WRFest 24Feb08(Finance Industry): Troubles Continue to Accumulate
We've ended up splitting our regular news summaries into multiple parts because of the number of valuable stories. Not just splitting Econom, Market and Business but in turn we'll end up splitting business itself into four parts, of which this is the the 2nd. The prior post looked at the strategic context and even provided a graphical chart to conceptualize all the multiple factors that any business must face, in general and specifically at these times.
These particular story excerpts focus on the Finance Industry and build on prior posts on the general conditions in the Economy, Market and, most...most especially, the Credit Markets. The bottom line is that a) the credit markets continue to experience a widening crisis whose end is not in sight. In fact whose details and working out are not at all clear. So, b) we think it's fair to consider that the Finance Industry as a whole is in as severe an emerging crisis as the Housing industry. Without the same level of broad understanding or consensus.
One that will, eventually, force serious re-thinking of the strategies, product offerrings, company structures and operating principles. Yet at the same time, given past history, who's corrective measures will be temporary pallative fixes because the Industry, despite it's vaunted "free-market" principles is in fact dominated by near-term and short-sighted thinking. Which tells us that, as investors, we can look forward to continued downtrends in these firms. And recurring cyclic opportunities to ride up and down with these cycles.
None of which is good long-term news.
UPDATE: for anybody who thinks the bad news is over we suggest listening to this Bloomberg vidclip of Meredith Whitney's outlook for Cit and the Finance Industry. She expects that Citi will have to start selling it's highest quality assets, upto and including Smith-Barney, to raise capital to offset more writedowns. Her slashing of earnings estimates is startling:
Whitney of Oppenheimer Slashes 2008 Citigroup Forecast: Video
If you can't see the video trying searching the Bloomberg site. Meanwhile here is the associated story: Citigroup May Post First-Quarter Loss, Whitney Says
Finance Industries
Fear and loathing, and a hint of hope Not all is lost for the structured-finance business. But it faces further discomfort before it can start to recover some of its past sheen. Securitisation has greatly enhanced the secondary market for loans, giving originators, mainly banks, more balance-sheet flexibility and investors of all sorts greater access to credit risk. Both have embraced it. By 2006 the volume of outstanding securitised loans had reached $28 trillion. Last year three-fifths of America's mortgages and one-quarter of consumer debt were bundled up and sold on. Though few bankers worked in structured finance, it was a huge earner, accounting for 20-30% of big investment banks' profits before the crisis … Alongside the banks, the “gatekeepers” who were supposed to lend stability and credibility to the new originate-and-distribute model of finance have also been found wanting. Rating agencies' models underplayed the risk that loans from different lenders and regions could turn sour at the same time. Bond insurers, too, misjudged the risks lurking in CDOs. That failing has undermined the worth of their guarantees and strained their own credit ratings—and hence financial markets.
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.
LBO Executives Gather in Germany as Takeovers Vanish, Fund Returns Decline Carlyle Group founder David Rubenstein and TPG Inc.'s David Bonderman will join a meeting of about 1,500 executives from the leveraged buyout industry in Germany this week, as funding for takeovers vanishes and returns deteriorate. At last year's Super Return conference, executives toasted an unprecedented $713 billion of acquisitions with a reception at the Frankfurt Zoo, where they were entertained by a dance troupe and challenged to find the glass of champagne containing a real diamond. That was four months before the U.S. subprime mortgage market started to collapse, leaving banks with a backlog of about $230 billion in buyout loans and reducing their appetite to fund any new takeovers. Two preferred routes to generate quick returns, selling assets to other buyout firms or taking dividends from investments, also withered in the credit drought. ``The industry made its fortune on the debt bubble and now it's got to harvest it,'' said Jon Moulton, the managing partner of Alchemy Partners, who will give the conference's opening address in Munich tomorrow. ``Returns will go to hell in a hand- basket.'' Only three months ago, Johannes Huth, Kohlberg Kravis Roberts & Co.'s European chief, stood up in front of a conference of private equity executives in Paris and reassured them that bankers would resume lending in January. ``Slightly wrong there, I think,'' Moulton said. ``We've got at least a year of very tough credit markets. Banks are short of capital.''
A painful fix for the credit crisis Splitting the debt insurers in two -- an idea the banks hate -- would be drastic medicine. But for the financial markets, it's the only relatively fast-acting antidote available. It's the end of the beginning for the credit crisis: There are now plans to split up the companies that insure bonds and derivatives based on mortgages and buyout loans. What that means for you and me is that the credit crunch -- which has hobbled the stock and bond markets and is causing the U.S. economy to grind to a halt -- would be over in 2008 rather than producing a Japanese-style lost decade. The breakup plans also would lead to tens of billions more in write-downs from banks and other investment companies that have already written down tens of billions. And I'd expect the likely losers from these plans would fight them tooth and nail in the courts. It could be years before all the litigation was settled. But confirmation that a big insurer like Ambac Financial Group (ABK, news, msgs) is well along in talks to pursue this kind of breakup will provoke a rush to the exits by investors and institutions. They know prices for risky debt aren't going to get any better and could indeed get a whole lot worse. That giant whoosh you'll hear is the sound of somewhere between $50 billion and $125 billion in losses getting flushed down the toilet by the end of 2008. And that's a good thing. This drastic medicine is the only remedy that would put the financial markets on a relatively quick path to health. Anything else promises to stretch this crisis out for years and years and keep the U.S. economy grinding along in low gear.