PrefBlog

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.
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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.
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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.

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

This entry was posted on Friday, December 19th, 2008 at 2:20 am and is filed under Market Action. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.