To the long list of troubles plaguing the financial industry, add three big ones – make that Big Three ones.
The struggling Detroit automakers owe more than $100 billion to their bankers and bondholders, and Wall Street is starting to wonder how much of that will be paid back.
With Congress balking at a rescue for the auto industry, and Chrysler and General Motors warning that they could face bankruptcy without one, investors are worrying about financial companies’ exposure to the Big Three, as well as to automotive suppliers and dealers.
The intertwining troubles of the auto and financial industries were partly behind the sharp sell-off in financial stocks last week, when banking shares fell to their lowest levels since the economic crisis broke out and questions swirled about the future of Citigroup.
“It’s pretty clear there was a cause and effect,” said Wilbur L. Ross Jr., a prominent financier who specializes in distressed industries and has invested in auto parts companies.
Big banks say that their exposure to the auto industry is relatively small and that in any case most of the loans are secured by vehicles or other assets, which would help minimize any losses.
But the true risks are difficult to ascertain because banks do not disclose much about their exposure. Of particular concern is the fate of billions of dollars of bonds that were used to finance the 2007 acquisition of Chrysler by a large private investment fund, Cerberus Capital Management.
The potential losses do not end with those high-risk loans, however. Over the past three years, as the auto industry’s fortunes darkened, big banks like Bank of America, Citigroup and JPMorgan Chase helped the automakers sell more than $56 billion of new debt securities, according to Dealogic. Most of those securities were bought by investors like insurance companies, pension funds and hedge funds, many of which have been staggered by losses on other investments. Some hedge funds already have been forced to dump investments into a falling market to meet demands.
That figure does not include $47 billion of risky loans made to various affiliates of Chrysler, Ford and G.M. that are backed by auto leases and car loans to individual car buyers, some of whom are now struggling to pay their own bills as the economy craters.
Many of these auto bonds and loans have plummeted in value as things have gone from bad to worse for Detroit’s once-proud carmakers. A $7 billion term loan that Ford issued in 2006, for instance, was trading for 32 cents on the dollar late last week in the secondary, or resale, market. That is particularly worrisome given that this debt would be the first to be repaid in the event that Ford filed for bankruptcy.
But businesses and ordinary people all the way down the automotive food chain are shouldering a lot of debt too. That includes autoworkers, but also everyone from makers of car stereos to dealerships to parts suppliers, as well as the people who work for those companies. Many of these borrowers could run into trouble if the automakers implode, leaving lenders in the lurch.
“The bigger fear is banks’ indirect exposure to suppliers and related companies in the auto industry,” said Ricardo Kleinbaum, an analyst at BNP Paribas in New York. “The real issue is the effect of an automaker bankruptcy on employment, credit card payments and mortgage defaults in the regions that are affected.”
A big worry is whether banks that have extended loans or underwritten bonds for the auto industry have held on to this debt or sold it to other investors. Banks typically retain a small portion of the securities they underwrite, and many banks that had hoped to sell high-risk loans have been unable to find buyers for them since the credit markets froze over.
“The question is, how much of these loans have they retained on their balance sheet?” said Tanya Azarchs, a credit analyst at Standard and Poor’s Ratings Service.
Few doubt that banks are sitting on billions of dollars of loans to the industry, though. Citigroup, Goldman Sachs, JPMorgan Chase and Morgan Stanley were among the banks that arranged $11.5 billion in financing for Cerberus’s takeover of Chrysler. Analysts say the banks are stuck with much of that debt.
And then there is GMAC, the finance arm of G.M. GMAC, which is half-owned by Cerberus, applied last week to become a bank holding company in hopes of qualifying for the government’s bank rescue.
In 2005, when banking was still strong, Bank of America bought $55 billion in loans from GMAC and then sold most of them to other investors. In June, the bank, which has itself received billions of dollars from the government, helped GMAC refinance $60 billion of debt.