PrefBlog

Accrued Interest has a very good post today regarding S&P’s views on the monolines:

S&P and Moody’s have now both affirmed MBIA. S&P also more or less said they would affirm Ambac as well if the reported $3 billion capital infusion is completed. MBIA’s infamous 14% surplus note is now trading comfortably above par ($101 bid, $104 offer last night). So are we out of the woods with the monolines?

Well let’s start by looking at S&P’s methodology. In short, S&P will bestow a AAA rating if they believe an insurer can survive their “stressed” scenario. Here are their assumptions for various types of mortgage-related securities.
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So all in all, I’d say that’s a pretty stressful scenario.

S&P, with its customary eagerness to become a credit rating agency that charges both the issuers and the subscribers, does not make the full report freely available. But Moody’s has published some notes:

Although losses on the 2006 mortgages are still low – mainly because the loans are still relatively unseasoned and the foreclosure process is taking longer than in previous years – Moody’s expects that they will rise considerably in the next few years. The most significant components of the uncertainty regarding the ultimate loss outcomes are (1) the extent to which loans will be modified and these modifications are successful in preventing defaults, (2) the impact of interest rate resets in 2008 and (3) the strength of the US economy in 2008 and beyond.

In this article, we provide projections of the lifetime average cumulative losses for each of 2006’s quarterly vintages, given each transaction’s current level of losses and delinquencies, and assumptions regarding the “roll rates” into default from various categories of delinquent loans and the severity of losses on loans that default.
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Moody’s projection for mortgage losses on the 2006 vintage is in the 14-18% range

The Buiter/Sibert column on Barack Obama’s “Patriot Employer Act”, mentioned yesterday,  has drawn a lot of comment. Tanta at Calculated Risk has a very entertaining and devastating commentary about Lost Note Affidavits with respect to foreclosures, prompted by a story about legal maneuvering that caught my eye at the time, but went unremarked here. I’ve added some updates to the Crony Capitalism post and have made a little progress on Seniority of Bankers Acceptances.

The rather surprising level of lending by the Federal Home Loan Banks (FHLB) mentioned here on November 26 was attacked by Nouriel Roubini yesterday, as noted by the WSJ. I found his views on the monolines more interesting:

Similarly, the concern about the writedowns that will follow a downgrade of the monolines is well taken. However, desperate attempt to avoid a rating downgrade of monolines that do not deserve such AAA rating are highly inappropriate as the insurance by these monolines of toxic ABS was reckless in the first place. If public concerns about access to financing by state and local governments during a recession period are warranted it is better to split the monoline insured assets between muni bonds and structured finance vehicle, ring fence the muni component and let the rest be downgraded and accept the necessary writedowns on the structured finance assets. If these necessary writedowns will then hurt financial institutions that hold this “insured” toxic waste so be it as these assets should have never been insured in the first place. The ensuing fallout from the necessary writedown – such as the need to avoid fire sales in illiquid markets – should then be addressed with other policy actions.

I can’t agree with this at all. You can’t just split up a company’s committments – effectively, expropriating the rights of whoever’s guaranteed by the “bad” side – just on the basis of which set of guaranteed counterparties are nicer people. Should the monolines fail – and they’re not close to that yet, they’re merely close to losing their AAA ratings – and need to be recapitalized, then company splits can make sense. But not until their equity has gone to zero!

The hills are alive with the word that Apex & Sitka trusts might fail, costing the Bank of Montreal something like $495-million. DBRS explained in a Feb. 25 press release:

The Trusts were organized to enter into collateralized debt obligation (CDO) transactions, including CDO transactions that employ leverage. As of the date of this press release, 100% of the transactions entered into by the Trusts are LSS transactions. A LSS transaction is a type of transaction where a credit protection seller (such as a Canadian asset-backed commercial paper (ABCP) issuer (Conduit) that issues ABCP, extendible commercial paper or floating rate notes) writes credit protection on a tranche of a CDO transaction which is less than 100% collateralized and that will incur its first dollar of loss above the AAA attachment point. Losses to LSS transactions are considered a remote credit risk; however, these transactions exhibit funding risk. LSS transactions include leverage in that the collateral held by the Swap Counterparty will be smaller than the potential maximum exposure under the credit default swap. As such, the credit protection seller may be required to post additional collateral if its exposure under the swap increases.

Well, I’m not going to take a strong view on this. I don’t know how profitable the business was for BMO or how carefully they measured their risk. On the surface, it sounds like just another failed CDPO (“Whoopsy! Long term returns can be interupted by margin calls!”) … but again, I don’t know what risk controls BMO had in place (and leverage of loans is what banks do, right? The difference is that most loans don’t have to be marked-to-panicky-market every day … the bankers exercise judgement, good or bad, as to whether there is permanent impairment). What I do know is: Show me somebody who’s never failed, and I’ll show you somebody who’s never tried.

Another quiet day, with PerpetualDiscounts easing down.

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

Nobody must ever get hurt in the field of finance! This has been confirmed by all the political attention paid to states and municipalities now that their auction rate securities are paying high yields:

Gregoire, Corzine and Spitzer joined other governors Feb. 24 in forming a group that will “produce something that gets us out of the problem, but most importantly produce something for Congress” to deter a future borrowing squeeze, Gregoire, a Democrat, said during a National Governors Association meeting in Washington yesterday…

“A lot of governors really hadn’t anticipated that,” Gregoire told reporters in Washington. The group, which plans to meet soon, hasn’t discussed specific solutions, she said

Some people may also be upset that the Fed has no direct power over mortgage rates:

When Bernanke faces Congress tomorrow and Feb. 28, he will be questioned about why long-term bond yields are moving in the opposite direction to the Fed funds rate, said Credit Suisse Group Chief Economist Neal Soss. Lower fixed mortgage rates would avert foreclosures and give consumers more money to spend, said Diane Swonk, chief economist of Mesirow Financial Inc. in Chicago.

“Chairman Bernanke is caught in a tug-of-war between growth and inflation,” said Swonk, who is a member of the Congressional Budget Office’s panel of economic advisers. “Inflation is still a threat and that influences the mortgage-bond investors who ultimately set the fixed rates.”

All the above is probably just political grand-standing in an election year, but boy! Does this kind of thing ever irritate me!

The always reliable Willem Buiter, with Anne Sibert, highlights an interesting plank in Barack Obama’s presidential platform:

on 2 Aug 2007, along with Senators Dick Durbin and Sherrod Brown and Representative Jan Schakowsky, Obama introduced the yet unpassed Patriot Employer Act. On 13 February 2008, he stopped in Janesville, Wisconsin to give a speech extolling this accomplishment.
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The legislation would provide a tax credit equal to one percent of taxable income to employers who fulfill the following conditions:

• First, employers must not decrease their ratio of full-time workers in the United States to full-time workers outside the United States and they must maintain corporate headquarters in the United States if the company has ever been headquartered there. 
• Second, they must pay a minimum hourly wage sufficient to keep a family of three out of poverty: at least $7.80 per hour. 
• Third, they must provide a defined benefit retirement plan or a defined contribution retirement plan that fully matches at least five percent of each worker’s contribution. 
• Fourth, they must pay at least sixty percent of each worker’s health care premiums. 
• Fifth, they must pay the difference between a worker’s regular salary and military salary and continue the health insurance for all National Guard and Reserve employees who are called for active duty. 
• Sixth, they must maintain neutrality in employee organising campaigns. 

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Sen. Barack Obama’s proposal is reactionary, populist, xenophobic and just plain silly. It is time for him to stop pandering and to show the world that hope and reason are not mutually exclusive. 

There was some interesting news on the regulatory front today, with respect to hedge funds front-running PIPEs:

Since October, judges in three cases rejected the U.S. Securities and Exchange Commission’s argument that closing out short positions with shares bought in private offerings is illegal. The SEC sued hedge-fund managers that engaged in the transactions.
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PIPEs offer a chance to make a guaranteed profit because the stock is sold for less than market prices. The average discount was 12 percent last year, according to PlacementTracker.

In a typical scenario the SEC has targeted, a hedge-fund manager learned of a PIPE through a placement agent and shorted the company’s stock before the offer was announced. The fund bought the equity at a discount in the private sale to cover the short position.

The SEC lost its argument that the entire transaction was completed when the short position was created. The insider- trading claim is based on the SEC’s accusation that the hedge funds used confidential information to trade before the PIPE was disclosed.

The accused managers argue in part they didn’t have nonpublic information or agree to forgo trading before the PIPEs were announced.
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Robert A. Berlacher, 53, on Feb. 15 asked a judge in Philadelphia to dismiss the insider-trading accusations in a case involving buying and selling Radyne Comstream Inc., now Radyne Corp., in 2004. Berlacher’s lawyer, Perrie M. Weiner of DLA Piper in Los Angeles, said knowledge of a PIPE isn’t the “material nonpublic information” required to show insider trading.

My sympathies are entirely with the SEC on this matter. It may possibly be that the hedge fund managers are taking advantage of a loophole and should not be punished … but in such a case, the loophole must be plugged. If I’m considering placing an order to buy XYZ Corp. at $50.00, then I consider XYZ’s plans to issue more shares – and dilute my holdings – at $45.00 to be material.

I can see that with such private placements, the company may have a legitimate interest in keeping the plans quiet … but sizes and prices should not be negotiated with other players unless those players have entered a short-term stand-still and confidentiality agreement.

I’m uncomfortable with this method of financing, anyway. Let’s see more exchange offerings and rights issues!

Yields on the Fed’s Term Auction Facility increased in the current auction to 3.08%. This auction was for $30-billion in term loans, from Feb 28 – March 27. It replaces funds awarded in the January 28 auction, which went for 3.123%. The Fed Funds contract for March is now trading at about 2.77%; as of Feb 25, both the target and the effective Fed Funds Rates were 3.00%. It would appear that a term premium has now crept into the auctions … I note that one month LIBOR is at 3.12%. So … I think the result, together with an entirely reasonable FDIC report, is pretty good sign. If the sky really were falling, then insolvent banks, shut out of the uncollateralized interbank market, would bid the TAF rate to the sky as they attempted to foist their worthless collateral on the dumb old Fed.

Reliable data is hard to come by, but preliminary indications are that the new Federal Budget is dividend hostile – not good news for prefs, but (based on historical experience with the trend in the other direction) probably not that bad, either. Fresh from flapping his yap about the need for efficiency (except in egg and dairy products), Our Glorious Finance Minister introduced yet another tax-assisted savings plan, which will be of interest to the few Canadians who have maxed out their RRSPs (which is to say: those who don’t need any specially targetted help anyway). It is not clear whether the line item for this deduction has been efficiently placed above or below the line where you claim your public transit fare deduction. There are things, Assiduous Readers, which man was not meant to know.

On the plus side, the government’s desire to spend every cent coming in and to bloat the size of the Income Tax Act makes deficits much more likely. This will increase the supply of government bonds and hence act to decrease Preferred/Government yield spreads.

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

Today’s post may be foreshortened, due to the time I spent on crony capitalism. Well, anyway, here goes…

Naked Capitalism leads off with a piece suggesting that there’s not much worth saving in the monolines taking great exception to the idea that the proposed recapitalization of Ambac will be via a rights offering. I don’t see anything wrong with a rights offering myself … it allows existing shareholders to avoid dilution and, perhaps, get in on the opportunity to increase their position at a discounted price. And if they don’t want to increase their position, they can sell their rights to take their money off the table. Such procedures are much more fair to extant shareholders than private placements; I don’t understand why there aren’t more of them.

Naked Capitalism suggests that even the Good Insurer part of potential splits might be not all that good, citing a third party’s mention of the City of Vallejo, CA’s current problems:

Vallejo is a municipality. Presumably its debt would be considered AAA. Yet its civic leaders are talking about filing for bankruptcy. You wonder why local government and public works-related auction bonds are failing left, right and centre? US state and municipal finances are in dire shape – just as you would expect when the housing market is in deep depression and the economy is in recession.

And if you think Vallejo is a one off, consider California itself (isn’t it something like the tenth largest economy in the world in its own right?). Remember, US states are constitutionally bound to run a balanced budget. California is now faced with a US$16bn deficit (see here). Some legislators are calling for unilateral tax INCREASES (where’s your $170bn stimulus package now Mr Bush?) as well as spending CUTS. The US is in deep, deep trouble and it isn’t coming out of it for years.

So I looked a little into press reports about Vallejo:

Vallejo may run out of cash as early as March, council member Stephanie Gomes said.

“Not only that, but now we have 20 police and fire employees retiring because they are afraid of not getting their payouts,” Gomes said. “That means we have another few million dollars in payouts that we had not expected. So the situation is quite dire.”
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The city currently has a $135 million liability for the present value of retiree benefits already earned by active and retired employees and an additional $6 million a year as employees continue to vest and earn this future benefit, [City Manager] Tanner said.

“The problem is basically bloated union contracts,” [Council Member] Shively said.

… and, with a bit more detail:

[Council Member] Gomes said salaries and benefits for public safety workers account for 80 percent of Vallejo’s general operating budget. “The city cannot support this anymore,” she said.

Gomes said that last year, 98 firefighters made more than $100,000 and 10 made more than $200,000 including overtime. It is overtime that some firefighters say they would just as soon not have to work.

This is happening in a city with a population of about 120,000. Quick! Somebody call David Miller! We’ve finally found a city that’s run worse than Toronto!

Vallejo was recently downgraded by Moody’s (enormous spreadsheet) to A3 (Watch Negative) from Aaa (Watch Negative), as a result of the downgrade of FGIC.

The monolines did catch a break today! S&P affirmed MBIA as AAA though it remained on Watch Negative. Ambac is still under review.

Naked Capitalism also reprints a report on the collateral accepted by the TAF. The Fed claims it lends only to sound banks, irrespective of collateral; NC says he doubts it. I’ll go with the Fed.

In what BCE shareholders will hope is not a foreshadowing of things to come, Wachovia has sued Providence Equity Partners (part of the BCE acquisition group) to get out of a financing:

Wachovia, the fourth-largest U.S. bank, said Providence officials changed the terms of the accord without consent from the Charlotte, North Carolina-based bank and voided the agreement, according to a lawsuit filed in state court in North Carolina Feb. 22. Providence and two of its investment banks, Goldman Sachs Group Inc. and UBS AG, agreed over the weekend to drop the price from $1.2 billion for the Clear Channel unit, a person briefed on the negotiations said.

Well! They drop the price and Wachovia jumps at the opportunity to call foul! This is an interesting development.

Rather a dull day for prefs, although the fact that this is only the third trading day this month that PerpetualDiscounts were down gave it some interest. Not much price action and the volume was rather lame as well.

Still no sign of new issues, much to my chagrin!

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