PrefBlog

More details are emerging regarding the SIV situation: FT-Alphaville has republished a Fitch graph showing the NAV of the SIVs it rates:

In this case, “NAV” is a measure of the asset coverage provided to the equity noteholders; therefore, when it’s below 100%, they’ve lost money. These numbers have no independent implications for the asset coverage ratios for the senior noteholders; that will depend on the original capital structure of the SIV.

Naked Capitalism discusses this and other tidbits from the SIV front. An anonymous Fed tipster is putting out the word that the Fed’s silence should not be misconstrued. The WSJ has published an extract from an interview with the head of the Basel Committee on Banking Supervision – he’s not impressed by the Super-Conduit idea. One question-and-answer brought tears of gratitude to my eyes:

Might Basel II’s reliance on rating agencies, for instance, come under consideration?

There are problems to be solved with rating agencies. … but you remain responsible at the end of the day, yourself, and you have to make your own assessments.

Fitch Ratings has published an initial review, dated September 20, and an update, dated October 12, of the SIVs it rates (the chart above is taken from the update). Credit Sights, an independent credit rating agency (that is, one paid by its subscribers rather than – gasp! – the issuers) that delights in being gloomier than the the issuer-paid credit rating agencies, has released a report (to paying clients) that claims:

Many structured-investment vehicles may be forced to close in the next few months as defaults by SIVs run by European hedge funds make it harder for others to avoid selling off their assets

So if Super-Conduit ever gets off the ground, there is every indication that it will have plenty of assets to choose from!

I mentioned the issue of bank purchases of ABCP held in their money-market funds on August 20 in the context of managerial independence, but there are other problems with the idea. Mainly, is a MMF a stand-alone investment vehicle, or is it a bank deposit? There are some US banks purchasing SIV paper from their MMFs; this is not a right and proper thing to do. I hope that the OSFI in Canada and the Fed in the US will nail these banks to the wall on their next audit; unless unitholders are taking ALL the risk of the investment, EVERY SINGLE PENNY, then the MMF is not a stand-alone vehicle.

Given all the excitement regarding the issuance of covered bonds, it would seem that if bank-run MMFs are really “covered bank deposits” then the banks’ balance sheets should be grossed up by the size of their funds and capital adequacy determined from these figures. The National Bank, for example, has total assets of about $117-billion and a total of about $1.7-billion in various MMF vehicles: Money Market Fund, Treasury Bill Plus, US MMF, Corporate Cash Management, Treasury Management and Strategic Yield. Grossing up the balance sheet would not be the biggest charge in the world, but if the banks are going to give implicit support to their funds, it is a charge that should be taken in order to protect depositors.

Business Week has a fascinating story on the implosion of the two Bear Stearns hedge funds that triggered the whole crisis. I have updated my post on stress-testing of Australian mortgages with a report from Bloomberg that one of the largest mortgage insurers is being downgraded.

The decline in perpetual preferreds actually accellerated today; to me, the yields have gone beyond “wow!” and into “outlandish” territory … but those who are selling evidently disagree with me!

There are some proxy-variables in the yield curve analysis that lead me to suspect that there is a definite bias towards selling the newer issues – by which I mainly mean everything issued in the last year; this is a change from the situation last spring. I had mentioned at that point that liquidity appeared to be at a premium – and so it was, according to the analysis. I am beginning to suspect, however, that the yield curve needs some kind of – yech! – momentum indicator, because I am now hypothesizing that the liquidity premium was actually a proxy for a “recent issue premium”. Currently, I am analyzing a premium being paid for “cumulative dividends”; this might be a proxy for “recent issue discount”.

There’s always something new, something to be tested, that becomes apparent only in times of extreme stress. ‘Nature reveals her secrets best under torture’, and all that. If Bacon didn’t say it, then I will.

I should note – for those who might be alarmed at the idea that I don’t know everything already – that yield curve analysis is the least of my analytical worries right now. Fits to the curve are excellent; it’s diversification that has me concerned. The yield pick-up of Perpetuals over Retractibles is now so extreme it’s becoming harder and harder to justify any holdings of the latter at all!

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

Sometimes I wish that this blog would get more comments. At other times, I’m glad that I don’t have to make the decision ten times per day on whether a particular comment is so ad hominem that I have to zap it. Today is one of those other days!

Menzie Chinn of Econbrowser posted a graph for which the general outlines have been known for a long time by those who are following the subprime debacle:

…and it triggered a lot of nastiness in the comments when a (purported – I haven’t checked!) market professional asked, essentially, ‘What’s the big deal?’.

It continually surprises me to see just how much bitterness there is out there against investment managers. But – that’s the Internet! As far as graphs go, I like the one from Moody’s showing mortgage delinquency rates:

 

Bear Stearns has agreed to a deal with CITIC whereby CITIC will take equity in Bear Stearns and Bear Stearns will, essentially, provide vendor financing. This should calm some fears about the future independence and financial viability of Bear Stearns going forward, and a joint-venture deal in Hong Kong with CITIC might even be profitable!

whereby CITIC will take equity in Bear Stearns and Bear Stearns will, essentially, provide vendor financing. This should calm some fears about the future independence and financial viability of Bear Stearns going forward, and a joint-venture deal in Hong Kong with CITIC might even be profitable!whereby CITIC will take equity in Bear Stearns and Bear Stearns will, essentially, provide vendor financing. This should calm some fears about the future independence and financial viability of Bear Stearns going forward, and a joint-venture deal in Hong Kong with CITIC might even be profitable!Naked Capitalism has again done a good job of collecting media references to the Super-Conduit … and it looks like my speculation regarding the operation of this vehicle as a Vulture Fund is both right and wrong. Wrong because that’s not what the primary sponsors have in mind. Right because if it ain’t, there won’t be any secondary sponsors:

One key concern is over the process by which it is proposed that the fund will decide on prices to offer SIVs for their securities. The lead banks are proposing that prices should be determined according to quotes provided by dealers for small volumes of the particular security rather than large trades. Critics say this means prices will be artificially high. “Banks are being asked to finance a vehicle full of overvalued assets which is not very attractive,” said one banker. Critics believe it would be better to work with true market prices – however painful.

I will now speculate that buying good assets from distressed SIVs is exactly how the RBS / Cheyne deal will unfold … but we will see! Accrued Interest has clearly been puzzling over the sponsors’ motivations as much as I have … he has introduced the rather Machievellian possibility that it is actually a rescue of the bank Money Market Funds.

The fair value estimate for the TD 5.25% Perpetual New Issue has been updated to $24.05 as of the close today.

Perpetuals continued to decline today. Holders of the Royal Bank issues should note – before they have a heart attack at 9:31 tomorrow – that today, 10/22 was the last day of cum-dividend trading; tomorrow, 10/23, will be the first day of ex-dividend trading for the current dividend.

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

 The box-score for today is:

• Fear: 1 Treasuries way up
• Greed: 0 Equities way down
• Analysis: What?

In more interesting news, the media has reported somebody saying something intelligent about regulation:

“If you intervene in the system, the vultures stay away,” [Former Fed Chairman Greenspan] said. “The vultures sometimes are very useful.”

“When it breaks, it’s very abrupt and you just have to wait it out,” he added.

This was in an interview with Emerging Markets, which was in turn linked by the WSJ.

More rules will not stop market booms, busts or outright fraud. They can – sometimes – mitigate and contain the effects; I have previously suggested that rules for the capital treatment of liquidity guarantees be reviewed with an eye to ensuring the banking system, as a whole, can withstand bigger shocks than this piddly little liquidity crisis. But there are far too many people around who rush to revise the rule book every time something bad happens. Life sucks. Get used to it.

Specifically, Greenspan was opining on Super-Conduit:

But Greenspan argued that that a delicate market psychology could be speared by the move. “It could conceivably make [conditions affecting investor psychology] somewhat adverse because if you believe some form of artificial non-market force is propping up the market you don’t believe the market price has exhausted itself.

“What creates strong markets is a belief in the investment community that everybody has been scared out of the market, pressed prices too low and they’re wildly attractive bargaining prices there,” he said.

“If you intervene in the system, the vultures stay away,” he said. “The vultures sometimes are very useful.”

Well, I’ve speculated that Super-Conduit is the vulture; and that the aim of the exercise is to wipe out the junior note-holders of the shakier SIVs to leave only the strong still standing. This got a little support in an unsubstantiated, anonymous comment on Accrued Interest:

From Total Securitization:

“Citigroup Won’t Use Super SIV To Save Its Own

Citigroup officials, reacting to claims that the master liquidity enhancement conduit it is creating with JPMorgan and Bank of America will be used to specifically rescue Citi’s more than $80 billion SIV exposure, is expected to announce that it will not utilize the fund at all.”

Well, it ties in with my thought on Super-Conduit; but I don’t have a subscription to Total Securitization, so I’ll have to wait for those remarks to be reported elsewhere.

Cheyne and Rhinebridge officially defaulted on their commercial paper today:

Rhinebridge has $791 million of commercial paper and a portfolio with a face value of $1.1 billion, S&P said. The market value of the assets is now 63 percent of face value, having fallen $69 million since Oct. 16 alone, S&P said. Revaluations of CDOs of asset-backed securities have caused a “dramatic” fall in value, the rating company said.
…
Cheyne Finance’s managers said its assets are worth 93 percent of face value, enough to pay back all of its $6.6 billion of senior debt, S&P said. CDOs of asset-backed securities make up 6 percent of Cheyne Finance’s holdings.

The SIVs aren’t the only outfits being affected by the market revulsion to all things sub-prime – after announcing mark-to-market write-downs of $1.3-billion, Wachovia has discussed its earnings:

“Next line addresses other structured products [Total of $438MM]. Here we have the marks on warehouse positions and trading inventory, both of which we hold in trading portfolios. This includes the positioning Ken referred to in reference to sub prime mortgage exposure and AAA rated securities. $308 million is associated with sub prime securities [Their slides say $347 of the mark was related to subprime of which $308 was AAA subprime]. Basically there, we never would have expected that you see AAA securities trade so far so quickly from par.”

The same comments thread on Accrued Interest yielded the following revealing exchange:

Anonymous: IF my money market funds invest in this SIV I will sell them and buy one that doesn’t. Plain and simple.

Accrued Interest: A **TON** of investors have moved into government money market funds to ensure they don’t own any ABCP over the last 2 months. I think that’s the right move. Money Market funds aren’t a place to take any risk at all as far as I’m concerned.

In other – No Analysis Necessary. As soon as the dreaded words of power are spoken – SELL! It is no wonder that, as I mentioned yesterday:

asset-backed commercial paper backstopped by real assets and a full bank credit backstop yielding more than unsecured commercial paper issued by the same bank—in other words, the real assets as collateral viewed by market participants as a negative rather than a positive,

To how many people does this make sense? Stick yer hands up!

I’ve said before that the danger of the credit crunch has not passed – that we’ve got a long way to go before we’re out of the woods (and, I hasten to add, I am not suggesting that market timing is the investor’s answer; analysis and diversification is the investor’s answer). Some of the specific risks to markets over the next six(?) months are outlined at the WSJ

This may be a little off-topic; but I want to point out that the benefits of diversification are everywhere:

The Utah scientists are trying to sell farmers on the idea that more bee diversity is needed, which was a hard sell because farmers had to pay more for wild bees. Now that honeybee prices are rising, farmers are more willing to try other species, James says.

Getting back to Canada and economic news for a moment, the Canadian CPI numbers were released today, and:

It was the highest year-over-year increase in the all-items index since May 2006, and the sharpest acceleration since February of this year.

Gasoline prices were the primary cause of an increase in the 12-month variation of the Consumer Price Index (CPI) in most provinces.

The year-over-year increase in gasoline prices (+12.7%) owed more to a sudden drop in last year’s prices than to any significant developments in the most recent month. Indeed, on a month-to-month basis, gasoline prices barely budged, rising a mere 0.8% from August to September 2007.

 

Of particular interest is:

On a year-over-year basis, consumer prices increased at a faster pace than the national average in only four provinces in September: New Brunswick (+2.9%), Manitoba (+2.8%), Saskatchewan (+3.8%) and Alberta (+4.6%).

In other words, inflation (such as it is) remains fairly well localized to the petro-provinces (with the exception of poor old Brunny). This suggests – to me – that there is nothing much in this report that would lead anybody to expect a rate-hike in the near future. Mind you, there are many who believe that the level was sufficiently high that we shouldn’t expect any lowering, either:

The Canadian dollar jumped 0.98 of a cent to 103.68 cents US – a level last seen in mid-1976 – after going as high as 103.71 cents US on expectations the higher CPI reading means the Bank of Canada won’t be lowering interest rates any time soon. The bank stood pat on interest rates Tuesday.

All this talk of inflation inevitably leads to the Fed. James Hamilton of Econbrowser attended a St. Louis Fed conference and reports that a hot topic of conversation was whether the Fed should operate according to a few simple and mechanical rules. Well, I haven’t read the papers yet, but my gut reaction is: “Sort of”. There should be enough mechanical rules so that Fed action is reasonably predictable; but none so binding as prevent reaction to special cases. Of course, there’s always going to be a lot of pressure to declare a special case so, as Poole said in his concluding remarks, central bankers need to be people of unquestionable integrity.

Mainly, though, I liked the graph:

Actual path of fed funds rate (black line), path predicted by a Taylor Rule that uses actual values of inflation and GDP (blue line), and path predicted by a Taylor Rule that uses forecasts of inflation and GDP (red line). Source: Orphanides and Wieland (2007).

Look carefully! Do you see the bit that has Greenspan blamed for the housing bubble? He was relying on forecasts, wasn’t he?

Another day of heavy volume for preferreds – and, er, yields were up! Yes, hold that thought firmly in your minds … yields, and therefore expectations of future returns, were up!

This is starting to get somewhat annoying. According to Canadian Bond Indices, long corporates are up 1.64% on the month, but prefs are getting killed … CPD is down a little over 1.5% month-to-date, perpetualDiscounts are down about 2.8%. Yield on long corporates is around 5.9% … about the same as it was on October 10, when I looked at spreads on One Bull Checks In. Since then, the perpetualDiscount yield has increased from 5.42% to 5.49%, and return for this index has been -1.28% (this doesn’t work out nicely with the Modified Duration in the range of 14.7 because of rounding errors and the obscuring effects of averages and outliers).

I think retail is mistaking preferreds for common again! And with things like CM.PR.D yielding 5.81% at the bid (interest equivalent of 8.13%) … well, they can mistake preferreds for common all they like, I guess!

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