28JAN09:
Q1-09 DOW: 8900
Q2-09 DOW: 7250
Q3-09 DOW: 5810
Q4-09 DOW: 3960
CITI NATIONALIZED
OBAMA GETS SICK 30SEP08:
31DEC08 INDICES:
FTSE100:3550
DOW30:7550
# HEDGE FUNDS:4425 30JUN08: Oil to be USD200 by 30OCT08 USA Inflation to be 7.5% by 30OCT08
...oops 23APR08:
Next Rights Issue:
HBOS...yes
All & Lec ...
...1 Nil. 17APR08: Oil to be USD127 by 30SEP08
...16MAY08 losing my touch 27FEB08:
2 Banks go bust by 30JUN08
BS down, Lehman (a bit late I know) 20NOV07: Northern Crock to be sold for 15p
Nationalized 01NOV07: Oil to be USD103 EOM
...peaked too soon 08OCT07:
SEC to fine Goldman for pricing issues
...still waiting 15JUN07: ML to buy-out BS
JPM got there first 06JUN07: The Big Crash: 17OCT07
...well it's here
I found some US dollars in my wallet, checked the GBP/USD fx rate and subsequently threw them away. The world's currency of choice is following the Deutschmark in the 1920's. Worthless. This is bad news for many European hedge funds who historically have USD as their base currency. As we predicted, the Bear Stearns ABS hedge funds are also worthless but for different reasons.
We have mostly highs beating the lows, as nobody wants to be a party pooper. Just yet.
Gold, Euros, the Dow, Sterling and the Aussie Dollar reach new generation highs.
Again the markets see nothing wrong with the USD becoming the sick man of the world.
Subprime wipes out Bear Stearns Asset Management - funds valued at zero; takeover target, FiNTAG offering odds.
2 Hedge Funds in distress - apparently.
The M&A party almost over.
ABX turns into a snowboarders paradise.
Finbar maybe leaving London to .... wait for it ... San Francisco (more to be revealed later).
And more subprime analysis. If your are writing a thesis on it, then come on down.
Democrats overplay the tax card and lose friends.
GLG fund Alpha One magazine to compete with portfolio.com.
Understatement of the day ""This could force a wide variety of other holders of subprime mortgage securities and CDOs to meaningfully revalue their holdings," Richard Bove, analyst at Punk Ziegel.
Estimates show there is ``effectively no value left'' in the High-Grade Structured Credit Strategies Enhanced Leverage Fund and ``very little value left'' in the High-Grade Structured Credit Strategies Fund, Bear Stearns said in a two-page letter. The second fund still has ``sufficient assets'' to cover the $1.4 billion it owes Bear Stearns, according to the letter, which was obtained yesterday by Bloomberg News from a person involved in the matter.
``This is a watershed,'' said Sean Egan, managing director of Egan-Jones Ratings Co. in Haverford, Pennsylvania. ``A leading player, which has honed a reputation as a sage investor in mortgage securities, has faltered. It begs the question of how other market participants have fared.''
Bear Stearns provided the second fund with $1.6 billion of emergency funding last month in the biggest hedge fund bailout since the collapse of Long-Term Capital Management LP in 1998. The losses investors now face underscore the severity of the shakeout in the market for collateralized debt obligations, or CDOs, investment vehicles that repackage bonds, loans, derivatives and other CDOs into new securities.
Ralph Cioffi, the 22-year Bear Stearns veteran who managed the two funds, sought to minimize risk by investing in the top- rated portions of CDOs, hence the ``high-grade'' label. Under Cioffi, 51, the funds also borrowed money in an effort to boost returns. Instead, as defaults surged on subprime mortgages, they grappled with declines in the values of AAA and AA securities, Bear Stearns said in the letter.
Market Implications
``That has implications for credit weakness in the next several days and weeks,'' said Peter Plaut, an analyst at New York-based hedge fund Sanno Point Capital Management. ``There's going to be more risk aversion.''
Bear Stearns spokeswoman Elizabeth Ventura declined to comment.
Shares of Bear Stearns have dropped 14 percent this year, sliding further as the crisis in subprime mortgages deepened and the two funds flirted with collapse. The risk of owning corporate bonds issued by Bear Stearns surged today to the highest since November 2002, according to credit default swap traders.
In an interview with the New York Times published on June 29, Bear Stearns Chief Executive Officer Jimmy Cayne said the debacle was a ``body blow of massive proportion.'' Sanford C. Bernstein & Co. analyst Brad Hintz estimated in a July 16 report that Bear Stearns's profit may decline 6.8 percent this year as the firm restricts lending to hedge funds and declining demand for mortgage bonds cuts trading revenue.
`Dear Client'
Hedge funds are private, largely unregulated pools of capital whose managers participate substantially in any gains on the money invested.
Today's letter, addressed ``Dear Client of Bear, Stearns & Co. Inc.,'' recounts how the firm's two funds unraveled in less than a month. In early June, faced with redemption requests from investors and margin calls from lenders, the funds were forced to sell assets. When those efforts failed to raise enough cash, creditors moved to seize collateral or terminate financing.
The fund that now has nothing left for investors, known as the enhanced fund, had $638 million of capital as of March 31, according to performance reports sent to clients at the time. It also borrowed about $11 billion to make bigger bets.
The larger fund, which had $925 million, is down about 91 percent this year, according to a person with direct knowledge of the performance, who declined to be identified because the figures aren't public. It borrowed almost $9 billion.
Investors at Risk
Investors in that second fund include Tremont Capital Management Inc. and Paradigm Cos., two firms that place client money with other hedge fund managers. Together, they have more than $9 million at risk.
Bear Stearns itself invested about $35 million in the funds, Chief Financial Officer Samuel Molinaro said on a June 22 conference call. The firm bailed out the larger pool to keep lenders from auctioning off assets and driving down the value of its investments.
``For them to put up so much capital, just for reputational risk, wouldn't make sense unless they believe they won't lose money on it,'' said Erin Archer, an analyst at Minneapolis-based Thrivent Financial for Lutherans, which owns about 200,000 Bear Stearns shares.
Merrill Lynch & Co., which was among the creditors to seize collateral, considers its ``exposure'' to be ``limited'' and ``appropriately marked'' to market, Chief Financial Officer Jeff Edwards said on a conference call yesterday. Merrill reported a 31 percent increase in second-quarter profit, even after revenue in the business that includes mortgages and CDOs declined.
Bear Stearns Shakeup
Bear Stearns shook up its asset-management unit last month, as the losses mounted. The firm ousted Richard Marin as head of the division, replacing him with Lehman Brothers Holdings Inc. Vice Chairman Jeffrey Lane, 65. Tom Marano, 45, Bear Stearns's top mortgage trader, moved over to asset management to help sell the fund assets. Marin, 53, and Cioffi remain advisers to the firm.
In today's letter, Bear Stearns said it made such moves to ``restore investor confidence'' in its asset-management division.
``Let us take this opportunity to reconfirm that the Bear Stearns franchise is financially strong and committed to meeting your investment needs,'' the letter reads. ``Our highest priority is to continue to earn your trust and confidence every day.''
As we have been saying since the debacle first unfolded, disposing of the subprime based assets wasn't going to be easy. Illiquid, impossible to price, us Hedgies just took the piss as nobody wanted to buy the junk collateral on Hedgebay or anywhere else, and despite Bear Stearns bailing out a third party company (which is unprecedented and the SEC should fine them for abuse of shareholder capital) because LTCM memories are long and its competitors refused to help out, the reputation damage is huge.
Not only has golf cheating CEO Jimmy Cayne' been made to look like a fool along with his management team, its own Risk Management system measuRisk appears no more useful than my blackberry without a battery and we have a large number of creditors who have walked away with nothing; many are the same creditors who are still sore Bear Stearns did not help them save the world from financial collapse during the LTCM crisis.
Bear Stearns must be feeling very lonely and stupid. Another Facebook hermit.
My current book (given BS shares fell 3% last night) of potential takeover suitor:
The Letter "Dear Client of Bear, Stearns & Co. Inc,
Let me take this opportunity to provide you with an update on the status of the High-Grade Structured Credit Strategies and High-Grade Structured Credit Strategies Enhanced Leveraged Funds managed by Bear Stearns Asset Management.
A team at BSAM has been working diligently to calculate the 2007 month-end performance for both May and June for the funds This process has been much more time-consuming than in prior months due to increasingly difficult market conditions.
As you know, in early June, the Funds were faced with investor redemption requests and margin calls that they were unable to meet. The Funds sold assets in an attempt to raise liquidity, but were unable to generate sufficient cash to meet the outstanding margin obligations.
As a result, counterparties moved to seize collateral or otherwise terminate financing arrangements they had with the Funds. During June, the Funds experienced significant declines in the value of their assets resulting in losses of net asset value.
The Funds' reported performance, in part, reflects the unprecedented declines in the valuations of a number of highly-rated (AA and AAA) securities.
Fund managers and account executives have been informing the Funds' investors of the significant deterioration in performance for May and June.
The preliminary estimates show there is effectively no value left for the investors in the Enhanced Leverage Fund and very little value left for the investors in the High-Grade Fund as of June 30, 2007. In light of these returns, we will seek an orderly wind-down of the Funds over time.
This is a difficult development for investors in these Funds and it is certainly uncharacteristic of BSAM's overall strong record of performance.
Bear Steams has been working to achieve the best possible outcome for investors under these circumstances. On June 26th, Bear Stearns committed $1.6bn in a collateralized repo line to the High-Grade Fund
At this time, approximately $1.4bn remains outstanding on this line and we continue to believe there are sufficient assets available in the High-Grade Fund to fully collateralize the repo facility.
In the past weeks. Bear Steams has taken action to restore investor confidence in BSAM. On June 29th, we announced that Jeff Lane was appointed chairman and chief executive officer of BSAM. Tom Marano, head of Bear Steams' mortgage department, has been assigned to BSAM to aid in achieving orderly sales of the Funds' assets.
The risk management function at BSAM has been restructured so that it will now report up to Mike Alix, Bear Stearns' chief risk officer, creating an additional layer of oversight. Mike Winchell, former head of risk management for Bear Stearns and most recently with Bear Wagner, has been engaged to consult with BSAM with regard to its hedge fund risk management function.
Throughout this time, we have appreciated the support of our loyal client base and we will work to continue to provide you with the high quality products and services you have come to expect from Bear Stearns.
Let us take this opportunity to reconfirm that the Bear Steams franchise is financially strong and committed to meeting your investment needs.
Our highest priority is to continue to earn your trust and confidence each and every day, consistent with the Firm's proud history of achievement. As always, please contact us if we can be of service."
NOT ME
Hedge Fund Meltdown Rumors: Chapter Whatever (dealbreaker) Rumors have been swirling around about two separate hedge fund meltdowns. According to one set of rumors a multi-strategy hedge fund facing impending doom due to leveraged bets in credit derivatives. Entirely different sources have mentioned a major meltdown from natural gas bets. DealBreaker calls to some of the usual suspects could not confirm the identities of the allegedly troubled funds.
And we're not naming the names being whispered because life is hard enough without getting called out on DealBreaker as a meltdown candidate when things might be going just fine.
Both rumored meltdowns are plausible given recent market movements. The credit markets have been rocked by a level of volatility unseen in recent times. Earlier today Bloomberg reported that many large financial institutions believe that hedge funds are using too much leverage to finance credit derivative investments, according to a Fitch Ratings survey of 65 banks, insurers and money managers.
Natural gas futures prices are flat to down, and the spread between summer-winter season is narrowing. The spreads in future contracts fell from $2.50 to pennies in two weeks. Similar movements in the markets for natural gas futures helped bring down Amaranth last year.
If you've got a likely candidate for either rumor—natural gas or credit derivative blow-up—feel free to leave a comment below or email us at tips@dealbreaker.com
Fintag says I know of one large fund that is delaying its June end NAV's and is looking to locking in its investors for fear of collapse. I am sure there are more but because I have some trades with them and unable to say who they are. So much for blog gossip eh? A conflict of interest. In these times I have to think of Mrs Taggit's shopping addiction.
WHITE CLIFFS OF DOVER
Bloodbath in the ABX? (wsj) Worries about subprime lending drove the riskiest tranche of the closely-watched subprime ABX derivative index to a record low of 44 cents on the dollar today — understandable, given everything that's gone on in the subprime sector.
But higher-quality tranches of the ABX also took an ugly haircut today — the AAA-rated section of the index fell to 95 from about 100, while the AA-rated tranche fell to 88 from 100, according to Markit. The A-rated tranche is down to 70 from 90 a month ago, Andrew Lahde, managing partner of Lahde Capital Management, a hedge fund in Santa Monica, Calif., told Dow Jones Newswires.
And all of this happened without any news to drive the market.
“People are panicked,” Alex Pritchartt, a trader at UBS, told Dow Jones. “I think people are betting on a bloodbath,” Lahde added, saying he didn't expect the higher tranches to come “unglued” so quickly.
“It looks like either a fund is getting liquidated across all asset qualities — or someone is panicking,” writes Barry Ritholtz on his blog, The Big Picture (warning: scary charts of prices falling off a cliff). His theory: The market for subprime debt is inefficient. That wouldn't be too surprising. The question is what impact its potential meltdown would have on other credit markets. The upside is that the hunt for safety pushed people to buy Treasury bonds, sending the yield on the 10-year note tumbling to 5.04%.
Fintag says Here is the proof:
With supposedly solid Triple AAA falling steeply, we have the situation where Double AA is moving into Junk territory.
*ANKERS
KPMG says Global M&A market about to peak (finfacts) KPMG Corporate Finance's Global M&A Predictor suggests that global merger and acquisition (M&A) activity is about to peak, and forecasts a fall in overall deal volumes this year. Although liquidity remains high, and deal values continue to rise, Big 4 accounting firm KPMG expects global deal volumes in 2007 to be below those achieved in 2006, a year during which both average deal size and the number of deals hit record highs.
The forecast, based on a detailed analysis of KPMG Corporate Finance's Global M&A Predictor - a forward looking index of 1,000 leading companies' net debt to EBITDA (earnings before interest, taxes, depreciation and amortization) ratios and Price Earnings ratios - reveals that pressure on the accelerator pedal has come off, as regards international asset prices, with 12 month forward PE valuations (the valuation ratio of share price to estimated earnings per share) increasing only marginally.
KPMG's research also highlights that significant cash and debt capacity remain. However, a modest decline in deal appetite and confidence, rather than capacity or average deal value, is expected to prevail in the coming months.
KPMG Corporate Finance's Global 1,000 M&A Predictor suggests that the current M&A cycle is about to peak, and believes that Dealogic's latest data, which shows increasing average deal size on lower volumes, indicates a "final hurrah" with fewer, but larger deals, being done. Importantly, due to the relatively sound market fundamentals and generally strong corporate balance sheets, KPMG believes that, in contrast to the steep dot-com collapse of 2000, the slow-down will be gradual.
Stephen Barrett, International Chairman, Corporate Finance at KPMG, comments: “Macro-economic fundamentals remain strong. However, the momentum, which delivered record M&A growth in 2006 is not likely to be sustained. Global activity is about to peak, certainly in terms of deal volume, and we foresee a continued fall in deal numbers during the course of 2007. Acquisitive companies will remain alive to the prospect of good assets, but they will be more cautious about the prognosis for extracting real value from targets during this 'cooling off' period for M&A, while increased attention to creating value through balance sheet restructuring will increasingly return to the CEO's agenda.”
Forecast M&A Activity by World Region
KPMG's Global 1,000 analysis shows that, in the first five months of 2007, there was a significant discrepancy between the key trend indicators of deal values and volumes. The last time the market witnessed this kind of 'disconnect' - where the average deal size rose, but the number of deals fell - occurred at the height of the dot com boom in 2000. A sign that the market is starting to cool came in H2 2006 when the total number of deals fell for the first time since H1 2003 (dropping 8 percent compared to H1 2006).
KPMG's analysis shows that the appetite for M&A transactions appears to be slowing, despite conservative balance sheets. Twelve month forward PE valuations rose marginally to 17.1x compared to 16.8x in both June and December 2006 which implies a restriction on the available “bid” premium in the marketplace. Balance sheet capacity remains conservative but has tightened marginally from 0.85 times to 0.91 times.
Of the major global regions, Europe remains the most positive in terms of potential M&A activity, due to rising PE momentum, while AsPac once again looks the weakest. The U.S. remains static in terms of valuation, suggesting the potential for a slow down.
In terms of sector regions, the best M&A prospects appear to reside in Utilities Europe, Basic Materials North America, Oil and Gas North America, Industrials Europe and Consumer Services Europe with the weakest prospects being Consumer Services AsPac and Consumer Goods AsPac.
Europe
KPMG's analysis shows that Europe continues to exhibit the strongest M&A picture out of all the major global regions. Twelve month forward PEs for those constituents within KPMG's Global 1,000 stood at 16.2x at the end of the first five months of 2007, some 7.3 percent above the 15.1x at the end of 2006. Net debt to EBITDA ratios for the region weakened slightly, from 0.8 times to 0.88 times.
By sector, Utilities are eliciting the most significant “activity” signals, with forward PEs up 12.7 percent to 19.8x. Net debt to EBITDA ratios in European Utilities remain typically among the highest of any sector and have deteriorated slightly from 1.44 x to 1.52 x. Industrials has also shown a strong tendency with PE's up 10.9 percent to 17.7x, with net debt to EBITDA weakening slightly from 1.59 x to 1.65 x. Consumer Services and Telecoms were also strong (PE up 9.6 percent and 8.4 percent respectively). Oil and Gas was the weakest performer though balance sheets remain very strong with net cash, though this position has deteriorated during the past six months.
Commenting from a European perspective, Netherlands Corporate Finance Head, Jurgen van Breukelen, said: “The European market remains largely buoyant. The key difference between now and then, however, is the dramatic influence of private equity, which continues to hunt-down stable cash flow, attractive growth prospects and profitable companies.
“Private equity players are accounting for a greater volume of deals being done, but more importantly average private equity deal size is increasing, with the likes of Carlyle and Blackstone highly prominent in Europe”.
He continued: “Market buoyancy is of course supported by an efficient debt market. Liquidity remains good, enabling highly-leveraged deals to be undertaken. Sector wise, deal activity is strong right across the board - with Utilities hitting the headlines due to the scale of the transactions. But there is lots of activity in other previously 'new economy' sectors such as ICT and Media, which are all now very profitable.
“Naturally, the sheer scale of M&A activity is putting pressure on asset prices, and deals from private equity players are increasingly impacting on quoted companies. At the same time, activist hedge funds are beginning to tinker with quoted companies, ensuring a squeeze on their public status”.
The Americas
The U.S. traded sideways in terms of valuation with an almost unchanged forward PE of 17.9x, slightly up from 17.7x six months ago. Similar to Europe, balance sheets remain robust though have deteriorated with net debt to EBITDA ratios of 0.82 times to 0.96 times.
Within the region, the most positive sector is Oil and Gas with forward PEs rising 13.6 percent from 11.7x to 13.3x. Balance sheets remain strong at 0.41 times indicating that this represents the comparatively hot sector going forward. Telecoms is close behind with forward PEs rising 11.2 percent from 15.7x to 17.5x, though net debt EBITDA ratios have deteriorated to 1.41 times. According to Dealogic data this is the fourth consecutive drop in deal volumes.
Most other sectors within the U.S. remain relatively stable, though Healthcare has experienced negative developments in forward PEs from six months ago (down 4.1 percent to 17.7x).
Commenting on M&A prospects in the Americas, KPMG Americas Corporate Finance Head, Peter Hatges said: “Liquidity in the market is still good so the ability to get deals financed remains high, fuelling M&A activity in North America. A lot hinges on the recovery for North American Auto Original Equipment Manufacturers and the impact it could have on the significant parts suppliers throughout the continent. Consolidation in the auto parts industries is expected to pick up pace. Furthermore, competitive global pressure on North American manufacturers has put significant pressure on CEOs to reach for increased economies of scale and penetrate new markets, which should support M&A activity in the medium term.
“North of the border, there may be a more robust picture. A large part of Canada's ever-popular income trust sector was halted last year by proposed changes to the Canadian Income Tax Act causing many of these mid-size public companies to evaluate their strategic options and participate in significant M&A activity. There are 250 income trusts in Canada with a market capitalization of approximately US$200 billion. Energy and resource companies are still expected to remain strong as world commodity markets experience strong growth from growing global demand”.
Asia Pacific
Asia Pacific has continued to experience a valuation decline, down a further 4.9 percent to 17.0x, compared to 17.9x as at the end of December 2006 and 18.9x as at the end of June 2006 continuing to suggest an “easing” of potential M&A activity. Contrary to North America and Europe, its balance sheet has strengthened with net debt EBITDA falling from 1.0 times to 0.97 times. Furthermore foreign direct investment in Asia is expected to remain strong, particularly China.
The biggest “fallers” contributing to valuation weakness and therefore falling appetite for deals in the region are Consumer Services and Oil and Gas. Consumer Services forward valuation declined 8.7 percent from 22.5x to 20.6x, with Oil and Gas forward PE down by 7.1 percent from 12.4x to 11.5x. Only telecoms remained “warm” with forward PE's up 9.4 percent to 17.5x with net debt EBITDA remaining modest and 0.34 times.
Fintag says Time for bonus pool preservation me thinks.
The fixed-income market has faced its share of challenges over the past six years. Enron, the downgrades at US carmakers General Motors and Ford, and the collapse of futures brokerage Refco and hedge fund Amaranth Advisors were enough to strain any financial system, but the credit markets have repeatedly outperformed expectations. Related Stories
Nomura's former head of fixed income resurfaces 14 May 2007 Fixed income finds new champions 11 Dec 2006 Graphics
Click on the thumbnail to view the full-size graphic
Fixed income revenues of top 10 global banks
After each problem, analysts and bankers have voiced concerns about a credit meltdown and each time the market has bounced back. Over the past few months, however, concerns have grown that the longest bull run in credit market history could finally be over.
Once again, bankers are trying to figure out whether the latest problems will soon be forgotten, or whether they will send the market into a tailspin.
The dollar hit a low against the euro last week amid fears that the American sub-prime property debacle was setting off a broader credit crunch.
That was prompted by rating agency Standard & Poor's decision to place the ratings of $12bn (€8.8bn) of sub-prime mortgage bonds on review for possible downgrade and followed the closure of five high-profile investment funds in connection with sub-prime losses, including Dillon Read Capital Management and a pair of Bear Stearns' structured credit vehicles.
While predictions of a meltdown in the financial markets are growing in the media and among some investors, many analysts and bankers believe fears are overblown and that the diversification of banks' revenue streams and of institutional investors' portfolios will allow them to ride out the storm, albeit after heavy losses.
Analysts say two catalysts could lead to a meltdown. On one side is the overheated leveraged finance market and on the other is the sell-off in the market for asset-backed collateralised debt obligations, above all those with exposure to the US housing market.
Analysts at Credit Suisse have estimated the potential losses for investors in asset-backed CDOs could reach $52bn but have played down suggestions that such losses will lead to a meltdown across the credit markets.
In a report this month, Credit Suisse analysts Jagdeep Kalsi, Ivan Vatchkov and Guillaume Tiberghien said: “Losses in the tens of billions of dollars are clearly a huge problem, but we do not think they are a systemic one.
"The top 10 global investment banks hold $513bn of equity capital, which should, even in the worst case, be sufficient, as the losses are unlikely to be confined just to the investment banks, but will include commercial and mortgage banks in the US.”
The analysts said potential losses would also be distributed by hedging, thereby further reducing the risk of a systemic meltdown.
According to the report, banks are unlikely to bear a substantial part of the $52bn of losses and the Swiss bank called the risks to their revenues “not immaterial, but hardly consequential”.
The analysts said: “Securitization represents only 4% to 5% of industry revenues, and there is ample evidence that rising volatility, equity markets and derivatives are comfortably offsetting revenue shortfalls.”
Citi researchers said banks hold a maximum of 20% of the equity and mezzanine tranches of CDOs, the riskiest parts, focusing instead on the lower risk senior tranches.
European banks are less exposed than their US counterparts. Credit Suisse estimates that of the banking industry's $5bn to $10bn in direct CDO exposure globally, European banks' share of losses will be markedly smaller than that of their US peers.
Some observers have expressed concerns that CDO losses could derail investment banks' business outside that market, but analysts regard that as a possibility rather than a certainty and many bankers in Europe remain upbeat about the prospects for the issuance market.
Geert Vinken, head of global debt syndicate at Barclays Capital, said: “Sub-prime fears are important but they don't affect every investor. There will probably be more pain to be taken in the CDO market but the technicals of the overall debt market remain good.
"Six weeks ago, there was a wall of money waiting to be put to work. It is still there, it is just that investors are waiting for the right time to invest.”
Credit Suisse's analysts said in their report that the potential client losses to banks were “so far comfortably offset by healthy inflows - in the first quarter of this year the $217bn of inflows comfortably exceeded our total CDO loss estimates of $52bn.”
Bankers believe the flow in client business has some way left to run, even if issuance in the CDO market will all but dry up.
One head of European debt syndicate said: “The mood in the market is pretty ugly at the moment but it is fickle. There is a flight to quality among investors who are looking for higher-rated assets but we are confident the market will stabilize and buyers will return. The key is in pricing deals sensibly. Issuers are no longer calling the shots.”
While bankers and analysts believe there is a great deal to be worried about, they say the fundamental strength of the credit markets could allow them to overcome its latest challenge.
The Credit Suisse analysts said: “If normal conditions are maintained and no big wave of bankruptcies materializes, investors should be able gradually to regain their ability to focus on the recent favorable flow of macro-economic data. This is a macro backdrop that the credit and equity markets would normally welcome.”
Fintag says Without a bullish market there is no M&A. About 4 years ago, most corporate financiers were hanging onto their jobs kicking around the golf courses pretending to be busy. The only people who play golf today are people who work at Bear Stearns.
SLOW, PAINFUL, DEATH
Subprime woes spread to loans; stocks next:James Saft (reuters) It may not be dramatic, it almost certainly will not be quick, and it definitely will not be pretty. A fundamental factor supporting the astonishing recent performance of global markets -- the super easy availability of credit -- is in the process of reversing.
The credit pullback has spread from the mortgage market for subprime, or less creditworthy, borrowers to the most aggressive sectors of corporate and buyout lending -- in part because the hedge funds and complex financing vehicles that extend credit to both have taken a hit in housing finance.
And because the corporate credit market now facing difficulties is the bulwark of private equity, share market valuations may soon come under pressure.
"The deals which were being done in private equity are going slightly astray," said Albert Edwards, global head of asset allocation at Dresdner Kleinwort in London.
"A lot of the stock market has a bid premium, apart from the mega caps. If companies have problems getting debt paper away, the big marginal bidder goes away."
The MSCI World equity index hit a lifetime high on Monday, with much of the excitement based on the idea of more bids from private equity buyers yet to come.
But the richness of those bids depends in turn on readily available cheap financing, often dispensing with the traditional strictures on what borrowers can do with the money and with their businesses.
A number of high yield bond and leveraged loan offerings supporting such bids have been scrapped, postponed or restructured due to market resistance.
Ratings agency Fitch said in a Friday report that of six deals that have been pulled or postponed since late June -- U.S. Foodservice (UFS.N: Quote, Profile, Research), ServiceMaster (SVM.N: Quote, Profile, Research), Magnum Coal, Catalyst Paper Corp., Swift & Co. and Quebecor Media -- it is estimated that a total of nearly $13 billion of debt could be bridged by the underwriters.
On Monday, a 1.075 billion euro loan backing the buyout of Dutch retailer Maxeda DIY was pulled after its structure, which gave lenders little say over how the borrower managed its balance sheet in future, failed to attract sufficient commitments.
While that may be small in proportion to the overall amount of debt being extended and buyouts offered, the leveraged markets are not based on underwriters actually holding large amounts of the debt: indeed, it is quite the opposite of how they see their role, raising the possibility that they will not be so quick to underwrite future deals.
Other measures of the willingness to lend are showing signs of strain. The iTraxx Crossover index , which measures the cost of insuring a group of European below investment grade names against default, widened sharply after the Maxeda news.
The index has now moved more than 95 basis points wider, or about 50 percent, since mid June.
If credit markets demand more payment to take on the same risk, or simply won't do some deals at any price, the flow of private equity and leveraged buyouts, much less debt-financed share repurchases, must be in doubt.
THE SUBPRIME CONNECTION
But what has all this got to do with U.S. subprime mortgages?
Both types of finance are at the aggressive end of their markets, with less borrower equity, and both are now largely made by people hoping to sell the loans on quickly to a third party.
Tellingly, lending safeguards that would have been standard only two or three years ago have been eroded in both leveraged finance and subprime lending.
Subprime lending had its "liar loans," in which borrowers simply state their income without documentation. Leveraged lending has spawned "covenant-lite" lending, which lacks tests, or covenants, that allow lenders to throw borrowers into default if they don't meet pre-agreed financial hurdles. The Maxeda deal was among the first in Europe to attempt the covenant-lite structure.
But the most important connection, and one that bodes poorly for corporate credit, is that both assets are sold on to the same kind of investors; sometimes through structured finance vehicles such as collateralized debt obligations or collateralized loan obligations, which bundle debt together, and sometimes directly to hedge funds.
That means the ugly losses suffered by investors in subprime structured vehicles are having a knock-on effect on appetite for corporate credit.
DOWNGRADES, FORCED SELLERS AND LOANS STILL TO SELL
As such, the extreme volatility in corporate credit last week, coinciding with a huge wave of subprime downgrades and warnings from ratings agencies, was no surprise. All three main debt rating houses, Fitch, Moody's and Standard & Poor's, announced last week that they were downgrading subprime loans and related assets, with signs of more to follow.
A large risk is that the downgrades turn investors such as pension funds or insurance companies, which may be allowed to hold only highly rated debt, into forced sellers of subprime assets.
If that happens -- and some believe it already is -- the fall in subprime debt prices would accelerate and further reduce the risk appetite of investors and structured financiers buying corporate loans and bonds.
Eric Tutterow, managing director of leveraged finance at Fitch Ratings in Chicago, says this is all happening just as a huge group of loans is set to be marketed to finance deals already announced. Fitch says investors are about to be offered more than $300 billion of this high-yield and leveraged debt.
"There will be some good tests of the market coming up with some large numbers," Tutterow said. Arrangers "don't want to be left holding the bag, they want to get this stuff syndicated out."
If more of those tests go bad, look to the stock market to pay the price.
Fitch Ratings' global credit derivatives survey of 65 banks and insurers found that the total amount of credit derivatives bought and sold reached nearly $50 trillion at year-end 2006, an increase of 113% over the $23.4 trillion reported for year-end 2005. It also represents a 1,326% boost from the volumes of credit derivatives bought and sold in 2003, when Fitch first started the survey.
Credit derivatives include credit default swaps, which allow investors to bet that a company can't pay back its debt. They also include collateralized debt obligations, or CDOs, which bundle together bonds, loans or other kinds of debt securities and sell notes that represent different levels of risk in the group. The levels of risk range from large triple A-rated tranches, which pay modest returns, to small unrated equity tranches, which are most likely to be among the first defaults.
Banks and broker-dealers dominate credit derivatives volumes, according to Fitch. Around 44 banks held about $24.6 trillion of the securities at the end of 2006, more than double the $11.3 trillion of volume at the end of 2005.
However, a rising proportion of last year's debt derivatives have low credit ratings, which means the banks are often holding securities that have a higher risk of defaults and difficulty in paying them back.
At the end of 2006, 38% of the credit derivatives were speculative grade, meaning junk status, or unrated. That's more than double the proportion of unrated credit derivatives in 2003, when they made up only 18% of the market.
The banks primarily use credit-default swaps as a way to hedge their risks. However, banks increasingly said they use credit derivatives in general to aid their trading operations, Fitch said.
The study also found that most of the respondents have concerns about a credit crisis, but put the greatest risk beyond a year from now.
Among the top 20 traders of credit derivatives, only five increased their use of the securities last year: Morgan Stanley, ABN Amro, Dresdner, Bear Stearns and Royal Bank of Scotland. Nine others reduced their volumes, including Goldman Sachs, Deutsche Bank, Merrill Lynch, Credit Suisse and Citigroup.
Earlier this week, a report from Phoenix Partners Group found that the top investment banks, including Bear Stearns, Lehman Brothers, Goldman Sachs, Merrill Lynch, Morgan Stanley, Bank of America, Citi and JPMorgan, have seen significant increases in the cost of protecting their debt against default. Bank of America saw its cost of protection jump 48%, while Citi's cost rose 45%. The independent banks, including Bear, Goldman, Lehman, Morgan Stanley and Merrill, have seen their cost of protection grow in the range of 20%.
Fintag says When the markets go into bull mode, things get done quicker, corners are cut and products launched without full due diligence. It is when we go into bear mode that the nasties come out of the woodwork. I look forward to that - but without being on the other side of course. My biggest fear is so much is doc-lite, especially the credit derivatives where quite frankly the ISDAs are not up to the job and lawyers will be brought in to settle disputes.
Staff at the biggest buyout firms, who traditionally have donated far more to the Democrats, funnelled 53 per cent of their $493,000 (£242,000) presidential campaign contributions to leading Republican candidates in the first half of 2007.
This is a dramatic increase on the 31 per cent of private equity contributions that went to Republican candidates in the 2004 presidential and congressional elections, according to the Centre for Responsive Politics, a research organisation.
Private equity firms have changed their financial allegiance as the Democrats' campaign to raise their taxes has gathered momentum. The party's leading presidential candidates - Hillary Clinton, Barack Obama and John Edwards - have lined up in recent days to support the tax rises, which many Democrats have been demanding for weeks. Related Links
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The support of the candidates for the campaign threatens to extend the Republicans' lead in private equity contributions. It could also hit the Democrats' fundraising efforts more generally, since private equity executives often use their vast networks of financial contracts to raise money on behalf of candidates.
Private equity executives pay 15 per cent capital gains tax rate on their carried interest - or share of the firm's investment profits - which makes up the bulk of their earnings.
Critics argue that they should pay 35 per cent, the top rate of income tax, because the bulk of the carried interest comes from money that they invest on behalf of institutions, rather than from their own pocket. The lower capital gains tax rate is intended to provide an incentive to encourage people to invest their own money and so take a risk, they contend.
The stage for a showdown was set in November, when the Democrats regained control of the Senate and of the House of Representatives. The issue of private equity taxation began to build momentum in March, when Blackstone bosses announced plans to float, forcing their tax treatment into the open, along with the vast wealth that the private equity executives were accumulating.
In addition to its proposal to increase taxes on private equity chiefs, Congress is also debating legislation that would increase taxes paid by publicly quoted investment firms, again from 15 per cent to 35 per cent. As America's presidential candidates stake out their positions, the Republicans have opposed changes to private equity taxation, arguing that it would discourage investment and harm the American economy.
Some Democratic candidates have decided to put taxes at the centre of their manifestos as they seek to tap the growing dissatisfaction among America's middle classes with the country's growing super-rich. They would use the estimated $4 billion to $6 billion that the tax rise on carried interest would produce to fund initiatives such as health and education reforms.
Democratic presidential candidates have been wary of being too aggressive towards private equity firms because they are large political donors and are very well connected, but they appear to have decided that they cannot turn their backs on an issue that is so central to Democrat ideology.
James Lucier, an independent political analyst, said: “The fact that it has taken them so long to comment on the issue is because they wanted to keep the bridges open to private equity and hedge funds for as long as possible.” The Centre for Responsive Politics data shows that in the first half of this year Rudy Giuliani, Mitt Romney and John McCain, the leading Republican candidates, received $262,000 in contributions from the 11 private equity firms that make up the Private Equity Council. Meanwhile, they gave only $231,000 to Mrs Clinton, Mr Obama and Mr Edwards.
Fintag says I have been bemused by the Democrat candidates courting capitalism. I was lucky to experience this the last time I was in Greenwich and it reminded me of a scene from Desperate Housewives and Cheers. Don't ask why but now the dreaded "tax" word has been banded about too much, Pirates and Hedgies are moving back to the Republicans. What a surprise.
1 comment
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