Banks Show No Signs of Easing in Step With Fed’s Cuts
By Liz Capo McCormick and Gavin Finch
Dec. 17 (Bloomberg) -- For all their efforts to liquefy credit markets, the Federal Reserve and the Treasury show no signs of ending the 18-month freeze, as evidenced by the unprecedented gap between what banks and the U.S. government pay to borrow money.
The difference between the London interbank offered rate, or Libor, that banks charge each other for three-month loans and Treasury bill rates is six times wider than before markets began to seize up in June 2007. Even though the so-called TED spread narrowed to 1.55 percentage points from 4.64 percentage points in October, prices of contracts to borrow money months from now show investors don’t expect lending to recover until at least the second half of 2009.
“If you take a full assessment of the credit markets, conditions have certainly eased from their worst, but they still are at extraordinary tight levels, which are far from normal,” said Michael Darda, the chief economist at MKM Partners LP in Greenwich, Connecticut. “Short-term funding spreads are all still very wide relative to historical norms. There is a massive pullback going on in the private sector.”
While the Standard & Poor’s 500 Index is up 23 percent from last month’s low and the Fed promised to use all tools at its disposal to end the longest recession in a quarter century, investors remain wary of any securities except Treasuries. As banks hoard cash, businesses are struggling to refinance debt and consumers can’t get loans, restraining an economy forecast to shrink 4 percent this quarter, according to the median estimate of 79 strategists surveyed by Bloomberg.
Consumer credit fell $6.4 billion in August and $3.5 billion in October, making 2008 the first year with at least two declines since 1992, according to Fed data. August’s decline was the biggest in at least 65 years.
Bond sales by companies rated below investment-grade fell 57 percent to $63.3 billion this year from 2007, according to data compiled by Bloomberg. The extra yield investors demand to own the debt instead of Treasuries rose to a record 21.4 percentage points yesterday from 1.32 percent 18 months ago.
Instead, investors are committing more money to government bonds. Treasury three-month bill rates fell below zero percent for the first time last week, meaning investors were willing to pay the government to protect them from further losses. Yields on 30-year Treasuries dropped as low as 2.68 percent after the central bank yesterday cut the main U.S. interest rate to a target range of between zero and 0.25 percent from 1 percent.
Personal bankruptcies rose 34 percent in the third quarter from the same period of 2007, according to the American Bankruptcy Institute in Alexandria, Virginia. Moody’s Investors Service predicted in November that corporate defaults in the U.S. will surge threefold to 11.4 percent in the next 12 months.
“There are a lot more requests for loans than we are granting, particularly from real estate developers who are desperately trying to raise money,” said Wes Sturges, president of Bank of Commerce, a Charlotte, North Carolina, bank with $107 million in assets. “We can’t do that because they are tied so closely to the housing economy.”
Traders don’t expect lending to improve until mid-2009 at the earliest, based on the difference between Libor and the expected average federal funds rate over the next three months, known as the Libor-OIS spread. The spread, now at about 1.4 percentage points, may narrow to about 0.84 percentage point by June, forwards contracts show.
Former Fed Chairman Alan Greenspan said in June that the measure was the best way to tell when lending returned to “normal.” He said it would need to narrow to about 25 basis points, or 0.25 percentage point, for that to happen.
“There is no demand coming from the interbank market at all,” said Patrick Jacq, a senior fixed-income strategist for Paris-based BNP Paribas SA, France’s largest bank. “Banks are borrowing straight from the Fed and hoarding that cash till they need some and then returning to the Fed. We don’t expect a return to normal conditions in the coming six months.”
The average spread was less than 10 basis points this decade through June, 2007, when markets started to unravel as losses on subprime mortgages caused two Bear Stearns Cos. hedge funds to collapse.
Banks suddenly became wary of lending to each other amid concern that the same securities that ruined Bear Stearns would cripple other banks. Financial institutions reported almost $1 trillion in losses and writedowns since the start of 2007, according to data compiled by Bloomberg.
Fed Chairman Ben S. Bernanke and Treasury Secretary Henry Paulson are taking steps to make it easier for banks and companies to get cash through $8.5 trillion of commitments. The Treasury’s $700 billion Troubled Assets Relief Program is providing capital to the biggest U.S. banks. The Fed more than doubled its assets since August to $2.21 trillion with emergency-lending programs.
Libor, which rose as high as 4.82 percent on Oct. 10, tumbled to 1.58 percent, the lowest level since July 2004. Even if banks aren’t providing each other with loans for that long, the rate sets values for financial contracts valued at $360 trillion, according to the Bank for International Settlements in Basel, Switzerland.
Commercial and industrial loans at banks surged to $1.61 trillion in the week ended Oct. 22 from $1.51 trillion on Sept. 10 as companies wary of losing access to capital in the wake of Lehman Brothers’ collapse drew on lines of credit arranged before markets seized up.
Blockbuster Inc., the world’s largest movie-rental chain, borrowed $135 million from its credit line in October to ensure the Dallas-based company has enough cash in case access to credit worsens, Chief Financial Officer Thomas Casey said.
“We said to ourselves, it’s prudent for us to come up with a backup plan that says in a worst case scenario that we want to be able to continue to fund the business” through August 2009, when the revolving credit facility expires, Casey said on a Dec. 10 conference call with analysts.
The increase in loans doesn’t mean credit is getting easier. The Fed said last month that large businesses faced the tightest lending standards on record over the previous 90-day period as the risks of a deeper economic downturn increased.
About 85 percent of domestic banks tightened lending standards on commercial and industrial loans to large and mid- size firms, the highest since the survey began in its current format in 1991, the Fed said in its latest quarterly Senior Loan Officer Survey conducted between Oct. 2 and Oct. 16.
“There isn’t a community banker in America who doesn’t want to make good loans,” said James McKillop, chief executive officer of the Independent Bankers’ Bank of Lake Mary, Florida, which provides loans to 350 community banks in Florida and Georgia. “But finding loans that they feel are going to be good is becoming more and more difficult.”
To contact the reporters on this story: Liz Capo McCormick in New York at email@example.com; Gavin Finch in London at firstname.lastname@example.org.
Last Updated: December 17, 2008 07:38 EST
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