Our Mortgage Banking Segment produces mortgage loans through a variety of channels on a national scale. The mortgage loans we produce in this segment are generally sold into the secondary mortgage market, primarily in the form of securities, and to a lesser extent in the form of loans. We typically perform the ongoing servicing functions related to the mortgage loans that we produce. We also provide various loan closing services such as escrow, flood determination and appraisal. Historically, mortgage banking loan production has occurred in Countrywide Home Loans ("CHL"). Over the past several years, we have been transitioning this production to our bank subsidiary, Countrywide Bank, FSB ("Countrywide Bank" or the "Bank"). As of December 31, 2007, over 90% of our monthly mortgage loan production occurred in Countrywide Bank. Effective January 1, 2008, our production channels have moved into the Bank, completing the migration of substantially all of our loan production activities from CHL to the Bank. The mortgage loan production, the related balance sheet and the income relating to the holding and sale of these loans is included in our Mortgage Banking Segment regardless of whether the activity occurred in CHL or Countrywide Bank. We group the activities of our Mortgage Banking Segment into three business sectors—Loan Production, Loan Servicing and Loan Closing Services.
Banking Operations
Our Banking Operations primarily fund and purchase mortgage loans and home equity loans for investment purposes. The majority of these loans are sourced through our production channels. For liquidity and asset-liability management purposes, we also invest in securities such as collateralized mortgage obligations and agency MBS. Banking Operations activities provide the Company with an expanded product menu, lower cost funding sources and opportunities for a stable source of revenue in the form of net interest income.
Asset growth is funded by the Bank's liability base. The Bank obtains retail deposits, primarily certificates of deposit, through 194 financial centers (163 of which are located in CHL's retail branch offices) as of December 31, 2007, call centers and the Internet. Countrywide Bank also offers deposit accounts through deposit brokers (generally, well-recognized financial intermediaries).
A significant portion of Countrywide Bank's deposit liabilities are comprised of custodial funds that relate to our loan servicing portfolio. Countrywide Bank also offers commercial deposit accounts to title and mortgage insurance companies through a commercial banking unit. The Bank also borrows funds from other sources to supplement its deposit liabilities, including mortgage loan-secured borrowings from the Federal Home Loan Bank ("FHLB") of Atlanta and repurchase agreements secured by loans and securities.
Countrywide Bank acts as a mortgage document custodian, primarily for our mortgage banking operations. As a document custodian, we verify, maintain and release collateral for issuers, servicers, sellers and purchasers of debt securitizations. We also provide other services, including safekeeping, collateral review/certification, collateral releases and customer reporting.
Wednesday, April 30, 2008
Japan's Companies Gird for Attack
After years of opening up to foreign investment and takeovers, the world's No. 2 economy is getting back to fending them off. Many companies are reviving cross-shareholdings, in which business partners or even competitors buy stakes in each other to make takeovers harder. They're dusting off an American antitakeover defense out of the 1980s, the poison pill. Government ministries have joined in, attempting to ring-fence industries they deem strategic.
The new bulwark-building marks a major reversal for Japan. The nation has long been one of the most closed among major economies. But in the 1990s, during a decade of economic stagnation, international investors began pouring in. Japan allowed signature corporations to fall into foreign hands, including Nissan Motor Co. and Long-Term Credit Bank of Japan, since renamed Shinsei Bank Ltd. Under former Prime Minister Junichiro Koizumi earlier this decade, the country allowed foreign companies to buy Japanese companies with their own shares. Foreign ownership of shares soared, to 28% in 2006 from 4% in 1988.
Now the opening appears to be narrowing again. In a controversial recommendation this month, the Ministry of Economy, Trade and Industry said that The Children's Investment Fund LLP, a United Kingdom-based hedge fund, shouldn't be allowed to increase its stake in Electric Power Development Co., a formerly government-owned utility, beyond its current 9.9%.
In a speech shortly afterward, European Union trade chief Peter Mandelson told Japanese officials and businessmen that Japan "remains the most closed investment market in the developed world."
Distrust of outside investors is bleeding into popular culture. Last year, public broadcaster NHK ran a drama series called "Vulture," about a Japanese fund manager who acquires indebted companies for a U.S. investment firm. Its tagline: "Is that man the devil or a savior?"
Behind Japan's renewed fortress mentality: Many companies here look ripe for takeovers. Though profits are up, shares remain cheap. On average, Japanese stocks are now trading at about 15 times earnings, down from a price-to-earnings ratio of more than 50 just five years ago, according to Nikko Citigroup Ltd. Nearly two-thirds of Japan's listed companies trade at a price-to-book ratio of less than 1, according to consulting firm UWiN Corp. That means their assets could be sold for more than the cost of buying the whole company.
That spells opportunity for growing ranks of activist shareholders and private-equity funds here. Over the past five years, foreign firms including TPG and Kohlberg Kravis Roberts & Co. have set up shop in Japan. Between 2002 and 2007, the value of private-equity buyouts has almost tripled to $11.1 billion, according to data tracker Dealogic.
The activity is modest compared with the U.S.'s $434 billion in buyouts last year. Hostile takeovers, meanwhile, have been practically nonexistent in Japan. Dealogic says there were five such attempts last year, together worth a modest $477 million. None were successful.
Yet the fear is real. In a society that until recently counted on lifetime employment, some managers worry that acquirers will ax jobs. Others suggest that outside investors' pursuit of profits could clash with ideals such as honoring a founder's vision.
'Greedy, Adulterous'
In a speech earlier this year, Takao Kitabata, a vice minister of Economy, Trade and Industry, posed the question, "Are corporations the property of stockholders?" Shareholders are "stupid, greedy, adulterous, irresponsible and threatening," he said. "They are the type of people who just sell the stock if they get mad."
Japan isn't alone in its protectionist tendencies: Governments including the U.S., Germany and Australia have lately proposed or erected barriers to foreign investors. And Japan's shift isn't universal. Many top officials continue to argue for openness to outside investors. Some companies are lowering their guard: Mail-order company Nissen Holdings Co. and contact-lens retailer Nihon Optical Co. have let their poison-pill protections elapse. "Adopting takeover defenses doesn't give us the right image in the market," says a Nihon Optical spokeswoman.
The country's renewed willingness to coddle corporations comes at a time when it arguably needs to shake them up. Japan's per-capita gross domestic product was the lowest in the Group of Seven rich nations last year. In the early 1990s, it was the highest. Making matters worse, more Japanese are retiring each year than are joining the work force.
To avoid falling living standards, Japan needs to raise its work force's productivity. It must also generate more wealth with its vast savings -- about $15 trillion, mostly earning near-zero interest in bank accounts.
....
http://online.wsj.com/article/SB120951658668054687.html?mod=todays_us_page_one
The new bulwark-building marks a major reversal for Japan. The nation has long been one of the most closed among major economies. But in the 1990s, during a decade of economic stagnation, international investors began pouring in. Japan allowed signature corporations to fall into foreign hands, including Nissan Motor Co. and Long-Term Credit Bank of Japan, since renamed Shinsei Bank Ltd. Under former Prime Minister Junichiro Koizumi earlier this decade, the country allowed foreign companies to buy Japanese companies with their own shares. Foreign ownership of shares soared, to 28% in 2006 from 4% in 1988.
Now the opening appears to be narrowing again. In a controversial recommendation this month, the Ministry of Economy, Trade and Industry said that The Children's Investment Fund LLP, a United Kingdom-based hedge fund, shouldn't be allowed to increase its stake in Electric Power Development Co., a formerly government-owned utility, beyond its current 9.9%.
In a speech shortly afterward, European Union trade chief Peter Mandelson told Japanese officials and businessmen that Japan "remains the most closed investment market in the developed world."
Distrust of outside investors is bleeding into popular culture. Last year, public broadcaster NHK ran a drama series called "Vulture," about a Japanese fund manager who acquires indebted companies for a U.S. investment firm. Its tagline: "Is that man the devil or a savior?"
Behind Japan's renewed fortress mentality: Many companies here look ripe for takeovers. Though profits are up, shares remain cheap. On average, Japanese stocks are now trading at about 15 times earnings, down from a price-to-earnings ratio of more than 50 just five years ago, according to Nikko Citigroup Ltd. Nearly two-thirds of Japan's listed companies trade at a price-to-book ratio of less than 1, according to consulting firm UWiN Corp. That means their assets could be sold for more than the cost of buying the whole company.
That spells opportunity for growing ranks of activist shareholders and private-equity funds here. Over the past five years, foreign firms including TPG and Kohlberg Kravis Roberts & Co. have set up shop in Japan. Between 2002 and 2007, the value of private-equity buyouts has almost tripled to $11.1 billion, according to data tracker Dealogic.
The activity is modest compared with the U.S.'s $434 billion in buyouts last year. Hostile takeovers, meanwhile, have been practically nonexistent in Japan. Dealogic says there were five such attempts last year, together worth a modest $477 million. None were successful.
Yet the fear is real. In a society that until recently counted on lifetime employment, some managers worry that acquirers will ax jobs. Others suggest that outside investors' pursuit of profits could clash with ideals such as honoring a founder's vision.
'Greedy, Adulterous'
In a speech earlier this year, Takao Kitabata, a vice minister of Economy, Trade and Industry, posed the question, "Are corporations the property of stockholders?" Shareholders are "stupid, greedy, adulterous, irresponsible and threatening," he said. "They are the type of people who just sell the stock if they get mad."
Japan isn't alone in its protectionist tendencies: Governments including the U.S., Germany and Australia have lately proposed or erected barriers to foreign investors. And Japan's shift isn't universal. Many top officials continue to argue for openness to outside investors. Some companies are lowering their guard: Mail-order company Nissen Holdings Co. and contact-lens retailer Nihon Optical Co. have let their poison-pill protections elapse. "Adopting takeover defenses doesn't give us the right image in the market," says a Nihon Optical spokeswoman.
The country's renewed willingness to coddle corporations comes at a time when it arguably needs to shake them up. Japan's per-capita gross domestic product was the lowest in the Group of Seven rich nations last year. In the early 1990s, it was the highest. Making matters worse, more Japanese are retiring each year than are joining the work force.
To avoid falling living standards, Japan needs to raise its work force's productivity. It must also generate more wealth with its vast savings -- about $15 trillion, mostly earning near-zero interest in bank accounts.
....
http://online.wsj.com/article/SB120951658668054687.html?mod=todays_us_page_one
GDP Q1 08
--Real GDP QoQ is 0.6%, beating estimate and , same level as Q4 07 (GDP 11.7 tril)
--Major driver is consumer service, especially Medi care expense (11% of GDP)
--net export shrink due to currency devaluation
--Business investment decline (-0.7%), but still holding at similar level, implying corporations are expanding moderately and gearing up for recession
--Inventory increased 0.81%, reflecting stronger demand compared to last quarter
--Major driver is consumer service, especially Medi care expense (11% of GDP)
--net export shrink due to currency devaluation
--Business investment decline (-0.7%), but still holding at similar level, implying corporations are expanding moderately and gearing up for recession
--Inventory increased 0.81%, reflecting stronger demand compared to last quarter
Subprime Delinquency Rate Growing More Slowly
The subprime-mortgage market still is getting worse each month, but there are some indications that the massive problem of borrowers falling behind on their loans may be moderating.
Data provided recently to holders of securities backed by subprime mortgages showed that the number of borrowers who were delinquent on their home loans rose at a slower pace in April than in March. It was the third month in a row in which mortgages went bad at a slower rate. The data come from so-called "remittance reports" that are distributed monthly by trustees of mortgage-backed securities tracked by the widely followed ABX indexes.
Among pools of subprime mortgages made in the second half of 2005, the proportion of loans that were more than 60 days delinquent rose by 1.23 percentage points in April to 35.9%. That compared with a 1.61-percentage-point increase in March, a 2.36-point increase in February and a 2.64-point rise in January, according to a report from Wachovia Capital Markets. The report said similar trends were observed in April for loans made in 2006 and the first half of 2007. On average, between 25% and 40% of the subprime loans in these groups are more than 60 days delinquent.
While it is hard to predict when the subprime market will hit bottom, some analysts think the recent data indicate that some sort of stabilization is under way.
"The trajectory is beginning to flatten out, and this could be a turning point for prices" of mortgage securities, said Glenn Schultz, a senior analyst at Wachovia. As many poorly underwritten subprime loans made between mid-2005 and mid-2007 go bad early in their lives, Mr. Schultz expects the remaining loans to perform more normally.
In recent weeks, some portions of the ABX indexes have bounced off their record lows, and traders say some investors are buying subprime bonds again after their market prices dropped to deeply discounted levels.
But many market participants remain skeptical or bearish about the outlook for subprime. Richard Parkus, an analyst at Deutsche Bank Securities, says the recent remittance data showed "no clear evidence of any recovery," and his firm continues to expect extraordinarily high levels of losses among subprime loans.
Skeptics also say that with home prices falling and unemployment rising, delinquencies will keep climbing. There is also a possibility that the recent delinquency data might have been influenced by seasonal factors, such as individuals using recent tax refunds to become current on their mortgage payments.
Data provided recently to holders of securities backed by subprime mortgages showed that the number of borrowers who were delinquent on their home loans rose at a slower pace in April than in March. It was the third month in a row in which mortgages went bad at a slower rate. The data come from so-called "remittance reports" that are distributed monthly by trustees of mortgage-backed securities tracked by the widely followed ABX indexes.
Among pools of subprime mortgages made in the second half of 2005, the proportion of loans that were more than 60 days delinquent rose by 1.23 percentage points in April to 35.9%. That compared with a 1.61-percentage-point increase in March, a 2.36-point increase in February and a 2.64-point rise in January, according to a report from Wachovia Capital Markets. The report said similar trends were observed in April for loans made in 2006 and the first half of 2007. On average, between 25% and 40% of the subprime loans in these groups are more than 60 days delinquent.
While it is hard to predict when the subprime market will hit bottom, some analysts think the recent data indicate that some sort of stabilization is under way.
"The trajectory is beginning to flatten out, and this could be a turning point for prices" of mortgage securities, said Glenn Schultz, a senior analyst at Wachovia. As many poorly underwritten subprime loans made between mid-2005 and mid-2007 go bad early in their lives, Mr. Schultz expects the remaining loans to perform more normally.
In recent weeks, some portions of the ABX indexes have bounced off their record lows, and traders say some investors are buying subprime bonds again after their market prices dropped to deeply discounted levels.
But many market participants remain skeptical or bearish about the outlook for subprime. Richard Parkus, an analyst at Deutsche Bank Securities, says the recent remittance data showed "no clear evidence of any recovery," and his firm continues to expect extraordinarily high levels of losses among subprime loans.
Skeptics also say that with home prices falling and unemployment rising, delinquencies will keep climbing. There is also a possibility that the recent delinquency data might have been influenced by seasonal factors, such as individuals using recent tax refunds to become current on their mortgage payments.
Junk Bonds Are on a Roll, But Danger Lies Ahead
The junk-bond market is closing out its best month in years, but many investors and analysts are skeptical about the outlook.
The concern in the junk, or "high yield," market isn't just a likely surge in defaults, which is the norm for companies with low credit quality during an economic downturn. This time around, there are worries that when defaults occur, the recovery rates on those bonds and loans will be far more meager than in the past.
The main source of those concerns is the hundreds of billions of dollars of noninvestment-grade loans issued in recent years. Before the onset of the credit crunch, such loans went to market with fewer protections for holders in the event that issuers ran into financial trouble. In order to compensate investors for the increased risks of holding that debt, some say yields will need to stay relatively high and that prices may not improve much.
Still, investors in the high-yield debt market can smile for now. The Merrill Lynch High-Yield Bond Index is up 0.6% for the year, having been down 4.5% on March 17, the day after the collapse of Bear Stearns Cos. The yield spread over comparable U.S. Treasurys, a barometer of market sentiment, has narrowed sharply to 6.85 percentage points from a high of 8.6 percentage points. Yet, with an average yield of about 10%, high-yield debt offers a healthy income stream. Investment-grade corporate bonds are yielding around 6%.
Like other parts of the bond market, sentiment rebounded after the Federal Reserve aided J.P. Morgan Chase & Co.'s pending takeover of Bear Stearns in an attempt to keep the brokerage house's problems from spiraling through the financial system. That, combined with the Fed's decision to let brokerage houses borrow from the central bank, created a greater comfort with taking on risk.
Meanwhile, brokerage houses have made progress in clearing the decks of hundreds of billions of dollars of high-yield debt that had been sitting on their books since last summer, particularly loans backing leveraged buyouts.
Now the focus is on the economy and credit quality of low-rated issuers. "This is the most dangerous time of the cycle for high yield," says Tom Swaney, a portfolio manager and head of the credit team at OppenheimerFunds. "You know the defaults are going to come, but you don't know exactly when, and you don't know what kind of risk premium you need to earn to ride it out."
Thus far, default rates, which have risen, remain low. Still, Moody's Investors Service last month said it expects defaults on U.S. speculative-grade debt to rise to 6.6% by next March from 2.2% last month. If the economy goes into a deep recession, defaults could top 10%, Moody's says. However, Moody's believes that, thanks to healthy corporate balance sheets outside the financial sector, a more likely outcome is that fewer defaults will materialize.
While high-yield investors are used to the ups and downs of the default cycle, there is a new wrinkle to contend with. Starting in 2004, many low-quality companies that would have issued conventional, unsecured high-yield debt instead turned to the syndicated-loan market, especially for leveraged buyouts.
The concern in the junk, or "high yield," market isn't just a likely surge in defaults, which is the norm for companies with low credit quality during an economic downturn. This time around, there are worries that when defaults occur, the recovery rates on those bonds and loans will be far more meager than in the past.
The main source of those concerns is the hundreds of billions of dollars of noninvestment-grade loans issued in recent years. Before the onset of the credit crunch, such loans went to market with fewer protections for holders in the event that issuers ran into financial trouble. In order to compensate investors for the increased risks of holding that debt, some say yields will need to stay relatively high and that prices may not improve much.
Still, investors in the high-yield debt market can smile for now. The Merrill Lynch High-Yield Bond Index is up 0.6% for the year, having been down 4.5% on March 17, the day after the collapse of Bear Stearns Cos. The yield spread over comparable U.S. Treasurys, a barometer of market sentiment, has narrowed sharply to 6.85 percentage points from a high of 8.6 percentage points. Yet, with an average yield of about 10%, high-yield debt offers a healthy income stream. Investment-grade corporate bonds are yielding around 6%.
Like other parts of the bond market, sentiment rebounded after the Federal Reserve aided J.P. Morgan Chase & Co.'s pending takeover of Bear Stearns in an attempt to keep the brokerage house's problems from spiraling through the financial system. That, combined with the Fed's decision to let brokerage houses borrow from the central bank, created a greater comfort with taking on risk.
Meanwhile, brokerage houses have made progress in clearing the decks of hundreds of billions of dollars of high-yield debt that had been sitting on their books since last summer, particularly loans backing leveraged buyouts.
Now the focus is on the economy and credit quality of low-rated issuers. "This is the most dangerous time of the cycle for high yield," says Tom Swaney, a portfolio manager and head of the credit team at OppenheimerFunds. "You know the defaults are going to come, but you don't know exactly when, and you don't know what kind of risk premium you need to earn to ride it out."
Thus far, default rates, which have risen, remain low. Still, Moody's Investors Service last month said it expects defaults on U.S. speculative-grade debt to rise to 6.6% by next March from 2.2% last month. If the economy goes into a deep recession, defaults could top 10%, Moody's says. However, Moody's believes that, thanks to healthy corporate balance sheets outside the financial sector, a more likely outcome is that fewer defaults will materialize.
While high-yield investors are used to the ups and downs of the default cycle, there is a new wrinkle to contend with. Starting in 2004, many low-quality companies that would have issued conventional, unsecured high-yield debt instead turned to the syndicated-loan market, especially for leveraged buyouts.
Monday, April 28, 2008
Weak Board Salvage Regional Banks' Chiefs' Misbehalf
How can the chiefs of these banks still be at the helm when leaders like Charles Prince, Stanley O'Neal and Marcel Ospel were shoved out of Citi, Merrill and UBS, respectively? Sure, all three companies lost about half their value in the past year. That's bad. But so has RBS. And the losses inflicted by WaMu and National City on their investors are far more horrific.
There are probably a few reasons for the discrepancy over which bosses get the ax. The main reason may be the composition of their respective boards. Unlike the big Wall Street banks, regional institutions tend to draw local executives, who may be more forgiving when it comes to a neighbor's shortcomings. After all, it would be quite uncomfortable to bump into somebody you have just sacked on the local golf course.
National City may be a case in point. Its board mainly consists not of global financial heavyweights, but of local worthies. There is the president of a hometown community college, the boss of a paint company based down the street and the head of a restaurant group named Eat'n Park. The situation is a bit better at RBS. But for an institution that has global pretensions, its board is stuffed with a lot of Scots.
But it isn't just weak boards that have saved the scalps of provincial-bank bosses. It is up to shareholders to hold directors accountable. Because investment banks tend to pay their employees giant bonuses loaded with restricted stock, they often make up the largest block of shareholders. So when the stock buckles, the blade gets sharpened fast.
There are probably a few reasons for the discrepancy over which bosses get the ax. The main reason may be the composition of their respective boards. Unlike the big Wall Street banks, regional institutions tend to draw local executives, who may be more forgiving when it comes to a neighbor's shortcomings. After all, it would be quite uncomfortable to bump into somebody you have just sacked on the local golf course.
National City may be a case in point. Its board mainly consists not of global financial heavyweights, but of local worthies. There is the president of a hometown community college, the boss of a paint company based down the street and the head of a restaurant group named Eat'n Park. The situation is a bit better at RBS. But for an institution that has global pretensions, its board is stuffed with a lot of Scots.
But it isn't just weak boards that have saved the scalps of provincial-bank bosses. It is up to shareholders to hold directors accountable. Because investment banks tend to pay their employees giant bonuses loaded with restricted stock, they often make up the largest block of shareholders. So when the stock buckles, the blade gets sharpened fast.
Sunday, April 27, 2008
ETF redemption -- exhchange for underlying wo tax efficient
An exchange-traded fund (or ETF) is an investment vehicle traded on stock exchanges, much like stocks or bonds. An ETF holds assets such as stocks, bonds, or futures. Institutional investors can redeem large blocks of shares of the ETF (known as "creation units") for a "basket" of the underlying assets or, alternately, exchange the underlying assets for creation units. This creation and redemption of shares enables institutions to engage in arbitrage and causes the value of the ETF to approximate the net asset value of the underlying assets. Most ETFs track an index, such as the Dow Jones Industrial Average or the S&P 500.
An index mutual funds redemption when fund sell actual shares for investors with tax implications. But ETF usually just exchange shares without tax implications. Hence ETF is more tax efficient.
An index mutual funds redemption when fund sell actual shares for investors with tax implications. But ETF usually just exchange shares without tax implications. Hence ETF is more tax efficient.
Saturday, April 26, 2008
bottom comparison beteween 1990s and 2008 by buyout firms
Some buyout bigwigs compare the situation with the early 1990s. Then, U.S. credit woes stemmed from a deflating junk-bond bubble, which had fueled a commercial-real-estate boom. The blowup of Drexel Burnham Lambert was an early sign the bottom was approaching. Several regional banks subsequently collapsed. By this analogy, Bear Stearns's meltdown may have marked the beginning of the end of the current credit crunch.
The more-cautious buyout firms may, however, doubt the worst is really over until regional banks start failing. The Federal Reserve's moves to stabilize markets and rescue Bear may prevent that from happening. Investments by private-equity firms such as TPG and Corsair could also shore up some banks. So buyout shops waiting for better deals may miss the boat.
The more-cautious buyout firms may, however, doubt the worst is really over until regional banks start failing. The Federal Reserve's moves to stabilize markets and rescue Bear may prevent that from happening. Investments by private-equity firms such as TPG and Corsair could also shore up some banks. So buyout shops waiting for better deals may miss the boat.
Friday, April 25, 2008
Why Banks Raise Hybrids
Hybrid bonds such as preferred shares that havecharacteristics of both debt and equity count toward capitalreserves, allowing banks to replenish their coffers withoutdiluting equity. Hybrids typically allow issuers to defer interest payments without defaulting, and credit-rating companies usually consider the bulk of the money raised as equity, meaning only a portion is counted as debt on an issuer's balance sheet.
Merrill Lynch, after writing down the value of $6.5 billionof assets, sold $7 billion of senior unsecured notes in itsbiggest debt offering, attracting investors with spreads as muchas triple what it paid a year ago. Merrill Lynch, the third-biggest U.S. securities firm, also issued $2.55 billion ofperpetual preferred shares that yield 8.625 percent, its largestsale of the securities.
The firm split its bond sale between $1.5 billion of 5-year6.15 percent notes that priced to yield 325 basis points morethan Treasuries of similar maturity and $5.5 billion of 10-year6.875 percent notes that paid a spread of 320 basis points,Bloomberg data show. That compares with the 107-basis pointspread Merrill Lynch paid on $1 billion of 10-year notes in April2007.
Merrill Lynch may now lose its A1 ranking at Moody'sInvestors Service because the credit rating service won't countthe proceeds of the preferred sale as equity, Sanford C. Bernstein & Co. analyst Brad Hintz said today in a note toclients. Credit-rating companies typically don't allow more than 25 percent of a bank's capital base to be made up of preferred stock, a limit Merrill is ``well over,'' he said.
Merrill Lynch, after writing down the value of $6.5 billionof assets, sold $7 billion of senior unsecured notes in itsbiggest debt offering, attracting investors with spreads as muchas triple what it paid a year ago. Merrill Lynch, the third-biggest U.S. securities firm, also issued $2.55 billion ofperpetual preferred shares that yield 8.625 percent, its largestsale of the securities.
The firm split its bond sale between $1.5 billion of 5-year6.15 percent notes that priced to yield 325 basis points morethan Treasuries of similar maturity and $5.5 billion of 10-year6.875 percent notes that paid a spread of 320 basis points,Bloomberg data show. That compares with the 107-basis pointspread Merrill Lynch paid on $1 billion of 10-year notes in April2007.
Merrill Lynch may now lose its A1 ranking at Moody'sInvestors Service because the credit rating service won't countthe proceeds of the preferred sale as equity, Sanford C. Bernstein & Co. analyst Brad Hintz said today in a note toclients. Credit-rating companies typically don't allow more than 25 percent of a bank's capital base to be made up of preferred stock, a limit Merrill is ``well over,'' he said.
Juniper (JNPR) Q1 08
Overall
--Earning 110 mil, EPS 0.2 up 44%
--Revenue 822.9 mil, up 31%
Comments:
--High profit and high quality
--Earning 110 mil, EPS 0.2 up 44%
--Revenue 822.9 mil, up 31%
Comments:
--High profit and high quality
American Express (AXP) Q1 08
Overall
--Earning 991 mil, -6%
--Revenue 7.2 bil, 11% up
--driver: interntional market
Segments:
Card Services (3.7 bil 50% share)
--earning 523 mil, -19%, revenue up 11% to 3.7 bil
--provision 881 mil, up 52%
Internatonal Card (20%)
--earning: 133 mil, up 30%, revenue up 22% to 1.2 bil
--provision 229, up 24%
Credit quality
--provision match writeoff closely, not dramatic change
comments:
--overall credit quality is fine
--Earning 991 mil, -6%
--Revenue 7.2 bil, 11% up
--driver: interntional market
Segments:
Card Services (3.7 bil 50% share)
--earning 523 mil, -19%, revenue up 11% to 3.7 bil
--provision 881 mil, up 52%
Internatonal Card (20%)
--earning: 133 mil, up 30%, revenue up 22% to 1.2 bil
--provision 229, up 24%
Credit quality
--provision match writeoff closely, not dramatic change
comments:
--overall credit quality is fine
Leverage Crushed Austraillian Brokerage
Freewheeling borrowing to buy stocks has led to brokerage collapses in Australia, fueled by broad-ranging margin calls in a rocky market.
Two brokerage firms -- Opes Prime Stockbroking Ltd. in Melbourne and Lift Capital Ltd. in Sydney -- have been forced into receivership, the Australian equivalent of bankruptcy, after nervous creditors withdrew their support. A third brokerage, Tricom Equities Ltd., is staggering under similar debt burdens. Traders expect more firms will go under.
Victims include the brokerages' customers. The expansion-minded brokers borrowed heavily, using customers' shares as collateral. When the market went south, the lenders liquidated the customers' holdings in an attempt to minimize their own losses.
The brokerages' creditors, Australia & New Zealand Banking Group Ltd., the country's fourth-biggest lender by market capitalization, and Merrill Lynch & Co. together dumped more than two billion Australian dollars (US$1.9 billion) in shares they held as collateral.
The mess has provoked a series of investigations and threats of lawsuits, and has shaken confidence in Australia's stock market.
The root of the problem is a loophole in Australian regulations that allows brokers to put up customers' shares as loan collateral, without notifying the customers. The investors apparently didn't know their shares had been pledged against the loans until it was too late.
In the U.S., brokers are forbidden from dipping into a customer's account for their own purposes. Opes, which began operations in 2003, disclosed in documents to investors that it could do this. But many customers now say they had no idea their stock had been so pledged.
The brokers used the loans to expand their own margin-lending activities to customers. Margin lending can be quite profitable for brokers, who earn interest from the borrowings.
That setup worked fine as long as the Australian market rose. During its five-year run, the A&P/ASX 200, Australia's benchmark index, climbed 130%. But since hitting a high Nov. 1, the index has dropped 18%, joining a global market rout. Suddenly, the brokers were hit by margin calls of their own from ANZ and Merrill.
Some Opes and Lift customers have lost millions of dollars in equity as ANZ and Merrill sold off these shares.
Two directors of mineral-resources company Paladin Energy Ltd. had their stakes sold without their consent, the company said in a filing with the stock exchange. Those directors are planning to sue, the filing said. Paladin directors didn't respond to calls seeking comment.
The tumult isn't confined to Australia. In Singapore, the management-led buyout of an engineering concern called Jade Technologies Holdings Ltd. fell apart after the chief executive, Anthony Soh, had his stake sold out from under him. Mr. Soh's shares had resided in an Opes account.
The investigations are mounting. The Australian Securities and Investments Commission and the Australian Securities Exchange have launched probes into possible fraud. Singapore's white-collar-crime unit has started its own inquiry.
ANZ faces a public-relations nightmare for its involvement. The bank is conducting an internal inquiry to uncover whether any of the bank's employees breached risk controls or ethical standards. During a briefing Wednesday of the bank's financial results, Chief Executive Mike Smith expressed frustration with the bank's involvement in the collapse of Opes.
"This is very irritating. I'm absolutely determined to see whether there have been any breaches in our processes or standards," Mr. Smith said. He said the internal probe includes all the bank's securities-lending activities, not just the loans to Opes, but he added that he wasn't prepared yet to provide any details.
Merrill and the regulators declined to comment.
Two brokerage firms -- Opes Prime Stockbroking Ltd. in Melbourne and Lift Capital Ltd. in Sydney -- have been forced into receivership, the Australian equivalent of bankruptcy, after nervous creditors withdrew their support. A third brokerage, Tricom Equities Ltd., is staggering under similar debt burdens. Traders expect more firms will go under.
Victims include the brokerages' customers. The expansion-minded brokers borrowed heavily, using customers' shares as collateral. When the market went south, the lenders liquidated the customers' holdings in an attempt to minimize their own losses.
The brokerages' creditors, Australia & New Zealand Banking Group Ltd., the country's fourth-biggest lender by market capitalization, and Merrill Lynch & Co. together dumped more than two billion Australian dollars (US$1.9 billion) in shares they held as collateral.
The mess has provoked a series of investigations and threats of lawsuits, and has shaken confidence in Australia's stock market.
The root of the problem is a loophole in Australian regulations that allows brokers to put up customers' shares as loan collateral, without notifying the customers. The investors apparently didn't know their shares had been pledged against the loans until it was too late.
In the U.S., brokers are forbidden from dipping into a customer's account for their own purposes. Opes, which began operations in 2003, disclosed in documents to investors that it could do this. But many customers now say they had no idea their stock had been so pledged.
The brokers used the loans to expand their own margin-lending activities to customers. Margin lending can be quite profitable for brokers, who earn interest from the borrowings.
That setup worked fine as long as the Australian market rose. During its five-year run, the A&P/ASX 200, Australia's benchmark index, climbed 130%. But since hitting a high Nov. 1, the index has dropped 18%, joining a global market rout. Suddenly, the brokers were hit by margin calls of their own from ANZ and Merrill.
Some Opes and Lift customers have lost millions of dollars in equity as ANZ and Merrill sold off these shares.
Two directors of mineral-resources company Paladin Energy Ltd. had their stakes sold without their consent, the company said in a filing with the stock exchange. Those directors are planning to sue, the filing said. Paladin directors didn't respond to calls seeking comment.
The tumult isn't confined to Australia. In Singapore, the management-led buyout of an engineering concern called Jade Technologies Holdings Ltd. fell apart after the chief executive, Anthony Soh, had his stake sold out from under him. Mr. Soh's shares had resided in an Opes account.
The investigations are mounting. The Australian Securities and Investments Commission and the Australian Securities Exchange have launched probes into possible fraud. Singapore's white-collar-crime unit has started its own inquiry.
ANZ faces a public-relations nightmare for its involvement. The bank is conducting an internal inquiry to uncover whether any of the bank's employees breached risk controls or ethical standards. During a briefing Wednesday of the bank's financial results, Chief Executive Mike Smith expressed frustration with the bank's involvement in the collapse of Opes.
"This is very irritating. I'm absolutely determined to see whether there have been any breaches in our processes or standards," Mr. Smith said. He said the internal probe includes all the bank's securities-lending activities, not just the loans to Opes, but he added that he wasn't prepared yet to provide any details.
Merrill and the regulators declined to comment.
Lehman Mortgage Servicing Rights
Lehman also booked a $364 million pretax gain on changes in the value of mortgage-servicing rights, which are treated as an asset because they represent the future cash flows from fees borrowers pay to the companies that collect mortgage payments.
The value of these rights changes depending on expectations of things like the future direction of interest rates, risk associated with mortgages and, most importantly, the likelihood that investors will prepay their loans.
When expected prepayments decline, holders of servicing rights see gains. Prepayment rates have been dropping since last year because fewer people can refinance mortgages.
The value of these rights changes depending on expectations of things like the future direction of interest rates, risk associated with mortgages and, most importantly, the likelihood that investors will prepay their loans.
When expected prepayments decline, holders of servicing rights see gains. Prepayment rates have been dropping since last year because fewer people can refinance mortgages.
Thursday, April 24, 2008
The Changing Business of Banking: Implications for Financial Stability and Lessons from Recent Market Turmoil
The recent market turmoil certainly has underscored how banking and financial intermediation have been changing, and it has taught some important lessons about the implications for financial stability that I don't believe were previously well understood. Commercial banks and other financial market participants need to incorporate those lessons into their risk-management practices. Bank supervisors need to encourage and monitor banks' efforts to strengthen their practices and we need to consider how regulatory and supervisory policies should be modified to reinforce incentives for sound practices. Finally, changes in the ways savings are channeled to borrowers have also affected the role of the nonbank sector. Central banks and other policymakers need to think carefully about the implications of these changes for financial stability and the appropriate prudential regulation of nonbank financial institutions.1
The Changing Business of Banking Even before the recent market turmoil, it was abundantly clear that the business of banking has changed quite significantly over the past several decades. The primary impetus for change has been intensified competitive pressures from the securities markets. Changes in technology (for example, the development and expansion of credit-scoring techniques) have allowed a larger share of credit extensions to households and businesses to be packaged in securities and sold to entities that often can fund the securities more cheaply than banks can fund loans. The effects probably have been greatest for the U.S. household sector.
Securitization of residential mortgages began in the 1970s; the share of outstanding mortgages that have been securitized grew fairly steadily throughout the 1980s and 1990s and has fluctuated between 50 and 60 percent since then. Nonmortgage consumer credit (credit card and installment debt) began to be securitized in the late 1980s, and in recent years more than 20 percent of the outstanding stock has been securitized. Until the summer of 2007, there was very strong demand for securitized credit from mutual funds, pension funds, and other institutional investors. Throughout that period, household wealth was rising rapidly, and, directly or indirectly, households were allocating an increasing share of their wealth to vehicles that were managed or advised by professional asset managers. At the same time, advances in the technology of modeling, pricing, and trading of risk over the past several decades gave added impetus to the migration of credit to securities markets.
Competition from the securities market has significantly affected all segments of banking, but the most dramatic changes have occurred at the very largest banks. One could say that their strategic response was, "If you can't beat them, join them." Freed from the constraints of the Glass-Steagall Act by incremental regulatory changes that were expanded and codified in the Gramm-Leach-Bliley Act of 1999, the very largest banking organizations have significantly increased their capital markets businesses, including arranging and underwriting securitizations, securities custody, prime brokerage, and both over-the-counter and exchange-traded derivatives. They have also made significant inroads into both traditional asset management and the management of hedge funds. Indeed, the largest commercial banks are now major competitors in many of the business lines that were historically viewed as the province of investment banks. Together, the very large commercial and investment banks have become indispensable to the efficiency and stability of the securities markets. For example, the $2 trillion hedge fund sector is critically dependent on a relatively small number of commercial and investment banks that serve as secured creditors and derivatives counterparties. And, as the financial market turmoil has revealed, banks provide liquidity support to various short-term financial markets, including the commercial paper market and markets for various types of tax-exempt debt.
Competition from securities markets has also affected smaller banks significantly, though less dramatically than larger banks. For example, the portfolio share of commercial real estate loans, which are not amenable to standardization and therefore are difficult to securitize, has increased markedly. Setting aside the 100 largest banks, the share of commercial real estate loans in bank loan portfolios nearly doubled over the past 10 years and is approaching 50 percent. The portfolio share at these banks of residential mortgage and other consumer loans, which are more readily securitized, fell by 20 percentage points over the same period.
The Implications for Financial Stability from the Recent Market Turmoil
The changing business of the largest commercial banks means that threats to financial stability do not necessarily come from traditional sources such as a deposit run or a deterioration in a bank's portfolio of business loans. The largest banks' capital markets businesses have given rise to new threats to financial stability. These threats stem from banks' securitization activity, from the complexity of banks' capital markets activity, and from the services that banks provide to the asset-management industry, including hedge funds. And risks that are more traditional to banking, such as liquidity risk and concentration risk, have appeared in new forms.
The securitization activity of the largest banks is often described as following an originate-to-distribute model. Chairman Bernanke described this model in some detail in a speech he gave last week in Richmond.2 In an originate-to-distribute model of banking, assets are originated to be packaged into securities, which are distributed broadly.
However, in the recent market turmoil, problems arose at both ends of the originate-to-distribute chain as it was being applied to subprime mortgages. The quality of subprime origination declined because of a serious erosion in underwriting standards at banks and especially at nonbanks. Underwriting standards for subprime mortgages fell as loans were increasingly made on the basis of expected increases in collateral value, without a careful evaluation of the borrower's ability to repay. Several years of rapidly rising house prices had reduced the delinquency rates on mortgages with historically high loan-to-value ratios, making these mortgages look less risky than they, in fact, turned out to be. As loan amounts rose relative to the value of properties, the performance of the subprime mortgage sector as a whole became sensitive to even small declines in house prices, with the distressing results that we have seen since house price growth decelerated beginning in 2006. A similar decline in underwriting standards occurred in other market segments, such as the market for leveraged loans, where banks increasingly originated loans with less-stringent covenants through the first half of last year. More generally, insufficient appreciation that economic conditions might not always be benign and that trading conditions in markets might not always be highly liquid led to an underpricing of both credit and liquidity risks.
At the other end of the originate-to-distribute chain, a good part of the risk associated with the securitization of subprime mortgages was not distributed into the market but was retained by banks. The most glaring example is their exposures to super senior tranches of collateralized debt obligations (CDOs) that had invested in subprime mortgage-backed securities. Super senior CDO tranches--the last to bear the costs of defaults on the underlying mortgages--were considered to be extremely safe investments, and little of the risk of these instruments was truly distributed into the market.
Three things hindered the distribution of super senior CDO risk. First, underwriters sold some of the risk to off-balance-sheet vehicles, but they also provided explicit or implicit liquidity backstops to the vehicles. Much of this risk came back onto banks' balance sheets when liquidity pressures emerged in the second half of last year. Second, underwriters chose to retain some of the super senior exposure, in some cases reportedly because they met some resistance when they attempted to sell them at very slim spreads. The underwriters evidently misjudged the risk of those positions, in some cases because they relied too heavily on external triple-A ratings. Third, underwriters hedged some of the risk with monoline financial guarantors. But some of the guarantors took on so much subprime-related risk that their financial condition had become highly correlated with the performance of the subprime mortgage sector, which has called into question the effectiveness of those hedges.
As I mentioned earlier, the growth of securitization is in large part a response to the growing demands of institutional investors for fixed-income securities. These investors clearly had a financial incentive to do better due diligence on the subprime risks they were taking on, but they largely failed to do so. We can only speculate as to why this was the case. I see three possibilities: First, they underestimated the potential for a nationwide decline in house prices; second, they relied on credit-rating agency analyses that have proven to be inadequate; or third, they simply misunderstood the risk of these often very complex securities.
The complexity of CDOs is one example of a widespread increase in the complexity of the capital market activities in which the largest banks now engage. Some banks' failure to adequately manage this complexity has weakened financial stability in the current market turmoil. CDOs and other structured credit products can be very complicated. Among the CDOs that invested in subprime mortgage-backed securities, it was common for a single CDO to own hundreds of different mortgage-backed securities, each with its own pool of underlying mortgage loans. Clearly, the valuation of such products and the measurement and hedging of the risks they entail are very complicated. Securities pools reduce idiosyncratic risk--the potential for problems particular to individual borrowers to have a material effect on overall values--but they are quite subject to systematic risk from broad-based macroeconomic developments that affect all loans at the same time. I believe it is fair to say that the creation of new, innovative financial products outstripped banks' risk-management capabilities. As I noted earlier, some banks that chose to hold super senior CDO securities did so because they trusted in an external triple-A credit rating. Because some banks did not fully understand all aspects of these exposures, once the risks crystallized last year in a weak house price environment, compounded by widespread liquidity pressures in many markets, banks had to scramble to measure and hedge these risks.
Another aspect of the changing business of banking with possible implications for financial stability is the growth of services that banks provide, including running their own asset-management businesses and providing prime brokerage services to hedge funds. Banks with asset-management businesses must manage the reputation risk that such businesses entail. Because institutional investors are naturally sensitive to the reputation of their asset managers, losses elsewhere in the bank can be compounded if they leave the bank's asset-management business exposed to a flight of business and a sharp reduction in fee income. An increase in the business that banks do with highly leveraged investors, like some hedge funds, leads to an increase in the attention that banks must pay to counterparty risk management.
Liquidity risk is a familiar risk to banks, but it has appeared in somewhat new forms recently. While the originate-to-distribute model aims to move exposures off of banks' balance sheets, the risk remains that a sudden closing of securitization markets can force a bank to hold and fund exposures that it had originated with the intent to distribute. And in many cases when banks did distribute exposures, they did so to various off-balance-sheet financing vehicles in which they retained contractual and reputational liquidity exposures. These vehicles, like banks themselves, were funding longer-term assets with short-term liabilities, and, like banks, they were subject to a run when their lenders became concerned about the quality of the assets. Some banks wound up using their own liquidity to support financing vehicles that were no longer able to fund themselves on anything like the same terms and conditions as before the market turmoil began. And as banks made good on the implicit or explicit liquidity insurance they sold, they found themselves with larger balance sheets and less-robust capital cushions than they anticipated. As the banks' capital and liquidity cushions unexpectedly eroded, they became quite cautious about extending credit, a dramatic change from the more complacent attitudes of previous years.
Concentration risk is another familiar risk that is appearing in a new form. Banks have always had to worry about lending too much to one borrower, one industry, or one geographic region. But as smaller banks hold more of their balance sheet in types of loans that are difficult to securitize, concentration risks can develop. Concentrations of commercial real estate exposures are currently quite high at some smaller banks. This has the potential to make the banking sector much more sensitive to a downturn in the commercial real estate market.
The Private Sector Needs to Respond To
protect their capital and liquidity, banks and other financial market participants are addressing the weaknesses revealed by market developments by becoming much more careful about the risks they are taking. This is a necessary process, but it has been a difficult one as well; it is reducing the values of some assets and tightening credit cost and availability across a wide range of instruments and counterparties, despite considerable easing in the stance of monetary policy. It is this tightening that is accentuating the downside risks for the economy as a whole. And in some sectors, as lenders seek protection against perceived downside risks, it is probably going further than is necessary to foster financial stability in the long run. But we will end up with a safer, more robust financial system.
For banks, a safer and more robust financial system will be characterized by improved risk management that incorporates the lessons from the recent turmoil. Successful risk management looks comprehensively across business lines and is fully integrated into the decisionmaking of senior management. It identifies stresses and scenarios that might seem remote, but that could threaten safety and soundness. Banks' own self-interest clearly provides a strong incentive to improve risk management, but better risk management at the largest banks would benefit the broader financial system, too.
A more resilient financial system will also require banks to strengthen all aspects of the originate-to-distribute model. They need to pay more attention to origination, including when they are distributing credits they have not originated. And they need to ensure that when they distribute risks into the market with securitization, the risks really are distributed and will not come back onto their balance sheet later. If the credits end up in off-balance-sheet entities, banks need to pay more attention to the capital and liquidity impact of any residual claim these entities may have on the banks, even where that claim may arise through a desire to protect the bank's reputation rather than through any contractual obligation.
The structured credit products that are part of a safer banking system are likely to be simpler and more transparent. Recent experience has shown that more readily understood products would be in banks' own self-interest. Banks and investors must devote more effort to due diligence when investing in structured products, and they must avoid relying so heavily on credit rating agencies to do all their homework for them.
Banks must continue to focus on improving their management of counterparty risks. During the financial market disruptions surrounding the hedge fund Long-Term Capital Management almost 10 years ago, counterparty risk was a central concern. Subsequently, a private-sector group called the Counterparty Risk Management Policy Group developed a set of best practices for counterparty risk that greatly helped to set the tone for the needed improvements. These efforts do not appear to have been wasted, as attested to by the lack of serious losses from defaults of hedge fund counterparties in the recent turmoil. However, banks do not appear to have followed those best practices for their counterparty relationships with monoline financial guarantors, where counterparty risk has crystallized into large losses.
Banks must come to grips with the implications that their capital markets businesses have for liquidity risk management. While securitization can transform illiquid assets into more-liquid securities, risk managers must be more aware of the ways that securitization can become a drain on a bank's liquidity position in times of stress.
Smaller banks, too, need to improve aspects of their risk management. They should take steps to manage any portfolio concentrations that may arise because competition from securitization is less intense in certain market segments. When they do increase the share of their portfolio in a given market segment above historical levels, they must ensure that their risk-management processes and controls are commensurate with the level and complexity of their exposures.
All banks--large and small--need to consider whether they need greater capital cushions. The largest banks should consider whether their changing business model means that they need to hold more capital against some of the newer risks I discussed earlier. It is especially concerning that so many of these newer risks have arisen at the same time. Smaller banks must make sure their capital is sufficient to protect against the risk associated with the greater concentrations that have seemed to accompany the increased competition from securities markets.
Banks might find the current circumstances to be especially favorable for raising new capital. Not only would more capital provide a cushion against the sorts of unexpected declines in creditworthiness and asset values that have marked recent months, it would also position banks well for expansion. The safer, more resilient financial system that will emerge from this episode is likely to be characterized by a greater reliance on bank financing, as borrowers and lenders take on board the weaknesses that have become evident in securities markets. It also is likely to offer more generous compensation for risk-bearing. For banks with plenty of capital, that adjustment process is likely to present a chance to pick up business that, appropriately managed, will prove quite profitable over time.
I acknowledge that this is a formidable "to do" list for banks. But it has been a formidable episode of financial turbulence that has revealed major weaknesses in our financial system, including the business practices of many banks. And this episode has also left the regulators with many issues to consider.
The Federal Reserve and Other Regulators Need to RespondAt the Federal Reserve and at other bank regulatory agencies, our job is to reinforce the incentives and actions that are building a more resilient financial system. We need to make sure that regulatory minimum capital requirements and liquidity management plans protect reasonably well against shocks becoming systemic. Our supervisory guidance needs to be in place to prevent backsliding when, over the coming years, the memories and lessons of the current market turmoil fade, as they certainly will.
To these ends, we are reexamining a host of things ranging from Basel II to liquidity to transparency. Working with our domestic and international colleagues, we are looking to raise the Basel II capital requirements on specific exposures that have been troublesome, such as super senior CDOs of asset-backed securities and off-balance-sheet commitments. We are looking to the Basel Committee on Banking Supervision to update its guidance on liquidity management in light of the recent experience. And we and our supervisory colleagues are looking to require better disclosures of off-balance-sheet commitments and of valuations of complex structured products.
Threats to Financial Stability from Outside the Banking SystemIn the past, commercial banks and securities markets could be considered as separate channels for credit intermediation. One important implication of this was that if one channel for credit provision became impaired, the other would usually be functioning and able to insulate, to a degree, overall credit provision and the economy from financial sector shocks. For example, when the depository credit channel became impaired in the late 1980s and early 1990s, many borrowers were able to turn to liquid securities markets to meet a substantial portion of their needs for credit.
That isn't working in the current period of turmoil, and for the reasons inherent in our discussion so far. First, securities markets have become so large that commercial banks simply lack sufficient capital and balance sheet capacity to readily fill the gap when markets are impaired. We saw this initially in mortgage markets when the securitization of nonconforming mortgages seized up; banks stepped up to make more jumbo prime mortgages and hold them on their books, but the cost of such credit rose substantially, and the amount of lending was reduced.
Second, banks themselves are more dependent on well-functioning securities markets, and as that dependence and the important role of banks as ultimate providers of funding to those markets became clearer, pressures on banks mounted. So, in August, the turmoil crossed into the banking system when banks were challenged to backstop asset-backed commercial paper conduits and structured investment vehicles; under these circumstances, they were no longer comfortable fulfilling their traditional lending roles, and they tightened lending terms substantially, becoming part of the problem of credit availability, rather than a solution to it. In our more security-oriented intermediation systems, both commercial banks and security markets seem to be critical to the stability of the financial system and the economy.
Third, large commercial banks and investment banks have increasingly similar risk profiles, so that all are subject to the same risk-management challenges under the same circumstances. As the activities and risk profiles of large banks and securities firms have become increasingly similar, and as financial intermediation has run more through securities markets, we've certainly learned in the past month or so that it is not only commercial banks that can threaten financial stability.
So we must worry about excessive leverage and susceptibility to runs not only at banks but also at securities firms. To be sure, investment banks are still different in many ways from commercial banks. Among other things, their assets are mostly marketable and their borrowing mostly secured. Ordinarily, this should protect them from liquidity concerns. But we learned that short-term securities markets can suddenly seize up because of a loss of investor confidence, such as in the unusual circumstances building over the past six months or so. And investment banks had no safety net to discourage runs or to fall back on if runs occurred. Securities firms have been traditionally managed to a standard of surviving for one year without access to unsecured funding. The recent market turmoil has taught us that this is not adequate, because short-term secured funding, which these firms heavily rely upon, also can become impaired.
With many securities markets not functioning well, with the funding of investment banks threatened, and with commercial banks unable and unwilling to fill the gap, the Federal Reserve exercised emergency powers to extend the liquidity safety net of the discount window to the primary dealers.3 Our goal was to forestall substantial damage to the financial markets and the economy. Given the changes to financial markets and banking that we've been discussing this morning, a pressing public policy issue is what kind of liquidity backstop the central bank ought to supply to these institutions. And, assuming that some backstop is considered necessary because under some circumstances a run on an investment bank can threaten financial and economic stability, an associated issue is what sorts of regulations are required to make the financial system more resilient and to avoid excessive reliance on any such facility and the erosion of private-sector discipline.
I don't have ready answers to these difficult questions. It is evident that the balance of market discipline and regulation is in the process of being adjusted to the reality of how our financial system has evolved. In my remarks, I've stressed the need for both private and public actions to build a more resilient financial system. But we need to make adjustments in such a way as to preserve the benefits of highly innovative financial markets where many advances have enabled risks to be better diversified and credit more readily available to more people.
Whatever type of backstop is put in place, in my view greater regulatory attention will need to be devoted to the liquidity risk-management policies and practices of major investment banks. In particular, these firms will need to have robust contingency plans for situations in which their access to short-term secured funding also becomes impaired. Commercial banks should meet the same requirement. Implementation of such plans is likely to entail substitution of longer-term secured or unsecured financing for overnight secured financing. Because those longer-term funding sources will tend to be more costly, both investment banks and commercial banks are likely to conclude that it is more profitable to operate with less leverage than heretofore. No doubt their internalization of the costs of potential liquidity shocks will be costly to their shareholders, and a portion of the costs likely will be passed on to other borrowers and lenders. But a financial system with less leverage at its core will be a more stable and resilient system, and recent experience has driven home the very real costs of financial instability.
The Changing Business of Banking Even before the recent market turmoil, it was abundantly clear that the business of banking has changed quite significantly over the past several decades. The primary impetus for change has been intensified competitive pressures from the securities markets. Changes in technology (for example, the development and expansion of credit-scoring techniques) have allowed a larger share of credit extensions to households and businesses to be packaged in securities and sold to entities that often can fund the securities more cheaply than banks can fund loans. The effects probably have been greatest for the U.S. household sector.
Securitization of residential mortgages began in the 1970s; the share of outstanding mortgages that have been securitized grew fairly steadily throughout the 1980s and 1990s and has fluctuated between 50 and 60 percent since then. Nonmortgage consumer credit (credit card and installment debt) began to be securitized in the late 1980s, and in recent years more than 20 percent of the outstanding stock has been securitized. Until the summer of 2007, there was very strong demand for securitized credit from mutual funds, pension funds, and other institutional investors. Throughout that period, household wealth was rising rapidly, and, directly or indirectly, households were allocating an increasing share of their wealth to vehicles that were managed or advised by professional asset managers. At the same time, advances in the technology of modeling, pricing, and trading of risk over the past several decades gave added impetus to the migration of credit to securities markets.
Competition from the securities market has significantly affected all segments of banking, but the most dramatic changes have occurred at the very largest banks. One could say that their strategic response was, "If you can't beat them, join them." Freed from the constraints of the Glass-Steagall Act by incremental regulatory changes that were expanded and codified in the Gramm-Leach-Bliley Act of 1999, the very largest banking organizations have significantly increased their capital markets businesses, including arranging and underwriting securitizations, securities custody, prime brokerage, and both over-the-counter and exchange-traded derivatives. They have also made significant inroads into both traditional asset management and the management of hedge funds. Indeed, the largest commercial banks are now major competitors in many of the business lines that were historically viewed as the province of investment banks. Together, the very large commercial and investment banks have become indispensable to the efficiency and stability of the securities markets. For example, the $2 trillion hedge fund sector is critically dependent on a relatively small number of commercial and investment banks that serve as secured creditors and derivatives counterparties. And, as the financial market turmoil has revealed, banks provide liquidity support to various short-term financial markets, including the commercial paper market and markets for various types of tax-exempt debt.
Competition from securities markets has also affected smaller banks significantly, though less dramatically than larger banks. For example, the portfolio share of commercial real estate loans, which are not amenable to standardization and therefore are difficult to securitize, has increased markedly. Setting aside the 100 largest banks, the share of commercial real estate loans in bank loan portfolios nearly doubled over the past 10 years and is approaching 50 percent. The portfolio share at these banks of residential mortgage and other consumer loans, which are more readily securitized, fell by 20 percentage points over the same period.
The Implications for Financial Stability from the Recent Market Turmoil
The changing business of the largest commercial banks means that threats to financial stability do not necessarily come from traditional sources such as a deposit run or a deterioration in a bank's portfolio of business loans. The largest banks' capital markets businesses have given rise to new threats to financial stability. These threats stem from banks' securitization activity, from the complexity of banks' capital markets activity, and from the services that banks provide to the asset-management industry, including hedge funds. And risks that are more traditional to banking, such as liquidity risk and concentration risk, have appeared in new forms.
The securitization activity of the largest banks is often described as following an originate-to-distribute model. Chairman Bernanke described this model in some detail in a speech he gave last week in Richmond.2 In an originate-to-distribute model of banking, assets are originated to be packaged into securities, which are distributed broadly.
However, in the recent market turmoil, problems arose at both ends of the originate-to-distribute chain as it was being applied to subprime mortgages. The quality of subprime origination declined because of a serious erosion in underwriting standards at banks and especially at nonbanks. Underwriting standards for subprime mortgages fell as loans were increasingly made on the basis of expected increases in collateral value, without a careful evaluation of the borrower's ability to repay. Several years of rapidly rising house prices had reduced the delinquency rates on mortgages with historically high loan-to-value ratios, making these mortgages look less risky than they, in fact, turned out to be. As loan amounts rose relative to the value of properties, the performance of the subprime mortgage sector as a whole became sensitive to even small declines in house prices, with the distressing results that we have seen since house price growth decelerated beginning in 2006. A similar decline in underwriting standards occurred in other market segments, such as the market for leveraged loans, where banks increasingly originated loans with less-stringent covenants through the first half of last year. More generally, insufficient appreciation that economic conditions might not always be benign and that trading conditions in markets might not always be highly liquid led to an underpricing of both credit and liquidity risks.
At the other end of the originate-to-distribute chain, a good part of the risk associated with the securitization of subprime mortgages was not distributed into the market but was retained by banks. The most glaring example is their exposures to super senior tranches of collateralized debt obligations (CDOs) that had invested in subprime mortgage-backed securities. Super senior CDO tranches--the last to bear the costs of defaults on the underlying mortgages--were considered to be extremely safe investments, and little of the risk of these instruments was truly distributed into the market.
Three things hindered the distribution of super senior CDO risk. First, underwriters sold some of the risk to off-balance-sheet vehicles, but they also provided explicit or implicit liquidity backstops to the vehicles. Much of this risk came back onto banks' balance sheets when liquidity pressures emerged in the second half of last year. Second, underwriters chose to retain some of the super senior exposure, in some cases reportedly because they met some resistance when they attempted to sell them at very slim spreads. The underwriters evidently misjudged the risk of those positions, in some cases because they relied too heavily on external triple-A ratings. Third, underwriters hedged some of the risk with monoline financial guarantors. But some of the guarantors took on so much subprime-related risk that their financial condition had become highly correlated with the performance of the subprime mortgage sector, which has called into question the effectiveness of those hedges.
As I mentioned earlier, the growth of securitization is in large part a response to the growing demands of institutional investors for fixed-income securities. These investors clearly had a financial incentive to do better due diligence on the subprime risks they were taking on, but they largely failed to do so. We can only speculate as to why this was the case. I see three possibilities: First, they underestimated the potential for a nationwide decline in house prices; second, they relied on credit-rating agency analyses that have proven to be inadequate; or third, they simply misunderstood the risk of these often very complex securities.
The complexity of CDOs is one example of a widespread increase in the complexity of the capital market activities in which the largest banks now engage. Some banks' failure to adequately manage this complexity has weakened financial stability in the current market turmoil. CDOs and other structured credit products can be very complicated. Among the CDOs that invested in subprime mortgage-backed securities, it was common for a single CDO to own hundreds of different mortgage-backed securities, each with its own pool of underlying mortgage loans. Clearly, the valuation of such products and the measurement and hedging of the risks they entail are very complicated. Securities pools reduce idiosyncratic risk--the potential for problems particular to individual borrowers to have a material effect on overall values--but they are quite subject to systematic risk from broad-based macroeconomic developments that affect all loans at the same time. I believe it is fair to say that the creation of new, innovative financial products outstripped banks' risk-management capabilities. As I noted earlier, some banks that chose to hold super senior CDO securities did so because they trusted in an external triple-A credit rating. Because some banks did not fully understand all aspects of these exposures, once the risks crystallized last year in a weak house price environment, compounded by widespread liquidity pressures in many markets, banks had to scramble to measure and hedge these risks.
Another aspect of the changing business of banking with possible implications for financial stability is the growth of services that banks provide, including running their own asset-management businesses and providing prime brokerage services to hedge funds. Banks with asset-management businesses must manage the reputation risk that such businesses entail. Because institutional investors are naturally sensitive to the reputation of their asset managers, losses elsewhere in the bank can be compounded if they leave the bank's asset-management business exposed to a flight of business and a sharp reduction in fee income. An increase in the business that banks do with highly leveraged investors, like some hedge funds, leads to an increase in the attention that banks must pay to counterparty risk management.
Liquidity risk is a familiar risk to banks, but it has appeared in somewhat new forms recently. While the originate-to-distribute model aims to move exposures off of banks' balance sheets, the risk remains that a sudden closing of securitization markets can force a bank to hold and fund exposures that it had originated with the intent to distribute. And in many cases when banks did distribute exposures, they did so to various off-balance-sheet financing vehicles in which they retained contractual and reputational liquidity exposures. These vehicles, like banks themselves, were funding longer-term assets with short-term liabilities, and, like banks, they were subject to a run when their lenders became concerned about the quality of the assets. Some banks wound up using their own liquidity to support financing vehicles that were no longer able to fund themselves on anything like the same terms and conditions as before the market turmoil began. And as banks made good on the implicit or explicit liquidity insurance they sold, they found themselves with larger balance sheets and less-robust capital cushions than they anticipated. As the banks' capital and liquidity cushions unexpectedly eroded, they became quite cautious about extending credit, a dramatic change from the more complacent attitudes of previous years.
Concentration risk is another familiar risk that is appearing in a new form. Banks have always had to worry about lending too much to one borrower, one industry, or one geographic region. But as smaller banks hold more of their balance sheet in types of loans that are difficult to securitize, concentration risks can develop. Concentrations of commercial real estate exposures are currently quite high at some smaller banks. This has the potential to make the banking sector much more sensitive to a downturn in the commercial real estate market.
The Private Sector Needs to Respond To
protect their capital and liquidity, banks and other financial market participants are addressing the weaknesses revealed by market developments by becoming much more careful about the risks they are taking. This is a necessary process, but it has been a difficult one as well; it is reducing the values of some assets and tightening credit cost and availability across a wide range of instruments and counterparties, despite considerable easing in the stance of monetary policy. It is this tightening that is accentuating the downside risks for the economy as a whole. And in some sectors, as lenders seek protection against perceived downside risks, it is probably going further than is necessary to foster financial stability in the long run. But we will end up with a safer, more robust financial system.
For banks, a safer and more robust financial system will be characterized by improved risk management that incorporates the lessons from the recent turmoil. Successful risk management looks comprehensively across business lines and is fully integrated into the decisionmaking of senior management. It identifies stresses and scenarios that might seem remote, but that could threaten safety and soundness. Banks' own self-interest clearly provides a strong incentive to improve risk management, but better risk management at the largest banks would benefit the broader financial system, too.
A more resilient financial system will also require banks to strengthen all aspects of the originate-to-distribute model. They need to pay more attention to origination, including when they are distributing credits they have not originated. And they need to ensure that when they distribute risks into the market with securitization, the risks really are distributed and will not come back onto their balance sheet later. If the credits end up in off-balance-sheet entities, banks need to pay more attention to the capital and liquidity impact of any residual claim these entities may have on the banks, even where that claim may arise through a desire to protect the bank's reputation rather than through any contractual obligation.
The structured credit products that are part of a safer banking system are likely to be simpler and more transparent. Recent experience has shown that more readily understood products would be in banks' own self-interest. Banks and investors must devote more effort to due diligence when investing in structured products, and they must avoid relying so heavily on credit rating agencies to do all their homework for them.
Banks must continue to focus on improving their management of counterparty risks. During the financial market disruptions surrounding the hedge fund Long-Term Capital Management almost 10 years ago, counterparty risk was a central concern. Subsequently, a private-sector group called the Counterparty Risk Management Policy Group developed a set of best practices for counterparty risk that greatly helped to set the tone for the needed improvements. These efforts do not appear to have been wasted, as attested to by the lack of serious losses from defaults of hedge fund counterparties in the recent turmoil. However, banks do not appear to have followed those best practices for their counterparty relationships with monoline financial guarantors, where counterparty risk has crystallized into large losses.
Banks must come to grips with the implications that their capital markets businesses have for liquidity risk management. While securitization can transform illiquid assets into more-liquid securities, risk managers must be more aware of the ways that securitization can become a drain on a bank's liquidity position in times of stress.
Smaller banks, too, need to improve aspects of their risk management. They should take steps to manage any portfolio concentrations that may arise because competition from securitization is less intense in certain market segments. When they do increase the share of their portfolio in a given market segment above historical levels, they must ensure that their risk-management processes and controls are commensurate with the level and complexity of their exposures.
All banks--large and small--need to consider whether they need greater capital cushions. The largest banks should consider whether their changing business model means that they need to hold more capital against some of the newer risks I discussed earlier. It is especially concerning that so many of these newer risks have arisen at the same time. Smaller banks must make sure their capital is sufficient to protect against the risk associated with the greater concentrations that have seemed to accompany the increased competition from securities markets.
Banks might find the current circumstances to be especially favorable for raising new capital. Not only would more capital provide a cushion against the sorts of unexpected declines in creditworthiness and asset values that have marked recent months, it would also position banks well for expansion. The safer, more resilient financial system that will emerge from this episode is likely to be characterized by a greater reliance on bank financing, as borrowers and lenders take on board the weaknesses that have become evident in securities markets. It also is likely to offer more generous compensation for risk-bearing. For banks with plenty of capital, that adjustment process is likely to present a chance to pick up business that, appropriately managed, will prove quite profitable over time.
I acknowledge that this is a formidable "to do" list for banks. But it has been a formidable episode of financial turbulence that has revealed major weaknesses in our financial system, including the business practices of many banks. And this episode has also left the regulators with many issues to consider.
The Federal Reserve and Other Regulators Need to RespondAt the Federal Reserve and at other bank regulatory agencies, our job is to reinforce the incentives and actions that are building a more resilient financial system. We need to make sure that regulatory minimum capital requirements and liquidity management plans protect reasonably well against shocks becoming systemic. Our supervisory guidance needs to be in place to prevent backsliding when, over the coming years, the memories and lessons of the current market turmoil fade, as they certainly will.
To these ends, we are reexamining a host of things ranging from Basel II to liquidity to transparency. Working with our domestic and international colleagues, we are looking to raise the Basel II capital requirements on specific exposures that have been troublesome, such as super senior CDOs of asset-backed securities and off-balance-sheet commitments. We are looking to the Basel Committee on Banking Supervision to update its guidance on liquidity management in light of the recent experience. And we and our supervisory colleagues are looking to require better disclosures of off-balance-sheet commitments and of valuations of complex structured products.
Threats to Financial Stability from Outside the Banking SystemIn the past, commercial banks and securities markets could be considered as separate channels for credit intermediation. One important implication of this was that if one channel for credit provision became impaired, the other would usually be functioning and able to insulate, to a degree, overall credit provision and the economy from financial sector shocks. For example, when the depository credit channel became impaired in the late 1980s and early 1990s, many borrowers were able to turn to liquid securities markets to meet a substantial portion of their needs for credit.
That isn't working in the current period of turmoil, and for the reasons inherent in our discussion so far. First, securities markets have become so large that commercial banks simply lack sufficient capital and balance sheet capacity to readily fill the gap when markets are impaired. We saw this initially in mortgage markets when the securitization of nonconforming mortgages seized up; banks stepped up to make more jumbo prime mortgages and hold them on their books, but the cost of such credit rose substantially, and the amount of lending was reduced.
Second, banks themselves are more dependent on well-functioning securities markets, and as that dependence and the important role of banks as ultimate providers of funding to those markets became clearer, pressures on banks mounted. So, in August, the turmoil crossed into the banking system when banks were challenged to backstop asset-backed commercial paper conduits and structured investment vehicles; under these circumstances, they were no longer comfortable fulfilling their traditional lending roles, and they tightened lending terms substantially, becoming part of the problem of credit availability, rather than a solution to it. In our more security-oriented intermediation systems, both commercial banks and security markets seem to be critical to the stability of the financial system and the economy.
Third, large commercial banks and investment banks have increasingly similar risk profiles, so that all are subject to the same risk-management challenges under the same circumstances. As the activities and risk profiles of large banks and securities firms have become increasingly similar, and as financial intermediation has run more through securities markets, we've certainly learned in the past month or so that it is not only commercial banks that can threaten financial stability.
So we must worry about excessive leverage and susceptibility to runs not only at banks but also at securities firms. To be sure, investment banks are still different in many ways from commercial banks. Among other things, their assets are mostly marketable and their borrowing mostly secured. Ordinarily, this should protect them from liquidity concerns. But we learned that short-term securities markets can suddenly seize up because of a loss of investor confidence, such as in the unusual circumstances building over the past six months or so. And investment banks had no safety net to discourage runs or to fall back on if runs occurred. Securities firms have been traditionally managed to a standard of surviving for one year without access to unsecured funding. The recent market turmoil has taught us that this is not adequate, because short-term secured funding, which these firms heavily rely upon, also can become impaired.
With many securities markets not functioning well, with the funding of investment banks threatened, and with commercial banks unable and unwilling to fill the gap, the Federal Reserve exercised emergency powers to extend the liquidity safety net of the discount window to the primary dealers.3 Our goal was to forestall substantial damage to the financial markets and the economy. Given the changes to financial markets and banking that we've been discussing this morning, a pressing public policy issue is what kind of liquidity backstop the central bank ought to supply to these institutions. And, assuming that some backstop is considered necessary because under some circumstances a run on an investment bank can threaten financial and economic stability, an associated issue is what sorts of regulations are required to make the financial system more resilient and to avoid excessive reliance on any such facility and the erosion of private-sector discipline.
I don't have ready answers to these difficult questions. It is evident that the balance of market discipline and regulation is in the process of being adjusted to the reality of how our financial system has evolved. In my remarks, I've stressed the need for both private and public actions to build a more resilient financial system. But we need to make adjustments in such a way as to preserve the benefits of highly innovative financial markets where many advances have enabled risks to be better diversified and credit more readily available to more people.
Whatever type of backstop is put in place, in my view greater regulatory attention will need to be devoted to the liquidity risk-management policies and practices of major investment banks. In particular, these firms will need to have robust contingency plans for situations in which their access to short-term secured funding also becomes impaired. Commercial banks should meet the same requirement. Implementation of such plans is likely to entail substitution of longer-term secured or unsecured financing for overnight secured financing. Because those longer-term funding sources will tend to be more costly, both investment banks and commercial banks are likely to conclude that it is more profitable to operate with less leverage than heretofore. No doubt their internalization of the costs of potential liquidity shocks will be costly to their shareholders, and a portion of the costs likely will be passed on to other borrowers and lenders. But a financial system with less leverage at its core will be a more stable and resilient system, and recent experience has driven home the very real costs of financial instability.
China Bans Funds from Mid-Term Bonds
China's securities watchdog orderedthe nation's funds not to buy unsecured corporate debt maturingin more than a year that's traded in the interbank market,according to a document obtained by Bloomberg News.
The China Securities Regulatory Commission said in thedocument it needs more time to assess whether trading volumeswill be active enough for so-called medium-term corporate debt,after the central bank this month allowed the sales. The CSRC,which regulates funds' investments, didn't say whether banks,insurers and other corporations can still buy the debt.
The notes ``have relatively longer maturities and theirliquidity requires further evaluation,'' said the documentissued by the CSRC's Funds Supervisory Department on April 22.An official in the department, who asked not to be identified,confirmed the issuance of the document and declined to elaborate.
Global financial companies have been forced to makewritedowns after the collapse of trading in markets for commercial paper, collateralized debt obligation guarantees andmortgage-backed securities.
China's interbank debt turnover ratio, which measurestrading volume over outstanding amount, was 1.34 in 2007, said areport by the China Government Securities Depository Trust &Clearing Co., the nation's biggest debt clearing house. Thatcompares to an average turnover ratio of about 15 for the U.S.bond market, based on data on the Web site of the SecuritiesIndustry and Financial Markets Association.
Low Turnover
Commercial paper, offered by companies due in less than oneyear, traded at a 4.2 times ratio at the end of last year, themost liquid of all types of debt in China's interbank market.
The People's Bank of China, which regulates the nation'sinterbank market, issued a statement April 12 to allow companiesto offer interbank medium-term notes from April 25. Six agenciesor companies this week priced their first issues of three- andfive-year notes under the new rules. Issuers included China Ministry of Railway and China Minmetals Corp.
Previously, companies could only issue commercial paper andfunds can still buy that debt. The document added that furtherdecisions will be made after watching the sale and trading ofthe new financing tool.
The central bank also simplified the debt-issuance processfor companies by shifting its approval authority to registrationat the National Association of Financial Market InstitutionalInvestors, a trade group under its supervision.
Four government agencies control companies' debt sales,which are the CSRC, the central bank, the State-owned Assets Supervision and Administration Commission and the NationalDevelopment and Reform Commission.
The NDRC is the approver of so-called enterprise debt, orbonds issued by state-owned firms to fund infrastructureprojects. The SASAC said April 11 it must approve any bondissues by the 150 largest companies under its control, whichinclude China Mobile Communications Corp. and China NationalPetroleum Corp.
The China Securities Regulatory Commission said in thedocument it needs more time to assess whether trading volumeswill be active enough for so-called medium-term corporate debt,after the central bank this month allowed the sales. The CSRC,which regulates funds' investments, didn't say whether banks,insurers and other corporations can still buy the debt.
The notes ``have relatively longer maturities and theirliquidity requires further evaluation,'' said the documentissued by the CSRC's Funds Supervisory Department on April 22.An official in the department, who asked not to be identified,confirmed the issuance of the document and declined to elaborate.
Global financial companies have been forced to makewritedowns after the collapse of trading in markets for commercial paper, collateralized debt obligation guarantees andmortgage-backed securities.
China's interbank debt turnover ratio, which measurestrading volume over outstanding amount, was 1.34 in 2007, said areport by the China Government Securities Depository Trust &Clearing Co., the nation's biggest debt clearing house. Thatcompares to an average turnover ratio of about 15 for the U.S.bond market, based on data on the Web site of the SecuritiesIndustry and Financial Markets Association.
Low Turnover
Commercial paper, offered by companies due in less than oneyear, traded at a 4.2 times ratio at the end of last year, themost liquid of all types of debt in China's interbank market.
The People's Bank of China, which regulates the nation'sinterbank market, issued a statement April 12 to allow companiesto offer interbank medium-term notes from April 25. Six agenciesor companies this week priced their first issues of three- andfive-year notes under the new rules. Issuers included China Ministry of Railway and China Minmetals Corp.
Previously, companies could only issue commercial paper andfunds can still buy that debt. The document added that furtherdecisions will be made after watching the sale and trading ofthe new financing tool.
The central bank also simplified the debt-issuance processfor companies by shifting its approval authority to registrationat the National Association of Financial Market InstitutionalInvestors, a trade group under its supervision.
Four government agencies control companies' debt sales,which are the CSRC, the central bank, the State-owned Assets Supervision and Administration Commission and the NationalDevelopment and Reform Commission.
The NDRC is the approver of so-called enterprise debt, orbonds issued by state-owned firms to fund infrastructureprojects. The SASAC said April 11 it must approve any bondissues by the 150 largest companies under its control, whichinclude China Mobile Communications Corp. and China NationalPetroleum Corp.
Street Seeks Credit-Default Safety Net
More than a dozen firms including investment banks, brokerage firms and futures exchanges are accelerating efforts to create a clearing entity that would function as the middleman between firms on both sides of a credit-default swap. The clearinghouse would guarantee payment on the contracts it handles, reducing the risk of a catastrophic ripple effect if one or more firms were unable to make good on their trades.
Behind the push is growing worry about the runaway popularity of credit derivatives. The volume of credit-default swaps, which are private financial contracts that act as a form of insurance against bond and loan defaults, has surged to new highs. But last month's near collapse of Bear Stearns Cos. underscored the vulnerability of other firms that had trades with the Wall Street firm.
Plans call for the credit-default-swaps clearinghouse to be operated by Clearing Corp., a Chicago futures-clearing firm that is backed by Goldman Sachs Group Inc., Citigroup Inc., J.P. Morgan Chase & Co., Deutsche Bank AG, German-Swiss futures exchange Eurex AG and other financial-services firms. The project is likely to be launched in the second half of 2008.
Supporters say the operation would back the obligations of credit-default swaps, standing between dealers in such trades, just as clearinghouses now do for a wide variety of other investments. The behind-the-scenes clearing business is a lucrative and fast-growing area of Wall Street, especially for exchange operators.
Regulators also believe that a "central counterparty" could reduce the risk of a financial epidemic triggered by problems at one financial institution. Barclays Capital earlier this year estimated the failure of a major credit-derivatives player could lead to losses of $36 billion to $47 billion across the financial system.
But the inherent lack of transparency in the largely unregulated credit-derivatives market could make the task difficult. Unlike the stock, futures and options markets, where market prices of securities and contracts are widely available, credit-default swaps trade "over the counter" -- or away from exchanges -- and prices can vary from firm to firm.
Hoping to overcome the pricing problems, Clearing Corp. is working with Markit Group, which collects credit-default-swap prices from multiple firms. It also plans to initially clear trades for indexes of credit-default swaps, which have terms that are more standardized than swaps on individual bonds.
"We are intent on maintaining a vibrant over-the-counter market for credit-default swaps," says Athanassios Diplas, chief risk officer for global credit trading at Deutsche Bank.
Under the Clearing Corp. plan, participating dealers would each put money in a fund to help cover trading losses if any one firm fails. To protect itself, the clearinghouse will require margin from each firm and could request more collateral based on market moves. Industry participants have been working on the plan for about a year and hope to hammer out details in time to clear trades this year.
For most of its history, Clearing Corp. cleared Treasury and other futures contracts for the Chicago Board of Trade. It lost that business in 2003 when CBOT moved its clearing to the Chicago Mercantile Exchange.
Clearing Corp. has since expanded from exchange-listed futures to the over-the-counter market. Last year, it restructured its shareholder base, adding some holders that specialize in over-the-counter trading.
Meanwhile, CME Group Inc., which now owns the Chicago Merc and the Chicago Board of Trade, also wants to expand into the bigger over-the-counter market. In March, it bought Credit Market Analysis Ltd., a credit-derivatives-data provider. "We view that as an entree" into credit-derivatives trading or clearing, says Craig Donohue, the exchange company's CEO.
Behind the push is growing worry about the runaway popularity of credit derivatives. The volume of credit-default swaps, which are private financial contracts that act as a form of insurance against bond and loan defaults, has surged to new highs. But last month's near collapse of Bear Stearns Cos. underscored the vulnerability of other firms that had trades with the Wall Street firm.
Plans call for the credit-default-swaps clearinghouse to be operated by Clearing Corp., a Chicago futures-clearing firm that is backed by Goldman Sachs Group Inc., Citigroup Inc., J.P. Morgan Chase & Co., Deutsche Bank AG, German-Swiss futures exchange Eurex AG and other financial-services firms. The project is likely to be launched in the second half of 2008.
Supporters say the operation would back the obligations of credit-default swaps, standing between dealers in such trades, just as clearinghouses now do for a wide variety of other investments. The behind-the-scenes clearing business is a lucrative and fast-growing area of Wall Street, especially for exchange operators.
Regulators also believe that a "central counterparty" could reduce the risk of a financial epidemic triggered by problems at one financial institution. Barclays Capital earlier this year estimated the failure of a major credit-derivatives player could lead to losses of $36 billion to $47 billion across the financial system.
But the inherent lack of transparency in the largely unregulated credit-derivatives market could make the task difficult. Unlike the stock, futures and options markets, where market prices of securities and contracts are widely available, credit-default swaps trade "over the counter" -- or away from exchanges -- and prices can vary from firm to firm.
Hoping to overcome the pricing problems, Clearing Corp. is working with Markit Group, which collects credit-default-swap prices from multiple firms. It also plans to initially clear trades for indexes of credit-default swaps, which have terms that are more standardized than swaps on individual bonds.
"We are intent on maintaining a vibrant over-the-counter market for credit-default swaps," says Athanassios Diplas, chief risk officer for global credit trading at Deutsche Bank.
Under the Clearing Corp. plan, participating dealers would each put money in a fund to help cover trading losses if any one firm fails. To protect itself, the clearinghouse will require margin from each firm and could request more collateral based on market moves. Industry participants have been working on the plan for about a year and hope to hammer out details in time to clear trades this year.
For most of its history, Clearing Corp. cleared Treasury and other futures contracts for the Chicago Board of Trade. It lost that business in 2003 when CBOT moved its clearing to the Chicago Mercantile Exchange.
Clearing Corp. has since expanded from exchange-listed futures to the over-the-counter market. Last year, it restructured its shareholder base, adding some holders that specialize in over-the-counter trading.
Meanwhile, CME Group Inc., which now owns the Chicago Merc and the Chicago Board of Trade, also wants to expand into the bigger over-the-counter market. In March, it bought Credit Market Analysis Ltd., a credit-derivatives-data provider. "We view that as an entree" into credit-derivatives trading or clearing, says Craig Donohue, the exchange company's CEO.
Soaring Food Cost, To Be Boosted Minimum Wages, and Sagging Consumer Spending Rattled Restaurant Business
The $558 billion restaurant industry is hitting rough times, squeezed by many of the same woes affecting other sectors of the economy: tightfisted consumers, scarce credit and surging commodity prices. Adding to the pressure is a big jump in the minimum wage starting this summer, which will boost wages by 12% in some states.
That's sent the industry into its worst slump in decades. Many chains have scaled back expansion plans or cut costs by skimping on things like extra sauce and free sour cream. Some are shuttering sites and laying off workers. Private-equity firms, which plunged into the business earlier this decade using gobs of borrowed money, are now especially vulnerable as those debts come due.
This week's earnings results, despite some glimmers of good news, paint a sobering picture. McDonald's Corp., the world's largest restaurant chain, saw U.S. sales at restaurants open at least 13 months fall 0.8% in March, the first decline in monthly same-store sales in five years. Brinker International Inc., parent of Chili's, says it lost $38.8 million in its latest quarter. Analysts expect that when Cheesecake Factory Inc. reports first-quarter earnings on Thursday, same-store sales will have dipped and profit will have been pressured by spikes in the cost of dairy products, a key component of the chain's 30 cheesecakes. Restaurants will be watching closely next week, when the first government tax-rebate checks go out, hoping people use that cash to eat out.
The slowdown has broad implications for the economy. The industry employs 13.1 million people, making it the nation's third-largest employer, behind the U.S. government and the health-care industry, according to the National Restaurant Association, a trade group. Many of those jobs are held by the poor and immigrants who have few other options for work.
Vicorp and Buffets Holdings Inc., which owns the Ryan's Steakhouse chain and filed for bankruptcy-court protection in January, together are closing about 110 restaurants and cutting 4,300 jobs. Both companies say more cuts could be in the offing.
For consumers, the closing of their neighborhood restaurants may be one of the most visible signs of a slowing economy. The chains anchor strip malls and highway exits, busy street corners and suburban downtowns. Trying to ingratiate themselves with the community, many restaurants fill their lobbies with local high-school pennants and yearbook photos or sponsor little-league teams.
Moody's Investors Service has downgraded seven prominent national and regional chains, including Landry's Restaurants and the parent of Pizzeria Uno, to its lowest liquidity rating -- the most restaurants to be given this rating at once since it was created in 2002. One in five companies that winds up on this list ultimately defaults. Representatives for Landry's and Pizzeria Uno declined to comment.
That's sent the industry into its worst slump in decades. Many chains have scaled back expansion plans or cut costs by skimping on things like extra sauce and free sour cream. Some are shuttering sites and laying off workers. Private-equity firms, which plunged into the business earlier this decade using gobs of borrowed money, are now especially vulnerable as those debts come due.
This week's earnings results, despite some glimmers of good news, paint a sobering picture. McDonald's Corp., the world's largest restaurant chain, saw U.S. sales at restaurants open at least 13 months fall 0.8% in March, the first decline in monthly same-store sales in five years. Brinker International Inc., parent of Chili's, says it lost $38.8 million in its latest quarter. Analysts expect that when Cheesecake Factory Inc. reports first-quarter earnings on Thursday, same-store sales will have dipped and profit will have been pressured by spikes in the cost of dairy products, a key component of the chain's 30 cheesecakes. Restaurants will be watching closely next week, when the first government tax-rebate checks go out, hoping people use that cash to eat out.
The slowdown has broad implications for the economy. The industry employs 13.1 million people, making it the nation's third-largest employer, behind the U.S. government and the health-care industry, according to the National Restaurant Association, a trade group. Many of those jobs are held by the poor and immigrants who have few other options for work.
Vicorp and Buffets Holdings Inc., which owns the Ryan's Steakhouse chain and filed for bankruptcy-court protection in January, together are closing about 110 restaurants and cutting 4,300 jobs. Both companies say more cuts could be in the offing.
For consumers, the closing of their neighborhood restaurants may be one of the most visible signs of a slowing economy. The chains anchor strip malls and highway exits, busy street corners and suburban downtowns. Trying to ingratiate themselves with the community, many restaurants fill their lobbies with local high-school pennants and yearbook photos or sponsor little-league teams.
Moody's Investors Service has downgraded seven prominent national and regional chains, including Landry's Restaurants and the parent of Pizzeria Uno, to its lowest liquidity rating -- the most restaurants to be given this rating at once since it was created in 2002. One in five companies that winds up on this list ultimately defaults. Representatives for Landry's and Pizzeria Uno declined to comment.
Wednesday, April 23, 2008
New Tax Law Allow Companies to Carry Back Mortgage Loans Losses
The Internal Revenue Service withdrew proposed regulationsthat had asserted that mortgage loans are capital assets and anylosses from them could be used only to offset capital gains. Theagency also said it wouldn't challenge companies that count suchlosses against ordinary income.
Tax law generally allows companies to ``carry back'' losses realized this year to previous years and get a refund for earlier taxes paid or apply them to later years, known as a ``carryforward'' to reduce future liability. Carry backs currently are limited to two years; the Senate legislation would temporarily expand that to four. A House panel passed a separate relief measure that doesn't contain the provision.
Tax law generally allows companies to ``carry back'' losses realized this year to previous years and get a refund for earlier taxes paid or apply them to later years, known as a ``carryforward'' to reduce future liability. Carry backs currently are limited to two years; the Senate legislation would temporarily expand that to four. A House panel passed a separate relief measure that doesn't contain the provision.
International Banks in China
Goldman Sachs Group and UBS AG are currently the only two major global investment banks with the ability to underwrite shares on China's domestic markets. Beijing agreed late last year to reopen the market to new ventures and at least three global banks are at various stages of applying to form new ventures. These include Citigroup Inc., Credit Suisse Group and Morgan Stanley, which has long had little say in how CICC operates. It wants to sell its 34.3% stake in CICC to enter a new venture in which it will have greater control, although that process for the sale has stalled.
Libor Hits US Borrowers
The troubles of banks in Europe are pushing up an interest rate widely used in the U.S., prompting the idea of a U.S.-based alternative to that rate, known as the London interbank offered rate, or Libor.
The problem: Payments on trillions of dollars in U.S. corporate and mortgage loans are set according to dollar Libor, but only three of the 16 banks that contribute their borrowing costs to calculate the rate are based in the U.S. That means the financial difficulties of European banks are having an outsized effect on U.S. borrowing costs, and could complicate the Federal Reserve's efforts to bring those borrowing costs down.
A significant gap between borrowing rates reported by European and U.S. banks has opened up since last week, when many banks started raising their reported Libor rates. The banks' moves came as the British Bankers' Association, which oversees Libor, said it was investigating bankers' concerns that their rivals were understating their actual borrowing costs to avoid looking desperate for cash.
On Friday, the gap between three-month dollar Libor and the average three-month borrowing rates for U.S. banks in the 16-bank Libor dollar panel reached 0.04 percentage point, its highest level since the financial crisis began in August. If sustained, that would represent an added $2.8 billion in annual interest costs on some $6.9 trillion in U.S. corporate and subprime-mortgage debt tied to Libor. It has since fallen, but analysts said it ultimately could increase to 0.10 percentage point as European banks' difficulties become fully reflected in their Libor quotes.
Analysts attribute the sharper rise in European banks' borrowing rates to the fact that they're scrambling for dollars to pay off dollar-denominated debts. Pressure is particularly acute in Europe in part because it lacks analogs to such U.S. institutions as Fannie Mae, Freddie Mac and the Federal Home Loan Banks, which provide U.S. banks with access to additional funding.
The problem: Payments on trillions of dollars in U.S. corporate and mortgage loans are set according to dollar Libor, but only three of the 16 banks that contribute their borrowing costs to calculate the rate are based in the U.S. That means the financial difficulties of European banks are having an outsized effect on U.S. borrowing costs, and could complicate the Federal Reserve's efforts to bring those borrowing costs down.
A significant gap between borrowing rates reported by European and U.S. banks has opened up since last week, when many banks started raising their reported Libor rates. The banks' moves came as the British Bankers' Association, which oversees Libor, said it was investigating bankers' concerns that their rivals were understating their actual borrowing costs to avoid looking desperate for cash.
On Friday, the gap between three-month dollar Libor and the average three-month borrowing rates for U.S. banks in the 16-bank Libor dollar panel reached 0.04 percentage point, its highest level since the financial crisis began in August. If sustained, that would represent an added $2.8 billion in annual interest costs on some $6.9 trillion in U.S. corporate and subprime-mortgage debt tied to Libor. It has since fallen, but analysts said it ultimately could increase to 0.10 percentage point as European banks' difficulties become fully reflected in their Libor quotes.
Analysts attribute the sharper rise in European banks' borrowing rates to the fact that they're scrambling for dollars to pay off dollar-denominated debts. Pressure is particularly acute in Europe in part because it lacks analogs to such U.S. institutions as Fannie Mae, Freddie Mac and the Federal Home Loan Banks, which provide U.S. banks with access to additional funding.
Tuesday, April 22, 2008
Chian Cut Short Term Foreign Currency Loans to Reduce Hot Money
China ordered foreign and localbanks to rein in overseas borrowings in a bid to curbspeculative capital inflows, a document obtained by BloombergNews showed.
Overseas loans with a maturity of less than a year will belimited to $12.7 billion by June for 23 foreign banks and to $8billion for 19 local banks, the State Administration of ForeignExchange, or SAFE, document showed. That's a reduction of 15percent for global lenders from the March-end levels, and 5percent for domestic lenders, said Xu Hanfei, an analyst atIndustrial Bank Co. in Shanghai. The new quotas are validthrough March 31, 2009.
China's foreign-exchange reserves rose to a record $1.68trillion at the end of March, the central bank said on April 11,fueling concerns that inflows of speculative capital will hamperthe government's efforts to damp inflation close to the fastestin 11 years.
``Growth in foreign-exchange lending exceeded that of yuanloans from last year,'' said Li Huiyong, a foreign-exchange analyst at Shenyin Wanguo Research and Consulting Co. inShanghai. ``Short-term lending is one of the channels forinflows of so-called hot-money.'' A SAFE official said he was aware of the document, butwouldn't make further comments.
Premier Wen Jiabao said last month that the government'stop priorities this year are curbing inflation and preventingeconomic overheating. The central bank has ordered lenders toset aside larger reserves three times this year, following sixinterest-rate increases in 2007. Inflation surged to 8.3 percentin March, little changed from 8.7 percent in March.
``Investors borrow dollars from banks and convert them intothe Chinese yuan,'' said Wang Qian, economist at JPMorgan Chase& Co. in Hong Kong. ``Even a simple deposit of the currencywould give them a nice return on investment.''
SAFE said in March last year that it would cut local banks'short-term foreign debt quotas to 30 percent of their 2006levels by March 2008 to stem foreign-currency inflows.
Overseasfinancial institutions' short-term foreign debt quotas were cut``by a relatively small margin'' because of their limitedfunding sources, it said then, without giving details.
Outstanding foreign-currency loans surged 56.9 percent froma year earlier to $268.8 billion at the end of March, accordingto central bank data. Outstanding short-term debt increased19.85 percent to $220 billion at the end of 2007 from a yearearlier, accounting for 58.9 percent of the total foreign debt, according to government data.
Overseas loans with a maturity of less than a year will belimited to $12.7 billion by June for 23 foreign banks and to $8billion for 19 local banks, the State Administration of ForeignExchange, or SAFE, document showed. That's a reduction of 15percent for global lenders from the March-end levels, and 5percent for domestic lenders, said Xu Hanfei, an analyst atIndustrial Bank Co. in Shanghai. The new quotas are validthrough March 31, 2009.
China's foreign-exchange reserves rose to a record $1.68trillion at the end of March, the central bank said on April 11,fueling concerns that inflows of speculative capital will hamperthe government's efforts to damp inflation close to the fastestin 11 years.
``Growth in foreign-exchange lending exceeded that of yuanloans from last year,'' said Li Huiyong, a foreign-exchange analyst at Shenyin Wanguo Research and Consulting Co. inShanghai. ``Short-term lending is one of the channels forinflows of so-called hot-money.'' A SAFE official said he was aware of the document, butwouldn't make further comments.
Premier Wen Jiabao said last month that the government'stop priorities this year are curbing inflation and preventingeconomic overheating. The central bank has ordered lenders toset aside larger reserves three times this year, following sixinterest-rate increases in 2007. Inflation surged to 8.3 percentin March, little changed from 8.7 percent in March.
``Investors borrow dollars from banks and convert them intothe Chinese yuan,'' said Wang Qian, economist at JPMorgan Chase& Co. in Hong Kong. ``Even a simple deposit of the currencywould give them a nice return on investment.''
SAFE said in March last year that it would cut local banks'short-term foreign debt quotas to 30 percent of their 2006levels by March 2008 to stem foreign-currency inflows.
Overseasfinancial institutions' short-term foreign debt quotas were cut``by a relatively small margin'' because of their limitedfunding sources, it said then, without giving details.
Outstanding foreign-currency loans surged 56.9 percent froma year earlier to $268.8 billion at the end of March, accordingto central bank data. Outstanding short-term debt increased19.85 percent to $220 billion at the end of 2007 from a yearearlier, accounting for 58.9 percent of the total foreign debt, according to government data.
Japan Banks Return to Global Stage After A Decode and A Half of Retrenchment
Japan's big banks are quietly expanding their lending business in the global market as many U.S. and European banks, facing mounting losses from the credit crisis, begin to tighten their spigots.
Thanks to their conservative styles adopted after their long struggle with bad loans in the 1990s and the early part of this decade, Japanese banks such as Mitsubishi UFJ Financial Group Inc., known as MUFG, and Sumitomo Mitsui Financial Group Inc., known as SMFG, have posted relatively narrow losses from securities affected by the U.S. mortgage problems. Now the banks, armed with huge assets gathered from Japanese savers, are turning this situation into an opportunity to become powerful suppliers of loans to fund costly acquisitions and infrastructure projects around the world.
At Bank of Tokyo-Mitsubishi UFJ Ltd., the primary banking unit of MUFG, Japan's largest bank by both assets and market value, the balance of overseas lending jumped by roughly 20% in the last quarter of 2007 to 12 trillion yen, or about $115 billion, and has continued to grow this year. In March, it and Mizuho Financial Group Inc. were among the eight arrangers for a $3 billion loan taken out by India's Tata Motors Ltd. to pay for its acquisition of Ford Motor Co.'s Jaguar and Land Rover brands, according to people familiar with the deal.
While MUFG and other Japanese banks are still far behind their Western peers in areas like investment banking, their growing presence in the loan market marks an important step forward as these banks slowly try to return to the global stage after a decade and a half of retrenchment. During Japan's asset boom in 1980s, these banks stirred fear among their Western rivals with splashy deals such as the acquisition of Union Bank of California by one of the predecessor banks of MUFG, and the purchase of a major stake in Goldman Sachs Group by one of SMFG's predecessors.
But they were forced to spend the 1990s and the early part of this decade coping with their domestic bad-loan problems. During the past few years, the big banks have regained their financial health and seen their earnings grow. Yet their focus has been building domestic businesses in areas like wealth management and credit cards.
The market turmoil has given Japanese banks a sudden edge in the world's loan market. While subprime-related losses forced big Western banks such as Citigroup and UBS AG to shrink their operations and raise money to mend their depleted capital basis, Japanese banks have remained awash with funds thanks to the nation's investors, many of whom prefer keeping money in bank deposits, rather than investing in stocks or bonds.
Thanks to their conservative styles adopted after their long struggle with bad loans in the 1990s and the early part of this decade, Japanese banks such as Mitsubishi UFJ Financial Group Inc., known as MUFG, and Sumitomo Mitsui Financial Group Inc., known as SMFG, have posted relatively narrow losses from securities affected by the U.S. mortgage problems. Now the banks, armed with huge assets gathered from Japanese savers, are turning this situation into an opportunity to become powerful suppliers of loans to fund costly acquisitions and infrastructure projects around the world.
At Bank of Tokyo-Mitsubishi UFJ Ltd., the primary banking unit of MUFG, Japan's largest bank by both assets and market value, the balance of overseas lending jumped by roughly 20% in the last quarter of 2007 to 12 trillion yen, or about $115 billion, and has continued to grow this year. In March, it and Mizuho Financial Group Inc. were among the eight arrangers for a $3 billion loan taken out by India's Tata Motors Ltd. to pay for its acquisition of Ford Motor Co.'s Jaguar and Land Rover brands, according to people familiar with the deal.
While MUFG and other Japanese banks are still far behind their Western peers in areas like investment banking, their growing presence in the loan market marks an important step forward as these banks slowly try to return to the global stage after a decade and a half of retrenchment. During Japan's asset boom in 1980s, these banks stirred fear among their Western rivals with splashy deals such as the acquisition of Union Bank of California by one of the predecessor banks of MUFG, and the purchase of a major stake in Goldman Sachs Group by one of SMFG's predecessors.
But they were forced to spend the 1990s and the early part of this decade coping with their domestic bad-loan problems. During the past few years, the big banks have regained their financial health and seen their earnings grow. Yet their focus has been building domestic businesses in areas like wealth management and credit cards.
The market turmoil has given Japanese banks a sudden edge in the world's loan market. While subprime-related losses forced big Western banks such as Citigroup and UBS AG to shrink their operations and raise money to mend their depleted capital basis, Japanese banks have remained awash with funds thanks to the nation's investors, many of whom prefer keeping money in bank deposits, rather than investing in stocks or bonds.
Fed need give more leeway to PE to bail out banks
In the case of National City, this was accomplished in ways that would have been virtually impossible during the savings-and-loan crisis of the late 1980s and early 1990s. Not only were private-equity funds such as Kohlberg Kravis Roberts and Warburg Pincus examining the books, but hedge funds and mutual funds were "brought over the wall" and given access to National City's confidential records.
Once "wallcrossed" as they say on Wall Street, these potential buyers were able to move very quickly to shore up National City's gaping capital hole.
Would this breadth and speed been available in the last crisis? Absolutely not, say people involved in the NatCity deal. In these unsettling months of crisis, that should be some reason for hope.
It shouldn't be blind hope. There's no guarantee that the capital will be there for the next round of infusions.
Here the government might make a difference. The first step would be to give private-equity firms more leeway in exerting control over a bank investment. Today they're largely limited to 9.9% stakes. The second would be a more controversial change of the accounting rules for bank acquisitions. When a bank acquires another, it has to take an immediate write-down on the value of bad loans, as opposed to writing them down over time.
That rule means that healthy banks acquiring bad banks have to come up with a huge chunk of new capital. That was the primary reason why the likes of KeyCorp and Fifth Third Bancorp steered way clear of National City last week. It was also why banks were begging the Fed for a backstop on National City's bad loans.
Luckily, the Fed's mettle wasn't tested. But eventually it will be. And when it is, take comfort in an old European saying that has already been proven: Planned disasters never happen.
Once "wallcrossed" as they say on Wall Street, these potential buyers were able to move very quickly to shore up National City's gaping capital hole.
Would this breadth and speed been available in the last crisis? Absolutely not, say people involved in the NatCity deal. In these unsettling months of crisis, that should be some reason for hope.
It shouldn't be blind hope. There's no guarantee that the capital will be there for the next round of infusions.
Here the government might make a difference. The first step would be to give private-equity firms more leeway in exerting control over a bank investment. Today they're largely limited to 9.9% stakes. The second would be a more controversial change of the accounting rules for bank acquisitions. When a bank acquires another, it has to take an immediate write-down on the value of bad loans, as opposed to writing them down over time.
That rule means that healthy banks acquiring bad banks have to come up with a huge chunk of new capital. That was the primary reason why the likes of KeyCorp and Fifth Third Bancorp steered way clear of National City last week. It was also why banks were begging the Fed for a backstop on National City's bad loans.
Luckily, the Fed's mettle wasn't tested. But eventually it will be. And when it is, take comfort in an old European saying that has already been proven: Planned disasters never happen.
Private Equity Snapp up Ailing Banks
Cleveland-based National City Corp.'s announcement Monday that it is getting $7 billion in capital to shore up its balance sheet is the latest sign that private-equity firms think there is big money to be made by investing in banks pummeled by bad loans and the economy.
Private-equity firms raised about $550 billion of capital in 2007, adding roughly $150 billion more in the first quarter of 2008, according to data provider Private Equity Intelligence Ltd. The biggest firms have raised staggering amounts of capital, with KKR recently closing on a $17.6 billion fund and Blackstone amassing a $21.7 billion fund last year.
Snapping up stakes in ailing banks represents a shift away from the big deals of recent years in which private-equity firms dominated the merger boom with a string of blockbusters. The credit crunch has shut down financing markets for leveraged buyouts, leaving the funds flush with cash.
The recent bank deals are different than the traditional deals that private-equity firms typically hunt down. For example, private-equity players are minority shareholders in the banks, potentially limiting the sway that they can hold over management and strategic direction. The reason: Regulators don't permit nonbank investors to take a voting stake of greater than 9.9% in a bank. In most LBOs, private-equity firms buy the entire company, load it up with debt, and slash costs before taking it public or selling it to other investors.
At smaller banks, private-equity firms are likely to increasingly use "special purpose acquisition companies" -- or SPACs -- to invest, says Gerard Comizio, a partner at law firm Paul Hastings Janofsky & Walker LLP. These so-called "blank check companies" raise money from public investors and then are free to use those funds to buy companies.
There are 71 SPACs in the market for deals, and many are eyeing banks and other financial institutions, says Melissa Roberts, a vice president of quantitative research at Keefe, Bruyette & Woods.
Private-equity firms raised about $550 billion of capital in 2007, adding roughly $150 billion more in the first quarter of 2008, according to data provider Private Equity Intelligence Ltd. The biggest firms have raised staggering amounts of capital, with KKR recently closing on a $17.6 billion fund and Blackstone amassing a $21.7 billion fund last year.
Snapping up stakes in ailing banks represents a shift away from the big deals of recent years in which private-equity firms dominated the merger boom with a string of blockbusters. The credit crunch has shut down financing markets for leveraged buyouts, leaving the funds flush with cash.
The recent bank deals are different than the traditional deals that private-equity firms typically hunt down. For example, private-equity players are minority shareholders in the banks, potentially limiting the sway that they can hold over management and strategic direction. The reason: Regulators don't permit nonbank investors to take a voting stake of greater than 9.9% in a bank. In most LBOs, private-equity firms buy the entire company, load it up with debt, and slash costs before taking it public or selling it to other investors.
At smaller banks, private-equity firms are likely to increasingly use "special purpose acquisition companies" -- or SPACs -- to invest, says Gerard Comizio, a partner at law firm Paul Hastings Janofsky & Walker LLP. These so-called "blank check companies" raise money from public investors and then are free to use those funds to buy companies.
There are 71 SPACs in the market for deals, and many are eyeing banks and other financial institutions, says Melissa Roberts, a vice president of quantitative research at Keefe, Bruyette & Woods.
Monday, April 21, 2008
Bank of America Q1 08
Overall
--earnings declined to $1.21 billion from $5.26 billion a year earlier
--The primary factors reducing first-quarter earnings were the following:
• Provision expense increased by $4.78 billion from a year-ago, to $6.01 billion due to rising credit costs – particularly in the home equity, small business and homebuilder portfolios – including a $3.30 billion increase to the reserve.
• Trading-related losses were $1.31 billion compared with income of $1.66 billion a year earlier, driven primarily by $1.47 billion in writedowns of collateralized debt obligations (CDOs) and $439 million in writedowns of leveraged loans. Trading-related losses were $5.15 billion in the fourth quarter of 2007, which included CDO-related writedowns of $5.28 billion.
Credit
--net charge off 2.7 bil (1.25% of avg loan), 1.4 bil (0.81%) Q1 07 (Q4 07 national net charge off 0.83%)
--allowance 14.9 bil(1.71 of total loan), 8.7 bil (1.2%) (1.29 Q4 07 national) --> conservative allowance
--non performing 7.8 bil (0.9% of loan) (1.4 Q4 07 national) -> lower than national, relative higher quality loans
--Tier 1 capital 7.51%, 8.57% Q1 07
--earnings declined to $1.21 billion from $5.26 billion a year earlier
--The primary factors reducing first-quarter earnings were the following:
• Provision expense increased by $4.78 billion from a year-ago, to $6.01 billion due to rising credit costs – particularly in the home equity, small business and homebuilder portfolios – including a $3.30 billion increase to the reserve.
• Trading-related losses were $1.31 billion compared with income of $1.66 billion a year earlier, driven primarily by $1.47 billion in writedowns of collateralized debt obligations (CDOs) and $439 million in writedowns of leveraged loans. Trading-related losses were $5.15 billion in the fourth quarter of 2007, which included CDO-related writedowns of $5.28 billion.
Credit
--net charge off 2.7 bil (1.25% of avg loan), 1.4 bil (0.81%) Q1 07 (Q4 07 national net charge off 0.83%)
--allowance 14.9 bil(1.71 of total loan), 8.7 bil (1.2%) (1.29 Q4 07 national) --> conservative allowance
--non performing 7.8 bil (0.9% of loan) (1.4 Q4 07 national) -> lower than national, relative higher quality loans
--Tier 1 capital 7.51%, 8.57% Q1 07
provision vs net charge offs
http://www.fool.com/investing/beginning/2007/04/09/whats-the-deal-with-bank-reserves.aspx
Loan loss provisions
When a bank makes 1,000 loans during the quarter, it knows from experience that, say, 1% of those loans will go bad. It doesn't know which ones will go bad -- it just knows from statistical experience that 10 of those loans will not be repaid, or will become slow-paying loans.
Rather than waiting for the credit loss to occur, a bank uses its best judgment to account for those losses through the provision for loan losses, a non-cash charge to earnings. Here's a simplified income statement for Ohio-based KeyCorp (NYSE: KEY), highlighting the provision for loan losses.
KeyCorp
FY 2006
Net Interest Income 2,815
Provision for Loan Losses (150)
Noninterest Income 2,127
Noninterest Expense (3,149)
Earnings Before Taxes 1,643
Numbers in millions of dollars.
Again, the $150 million loan loss provision is not a cash expense. Instead, that $150 million charge builds the loan loss reserve on the balance sheet. The reserve provides a cushion if and when customers don't repay their loans. Without this cushion, there's a chance the bank could be caught with little or no capital.
Think of the reserve as a bucket of water that should stay full. Water leaks out of the bucket when the bank abandons hope of collecting on a loan (called a charge-off). Every charge-off causes the reserve to shrink. If this reserve gets too low, the bank replenishes the reserve with the provision for loan losses. Over time, provisions for loan losses should be about equal to charge-offs, ensuring that the reserve doesn't get too low.
The bank can also recover previously charged-off loans, which adds to the reserve. On the way out of a recession, a bank can frequently lessen its loan loss provision on the income statement because recoveries of charged-off loans build up the loan loss reserve.
Putting it all together
The important things to remember are that the provision for loan losses builds the reserve, and charge-offs deplete the reserve. For example, KeyCorp's reserve fell in 2006, as net charge-offs outpaced the provision for loan losses:
KeyCorp
FY 2006
Reserve at beginning of year 966
Net charge-offs (170)
Provision for loan losses 147
Reserve at end of year 943
Loan loss provisions
When a bank makes 1,000 loans during the quarter, it knows from experience that, say, 1% of those loans will go bad. It doesn't know which ones will go bad -- it just knows from statistical experience that 10 of those loans will not be repaid, or will become slow-paying loans.
Rather than waiting for the credit loss to occur, a bank uses its best judgment to account for those losses through the provision for loan losses, a non-cash charge to earnings. Here's a simplified income statement for Ohio-based KeyCorp (NYSE: KEY), highlighting the provision for loan losses.
KeyCorp
FY 2006
Net Interest Income 2,815
Provision for Loan Losses (150)
Noninterest Income 2,127
Noninterest Expense (3,149)
Earnings Before Taxes 1,643
Numbers in millions of dollars.
Again, the $150 million loan loss provision is not a cash expense. Instead, that $150 million charge builds the loan loss reserve on the balance sheet. The reserve provides a cushion if and when customers don't repay their loans. Without this cushion, there's a chance the bank could be caught with little or no capital.
Think of the reserve as a bucket of water that should stay full. Water leaks out of the bucket when the bank abandons hope of collecting on a loan (called a charge-off). Every charge-off causes the reserve to shrink. If this reserve gets too low, the bank replenishes the reserve with the provision for loan losses. Over time, provisions for loan losses should be about equal to charge-offs, ensuring that the reserve doesn't get too low.
The bank can also recover previously charged-off loans, which adds to the reserve. On the way out of a recession, a bank can frequently lessen its loan loss provision on the income statement because recoveries of charged-off loans build up the loan loss reserve.
Putting it all together
The important things to remember are that the provision for loan losses builds the reserve, and charge-offs deplete the reserve. For example, KeyCorp's reserve fell in 2006, as net charge-offs outpaced the provision for loan losses:
KeyCorp
FY 2006
Reserve at beginning of year 966
Net charge-offs (170)
Provision for loan losses 147
Reserve at end of year 943
Regional Banks Begin Paying Prices for Their Boomtime Expansion
Concentrating on auto loans, Sovereign offered some of the best terms around to car buyers in Arizona and eight other states far from Sovereign's home branches. "They came on like a tidal wave," says Steve Dancy, finance director at Mel Clayton Ford here. "It was a car dealer's dream."
Now, two years after its expansion push, Sovereign has quit making auto loans outside the Northeast because too many borrowers fell behind on their bills. Losses on the bank's loans ballooned. In January, to conserve cash as it wrote off more bad loans, Sovereign eliminated dividend payments. On Tuesday, the bank is expected to announce a 40% drop in first-quarter earnings.
Similar troubles are echoing through small and midsize banks across the U.S. In a bid to expand during the recent boom, many set up operations in unfamiliar markets or started pitching new products. Others, aiming to stave off encroachment by huge U.S. financial institutions, boosted their lending by offering easy terms or lower rates. Now the slowing economy is exposing bad timing and blunders.
Big U.S. banks have received the lion's share of attention since the crisis began, due to their exposure to housing-related woes.
But there's a growing sense that there's another shoe to drop: losses at smaller banks. Regional and local institutions mostly dodged the initial wave of troubles because many weren't exposed to the complex mortgage-backed securities that slammed the behemoths. As housing prices continue to erode and the economy weakens, they're taking their lumps now, too.
Overall, profits at the 8,533 banks backed by the Federal Deposit Insurance Corp. dropped 84% to $5.8 billion in the fourth quarter, a 16-year low. Fewer than half of all banks posted a rise in net income for the full year. That hadn't happened since at least 1984, according to the FDIC.
Despite the glum outlook, few analysts are predicting a repeat of the savings-and-loan crisis of the late 1980s and early 1990s, which led to the failure of more than 1,000 U.S. banks and cost taxpayers about $130 billion. Many of today's problems are occurring at small banks: The average asset size of the 76 financial institutions on the FDIC's "problem list" of banks getting extra regulatory scrutiny was $292 million as of Dec. 31. By comparison, Bank of America Corp., the largest U.S. bank, has $1.72 trillion in assets. Bank of America reports earnings Monday.
Though delinquencies and losses have risen in many types of loans, both remain below peak levels. About 1.4% of all loans were between 30 and 90 days delinquent at the end of last year. That's the highest level since 1992 but still below 1990 and 1991, when more than 2% were delinquent, according to the FDIC.
As a result, Sovereign now has 750 branches in eight states, with nearly $85 billion in assets. Its market value of about $4.4 billion is slight compared with Bank of America's $169 billion. The core of its business is traditional banking operations -- taking deposits, making loans to small businesses and pitching mortgages.
Sovereign extended its best rates to buyers with credit scores above 700, say people familiar with the bank's strategy, while other banks typically started at scores of 730. (Credit scores generally range from 300 to 900.) Dealers also pitched Sovereign loans at 9% interest to some buyers with 620 credit scores; other banks would typically offer 14% rates to customers with scores of around 640, turning down those with anything lower.
By the summer of 2007, Mr. Dancy says he was lining up more than 100 borrowers a month with Sovereign, compared with 40 apiece with the area's traditional lenders. "Sovereign absolutely was the lowest in terms of rates and terms," says Mr. Dancy. "I'm going to do whatever it takes to move my inventory."
By year's end, Sovereign's auto-loan portfolio had grown to $7 billion, up from $4.9 billion in 2006, a rising share of its $57.8 billion in consumer and commercial loans. New markets accounted for more than half of the bank's new auto loans, as well as a majority of its losses on them. The bank wrote off $76.2 million in charges for auto loans, more than double its write-offs in 2006.
Now, two years after its expansion push, Sovereign has quit making auto loans outside the Northeast because too many borrowers fell behind on their bills. Losses on the bank's loans ballooned. In January, to conserve cash as it wrote off more bad loans, Sovereign eliminated dividend payments. On Tuesday, the bank is expected to announce a 40% drop in first-quarter earnings.
Similar troubles are echoing through small and midsize banks across the U.S. In a bid to expand during the recent boom, many set up operations in unfamiliar markets or started pitching new products. Others, aiming to stave off encroachment by huge U.S. financial institutions, boosted their lending by offering easy terms or lower rates. Now the slowing economy is exposing bad timing and blunders.
Big U.S. banks have received the lion's share of attention since the crisis began, due to their exposure to housing-related woes.
But there's a growing sense that there's another shoe to drop: losses at smaller banks. Regional and local institutions mostly dodged the initial wave of troubles because many weren't exposed to the complex mortgage-backed securities that slammed the behemoths. As housing prices continue to erode and the economy weakens, they're taking their lumps now, too.
Overall, profits at the 8,533 banks backed by the Federal Deposit Insurance Corp. dropped 84% to $5.8 billion in the fourth quarter, a 16-year low. Fewer than half of all banks posted a rise in net income for the full year. That hadn't happened since at least 1984, according to the FDIC.
Despite the glum outlook, few analysts are predicting a repeat of the savings-and-loan crisis of the late 1980s and early 1990s, which led to the failure of more than 1,000 U.S. banks and cost taxpayers about $130 billion. Many of today's problems are occurring at small banks: The average asset size of the 76 financial institutions on the FDIC's "problem list" of banks getting extra regulatory scrutiny was $292 million as of Dec. 31. By comparison, Bank of America Corp., the largest U.S. bank, has $1.72 trillion in assets. Bank of America reports earnings Monday.
Though delinquencies and losses have risen in many types of loans, both remain below peak levels. About 1.4% of all loans were between 30 and 90 days delinquent at the end of last year. That's the highest level since 1992 but still below 1990 and 1991, when more than 2% were delinquent, according to the FDIC.
As a result, Sovereign now has 750 branches in eight states, with nearly $85 billion in assets. Its market value of about $4.4 billion is slight compared with Bank of America's $169 billion. The core of its business is traditional banking operations -- taking deposits, making loans to small businesses and pitching mortgages.
Sovereign extended its best rates to buyers with credit scores above 700, say people familiar with the bank's strategy, while other banks typically started at scores of 730. (Credit scores generally range from 300 to 900.) Dealers also pitched Sovereign loans at 9% interest to some buyers with 620 credit scores; other banks would typically offer 14% rates to customers with scores of around 640, turning down those with anything lower.
By the summer of 2007, Mr. Dancy says he was lining up more than 100 borrowers a month with Sovereign, compared with 40 apiece with the area's traditional lenders. "Sovereign absolutely was the lowest in terms of rates and terms," says Mr. Dancy. "I'm going to do whatever it takes to move my inventory."
By year's end, Sovereign's auto-loan portfolio had grown to $7 billion, up from $4.9 billion in 2006, a rising share of its $57.8 billion in consumer and commercial loans. New markets accounted for more than half of the bank's new auto loans, as well as a majority of its losses on them. The bank wrote off $76.2 million in charges for auto loans, more than double its write-offs in 2006.
Sunday, April 20, 2008
China Battles Image Woes
-- The protests and mutual recriminations between China and its foreign critics -- highlighted by more anti-Western demonstrations this weekend -- are exposing a stark disconnect between how China views itself and how many people abroad view China.
Misunderstandings have multiplied as the opposing sides seem to consistently talk past each other. Foreign critics are focusing on issues, such as Beijing's policies in Tibet, that many Chinese feel ignore decades of broader economic and social progress in their country.
Chinese students and citizens chant slogans and hold up banners, calling for boycotting French Carrefour supermarket in Xi'an, northwest China's Shaanxi province on Sunday.
Condemnation of Chinese government policies is being received in China as attacking the nation as a whole, arousing widespread public resentment. The most vocal responses are then seen with alarm overseas as government-sanctioned nationalism run amok, further reinforcing negative images of China.
Over the weekend, there were demonstrations against French retailer Carrefour SA involving thousands of people in several cities across China. They were part of a broader push for a boycott of the retailer, one of France's biggest investors in China, as punishment for the chaos of the Olympic torch relay in Paris, and for the purported support of the Dalai Lama -- widely vilified in China -- by one of the Paris company's shareholders. Carrefour has said it has no ties with the Tibetan spiritual leader, and pointed out that the vast majority of its products and employees in the country are Chinese.
Many Chinese expected this summer's Olympics in Beijing to make 2008 a year for celebrating their country's re-entry to the international community, and its rising global status from three decades of economic and political reforms. The international furor instead is feeding a deepening disappointment.
"Many Westerners still see China like the Stalinist-era Soviet Union. But most of them have never been here...today China is different," says Pu Chengchuan, a 21-year-old college senior in Beijing. He says China's human-rights records isn't perfect, but "it's a lot better than it used to be."
Mr. Pu says he has hoped that the Olympics would "let the world understand China better," but now worries that "critics of China are going to use the Olympics for their own purposes."
Some Western businesspeople fear that the divide could continue to widen, leading to tension within multinationals' operations or broader action against foreign companies that operate in China. "Foreign companies are indeed concerned and especially those companies that are highly visible in and outside of China," said James Zimmerman, chairman of the American Chamber of Commerce in China. Mr. Zimmerman urged "open and respectful dialogue" about the issues in dispute, but said "there are challenges to getting people with different points of view to sit down and talk."
The backlash against foreign critics has also targeted Western media for alleged bias in their coverage of deadly antigovernment riots in the Tibetan capital of Lhasa last month and the resulting crackdown by Beijing. Over the weekend, Chinese students protested media bias in front of the German parliament in Berlin and thousands protested outside the Los Angeles offices of Time Warner Inc.-owned Cable News Network.
China's government appears worried. The ruling Communist Party walks a fine line in handling outbursts of nationalism. As the self-appointed champion of national unity, it embraces, up to a point, popular expressions of nationalism -- but also fears that, unchecked, they could derail economic growth and ruffle foreign relations.
In recent days, official commentary has urged citizens to apply their patriotic fervor in their daily work, and a front-page commentary Sunday in the People's Daily, the Communist Party mouthpiece, urged the "rational expression" of patriotism.
In recent months, China has faced devastating winter storms, a plunging stock market and consumer-price inflation at 12-year highs. The criticism of China has only added to the frustrations. "Obviously, there is a cabal, a cold war against China!" proclaims a homemade video circulating on the Internet in recent days.
China's government has seemed often unaware of how it is perceived abroad -- and often appeared far less capable than its opponents at getting its message across. "The recent events made me realize there is a huge information gap about China in this country," China's ambassador to the U.K., Fu Ying, said in a speech in London last week.
Within China, the sense of injury from foreign critics is compounded by an education system that instills a deep sense of suspicion that Western powers are bent on weakening and dividing China, as they did in the 19th century. Protests advocating Tibetan independence mystify most Chinese, who have been taught all their lives that Tibet has long been part of China. And the deeply emotional Chinese response to the Tibet protests has also surprised some Westerners.
"American people feel that freedom and self-expression are very important. Chinese people feel that national unity is very important," says Wang Jianshuo, 30 years old, who works for an Internet company in Shanghai and writes a blog in English and Chinese. "There is a big gap between the West and China on which values are more important. It's not right or wrong, it's just different."
Many Chinese who are critical of their own government also feel Western condemnations of China fail to acknowledge its advances in recent decades, from lifting hundreds of millions of people out of poverty to expanding the freedoms -- albeit still limited -- that Chinese enjoy.
Western critics "think China is still very closed and that Chinese people are under one-party control and [therefore] have no human rights," says Guan Xiao, a 52-year-old Beijing resident.
Mr. Pu, the Beijing physics student, says his own background illustrates some of the progress China has experienced. Born in a poor farming village in China's northeast, he now attends one of China's top universities. Thanks to the Internet, he says, he and his classmates have access to a broad array of information, including some Western media.
People like Mr. Pu and Mr. Wang, the Shanghai blogger, feel that China doesn't often get credit in the Western media for its recent progress. "When we were silent, you said you want us to have free speech. When we were silent no more, you say we were brainwashed xenophobics," reads an anonymous Internet posting now circulating among Chinese working in foreign companies, in Chinese, English and French. "What do you really want from us?"
Often, Western critics and their Chinese respondents seem to be seeing entirely different things in the same events. Western accounts of the fracas surrounding the Olympic torch relay tend to emphasize the demands of pro-Tibet protesters, and have pointed to accusations of heavy-handedness by the blue-and-white-clad Chinese security guards accompanying the torch.
For Chinese, the image that lingers from the Paris protests is of a slight, wheelchair-bound woman clasping the Olympic torch to her body as a man wearing a Tibetan-flag bandana tries to pull it away from her. Since then, the woman, a 28-year-old fencer named Jin Jing, has become a household name and media star, an icon for those who see China as a nation beset by unfair attacks.
Looking for outlets for their anger at western critics, many Chinese are conflicted about the growing calls for boycotts and protests, but say such actions are the only way frustrated Chinese can get their message across. "The only thing we can do is to warn them and to give vent to our anger through their representatives in China, like with the boycott of Carrefour or French companies," says Ma Fei, 37, a businessman in the southern city of Shenzhen. Foreigners, he says, "especially those who don't live in China, just cannot understand how much the Olympics means to the Chinese people."
Misunderstandings have multiplied as the opposing sides seem to consistently talk past each other. Foreign critics are focusing on issues, such as Beijing's policies in Tibet, that many Chinese feel ignore decades of broader economic and social progress in their country.
Chinese students and citizens chant slogans and hold up banners, calling for boycotting French Carrefour supermarket in Xi'an, northwest China's Shaanxi province on Sunday.
Condemnation of Chinese government policies is being received in China as attacking the nation as a whole, arousing widespread public resentment. The most vocal responses are then seen with alarm overseas as government-sanctioned nationalism run amok, further reinforcing negative images of China.
Over the weekend, there were demonstrations against French retailer Carrefour SA involving thousands of people in several cities across China. They were part of a broader push for a boycott of the retailer, one of France's biggest investors in China, as punishment for the chaos of the Olympic torch relay in Paris, and for the purported support of the Dalai Lama -- widely vilified in China -- by one of the Paris company's shareholders. Carrefour has said it has no ties with the Tibetan spiritual leader, and pointed out that the vast majority of its products and employees in the country are Chinese.
Many Chinese expected this summer's Olympics in Beijing to make 2008 a year for celebrating their country's re-entry to the international community, and its rising global status from three decades of economic and political reforms. The international furor instead is feeding a deepening disappointment.
"Many Westerners still see China like the Stalinist-era Soviet Union. But most of them have never been here...today China is different," says Pu Chengchuan, a 21-year-old college senior in Beijing. He says China's human-rights records isn't perfect, but "it's a lot better than it used to be."
Mr. Pu says he has hoped that the Olympics would "let the world understand China better," but now worries that "critics of China are going to use the Olympics for their own purposes."
Some Western businesspeople fear that the divide could continue to widen, leading to tension within multinationals' operations or broader action against foreign companies that operate in China. "Foreign companies are indeed concerned and especially those companies that are highly visible in and outside of China," said James Zimmerman, chairman of the American Chamber of Commerce in China. Mr. Zimmerman urged "open and respectful dialogue" about the issues in dispute, but said "there are challenges to getting people with different points of view to sit down and talk."
The backlash against foreign critics has also targeted Western media for alleged bias in their coverage of deadly antigovernment riots in the Tibetan capital of Lhasa last month and the resulting crackdown by Beijing. Over the weekend, Chinese students protested media bias in front of the German parliament in Berlin and thousands protested outside the Los Angeles offices of Time Warner Inc.-owned Cable News Network.
China's government appears worried. The ruling Communist Party walks a fine line in handling outbursts of nationalism. As the self-appointed champion of national unity, it embraces, up to a point, popular expressions of nationalism -- but also fears that, unchecked, they could derail economic growth and ruffle foreign relations.
In recent days, official commentary has urged citizens to apply their patriotic fervor in their daily work, and a front-page commentary Sunday in the People's Daily, the Communist Party mouthpiece, urged the "rational expression" of patriotism.
In recent months, China has faced devastating winter storms, a plunging stock market and consumer-price inflation at 12-year highs. The criticism of China has only added to the frustrations. "Obviously, there is a cabal, a cold war against China!" proclaims a homemade video circulating on the Internet in recent days.
China's government has seemed often unaware of how it is perceived abroad -- and often appeared far less capable than its opponents at getting its message across. "The recent events made me realize there is a huge information gap about China in this country," China's ambassador to the U.K., Fu Ying, said in a speech in London last week.
Within China, the sense of injury from foreign critics is compounded by an education system that instills a deep sense of suspicion that Western powers are bent on weakening and dividing China, as they did in the 19th century. Protests advocating Tibetan independence mystify most Chinese, who have been taught all their lives that Tibet has long been part of China. And the deeply emotional Chinese response to the Tibet protests has also surprised some Westerners.
"American people feel that freedom and self-expression are very important. Chinese people feel that national unity is very important," says Wang Jianshuo, 30 years old, who works for an Internet company in Shanghai and writes a blog in English and Chinese. "There is a big gap between the West and China on which values are more important. It's not right or wrong, it's just different."
Many Chinese who are critical of their own government also feel Western condemnations of China fail to acknowledge its advances in recent decades, from lifting hundreds of millions of people out of poverty to expanding the freedoms -- albeit still limited -- that Chinese enjoy.
Western critics "think China is still very closed and that Chinese people are under one-party control and [therefore] have no human rights," says Guan Xiao, a 52-year-old Beijing resident.
Mr. Pu, the Beijing physics student, says his own background illustrates some of the progress China has experienced. Born in a poor farming village in China's northeast, he now attends one of China's top universities. Thanks to the Internet, he says, he and his classmates have access to a broad array of information, including some Western media.
People like Mr. Pu and Mr. Wang, the Shanghai blogger, feel that China doesn't often get credit in the Western media for its recent progress. "When we were silent, you said you want us to have free speech. When we were silent no more, you say we were brainwashed xenophobics," reads an anonymous Internet posting now circulating among Chinese working in foreign companies, in Chinese, English and French. "What do you really want from us?"
Often, Western critics and their Chinese respondents seem to be seeing entirely different things in the same events. Western accounts of the fracas surrounding the Olympic torch relay tend to emphasize the demands of pro-Tibet protesters, and have pointed to accusations of heavy-handedness by the blue-and-white-clad Chinese security guards accompanying the torch.
For Chinese, the image that lingers from the Paris protests is of a slight, wheelchair-bound woman clasping the Olympic torch to her body as a man wearing a Tibetan-flag bandana tries to pull it away from her. Since then, the woman, a 28-year-old fencer named Jin Jing, has become a household name and media star, an icon for those who see China as a nation beset by unfair attacks.
Looking for outlets for their anger at western critics, many Chinese are conflicted about the growing calls for boycotts and protests, but say such actions are the only way frustrated Chinese can get their message across. "The only thing we can do is to warn them and to give vent to our anger through their representatives in China, like with the boycott of Carrefour or French companies," says Ma Fei, 37, a businessman in the southern city of Shenzhen. Foreigners, he says, "especially those who don't live in China, just cannot understand how much the Olympics means to the Chinese people."
Saturday, April 19, 2008
Slowdown of economy is taking toll on VC business
Venture capital funding dropped more steeply in New England than the nation as a whole in the first three months of 2008, as the slowing economy began taking a toll on entrepreneurial companies, according to the MoneyTree first-quarter report being released today.
In the six-state region, the second-largest US venture hub after Silicon Valley, investments fell 24.1 percent to $721.4 million in the January-to-March period from $951.1 million in the prior quarter. It was the smallest outlay in New England since the second quarter of 2006.
Nationally, venture outlays dropped 8.5 percent to $7.1 billion in the three months ending March 31 from the $7.8 billion invested in the previous quarter. First-quarter US investment totals were the smallest since the fourth quarter of 2006, according to the report prepared by the Thomson Reuters research house and the PricewaterhouseCoopers accounting firm for the National Venture Capital Association.
"We see from early-stage investments that the economic slowdown has had an impact," said Nina Saberi, managing general partner for Castile Ventures, a Waltham venture capital firm. She cited an inhospitable climate for initial public offerings and a tougher market for acquisitions, two routes for cashing out of investments.
But the outlays, while lower, remained in line with the $7 billion-plus level seen in each of the past five quarters as venture capitalists put money to work funding innovative companies.
At least some of the decline appeared to be seasonal. Investment totals are typically lowest in the first quarter and highest in the second and fourth quarters, said John S. Taylor, vice president of research at the venture association. "Venture capitalists are still investing in new projects now, though with a sense of caution," Taylor said.
Still, the trend was clearly downward. There were 922 financing deals in the quarter nationally, down from 1,045 in the fourth quarter of last year. There were 108 deals in New England, down from 118. Eleven of the 16 industry sectors tracked in the MoneyTree report drew fewer dollars, and 14 of the 16 saw fewer funding deals.
Biotechnology attracted more venture money than any other sector in the first quarter, with $1.27 billion flowing into 126 deals. A close second was computer software, with $1.26 billion funding 234 deals. But outlays for both sectors, along with industrial and energy, clean technology, and Internet-specific investments, all tumbled from fourth-quarter levels. Two sectors that drew higher venture outlays in the first quarter were semiconductors and medical equipment.
Funding for early- and late-stage companies declined in the first quarter, though funding rose for expansion-stage companies.
James E. Thomas, partner at Thomas, McNerney Partners, a Stamford, Conn., venture firm focusing on healthcare and medical technologies, said venture capitalists are resigned to managing their portfolio companies more conservatively and for longer periods before they can "exit" by going public or selling to larger companies.
He also warned of a regulatory environment that "is uncertain and frankly trending toward more regulation rather than less regulation," potentially souring the outlook for healthcare and medical start-ups.
But with many venture firms still sitting on large pools of cash from limited partners such as pension funds and university endowments, this may simply be a period when investors are being more patient and selective, suggested Kevin Shaw, partner in charge of the Cambridge entrepreneurial services center for PricewaterhouseCoopers.
"Given the economy we're in now, these are still pretty good results," Shaw said. "Venture capital firms know they have to stay in the game longer. So the investments today might be a little more conservative and selective, but they're not falling off a cliff."
In the six-state region, the second-largest US venture hub after Silicon Valley, investments fell 24.1 percent to $721.4 million in the January-to-March period from $951.1 million in the prior quarter. It was the smallest outlay in New England since the second quarter of 2006.
Nationally, venture outlays dropped 8.5 percent to $7.1 billion in the three months ending March 31 from the $7.8 billion invested in the previous quarter. First-quarter US investment totals were the smallest since the fourth quarter of 2006, according to the report prepared by the Thomson Reuters research house and the PricewaterhouseCoopers accounting firm for the National Venture Capital Association.
"We see from early-stage investments that the economic slowdown has had an impact," said Nina Saberi, managing general partner for Castile Ventures, a Waltham venture capital firm. She cited an inhospitable climate for initial public offerings and a tougher market for acquisitions, two routes for cashing out of investments.
But the outlays, while lower, remained in line with the $7 billion-plus level seen in each of the past five quarters as venture capitalists put money to work funding innovative companies.
At least some of the decline appeared to be seasonal. Investment totals are typically lowest in the first quarter and highest in the second and fourth quarters, said John S. Taylor, vice president of research at the venture association. "Venture capitalists are still investing in new projects now, though with a sense of caution," Taylor said.
Still, the trend was clearly downward. There were 922 financing deals in the quarter nationally, down from 1,045 in the fourth quarter of last year. There were 108 deals in New England, down from 118. Eleven of the 16 industry sectors tracked in the MoneyTree report drew fewer dollars, and 14 of the 16 saw fewer funding deals.
Biotechnology attracted more venture money than any other sector in the first quarter, with $1.27 billion flowing into 126 deals. A close second was computer software, with $1.26 billion funding 234 deals. But outlays for both sectors, along with industrial and energy, clean technology, and Internet-specific investments, all tumbled from fourth-quarter levels. Two sectors that drew higher venture outlays in the first quarter were semiconductors and medical equipment.
Funding for early- and late-stage companies declined in the first quarter, though funding rose for expansion-stage companies.
James E. Thomas, partner at Thomas, McNerney Partners, a Stamford, Conn., venture firm focusing on healthcare and medical technologies, said venture capitalists are resigned to managing their portfolio companies more conservatively and for longer periods before they can "exit" by going public or selling to larger companies.
He also warned of a regulatory environment that "is uncertain and frankly trending toward more regulation rather than less regulation," potentially souring the outlook for healthcare and medical start-ups.
But with many venture firms still sitting on large pools of cash from limited partners such as pension funds and university endowments, this may simply be a period when investors are being more patient and selective, suggested Kevin Shaw, partner in charge of the Cambridge entrepreneurial services center for PricewaterhouseCoopers.
"Given the economy we're in now, these are still pretty good results," Shaw said. "Venture capital firms know they have to stay in the game longer. So the investments today might be a little more conservative and selective, but they're not falling off a cliff."
Libor's Rise will Sock Borrowers
Libor is one of the world's most important financial indicators. It serves as a benchmark for $900 billion in subprime mortgage loans that adjust -- typically every six months -- according to its movements. Companies globally have nearly $9 trillion in debt with interest payments pegged to Libor, according to data provider Dealogic.
A sharp and unexpected rise in a widely used interest rate is threatening to add billions of dollars to the interest bills of homeowners, companies and other borrowers around the world.
If sustained, the past week's rise of Libor could add roughly $18 billion in annual interest costs on that corporate debt, or about $100 to the monthly payment on a $500,000 adjustable-rate mortgage loan
The Libor rate, which is supposed to reflect the average borrowing costs of banks, had been falling in recent months as the Fed lowered interest rates. At the same time, though, the gap between the interest rates central banks set and Libor has risen -- an indicator of increased concerns about banks' financial health. That, combined with this weeks' moves, counteracts efforts by the Fed to ease pressures on the economy.
While Fed officials see the rise in Libor spreads as predominantly reflecting pressures on European banks, they also see it as symptomatic of a broad reluctance by banks in the U.S. and elsewhere to lend money they think they may need a few weeks from now. They continue to study options for addressing the pressures.
One way might be to expand the Fed's "term auction facility," from the $100 billion it has currently lent to banks. It could also extend the term of loans made through the facility from the current 28 days, perhaps to three months or as long as six months.
Friday, the closely watched three-month U.S. dollar Libor rose 0.09 percentage point to 2.9075%, its highest in nearly six weeks. Between Wednesday and Friday, the rate rose 0.174 percentage point, an increase that hadn't been seen since August and the start of the financial turndown that has spread from banks into the broader economy. Meanwhile, the six-month U.S. dollar rate -- used as the basis for payments on most subprime mortgages -- rose even more sharply and was quoted Friday at 3.01875%, or 0.33 percentage point more than at the start of the week.
In commercial real estate, the rise in Libor is bound to have a chilling effect, because many developers borrow heavily using floating-rate debt linked to Libor. Until recently, declining rates had benefited borrowers, but some lenders were growing wary. Banks have started to include a floor in Libor-linked loans, said Peter Fitzgerald, chief financial officer at Radco Cos., an Atlanta developer. That means borrowers' savings would be limited if Libor continued to sink, but borrowers can be hit by the latest rise.
"If Libor were at 4% instead of under 3%, there would be a disaster that would take years to unwind," he said.
A sharp and unexpected rise in a widely used interest rate is threatening to add billions of dollars to the interest bills of homeowners, companies and other borrowers around the world.
If sustained, the past week's rise of Libor could add roughly $18 billion in annual interest costs on that corporate debt, or about $100 to the monthly payment on a $500,000 adjustable-rate mortgage loan
The Libor rate, which is supposed to reflect the average borrowing costs of banks, had been falling in recent months as the Fed lowered interest rates. At the same time, though, the gap between the interest rates central banks set and Libor has risen -- an indicator of increased concerns about banks' financial health. That, combined with this weeks' moves, counteracts efforts by the Fed to ease pressures on the economy.
While Fed officials see the rise in Libor spreads as predominantly reflecting pressures on European banks, they also see it as symptomatic of a broad reluctance by banks in the U.S. and elsewhere to lend money they think they may need a few weeks from now. They continue to study options for addressing the pressures.
One way might be to expand the Fed's "term auction facility," from the $100 billion it has currently lent to banks. It could also extend the term of loans made through the facility from the current 28 days, perhaps to three months or as long as six months.
Friday, the closely watched three-month U.S. dollar Libor rose 0.09 percentage point to 2.9075%, its highest in nearly six weeks. Between Wednesday and Friday, the rate rose 0.174 percentage point, an increase that hadn't been seen since August and the start of the financial turndown that has spread from banks into the broader economy. Meanwhile, the six-month U.S. dollar rate -- used as the basis for payments on most subprime mortgages -- rose even more sharply and was quoted Friday at 3.01875%, or 0.33 percentage point more than at the start of the week.
In commercial real estate, the rise in Libor is bound to have a chilling effect, because many developers borrow heavily using floating-rate debt linked to Libor. Until recently, declining rates had benefited borrowers, but some lenders were growing wary. Banks have started to include a floor in Libor-linked loans, said Peter Fitzgerald, chief financial officer at Radco Cos., an Atlanta developer. That means borrowers' savings would be limited if Libor continued to sink, but borrowers can be hit by the latest rise.
"If Libor were at 4% instead of under 3%, there would be a disaster that would take years to unwind," he said.
Friday, April 18, 2008
Citigroup Q1 08
--5.1 bil earning loss vs 11 bil loss in Q4 07 vs 5 bil Q 1 07
--revenue
Capital Market -- 35% revenue, 50% NI contributor
ABS CDO
--ABCP: exp 16.8 bil, markdown 3.1 bil (15%), original face value 24 bil(30% off)
--High Grade CDO: 3.8 bil, markedown 1 bil (20%), original face 9.3 bil (60% off)
--Mezzanine CDO: 2 bil, markdown 1.5 bil (40%), original face value 9 bil (80% off)
Consumer loans (including corporate loans) --60% revenue, 30% earning contributor
Credit Loss
--Net Credit Loss/net charge off 3.8 bil
--non-performing loans: 11.8 bil
--provision 5.7 bil vs 7.4 bil Q4 07
--total allowance end Q1 08 19.5 bil (2.47% of loan vs 2.47% Q4 07 vs 1.53% Q1 07)
comments:
--ABS CDO further markdown of 2 bil+ 1 bil = 3 bil
--global consumer credit credit continue to deteriorate, but Citigroup has built enough provision. further provision will be ~6 bil
--revenue
Capital Market -- 35% revenue, 50% NI contributor
ABS CDO
--ABCP: exp 16.8 bil, markdown 3.1 bil (15%), original face value 24 bil(30% off)
--High Grade CDO: 3.8 bil, markedown 1 bil (20%), original face 9.3 bil (60% off)
--Mezzanine CDO: 2 bil, markdown 1.5 bil (40%), original face value 9 bil (80% off)
Consumer loans (including corporate loans) --60% revenue, 30% earning contributor
Credit Loss
--Net Credit Loss/net charge off 3.8 bil
--non-performing loans: 11.8 bil
--provision 5.7 bil vs 7.4 bil Q4 07
--total allowance end Q1 08 19.5 bil (2.47% of loan vs 2.47% Q4 07 vs 1.53% Q1 07)
comments:
--ABS CDO further markdown of 2 bil+ 1 bil = 3 bil
--global consumer credit credit continue to deteriorate, but Citigroup has built enough provision. further provision will be ~6 bil
The Bank of England is considering accepting as much as €30 billion ($59.1 billion) in mortgages from banks as collateral for loans of government securities, which the banks could then use to raise cash, a person familiar with the matter said. The plan would go a step further than central banks in the U.S. and Europe by allowing banks to borrow for periods of a year or possibly more, said people familiar with the matter.
Bankers have been lobbying the U.K. government for help as the markets they typically depend on to borrow money have all but dried up. Interest rates in short-term lending markets have shot up as banks, worried about failures among their peers, have become reluctant to lend to one another for more than a week. Meanwhile, the "securitization" markets where banks packaged and sold their mortgages to investors are all but shut: Investors bought only $10.4 billion in European mortgage-backed securities in the first three months of 2008, down 92% from the same period a year earlier.
U.K. banks' heavy reliance on lending markets -- as opposed to depositors or other sources of funding -- has made the problem more acute. U.K. banks, for example, lack the range of options available to banks in the U.S., where institutions such as mortgage guarantor Fannie Mae and the Federal Home Loan Banks provide added sources of financing.
Analysts note larger U.K. banks with diversified operations throughout Europe -- such as HSBC Holdings PLC, Barclays PLC and HBOS PLC -- can tap the ECB and other sources for short-term loans, but smaller banks -- such as Alliance & Leicester PLC and Bradford & Bingley PLC -- have fewer alternatives.
The dearth of financing has forced mortgage lenders to cut back sharply, putting an end to a housing boom that had been a major driver of consumer spending. Even as the Bank of England has cut its short-term interest-rate target, rates on new mortgage loans have risen. In the three months ended February, new mortgage approvals for house purchases averaged only 73,000 a month -- the lowest level since mid-1995
Bankers have been lobbying the U.K. government for help as the markets they typically depend on to borrow money have all but dried up. Interest rates in short-term lending markets have shot up as banks, worried about failures among their peers, have become reluctant to lend to one another for more than a week. Meanwhile, the "securitization" markets where banks packaged and sold their mortgages to investors are all but shut: Investors bought only $10.4 billion in European mortgage-backed securities in the first three months of 2008, down 92% from the same period a year earlier.
U.K. banks' heavy reliance on lending markets -- as opposed to depositors or other sources of funding -- has made the problem more acute. U.K. banks, for example, lack the range of options available to banks in the U.S., where institutions such as mortgage guarantor Fannie Mae and the Federal Home Loan Banks provide added sources of financing.
Analysts note larger U.K. banks with diversified operations throughout Europe -- such as HSBC Holdings PLC, Barclays PLC and HBOS PLC -- can tap the ECB and other sources for short-term loans, but smaller banks -- such as Alliance & Leicester PLC and Bradford & Bingley PLC -- have fewer alternatives.
The dearth of financing has forced mortgage lenders to cut back sharply, putting an end to a housing boom that had been a major driver of consumer spending. Even as the Bank of England has cut its short-term interest-rate target, rates on new mortgage loans have risen. In the three months ended February, new mortgage approvals for house purchases averaged only 73,000 a month -- the lowest level since mid-1995
Thursday, April 17, 2008
Merrill Lynch Q1 08
--earning -1.97 bil vs 2.03 bil Q1 07
--Net rev 2.9 bil, down 69% from prior-year period. Execluding writedown it is 7.9 bil
--drivers: write down 1.5 bil of US ABS CDOS. Credit valuation adjustments of -3.0 bil related to hedge s w financial guarantors, most of which related to US super senior ABS CDOs. Leveraged loand offsetby net benefits of 2.1 bil due to widenning carry credit spreadds
FICC
--net exposure of US ABS CDOs as of Q1 08 is 6.7 bil, up from 5.1 bil at Q1 07.
--credit valuation adjustments -3.0 bil, 2.2 goes to super senior ABS CDOs
--residential mortgage
a.net expsorue to US subprime 1.4 bil, due to hegding, assets sales and net wrodowns..
b.net expsure sto Alt-A residential 3.2 bil, purchases offset by 402 mil net write downs.
c.net expsorue to prime residential mortgae 30.8 bil
c.non-US mortgegae 8.8 bil
--banks invesment portfolio: net expsoure 42.5 bil. net pre-tax wrife downs of 3.1 bil due to Alt-A MBS.
--leveraged loans: 14 bil, down from 18 bil Q4 07. net write-down 825 mil
--Commercial Real Estate: exposure 21 bil
For total U.S. super senior ABS CDOs, long exposures (including associated gains and losses reported in income and other net changes in net exposures) were $26.3 billion and $30.4 billion at March 28, 2008 and December 28, 2007, respectively.
Short exposures (including associated gains and losses reported in income and other net changes in net exposures) were $19.8 billion and $23.6 billion at March 28, 2008 and December 28, 2007, respectively. Short exposures primarily consist of purchases of credit default swap protection from various third parties, including monoline financial guarantors, insurers and other market participants.
During the first quarter of 2008, credit valuation adjustments related to the firm’s hedges with financial guarantors were negative $3.0 billion, including negative $2.2 billion related to U.S. super senior ABS CDOs.
The hedges with financial guarantors related to U.S. super senior ABS CDOs declined to $10.9 billion due to net gains on these hedges and the firm’s decision to consider $1.1 billion notional amount of certain hedges with a highly rated financial guarantor as ineffective, which resulted in a write-off of $45 million. The net gains, coupled with the deteriorating environment for financial guarantors, resulted in credit valuation adjustments of negative $2.2 billion during the 2008 first quarter. As a result, the carrying value of these hedges related to U.S. super senior ABS CDOs was $3.0 billion at quarter end. Please see attachment V for details related to these hedges.
Credit Valuation Adjustment
During the first quarter of 2008, credit valuation adjustments related to the firm’s hedges with financial guarantors were negative $3.0 billion, including negative $2.2 billion related to U.S. super senior ABS CDOs.
The hedges with financial guarantors related to U.S. super senior ABS CDOs declined to $10.9 billion due to net gains on these hedges and the firm’s decision to consider $1.1 billion notional amount of certain hedges with a highly rated financial guarantor as ineffective, which resulted in a write-off of $45 million. The net gains, coupled with the deteriorating environment for financial guarantors, resulted in credit valuation adjustments of negative $2.2 billion during the 2008 first quarter. As a result, the carrying value of these hedges related to U.S. super senior ABS CDOs was $3.0 billion at quarter end. Please see attachment V for details related to these hedges.
comments
--US ABS CDO futher writedown 1-2 bil
--Financial Garanteer 1-2 bil
--Residential MBS futher writedown of 1 bil
--Banks portfolio 500 mil
--credit valuation adjustments 1-2 bil
--total 5 bil in Q2 08
--Net rev 2.9 bil, down 69% from prior-year period. Execluding writedown it is 7.9 bil
--drivers: write down 1.5 bil of US ABS CDOS. Credit valuation adjustments of -3.0 bil related to hedge s w financial guarantors, most of which related to US super senior ABS CDOs. Leveraged loand offsetby net benefits of 2.1 bil due to widenning carry credit spreadds
FICC
--net exposure of US ABS CDOs as of Q1 08 is 6.7 bil, up from 5.1 bil at Q1 07.
--credit valuation adjustments -3.0 bil, 2.2 goes to super senior ABS CDOs
--residential mortgage
a.net expsorue to US subprime 1.4 bil, due to hegding, assets sales and net wrodowns..
b.net expsure sto Alt-A residential 3.2 bil, purchases offset by 402 mil net write downs.
c.net expsorue to prime residential mortgae 30.8 bil
c.non-US mortgegae 8.8 bil
--banks invesment portfolio: net expsoure 42.5 bil. net pre-tax wrife downs of 3.1 bil due to Alt-A MBS.
--leveraged loans: 14 bil, down from 18 bil Q4 07. net write-down 825 mil
--Commercial Real Estate: exposure 21 bil
For total U.S. super senior ABS CDOs, long exposures (including associated gains and losses reported in income and other net changes in net exposures) were $26.3 billion and $30.4 billion at March 28, 2008 and December 28, 2007, respectively.
Short exposures (including associated gains and losses reported in income and other net changes in net exposures) were $19.8 billion and $23.6 billion at March 28, 2008 and December 28, 2007, respectively. Short exposures primarily consist of purchases of credit default swap protection from various third parties, including monoline financial guarantors, insurers and other market participants.
During the first quarter of 2008, credit valuation adjustments related to the firm’s hedges with financial guarantors were negative $3.0 billion, including negative $2.2 billion related to U.S. super senior ABS CDOs.
The hedges with financial guarantors related to U.S. super senior ABS CDOs declined to $10.9 billion due to net gains on these hedges and the firm’s decision to consider $1.1 billion notional amount of certain hedges with a highly rated financial guarantor as ineffective, which resulted in a write-off of $45 million. The net gains, coupled with the deteriorating environment for financial guarantors, resulted in credit valuation adjustments of negative $2.2 billion during the 2008 first quarter. As a result, the carrying value of these hedges related to U.S. super senior ABS CDOs was $3.0 billion at quarter end. Please see attachment V for details related to these hedges.
Credit Valuation Adjustment
During the first quarter of 2008, credit valuation adjustments related to the firm’s hedges with financial guarantors were negative $3.0 billion, including negative $2.2 billion related to U.S. super senior ABS CDOs.
The hedges with financial guarantors related to U.S. super senior ABS CDOs declined to $10.9 billion due to net gains on these hedges and the firm’s decision to consider $1.1 billion notional amount of certain hedges with a highly rated financial guarantor as ineffective, which resulted in a write-off of $45 million. The net gains, coupled with the deteriorating environment for financial guarantors, resulted in credit valuation adjustments of negative $2.2 billion during the 2008 first quarter. As a result, the carrying value of these hedges related to U.S. super senior ABS CDOs was $3.0 billion at quarter end. Please see attachment V for details related to these hedges.
comments
--US ABS CDO futher writedown 1-2 bil
--Financial Garanteer 1-2 bil
--Residential MBS futher writedown of 1 bil
--Banks portfolio 500 mil
--credit valuation adjustments 1-2 bil
--total 5 bil in Q2 08
Wednesday, April 16, 2008
Tech Seems Immune from Subprime Fallout
International Business Machines Corp. posted a 26% jump in first-quarter profit, supporting investors' hopes that corporate spending, especially overseas, may be a bulwark against the deteriorating U.S. economic picture.
IBM reported net income of $2.32 billion, or $1.65 a share, up from $1.84 billion, or $1.21 a share, a year earlier. Per-share earnings rose by 36% because IBM has been buying in its shares aggressively to reduce the number of shares outstanding.
Coupled with Tuesday's bullish outlook from semiconductor giant Intel Corp., IBM's results and profit forecast appeared to show that some technology companies are so far escaping fallout from the U.S. subprime mortgage crisis and the subsequent consumer slowdown.
一季度国民经济运行总体平稳（2008年4月16日）
中华人民共和国国家统计局新闻发言人 李晓超
今年以来，面对国内遭遇历史罕见的低温雨雪冰冻灾害、国际次贷危机不断蔓延和加深的严峻复杂形势，通过采取措施，有效应对，国民经济保持了平稳较快发展。
初步核算，一季度国内生产总值61491亿元，按可比价格计算，同比增长10.6%，比上年同期回落1.1个百分点。其中，第一产业增加值4720亿元，增长2.8%，回落1.6个百分点；第二产业增加值30778亿元，增长11.5%，回落1.7个百分点；第三产业增加值25993亿元，增长10.9%，回落0.4个百分点。
1、农业灾后重建进展顺利，春耕生产势头较好。尽管年初的低温雨雪冰冻灾害对部分地区农业生产造成了不同程度的影响，但各地灾后恢复重建工作效果显著，农业生产整体恢复状况良好。根据农作物种植意向调查，预计全国粮食播种面积10562万公顷，其中夏粮2674万公顷，早稻583万公顷，秋粮7305万公顷。目前冬小麦长势良好，总体好于前期和上年同期，冬小麦一、二类苗比例为82.3%，比上年同期增加2.8个百分点。一季度，猪牛羊禽肉产量1917万吨，同比增长3.7%，其中猪肉产量1284万吨，增长2.3%。
2、工业生产增速减缓，企业利润增幅回落。一季度，全国规模以上工业增加值同比增长16.4%（3月份增长17.8%），比上年同期回落1.9个百分点。分企业类型看，国有及国有控股企业增加值增长12.9%；集体企业增长11.6%；股份制企业增长18.9%；外商及港澳台投资企业增长14.3%。分轻重工业看，重工业增长17.3%，轻工业增长14.7%。分产品看，发电量和原煤产量分别增长14.0%和14.6%；粗钢和钢材产量分别增长8.6%和12.2%；汽车增长15.8%，其中轿车增长14.7%。工业产销衔接状况良好。一季度，工业产品销售率为97.7%，比上年同期提高0.5个百分点。
1-2月份，全国规模以上工业实现利润3482亿元(50%)，同比增长16.5%，比上年同期回落27.3个百分点。在39个工业大类行业中，34个行业利润同比增长。新增利润前五大行业是：石油和天然气开采业、煤炭开采和洗选业、交通运输设备制造业、农副食品加工业、通信设备计算机及其他电子设备制造业。由于原油、煤炭价格大幅上涨，石油加工炼焦及核燃料加工业由去年的盈利转为亏损，电力、热力的生产和供应业盈利大幅度下降。若剔除这两个行业，其它行业实现利润同比增长37.5%，上升6.1个百分点。
3、固定资产投资平稳增长，中西部地区投资所占比重上升。一季度，全社会固定资产投资21845亿元(35%)，同比增长24.6%，比上年同期加快0.9个百分点。其中，城镇固定资产投资18317亿元，增长25.9%，加快0.6个百分点；农村固定资产投资3529亿元，增长18.3%，加快1.6个百分点。在城镇固定资产投资中，房地产开发投资4688亿元，增长32.3%，同比加快5.4个百分点。分产业看，三次产业投资分别增长80.8%、25.9%和25.3%。分地区看，东、中、西部地区城镇投资分别增长22.3%、35.2%和27.7%，中、西部投资占全国投资的比重分别比上年同期提高1.5和0.2个百分点。
4、国内市场销售增长加快，城乡消费均保持快速增长。一季度，社会消费品零售总额25555亿元(35%)，同比增长20.6%（3月份增长21.5%），比上年同期加快5.7个百分点。其中，城市消费品零售额17377亿元，增长21.2%；县及县以下消费品零售额8178亿元，增长19.3%。分行业看，批发和零售业消费品零售额21490亿元，增长20.4%；住宿和餐饮业3687亿元，增长23.6%。限额以上批发零售贸易业大类商品零售中，汽车类、石油及制品类、家具类和金银珠宝类均增长30%以上。
5、价格总水平处于高位，房屋销售价格继续上涨。一季度，居民消费价格总水平上涨8.0%（3月份同比上涨8.3%，环比下降0.7%），涨幅比上年同期高5.3个百分点。其中，城市上涨7.8%，农村上涨8.7%。分类别看，一季度，食品价格上涨21.0%，拉动价格总水平上涨6.8个百分点；居住价格上涨6.6%，拉动价格总水平上涨1个百分点；其余各类商品价格略有涨跌。一季度，商品零售价格同比上涨7.4%（3月份上涨7.8%），比上年同期高5.3个百分点；工业品出厂价格同比上涨6.9%（3月份上涨8.0%），比上年同期高4.0个百分点；原材料、燃料、动力购进价格同比上涨9.8%（3月份上涨11.0%），比上年同期高5.7个百分点；70个大中城市房屋销售价格同比上涨11.0%（3月份上涨10.7%），比上年同期高5.4个百分点。
6、出口增速回落，实际使用外资增长加快。一季度，进出口总额5704亿美元，同比增长24.6%，比上年同期加快1.3个百分点。其中，出口3059亿美元，增长21.4%，回落6.4个百分点;进口2645亿美元，增长28.6%，加快10.4个百分点。贸易顺差414亿美元，同比减少49亿美元。从动态看，2月份因受上年基数较高的影响，出口同比增长6.5%，增速回落45.2个百分点，但3月份增速又恢复到增长30.6%的水平，加快23.7个百分点。一季度，实际使用外商直接投资274亿美元，同比增长61.3%。3月末，国家外汇储备余额16822亿美元，比上年末增加1539亿美元。
7、城乡居民收入继续提高，城镇新增就业稳定增加。一季度，城镇居民人均可支配收入4386元，同比增长11.5%。农村居民人均现金收入1494元，同比增长18.5%。一季度，全国城镇新增就业人数303万人，完成全年新增就业1000万人目标的30.3%。其中，下岗失业人员实现再就业128万人，完成全年实现再就业500万人目标的25.6%。
8、货币供应量增速回落，新增贷款有所减少。3月末，广义货币（M2）余额423055亿元，同比增长16.3%，比上年同期回落1个百分点；狭义货币供应量(M1)150867亿元，增长18.3%，回落1.6个百分点；流通中现金（M0）30433亿元，增长11.1%，回落5.6个百分点。金融机构各项贷款比年初增加13326亿元，同比少增891亿元。各项存款增加26353亿元，多增7606亿元。1-3月份，货币净投放58亿元，同比少投放258亿元。
当前要坚持以科学发展观为指导，认真贯彻落实中央经济工作会议和政府工作报告的各项部署，继续实施稳健的财政政策和从紧的货币政策，按照控总量、稳物价、调结构、促平衡的指导思想，把握宏观调控的节奏、重点和力度，力争实现国民经济又好又快发展。
今年以来，面对国内遭遇历史罕见的低温雨雪冰冻灾害、国际次贷危机不断蔓延和加深的严峻复杂形势，通过采取措施，有效应对，国民经济保持了平稳较快发展。
初步核算，一季度国内生产总值61491亿元，按可比价格计算，同比增长10.6%，比上年同期回落1.1个百分点。其中，第一产业增加值4720亿元，增长2.8%，回落1.6个百分点；第二产业增加值30778亿元，增长11.5%，回落1.7个百分点；第三产业增加值25993亿元，增长10.9%，回落0.4个百分点。
1、农业灾后重建进展顺利，春耕生产势头较好。尽管年初的低温雨雪冰冻灾害对部分地区农业生产造成了不同程度的影响，但各地灾后恢复重建工作效果显著，农业生产整体恢复状况良好。根据农作物种植意向调查，预计全国粮食播种面积10562万公顷，其中夏粮2674万公顷，早稻583万公顷，秋粮7305万公顷。目前冬小麦长势良好，总体好于前期和上年同期，冬小麦一、二类苗比例为82.3%，比上年同期增加2.8个百分点。一季度，猪牛羊禽肉产量1917万吨，同比增长3.7%，其中猪肉产量1284万吨，增长2.3%。
2、工业生产增速减缓，企业利润增幅回落。一季度，全国规模以上工业增加值同比增长16.4%（3月份增长17.8%），比上年同期回落1.9个百分点。分企业类型看，国有及国有控股企业增加值增长12.9%；集体企业增长11.6%；股份制企业增长18.9%；外商及港澳台投资企业增长14.3%。分轻重工业看，重工业增长17.3%，轻工业增长14.7%。分产品看，发电量和原煤产量分别增长14.0%和14.6%；粗钢和钢材产量分别增长8.6%和12.2%；汽车增长15.8%，其中轿车增长14.7%。工业产销衔接状况良好。一季度，工业产品销售率为97.7%，比上年同期提高0.5个百分点。
1-2月份，全国规模以上工业实现利润3482亿元(50%)，同比增长16.5%，比上年同期回落27.3个百分点。在39个工业大类行业中，34个行业利润同比增长。新增利润前五大行业是：石油和天然气开采业、煤炭开采和洗选业、交通运输设备制造业、农副食品加工业、通信设备计算机及其他电子设备制造业。由于原油、煤炭价格大幅上涨，石油加工炼焦及核燃料加工业由去年的盈利转为亏损，电力、热力的生产和供应业盈利大幅度下降。若剔除这两个行业，其它行业实现利润同比增长37.5%，上升6.1个百分点。
3、固定资产投资平稳增长，中西部地区投资所占比重上升。一季度，全社会固定资产投资21845亿元(35%)，同比增长24.6%，比上年同期加快0.9个百分点。其中，城镇固定资产投资18317亿元，增长25.9%，加快0.6个百分点；农村固定资产投资3529亿元，增长18.3%，加快1.6个百分点。在城镇固定资产投资中，房地产开发投资4688亿元，增长32.3%，同比加快5.4个百分点。分产业看，三次产业投资分别增长80.8%、25.9%和25.3%。分地区看，东、中、西部地区城镇投资分别增长22.3%、35.2%和27.7%，中、西部投资占全国投资的比重分别比上年同期提高1.5和0.2个百分点。
4、国内市场销售增长加快，城乡消费均保持快速增长。一季度，社会消费品零售总额25555亿元(35%)，同比增长20.6%（3月份增长21.5%），比上年同期加快5.7个百分点。其中，城市消费品零售额17377亿元，增长21.2%；县及县以下消费品零售额8178亿元，增长19.3%。分行业看，批发和零售业消费品零售额21490亿元，增长20.4%；住宿和餐饮业3687亿元，增长23.6%。限额以上批发零售贸易业大类商品零售中，汽车类、石油及制品类、家具类和金银珠宝类均增长30%以上。
5、价格总水平处于高位，房屋销售价格继续上涨。一季度，居民消费价格总水平上涨8.0%（3月份同比上涨8.3%，环比下降0.7%），涨幅比上年同期高5.3个百分点。其中，城市上涨7.8%，农村上涨8.7%。分类别看，一季度，食品价格上涨21.0%，拉动价格总水平上涨6.8个百分点；居住价格上涨6.6%，拉动价格总水平上涨1个百分点；其余各类商品价格略有涨跌。一季度，商品零售价格同比上涨7.4%（3月份上涨7.8%），比上年同期高5.3个百分点；工业品出厂价格同比上涨6.9%（3月份上涨8.0%），比上年同期高4.0个百分点；原材料、燃料、动力购进价格同比上涨9.8%（3月份上涨11.0%），比上年同期高5.7个百分点；70个大中城市房屋销售价格同比上涨11.0%（3月份上涨10.7%），比上年同期高5.4个百分点。
6、出口增速回落，实际使用外资增长加快。一季度，进出口总额5704亿美元，同比增长24.6%，比上年同期加快1.3个百分点。其中，出口3059亿美元，增长21.4%，回落6.4个百分点;进口2645亿美元，增长28.6%，加快10.4个百分点。贸易顺差414亿美元，同比减少49亿美元。从动态看，2月份因受上年基数较高的影响，出口同比增长6.5%，增速回落45.2个百分点，但3月份增速又恢复到增长30.6%的水平，加快23.7个百分点。一季度，实际使用外商直接投资274亿美元，同比增长61.3%。3月末，国家外汇储备余额16822亿美元，比上年末增加1539亿美元。
7、城乡居民收入继续提高，城镇新增就业稳定增加。一季度，城镇居民人均可支配收入4386元，同比增长11.5%。农村居民人均现金收入1494元，同比增长18.5%。一季度，全国城镇新增就业人数303万人，完成全年新增就业1000万人目标的30.3%。其中，下岗失业人员实现再就业128万人，完成全年实现再就业500万人目标的25.6%。
8、货币供应量增速回落，新增贷款有所减少。3月末，广义货币（M2）余额423055亿元，同比增长16.3%，比上年同期回落1个百分点；狭义货币供应量(M1)150867亿元，增长18.3%，回落1.6个百分点；流通中现金（M0）30433亿元，增长11.1%，回落5.6个百分点。金融机构各项贷款比年初增加13326亿元，同比少增891亿元。各项存款增加26353亿元，多增7606亿元。1-3月份，货币净投放58亿元，同比少投放258亿元。
当前要坚持以科学发展观为指导，认真贯彻落实中央经济工作会议和政府工作报告的各项部署，继续实施稳健的财政政策和从紧的货币政策，按照控总量、稳物价、调结构、促平衡的指导思想，把握宏观调控的节奏、重点和力度，力争实现国民经济又好又快发展。
Wells Fargo Q1 08
-- Wells Fargo & Co., the biggest bankon the U.S. West Coast, said first-quarter profit fell less thananalysts estimated as the company limited losses from the declinein California home prices. The bank rose 7.4 percent in earlytrading.
--Net income dropped 11 percent to $2 billion, or 60 cents ashare, from $2.24 billion, or 66 cents, a year earlier, the SanFrancisco-based company said today in a statement.
--Earningsincluded a $334 million gain from Visa Inc.'s initial publicoffering. Analysts were estimating Wells Fargo would earn 57cents a share, according to a survey compiled by Bloomberg.
Wells Fargo was profitable even as competitors such asWachovia Corp. and Washington Mutual Inc. posted losses becauseof the slumping West Coast housing market. The company is thenation's second-largest home lender behind Countrywide FinancialCorp., which is selling itself to Bank of America Corp. afterbeing crippled by bad home loans.
``This bank has the most conservative credit culture of anymajor bank and the strongest sales culture,'' said Robert Millen,a fund manager at Portland, Oregon-based Jensen InvestmentManagement Inc., which held 3.3 million Wells Fargo shares as ofDec. 31. ``They've not gotten too much into these exoticinstruments that are causing problems at so many other bigbanks.''
First-quarter revenue at Wells Fargo increased 12 percent to$10.6 billion. Net charge-offs, the cost of bad loans that won't be fully repaid, jumped to $1.53 billion from $1.21 billion inthe fourth quarter. Charge-offs for consumer loans, which includecredit cards and automobile financing, rose 26 percent to $1.21billion.
--Provision 2 bil
--Net charge-offs 1.5 bil
--allowance 5 bil vs 4 bil Q1 07
--Net income dropped 11 percent to $2 billion, or 60 cents ashare, from $2.24 billion, or 66 cents, a year earlier, the SanFrancisco-based company said today in a statement.
--Earningsincluded a $334 million gain from Visa Inc.'s initial publicoffering. Analysts were estimating Wells Fargo would earn 57cents a share, according to a survey compiled by Bloomberg.
Wells Fargo was profitable even as competitors such asWachovia Corp. and Washington Mutual Inc. posted losses becauseof the slumping West Coast housing market. The company is thenation's second-largest home lender behind Countrywide FinancialCorp., which is selling itself to Bank of America Corp. afterbeing crippled by bad home loans.
``This bank has the most conservative credit culture of anymajor bank and the strongest sales culture,'' said Robert Millen,a fund manager at Portland, Oregon-based Jensen InvestmentManagement Inc., which held 3.3 million Wells Fargo shares as ofDec. 31. ``They've not gotten too much into these exoticinstruments that are causing problems at so many other bigbanks.''
First-quarter revenue at Wells Fargo increased 12 percent to$10.6 billion. Net charge-offs, the cost of bad loans that won't be fully repaid, jumped to $1.53 billion from $1.21 billion inthe fourth quarter. Charge-offs for consumer loans, which includecredit cards and automobile financing, rose 26 percent to $1.21billion.
--Provision 2 bil
--Net charge-offs 1.5 bil
--allowance 5 bil vs 4 bil Q1 07
JPMorgan Q1 2008
--Earning 2.4 bil, -50% drop from 4.8 bil in Q1 07
--Add 2.5 bil to alloance for credit losses (total 12.6 bil)
--provision 5 bil
--Tier 1 capital 8.3%
--total asset 755 bil
Investment Bank
--Net Rev 3 bil, -50% drop from 6.3 bil in Q1 07, reflecting lower underwriting fees and markdown of 1.2 bil on prime, Alt-A an subprime mortgges; markdown of 1.1 bil on leveraged lending; markdown of 266 mil CDO; offset by equity and rate, and currencies.
--provision 618 mil vs 63 mil Q1 07. The current-quarter provision reflects an increase of $605 million in the allowance for credit losses, reflecting the impact of the transfer of $4.9 billion of leveraged lending commitments to retained loans from held-for-sale loans and the effect of a weakening credit environment. Net charge-offs were $13 million, compared with net recoveries of $6 million in the prior year.
Retail Financial Services
--Net loss 227 mil vs 859 mil in Q1 07, due to an increase in the provision.
--Provision 2.5 bil, vs 292 mil in Q1 07, reflecting 1.1 bil in allowanc efor loan losses realted to HEL; 417 mil increas in the allowance for loan losses related to subprime mortgage loan.
--exposure: HEL 95 bil, mortgage 47 bil
Card Services
--Net Rev: 3.9 bil vs 3.7 bil Q1 07
--provision increased at smaller pace
--loan exposure 151 bil
Credit Data and Quality of IBanking
--Nonperforming loans: 321 mil vs 92 bil Q1 07, other nonperforming assets 118 mil vs 36 mil
--allowance for credit losses 2.5 Q1 08 vs 1.4 Q1 07
--provision 618 mil vs 63 mil Q1 07
--but net charge off is just 13 mil vs -6 mil Q1 07
Credit Data and Quality of IBanking
--Nonperforming loans: 3.2 bil vs 1.7 bil Q1 07, other nonperforming assets 2.8 bil vs 1.9 bil
--allowance for credit losses 4.2 Q1 08 vs 1.5 Q1 07
--provision 2.5 bil vs 292 mil Q1 07
--net charge-offs 789 mil vs 185 mil Q1 07
--Add 2.5 bil to alloance for credit losses (total 12.6 bil)
--provision 5 bil
--Tier 1 capital 8.3%
--total asset 755 bil
Investment Bank
--Net Rev 3 bil, -50% drop from 6.3 bil in Q1 07, reflecting lower underwriting fees and markdown of 1.2 bil on prime, Alt-A an subprime mortgges; markdown of 1.1 bil on leveraged lending; markdown of 266 mil CDO; offset by equity and rate, and currencies.
--provision 618 mil vs 63 mil Q1 07. The current-quarter provision reflects an increase of $605 million in the allowance for credit losses, reflecting the impact of the transfer of $4.9 billion of leveraged lending commitments to retained loans from held-for-sale loans and the effect of a weakening credit environment. Net charge-offs were $13 million, compared with net recoveries of $6 million in the prior year.
Retail Financial Services
--Net loss 227 mil vs 859 mil in Q1 07, due to an increase in the provision.
--Provision 2.5 bil, vs 292 mil in Q1 07, reflecting 1.1 bil in allowanc efor loan losses realted to HEL; 417 mil increas in the allowance for loan losses related to subprime mortgage loan.
--exposure: HEL 95 bil, mortgage 47 bil
Card Services
--Net Rev: 3.9 bil vs 3.7 bil Q1 07
--provision increased at smaller pace
--loan exposure 151 bil
Credit Data and Quality of IBanking
--Nonperforming loans: 321 mil vs 92 bil Q1 07, other nonperforming assets 118 mil vs 36 mil
--allowance for credit losses 2.5 Q1 08 vs 1.4 Q1 07
--provision 618 mil vs 63 mil Q1 07
--but net charge off is just 13 mil vs -6 mil Q1 07
Credit Data and Quality of IBanking
--Nonperforming loans: 3.2 bil vs 1.7 bil Q1 07, other nonperforming assets 2.8 bil vs 1.9 bil
--allowance for credit losses 4.2 Q1 08 vs 1.5 Q1 07
--provision 2.5 bil vs 292 mil Q1 07
--net charge-offs 789 mil vs 185 mil Q1 07
Tuesday, April 15, 2008
Bankruptcies Rise in Subprime Fallout
U.S. corporate bankruptcies areaccelerating as the economic slowdown compounds the end of easycredit.
The filing by Frontier Airlines Holdings Inc. April 11followed those of three other airlines and companies in restaurants and retailing this year. Increased levels ofdistressed corporate debt signal that failures will accelerate,says Lynn LoPucki, a professor at the University of California,Los Angeles law school who studies bankruptcies.
The amount of distressed corporate bonds jumped to $206billion April 11 from $4.4 billion in March 2007, according to aMerrill Lynch & Co. index of bonds yielding at least 10percentage points more than Treasuries. The share of leveragedloans considered distressed was 16 percent at the end of March,the highest since 1997, says Standard & Poor's, based on loanstrading below 80 percent of their face value.
Some of the early bankruptcy filers this year reflect thedecline in the housing industry, including homebuilder TousaInc. of Hollywood, Florida, and moving company Sirva Inc., ofWestmont, Illinois. Now following them are small airlinesfighting rising fuel costs and competition from bigger carriers.
Virgin America Inc., the startup airline partly owned byU.K. billionaire Richard Branson, may be among the next airlinesto fail, analysts at JPMorgan Chase & Co. and Avondale PartnersLLC wrote in April 7 reports. The private airline lost $34.8million in its first quarter of operation, which ended Sept. 30.
Sagging Purchasing Power
Some issuers of bonds that are currently distressed, orconsidered at risk of default, are affected by cutbacks inspending by consumers. They include Claire's Stores Inc. ofPembroke Pines, Florida; Michael's Stores Inc. of Irving, Texas;and Herbst Gaming Inc., Tropicana Entertainment LLC and StationCasinos Inc., all of Las Vegas.
Linens 'n Things Inc., the Clifton, New Jersey-basedhousewares retailer, hired a restructuring company to explore
The highest default rate for speculative bonds and loanssince 1983 was 9.98 percent in 2001, during the last U.S.recession. The average annual default rate over the same periodwas 4.48 percent, Moody's says.
Default rates may not rise along with a company's financialdistress this time as they have in the past because somecompanies got so-called ``covenant lite'' loans, withoutrestrictions that can trigger defaults, said Kenneth Emery,Moody's director of corporate default research, in an interview.The covenants are usually financial ratios that measure abilityto service debts, such as a quarterly limit on total debtrelated to cash flow.
The filing by Frontier Airlines Holdings Inc. April 11followed those of three other airlines and companies in restaurants and retailing this year. Increased levels ofdistressed corporate debt signal that failures will accelerate,says Lynn LoPucki, a professor at the University of California,Los Angeles law school who studies bankruptcies.
The amount of distressed corporate bonds jumped to $206billion April 11 from $4.4 billion in March 2007, according to aMerrill Lynch & Co. index of bonds yielding at least 10percentage points more than Treasuries. The share of leveragedloans considered distressed was 16 percent at the end of March,the highest since 1997, says Standard & Poor's, based on loanstrading below 80 percent of their face value.
Some of the early bankruptcy filers this year reflect thedecline in the housing industry, including homebuilder TousaInc. of Hollywood, Florida, and moving company Sirva Inc., ofWestmont, Illinois. Now following them are small airlinesfighting rising fuel costs and competition from bigger carriers.
Virgin America Inc., the startup airline partly owned byU.K. billionaire Richard Branson, may be among the next airlinesto fail, analysts at JPMorgan Chase & Co. and Avondale PartnersLLC wrote in April 7 reports. The private airline lost $34.8million in its first quarter of operation, which ended Sept. 30.
Sagging Purchasing Power
Some issuers of bonds that are currently distressed, orconsidered at risk of default, are affected by cutbacks inspending by consumers. They include Claire's Stores Inc. ofPembroke Pines, Florida; Michael's Stores Inc. of Irving, Texas;and Herbst Gaming Inc., Tropicana Entertainment LLC and StationCasinos Inc., all of Las Vegas.
Linens 'n Things Inc., the Clifton, New Jersey-basedhousewares retailer, hired a restructuring company to explore
The highest default rate for speculative bonds and loanssince 1983 was 9.98 percent in 2001, during the last U.S.recession. The average annual default rate over the same periodwas 4.48 percent, Moody's says.
Default rates may not rise along with a company's financialdistress this time as they have in the past because somecompanies got so-called ``covenant lite'' loans, withoutrestrictions that can trigger defaults, said Kenneth Emery,Moody's director of corporate default research, in an interview.The covenants are usually financial ratios that measure abilityto service debts, such as a quarterly limit on total debtrelated to cash flow.
Markit Index is Questioned
The Commercial Mortgage Securities Association, an industrybody whose more than 470 members include banks, pension fundsand real-estate owners, wrote an open letter to Markit thismonth asking for details on the amount of trading on the CMBX tohelp gauge how useful its prices are for valuing mortgagesecurities.
``In a volatile market, this mark-to-market process becomes a self-fulfilling prophecy, driving prices down based on index trading activity rather than asset fundamentals,'' wrote DottieCunningham, chief executive officer of the New York-based CMSA.
``In a volatile market, this mark-to-market process becomes a self-fulfilling prophecy, driving prices down based on index trading activity rather than asset fundamentals,'' wrote DottieCunningham, chief executive officer of the New York-based CMSA.
Top 3 Fixed Income Asset Mgr
BlackRock, which has $513 billion in fixed-income assets,ranks third among U.S. bond managers. Newport Beach, California-based Pimco manages $746 billion and Legg Mason in Baltimore has$514.5 billion of bond assets.
BlackRock has not been completely immune to losses oncollateralized debt obligations, which are securities backed bybonds and mortgages. The firm, which manages about $20 billion in CDO funds, incurred a $12 million expense in the fourthquarter on the securities. BlackRock also spent $18 million inthe quarter to support the net asset value of two enhanced cash funds whose values fell as the credit markets got squeezed.
BlackRock has not been completely immune to losses oncollateralized debt obligations, which are securities backed bybonds and mortgages. The firm, which manages about $20 billion in CDO funds, incurred a $12 million expense in the fourthquarter on the securities. BlackRock also spent $18 million inthe quarter to support the net asset value of two enhanced cash funds whose values fell as the credit markets got squeezed.
STT Q1 08
--EPS 1.39 vs 1.3 est
--Rev 2.57 vw 2.48 Q4 07, almost flat
--Salaries and employee benefits 1.062 vs 0.793 bil, 20% increase
Others
--Agency MBS 14 bil, 100 mil mark down in Q4
--ABS 26 bil, 1 bil mark down in Q4
Conduits/ABCP
--1.5 bil mark down
--exposure 28.3 bil
--3.3 bil are wrapped by monoline insurer
--4 bil exposure to US RMBS (collateral are floating rate, Alt-A, HEL), WA FICO 714, WA LTV 74.8%
--Tier 1 leverage will decreased from 6.08% to 4.99% had these conduits consolidated
Investment Portfolio
--unrealzied loss 3.1 bil HTM and AFS
--exposure: AFS 68 bil, HTM 4.3 bil, 87% of them are AAA
--ABS collaterized by subprime mortgages 5.9 bil vs 6.2 bil Q4 2007
--Rev 2.57 vw 2.48 Q4 07, almost flat
--Salaries and employee benefits 1.062 vs 0.793 bil, 20% increase
Others
--Agency MBS 14 bil, 100 mil mark down in Q4
--ABS 26 bil, 1 bil mark down in Q4
Conduits/ABCP
--1.5 bil mark down
--exposure 28.3 bil
--3.3 bil are wrapped by monoline insurer
--4 bil exposure to US RMBS (collateral are floating rate, Alt-A, HEL), WA FICO 714, WA LTV 74.8%
--Tier 1 leverage will decreased from 6.08% to 4.99% had these conduits consolidated
Investment Portfolio
--unrealzied loss 3.1 bil HTM and AFS
--exposure: AFS 68 bil, HTM 4.3 bil, 87% of them are AAA
--ABS collaterized by subprime mortgages 5.9 bil vs 6.2 bil Q4 2007
Monday, April 14, 2008
Bearn Stearns Q1 08
Liquidity Development
On February 29, 2008, the Company had available liquidity at the parent companyequal to $17.3 billion. However, over the course of the week of March 10, marketspeculation was that Bear Stearns was experiencing a serious liquidity problem.On the evening of March 10, 2008, the Company issued a press release denying themarket rumors. On Wednesday, March 12, 2008, the Company disclosed that its liquidity position was largely unchanged since the beginning of the year as contrasted with the unsubstantiated market rumor and speculation. During the course of the day on March 12, 2008, however, an increased volume of customers expressed a desire to withdraw funds from and certain counterparties expressed increased concern regarding maintaining their ordinary course exposure to Bear Stearns. Over the course of the day on March 13, 2008, an unusually high number of customers withdrew funds and a significant number of counterparties and lenders were unwilling to make secured financing available on customary terms,which resulted in a sharp deterioration in the Company's liquidity position. As of the evening of March 13, 2008, available liquidity declined materially and expected funding requirements on March 14, 2008 were significantly in excess of available liquidity. The inability to borrow against high quality collateral and rapid withdrawal of customer funds contributed to the liquidity issues. On the morning of March 14, 2008, the Company issued a press release announcing that it had obtained a secured lending facility from JPMorgan Chase and that it was discussing permanent financing and other alternatives with JPMorgan Chase. Despite this announcement, throughout the day on March 14, 2008, customerscontinued to withdraw funds at an increasing rate and counterparties continuedto seek to reduce their exposure to the Company also at an increasing rate. On the evening of March 14, 2008, the Company was informed that the secured lending facility that had been entered into earlier that day would not be available onMarch 17, 2008. On March 16, 2008, the Company and JPMorgan Chase entered into the agreement and plan of merger. JPMorgan Chase issued the Guaranty (as definedin Note 17) of the Company's trading and certain other obligations.
Despite the financial support from the merger agreement and the Guaranty, theCompany's liquidity position continued to deteriorate, customers continued towithdraw funds and funding (other than from JPMorgan Chase and the New York Fed)was not available. As of March 21, 2007, management estimated that Bear Stearnshad little to no available liquidity. On March 24, 2008, the Company andJPMorgan Chase entered into the amendment to the agreement and plan of merger,the share exchange agreement and certain other ancillary transaction documentsand JPMorgan Chase issued the guaranty to the New York Fed and the amended andrestated operating guaranty, which clarified and enhanced the terms of theguaranty.
As of February 29, 2008, the market value of eligible unencumbered, unhypothecated financial instruments owned by the Company was approximately$14.4 billion with a borrowing value of $12.3 billion. These eligible assets areprimarily comprised of U.S. equities and residential and commercial mortgage whole loans, mortgage- and asset-backed securities, investment grade municipaland corporate bonds. The vast majority of advance rates on these different assettypes are 70% or higher, and as described above, is based predominantly on committed, secured facilities that the Company and its subsidiaries maintain indifferent regions globally. The liquidity ratio, explained above, based solely on Company-owned securities, has averaged 161% over the previous 12 months, including the Company's $2.9 billion unused committed unsecured bank credit, and 145%, excluding the committed unsecured revolving credit facility. On this samebasis, as of February 29, 2008 the liquidity ratio was 183% and 167%,respectively.
The Company monitors unrestricted liquidity available to the Parent Company viathe ability to monetize unencumbered assets held in unregulated and regulatedentities. As of February 29, 2008, approximately $4.5 billion of the marketvalue identified in the liquidity ratio data above was held in unregulated entities and thus likely to be available to the Parent Company. The remaining$9.9 billion market value of unencumbered securities was held in regulatedentities, a portion of which may not be available to provide liquidity to theParent Company.
As of February 29, 2008 the Parent Company Liquidity Pool was $17.3 billion comprised entirely of money market funds, bank deposits and short-term high quality money market investments.
Liquidity comparison with Q4 07
Collateral
--Eligible collater borrowing value $12.3, declining from $14 bil
--parent unregulated $4.5 bil, dropping from $5.1 bil
Excess Liquidity
--17.3 bil, down from $17.4 bil
Total available liquidity around 30 bil, 10% of liability
Asset Quality
Mortgages, mortgage- and asset-backed Level 3, 22 bil exposure, 1.5 bil writedown in Q1 07.
At November 30, 2007, the Company had approximately $46 billion of mortgages,mortgage backed and asset backed securities including approximately $12 billionof floating rate commercial loans and approximately $3 billion of fixed ratecommercial loans.
Conclusions:
--Until March 10, Bearn Stearns has similar position as Dec 31th, 2007
--Liqidity issues caused the company to collapse. Its excess liquidity is too few (17 bil, 5% of liability) to hold up until secured lending was available.
--Overall liquidity is around 10%, not fewer
Why ETF is Tax Efficient as Opposed to Mutual Funds
Because most ETFs are mutual funds, you are also subject to many of the tax liabilities that apply to mutual funds. That is, when a fund is forced to sell stock to change its composition, for example, when an index rebalances, the fundholders have to pay capital gains on whatever the gain was of the stock that is sold. Here's where it gets tricky, though. ETFs have the potential to make that gain smaller than it might be in a traditional mutual fund. How? Simple. Because ETFs are created and redeemed with stock that is traded in-kind, it is possible to raise the overall cost-basis of the stock that underlies the fund. Whenever a basket of stock is redeemed, the fund gives the redeemer the lowest cost-basis underlying stock. It doesn't matter to the redeemer. He pays based on his individual cost-basis regardless. The net result is that the fund is holding higher cost-basis stock, making the exposure to capital gains less when a particular stock must be sold in rebalancing.
Slimmer Pickings for Vultures
Double-digit returns sound pretty attractive when the economy is slumping. So it's no surprise that cash ploughed into distressed-debt funds now tops $200 billion. These so-called vulture funds can return 30% or more annually during economic meltdowns. But credit-boom innovations will make it harder for them to wring such rewards out of the current rising level of defaults.
The best-performing vulture funds typically take an active role in a borrower's bankruptcy. They may snap up deeply discounted debt and hope it pops after a company restructures. Or they may seek to get the debt exchanged for equity, giving them a big stake in -- if not outright ownership of -- the restructured firm.
This now may be more complicated. First, the loan-market boom caused borrowers to pile on senior secured debt. Senior debtholders are first in line for company assets or equity. With more senior lenders to deal with, vulture investors may find it more expensive to acquire a controlling position.
Then there are second-lien loans. These credit-boom innovations are wedged between a company's senior-secured and senior-unsecured debt. But their rights in bankruptcy aren't well-established. Legal spats between senior secured and second-lien lenders over the division of spoils could gum up bankruptcy negotiations.
Meanwhile, so-called covenant-lite loans can allow troubled companies to stagger on for longer, burning through cash and leaving vulture investors with less meat to chew off their carcasses.
The news isn't all bad. The fact that collateralized debt obligations now hold lots of leveraged loans could be helpful. Some of these have to sell when the value of those loans drops. That is beginning to happen, and it means there should be a steady stream of cheap loans for vultures to swoop on.
The best-performing vulture funds typically take an active role in a borrower's bankruptcy. They may snap up deeply discounted debt and hope it pops after a company restructures. Or they may seek to get the debt exchanged for equity, giving them a big stake in -- if not outright ownership of -- the restructured firm.
This now may be more complicated. First, the loan-market boom caused borrowers to pile on senior secured debt. Senior debtholders are first in line for company assets or equity. With more senior lenders to deal with, vulture investors may find it more expensive to acquire a controlling position.
Then there are second-lien loans. These credit-boom innovations are wedged between a company's senior-secured and senior-unsecured debt. But their rights in bankruptcy aren't well-established. Legal spats between senior secured and second-lien lenders over the division of spoils could gum up bankruptcy negotiations.
Meanwhile, so-called covenant-lite loans can allow troubled companies to stagger on for longer, burning through cash and leaving vulture investors with less meat to chew off their carcasses.
The news isn't all bad. The fact that collateralized debt obligations now hold lots of leveraged loans could be helpful. Some of these have to sell when the value of those loans drops. That is beginning to happen, and it means there should be a steady stream of cheap loans for vultures to swoop on.
Wachovia Q1 08
--NI -350 mil, 2.3 bil Q2 07, reflecting market down valuation loss of $2 billion
--Revenu 7.9 bil
Parent Corp
--Provision for credit losses of $2.8 billion, which exceeded net charge-offs by $2.1 billion. The provision largely reflected more severe deterioration in the residential housing market, particularly in specific markets in California and Florida, as well as the result of the refinements made to the credit reserve model for the payment option product. These refinements incorporate multiple and more granular factors regarding unprecedented consumer behavior, housing price deterioration and increased foreclosures. Net charge-offs were $765 million, or an annualized 0.66 percent of average net loans. Total nonperforming assets including loans held for sale were $8.4 billion, or 1.70 percent of loans, foreclosed properties and loans held for sale, largely reflecting increases in consumer real estate-related nonperforming assets due to the effects of the weakened housing industry.
--Provision for end 2007 is 1.497 bil + net charge off this Q (765 mil) = 2.2 bil. 2.2/(8.4 + 2.2) = 20%, write off rate
Corporate and Investment Banking
•Market valuation losses, net of applicable hedges, of:
•$339 million in subprime residential asset-backed collateralized debt obligations and other related exposures, compared with $818 million in fourth quarter 2007, excluding discontinued operations;
•$521 million in commercial mortgage structured products, compared with $600 million in fourth quarter 2007;
•$251 million in consumer mortgage structured products, compared with $123 million in fourth quarter 2007;
•$309 million in leveraged finance net of fees, compared with a net $93 million gain in fourth quarter 2007; and
•$144 million in non-subprime collateralized debt obligations and other structured products, compared with a $59 million net gain in fourth quarter 2007.
Loan Portfolio
--480 bil Q1 08 vs 462 bil Q4 07; 230 bil of them are consumer real esta secured
allowance bal at the beg 3,514
provision for credit 175
loan losses (218)
loan recover 63
allowance bal at the beg 3,534
--Revenu 7.9 bil
Parent Corp
--Provision for credit losses of $2.8 billion, which exceeded net charge-offs by $2.1 billion. The provision largely reflected more severe deterioration in the residential housing market, particularly in specific markets in California and Florida, as well as the result of the refinements made to the credit reserve model for the payment option product. These refinements incorporate multiple and more granular factors regarding unprecedented consumer behavior, housing price deterioration and increased foreclosures. Net charge-offs were $765 million, or an annualized 0.66 percent of average net loans. Total nonperforming assets including loans held for sale were $8.4 billion, or 1.70 percent of loans, foreclosed properties and loans held for sale, largely reflecting increases in consumer real estate-related nonperforming assets due to the effects of the weakened housing industry.
--Provision for end 2007 is 1.497 bil + net charge off this Q (765 mil) = 2.2 bil. 2.2/(8.4 + 2.2) = 20%, write off rate
Corporate and Investment Banking
•Market valuation losses, net of applicable hedges, of:
•$339 million in subprime residential asset-backed collateralized debt obligations and other related exposures, compared with $818 million in fourth quarter 2007, excluding discontinued operations;
•$521 million in commercial mortgage structured products, compared with $600 million in fourth quarter 2007;
•$251 million in consumer mortgage structured products, compared with $123 million in fourth quarter 2007;
•$309 million in leveraged finance net of fees, compared with a net $93 million gain in fourth quarter 2007; and
•$144 million in non-subprime collateralized debt obligations and other structured products, compared with a $59 million net gain in fourth quarter 2007.
Loan Portfolio
--480 bil Q1 08 vs 462 bil Q4 07; 230 bil of them are consumer real esta secured
allowance bal at the beg 3,514
provision for credit 175
loan losses (218)
loan recover 63
allowance bal at the beg 3,534
Saturday, April 12, 2008
Bear Reveals Plunge in Sales, Trading
As of March 24, customer margin balances, an important measure of how much money hedge funds and other trading firms are borrowing from the firm to make transactions, had shrunk 23% to $66 billion from $86 billion on Nov. 30.
In disclosing the exodus of hedge funds and other clients who use Bear's clearing services, also known as its prime-brokerage unit, to borrow money for trades and obtain other trading services, Bear added that customer short positions -- or bets that certain securities would fall, made by borrowing stock from Bear -- had fallen to $66 billion at March 24, a 25% drop from Nov. 30. "A substantial number of prime brokerage clients have moved accounts to other clearing brokers," Bear Stearns said.
Summary of Liquidity Review
Lazard reviewed Bear Stearns’ management’s estimates of Bear Stearns’ liquidity during the period leading up to the execution of the merger agreement. On March 10, 2008, management estimated that Bear Stearns had available liquidity equal to approximately $18.3 billion. As of March 14, 2008, management estimated that this amount had decreased to no more than $4.8 billion, and Bear Stearns had anticipated funding requirements of between $60 billion and $100 billion assuming counterparties to secured repo facilities were unwilling to renew these facilities on March 17, 2008. In addition, as of March 21, 2007, management estimated that Bear Stearns had little to no available liquidity.
In disclosing the exodus of hedge funds and other clients who use Bear's clearing services, also known as its prime-brokerage unit, to borrow money for trades and obtain other trading services, Bear added that customer short positions -- or bets that certain securities would fall, made by borrowing stock from Bear -- had fallen to $66 billion at March 24, a 25% drop from Nov. 30. "A substantial number of prime brokerage clients have moved accounts to other clearing brokers," Bear Stearns said.
Summary of Liquidity Review
Lazard reviewed Bear Stearns’ management’s estimates of Bear Stearns’ liquidity during the period leading up to the execution of the merger agreement. On March 10, 2008, management estimated that Bear Stearns had available liquidity equal to approximately $18.3 billion. As of March 14, 2008, management estimated that this amount had decreased to no more than $4.8 billion, and Bear Stearns had anticipated funding requirements of between $60 billion and $100 billion assuming counterparties to secured repo facilities were unwilling to renew these facilities on March 17, 2008. In addition, as of March 21, 2007, management estimated that Bear Stearns had little to no available liquidity.
Paulson : 2008 will be a difficult year
We must expect more bumps in the road. 2008 will be difficult year, with headwinds coming from slumping U.S economy, soaring commodity prices, and higher than deseriable inflation.
It took time to build up recent excesses and it will take time to work through the consequences.
It is critical for policy makers to put in place sound policy frameworks that support growth and enhance economic resilience
---- text
Today's meeting takes place against the backdrop of considerable challenges to the global economy. In recent years, global economic conditions have been quite favorable, with growth averaging nearly 5% per year. 2008 will be a more difficult year, with headwinds coming from adjustments in the U.S. economy, financial market stress, higher commodity prices, and higher than desirable inflation. Downside risks will vary, and many European and emerging market economies have stood up relatively well so far to the recent financial turmoil, but no economy is entirely immune from global forces. In this context, it is critical for policy makers to put in place sound policy frameworks that support growth and enhance economic resilience.
While I am confident in the long-term economic prospects of the United States, clearly for the moment, the risks facing the U.S. economy are to the downside. We are responding vigorously. First, we have adjusted macroeconomic policy to support the broad U.S. economy while the corrections take place in the housing and credit markets. The President and Congress responded with a bipartisan fiscal stimulus package that will inject more than $150 billion into our economy in the near term and boost GDP growth this year. Second, the Administration has supported a number of initiatives ?/SPAN> both private-sector led and public-sector initiatives ?/SPAN> in response to the housing correction, designed to prevent avoidable foreclosures and maintain viable credit markets while allowing the needed adjustment to proceed.
Since last August, financial markets have been reassessing risk, re-pricing assets and de-leveraging. It took time to build up recent excesses and it will take time to work through the consequences. We must expect more bumps in the road. Global financial institutions are making progress, with some announcing write-downs and acting to raise capital. Additional disclosures of risks and material conditions and sound capitalization continue to be important, as does the ability of financial market participants to provide liquidity and of banks to extend credit. I have confidence in our capital markets and in their resilience, flexibility, and strength.
....
Openness to trade and investment helps underpin global growth and has been a source of strength for the U.S. economy. We remain committed to opposing protectionist sentiment wherever it may be found and to advancing greater openness globally. The Doha Development Round is at a critical juncture if negotiations are to be completed by the end of the year. The United States is willing to step forward with the necessary leadership ?however, a significant contribution by the advanced developing countries is critical to Doha's success. Doha's development promise can only be met through agreement to significantly open markets, including financial services markets.
It took time to build up recent excesses and it will take time to work through the consequences.
It is critical for policy makers to put in place sound policy frameworks that support growth and enhance economic resilience
---- text
Today's meeting takes place against the backdrop of considerable challenges to the global economy. In recent years, global economic conditions have been quite favorable, with growth averaging nearly 5% per year. 2008 will be a more difficult year, with headwinds coming from adjustments in the U.S. economy, financial market stress, higher commodity prices, and higher than desirable inflation. Downside risks will vary, and many European and emerging market economies have stood up relatively well so far to the recent financial turmoil, but no economy is entirely immune from global forces. In this context, it is critical for policy makers to put in place sound policy frameworks that support growth and enhance economic resilience.
While I am confident in the long-term economic prospects of the United States, clearly for the moment, the risks facing the U.S. economy are to the downside. We are responding vigorously. First, we have adjusted macroeconomic policy to support the broad U.S. economy while the corrections take place in the housing and credit markets. The President and Congress responded with a bipartisan fiscal stimulus package that will inject more than $150 billion into our economy in the near term and boost GDP growth this year. Second, the Administration has supported a number of initiatives ?/SPAN> both private-sector led and public-sector initiatives ?/SPAN> in response to the housing correction, designed to prevent avoidable foreclosures and maintain viable credit markets while allowing the needed adjustment to proceed.
Since last August, financial markets have been reassessing risk, re-pricing assets and de-leveraging. It took time to build up recent excesses and it will take time to work through the consequences. We must expect more bumps in the road. Global financial institutions are making progress, with some announcing write-downs and acting to raise capital. Additional disclosures of risks and material conditions and sound capitalization continue to be important, as does the ability of financial market participants to provide liquidity and of banks to extend credit. I have confidence in our capital markets and in their resilience, flexibility, and strength.
....
Openness to trade and investment helps underpin global growth and has been a source of strength for the U.S. economy. We remain committed to opposing protectionist sentiment wherever it may be found and to advancing greater openness globally. The Doha Development Round is at a critical juncture if negotiations are to be completed by the end of the year. The United States is willing to step forward with the necessary leadership ?however, a significant contribution by the advanced developing countries is critical to Doha's success. Doha's development promise can only be met through agreement to significantly open markets, including financial services markets.
Friday, April 11, 2008
LEH SPE vs VIE, SIV
Non-QSPE activities. We have transactional activity with SPEs that do not meet the QSPE criteria because their permitted activities are not limited sufficiently or the assets are non-qualifying financial instruments (e.g., real estate). These SPEs issue credit-linked notes, invest in real estate or are established for other structured financing transactions designed to meet clients’ investing or financing needs.
A collateralized debt obligation (“CDO”) transaction involves the purchase by an SPE of a diversified portfolio of securities and/or loans that are then managed by an independent asset manager. Interests in the SPE (debt and equity) are sold to third party investors. Our primary role in a CDO is to act as structuring and placement agent, warehouse provider, underwriter and market maker in the related CDO securities. In a typical CDO, at the direction of a third party asset manager, we will temporarily warehouse securities or loans on our balance sheet pending the sale to the SPE once the permanent financing is completed. At November 30, 2007 and 2006, we owned approximately $581.2 million and $55.1 million of equity securities in CDOs, respectively. Because our investments do not represent a majority of the CDOs’ equity, we are not exposed to the majority of the CDOs’ expected losses. Accordingly, we are not the primary beneficiary of the CDOs and therefore we do not consolidate them.
As a dealer in credit default swaps, we make a market in buying and selling credit protection on single issuers as well as on portfolios of credit exposures. We mitigate our credit risk, in part, by purchasing default protection through credit default swaps with SPEs. We pay a premium to the SPEs for assuming credit risk under the credit default swap. In these transactions, SPEs issue credit-linked notes to investors and use the proceeds to invest in high quality collateral. Our maximum potential loss associated with our involvement with such credit-linked note transactions is measured by the fair value of our credit default swaps with such SPEs. At November 30, 2007 and 2006, respectively, the fair values of these credit default swaps were $3.9 billion and $155 million. The underlying investment grade collateral held by SPEs where we are the first-lien holder was $15.7 billion and $10.8 billion at November 30, 2007 and 2006, respectively.
Because the investors assume default risk associated with both the reference portfolio and the SPEs’ assets, our expected loss calculations generally demonstrate the investors in the SPEs bear a majority of the entity’s expected losses. Accordingly, we generally are not the primary beneficiary and therefore do not consolidate these SPEs. In instances where we are the primary beneficiary of the SPEs, we consolidate the SPEs. At November 30, 2007 and 2006, we consolidated approximately $180 million and $718 million of these SPEs, respectively. The assets associated with these consolidated SPEs are presented as a component of Financial instruments and other inventory positions owned, and the liabilities are presented as a component of Other secured borrowings.
We also invest in real estate directly through consolidated subsidiaries and through VIEs. We consolidate our investments in real estate VIEs when we are the primary beneficiary. We record the assets of these consolidated real estate VIEs as a component of Financial instruments and other inventory positions owned, and the liabilities are presented as a component of Other secured borrowings. At November 30, 2007 and 2006, we consolidated approximately $9.8 billion and $3.4 billion, respectively, of real estate-related investments. After giving effect to non-recourse financing, our net investment position in these consolidated real estate VIEs was $6.0 billion and $2.2 billion at November 30, 2007 and 2006, respectively.
SIVs. A structured investment vehicle (“SIV”) is an entity that borrows money in the form of commercial paper, medium-term notes or subordinated capital notes, and uses the proceeds to purchase assets, including asset-backed or mortgage-backed securities. We do not own, manage or sponsor any SIVs. Our SIV-related exposure is limited to that acquired through proprietary investments or trading activity, specifically:
· At November 30, 2007, we had approximately $75 million of balance sheet exposure representing the aggregate of a fully drawn liquidity loan to a SIV, and medium-term notes and commercial paper issued by SIVs bought in the primary or secondary markets.
· We have entered into derivative transactions to which SIVs are counterparties. The total notional amount of these derivative transactions was approximately $4.1 billion at November 30, 2007. We believe the fair value of these derivative transactions is a more relevant measure of the obligations because we believe the notional amount overstates the expected payout. At November 30, 2007, the fair value of these derivative contracts approximated $50 million. For a further discussion of derivative transactions, see Note 9, “Commitments, Contingencies and Guarantees— Other Commitments and Guarantees,” to the Consolidated Financial Statements.
· Under resell or repurchase agreements, we have balance sheet exposure to commercial paper issued by SIVs. This exposure was approximately $14 million at November 30, 2007. For a further discussion of resell and repurchase agreements, see Note 5, “Securities Received and Pledged as Collateral,” to the Consolidated Financial Statements.
· We manage certain private equity and other alternative investment funds which are not consolidated into our results of operations. At November 30, 2007, a small percentage of the assets within those funds have SIV-related exposure.
A collateralized debt obligation (“CDO”) transaction involves the purchase by an SPE of a diversified portfolio of securities and/or loans that are then managed by an independent asset manager. Interests in the SPE (debt and equity) are sold to third party investors. Our primary role in a CDO is to act as structuring and placement agent, warehouse provider, underwriter and market maker in the related CDO securities. In a typical CDO, at the direction of a third party asset manager, we will temporarily warehouse securities or loans on our balance sheet pending the sale to the SPE once the permanent financing is completed. At November 30, 2007 and 2006, we owned approximately $581.2 million and $55.1 million of equity securities in CDOs, respectively. Because our investments do not represent a majority of the CDOs’ equity, we are not exposed to the majority of the CDOs’ expected losses. Accordingly, we are not the primary beneficiary of the CDOs and therefore we do not consolidate them.
As a dealer in credit default swaps, we make a market in buying and selling credit protection on single issuers as well as on portfolios of credit exposures. We mitigate our credit risk, in part, by purchasing default protection through credit default swaps with SPEs. We pay a premium to the SPEs for assuming credit risk under the credit default swap. In these transactions, SPEs issue credit-linked notes to investors and use the proceeds to invest in high quality collateral. Our maximum potential loss associated with our involvement with such credit-linked note transactions is measured by the fair value of our credit default swaps with such SPEs. At November 30, 2007 and 2006, respectively, the fair values of these credit default swaps were $3.9 billion and $155 million. The underlying investment grade collateral held by SPEs where we are the first-lien holder was $15.7 billion and $10.8 billion at November 30, 2007 and 2006, respectively.
Because the investors assume default risk associated with both the reference portfolio and the SPEs’ assets, our expected loss calculations generally demonstrate the investors in the SPEs bear a majority of the entity’s expected losses. Accordingly, we generally are not the primary beneficiary and therefore do not consolidate these SPEs. In instances where we are the primary beneficiary of the SPEs, we consolidate the SPEs. At November 30, 2007 and 2006, we consolidated approximately $180 million and $718 million of these SPEs, respectively. The assets associated with these consolidated SPEs are presented as a component of Financial instruments and other inventory positions owned, and the liabilities are presented as a component of Other secured borrowings.
We also invest in real estate directly through consolidated subsidiaries and through VIEs. We consolidate our investments in real estate VIEs when we are the primary beneficiary. We record the assets of these consolidated real estate VIEs as a component of Financial instruments and other inventory positions owned, and the liabilities are presented as a component of Other secured borrowings. At November 30, 2007 and 2006, we consolidated approximately $9.8 billion and $3.4 billion, respectively, of real estate-related investments. After giving effect to non-recourse financing, our net investment position in these consolidated real estate VIEs was $6.0 billion and $2.2 billion at November 30, 2007 and 2006, respectively.
SIVs. A structured investment vehicle (“SIV”) is an entity that borrows money in the form of commercial paper, medium-term notes or subordinated capital notes, and uses the proceeds to purchase assets, including asset-backed or mortgage-backed securities. We do not own, manage or sponsor any SIVs. Our SIV-related exposure is limited to that acquired through proprietary investments or trading activity, specifically:
· At November 30, 2007, we had approximately $75 million of balance sheet exposure representing the aggregate of a fully drawn liquidity loan to a SIV, and medium-term notes and commercial paper issued by SIVs bought in the primary or secondary markets.
· We have entered into derivative transactions to which SIVs are counterparties. The total notional amount of these derivative transactions was approximately $4.1 billion at November 30, 2007. We believe the fair value of these derivative transactions is a more relevant measure of the obligations because we believe the notional amount overstates the expected payout. At November 30, 2007, the fair value of these derivative contracts approximated $50 million. For a further discussion of derivative transactions, see Note 9, “Commitments, Contingencies and Guarantees— Other Commitments and Guarantees,” to the Consolidated Financial Statements.
· Under resell or repurchase agreements, we have balance sheet exposure to commercial paper issued by SIVs. This exposure was approximately $14 million at November 30, 2007. For a further discussion of resell and repurchase agreements, see Note 5, “Securities Received and Pledged as Collateral,” to the Consolidated Financial Statements.
· We manage certain private equity and other alternative investment funds which are not consolidated into our results of operations. At November 30, 2007, a small percentage of the assets within those funds have SIV-related exposure.
Regional Banks Will have More Issues
Earlier this week, deposit-taking banks paid 2.82% to borrow at the Federal Reserve's Term Auction Facility for 28 days, far above the one-month Libor rate of 2.722% on the day of the auction. Analysts said that indicates that money wasn't readily available at the rate at which Libor was trading.
Term Auction Facility is only open to depository insitutions, like FDIC banks and collateral has to be rgulatory standards. Most of their assets are loans and they can not sell them easily and do not have SPE to securitize these loans.
But Temp Securities Lending Facility only attracted limited order from investment banks, ~40 bil util last week. Most importantly, Investment's assets are securities. They can even securitized loans using their SPE.
Term Auction Facility is only open to depository insitutions, like FDIC banks and collateral has to be rgulatory standards. Most of their assets are loans and they can not sell them easily and do not have SPE to securitize these loans.
But Temp Securities Lending Facility only attracted limited order from investment banks, ~40 bil util last week. Most importantly, Investment's assets are securities. They can even securitized loans using their SPE.
Bankruptcy Starts NonFinancial setcotr - the first major shoe to drop in this retail sector
Linens 'n Things Inc., a home-furnishings retailer caught by an increasing debt load and shrinking housing market, is expected to file for Chapter 11 bankruptcy-court protection by Tuesday, several people familiar with the matter said.
A Linens 'n Things filing would mark one of the first major retailers to seek bankruptcy protection in this economic downturn. The New Jersey retailer, which sells home products like towels, bath rugs and kitchen appliances, has about 590 stores in 46 states and employs 17,000 people.
Linens would be one of the largest buyouts to go bust since the credit crisis took hold last summer. In February 2006, Apollo Management LP acquired Linens for $1.3 billion. The housing crisis made the home-furnishings space ultracompetitive, and the debt on the company's balance sheet gave it diminished flexibility to ride out the downturn.
In a recent letter to investors, Apollo founder Leon Black acknowledged that the company was troubled, explaining that while it had made operational improvements, its financial results "remain challenged." Apollo filed to go public in a share offering this week.
A Linens 'n Things filing would mark one of the first major retailers to seek bankruptcy protection in this economic downturn. The New Jersey retailer, which sells home products like towels, bath rugs and kitchen appliances, has about 590 stores in 46 states and employs 17,000 people.
Linens would be one of the largest buyouts to go bust since the credit crisis took hold last summer. In February 2006, Apollo Management LP acquired Linens for $1.3 billion. The housing crisis made the home-furnishings space ultracompetitive, and the debt on the company's balance sheet gave it diminished flexibility to ride out the downturn.
In a recent letter to investors, Apollo founder Leon Black acknowledged that the company was troubled, explaining that while it had made operational improvements, its financial results "remain challenged." Apollo filed to go public in a share offering this week.
Auction Market Shrinks by $51 Billion, With Failure Rate at 71%
April 11 (Bloomberg) -- The auction-rate securities marketis shrinking by at least 15 percent, or $51 billion, as U.S.municipal borrowers refinance to escape higher costs and closed-end funds begin to bail out investors.
States, cities, hospitals and colleges from Denver toWashington, D.C., have converted or are planning to replace atleast $43.1 billion of the debt, according to data compiled byBloomberg. Nuveen Investments Inc. and seven other fund managerssaid they will redeem $7.8 billion in taxable preferred sharesthat have rates set through periodic dealer-run auctions.
``On the municipal side, things are starting to unclog,''said Judy Wesalo Temel, director of credit research at Samson Capital Advisors LLC, a fixed-income manager in New York.
The Bond Buyer 20-Bond Index, a weekly gauge of long-termmunicipal yields, fell 29 basis points, the most in at least 18years, to 4.61 percent yesterday. That's the lowest since Feb.14, the week the auction market collapsed. A basis point is 0.01percentage point.
An index of rates on debt with auctions held every sevendays fell 1.05 percentage points to 5.67 percent on April 2, aneight-week low, according to the latest available data from theSecurities Industry and Financial Markets Association.
About 71 percent of weekly or monthly auctions, includingthose of student lenders, were unsuccessful this week, about thesame as last week, Bloomberg data show. Dealers, who typically stepped in with their own capital to prevent failures when thereweren't enough bidders, pulled back their support in February.
Auction-rate bonds had allowed issuers to achieve money-market-like costs on borrowings of 20 years or longer by havinginvestors bid regularly to change the rates and giving them theoption, though not the right, to move in and out of the debt.
States, cities, hospitals and colleges from Denver toWashington, D.C., have converted or are planning to replace atleast $43.1 billion of the debt, according to data compiled byBloomberg. Nuveen Investments Inc. and seven other fund managerssaid they will redeem $7.8 billion in taxable preferred sharesthat have rates set through periodic dealer-run auctions.
``On the municipal side, things are starting to unclog,''said Judy Wesalo Temel, director of credit research at Samson Capital Advisors LLC, a fixed-income manager in New York.
The Bond Buyer 20-Bond Index, a weekly gauge of long-termmunicipal yields, fell 29 basis points, the most in at least 18years, to 4.61 percent yesterday. That's the lowest since Feb.14, the week the auction market collapsed. A basis point is 0.01percentage point.
An index of rates on debt with auctions held every sevendays fell 1.05 percentage points to 5.67 percent on April 2, aneight-week low, according to the latest available data from theSecurities Industry and Financial Markets Association.
About 71 percent of weekly or monthly auctions, includingthose of student lenders, were unsuccessful this week, about thesame as last week, Bloomberg data show. Dealers, who typically stepped in with their own capital to prevent failures when thereweren't enough bidders, pulled back their support in February.
Auction-rate bonds had allowed issuers to achieve money-market-like costs on borrowings of 20 years or longer by havinginvestors bid regularly to change the rates and giving them theoption, though not the right, to move in and out of the debt.
Thursday, April 10, 2008
GMAC's Bank Unit Has a Problem
With bad news swamping GMAC LLC, potential problems at an obscure bank unit threaten to further sink the finance company's prospects and add to the woes of private-equity firm Cerberus Capital Management LLP, majority owner of GMAC.
A technical snag at GMAC Bank LLC -- a small part of GMAC but crucial to its financial health -- has Cerberus attempting to salvage its ownership of the small Utah bank.
Cerberus has until November to get a waiver from the Federal Deposit Insurance Corp. that will allow the group's continued control of GMAC Bank, a so-called industrial-loan corporation. ILCs are FDIC-supervised lenders that offer a way for commercial firms to own banks without being regulated by a federal banking agency.
When Cerberus and its co-investors bought a 51% GMAC stake in 2006 from General Motors Corp., the FDIC had imposed a moratorium on the approval of banks owned by nonfinancial companies, such as Wal-Mart Stores Inc., to allow Congress to debate the issue of mixing banking and commerce.
Despite the freeze, the FDIC granted Cerberus and GMAC's application because of "the unique circumstances" of GM's restructuring. In exchange, GMAC and Cerberus agreed to satisfy one of the following conditions by November: sell GMAC Bank; the bank would cease using FDIC insurance; or register as a bank holding company. If none of these terms could be achieved, Cerberus would have to get an FDIC waiver.
There are still seven months until deadline, but satisfying any of the terms could take time. The options for Cerberus and GMAC are narrowing amid a souring market for lenders like GMAC Bank that are exposed to the slumping residential-mortgage sector. Economic conditions make GMAC Bank a tough sell.
"It would be hard to see many interested buyers," says Craig Emrick, a credit analyst at Moody's Investors Service.
Getting the waiver also gains more urgency as political sensitivities heat up ahead of the general election. While securing a waiver would be a coup for Cerberus, it also has the potential of being cast by critics as special treatment for a firm that has former high-ranking Republican officials, including John Snow and Dan Quayle, on its payroll.
As the credit crunch has made short-term financing costly and elusive, GMAC Bank's $13 billion in deposits and $11 billion in Federal Home Loan Bank advances have become increasingly important sources of stable, low-cost funding for Residential Capital LLC, or ResCap, GMAC's struggling mortgage subsidiary that has come to rely on GMAC Bank for cheap, reliable funding.
A deterioration of GMAC Bank's health would likely worsen the weak financial strength of ResCap and GMAC, whose bonds already are suffering due to its exposure to the sickly mortgage market and wilting consumer sector.
"If the credit markets continue to decline and we find ourselves in a prolonged environment of capital market shutdown, GMAC could run into substantial difficulty," Cerberus said in a recent letter to investors.
The uncertainty surrounding GMAC Bank comes as GMAC and its owners are considering strategic alternatives for ResCap.
On Friday the auto-lender injected capital into its struggling mortgage unit by buying back $1.2 billion of debt to ease ResCap's debt burden. GMAC paid a little more than $600 million in the open market for the bonds, or about half their face value.
GMAC Bank, which accounted for about 30% of ResCap's funding last year, isn't a specimen of financial vigor. According to the FDIC, the bank lent $17 billion to the residential real-estate sector and retained just $3.3 billion in capital. About $3 billion of those loans were backed by junior liens, while $2 billion went to home-equity loans -- types of debt that have sunk in value during the housing crisis.
While selling GMAC Bank near term would be problematic for GMAC, forgoing FDIC insurance, another option, is a nonstarter for a bank that takes deposits.
Finally, registering as a bank holding company would likely be anathema to Cerberus, a low-profile firm that doesn't want to disclose its inner workings -- which it would then be required to do. "In general, we despise all the attention we've been getting," Cerberus wrote to investors last month, reflecting on scrutiny of its purchases of GMAC and Chrysler LLC, bought in 2007.
That leaves only two options for Cerberus: The FDIC grants it and GMAC a waiver, or Congress enacts legislation allowing GMAC and other nonbank businesses to own ILCs, such as GMAC Bank. So far, the full House has passed a bill, as has the Senate Banking Committee, that would ban most commercial firms from owning ILCs but make an exception for U.S. car makers. That would likely grandfather Cerberus's ownership of GMAC Bank. The bill in the full Senate is stalled and isn't expected to win approval this year.
Wednesday Cerberus reiterated a statement it made last week, saying, "We have worked cooperatively with the regulators and believe they will grant the requisite approvals on a timely basis."
An FDIC spokesman said on Friday, "The application has been received and it is under consideration."
A technical snag at GMAC Bank LLC -- a small part of GMAC but crucial to its financial health -- has Cerberus attempting to salvage its ownership of the small Utah bank.
Cerberus has until November to get a waiver from the Federal Deposit Insurance Corp. that will allow the group's continued control of GMAC Bank, a so-called industrial-loan corporation. ILCs are FDIC-supervised lenders that offer a way for commercial firms to own banks without being regulated by a federal banking agency.
When Cerberus and its co-investors bought a 51% GMAC stake in 2006 from General Motors Corp., the FDIC had imposed a moratorium on the approval of banks owned by nonfinancial companies, such as Wal-Mart Stores Inc., to allow Congress to debate the issue of mixing banking and commerce.
Despite the freeze, the FDIC granted Cerberus and GMAC's application because of "the unique circumstances" of GM's restructuring. In exchange, GMAC and Cerberus agreed to satisfy one of the following conditions by November: sell GMAC Bank; the bank would cease using FDIC insurance; or register as a bank holding company. If none of these terms could be achieved, Cerberus would have to get an FDIC waiver.
There are still seven months until deadline, but satisfying any of the terms could take time. The options for Cerberus and GMAC are narrowing amid a souring market for lenders like GMAC Bank that are exposed to the slumping residential-mortgage sector. Economic conditions make GMAC Bank a tough sell.
"It would be hard to see many interested buyers," says Craig Emrick, a credit analyst at Moody's Investors Service.
Getting the waiver also gains more urgency as political sensitivities heat up ahead of the general election. While securing a waiver would be a coup for Cerberus, it also has the potential of being cast by critics as special treatment for a firm that has former high-ranking Republican officials, including John Snow and Dan Quayle, on its payroll.
As the credit crunch has made short-term financing costly and elusive, GMAC Bank's $13 billion in deposits and $11 billion in Federal Home Loan Bank advances have become increasingly important sources of stable, low-cost funding for Residential Capital LLC, or ResCap, GMAC's struggling mortgage subsidiary that has come to rely on GMAC Bank for cheap, reliable funding.
A deterioration of GMAC Bank's health would likely worsen the weak financial strength of ResCap and GMAC, whose bonds already are suffering due to its exposure to the sickly mortgage market and wilting consumer sector.
"If the credit markets continue to decline and we find ourselves in a prolonged environment of capital market shutdown, GMAC could run into substantial difficulty," Cerberus said in a recent letter to investors.
The uncertainty surrounding GMAC Bank comes as GMAC and its owners are considering strategic alternatives for ResCap.
On Friday the auto-lender injected capital into its struggling mortgage unit by buying back $1.2 billion of debt to ease ResCap's debt burden. GMAC paid a little more than $600 million in the open market for the bonds, or about half their face value.
GMAC Bank, which accounted for about 30% of ResCap's funding last year, isn't a specimen of financial vigor. According to the FDIC, the bank lent $17 billion to the residential real-estate sector and retained just $3.3 billion in capital. About $3 billion of those loans were backed by junior liens, while $2 billion went to home-equity loans -- types of debt that have sunk in value during the housing crisis.
While selling GMAC Bank near term would be problematic for GMAC, forgoing FDIC insurance, another option, is a nonstarter for a bank that takes deposits.
Finally, registering as a bank holding company would likely be anathema to Cerberus, a low-profile firm that doesn't want to disclose its inner workings -- which it would then be required to do. "In general, we despise all the attention we've been getting," Cerberus wrote to investors last month, reflecting on scrutiny of its purchases of GMAC and Chrysler LLC, bought in 2007.
That leaves only two options for Cerberus: The FDIC grants it and GMAC a waiver, or Congress enacts legislation allowing GMAC and other nonbank businesses to own ILCs, such as GMAC Bank. So far, the full House has passed a bill, as has the Senate Banking Committee, that would ban most commercial firms from owning ILCs but make an exception for U.S. car makers. That would likely grandfather Cerberus's ownership of GMAC Bank. The bill in the full Senate is stalled and isn't expected to win approval this year.
Wednesday Cerberus reiterated a statement it made last week, saying, "We have worked cooperatively with the regulators and believe they will grant the requisite approvals on a timely basis."
An FDIC spokesman said on Friday, "The application has been received and it is under consideration."
Wednesday, April 9, 2008
Fed Weights its options in easing crunch
--The Federal Reserve is considering contingency plans for expanding its lending power in the event its recent steps to unfreeze credit markets fail.
--Among the options: Having the Treasury borrow more money than it needs to fund the government and leave the proceeds on deposit at the Fed; issuing debt under the Fed's name rather than the Treasury's; and asking Congress for immediate authority for the Fed to pay interest on commercial-bank reserves instead of waiting until a previously enacted law permits it in 2011.
--No moves are imminent because the Fed still has plenty of balance sheet room for additional lending now. Fed officials believe the availability of such options largely eliminates the risk of exhausting its stockpile of Treasury bonds and thus losing its ability to backstop the financial system, as some on Wall Street fear.
--British and Swiss central banks also are contemplating contingency plans. For now, the European Central Bank is reluctant to consider options that require substantial modifications of its standard tools.
--The Fed, like any central bank, could print unlimited amounts of money, but that would push short-term interest rates lower than it believes would be wise. The contingency planning seeks ways to relieve strains in credit markets and restore liquidity without pushing down rates.
--The Fed is reluctant to heed calls from some Wall Street participants and foreign officials for the Fed to directly purchase mortgage-backed securities to help a market that still is not functioning normally.
--Before the credit crunch began in August, the Fed had $790 billion in Treasury securities on its balance sheet, about 87% of its total assets. Since then, it has sold or lent about $300 billion. In their place, the Fed has made loans to banks and securities firms to assist them in financing holdings of mortgage-backed and other securities. Some on Wall Street say the potential for further declines in Fed treasury holdings could leave it out of ammunition
--The Fed holds assets to manage the nation's money supply and influence the federal-funds rate, which banks charge each other on overnight loans. When the Fed buys Treasurys or makes loans directly to banks, it supplies financial institutions with cash; in effect, it prints money. The cash ends up as currency in circulation or in banks' reserve accounts at the Fed.
--Since reserves earn no interest, banks lend cash that exceeds their required minimum. That puts downward pressure on the federal funds rate, currently targeted by the Fed at 2.25%. The Fed could purchase securities and make loans almost without limit, expanding its balance sheet. That would cause excess reserves to skyrocket and the federal funds rate to fall to zero. The Fed would contemplate such "quantitative easing" only in dire circumstances. The Bank of Japan took this step this decade after years of economic stagnation.
--Weighing the Possibilities
--So the Fed is seeking ways to expand its balance sheet without causing the federal funds rate to drop. The likeliest option, one the Fed and Treasury have discussed, is for the Treasury to issue more debt than it needs to fund government operations. The extra cash would be left on deposit at the Fed, where it would be separate from bank reserves on deposit and thus would have no impact on interest rates. The Fed would use the cash to purchase an offsetting amount of Treasurys in the open market; for legal reasons, it generally cannot buy them directly from Treasury.
--Treasury's principal constraint is the statutory limit debt. Treasury debt was $453 billion below the limit Monday. In the past, Congress always has responded to administration requests to raise the limit, sometimes only after political theatrics.
--Fed officials also are investigating the feasibility of the Fed issuing its own debt and using the proceeds to purchase other assets or make loans. It has never done so; the legality is unclear. Some foreign central banks, such as the Bank of Japan, do so.
--Another possibility is seeking congressional approval to pay interest on banks' reserves immediately instead of waiting until a 2006 law permits that in 2011. If the Fed paid, say, 2% interest on reserves, banks would have no incentive to lend out excess reserves once the federal funds rate fell to that level.
--Congress put off the effective date because paying interest on reserves reduces the Fed profits that are turned over to the Treasury each year, widening the budget deficit. Although preliminary explorations suggest Congress would be open to accelerating the date, the Fed is leery of depending on action by Congress.
--The Fed is inclined to use any additional maneuvering room to lend through its existing and recently expanded avenues. Officials are reluctant to buy mortgage-backed securities directly. They worry that such purchases would hurt the market for MBS that the Fed is not permitted to buy: those backed by jumbo and subprime and alt-A mortgages, which are under the greatest strain.
Moreover, the Fed is not operationally equipped to hold MBS and would probably have to outsource their management. Such holdings wouldn't help avert foreclosures much, since the Fed would have little control over the mortgages that comprise MBS.
--Among the options: Having the Treasury borrow more money than it needs to fund the government and leave the proceeds on deposit at the Fed; issuing debt under the Fed's name rather than the Treasury's; and asking Congress for immediate authority for the Fed to pay interest on commercial-bank reserves instead of waiting until a previously enacted law permits it in 2011.
--No moves are imminent because the Fed still has plenty of balance sheet room for additional lending now. Fed officials believe the availability of such options largely eliminates the risk of exhausting its stockpile of Treasury bonds and thus losing its ability to backstop the financial system, as some on Wall Street fear.
--British and Swiss central banks also are contemplating contingency plans. For now, the European Central Bank is reluctant to consider options that require substantial modifications of its standard tools.
--The Fed, like any central bank, could print unlimited amounts of money, but that would push short-term interest rates lower than it believes would be wise. The contingency planning seeks ways to relieve strains in credit markets and restore liquidity without pushing down rates.
--The Fed is reluctant to heed calls from some Wall Street participants and foreign officials for the Fed to directly purchase mortgage-backed securities to help a market that still is not functioning normally.
--Before the credit crunch began in August, the Fed had $790 billion in Treasury securities on its balance sheet, about 87% of its total assets. Since then, it has sold or lent about $300 billion. In their place, the Fed has made loans to banks and securities firms to assist them in financing holdings of mortgage-backed and other securities. Some on Wall Street say the potential for further declines in Fed treasury holdings could leave it out of ammunition
--The Fed holds assets to manage the nation's money supply and influence the federal-funds rate, which banks charge each other on overnight loans. When the Fed buys Treasurys or makes loans directly to banks, it supplies financial institutions with cash; in effect, it prints money. The cash ends up as currency in circulation or in banks' reserve accounts at the Fed.
--Since reserves earn no interest, banks lend cash that exceeds their required minimum. That puts downward pressure on the federal funds rate, currently targeted by the Fed at 2.25%. The Fed could purchase securities and make loans almost without limit, expanding its balance sheet. That would cause excess reserves to skyrocket and the federal funds rate to fall to zero. The Fed would contemplate such "quantitative easing" only in dire circumstances. The Bank of Japan took this step this decade after years of economic stagnation.
--Weighing the Possibilities
--So the Fed is seeking ways to expand its balance sheet without causing the federal funds rate to drop. The likeliest option, one the Fed and Treasury have discussed, is for the Treasury to issue more debt than it needs to fund government operations. The extra cash would be left on deposit at the Fed, where it would be separate from bank reserves on deposit and thus would have no impact on interest rates. The Fed would use the cash to purchase an offsetting amount of Treasurys in the open market; for legal reasons, it generally cannot buy them directly from Treasury.
--Treasury's principal constraint is the statutory limit debt. Treasury debt was $453 billion below the limit Monday. In the past, Congress always has responded to administration requests to raise the limit, sometimes only after political theatrics.
--Fed officials also are investigating the feasibility of the Fed issuing its own debt and using the proceeds to purchase other assets or make loans. It has never done so; the legality is unclear. Some foreign central banks, such as the Bank of Japan, do so.
--Another possibility is seeking congressional approval to pay interest on banks' reserves immediately instead of waiting until a 2006 law permits that in 2011. If the Fed paid, say, 2% interest on reserves, banks would have no incentive to lend out excess reserves once the federal funds rate fell to that level.
--Congress put off the effective date because paying interest on reserves reduces the Fed profits that are turned over to the Treasury each year, widening the budget deficit. Although preliminary explorations suggest Congress would be open to accelerating the date, the Fed is leery of depending on action by Congress.
--The Fed is inclined to use any additional maneuvering room to lend through its existing and recently expanded avenues. Officials are reluctant to buy mortgage-backed securities directly. They worry that such purchases would hurt the market for MBS that the Fed is not permitted to buy: those backed by jumbo and subprime and alt-A mortgages, which are under the greatest strain.
Moreover, the Fed is not operationally equipped to hold MBS and would probably have to outsource their management. Such holdings wouldn't help avert foreclosures much, since the Fed would have little control over the mortgages that comprise MBS.
Tuesday, April 8, 2008
Bank Capitalization
Federal law and regulations also establish five capital categories: well-capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized.
An institution is treated as well-capitalized if its ratio of total risk-based capital to total risk-weighted assets is 10.00% or more, its ratio of adjusted Tier 1 capital to total risk-weighted assets is 6.00% or more, its leverage ratio is 5.00% or more, and it is not subject to any federal supervisory order or directive to meet a specific capital level.
In order to be adequately capitalized, an institution must have a total risk-based capital to total risk-weighted assets ratio of not less than 8.00%, an adjusted Tier 1 capital to total risk-weighted assets ratio of not less than 4.00%, and (unless it is in the most highly-rated category) a leverage ratio of not less than 4.00%.
An institution is undercapitalized if its total risk-based capital to total risk-weighted assets ratio is less than 8.00%, or its adjusted Tier 1 capital to total risk-weighted assets capital ratio is less than 4.00%, or (unless it is in the most highly-rated category) its leverage ratio is less than 4.00%.
An institution is treated as significantly undercapitalized if its total risk-based capital to total risk-weighted assets ratio is less than 6.00%, or its adjusted Tier 1 capital to total risk-weighted assets ratio is less than 3.00%, or its leverage ratio is less than 3.00%. Any institution with a tangible equity to tangible assets ratio of 2.00% or less will be considered critically undercapitalized.
An institution is treated as well-capitalized if its ratio of total risk-based capital to total risk-weighted assets is 10.00% or more, its ratio of adjusted Tier 1 capital to total risk-weighted assets is 6.00% or more, its leverage ratio is 5.00% or more, and it is not subject to any federal supervisory order or directive to meet a specific capital level.
In order to be adequately capitalized, an institution must have a total risk-based capital to total risk-weighted assets ratio of not less than 8.00%, an adjusted Tier 1 capital to total risk-weighted assets ratio of not less than 4.00%, and (unless it is in the most highly-rated category) a leverage ratio of not less than 4.00%.
An institution is undercapitalized if its total risk-based capital to total risk-weighted assets ratio is less than 8.00%, or its adjusted Tier 1 capital to total risk-weighted assets capital ratio is less than 4.00%, or (unless it is in the most highly-rated category) its leverage ratio is less than 4.00%.
An institution is treated as significantly undercapitalized if its total risk-based capital to total risk-weighted assets ratio is less than 6.00%, or its adjusted Tier 1 capital to total risk-weighted assets ratio is less than 3.00%, or its leverage ratio is less than 3.00%. Any institution with a tangible equity to tangible assets ratio of 2.00% or less will be considered critically undercapitalized.
Citigroup, Wells Fargo May Fuel Recession by Curtailing Lending
The banks need to shore up the ratio of the value of theircommon stock, preferred shares, retained earnings and lossreserves to the total of risk-adjusted assets, which areaffected by credit ratings. To be considered a ``well capitalized bank'' by U.S. regulators, an institution can't have more than 10 times its capital in risk-weighted assets. More than 99 percent of American banks qualify as well capitalized. As a group, regulated banks had a total risk-based capital ratio of 12.79 percent at the end of last year, according todata compiled by Bloomberg. The figure was the lowest since2000, before the last U.S. recession.
Pittsburgh-based PNC Financial Services Group Inc.'sbanking unit had a 10.24 percent total risk-capital ratio at the end of 2007, according to the FDIC. Cleveland-based National City Corp.'s banking unit had a ratio of 10.31 percent.
The holding companies for Citigroup, Bank of America andWells Fargo have the lowest ratios in at least the five yearsthat the Federal Reserve has been tracking the data. Citigroup, based in New York, had stock, retained earningsand preferred shares in 2007 equal to 10.7 percent of its risk-weighted assets. That's down from 12.02 percent in 2005. WellsFargo, based in San Francisco, was at 10.68 percent, down from11.76 percent, and Charlotte, North Carolina-based Bank ofAmerica, 11.02 percent, down from 11.08.
By contrast, the average ratio for the nation's 66 biggest bank-holding companies was 11.63 percent. New York-basedJPMorgan Chase & Co., the third-biggest U.S. bank holdingcompany, had a ratio of 12.57 percent, up from 12.04 percent.The measurements are so important that JPMorgan obtained anexemption from the Fed last week so it could exclude from risk-weighted assets certain securities in the planned takeover ofBear Stearns.
To maintain the ratio of 10 percent when a $100 million AAAsecurity is dropped to BBB, a bank's needed capital would riseto $10 million from $2 million. An institution can raise the $8million by selling stock or preferred shares. The bank can alsocompensate by selling the security, or cutting back on otherlending.
A risk-based capital ratio lower than 10 percentautomatically pulls a bank into a lower regulatory category,called ``adequately capitalized.'' By itself, that wouldn't setoff runs on teller windows, said Isaac, the former FDICchairman. Individual depositors will rely on FDIC insurance toprotect their savings while larger business clients will examinethe overall health of the bank, Isaac said.
Pittsburgh-based PNC Financial Services Group Inc.'sbanking unit had a 10.24 percent total risk-capital ratio at the end of 2007, according to the FDIC. Cleveland-based National City Corp.'s banking unit had a ratio of 10.31 percent.
The holding companies for Citigroup, Bank of America andWells Fargo have the lowest ratios in at least the five yearsthat the Federal Reserve has been tracking the data. Citigroup, based in New York, had stock, retained earningsand preferred shares in 2007 equal to 10.7 percent of its risk-weighted assets. That's down from 12.02 percent in 2005. WellsFargo, based in San Francisco, was at 10.68 percent, down from11.76 percent, and Charlotte, North Carolina-based Bank ofAmerica, 11.02 percent, down from 11.08.
By contrast, the average ratio for the nation's 66 biggest bank-holding companies was 11.63 percent. New York-basedJPMorgan Chase & Co., the third-biggest U.S. bank holdingcompany, had a ratio of 12.57 percent, up from 12.04 percent.The measurements are so important that JPMorgan obtained anexemption from the Fed last week so it could exclude from risk-weighted assets certain securities in the planned takeover ofBear Stearns.
To maintain the ratio of 10 percent when a $100 million AAAsecurity is dropped to BBB, a bank's needed capital would riseto $10 million from $2 million. An institution can raise the $8million by selling stock or preferred shares. The bank can alsocompensate by selling the security, or cutting back on otherlending.
A risk-based capital ratio lower than 10 percentautomatically pulls a bank into a lower regulatory category,called ``adequately capitalized.'' By itself, that wouldn't setoff runs on teller windows, said Isaac, the former FDICchairman. Individual depositors will rely on FDIC insurance toprotect their savings while larger business clients will examinethe overall health of the bank, Isaac said.
history repeats itself; PE helps distressed banking sector
In 1988, two young deal makers helped Texas billionaire Robert Bass buy American Savings Bank, one of the country's largest failed savings-and-loan associations. As part of the transaction, David Bonderman and Jim Coulter took seats on the board and helped turn around the thrift. Eight years later, they sold the business to Washington Mutual Inc. for a roughly $750 million profit.
Now, Washington Mutual, the country's largest S&L, is struggling because of stinging losses from subprime mortgages. And Messrs. Bonderman and Coulter -- older, grayer and richer -- run TPG, the former Texas Pacific Group, which is one of the world's largest private-equity firms. Their lead role in a capital injection into WaMu would be a bold bet that they can again profit from a banking crisis.
But since the credit crunch took hold last summer, banks and other financial institutions have seen their valuations plummet and their capital bases dry up. And it has become difficult for financial-services firms to raise money in the public markets. So cash-rich private-equity shops are now swooping in, injecting fresh capital into these sputtering companies.
History is now repeating itself in the buyout business, and it isn't just TPG that is giving Wall Street a sense of déjà vu. Though the private-equity industry has mushroomed, many of the same players who rose to prominence two decades ago -- Mr. Bonderman, Henry Kravis of Kohlberg Kravis Roberts & Co. and Leon Black of Apollo Management LP -- still dominate the scene. And now, with banks having troubles reminiscent of the savings-and-loan crisis -- and private-equity firms unable to do traditional buyouts -- the investments are beginning to look the same, too.
Consider KKR, the New York private-equity firm that recently closed on a $17.6 billion buyout fund. After being the most active buyout player last year, KKR has yet to do a U.S. leveraged buyout in 2008. Instead, it has made a $1.25 billion investment in Legg Mason Inc., a healthy asset manager, and has explored an investment in National City Corp., the struggling Cleveland bank.
But a major difference between the American Savings acquisition and a potential WaMu stake is the degree of control. During the S&L crisis, federal regulators had waived the rule that required entities controlling financial institutions to register as bank-holding companies. Today, without a government waiver, buyout firms are loath to register and be subjected to federal regulation. Instead, they are passive investors, a less comfortable position for deal makers used to having total control.
Now, Washington Mutual, the country's largest S&L, is struggling because of stinging losses from subprime mortgages. And Messrs. Bonderman and Coulter -- older, grayer and richer -- run TPG, the former Texas Pacific Group, which is one of the world's largest private-equity firms. Their lead role in a capital injection into WaMu would be a bold bet that they can again profit from a banking crisis.
But since the credit crunch took hold last summer, banks and other financial institutions have seen their valuations plummet and their capital bases dry up. And it has become difficult for financial-services firms to raise money in the public markets. So cash-rich private-equity shops are now swooping in, injecting fresh capital into these sputtering companies.
History is now repeating itself in the buyout business, and it isn't just TPG that is giving Wall Street a sense of déjà vu. Though the private-equity industry has mushroomed, many of the same players who rose to prominence two decades ago -- Mr. Bonderman, Henry Kravis of Kohlberg Kravis Roberts & Co. and Leon Black of Apollo Management LP -- still dominate the scene. And now, with banks having troubles reminiscent of the savings-and-loan crisis -- and private-equity firms unable to do traditional buyouts -- the investments are beginning to look the same, too.
Consider KKR, the New York private-equity firm that recently closed on a $17.6 billion buyout fund. After being the most active buyout player last year, KKR has yet to do a U.S. leveraged buyout in 2008. Instead, it has made a $1.25 billion investment in Legg Mason Inc., a healthy asset manager, and has explored an investment in National City Corp., the struggling Cleveland bank.
But a major difference between the American Savings acquisition and a potential WaMu stake is the degree of control. During the S&L crisis, federal regulators had waived the rule that required entities controlling financial institutions to register as bank-holding companies. Today, without a government waiver, buyout firms are loath to register and be subjected to federal regulation. Instead, they are passive investors, a less comfortable position for deal makers used to having total control.
Monday, April 7, 2008
Bear Stearns Consequences
The idea of the Fed taking protective custody of big investment banks has already led to arguments that those firms should be subject to the same capital requirements faced by the commercial banks already in the Fed's care.
Worse, whatever flaws exist in current imperfect bank regulations would infect more of the financial system. Capital requirements inspired some commercial banks to mask some of their most toxic assets in "off-balance-sheet" instruments. Investment banks might be inspired to do the same, making their true financial health even murkier.
Today's capital requirements also have the perverse effect of encouraging banks to shed capital when times are good and raise it just when they need it most, says Michael Peterson, research director at Pzena Investment Management, which owns shares of both flavors of bank.
Thus, they are forced to sell assets in falling markets, while diluting their already beleaguered shareholders by issuing fresh equity and paying usurious interest rates for preferred stock and debt.
This is what economists call "pro-cyclicality," a fancy way of saying it makes bad situations worse, possibly raising the likelihood that there will be more Bear Stearnses in the future.
This is an extreme example, but it is worth remembering that the 1989 law passed to bail out the savings-and-loan industry pushed hundreds of thrifts to an early grave by raising their capital requirements when it was hardest to raise money.
That law also created the Resolution Trust Corporation to dispose of the assets of defunct thrifts. The RTC became a greenhouse for bundling together risky assets into securities, which worked for a while, until the subprime disaster that just visited Wall Street.
This isn't to suggest there should be no regulation. On the contrary, smarter regulation probably could have averted the mess we're in today. Rather, it's a reminder of the minefields policy makers face as they consider a post-Bear Stearns world.
Worse, whatever flaws exist in current imperfect bank regulations would infect more of the financial system. Capital requirements inspired some commercial banks to mask some of their most toxic assets in "off-balance-sheet" instruments. Investment banks might be inspired to do the same, making their true financial health even murkier.
Today's capital requirements also have the perverse effect of encouraging banks to shed capital when times are good and raise it just when they need it most, says Michael Peterson, research director at Pzena Investment Management, which owns shares of both flavors of bank.
Thus, they are forced to sell assets in falling markets, while diluting their already beleaguered shareholders by issuing fresh equity and paying usurious interest rates for preferred stock and debt.
This is what economists call "pro-cyclicality," a fancy way of saying it makes bad situations worse, possibly raising the likelihood that there will be more Bear Stearnses in the future.
This is an extreme example, but it is worth remembering that the 1989 law passed to bail out the savings-and-loan industry pushed hundreds of thrifts to an early grave by raising their capital requirements when it was hardest to raise money.
That law also created the Resolution Trust Corporation to dispose of the assets of defunct thrifts. The RTC became a greenhouse for bundling together risky assets into securities, which worked for a while, until the subprime disaster that just visited Wall Street.
This isn't to suggest there should be no regulation. On the contrary, smarter regulation probably could have averted the mess we're in today. Rather, it's a reminder of the minefields policy makers face as they consider a post-Bear Stearns world.
Sunday, April 6, 2008
commnet: Bear Stearns Lqiudity Evolvement
total liability 384 bil Q3, 395 bil Q4
equity: 13 bil Q3, 11.7 Q4
Q3 2007
--funding sources
--1.Short-term
--a.collateralized (secured) borrowings, including repurchase transactions, sell/buy arrangements, securities lending arrangements and customer short balances.
--b.unsecured funding sources expose the Company to rollover risk, as providers of credit are not obligated to refinance the instruments at maturity.
--c.it use secured borrowing extensively
--2.equity and long term bonds
--net capital cash 2.8 bil
--eligible unencumbered 20.9 bil with borrowing value of $17.7 bil.
--As of August 31, 2007 theParent Company Liquidity Pool was $13.6 billion comprised entirely of short termmoney funds, bank deposits and short term high quality money market investments. This liquidity pool can take the form of cash deposits andmoney market instruments that are held at the Parent Company level andhigh-quality collateral (corporate bonds, municipal bonds, equity securities)that is owned by subsidiaries and explicitly pledged to and segregated for thebenefit of the Parent Company and maintained at a third-party custodian. As of September 19, 2007, the Parent Company Liquidity Pool had increased to arecord level of $19.0 billion.
--As of August 31, 2007, approximately $7.1 billion of themarket value identified in the liquidity ratio data above was held inunregulated entities and thus likely to be available to the Parent Company. $13.8 in regulated subsidary.
Q4 2007
--As of November 30, 2007, the market value of eligible unencumbered,unhypothecated financial instruments owned by the Company was approximately$16.3 billion with a borrowing value of $14.0 billion.
--The Company monitors unrestricted liquidity available to the Parent Company viathe ability to monetize unencumbered assets held in unregulated and regulatedentities. As of November 30, 2007, approximately $5.1 billion of the marketvalue identified in the liquidity ratio data above was held in unregulatedentities and thus likely to be available to the Parent Company. $11.2 in regulatred subsidary.
--As of November 30, 2007 theParent Company Liquidity Pool was $17.4 billion comprised entirely of moneymarket funds, bank deposits and short-term high quality money marketinvestments.
--At November 30, 2007, the Company's net cash capital position, defined as thesurplus of long-term funding sources versus long-term funding requirements was$8.2 billion.
equity: 13 bil Q3, 11.7 Q4
Q3 2007
--funding sources
--1.Short-term
--a.collateralized (secured) borrowings, including repurchase transactions, sell/buy arrangements, securities lending arrangements and customer short balances.
--b.unsecured funding sources expose the Company to rollover risk, as providers of credit are not obligated to refinance the instruments at maturity.
--c.it use secured borrowing extensively
--2.equity and long term bonds
--net capital cash 2.8 bil
--eligible unencumbered 20.9 bil with borrowing value of $17.7 bil.
--As of August 31, 2007 theParent Company Liquidity Pool was $13.6 billion comprised entirely of short termmoney funds, bank deposits and short term high quality money market investments. This liquidity pool can take the form of cash deposits andmoney market instruments that are held at the Parent Company level andhigh-quality collateral (corporate bonds, municipal bonds, equity securities)that is owned by subsidiaries and explicitly pledged to and segregated for thebenefit of the Parent Company and maintained at a third-party custodian. As of September 19, 2007, the Parent Company Liquidity Pool had increased to arecord level of $19.0 billion.
--As of August 31, 2007, approximately $7.1 billion of themarket value identified in the liquidity ratio data above was held inunregulated entities and thus likely to be available to the Parent Company. $13.8 in regulated subsidary.
Q4 2007
--As of November 30, 2007, the market value of eligible unencumbered,unhypothecated financial instruments owned by the Company was approximately$16.3 billion with a borrowing value of $14.0 billion.
--The Company monitors unrestricted liquidity available to the Parent Company viathe ability to monetize unencumbered assets held in unregulated and regulatedentities. As of November 30, 2007, approximately $5.1 billion of the marketvalue identified in the liquidity ratio data above was held in unregulatedentities and thus likely to be available to the Parent Company. $11.2 in regulatred subsidary.
--As of November 30, 2007 theParent Company Liquidity Pool was $17.4 billion comprised entirely of moneymarket funds, bank deposits and short-term high quality money marketinvestments.
--At November 30, 2007, the Company's net cash capital position, defined as thesurplus of long-term funding sources versus long-term funding requirements was$8.2 billion.
Friday, April 4, 2008
Unemployment Numbers Gived Mixed Information
--US Shed another 80k non-farm jobs in March, continuting a three month losing stream. It provided another solid clue that U.S economy is heading to recession. But average weekly earnings and worked hours all increased, indicating the demand of economy is not so weak.
--The unemployment claims in March exceeded 400k, the long-held triggering point to recession. But some economists explained the 400k is not longer appropriate given the increasd labor force.
--The unemployment claims in March exceeded 400k, the long-held triggering point to recession. But some economists explained the 400k is not longer appropriate given the increasd labor force.
CDO Downgrades Concentrated In 2006 and 2007 Vintages
While many people who follow these arcane instruments reflexively associate collateralized debt obligations (CDOs) with credit deterioration in general, Moody’s stresses in a new report that the deterioration in 2007 was almost wholly contained to a single sector: U.S. dollar-denominated
Outside of this sector, rates of rating downgrades in 2007 were lower generally than their historical averages.
"A review of the CDO market's credit performance in 2007 underscores its diversity," said Moody's senior vice president Danielle Nazarian. "While subprime RMBS-backed resecuritization CDOs underwent widespread and severe downgrades, other key CDO sectors performed well, including those tied to the U.S. and European corporate credit markets."
Moody's downgraded a total of 1,331 tranches of U.S. dollar-denominated resecuritizations in 2007. These accounted for 92 percent of the 1,448 downgrade actions for all CDOs during the year.
Within the dollar-denominated resecuritization category, downgrades were heavily concentrated in the 2006 and 2007 vintages. These two groups alone represented 87 percent of the 1,448 total downgrades.
Looking ahead throughout 2008, Moody’s projects even greater ratings volatility among U.S. dollar resecuritization CDOs as signaled by the nearly 2,000 tranches currently under review for downgrade.
Outside of this sector, rates of rating downgrades in 2007 were lower generally than their historical averages.
"A review of the CDO market's credit performance in 2007 underscores its diversity," said Moody's senior vice president Danielle Nazarian. "While subprime RMBS-backed resecuritization CDOs underwent widespread and severe downgrades, other key CDO sectors performed well, including those tied to the U.S. and European corporate credit markets."
Moody's downgraded a total of 1,331 tranches of U.S. dollar-denominated resecuritizations in 2007. These accounted for 92 percent of the 1,448 downgrade actions for all CDOs during the year.
Within the dollar-denominated resecuritization category, downgrades were heavily concentrated in the 2006 and 2007 vintages. These two groups alone represented 87 percent of the 1,448 total downgrades.
Looking ahead throughout 2008, Moody’s projects even greater ratings volatility among U.S. dollar resecuritization CDOs as signaled by the nearly 2,000 tranches currently under review for downgrade.
Regulatory Rules Fall Short
Christopher Cox is rightly concerned that the brokerage houses he oversees could be savaged by liquidity crises, as Bear Stearns was. The Securities and Exchange Commission chairman thinks it makes sense to reassess how regulators deal with the risk that firms' access to crucial everyday cash dries up, perhaps even by extending capital adequacy rules to deal explicitly with this risk. Unfortunately, that probably wouldn't work.
It sounds reasonable. Regulators have expanded the rules governing the capital banks set aside to cover an ever-greater variety of perils. They originally told banks to base capital reserves on how much credit risk they had. Then they added risks associated with market prices. The latest version of the rules added operational risks -- the possibility of loss stemming from human or logistical snafus.
So why not bolt on liquidity risk and require firms to raise capital when trading counterparties or lenders get skittish about dealing with them? One problem is that liquidity can evaporate in the blink of an eye. In congressional testimony Thursday, Mr. Cox noted that Bear's cash pool fell from more than $12 billion to $2 billion in a single day. It usually takes weeks or months to raise new capital.
Also, forcing firms to raise capital would raise red flags that could accelerate a crisis -- even if a firm in the midst of a cash crunch could persuade investors to pony up capital in the first place.
Firms might try establishing contingent capital facilities before disaster strikes so they could draw on them when needed. But that would be expensive, eating into and perhaps obliterating earnings.
Mr. Cox and his confreres at the Fed and the U.S. Treasury would clearly prefer to avoid having to cobble together responses like the one that rescued Bear. But forcing firms to raise capital as liquidity declines isn't practical. The sentiment governing bank runs is too volatile to be tamed by the blunt instrument of regulatory capital rules.
It sounds reasonable. Regulators have expanded the rules governing the capital banks set aside to cover an ever-greater variety of perils. They originally told banks to base capital reserves on how much credit risk they had. Then they added risks associated with market prices. The latest version of the rules added operational risks -- the possibility of loss stemming from human or logistical snafus.
So why not bolt on liquidity risk and require firms to raise capital when trading counterparties or lenders get skittish about dealing with them? One problem is that liquidity can evaporate in the blink of an eye. In congressional testimony Thursday, Mr. Cox noted that Bear's cash pool fell from more than $12 billion to $2 billion in a single day. It usually takes weeks or months to raise new capital.
Also, forcing firms to raise capital would raise red flags that could accelerate a crisis -- even if a firm in the midst of a cash crunch could persuade investors to pony up capital in the first place.
Firms might try establishing contingent capital facilities before disaster strikes so they could draw on them when needed. But that would be expensive, eating into and perhaps obliterating earnings.
Mr. Cox and his confreres at the Fed and the U.S. Treasury would clearly prefer to avoid having to cobble together responses like the one that rescued Bear. But forcing firms to raise capital as liquidity declines isn't practical. The sentiment governing bank runs is too volatile to be tamed by the blunt instrument of regulatory capital rules.
TIAA-CREF Taps Ferguson As New Chief
The nation's main retirement plan for academia, TIAA-CREF, named economist and former Federal Reserve Vice Chairman Roger Ferguson its new chief executive, as the sprawling nonprofit that manages $435 billion in assets tries to fend off challenges to its position.
TIAA, which invests in bonds and real estate, stands for Teachers Insurance and Annuity Association. CREF, or College Retirement Equities Fund, invests in stocks. TIAA-CREF's assets under management have grown dramatically since Mr. Allison took over in 2002, when the firm had $264 billion in under management.
Mr. Allison tried to transform TIAA-CREF into a more diverse, full-service financial-services company. He worked to expand the firm's mutual-fund lineup, hire more financial advisers, and add client centers and online-brokerage operations.
He also slashed 8% of the work force early on, spreading fear through the paternalistic firm. He would later take heat for pushing aggressively to raise fees on several mutual funds it offered, angering clients who had long viewed the firm as a low-cost, shareholder-friendly fund provider.
Mr. Davis said that "undemocratic, un-shareholder friendly action" was the "biggest stain on his legacy." TIAA-CREF has said the move was necessary to stop the funds from operating at a loss.
TIAA, which invests in bonds and real estate, stands for Teachers Insurance and Annuity Association. CREF, or College Retirement Equities Fund, invests in stocks. TIAA-CREF's assets under management have grown dramatically since Mr. Allison took over in 2002, when the firm had $264 billion in under management.
Mr. Allison tried to transform TIAA-CREF into a more diverse, full-service financial-services company. He worked to expand the firm's mutual-fund lineup, hire more financial advisers, and add client centers and online-brokerage operations.
He also slashed 8% of the work force early on, spreading fear through the paternalistic firm. He would later take heat for pushing aggressively to raise fees on several mutual funds it offered, angering clients who had long viewed the firm as a low-cost, shareholder-friendly fund provider.
Mr. Davis said that "undemocratic, un-shareholder friendly action" was the "biggest stain on his legacy." TIAA-CREF has said the move was necessary to stop the funds from operating at a loss.
buying a house is not the same as buying a house on fire
During the week of March 10, market rumors swirled that Bear Stearns might not be able to stay in business. At the hearing Alan Schwartz, Bear Stearns's chief executive, said that the firm's balance sheet was strong -- as good as that of any other financial institution -- but that Bear Stearns couldn't keep up with the rumors.
By Thursday, March 13, the rumors had become a "self-fulfilling prophecy" and resulted in a "run on the bank," Mr. Schwartz said. Bear Stearns reached out to the regulators, who worked throughout the night. By Friday morning, March 14, the Fed agreed to extend financing to Bear Stearns through J.P. Morgan. Then the firms and government officials worked through the weekend to spur Bear Stearns's sale and prevent a bankruptcy filing.
At the hearing, those testifying danced around the question of how the initial $2-per-share price was determined. Mr. Dimon said both Treasury Secretary Henry Paulson and Mr. Geithner were aware that J.P. Morgan was prepared to bid $2 a share. Both men, according to Mr. Dimon, said the decision was J.P. Morgan's to make. However, Mr. Dimon said Mr. Paulson raised the point of view that the higher the price, the higher the possibility of creating moral hazard.
Mr. Dimon said the $2 figure was not based on the value of the Bear Stearns, but "was based on protecting the downside" that J.P. Morgan faced. "I tell people that buying a house is not the same as buying a house on fire," he said.
Mr. Dimon also disclosed that the Fed has lent Bear Stearns $25 billion -- separate from the $30 billion loan -- under the central bank's new program of direct lending available to major investment banks. Mr. Dimon said J.P. Morgan also guaranteed the $25 billion loan, which was made as part of the renegotiated deal that raised the price for Bear.
Fed should have the authority and responsibility "to respond with adequate speed and force to the prospects of systemic threats to financial stability." That echoed a blueprint for a new regulatory system issued Monday by the Treasury Department that called for the Fed to take on a larger role as a risk manager for the financial system.
By Thursday, March 13, the rumors had become a "self-fulfilling prophecy" and resulted in a "run on the bank," Mr. Schwartz said. Bear Stearns reached out to the regulators, who worked throughout the night. By Friday morning, March 14, the Fed agreed to extend financing to Bear Stearns through J.P. Morgan. Then the firms and government officials worked through the weekend to spur Bear Stearns's sale and prevent a bankruptcy filing.
At the hearing, those testifying danced around the question of how the initial $2-per-share price was determined. Mr. Dimon said both Treasury Secretary Henry Paulson and Mr. Geithner were aware that J.P. Morgan was prepared to bid $2 a share. Both men, according to Mr. Dimon, said the decision was J.P. Morgan's to make. However, Mr. Dimon said Mr. Paulson raised the point of view that the higher the price, the higher the possibility of creating moral hazard.
Mr. Dimon said the $2 figure was not based on the value of the Bear Stearns, but "was based on protecting the downside" that J.P. Morgan faced. "I tell people that buying a house is not the same as buying a house on fire," he said.
Mr. Dimon also disclosed that the Fed has lent Bear Stearns $25 billion -- separate from the $30 billion loan -- under the central bank's new program of direct lending available to major investment banks. Mr. Dimon said J.P. Morgan also guaranteed the $25 billion loan, which was made as part of the renegotiated deal that raised the price for Bear.
Fed should have the authority and responsibility "to respond with adequate speed and force to the prospects of systemic threats to financial stability." That echoed a blueprint for a new regulatory system issued Monday by the Treasury Department that called for the Fed to take on a larger role as a risk manager for the financial system.
Thursday, April 3, 2008
UK Mortgage Lender Took Hit
HBOS PLC, the United Kingdom's largest mortgage lender, expects to further mark down the value of assets in the first quarter, after taking relatively small write-downs last year, Chief Financial Officer Mike Ellis said.
Mr. Ellis said that fair-value adjustments on the assets are to be expected, "given the further and significant deterioration in financial markets since the year end," although he added that the bank expects to reverse the negative adjustments over time. He made the comments at a Morgan Stanley banking conference in London.
The performance of HBOS, which owns the Halifax brand and has one-fifth of the U.K. mortgage market, and its ability to extend loans to customers is closely watched by economists, analysts and industry participants, as it is considered a reflection of the general condition of the housing market.
HSBC Holdings PLC said this week that its First Direct subsidiary in the U.K. has withdrawn mortgages for new customers, though it expected the suspension to be temporary.
Last year, HBOS made a negative fair-value adjustment of £227 million ($448.6 million) on assets that it held on its trading book. The adjustment was made according to what the assets would have been worth if sold in the market on the valuation date.
HBOS had a total £34.3 billion in debt securities on its trading book at the end of 2007, of which £13.7 billion was asset-backed securities.
In addition, the bank in 2007 recorded a value reduction of £509 million on the total £46.9 billion in debt securities held on the banking book. HBOS doesn't plan to sell these assets but will hold them until they mature. A negative fair-value adjustment on the banking book won't affect net profit but will reduce the total shareholders' equity.
According to the group's annual report, subprime assets make up £20 million of the total £9.51 billion in U.S. residential-mortgage-backed securities held by the bank.
Mr. Ellis said that fair-value adjustments on the assets are to be expected, "given the further and significant deterioration in financial markets since the year end," although he added that the bank expects to reverse the negative adjustments over time. He made the comments at a Morgan Stanley banking conference in London.
The performance of HBOS, which owns the Halifax brand and has one-fifth of the U.K. mortgage market, and its ability to extend loans to customers is closely watched by economists, analysts and industry participants, as it is considered a reflection of the general condition of the housing market.
HSBC Holdings PLC said this week that its First Direct subsidiary in the U.K. has withdrawn mortgages for new customers, though it expected the suspension to be temporary.
Last year, HBOS made a negative fair-value adjustment of £227 million ($448.6 million) on assets that it held on its trading book. The adjustment was made according to what the assets would have been worth if sold in the market on the valuation date.
HBOS had a total £34.3 billion in debt securities on its trading book at the end of 2007, of which £13.7 billion was asset-backed securities.
In addition, the bank in 2007 recorded a value reduction of £509 million on the total £46.9 billion in debt securities held on the banking book. HBOS doesn't plan to sell these assets but will hold them until they mature. A negative fair-value adjustment on the banking book won't affect net profit but will reduce the total shareholders' equity.
According to the group's annual report, subprime assets make up £20 million of the total £9.51 billion in U.S. residential-mortgage-backed securities held by the bank.
Auction Rate Security Maket Mess
Brokerage-firm clients buy auction-rate securities that are issued by mutual-fund companies, student-loan companies, nonprofit entities, schools, museums and municipalities to raise cash. In all, it is a $330 billion market.
Many in the industry say it will take months to fully fix the mess. An executive at one firm said because there is no secondary market in which to sell these securities, it is almost impossible to put a realistic price on them.
UBS and Goldman Sachs Group Inc. are among the firms that have decided to mark down the value of these securities on client statements. Although there is no evident market for these securities, firms have used internal models to estimate a price. Markdowns vary, but most are between 3% and 5%.
This is a very painful issue for clients," said Marten Hoekstra, UBS's head of wealth management. The Swiss bank has also marked down by $800 million the value of nearly $11 billion of auction-rate securities it holds in its own trading book.
Of the $330 billion market for these securities, closed-end funds issued about $65 billion of the total; firms like Eaton Vance Corp., BlackRock Inc., Legg Mason Inc. and Nuveen Investments were among the primary sellers. When the market seized up, brokerage firms, fund companies and regulators began talking to see if there was a way to refinance these securities and get owners of the securities out at full value.
One idea is for banks, for a fee, to provide financial backing to make the investments more liquid and secure. The problem is banks are reluctant to make such guarantees these days. The approach would also likely require the cooperation of regulators and the Internal Revenue Service, because there could be complex tax implications.
Many in the industry say it will take months to fully fix the mess. An executive at one firm said because there is no secondary market in which to sell these securities, it is almost impossible to put a realistic price on them.
UBS and Goldman Sachs Group Inc. are among the firms that have decided to mark down the value of these securities on client statements. Although there is no evident market for these securities, firms have used internal models to estimate a price. Markdowns vary, but most are between 3% and 5%.
This is a very painful issue for clients," said Marten Hoekstra, UBS's head of wealth management. The Swiss bank has also marked down by $800 million the value of nearly $11 billion of auction-rate securities it holds in its own trading book.
Of the $330 billion market for these securities, closed-end funds issued about $65 billion of the total; firms like Eaton Vance Corp., BlackRock Inc., Legg Mason Inc. and Nuveen Investments were among the primary sellers. When the market seized up, brokerage firms, fund companies and regulators began talking to see if there was a way to refinance these securities and get owners of the securities out at full value.
One idea is for banks, for a fee, to provide financial backing to make the investments more liquid and secure. The problem is banks are reluctant to make such guarantees these days. The approach would also likely require the cooperation of regulators and the Internal Revenue Service, because there could be complex tax implications.
Wednesday, April 2, 2008
Bernanke's view of market as 04 02 2008
Remain Under Stress
Although our recent actions appear to have helped stabilize the situation somewhat, financial markets remain under considerable stress. Pressures in short-term bank funding markets, which had abated somewhat beginning late last year, have increased once again. Many lenders have been reluctant to provide credit to counterparties, especially leveraged investors, and have increased the amount of collateral they require to back short-term security financing agreements. To meet those demands, investors have reduced their leverage and liquidated holdings of securities, putting further downward pressure on security prices.
Limited Credit Available In Overall Market
Credit availability has also been restricted because some large financial institutions, including some commercial and investment banks and the government-sponsored enterprises (GSEs), have reported substantial losses and writedowns, reducing their available capital. Several of these firms have been able to raise fresh capital to offset at least some of those losses, and others are in the process of doing so. However, financial institutions' balance sheets have also expanded, as banks and other institutions have taken on their balance sheets various assets that can no longer be financed on a standalone basis. Thus, the capacity and willingness of some large institutions to extend new credit remains limited.
Strains on Credit Cost of Mortgage and ARS Remain Evident
The effects of the financial strains on credit cost and availability have become increasingly evident, with some portions of the system that had previously escaped the worst of the turmoil--such as the markets for municipal bonds and student loans--having been affected. Another market that had previously been largely exempt from disruptions was that for mortgage-backed securities (MBS) issued by government agencies. However, beginning in mid-February, worsening liquidity conditions and reports of losses at the GSEs, Fannie Mae and Freddie Mac, caused the spread of agency MBS yields over the yields on comparable Treasury securities to rise sharply. Together with the increased fees imposed by the GSEs, the rise in this spread resulted in higher interest rates on conforming mortgages. More recently, agency MBS spreads and conforming mortgage rates have retraced part of this increase, and conforming mortgages continue to be readily available to households. However, for the most part, the nonconforming segment of the mortgage market continues to function poorly.
Corporate Bonds Market Subsiding and Commercial Paper Market Strained
In corporate debt markets, yields and spreads on both investment-grade and speculative-grade corporate bonds rose through mid-March before falling more recently. Issuance of investment-grade bonds by both financial and nonfinancial corporations has been quite robust so far this year, but issuance of new high-yield debt has stalled. Strains continue to be evident in the commercial paper market as well, where risk spreads remain elevated and the quantity of commercial paper outstanding, particularly asset-backed paper, has decreased. Commercial and industrial loans at banks grew in January and February, but at a considerably slower pace than in previous months.
Weigh on Economic Activities
These developments in financial markets--which themselves reflect, in part, greater concerns about housing and the economic outlook more generally--have weighed on real economic activity. Notably, in the housing market, sales of both new and existing homes have generally continued weak, partly as a result of the reduced availability of mortgage credit, and home prices have continued to fall.1 Starts of new single-family homes declined an additional 7 percent in February, bringing the cumulative decline since the early 2006 peak in single-family starts to more than 60 percent. Residential construction is likely to contract somewhat further in coming quarters as builders try to reduce their high inventories of unsold new homes.
Labor Market Moderate
Private payroll employment fell 101,000 in February, after two months of smaller job losses, with job cuts in construction and closely related industries accounting for a significant share of the decline. But the demand for labor has also moderated recently in other industries, such as business services and retail trade, and manufacturing employment has continued on its downward trend. Meanwhile, claims for unemployment insurance have risen somewhat on balance, and surveys indicate that employers have scaled back hiring plans and that jobseekers are experiencing greater difficulties finding work. The unemployment rate edged down in February and remains at a relatively low level; however, in light of the sluggishness of economic activity and other indicators of a softer labor market, I expect it to move somewhat higher in coming months.
Consumer Power Weakened
After rising at an annual rate of about 3 percent over the first three quarters of last year, real disposable income has since increased at only about a 1 percent annual rate, reflecting weaker employment conditions and higher prices for energy and food. Concerns about employment and income prospects, together with declining home values and tighter credit conditions, have caused consumer spending to decelerate considerably from the solid pace seen during the first three quarters of last year. I expect the tax rebates associated with the fiscal stimulus package recently passed by the Congress to provide some support to consumer spending in coming quarters.
Layoff Concided with Reduced Capital Spending
In the business sector, the pullback in hiring that I noted earlier has been accompanied by some reduction in capital spending plans, as weaker sales prospects, tighter credit, and heightened uncertainty have made business leaders more cautious. On a more positive note, the nonfinancial business sector remains financially sound, with liquid balance sheets and low leverage ratios, and most firms have been able to avoid unwanted buildups in inventories. In addition, many businesses are enjoying strong demand from abroad. Although the prospects for foreign economic growth have diminished somewhat in recent months, net exports should continue to provide considerable support to U.S. economic activity in coming quarters.
Overall, the near-term economic outlook has weakened relative to the projections released by the Federal Open Market Committee (FOMC) at the end of January. It now appears likely that real gross domestic product (GDP) will not grow much, if at all, over the first half of 2008 and could even contract slightly. We expect economic activity to strengthen in the second half of the year, in part as the result of stimulative monetary and fiscal policies; and growth is expected to proceed at or a little above its sustainable pace in 2009, bolstered by a stabilization of housing activity, albeit at low levels, and gradually improving financial conditions. However, in light of the recent turbulence in financial markets, the uncertainty attending this forecast is quite high and the risks remain to the downside.
Inflation Shot Up; Core Inflation Edged Down After Firming
Inflation has also been a source of concern. The price index for personal consumption expenditures rose 3.4 percent over the twelve months ending in February, up from 2.3 percent over the preceding twelve-month period. To a large extent, this pickup in inflation has been the result of sharp increases in the prices of crude oil, agricultural products, and other globally traded commodities. Additionally, the decline in the foreign exchange value of the dollar has boosted some non-commodity import prices and thus contributed to inflation. However, the so-called core rate of inflation--that is, inflation excluding food and energy prices--has edged down recently after firming somewhat late last year.
We expect inflation to moderate in coming quarters. That expectation is based, in part, on futures markets' indications of a leveling out of prices for oil and other commodities, and it is consistent with our projection that global growth--and thus the demand for commodities--will slow somewhat during this period. And, as I noted, we project an easing of pressures on resource utilization. However, some indicators of inflation expectations have risen, and, overall, uncertainty about the inflation outlook has increased. It will be necessary to continue to monitor inflation developments carefully in the months ahead.
Although our recent actions appear to have helped stabilize the situation somewhat, financial markets remain under considerable stress. Pressures in short-term bank funding markets, which had abated somewhat beginning late last year, have increased once again. Many lenders have been reluctant to provide credit to counterparties, especially leveraged investors, and have increased the amount of collateral they require to back short-term security financing agreements. To meet those demands, investors have reduced their leverage and liquidated holdings of securities, putting further downward pressure on security prices.
Limited Credit Available In Overall Market
Credit availability has also been restricted because some large financial institutions, including some commercial and investment banks and the government-sponsored enterprises (GSEs), have reported substantial losses and writedowns, reducing their available capital. Several of these firms have been able to raise fresh capital to offset at least some of those losses, and others are in the process of doing so. However, financial institutions' balance sheets have also expanded, as banks and other institutions have taken on their balance sheets various assets that can no longer be financed on a standalone basis. Thus, the capacity and willingness of some large institutions to extend new credit remains limited.
Strains on Credit Cost of Mortgage and ARS Remain Evident
The effects of the financial strains on credit cost and availability have become increasingly evident, with some portions of the system that had previously escaped the worst of the turmoil--such as the markets for municipal bonds and student loans--having been affected. Another market that had previously been largely exempt from disruptions was that for mortgage-backed securities (MBS) issued by government agencies. However, beginning in mid-February, worsening liquidity conditions and reports of losses at the GSEs, Fannie Mae and Freddie Mac, caused the spread of agency MBS yields over the yields on comparable Treasury securities to rise sharply. Together with the increased fees imposed by the GSEs, the rise in this spread resulted in higher interest rates on conforming mortgages. More recently, agency MBS spreads and conforming mortgage rates have retraced part of this increase, and conforming mortgages continue to be readily available to households. However, for the most part, the nonconforming segment of the mortgage market continues to function poorly.
Corporate Bonds Market Subsiding and Commercial Paper Market Strained
In corporate debt markets, yields and spreads on both investment-grade and speculative-grade corporate bonds rose through mid-March before falling more recently. Issuance of investment-grade bonds by both financial and nonfinancial corporations has been quite robust so far this year, but issuance of new high-yield debt has stalled. Strains continue to be evident in the commercial paper market as well, where risk spreads remain elevated and the quantity of commercial paper outstanding, particularly asset-backed paper, has decreased. Commercial and industrial loans at banks grew in January and February, but at a considerably slower pace than in previous months.
Weigh on Economic Activities
These developments in financial markets--which themselves reflect, in part, greater concerns about housing and the economic outlook more generally--have weighed on real economic activity. Notably, in the housing market, sales of both new and existing homes have generally continued weak, partly as a result of the reduced availability of mortgage credit, and home prices have continued to fall.1 Starts of new single-family homes declined an additional 7 percent in February, bringing the cumulative decline since the early 2006 peak in single-family starts to more than 60 percent. Residential construction is likely to contract somewhat further in coming quarters as builders try to reduce their high inventories of unsold new homes.
Labor Market Moderate
Private payroll employment fell 101,000 in February, after two months of smaller job losses, with job cuts in construction and closely related industries accounting for a significant share of the decline. But the demand for labor has also moderated recently in other industries, such as business services and retail trade, and manufacturing employment has continued on its downward trend. Meanwhile, claims for unemployment insurance have risen somewhat on balance, and surveys indicate that employers have scaled back hiring plans and that jobseekers are experiencing greater difficulties finding work. The unemployment rate edged down in February and remains at a relatively low level; however, in light of the sluggishness of economic activity and other indicators of a softer labor market, I expect it to move somewhat higher in coming months.
Consumer Power Weakened
After rising at an annual rate of about 3 percent over the first three quarters of last year, real disposable income has since increased at only about a 1 percent annual rate, reflecting weaker employment conditions and higher prices for energy and food. Concerns about employment and income prospects, together with declining home values and tighter credit conditions, have caused consumer spending to decelerate considerably from the solid pace seen during the first three quarters of last year. I expect the tax rebates associated with the fiscal stimulus package recently passed by the Congress to provide some support to consumer spending in coming quarters.
Layoff Concided with Reduced Capital Spending
In the business sector, the pullback in hiring that I noted earlier has been accompanied by some reduction in capital spending plans, as weaker sales prospects, tighter credit, and heightened uncertainty have made business leaders more cautious. On a more positive note, the nonfinancial business sector remains financially sound, with liquid balance sheets and low leverage ratios, and most firms have been able to avoid unwanted buildups in inventories. In addition, many businesses are enjoying strong demand from abroad. Although the prospects for foreign economic growth have diminished somewhat in recent months, net exports should continue to provide considerable support to U.S. economic activity in coming quarters.
Overall, the near-term economic outlook has weakened relative to the projections released by the Federal Open Market Committee (FOMC) at the end of January. It now appears likely that real gross domestic product (GDP) will not grow much, if at all, over the first half of 2008 and could even contract slightly. We expect economic activity to strengthen in the second half of the year, in part as the result of stimulative monetary and fiscal policies; and growth is expected to proceed at or a little above its sustainable pace in 2009, bolstered by a stabilization of housing activity, albeit at low levels, and gradually improving financial conditions. However, in light of the recent turbulence in financial markets, the uncertainty attending this forecast is quite high and the risks remain to the downside.
Inflation Shot Up; Core Inflation Edged Down After Firming
Inflation has also been a source of concern. The price index for personal consumption expenditures rose 3.4 percent over the twelve months ending in February, up from 2.3 percent over the preceding twelve-month period. To a large extent, this pickup in inflation has been the result of sharp increases in the prices of crude oil, agricultural products, and other globally traded commodities. Additionally, the decline in the foreign exchange value of the dollar has boosted some non-commodity import prices and thus contributed to inflation. However, the so-called core rate of inflation--that is, inflation excluding food and energy prices--has edged down recently after firming somewhat late last year.
We expect inflation to moderate in coming quarters. That expectation is based, in part, on futures markets' indications of a leveling out of prices for oil and other commodities, and it is consistent with our projection that global growth--and thus the demand for commodities--will slow somewhat during this period. And, as I noted, we project an easing of pressures on resource utilization. However, some indicators of inflation expectations have risen, and, overall, uncertainty about the inflation outlook has increased. It will be necessary to continue to monitor inflation developments carefully in the months ahead.
Contraction is possible, but most adjustments are complete
Federal Reserve Chairman Ben Bernanke publicly raised the prospect of a U.S. recession for the first time since the current slowdown began last year.
But he also signaled that "much" of the needed economic and financial market adjustment has already taken place and that conditions should improve later this year, suggesting there may not be much need for additional monetary stimulus, especially with inflation still a concern.
Though Mr. Bernanke testifies often to Congress, Wednesday's appearance was unique in that it came fresh on the heels of three major events for the Fed: last month's aggressive three-quarter-percentage-point interest rate cut to shore up the economy; its intervention in J.P. Morgan Chase & Co.'s proposed takeover of Bear Stearns Cos.; and a Treasury blueprint released Monday that could eventually give the Fed unprecedented oversight over -- and accountability for -- virtually every corner of the financial markets.
But he also signaled that "much" of the needed economic and financial market adjustment has already taken place and that conditions should improve later this year, suggesting there may not be much need for additional monetary stimulus, especially with inflation still a concern.
Though Mr. Bernanke testifies often to Congress, Wednesday's appearance was unique in that it came fresh on the heels of three major events for the Fed: last month's aggressive three-quarter-percentage-point interest rate cut to shore up the economy; its intervention in J.P. Morgan Chase & Co.'s proposed takeover of Bear Stearns Cos.; and a Treasury blueprint released Monday that could eventually give the Fed unprecedented oversight over -- and accountability for -- virtually every corner of the financial markets.
Bonds Win and Stock Screw
One important fact about recent market turmoil is that while it has its roots in troubled debt, it is stock investors who usually pay the price for a company's missteps.
Bank of America agreed to buy Countrywide Financial at a huge discount, ensuring Countrywide's lenders would get paid back. But shareholders were left down more than 80%. J.P. Morgan Chase swallowed Bear Stearns in a fire sale that staved off bankruptcy, good for bondholders but, again, bad for stock investors.
Bond insurers MBIA and Ambac Financial Group issued stock to build needed capital, helping their debt while diluting the stock. Thornburg Mortgage avoided default in part by issuing warrants to purchase its common shares, which will dilute shareholders. The stock is 95% below its 52-week high. Lehman Brothers Holdings and UBS unveiled plans to raise capital by issuing new shares. Stock investors celebrated, even though it watered down their shares.
"The debtholders have done extremely well because the company either sells itself at a discount or issues enough equity to put off a bankruptcy," says Boaz Weinstein, co-head of global credit trading at Deutsche Bank. He's searching out financial companies with bonds that look beat up relative to their shares, and buying the bonds while shorting the stocks.
Another example: Ruby Tuesday, the restaurant chain, which reports earnings Wednesday, avoided default by asking lenders to change loan agreements and cutting its dividend. It's supposed to work this way. Creditors are first in line to get paid when problems emerge. Shareholders are the end of the line.
Yet the broader market doesn't seem to reflect this trend. True, even after Tuesday's rally, the Dow Jones Industrial Average is down 11% from its record high. But corporate bonds have also been trounced. Junk-bond defaults are still low, but the yields demanded by investors have soared.
"Credit has decoupled from equities," wrote Bank of America credit strategist Jeffrey Rosenberg in a Monday note. He favors high-grade corporate bonds to stocks.
Because stocks are a riskier asset class than bonds, they tend to do better when times are good, paying investors for their willingness to take risk. But when times are tough, shareholders suffer. If the market starts pricing that in, the much-maligned bond market might be the safer place to be while Wall Street scrambles to raise money.
Bank of America agreed to buy Countrywide Financial at a huge discount, ensuring Countrywide's lenders would get paid back. But shareholders were left down more than 80%. J.P. Morgan Chase swallowed Bear Stearns in a fire sale that staved off bankruptcy, good for bondholders but, again, bad for stock investors.
Bond insurers MBIA and Ambac Financial Group issued stock to build needed capital, helping their debt while diluting the stock. Thornburg Mortgage avoided default in part by issuing warrants to purchase its common shares, which will dilute shareholders. The stock is 95% below its 52-week high. Lehman Brothers Holdings and UBS unveiled plans to raise capital by issuing new shares. Stock investors celebrated, even though it watered down their shares.
"The debtholders have done extremely well because the company either sells itself at a discount or issues enough equity to put off a bankruptcy," says Boaz Weinstein, co-head of global credit trading at Deutsche Bank. He's searching out financial companies with bonds that look beat up relative to their shares, and buying the bonds while shorting the stocks.
Another example: Ruby Tuesday, the restaurant chain, which reports earnings Wednesday, avoided default by asking lenders to change loan agreements and cutting its dividend. It's supposed to work this way. Creditors are first in line to get paid when problems emerge. Shareholders are the end of the line.
Yet the broader market doesn't seem to reflect this trend. True, even after Tuesday's rally, the Dow Jones Industrial Average is down 11% from its record high. But corporate bonds have also been trounced. Junk-bond defaults are still low, but the yields demanded by investors have soared.
"Credit has decoupled from equities," wrote Bank of America credit strategist Jeffrey Rosenberg in a Monday note. He favors high-grade corporate bonds to stocks.
Because stocks are a riskier asset class than bonds, they tend to do better when times are good, paying investors for their willingness to take risk. But when times are tough, shareholders suffer. If the market starts pricing that in, the much-maligned bond market might be the safer place to be while Wall Street scrambles to raise money.
Tuesday, April 1, 2008
Comment: Hedging comparison betwene Lehman and Bear Stearn
Lehman - strong hedging
--Net credit exposure 34.1 bil of OTC deritivatives asset in 07, vs 15.9 bil in 06; where interest rate, currency, and CDS 21.7 bil in 07, vs 8.8 in 06. asset are realized gain, not noational amount. In 2007, it increased CDS protection by approximately 4 bil of gains, reflection of bringing down gross writedown 5.4 bil to just $2 bil of net writedown ( 60% heding ratio).
--unrelized level III net derivative gains are 1.58 bil vs 2.663 bil of M and Asset Backed Secs in 07 (hedging ratio 60%)
Bear Stearn - weak hedging
--short in details. notional amount of derivatives 13.4 in 07 vs 8.74 in 06. 11 tril in 2007 falls into swaps (options, swaptions, caps, collars and floors)
--net derivatives gain in 07 is 375 mil, non derivatives loss is 1.89 bil in 07 (20% hedging ratio)
Merrill Lynch - aweful hedging
--Unrealized net derivative loss in 07 is -7.7 bil vs -4.2 bil net loss in trading assets.
--The contractual obgliation assets in the form of CDS is 3.8 bil, but its contratual oglibation liability in the form of CDS is 8.5 bil, net effect is negative CDS.
--It has CDS exposure 19.9 bil to financial guarantor, net gain of 3.4 bil
--Net credit exposure 34.1 bil of OTC deritivatives asset in 07, vs 15.9 bil in 06; where interest rate, currency, and CDS 21.7 bil in 07, vs 8.8 in 06. asset are realized gain, not noational amount. In 2007, it increased CDS protection by approximately 4 bil of gains, reflection of bringing down gross writedown 5.4 bil to just $2 bil of net writedown ( 60% heding ratio).
--unrelized level III net derivative gains are 1.58 bil vs 2.663 bil of M and Asset Backed Secs in 07 (hedging ratio 60%)
Bear Stearn - weak hedging
--short in details. notional amount of derivatives 13.4 in 07 vs 8.74 in 06. 11 tril in 2007 falls into swaps (options, swaptions, caps, collars and floors)
--net derivatives gain in 07 is 375 mil, non derivatives loss is 1.89 bil in 07 (20% hedging ratio)
Merrill Lynch - aweful hedging
--Unrealized net derivative loss in 07 is -7.7 bil vs -4.2 bil net loss in trading assets.
--The contractual obgliation assets in the form of CDS is 3.8 bil, but its contratual oglibation liability in the form of CDS is 8.5 bil, net effect is negative CDS.
--It has CDS exposure 19.9 bil to financial guarantor, net gain of 3.4 bil
Types of CMBS in the Market
Agency
--Ginnie Mae passthrough certificates backed by loans insured by FHA. Loan limit, prepayment features, or the presence of rent subsidies will affect the performance of a pool.
--Fannie Maeo. the most porminent program is Delegated Undweriting and Servicing (DUS) program. DUS are differentiated by credit tiering, with each security assigned a rating from one to four. Each DUS is placed in a tier based on tis loan-to-value ratio and minimum debt coverage ratio, wtih tier four being the highest quality.
Non Agency or Private Label - Majority
--Some are collateralized by pools of seasoned commercial loans. Challengs: a wide range of coupons and loan types and wide prepayment protection
--Most private label CMBS are backed by newly originated loans. Two major categories: backed by loans made by a single borrower vs backed by loans made by multiple borrowers.
--single borrower deals can involve one property or a group (large properties such as office building or reginonal malls). lower reserving requirements; pall properties backing a particular deal are cross-defaulted. A release provision rqeuires a borrower to prepay a percentage of the remaining balance of the underlying loans if it wishes to prepay one of hte loands and remove the property from the pool.
--Multiple borrowers are more common. Conduit deals are the most prevalent examp.le of multiple borrower deals.
--Conduit deals: loans types tend to be more homogeneous and call protection is strong.
--Another kind of CMBS deal is one backed by lease on property. These triple-net lease or crdit tenant loan deals are collateralized by lease agreements between the property owner and a tenant. Majority of these securities have been collateralized by mortgages on retail stores with lessess, such as Wal-Mart.
--Ginnie Mae passthrough certificates backed by loans insured by FHA. Loan limit, prepayment features, or the presence of rent subsidies will affect the performance of a pool.
--Fannie Maeo. the most porminent program is Delegated Undweriting and Servicing (DUS) program. DUS are differentiated by credit tiering, with each security assigned a rating from one to four. Each DUS is placed in a tier based on tis loan-to-value ratio and minimum debt coverage ratio, wtih tier four being the highest quality.
Non Agency or Private Label - Majority
--Some are collateralized by pools of seasoned commercial loans. Challengs: a wide range of coupons and loan types and wide prepayment protection
--Most private label CMBS are backed by newly originated loans. Two major categories: backed by loans made by a single borrower vs backed by loans made by multiple borrowers.
--single borrower deals can involve one property or a group (large properties such as office building or reginonal malls). lower reserving requirements; pall properties backing a particular deal are cross-defaulted. A release provision rqeuires a borrower to prepay a percentage of the remaining balance of the underlying loans if it wishes to prepay one of hte loands and remove the property from the pool.
--Multiple borrowers are more common. Conduit deals are the most prevalent examp.le of multiple borrower deals.
--Conduit deals: loans types tend to be more homogeneous and call protection is strong.
--Another kind of CMBS deal is one backed by lease on property. These triple-net lease or crdit tenant loan deals are collateralized by lease agreements between the property owner and a tenant. Majority of these securities have been collateralized by mortgages on retail stores with lessess, such as Wal-Mart.
WHAT IS FANNIE MAE DUS?
Fannie Mae has clearly been the nation' dominant provider of permanent financing for multifamily (apartment) housing since 1987. Fannie Mae' flagship program, the Delegated Underwriting and Servicing (DUS) product line, has emerged as the multifamily loan product of choice, while gaining strength as the preferred financing option for other property types as well. The customer-centric features of the DUS loan have served to distinguish DUS lenders from their competitors. Additionally, Fannie Mae' commitment to the multifamily housing industry, combined with its innovative approach to constant product improvement, ensures that the DUS loan will continue to lead the multifamily finance industry into the 2't century.
Fannie Mae is "in the market" every day regardless of economic conditions, providing capital for multifamily mortgage loans through its DUS lender network. Currently Fannie Mae' multifamily loan portfolio stands at an astonishing $64 billion. In the year 2000 alone, Fannie Mae provided $8.7 billion for multifamily permanent financing through approved DUS lenders. It' important to keep in mind that DUS is not a construction loan product -- this funding is for existing properties.
To comprehend the DUS product is to understand the unique partnership between Fannie Mae and its DUS lender network. Fannie Mae has licensed 25 select lenders across the country to originate multifamily loans. These lenders are granted broad discretion in making lending decisions. In fact, Fannie Mae delegates the responsibility for pricing, processing, approving, closing and servicing to its DUS lenders. The DUS lender, therefore, controls the entire process within the parameters prescribed by Fannie Mae. DUS lenders are not subject to "re-trading" by another loan committee in another city, a practice that has become commonplace with some lenders.
Why would Fannie Mae, who guarantees the DUS loan to the ultimate purchaser of the underlying security, grant such broad discretion to its DUS lenders? The basic answer to this question is twofold. First, the lending industry' best and brightest professionals represent DUS lenders. Loan officers typically possess years of experience combined with rigorous training specifically related to the DUS product line. Second, companies holding DUS licenses are well capitalized organizations willing to share the risk associated with the loans originated by their officers. This risk sharing component serves to ensure that prudent lending decisions are made.
What enables superior pricing through DUS lenders? The answer to this question is simple. The DUS loan is guaranteed by Fannie Mae to the purchaser of the securities issued by the DUS lender. These securities are backed by the mortgage loan. The Fannie Mae guarantee is viewed as a significant enhancement to the quality of the loan, thus driving up the value of the security to an investor. This enhancement permits the DUS lender to deliver a loan that includes an attractive interest rate to the borrower.
What elements of the DUS loan set it apart from the typical long-term loan available in today' market place? Unlike the typical 10-year, fixed rate loan available today, there really is no "typical" DUS loan. The structure of a DUS loan is truly flexible. Adjustable or fixed rate pricing is available and loan terms from five to 30 years are offered under the DUS product line. DUS loans are assumable to qualified borrowers, but that is not all; perhaps the most attractive feature recently added to the fixed rate product line is the ability to place subordinate financing after the first loan year. This is particularly advantageous to borrowers who wish to place long-term fixed rate financing without "locking up" potential equity generated over time as rents increase and values rise. The ability to apply for subordinate financing also enhances the value of an assumption provision whereby a conservative loan may be "leveraged up," thus avoiding the heavy cost of paying a yield maintenance penalty upon the retirement of a loan by a buyer. The buyer may simply assume existing financing and take down a subordinate loan to bridge the gap between the existing loan amount and what might otherwise be achievable through new financing.
Another reason to consider the Fannie Mae DUS product is servicing, the collection of payments and monitoring of the community securing the loan. This function is also delegated to the DUS lender. Borrowers can expect to deal with representatives of the same company that originated their loan rather than a sometimes disinterested and less than helpful organization that simply purchases loan-servicing rights. Many times these servicers, unlike the DUS lender, are not engaged in the business of originating new loans and lack a commitment to customer service. DUS lenders, who appreciate the value of a repeat customer, tend to be exceptional at loan servicing functions.
Is a Fannie Mae DUS loan a "government" loan or a loan for low-income housing? No. This is a frequent misconception. Although Fannie Mae' charter is with the federal government, Fannie Mae is a publicly traded for-profit corporation. Fannie Mae DUS loans are most commonly utilized to finance premium quality communities. One of Fannie Mae' charter provisions stipulates that Fannie Mae is to promote affordable housing in the United States of America. However, the Fannie Mae product line is designed to make economic sense, or Fannie Mae, like any other company, would be unable to deliver an acceptable profit to its stockholders. These provisions are an excellent fit with the multifamily housing industry, allowing DUS lenders to finance quality affordable housing for people all over the U.S.
Which products can be financed through DUS lending? Fannie Mae' DUS product, the multifamily industry' most popular permanent loan for financing apartments, is now available for financing manufactured home communities. The DUS loan is also available for financing senior housing communities, including congregate and assisted living facilities. Owners of these property types will receive better pricing, more flexible terms and premium customer service through the DUS product line -- features previously available only to apartment community owners.
Does Fannie Mae really understand manufactured housing? While the DUS product line has just now become available for financing manufactured home communities, Fannie Mae is no newcomer to the industry. In the summer of 2000, Collateral Mortgage Capital, one of Fannie Mae' select DUS lenders, closed a $177 million master credit facility secured by several manufactured home communities owned by Chateau Communities, the nation' largest manufactured home community REIT. This transaction was originated and closed by Collateral Mortgage Capital, one of only a handful of DUS lenders who provide financing for manufactured home communities. Fannie Mae understands the manufactured home community industry and is eager to participate in a bigger way since Fannie Mae' mission to promote quality affordable housing is consistent with the affordability of living in a manufactured home community.
To summarize, it is no surprise that Fannie Mae' DUS product line has emerged as the loan of choice among owners of apartments across the U.S. Reliability, flexibility, attractive pricing and quality customer service set DUS lenders apart from the myriad of competitors seeking to finance apartments, manufactured home communities and senior housing.
http://www.southeastrebusiness.com/articles/MAY01/feature7.html
Fannie Mae is "in the market" every day regardless of economic conditions, providing capital for multifamily mortgage loans through its DUS lender network. Currently Fannie Mae' multifamily loan portfolio stands at an astonishing $64 billion. In the year 2000 alone, Fannie Mae provided $8.7 billion for multifamily permanent financing through approved DUS lenders. It' important to keep in mind that DUS is not a construction loan product -- this funding is for existing properties.
To comprehend the DUS product is to understand the unique partnership between Fannie Mae and its DUS lender network. Fannie Mae has licensed 25 select lenders across the country to originate multifamily loans. These lenders are granted broad discretion in making lending decisions. In fact, Fannie Mae delegates the responsibility for pricing, processing, approving, closing and servicing to its DUS lenders. The DUS lender, therefore, controls the entire process within the parameters prescribed by Fannie Mae. DUS lenders are not subject to "re-trading" by another loan committee in another city, a practice that has become commonplace with some lenders.
Why would Fannie Mae, who guarantees the DUS loan to the ultimate purchaser of the underlying security, grant such broad discretion to its DUS lenders? The basic answer to this question is twofold. First, the lending industry' best and brightest professionals represent DUS lenders. Loan officers typically possess years of experience combined with rigorous training specifically related to the DUS product line. Second, companies holding DUS licenses are well capitalized organizations willing to share the risk associated with the loans originated by their officers. This risk sharing component serves to ensure that prudent lending decisions are made.
What enables superior pricing through DUS lenders? The answer to this question is simple. The DUS loan is guaranteed by Fannie Mae to the purchaser of the securities issued by the DUS lender. These securities are backed by the mortgage loan. The Fannie Mae guarantee is viewed as a significant enhancement to the quality of the loan, thus driving up the value of the security to an investor. This enhancement permits the DUS lender to deliver a loan that includes an attractive interest rate to the borrower.
What elements of the DUS loan set it apart from the typical long-term loan available in today' market place? Unlike the typical 10-year, fixed rate loan available today, there really is no "typical" DUS loan. The structure of a DUS loan is truly flexible. Adjustable or fixed rate pricing is available and loan terms from five to 30 years are offered under the DUS product line. DUS loans are assumable to qualified borrowers, but that is not all; perhaps the most attractive feature recently added to the fixed rate product line is the ability to place subordinate financing after the first loan year. This is particularly advantageous to borrowers who wish to place long-term fixed rate financing without "locking up" potential equity generated over time as rents increase and values rise. The ability to apply for subordinate financing also enhances the value of an assumption provision whereby a conservative loan may be "leveraged up," thus avoiding the heavy cost of paying a yield maintenance penalty upon the retirement of a loan by a buyer. The buyer may simply assume existing financing and take down a subordinate loan to bridge the gap between the existing loan amount and what might otherwise be achievable through new financing.
Another reason to consider the Fannie Mae DUS product is servicing, the collection of payments and monitoring of the community securing the loan. This function is also delegated to the DUS lender. Borrowers can expect to deal with representatives of the same company that originated their loan rather than a sometimes disinterested and less than helpful organization that simply purchases loan-servicing rights. Many times these servicers, unlike the DUS lender, are not engaged in the business of originating new loans and lack a commitment to customer service. DUS lenders, who appreciate the value of a repeat customer, tend to be exceptional at loan servicing functions.
Is a Fannie Mae DUS loan a "government" loan or a loan for low-income housing? No. This is a frequent misconception. Although Fannie Mae' charter is with the federal government, Fannie Mae is a publicly traded for-profit corporation. Fannie Mae DUS loans are most commonly utilized to finance premium quality communities. One of Fannie Mae' charter provisions stipulates that Fannie Mae is to promote affordable housing in the United States of America. However, the Fannie Mae product line is designed to make economic sense, or Fannie Mae, like any other company, would be unable to deliver an acceptable profit to its stockholders. These provisions are an excellent fit with the multifamily housing industry, allowing DUS lenders to finance quality affordable housing for people all over the U.S.
Which products can be financed through DUS lending? Fannie Mae' DUS product, the multifamily industry' most popular permanent loan for financing apartments, is now available for financing manufactured home communities. The DUS loan is also available for financing senior housing communities, including congregate and assisted living facilities. Owners of these property types will receive better pricing, more flexible terms and premium customer service through the DUS product line -- features previously available only to apartment community owners.
Does Fannie Mae really understand manufactured housing? While the DUS product line has just now become available for financing manufactured home communities, Fannie Mae is no newcomer to the industry. In the summer of 2000, Collateral Mortgage Capital, one of Fannie Mae' select DUS lenders, closed a $177 million master credit facility secured by several manufactured home communities owned by Chateau Communities, the nation' largest manufactured home community REIT. This transaction was originated and closed by Collateral Mortgage Capital, one of only a handful of DUS lenders who provide financing for manufactured home communities. Fannie Mae understands the manufactured home community industry and is eager to participate in a bigger way since Fannie Mae' mission to promote quality affordable housing is consistent with the affordability of living in a manufactured home community.
To summarize, it is no surprise that Fannie Mae' DUS product line has emerged as the loan of choice among owners of apartments across the U.S. Reliability, flexibility, attractive pricing and quality customer service set DUS lenders apart from the myriad of competitors seeking to finance apartments, manufactured home communities and senior housing.
http://www.southeastrebusiness.com/articles/MAY01/feature7.html
Banks Face Biggest Crisis in 30 Years
-- Credit market turmoil poses the mostsevere crisis for banks in 30 years, surpassing Black Monday in1987, the Asia currency crisis and the bursting of the dot-combubble, Morgan Stanley and Oliver Wyman said in a joint report.
Revenue from investment banking may drop 20 percent in2008, with credit businesses declining 60 percent, analysts ledby Huw van Steenis said in a note to clients today. Six quartersof earnings will be erased by writedowns and falling revenue bythis month, rivaling the collapse of the junk bond market at theend of the 1980s that put Drexel Burnham Lambert Inc. out ofbusiness, the report said.
``The industry is facing the most severe investment bankingcrisis in 30 years,'' the analysts wrote in the report. ``Globalsecurities markets are in the midst of profound cyclical andstructural change.''
UBS AG and Deutsche Bank AG, two of Europe's biggest banks,posted today a combined $23 billion of writedowns linked to thecollapse of the subprime mortgage market. In all, investmentbanks may post $75 billion in markdowns in 2008, according tothe report. Writedowns and losses on subprime-infected assetshave already cost the world's biggest banks about $230 billionsince the start of 2007.
Investment-banking revenue has also stalled as the pace oftakeovers and initial public offerings declined in the firstquarter of 2008. Mergers and acquisitions bankers suffered a 35percent drop in fees during the first quarter as the value ofannounced takeovers fell to $656 billion from $971 billion ayear earlier, according to data compiled by Bloomberg.
Crisis Duration
Banks' earnings have been hurt for the past three quartersby the turmoil in the credit markets. In total, the crisis maylast for eight to 10 quarters, exceeding the six-quarter durationof the Asia crisis and bailout of LTCM in 1997-8, and the seven-quarter fallout from the bursting of the dot-com bubble, thereport said. The 1987 stock market crash hurt earnings in just asingle quarter, according to the report, entitled ``Outlook forInvestment Banking and Capital Market Financials.''
Regulators will also push the industry to retain morecapital as a cushion, hurting banks' return on equity in thelong term, the group added. Treasury Secretary Henry Paulsonproposed yesterday the biggest overhaul of U.S. financial rulessince the Great Depression, saying the Federal Reserve shouldexpand its oversight of financial services beyond banks.
Banks are also finding their cost of capital is increasingrelative to other investment-grade companies. Traditionalsources of money, like structured investment vehicles, are lessavailable, the report said. Banks are struggling to offloadloans, leaving leverage ratios high, it said.
Diversified Funding
``Firms with diverse sources of funding, with retail andcommercial deposits clearly helping, and a diversified businesswill have a funding advantage over the coming years,'' theanalysts wrote. ``This may lead to a material reassessment ofbusiness models over time.''
Zurich-based UBS today posted an additional $19 billion ofwritedowns and said it would seek $15.1 billion in a rightsoffering to replenish capital. Deutsche Bank, Germany's biggestbank, also said today it expects to book about 2.5 billion euros($3.9 billion) in writedowns for the quarter.
Separately, Merrill Lynch & Co. and Citigroup Inc. hadtheir first-quarter earnings estimates cut by Goldman SachsGroup Inc., which said the two banks may post $14 billion inwritedowns on assets linked to collateralized debt obligations.
Revenue from investment banking may drop 20 percent in2008, with credit businesses declining 60 percent, analysts ledby Huw van Steenis said in a note to clients today. Six quartersof earnings will be erased by writedowns and falling revenue bythis month, rivaling the collapse of the junk bond market at theend of the 1980s that put Drexel Burnham Lambert Inc. out ofbusiness, the report said.
``The industry is facing the most severe investment bankingcrisis in 30 years,'' the analysts wrote in the report. ``Globalsecurities markets are in the midst of profound cyclical andstructural change.''
UBS AG and Deutsche Bank AG, two of Europe's biggest banks,posted today a combined $23 billion of writedowns linked to thecollapse of the subprime mortgage market. In all, investmentbanks may post $75 billion in markdowns in 2008, according tothe report. Writedowns and losses on subprime-infected assetshave already cost the world's biggest banks about $230 billionsince the start of 2007.
Investment-banking revenue has also stalled as the pace oftakeovers and initial public offerings declined in the firstquarter of 2008. Mergers and acquisitions bankers suffered a 35percent drop in fees during the first quarter as the value ofannounced takeovers fell to $656 billion from $971 billion ayear earlier, according to data compiled by Bloomberg.
Crisis Duration
Banks' earnings have been hurt for the past three quartersby the turmoil in the credit markets. In total, the crisis maylast for eight to 10 quarters, exceeding the six-quarter durationof the Asia crisis and bailout of LTCM in 1997-8, and the seven-quarter fallout from the bursting of the dot-com bubble, thereport said. The 1987 stock market crash hurt earnings in just asingle quarter, according to the report, entitled ``Outlook forInvestment Banking and Capital Market Financials.''
Regulators will also push the industry to retain morecapital as a cushion, hurting banks' return on equity in thelong term, the group added. Treasury Secretary Henry Paulsonproposed yesterday the biggest overhaul of U.S. financial rulessince the Great Depression, saying the Federal Reserve shouldexpand its oversight of financial services beyond banks.
Banks are also finding their cost of capital is increasingrelative to other investment-grade companies. Traditionalsources of money, like structured investment vehicles, are lessavailable, the report said. Banks are struggling to offloadloans, leaving leverage ratios high, it said.
Diversified Funding
``Firms with diverse sources of funding, with retail andcommercial deposits clearly helping, and a diversified businesswill have a funding advantage over the coming years,'' theanalysts wrote. ``This may lead to a material reassessment ofbusiness models over time.''
Zurich-based UBS today posted an additional $19 billion ofwritedowns and said it would seek $15.1 billion in a rightsoffering to replenish capital. Deutsche Bank, Germany's biggestbank, also said today it expects to book about 2.5 billion euros($3.9 billion) in writedowns for the quarter.
Separately, Merrill Lynch & Co. and Citigroup Inc. hadtheir first-quarter earnings estimates cut by Goldman SachsGroup Inc., which said the two banks may post $14 billion inwritedowns on assets linked to collateralized debt obligations.
Swaps Hold Huge Corner Needing Focus
As policy makers plot out a grand redesign of financial-market regulation, one huge corner of the marketplace ought to get a lot of attention: credit-default swaps.
These financial instruments, which don't trade on exchanges, are like disaster insurance on debt defaults. Investors who buy these swaps get a big payment if a bond or loan defaults. In return for the protection, the investor has to make regular payments to the seller of the swap.
The market has become immensely important, yet regulators still haven't figured out how to deal with it. The Bush administration's blueprint for new regulation curiously had almost nothing to say about it.
Importance of Swaps
Swaps also played a deciding factor in the Federal Reserve's dramatic intervention. If Bear went down, others could have been dragged down through their exposure to the firm through swaps.
The market is important for other reasons. The explosion in these derivatives occurred at a time when corporate defaults were near record lows. Moody's Investors Service expects the junk-bond default rate to climb to a range of 7% to 7.5% in the next 12 months from just 1.5% now.
"We haven't gone through a massive default cycle," says Gregg Berman, co-head of the risk management unit at RiskMetrics Group. "I do not believe the market is remotely prepared for the fallout if that happens."
Swaps also present potential insider-trading problems for regulators to work out. In 2006 and early 2007, during the leveraged buyout boom, credit-default swaps at times soared in value before details of big deals were announced. Just last week, swap values were moving before news broke that the buyout of Clear Channel Communications was in jeopardy.
One problem for securities regulators: Because these can be considered private contracts, and not securities, it's not even clear if traditional securities laws apply to them.
Large commercial banks do need to file regular reports on their derivative exposures with the Office of the Comptroller of the Currency. The Depository Trust & Clearing Corporation also has set up an information warehouse that stores records of CDS trades. And the Federal Reserve Bank of New York has been pushing dealers and other firms to confirm and process trades more quickly. Last week, large dealers unveiled plans to centralize settlement of their credit-derivative trades by September.
But credit-default swaps have become too important for the wattle and daub approach regulators have given them in the past few years.
These financial instruments, which don't trade on exchanges, are like disaster insurance on debt defaults. Investors who buy these swaps get a big payment if a bond or loan defaults. In return for the protection, the investor has to make regular payments to the seller of the swap.
The market has become immensely important, yet regulators still haven't figured out how to deal with it. The Bush administration's blueprint for new regulation curiously had almost nothing to say about it.
Importance of Swaps
Swaps also played a deciding factor in the Federal Reserve's dramatic intervention. If Bear went down, others could have been dragged down through their exposure to the firm through swaps.
The market is important for other reasons. The explosion in these derivatives occurred at a time when corporate defaults were near record lows. Moody's Investors Service expects the junk-bond default rate to climb to a range of 7% to 7.5% in the next 12 months from just 1.5% now.
"We haven't gone through a massive default cycle," says Gregg Berman, co-head of the risk management unit at RiskMetrics Group. "I do not believe the market is remotely prepared for the fallout if that happens."
Swaps also present potential insider-trading problems for regulators to work out. In 2006 and early 2007, during the leveraged buyout boom, credit-default swaps at times soared in value before details of big deals were announced. Just last week, swap values were moving before news broke that the buyout of Clear Channel Communications was in jeopardy.
One problem for securities regulators: Because these can be considered private contracts, and not securities, it's not even clear if traditional securities laws apply to them.
Large commercial banks do need to file regular reports on their derivative exposures with the Office of the Comptroller of the Currency. The Depository Trust & Clearing Corporation also has set up an information warehouse that stores records of CDS trades. And the Federal Reserve Bank of New York has been pushing dealers and other firms to confirm and process trades more quickly. Last week, large dealers unveiled plans to centralize settlement of their credit-derivative trades by September.
But credit-default swaps have become too important for the wattle and daub approach regulators have given them in the past few years.
comments: Lehman Will Survive
Rumors are circulating that Lehman will collapse like Bear. I say it won't happen.
Negatives Sides
Admittedly, the concerns centes on the similarity between Bearn Stearn and Lehman. Similar to Bearn Stearns, Lehman has similar share of asset exposure to mortgages, around ~29%(BSC 33%), similar share of liabilities exposured to repo, ~27%, similar of liabiliteis in long term debt, ~20%. Pepole believe that Lehman will be next after the Bearns Stearns go down.
More liquidity available
Until end of Feb, Lehman has 34 bil of liquidity pool and 64 bil of unregulated eligible asset for collateral, approximately 15% of $600 bil of liabilties. The number has not changed since Q4 2007. It implied the underlying assets are high quality.
Before collapse, Bear Stearns has only 17 bil cash plus 5 bill unregulated eligible assts, 5% of $300 liabilities.
More Diversified Business Model
Lehman is far more diversified than Bearn Steans. 40% revenue comes from Equity(around 2 bil), 40% revenue comes from FI. Furthermore, nearly 50% revenue comes overseas.
Bearn Steran is purely domestic and focused exclusively on FI.
Hedging is working
In Q1 2008, total gross writedown is around 5.4 bil, net writedown is 2 bil. It implies that nearly 60% of toxic exposure is hedged. I am forecasting anothher 2 bil - 3 bil net writedown in Q2 2008 if market condition deteriorates.
Existing Exposure to Toxic Assets
In Q1. US mortgage exposure is $22 bil, CMBS $36.1 bil ($17 bil US)
Why does it still need Raise Capital
Lehman is planning to raise $3.7 bil convertible preffereed stock.
Simply put, it needs to shore up balance sheet. The writedown are directly cut into company equity capital, resulting in lower capital ratios (captial /asset). To avoid this and negative implication, Lehman raise further capital.
Lehman also raise capital to pad itis cushion for further deterioration of credit market.
Liquidity Alternatives
First, Lehman can borrow against 64 bil assets. It can have up to at least 50 billion.
Second, Lehman can tap the Term Security Lending Facility to swap part of toxic assets (US mortgage or CMBS) with Fed for Treasuries. I believe it can swap upto $5 bil
All of these liquditity should be ample enough to keep Lehman float until after Q2 2008 when credit market bottom out.
Negatives Sides
Admittedly, the concerns centes on the similarity between Bearn Stearn and Lehman. Similar to Bearn Stearns, Lehman has similar share of asset exposure to mortgages, around ~29%(BSC 33%), similar share of liabilities exposured to repo, ~27%, similar of liabiliteis in long term debt, ~20%. Pepole believe that Lehman will be next after the Bearns Stearns go down.
More liquidity available
Until end of Feb, Lehman has 34 bil of liquidity pool and 64 bil of unregulated eligible asset for collateral, approximately 15% of $600 bil of liabilties. The number has not changed since Q4 2007. It implied the underlying assets are high quality.
Before collapse, Bear Stearns has only 17 bil cash plus 5 bill unregulated eligible assts, 5% of $300 liabilities.
More Diversified Business Model
Lehman is far more diversified than Bearn Steans. 40% revenue comes from Equity(around 2 bil), 40% revenue comes from FI. Furthermore, nearly 50% revenue comes overseas.
Bearn Steran is purely domestic and focused exclusively on FI.
Hedging is working
In Q1 2008, total gross writedown is around 5.4 bil, net writedown is 2 bil. It implies that nearly 60% of toxic exposure is hedged. I am forecasting anothher 2 bil - 3 bil net writedown in Q2 2008 if market condition deteriorates.
Existing Exposure to Toxic Assets
In Q1. US mortgage exposure is $22 bil, CMBS $36.1 bil ($17 bil US)
Why does it still need Raise Capital
Lehman is planning to raise $3.7 bil convertible preffereed stock.
Simply put, it needs to shore up balance sheet. The writedown are directly cut into company equity capital, resulting in lower capital ratios (captial /asset). To avoid this and negative implication, Lehman raise further capital.
Lehman also raise capital to pad itis cushion for further deterioration of credit market.
Liquidity Alternatives
First, Lehman can borrow against 64 bil assets. It can have up to at least 50 billion.
Second, Lehman can tap the Term Security Lending Facility to swap part of toxic assets (US mortgage or CMBS) with Fed for Treasuries. I believe it can swap upto $5 bil
All of these liquditity should be ample enough to keep Lehman float until after Q2 2008 when credit market bottom out.
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