PrefBlog

The recent rally in junk bonds is having some interesting knock-on effects:

The biggest high-yield rally ever is punishing the lowest- rated companies that may no longer be able to afford avoiding bankruptcy by exchanging or buying back debt at the lowest prices on record. The “cruel irony” of rising prices means the neediest businesses will have a harder time finding financing, Morgan Stanley analysts led by Jocelyn Chu in New York said in a May 15 report. That may lead to more defaults than anticipated.

Freescale Semiconductor Inc., part-owned by 62-year-old Schwarzman’s Blackstone Group LP, wiped away $1.9 billion of debt in March by giving investors an average of 32 cents on the dollar in loans. Since the bond exchange was announced March 4, the securities have tripled to as high as 54.1 cents on the dollar, curtailing the chipmaker’s ability to cut the rest of its $7.5 billion debt load.

C-EBS is hosting a public hearing on liquidity buffers, in an attempt to finalize a framework for EU national bank supervision. There is a a wide range of industry practices:

– Within the industry, most banks either formally define a liquidity buffer or alternatively it is a concept implicit in their liquidity management policy.

– One institution formally defines its liquidity buffer as highly liquid unencumbered assets set at a level to get through the initial stages of a liquidity shock. It also defines a maximum amount of collateral that may be needed for intraday payment system purposes and deducts this from the stock of unencumbered assets. Buffers are formed for each of the currencies in which it is active. A survival period of 90 days is defined and liquidity shock scenarios developed to calibrate the size of the buffer.

– Another bank defines the buffer as a liquidity gap based on a runoff scenario (all maturing assets and liabilities not renewed during a 4 week period) that can be covered from high quality funding sources.

– Another bank defines the buffer over 30 days but does not use stress tests to measure the required size of buffer. Instead, expert judgement from the ALCO sets the buffer level. The quality of the assets in the buffer also impacts the level of buffer held.

– Another bank does not formally define a buffer. Instead it manages its overall counterbalancing capacity. As part of this, it uses projected flows to estimate a level of unencumbered assets that will cover the liquidity gap such that no change to the bank’s business model is required. This output is an input to the overall policy on managing its counterbalancing capacity.

The Globe and Mail has a story on Property & Casualty insurers:

The Office of the Superintendent of Financial Institutions (OSFI), which regulates about 200 companies in the sector, is worried about capital levels in the industry.

“It’s a period of great uncertainty right now,” said Bruce Thompson, a director in the supervision sector of OSFI’s Toronto office. “Our expectation is that 2009 is going to be a difficult year for the industry.”
…
Its total capital level dropped last year for the first time since 2003. The key measure of a property and casualty insurer’s financial cushion is called the Minimum Capital Test. The sector-wide ratio fell to 238 per cent at the end of 2008, from 252 per cent at the end of 2007. (Regulators require it to remain above a floor of 150 per cent, but Mr. Thompson pointed out that “companies know darn well that 150 is a territory you don’t go.”)

A basically flat day for preferreds amidst continued heavy volume.

The IMF has released a working paper by Peter Stella, The Federal Reserve System Balance Sheet: What Happened and Why it Matters:

The recent expansion of the balance sheet of the consolidated Federal Reserve Banks (FRB) is analyzed in an historical context. The analysis reveals that the nature of Fed involvement in U.S. financial markets has changed dramatically and its expansion is several orders of magnitude beyond what is usually reported. The associated fiscal risks and potential exit strategies are then considered. Although risks are considerable in certain unlikely scenarios, FRB capital, earnings capacity, and reserves are more than ample to preserve their financial independence. Nevertheless, the occurrence of losses or a significant drop in FRB profit might lead to an eventual curtailment of Fed operational independence. The paper concludes by considering options to enhance FRB risk management and to assign responsibilities for monetary, financial stability and fiscal policies once the current crisis is overcome.

Bank of America expects to complete its capital raise shortly:

Bank of America Corporation today said it has raised almost $33 billion towards the $33.9 billion capital buffer identified by the Federal Reserve’s Supervisory Capital Assessment Program (SCAP) and now believes it will comfortably exceed that number.

To date, Bank of America has entered into agreements with certain holders of (non-government) perpetual preferred shares to exchange their holdings of approximately $9.5 billion of perpetual preferred stock into approximately 704 million shares of common stock. This results in a total benefit to Tier 1 common capital of $9.5 billion.

Their exchange offer was announced May 28:

Bank of America is offering to issue shares of common stock in the exchange offer in the applicable consideration amount per depositary share specified in the table below. The number of shares of common stock issuable for each exchanged depositary share will be equal to this consideration amount divided by the average of the daily per share volume-weighted average price of Bank of America common stock for each of the five consecutive trading days ending on and including June 22, 2009 (the second business day prior to the scheduled expiration date of the exchange offer). Bank of America will announce this common stock average price no later than 9 a.m., New York City time, on June 23, 2009. One of the conditions of the exchange offer that must be satisfied or waived is that the common stock average price be $10 or greater.

To give you an idea of the rates, the consideration for the Series I is $17.50; it pays 1.65624 annually.

DBRS has changed the trend on Ontario’s long-term debt to negative:

DBRS has today changed the trend on the long-term debt rating of the Province of Ontario (the Province or Ontario) to Negative from Stable. The trend on the Province’s short-term rating remains Stable. The rating action reflects the material erosion observed in the Province’s already depressed fiscal outlook since the beginning of the fiscal year, due in part to the larger-than-expected government bailouts recently announced for two large North American auto companies, amidst significant economic and fiscal uncertainty. As a result, while DBRS takes comfort in the economic diversification and moderately low debt burden of the Province, concerns have increased with respect to the Province’s ability to weather the global recession and the crisis of its auto sector without unduly weakening its credit metrics.

Hardly a surprise. The charlatans of the mid-90’s to mid-00’s cut the good-time surplus to nothing and the current bozos felt they had to compete. The lesson of 1994 has been forgotten; I’d say we’ll hit it again in 10-20 years.

I had a quick look for a historical budgetary balance graph that would include Rae’s recession … unfortunately, no politician wants to admit that the good-time surplus was derisory – the Conservatives because it betrays their fiscal ineptitude, the Liberals because they’ve made a point of complaining about the ever-so-horrible spending reductions in that period, the NDP because they don’t understand the question.

Fortunately, by the time we hit the wall, we’ll be able to push our expensive electric cars to work instead of taking the expensive hybrid busses. But at least we’ll be precious.

The Globe and Mail reports:

Unable to win over the recalcitrant investors, sources said GM Canada officials called for help. Their plea went to Ottawa. Could the government help break the stalemate?

The answer came at shortly after 8 p.m. ET Sunday, when the government announced that Prime Minister Stephen Harper, Industry Minister Tony Clement and Ontario Premier Dalton McGuinty would be speaking at 1 p.m. yesterday in Toronto. No public explanation was offered for the news conference. Privately, however, sources said General Motors officials and their advisers worked the phones through the night to warn the investors that the notice meant the Prime Minister was preparing to single out the bondholders for failing to support a bailout of the troubled auto maker.

“We told the bondholders that the Prime Minister of Canada was going to stand up before the country and say that a reasonable corporate solution had failed and the Canadian operations had landed in bankruptcy proceedings because of the bondholders,” said one person involved in the discussions.

Assuming that these unsupported and anonymous allegations are correct, it’s not clear who is more contemptible: GM Canada, for even thinking of the idea; What-Debt?, for enthusiastically offering to attack on command; the Portfolio Managers, for knuckling under instead of representing their clients; or the regulators who, you may be sure, will not be investigating the matter for possible breach of duty.

The immediate practical implications are, I suggest, an increased chance of increased credit notching for Tier 1 (and equivalent) capital; which is to say, lower credit quality. Throwing your weight around in the capital markets is like eating peanuts…

Knock-on implications – which have probably been ignored when making these decisions – are interesting. I suggest that Recovery-Lock Credit Default Swaps will become more popular.

The preferred share market squeaked out another win today, on continued heavy volume.

Econbrowser‘s James Hamilton has put together a very good collection of links regarding the Credit Crisis.

Treasuries got hit today, with a Bloomberg story suggesting a cyclical shift:

“Money is rotating out of Treasuries and into other areas,” said Thomas Roth, head of U.S. government-bond trading in New York at Dresdner Kleinwort, one of 16 primary dealers that trade with the Federal Reserve. “There has been a tremendous flight into Treasuries over the past year and if things get better we will see a flight out.”

The yield on the benchmark 10-year note rose 20 basis points, or 0.20 percentage points, to 3.67 percent at 4:03 p.m. in New York, according to BGCantor Market Data. The yield earlier rose as much as 27.74 basis points, the most since advancing 32.97 basis points on Oct. 8. The 3.125 percent security due in May 2019 dropped 1 5/8, or $16.25 per $1,000 face value, to 95 1/2.

Ten-year yields have risen more than 165 basis points since falling to a record low of 2.03 percent last year.

The yield on the 30-year bond climbed 18 basis points to 4.53 percent.

… and Across the curve agrees:

I also believe that we are seeing a reversal of the flight to quality. Investors had piled into risk averse government bonds and they are now fleeing them for equities and investment grade corporate bonds. The change of heart could not come at a worse time as it collides with the massive financing needs of the US Government.

Place yer bets, gents!

June got off to a strong start on continued high volume.