PrefBlog

I can’t resist picking on Basis Yield Alpha Fund (discussed yesterday; it’s crying about having bought Timberwolf notes from Goldman) a little bit more. It was among the earliest crunch casualties:

[2007-08-28] Basis Yield Alpha Fund, a hedge fund specializing in corporate and structured credit, on Wednesday filed for bankruptcy protection in the United States amid mounting losses from U.S. subprime mortgage assets, court papers show.
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Earlier in the month, the hedge fund firm told investors that losses at one of its portfolios had lost more than 80 percent in assets.

Award winning!

Basis earned the “Fund of the Year” title at the 2005 AsiaHedge awards and Macquarie Bank Ltd.’s “Skilled Manager of the Year” in 2004.

The lenders got paid:

Banks that lent to failed hedge fund Basis Yield Alpha, run by Australia’s Basis Capital, are likely to get all their money back and there could be a payment to investors, the fund said. Yield Alpha, which started the year with about $700m, has returned to solvency and can afford to repay banks which seized the fund’s assets when it missed margin calls earlier this year. The development is a result of continued payouts by structured credits in which Basis invested, apparently resolving one of the few situations in which lenders to a hedge fund lost money. Basis became the second hedge fund group this year to see one of its funds collapse amid the US subprime crisis, after the failure of two funds run by Bear Stearns.

Budget cuts in Greece may put Canada’s 1990’s experience to shame:

Greek Prime Minister George Papandreou said the country’s survival was at stake in talks to win a potential $159 billion European Union-led bailout in exchange for budget cuts denounced by unions as “savage.”
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Papandreou’s budget cuts may include a three-year wage freeze for public workers and eliminating two of their 14 annual salary payments, the ADEDY union said. Greece’s NET Radio reported that cuts could amount to 10 percentage points of gross domestic product. The deficit was 13.6 percent of GDP in 2009.
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Other deficit-cutting steps include increasing sales tax and raising the cap on the number of workers who can be fired to 4 percent from 2 percent, Kathimerini newspaper said, without saying where it got the information.

There is a sort-of encouraging trend for US banks:

Gerald J. Ford, who became a billionaire by purchasing distressed lenders during the last banking crisis, isn’t waiting around during this one for Sheila Bair’s Federal Deposit Insurance Corp. to offer him a deal.

After bidding unsuccessfully on several lenders seized by the FDIC, Ford said he’s pushing ahead with a $500 million injection for Pacific Capital Bancorp, a California lender that has said it may collapse. He’s among the private-equity investors who are now willing to buy banks without an FDIC guarantee on loan losses.

“We’re trying to do this one sooner rather than later,” Ford, 65, said in an interview yesterday. “We’ve been out there looking for a long time.”

Private-equity firms are going after live banks after complaining the FDIC put up too many obstacles and changed the rules for buying failed lenders, which are piling up at the fastest rate in two decades. Three days before Ford’s deal, private-equity firm Thomas H. Lee Partners LP agreed to pay $134.7 million for a stake in Sterling Financial Corp., a Spokane, Washington-based lender that’s still open after posting two annual losses.

Both deals depend on the U.S. Treasury Department agreeing to take a loss on the stake held by its bank bailout fund. The Treasury signed on to the Sterling deal yesterday, according to the bank.
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The Sterling accord calls for the bank to raise a total of $720 million and would give Boston-based Lee a 19.9 percent stake. The U.S. agreed to swap its $303 million stake for new securities valued at $75.8 million, Sterling said in a statement on April 29. Treasury spokesman Andrew Williams declined to comment and Richard Walsh Jr. at Thomas H. Lee didn’t immediately respond to a request for comment.

At Pacific Capital, the agency would be required to exchange $180.6 million for common shares at about 20 cents on the dollar, according to a statement. Pacific Capital has told investors it may not survive without new capital.

If Treasury is involved, then it’s a political issue – which it should be. However, the details of the deals would have to be examined very closely to see whether, all in, Treasury taking a loss now is better for taxpayers than the FDIC (maybe) taking a loss later.

The forces of do-goodism have received a mild rebuff:

Spain is lancing an 18 billion-euro ($24 billion) investment bubble in solar energy that has boosted public liabilities, choking off new projects as it works to cut power prices and insulate itself from Greece’s debt crisis.

Industry Minister Miguel Sebastian is negotiating reductions in subsidies for solar plants that would curb energy costs, a ministry spokesman said this week. Grupo T-Solar Global SA, the world’s biggest photovoltaic plant owner, shelved its Spanish stock offering three days ago. Solar Opportunities SL postponed a 130 million-euro deal due to be signed today.
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Spain is battling on several fronts to revive its economy and convince government bondholders it can avoid getting dragged into a Greek-style debt spiral after Standard & Poor’s cut its credit rating April 28. Solar-plant owners including General Electric Co. earn about 12 times what’s paid for power from fossil fuels. Most of that is a subsidy charged to customers.

You can only waste money if you’ve got money to waste! Unfortunately, the Smitherman subsidy aimed at making Ontario a hot-bed of world-class lobbying is still considered sane.

OSFI’s Mark White has delivered a speech titled P&C Reinsurance to Fit the Times – A Question of Balance; the limits and collateralization rules on Property and Casualty reinsurance are being revamped. This follows the Response Paper: Reforming OSFI’s Regulatory and Supervisory Regime for Reinsurance, published in late March.

Transcripts from 2004 show that the Fed was perplexed by the early housing boom; at the June meeting a researcher stated:

With regard to the question of owning versus renting, it depends to some extent on what is happening to interest rates because that changes that calculation at the margin. So it’s really important to plot any kind of valuation measure relative to an opportunity cost. Just showing the rent-to-price ratio I think would have been somewhat misleading; it’s really that gap that we think is the meaningful measure of valuation. And it looks somewhat rich, taking account of the fact that interest rates are relatively low and income growth has been relatively strong. I don’t want to leave the impression that we think there’s a huge housing bubble. We believe a lot of the rise in house prices is rooted in fundamentals. But even after you account for the fundamentals, there’s a part of the increase that is hard to explain.

SEC Commissioner Luis A. Aguilar has delivered a speech to the Investment Adviser Association Annual Conference

The Senate Bill, however, has abandoned its strong position in the face of determined lobbying by the insurance and brokerage industries. The revised version that was voted out of the Senate Banking Committee on March 22nd has eliminated the provision applying the fiduciary standard to brokers who provide investment advice. It would, instead, require a one-year study by the SEC concerning the effectiveness of existing standards for “providing personalized investment advice and recommendations about securities to retail customers.”

I continue to have concerns about this retreat from requiring a fiduciary standard for all who provide investment advice. First, I see no need to study the effectiveness of existing obligations for investment advisers. We already have a strong, workable standard that has been in use successfully for decades, and I would not support any attempt to weaken it. Second, as with the House Bill, I question why the protection of the fiduciary standard should be limited to “retail” customers. It is readily apparent from recent Commission enforcement cases — such as the cases involving auction rate securities — that all investors, including institutional investors, need the protection of the fiduciary standard. Third, I question why the study, as well as the reach of the House Bill, should be limited to “personalized services.” This qualification would narrow the range of clients that would be protected by the fiduciary standard, and I fear that it may become a loophole that would make it easy to avoid putting clients first.

This is completely insane. Institutional investors are acting as fiduciaries for the institutions they represent. How many layers of fiduciary responsibility are necessary? How many have to be paid for? Why do F-Class and discount brokerages exist in the first place? As discussed yesterday, an institutional investor will discuss trades with the sell side with the clear understanding that his counterparty wants to clean him out and send him home naked and hungry. Any buy-side investor who does not understand this – and does not understand that there is exactly one layer of fiduciary between the lions and lambs an that he’s it; or who does not devote independent analysis to each investment idea with precisely this fact in mind – should lose his license. I am sick to bloody death of politicians and regulators telling me that I’m too stupid to negotiate deals for my clients — and that only the sell side can be trusted with such important decisions.

Commissioner Aguilar’s background should be noted:

Prior to his appointment as an SEC Commissioner, Mr. Aguilar was a partner with the international law firm of McKenna Long & Aldridge, LLP, specializing in securities law. During his career, his practice included matters pertaining to general corporate and business law, international transactions, investment companies and investment advisers, securities law, and corporate finance. He also focused on issues related to corporate governance, public and private offerings (IPOs and secondary offerings), mergers and acquisitions, mutual funds, investment advisers, broker-dealers, and other aspects of federal and state securities laws and regulations.

A lawyer. Almost certainly has never been on the ‘phone and said “done” in his life.

A long, long month for Canadian preferred share investors shuddered to an end today with, wonder of wonders, gains for both PerpetualDiscounts (up 5bp) and FixedResets (up 3bp). Volume continued heavy.

PerpetualDiscounts now yield 6.35%, equivalent to 8.89% interest at the standard equivalency factor of 1.4x. Long corporates have returned +1.21% on the month (+6.29% on the year-to-date) and now yield about 5.7%, making the pre-tax interest-equivalent spread (also called the Seniority Spread) about 320bp, about the same as was reported April 28 and a massive jump higher than the +285 bp reported March 31.

Interesting mutual fund idea:

BlackRock Inc., the world’s largest asset manager, and Blackstone Group LP’s GSO Capital Partners LP are forming mutual funds to invest in loans as the London interbank offered rate rises to the highest level since August.

Within the past two months, the firms have joined Goldman Sachs Group Inc. in announcing funds that invest in leveraged loans pegged to short-term interest rates. Investors poured more than $2.5 billion into bank loan mutual-funds in March and the first three weeks of April, more than triple the amount for March and April last year, according to Lipper FMI data.
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The S&P/LSTA U.S. Leveraged Loan 100 Index has returned 5.68 percent this year, building on last year’s record 52 percent as lending continues to open up. New money “will provide financing, which will help” merger and acquisition deals get done, according to Invesco Ltd.’s Tom Ewald.
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This year, $91.6 billion in leveraged loans have been underwritten, more than four times the figure from the same period in 2009, according to data compiled by Bloomberg. The interest charge on leveraged loans is typically tied to Libor.

However, the only term-criteria for inclusion in the index is:

Minimum initial term of one year

… which suggests that – as always – people are so fixated on interest-rate risk that credit risk is forgotten. It brings up a number of issues … we’ve seen (oh boy, have we ever seen) how the redemption on demand nature of mutual funds doesn’t mix too well with borrowers’ desire for long-term funding at short term rates (see Volcker to Regulate Money Market Funds as Banks? and The US Dollar Shortage & Policy Response).

This dichotomy will not play out in precisely the same manner as the USD MMF crisis, of course, since the loans have a contractual term that didn’t begin as money-market …. but a similar crunch could lead to forced selling that that will put the Credit Crunch to shame.

There are rumours that regulatory extortion works as well as ever:

After 11 hours of accusations by members of the Senate Subcommittee on Permanent Investigations, people close to the bank said Goldman is mulling closing the SEC fraud-case chapter on the belief the firm’s reputation, already damaged, might not endure a street fight with the Wall Street watchdog.

“It’s almost a certainty that there will be a settlement,” said a source.

As another person put it, the SEC has an “unlimited supply of ammunition” in the form of e-mails and records that it could release, and Goldman officials would like to avoid having those documents fired back at them the way they were on Tuesday.

Predictably, the boo-hoo-hoo brigade is in full cry. For example, there are reports that Basis Yield Alpha Fund is claiming that it did not independently analyze its investment and simply bought whatever their salesman offered:

Citing several people familiar with the matter, The FT said Basis Yield Alpha Fund was seeking compensation over its $100 million investment in Timberwolf, a so-called hybrid collateralized debt obligation that Goldman took to market in March 2007, Reuters reported.

As far as I can tell, Basis Yield Alpha Fund was run by Basis Capital. It is worthwhile to note the company’s Executive Team page; the proprietors, Steven Howell and Stuart Fowler tout their experience but not their results.

There is pressure to use German banks as a political tool:

German lawmakers considering a bill to aid Greece challenged Chancellor Angela Merkel to involve banks in the rescue, refusing to back down after her government said that would send a “fatal signal” to markets.

The main opposition Social Democratic Party threatened to withhold support for aid next week when the bill is fast-tracked through parliament unless banks are asked to contribute. Members of Merkel’s Christian Democrats said the government should ask banks to voluntarily accept losses on their investments.

After having been hammered by dumb investments in CDOs, the banks should be grateful to the politicians for pointing out better investments, eh?

So-called “Strategic Mortgage Defaults” in the States are increasing:

Decisions by U.S. homeowners to walk away from mortgages they can afford account for an increasing share of defaults, according to Morgan Stanley.

About 12 percent of all mortgage defaults in February were “strategic,” up from 4 percent in mid-2007, New York-based Morgan Stanley analysts led by Vishwanath Tirupattur wrote in a report today. Borrowers are more likely to stop paying their mortgages the higher their credit scores and the larger their loans, the analysts said.

Defaults by borrowers who owe more than their homes’ values are among the biggest risks for the housing market, according to analysts including Zelman & Associates’ Ivy Zelman and Amherst Securities Group LP’s Laurie Goodman. Last month, the Obama administration said it would adjust its anti-foreclosure program to encourage reductions to borrowers’ principal amounts, instead of just the payments they make, to address the issue.

The importance of asset-ratio relative to income-ratio in mortgage default analysis was discussed in the post Redefault on Modified Mortgages

You knew this was coming, didn’t you? The US Senate financial regulation bill says that pension fund managers are too dumb to act as principal or, to put it another way, only the sell-side has the ability to analyze financial instruments:

Fannie Mae, Freddie Mac and Harvard University are among public and private entities that could be shut out of the $605 trillion privately negotiated derivatives market they use to manage risks under legislation being debated in the U.S. Senate, according to an industry group.

The bill would impose a fiduciary duty on swaps dealers doing business with cities, states, government agencies, pension plans and endowments, applying standards that would require banks such as JPMorgan Chase & Co. and Goldman Sachs Group Inc. to put the interest of those entities ahead of their own.

But I guess it all makes sense, eh? The politicians have to do something to show they are Responding To The Credit Crunch and since the buy side was (approximately, more or less, give or take) unscathed by the horror, the sell side (which nearly destroyed itself) must take on responsibility for advising it.

A mixed day on continued heavy volume for the Canadian preferred share market, as PerpetualDiscounts were able to record a gain of 9bp, while FixedResets continued their descent, losing 17bp to bring the median average yield-to-worst up to 4.56%. That’s a point more than their yield on March 31. A full point!

Spain’s been downgraded:

Spain had its credit rating cut one step by Standard & Poor’s to AA, putting it on a par with Slovenia, as contagion from Greece’s debt crisis spreads through the euro region.

S&P said in a statement today that the outlook on Spain is negative, reflecting the chance of a possible further downgrade if the “budgetary position underperforms to a greater extent than we currently anticipate.” Spain was last cut by S&P in January 2009.

The risk premium investors demand to hold Spanish bonds surged to the highest in more than a year today and the price of insuring Spanish bonds against default reached a record as doubts about Greece’s ability to pay its debt spilled over into Spanish and Portuguese markets.

… and S&P is making recovery-on-default estimates for Greece:

The ratings firm yesterday cut Greece three steps to BB+, or below investment grade, and said bondholders may recover only 30 percent to 50 percent of their investments if the nation fails to make debt payments. Europe’s most-indebted country relative to the size of its economy has about 296 billion euros of bonds outstanding, according to data compiled by Bloomberg.

OSFI’s Assia Billig gave a presentation on the Canada Pension Plan. Real returns on the fund’s portfolio are estimated to be 4.2% +/- 1.5% with 95% confidence. It won’t be holding a lot of government bonds!

Senator Levin is doing some more grandstanding:

Levin, who questioned Goldman Sachs executives during a hearing in Washington yesterday, said the regulatory reform bill being weighed in the Senate will address conflicts where companies have undisclosed interest in betting against clients.

Today’s FOMC statement was encouraging for fixed-income investors:

Although the pace of economic recovery is likely to be moderate for a time, the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability.

With substantial resource slack continuing to restrain cost pressures and longer-term inflation expectations stable, inflation is likely to be subdued for some time.

The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period.

Another day of poor performance on high volume for the Canadian preferred share market, as PerpetualDiscounts lost 16bp while FixedResets were down 12bp.

PerpetualDiscounts now yield 6.35%, equivalent to 8.89% interest at the standard equivalency factor of 1.4x. Long corporates (which are up 0.70% on the month-to-date and +5.76% year-to-date) now yield about 5.7% (edging towards 5.6%!) so the pre-tax interest-equivalent spread is now about 320bp, a significant widening from the 305bp reported April 22, above the recent high of +310bp reported April 7 and a big move wider than the +285bp reported on March 31.