and equity and fixed income markets? ....and banks
http://www.minyanville.com/articles/index.php?a=13898
I am a new Minyan, but in my former life I helped build and ultimately ran a Wall Street asset-backed securities business, was treasurer of a top credit card company and treasurer of one of the largest banks in the Midwest.
In light of the past several weeks in the markets, and in the interest of sharing, here are some observations that I think may be helpful to you and the Minyanville community at large.
First, having been there at the beginning, the genesis of the asset-backed commercial conduits was regulatory capital arbitrage. Through the conduits? convoluted structures, banks were able to "lend" huge amounts off-balance sheet and collect fees on no-capital-required lines of credit. No one - and I mean no one - ever expected these conduits to move from off-balance sheet back on-balance sheet and I don't think the market yet understands the earnings, capital and liquidity impact of this migration. If you figure you need anywhere from 6-8% capital per dollar of loans, then a move of $1.0 trln from off-balance sheet to on requires $60-80 bln in additional equity capital. I don't know about you, but I don't see this kind of free capital sitting around.
Second, I don't think people appreciate the significance of the change in Fed policy that took place on Friday involving the brokerage affiliates of several money center banks. In the asset-backed commercial paper market, maturing commercial paper is normally either rolled over or replaced by loans from standby liquidity banks when it can't be rolled over. With Friday?s change, it would appear that investors now have the ability to "put" unmatured commercial paper back to the bank affiliated brokers - who in turn will pass it along through the Discount window to the Fed.
In doing this, I believe the Fed has established a very dangerous precedent. If investors can now put unmatured CP to the banks (instead of waiting for the standby liquidity banks to fund at maturity), it may not be long before investors pressure the bank-affiliated brokers to accept MTNs and who knows what else further out the curve.
Third, the last consumer led recession was around 1990. Since then, the SEC has placed enormous pressure on the banks to minimize their loan loss reserves. The SEC hates earnings management and the loan loss provision has historically been a key way for banks to "save for a rainy day." I don't think the market yet appreciates the fact that banks are currently provisioned for the top of the market. (And, in fact, up until recently, most major banks reported net provision reductions over the last several quarters.) As credit continues to deteriorate, the earnings/capital hits will be enormous as provisions need to reflect higher and higher delinquency and loss rates. And, experience suggests, that when the banking regulators finally do begin to act (as they did in New England during the late 1980?s), the pendulum will push banks to over-reserve at what will ultimately be the bottom of the credit cycle.
Finally, no one is talking about it yet, but I think the market will soon begin to realize that the credit card lenders have in essence become the consumer lenders of last resort. As consumers have been shut out of the mortgage and home equity world, the last available credit is plastic. One statistic that I have found very troubling is the degree to which credit card balance growth is running ahead of retail sales growth - a key sign that the consumer is stretched. In normal times, you would expect aggregate credit card balance growth to run about in line with GDP and retail sales growth. This year it is running almost 2.5 times that. Clearly consumers are using their cards for far more than purchases. And my guess is that for many Americans their credit cards have become the latest, but potentially last, source of financing available.
Because of the oversized credit card balance growth, however, I think the market is missing what is really happening within card issuer portfolios ? particularly loss and delinquency data. Today, no one seems to be very concerned about the increases in reported losses and delinquencies. However, when you start to normalize these statistics for the enormous balance growth we?ve seen, the increases in both are quite dramatic.
To put this all together, take Target?s (TGT) latest financial results and you can see the numbers for real. First, credit card balance growth was up 14% year-on-year - almost 1.5 times Target sales growth of 9.5%. Second, thanks to this balance growth, reported year-on-year delinquency ratios are up only a little bit (60+ days delinquencies of 3.5% versus 3.4% a year ago), but the dollars of delinquent accounts are up almost 18% - to $242 mln from $205 mln ? and, as an aside, ?late fees and other revenue? are up more than 36% year-on-year.
Digging even deeper, you come away with more unanswered questions. First, annualized net write-offs for the quarter were up 17% - 5.4% of loans versus 4.6% during the year ago quarter. But behind that, masked by 14% balance growth, there is a 32% increase in the dollars charged off. Further, and to me more troubling, Target dropped its loan loss allowance from 8.3% of loans at the end of July 2006 ($501 mln) to 7.4% at the end of July 2007 ($509 mln). Had Target kept its provision at 8.3% of loans, the incremental cost would have been over $64 mln or almost 40% of the pre-tax quarterly earnings of Target?s credit card business. Alternatively, had Target kept its provision at the same 1.8 times net charge-offs as last year (an 8.3% allowance on 4.6% in net write-offs), the required ending provision would have been over 9.7% of loans - at an incremental cost to the company of almost $144 mln ? all but eliminating earnings from the credit card operation for the quarter. Put simply, when measured in dollars (rather than percentages of balances) Target?s nearly flat year-on-year loan loss allowance does not synch with the increase in loan balances, delinquencies, charge-offs, and late fees.
And while I have used Target as an example, I don?t think Target is alone. As we have seen already in other parts of the credit markets, many banks and finance companies are managing their businesses as if today?s increases in credit deterioration are merely a ?blip?, rather than the beginning of a broader, potentially more serious, decline. From where I sit, it looks like it is only going to get worse, and ?it?s already in the cards.?
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US distressed debt jumps fivefold - 28 Aug 2007
The amount of US debt trading as distressed has jumped fivefold to $12.7bn in the past month, which could be an indicator of increased defaults as credit conditions worsen.
Last month, distressed issues affected debt worth $2.5bn across seven sectors, according to a report from ratings agency Standard & Poor's. By August 15, distressed issues had spread across 13 sectors with media and entertainment making up the largest portion: 37%.
Distressed issues trade at spreads which are more than 1,000 basis points relative to US Treasuries.
The total number of rated companies with issues trading at distressed levels rose to 148, nearly triple the 57 from a month earlier. Of the 148 companies on this month's distressed list nearly half are likely to be downgraded.
Diane Vazza, managing director at S&P, said: ?Over the long term, movements in the distress ratio correspond well with trends in the speculative-grade default rate, with a peak in the distress ratio generally signaling a peak in default rates about nine months later.?
S&P said distress in the US leveraged-loan market also rose but was less affected than corporates. At the end of July, the share of performing loans trading at prices of less than 80 cents on the dollar increased to 0.63%, the highest level since November 2005.
As market volatility has increased, credit conditions have tightened resulting in increased spreads and an abrupt cessation of high-yield issuance.
Through August 15, there has not been a single new US high-yield bond issue.
The spread of speculative-grade issues widened to 427 basis points on August 15. It was the first increase over 400 basis points in the past two years aside from a spike in May 2005 that was caused by the automakers' downgrades.
S&P said the US default rate is expected to edge up to 1.4% by the end of this year, which would imply 13 more defaults through to December, compared to 10 so far this year.
Private equity deals have been affected by the credit squeeze and yesterday Home Depot, the home improvement retailer was forced to sell Home Depot Supply, its wholesale unit, to private equity firms Bain Capital, Carlyle Group and Clayton, Dubilier & Rice for $8.5bn, or about a fifth of the price that had been agreed in June.
Home Depot also agreed to purchase a 12.5% equity interest in the unit for for $325m and guarantee a $1bn senior secured loan of HD Supply. Goldman Sachs was the company's financial advisor for the amended purchase and sale agreement.
http://www.financialnews-us.com/inde...-810706-200713
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