PrefBlog

Treasury has released FAQs regarding the FNM/FRE Preferred Stock Purchase Agreement.

Naked Capitalism reprints an article in the Financial Times claiming that a consortium including BofA is looking at Lehman. Who knows? We could be having yet another Sunday Special!

Moody’s has cut Washington Mutual’s senior unsecured rating to junk:

Moody’s Investors Service downgraded the long-term deposit and issuer ratings of Washington Mutual Bank to Baa3 from Baa2. The bank’s financial strength rating was downgraded to D+ from C-, base line credit assessment (BCA) to Ba1 from Baa2, and short term rating to Prime-3 from Prime-2. Washington Mutual Inc.’s senior unsecured rating was downgraded to Ba2 from Baa3. The rating action concludes the review that was initiated on July 22, 2008. The outlook is negative.
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Moody’s also expects WaMu to report future quarters of large losses. This could exacerbate negative market sentiment and lead to franchise impairment.
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Washington Mutual Inc.’s preferred stock was downgraded to B2 from Ba2, reflecting Moody’s view that the risk of a suspension of dividends on these instruments has risen materially.

The Auction Rate Securities shakedown in the States continues, with Fidelity close to a $300-million buy-back:

Fidelity Investments is close to a settlement with New York Attorney General Andrew Cuomo to buy back $300 million in auction-rate securities, according to a person familiar with the negotiations.

If there was misrepresentation of the product, or if clients were given grossly unsuitable advice, then somebody should be losing their license. After public hearings. If there was no such fraudulent misrepresentation, if the only problem was that investments didn’t work out as hoped, then nobody should be doing anything. Attorney General Andrew Cuomo would be well advised to look back at his schoolbooks, under “Rule of Law”. This whole business of negotiated settlements in regulatory matters is an affront to civilized values.

Hard on the heels of my speculation yesterday that the BoE was preparing the ground for a more punitive rate for its liquidity operations comes the news that the Fed’s discount window is working overtime:

Borrowing from the Fed’s discount window hit record levels in six of the past eight weeks, and reached $23.5 billion as of Sept. 10, Fed data show. By comparison, lending averaged just $779 million a week in the three months after New York Fed President Timothy Geithner urged banks to use the program.

The increasing use of the funds risks delaying banks’ disposal of nonperforming assets and capital raising. It also may make it tough to restore the rate on the loans to the historical 1 percentage point premium over overnight funds, analysts said. The Fed has lowered the rate nine times since August 2007.

The data comes from the Federal Reserve Statistical Release H.4.1. Bloomberg has a neat graph:

Nine times in twelve months! There is even some speculation that that the next move move might be a loosening:

Inflation looks likely to ebb, thanks to falling commodity prices and contained labor costs. The U.S. economy, meanwhile, may be set to take another lurch down as consumer spending gives way and the credit crunch intensifies with the plunge in Lehman Brothers Holdings Inc.’s shares.
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San Francisco Fed President Janet Yellen left open the possibility of a rate cut in comments to reporters after a Sept. 4 speech in Salt Lake City. “There is some chance” of easing credit “if things start going seriously wrong,” she said.

Well … in and of itself, Yellen’s comment doesn’t mean anything. Of course there’s always the possibility of easing. There is also the possibility of … well, just about anything!

Including Lehman’s survival! They have reportedly received some serious bids for their Asset Management business:

Lehman Brothers Holdings Inc. received bids for its asset-management unit from private-equity firms including Bain Capital LLC and Clayton Dubilier & Rice Inc., as the investment bank seeks offers for the entire firm.

The bids value the unit, which includes the Neuberger Berman fund-management business, private-equity funds and a brokerage firm serving wealthy individuals, at about $5 billion, according to people familiar with the auction who asked not to be named because the process is private.

A very good day for the PerpetualDiscount sector on decent volume.

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

A Bloomberg story pointed me towards remarks by Mervyn King of the BoE regarding long- and short-term bank funding:

we will also set out arrangements to ensure the banking system as a whole will continue to be able to access liquidity insurance from the Bank of England from October 22nd.

The objective of the new facility will be to provide short-term liquidity insurance to smooth the adjustment of financial institutions hit by unexpected shocks. The facility will be an important part of the contribution which the Bank can make to enhance the stability of the banking system. But it is not the purpose of central bank liquidity insurance to provide a source of long-term funding to the financial system – indeed it cannot do that. Only private savers or taxpayers via the government can provide such funds. So I hope everyone will understand that the proposals to be published next week, important though they are, will not and cannot solve the shortage of funding to finance bank lending, including mortgage lending.

So there’s a warning shot! I suspect that the touted new facility – the Special Liquidity Scheme (SLS) will not make new loans after October 21 – will follow Bagehot and include a far more penalizing rate for liquidity injections. The SLS fee is minimal:

Banks will be required to pay a fee to borrow the Treasury Bills. The fee charged will be the spread between the 3-month London Interbank interest rate (Libor) and the 3-month interest rate for borrowing against the security of government bonds, subject to a floor of 20 basis points.

Meanwhile there is the chance that Fannie & Freddie debt might be explicitly nationalized:

The federal takeover of the government-sponsored enterprises, or GSEs, on Sept. 7 failed to address whether the debt of Fannie and Freddie should be included in the budget, or whether it carries an explicit government guarantee. In an interview this week, Treasury Secretary Henry Paulson cited the “incongruities” in the law and said “we should be clear, is there a government guarantee or isn’t there?”

Any decision to add Fannie and Freddie to the budget wouldn’t automatically translate into an explicit government backing for the companies’ combined $1.7 trillion in unsecured debt and $3.5 trillion of mortgage guarantees. Granting the full faith and credit of the U.S. would require an act of Congress to change the companies’ legal status.

This would bring the Fannie/Freddie debt into a position resembling CMHC mortgage bonds:

CMHC’S GUARANTEE OF CANADA MORTGAGE BONDS CARRIES THE FULL FAITH AND CREDIT OF CANADA, AND CONSTITUTES A DIRECT, UNCONDITIONAL OBLIGATION OF CANADA
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CMB have been given Canada’s S&P AAA/Moody’s Aaa credit rating and a 0% capital weighting under the BIS guidelines. CMB are not subject to withholding tax by Canada.

… and its direct debt:

CMHC’S DEBT OBLIGATIONS CARRY THE FULL FAITH AND CREDIT OF CANADA, AND CONSTITUTE DIRECT, UNCONDITIONAL OBLIGATIONS OF AND BY CANADA.
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Canada credit and a 0% capital weighting under the BIS guidelines

Though mind you, the CMHC is virtually invisible to retail-level Canadians – they buy their mortgages wholesale from the banks, except for those made in order to help cities build slums. The FannieFreddieFiasco has politicized foreclosures in an election year:

U.S. Senate Banking Committee members urged Fannie Mae and Freddie Mac, the mortgage companies placed under federal control this week, to freeze foreclosures on loans in their portfolios for at least 90 days.

“This action would provide immediate relief to many homeowners” and let the companies “turn these non-performing loans into performing assets to minimize losses,” Senators Charles Schumer, Robert Menendez and other panel Democrats said today in a letter to the companies and the Federal Housing Finance Agency, which is overseeing them under the government conservatorship. The companies also should ease their policies on modifying mortgages, the senators wrote.

I guess, if you squint, you can put this politicization in the “unintended consequences” category, together with the Municipal Ratings Mess I posted about today. I just can’t resist noting another unintended consequence of feel-good politics that I learned about today: European Universities get paid for granting diplomas:

Indeed, with the notable exception of the UK, European universities display a poor performance in most international education rankings. According to both the Times Higher Education Supplement and the Shanghai Jiao Tong university rankings, only four institutions in continental Europe would rank among the top 50 universities in the world.
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More precisely, the funds allocated to a university [in Italy] increase with the total number of full-time equivalent students (FTE), which is defined as the ratio between the number of exams passed and the number of exams that students should have taken.
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The evidence suggests that a financing scheme that was meant to reward universities that produce higher value added is, instead, favouring universities with lower standards.

Surprise, surprise! It reminds me of Communist Russia’s Five Year Plans … tractor factory heads had to meet a production quota measured by weight of shipped products … and responded by building the world’s heaviest tractors.

Lehman continues to twist in the wind and is looking – urgently – for a buyer. The Bank of America has been mentioned. Why not? They’ve warmed up with Countrywide:

“This deal is so rancid and unpredictable,” said Christopher Whalen, managing director at the consulting firm Institutional Risk Analytics. “Bank of America’s executives can’t even articulate what the total liabilities from this deal are.”

Another possibility is for them simply to sell off their crown jewel, but there are financing problems:

Lehman Brothers Holdings originally sought to sell as much as 70% of its investment-management division but scaled that back to a sale of a 55% stake thinking that the private-equity firms mulling a bid would have trouble finding the financing for a bigger deal.

Final bids are due Friday, setting the stage for a weekend of wheeling and dealing if Lehman can fend off today’s brutal market evisceration of its stock, according to people familiar with the matter.
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In a comment completely unrelated to Lehman, Blackstone Group COO Tony James said Wednesday that LBO financing has a hard limit of $5 billion these days.

A lot of European junk bond product is now classified as distressed:

More than 30 percent of European high-risk, high-yield bonds are trading at distressed levels, the most in five years, stoking speculation defaults will rise.

Investors demand an extra yield over government debt of more than 10 percentage points to hold 53 of the 169 bonds in Merrill Lynch & Co.’s Euro High Yield Constrained Index. That’s the biggest proportion of distressed debt since March 2003, in the aftermath of the Sept. 11 terror attacks and the dot-com crisis.

A surprisingly quiet day on the market, with very few issues trading in substantial size. PerpetualDiscounts eked out a small gain, closing with a pre-tax bid-YTW of 6.09%, equivalent to interest of 8.53% at the standard 1.4x tax-equivalency factor. Long corporates are at 6.20%, so the spread is still a relatively high 233bp.

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

The question of whether the functions of Central Bank and Bank Regulator should be combined or not has been often discussed on PrefBlog. Elsewhere, too, like Frankfurt, with remarks by Ms. Gertrude Tumpel-Gugerell of the ECB:

The main position at that time, which remains valid today, is that there is no optimal arrangement for the organisation of supervision at the national level. All organisational models – sectoral supervision, supervision by objectives, supervision in a single authority – can in principle work well or fail depending on circumstances. However, regardless of the model, it is important that there exists a very close and smooth interplay between the central banking and the supervisory function.
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Provision of Emergency Liquidity Assistance is a clear point in case where central banks need supervisory information for decision-making. In this field, I believe that an important step forward is represented by the recent MoU on financial stability arrangement signed by the EU central banks, supervisors and ministries of finance in June 2008.

Finally, referring more to the supervisory domain but still linked to the central bank interest, the turmoil has evidenced the need for strengthening the macro-prudential dimension of regulation and supervision. This means the regulatory and supervisory requirements should be able to ensure adequate capital and liquidity buffers throughout the economic cycle. In this regard, the actual impact of the new capital adequacy regime under of Basel II will have to be monitored very closely.

Very bureaucratic! There isn’t the slightest hint of a recommendation in these remarks!

Lehman reported today:

Lehman Brothers Holdings Inc., reporting the biggest loss in its 158-year history, said it will sell a majority stake in its asset-management unit, spin off commercial real-estate holdings and cut the dividend in an effort to shore up capital and regain investor confidence.

There is little risk I can see that Lehman will flame out with the frightening speed of Bear Stearns – they have access to the discount window:

The program instituted in the aftermath of the Bear Stearns debacle, the Primary Dealer Credit Facility, could be used for funding while officials, regulators and executives find alternative sources of cash, Fed watchers said.

“The PDCF could be used to keep Lehman operating until a broader solution was found,” said Brian Sack, a former Fed research manager who’s now senior economist at Macroeconomic Advisers LLC in Washington. “The challenge is figuring out what the broader solution is.”

Lehman can borrow overnight from the central bank, with escalating costs if it keeps using the program. Because it’s a stopgap, speculation may mount that the government will again intervene to prevent a large financial company from failing, after the Bear Stearns rescue and takeovers of Fannie Mae and Freddie Mac.

Speaking of Fannie & Freddie, repercussions on the US preferred share market have been severe:

Prices of fixed-rate preferred stock fell an average of 9 cents to 71.5 cents on the dollar this week, according to Merrill Lynch & Co. index data, the biggest two-day drop in more than a decade. The 11 percent decline compares with a 1.4 percent drop in the Standard & Poor’s 500 index over the same time.
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Sales of preferred securities in the U.S. have risen 48 percent this year to about $44 billion from more than $30 billion in the same period of 2007, according to data compiled by Bloomberg. The average yield as measured by the Merrill index has risen to 10.1 percent from 8.8 percent on Sept. 5 and 7.9 percent at the end of last year.

Accrued Interest surveys the wreckage and recommends buying mortgage-backeds, while Fannie Mae has announced a $7-billion 2-year issue of its own debt (which, as Accrued Interest pointed out, had a lot taken up by central banks) … and at the same time, Vivendi has cancelled an offering of $846-million 7-years. And another US banking company slashed its common dividend:

Synovus Financial Corp., owner of 35 banks in the Southeastern U.S., will cut 650 jobs, or about 9 percent of its staff, and reduce the dividend by 65 percent to preserve capital depleted by mortgage losses.

The bank will record $15 million in costs for the two-year plan in 2008 and another $6 million later, and expects it will add $75 million in annual pretax earnings, the Columbus, Georgia- based Synovus said today in a statement. The quarterly payout was lowered to 6 cents a share.

All this excitement leaves little time for regulatory grandstanding, but some of them manage it:

Bank of America Corp. will buy back $4.5 billion of auction-rate securities to settle a nationwide probe led by Massachusetts Secretary of State William Galvin into its sales and marketing of the failed debt.

Bank of America, one of the largest underwriters of the securities, will offer to redeem the securities from its customers between Oct. 1 and Dec. 31, it said in a statement today. The Charlotte, North Carolina-based bank said it expects to record a pretax charge of about $275 million in connection with the buybacks.

Nothing like a little extortion to spice up a regulator’s life, eh?

“Liquidity” has often been mentioned in this blog – there was a story on Bloomberg today highlighting its importance in the day-to-day mechanics of bond trading:

Trading in the corporate bond market has fallen a third after averaging $26 billion a day in the first eight months of 2007, according to Federal Reserve data on primary dealers.
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The biggest bond dealers, including JPMorgan Chase & Co., and Citigroup Inc., aren’t committing as much cash to boost corporate-bond trading. That’s because they’re shoring up their capital after the collapse of the subprime-mortgage market spurred about $511.4 billion of writedowns and losses.

While corporate-bond trading is shrinking, average daily trading in government securities has risen to about $584 billion this year from $560 billion in the same period of 2007, Fed data show.

The decline in corporate-debt trading, known in market parlance as illiquidity, is prompting fund managers to demand higher compensation to buy new bonds, driving up borrowing costs for companies, including American Express Co. and Verizon Communications Inc., and reducing returns on existing securities.

PerpetualDiscounts moved solidly upward on a moderately busy day. Royal Bank issues took the spotlight, with high volume and strong performance.

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