Presentation on theme: "Subprime Crisis and Global Economic Outlook"— Presentation transcript:
1 Subprime Crisis and Global Economic Outlook See the Disclosure Appendix for the AnalystCertification and Other DisclosuresSubprime Crisis and Global Economic OutlookCheng-Mount ChengVice PresidentTaiwan Chief EconomistAsia Pacific Economic & Market AnalysisI will cover three issues: the current state of the economy, the WTO accession, and the implications for other Asian economiesApril 18, 2008
2 An Evolving View: Key Issues Real factors -- housing and energy--are combining with financial stress to slow the U.S. economy sharply.The U.S. is probably in a recession.Financial stress remains intense.Looking ahead the critical issues are:The dynamics of the housing adjustment;The depth of the financial sector problems;How aggressive will the Fed be in trying to contain the impact of financial turbulence.Other industrial countries are facing different versions of the same problems.The U.K. is experiencing a housing-led slowdown.Europe may be vulnerable, but later.We expect only a modest slowdown for most emerging markets.But the EM countries are more vulnerable to downside scenarios.
4 Securitization manufacture of CDOs Subprime Money TrailHow subprime mortgage can end up in your investmentsHome buyersMortgage brokersBig banksSubprime lendersSecuritization manufacture of CDOsWALL STInvestorsLOAN DEBTSCDOSecurities /CDOsMBSMORTGAGELOANSAAA AA- BBBRatingRating companiesSource: Bloomberg Markets, July 2007
5 Unrated equity(toxic waste) Financial AlchemyWall Street has a way to transform risky debt into CDOs rated AAA or Aaa.1.The CDOA CDO is a company typically incorporated offshore that buys collateral such as bonds, mortgage-backed securities and loans and sells debt securities with varying degrees of risk2.Multiply CDOsA CDO with collateral consisting of pieces of other CDOs is called a CDO squared. When a CDO is built of CDO squareds, it’s called a CDO cubed.Unrated equity(toxic waste)AA-BBBAAA$Interest paymentPotential lossesBondsMortgage-backedsecuritiesOther asset-BackedSECURITIESCOLLATERALUpdated 30/5/06CDOCDO squaredsCDO cubedsSource: Bloomberg Markets, July 2007
6 Rapid Growth of Alternative Mortgage Products and Structured Credit We do anticipate a drag on consumption from housing.But it’s a conventional wealth effectWill be offset to by lower energy prices
9 The additional problems with complicated structures Typical Mezzanine CDO of ABSCDO of ABSUnderlying0%10%20%30%40%50%60%70%80%90%100%Super seniorAAAEquityAAAUnratedBBBBBB-CDOTypical RMBSUnderlying loansPotential loss 75%Potential loss 10%Source: Citi.
10 Sub-prime Woes as a Trigger of Credit Market Disruptions Sub-prime & Alter-A mortgages at end ’06more than US$1 trillion outstandingroughly one-third of total US mortgages10% of bank assetssub-prime delinquency ratio up to 13.8% in 1Q07 and 14.8% in 2Q07US sub-prime related credit loss at around US$ billion (Fed estimate)But sub-prime mortgages triggered confidence crisis & liquidity crunchinvestors can’t assess the fair value of complicated and illiquid structured credit securities backed by sub-prime mortgageshedge funds dump leveraged buy-out (LBO) and corporate notes after losing heavily in mortgage-backed securities and credit default swapsconfidence crisis spread to corporate note and inter-bank markets
11 Major Fund/Corporate Losses Leading up to ABCP Market Crisis Jun 20: Merrill Lynch seized assets from two Bear Stearns hedge funds that were backed by sub-prime loans. Bear Steams froze withdrawals from a third fund on Aug 1.Jul 10: S&P put on Watch negative 622 sub-prime deals worth US$12.1 billion, with loss expectations rising to 10-14%. (S&P subsequently downgraded 582 out the 622 deals for a total of US$6.38 billion)Aug 6: American Home Mortgage Investment Corporation filed Chapter 11 bankruptcyAug 10: BNP Paribas stopped valuing three of its funds and suspended all withdrawals by investorsAug 14: Countrywide Financial, the largest mortgage lender in the US, said foreclosures and mortgage delinquencies had risen to their highest levels since early 2002, raising fears that the company could face bankruptcy.Sep 13: UK’s 5th largest mortgage lender Northern Rock asked the Bank of England for emergency lending due to a "liquidity squeeze.“ Concerned customers produced an estimated GBP2bn withdrawn in just three days.
12 Source: US Federal Reserve Board, Hover Analytics, Bloomberg, Reuters A Mild Improvement of Credit Market Strain Following Fed 50bp Rate Cut; Tightening in Credit Market Unlikely to Fully ReverseContraction in commercial papers (CP) shows borrowers’ failure to roll over debtsCP issuers draw down credit lines, reducing bank liquidityCorporate issuers face higher interest rates and shorter maturitySource: US Federal Reserve Board, Hover Analytics, Bloomberg, Reuters
13 Corporate Credit Spreads Have Widened Source: Citi
14 Other Spreads Have Widened as Well Source: Citi
15 International markets have entered a difficult period Updated 30/5/06
16 Losses across the mortgage supply chain – who holds the risk? Updated 30/5/06
17 Estimates of nonprime mortgage losses Updated 30/5/06
18 There has been a parallel weakening of credit discipline in the corporate segment Updated 30/5/06
20 Financial Stress Remains Global growth has been strong for the last two yearsWe expect it will be strong again this year and next.We do expect the global economy to slow going forward as:The US economy slowsAnd China slows.
21 Credit Tightening Across Loan Categories Credit Tightening at Banks for Select Lending Categories, Q 08 (Percent)Global growth has been strong for the last two yearsWe expect it will be strong again this year and next.We do expect the global economy to slow going forward as:The US economy slowsAnd China slows.Source: Federal Reserve
22 Larger Haircuts and margins reduces leverage Typical Haircut / Initial Margin Levels by Asset Class (Percent, Approximate Estimates)ProductMar07Mar08ProductMar07Mar08AA corp bond0-38-12AAA CDO of ABS4n/aBB lev loan15-2025-35AAA CLO410-20**BB HY bond10-15525-40AAA RMBS210-20*Equities1520Synth super snr12IG CDS / derivs15Source: Citi.Source: Citi. * May be difficult to find ** May be even more difficult to find.
23 Deleveraging is still having a deep impact on credit markets
25 The Economy Now Shows the Effects of Earlier Tightengin Citi Financial Conditions Index and Year-to-Year Percent Change in Same Store Sales (13-Week Average), Apr 08Note: Shaded region denotes recession. Sources: Redbook Research and Citi.
26 Forecast DetailsNotes: F Citi forecast. YoY Year-to-year percent change. SAAR Seasonally adjusted annual rate. Sources: Bureau of Economic Analysis, Bureau of Labor Statistics, I/B/E/S, Treasury Department, Wall Street Journal, and Citi.
27 Small Business Sector Retreats Sharply Manpower Employment Current Quarter Outlook (Inverted), Unemployment Rate and Percent of Small Businesses Planning to Increase Employment (Inverted), 1988-Mar 08Percent of Small Businesses Reporting Higher Earnings this Quarter vs. Year-to-Year Percent Change in Nominal GDP, 1986-Mar 08Global growth has been strong for the last two yearsWe expect it will be strong again this year and next.We do expect the global economy to slow going forward as:The US economy slowsAnd China slows.Sources: National Federation of Independent Businesses and Bureau of Economic AnalysisNotes: Manpower results are plotted in the quarter the survey was taken. Shaded regions denote recession. Sources: National Federation of Independent Businesses, Manpower Inc., and Bureau of Labor Statistics.
28 Housing Markets Reveal Only Tentative Signs of Reviving Investor Confidence NAHB Housing Market Index and Michigan Consumer Assessments on Current Conditions for Buying Houses, 1992-Apr 08Sources: National Association of Home Builders and University of Michigan.
29 Home Prices Most Vulnerable In Nonprime/Nonconforming Properties
30 Rate/Price Balance Needed to Maintain Housing Adjustment
33 Softening Demand Should Moderate Price Pressures
34 The Fed is still trying to stabilize financial conditions
35 Financial Conditions Have Not Responded Normally to Policy Action Twelve-Month Change in Fed Target Rate and Citigroup Financial Conditions Index, 1988-Mar 08Note: Shaded regions denote recession. Sources: Federal Reserve Board and Citi.
41 Re-Distribution of Economic Activity in Favor of Germany Euro Area — Manufacturing PMI (Diffusion Index), 2004-Mar 08Euro Area — Real Exports of Goods and Services (Index 1Q 1999 = 100), Q 07Sources: NTC Economics Limited.Sources: Eurostat
42 Business Confidence Among Large Manufacturers Fell More Than Expected Japan — Proportion of Companies Reporting Business Conditions Are “Unfavorable” (Large Manufacturing), 1980-March 2008 (Percent)Japan — Business Investment Plans (Including Software Investment but Excluding Land Purchases), FY (Yr-Yr-CHg, Percent)Note: There is a break in the data at the end of 2003.Sources: NTC Economics Limited.Sources: Bank of Japan, Nikko Citigroup.
43 The Central Bank Response Global — Forecasts for Key Policy Rates and FX Rates (End-Quarter), Changes Since GEOS of February 2008Updated 30/5/06Source: Central banks and Citi.
44 The Details of Vulnerability The index is a ranking of internal and external cyclical and structural measures: inflation, fiscal balances, public debt-to-GDP ratios, current account balances, net international reserves to short term debt, trade as a share of GDP and foreign direct investment as a share of GDP. For each indicator we split the range between the minimum and maximum into ten levels, assigning numbers from -5 to +5, with the negative number associated with more international exposure or a greater vulnerability. The numbers are summed to give the overall vulnerability index. Source: Citi
45 Monetary Tightening Likely Will Continue on Strong Growth and Rising Inflation China -- 1Q GDP Growth SlowsSource: National Statistics Bureau and Citi.China – Summary of Production Cost DistributionsChina – Uneven Squeeze: Industrial Profit Growth by Type of EnterpriseSource: National Statistics Bureau and Citi.Source: Citi.
46 The Gov’t Regards Current Inflation as Structural Price Increases China’s Inflation – Headline, Food and Non-Food CPI, January 2001 – March 2008 (%)China’s Export Growth and Headline CPI Inflation, (%)Source: CEIC Data Company and Citi.Source: CEIC Data Company and Citi.
47 Cautious Outlook for RMB China -- RMB/USD Exchange Rate: Actual, Forward Markets and Citi Forecast, May 2007-April 2008China -- Annualized Monthly Appreciation Rate of RMB Against US Dollar, November 2005 – March 2008 (%)Source: Chicago Board of Trade and Citi .Source: CEIC Data Company and Citi.
48 Strong demand, limited excess capacity, and Geopolitical risk
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