I don’t like it when the most accurate prediction I make for a day ahead in markets proves to have been that it will be boring and uneventful but I did just that yesterday, Wednesday, and how accurate it proved to be.
That said, there was one little snippet which might have slipped past many non-American investors and that was the savaging of Macy’s share price. Macy’s, just to set the scene, is not just any department store. Founded in 1854, it is New York’s equivalent to Harrods, Galleries Lafayette or KdW; it is an institution, a way of life. Mind you, this is America and if the numbers don’t stack up, the name counts for nothing. Unlike Harrods, Macy’s is not a rich man’s trophy toy. Anyhow, Macy’s share price dropped 14% on poor 3rd quarter earnings and downward guidance for the full year – and that on the same day as Alibaba racked up a record day for online sales for what is known as “singles day” in China.
The debate as to whether bricks and mortar retailing is either dead or dying is a bit like the argument over climate change in that there are believers and deniers and of course all hues in between. In all, Macy’s shares have fallen 32% year to date at a time when unemployment is falling and earnings are rising.
Initial response to Macy’s numbers will have been one of those “Yeah, yeah, sure….” ones as the US department store sector goes up and down and in and out of private equity hands but I believe that there is a “cross-discipline” issue here which must not be overlooked and that has to be in the REIT (Real Estate Investment Trust) and in the CMBS markets. America loves its shopping malls and most of those – frequent travellers to the Land of the Free (where next to nothing comes for free) will recognise the picture – are built around the simple barbell formula of one department store on either end and all the other shops in the connecting middle. Were one of the two big guys to pull out, then the economics of the entire mall would surely become questionable and suddenly one might find retail space heavy investment trusts and secured bonds looking a bit sick.
Twenty five or so years ago I was involved with a bond issue aimed at refinancing the picture theatres of the Universal Cinema Circuit. It was a very cleverly structured deal – I think Goldman was the lead – secured on the actual real estate. At the time I was running something akin to a high-yield bond portfolio for Bank of New York so I did my own analysis. I declined the deal on the basis that the value of a picture house in Omaha, Nebraska or Des Moines, Iowa was no more than the value of the ground it stood on minus the cost of knocking the cinema down, for if the cinema chain went under, it would be because of the lack of movie goers. Therefore the book value of an empty picture house accounted for nothing. In the event, the deal did fine as did the cinemas but my thinking on how to put a proper value a real-estate asset other than the way proposed by the issuer and lead manager has not gone away
If the future of the physical middle market department store were to be in doubt, then the value of out-of-town malls must be too and a significant reassessment of many of the assets in retail space owning REITs and in the asset pools of Commercial Asset Backed Securities need to be undertaken. Much was made last week of Amazon’s idea of dipping into the bricks and mortar business but I suspect that they are thinking more along the line of the quick response model employed by the likes of Zara than the all product carrying one stop shop. One swallow a summer does not make and following Macy’s, we still have the figures for Nordstrom, J.C. Penney and Kohl’s to follow but I’d suggest firstly watching those carefully and then assessing the impact of future cost cutting by way of store closures on some of those copper-bottomed commercial real estate investments.
Glass-Steagall houses
The debate as to the future of our industry continues apace. This morning the FT carries an article penned by John Reed, former chairman of the NYSE but before that chairman and CEO of Citibank and the man who, together with the mercurial Sandy Weill, engineered the merger of Citi with Travellers Group, the insurer, during the period when the all singing, all dancing financial services group was plat du jour. It is a very, very short mea culpa which in essence concludes that the reversal of the 1933 Glass-Steagall Act which enshrined the separation of commercial from investment banking after the Crash of ’29 was a mistake and that all the stimulus in the world will do no good if the structure of the underlying financial services business is wrong.
I don’t think that there are too many thinking bods in the Square Mile or on Wall Street who would disagree and I have raised the point in this column on a number of occasions in the past. I started in our industry when investment banks needed to be fleet of foot in order to optimise the use of their scarce capital. Access to the near endless balance sheet capacity of a big, lugubrious commercial bank made the risk takers lazy and greedy.
What is often overlooked, however, is the way in which corporate clients have learnt to make investment banking mandates contingent on the provision of balance sheet. How else did former savings banks and regional lenders end up on the ticket with the old established investment banks and why else did the latter end up with full banking licenses?
Changing the banking model sounds good but whereas the Macy’s and J.C.Penneys of this world need to adapt to the shift in client behaviour, in the financial services space it is the customers who will have to revise their thinking and the pressure they have been putting on their providers of investment banking services.
Funnily enough, the demand by US investment banks to be given access to commercial banking balance sheets was not driven by domestic demand but by the need to be able compete on the global scene with the likes of Deutsche Bank which was envied for its ability to bury its mistakes in the back book.
Now, as Deutsche struggles to revive itself, detractors are gleefully noting that what goes around comes around. It is of course much easier for Reed to acknowledge the mistakes made than to propose how to reverse the damage. He is, nevertheless, right when he concludes that simply trying to regulate what we have is as good as futile. It’s actually about as much use as passing a law which bans foxes from killing chickens.
