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Next Stop: Desperation Station


Stage two of credit crisis could be hard and fast.

I've been writing about financial institutions starved for more capital. So far they have gone to Sovereign Wealth Funds, which are now severely underwater and may have stepped away from the table permanently.

Note in Lehman's (LEH) recent capital raise, folks like Putnam stepped up to 'defend its position'. I'm fairly certain it'll rue the day it made that purchase. Then, we had the Bond King at PIMCO say he would buy anything under the 'Fed Umbrella', whatever that is. After all, the Fed's balance sheet is just as impaired as anyone's. Using its alphabet soup of repo and term facilities, the Fed has jettisoned over $300 billion of Treasuries in exchange for esoteric garbage from banks and brokers. So, as the 'lender of last resort', the Fed is close to tapped out.

We've seen most financial institutions offer preferred stock and hybrids (those that are fixed rate that then convert to floating rate). The offerings started at 7% and then went to 8%, and many preferred shares and hybrids are now trading in the 9-10% range. So, imagine you're one of these over-leveraged, under-capitalized institutions and you need money. Badly. Without the capital to replace the write-downs you've taken in sub-prime and are likely to take in Alt-A and construction loans, you're in an impaired position. Issuing securities at 10% is not only non-economic; it re-prices everything else in the marketplace lower.

And now you become desperate. Just ask Fifth Third Bancorp (FITB), a bank I've talked about often. Fifth Third, along with National City (NCC) and KeyCorp (KEY) have the same, decimated business models. They're based in the Rust belt, where manufacturing jobs are losing ground by the day. To come to market with a preferred offering, if I had to take a guess, it would need to be 10+%. FITB announced that it's slashing the dividend and will attempt to sell $2 billion in convertible preferred shares with a yield in the 8.5% along with some nasty dilution for current equity owners. This is a disastrous turn of events, but one that was inevitable. Welcome to desperation station.

Who are the usual buyers of all the preferred deals we've been seeing over the past year? Mom and Pop retail-they won't buy anymore, as Wall Street has jammed them full of securities that are severely underwater. Insurance companies--hmmm, let's see--they won't buy as they're so deep in Level 3 Assets that they're issuing themselves! What about the PIMCO's of the world? It's most likely full up as well. So the capital raising window, in the sense we're used to is in the process of closing.

This means that corporations will now do whatever they must in order to stay solvent? They'll slash jobs and dividends and attempt to raise capital by issuing common equity. The problem is that they're too late; they should have done this already. Instead they were stubborn and 'hoped' they would be OK and the economy would recover. But as they say 'hope is a poor roadmap to success'.

Ladies and gentleman, welcome to Stage 2 of the Credit Crisis. This, in my opinion (a nod to the market Gods) will likely be more swift and unpleasant than Stage 1. And again, if I'm wrong, all I will have lost is opportunity, not capital.
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