November 26, 2007

The big news today was Quebecor World’s suspension of preferred dividends; but that has its own post.

There was a fair bit of news on the MLEC/Super-conduit front. HSBC is bailing out its SIVs, taking $35-45-billion onto its balance sheet to avoid a fire-sale of the assets. It has been reported:

The SuperSIV is “is all good and well, but it’s not big enough,” said Tom Jenkins, a credit analyst at Royal Bank of Scotland Group Plc in London. “If you have a large SIV, you’re going to need to find another solution.”

Cullinan’s net asset value, the amount left over after selling all its assets and repaying debt, fell to 69 percent of its capital, Moody’s Investors Service said Nov. 7. Asscher’s net asset value has declined to 71 percent, Moody’s said.

HSBC plans to make a formal offer to investors in the SIVs’ lower-ranking mezzanine and income notes later this year or early 2008. It expects to complete the restructuring by August 2008.

“HSBC believes there is not likely to be a near-term resolution of the funding problems faced by the SIV sector,” the bank said.

It will be most interesting to see what kind of bid the capital noteholders will see – I bet HSBC sticks it to them!

Meanwhile, there is a report that marketting of the Super-Conduit is about to commence in earnest … but one can detect a certain jeering tone in the commentary:

“Why should we put something on our balance sheet that is going to result in further writedowns?” is how most contributors will respond, [Punk Ziegel & Co. analyst Richard] Bove said in an interview. “The job of the Treasury isn’t to go out and defraud investors.”

Bank of America “has far more to gain down the road” with regulators by backing SuperSIV, said Tony Plath, a financial professor at the University of North Carolina at Charlotte, who expects the plan to fail. “They are setting themselves up so they aren’t criticized when this thing falls apart.”

The fund’s lack of disclosure makes it “a necessary failure,” Bill Gross, manager of the world’s biggest bond fund at Newport Beach, California-based Pacific Investment Management Co., said in an Oct. 31 interview. “Transparency is what the Treasury and Fed are supposedly all about.”

Loomis Sayles & Co. declined to invest after receiving one of 16 invitations for a personal meeting last week with current Fed Chairman Ben Bernanke, said Daniel Fuss, who oversees $22 billion as chief investment officer at the Boston-based firm. The Securities Industries Financial Markets Association trade group extended the invitations, Fuss said.

“It’s so nice to get a personal invitation to go to Washington and have a one-hour visit with Ben Bernanke,” said Fuss, who decided participating wasn’t worth the risk to his firm. “Oh, boy, did I feel important for about 27 seconds, and then you smell a rat.”

Well … we shall see! But it is certain that a certain amount of forceful statements need to be made by the sponsors if there is to be any funding extended … but, on the other hand, if the idea is to stick it to the SIVs that are in trouble, how much sales will be needed? Given a choice between defaulting on their senior debt and getting a fistful of Super-Conduit term senior FRNs and capital notes, sponsors of troubled SIVs will find themselves between a rock and hard place. Naked Capitalism notes that Larry Summers writes in the Financial Times:

The priority now has to be maintaining the flow of credit. The current main policy thrust – the so-called “super conduit”, in which banks co-operate to take on the assets of troubled investment vehicles – has never been publicly explained in any detail by the US Treasury. On the information available, the “super conduit” has worrying similarities with Japanese banking practices of the 1990s that aroused criticism from American authorities for their lack of transparency, suppression of genuine market pricing of bad credits, and inhibiting effect on new lending. Perhaps there is a strong case for it, but that case has yet to be made.

Mr. Summers predicts a recession, but many disagree with him … for now:

Even bulls say that the biggest rally in government debt since 2002 has pushed yields on 10-year notes so low that they can only decline if the economy shrinks. None of the 68 economists surveyed by Bloomberg News from Nov. 1 to Nov. 8 expect the economy to contract before the end of 2008.

Prof. Stephen Cecchetti of Brandeis has been quoted here on August 27 (blaming rating agencies) and November 19 (wanting as much trading as possible on regulated exchanges) and has now commenced a four part series for VoxEU. In Part 1 he notes that:

Financial institutions have been allowed to reduce the capital that they hold by shifting assets to various legal entities that they did not own – what we now know refer to as “conduits” and “special investment vehicles” (SIV). (Every financial crisis seems to come with a new vocabulary.) Instead of owning the assets, which would have attracted a capital charge, the banks issued various guarantees to the SIVs; guarantees that did not require the banks to hold capital.

but does not suggest a solution, noting that:

under any system of rules, clever (and very highly paid) bankers will always develop strategies for holding the risks that they wanted as cheaply as they can, thereby minimizing their capital.

I have suggested that the 10% charge for a liquidity guarantee should (almost certainly) be increased; to avoid the next evasion, regulators should deem these guarantees to be in place if the bank is merely sponsoring the SIV without a guarantee; or if it has an economic interest in the survival of the SIV. Or maybe X% for an arm’s-length guarantee, double that if the bank has an economic interest.

Yes, it’s a bit like trying to plug a seive (hah!). But you do what you can.

He admits that another problem defies solution in this wicked world:

Think about the manager of a pension fund who is looking for a place to put some cash. Rules, both governmental and institutional, restrict the choices to high-rated fixed-income securities. The manager finds some AAA-rated bond that has a slightly higher yield than the rest. Because of differences in liquidity risk, for example, one bond might have a yield that is 20 or 30 basis points (0.30 or 0.30 percentage points) higher. Looking at this higher-yielding option, the pension-fund manager notices that there is a very slightly higher probability of a loss. But, on closer examination, he sees that this higher-yielding bond will only start experiencing difficulties if there is a system-wide catastrophe. Knowing that in the event of crisis, he will have bigger problems that just this one bond, the manager buys it; thereby beating the benchmark against which his performance is measured.I submit that there is no way to stop this. Managers of financial institutions will always search for the boundaries defined by the regulatory apparatus, and they will find them.

I don’t have much of a solution either! Enforcement of the Prudent Man Rule can only go so far … and if some paper defaults, it’s very difficult to show that the chance of this happening was underestimated at time of purchase. But … Prudent Man Rule will help, anyway!

Remember the Federal Home Loan Banks (FHLBs) mentioned here on October 30? It seems that FHLB Atlanta has credit policies that would be considered somewhat unusual in the private sector:

Countrywide Financial Corp. fell more than 10 percent in New York Stock Exchange trading after U.S. Senator Charles Schumer urged the regulator of the Federal Home Loan Bank system to probe cash advances to the largest U.S. mortgage lender.

Schumer said he was alarmed by the volume of advances the system’s Atlanta bank has made to Countrywide considering “the rapid deterioration” in the credit quality of some of the Calabasas, California-based company’s mortgages. Schumer expressed his concerns in a letter sent today to Federal Housing Finance Board Chairman Ronald Rosenfeld.

The Atlanta bank has made $51.1 billion in advances to Countrywide as of Sept. 30, representing 37 percent of the bank’s total outstanding advances, Schumer wrote, citing U.S. Securities and Exchange Commission filings.

In more cheerful news, Naked Capitalism reports on a hedge fund that’s hit a ten-bagger betting against sub-prime and Ed Yardeni, of Millennium Bug fame, offers up nine reasons to be thankful:

(1) The S&P 500 is up 53% since Thanksgiving 2002. The current bull market has been the third best since 1960.
(2) The 10-year Treasury yield was near 5.5% in early 2002. It is down to 4.0% this morning.
(3) The core CPI inflation rate in the US has been remarkably steady around 2%, and down from 2.6% to 1.8% on average among the 30 members of the OECD, despite the soaring price of crude oil, which is up from $27 a barrel to $99 a barrel since Thanksgiving 2002, based on West Texas Intermediate price.
(4) Notwithstanding all the nonsense about outsourcing, the unemployment rate was down to 4.7% in October vs. 5.7% five years ago as payroll employment rose 8.1 million to a record high of 138.4 million.
(5) Real disposable personal income was at a record high in September, up 16.0% since September 2002. Real per capita income is also at a record high and up 2.1% per year, on average, over the past five years.
(6) Real GDP is up 15.3% over the past five years.
(7) In the US, since the end of 2002, household net worth is up nearly 50% to a record $57.9 trillion.
(8) World exports have doubled since November 2002. The OECD world industrial production index is up 30% since then. Today, roughly three billion people around the world are aspiring and perspiring to improve their standards of living.
(9) Alan Greenspan’s book tour is over.

The New York Fed made headlines, pumping $8-billion into the term-repo market, stating:

In response to heightened pressures in money markets for funding through the year-end, the Federal Reserve Bank of New York’s Open Market Trading Desk plans to conduct a series of term repurchase agreements that will extend into the new year.

The first such operation will be arranged and settle on Wednesday, November 28, and mature on January 10, 2008, for an amount of about $8 billion. The timing and amounts of subsequent term operations spanning the year-end will be influenced by market and reserve developments.

In addition, the Desk plans to provide sufficient reserves to resist upward pressures on the federal funds rate above the FOMC’s target rate around year-end.

The Bloomberg story seems a bit peculiar – they claim that:

Fed officials acted after the average U.S. overnight lending rate between banks exceeded their target seven of the past eight days, suggesting a reluctance to lend amid mounting subprime mortgage losses. In most years, banks face year-end pressures as they adjust their books to show ample liquidity and at the same time meet a jump in demand for cash from consumers.

While there may well be pressures, Fed Funds Data show that, in terms of averages, we’re only talking about a basis point or so. However, the maintenance period ended November 21 was clearly tighter than the period ended November 4 – and we don’t know what they had to do to keep the actual rate so well aligned with target. They may well have been influenced by the fearsome size of the TED spread:

The cost of borrowing dollars for three months rose as banks hoarded cash to cover their commitments through the end of the year. The London interbank offered rate, or Libor, for dollars rose 1 basis point to 5.05 percent, for a four-week high and the ninth straight day of gains, the British Bankers’ Association said today.

That pushed the “TED” spread, or the difference between three-month Treasury bill yields and Libor, to 1.92 percentage points from 1.82 percentage points on Nov. 23. The yield on the three-month bill fell 9 basis points to 3.12 percent.

Preferreds saw heavy volume today and violent random (as far as I can tell!) price movements based on the latest headlines. PerpetualDiscounts hit a new post-2006-6-30 low, as did SplitShares, the latter now having provided negative return since the start of these temporary indices.

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 4.81% 4.82% 124,920 15.76 2 +0.1229% 1,045.6
Fixed-Floater 4.88% 4.88% 86,257 15.69 8 -0.0180% 1,040.3
Floater 4.78% 4.83% 59,270 15.72 3 -0.6483% 984.3
Op. Retract 4.87% 3.68% 76,907 3.67 16 -0.1070% 1,031.6
Split-Share 5.46% 6.24% 92,732 4.04 15 -0.9907% 993.5
Interest Bearing 6.32% 6.77% 66,740 3.70 4 +0.1436% 1,048.3
Perpetual-Premium 5.87% 5.65% 83,316 7.29 11 -0.0237% 1,004.8
Perpetual-Discount 5.63% 5.67% 335,737 14.38 55 -0.2240% 900.2
Major Price Changes
Issue Index Change Notes
BNA.PR.B SplitShare -5.6180% Asset coverage of just under 4.0:1 as of October 31, according to the company. Now with a pre-tax bid-YTW of 7.60% based on a bid of 21.00 and a hardMaturity 2016-3-25 at 25.00. This will make arbitrageurs happy! The yield may be compared with 6.66% on BNA.PR.A (2010-9-30 maturity) and 8.66% on BNA.PR.C (2019-1-10 maturity).
HSB.PR.D PerpetualDiscount -3.5088% Presumably a reaction to the the SIV bail-out, but holy smokes, the common was only down 1.9%! Now with a pre-tax bid-YTW of 6.09% based on a bid of 20.90 and a limitMaturity. HSB.PR.C, a comparable issue with a little less upside, was unchanged and yields 5.78%.
BAM.PR.M PerpetualDiscount -2.9428% Now with a pre-tax bid-YTW of 6.94% based on a bid of 17.48 and a limitMaturity.
ELF.PR.F PerpetualDiscount -2.2959% Now with a pre-tax bid-YTW of 7.04% based on a bid of 19.15 and a limitMaturity.
BAM.PR.N PerpetualDiscount -2.2284% Now with a pre-tax bid-YTW of 6.91% based on a bid of 17.55 and a limitMaturity.
BNA.PR.C SplitShare -2.1312% Asset coverage of just under 4.0:1 as of October 31, according to the company. Now with a pre-tax bid-YTW of 8.66% (interest equivalent of 12.12%!) based on a bid of 17.45 and a hardMaturity 2019-1-10 at 25.00.
PIC.PR.A SplitShare -1.8767% Asset coverage of 1.6+:1 as of November 15 according to Mulvihill. Now with a pre-tax bid-YTW of 6.87% based on a bid of 14.64 and a hardMaturity 2010-11-1 at 15.00.
BNA.PR.A SplitShare -1.5139% Asset coverage of just under 4.0:1 as of October 31, according to the company. Now with a pre-tax bid-YTW of 6.66% based on a bid of 24.72 and a hardMaturity 2010-9-30 at 25.00.
BMO.PR.H PerpetualDiscount -1.4907% Now with a pre-tax bid-YTW of 5.37% based on a bid of 24.45 and a limitMaturity.
PWF.PR.D OpRet -1.2879% Now with a pre-tax bid-YTW of 4.34% based on a bid of 26.06 and a softMaturity 2012-10-30 at 25.00.
BAM.PR.K Floater -1.1494% Because it’s BAM or because it’s a floater? Your guess is as good as mine … but volume was only 1,500 shares.
BCE.PR.S Ratchet -1.1382%  
BCE.PR.R FixFloat -1.0976%  
PWF.PR.L PerpetualDiscount -1.0526% Now with a pre-tax bid-YTW of 5.71% based on a bid of 22.56 and a limitMaturity.
FIG.PR.A InterestBearing -1.0417% Asset coverage of just under 2.2:1 as of November 23 according to Faircourt. Now with a pre-tax bid-YTW of 7.40% (mostly as interest) based on a bid of 9.50 and a hardMaturity 2014-12-31 at 10.00.
DFN.PR.A SplitShare -1.0000% Asset coverage of 2.7+:1 as of November 15, according to Quadravest. Now with a pre-tax bid-YTW of 5.52% based on a bid of 9.90 and a hardMaturity 2014-12-1 at 10.00.
CM.PR.J PerpetualDiscount +1.2225% Now with a pre-tax bid-YTW of 5.50% based on a bid of 20.70 and a limitMaturity.
BSD.PR.A FixFloat -1.0976% Asset coverage of just under 1.7:1 according to Brookfield Funds. Now with a pre-tax bid-YTW of 7.04% (mostly as interest) based on a bid of 9.56 and a hardMaturity 2015-3-31 at 10.00.
Volume Highlights
Issue Index Volume Notes
IQW.PR.C Scraps (would be OpRet but there are urgent and pressing credit concerns) 222,586 ITG (who?) bought 10,000 from Nesbitt at 16.50. Defaulted today. Now with a pre-tax bid-YTW of 278.53% (annualized) based on a bid of 16.15 and a softMaturity 2008-2-29 at 25.00.
IQW.PR.D Scraps (would be FixFloat, but there are urgent and pressing credit concerns) 169,285 Defaulted today.
RY.PR.C PerpetualDiscount 95,559 National Bank crossed 80,000 at 21.36. Now with a pre-tax bid-YTW of 5.41% based on a bid of 21.39 and a limitMaturity.
TD.PR.P PerpetualDiscount 86,695 Now with a pre-tax bid-YTW of 5.46% based on a bid of 24.25 and a limitMaturity.
BAM.PR.M PerpetualDiscount 60,104 Now with a pre-tax bid-YTW of 6.94% based on a bid of 17.48 and a limitMaturity.
ELF.PR.G PerpetualDiscount 46,250 Now with a pre-tax bid-YTW of 7.02% based on a bid of 17.20 and a limitMaturity.
CM.PR.J PerpetualDiscount 45,494 Now with a pre-tax bid-YTW of 5.50% based on a bid of 20.70 and a limitMaturity.

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

2 Responses to “November 26, 2007”

  1. […] Prof. Stephen Cecchetti continued his VoxEU series today, which commenced on November 26. He concludes: So, here’s the problem: discount lending requires discretionary evaluations based on incomplete information during a crisis. Deposit insurance is a set of pre-announced rules. The lesson I take away from this is that if you want to stop bank runs – and I think we all do – rules are better. […]

  2. […] The rather surprising level of lending by the Federal Home Loan Banks (FHLB) mentioned here on November 26 was attacked by Nouriel Roubini yesterday, as noted by the WSJ. I found his views on the monolines more interesting: Similarly, the concern about the writedowns that will follow a downgrade of the monolines is well taken. However, desperate attempt to avoid a rating downgrade of monolines that do not deserve such AAA rating are highly inappropriate as the insurance by these monolines of toxic ABS was reckless in the first place. If public concerns about access to financing by state and local governments during a recession period are warranted it is better to split the monoline insured assets between muni bonds and structured finance vehicle, ring fence the muni component and let the rest be downgraded and accept the necessary writedowns on the structured finance assets. If these necessary writedowns will then hurt financial institutions that hold this “insured” toxic waste so be it as these assets should have never been insured in the first place. The ensuing fallout from the necessary writedown – such as the need to avoid fire sales in illiquid markets – should then be addressed with other policy actions. […]

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