It was a dismal week for the stock market. For the week, the Dow dropped 4% and the S&P500 declined 5%. The Transports were smacked for 7%, while the Utilities dipped 3%. The Morgan Stanley Consumer and Morgan Stanley Cyclical indices dropped about 5%. Selling in the broader market was generally less intense, as the small cap Russell 2000 and S&P400 Mid-Cap indices declined about 3%. The NASDAQ100 and the Morgan Stanley High Tech indices declined about 2%. The Semiconductors dropped 5%, The Street.com Internet index 3%, and the NASDAQ Telecom index 4%. The financial stocks came under heavy selling pressure, with the Securities Broker/Dealer index hammered for 8% and the Banks 4%. With bullion up almost $12 to a six-year high, the HUI Gold index jumped 6%.
The Credit market benefited. For the week, two-year Treasury yields declined three basis points to 1.65%. The 5-year Treasury yield declined 10 basis points to 2.87%, while 10-year yields dipped eight basis points to 3.93%. The long-bond saw its yield decline six basis points to 4.86%. Benchmark mortgage-backs and agency securities performed well, with yields generally declining 10 or 11 basis points. The spread on Fannie’s 5 3/8 2011 note narrowed one to 37, while the benchmark 10-year dollar swap spread was unchanged at 44. Corporate bond spreads widened marginally. The dollar index declined another 1%, ending the week below 100 for the first time since January 2000. The CRB index added better than 1%, with commodity prices strong almost across the board. Even copper prices are up about 10% this month.
January 24 – Dow Jones: “National Century Financial Enterprises Inc. will cease operations in the next few months after the restructuring experts brought in to revive the scandal-ridden health-care financier decided that its problems were even more widespread than originally thought… David Coles, a corporate-restructuring specialist with Alvarez & Marsal Inc… who took over as National Century’s chief executive in November, painted a picture of widespread deception at the company… ‘I’ve been involved in badly run businesses, some of which we’ve been able to recuperate, others which we’ve had to liquidate, but I’ve not had experience with a falsification of information component that compares to this,’ said Mr. Coles. The closing of closely held National Century not only runs counter to earlier expectations that the company could be revived, but it could cost bondholders more than $2 billion, depending on what can be recovered through litigation. As a result of National Century’s problems, more than 15 health-care providers that relied on the company for operating funds have filed for protection under Chapter 11 of the U.S. Bankruptcy Code.”
January 21 – Bloomberg: “Arizona’s new treasurer may seek tighter limits on how much money a government pool can put in some investments to lower risk after the state lost money last year on bonds sold by a bankrupt health-care finance company… Arizona’s local treasurers last month urged a review because they stand to lose money on $131 million in debt the pool bought from Dublin, Ohio-based National Century Financial Enterprises Inc., which provided cash to health-care providers by buying medical bills and then packaged them into asset-backed bonds.”
January 21 – Bloomberg: “Manhattan apartment prices fell 4.8 percent in the fourth quarter and sales declined 9.5 percent as a slowing economy pushed New Yorkers to search for smaller and cheaper apartments. The average price dropped to $808,657 from $849,013 the previous quarter, according to appraiser Miller Samuel Inc. and Insignia Douglas Elliman, a Manhattan residential brokerage. The number of sales fell to 2,028 from 2,241, the lowest since the third quarter of 2001.”
Providing further confirmation of the dramatic deterioration in federal government finances, the typically strong surplus month of December saw receipts only $4.37 billion more than expenditures. The December 2001 surplus was $26.6 billion. After only three months of the fiscal year, the fiscal deficit has already reached $108.72 billion. The comparable deficit from last year was $35.4 billion. Fiscal y-t-d revenues are down 8.3%, with Individual Income Tax Receipts declining 12.7%. Conversely, spending has jumped 6.9%. By leading categories, Social Security is up 5.2% to $115.5 billion, National Defense 16.5% to $98.3 billion, Income Security 14.2% to $78.5 billion, Medicare 14.3% to $65 billion, Health 10.2% to $53.8 billion, and Education, Social Welfare 13.2% to $18 billion. Interest expense has declined 6.5% to $42.9 billion.
January 21 – Bloomberg: “Nevada Governor Kenny Guinn proposed raising almost $1 billion from higher taxes on businesses, cigarettes, and property to help close a deficit and fund schools and other programs in the fastest-growing U.S. state. Nevada’s strategy of generating three-fourths of its revenue from taxes on sales and gambling in cities such as Las Vegas has made the state vulnerable to economic swings and isn’t meeting the demands of a growing population, Guinn said last night in his annual state of the state address.”
January 22 – Bloomberg: “Moody’s ratings have been downgraded to A3 from A1 for municipal bond issues backed by a letter of credit issued by Bayerische Hypo-Und Vereinsbank AG.”
From Bank of America Structured Products: “The year 2002 will be recorded as having the most downgrades in CDO (Collateralized Debt Obligations) history… Moody’s downgraded actions affected 865 tranches, or $32.5 billion of par, in 350 deals over 2002. This represented 318% yoy growth over its 205 tranche downgrades in 2001.”
January 22 – Dow Jones (John Conner): “The amount of loans outstanding under the Federal Home Loan Banks’ ‘Mortgage Partnership Finance’ program grew 68% during 2002, ending the year at $41.7 billion, up from $24.8 billion a year earlier, the Chicago FHLB said Wednesday.”
January 24 – Moody’s: “U.S. asset-backed securities (ABS) public issuance should reach $375 billion in 2003, a 6% increase over the robust total of $354 billion posted in 2002, says Moody’s Investors Service in a year-in-review and ABS outlook report… U.S. (2002) public ABS issuance…(was) up 26% over the previous record of $280 billion established in 2001, and up 63% over 2000 issuance.”
Broad money supply declined by $4.1 billion last week. Combined Demand and Checkable Deposits declined $8 billion, while Savings Deposits jumped $34.9 billion. Small Denominated Deposits declined $2.9 billion and Retail Money Fund deposits dropped $11.7 billion. Institutional Money Fund deposits dropped $23.7 billion, while Large Denominated Deposits increased $7 billion. Repurchase Agreements declined $3.8 billion, while Eurodollars added $4 billion. Elsewhere, Total Bank Credit increased $1.7 billion, with Securities holdings declining $3.3 billion. Bank Loans and Leases increased $5 billion, with Revolving Home loans and Security loans each up $3.3 billion. Commercial and Industrial loans were unchanged. Total Commercial Paper (CP) borrowings increased $5.6 billion ($24 billion in three weeks). Total financial sector issuance rose $5.8 billion ($20.3 billion in three weeks), while non-financial issuance was about unchanged. The ABS market boom continues, with about $8 billion issued this week. It was also another strong week in the corporate bond market with almost $38 billion of domestic corporate and agency issuance. Year-to-date issuance is already up to $155 billion (after only ten business days!).
A recent Moody’s downgrade did not keep Georgia-Pacific from twice raising the size of its junk bond offering from $500 million $1.5 billion. Tenet Healthcare doubled the size of its offering to $1 billion. From Bloomberg: “‘The demand in the market was overwhelming, we had nearly $2 billion in demand,’ CFO Stephen Farber said… The bank loan ‘was still in process. We decided to take the whole $1 billion from the bond market.” Dallas-based homebuilder Centex sold $300 million five year notes at a spread of 187.5 basis points. Bloomberg quoted a Centex executive: “These are the best spreads and coupons that we’ve experienced since we’ve been issuing notes. That’s for the last three years.” KB Homes sold $250 million of 7-year debt, with the CFO stating “the market was extremely attractive for the building sector for high yield companies.” GE sold $5 billion five-year notes at a spread of 112 basis points. A GE exec was quoted by Bloomberg: “We had close to $9 billion of orders from over 300 investors. We were pretty pleased…” JPMorgan Chase issued $1.75 billion of debt yesterday. One billion of 10-year notes were sold at 151 basis points over Treasuries compared to the 175 basis points paid back in November. Citigroup increased the size of its bond offering by one-third to $2 billion. There sure is a lot of liquidity. What used to work it’s magic may today be Too Much.
From today’s Financial Times (Kevin Morrison): “Managers of hedge funds have been switching from falling equity markets and taking a fresh look at commodities, pushing gold, platinum and nickel prices to highs not seen for years. Hugh Hendry, fund manager at London-based Odey Asset Management, says central banks have contributed to the increasing interest in commodities. ‘They are able to print money to keep the economy going and that money always finds its way to the fastest rising asset class. In the 1990s that was Nasdaq and now it looks like commodities.’ Metals are not the only class of commodities to benefit. Products such as cocoa, wool, soybeans, palm oil, wheat and corn have risen by between 13 per cent and almost 60 per cent since the start of last year.” The article concluded with a telling quote: “I like the prospects for wheat and corn – not that I’m an expert on the latest harvests – but then the people that bought Microsoft during the boom didn’t have to know about servers and LANs (Local Area Networks).” (“Liquidity Loves Inflation” and “The Trials and Tribulations of Speculative Finance.” – The Revival of Inflation Psychology?)
Although speculative bets in the commodity markets are now apparently becoming the trade de jour, let’s not forget that speculative infatuation with U.S. financial assets has absolutely dominated the financial landscape for several years now. Many trades will need to be unwound and leverage within dollar-denominated securities markets reduced. Considering the enormity and length of this protracted speculation, the unfolding transition period will surely be fraught with uncertainly and turmoil. Were Wall Street and the hedge funds borrowing overseas to finance their ballooning securities holdings? It is worth noting that since the beginning of 1998 (19 quarters), Securities Broker/Dealers have ballooned balance sheets 81% to $1.4 Trillion. Have the Wall Street firms partially financed their enormous holdings of U.S. securities by borrowing in Euros, Swiss francs or other low-yielding foreign currencies (“King Dollar Global Carry Trade”)? Such a strategy worked wonderfully while the euro was losing ground against King Dollar. Not today.
And are the major Wall Street firms and money center banks exposed to dollar weakness through their derivative books? After all, for some time they have enjoyed writing dollar protection (either directly or in the swaps market) with little concern for hedging King Dollar exposure. Today they worry. And how extensively had the Global Leveraged Speculating Community obtained cheap finance borrowing in previously weak euros (or shorting a sinking gold?) to finance inflating U.S. financial assets? And, did it become popular to borrow in Euros to speculate in higher-yielding Mexican or Brazilian securities? Such a strategy would have been hugely profitable for some time, but has abruptly turned quite sour. Priced in Euros, the Mexican peso is already down 7.5% this month, with the Brazilian real, Columbian peso, and Chilean peso down about 5%. The demise of King Dollar alters so many things…including relative prices, relationships, and perceptions.
There were 28,388 bankruptcy filings last week, up 1% y-o-y. The Mortgage Bankers Association’s weekly index had Refi Applications declining 6%, although remaining at an elevated level (double the year ago). Purchase Applications were down about 1% to a level about 4% below one year ago. December housing data was exceptionally strong. Housing Starts were reported at an annualized rate of 1.835 million, up 16% y-o-y. Multi-family Starts were up almost 24% from December 2001. New Building Permits jumped to a 1.88 million pace, up 13% y-o-y to the highest level since December 1986. It is also worth noting that December permits were 29% above (pre-Bubble) December 1997 and 118% above the recessionary level of December 1990. Total 2002 Starts were 7% above 2001.
There have been a couple recent articles from the Dallas Morning News worth underscoring, keeping in mind our view of greater Dallas as a “marginal” housing market to monitor closely. From “Apartment Vacancies Hit High” (Steve Brown): “Apartment vacancy rates in the Dallas-Fort Worth area have risen to a 10-year high, as building far outpaces demand… In 2002, builders completed more than 11,000 additional apartments in North Texas. But tenant demand filled a paltry 1,030. And during the fourth quarter, occupancy fell by 1,150 units.” Yet, there are 10,000 additional apartments in the development pipeline. The dearth of renters is explained by a “sluggish economy,” but also because “thousands of renters have fueled a boom in local new-home building…”
In Dallas, and likely in many markets across the country, the consequences of a multi-year housing construction boom are increasingly apparent. For one, apartment vacancies are rising, especially at the overbuilt upper-end. And, at least in Dallas, the previous boom-time seller’s market is rapidly fading into memory. I drive through an older modest neighborhood each day on my way to the office. I have watched as a few For Sale and For Rent signs last summer have turned into an alarmingly large number as we begin a New Year. It is my impression that, despite low rates and ultra-easy Credit availability, the local existing home market has hit the wall. Interestingly, however, only a dozen or so miles north into suburbia and the market for new homes remains quite strong. This is an unusual two-tiered marketplace worth contemplating.
In the past, a weakening housing market and rising inventory would rattle the nerves of local bankers; financing for new construction would quickly run dry. But this New Age housing cycle has evolved into something quite different. For one, it is dominated by large national builders with close ties to Wall Street and the mortgage-backed securities marketplace. Importantly, these builders today have unlimited access to cheap finance to pursue their aggressive growth strategies. And not dissimilar to the telecom sector during 1999, The Street, bankers, and Washington are today content to cheer along the construction boom and disregard the consequences. As we have witnessed, the weaker the economy (and more intense the financial stress) the greater the impetus for stoking the Great Mortgage Finance Bubble. Limitless Credit availability also affords the aggressive builders the decisive advantage of providing zero (“Nehemiah and the Copycats”) or minimal down-payment mortgages, along with other inducements. Along with ultra-easy financing, new home are also effortless to insure, an attribute that has taken on new significance with homeowners insurance increasingly difficult to obtain in Texas and elsewhere.
So, similar to how “zero-down, no payments until 2004” market distortions sustain strong new car sales in the face of a ballooning inventory of used cars (who wouldn’t want to buy new instead of used?), we see distortions emanating from mortgage finance excess increasingly coming at the expense of the “used” home market. From a second Dallas Morning News article – Home Foreclosures are Casualties of Economy (again by Steve Brown): “A bleak economy hit home in North Texas last year, putting thousands in danger of losing their homes. The number of homeowners threatened with foreclosure in Dallas County jumped 32 percent. And in Collin County – which has been ravaged by layoffs in the high-tech and telecom sectors – home foreclosure postings soared by 73% in 2002… January foreclosure postings for Dallas County were up 43% from January 2002. And in Collin County, foreclosure postings for the month were up a staggering 94%.” And, yet, the building boom hardly misses a beat.
One could build a case that, basically up to this point, the Mortgage Finance Bubble has worked to the interest of buyers, typical sellers and builders, alike. Perhaps this year gains for the builders come out of the hides of many distressed sellers (and their lenders and mortgage insurers!). Again, reflecting back to the telecom boom: Many prosper for some time even after the boom has passed it peak, although the “marginal” player can be devastated as new finance is no longer forthcoming from increasingly cautious lenders.
It may also be helpful to recall the late-eighties office building boom (and later bust). Even though vacancies began rising markedly and serious problems were appearing on the horizon – with it in virtually everyone’s best-interest to put a moratorium on new construction - finance just rolled into the sector and additional high-rises were added to the developing glut. Many “investors” found the sector’s above-market yields too enticing; and, besides, the returns had been quite strong for a few years! As we are witnessing today in historical proportions throughout Mortgage Finance, once the financial apparatus (and speculative infatuation) has reached a critical mass it is nearly impossible to temper. The flow of finance invariable turns to flood, and a painful bust becomes unavoidable. Indeed, it is the awe-inspiring nature of speculative markets to inundate a sector with destabilizing finance at the very late stages of the boom (The “blow-off” or “Terminal Stage of Excess”). The home-building boom is poised to run through 2003, but the cost will be high.
We are in the midst of another fascinating earnings reporting season – at least in the financial arena. Clearly, the entire financial sector continues to push consumer and Mortgage Finance to its absolute limit – pedal to the metal. Avoid commercial lending at all cost, while playing mortgage finance like there’s no tomorrow. But rampant lending excess appears to have decidedly hit the point of diminishing returns. At least one should find fourth quarter economic performance all the more alarming after confirmation that it was another truly extraordinary quarter of lending. In addition, the ominous signs of acute Credit problems afflicting the consumer sector become increasingly obvious. The ramifications for the Credit insures are becoming only more troubling. Today’s downgrades of key Structured Finance players AIG and MBIA, as well as a group of other insurance companies, should be heeded as an early warning.
January 21 – American Banker (Matthias Rieker): “UnionBanCal Corp. said its campaign to cut credit costs helped its fourth-quarter profits rise 10%. The $36 billion-asset company…has been reducing its exposure to syndicated lending and making fewer loans to companies that are not already customers… To offset the shrinking of its commercial portfolio and falling loan spreads, the parent of Union Bank of California actively marketed residential mortgages, taking advantage of the home finance boom… For the three months, commercial and industrial loans fell 10.23%… commercial mortgages rose 17.41%…and residential mortgages rose 31.85%…”
Golden West Financial expanded assets at an 18% annualized rate during the quarter (17% for 2002). At Washington Mutual, assets expanded at a 9% pace (11% for 2002). Wells Fargo saw Total Assets expand at an 18% rate during the fourth quarter to $349 billion (up 14% for the year). “The home finance businesses saw exceptional growth in 2002, with total originations of $333 billion surpassing our 2001 industry record of $202 billion… Our owned servicing portfolio grew 26 percent during 2002 to $535 billion and our home equity portfolio grew 41 percent during the year to $36 billion.” Fourth quarter mortgage banking fees were up 31% and Credit card fees rose 18%. Average commercial loans declined year-over-year.
Countrywide Financial reported fourth quarter earnings per share up 53%. The quarterly Gain on Sale of Loans and Securities surged 128% y-o-y to $1.3 billion. Loan fundings of $102 billion were up 142%” from 2001’s fourth quarter. “The servicing portfolio topped $452 billion, an increase of $121 billion over last year.” Total Assets surged 56% y-o-y to $58 billion. During a huge fourth quarter, total assets increased almost $13 billion, or more than 110% annualized. Mortgage Loans and Mortgage-backed Securities Held for Sale doubled in three months to $15 billion. The company’s balance sheet also has a new line item - “Loans Held for Investment” – that ended the year at $6.1 billion. It is worth noting that Countrywide ended 1997 with Total Assets of $7.7 billion. Also from the earnings release: “Third-party estimates indicate total mortgage originations in the range of $1.8 - $2 trillion in 2003…”
Highlights from Bank of America’s fourth quarter: “Average consumer loans increased 19% to $196 billion. Mortgage banking income rose 23 percent… Card income was up 17 percent…” “Consumer loans grew 16 percent (during 2002), primarily in residential mortgages and credit cards. Commercial loan levels declined 12 percent…” Global Corporate and Investment Banking earnings declined 17%.
Citigroup “reported record net income of $15.28 billion for” 2002, an 8% increase over 2001. By business unit, Global Corporate and Investment Banking lost “$344 million for the fourth quarter, including a $1.3 billion after-tax charge related to the establishment of reserves for the previously announced proposed settlement with regulators…” “Full year core income of $3.02 billion [was] down 33%.” Fourth quarter (Global Corp. and Invest. Banking) revenue dropped 9%. Private Client Services fourth quarter income was down 19%, while Global Investment Management saw income increase 5% during the quarter. Proprietary Investment Activities and Corporate/Other “recorded a loss of $75 million…”
The action continues to be with the consumer. The Global Consumer (Cards, Consumer Finance, and Retail Banking) group saw “core income of $2.37 billion for the fourth quarter, up 26%... Cards, which now serves 102 million accounts in 47 countries, increased income by 30%... In North America, income grew 22%... Consumer Finance saw North America income rise 19%, with average loan growth of 11%. Retail Banking income rose 25%, with North American income up 35%. “The growth in Consumer Assets income also reflected the continued record levels of mortgage refinancings and substantial volume growth in student loans.”
JPMorgan Chase fourth-quarter Total Assets were up 9% y-o-y to $759 billion. Loans were down 1% y-o-y to $211 billion (fourth quarter Average Loans were down 3% y-o-y). Trading Assets, on the other hand, jumped 31% y-o-y to $248 billion. By Trading Asset category, Debt and Equity Instruments jumped 40% y-o-y to $165.2 billion, while Derivative Receivables were up 17% to $84.5 billion. On the liability side, we see that Deposits rose 4% y-o-y to $304.8 billion, while Commercial Paper declined 10% to $16.6 billion. Federal Funds Purchased and Securities Sold Under Repurchase Agreements surged 32% to $169.5 billion. “Trading Liabilities” were up 22% y-o-y to $133 billion.
Chase Financial Services (consumer banking) saw fourth-quarter revenues jump 16% y-o-y, with Average Managed Assets up 13% y-o-y to $188 billion. Viewing Operating Revenue by business unit, Chase Cardmember Services revenue was up 25%, Chase Home Finance 45%, Auto Finance up 16%, Chase Middle Market up 3%, and Chase Regional Banking down 7%. Or, by end of period assets, Cardmember Services up 23%, Chase Home Finance up 21%, Chase Auto Finance up 28%, Chase Regional Banking up 6%, and Middle Market unchanged.
Credit card lender MBNA Financial - The King of Steady Growth – disappointed The Street by missing earnings estimates. The company took a special provision to increase its reserve for future loan losses. Managed delinquencies increased nine basis points sequentially to 4.88%, but were down 21 basis points year-over-year. Credit Losses were up 20 basis points for the quarter and 18 basis points y-o-y. Total Managed Loans expanded at a 17% annualized rate during the fourth quarter to $107.4 billion and were up 16% for the year. Total Assets increased 16% for the year to $52.9 billion.
Credit insurer Radian group reported an unimpressive quarter, although Net Income was up 12% y-o-y. Total Debt Service Outstanding expanded 7% y-o-y to $104.8 billion. The Provision (expense) for Losses was up 27% from 2001’s fourth quarter, although this was off-set by a doubling of Equity in Net Income of Affiliates (primarily from subprime securitizer C-BASS) to $23.4 million. It is fascinating to watch the risk profile of this company rise each quarter. While the number of Prime loans insured was down 7% y-o-y (primarily due to cancelled policies), Non-prime loans insured jumped 31%. Ominously, Non-Prime Loans in Default surged 86% y-o-y. Non-prime loans delinquent jumped to 7.83% from last year’s (4th quarter) 5.54%. The lowest quality loans (“A-Minus”) saw delinquencies jump from 6.35% to 11.27%. Direct Claims paid were up 50% y-o-y to $47.5 million (up from the third quarter’s $41.2 million). Direct Claims paid have now doubled in just five quarters. Radian also ballooned its balance sheet, with Total Assets up 22% y-o-y to $5.4 billion.
Credit insurer Ambac saw earnings hurt by previously disclosed losses on National Century asset-backs. But when it comes to writing new Credit insurance, it was a huge quarter. Quoting Phillip Lassiter, Chairman and CEO: “We wrapped up the year with an extraordinary quarter of business production. All sectors evidenced vibrant business activity at attractive pricing levels. We enter the new year with significant momentum and an apparent abundance of attractive opportunities.” “Adjusted gross premiums written in the fourth quarter of 2002 were…up 54% from the fourth quarter of 2001…” Public Finance premiums were up 85% and Structured Finance premiums were up 65%. Total assets expanded 24% for the year to $15.4 billion. Net Financial Guarantees in Force (NFGIF) expanded by almost $33 billion for the quarter to $557 billion, a 25% annualized growth rate. NFGIF was up $81 billion, or 17%, for all of 2002. Ambac ended the year with Qualified Statutory Capital (Capital and Surplus, along with Contingency Reserves) of $3.7 billion for a Capital Ratio (Qual. Capital to NFGIF) of 149 to 1. Returning to our favorite flood insurance analogy, there is torrential rain falling, the river is rising rapidly, and there is near panic to acquire (and reinsure) flood protection. Apparently without a care in the world, Ambac is all too happy to sell inexpensive flood insurance to any and all takers. We are all left to fear the inevitable “100-year” flood…
January 21 – American Banker (Rob Blackwell): “Several prominent ex-regulators are set to unveil a network this week designed to maximize federal coverage of deposits at small and midsize banks and make it easier for them to compete for the accounts of businesses, municipalities, and wealthy individuals. Its creators, led by former Comptroller of the Currency Eugene Ludwig and former Federal Reserve Board Vice Chairman Alan Blinder, said their marketing pitches have been well received… In theory, at least, the Promontory Interfinancial Network offers banks an opportunity to sell certificates of deposit as large as customers want, and have them fully insured by the federal government… Here is how it works: Member banks can put their customers’ funds in CDs for up to $100,000 at another Federal Deposit Insurance Corp. insured institution. In return, the banks would expect to receive an equal amount of funds from other members. For example, a bank in California could take a CD from a customer for $300,000 and send $100,000 each to banks in New York and North Carolina. In return, the California bank would receive $200,000 from other banks on the network that were engaged in similar transactions… FDIC Chairman Don Powell said that his agency will watch the network as it develops, but he does not have any immediate concerns about it. ‘New deposits coming into the banking industry is not anything we are concerned about. It means the industry is healthy – the industry has to be funded. The deposits help economic conditions at banks who can take that money and loan it out.” “Promontory is hoping the network will take off in the coming weeks as banks learn more about it, and it has assembled an industry Who’s Who to serve as its board of directors” including a former chief of staff for both the OCC and FDIC, former Senator Warren Rudman, former FDIC chairman William Seidman, and former Fed Governor Edward Kelley Jr.
Who, might we ask, is protecting the interests of the taxpayer? It is truly amazing to watch as federal government (explicit and implied) guarantees and backing are called upon to support the vulnerable mortgage market, pension and healthcare liabilities, and bank deposits (to mention only a few of the largest obligations). Over the past five years (Wall Street-created) money market fund deposits have doubled to about $2.4 Trillion. It will now be interesting to follow developments and witness the degree to which these funds are “transformed” into insured “bank” deposits. Non-bank Credit excess works magically during the boom, but has a critical deficiency come the bust. It appears some of our leading financial authorities are hard at work developing schemes to subvert the spirit of FDIC insurance. Hide your wallet.
As the week came to its conclusion, the markets found much to worry about. Importantly, the world’s reserve currency now sinks on a daily basis. And while we believe we are witnessing a momentous inflection point in financial and economic history, it is difficult to know what this dollar decline means with respect to near-term financial fragility and systemic risk. It was clear that years of recklessly inflating specious dollar financial claims (non-productive Credit creation) were destined to end in a devaluation of dollar purchasing power. This has commenced. But does it, today, also unleash acute financial fragility? Well, something clearly has players running from the Wall Street firms, the money center banks, the Credit insurers, the GSEs, and the consumer lenders. Indeed, not since those dark days back in October have we seen such pressure on the stocks of the key Structured Finance operators. This is likely partially related to recognition of the faltering consumer debt Bubble, which would seemingly provide the final impetus for a move away from U.S. financial sector claims and other dollar-denominated assets.
As we’ve written numerous times before, “As Goes the Dollar, So Goes Structured Finance.” Or was it, “As goes Structured Finance, So Goes the Dollar.” It is almost as if the symbiotic relationship conjoining Structured Finance and the dollar has (finally) come face-to-face with An Integrity Problem. And at times – probably most times, questions of marketplace Integrity are but only an annoyance that must be ameliorated with liquidity operations and demonstrations of Federal Reserve resolve. Yet there comes that fateful day when the old tricks become The Issue – the basis for a very problematic systemic Integrity Problem. Confidence Games are Dangerous Endeavors.
January 22 – Dow Jones (John Conner): “The amount of loans outstanding under the Federal Home Loan Banks’ ‘Mortgage Partnership Finance’ program grew 68% during 2002, ending the year at $41.7 billion, up from $24.8 billion a year earlier, the Chicago FHLB said Wednesday.”
January 24 – Moody’s: “U.S. asset-backed securities (ABS) public issuance should reach $375 billion in 2003, a 6% increase over the robust total of $354 billion posted in 2002, says Moody’s Investors Service in a year-in-review and ABS outlook report… U.S. (2002) public ABS issuance…(was) up 26% over the previous record of $280 billion established in 2001, and up 63% over 2000 issuance.”
Broad money supply declined by $4.1 billion last week. Combined Demand and Checkable Deposits declined $8 billion, while Savings Deposits jumped $34.9 billion. Small Denominated Deposits declined $2.9 billion and Retail Money Fund deposits dropped $11.7 billion. Institutional Money Fund deposits dropped $23.7 billion, while Large Denominated Deposits increased $7 billion. Repurchase Agreements declined $3.8 billion, while Eurodollars added $4 billion. Elsewhere, Total Bank Credit increased $1.7 billion, with Securities holdings declining $3.3 billion. Bank Loans and Leases increased $5 billion, with Revolving Home loans and Security loans each up $3.3 billion. Commercial and Industrial loans were unchanged. Total Commercial Paper (CP) borrowings increased $5.6 billion ($24 billion in three weeks). Total financial sector issuance rose $5.8 billion ($20.3 billion in three weeks), while non-financial issuance was about unchanged. The ABS market boom continues, with about $8 billion issued this week. It was also another strong week in the corporate bond market with almost $38 billion of domestic corporate and agency issuance. Year-to-date issuance is already up to $155 billion (after only ten business days!).
A recent Moody’s downgrade did not keep Georgia-Pacific from twice raising the size of its junk bond offering from $500 million $1.5 billion. Tenet Healthcare doubled the size of its offering to $1 billion. From Bloomberg: “‘The demand in the market was overwhelming, we had nearly $2 billion in demand,’ CFO Stephen Farber said… The bank loan ‘was still in process. We decided to take the whole $1 billion from the bond market.” Dallas-based homebuilder Centex sold $300 million five year notes at a spread of 187.5 basis points. Bloomberg quoted a Centex executive: “These are the best spreads and coupons that we’ve experienced since we’ve been issuing notes. That’s for the last three years.” KB Homes sold $250 million of 7-year debt, with the CFO stating “the market was extremely attractive for the building sector for high yield companies.” GE sold $5 billion five-year notes at a spread of 112 basis points. A GE exec was quoted by Bloomberg: “We had close to $9 billion of orders from over 300 investors. We were pretty pleased…” JPMorgan Chase issued $1.75 billion of debt yesterday. One billion of 10-year notes were sold at 151 basis points over Treasuries compared to the 175 basis points paid back in November. Citigroup increased the size of its bond offering by one-third to $2 billion. There sure is a lot of liquidity. What used to work it’s magic may today be Too Much.
From today’s Financial Times (Kevin Morrison): “Managers of hedge funds have been switching from falling equity markets and taking a fresh look at commodities, pushing gold, platinum and nickel prices to highs not seen for years. Hugh Hendry, fund manager at London-based Odey Asset Management, says central banks have contributed to the increasing interest in commodities. ‘They are able to print money to keep the economy going and that money always finds its way to the fastest rising asset class. In the 1990s that was Nasdaq and now it looks like commodities.’ Metals are not the only class of commodities to benefit. Products such as cocoa, wool, soybeans, palm oil, wheat and corn have risen by between 13 per cent and almost 60 per cent since the start of last year.” The article concluded with a telling quote: “I like the prospects for wheat and corn – not that I’m an expert on the latest harvests – but then the people that bought Microsoft during the boom didn’t have to know about servers and LANs (Local Area Networks).” (“Liquidity Loves Inflation” and “The Trials and Tribulations of Speculative Finance.” – The Revival of Inflation Psychology?)
Although speculative bets in the commodity markets are now apparently becoming the trade de jour, let’s not forget that speculative infatuation with U.S. financial assets has absolutely dominated the financial landscape for several years now. Many trades will need to be unwound and leverage within dollar-denominated securities markets reduced. Considering the enormity and length of this protracted speculation, the unfolding transition period will surely be fraught with uncertainly and turmoil. Were Wall Street and the hedge funds borrowing overseas to finance their ballooning securities holdings? It is worth noting that since the beginning of 1998 (19 quarters), Securities Broker/Dealers have ballooned balance sheets 81% to $1.4 Trillion. Have the Wall Street firms partially financed their enormous holdings of U.S. securities by borrowing in Euros, Swiss francs or other low-yielding foreign currencies (“King Dollar Global Carry Trade”)? Such a strategy worked wonderfully while the euro was losing ground against King Dollar. Not today.
And are the major Wall Street firms and money center banks exposed to dollar weakness through their derivative books? After all, for some time they have enjoyed writing dollar protection (either directly or in the swaps market) with little concern for hedging King Dollar exposure. Today they worry. And how extensively had the Global Leveraged Speculating Community obtained cheap finance borrowing in previously weak euros (or shorting a sinking gold?) to finance inflating U.S. financial assets? And, did it become popular to borrow in Euros to speculate in higher-yielding Mexican or Brazilian securities? Such a strategy would have been hugely profitable for some time, but has abruptly turned quite sour. Priced in Euros, the Mexican peso is already down 7.5% this month, with the Brazilian real, Columbian peso, and Chilean peso down about 5%. The demise of King Dollar alters so many things…including relative prices, relationships, and perceptions.
There were 28,388 bankruptcy filings last week, up 1% y-o-y. The Mortgage Bankers Association’s weekly index had Refi Applications declining 6%, although remaining at an elevated level (double the year ago). Purchase Applications were down about 1% to a level about 4% below one year ago. December housing data was exceptionally strong. Housing Starts were reported at an annualized rate of 1.835 million, up 16% y-o-y. Multi-family Starts were up almost 24% from December 2001. New Building Permits jumped to a 1.88 million pace, up 13% y-o-y to the highest level since December 1986. It is also worth noting that December permits were 29% above (pre-Bubble) December 1997 and 118% above the recessionary level of December 1990. Total 2002 Starts were 7% above 2001.
There have been a couple recent articles from the Dallas Morning News worth underscoring, keeping in mind our view of greater Dallas as a “marginal” housing market to monitor closely. From “Apartment Vacancies Hit High” (Steve Brown): “Apartment vacancy rates in the Dallas-Fort Worth area have risen to a 10-year high, as building far outpaces demand… In 2002, builders completed more than 11,000 additional apartments in North Texas. But tenant demand filled a paltry 1,030. And during the fourth quarter, occupancy fell by 1,150 units.” Yet, there are 10,000 additional apartments in the development pipeline. The dearth of renters is explained by a “sluggish economy,” but also because “thousands of renters have fueled a boom in local new-home building…”
In Dallas, and likely in many markets across the country, the consequences of a multi-year housing construction boom are increasingly apparent. For one, apartment vacancies are rising, especially at the overbuilt upper-end. And, at least in Dallas, the previous boom-time seller’s market is rapidly fading into memory. I drive through an older modest neighborhood each day on my way to the office. I have watched as a few For Sale and For Rent signs last summer have turned into an alarmingly large number as we begin a New Year. It is my impression that, despite low rates and ultra-easy Credit availability, the local existing home market has hit the wall. Interestingly, however, only a dozen or so miles north into suburbia and the market for new homes remains quite strong. This is an unusual two-tiered marketplace worth contemplating.
In the past, a weakening housing market and rising inventory would rattle the nerves of local bankers; financing for new construction would quickly run dry. But this New Age housing cycle has evolved into something quite different. For one, it is dominated by large national builders with close ties to Wall Street and the mortgage-backed securities marketplace. Importantly, these builders today have unlimited access to cheap finance to pursue their aggressive growth strategies. And not dissimilar to the telecom sector during 1999, The Street, bankers, and Washington are today content to cheer along the construction boom and disregard the consequences. As we have witnessed, the weaker the economy (and more intense the financial stress) the greater the impetus for stoking the Great Mortgage Finance Bubble. Limitless Credit availability also affords the aggressive builders the decisive advantage of providing zero (“Nehemiah and the Copycats”) or minimal down-payment mortgages, along with other inducements. Along with ultra-easy financing, new home are also effortless to insure, an attribute that has taken on new significance with homeowners insurance increasingly difficult to obtain in Texas and elsewhere.
So, similar to how “zero-down, no payments until 2004” market distortions sustain strong new car sales in the face of a ballooning inventory of used cars (who wouldn’t want to buy new instead of used?), we see distortions emanating from mortgage finance excess increasingly coming at the expense of the “used” home market. From a second Dallas Morning News article – Home Foreclosures are Casualties of Economy (again by Steve Brown): “A bleak economy hit home in North Texas last year, putting thousands in danger of losing their homes. The number of homeowners threatened with foreclosure in Dallas County jumped 32 percent. And in Collin County – which has been ravaged by layoffs in the high-tech and telecom sectors – home foreclosure postings soared by 73% in 2002… January foreclosure postings for Dallas County were up 43% from January 2002. And in Collin County, foreclosure postings for the month were up a staggering 94%.” And, yet, the building boom hardly misses a beat.
One could build a case that, basically up to this point, the Mortgage Finance Bubble has worked to the interest of buyers, typical sellers and builders, alike. Perhaps this year gains for the builders come out of the hides of many distressed sellers (and their lenders and mortgage insurers!). Again, reflecting back to the telecom boom: Many prosper for some time even after the boom has passed it peak, although the “marginal” player can be devastated as new finance is no longer forthcoming from increasingly cautious lenders.
It may also be helpful to recall the late-eighties office building boom (and later bust). Even though vacancies began rising markedly and serious problems were appearing on the horizon – with it in virtually everyone’s best-interest to put a moratorium on new construction - finance just rolled into the sector and additional high-rises were added to the developing glut. Many “investors” found the sector’s above-market yields too enticing; and, besides, the returns had been quite strong for a few years! As we are witnessing today in historical proportions throughout Mortgage Finance, once the financial apparatus (and speculative infatuation) has reached a critical mass it is nearly impossible to temper. The flow of finance invariable turns to flood, and a painful bust becomes unavoidable. Indeed, it is the awe-inspiring nature of speculative markets to inundate a sector with destabilizing finance at the very late stages of the boom (The “blow-off” or “Terminal Stage of Excess”). The home-building boom is poised to run through 2003, but the cost will be high.
We are in the midst of another fascinating earnings reporting season – at least in the financial arena. Clearly, the entire financial sector continues to push consumer and Mortgage Finance to its absolute limit – pedal to the metal. Avoid commercial lending at all cost, while playing mortgage finance like there’s no tomorrow. But rampant lending excess appears to have decidedly hit the point of diminishing returns. At least one should find fourth quarter economic performance all the more alarming after confirmation that it was another truly extraordinary quarter of lending. In addition, the ominous signs of acute Credit problems afflicting the consumer sector become increasingly obvious. The ramifications for the Credit insures are becoming only more troubling. Today’s downgrades of key Structured Finance players AIG and MBIA, as well as a group of other insurance companies, should be heeded as an early warning.
January 21 – American Banker (Matthias Rieker): “UnionBanCal Corp. said its campaign to cut credit costs helped its fourth-quarter profits rise 10%. The $36 billion-asset company…has been reducing its exposure to syndicated lending and making fewer loans to companies that are not already customers… To offset the shrinking of its commercial portfolio and falling loan spreads, the parent of Union Bank of California actively marketed residential mortgages, taking advantage of the home finance boom… For the three months, commercial and industrial loans fell 10.23%… commercial mortgages rose 17.41%…and residential mortgages rose 31.85%…”
Golden West Financial expanded assets at an 18% annualized rate during the quarter (17% for 2002). At Washington Mutual, assets expanded at a 9% pace (11% for 2002). Wells Fargo saw Total Assets expand at an 18% rate during the fourth quarter to $349 billion (up 14% for the year). “The home finance businesses saw exceptional growth in 2002, with total originations of $333 billion surpassing our 2001 industry record of $202 billion… Our owned servicing portfolio grew 26 percent during 2002 to $535 billion and our home equity portfolio grew 41 percent during the year to $36 billion.” Fourth quarter mortgage banking fees were up 31% and Credit card fees rose 18%. Average commercial loans declined year-over-year.
Countrywide Financial reported fourth quarter earnings per share up 53%. The quarterly Gain on Sale of Loans and Securities surged 128% y-o-y to $1.3 billion. Loan fundings of $102 billion were up 142%” from 2001’s fourth quarter. “The servicing portfolio topped $452 billion, an increase of $121 billion over last year.” Total Assets surged 56% y-o-y to $58 billion. During a huge fourth quarter, total assets increased almost $13 billion, or more than 110% annualized. Mortgage Loans and Mortgage-backed Securities Held for Sale doubled in three months to $15 billion. The company’s balance sheet also has a new line item - “Loans Held for Investment” – that ended the year at $6.1 billion. It is worth noting that Countrywide ended 1997 with Total Assets of $7.7 billion. Also from the earnings release: “Third-party estimates indicate total mortgage originations in the range of $1.8 - $2 trillion in 2003…”
Highlights from Bank of America’s fourth quarter: “Average consumer loans increased 19% to $196 billion. Mortgage banking income rose 23 percent… Card income was up 17 percent…” “Consumer loans grew 16 percent (during 2002), primarily in residential mortgages and credit cards. Commercial loan levels declined 12 percent…” Global Corporate and Investment Banking earnings declined 17%.
Citigroup “reported record net income of $15.28 billion for” 2002, an 8% increase over 2001. By business unit, Global Corporate and Investment Banking lost “$344 million for the fourth quarter, including a $1.3 billion after-tax charge related to the establishment of reserves for the previously announced proposed settlement with regulators…” “Full year core income of $3.02 billion [was] down 33%.” Fourth quarter (Global Corp. and Invest. Banking) revenue dropped 9%. Private Client Services fourth quarter income was down 19%, while Global Investment Management saw income increase 5% during the quarter. Proprietary Investment Activities and Corporate/Other “recorded a loss of $75 million…”
The action continues to be with the consumer. The Global Consumer (Cards, Consumer Finance, and Retail Banking) group saw “core income of $2.37 billion for the fourth quarter, up 26%... Cards, which now serves 102 million accounts in 47 countries, increased income by 30%... In North America, income grew 22%... Consumer Finance saw North America income rise 19%, with average loan growth of 11%. Retail Banking income rose 25%, with North American income up 35%. “The growth in Consumer Assets income also reflected the continued record levels of mortgage refinancings and substantial volume growth in student loans.”
JPMorgan Chase fourth-quarter Total Assets were up 9% y-o-y to $759 billion. Loans were down 1% y-o-y to $211 billion (fourth quarter Average Loans were down 3% y-o-y). Trading Assets, on the other hand, jumped 31% y-o-y to $248 billion. By Trading Asset category, Debt and Equity Instruments jumped 40% y-o-y to $165.2 billion, while Derivative Receivables were up 17% to $84.5 billion. On the liability side, we see that Deposits rose 4% y-o-y to $304.8 billion, while Commercial Paper declined 10% to $16.6 billion. Federal Funds Purchased and Securities Sold Under Repurchase Agreements surged 32% to $169.5 billion. “Trading Liabilities” were up 22% y-o-y to $133 billion.
Chase Financial Services (consumer banking) saw fourth-quarter revenues jump 16% y-o-y, with Average Managed Assets up 13% y-o-y to $188 billion. Viewing Operating Revenue by business unit, Chase Cardmember Services revenue was up 25%, Chase Home Finance 45%, Auto Finance up 16%, Chase Middle Market up 3%, and Chase Regional Banking down 7%. Or, by end of period assets, Cardmember Services up 23%, Chase Home Finance up 21%, Chase Auto Finance up 28%, Chase Regional Banking up 6%, and Middle Market unchanged.
Credit card lender MBNA Financial - The King of Steady Growth – disappointed The Street by missing earnings estimates. The company took a special provision to increase its reserve for future loan losses. Managed delinquencies increased nine basis points sequentially to 4.88%, but were down 21 basis points year-over-year. Credit Losses were up 20 basis points for the quarter and 18 basis points y-o-y. Total Managed Loans expanded at a 17% annualized rate during the fourth quarter to $107.4 billion and were up 16% for the year. Total Assets increased 16% for the year to $52.9 billion.
Credit insurer Radian group reported an unimpressive quarter, although Net Income was up 12% y-o-y. Total Debt Service Outstanding expanded 7% y-o-y to $104.8 billion. The Provision (expense) for Losses was up 27% from 2001’s fourth quarter, although this was off-set by a doubling of Equity in Net Income of Affiliates (primarily from subprime securitizer C-BASS) to $23.4 million. It is fascinating to watch the risk profile of this company rise each quarter. While the number of Prime loans insured was down 7% y-o-y (primarily due to cancelled policies), Non-prime loans insured jumped 31%. Ominously, Non-Prime Loans in Default surged 86% y-o-y. Non-prime loans delinquent jumped to 7.83% from last year’s (4th quarter) 5.54%. The lowest quality loans (“A-Minus”) saw delinquencies jump from 6.35% to 11.27%. Direct Claims paid were up 50% y-o-y to $47.5 million (up from the third quarter’s $41.2 million). Direct Claims paid have now doubled in just five quarters. Radian also ballooned its balance sheet, with Total Assets up 22% y-o-y to $5.4 billion.
Credit insurer Ambac saw earnings hurt by previously disclosed losses on National Century asset-backs. But when it comes to writing new Credit insurance, it was a huge quarter. Quoting Phillip Lassiter, Chairman and CEO: “We wrapped up the year with an extraordinary quarter of business production. All sectors evidenced vibrant business activity at attractive pricing levels. We enter the new year with significant momentum and an apparent abundance of attractive opportunities.” “Adjusted gross premiums written in the fourth quarter of 2002 were…up 54% from the fourth quarter of 2001…” Public Finance premiums were up 85% and Structured Finance premiums were up 65%. Total assets expanded 24% for the year to $15.4 billion. Net Financial Guarantees in Force (NFGIF) expanded by almost $33 billion for the quarter to $557 billion, a 25% annualized growth rate. NFGIF was up $81 billion, or 17%, for all of 2002. Ambac ended the year with Qualified Statutory Capital (Capital and Surplus, along with Contingency Reserves) of $3.7 billion for a Capital Ratio (Qual. Capital to NFGIF) of 149 to 1. Returning to our favorite flood insurance analogy, there is torrential rain falling, the river is rising rapidly, and there is near panic to acquire (and reinsure) flood protection. Apparently without a care in the world, Ambac is all too happy to sell inexpensive flood insurance to any and all takers. We are all left to fear the inevitable “100-year” flood…
January 21 – American Banker (Rob Blackwell): “Several prominent ex-regulators are set to unveil a network this week designed to maximize federal coverage of deposits at small and midsize banks and make it easier for them to compete for the accounts of businesses, municipalities, and wealthy individuals. Its creators, led by former Comptroller of the Currency Eugene Ludwig and former Federal Reserve Board Vice Chairman Alan Blinder, said their marketing pitches have been well received… In theory, at least, the Promontory Interfinancial Network offers banks an opportunity to sell certificates of deposit as large as customers want, and have them fully insured by the federal government… Here is how it works: Member banks can put their customers’ funds in CDs for up to $100,000 at another Federal Deposit Insurance Corp. insured institution. In return, the banks would expect to receive an equal amount of funds from other members. For example, a bank in California could take a CD from a customer for $300,000 and send $100,000 each to banks in New York and North Carolina. In return, the California bank would receive $200,000 from other banks on the network that were engaged in similar transactions… FDIC Chairman Don Powell said that his agency will watch the network as it develops, but he does not have any immediate concerns about it. ‘New deposits coming into the banking industry is not anything we are concerned about. It means the industry is healthy – the industry has to be funded. The deposits help economic conditions at banks who can take that money and loan it out.” “Promontory is hoping the network will take off in the coming weeks as banks learn more about it, and it has assembled an industry Who’s Who to serve as its board of directors” including a former chief of staff for both the OCC and FDIC, former Senator Warren Rudman, former FDIC chairman William Seidman, and former Fed Governor Edward Kelley Jr.
Who, might we ask, is protecting the interests of the taxpayer? It is truly amazing to watch as federal government (explicit and implied) guarantees and backing are called upon to support the vulnerable mortgage market, pension and healthcare liabilities, and bank deposits (to mention only a few of the largest obligations). Over the past five years (Wall Street-created) money market fund deposits have doubled to about $2.4 Trillion. It will now be interesting to follow developments and witness the degree to which these funds are “transformed” into insured “bank” deposits. Non-bank Credit excess works magically during the boom, but has a critical deficiency come the bust. It appears some of our leading financial authorities are hard at work developing schemes to subvert the spirit of FDIC insurance. Hide your wallet.
As the week came to its conclusion, the markets found much to worry about. Importantly, the world’s reserve currency now sinks on a daily basis. And while we believe we are witnessing a momentous inflection point in financial and economic history, it is difficult to know what this dollar decline means with respect to near-term financial fragility and systemic risk. It was clear that years of recklessly inflating specious dollar financial claims (non-productive Credit creation) were destined to end in a devaluation of dollar purchasing power. This has commenced. But does it, today, also unleash acute financial fragility? Well, something clearly has players running from the Wall Street firms, the money center banks, the Credit insurers, the GSEs, and the consumer lenders. Indeed, not since those dark days back in October have we seen such pressure on the stocks of the key Structured Finance operators. This is likely partially related to recognition of the faltering consumer debt Bubble, which would seemingly provide the final impetus for a move away from U.S. financial sector claims and other dollar-denominated assets.
As we’ve written numerous times before, “As Goes the Dollar, So Goes Structured Finance.” Or was it, “As goes Structured Finance, So Goes the Dollar.” It is almost as if the symbiotic relationship conjoining Structured Finance and the dollar has (finally) come face-to-face with An Integrity Problem. And at times – probably most times, questions of marketplace Integrity are but only an annoyance that must be ameliorated with liquidity operations and demonstrations of Federal Reserve resolve. Yet there comes that fateful day when the old tricks become The Issue – the basis for a very problematic systemic Integrity Problem. Confidence Games are Dangerous Endeavors.
