On top of the less-bad-than-expected US GDP performance in the second quarter, the US economy should get a big shot of performance-enhancing stimulus funds in the third quarter.
As the International Monetary Fund’s analysis of stimulus activities around the world shows, stimulus spending is picking up, with $64 billion paid out through mid July, 35% of the amount available. The amount of stimulus has roughly doubled each month since February. The pace of social security spending has been relatively quick, while expenditures in energy and transportation have been slower (just 1% of planned infrastructure spending has taken place).
Together with over US$50 billion worth of tax breaks provided, 41% of the expected annual U.S. stimulus ($283 billion) has been paid out, or 0.8% of GDP.
Mark Zandi of Moody’s economy.com expects the stimulus to have its biggest impact in the third quarter, contributing over three percentage points. “The stimulus that became law in February should reach its point of maximum economic benefit this summer. If the plan is working, retailing will improve soon, and businesses should respond by curtailing layoffs measurably.”
Early results suggest the stimulus is performing close to expectations, but policymakers should be prepared to provide more help to the economy if things don’t work as expected in coming months.
“Policymakers should thus be quietly preparing another round of fiscal stimulus for early 2010,” Zandi says.” Effective additional stimulus might include more help to state and local governments, whose budget problems will probably be even worse next year; an expanded housing tax credit to address the foreclosure crisis; and a payroll tax holiday. Delaying increases in marginal personal tax rates, now legislated to occur at the start of 2011, would likely also make sense. Higher-income households may begin to rein in spending in 2010 as they prepare for the higher tax rates.”
Newspaper company McClatchy (MNI) tops CreditSights’ latest list of most distressed credits among US industrial businesses. However, in a July 21 report, CreditSights upgraded McClatchy to marketweight after the company “logged awe-inspiring cost cuts that lifted the company out of the mire of perceptions that the company could violate its bank financial covenants in 2009.”
We change our short-term recommendation on McClatchy to marketweight because the company’s cost reduction gives it more time to use other options to reduce debt, but longer-term we will need to assess the ability of management to sustain cost-reductions to offset secularly declining revenue.
PaidContent reports that “While many observers argue that recent profit swings for Gannett ( NYSE: GCI ), McClatchy ( NYSE: MNI ) and other newspaper publishers will be short lived, Ariel Investments CEO John Rogers Jr is far more bullish. In fact, Rogers tells Bloomberg that he expects the newspapers to defy analysts’ dour projections and post profits for the next five or six quarters.” [Rogers is one of the largest investors in Gannett and McClatchy.]
The North American Industrial Credits to Watch List uses CreditSights’ BondScore Reports screening tool to identify candidates in each of the following screening categories: the most distressed credits, the steepest six month improvement, the steepest six month deterioration, and the most likely ratings transition candidates.
US Concrete (RMIX) has shown the most deterioration over the last 6 months, while SMTC Manufacturing (SMX) has shown the greatest improvement.
Alcoa (AA) is the leading candidate for a ratings downgrade, based on the difference between CreditSights Bond Score rating and its agency rating. In a July 9 report on Alcoa, CreditSights said that “While AA’s liquidity position remains healthy, it continues to burn cash and has significantly higher pension and debt obligations over the upcoming years. We are affirming our underweight recommendation”
The full list is available here.
Shareholder class action filings in the first half of 2009 were on a pace to match last year’s high level annual total, driven by the continued surge of Ponzi scheme and credit crisis allegations, according to NERA Economic Consulting. However, filings have tapered off during the second quarter.
In 2008, filings hit a five-year high, driven up by the surge in litigation related to the credit crisis. This trend started with the subprime lending meltdown in 2007 and has continued into the first half of 2009. Through June 30, 2009, there were 127 federal securities class action filings. If filings continue at this pace in the second half of the year, 2009 will receive approximately the same number of filings as 2008, or more than 250.
Although filings peaked in March 2009 with 31 cases, and gradually declined each month in the 2nd quarter, filings currently remain on track to match the 2008 level.
Annual filings on average over 2008 and 2009 are on pace to come in above the average level of 230 standard filings over the 1997-2004 period. While in 2001 and 2002 total filings exceeded this average level, this was driven by the large number of one-time cases related to the IPO laddering filed during those years, and those IPO laddering allegations have not been repeated in subsequent years.
In 2009, cases related to the credit crisis continue to drive filings: 54 of the 127 filings this year, or over 40% of filings, had allegations related to the credit crisis. In addition, cases related to Ponzi schemes have made up a substantial fraction of the cases in 2008 and 2009, as the revelations of alleged schemes perpetrated by Bernard Madoff, R. Allen Stanford, Howard K. Waxenberg, Thomas Petters, and others led to many filings starting in December 2008.
NERA’s numbers and projections differ from those from a recent Stanford/Cornerstone analysis featured on Research Recap. That study projected a 22% decline for the year based on the first half results it found. However, if the second quarter trend of declining filings in NERA’s report continues, then filings this year would be lower than in 2008. Filings declined in the second quarter last year, but then rose again in the second half:
Stress tests reveal that major Canadian banks have sufficient capital to withstand losses in the likeliest economic outlook, according to Standard & Poor’s. Furthermore, most but not all Canadian banks are in a position to withstand even higher losses, S&P adds. “In fact, as a group, Canadian financial institutions perform better under our stress tests than do those we rate in the U.S. under similar tests,” says S&P in “Stress-Test Results For Canadian Banks Point To Adequate Capital Even Under Worsening Conditions.”
“Our stress test of Canadian financial institutions is in line with Standard & Poor’s revised credit loss assumptions. The financial institutions in the stress test include the five large Canadian banks– Bank of Montreal, Bank of Nova Scotia, Canadian Imperial Bank of Commerce, Royal Bank of Canada, and Toronto Dominion Bank Financial Group–which represent the lion’s share of loans and deposits in Canada. We also included National Bank of Canada, Laurentian Bank, and the Desjardins Group with operations in Quebec, as well as the British Columbia Credit Union System and HSBC Canada.”
We also estimated losses under a more-severe stress case, which we currently believe is only a remote possibility and which we have not built into our ratings. Under that scenario, a few Canadian financial institutions would require a modest amount of additional capital.
“Our ongoing review of the Canadian financial institutions industry has led us to revise our expectations for credit losses and earnings. Apart from identifying credit and earnings risks from our new loss expectations, we seek to determine whether loan losses can erode common equity capital to the point that a capital infusion would become necessary relative to the rating level. The results of our base-case stress test–which is also our expected case–indicate that the sector exceeds our minimum capital thresholds,” said Standard & Poor’s credit analyst Lidia Parfeniuk.
Canadian banks have so far not needed extraordinary government support, but we believe such support would be forthcoming for the highly systemically important banks if needed. “We consider only a few smaller financial institutions to be of moderate systemic importance, and see those banks as benefiting from government support more likely through a market solution, such as a purchase by a stronger bank, rather than outright government support in the form of capital,” Ms. Parfeniuk added.
The Economist catches up with the developing commercial real estate bust in its latest issue. The magazine notes that Realpoint, a credit-rating agency, says that nearly $29 billion of Commercial-backed mortgage securities, around 3.5% of the total, have become delinquent in the past 12 months. Realpoint thinks the delinquency rate could reach 6% by the end of the year. Richard Parkus of Deutsche Bank reckons the default rate could eventually reach 12%. Together with bad construction loans, that could push the losses of American banks on commercial property to $200 billion-230 billion. Many small banks will go under as a result. [Realpoint's full free report is available here.]
“European banks are exposed to property, too. The good news is that the two biggest euro-zone economies, France and Germany, have seen only modest declines in rents and prices. But one of Italy’s biggest property companies, Risanamento, is fighting to stave off its creditors. And pain is being felt all around the periphery of the euro area. In Spain and Ireland vacancies are surging, property prices are plummeting and cranes are standing idle.”
[Gertraud Dirscherl a Valuations partner with KPMG in Germany recently warned of significant writedowns of corporate real estate holdings: "Once some of the big rental payers start to default — and there are already signs in the media that this may happen sooner rather than later — then the process begins in earnest. I’d expect to see significant write-downs in real estate valuations and a number of properties changing hands in the very near future. Once that happens, the quiet will have been well and truly shattered."]
The Economist ends on an ominous note:
History suggests downturns in that market last for years, rather than months. Almost 20 years have passed since the Japanese property market peaked. Prices still fell by 4.7% last year.
As the U.S. restaurant industry struggles through the economic downturn, quick-service operators such as McDonald’s, Burger King and Wendy’s may enjoy a comparative advantage that helps them navigate the weakness better than their competitors in the casual-dining and higher-end segments, according to Moody’s Investors Service.
“Fast-food restaurants have a lower average check, greater convenience and increased food choices that resonate well with today’s financially stressed consumer,” says Moody’s VP-Senior Analyst William Fahy.
However, one threat to quick-service restaurants (QSRs) is the option of eating at home, or “trading out,” which is almost always less expensive than dining out. “As more consumers choose to eat their meals at home, QSRs will be negatively affected, but to a lesser degree than casual dining,” said Fahy.
With a lower price point and an increased emphasis on healthier food options, QSRs should be better-positioned to satisfy the consumer’s desire to dine out and save money. This will help QSRs better weather the “trading out” effect, the report says.
In addition to these operating advantages, QSRs also benefit from their predominantly franchise-based business model, which should reduce earnings volatility and capital spending.
Yet amid a weak economy that shows little sign of near-term improvement, QSRs are not immune to reduced traffic, forcing them to cut costs and offer promotions or discounts to stay competitive and attract customers in order to stem deterioration in operating leverage.
Further, a recent history of generous share repurchases and dividends across the industry —- often funded with debt and other non-operating cash flows —- has placed greater pressure on restaurant operators to manage debt loads and maintain credit ratings as the economic downturn persists.
Key points of Moody’s report:
- Lower average cost of a meal at quick-service restaurants is an advantage as consumers become ever more frugal.
- Conveniences like drive-thru windows and late-night hours remain a competitive advantage over casual dining.
- New menu options at fast-food restaurants increase appeal for consumers that are more health-conscious.
- Franchise-based business model should provide greater stability to earnings.
- Discounting and promotions become key marketing tool to bolster traffic but squeeze margins.
- Many restaurants, including some quick-service operators, face weaker debt-protection metrics and eroding covenant cushions due to weaker operating performance.
A recent analysis by restaurant industry consultant John Gordon showed a mixed picture for fast food restaurants, with McDonald’s (MCD), Chipotle (CMG) and Steak N Shake (SNS) faring better than Yum Brands (YUM) and than Darden’s (DRI) Red Lobster and Olive Garden. All were faring much better than fine dining , where sales are down some 15% from a year earlier. Gordon also questions the wisdom of Wendy’s/Arby’s (WEN) following a multi-brand strategy which has not worked well, with the exception of Yum Brands (KFC/Taco Bell).
PIMCO’s Bill Gross: “New normal” 3% nominal GDP growth substantially changes character of American capitalistic model
Wells Fargo, State Street earnings benefit from looser FASB standards for impaired loans $WFC $STT (Heard on the Street)
KPMG: Corporate real estate valuations poised for significant writedowns
RT @implode_o_meter Study Finds Underwater Borrowers Drowned Themselves with Refinancings (WSJ Blog)
RT @RetailTraffic Goldman backing away from commercial real estate(Reuters)
Yahoo! (YHOO) and Microsoft (MSFT) are certainly pulling out all the stops to put the best face on the merger of their search activities. Yahoo! CEO Carol Bartz gushes that “everything’s just going to get a whole lot better” and that “this deal will make the difference between a great Yahoo! search experience and an awesome one.” Maybe that’s to make up for the promised boatloads of cash Yahoo! is not getting.
She also features in a dull video extolling the virtues of the deal. Microsoft’ CEO Steve Ballmer’s version is slightly more interesting thanks to the live background. Both appear at a special website set up to tout the venture www.choicevalueinnovation.com, thought it’s hard to see how the deal advances any of these goals.
A quick scan of Alacra StreetPulse finds that most analysts greeted the deal with a yawn:
Mark May of Needham & Co says the deal is a clear negative for Yahoo because: 1) There’s no upfront payment;. 2) The minimum guarantee is only for 18 month of the 120 month deal;. 3) The deal requires regulatory approval and management expects closing in early 2010;. 4) Management doesn’t expect to see the full benefits of the deal until 24 month after regulatory approval, which could mean not until 2012;.
The deal, which lets the two companies share revenue from ads sold next to results generated by Microsoft’s Bing search engine, may disappoint some investors because it doesn’t include an immediate payment to Yahoo - Jeff Lindsay , Sanford C. Bernstein & Co.
BusinessInsider’s Henry Blodgett sees trouble ahead for Yahoo!:
- The deal is significantly worse than expected for Yahoo, as the company will get no money upfront.
- The deal is positive for Microsoft, but largely because Microsoft was nowhere in search without it. Saving the upfront payment is also a help.
- Ironically, the deal will likely be positive for Google, which will now likely benefit from months of purgatory as Microsoft and Yahoo work to clear regulatory scrutiny and then go through the massive challenge of trying to integrate their sales forces and technology. Google itself will also now be able to argue persuasively that there is a big, viable (if discombobulated) competitor in the market.
Conceptually, the idea of Microsoft and Yahoo combining forces is smart. Neither alone has enough share of the search market to be a “must buy,” and search relevance and pricing improves with scale. Both companies would likely just continue to lose share ad infinitum without a deal, so they have little to lose by working together. And Yahoo will gain some cost savings, at least for a while.
That said, we think the structure of the deal could end up being a disaster.
Rebecca Jennings, Forrester Research’s principal London analyst is more positive: “This deal should allow Yahoo! to give up its drive to to beat Google, and concentrate on the elements it does do better , display media and social media , devolving the competition and the significant investment involved off to Microsoft.”
Likewise, The Economist: “The combination, which was announced on Wednesday July 29th, is not as far-reaching as originally envisaged. But it is likely to create a serious rival to Google, the online giant that dominates both of these markets.”
(Logos courtesy The Economist)
The Obama Administration is strong-arming loan servicers to step up their loan modification programs, which so far have had little impact in slowing foreclosures. With good reason.
After a series of meetings with top banking executives, Treasury Department officials said they want lenders to modify 500,0000 mortgages by Nov. 1, the Washington Post reports. Since the program, known as Making Home Affordable, began in March, it has recorded about 200,000 loan modifications.
But more than 1 million borrowers received default notices during the first half of the year, and falling home prices and rising unemployment are pushing ever more homeowners into delinquency.
Felix Salmon at Reuters draws attention to a recent report from the Center for Responsible Lending confirming that loan modifications are not keeping pace with foreclosures.
According to Congressional testimony from CRL director Keith Ernst, the 1.5 million homes which have already been lost to foreclosure are just the tip of the iceberg compared to the 13 million total foreclosures expected over the five years from end-08 to 2014.
Mark Zandi at Mooody’s economy.com also has a worrisome chart showing the clear inverse relationship between housing prices and foreclosures as a share of housing sales. And given the historic close but lagging correlation between umeployment and foreclosures, further increases are inevitable. Zandi expects foreclosures to peak early in 2010.
CreditSights continues to believe that risks remain for the housing sector:
Any apparent stabilization that we see in the homebuilding sector at this time would most likely be challenged by persistent high unemployment and rising foreclosures.
A glimmer of hope: according to emii, Bank of America (BAC) has kicked off its foreclosure relief program for borrowers from its recently acquired Countrywide with a letter of notification regarding eligibility. BoA says up to $150 million has been allocated nationally for Countrywide borrowers in 40 states as part of a settlement with state attorneys general.