Too much credit where it’s not due?
12 February 2007
Lots of discussion last week about HSBC’s disclosure that their US subprime mortgage operation is worse off than they thought. The stock is down, people are fired, usual stuff. It makes me start to wonder, though, is the credit cycle about to end in tears? Is there a potential contagion (love that word) that could affect our market?
On the mortgage front, the Wall Street Journal reported that US subprime mortgage firms were issuing paper without even asking for a pay stub. How could they expect anything but disaster? Even the bureaucrats in Ottawa have the bug. CMHC – which should be above pushing bad ideas to grab market share – bizarrely started to offer 100% financing and interest-only mortgages a year or so ago.
According to Forbes, high yield corporate debt has done so well for so long that S&P has reclassified “distressed debt” from 600 basis points over lending rates to 1000 basis points. But can those default rates stay at sub 1.5% forever?
Increasing credit availability can be a good thing when it is driven by some kind of positive catalyst. Lenders developing a better understanding of what drives risks for a borrower would be a good example and one which we have certainly experienced over the years. Improving fundamentals for a borrower would be another.
In our venture debt world we have seen a few loans lately that have struck us as a bit aggressive. Granted our view is from the outside of the actual transactions so things may not be as they appear, but some deals appear to have mis-priced risk or have stretched debt into equity territory.
Time will tell what happens to those deals and to the lenders involved.
I’ll follow up shortly with my own thoughts on why borrowers and their investors should care.
CWN
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