Author: Stewart Eisenhart

Two years after the Securities and Exchange Commission took unprecedented steps to curb abusive naked short selling, the securities lending business and hedge funds are still feeling the after affects.

Many blamed speculative short sellers for much of the financial crisis, particularly so-called naked shorts, in which the seller does not borrow the stock to cover the short position.

The SEC requires that requires that broker-dealers locate an entity that the broker reasonably believes can deliver the shares within three days after the trade. In addition, the recently passed financial reform legislation includes stringent new reporting and disclosure requirements for all short sales.

“Activity will likely increase in the highly lucrative securities lending business, but so will transparency in this currently still opaque corner of the financial markets,” Sol Zlotchenko, chief technology officer at Paladyne Systems, told Markets Media.

The changes will fall particularly heavily on hedge funds, many of which make considerable use of shorting in their investment strategies. Hedge funds face skyrocketing borrow costs on securities transactions and depending on the strategy these costs can represent their largest portfolio expense.

Hedge funds execute their short positions through their prime brokers, which borrow the stock from large, institutional buy-and-hold investors such as pension funds and insurance companies. The prime brokers pay these institutions a premium, then assess their hedge fund clients a daily charge for financing these short positions.

Daily charges can add up quickly for a hedge fund, hitting their profits directly. Brokers sometimes change their rates without warning after a hedge fund has established its short position.  “We’re seeing an increase in adding additional prime broker relationships in order to seek out the lowest lending rates,” Vince Cutaia, equity trader at Conifer Securities, told Markets Media. “In addition there are some 3rd party firms offering to ensure you are getting the best rate on your locates and charging a percentage fee on the savings. All these services can be helpful to the Fund Manager but it is also time consuming and requires additional record keeping for all the locates and the associated lending rates.”

Charges can vary widely, depending on a variety of factors, such as how difficult and expensive it is for the broker to borrow a particular stock. Institutions generally charge brokers a considerable premium for less-liquid securities with a smaller float, called hard-to-borrow stocks.

“The locate charges are now a key part of the decision making in short selling. Excessive rates have had an affect on the investment process as charges can outweigh the profit potential. Many short ideas are now played via the option market even though the ‘hard to borrow’ or ‘excessive lending rate’ is already priced into the option premiums,” says Conifer’s Cutaia.

Individual relationships among brokers, institutions and global custodians often determine pricing and whether a prime broker can source the stock at all. Another factor can be the individual hedge fund’s relationship with the prime broker—small and mid-size funds with weaker credit and a less-lucrative stream of business may pay more.

Paladyne Systems, a technology provider for the hedge fund industry, is rolling out a specialized module, Short Availability Manager, that helps hedge funds cope with the new reporting requirements, locate the stocks they need to borrow, and compare pricing among brokers for maintaining short positions. “The key is helping users manage their locate processes and borrow costs in a transparent manner,” Zlotchenko said.

Short Availability Manager helps hedge funds locate stocks for borrowing, compare rates simultaneously among multiple brokers, and keep up with pricing changes, helping to manage costs through transparency and automation.

“The Short Availability Manager automates tracking of short positions for the fund’s own risk management, valuation, auditing and accounting, as well as for regulatory compliance and reporting,” Zlotchenko said. “Potentially, a hedge fund could save up to 10 to 20 basis points on their fees if they are able to manage borrow costs efficiently.”

While a few other short selling applications are currently on the market, they are either not integrated into a comprehensive portfolio management solution or lack some of Short Availability Manager functionality. “All hedge funds eventually will need a system of this type to handle their obligations under the new regulations,” Zlotchenko said, noting that leading prime brokers have agreed to electronically connect with the system.

Author: Stewart Eisenhart

        Sameer Shalaby, Paladyne Systems

The newest version of hedge fund technology developer Paladyne Systems’ order and portfolio management product, Paladyne Portfolio Master Version 7.0, features a capability enabling users to locate short-trading opportunities in real time.

Paladyne developed the module to help hedge funds address new regulatory reporting requirements around short trading, and to provide more automation and transparency around these activities.

The new tool, Short Availability Manager, connects Paladyne clients to prime brokers to facilitate real-time identification of short opportunities; the module can also track borrowing fees and rebates as well as transparently manage borrowing costs, according to the vendor. Specifically, managers can use Short Availability Manager to locate stocks for borrowing, simultaneously compare rates from multiple prime brokers, and to monitor changes in pricing.

Using the module, managers can also track their short positions for their own internal requirements such as risk management, valuation, accounting and regulatory compliance.

Other enhancements to Paladyne Portfolio Master Version 7.0 include a bigger compliance rules engine to support UCITS funds, real-time portfolio management and trading dashboards, and improved workflows to support repos and contracts for differences (CFDs). The platform also offers tighter integration with Bloomberg SAPI for dynamic field mapping, SunGard Monis for real-time convertible bond valuations, and RiskMetrics for multi-asset portfolio risk reporting.

Bottom line: Providing hedge funds with an automated and transparent method for tracking their short activities should prove useful as these trading strategies attract more regulatory scrutiny.

Listen to the bank experts on the state of the industry and future outlook

Well-known experts in the banking industry came together on June 10 for a seminar focused on the future of the sector that was broadcast live from the NASDAQ Market Site via webinar. Co-sponsored by Highline Financial and NASDAQ OMX, the panel was moderated by American Banker senior report Heather Landy and included:

    ·Bob Davis, American Bankers Association

    · Andrea Jao, Wharton

    · Rudy Schupp, 1^st United Bank

    ·Peter Wirth, KBW

Watch a replay video from the webinar  

Highline Financial’s Terry Waters opens the panel

“The webinar was an exceptionally intelligent discussion of the state of the industry. Well done and very useful.” Bill Traynham, CFO, American National Bank & Trust

                                                                                                                                                                                                                               HedgeOp Compliance, which provides compliance software and consulting services to alternative asset managers, has introduced two new services to its adviser registration platform.

The new suite of services, ADVassist Basic and ADVassist Advanced, enable private fund advisers to fulfill registration and compliance requirements cost-effectively and appropriate to a fund’s size and infrastructure, according to the firm.
 
“With financial reform a reality, private fund advisers should be preparing for registration now,” said William Mulligan, managing partner and chief executive officer of HedgeOp Compliance. “Now is the time for these firms to implement a formal testing and review of their compliance procedures. In so doing, they’ll be better equipped to identify issues that are of concern before they become problem spots.”

ADVassist’s new structure features two levels of service that are designed to meet the needs of firms on an individualized basis, providing the flexibility for advisers—from billion dollar global funds to single manager firms. Firms can opt for varying levels of support, ranging from basic SEC registration to more in-depth compliance infrastructure creation.

“There are vast differences in the structure and operations of a billion dollar global hedge fund firm and a single manager long-short fund firm and their respective compliance needs,” said Mulligan. “We think that many firms will need this level of support, and we now have a service that can be scaled up or down to effectively meet the unique requirements a fund may have.”

HedgeOp Compliance, which was founded in 2001, focuses exclusively on helping investment managers meet their compliance, operational and due diligence challenges

 

New York and Austin TX - Highline Financial, the preferred source for banking information and analytics for the financial sector, has developed a Watch List based on the Highline Rating, detailing the worst performing US  financial institutions including commercial banks, savings banks and savings & loans.

According to Highline Financial, 796 financial institutions with assets close to $478 billion are on the Highline Watch List.  The Watch List includes institutions with a Highline Peer Rating below 10 for three consecutive quarters. Of that list, 271 financial institutions with assets over $130 billion are at extreme risk of failing this year with a Highline Peer Rating at 0 for three consecutive quarters. 

The 271 institutions at extreme risk break out by asset size as follows:

Assets                   Number of Institutions

$10B+                                    2

$1 – 10B                               17

$250M – 1B                         71

$<250M                                181

According to Highline Financial, the number of US bank and savings & loan failures in 2010 are set to surpass the totals for 2009.  In 2009, there were 139 failures with combined total assets of $169 billion.  Through June 11 2010, 82 banks and S&Ls had failed with combined assets of $71 billion. 

Highline Financial rates every bank, S&L, credit union and consolidated bank holding company on a quarterly basis.  The Highline Rating is based on a scale from 0 - 99 with 0 being the lowest and 99 being the highest.  Highline rates over 8,000 commercial banks, savings banks and savings & loans as well as over 7,500 credit unions and 1,300 bank holding companies.

Terry Waters, Highline Financial CEO said “The Highline Rating offers the market a strong predictor of any financial institution’s health and potential for failure, whether it is a bank, credit union, S&L or holding company.   The Highline Rating excels at forecasting an institution’s troubles far in advance of failure. Of the commercial banks, savings banks and savings & loans that have failed since 2008, 75% had a Highline Financial Peer Group Rating of 0 three quarters before they failed.  In the current economic climate, providing our clients with visibility up to three quarters out is a key way we help them manage financial risks and make profitable investment decisions every day. “

The Highline Rating compares institutions on a national, regional basis and by asset size. Regionally, banks in four states — Georgia, Florida, California and Illinois — have been the hardest hit. Of the failed banks in the U.S. since 2008, more than half have occurred in these states: Georgia (16%), Illinois (14%), California (11%), and Florida (11%).

 The top performing states as measured by the fewest bank failures include Nebraska, and three states in the northeast: Massachusetts, Vermont, and Rhode Island.  Top performing institutions in Massachusetts, Vermont, Rhode Island, and Nebraska included community banks such as: Danvers Bank (Danvers, MA); Peoples Bank (Holyoke, MA); Merchants Bank (Burlington, VT); Centreville Savings Bank (West Warwick, RI); Bank Newport (Newport, RI); and World’s Foremost Bank (Sidley, NE.)

The top performers among large banking institutions (banks with assets of $10 billion or greater)  include: State Street (Boston, MA); Valley National Bank (Passaic, NJ) ; Silicon Valley Bank (Santa Clara, CA);  Northern Trust (Chicago, IL); First  Hawaiian (Honolulu, HI); Commerce Bank NA (Kansas City, MO); Bank of Hawaii (Honolulu, HI); and First National Bank of Omaha (Omaha, NE).

About Highline Financial Ratings

The Highline Rating has been used for rating banks, S&Ls credit unions and bank holding companies since 1985. Originally developed by Sheshunoff Information Services, it was first known as the Sheshunoff Rating. Over the last 24 years, the Highline Rating has undergone periodic evaluations and improvements to ensure its effectiveness as a strong predictor of a financial institution’s health and potential for failure.

The Highline Rating is calculated on a quarterly basis using four key ratios (capital adequacy, asset quality, earnings strength and liquidity) and encompasses both current and historical data. In addition, all ratings assess an institutions’ health using weighted criteria to evaluate the industry’s condition as a whole, with ratios and respective weights adjusting to meet industry changes. Used by government entities, and leading investment banks, law firms, advisories, and other financial institutions, the Highline Rating enables companies to manage financial risk and make profitable investment decisions on a daily basis.

About Highline Financial

Highline Financial is the preferred source of banking information and tools with decades of experience serving the financial industry.  Our mission is to deliver the highest quality and most relevant banking data and analytics solutions that enable our clients to manage financial risks and make profitable investment decisions every day, at a lower cost of ownership. We do this by combining our focused industry expertise in banking with best of breed industry partnerships to fulfill the real-time strategic needs of executives, business leaders and analysts in financial institutions, corporations and public sector agencies. For more information visit http://www.highlinefi.com/

LJO Newsletter: May 2010

LJO Associates spent the first quarter handling a variety of client outreaches that revolved around the topic of bank debt, investment opportunities, and financial restructurings.

Featured in the Spring Newsletter:

·         On the back of a timely and successful fund closing, we took advantage of fund manager Atalaya Capital’s strategic investment focus on FDIC distressed assets and credit opportunities to create media and investor awareness for the firm’s innovative investment model.

·         Highline Financial, a banking and analytics data vendor, unveiled a partnership with NASDAQ OMX to provide an investor relations web solution to the banking sector. We will further promote the partnership on June 10 at a NASDAQ OMX Banking Sector Seminar on banking reform.

·         As alternative asset firms take advantage of the opportunities in bank debt deals, it also raises operational risk issues that need to be properly managed. We created a thought leadership opportunity for Paladyne Systems to discuss how technology can play a role.

FEATURED CLIENTS

Atalaya Capital Raises $250 million, Targets Banks and Credit Opportunities 

In early April, LJO Associates led the announcement on the close of a third fund offering for Atalaya Capital Management, a special opportunities credit fund led by Ivan Zinn. New York-based Atalaya Capital has plans to aggressively take advantage of special opportunity investments in the small and middle credit markets, particularly those in the distressed banking sector.

Top line coverage was highlighted in MarketWatch, Dow Jones News Service as well as Hedge Fund Alert, Hedge Funds Review, HFN Daily News, The Financial Express, Euromoney, Asset Backed Alert, Credit Flux and Structured Credit Investor.  

On the back of this very successful and timely fund closing, Atalaya Capital has been nominated in the Emerging Hedge Fund Firm of the Year Category at the Institutional Investor’s 8th Annual Hedge Fund Industry Awards. The winners will be announced at a dinner and awards ceremony on Monday, June 21, 2010.                                                                                              

Highline Financial Re-Brands, Signs Partnership with NASDAQ     

 In late 2009, LJO Associates kicked off a PR & Marketing engagement with Highline Financial, the preferred source of banking information and tools for the financial industry. Focused solely on the banking sector, Highline Financial’s data and analytics are relied upon by senior executives to manage risk and make profitable investment decisions daily.

Working closely with the executive team, LJO Associates has strategically advised Highline Financial on new messaging and positioning for the company. Plans for growth through strategic partnerships are now underway.

In March, NASDAQ OMX partnered with Highline Financial to provide data and analytics on its WebCenter360 Banking Suite, a competitively priced investor relations website solution built for global, regional and community banks.

To further promote the partnership, LJO is working with Highline Financial on a co-sponsored NASDAQ OMX Banking Industry Seminar. The event, to be held both live and via webinar on June 10, will bring together prominent industry experts to discuss and debate the impact of pending banking reforms on community and regional banks.

                                 Bank Debt Deals Pose Operational Risk 

To create awareness of Paladyne’s new product CreditMaster ™, we drew on the intellectual capital of the company’s new resident bank debt expert, John Rizzo. John was formely the founder and CEO of Oakwood Technologies, acquired late last year by Paladyne.

As an asset class, bank debt is growing as low asset prices prompt many alternative asset managers to buy into distressed debt and other opportunities. Bank debt is a resource-heavy asset class to manage and last year’s failures underscored the need for standardization and systematic operations to avoid risk.

We worked closely with John to develop, write and promote a timely thought leadership article on this topic. The resulting by-line article was printed in full in Private Equity Central, Hedge Funds Review and Wall Street & Tech.  The article was also a popular read in further promotion via Paladyne’s external marketing.

By Christopher Gohlke

The credit crisis made hedge funds more selective about their service providers in the wake of Bear Stearns and Lehman Brothers. Credit Suisse adopted a similar approach to their clients-and it has made all of the difference.

Until recently, Credit Suisse has been secretive about its strategy for choosing clients in its prime brokerage unit. Whatever the strategy, it seems to be working: Credit Suisse topped Global Custodian’s 2009 survey of prime brokers, bumping industry heavyweights Goldman Sachs and Morgan Stanley down the list.

Then a story broke in the Wall Street Journal in early 2009 that let the cat out of the bag on Credit Suisse’s game plan.

Its prime brokerage group had garnered its success by rejecting more than half of prospective clients in favor of clients with the most “potential.”

In other words, it was choosing hedge fund clients that would boost its own track record.

Word got out about the “CS400,” Credit Suisse’s list of the best hedge funds it wants as clients.

“As soon as that word got out, we started fielding phone calls from clients asking if they were on the list, and if not, how to get on the list,” says Philip Vasan, GC Legend and head of prime brokerage for Credit Suisse.

Vasan explains his business is set up “almost like a hedge fund of fund,” in that it seeks what he calls “long-term winners,” or hedge funds he feels would do better working with Credit Suisse.

Traditionally it selected less than 50% of potential hedge 12 Winter 2009 fund clients, and more recently, less than 40% during the current market dislocation.

“We’ve tried to look at the hedge funds’ prospects for success, as well as the best practices around what they do,” Vasan says.

“So we’ve moved early to think about best practices as well as performance being equally important, and that’s informed a lot of our strategy and who we pick.”

In light of the collapse of Lehman Brothers in 2008, it has become obvious to hedge funds that they must spread their business around multiple prime brokers.

Vasan says Credit Suisse has helped clients go multiprime for years.

“For Credit Suisse, providing clients with quality is not just about Credit Suisse, it’s always been about giving them the best of both the bank and the market,” he says.

“That’s why we and our partners at Paladyne rolled out the Advanced Prime offering.”

Advanced Prime, launched in summer 2007, is a key element in Credit Suisse’s bag of tricks.

The platform, developed in partnership with Paladyne Systems, made Credit Suisse the first prime broker to facilitate and simplify multi-prime strategies for its clients, well before hedge funds began requiring it in light of the turmoil that was set into motion in autumn the following year.

That head start was an important one for Credit Suisse, giving it a leg up on its peers who scrambled to win over the hedge fund business lost by Morgan Stanley and Goldman Sachs, both devastated by their exposure to Lehman Brothers.

“Those five days on Wall St. (after the collapse of Lehman Brothers) brought home to roost the imperative of multi-priming,” Vasan says.

“We’re just glad to have been working on that a few years before the fall of 2008.”

Credit Suisse’s partnership with Paladyne Systems is a symbiotic one, and the two are clearly on the same page. Sameer Shalaby, CEO of Paladyne Systems, says the single prime strategy is a thing of the past.

“The prime brokers are recognizing more and more that the single prime model is now dead, and that they need to compete with their peers in the industry to gain more of the share of that business from their hedge fund clients. To do that, they are looking to offer more capabilities.”Those capabilities, says Shalaby, include adding middle and back-office offerings and expanding multi-prime services, all of which Credit Suisse and Paladyne launched with Advanced Prime several years ago.

“It’s very clear to all the other prime brokers that to compete for this business, to compete with the Credit Suisse offering, they need to expand their services to include some of the aspects we refer to as Advanced Prime with Credit Suisse.”

The open architecture technology of Advanced Prime aggregates multiple prime broker feeds at either a third-party hosted site or within a client’s environment, Credit Suisse says.

Technology infrastructure and support costs are streamlined, it adds, as Credit Suisse centrally provides core functions.

With the combination of its Advanced Prime suite and its selective strategy in choosing clients, Credit Suisse came out on top this year among prime brokers. But now that other prime brokers have had the opportunity to catch up on their multi-prime offerings and the market has had a chance to settle, the true test of the Credit Suisse strategy will come when Global Custodian’s next Prime rokerage Survey is released in Summer 2010.

A wave of New Year’s research reports on the state of information technology at securities firms describe an industry failing to keep up with change and in some ways blind to the interconnectedness and importance of IT.

“Half of banks will still lack a formal innovation program and budget by 2013,” says a dismal assessment by Gartner, the U.K.-based research conglomerate.

“Pressure from governments, regulators and consumers is making
some banks risk-averse and creating a culture of introversion and inflexibility,” Richard De Lotto, principal research analyst at Gartner, said in a published statement.

“The predominant view of IT is that it is only useful for cutting costs, so tactical thinking about automation and rationalization overwhelms longer term decision and strategic plans and goals.”

Armanta, a Summit, N.J.-based software- development company whose specialties include designing risk management systems, asserts that much of the industry is crippled by a hodgepodge of incompatible IT systems.

“Come to terms with your firm’s patchwork infrastructure,” Armanta says in a note that has a tough-love tone.

“Although financial institutions spend billions annually on IT, one area that has been consistently neglected is cross departmental integration – a fact that makes it extremely difficult for firms to accurately assess their firm-wide exposures in a crisis.”

“In 2010,” it adds, “firms need to look at solutions that will bridge the divide and produce data that is accurate and meaningful.”

The note is written around a top-five list of what Armanta executives say are actions the industry “must take in 2010 to improve transparency, reduce operational risk and thrive in uncertain markets.”

Peter J. Chirlian, Armanta’s chief executive, said the economic trauma of 2008 and 2009 pulled an industry curtain aside.

The financial crisis revealed that many, if not all, major financial institutions have patchwork infrastructures that make it extremely difficult to understand the firm’s market and counterparty exposures. The crisis may be over, but the data problems are fundamental,” Chirlian said.

He called for “positive operational changes” that would help financial institutions “highlight their exposures across business units, improve their market reaction times, and simplify reporting for investors and regulators.”

Armanta’s list includes – in addition to better systems integration – the following IT-improvement themes:

• Reducing systemic IT risk. The note says mismatched systems “can cause a domino effect of bad decisions throughout an organization, which can have devastating systemic shocks not only for the firm, but also for the economy.”

• Ensuring that new product offerings are adequately supported.
“A fast-moving and responsive financial firm can develop thousands of new products in a short period of time. The mistake many firms make is in allowing business units to develop spreadsheet-based systems to manage those products.

In an already fragmented IT organization, spreadsheets that sit on people’s desktops are difficult to integrate: This is dangerous because particularly complex products can carry risks that don’t get figured into the organization’s firm-wide view of its exposures.”