Archive for August, 2007

August 28, 2007

Tuesday, August 28th, 2007


Just when you thought you were safe …

I was most impressed today by the DG.UN suspension of redemptions, a made-in-Canada $1.4-billion whoopsee, when in comes news of S&P’s downgrade of Cheyne, a $6-billion oopsy-daisy. According to S&P’s actual release (emphasis added):

Cheyne Finance is a SIV structure managed by Cheyne Capital Management Ltd. who has responsibility for purchasing assets, managing the portfolio, and overseeing the issuance of CP and medium-term notes.
Current pressure on market prices and the associated recent deterioration in the net asset value (NAV) of this vehicle have reached a level where the ratings have come under pressure.

The portfolio is predominantly invested in real estate securitizations, and we note that the portfolio has not suffered any downgrades to these underlying assets.
We have been notified today that the vehicle breached its major capital loss
test and so an enforcement event has occurred. In accordance with the program documents, the portfolio manager upon consultation with the security trustee may begin an orderly liquidation of assets and by Aug. 30 it will estimate the expected proceeds from future liquidations.

Both the “Issuer Credit Rating” and the rating on the Senior Notes has been downgraded from AAA to A-[Watch Negative]. Those of you who are in furious disagreement with my defense of the ratings agencies and eager to see me with egg all over my face (which I know is practically all of you, you’re not fooling anybody) will be most pleased!

What makes this event notable is the bolded disclosure above that this event results from a decline in market prices of the underlying security, not simply an inability to roll the paper at sensible prices. I eagerly await more information regarding Euromoney’s Best CDO Manager of 2006.

The good part about these events with Cheyne is that some actual liquidation of the underlying portfolio will take place. This will lead to at least some delevering of the financial system – this calling on bank lines stuff merely transfers debt. Some equity guys will be wiped out, but that’s what equity guys are for.

There’s more ghoulish news about liquidity exposures, this time from the Times:

State Street, the American bank, has been identified as having $22 billion (£10.9 billion) of exposure to asset-backed commercial paper conduits, the off-balance sheet vehicles that have caused severe problems for rivals in recent weeks amid turmoil in credit markets.

According to regulatory filings, the Boston-based bank has credit lines to at least six conduits, which account for 17 per cent of its total assets. That proportion makes State Street the most highly exposed bank to conduits among its European and American peers.

17% of assets is a very lot. On a positive note, their most recent 10-Q filing discloses that the bank had a Tier 1 Capital ratio of 12%, which is quite good, equal to TD Bank’s ratio as of last year-end, which was the best of the big 5. Even if we divide their 12% by 1.17 to get a ballpark idea of capital adequacy in the event all their lines get called on, we’re still in excess of 10%, which is still quite reasonable. But holy smokes, that’s a lot of lines!

Meanwhile, credit card delinquencies are rising while housing prices are falling, not a great combination.

The Fed’s trying to help! More banks got an exemption allowing them to lend discount money to their broker subsidiaries and I think we can count on this sort of thing being earnestly debated at this weekend’s Jackson Hole conference.

However, I can now provide links to another panic: the Panic of ’07 (not this ’07, the last one), brought to my attention by the WSJ Economics blog, which has some interesting-sounding links to papers I haven’t yet read. If I do read them and they’re good, I’ll post again. Panics, panics panics! Collect them all at PrefBlog!

In other news, some brave Australians are putting together a $1.9-billion LBO, Brad Setser discusses a claim that sub-prime was dumped on the Chinese, jumbo mortgages have become much less available, which is hitting Californial real-estate where the average house needs a jumbo loan and European politicians are planning to do some credit-crunch grandstanding.

Given the gloomy tone of today’s post, nobody will be surprised that US Equities got hammered, mainly financials. Canadian equities got pasted as well, but here it was mainly commodity-related stocks. Treasuries steepened on a banner day with more of the same for Canadas.

Preferreds had quite a good day, ignoring the stock market and the credit concerns. But it’s always the way! No sooner do I point out what a lousy month the splitShares are having than they have a great day and make up half the difference between their returns and OpRet’s. It’s nice to see, but maybe I should just keep my mouth shut from now on.

BAM.PR.N had very high volume today, courtesy of two large blocks crossed by Scotia. I have no idea whether that’s cleaned out their inventory or not, but it’s about time we saw some big-time crosses! Volume in general picked up, which is good to see … equity refugees?

BMO.PR.G has been removed from the OpRet index because it no longer exists. It’s the end of an era … the world was different at the time of its first month-end in the index, February, 1998.

Note that these indices are experimental; the absolute and relative daily values are expected to change in the final version. In this version, index values are based at 1,000.0 on 2006-6-30
Index Mean Current Yield (at bid) Mean YTW Mean Average Trading Value Mean Mod Dur (YTW) Issues Day’s Perf. Index Value
Ratchet 4.80% 4.84% 22,933 15.82 1 +0.0410% 1,044.1
Fixed-Floater 4.98% 4.81% 112,352 15.85 8 +0.2382% 1,023.0
Floater 4.93% -0.46% 75,222 7.95 4 +0.0918% 1,038.1
Op. Retract 4.84% 4.12% 81,061 3.53 15 -0.0446% 1,022.5
Split-Share 5.07% 4.87% 96,148 3.85 15 +0.5090% 1,043.2
Interest Bearing 6.22% 6.72% 67,002 4.58 3 -0.2351% 1,037.3
Perpetual-Premium 5.53% 5.19% 93,897 6.20 24 +0.1018% 1,025.0
Perpetual-Discount 5.11% 5.15% 271,118 15.24 39 +0.1515% 971.6
Major Price Changes
Issue Index Change Notes
IGM.PR.A OpRet -1.0440% Now with a pre-tax bid-YTW of 4.75% based on a bid of 26.54 and a softMaturity 2013-6-29 at 25.00.
FIG.PR.A InterestBearing -1.0050% There go most of yesterday’s gains! Asset coverage of just over 2.3:1 as of August 27 according to Faircourt. Now with a pre-tax bid-YTW of 6.73% (almost all as interest) based on a bid of 9.85 and a hardMaturity 2014-12-31 at 10.00.
PWF.PR.K PerpetualDiscount +1.1859% Now with a pre-tax bid-YTW of 5.23% based on a bid of 23.89 and a limitMaturity.
LFE.PR.A SplitShare +2.3346% Makes up for yesterday’s loss and then some! Asset coverage of just over 2.6:1 as of August 15 according to the company. Now with a pre-tax bid-YTW of 4.23% based on a bid of 10.52 and a hardMaturity 2012-12-1 at 10.00.
Volume Highlights
Issue Index Volume Notes
BAM.PR.N PerpetualDiscount 257,600 Scotia crossed 150,000 at 20.00, then another 100,000 at the same price. Now with a pre-tax bid-YTW of 6.05% based on a bid of 20.00 and a limitMaturity. There was a good bid at the close, too, closing at 20.00-13, 33×10; the almost-identical, very very slightly inferior BAM.PR.M closed at 20.23-35, 2×11.
TD.PR.O PerpetualDiscount 114,700 Nesbitt was working the ‘phones today, obviously, crossing 30,000, then 50,000, then 30,000, all at 24.61. Now with a pre-tax bid-YTW of 4.97% based on a bid of 24.61 and a limitMaturity.
GWO.PR.E OpRet 45,151 Now with a pre-tax bid-YTW of 4.07% based on a bid of 25.75 and a call 2011-4-30 at 25.00.
BCE.PR.C FixFloat 40,125  
ALB.PR.A SplitShare 30,937 Now with a pre-tax bid-YTW of 4.38% based on a bid of 24.90 and a hardMaturity 2011-2-28 at 25.00.

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

HIMIPref™ Preferred Indices : May 31, 2000

Tuesday, August 28th, 2007

All indices were assigned a value of 1000.0 as of December 31, 1993.

HIMI Index Values 2000-05-31
Index Closing Value (Total Return) Issues Mean Credit Quality Median YTW Median DTW Median Daily Trading Mean Current Yield
Ratchet 1,437.5 0 0 0 0 0 0
FixedFloater 1,860.4 8 1.87 6.39% 12.8 253M 5.48%
Floater 1,353.6 2 2.00 0.00% 0.08 165M 7.29%
OpRet 1,351.0 33 1.24 5.58% 4.1 90M 6.21%
SplitShare 1,371.4 3 1.66 6.17% 6.2 65M 5.80%
Interest-Bearing 1,454.0 7 2.00 8.37% 10.5 202M 8.45%
Perpetual-Premium 1,037.0 0 0 0 0 0 0
Perpetual-Discount 1,061.7 12 1.57 6.29% 13.5 131M 6.40%

Index Constitution, 2000-05-31, Pre-rebalancing

Index Constitution, 2000-05-31, Post-rebalancing

Split-Share Spread Widening

Tuesday, August 28th, 2007

I briefly mentioned yesterday that split-shares were getting hit this month relative to Operating Retractible issues, so I’ll just post a few things to substantiate that claim.

Comparitive Performance, Month to August 27
Index Value
OpRet 1,020.3 1,023.0 +0.26%
SplitShare 1,046.5 1,037.9 -0.83%

… which seems clear enough.

Additionally, I have uploaded:


Sub-Prime! DG.UN Suspends Redemptions

Tuesday, August 28th, 2007

Sorry about all this sub-prime stuff in a blog that usually sticks pretty close to its knitting, but this is a lot of fun!

Global Diversified Investment Grade Income Trust (TSX: DG.UN) (“Global DIGIT”) has announced:

that, considering the liquidity problems of MMAI-I Trust (“MMAI”) due to its inability to roll its maturing commercial paper in the present state of the Canadian asset-backed commercial paper market, it will not have sufficient financial resources to allow for the payment of the redemption price for the redemption of Units and consequently must announce the suspension, until further notice, of the August 31st, 2007 annual and quarterly redemptions of Units.

This is a fascinating investment scheme. What they have done, according to their financials is (with lots of rounding by me):

– taken $89-million of unitholders equity

– borrowed about $1,400-million, mostly as commercial paper

– put all this money into term deposits in banks, at the Bankers’ Acceptance rate plus a spread.

– written Credit Default Swaps against a portfolio of mainly mortgage backed securities and pledged the term deposits as security (note that writing a CDS gives you exposure and, hopefully, yield basically equivalent to what you wrote the CDS on)

The point? It’s discussed:

The Trust’s objective (save for any loss exceeding the first loss amount) is to provide a return on investment of 5.94% per annum to Unitholders up to September 7, 2009 and thereafter a floating distribution equal to the rate of bankers acceptance plus 2%.

Units cost $10.00 at issue in September 2004, of which sixty-five cents went to start-up costs. The provide a handy computation of their returns since inception, using a starting point of $9.35 net … they’ve made about 5.5% annualized.

It seems to me like a helluva complicated & (term-mismatch-) risky & very highly-leveraged way to go after BAs+200, but I should have said that three years ago if I wanted to be taken seriously.

And now they’re having a little difficulty rolling their CP, have suspended redemptions and I see that DG.UN is now quoted at $2.90-99 on the TSX, compared with a NAVPU of $9.17 reported as of 2007-6-30.

Y’know, the underlying doesn’t look all that terrible to me … having looked at it very, very briefly and with no intent of investing or recommending. The big question is how much of the lolly the CP holders are going to grab and, frankly, I’m not going to rip apart the prospectuses trying to find out. I’m not going to pay for any expensive legal opinions, either! But it does seem to me that this very, very distressed security that has enormous liquidity problems would be worth looking at … although, until we know more about what the CP guys are going to take, it’s a wild speculation and, what’s worse, blind.

Too bad the damn thing’s $1.4-billion … that’s getting into serious money that will be hard to finance in this environment … which, I imagine, is part of the problem. If it were smaller, it would be (I think) attractive to the hedge fund crowd. If any of my readers has $1.4-billion they want to put into a nice floating rate note with a term of nine years, call me and maybe we can help these guys out a little … after looking at this stuff a whole lot more closely, of course!

Hat tip : Financial Webring Forum.

More Sub-Prime!

Tuesday, August 28th, 2007

Gee, the last one was so much fun I think I’ll do another! Let’s look at “Bear Stearns Asset Backed Securities Trust 2005-1”.

On August 24, S&P released the following:

Standard & Poor’s Ratings Services today lowered its ratings on seven classes from Bear Stearns Asset Backed Securities Trust’s series 2001-3, 2005-1, 2005-2 and 2005-3 transactions (see list).
     The lowered ratings reflect pool performance that has caused actual and projected credit support for the affected classes to decline considerably. All four transactions have experienced losses that have eroded overcollateralization (O/C) to levels that are significantly below their targets. Furthermore, delinquencies have escalated over the past six months. For series 2001-3, losses have, on average over the past six months, been approximately 2.10x monthly excess interest. For series 2005-1, losses have, on average over the past six months, been approximately 3.73x monthly excess interest. Severe delinquencies (90-plus days, foreclosures, and REOs) for the transactions, as a percentage of the current pool balances, range between
approximately 17.09% (series 2005-1) and 13.40% (series 2001-3). Realized losses for the transactions, as a percentage of the original pool balances, range between approximately 9.20% (series 2001-3) and 1.33% (series 2005-3).
     These performance trends have caused projected credit support for the transactions to fall well below the required levels. Standard & Poor’s will continue to closely monitor the performance of these transactions. If the transactions incur further losses and delinquencies continue to erode projected credit support, we will take further negative rating actions.
     Subordination, excess interest, and O/C provide credit support for the two transactions. The underlying collateral backing the certificates consists of both fixed- and adjustable-rate mortgage loans.

Bear Stearns Asset Backed Securities Trust
Residential mortgage-backed certificates
Series      Class       To              From
2001-3      M-2         BB              A
2001-3      B           B               BBB
2005-1      M-6         BB              BBB-
2005-1      M-7         CCC             BB
2005-2      M-7         B               BB
2005-3      M-6         B               BBB-
2005-3      M-7         CCC             BB

… which looks pretty horrific. But now let’s look at ALL of BSABST 2005-1:


 US$395 million asset-backed certificates, series 2005-1 
Class  Maturity Date   Rating  Rating Date    
A  Mar 25, 2035  AAA  Feb 24, 2005    
M-1  Mar 25, 2035  AA  Feb 24, 2005    
M-2  Mar 25, 2035  A  Feb 24, 2005    
M-3  Mar 25, 2035  A-  Feb 24, 2005    
M-4  Mar 25, 2035  BBB+  Feb 24, 2005    
M-5  Mar 25, 2035  BBB  Feb 24, 2005    
M-6  Mar 25, 2035  BB  Aug 24, 2007    
M-7  Mar 25, 2035  CCC  Aug 24, 2007    
R-I  Mar 25, 2035  NR  Feb 24, 2005    
R-II  Mar 25, 2035  NR  Feb 24, 2005    
B-IO  Mar 25, 2035  NR  Feb 24, 2005 

The SEC ID for this trust is 333-113636, for those who wish to see all the gory detail. Tranche sizes, from the prospectus on SEC / EDGAR are (this is SEC document 0000911420-05-000084.txt : 20050216) are:

Class A : $313,746,000 (pays LIBOR + 0.35% before optional termination / +0.70% afterwards)

Class M-1: $37,689,000 (+0.70% / +1.05%)

Class M-2: $18,549,000 (+1.40% / +2.10%)

Class M-3: $4,341,000 (+1.60% / +2.40%)

Class M-4: $3,946,000 (+2.20% / +3.30%)

Class M-5: $2,960,000 (+3.00% / +4.50%)

Class M-6: $4,538,000 (+3.50% / +5.25%)

Class M-7 was not offered in the prospectus. R-I and R-II are “residual interests in the real estate mortgage investment conduits established by the trust”, and were also not offered. B-IO gets all the Excess Spread. None of these last three classes had a stated principal value; I’m not going to tear apart the prospectus analyzing them because I don’t really care a lot how they work … I’m just after the principal values here!

The “optional termination” becomes effective “when the stated principal balance of the mortgage loans and any foreclosed real estate owned by the trust fund has declined to or below 10% of the stated principal balance of the mortgage loans as of the cut-off date”. At this point EMC Mortgage corporation could purchase all the assets.

At any rate, it should be clear that – while downgrades are always bad, and to be deplored by all right-thinking people – the downgrades that sounded so awful at the beginning of this post lose a lot of their ability to terrify when put into perspective.

Perspective is what’s needed when thinking about sub-prime … and I can’t provide it. I’m not a specialist, and I think a specialist would need a pretty good database to get it. What I really want is a transition study that has dollar figures attached, not just number of ratings. It would be nice, too, if interest rates could be attached to such a study … because, well, gee, the guys in the downgraded class M-6 were getting LIBOR + 350bp (and still are, since the issue is not in default)!

I’ll keep my eyes out, however, and whenever I see something interesting, I’ll post again.

Update 2007-09-18: I became involved in a discussion at Econbrowser in which this issue came up. In the course of the discussion I retrieved a bit more information from the prospectus, which I shall reproduce here:

The following table summarizes certain characteristics of the mortgage loans as of the cut-off date:

Number of mortgage loans……………………3,527
Aggregate principal balance…………..$394,649,130
Average principal balance………………..$111,894
Range of principal balance………$1,041 to $800,000
Range of mortgage rates……………0.00% to 16.50%
Weighted average mortgage rate……………..8.032%
Weighted average combined loan-to-value ratio……………………84.50%
Range of scheduled remaining terms to maturity……….9 months to 361 months

August 27, 2007

Monday, August 27th, 2007

Another reasonably normal day, bearing in mind that we’re talking about financial markets here and the word “normal” needs to be taken with a grain of salt.

Of great interest to me (I dare not say, “Of prime interest”, for fear of being misunderstood) was the Bank of Canada’s cash management bill, $2.5-billion of one-month bills to be auctioned tomorrow morning. They had to do something! The spread between 1-month bills and one-month CP as of the 24th had widened to 137bp (out 40bp just on the week) which I find just incredible … I mentioned on the 21st that I thought a 60bp three-month Bill/BA spread was amazing.”Cash Management Bill” is simply what they’re calling it – I’m not even sure if they can call it anything else, given that it’s not part of the regular auction routine.

I suspect that all the actual cash will be pushed right back into the money supply as loans against ABCP (maybe indirectly, e.g., National finances all the ABCP it suddenly owns by repo-ing more of its Canada holdings) … but I’m sure only a few people know that for sure at this point.

Bank of Canada deputy governor Pierre Duguay stated:

“Specifically, we are asking ourselves two questions: First, how much greater is the risk to the Canadian economy now posed by developments in the U.S. economy? And second, to what extent would the re-pricing of credit risk lead to a sustained tightening of credit conditions in Canada?”

In other words, they may have to ease considerably just to keep the commercial paper market (and the rest of the corporate curve) where they want it to be. We’ll see! The money-market quality spread has, maybe, stabilized in the US.

Speaking of the US, Brad Setser continues his probing of the current account deficit, Menzie Chinn highlights risks to the US deficit projections and Stephen Cecchetti reviews the Fed reaction to the crisis. He also includes the sentence

The sub-prime crisis made it clear that the rating agencies were doing a poor job of evaluating risks in securities that were backed by sub-prime mortgages.

but does not substantiate the charge that they’re doing a poor job. But that’s another post … and doubtless many more, as actual data start to come in to replace all this guessing.

I hope nobody thinks I’m totally indifferent to the situation, or that I’m carrying a torch for the ratings agencies. It’s just that … I’m not the oldest guy in the business, not by a long shot, but I’ve been around the block. If I had a nickel for every time I’ve been told the world’s about to end (and a dime for each time it was the result of a conspiracy or massive negligence by big institutions) … I’d be too busy with my troupe of dancing girls to bother writing this blog.

A lot of hedgies are going to get wiped out and the sooner the better; a few pension funds are going to play blame the manager; credit squeezes and the sudden conversion of Money Market instruments to term debt a la Coventree may give a recessionary cast to the economy; the US may well enter a recession, since a lot of their deficit-fuelled growth in the past few years has been housing-related and there ain’t gonna be much more of that; a few real companies will probably get weak enough that they get taken over at prices that don’t make long-term shareholders very happy (like just happened to Sachsen, mentioned here on August 20); and we might even see a spectacular flame-out if a big institution’s risk-controls are found wanting  … but I’m not so sure that the solidly investment-grade tranches of sub-prime debt are as bad as they’re made out to be.

What I am sure of, is that if I was a hedgie myself, I’d be bidding … low. And telling the newspapers how awful everything is.

US Equities fell a bit, as did those in Canada. There is concern that the de facto easing will be bad for Treasuries; the Fed Fund Futures are pricing in an immediate ease to 5.00% (the current de facto rate) and another ease to the 4.75% area – and beyond – by November. Canadas had a good day, with a basically parallel shift.

Another quiet, directionless day in pref land. Split shares are getting hit this month … people appear to want direct investments in companies with recognizable names!

Note that these indices are experimental; the absolute and relative daily values are expected to change in the final version. In this version, index values are based at 1,000.0 on 2006-6-30
Index Mean Current Yield (at bid) Mean YTW Mean Average Trading Value Mean Mod Dur (YTW) Issues Day’s Perf. Index Value
Ratchet 4.79% 4.83% 23,170 15.84 1 +0.3289% 1,043.7
Fixed-Floater 4.99% 4.82% 111,071 15.82 8 +0.0003% 1,020.5
Floater 4.93% -0.35% 73,700 7.94 4 +0.0312% 1,037.1
Op. Retract 4.84% 4.13% 79,637 3.16 16 +0.0848% 1,023.0
Split-Share 5.10% 4.93% 95,761 3.96 15 -0.2316% 1,037.9
Interest Bearing 6.21% 6.68% 66,919 4.59 3 +0.3803% 1,039.7
Perpetual-Premium 5.53% 5.20% 94,143 5.78 24 +0.0443% 1,024.0
Perpetual-Discount 5.12% 5.16% 272,353 15.23 39 +0.0423% 970.2
Major Price Changes
Issue Index Change Notes
LBS.PR.A SplitShare -1.9139% Asset coverage of just under 2.5:1 as of August 23 according to Brompton Group. Now with a pre-tax bid-YTW of 4.92% based on a bid of 10.25 and a hardMaturity 2013-11-29 at 10.00.
LFE.PR.A SplitShare -1.4382% Asset coverage of just over 2.6:1 as of August 15 according to the company. Now with a pre-tax bid-YTW of 4.74% based on a bid of 10.28 and a hardMaturity 2012-12-1 at 10.00.
FIG.PR.A SplitShare +1.3238% Asset coverage of over 2.3:1 as of August 24 according to Faircourt. Now with a pre-tax bid-YTW of 6.55% (almost all as interest) based on a bid of 9.95 and a hardMaturity 2014-12-31 at 10.00.
Volume Highlights
Issue Index Volume Notes
GWO.PR.I PerpetualDiscount 20,663 RBC crossed 10,000 at 22.21. Now with a pre-tax bid-YTW of 5.14% based on a bid of 22.25 and a limitMaturity.
SLF.PR.D PerpetualDiscount 19,934 Nesbitt bought a total of 16,300 from “Anonymous” (various Anonymouses? Anonymice?) in five tranches from 22.18 to 22.25. Now with a pre-tax bid-YTW of 5.01% based on a bid of 22.20 and a limitMaturity.
BNS.PR.M PerpetualDiscount 17,925 Now with a pre-tax bid-YTW of 4.94% based on a bid of 23.01 and a limitMaturity.
RY.PR.C PerpetualDiscount 17,600 National Bank crossed 11,900 at 23.05. Now with a pre-tax bid-YTW of 5.01% based on a bid of 23.05 and a limitMaturity.
MFC.PR.C PerpetualDiscount 17,300 Now with a pre-tax bid-YTW of 4.89% based on a bid of 23.00 and a limitMaturity.

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

HIMIPref™ Indices : April 28, 2000

Monday, August 27th, 2007

All indices were assigned a value of 1000.0 as of December 31, 1993.

HIMI Index Values 2000-04-28
Index Closing Value (Total Return) Issues Mean Credit Quality Median YTW Median DTW Median Daily Trading Mean Current Yield
Ratchet 1,394.2 0 0 0 0 0 0
FixedFloater 1,839.3 8 1.87 6.25% 13.3 328M 5.53%
Floater 1,312.8 2 2.00 7.22% 12.1 134M 6.94%
OpRet 1,348.4 34 1.27 5.53% 3.8 80M 6.32%
SplitShare 1,377.9 3 1.66 6.22% 6.2 66M 5.77%
Interest-Bearing 1,442.9 7 2.00 8.46% 10.6 233M 8.51%
Perpetual-Premium 1,030.2 0 0 0 0 0 0
Perpetual-Discount 1,054.7 12 1.57 6.40% 13.3 121M 6.42%

Index Constitution, 2000-04-28, Pre-rebalancing

Index Constitution, 2000-04-28, Post-rebalancing


Monday, August 27th, 2007

I’ve just read a good paper by Engel & McCoy, Turning a Blind Eye: Wall Street Finance of Predatory Lending, which, while certainly having an axe to grind (they want more regulation), does give a good overview of the problems. Their central point is:

As this excerpt from one prospectus illustrates,securitization turns a blind eye to the underwriting of subprime loans:

With the exception of approximately 20.82% of the mortgage loans in the statistical mortgage pool that were underwritten in accordance with the underwriting criteria of The Winter Group, underwriting criteria are generally not available with respect to the mortgage loans. In many instances the mortgage loans in the statistical mortgage pool were acquired by Terwin Advisors LLC from sources, including mortgage brokers and other non-originators, that could not provide detailed information regarding the underwriting guidelines of the originators.

As this suggests, Wall Street firms securitize subprime home loans without determining if loan pools contain predatory loans. In the worst situations, secondary market actors have actively facilitated abusive lending.

The big problem (to me) is loan re-negotiation, which has been the subject of some political chatter in recent weeks:

Securitization complicates and often blocks work-outs with borrowers who are harmed by predatory loans. This is because the underlying securitization contracts tie the trustee’s and servicer’s hands if they attempt to negotiate a repayment plan in lieu of foreclosure. The value of the securities and the amount of their returns are based on cash flows that are determined, in part, by the loan terms. To protect these cash flows, securitization contracts typically prohibit changes to the terms of the underlying loans. In addition, securitization contracts often prohibit servicers from waiving prepayment penalties and other loan provisions.

There is a very good table in the Engel & McCoy paper (on page 2056 of the Fordham Law Review), showing S&P Upgrades and Downgrades of Public Subprime RMBS, 2003-2006. It’s not a proper transition matrix, but it’s a start. 

Anyway, what brought on this surge of interest in the mechanics of sub-prime was the recent announce by Fitch:

Fitch has affirmed three classes and downgraded one class of notes issued by Northwall Funding CDO I, Ltd., (Northwall). The following rating actions are effective immediately:

–$165,326,758 class A-1 notes affirmed at ‘AAA’;
–$46,500,000 class A-2 notes affirmed at ‘AAA’;
–$40,500,000 class B notes affirmed at ‘AA’;
–$18,000,000 class C notes downgraded to ‘BB’ from ‘BBB’ and remain on Rating Watch Negative (RWN).

Northwall is a collateralized debt obligation (CDO) that closed May 17, 2005 and is managed by Terwin Money Management, LLC (Terwin). Northwall has a substitution period that grants Terwin limited trading ability until September 2007. The portfolio is composed of approximately 89% subprime residential mortgage-backed securities (RMBS), 8% Prime RMBS, and 3% CDOs.

The downgrade of the class C notes reflects the deterioration in credit quality of the portfolio.
Approximately 11% of the portfolio has been downgraded since last review and as of the most recent trustee report the WARF has increased to 5.07 (‘BBB/BBB-‘) from 4.35 (‘BBB/BBB-‘) at last review. In Fitch’s view approximately 13.5% of the portfolio is below investment grade quality, including approximately 5.9% ‘CCC’ or lower quality. There is one defaulted asset comprising $994,341 of the portfolio. In addition, approximately 7% of bonds in the portfolio are on Rating Watch Negative (RWN).

As far as I can make out from a google-cached report by Credit Suisse, the original issue came in the tranches indicated above, with an additional “equity tranche” representing 5% of the issue.

There was another announcement by Moody’s:

Moody’s Investors Service today announced downgrades on 120 securities originated in the second half of 2005 and backed by subprime, first-lien mortgage loans. The actions follow a review of the securities rated in the second half of 2005 and affect securities with an original face value of over $1.5 billion, representing 0.7% of the dollar volume and 4.1% of the securities rated by Moody’s in the second-half of 2005 that were backed by subprime, first-lien loans.


The actions reflect the higher than anticipated delinquency rates of first-lien subprime mortgage loans securitized in the second half of 2005. These loans were originated in an environment of aggressive underwriting, although not to the same degree as the subprime loans originated in 2006. Aggressive underwriting combined with the prolonged slowdown in the housing market has caused significant loan performance deterioration and is the primary factor in these rating actions. Moody’s has noted a persistent negative trend in severe delinquencies for first-lien subprime mortgage loans securitized in late 2005 and 2006.


The vast majority of these downgrades impacted securities originally rated Baa or lower. In total 54 securities originally rated Baa and 60 securities previously rated Ba were downgraded. Additionally, 6 tranches originally rated A were downgraded. No action was taken on securities rated Aaa or Aa.


In addition to the high rates of early delinquency predicating today’s actions, Moody’s notes that subprime mortgages originated in late 2005 and 2006 that are subject to interest rate reset present an additional cause for credit concern. Subprime borrowers from previous vintages of such collateral avoided “payment shock” and potential default by refinancing. However, with the recent pressure in home price appreciation and tightening of mortgage lending standards, such refinancing opportunities may be more limited. Moody’s has noted that transactions issued in the second half of 2005 have begun to exhibit slower prepayment speeds as they near the two-year interest reset than did prior vintages. Moody’s is actively surveying loan servicers to evaluate the impact of potential increases in loan modification due to these upcoming resets.

Why do I bring this up? Well … no real reason. I just wanted to point out that the highest rated tranche of the issue reviewed by Fitch was the best-protected $165-million of a $300-million issue … asset coverage of 1.8:1, in fact, to put it in terms familiar to those who invest in Split-Share preferreds.

Also, I’m really annoyed at all the weeping and wailing over sub-prime. There have been significant losses, but so far they have been borne by

i) those who bought the lower-rated or equity tranches, and it serves ’em right!

ii) those who have panicked and sold stuff into a panicked market because it has the word “sub-prime” in it somewhere. To say something is a sub-prime derivative is about as meaningful as saying something else is an equity. It comes in many flavours.

There’s more perspective over at Tom Graff’s Accrued Interest.

Research : Portfolio Construction

Saturday, August 25th, 2007

Most analysis, both here and elsewhere, is focussed on security selection. Now that the September edition of Canadian Moneysaver has been published, I can now release this more general, portfolio level, analysis published in their July/August edition.

Look for the research link!

August 24, 2007

Friday, August 24th, 2007

Another normal day! At this rate, I’m going to have to make notes when preparing remarks about ‘What happened in August’!

The Fed made it clear that it will accept ABCP at the discount window. This will aid in delevering the financial system since it makes it easier for the banks to buy, or to lend against, the ABCP that has been issued in an attempt to avoid the banks. The latter process is referred to as disintermediation; I’m not sure what to call the process of reversal.

In related news, two Canadian sub-prime lenders have tightened their standards, citing inability to fund the loans at a decent price.

There was good economic news in the US (especially durable goods orders) … but that was for July! Considerable uncertainty remains over how the recent events will affect the real economy.

Brad Setser speculates, based on foreign official reserves held in custody at the Fed, that private investment in emerging economies is being reduced – funds reducing risk, funds meeting margin calls.

On the other hand … US equities capped a fine week with a good gain and Canadian equities did even better. So who knows? Markets will do what markets want to do when they want to do it.

But in signs that many, anyway, are calming down after the panic the US bond curve flattened and

Benchmark 10-year notes rose as traders said corporate bond sales created demand for long-term products sold earlier as hedges.

So in general, it would appear that term is being extended (even if merely via intermediaries), which is a Good Thing. Canadas flattened a lot with the 2-10 spread moving to 12.1bp from 19.1bp.

A quiet, directionless day in pref land.

Note that these indices are experimental; the absolute and relative daily values are expected to change in the final version. In this version, index values are based at 1,000.0 on 2006-6-30
Index Mean Current Yield (at bid) Mean YTW Mean Average Trading Value Mean Mod Dur (YTW) Issues Day’s Perf. Index Value
Ratchet 4.79% 4.84% 22,997 15.85 1 -0.5317% 1,040.3
Fixed-Floater 4.99% 4.83% 113,133 15.82 8 +0.1763% 1,020.5
Floater 4.93% -0.05% 73,449 7.94 4 +0.4314% 1,036.8
Op. Retract 4.84% 3.98% 80,515 3.11 16 -0.0284% 1,022.1
Split-Share 5.09% 4.95% 97,214 4.20 15 +0.0356% 1,040.3
Interest Bearing 6.23% 6.70% 66,037 4.58 3 -0.3730% 1,035.8
Perpetual-Premium 5.53% 5.18% 94,698 5.78 24 -0.0209% 1,023.5
Perpetual-Discount 5.12% 5.16% 274,490 15.23 39 +0.0259% 969.8
Major Price Changes
Issue Index Change Notes
NA.PR.L PerpetualDiscount -1.3389% Now with a pre-tax bid-YTW of 5.17% based on a bid of 23.58 and a limitMaturity.
IAG.PR.A PerpetualDiscount -1.3043% Now with a pre-tax bid-YTW of 5.14% based on a bid of 22.70 and a limitMaturity.
BAM.PR.K Floater +1.0526%  
PWF.PR.K PerpetualDiscount +1.8400% Now with a pre-tax bid-YTW of 5.24% based on a bid of 23.80 and a limitMaturity.
Volume Highlights
Issue Index Volume Notes
BMO.PR.J PerpetualDiscount 36,000 Now with a pre-tax bid-YTW of 5.04% based on a bid of 22.42 and a limitMaturity.
GWO.PR.E OpRet 27,045 Now with a pre-tax bid-YTW of 4.12% based on a bid of 25.70 and a call 2011-4-30 at 25.00.
CM.PR.H PerpetualDiscount 12,930 Now with a pre-tax bid-YTW of 5.10% based on a bid of 23.73 and a limitMaturity.
RY.PR.C PerpetualDiscount 12,800 Now with a pre-tax bid-YTW of 5.02% based on a bid of 23.02 and a limitMaturity.
SLF.PR.C PerpetualDiscount 12,240 Now with a pre-tax bid-YTW of 5.01% based on a bid of 22.20 and a limitMaturity.

There was ONE other $25-equivalent index-included issues trading over 10,000 shares today.