C.M.O. 7.23.2009
Credit Market Overview
July 23, 2009
The story of “Chicken Little” and his famous proclamation was originally thought to be one of Aesop’s Fables but really got its start in early Africa. The main tenet can also be traced to Gautama Buddha’s time (600 BC) although the latter tale uses a hare and a lion. Regardless of the exact provenance, the moral is the same; keep the exaggeration to a minimum and always look on the bright side.
Given then, that most have us have heard this story at least once in our lives and have passed it on, possibly multiple times, it is not a stretch to think that it has had some impact on our outlook.
As such, not believing the Marc Farber’s, Nouriel Roubini’s and Meredith Whitney’s of the world when their first prognostications of a possible complete collapse of the global financial system became public would seem to attest to the effectiveness of CL’s story and for which we can all be forgiven, somewhat.
Now that the sky has fallen we know that it is worth heeding those seers and even though the worst of the “housing” part of this economic Tsunami has passed the other things of which they forewarned appear to be in the offing.
Even older than the tale of Mr. C. Little is the knowledge that gigantic Tidal waves come in sets of 2-4, but never one. With regard to the financial crisis the second and third waves seem to be emanating from commercial real estate and personal credit cards.
Even as Ben endures days of public scrutiny in front of politicians, who appear to care about those in constituencies other than their own, describing his “exit strategy” the follow on waves are building.
According to an analysis by the WSJ, the 8,000 U.S. banks that are still around (57 less than at the start of the year.) are taking write downs on their commercial mortgage portfolio’s at the quickest rate in 20 years. They estimate that losses on these loans could hit the $30BN mark by year end. This number should be measured against a total value of $6.7TN or 13% of America’s GDP. In the second quarter alone delinquencies equaled 4.3% a number more than twice that seen in the same period last year.
To the extent that the reporter’s at the WSJ have copies of CL in their desk drawers CNNmoney reported that an associate director of the Fed recently testified before the Congressional Joint Economic Committee that “at the end of the first quarter, about 7% of commercial real estate loans on banks’ books were considered delinquent. This was about double from the level a year earlier”.
Proof that the wave is beginning to hit the beach came with Morgan Stanley’s (MS) earnings announcement as in addition to losses in its institutional securities and investment banking businesses analysts said problems with the company’s commercial real estate portfolio were a big driver of the loss.
The Treasury’s recent stress test found that MS could experience losses of about 45% of its commercial real estate loans under their “worst case scenario”. Remember too that one of the parameters of that WCS was an unemployment rate of 8.9% by the end of 2009. Check if you like but I think we’ve passed that mark already and it’s only July!
Morgan Stanley’s equity price hit $31.39 recently (6/8/2009) after bouncing off $16.48 on March 9th of this year. That 3/9 date also saw the top level for MS’s CDS’s this year at 476bps. Since that time the firm’s CDS levels have declined at a reasonably steady rate as the stock price rose. The equity markets seemed to anticipate the bad news before the CDS market this time around as the low in MS default protection did not occur until July 21st at 156bps.
The stock appears to continue to be making a series of higher highs and, more importantly, higher lows and the short pop to 176bps in the CDS as of last night’s close is still below the most recent previous low of 191bps keeping both trends intact.
Throughout this credit crisis we have been inundated with news of how firms like MS and its ilk have faired. What needs to be considered is that the WSJ survey included 8,000 institutions and unlike the retail mortgage business where loans were packaged and resold, most commercial mortgages are held on the originator’s books.
I don’t know if all of this means the sky is falling but I have started carrying an umbrella!
Enjoy the week.
Jim Delaney
