Markets live chat transcript for the chat ending at 12:08 on 26 Nov 2008. Participants in this chat were: Paul Murphy (PM) Neil Hume (NH)
PM:
Okay welcome to Markets Live – FT Alphaville’s daily stock knock about.
PM:
I can report that Neil and I are feeling a tad uneasy this morning.
PM:
No sooner had we called the bottom on Friday afternoon – reiterated again on Monday.
PM:
Well, actually I should say called a big bear market rally.
NH:
No sooner had our pixels appeared than everyone has jumped on the AV bandwagon.
NH:
Been a rush of broker notes.
PM:
Even James Montier of SocGen has turned buyer.
PM:
We’ve got Credit Suisse this morning saying:
PM:
Policy innovations since last Friday are startling, and bring us much closer to
the point where they seem adequate to slow down, and even partially reverse,
the overwhelming force of deleveraging that has so deeply damaged global
growth, confidence and asset values since mid-September.
the point where they seem adequate to slow down, and even partially reverse,
the overwhelming force of deleveraging that has so deeply damaged global
growth, confidence and asset values since mid-September.
PM:
And now we’ve got this:
NH:
Martin Wolf says “BUY!”
PM:
What do we say? Get off our bandwagon, Martin?
NH:
Nah, you can’t say that to the FT’s chief economics columnist.
PM:
I think we should perhaps disembark from the bandwagon ourselves.
NH:
A consensus might be forming amongst strategists and commentators – but the markets generally still seem very cautious.
NH:
Or confused.
NH:
Well its off.
PM:
What’s the Footsie doing ?
NH:
ftse OFF 85 at 4,086
PM:
I’m not surprised after the last few days. Going up to quickly can feel just as sickly as dropping like a stone.
NH:
well I am
NH:
slighlty anyway
NH:
after all there were some big moves in the credit market overnight
NH:
the Fed intervention pushed down rates on 30-year mortgages by as much as one-half percentage point.
NH:
The spread between mortgages and Treasurys fell from 2.09 percentage points to 1.86, the biggest drop since the government put Fannie and Freddie into conservatorship Sept. 8
PM:
Im growing increasingly dizzy from all this quantitative easing stuff.
PM:
QE-ed
NH:
I know
NH:
First there’s an asset purchase plan
NH:
Then it turns into a capital injection plan
NH:
Then they buy the assets anyway – as well as injecting the capital
NH:
Ive lost sight of the real numbers
NH:
and why did they bother with the TARP
NH:
when all along they could have used the Fed and its printing presses
PM:
Outsourced to the Fed
NH:
We’re drowning in theory – what I want to see now is is some clarity on how the credit markets are reading this.
PM:
That’s not clear. QE involves the Fed manipulating the whole yield curve.
NH:
Oh don’t start. Fact is until we get evidence that this new policy is actually working I think the stock market will continue to lurch around.
PM:
I’ve got some more from Kemp on this.
NH:
Oh do share.
PM:
From John Kemp – Sempra economist who has now rocked up at Reuters.
PM:
Although good luck finding his stuff.
NH:
Just search with his name, no?
PM:
Well yeah.
PM:
Here’s some more from him anyway – on the issue of ineffective monetary policy:
PM:
Two solutions suggest themselves:
(1) Persuade the banks to start shifting the loans/reserves ratio back to more normal levels — either by improving economic stability or by threatening them with dire consequences if they do not resume lending voluntarily (nationalisation or state-directed lending programmes). There is a collective action problem here. Because so many households and firms are insolvent, or could easily become insolvent if the economy continues to deteriorate, it is irrational for any one bank to lend. The risk of loss is too great and the additional loans extended by any one bank would be insufficient to make a material difference to the prospective economic outlook and loss rates. But if ALL the banks increased their lending, the outlook would probably improve sufficiently that loss rates for ALL of them would be reduced. This is essentially why policymakers are trying to cajole or force the banks collectively to resume lending, but also why it is proving so difficult.
(2) The alternative is to by-pass the banks and begin providing direct credit to firms and households. This is in effect what the Fed started to do yesterday when it announced it would provide up to $600 billion to buy mortgage-backed securities issued by Fannie Mae and Freddie Mac, and another $200 billion to provide support to buyers of commercial loans, consumer loans and auto credit. If the banks will not or cannot lend, the Fed will do it for them. Direct lending (or support to other intermediaries who will do the lending instead) exposes the Fed to substantial credit risks. But if it can extend a sufficient volume of credits, it may hope to alter the economic outlook and thus the prospective loss rates.
PM:
More generally, the big problem for both the banks and the government is the difference between ex ante and ex post default rates.
Loans that would be sound ex ante in normal economic conditions or during a normal recession, could default ex post if the recession proves to be unusually severe or turns into a depression.
The lending bank does not know whether the next twelve months will see a recession or a depression. In effect, the outlook is a probability distribution with unknown parameters. There is a non-zero chance of depression with surging default rates.
To calculate prospective loss rates, the bank has to assign a non-zero chance of depression inducing a sharp rise in defaults. The prospective rise in loss rates must be reflected in an increased cost of credit and therefore a sharp reduction in the volume of loans actually made.
PM:
The more the banks scale back their lending, however, the more likely a depression becomes. If all the banks resumed strong lending, depression would be less likely. But no one bank is big enough to extend enough loans to have a material difference on the outcome. So it is rational for each bank to scale back lending even when it would be rational for all of them to resume.
The only solutions to this collective action problem are (1) lending by the central bank, (2) agreement among the banks collectively to resume loans (perhaps incentivised by some arrangement where the government absorbs some losses if they rise above a certain level), and (3) massive fiscal stimulus to prevent a deterioration in output, employment and default rates, which could then give the banks more confidence to resume lending.
In each case, the government/central bank is essentially acting as an “insurer” for households (against extreme unemployment) for firms (against extreme output declines) and for banks (against an extreme rise in default rates). By creating more certainty about the outlook, it gives everyone the confidence to continue spending, producing/investing and lending in normal volumes (or at least to retrench by only a moderate amount).
The government/central bank can avoid the collective action problems bedevilling the banking system because it can take a whole economy perspective and can lend in sufficiently massive volumes (or apply sufficiently massive stimulus) to alter the distribution of economic outcomes and thus the potential loss rates.
NH:
bickie
Reminder to readers – if you arrived late and want to stop the dialogue ‘jumping’ as you catch up, hit the ‘pause auto-scrolling’ tab at the bottom right hand corner
NH:
actually I have just dug out some facts and figures from the US market overnight
NH:
this is from Dresdner
NH:
The Federal Reserve and US Treasury today announced two new programs to help thaw the frozen credit markets. The initiatives are intended to lower the cost of borrowing for home mortgages, for car loans, for small business loans, for student loans and for credit card debt. The first program involves direct purchases by the Fed of up to $100bn in GSE debt and up to $500bn in MBS backed by the GSEs. The second program involves the Fed and the Treasury, in which they will provide loans up to $200bn to facilitate the issuance of ABS.
NH:
The broad equity indexes initially greeted the new government credit market programs with a rally but proceeded to spend most of the session in the red. A recovery near the close left the indexes mixed for the day with small changes. (DJ INDU 8479, +36;
S&P500 857, +6; NASDAQ 1465, -7)
S&P500 857, +6; NASDAQ 1465, -7)
NH:
The dollar continued its decline against the euro as Fed and Treasury actions mitigated the flight to liquidity that characterized most of last week’s FX trading. The dollar also fell against the yen on bets that carry trade activity will remain depressed by the global recession. (EUR/USD 1.3066, +0.0113; JPY/USD 95.47, -1.88)
Treasury coupon securities rallied strongly today, partly on mortgage duration buying in response to the government initiatives. The 2-yr to 10-yr yield curve flattened by about 12bp on the rally, erasing all the steepening seen since late September. (2-year note 1.15%, -13bp; 10-year note 3.08%, -25bp)
NH:
I think it was worth keeping an eye on the dollar
NH:
the massive expansion of the Fed balance sheet, is starting to worry investors
NH:
Dollar around 95 against the yen
NH:
that’s not far off the recent low of 93.85, recorded on Oct 27
NH:
in fact there is plenty of comment around on the Fed move
NH:
got this from Andrew Garthwaite at Credit Suisse
NH:
Following the Fed’s announcements we would make the following points:
NH:
This represents 8% of GSEs assets and 6% of the US mortgage market. That the Fed designs a package of this size is clearly positive.
Each 10bp off mortgage rates improves housing affordability by 1%. After the Fed’s announcement the 30-year mortgage yield has fallen by 50bp to 4.8% – equivalent to 5% decline in house prices (in terms of affordability).
NH:
We still think that US house prices will still fall by 5-10% because:
(i) there are still excess inventories of 1.5m homes in the US, which, we think, it will take approximately 2 years to clear
(ii)
(ii) US houses are still not cheap when we look at the price-to-wage ratio. Housing affordability, while improving, is still below previous peaks.
We think the Fed is willing to become even more aggressive by contemplating to print money to buy securitised assets. The FED balance sheet has already expanded to $2.2tn, equivalent to 15% of US GDP. Clearly, the US authorities are willing to do whatever it takes.
NH:
and here’s a bit more comment from Dresdner
NH:
The Federal Reserve and Treasury today announced two new programs to
purchase credit securities directly from private markets. This initative is
intended to lower the cost of borrowing for home mortgages, for car loans,
for small business loans, for student loans and for credit card debt. The
first program involves direct purchases by the Fed of up to $100bn in GSE
debt and up to $500bn in MBS backed by the GSEs. The second program
involves the Fed and the Treasury, in which they will jointly purchase up to
$200bn in ABS.
purchase credit securities directly from private markets. This initative is
intended to lower the cost of borrowing for home mortgages, for car loans,
for small business loans, for student loans and for credit card debt. The
first program involves direct purchases by the Fed of up to $100bn in GSE
debt and up to $500bn in MBS backed by the GSEs. The second program
involves the Fed and the Treasury, in which they will jointly purchase up to
$200bn in ABS.
NH:
Despite a pronounced lowering of the fed funds rate over the past year and a
number of government initatives to bolster the creditworthiness of financial
institutions, the availability of credit has not improved for many sectors of the
economy. Mortgage credit, for example, has become harder to get this year
compared to a year ago. The Fed’s Senior Loan Officer Survey shows that 78%
of banks are currently tightening standards for mortgage loans. In Q3 2007, just
as the current financial crisis started, only 31% of banks were tightening
conditions for mortgage loans. Despite a sharp decline in yields on long-term
Treasury securities, mortgage rates are higher now than at the start of the year
(see chart).
number of government initatives to bolster the creditworthiness of financial
institutions, the availability of credit has not improved for many sectors of the
economy. Mortgage credit, for example, has become harder to get this year
compared to a year ago. The Fed’s Senior Loan Officer Survey shows that 78%
of banks are currently tightening standards for mortgage loans. In Q3 2007, just
as the current financial crisis started, only 31% of banks were tightening
conditions for mortgage loans. Despite a sharp decline in yields on long-term
Treasury securities, mortgage rates are higher now than at the start of the year
(see chart).
NH:
Mortgage rates have remained high because of the reduced appetite for risk on
the part of private investors. These investors include central banks around the
world who were previously avid buyers of GSE debt and of MBS issued by the
GSEs. In the year through July, foreign official institutions increased their
holdings of federal agency securities (held in custody at the Fed) by $222bn. In
the last three months, these holdings have dropped -$72bn.
The reduced appetite for GSE debt and MBS have pushed up the yield on these
securities. This means the GSEs have not benefitted from the reduction in the
fed funds rate, nor have they benefitted very much from their status as
“government guaranteed debt.” By buying GSE debt and MBS, the Fed should
be able to push down the yield on these securities, enabling the GSEs to acquire
new financing at a lower rate. That would enable the GSEs to purchase home
mortgages at lower rates as well.
the part of private investors. These investors include central banks around the
world who were previously avid buyers of GSE debt and of MBS issued by the
GSEs. In the year through July, foreign official institutions increased their
holdings of federal agency securities (held in custody at the Fed) by $222bn. In
the last three months, these holdings have dropped -$72bn.
The reduced appetite for GSE debt and MBS have pushed up the yield on these
securities. This means the GSEs have not benefitted from the reduction in the
fed funds rate, nor have they benefitted very much from their status as
“government guaranteed debt.” By buying GSE debt and MBS, the Fed should
be able to push down the yield on these securities, enabling the GSEs to acquire
new financing at a lower rate. That would enable the GSEs to purchase home
mortgages at lower rates as well.
PM:
Thanks for all that
PM:
Actually — got an up to date number for the dollar
PM:
v yen
NH:
hang on
NH:
against the GBK it is $1.5326
NH:
so dollar weaker there
NH:
and the yen?
NH:
at 95.15
PM:
Oooh — so threatening to go thru 95 again
NH:
and at some point the Fed will have to fund this QE policy and one hopes the Chinese will still want to buy Treasuries
PM:
the figure of 95 reminds me of Peter Garnham’s piece from the weekend
PM:
The new menace
PM:
Power-reverse dual currency bonds 
PM:
Supposed to be a trigger of 95 for unwinding or hedging those — with another trigger epxected at 90
NH:
ah, yes. I read that
NH:
sorry we have been distracted by post by Michael Fowke
NH:
he had lunch with our editor apparently
PM:
Excelled himself
NH:
they had pot noddles – spicy curry flavour – washed down with cans of Fanta
NH:
beat that Paul
PM:
Afterwards, we had a couple of those little blackcurrant cheesecake things. Lovely
PM:
Actually — im off to J Sheekey’s a t lunch
NH:
not again
PM:
Tough this credit crunch
PM:
NH:
I am going to die in the corner
NH:
think I might have man flu
PM:
PM:
Let’s get to some stock specific stuff
PM:
how about Rio Tinto
PM:
Any recovery after yesterday’s mauling??
NH:
none whatsoever
NH:
shares off a further 66p at £14.85
NH:
and that’s in spite of the rest of the rest of the mining sector moving higher in the wake of the Chinese rate cuts
PM:
so what’s going on here
PM:
the company were pretty clear yesterday
PM:
debt is not a problem
PM:
they can meet next year’s refinancing of around $9bn
PM:
and there will be no rights issue
NH:
well
PM:
in fact they said as much on the site yesterday — put it up as a late comment
NH:
it would seem that no one wants to own a heavily indebted mining company heading in to a global economic slowdown
NH:
and until Rio cuts its debt position, through disposals, free cash flow, or whatever else
NH:
the shares are going to languish, IMO
NH:
and I can’t even see the Chinese angle providing much support
NH:
because they have only been given approval from the Aussie govt to buy up to 14.99%
NH:
The Aussie’s a v sensitive about Chinese influence
NH:
and it is not even obvious that valuation will provide much support
NH:
on a debt adjusted basis Rio just does not look at attractive
NH:
this is how one broker put to me this morning
NH:
Rio is trading around 3.8x next year’s ebitda
NH:
BHP is on 2.9
NH:
and
NH:
Rio has more debt
NH:
it’s net debt/ebitda is 2.3
NH:
all of which begs the question of why Rio should not trade on a BHP type multiple
NH:
and on top of all of that
NH:
lot of people bought into Rio yesterday
NH:
saying the fall had been overdone
NH:
that has not proved to be the case
NH:
and those punters are cutting positions this morning
PM:
I see — v painful 
NH:
mind you I take my hat off to the Rio PR machine
NH:
the are pelting jornos’ with notes saying Rio
PM:
NH:
Rio is cheap
NH:
the reason the bid fell apart was not debt, but BHP misreading the EU
NH:
and all the debt can be safely paid down by 2013
PM:
Tinto Feltos
PM:
NH:
but no one wants to know
NH:
they are not buying into the argument
NH:
and here are a few examples
NH:
Please see attached another Buy note on Rio, this one from Canaccord describing the share price reaction to BHP’s withdrawal as “a gross overreaction” and commenting “In our view, Rio Tinto’s balance sheet is not unduly stressed in the commodity price environment we are projecting. On our numbers, the entire US$42 billion of borrowings can be paid down by 2013 without recourse to asset sales.”
PM:
NH:
We also believe the fall in Rio Tinto’s share price is a gross over-reaction to the perceived financial risk. Rio’s net debt is US$42 billion at three-month LIBOR plus 30 to 40 basis points, depending on the facility, which means today that the interest burden is well below
3%.
3%.
This translates to an interest charge of circa US$1.26 billion for a company with an
estimated US$23.8 billion of EBITDA this year and US$19.8 billion in 2009. The loan repayment schedule calls for US$9.95 billion to be repaid or replaced in October 2009 and $13.5 billion in October 2010.
NH:
In our view, Rio Tinto’s balance sheet is not unduly stressed in the commodity price
environment we are projecting. On our numbers, the entire US$42 billion of borrowings can be paid down by 2013 without recourse to asset sales.
environment we are projecting. On our numbers, the entire US$42 billion of borrowings can be paid down by 2013 without recourse to asset sales.
NH:
and this
NH:
hang on small tech problem
NH:
email may have gone down
NH:
bear with me
NH:
working again
NH:
but very slow
NH:
very slow
NH:
Oh no
NH:
the sucker has gone down
NH:
email system gone
NH:
hope the server is OK
NH:
have the hoodies attacked the data center again?
NH:
right, while we wait for that to come up
NH:
here’s another note
NH:
Interesting note from Bernstein.
NH:
says the flack
NH:
We believe the fall in Rio Tinto’s stock yesterday (-35%) was an overreaction and would buy on the current weakness. We place the fundamental valuation ratio of Rio Tinto and BHP Billiton using EV/EBITDA methodology at approximately 2:1, but yesterday’s move took the stocks from a 2.5 ratio to
1.47.
1.47.
NH:
We believe this reflects a pricing in of liquidity and debt risk that we believe is overstated for Rio Tinto (see our call of November 20th, Diversified Miners: A Review of Cash Flow and Debt Under Various Commodity Scenarios).
The news-flow on Rio Tinto may improve. Management is likely to switch its emphasis from relative value to liquidity and we would view announcements of capex reductions as positive as we believe they (in addition to asset sales and iron ore outcomes being higher than the market is pricing in) will reduce the perceived debt risk going forward. We have removed the bid premium from our target price
calculation. We had never ascribed any synergy value to the deal in our valuations
PM:
Well I supposed you are telling how it is, Neil.
PM:
Just to catch up on a conversation below…
PM:
Idea of starting an energy table in the Long Room
PM:
We can definitely do that — my colleague Izabella might be able to host
PM:
She used to work at BP, for her sins
PM:
Actually i think she had a good time there
PM:
PM:
Right — Neil is just digging something out of the paper
NH:
Media in dock
By James Mackintosh
Published: November 26 2008 02:00 | Last updated: November 26 2008 02:00
NH:
The parliamentary probe into the banking crisis will consider whether journalists should be gagged during an emergency to preserve financial stability, writes James Mackintosh .
The inquiry by the Treasury select committee will consider “the role of the media in financial stability and whether financial journalists should operate under any form of reporting restrictions during banking crises”.
The inclusion of the media comes after calls by Michael Howard, former Tory leader, for the Financial Services Authority to investigate the source of BBC reporter Robert Peston’s story that banks had asked for government cash.
John McFall, Labour chairman of the committee, said the media were just one part of the debate.
PM:
NH:
that got me spluttering into the cornflakes this morning
PM:
So how are they going to do that, issue D notices?
PM:
Cut off the electricity?
NH:
and insist all copy on banks goes through Pestowire
Top News from Top Sources. The BBC’s Business Editor, Robert Peston, has played in important role keeping the British public fully informed during these difficult times.
PM:
Oh of course
PM:
Quite sensible really
NH:
but seriously are these people nuts
NH:
gagging the press
PM:
NH:
we are not on a war footing
NH:
really, really worrying
PM:
Maybe the FSA could come up with a list — like the short list — where we can only make positive comments
PM:
Taylor Value
PM:
HUP
PM:
Northern Opportunity
NH:
well, the FSA are first trying to shut down the rumour mill
NH:
they wanted to outlaw market discussion
PM:
yes, everyone’s got to have a policy on having market discussions
NH:
NH:
actually talking of Taylor, very, very good value, Wimpey
PM:
NH:
how is the house seller going on the back of our story??
PM:
Alphaville, the site the support our stocks
PM:
Price is up 1.2p at 5.6p 
NH:
hmmm
NH:
so the idea is that the lenders are going to take a small equity stake in return for a covenant waiver?
PM:
Hmm, thought they’d want more tangible security than that
NH:
me too, but this company is probably worth more to them alive than dead
NH:
ie – it is worth preserving as a zombie company
PM:
Actually, im surprised the price has risen this morning
PM:
Whatever stake the banks might take, they are not going to take it above market price
PM:
If you look at all the debt for equity swaps from the early 90s
PM:
All done under the so called London Approach
PM:
They tended to be done at 2p or something — for a huge stake
PM:
Workout would last a number of years
PM:
I have no inside knowledge — but my guess would be that any refinancing is done rather closer to 2p
NH:
I have a bit of comment on this
NH:
from Singer
NH:
the FT is reporting that TW is prepared to let its lending banks take equity stakes in the group (in addition to charging higher loan rates) in return for re-financing with covenant condition waivers. To be fair the group commented in its last IMS conference call that the banks were seeking some participation in the ‘economic value’ over and above a straight re-financing of its £2.4bn facilities (£1.7bn outstanding net debt) with higher interest rates so this is hardly a shock report by the FT
NH:
It is however claiming that they will be allowed to take “single-digit” stakes although does not say whether these will be ‘debt-for-equity’ or merely additional to a core re-financing; our guess would be the latter, or at least some sort of deferred convertible. Of course such a concession raises issues for both the US private placements and the Eurobond holders. Technically the banks support runs out on 1st Jan whilst the PPs and Eurobonds will probably need to see audited accounts late February.
NH:
Meanwhile this type of news will do little to allay fears that the existing equity will be potentially diluted away to negligible. We are unable to put a sensible value the stock under the current circumstances, if indeed there is any.
NH:
actually that is it
NH:
looks like most analysts can’t be bothered with Wipeout anymore
PM:
hmmm
NH:
as for New Star Asset Management
NH:
got hammered yesterday
NH:
and there has been no respite this morning
NH:
down a further 17.2% to 13.25p
PM:
Neil — you must remember that John Jay of New Star voted for you last week with big M&A gong
PM:
Also, I forgot to tell readers that you had to make a speech
PM:
PM:
600 assembled M&A bankers in some opera house
PM:
Neil had to explain how he came about the story
PM:
NH:
yes, very embarassing
PM:
You can image. Neil said: “Er….”
NH:
actually what I said was
NH:
I would like to thank a few people for help with the story
NH:
ie you
NH:
and Helen
NH:
mind you some of winners went all Gwyenth Paltrow
NH:
annd thanked everyone
NH:
mums, dad, cousins, brothers, sisters, the baker, the butcher etc
PM:
I can imagine
NH:
the news on New Star for those who missed is that they have suspended trading in its property fund
NH:
because of massive redemptions
NH:
the fund has not actually performed that badly
NH:
relative
PM:
PM:
Moving on
PM:
Just to a couple of points below
PM:
hedgehog — that is what is known in the journalist trade as an escape chute
PM:
TheHoof — no transcript i am afraid, otherwise would have published
PM:
Obviously
NH:
just found some comment on New Star
PM:
Bohemia — take you r ponit
NH:
from Altium
NH:
temporary suspension in dealing in the group’s International Property Fund.
§ Altium view: The announcement yesterday that the group has suspended dealing in
its International Property Fund temporarily with immediate effect was, we understand,
a decision taken reluctantly by the company. We see this as unhelpful news flow for
NSAM.
§ Implications for estimates / valuation / recommendation: We are not changing our
towards the bottom of the range FY 2009E EBITDA estimates (following yesterday’s
revisions) but feel it is prudent to trim our target price to 12p (15p).
§ Altium view: The announcement yesterday that the group has suspended dealing in
its International Property Fund temporarily with immediate effect was, we understand,
a decision taken reluctantly by the company. We see this as unhelpful news flow for
NSAM.
§ Implications for estimates / valuation / recommendation: We are not changing our
towards the bottom of the range FY 2009E EBITDA estimates (following yesterday’s
revisions) but feel it is prudent to trim our target price to 12p (15p).
PM:
PM:
What else have you been lookng at Neil??
NH:
insurers
NH:
for a while now
NH:
this sector has been worrying market professionals
NH:
while most of the problems in the banking sector are out in the open
NH:
they reckon things aren’t so clear in the insurance world
NH:
and they can’t believe insurers will get through the worst financial crisis since 1930′s
NH:
without there being a major blow up or fund raisings
PM:
well, we have had AIG
PM:
and a number of profit warnings
NH:
true
NH:
but in Europe, there has not been a significant blow up
PM:
hmm
PM:
but share prices have taken a hammering
NH:
fair point
NH:
but not on par with the banking sector
NH:
anyway, all of this is just a long winded way of bringing us to note out from Cazenove this morning
NH:
and here is the piece
NH:
says sector looks cheap
NH:
but a problem looms and it is not falling equity markets
NH:
but corporate bond default
NH:
and here is the piece
NH:
The UK life sector looks cheap relative to historic valuation multiples, but this reflects
legitimate fears of dividend cuts, or even rights issues, due to asset declines and the
potential need to repair solvency buffers. Solvency surpluses fell by 9% in Q3 and have
probably fallen a further 5% in Q4, with equity falls being partly offset by lower risk free
rates. Corporate bond default risk looms large, given record spreads. We have cut EPS
estimates by a further 11-12% for 2009E-2010E to reflect Q4 asset declines so far.
legitimate fears of dividend cuts, or even rights issues, due to asset declines and the
potential need to repair solvency buffers. Solvency surpluses fell by 9% in Q3 and have
probably fallen a further 5% in Q4, with equity falls being partly offset by lower risk free
rates. Corporate bond default risk looms large, given record spreads. We have cut EPS
estimates by a further 11-12% for 2009E-2010E to reflect Q4 asset declines so far.
NH:
The three internationally diversified life companies (Old Mutual, the Pru, and Aviva)
carry the most asset risk relative to their solvency cushions. We have already cut our
final DPS forecast for OM to zero in light of asset market, FX, and hedging
ineffectiveness losses. The other two are paying out an above average level of solvency
surplus in dividends. At least Aviva can fall back on its general insurance cashflows, but
neither has much room to manoeuvre compared to the domestic peer group. This risk
cuts both ways, and we recommend investors looking for a geared play on a market
recovery should invest in Aviva (Outperform) as the company with what we believe is the
best risk/reward profile in the sub-group. We recommend investors looking for more
conservatively managed companies with solid balance sheets should look at L&G and
FP [both Outperform]. Neither is taking much credit risk in proportion to its solvency
surplus, and neither dividend appears at risk.
carry the most asset risk relative to their solvency cushions. We have already cut our
final DPS forecast for OM to zero in light of asset market, FX, and hedging
ineffectiveness losses. The other two are paying out an above average level of solvency
surplus in dividends. At least Aviva can fall back on its general insurance cashflows, but
neither has much room to manoeuvre compared to the domestic peer group. This risk
cuts both ways, and we recommend investors looking for a geared play on a market
recovery should invest in Aviva (Outperform) as the company with what we believe is the
best risk/reward profile in the sub-group. We recommend investors looking for more
conservatively managed companies with solid balance sheets should look at L&G and
FP [both Outperform]. Neither is taking much credit risk in proportion to its solvency
surplus, and neither dividend appears at risk.
NH:
9% average Q3 falls in EUIGD surplus
The sector’s EUIGD surplus fell on average by 9% during Q3 (figure 2). Old Mutual underwent the
most precipitate fall of 27%, although both Pru and L&G saw falls in the mid-teens. Old Mutual
fared particularly badly due to hedging ineffectiveness and bond defaults, in addition to equity
market losses. Aviva, FP, and Standard Life were relatively insensitive to market turmoil in Q3,
although Aviva was helped by a change in the solvency treatment of its RAC subsidiary and some
hybrid issuance.
The sector’s EUIGD surplus fell on average by 9% during Q3 (figure 2). Old Mutual underwent the
most precipitate fall of 27%, although both Pru and L&G saw falls in the mid-teens. Old Mutual
fared particularly badly due to hedging ineffectiveness and bond defaults, in addition to equity
market losses. Aviva, FP, and Standard Life were relatively insensitive to market turmoil in Q3,
although Aviva was helped by a change in the solvency treatment of its RAC subsidiary and some
hybrid issuance.
and we forecast 5% in further falls in Q4
NH:
Figure 2 also shows the sensitivity of each group to further market volatility compared to end
September levels. Each company presents its sensitivities at different points but we have
interpolated to estimate the Q4 impact of equity and gilt movements for all the companies. In the
case of Old Mutual the surplus is quite sensitive to the dollar/sterling exchange rate, which has
been a big drag on solvency in Q4.
September levels. Each company presents its sensitivities at different points but we have
interpolated to estimate the Q4 impact of equity and gilt movements for all the companies. In the
case of Old Mutual the surplus is quite sensitive to the dollar/sterling exchange rate, which has
been a big drag on solvency in Q4.
NH:
Old Mutual solvency collapse continued in Q4
This suggests that Old Mutual would again be comfortably the worst affected group in Q4 to date,
with a 37% expected fall in solvency, with its dollar sensitivity a key factor. Old Mutual’s surplus
falls by £17m for every 1% of dollar appreciation, which has been painful in Q4 so far. Old
Mutual’s position appears particularly precarious in light of the outgoing finance director’s view
that a £750m surplus was the group’s pain threshold. Although L&G has probably suffered a
significant 14% decline in solvency surplus, the absolute amount of capital remains high in relation
to its medium sized balance sheet. The Pru probably experienced a further 17% decline too, and
continues to offer above average solvency risk.
This suggests that Old Mutual would again be comfortably the worst affected group in Q4 to date,
with a 37% expected fall in solvency, with its dollar sensitivity a key factor. Old Mutual’s surplus
falls by £17m for every 1% of dollar appreciation, which has been painful in Q4 so far. Old
Mutual’s position appears particularly precarious in light of the outgoing finance director’s view
that a £750m surplus was the group’s pain threshold. Although L&G has probably suffered a
significant 14% decline in solvency surplus, the absolute amount of capital remains high in relation
to its medium sized balance sheet. The Pru probably experienced a further 17% decline too, and
continues to offer above average solvency risk.
PM:
thanks for that
PM:
PM:
LIBOR?
NH:
yup have that
NH:
THREE-MONTH STERLING LIBOR/OIS SPREAD AT 231 BPS VS 223 BPS ON T
NH:
THREE-MONTH EURO LIBOR/OIS SPREAD AT 166 BPS VS 168 BPS – REUTER
NH:
THREE-MONTH DOLLAR LIBOR/OIS SPREAD AT 179 BPS VS 172 BPS – REUT
PM:
oh dear – sterling OIS
NH:
LIBOR THREE-MONTH STERLING RATES FIX AT 3.94625 PCT
PM:
$ going wrong way also
NH:
LIBOR THREE-MONTH EURO RATES FIX AT 3.90625 PCT VS 3
NH:
LIBOR THREE-MONTH DOLLAR RATES FIX AT 2.18125 VS 2.1
PM:
cheers
NH:
2.19625 PCT
PM:
PM:
we must finish up – quite soon
NH:
before we do
NH:
one thing I want to mention
NH:
we are frequently asked about the lack of RAW on the site
RAW is market chatter – information that has not been formally tested through traditional journalistic channels (PRs etc). The story might be complete rubbish, but if we believe there is some substance to it we will say so. Either way, Reader Beware.
NH:
why are there no stories
NH:
and the answer is there are no deals being plotted
NH:
I know of one involving a FTSE 100 company that was pulled a few weeks because of problems with funding
NH:
and it is the same across the board
NH:
and unfortunately readers
NH:
it does not look like things are going to get any better in the short term
NH:
in fact all we have got to look forward to next year
NH:
is a few all paper deals
PM:
Says how???
NH:
UBS
NH:
they have published a note on M&A financing
NH:
and for deal junkies like myself the outlook is pretty bleak
NH:
which is why I will have to start mugging up on credit and quantative easing
NH:
because M&A is in hibernation
NH:
here’s the note
NH:
Does Inbev mark a turning point?
Last week Inbev completed its $52bn acquisition of Anheuser-Busch. However,
the AB-InBev deal had already launched into general syndication pre-Lehman so a
successful syndication of debt on this scale is not indicative of the level of
acquisition financing available in the current markets, in our view.
Last week Inbev completed its $52bn acquisition of Anheuser-Busch. However,
the AB-InBev deal had already launched into general syndication pre-Lehman so a
successful syndication of debt on this scale is not indicative of the level of
acquisition financing available in the current markets, in our view.
NH:
Several big deals still awaiting syndication
Currently there are four sizeable deals that have been underwritten but still
awaiting syndication including EDF/British Energy, BASF/Ciba, Schaeffler/Conti
and Gas Nat/Fenosa. Certain funds have not been a comfort as far as deal spreads
are concerned. Also we understand that Roche had tentative commitments from
banks back in August for its $45bn Genentech bid but current credit market
conditions are likely to necessitate a delay to the bidding process. .
Currently there are four sizeable deals that have been underwritten but still
awaiting syndication including EDF/British Energy, BASF/Ciba, Schaeffler/Conti
and Gas Nat/Fenosa. Certain funds have not been a comfort as far as deal spreads
are concerned. Also we understand that Roche had tentative commitments from
banks back in August for its $45bn Genentech bid but current credit market
conditions are likely to necessitate a delay to the bidding process. .
NH:
M&A lending appetite close to nil and M&A refinancing issues from some
We have not seen a large deal launched and successfully syndicated since the
dislocation in September and lack of syndication success has severely impacted
appetite for future underwriting. And it is also clear that some corporates will
spend some of 2009 dealing with acquisition refinancing issues arising from deals
done this year and last.
We have not seen a large deal launched and successfully syndicated since the
dislocation in September and lack of syndication success has severely impacted
appetite for future underwriting. And it is also clear that some corporates will
spend some of 2009 dealing with acquisition refinancing issues arising from deals
done this year and last.
NH:
Which means 2009 M&A needs to be driven by paperand ‘winners’
The foregoing suggests to us that incremental deals – which we do expect in 2009
given the scope for consolidation, etc. – will largely be financed via rights issues or
be executed where feasible as share for share exchanges. Bankable companies with
leading market share, strong cash flow and “cast-iron” dividends will be at a
distinct advantage.
The foregoing suggests to us that incremental deals – which we do expect in 2009
given the scope for consolidation, etc. – will largely be financed via rights issues or
be executed where feasible as share for share exchanges. Bankable companies with
leading market share, strong cash flow and “cast-iron” dividends will be at a
distinct advantage.
NH:
The M&A market has been most obviously affected by issues in bank financing.
This is apparent in both deal volumes and spreads on existing deals. Pressure on
the banks is coming from governments and other new shareholders to deemphasise
M&A financing in favour of mainstream corporate lending to smalland
medium-sized enterprises. Importantly, not one large deal has been launched
and successfully syndicated since the dislocation in September. In a few cases,
terms have had to be flexed upwards. This combined with the need to provide
finance to bidders who must generally bid on a “certain funds” basis has
severely impacted appetite for future underwriting.
This is apparent in both deal volumes and spreads on existing deals. Pressure on
the banks is coming from governments and other new shareholders to deemphasise
M&A financing in favour of mainstream corporate lending to smalland
medium-sized enterprises. Importantly, not one large deal has been launched
and successfully syndicated since the dislocation in September. In a few cases,
terms have had to be flexed upwards. This combined with the need to provide
finance to bidders who must generally bid on a “certain funds” basis has
severely impacted appetite for future underwriting.
NH:
Our analysis of financing markets1 suggests that incremental deals – which we
do expect in 2009 given the scope for consolidation, etc. – will largely be paperfinanced.
We also expect to see attempts to raise debt and equity financing to
build up moderate “war chests” for acquisitions as 2009 progresses. For example,
Resolution recently disclosed plans to capitalise an acquisition vehicle by up to
£1bn in equity and Marfin shareholders approved a
do expect in 2009 given the scope for consolidation, etc. – will largely be paperfinanced.
We also expect to see attempts to raise debt and equity financing to
build up moderate “war chests” for acquisitions as 2009 progresses. For example,
Resolution recently disclosed plans to capitalise an acquisition vehicle by up to
£1bn in equity and Marfin shareholders approved a