Corporate financing woes spell more trouble for banks
Posted by Stefan Isaacs on 28 March 2008 09:08:00 GMT
We're heading into the ninth month of the credit crunch, and there still hasn't been any issuance in the European high yield market. Investment grade companies are also having serious problems getting anything done in Europe, and any brief rally in risky assets is being viewed as a window of opportunity to issue bonds. On Wednesday, for example, we saw £500m of issuance from Citigroup, £500m from Standard Chartered, €850m from Dutch telecom company KPN and €650m from French supermarket company Casino. Yesterday, Diageo jumped in with a €850m deal, Thames Water issued £400m, AT&T issued €1.25bn and BNP Paribas issued €3bn. These deals are coming to the market at a significant premium to where CDS and existing bond issues trade from these companies, and at considerably wider levels than seen over the last few years.
There is still a huge number of companies desperate to raise finance. A number of companies have sought alternative means. Richard recently wrote here about how Porsche managed to draw on a bank overdraft facility at very favourable terms. Last week, the battered US consumer finance company CIT Group announced that it was drawing on a $7.3bn credit facility from its banks, for which they are rumoured to be paying around 0.4% to 0.7% over LIBOR. This bank facility is a bit of a coup for CIT Group, if you consider that CIT Group 5 year credit default swaps are currently trading at 990 basis points, and CIT bonds maturing in 2012 yield about 13%. (Incidentally, S&P and Moody's rate this bond A- and A3 respectively, suggesting that either the ratings agencies or the market has got it a bit wrong).
The clear losers from these credit facilities are the banks. The banks offered credit facilities to companies when times were good. Now that times are bad, banks are contractually obliged (subject to ratings downgrades, which may void this contract) to lend to borrowers that may be distressed, and they are lending to vulnerable companies at rates that AAA rated corporates would struggle to achieve in the bond market right now. Clearly the implications for banks is a further squeeze on profits.
There is still a huge number of companies desperate to raise finance. A number of companies have sought alternative means. Richard recently wrote here about how Porsche managed to draw on a bank overdraft facility at very favourable terms. Last week, the battered US consumer finance company CIT Group announced that it was drawing on a $7.3bn credit facility from its banks, for which they are rumoured to be paying around 0.4% to 0.7% over LIBOR. This bank facility is a bit of a coup for CIT Group, if you consider that CIT Group 5 year credit default swaps are currently trading at 990 basis points, and CIT bonds maturing in 2012 yield about 13%. (Incidentally, S&P and Moody's rate this bond A- and A3 respectively, suggesting that either the ratings agencies or the market has got it a bit wrong).
The clear losers from these credit facilities are the banks. The banks offered credit facilities to companies when times were good. Now that times are bad, banks are contractually obliged (subject to ratings downgrades, which may void this contract) to lend to borrowers that may be distressed, and they are lending to vulnerable companies at rates that AAA rated corporates would struggle to achieve in the bond market right now. Clearly the implications for banks is a further squeeze on profits.
Re: Corporate financing woes spell more trouble for banks
It's taken time but a sense of reality does now (24th April 2008) seem to be catching up with those who hold bank shares. That I think is no thanks to the banks who are masters of obfuscation - as honest with their shareholders as they have been with their hidden charges for personal banking customers. RBS did I believe mislead at the end of February when the announced a profit of more than £10 billion but gave no inkling of what was hidden below deck. Now just a few weeks later we have a record breaking rights issue of £12 billion,write-downs on credit exposures of £4.4 billion (so far) and a proposal to raise cash of £4 billion + via asset sales. You were right Stefan about the pain to come and I don't think we have seen the end of it nor will this be the last piece of bad news for RBS shareholdersd
Hooray for Helicopter Ben
Posted by Richard Woolnough on 12 March 2008 16:40:00 GMT
Helicopter Ben yesterday announced that the Fed would lend $200bn of Treasuries to banks in return for AAA rated collateral. Equity markets were delirious - the S&P recorded its biggest one day jump in over five years. Risky credit also staged a rally, but the reaction was a bit more muted. The iTraxx Europe Crossover Index, an index measuring the default risk of the most liquid European high yield names (see here for more info) rallied from its all time high but spreads are still higher than at the end of February.
What difference will the Fed's actions make? The liquidity injection is certainly helpful to all the banks that were having liquidity problems, and the extra liquidity will help the market determine the fair price of some of the more esoteric debt instruments. Much of the distressed selling we've seen in the past few months has been because investors are trying to sell but nobody's willing to buy, and prices have spiralled downwards.
But will the Fed's actions get the global economy out of a hole? No, not really. The value of AAA rated mortgage securities are ultimately determined by house prices and delinquencies. Banks may react to the liquidity injection by slashing mortgage rates, but this is unlikely given that banks are currently trying to rein in lending and patch up their balance sheets. The Fed's actions will therefore do little to tempt US citizens into buying houses again, and US house prices will therefore continue falling until some of the near-record supply of houses for sale is reduced. I can't see the Fed's actions resulting in the US avoiding recession - at very best, it might make things slightly less bad.
The Fed's decision to allow AAA-rated mortgage securities to be posted as collateral raises some interesting political questions. It's very hard to imagine that S&P and Moody's will implement a wave of downgrades any time soon, because this would completely undermine yesterday's actions from the Fed. As yesterday's excellent article on Bloomberg explains, none of the 80 AAA securities in the ABX indices (these track subprime bonds) meet the ratings agencies' normal AAA criteria. Helicopter Ben is loading up with assets that are very heavy in risk. This is alleviating the liquidity pain of the financial system, but is risking his ability to pilot the Fed. If these AAA assets start to turn sour, then the Fed will be yet another bank burdened with the woes of the US housing market.
What difference will the Fed's actions make? The liquidity injection is certainly helpful to all the banks that were having liquidity problems, and the extra liquidity will help the market determine the fair price of some of the more esoteric debt instruments. Much of the distressed selling we've seen in the past few months has been because investors are trying to sell but nobody's willing to buy, and prices have spiralled downwards.
But will the Fed's actions get the global economy out of a hole? No, not really. The value of AAA rated mortgage securities are ultimately determined by house prices and delinquencies. Banks may react to the liquidity injection by slashing mortgage rates, but this is unlikely given that banks are currently trying to rein in lending and patch up their balance sheets. The Fed's actions will therefore do little to tempt US citizens into buying houses again, and US house prices will therefore continue falling until some of the near-record supply of houses for sale is reduced. I can't see the Fed's actions resulting in the US avoiding recession - at very best, it might make things slightly less bad.
The Fed's decision to allow AAA-rated mortgage securities to be posted as collateral raises some interesting political questions. It's very hard to imagine that S&P and Moody's will implement a wave of downgrades any time soon, because this would completely undermine yesterday's actions from the Fed. As yesterday's excellent article on Bloomberg explains, none of the 80 AAA securities in the ABX indices (these track subprime bonds) meet the ratings agencies' normal AAA criteria. Helicopter Ben is loading up with assets that are very heavy in risk. This is alleviating the liquidity pain of the financial system, but is risking his ability to pilot the Fed. If these AAA assets start to turn sour, then the Fed will be yet another bank burdened with the woes of the US housing market.
Re: Hooray for Helicopter Ben
I know you M&G guys are celebrating about the equity folks getting Vanguard Intl Growth money to subadvise, so I think you should read the Fed's statement on the new Term Security Lending Facility a little more closely. The loans are only for 28 days, and the Fed gets to determine the haircut on how much can be lent using the "AAA" subprime securities. So if the securities "go sour," as you put it, then the Fed simply doesn't renew the 28-day loan term. It will be the borrower who will be burdened with bad collateral. Of course, it's possible that the borrower won't be able to repay the Fed, but the same can be said for discount window, TAF and Fed Funds borrowing. Love the blog; wish my employer would let me opine on the bond markets online. U.S. lawsuit and insurance costs make it impossible, they say.... Re: Hooray for Helicopter Ben
Hoarding ham and cornering corn
Posted by Jim Leaviss on 11 March 2008 11:25:00 GMT
I wrote recently about the impact of banking crises on inflation (read comment here). In short, banking crises are significantly disinflationary at best - and at worse, in the cases of the 1930s Great Depression and the bursting of the Japanese bubble in the 1990s, actually deflationary. There is still a lot of reluctance to accept this evidence though, and the most common objection is the strength of commodity prices. After all, how can inflationary pressures subside if oil is $108 per barrel and wheat has doubled in price over the past year? I think there are a couple of reasons why we shouldn't worry too much about commodity prices - at least for our western economies where food and energy prices are a relatively small portion of our expenditure (below 20%), but for developing countries these higher costs are already causing political and societal tensions.
Firstly there's evidence that there is a lot of speculation in commodity markets, with hot money having flooded into the asset class. In contrast with speculation in paper assets like shares and bonds however, if you've bought a million pork bellies for delivery in June, you better have a plan for getting them out to people who actually want to eat them. You can't hoard ham for long. Secondly there's good evidence that commodity prices are a lagging indicator of past economic growth. Goldman Sachs have looked at their own commodity index (the GSCI) over the past couple of recessions and found that once growth slows, prices fall significantly. In the 1990-91 recession the index fell by 28%, and in the 2001 recession by 37%. The slowing global growth picture is what concerns central banks the most - the recent elevated commodity prices will not prevent them from cutting rates aggressively in 2008.
Firstly there's evidence that there is a lot of speculation in commodity markets, with hot money having flooded into the asset class. In contrast with speculation in paper assets like shares and bonds however, if you've bought a million pork bellies for delivery in June, you better have a plan for getting them out to people who actually want to eat them. You can't hoard ham for long. Secondly there's good evidence that commodity prices are a lagging indicator of past economic growth. Goldman Sachs have looked at their own commodity index (the GSCI) over the past couple of recessions and found that once growth slows, prices fall significantly. In the 1990-91 recession the index fell by 28%, and in the 2001 recession by 37%. The slowing global growth picture is what concerns central banks the most - the recent elevated commodity prices will not prevent them from cutting rates aggressively in 2008.
Re: Hoarding ham and cornering corn
That's how we are positioned - if inflation does start to surprise to the downside (which may not be for a few months yet) then government bonds should benefit from expectations of much lower interest rates. Remember that rates got down to 1% in the US in 2003 as the Fed started to panic about deflation (and previously down to zero in Japan where deflation was a reality). For bond fund managers the inflation/stagflation/deflation issue is the most important we face - in my view I think it is inevitable that global economic growth will be very weak for some time, but my conviction on the inflation outlook is less stridant, and it pays to be cautious and flexible on that issue. On balance though the big driver of inflation will be the widening output gap (the difference between actual growth and potential growth in the global economy) and this should be disinflationary - this doesn't mean though that pockets of inflation (food and energy) won't persist for some time. Not a huge problem for the developed world, but in the emerging markets where food is 50% of the inflation basket in some cases this could cause political tensions. Re: Hoarding ham and cornering corn
“If it ain’t your cods, it’s pollocks”
Posted by Stefan Isaacs on 03 March 2008 14:29:00 GMT
An interesting set of events was set in motion a fortnight ago, though its roots lay somewhere in late February 2007. A recent trip by an anonymous team member to double Michelin-starred Tom Aiken’s latest venture, Tom’s Place; in essence a posh chippy, bemoaned the lack of cod & suggested that the pollock wasn’t up to much. AA Gill agreed in his unique indomitable fashion the following Sunday & all the talk of cod had me thinking of the Icelandic banks.
Almost exactly a year previous, Moody’s released the results of its widespread review of the banking sector. Its JDA (Joint Default Analysis) allowed ratings to take into account the potential for government support. As a consequence the three largest Icelandic banks, Kaupthing, Landsbanki & Glitnir were upgraded several notches from A1 to Aaa by Moody’s. I wrote at the time that this was a load of Codswallop (see here). “Investors have questioned for example whether a country such as Iceland (with a population similar in size to Hull, and an economy based around cod) has the ability to support banks which has liabilities three times the nation's Gross Domestic Product.”
The market initially bought into Moodys’ story, pricing five year credit default swaps at around sixty basis points back in February 2007 (the cost of 'insuring' against default). A mere six months later and Moody’s had lowered the rating three notches. A year to the day after my initial blog the whole affair had come full circle with Moody’s returning the bank to its A1 rating. At the time of writing, five year credit default swaps are trading between 500 & 700 basis points, much more in line with a high yield credit carrying significantly lower ratings, and the Icelandic Prime Minister plans to conduct a ‘confidence boosting’ investor roadshow. Fish and chips sales may benefit from a recession, Icelandic banks clearly don’t!
Almost exactly a year previous, Moody’s released the results of its widespread review of the banking sector. Its JDA (Joint Default Analysis) allowed ratings to take into account the potential for government support. As a consequence the three largest Icelandic banks, Kaupthing, Landsbanki & Glitnir were upgraded several notches from A1 to Aaa by Moody’s. I wrote at the time that this was a load of Codswallop (see here). “Investors have questioned for example whether a country such as Iceland (with a population similar in size to Hull, and an economy based around cod) has the ability to support banks which has liabilities three times the nation's Gross Domestic Product.”
The market initially bought into Moodys’ story, pricing five year credit default swaps at around sixty basis points back in February 2007 (the cost of 'insuring' against default). A mere six months later and Moody’s had lowered the rating three notches. A year to the day after my initial blog the whole affair had come full circle with Moody’s returning the bank to its A1 rating. At the time of writing, five year credit default swaps are trading between 500 & 700 basis points, much more in line with a high yield credit carrying significantly lower ratings, and the Icelandic Prime Minister plans to conduct a ‘confidence boosting’ investor roadshow. Fish and chips sales may benefit from a recession, Icelandic banks clearly don’t!
