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Financial crisis update

Wed, Mar 12 2008, 15:30 GMT
by Allan von Mehren

Danske Bank A/S

The aim of this publication is to provide an overview of current stories/issues in relation to the financial market crisis. We update this regularly, the last time being on February 28. Key points in this issue are:

• • The financial crisis has flared up again, and fears of systemic risks in the financial sector are high. Credit spreads have soared and equities have dropped. Municipalities and intra-Euroland spreads were two of the markets much harder hit this time around. The renewed tension brought a swift response from central banks - principally the Fed, which is clearly deeply worried. Yesterday's newest initiative contained a new Term Securities Lending Facility (TSLF), by which the Fed will lend up to USD 200bn of Treasury securities to primary dealers for an extended term of 28 days against collateral in other securities such as agencies and MBS. This is clearly intended to promote liquidity and foster the functioning of financial markets. The knee-jerk reaction from markets has been positive, but the long-lasting effects are yet to be seen.
  

• • Despite avoiding downgrades from S&P and Moody’s for now, the monolines like Ambac and MBIA remain in serious trouble. Fitch seems somewhat more worried and still has MBIA on negative outlook. In a broader perspective there is little doubt in our view that the heat remains on the monolines.
  

• • A series of auctions of municipalities failed, as investor interest in the secured debt fell and the municipality market fell into disarray as hedge funds were squeezed to sell. The last few days have seen some buying and the new Fed initiative also helped bring the spread between municipalities and treasuries in from record highs.

• • Agency spreads have also surged, hitting fresh multi-year highs.

• • The renewed money market tensions brought a swift response from central banks mainly the Fed. However, a lot of the fundamental problems remain and there is risk of renewed tension going forward.
  

• • Leveraged loans to finance buy-outs, LBOs, have been a burden for many banks since last summer. The prices of these loans in secondary markets have declined since the turn of the year. The bottom line is that recent price falls on LBOs in secondary markets, combined with the warning from S&P on the future performance of these loans, is unlikely to provide any relief to banks’ balance sheets from the LBO front.

• • Is commercial real-estate going to be the next domino to topple as the crisis escalates? Recent spread widening does not look pretty.
  

• • The size of asset-backed commercial papers in the US has stabilised somewhat recently following large falls last year. However, new declines cannot be ruled out.
  

• • The initial source of the shock driving the current crisis was the decline in the value of US subprime mortgages. The high rated ABX indices have renewed their downward trend pointing to a worsening outlook for subprime mortgages. Rating agencies seem to be falling behind reality and downgrades are expected. This is likely to result in more losses for banks. Reported subprime-related losses so far amount to around USD 175bn. Estimates of total losses range between USD 200bn and USD 400bn, so further write-downs seem in the pipeline.
  

• • Each time the crisis flares up again new markets are affected. The intra-Euroland yield spreads have ballooned lately. For example, the 10 year government yield is now 61bp higher in Italy than in it is Germany.

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Published on  Wed, Mar 12 2008, 15:55 GMT