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Strategies & Market Trends : Galapagos Islands -- Ignore unavailable to you. Want to Upgrade?

To: Techplayer who wrote (16825)	12/16/2002 12:33:19 AM
From: Techplayer	Read Replies (1) \| Respond to of 57110

Q: That's a nice segue to talk about financial stocks. What do you make of the HSBC-Household deal? A: The biggest impact, one that will be monumental, is that $20 billion of debt will likely disappear from the bond market if HSBC takes Household International's debt onto its balance sheet. Why pay 4% to 5% for money when you can earn 1½% on it. So the deal does two things: It allows HSBC to make a tremendous spread on its deposits by buying Household's assets and it takes the pressure off the bank to make new loans. This purchase alone probably gives them one to two years of asset growth. The capital discipline in the banking industry is greatly underestimated. Something that's gone unrecognized is that the second and third quarter of this year were the two of the most profitable quarters in history for banks in this country by wide, wide margins. Last quarter, the return on assets for commercial banks rose to 1.37%, up from basically 1.2% a year ago. Q: So why will HSBC-Household be monumental for the bond market? A: When the deal is completed it will result in a major, major turn in the corporate market. All of a sudden, a $20 billion-plus borrower in the bond market disappears forever. This will be as monumental an event as maybe the Penn Square or Bank of New England bankruptcies in terms of marking a bottom. Spreads of double-BB rated companies over Treasuries are at record levels. When this acquisition is completed you are going to see those spreads tighten dramatically. The big trade to be made is buying strong double-BB credits and shorting Treasuries, because there is an economic recovery and you are going to have a corporate bond market that just feels better, and people are going to be willing to take more risk in bonds. You will also see other banks go into the market and buy other commercial lenders -- companies that can add to their capacity at very low cost. Q: What's the time frame for the turn in the bond market? A: It will play out over the next 90 days, because the HSBC-Household deal should be completed somewhere between March or April. We should get a sense of whether the regulators are inclined to approve it in the next 30 to 60 days. A lot of people are speculating the deal falls through, though I think it will happen. We bought a lot of shares in both companies after the deal was announced because it seemed people didn't understand its value. We own more Household because it trades at a huge discount to its deal price. We expect the arbitrage gap to close dramatically. When people realize what the earnings growth at Hong Kong Shanghai will be as a result of buying Household, HSBC shares will trade at much higher levels once the deal goes through. online.wsj.com