Category: Market Action

PerpetualDiscounts managed to keep the rally going today, with a gain of 18bp taking yields down to 5.61%. Today was the eighteenth consecutive trading day of advances, with the index gaining 9.71% total return in this span, with yields declining from 6.15% on July 27 to 5.61% today.

The preferred share market just kept on keeping on today, with PerpetualDiscounts gaining 42bp to close with a yield of 5.65%. The last time yields on this index were this low was May 28, 2008. FixedResets are in something of a holding pattern, seeming reluctant to reduce yields below 4%.

The Congressional Budget Office has released a major report on budget options for Congress. Among the more interesting are:

• Reduce the Mortgage Interest Deduction or Replace It with a Tax Credit
• Replace the Tax Exclusion for Interest Income on State and Local Bonds with a Tax Credit

The second alternative [converting the mortgage interest deduction to a credit] would replace the deduction with a 15 percent tax credit for interest on mortgages below the declining limits in the first alternative. (In 2005, the President’s Advisory Panel on Federal Tax Reform proposed a variant of that approach.) The change would reduce taxes for some owners and raise them for others, with a net increase of $13 billion in 2013 and $388 billion over the period from 2013 to 2019.

Creating a tax credit for the interest paid on state and local debt could have several advantages. First, it could lower states’ and localities’ borrowing costs by about the same amount as the current tax exclusion but cause a smaller reduction in federal revenues. The reduction would be smaller because switching to the credit would prevent bondholders in higher tax brackets from receiving gains that exceeded the investment return necessary to induce them to buy the bonds. Second, the size of the tax credit could be varied to allow lawmakers to adjust the extent of the federal subsidy—on the basis of its perceived benefit to the public—for different categories of borrowing by state and local governments. (Even with a tax credit, however, the federal subsidy would remain akin to an entitlement; that is, it would not automatically be subject to annual Congressional scrutiny.)

Good ideas, but I don’t think they’ll go anywhere until Treasury reports a significant risk of bond auction failure.

How ’bout that preferred share market, eh? PerpetualDiscounts dominated the volume table while roaring up another 60bp today, taking their yield down to 5.63%, equivalent to 7.88% interest at the standard equivalency factor of 1.4x. Long Corporates now yield 6.0% – well, maybe just a hair less – so the pre-tax interest-equivalent spread is now 188bp, a decisive break through the ‘credit-crunch-normal’ level of about 200bp and considerably tighter than the 215bp recorded on August 12.

Dealbreaker is a gossipy tabloid style website billing itself as a tabloid – most of the offerings are vapid commentaries on topics as diverse as Bernie Madoff’s pants and the amount of cleavage being shown by business news commentators. Every now and then, though, they come up with something good; today there is an interesting post on the Nigerian banking system.

If anything, the preferred share market rally is accellerating, with PerpetualDiscounts up 75bp today, while FixedResets were down 14bp. Volume continued high, well spread out amongst the various classes.

Themis Trading published a white paper on High Frequency Trading (hat tip: Financial Webring Forum) that is most interesting:

This paper will explain how these traders – namely liquidity rebate traders, predatory algorithmic traders, automated market makers, and program traders – are exploiting the new market dynamics and negatively affecting real investors. We conclude with suggestions on what can be done to mitigate or reduce these effects.
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The number of quote changes has exploded. The reason is high frequency traders searching for hidden liquidity. Some estimates are that these traders enter anywhere from several hundred to one million orders for every 100 trades they actually execute.

For the life of me, I was unable to find any real public policy concerns in this paper. Smart traders are making money at the expense of dumb traders, which sounds very right and proper to me. A dumb trader with algorithmic trading software … is a fast dumb trader.

A lot of the kerfuffle, I am convinced, is simply an replay of the floor-traders fight of about 20 years ago. Remember? All those floor traders who’d gotten fat and comfortable with their sinecures suddenly found out that computers had made their jobs obsolete. Nowadays, there are a lot of prop traders at dealerships (not to mention buy-side traders) who are finding out the same thing … and they’re trying to hold back the tide with whatever scare stories a credulous public will swallow.

Unfortunately, the piece was written before the controversy on flash orders (last mentioned August 5), so there is no enlightenment on this issue from that source. The Themis Trading Blog, though, has a lot of good information on HFT in general and has been added to the Blogroll.

CIT has declared that its tender offer was successful:

today announced the expiration and successful completion of its tender offer (the “Offer”) for its $1 billion of Floating Rate Senior Secured Notes due August 17, 2009 (the “Notes”). The Offer expired at 12:00 midnight, New York City time, at the end of August 14, 2009. The completion of this tender offer is another important milestone as the Company continues to make progress on the development and execution of a comprehensive restructuring plan.

As of the expiration date, 59.81% of the total Notes outstanding were validly tendered and not withdrawn, an amount in excess of the minimum condition. In accordance with the terms and conditions of the Offer, CIT will accept tendered Notes for payment on August 17, 2009, the settlement date, at a purchase price of $875 per $1,000 principal amount of Notes. CIT will pay amounts due on Notes that have matured but were neither tendered in, nor subject to the Offer in accordance with the terms of those Notes.

The preferred share market just kept on keeping on today, with PerpetualDiscounts up just over 41bp, leaving the FixedReset return of +2bp looking a little sad. Volume continued high.

Non-performing loans in the States are reaching extraordinary levels:

More than 150 publicly traded U.S. lenders own nonperforming loans that equal 5 percent or more of their holdings, a level that former regulators say can wipe out a bank’s equity and threaten its survival.

The number of banks exceeding the threshold more than doubled in the year through June, according to data compiled by Bloomberg, as real estate and credit-card defaults surged. Almost 300 reported 3 percent or more of their loans were nonperforming, a term for commercial and consumer debt that has stopped collecting interest or will no longer be paid in full.

On August 12 I mentioned some proposed changes to rules in the States that would draw some clearer lines between a broker’s agent & principal functions when underwriting new municipal issues. There’s an example of bone-headed new issue pricing from Chicago:

The Metropolitan Water Reclamation District of Greater Chicago, in a debt offering typical of President Barack Obama’s Build America Bonds, raised $600 million this week, relying on advice from Mesirow Financial Inc., a 72-year-old investment bank based in the city. Within 12 hours, the firm assured itself and investors a profit of at least 2 percent as the bonds appreciated as much as $25.82 for each $1,000 face amount, according to the Municipal Securities Rulemaking Board.
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The water district saved money for taxpayers with Build America Bonds, said Treasurer Harold Downs. The program, which started in April as part of President Barack Obama’s $787 billion stimulus plan, pays a subsidy for 35 percent of the interest costs on taxable debt sold by states, local governments and universities to finance capital projects creating jobs.

Does this prove that the underwriter was incompetent or that there was hanky-panky? No. Is this a question that really needs to be looked at carefully? Yes.

The preferred share market was on fire today, with PerpetualDiscounts gaining 83bp in their thirteenth consecutive trading day of gains. Yawn. In the course of this run, they have gained 6.63%. Yawn. FixedResets trailed, but were in the black at +39bp today, but were shut out of the volume tables. Yawn. Volume continued high. Yawn.

The Fed has announced a written agreement with CIT Group. Most of it is the usual regulatory ‘run your business properly and tell us what’s going on’ boilerplate (annoying and embarrassing, but it’s only paperwork) but there are some points of particular interest:

Within 15 days of this Agreement, Bancorp shall submit to the Reserve Bank an acceptable written plan (the “Capital Plan”) to maintain sufficient capital at Bancorp, on a consolidated basis, and at the Bank, as a separate legal entity on a stand-alone basis. The Capital Plan shall describe the specific actions that Bancorp proposes to take, and the timeframes for these actions. Within 15 days of this Agreement, Bancorp shall submit to the Reserve Bank an acceptable written plan (the “Capital Plan”) to maintain sufficient capital at Bancorp, on a consolidated basis, and at the Bank, as a separate legal entity on a stand-alone basis. The Capital Plan shall describe the specific actions that Bancorp proposes to take, and the timeframes for these actions. The Capital Plan shall, at a minimum, address, consider, and include:
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(d) the source and timing of additional funds necessary to fulfill the consolidated organization’s and the Bank’s future capital requirements, as well as the impact that the actions to generate such funds will have on projected net income and retained earnings;
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8. (a) Bancorp shall not declare or pay any dividends without the prior written approval of the Reserve Bank and the Director of the Division of Banking Supervision and Regulation (the “Director”) of the Board of Governors.
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(c) Bancorp and its nonbank subsidiaries shall not make any distributions of interest, principal or other sums on subordinated debentures or trust preferred securities without the prior written approval of the Reserve Bank and the Director.

The agreement is dated August 12, so the Capital Plan must be in place by month-end. When announcing the agreement itself, CIT also announced a Rights plan:

adopted a Tax Benefits Preservation Plan (the “Rights Plan”).

While the Rights Plan will not impede the Company’s ability to pursue restructuring or strategic opportunities, it is designed to protect the Company’s ability to utilize its net operating losses and other tax assets, preserving value for the benefit of all stakeholders. This value could be reduced if the Company experiences an “ownership change” under U.S. federal income tax rules, which occurs if one or more “5% shareholders” (as defined under U.S. federal income tax laws) have aggregate increases of 50% in their CIT ownership over a three year historic period. The Rights Plan reduces the likelihood that CIT experiences such an ownership change by discouraging any person or group from becoming a “5% shareholder.”

Bloomberg reported on the Rights plan:

“By protecting these net operating losses, they’re preserving value for the estate should they see a bankruptcy or other types of restructuring,” CreditSights Inc. analyst Adam Steer said in an interview. “They’re trying to protect value, in this case, tax benefits, which is good, good for shareholders, and it would also be good for the bondholders and other creditors of the estate.”

Citigroup Inc., the third-biggest U.S. bank by assets, adopted a similar plan in June, and other companies including homebuilder Hovnanian Enterprises Inc. and Stamps.com have taken steps in the last year to limit the size of individual stakes. CIT said it would disclose the details of the plan in a filing with the Securities and Exchange Commission.

The plan would “deter in a pretty effective way the possibility of an ownership change” by activating the rights of existing owners to buy CIT stock at half its trading value — instantly forcing the new stockholder to “suffer a very serious and immediate dilution,” Willens said.

Yet another day of good returns for PerpetualDiscounts, slightly OK returns for FixedResets and good volume. This is getting BORING. Remember the good old days, when you were never sure whether the market would go down fifty cents or a whole dollar? That was exciting. Will somebody PLEASE go bankrupt and give me something to write about?

Some Assiduous Readers may feel that I have a knee jerk reaction to increased rule-making … but it isn’t always the case! The proposed rules on US Municipal bond new issues isn’t all that bad:

Some institutional investors claimed that underwriters and their related accounts “buy bonds in the primary offering for their own account even though other orders remain unfilled,” the Municipal Securities Rulemaking Board said in a statement today. The board is an industry self-regulatory group dominated by securities dealers.

The board proposal would require underwriters to “give priority to customer orders over orders for its own account” or from affiliates. It wouldn’t prohibit sales to related accounts, though underwriters “shall have the burden of justifying that such allocation was in the best interests of the syndicate” and in accord with principles of “fair dealing,” the board said in a draft interpretive notice.
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The board’s announcement doesn’t mention complaints by issuers, who incur extra costs if bonds are sold at lower prices and higher interest rates than needed.

“The proposed changes help make the case for competitive rather than negotiated bond sales,” said Robert Doty, president of American Government Financial Services, a Sacramento, California-based adviser to issuers.

In competitive sales, issuers take the best price offered by bankers, whereas in negotiated sales, they rely on the advice of their underwriter and sometimes a financial adviser. Local governments’ and not-for-profits’ negotiated deals accounted for 86 percent of the $391.3 billion of new municipal bonds sold last year, according to Thomson Reuters data.

“Bond pricing in 2009 is the least efficient in years,” bankers at Ziegler Cos. said in a July 27 letter sent to clients who issue bonds. After underwriters set prices low enough to attract more orders than there are bonds, “investors rush to buy the cheap securities, and many flip them the next day for a quick profit,” the Chicago-based firm said.

Conflict of interest is an often overrated fault, but acting as both advisor and counterparty to an issuer … well, I call that a step over the line. By me, advising on price is an advisory matter and the brokerage is an agent; they are more than welcome to backup their advice with money and say something like …. ‘well, we can try and sell it at 5.50%, but if you go to 5.60% we’ll guarantee it’, and provide a backstop for the success of the underwriting. The key part of the word “backstop”, however, is “back” and third party orders should take priority. Once they start giving preferential – or even pro-rata – fills to related accounts, however, they are no longer agents but principals; they should make it very clear from the beginning just how they are acting.

Frankly, I’m a little surprised this issue hasn’t surfaced before, or that clients have allowed it! The source document states:

The Municipal Securities Rulemaking Board (the “MSRB”) is requesting comment on draft amendments to Rule G-11, on new issue syndicate practices, Rule G-8, on books and records, and Rule G-9, on preservation of records. The draft amendments to Rule G-11 would expand the rule to cover all primary market offerings, not just those for which syndicates are formed. They would also provide that, in general, unless otherwise agreed to by the issuer, the syndicate manager or the sole underwriter (as the case may be) shall give priority to customer orders over orders for its own account, orders from an affiliate for its account, or orders for their respective related accounts.

The UK FSA has published its rules on bonuses. Many of the principles insist on giving the employer a great deal of discretion:

Non-financial performance metrics should form a significant part of the performance assessment process.
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The measurement of performance for long-term incentive plans, including those based on the performance of shares, should be risk-adjusted.

These changes will make lawyers very, very happy.

The CIT drama continues with a SEC filing:

As a first step of the restructuring plan, on July 20, 2009, the Company commenced a cash tender offer for its outstanding $1 billion in floating rate senior notes due August 17, 2009 and amended the offer on August 3, 2009. A description of the terms of the offer and the amendment are contained in Form 8-K’s filed by the Company on July 21, July 24 and August 3, 2009.

If the tender offer is successfully completed, the Company intends to use the proceeds of the Credit Facility to complete the tender offer and make payment for the August 17 notes. Further, the Company and a Steering Committee of the bond holder lending group do not intend for the Company to seek relief under the U.S. Bankruptcy Code, but rather will pursue restructuring efforts as part of the comprehensive restructuring plan to enhance the Company’s liquidity and capital position. If the pending tender offer is not successfully completed, and the Company is unable to obtain alternative financing, an event of default under the provisions of the Credit Facility would result and the Company could seek relief under the U.S. Bankruptcy Code.

The Credit Facility contains provisions (i) requiring the Company and the Steering Committee to work together in good faith to promptly develop a mutually acceptable restructuring plan for the Company and its Subsidiaries and (ii) requiring the Company to adopt a restructuring plan acceptable to the majority in number of the Steering Committee by October 1, 2009. The agreement also calls for a draft of the restructuring plan on a “best efforts basis” by August 14, 2009. As a result, the Company currently expects to complete and begin executing on the restructuring plan prior to the required October 1 deadline.

In a successful effort to prove that they are morons, they copy-protected the PDF, so I copy-pasted from the MS-Word version. Just so you know.

Bloomberg had an interesting piece on the market for US RMBS:

Investors are overestimating potential yields in part because they are failing to consider how many loans are becoming delinquent for the first time and in part because they are arriving at incorrect conclusions on how long it will take to liquidate seized homes, the [Amherst Securities Group LP] New York-based analysts led by Laurie Goodman wrote in a report yesterday. Those issues can influence both the size of foreclosure losses and how quickly bonds get paid down.

“Do your homework, and sell securities which are being evaluated incorrectly by the marketplace,” the analysts wrote.
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For example, the most-senior classes of 2006 and 2007 securities backed by prime-jumbo mortgages have rallied to more than 80 cents on the dollar, from as low as 55 cents, according to Amherst. So-called super-senior bonds backed by “option” adjustable-rate mortgages have jumped to about 48 cents, from the “low 30s,” the analysts wrote.

Investors also have been doing too little analysis of the differences, such as the level of home equity, among borrowers with currently non-delinquent mortgages backing non-agency bonds, which lack guarantees from government-supported Fannie Mae and Freddie Mac or U.S. agency Ginnie Mae, they said.

What? Homework? Analysis? Who has time for that stuff, anyway, in between client meetings and sales? Just buy what the smiley-boy at the dealer’s tells you is good.

PerpetualDiscounts had yet another good day today, with a total return of +62bp to bring the median YTW down to 5.84%, equivalent to 8.18% interest at the standard pre-tax equivalency factor of 1.4x for taxable holders. Long Corporates now yield a hair over 6.0%, so the pre-tax interest-equivalent spread is now about 215bp, narrowing in from the 230bp recorded on August 5 and returning to its month-end level.

Volume continued strong, with PerpetualDiscounts dominating the volume highlights table.

There’s an interesting bit of law being litigated, regarding securitization and bankruptcy:

Terms of the two Lehman transactions, named Dante after the entity that issued the notes, specify that investors have first claim on whatever money is available if Lehman defaults or goes bankrupt. While the U.K.-based contract favors the noteholders, U.S. bankruptcy law normally protects a debtor company’s assets. Lehman is asking the bankruptcy judge to rule in its favor.

Not Yet Tested

Not yet tested is whether U.S. law permits the investors to use a written contract to give themselves priority claims after a bankruptcy. In the U.K., the related case was brought against Lehman and Bank of New York by a trustee for Australian noteholder Perpetual Trustee Co.

Rating agencies could start to downgrade credit-linked notes if Peck says Lehman can take away assets protecting the investments, debt research firm CreditSights Inc. said in a July 12 report. Insulating such deals from bankruptcy “forms the bedrock of securitization,” CreditSights analyst Atish Kakodkar said in the report.

Comrade Obama announced today that Americans are too stupid to invest:

The main difference in the proposal from earlier outlines is a provision to “better protect” small municipalities and “unsophisticated investors” by limiting their eligibility to trade derivatives. The rest of the statement mirrors earlier proposals by asking Congress to impose higher capital and margin requirements, move most derivatives to regulated exchanges and clearinghouses and impose supervision over all dealers.
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Frank and Peterson’s proposal also left open whether to ban trading of so-called naked credit-default swaps, which were designed to insure against the default of a company’s bonds. Lawmakers and administration officials say the product has been abused by hedge funds and other investors who used them to speculate on the likelihood of a company’s collapse.

Naked contracts or positions are those in which the buyer doesn’t own the underlying asset or stock on which the trading is based.

Frank told reporters last month that he supports proposals to restrict derivatives sales to municipalities.

Soon all shorting will be illegal, and then everything will always go up!

DBRS downgraded some MAV2 notes today (MAV2 is the reincarnation of ABCP):

Negative rating migration in the underlying asset interests, particularly in CDO transactions with relatively low levels of credit enhancement, has increased the required enhancement level for the Notes to above that commensurate with the “A” rating assigned on January 21, 2009. Numerous reference entities have been downgraded (in some cases by more than ten notches), resulting in higher probabilities of default for the CDO asset interests. Monoline downgrades in particular have put pressure on the rating of the Notes. Any future deterioration in the credit quality of monoline insurers may lead to further ratings action. Figure 1 below lists the most notable downgrades of reference entities since January 1, 2009. In addition, a number of credit events, coupled with historically low realized recoveries, have reduced enhancement levels available to the CDO transactions. Figure 2 below lists the credit events and International Swaps and Derivatives Association (ISDA) protocol recoveries since January 1, 2009. These factors have resulted in a rapid deterioration in the credit quality of certain CDO asset interests.

Preferreds continued their winning ways today (this is the tenth consecutive trading day of gains for PerpetualDiscounts, over the course of which they have gained 4.81%) amidst continued heavy volume.

CIT has amended its exchange offer for its debentures due August 17:

As a result of the amendment, holders of all Notes tendered prior to the expiration date at midnight, New York City time, at the end of Friday, August 14, 2009, will receive the amended purchase price of $875 in cash per $1,000 principal amount of Notes, as total consideration in the Offer. Previously, the purchase price, which included an early delivery payment, was $825 per $1,000 principal amount of Notes.

CIT announced that the amendment to the Offer also reduces the minimum tender condition to 58% of the Notes, an amount approximately equal to the number of Notes which pursuant to the Credit Facility the lenders are committed to tender and not withdraw. As of 5:00 p.m., New York City time, on Friday, July 31, 2009, CIT had received tenders for 64.97% of the Notes.

The withdrawal deadline for the Offer has been extended until midnight, New York City time, at the end of Wednesday, August 5, 2009. All other terms of the Offer remain unchanged.

They have also suspended preferred dividends:

the Company’s Board of Directors has decided to suspend dividend payments on its four series of Preferred Stock in order to improve liquidity and preserve capital while restructuring efforts are ongoing. Payments on the Company’s Equity Units (NYSE: CIT PrZ) are not affected by this decision.

China has claimed that industrial espionage by Rio Tinto has cost the country’s steel mills over $100-billion, in connection with recent arrests. I have no idea whether the charges are well-founded or not; but if true, a vigorous response should provide a hint to Canada and Germany, inter alia, that confident countries don’t just whine about it.

There has been a fascinating hiccup in BAC / SEC lawsuit over the MER bonuses:

U.S. District Judge Jed Rakoff ended the hearing saying that he needs more information on the Aug. 3 accord between the bank and the U.S. Securities and Exchange Commission, which filed the suit. The settlement won’t be final unless Rakoff approves it.

If the SEC is correct that Bank of America lied about whether to pay the bonuses, then the proposed settlement isn’t “remotely reasonable,” Rakoff said.

Not a lot of price action today, but volume continued strong.