A Sign That All Is Not Hunky-dory Behind The Scenes

Sydney Morning Herald

Wednesday January 30, 2008

Malcolm Maiden

THE risks still in this sharemarket were highlighted yesterday by an extraordinary development: the settlement of all share trades was held up for several hours after the failure of the broking firm Tricom Equities to settle on its transactions.

After settlements through the Australian Securities Exchange's CHESS system failed to occur as usual about 12.30pm rumours swept through the broking fraternity that the problem had been caused by Tricom, one of the most aggressive brokers during the market boom.

Tricom's managing director, Lance Rosenberg, said last night that last week's huge trading volumes had created "administrative issues" that Tricom was confident it could resolve - but the bottom line appears to be that the firm had insufficient funds to cover last Friday's trades under the three-day settlement rule.

The ASX is working with Tricom to enable it to settle the trades today, a day late: that may be contingent on Tricom securing new lines of finance.

Even if the Tricom problem is contained, it will be seen as evidence that the repercussions of the market shake-out are still being tallied.

The ASX informed other firms during the day about the situation, without identifying the firm involved. Brokers in other firms were asking last night whether that was sufficient, given that the brokers that operate on the Australian Securities Exchange are all counterparties of each other. There was no official communication about the problem and settlements finally went through at 5.15pm, after being reconfigured to exclude Tricom's share.

Shares that Tricom has in the past traded heavily, including the Babcock & Brown stable, could come under pressure, on the theory that Tricom and its clients could be forced sellers in a liquidity shortfall.

Tricom grew aggressively during the market boom, partly by funding clients with margin lending, and has been a key supporter of financially engineered stocks such as the B&B stable. Its balance sheet showed loans and overdrafts grew from $926 million in the year to June 30, 2006, to $2.38 billion a year later, with much of the growth coming from margin lending.

The Sydney firm was the subject of speculation about its financial condition last August when Australian share prices tumbled in response to the emergence of the credit crisis. The ASX queried Tricom behind closed doors at the time and Tricom was able to confirm that it was paying its bills and that its margin loans were still comfortably covered by the value of shares acquired by clients, with an overall debt to valuation ratio of 62 per cent.

Before it bounced last week the sharemarket fell 5.4 per cent below last August's nadir, however, renewing pressure on margin loans everywhere.

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The US asset manager Legg Mason's fixed interest investment manager, Western Asset, has $US630 billion ($710 billion) invested globally and it's worth noting that even as the market volatility continues, the man leading Western's global multi-sector investment strategy, Michael Zelouf, is quietly bullish.

Western is an active fixed interest manager that seeks to add cream to the returns it achieves by investing in sectors according to the views it reaches about the state of the credit markets and the economies that drive them. It is not always a counter-cyclical investor, but right now that is where it finds itself.

Depending on whether the fund is on a conservative or aggressive footing, money sunk in sovereign debt including US bonds can account for as much as 40 per cent of assets, or as little as 5 per cent. Exposure to investment-grade corporate debt can range from 20 per cent to 10 per cent, high-yield corporate debt can run as low as 20 per cent and as high as 35 per cent (the multi-sector operation always has a high yield bias), and emerging market debt can be as low as zero when Western is defensive, and up to 35 per cent if the mood is bullish.

Western was on a defensive footing with relatively high exposure to government and other "safe"debt at the beginning of last year, when real interest rates were high at about 3 per cent in the United States, interest rate spreads were narrow and, with the benefit of hindsight, high-yield corporate debt was over-priced.

Zelouf says that the credit crunch has now pushed prices down to a point where valuations and rates were becoming compelling and Western has shifted weights to become more aggressive. Government paper is down to 6 per cent of the portfolio, cash or near-cash is low at 3 per cent, investment grade corporate debt has expanded from a few per cent of the portfolio last year to 19 per cent, high-quality mortgage-backed debt is overweight at 18 per cent and high-yield corporate debt is sitting at 31 per cent. Emerging market debt is being held at about 20 per cent of the portfolio.

Western could more aggressive, as its range of weightings suggests, but Zelouf says the firm is already "cautiously optimistic". It thinks global economic growth will moderate but continue to be solid, with growth in the emerging economies including China more than compensating for a slowdown in the US and Japan. Inflation will be contained and the US will narrowly avoid recession, Zelouf says - and he believes that US rate cuts have turned falling US house prices around in previous cycles, and will do so again as the US Federal Reserve cuts rates aggressively.

mmaiden@theage.com.au