Cut To The Chase

The Great Game said...
Hi Dali, Have been a silent reader of your blog for some time, and I found it to be highly educational for a novice like me. Just to share my 2 cents on this subprime crisis. Although subprime only constitutes a relative small % of total mortgage market, the rippling effect to other credit markets (or the investor confidence in strucutred finance), e.g. the leveraged loans is unquantifiable, & has been grossly underestimated by many. The financial institutions are trading at such low multiples mainly due to the huge leveraged loan (those funky 'covenant-lite' notes) that they warehoused for the buyout house especially for the notoriouly tough negotiator like KKR.

In particular, I think Bear Stearns and Lehman would be hit the worst, given their lack of balance sheet strength and hence high % of leveraged loan to market cap, vs the like of Citi & JP Morgan. If the credit market deteriorates, some of the early LBO transaction commensurated might even folded. Let alone the constraints on capex spending (which further impending growth), massive layoff to meet the rising interest cost might even be plausible. Thus, the current healthy corporate performance is not going to last for too long (even less than 24 months). This might transpire to be even worse than the collapse of the junk bond market in the 80s.

In the worst case scenario, the liquidity would soon be drying up due to the self-perpetatuing investor confidence crisis when every hedge fund is being forced sale to meet the margin call, which results in further decline in asset value and further forced sale. Coupled with the intrisicaly linked global financial market (mainly via CDS) we have today , the result would be truly disatrous.

What I have found interesting is that nobody has highlighted the conflicting role of the rating agencies (the big 3, S&P, Moody and Fitch) play in this crisis. Being highly profitable, structured finance (both advising and evaluating) has been a bonanza for them in the past few years.

Dali: great game,

thats one of the best postings fm a reader... thanks ... you made a few great points which I wish to elaborate here ...u r right in that Bear Stearns and Lehman might be in deeper waters, that's the consequences of being in the second tier in investment banking rankings... the top ones such as Goldman, Citigroup, Merrill, JP are more well diversified, more international in their revenue base, and may not have a similar proportion of exposure to CDOs...the second tier houses, to boost revenues may have to be more aggressive in CDOs as they cannot match the top tier in IPOs and top tier advisory work in LBOs, private equity, restructurings etc...

the other point to make is that many investment banks do not have a big exposure to CDOs because these have been packaged and sold to funds and other institutions ... unlike LTCM debacle where the big houses are left holding the bag, hence the "rescue", the fat pigs do sleep with the fat cats...
where these CDOs end up is what's critical here .. a lot went to hedge funds and private institutions and/ or corporate funds vehicles... some asian banks are hit as well esp if they have US bases such as HSBC, but they have come clean fast and cleared the rubble before anyone could say "hey, what was that" (10/10 for managing a potential disaster) ... DBS was also hit a bit bad comparatively for an asian bank ... due to the "slowness to expand internationally" Malaysian banks are safe ... hence if the losses are largely in "private vehicles", the danger is not as severe, a few hedge funds folding will result in some rich people or endowment fund losing a few hundred millions here and there ... its a bitch but not exasperatingly so

there is a buy-sell betting options on the likelihood of the Fed dropping rates by at least 25 basis points tonight.... two weeks back the contract was trading at 30%-40% likelihood, as of yesterday I saw the contract in the 90% likelihood levels..