Dangerous to bottom pick during credit crunch


By Neil Behrmann


In the past few months, several hedge fund firms have announced plans to establish credit funds to take advantage of distressed securities. Investors purchasing junk bond and credit hedge funds may still be at risk. Premature bottom picking in past bear markets has damaged investors.

Several warning signs exist that the credit crunch in the US and Europe is continuing. Analysts are also focusing on deteriorating credit in Japan.

Finance chiefs from the Group of Seven projected over the weekend that US and European subprime losses could be as high as $400 billion. Mario Draghi, governor of the Bank of Italy and chair of the Financial Stability Forum, a committee of international supervisors and central bankers, said that the next two weeks would be crucial as many banks issue their first audited accounts since the crisis began last summer.

Asked about the extent of total exposure to the US subprime mortgage sector, Draghi said, "The only thing we know is that its big and we keep on discovering new dimensions to it."

The potential exists that global risk shedding could tighten credit constraints on a widening set of borrowers and therefore slow economic growth which could further impair credit, the Financial Stability Forum said in its interim report. “There remains a risk that further shocks may lead to a recurrence of the acute liquidity pressures experienced last year. It is likely that we face a prolonged adjustment, which could be difficult.”

Private equity debt

The areas of concern for investors do not only include subprime and other mortgage-related securities. According to some estimates around $1 trillion of private equity debt was issued to finance leveraged buy-outs and mergers and acquisitions. Since the US, European and other economies are turning down, highly leveraged companies could have poor results leading to downgrades to junk status and the inevitable slide in values. This would have a negative impact on performance for both private equity and hedge funds holding high yield corporate debt.

Standard Chartered case study

Standard Chartered’s structured investment vehicle (SIV), called Whistlejacket has been put into receivership. The move follows a 61 per cent slump in the value of its assets to $7.15 billion from $18.2 billion at the end of August after the SIV sold holdings to repay maturing debt. The bank said the slide was "very recent". This indicates that other SIVs have experienced downturns that will place banks and other investors in structured vehicles and other credits, under pressure.

SIVs sell short-term commercial paper debt to buy longer-term, higher-yielding, assets. About 7 per cent of Whistlejacket's exposure was to US monoline bond insurers, that have been hit by rating downgrades. The monolines' troubles are partly to blame for a deterioration in investor confidence in Whistlejacket's assets. Standard Chartered’s SIV receivership follows auditor criticism of AIG’s valuation of credit default swap obligations. AIG has increased estimates of losses from insuring mortgage-related products to $5bn from US$1bn and its stock has slumped. Less than 5 per cent of Whistlejacket's assets are linked to subprime mortgages, according to Standard Chartered.

There are fears that the bottom the credit crunch won’t be reached for some time. A recent Moody’s report estimated that SIVs cut their holdings of securities by more than US$100 billion from a peak of US$400 billion last year. The failure of Whistlejacket is increasing fears that there will be fire sales of other structured credits and bonds. Numerous banks, including HSBC Holdings and Citigroup issued SIVs and are caught in the SIV crisis. Deutche Bank analysts fear that SIV companies still have a ``significant'' amount of assets to sell.

The average net asset value for SIVs is now hovering just above the 50 per cent mark, according to Moody’s.


Copyright © www.marketpredict.com. All Rights Reserved.

Content on the site is copyright of Marketpredict.com and its writers. Reproduction of this publication's copyright material is not permitted in web, electronic, printed or any other form without the written consent of the publisher. See Dangers of Flouting International Copyright Law For syndication rights please email syndication@marketpredict.com. This site is for information purposes only. The publication neither recommends nor advises on the investment and trade in currencies, bonds, stocks, commodities, futures, options, other derivatives, funds or any other financial or investment product or instrument. All information has been obtained from sources believed to be reliable, but accuracy cannot be guaranteed. Readers are solely responsible for the use of this information. They should not rely on it and should regard it as only one of their sources. They should seek advice elsewhere. The publisher of Marketpredict.com, panellists, other forecasters and contributors disclaim liability for any loss, damage, injury or expense that might arise from the use of the information and services contained herein. For further details on Marketpredict's code of conduct, disclaimers and dangers of flouting international copyright law, please examine Who We Are.


no registration needed

Research & Consultancy
services from Market Predict

Research & Consultancy

Asset allocation
Base Metals
Precious Metals
Softs & Grains
Hedge Funds
Endowments & Pensions
Environment & Recycling

  Lateral Scenarios
Market Psyche
  Code of Conduct
Who we are
Useful sites
Website Design
© 2006 Command Media