Musical Chairs

I WAS RECENTLY asked if I saw anything whatsoever that suggested lenders are at all tightening in the face of declining collateral and rising debt service pressures on their customers.

The answer to that question is a resounding no. In fact, the latest data show the opposite: Credit standards are still getting easier and businesses are still trying to expand or capture market share, regardless of the consequences down the road.

Bank Lending Survey

According to The April 2006 Senior Loan Officer Opinion Survey on Bank Lending Practices:

· On net, 12% of domestic institutions indicated that they had eased standards on business loans to large and middle-market firms

· About 60% of domestic respondents, a notably larger net fraction than in the previous survey, reported that they had trimmed spreads of loan rates over their cost of funds for such firms

· Almost 40% of domestic institutions, again a larger net fraction than in the January survey, indicated that they had reduced the costs of credit lines over the past three months

· About one-fifth of domestic banks, on balance, noted that they had increased the maximum maturity of C&I loans or credit lines that they were willing to extend to their business borrowers

· For C&I loans to small firms, 7% of domestic respondents, on net, noted that they had eased lending standards in the April survey

· On balance, almost 50% of respondents indicated that they had narrowed spreads of loan rates over their cost of funds

· About 30% [of respondents] reported having reduced the cost of credit lines over the same period

· Most respondents reporting easing of their lending standards cited more aggressive competition as an important reason for having done so.

Perhaps lending standards have changed given the market downdraft in equity markets in May, but I doubt it. Note that housing starts are up this month even though inventories are skyrocketing and buyer traffic is back at 1990 levels. “Have Funding, Will Build” seems to be the homebuilder motto of the day.

Housing Starts

Here is another angle on housing starts: Bloomberg is reporting, “Copper Rises After U.S. Housing Starts Gain More-Than-Expected”:

“Copper in London and Shanghai rose after home construction rebounded in the U.S. last month, spurring optimism for sustained demand in the world’s second- biggest user of the metal.

“Housing starts rose a greater-than-expected 5%, to an annual rate of 1.957 million, the Commerce Department said yesterday in Washington. The average U.S. home contains about 400 pounds (181.4 kilograms) of copper wire and pipes, according to the New York-based Copper Development Association.

“‘Prior to these numbers, there was some concern that the U.S. property market was cooling, but the announcement showed that is not the case,’ Cai Luoyi, a metals analyst at China International Futures (Shanghai) Co., said by phone.”

So there was “some concern” about U.S. housing, but I see that one month of data removes all that concern. By any chance is Cai Luoyi the replacement for the rogue trader that cost China $200 million by shorting copper futures last year?

Flashback to Nov. 25. TheWashington Post reported, “Losses on Copper Futures Have Leadership Spinning.”

There are now record numbers of unsold homes on the market. There were 565,000 new and 3.4 million existing residences for sale in April, according to the National Association of REALTORS and the Commerce Department. That is a lot of supply, and homebuilders keep adding to it every month at a far faster pace than sales.

Danielle DiMartino writing for The Dallas Morning News is asking, “Which Builders Will Be Left Standing?”:

“After I had mulled over the troubling 5% rise in May housing starts, a brilliantly simple explanation hit my inbox.

“‘Builders with no starts are “unemployed,”‘ wrote James Bandy of Dallas, ‘and they will never be voluntarily unemployed.’

“Mr. Bandy said he recalls Texas in the mid-1980s well enough to recognize the sequel to the high-stakes game of musical chairs.

“Given that we all know how the game ends, it’s hard to see why so many builders continue to be willing participants. Yet they play on.

“In case you’ve missed the most massive buildup since the Cold War, inventories of new and existing homes are at the highest levels ever recorded. Combine existing and new construction and you get a cool 4 million unsold units.

“With this much supply, you’d think starts would be down by more than 3.8% from January’s 33-year high.

“Wouldn’t it be smarter to show a bit of restraint and shelter what profit margins do remain? It’s not as if retaining sales volumes to keep up appearances is still a legitimate excuse. Wall Street long ago pummeled homebuilder stocks.

“In fact, the meltdown in share prices has freed homebuilders to shift their focus back to profits. Rather than pile on more incentives to stanch plummeting demand, those with an eye on survival could simply cancel, or at least postpone, groundbreakings…

“It’s painfully apparent that, somewhere along the way, the industry abandoned concern for its customers’ long-term well-being.

“Maybe builders just don’t appreciate how critical a role they play. Oversupply is but one issue when viewed in isolation — as is the risk to the labor market, as is the threat to the banking system.

“Add them together, though, and we’re not talking child’s play. We’re talking about a seriously brutal session of musical chairs.”

One has to laugh over that musical chairs analogy, but it goes beyond homebuilding and into every aspect of this financial economy totally dependent on ever-increasing amounts of risk. Not only are more and more players struggling to get into the game (with no additional chairs being added), but those already in are struggling to increase leverage.

AmeriCredit Expansion

Please consider “AmeriCredit Plans Lending Expansion”:

“AmeriCredit Corp., which makes auto loans to consumers with risky or limited credit histories, plans to make more loans through additional car dealers, to a wider variety of consumers.

“But by expanding into an economic landscape marked by concerns about inflation, rising interest rates, and tightening credit, the company may be preparing to swim against the current.

“The Fort Worth, Texas-based lender is in the early phases of a multidimensional expansion plan to grow the company’s $10.38 billion auto loan portfolio 10-15% annually by moving into new geographic regions, making new kinds of loans, offering fresh types of products, and approving loans to consumers with credit the company had previously considered too pristine…

“The company is also expanding geographically and considering direct-to-consumer loans and some other products within auto finance, such as warranties. The idea to is to become a ‘full-spectrum, one-stop shop’ for auto dealers, Chief Operating Officer Preston Miller said at [a] conference.

“AmeriCredit executives say credit measures such as defaults and loan write-offs are at their safest levels in years, meaning the company can wade into deeper waters without hurting profits…

“‘Unless you can draw some correlation between those types of events and what is going to happen to the consumer’s job, we really don’t see that that would have a direct impact on our portfolio,’ [CFO Chris] Choate said. ‘Our view is that they would continue to make their car payment in order to get to their job.’

“‘If they’re getting their paycheck, they’re going to use it to pay their car bill,’ [Stifel Nicolaus consumer finance analyst Christopher] Brendler said. ‘That typically is a very powerful motivator.'”

Excuse me, but didn’t AmeriCredit practically go bankrupt in the last downturn? Here is a weekly chart to consider:

The above chart suggests AmeriCredit had a near brush with death. I seem to recall some of its competitors actually going under. Somehow, they seemed to snag the last chair before Greenspan flooded the economy with dollars, bailing out the near dead. Yet now with a Fed merrily hiking away, jobs data weakening, real wages falling (and more so for AmeriCredit customers than on average), somehow, AmeriCredit thinks this is the ideal time to expand.

Perhaps AmeriCredit is emboldened by the fact it managed to find a chair the last time the music stopped, but I have my doubts about the next game, in which chairs will be yanked left and right.

Let’s look at one more interesting article from Danielle DiMartino. This one is called, “Not Feeling at Home With Risk”:

“Three weeks ago, the portfolio manager at Pacific Investment Management Co. sold his house and moved into an apartment with his wife. Though his wife wasn’t exactly happy with the move, his sense is ‘she will look back on our sale and view it as a good one.’

“Curiously, Mr. Kiesel’s specialty is corporate bonds, which he says have given him a unique perspective on the U.S. housing market…

“‘Rising home prices have been the key driver of U.S. economic growth, which in turn has played a major role in the tightening of corporate bond spreads,’ Mr. Kiesel said…

“Many of these companies are buying back their stock, which weakens bondholders’ cash cushion on the balance sheet…

“‘In this environment, bondholders should be demanding covenant protection, as well as higher spreads on homebuilder bonds’…

“Because housing has driven the economy for so long, the slowdown will bring, among other things, tighter lending standards, less willingness to take risk, lower asset price appreciation outside housing, less liquid financial markets, and rising volatility.

“‘At that point, “For Sale” will not just be a sign you see in front of your neighbor’s yard,’ Mr. Kiesel added. ‘Investors may also put a “For Sale” sign on risk assets as well’…

“Judging from the huge swings we’ve seen in emerging markets, stocks, and commodities in recent weeks, big institutional investors have already started to shift away from risk, something that carries deeper implications for bondholders.”

Junk bond spreads are widening, the Fed is still hiking, housing inventory is soaring, but builders are still building, companies are still wasting cash on share buybacks at inflated prices, and credit standards, amazingly, are still headed lower. It’s not readily apparent right now, but I suspect there will be a severe shortage of chairs when Bernanke’s Big Band stops the rate-hike music.

Regards,
Mike Shedlock ~ “Mish”
June 28, 2006