My Diary 312 --- Scared Market, KKR, CFC, Northern Rock and BOJ

My Diary 312 --- Scared Market, KKR, CFC, Northern Rock and BOJ

August 16, 2007

 

Sitting in front of Bloomberg to see global equity markets dropped like rocks, I turned my head to the other parts of markets and find some interesting comments, including many highly quoted words in these days -- European banks, ABCP,  KKR, Sub-prime, USD, Bank of Japan and Fed….. I think I have quoted enough…. Let us start…

Today, markets are running scared with certain names getting badly hit on both sides of the Atlantic.

Starting with a paraphrase of a comment from the RBS Senior Analyst this morning -- my overlay on it, is that European banks look in better shape than their US peers and I also believe that anyone struggling will get support from the state or taken out by a stronger institution. However there is clearly a limit to the amount of bailing out that can happen in a short space of time.

"The morning papers are full of reports about the ABCP market and many commentators are now extrapolating the effects into expectations of GDP slowdown and of rate cuts.  Where are we on the basics?  Overnight rates are volatile but settling around base rates with the exception of the USD where the fixing looks to be well below at 4.5%.  The focus is now shifting out to the 1 month and 3 month points where there is a very broad range of interbank (cash) rates reflecting the fact that some banks are more desperate to get some slightly longer term liquidity onto the books. That volatility is still making life difficult in the CP markets in terms of finding a base point from which to price (not to mention the demand side).

Yesterday saw the first big scale wind down of one of the credit arb funds - KKR sold USD5.1bn in RMBS taking a hit of USD40m - on the face of its that looks a pretty good result but as with other players, it looks to have sold the good stuff first and is looking at a further hit of around USD250m to close out the remaining USD5bn portfolio. It is also  no surprise that CFC and Northern Rock are all getting hit because of their respective reliance on wholesale funding with Americans further hit because of exposure  to subprime.

The drying up of short term liquidity was indicated by talk yesterday of CFC having to pay 12.54% for 1 month paper) with Libor quoted at around 5.57%. The (simplistically described) theory is that funding business on these levels is unsustainable which has the obvious hit to the share price, which then makes the name more toxic to potential lenders and so on.

Bottom line: both CFC and Northern Rock (whose stock has opened another 7% off this morning) may  get bought out by more robust banks at these discounted prices but the timing is crucial. The future is far less certain and private equity (possibly including a later break up of the company) has been rumoured.

BoJ  23rd meeting

In the FX market, sub-prime has morphed from being a USD-negative event to risk appetite-negative generally. Risk reduction has put EM currencies on the defensive and this is likely to remain the core FX theme for now. The USD has also rallied against most major currencies - with the one exception of the JPY.

I think that investors will refocus on the specific U.S. aspects of sub-prime and that it will be seen once again as a USD-negative issue. For that to happen of course, cross market volatility has to calm down and investors will renew carry trades, albeit perhaps with slightly less fervor than before.

In this regard, the Bank of Japan's 23rd August policy meeting takes on particular importance. At this fragile time, a rate hike by the Bank of Japan would be a bombshell for global markets. I guess that the BoJ will stay on hold and that this could potentially be a trigger for risk appetite to stabilize. When that happens, this will present a good opportunity to sell the USD.

A reminder that the Federal Reserve at least is not panicking about the recent turmoil came from Fed President Poole earlier when he said that the Fed does not intend to make a decision before the 18th Sep meeting (i.e. there will be no inter-meeting rate cut).