November 27, 2007

Of most interest today (well … last night!) was the Abu-Dhabi SWF investment in Citigroup. As noted by Naked Capitalism, this deal was done, effectively, at a concession to the current market price, given that the preferreds are protected against a dividend cut on the common, have a dividend yield that is greatly in excess of the common yield, and convert to common at prices not all that much in excess of current prices in a few years’ time. The concession has not escaped notice:

The deal may dilute the value of Citigroup’s stock, reducing 2008 earnings by as much as 20 cents a share, Bank of America analyst John McDonald estimated.

Citigroup shareholders are “ultimately the ones who are paying,” said William Smith, chief executive officer of Smith Asset Management in New York, which oversees $80 million, including about 70,000 Citigroup shares. “If you look at 11 percent, that’s basically junk bond yields, and so it’s great for Abu Dhabi.”

However, the deal will reinforce Citigroup’s capital ratios and that’s what counts. A bad capital ratio could mean no profits to be diluted! Freddie Mac is also selling prefs at concessionary prices:

Freddie Mac, the second-biggest source of money for U.S. home loans, plans to sell $6 billion in preferred stock and cut its dividend in half to shore up capital depleted by record mortgage defaults and foreclosures.

The two-part sale will include non-convertible, non- cumulative preferred stock and a “substantially smaller” portion of convertible preferred shares, Freddie Mac said in a statement today.

Freddie Mac sold $500 million of preferred shares in September with a fixed dividend rate of 6.55 percent. The shares, issued at $25 each, were trading at about $20 today.

Those who are familiar with the rules for Tier 1 bank capital will be most amused by the following bizarre attempt to create a controversy (hat tip: Financial Webring Forum):

When either Freddie or Fannie attempt to build capital, they are handicapped by a peculiarity that very few investors know about: They cannot sell the most popular kind of preferred stock, the “cumulative” variety, because their regulator will not let these securities count toward capital.

What “cumulative” signifies in this context is that if dividends are missed, they pile up to be paid on some brighter day, if that arrives. To the extent that Freddie and Fannie issue preferred shares, therefore, they are forced into selling the “non-cumulative” variety. That means if a dividend is missed, say, in the first quarter of 2008, the owners of the preferred will never get that dividend. It’s just gone, zip!

Naturally, prudent investors are not wild about owning non-cumulative preferred shares, which is why there are not many of these securities around. What smart investor unnecessarily wants to put himself in the position – no matter how remote – of missing a dividend and never thereafter being able to capture it?

Note that Quantum Online lists 144 non-cumulative US issues. Cumulative issues are very nice to have, but they don’t count as Tier 1 Capital for banks. OFHEO is to be applauded for disallowing the inclusion of such issues in capital.

These deals, I think, may be classed in the same category as GWO’s sale of its US healthcare business, in that what is going on – once all the frippery is tossed aside, is a conversion of debt into equity. Lord knows what Abu-Dhabi has had its money invested in until now – I mentioned the transparency issue briefly on September 24 – but there is no reason why it can’t have been a savings account at Citigroup, which is now, as far as they’re concerned, moving up the ladder to become equity; with no effect on Citigroup’s cash, but salutary effects on their ratios.

GWO  is using the proceeds of their sale to repay the bridge debt on their purchase of Putnam, instead of selling term debt to finance this. Even if the buyer, Cigna, finances through debt it will be term debt from a strategic buyer.

There is another very similar – in its essentials – situation occuring in the SIV area. MBIA and its problems in finding financing for its conduit, Hudson-Thames was mentioned here on October 25. Now we learn that:

MBIA Inc., the largest bond insurer, is winding down its structured investment vehicle after failing to find buyers for the SIV’s short-term debt since August, Chief Financial Officer Chuck Chaplin said.

MBIA has shrunk its Hudson Thames Capital SIV to about $400 million from $2 billion through asset sales to bondholders, Chaplin said. The Armonk, New York-based company has taken an “impairment” on its own $15.8 million equity stake, Chaplin told a conference hosted by Bank of America Corp. in New York today.

MBIA asked holders of the lowest ranking bonds of Hudson Thames, known as capital notes, to buy a share of the SIV’s bank bonds, asset-backed securities and other holdings in proportion to the amount of debt they own.

The so-called “vertical slice” deals enable SIVs to raise cash while bondholders avoid the risk of their investment being wiped out in a fire sale, Fitch said in a report this month.

And this is how the credit crunch will be resolved. Equity holders will take their lumps; debt holders will move up the risk-return ladder at concessionary prices; and the indigestible debt will slowly, but as inexorably as the ticking of a clock, be run off the books.

I think.

There is shock and horror all over the place with the release of the Case-Shiller US Housing Price Index for September:

“The declines in the national figure are notable for two reasons,” says Robert J. Shiller, Chief Economist at MacroMarkets LLC. “First, the 3rd quarter decline, at 1.7%, was the largest quarterly decline in the index’s 21-year history. And, second, the year-over-year decline posted its second consecutive record low at -4.5%. Consistent with prior 2007 reports, there is no real positive news in today’s data. Most of the metro areas continue to show declining or decelerating returns on both an annual and monthly basis. All 20 metro areas were in decline in September over August. Even the five metro areas that still have positive annual growth rates — Atlanta, Charlotte, Dallas, Portland and Seattle — show continued deceleration in returns.”

Appallingly, the annualized internal rate of return for the indices since their base-date of January 2000 is a mere 9.15%. There’s a great post at the Irvine Housing Blog (hat tip: WSJ) about the loan history of a Very Nice House:

The property was purchased in January 2005 for $1,157,000. The combined first and second mortgages totalled $1,156,730 leaving a downpayment of $270. Let’s just call it 100% financing.

By April, they owners were able to find refinancing through Countrywide with a $999,999 first mortgage. This mortgage was an Option ARM with a 1% teaser rate. The minimum payment would be $3,216 per month.

Also in April of 2005, they took out a simultaneous second mortgage for $215,000 pulling out their first $58,000.

So look at their situation: They are living in a million dollar plus home in Turtle Ridge making payments less than those renting, and they “made” $58,000 in their first 4 months of ownership.

Apparently, these owners liked how hard their house was working for them, so they opened a revolving line of credit (HELOC) in August 2005 for $293,000. Did they spend it all? I can’t be sure, but the following certainly suggests they did.

In December of 2005, they extended their HELOC to $397,990.

In June of 2006, they extended their HELOC to $485,000.

In April of 2007, the well ran dry as they did their final HELOC of $491,000. I bet they were pissed when they couldn’t get more money.

So by April 2007, they have a first mortgage (Option ARM with a 1% teaser rate) for $999,999, and a HELOC for $491,000. These owners pulled $333,000 in HELOC money to fuel consumer spending.

Assuming they spent the entire HELOC (does anyone think they didn’t?), and assuming the negative amortization on the first mortgage has increased the loan balance, the total debt on the property exceeds $1,500,000. The asking price of $1,249,000 does not look like a rollback, but if the property actually sells at this price, the lender on the HELOC (Washington Mutual) will lose over $300,000.

Speculation about the forthcoming Fed meeting is ramping up, with Goldman calling for 150bp easing by the second quarter, but … what are the implications for inflation?

So far, inflation expectations have remained stable. Yet I consider those expectations more fragile now than I did four to six months ago. The rise in oil prices and the simultaneous increases in a broader basket of commodity prices suggest that significant inflationary pressures exist in the economy and thus the Fed must be very vigilant. If inflationary expectations rise, it could prove very costly to put the genie back in the bottle.

Very good volume in the pref market today, but performance continued to be (i) Weird and (ii) Poor. Splitshares bounced back (despite their expulsion from the S&P/TSX index), but that was more of a dead cat kind of thing than anything else – although it is rather pleasant to say that WFS.PR.A closed at 9.70-79, 121x10.

The PerpetualDiscount index broke below the 900-mark, setting yet another new low. But with all this volume, things must rationalize soon … mustn’t they?


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 4.82% 4.83% 123,589 15.73 2 -0.0409% 1,045.2
Fixed-Floater 4.90% 4.90% 88,867 15.65 8 -0.2690% 1,037.5
Floater 4.78% 4.83% 58,734 15.70 3 -0.0939% 983.4
Op. Retract 4.86% 3.64% 77,012 3.64 16 +0.0974% 1,032.6
Split-Share 5.44% 6.16% 92,194 4.04 15 +0.4340% 997.8
Interest Bearing 6.35% 6.90% 66,675 3.68 4 -0.5087% 1,043.0
Perpetual-Premium 5.88% 5.70% 83,742 8.21 11 -0.1958% 1,002.8
Perpetual-Discount 5.63% 5.68% 340,747 14.36 55 -0.1285% 899.0
Major Price Changes
Issue Index Change Notes
PWF.PR.L PerpetualDiscount -2.4823% Now with a pre-tax bid-YTW of 5.86% based on a bid of 22.00 and a limitMaturity.
HSB.PR.C PerpetualDiscount -2.0045% Now with a pre-tax bid-YTW of 5.90% based on a bid of 22.00 and a limitMaturity.
BAM.PR.B Floater -1.2500%  
BNA.PR.B SplitShare -1.1905% Asset coverage of just under 4.0:1 as of October 31, according to the company. Now with a pre-tax bid-YTW of 7.79% based on a bid of 20.75 and a hardMaturity 2016-3-25 at 25.00. The yield may be compared to BNA.PR.A (6.69% to 2010-9-30) and BNA.PR.C (8.62% to 2019-1-10).
FIG.PR.A InterestBearing -1.1579% Asset coverage of 2.1+:1 as of November 26, according to Faircourt. Now with a pre-tax bid-YTW of 7.62% (mostly as interest) based on a bid of 9.39 and a hardMaturity 2014-12-31 at 10.00.
BCE.PR.Z FixFloat -1.0695%  
SBN.PR.A SplitShare +1.0299% Asset coverage of just under 2.3:1 as of November 22 according to Mulvihill. Now with a pre-tax bid-YTW of 5.63% based on a bid of 9.81 and a hardMaturity 2014-12-01 at 10.00.
ACO.PR.A OpRet +1.1171% Now with a pre-tax bid-YTW of 4.15% based on a bid of 26.25 and a call 2009-12-31 at 25.50
BNS.PR.N PerpetualDiscount +1.1475% Now with a pre-tax bid-YTW of 5.39% based on a bid of 24.68 and a limitMaturity.
LFE.PR.A SplitShare +1.8981% Asset coverage of 2.6+:1 as of November 15, according to the company. Now with a pre-tax bid-YTW of 4.90% based on a bid of 10.20 and a hardMaturity 2012-12-1 at 10.00
WFS.PR.A SplitShare +2.6455% Asset coverage of 1.9+:1 as of November 22 according to Mulvihill. Now with a pre-tax bid-YTW of 6.52% based on a bid of 9.70 and a hardMaturity 2011-6-30 at 10.00.
Volume Highlights
Issue Index Volume Notes
BMO.PR.K PerpetualDiscount 157,870 Now with a pre-tax bid-YTW of 5.46% based on a bid of 24.35 and a limitMaturity.
BMO.PR.H PerpetualDiscount 140,230 Scotia crossed 132,800 at 24.80. Now with a pre-tax bid-YTW of 5.35% based on a bid of 24.52 and a limitMaturity.
PWF.PR.E PerpetualDiscount 138,000 Scotia crossed 135,000 at 24.60. Now with a pre-tax bid-YTW of 5.57% based on a bid of 24.60 and a limitMaturity.
GWO.PR.G PerpetualDiscount 111,950 Now with a pre-tax bid-YTW of 5.82% based on a bid of 22.70 and a limitMaturity.
BMO.PR.J PerpetualDiscount 110,400 Now with a pre-tax bid-YTW of 5.57% based on a bid of 20.35 and a limitMaturity.
TD.PR.P PerpetualDiscount 107,435 Nesbitt crossed 25,300 at 24.30. Now with a pre-tax bid-YTW of 5.46% based on a bid of 24.25 and a limitMaturity.

There were forty-eight other index-included $25.00-equivalent issues trading over 10,000 shares today.

One Response to “November 27, 2007”

  1. […] November 27, 2007 commentary on the Abu Dhabi – Citigroup deal is now looking a little dated: Citigroup Inc. said […]

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