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Is the Shadow Banking System Recovering?

(February 25, 2011)

Dear Subscribers and Readers,

Sure, bank lending (especially residential mortgage lending) is still depressed, and private equity lending is still non-existent.  Nevertheless, the global economy, with the exception of some “flare-ups” in the Middle East, is humming along.  The US population is still growing at about 3 million a year; while technological improvements are being adopted (e.g. cloud computing standards/infrastructure, more efficient battery storage, “smart grid” research, etc.) in order to drive Schumpeterian growth going forward.  The Federal Reserve, meanwhile, is still purchasing on average $18 billion of Treasuries on a net weekly basis—while global asset prices, despite the latest correction, have been on a tear since early March 2009.

Global consumption remains robust, while the US commercial real estate market is hanging on.  In light of a more “normalized” level of economic and real estate activity, it is not surprising to see that—over the last few weeks, there has been more than $6.5 billion in new global CMBS securitization, as shown in the following chart/table (courtesy of Commercial Mortgage Alert): 

Of the $6.5 billion in new CMBS securitization, more than $5 billion occurred in the US.  And February isn't over yet!  More important, the amount of global CMBS securitization on a YTD basis is already more than one-third of total global CMBS securitization for the whole of 2010!  As long as global central banks do not tighten anytime soon (and remain flexible to loosening policy as needed), this renewed lending could drive commercial real estate prices higher—that would in turn result in more lending activity, and so forth.  Furthermore, CMBS spreads and yields will continue to be conducive to more lending—as 10-year AAA CMBS spreads are making post-crisis lows, as evident in the following chart (again courtesy of Commercial Mortgage Alert):

Note that the “revival” of CMBS issuance is being somewhat supported by the global issuance of asset-backed securities.  After starting weakly, global ABS issuance has perked up in February—and is now almost up to last year's level at this time (following courtesy of Asset-Backed Alert):

Speaking of leverage and liquidity, I now want to address the ongoing rise in leverage within the stock market, as exemplified by the amount of margin debt outstanding.  Since the February 2009 bottom, total margin debt outstanding has increased by 64%, and in fact has retraced nearly 60% of its peak-to-trough decline from July 2007 to February 2009. Total margin debt outstanding increased by$13.2 billion during the month of January—standing at $326.9 billion, its highest level since month-end September 2008:

No doubt margin debt outstanding is now very elevated—and given the ongoing rise in geopolitical risks, commodity prices, as well as the negative technical divergences we covered in last weekend's commentary, we expect the current correction to continue for the foreseeable future.  Subscribers please stay tuned.

Signing off,

Henry To, CFA, CAIA


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