Excellent Credit Bubble Bulletin by Doug Noland tonight...it deals almost exclusively with the real estate and home mortgage bubble, and their expected consequences:
prudentbear.com
Credit Bubble Bulletin, by Doug Noland (Part I)
Monetary Policy and the Character of Lending
April 19, 2002
UNEDITED!
There was certainly no let up in stock market volatility this week, as global financial markets continue in their especially unsettled states. For the week, the Dow and S&P500 gained about 1%. The Morgan Stanley Cyclical and Morgan Stanley Consumer indices were both virtually unchanged. The Transports dropped 3%, while the Utilities added 2%. The broader market continues to outperform the large caps, with the S&P400 Mid-Cap index adding 1% and the small cap Russell 2000 gaining marginally. Year-to-date, the small-caps have gained 6% and the mid-caps 8%. The NASDAQ100 gained almost 3% this week, with the Morgan Stanley High Tech and Semiconductor indices jumping 4%. The Street.com Internet index added 2%, while the NASDAQ Telecommunications index gained 5%. The biotechs had a strong week, rising almost 3%. The financial stocks performed well also, with the AMEX Securities Broker/Dealer gaining 3% and Bank index adding 2%. With bullion about unchanged, the HUI gold index nonetheless added about 3%.
The Credit market was mixed, with the front of the curve (short-maturities) outperforming. For the week, yields on December eurodollars dropped another 13 basis points, making it a decline of 63 basis points over the past 14 sessions. Two-year Treasury yields declined 4 basis points to 3.31%, while 5-year yields dropped 2 basis points to 4.52%. Ten-year yields, however, rose 4 basis points to 5.20, while the long-bond saw its yield rise 4 basis points to 5.69%. Benchmark mortgage-back and agency bonds outperformed, with yields generally declining one basis point. Fannie Mae saw the spread to Treasuries on its 5 3/8 2011 note narrowed 4 to 64. The benchmark 10-year dollar swap spread also narrowed 4 to 62. The dollar index dropped better than 1% this week, with the euro and pound moving to three-month highs against the dollar. Asian currencies gained as well, with the Taiwan dollar moving to four-month highs against the greenback.
Last week saw $34.9 billion of new U.S. public corporate and agency bonds issued, with Bloomberg’s y-t-d tally at $526 billion, up 4.5% y-o-y. Convert.com has 54 new convertible bond issues y-t-d, with proceeds of $30.4 billion running up 30% from last year’s record pace. Year-to-date asset-backed security issuance of $99 billion is running about 9% above last year’s record. Almost $10 billion of asset-backs were issued this week, with home equity issuance about one-third of total volume. Broad money supply declined about $16 billion last week, with most of this explained by a significant drop in demand deposits. Perhaps this was tax related.
We keep a vigilant eye on quarterly earnings reports, especially following periods of aggressive Fed and GSE operations. These “reliquefication” periods – the response to the collapse of previous speculative Bubbles – generally usher in a new cycle of only more extreme Credit and speculative excess. As analysts, it becomes our focus to recognize the nature of the game and how it is changing – the sectors going out of favor and those that appear primed to receive at least their share of unfolding excess. To help in this analytical process, it is hopefully worthwhile to briefly take a look back at excerpts from a couple of earnings reports - post SE Asia/Russia/LTCM “reliquefication.” Remember how the game quickly changed from the emerging markets to trading, underwriting and the technology Bubble. One could certainly have looked to earnings reports and garnered hints of what was to come.
Bloomberg reports on JP Morgan’s Q1 1999 earnings: “The 137-year-old bank said profits from operations climbed to $600 million, or $3.01 a share, from $366 million, or $1.80, in the first quarter of 1998. Surging revenue from underwriting and trading stocks and bonds were responsible for most of the gains... J.P. Morgan’s profit ‘validates their strategy...’ ‘J.P. Morgan was in a business which was dead, which was large corporate banking. They’ve converted themselves, albeit with some problems, into a capital markets investment-banking firm...’ At J.P. Morgan, credit-market revenue, which includes bond trading and underwriting, surged 91 percent to $696 million. Equities revenue from businesses such as underwriting stocks and trading equity derivatives, more than doubled to $288 million.”
Bloomberg on Chase’s Q1 1999 earnings: “Chase Manhattan Corp., the nation’s second-largest bank, said first-quarter earnings rose a greater-than-expected 11 percent as securities trading and consumer banking gains more than offset lower revenue from junk-bond underwriting... Trading revenue and related net interest revenue was a record $837 million, up 21 percent from the same period last year. Securities gains rose 88 percent to $156 million, and gains from private-equity investments increased 11 percent to $325 million... The bank’s noninterest revenue rose 20 percent to $2.94 billion, as credit-card revenue gained 26 percent to $379 million, trading revenue surged 29 percent to $618 million, and investment management fees increased 19 percent to $414 million.”
Five months later, Chase purchased Hambecht and Quist for $1.35 billion and dove headfirst into technology IPOs, telecom debt underwriting, equity derivatives, and aggressive private equity investments. Bank of Boston (later acquired by Fleet) had purchased Robertson Stephens the previous year in a mad rush by the major banks to play the IPO boom and technology Bubble. Tech was the “hot game” and everybody wanted a piece of the action. Now, post-tech Bubble, we see that FleetBoston is admitting that expected “synergies” never developed and is looking to dump Robertson Stephens. Almost across the board, we note that banks are now looking to pare back “principal investing,” equity underwriting, and commercial lending. Nowadays, every banker seems to recognize that consumer and mortgage finance is the “safe” growth business going forward. We find this very troubling, and as further evidence supporting our view that the financial sector is in gear to finance the terminal stage of consumer Credit excess. Please read carefully the following comments and analysis from some of our country’s largest lenders.
From Washington Mutual, the nation’s largest Savings and Loan: “Record loan volume of $65.27 billion, including a 187 percent increase in total single-family residential loan volume and a 39% increase in [non-single family residential] loan volume from the first quarter of 2001.” While acquisitions make comparisons difficult, it is worth noting that origination volumes increased 10% from very strong forth quarter lending. From National City Bank, the nation’s ninth largest, after reporting a 19% increase in revenues and record earnings: “The blockbuster performance of our mortgage banking business this business cycle provided us with the capacity to produce record-breaking financial results while we prudently addressed credit issues... Commercial loan activity continued to be sluggish, but consumer and mortgage loan volumes were relatively strong.” Year-over-year, average asset balances were up 17%, with average loans up 3%. Commercial loans were down 3%, credit cards declined 16%, and other consumer loans were down 7%. At the same time, residential real estate loans were up 10%, commercial real estate 17%, and home equity loans were up 25%.
From Bank of America’s Financial Highlights: “Mortgage banking income grew 59 percent led by continued strength in origination volume and margins.” Year-over-year, total company revenues increased 2%. “Global Corporate and Investment Banking” revenue declined 5%, with earnings down 13% y-o-y. “Asset Management” revenues were “slightly below” last year, with a small gain in earnings. “Equity Investments” reported a loss of $32 million compared to last year’s earnings of $33 million. Meanwhile, “Consumer and Commercial Banking” revenues were up 10% and earnings increased 11%. “Average loans grew 4 percent, led by consumer loan growth of 20 percent, primarily in residential first mortgage and credit card.” Consumer credit card outstandings held were up 33% y-o-y to $19.5 billion, while total loans and leases in the Global Corporate and Investment Banking segment were down 29% to $65 billion. Total managed Consumer Credit Card outstandings were up 15%, while total Global Corporate and Investment Banking earning assets were down 2% y-o-y.
Bloomberg quoted Wells Fargo CEO Richard Kovacevich (through a spokesman): “The mortgage industry will be solid through the first half of the year because interest rates and unemployment are low by historical standards and consumer confidence as a result remains high.” From the company’s earnings release: “Commercial loans outstanding modestly declined in the first quarter in line with slow economic growth. However, we are extremely pleased with the continued strong consumer loan growth largely driven by strong sales of our industry-leading home equity and home mortgage products.” Average core deposits are up 13% y-o-y to $178 billion. First quarter mortgage originations of $68 billion were up 134% y-o-y, with Wells’ mortgage servicing portfolio surpassing one-half trillion dollars. The company’s home equity loans were up about $2 billion for the quarter (32% annual growth rate), with home equity loans up 46 percent y-o-y.
Year-over-year, Wells’ total assets were up 11.4%. One does not need to dig to deep to into the composition of the company’s loan portfolio to get a good idea of the way commercial banking is moving. Consumer loans expanded at a 17% rate during the quarter and are up 18% y-o-y. Year-over-year, commercial loans declined 4% to $47.4 billion, while total mortgage related loans jumped 28% to about $90 billion. By the two largest categories, “real estate 1-4 family first mortgage” were up 50% to $28.5 billion and “consumer – real estate 1-4 family junior lien mortgage” (home equity loans) were up 47% to $27.7 billion.” Curiously, the only mortgage category not showing strong growth was “construction” that actually declined slightly y-o-y. Elsewhere, other consumer loans were basically unchanged from one year ago.
Looking at Citigroup y-o-y revenues by segment, we see “Global Corporate and Investment Banking” down 11%, “Emerging Markets Corporate Banking and Global Transaction Services” down 11%, “Total Global Investment Management and Private Banking” down 12%, and “Total Travelers Property and Casualty” up 5%. Meanwhile, Citigroups’s “Total Global Consumer” segment saw revenues surge 20%, led by “Citibanking North America” up 25%, “Mortgage Banking” up 25%, and “North America Cards” up 14%. Total North America consumer revenues were up 14% y-o-y.
At JPMorgan Chase, investment banking revenues were down 16% y-o-y, investment management revenues were down 10%, and “Treasury securities and services” were down 2%. Meanwhile, “Retail and Middle Market” were up 18%. Looking at operating earnings, investment banking earnings were down 27% y-o-y, while retail and middle-market were up 25%. Commercial loans were down 3% for the quarter and 10% y-o-y. Elsewhere, credit card loans outstanding jumped 31% y-o-y to $49 billion.
Household International (HI) earnings were up 18% year-over-year. Total company assets were up 16% y-o-y to $90.4 billion. Total managed loans increased 15% to $101.2 billion. Managed real estate loans increased at a 14% rate during the quarter, and were up 22% y-o-y to $46.3 billion. Managed real estate loans are up 72% over the past nine quarters. Household is one of those companies that came under close scrutiny during the quarter, and it is worth noting that it used proceeds from securitizations to reduce its commercial paper borrowings by one-third to $5.8 billion.
The Capital One Bubble continues to expand. For the quarter, total assets expanded at a 44% annual rate to $31.3 billion. Total assets are up 50% y-o-y. Total managed loans increased at a 29% rate during the quarter, and are up 54% y-o-y. The company added 2.8 million new accounts during the quarter to 46.6 million. Industry leader MBNA added 2.4 million new customers during the quarter, with total managed loans up 8.5% y-o-y to $95.4 billion. Company assets are up 18% y-o-y to $46.5 billion.
Fannie Mae enjoyed record business volume (total mortgage purchases) of $197 billion for the quarter, with y-o-y revenues up 26%. During the past 12 months, Fannie’s total book of business (mortgages retained and guaranteed mortgage-backs sold into the marketplace) increased a stunning $262 billion, or 19%, to $1.63 trillion. If nothing else, at least the chatter that they are but 10% of the mortgage industry has died down. To put this growth into perspective, Fannie’s total book of business increased $145 billion during the preceding 12-month period (Q2 2000 through Q1 2001). It is also worth noting that Fannie’s 12-month book of business growth surpasses total annual U.S. household mortgage debt growth for any year prior to 1998 (commencement of mortgage finance Bubble), with total U.S. household mortgage growth averaging $194 billion during the first 8 years of the nineties.
Interestingly, despite Fannie’s average retained mortgage portfolio expanding at a 15% rate during the quarter, the company’s total assets increased at only a 4% rate. This anomaly is explained by the company reducing its short-term “liquid investments” by $18.8 billion during the quarter to $57.3 billion. At year-end, Fannie Mae “liquid investments” included $21 billion of asset-backed securities, $12 billion of commercial paper, $12 billion of floating rate notes, $11 billion of eurodollar deposits, $9.4 billion of repurchase agreements, $5 billion of fed funds, and $4 billion other investments. Fannie Mae’s decision to finance its mortgage purchases by running down “liquid investments” provides a good illustration of an operation that has pressured money supply expansion during the first quarter. Now that 2001 financial statements are available, we see that Fannie increased short-term borrowings last year by $63 billion, or 23%, to $344 billion.
This week from the LA Times’ Daryl Strickland: “The housing market across much of Southern California grew at a blistering pace last month, achieving the strongest sales and price gains in any March in 13 years. Los Angeles County’s median home price jumped 15% from a year ago to a record $251,000, according to a report released Tuesday by DataQuick information Systems Inc. Sales of new and existing homes rose 17% to 10,651, the highest level in March since 1989. Sales and prices also grew robustly in Orange County and other markets as buyers across much of the region searched anxiously for the right house. Brokers said multiple offers grew more common in March, pushing up the cost of homes and leaving first-time buyers, in particular, frustrated at their lack of options... In Southern California, barring a severe change in consumer sentiment, current conditions could be sustained through much of the year... John Karevoll, the analyst who compiled the report, sees faster growth through summer and into fall throughout California. ‘The trends are quite uniform across the board.’” For the first three months of the year, both sales and price gains are the strongest since the late 1980s.
This week from the San Diego Union-Tribune’s Roger Showley: “San Diego County housing prices rose last month nearly 17 percent from the same month in 2001, crossing over the $300,000 threshold for the first time... The overall median for new and existing houses and condominiums was $304,000, up from $260,000 in March 2001, and $15,000 more than in February 2002. Existing single-family homes, which had hit the $300,000 mark in February, rose to $307,250 and existing condos were up 22.2 percent, from $180,000 in March last year to $220,000 last month. Newly built houses and condos rose 14 percent to $394,000, no doubt headed for the $400,000 mark this month.”
From another Daryl Strickland LA Times article: “Flush with a $95,000 profit from a Los Angeles County home, Mike Riach thought he’d have no trouble finding a house he could afford in Ventura County. But the 33-year-old firefighter lost out on a full-price offer in Ventura. Then he found that just about anything in his price range was sold by the time he saw it. Finally, after months of hunting, Riach and his wife, Suzie, got lucky in a lottery-type sale in Camarillo and bought the last model home in a new subdivision for $340,000. Eighty people had signed a waiting list for the opportunity. ‘They called out our name and my wife jumped up screaming,’ he said. The victory will cost the Riaches 44% of their take-home income each month. ‘It’s $100,000 more than I wanted to spend; just way too much,’ Riach said. ‘But it’s really good for today’s market. It’s amazing what’s going on.’ In the last two months, Ventura County’s scorching housing market has gotten so hot that some veteran agents say it matches or surpasses the real estate run-ups of the late 1980s. Bidding wars are back, agents say. Some owners sell their own homes without an agent in days. And even houses priced above the perceived market are fetching more than owners are asking. ‘It’s almost as if somebody flipped a switch in late January, and everybody came out in droves,’ said Ventura agent Harold Powell. ‘In the last month we’ve had multiple offers on four or five properties. Three of them have sold over the asking price.’ Those houses sold for $285,000 to $500,000, he said. A year or two ago, they would have cost $50,000 to $100,000 less.”
All of the sudden the media is taking an interest in the real estate Bubble. Kudos to Barron’s talented Jonathan Laing for his excellent piece last week, “Home Grown – Rising Prices have kept the economy afloat. What happens if the bubble bursts?” It seems to have struck a nerve... |
