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Five Things You Need to Know: Prognosis: Negative; Back in the Real World; Consumer Credit; Repo Man; Modern Day Nursery Rhymes


What you need to know (and what it means)!


Minyanville's daily Five Things You Need to Know to stay ahead of the pack on Wall Street:

1. Prognosis: Negative

Standard & Poor's may soon cut credit ratings on $12 billion of bonds backed by subprime mortgages citing expectations that losses will continue, Bloomberg is reporting this morning.

  • Ratings of 612 pieces of residential mortgage-backed securities were placed on CreditWatch with negative implications, S&P said.
  • Why does this matter?
  • Go back to our (sub)primer on mark-to-model versus mark-to-market.
  • In addition to changes in valuation models, some investors will be required to sell their bonds if they are downgraded, which would further pressure the market.
  • S&P said today it is also reviewing the "global universe'' of CDOs that contain subprime mortgages, Bloomberg said.
  • "We do not foresee the poor performance abating,'' S&P said. "Loss rates, which are being fueled by shifting patterns in loss behavior and further evidence of lower underwriting standards and misrepresentations in the mortgage market, remain in excess of historical precedents and our initial assumptions.''
  • Meanwhile, in a separate but related story, Delaware Investments increased the size of a bond offering backed by home mortgages to $1.63 billion from $1.22 billion due to greater investor demand, Bloomberg said.
  • A third of the mortgages in the collateralized debt obligation are subprime, though two-thirds of the mortgages in the CDO were issued this year, as opposed to 2006, Mizuho Securities Group said, presumably with a combination of tremendous optimism and straight faces.

2. Back in the Real World

Meanwhile, back in the real world of things that actually trade, the ABX-HE-BBB-07-1 index, an index of credit-default swaps linked with 20 securities rated BBB- and created in the second half of 2006 fell 9.5% as of press time this morning, hitting a new low.

  • The ABX-HE-BBB-07-1 index has fallen by nearly 50% since the beginning of this year.
  • The price for ABX-HE-BBB- 07-1 contracts translates to annual payments of almost $2 million to protect against defaults on $10 million of bonds, Bloomberg said.
  • New ABX indexes are created every six months by a handful of securities firms, including Deutsche Bank and Goldman Sachs, and administered by London-based Markit Group Ltd.
  • They indicate prices for credit-default swaps linked to 20 bonds, not for contracts on each, Bloomberg noted.
  • For more on these indexes visit the Markit site where you can also see charts (such as below) for each index.

    Click to Enlarge

3. Consumer Credit

Borrowing by U.S. consumers rose more than forecast in May the Federal Reserve reported yesterday afternoon.

  • Consumer credit rose by $12.9 billion in May, a 6.4% annual rate, to $2.44 trillion, as Americans took on additional credit-card debt.
  • Revolving credit (read: credit cards) saw the largest increase (+$7.2 billion), while nonrevolving credit rose by $5.7 billion.
  • So, what does this mean?
  • Essentially, consumers are changing their "Capital Structure."
  • In Corporate Finance, "Capital Structure" refers to a company's method of financing its operations, typically thorough a mix of long-term debt, equity or some combination of the two.
  • For most consumers, "Capital Structure" consists of "sweat equity" sold to an employer (which takes the form of a paycheck issued at regular intervals), a mortgage (long-term debt) and credit cards (short-term debt).
  • During the housing boom, growth in asset prices (homes) helped boost the appearance of credit quality, which allowed consumers to readily finance their activities - even (perhaps especially) those activities that contribute primarily to comfort over production.
  • That is, consumers were able to buy more useless crap than anyone would ever have thought possible!
  • Whereas home refinancing and equity withdrawals fueled purchases over the past five years, these days credit cards and bank loans are fueling purchases.
  • As a percentage of personal disposable income, credit remained about flat at 24.5%, so as of yet there has been no deterioration in credit conditions.
  • However, without asset price growth, it is clear that the consumer's "Capital Structure", their debt-to-equity ratio, can only remain healthy for so long.

4. Repo Man

Speaking of credit quality and the abuse of the phrase "well contained," it turns out that the same subprime lending problems affecting the housing market are now affecting the auto market.

  • Much of the problems in subprime mortgage lending were (are) related to weak lending standards and too much credit pursuing too few borrowers.
  • The "competitive bids" for borrowers resulted in many people finding themselves with homes they cannot afford and paying mortgages they cannot carry.
  • A similar situation may be emerging in auto loans.
  • The consumer credit-agency Experian says one in three auto-loan borrowers have payments greater than $500 a month, while 12% have been late at least once, according to an article on MSN Money.
  • BenchMark Consulting International reported monthly repossessions by subprime lenders increased 15% last year.
  • Meanwhile, Manheim Consulting estimates there was a 5% increase in the total number of repossessed vehicles in 2006 to 1.4 million.
  • One way to track potential borrower stress before it becomes actualized is through long-term loans.
  • Because autos (unlike houses) are depreciating assets - that is, your car is declining in value even as you read this, an increase in the use of long-term loans for autos leads to an increase in negative equity situations - called being "upside down" in the business.
  • That's when you owe more on your car than it's worth.
  • According to Benchmark, for subprime lenders more than 80% of new-car loans were for 61 to 72 months, up from 67% in 2005.
  • Among prime lenders, 61% of new-auto loans were for at least 60 months, with 17% of those exceeding 72 months, nearly double the 9% in 2005.

5. Modern Day Nursery Rhymes

According to Annanova ("The Most Trusted Name in Wacky News"), nursery rhymes are in danger of dying out... because parents are singing pop songs to their children instead.

  • Three quarters of parents surveyed agreed singing to young children was a good way to help them to learn to read, the news story said.
  • But 44% said they were singing pop songs and TV theme tunes instead.
  • For example, Minyanville has learned that instead of singing the children's nursery rhyme Jack and Jill, parents are reportedly singing the Ray Parker Jr. and Raydio song Jack and Jill!
  • Hmm, that might be introducing the kids to adultery and infidelity a little bit early, no?
  • And instead of singing Humpty Dumpty, parents are singing Digital Underground's The Humpty Dance!
  • That can't be appropriate!

    Minyanville Classic Nursery Rhymes versus Modern Pop Nursery Rhymes Comparison

    Jack and Jill by Mother Goose
    Jack and Jill
    Went up the hill
    To fetch a pail of water.
    Jack fell down
    And broke his crown
    And Jill came tumbling after.

    Jack and Jill by Raydio
    Now why do you think
    Jack snuck down the hill? (He snuck down, he snuck down, broke his crown!)
    He needed love (Sweet love!)
    (He needed) Love he couldn't get from Jill! (Ah, sweet, sweet love, uh-huh!)

    Humpty Dumpty by Mother Goose
    Humpty Dumpty sat on a wall.
    Humpty Dumpty had a great fall.
    All the king's horses and all the king's men
    Couldn't put Humpty together again!

    Humpty Dance by Digital Underground
    First I limp to the side like my leg was broken
    Shakin' and twitchin' kinda like I was smokin'
    Crazy wack funky
    People say ya look like M.C. Hammer on crack, Humpty
    That's all right 'cause my body's in motion
    It's supposed to look like a fit or a convulsion
    The Humpty Dance is your chance to do the hump
    Do the Humpty Hump, come on and do the Humpty Hump
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