Although performance on U.S. credit card securities remains well within long-term historical trends and continues to resist the rapid deterioration of subprime mortgage-backed securities, rising credit card balances, delinquencies and chargeoffs are becoming a cause for concern.
According to Fitch Ratings’ latest ‘Credit Card Movers & Shakers,’ revolving consumer credit, which is predominantly composed of credit card receivables, grew over 7.5% in 2007 and now stands at almost $952 billion.
Credit card balances have been building as other sources of funding, such as home equity lines of credit and cash out mortgage refinancing, have become less readily available. This comes as consumer confidence has weakened and unemployment has been rising in recent months.
Fitch Ratings continues to expect declining asset performance for the credit card sector mainly due to higher delinquencies, higher chargeoffs, and slower monthly payment rates.
“Despite these negative macroeconomic trends, credit card delinquencies and chargeoffs have just recently returned to their long-term averages following a two-year period of exceptionally strong performance in the wake of the implementation of new bankruptcy legislation in 2005″, said Senior Director Cynthia Ullrich. In addition, excess spread has remained near historical highs.
Fitch’s comments are consistent with a March report from CreditSights featured on Research Recap, Warning Signs Seen in Rising Credit Card Delinquencies.
Fitch says it continues to expect that credit card asset-backed securities will perform within expectations, with limited ratings volatility anticipated, due to the significant credit enhancement and structural protections incorporated into these transactions.
The idea of a “gas tax holiday” proposed by John McCain and embraced by Hillary Clinton may be politically popular but gets a resounding thumbs down from economists.
“Score one for Obama,” wrote Greg Mankiw, a former chairman of President George W. Bush’s Council of Economic Advisers, as reported by Reuters. “In light of the side effects associated with driving … gasoline taxes should be higher than they are, not lower.”
Economists said that since refineries cannot increase their supply of gasoline in the space of a few summer months, lower prices will just boost demand and the benefits will flow to oil companies, not consumers.
“You are just going to push up the price of gas by almost the size of the tax cut,” said Eric Toder, a senior fellow at the Urban-Brookings Tax Policy Center in Washington.
Barack Obama criticized the plan as pure politics and said the only way to lower the price of gas is to use less oil.
“It would last for three months and it would save you on average half a tank of gas, $25 to $30. That’s what Senator Clinton and Senator McCain are proposing to deal with the gas crisis,” he said on Tuesday in Winston-Salem, North Carolina.
According to the Autopia blog, The Arizona Republic – McCain’s hometown paper – says the average Phoenix commuter will save $23 under McCain’s proposal. The American Association of State Highway and Transportation Officials says the average American will save $28.
On the other hand, the Republic found, suspending the gas tax for three months would free up $88.36 million in consumer spending throughout the greater Phoenix area. And companies like FedEx that are losing their shirts to high fuel prices could use some relief.
But McCain’s proposal could cost the government some $9 billion dollars – and more than 300,000 jobs.
“The tax supports the federal Highway Trust Fund, which finances road projects nationwide and is already facing a $3.4 billion shortfall, the American Association of State Highway and Transportation Officials says. The American Society of Civil Engineers says every dollar invested in highway infrastructure generates $5.40 in economic benefits through reduced delays, improved safety and lower vehicle operating costs. And the federal transportation department says every $1 billion in highway spending creates 34,779 jobs.”
“You don’t want to stimulate consumption,” Lawrence Goldstein, an economist at the Energy Policy Research Foundation, told the New York Times. “The signal you want to send is the opposite one. Politicians should say that conservation is where people’s mindset ought to be.”
Paul Krugman calls it “a really bad idea:”
The Clinton twist is that she proposes paying for the revenue loss with an excess profits tax on oil companies. In one pocket, out the other. So it’s pointless, not evil. But it is pointless, and disappointing.
Major oil companies will need to invest a higher proportion of their cash flow to bolster reserves and expand production, Oxford Analytica says in a new analysis.
With the exception of BP, oil majors in 2007 failed to replace reserves, according to US Securities and Exchange Commission (SEC) definitions of proved reserves. OxAn says oil refiners’ SEC filings indicate that:
- Their loss of reserves in Venezuela and Russia, and more generally through greater competition for access to resources, has hit them hard;
- Except BP and Chevron, organic growth is failing to match production levels, even for firms that produced less in 2007 than 2006;
- Chevron and BP’s Russian interests were critical in achieving organic growth above production levels; and
- Improving replacement ratios will require higher levels of future investment, implying less shareholder return.
However, OxAn notes that SEC measures do not accurately illustrate companies’ resource bases, due to stringent definitions. For example:
Unconventional resources, such as oil sands, are excluded as these were considered mining operations when SEC regulations were formulated in 1978.
Following recent consultation, changes to standards are expected, which should see the SEC come closer to other bodies’ measurement standards. When presenting to investors, companies generally use the Society of Petroleum Engineers classification system for reserve estimates. These produce a markedly different picture:
For example, Shell claims an organic reserves replacement ratio of 124%, contrasting an SEC reserve replacement ratio of 17%.
Still, OxAn says, while changes to SEC reserve reporting standards will expand companies’ reserves data, this adds little new market information. “Returning a higher proportion of cash flow for investment is required to turn large resource bases into production, thus bolstering reserves and expanding capacity.”
The Federal Depost Insurance Corporation today proposed that the Treasury Department be authorized to make loans to borrowers with unaffordable mortgages to pay down up to 20 percent of their principal.
The repayment and financing costs for these Home Ownership Preservation (HOP) loans would be borne by mortgage investors and borrowers, the FDIC said.
This approach is scaleable, administratively simple, and will avoid unnecessary foreclosures to help stabilize mortgage and housing prices.
Borrowers must repay their restructured mortgage and the HOP loan.
To enter the program, mortgage investors pay Treasury’s financing costs and agree to concessions on the underlying mortgage to achieve an affordable payment. Unaffordable loans are desfined by the FDIC as those held by borrowers with a debt-t0-income ratio of over 40%.
Key provisions of the proposed plan:
- Treasury would have a super-priority interest — superior to mortgage investors’ interest — to guarantee repayment. If the borrower defaulted, refinanced or sold the property, Treasury would have a priority recovery for the amount of its loan from any proceeds.
- The government has no continued obligation and the loans are repaid in full.
- Eligible, unaffordable mortgages would be paid down by up to 20 percent and restructured into fully-amortized, fixed rate loans for the balance of the original loan term at the lower balance. New interest rate capped at Freddie Mac 30-year fixed rate.
- Restructured mortgages cannot exceed a debt-to-income ratio for all housing-related expenses greater than 35 percent of the borrower’s verified current gross income (’front-end DTI’). Prepayment penalties, deferred interest, or negative amortization are barred.
- Mortgage investors would pay the first five years of interest due to Treasury on the HOP loans when they enter the program. After 5 years, borrowers would begin repaying the HOP loan at fixed Treasury rates.
- Servicers would agree to periodic special audits by a federal banking agency.
A Treasury public debt offering of $50 billion would be sufficient to fund modifications of approximately 1 million loans that were “unsustainable at origination,” according to the FDIC.
FDIC Chairman Susan Bair advocates the approach in an article in today’s Financial Times. She sees the loans as complementing plans by Congress and the White House to expand eligibility for loans guaranteed by the Federal Housing Administration. “These proposals are laudable and will help some borrowers, but they have generally acknowledged limitations.”
“Borrower loan programmes have been suggested by eminent economists, such as Martin Feldstein. This proposal would require cost-sharing by mortgage investors as well as borrowers; it limits eligibility to mortgages that were al- ways unaffordable and provides a super- priority interest to assure repayment.”
Importantly, this proposal keeps the risk of re-default on mortgage investors. It allows the government to leverage its lower borrowing costs to reduce fore-closures significantly with no expansion of contingent liabilities and little net cost.
An interesting illustration of subprime mortgage data can be found at the New York Federal Reserve Bank’s website, which features a number of dynamic maps, currently based on December 2007 data.
The maps allow you to zoom in by state or zipcode to see the percentage of subprime and Alt-A mortgages that are, for example, current, delinquent, in foreclosure, and so on. Of note is the high percentage of subprime loans that are ARMs and low or no documentation loans, often between a third and two thirds of all subprime mortgages.
There was no sign of the US housing market hitting bottom in February as sales prices of existing single-family homes showed double digit year-over-year declines in 10 of the 20 markets included in the S&P/Case-Shiller Home Price Indices.
The 10-City Composite posted a new record low annual decline of 13.6%, and the 20-City Composite recorded an annual decline of 12.7%.
Prices in all 20 metropolitan statistical areas were down from the previous month and only Charlotte was up from a year earlier at +1.5%.
The monthly data show that every one of the MSAs has now declined every month since September 2007, marking six consecutive months. On top of that, the declines have remained steep with eight of the 20 MSAs and both composites reporting their single largest monthly decline in February.
Las Vegas and Miami were again the weakest markets with year-on-year declines of 22.8% and 21.7% respectively. San Francisco, Las Vegas and Los Angeles each were down more than 4% from the previous month.
More evidence that prices have further to fall can be found in a recent presentation by Desmond Lachman, Chief Economist of the American Enterprise Institute. In a panel discussion Monday, Lachman said further declines are indicated by futures prices based on the Case Shiller Indices and by the historically high level of unsold housing inventory. He also said expects “a burst in the commercial property market.”
He noted that interest rate cuts have been offset by widening credit spreads and that the stimulus package has been negated by higher oil prices. Therefore:
Further interest rate cuts and a second stimulus package are
required. Unorthodox measures are needed to stabilize the housing
Another AEI scholar, former Fed official Vincent Reinhart said at the same panel that the rescue of Bear Stearns was “the worst policy decision in a generation,” Bloomberg reported.
“The panicked decision jumped over other possibilities” and may prove as damaging as Fed policy errors that caused the “great contraction” of the 1930s and the “great inflation” of the 1970s, he said.
Collateralized debt obligation securities (CDOs) backed by US subprime mortgages are facing further downgrades after Standard & Poor’s cut its assumptions of how much might be recovered when mortgagees default on their loans.
S&P now expects zero recovery in the event of default for the affected CDOs rated A or lower. For CDOs rated AA, the expected recovery-on-default assumption is 5% , for Junior AAA it is 35% and for Senior AAA it is 60%.
The new assumptions apply to CDOs of asset-backed securities (ABS) tranches for which 40% or more of the collateral consists of the affected U.S. Residential Mortgage-Backed Securities, including Alternative-A (Alt-A), subprime, home equity loan, and tax-lien RMBS issued in the U.S. during and after the fourth quarter of 2005. Also affected are CDOs backed by tranches from other CDOs, which themselves are backed by the affected U.S. RMBS in a proportion of 40% or more of their respective asset balances.
Due to the potential variability surrounding the performance of the affected CDO collateral, Standard & Poor’s said it will no longer tier its expected recovery according to the rating of the CDO liability (tranche). Therefore, the recovery values outlined above are applicable to all CDO liability ratings.
The changes to our recovery-upon-default assumptions may have a negative impact on the ratings assigned to the affected CDOs because a reduction in expected recoveries typically necessitates more subordination to sustain the ratings on the tranches.
Full details are available in the report Criteria: Recovery Assumptions Revised For Certain CDOs Backed Predominantly By U.S. RMBS.
Fitch Ratings today defended fair value accounting methods, but argued that greater judgment is needed in arriving at a true fair value.
Volatile and unstable conditions in the financial markets have caused many reporting financial institutions to call for a relaxation of fair value accounting, allowing issuers the option of when to apply fair value measurement and when to apply historical cost.
In a special report Fitch says companies should not stop accounting for assets at fair value in illiquid markets. However, better disclosure is required as to the rationale, assumptions and sensitivities behind these valuations.
“The most salient issue is not whether fair value per se should be used to report numbers, but how that fair value should be measured,” says Bridget Gandy, Managing Director in Fitch’s Credit Policy Group. “If values are being taken from markets that are not striking a fair balance between buyers and sellers, it is hard to argue that those values are fair.”
In the report, Fair Value Accounting: Is It Helpful In Illiquid Markets?, Fitch notes that fair values are helpful to analysts and investors when they represent realistic and reliable indications of the net present values of future cash flows. “The disconnect with market prices comes when there is no intention to sell an asset in the short term and a lack of market liquidity means that current values are either much higher or much lower than the amount that will ultimately be received for the asset. However, holding assets in trading books is a clear indication of a company’s intent to sell in the short term and market values should be taken.”
When market liquidity has dried up, resulting in market prices that tell little about future cash flows of an entity that can hold onto an asset, clinging onto a strict interpretation of rules rather than exercising judgement can make a nonsense of financial reporting.
Fitch would not support any loosening of accounting that enabled companies to move assets from one place in the balance sheet to another, because this would leave accounting wide open to profit smoothing. However, in terms of measuring the fair value of an asset in an illiquid market, a company’s own discounted cash flow measurement may well provide a better indication of its “fair” value and provide analysts and investors with better information about future cash flows than the latest market transaction price.
More extensive disclosure will help investors to understand the limitations around the values reported, Fitch says. “These should include indications of market prices versus expected cash flows, amounts companies expect to lose in real cash on assets written down to market values and how such assets will be funded whilst they are held for longer than originally anticipated.”
“While Fitch does not think that market prices not directly related to the assets being valued using internal models should be required as inputs, the agency also does not think that they should be ignored. A company that is not using the best observable data available should explain why it is not using this, demonstrate why the alternative measurement is more appropriate and provide an indication of how the value would have differed if the market prices were used as inputs in the notes to the accounts.”
In this week’s New York Times Sunday Magazine, Roger Lowenstein attempts to untangle the process of rating mortgage-backed securities and collateralized debt obligations. Lowenstein got Moody’s to walk him through its process for rating a typical subprime MBS from the 2006 vintage (though the performance of that year’s bonds have proved to be anything but typical by historical standards.)
Apart from a couple of debatable analogies by sources he quotes, the article provides a helpful explanation of the process, and with the benefit of hindsight makes it easy to see where things went wrong. It’s well worth reading.
Moody’s was fair-minded in choosing an example; the case they showed me, which they masked with the name “Subprime XYZ,” was a pool of 2,393 mortgages with a total face value of $430 million.
“Subprime XYZ typified the exuberance of the age. All the mortgages in the pool were subprime — that is, they had been extended to borrowers with checkered credit histories. In an earlier era, such people would have been restricted from borrowing more than 75 percent or so of the value of their homes, but during the great bubble, no such limits applied.”
Lowenstein concludes by addressing the conflict of interest inherent in the rating agencies making their money from the firms whose bonds they rate, suggesting that the government should stop certifying the agencies altogether.
“Then, if the Fed or other regulators wanted to restrict what sorts of bonds could be owned by banks, or by pension funds or by anyone else in need of protection, they would have to do it themselves — not farm the job out to Moody’s. The ratings agencies would still exist, but stripped of their official imprimatur, their ratings would lose a little of their aura, and investors might trust in them a bit less. Moody’s itself favors doing away with the official designation, and it, like S.&P., embraces the idea that investors should not “rely” on ratings for buy-and-sell decisions.”
The International Monetary Fund’s Annual Economic Health Check of Germany’s banking system finds the patient in need of reconstructive surgery. The near collapse of IKB and West LB last year point up significant structural and supervisory challenges, the Fund’s Jurgen Odenius writes in an article in the latest IMF Survey magazine.
The article blames German entanglement in the subprime crisis on an antiquated banking structure that unintentionally pushed banks such as IKB to bet on risky conduits such as subprime-mortgage-backed Special Investment Vehicles (SIVs).
“As a result of deep-rooted fragmentation, interest margins remain low by international standards, and Germany’s banking sector has made only modest progress in generating income from nontraditional services. Sector-wide profitability remains low and banks, therefore, may be inclined to take on excessive risks,” Odenius writes.
Further, the recent trend of consolidation in German banking (there has been a 25% decline in the number of German banks since 2000) has not occurred in the ideal sectors:
Moreover, the current policy of consolidating mainly from within the public pillar of the three-pillar banking system—comprising the private, cooperative, and public pillars—risks creating regional banks that may not withstand intensifying global financial sector competition.
To ensure that viability of business models is achieved, policy measures must ensure that market forces and private sector capital can play their legitimate role:
Broadening private sector investment opportunities in the public pillar—as was the case of HSH Nordbank in 2006—would be major step forward.
“Lifting of regional limitations on the business operations of the publicly owned savings banks is needed to enhance the efficiency of the public pillar. Where political compromises are made, these should not be at the cost of constraining future options,” Odenius writes.
The ultimate cause of the subprime crisis was similar in Germany as elsewhere: “While their operations were, at least in broad terms, known to the supervisory authorities, the risks posed by their conduits were underestimated, not unlike in other countries.”
The article concludes with recommendations for strengthening supervision and enhancing crisis prevention.
Further German bank consolidation seems likely based on the comments of Deutsche Bank’s Juergen Fitschen, who favors seeing the country’s four big commercial banks — Deutsche Bank , Dresdner Bank, Commerzbank and Postbank — form two big groups that could better compete internationally.
Meawhile FT Alphaville details Deutsche’s (Frankfurt: DBK)reported plans to raise capital and possibly report its first quarterly loss in five years.
Fitch Ratings says the performance of Germany’s major banks is expected to remain under significant pressure in light of the prevailing financial crisis. “However, Fitch believes the banks can absorb a reasonable level of adjustments, either through diversified revenues and/or capitalisation.”
“On the M&A front, the announcement that Postbank’s majority owner is considering a sale of its shares, as well as the recently announced split of Dresdner’s operating business segments, have revived discussions regarding possible consolidation steps among the major German banks,” Fitch notes in its Semi Annual Review of Major German Banks:
Fitch considers the prevailing crisis to be a potential catalyst for consolidation of the German banking market.