This article was my first encounter with the sub-prime crisis. In a phone call, a fund manager from Deutsche Asset Management told me it was something I should mention in a routine article about US banks. Back then we had no idea it would bring global capitalism to its knees..Australian fund managers hoovered up US bank bonds and sang the praises of the US Investment Banking sector (could they have got things more wrong!) and even the analyst I interviewed thought that bank M&A activity was the bigger theme in the sector. Markets at the time agreed. Deals continued to print at record volumes, credit spreads tightened further and the equity maket continued to storm ahead. But the warning signs were there and it would still be several months until the rest of the world would awaken to the sub-prime nightmare.
Insto Bond Diary
**US banks flood market, as sub-prime lenders feel the pressure (9 February 2007)***
US financial institutions have rushed to the Kangaroo market with over A$4 billion issued by the sector in February.
Citigroup, Bank of America and Morgan Stanley have all completed billion plus trades with other names such as Merrill Lynch, touted to follow in the near future.
“Banks got off to a strong start in 07 and pricing levels are tight reflecting a benign outlook for global credit,” said a fund manager.
Demand for exposure to US financial institutions remains strong.
“The sector has been very solid. We’re quite happy with the way they have performed and we’re prepared to pick up decent exposure,” said an investor.
Citigroup and Bank of America saw deals upsized, with Citigroup completing a US$1.55 million five and 10 year issue on Friday and Bank of America pricing a A$1.2 billion five year senior and 10 year subordinated tranche on Wednesday.
Both five year tranches priced at 18 basis points over swap. “Bank of America was fairly tight compared to the level where a better rated Citigroup priced. We thought it should have paid at least a basis point more, so we were picky there,“ said a fund manager.
Bank of America’s 10 year subordinated piece provided a pick-up and variety for investors. “Under Basel II subordinated debt should outperform senior debt,” said an investor that participated in the sub debt tranche.
“The sub debt priced in line with offshore levels. We’re comfortable with all names in the sector but are full up on exposure,” said another investor.
Investment Bank Morgan Stanley priced a large four and 10 year issue today. Like Citigroup and Bank of America, the trade offered a large liquid line of floating rate notes, with investors favouring the format amidst concerns about inflation and future rate rises.
“Morgan Stanley priced pretty much in line with where it trades in the US. Results have been very good, easily above expectations and we don’t see any huge catalyst to cause deterioration in underlying fundamentals,” said an investor.
The IB sector remains a strong favourite with investors, and Merrill Lynch and one other set to follow Morgan Stanley’s lead and return to the domestic market.
“The US economy is showing signs of slowing but investment banks are in good shape and M&A remains strong. Fixed income and equity businesses are also performing better,” said a fund manager.
While the major banks are in good shape there are some jitters at the lower end of the lending spectrum.
This week saw HSBC increase their loss provisions as default rates in the US sub prime lending market start to rise.
The effects of a weaker US housing market and continuous rate hikes have begun to appear, putting pressure on sub-prime borrowers.
The increased provision will impact the earnings of HSBC as a whole but the bonds of HSBC Finance - the group's predominantly US household lending arm - are expected to be hit hardest given this is where credit quality is under the most pressure.
“The increase in delinquencies and corresponding increase in provisions is impacting on equity prices. We expect this trend to impact credit spreads, particularly on those issuers exposed to the subprime market,” said Andrew Morgan, fund manager at QIC.
"Current spread differentials between HSBC Finance and HSBC Bank should be greater because of HSBC Finance's exposure to sub-prime loans," said Bradley Bugg, senior credit analyst, ANZ Investment Bank.
Apprehension in the sub-prime space may also impact other Kangaroo issuers.
Wells Fargo has said its provision levels were better than expected, but they have seen an impact on their sub prime auto loan book.
Conditions are also difficult for another regular issuer, Countrywide, which says it is able to manage the effects of challenging times in the sub-prime sector but is expecting a softer 2007.
While there is pressure on cash and credit default swaps spreads, there are other factors at play to keep spreads in check.
Spreads of sub-prime lenders had held tight as lenders are targeted by the stronger rated financial institutions looking to ‘buy’ growth.
“The two best performers of the US financial sector - Bank of America and Wachovia - have achieved their growth through acquisitions. While there will be greater scrutiny of asset quality, we still see M&A as the bigger theme of 2007,” said Bugg.
Another US lender and Kangaroo issuer - SLM Corporation (Sallie Mae) has also been in the news. Sallie Mae, the provider student loans, has seen fiscal reshuffling reduce the level of government support given to loans over time. The reduction had been greater than anticipated but with a large majority of loans still benefiting from a government guarantee, the news did not have a significant impact on the performance of SLM credit.
“Banks got off to a strong start in 07 and pricing levels are tight reflecting a benign outlook for global credit,” said a fund manager.
Demand for exposure to US financial institutions remains strong.
“The sector has been very solid. We’re quite happy with the way they have performed and we’re prepared to pick up decent exposure,” said an investor.
Citigroup and Bank of America saw deals upsized, with Citigroup completing a US$1.55 million five and 10 year issue on Friday and Bank of America pricing a A$1.2 billion five year senior and 10 year subordinated tranche on Wednesday.
Both five year tranches priced at 18 basis points over swap. “Bank of America was fairly tight compared to the level where a better rated Citigroup priced. We thought it should have paid at least a basis point more, so we were picky there,“ said a fund manager.
Bank of America’s 10 year subordinated piece provided a pick-up and variety for investors. “Under Basel II subordinated debt should outperform senior debt,” said an investor that participated in the sub debt tranche.
“The sub debt priced in line with offshore levels. We’re comfortable with all names in the sector but are full up on exposure,” said another investor.
Investment Bank Morgan Stanley priced a large four and 10 year issue today. Like Citigroup and Bank of America, the trade offered a large liquid line of floating rate notes, with investors favouring the format amidst concerns about inflation and future rate rises.
“Morgan Stanley priced pretty much in line with where it trades in the US. Results have been very good, easily above expectations and we don’t see any huge catalyst to cause deterioration in underlying fundamentals,” said an investor.
The IB sector remains a strong favourite with investors, and Merrill Lynch and one other set to follow Morgan Stanley’s lead and return to the domestic market.
“The US economy is showing signs of slowing but investment banks are in good shape and M&A remains strong. Fixed income and equity businesses are also performing better,” said a fund manager.
While the major banks are in good shape there are some jitters at the lower end of the lending spectrum.
This week saw HSBC increase their loss provisions as default rates in the US sub prime lending market start to rise.
The effects of a weaker US housing market and continuous rate hikes have begun to appear, putting pressure on sub-prime borrowers.
The increased provision will impact the earnings of HSBC as a whole but the bonds of HSBC Finance - the group's predominantly US household lending arm - are expected to be hit hardest given this is where credit quality is under the most pressure.
“The increase in delinquencies and corresponding increase in provisions is impacting on equity prices. We expect this trend to impact credit spreads, particularly on those issuers exposed to the subprime market,” said Andrew Morgan, fund manager at QIC.
"Current spread differentials between HSBC Finance and HSBC Bank should be greater because of HSBC Finance's exposure to sub-prime loans," said Bradley Bugg, senior credit analyst, ANZ Investment Bank.
Apprehension in the sub-prime space may also impact other Kangaroo issuers.
Wells Fargo has said its provision levels were better than expected, but they have seen an impact on their sub prime auto loan book.
Conditions are also difficult for another regular issuer, Countrywide, which says it is able to manage the effects of challenging times in the sub-prime sector but is expecting a softer 2007.
While there is pressure on cash and credit default swaps spreads, there are other factors at play to keep spreads in check.
Spreads of sub-prime lenders had held tight as lenders are targeted by the stronger rated financial institutions looking to ‘buy’ growth.
“The two best performers of the US financial sector - Bank of America and Wachovia - have achieved their growth through acquisitions. While there will be greater scrutiny of asset quality, we still see M&A as the bigger theme of 2007,” said Bugg.
Another US lender and Kangaroo issuer - SLM Corporation (Sallie Mae) has also been in the news. Sallie Mae, the provider student loans, has seen fiscal reshuffling reduce the level of government support given to loans over time. The reduction had been greater than anticipated but with a large majority of loans still benefiting from a government guarantee, the news did not have a significant impact on the performance of SLM credit.
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