October 2, 2022

Archives for November 2008

The Invisible Meltdown Of The Insurance Industry

As discussed previously, Next Bailout – Insurance Industry?, the insurance stocks have continued their disastrous sell off.  Yet, I have seen virtually nothing in the mainstream press about the dangers of an imploding insurance industry – this invisible crash has reached the point where the Treasury and the Federal Reserve need to address this prior to the point of policy holder and public panic.   The insurance industry is in many ways more important to our economy than the banks and their problems need to be addressed soon.

The individual State guarantee funds backing the insurance industry are woefully under capitalized and were designed to address one failure, not an industry wide meltdown.  The State funds rely on assessments of healthy surviving insurance companies when one fails; unfortunately this does not provide much comfort when the entire industry is starved for capital.

The price declines from my October 1, 2008 price summary (updated below) has been catastrophic to the industry’s ability to maintain confidence of their investors and policy holders as well as their ability to raise capital.

STOCK  PRICE OCT 1’08    PRICE NOV 21’08    %DECLINE

MET      48.15                     18.48                      -62

GNW       7.36                          .90                     -88

ALL       44.00                     21.52                      -51

CB         51.55                     42.76                      -17

PRU       64.80                     16.30                      -75

HIG        38.11                       4.95                      -87

The insurance stocks went into a tailspin once it became obvious that commercial real estate values are declining rapidly as the economy continues its deleveraging.  Commercial real estate had not been subject to the massive overbuilding and speculation that occurred in residential real estate and until recently had been considered relatively immune to the credit crisis.  Since early November, however, the cost of buying default protection on AAA commercial debt via credit default swaps (CDS) has tripled from 200 to 550 basis points (down from a recent high of 847).   Financing for new deals or maturing debt on many commercial loans has become almost impossible to obtain with AAA commercial securities trading at junk bond levels.

At Markit.com, the situation was summarized in their Credit Wrap as follows:

“The commercial mortgage market, often in the shadow of its residential sibling, made its presence known this week. The CMBS sector has been under pressure since the government changed the focus of TARP away from buying distressed and illiquid assets and helped push spreads wider. But the real impetus behind the widening this week came from two CMBS deals. The securities, backed by hotels and a retail centre, are reported to be close to default… The CMBS meltdown was felt in the broader market. The Markit CDX IG widened to record levels, driven by the insurance sector. Life insurers such as Hartford Financial and Lincoln National have significant exposure to CMBS, and losses could well force them to raise more capital.”

The insurance industry companies have always been major investors in commercial real estate as they seek to match long term assets with long term liabilities.   The problem is the overallocation of capital to this one sector as reported by Smart Money.

“Should commercial real-estate turn out to be next focus of the financial crisis, life insurers will be among the companies feeling the most heat.

Life insurers on average have the equivalent of about 41% of their equity invested in commercial mortgage-backed securities, or CMBS, compared with 23% on average for property/casualty insurers, according to a Thursday analysis of 10 large public insurers by Fox-Pitt Kelton analyst Adam Klauber. He said Hartford Financial Services Group Inc. (HIG), Protective Life Corp. (PL) and MetLife Inc. (MET) had the highest exposures.

Investment banks, by contrast, hold about 18% of their equity in CMBS.

While the financial crisis has come late to the life insurance industry, it has hit them hard. Shares of life insurers are down nearly 72% so far this year, a bigger drop than for other types of insurers. The pressure on life insurers, some of which may become bank holding companies to get access to investments from the Treasury, makes government efforts to contain the financial crisis yet more complicated.

The latest blow is coming from commercial mortgages, which are beginning to look like they may follow the dismal example of home mortgages, with a few big defaults hitting the news in recent days. Life insurers, big investors in mortgage-backed securities of all types, are taking another big hit.

UBS analyst Andrew Kligerman calls the concerns about commercial real estate the “leading factor” in insurance stocks‘ poor performance this week. Lincoln National Corp. (LNC) was the big loser Thursday, closing down 30.6% to 5.07. Shares of Hartford closed down 19% to $5.57 and Principal Financial Group (PFG) closed down 19.2% to $9.43.”

Although some of these companies have applied for bank holding status so that they can access the Fed for borrowings, these six companies (representing only part of the insurance industry) have assets of over $1.7 trillion.  Assuming significant losses as implied by CDS pricing, recapitalizing the insurance industry could easily consume the second half of the $700 billion bailout fund,  while the demands on the treasury grow ever larger, as discussed in The Line at the Treasury Grows Longer.

There would seem to be a finite limit to the amount of losses/guarantees that can be assumed by the US Treasury (taxpayers).  Bloomberg is reporting that the total Fed credit pledges and loans now exceed a staggering $7.4 trillion.  Let us all hope that we do not find out what the limits of the Fed are.   Obviously at some point, the  US Government’s credit and ability to fund never ending losses will be questioned.

Debt Collection M&A Is Booming As Collections Collapse

Business Week reports that amid a general collapse in the mergers and acquisitions (M&A) field, one area that is still booming is in acquisitions of companies that buy and collect on defaulted consumer debt.  Acquisitions of $1.8 billion this year already exceed last years total of $1.65 billion.

The apparent lure of the hot money M&A crowd is that with a collapsing economy, there is an ocean of debt that is defaulting giving the debt collectors an opportunity to cash in on chasing delinquent customers.  Every company in the country from small businesses to the S&P 500 list are finding out to their surprise that when you extend credit to already heavily leveraged and/or poor credit risks, it doesn’t take much before your customer is unable to pay.

My forecast is that the buyers of debt collection firms that the hot money deal makers are selling will not be sailing on their yachts next summer.

Borrowers of all credit levels suddenly have a new mentality:

-there is no job security and layoffs in the thousands are announced daily; even if I have the money, it is better to keep it in my pocket than to pay off overdue bills.  The choice between being able to buy groceries or pay off a delinquent bill is an easy one.

-the massive bailout of of the banking industry has caused much resentment among working people who justifiably perceive this to be a handout to those who caused the problem to begin with and in addition, made multi millions of dollars in the process.

-the idea that debts really don’t have to be paid back is being encouraged by the government’s bailout mania, especially with the institution of mortgage modifications for delinquent borrowers.  If I don’t have to pay my mortgage back, I am certainly not going to worry much about defaulted credit card debt.  The repudiation of debts is being encouraged by the very actions that the government is taking to contain the economic crisis.

-lending to many consumers, especially the weaker credits, has been drastically curtailed.  If I won’t be able to get new credit, why would I worry about the credit implications of not paying off old debts?

-I know many people who are not using bank accounts anymore, but cashing their paychecks and paying their bills in cash to forestall the seizure of their money by creditors who have judgments against them.

-the change of power in Washington along with the current job losses and declining economy will lead to a revision of the bankruptcy laws, essentially reversing the changes made in the recent past which made it much harder to file a Chapter 7 liquidation bankruptcy.  The debt collectors who think they can obtain a judgement and wage garnishment may soon find that their claims are now worthless.

-the most obvious reason that debts will not be collected easily or at all is the fact that the American consumer simply does not have the money; squeeze as hard as you want to – there is nothing left so nothing will be paid.   As reported in The Wall Street Journal,

“This should be the best of times for America’s debt collectors, since never has a society been so in hock. But ironically, much of the debt-collection industry is struggling because there’s little cash left to squeeze from strapped consumers.

Encore Capital Group Inc., a San Diego debt buyer, said third-quarter profit fell 30% to $3.8 million after its impairment provision for debt — an accounting term for debt it doesn’t think it can collect — rose to $7.3 million from $2.4 million. And Debt Resolve Inc. of White Plains, N.Y., said big losses at its debt-collection unit led to a second-quarter loss of $4.2 million.

“More and more accounts are going out to debt collectors, but it’s harder than ever to collect,” said John Nemo, a spokesman for ACA International, a Minneapolis-based trade group that includes 3,500 of the country’s estimated 4,500 collection agencies.

“There may be no other industry that has such immediate knowledge of consumer liquidity,” said Paul Legrady of Kaulkin Ginsberg Co., a Rockville, Md., consulting firm that advises collectors and others who manage accounts-receivable. The company publishes the Kaulkin Ginsberg Index of indicators such as corporate charge-offs of unpaid debt. “There’s been a clear downward trend for the past year,” Mr. Legrady said.

The slump also hurts businesses that supply equipment and services to debt collectors. Soundbite Communications Inc., a Bedford, Mass., company that makes automated robo-callers for debt collectors, told investors recently that it expects sales to agencies to decline in the second half of this year.

“Their ability to actually collect payment is significantly reduced because more and more debtors are simply unable to pay,” said Soundbite’s chief executive, Peter Shields. he said. As a result, debt-collection agencies are “becoming more selective in their spending.”

Good luck to the new owners of the debt collection agencies – I would say that the other side of this trade got the better deal.

Bailout Demands Reach New Levels Of Lunacy

As reported in the RepublicanAmerican newspaper, the demand for a piece of the $700 billion bailout fund has reached new levels of lunacy.  Originally, the bailout was passed by Congress to rescue our banking system from collapse, but the idea of being bailed out with taxpayer money has apparently become very appealing to anyone who might have made a bad financial decision.  Apparently, some of those individuals who locked in home heating oil at $5 a gallon earlier in the year feel some sense of entitlement for their bad call now that the same oil can be had for $2.40.

The RepublicanAmerican reports that:

“In July, when heating oil was approaching $5 a gallon and the so-called experts were saying crude was headed to $200 and beyond, millions of homeowners were flipping coins. Heads, they’d commit to pay $4.50 to $4.75 a gallon for heating oil this winter; tails, they’d gamble it wouldn’t going to $6 as predicted.

In Connecticut, heads came up about 200,000 times. And as soon as those homeowners signed contracts with their suppliers, crude prices crashed 60 percent in less than four months.

Today, heating oil can be had for as little as $2.40, c.o.d. As awful as those contracts are, they were signed by willing sellers and willing buyers. Legally binding contracts are fundamental if we are to have faith in our economy and the rule of law.

Heating-oil contracts have an excellent track record. In the last 20 years, for example, customers of Wesson Oil of Waterbury who signed oil contracts saved money in every year but two, including one in which they broke even. Last winter, when the average retail price was $3.31, those who reserved 700 gallons saved about $500.

The Independent Connecticut Petroleum Association and eight other energy associations want Treasury Secretary Henry Paulson to redirect some of the $700 billion allocated to ease the credit crisis to allow them and their customers to get out of their contracts.

Their hearts may be in the right place, but the feds already have bailed out the lending, financial and insurance industries.

Congress is poised to spend billions more to rescue borrowers who through stupidity or duplicity got mortgages they couldn’t afford.

The auto industry got $25 billion and this week was back in Washington for $25 billion more. Spendthrift states are asking for upward of $30 billion.

The list goes on. The retail, construction, electronics and tourism industries are reeling. The service sector is shedding jobs left and right. Should the feds bail them out, too? Where are they getting the money? Between deficits, long-term debt and unfunded entitlement liabilities, they (present and future taxpayers) are in hock for nearly $100 trillion.

Comparatively speaking, no person or company is in worse financial shape than the government, yet pain-averse Americans continue to go to the government for handouts or bailouts to indemnify their mistakes.

We don’t doubt that heating-oil retailers and customers would love to get out of their costly contracts. But what about investors who bought stock in AIG this year for $62 a share, people who three years ago purchased flat-screen TVs for twice what they’re selling for today, and millions of Americans who suffer buyer’s remorse every day?

Where does it end?”

Excellent article and there is no need to answer the last question posed by the author since it is obvious, as manifested by our collapsing stock market and economy.  A sovereign nation’s credit rating and ability to pay its bills is no greater than the sum of its citizens earnings capacity.  If member A of our society receives some sort of entitlement, by definition it must be paid for by some other member B.   Member C, the government brings no money to the table; they merely sit at the table and divide the wealth between A and B.

A national government does not have an unlimited ability to borrow and spend without eventually defaulting on its debts and impoverishing its citizens.

Where Have All The Stock Buybacks Gone?

Given the magnitude of the stock markets decline, one would think that there would be major announcements from companies announcing stock buybacks.  I recall after the crash of 1987 when numerous companies announced major stock buyback programs in an attempt to inspire confidence and shore up stock prices.

As reported in Barrons this week,  stock buybacks declined by 90% from last year during the latest 10 day period, this despite the fact that the average stock has declined by around 50%.  So one may certainly be inclined to wonder why corporate America would be heavily buying back their own stock as the market was at all time highs but not now when, arguably, the stock is a better buy due to price declines.  Maybe some shareholder will ask this question of management at the next annual stockholders meeting.  Perhaps a better time to have asked about stock buybacks was when corporate management was spending hundreds of billions to buyback stock when times were good.

I have never been a fan of stock buybacks for these reasons:

– studies have shown that over time, share price performance of companies buying back stock does not exceed those of companies that do not repurchase shares.

-if management cannot intelligently invest funds back into their core business at a greater return than the cost of capital, then they should instead pay dividends to the shareholders, who will at least have something to show for their investment, since as stated above, stock buybacks do not lead to share price gains.   Microsoft was one of the few major corporations that actually paid a substantial dividend  to shareholders a few years back instead of repurchasing stock.

-unless a company is debt free, would it not have been better to have paid down debt instead of dissipating funds buying back stock?   As mentioned in a previous post, GE spent billions on stock buybacks at high prices and now has to borrow money at 10% rates.   I don’t see how this makes sense as a long term strategy.

-how many of the companies buying back stock have their long term compensation plans and bonuses tied to the EPS performance?  Quite a few I would imagine, which makes the decision to buy back stock all the easier since it directly increases management’s pay while the shareholders get nothing.  (Buying back stock decreases the outstanding shares used in computing the earnings per share, so a stock buyback will serve to increase the reported EPS.)

-how hard is it to conceive of the possibility that someday, markets will decline and cash will be dear, so why not pay down debt or simply increase your cash holdings to be used in an opportunistic manner at some point in the future?  Apparently, not too many members of corporate America ever thought about this or else we would now be hearing about a lot of stock buybacks and company buyouts.

-Exxon Mobil has spent billions buying back stock as their oil reserves shrink year after year.  With prices of oil and gas companies selling for a fraction of the price of a year ago, why are they not opportunistically reinvesting in their business by buying cheap oil and gas reserves via cash acquisitions?

-Merrill Lynch announcing a $6 billion stock buyback in 2006 – one for the history books of poor timing and inept management, although it may be topped by Merrill’s prospective owner, Bank of America, who despite needing taxpayers funds from the TARP, decides to invest $7 billion in the China Construction Bank.  I think BAC has a real problem here and the stock price reflects management’s decision making.  BAC’s
“investment” in China, GM executives flying on their plush corporate jet to Washington to beg for taxpayer funds – I think the pattern here is part of the reason for the economic crisis that we are in.

My conclusion is that a shareholder should carefully evaluate an investment in any company engaging in major stock repurchase plans.

Loan Modifications – Salvation For Former Mortgage Brokers?

From my industry contacts and investigation of the loan modification “business” there are several conclusions easily reached:

The Internet is extremely crowded with unknowledgeable, coarse idiots who are all attempting to haphazardly create businesses doing loan modifications. Very few of them have thought through whether or not they can be profitable, or the long term destination of the new industry.Many of the new loan mod businesses are being started by unemployed members of the mortgage brokerage industry who helped to create the very problem that they are now offering to cure. In fact, the very same people who were “helped” by the mortgage industry by getting them approved for subprime and Alt A mortgages are now on the top of the calling list as potential “loan mod” customers.

The press is highly critical of anyone who tries to assist homeowners with loan modifications. Beyond news driven stories, the only loan mod stories are about bad providers who charge huge upfront fees and deliver little or no results, or others who are simply defrauding customers outright.

The press and the government, for lack of a real solution, see the idea of loan modifications as THE solution to the housing crisis. If payments are lowered for 2 million of the country’s biggest financial losers, the economy will snap back immediately, job losses will cease and all will be well.  The consensus seems to be that the government should pay for this, and make rules about which people are “distressed” enough to receive a lower rate and mortgage payment through a loan mod. The cost of all of this, as you may guess, will be borne by those who handled their finances responsibly and did not borrow themselves into oblivion speculating on the certainty of eternal home appreciation.

Here is where I think things are going:

In response to concerns about fraudulent or unknowledgeable companies assisting with loan modifications, most states will implement licensing requirements, as is already happening. Among other things, to maintain the license, you will be subject to strict guidelines on how much you can charge for loan modifications. The fees will be low enough to make any business which exclusively performs loan modifications unprofitable; the theory being that people behind on their mortgages should not have to pay since they are in financial difficulty.  Several states have recently created licensing requirements. Colorado was the latest: http://www.rockymountainnews.com/news/2008/nov/20/loan-modifications-require-mortgage-broker/ .

As more of our nationalized banking system is pressured/required to do loan modifications, certain universal standards and calculations will develop. These will eventually evolve into a simple calculation that will require only a few inputs to determine exactly how a loan will be modified. This may even reach a point where banks routinely modify loans without even taking an application. This technology provider for the mortgage industry just released an early version of such software: http://www.marketwatch.com/news/story/Lender-Processing-Services-Announces-New/story.aspx?guid={58FCD216-F636-4EF9-8B93-5C1C1A41AD2F}

The government will eventually fully endorse the idea of loan modifications for troubled homeowners and subsidize the losses. Of all the problems the country faces, for some reason the politicians will decide that keeping 2 million “homeowners” (who should be renters) out of foreclosure is the most pressing issue, instead of letting the free markets, via time and price solve the problem. With the government involved, the criteria will become even more formalized and systematic. Loan servicers or banks will be encouraged or required to deal with borrowers directly. The entire process will become formulaic and there will be little need for an outside party to assist with the loan modification.

As modified loans default again and further borrowers fall into distress, whatever small scale plan the government implemented will be expanded dramatically. The government will increase pressure and incentives for banks and loan servicers to perform loan modifications en mass. Getting a loan modification will become as easy as it used to be to get a loan. Of course, one may wonder when it last occurred, that a government solution to a problem actually worked. Nonetheless, as home prices continue their inexorably decline for years and given the inability to find a better solution, this program will continue and expand, attempting to artificially arrest the decline in home prices that will occur anyways. Someone should clue in the powers to be that unless we want to totally socialize our economy, the free market, if left to do its work, would quickly solve the housing crisis by bringing prices to the point where they are worth investing in again and at a ratio of family income to cost that is sustainable for qualified borrowers.

Conclusion

Loan modification as a stand alone business is transitory since circumstances will change to make the current business models obsolete. At the same time, the fees that will be legally allowed will be too small to allow most businesses to be profitable. To turn this into a business, one would need to align his strategy to be way ahead of the curve and I have only seen one business model for loan modifications that would work if applied by an industrious and ethical entrepreneur.

In the meantime, potential customers who are solicited to have their loans “modified” would be well advised to do a complete background check on the firm that they may chose to deal with. In addition, under no circumstances should anyone pay a nonrefundable fee upfront (other than a modest processing fee). Guidelines vary with each loan depending on the investor, but if you are dealing with a knowledgeable firm, they should be able to determine from an initial prequalification if someone qualifies for a loan modification and accordingly, should only charge a fee if the loan is successfully modified.

As to the financial cost and moral hazards of the loan modification scheme, one should consider the words of Representative Ron Paul, when speaking out against the original $700 billion bank/homeowner bailout bill:

“It is neither morally right nor fiscally wise to socialize private losses in this way. The solution is for government to stop micromanaging the economy and let the market adjust, as painful as that will be for some. We should not force taxpayers, including renters and more frugal homeowners, to switch places with the speculators and take on those same risks that bankrupted them. It is a terrible idea to spread the financial crisis any wider or deeper than it already is, and to prolong the agony years into the future. Socializing the losses now will only create more unintended consequences that will give new excuses for further government interventions in the future. This is how government grows – by claiming to correct the mistakes it earlier created, all the while constantly shaking down the taxpayer. The market needs a chance to correct itself, and Congress needs to avoid making the situation worse by pretending to ride to the rescue.”


Treasury Officials Announce Mortgage Holiday

News Release: Sometime in 2010.

The United States Treasury Secretary is expected to release details today of the Government’s plan to suspend for one year all payments due on mortgages secured by single family residences.  The Government announced that it was taking this action due to unprecedented conditions in the economy and record numbers of mortgage delinquencies.   With close to half of all mortgages in arrears, a jobless rate approaching 20% and retail sales collapsing by double digits for the third consecutive year, the latest government move to boost the economy was applauded by analysts as the best direct method of putting funds in the pocket of cash starved consumers.

Government officials noted that since most of the mortgages affected had already been purchased or guaranteed by the US Government, there would be no direct cost to the taxpayer.  Analysts noted that this latest move was necessary after a long series of loan modifications for many borrowers had failed due to the continued decline in housing prices and incomes.  Brushing aside suggestions that this program was unfair to those who had no mortgage debt, Treasury officials stated that the program was initiated to help those most in need and that those without mortgages might be eligible for funds under the latest rebate stimulus plan.

In response to questions as to whether or not the Mortgage Holiday Plan might be extended beyond one year, Treasury officials stated that the Government would do everything in its power to assure that affordable housing was available to every citizen and that every measure would be taken to prevent homeowners from losing their homes due to unaffordable payments.

The Treasury Secretary noted that while many sovereign nations had become insolvent due to the ongoing financial crisis, the United States remains “fiscally strong”.

So there you go; congratulations to the Federal Reserve and our fiscally imprudent leaders who have brought this nation to the brink of economic collapse.

    Loan Modification – Someone Forgot To Ask The Investors

    Purchasers of mortgage debt, formerly known as investors but now known as bag holders were distressed that Bank of America (BAC) did not consult with them prior to deciding to modify customer mortgages, as reported by the Wall Street Journal.   The problem was not with the mortgages actually owned by BAC, but rather the mortgages owned by others and merely serviced by BAC.  Apparently so enamored with the idea of saving the banking industry by reducing the rate and loan balances of the lucky mortgagees, BAC decided to apply their therapy to mortgages that they merely service but do not own.

    The problem with attempting to modify mortgage loans en masse is that many mortgages originated over the past 5 years were sold to investors as mortgaged backed securities.  BAC maintains that they can modify these investor owned mortgages based on “delegated authority” per the loan servicing contract they have with the investors.   Obviously some of the investors in the serviced mortgages don’t see it that way and are looking to BAC to make them whole on any write downs given to the borrowers at their expense.   These are the types of issues confronting the industry in their attempts to modify mortgages.

    Mortgage modifications are seen as a win/win situation by the FDIC, many banks and some of the mortgaged backed securities investors since it appears to offer the ideal solution – homeowners get to keep their homes, foreclosures decrease and the ultimate loss on the loan modification theoretically is less than   foreclosing on the property.  This may all be work out to every one’s advantage unless property values continue their decline which I consider to be a likely scenario.   Home prices won’t stop dropping regardless of government efforts until the economy stabilizes and until the ratio of family income to cost of ownership reaches an affordable level.

    The issue with loan modifications that I and others see is one of moral hazard; this program is institutionalizing the repudiation of debt on a national scale and the cost and negative consequences of this rationale are open ended.  In an excellent article by Peter Schiff, he describes loan modifications as “the mother of all moral hazards” as follows:

    “No doubt prodded by the administration, Fannie Mae and Freddie Mac announced a new attempt to stop the fall in home prices and foreclosures through a loan modification program that would cap mortgage payments so that a homeowner’s total housing expenses would not exceed 38% of household income for home owners who are 90 days delinquent.

    In a classic case of unintended consequences, the plan will encourage a massive new round of delinquencies and household income reduction as homeowners will jump through hoops to qualify for the program and maximize their benefit. Those who could conceivably economize to meet their existing obligations will now have a strong reason to forgo such sacrifices. Those who are not 90 days past due will intentionally become so. In many cases, dual income families may decide to eliminate one job altogether as reduced mortgage payments combined with lower child care and other work related expenses will likely exceed the after-tax value of the lost paycheck.

    Unfortunately, the last thing our economy needs is falling household incomes and even more bad debt. But that is precisely what this plan will give us.”

    Transferring all the losses of homeowners, automakers, banks, insurance companies, credit card companies, mortgage companies etc etc onto the balance sheet of the US Government does not correct the incredible excess of leverage that has been ongoing in this country since the early 1980’s; it merely transfers the losses to the US taxpayers and shortens the day that the US Government itself will need to be bailed out.

    American Express – A Single Digit Stock?

    Despite the horrendous 72% sell off in American Express this year, I would still not be a buyer at the recent price of $19 for the following reasons.

    From my personal experience in the mortgage business, I have seen many people turn to their credit cards once the home equity cash out loans were no longer available to them.  The credit cards were used to maintain a now unsustainable life style or to bridge the gap between income and living expenses.  Now that credit card lines are being reduced or simply maxed out, the last option for many people is now closed.  Since AXP gets around half of their revenue from the fee charged to merchants when a credit card is used, this income is obviously going to see a reduction.

    Moody’s recently cut AXP’s investment grade by one notch to A2 (still very respectable) but the trend is clear.  Moody’s is expecting the recent earnings decline at AXP to continue, especially in view of the broad economic weakness and overleveraged consumer.

    The fact that AXP decided to request $3.5 billion in capital from the Treasury’s TARP fund also raises many red flags – if AXP wasn’t expecting further problems in its basic business they would not be requesting theses funds.  In any event, AXP needs to refinance approximately $24 billion of debt over the next year; if the credit card securitization window remains closed, AXP may be back in line very soon for another TARP injection.

    AXP expanded its business during the peak of the credit boom, expanding their credit card loans by some $26 billion over the past 4 years – an increase of 68%.  Timing is everything and they definitely got this one wrong, possibly by assuming that an overextended credit card customer would simply pay off his unmanageable credit card debt with his next cash out mortgage refinance.  Unfortunately for AXP, the days of constantly borrowing more money to pay off past borrowings has come to a halt.

    Also, extremely unfortunate for AXP is the consumer attitude that debt that cannot be easily paid off should be easily forgiven, either by the company that lent the money or the bankruptcy courts.  If AXP needs proof of this, they can check out the Bank of America, Citibank, JP Morgan etc loan modification programs for mortgages.  At a time when collarteralized debt is being forgiven, unsecured credit card debt will be easily walked away from as well, as evidenced by the 100,000 plus (and increasing) personal bankruptcy filings each month.  Overleveraged consumers forced to borrow for years to bridge the gap between incomes and expenses will no doubt have no trouble being approved for a Chapter 7 debt liquidation instead of the Chapter 13 payment workout resulting in zero recoveries for AXP on outstanding credit card debt.

    If you apply conventional, historical valuation metrics to American Express, the stock looks ridiculously cheap.   Unfortunately, I don’t thinkthe present economic disaster is going to end anytime soon and if that is the case, AXP will be facing a bleak future not only in its future earnings but also in its ability to refinance their 6/1 leveraged balance sheet.