PrefBlog

This is way, way, way WAY off topic, but I grew up with Vivien Leigh telling the Beatrix Potter stories (on 45s – if anybody remembers what those were) and have been looking for re-releases for years. Found ’em! The best is Peter Rabbit.

Yet another major US housing subsidizer is in trouble:

The Federal Housing Administration, which insures mortgages with low down payments, may require a U.S. bailout because of $54 billion more in losses than it can withstand, a former Fannie Mae executive said.

“It appears destined for a taxpayer bailout in the next 24 to 36 months,” consultant Edward Pinto said in testimony prepared for a House committee hearing in Washington today.
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The FHA program’s volumes have quadrupled since 2006 as private lenders and insurers pulled back amid the U.S. housing slump, Pinto said. The jump has left the agency backing risky loans and exposed to fraud in a “market where prices have yet to stabilize,” he said.

Representative Scott Garrett, a New Jersey Republican, introduced legislation this month to boost the FHA’s minimum down payment to 5 percent from 3.5 percent to help shore up the agency’s insurance fund, a move that could add to the housing market’s burdens as it struggles to recover.
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Falling prices will push the FHA’s single-family fund’s reserves below a 2 percent cushion required by Congress, Commissioner David H. Stevens, who will also speak today, said last month. “Under no circumstances will a taxpayer bailout be needed” because the shortfall will be cured over time, he said.

The idea the FHA needs a rescue is “just plain wrong,” Stevens said in an Oct. 6 letter to the Wall Street Journal. That’s in part because the FHA’s accounting method mean its reserves are enough to cover more than 30 years of projected losses, assuming no revenue from new business, he said.

FHA’s total reserves exceed $30 billion, or more than 4.4 percent of its insurance, according to Stevens. The loan- insurance ratio, which compares the reserves with the loans insured, was 6.4 percent a year ago, government data shows.
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Official figures on FHA’s reserves as of Sept. 30 won’t show a shortfall when released because “the assumptions used will be overly optimistic relative to loss mitigation resulting from both loan modifications and recent and expected underwriting changes,” Pinto said.

In the early days of MLEC (remember MLEC? It was going to save the world from a possible credit crunch) I argued that the only way it could work would be if it had the plan of buying wonderful assets from distressed SIVs. Now that PPIP is the acronym of the day, it looks like I was right:

Starwood Capital Group LLC and TPG’s agreement to buy $4.5 billion of Corus Bankshares Inc.’s real estate assets shows investors are ready to bet on distressed property — as long as the U.S. helps finance the deals.

The private-equity firms led a group that won the auction for loans and properties of the failed Chicago lender, offering $554 million, the Federal Deposit Insurance Corp. said Oct. 6. They will take a 40 percent stake and manage the portfolio, while the FDIC keeps 60 percent and lends the buyers as much as $2.39 billion to complete the sale.

The investors, who are paying about 60 cents on the dollar, beat out seven other bidders.

Some may quibble over my equating these distressed mortgages with “wonderful assets” … but with vendor financing of over 80% of the price on a non-recourse basis … well, it works just like that extra glass of beer in a pick-up bar near closing time, you know?

THUMP! The preferred share market got whacked again today, with PerpetualDiscounts down 43bp and FixedResets losing 16bp on good volume. I am pleased to see a lot of volatility evidenced in the composition of the performance table: there were fifteen index included issues losing more than a point (total return), but five gained more than this. Increasing volatility means more trading chances!

The new PWF 5.80% Straight starts trading tomorrow … that should be fun.

The OSFI Annual Report 2008-09 has been published. Standard corporate puffery, but this part was amusing:

Because the Canadian financial system withstood the first wave — global financial market turmoil — better than many systems, OSFI has received a lot more attention than we normally do, and fielded many questions as to why Canada has faired relatively well. Our answer has been that the strength of the Canadian system is due to Canada’s overall policy framework, the quality of OSFI’s supervision and regulation, cooperation and communication among Financial Institutions Supervisory Committee (FISC) partners (OSFI, the Bank of Canada, the Canada Deposit Insurance Corporation, the Financial Consumer Agency of Canada and the Department of Finance) and the risk management skills of Canada’s financial institutions. The contributions of all the players in the system have led to Canada’s success to date.

There is no acknowledgement of other answers to the question either here or by comparison with Australia. However, given the quality of Canada’s governance, it doesn’t need to be particularly rigorous, does it?

The SEC’s Department In Charge of Making Prospectuses Longer has proposed new rules regarding credit rating related disclosure:

We believe that today’s proposals could help reduce undue reliance on credit ratings by providing investors with information about what a credit rating is, and what it is not, and other information bearing on the reliability of ratings to place the credit rating in its proper context. In light of the importance of credit ratings to investors and their use by registrants in marketing securities, we believe it is appropriate to require that this information be included in a registrant’s prospectus so that all investors receive this information.

Finally! In the past, advisor/investor conversations about credit quality have been along the lines of “General Motors Microsoft’s always going to be around, Jack. I wouldn’t worry about it!”. But now that this information will at last be available to investors who have searched hopelessly for this kind of vital information, they may now read all about it and engage in learned discussions with their advisors. Then Prime Minister Layton will present Conrad Black with the Order of Canada, while City of Toronto Councillors make intelligent remarks in the background.

More alarmingly, the SEC is also proposing to treat CRAs as “experts”; this will require them to give consent to having their ratings included in a prospectus, and allow third parties to use the ‘experts defense’, that they are not liable for things not working out properly if they relied on an expert when making the decision. The more I think about this, the more insanely complicated the potential knock-on effects appear. The SEC notes:

Of course, we are mindful of the possibility that a risk of greater NRSRO liability as a result of subjecting NRSROs to Section 11 may undermine competition if credit rating agencies decide that they are unable to bear the risk of liability and thus exit the ratings business. Similarly, firms considering entering the ratings business may reconsider in the face of an increased risk of legal liability. The threat of liability may particularly affect smaller, less-established rating agencies that may find it more difficult to negotiate for indemnification or bear the risk of additional liability. It also is possible that, in response to the rescission of Rule 436(g), registrants would begin to take greater advantage of private placements instead of public offerings.

I hope they’re really careful with this one! The ‘experts defense’ was enthusiastically promoted by a Council of Institutional Investors [who?] white paper:

The accountability of NRSROs has deteriorated so much that institutional investors now are vulnerable if they rely on credit ratings in making investment decisions. To the extent rating agencies are not subject to liability, an institutional investor’s defense of reliance on ratings is weakened, because constituents can argue that ratings are less reliable when rating agencies are not accountable for fraudulent or reckless ratings.

I confess that I have not read the white paper thoroughly; it has a good discussion of the concept of “regulatory license” (in which a credit rating is considered a license to buy by a bozo) but by and large it draws its conclusions from flimsy premises (e.g., no subprime should ever have been AAA; Lehman should not have been A, et c.).

The situation with CIT Group is getting muddier:

Pacific Investment Management Co. and Baupost Group LLC resigned from CIT Group Inc.’s bondholder steering committee, reducing the group to four members, according to a person familiar with the situation.

Pimco, which manages the world’s largest bond fund, and Baupost weren’t part of the group as of about a month ago, said the person, who declined to be identified because the firms haven’t disclosed their decision. The remaining creditors on the committee are Centerbridge Partners LP, Oaktree Capital Management LLC, Capital Research & Management Co. and Silver Point Capital LP.
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CIT’s $500 million of 4.125 percent notes due Nov. 3 fell 4 cents to 67 cents on the dollar as of 2:52 p.m. in New York, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

Credit-default swaps on five-year CIT debt rose 2 percentage points to a mid-price of 40 percent upfront, according to CMA DataVision. That means it would cost $4 million initially and $500,000 annually to protect $10 million of CIT debt from default for five years.

KERRR-UNCH! It’s just like old time, with PerpetualDiscounts getting whacked for a loss of 70bp on the day, while FixedResets were able to pick up 12bp worth of total return. There is a long list of losers in the performance tables; volume was quite good.

PerpetualDiscounts now yield 5.92%, equivalent to 8.29% interest at the standard equivalency factor of 1.4x. Long Corporates now yield … oh, call it 5.95% so the pre-tax interest-equivalent spread has now widened to about 235bp, a large increase over the 215bp reported on September 30. So who’s smarter? Bond Guys or Pref Guys? Place yer bets, gents, place yer bets!

Australia has hiked the overnight right:

Reserve Bank Governor Glenn Stevens increased the overnight cash rate target to 3.25 percent from 3 percent in Sydney today. Only one of 20 economists surveyed by Bloomberg News forecast today’s move. The rest predicted no change.

The local currency jumped as Australia became the first Group of 20 nation to raise borrowing costs since the start of the global financial crisis more than a year ago. Rising job vacancies, retail sales and house prices, plus surging business and consumer confidence support Stevens’ view that the “basis for such a low interest rate setting has now passed.”

BIS has reported Bernanke’s most recent testimony. Not much new, but I was disappointed to see:

The current financial crisis has clearly demonstrated that risks to the financial system can arise not only in the banking sector, but also from the activities of other financial firms – such as investment banks or insurance companies – that traditionally have not been subject to the type of regulation and consolidated supervision applicable to bank holding companies. To close this important gap in our regulatory structure, legislative action is needed that would subject all systemically important financial institutions to the same framework for consolidated prudential supervision that currently applies to bank holding companies. Such action would prevent financial firms that do not own a bank, but that nonetheless pose risks to the overall financial system because of the size, risks, or interconnectedness of their financial activities, from avoiding comprehensive supervisory oversight.

Supervision should be narrowly focussed on banks, with an additional layer of less onerous restrictions on brokers. Interconnectedness is not a problem, as long as deals are adequately collateralized, either explicitly by the party ‘outside the wall’ of regulation, or by the bank inside the wall via capital charges.

To pretend that everything that moves can be regulated adequately will be incredibly expensive, stifling and, ultimately, ineffective.

Yet another poor day for preferreds, with PerpetualDiscounts down 33bp, although FixedResets gained 2bp. The declines were led by IAG.PR.A, possibly due to the new IAG straight 6% announced today. This issue now yields more than the new issue as well as having a more symetric risk/reward profile. The sellers will have to earn their 3%!

CreditSights has recommended against the CIT restructuring:

CIT Group Inc. bondholders should sell their investments as efforts by the 101-year-old commercial lender to restructure have “very little hope of succeeding,” according to CreditSights Inc.

CIT Chief Executive Officer Jeffrey Peek is seeking to cut at least $5.7 billion of debt through a swap of unsecured obligations for preferred shares and new secured notes maturing later. The New York-based commercial finance company is also asking creditors to approve a pre-packaged bankruptcy if it misses the exchange target.

“Currently CIT’s interest expense is too high, it cannot borrow economically to fund new business, and its liquidity is stressed,” CreditSights analysts Adam Steer, David Hendler and Jesse Rosenthal in New York wrote in an Oct. 4 report. “After digging through the details of the exchange offer and subsequent liquidity plans, we believe CIT’s plan has very little hope of succeeding.”

Investors that hold onto CIT bonds should accept the pre- packaged option, the analysts wrote.

Sub-prime mortgage packages are recovering from fire-sale prices:

Typical prices for the most-senior prime-jumbo securities rose 2 cents on the dollar last week to 84 cents, according to Barclays Capital data. Similar bonds backed by Alt-A loans with a few years of fixed rates increased 2 cents to 60 cents. The jumbo bonds are up from about 75 cents three months earlier, while the Alt-A bonds have climbed from 47 cents.

The debt has jumped from 63 cents for the jumbos and 35 cents for Alt-As in mid-March, as investors accept lower potential yields amid a rally across debt markets and traders anticipate demand from the U.S. Public-Private Investment Program. Investment funds, banks, insurers and Wall Street brokers have been among buyers, according to Scott Buchta, head of investment strategy at Guggenheim Capital Markets LLC in Chicago.
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Advantus Capital Management Inc., which oversees about $14 billion, is telling investors as it seeks more cash to buy devalued mortgage bonds they’d be better off with managers like it that aren’t part of the PPIP and thus have more freedom in selecting assets. The marketing underscores PPIP managers’ difficulty immediately raising the maximum amounts allowed and the possibility they may hold back on buying until prices drop.

PPIP managers Invesco, AllianceBernstein Holding LP and Marathon Asset Management LP have told potential investors they are targeting annual returns of at least 18 percent, according to a Sept. 2 memo by M. Timothy Corbett, chief investment officer of the Connecticut Retirement Plans and Trust Funds.

Amid the higher prices among eligible securities, “the likelihood of generating those types of returns are becoming remote, unless one were to take ever-riskier bets,” Dean Di Bias, high-yield mortgage portfolio manager at St. Paul, Minnesota-based Advantus, said in an interview last month.

Citigroup is sick and tired of doing all the paperwork for passive investors for free:

Citigroup Inc., the U.S. bank that got a $45 billion bailout last year, will revamp its North American brokerage business so that financial advisers charge ongoing fees instead of commissions on stock and fund sales.

The “strategic shift” will begin immediately, with the assignment of 600 bank-branch-based brokers to teams, New York- based Citigroup said today in a statement. Customers who think they’re better off paying commissions can do so by calling representatives at the company’s National Investor Center in San Antonio, the company said.

Frankly, I’m not sure what to make of changes in pending derivative collateral legislation:

House Financial Services Committee Chairman Barney Frank released a 187-page draft bill on Oct. 2 aimed at tightening oversight of the $592 trillion derivatives market. The measure, drawn from the Obama administration’s proposals, would require the most common and actively traded over-the-counter derivatives contracts to be bought and sold on exchanges or processed through a regulated trading platform.

The National Association of Manufacturers, U.S. Chamber of Commerce and the Business Roundtable, three of the biggest trade associations in Washington, lobbied Congress and the administration to exempt derivatives “end-users” from new rules and collateral requirements. End-users employ derivatives to hedge a risk to their operations, such as swings in interest rates, foreign currency shifts or changes in commodities prices.
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The draft would expand the administration’s exemption of end-users from collateral and clearing requirements. The administration proposal, released Aug. 11, would give a dispensation only to companies that use so-called hedge accounting. Frank’s proposal would exempt all end-user transactions and would let companies post non-cash items as collateral to satisfy margin requirements, Coleman said.

… but I’ll venture to suggest that it means lots of work for lawyers, anyway! It should also be noted that the change results in the ‘tax on derivatives use’ becomes a ‘tax on speculation’, which will hurt depth of market.

Barney Frank, by the way, thinks that since TARP equity-loans against good assets have worked out well, it’s time to extend the programme to bad assets:

House Financial Services Committee Chairman Barney Frank said he plans to introduce legislation next week to steer $2 billion in rescue funds repaid by U.S. banks to foreclosure relief for unemployed workers.

Funds from the $700 billion Troubled Asset Relief Program should be loaned to Americans without jobs and at risk of losing their homes, Frank said today in a telephone interview. Frank has said the program will be extended beyond its December expiration for foreclosure relief and to help community banks.

The SEC is continuing its search for infallable credit analysts:

When calculating net capital, broker-dealers are permitted to take a lower capital charge, called a “haircut,” for certain types of securities that are rated investment grade by an NRSRO.
As the Commission stated in proposing to remove references to NRSROs from the Net Capital Rule, broker-dealers are sophisticated market participants regulated by at least one self-regulatory organization. Accordingly, the Commission expressed its preliminary belief that broker-dealers would be able to assess the creditworthiness of the securities they own without undue hardship.30 In lieu of the references to NRSROs in the Net Capital Rule, the Commission proposed substituting two subjective standards for credit risk and liquidity risk. For the purposes of determining haircuts on commercial paper, the Commission proposed to replace the current NRSRO ratings-based criterion with a requirement that the instrument be subject to a minimal amount of credit risk and have sufficient liquidity such that it can be sold at or near its carrying value almost immediately.
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Notwithstanding the Commission’s belief that broker-dealers have the financial sophistication and resources to make these determinations,33 the Commission stated that it would be appropriate, as one means of complying with the proposed amendments, for broker-dealers that wished to continue to rely on credit ratings of NRSROs to do so.34
The majority of the commenters to the Commission’s proposal to remove references to NRSROs from the Net Capital Rule were opposed to the change.35 Generally, commenters stated that they preferred the existing rule because it is a bright line objective test that is relatively inexpensive to utilize.
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The Commission also requests comments on the following specific questions:

• • Are there factors other than creditworthiness and liquidity that should be required to be considered in determining the appropriate haircut for a proprietary securities position?
• • What would be the cost to broker-dealers to develop, document, and enforce internal procedures to evaluating the creditworthiness and liquidity of proprietary securities positions?
• • Do certain broker-dealers lack sufficient resources or expertise to independently assess the creditworthiness of securities?

I have no problem with allowing broker-dealers to assess credit risk themselves; this might even increase pressure to repeal Regulation FD, which is the most serious impediment to investors’ credit analysis. I don’t have any expectation of such analyses being better, however; merely different.

Another day of declines for preferred shares, with PerpetualDiscounts down 15bp on the day and FixedResets losing 6bp. The market is getting a little sloppier, according to HIMIPref™’s curve-fitting algorithms.