Libor Dropping, Drastic Fed Actions Finally Working

Three-month Libor fell again to 3.03%, the 15th consecutive drop, indicating that the Fed's dramatic actions are making a difference.  Make no mistake, however, the Fed's actions are dramatic with a capital "D."  Yesterday's release of the Fed's balance sheet showed it ballooning to $2 trillion.  As of October 29th, the Fed had lent $145 billion out of its new commercial paper facility directly to companies which had been shut out from raising short-term financing due to the seizure in the credit markets.  For those unfamiliar with this new facility, it is the first time that the Fed has lent money directly to companies that are not banks (excluding AIG, of course) since the Great Depression.  Other than the new commercial paper funding facility, borrowings from the various other facilities remained relatively unchanged, give or take a couple billion here and there.  

AIG's borrowings declined a bit.  Well, sort of.  It paid back some of the expensive 8.5% money from the special loan it was granted by the Fed, by borrowing from the new commercial paper funding facility at rates of 2-3%.  You can't fault the insurer from trying to reduce its funding costs.  Sadly, there are many other things to fault the insurer for, which require a completely new post (coming soon.)  

In any event, less stress in the money markets is extremely positive news.  Although it doesn't mean the Dow will race right back to 14,000, it does significantly reduce the probability of solvent companies facing bankruptcy because they cannot access short-term financing to run their day-to-day operations.  It also means that every company with an unused revolving borrowing facility doesn't have to draw it down fully from its bank out of sheer panic, thus causing further stress on the banking system.  It is true that we have yet to return to normal business conditions, for without the Fed, we would be facing global banking failures and bankruptcies left and right.  But at least we have stepped back from the precipice.   

Barclays Spurns British Bailout Money in Favor of More Expensive Private Capital

Rather than face the indignity of a capital injection from its own government, Barclays chose instead to raise capital from Middle Eastern investors on more onerous terms.  Alphaville has a nice summary of the financing package it arranged with Qatar and Abu Dhabi and concludes that executives made these decisions in their own self-interest at significant cost to shareholders to keep the British government from meddling in their bonus pools and corporate governance.  Here's a quick summary of the terms:

• $4.86 billion paying a coupon of 14% until 2019, with in-the-money (as of Thursday's price) warrants worth around $1.2 billion.
• $7 billion billion short-term converts paying 9.75% until conversion (sometime next June) at a 25% discount to Thursday's close
• Assuming full conversion, Middle Eastern investors will own 31.2% of the bank.

Compare this to a 10-11% coupon for the British package with no warrants, with the caveat that the bank would have to issue a full blown prospectus and let the British government have a say  in compensation and the composition of top executives.  Shareholders will need to vote on this so the possibility exists of a shareholder revolt.  Barclays may find itself turning to the government, hat in hand, after all.   

Anemic GDP Helps Market, Except HIG

The first estimate of third-quarter GDP came in slightly better than expected at negative 0.3%.  In a quarter that included the virtual collapse and de-privatization of the global financial system, that is positively rosy.  Of course, because things didn't really hit the fan until the end of the third quarter, the effects of the seizure in most forms of lending won't appear in GDP, a notoriously lagging indicator, until the fourth-quarter.  

Equity markets are higher on a smattering of non-catastrophic earnings reports and yesterday's 50 basis point cut by the Fed.  Here are some company specific headlines:

•  Exxon reported a profit of $14.8 billion, a number that was and probably will remain the biggest quarterly profit ever, since the price of crude oil has tumbled precipitously in the past month.  
• Amex announced it will cut 7,000 jobs.  
• Motorola posted a $397 million loss on a one-time restructuring charge and postponed its planned spin-off. 
• CBS lost $12.5 billion on a non-cash write-down of goodwill and other intangibles.  Without the write-down, the company reported earnings of 43 cents a share on a 2.9% increase in revenue, which beat earnings expectations.  It is nice to know that you can lose $12.5 billion in a quarter and have your stock rally 11% because you "beat expectations."

And then there was Hartford, the insurance company, who shares have plummeted precipitously recently in anticipation of horrendous earnings.  As it turned out, the company managed to disappoint even lowered expectations by reporting a $2.6 billion loss.  As the joker at Fox-Pitt Kelton, who somehow still has a job as an analyst, so eloquently stated: "The risk of a rating agency downgrade and the inability of management to provide comfort on the level of their capital cushion make it very difficult to assess the downside or to argue that there is significant upside in the near term."  And then, Mr. Fox-Pitt Kelton analyst downgraded the stock from "outperform" to "in-line."  I don't know what "in-line" actually means in analyst-speak, but I can say with authority that HIG's stock has outperformed nothing in the past few months, other than maybe LEH, FNM, FRE, AIG and my running shoes.   

Even "The Donald" Can't Escape Commercial Real Estate Slump

The Wall Street Journal is packed to the gills with fascinating accounts of commercial real estate developers currently confronting a deadly combination of a precipitous drop in demand for real estate (any type of real estate), surging supply (due to overbuilding), and a lack of refinancing options.  The crack in the market is not due to the current "credit crunch," as struggling developers and lenders would have you believe, but the inevitable result of horrible lending decisions made by banks and lenders to projects with unrealistic expectations hatched into markets flooded with too many competing projects.  Did it really not occur to anyone in places like Las Vegas, Phoenix, and Miami that the market couldn't support 10 years' worth of new  condo supply?  That not every single high-rise project envisioned by real estate developers needed to be built?  Is anyone really surprised by the slow-motion train wreck of failed development projects and those teetering on the brink?  

Interestingly, Deutsche Bank's name pops up with alarming frequency in most of the recent stories about failed commercial real estate projects (see prior posts about Deutsche in Casino Business and Harry Macklowe.)  Deutsche probably would've lent $1 billion to my toddler a year ago to finance her lemonade stand built out of popsicle sticks.  And they would've been stunned to discover a year later that construction of the lemonade stand was way behind schedule because she'd eaten most of the popsicles.

Donald Trump, master of the comeback, finds himself embroiled in perhaps some deja vu of the early 90's, as one of his ambitious projects faces tenuous prospects.  Mr. Trump's 92-story Trump International Hotel & Tower will be the tallest building constructed in the US since the Sears Tower was built in 1973.  According to the Wall Street Journal article, Mr. Trump has sold $600 million in condo units and condo-hotel units, yet owes lenders as much as $1 billion.  Although Mr. Trump's building is apparently on-time and on-budget, the current slump in the housing market begs the question of whether he will be able to pay off the loans.  In order to stay current on the debt, Mr. Trump needs to negotiate by Nov. 1st to exercise an extension provision in the original loan which could prove costly.  The loan includes a $40 million recourse completion guarantee, meaning that Deutsche can both foreclose on the property and go after Mr. Trump for $40 million.  Mr. Trump also has borrowed $130 million in a mezzanine loan from Fortress Investment.  The mezzanine loan includes harsh terms such as a $50 million "exit fee" when the loan is due, in addition to accrued interest.  Fortress, incidentally, proved itself to be the shrewdest of lenders, as evidenced by the investment fund's fortuitous escape from the Harry Macklowe debacle with all of its cash and interest intact while the senior lenders had to deal with a messy foreclosure.  According to the loan terms of Mr. Trump's mezzanine loan with Fortress, he could wind up owing $360 million to Fortress depending on how long the loan accrues interest.  

The outcome of this commercial real estate drama will be determined, as always, by market forces.  Contract signings on condos in downtown Chicago were down 72% the first half of the year from a year earlier, with 10,000 new condo units expected to be delivered in 2008 & 2009.  I suspect this will not end well for Mr. Trump, but I'll be looking for his next comeback in 2015.  Or maybe I'll see him first on QVC hocking his condos.           

GMAC, Cerberus Looking For a Piece of Bailout Money

GM's finance arm, GMAC Financial Services has already been granted some federal assistance.  GMAC was allowed access to the new short-term funding facility created by the Fed that went into operation on Monday.  The Fed's new facility has been credited with returning liquidity back to the commercial paper market which disintegrated after the Lehman bankruptcy caused the largest money market fund to break the buck.  

GMAC is also seeking to become a bank holding company so that it can have access to a piece of the government's $700 billion financial rescue plan.  The Fed has been holding discussions with GMAC about this move for over a month.  The boneheads at Cerberus, the private equity firm that has the misfortune of owning controlling stakes in both Chrysler and GMAC, is attempting to swap its stake in Chrysler for a larger share of GMAC.  Why?  Because why would you own a crappy US auto-maker that cannot compete with foreign rivals that you happened to purchase at the absolute peak of the market, when you can own a bank holding company that has access to federal government bailout money?  So, you see, this swap is absolutely necessary for the good of the US auto-industry, the US consumer, but particularly for Cerberus.  Without some sort of bailout money, both Chrysler and GMAC are toast which would be very bad for Cerberus and its three-headed dog-loving investors.  And that would be bad for America.  When you hear your favorite congressman preaching about the need to bail out the US auto-industry that is finally crashing under its own uncompetitive weight, think about who stands the benefit the most: the private equity clowns that made a terrible investment decision.       

      

Waiting on the Fed

US equity markets are clinging to yesterday's 10% rally, awaiting the Fed's decision on interest rates.  Investors are anticipating a 50 basis point cut in the Fed Funds target, with some calling for 75 basis points.  It's hard to imagine that the Fed will do anything to surprise the market today given how fragile conditions remain in the credit markets.  I anticipate a 50 basis point cut, because that is the most expected action and frankly, it really doesn't matter what the Fed does with the Fed Funds target.  Three-month Libor fell 5 basis points to 3.42%, which is a huge improvement over October 10's fix at 4.82%, but still nearly 200 basis points over the current fed funds rate.  It seems hard to imagine that another 50 basis points is going to crack Libor if 17 new Fed Facilities have yet to do the trick. 

In the "completely unexpected good news" department, durable-goods orders rose 0.8%, although the ex-transportation number was down 1.1%.  The rebound was due to an increase in aircraft orders (seriously?) and an increase in defense bookings (yeah, that makes sense.)  The durable-goods numbers are notoriously volatile so reading anything into this number about the US economy being "strong" would be foolish for anyone other than, perhaps, a Presidential candidate of the current US ruling party.

In the "genuinely good news" department, Proctor & Gamble posted solid earnings, benefitting from price increases and favorable foreign exchange rates.  Both Kraft and Kellogg reported higher-than-expected third-quarter profits also due to price hikes.  Despite all of the bleak news related to housing, banking, and stock market declines, Americans can still afford food and diapers.  That, my friends, is better than nothing.      

US Equity Futures Perk Up on the Heels of Global Rebound

Optimism about the Fed rate-cut? Renewed confidence that the government interventions are working?  Dead-cat bounce?  Whatever the underlying reason, equity investors around the world decided that stocks are a bargain, for today at least.  The Japanese Nikkei was higher by 6.4%, and Hong Kong soared 14.4%.  European stocks joined the party with sharp rallies across the board.  Germany's DAX jumped an astonishing 8.3% (related in part to a 90% surge in Volkswagen shares due to Porsche's plan to take three-quarter's of Volkswagen's stock.)  Germany aside, the FTSE 100 was 4.6% higher and the French CAC-40 rose 3.2%.  US futures are poised for a rebound.  

GM may receive a $5 billion loan to aid its planned merger with Chrysler.  Ordinarily I would spend at least a paragraph mocking the idea of two huge money-losing companies getting government aid to become one gargantuan money-losing company, but at this point, I am just relieved that they are ONLY receiving $5 billion.  If the government is giving $25 billion to Citigroup, might as well throw the US auto industry a small, but tasty, bone.  The only disheartening aspect of this news is that it indirectly aids the private equity firm Cerberus, who owns part of Chrysler and GMAC.  But at least the private equity guys are finally having to work their butts off to save an investment rather than just borrowing money to pay themselves dividends every few months.  If Cerberus can single-handedly turn the US auto industry around, then they've officially earned all the fees they've been collecting for operating in an easy-credit bull market for the past 15 years.