To paraphrase Mark Twain, rumors of the demise of Ford and the major homebuilders is greatly exaggerated. While GM, Chrysler and a number of private builders are in or near bankruptcy, some of their larger public competitors are evidencing something even more significant than rising stock prices. They are raising significant amounts of capital!!
New capital is significant in many ways. It can allow companies to refinance maturing debt, reduce leverage and facilitate growth. Most important, it requires investor confidence. Raising new capital can only be accomplished when large groups of investors simultaneously commit to buy a company’s debt or equity securities. It is axiomatic that this is a formidable task if a company’s viability is in doubt. We are increasingly starting to see new capital commitments becoming the new “Good Housekeeping Seal of Approval”. They can signal that investors believe that a good company in a troubled industry should survive. The capital commitments often assure this inevitability and lead to post financing price increases from the abyss.
In the last few weeks we have seen the following financings for Ford and a group of large Builders:
Issuer Amount Security
Ford $1.6 bil equity
Toll $400mil bonds
Ryland $230mil bonds
Lennar $400mil bonds
Horton $450mil converts
Lennar $275mil equity
In the wake of these financings, including those who issued equity or converts that diluted existing shareholders, the newly issued debt and equity securities are trading at generally higher levels. While not necessarily a guarantee of long term success for the issuers, it has to be construed as a near term positive for both equity and debt investors. All have already registered gains in companies which the market sees as improved risks.
In a larger sense, the ability of companies in weaker industries to access the capital markets is a very positive indicator for a broad based recovery and further market advances. Six months ago Ford was a supplicant at TARP’s table. Today it is viewed as the long term winner in the US auto industry. As recently as three months ago, few would have made any bets on even one US homebuilder being able to access the capital markets for the foreseeable future. The foreseeable future is NOW!! Four builders have successfully financed and the securities issued are all trading at premiums.
Virtually all experts agree that the opening of the capital markets is essential to the end of the recession. The ability of Ford and the larger builders is a clear and significant harbinger of a major market opening. Like Mark Twain, the demise of the markets and the dire prospects for Ford and the large public builders was greatly exaggerated!
PS It is also very interesting to note that Citibank sole lead managed all of the builder financings. Their ability to execute such transactions also suggests that their demise as an underwriter may also be overstated.
Given that Wall Street functions largely as a “Land of Lemmings” where one idea, regardless how good or bad, is usually criticised and then copied if it is seen as potentially beneficial to either personal pecuniary interests or corporate revenue generation. Right now, many on Wall Street believe that repaying TARP money certainly addresses the first point and could serve the second (or give a competitor a leg up if not followed). The article attached goes into detail on many of the implications of possible paybacks. One that seems to be missing is details on how many of the banks can raise the capital quickly. One needs only look to a bank’s loan book for the answer. To the extent that a bank can find a way not to “roll” a large revolver, use a technical covenant default to reduce exposure, not reapply toxic loan sales to new credits or generally accellerate a cutback in corporate lending (because that’s where the large loans are and Congress is not focusing on corporate liquidity), it can free up capital for repaying the government. Unfortunately, the casualty of this is a major reduction in corporate credit just when we need to help corporations make it through the downturn with available loan capital. In no small way is this part of the “unintended consequences” we addressed in our earlier piece on Congress’ compensation legislation. Even if the bill does not become law, the simple passage by the House has put the fear of God into banks. The really bad news is that the Lemmings of Wall Street may march their corporate clients into the sea to rid themselves of the yoke of TARP!
Beneficiaries of a Jesuit education learn early that logic and careful analysis are predicates to better judgments and conclusions. Jesuit pedagogues would also suggest that careful analysis and judgments are also necessary for appropriate corrective actions in addressing major problems. When it comes to our current national and global financial mess, blaming the usual suspects (George Bush, greedy CEOs, Wall Street, high executive compensation et al) or pandering to mass frustration may be cathartic but can never be confused with analysis or be a basis for corrective action.
In the coming days, we hope to address the nature of many of the issues that we believe contributed to our current economic troubles. We will endeavor to do so in a clear, simple and concise manner. Please do not be offended if we do not cover each issue in the first or second post. We believe that the issues fed on one another and are best examined seriatim rather than in one fell swoop.
What then were some of the most significant issues?
• The Growth of Leverage, Particularly in the Last Five Years
• Credit Default Insurance
• Mark to Market Rules
• CDOs (Collateralized Debt Obligations) and CLOs (Collateralized Loan Obligations)
• Failure to Guarantee Fannie and Freddie Preferred Shares
• Letting Lehman Fail
• Delayed and Insufficient Action on AIG
• Treasury “Crying Fire in a Burning Building” to Pass TARP
• TARP Mismanagement
From these issues flowed incremental and very significant problems and issues including:
• Bank Failures and Capital Inadequacy in the Financial Sector
• AIG Insolvency
• Sub-prime Surge and Failings
• Mortgage Foreclosures
• Stock Market Meltdown
• Post-TARP AIG Compensation Levels
In the coming days we will deal with each issue and seek to expand our discussion by building on each issue and reflecting on subsequent problems that flowed from them. Stay tuned!!
(Note: While the author has long admired the discipline, training and learned nature of the Jesuit Order, he is neither a Roman Catholic nor the beneficiary of a Jesuit education.)