Category: Market Action

Controversy continued regarding the US ABCP Super-Conduit mentioned yesterday. Noriel Roubini dislikes the plan, but bases his reasoning on a somewhat dubious assumption:

Indeed, if we assume that many of the assets held by the SIVs are of low quality, the attempt to avoid losses that would be incurred by selling these assets in secondary markets would not be possible.

Sadly, his alternative to what he perceives as regulatory interference in the market is simply more interference; different interference:

The right solution would have been to punish the banks that created these dangerous schemes in the first place by forcing them to take the losses on their illiquid and/or impaired asset; or to bring such asset on balance sheet and take the capital charges or liquidity charges required to do that.  Forcing the banks to sell the asset and take the losses would have helped to create secondary markets for these illiquid assets; thus, while losses would have occurred this would have reliquified a frozen market.

Meanwhile, Naked Capitalism supports my hypothesis that the super-conduit is not so much of a bail-out fund as a vulture fund, although he doesn’t yet know it!

If you want a rescue program, you don’t lard it up with fees beyond what is necessary for costs and risk assumption. In this case, that would mean market fees for any credit enhancement provided by third parties, plus a mechanism for recovery of costs (and we mean real costs) of establishing and running the entity. That means no debt placement fees, since the old SIV owners were capable of doing that for themselves. If the spin is that this vehicle is being established to prevent a possible crisis, then it behooves the organizers to do so on a cost recovery basis. Anything else raises questions about the real motives (including are the fees yet another way to shore up Citigroup?).
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The MLEC, by cherry picking assets, will make thing worse for the remaining SIVs

How do I see this working? Let’s say we have an SIV with $100 “good” assets, $5 “bad” assets, financed with $100 ABCP and $5 subordinated or equity financing. The asset pool is earning $7 annually, but due to increased spreads in the ABCP market, it’s costing them $8 to finance and operate. So the sponsors have no equity and negative carry; they’d love to get out of the business, but they would only be able to realize $80 if they sold out. That’s too much, so they struggle along.So along comes a friendly super-conduit. “Hi! I’m from the Big Bank, and I’m here to help you!”. Super-Conduit offers $95 for the “good” assets. Accepting the offer will let the sponsors get out of the business gracefully, so they accept. Super-Conduit can finance with a positive carry AND make a fat capital gain on maturity of the assets AND eliminate competitors, so everybody’s happy.

Is this the case? I don’t know; I don’t have access to all the details on the assets. But most of the underlying remains highly rated – it’s only the speculative junior tranches of ABS that are genuinely impaired.

Could it be the case? Most certainly. I’m going to let you in on a little secret here: investment management has nothing to do with managing investments. It’s all about selling. Huge pools of capital are controlled by guys who, frankly, don’t really know what they’re doing. If they do know how to do it, guess what? Their clients have to be kept happy. Look at what happened in August – US T-bills dipping to three percent and change, simply due to a public relations effort on the part of money-market funds desperate to have a higher quality portfolio than the next guy, even if it meant giving away money.

I’m sure there were quite a few portfolio managers and traders executing those purchases while holding their noses; knowing that what they were doing was best defined as “panic”, but either having been given the orders, or having to provide window dressing for the paying customers.

As far as I have been able to make out, the current crisis has everything to do with fear and greed, and nothing to do with analysis. The super-conduit will make boatloads of money for its sponsors and Treasury will achieve its objective of a functioning ABCP market.

As an example of how this might work, and to get a ballpark idea of the numbers, let’s  look at Global DIGIT (DG.UN) again. This is cheating, because DG.UN has sub-prime exposure through derivatives, but let’s look anyway. There are about 9.75-million units outstanding, supporting $1.4-billion in ABCP via the net asset value (NAV). The NAV is most recently estimated as $7.92; the units are trading on the TSX at a little less than $3.00.

So lets say Super-Conduit comes along and says – ‘I’ll bail you out, with enough to pay the unitholders $3.50. Or you can just wait until the ABCP holders bankrupt you. Choose!’

So Super-Conduit makes the loan of $1.4-billion and pays the unitholders $34-million. That’s an immediate profit of $43-million  (about 3% of the loan) AND the $1.4-billion is in a comfortable positive-carry situation. To me, this sounds like good business.

How may such interuptions in the smooth functioning of capital markets be avoided in future? Well, I’ve already given one possibility: increase the capital charge on Global Liquidity Guarantees, preferably on a sliding scale based on bank capital, to decrease the attractiveness of issuance. Other adjustments to this charge could include a charge for the term mis-match between the guarantee’s assets & liabilities … it seems reasonable that if a conduit has 8-year liabilities, a guarantee of financing via 1-2 year FRNs is less risky – given staggered maturities – than a guarantee of financing via 30-day paper. One may also wish to increase the charge when the bank is thinly capitalized to begin with; that is, pay more attention to what will happen if the guarantee is actually triggered. There is news today that:

the Bush administration will review accounting rules for the off-balance sheet units that large U.S. banks set up to invest in assets including mortgage-backed securities.

In somewhat related US brokerage news, there are reports that CITIC will buy a piece of Bear Stearns – which has lost a lot of value due to sub-prime contagion and the blow-up of two of its hedge funds – while Merrill Lynch’s CEO O’Neal is facing criticism due to its quarterly loss, which is in no small part due to its investment in a sub-prime mortgage originator last year. This is happening while Morgan Stanley is bulking up its mortgage servicing unit via a purchase from an originator that is desperately trying to survive. Sub-prime is casting a long shadow!

Good volume in the preferred share market, but no returns as the slide continued.

There were twenty-three other index-included $25.00-equivalent issues trading over 10,000 shares today.

The Web is alive with commentary on the plan to create a super-SIV, which would hold about $80-billion in non-sub-prime ABS, finance with commercial paper and be guaranteed by the super-major banks – notably Citigroup, which took a beating today on credit concerns.

The Wall Street Journal has used the word “Bailout” in describing this plan; James Hamilton at Econbrowser asks:

The reality is that someone must absorb a huge capital loss. The question we should be asking from the point of view of public policy is, Who should that someone be?

My answer is: the shareholders of Citigroup.

Accrued Interest has taken a more nuanced view:

if the assets are valued correctly, a significant loss will still be realized by the sellers, because even very strong non-resi ABS have widened significantly in recent months. The losses might only be like 1-2% of par, … We’ll see how well the assets are indeed valued. Call me highly skeptical.
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SivieMae will supposedly have a limited life, although I’m skeptical on that as well, perhaps as short as 1-year.
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Here we have some banks, particularly Citigroup, who were using off-balance sheet vehicles to increase their leverage. … Those that choose to stay away from the SIV structures were still dragged down by the liquidity crunch.
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Now squint your eyes a little and what do you see? One bank paying another bank a fee to avoid reporting their complete assets and liabilities on their balance sheet.

I find it rather surprising that this move should arouse so much interest, frankly. $80-billion in financing is a big deal, but not an incredible deal. What interests me much more about the deal is the banks motivations. Liquidity guarantees are charged to the banks’ risk-weighted assets at a 10% CCF. If the banks actually have to implement those guarantees – either directly or through buying the commercial paper – then it gets charged at a 100% CCF.

Naked Capitalism notes:

Citi can provide funding for however many days and weeks until the conduit is functioning, but it seems highly unlikely that this entity will be up and running before Citi starts feeling squeezed.

I have previously speculated as to the adequacy of the 10% number, suggesting that:

perhaps something like … “10% on the first capital-equivalent, 15% on the next, 20%…” might permit the market to operate efficiently while keeping the number of lines under control.

However, Citigroup’s Tier 1 Capital Ratio has declined to 7.4% in 3Q07, from 8.6% in 1Q06. That’s a hell of a drop, and it has occurred even as Shareholders equity increased from $114.4-billion to $127.4-billion. Note that HSBC had a Tier 1 ratio of 9.3% at June 30, 2007, while Bank of America was at 8.64% at year-end and 8.52% at the half. Bank of America, it will be recalled, recently purchased LaSalle Bank as part of the ABN AMRO deal for USD 21-billion. Bank of America has issued a press release stating:

consortium of leading global banks today announced an agreement in principle to create and provide liquidity support to a master conduit to enhance liquidity in the market for asset-backed commercial paper and medium-term notes issued by structured investment vehicles (“SIVs”).
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Bank of America Corp. (NYSE: BAC), Citigroup Inc. (NYSE: C), JPMorgan Chase & Co. (NYSE: JPM) and several other financial institutions have reached an agreement in principle to create a single master liquidity enhancement conduit (“M-LEC”). Once established, M-LEC will agree, for a set period of time, to purchase qualifying highly-rated assets from certain existing SIVs that choose, in their sole discretion, to take advantage of this new source of liquidity. Access to such liquidity is intended to allow participating sellers to meet pending redemptions and facilitate asset-backed commercial paper rollovers.

Now: why?

All the comment so far is to the effect that this is a bail-out of Citigroup. Is it? Is it really?

Citigroup’s Tier 1 ratio is low for a global bank, but it not yet anywhere close to the point where they have to make room for extra Fed Inspectors. Given Citigroup’s exposure to the SIV market of about $100-billion, they clearly have the most to gain from a re-normalization in ABCP … but are they really afraid of financing or are they afraid of spreads?

I’m not going to stick my neck out too far here. I haven’t studied the market in detail, I’m not hearing the gossip. But I will suggest that there’s a reasonable chance that the consortium is pulling a JPMorgan.

We all remember, of course, the Panic of 1907. In the denouement to that crisis, Morgan stuck it to a fellow banker, purchasing a big whack of stock extremely cheaply – and I’m afraid I cannot remember the name of the company off-hand. I don’t think it was the US Steel deal; US Steel had to be bullied into buying whichever it was they bought. This was Morgan’s bank buying common equity in something else, a railroad, perhaps, if memory serves. At any rate, once Morgan had become convinced the world was not going to end, he got down to the serious business of sticking it to the competition.

Update: I am remembering two different versions of the same incident. Geisst claims that “Morgan agreed to rescue Moore & Schley if it would sell him its holdings in Tennessee Coal & Iron at $45-million, considerably less than the market price…. US Steel acquired the stock, Moore & Schley and the Trust Company of America were saved, and the steel trust became larger and more influential than ever. … Almost all were in agreement that the deal found remarkably little resistance given that Morgan made at least a $650 million profit”. The story in Bruner & Carr is more complex, and has US Steel resisting the importunities to take over TC&I. For sources, see The Panic of 1907

So how about this scenario? The ABCP market could really use a helping hand, and this consortium is going to provide it. A decline in spreads will benefit Citigroup. And note, from BofA’s press release:

Once established, M-LEC will agree, for a set period of time, to purchase qualifying highly-rated assets from certain existing SIVs that choose, in their sole discretion, to take advantage of this new source of liquidity. Access to such liquidity is intended to allow participating sellers to meet pending redemptions and facilitate asset-backed commercial paper rollovers.

We know, from the continuing decline in US ABCP that I have been gleefully documenting every Thursday for the past month or so, that there are some US conduits that are on the ropes. And Canadian conduits, of course, are on the mat, but there’s no indication as yet whether these conduits will be eligible to sell assets to the consortium.

I suggest that the following hypothesis at least be considered: the consortium is willing to extend itself to bail out the non-bank conduits. With every expectation of making an obscene profit from the deal.

As support for this idea, I’ll go back to the Naked Capitalism post:

That takes us to the problem of the assets that will go into the MLEC. As the New York Times tells us:

To maintain its credibility with investors from whom it would raising money, the conduit will not buy any bonds that are tied to mortgages made to people with spotty, or subprime, credit histories. Rather, it will buy debt with the highest ratings — AAA and AA — and debt that is backed by other mortgages, credit card receipts and other assets.

Huh? The market is objecting to the crappy assets in the SIVs, not the better quality ones. It would seem more logical to take the lousy assets, issue a guarantee, and seek funding for them, and let the banks keep the good assets in existing SIVs, which ought to be marketable once the dodgy assets are excised. The banks are on the hook for the SIVs, anyhow, since they are having to fund the SIVs via backup credit lines, so any mechanism that enables them to get third party funding advances the ball.

My point exactly. Everybody’s screaming bail-out here, worried about Citigroup’s finances and deeply suspicious of Treasury’s involvement … but the actual structure looks a lot more like a vulture fund than anything else to me – with, perhaps, Citigroup as weak sister, but still a member of the family … especially as it benefits so directly from tighter spreads on ABCP in general.

I’ll look up the details on the 1907 Morgan thing shortly.

Good volume in prefs today; perpetuals continued to slide.

There were seventeen other index-included $25.00-equivalent issues trading over 10,000 shares today.

Update: I have updated the reference to Morgan in the body of the post.

There’s no commentary today, I’m afraid! What with PrefLetter production, seeing whether the IIF had anything interesting to say, admitting that I cannot time the markets and so on, I’m just running out of time!

There were nine other index-included $25.00-equivalent issues trading over 10,000 shares today.

Willem Buiter is outraged at some aspects of the Northern Rock bail-out – specifically, the extension of deposit insurance to new money:

Why should the unsecured wholesale creditors of Northern Rock get any protection at all? There is no social justice (widows and orphans) argument to support this intervention, nor an efficiency argument – the wholesale creditors to Northern Rock should be expected to be able to pay the cost of verifying its financial viability. No public purpose is served by subsidising, through ex-post insurance, the ‘rate whores’ that are likely to make up the bulk of the wholesale creditors of Northern Rock. Municipalities, charities and professional and institutional investors that were happy to pocket the slightly above-market interest rates offered by Northern Rock should not be able to dump the default risk (whose anticipation/perception was the reason for the higher rates) on the tax payer. 

Meanwhile, the situation at Countrywide isn’t looking very pretty:

Overdue loans as a percentage of unpaid principal increased to 5.85 percent in September from 4.04 percent a year earlier, the company said in a statement. Foreclosures climbed to 1.27 percent from 0.51 percent. Mortgages funded by the Calabasas, California-based company last month declined to $21 billion.

Which appears to be a nationwide phenomenon:

U.S. home foreclosures doubled in September from a year earlier as subprime borrowers struggled to make payments on adjustable-rate mortgages, RealtyTrac Inc. said.

In related news, Moody’s downgraded a big batch of sub-prime today. From their press release:

Moody’s Investors Service today announced that it has downgraded $33.4 billion of securities issued in 2006 backed by subprime first lien mortgages, representing 7.8% of the original dollar volume of such securities rated by Moody’s. Of the $33.4 billion downgraded securities, $3.8 billion remain on review for further downgrade. Moody’s also affirmed the ratings on $258.6 billion of Aaa-rated securities and $21.3 billion of Aa-rated securities, representing 74.7% and 52.0% of the original dollar volume of such securities rated in 2006, respectively. In addition, another $23.8 billion of first-lien RMBS were placed on review for downgrade, representing 5.6% of the dollar volume of subprime first-lien securities rated in 2006, including 48 Aaa-rated and 529 Aa-rated securities.
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The analysis driving today’s rating actions takes into account several key factors. First, Moody’s assumes that the severity of loss associated with loans that are now seriously delinquent will be 40%-50% on average. Second, based on its recent survey of subprime loan servicers, Moody’s analysis assumes that significant loan modifications that might mitigate future losses are not likely to occur in the near term.

There was continued decline in outstanding ABCP in the States; on a probably-not-entirely-unrelated note, bond issuance is massive this week.

There was good volume in the preferred share market today … and continued declines in the perpetual sector which, quite frankly, I am at a loss to understand.

I have uploaded a graph comparing the yield curves as of the June 12 trough in the PerpetualDiscount index; the September 19 peak, and today. Note that the graph shown plots AFTER-TAX SPOT YIELDS:

• After Tax: The after tax yield received by an investor for an investment
• Spot Yields: Every cash flow is discounted with its own yield. For a “30-year” perpetual (I make the approximation of “30 Years = Forever” in the analysis), there will be
  • 120 dividend payments
  • 30 tax payments
  • 1 return of principal

  making a total 151 cash flows, each of which gets its own yield in accordance with the yield curve. In traditional bond mathematics, a flat yield curve is assumed and all cash flows are discounted with the same yield

At any rate, the steepening in the past three weeks is stupendous. This is really strange!

There were twenty-four other index-included $25.00-equivalent issues trading over 10,000 shares today.

On September 18 I mentioned the investment firm Calyon and its sudden discovery that it had a big position in credit derivatives it didn’t want. Today, the plot thickened:

The Calyon trader fired last month for alleged unauthorized trading that led to 250 million euros ($353 million) of losses said his bosses knew what he was doing and considered him a “golden child” of the New York office.”There was nothing deceptive or rogue,” Richard “Chip” Bierbaum, 26, said in an interview. “My positions were reported on a daily basis. It did not blow up. I expect there were some losses but nowhere near the amounts they are discussing. I was the golden child of credit trading in New York.”

It will be most interesting to see how this unfolds; but when things go wrong, all bureaucrats go into ass-covering mode, integrity be hanged. A trading loss of $353-million is a mere bagatelle anyway.

James Hamilton of Econbrowser writes about the return of backwardation to oil futures. A friend of mine claims that the recent contango in oil futures showed that there was no real North American oil shortage; contango implies that you can buy spot, sell futures, pay storage and make a profit. Therefore, the huge amount of contango in the recent past simply proved that there was so much oil around that the market had run out of places to store it for a few months … therefore no shortage. The current backwardation implies that the market is returning to normal, at any rate – as long as one considers a spot price of USD 80+ normal!

We will probably be hearing a lot about free trade in the next year, as the American presidential cycle ticks over. There are some polls that show the average North American supports free trade; other polls that show the opposite. The Republican front-runners are largely in favour; the Cato Institute considers Hillary Clinton to be an “interventionist” in its classification:

On the basis of their voting records, members of the 107th Congress can be classified in four categories: free traders, who oppose both trade barriers and subsidies; internationalists, who oppose barriers and support subsidies; isolationists, who support barriers and oppose subsidies; and interventionists, who support barriers and subsidies.

Her website does not discuss free trade as an issue. Anyway, in the grand tradition of American politics, we’re going to hear a lot of disingenuous statements, unfounded assertions and outright lies over the next year. Jagdish Bhagwati has written a short essay on current economic thought.

Eric Rosengren of the Boston Fed has spoken in favour of the concept of sub-prime mortgages and noted that important regional benefits resulted from their existence. His speech, published on the Boston Fed’s website, conveys some fascinating detail:

A  first finding is that recent foreclosures have been disproportionately related to multi-family dwellings.  In Middlesex County, Massachusetts, multi-family properties accounted for approximately 10 percent of all homes, but 27 percent of foreclosures in 2007.  This highlights a potentially serious problem for tenants, who may not have known that the owner might be in a precarious financial position.

Second, the Bank’s research shows that the duration of a subprime mortgages is on average quite short – for a sample of subprime mortgages used to purchase a home between 1999 and 2004,  two-thirds have prepaid within two years and almost 90 percent have prepaid within three years.  Prepayment will occur if the home is refinanced or if it is sold.  While some of those sales may have been under difficult circumstances, it is plausible that many borrowers who purchased homes with subprime products did benefit from the appreciation of home prices in New England that occurred over the last decade.
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First, many subprime borrowers have respectable credit histories.  LoanPerformance data from Middlesex County show that almost two-thirds (64 cent) of borrowers who received subprime loans had FICO scores greater than 620, and 18 percent had scores over 700.  They may have been in subprime products because they chose to make a highly leveraged home purchase, or they may have been steered to a more costly mortgage for which they might have otherwise qualified.  Either way, it is encouraging to note that these borrowers could be in a position to refinance to another product.

Third, many borrowers of so-called “teaser” 2/28 mortgages were actually paying a much higher rate than is found on prime loans.  The average “teaser” rate was 7.3 percent in 2005 and 8.35 percent in 2006 for loans located in Middlesex County in Massachusetts.  This suggests that if these borrowers could qualify for a prime product, they would likely see a significant reduction in their interest rate.

Second, many subprime borrowers have held their house long enough for it to appreciate, so they may now have sufficient equity in their house to facilitate refinancing into a prime product.

Sorry to include such a long quote – but seeing some actual data on subPrime, as opposed to reporters’ drivel, is very exciting!

He even included a rather puzzling note, that may be an elliptic reference to Canadian ABCP:

Much of the asset-backed commercial paper had liquidity and often credit enhancements provided by banks, to insure that investors would receive their money should they decide they no longer wanted to hold the commercial paper.  The success of the asset-backed commercial paper in financing assets has encouraged some organizations to choose structures that were less reliant on liquidity provisions by banks.

But … that’s it for me. I have better things to do this evening; I will be updating HIMIPref™ data later and may have time for some comments (and perhaps some snarky comments about the election) but no guarantees!

Update: So … the Ontario election results are in and it looks like John Tory will have to run for Prime Minister next time. It’s a bit of a shame, in many ways, because he ran an absolutely masterful campaign. The faith-based-school thing (which was only charter-school-lite, anyway) was a beautiful distraction from the completely ludicrous budgetary plan and he managed to escape with a reputation as an earnestly mistaken zealot, rather than a dangerous bozo.

What has happened to the (Progressive) Conservative party to which I used to belong in pre-Harper, pre-Eves days? It used to be the party of fiscal responsibility and competent management; it has become the party of moronic tax cuts and vindictive politics of resentment.

Ontario voters have also shown good sense in rejecting proportional representation; a number of supporters are showing all the intellectual honesty of unrepentent Stalinists: ‘It’s a great system! It just wasn’t done right!’. Still rejection of the changes as written provides Ontario with an opportunity to increase revenues at some point in the future … instead of presenting the party leaders with a batch of seats to sell, the province might in the future sell them directly, at so much per year. This makes a lot more fiscal sense in these troubled times.

It was another bad day for prefs, with the PerpetualDiscount index down just over a third of a percentage point. PerpetualPremiums were down marginally.

I received some more fascinating correspondence tonight and will post about it tomorrow.

Update 2007-10-11

There were fourteen other index-included $25.00-equivalent issues trading over 10,000 shares today.

Worry over the fate of the USD continues to be a theme in the markets, and Menzie Chinn of Econbrowser has posted a review of the issues. I will admit, this post is notable mainly for its links to definitions and prior reviews of the issue, but these are good links. The 2005 post includes a link to a paper showing the futility of forecasting: it’s always gratifying to get some agreement with one’s prejudices! The examination of the interest-rate parity predictions are interesting, if only because I have seen it claimed – by a sophisticated retail investor – that carry trades are intrinsically unsound because interest-rate parity is guaranteed. Well … not in this world!

Accrued Interest reviewed the jobs numbers on the weekend, with a view to discussing the investment difference between “lawyers” and “detectives” – the former seeking evidence to support a particular view; the latter (greatly favoured) seeking to examine evidence to form a view.

What’s a good name for those, such as myself, who feel that the process is pointless because natural chaos will destroy any prediction as soon as it’s made? Weatherman, perhaps? I’m not going to predict a hurricane, but I will say that if there is a hurricane, you should have a good solid house; but if it’s sunny and pleasant, you’ll want nice windows; so build your house with the objective of surviving hurricanes with not too much damage while being able to enjoy the sunny times.

Perhaps this is stretching a metaphor too far! The markets can be outperformed, but you have to get your hands dirty and examine a wide variety of scenarios. And – assuming you are a rational investor and avoid the One Big Bet school of thought – you’re not going to double your money while everyone else goes broke, either! Ideally, you’ll outperform by a constant, small-but-worthwhile amount, irregardless of economic conditions.

The Northern Rock Saga continues:

Northern Rock, based in Newcastle, England, said in a statement today that money deposited after Sept. 19 will now be covered by the Bank of England, the U.K. Treasury and Financial Services Authority. The authorities previously only protected deposits made before then.

“This may make Northern Rock easier to sell,” said Philip Shaw, chief European economist at Investec Bank in London.
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The case has been “damaging” for the reputation of the U.K., Financial Services Authority Chairman Callum McCarthy told the Treasury Select Committee of lawmakers today. Still, it was “impossible” to predict closure of the markets both for securitization and for short-term repurchase agreements, he said.

“We didn’t identify the probability of that happening,” McCarthy said. “No regulator anywhere around the world succeeded in predicting that.”

Sion Simon, a Labour Party member of the committee, said he had heard that relations between the FSA and the Bank of England were “poisonous” and compared McCarthy to a boxer.

“You are the Sugar Ray Leonard of the financial-services sector. You are a world-class ducker and diver.” Simon told McCarthy. “There was a run on the bank, the nation was a global laughing stock, and you say the provisions worked?”

Instead of saying ‘We didn’t predict it and neither did anybody else’, McCarthy should have blamed the credit rating agencies. That technique is working beautifully in North America!

Speaking of credit rating agencies, I see in the Globe today that State Street (among other Money-Market-Fund sponsors) is seeing a big uptick in business:

Executives at many small to mid-sized companies across Canada woke up in mid-August to find a portion of their supposedly liquid cash holdings were frozen, as a $30-billion segment of the asset-backed commercial paper market (ABCP) collapsed. Airline Transat A.T. Inc., for example, has $154-million of its $340-million in cash reserves stuck in a holding pattern.

“Corporate treasurers suddenly became aware that they face risks in their cash holdings, and they’re rushing to deal with these risks,” said Gregory Chrispin, president of State Street’s Canadian arm and former treasurer of Export Development Canada.

It is nice to see that some companies are taking my advice to stick to what they’re good at and pay for portfolio management. Whether or not there will be a surge of CFO replacements to accompany the sudden discovery that treasury departments have been speculating with shareholder assets remains to be seen! 

Treasuries drifted downwards, attributed to a ‘no-recession’ indication by the Fed, though today’s retail sales number provided no indication of a huge economic boom. Canadas fell, as a strong housing number decreased chances for a rate cut. US equities rose (no recession!) while Canadian equities were pretty quiet.

The news in the preferred share market today was that the TD New Issue and the closing of the BMO new issue combined to drive the PerpetualDiscount index to a new low. The prior low (since the temporary index was started, as of 2006-6-30, that is) was set on June 12, 2007. The four main indices since then have returned:

If we look at returns for CPD …

So, speculating on price movements in prefs has not been a jolly time for the past four months! Fortunately, the investments are paying the same income as they have done in the past, so income – which is the entire reason for investing in prefs, right? – is unaffected. Market timers may wish to kick themselves for getting it wrong, but an honest market timer is always kicking himself anyway, so there’s not much difference there.

It was nice to see some good volume in the pref market today, with a few good-sized crosses courtesy of Scotia.

There were sixteen other index-included $25.00-equivalent issues trading over 10,000 shares today.

Remember last month’s US jobs number? Don’t. It’s been revised upwards with an entirely solid number reported for September, which has been enthusiastically greeted by most economists, ( including JDH of Econbrowser) although Noriel Roubini sees the devil in the details. There was much the same thing in Canada. So, basically, bad news for bonds.

But in a reminder that, yes, sub-prime is really still a concern, both Merrill Lynch and Washington Mutual took big housing-related write-downs amidst reports of fire-sale liquidations and horrifying lack of quality in 2007-vintage sub-prime loans. Concern, yes; end of the world, no. For sure, $150-billion in sub-prime losses ($50-billion? $100-billion?) sounds like a very big number, but I’ll just take a moment to remind readers of Nortel’s market cap in 2000: almost $400-billion. So by all means, worry. But don’t try to tell me that this is an unprecedented disaster requiring extensive regulation. Accrued Interest has taken a look at contagion in non-RMBS asset-backed paper.

There’s entirely too much speculation that the credit crunch is over. Accrued Interest is concerned that the pendulum, having swung too far one way, will promply over-correct in the other direction. Panic, ecstasy … just another day in the markets. Those who wish to profit from panic without having access to institutional markets might wish to take a look at DG.UN, which was mentioned here on August 28 when it suspended redemptions (ABCP financing dried up). According to their September 26 Press Release:

its net asset value (“NAV”) per unit as at August 31, 2007 was $7.92 based on an indicative price received from a large international bank (the “Bank”) as of August 28, 2007.
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The NAV on a particular date is equal to the aggregate value of the assets of the Trust, less the aggregate value of its liabilities (calculated in conformity with Generally Accepted Accounting Principles (GAAP)). The NAV does not reflect any eventual write-down resulting from the interruption of payments that MMAI is required to make to Global DIGIT under the swaps, nor does it reflect any potential impairment in the value of the assets of Global DIGIT from any eventual restructuring of MMAI debts, as it not possible at present to determine if, when and to what extent such payments to Global DIGIT under the swaps will resume or the effect of any eventual restructuring of any such MMAI debts.

So … there’s some warnings there and there could be legal problems and all sorts of things. But from what I could make out with a VERY brief look, the underlying credit was fine – it’s just liquidity that causes concern … and it’s quoted today on the TSX at 2.80-00, 8×23; so it seems to me it’s worth closer inspection by those willing to rip apart the books and make a few ‘phone calls prior to a decision.

The Economist has published a commentary on bank liquidity that echoes Dodge’s comments on the seemingly very high level of liquidity guarantees given by the banks. I suggest that one thing that be considered is a sliding scale of capital charges for liquidity guarantees: the charge is now a 10% CCF across the board; perhaps something like … “10% on the first capital-equivalent, 15% on the next, 20%…” might permit the market to operate efficiently while keeping the number of lines under control.

Brad Setser continues to worry about the USD, which has been a topic of some concern lately.

I added an ad to the recent reader inquiry; you don’t really need to do it all yourselves, you know! I’m willing to help!

The jobs numbers crushed bonds in both the US and Canada today.

It was an interesting day for prefs! The yield on PerpetualPremiums is finally back below PerpetualDiscounts, which is only sensible given the greater interest rate risk on the latter. Operating Retractibles and SplitShares have been virtually immune to the recent declines in perpetuals … this makes sense up to a point, but only up to that point.

There were four other index-included $25.00-equivalent issues trading over 10,000 shares today.

There was a report today of another sub-prime winner:

Harbinger Capital Partners, the hedge fund firm run by former Barclays Capital trader Philip Falcone, generated returns of more than 65 percent this year, helped by bets against subprime-mortgage bonds and gains on commodities.Harbinger’s $2.5 billion Special Situations fund increased 9.9 percent last month and more than 100 percent in 2007, said two of the firm’s investors. The $11 billion Harbinger Capital Partners fund rose 5.4 percent last month and 65 percent this year.

Lucky or smart? Does it matter?

The Fed released Commercial Paper Outstandings today; it would appear the situation is normalizing rapidly. ABCP outstanding was down about $6-billion on the week, a nice chunk of change but relatively small in the context of the $906-billion total outstanding. Quality spreads, while still high compared to the last six years, are in decline.

The following posts were either written or updated today:

• Whoosh! Market Adjustment Affects Fair Value of New Issues
• Early Commentary on Canadian ABCP
• Fed Regulation of US ABCP Liquidity Guarantees
• Query from a Reader: Time to Buy?

… which should go a long way towards explaining the brevity of today’s round-up!

There are some very thoughtful essays regarding the Northern Rock bail-out in the WSG Economics Blog and the Economist. There’s another link to an Economist article about the funding gap in British banking … there is an increased reliance on commercial paper, as opposed to deposits, to fund bank loans:

 

Meanwhile, the preferred share market showed a little stability today. There were some rather violent individual moves, but most of these were reversals of previous silliness.

There were eleven other index-included $25.00-equivalent issues trading over 10,000 shares today.

The latest passion on the Street is telling everybody how lousy everything is! PIMCO & TIAA-CREF hate the market, Greenspan hates the market, Credit Suisse hates the market … there’s no shortage. But it takes two to make a market! James Hamilton at Econbrowser takes a look at recent indicators and points out that – so far, anyway – the problems in the US housing market haven’t spread to other areas of the US economy. So take your choice!

The BIS Quarterly Review has a good review of the credit crunch.

I’ve updated the post about the Globe’s reporting of Dickson’s speech with a link and extract from the National Post’s article, which is much more reflective of what was actually said. You almost wonder if the reporters are reporting the same speech!

Fitch Ratings has announced that it completed its review of 2006-vintage sub-prime issues:

For first- and second-lien transactions combined, Fitch has affirmed 2,228 classes with a par balance of $155.1 billion and downgraded 1,003 classes with a par balance of $18.4 billion. While Fitch’s reviewed all rating categories, downgrades were most heavily concentrated among classes originally rated ‘BBB+’ or lower. Fitch believes that those classes that have been downgraded to below-investment grade have substantial risk of principal loss. However those bonds remaining investment grade still exhibit the ability to withstand the higher projected collateral default and loss expectations without principal loss. Those classes affirmed at ‘AAA’ are able to withstand a substantial multiple of expected collateral performance without experiencing loss.

This action was gleefully reported by Bloomberg and commented upon by Joseph Mason, an associate professor at Drexel University. Mr. Mason has testified to the Subcommittee on  Capital Markets, Insurance, and Government … woo-hoo! I haven’t read his testimony thoroughly yet, but a quick skim suggests that he doesn’t like the Credit Rating Agencies very much! I’d better get cracking on my reading, because his faculty web-page pointed me to a paper on the value of recourse which has implications for bank-sponsored ABCP. Briefly, it would appear – the authors claim – that the market is implicitly assuming that there will be support for conduits even when there doesn’t need to be; this is very similar to the US mortgage GSEs and implicit ‘off-balance-sheet’ Treasury backing.

By providing recourse in cases where none is explicitly required, the sponsor demonstrates the presence of de facto recourse and therefore previously unreported contingent liabilities. The present paper examines the effects of these revelations on the sponsor. On the face of it, one might expect that revealing previously unreported contingent liabilities could heighten asymmetric information about firm conditions, resulting in poor short- and long-term stock price performance, poor long-term financial performance, and reduced proceeds from subsequent loan sales. However, we find that, conditional on being in a position where honoring implicit recourse has become necessary and conditional on actually providing that recourse, the sponsors, on average, exhibit improved short- and long-term stock price performance, improved long-term financial performance, and similar proceeds from subsequent loan sales.

This is of interest in terms of assessing market discipline and credit analysis of the banks. For example, note 5 of the 2006 BMO Financials discloses that almost CAD 80-billion of liquidity guarantees had been extended, none of which found its way into risk-weighted assets (that’s none. N-U-N. none). Given the bank’s capital of CAD 16,641-billion, reported risk-weighted assets of CAD 162,794 and a CCF of 10%, this would not make a huge difference to the tier 1 capital ratio. But – given recent experience – is the CCF of 10% high enough? Eighty-billion landing suddenly on their balance sheet might give them collywobbles – and Rule #1 states that Everything Bad Happens at the Same Time.

Market discipline is something of a worry, despite the investment industry’s constant reiteration that we’re such a bunch of tough guys. However, Beloved Leader And Economic Genius for Life Stephen Harper is taking care of an oversight, and reminding investors that they are stupid:

Sources told The Canadian Press on Tuesday that Industry Minister Jim Prentice is concerned about foreign state-owned entities snapping up Canadian resource firms.

Among those currently being reviewed, sources said, is the PrimeWest acquisition, part of TAQA’s stated goal of dramatically growing its presence in Canada’s energy sector.

At a late Wednesday news conference in Ottawa, Prime Minister Stephen Harper said his government will address the lack of a national security test for foreign takeovers of Canadian companies.

It’s about time this country was protected from foreigners offering enormous bundles of cash! If such sums ever reach Canadian hands, we’ll just blow it on beer and prostitutes.

Volume picked up today, but perpetuals continued their slide. I confess that I find this continued weakness somewhat odd … but market volatility brings trading opportunities, and the passage of time brings dividends, so my curiosity is somewhat muted.

There were nineteen other index-included $25.00-equivalent issues trading over 10,000 shares today.

The private equity bid for Sallie Mae has been revised – the much lower price is attributed to cuts in the US Federal subsidy of student loans. Accrued Interest called it right! The idea that the bidders believe they’ll be able to finance a $20-billion takeover is a good sign for the credit markets. It looks as if the target company will not agree instantly to the proposed price reduction.

There’s more than one takeover in the news as cross-border shopping is taking off … TD is buying a US bank for $8.5-billion, doubling the size of their US operation. RBC has spent $2.2-billion on a Trinidadian bank. Even the Montreal Exchange is increasing its stake in the Boston Options Exchange. Despite this, the ‘Hollowing-Out Crowd’ is flexing its muscles in the apparent belief that Canadians are too stupid to charge a good price for assets and too lazy to put cash to good use once a sale closes.

Despite periodic chatter that the ‘market believes the credit crunch is over’, I’ll stick to my guns and say we haven’t seen the worst yet. Interest rate adjustments take some time to percolate through the system – and there was bad news from US housing today, with liquidity drying up a lot. However, in another sign that the market is reacting rationally to changed circumstances, there are rumours that:

Goldman Sachs Group Inc. may buy Litton Loan Servicing LP, the Houston-based servicer of U.S. subprime mortgages, said people with knowledge of the matter.
…
Goldman may be betting it can increase the value of mortgage assets by reworking loan terms to make it easier for borrowers to pay their debt, said Terry Couto, a partner at Newbold Advisors, a mortgage-consulting firm.

Buying a servicing business would allow the owners “to go out and buy distressed loan portfolios, or work out what they already own,” Couto said.

Don’t take the brevity of this post as a sign I am ignoring you! The following posts are new today:

• HIMIPref™ Index Performance, September 2007
• MAPF Portfolio Composition : September 28, 2007
• What Dickson REALLY said about DBRS / ABCP

Additionally, I added some new information to MAPF Performance : September, 2007 and the “fair price” of the two new issues. So read all that stuff instead.

Overall performance in the preferred share market was mixed, enlivened somewhat by the slowing, but never-the-less continuing decline in the PerpetualDiscount index. It is now down 3.89% from its value on September 24, and not much above the recent worst level of 943.3 reached on June 12.

There were fourteen other index-included $25.00-equivalent issues trading over 10,000 shares today.