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Refinancing Risk Runs Rampant…Get To Higher Ground!

Posted by Larry Doyle on April 6, 2009 10:27 AM |

The key for the global markets and economy is the ability to refinance outstanding debt. In the absence of a viable asset securitization market, will banks provide financing for current loans to be refinanced as they come due? Please remember the asset securitization market represented approximately 40% of total lending, so we are talking about a MAJOR segment of the market.

As banks assess applications for loan refinancings, they will impose ever more stringent underwriting standards as they will most likely put these loans on their books. Consumers, small businesses, and major corporations that do not have solid balance sheets and income statements will NOT get new financing. What happens to the existing loans that can’t get refinanced?  The process is as such:

1. loan becomes delinquent
2. loan defaults
3. lender forecloses and takes possession of asset
4. lender attempts to liquidate asset via sale, pressuring valuation of assets in that sector.
5. original lender books loss on non-performing asset

What does it all mean?  Losses on asset classes across the board. Can government programs plug the holes in the refinancing markets? Well, the Federal Reserve is known as the lender of last resort but their loans extend primarily to the banks themselves to plug holes in their balance sheets. The other governmental programs (TALF, PPIP) will hopefully restart the asset securitization markets and bring liquidity back in for refinancing. Will these programs hold the waves behind the dike? To a certain extent, but my recommendation is . . . get to higher ground.

Why will these programs be limited and only have a measure of success? Very simply because a large percentage of loans underwritten between 2005-mid 2007 lacked the necessary underwriting rigor and discipline. Prospective lenders in reviewing these credits will have no appetite in lending to these consumers, businesses, and corporations.

What happens? Massive defaults. To wit, Bloomberg offers:

About 53 percent of U.S. companies that issued high-risk, high-yield bonds will default over the next five years, according to Jim Reid at Deutsche Bank AG.

The figure compares with a 31 percent five-year rate in the early 1990s and 2000s, and as much as 45 percent “in a very, very different market in the Great Depression,” Reid, the London-based head of fundamental credit strategy, wrote in a note to clients today. The estimate is based on the premium investors demand to hold the notes and assumes recoveries from the defaults will be zero, Reid wrote.

Additionally, for banks as a whole, top rated analyst Mike Mayo offers further color via another Bloomberg report:

— Mike Mayo, who left Deutsche Bank AG to join Calyon Securities, assigned an “underweight” rating to banks on expectations that loan losses will exceed levels from the Great Depression.

“While certain mortgage problems are farther along, other areas are likely to accelerate, reflecting a rolling recession by asset class,” Mayo wrote in a report today. “New government actions might not help as much as expected, especially given that loans have been marked down to only 98 cents on the dollar, on average.”

The 46-year-old Mayo gained a reputation for independence at Deutsche Bank for his willingness to put a “sell” rating on banks and to criticize investors and companies for trying to curb objective analysis. At Deutsche, Mayo had “sell” or “hold” ratings on all 18 companies he covered, according to data compiled by Bloomberg.

Mayo said in the report that he expects loan losses to increase to 3.5 percent by the end of 2010. Mortgage-related losses are about halfway to their peak, while credit card and consumer losses are only one-third of way to their expected highest levels, Mayo wrote.

The changes to mark-to-market accounting rules will impact banks’ balance sheets by one-third or less and will have no impact on the economics of bank troubles, Mayo wrote. Banks committed the “seven deadly sins” of banking in trying to compensate for lower natural growth rates and will now feel the costs of those actions, Mayo wrote.

Mayo gave “sell” ratings to BB&T Corp., Fifth Third Bancorp, KeyCorp, SunTrust Banks Inc. and U.S. Bancorp, while “underperform” ratings were assigned to Bank of America Corp., Citigroup Inc., Comerica Inc., JPMorgan Chase & Co., PNC Financial Services Group Inc. and Wells Fargo & Co.

The equity market is down 1% on the heels of these reports.

Sense on Cents cautions investors to remain on guard!!


  • Donnie

    LD Great show and guest.You do know you paint a bleak picture on this whole bailout mess as you should.Last month I suggested that stimulis money be given direct to taxpayer so people can refinance which would help the banks on default.Am I way off base here and is this impossible to do?Will they ever be able to track where this bailout money has gone and into whose pocket?

  • Donnie…no pandering here at Sense on Cents!! The govt actually is actually planning on giving funds to a certain percenatge of taxpayers vis the redistribution plans embedded in the Stimulus and Budget. Those funds will not produce a significnat bounce in the economy, though, as it will be used primarily to pay down debts.

    Money for small businesses and the bulk of taxpaeyrs? Don’t hold your breath. Why? These people do not present “systemic” risk to the economy while the banks and AIG are viewed as presenting “systemic” risk. That risk is defined as a risk so great that if the entity went down it would take a large part of the economy with it.

    What happens as a result? Buy time and keep running on the treadmill and pay more for the privilege of running. What fun!!

    Money is “fungible” meaning one dollar looks and acts just like every other dollar so the smoke and mirrors are way to effective in covering it all up.

    Taxpayers are getting screwed.

  • Pingback: Posts about Mortgage Market Report as of April 6, 2009 | Real Estate Market Reports()

  • 3AleneMcelroy

    Great comments ! Speaking of which , if your company needs a MD Comptroller 515 , my colleague discovered a fillable version here

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