And speaking of credit cards, JPM has just imposed a 5% credit card balance fee (higher than even that at nationalized in all but name bank BofA which only went as high as 4%). This is sure to "facilitate" the willingness of consumers to borrow the nearly $1 trillion in excess cash held in assorted bank basements. Also, it might put a damper on future iPhone sales: every iPhone purchase is roughly equivalent to 0.0001% increase in charge off rates."These trajectories are both consistent with our revised expectation for the charge-off rate index to peak in the second quarter of 2010 at about 12 percent, assuming an unemployment rate peak close to 10 percent in the first half of 2010," the report said.
The charge-off rate for accounts assumed to be bad debts increased to a new high in April for the fifth consecutive month, settling at 9.97 percent, the report said.
"After tacking on another 60-plus basis points in April, the index charge-off rate is now almost 60 percent higher than a year ago," the report said.
"This pace of rising charge-offs is unprecedented as year-over-year changes continue to surpass the magnitude of either increases or decreases experienced during any previous period," the report said.
"We anticipate that by mid-year delinquency rates will again be on the rise in concert with a deteriorating employment picture into 2010," the report said.
New York, June 22, 2009 -- Commercial real estate prices as measured by Moody's/REAL Commercial Property Price Indices (CPPI) decreased 8.6% in April, leaving the index at 25.3% below its level a year ago and 29.5% below the peak in prices measured in October 2007.
Moody's says the large negative return for April likely reflects in part the fact that deals closed during that month were negotiated at the end of 2008 and in the first quarter of 2009, when securities markets and overall sentiment were plunging.
"The size of April's decline, following a 5.5% decline in January, also suggests that sellers are beginning to capitulate to the realities of commercial real estate markets," says Moody's Managing Director Nick Levidy. "While loss aversion is no doubt still in play with many owners, more distressed sales appear to be occurring, resulting in more negative returns and causing larger drops in the index."
Overall sales volume in the market also fell in April as compared to March, and by count April had the lowest number of transactions in the history of the CPPI.
In the Eastern region, the CPPI shows prices for all four property types declining over the last year, but with apartment prices holding up best. These have declined 11.8% from a year before, compared with drops of 15.9% for industrial properties, 27.2% for offices, and 21.5% for retail.
Overall, the South has been the worst performing region over the last year. All four property types have seen annual declines of more than 20%, with industrial properties falling the most, with a decline of 28.8%.
The indices also show that all four property types have performed worse in Southern California than they have in the Western region as a whole. In Southern California, the office market has been the worst performer, with prices dropping 22.2% in the last year.
The three major office markets -- New York, San Francisco, and Washington DC—have all posted significant annual declines. The San Francisco office market saw a drop of 20.3%, while New York had a decline of 12.9% and Washington 21.1%, both less than the yearly decline for the Eastern region of 27.2%.
Moody's notes the Florida apartment market, like the apartment market in the South as a whole, has experienced three straight years of falling prices. Florida apartment prices are now down 31% from their peak.
The CPPI
Moody's/REAL Commercial Property Prices Indices are based on the repeat sales of the same properties across the US at different points in time. Analyzing price changes measured in this way provides maximum transparency and methodological rigor. This approach also circumvents the distortions that can occur with other commercial property value measurements such as appraisals or average prices, says Moody's.
The need to have a AAA rating to be eligible “for government programs raises the specter of rating shopping,” Andrew Kimball, head of the global structured finance business at Moody’s Investors Service, said during the company’s investor day today. “Those programs don’t differentiate on the quality of the rating. Rating shopping becomes a problem.”As I observed a few weeks back, in an effort to facilitate just this kind of rating shopping phenomenon, the Fed, for the first time, allowed DBRS and Realpoint to participate in the list of TALF rating-eligible rating agencies. Of course, this is meant only to provide a larger universe from which to pick for those 2 (or however many) raters that will provide the increasingly elusive AAA rating.
As a result, New York-based Moody’s hasn’t been included in some recent transactions, Kimball said on a conference call broadcast from the event. Under TALF, the Fed provides low-cost loans to investors to buy AAA rated securities backed by auto, credit card, equipment, education and other kinds of loans. Companies sold about $15 billion of eligible asset-backed debt ahead of the fourth deadline for the Fed’s TALF on June 2, up from about $13.5 billion in May, according to Bloomberg data.
...
The Obama administration and Bernanke are counting on the TALF as a cornerstone of plans to revive credit and end the recession. While the program is on pace to fall short of its $1 trillion official ceiling, Bernanke said in a letter to a lawmaker last month that the TALF has helped create “improved conditions” in the asset-backed securities market.
Cabela’s Inc., a Sidney, Nebraska-based chain that specializes in hunting and fishing gear, sold about $425 million in bonds backed by payments on its store card for TALF in April. The securities had AAA ratings from S&P, Fitch, and Toronto- based Dominion Bond Rating Service Ltd. Moody’s doesn’t grade the debt.
“The most conservative rating agency usually has the lowest market share, and in the case of TALF-eligible ABS, that would be Fitch,” said Kevin Duignan, spokesman for Fitch in New York.
‘Fact of Life’
“It is the internal mandate to maintain market share that leads an analyst to compromise credit quality,” said Jack Toliver, managing director of global commercial mortgage-backed securities at Dominion.
Last Tuesday, two TALF-eligible credit card transactions were completed in the second round of TALF issuance. Credit card issuers Cabela’s and WFN issued $425 million and $560 million, respectively. As we had anticipated in our Special Comment of March 31,5 these early stage issuances under TALF are modest relative to the size of the market and to the TALF budget ($1 trillion). Meanwhile, however, these transactions are interesting for the information they provide on the early steps of the much-anticipated price discovery that we expect TALF to trigger.
Both credit card deals have three-year maturities and are priced comparatively wider than the Citibank TALF credit card transaction executed last month. As shown below, the estimated ROI for TALF investors ranged from a low of 14% for the Citibank transaction to a high of 24% for the WFN transaction.
In addition to above-average catastrophe losses in 2008 and the increasing severity of investment losses through year-end and the first quarter of 2009, Moody's expects that these pressures will likely continue to expose commercial P&C insurers to a degree of credit erosion over the medium term. This outlook expresses Moody's expectations for fundamental credit conditions affecting this industry sector over the coming 12-18 months.Moody's has failed to observe the fact that AIG is also making business for all its competitors impossible as taxpayers have provided for insurance policies in which AIG ends up paying you ... However, a bigger issue is that Timmy will likely wake up and realize this next upcoming "shoe drop" threat, and throw yet another cool $100 billion at the fire. It's only money, and as we have already passed the $1 trillion deficit mark, what is a mere $100 billion. In Zimbabwe you can barely buy 4 loaves of bread with that. Sphere: Related Content
Moody's noted that further deterioration in investment portfolios, outsized catastrophe losses, and the potential for significant litigation costs relating to corporate bankruptcies and the sub-prime mortgage crisis all could place additional strain on the sector over the intermediate term, particularly if capital market access remains frozen for a prolonged period.
"Moody's currently believes that commercial insurers hold adequate overall reserves for their expected ultimate policy liabilities" Mr. Murray says. "However, we also believe that the redundancy margin has thinned to a level at which earnings could soon cease to benefit from reserve releases, thereby adding significant pressure to insurers' underwriting margins."
"Macroeconomic stress and contraction will likely reduce business volume over the intermediate term, and will continue to pressure insurers' asset quality and capital strength. The impact of these pressures, however, should be muted somewhat by reduced exposure levels, given a smaller employed workforce and lower levels of commercial activity" notes Mr. Murray.
"Together," the analyst says, "the combined multi-year trends of weakened pricing and depleted reserve redundancies, as well as recent catastrophe losses and ongoing investment-related strains, have compressed commercial insurers' risk-adjusted capitalization in 2008. Looking ahead, ongoing strain on investment valuations, reserve margins, and embedded underwriting profits will likely continue to pressure risk-adjusted capital levels through 2009."
Even though CDOs maintain only small exposures to the two troubled automakers, there may be collateral damage as the bankruptcies ripple through the U.S. auto industry. Our CDO ratings, however, are unlikely to be significantly affected because of previous, forward-looking changes to our rating assumptions and stress tests.
CDO exposure to Chrysler and GM is not large. Of 2,262 Moody’s-rated CDOs, none have exposure to Chrysler. Some 10% have exposure to GM, of which the average amount is 1% with a range from 0.25% to 2.45%. Pro forma model analyses suggest that ratings of more than two thirds of exposed CDOs will be unaffected even if CDS settlement amounts approach 100%.
Nevertheless, there may be collateral damage from a bankruptcy. A GM bankruptcy may worsen the credit position of some GM affiliates, such as General Motors Acceptance Corp. (GMAC) or Residential Capital LLC (ResCap). Similarly, the credit effect on suppliers (e.g., Visteon ) or users (e.g., Hertz ) would be negative. Even competitors may suffer, possibly as an unintended result of government intervention, from effects that impede their competitiveness, cause the loss of mutual suppliers, or further harm consumer confidence.
CDO exposures to the U.S. auto industry, in general, are more significant than just for Chrysler and GM. Nearly 25% of all CDOs have some exposure to U.S. autos, and of those with exposure, the average exposure is 5.2% with a range from 0.2% to 24%. The chart below shows exposure across all Moody’s-rated CSOs to the top 20 U.S. auto industry companies.
In recent months, issuers have increasingly been proposing debt exchanges and tender offers at discounts to par. In many instances, these proposed exchanges reflect an opportunistic motivation as financially healthy issuers see a chance to reduce debt levels at attractive valuations. In other cases, however, the proposals are being made by financially distressed issuers and the effect of the exchange is to allow the issuer to ultimately avoid a default event, whether it is a bankruptcy filing or a missed payment on principal or interest.The critical take home message here is the subjective determination that Moody's and Moody's alone will make whether or not a company is to be branded a Defaulter or not. The implications across the capital structure, in the case of even one security defaulting, are obviously staggering, due to legacy limitations on what securities can and can not be held in a given defaulted corporate issuer by many asset managers. However, whereas the distressed exchange is much less of a judgment call if one is familiar with Moody's approaches and criteria for evaluating these events, a minor addition to the terminology by Moody's could jeopardize the recently gaining significant popularity phenomenon of open market distressed buybacks. As Moody's says:
Exchanges made by distressed issuers at discounts to par which have the effect of allowing the issuer to avoid a bankruptcy filing or a payment default (i.e., "distressed exchanges") are considered default events under Moody’s definition of default. However, since whether an issuer would have defaulted absent an exchange is unobservable, the determination of whether an exchange constitutes a default event is inherently a judgment call. As such, it is important for market participants to understand the criteria Moody’s considers in evaluating whether a particular exchange offer constitutes an event of default.
All formal debt exchanges and tender offers are candidates for distressed exchanges. Additionally, open market and bilateral negotiated purchases of debt are also possible candidates for distressed exchanges. While purchases and exchanges are typically voluntary transactions, they can have the effect of allowing the issuer to avoid a bankruptcy filing or missed payment and, therefore, constitute an event of default.And while one may have been forgiven to assume that this is merely posturing on the side of Moody's, the rating agency showed it was not bluffing when it assigned a rating of Limited Default to Hovnanian, following its presumed "debt exchange." From Moody's Hovnanian release:
In evaluating exchange offers, Moody’s interprets the term "debt exchange" very broadly. For example, when distressed issuers restructure or amend bank loan agreements which have the effect of allowing the issuer to avoid a bankruptcy filing or payment default, such transactions will be classified as distressed exchanges.
Moody's Investors Service assigned a Caa1/LD probability of default rating ("PDR") to Hovnanian Enterprises, Inc. ("Hovnanian") following the company's disclosure in its most recent 10-Q filing that between October 31, 2008 and March 11, 2009, it repurchased approximately $368 million face value of senior unsecured and senior subordinated notes at substantial discounts to par. The open market transactions, considered together, constitute a distressed exchange and a limited default by Moody's definition. The LD designation signifies a limited default and also incorporates Moody's expectations of open market transactions at substantial discounts to par over the next twelve months.Two months ago, Zero Hedge wrote about the incentives, most notably from a tax perspective, for corporate issuers to buy back their "distressed" debt after a proposal by Max Baucus was included in the stimulus bill, made it beneficial for companies to repurchase debt in the open market. The irony of Moody's action is that with one ill-crafted sentence it has the potential to undo the stimulus plan's tax benefit to corporate issuers.
Senior Bank Bond Holders -- at Risk or Not?Sphere: Related Content
Over the past week, a growing number of bondholders have expressed concerns that they risk being forced to incur losses because of government pressure on the banks that receive public assistance. This concern has been fueled both by widespread media attention and by some members of Congress.
Nevertheless, we consider this risk to be unlikely for banks that enjoy high systemic support. Such actions would run counter to the overall policy objectives underlying the provision of support to the banking system. Having said this, risks to bondholders do indeed increase for lower priority capital instruments and for those that hold the debt of weaker banks that are less important to the nation’s financial system.
The US banks that we believe benefit from very high systemic support are the Bank of America, Bank of New York, Citigroup, JPMorgan Chase, and Wells Fargo; for these institutions, we see the likelihood of senior or senior subordinated creditors taking losses as being very modest. If senior or senior subordinated creditors were made to suffer losses, the risk that systemic credit flow would contract increases, thus prompting further market turmoil and economic damage. Such an outcome is directly contrary to the Administration’s policy goals, which are to instill confidence in the financial industry and to restore the flow of credit in the economy.
Of course, we do differentiate, or notch, ratings to reflect the relative positioning of various security classes. This is done based upon their positions in the capital structure or in the legal framework of an entity. Subordinated creditors are clearly in an inferior position to senior debtholders, and those owning holding company obligations are certainly behind bank creditors in priority. In both cases, however, we believe all of these creditors should benefit from some systemic support, albeit to different degrees.
Even at banks that are very likely to receive support, there remain the risks of coupon suspensions or of distressed exchanges for preferred shares. This situation is especially true for those institutions whose noncumulative preferred coupon payments impair their abilities to replenish capital from earnings. Consequently, the notching among these instruments and senior and subordinated debt ratings is likely to widen in cases where a bank’s financial strength rating declines.
Sean Jones
Senior Vice President
The negative outlook reflects the deterioration of DDR's results over the past year due to a difficult operating environment and a development pipeline with a sizable amount of leasing required in a very challenging economic environment. DDR also has exposure to several tenant bankruptcies/store closings, three of which are in the REIT's top ten. Moody's expects earnings and credit metrics will remain pressured over the near term as market conditions for retailers continue to deteriorate. Moody's does note that management is making progress and has clearly defined deleveraging and refinancing goals.Sphere: Related Content
Although DDR has substantially scaled back its developments, and mitigated most of the pre-leasing exposure, Moody's concludes that such near term improvements will have a modest effect on its credit profile. Moody's expects the challenging operating and credit environment will pressure retailers and will continue to increase debt refinancing costs. DDR currently has exposure to manageable bankrupt and troubled retailers such as Mervyns, Circuit City and Rite Aid. In addition, asset sales will be challenged as cap rates are expected to continue to rise and acquisition financing remains scarce.
In adhering to its strict philosophy of throwing out all babies with the bathwater and never believing in fundamental analysis, and also continuing with its recent mass downgrades of all the assets it had been pumping for ages, Moody's earlier came out with a bomb on an announcement saying it has put essentially all CLO tranches on downgrade review. The only tranche spared was the super senior AAA tranche, yet another example of survivorship bias.Moody's break-even default analysis indicates that the Aaa-rated senior tranche of a typical CLO has enough protection to survive a 50% collateral default rate over the life of the transaction under a 40% recovery rate assumption for a pool of mostly senior secured loans. (See Moody's Special Report titled: CLOs: History, Structure, and Perspectives dated August 1, 2008.) Such levels have not been seen since the Great Depression. By way of comparison, Moody's default rate forecasting model currently projects the five-year cumulative default rate for all speculative-grade corporates at roughly 30% under a baseline scenario and 36% under a pessimistic scenario. (See Moody's Monthly Default Report -- January 2009, dated February 10, 2009.) Moody's does not anticipate changes in the Aaa rating of the senior-most tranches of a typical CLO unless corporate credit conditions deteriorate further and realization of the pessimistic scenario becomes more likely.Two Stages of CLO Rating Review
Moody's will conduct its CLO ratings review in two stages. In Stage I, which will begin immediately, Moody's will use a parameter-based approach to calibrate the extent of downgrades to tranches currently rated single-A and below in the vast majority of cash flow CLOs. Any senior-most CLO tranches that appear to have significantly weaker than average structures and portfolios may be placed on watch for possible downgrade at that time as well. In Stage II, which is expected to begin at the end of March, Moody's will perform a more comprehensive analysis by modeling each CLO individually. At that time, additional rating actions will be taken as necessary for all rated liabilities, including tranches currently rated Aa and Aaa. Moody's expects to complete Stage II by the end of the second quarter of 2009.
The collateral portfolio characteristics that will be examined as part of Stage I include (1) the current rating, (2) the level of over-collateralization (O/C), (3) the Weighted Average Rating Factor (WARF) transition since mid-2008, (4) the absolute increase in percentage of Caa-rated assets since mid-2008, (5) whether a tranche is currently, or is expected on an upcoming payment date, to pay-in-kind (PIK), and (6) the concentration of structured finance securities, such as other CLOs, in the collateral pool.
This wholesale approach to reevaluating embedded risk is very troubling as for once Moody's chance to impair some assets that may be more viable than its comparable peers but just from being lumped into the same category will get an adversely negative treatment. It is also bad news for GE, which may truly be faced with a very aggressive downgrade, spanning more than one notch, and approaching the critical 3 notch level which would throw the company into a liquidity tailspin. Lastly, the CLO action is bad news, obviously, for CLOs who will have to force-sell any previously held tranches that post the downgrade are no longer eligible for portfolio holdings, and will likely cause a significant ramp up in matched CDS book due to the issue of negative convexity we discussed earlier.
Moody's assigns SGL ratings to 512 issuers covering about $1.16 trillion of rated debt. The company estimates that SGL ratings cover about one-third of Moody's-rated speculative-grade issuers in the U.S. and Canada, about 62% of the rated debt. This differential is due primarily to Moody's practice of assigning SGL ratings only to companies with publicly available financial statements, which typically are larger issuers of debt.If a company is in SGL 4, the likelihood it will go from operating to bankrupt without passing go is virtually a certainty, especially in the current credit climate. The chart below demonstrates the rapid increase in the absolute number of SGL 4-rated companies as well as their portion of all SGL issuers.
To arrive at an overall SGL rating, Moody's analyzes four components and assigns a score to each one: cash flow and internal sources of cash; liquidity availability and external sources of cash; covenants; and alternative sources of liquidity (so-called back-door financing). The individual assessment of the four components may be different than the overall SGL rating.The outcome of the framework is nevertheless an overall SGL rating on a scale of 1 to 4 that is comparable across the rated universe. The definitions are as follows:
- SGL-1: Issuers rated SGL-1 possess very good liquidity. They are most likely to have the capacity to meet their obligations over the coming 12 months through internal resources without relying on external sources of committed
financing.- SGL-2: Issuers rated SGL-2 possess good liquidity. They are likely to meet their obligations over the coming 12 months through internal resources but may rely on external sources of committed financing. The issuer's ability to access committed financing is highly likely based on Moody’s evaluation of near-term covenant compliance.
- SGL-3: Issuers rated SGL-3 possess adequate liquidity. They are expected to rely on external sources of committed financing. Based on Moody's evaluation of near-term covenant compliance there is only a modest cushion, and the issuer may require covenant relief in order to maintain orderly access to funding lines.
- SGL-4: Issuers rated SGL-4 possess weak liquidity. They rely on external sources of financing and the availability of that financing is in Moody's opinion highly uncertain.
East European banks, which are mainly subsidiaries of financial institutions such as Raiffeisen Zentralbank Oesterreich AG and Swedbank AB, are likely to come under “downward pressure” which may also weaken their parent companies, Moody’s wrote in a report released today in London.Zero Hedge previously discussed the extensive exposure that banks have in Eastern Europe, which according to estimates could amount to a total of €1.3 trillion. Banks from Austria, Italy, France, Belgium, Germany and Sweden account for 84% of Western European bank loans in Eastern Europe.
Austria, whose banking system is “most exposed” to central and eastern Europe, has two of the biggest lenders in the region. RZB made 79 percent of its 2007 pretax profits in eastern Europe, including Russia and Ukraine through its Raiffeisen International Bank Holding AG unit, and Erste Group Bank AG earned 65 percent of its pretax profits in countries including Romania, the Czech Republic and Slovakia.
Erste, which said last week that full-year profit probably slumped about 26 percent, is in talks with the Austrian government to get 2.7 billion euros ($3.4 billion) in state aid. RZB, which owns a 69 percent stake in Raiffeisen International, which is active in 18 eastern European countries, is also in talks with the Austrian state and has asked for 1.75 billion euros.
