Articles About Trading & Investing

Shah Takes on High-Frequency Trading

0 | By Wall Street Insights and Indictments Staff

Remember the May 2010 “Flash Crash,” when the Dow Jones Industrial Average dropped more than 1,000 points in one day? Now, the British high-frequency trader who stands accused of contributing to the crash, Navinder Singh Sarao, is fighting the U.S. extradition.

Should this sort of trading be illegal – or is the system the real problem? In his most recent Fox Business appearance, Shah revealed some of the bigger truths about high-frequency trading and answered even more of your biggest questions.


Healthcare Disruptors and the “New War” on Alzheimer’s

0 | By Shah Gilani

Someone I love very much – in fact, a family member I idolize – was recently diagnosed with Parkinson’s disease. We are all in shock, and some members of my family are very frightened.

But I made a decision. Instead of being frightened, I’m going on the attack. As transformational thinking lecturer (and “Est” founder) Werner Hans Erhard advocates, I’m going to be “cause in the matter.”

So I’ve given myself a mission… to do my part to help find a cure.

And it’s an opportune time…

Major diseases like Parkinson’s, Alzheimer’s and diabetes have a new enemy: research initiatives that attack them from fantastic new angles – yielding new protocols and medicines that can stop these maladies in their tracks or even reverse their chilling effects.

I’m not talking about “old school” drug protocols or research. I’m referring to the new healthcare and research Disruptors that I’ve been watching – and that are everywhere.

A powerful confluence of catalysts is making this possible, including new science, new technologies and even new policies at the U.S. Food and Drug Administration (FDA) - such as a groundbreaking “Fast Track” designation that slashes the time it takes to get new drugs into the hands of the patients who need them.

My resolve to help fight Parkinson’s – as well as the other terrible diseases I mentioned – has already gained me access to some rarefied circles. I’ve been asked to join the board of an extraordinary company whose partnering doctors head up the research units in their respective medical specialties at the top hospitals in the United States.

I’m also helping raise money for research – which includes making contributions myself.

The doctors I’m backing are leaning into the future in a big way. The head of the research-and-development company I’m involved with previously ran a giant pharmaceutical company. He’s now attacking the diseases his old pharma company treated with drugs by developing completely new protocols to stop diseases from spreading and eventually reverse the damage that they do.

I’m not permitted to reveal the name of the company I’m working with just yet.

But I will make this promise: Over time – as we crusade toward our goals of arresting the spread of the diseases we’re attacking and advance development of reversal protocols – I will be able to share some of what we’re learning, how trials are going and how our success will benefit everyone.

Eventually, there may even be ways for you or your loved ones to get into trials (we’re not there yet, but getting closer) by participating directly through new healthcare Disruptor tools like iPads and iPhones.

Meanwhile, we can invest in the Disruptor players, a move that will have dual benefits. It will not only aid the eventual defeat of these dreaded diseases, but it will allow us to profit from the full-frontal assault on them.

And that’s what we’re going to start looking at today…

A True “Game-Changer”

As you probably gleaned from my reference to iPhones and iPads, Apple Inc. (Nasdaq: AAPL) is a focus of interest for me – a true Disruptor company whose muscle is changing an array of sectors, markets and disciplines.

The Cupertino, Calif.-based company and its stock obviously benefits from heavy analyst and media coverage – some might even say over-coverage.

Even so, because of the way I’m looking at this, you’re in for a beautiful awakening.

Tim Cook, Apple’s brilliant and visionary chief executive officer, recently appeared on Jim Cramer’s CNBC Mad Money‘s 10th anniversary show, where he discussed the impact of the soon-to-ship Apple Watch on medical research through the company’s ResearchKit open-source software framework. He told Cramer that the effect “has been so strong that, within the first 24 hours of announcing the ResearchKit, some 11,000 people signed up for a study in cardiovascular disease through Stanford University.”

In fact, Cook told Cramer “it would typically have taken 50 medical centers an entire year to sign up that many people.”

Here’s an example.

In a ResearchKit case study, Kathryn H. Schmitz, professor of epidemiology in biostatistics at the University of Pennsylvania’s Perelman School of Medicine, recounted how they mailed printed fliers to 60,000 women and got only 305 to reply and sign up for a research project. She calls ResearchKit and Apple’s related HealthKit a “game-changer.”

And the disruptions don’t stop there.

Just on April 13, International Business Machines Corp. (NYSE: IBM) announced a far-reaching new partnership with Apple. IBM is linking its HIPAA-enabled Watson Health Cloud up with Apple’s HealthKit and ResearchKit. In conjunction with additional partners Johnson & Johnson (NYSE: JNJ) and Medtronic PLC (NYSE: MDT), IBM and Apple will develop “enterprise wellness apps” made possible by the merged medical and health data gleaned from Apple devices. Watson’s job will be to facilitate data-mining and provide predictive analytics.

The University of Rochester and Seattle nonprofit Sage Bionetworks are also working together to create the Parkinson’s research app, mPower, using Apple’s ResearchKit.

According to Sage, “mPower aims to make it easier for people to sign up for studies and providing consent to do so. The app can detect symptoms in Parkinson’s patients just by having them say ‘ahhhh’ into the phone. It also includes a finger-tapping feature that can detect symptoms, too. Finally, the app can analyze the user’s gait and balance by having them walk 20 steps then turn around and take 20 steps back.”

(If you want to check this out, this link will take you to Sage – where you can find out more about mPower and possibly get into its research program.)

The Next Sector to Be Upended

As far as making money as you help with the assault on these terrible diseases, one way is owning Apple stock. Because of the “ecosystem” it is creating, Apple’s long-term financial health is, by design, tethered to the future health of the world.

That’s big, and it’s going to make Apple one of the world’s most critical companies. In turn, the company will become even more profitable and a fantastic long-term investment for decades to come.

While Apple is the first investment idea I love because it is a healthcare Disruptor in every sense of the word, I’m following others, too.

You’ll be reading about them here for some time to come.

But I’m not done with explaining how Apple’s products are “cause-in-the-matter” Disruptors.

I know of at least one other industry – not healthcare, but related – the new Apple Watch is going to disrupt. It’s an industry you never imagined would ever change. And there’s going to be money to be made there, too.

I’ll tell you what that industry is later this week.

In the interim, however, I will give you a hint – so see if you can guess what it is.

The hint: This industry is both hated and loved. It’s hated, because it costs us a lot of money. It’s loved, by some, because it saves us a fortune.

[Editor's Note: Shah welcomes your questions and comments. Feel free to post them below.]

Related Reports:

Tread Softly… and Carry a Big Risk-Management Calculator

0 | By Shah Gilani

We’ve been talking here for the past two weeks about peer-to-peer lending – or P2P lending, as it is known – and have given you several ways to cash in on these new Lending Disruptors.

And if you’ve acted on our recommendations, you’re already making money.

In my April 6 report on the New Lenders, I recommended Goldman Sachs BDC Inc. (NYSE: GSBD) and Apollo Management Corp. (Nasdaq: AINV).

GSBD, which yields more than 8%, popped at the open of trading Monday. At its high price Monday morning, you were up almost 10% from where I recommended it only six trading days ago (an annualized gain of nearly 2,600%). And just two days after we told you about it, the widely read Investor’s Business Daily highlighted the Goldman business-development entity as one of two recent initial-public-offering (IPO) stocks “notable for their eye-catching earnings and sales growth in recent quarters.”

Triple-digit sales and profit gains is part of what caught my eye.

As for Apollo Management – it’s roughly flat from where I recommended it. But the stock has a juicy yield approaching 11%, which means you’re ahead of the game even before it delivers the gains I’m predicting.

The bottom line: Stick with these two investments. They’ll rise nicely in due course. In the meantime, you’re getting a better risk-adjusted yield than you’ll find in most other places.

That brings me to the market intelligence I want to share with you today.

Most of our talks here focus on opportunities – places and ways to make money.

But successful investing also involves managing risk – minimizing the losses you incur… or avoiding them altogether.

Thanks to Disruptors like Goldman and Apollo, the new lending market is one of the sexiest profit opportunities in the finance arena.

But what you don’t know can hurt you.

So today I’m going to show you how to avoid losing money in the shifting lending market…

Don’t Follow the Herd

Investors are heading into the new lending arena for a lot of reasons.

They’re heading there to pick up yield.

They’re increasingly “investing” on (that’s “on,” not “in“) P2P lending sites like the one operated by LendingClub Corp. (NYSE: LC), a publicly traded firm, and Prosper, a privately owned Disruptor site.

On both the LendingClub and Prosper sites, investors fund borrowers looking for loans. You can see on the sites what borrowers want money for. They are all personal loans, mostly for such things as consolidating high-interest-rate credit-card debt.

The interest rates that the “lenders” (investors) earn are based on each borrower’s creditworthiness, as measured by new Disruptor credit calculation metrics and algorithms meant to be predictive of a borrower’s likelihood to repay their debts, as well as on the term (length) of the loan. Terms vary, but most are three-year (36-month) and five-year (60-month) loans.

If you’re considering funding a stranger’s loan request – because the interest rate being dangled is attractive to you – here’s what you need to know…

About Those Enticing “Interest Rates”

I said earlier that what you don’t know can hurt you.

Here’s where that warning comes home to roost.

You see, the posted rates aren’t really what you get.

And you’re funding someone’s personal loan – someone who can default and not pay you back.

About those rates.

First of all, you’ve got to pay a “service fee” to the site operator. Typically platform operators charge lenders 1% of every payment they collect from the borrower and pass the money through to the lending investor. So right away, knock off one percentage point from the posted rate the borrower is paying and that you think you’re getting.

Second – and more important – the borrower can default, meaning he or she stops making payments.

Because you’ve made a loan to that person, you’re screwed – as in, you’re not netting the interest you expected to earn on your money. And because these loans are unsecured, you may not get back the money you lent – as in never.

Here’s a good way to look at defaults and how to figure your real risk.

LendingClub and Prosper have to declare all their transactions in U.S. Securities and Exchange Commission (SEC) filings. So the data is there.

Sites like LendingMemo and Nickel Streamroller track P2P lending statistics. The data I’m going to consolidate for you comes from them.

LendingClub’s 2007-2014 average interest rate paid by borrowers was 12.533%. The average default rate per year for the same period was 6.9%. Default rates plummeted from 14.81% in 2007 to 2.38% in 2014. And although the return on investment (ROI) was (3.44%) – a loss – in 2007 and rose handsomely to 9.61% in 2014, the average ROI over the period was just 4.587%.

The average interest rate borrowers paid on Prosper from 2009 through 2014 was a whopping 17.945%. The default rate over the same period averaged 7.18%. And the average ROI for the period was 9.68%.

But there’s more to numbers than digits on a page. For one thing, both platforms changed their borrower credit requirements – mostly easing them as the economic cycle moved away from the Great Recession and as unemployment, a key factor in their repayment metrics, dropped.

Interest charges over the respective periods changed, too.

To better understand the available numbers, or the ones you calculate yourself (as I did), you have to further “look through” them to better understand what they’re telling you.

There’s a lot more to the statistics.

And, on some levels, there’s also less.

These stats are for three-year term loans over the period we’re talking about.

That means the 2007 vintage loans were closed out by 2010. Most of the 2012 loans are winding down (depending on the month they began). That means some of the 2012 loans – and their successors from 2013 and 2014 – are technically not “completed.”

The takeaway: The final default rate tally isn’t available and won’t be for years to come on some of the loans.

And that changes the real numbers.

If you use the data of completed loans for three-year and five-year loans (for which there is a lot less data), the average default rate for three-year loans might be about 5% and for five-year loans about 10%.

Matt Burton, CEO of Orchard Platform, a New York firm that works with mostly institutional lenders on P2P sites, says that “performance can vary significantly, though returns have typically ranged from 6% to 7.5% over the past three years across all LendingClub and Prosper loans, net of fees and defaults.”

Burton’s right. And that’s just what I’m talking about.

The returns sound good, but because the more recent loans are largely not completed, the whole game has yet to be played. A downturn in the economy and a jump in unemployment could cause the default rates to balloon, blowing the results apart.

This is the definition of real risk. Unless you’re going to be really, really diversified -meaning you fund lots of loans in equal increments – or devise your own diversification modeling program, you’re more exposed to risk than you realize.

It only takes one default on the one loan you fund to wipe out your entire investment, net of any interest you may have received.

So be careful – very careful. If you like the nice fat yields you see on the lending sites, remember you need to engage in some risk-adjusting calculations to see if the return you hope to get is worth the risk of not getting your whole investment returned or “Not Completed.”

That’s why I recommended you invest in some of the players – instead of becoming one yourself.

[Editor's Note: Shah appreciates the big response he's received for his recent reports on "Disruptor" investments and will be addressing some of your questions. Keep the comments and queries coming. Just post them in the comment box below.]

Related Reports:

 

Don’t Get Sandbagged: Here’s Where the “New Credit Scorers” Are Watching You

3 | By Shah Gilani

In our talks here over the last week or so, we’ve been focusing our attention on so-called “Disruptors” – the catalysts of change that are impacting everything we do.

And one particular point that I made underscores just how wide-ranging these Disruptor-driven changes really are.

As I told you all last week, Disruptors are already changing how we communicate (smartphones), how we date (Match.com, eHarmony), how we mate (Tinder… or so I’ve heard), what we eat (genetically modified and so-called “super foods”), how we work (Monster.com, Jobr), how we get heat, cooling and light (fracking), how we get around (Uber and Tesla), how we get where we’re going (GPS) – and where we stay once we get there (Airbnb).

And tucked behind each one of these changes is a major opportunity to make money – and often an opportunity to turn life to your own advantage.

Here’s just such an opportunity: In the area of lending and borrowing, there are ways to “fix” your credit – or to develop a credit score if you’ve never had one.

And that’s the Disruptor secret I’m going to share with you today…

Forewarned Is Forearmed

One of the new developments in this slice of the credit market is this: New credit-scoring companies now provide nontraditional, credit-related data models to lending Disruptors. They’re also selling their new credit-scoring methodologies to traditional lenders – like banks.

Because lending Disruptors increasingly rely on new credit-scoring metrics to make loans easier and faster to get, established credit-scorers, like Fair Isaac Corp. (NYSE: FICO) – better known as FICO – are being forced to develop new scoring systems. That’s so their bank, mortgage and auto finance clients can compete with the “new” vanguard of credit-market players that are turning the lending market on its head.

These are the players we refer to as the “Lending Disruptors.”

What you need to understand is that many things you previously disregarded, or viewed as irrelevant, now matter a great deal.

In fact, the old maxim “It’s what you don’t know that can hurt you most” really applies here: These days, not knowing what increasingly will be used to calculate creditworthiness – the “new credit scores” – can lead to a self-inflicted borrowing wound.

In the good old days (or bad old days, depending on your perspective), credit scores were almost entirely based on such metrics as how much credit-card debt you had and your record of repayment, how you financed your car or education, your track record with your mortgage, and whether or not you had a tendency to make debt payments late or skipped them altogether.

Banks and traditional lenders mostly rely on FICO consumer credit risk scores as the most important metric in a consumer’s creditworthiness toolbox. That’s because FICO scores reflect loan amounts and payment histories on credit cards, mortgages, cars, student loans and personal borrowings – data that’s all submitted to, and modeled by, FICO.

The Game Changers

In the “traditional” market, FICO is pervasive: Fully 90% of U.S. banks in the United States make loan decisions using this credit scoring system.

But that’s changing.

New credit-scoring companies like VantageScore – a joint venture of credit bureaus Experian PLC (OTC ADR: EXPGY), Equifax Inc. (NYSE: EFX) and TransUnion Corp. – and Revolution Credit are changing the “inputs” used in ratings-systems models and presenting traditional lenders with new credit-scoring tools.

According to American Banker, VantageScore uses “so-called alternative data to evaluate consumers who cannot be scored using traditional criteria like timely credit card payments.” And RevolutionCredit “offers an alternative based on financial education. Consumers who sign up for the service – usually at the recommendation of their banks – are put through a series of online courses and tests on financial topics, the idea being that they will be more creditworthy once they complete the series.”

Nowadays, Big Data pipes deliver payment histories. They do so on our utility bills, our Internet and cable bills, our online shopping and payment habits, and on sales data from eBay Inc. (Nasdaq: EBAY) and other transaction platforms. That data is sold to third-party aggregators and directly to credit-scoring companies. Data is then modeled and run through proprietary algorithms to generate scores that are more “predictive” than their simple payment-history predecessors.

To keep up with the competition, FICO has had to build and test new models that they hope to make available by the end of this year.

Indeed, Dave Shellenberger, FICO’s senior director of scoring and predictive analytics, told American Banker that “using the new data [we] found that more than a third of previously unscorable consumers got above 620 on the new score, representing an acceptable level of credit risk.”

It’s all about modeling – to create “useful” credit-score insights. Said Shellenberger: “Because we’re an analytic company, it’s critical that the data is predictive of future payments.”

Whether you have “impaired” credit – or no credit history at all – understand the New Landscape in credit. Know that your day-to-day bill-paying habits – in fact, all your online purchase and sales transactions – are being gathered up and modeled to determine if you’re a candidate for a loan. And this is being pulled off by any number of the new lending platforms – as well as a lot of the traditional lenders.

Know this and you’re ahead of the game, because you may need to borrow from these folks at some point.

In the Land of the New Disruptors, knowledge is power – as well as an avenue to profit.

P.S. I encourage you all to “like” and “follow” me on Facebook and Twitter. Once you’re there, we’ll work together to uncover Wall Street’s latest debaucheries – and then we’ll bank some sky-high profits.

[Editor's Note: Shah likes to hear from you. Let us know what you think about the financial Disruptors he's been sharing with you. Just post a reply in the comment box below.]

Today You’re Going to Become a Big-Time Banker – Pulling Down Big-Time Profits

6 | By Shah Gilani

In Hamlet, we’re told “Neither a borrower nor a lender be.”

In essence, William Shakespeare was telling us to avoid borrowing and lending. Borrowing turns you into a spendthrift, while lending puts relationships at risk.

But “The Bard” may have adopted a different viewpoint had he known about the Internet and the financial “Disruptors” that are standing the lending business on its ear – creating one of the greatest “Extreme Growth” profit opportunities I currently see.

In my last report on Extreme Growth investments, I shared an analysis tool that I’ve long used to identify the very best profit plays. I also detailed the revolution we’re seeing in lending. And I promised to zero in on the single-best current profit opportunity.

Today I’m keeping that promise…

The New Rules of the Game

As surprising as it sounds, if you want to make some money, lend some.

Just look how well it works for banks.

You say you don’t have money to lend? Stop buying $4 coffees at Starbucks Corp. (Nasdaq: SBUX) for a week and you will – because the new, Internet-based models allow you to lend in small increments.

Peer-to-peer (P2P) lending is all the rage. You can join a P2P lending platform in minutes and start “funding” someone’s loan request with as little as $25.

But maybe you think The Bard was onto something with his advice and don’t want to lend money to strangers – sweating it out until they hopefully pay you back. You want to break into the loan business with $25, get your money back any day you want it and still make fat returns.

It’s a tall order – and a one-sided one, at that.

But you’re in luck.

For $25 – or less than a third of that, meaning as little as $7.70 – you can play the lending game and earn between 8% and 11% a year… and maybe more.

The easy, safe way to play the new lending game is by buying stock in a Disruptor.

There are publicly traded companies that act like banks – lending at high rates and passing the profits along to shareholders – that you can invest in with a few or a fistful of dollars.

Goldman Sachs Group Inc. (NYSE: GS), the mega-investment bank, and Apollo Global Management LLC (NYSE: APO), the giant private-equity (PE) firm, are two players in the new lending game that you can invest with.

Both Goldman and Apollo have publicly traded “business-development companies” (BDCs) that lend money to high-interest-paying borrowers, while avoiding cumbersome banking regulations. And because BDCs are required by law to pass along at least 90% of their net income to shareholders, investors enjoy fat returns, just like big-shot bankers.

The Goldman BDC – Goldman Sachs BDC Inc. (NYSE: GSBD) - debuted on March 23 after its initial public offering (IPO). Apollo’s entrant – Apollo Management Corp. (Nasdaq: AINV) – ranks as one of the first BDCs: It’s also more seasoned, by virtue of its IPO back in 2004.

“Like a Hedge Fund”

The BDC structure is what gives these lending operations their advantages.

In 1980, Congress passed the Small Business Inventive Investment Act as a kind of “end run” around the Investment Company Act of 1940 – to let public companies pool money to invest in private companies. Because the new rules were tied to the Investment Company Act of 1940, the allowance of BDCs became known as the “1980 Amendments.”

Business-development companies are publicly traded, closed-end companies that are subject to U.S. Securities and Exchange Commission rules and regulations. A majority of the boards of directors must not be “interested persons,” as defined by the 1940 Act.

BDC stockholders enjoy the liquidity that comes with the investment in an exchange-traded company whose business is lending at fairly high interest rates to small- and mid-market private companies. Although BDCs can make unsecured loans, most of the term loans they make are senior-secured loans backed by assets such as property, inventory, equipment and cash flow.

Most of their loans are “adjustable-rate notes,” meaning they provide lenders some protection when interest rates rise.

In addition to lending to companies, BDCs can make direct investments to grow capital. And they generally provide a great deal of managerial assistance.

For tax purposes, business-development companies are treated as registered investment companies (RICs). That allows them to avoid being taxed on “ordinary income” at the corporate level and forces them to “pass through” to shareholders – in the form of dividends – at least 90% of their capital gains.

Another thing I like about BDCs, which not every investor will agree is a good thing, is that managers are incentivized to earn rich profits.

In addition to the management fees charged by third-party managers of the loans and business, BDC managers typically charge an incentive fee. Management fees range from 1.5% to 2%, and incentive fees typically are 20% of the net profits.

These fees are typical of what regular hedge funds charge, which is why a lot of hedge-fund players are known as “2 and 20 managers.” I’m a fan of reasonable incentive fees – not just because I’ve managed my own hedge funds, but also because incentive fees align the interests of management with those of shareholders and stakeholders.

Like hedge funds, BDCs also have “hurdle rates,” and sometimes “high-water marks,” which means they have to return a minimum amount before they make their incentive fee. And if these BDCs take an incentive fee, and then lose money, they have to make up for any losses before paying themselves any incentive fee again.

Now that we understand how these Disruptors work – as well as the “new” lending model and associated companies that financial Disruptors have spawned – it’s time to put all these insights to profitable use.

Players Without Peer

For my money, if I want to get into the lucrative lending game, I’m going to “lend” my money by buying shares of stock in a venture that makes high-interest-rate loans, helps manage the companies they loan to, has the expertise to assess and manage credit and business risks, isn’t over-regulated like most banks, aligns its interests with mine and has to pass through at least 90% of its profits to me.

In lending, it literally doesn’t get any better than that.

That’s why I like publicly traded BDCs, like the newly public Goldman Sachs BDC Inc. (NYSE: GSBD), which trades at $20.30 a share and will yield around 8%. And I like Apollo Management Corp. (Nasdaq: AINV), which trades at $7.75 and yields 10.3%.

If you can lend your money for a fat return and still have daily liquidity to get it all back with the click of a mouse, why not become a new Disruptor lender yourself?

[Editor's Note: Shah likes to hear from you. Let us know what you think about the financial Disruptors he's been sharing with you and about this Extreme Growth profit opportunity. Just post a reply in the comment box below.]

I’m Going to “Loan” You a Secret – so You Can Cash In

2 | By Shah Gilani

Today I’m going to let you in on an investing secret.

And it’s a big one – a huge one, actually.

It’s a secret that I use in my own work – in fact, it serves as the framework for everything that I do. And if you embrace it – as I have – you’ll find that this secret will pave the way to life-changing wealth.

In our talk here today, I’m going to tell you all about this secret. I’m going to explain what it is – and how to use it.

The goal, of course, is to bring to you a stock that will let you put this secret to work – immediately…

A Welcome Disruption

We’re all familiar with the term “Disruptive Technology.”

It’s a powerful concept.

At least, as far as it goes.

You see, so-called “Disruptors” aren’t limited to the tech sector.

These catalysts and Agents for Change affect everything we do.

Disruptors are already changing how we communicate (smartphones), how we date (Match.com, eHarmony), how we mate (Viagra and Tinder… or so I’ve heard), what we eat (genetically modified and so-called “super foods”), how we work (Monster.com, Jobr), how we get heat, cooling and light (fracking), how we get around (Uber and Tesla), how we get where we’re going (GPS) – and where we stay once we get there (Airbnb).

What investors need to realize is that, hidden behind each of these changes, is a major opportunity to make money.

Take lending, where Disruptors are completely changing the business – right now.

I’ve been following this business very closely for just this reason: If you understand how the business is being disrupted, you have a very good shot at extreme profits.

In fact, by identifying the specific Disruptors, you can make money on both the lenders and borrowers – as well as on the new players that are quickly taking the field here.

Here are the Disruptors, here’s what’s changing – and here’s how we’ll cash in.

Rule Breakers

The lending business used to be a simple one – so simple, in fact, that it was said to be governed by the “3-6-3 Rule.”

During the four decades that spanned the 1950s through the 1980s, the lending industry was viewed as being so stable that bankers could take in deposits at 3%, lend the money out at 6% – and be out on the golf course by 3 p.m.

More recently, small borrowers – meaning individuals, families and small businesses – mostly relied on banks, credit unions, finance companies and credit cards to pay for things or obtain cash.

All those lenders have “fixed costs,” like brick-and-mortar offices and paid staffers. Traditional banks needed those physical locations and workers to accept loan applications, check credit scores, verify employment and income, underwrite and service loans and run the marketing, advertising, regulatory and compliance operations that kept the bank alive.

After all, it costs money to source deposits and to borrow in the capital markets.

And on top of those fixed costs, lenders have to eat losses when borrowers default.

Lenders typically charge high interest rates to cover their fixed costs and as compensation for the risks they had to take.

But because there were so few choices, borrowers had to pay whatever rates the lenders sought.

That’s how it’s been for years for both lenders and borrowers.

Then along came the Disruptors.

Profiting From Our Peers

Today’s borrowers can go online, answer as few as seven questions – and have their loan approved in a matter of minutes. And I’m talking about a full approval, meaning most borrowers know how much money they’re getting, the interest rate they have to pay and how long they have to pay the loan back.

Lending has been changed forever.

Thanks to the new market Disruptors.

Those new players figured out that the fixed costs and loss expectations added an average of 425 “basis points” (4.25 percentage points) to the interest rates borrowers had to pay on small loans.

What these new market challengers realized is that – if they could cut fixed costs and do a better job assessing risk and managing loan losses – they could make the loans easier to get, slash the costs for borrowers and grab market share. The upshot: They could make fat profits for themselves, for the investors who lend on their platforms and for their financial backers.

Of course, technology and data make this latest Disruptor possible.

And a new market entrant – known as peer-to-peer (P2P) - illustrates how the lending business has changed. Indeed, this P2P lending model shows us how the new Disruptors operate.

The premise of P2P lending is pretty simple: Individuals lend to individuals. Borrowers are matched with lenders based on who wants to borrow how much for how long – and who’s willing to meet those needs based on the prospective borrowers’ credit scores and measures of creditworthiness.

To give you a better picture of this, let’s take a look at some intriguing examples…

A Borrower… or a Lender Be

Prosper is an example of a P2P lending site. Lenders can partially fund a loan request – with as little as $25 in some cases – or lend the full amount of a borrower’s request based on how much the borrower wants, what they want it for, what interest rate they will pay and their creditworthiness.

(If you want to take a look and see what this looks like, check out the loan requests being fulfilled on the site’s Browse Listings.”)

LendingClub Corp. (NYSE: LC), a publicly traded online lending company that offers personal loans up to $35,000, started out as a P2P lender. But it isn’t a P2P player anymore.

While there are variations in how borrowers are profiled at different lending sites, the real difference in business models comes down to how loan requests are funded.

Credit scores, checks on creditworthiness and traditional borrower profiling techniques are used by almost all the lending businesses. But Big Data analytics and proprietary “algorithms” are increasingly giving lending-market Disruptors a massive edge over all their competitors.

An example of how aggregating data and parsing it gives lenders a comfort level with borrowers is plain to see over at Kabbage, which claims to be the “No. 1 Online Provider of Small Business Loans.”

Lenders who fund Kabbage customers’ business loan requests for as much as $100,000 – sometimes in only a matter of minutes – use data about the borrowing business pulled from places like eBay Inc. (Nasdaq: EBAY), Amazon.com Inc. (Nasdaq: AMZN), PayPal, Intuit QuickBooks and even business checking accounts to assess the prospective business borrower’s revenue, cash flow and profits.

To aid this bit of “borrower profiling,” algorithms sift through billions of bytes of Big Data to assess a borrower’s spending habits, payment routines, banking patterns and ability to repay the loan.

That’s important to lenders. Without lenders ready and willing to fund loan requests based on risk measures they understand, this new lending paradigm wouldn’t exist.

But because Big Data analytics, predictive algorithms and online efficiencies make the new lending landscape flatter and more “transparent” than it’s ever been, lending Disruptors are lining up to fund loans.

That’s why the P2P lending model is already almost completely outdated.

And we already know what’s coming next.

Banks, private-equity (PE) companies, hedge funds, insurance companies, high-net-worth individuals and institutional investors are all lining up to lend into the new models.

Loans to individuals, families and small businesses typically carry above-market interest rates, which is what attracts all these professional money managers.

In fact, some lenders have already co-located their servers next to – or as close as possible to – the servers of lending sites. So when loan requests come into the lending sites, the computers of “High-Frequency Lenders” can grab all the pertinent data they need of a borrower before other potential lenders hoping to fund high-interest loans to qualified borrowers, and fulfill the loan request as fast as possible.

Of course, there’s more to institutional investors just wanting to lend to small investors shunning banks and traditional financing channels – many of them are owned or managed by the same lenders chasing the “new Disruptors.” Small loans can be packaged, securitized, sold, traded and invested in, just like mortgage-backed securities (MBS), leveraged loans and high-yield loans.

Think about that: When the “securitization” market was created – meaning individual mortgages could be packaged up and sold – the money originators collected from selling their loans kept coming back to them so they could make more and more mortgage loans.

All that money doubling back through mortgage lenders increased competition and helped ratchet down mortgage rates.

The same thing is going to happen to small-loan lending.

There will be winners and losers in this new lending paradigm – as is always the case when the “New Disruptors” do their thing.

In fact, there’s already a new twist in the new lending game. And there’s a way to play it.

And we’re going to drill into the specifics in our next report, when I tell you about the “new, new lending model” – and show you exactly how to invest in it… and its offspring.

See you then.

P.S. I encourage you all to “like” and “follow” me on Facebook and Twitter. Once you’re there, we’ll work together to uncover Wall Street’s latest debaucheries – and then we’ll bank some sky-high profits.

Don’t Celebrate the Housing “Recovery” Yet

5 | By Shah Gilani

When I moved to Sarasota, Fla., in 1999, I was invited by a prominent local to an “un-wedding wedding” to make new friends in town. I accepted the invitation and, not wanting to display my ignorance, avoided asking the burning question: “What’s an un-wedding wedding?”

Inevitably, I found out what an un-wedding wedding is. It’s a full-blown wedding, only the host isn’t actually getting married. He or she wants to get married but isn’t – and goes through the motions anyway.

This manipulation of celebratory events to fabricate optimism about a desired future reminds me of the state of housing in the United States today.

Here’s why…

The Un-Recovery

There’s no reason to celebrate anything in the housing market’s un-recovery recovery.

Past and present manipulations must be continued to prevent collapse, but they won’t help economic growth in the United States as they did until 2000. Instead, those manipulations only act as a headwind from time to time.

Take February housing “starts.” They were down 17% from January. The annualized single-family starts number for February was 593,000 units, which was essentially flat from the year-ago February 2014 starts number of 589,000.

According to the U.S. Department of Commerce, “Start of construction occurs when excavation begins for the footings or foundation of a building.”

In a recent column, David Stockman, the head of the Office of Management and Budget in the Reagan administration, says the slow starts aren’t due to the weather – although February 2014 and 2015 were especially cold months in the East – but about swings in interest rates.

“The seasonal adjustments are supposed to factor in weather,” Stockman writes. But the raw unadjusted, non-annualized starts number for February 2015 was 40,700. In February 2014, it was 40,600. In 2009, it was 25,000. In 2005, starts were 124,000, and in 2000, they were 88,000 units.

He makes the case that Federal Reserve manipulation of interest rates, not weather, caused these wild fluctuations.

“In short, in the name of improving upon the alleged instability of the private economy – absent the Fed’s expert ministrations – the geniuses in the [Fed] have actually caused the rate of housing starts to gyrate wildly,” Stockman writes.

Stockman goes on to say that the U.S. economy isn’t analogous to a giant bathtub, as Keynesians might suggest. That’s because, he writes, pouring “‘demand’ into the housing market through what amounts to cheap, subsidized interest rates (from the hides of savers) and, presto, activity rates will soar.”

That hasn’t happened.

Free Market Suppression

New home sales in February rose 7.8%, to a seasonally adjusted 539,000 units. That’s the best number for new home sales in seven years.

Still, according to a graph on the National Association of Home Builders’ website, new single-family home sales going back to 1978 show that current levels of sales are barely approaching 1980 levels. They are more than 50% below average sales from 1980 to 2006.

While new home sales, which make up one-tenth of home sales, on the surface looked robust in February, existing home sales rose a scant 1.2% according to the National Association of Realtors.

That’s what I call an un-recovery recovery, or a bum wedding.

Free-market capitalism wedded to democracy yields a living, changing economic system that thrives on creative destruction and withers under socialist-style command and control. The Federal Reserve’s interest-rate manipulations over the past 20 years only prove they are incapable of fostering natural growth in the economy.

The Fed never should have been allowed to manipulate rates so low for so long to inflate the housing bubble in the first place. Fannie Mae and Freddie Mac had to be bailed out, but by now should have been dismantled. They’re backing more mortgages now than ever before.

While two governments and the Fed couldn’t let the financial system implode and too-big-to-fail insolvent banks eat their own poison, everybody should have by now worked together to have broken up Fannie Mae and Freddie Mac once they were back on their feet.

What people forget is the Fed and the government helped bail out builders after the crash.

In a May 6, 2010, Reuters article, author Helen Chernikoff quoted Moody’s Economy.com Chief Economist Mark Zandi saying, “Without the government’s support, in all likelihood we would have seen more failures among the builders. It’s almost hard to list all the things that have been done to support homebuilding either directly or indirectly.”

Then the Fed, with a wink and a nod from successive government administrations went on a $2 trillion Treasury bond-buying binge to start up its zero interest-rate policy (ZIRP).

And to prove no matter how much money it throws at housing it is hapless, the Fed bought $1.8 trillion of mortgage-backed securities (MBS) to narrow the MBS-over-Treasury spread to try and make more mortgage money available.

That didn’t work.

The Takeaway

Without a so-called “clearing mechanism” that balances home sales and rental rates based on supply and demand against free-market interest rates reflecting real-world risk and returns in the $16.8 trillion U.S. economy, not only won’t the housing market ever fully recover, but the economy won’t either.

Like an un-wedding wedding, the housing market’s un-recovery recovery is a sad state of affairs.

P.S. I encourage you all to “like” and “follow” me on Facebook and Twitter. Once you’re there, we’ll work together to uncover Wall Street’s latest debaucheries – and then we’ll bank some sky-high profits.

Related Reports:

Apple Is a “Buy” on Every Dip

0 | By Wall Street Insights and Indictments Staff

We’re in the middle of a tech sell-off, so Shah says now is the time to scoop up discounted shares of Apple Inc. (Nasdaq: AAPL) while you can – the company’s shares are now 9% off their 52-week highs. “The company is just extraordinary in every respect.” Shah told Stuart Varney during his latest appearance on Fox Business.

Shah weights in on how the Apple Watch and the company’s performance in China are going to affect the tech powerhouse’s near-future growth, earnings and share price.

 



Why “Patient” Doesn’t Matter on Fed Day

0 | By Wall Street Insights and Indictments Staff

All eyes were on Janet Yellen on Fed Day to find out if, and when, interest rates were going to be raised. In a recent appearance on Fox Business, Shah reveals to Varney & Co. watchers why the word “patient” doesn’t matter one way or another when it comes to the latest statement from the Federal Reserve.

 



At Citigroup, It’s the Same as It Ever Was

6 | By Shah Gilani

Flashback to the 2008 credit crisis.

There’s Citigroup Inc. (NYSE: C) – bent-over by arrogance, off-balance sheet liabilities and derivative weapons of mass destruction in an insolvent fetal position.

Back in those dark days, Citi’s “Help! I’ve fallen, and I can’t get up!” cries were heard loudly across the interconnected, too closely correlated banking landscape.

Federal Reserve defibrillators were immediately attached to the heart of the too-big-to-fail bank, via its capital and liquidity arteries, and its survival was miraculously guaranteed.

Fast-forward to the gold statue just awarded to Citigroup for passing the Federal Reserve’s 2015 bank stress tests.

As Citi grabbed the Oscar from winking Fed presenters, the capital markets and America cheered, “You’ve come a long way baby!”…

Repeating the Past

Too bad the truth is that Citi has gone a long way back to where it was in 2008. And the Fed, which acted like a regulator and resuscitator back then, is now only acting out its part as regulator and likely will have to resuscitate Citigroup yet again in the coming financial crisis.

What’s really going on behind the curtain is nothing short of frightening.

First of all, the Fed is as clueless now as a regulator as it was going into the credit crisis.

As Citigroup’s principal regulator, the Fed was blind right up to Oct. 28, 2008, when it had to direct $25 billion from the new Troubled Asset Relief Program (TARP) to Citi. Nor did it see that on November 17, 2008, the failing bank would have to fire 52,000 employees.

Or that by the end of the following week Citi shares would lose 60% of their market value. Or that a week later Citi would need another TARP infusion of $20 billion, in addition to Fed guarantees on $306 billion of its securities held as “investments.”

In fact, the Fed never saw it would have to, according to a 2010 Government Accounting Office report, soak up more than $2 trillion in below-market-rate loans as part of its bailout lending programs.

So it shouldn’t surprise anyone that, following the latest stress tests, the Fed now thinks Citigroup has done a good job managing its capital and capital ratios.

Citi has done a good job.

But how it has done good is the problem.

A Crooked Scale

Citigroup has been trumpeting its exit from subprime lending and talking up how it has become more focused on capital and return on capital and equity metrics. And while Citi has been doing that, the Fed hasn’t noticed the bank has done that by taking on more “assets” that require less capital to hold.

I’m talking about derivatives.

The problem with calculating reserve requirements and capital requirements when it comes to derivatives is that there’s no real transparency on derivatives positions or counterparty risk calculations. How a bank accounts for its derivatives risk exposure can be masked in multiple ways. For example, how banks weigh the risks of certain assets is a matter of internal modeling.

Applying standardized capital reserve requirements to “risk-weighted” assets is a slippery slope if the assessment on the building in question can be mitigated by obscuring what’s really in the building. With internal models, it’s your building – you describe to the regulators what’s in it.

Citigroup’s investment bank unit held $32 trillion (notional amount) worth of derivatives in 2009. At the end of the third quarter of 2014, the unit held $70 trillion of derivatives.

The New York Times reported the other day that while the nation’s largest bank, JPMorgan Chase & Co. (NYSE: JPM), decreased its derivatives holdings by 17%, Citi has been buying up derivatives portfolios, including a $250 billion derivatives book from Deutsche Bank AG (NYSE: DB).

Adding weapons of mass financial destruction into a black-box building like Citi, where it tells regulators how solid its foundation is, against which it is assessed, is scary.

In her 2012 book, Bull by the Horns: Fighting to Save Main Street From Wall Street and Wall Street From Itself, former Federal Deposit Insurance Corp. (FDIC) Chair Sheila Bair gives us her insider view of Citigroup at the time of the credit crisis.

“By November, the supposedly solvent Citi was back on the ropes, in need of another government handout,” Bair writes. “The market didn’t buy the [Office of the Comptroller of the Currency]‘s and NY Fed‘s strategy of making it look as though Citi was as healthy as the other commercial banks. Citi had not had a profitable quarter since the second quarter of 2007. Its losses were not attributable to uncontrollable ‘market conditions’; they were attributable to weak management, high levels of leverage, and excessive risk taking. It had major losses driven by their exposures to a virtual hit list of high-risk lending; subprime mortgages, ‘Alt-A’ mortgages, ‘designer’ credit cards, leveraged loans, and poorly underwritten commercial real estate. It had loaded up on exotic [collateralized debt obligation]s and auction-rate securities. It was taking losses on credit default swaps entered into with weak counterparties, and it had relied on unstable volatile funding – a lot of short-term loans and foreign deposits.”

There’s a history of bad acting, both on the part of the Fed as a regulator and of Citi as a badly managed, leveraged risk-taking-for-profits TBTF bank. So I might be forgiven for being skeptical that Citi’s passing grade on its Fed-administered stress tests is a sign anything other than business as usual in the world of protected banks being coddled by their central bank supervising saviors.

P.S. I encourage you all to “like” and “follow me on Facebook and Twitter. Once you’re there, we’ll work together to uncover Wall Street’s latest debaucheries – and then we’ll bank some sky-high profits.

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