December 18, 2008

There’s an amusing story today about bonus policies at Credit Suisse:

Credit Suisse Group AG’s investment bank has found a new way to reduce the risk of losses from about $5 billion of its most illiquid loans and bonds: using them to pay employees’ year-end bonuses.

The bank will use leveraged loans and commercial mortgage- backed debt, some of the securities blamed for generating the worst financial crisis since the Great Depression, to fund executive compensation packages, people familiar with the matter said. The new policy applies only to managing directors and directors, the two most senior ranks at the Zurich-based company, according to a memo sent to employees today.

Credit Suisse is the first to use the debt to pay employees. Outside investors may also be permitted to invest in the facility, according to the people familiar with the matter, who declined to be identified because the plan hasn’t been made public. The bank will boost the potential for returns by providing leverage to the facility, and will be paid back first, according to the people.

If I am correct – with the support of the BoE – and bank assets have, in general, been written down to far below fundamental value, this is a clever way for the executives to (a) earn brownie points, and (b) give themselves enormous bonuses.

In sad news for bond investors, General Electric’s debt ratings are at risk. This is particularly grievous because GE has long had a well-deserved AAA rating but has yielded like a single-A … and any time you can pick up free credit quality is a Good Time.

Allan Greenspan opines in an Economist op-ed Banks need more capital:

As recently as the summer of 2006, with average book capital at 10%, a federal agency noted that “more than 99% of all insured institutions met or exceeded the requirements of the highest regulatory capital standards.”

Today, fearful investors clearly require a far larger capital cushion to lend, unsecured, to any financial intermediary. When bank book capital finally adjusts to current market imperatives, it may well reach its highest levels in 75 years, at least temporarily (see chart). It is not a stretch to infer that these heightened levels will be the basis of a new regulatory system.

Note that the chart shows “Book equity as % of book assets”. I believe that this is equal to the FDIC’s ratio “Equity capital to assets”. The FDIC defines this as “Total equity capital as a percent of total assets”, whereas the more commonly referenced “Leverage Ratio” is

Tier 1 (core) capital as a percent of average total assets minus ineligible intangibles.

Tier 1 (core) capital includes: common equity plus noncumulative perpetual preferred stock plus minority interests in consolidated subsidiaries less goodwill and other ineligible intangible assets. The amount of eligible intangibles (including mortgage servicing rights) included in core capital is limited in accordance with supervisory capital regulations. Average total assets used in this computation are an average of daily or weekly figures for the quarter.

The equity capital ratio for all FDIC insured institutions was reported in their 3Q08 Report to be 9.63%, compared to 10.45% (3Q07); 10.25% (3Q05); and 9.13% (3Q03). Note that Mr. Greenspan’s chart forecasts a massive increase in this ratio without this forecast being justified in the text.

Moody’s cut Citigroup from Aa3 to A2:

Moody’s Investors Service lowered the debt ratings of Citigroup Inc. (senior debt to A2 from Aa3) and the ratings on its lead bank, Citibank N.A. (long-term bank deposits to Aa3 from Aa1). The financial strength rating on the bank was lowered three notches to C from B, which translates to a change in the baseline credit assessment to A3 from Aa3. The outlook on the bank financial strength rating is negative and the rating outlooks on the deposit and debt ratings at both the bank and the holding company are stable.

Moody’s said that its downgrade of Citigroup’s debt and deposit ratings was moderated by Moody’s opinion that Citigroup enjoys a very high probability of systemic support from the U.S. government. The benefits of this systemic support partially offset the deterioration in Citigroup’s stand-alone credit quality, which is driven by worsening asset quality and the likelihood that Citigroup could see further decline in its tangible capital base in the next two years.

This had immediate contagion effects, with HSBC getting hammered in Hong Kong. Look out below!

Holy smokes, what a day. Very heavy volume and the market tanked. An Assiduous Reader wrote in:

Another dismal day for PerpetualDiscounts on fairly big volume. Could this downward momentum be caused by margin calls…forced selling…or panicking investors and their advisors?

I’m ready to pull the sell trigger myself….Clients will be in disbelief with Dec 31st statements.

Well … I still like the tax-loss-selling hypothesis. It fits with the season, volume and direction. Margin calls and forced selling, not so much, because I don’t think a lot of prefs are bought on margin, or are held in margin accounts that are levered to the max (I could be wrong. It would be interesting to see some figures). Panicking clients? I would think that any client with the guts to hang in this long will consider recent declines to be a mere bagatelle, but panicking advisors sounds more possible. There will be a fair number of clients who haven’t received a statement since September and things …. are a little different now.

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 8.56% 8.74% 123,030 11.89 7 -6.8574% 615.9
Floater 9.92% 10.00% 87,719 9.59 2 -5.6942% 326.8
Op. Retract 5.59% 7.05% 161,126 4.12 15 -1.2140% 973,7
Split-Share 6.77% 12.78% 93,946 3.94 15 -0.6757% 910.4
Interest Bearing 10.04% 20.69% 58,158 2.65 3 -2.5488% 738.5
Perpetual-Premium N/A N/A N/A N/A N/A N/A N/A
Perpetual-Discount 8.12% 8.26% 234,276 11.15 71 -1.7264% 683.0
Fixed-Reset 6.03% 5.38% 1,185,392 13.83 18 -0.3100% 1,001.8
Major Price Changes
Issue Index Change Notes
BCE.PR.F FixFloat -12.7857%  
BAM.PR.J OpRet -12.1374% Now with a pre-tax bid-YTW of 17.40% based on a bid of 11.51 and a softMaturity 2018-3-30 at 25.00. Closing quote of 11.51-99, 1×10. Day’s range of 10.71-13.50 (!).
BCE.PR.S FixFloat -9.1544%  
BSD.PR.A InterestBearing (for now!) -9.0703% Asset coverage of 0.8-:1 as of December 12, according to Brookfield Funds. Now with a (currently dubious) yield of 26.12% based on a bid of 4.01 and a hardMaturity 2015-3-31 at (a currently dubious value of) 10.00. Closing quote of 4.01-10, 5×1. Day’s range of 4.00-41.
BAM.PR.K Floater -8.7019%  
BCE.PR.R FixFloat -8.6207%  
HSB.PR.D PerpetualDiscount -7.8125% Now with a pre-tax bid-YTW of 8.54% based on a bid of 14.75 and a limitMaturity. Closing quote 14.75-35, 6×5. Day’s range of 14.75-16.25.
BCE.PR.G FixFloat -7.1429%  
FBS.PR.B SplitShare -6.5772% Asset coverage of 1.1-:1 as of December 15 according to TD Securities. Now with a pre-tax bid-YTW of 18.59% based on a bid of 6.96 and a hardMaturity 2011-12-15 at 10.00. Closing quote of 6.96-20, 45×10. Day’s range of 6.90-35.
BCE.PR.I FixFloat -6.2676%  
BCE.PR.Z FixFloat -6.2500%  
POW.PR.D PerpetualDiscount -6.1856% Now with a pre-tax bid-YTW of 8.82% based on a bid of 14.56 and a limitMaturity. Closing quote 14.56-89, 4×4. Day’s range of 14.51-50.
BCE.PR.A FixFloat -5.9761%  
BAM.PR.H OpRet -5.8680% Now with a pre-tax bid-YTW of 14.89% based on a bid of 19.25 and a softMaturity 2012-3-30 at 25.00. Closing quote of 19.25-89, 2×5. Day’s range of 18.30-20.75 (!).
POW.PR.B PerpetualDiscount -5.4328% Now with a pre-tax bid-YTW of 8.67% based on a bid of 15.84 and a limitMaturity. Closing quote 15.84-09, 2×5. Day’s range of 15.75-16.80.
CM.PR.J PerpetualDiscount -5.1355% Now with a pre-tax bid-YTW of 8.6584% based on a bid of 13.30 and a limitMaturity. Closing quote 13.30-74, 15×15. Day’s range of 13.00-14.19.
Volume Highlights
Issue Index Volume Notes
RY.PR.N FixedReset 255,145 Royal bought 163,700 from National in five blocks at 26.00.
MFC.PR.A OpRet 173,150 Desjardins crossed 60,000 at 24.25; Nesbitt crossed 100,000 at the same price. Now with a pre-tax bid-YTW of 4.67% based on a bid of 24.19 and a softMaturity 2015-12-18 at 25.00.
BNS.PR.K PerpetualDiscount 129,905 TD crossed 100,000 at 16.00. Now with a pre-tax bid-YTW of 7.64% based on a bid of 16.02 and a limitMaturity.
RY.PR.I FixedReset 90,270 RBC crossed 19,700 at 22.00.
CM.PR.I PerpetualDiscount 88,372 Now with a pre-tax bid-YTW of 8.53% based on a bid of 14.10 and a limitMaturity.

There were one hundred and twelve other index-included $25-pv-equivalent issues trading over 10,000 shares today.

2 Responses to “December 18, 2008”

  1. […] the mechanism was announced on December 18, I commented: If I am correct – with the support of the BoE – and bank assets have, in general, […]

  2. […] Readers with extremely good memories will remember that on December 18, 2008 I wrote: If I am correct – with the support of the BoE – and bank assets have, in […]

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