Thames River fund, the same fund that made a small fortune (actually a large fortune) shorting subprime last year has gone long a few subprime assets that have been hit hard over the last year. The call is less about the quality of subprime, and simply a valuation play - the assets have gotten cheap with prices that are low relative to their expected default rates. With a few subprime securities trading at 10 cents on the dollar, the risk/reward is appearing favorable, but picking a bottom is difficult. Cheap assets can always get cheaper. Even so, it encouraging that some of the same traders and funds that successfully sold the market down during last year's credit fallout are beginning to take the other side. The smart money tends to buy when things look the worst, or at least that is what we are led to believe. I am sure there is also a little selection bias here as with other trades and asset classes, as those incorrectly predicting market tops and bottoms get filtered out. Regardless (easy for us to say), at least we are hearing of major players with large capital going long, signaling a potential shift in market sentiment for this area of the credit markets - a signal that if true, even if early, has much larger ramifications.

The hedge fund firm Structured Portfolio Management has tried to take advantage of the different stages of the recent and on-going credit problems. Initially, the fund shorted subprime mortgages back in February of 2007. In May, the fund took bets on volatility increasing. In September, they started buying discounted AAA and AA rated paper from banks and others forced to liquidate. Senior tranches were also looked at in an attempt to pick up the liquidity premium, but still maintain some safety with the senior tranches. Hindsight is always 20-20, but the fund certainly had a nice track record and made some smart moves. Currently, the fund is investing in interest-only paper, hoping to benefit from the recent slowdowns in the mortgage market. This paper typically has prepayment risk, such that you will need to reallocate funds earlier than expected, often at a lower yield. Nonetheless, current mortgage problems, and the subsequent stricter regulations placed on lenders and borrowers, are making new loans and refinancing more difficult and expensive. For funds, this may be an opportunity to lock in a higher rate for a longer than expected period, often boosted by getting this paper at a discount.

As a general rule of thumb, crude oil has traditionally traded at a 7-8 multiple to natural gas, or put another way, natural gas trades at a 7-8 times discount to crude. With May crude contracts hitting $116.69 a barrel, and May natural gas contracts at $10.587 mmBtu, is the traditional 7-8 crude oil to natural gas multiple breaking down, or will we see a correction soon? Given the current price of crude, natural gas should be trading somewhere in the range of $14.586 to $16.670. Does this make natural gas a possible trade? It depends on two things. First, do you believe the crude oil / natural gas multiple is valid during a period of increased volatility? Second, will crude continue its march to $120 and beyond, or at least stay above $100 per barrel. Given the beginning of the summer driving season, and the published supply and demand constraints, a price for crude staying over $100 a barrel through the summer seems possible. Even at $100, natural gas should approach $12.5 mmBtu on the low end with the 8 multiple. Recent natural gas finds will add some relief, but this supply will take a while to materialize. Increased use of natural gas to fuel power plants, driven by both environmental concerns with coal and safety concerns with nuclear (both interesting plays in and of themselves), will put further pressures on natural gas supply.

While futures are a natural position, many traders have a bias or preference for equities. Fortunately, numerous stocks with natural gas exposure exist, many of which also include exposure to crude oil. A few of interest including the following:

Anadarko (APC, $68.90, P/E 8.53, Market Cap 32.25B): Involved in exploration, development, and production of oil and natural gas, with proved reserves of 8.5 trillion cubic feet of natural gas. The company is buying back shares and paying down debt, with the stock price currently in an up trend.

Apache (APA, $142.51, P/E 16.99, Market Cap 47.45B): An independent energy company engaging in exploration, development, and production of oil and natural gas, with proved reserves of 14.7 trillion cubic feet of natural gas. The company has a dependent on crude oil prices more than some purer plays, even beyond any multiples. The stock is currently in an up trend.

Canadian Natural Resources (CNQ, $84.50, P/E 17.70, Market Cap 45.65B): The second largest oil and natural gas producer in Canada with proved reserves of 3.8 trillion cubic feet of natural gas. Operating expenses have been a worry, and the stock is strongly levered to oil in addition to natural gas. The stock is currently hitting upper resistance, with a potential double top.

Chesapeake Energy (CHK, $50.39, P/E 19.23, Market Cap 25.90B) An oil and natural gas exploration and production company with 10.879 trillion cubic feed equivalent of proved reserves. As discussed before, Chesapeake Energy is the second largest independent producer of natural gas in the U.S., and recently announced new natural gas discoveries. The company is expecting output increases of 21% this year, and 16% next year. The CEO, Aubrey McClendon, is also increasing his position in the company, purchasing another 1.5 million shares recently, raising his stock total to $1.2 billion. He also recently stated how the impact of the Fayetteville Shale could total $18 billion over the coming decade. Obviously, he believes the natural gas story, as well as his company's prospects. The stock is in an up trend.

Devon Energy Corporation (DVN, $118.40, P/E 14.82, Market Cap 52.62B): Involved in exploration, development, production, and transport of oil and natural gas with proved natural gas reserves of 8,994 billion cubic feet and 321 million barrels of natural gas liquids. Recently, the stock is in a strong up trend.

El Paso Corporation (EP, $17.62, P/E 11.48, Market Cap 12.35B): A natural gas exploration, production and transmission operations company, with an estimated 2.9 trillion cubic feet of natural gas equivalents of proved natural gas and oil reserves. The stock is nearing overhead resistance.

Encana Corporation (ECA, $86.23, P/E 16.65, Market Cap 64.69B): Exploration, production, and marketing of natural gas, crude oil, and natural gas liquids. Largest natural gas producer in Canada with 13.3 trillion cubic feet of natural gas. The stock is in an up trend.

EOG Resources (EOG, $134.17, P/E 30.67, Market Cap 33.14B): Exploration, production, and marketing of natural gas and crude oil, with estimated net proved reserves of 6,669 billion cubic feet of natural gas. The stock is in a strong up trend.

Equitable Resources (EQT, $67.96, P/E 32.42, Market Cap 8.30B): Equitable operates an integrated energy company in the Appalachian area, with natural gas production, distribution, and transportation activities, with approximately 2,682 billions of cubic feet equivalent of natural gas. EQT is in a recent up trend.

Noble Energy (NBL, $90.55, P/E 16.63, Market Cap 15.56B): Involved in exploration, development, production, and marketing of crude oil and natural gas in the U.S., with proved reserves of 3.3 trillion cubic feet. The stock is in an up trend after recently coming out of a trading range.

Petroleum Development Corporation (PETD, $77.14, P/E 34.47, Market Cap 1.15B): Involved in acquisition, development, production, and marketing with proved reserves of 593,563 million cubic feet of natural gas. The stock is in an up trend.

Quicksilver Resources (KWK, $41.48, P/E 14.48, Market Cap 6.57B): Independent energy company engaging in acquisition, exploration, production, and sale of natural gas, natural gas liquids, and crude oil, with proved reserves of 1.5 trillion cubic feet equivalents of natural gas. The stock is in an up trend.

Range Resources Corporation (RRC, $71.60, P/E 46.55, Market Cap 10.73B): Involved in exploration, development, and acquisition of oil and gas properties, with approximately 1,125,410 million cubic feet of natural gas reserves. The stock is in an up trend.

XTO Energy (XTO, $67.57, P/E 19.14, Market Cap 34.48B): Company involved in acquisition, development, and exploitation of natural gas properties, with proved reserves of 6.94 trillion cubic feet of natural gas. Recently agreed to pay $600 million for Linn Energy. The company also recently priced $2 billion in senior notes. The stock is currently in an up trend.

From the list, APC, APA, CNQ, CHK, ECA, EQT, and XTO all seem to be on the radar of just about everyone, as these stock are often mentioned by analysts on TV, in the print media, and discussed on the blogs. Each also has a relatively/historically high P/E (each over 16, with the exception of Anadarko). Nonetheless, if the 7-8 multiple holds, those stocks levered more to natural gas, such as Chesapeake, could see even higher valuations.

LIBOR has begun rising after a recent WSJ article (see previous post) mentioned that some BBA member banks may be under-reporting their costs for borrowing money. Various analysts estimate that the rate could be 30 to 40 bps lower than it should be. During Thursday trading, the benchmark 3-month rate rose about 8 bps, in what is typically a large daily move for the rate.

There is a nice article over at the Information Arbitrage blog regarding the state of the hedge fund industry. In a nutshell, while the number of funds have grown, it is expected that consolidation will continue, and that shape of the industry will continue to approach a "barbell," with large players on one end, and smaller boutiques on the other. The smaller companies will continue to tailor their strategy to their client's needs (which are often fewer in size and looking for diversification), while the larger funds, each offering management stability and track record, reporting, and risk management operations, will continue to attract larger institutional investors. Also noted is the rise of multi-strategy funds that give managers the ability to allocate capital to those strategies that make sense for the current market (essentially, acting like a hedge fund). Finally, funds-of-funds, which in some ways defeat the principle of hedge funds, will continue to gain popularity before leveling off. Even while paying additional fees, recent high profile losses (Bear Stearns, Amaranth) will continue to sway some larger institutional investors to further diversification of alternative investment risk.

Hedge fund assets were up 27% from last year, according to HedgeFund Intelligence. While hedge funds did record about an 8% return in a difficult market, more than two-thirds of the asset increases came from new investors - primarily institutional investors allocating new money into "funds of funds." Of interest is how 391 funds have assets greater than $1 billion, with this figure representing around 80% of the total industry assets. Of these large funds, 255 are in the U.S., with New York alone having $973 billion in hedge fund assets under management. Given the standard 2-20 structure (admittedly not used by all), the 2% asset fee would generate a starting point of about $19.5 billion in revenue for New York funds alone.

Merrill Lynch posted a quarterly loss of $1.96 billion, due to $6.6 billion in write-downs related to mortgages, CDOs, and junk loans. There were also an additional $3.1 billion in mortgage-related securities that were held at its U.S. banks. Astonishingly, the losses over the past three quarters have been $14 billion, more than the bank earned in 2005 and 2006. Merrill will also let go of 4,000 employees in the capital market and trading groups, passing over the large network of financial advisers and staff. This news, while not good for Merrill employees, should temper the market's response to its recent losses.

Given the losses and on-going struggles, Moody's is warning that it could downgrade the bank's credit rating, in part because they may be forced to take another $6 billion in future write-downs. Looking at the last nine months, CDO write-downs alone have totaled over $18 billion, with $1.5 billion coming in the last quarter. While it looks like the level of CDO write-downs is decreasing, exposure isn't. In the last quarter, CDO exposure rose from $5.1 billion at the end of last year, to $6.7 billion at the end of this quarter. This of course, begs the question: "What previous risk is left on the books, and is the new risk exposure being properly managed?" As we have seen too often, it is not always the size of exposure (see Goldman), but the type and level of counter-party risk you are taking, and more importantly, the risk measures you have in place to manage such risk. Until we get more clarity, further write-downs and ratings downgrades should not really come as a surprise, and the market will certainly continue to price in this uncertainty.

Tickers: MER

China had another stellar period of growth as its GDP rose 10.6% in the first quarter. Unfortunately, consumer prices in China climbed 8.3% in March, driven by the usual suspects. The government did not hesitate, immediately raising reserve requirements to 16%, taking additional currency out of the system. Analysts at Goldman Sachs believe it will not be enough, and that China's central bank will need to further raise interest rates and implement even higher reserve requirements. In the mean time, higher currency gains are expected as rates increase. Whether the Chinese central bank can raise rates faster than the currency is appreciating is still to be seen.

LIBOR has been spiking downward in the last few months as the sub-prime mess has unfolded (see WSJ article). Some feel this sharp downward move is signaling more trouble ahead in the financial markets. As it turns out, this downward spike may be signaling a different problem. Remember that LIBOR is the global interest rate that is calculated each morning from rate data supplied to the British Bankers' Association, the group that oversees the calculation of LIBOR. LIBOR has become the global interest rate of choice, and while being used to price many option and futures contracts, it is also increasingly being used to set rates for corporate debt and home mortgages, throughout the world. The problem is that the data being supplied may not be reliable. The system for setting the rate depends on member banks telling the truth about their borrowing rates. Given that some banks, especially those in trouble, are paying higher rates for the short-term loans they need to finance operations, they should be reporting these higher rates. It is speculated that some are not. Why not you say? Because these same banks do not want to signal to their investors that they are in trouble, such that they not only need additional cash, but they are being forced to pay higher rates, possibly due to decreasing credit quality.

What does it mean? Well, if true, borrowers are getting a good deal, but of course, the banks that are loaning to the borrowers are getting the shorter end of the stick. Estimates show that the actual rate should be as much as 0.3% higher. Should we care? Yes. As mentioned in the WSJ, an extra 0.3% on a $500,000 loan is about $100 a month more in interest. If adjustable rates move up to the "real" LIBOR rate, the impact on the US, including California, Nevada, and Florida, in particular, could be significant. Given that much of the current mortgage debt is also "hedged" using interest-rate swaps, various banks and agencies may find that anticipated delta moves and positions are not achieving the goal they are looking for - reducing their risk. To address the problems, banks are already looking for alternatives, with some considering the overnight Repo rate as a better gauge of short-term lending given that securities are put-up for collateral, making for a more reliable measure of rates.

To date, there is no hard evidence that this practice is occurring, or that it is nothing more than a reflection of the general decline in lending and data, but banks are concerned, and the BBA is looking into it. As reported at Bloomberg, the BBA is even going as far as to "... ban any member deliberately misquoting lending rates at daily money-market operations ...." A nice step, but possibly adding more fuel to the fire. What may be more damaging is perception. Having the LIBOR rate come into question may be just another message that the market does not need on its mind.

On Fast Money (CNBC, Monday), it was mentioned that Wachovia was setting up for a good trade. Reasons for the trade included the current write-downs (assuming that all the bad news is out?), and the mention of the stock approaching recent lows (the 3 month chart does show $25 providing some short-term support, but the longer-term trend looks less bullish). As a caveat, it was mention that any buy here should have tight stops, very tight stops. In general, it is probably more prudent to wait until one sees a break from the longer-term downtrend, currently at around $28, before stepping in the waters. Granted, you lose that 10% move, which I am sure the $25.50 trade with tight stops is hoping to capture, but the risk in financials in general is a little too steep. There are also new concerns with dilution, the reduced dividend, and the extra cash that is not needed for current write-downs ($7 billion in new stock offerings and saving $2 billion in reduced dividends to cover $4.1 billion in write-downs and credit loss provisions). Where is the other money going? If future write-downs are expected, and anticipated, then the stock may trade lower. On the other hand, if the extra cash is to sure up the balance sheet, and give Wall Street confidence that the bank can weather any new, smaller hiccups, then we may see higher prices. Either way, the recommended tight stops are certainly in order, and prudent, not just for WB, but all financials. If one really wants to consider any potential bottom move for financials, the Financial Select Sector SPDR (XLF) ETF may be a safer trade. It will help reduce your firm-specific risk, which still seems to frequently pop-up in this sector.

Ticker: WB, XLF

Some investors who purchased the "super-senior" portions of CDOs are beginning to take action to try and protect their investment. Traditionally, super-senior tranches are the safe portion of the CDO, usually safe enough to garner an AA or AAA rating. This comes in part, not just because the super-senior tranches are senior, thereby being the last to incur losses when the debt backing the CDO goes bad, but they are further protected since the senior tranche has now been broken into two tranches, with the super-senior tranche being the highest. Therefore, even if losses approach the senior portion of the CDO, which they have in some instance with the mortgage-backed CDOs, the super-senior investors are suppose to still be safe. Unfortunately, this has not been the case for all CDOs, causing investors in these securities to take action. Some investor groups are now using any power they have to seize control of the deals to make sure they receive their money first. What options do they have? The super-senior investors can either redirect cash flows until they are paid off (acceleration), or pursue what is called the "nuclear option", which involves immediate liquidation. Each are a difficult call since the redirection of cash flows may decrease or stop all together, while the nuclear option causes the securities to be sold at fire-sale prices, sometimes at 60 cents on the dollar. Nonetheless, many super-senior investors feel they have no other options considering that they often bought the highly rated debt as part of the "safe" investment portion of their portfolios, and were not expecting any losses or risk with these securities. The problem is widespread. Morgan Stanley research shows 4,485 downgrades this year alone for various CDOs, with over 4,000 of the downgrades related to CDOs of asset backed securities.

Many outlets are reporting that retail sales are up 0.2% when economist were expecting them to be flat at best. Don't forget that retail sales are given in nominal terms (not real terms), and are not adjusted for inflation. For instance, if you buy the same quantity of items, but they are 3% more expensive, retail sales will be up 3%. Digging deeper in the data we find that we spent less on furniture, clothing, and appliances (new things we don't need, at least not right now), and more on food and gasoline (things we do need). As it turns out, excluding gasoline, sales were unchanged, which was probably better than expected. We also probably bought less gas, but it was up 11% this year (6.9% in February), resulting in higher overall retail sales numbers.

Do two struggling companies make for one good company (or just an OK company)? That is the question that Blockbuster and Circuit City may get to find out ...... that is if Blockbuster can convince Circuit City that it has the goods (ie., financing). Per the WSJ and elsewhere, Circuit City confirmed that it received an unsolicited bid from Blockbuster to acquire CC for $6 per share. Apparently, the proposal calls for a "rights offering" of such a size relative to the issuing company's market cap and at a price that is a premium to Blockbuster's current share price. Both hurdles indeed. Most rights offerings occur at a discount to the market value. Of course for many, due to their limited use, this begs the $64,000 question ...... "What is a rights offering." In a nut shell, a rights offering involves issuing rights to a the shareholders of a company to buy a proportional number of additional securities at a given price over a given period of time, with the price usually at a discount. Clear now? What the offering does is allow a company to raise money by selling new shares of stock to the public. Like a secondary offering, it raises money by selling shares, but now the shares are sold directly to existing shareholders. Now how do you get shareholders to buy more shares from the offering, when they can just go into the market? You offer them at a discount. What if the price is at a premium? Your success is less. What if the amount of the offering is high compared to your current market cap? Even less success. Now we know why CC is concerned. To make matters worse, BBI is down over 10% in the market today. Dilution has that effect. On the other hand, CC is up. Does the offer imply that CC is worth at least $6 per share. The market certainly thinks so (well, not quite $6, but up). What happens to the CC stock if the deal falls? That will be a question to be answered later.

Tickers: BBI, CC

Wachovia took $2 billion in write-downs and another $2.1 billion in new provisions against credit losses, causing it to raise $7 billion in new capital through the sale of common and preferred stock. Of interest is that 2 + 2.1 does not equal 7. Given that the company also expects to save $2 billion by cutting its dividend by 41%, I wonder what the other funds are being used for? Recent problems apparently resulted from the acquisition of Golden West, a California bank and mortgage lender. Right now, "mortgage" and "California" are not two terms you want showing up in your quarterly and annual reports. Not that all acquisitions for Wachovia have been bad, given that the A.G. Edwards acquisition may help them overcome some of their recent problems, or at least provide some steady capital. Of course, I am sure the good folks at A.G. Edwards are not happy, given that their previous stronger shares were converted to Wachovia shares after the acquisition, and are now being further diluted, including a reduced dividend.

Ticker: WB

Deal Journal over at the WSJ explores the valuation of various possible Microsoft, Yahoo!, News Corp, Google, AOL partnerships. Adding Google in the exercise is probably purely academic given that anti-trust regulations would preclude any potential Google-Yahoo alliance. Sanford C. Bernstein figures that a Yahoo-AOL-Google structure would increase the valuation of Yahoo! to $37.01 per share, after adding more than $550 million in earnings EBITA. Interestingly, the combined Yahoo!-AOL deal would be closer to $31.27 per share - with AOL on Google's platform - slightly north of the original offer from Microsoft. Of concern for current Yahoo! shareholders is that the terms of the AOL deal call for Yahoo! to buy back shares somewhere in the $30-40 per share range. Even with the $31 a share purchase price, the AOL dance may end up costing existing shareholders when, and if, any deal is made in the lower $30s.

Tickers: MSFT, YHOO, GOOG, TWX, NWS