Presentation on theme: "Subprime Crisis and Global Economic Outlook April 18, 2008 See the Disclosure Appendix for the Analyst Certification and Other Disclosures Cheng-Mount."— Presentation transcript:
Subprime Crisis and Global Economic Outlook April 18, 2008 See the Disclosure Appendix for the Analyst Certification and Other Disclosures Cheng-Mount Cheng Vice President Taiwan Chief Economist Asia Pacific Economic & Market Analysis
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.
3 US Subprime Woes
4 Subprime Money Trail How subprime mortgage can end up in your investments How subprime mortgage can end up in your investments Home buyers Mortgage brokers Big banks Subprime lenders Securitization manufacture of CDOs WALL ST Investors LOAN DEBTS CDO Securities /CDOs MBS MORTGAGE LOANS AAA AA- BBB Rating Rating companies Source: Bloomberg Markets, July 2007
5 Financial Alchemy 1.The CDO A 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 risk 2.Multiply CDOs A 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- BBB AAA $ Interest payment Potential losses Bonds Mortgage- backed securities Other asset- Backed securities $ SECURITIESCOLLATERAL CDO CDO squareds CDO CDO cubeds Wall Street has a way to transform risky debt into CDOs rated AAA or Aaa. Wall Street has a way to transform risky debt into CDOs rated AAA or Aaa. Source: Bloomberg Markets, July 2007
6 Rapid Growth of Alternative Mortgage Products and Structured Credit
7 Deterioration of Sub-Prime Mortgage Performance
8 Evolution of Prices of Sub-Prime Securities
9 The additional problems with complicated structures Source: Citi. Typical Mezzanine CDO of ABS Potential loss 75% Potential loss 10%
10 Sub-prime Woes as a Trigger of Credit Market Disruptions Sub-prime & Alter-A mortgages at end ’06 more than US$1 trillion outstanding roughly one-third of total US mortgages 10% of bank assets sub-prime delinquency ratio up to 13.8% in 1Q07 and 14.8% in 2Q07 US sub-prime related credit loss at around US$ billion (Fed estimate) But sub-prime mortgages triggered confidence crisis & liquidity crunch investors can’t assess the fair value of complicated and illiquid structured credit securities backed by sub-prime mortgages hedge funds dump leveraged buy-out (LBO) and corporate notes after losing heavily in mortgage-backed securities and credit default swaps confidence 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 bankruptcy Aug 10: BNP Paribas stopped valuing three of its funds and suspended all withdrawals by investors Aug 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 A Mild Improvement of Credit Market Strain Following Fed 50bp Rate Cut; Tightening in Credit Market Unlikely to Fully Reverse Contraction in commercial papers (CP) shows borrowers’ failure to roll over debts CP issuers draw down credit lines, reducing bank liquidity Corporate issuers face higher interest rates and shorter maturity Source: 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
16 Losses across the mortgage supply chain – who holds the risk?
17 Estimates of nonprime mortgage losses
18 There has been a parallel weakening of credit discipline in the corporate segment
19 U.S. Financial Stress
20 Financial Stress Remains
21 Credit Tightening Across Loan Categories Credit Tightening at Banks for Select Lending Categories, Q 08 (Percent) Source: Federal Reserve
22 Larger Haircuts and margins reduces leverage Source: Citi. Source: Citi. * May be difficult to find ** May be even more difficult to find. Product Mar07 Mar08 AA corp bond BB lev loan BB HY bond Equities 1520 IG CDS / derivs 1 5 Product Mar07 Mar08 AAA CDO of ABS4 n/a AAA CLO ** AAA RMBS * Typical Haircut / Initial Margin Levels by Asset Class ( Percent, Approximate Estimates) Synth super snr12
23 Deleveraging is still having a deep impact on credit markets
24 U.S. Outlook
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 08 Note: Shaded region denotes recession. Sources: Redbook Research and Citi.
26 Forecast Details Notes: 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 Percent of Small Businesses Reporting Higher Earnings this Quarter vs. Year-to- Year Percent Change in Nominal GDP, Mar 08 Manpower Employment Current Quarter Outlook (Inverted), Unemployment Rate and Percent of Small Businesses Planning to Increase Employment (Inverted), 1988-Mar 08 Sources: National Federation of Independent Businesses and Bureau of Economic Analysis Notes: 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 08 Sources: 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
31 Commercial Starts, moderate downside risk.
32 Corporate Spreads Have Over-shot Fundamentals
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 08 Note: Shaded regions denote recession. Sources: Federal Reserve Board and Citi.
36 Outlook For Policy
37 Outlook For Euro and Yen
38 Global Economic Outlook
39 A Global Slowdown Global — Forecasts for Growth and Inflation, Changes Since February 2008 GEOS Sources: Citi.
40 Spillovers from U.S. slowdown should increase
41 Re-Distribution of Economic Activity in Favor of Germany Euro Area — Manufacturing PMI (Diffusion Index), 2004-Mar 08 Sources: NTC Economics Limited. Euro Area — Real Exports of Goods and Services (Index 1Q 1999 = 100), Q 07 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) Note: There is a break in the data at the end of Sources: NTC Economics Limited. Japan — Business Investment Plans (Including Software Investment but Excluding Land Purchases), FY (Yr-Yr-CHg, Percent) Sources: Bank of Japan, Nikko Citigroup.
43 The Central Bank Response Source: Central banks and Citi. Global — Forecasts for Key Policy Rates and FX Rates (End-Quarter), Changes Since GEOS of February 2008
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 Slows China – Uneven Squeeze: Industrial Profit Growth by Type of Enterprise Source: National Statistics Bureau and Citi. Source: Citi. China – Summary of Production Cost Distributions Source: National Statistics Bureau and Citi.
46 The Gov’t Regards Current Inflation as Structural Price Increases Source: CEIC Data Company and Citi. 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.
47 Source: Chicago Board of Trade and Citi. Cautious Outlook for RMB China -- Annualized Monthly Appreciation Rate of RMB Against US Dollar, November 2005 – March 2008 (%) China -- RMB/USD Exchange Rate: Actual, Forward Markets and Citi Forecast, May April 2008 Source: CEIC Data Company and Citi.
48 Strong demand, limited excess capacity, and Geopolitical risk
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