WRFest 24Feb08(Credit Markets): More Fear, Loathing & Writedowns
No the headline isn't a mistake - this is indeed the news clippings intended for the weekend but the tsunamis of what we think are critical information just keep on coming. So we thought it best to get a jump ahead of what will be a large run of such postings. Just as a matter of fair disclosure not only may this suit your reading schedule but a good scotch would be appropriate as well.
First off walk, don't run, to watch this CNBC interview with Meredith Whitney who was the finance industry analyst who made the downgrade calls on the big banks and the mono-line bond insurers. Well unfortunately she's adding a bunch more bad news on earnings, write-downs, rising bad debt, the need for new capital & dilution and so forth. We'd suggest watching it at least twice and taking note the 2nd time. We'd provide them but haven't finished our scotches yet.
The Readings section below starts off with a diagnosis of whey the rescue attempts for the credit market breakdowns are failing, coupled with several of our prior posts worth reviewing. Not least because they're turning out to be more right than we anticipated. Which naturall leads into another more recent post on the failures of securitization and the long-term outlook for the instruments and the industry. Coupled with several interesting stories not least of which is David Faber of CNBC arguing that the credit markets a) aren't recovering and b) are badly broken. THIS...on CNBC ???? Wow !
All of which ripples forward to pressures on corporate loans and related debt instruments which are facing rising risks of default and will likely also metastasize into big time down pressures on the many weak companies out there. Which is now spreading across the private equity markets and down to the mid-size deal. While that may not sound like much to you - who cares if they have to drink less expensive cigars after all ? - but is actually both a major symptom and diagnostic as well as indicator of accelerating future troubles.
READINGS
Why Wall Street rescues are failing The financial system has become dependent on debt and the transfer of risk via convoluted debt instruments, creating a mess that will require hundreds of billions of dollars and global cooperation to fix. Yet each, including Federal Reserve Chairman Ben Bernanke and U.S. superinvestor Warren Buffett, has failed to lift investors' spirits for more than a couple of weeks, ultimately leaving stocks to tumble ever lower. Why? The fundamental problem in the world economy is that it grew over the past two decades to be incredibly reliant on optimistic risk takers' willingness to accept increasingly complex IOUs from companies, banks and government institutions as investments instead of real assets. Now we are seeing the same movie play back in reverse, as massive investor losses in debts once believed to be safe have led to falling confidence, rising pessimism and extreme risk avoidance. In a gentler era, debt was important but not as vital to world finance. In recent years, debt became the oxygen of the world financial system, along with a fanciful means of transferring its risks from borrowers and issuers to investors. To the extent that neither debt nor its conveyances are now trusted, even from organizations once considered rock-solid, the entire global banking system is asphyxiating before our eyes.
· Credit Spreads .....Visiting the Proctologist ? Or Frankenfinance Monsters ?
· More on the Credit Crisis: the Rocks in the Pond "Model",Rocks, Ponds, Perverse Incentives: More on Credit Contagion
· Credit Mess and the Fed: Understanding the Strategic Posture
Fear and Loathing on Wall Street: Credit Mess, Securitzation & More Here's a very recent set of stories on the widening of the credit mess, the impacts on the Finance industry and the whole strategic theory behind the Securitzation innovation. For example the metastasis of credit problems has reached the Student Loan market, is re-shaping the competitive landscape AND threatening a lot of loans, especially for poorer and/or dis-advantaged students. As Mohammad El-Arrian pointed out in a CNBC interview we posted a while back the whole process of securitization was a major new innovation with which the institutional and regulartory frameworks weren't prepared to cope. Worse the internal business practices and governence of the financial firms let short-term greed run ahead of themselves. In other words they screwed up big time by chasing quarterly returns that were badly, as in not at all, priced for the risks they were presuming. On the theory that they could always bail out. Belowis a set of readings that cover the Economist's take on the industry future. Also covered are the further massive writedowns the major banks, et.al. will be taking on mortgage related debt, the exposures to lose of credit insurance, and corporate/buyout writedowns. In other words you ain't seen nuthin yet ! Which pretty confirms what we've been saying for what now amounts to a couple of months.
- Credit Markets Are Broken The stock market has shown some resilience but not the credit markets, with CNBCs David Faber. Is Time Running Out for Bond Insurers?
- More Write-Downs Ahead? The Citigroup research of Meredith Whitney, executive director of CIBC World Markets, triggered a staggering global selloff, and now shes warning that banks could face additional write-downs of up to $70B if bond insurers are downgraded.
- BofA: Monoline Split "Significant cost" to Financial Markets In the current Situation Room report (no link), BofA analysts suggest the monoline insurer breakup could lead to $30 Billion in write-downs for banks. BofA suggests further capital infusions, aimed at stabilizing the monolines at AA, would be a possible alternative. This is the first suggestion I've seen of trying to stabilize the ratings at AA. I'm not sure how that would impact the muni bond market
Junk Borrowers at Risk of Violating Covenants Rises A record 41 companies with high- yield, high-risk credit ratings are in danger of breaching terms of their loan agreements within 12 months as the slowing economy cuts into corporate profits, Moody's Investors Service said. Junk-rated companies including Krispy Kreme Doughnuts Inc. and Blockbuster Inc. are becoming more at risk of violating loan covenants and defaulting as the slowing economy saps earnings and cash flow. Some companies including restaurant chain Buffets Holdings Inc. and homebuilder Tousa Inc. have already been forced into bankruptcy after bankers were unwilling to amend loan terms. The number of borrowers at risk at the end of January rose from 25 in June, Moody's analysts led by John Puchalla in New York said today in a report. Moody's used a four-step scale to rate how much a company is in compliance with its loan terms, which often include agreements to maintain a ratio of debt to earnings or cash flow. A weak cushion indicates a company may have trouble freeing up cash for spending and accessing revolving credit lines, according to the report. Violating covenants can lead to a default and the securities being called. Creditors are making borrowers increase the interest on their debt by an average 0.83 percentage point to change the terms of their loans, the highest price since at least 1997, according to data compiled by Standard & Poor's in New York. The penalties are four times higher than six months ago, S&P said. The percentage of speculative-grade bonds that are distressed, meaning their yields are at least 1,000 basis points higher than benchmark rates, rose to 20.9 percent as of Feb. 15, about the same ratio as in the months preceding the recession that began seven years ago, according to Merrill Lynch & Co. Debt is 20 times more likely to default within a year once it's crossed the distressed threshold, according to data by Martin Fridson, chief executive officer of high-yield research firm FridsonVision LLC in New York.
- Red Lights Flash in Credit Nooks The global financial squeeze is spreading to investments linked to the debt of major companies.
- Lending Squeeze Hits Ailing Firms Retailers Sharper Image and Lillian Vernon filed for Chapter 11 protection. Banks' mounting woes are adding to a rise in bankruptcies.
Mid-Market M&A Outlook: Spreading Downturn ? Being somewhat connected into the mid-market (that's smaller firms) M&A/Buyout market and community it's something I follow and every once in a while something really interesting comes across my desk. Now we've discussed before that the implosion in large deals might be spreading into the mid-market (circa Jan08) based on anecdotal evidence that the deal flow began drying up in late Dec07. Now some much harder data has crossed our desks from OEM Capital. OEM is a specialist in mid-market M&A for the technology space and has an enviable track record, and sterling reputation. They track activity in that space montly and from their data we can begin to see the downturn spreading. If you're interested check out their web site and see if you can subscribe to their monthly newsletter. An excellent if dry information source.