Category: Market Action

The SEC has brought the first insider trading action involving CDS:

The SEC’s complaint alleges that [Deutsche Bank salesman Jon-Paul] Rorech learned information from Deutsche Bank investment bankers about a change to the proposed VNU bond offering that was expected to increase the price of the CDS on VNU bonds. Deutsche Bank was the lead underwriter for a proposed bond offering by VNU. According to the SEC’s complaint, Rorech illegally tipped [former Millenium Partners portfolio manager Renato] Negrin about the contemplated change to the bond structure, and Negrin then purchased CDS on VNU for a Millennium hedge fund. When news of the restructured bond offering became public in late July 2006, the price of VNU CDS substantially increased, and Negrin closed Millennium’s VNU CDS position at a profit of approximately $1.2 million.

“This is the first insider trading enforcement action involving credit default swaps,” said Scott W. Friestad, Deputy Director of the SEC’s Division of Enforcement. “As alleged in our complaint, Rorech and Negrin checked their integrity at the door and schemed to engage in insider trading of CDS to the detriment of investors and our markets.”

The plot thickens with respect to Bernanke’s involvment in the BofA / Merrill Lynch cover-up, discussed on April 24:

“I absolutely did not in any way ask Mr. Lewis to obscure any disclosures or to fail to report information that he should be reporting,” Bernanke said today in testimony to the congressional Joint Economic Committee.

It is not inconsistent with Cuomo’s charges; the Fed wanted the merger to go ahead and did not necessarily say anything about disclosure. But we will see!

In more government interference news, there is a twist to the Chrysler bankruptcy:

Chrysler LLC’s plan to auction most of its assets to an entity managed by Fiat SpA is unfair because it prevents creditors from using their claims to make a non-cash bid, a group of secured lenders told a bankruptcy judge.

The group, calling itself Chrysler’s non-TARP lenders, in reference to the Troubled Assets Relief Program, said the proposed auction chills bids from other parties, and would prevent a so-called “credit bid” from its group.
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The non-TARP group asked U.S. Bankruptcy Judge Arthur Gonzalez not to reveal the identities of its members, even after the judge asked yesterday that they do so. A lawyer for the group, Thomas Lauria, has said members who have been identified have received death threats.

It might be grandstanding … the fears might be genuine but exaggerated … but the President of the United States has to cool things off a little and back away from his inflammatory rhetoric, as discussed on May 1. At any rate, the judge has ruled that they must identify themselves.

The market had another very good day on high volume, with PerpetualDiscounts leading the way (the way up! about time!) and dragging FixedResets behind them.

Some public sector funds in the US have banned placement agents:

The move by some U.S. public pension funds to ban middlemen who market the services of private equity and hedge fund investments is misguided, according to Michael Travaglini, Massachusetts system executive director.

The funds would be better served installing more checks and balances to prevent undue political influence, Travaglini said. New York, for instance, should broaden control of its pension so the state comptroller is no longer sole trustee, Travaglini said in a telephone interview.

New York State Comptroller Thomas DiNapoli, who runs the $121.9 billion fund, banned the use of placement agents, lobbyists or other paid intermediaries last month amid a widening pay-to-play investigation. New York City similarly told money managers they could no longer use middlemen get pension fund business.

“There’s a legitimate place for placement agents,” said Travaglini, who’s helped run the $34.2 billion retirement fund for public employees in Massachusetts since 2004. “I’m amazed that a political corruption case has led people to question the legitimacy of a long established part of the asset management business.”

The ban is craziness, but there will be many more babies thrown out with the bathwater as political posturing takes centre stage.

DBRS is forecasting a preponderance of downgrades in 2009:

In a commentary released today, DBRS notes that it has seen a significant increase in credit deterioration in Q1 2009. According to the report, corporate credits finished the quarter on a negative tone, with approximately 16% of the DBRS universe facing negative rating action over the next 12 months. In contrast, only 2% of credits reviewed by DBRS were facing positive rating action.

The preferred share market continued its rally today, with PerpetualDiscounts roaring ahead as – perhaps – the market has realized why embedded calls at par in five years are valuable for issuers of FixedResets.

I understand that Scotia has done an Innovative Tier 1 Capital deal, described as “650 million deal June 30, 2019-2108 … at 7.804%”, but have no further details, no press release, nothing on SEDAR.

One of my favourite words has been banned in the UK:

Liquidity, equity and stabilization are “grandiose or ambiguous” words that shouldn’t be used in investment brochures, Britain’s financial regulator said.

Short, punchy sentences with sub-headings and colored graphs should replace swathes of text, the Financial Services Authority said in a paper yesterday. Too much data is as bad as no information as it deters customers from properly reading documents, the London-based agency said.

If financial companies bamboozle customers with technical language, they won’t be treating them fairly — one of the principles by which they must abide — the FSA said. The regulator may not be following its own advice: FSA Chairman Adair Turner used the word “liquidity” 187 times in a 126-page report in March on financial regulation.

The actual paper is something of a hoot. The intent of the FSA is laudable, but … when you explain complex investment instruments to retail, you can have precision or comprehension. Pick One.

The Chrysler bankruptcy is becoming a political circus:

President Barack Obama said Chrysler LLC lenders who turned down his buyout offers are a “small group of speculators” who forced the automaker into bankruptcy.

“A group of investment firms and hedge funds decided to hold out for the prospect of an unjustified taxpayer-funded bailout,” Obama said today in Washington before Chrysler filed for bankruptcy protection.
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While lenders representing 70 percent of the Chrysler loans agreed to Obama’s offer of $2.25 billion in cash, the dissidents ignored a deadline of 6 p.m. yesterday, according to one of the investors who declined to be named.
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Chrysler’s dissident lenders have on their side the “absolute priority” bankruptcy rule, which holds that value must be distributed according to the legal priorities of the stakeholders. What riled the group that put out the statement today was the fact that junior creditors, consisting of a workers healthcare trust, would get equity in a new Chrysler entity while they would not.

In the deal Chrysler was trying to conclude out of court, Fiat would have become a 20 percent owner of Chrysler, and a union retiree health-care trust fund would hold 55 percent, with the rest of the company staying in the government’s hands initially, according to people familiar with the matter. The government intends to replicate this, using bankruptcy to set up a new company, people familiar with the plan said.
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“The U.S. bankruptcy code foresees the possibility that it may be necessary to vary from ‘absolute priority,’ in particular when a two-thirds majority is convinced it makes legal or business sense,” said Richard Hahn, co-chairman of the bankruptcy practice at Debevoise & Plimpton LLP, a New York law firm that isn’t involved in the Chrysler negotiations. “If the government has consents from 70 percent, that’s more than enough” to give equity to junior creditors.

The dissidents “may be calculating that they can get more money by waiting a bit longer,” Hahn said. “Presumably they will file objections in court. The issue is less whether they’ll win than whether they can cause a meaningful delay that may cause Chrysler or the government to come to an accommodation.”
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The objections from the group of lenders also drew criticism from Michigan lawmakers, including Democratic Representatives John Dingell and Sander Levin.

“The rogue hedge funds that refused to agree to a fair offer to exchange debt for cash from the U.S. Treasury — firms I label as the ‘vultures’ — will now be dealt with accordingly in court,” Dingell said.

Histrionics, flat declarations and squabbling over the carcass is nothing new in bankruptcy proceedings. The fact that one of the squabblers in the President of the United States of America is worrisome.

A paper on VoxEU titled Private pensions and policy responses to the crisis drew my attention to the OECD Pension Outlook 2008 that had many interesting things to say, for instance:

and (from the related documentation on Pension Plan fees, emphasis added):

While competition is normally expected to bring down costs, individual account pension markets behave in a counterintuitive manner. Marketing and sales agents have been used in the past to encourage members to switch providers, leading to an increase in operational expenses and fees. As members are not very responsive to higher fees, systems that a priori seemed to be highly competitive, with many players, have actually turned out to do rather poorly in terms of fees.

and

The paper argues that the particularly low fees observed in Bolivia and Sweden at the inception of their respective systems stem largely from a decision to force cost competition among providers via a central agency or ‗clearing house‘.
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One possible explanation for the low costs in countries like Bolivia and Uruguay may be the conservative asset allocation of pension funds in these countries (Bolivian pension funds invest more than 90% in domestic treasury bonds).

There’s also ancilliary documentation on performance which shows Canada doing well, although data is limited.

Volumes came down a little today, but remain very healthy – and the market continued to rise, with some very high prices being seen for recent fixed-resets.

Bloomberg reports that:

American Express Co.’s preferred stock rating was cut to BB, or non-investment grade, from BBB by Standard & Poor’s Ratings Services.

I don’t see anything on the S&P site as yet. Moodys downgraded on April 24:

Moody’s Investors Service downgraded the long-term and short-term ratings of American Express Company (“Amex”). The senior long-term debt rating was lowered to A3 from A2; and the short-term rating was lowered to Prime-2 from Prime-1. The outlook for the Amex long-term ratings is negative.

Moody’s also downgraded the long-term ratings of American Express Travel Related Services (“TRS”) and its rated operating subsidiaries, including American Express Credit Corp. The senior debt and deposit ratings of TRS and subsidiaries were downgraded to A2 from A1. The Bank Financial Strength Ratings of American Express Bank, FSB and American Express Centurion Bank were also lowered to C+ from B-. The Prime-1 short-term ratings for TRS and its rated operating subsidiaries were affirmed. The rating outlook for the TRS debt and deposit ratings is now stable. The outlook on the Banks’ Financial Strength Ratings (“BFSR”) is negative. These rating actions conclude the review initiated on February 25, 2009.

Today’s rating actions reflect the erosion of Amex’s asset quality and weaker revenue trends stemming from the severe U.S. economic recession and the firm’s relatively high credit exposure in the states most heavily affected by home price declines, particularly California and Florida. Moody’s believes that these developments, in combination with structural and regulatory changes in the credit card and consumer lending industry, pose longer term challenges to the company’s franchise.

Chrysler is bust and there could be a fascinating catfight in the works:

The iconic company, third biggest among U.S. automakers, missed a U.S. government deadline to come up with a restructuring plan by today that was rigorous enough to avoid bankruptcy and qualify for more bailout aid. The carmaker tried to negotiate an alliance with Fiat, reduce $6.9 billion in secured loans and cut $10.6 billion owed to a pension fund. Some lenders refused to slash the debt to $2.25 billion.
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Bankruptcy can involve uncertainty and delay. Dissident creditors intend to object to the company’s reorganization plan, a person familiar with their thinking said. That might thwart President Barack Obama’s goal of a “surgical” bankruptcy that would put a viable carmaker quickly into the market.

Funny story on credit ratings:

[Retired lawyer Ron] Grassi says the companies’ faulty debt analyses have been at the core of the global financial meltdown and the firms should be held accountable. Exhibit One is his own investment. He and his wife, Sally, held $40,000 in Lehman Brothers Holdings Inc. bonds because all three credit raters gave them at least an A rating — meaning they were a safe investment — right until Sept. 15, the day Lehman filed for bankruptcy.

“They’re supposed to spot time bombs,” Grassi says. “The bombs exploded before the credit companies acted.”

In the brave new world of credit ratings, there won’t be any of this mealy-mouthed “A” and “A(high)” stuff. Only two ratings will be allowed: “Good as Gold” and “Going Bankrupt Next Week”. Any errors will be prima facie evidence of a crime.

The Bank of Canada has released a new working paper, Price Movements in the Canadian Residential Mortgage Market:

The authors empirically analyze the price-setting behaviour of the major Canadian banks in the residential mortgage market over the period 1991–2007. They use weekly posted prices of the major mortgage providers to study the degree of competition in mortgage price setting. Their results suggest that the residential mortgage market is imperfectly competitive. They find distinct price leaders and that, as market concentration increases, so does price dispersion – helped by the increased use of discounting from posted prices. The authors also find that, although banks’ pass-through of input price changes to mortgage prices is complete in the long run under reasonable assumptions regarding discounting, there exists some level of pricing asymmetry in the short run.

And the FDIC has circulated a new batch of ticky-boxes:

A number of insured banks with portfolio holdings in private label mortgage-backed securities, collateralized debt obligations (CDOs), or asset-backed securities (ABS) are facing heightened losses as a result of significant investments in these products. Certain structured credit products, particularly private label mortgage-backed securities (MBS) and CDOs, have experienced deteriorating collateral performance, price declines, and credit rating downgrades. Management due diligence regarding purchases of these products was often lacking. This Financial Institution Letter reiterates and clarifies existing supervisory guidance on the purchase and holding of complex structured credit products. It focuses on the various supervisory concerns related to these securities: pre-purchase analysis, suitability determination, risk limits, credit ratings, valuation, ongoing due diligence, adverse classification, and capital treatment.

Whoosh, what a day! The seminar went well (by which I mean, nobody actually threw rocks at me) and I’ll be arranging the next one shortly. The preferred share market roared ahead on good volume.

Daniel Bouton is resigning as chairman of SocGen, brought down – at least in part – by the Kerviel scandal which exposed grossly incompetent management.

And Ken Lewis is defending his role in BofA’s Merrill purchase, on the grounds that he is responsible for the global financial system. Perhaps the global financial system should be the one paying him.

Ravi Balakrishnan (IMF), Stephan Danninger (IMF), Selim Elekdag (Central Bank Turkey) and Irina Tytell (IMF) have published an essay on VoxEU, How financial stress spreads – A first comprehensive look at the current crisis, in which they claim:

The twist in the current crisis is that bank-lending linkages appear to be the main driver, rather than the more mobile portfolio investment links that drove the Asian crisis. Since the mid-1990s, Western European banks have dominated bank-lending flows. Emerging Europe stands out as the largest recipient (Figure 2). Using an econometric model for stress transmission, we find that an increase in bank liabilities to Western Europe from 15% to 50% of GDP (roughly the difference between Emerging Europe and other emerging regions) doubles the strength of stress transmission. It is no surprise therefore that Emerging Europe was the first emerging market region to be hit hard by the crisis.

Just another reason to surcharge Risk-Weighted-Assets for bank size and for recent growth. There is also probably good reason to apply a higher risk-weight to holdings due from other banks.

A very good day for the market on increased volume … possibly artificially juiced by portfolio adjustment for the closing of RY.PR.Y. PerpetualDiscounts now yield 6.79%, equivalent to 9.51% interest at the standard equivalency factor of 1.4x. Long Corporates now yield 7.4% (a hair under? Maybe.), so the pre-tax interest-equivalent spread is now 211bp … about average for the Credit Crunch, well down from the highs of November, but still above the pre-Crunch range of 100-150bp.

CalPERS has announced:

it is voting against the re-election of all 18 Bank of America directors, including Chief Executive Officer and Chairman Ken Lewis.

CalPERS contends that Lewis and other directors failed to disclose information to shareowners in connection with Bank of America’s merger with Merrill Lynch. The pension fund also believes that the undisclosed payment of billions of dollars in bonuses to Merrill Lynch executives – before completion of the merger – warrants a vote against all directors.

“The entire board failed in its duties to shareowners and should be removed,” said CalPERS Board President Rob Feckner. He noted the poor condition of the company, the failure by directors to disclose the extent of Merrill Lynch’s losses prior to consummation of the merger, the payment of billions of dollars to Merrill executives in bonuses for failure, and the failure of the board to act in the best interests of shareowners in overseeing management.

Mr. Lewis’ travails, publicized by Andrew Cuomo, were discussed on PrefBlog on April 24.

One wonders whether the CalPERS decision is genuine or another machination of the Obama Administration which – as far as I can tell – is looking to blame US economic problems on Evil Bankers. The response is warranted enough, but the emphasis on bonuses detracts from the credibility of the release.

The bonus issue for investment managers surfaced in Parliament last week, according to the Globe & Mail:

Senior officers of the [Public Sector Pension Investment] board fielded numerous questions from MPs at the Commons finance committee about whether they would receive bonuses – answering only that it will be up to their board of directors to decide.

But MPs warned the board’s managers that taking bonuses for the 2008-09 fiscal year could not be justified.

“Anyone in this country running something called an investment board that lost billions of dollars last year that even thinks of paying themselves a bonus needs their head [examined],” NDP finance critic Tom Mulcair told John Valentini, the investment board’s chief operating officer. “I’d like you to give that message to your board of directors.

“We would find it properly scandalous if in the light of what happened last year, that in addition to your considerable salaries, you decide to vote yourself bonuses.”

Liberal MP John McKay echoed the sentiment, telling the board’s managers that they should be eschewing bonuses when Canadian taxpayers are suffering.

“It would be inappropriate for your organization to be awarding themselves significant bonuses in light of not only your performance … but also the market conditions,” said Mr. McKay, a former parliamentary secretary to the finance minister under the last Liberal government. “Canadians have taken a pretty major haircut in the market in the last while.”

The quoted statements are so ignorant that I do not believe they were honestly made. The implication is that investment managers’ bonuses should be determined by the performance of the market, rather than by performance relative to a benchmark; and that a manager should get a bonus for deliviering +10% returns in a +20% market, but not receive one for a -10% return in a -20% market.

The politicians know this as well as I do. But sleazebag gutter politics gets their names in the paper, which is all that counts, right?

Good volume in the pref market today; PerpetualDiscounts managed to eke out a gain and FixedResets outperformed.

Sheila Bair of the FDIC made a speech today indicating willingness to move towards better risk assessment of banks:

So who should pay for an “anybody can fail” doctrine? Certainly not the taxpayer. As a tax-paying citizen, I don’t favor encouraging foolish behavior. Nor should those costs be borne by the Deposit Insurance Fund, which should continue to be used only for the costs of protecting depositors when banks fail.

A new resolution authority could include assessments on larger firms to fund a reserve that would be tapped to absorb losses for a failure. I believe it’s only fair that the industry that benefits should pay … just as banks pay for deposit insurance.

The assessments could be based on the differential in the cost of capital between smaller institutions — which clearly can fail and thus have higher costs — and their larger competitors. Moreover, we should not base this strictly on size, which might not be perfectly aligned with risk. For example, a large mutual fund that invests in the S&P 500 is not systemic. Risk-based surcharges should be imposed on higher risk behavior. This might include certain derivatives, market making or proprietary trading, and rapid growth. We now have such a risk-based system for the insurance premiums we charge for deposit insurance, and it’s working very well.

My problem with the ideas as stated is that they are not integrated with other elements of bank regulation – which, to be fair, she probably does not want to be seen as encroaching upon. I certainly supported graduated risk premia – we have such a thing in Canada, but it’s a joke: just about everybody qualifies for the lowest premium level. And I support the idea that bank capital requirements should include elements such as a surcharge for size – say, for instance, risk-weighted-assets in excess of $250-billion attract a 10% surcharge – and better differentiation between investment banking (which should penalize buy-and-hold behaviour) and regular banking (which should penalize trading).

However, the FDIC still charges premia based on all deposits, not just insured deposits, which is simply craziness – it reduces the incentive for banks to pay premium rates for non-insured deposits and leaves the FDIC with something of an obligation to make good on the uninsured deposits of a failed bank. Premium reform needs to start there.

These are the germs of good ideas, but to some extent are encroaching on the role of the Fed as US banking regulator. If reform efforts are not to degenerate into intra-regulator cat-fights, Ms. Bair will have to be very careful!

Another good solid day for prefs, with FixedResets slightly outperforming PerpetualDiscounts.

It appears that we will be treated to the spectacle of a regulatory cat-fight in the States. Andrew Cuomo has released a letter to Congress in which he discusses the BofA / Merrill Lynch merger:

Immediately after learning on December 14,2008 of what Lewis described as the “staggering amount of deterioration” at Merrill Lynch, Lewis conferred with counsel to determine if Bank of America had grounds to rescind the merger agreement by using a clause that allowed Bank of America to exit the deal if a material adverse event (“MAC”) occurred. After a series of internal consultations and consultations with counsel, on December 17,2008, Lewis informed then-Treasury Secretary Henry Paulson that Bank of America was seriously considering invoking the MAC clause. Paulson asked Lewis to come to Washington that evening to discuss the matter.

At a meeting that evening Secretary Paulson, Federal Reserve Chairman Ben Bernanke, Lewis, Bank of America’s CFO, and other officials discussed the issues surrounding invocation of the MAC clause by Bank of America. The Federal officials asked Bank of America not to invoke the MAC until there was further consultation. There were follow-up calls with various Treasury and Federal Reserve officials, including with Treasury Secretary Paulson and Chairman Bernanke. During those meetings, the federal government officials pressured Bank of America not to seek to rescind the merger agreement. We do not yet have a complete picture of the Federal Reserve’s role in these matters because the Federal Reserve has invoked the bank examination privilege.

Bank of America’s attempt to exit the merger came to a halt on December 21, 2008. That day, Lewis informed Secretary Paulson that Bank of America still wanted to exit the merger agreement. According to Lewis, Secretary Paulson then advised Lewis that, if Bank of America invoked the MAC, its management and Board would be replaced.
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In an interview with this Office, Secretary Paulson [argely corroborated Lewis’s account. On the issue of terminating management and the Board, Secretary Paulson indicated that he told Lewis that if Bank of America were to back out of the Merrill Lynch deal, the government either could or would remove the Board and management. Secretary Paulson told Lewis a series of concerns, including that Bank of America’s invocation of the MAC would create systemic risk and that Bank of America did not have a legal basis to invoke the MAC (though Secretary Paulson’s basis for the opinion was e,ntirely based on what he was told by Federal Reserve officials).
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Notably, during Bank of America’s important communications with federal banking officials in late December 2008, the lone federal agency charged with protecting investor interests, the Securities and Exchange Commission, appears to have been kept in the dark. Indeed, Secretary Paulson informed this Office that he did not keep the SEC Chairman in the loop during the discussions and negotiations with Bank of America in December 2008.

The proper thing for Lewis and the board to do, of course, was to back out and get fired with honour; the claim is made that this would have increased systemic risk and they were craven in the best interests of the global financial system.

Now, Bloomberg reports that:

Bank of America Corp. Chief Executive Officer Kenneth D. Lewis may face scrutiny by the U.S. Securities and Exchange Commission for failing to disclose mounting losses at Merrill Lynch & Co. because of pressure from federal regulators to complete the takeover.

“We have been actively reviewing the disclosure surrounding the merger between Bank of America and Merrill Lynch,” said agency spokesman John Nester. “The issues identified in New York Attorney General Andrew Cuomo’s letter are part of our review.”

Sounds like Ken Lewis will be hung out to dry. While I think he made the wrong decision, he certainly has my sympathy; I know very well that being a mouse in a roomful of angry elephants is not a lot of fun.

One of the Master Asset Vehicle notes has been placed under Review-Negative:

In addition to the potential impact of the interest shortfall, the following factors contributed to DBRS placing the rating of the MAVII A-2 Notes Under Review with Negative Implications:

(1) On March 16, 2009, DBRS was advised that MAVII’s credit default swap transactions with Canadian Imperial Bank of Commerce (CIBC) were terminated due to the failure of MAVII to post additional collateral to meet a margin call. The termination resulted in losses of $107,742,597 (or approximately 1.1% of the assets of MAVII). As a result, the enhancement available to the MAVII A-2 Notes has been reduced by 1.1%, whereas the enhancement percentage for the MAVI Class A-2 Notes was unaffected.

Sorry that this is being published so late, folks, but I had an engagement Friday night.

The market was up today, FixedResets and PerpetualDiscounts gaining about 15bp each total return, but volume was down sharply to below-average levels, something that might be considered significant by the chartists among us (yes, there are still a few!) but not considered significant by right-thinking people.

The Fed has released its financial statements and Bloomberg notes:

its most detailed breakdown to date on the types of assets it accepted from Bear Stearns Cos. a year ago and the cause of losses on the portfolio.
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The biggest losses in the $25.7 billion portfolio of Bear Stearns assets as of the end of last year came from commercial and residential mortgages.
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The Fed wrote down the value of commercial mortgage holdings by 28 percent to $5.6 billion and residential loans by 38 percent to $937 million as of Dec. 31, the central bank said in a report today.

The Fed refers to table 4 in the the current H.4.1 report:

The unconsolidated financials of Maiden Lane have been published. The losses have been divided up as: $3.4-billion Fed; $1.2-billion JPM. That wipes out JPM’s subordinated loan to Maiden Lane, assuming there is no recovery.

PerpetualDiscounts fell slightly today, but FixedResets continued to impress on a day reduced, but still rather good, volume. The former now yield an average of 6.84%, equivalent to 9.58% interest at the standard equivalency factor of 1.4x, while long corporates now yield 7.4%; thus, the pre-tax interest-equivalent spread is 218bp; in what we may call the “Credit-Crisis-but-not-Apocalyptic-Panic” zone.

Sorry, folks! This is a busy time, so there’s no commentary.