PrefBlog

Willem Buiter has commented on the BoE liquidity operation discussed by PrefBlog on April 21:

The Bank of England is now wholeheartedly committed to acting as market marker of last resort for systemically important securities for which the markets have become illiquid, not to say defunct, since the start of the crisis in August 2007.

Dr. Buiter’s phrase “market maker of last resort” was introduced in his post from last August.

The market maker of last resort function can be fulfilled in two ways. First, outright purchases and sales of a wide range of private sector securities. Second, acceptance of a wide range of private sector securities as collateral in repos, and in collateralised loans and advances at the discount window.

I cannot help but feel that this phrasing is imprecise, because “Market Maker” implies a transfer of ownership; in the current agreement, the participating banks continue to bear the risk of the instruments used to collateralize their loans. Dr. Buiter argued last August that injection of liquidity in the market sector where it was needed most to the participants who wanted it most would achieve desirable effects with less disruption to the general market than across-the-board reductions in the lending rate:

Central banks have not been doing the job of market maker of last resort effectively, indeed they have barely been doing it at all. Following the stock market collapse of 1987, the Russian default of 1998 and the tech bubble crash of 2001, all that the key monetary authorities have done is (1) lower the short risk-free interest rate and (2) provide vast amounts of liquidity against high-grade collateral only, and nothing against illiquid collateral. The result has been that the ‘resolution’ of each of these financial crises created massive amounts of high-grade excess liquidity that was not withdrawn when market order was restored and provided the fuel that would produce the next credit boom and bust. By focusing instead on illiquid collateral, it should have been possible to achieve the same effect with a much smaller injection of liquidity.

This point, that overall liquidity changes can be minimized by a more careful targetting of liquidity injection, was mentioned on PrefBlog on March 31, quoting Xavier Vives. I haven’t seen anybody use the phrase “a rifle, not a shotgun” yet, but I’m sure it will be if the Central Bank actions become a political issue.

Anyway, back to Dr. Buiter’s remarks:

The “£50 billion bail-out for banks” headline of that fount of orginal analysis, the (free) London paper, is rubbish. The Special Liquidity Scheme is priced quite unpleasantly for the banks. The so-called fee (the difference between 3-month libor rate and the 3-month General collateral gilt repo rate) will be quite hefty, because it reflects not only bank default risk (libor is the rate for unsecured bank lending) but also liquidity risk. In addition, the haircuts (discounts) applied to the Bank of England’s valuation of the RMBS, covered bonds and credit card ABS ranges from 12 percent, for the shortest maturity to 22 percent for the longest maturity. That valuation will either be based on observed market prices that are independent and routinely publicly available or on the Bank of England’s own calculated prices. As most of the assets are illiquid, the prices of these assets will for the foreseeable future be set by the Bank of England. In that case it will also apply a higher haircut to the valuation. In addition, Bank officials have told me that should any of the assets lent by the banks to the Bank fall, during the life of the swap, below the required AAA rating, these assets will have to be replaced by AAA-rated securities.
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The UK scheme prices what amounts to a collateralised loan of Treasury bills by the Bank of England quite harshly. And appropriately so. There is no eartly reason for giving the banks a tax payer handout. The banks and their borrowers made the mistakes. They and their borrowers should pay the price.

He contrasts this with the valuation of securities accepted by the Fed:

All this is a lot more sensible and likely to minimise adverse selection than the insane valuation of the collateral offered by US Primary Dealers to the Fed at the Term Securities Lending Facility and the Primary Dealer Credit Facility. The collateral is priced by the clearing bank acting as agent for the Primary Dealer! If ever a scheme was designed to encourage collusion between Primary Dealer and Clearer to dump useless securities at inflated prices on the Fed, this is it.

I hadn’t been aware of that nuance! I am in complete agreement with Dr. Buiter: valuation should be performed by the Fed – with input and advice from the brokers and clearing banks, of course, but the final say should rest with the lender.

And finally, Dr. Buiter points out another nuance:

Unlike the US, where mortgages are non-recourse debt, the UK does not have mortgages that are non-recourse.

The standard terms on US mortgages are ridiculous and the standard provision of non-recourse loans is just one of the problems.

In a new development, a trader has been nailed for spreading false rumours:

Paul Berliner, 32, sought to profit by messaging traders at brokerages and hedge funds on Nov. 29, claiming Alliance Data’s board was meeting to discuss a reduced offer by Blackstone, the Securities and Exchange Commission said today in a suit at federal court in Manhattan. The shares plunged 17 percent in half an hour that day.
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Berliner, who was shorting the stock to profit from the drop in price, made more than $25,000 before the shares recovered, according to the SEC. He didn’t admit or deny the agency’s claims in agreeing to forfeit his gains, plus interest, and pay a $130,000 fine.

The trivial amounts for which a trader will put his reputation on the line never fails to astonish me … one can only imagine that the real-world repercussions for talking like an idiot to other idiots are not really all that harsh.

The story does not address what, if anything, happened to the morons who traded stock on the basis of an unverified text message. If they were acting as fiduciaries, one can only hope that their licenses will be yanked soon.

The market was off a bit today in what has now become normal volume. There were a few good crosses of the more liquid, high quality, perpetualDiscounts.

There were fifteen other index-included $25-pv-equivalent issues trading over 10,000 shares today.

Not much today, folks! In the spirit of the day, I had to spend some time slaying dragons and was unable to assemble my List of Interesting Things.

A return of good volume, the market was up and the index was down. What a great day!

There were thirty-four other index-included $25-pv-equivalent issues trading over 10,000 shares today.

Accrued Interest has reluctantly called a bottom in the credit markets:

But yeah, if you stick a gun to my head, I’d say we’ve seen the wides in credit spreads. Not because the economic problems are solved, but because liquidity has improved to the point that people are willing to be opportunistic. That will put a lid on how far investment-grade names will move before yield hungry investors come in. Issuers will be able to come to market with new issues, and the wheels of the credit market will continue to churn.

Meanwhile, today is the day that the CBOT officially attempts to find out why the basis on grain futures isn’t going to zero during the delivery period, as mentioned April 17. Naked Capitalism republishes a NYT article on the issue which suggests:

Mr. Grieder’s crop insurance premiums rise with the volatility. So does the cost of trading in options, which is the financial tool he has used to hedge against falling prices. Some grain elevators are coping with the volatility and hedging problems by refusing to buy crops in advance, foreclosing the most common way farmers lock in prices.
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Futures, for example, are less reliable. They work as a hedge only if they fall due at a price that roughly matches prices in the cash market, where the grain is actually sold. Increasingly — for disputed reasons — grain futures are expiring at prices well above the cash-market price.

When that happens, farmers or elevator owners wind up owing more on their futures hedge than the crops are worth in the cash market.
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John Fletcher, a grain elevator operator in Marshall, Mo., started pressing the C.B.O.T. to address the flaws of futures contracts almost two years ago — even before his futures hedge on a million bushels of soybeans failed to fully protect him last September, hitting him with a cash loss of $940,000.
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Frustrated over the flawed futures contract, Mr. Fletcher is voting with his feet. Last year, he entered into a contract with A.I.G. Financial Products, a leading sponsor of commodity index funds, which allows him and the index fund to hedge their risks without using the C.B.O.T.

Instead of using futures or options, A.I.G. simply buys the commodity directly from Mr. Fletcher, who stores it for a fee and buys it back six months later. His storage fee is lower than the one built into the C.B.O.T. contract, so A.I.G. pays less for its stake in the market. And he has a hedge he can rely on.

In a strong indication that Canadian banks are using their strong balance sheets to sniff around in the States, BMO has announced:

a definitive agreement today to acquire Chicago-based Griffin, Kubik, Stephens & Thompson Inc. (GKST). The acquisition will make BMO Capital Markets the sixth-largest bank qualified municipal bond dealer in the United States and the largest in Illinois, greatly accelerating BMO’s national presence in the municipal bond market.

Good for them! It would appear that the BNS / National City rumours discussed on April 11 have come to nothing:

Cleveland-based National City, Ohio’s biggest bank, agreed yesterday to sell a $7 billion stake to a group led by Corsair Capital LLC.
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National City agreed to sell the Corsair stake at a discount to market price, and increased the size of the offering after finding strong demand. The move, which may dilute existing shareholders by more than 50 percent, sent the stock plummeting almost 28 percent and drew complaints from investors who asked during a conference call whether there wasn’t “a more palatable alternative.”

The bank had to raise enough capital “to stabilize our debt ratings, beyond a shadow of a doubt,” National City Chief Executive Officer Peter Raskind responded, citing speculation about the bank’s condition. “We had counterparties who were uncomfortable interacting with us. That had to stop.”

Royal Bank of Scotland is also raising capital:

Royal Bank of Scotland Group Plc, the U.K. lender reeling from asset writedowns, will sell 12 billion pounds ($24 billion) of shares to investors in Europe’s largest rights offer and cut the dividend.
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RBS plans to raise its Tier 1 capital ratio, a measure of capital strength, to more than 8 percent from 7.3 percent and the core equity Tier 1 ratio to more than 6 percent from 4.5 percent by the end of the year, the bank said.

Good for them for doing it by a rights offering! It’s much fairer to existing investors, although I suppose it’s a little more expensive and slower.

Merrill has also joined the parade:

Merrill Lynch & Co., the third- biggest U.S. securities firm, plans to raise at least $7.3 billion by selling bonds and preferred shares after writing down the value of $6.5 billion of assets.

The firm today began offering $7 billion of senior unsecured notes in its biggest debt offering, luring investors with yields over Treasuries that would be as much as triple what it paid a year ago. Merrill is also selling at least $300 million of perpetual preferred shares that yield about 8.625 percent.

It should be noted, however, that the $7-billion headline number addresses liquidity issues, not equity; the preferred share issue is picayune.

I must say, it’s very pleasant for a fixed income guy to see the equity crowd get hit for a change. The last ten years have been all too often in the other direction.

There might be some adjustment to Regulation FD in the future – this is the source of National Policy 51-201, which states that Credit Rating Agencies may have access to material non-public information. Chairman Cox of the SEC said in testimony to the Senate Banking Committee:

To enhance transparency, the Commission may soon consider new rules that would require the disclosure of information about the assets underlying the mortgage-backed securities, CDOs, and other types of structured finance products they rate. This would allow market participants to better analyze the assets underlying structured securities, and reach their own conclusions about their creditworthiness. This data availability could particularly benefit subscriber-based NRSROs, who could use it to perform independent assessments of the validity of the ratings by their competitors who use the “issuer pays” model.

Further improvements in transparency could be considered in the form of enhanced disclosures about how NRSROs determine their ratings for structured products. This disclosure could include the manner of analysis of the mortgages’ conformance with underwriting standards, and the firms’ procedures for monitoring their current credit ratings.

The Commission may also consider rules requiring the disclosure of ratings information in a way that makes it possible for investors to readily distinguish among ratings for different types of securities, such as structured products, corporate securities, and municipal securities.

This is rather convoluted, frankly. The ratings agencies don’t release material non-public data because it’s non-public. The company or issuer makes the decision (subject to the SEC’s disclosure rules) regarding what’s public and what ain’t. All I can imagine is that the intended purpose of the rules the SEC is considering is to get disclosure by the back door … for one reason or another, the issuer can’t (or won’t) be forced by the SEC to disclose data, but the NRSRO’s will be … thus, if the information is to be kept out of the public domain, the company will have to forgo a NRSRO credit rating, which will (presumably) make the issue a much harder sell. If anybody has a better explanation, say so in the comments!

Following the BoC’s easing to 3.00% overnight rate, TD was the first major to cut Prime, although they were behind CCDQ. The second major was RY, followed by BMO, then BNS.

Another poor day for preferred shares, as PerpetualDiscounts are now yielding 5.73%, interest equivalent (at 1.4x) of 8.02%. Given that long corporates now yield about 6.1%, this represents spread maintenance against the competition.

There were fourteen other index-included $25-pv-equivalent issues trading over 10,000 shares today.

Slowly, slowly, loans are coming off the banks’ books:

Carlyle Group, the world’s second largest private-equity firm, is raising a $500 million collateralized loan obligation to buy high-risk, high-yield debt being sold by banks at discounted prices, according to people with knowledge of the plan.

The CLO is being arranged by Deutsche Bank AG, said the people, who declined to be identified because the terms aren’t public. The fund follows a similar $450 million CLO that Carlyle and JPMorgan Chase & Co. closed this month.

Carlyle, the Washington-based buyout firm run by David Rubenstein, joins Blackstone Group LP and Apollo Management LP in purchasing loans from banks that have struggled to offload the debt after losses on securities tied to subprime mortgages caused investors to shun all except the safest of government bonds. Private-equity firms are emerging as buyers at a time when financial institutions from Goldman Sachs Group Inc. to Citigroup Inc. are willing to sell the loans for as little as 63 cents on the dollar.

Royal Bank of Scotland is doing the same:

Royal Bank of Scotland Group Plc, the U.K.’s second-biggest lender, plans to start a fund to transfer the risk of losses from 1.5 billion euros ($2.3 billion) of high-yield loans, according to three people with knowledge of the proposal.

The fund will earn a return for investors by selling contracts to RBS that protect the bank from losses on 15 loans in euros and pounds and a further six in dollars, said the people who declined to be identified because the discussions are private.

And hedge funds are still pulling in money! I’m certainly not about to declare the credit crunch over, but this is a good sign:

Some investors expect the current credit crisis will create opportunities for managers who trade distressed bonds and loans. Such funds attracted $8 billion in the quarter. Investors allocated $8.2 billion to equity hedge funds and $6.5 billion relative-value strategies, which try to profit from price discrepancies between securities.

The biggest outflows in the quarter were from funds that trade the securities of companies going through mergers, which lost a net $4 billion. Investors pulled $1 billion out of macro funds, which chase macroeconomic trends by trading stocks, bonds, currencies and commodities. The funds were the best performers in the first quarter, rising 4.7 percent.

In a further sign that the banks are serious about repairing their balance sheets, Citigroup is issuing $6-billion hybrids, although it’s not entirely clear to me whether these are prefs or Innovative Tier 1 Capital, as if there’s any difference anyway:

Citigroup Inc., the biggest U.S. bank by assets, plans to sell $6 billion of hybrid securities to bolster its balance sheet after reporting almost $16 billion in writedowns.

The perpetual, preferred shares may pay a fixed rate of 8.4 percent for 10 years, according to a person who declined to be named because terms aren’t set. If not called, the debt will then begin to float, the person said.

This follows hard on the heels of JPMorgan’s monster deal. How much is enough, already? The Reuters tally grows daily:

Financial companies around the globe have scrambled to raise capital to offset massive write-offs. Below are the 15 largest capital infusions announced by financial institutions since the credit crisis began, totaling more than $150 billion.

The Bank of England is going forward with the bond lending programme discussed briefly on April 17 … it is, in fact, a bond LENDING programme, with quite rational terms:

The measures, backed by Prime Minister Gordon Brown’s government, mimic a swap of $200 billion of securities by the U.S. Federal Reserve last month as central banks around the world struggle to prop up financial markets.
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Financial institutions will retain responsibility for losses from the assets they loan to the Bank of England. The swaps will be for a period of one year, renewable for up to three years. Only assets existing at the end of 2007 can be used in the swap.

The Bank of England won’t announce how much money has been tapped until the borrowing window closes in six months.
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Assistance will come at a price. Banks will have to pay a borrowing fee to participate in the plan and the value of the securities they receive will be less than that of the mortgage- backed bonds they hand over to the Bank of England.

“The Bank of England’s actions do seem to be quite punitive,” said James Nixon, a director of Societe Generale SA in London. “The sense yet again from the Bank of England is that it will provide an absolute backstop to the financial system, but won’t make any effort to ease the market’s liquidity.”

The market fell – probably in response to the RY new issue as the RY issues were conspicuous by the presence in the list of poor performers … several issues lost just less than the 1% loss qualifying for mention on the list. Volume was average, as far as recent history goes.

There were fifteen other index-included $25-pv-equivalent issues trading over 10,000 shares today.