The Global Credit Crunch: How does it affect my personal wealth and investment strategy?

In about August last year a credit ripple was seen coming from the mid west of the United States. It reflected home owners walking away from their houses forever, unable to afford increasing loan repayments as interest rates went up and home values went down. Un-regulated mortgage brokers had been running amok facilitating loans between banks and borrowers. There was no accountability as the brokers weren’t actually lending the money. In many cases borrowers had absolutely no way to service their loan once interest rates started to rise or honeymoon periods were over.

The term sub-prime mortgage means that the quality of the loan is well below the level of a good quality mortgage and therefore the chances of default are very high. However many of these loans were packaged up and sold off to financial institutions as quality annuities and not the sub-prime disasters that they actually were. The institutions then used these quality annuities as security to borrow money to leverage their businesses and in some cases re-packaged the mortgages and sold them on to unsuspecting organisations looking for safe annuity products that were backed by insurance.

With extensive defaults, suddenly the so called quality annuities that were basically sub-prime mortgages were starting to lose value on their yield and before long they were next to worthless. Panic set in as margin lenders started to circle those institutions that had used the packaged sub-prime mortgages as security.

Why did Australian share values tumble?

The Australian share market is very liquid, very diverse and the top companies pay a consistent and regular dividend making it an attractive place for overseas companies to invest.

When margin lenders started making margin calls, companies had no alternative but to sell their liquid assets to cover the calls. In some cases their most liquid assets were Australian companies, so therefore millions of shares were sold to cover their positions. Unfortunately for some investment companies they didn’t have the liquid assets to sell to cover their margin loans and they folded as a result.

Some very big institutional banks shocked the financial world with announcements of how large their credit exposure was, in some cases writing off billions of dollars that they will never recover. This filtered right down to small organisations. In a quick space of time money was hard to borrow because the banks stopped lending due to the amount of defaults. Without money many businesses were finding it very difficult to operate - creating a credit crisis.

In Australia some second tier lenders and Private Banks announced they too had exposure to the sub-prime crisis and the share value reflected their announcements wiping millions of dollars off the value of the companies involved.

With money drying up, global property trusts couldn’t borrow to sustain their business models and they too fell foul of shareholder confidence. As suspicion grew, many Australian companies were now being pressured by the big institutional investors to disclose exactly what their credit positions were. It became apparent that there were a couple of large property companies in trouble due to their high credit strategies. With this information revealed, the market savaged their share prices and with it their ability to operate properly. They are still alive but only just!

In the end it wasn’t just the property companies that felt the heat. Other companies that had large debt strategies were in trouble. The market was twitchy and any excuse to dump shares was exploited, creating a haven for hedge fund managers and hell for company owners/shareholders

Has the Credit Crunch created opportunities?

To quote one of the best investors in the world, Warren Buffet, investors should “Buy at the sound of the guns and sell at the sound of the bells”.

Many analysts believe we have seen the worst of the credit crisis but they all agree there will be shockwaves to follow as no one really knows the depth of it or how far reaching it is on a global stage.

What this means is there will be terrific buying opportunities for investors as quality blue chip stocks have come down in price significantly. The market will recover over time but it will be volatile so investors need to be brave!

There are many different strategies that can be implemented in order to take advantage of the lower cost of the current share market. There is an old investment saying “it is time in market and not the timing”. With this in mind, now could potentially be a good time to start investing.

As everyone’s situation is different and there will no doubt still be some volatility to come, it would be very prudent to consult one of our Financial Advisers to discuss designing an investment strategy that suits your personal situation.

Author: Matthew Kidd, March 2008

Matthew is a Director of Wealth Investment Management, based in our Sydney office.

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