PrefBlog

The latest controversy is Flash Trading:

Charles Schumer, the third-ranking Democrat in the U.S. Senate, asked the Securities and Exchange Commission to ban so-called flash orders for stocks, saying they give high-speed traders an unfair advantage.

Schumer’s letter to SEC Chairman Mary Schapiro yesterday raised the stakes in a debate over the practice offered by Nasdaq OMX Group Inc., Bats Global Markets and Direct Edge Holdings LLC, which handle more than two-thirds of the shares traded in the U.S. With flash orders, exchanges wait up to half a second before they publish bids and offers on competing platforms, giving their own customers an opportunity to gauge demand before other traders.

The NYSE letter to the SEC has more details, but I must say I just don’t get it. As far as I can make out, the NYSE believes that Flash Trading will put traders who don’t work hard enough at a disadvantage. To which I say: So?

The Globe had a story on Saturday claiming regulators are seeking record settlements with respect to the ABCP fiasco:

Much of the regulatory attention is being paid to banks that sold the commercial paper. On July 24, 2007, dealers received an e-mail from Coventree disclosing some of its trusts’ exposures to U.S. subprime mortgage assets. Regulators have been focused on when institutions learned that ABCP had become infected by the troubled mortgages, and whether they profited by selling the notes from their own inventories to clients.

Settlements, eh? Regarding disclosure? Now, I’m certainly not going to take a stand in favour of incomplete disclosure, but I have a really hard time comprehending why that is the major issue. The way I see it, the major issues are:

• Portfolio Concentration, particularly with respect to retail clients putting an enormous chunk of their portfolios into a single name
• Portfolio Manager independence, as discussed on August 20, 2007
• Related to the above, the question of whether investment recommendations and actions were genuinely distinct from decisions in other parts of firms to invest in packagers of ABCP
• Why implicit bank guarantees are not included in their Risk-Weighted Assets (a matter of bank regulation rather than securities regulation, but I’ll put it in the list anyway)
• Why are there cash settlements? I’m sick and bloody tired of charlatans buying ‘their way out of trouble. If any advisor put any client into ABCP to the extent of more than 10% of net worth, that advisor should be in serious jeopordy of losing his license. His firm should be fined, certainly, for it’s dim-bulb supervision, but the advisor should be gone … and those responsible for compliance should be pretty damn nervous. But watch. It will just be fines, the only question being whether it’s one day’s profit, or two.

There shouldn’t be much surprise regarding hedge fund mobility news:

— David Butler, who advises hedge funds on tax issues, says he helped 23 firms leave London in the past 18 months, most of them for Switzerland.

“Managers do not feel there is a good relationship with politicians,” said Butler, founder of Kinetic Partners LLP in London. “When it is announced that taxes will go up, without any consultations, people understand there may be more on the way and they think the lifestyle they can have somewhere else is better than in London.”

Nova Scotia Power, proud issuers of NSI.PR.D, announced a 30-year bond issue today:

Nova Scotia Power Inc. completed the issue of $200 million Series W Medium Term Notes. The Series W Notes bear interest at the rate of 5.95% and yield 5.974% per annum until July 27, 2039.

The Offering was made to the public through a syndicate of agents co-led by TD Securities Inc. and RBC Dominion Securities Inc., and included CIBC World Markets Inc., Scotia Capital Inc., BMO Nesbitt Burns Inc., Merrill Lynch Canada Inc. and National Bank Financial Inc.

The net proceeds of the Offering will be used to repay short term borrowings.

Another good trading day for Canadian preferred shares, with high volume, not much direction (PerpetualDiscounts were off just a tad; FixedResets up very slightly) and a fair amount of price volatility.

Anybody want to buy a railcar leasing operation, cheap?

CIT Group Inc., the commercial lender seeking to avoid collapse, may sell units that lease railcars and aircraft to raise cash, said a person with knowledge of its plans.

The railcar business is the most likely to be sold, and CIT has identified about a half dozen potentially interested bidders, the person said, speaking on condition of anonymity because the talks are private. No final decisions on which units will be kept or sold have been made, the person said. CIT put the unit up for sale last year, only to take it off the market when bids came in below expectations, the person said.

They’re making the bond tender more coercive:

CIT Group Inc., the 101-year-old commercial lender seeking to avoid collapse, reworked its tender offer for $1 billion of notes maturing next month to encourage investors to deliver the debt to the company sooner.

Investors that tender their notes by July 31 will get $775 plus a $50 early delivery payment for every $1,000 of securities they own, the New York-based company said today in a regulatory filing. That compares with a previous offer of $800 plus an early payment of $25, CIT said. The offer expires on Aug. 14.

I’d happily tender for $825 … provided I got 200 common shares as well as the cash. Why should the creditors give a free gift to the owners?

Guido Tabellini of Bocconi University writes a review article for VoxEU, Lessons for the future: Ideas and rules for the world in the aftermath of the storm, Part I:

It’s time to start drawing conclusions about the global crisis. This column, the first of a two-part series, assesses the causes and nature of the problems. Although the crisis originated in financial market failings, policymakers are much to blame. Regulatory failure amplified private sector errors, and poorly planned policy responses exacerbated the troubles.
…
There are two aspects of regulation that have amplified the effects of the initial shock: (i) the procyclicality of leverage, induced by constraints on banks’ equity, and (ii) accounting principles that require assets to be evaluated according to their market value. In case of a loss on investments, which erodes the capital of financial intermediaries, capital adequacy constraints under the Basel accord require reduced leverage and thus force banks to sell assets to obtain liquidity. The problem is thus exacerbated: forced sales reduce the market price of assets, worsening the balance sheets of other investors and inducing further forced sales of assets, in a vicious circle.

Volume was off a bit on the day, but the market continued onwards and upwards. Price volatility was reduced, with only BNA.PR.A showing a loss of more than 1% among the HIMIPref™ index included issues.

Very strange things happening with CIT:

Even if CIT succeeds in getting 90 percent of the $1 billion of floating-rate notes due Aug. 17 swapped at a discount, the advisers will seek a so-called pre-packaged bankruptcy that would allow the company to restructure out of court, Jeffrey Werbalowsky, chief executive officer of Houlihan Lokey Howard & Zukin, told bondholders today, according to the person, who declined to be identified because the call was private.

Should the CIT offer to exchange the notes for as much as 82.5 cents on the dollar fail, Houlihan, the investment-banking firm advising the bondholders, will recommend the steering committee let CIT file for bankruptcy before paying the August maturity, the person said.

I don’t get it. There’s something going on here I don’t follow. Perhaps it’s some kind of CDS game, but this one controlled by bondholders who have also sold protection?

Me, I think what should be considered is:

• Pick a proportion of the outstanding bonds with the highest coupons.
• Make an exchange offer. For every $100 bond, a tendor gets:
  • 100 CIT shares
  • A warrant to exchange these shares back into bonds

Meanwhile, there are more rumblings in Washington:

Senate Banking Committee Chairman Christopher Dodd said the U.S. shouldn’t reject aiding CIT Group Inc., the 101-year-old commercial lender seeking to avert bankruptcy, while weighing alternatives to federal bailouts.

“There’s an exhaustion that’s settled in” to government rescues and policymakers should “look at alternative ideas to that rapid, massive injection of resources” into companies, Dodd said today in an interview in Washington.

“I wouldn’t rule out the possibility of government intervention financially” at CIT, said Dodd, a Connecticut Democrat. “Maybe there are some alternative ideas that would allow the company to survive in an altered state, but still allow it to provide the assistance and support they have to smaller business.”
…
Dodd said he would support having the government unwind CIT if the proposed authority were available. Obama’s plan would let the government disassemble failed firms in an orderly way instead of allowing them to go bankrupt and cause disruptions.

The world-wide push to ensure that investments other than government bills be restricted to institutions continues in Hong Kong:

The Securities and Futures Commission and the Hong Kong Monetary Authority said in a joint news briefing Wednesday that the 16 banks will offer to pay the 29,000 eligible minibond holders 60% of their original investment. Investors over 65 years of age will be repaid 70% of the principal amount.
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Those eligible account for more than 90% of all minibond holders in the territory, the regulators said. Institutional and professional investors are excluded from the deal.

Few of the articles I’ve seen even explain what a “minibond” is, but I did find Dictum Non Meum Pactum: Lehman’s Minibond Transactions:

This article examines problems pertaining to complex financial instruments highlighted by the September 2008 bankruptcy filing of Lehman Brothers Holding Inc. It deals mainly with sales to Hong Kong and Singapore retail buyers of structured notes branded ‘Minibonds’. These were debt issues arranged by Lehman and sold with its help through local bank and securities dealer distributors. Structuring securities was important in Lehman’s global activities and the firm’s sales to retail buyers in Asia were prolific. The analysis focuses on the even-handedness of the sale of complex instruments managed by Lehman in Hong Kong, and the supervisory regime under which such sales are made. It also asks whether certain common law jurisdictions might reconsider the formation of complex financial contracts and seek a more generally moral market for their use.
…
Most minibonds were referenced to credit risks, that is, the return on each issue was a function of the credit standing from time-to-time of specified borrowers, all well-known Chinese or international companies or banks. Recent issues had between six and eight reference names; earlier series were linked to one entity or as many as 150 separate companies. The last completed issue was series 36 in May 2008, which paid quarterly coupons of 5.0–5.5 per cent providing that during the three year term of the notes none of seven reference entities entered bankruptcy or an involuntary reorganisation, or defaulted on its borrowings. In each case, the notes would be redeemed immediately at a discount to their face value. Lehman could also exercise a free call option to redeem the notes early without compensating the holder for reinvestment losses. The notes were unlisted, intentionally illiquid, and at any time their value would be opaque. Taken together, these features mean that a non-retail intermediary would see minibonds as inherently costly and without utility as investments or for hedging purposes. Most non-retail actors seeking similar speculative exposure would negotiate with an arranger or issuer and never accept uncompensated credit risk or incomplete disclosure of core terms. The outcome might be a loss, but any purchase would result from balanced negotiation. Retail buyers lack all such leverage.

The last sentence is, of course, complete nonsense. Any buyer can just leave the offer on the table. However, I am reminded that preferred shares are WAY more complex than most people (including professionals) think and also have credit risk. Perhaps I should start lobbying for legislation that will make it illegal for anybody to buy a pref unless they have subscribed to all four of my video seminars and taken out a subscription to PrefLetter. It’s worth a thought!

The essay’s title, by the way, is a play on “Dictum Meum Pactum” (My Word is My Bond), the motto of the London Stock Exchange.

On a somewhat brighter note, it looks like the Fed will not get systemic risk authority:

The Obama administration’s plan to expand the Federal Reserve’s powers to oversee financial firms is failing to win supporters in Congress as some lawmakers back a proposal to give the responsibility to several regulators.

“It’s going to be shared authority,” House Financial Services Committee Chairman Barney Frank, whose panel will write the measure, told reporters July 21, without providing details.

Frank and lawmakers leading discussion on regulatory reform fault the central bank for slow action on lending abuses and want the Fed to focus on monetary policy. Support is emerging for a council of the Fed, Treasury Department, Federal Deposit Insurance Corp. and other regulators. The Senate Banking Committee will consider the systemic-risk plan today.

I’m not sure that shared authority is really all that much better, frankly. Committees are all about responsibility-avoidance and finger-pointing. It seems to me that a separate authority with close ties to international organizations would be better, much as it pains me to recommend a new bureaucratic structure.

The Bank of Canada has released its Monetary Policy Report – July 2009 with no real surprises.

One the one hand, it appears there are lots of bozos in Congress who want to move the capital markets to Dubai:

“Naked” credit-default swaps may be banned under provisions in the main U.S. House legislation overhauling oversight of the $592 trillion derivatives industry, House Financial Services Committee Chairman Barney Frank said.

“The question of banning naked credit-default swaps is on the table,” Frank, a Massachusetts Democrat, said during an interview on Bloomberg Television today. The legislative proposal will be released next week, Frank said.
…
Credit-default swaps do “perform a useful function” in the economy, Frank said, and there may be “alternatives to banning naked credit-default swaps” if most derivatives are moved to a regulated exchange.

“If we can get rules where almost every derivative is traded on an exchange, and those that aren’t because they are just too unique” are backed by extra capital, he said, “then that may do it.”

… but it might just be a bargaining chip to get the Holy Exchange Trading in place.

DBRS confirmed CIBC but the trend is still negative:

The trend remains Negative (where it was originally placed on April 2, 2008), reflecting DBRS’s view that the effectiveness of changes, including changing senior management at the Bank, increasing the depth of its senior risk management team, and revamping risk management process and procedures, has yet to be tested, particularly to generate consistent and sustainable earnings. Overshadowing these actions is CIBC’s exposures in the structured credit runoff business. With respect to the structured credit runoff portfolio, management believes it has taken actions to limit the losses on both earnings and capital. CIBC’s ability to improve business practices, reputational-related risk management, and the outcome from the run-off portfolio will have an impact on the trend.
…
Over the last decade, the Bank has repeatedly tightened risk management as a result of negative events surfacing, followed by increased concentration risk developed through rapid expansion of select business lines. DBRS remains concerned the actions taken by CIBC over the past year could potentially be a repetition of this pattern.

Today was just the sort of day I like – not much movement in the major subindices, but lots of volume and lots of price volatility.

CIT apparently turned down GE financing:

CIT Group Inc., the commercial lender seeking to avoid bankruptcy, rejected a General Electric Co. offer of at least $2 billion in senior secured loans backed by aircraft, four people familiar with the matter said.

CIT spurned the loans from GE’s finance arm, a rival in some lending businesses, over the weekend in favor of $3 billion in loans from a group of bondholders, two of the people said. GE’s offer, while less costly and requiring fewer assets as collateral, wouldn’t have provided cash until July 31 because of a delay in structuring the deal, said two of the people, who didn’t want to be identified because the offer wasn’t public.
…
The GE loan could have been expanded to include additional funds using other collateral if CIT required it, three of the people said. GE’s offer wouldn’t have presented cash until the end of July because the company would need time to check out CIT’s collateral.

A ten day delay was so important that CIT paid up for money and put up more collateral? It sounds like CIT management was in denial and waited until absolutely the last minute before biting the bullet. Perhaps their thoughts are more focussed now that the bondholders’ committee has some influence.

In the meantime, at least one investor is rather peeved:

Pacific Investment Management Co., Centerbridge Partners LP and the four other bondholders that put up $2 billion in financing for CIT Group Inc. made an instant $100 million on an investment analysts say is almost risk free.

CIT, the 101-year old commercial lender struggling to retire $1 billion of debt maturing next month, agreed to pay a 5 percent fee to the creditors and annual interest of at least 13 percent. On top of that, the New York-based company pledged assets worth more than five times the amount of the loan as collateral.

“The terms are egregious,” said Dwayne Moyers, the chief investment officer at Fort Worth, Texas-based SMH Capital Advisors, which oversees $1.4 billion, including more than $70 million of CIT bonds. “They ripped the faces off everyone with these terms.”
…
Even if CIT fails, the bondholder group will probably make money because of the collateral, according to Sean Egan, president of Egan-Jones Ratings Co. in Haverford, Pennsylvania. The lenders have “virtually 100 percent assurance” they’d be able to recoup all their money in a bankruptcy, said Sameer Gokhale, an analyst with Keefe Bruyette & Woods Inc. in New York.

“This is called Don Corleone financing,” Egan said, referring to the patriarch in the organized-crime family depicted in the 1972 film, “The Godfather.” “You can’t lose money on this deal.”

Outside of the “urban underworld,” Egan, 52, said he couldn’t recall ever seeing a loan backed by as much collateral that paid interest rates so high. “These terms would make a pawn-shop operator blush.”

Bankruptcy loans arranged this year have an average interest rate of 7.25 percentage points more than Libor, compared with 5.3 percentage points in 2008, Bank of America Merrill Lynch analysts led by Jeffrey Rosenberg wrote in a report last month. So-called debtor-in-possession loans never exceeded 4 percent over Libor before that, they said.

DBRS gave its opinion regarding the tender offer today:

Indicating that default is imminent, the $1.0 billion Floating Rate Senior Notes (the Notes) due August 17, 2009 were today downgraded to C from CCC. This action reflects the announced cash tender offer for the Notes. Under the terms of the offer, bondholders will receive $800 for each $1,000 of principal amount of the Notes tendered. Bondholders tendering their Notes on or before July 31, 2009, will receive $825 per $1,000 of principal of the Notes tendered. Importantly, CIT indicated that failure to receive tenders of at least 90% of the aggregate principal of the Notes outstanding would result in the offer not being completed, which may lead to the Company seeking protection under the U.S. Bankruptcy Code. DBRS views the tender offer as coercive and therefore a default under DBRS policy. DBRS will lower the rating to D upon completion of the exchange. Under DBRS policy, certain securities are typically placed in a default status, if an exchange results in a final outcome that leads to terms that are disadvantageous to bondholders or effectively a forced consent exchange because failure to do so would likely lead to an issuer’s inability to pay.

In addition, CIT’s announcement indicated that a comprehensive series of exchange offers will be forthcoming as part of the Company’s recapitalization plan. As such, DBRS has lowered the Long-Term Debt ratings on all remaining CIT long-term debt to CC, given DBRS’s anticipation that further exchange offers are likely to be coercive and disadvantageous to bondholders.

Fitch said much the same thing:

Fitch Ratings-New York-22 July 2009: CIT Group Inc. announced that it has commenced a cash tender offer to purchase the company’s senior notes due Aug. 17, 2009 (August Notes) for 80% of par, according to Fitch Ratings. Upon completion of the offer, Fitch expects to downgrade CIT’s long-term Issuer Default Rating (IDR) to ‘RD’ from ‘C’, as Fitch would consider the purchase a Coercive Debt Exchange (CDE). On July 16, 2009, Fitch downgraded CIT’s IDR to ‘C’ which indicated that a default (‘D’) or restricted default (‘RD’) appears imminent or inevitable. The tender offer has been driven by the announcement that CIT has entered into a $3 billion loan facility (Credit Facility) provided by the company’s major bondholders. The Credit Facility will be secured by substantially all of CIT’s unencumbered assets and includes fairly stringent collateral coverage covenants. Such terms are extremely onerous and may limit the company’s future financial flexibility.

While CIT’s announcements may forestall an event of default due to a bankruptcy filing, consummation of the debt tender offer is consistent with Fitch’s criteria of a CDE. Specifically, bondholders will receive a reduction in principal and, absent the tender offer, there would exist a high probability that CIT would file for bankruptcy. It is also possible that, as part of the company’s broader recapitalization plan, bondholders will receive equity or other hybrid instruments in exchange for debt which would also constitute a CDE.
…
Fitch also acknowledges CIT Bank’s consent to an Order to Cease and Desist (C&D) issued by the FDIC. The order prevents extension of credit to CIT and affiliates without written consent from the FDIC and the Utah Department of Financial Institutions (UDFI). CIT Bank is also prohibited from declaring or paying dividends and increasing brokered deposits above $5.5 billion. The ring-fencing of the bank’s assets significantly reduces any chance of CIT furthering its bank strategy. In the event CIT files for bankruptcy, Fitch believes it is highly likely that regulators would seize control of CIT Bank. Under that scenario Fitch would downgrade the bank’s IDR and Individual Ratings to ‘D’ and ‘F’, respectively.

The question of whether Central Banking should be held distinct from bank supervision is a knotty one that has been debated often; good arguments can be made both ways. I prefer separation of powers, because otherwise a single institution has too much power and can become unfocussed; the trend in the States is for increasing the mandate of the Fed, beyond the current combination of authority. Bernanke is in favour of mandate-creep:

Federal Reserve Chairman Ben S. Bernanke said consumer protection should be added to the Federal Reserve Act as a formal policy goal along with low inflation and full employment.

“We were not quick enough, we were not aggressive enough to address consumer issues earlier in this decade,” Bernanke, 55, said in response to a question from Christopher Dodd, the Connecticut Democrat who chairs the Senate Banking Committee.

“My recommendation to you to consider, Mr. Chairman, would be to ask whether there are steps that could be taken to strengthen the commitment of the Federal Reserve,” Bernanke said on the second day of his semiannual testimony to Congress. “One would be to put consumer protection in the Federal Reserve Act along with full employment and price stability as a major goal of the Fed.”

Not surprising, really, given all the turf battles between US agencies in the past year, but disappointing never-the-less. Stick to fighting defalation, Ben! You’re good at that!

The SEC is micro-managing the investment sales business:

The U.S. Securities and Exchange Commission may ban investment advisers from giving money to so- called placement agents and campaigns of politicians overseeing retirement funds as it cracks down on abuses at public pension funds overseeing $2.2 trillion of assets.
…
Investment advisers pay placement agents for access to pension-fund money. The SEC proposal would bar money managers and some of their “executives and employees” from making such payments, according to the statement.

In March, the SEC and Cuomo accused former New York Deputy Comptroller David Loglisci of arranging for the state pension fund to invest $5 billion with money managers who had paid kickbacks to former Democratic adviser Hank Morris. Morris ran a placement agency.

The ban on campaign donations makes some degree of sense, although it might not survive a freedom of speech challenge – but mind you, I haven’t seen any legal opinions on that one at all. The ban on placement agents, however, makes no sense at all.

It’s a trite expression at this time, but axioms become trite because they’re true: sunlight makes the best disinfectant. Publicize the presentations of investment managers, make public track records in a common format a requirement for anybody with discretionary authority … and a lot of the problems will disappear. Ensuring that allocation decisions of pension funds are not made by a single person would help a lot too.

As it stands, the prohibition on placement agents will serve only the interests of salesmen; each firm will be required to have sales agents and infrastructure in house, instead of outsourcing it so they can get on with investment management.

It was another day of strong advances for prefs, particularly the PerpetualDiscount issues of insurers. Volume was up sharply.

This is a much nicer market than last July’s! PerpetualDiscounts now yield 6.17%, equivalent to 8.64% interest at the standard equivalency factor of 1.4x. Long corporates have returned +0.67% month-to-date and now yield … oh, call it 6.35%, implying a pre-tax interest-equivalent spread of about 230bp; slightly tighter than last week’s spread of 235bp, but still well above the Credit Crunch Normal of about 200bp and, of course, much wider than the good old days of 100-150bp. Not quite as pleasant as November’s apocalyptic +400-odd, though!

CIT has confirmed its $3-billion line from bondholders and announced a very curious tender offer:

CIT Group Inc. (NYSE: CIT), a leading provider of financing to small businesses and middle market companies, today announced that it entered into a $3 billion loan facility provided by a group of the Company’s major bondholders. CIT further announced that it intends to commence a comprehensive restructuring of its liabilities to provide additional liquidity and further strengthen its capital position.

Today’s actions, including a $3 billion secured term loan with a 2.5 year maturity (the “Term Loan Financing”), are intended to provide CIT with liquidity necessary to ensure that its important base of small and middle market customers continues to have access to credit. Term loan proceeds of $2 billion are committed and available today, with an additional $1 billion expected to be committed and available within 10 days.
…
As the first step in a broader recapitalization plan, CIT has commenced a cash tender offer for its outstanding Floating Rate Senior Notes due August 17, 2009 (the “August 17 Notes”) for $825 for each $1,000 principal amount of notes tendered on or before July 31, 2009. Lenders in the Term Loan Financing have agreed to tender all of their August 17 notes.
…
The Company and the Term Loan Financing steering committee will work together on the balance of the recapitalization plan, which is expected to include a comprehensive series of exchange offers designed to further enhance CIT’s liquidity and capital.
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Pursuant to the Offer, CIT is offering to purchase any and all of its August 17 Notes for $800 for each $1,000 principal amount of outstanding August 17 Notes tendered and not validly withdrawn prior to 12:00 midnight, New York City time, at the end of August 14, 2009 (unless extended by CIT). Holders who validly tender their August 17 Notes prior to 5:00 p.m., New York City time, on July 31, 2009 (unless extended by CIT, the “early delivery time”), and who do not validly withdraw their tenders, will be paid an additional $25 cash for each $1,000 principal amount of outstanding August 17 Notes tendered by the early delivery time.
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The Offer is conditioned upon, among other things, holders of August 17 Notes tendering and not withdrawing an amount of August 17 Notes equal to at least 90% of the aggregate principal amount of August 17 Notes outstanding (the “Minimum Condition”). The Minimum Condition may be waived by CIT and the Term Loan Financing steering committee. If the Minimum Condition is satisfied or waived, CIT intends to use the proceeds of the Term Loan Financing to complete the Offer and make payment for the August 17 Notes. There can be no assurances that the restructuring plan or the Offer can be completed successfully.

A price of $82.50 is a lot more than the notes were trading for last week:

CIT’s floating-rate notes maturing Aug. 17 jumped about 17.1 cents to 87.6 cents on the dollar as of 4:32 p.m. in New York, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

Credit-default swaps that allow investors to hedge against a CIT default for five years dropped 5.5 percentage points to 39 percent upfront, according to broker Phoenix Partners Group.

… but I must say, I still don’t get it. They are expecting major losses:

CIT Group Inc., the 101-year old commercial lender seeking to avoid collapse, said it expects to report a loss of more than $1.5 billion for the second quarter and may need to file for bankruptcy if it’s unable to tender for notes maturing next month.

CIT’s “existing liquidity” isn’t enough to repay the $1 billion of floating-rate notes maturing on Aug. 17, the New York-based lender said today in a regulatory filing. CIT, which announced a $3 billion rescue financing from its bondholders yesterday, has asked holders of the August notes to swap their claims for 82.5 cents on the dollar.

California claims to have balanced the budget:

California lawmakers reached an agreement with Governor Arnold Schwarzenegger over how to close a $26 billion budget deficit that pushed the most-populous U.S. state to the brink of insolvency.

The deal, reached by legislative leaders after two months of frequently acrimonious negotiations, would slash spending for schools, public works and welfare programs amid the longest recession since the 1930s. If approved by the full Senate and Assembly, the agreement will also siphon money from municipalities, force companies and individuals to pay income taxes sooner and make it more difficult to receive state aid.

The WSJ points out:

Under the plan, state lawmakers would cut $15 billion in spending. The rest of the gap would be filled by taking funds from local governments and through one-time fixes and accounting maneuvers. The deal must still be approved by rank-and-file legislators, who are expected to vote on it Thursday.

No surprises in today’s BoC statement:

Some of the early strength in domestic demand represents a bringing forward of household expenditures, which modestly alters the profile of growth over the projection period relative to the April MPR. The Bank projects that the economy will contract by 2.3 per cent in 2009 and then grow by 3.0 per cent in 2010 and 3.5 per cent in 2011, reaching production capacity in the middle of 2011.

Total CPI inflation declined to -0.3 per cent in June and should trough in the third quarter of this year before returning to the 2 per cent target in the second quarter of 2011 as aggregate supply and demand return to balance. Core inflation held up at 1.9 per cent in the second quarter of 2009. The Bank still expects core inflation to diminish in the second half of this year before gradually returning to 2 per cent in the second quarter of 2011.
…
Conditional on the outlook for inflation, the target overnight rate can be expected to remain at its current level until the end of the second quarter of 2010 in order to achieve the inflation target.

Boris Johnson, the mayor of London, has warned that Hedge Funds are mobile:

The Mayor and shadow chancellor told Business Secretary Lord Mandelson that the tighter regulation proposed for hedge funds would drive London investors to cities such as New York, Singapore, Hong Kong and Geneva.
…
They said the new supervision regime for hedge funds, private equity and venture capital would be stricter than the rest of the world and weaken Europe’s competitive position. London would be worst hit because it was home to 80 per cent of European hedge funds.

They argued tough regulation was needed to prevent another financial crisis, but it had to be set at a global level to ensure a level playing field.

They did not, however, let us in on any hints about why tough regulation of hedge funds is needed to prevent another financial crisis. It’s just political posturing, unfortunately. I’m disappointed, however, that they did not mention Dubai as a possible destination.

S&P has raised eyebrows regarding volatile CMBS ratings:

Standard & Poor’s raised the ratings on commercial mortgage-backed debt from three bonds sold in 2007, restoring the top-ranked status of the securities.

The debt had been cut as recently as last week, rendering the securities ineligible for the Federal Reserve’s Term Asset- Backed Securities Loan Facility to jumpstart lending.

S&P lowered the ratings on a class of a commercial mortgage-backed bond offering from AAA to BBB-, the lowest investment-grade ranking, on July 14. The New York-based rating company reversed the cut today, S&P said in a statement.

One of the affected issues is a Credit Suisse deal:

Standard & Poor’s Ratings Services today raised its ratings on the class A-2 and A-3 commercial mortgage pass-through certificates from Credit Suisse Commercial Mortgage Trust 2007-C3 to ‘AAA’ from ‘BBB+’ (see list).

The raised ratings follow the implementation of our recently updated criteria for the application of ‘AAA’ losses on U.S. conduit and fusion commercial mortgage-backed securities (CMBS).

… which seems somewhat terse. The supporting publication U.S. CMBS ‘AAA’ Scenario Loss And Recovery Application doesn’t help a lot; it’s simply a review of the methodological changes, including:

Refining the methodology we use to assess the impact of losses and recoveries resulting from our ‘AAA’ rating scenario for super-senior classes in U.S. conduit/fusion CMBS.

Further differentiating the timing of the losses resulting from our ‘AAA’ term and maturity default tests when cash flow modeling transactions. See section VII-D of “U.S. CMBS Rating Methodology And Assumptions for Conduit/Fusion Pools” for our term and maturity default tests.

Spreading out losses that are applied to a transaction’s certificates over a longer period of time.

… but the “Impact on Outstanding Rating” sections notes:

We will use these criteria for rating all U.S. conduit/fusion CMBS transactions with super-senior classes. There are currently 336 deals with 1,436 certificates in this category. Our testing of the methodology suggests that applying losses and defaults under our ‘AAA’ scenario will account more fully for the benefits of time tranching. The application of these criteria will likely result in upgrades to seven super-senior tranches from three transactions that we recently downgraded.

“Time Tranching” refers to sequential pay structures. According to Nomura’s ABS primer:

“Time tranching” refers to dividing cash flows from securitized assets among different classes of securities so that some receive repayment of principal before others. In the simplest cases, a deal might offer several classes of serially maturing securities. Some investors might prefer the securities with shorter maturities while others might favor the ones with longer maturities. Collateralized mortgage obligations (CMOs) are the most ubiquitous examples of time tranching.

The trouble with structured securities is that small changes in assumptions can cause huge changes in ratings – especially considering that a percentage point or two takes you out of investment grade completely, never mind the AAA category. This is exacerbated by the philosophy of ratings: a default with a recovery of 99.9999% is the same thing as a total loss. Nevertheless, this story is going to earn S&P some mockery – particularly due to the implications with TALF.

Earnings calls are usually pretty boring affairs, with sell-side bozos lobbing softball questions at their lunch buddies, but the Western Union call today was different:

— Western Union Co. apologized to Piper Jaffray Cos.’ Robert Napoli after a man posing as the analyst infiltrated the money-transfer firm’s conference call and cursed at Chief Executive Officer Christina Gold.

Today’s call discussing Western Union’s second-quarter earnings had been under way for almost 52 minutes when a man identified as Napoli came on the line and delivered an expletive-laden tirade spanning about 40 seconds.
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[Western Union spokesman Tom] Fitzgerald said the call stems from a “long-running harassment case” involving the man that dates back to when Western Union was owned by Greenwood Village, Colorado-based First Data Corp. “It’s been going on for quite a while.”
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A pause of about 40 seconds followed the tirade before SunTrust Robinson Humphrey Inc. analyst Andrew Jeffrey asked about Western Union’s long-term earnings potential. No one answered. “So much for that,” he said about 20 seconds later and hung up.

Gary Kohn, a vice president for investor relations, came on the line two minutes later to apologize “for that rude interruption” and turned over the call to Gold for a minute- long closing comment.

Dealbreaker has the transcript:

Operator: Your next question comes from the line of Robert Napoli from Piper Jaffray. Please proceed.

(Q – Robert Napoli): Hi, Christina, you are going to jail — you really — you [indiscernible] now, and you are going to pay for the corruption. You buy judges [ph] — you buy everybody. You deserve [indiscernible] just to pull information on people, and I am going to name you and shame you, you bitch, and all of the people surrounding you, especially David Schlapbach, and you know all [indiscernible] with you. So get ready; you both in-charge [indiscernible]. You [indiscernible] a profit user, you bought the case [ph], but I am going to fuck you legally…

I like the parts about (a) the guy not being cut off after the first ten seconds, and (b) the Western Union guys running away and hiding for about three minutes.

A rip-roaring day for preferreds, with PerpetualDiscounts gaining nearly 80bp amidst good price volatility and relatively heavy volume.

CIT has reportedly received a $3-billion financing offer from extant bondholders:

CIT Group Inc. reached a deal with bondholders for $3 billion in financing to avoid bankruptcy and restructure out of court, the Wall Street Journal reported.
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Thomas Lauria, a lawyer at White & Case LLP, said in an e- mail last week that a group of CIT creditors he represents offered to provide $3 billion in new loans to bridge CIT to an out-of-court restructuring or an orderly bankruptcy. He said the group was waiting for a response from CIT and didn’t name its members.

CIT’s $300 million of 6.875 percent notes due in November rose 7.5 cents on the dollar to 64 cents on July 17, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

There are reports with more details, none of which are yet confirmed:

— CIT Group Inc., the 101-year-old commercial finance company seeking to ward off bankruptcy, agreed to a $3 billion loan for 2.5 years from a group of its bondholders, according to people familiar with the situation.

CIT bondholders have committed $2 billion of the loan as of today, and plan to raise the remaining $1 billion from existing bondholders within the next 10 days, said one of the people, who declined to be identified because the negotiations are private. The board agreed to the financing yesterday, and CIT plans to announce the agreement as soon as today, another person said.

Econbrowser‘s James Hamilton contributed to a piece in the NYT:

So there is a process of fumbling around on a case-by-case basis as we try to figure out where to draw the line — prop up A.I.G., let Lehman and CIT go. Uncertainty about just who is going to be protected and who will be allowed to fail is yet another factor exacerbating the current instabilities.

Since there’s no easy way out once we face that decision, the obvious answer is to use regulation to prevent any private institution from putting us in a position where policymakers feel their only option is a public bailout. “Too big to fail” is, in my opinion, “too big.”

And Accrued Interest urges letting it go:

So put this all together, and you have a basic business model: asset-based lender without access to bank funding, that just flat out doesn’t fit in today’s world. CIT may as well be making type writer ribbons. I’m sorry, it just has to go.

This is the moment were we take the training wheels off the economy. We had to do it at some point. We had to eventually send a message to the world of finance that not everything was going to be bailed out.

How great would it be for CIT to work something out with bond holders? I mean, an actual “normal” deal to avoid bankruptcy? I mean, it would almost be like capitalism is back!

The somewhat geeky topic of separation of Central Banking and Bank Supervision has become a political issue in the UK:

Conservative leader David Cameron proposed the most sweeping changes to Britain’s financial regulatory system in a decade, adopting U.S.-style plans to strengthen the central bank and create a consumer watchdog.

The opposition party will scrap the Financial Services Authority and hand powers over lenders deemed too big to fail to the Bank of England if it wins the next election due by June 2010. The plan mirrors proposals by U.S. President Barack Obama to beef up the Federal Reserve.

Standard political reaction. Find out who is least blameworthy in today’s crisis, put them on a pedestal, then act surprised when the next crisis (after the next election, they hope!) shows that nobody has perfect foresight.

Accrued Interest has some interesting things to say about bond indentures for US Municipals.

PerpetualDiscounts shot up today on good volume with a great deal of price volatility.

I have often noted on this blog that one problem with big banks is that there are too many layers of servile management between the people who really know what’s going on and the decision makers. Guess what happens when middle management is not servile?:

Paul Moore compares his dismissal as head of risk at failed U.K. bank HBOS Plc to King Henry VIII’s decapitation of his sainted Chancellor Thomas More 474 years ago.

Moore lost his job in 2004 after he warned that the bank’s growth strategy posed “a serious risk to financial stability.” More lost his head in 1535 after he refused to recognize Henry VIII’s self-appointment as head of the Church of England.

“There is a natural conflict of interest where people whose job it is to challenge have to report to those who have the power of life and death over them,” Moore, 50, said in an interview in London. “What caused this financial crisis was the inadequate balance and separation of powers.”

Risk and compliance managers should report to a non- executive director for “quality assurance,” rather than to the executives they monitor, Moore said. His idea was rejected yesterday in a preliminary government review of banks by former Bank of England director David Walker. Risk managers should report to both executives and non-executives, Walker said.

It’s something of tricky question. Dotted line reporting means no responsibility; dual reporting is just a shade on the nutbar side. On the other hand, if I was on the director’s risk committee and I didn’t have all the access I wanted to the Chief Risk Officer (or didn’t have confidence in him), I’d be a little upset. It should also be noted that risk management is a cost centre, not a profit centre. I’ve seen some of the ads for risk management personnel … invariably, anybody with enough brains, balls and knowledge to do the job properly can make way more money doing something else.

OSFI has promoted another ex-banker to help regulate the banks.

Today’s CIT news is:

CIT Group Inc. advisers, including JPMorgan Chase & Co. and Morgan Stanley, have begun discussing options for funding the lender if it succumbs to bankruptcy, according to people with knowledge of the matter.

JPMorgan and Morgan Stanley are in talks with other banks about a debtor-in-possession loan, used to fund a company’s operations after it seeks court protection from creditors, said the people, who declined to be identified because the negotiations are private. CIT and its advisers, including Morgan Stanley and Evercore Partners Inc., are also trying to arrange rescue financing to avert bankruptcy, they said.
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“This thing doesn’t have a future,” CreditSights analyst David Hendler said today in a telephone interview. “Anything is possible but the problem is not solvable anymore. They’re just in denial it’s finally over,” the New York-based analyst said referring to the rescue financing.

I have other things to do this weekend, so the market update will be late … really late … Sunday evening?

Update, 2009-7-19: Another good strong day for preferreds on good volume, with FixedReset median YTW all the way down to 4.20%!