Return of the Credit Crisis – Did It Ever Leave?
Time to brace for more bad news
By Frank Barbera CMT. June 3, 2008
Don't look now, but its back. Swept back upon the rocky shores and thrown harshly against the rocks by a vicious tide, the banks' shares are once again moving to new multi-year lows. Of course, the news is horrible, but the price action of financial shares suggests there is far worse yet to come. For those just looking at the last few days of the stock market rally, it might be very tempting to conclude that the averages are stabilizing and that things have gotten "back to normal." Ah, if only. As it happens, "normal" is not even within hailing distance and lo to the investor who decides that now is the time to take his eye off the bouncing ball. In this case, the bouncing ball has been and remains the monumental credit crunch sweeping the globe. It is the proverbial elephant in the middle of the room that few like to talk about, and which once again in the last few days has passed another major round of gas. To begin with, we note that for the first quarter 2008, Banks' earnings fell by 46% to $19.30 billion with the number of officially reported "problem" banks jumping from 76 to 90. In the first quarter, US Banks set aside a record $37.1 billion to cover losses, however, even government regulators don't believe that will be enough to stave off further problems. According to Sheila Bair, Chairwoman of the FDIC, Federal Deposit Insurance Corporation, loan-loss provisions and bank failures will likely continue to rise in coming quarters. "While we may be past the worst of the turmoil in the financial markets (ed. Don't count on it) we're still in the early stages of the traditional credit crisis you typically see during an economic downturn" stated Ms. Bair.
In fact, Ms. Bair went on to point out that the "coverage ratio" for banks is still declining, a "worrying trend." The coverage ratio compares bank reserves with the level of loans that are 90 days past due. According to the FDIC, "The ratio fell for the 8th consecutive quarter to .89 in reserves for every $1 of non-current loans, the lowest level since the 1st of 1993." This trend has been reflected in a constant parade of banks reporting "worse than expected" results and simultaneously increasing their loan-loss reserves. Take Keycorp (KEP) for example, which recently doubled its forecast for loan losses for the second time in the last few months. The stock collapsed by more then 10%, and as of last night closed at a new multi-year low and a new closing low for the entire decline.
Note the enormous downside gap which accompanies the Keycorp news. Yet as we will attempt to show in this article, the list of new lows for financials and banks is continuing to grow. As more and more names join the list, snap goes confidence, crack goes buying power. How long will the major indices manage to hold up above the March lows with charts like this taking shape? Just look at the chart below; it shows Barclays Bank of the UK, one of the largest banks in the world. Ladies and Gentlemen, this is the very picture of emboldened selling, aggressive selling, and more likely aggressive shorting. This is a picture of sharks circling a helpless victim because they know it is mortally wounded. This is NOT a case of too many shorts and the shorts get squeezed. This is one of those where what is driving the price action to this type of URGENT SELLING, day after day after day of unrelenting selling, has simply got to be bad news � very bad news not yet known to the public at large.
Above: Barclays PLC (BCS)
From February 2007 to March 2008, BCS declined from $59 to $31, a decline of 47.45%. In just the last 20 sessions, BSC has declined another 24% and using a daily median close, is down 17 of the last 20 days, something is seriously amiss. A look at the BCS headlines shows that Bradford and Bingley (BB:UK), a large scale UK mortgage lender, is coming apart at the seams with the stock now down 88% in the last 12 months with that decline accelerating sharply over just the last few weeks on news that profits have fallen by 48%. In addition, some of the major UK banks have fallen under the scrutiny of an antitrust probe, which may also be weighting on share prices.
Above: Union Bank of Switzerland, - UBS, plunges to new lows.
Yet the bad banking news does not stop at Keycorp or Barclays. No! Looking throughout the sector, globally, the picture is more or less the same "panic" urgent selling pushing share prices off the cliff in just the last three weeks. Look at the chart of UBS, which Forbes recently described as "a mess," and which in a desperate effort to raise capital recently launched a 15.5 billion dollar rights issue. Highly dilutive, but dilutive of what? The question must be asked, is there a business here that can be saved? The share price is acting like that may not be the case, having already tumbled 37.50% in just the last 25 days!
Above: UBS with a measure of medium term downside momentum - not a good picture.
If we look at UBS using a medium term momentum gauge, in this case, the 50 day average versus the 200 day average, notice the huge downside excursion below the neutral "zero" line at 1.00. While some may take comfort in the fact that the ratio recently turned higher, the recent price action simply has not yet factored into the mix, but will in the days just ahead. The aggregate message is that downside momentum in bank shares looks like a snowball rapidly picking up speed moving down the side of the Matterhorn, unlikely to find a reliable braking mechanism anytime soon. Of course, UBS has a great deal of company when it comes to the "Capital required" column, the gaping hole which has suddenly appeared on the balance sheet of so many financials. Since last summer, UBS estimates that major financial institutions worldwide have raised $213 billion dollars. But with bad loans continuing to pour from the sinking housing market, most experts now agree that a great deal more capital will need to be raised in order to shore up sagging balance sheets. Unfortunately, the great need for fresh capital comes at the very time when capital is scarce, scarcer in fact that it has been for decades.
In recent days, State Street Bank (STT), Washington Mutual (WM) and Wachovia (WB) have all gone looking for new capital. Unfortunately, such capital now comes at such a high price that investors are balking at the prospect of massive dilution and new share issuance and with that, bank shares have plunged to new lows. For some companies like bad debt ridden IndyMac Bank (IMB) or Downey Financial (DSL), perhaps only prayer will provide a path to new capital infusions. In every downcycle, there are the 'too big to fail' banks and then there is everyone else, with many of today's smaller falling into the category of the "expendable." In fact, the plunge to new lows for Bank America, the plunge to new lows for Wachovia, these are companies now choking on the bones of capital infusion/merger deals which should never have been done. Why did BofA move in to buy a sinking, rotted corpse like Countrywide? Why did Wachovia shoot itself in the head with a ridiculous purchase of adjustable rate loan specialist Golden West Financial right at the top of the market? Only one answer: Greed. The idea of getting "a great deal." Unfortunately, it is now plain to see that so many of these "great deals" were really quite the opposite. Just ask the first round financiers to Washington Mutual who are now slipping under water again. At some point, capital seeks self preservation, and the Darwinian survival of the fittest concept carries the day.
Above: Indymac Bank $50.50 in May 2006 to recent close of $1.75
Above: Downey Financial (DSL) $81.25 in July 2006 to a recent close of $6.32
Above: Washington Mutual (WM) $47.01 in May 2006 to $8.75 at present
Above: Wachovia Bank (WB) plunging to new lows.
Above: Huge Double top on Citicorp with failing rally halting right at long term overhead resistance line� one can only wonder what horrors await a break to new lows.
For Ben Bernanke, a quick reality check is shown in the charts of these sinking financial stocks. What was he thinking by making a statement this morning that "more rate cuts are unlikely." According to the AP, Bernanke said, "The Fed's powerful dose of rate reductions that started last September along with the governments $168 billion stimulus package, including rebates for people and tax breaks for businesses, should bring about "somewhat better economic conditions in the second half of this year." HA! Excuse me while I hang myself -- with this kind of logic, we are all doomed. Has anyone shown Dr. B the updated charts of Leading Indicators and Consumer Confidence? Has he bothered to look at what is happening to the banks and financial stocks at the very foundation of his monetary system? Guess not, because the unyielding set of new lows in the financials is probably enough to send any Fed chairman to the denial couch, and great doses of psycho-therapy. Even Gold seems to be having a good laugh at Dr. Bernanke's expense this morning, initially falling $16 dollars on the "dollar rally" (see chart below - what Dollar rally? Oh, they must mean the holding action of the last few weeks. That's a rally? Who's kidding who?). By mid session, Gold and Silver were both paring losses, with the Gold Stocks, normally very sensitive to moves in the market for a time, not even bothering to go down. The Gold Stocks seem to smell blood in the water, and like a great white shark, within no time, so will Gold and the other metals.
Above: get out your microscope and behold, the great Dollar rally!
While I do not mean to sound harsh on undoubtedly well intentioned officials, the problem here is that hope is ruling the day, and not a practical train of thought. At certain times, rather than hoping to jawbone markets, and interfere with markets, officials need to realize that sometimes the best thing which can be said, is to say nothing at all. Clearly it is easy to understand being "worried about high Oil prices" and trying to jawbone the Dollar higher with a statement to the affect that rate cuts are done for awhile. While that may sound fine, in the end, at least in my view, this simply removes flexibility from the policy making aspect of the current crisis. For example, we see right before our eye's the potential start of the next leg of the financial crisis as represented by the new lows in financial after financial. When some institution actually collapses in the days ahead, unable to raise capital, will the Fed then switch gears again (flip flop?) and talk soft on interest rate policy? What will happen to the US stock market averages if they don't? What will happen to Crude Oil, Gold and the Dollar if they do?
What then? Will the spread between Oil prices in Euro's and Oil prices in Dollars widen even further? Good bet. No, it seems this crisis is not being handled well, and that officials of many stripes are simply rapidly painting themselves into an unenviable and potentially ridiculous corner. In doing so, they are unwittingly inviting the financial markets in the fullest of all possible senses, to test their mettle where markets already suspect that no mettle exists. It seems to me that jawboning and meddling in markets has its own "built in" set of diminishing returns. Do it once or twice and you may get some bang, some affect, but do it much too often and well, like all forms of inflation, you end up getting ever less bang for your jawboning buck until at some point, the markets conclude that the "jawboning voice" is simply incorrect and worthless. Then it becomes a thousand times harder to restore any type of 'full faith and credit."
Of all commodities, once lost, "confidence" can be the hardest commodity to replace, and that lesson seems to be forgotten these days in the public discussions and statements being put forth by all manner of "representative" officials. In our view, monetary policy will remain soft, and will remain easy for the longest imaginable time, and short-term rates are very likely to come down sharply from where they are at present. 1% - Zero? Maybe. We say this not because we have any special inside knowledge, but because the share price declines seen throughout the financial sector suggests that a lot more pain and bad news is coming in the days and weeks ahead. Week by week, home prices, the collateral underpinning this financial house of cards, continues to decline. When the next scream of financial pain once again calls forth, the Federal Reserve has now placed itself "on the hook" for future fire suppression activities. They will not say NO, and more creative financing mechanisms will see the light of day and more officials will make more statements to the affect that all is well, things are getting better and are contained.
When that happens, commodities, acting in a vigilante role, and grounded in the base of their finite and limited supply, will once again shoot higher and the vicious downward circle of a deepening, stagflationary depression will continue. To break the down side cycle, real mettle is required, a willingness to let things take their natural course and at this point, there is no sign of this anywhere on the horizon. Thus, we continue to batten down the hatches as there are more highs seas ahead.
At the close, the S&P 500 ended on a negative note falling 8.02 points to finish at 1377.65, with the DJIA ending lower by 100.97 to close at 12,402.85. On the NASDAQ, prices also moved lower for a loss of 11.05 points finishing at 2480.48, with the 10 Year Bond yield also falling, with yields edging down by 7.3 basis points to finish at 3.898%. That's all for now,
© 2008 Frank Barbera