Posted on 01/15/2009 3:02:01 PM PST by gpk9
NEW YORK (AP) -- Shares of major U.S. banks plunged Thursday as the government mulled giving Bank of America Corp. a fresh multibillion-dollar aid package, raising fears on Wall Street that the battered financial sector may need an even bigger bailout.
Bank of America shares fell as much as 28 percent -- dropping to their lowest level in 18 years -- on news that the bank may seek another capital injection to manage losses from its takeover of Merrill Lynch. Citigroup Inc. shares fell to a near 16-year low as investors braced for horrible fourth-quarter earnings due Friday. And JPMorgan Chase & Co. added to the pessimism with a grim earnings outlook. Shares of all three banks came off their lows later in the day as part of a broad market turnaround.
Still, the carnage fanned investor fears that mounting bank losses and a darkening economic outlook are thwarting government efforts to resuscitate the banking sector. It raised the distinct possibility that the largest financial rescue package in history may swell even further.
"The perception on Wall Street is that things are getting worse and that the banks are bearing the brunt," said Jack A. Ablin, chief investment officer at Harris Private Bank in Chicago.
[snip]
(Excerpt) Read more at finance.yahoo.com ...
Minneapolis Star Tribune files for Chapter 11 bankruptcy
Star Tribune | 1/15/09
Posted on 01/15/2009 6:11:33 PM PST by LdSentinal
http://www.freerepublic.com/focus/f-news/2165471/posts
Either we can let them fail now - or we can give them a few billion more and let them fail later...
Nice post - what amazes me is that the banks are still not lending to even qualified businesses and consumers - that has got to change or the high job loss numbers are going to continue. Frankly what pisses me off most is some of these squirly mortgage brokers and loan originators from banks knew full well these mortgages were going to be trouble. That each state AG isn’t getting ready to file criminal suites blows me away. I know guys that made huge $s pushing crappy paper and they’re going to skate.
Oh and B of A took over Merrill at the Fed's request, the weekend that Lehman went down, to keep it from spreading. Its spreading anyway, and the Fed and treasury are barely supporting their own agents and seconds.
They aren't going to lend more until it pays to do so. You can't be against bankers making a buck and demand they lend. They only do the second in order to do the first, and only if it does. "But I'm in favor of bankers making a buck". Ok, then people have to actually pay them back instead of welshing and walking. And if they won't in their capacity as borrowers, they will in their capacity as taxpayers.
Capital is paid for in full or it evaporates completely.
banks make money off of
a) Deposit interest - which include retail and commercial deposits (typically required of those who they also lend to)
b) Loan interest
c) Fee income - overdrafts, checks, etc
d) Ancillary product sales/commissions like insurance, annuities, securities, etc.
e) Investment income/portfolio returns
Without customers they get no a, b, c or d and hence little e
A bank’s business model is built on lending.
They are paid not only loan interest but also loan principle. Letting debts run off means receiving loan principle back, not merely interest. It builds liquidity, and loan principle fully repaid cancels liabilities while realizing assets at full par value. In today's rate environment, it can also be reinvested extremely profitably.
Banks and other financial firms can invest in existing securities purchased at steep discounts and high interest rates, without making net new loans. This is easy because other holders of debts that involve any credit risk are selling hand over fist, scrambling to get into either treasuries or bank deposits, the latter to exploit their FDIC guarantee.
Thus, right now banks can meet their liquidity needs and increase their income simply by letting their debtors repay them on schedule, and parking the proceeds in existing distressed securities. This will be much more profitable in the medium term than forcing loans onto reluctant overstrapped deadbeats in response to some nonsensical government mandate.
Corporate bonds pay 9%, bank deposits cost them 2%. Spreads that wide make for healthy banking. Consumer loans at 5% with loan losses at record levels, are not nearly as attractive.
The simple truth is that unless the better corporate credits are all willingly "bid" by others to low rate spreads, there is no great reason for banks to lend to joe deadbeat.
Jason:
1) Do you really work for a financial institution?
2) Are you aware of certain economic factors right now - like rising unemployment, reduced spending, etc.
Sure they’re are a number of consumers and businesses who should pay their loans off - that is typically the goal. However, to restrict lending (which includes renewals) will actually dramatically increase non-performing assets which raises big red flags with bank investors and with the regulators. Also when liquidity is tight corporate bond rates will go down not up.
Great Line!!! Methinks that Hitler saw it that way too!(thought just crossed mind...no aspersions cast!) Simply, a great line. In the good old days banks never lost money! May be awhile before we get back to 'the good old days', won't it! oh, and Gerard, the list of fees is much longer than yours! The old First Union had the epitome of fees lists! Prolly what drove Wacovia out of business in the end! (full disclosure...don't own any bank stocks, but sometimes dabble for short periods in XLF).
The level of ignorance in that statement is hard to fathom.
Corporate bond rates are at epic high levels precisely because liquidity is tight. There is very little capital willing to take the risk of lending to corporations, compared to the huge pool of it willing to lend to the government, or government insured assets. That is the same as saying the spread between BBB corporates and treasuries is extremely wide.
Anyone who nevertheless lends to corporates is betting that the spread cannot stay so wide forever, and will be rewarded by a large appreciation in the value of his capital if he is right and spreads narrow. Spreads narrowing do not cost him money. They get capitalized into the price of his existing bond commitments. Buy a 10 year, 8% coupon bond at 77 to yield 12%, and if the yield falls to 9, the price will increase 20% or so to 93 and change.
When liquidity gets more abundant and people are willing to run credit risks again, that will happen. Anyone who buys corporates at the present epic spreads will get paid both the higher interest they offer, and that price pop as spreads return to sustainable levels. Minus, to be sure, some cost in defaults and credit losses in the meantime, but those aren't even going to reach the level of the rate differences.
Until rate spreads narrow again, there is no reason for banks to force capital into the hands of lower quality borrowers at authority-set low rates.
The only reason they have positions in the low rate, higher credit quality asset classes at all, right now, is they have smaller capital requirements under Basel II, and therefore they can carry their full asset size with less equity. Since they are undercapitalized, they are forced to do that by stupid regulations, which only recognize credit risk and not price risk. As they get recapitalized, they will increase the portion of the supposedly "riskier" asset classes, which in fact are the only paying ones right now and objectively lower risk.
A treasury paying 2.5% is in every real economic respect a riskier loan than an investment grade corporate paying 10%. But the regulations are too stupid to notice this, and banks are only legally entitled to act on it if they have more capital to hold as "reserve" against the supposedly greater risk of (credit) losses on the second. That is will inevitably give a higher total return, the regs simply do not acknowledge. They are written as though market prices are infallible, and this is far from true.
Undercapitalized banks mean irrational allocation of capital to comply with irrational regulations. That spells opportunity for everyone not restricted by those regs, to buy the higher return items they are limited in holding. The banks themselves know this, and seek to increase their liquidity and capital to be allowed to move to where they know the retutns are. The way to do that is to force a cash flow in their own direction by letting consumer loans and mortgages run off, and using the improved capital position that gives them, to shift into earning corporates instead.
That takes time and the authorities are pushing the other way by bidding up treasury and mortgage security prices, while sticking corporates with losses wherever they can. But they are whistling dixie. If they want a functioning banking system, they have to let rate spreads return to reality, and the reality is US corporations are vastly more creditworthy than your average overleveraged deadbeat homeowner.
Jason:
Nice post. However, let’s look at the following and point out to me why liquidity does not adversely affect corporate bond yields (please know I am not talking about junk bonds here)
1) Let’s first look at the correlation between liquidity and credit risks:
Liquidity risk refers to the chance that an entity will have insufficient cash flow to meet its obligations. This can be caused by the undesirability of an asset in the marketplace, such as a company’s products or fixed assets set for liquidation. It can also be caused by a slowing economy, longer Acct Receivable rates, etc.
Credit risk is the risk of loss due to non-payment of debts owed by an entity. So Credit risk may be compounded by liquidity risk.
2) We have to now assess where we really at in our economy. Are we still going further into recession, are we in process of taking steps to grow out of it, or are we already on the path to getting out of a recession. I pick the middle option.
So let’s now look at a portion of a key position paper from a widely regarded financial analyst named David Harper:
How Changes In The Credit Spread Affect The Bondholder
Predicting changes in a credit spread is difficult because it depends on both the specific corporate issuer and overall bond market conditions. For example, a credit upgrade on a specific corporate bond, say from S&P BBB to A, will narrow the credit spread for that particular bond because the risk of default lessens. If interest rates are unchanged, the total yield on this “upgraded” bond will go down in an amount equal to the narrowing spread, and the price will increase accordingly.
After purchasing a corporate bond, the bondholder will benefit from declining interest rates and from a narrowing of the credit spread, which contributes to a lessening yield to maturity of newly issued bonds. This in turn drives up the price of the bondholder’s corporate bond. On the other hand, rising interest rates and a widening of the credit spread work against the bondholder by causing a higher yield to maturity and a lower bond price. So, because narrowing spreads offer less ongoing yield and because any widening of the spread will hurt the price of the bond, investors should be wary of bonds with abnormally narrow credit spreads. Conversely, if the risk is acceptable, corporate bonds with high credit spreads offer the prospect of a narrowing spread, which, in turn, will create price appreciation.
But interest rates and credit spreads can move independently. In terms of business cycles, a slowing economy tends to widen credit spreads as companies are more likely to default, and an economy emerging from a recession tends to narrow the spread as companies are theoretically less likely to default in a growing economy. However, in an economy that is growing out of a recession, there is also a possibility for higher interest rates, which would cause Treasury yields to increase. This is a factor that offsets the narrowing credit spread, so the effects of a growing economy could produce either higher or lower total yields on corporate bonds.
Conclusion
If the extra yield is affordable from a risk perspective, the corporate bond investor is concerned with future interest rates and the credit spread. Like other bondholders, he or she is generally hoping that interest rates hold steady or, even better, decline. Additionally, he or she generally hopes that the credit spread either remains constant or narrows but does not widen too much. Because the width of the credit spread is a major determiner of your bond’s price, make sure you evaluate whether the spread is too narrow, but also make sure you evaluate the credit risk of companies with wide credit spreads.
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