Confidence In Credit? It's A Fragile Thing!
A: Most of the indicators on the credit markets have eased nicely since the chaos hit it's peak in mid-March, and the fed saved the financial system. But things are starting to seem a bit murky again in creditville; a not so nice place to call home. While things like the TED spread seem fine, the AAA ABX index is once again falling and when I look at the stock prices of investment bank Lehman Brothers and bank Washington Mutual, I wonder if another disaster is setting up? One thing I do know, is that if we do have another shock to the system, expect confidence in the credit markets to once again be rattled!
Take a look at what the ABX AAA Index has done over the past few weeks (via Markit):
Notice the deterioration in the past two weeks, quickly approaching the lows hit in mid-March when fear level from the credit crisis hit it's peak. The vix hit 32 during that time. Currently, the volatility index is around 19.50, up from a low of around 16.30 a few weeks ago, but still well below the fear level peak when Bear Stearns decided to hibernate forever.
Not all of the credit indicators are deteriorating though. Credit spreads seem ok for the most part, TED spread is below 1, and LIBOR seemed to come in a bit when compared to the fed funds rate of 2% (although it has come to light that banks have been misstating LIBOR rates for fear that it will show distress for those banks quoting higher rates). Yet all these indicators can change very quickly should another shock to the system occur; and when I look at where LEH, WM, and C are trading right now, it seems traders are pricing in some uncertainty for these guys.
LEHMAN BROTHERS (NYSE:LEH) - down 28% in 1 Month
CITIGROUP (NYSE: C) - down 18% in 1 Month
WASHINGTON MUTUAL (NYSE: WM) - down 26% in 1 Month
Imagine what would happen should Washington Mutual come out and say they are insolvent? Or, if Citigroup announces it must cut their dividend and write down another couple of billion? Or if Lehman comes out and says everything is fine, they dont need any capital, but they will dilute shareholders anyway and raise another $4 Billion? Oh wait, that just happened!
According to Clusterstock.com's article, "Lehman's Laughable Damage Control; Don't Need To Raise Capital, Just Might Want To":
Lehman Brothers (LEH) was hammered yesterday on fears that the company will have to sell more equity in another emergency capital raise. The WSJ put the amount at a highly dilutive $4 billion of common equity on an $18 billion market cap--this after the firm has raised $6 billion in the past two months.Why would a company dilute shareholders if they didn't need to? The answer: because they have to! I don't need to explain to this audience the critical nature of confidence, and how a crisis of confidence can destroy a firm. It seems Lehman is trying to retain confidence, and as the article states, "...understanding that preventing a run on the bank is all about perception."
In typical fashion, however, Lehman comes out fighting, saying in a statement (per CNBC) that it doesn't need to raise the money that it is only considering raising it because it might want to.
Please. Companies don't dilute shareholders by 20%+ when their stocks are already down more than 60% from their peaks unless they absolutely have to.
The point of this post is to explain that with the stock prices of LEH, C, & WM down at these levels, confidence is a very fragile thing right now. Sentiment, especially in the credit markets can change very quickly and do some damage. While the credit markets seem to be in a much better state than it was in mid March, there are still concerns! The last thing we need is an insolvent Lehman or a bankrupt Washington Mutual. Something like that will shatter confidence and erase all the progress that the credit markets made since the fed saved the financial system!