Category: Market Action

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.

DBRS reports that the ABCP Clean-up Vehicle is underpaying its first interest payment:

notice delivered by BlackRock (Institutional) Canada Ltd. (the Administrator) regarding the first payment date for Master Asset Vehicle I and Master Asset Vehicle II (collectively, the MAVs).

The notice advised that insufficient proceeds would be available to pay accrued interest in its entirety on the Class A-1 Notes and Class A-2 Notes (collectively, the Class A Notes). The Administrator identified the following three factors that it believes contributed to the interest shortfall:

(1) The MAVs were required to pay certain expenses related to the closing of the transaction.

(2) There was an abbreviated first interest period and a mismatch in the payment dates for certain underlying assets.

(3) A fixed-floating interest rate mismatch exists between the margin funding facility fees and the return generated by the underlying assets.

As outlined in the MAV rating reports published on January 21, 2009, the rating of the Class A Notes addresses the payment of interest as set out in the terms of the transaction documents. According to their respective Trust Indentures, the MAVs have no legal obligation to pay interest before January 22, 2019. Therefore, no negative rating action will result from the failure to pay the full amount of accrued interest on the Class A Notes on any given payment date. However, if after reviewing the first payment date report, DBRS determines that expenses and/or proceeds from the underlying assets are materially different from what was originally modelled, negative rating action may be required.

The saga just never ends, does it?

The Globe & Mail reports more pressure for captive pension managers to become commercial asset managers:

Michael Nobrega, chief executive officer of the Ontario Municipal Employees Retirement System (OMERS), said yesterday that his fund is now open for business and is actively seeking mandates to manage other pension funds’ assets.
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And while Mr. Nobrega said OMERS should become a superfund manager, he insisted his vision is not motivated by a personal desire to build an empire.

“This is not about Michael Nobrega trying to be president of a superfund,” he told reporters yesterday. “This is about what’s right for plan members. You need resources to manage these [plans]. These are very complex areas.”

There are a number of things that are massively wrong – well, suspicious, anyway – about this idea:

• Regardless of Mr. Nobrega’s personal motivations, concious and unconcious, turning a captive asset manager into just another asset management firm will change the culture. Sales is anti-thetical to performance; and once third-party run-awayable assets become important to the organization, then it’s bang, game over.
• I still see no evidence that large managers outperform small managers, or even medium-size managers. Take a look at all the biggest firms you can think of: they will tell you their headcount, they tout their Assets-under-management, they wax ecstatic about their multiplicity of offices that ensures that clients can be taken out to lunch no matter where they are …. but don’t spend too much time looking for audited performance reports, compliant with what are rather hopefully described as industry standards, unless you want to get as cynical as I am
• Private equity is – at least to some extent – a shell game. The reason you take something private is so that you can discount the expected cash flows from the private entity in your own way rather than marking to market; a bit like the infamous Level 3 Assets that people get so upset about. I will not suggest that private equity is not a good idea; I’ll just say that I suspect returns are subject to inherent smoothing
• Superfunds? Am I lekniW naV piR, the only guy in town who’s been awake for the past twenty years? One of the great scandal-shock-horrors of the recent credit crisis has been the discovery that some banks are too big to fail and that the cost of bail-outs represents an unprecedented strain on public finances. Willem Buiter, particularly, has been scornful of financial systems in which the banking system is not only concentrated, but large relative to GDP. What happens if a superfund gets into trouble? McGuinty is already wetting his pants about the prospect of having to bail-out (or take the political heat for not bailing out) a little rinky-dink plan like GM Canada. Do we really want to take the chance that half (at least) of all Ontario plans are going to make the same Big Bad Mistake?
• And there’s market influence. A certain teflon-coated regional superfund recently took investment action that had the effect of rigging the market in Canadian ABCP (whatever its intentions may have been; and it with some help from its allies) and remember? When it went bust it went bust big-time and in a hurry. Who is prepared to guarantee to me that that won’t happen again? Don’t waste my time snivelling that Bad People will be Frowned At. Guarantee that it won’t happen.

Very good volume today, with the market slightly off; FixedResets might have been adversely affected by news of $300-million+ new supply from RY.

Julia Dickson of OSFI gave a speech to the ABA clearly demonstrating her contempt for investors, the despised third pillar of the banking system. The role of investors – and their reliance on mandated disclosures – was, basically, ignored.

Bloomberg has reported on the Fed’s response to the controversy regarding the size and nature of its emergency actions:

Former Fed Chairman Paul Volcker said Congress will probably review the authority granted to the Fed following the expansion in its assets.

“I don’t think the political system will tolerate the degree of activity that the Federal Reserve, in conjunction with the Treasury, has taken,” Volcker, head of President Barack Obama’s Economic Recovery Advisory Board, said in remarks to the conference at Vanderbilt University.

U.S. lawmakers from both political parties, including House Financial Services Committee Chairman Barney Frank, have expressed concern in recent months that the central bank has overstepped its authority by providing emergency credit.

In his speech, Vice Chairman Donald L. Kohn said:

For the credit facilities that we make available to multiple firms, we are not taking significant credit risk that might end up being absorbed by the taxpayer. For almost all the loans made by the Federal Reserve, we look first to sound borrowers for repayment and then to underlying collateral. Moreover, we lend less than the value of the collateral, with the size of the “haircuts” depending on the riskiness of the collateral and on the availability of market prices for the collateral. Some of our lending programs involve nonrecourse loans that look primarily to the collateral rather than to the borrower for repayment in the event that the value of the collateral falls below the amount loaned. In these circumstances, we insist on taking only the very highest quality collateral, lend less than the face amount of the collateral, and typically have other sources to absorb any losses that might nonetheless occur–for example, Treasury capital for our lending against securitized loans.
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Will These Policies Lead to a Future Surge in Inflation?
No, and the key to preventing inflation will be reversing the programs, reducing reserves, and raising interest rates in a timely fashion. Our balance sheet has grown rapidly, the amount of reserves has skyrocketed, and announced plans imply further huge increases in Federal Reserve assets and bank reserves. Nonetheless, the size of our balance sheet will not preclude our raising interest rates when that becomes appropriate for macroeconomic stability. Many of the liquidity programs are authorized only while circumstances in the economy and financial markets are “unusual and exigent,” and such programs will be terminated when conditions are no longer so adverse. Those programs and others have been designed to be unattractive in normal market conditions and will naturally wind down as markets improve.

All this is Central Banking 101; we have to rely on the Fed to execute the theory correctly – and this will be fodder for academic arguments for the next century.

Bloomberg notes that inflation concerns are driving down bill yields:

Rates on three-month bills turned negative in December for the first time since the government began selling them in 1929 as investors sacrificed returns to preserve principal. After increasing at the start of the year, rates have dropped 0.20 percentage point since the beginning of February to 0.13 percent on April 17.

Demand for bills is rising again because investors including foreign central banks are snapping up the shortest- term U.S. securities as the Federal Reserve buys Treasuries to drive down borrowing costs in a policy of so-called quantitative easing. China, the largest U.S. creditor, with $744 billion of debt, has questioned the practice and shifted purchases to bills from longer-maturity securities.

“There’s a group of investors out there who are looking at what the Fed is doing and the policy action they’ve taken and the asset purchases, and saying ultimately this is inflationary,” said Stuart Spodek, co-head of U.S. bonds in New York at BlackRock Inc., which manages $483 billion in debt. “You’re going to invest in very short-term bills because you absolutely need not just the quality but also the absolute liquidity.”

An alleged leak of the US bank stress tests has been touted on the Web but frankly, it doesn’t look too credible. We shall see!

Today’s excitement was the DBRS Mass Review-Negative of bank prefs; this was not released in time to have an effect on the market, but we will see what tomorrow brings.

The PerpetualDiscount winning-streak came to an end today; sorry folks, that was my fault. I shouldn’t have posted about it after Friday’s gain. The market was well behaved, with few individual issues showing price changes of much note, on continued good volume.

The first round of the Abitibi CDS auction showed extremely low recovery:

Credit-default swaps traders set an initial value of 3.75 cents on the dollar for bonds of an AbitibiBowater Inc. unit to settle derivatives linked to the newsprint maker that’s now in bankruptcy protection.

Royal Bank has announced:

that it expects to record a goodwill impairment charge (on both a pre and after tax basis) of approximately US$850 million for the second quarter ending April 30, 2009. While the charge will reduce second quarter reported earnings by approximately US$850 million, it is a non-cash item and an accounting adjustment, and will not affect our ongoing operations, or our Tier 1 and Total capital ratios.

It does not affect the capital ratios because goodwill is already deducted from capital. The market yawned. What a difference six months makes, eh? If this announcement had been made at the height of the panic, Royal Bank stock … might have felt some effects.

Yet another strong day on elevated volume.