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Record Share Repurchases by U.S. Companies May Aid Stock Rally
By Hilary Johnson
Bloomberg, 2006-09-05
U.S. companies are spending record amounts of money on their shares, and the repurchases may help stocks exceed the five-year highs reached earlier in the year.
Microsoft Corp., the world's largest software maker, bought back $3.8 billion of stock last month. Realogy Corp., the real- estate broker spun off from Cendant Corp., offered last week to pay as much as $736 million for some of its shares.
The offers followed $116 billion of repurchases in the second quarter, the most ever, according to Standard & Poor's. Buybacks announced in 2006 already exceed the record amount for a full year, according to Birinyi Associates Inc., a money- management and research firm. Record levels of cash and relatively low interest rates have spurred buying.
``Supply's shrinking,'' said Kenneth Fisher, chairman of Fisher Investments Inc. in Woodside, California, who oversees $32 billion. ``That's got to be bullish.''
Stocks rose last week as data on inflation, job growth, manufacturing and consumer confidence reinforced the Federal Reserve's view that economic growth is slowing gradually.
The S&P 500 ended the week 1.1 percent below this year's peak of 1325.76, reached May 5, when the index climbed at the highest level since February 2001. U.S. markets were closed yesterday for the Labor Day holiday.
Reports tomorrow may provide more evidence that the economy is meeting the Fed's expectations, suggesting policy makers may be done raising interest rates after 17 increases in two years.
Advisers' Optimism
The Institute for Supply Management may say banks, builders, retailers and other service companies expanded last month, according to a survey of economists by Bloomberg News. Productivity probably rose in the second quarter at a faster pace than first reported, another survey showed.
Speculation that the Fed won't lift rates sent optimism about U.S. stocks to a five-week high, according to the latest survey by Investors Intelligence, a New Rochelle, New York-based financial newsletter.
The number of bullish newsletter writers rose during the week ended Aug. 25 by 2.1 percentage points, to 42.1 percent. Bearish, or pessimistic, writers fell to 33.7 percent, a six-week low, from 34.7 percent.
The S&P 500 advanced 1.2 percent last week to 1311.01. The Dow Jones Industrial Average added 1.6 percent to 11,464.15 and the Nasdaq Composite Index increased 2.5 percent to 2193.16.
$40 Billion Plan
Microsoft has risen 20 percent since June 13, when the S&P 500 reached its low for the year. The Redmond, Washington-based company announced plans in July to repurchase $40 billion of stock, including $20 billion through a tender offer.
Investors tendered only $3.8 billion of shares. To make up the difference, Microsoft boosted its repurchase program to $36 billion on Aug. 18. That day, its stock gained 4.4 percent, the most in a month.
Realogy, the company behind the Coldwell Banker and Century 21 real-estate brokerages, offered to buy as many as 32 million shares on Aug. 28. The company agreed to pay $20 to $23 a share in the so-called Dutch auction, allowing shareholders to set the price they will accept. The offer expires on Sept. 26.
A week earlier, Realogy authorized a buyback plan for a maximum of 48 million shares. The company, based in Parsippany, New Jersey, said the purchases may add as much as 10 percent to earnings per share next year.
`Being Pushed'
U.S. companies spent 16 percent more on their shares during the second quarter than in the prior three months, according to Howard Silverblatt, a senior index analyst at S&P in New York. They also beat the record of $104 billion set in last year's fourth quarter, S&P data showed.
Buyback announcements in the first eight months of 2006 totaled $507 billion, up 88 percent from the year-ago period, according to Birinyi, based in Westport, Connecticut. The full- year record of $470.7 billion had been set last year.
Boeing Co., the world's second-largest maker of commercial aircraft, said on Aug. 28 that it would buy back as much as $3 billion of shares. Amazon.com Inc., the world's biggest online retailer, authorized $500 million in repurchases that day.
Companies are making these plans after amassing record amounts of cash. S&P 500 members had $614 billion available as of Aug. 30, according to S&P, whose total excludes utilities and financial and transportation companies.
``They're being pushed to do something with the money,'' Silverblatt said. Buybacks enable companies to return cash to shareholders without committing themselves to future payments, as dividends do.
`Too Cheap'
Relatively low interest rates have also been a boon for buybacks, Fisher said. S&P 500 companies will earn $87.17 per ``share'' this year, about 6.6 percent of the index's current level, according to the average estimates of analysts surveyed by Thomson Financial. Ten-year U.S. Treasury notes, a benchmark for borrowing costs, yield 4.72 percent.
``What they're really saying is that the cost of the stock is too cheap relative to the cost of borrowed money,'' he said, referring to companies.
Repurchases can increase per-share earnings by reducing the amount of stock outstanding. Analysts see profit growth slowing through the second quarter of 2007, providing an incentive to make repurchases.
After surging 16.3 percent in the second quarter, S&P 500 profits will rise 14.3 percent in the third, 13.4 percent in the fourth and 11 percent in next year's first quarter, according to Thomson. Second-quarter profit is projected to rise 8.9 percent.
`Lack of Confidence'
``Companies buying back their own shares may well reflect a lack of confidence,'' said James Paulsen, chief investment strategist at Wells Capital Management in Minneapolis, who helps manage $150 billion. ``They feel they don't have any good investment opportunities.''
Announcements don't always lead to purchases. Since 2000, companies have bought only 65 percent of the shares they said they would, according to Birinyi's data.
Still, many investors can't help but be optimistic about what the increase in buybacks may mean for the market.
``How much can you shrink the denominator before it explodes the price?'' asked Kevin Bannon, who helps manage $116 billion as chief investment officer at Bank of New York. ``We're getting closer and closer to that point.''
Bloomberg Tickers
TNI US BBK BN To see Bloomberg stories on share repurchases
CACT 50 US For a table of U.S. companies that have announced repurchase programs.
Al Gordon, Wall Street Icon at 105, Is Bearish on U.S. Stocks
By Christine Harper
Bloomberg, 2006-08-30
Albert H. Gordon took over Kidder, Peabody & Co. in 1931, turned it into an underwriting leader on Wall Street, and saw opportunities overseas before many rivals.
He's still looking abroad at the age of 105.
After eight decades as an executive and investor that spanned from the roaring 1920s to the age of terrorism, Gordon says he's ``bearish'' on U.S. stocks partly because of the $8.41 trillion national debt. He prefers shares of companies such as Canada's EnCana Corp., Wal-Mart de Mexico SA de CV and Petroleo Brasileiro SA.
``At least three-quarters of whatever I own is foreign stocks,'' he says from his Manhattan apartment overlooking the East River.
Gordon, who has outlasted Kidder as well as Wall Street staples like ticker tape, is a role model even to octogenarian elder statesmen such as former Goldman Sachs Group Inc. Co- Chairman John Whitehead and ex-President George H.W. Bush. This year, Gordon stopped going to the office at Deltec Asset Management, where his son John is a senior managing director.
A marathon runner into his 80s, Gordon now has a hearing aid and walks with a cane and assistance from a nurse. His opinions are still sought because he's one of the few living Wall Street investors who worked in the years leading up to the stock market crash of 1929.
While his three current favorite stocks each climbed at least 13 percent this year through yesterday, almost triple the 4.5 percent gain in the Standard & Poor's 500 Index, Gordon built his reputation as a salesman rather than as an investor, says Whitehead, 84.
Presidential Role Model
``He was a famous business-getter,'' says Whitehead, a former rival. ``Work hard and never give up -- those were very valuable lessons I learned from trying to compete with him.''
Whitehead, who joined Goldman Sachs in 1947, remembers vying for clients against the more experienced Gordon at Minneapolis- based 3M Co., where Gordon's relationship was so close with then- Chief Executive Officer William McKnight that Whitehead says he focused instead on cultivating the next generation of executives. It didn't work right away, he says.
When McKnight died, Whitehead says, his will stipulated that Gordon and Kidder should handle any sales of McKnight's stake in 3M.
Gordon's influence extended to the highest levels of the U.S. government. He befriended Prescott Bush, a U.S. senator from Connecticut from 1952 to 1963 and grandfather of President George W. Bush, and served as a role model to George H.W. Bush, the 41st U.S. president.
``He taught me a lot about ethics and values,'' says George H.W. Bush, 82. ``He's a very energetic man of great character.''
Harvard Benefactor
Gordon, the son of a successful leather merchant in Boston, graduated from Harvard University in Cambridge, Massachusetts, in 1923 and from Harvard Business School two years later.
Today, one of the main roads into the business school bears a plaque calling it ``Albert H. Gordon Road'' in recognition of his advice and donations over the years. Harvard declined to comment on the amount Gordon has given to the school.
``Al Gordon was a master salesman,'' says Samuel Hayes, 71, an investment-banking professor emeritus at Harvard Business School who met Gordon in 1961. ``He was an effective rainmaker long after he ceased to manage the firm on a daily basis.''
As a bond salesman at Goldman Sachs in the 1920s, Gordon says he considered stock values excessive and steered clear of the market before it crashed. That helped him a year later in 1930 to capitalize when a Harvard classmate, Edward Webster, approached Gordon to help rescue Kidder, a brokerage based at the time in Gordon's hometown of Boston.
Planes and Trains
They moved the firm to New York, and Gordon, who would go on to become the firm's senior partner and biggest shareholder, built up its sales and underwriting divisions. Gordon expanded across the U.S. and overseas, taking airplanes to see clients when his competitors were more comfortable on trains like the 20th Century Limited to Chicago, he says.
``People wouldn't fly,'' he says. ``So there was virtually no competition.''
With the advent of jet travel, he flew to Japan with his wife ``to see if the people were friendly,'' paving the way for an expansion in Tokyo.
``We did a tremendous amount of business in Japan,'' he says. That followed expansions in Asia and Europe in the 1950s, he says: ``We were the first people to have an office in Hong Kong, the first people to have an office in England.''
Gordon began turning over chief executive officer duties at Kidder to Ralph DeNunzio in the 1970s, staying on as chairman. In 1986 Gordon helped engineer the firm's sale to General Electric Co. and remained at the firm until 1994, when GE sold the company to PaineWebber Group Inc., now part of Zurich-based UBS AG.
`Gold Mine'
Kidder's final years included criminal inquiries. Martin Siegel, who had been the firm's top merger banker, pleaded guilty in 1987 to one count of conspiracy to violate the securities laws and one count of tax evasion for failing to report payments he received from arbitrager Ivan Boesky.
The firm fired bond trader Joseph Jett in 1994, accusing him of manufacturing $350 million of false profits. On March 5, 2004, the U.S. Securities and Exchange Commission ordered Jett to pay $8.4 million and barred him from the securities industry after concluding he committed fraud and created phantom profits. Jett maintained his innocence after the order.
Kidder should have spotted the activities sooner, and the inquiries hurt the firm's reputation, Gordon says. Until that time, he says, ``it really was a gold mine.''
Growth Strategy
When it comes to investing, Gordon looks for companies that will grow for years, says Arthur Byrnes, who is co-head of Deltec Asset Management with Gordon's son John.
``Despite the fact that he's an old man, he buys things not for a quick trade,'' Byrnes says. ``Al is a long-term investor, if you can believe that someone who's 105 years old can be a long-term investor.''
Gordon favors countries with economies that will support growth, and he says the U.S. has too much debt. He says he liked Petroleo Brasileiro partly because South America had been successful for Kidder. Wal-Mart de Mexico and EnCana, Canada's largest natural-gas producer, may grow, he says.
``I read that Wal-Mart was stationary but Wal-Mart's Mexican subsidiary was on the move so that was enough for me so I bought quite a bit of Wal-Mart Mexico,'' he says. ``EnCana was owned by the Canadian Pacific Railroad and so you knew that its background was business, not government.''
Sleep and Run
A non-smoker who says he used to pay people to give up cigarettes, Gordon ran in the London marathons for the two years after his wife died in 1980. He credits his long life to exercise and at least nine hours of sleep a night. He would often walk or run between city centers and airports in New York and Los Angeles. He has three sons and two daughters, all between the ages of 70 and 55.
When it comes to investing, at least one of Gordon's contemporaries agrees that overseas stocks can provide more robust returns than U.S. shares.
``Al Gordon is right,'' says Irving Kahn, 100, chairman of New York-based investment firm Kahn Brothers & Co. He says global wealth imbalances and the rise of extremists should give investors pause: ``You don't have to be too alert to see how much terrorism is spreading.''
Highlights of the FOMC Minutes
The Detailed Minutes
Aug 29, 2006
The staff forecast prepared for this meeting indicated that real GDP growth would slow in the second half of 2006 and 2007, and to a lower rate than had been anticipated in the prior forecast. The marking down of the outlook was largely attributable to the annual revision of the national income and product accounts, which involved downward revisions to actual GDP growth in prior years and prompted reductions in the staff’s estimate of potential output.
The rate of new home sale cancellations, which was identified as an important leading indicator by some contacts in the construction industry, had spiked higher.
Although business fixed investment in the second quarter was a little lower than had been expected, participants noted that this development appeared mainly to reflect the timing of purchases, particularly of transportation equipment, and not weakness in the underlying trend.... However, it was noted that if the reported slowing of increases in retail sales continued, businesses might trim capital spending plans.
Several participants took note of the revisions to historical data that painted a more worrisome picture of cost trends; measures of unit labor costs had been marked up, reflecting upward revisions to labor compensation and downward revisions to labor productivity.
The recent pickup in price increases appeared to be broad-based, and a number of business contacts reported greater ability to pass through higher costs. However, some types of price pressures were not likely to continue to increase. The recent acceleration in shelter costs, which contributed substantially to the increase in core inflation this year, could prove short-lived. Moreover, while energy prices had risen further in the intermeeting period, energy prices could well level out in coming quarters. Also, the anticipated moderation in aggregate demand implied that pressures on resource utilization likely would not increase and could abate to a degree going forward. Finally, inflation expectations appeared to have remained contained despite adverse news about prices. In light of these factors, most participants expressed the view that core inflation was likely to decline gradually over the next several quarters, although appreciable upside risks remained.
In view of the elevated readings on costs and prices, many members thought that the decision to keep policy unchanged at this meeting was a close call and noted that additional firming could well be needed.
All members agreed that the statement to be released after the meeting should convey that inflation risks remained dominant and that consequently keeping policy unchanged at this meeting did not necessarily mark the end of the tightening cycle
Chinese Economy - Progress on Strategic Petroleum Reserve for Chin
G7 Group, Aug 29, 2006
China is in the process of building extensive storage capacity for a strategic petroleum reserve (SPR). The capacity goal is 90 days of net import volume, which is about 400 million barrels, but this is a long run target. China has not yet begun to fill the reserve (although it plans to start before year end), and the rate at which it supplies the reserve is dependent on petroleum prices. Large purchases of oil from the international market for the SPR are unlikely anytime soon unless the oil price drops significantly (say to under $60 a barrel). What is behind this effort?
Soaring oil prices combined with China’s increasing dependence on imported oil products have spurred the government to expedite the pace of building its strategic petroleum reserve. The purpose is to secure oil reserves in case of a supply shock and to cushion against the impact of oil price on China’s economic growth. China is aware that in the absence of a petroleum reserve it is increasingly susceptible to economic sanctions triggered by international conflicts and general supply interruptions. Currently, China's commercial petroleum storage can only meet the nation's consumption needs for 21.6 days, compared with about 160 days for the US and Japan. At what stage is the overall SPR project?
- Four reserve bases are currently under construction: Two at Zhenhai and Daishan in Zhejiang province, one at Huangdao in Shandong province, and one at Dalian in Liaoning province.
- After these four bases are put into operation in 2008, China’s total petroleum storage (including existing commercial storage) will be able to satisfy the nation’s 30 days consumption. The NDRC recently disclosed that all 52 oil storage tanks (16 of them already completed in October 2005) at the Zhenhai oil reserve base, the largest among the four, will be completed for use by the end of October this year. The total capacity of storage is
5.2 million cubic meters. The other reserve bases are expected to be completed in 2007-2008.
- But China’s buildup will go further than this. When the whole project is completed, China expects to have petroleum storage capacity of 400 million barrels, or equivalent to about 90 days of net import volume. The government is already starting to select the new sites for the second phase of the SPR. And after that, additional sites are expected to be built in the hinterland of the country (Phase Three). Total planned storage of strategic petroleum is 10-12 million tons during Phase One; 28 million tons at the end of Phase Two; and another 28 million tons at the end of Phase Three.
China plans to start filling the SPR this year, but it is expected to take a long time to complete. Some of the newly-found oilfield output is likely to be incorporated into the SPR; however, China is unlikely to choose this time to import large additional amounts of petroleum to build the SPR, because it does not recognize the current oil price as a good deal.
Moreover, the country’s new oil windfall tax does not encourage additional imports. Domestic oil producers will be charged a tax of 20% or higher when the price of crude oil stays above US$40 a barrel. The tax rate is 40% when the price rises above US$60 per barrel, which is indicative of how the policymakers perceive oil prices. Hence we may expect that the filling of China’s SPR to be a gradual process.
Large purchases of oil from the international market are unlikely at this point and may remain so unless the price of price drops significant (say, to under $60 a barrel). Obviously, this price point estimate is based on a current assessment of the likelihood of supply interruptions. If the geo-political environment becomes more risky for oil supply, the pace of supplying the SPR can change.
Bottom Line: China is building capacity for an ambitious SPR. But it is not filling the capacity yet and when it starts -- probably later this year-- it will not do so aggressively, given the high price of imported oil. The capacity building will take at least several more years, and filling will obviously take longer, perhaps much longer.
Asset – Credit Market
New World's Banker
WSJ, Aug 26, 2006
Some fear the U.S. credit markets are about to be submerged under a flood of leveraged buyouts. With a number of large deals seeking financing, that could mean higher borrowing costs and smaller profits for private-equity investors. The buyout kings have found a way around this potential crisis, however -- they are turning to Europe.
This year U.S. companies have raised $20 billion of leveraged loans outside America, according to Standard & Poor's Leveraged Commentary & Data. That's almost double the amount from the comparable period last year. The financing for HCA's record $33 billion buyout adds to this trend. More than a tenth of the institutional loans for HCA are expected to come from Europe. Yet only a small part of HCA's revenues originate in Europe.
Not long ago, American firms shied away from the European syndicated loan market. In the old days this market was dominated by banks, whose rigid practices made loans more expensive. Emsurope has since become more competitive. Several U.S. debt specialists, including Bain Capital's Sankaty Advisors, have set up shop there. European investment firms have also established specialist funds for leveraged loans. This influx of new investors has improved the position of borrowers. American firms often pay less on riskier dollar loans raised in Europe than at home.
The U.S. trade deficit is another reason why Americans are looking abroad. With a lot more cash going out of the country than coming in, U.S. leveraged buyouts could face financing constraints if they were restricted to domestic credit markets. Europe runs a trade surplus and, with lower interest rates, liquidity remains abundant. With a large number of leveraged loans in the pipeline, other issuers are likely to follow the example of HCA and head across the pond.
Citigroup, Bank of America Squeezed by Bond Market
By Mark Pittman
Bloomberg, 2006-08-29
Citigroup Inc., Bank of America Corp. and JPMorgan Chase & Co. are among the biggest losers in the bond market, where the largest U.S. banks' relative borrowing costs are the highest in three years.
A slowing economy has prompted investors to demand an additional 11 basis points of interest, or $1.1 million for each $1 billion face amount, on bank bonds since February, according to data compiled by Merrill Lynch & Co. The widening yield premium amounts to a loss of $7.3 billion on bondholders' principal the past six months and a profit squeeze for banks, which make money on the difference between their borrowing and lending charges.
Bank bonds, which account for almost one fifth of the $5.2 trillion U.S. corporate bond market, are heading for their worst year since 1999 after the Federal Reserve increased interest rates 17 times, the government reported a 4.3 percent slump in new-home sales in July and oil prices rose 14 percent since January. Slower growth may cause bond defaults to quadruple by 2008, adding to bank losses, Standard & Poor's says.
``Whenever you see some weakness in the economy, that has to get into investors' minds,'' said Alvaro de Molina, chief financial officer of Bank of America, in an Aug. 24 interview. Some fund managers may be questioning whether the Fed has pushed the economy into a recession, de Molina said.
Investors are demanding 81 basis points more than the yield on similar-maturity Treasuries. The spread was as high as 83 basis points on Aug. 11, which was the most since 2003. The spread has widened twice as much as the 5 basis point increase in yield premiums, or spreads, for investment-grade bonds, according to Merrill. A basis point is 0.01 percentage point.
Falling Prices
Bank bond prices have fallen on average 2 percent this year, according to a Merrill index that tracks the performance of 579 securities worth $365 billion. By contrast, the Merrill index of AA rated debt declined 1.8 percent this year.
The total return on the bank index, including both capital appreciation and reinvested interest, is 1.64 percent this year, the worst since it declined 1.73 percent in 1999.
Citigroup's $1 billion of 6 percent bonds due in 2033 have fallen 7 cents per dollar of face amount this year to 99 cents as the yield climbed to 6.06 percent from 5.6 percent, according to Trace, the bond-price reporting service of the NASD. The spread has widened 10 basis points to 1.11 percentage points since Jan. 1.
Citigroup spokeswoman Shannon Bell in New York declined to comment.
JPMorgan's $1 billion of 5.875 percent notes due in 2035 have fallen 6 cents per $1 face amount to 94 cents since the first of the year, according to Trace. The bond's yield has gone up 45 basis points to 6.31 percent.
JPMorgan spokeswoman Brooke Harlow declined to comment.
Threat of Default
A slowing economy also may cause a growing number of borrowers to default, requiring banks to set aside more money for losses and leaving less for debt payments. Defaults will rise to 4 percent from their current record low of 1.03 percent by the first quarter of 2008, according to S&P.
``We're probably at the top of the mountain for loan quality, and it's going to start falling pretty soon,'' said James Hannan, who oversees $3 billion in fixed income at MTB Investment Advisors in Baltimore.
Hannan, whose holdings include bonds of Charlotte, North Carolina-based Wachovia Corp. and Mellon Financial Corp. of Pittsburgh, said he is seeking debt of banks that make money from trading, underwriting and advisory services. He's avoiding companies that focus on housing loans, such as Calabasas, California-based Countrywide Financial Corp., the biggest U.S. mortgage provider.
Investors now demand 23 more basis points in yield over government debt, or 1.36 percentage points, to hold Countrywide's $1 billion of 6.25 percent notes than when they were sold in May. The securities mature in 2016.
Yield Premiums
The average yield premium for banks has widened 11 basis points from the low this year of 70 basis points in February, saddling bank bond investors with the biggest losses, Merrill data show. Bonds sold by companies in the telecommunications industry lost $5.3 billion because of declining prices.
Banks have $30.7 billion in debt coming due by year-end, more than any other industry, according to data compiled by Bloomberg. Bank of America has the most, or $5.7 billion, just ahead of the $3.5 billion for Minneapolis-based U.S. Bancorp.
Higher borrowing rates have contributed to shrinking lending margins, a measure of profitability. S&P said earlier this month that those margins are at their lowest since 1991.
Interest Margins
Citigroup's net interest margin, the difference between the average rate the bank pays to borrow and what it charges in interest, fell to 2.8 percent in the second quarter, the lowest since at least December 2000.
The net interest margin at New York-based JPMorgan has shrunk to 1.96 percent, the smallest since September 2001. The rate at Charlotte, North Carolina-based Bank of America is 3.02 percent, the lowest since at least March 1999.
Lending margins are ``a key factor in their earnings, and they're continuing to see some pressure,'' Baylor Lancaster, a Coconut Grove, Florida-based analyst from debt research firm CreditSights Inc., said in an interview. ``We view a future deterioration in credit quality as pretty much inevitable,'' Lancaster said in an Aug. 8 report.
Commercial banks make about two thirds of their income from the difference between their borrowing and lending costs, according to James Moss, an analyst at Fitch Ratings in Chicago. He said a 1 percentage point increase in benchmark interest rates could reduce profit on average by 4.6 percent.
Sell Bank Bonds
Investors ought to sell bank bonds or buy derivatives that would benefit from a decline in the price of debt issued by Wachovia and Citigroup, said Barclay's Capital analysts Melody Vogelmann and Julie Schultz in an Aug. 17 report.
Wachovia, the fourth-largest U.S. bank, has few operations outside the U.S., so it would be hurt by a slower U.S. economy more than other competitors, Vogelmann and Schultz said.
``No question, it's a headwind with regard to revenue growth,'' said Bank of America's de Molina. Higher borrowing costs won't hurt credit quality because the bank can make up the lost revenue in other ways, he said.
By de Molina's estimate, the worst-case scenario for interest rates next year would cost Bank of America about $600 million. The bank will earn $20 billion this year, according to the average forecast of 16 analysts surveyed by Thomson Financial.
``That's a pretty small number in comparison to a $20 billion revenue stream,'' de Molina said
Target Rate
Fed policy makers this month decided not to raise borrowing costs after pushing their target rate for overnight loans between banks to 5.25 percent from 1 percent in June 2004. New-home sales in July fell more than forecast and the number of unsold houses climbed to a record, according to a Commerce Department report released last week. Purchases of new homes dropped to an annual pace of 1.072 million.
The central bank should have stopped earlier, according to Robert Shiller, the Stanley B. Resor Professor of Economics at Yale University in New Haven, Connecticut. Shiller, the author of the book ``Irrational Exuberance'' that in 2000 predicted a slump in the stock market, said this month that a slowdown in the housing market will likely cause a recession.
``Banking spreads are going to widen much more meaningfully than they have now,'' said Nouriel Roubini, a professor of economics at New York University. ``The banking system as a whole is hugely vulnerable to the risk of recession.'' Roubini says there is a 70 percent chance of a recession.
Consumer Confidence
Confidence among consumers this month fell to its lowest since October because of concerns about terrorism and high gasoline prices, the University of Michigan said Aug. 18. The school's preliminary index of sentiment dropped to 78.7 from 84.7 in July.
Almost 30 percent of banks said they anticipate residential mortgages will deteriorate over the next year as the housing market cools, an Aug. 14 report by the Fed said.
``Banks will tighten their lending standards by increasing loan spreads and by simply refusing to lend to some at any spread,'' said Paul Kasriel, director of economic research at Northern Trust Securities, in an e-mail on Aug. 18. ``This, in turn, will create even more drag on economic growth.''
The three biggest U.S. banks all reported record profits last year led by Citigroup's $24.6 billion. Bank of America's net income totaled $16.5 billion and JPMorgan had $8.5 billion.
Corporate Lending
Bank of America has scaled back its corporate lending exposure to $35 billion, less than one-fourth of the $130 billion in company loans that the lender and its predecessor companies had in 2000, the last time the Fed ended a series of rate increases, de Molina said.
``If you look at the amount of corporate credit risk that we have in this cycle versus the last cycle, it's much, much smaller,'' de Molina said.
An expanding economy allowed borrowers to tap banks for cash with little trouble even as the Fed was raising rates. The lending environment is still favorable for banks.
Debt deemed uncollectible by U.S. banks fell to 0.4 percent of all loans and leases in March, the least since before 1985, according to the Fed. Borrowers defaulted on high-yield, high- risk, or leveraged, loans at a 3.2 percent rate in the first quarter, down from 10 percent in 2002, according to S&P.
SunTrust's Loan
Atlanta-based SunTrust Banks Inc. was stuck with a non- performing $200 million loan because the borrower's business deteriorated before the bank had a chance to sell the loan to investors, said Richard Bove, who follows the bank for Punk Ziegel & Co. in Pinellas Park, Florida.
The loan was to ``a large corporate client whose operating fundamentals are deteriorating,'' SunTrust Chairman and Chief Executive Officer Phillip Humann said Aug. 14 during a presentation at Keefe, Bruyette & Woods Inc.'s bank conference in Kohler, Wisconsin. He declined to name the borrower, saying it was ``very legitimate company'' that lost a major customer.
SunTrust spokesman Barry Koling said the loss on the loan isn't connected to the economy. The bank is working with the company to try to recover the money, he said.
``SunTrust is definitely a bellwether,'' said Tanya Azarchs, managing director and coordinator of global research at S&P in New York. ``We're going to see a lot more of this.''
