Last Revised: 09/08/2023

Sector Studies
Segments Page

Consumer Discretionary 2

Consumer Staples 13

Materials 19

Understanding Mining 24

Financials 31

Understanding Banks Part 1 36

Understanding Banks Part 2 - Liquidity 40

Understanding Banks Part 3 - Interest Rate Risk 43

Real Estate 48

M.M132743897.

This document should be used in conjunction with the corresponding segments for Sector Studies as provided on
MarkMeldrum.com. All content is copyright 2023. All rights reserved.

© markmeldrum.com. All rights reserved.

1
 Last Revised: 09/08/2023

Consumer Discretionary
Page 1/
Structure/ sectorspdr.com - XLY - 58 holdings
~ 11.7% of S&P 𝛒𝐗𝐋𝐘,𝐒𝐏𝐘 = . 𝟗𝟑𝟓
~ 8.8% of MSCI ACWI (5 yr.)
4
Industry
- sector "
& groups
$
" 11
TSLA 20.3% industries
'
# 29
! sub-industries
# (
$
)
AMZN 24.7% Global
*
Industry
+ Classification
!
Standard
% (demand
oriented)

remains
×
× all gone

× gone ➞ Staples
× e.g./ TGT
(Multiline) √ new DG
DLTR

remains
Retailing

√
M.M132743897.

remains

https://www.spglobal.com/spdji/en/governance/consultations/mr47787/
- XLS of companies affected globally
“Select List of Companies That May Be Impacted...”

2
 Last Revised: 09/08/2023

EM

NA

AP

EMEA

M.M132743897.

3
 Last Revised: 09/08/2023

Page 2/
Characteristics/ wants, not needs

elastic demand ➞ larger %∆𝐐𝐝 for a %∆𝐏 than other sectors

firms are economically sensitive - demand responds more than
from ∆𝐏
highly correlated with broad economic
performance
[𝐜𝐨𝐫𝐫(𝐚𝐥𝐜𝐨𝐡𝐨𝐥, 𝐫𝐆𝐏𝐏) < . 𝟏𝟎]
𝛒𝐂𝐃,𝐫𝐆𝐃𝐏 ~ .68
sensitive to consumer sentiment
sector leads market

CD - cycles more than

SPY SPY

𝐭
SPY lags lag

Page 3/
Characteristics/ sector leads market
larger gains
Jan./03

SPY + 13.28% from low

XLY + 22.32% from low
SPY XLY
-9.73% -17.12 Jan. 27 SPY - 23.41% YTD
XLY - 35.29% YTD
larger losses
Jun. 17
M.M132743897.

4
 Last Revised: 09/08/2023

CD top

CD tops ~ IQ before market

equity market top - Jan. 3

vs.

vs.

Jan. 31/2022 Oct. 30/21

Page 4/
Drivers/ largest driver ➞ GDP growth

high interest (NY Fed) PDI ➞ personal

rates credit availability disposable
Treasury income
Fed. Reserve -
employment
GDP growth PDI ➞ consumer ➞ Consumer
wages/incomes MPC spending Discretionary
+
durable
consumer goods
low interest non-durable
rates sentiment
Conference Board
Univ. of Michigan
M.M132743897. services
Bureau of Economic Analysis growth and
rGDP price indexes in
Consumer Spending (+ Retail Sales) consumer spending
Income and savings census.gov GDP
- industry group
Employment
data

5
 Last Revised: 09/08/2023

Page 5/
Drivers/ sector leads consumer spending

vol. ↑ at sector consumer

tops. spending

𝐭
lag - sector turns down before EPS/Rev.
(up)
- anticipates turndown in spending and
sets bull traps discounts that today

𝐂( Durables ~ 12% (~8% of GDP) ~ 50% of CD

𝐆𝐃𝐏 ~ 𝟕𝟎%
Non-durables ~ 22% (~15% of GDP) ~ 36% of CD
quite stable
Services ~ 66% (~ 44% of GDP) ~ 14% of CD
- even in recessions
in terms of spending
∴ 𝐂%
𝐆𝐃𝐏 ↑ in recessions explain ~ 20% of PCE volatility
↓ in expansions

Page 6/
Durables/ goods with life > 3 yrs. 𝛒𝐝𝐮𝐫𝐚𝐛𝐥𝐞𝐬,𝐜𝐨𝐧.𝐬𝐩 ~ 𝟕𝟎%

highly discretionary - first to drop, last to recover

interest rate sensitive - automobiles (TSLA, GM, F)

- homebuilders (DHI, LEN, PHM)
the higher the price, the more interest rate sensitive

Business typically slows

for ~ 1 yr.
cycle sector downturn leads after a bus.
lags sector rally - sets bull trap
cycle peak
- sets bear trap
M.M132743897.

OT ↑
Init. J. Claims ↓
(signals)

6
 Last Revised: 09/08/2023

Page 7/
Durables/ motor vehicles GM
YTD
recreational goods
- 41%
(2× vs. (electronics, sporting) BBY YTD
non-durables) - 25.3%

Furniture, appliances
WHR YTD
- 25.2%

𝐈𝐚𝐠 ↓ 𝐈𝐚𝐠 ↑

fiscal Stimulus usually targeted here

e.g. Cash for clunkers, EU tax credits
- sets a floor more than it creates growth
(employment sensitive sector of economy)

Non-durables/ < 3 yrs. or consumables - primarily sold by retailers

Services/ smallest segment of CD by spending

- both driven by PDI but far less interest rate sensitive

Page 8/
Industry group: Automobiles & Components
economic sensitivity - high
high barriers to entry
highest level of gov’t. regulation in CD

new cars aftermarket ➞ used car (more demand)

- most critical for tire
OEMs T1 T2 T3 manufacturers (5:1 ratio)
R.M. (e.g.)
transmissions ball
bearings commodity prices

PPI (Stage 1-4)

M.M132743897.

useful life increasing due to

improving quality ➞ reduces replacement sales ➞ 10M
vs. ~ 18% global sales
12.3 7M
11.2 𝟐𝟗𝟎𝐌
= 𝟐𝟑. 𝟓𝟕
9.6 𝟏𝟐. 𝟑
10 yrs. × .𝟑
10 yrs.

7
 Last Revised: 09/08/2023

Page 9/
Industry group: Automobiles & Components
critical issues: supply availability (EU, parts suppliers)
access to capital
higher rates = lower profitability
and higher supply chain disruption potential
Labour ➞ unions ~ 3 yr. cycles

ORLY 1.27% KMX .43%

GM 1.43% AZO 1.19% LKG .39%
XLY - 27.49%
F 1.65% APTV .73% AAP .32%
TSLA 19.25% GPC .58% BWA .25%
Auto Manufacturers (22.33%) Auto Parts and Equipment (5.16%)

Consumer Durables & Apparel ➞ Household Durables ➞ Home builders

DHI .67% XHB interest rates
LEN .60% ITB credit availability
1.91%
NVR .37% Inventory levels
PHM .27% rents

Page 10/
Trading the Sector/
Slowdown
Early
rising late falling rates
Contraction
rates bull
Late
Expansion
out
Late
CD-services Contraction
Mid
economic Expansion/Recovery
cycle
late
Early
bear XLY equity
Expansion/Recovery economy
levered syn. market
Consumer
M.M132743897.
- consider other bottom bottom
specialized ETFs
Discretionary
- Retail, homebuilding
in - turns up with
sector gains > market gains long XLY
short SPY - long XLY
XLY options - RR, synthetic

8
 Last Revised: 09/08/2023

Page 11/
Trading the Sector/ Relative to SPY
)𝐖𝐒𝐏 − 𝐖𝐒𝐁 , > 𝟎 $10k equity
(𝐑 𝐀 )
allocation

∗ $1,188 CD
equal weight

late bear mkt./

late contraction
∗
1,500 CD
lower allocation
to cons. st.
when O.W. CD ➞ U.W. Cons. Staples late expansion/
(U.W.) (O.W.) late bull market
900 CD
raise allocation
to cons. st.

Page 12/
Trading the Sector/ Absolute - long
1-2 ➞ multi-year
sell calls, lighten up
! bull run
- use pullbacks to
use leverage Retail increase ∆
add focus ETFs Services
Rest/Leisure
Homebuilders
economic cycle

"
+20% equity market
- new bull market
economic news still
negative M.M132743897.
sell puts ATM on XLY
(~ 45 days) full position (OW market - synthetic at ∆ ~ 𝟏. 𝟎
or/ weighting) (4-6 Qtrs. out)
buy 𝟏%𝟑 position
- sell puts @ ∆ = .2 or less - roll over
or use 60∆ RR for added income
(3-4 Qtrs. out) (𝟏%𝟐 Qtr. ~45d)

9
 Last Revised: 09/08/2023

Page 13/
Trading the Sector/ Absolute - short
market leads economy
CD leads market
- lower ∆ 45d
ATM
sell calls
OTM
sell shares 45-90d
sell calls on
equity
bear market
market
economy rallies (XLY)
(watch for bull traps)

raise ∆
exit high price durables first back to zero (or neutral)
autos - roll over to net long ∆
homebuilders - watch bear traps
lower leverage

Page 14/
Trading the Sector/ Removing a component

XLY ➞ TSLA 20.3%

AMZN 24.7%

long XLY ➞ $15,000 e.g. 𝐒𝟎 = 886 , short:

short TSLA 15,000 × .203 15,000 × .203 = 3.44 sh.
𝐒𝟎 886

w/ options ➞ 4-6 Qtr. synthetic long or short put w/ ∆ > .80

- short TSLA ➞ notional value of
× 𝐖𝐓𝐒𝐋𝐀
- Balance ETF (> CD > SPY) underlying
M.M132743897.

Reduce TSLA to 10.3% 𝐏𝐓𝐒𝐋𝐀

Add 5% to F & GM

sell ➞ ($ 𝐏𝐨𝐬𝐢𝐭𝐢𝐨𝐧 × . 𝟏)A sell ➞ ($ 𝐏𝐨𝐬𝐢𝐭𝐢𝐨𝐧 × . 𝟎𝟓)A

𝐏𝐓𝐒𝐋𝐀 𝐏𝐅 (𝐏𝐆𝐌 )

10
 Last Revised: 09/08/2023

Page 15/

outperformance
XLY can be used as a leveraged SPY market low
or in combination ➞ take advantage
of higher IV

higher IV ~ skew but a higher IV

days out

M.M132743897.

11
 Last Revised: 09/08/2023

Sources:

GICS:
https://www.msci.com/our-solutions/indexes/gics

https://www.spglobal.com/marketintelligence/en/documents/112727-gics-
mapbook_2018_v3_letter_digitalspreads.pdf

https://www.spglobal.com/spdji/en/governance/consultations/mr47787/

Economic Drivers:

GDP
https://www.bea.gov/data/gdp/gross-domestic-product

Employment, Wages, incomes, Inflation and Prices

https://www.bls.gov/bls/newsrels.htm

Retail Trade:
https://www.census.gov/retail/index.html

Personal Consumption Expenditure:

https://www.bea.gov/data/personal-consumption-expenditures-price-index-excluding-food-
and-energy

Consumer Confidence:
https://www.conference-board.org/topics/consumer-confidence

Interest rates:
https://home.treasury.gov/resource-center/data-chart-center/interest-
rates/TextView?type=daily_treasury_yield_curve&field_tdr_date_value=2022

Sector ETFs:
XLY – S&P500 – liquid + liquid options for close to ATM
https://www.sectorspdr.com/sectorspdr/sectorsM.M132743897.

PSCD – S&P500 small-cap – not liquid but useful for security selection
https://www.invesco.com/us/financial-products/etfs/product-
detail?audienceType=Investor&ticker=PSCD

12
 Last Revised: 09/08/2023

Consumer Staples
Page 1/
Structure/ sectorspdr.com - XLP - 33 holdings
𝛒𝐗𝐋𝐏,𝐒𝐏𝐘 ~ . 𝟖𝟏
~ 6.5% of S&P500
market cap
3
industry (~ 6.6% of MSCI ACWI)
groups
PG 15.11%
6
KO 10.67% 21.18%
industries
PEP 10.51%
12 COST 10.26% 46.55%
sub-industries (𝟒%𝟑𝟑 components)

Global
Industry Div. yield = 2.7%
Classification low vol. ~ 11.4%
Standard
(vs. ~ 18% SPY)
(demand
oriented)

M.M132743897.

13
 Last Revised: 09/08/2023

TGT
2023 DLTR
DG

same
same
same

Food & Staples Hypermarkets and

Retailing Super Centers
(current name) (current name)

Page 2/
characteristics/ necessities (need to have)

inelastic category demand (higher brand elasticity)

(contributes to pricing power) trade up/down
firms with positive, but low, economic sensitivity
but high input cost sensitivity (esp. energy-transportation
costs)
- relatively stable absolute performance
throughout the business cycle
➞ relative performance negatively correlated with the
business cycle
(i.e. outperforms in recessions)

- lower 𝜷etas, slightly M.M132743897.

higher PEs, dividend payers
(attract income investors)
but lower
- longer-term holders
FCF yields
- overall relative earnings stability with broad geographical earnings
diversification

14
 Last Revised: 09/08/2023

Page 3/
characteristics/

1 yr. YTD
XLP -1.09%
SPY > XLP 4.51%

-10.4%

XLP > SPY -3.39% SPY -10.41%

-23.55%

Page 4/
10 yr.
characteristics/
XLP
10 yr.
CD
20

7-10
SPY

CS
CS - 2× in 10 yrs. ~ 77 USD
SPY - 3× in 10 yrs. ~ 430 USD 1 yr.
CD - 3.8× in 10 yrs. ~ 173 USD 20 yr.
7-10 yr.
UST
UST

M.M132743897.

MER
.15 IEF yield ~ 2.67% (𝛔 ~ 6.6%)

.1 XLP div. y ~ 2.70% 3 yr.

.15 TLT yield ~ 3.11% (𝛔 ~ 14.68%)

15
 Last Revised: 09/08/2023

Page 5/
Drivers/
- low rGDP sensitivity
- curve inversion ➞ bullish
- 𝐜𝐨𝐫𝐫(𝐑 𝐀 − 𝐬𝐭𝐚𝐩𝐥𝐞𝐬, 𝐂𝐋𝐈) < 𝟎 ➞ CLI - composite leading index

(𝐫𝐗𝐋𝐏 − 𝐫𝐒𝐏𝐘 ) < 𝟎

when 𝐄(rGDP) > trend
factor
(𝐫𝐗𝐋𝐏 − 𝐫𝐒𝐏𝐘 ) > 𝟎
exposures
when 𝐄(rGDP) < trend

outperforms
when 𝛑𝐚𝐜𝐭𝐮𝐚𝐥 > 𝛑𝐭𝐚𝐫𝐠𝐞𝐭 (pricing
power)

data: OECD - global (and by country) - but absolute 𝐫𝐗𝐋𝐏 suffers

Conference Board - US as 𝛑𝐚𝐜𝐭𝐮𝐚𝐥 > 𝛑𝐭𝐚𝐫𝐠𝐞𝐭 for

(data sub. req.) longer

Page 6/

Absolute basis: safety and Income

- good substitute for a long-maturity bond allocation
- dividend rather than interest income (better after-tax return)
+/ ~ 6% dividend growth/yr. ap. g.
6.7% c
cagr
6.9% cagr (6% 5yr. cagr)
Q1 + Q2
3.85% 4.5% 4.65% 3.72% 13.8% 2.6% 9.5% 13.3%

M.M132743897.

- low beta, low duration

market risk interest rate risk
𝐫 > 𝟎 in expansions, 𝐫 ~ 𝟎% (or slightly less) in recessions

16
 Last Revised: 09/08/2023
Page 7/
Relative basis: Relative to SPY
when OW CD ➞ UW CS
- hold opposite of CD
(UW CD) (OW CS)
- Dec. 1960 to Nov. 2019/
outp. outp. outp. outp.

absolute abs. abs. abs.

relative rel. rel. rel.
𝐫>𝟎 absolute 𝐫 > 𝟎 abs. 𝐫 > 𝟎 abs. 𝐫 > 𝟎 abs.
relative rel. rel. rel.

during recessions:
𝐫𝐬𝐭𝐚𝐩𝐥𝐞𝐬 = 1% (for the period)
𝐫𝐬𝐭𝐚𝐩𝐥𝐞𝐬 − 𝐫𝐒𝐏𝐘 = 14% (for the period)

Page 8/
Income: low 𝛔 ➞ great setup for selling premium

covered calls ➞ ∆ ~ .2 to .3 - front month

or (~30¢) (~𝟒𝟎¢) (Mon. after exp.)
puts ~ 4.8% ~ 6.4% 12 × /yr.

➞ short straddles - long underlying - partial position

short call & put ∆ ~ .4 to .6
$1.20 to $1.60 12 × /yr.

slowdown very low call ∆

exp.
low call ∆ puts ~ ∆
M.M132743897.

higher put ∆ recession

calls ↑ ∆
puts ~ ∆ recovery
puts ↑ ∆
calls ↓ ∆

17
 Last Revised: 09/08/2023

Page 9/

XLP (Morningstar) (MER = .1%)

no covered calls

XYLD - S&P 500 Covered Call ETF (MER = .6%)

sells front month calls on SPX

XLP 16∆ Calls ➞ adds ~ 3.2%
- near ATM (sightly OTM)
(𝐒𝟎 × 1.035)
1𝛔 - cash settles
assumes 30-day options ∆ ~ .40 - .45

16∆ Puts ➞ adds ~ 3.2%

Page 10/

underperformance

outperf.

ATM
less liquid
options

lower IV
~ 6% M.M132743897.

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 Last Revised: 09/08/2023

Materials
Page 1/
Structure/ ~ 2.50% of S&P (smallest sector weight) Peru - 75%
Brazil - 30%
~ 5.5% of MSCI AWCI - largest exposures Australia - 25%
South Africa - 21%
Mexico - 17%
Canada - 17%
1
Industry sectorspdr.com XLB - 28 holdings
groups
Div. yield 2.05%
5 (~ 5.5% g/yr.)
industries
XHB 10 yr. Total Ret. ~ 10.7%/yr.
17 w/ 𝛔 = 18.6%
sub-industries SR = .47 vs. Index = .97

XME

~ 70%
*returns
best 10-yr.

* most profitable industry in Chemicals

* much less
cyclical
~ 5%

*
M.M132743897.

~ 13%
mining
more
profitable
~ 12% than
refining

19
 Last Revised: 09/08/2023
Page 2/
Characteristics/ - primarily global pricing (~ 53% non-US Revenue)

- esp. Metals and Mining

most Chemicals
- lower value-to-weight ratio, more regional markets/influences

- very energy intensive ➞ esp. mining operations (e.g. mining ➞ ~ 25% - 30% of
total costs)
- hugely capital intensive ➞ high operating leverage
- high barriers to entry ➞ results in sub-industry concentration
- much easier to buy growth than build it

Use vs. Intensity

Construction - all materials higher in EM/Developing
Infrastructure - non-metallic has been dropping per $ of GDP
Capital good - metallic efficiency, new materials
Energy ➞ metallic

Page 3/
YTD 1 YR

Inline

XLB > SPY July CPI flat

- commodity prices ↓
but XLP still outperforms - global PMIs ↓

XLB ➞ Initial recovery ➞ slight outperformance vs. SPY (but not XLY)
M.M132743897.

- best conditions - late expansion with strong rGDP globally

- above trend inflation
- strong outperformance (esp. Metals & Mining)

20
 Last Revised: 09/08/2023

Page 4/

10-yr.
massive XME (industry) SPY
outperformance market
staples 108%
11.93%
XLB
-10.13 12.9%
sector
sector
XME
industry

MER = .35%
XME - Metals &
Mining ETF Div. y. ~ .85%

- liquid options

Page 5/

Drivers/ - very sensitive to rGDP

both combined
esp. construction spending
use XME
manufacturing (PMIs ↑)

- commodity prices ➞ key driver of NI

- metals
Late
expansion
- if inflationary
pressure present
+ no slowdown
- XLB outperforms
early recovery
(mostly from Metals & Mining)
M.M132743897.

XLB slightly
outperforms

21
 Last Revised: 09/08/2023

Page 6/
Drivers/
Metals/Mining - higher 𝜷 industry
(XME) - high economic sensitivity + high operating leverage
∴ very cyclical
- outperforms ‘Sector’ - strong GDP growth + rising raw material
(esp. EM/DM) prices

Chemicals - prefers strong GDP growth with stable or falling energy

(oil/nat.-gas a key input) prices
esp.
- more specialized the output, the greater
commodity
the pricing power chemicals
- high VC, low FC ➞ ∴ lower 𝜷 and less cyclical than Metals & Mining

Fertilizers & Agricultural Chemicals - low market risk exposure but still
volatile
- climate change/flooding/growing conditions becoming
a significant driver

Page 7/
Drivers/
Construction Materials - tied heavily to Construction spending
- both residential and non-residential
(commercial) +
Paper & Forest Products - economic growth in developed markets
and residential construction (XHB more targeted)

Containers and Packaging - complement product with ‘Consumer Staples’

- most stable industry/sub-industries in Materials
Factor Smaller
exposure vs. size
S&P500 M.M132743897.
largest market-cap in
Materials is #
57 in Index

more value ~ 62%

higher div. y. (38% growth)

22
 Last Revised: 09/08/2023

Page 8/

XLB = 74.35 XLP = 72.32

𝛔 = 18.6%
𝛔√𝐓 ➞ . 𝟏𝟖𝟔7𝟐𝟖𝟒/𝟑𝟔𝟓 = .164
74.35 × 1.164 = 86.54

~30∆ 85 call JUNE/23 4.20 ➞ 75 XLP call ~45∆

(+14.23% over 𝐏𝟎 ) (+3.7% above 𝐏𝟎 )

~20∆ 90 call 1.80 ➞ 81 XLP call ~25∆

(21% over 𝐏𝟎 ) (12% over 𝐏𝟎 )

high 𝛔 low 𝛔
sell buy
➞ use as a funding source
- sell XLB calls , buy SPY (e.g.)

M.M132743897.

23
 Last Revised: 09/08/2023

Understanding Mining
Page 1
Phases search for resources
includes evaluation
- technical feasibility and commercial viability
of a resource
Juniors - greenfield: expensed until feasibility study
(generally) - brownfield: capitalized (then depleted)

capitalization begins - technical and commercial

Majors feasibility has been determined
(bankable feasibility study)
capital
expenses including depletion - usually on a
intensive
units-of-production basis based on reserves

no residual value - ore body depleted or mine closed

restoration/rehabilitation costs
current
- liability (obligation)
long
Environmental/Asset Retirement obligation
term

Page 2

1/ Exploration/Evaluation 2 to 8 yrs.
- determine possible size and value of the mineral deposit
exploration ➞ discovering the resource
evaluation ➞ proving technical and commercial viability
ends with production of a ‘bankable’, ‘definitive’ or
‘final’ feasibility study
Resources vs. Reserves ➞ the portion of the resource that can be
realistically and economically mined
a concentration of mineral
- must be proven by detailed
deposits of economic interest M.M132743897.
evaluation program
for extraction
(form, grade, quantity) (e.g. drilling, geophysical testing)
- will include allowances for losses
- discovered in the exploration
during extraction
phase
- categorized as probable or proven

24
 Last Revised: 09/08/2023

Page 3
not all
- resource resources
price ~ 50% ↑ are reserves - reserve price
spot price
~ 10% - 20% below
all reserves are spot price
- no agreed on resources
∴ as spot price ↓,
set of definitions reserves ↓
for resources and e.g./ reserve price
reserves of 1500 oz. gold
3 common ones - how much gold
can be economically
CIM - Canada recovered if gold
JORC - Australia spot = 1500
SAMREC - South
Africa
SEC has its own
definitions
- regulators often specify which set of definitions should be used
and prescribe disclosures

Page 4

Reserve price too high - overstates reserves

can be long-term historical average

3 yr. moving average
consensus pricing
contract pricing (if long-term)
margin over cash costs of production
% of current commodity price
- reserves the most valuable asset for a mining company
- not listed on the BS, but disclosed in filings
∴ important to assess the level of reserve pricing
M.M132743897.

- resources can become reserves

as spot price ↑
as more information is gathered (through ongoing ops.)
as technology improves (through innovation)

25
 Last Revised: 09/08/2023

Page 5

2/ Development 4 - 12 yrs. surface mining

3 major types of mining underground mining
solution mining

surface - strip, open-pit, mountain top removal

- may begin as soon as pre-development complete
underground - shafts and tunnels need to be built
- more expensive and complex
solution - in situ leaching
- pump leaching solution into ground, dissolves the
solid minerals, pump out pregnant solution and recover
minerals
- all development costs are capitalized and later depleted

UOP: depletion cost period = 𝐮𝐧𝐢𝐭𝐬 𝐩𝐫𝐨𝐝𝐮𝐜𝐞𝐝

× 𝐂𝐚𝐩. 𝐜𝐨𝐬𝐭𝐬
𝐫𝐞𝐬𝐞𝐫𝐯𝐞𝐬

Page 6

3/ Extraction - mineral removed from earth

- leaching vs. milling - high grade ores

low cost process higher recovery (90%)

recovery rates ~ 60% - 70% (oxide higher cost
ores) mostly sulfides (less abundant)
most profitable with low
(pyrometallurgical process)
grade ores (lower RR w/sulphide ores)
mostly oxides (more abundant near the surface)
(hydrometallurgical process)
milling cycle
- leach cycle: 1-2m up to 2 yrs. as low as 24 hours

majority copper laterite ores inventory will include

M.M132743897.

may be gold minerals in milling

recovered in stockpiles expected to
first year, inventory will include minerals be processed
remainder in leach stockpiles
larger
recovered over (estimates)
than
several years - based on yield and RR

26
 Last Revised: 09/08/2023

Page 7

3/ Extraction - mineral removed from earth

Hydrometallurgy Step 2 done at
ordinary temps.

gold
(cyanide) Step 3

copper, nickel, uranium

Step 1
e.g./ Copper oxide

Page 8

3/ Extraction - mineral removed from earth

Milling - pyrometallurgy (sulphide ores)
application of heat (energy intensive)

Steps 1. Grinding
2. Floatation, Magnetic or Gravity separation
may be integrated
or custom 3. Smelter - several heating steps to purity
(payable metal) 4. Electrolysis pyrometallurgy

Inventory run-of-mine ore

work-in-progress (crushed ore, ore in circuit)
M.M132743897.

finished goods (concentrate, metal)

- typically measured at cost

27
 Last Revised: 09/08/2023

Page 9

Inventory run-of-mine - ore mined and prior to processing

- can be recognized as inventory as soon as it is
extracted, assessment of mineral content is possible,
and a cost of production can be assigned
- listed as a current asset (stockpile)
also// long-term stockpiles ➞ high grade ore is prioritized for
processing - low grade ore stockpiled - sometimes for years
- mill stockpiles - sulphide ores, leach stockpiles - oxide ores
- use of estimates (content, recovery rates)
leaching
work-in-progress ➞ some stage of processing
milling
use of absorption costing ➞ all costs incurred in bringing
inventories to their present location
materials and supplies - extraction/processing inputs
finished goods - salable product

Page 10

Payable metal (Payability) - percent of metal paid for, less treatment

charges (and penalties)
- sometimes there is price participation
e.g./ copper concentrate ~ 30% , 100 lbs. = 30 lbs. copper
- smelter pays 96% of a benchmark price (spot)
- mining company revenue (28.8 lbs. × 𝐒𝟎 - TC - pen.)

- forecasting revenue (non-integrated smelting)

Ore production (𝐭) × Grade × Recovery × Payability
100 𝐭 1.05% 90% 94.5% = .893025/𝐭

Less: unit costs/𝐭 (/lb., /oz., etc.)

M.M132743897.
@ 8000/𝐭 spot
= 7,144.20 USD
e.g. cost/lb. Cu 1.65 (fairly stable) per 100 𝐭 ore
production
Rev./lb. Cu 3.24
÷ 2204.62
gross margin (49%) 1.59 - every 1¢ Cu = .3% gm. (22.05/100𝐭)

28
 Last Revised: 09/08/2023

Page 11

Terminology/ Metals: 3 classes of miners

Precious - gold, silver, platinum, diamonds, etc. ① Precious metals
Base - copper, lead, zinc
Ferrous - high in iron content (+ chromium, cobalt, molybdenum)
Non-ferrous - aluminum, copper, lead, magnesium, nickel, tin, zinc
Rare earths - not so rare but extraction is complex and difficult
scandium, yttrium, lanthanum + 14 elements that
follow
Alloys - mixing 2 or more metallic elements to
form a new substance (e.g. steel)
② Base or
Metallic Miners
③ Non-metallic Miners
(e.g. coal)

Page 12

Terminology/ rock that contains commercially profitable quantities

of one or more minerals is called the ore
- leftover, worthless rock is called gangue
- mineral content (%) in the ore is called the grade
- minerals can vary in quality and in states of purity
(e.g. brown coal - anthracite)

2 main types of ore deposits:

Placer deposits - found in rivers, streams, lake/sea beds, beach sands
Lode deposits - contained within rock bodies through layers,
veins, or in mineral grains
3 main types of mining (+ artisenal)
M.M132743897.

Surface (the most common)

strip, open-pit, quarrying, mountain top removal,
highwall mining, placer mining, in-situ leaching

29
 Last Revised: 09/08/2023

Page 13
Terminology/
2/ Underground mining
- drift, slope, shaft mining
(room & pillar, retreat, shrinkage stope, sublevel open stoping, etc.)
3/ Dredging - lake, river, sea bottoms

Regulation - mining industry is heavily regulated

handling of hazardous substances
solid waste disposal
air emissions
wastewater discharge
remediation, restoration, reclamation
protection of endangered/threatened species
climate change related fossil-fuel based energy
carbon pricing/taxes
health and safety increased disclosures

Page 14

Growth: all else equal (existing sites only)

higher margins
1/ Increase in commodity price (see sensitivity analysis)
more output
2/ Increase in production (production forecasts/guidance) lower unit
cash costs
3/ Increase in recovery rates (improvements in technology/processes)

4/ Increase in reserves improvements in technology that convert

more resources to reserves

M.M132743897.

30
 Last Revised: 09/08/2023

Financials
Page 1/
Structure/ 10.9% of S&P sectorspdr.com XLF - 66 holdings
14.4% of MSCI ACWI 𝛒XLF,SPY = .87
𝛃 = 1.14 low P/E @ 12.10
KBE
Industry
34%
groups
KRE 3
Top 5 holdings (Sep. 6/22)
- 46% Industries
14.3%
7 BRK.b 13.89
JPM 9.24
Sub-industries BAC 6.56
4.8%
17 WFC 4.55
26.6% (KCE)
SPG 3.34
37.58%

Div. yield ~ 1.65%

20% (KIE)

M.M132743897.

31
 Last Revised: 09/08/2023

gone
‘Other’
dropped

new
Diversified
new
Financials
M.M132743897.

32
 Last Revised: 09/08/2023
Page 2/
Characteristics/ interest rate sensitive companies
business cycle sensitive (or credit cycle sensitive)
Dividend safety
- low operating leverage, high financial leverage
𝐀
ROE = ROA × leverage G (𝐄I
- balance sheet dominated by financial assets (𝐏%𝐁 key valuation metric)
- highly regulated industries ➞ banking, insurance, capital markets

P/E P/B Beta Div. y. Components

XLF 12.10 1.38 1.14 1.65 66
KCE 11.04 2.12 1.209 2.93 65 (Asset Mgmt. 45%,
MER Inv. Banking 31.6%
KRE 10.17 1.20 1.172 2.87 144 Exch./Data 23.5%)
.35%
KBE 9.27 1.11 1.206 2.90 101
KIE 11.23 1.11 .93 1.95 52 (P&C 45%, Life/health
25.6%
(Regionals 75%, Thrifts/Mtgs. 12.2%, Div. B 5.8%, others) Brokers 14%, Re ln. 9.1%
Multi-line 6%)

Page 3/
Characteristics/
curve flattens/inverts downturn in
upswing in credit losses ↑ credit cycle
credit cycle loan demand ↓
exit credit availability ↓

rates ↓ MBS ↑ employment ↑ L&H insurance ↑

curve steepens loan demand ↑ , credit losses low
(residential, commercial, property)
rising property prices
entry for P&C insurance ↑ - higher mortgage
Financials M.M132743897. balances
- higher insurance
premiums
Generally: curve steepens (3m 5y, 3m10y, 6mos.5yr.) = positive
curve flattens = negative
GDP ↑ primary driver

33
 Last Revised: 09/08/2023

Page 4/
Banks/
Assets Liabilities
loan growth
= more assets Interest Interest
+
Income expense
𝛒(GDP growth, loan growth) net interest income ÷ Assets = Net Income
+ Margin
very high
Steeper curve = higher spread (𝐫𝐢𝐧𝐜 − 𝐫𝐞𝐱𝐩 )
when early recovery - low 3m, 6m + steep curve
loan growth > GDP growth late expansion - high 3m, 6m - flat curve
- adding leverage (+ for EPS) slowdown - inverted curve
NII - Net Interest Income
loan growth < GDP growth
NCI - Net fee/commission Income - will
- de-leveraging increase faster in expansions (and decrease
faster in contractions)
- when NCI > NII - peak of credit
cycle may be near

Page 5/
Insurance/ Life/Health Property/Casualty
more variable cash flows Drivers GDP growth
high income & price elasticity Business formation
Drivers GDP growth employment New Home Sales
credit expansion

rates ↑, Invest. Income ↑ GDP growth ↑ = premiums ↑ (higher with inflation)

= cash flow ↑ Net premiums
Life - interest rate
Life: LT bonds sensitive
Assets Liabilities
(high duration) (interest credited)
- HTM, ∴ effective int. Reserve reserves for - some fixed or
portfolio future potential guaranteed
method
payouts i.e. annuities
- rates drop, asset values ↑ Surplus
M.M132743897.
- flatter curve, spread
but will not improve portfolio compressed
statutory capital position
GDP growth P/C - liquidity
P/C : ST bonds sensitive requirement
liquidity dominant

34
 Last Revised: 09/08/2023

Page 6/

spread compression
Performance of US Life Ins. companies in
rising yield environments

falling rates

bull flattener top 6 largest companies

lower spreads
- incoming premiums invested at higher rates

bear
steepener

safe haven of
YTD
financials 1 YR.

very market sensitive

5 yr.
Cap. Mkts.
Cryto, SPACs,
M.M132743897.

Memes,
Fed. BS.

35
 Last Revised: 09/08/2023

Understanding Banks
Page 1

every loan must

be funded sets
buffer of liquid as
deposits
bank’s equity liquid assets continuous
customer
wholesale funds (T-Bills, bonds) liquidity provision
deposits
secured loan facility Retail
Loans
Corporate
credit longer term shorter term
risk
maturity transformation - the very definition of
interest rate risk a bank
- creates a balance sheet
liquidity risk
vulnerability that must be
Assets
managed
Liabilities
interest received
interest paid

net interest income/margin

Page 2
Key Concepts:
1
A - L = E ➞ capital base (or capital buffer)
- shareholder funds
about
- typically not used to fund credit-risky loans
10% - 20% of
used to absorb unexpected losses
total assets
placed in 𝐫𝐟 securities

heavily regulated - subject to regulatory

capital rules (Basel III)

A L 2
Maturity gap - between A and L
liquid assets - introduces liquidity risk
M.M132743897.

20yr. loan deposits

- continuous liquidity implies a bank can
wholesale funds
always find funding
equity
- liquidity is life or death of a bank
leverage

36
 Last Revised: 09/08/2023

Page 3
Key Concepts:
3 Yield curve - maturity transformation places a heavy reliance on
an upward sloping YC

20yr. as MM rates ↑,
20 yr. loan deposits spread loan wholesale funding
wholesale
𝐫𝐟 costs ↑
funding
- since every loan
MM CM must be funded, a
4 Liquidity - the ability to
drop in deposits requires
rollover/locate/raise funding
an increase in wholesale
as it is required/comes due
funding

5 Risk management - credit risk - as rates ↑, deposits may

(default risk) move to MM funds, incrementally
- loan origination standards raising bank’s cost of funds
- as rates ↑, standards ↑

Page 4

Retail/Wholesale
Banking
Private Wealth Trust Banking Retail Commercial
Mgmt. custody deposits deposits
administration loans loans
servicing mortgages leasing
factoring
project financing
Investment Banking
Asset Mgmt. M&A
advisory
listing/underwriting
M.M132743897.
Structured finance
Security market-making
proprietary trading

fee-based, trading activity

37
 Last Revised: 09/08/2023

Page 5

bank’s business is broadly grouped into a:

banking book
trading book market making, proprietary trading in
deposit/loans bonds and derivatives (mostly)
historical cost/amort. cost mark-to-market
- longer-term holdings high turnover /short-term
(buy/originate and hold) (1d. to 6m.)
regulatory
- generates risks - usually a max holding
capital
interest rate period (called a churn rule)
different
credit for each - Credit, market, and liquidity risk
maturity mismatch int. rates
liquidity ➞ 1 how easy an asset forex

can be converted to cash

- lots of derivatives (futures,
forwards, swaps, options)
2 ease with which funds
can be raised in the market

Page 6

Revenues: 1/ NII/NIM - traditional source of revenue

2/ fees/commissions
3/ other non-interest income

Interest Income - Interest Expense (cost of funding)

- loans + investment portfolio - cheapest source = deposits
- affected by risk profile of assets - NIBL ➞ non-interest bearing liabilities

NIM: int. inc. - int. exp.

key measure of bank profitability
avg. assets
- function of the structure of
U.S. - avg. interest-earning assets the balance sheet and the
Eur. - avg. total assets bank’s attitude towards risk
M.M132743897.

- avg. U.S. ~ 1% - 2.5%

NII fluctuates, but NIM much more stable

38
 Last Revised: 09/08/2023

Page 7

Factors affecting NIM:

capital base ➞ larger - less interest bearing liabilities boosts NIM
level of credit risk ➞ higher risk = higher interest income
level of interest rate risk (D) ➞ higher = more volatile
proportion of NIBLs ➞ higher = higher NIM
greater proportion of retail/SME higher margin = higher NIM
vs. corporate/wholesale business

proportion of residential mortgages ➞ higher = lower NIM

M.M132743897.

39
 Last Revised: 09/08/2023

Understanding Banks - Liquidity

Page 1
banks produce mismatched balance sheets
tenors of loans/deposits - liquidity gap ALM
interest rate bases - interest rate gap gap

ALM (asset-liability management) desk manages liquidity and market

risk (usually implemented within a bank’s Treasury department)
interest rate risk - PV(A,L), NII, optionality (paying a loan or
redeeming a deposit early)
liquidity risk - funding - liability structure is rate dependent
(as rates ↑, deposits move to MM funds)
- deposits have no contractual maturity but do
have a behavioral maturity
a lack of liquidity
can kill a bank quickly, whereas too
much liquidity can kill a bank slowly

Page 2

Liquidity risk - must have reasonable certainty of ability to

obtain funding
- the risk is not being able to refinance assets as liabilities come due
sources of liquidity - stable/core deposits, wholesale funding sources, FHLB
Liquid assets - MM securities, CB reserves, gov’t. bonds (has an opportunity
cost)
- surplus of L over A ➞ must be placed somewhere
A over L ➞ must be financed somewhere

liquidity mgmt. - process of raising and investing funds

- net zero cash position each day
terms and amounts mayM.M132743897.
depend on market view of ALM desk
- will position for expected changes in rates (attempt to hedge unexpected)
rates exp. ↓ - rely more on s.t. funding (low 𝐃𝐋 )
rates exp. ↑ - rely more on L.T. funding (high 𝐃𝐋 )
- opens the possibility ALM desk could be wrong

40
 Last Revised: 09/08/2023

Page 3

Liquidity risk - typically primary source of liquidity is core deposits

- Deposits - brokered dep. - CDs
- look at 𝐜𝐨𝐫𝐞 𝐝𝐞𝐩.
%𝐭𝐨𝐭𝐚𝐥 𝐝𝐞𝐩. ~ 85% - 90% considered
solid.
HBAN: Q1/2023 𝟏𝟒𝟎, 𝟒𝟏𝟗%
𝟏𝟒𝟓, 𝟐𝟕𝟖 = 96.65%
(Table 15)
30% or
𝐍𝐈𝐁𝐋Q 𝟑𝟔, 𝟕𝟖𝟗%
𝐭𝐨𝐭𝐚𝐥 𝐝𝐞𝐩. = 𝟏𝟒𝟓, 𝟐𝟕𝟖 = 25.32% higher

- success of a bank relies on growth in core deposits

HBAN: QoQ #𝟏𝟒𝟎, 𝟒𝟏𝟗*𝟏𝟒𝟐, 𝟏𝟒𝟏+ − 𝟏 = -1.21% (Q1/2023 10Q)

YoY #𝟏𝟒𝟎, 𝟒𝟏𝟗*𝟏𝟒𝟑, 𝟒𝟒𝟏+ − 𝟏 = -2.11% (Q1/2022 10Q)

- LTD ratio 𝐋𝐨𝐚𝐧𝐬Q 𝟏𝟐𝟎, 𝟒𝟐𝟎- larger = greater

𝐃𝐞𝐩𝐨𝐬𝐢𝐭𝐬 𝟏𝟒𝟓, 𝟐𝟕𝟖 = 82.9%
(or LDR) liquidity risk
- ideal ~ 80% - 90%

Page 4

𝐋𝐢𝐪𝐮𝐢𝐝 𝐀𝐬𝐬𝐞𝐭𝐬( YoY: FY22 (end) FY21 (end)

𝐍𝐋𝐋 𝟑𝟎, 𝟑𝟔𝟎* 𝟑𝟒, 𝟒𝟐𝟎*
𝟏𝟏𝟕, 𝟒𝟎𝟐 = 25.86% 𝟏𝟎𝟗, 𝟐𝟑𝟕 = 31.5%

(-3680 from AC) (-46M from AC)

QoQ: Q1/2023
𝟑𝟒, 𝟔𝟕𝟔*
(-3324 from AC) 𝟏𝟏𝟗, 𝟎𝟑𝟕 = 29.13%

- for composition of changes (YoY, QoQ), see CFI

not equivalent with HQLA
unencumbered
➞ liquid in markets during a time of stress
M.M132743897.
➞ ideally central bank eligible

stress times - CB can expand eligibility

criteria

41
 Last Revised: 09/08/2023

Page 5
Liquidity risk
funding gap
deposit - typically
- difficult to change the structure of the
outflow managed in A B.S. in a short period of time
L
wholesale + client relationships must be maintained
market
excess bank’s have target return on capital (ROC)
deposit
liabilities
inflow
L ∴ funds must be put to use by
A
acquiring assets

e.g./ Day 1 2 3
A 1000 1100 1200
L 500 700 950
-500 -400 -250 funding gap.
250 250 250
borrow 250 for 3 days
-250 -150 ∅
borrow 150 for 2 days
150 150
borrow 100 for 1 day -100 ∅

Page 6

e.g. 2/ Day 1 2 3
A 1000 1100 1200
L 500 200 1100
-500 -900 -100
borrow 100 for 3 days 100 100 100
-400 -800 ∅
borrow 400 for 2 days 400 400
∅ -400
wait 1 day or use a forward
rate agreement (FRA)

BIS - Principles for Sound Liquidity Risk Mgmt. and Supervision

17 Principles ➞ Fundamental Principle
M.M132743897.
(1)
➞ Governance (3)
➞ Measurement and Management (8)
➞ Public Disclosure (1) ➞ 10k vs. 10Q (Liquidity)
➞ Role of Supervisors (4)

42
 Last Revised: 09/08/2023

Understanding Banks - Part 3

Page 1
Interest Rate Risk/Sources
∆𝐏𝐕𝐀6 as a result of ∆rates (investment risk or price risk)
𝐋
∆income/expense as a result of ∆rates (income risk)
- active ALM seeks to position the banking book to gain from ∆rates
(passive ALM-hedge)
i.e. asset or liability sensitive
∆r ↑ ∆r ↓

sources of interest rate risk in the banking book (IRRBB) level

slope
1/ mismatch risk (gap risk) ➞ ∆rev./∆earnings from ∆rates
due to differences in maturity profile of A and L
also
ed
call rve i.e. 𝐃𝐀 vs. 𝐃𝐋 - higher leverage S𝐀Q𝐄V + greater mismatch
d cu
yiel k
ris = higher risk

Page 2
sources of interest rate risk in the banking book
1/ - non-parallel changes also affect NII and economic value
∆rates ➞ ∆int. income
different from
∆int. expense

2/ Basis risk - assets priced off one rate while funding is priced off
another
or/ derivatives (hedge inst.) are often linked to a different
interest rate than the product they are hedging
YC changes typicallyM.M132743897.
not parallel ➞ introduces basis risk

3/ run-off risk - associated with NIBLs

- higher rates ➞ deposits leave for MM funds
either - leave bank or leave core deposits

43
 Last Revised: 09/08/2023

Page 3

sources of interest rate risk in the banking book

4/ option risk - option to terminate contractual arrangements ahead of
stated maturity term
(e.g. 1 yr. term deposit, min. 30-day holding, no penalty)

IRRBB - 2 metrics 1/ NII at risk

2/ EVE at risk (economic value of equity)

Static interest rate gap report (starting point to understand

simulation)
A L gap cum. g.
0 - 1m 3000 2000 +1000 +1000
rom rising
1 - 2m benefit f
3500 4000 -1500 -500 reprice
rates ➞ A
an L
etc ... faster th
11 - 12m > 0 - asset sensitive for that time
1y - 2y bucket
all principal
< 0 - liability sensitive
balances
10 y + benefit from falling rates

Page 4

Static interest rate gap report (starting point to understand

simulation)
A L gap cum. g.
0 - 1m 3000 2000 +1000 +1000

- some balances will be estimates of behavioral run-off

- NIBLs will be treated as long term as possible
assumes a static BS (at a point in time)
- simulation allows assumptions on how A/L grow/change over
(dynamic vs. static) next 12m.
M.M132743897.

NII at risk - profile of A & L subjected to parallel shocks

generally +⁄− 100/200 bps
- assumed to be sustained for 12-mos.

44
 Last Revised: 09/08/2023

Page 5

EVE at risk - all A & L profiles are stated in NPV terms

∆ NPV - a shock (shift/slope) is introduced ➞ new YC

= sensitivity - recalculate NPV of BS
could be rfr curve
(limits on EVE sensitivity or internal COF curve
usually some % of Tier 1 capital)
Basel guidance

➞ See ‘Market Risk’ section

∆𝐫 ↓ ∆𝐫 ↑
(neg.) (pos.)

B.S. is asset sensitive

∆𝐏𝐕𝐀 > ∆𝐏𝐕𝐋

Page 6

Risk Mgmt./ Gap risk

1/ cash hedges (natural hedges)
- increase/decrease A or L to change 𝐃𝐀 or 𝐃𝐋
2/ Derivatives hedges FRAs
futures (interest rate)
r ↑ ➞ pay fx., rec. fl.
interest rate swaps
r ↓ ➞ pay fl., rec. fx.
➞ NII/EVE at risk already considers the derivative hedges
Basis risk A & L price off different benchmark rates at the
same tenor, or off the same benchmark rate at
M.M132743897.
different tenors
e.g. A priced to 3m 𝐫𝐟 funded by a liability
priced in relation to 1mos. MRR

➞ use of basis swaps (swap 2 floating rates)

45
 Last Revised: 09/08/2023

Page 7
Risk Mgmt./ Option Risks
a) prepayment or early redemption - applies on fixed rate loans & deposits
as rates ↓ , loan pre-payments ↑
- asset would be replaced at lower rates
as rates ↑ , redemptions ↑
- liability would be replaced at higher rates
- pre-payment or early redemption fees may be insufficient
to offset ↓ int. inc. or ↑ int. exp. over the A or L residual life
- corporate/wholesale counterparties typically have make-whole
early prepayment/redemption charges
- primarily retail client risk (regulatory limits on charges)

use of swaptions ➞ right to enter into a swap

pre-payment risk ➞ r ↓ ➞ buy receiver swaption with a
NA ~ estimate of prepayments

Page 8

Risk Mgmt./ Option Risks

a) prepayment or early redemption
swaptions ➞ redemption risk ➞ r ↑ ➞ buy payer swaption
with NA ~ estimated redemptions
have an upfront cost
- more commonly ➞ dynamic hedging
NA

contractual run-off (fixed rate loan)

behavioral run-off/hedge
M.M132743897.
swap ➞ pay fx./rec. fl.

time
current run-off
- prepayment fees set > costs of realigning the hedge

46
 Last Revised: 09/08/2023

Page 9

Risk Mgmt./ Option Risks

b) Pipeline risk - applies to fixed rate loans & deposits
- pre-approved rates for some future loan or deposit
- mostly with retail clients
- can use swaptions or dynamic hedging
forward starting swap booked when
commitment is made based on anticipated
levels of take-up
- as time passes, assessments of take-up may change
- any booking or commitment fees > swap re-alignment
costs
c) Cap and floor risk - deposits/liabilities with a minimum rate

loans with a maximum rate

- will reduce NII and NIM
- use of interest rate caps/floors (options with a cost)

M.M132743897.

47
 Last Revised: 09/08/2023

Real Estate
Page 1/
Structure/
sectorspdr.com - XLRE - 32 holdings
~ 2.75% of S&P500
~ 3.6% of MSCI ACWI 𝛒XLRE,SPY ~ .83 (5yr.) ( 𝛃 = .86)
Div. yield ~ 3.8% 𝛔 = 22.25
𝛒REITS,equities ~ .7 (common risk factor = 𝜷) (1yr.)
~ 95% REITs, 5% REMDs
𝛒REITs,bonds ~ .3 - .4 (common risk factor = D)
Top 5/ AMT 12.09
Top 10
PLD 8.92
1 58.37%
CCI 7.55
industry
EQIX 6.09
groups
c - 3rd largest PSA 5.35 40%
- 2
tax pt
em
ex c industries iShares - 1YR - 80 holdings
c - 2nd largest Div. yield ~ 2.94 ( 𝛃 = .99)
c - 4th 12 𝛔 = 21.49 (1yr.)
- largest
sub-industries Top 5 - same as above
- same order
e Top 10
abl ~ 5.6% REMD
tax 27.55 43.11%
~ 2.4% mREITs
~ 92% REITs

M.M132743897.

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 Last Revised: 09/08/2023

- industry group
- current = Real
Estate
- new ➞ 2

- Industries
- current ➞ 2
REITs
REMDs
- new ➞ 9

all
new

new same
industry
group

Page 2/
Characteristics/
economically sensitive - degree of sensitivity varies by REIT type
interest rate sensitive (high 𝛒 with 10-yr. yield)
possible inflation hedge - especially when vacancy rates are low
- higher rents ➞ higher NOI ➞ higher valuations
but// - higher interest rates ➞ lower valuations
high current returns ➞ income high dividend yield (non-qualified)
➞ best in tax-deferred accounts
Returns: capital
appreciation bond-like cash flows Best conditions:
low vacancy
equity > REITs > IG corp. bond
M.M132743897.

strong GDP growth

ex-RE.
adopts interest rate low interest rates
adopts economic/market sensitivity of bonds
sensitivity of equities (high duration)
∆Property values affect equity

49
 Last Revised: 09/08/2023
Page 3/
Characteristics/ real estate cycle ~ 17 - 18 years
1980’s
- apartment ➞ 1990s crash +17/18 ➞ 2007/08 +17/8 ➞ 2024/25
building boom S&L crisis housing crash (?)
- credit crisis
- MBS meltdown
may take

2 development of ➞ 4 overbuilding
years for
excess supply
new properties to be
new supply vacancy rates ↑ absorbed
1 perceptions of
Boom Bust rents flat or falling
rising rents 3
occupancy drives the all made worse if
rein
property values
fo r
c es economic cycle recession happens at
(greater same time
than replacement new development zero
cost) or very low
high returns exit falling prices
entry
increasing dividends peak
dividend cuts

Page 4/
Characteristics/ Business cycle
- cyclical behavior depends on type/quality of property
lower risk
property quality high low turnover
market quality leading/primary stable rents
and occupancy
lease term long
rates
leverage low

low vacancy rates, low interest rates, strong GDP growth, move to:
Non-core: secondary city properties, shorter lease terms and higher leverage
M.M132743897.

rents adjust to local

supply/demand conditions more quickly

Core ➞ Office, Residential, Retail, Industrial

- high quality, well-leased, low leverage ( < 30% of asset value)

50
 Last Revised: 09/08/2023

Page 5/

(Div. y)

price ↑ faster than

rising dividend
dividends
low div. y.
variable
series - possible
exit signal
(ETF or index
stable series signal only)

(TR)
boom
~14.8% cagr
low interest rates
Jan./00
1418
1455 Dec./07

Page 6/

➞ high yields - possible entry

price ↓ faster
(ETF/index
than dividends
signal only)

M.M132743897.

Jan./07 Dec./10
71%

51
 Last Revised: 09/08/2023

Page 7/

last 3 yrs.

𝟐.𝟖𝟎𝟖
𝐃𝟎A = 65.30
𝐲 .𝟎𝟒𝟑 short interest

( )
vs. ~33.15%
80.64

still below
MRL

(TR)

Page 8/
➞ Economic Drivers/ all REITS
occupancy g - growth rate
GDP growth NOI in NOI
rent
r - discount rate
Cap. rate: r - g
den./
higher GDP growth ➞ higher g ➞ lower cap. rate
discount rate
higher asset valuation
interest rates
lower interest rates ➞ lower r ➞ lower cap. rate

Property value = 𝐍𝐎𝐈 higher PV of future cash

𝐫−𝐠 flows
num./
higher GDP growth ➞ higher g ➞ higher NOI
M.M132743897.

∴ higher cash flows

higher property values
- generally, a long-term appreciating asset that generates cash flows

52
 Last Revised: 09/08/2023

Page 9/
601010 - Equity REITs
- own, operate (maybe develop)
income-producing real-estate
but do not operate the business that
occupies the location ➞ Income Trust
- corporations or trusts, tax advantaged
required to distribute 90% - 100% of
taxable earnings
> 75% of assets in real estate
∴ tend to have a lower > 75% of income from rental or interest
income
rate of retained earnings growth
Depreciation - non-cash
- will more often rely on Secondary FV gains/losses - non-cash (depends on
offerings than non-REITs actg. standard/regime)
- esp. when 𝐃𝐢𝐯.(𝐀𝐅𝐅𝐎 is high ∴ 𝐏Q𝐀𝐅𝐅𝐎 more relevant than 𝐏Q𝐄

Page 10/
Residential REITs single family (houses) and Multi-family that are
non-owner occupied
Demand Driver: Household formation (HF)
- when HF > New Resi. Construction: occupancy ↑, upward pressure on rent g
Single family - substitute ➞ housing affordability index (NAR)
multi-family - supply - lower = ↑ rent g
New Residential Construction: Census bureau (3rd w/ of each month)

unit: a house or
an apartment

- report released on
M.M132743897.
12th working day
following reference
month

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 Last Revised: 09/08/2023

Page 11/
Residential REITs: terminology: high rise > 10 floors
mid-rise > 3 floors
low-rise 2 - 3 floors
garden townhouse style
Class A ➞ < 5 yrs. old, high-quality, desirable neighbourhoods,
high credit-quality tenants, more liquid
- class A in a secondary market (e.g. Cleveland) will outperform
a class B property in a primary market (e.g. NY, Boston)
Class B ➞ average quality, older, fewer amenities - step down from Class A
on most dimensions
- riskier profile (income, cap. app.) ∴ can be bought at lower price
(or higher cap-rate)
- appealing to a unit-CAPEX/higher rent turnover strategy
very high ROI on these - can even outperform
Class A
Class C ➞ > 30 yrs. - typically not a REIT target
- would have to be upgraded to Class B

Page 12/
Residential REITs: NOI - net operating income

IS
(Rents + Other Incomes - Operating Expenses)
𝐍𝐎𝐈Q
𝐀𝐬𝐬𝐞𝐭 𝐕𝐚𝐥𝐮𝐞 = cap. rate = r - g
NOI g over last 12 months or
BS. calculate
average over last 5-10 yrs.
solve for r
> 3% is good (Resi.)
Apts. ~ 4.5-5.0% (implied)
NOI g can be bought with
vs. 5.0-7.5% pre-GFC
CAPEX
expectation - cap-rate expansion ➞ Asset value ↓
or compression ➞ Asset value ↑
M.M132743897.

∴ E(R) = Cap. rate + NOI g + %∆cap-rate current cap-rate

current
too low
cap. app. further ∆Asset Value loss
income given current given expectation of too high
cap-rate r and g gain

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 Last Revised: 09/08/2023

Page 13/
Residential REITs:
Spread: cap-rate - 10 yr. Treasury yield
positive correlation
vs. OAS on 3-5 yr. B-rated bond

10yUSTy ↑
OAS ↓ 10yUSTy ↓
economy
∴ spread ↓ OAS ↑ implies the
improving ∴ spread ↑ cap-rate is
inflation ↑
credit conditions more stable than
improving yields/OAS (typical
cycle)
- worst combination ➞ 10y USTy ↑ most of 2022
B-rated OAS ↑
really constrains credit availability - new construction
slows considerably ➞ limits future supply

Page 14/
Residential REITs:
higher turnover ➞ better opportunity to
adjust to market
but:/ higher costs + potential
vacancy in weak markets
Rent ~ 30% turnover/yr. 12-month
Inc: market rate
Rent 12 month fixed
NOI offset NOI
time line
squeeze expansion typically
1 year
- Exp: gross lease
owner exp.
maintenance
higher wages
operating exp. fixed to variable
higher utilities and other
common area fees M.M132743897.
OpEx.
insurance
fixed
tax

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 Last Revised: 09/08/2023

Page 15/
Residential REITs: Net Income
FFO - funds from operations + Dep./Amort.
non-cash + losses/impairments/writedowns
- gains

AFFO - adjusted FFO (or FAD - funds available for distribution)

= FFO
+⁄− non-cash rents (more common for non-residential)
- maintenance CAPEX
- leasing commissions (more common for non-residential)
𝐃𝐢𝐯./𝐬𝐡. newer buildings - high Dep., low main. CAPEX
➞ payout ratio
𝐀𝐅𝐅𝐎/𝐬𝐡. FFO much higher that NI
FFO ~ AFFO
older building - low Dep., high main. CAPEX
FFO ~ NI, AFFO much lower
𝐏 than FFO
or 𝐏( ➞ more appropriate valuation multiples
𝐅𝐅𝐎( 𝐀𝐅𝐅𝐎/𝐬𝐡.
𝐬𝐡.

Page 16/
Residential REITs:
Drivers of multiples:
1/ FFO/AFFO growth expectations - higher expectations = higher multiple
2/ risks of underlying real estate - cash flow volatility ➞ non-core more risky
- Resi. less risky than other REIT types ∴ higher multiples
- Core > non-core, primary markets > secondary markets, Class A > Class B
3/ risks associated with REITs capital structure and access to capital
- as leverage ↑, multiples ↓

e.g./
Office REIT
June 30/22 - migrating to Class A (but ↓ NOI in s.t.)
Oct. 4/2022 M.M132743897.
𝛒 = 4.65
Press release

- reduce risk of underlying assets IFRS NAVPS 8.71

- reduce leverage
- multiple ↑ to offset NOI ↓ ?

56
 Last Revised: 09/08/2023

Page 17/
Residential REITs:
NAVPS - Net Asset Value per share: typically provided in 10 - Q/K
largest component of premium ➞ 𝐏𝟎 > NAVPS - potential overvaluation
intrinsic value discount ➞ 𝐏𝟎 < NAVPS - potential undervaluation
may be justified
𝐌𝐕𝐀 - appraisal value or (𝐍𝐎𝐈H𝐜𝐚𝐩-𝐫𝐚𝐭𝐞 + other assets)
NAV (-goodwill, DTA, deferred financing charges)
- 𝐌𝐕𝐋 (-DTL)
(Oct. 04 - Raymond James - $59) Oct. 04 𝐏𝟎 = 43
# of shares
CAR.UN - Canadian Apartment REIT

= Prop. val. ↑ = Prop. val. ↓

𝐏𝟎 = 44.82 June 30.

Q3 results (July 1 - Sep. 30) ➞ Nov.
8/2022
Page 18/

g/ - growth in AFFO the key driver of share price appreciation

1/ internal growth ➞ growth without the need for new equity or debt
unit upgrades
e.g. rental increases best measured
bumps (annual)
turnover (customer upgrades) by same-door
(called re-tenanting) NOI
(or property, or
higher occupancy rates, lower operating expenses
community)
asset turnover - sell low growth properties and
reinvest in high growth properties, called capital
repurchase shares, pay down high-cost recycling
M.M132743897.
debt
2/ external growth e.g. A V B
acquisition or property development - involves access to
IRR must be greater than capital (depends on both
project wacc availability and cost)
- higher quality REITs will have lower
costs of capital
https://s25.q4cdn.com/722916301/files/doc_financials/2022/q2/Q2-22-Full-Report.pdf

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