The great credit crunch monster has struck again on two continents: pushing those desperate twins, Fannie Mae and Freddie Mac to the edge for the second time in six weeks in the US, and finally crunching financial engineer, Babcock and Brown in Australia, sending chairman, Jim Babcock into early retirement and CEO, Phil Green to the backbench.
We will look at the situation with the twin basket cases of US mortgage finance shortly, but yesterday’s announcement from the embattled investment bank and financial engineer marked the end of the first round.
BNB shares ended a big day down sharply, $1.23 to a new all time low of $2.22. The 35.6% fall on the day understandable given the news of the changes and the poor state of the company’s finances.
In contrast its troubled affiliate, Babcock and Brown Power, the source of much of its parent’s recent woes with big debts, write downs of $452 million and falling distributions, saw the price of its securities rise 2 cents to 18 cents at the close.
BNB shares have shed more than 90% in value so far this year as talk of problems, losses, instability and growing investor distrust have taken their toll.
CEO Phil Green has been replaced by Michael Larkin, the chief financial officer, while Jim Babcock, chairman and founder, is being replaced by Elizabeth Nosworthy.
She was chairman of Commander Communications which went belly up owing over $300 million a fortnight ago. She was deputy chairman of BNB, so she’s has as much responsibility for the problems as Mr Babcock and Mr Green.
BNB is to unveil the result of a strategic review in the near future (it still “has a way to go” was the timetable in yesterday’s documentation), which is expected to recommend that the company re-organise itself as an alternative asset manager and increase its focus on real estate and leasing as well as infrastructure investment.
That’s all a bit late, and all a bit like Allco Finance Group, which fell over earlier in the year and is now in deep negotiations with its banks.
Allco reports next week and losses of $1 billion and a bit more are expected from that disaster.
We will also hear from Centro Properties and Centro Retail in the next week and those two victims of the credit crunch monster will produce losses in the hundreds of millions of dollars.
BNB said net profit for the six months to June 30 fell 34% to $211.08 million, in line with its recent wide guidance of a fall of between 25% and 40%. The company repeated that it did not expect its full year profit to exceed last year’s figure.
Net profit attributable to the group was $175 million, down 30% from the $250.1 million in the first half of 2007, when times were good and credit easy.
The result included the impact of non-cash impairment charges of $386 million and realised trading losses of $55 million across its four divisions.
Net revenue for the half, excluding impairment charges and asset revaluations, was $764 million, up 31%.
“As previously advised, the group 2008 NPAT is not expected to be above the 2007 group NPAT of $643 million,” it said and the actual result depends on market conditions, assets sales, the execution of its 2008 transaction pipeline and its progress on a restructuring and cost cutting program.
“The volatile global capital market conditions have made and continue to make business conditions uncertain and forecasting in the short term difficult,” Mr Larkin said.
“The environment has created a number of challenges for the group, which we are actively working through at the current time to reach resolutions which endeavour to weigh the interests of all stakeholder groups.”
BNB also said that as part of a strategic review of its business it planned to wind down its corporate and structured finance division.
“The corporate and structured finance division will gradually be wound down,” Mr Larkin said.
“Other assets and businesses not within the key areas of focus will be kept under review and divested or wound down as appropriate to maximise shareholder value.”
Its existing private equity funds - BBDIF and BBGP - will continue to be managed by the group and have access to its co-investment pipeline.
B&B Communities Group, B&B Capital Ltd and BBGI will continue to be managed by the group and will pursue strategies to maximise value for investors, said Mr Larkin.
“As a matter of prudence, no dividend will be paid until sufficient progress has been made on corporate debt reduction,” it said.
And in a burst of confidence, the company says that dividends are expected to re-commence in calendar 2009.
In the US a far more dangerous game is being played with the shares of Fannie Mae and Freddie Mac.
Is it a coincidence that a week after the ban on naked short selling on Freddie Mac and Fannie Mae (and 17 other US banks and financial groups) the troubled quasi-US Government backed mortgage giants, that both are now back under pressure?
Probably not, but it’s convenient to blame the shorts for the emerging train wreck that is Fannie and Freddie.
Very soon, the US Government will be forced into some sort of bailout. It is coming, very quickly and the sharks in the credit markets sense that.
But has the Bush Administration, in its twilight days, the wit and the people to pull off what will be the most complicated refinancing deal the world will see in a long time?
Basically, it has to stop the terrible twins from defaulting on the debt, while allowing them to continue to fund the current meagre amount of mortgage refinancing that they are now carrying out.
The shareholders in both have lost their money; but the bond holders and others have a lot to do if they are to avoid collaterall damage.
It’s probably why US dollar short term interbank rates in Europe persist well above the 2% Federal Funds Rate and 2.25% Fed discount rate. There seems to be a growing fear that another big financial group is having problems.
Fannie and Freddie are the most obvious candidates, after the events of the past three days.
The duo has $US230 billion in debt that has to be rolled over or repaid by the end of next month.
It won’t happen without them paying huge premiums on the debt, which in turn will force up mortgage interest rates, further hurting the depressed housing and finance sectors, and triggering more foreclosures.
All of that six weeks out before the US presidential poll!
An auction of Freddie debt this week exposed this potential explosion: Freddie sold $US3 billion in new debt, but at a margin of 1.13% over the equivalent US government debt rate.
These were five year ‘reference notes’ and the premium means that the hard heads in the credit markets reckon that these quasi-government companies are increasingly risky.
It had been expected that after the passage of legislation through the US Congress formalising the US Government plan to support them, that the debt premiums would gradually settle down.
Far from it and the news of the premium saw Freddie and Fannie shares hit their lowest levels in nearly 20 years, dropping below the levels they bottomed out at last month in the panic that led Treasury Secretary Henry Paulson to propose government-funded ’support’ that later became law when approved by Congress.
So while the US Securities and Exchange Commission ban on naked short selling helped stabilise the market (so it now seems ) while that legislation was put through the US Congress, the deeper problems at Fannie and Freddie are still there for everyone to see.
The ban expired on August 12 with the SEC promising new rules on short selling as soon as possible. The twins’ shares were attacked on Monday, Tuesday and Wednesday in US markets.
The shares in both companies are now down 90% or more from their highs
But it’s not just the shorts that are causing them pain: the credit markets just don’t believe the two when they argue they are well capitalised and investors seem to be challenging the US Government to intervene and back them directly.
According to Bloomberg, Fannie and Freddie have $US223 billion of bonds due by the end of this quarter and their success in rolling over that debt may determine whether they can avoid a bailout.
Fannie has about $US120 billion of debt maturing between now and September 30, while Freddie has an estimated $US103 billion.
If these bonds can’t be rolled over, then the government will have to step in with support; if they are rolled over, payment of premium rates of 1% or more will turn the housing sector into a bigger disaster area.
In July Fannie and Freddie did almost 100% of the refinancing of less than $US100 billion in mortgage debt.
The private sector has runaway to hide and the big US banks and other lenders are cutting back every day by raising their lending standards, and seeing more and more defaults among high quality prime home loans.
Unless there is a dramatic turnaround in sentiment, judgement day is approaching rapidly for Fannie, Freddie and the US Government.
The optimists are those who continue to own the shares, which have tanked. They have no value whatsoever.
The results this week of leading Australian building companies, Boral and James Hardie tell the story of the US housing slump and the damage it continues to cause.
We had another reminder overnight of the extent of the slump with new home starts for July falling once again and permits to build also dropping to a 17 year low as well.
US new home starts in July fell 11% from June to a seasonally-adjusted level of 965,000 units - slightly better than expectations, but still the lowest since 1991.
That’s 30% down on July 2007 and single home starts fell 2.9% from June as well. The 18% drop in new building permits says there will be further falls in new home starts in coming months.
That’s not good news for companies operating in the US housing sector.
Boral revealed that its US business, which generates 12% of its $5.2 billion a year in sales, slumped so badly that it helped drop overall earnings 19%. Sales in the US plunged 24% and pre-tax earnings fell from $118 million in 2007 to just $11 million in 2008.
And James Hardie revealed that first quarter profit fell 39% as the US housing crash again bit into the company’s main business, where 80% of its earnings come from.
Hardie said its net operating profit in the June quarter, (excluding costs related to compensation payment to victims of asbestos related diseases); fell to $41.6 million from $68.6 million in the same quarter in 2007.
On top of this news a number of major US retailers all reported poor quarterly profit figures, and no sign of any improvement.
Quarterly results came from Home Depot, the home improvement chain that Bunnings here in Australia is modelled on, Target, the mass discounter whose name is used by the Wesfarmers’ chain here, Saks, the luxury fashion retailer and corporate stationery group, Staples. They were all disappointing.
Saks was the worst hit: its shares fall more than 10 per cent to $10.02 after it reported a loss on softening demand for its luxury ¬clothing, shoes and accessories. Saks also predicted flat or falling comparable sales for the second half of the year.
Over the first six months of the year Saks comparable store sales have increased just 2.7 per cent, compared to the high-single digit growth it saw before the economic slowdown started to hit higher-end consumers at the end of last year.
Target’s sales and profits were both lower as it’s bigger and cheaper rival, Wal-Mart once again proved it was a better mass discounter. Home Depot expressed hopes that the bottom in housing was being reached, but said it wasn’t seeing any sign of that happening.
But the most interest comments came from Staples, the world’s biggest office and home office supplier (it just bought Corporate Express of Holland, which operates here in Australia).
Staples said it will report quarterly results below Wall Street expectations and cut its full-year outlook, sending its shares down 10%.
The company blamed weak sales in North America and Europe caused by small-business customers cutting purchases, a good indicator of how intensely the slowdown in the US, and now Europe is starting to bite.
The company also said the mortgage and housing slump was hurting home workers and small businesses especially hard.
Seven or eight US retail chains have gone bust or filed for bankruptcy protection so far this year, the latest was the Mrs Fields Original Cookie chain, which has around 300-odd stores in the US and 80 overseas, including some here.
As bad as all this news was, the big surprise was from the July figure for wholesale, or producer price inflation in the US.
US wholesale prices rose twice as fast as expected last month, rising 1.2% in the month for an annual rate of 9.8%.
It had been forecast to rise by 0.6%, down from the 1.8% rise in June. Economists cautioned that the survey was taken before the mid-month slide in oil and other commodity prices (as was the consumer price survey which showed an annual rate of 5.6% in July and a monthly increase of 0.8%, double the forecast as well).
But what really worried economist was the so-called core inflation fire for the PPI: it rose 0.7% in July, more than three times as much as the 0.2% rise in June.
The annual rate was a worrying 3.5%, the highest since 1991. If core inflation for the PPI and the CPI continues above 2%-2.5% for the rest of this year then the Fed will be under more pressure from the inflation hawks on its board, to bump rates up to 2.5%.
Economists said what troubled them was the broad spread of items which rose in the core measurement: just as there was a wide range of items which rose in the core CPI measure last week. It indicates that inflation might be more entrenched in the US than thought.
Economists do expect a slowdown to start happening from this month, but they wonder if it will take a lurch into an actual recession and a rise in unemployment above 6% to get embedded price pressures out of the system.
The Fed thinks that will happen, rather it hopes it will happen.
And next week’s second reading of US GDP will be up on the 1.9% first estimate. It’s an illusion, driven by higher exports and a smaller trade deficit!
The latest figures on industrial production for an eastern US region, and an index of leading indicators are all pointing to slowing US economic activity over the remainder of 2008 and into 2009.
