March 26, 2008

There’s a bit more colour on the Clear Channel deal today, which will of intense interest to those watching the BCE / Teachers deal:

Banks financing the $19.5 billion buyout of Clear Channel Communications Inc. stand to lose about $3 billion on the transaction because loan prices have tumbled since they promised to fund the deal.

Banks led by Citigroup Inc. and Deutsche Bank AG agreed in April to provide $22.1 billion for the purchase by private- equity firms Thomas H. Lee Partners LP and Bain Capital Partners LLC. Since then, losses on subprime-mortgage securities spread throughout credit markets and loan prices for similar LBOs fell to as low as 85 cents on the dollar

“It doesn’t appear to be a gentleman’s market anymore,” said Neal Schweitzer, who analyzes the bank loan market as senior vice president at Moody’s Investors Service in New York. “The larger the transaction, the greater the potential for bigger discounts” when selling the debt.

The BCE buying group has repeated the same old party line.

Econbrowser‘s James Hamilton voices his support for Jeff Frankel’s explanation of high commodity prices mentioned here yesterday and follows up with a warning:

I have long argued that the broad increase in commodity prices over the last five years has primarily been driven by strong global demand. But I am equally persuaded that the phenomenal increase ([1], [2]) in the price of virtually every storable commodity in January and February cannot be due to those same forces.

Nor do I agree with those who attribute the recent commodity price increases primarily to the falling value of the dollar.

Instead I believe that Harvard Professor Jeff Frankel has the correct explanation– commodity prices at the moment are being driven by interest rates, with a strongly negative real interest rate increasing the incentives for speculation in any storable commodity.

Swings in relative prices of this magnitude are destabilizing. The Fed would like to stimulate more, but it also has to be realistic about what it is capable of accomplishing through manipulation of the fed funds target. Bernanke also needs to be mindful that one of his most valuable assets, if he hopes to be able to accomplish anything through adjustments of the fed funds rate, is the confidence on the part of the public in the Fed’s long-run inflation-fighting resolve.

I agree. As written here on March 19:

I agree with him, as I agreed with his recently expressed view on limits to monetary policy. It seems to me that as far as the overall economy is concerned, the Fed should be waiting to see what its cuts – now 300bp cumulative since August – do to the economy. At the moment, the problem is land-mines of illiquidity blowing up unexpectedly, and the TSLF, together with the occasional spectacular display of force are the best defense against that.

I will also note that a linking of commodities with short-term rates seems in large part to be an attempt to treat them as money market substitutes … we’ve had far too much problems with money-market substitutes in the last year to start inventing more! Well … it’s not my money, and I suspect that the speculators will – eventually – pay through the nose for their presumption.
Accrued Interest mourns the lot of fixed income analysts in this environment:

In the case of mortgage-related credit risk, for instance the ABX index, prices should obviously be drastically lower. This is the kind of risk pricing that capital markets can handle. In fact, that kind of risk pricing is exactly why capital markets are an important part of our free-market system.

But the second major theme is interfering with the market’s ability to properly price risks. Potential buyers of risk, from hedge funds to banks to broker/dealers, became overextended during the credit bull market and now need to repair their their own balance sheets. No matter how attractive various pricing levels are, these buyers are are not a position to take advantage. Some of those that became overextended have been forced to unwind some or all of their positions.

As a result, classic investment analysis, pouring over 10K’s and analyzing cash flows, has not been a winning strategy. Until very recently, investors who dabbled in anything that looked fundamentally “cheap” got burned. Sector after sector suffered historic spread widening amidst persistent forced selling.

A major (major! major!) problem this time ’round is that we are currently experiencing the very first credit crisis in which it has been possible to short credit on a large scale – via Credit Default Swaps and Index shorts, for instance. In every other crisis to date, anybody who wanted to speculate against corporate credit had to arrange to borrow physical bonds, preferrably for a long term … at the very least, this added to frictional costs, even assuming a counterparty could be found.

No more. Just buy protection on a billion corporates and wait for the money to roll in.

The problem with this strategy is that shorting credit is ultimately a losing game. Issuers short their own credit because they can (or think they can) use the funds to invest in profitable ventures; ventures not available for the speculator, especially one who isn’t actually getting the funds but is just paying the spread. Shorting credit is a game for the short term only.

From a policy perspective, the ability to short credit is disturbing due to its procyclical nature – that is, speculation may be counted upon to exaggerate legitimate price swings.

Which is not to say I am in favour of banning the practice! However, I do think the margin requirements applicable to players in the core banking system and investment banking system should be reviewed to ensure that speculation is contained. This is similar to regulatory margin requirements on stocks: set partially in order to ensure that there are no destabilizing bankruptcies; and also to discourage ‘walk-away’ trades, in which a player just walks away from a losing bet. We’ve seen quite enough walk-away trades in the US housing market, thank you very much!

As an aside … I mentioned BMO’s new issue of sub-debt yesterday, as a note to the the 5.80% pref new issue announcement … that was a 10+5 year deal at 10s + 260. I have now been advised that TD is also issuing sub-debt, a 7+5 deal at 7s + 225.

In a speech that may be laying the groundwork for massive regulatory changes, Treasury Secretary Paulson has opined:

the Federal Reserve should broaden its oversight to include Wall Street investment firms that borrow from the central bank at the same interest rate as commercial lenders.

“The Bear Stearns action was a sea change,” said Gilbert Schwartz, a former associate general counsel at the Fed, and now a partner at Schwartz & Ballen in Washington. “The Fed should be the umbrella agency for all these institutions. The SEC is not set up to handle this.”

“We don’t think the SEC has the tenure and the expertise in a lot of these global capital adequacy, funding and derivative issues that the Fed would have,” said David Hendler, an analyst at CreditSights Inc. in New York. “If you’re going to extend the money you should have the right to look over the books.”

“The Federal Reserve should have the information about these institutions it deems necessary for making informed lending decisions,” said Paulson, whose three decades on Wall Street culminated in seven years as chief executive officer of Goldman Sachs Group Inc. “Certainly, any regular access to the discount window should involve the same type of regulation and supervision.”

I’m not sure how much I agree with this. I am opposed to regulating investment banks on the same basis as regular banks, for reasons that I have stated until I have bored even myself: they represent part of the grey zone between banks – that should be ultra-regulated – and hedge funds – that should not be regulated at all. If the Fed extends only over-collateralized to brokerages, how necessary is it that they have supervisory responsibilities? Many countries – Canada included – separate central bank & bank supervision, a separation that I feel is sub-optimal, but not all that much sub-optimal.

Is there really anything wrong with the Fed simply seeking an opinion from the SEC regarding solvency of a brokerage prior to extending an over-collateralized loan in emergency circumstances? One thing’s for sure: we don’t want too many rules. Get good people at the Fed, pay them well and give them discretion; that’s the winning formula.

An increased field of operations for the Fed has been endorsed by Dallas Fed President Fisher.

Maybe they can lend money to the monolines next! FGIC dropped a bomb today:

Bond insurer FGIC Corp said on Wednesday that its exposure to mortgage losses exceeded legal risk limits and it may raise loss reserves due to litigation related to stricken German bank IKB.

FGIC in a statement also said it has a substantially reduced capital and surplus position through December 31. As a result, insured exposures exceeded risk limits required by New York state insurance law, the New York-based company said.

Moody’s downgraded FGIC in mid-February … there’s no word yet on the implications of the new revelations. They recently downgraded Security Capital Assurance when:

elected not to declare the semi-annual dividend payment on its Series A perpetual non-cumulative preference shares.

In other monoline news, Fitch has published a monograph on their ratings model, which takes note of the special characteristics of municipals.

Not a very good day for the markets, but no disaster and volume held steady. I regret I don’t have time for the indices tonight … I’ll try to get to them tomorrow.

Major Price Changes
Issue Index Change Notes
TD.PR.O PerpetualDiscount -1.8072% Now with a pre-tax bid-YTW of 5.39% based on a bid of 22.82 and a limitMaturity.
BMO.PR.K PerpetualDiscount -1.7695% Now with a pre-tax bid-YTW of 5.84% based on a bid of 22.76 and a limitMaturity.
BCE.PR.Z FixFloat -1.6387%
SLF.PR.D PerpetualDiscount -1.5339% Now with a pre-tax bid-YTW of 5.62% based on a bid of 19.90 and a limitMaturity.
ELF.PR.F PerpetualDiscount -1.4184% Now with a pre-tax bid-YTW of 6.50% based on a bid of 20.85 and a limitMaturity.
RY.PR.B PerpetualDiscount -1.3630% Now with a pre-tax bid-YTW of 5.46% based on a bid of 21.71 and a limitMaturity.
PWF.PR.L PerpetualDiscount -1.0865% Now with a pre-tax bid-YTW of 5.69% based on a bid of 22.76 and a limitMaturity.
IAG.PR.A PerpetualDiscount -1.0189% Now with a pre-tax bid-YTW of 5.67% based on a bid of 20.40 and a limitMaturity.
BAM.PR.M PerpetualDiscount -1.0096% Now with a pre-tax bid-YTW of 6.09% based on a bid of 19.61 and a limitMaturity.
FBS.PR.B SplitShare +1.0870% Asset coverage of 1.5+:1 as of March 20, according to the company. Now with a pre-tax bid-YTW of 7.01% based on a bid of 9.30 and a hardMaturity 2011-12-15 at 10.00.
CU.PR.B PerpetualPremium +1.2836% Now with a pre-tax bid-YTW of 5.88% based on a bid of 25.25 and a call 2012-7-1 at 25.00.
LFE.PR.A SplitShare +1.2871% Asset coverage of 2.2+:1 as of March 14, according to the company. Now with a pre-tax bid-YTW of 4.80% based on a bid of 10.23 and a hardMaturity 2012-12-1 at 10.00.
PIC.PR.A SplitShare +1.5572% Asset coverage of 1.4+:1 as of March 20, according to Mulvihill. Now with a pre-tax bid-YTW of 6.16% based on a bid of 15.00 and a hardMaturity 2010-11-1 at 15.00.
BCE.PR.R FixFloat +2.3707%
Volume Highlights
Issue Index Volume Notes
TD.PR.N OpRet 150,155 CIBC crossed 150,000 at 26.15. Now with a pre-tax bid-YTW based on a bid of 26.15 and a softMaturity 2014-1-30 at 25.00.
BMO.PR.K PerpetualDiscount 80,750 Now with a pre-tax bid-YTW of 5.84% based on a bid of 22.76 and a limitMaturity.
TD.PR.P PerpetualDiscount 79,175 RBC crossed 75,000 at 24.40. Now with a pre-tax bid-YTW of 5.48% based on a bid of 24.31 and a limitMaturity.
RY.PR.C PerpetualDiscount 27,000 National Bank crossed 25,000 at 21.24. Now with a pre-tax bid-YTW of 5.51% based on a bid of 21.15 and a limitMaturity.
TD.PR.R PerpetualDiscount 25,545 Now with a pre-tax bid-YTW of 5.67% based on a bid of 24.86 and a limitMaturity.

There were nineteen other index-included $25-pv-equivalent issues trading over 10,000 shares today.
Update, 2008-3-27:

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 5.36% 5.39% 32,417 14.80 2 +0.2043% 1,094.5
Fixed-Floater 4.78% 5.48% 60,282 14.87 8 -0.0777% 1,039.1
Floater 4.91% 4.91% 78,695 15.66 2 -0.3972% 848.3
Op. Retract 4.85% 4.11% 77,167 3.13 15 -0.0334% 1,047.1
Split-Share 5.38% 5.99% 93,464 4.11 14 +0.1927% 1,023.7
Interest Bearing 6.20% 6.64% 66,022 4.21 3 +0.1706% 1,086.7
Perpetual-Premium 5.81% 5.67% 251,185 10.78 17 -0.0528% 1,017.7
Perpetual-Discount 5.61% 5.66% 293,629 14.41 52 -0.3533% 922.7

6 Responses to “March 26, 2008”

  1. kaspu says:

    Do you know of any particular reason why the ELFs are yielding so high? Other than obscurity and liquidity issues regarding the common, the prefs look clean. That 6.4% YTW is awfully hard to ignore

  2. madequota says:

    There are many reasons, K. The first one, which most here refuse to accept, is that when an issuer like BMO comes to an already illiquid market at an unexplainable discount, then the rest of the market suffers. Think ELF is a good deal now? take a look at the SLF’s; particularly SLF.PR.D which is offered at $19.80, and nobody wants. How about all the RY’S? most of them down almost $1.00 from their pre-BMO levels. Some day, someone here . . . anyone . . . is going to give me an explanation that makes sense for why this is a good thing. Otherwise, they should come on board, and at least admit, that the fipref issuers are making a mockery out of this market.

    The second reason? There isn’t one that really matters. The first one is the harsh reality of what’s going on with ELF, and most others right now.


  3. madequota says:

    OK, rant out of the way now . . . caution on ELF.PR.G; Merrill [who’s been trashing prefs since yesterday] has an iceberg sell above the market at $19.16 . . . his behaviour has been such that he sits around for about 2 hours and then moves another .30 or .40 lower to see what happens at that level. He’s due to come down again any minute.

    He’s the seller of SLF.PR.D as well, and until he’s satisfied, this thing’s going to palukaville and fast.

    My buying advice is to stick with really below market bids until this guy’s buried and gone.


  4. jiHymas says:

    I don’t know of anything wrong with the ELF preferreds other than obscurity (the company doesn’t even have a website!). The Fund owns them from time to time.

  5. jiHymas says:

    Some day, someone here . . . anyone . . . is going to give me an explanation that makes sense for why this is a good thing.

    Nobody, ever, anywhere is going to give you an explanation that makes sense for why this is a good thing.

    It is neither good nor bad. It is data. The issuers are going to exercise their best judgement as to what is good for them, without concerning themselves about the effects on you, me, or the Queen of England.

  6. madequota says:

    fair enough . . . I think the heat of the day [namely Merrill-related] got the better of me for the moment! some amazing buying opps today for sure (Mr. Lafontaine was probably out there on the bid!)

    do you think that Rob Carrick might reprint his “time to buy lowly prefs” article? that . . . was a good thing!


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