Synopsis: Questions about MS's French bank exposure and level of derivatives exposure. While June results were good, MS' French bank exposure (all asset and off balance sheet classes except derivatives) is estimated at $39B (57% of equity of $68B and 150% of market cap of $26B) of which interbank placements is believed to be a small component. These exposures are significant and unusually large as a percentage of capital. Of equal concern is the estimated $1.78T in notional value of CDS' on MS' books although EJR does acknowledge the netting effect (the net estimated exposure is $457M). The US is likely to provide MS additional support if needed, despite wind-down procedures contained in Dodd Frank. We are downgrading with a neg outlook.
While others huff and puff, and threaten to do what had to be done ages ago, the one truly independent and capable NRSRO, Egan-Jones, downgraded the US from AAA to AA+ over the weekend.
As Egan-Jones says,the downgrade should be a "big heads up for Money Market Funds." Not to worry, we are confident that two years after the Reserve fund broke the buck, financial regulation has moved far enough to contain any potential fall out from massive redemptions. Right. Right?
The most perplexing issue in assessing credit quality for various industries over the next six to eighteen months is determining what is real, what is sustainable. As illustrated in the below graph, the monetary base has exploded over the past couple of years - a manifestation of the FED's effort to pump liquidity into the system to support the financial sector and prop up the broader economy. Other "props" are the step yield curve, FDIC backing for the bonds of the few and chosen, and the continued direct support of the particularly important (politically) and particularly wounded such as GMAC. Will we exit the matrix and if so, when? The short answer is that we will probably exit when we are able. Despite the massive cost of the bailout, the US has the will, and China and the multitude of other buyers of US Treasuries have the means, to continue to support the bailout. However, change is coming; some of it would come even without the great recession. The massive drivers of economic change in the US over the past 40 years, the baby boomers, are changing their ways and will not be making the expenditures they have previously. Forget the regular upgrading of housing (the more likely step is a reduction in housing needs), forget the three year upgrade of vehicles (most will last six years or more), and forget most other huge purchases. Rebuilding savings is likely to be the new norm for many baby boomers, and the other generations are not making enough yet to fill the void. A translation for fixed income investors is that the anointed financial service firms will thrive over the next couple of years as will most money managers. However, the consumer-based, capital intensive industries such as auto, home building, and retailing will lag, especially as the various stimulus programs wear off.
Our view is that creditors of CIT would realize optimal value by not selling bonds currently at distressed levels, not voting for an exchange of bonds (see Exhibit G for a summary), not voting for the prepackaged bankruptcy (see Exhibit G), and probably not accepting an investment from Carl Icahn (there has been no firm proposal to date). Fair value for CIT’s senior unsecured creditors is in the area of 90% of face. - Egan Jones
"Forget Icahn, forget the exchange - Neither Icahn's offer nor the revised exchange (which reduces maturities by 6 mos.) provides the best value to creditors. Creditors can realize more value via a sale/liquidation of CIT assets." Egan-Jones