Credit Markets Check: Running Out Of Bullets
A: The harsh reality of incoming weak economic data, a confused fed chairman who admittedly doesn't have the answers to our problems, and spent fiscal & monetary policy thus limiting future bullets in the fight against a severe recession is starting to set in. There is so much going on in creditville, a not so good place to call home, that this post is going to be more of an overview of recent events rather than a focus on one topic. With future rate cuts likely resulting in further commodity inflation, I'm concerned that we are going to be running out of bullets soon and will have to deal with a period of financial stress without the fed's strongest weapon available to us.
According to MARKIT indices for a glimpse into investor sentiment in the credit markets, things actually got noticeably worse since the end of January with one exception; corporate spreads narrowed a bit. Nothing to get excited about though as it didn't last long, but then again, anything other than straight deterioration is good in my mind. First I'll describe what I am seeing in the ABX, CMBX, & CDX indices and then you can see the chart below showing you a visual of the ABX & CMBX:
ABX Inidices Continue To Dive - investor sentiment weakens as expectations for rising defaults on subprime loans continue.
CMBX Spreads Narrow Then Widen Again - a fakeout. For a few days I was getting a bit hopeful that this commercial mortgage backed securities index would show some stabilization. But then spreads widened again with a big uptick showing continued distress in the commercial MBS markets. Investors seem to be waiting for commercial real estate to be the next shoe to drop, resulting in a new wave of losses for financials holding toxic CMBS bonds.
CDX Spreads Narrow Then Widen Again - another fakeout probably in reaction from the affirmation of AAA ratings at MBIA, and talk of an Ambac rescue plan; of course now it looks like the Ambac deal hit a snag according to Charlie Gasparino this morning. Credit still appears to be tight and spreads wide as risk aversion remains in place.
Add to these credit market indicators weak economic data, a HUGE loss over at AIG, Thornburg mortgage selling assets to meet margin calls, MBIA calling for more losses, UBS predicting $600 billion in credit market related losses throughout financial sector, Peloton Partners forced liquidation of $1.8 billion asset backed hedge fund, and the list goes on and on. To me, two of the above listed pieces of news sticks out: Thornburg forced sales to meet margin calls & Peloton forced liquidations. The UBS prediction of massive losses is not news, its a somber reality check.
The Thornburg news reminds us that all is NOT well in default land and that the trend for future defaults is rising; which is what the ABX indices are telling us as well. It seems we have forgotten about this recently as the bond insurer saga, Fannie & Freddie cap lifts took center stage this past week. Housing is the runaway train that is fueling all these problems, and the data is showing no end in sight yet. While subprime sparked the fire, it is the threat of spreading to higher quality debt classes that is scary. News on rising Alt-a defaults, or near prime, is starting to come in.
According to Bloomberg's article "Alt-A Mortgage Securities Tumble, Signaling Losses":
Securities backed by Alt-A mortgages and other home loans to borrowers with better-than-subprime credit tumbled this month, causing investment funds to unwind or meet margin calls and signaling larger losses for Wall Street.So what happened on February 14th? UBS announced a $2 billion write down and disclosed some $26.6 billion in Alt-A exposure! The Alt-A mortgage securities market totals just under $1 trillion; so the risk is validated. I guess it's all a matter of what you believe. You all know my concerns and I think it is just a matter of time for the problem to spread to other debt classes; you are starting to see it already. The problem now is that nobody wants to throw good money into bad, options for struggling institutions are very limited, and you are likely to see more forced liquidations of assets to meet margin calls in the near term. The fed is running out of bullets as commodity inflation runs wild, but we will certainly see more rate cuts soon in an attempt to limit the destructiveness of the coming slowdown. Just listening to Bernanke yesterday sent chills down my spine as we all learned even the fed chief is not sure how bad this problem is; only that it is "worse than 2001's environment" that caused a minor recession.London-based Peloton Partners LLP, which owns debt tied to home loans considered safer as well as bets against subprime, is liquidating a $1.8 billion hedge fund.
Valuations for AAA rated securities backed by Alt-A loans, deemed between prime and subprime in terms of expected defaults, slumped 10 percent to 15 percent this month, partly because it's so difficult to trade or find prices for them, Thornburg Mortgage Inc., the Santa Fe, New Mexico-based lender and investor, said in a securities filing today.
Alt-A securities began tumbling on Feb. 14, when UBS disclosed its holdings and speculation began spreading that the Zurich-based company would sell a large amount, Thornburg President Larry Goldstone said in a Bloomberg Radio interview today.
The economic data & stock markets are lagging the credit markets, so I'm keeping tabs on how fiscal & monetary policy is being absorbed by the credit markets. We need to see:
a) confidence return to secondary mortgage markets
b) corporate spreads narrow
c) housing fundamentals reverse negative trend
d) financial write-downs coming to an end; clean balance sheets
...before we will see risk aversion dissipate and the credit markets start to normalize again where access to credit returns. When this happens, it is just a matter of how much bad lagging economic data resulting from this whole mess & seizing up of the credit markets is yet to come.
Comments (5)
Noah, also note the 110 billion pounds bailout of Northern Rock plc by the UK government.
The opacity of our Fed back-door funding of US banks.
So, what does all this mean? The global financial system is bankrupt?
Only being held together by influx of public monies to keep the bankruptcy from being exposed?
Is this not a more serious situation than what people what to believe?
Posted by Jose | February 29, 2008 6:11 PM
grrr, I hate typos. Last line should read:
"...people want to believe?"
Posted by Jose | February 29, 2008 6:13 PM
Calling CMBS securities toxic is quite premature based on a synthetic index. That's like holding a day old piece of bread and calling it mold. No matter how you look at it, CMBS hasn't taken losses, and defaults are still at the lowest level ever - less than 0.4% of outstanding CRE loans. Write downs on CMBS to this point have come from the coupons on the notes/bonds, not from the underlying credit.
Spreads have increased at this point, because investors are now refusing to buy because they're worried about downgrades. It seems like downgrades and defaults go hand in hand, but if you have 1% defaults, you don't need to downgrade anything. Investors are worried that Moody's specifically will retroactively apply future increases to subordination to older vintages (downgrades because the new stuff needs higher subordination). Whether or not that happens is still up in the air, but it is certainly not spurred by increasing defaults that are really just speculation at this point.
Posted by mike | February 29, 2008 9:03 PM
Mike - true, but that sentence was more in regards to the sentiment, or concerns that I am hearing from people I know on wall street.
Obviously you are one, so I ask you, is this a valid concern as a future shoe to drop with resulting losses on books of financials?
Posted by Noah | February 29, 2008 10:01 PM
Valuations for commercial real estate have been very high and it has been easy to take on debt. I would think that the increasing CMBX spread would mean that this debt will have to get more expensive over the next year.
An economic slowdown will inevitably lead to higher vacancy rates and lower net effective rents. It won't happen right away given the long term nature of leases and because giving up your space is really a cut-back of last resort for most tenants.
Landlords will be squeezed from the revenue side and the cost side. If the cost of debt goes up just a bit and vacancies go up just a bit it won't be long before there are many commercial defaults.
Posted by Mikael | March 3, 2008 4:53 PM