“The banks are still clinging to their reserve reports and praying. The bonds are all toast. Most are in the single digits or teens.”
I asked a former colleague of mine from my Bankers Trust junk bond days who is now a distressed debt trader what was going on in the secondary market for energy sector bank debt and junk bonds. The quote above was his response.
Zerohedge posted a report last night with a Bloomberg article linked that describes what is going on – “Assets selling for far less than what companies owe lenders – Creditors are left holding prospects no one wants to buy.” the article further cites the ridiculously small reserves that four biggest banks in the energy sector have set aside: “Bank of America Corp., Citigroup Inc., JPMorgan Chase & Co. and Wells Fargo & Co. — have set aside at least $2.5 billion combined to cover souring energy loans and have said they’ll add to that if prices stay low” – (Bloomberg).
Considering that those four banks combined probably have at least $100 billion of exposure to sector – not counting the unknowable amount of credit default swaps and other funky OTC derivative configurations the financalized Thomas Edisons at these banks dreamed up – the $2.5 billion in loss reserves is a complete joke. It’s an insult to our collective intelligence. Of course, Congress and the SEC took care of the problem of forcing banks to do a bona fide mark to market after the 2008 financial crash.
This is the 2008 “The Big Short” scenario Part 2. The banks underwrote over $500 billion in debt they knew was backed by largely fraudulent reserve estimates. I bet most of the “professional” investors at pension funds and mutual fund companies were not even aware that oil extracted from shale formations trades at a big discount to WTI. When creditors go to grab assets in liquidation, they’ll get a few handfuls of dirt to resell. And when the bondholders go to grab assets, they’ll get an armful of air.
The same dynamic is about to invade and infect the housing market. Notwithstanding the incredulous existing home sales report released on Friday – (how can the NAR expect us to believe that December experienced the largest one month percentage increase in existing home sales in history when the economy is sliding into recession and retail sales were a disaster?) – the housing market is on the cusp of imploding. I was expecting to see a unusually high number of new listings hit the Denver market right after Jan 1st and so far my expectations have been met. The acceleration of new listings is being accompanied by a flood of “new price” notices. I believe a rapid deterioration in home sales activity will take a lot of the housing bulls by surprise.
The stock market’s reflection of my assertions about the housing market is exemplified by the homebuilder stock I feature in this week’s issue of the Short Seller’s Journal. This stock is down 16% from when I first published a stock report on this Company in 2014. This is a remarkable fact considering that the S&P 500 is down only 4% in the same time period AND the Dow Jones Home Construction Index UP 8% in that time period. This company happens to originate a high percentage of the mortgages used to finance the sale of its homes.
The company relies on an ability to dump these mortgages into the CDO and Bespoke Tranche Opportunity configures conjured up by Wall Street in order to seduce dumb pension and mutual fund money into higher yielding “safe” assets. As the energy debt market implodes, it will cause the entire Wall Street supported asset-backed credit market to seize up. The next biggest losers after the energy sector will autos and housing.
This week’s Short Seller’s Journal features the above housing stock plus a copy of the report I originally published (the data is old but the ideas behind why the stock is a short are intact, if not more pronounced) plus I have presented two “Quick Hit” energy sector stock short ideas. All three ideas are accompanied with my suggestions for using puts and calls to replicate shorting the stock You can access this report here: