FYI | Jun 13 2007
By Greg Peel
The Bank for International Settlements, the central bank to central banks, is known for its predilection for “severe admonishments”, as the London Telegraph puts it, from its cosy headquarters in Switzerland. In its latest critique, it warns about the increasing use of debt in the current takeover boom.
The bank’s quarterly report, released this week, noted M&A activity reached an unprecedented US$1.1 trillion in the US and US$1.0 trillion in Europe in the five months to May. Only 12% of these deals were financed by equity. To put that into perspective, the last merger boom – amongst tech stocks in 1998-00 – averaged 50% equity.
Total signings of syndicated loans for leveraged buyouts reached US$82.3 billion in the first quarter 2007, almost double the previous quarter. BIS had already warned in an earlier report that extreme leverage was likely to lead to a sharp increase in defaults once the global credit cycle began to turn.
Part of the problem is a prolific growth in the development of new financial instruments as excess global liquidity looks for a home and a level of diversity. One of the more popular new fads has been in collateralised debt obligations (CDOs) in which mortgages or other asset-backed loans are packaged and sold off as securities. This market reached a record US$251 billion in the first quarter alone.
Another worrying development is the huge transfers of foreign investment into Eastern European bonds. Risk spreads on this paper have fallen below the level of those on corporate bonds with equivalent credit rating. The flow of private credit to developing world reached US$341 billion in 2006 – a 46% increase on 2005. 60% headed to ex-Communist states, particularly Romania, Bulgaria, Ukraine and the Baltic states. Much of the paper is denominated in euros or Swiss francs.
Cross-border claims amongst banks increased by US$1 trillion in the fourth quarter 2006 to US$13 trillion, suggesting there is no end in sight to global excess liquidity.
And that old whipping boy – derivatives – came under scrutiny from BIS as well. Outstanding global derivatives positions were worth US$415 trillion at the end of May, or about seven times global GDP. This figure has grown 40% in twelve months.
Offshore banks are increasingly more popular, with credit volumes in the Caribbean increasing 23% in 2006 to US$3.3 trillion.
With money flying all around the world looking for the next big return, investment in the US is declining in popularity. Only 15% of the estimated US$1 trillion of accumulated bank holdings of OPEC remains in the US. Some 71% now resides in European accounts.
All this, and global interest rates are under tightening pressure as inflation creeps in.