November 7, 2007

It looks like the Super-Conduit MLEC is having difficulty getting started even as SIVs are getting shakier by the day. Naked Capitalism reprinted a piece about a downgrade today by Moody’s of 16 SIVs representing about 10% of the market; but only two capital notes were actually downgraded; the senior paper and other capital notes are merely (!) under review according to Moody’s:

Moody’s Investors Service announced today that it has substantially completed another review of the Structured Investment Vehicle (SIV) sector following continued market value declines of SIV portfolios since our most recent review completed on September 5th of this year. As a result of this review, Moody’s has confirmed the short term ratings of the senior debt programmes of Kestrel Funding PLC and Kestrel Funding LLC (which hold approximately US$3 billion of debt securities) that were on review for possible downgrade. Moody’s also downgraded, or placed on review for possible downgrade, the ratings of 28 debt programmes of 16 SIVs (which hold approximately US$33 billion of debt securities) as described below.

The ongoing liquidity crisis facing SIVs has continued almost unabated since September 5th, when Moody’s completed its last review of the sector. The inability of some of the SIVs to issue sufficient Asset Backed Commercial Paper (ABCP) or Medium Term Notes (MTNs) over a prolonged period has led to the crystallisation of mark-to-market losses in some cases and the potential for such losses to be realised in others.

Moody’s has taken certain rating actions as a result of deteriorating credit and other market conditions. It seems clear that the situation has not yet stabilised and further rating actions could follow. As with previous actions, the rating actions Moody’s has taken today in response to the current situation are not a result of any credit problems in the assets held by SIVs, but rather a reflection of the continued deterioration in market value of SIV portfolios combined with the liquidity crisis.

SIV senior note ratings continue to be vulnerable to the unprecedented large and sustained declines in portfolio value combined with a prolonged inability to refinance maturing debt. SIV capital note ratings will be affected primarily by further deterioration in the market value of the portfolio. The risk of realised losses on capital and even senior notes is likely to increase significantly if the SIV is placed in a position where it must sell assets rapidly in a “fire sale.”

A lot of the problems are related to turmoil at Citigroup; its support of its SIVs (through the purchase of $7.6-billion in commercial paper) was discussed yesterday. Even worse, Citigroup has increased its exposure to CDO-issued CP, which has had the effect of ballooning the amount of Level 3 ‘Mark-to-Make-Believe’ assets. Citigroup’s cost of borrowing, as proxied through Credit Default Swaps, is skyrocketting.

They’re all in trouble! Latest estimates (which may have been padded to make them more interesting) are that Wall Street will take massive writedowns:

U.S. banks and brokers face as much as $100 billion of writedowns because of Level 3 accounting rules, in addition to the losses caused by the subprime credit slump, according to Royal Bank of Scotland Group Plc.

It would appear that at least some of the money written-off is finding its way into the profits of hedge funds:

Hedge funds returned 3.2 percent on average in October, the biggest gain in almost two years, as managers profited from rising stock prices and declining values of debt tied to home mortgages.

The monthly increase brought the advance to 12.3 percent so far this year, according to a report today from Chicago-based Hedge Fund Research Inc.

It should be noted that the dollar figures in the above paragraphs are US Dollars, not real money:

The dollar is “losing its status as the world currency,” Xu Jian, a central bank vice director, told a conference in Beijing. “We will favor stronger currencies over weaker ones, and will readjust accordingly,” Cheng Siwei, vice chairman of China’s National People’s Congress, said at the same meeting.

Chinese investors have reduced their holdings of U.S. Treasuries by 5 percent to $400 billion in the five months to August. China Investment Corp., which manages the nation’s $200 billion sovereign wealth fund, said last month it may get more of the nation’s reserves to invest to improve returns.

Analyst reactions to these specific remarks are split between yawning and mocking, but years of fiscal profligacy in the US are inexorably coming home to roost.  Maybe they should cut taxes again, or something. Giancarlo Corsetti provides a review of some possible outcomes; one scenario is

In their well-known work, Obstfeld and Rogoff (2005, 2007) propose the following scenario. Closing the US external deficit to within 5% of the US GDP will require the US terms of trade to fall between 5% and 15% – a surprisingly contained movement. By contrast, the fall in the internal relative price should be 3 to 5 times larger, namely the relative price of nontradeables inside the US must get between 20% and 30% cheaper.

To translate these figures into the current macroeconomic stance, keep in mind that, over time, productivity growth is faster in manufacturing (producing most tradables) than in services (mostly nontradables). These productivity differentials across sectors mean that the price of manufacturing decline steadily in terms of services. Now, relative to these long-run trends, we should see the price of US services drop by about one third in terms of US manufacturing, as the US eliminates their current account deficit.

… while another is …

Results from numerical exercises developed in joint work with Martin, and Pesenti, suggests that closing the US current account deficit (from 5% of GDP to zero) could lead to a combination of lower US consumption (-6%), and higher US employment (+3%), relative to trend. This would then correspond to a rate of real dollar depreciation of the order of 20% – close to what we have experienced so far.

We shall see! I will admit to having something of a bias in favour of Rogoff’s work – but only because he’s a chess player. I will have to ensure that bias doesn’t affect anything else!

To keep things interesting, there are predictions of bond-insurer failure:

MBIA may lose $20.2 billion on guarantees and securities holdings, Sean Egan, managing director of Egan-Jones, said on a conference call today. ACA Capital may take losses of at least $10 billion; New York-based Ambac may reach $4.3 billion; mortgage insurers MGIC Investment Corp. and Radian Group Inc. may see losses of $7.25 billion and $7.2 billion, respectively, Egan said.

“There is little doubt that the credit and bond insurers face massive losses over the next few quarters and many will be capital challenged,” Egan said.

Moody’s Investors Service and Standard & Poor’s will downgrade the ratings only after problems have become more obvious, Egan said.

Surprise!  Egan-Jones is a subscription-based rating service. Note that failure of an insurer could have serious knock-on effects in the US Municipals market.

Preferreds continued their recent showing of decent volume, but it seems like everybody was too busy financing their next trip to Buffalo by selling common shares to be fussed much about preferreds, which were … off a tad, but only technically.

Note that these indices are experimental; the absolute and relative daily values are expected to change in the final version. In this version, index values are based at 1,000.0 on 2006-6-30
Index Mean Current Yield (at bid) Mean YTW Mean Average Trading Value Mean Mod Dur (YTW) Issues Day’s Perf. Index Value
Ratchet 4.89% 4.88% 191,608 15.68 2 +0.1844% 1,047.1
Fixed-Floater 4.85% 4.82% 84,445 15.81 8 +0.0617% 1,047.1
Floater 4.50% 4.53% 63,970 16.29 3 +0.0137% 1,044.6
Op. Retract 4.87% 3.84% 75,327 3.55 16 +0.0324% 1,030.4
Split-Share 5.21% 5.16% 87,587 4.18 15 +0.0034% 1,036.6
Interest Bearing 6.26% 6.34% 61,870 3.56 4 +0.4343% 1,057.0
Perpetual-Premium 5.82% 5.40% 80,902 6.05 11 -0.1415% 1,012.5
Perpetual-Discount 5.53% 5.56% 332,539 14.33 55 -0.0391% 914.1
Major Price Changes
Issue Index Change Notes
BNA.PR.C SplitShare -1.3773% Asset coverage of 3.83+:1 as of July 31 according to the company. Now with a pre-tax bid-YTW of 7.08% (!) based on a bid of 20.05 and a hardMaturity 2019-01-10 at 25.00.
HSB.PR.D PerpetualDiscount -1.0776% Now with a pre-tax bid-YTW of 5.51% based on a bid of 22.95 and a limitMaturity.
BSD.PR.A InterestBearing +1.3001% Asset coverage of just under 1.8:1 as of November 2, according to Brookfield Funds. Now with a pre-tax bid-YTW of 7.37% (mostly as interest) based on a bid of 9.35 and a hardMaturity 2015-3-31 at 10.00.
Volume Highlights
Issue Index Volume Notes
PWF.PR.F PerpetualDiscount 244,100 Nesbitt crossed 232,500 at 23.25. Now with a pre-tax bid-YTW of 5.69% based on a bid of 23.22 and a limitMaturity.
PWF.PR.L PerpetualDiscount 159,530 Scotia crossed 50,000 at 22.60. Now with a pre-tax bid-YTW of 5.68% based on a bid of 22.61 and a limitMaturity.
CM.PR.H PerpetualDiscount 50,645 Scotia crossed 25,000 at 21.83. Now with a pre-tax bid-YTW of 5.53% based on a bid of 21.80 and a limitMaturity.
CU.PR.B PerpetualPremium 38,725 Nesbitt crossed 35,000 at 25.90. Now with a pre-tax bid-YTW of 5.06% based on a bid of 25.90 and a call 2012-7-1 at 25.00.
BNS.PR.M PerpetualDiscount 37,580 Now with a pre-tax bid-YTW of 5.40% based on a bid of 21.00 and a limitMaturity.

There were twenty-one other index-included $25.00-equivalent issues trading over 10,000 shares today.

3 Responses to “November 7, 2007”

  1. Ian says:

    The situation seems dire indeed: Dr. Kotlikoff attributes the problem to spending – but goes in depth to reveal a purposefully complex and inequitable system of tax regulations for individuals and businesses. Taxing business is the politician’s friend in that it permits a hidden tax via higher prices accruing from high compliance costs and tax-break advocacy by high-priced lobbyists all of which is ultimately borne by the consumer in higher prices. His solution? Passage of the FairTax bill (HR 25 – ) – a progressive national sales tax recently stated as “preferred” to the income tax by Warren Buffet).

  2. […] In SIV news that I missed yesterday … one of the SIVs affected by Moody’s mass review was Links Finance … proudly owned and operated by our very own Bank of Montreal: Links Finance Corporation (US$1.9 billion of debt securities affected) […]

  3. […] On November 7 I made the comment: Even worse, Citigroup has increased its exposure to CDO-issued CP, which has had the effect of ballooning the amount of Level 3 ‘Mark-to-Make-Believe’ assets. Citigroup’s cost of borrowing, as proxied through Credit Default Swaps, is skyrocketting. […]

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