Is the storm over? Credit market conditions look changeable - By Gillian Tett
Posted by ProjectC
"...At the root of the current crisis is an information crunch that cannot be easily resolved."
Is the storm over? Credit market conditions look changeable
By Gillian Tett
October 3 2007
Source
A month ago, the mood on the credit trading desks of JPMorgan was decidedly dark. As turmoil erupted in the credit markets this summer, activity in many parts dried up and traders at the US investment bank were seeing far more sellers than buyers.
But a shift has since occurred. “In structured credit our desks [are seeing] more bids than offers – a clear improvement,” says Jan Loeys, a JPMorgan economist, who points out that investors are also putting money into risky bond funds at the fastest pace since 2005.
Such tales are being echoed all over Wall Street and the City of London. During most of August and early September, activity in much of the credit world was panic-stricken or just plain paralysed, as investors reacted to the scale of losses in America’s subprime mortgage sector. Indeed, there is still plenty of bad news: this week UBS and Citigroup revealed large losses as a result of credit bets gone wrong, while in the interbank market, where banks lend to each other, the cost of three-month borrowing in euros hit a six-year high.
But down on the trading floors and in the treasury departments of financial services groups, a subtle psychological shift is under way: as the shock of the summer’s events starts to fade, traders, investors and issuers are starting to adapt to the idea that the cost of borrowing has changed. As a result, activity in debt markets is picking up again. Or as Ben Bennett, an analyst at Lehman Brothers, says: “The credit machine is slowly restarting.”
Last week, for example, Barclays Capital successfully sold a bond for Schneider Electric, the French electrical engineering company. Though the cost of raising finance was higher than on comparable deals earlier this year, the issue was significant since it was the first successful sale of sub-investment grade corporate debt in Europe for several months.
In the US, investment banks have just sold, at a discount, half the $15bn (£7.4bn, €10.6bn) financing package for a planned buy-out by Kohlberg Kravis Roberts of First Data, a payments processor – another milestone, since the banks are burdened with a huge backlog of loans that they have been unable to sell this summer.
Mainstream investment-grade companies are raising finance again too. Last week was the busiest for corporate issuance in the euro market since early June, with €7.3bn of bonds sold, many from US companies such as General Electric. Activity in the dollar markets has also revived sharply. Last week, even Ghana – a country once deemed ultra-high risk – managed to sell a $750m bond.
The revival in activity is reinforcing a modest rally in some debt prices (with a corresponding fall in yields) – albeit on a far smaller scale than the dramatic rally recently seen in equities. “Corporate spreads are tightening on the back of the good reception given to issuers,” says Geraud Charpin, a credit analyst at UBS.
This rebound comes as a great relief to politicians on both sides of the Atlantic, who are hoping the turmoil does not trigger a broader downturn in the economy. “The good news is that things are starting to get better,” Robert Steel, US Treasury undersecretary for domestic finance, declared last week after the sale of the First Data loans.
It has also been eagerly welcomed by beleaguered investment bankers. “The worst of this credit correction is behind us,” says Dick Fuld, chief executive of Lehman Brothers, who – like most of his counterparts – is forecasting a return to more normal levels of activity in the credit world this winter.
But the problem that haunts both the politicians and banks is that while the signs of a rebound may be tangible, they remain patchy – and, above all, decidedly fragile. That suggests that the current apparent calm could quickly give way to another bout of turmoil if any new shocks emerge.
“Fragile” is probably the best word to use,” says one central banker. Or as a senior private sector banker admits: “We are on a knife-edge ... there are still worrying signals in the markets.”
One issue provoking worry is that there is still alarmingly little evidence of genuine trading under way in many of the complex securities that were at the heart of the summer credit storm. While bargain hunters, such as hedge funds, have started snapping up corporate debt, the same does not appear to be happening much in derivatives linked to mortgage securities. Meanwhile prices in that sector – insofar as there are any prices – are still falling. Last week, a derivatives index linked to US mortgage loans touched a new low.
Another – potentially more pernicious – problem is the state of the interbank market. In recent weeks, the cost of borrowing funds overnight has dropped in Europe and the US as central banks have flooded the money markets with funds. However, in the three-month money market, rates remain very high because banks are apparently hoarding their funds rather than lending them out.
“Overall, central banks have been successful in stabilising conditions at the short end of money markets,” says Lena Komileva of Tullett Prebon, the inter-dealer broker. “But persistent tightness in [three-month] funds suggests that developments in the overnight market create an illusion of normality.”
This is alarming for those central banks that have been flooding the markets with money, since it will be hard for the financial system to function healthily again while the interbank market remains frozen. It also has troubling implications for investors: the interbank freeze in effect suggests that banks do not believe their own rhetoric that the outlook is improving. In public, in other words, they may seem upbeat but they are not putting their money where their mouth is.
Some observers hope this discrepancy simply reflects technical phenomena that should disappear soon. More specifically, one reason why banks are hoarding funds is that they fear that a flood of assets, such as loans, will roll back on to their balance sheets because these instruments can no longer be sold in the credit markets.
But while the scale of this potential roll-back is huge, it should not continue indefinitely: Société Générale, for example, thinks that once the current financial year has ended, banks will become more willing to lend to each other. “We expect the pressures on the money markets to reverse [soon],” it says.
But the problem with this optimistic projection is that there appear to be other factors that are also provoking unease – not just among bank treasurers but other investors too.
One is the continued uncertainty as to where all the rot related to the subprime mortgage sector now lies. Although some banks, such as UBS and Credit Suisse, have already revealed losses, there are widespread suspicions that other large and small banks and asset management groups are still concealing problems – not least because it remains hard to value complex credit securities while markets remain paralysed.
“There is still an information logjam in term of ‘who owes what to whom?’ and ‘what are the assets really worth?’ ” says Andrew Milligan, head of global strategy at Standard Life Investments. Or as Marco Annunziata of Unicredit echoes:“At the root of the current crisis is an information crunch that cannot be easily resolved.”
A second set of concerns revolves around “deleveraging” – the banking term for the process by which investors and institutions cut their levels of debt. This issue is crucial because in recent years many investors and financial institutions have sharply increased their borrowing in order to buy loans and other assets. Many are now cutting this, either because they have suffered painful losses on their investments or because the banks themselves are no longer willing to supply funds, and the cost of capital is rising.
Citigroup estimates that back in January a hedge fund that owned an AA rated debt instrument could typically post that as collateral with an investment bank and borrow 10 times that value of funds. Now it can typically borrow only five times the value of this collateral, or less for riskier assets. “From one asset class to another, everyone is strapped for cash,” says Matt King, analyst at Citigroup.
This shift could force many investors to sell assets in the coming months. Worse, it is difficult to tell how this deleveraging process will play out, since many of these markets and their investors are opaque: little is traded publicly. Thus, while some observers hope the worst of the deleveraging is past, others fear the full impact will emerge only over the next year.
This, in turn, creates a third huge uncertainty: the impact of this summer’s turmoil on the real economy. Thus far, there have been few signs that the credit upheavals and the associated rise in funding costs have triggered corporate panic. That may be because the global economy remains in a healthy state and most companies are enjoying strong balance sheets and good earnings. Moreover, while borrowing costs have risen, they are not at all high by historic standards – not least because they were so abnormally low last year.
But this sense of calm could be illusory, owing to a time-lag effect. Financial history suggests that whenever funding costs have risen in previous cycles, it has typically taken several months for the full impact on companies or consumers to show up. Indeed, behind the scenes, banks are preparing to cut their lending. A survey of loan officers in the US by the Federal Reserve, for example, suggests that banks are imposing the tightest lending criteria in their mortgage business for 16 years.
Merrill Lynch believes, on the basis of research among its own client base, that two-thirds of lending officers in Europe and the US are planning to cut credit. “The days of cheap and easy money for sub-investment grade companies are over,” says Merrill’s Karen Olney, who points out that “normally defaults follow tightening by about 12 months”.
Most economists think the global economy will be able to weather a moderate rise in corporate defaults or fall in house sales. But if anything else hurts sentiment, such as an associated crash in house prices or the dollar, the panic could rise.
That, in turn, might create a vicious feedback loop, where a decline in economic activity leads to more credit losses – which prompt the banks to tighten lending further, triggering further borrower pain. There is risk, in other words, that the developments of this summer were merely the first chapter of a long saga of pain.
Almost nobody in the political or banking world will publicly admit that they are preparing for this worst-case scenario. But if nothing else, the events that started in August have reminded investors that the worst-case scenario can sometimes play out, however unlikely.
Investor psychology, in other words, has changed. As long as uncertainties remain about issues such as deleveraging, subprime losses and the risks to economic growth, a sense of fragility will endure. The days of ultra-easy credit will not return soon – on the JPMorgan trading desks or anywhere else.
Copyright The Financial Times Limited 2007
Is the storm over? Credit market conditions look changeable
By Gillian Tett
October 3 2007
Source
A month ago, the mood on the credit trading desks of JPMorgan was decidedly dark. As turmoil erupted in the credit markets this summer, activity in many parts dried up and traders at the US investment bank were seeing far more sellers than buyers.
But a shift has since occurred. “In structured credit our desks [are seeing] more bids than offers – a clear improvement,” says Jan Loeys, a JPMorgan economist, who points out that investors are also putting money into risky bond funds at the fastest pace since 2005.
Such tales are being echoed all over Wall Street and the City of London. During most of August and early September, activity in much of the credit world was panic-stricken or just plain paralysed, as investors reacted to the scale of losses in America’s subprime mortgage sector. Indeed, there is still plenty of bad news: this week UBS and Citigroup revealed large losses as a result of credit bets gone wrong, while in the interbank market, where banks lend to each other, the cost of three-month borrowing in euros hit a six-year high.
But down on the trading floors and in the treasury departments of financial services groups, a subtle psychological shift is under way: as the shock of the summer’s events starts to fade, traders, investors and issuers are starting to adapt to the idea that the cost of borrowing has changed. As a result, activity in debt markets is picking up again. Or as Ben Bennett, an analyst at Lehman Brothers, says: “The credit machine is slowly restarting.”
Last week, for example, Barclays Capital successfully sold a bond for Schneider Electric, the French electrical engineering company. Though the cost of raising finance was higher than on comparable deals earlier this year, the issue was significant since it was the first successful sale of sub-investment grade corporate debt in Europe for several months.
In the US, investment banks have just sold, at a discount, half the $15bn (£7.4bn, €10.6bn) financing package for a planned buy-out by Kohlberg Kravis Roberts of First Data, a payments processor – another milestone, since the banks are burdened with a huge backlog of loans that they have been unable to sell this summer.
Mainstream investment-grade companies are raising finance again too. Last week was the busiest for corporate issuance in the euro market since early June, with €7.3bn of bonds sold, many from US companies such as General Electric. Activity in the dollar markets has also revived sharply. Last week, even Ghana – a country once deemed ultra-high risk – managed to sell a $750m bond.
The revival in activity is reinforcing a modest rally in some debt prices (with a corresponding fall in yields) – albeit on a far smaller scale than the dramatic rally recently seen in equities. “Corporate spreads are tightening on the back of the good reception given to issuers,” says Geraud Charpin, a credit analyst at UBS.
This rebound comes as a great relief to politicians on both sides of the Atlantic, who are hoping the turmoil does not trigger a broader downturn in the economy. “The good news is that things are starting to get better,” Robert Steel, US Treasury undersecretary for domestic finance, declared last week after the sale of the First Data loans.
It has also been eagerly welcomed by beleaguered investment bankers. “The worst of this credit correction is behind us,” says Dick Fuld, chief executive of Lehman Brothers, who – like most of his counterparts – is forecasting a return to more normal levels of activity in the credit world this winter.
But the problem that haunts both the politicians and banks is that while the signs of a rebound may be tangible, they remain patchy – and, above all, decidedly fragile. That suggests that the current apparent calm could quickly give way to another bout of turmoil if any new shocks emerge.
“Fragile” is probably the best word to use,” says one central banker. Or as a senior private sector banker admits: “We are on a knife-edge ... there are still worrying signals in the markets.”
One issue provoking worry is that there is still alarmingly little evidence of genuine trading under way in many of the complex securities that were at the heart of the summer credit storm. While bargain hunters, such as hedge funds, have started snapping up corporate debt, the same does not appear to be happening much in derivatives linked to mortgage securities. Meanwhile prices in that sector – insofar as there are any prices – are still falling. Last week, a derivatives index linked to US mortgage loans touched a new low.
Another – potentially more pernicious – problem is the state of the interbank market. In recent weeks, the cost of borrowing funds overnight has dropped in Europe and the US as central banks have flooded the money markets with funds. However, in the three-month money market, rates remain very high because banks are apparently hoarding their funds rather than lending them out.
“Overall, central banks have been successful in stabilising conditions at the short end of money markets,” says Lena Komileva of Tullett Prebon, the inter-dealer broker. “But persistent tightness in [three-month] funds suggests that developments in the overnight market create an illusion of normality.”
This is alarming for those central banks that have been flooding the markets with money, since it will be hard for the financial system to function healthily again while the interbank market remains frozen. It also has troubling implications for investors: the interbank freeze in effect suggests that banks do not believe their own rhetoric that the outlook is improving. In public, in other words, they may seem upbeat but they are not putting their money where their mouth is.
Some observers hope this discrepancy simply reflects technical phenomena that should disappear soon. More specifically, one reason why banks are hoarding funds is that they fear that a flood of assets, such as loans, will roll back on to their balance sheets because these instruments can no longer be sold in the credit markets.
But while the scale of this potential roll-back is huge, it should not continue indefinitely: Société Générale, for example, thinks that once the current financial year has ended, banks will become more willing to lend to each other. “We expect the pressures on the money markets to reverse [soon],” it says.
But the problem with this optimistic projection is that there appear to be other factors that are also provoking unease – not just among bank treasurers but other investors too.
One is the continued uncertainty as to where all the rot related to the subprime mortgage sector now lies. Although some banks, such as UBS and Credit Suisse, have already revealed losses, there are widespread suspicions that other large and small banks and asset management groups are still concealing problems – not least because it remains hard to value complex credit securities while markets remain paralysed.
“There is still an information logjam in term of ‘who owes what to whom?’ and ‘what are the assets really worth?’ ” says Andrew Milligan, head of global strategy at Standard Life Investments. Or as Marco Annunziata of Unicredit echoes:“At the root of the current crisis is an information crunch that cannot be easily resolved.”
A second set of concerns revolves around “deleveraging” – the banking term for the process by which investors and institutions cut their levels of debt. This issue is crucial because in recent years many investors and financial institutions have sharply increased their borrowing in order to buy loans and other assets. Many are now cutting this, either because they have suffered painful losses on their investments or because the banks themselves are no longer willing to supply funds, and the cost of capital is rising.
Citigroup estimates that back in January a hedge fund that owned an AA rated debt instrument could typically post that as collateral with an investment bank and borrow 10 times that value of funds. Now it can typically borrow only five times the value of this collateral, or less for riskier assets. “From one asset class to another, everyone is strapped for cash,” says Matt King, analyst at Citigroup.
This shift could force many investors to sell assets in the coming months. Worse, it is difficult to tell how this deleveraging process will play out, since many of these markets and their investors are opaque: little is traded publicly. Thus, while some observers hope the worst of the deleveraging is past, others fear the full impact will emerge only over the next year.
This, in turn, creates a third huge uncertainty: the impact of this summer’s turmoil on the real economy. Thus far, there have been few signs that the credit upheavals and the associated rise in funding costs have triggered corporate panic. That may be because the global economy remains in a healthy state and most companies are enjoying strong balance sheets and good earnings. Moreover, while borrowing costs have risen, they are not at all high by historic standards – not least because they were so abnormally low last year.
But this sense of calm could be illusory, owing to a time-lag effect. Financial history suggests that whenever funding costs have risen in previous cycles, it has typically taken several months for the full impact on companies or consumers to show up. Indeed, behind the scenes, banks are preparing to cut their lending. A survey of loan officers in the US by the Federal Reserve, for example, suggests that banks are imposing the tightest lending criteria in their mortgage business for 16 years.
Merrill Lynch believes, on the basis of research among its own client base, that two-thirds of lending officers in Europe and the US are planning to cut credit. “The days of cheap and easy money for sub-investment grade companies are over,” says Merrill’s Karen Olney, who points out that “normally defaults follow tightening by about 12 months”.
Most economists think the global economy will be able to weather a moderate rise in corporate defaults or fall in house sales. But if anything else hurts sentiment, such as an associated crash in house prices or the dollar, the panic could rise.
That, in turn, might create a vicious feedback loop, where a decline in economic activity leads to more credit losses – which prompt the banks to tighten lending further, triggering further borrower pain. There is risk, in other words, that the developments of this summer were merely the first chapter of a long saga of pain.
Almost nobody in the political or banking world will publicly admit that they are preparing for this worst-case scenario. But if nothing else, the events that started in August have reminded investors that the worst-case scenario can sometimes play out, however unlikely.
Investor psychology, in other words, has changed. As long as uncertainties remain about issues such as deleveraging, subprime losses and the risks to economic growth, a sense of fragility will endure. The days of ultra-easy credit will not return soon – on the JPMorgan trading desks or anywhere else.
Copyright The Financial Times Limited 2007