September 15, 2008

You guys all think I’m going to talk about the Lehman bankruptcy, the scramble for funding by AIG and, given the devil-take-hindmost nature of short attacks on Large Complex Financial Institutions recently, Merrill’s determination not to be hindmost. But I ain’t, except to note in passing that Merrill’s days have been numbered ever since I quit my Operations Assistant Supervisor position with them in a huff about 20 years ago. Serves ’em right.

All that stuff has been discussed to death; I have no particular insights or comments. Accrued Interest‘s post sounds a little shell-shocked. The Fed turned on the tap full force as the Fed Funds market seemed to lock up:

The Federal Reserve added $70 billion in reserves to the banking system, the most since the September 2001 terrorist attacks, to keep bank borrowing costs low after the bankruptcy of Leman Brothers Holdings Inc.

Fed funds traded as high as 6 percent, or 4 percentage points above the central bank’s target rate for overnight loans between banks, according to ICAP Plc, the world’s largest inter- dealer broker. The margin is the greatest since Bloomberg began tracking the data in 1998. The rate dropped to as low as 1.75 percent after the Fed added the temporary reserves.

“If the fed funds rate closes high today, I would be really worried as it would mean that there really is no money out there to be lent,” said Stan Jonas, who trades interest- rate derivatives at Axiom Management Partners LLC in New York.

I’m not too sure about that ‘no money available’ line. I suspect that it’s unwillingness rather than inability that drove the spike … but there will doubtless be more data and commentary in the near future.

There’s a good review piece on VoxEU titled Transmission of liquidity shocks: Evidence from the 2007 subprime crisis:

The results of a very pronounced interaction between market and funding liquidity are consistent with the emergence of re-enforcing liquidity spirals during the crisis period. On the one side of this liquidity spiral, financial institutions were exposed to refinancing needs in the form of issuing ABCP, a situation where market illiquidity in complex structured products led to funding illiquidity. In this regard, the results also show that increased correlations between the ABCP and Libor spreads reduced the possibilities of funding from the interbank money market, thus highlighting systemic risks. On the other side of this spiral, many European banks that had large exposures to US asset-backed securities had difficulties accessing wholesale funding, inducing subsequent market illiquidity in different market segments. Due to the major importance of the interbank money market, central banks in turn intervened by reducing interest rates and providing additional liquidity to the markets in order to reduce pressures.

The analysis presented here suggests that innovation, such as structured credit products and banks’ increased ability to move risk off their balance sheets as well as augmented interconnectedness of large complex banks, made market and funding liquidity pressures readily turn into issues of insolvency.

The full paper, on which the column is based, is available from the IMF. It makes an interesting point not highlighted in the column:

Finally, increased correlations between returns of differing asset classes due to algorithmic trading, such as by quantitative hedge funds, has heightened the vulnerability with regard to the transmission of illiquidity.

Which is kind of interesting. The great strength of a quantitative approach is that it allows the quick relative valuation of two assets (whether that relative valuation achieved so quickly is any good or not is another question entirely!) and the great strength of algorithmic trading is that it allows the quick execution of a quantitatively derived plan. Stock market “circuit breakers” were introduced in the wake of the the realization that portfolio insurance had exacerbated the crash of 1987; it is hard to tell how circuit breakers might be implemented across markets, but doubtless some regulator will be jumping up soon to tell us.

The source paper references a fascinating MIT paper by Khandani & Lo, What Happened to the Quants in August 2007?, which has the abstract:

During the week of August 6, 2007, a number of high-profile and highly successful quantitative long/short equity hedge funds experienced unprecedented losses. Based on empirical results from TASS hedge-fund data as well as the simulated performance of a specific long/short equity strategy, we hypothesize that the losses were initiated by the rapid unwinding of one or more sizable quantitative equity market-neutral portfolios. Given the speed and price impact with which this occurred, it was likely the result of a sudden liquidation by a multi-strategy fund or proprietary-trading desk, possibly due to margin calls or a risk reduction. These initial losses then put pressure on a broader set of long/short and long-only equity portfolios, causing further losses on August 9th by triggering stop-loss and de-leveraging policies. A significant rebound of these strategies occurred on August 10th, which is also consistent with the sudden liquidation hypothesis. This hypothesis suggests that the quantitative nature of the losing strategies was incidental, and the main driver of the losses in August 2007 was the firesale liquidation of similar portfolios that happened to be quantitatively constructed. The fact that the source of dislocation in long/short equity portfolios seems to lie elsewhere – apparently in a completely unrelated set of markets and instruments – suggests that systemic risk in the hedge-fund industry may have increased in recent years.

This paper looks like it has a good chance of being interesting enough to highlight … I’m working through it!

Following a press release regarding its holdings, there has been some press commentary on SunLife’s exposure to Lehman:

RBC Capital Markets analyst Andre-Philippe Hardy said he expects Sun Life to take a pre-tax charge of $167-million, assuming a 50 per cent recovery rate on Lehman exposure.

Most unpleasant, but they earn about $500-million per quarter. So, unless this relatively small exposure (about 0.3% of their investments) is a precursor of Bad Things to Come, this is a non-event for credit. They’ve got $5.2-billion in equities on the books as of June 30 … their mark-to-market losses for today alone will be comparable to their Lehman exposure.

A gory day for PerpetualDiscounts – the worst since July 16, in fact, the infamous nadir of the market – but not as bad as for stocks. Names that will be familiar in the Price Changes section below (hint: they’re all negative) include:

Brookfield Properties dropped 16 percent to C$18.99, the most since August 1993. Brookfield was cut to “market perform” by BMO Capital Markets analyst Karine MacIndoe, who said that the company may face “what is likely to be an accelerated deterioration of fundamentals” in its “core Manhattan market.”

Parent company Brookfield Asset Management Inc. slid 11 percent to C$28.49, the most since the Sept. 11, 2001, attacks on the U.S.

Canadian Imperial Bank of Commerce, which accounted for two-thirds of total Canadian writedowns, fell the most since July 24, losing 4.8 percent to C$61.11. CIBC Chief Executive Officer Richard Nesbitt said at a conference that his bank expects a loss of about C$25 million from Lehman.

Update: Inspired by a thread on Financial Webring Forum, I will post a link to Across the Curve‘s closing commentary for today. The Canadian Market saw massive steepening, but not as much action as the US; two year yield down 28bp to 2.82%; five year down 21bp to 3.09%; ten year down 15bp to 3.60%; thirty-year down 8bp to 4.05%. Bets on an easing run rampant!

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.
The Fixed-Reset index was added effective 2008-9-5 at that day’s closing value of 1,119.4 for the Fixed-Floater index.
Index Mean Current Yield (at bid) Mean YTW Mean Average Trading Value Mean Mod Dur (YTW) Issues Day’s Perf. Index Value
Ratchet N/A N/A N/A N/A 0 N/A N/A
Fixed-Floater 4.63% 4.67% 67,806 15.92 6 -0.7416% 1,104.2
Floater 4.41% 4.41% 47,451 16.62 2 -0.2373% 906.1
Op. Retract 4.96% 4.34% 124,632 3.31 14 -0.2642% 1,053.0
Split-Share 5.39% 6.12% 48,769 4.37 14 -0.9792% 1,036.5
Interest Bearing 6.43% 7.22% 51,633 5.18 2 -0.1048% 1,097.9
Perpetual-Premium 6.22% 5.99% 56,654 2.20 1 -0.5151% 997.4
Perpetual-Discount 6.03% 6.10% 183,186 13.74 70 -0.5709% 884.0
Fixed-Reset 5.07% 4.92% 1,410,445 14.14 9 -0.1897% 1,118.6
Major Price Changes
Issue Index Change Notes
WFS.PR.A SplitShare -4.5643% I guess on a day like today, something with the name “World Financial … ” is just about an automatic sell! Asset coverage of just under 1.6:1 as of September 4, according to Mulvihill. Now with a pre-tax bid-YTW of 8.51% based on a bid of 9.20 and a hardMaturity 2011-6-30 at 10.00.
ELF.PR.G PerpetualDiscount -2.8361% Now with a pre-tax bid-YTW of 7.08% based on a bid of 17.13 and a limitMaturity.
BNA.PR.C SplitShare -2.6549% Asset coverage of 3.2+:1 as of August 29 according to the company. Now with a pre-tax bid-YTW of 9.71% based on a bid of 16.50 and a hardMaturity 2019-1-10 at 25.00. Compare with BNA.PR.A (7.02% to 2010-9-30) and BNA.PR.B (8.92% to 2016-3-25). Note that, given 2.4 shares of BAM.A per BNA preferred and a price of 28.49 on BAM.A (see above), asset coverage is now 2.7+:1.
BCE.PR.Z FixFloater -2.4280%  
W.PR.J PerpetualDiscount +1.0348% Now with a pre-tax bid-YTW of 6.65% based on a bid of 21.48 and a limitMaturity.
SLF.PR.D PerpetualDiscount -1.9334% Now with a pre-tax bid-YTW of 6.12% based on a bid of 18.26 and a limitMaturity.
GWO.PR.G PerpetualDiscount -1.9284% Now with a pre-tax bid-YTW of 6.11% based on a bid of 21.36 and a limitMaturity.
BAM.PR.N PerpetualDiscount -1.8913% Now with a pre-tax bid-YTW of 7.19% based on a bid of 16.60 and a limitMaturity.
CM.PR.P PerpetualDiscount -1.8047% Now with a pre-tax bid-YTW of 6.60% based on a bid of 21.22 and a limitMaturity.
POW.PR.C PerpetualDiscount -1.6632% Now with a pre-tax bid-YTW of 6.24% based on a bid of 23.65 and a limitMaturity.
PWF.PR.G PerpetualDiscount -1.5663% Now with a pre-tax bid-YTW of 6.10% based on a bid of 24.51 and a limitMaturity.
GWO.PR.I PerpetualDiscount -1.4768% Now with a pre-tax bid-YTW of 6.05% based on a bid of 18.68 and a limitMaturity.
IAG.PR.A PerpetualDiscount -1.4400% Now with a pre-tax bid-YTW of 6.25% based on a bid of 18.48 and a limitMaturity.
LBS.PR.A PerpetualDiscount -1.3672% Asset coverage of just under 2.1:1 as of September 11, according to Brompton Group. Now with a pre-tax bid-YTW of 5.26% based on a bid of 10.10 and a hardMaturity 2013-11-29 at 10.00.
CM.PR.D PerpetualDiscount -1.3274% Now with a pre-tax bid-YTW of 6.56% based on a bid of 22.30 and a limitMaturity.
BNS.PR.J PerpetualDiscount -1.3203% Now with a pre-tax bid-YTW of 5.71% based on a bid of 23.17 and a limitMaturity.
SLF.PR.E PerpetualDiscount -1.3186% Now with a pre-tax bid-YTW of 6.04% based on a bid of 18.71 and a limitMaturity.
CM.PR.G PerpetualDiscount -1.2640% Now with a pre-tax bid-YTW of 6.52% based on a bid of 21.09 and a limitMaturity.
BNA.PR.A SplitShare -1.2395% See BNA.PR.C, above.
FFN.PR.A SplitShare -1.2308% Asset coverage of just under 1.9:1 as of August 31, according to the company. Now with a pre-tax bid-YTW of 6.05% based on a bid of 9.63 and a hardMaturity 2014-12-1 at 10.00.
CM.PR.H PerpetualDiscount -1.1740% Now with a pre-tax bid-YTW of 6.60% based on a bid of 18.52 and a limitMaturity.
SLF.PR.B PerpetualDiscount -1.0929% Now with a pre-tax bid-YTW of 6.06% based on a bid of 19.91 and a limitMaturity.
NA.PR.M PerpetualDiscount -1.0835% Now with a pre-tax bid-YTW of 6.16% based on a bid of 24.65 and a limitMaturity.
PWF.PR.K PerpetualDiscount -1.0521% Now with a pre-tax bid-YTW of 6.08% based on a bid of 20.69 and a limitMaturity.
SBN.PR.A SplitShare -1.0081% Asset coverage of 2.1+:1 as of September 4, according to Mulvihill. Now with a pre-tax bid-YTW of 5.61% based on a bid of 9.82 and a hardMaturity 2014-12-1 at 10.00.
PWF.PR.J OpRet -1.0066% Now with a pre-tax bid-YTW of 4.34% based on a bid of 25.57 and a softMaturity 2013-7-30 at 25.00.
Volume Highlights
Issue Index Volume Notes
BCE.PR.T Scraps (Would be FixFloat but there are volume concerns) 154,220 Desjardins crossed 144,900 at 24.70.
BMO.PR.J PerpetualDiscount 104,140 Nesbitt crossed two blocks of 50,000, both at 18.88. Now with a pre-tax bid-YTW of 6.03% based on a bid of 18.86 and a limitMaturity.
BNS.PR.R FixedReset 86,125 Scotia bought 17,600 from anonymous at 25.05, then another 14,500 from a possibly different anonymous at the same price, and finally 12,000 from Nesbitt at 25.04.
CM.PR.D PerpetualDiscount 60,182 CIBC crossed 50,000 at 22.40. Now with a pre-tax bid-YTW of 6.56% based on a bid of 22.30 and a limitMaturity.
TD.PR.A FixedReset 52,660  
CM.PR.K FixedReset 48,750  

There were seventeen other index-included $25-pv-equivalent issues trading over 10,000 shares today.

One Response to “September 15, 2008”

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