A trilogy of financial time bombs has just gone off in the US as the fallout spreads from the subprime mortgage meltdown.
A new crescendo is building in the credit crunch. US banks are getting more jittery about lending to each other in a stampede to call in loans or demand more collateral as security.
Sorry to be the constant bearer of bad news, but a trilogy of financial time bombs has just gone off as the fallout spreads from the subprime mortgage meltdown.
Citigroup, the fourth largest home lender and the biggest US bank by assets, plans to prune its mortgage holdings by about 20%, equivalent to around $45bn (£22.5bn), over the next year.
Carlyle Capital Corporation (CCC), an offshoot of the US private equity firm Carlyle Group, has admitted being unable to pay margin calls, i.e. collateral required as cover for loans used to buy mortgage-backed securities, forcing emergency restructuring talks with its banks as well as an asset ‘fire sale'.
And Thornburg, the American mortgage lender, is tottering on the brink of bankruptcy, beset by the same collateral problem.
It all points to a lot more trouble ahead for the US housing market. But the ripples could well spread across the pond.
Having already ‘fessed up to a record $9.8bn fourth quarter loss, chopping the dividend by 41%, Citigroup will sharply slash new lending, cutting its exposure to the foundering residential property market as existing borrowings are repaid or sold off. The plan is to sell about 90% of the bank's home loans by the third quarter, up from 65% last year, as new lending drops 50%.
Net result: financing available to US borrowers will fall even further, as investors shun even government-guaranteed mortgage bonds. This is what happens in a credit crunch as the banks themselves feel the pinch.
Following the recent collapse of London-based hedge fund Peloton, the CCC and Thornburg bombshells are another classic case of leverage - buying on borrowed money - fast unwinding.
Here's how it works...
CCC leveraged its $670m equity base by 32 times (no misprint, it borrowed 32 times its capital!) to finance a $21.7bn fund of residential mortgage-backed securities issued by the housing agencies Freddie Mac and Fannie Mae. The securities were deposited with banks as collateral in exchange for cash.
If these securities fall in value, the lender will ask for more collateral - a margin call - to secure the loan. If the borrower neither meets the margin call by putting up more collateral, nor repays the loan, the lender can sell the securities. Often at knock-down ‘fire sale' values which raise cash at any price.
Even highly-rated assets have been hit hard by the fallout from the subprime credit crisis, so banks including Bank of America, Bear Stearns, BNP Paribas, Citigroup, Credit Suisse, Deutsche Bank and ING have demanded more collateral as guarantees.
Highly-leveraged funds have become increasingly vulnerable as their cash cushions are tiny compared with actual assets, so sudden price moves can quickly deplete a portfolio's liquidity.
CCC has admitted being unable to meet margin calls, so lenders have begun to liquidate as much as $16bn of the securities they hold as collateral. The fund is considering "all available options" and has begged its banks for extra negotiation time.
And what of American mortgage lender Thornburg, in the same margin call boat and now on the brink of bankruptcy?
Despite investing in large, adjustable-rate mortgages, including many with "triple-A" credit ratings, Thornburg is in big trouble.
Its own bankers have demanded collateral of $610m, according to Thornburg, which "significantly exceeds" available cash. Although some creditors are holding fire for now, there are big doubts about the lender's ability to continue trading.
Even worse, Thornburg also said it will restate 2007 results and make a $428m charge as of 31 December for its adjustable-rate mortgage holdings, because its auditor KPMG LLP reckoned the 2006 and 2007 audit reports were no longer reliable.
Again, this is what can happen in a credit crunch.
As investors in Northern Rock know only too well.
One reader's response to the last piece I wrote about US housing market woes was: "So what, that's all in the States".
Very true. But so was the start of the whole credit contraction cycle, as American subprime mortgages went toxic. And we all know how that ‘little local difficulty' has spread all around the world...
More:
Housing Market Horrors |
US Rate Cut Could Mean More Trouble
