Minyan Mailbag: Loan Types This Credit Cycle... All the Same To Me
There are significant similarities across all major US loan categories in this credit cycle - from car loans to credit card loans to home equity and higher quality mortgage loans, all the way to LBO loans.
Below is another missive from Minyan Peter, who has become quite popular around the 'Ville with readers and professors alike since his first letter, A Bird's-Eye View of the Credit Conundrum and Brave New World for Debt Issuers.
There continue to be a number of pundits who suggest that US credit issues are contained in subprime mortgages. But that may not be the case.
While subprime mortgages may be the first to surface (which makes perfect sense to me, these were the most stretched borrowers), there are significant similarities across all major US loan categories in this credit cycle - from car loans to credit card loans to home equity and higher quality mortgage loans, all the way to LBO loans. The underpinnings for growth were fundamentally the same. How?
- An unprecedented volume of loans in this credit cycle were originated for sale. Whether these were car loans from the Big Three or LBO loans, securitization or outright sale was an integral part of the business model.
- With securitization came an unprecedented reliance on the rating agencies for asset quality judgment. If the rating agencies liked it, it was liquid. (And what I don't think anyone has thought through is the liquidity consequences of hundreds of billions of dollars of securities being downgraded simultaneously by the rating agencies. In the old days, the rating agencies gave big companies a little time to get their liquidity house in order before they hit them. How do you handle that when you are talking about potentially whole asset classes?)
- Many of the lenders/investors were thinly capitalized, gaining access to the credit markets through the underlying ratings on their collateral and standby liquidity facilities from a major bank. Further, and as a consequence, there was a serious asset/liability mismatch with many long-term assets funded in the short-term credit markets. While the CP conduits were rooted in funding short term trade receivables, their use has now stretched to finance 30 year mortgages.
- Many of the ultimate lenders/investors (hedge funds, CDO sponsors etc.) were start ups. Like the dot.com boom, if you had a concept as to how to make money using leverage, you had access to capital.
- There were aggressive covenant/credit terms in the underlying loans. One of the clear consequences of an originate-for-sale underwriting mindset is that unless someone else says no, anything is possible.
- Loan maturities were stretched, and, in some cases, even waived. For example, the average maturity on a car loan originated in 2006 was 65 months up from 48 months in the last cycle. And the use of PIK bonds became standard operating procedure in the LBO market.
Finally, and with all due respect to my younger banking brethren, there was inexperience through a real credit cycle. Yes, 1998 was a battle, but it has been a full generation (almost 20 years) since the last really tough, "banks being taken over by the regulators," credit cycle. I would suggest we have a lot of generals in the financial services sector right now who have never seen a war. And I can tell you that watching a bank CEO turn over the keys is an experience you never forget.
Copyright 2011 Minyanville Media, Inc. All Rights Reserved.
Daily Recap Newsletter