Wall Street fell sharply again Thursday after a French bank said it was freezing three funds that invested in U.S. subprime mortgages because it was unable to properly value their assets. . . .
A move by the European Central Bank to provide more cash to money markets intensified Wall Street's angst. Although the bank's loan of more than $130 billion in overnight funds to banks at a low rate of 4 percent was intended to calm investors, Wall Street saw it as confirmation of the credit markets' problems. It was the ECB's biggest injection ever [according to CNBC reporters, twice as big as after 9/11].
The Federal Reserve added a larger-than-normal $24 billion in temporary reserves to the U.S. banking system.
The ECB's injection of money into the system is an unprecedented move, said Joseph V. Battipaglia, chief investment officer at Ryan Beck & Co., adding that it shows that problems in subprime lending are, in fact, spilling into the general economy.
"This is a mini-panic," he said. "All the things that had been denied up until this point are unraveling. On top of this, retail sales were mediocre, which shows that indeed, the housing collapse is affecting the consumer."
BNP Paribas Freezes Security Funds
A major French bank, BNP Paribas, announced Thursday that it was suspending three of its asset-backed securities funds, saying it could no longer value them accurately because of problems in the U.S. subprime mortgage market. . . .
The bank, France's largest bank by market value, said it was suspending three funds worth a total of 2 billion euros ($2.75 billion): Parvest Dynamic ABS, BNP Paribas ABS Euribor and BNP Paribas ABS Eonia. All funds combined at BNP Paribas Investment Partners are worth more than 350 billion euros ($482.79 billion).
"The complete evaporation of liquidity in certain market segments of the U.S. securitization market has made it impossible to value certain assets fairly regardless of their quality or credit rating," BNP Paribas SA said in a statement.
"The situation is such that it is no longer possible to value fairly the underlying U.S. ABS assets in the three above-mentioned funds" and "therefore unable to calculate a reliable net asset value, NAV, for the funds," the company said. . . .
This week WestLB Mellon Asset Management, the asset management joint venture of German state bank WestLB AG and The Bank of New York Mellon Corp., suspended redemptions from its asset-backed securities ABS Fund, which is part of the West LB Mellon Compass Fund.
WestLB AG denied speculation on Thursday that it is facing a fund liquidity problem.
Other companies, including Union Investment Asset Management, a German mutual fund manager, and Frankfurt Trust, a unit of BHF-Bank, have also halted redemptions.
ECB Moves to Add Liquidity to Market
The European Central Bank loaned nearly 95 billion euros ($130.81 billion) in overnight funds to banks at a bargain rate of 4 percent on Thursday, putting more cash into a global financial system jolted by the collapse of the U.S. subprime mortgage market.
Analysts and economists were surprised by the move, with some seeing it as evidence that the problems in subprime lending are spilling into the general economy and others as a case of the European Central Bank stepping in where the U.S. Federal Reserve Bank has not. . . .
"Today's events show that either the Fed committed a large policy error on Tuesday, or that both the Fed and the ECB are themselves more in the dark on the problems that lie underneath the surface than are investors in the financial markets," Tony Crescenzi of Miller Tabak said in a research note.
"While the Fed and the ECB may not have the providence to see all problems that exist, it should at the very least have a greater sense about conditions in the markets it controls — the money market and the credit markets more generally — and of conditions in the banking system."
The Fed met Tuesday to discuss monetary policy and announced after the meeting that inflation, not credit problems, remained its major concern.
Mortgage delinquencies, defaults spreading: AIG
'PANIC MODE'
"The market's in a panic mode because the subprime crisis is spreading into other areas of the economy," said Bill Hackney, a managing partner of Atlanta Capital Management. . . .
'WHISTLING IN THE DARK'
"Problems in July have gone beyond the subprime market," said Bill Bergman, an analyst with Morningstar. "Maybe not AIG, but some of these lenders have been whistling in the dark."
Expressing a different view a few days ago, Ben Stein argued against any significant spread in the “subprime mess.” I found most of his arguments unpersuasive (including his assertion that US subprime woes had “no connection” to other developed or developing stock markets).
But Stein made one excellent point:
Ben Stein: "How Not to Ruin Your Life"
What about the supposed drying up of loans for mergers and acquisitions by private equity firms? Well, here's a good, simple test of just how valid that explanation is for stock market moves: The majority of private equity takeovers are financed with junk debt.
If there really were a major shortage of funds for these deals, the interest rate on the junk would skyrocket. Instead, while the rate has risen by about 150 basis points in the past month, the spread between junk and investment grade is now about 290 basis points, according to leading junk analyst Martin Fridson.
This is a lot lower than the year-end average of the spread from 2002 to 2006, and far below the almost 800 basis point spread during a true interest-rate crunch like the one after the tech meltdown in 2000-2002.
So that's phony, too. Interest rates have risen, but not anything like what they've done in real crises.
(a) The big buyouts are now financed less by junk bonds than they are by leveraged/syndicated loans; high-yield debt makes up a much smaller percentage of the debt used to fund buyouts than it did historically. There's been a great deal of talk about this in the financial press - it's not a secret.
(b) The rise of so-called "covenant lite" loans and PIK toggle notes have been the first to go, rather than jumping straight to interest rates. Covenant lite refers to bank/syndicated loans with bond-like covenants (i.e. very borrower/PE friendly), and PIK toggle notes are ones that let the borrower defer paying interest payments by granting equity interests at their option.
Both of these features are quickly drying up. Banks/lenders/borrowers/etc are all trying to keep interest rates steady while negotiating these covenants. Remember, any rational person might, in lieu of taking a higher interest rate, take some accession on the covenants/terms first. Ben Stein's theory assumes that the only feature worth looking at is the interest rate. Before I saw this stuff first hand, I would have agreed with his analysis. Interest rates will rise when the "frothy" nature of covenants and bond terms come back down to historical levels.
I can't by any means predict when that will be (or if it will even happen) but I can tell you that looking at interest rates on HY/junk debt alone as a barometer for buyouts is insufficient. Another explanation could also just be that the markets aren't reacting so smoothly just yet. I saw in the WSJ that something like 46 bond offerings have been shelved or given up on in the last few months, compared to zero last year. They could be trying to get the deals done at higher interest rates, but those same PE shops are unwilling to take those deals yet and instead are forcing the banks into funding the bridge loans under their existing commitment papers - they are a better deal for the big PE shops than 15% bonds.
Interesting points. Thanks.
Stein can say whatever he wants. The fact of the matter is that deals are not closing. That suggests that credit terms are becoming onerous. Credit is always available at some price. The question is when will the price go so high as to prevent low value but highly leveraged investments by rational people?
There just isn't that much sub-prime paper; unfortunately people whose fingers have been deep in CDOs are making a lot of noise. Their desperation seems to be contagious.
Another thing to consider is the commitments that are already out there - typically commitment letters are signed up about 3 to 6 months in advance (sometimes more). The letters signed 8 weeks ago are stil VERY borrower-friendly, including no Market MAC (a lender out for material adverse changes in the syndicated loan market). There really have been no Market MAC clauses for at least the last year - so banks will either have to fund their commitments or they will be in breach of contract (and more importantly, will be trashing their brand). So if the banks fund but cannot syndicate (or can only do so at a loss) then they will either incur huge costs or will be stuck with a ton of paper they never wanted to hold. Think about it this way - the banks are committed to buy paper at a certain price, with maybe a little allowance for price flex to achieve a successful syndication, but the market says that the rate on that debt should be significantly higher, so the bank is stuck holding or selling at a loss, so even though there is $$ out there, it cannot be usefully accessed.
So now the banks (ie loan originators) are stuck holding and/or selling at a discount - how keen are they going to be to commit to new financings, even ones now negotiated on much better terms (better outs, higher flex, more financial covenants) - they have to live within the capital adequacy rules, and if their cash is tied up they CANNOT commit to financings, which basically leaves best-efforts deals. Should be fun times.