Funds Put Us Banks Back On Track
Tuesday, 14 October, 2008
The US banking industry, which had appeared to be heading towards a cliff, seems back on track, thanks to the federal government’s infusion of capital in the nation’s top banks.
The government’s injection, coupled with its promise to guarantee unsecured loans by financial institutions, has punctured ballooning prices on the credit default swap market and restored some faith in the financial sector.
But, in spite of the extraordinary powers Congress has invested in him to save the marketplace, Henry Paulson, US Treasury Secretary, is not able to turn water into wine. So when the big banks report their earnings this week, starting with JPMorgan Chase and Wells Fargo on Wednesday, investors should be ready for a sobering reminder that the economic landscape looks bleak.
Bank analysts say JPMorgan’s earnings are expected to be less than stellar.
For an institution that served as a safe haven for investors over the past four weeks, the government injection appears to have removed that competitive advantage, at least temporarily. Shares in JPMorgan Chase were down 2 per cent in midday trading on Tuesday, after lagging behind the rest of the sector during Monday’s furious rally.
Morgan Stanley’s share price closed up 21 per cent, at $21.94, while Bank of America’s shares rose 14.5 per cent to $26.09. Citigroup’s shares climbed 17.3 per cent to $18.47.
Citi reports earnings on Thursday. In its case, the numbers are not expected to look good.
And yet, the US government’s action on Monday has restored some semblance of normality to the volatile credit default swap market.
“They’ve defined ‘too big to fail’ and taken away uncertainty,” said Brad Hintz, an analyst at Sanford Bernstein. “We are in a recession and a difficult credit environment but the financial sector survives.”
The cost of default protection of financial companies, which had risen in the month since Lehman Brothers filed for bankruptcy, plummeted on Tuesday.
The federal plan allayed fears that the financial system was facing the collapse of another large counterparty and encouraged investors that the recent lockdown on credit would begin to ease.
Default protection on Morgan Stanley’s debt was quoted at 385bps, or $385,000 a year to insure $10m of debt for five years, according to Market. Late last week, default protection soared to 1,420bps.
Credit default swaps on Goldman Sachs dropped to 205bps from 539bps and Citigroup fell to 145bps from 347bps on Friday.
“It’s very likely financial companies and funds were hedging their own counterparty risk to individual firms and each other,” said Daniel Barrett, a research analyst at Tradition Equities. The federal plan “has mitigated the risk that another major counterparty goes down”.
Risk premiums, or spreads, on bonds issued by financial companies also fell sharply. Spreads on Citigroup’s 10-year debt tightened about 150 basis points to 425bps over comparable Treasuries, compared with 575bps on Friday.
Morgan Stanley’s 10-year debt was trading at 86 cents on the dollar, compared with 56 on Friday.
Source: http://www.ft.com
