Mr. Willoughby Shoots the Messenger

June 25, 2007

That makes [State Street] a far different sort of bank than, say, Citigroup…which has struggled to get its multi-faceted global financial supermarket in synch.

—Jack Willoughby, Barron’s


September 3, 2007

The fear — some of it no doubt fanned by hedge funds — is that these [State Street] conduits’ portfolios, full of credit-card, auto, and mortgage loans the bank uses as collateral for selling commercial paper to investors, have undisclosed losses. If spooked buyers were to balk at buying more commercial paper, State Street might have to provide some funding. Obviously, $29 billion is a big exposure relative to the bank’s total capital of $113 billion.

—Jack Willoughby, Barron’s

State Street has a problem.

It seems the bank, which over the years carefully built the best securities processing franchise going, has also accumulated $29 billion worth of off-balance sheet credit exposure to four special investment vehicles known as “conduits.”

“Conduits” is, I think, an excellent term for such financial structures, since what flows through them can be the financial equivalent of anything ranging from spring water to raw sewage.

In the case of certain “conduits” established by a pair of German banks—IKG Deutshe Industriebank and Sachsen—the financial effluent was, as it turned out, a lot like sewage, and would have brought the banks down but for their ignominious rescues.

As for State Street, precisely what is flowing through its “conduits” is not clear except to State Street, which says the assets include credit card debt, auto loans and NOT sub-prime mortgages—all properly priced and liquid as can be.

Mr. Market is not so sure.

After all, $29 billion worth of headline credit exposure to the four measly conduits is a much larger number than State Street’s own shareholder’s equity of just under $8 billion—making those very shareholders understandably nervous.

Furthermore, sentiment towards the company—grandly touted by Barron’s Jack Willoughby as “a far different sort of bank” just weeks before its “conduits” exposure knocked the legs out from under the stock—has not been helped by the fact that one of State Street’s many investment funds was, apparently, so chock full of sub-prime something that it lost enough money in early August to make headlines in the Boston Globe.

Which brings us to Mr. Willoughby’s messenger-shooting.

The recent conduit-related decline in State Street’s stock triggered a defensive “Follow-Up” column from Barron’s this weekend, in which Willoughby, as quoted at the top, placed blame for State Street’s problems squarely on the shoulders of where it belongs…the management team that elected to accumulate $29 billion worth of credit exposure to off-balance sheet financing vehicles in the first place.

Actually, I am making that up.

He blames hedge funds, in part. I am not making that up:

The fear — some of it no doubt fanned by hedge funds [emphasis added]– is that these conduits’ portfolios, full of credit-card, auto, and mortgage loans the bank uses as collateral for selling commercial paper to investors, have undisclosed losses.

Why a Barron’s reporter should take am at the hedge fund messenger, rather than the P.R. flak who presumably pitched him the State Street story in the first place, is beyond me.

Hedge funds had nothing to do with establishing State Street’s off-balance sheet “conduits,” or loading them with credit card debt, or mortgage debt, or auto loan debt.

Nor did any “hedge fund” that I know of encourage State Street’s Limited Duration Bond Fund to lose enough money in early August to make a story out of it in the Boston Globe.

In fact, I can’t think of anything at all that “hedge funds” have had to do with State Street except use their excellent back-office services, and, perhaps, short the stock.

Perhaps if Mr. Willoughby had called one of those “hedge funds” savvy enough to have shorted State Street when he was preparing his original puff piece, he might have seen what was coming and toned down his glowing company love-fest, which called State Street “a different kind of bank” and contained such cringe-making quotes as this, from State Street’s CEO:

“Revenue growth will separate the men from the boys.”

In fact, had Mr. Willoughby spoken to a hedge fund manager or two about the company’s ballooning exposure to off-balance sheet “conduits” rather than relying, as he apparently did, on the good graces of the company’s own P.R. flaks to make the CEO available for carefully scripted interviews, he might even have given Barron’s readers a useful heads up, instead of cringe-making observations such as this one:

Such a well-informed streak of independence is refreshing in a CEO, even if it doesn’t always make him popular.

Of course, defending a one-sided, rose-colored bit of reporting is easier to do if one blames the messenger without re-examining the original premise of the piece in the first place.

However, if he had indeed chosen the harder way, Mr. Willoughby might have found that he had actually identified the source of State Street’s current dilemma in his original puff-piece, when he stated:

As always, State Street stands ready to exploit the next professional money-management trend.

Trends such as “conduits,” perhaps?

Jeff Matthews
I Am Not Making This Up

© 2007 NotMakingThisUp, LLC

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author.