presentation for vba may 2008wouter ten brinke, cfa

Presentation for VBA

May 2008 Wouter ten Brinke, CFA

Bubble Talk

• Introduction Theta Capital Management

• Financial alchemy: growth of the non-bank banking system

• Deflating the credit bubble: the cycle in reverse

• Long/short investing: how to benefit from upcoming

opportunities

Agenda

Independent Hedge Fund Boutique

• Founded in January 2001

• Management of multi-hedge fund portfolios

• EUR 950m AuM in customized mandates & funds of funds• EUR 600m in Medium Volatility strategy• EUR 200m in Low Volatility strategy• EUR 150m in Deep Value strategy

• Staff of 8 investment professionals and 4 support

• Research-driven investment process

• Advisory board of hedge fund experts

Theta Capital Management


Products

Performance statistics since inception

ProductReturn

p.a.Vol

Sharpe ratio

Inception

Theta Multistar Medium Volatility 10.34% 5.81% 1.29 Feb- 04

Theta Multistar Low Volatility 6.10% 2.67% 1.23 J an- 04

VP Theta Hedge Funds Strategy 10.15% 5.11% 1.43 J ul- 05

Vermeer Mid Volatility 10.88% 5.49% 1.47 Mar- 03

Vermeer Low Volatility 6.29% 2.33% 1.49 Mar- 03

Theta Client Portfolios * 11.33% 5.34% 1.59 Sep- 01

Theta Master Fund * * 7.10% 3.10% 1.38 May- 05

Theta Deep Value Fund 31.55% 8.96% 3.21 J ul- 06

* C omposite of Theta managed accounts* * Underlying fund for Theta S tructured Products


• Financial alchemy: growth of the non-bank banking

system



opportunities

Agenda

Financial alchemy

Source: Theta

Bank Balance Sheet

Deposits

AA

AAA

Equity

Loans

Source: Theta

Bank Balance Sheet

Deposits

AA

AAA

Equity

Loans

12 X leverage

Financial alchemy

Source: Theta

CDO Balance Sheet

BBB

A

AA

AAA

Equity

Bonds / CDS

Source: Theta

CDO Balance Sheet

BBB

A

AA

AAA

Equity

Bonds / CDS

Financial alchemy

Source: Theta

MBS Balance Sheet

BBB-

BBB

A

AA

AAA

Equity

Mortgages

Source: Theta

MBS Balance Sheet

BBB-

BBB

A

AA

AAA

Equity

Mortgages

Financial alchemy

Source: Theta

CDO of ABS Balance Sheet

BBB-

BBB

A

AA

AAA

Equity

ABS / MBS / CDOs

Source: Theta

CDO of ABS Balance Sheet

BBB-

BBB

A

AA

AAA

Equity

ABS / MBS / CDOs

Financial alchemy

Source: Theta

Monoline insurer Balance Sheet

BBB-

BBB

A

AA

AAA

Equity

Financialguarantees

Source: Theta

Monoline insurer Balance Sheet

BBB-

BBB

A

AA

AAA

Equity

Financialguarantees

94 X leverage !

The result: a shadow banking system

• CDO’s turned low quality assets into combination of high and low

rated assets

• CDO’s provided additional capital to weak lenders, adding

leverage to the system

• CDO’s segregated risk takers from risk assessors (leveraged &

engineered pools of credit replaced old-fashioned credit analysis)

• All these vehicles are effectively non-regulated banks, not

required to hold reserves, except as negotiated with the rating

agencies

• Agents had similar incentives: banks, rating agencies, CDO

managers

Financial alchemy

Inflating the credit bubble

Leverage in US defies the long-term trend

(10% of GDP)(10% of GDP)


Freely available credit• Low interest rates

• Relaxed lending standards

• Financial “innovation”

• CDO demand

More leverage / More buyers:• LBO Hedge funds

• CDO Other investors

Increasing

asset values

Decreasing

default rates

Freely available credit• Low interest rates

• Relaxed lending standards

• Financial “innovation”

• CDO demand

More leverage / More buyers:• LBO Hedge funds


Increasing

asset values

Decreasing

default rates

Source: Theta


Source: Theta

Rapid acceleration of debt for productive use

Profitable companiestake on more debt

Most debt is used to rollover existing debtCompanies pay back

interest & principal at maturity

Traditional finance:

Companies pay back only interest

Speculative finance:

Relaxed lending standards:

“Worst loans are made in the best times”

Companies borrow more to pay back interest

Ponzi finance: Minsky Moment:

Lenders become cautious

Debt structures are nolonger accepted

High-profile entity has toliquidate assets

Rapid acceleration of debt for productive use

Profitable companiestake on more debt

Most debt is used to rollover existing debtCompanies pay back

interest & principal at maturity

Traditional finance:

Companies pay back only interest

Speculative finance:

Relaxed lending standards:

“Worst loans are made in the best times”

Companies borrow more to pay back interest

Ponzi finance: Minsky Moment:

Lenders become cautious

Debt structures are nolonger accepted

High-profile entity has toliquidate assets

Crucial element: it is the new liquidity that supports the asset values and keep existing investors happy

Financial Instability Hypothesis (Hyman Minsky, 1982)

• Financial structure becomes more fragile over periods of

prosperity

• We fall in love with innovations (with no history, by

definition)

• In prosperity, we are gradually testing the limits of the

market, but the adjustment and revaluation can be sudden

and violent


2000 20072000 2007





opportunities

Agenda

Reduced availability credit• Higher interest rates

• Tigther lending standards

• Stop to financial “innovation”

• CDO demand halts

Less leverage / less buyers:• LBO Hedge funds


Decreasing

asset values

Rising defaultrates, lowerrecovery

Catalyst: unexpected defaults

Reduced availability credit• Higher interest rates

• Tigther lending standards

• Stop to financial “innovation”

• CDO demand halts

Less leverage / less buyers:• LBO Hedge funds


Decreasing

asset values

Rising defaultrates, lowerrecovery

Catalyst: unexpected defaults

Deflating the credit bubble: cycle in reverse

Deflating the credit bubble: mortgage credit

Long-term investment theme: US Housing market



S&P Case-Shiller US Home Price Index

- 15%

- 10%

- 5%

0%

5%

10%

15%

20%

Ma

r-8

8

Ma

r-9

0

Ma

r-9

2

Ma

r-9

4

Ma

r-9

6

Ma

r-9

8

Ma

r-0

0

Ma

r-0

2

Ma

r-0

4

Ma

r-0

6

Home Price Appreciation (HPA) YoY


BBB-

BBB

A

AA

AAA

Credit support for ABX tranches

0%

4.5%

5.6%

8.6%

14.0%

23.9%

4y Cumulative HPA

-40%

-20%

+5%

+20%

Mortgagepool

Source: Citi, Theta


Long-term investment theme (2006): US Housing market

Moody’s expected loss:

0.001%

0.025%

0.180%

1.309%


Funding liquidity risk

• Funding risk = liabilities reprice before assets reprice

• Who can post collateral when the market moves against him?

• Weak hands: the importance of long-term funding (SIV, CLO,

TRS)

Counterparty risk

• CDS market has grown 10X in last 4 years

• Who is selling CDS? (source: BBA)• 34% Banks• 21% Insurance companies• 15% Hedge funds • 14% Securities houses• 16% Other

Who’s next? The weakest hands

Who’s next? Corporate credit

Compostion of High Yield Market and Default Rates

18%

23%

19%21%

27%

41%

30%

33%

14% 14%

30%

39%

33% 34%

51%

0%

10%

20%

30%

40%

50%

60%

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Source: E. Altman, NYU Salomon C enter

Default Rate (%, RHS) % New HY Issues Rated B- or below

Who’s next? Corporate credit

Never before have we turned the credit (and economic) cycle with so much

leverage in the system

Who’s next? Commercial real estate

Lending standards are tightening...





opportunities

Agenda

1. During the credit unwind (short positions):

• Mortgage credit: residential & commercial, US & Europe

• Other US consumer credit: credit cards & autoloans

• Corporate credit: focus on HY and lower rated tranches with

default risk rather than spread risk

2. After the credit unwind (establish deep value long positions):

• Distressed ABS

• Distressed corporate credit

3. More volatility/price dispersion in all risky assets (example trades):

• ABS, corporate debt, equity long/short

• Emerging markets sovereign debt

• European sovereign debt

How to benefit?

The credit opportunity set

Long/short emerging markets

No broad decoupling but divergence between countries

Components: inflation, fiscal balance, debt/GBP ratio, current account, FX reserves, trade/GDP, FDI/GDP

Example portfolio

Long/short emerging markets

European Sovereign Divergence

The Stability Pact is dead and the ECB will not bail out

European Sovereign Divergence

“EU bond markets begin to diverge”

Wall Street Journal, 7 Feb 2008

“Europe ministers call on France to meet budget pledge”

Bloomberg, 12 Feb 2008


Contact Details

Theta Capital Management B.V.Johannes Vermeerstraat 91071 DK AmsterdamThe Netherlands

Telephone: +31 (0) 20 5722733Fax: +31 (0) 20 5722744E-mail: [email protected]: www.thetacapital.com

presentation for vba may 2008wouter ten brinke, cfa

Documents

credit bubblesource

credit bubbleleverage

engineered pools of

us housing marketdeflating

investment professionals

us housing marketwhos

additional capital

hedge funds