Credit Drops ==> Retail Sales Drop ==> GDP Drops

As I have noted in previous posts, consumer borrowing is grinding to a halt. Whether it is forced or voluntary, the decline in leverage will have a profound impact on retail sales going forward. To quickly review, outstanding household mortgage debt grew from $4.8 trillion in 2000 to $10.5 trillion in 2007. However, it has expanded by only $200 billion this year (my forecast based on Federal Reserve 3rd quarter data). Outstanding consumer credit grew from $1.7 trillion in 2000 to $2.6 trillion in 2007. My guess is that it will expand to $2.7 trillion by year end since credit providers did not aggressively cut access until the third quarter.

Last year's $4.5 trillion represented 32% of GDP. The consumer is a huge part of our economy. Be prepared for an extended economic downturn.

Bad Bank Alert

I scanned the FDIC data for the banks that had the smallest cushion against defaulting loans. The latest data available is from 6/30/08, so there might be some additions when the 9/30/08 data becomes available. In short, the ratios measure the amount of loans past due and in non accrual (bad loans) and non-accrual loans (separately) relative to the total of Tier 1 Capital and Loan Loss Allowance. It would be prudent to review your accounts with these banks to make sure that your funds are fully insured. The FDIC website is quite helpful in evaluating account limits.

http://www.myfdicinsurance.gov/

How Much is Citigroup Worth?

Citigroup, Inc. (C) has been beaten up pretty badly in the last few weeks. It is currently trading a about $9.00 per share.

Current book value is $17.12, but I dropped that by 20%: $14.26
Earnings per share: I used $1.14 for full year 2009
Return on Equity: 8%
I assumed no dividend cut
Dividend payout rate of 20% for the next 3 years, increasing a bit after that
Cost of capital assumption: 12.7%

$8.37 per share

Equity Market Bottom Re-Revisited

Well that didn't take long. The market rallied in almost a straight line after 1:00 pm EST as the bottom seemed to hold one more time. The intraday low in the DJIA was 7,965.42 and 818.69 was the low for the S&P 500.

Volume for the DJIA was respectable at 475 million shares traded, implying some interest in going long. I will post more details in a bit.

Largest One Day Point Increases
Date	Closing Value	Change (points)	Change (%)
10/13/2008	9,387.61	936.42	11.08%
10/28/2008	9,065.12	889.35	10.88%
11/13/2008	8,835.25	552.59	6.67%
03/16/2000	10,630.60	499.19	4.93%
07/24/2002	8,191.29	488.95	6.35%
09/30/2008	10,850.66	485.21	4.68%
07/29/2002	8,711.88	447.49	5.41%
03/18/2008	12,392.66	420.41	3.51%
03/11/2008	12,156.81	416.66	3.55%
10/20/2008	9,265.43	413.21	4.67%
Largest One Day Percentage Increases
Date	Closing Value	Change (points)	Change (%)
03/15/1933	62.10	8.26	15.34%
10/06/1931	99.34	12.86	14.87%
10/30/1929	258.47	28.40	12.34%
06/22/1931	145.82	15.51	11.90%
09/21/1932	75.16	7.67	11.36%
10/13/2008	9,387.61	936.42	11.08%
10/28/2008	9,065.12	889.35	10.88%
10/21/1987	2,027.85	186.84	10.15%
08/03/1932	58.22	5.06	9.52%
09/05/1939	148.12	12.87	9.52%

Market Cap: ReDux

Another look at the TARP capital infusions and current stock market capitalization.

Another Addition to the Big Drop List: DJIA

Largest One Day Point Declines
Date	Closing Value	Change (points)	Change (%)
09/29/2008	10,365.45	-777.68	-6.98%
10/15/2008	8,577.91	-733.08	-7.87%
09/17/2001	8,920.70	-684.81	-7.13%
10/09/2008	8,579.19	-678.91	-7.33%
04/14/2000	10,305.77	-617.78	-5.66%
10/27/1997	7,161.15	-554.26	-7.18%
10/22/2008	8,519.21	-514.45	-5.69%
08/31/1998	7,539.07	-512.61	-6.37%
10/07/2008	9,447.11	-508.39	-5.11%
10/19/1987	1,738.74	-507.99	-22.61%
09/15/2008	10,917.51	-504.48	-4.42%
09/17/2008	10,609.66	-449.36	-4.06%
03/12/2001	10,208.25	-436.37	-4.10%
02/27/2007	12,216.24	-416.02	-3.29%
11/12/2008	8,282.66	-411.30	-4.73%
Largest One Day Percentage Declines
Date	Closing Value	Change (points)	Change (%)
10/19/1987	1,738.74	-507.99	-22.61%
10/28/1929	260.64	-40.58	-13.47%
10/29/1929	230.07	-30.57	-11.73%
10/05/1931	86.48	-10.40	-10.73%
11/06/1929	232.13	-25.55	-9.92%
08/12/1932	63.11	-5.79	-8.40%
01/04/1932	71.59	-6.31	-8.10%
10/26/1987	1,793.93	-156.83	-8.04%
10/15/2008	8,577.91	-733.08	-7.87%
06/16/1930	230.05	-19.64	-7.87%
07/21/1933	88.71	-7.55	-7.84%
10/09/2008	8,579.19	-678.91	-7.33%
10/18/1937	125.73	-9.75	-7.20%
10/27/1997	7,161.15	-554.26	-7.18%
10/05/1932	66.07	-5.09	-7.15%

Au, Ag, Pt, Pd Derivatives

In a comment to a reader, I mentioned that JP Morgan Chase was the largest player in the precious metals derivatives market. I think that needs a graphic aid.

Wow indeed. According to the Office of the Comptroller of the Currency's June 30, 2008 report, commercial bank and trust companies hold $134.85 billion in gold and precious metals derivatives. JPM holds $96.15 billion of that total.

According to the U.S. Mint, the depository at Fort Knox hold 147.3 million troy ounces of gold (exactly who owns that gold is a subject for another post). Using $723.00 as the price per ounce, the value would be $106.5 billion. The Federal Reserve Bank held 266 million troy ounces in 2004, according to their publications. Once again, the Fed safeguards the gold for other countries and entities, so the entire balance is not owned by the U.S.

I Guess Paulson Reads This Blog

``Illiquidity in this sector is raising the cost and reducing the availability of car loans, student loans and credit cards,'' Paulson said today in a speech at the Treasury in Washington. ``This is creating a heavy burden on the American people and reducing the number of jobs in our economy.''


http://www.bloomberg.com/apps/news?pid=20601087&sid=aUBsSA1_p9aQ&refer=home



Consumer credit will now be the focus of the remaining bullets in the TARP gun.

Equity Bottom Revisited

A few posts back (10/10/08), I made note of the 8,000 level on the Dow Jones Industrial Average as a key support level. The index hit an intraday low of 7,773.71 on that day and hit an intraday low of 8,085.37 on 10/27/08. Let's see if the fundamentals tie out with this technical support level.

For this exercise I will use the S&P 500 as the equity market proxy because data is more readily available.

- Quarterly earnings peaked in the 2nd quarter of 2007 at $84.95

- S&P is forecasting earnings of $48.52 for the 4th quarter of 2009

- I think that forecast is a bit aggressive. Based on past peak to trough earnings swings, I am estimating earnings for the last quarter of 2009 will be $39.93

- The average earnings yield for the S&P 500 for the last 20 years is 4.886%

- $39.93 / 4.886% = 817.23

A bottom of 817.23 in the S&P 500 would roughly tie out to a level of 7,903.60 in the Dow, which is obviously pretty close to the technical support level. These levels would correspond to a drop of 9.09% from Tuesday's close and a drop of roughly 46% from the all-time highs set back in October, 2007.

I still believe that one must assign some probability to a scenario that drives corporate earnings even lower than my estimates. Therefore, I would not suggest a 100% portfolio exposure to equities, even at the support level. In the coming weeks, I would expect another test of the support level.

Another Bubble Will Burst

Consumer credit will be the next asset class to deplete the capital of financial institutions. In this post, consumer credit will be considered credit card loans (and similar revolving credit lines) and automobile loans (car leases are not included). The use of loan securitization and the deterioration of underwriting standards that affected the mortgage industry were also present in the consumer credit market.



The market has grown considerably over the last 30 years. Technological advances (increased bandwidth, Internet, etc.) have contributed to the expansion. In addition, the growth of the loan securitization markets has aided as well.






The asset backed securities market is currently the second largest holder of these loans. It trails only the commercial banks in this regard. The importance of this market is clear from the graph on the right.

However, it is also clear from both graphs that the demand for these assets as collateral for structured bonds peaked in 2003. Obviously, consumer credit continued to grow since then, meaning that originators were probably holding a larger proportion of their loans. The key is then what can be said about the quality of this collateral?




Well, the data to the left and below describe both loan maturity and loan to value characteristics of automobile loans. Longer dated and more levered loans prevailed until the last few months.







On another note, it becomes easy to see why the automobile manufacturers are having such a difficult time. They relied on easy credit terms to "forward sell" inventory.






Recent earning reports have also clued us in to the issues facing consumer credit. Citigroup's North American credit card division (3rd quarter, 2008) experienced a 35% annual increase in managed loans 90 or more days past due. Managed net credit losses increased by 63%.

American Express increased loss provisions by almost $1 billion in the 3rd quarter and reported a net-loan write off rate of 5.9% for their managed loans. The rate stood at 3% the year before.

AIG: What A Country

The Federal Reserve and the U.S. Treasury Department have announced a restructuring of the AIG rescue package. As with the original plan (and most of the other rescues), the authority to take these actions is granted under Section 13(3) of the Federal Reserve Act.

http://www.federalreserve.gov/aboutthefed/section13.htm


There are several moving parts:

- The original $85 billion loan will be reduced to $60 billion. The interest rate will be dropped from 3 month LIBOR + 850 basis points to 3 month LIBOR + 300 basis points. AIG will have 5 years from the original date to pay off the facility, instead of the original 2 years.

- The supplementary loan (10/8/08 collateralized borrowing) of $37.8 billion will be repaid.

- The U.S. Treasury will purchase $40 billion of preferred shares in AIG. These funds are part of the Troubled Asset Relief Program (TARP), but will not reduce the $250 billion dedicated to supporting financial institutions. The $40 billion is a part of the $100 billion that will be authorized by President Bush. The shares will pay a 10% dividend.

- The remainder of the new funds will be used to acquire assets to support AIG's balance sheet and credit default exposure. Two limited liability companies will be formed to house the assets. (This is similar to the method used to purchase those Bear Stearns assets on behalf of JP Morgan: Maiden Lane, LLC. The details of the LLC can be monitored weekly in the Fed's H.4.1 release.):

----- One facility will acquire residential mortgage backed securities that are currently held by AIG. $22.5 billion will be provided by the Fed and $1 billion will be funded by AIG. The Fed's loan will be secured by ONLY the holdings of the LLC. AIG will absorb the first $1 billion of losses.

----- The second facility will acquire collateralized debt obligations (CDOs). $30 billion will be provided by the Fed and $5 billion will be funded by AIG. The Fed's loan will be secured by ONLY the holdings of the LLC. AIG will absorb the first $5 billion in losses. The purpose here is to decrease the exposure AIG has to credit default swaps (CDS). AIG, in essence, sold insurance to protect owners of CDOs. As the the CDOs declined in price, the CDS would increase in value. So, if the new LLC acquires the CDOs, the owners would be able to unwind the CDS that they purchased and reduce AIG's liability.

In review:

Old deal: $122.8 billion

New deal: $152.5 billion

Wow. First, AIG needs some bucks to stave off failure. Next, they need a little bit more cash. Then, they need to restructure the whole thing because they can't pay their bills. It would be nice if the citizens who actually make all of this possible with their tax payments could participate was well.

Good Day, Sunshine

- Circuit City files for bankruptcy

http://newsroom.circuitcity.com/releasedetail.cfm?ReleaseID=346614


- General Motors equity & debt downgraded to laughable proportions

http://www.marketwatch.com/News/Story/Story.aspx?guid=%7b5BBC7AEE-1D84-40F6-95E2-241FB03C17EC%7d&siteid=yhoof2


http://www.businessweek.com/investor/content/nov2008/pi2008117_477694.htm?campaign_id=yhoo


- AIG is re-rescued

http://www.bloomberg.com/apps/news?pid=20601087&sid=aoj_ojzEcu9w&refer=home

Spin That Wheel Bernanke !!!

From the Federal Reserve statistical release H.4.1 (11/06/08):

-- The Federal Reserve System holds $50.44 in assets for each dollar of capital

-- Their holdings of U.S. Treasury securities have decreased by $303 billion in 1 year

-- Other loans (this includes broker/dealer loans, the asset backed commercial paper liquidity program and the initial AIG loan) total $347 billion

-- Commercial Paper Funding Facility has provided $243 billion in liquidity

-- Other assets stand at $570 billion, a $529 billion increase from 1 year ago

-- The U.S. Treasury has now supplied the Fed with $559 billion via the Supplementary Financing Program (unchanged versus last week). Please check the 10/8/08 post "Some Bullet Points" for Program details.

Banks #19 & #20

Two more banks were shut down on Friday, bringing the 2008 total to 20 closures. I know it sounds like a broken record, but take a peek at the loss ratios. If it is not crystal clear that bank regulators were not doing their job.........

Market Cap

A snapshot of stock market values and capital infusions:






So, almost 25% of this group's market cap is the govenment's bucks...........