Since mid-June 10-year Treasury yields have dropped 85 basis points to 4.32%, yet Wall Street’s borrowing costs are going up, as Bloomberg reported:
Wall Street is getting no benefit from the biggest bond market rally in five years.
Lehman Brothers Holdings Inc. faces higher borrowing costs today than it did in June, even after the steepest quarterly drop in U.S. Treasury yields since 2002 pushed interest rates down for everyone from Procter & Gamble Co. to AT&T Inc. Investors are so leery of Bear Stearns Cos. that its 10-year bonds trade at a discount to Colombia, the South American nation that’s barely investment grade. Goldman Sachs Group Inc. is being punished with a higher yield than Caterpillar Inc., the heavy-equipment maker.
The Big 5 investment banks are now paying 1.80%-2.35% over Treasurys on subordinated 10-year debt:
Goldman Sachs 6.25% senior notes due 9/2017: 6.040%
Morgan Stanley 5.45% senior notes due 1/2017: 5.926%
Goldman Sachs 5.625% subordinated notes due 1/2017: 6.167%
Merrill Lynch 5.7% subordinated notes due 5/2017: 6.110%
Lehman Bros 5.75% subordinated notes due 1/2017: 6.658%
Bear Stearns 5.55% subordinated notes due 1/2017: 6.720%
Higher borrowing costs will take a bite out of profits:
The explosion in credit spreads on Wall Street may take an even heavier toll on profit next year, when the five firms have almost $133 billion of bonds maturing, according to data compiled by Bloomberg. Bond indexes maintained by Merrill show that the cost of refinancing that debt has swelled by about $1.3 billion since the beginning of 2007, excluding the cushioning effect of any interest-rate hedges.
“Any securities firm is an institution that requires access to capital to fund itself,” said Mitch Stapley, who helps manage $12.7 billion at Fifth Third Asset Management in Grand Rapids, Michigan. Wider spreads “will impact their profitability,” he said.
Goldman is the only firm to have distributed its refinancing obligations so there’s no outsized amount of debt coming due in a single year.
Merrill has $42 billion of bonds maturing next year, the most on Wall Street and about 50 percent more than in 2009. Morgan Stanley is next at $34 billion.
$1.3 billion in extra borrowing costs pale next to a combined $30.6 billion in combined net income in 2006. Still, the boom in Wall Street profits appears to be over; net income as recently as 2004 was a more pedestrian $17.2 billion.
As Lloyd Blankfein warned in June, an end to the days of cheap credit wouldn’t be pretty for Wall Street:
Goldman CEO Lloyd Blankfein, who led the firm to a Wall Street record $9.54 billion in earnings last year, said in June that low interest rates and easy credit helped fuel the five-year boom in real estate, LBOs and emerging-market investments. He also warned them what to expect when spreads widen.
You’d see “a lot of that wealth, which was created over the years, unravel very quickly,” he said at a June 27 conference at the New York Stock Exchange. “You wouldn’t enjoy that.”
My comment: The investment banks are caught in a vice – bad bets being exposed, business drying up, lenders getting nervous, and financing costs going up.