Self-Induced Balance-Sheet Destruction

Signs suggest that the credit crunch is picking up steam. Worried banks are reducing business loans as noted in We�re Saying No To Almost Everybody, and now corporate bonds yields show biggest rise since 2000.

Bondholders are demanding the highest interest rates for Wall Street debt since 2000, threatening the industry's business model of acquiring assets with borrowed money. Lehman (LEH) has seen borrowing costs for its five-year bonds rise to 7.7 percent, up from 5.2 percent six months ago, the biggest jump of the four largest U.S. securities firms, data compiled by Bloomberg show.

"This is almost self-induced balance-sheet destruction," said Joseph Balestrino, a fixed-income strategist at Pittsburgh- based Federated Investors Inc., which manages about $330 billion. "This is far beyond just your basic slowdown."

In some debt maturities, Merrill's bond yields are higher than Lehman's. For instance, Merrill debt that matures in April 2018 yielded 8.15 percent as of July 25, compared with 8.01 percent on Lehman notes that mature on May 2018.

"If you're going to be a big user of capital, then you have to be worried about how you finance your business," said William Cohan, a former investment banker at Lazard Ltd. and JPMorgan Chase & Co. and the author of "The Last Tycoons" about Lazard. "A lot of these guys don't know what to do. They're frozen, and they're just hoping that in time things will get better."

"It's going to be harder and harder for them to borrow long-term in this environment, to pay the spreads that investors are going to want," said David Hendler, an analyst at CreditSights Inc., a research firm in New York. "Can they deal with this type of funding environment?"

Lehman's long-term debt outstanding rose to $128 billion from $123 billion in the first half of fiscal 2008, as the firm cut its dependence on overnight funding, company reports show. Morgan Stanley's long-term borrowings totaled $211 billion on May 31, up from $191 billion at the end of November.

Today, a decade after the Russian government defaulted on bond payments, the country's bonds are yielding less than Lehman's -- meaning investors have more faith in Russia's prospects than in Lehman's future.

Russia's 11 percent BBB+ rated bond that matures in 2018 yields 5.68 percent, two percentage points less than the Lehman 2012 bond that's rated two notches higher by S&P.

"They do have the Fed as a backstop," said Balestrino, whose company owns bonds in Lehman, Morgan Stanley and Goldman Sachs. "In the meantime you probably are setting records in terms of yield spreads."

Record In Yield Spreads Coming

The Fed has circled the wagons but the odds of another huge Bear Stearns type blowup somewhere are strong. And as for this being a record in spreads, I strongly disagree. The record will come when deals can't get done, when this long term debt cannot get rolled over.

Take another look at those Lehman 5 year bonds at 7.7%. If that is what it takes for Lehman, then Ford and GM are in for a world of hurt when they roll their bonds or when they need to raise more capital.

And in spite of the big rally in financials a week or so ago, the corporate bond just market doesn't seem to believe it. If it doesn't buy the story, then why should I?

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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