The theme du jour, at least in the world of Dow Jones, is the sorry condition of the financial services industry. While the basic thrust is nothing new, some of the data point are revealing.
The Journal’s Heard on the Street column tells us that banks like Citigroup and HSBC are likely to sell business units next year, This is no surprise, but the article suggests that a lot of sales will come in the first half of next year. Presumably, the logic is that the markets will be somewhat less punitive about writedowns if the firms show they have ways to plug the leaks in their balance sheets. And in a deteriorating environment, it’s better to sell early before valuations get even worse. However, in an environment with a lot of merchandise on offer and strategic buyers sidelined by their own capital structure woes, that strategy may backfire.
From the story:
Why do we think a bottom is not yet nigh? Six analysts rate Citigroup a sell, eight a hold, and nine a buy. Analyst ratings are a lagging indicator. One study ascertained that the best time to buy a stock is when virtually all the analysts have a sell rating on it.
More interestingly, the Journal also reports that investment banks are cutting back on lending to hedge funds. Things are bad when you can’t give top notch service to your best clients. From the story:
Investment banks are cutting back on loans to hedge funds, eliminating some clients and raising borrowing fees for others.
The lenders are slimming their balance sheets after heavy losses in the debt markets in recent months. And, after taking multibillion-dollar write-downs, they also are becoming more cautious as the economy slows, according to people familiar with the situation.
“Banks aren’t in a position to be accommodating at the moment,” said Michael Hintze, chief executive of CQS, a London-based hedge fund with $9 billion under management.
If the change continues, it could put some pressure on the profits of the prime-brokerage units of the major banks, which make big money by lending to hedge funds, as well as helping the funds manage their cash and short stocks by borrowing and selling shares as a bet on falling prices.
The move also could put pressure on the returns of some hedge funds, which often rely on healthy doses of borrowed money, or leverage, to boost their returns.
“Leverage definitely drives returns,” says David Gold, an executive at Watson Wyatt Worldwide, which works with corporate pension plans on their hedge-fund investments.
In particular, Mr. Gold says quantitative funds — those that trade using certain computer models — are seeing their borrowing ability reduced, on the heels of the uneven performance of some funds this year. He says the move by the banks will have the biggest impact on smaller hedge funds.
“Groups like Morgan Stanley and Goldman Sachs will feed more leverage to their bigger, better clients,” Mr. Gold says…..
Prime brokers like Morgan Stanley, which has one of the largest businesses catering to hedge funds, have made repurchase agreements so expensive that some funds are going to rival firms to borrow money, according to people familiar with the matter…
Morgan Stanley isn’t alone in making lending rates more expensive for funds. Merrill Lynch & Co. also has been increasing its rates, a person familiar with the matter said.
This development has the potential to have interesting side effects. First, hedge funds have been a significant source of credit (they are the protection writers for over 35% of credit default swaps, and also have been active buyers of debt issues). Less lending to them will mean less credit market investment, which it turn will affect new issue pricing Second, scarcer and more costly credit will make the role of leverage in hedge fund returns more apparent, and will lead to underwhelming results at many firms.
Finally, MarketWatch tells us to expect more business bankruptcies next year. Corporate debt has been one of the few areas relatively unscathed in the credit markets. That is about to change. Note that the article focuses on public companies. Smaller, private firms are likely to show a more dramatic increase:
Market analysts warn that more U.S. businesses are likely to hang “going bankrupt” signs on their doors next year as the twinned blows of slower economic growth and pricey commodities force the weakest companies to seek refuge from creditors.
In a twist from this year’s trends, the pain is likely to spread from mortgage lenders, homebuilders and consumer-oriented firms – all areas that contributed to a 40% jump in bankruptcy filings in 2007 and are expected to play a role in 2008’s misery.
Next year, industries at risk for the biggest increases in Chapter 11 filings include electronics makers, energy miners like coal companies and agriculture firms, according to Global Insight.
Makers of durable goods like machinery are also more at risk and will likely contribute to a 13% rise in bankruptcies in 2008, says the private research firm, which bases its estimates on issuers’ credit quality and operating conditions….
On the macro front, new bankruptcy risk to makers of such goods as electronics and heavy equipment comes from an expected slowdown, or even recession, in the United States next year. For raw materials producers, say metals makers, that slowdown risk is combined with supply competition from new industrial juggernaut China.
Meanwhile rising raw material prices, from fuel to metals to grains, have raised cost pressures for makers of equipment and even some high-flying commodities producers.
“Outside of oil, whatever the ability there is to raise prices, the fact is that input prices are going up at a similar rate,” said Killion….
Meanwhile, analysts anticipate more companies in industries linked to housing will file for bankruptcy or follow the increasingly popular course of opting to sell their assets to a restructuring firm and then declare themselves out of business.
“Homebuilders will continue to be on the edge,” predicted Reginald Jackson, president of the American Bankruptcy Institute and a bankruptcy attorney at Vorys, Sater, Seymour and Pease LLP in Columbus, Ohio…..
Foreshadowing of more pain is playing out in the bond market, where ratings agencies are slashing credit outlooks to levels where, historically, the risk of default has been high.
Standard & Poor’s counted consumer products as the global sector with the highest risk of a defaulting on their credits, followed by retail/restaurants, and media and entertainment. Most of these are in the United States. Forest products, fourth on the list, had the most defaults in the United States during the 12 months until November.
Companies in these sectors have more ratings of B- or lower as well as credit watch negative or negative outlooks assigned by Standard & Poor’s.
“We think of those companies as being on a slippery slope with the potential to go into default,” said Diane Vazza, head of global fixed income research at Standard & Poor’s.
In general, default rates for riskiest borrowers are expected to rise. Standard & Poor’s estimates 56 speculative debt issuers will default in the next 12 months, a rate of 3.4% compared with less than 1% this year. The term “speculative” refers to the riskier borrowers whose debt falls below investment grade and is often called junk.
Moody’s Investors Service, for its part, anticipates the default rate to rise to 4.7% over the next 12 months.
