Today's Tidbits

Non-Bank Lending Down 60% YoY Since Credit Crunch Began a Year Ago

From CFO: “The credit crunch continues to severely hamper corporations' ability to raise capital. The latest evidence: the dollar volume of new-issue fixed income products fell off more than 60 percent in August versus a year ago, according to a report from Lehman Brothers…. That made it the worst August for new-issue fixed income products since 2002…August's volume was down 32.6 percent from July's $379.3 billion. Lehman noted that August is historically down only around 13 percent from July. ..The U.S. dollar volume was off 77.3 percent from last August. Looking at specific asset classes, investment-grade bonds decreased 69.8 percent year-over-year, high-yield bonds 78.3 percent, syndicated bank loans 84.6 percent, asset-backed securities 78.7 percent, residential mortgage-backed securities 95.2 percent, and commercial MBS 100 percent. The only relative bright spot in the fixed-income market was municipals, which increased 4 percent. In Europe, new-issue dollar volume for August decreased a total of only 24.2 percent, because investment-grade bonds shot up 102.2 percent. However, high-yield bonds decreased 68.6 percent, syndicated bank loans 35.6 percent, ABS 84.8 percent, RMBS 50.1 percent, and CMBS 100 percent. Sovereign bonds decreased 28.9 percent in August, helped by the generally higher-quality nature of that marketplace, Lehman explained.”

More Bank Consolidation Likely as Capital Erodes

From Citi: “Consolidation in the US financial system? As we noted yesterday the terms of the settlement for shareholders in the two GSE's (i.e. they lose out) also raises questions about the capital base of many of these shareholders - the smaller regional US banks. In the wake of the 1980’s savings and loans crisis there was a wave of consolidation in the US banking system which saw M&A peak in 1986/87 but failures not peak until 1988/89. From then on there was a major concentration in the banking industry with the share of the top 25 institutions rising to c53% in 1997 from 33% in 1985. This trend was boosted by deregulation. Less regulation does not seem to be part of the current policy response. On the other hand this solution to the GSE’s situation does add to question marks over the capital adequacy of many smaller banks. Their situation will be exacerbated the longer the underlying fundamental housing problem persists. Over the next couple of months many US financials will be reporting earnings so there’s scope for disappointment as well as for news of further failures and mergers. None of this is likely to have much sway on monetary policy as the Fed feels current problems are indeed mainly balance sheet issues rather than the level of interest rates. Monetary policy will continue to be dominated by the outlook for inflation.”

From RBSGC: “S&P places Lehman on Watch Negative -- citing decline in share prices as problematic for raising additional capital. Shares dipped as low as $7.75/share intra-day vs. a $12.92/share open.”

Declining Oil Production in Mexico is Bad for Mexico and US

From Pipeline and Gas Journal : “At 1.5 million barrels per day (bpd), oil from Mexico comprises about 11% of U.S. imports. As a top-three supplier to the U.S., Mexico has been a consistent and reliable source of oil for years. In the first half of this decade, that role increased even further as growing U.S. demand was met with rising Mexican production. Since 2005, however, it has been increasingly apparent that Mexico’s largest oil field - Cantarell - is in irreversible decline. Cantarell accounts for 26% of Mexico’s proven reserves and provides more than half of the nation’s oil output. But the field peaked in 2005 at 2.1 million bpd and by 2008 has fallen to only 1.46 million bpd - a decline of 31%. Further, the U.S. Energy Information Administration (EIA) has suggested Cantarell will likely average an annual decline rate of 14% through 2015. And even that may be an underestimate. An upstream industry magazine recently reported that Mexico’s oil production dropped over 400,000 bpd in the first quarter of 2008 alone. Additionally, estimated production in April is down 12% from March levels. The implications of Cantarell’s decline are far reaching for both the U.S. and Mexico. For the U.S., less oil supply from Mexico means increased reliance on more distant and potentially unstable sources. For Mexico, any drop-off in oil exports could have reverberating socioeconomic and political impacts, as many social welfare programs are funded by oil revenues. In 2006, for example, of the $97 billion in sales by the state-owned Petroleos Mexicanos (Pemex), $79 billion went to the Mexican government. This energy revenue windfall accounted for about 40% of the national budget… Given the broad social, economic and political ramifications of declining oil production, it is difficult to fault government officials who hope for the best. Mexico has: (1) used its oil reserves as collateral for loans, (2) employed its oil profits to fund social programs, and (3) spent much of its increased wealth to develop a growing middle class with rising expectations. The grim reality of oil production decline, and the concomitant erosion of oil revenues, will take some time to filter through Mexico’s national mindset.”
Note – Mexico is currently the third largest foreign supplier of oil imports to the US, and may stop exporting totally by 2012.

India and South America Show Strongest Employment Growth Prospects

From Barclays: “Manpower's global employment outlook survey for Q4 reveals a further moderation in hiring activity, with 25 out of 33 countries reporting a slower pace of hiring versus a quarter ago. The weakest hiring intentions were reported by employers in Spain, Ireland and Italy, which were the only countries expecting negative hiring expectations for the quarter ahead. Conversely, the most favourable fourth-quarter hiring plans globally are reported by employers in India, Costa Rica, Peru, Singapore, Taiwan, Colombia, Romania, Poland, Argentina, Australia and South Africa…In the US, the seasonally adjusted net employment outlook balance fell to +9 in Q4, the weakest since 2004, from +12 in Q3 and +14 in Q2. Across regions, employers in the West and the Northeast have the most favourable hiring outlook, while Midwest employers are most pessimistic. Sectorally, employers in the construction sector remain the most pessimistic, while mining companies are the most optimistic.”

MISC

From Citi: “Total agency MBS issuance fell by 3% in August and is down 39% from May, which was the highest issuance month of 2008. Conventional issuance fell by 10% in July while Ginnie Mae issuance rose by 11%. Ginnie Mae issuance was over 35% of total agency MBS issuance, the highest percentage since July 1997. Issuance should bottom slightly below August levels in September before beginning to climb given the 50bp drop in mortgage rates since mid August. Fannie Mae and Freddie Mac are likely to reduce guarantee fees in the near future based upon comments from the Treasury and FHFA which would further support lower mortgage rates and higher future issuance.”

From Lehman: “The more I look at the Treasury [GSE] plan, the more it looks like a nice way to stop the downside risk of a mortgage market meltdown, but not a way to jump start the economy… the effect is to avoid disaster, not spur growth.”

From RBSGC: “In contemplating the broader implications of the GSE conservatorship, we note that this administration has now done everything it can to support the troubled housing market -- and the structure of the deal buys enough time to make it through the election and into next year, but falls short of a permanent remedy to the GSE's troubles -- policy options are running out.”

From Merrill Lynch: “The announcement of explicit US government support for both Fannie Mae and Freddie Mac has produced both a rally in risk sensitive assets/currencies and short-lived pressure on the USD. Our initial call is that the government intervention carries with it short-term USD positives but longer-term risks, while the moves do little address the broader macroeconomic risks currently troubling markets.”

From CITI: “What a difference a day makes. After yesterday's "euphoria" over the bailout of the two US mortgage GSE's, overnight the realisation that this deals mainly with the symptom rather than the causes of the problem has come to dominate sentiment. This leaves markets to focus on the likelihood that US (and world) growth remains subdued and that central banks will continue to focus on upside inflation risks.”

From MNI: “The US government's decision to take control of Fannie Mae and Freddie Mac has caused widespread relief across Asia, but China is likely to stick to its decision to restrict substantial offshore investment until solid signs of economic recovery emerge, Moody's Economy.com said.”

From JPMorgan: “The most direct way in which the government’s action should affect the economy is through lower mortgage rates at origination, which should spur home sales, thereby reducing inventories of unsold homes. There are possibly other, indirect, effects, such as stabilizing the financial system which could forestall some of the adverse feedback dynamics that have been developing between the economy and financial system.… When looked at using various specifications of home sales models, the estimated response gravitates to a 10% increase in home sales following a 100bp decline in mortgage rates. We mention 100bp not only because it is a round number, but also because this is roughly the decline in mortgage rates that our fixed-income team believes will be experienced by final borrowers relative to the peak reached a few weeks ago. A 10% increase in home sales would pale next to the 35% decline in total home sales experienced in the housing downturn, however, if realized, it would be helpful in contributing to the normalization of housing inventories.”

From UBS: “…in its update on the budget, the Congressional Budget Office revised its baseline budget deficit estimate for 2008 to $407B from the $357B projected in January, with the increase reflecting higher outlays. The CBO also increased its 2009 deficit estimate to $438B from $342B. It should be noted, however, that these deficit projections do NOT take into account the costs of the GSE actions from this past weekend.”

From RBSGC: “The TIPP Economic Optimism index hit the highest since Oct '07 -- a strong correlation with the major consumer sentiment surveys and a clear reflection of the pull-back in gasoline prices.”

From Nomura: “Once again, the sales results from the two weekly surveys of large retail stores were somewhat mixed. The ICSC index fell 0.1% and the 52-week growth slowed to 1.9%, a 12-week low. Owing to strong sales over Labor Day weekend, the Redbook index … 0.8% drop from the August index in the first week was a bit ahead of target. Sales fell off sharply after the holiday but the ICSC report noted that colder and wetter than normal weather in September, which has been forecast for this month, has been associated with relatively strong sales. Further declines in gasoline prices should also help get sales back on a stronger trajectory.”

From BMO: “Japanese machine tool orders fell 14.2% y/y in August, the sharpest decline since
2002.”

From Bloomberg: “Wells Fargo & Co., the California lender that skirted the subprime collapse, topped Citigroup Inc. by market value to become the third-most valuable U.S. bank.”

End-of-Day Market Update

From SunTrust: “Yesterday's euphoric reaction to the bail-out of Fannie/Freddie is fading somewhat. The bulk of the progress made in shrinking agency spreads is still intact, but about 5 bp of widening has occurred today. Ditto for MBS spreads, wider by about 5 bps. Financial shares are also seeing reversals. Both Wells Fargo and Sovereign Bancorp have announced impairment charges will be taken in Q3 related to Fannie/Freddie preferred stock holdings. Lehman, now down 36% on news that talks between the company and KDB have ended, has announced it may release Q3 results as early as today to assuage investors. There is nary a profit-taker for Treasuries, however. The long end of the market is on fire. 10 yr notes are bid at 103-16, up 23 ticks. The bond is higher by 52 ticks at 105-31 (4.18), close to a record low yield. The huge narrowing of agency/MBS spreads yesterday has unleashed a massive amount of convexity buying in Treasuries. Some models estimate that a 50 bp drop in mortgage rates would translate into as much as $200 bln 10 yr equivalents needed in 10 yr notes. This represents much pain for shorts.”

From UBS: “Treasuries rallied 7-8bps across the board today as the market realized that the initial euphoria over the GSE bailout was overdone. While this government takeover may help solve some problems, the wipeout in GSE preferred stock would cause other problems by further depleting capital at some banks. US Bancorp warned that bad loans and impairment from GSE preferreds would lead to Q3 charge-offs of 25% to 28% (Informa reported this). There were other headlines like this and stocks fell hard again (-280 Dow pts) for the biggest drop since February. Lehman Bros. lost as much as 46% intraday (on huge volume) after reports that its talks with KDB have ended without a deal in place. Further jeopardizing Lehman's situation, S&P placed Lehman's 'A' senior debt rating on review for downgrade, potentially forcing the firm to pony up billions more in collateral according to some. Meanwhile, crude oil continued its fall after the oil ministers from Saudi Arabia and Venezuela indicated that OPEC will vote to maintain output. With crude as low as $101.85/barrel earlier this afternoon, TIPS took another severe hammering, and front-end breakevens narrowed by double-digit basis points. Today's volume was a robust 147% of the 30-day average… Swaps saw steepener trades, and spreads widened across the board, especially in the front end. Agencies witnessed very little flow, underperforming Libor by 1-2bps on the day. Fannie Mae announced a new 2-year issue, with the size and pricing to be determined tomorrow. Meanwhile, yesterday's record-setting MBS tightening was followed by an historic widening, with mortgages underperforming Treasuries by 25-30 ticks and swaps by 21-26 ticks. The higher dollar prices from yesterday's move brought in origination, as well as selling by banks and foreign accounts. Today has been one of the heaviest MBS trading days of the year.”

From RBSGC: “The Treasury market put in another impressive performance as yields pushed lower with 2s testing 2.175% and 10s dipping below 3.60% -- back squarely into the pre-NFP range. Domestic equities were under pressure -- with the S&P down more than 2.5%. The fundamental drivers were more flight-to-quality than data skews, as troubles in the financial sector were led by S&P's placement of Lehman's credit ratings on Watch Negative. There were other negative headlines from the sector, and with next week's set of earnings including Lehman, Goldman, and Morgan Stanley -- there remains a heightened sense that the GSE bailout came too late to prevent another round of losses/writedowns. Flows also played a key role in Tuesday's price action, with convexity-related hedging demand for duration at play, as were rate-lock unwinds associated with a series of corporate deals. While the corporate calendar was limited to $3-$4 bn of new deals, the potential for more issuance later in the week is undoubtedly going to be a factor. Position surveys reflect a market caught somewhat offsides by this week's sharp rally in Treasuries -- with the JPM weekly release showing investors the shortest in more than a month -- but flats dominate the responses at 76%... Tuesday's volumes were very strong…”

From Bloomberg: “Crude oil fell to a five-month low, leading commodities lower, after Saudi Arabia's oil minister said supplies are sufficient to meet demand. Orange juice slumped to the lowest in three years. The S&P GSCI index of 24 commodities fell as much as 2.4 percent as gasoline, gold and wheat dropped… Lower costs for raw materials may signal slowing inflation… Agricultural commodities and metals dropped on speculation a worsening global-growth outlook will lead to reduced demand for raw materials.”

From MSNBC: “Stocks ended down sharply Tuesday after fresh worries about the stability of Lehman Brothers Holdings Inc. touched off renewed jitters about the overall financial sector. The Dow Jones industrials fell 279 points. Bond prices jumped as investors sought the safety of government debt. Wall Street’s pullback comes a day after the biggest single-session rally in a month in the Dow so some retrenchment might have been expected. But it was worries about Lehman that punctured a sense of optimism about the financials. Investors had been optimistic about the sector after the Treasury Department announced Sunday it would seize control of mortgage lenders Fannie Mae and Freddie Mac to stabilize the companies. Lehman fell $5.15, or 36 percent, to $9 as investors worried that the No. 4 U.S. investment bank is having trouble finding fresh sources of capital. Investors grew worried that a possible investment from South Korea’s government owned Korea Development Bank remained in doubt. The two sides are said to have called off talks, according to media reports… In midafternoon trading, the Dow fell 279.68, or 2.43 percent, to 11,231.06. Broader indexes also fell. The Standard & Poor’s 500 index declined 43.25, or 3.41 percent, to 1,224.54 and the Nasdaq composite index fell 59.95, or 2.64 percent, to 2,209.81. The declines ate into returns logged Monday when the Dow jumped 2.6 percent, the S&P 500 rose 2.1 percent and the technology-heavy Nasdaq composite index added 0.62 percent… The market’s decline comes a day after investors greeted the government’s plan to take over Fannie Mae and Freddie Mac with a burst of enthusiasm. Investors had been worried that the companies, which hold or back about half the nation’s mortgage debt, would succumb to a spike in bad loans. Fannie Mae rose 34 cents, or 47 percent, to $1.07, while Freddie Mac rose 10 cents, or 10 percent, to 98 cents. Among financial names, Citigroup Inc. fell 85 cents, or 4.2 percent, to $19.47, while Morgan Stanley fell $2.05, or 4.8 percent, to $41.22. Merrill Lynch & Co. declined $1.99, or 7.2 percent, to $25.60. Energy names also lost ground as oil fell. ConocoPhillips fell $2.77, or 3.7 percent, to $71.92 and Schlumberger Ltd. slid $3.06, or 3.6 percent, to $82.95. In corporate news, McDonald’s Corp. said its same-store sales, or sales at stores open at least 13 months, rose 4.5 percent in the U.S. in August and 8.5 percent globally. Shares rose $1.21, or 2 percent, to $63.61.
The Russell 2000 index of smaller companies fell 11.44, or 1.56 percent, to 721.42. Declining issues outnumbered advancers by about 4 to 1 on the New York Stock Exchange, where volume came to 957.1 million shares.”

Prices as of 4:30
Three month T-Bill yield fell 6 bp at 1.65%
Two year T-Note yield fell 9 bp to 2.21%
Ten year T-Note yield fell 8.5 bp to 3.59%
30-year FNMA current coupon fell 4 bp to 5.18%
Dow fell 280 points to 11,231
S&P fell 43 points to 1225
Dollar index fell .08 points to 79.51
Yen at 106.9
Euro at 1.411
Gold fell $26 to $776.50
Oil fell $4.40 to $102