Comments from a blog member - I would like to hear my constituency's opinion on this:
One of the banks that I have been following in the recent months is ICICI bank. The stock peaked around $71 on Jan 10th and is down to around $36 of late. From what I can observe, Indian market took off just around the time MER was making margin calls on BSC (last July-August) mostly due to foreign money flows. (Smart money got in early and setup rising expectations). Of late ICICI has revealed derivative losses and may be there is more to come. And this has shown up in the near 50% drop in the stock over a 10 week period. (By the time CNBC started touting "Emerging market safe havens" smart money was already getting out). Lot of common people in India are getting hurt in the process and are learning a hard lesson. On the ground in Indian real estate is beyond bubble territory, people buying multiple homes as investment at the height of the bubble, but there are signs of sentiment turning negative. For the service industry the Rupee appreciation along with US downturn is becoming a serious problem. Although service export industry is a net positive, it can only employ a very small slice of the population. Despite all this India may not be as dependent on exports as China and has a reasonably mature/strong domestic market.
Recent news bytes:
- Bloomberg: Treasuries rose and three-month bill rates plunged to to 0.56%,
the lowest level in almost 50 years on speculation credit market losses
will widen (e.g. ex-LTCM Meriwether's fund facing losses, Thornburg
Mortgage Inc. may go bankrupt, Merrill suing monoliner over recalled
$3.1bn CDO guarantee)
- RGE Montitor: Flight to quality trades:
The rate on the three-month Treasury bill, viewed by investors as a
haven in times of trouble, dropped 32 basis points to 0.56% on Feb 19;
- Capital preservation trade: buy Treasuries sell stocks;
- TED spreads (= LIBOR- T-Bill) spiking upwards in all markets
- 2-year swap spreads widening
Signs of interbank lending stress and liquidity hoarding eased after
Fed actions on March 16/17; spreads on the rise again in US, UK and
Euro market. Interbank spread decomposition shows that crunch is driven
by upward trending credit premium since 2008 instead of liquidity
premium as was the case in H2 2007. Fed interventions ultimately can
address liquidity, not credit concerns.
- Fed, BoE, ECB intervening in their respective markets
Flight to quality and cash hoarding lead to Treasury yields close to
zero--> if there is no compensation for holding Treasury paper,
investors prefer to hold cash--> normal monetary policy channel via
buying and selling of Treasuries breaks down (i.e. liquidity trap). He also points out that TED spreads - between 3-month Libor and 3-month treasuries - are now
back to where it was, saying that the results of the rate cut and the
new liquidity measures must be disappointing to the Fed.
- Yves Smith
at Naked Capitalism backs up my assertion that all attention has focused so far on US banks, but European banks are in at least as much trouble, citing research that some European banks have written off senior and
mezzanine tranches of CDOs to a large extent, while others have not at
all, quoting CreditSights, whose model indicates a shortfall in
write-downs of over $3bn for Barclays, RBS and SocGen, and of over $6bn
for UBS .
has been in my bearish sites, but until now I have not put the
microscope on them. That will change very soon. I am also intensifying my
research on Morgan Stanley since I feel they carry the most credit
risk, leverage and level 3 asset concentrations (bullsh1t risk) on the
street. I will also start covering the borrow short buy long funds that have been going bust lately like TMA and Carlyle Capital which are still over $10 per share. I had a short position on KFN, which I unfortunately closed out a while back. I am looking into to going back in, although to do so would be a bet that they will be wiped out of existence since their share price has fallen so much thus far. They have the exact same problem Carlyle Capital has (had?).
I am very close to spreading out to the European and Asian banks. I know they are in serious trouble, it is just that I have but so much to dedicate in analytical resources and time. I hate running in blind. Anyone who has experise in any of these areas (or any other areas of interest), feel free to start a post, thread or user group - or contact me to share info and thoughts.
The Naked Capitalism Blog
alleges the collateral pledged by prime brokers to the Fed via commercial
banks will be valued by the commercial banks. Since they often hold the
same collateral, this facility may induce them not to write down their
own assets and put on excessive valuations. One way to counter this is to try to identify the classes of assets and put our own gross marks on them. This is what I did with GGP and the monolines. It may not be the most accurate in some cases. GGP is quite accurate in my opinion due to ample supporting data and proven robust modeling, the monolines were educated guesses just like everyone else's opinion on valuation. What makes the monoline situation believable is that you can be off by a whopping 25% and still see how they are in trouble because the losses x leverage x macro trend is not very ambiguous.
...and for those who haven't read the popular Money Trap article, click here,
Not only did they add that much liqudity, they expanded the eligible collateral to include CMBS. It appears that the I banking system was in more trouble than we were led to believe. Now, those companies with high levels of ineligible collateral will still have many of the same problems as last week. In addition, the Fed can swap for treasuries all it wants, no one will want to buy these structured and MBS securities. Too many people know what's behind them and what level in the boom-bust cycle they were written on.
From Bloomberg :
The Federal Reserve, in its first extension of credit to non-banks since the Great Depression, lent $28.8 billion as of yesterday to the biggest securities firms to try to stabilize capital markets.
In a separate announcement, the Fed expanded collateral eligible for its first auction of Treasuries March 27 to include bundled mortgage debt and securities linked to commercial real- estate loans. The value of the sale was set at $75 billion, part of a $200 billion facility unveiled last week... The recipients of the Fed's credit are getting cash and Treasury notes in exchange for securities tied to mortgages and other distressed debt...
The central bank's Primary Dealer Credit Facility, announced March 16, allows Wall Street banks to borrow money overnight at a 2.5 percent interest rate, the same charged to commercial banks. The Fed bypassed its own emergency-lending policies and used broader authority in the Federal Reserve Act to give both kinds of companies the same borrowing costs.
The central bank said the loans will be available for at least six months. The Fed's decision to be lender of last resort to the 20 primary dealers of government debt came two days after the Fed provided emergency financing to Bear Stearns through JPMorgan.
The Fed's weekly balance sheet released today showed other credit extensions, including loans to facilitate JPMorgan's purchase of Bear Stearns, averaged $5.5 billion a day for the week ended yesterday. The balance ended at zero, according to the Fed's weekly balance sheet.
The zero balance on the Bear Stearns loans signals that the Fed has yet to extend the $30 billion in financing to JPMorgan in exchange for collateral that includes ``less liquid'' Bear assets. The $5.5 billion daily average of the JPMorgan-Bear Stearns loan indicates that a March 14 bridge loan, assuming it was paid off three days later, totaled about $13 billion.
`Show Some Leadership'
Morgan Stanley and Goldman Sachs Group Inc. said yesterday that they borrowed to ``test'' the new lending facility. Lehman Brothers Holdings Inc. Chief Financial Officer Erin Callan said in a Bloomberg Television interview that the firm was using the lending window to ``show some leadership.'' The Fed report today showed that the lending averaged $13.4 billion in the week ended yesterday...
In the Term Securities Lending Facility, the New York Fed bank today altered its plans so it will accept the expanded collateral list, which includes residential mortgage-backed securities, in the first weekly auction instead of the second.
The new eligible collateral for the TSLF includes agency collateralized-mortgage obligations and AAA/Aaa-rated commercial mortgage-backed securities, in addition to similarly rated private-label residential mortgage-backed securities and any collateral normally eligible for Fed open-market operations...
The Fed scheduled the second auction for April 3 and said the central bank's Open Markets Desk will announce the size and the eligible collateral the prior day.
This is a refresher to the
The Riskiest Bank on the Street piece that I posted a few months ago on Morgan Stanley. Let me get straight to the salient points.
High exposure to level 3 assets to cause
- Morgan Stanley’s exposure to level 2 and level 3 assets (this is about more than subprime) stood at $226 bn and
$74 bn as of November 30, 2007. Morgan Stanley has the highest ‘Level 3
assets-to-equity’ of 236% after Bear Stearns. In 4Q2007, Morgan Stanley
reported a $9.4 bn write-off primarily relating subprime related mortgages.
With nearly 50% decline in ABX-HE-BBB 06-2 index since November 2007, more
losses are likely to be reported in the coming quarters.
Drying liquidity in the repo market to impact
Morgan Stanley’s funding - The $4.5 trillion repo market, accounting for 20-25% of
assets of five top brokerage firms, enables short-term financing by selling
securities and agreeing to repurchase them. During good times these loans were
inexpensive and could be easily rolled over. However with declining value of
securities used as collateral, lenders in repo market have become increasingly
worried about losing money on securities used as collateral. In addition to
being selective and cautious while lending, lenders are also demanding higher
amount of collateral. For instance, for every $100 to be lent, lenders are
requiring $105 for bonds backed by Fannie Mae and Freddie Mac (up from $102 few
weeks ago) and $130 for bonds backed by 'Alt-A' loans. This is leading to
tightening credit conditions and severe liquidity crunch in the repo market.
The liquidly crisis took its toll on Bear Stearns
(see The Breaking of the Bear)
which sought an emergency funding from the Federal Reserve on March 14,
as its clients withdrew assets while their creditors stopped renewing
short-term loans. Bear Stearns' financing crisis has created wide
concerns on the brokerage firms relying heavily on repo markets for
cash requirements. Morgan Stanley relies heavily on short term
$162.8 bn or 16% of total assets in form of repo financing as of
2007. Although we believe that Morgan Stanley along with other
could face short-term cash problems owing to declining confidence in
capital markets, the Fed’s recent initiative by allowing brokers to
directly from the central bank (and lowering the Fed rate to 2.25%)
the liquidity concerns to a considerable extent. This is something that
I will explore in depth in the very near future, since much of the
level three assets may or may not qualify for "Fed Funding". This may
portend less liquidity than the popular media may have you believe. See
the overview of recent events for more on the Fed's move .
Decline in investment banking revenues
- In view of
declining activity in the capital markets, Morgan Stanley in line with
brokerage firms, is expected to show a decline in investment-banking
In 1Q08, Lehman brothers and Goldman Sachs reported a 20% and 16.4%
decline in net revenues. As per Bloomberg, Morgan Stanley’s sale of
equity-linked offerings declined to $7.77 bn in 1Q08 compared to $14 bn
while Morgan Stanley’s sales of high-yield bonds plunged to $101.5 mn
$2.46 bn in 1Q207. Morgan
Stanley’s reported earnings dropped 47% in 1Q08. This has been hailed
as a near "blowout" quarter by the sell side and the media, even though
it clearly shows a rapidly deteriorating business and is a very
disappointing result. The street's game of lowering expectations to
create the aura of "better than expected" results should not pass
muster with the quality of readers that I have visit my blog.
Challenges ahead - Brokerage firms are
facing several challenges owing to a slow down in economy, increased regulation,
lightening credit conditions and reduced capital market activity particularly
relating to mergers & acquisitions and corporate-finance. Traditionally
brokerage firms have borrowed money to growth their business. Now with credit
being harder to come by despite falling interest rates, brokerage firms going
forward will operate at reduced leverage levels impacting their future
Valuation – Owing to continuing write-downs due to
widening credit spreads and persistent weakness in the credit markets, we
expect financial services firms’ valuation to remain under pressure until the
credit market situation eases off significantly. Decline in fixed-income
securities has negatively impacted the book value of securities. Based on a 15%
haircut of illiquid assets, Morgan Stanley’s adjusted book value stands at
$18.4 per share. Based on price-to-book value multiple of 1.23, Morgan
Stanley’s valuation comes approximately $22.7 per share implying a downward
potential of 47.0% from current share price of $42.9.
Next up will be a complete and verbose forensic analysis of Assured Guaranty.
Source: As per latest filings
Here is a quip from an email that I recieved earlier that prompted me to explain how I fell about the I banking industry now:
Longer term, politically the Fed may be forced to cut them off --- but we are obviously quite a ways away from that happening just yet. (referring to the I banks that just got access to the Fed window)
Great call on Bear. If these guys can now submit almost anything to the fed window --- munis, mortgages, etc. and fund at FF+25, doesn't that take funding off the table and then really it becomes an issue of the credit quality of the collateral. In past banking cycles --- low Fed funding almost always reliquified the banks, and I assume it will work again this cycle.
Is it time to move on to the next stage --- companies that are going to experience credit issues on assets but can not fall into the arms of the central bank?
Well, to begin with the I banks are holding a lot of stuff they can’t submit to the Fed. They were also starving for liquidity despite what they said (ex. Bear Stearn’s Schwartz on CNBC, who is bound to get sued for those statements). This is why they all hit the window the day after it was opened. The industry in general is heading for a downturn. Many can’t be patient, but a macro bet against the investment banking business is not a bad bet at all, particularly if you catch it after a euphoric rally like we just had. Look at GS and LEH stock already, less than 24 hours after “beating the Street”. MS is moving lower too.
I am having my analysts look into exactly where the Fed assistance will or will not help the banks and I will probably post my findings some time late next week. The fed has mitigated the Bear Stearns style run on the bank, but all is still not well. There is a lot of counterparty credit risk abound, and the I banks shoulder most of it. They are the ones exposed to the parties that cannot run to the Fed!
If I were a Bear Stearns employee or shareholder I would opt to force the firm into bankruptcy protection over selling for 1.25% of last year’s share price. At $2, the sales price is analogous to an under priced put option for the shareholders to hold the threat of bankruptcy over the Fed’s head. Once in bankruptcy protection, the prime brokerage clients and CDS counterparties will try to run for cover and all hell will break loose with the other banks. I think you realize there are a lot of under capitalized CDS counterparties abound that in no way could pay off on these things. These are the guys that use one CDS to hedge against another. Once the domino effect gets going…
With all of that being said, you are right about looking for the other weak credit companies. I need to find the TMAs and Carlyle Capitals. Theoretically, the I banks should extend their new found credit to these companies, but I doubt it would happen.
In addition, I listen to the talking heads on CNBC who say that we need to stabilize housing prices in order to move forward, blah, blah, blah.... I consider this to be total nonsense and indicative of extreme ignorance in regards to what the problems are in the macro sector and how we got here in the first place.
These many issues that we see around us will not go away until housing prices go back to historical norms. If you stabilize prices before prices go back down to where they should be, you will simply have another bust - on top of the one that we just had.
It is as simple as this. People are not going to buy houses until they can afford to buy houses. Housing prices have outstripped real incomes by multiples. This relationship is what must be stabilized and reversed.
From RGE Monitor:
- FT: Financial Stability Forum urges prompt writedowns and warned that the full impact of the credit squeeze had yet to be felt. Banks wrote down $140bn by Q4 ($84bn in U.S., about $40bn in Europe) subprime securities so far, finance ministers expect $400bn. Half of it expected in U.S., other half rest of world.
- Fitch: Basel II rules allow easier clean break with off-balance sheet vehicles.
- SIFMA: Outstanding volume for the European securitization market stood at €1.32 trillion, as of 30 September 2007. Euro-denominated CDO market volume 2004-2007= €285.4bn (around $410bn)
- WSJ: EU banks reported to be exposed to monoliners via popular 'negative basis trades' in past few years (arbitrage opportunity technically due to oversupply when CDS spread (i.e. cost to buy protection) on a single name is smaller than the bond yield--> buy both bond and protection from monoliner and cash in the risk-free spread difference.)
--> 6 banks out of 8 planning monoline rescue were European; expected losses in $20-140bn range
- European banks also reported to be exposed to commercial real estate loans/CMBS and leveraged loans stemming from buy-out boom. These markets are turning now and additional writedowns are expected ($100-200bn)
- UK, Spain, Ireland financial sector additionally exposed to domestic housing bust--> Spanish banks e.g. less exposed to U.S. subprime fallout and off-balance sheet SIVs but draws heavily on ECB lending facility which delays actual writedowns on unviable collateral. I have warned members of this blog about this several times.
- Bloomberg: Treasuries rose and three-month bill rates plunged to to 0.56%, the lowest level in almost 50 years on speculation credit market losses will widen (e.g. ex-LTCM Meriwether's fund facing losses, Thornburg Mortgage Inc. may go bankrupt)
- Flight to quality trades:
- The rate on the three-month Treasury bill, viewed by investors as a haven in times of trouble, dropped 32 basis points to 0.56% on Feb 19;
- Capital preservation trade: buy Treasuries sell stocks;
- TED spreads (= LIBOR- T-Bill) spiking upwards in all markets
- BNP: Signs of interbank lending stress and liquidity hoarding eased after Fed actions on March 16/17; spreads on the rise again in US, UK and Euro market. Interbank spread decomposition shows that crunch is driven by upward trending credit premium since 2008 instead of liquidity premium as was the case in H2 2007. Fed interventions ultimately can address liquidity, not credit concerns.
- Fed, BoE, ECB intervening in their respective markets (see all measures below)
- Krugman: Flight to quality and cash hoarding lead to Treasury yields close to zero--> if there is no compensation for holding Treasury paper, investors prefer to hold cash--> normal monetary policy channel via buying and selling of Treasuries breaks down (i.e. liquidity trap)
From CNBC.com :
Lehman Brothers Holdings is unlikely to face the kind of liquidity crisis that brought down Bear Stearns
over the weekend because of the Federal Reserve's decision to let Wall
Street brokerage firms borrow directly from the central bank, CFO Erin
Callan told CNBC. It appears that in the short
term, she is right. But it also shows a big hole in both the business
model of the I banks and a dire macro situation that had to be averted
by the Fed. This is not a positive sign.
certainly takes the question of liquidity off the table," Callan said
in a live interview. "I think [the Fed's decision is] the great news
that happened over the weekend." Again, I agree.
Callan said Tuesday that Lehman , which reported better-than-expected earnings on Tuesday but
has faced persistent rumors of a Bear Stearns-type liquidity crisis,
plans to borrow from the Fed through the discount window. This
is problem indicator number one. After harping on how strong your
liquidity position was and how you didn't need money, why in the world
would you go to the Fed for money, and particularly why so soon??? I
know they probably need some to help fund the accounts that left you
for fear of insolvency.
followed up on Callan's announcement by borrowing from the window
within minutes of her appearance. At 5 p.m. New York time, Lehman
borrowed $2 billion, sources said -- a small amount relative to the
bank's $375 billion balance sheet. Hmmm, this smells very fishy. They just got finished invoking the "Short me, Please" phrase , as well.
Goldman Sachs also used the discount window late Tuesday, sources said, but it wasn't clear how much money the investment bank asked for. Again,
highly suspicious. This is a tool that wasn't invoked since the Great
Depression! Doesn't this raise speculative alarms with ANYONE besides
"It’s going to be actively used" by many brokerages, Callan said. “We’ll be a participant. It’s a great opportunity." This
shows that many brokerages were either insolvent or on the brink of
insolvency. Since I am probably not the only one that sees this, I
expect credit risk monitory will increase sharply, thus making banks
much stingier. Or is it that every primary dealer is a good credit risk
since they are all backstopped by the Fed now. This is an interesting
The Fed announced the new lending facility for Wall Street firms on Sunday night, shortly after it helped facilitate the sale of Bear Stearns to JP Morgan Chase . And
if that deal doesn't go through, and is edged into bankruptcy, who will
honor BSC's CDS obligations? After all, I really don't see Joe Lewis
are the burned and spurned employees approving the deal, and they
collectively control 40% of the vote!
the plan, primary dealers -- big Wall Street firms that deal directly
with the Fed in financial markets -- would be allowed to borrow
directly from the Fed for at least the next six months.
which normally lends through its discount window only to banks that
take deposits, can lend to nondepository institutions under special
circumstances. It last did so in the 1930s. The Great Depression!
the CNBC interview, Callan acknowledged that Lehman has had a difficult
time recently amid all the rumors that it's in financial trouble. I
heard you were losing a lot of accounts and a lot of counterparties
were quite skeptical, yet it appears as if you did a professional job
in handling the situation.
know we're always the next name on the list," she said. “There isn’t a
great appreciation for the fact that we’ve evolved our franchise
dramatically over the last decade. In fact, we’ve structured our
liquidity exactly for this kind of situation. So, we feel like we’re in
a good spot."
However, Callan said
Lehman's difficulties aren't over. “Expect to see more [writedowns] in
the second quarter," she said. "Later in the year things will start to
stabilize more in asset prices.” And how do
you know this? The cause of the asset price destabilization, housing,
will probably not stabilize later in the year, so who do you think the
derivative written on top of housing will? What about the things that
are just starting to get worse: leveraged loans, high yield securities,
consumer finance securities written at the apex of an easy money bubble
that is popping in a recession, high yield securities with naught the
covenant protection of the past...
feels like, at this point, the greater part of the calendar year will
be rough sledding and I wouldn’t expect it to feel pretty stable until
As far as I can discern, Lehman effectively had a run on the bank Monday. They admitted portions of it in the WSJ article I linked to earlier, and word is that many clients left to the tune of several billion dollars. They same appears to be happening in the UK, this is after:
- one of their largest mortgage banks faced a run and had to be nationalized,;
- The biggest US investment banks, numbers 1, 2 and 5 just ran to the government for emergency funds and investment bank 5's shareholders just got wiped out.
- Investment banks 1 and 4 reported 50% drops in earnings and revenue, but rallied because analysts dropped expectations enough to say that they were beat;
- They then started to recommend "buys" on each other;
- The mechanism used by the Fed to prop up the I banks was used only once before, and that was during the worst economic period in the history of this country - the "Great Depression".
It doesn't take a detective to figure out all is not well in Smallville! There is probably a big negative waiting in the near future for the financial sector. The problem is that I have not fully deduced what it is, yet. I am growing extremely suspect of the Fed's move. I definitely understand why they felt they had to do it, the issue is the true facts surrounding the move and what the repercussions are. I think the US tax payers can kiss that $30 billion dollar back stop goodbye.
From the WSJ:
Stocks were unable to
hold onto Tuesday’s 400-plus point rally in the Dow industrials and
attendant rallies in other indexes, and steadily marched lower through
the afternoon, until news of a lawsuit filed by Merrill Lynch against a
unit of bond insurer Security Capital Assurance, alleging the company
is trying to avoid obligations of up to $3.1 billion under seven credit default swaps.
Merrill’s own CDS widened on the news, moving to 250 basis points from
210 basis points, according to Phoenix Partners Group, and the stock
market dove, with the Dow giving back a good lot of the previous day’s
I stated several
times in the comments that the CDS market may very well lead us into
the next serious leg down. Many of the guys who wrote these either
don't have the cash to pay up or are wrapped up in hedges using CDS
which will easily get @#$@ed up once one leg of the hedge falls.