|
READING LEVEL-UP(2/4회), DECEMBER, 2007 TERMS & BACKGROUND INSTRUCTOR KIM SOO-YEON
Business and the credit crunch: At the gates of hell
Banks and brokers are having a terrible time. Now the misery is spreading
Only months ago Cerberus was praised as the saviour of the American car industry when it bought Chrysler from its German owner and struck a remarkable deal with the unions to cut jobs and benefits. But on November 20th it emerged that Cerberus's bankers had abandoned efforts to sell $4 billion of the debt it took on when it bought Chrysler. Investors turned up their noses even when offered a 3% discount.
Cerberus has also been hit by growing problems at GMAC, the financing arm of General Motors, in which it bought a 51% stake for $14 billion last year. GMAC reported a net loss of $1.6 billion for the third quarter, up from a loss of $173m in the same period last year.
More controversially, on November 14th Cerberus pulled out of a $4 billion deal to buy United Rentals, a power-tool rental firm. This provoked so much criticism that the famously secretive private-equity firm broke its vow of silence, telling the Wall Street Journal that the attacks on its credibility and integrity were “unfounded” and that it still has “more than $10 billion of available liquidity”.
What happens to private equity may be a leading indicator of how the crisis in the financial system will affect the rest of the business world, both because private-equity deals are so dependent on large amounts of debt, and because many of the shrewdest judges of corporate value work for private-equity funds. The number of new private-equity deals has plunged with the financial crisis, and nobody expects activity to pick up again soon. The collapse of deals suggests(=indicator) that the business climate has changed sharply.
But how, exactly? Were the cancelled deals so marginal, and so dependent on cheap credit, that a relatively small rise in the cost of debt ruined them? Did Cerberus conclude that prospects for the American economy are now too bad to go ahead with the United Rentals deal? Does it see better uses for its capital elsewhere, in distressed debt, say? Is that $10 billion of liquidity really available? And is it really true that as goes Cerberus, so goes the rest of private equity, and the rest of business?
The only truly upbeat firms in America nowadays are the accounting giants, which for once are not being blamed for a financial disaster (this time that honour belongs to the rating agencies). They are determined to keep it that way, and are said to be racking up huge fees by challenging every assumption in banks' financial models to make sure they cannot be accused of optimism. The banks are thus having to disclose ever bigger write-offs, contributing to fear of recession in
The reduced supply of credit is contributing to recessionary fears that are greater in America than in the rest of the world, because the American consumer faces an unusual combination of difficulties, says Ian Shepherdson of High Frequency Economics, a research firm. Fuel prices are soaring, house prices are falling, confidence is plunging and there are early signs that the jobs market is weakening, he says.
So far, the evidence that the credit crisis is spreading to other industries is more in the mind than in the data. For instance, most of GMAC's problems relate to its subprime mortgage lending, rather than defaults on car loans. But there are gloomy predictions about the outlook for consumer spending. Car sales are expected to be down from 16.5m last year to 16m this year, for example. The outlook for 2008 is even worse. Jerry York, a former GM board member, sees sales slipping to 15.5m, and Thomas Stallkamp, a former Chrysler president who oversees automotive investments at Ripplewood, another private-equity firm, expects something between 14.5m-15m. The lower figure would amount to the largest decline since 1991, when there was a full-blown recession.
There are other signs that stress is spreading, though it is not yet at recessionary levels—not least because corporate profits remain at record highs in
Between June 12th and November 19th, the spread in interest rates between high-yield corporate debt and Treasury bonds doubled, from 2.6 percentage points to 5.2, says Ed Altman of
Martin Fridson of FridsonVision, a research firm, has calculated that a severe recession (which, he stresses, he is not predicting) could result in a peak rate of between 16% and 20% of annual defaults on corporate bonds, far higher than in 1991. If so, lenders will retreat further and distressed-debt investors like Cerberus will be baying for blood. Businesses need lenders to finance their operations: they must be quaking at the prospect.
BACKGROUND for ‘Bussiness and the Credit Crunch’
*The Private Equity sector is broadly defined as investing in a company through a negotiated process. Investments typically involve a transformational, value-added, active management strategy. Private Equity investments can be divided into the following categories:
Venture capital: an investment to create a new company, or expand a smaller company that has undeveloped or developing revenues
Buy-out: acquisition of a significant portion or a majority control in a more mature company. The acquisition normally entails a change of ownership
Special situation: investments in a distressed company, or a company where value can be unlocked as a result of a one-time opportunity (Changing industry trends, government regulations etc.)
Private equity firms generally receive a return on their investments through one of three ways: an IPO, a sale or merger of the company they control, or a recapitalization. Unlisted securities may be sold directly to investors by the company (called a private offering) or to a private equity fund, which pools contributions from smaller investors to create a capital pool.
*Cerberus: In Greek mythology, Cerberus or Kerberos (Greek Κέρβερος, Kerberos, "demon of the pit") was the hound of Hades, a monstrous three-headed dog with a snake for a tail (sometimes said to have 50 or 100 heads) called a hellhound. Other hell hounds included Orthus, his two headed brother. Cerberus guarded the gate to Hades and ensured that spirits of the dead could enter, but none could exit (additionally, no living person was to come into Hades). Among his siblings are Chimera and the Hydra. He is the offspring of Echidna and Typhon.
*Distressed securities are securities of companies or a nation's central bank that are either already in default, under bankruptcy protection, or in distress and heading toward such a condition. When it comes to fixed income, these types of securities are below investment grade, and can include corporate credit as well as emerging market government fixed income. The most common distressed securities are bonds and bank debt. While there is no precise definition, fixed income instruments with a Yield to Maturity in excess of 1000 basis points over the risk-free rate of return (e.g. Treasuries) are commonly thought of as being distressed. A related category is stressed debt yielding between 600-800 basis points over Treasuries.
*Leveraged loans are loans extended to companies or individuals that already have considerable amounts of debt. Lenders consider these loans to carry a higher risk of default and, as a result, a leveraged loan is more costly to the borrower.
*Bulls & Bears is an American business analysis program, the first show of the The Cost of Freedom business block, on Saturdays at
*Write-offs are changes in the value of banks’ assets resulting from their active decisions to revalue claims. These cover primarily write-offs of bank loans and disposals of assets at a premium or discount to book value.
READING LEVEL-UP(2/4회), DECEMBER, 2007 TERMS & BACKGROUND INSTRUCTOR KIM SOO-YEON
Put the following passages into Korean:
PASSAGE1: Potential ambivalence or ambiguity or any sign of weakening commitment of
PASSAGE2: As our influence in the community of nations grows day after day, it has become imperative for the
PASSAGE3: MEDICINE has long been a mysterious art. Some people are more susceptible to disease than others, and the pills and potions that may help one person leave others uncured. But the past few days have seen steps forward in personalised medicine, in which diagnosis and treatments are tailored to each person's genetic make-up. Two rival firms have just unveiled services that will allow people to scrutinise their own genomes for $1,000.