Brokers Get the Message, Mythical Bottom in Sight?

Brokerage executives were put on notice earlier this week that they will need to get their houses in order, and quickly.

While Vikram Pandit would like to see the new regulatory "unified framework" treat banks and brokers equally, that is simply not going to happen, as I had mentioned Wednesday:

“For years, we have made a distinction between depository and non-depository institutions,” said Mr Steel, Treasury secretary Hank Paulson’s right-hand man during the credit crunch. “I don’t think [future regulation] will be the same as for a depository institution.” FT

The various government agencies (CFTC, Federal Reserve, Treasury Dept. and even the ECB) are talking tough. Bernanke's actions staved off an out and out rout, and commodity traders ran with the ball, but they are clearly preparing to take back the easy credit, and bring a little tough love to the markets.

Steel put the brokers on notice this week as well, and they have roughly three months to get their balance sheets in order. Dividend reductions and/or eliminations are imminent for the weaker firms, and the capital raising will be fast and furious.

Merrill Lynch got the memo, and John Thain is already at work exploring sales of Merrill's stakes In Bloomberg LP and Blackrock (BLK-NYSE). Together with a capital raise, Thain should be able to raise about $10 to $15 billion. And he will need it; Steel indicated the the credit facilities provided by the Fed are going to be pulled, as we noted 60 hours ago.

Mr Steel stressed that the borrowing window for investment banks was a temporary measure. When asked if the window would remain open beyond its September deadline, as is widely believed on Wall Street, Mr Steel said: “I stressed the word temporary.” FT

I had mused on Wednesday evening that this might bring some cheer to brokerage execs, whose stocks have been clobbered, in part, by fears of a draconian regulatory posture.

But with Treasury controlled by Goldman alums, that is not going to happen. Vikram loses again. But it is a trade off, as the brokers go off the government dole.

The thesis we have borrowed for Mohamed El-Erian is crucial to building an investment case:

If you are a bond holder, you want to be ahead of a recapitalization. If you are an equity holder, you always want to come in after. When people have been pushing the financial sector, they haven’t made the distinction between what is is good for the bondholder and what is good for the equity holder.

The equity holder wanted to buy emerging markets after they recapitalized in the late 1990’s, U.S. corporates after after they recapitalized in 2002 and 2003 on the back of Enron, Worldcom, etc. The timing is critical. For the bondholder’s it’s the other way around because a recapitalization lowers risk and therefore brings in spreads. And the people who are diluted are equity holders. Mohamed El-Erian/PIMCO

The nasty little selloff in Merrill’s (MER-NYSE) stock today, spurred by Charlie Gaparino’s CNBC Powerlunch report on Thain’s trial balloon is a clear example; the brokerage stocks, outside of Goldman, cannot be bought until the money is raised. Lucky for Merrill they have some choice assets to put on the block.

But getting ahead of a capital raise, particularly a dilutive equity deal is ill-advised, as we saw with Lehman earlier this week. The landscape is getting easier to handicap however, and scaling in to positions might suit some people just fine. But the bloodletting should be coming to an end.

The brokers have to get liquid, and fast, as the clock is ticking. More layoffs are likely as well, as the SellSide continues to shrink and reduce its cost structure.

It should make for an interesting summer as sovereign wealth and private equity funds explore options; the Blackstone (BX-NYSE) rumors today, vis a vis Lehman, are an example of what we will hear for the next few months.

By Halloween the process should be complete, something the stocks are beginning to sniff out. But life will never be the same. There might be light at the end of the tunnel however, as distressed and credit hedge funds such as the one recently formed by Paulson & Co. pick through the bargain bin. Brokers will be holding one final tag sale as the delevering process comes to an end.

For better or worse, Goldman will likely come out of this in better shape than their Wall Street rivals. Some things never change on Wall Street.

Of course, it is all too late to save Erin Callan. Part of her supposed “credibility” problem was saying Lehman did not need to raise capital, and of course they relented. John Thain has been saying the same thing, but now he has relented. Yes, there were other issues with Erin, including more bloat on the books, but it reminds me off an old phrase.

Life ain’t fair.
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Combine the fundamentals with Jordan Kotick’s technicals, and the planets might be starting to align.

There are differences between the banks and brokers, but the correlation is close enough to make this worthwhile in building a thesis for financials. Patience required.

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No Retreat for Wall Street as Robert Steel Burns the Boats
1440 Wall Street

Top Treasury official eases Wall St fears
Financial Times
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Wrong! The selloff in brokers earlier this week was driven, in part, by articles like this. There was a trade there, did you take it?

Big brokerage firms may be regulated like banks
Marketwatch

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StockJockey Geithner’s unifed framework speech was a downer for brokers on Monday, but your Steel piece rebuts that. So brokers should rally
01:09 AM June 12, 2008

StockJockey Geithner’s speech hit brokers Tuesday, but Treasury’s Steel is opposed. Could set up a bounce for brokers ..just thinking aloud ..pardon
01:14 AM June 12, 2008

StockJockey Which makes them forced sellers down here, and then coast is clearer according to El-Erian’s theory. MER raises next? 
11:45 AM June 12, 2008

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