Payments shocks associated with the resetting of a large number of UK mortgage loans in the coming months are likely to be “relatively severe,” especially in the nonconforming sector, Standard & Poors says in a new report.
For the UK mortgage market as a whole an estimated 2 million loans are due to reset by the end of 2008, equivalent to approximately 17% of all mortgages outstanding, S&P says in Payment Shock Approaching For Borrowers In U.K. Nonconforming RMBS.
Looking at the U.K. nonconforming loans backing the RMBS transactions that we rate, we estimate that around £9 billion of fixed-rate loans are scheduled to reset by the end of 2008, representing 23% of total balances outstanding. A particularly large volume of resets—nearly £5 billion—look set to occur during the first half of 2008.
UK mortgage borrowers are coming under increasing strain from rising interest rates. Five hikes in the Bank of England base rate since last summer would have been testing enough. But recent events in financial markets has meant an even sharper increase in wholesale funding costs for lenders, who are passing those costs on to borrowers in the mortgage rates they offer, S&P says.
Borrowers with floating-rate loans have already seen their monthly mortgage payments rise as a result. However, the majority of UK mortgage lending currently takes the form of short-term fixed-rate loans, which only reset to a floating rate after two or three years. This could prove a concern for many borrowers who took out fixed-rate loans between late 2005 and late 2006: most of these are due to reset to significantly higher rates over the next 12-18 months, giving rise to a sudden “payment shock” for many borrowers.
A number of coinciding factors mean the likely scale of this upcoming effect—and the potential subsequent impact on borrowers’ payment behavior—is relatively severe by recent standards. The pace of rate rises means payment jumps will be larger. Slowing house price appreciation and tightening lending standards could give borrowers fewer refinancing options. Recent increases in the uptake of fixed-rate loans also mean the effect will be more widespread.
Assuming current market conditions persist, we think that even borrowers who are able to refinance will suffer an average increase of 26% in their monthly payments. For those unable to refinance, the shock could be significantly more severe.
Although the risk of payment shock is considered in our RMBS rating analysis, realization of that risk could still have an impact on transactions, increasing the likelihood of reserve fund draws, for example. The precise effect on outstanding ratings will depend on many macroeconomic and transaction-specific factors. We will, as always, monitor closely the evolution of these factors and their influence on RMBS ratings, S&P concludes.
The full report can be purchased here.
Hedge funds are frequently criticized for adding risk and volatility to financial markets. However, a recent paper shows that they benefit financial markets by dispersing risk and contribute to stability by providing liquidity. Further, hedge fund investors are more interested in long-term returns than short-term gains.
Published by the Federal Reserve Bank of Dallas, the paper is a useful primer on the role of hedge funds in the financial system and provides clear explanations of hedge fund terms and investment strategies.
The paper says data on hedge fund performance and money flows reveal factors that enhance stability. “Longer-term performance matters for hedge fund money flows, apparently more than short-run gyrations in returns. Money flows also suggest that investors are attracted substantially by hedge funds’ performance relative to others following the same strategy, providing a cushion for funds that do relatively well in a falling market.”
Except in especially adverse circumstances, we find hedge fund investors tend to focus on longer term rather than immediate performance. In addition, they often stick with successful fund managers through a downturn. Such behavior adds stability to hedge funds’ financial bases and limits capital flight.
“We must never forget, however, that especially adverse performance can lead to more abrupt capital outflows,” the paper concludes. “All told, the links between hedge funds’ performance and money flows point to both the sources and limits of stability in today’s financial system.”
The paper, Hedge Fund Investors More Rational Than Rash, is available free of charge from the Dallas Fed website.
Angel investors are continuing to shift their focus to the post-start-up stage of business formation, exacerbating the capital gap for seed capital in the US, according to the latest survey of angel investor activity from the Center for Venture Research at the University of New Hampshire.
The angel investor market in the first half of 2007 showed signs of a small retreat from the growth of the past several years, with total investments of $11.9 billion, a decrease of 6% over the first half of 2006, according to the survey. A total of 24,000 entrepreneurial ventures received angel funding in the first half of 2007, a 2% decline from the first half of 2006. The number of active investors in the first half of 2007 was 140,000 individuals, 8% above the first half of 2006.
“These trends indicate that while the total dollar size of the market and the number of investments exhibited a slight decline from the first half 2006, there was a significant increase in the number of investors,” said Jeffrey Sohl, director of the Center for Venture Research. “Reflecting this trend is the decrease in the average deal size by 4% over the first half of 2006 and an increase of 10% in the number of investors per deal.”
Angels continue to be the largest source of seed and start-up capital in the United States, with 42% of the first half of 2007 angel investments in the seed and start-up stage. This preference for seed and start-up investing is followed closely by post-seed/start-up investments of 48%.
“This appetite for post-seed/start-up investing continues a trend that began in 2004 and represents a significant change from historical levels. While angels are not abandoning seed and start-up investing, it appears that market conditions, the preferences of large formal angel alliances, and a possible slight restructuring of the angel market are resulting in angels engaging in more later-stage investments,” Sohl said.
New, first sequence investments represent 55% of first half 2007 angel activity, indicating that some of this post-seed investing is in new deals. “This shift in investment strategies toward post-seed investments reduces the proportional amount of seed and start-up capital.
This restructuring of the angel market has in turn resulted in fewer dollars available for seed investments, thus exacerbating the capital gap for seed and start-up capital in the United States.
In the first half of 2007 angels exited their investments primarily through sale of the business (acquisitions by another firm), with 61% of the first half 2007 exits through trade sales. Exits by initial public offerings represented 6% of exits and bankruptcy occurred in 33% of the exits. For all these exits the average rate of return was 30-40% and roughly half were at a profit, the survey shows.
The yield (acceptance) rate is defined as the percentage of investment opportunities that are brought to the attention of investors that result in an investment. The peak yield rate of 23.3% occurred during the height of the investment bubble in 2000. Post 2000 the yield rate stabilized around 10%. In 2006 yield rates leveled off at 20.1% after a steady growth that began in 2004. For the first half of 2007 the yield rate was 19%. “This mitigation in the rise in the yield rate from the historical average reduces the concern of an unsustainable investment rate, at least for the short term,” said Sohl.
Healthcare services/medical devices/equipment and software remained the sectors of choice, with 22% and 14%, respectively, of total angel investments in the first half of 2007. This was followed closely by biotech at 10%. Electronics/computer hardware, IT services, retail and industrial/energy (which include environmental products and services) garnered close to 10% each. The remaining investments were approximately equally weighted across high tech sectors, with each having 3-5% of the total deals.
More details are available at the Center for Venture Research website.
Large Private Equity-backed businesses are significantly outperforming equivalent public companies, a new survey from Ernst & Young shows. The annual rate of growth in enterprise value (EV) achieved last year by the largest PE-backed firms was 33% in the US and 23% in Europe, compared to public company equivalents of 11% and 15% respectively.
This one of the key findings of “How Do Private Equity Investors Create Value?” — the second annual E&Y study of the business performance and strategies of PE firms, which examined the largest deals exited throughout 2006.
The study emphasizes how the PE industry is consistently able to grow and strengthen the companies under its ownership. The average enterprise value of the businesses studied in the US grew from $1.2 billion when acquired to $2.2 billion at exit. In Europe, the average value grew from $800 million to $1.5 billion at exit.
Despite public comment that Private Equity ownership is synonymous with short-term cost-cutting, the study shows the bulk of growth coming from organic revenue growth, and acquisitions.
Cost reduction is the third most important element, but employment levels remained the same, or higher, at exit versus entry in 80% of US deals and 60% of European deals. In Europe employment in businesses owned by PE grew by an average of 5% per annum across the UK, France and Germany, where two-thirds of the deals took place, compared to 3% for equivalent public company benchmarks.
The study shows that Private Equity investors are highly selective and well researched when making the decision to buy a business and have the ability to drive real efficiencies through the business plan under their ownership. This finding was true across deals in the US and all main European countries.
E&Y notes that recent credit market squeeze may prompt a more conservative approach with an increasing need for due diligence at acquisition. In Europe, a key challenge will be developing alternative exit routes alongside secondary sales. However, market participants view this as a short term dip in activity prior to returning to a more rational climate in 2008.
There is widespread solid belief in the PE model and the long-term fundamentals remain strong.
The full report is available at no charge through E&Y’s website (registration required).
Capitalism as currently practiced in the United States and many other countries is both lucrative for its most successful participants and a source of profound political fractures, Oxford Analytica argues in a new analysis.
This “new American capitalism” has, and will, inspire increasing global innovation and emulation — but will also create more worker insecurity and political tension, Oxford says.
The sub-prime mortgage crisis illustrates important ways in which US capitalism has changed in the last 20 years. Changing structures, financial products and globalisation have both mitigated old risks and created new ones.
The widely emulated US model now is characterized by:
- Hedge funds emerging as powerful drivers of speculative activity and innovation in financial markets.
- The explosion in global financial assets providing a wider base for speculation, transactions and profits.
- The creation of new, often highly complex financial instruments.
- Easing of regulatory barriers to trade and financial transactions .
Factors affecting the US capitalism model include:
1. Weakening unions. Unless and until unions find means of organising unskilled and semi-skilled service industry workers labor’s political influence will continue to fall.
2. Wealth gap. The new capitalism has produced many exceptionally wealthy individuals. This has led to an upsurge in ‘market-based’ philanthropy, but created massive gaps in societal wealth and income distribution.
3. Emphasis on education. Without proper science and math education, many US workers will be marginal to the country’s new capitalism.
4. Regulatory culture. Designing and enforcing regulatory mechanisms appropriate to the new capitalism presents a continuing challenge; the financial system’s most skilled entrepreneurs constantly seek to devise means to circumvent regulatory
5. Corporate influence. The influence of corporations in US politics will continue to grow. The insatiable need for campaign funds and the explosion in personal and corporate wealth gives business a powerful structural position to leverage influence.
6. Trade politics. The path to wealth in the new capitalism inherently involves participation in global markets — but increased migration and labour competition have also created widespread worker distress and insecurity.
Oxford says the new capitalism is also a US intellectual achievement in two senses:
Market participants have used the opportunities created by modern IT systems, within a deregulated environment, in ways that are genuinely innovative and part of capitalism’s rejuvenation. This has spurred new wealth creation.
The ideology of the market as the most appropriate mechanism for wealth generation and distribution is such that even social democratic or labor groups accept it as a common framework. Only outside the developed capitalist zone — for example, in some Islamic communities and, again, in Russia and China — are there real differences.
The full report can be purchased here.
Turnover in traditional foreign exchange instruments increased by an unprecedented 71% to $3.2 trillion in the last three years, according to the Bank for International Settlements. During the period London, Switzerland and Singapore gained market share, while the shares of the United States and Japan dropped.
Although broad-based across instruments, growth in FX swap turnover was particularly strong, up by 82% in April 2007, the BIS said in its Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity in April 2007.
Reporting dealers’ foreign exchange market turnover with both other financial institutions and non-financial customers more than doubled since the previous survey in 2004. As a consequence, the share of transactions between reporting dealers and other financial institutions, which mainly comprise hedge funds, mutual funds, pension funds and insurance companies, increased by 7 percentage points to 40%.
London’s markert share grew to 34.1% from 31.3% while the US share fell to 16.6% from 19.2%.
Activity in OTC derivatives markets also continued to expand at a rapid pace. Average daily turnover of interest rate and non-traditional foreign exchange contracts increased by 71% to $2.1 trillion in April 2007.
Turnover of foreign exchange options and cross-currency swaps more than doubled to $0.3 trillion per day, thus outpacing the above-mentioned growth in “traditional” instruments such as spot trades, forwards or plain FX swaps Less brisk growth was recorded in the much larger interest rate segment, where average daily turnover increased by 64% to $1.7 trillion.
The derivatives market shares of London and the US were virtually unchanged from 2004 at 42.5% and 23.8% respectively.
The complete report with statistical tables for individual currencies, instruments and countries, can be downloaded at no charge here.
Venture capitalists continued to demonstrate a healthy interest in clean-technology companies in the first half of this year, investing 70% more than in the comparable year-ago period, according to a report from Ernst & Young LLP and VentureOne.
US-based clean-tech companies received $893 million across 71 deals in the first half, up from $525.1 million invested in 49 deals in the year-ago first half, Dow Jones VentureWire reports (subscription required).
Clean-tech, while still a relatively small part of the VC pie, is seeing growth that far outpaces growth in overall VC investing. VCs invested $14.5 billion in all sectors through June 31, up 9% from $13.3 billion in the same period a year ago.
Clean-tech companies continue to see high valuations, with a pre-money median of $30.5 million, compared with $17.9 million for non-clean tech companies in the first half of the year. This disparity continues a trend seen in 2006.
The report is consistent with a prediction from E&Y posted earlier on Research Recap that Clean Tech was poised for a venture capital breakthrough. That prediction, included in Acceleration: Global Venture Capital Insights Report 2007, is available online at no charge from E&Y (registration required).
Distressed UK lender Northern Rock is exploring a potential sale, having announced that it is suspending its dividend payment for now. As late as yesterday, the company insisted it would pay its dividend of roughly $119M USD.
According to reports, UK regulators have hired Goldman Sachs to advise the lender on strategic alternatives. In today’s WSJ, the BreakingViews column suggests that this appears to be closing the barn door after the horses have left.
According to Credit Sights, there remain three alternatives for the troubled bank:
The situation is very fluid, but for now we see three main possibilities: i) an acquisition, ii) an orderly wind-down and iii) a stabilisation and return to stand-alone operations.
Credit Sights suggests that an acquisition by a larger bank would likely be the preferable outcome for debt holders and the Bank of England, though perhaps not as attractive for shareholders. They see a wind-down as relatively painless, but a less-likely option. A stabilisation program, seems even less likely, particularly due to response of the market.
The Credit Sights report, Northern Rock: Will They, Won’t They?, is available for purchase here.
Though they recognize the financial risks associated with climate change, major US firms have been slow to quantify those risks and outline concrete plans to address them. This is one of the conclusions of the fifth Carbon Disclosure Project survey (CDP5) of S&P500 companies.
More than half of S&P500 firms responded to the CDP5 survey, which was written by The Riskmetrics Group on behalf of 315 institutional investors with assets of $41 trillion under management. The increase in respondents to 56% represents a jump of almost 10 percentage points compared to the previous survey results, but lags the 77% response rate of the companion CDP5 FT500 survey of companies worldwide.
In conjunction with the survey, Riskmetrics created a Climate Governance Index based on five criteria: Board oversight, Management execution, Public disclosure, Emissions accounting, Emissions reductions and strategic opportunities. Top scoring companies by sector were DuPont, General Motors, ConEdison, 3M, Merrill Lynch, Morgan Stanley, Hewlett-Packard, Chevron, WalMart, Hospira and Verizon. Other high scoring companies were Entergy, Exelon, Alcoa, Ford Motor, United Technologies, American Electric Power, News Corp, Weyerhaueser, Johnson Controls, Keyspan and XL Energy.
Other conclusions of the S&P500 survey:
- The highest-emitting sectors are providing the most disclosure. Electric utilities and Materials companies had the highest response rates and generated the best Climate Governance Index scores. Only the Consumer Discretionary sector had a response rate below 50%.
- Management and directors are paying more attention to climate issues. Half of the S&P500 respondents have assigned board and/or upper-level management responsibility for overseeing climate-related issues. Two-thirds of respondents are tracking and have reported greenhouse gas emissions data.
- Four-fifths of respondents recognize commercial risks posed by climate change and two-thirds are tracking and have reported greenhouse gas emissions data. But less than a third have set GHG reduction targets
American industry still lags behind its international competitors in some key respects.
S&P500 firms lag the FT500 in responding to CDP. Three-quarters of the world’s largest publicly traded companies (in the FT500) responded to CDP5, compared to 56% of the S&P500. However, the large increase in the S&P500 response rate this year is in line with historical trends for the FT500 survey.
Action to reduce emissions lags well behind climate awareness. Only 29% of S&P500 respondents have implemented GHG control programs with specific targets and timelines. Many of the targets set do not limit absolute emissions. The lack of federal GHG controls is clearly a factor in this low percentage.
Material effects of climate change remain largely undetermined and undisclosed. While most S&P500 respondents can identify regulatory and physical risks associated with climate change, few have attempted to quantify these risks in dollar terms or have discussed them in securities filings. In addition, carbon pricing is rarely factored into their capital investment decisions, even though such decisions typically require a multi-year planning process and have long payback periods.
Energy efficiency and renewables will be drivers of GHG emission reductions.
The US now rivals Europe in total annual investment in clean energy. More than one-third of S&P500 respondents are involved in renewable energy projects or purchases, and three-quarters are engaged in energy efficiency initiatives.
Much more investment will be required to achieve major cuts in GHG emissions over the next half-century. This will require a massive transformation of the global economy and a sustained commitment to low-carbon energy supplies and energy-efficient equipment.
Companies that are ahead of the curve support mandatory, market-based policies to achieve emission reductions. In embracing greenhouse gas controls, these companies know they will have greater certainty in their investment planning decisions and new business opportunities to exploit, giving them an edge over companies that hang on to business-as-usual strategies.
The S&P500 and FT500 surveys, both of whichl also include several papers on climate change issues from guest contributors, are avalailable at no charge here.
While concern about climate change is high, confidence in the world’s ability to address it is low, according to a new survey sponsored by HSBC.
The HSBC Climate Confidence Index, developed in conjunction with brand strategy consulting firm Lippincott, is based on a sample of 9,000 people across nine economies in four continents.
Key findings of the first survey are:
- Concern about climate change is high especially in developing economies and so is people’s individual commitment to address it.
- Confidence in what is being done today is generally low, with China and Hong Kong being exceptions. Low optimism reflects this lack of confidence.
Most people do not believe we will stop climate change.
- Attitudes differ far more between economies than they do between different ages, incomes or gender within each.
- Climate change is having a significant impact on public opinion in the developing countries surveyed. Around 60% of respondents registered a high level of concern in China, India, Mexico and Brazil, compared with only 22% in the UK and 26% in Germany
- People’s assessment of their commitment to tackling climate is higher in developing economies. Around 47% of people indicated high levels of personal commitment to combating climate change in India and Brazil, compared with only 19% in the UK.
The full report and individual country surveys are available free of charge here.
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