Just wanted to say that you've been doing an excellent job describing the happenings over the last few days. In regards to the credit crunch here's another piece of evidence of how the credit markets are starting to freeze up.There is a new issue corporate bond today from Caterpillar (CAT) and the pricing of that issue is troublesome - quite troublesome, and reflective of the dire straits of the credit market and the dysfunction which has engulfed the corporate market.Caterpillar announced a 5 year and a 10 year this morning. The size has yet to be determined, but it is likely to be around $500 million for each tranche
In early August Caterpillar brought a 5 year bond to market, the 4.90 of August 2013. That bond priced 175 basis points cheap to the benchmark 5 year Treasury note. With the turmoil in the credit markets the last several weeks, the issue has widened on spread and this morning it was quoted 225/ 210.
The talk on the new issue is T + 325 basis points. That is fully 100 basis points cheap to the outstanding issue and 150 basis points above where the same maturity was priced six weeks ago
This is very disturbing because Caterpillar is an industrial company, unsullied by association with the credit crunch. If it takes that much concession to sell a solid stable industrial, what might the outcome be when a large financial seeks to tap the marketRest assured that the result will be gory.
« What I think about the bailout plans | Main | And it spreads . . . » The bad news continues to spread24 Sep 2008 12:38 pm
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Yet economist like these, for example, say no to bailouts:
http://www.bepress.com/ev/announce/20080923/
Link is wrong.
It is gory, and I think the bond markets are pricing in, already assuming that is, some kind of big-ticket bailout from Congress.
How much will $700 billion really buy at near face value and held to maturity as Bernanke suggests? Is that really what Paulson expects, or is he assuming a series of liquidations and further purchases?
Um, could somebody please explain what some of this jargon means? What exactly are basis points, and what does it mean to say a bond issue is "xx basis points cheap?"
Your links are broken because they're being directed through nationaljournal.com instead of linking directly to seekingalpha.com.
Also, I don't really see what the problem is. The 5 year note has an interest rate below 5% and the 10 year note, though it has a higher interest rate, is callable after 5 years.
What incentive to Dems in Congress have to approve a solution at this point? Why not let the financial system collapse? Obama would ride the wave of destruction into the White House, with coattails. He could then use the resulting depression in the real economy to expand the reach of government, as FDR did. He could start a Community Organization Authority to hire hundreds of thousands of community organizers to replicate the improvements in quality of life he achieved in the South Side of Chicago; he could turn the Dow Thirty into Government-Sponsored Enterprises and appoint folks like Franklin Raines in charge of them; etc. The pain would be worth it, from the Lefty perspective, to permanently shift the country further in a statist/socialist direction.
Our only hope is that the Billionaires for Obama will stop this madness. Will the Pritzkers, Buffetts, etc. talk the Dems back from this?
Be sure to read the comments in the linked article. There is an especially good set of comments by "Gramps" who makes a good case that CAT is really a "bank in drag".
In a sense, many seemingly unrelated entities are "banks in drag." There are many recent years where Chrysler Financial, GMAC and Ford Credit have been profitable while the actual businesses manufacturing and selling cars have been bleeding. John Deere Credit provides a substantial boost to Deere's bottom line. (All of this is a little like the wireless divisions propping up nearly every major telephone company where the traditional landline businesses have often been underwater).
During the loose credit, stigma-less debt era of the 80s-summer 2008, anyone who had an in-house financing arm for its goods or services, or who issued credit cards (heck, even Wal-Mart filed papers to be a bank at one point) likely became quickly addicted as the finance arm became more profitable than the core business.
Such subtle draining off of economic diversification has set the table for this kind of credit/financial market metldown to be much more damaging than it would have been back when the US actually made physical things rather than simply adding subjective value through services.
Sounds like folks are getting taken in by hysteria generated by short sellers. This is a pretty conventional bond offering & typically to see any day of the week.
I have no doubt that the financial sector needs a degree of government help, but this anecdote seems to support the "go slow" camp. I mean, it appears the debt market is functioning, but that lenders are quite sensibly raising prices. Given the troubles associated with cheap money, this strikes me as both inevitable and desirable.
Sooo, what happens to Cat if there's a global recession? Does Cat sell a lot of equipment (either new or parts) when construction is slowing down? What happens to mineral exploration and extraction (HUGE Cat customers) if commodity prices drop?
What's that, you say, Cat struggles a bit? And what would you say the prospects are for a global slowdown, if not a global recession, in the next five years? Pretty decent, no? Then Cat should have to pay more to get money--there's some actually risk to their performace.
Americans are being forced to bailout financial markets so Caterpillar can have access to cheap capital and keep selling bull dozers to Israel.
People are confusing rates and spreads. A 325 bp spread is a lot for an "A" rated company like Caterpillar. It means, roughly, that investors are saying that there is a one-third chance that Caterpillar goes bankrupt during the next ten years. (Having said that, I admit that I don't know how much of Caterpillar's revenue actually comes from its financing activities; I'm just looking at its credit rating.)
It's true that Caterpillar isn't actually paying a high interest rate, because Treasury rates are so low. But that is what normally happens in a credit crisis: spreads widen, which means that the money put out by the Fed on easy terms does not get lent to private borrowers on easy terms.
Caterpillar builds construction equipment. And the construction industry has been hit earlier and harder by the credit crunch than the financial industry.
It's not a huge surprise that investors currently have doubts about Cat's short to medium term profitability.
Oh. My. God. A huge manufacturer might have to pay a few more percent interest on its callable bonds. Stop the presses. Let's get a big government bailout going, because it's such an atrocity to have to pay more than 5% in interest. Caterpillar has the RIGHT, the inalienable RIGHT to cheap loans.
And obviously, these higher interest rates are not allowed to trickle down to anyone saving for retirement. Only the big players can get high interest on their savings, not the rest of us.
I think others have said this, but isn't some of the spread caused by an increased inflation risk?
Wolfwalker,
1. A "basis point" is 1/100th of 1%. People in finance use this to avoid having to talk in decimals (it's more natural to say "the fee is 35 basis points" than "the fee is zero-point-three-five-percent").
2. "Cheap" means a discount. Bonds are typically issued at something other than par, at a premium or a discount, based on what the market feels is an appropriate return.
To explain:
Let's say you're issuing a new bond. Your bankers think that, based on market conditions, the creditworthiness of your company, and the likely demand for a new issuance from your company, the return demanded by investors (and interest rate you'll need to pay) will be around 5%.
So you go to market offering bonds with a coupon of 5%. If your bankers are any good, this will be pretty close. But let's say that, when the bonds price, investors in their collective wisdom think they should actually make 5.3% to buy your debt. What happens then is that the bonds issue at a discount to "par value", or the stated value of the bond that is repaid at maturity.
Each $1,000 face value bond, for instance, may sell to investors for $980. This means the company raises less value from the issuance. It also means that investors, because they get $1,000 back from the company in 5, 10 years (or whenever the bond matures), receive an increase in principal in addition to interest payments. As a result, their return is higher than the interest coupon of 5% stated on the bond.
When this reader says that the new bonds are pricing 150 basis points "cheap" to where an equivalent bond was pricing 6 weeks ago, it means that investors are now demanding a rate of return 1.5% higher than what they wanted back then.
This has quite dire implications for companies across all industries, because all of them depend on issuing new debt and rolling over existing debt to fund expansion and operations. If it gets more expensive for them, that's a bad thing.
Kolohe, Treasury yields should reflect inflation concerns, and those concerns should not affect spreads to Treasuries.
I don't follow Person's point. For one thing, higher yields do "trickle down" to investors: call your broker and ask him to buy some Caterpillar bonds for your IRA. Or put your money in a high-yield mutual fund. Second, there's no claim that companies have a "right" to borrow at a particular rate, but, if rates are higher, companies are less able to expand, meaning employment and production are lower.
Anecdotal evidence aside, why is Robert Higgs wrong here?
Christian McClellan, several reasons. First, the cited source is only discussing bank loans. This would be only a portion of total financing, which used to include securitized loans. If the latter have disappeared, and the former are essentially at the same level as last year, then obviously total credit has contracted.
Second, it's not just anecdotal evidence (like Caterpillar) that credit spreads are much wider. There is all sorts of published data (surf the net) measuring credit spreads in the aggregate, and they are much higher than they were a year and a half ago.
2 year swap spreads are out 23+ bps today. To 162.5 bps - new all time wides.
TH,
Thanks for taking the time to explain.
Caterpillar is pretty exposed to the building markets, no? Not a good bet at the moment. They should take the money and run.
McCardle, stop being a chicken little. The fundamentals of the economy are rock solid - this is just a little tempest in a teapot. Nothing can stop American economic destiny!
"Unsullied" by the credit crunch?? Last I checked, this all came about because of the bursting of the real estate bubble, and last I checked, CAT was in the business of building machines that build things. Like, real estate?
Sounds to me like Catepillar can get financing, albiet it's now more expensive than it was 6 weeks ago.
That's not an indication of a credit freeze, my friends.
That's an indication that, despite all of the frenzy on Wall Street, reputable companies can get long-term financing.
Nobody guaranteed CAT money at 150 basis points. Sorry.
Call me back when CAT can't get financing.
THEN, they have a problem.
On the Dennis Miller show, sportscaster Al Michaels pointed out that in retrospect, this AIG commercial is pretty ironic: http://www.youtube.com/watch?v=kBjUDRH16Kw
Wait, what?
This guy is pointing to a firm that supplies CONSTRUCTION FIRMS in a recession having problems with a bond issuance as evidence of a OMFGWTFCREDITCRUNCH?!
Do these people really think we are this stupid?
Instead of alluding to the information that's "all over the net", just check out Yahoo's Composite Bond Rates. Pretty wild! 2-year A-grade bonds went for ~5% a month ago, and are now almost 9%.
All I can say is, this better show up when I buy into bond funds, or there will be hell to pay.
Please consider posting on the alternate pathways of suspending "mark to market" under GAAP, and loosening reserve requirements as "Third ways" to go as opposed to 700 billion in asset purchase by the FED. Constructive debate trumps breathless rumor mongering at this juncture. Like it or not, we have to choose a path here. Some reasoned debate would be helpful.
Excuse me while I cry a river.
The market is doing exactly what it is supposed to do at any given moment.
In crude terms it is telling Caterpillar that given the background uncertainty in the marketplace, as opposed to six weeks ago, what you want, will cost you this. Now go home and think about it. If you come back to the table this is what it will cost. If you can find it cheaper anywhere else have at it.
The lesson for Caterpillar is run your company such that you can pick your spots when to borrow. If you can't that's your fault. Pay up.
Stop complaining about the market and how it adjudicates risk. That's its function. When it starts charging more for money its telling you why. Right now it is telling you that a real estate bubble has burst and cash is very valuable, as it should be. I'm surprised its not double digit yet.
With all this valuable information on Bonds can anyone tell me what I can expect to get for the FNM-t bonds that I bought for 25,000 a piece and are now selling for $2.65
Patrick Neid,
Yes the market is telling CAT that the price went up. The thing to note is the speed with which it went up for the most creditworthy corporation. It really has little to do with a reassessment of their business prospects since a couple of months ago. It is caused by the lack of liquidity in the market. It is possible that No lender will lend to ANY borrower, without regard to the quality of the borrower. IF CAT cannot borrow, who will make an inventory loan to the gas station you use?
The nonsense post by Tommy reveals the understanding of economics the poster has developed. What difference does it make where CAT sells the dozers or equipment. The machines are American made with American employees. IF CAT doesn't sell to Israel, then some American workers will be without jobs. Maybe Tommy would feel better with unemployed Americans than he does about some yellow equipment being shipped to the Israelies. I'm at a loss to understand why.
I was try to figure out the magnitude of the increase in borrowing costs to CAT.
The MTNs just issued by CAT (actually, its financing subsidiary) were sold at an All-in-Price of 99.527%, whereas in August the All-in-Price was 99.543%. This means that, on $100,000,000 face amount of bonds, CAT is paying about $16,000 more than they did in August (more precisely, they are receiving $16,000 less in proceeds). Since CAT issued $750,000,000 face amount of bonds, the credit crunch increased their borrowing costs by about $120,000. Not completely insignificant, given that CAT issues a lot of bonds (in excess of $17 billion of MTNs outstanding as of 12/31/07 - with almost $5 billion coming due in each of 2008 and 2009). But CAT Financial made a profit of $494,000,000 last year. Even if they pay the additional borrowing costs with respect to rolling over the entire $5 billion of MTNs coming due over the next year, the increase in borrowing costs would be less $1,000,000.
"Yes the market is telling CAT that the price went up. The thing to note is the speed with which it went up for the most creditworthy corporation. It really has little to do with a reassessment of their business prospects since a couple of months ago. It is caused by the lack of liquidity in the market."
Understood, Augustus and true enough. That's the value of an unimpeded market doing what it should. My point is, where's the problem? Yeah rates went up. The comptroller at Cat should be fired if he thought for a New York minute that the lending environment going forward was going to be the status quo. By the hyperventilating taking place in DC by Paulson and crew about depressions and the world ending they are lucky they found any money.
In fact the market is telling us quite the opposite. There is plenty of liquidity for solid companies. When rates go north of 10% I'll start to believe the end of the world wailing I'm hearing these days.
I just saw some Cats in China removing an entire mountain. I'd hazard that CAT is a big exporter with lots of sales to the developing world where the economies are growing rapidly. Plus, the weak US dollar would help their sales.
That should offset lower sales in the USA, so their bond issue woes isn't maybe just about weak housing in the USA.
p.s. To everyone saying "no big deal that they have to pay more" keep that in mind when you're paying 4 bucks for gas or the price of bread goes up 25%. No big deal right? And its not just that you have to pay more, but a sign that other things are afoot in the economy.
Wow, there are some ignorant people on this thread. I guess it was easier to take a sociology class in college than finance or accounting.
And yes, I'm talking to you, Tommy, Person, and SomeAverageGuy.
But KMan, I guess your glowing treasure chest of knowledge on this issue just isn't enough to explain why the health of the economy depends on CAT being able to pay less than 5% on its borrowing.
Hey Agustus,
The price for my tank of gas went up today. The speed with which it did that was STUNNING. Yesterday, it was $3.50 a gallon. Today, it's $3.75 a gallon.
So fkin what? I still have to drive to work. And the government didn't bail me out.
Catepillar being able to borrow capital at perfectly reasonable historic rates is evidence that the credit markets working just fine.
Wow lot of wrong stuff in here. As someone running money, who bought and wrote up this new issue:
Explanation of a basis point/bip/bp was right.
There were $1.3B of bonds issued split $750M 5Y and $550M 10Y.
Cheap in this case did not mean at a discount it merely meant that it was spread on top of the treasury, i.e. the bonds are yielding the 5Y Treasury rate +320 bp which means if the 5Y Treasury is yielding 3% the interest rate on the bonds will be 6.2%. Cheap/wide means addition, rich/tight means subtraction.
Bonds came at a slight discount (99.893 cents on the dollar) due to 2 things; there are 4 days you are effectively not receiving interest for since the bonds are issued on Sept 26th, but coupons and maturity are on March and Sept 30th of subsequent years; Also they picked an even number for the coupon, 6.2%, even though the 5Y rate was slightly over 3% at the time the issue was priced, so there is a discount to make up for the small amount of lost yield.
While very tied to each other the issuer was CAT Finance not CAT Inc, by virtue of being the finance arm and given the current market you will pay a steeper price for having anything to do with finance. CAT Inc CDS is quoted ~80-100 bp rich to CAT Finance and bonds are probably 50 bp tighter as well.
Also residential construction exposure isn’t as big as you think, world wide general construction is ~12.6% of sales, CAT has exposure to mining and minerals, quarry and aggregates, paving and compaction, forestry, industrial, and waste markets for heavy machinery and oil and gas, electrical power generation, industrial, marine and truck engine markets.
JPKK--
Whaddya think about the "325 bips implies a 1 in 3 risk of failure within 10 years"? Is that the funniest misstatement on the thread, or something else?