Wednesday, February 14, 2007

“Let’s keep going”: The Credit Markets Find Their Inner Thelma and Louise



Thelma Dickinson: OK, then listen, let's not get caught.
Louise Sawyer: What're you talking about?
Thelma: Let's keep going.
Louise: What do you mean?
Thelma: Go.
Louise: You sure?
Thelma: Yeah, yeah. Let's.

—Thelma and Louise
Written by Callie Khouri


Seems to me the world’s credit markets have found their Inner Thelma and Louise.

For those not familiar with that movie of “lady fugitives on the run,” the quote above is from the final scene in which the pair of sympathetically-depicted criminals in their getaway car decide—police behind them and canyon in front—to “keep going” over the cliff.

Which is, it seems to me, exactly what the world's credit markets have decided to do en masse, so inexorable is their drive to lend to anybody with title to an asset—any asset—and a pulse.

The head-scratcher, of course, is that it was precisely the same type of non-existent credit standards that got America’s home-buyers, and their lenders, in trouble not so long ago.

And by “not so long ago,” I mean, “like, last week.”

For that is when HSBC announced a $1.76 billion dollar sub-prime debt impairment charge, blowing the collective minds of HSBC shareholders and U.S. sub-prime mortgage lenders alike.

Here's how last week's Wall Street Journal described the errors of HSBC's ways:

When the U.S. housing market was booming, HSBC Holdings PLC raced to join the party. Sensing opportunity in the bottom end of the mortgage market, the giant British bank bet big on borrowers with sketchy credit records.

Yet according to my Bloomberg, the lessons learned are not, apparently, stopping anybody from throwing money at leveraged buyouts the way HSBC was throwing money at the Thelmas and Louises of the sub-prime mortgage market.

Univision Seeking Record “Covenant-Lite” Loan for LBO — By Harris Rubinroit, Bloomberg

Feb. 13 (Bloomberg) -- Univision Communications Inc., the largest U.S. Spanish-language broadcaster, is asking potential lenders to forgo restrictions on a $7 billion loan to fund its leveraged buyout, according to investors who may participate.

Now, you might think that those “potential lenders” would have second or third thoughts before committing to such terms, what with the sub-prime blow-up still reverberating on the Wall Street Journal's front page this very morning:

Rising defaults are prompting some lenders to clamp down on the use of “piggyback” mortgages, a risky type of loan that allows borrowers to finance up to 100% of the purchase price.

Yet according to the Bloomberg story it would appear that sub-prime commercial borrowers are being courted with as much fervor as the sub-prime Thelma and Louise-type home buyers during the housing boom of, oh, eighteen months ago:

Univision is seeking a covenant-lite loan, which has no quarterly limit on the borrower's amount of debt relative to cash flow. The Los Angeles-based company also wants no quarterly requirement for the minimum amount of cash flow it must generatein proportion to interest expense, said three investors, who declined to be identified because the terms aren't public.

Correct me if I’m wrong, but that looks suspiciously like a sort of corporate version of the “no documentation” loans described in the HSBC report just last week:

To speed up these purchases from other lenders, HSBC accepted loan paperwork that didn't verify whether borrowers made as much as they claimed. Mortgages that rely on the borrower's word about that are called "stated-income" loans. (More conservative lenders might demand full documentation of income.)

More conservative lenders than HSBC are not taking $1.76 billion charges for their fully documented loans.

And more conservative lenders will probably shy away from deals like Univision. But that is not stopping Univision from demanding the virtual equivalent of “stated-income” loans for its multi-billion dollar buyout from the HSBC's of the commercial markets:

The seven-and-a-half year covenant-lite loan would be the largest loan of its type. The money is part of $10.2 billion in financing to be used to help pay for Univision's $12.3 billion takeover by a buyout group that includes Madison DearbornPartners LLC, Providence Equity Partners Inc., Texas Pacific Group, Thomas H. Lee Partners LP and Saban Capital Group Inc.

And despite what you heard Mick Jagger sing growing up in the early 70's, Univision will probably get what it wants.

The Univision loans are a ``function of excess liquidity in the market driven by institutional investors,'' said Neal Schweitzer, a senior vice president in corporate finance at Moody's Investors Service in New York. ``The loans are structured to weather a potential hiccup.''

As with HSBC and its sorry tale of woe, however, I suspect we will find in the not too distant future that the Univision loans are structured for nothing but the simple blind faith that the worldwide asset bubble will continue to expand—the same kind of blind faith that blew up HSBC:

"There was very little data on loans to subprime borrowers where the borrower put very little down," says Thomas Lawler, a housing economist in Vienna, Va.

Chris Freemott, president of All American Mortgage Inc. in Naperville, Ill., says it was a time when "everyone lowered their credit standards" in what he refers to as "a race to the bottom." Adds Mr. Hamilton at Lime Financial: "People got way too aggressive in pricing, and they weren't pricing for the risk."

And so the commercial credit markets, as did the sub-prime mortgage market once upon a time, “race to the bottom.”

While Thelma and her pal have already driven off the cliff.


Jeff Matthews
I Am Not Making This Up

© 2007 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author.



3 comments:

Aaron said...

Two quick comments, Jeff:

A) HSBC isn't the only bank that got caught with losses from sub-prime mortgage securities. Merrill Lynch lost money too from its relationships with sub-prime lenders like Ownit and Mortgage Lenders Network, who have since failed. Guess those investments by Merrill were strong buys (not)!

In the spirit of your mantra, I am not makng that up - readers can see for themselves by clicking here on Bloomberg's website.

B) If lending standards are tightening around the globe, and assets are put at risk when it comes to no-covenant loans, I wonder whether "insurance" (i.e., credit-default swaps) would be worth buying, in spite of its cost, to protect one's investment in case of a credit event like a bankruptcy or corporate restructuring? Just wondering, but then hey, I could be wrong.

smithycroftman said...

"There was very little data on loans to subprime borrowers where the borrower put very little down," says Thomas Lawler, a housing economist in Vienna, Va.

This is back to your "Beware the Model" post, Jeff. It is amazing how excel spreadsheets have taken the place of good old fashioned judgement. There was little data because local bankers would have laughed these borrowers out of the branch, "back in the day". Just sign up for my favourite the Ninja loan (No Income No Job Application). I wonder how the backtesting for that looks?

fiveyearhold said...

I remember at the time HSBC bought Household, their CEO bragged that they had some thing like 100 or 200 PhD's focussed solely on managing credit risk. Turns out they were relying heavily on FICO scores, which had never been tested in difficult housing markets. Garbage in, garbage out.