lot of trouble in the investing world.

Now back to JP Morgan Chase

The company operates in over 50 countries worldwide and has assets of 1.3 trillion dollars. The market value of JPM’s equity is 133 billion dollars, 71% of which is owned by institutions.  JPMorgan’s operations are divided into the following six divisions: Investment

Banking, Retail Financial Services (RFS), Card Services (CS)( 155 million cards in circulation, 157 billion in loans), Commercial Banking (CB), Treasury & Securities Services (TSS)( 15.9 trillion dollars in custody in 2007), and Asset Management (AM)( 1.5 trillion dollars under management).The stock yields about 4% and trades for about 11x next year’s earnings. In July, the company wrote down 1.5 billion dollars of mortgage backed assets.

From 2007 Annual Report.

Lower Risk in a Risky Sector

In my opinion JP Morgan is a lot less risky than most other stocks in the financial sector. Firstly, JPM has a Tier 1 capital ratio of 9.1%, and a reserve ratio which is 2.47% of loans.  Moreover, the company is expanding into emerging markets and already has a strong international presence. International diversification is one of the key factors that separate those “cheap” regional banks like WM and SOV, from the big guys like JPM that are worth investing in.

JP Morgan in a Good Place to Take Advantage of Subprime Crisis

Although the financial institution will undoubtedly be affected by the deteriorating credit situation, I believe JPM is in a good position to buy underpriced assets as the downturn continues. In late March, the company bought Bear Sterns for the fire sale price of $10 per share. This deal gives JPM the lead in the in the prime brokerage business – which could be a very good business to be in as the financial markets eventually rebound. I think that JPM got Bear really cheap and can continue to do such deals in the future because it has a stronger balance sheet than many of its peers. In addition to that, JPM should be able to gain market share in many of the businesses it operates in as weaker companies lose ground.

Conclusion

Finally, JPM’s CEO Jamie Dimon just seems like the more level headed than the CEO of the other major banks. He put aside more money for bad loans than many competitors and he is not overly optimistic about the future. When he saw that prime sucked he said it – I like that. I believe the banks will remain very volatile over the next 6 months, but if you have a long term investment horizon and want to buy a bank stock I would recommend you look at JPM and start dollar cost averaging.

Questions/Comments - feel free to email me at domenic@domenicstrazzulla.com
Disclosures – None, potentially Long JPM soon

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A very interesting ETF launched on 8/25/08 – the Claymore/Delta Global Shipping Index ETF (SEA). This is the first ever ETF that tracks only companies involved in the global shipping industry. In case you are not familiar with ETF’s- which you should be since I think they are one of the greatest things to happen to the investment world in the last 2 decades- ETF stand for Exchange Traded Fund. These investment vehicles are traded just like stocks, and have very low expense ratios (and no loads). Essentially, ETF’s are indexes that track a basket of stocks while giving investors easy diversification and tax efficiency with very low fees.
SEA’s Specs
SEA is comprised of 30 securities, with a weighted average market cap of 2.9 billion and a weighted average P/E of 10.3. Popular names in the fund include such global shipping players as DRYSHIPS INC(2.48 %), FRONTLINE LTD(3.91 %), EUROSEAS LTD(4.57 %), NAVIOS MARITIME HOLDINGS(4.21 %), and DIANA SHIPPING INC(4.09 %). The fund also sports a very low expense cap of .65 percent. The top country weightings of the index are Greece – 35.3% (surprise, surprise), USA - 19.08%, Bermuda – 15.37 % and Bahamas - 10.09%. The fund will also distribute a dividend( if there is any) on a quarterly basis.
Why I like SEA
I like SEA, because I like the shipping sector and SEA gives me a low cost, diversified way to play the sector. I like the shipping sector because of the shortage of dry bulk capacity coupled with an increase in shipping demand coming from manufacturing growth in Asia and new investment in infrastructure worldwide. Dry bulk capacity lagged due largely to the credit crisis which held back some investment in new shipyards, that’s the supply, part. As the trend toward globalization continues, demand for shipping should remain strong, that’ the demand part. Global transport demand should also grow with the move towards urbanization in the emerging markets, and greater trade due to greater international wealth.

Questions/Comments - feel free to email me at domenic@domenicstrazzulla.com

Disclosure- None

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