April 8, 2008

Naked Capitalism points out that banks’ balance sheets tend to bloat in times of economic stress (this has been true for a long time – see Banks’ Advantage in Hedging Liquidity Risk) but manages to overstate his case:

A reader pointed us to this Bloomberg story, “Tribune, Dole May Need to Draw Down Bank Credit Lines,” which suggests that these two companies accessing committed credit lines is a harbinger of further demands on bank equity (note that a standby line does not result in a capital charge until the funds are drawn down).

Unfortunately, the helpful note is incorrect: a standby line does indeed result in a capital charge, equal to 50% of the charge that would be applied if the funds were actually drawn, provided this line is irrevokable:

Off-balance sheet items subject to a 50 percent conversion factor:
(1) Transaction-related contingencies, including performance standby letters of credit, shipside guarantees, bid bonds, performance bonds, and warranties.
(2) Unused portions of commitments with an original maturity exceeding one year, including underwriting commitments and commercial credit lines.
(3) Revolving underwriting facilities (RUFs), note issuance facilities (NIFs), and other similar arrangements, regardless of maturity.

Off-balance sheet items subject to a zero percent conversion factor:
(1) Unused portions of commitments with an original maturity of one year or less.
(2) Unused portions of commitments (regardless of maturity) which are unconditionally cancellable at any time, provided a separate credit decision is made before each drawing.

Assiduous Readers will remember that liquidity guarantees for ABCP are charged at a 10% conversion factor, subject to certain qualifying rules, and that there are rumblings (supported by me) that this might change.

For further confirmation of this fact, we can look at Citigroup’s Annual Report, page 75, “Components of Capital Under Regulatory Guidelines”, Note 7:

Risk-adjusted assets also include the effect of other off-balance-sheet exposures, such as unused loan commitments and letters of credit, and reflect deductions for certain intangible assets and any excess allowance for credit losses.

According to the most recent FDIC quarterly report:

Unused loan commitments – includes credit card lines, home equity lines, commitments to make loans for construction, loans secured by commercial real estate, and unused commitments to originate or purchase loans. (Excluded are commitments after June 2003 for originated mortgage loans held for sale, which are accounted for as derivatives on the balance sheet.)

This line item (see Table II-A) totalled USD 8.3-trillion in the fourth quarter of 2007, up 10% from 4Q06.

Accrued Interest looks at the US Jobs number as a predictor of stock prices:

Conclusion? During the last recession, unemployment predicted nothing useful to investors. Even had you been given a crystal ball and knew for a fact what future unemployment figures would be, it still wouldn’t have consistently indicated the right market trade. In fact it often would have given you the wrong indication.

True enough, but the last recession was a little funny … the market spent the first 2-3 years of this century unwinding the Tech Wreck … which is not to say that Accrued Interest is wrong, mind you, but rather to point out that there are a lot of factors in this chaotic world, and it is just as wrong to dismiss an indicator out of hand as it is to place blind faith in it. It’s all data.

Volume picked up today, although it can be called “good” only in contrast to recent depressed levels. Not too many price moves.

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 5.18% 5.22% 28,707 15.20 2 -0.0609% 1,088.8
Fixed-Floater 4.85% 5.39% 62,096 15.02 8 +0.0340% 1,029.2
Floater 5.13% 5.17% 72,102 15.24 2 -2.4196% 811.8
Op. Retract 4.86% 4.19% 82,951 3.52 15 +0.0655% 1,046.6
Split-Share 5.36% 5.92% 91,100 4.09 14 +0.1595% 1,030.5
Interest Bearing 6.19% 6.29% 65,491 3.91 3 -0.0337% 1,095.3
Perpetual-Premium 5.91% 5.44% 206,445 5.87 7 +0.0398% 1,017.7
Perpetual-Discount 5.68% 5.71% 304,416 14.14 63 +0.0128% 916.6
Major Price Changes
Issue Index Change Notes
BAM.PR.K Floater -4.8361%  
ELF.PR.G PerpetualDiscount -2.8424% Now with a pre-tax bid-YTW of 6.35% based on a bid of 18.80 and a limitMaturity.
BAM.PR.G FixFloat -1.0116%  
IAG.PR.A PerpetualDiscount +1.2249% Now with a pre-tax bid-YTW of 5.61% based on a bid of 20.66 and a limitMaturity.
Volume Highlights
Issue Index Volume Notes
TD.PR.R PerpetualDiscount 239,800 TD bought 38,600 from Nesbitt at 24.90; Nesbitt crossed 100,000 at 24.90; TD bought 25,000 from Desjardins at 24.89. Now with a pre-tax bid-YTW of 5.68% based on a bid of 24.89 and a limitMaturity.
BMO.PR.L PerpetualDiscount 128,300 Nesbitt crossed 50,000 at 24.61, then bought 38,000 in two tranches at 24.60 from “Anonymous” (not necessarily the same anonymous). Now with a pre-tax bid-YTW of 5.93% based on a bid of 24.60 and a limitMaturity.
MFC.PR.B PerpetualDiscount 109,165 TD crossed 100,000 at 22.10. Now with a pre-tax bid-YTW of 5.33% based on a bid of 22.00 and a limitMaturity.
NA.PR.L PerpetualDiscount 59,320 Nesbitt crossed 13,400 at 21.07. Ex-Dividend April 9. Now with a pre-tax bid-YTW of 5.88% based on a bid of 20.98 and a limitMaturity.
BMO.PR.J PerpetualDiscount 37,365 Nesbitt crossed 30,000 at 20.09. Now with a pre-tax bid-YTW of 5.70% based on a bid of 20.05 and a limitMaturity.

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

6 Responses to “April 8, 2008”

  1. prefhound says:

    Economics 101: the unemployment rate is considered a trailing indicator.
    Since the stock market is supposed to be a leading indicator, it is not surprising that unemployment doesn’t tell us where the stock market is going.

  2. jiHymas says:

    Whether or not there’s any long-term effect on stock prices, there is a short-term effect based on surprises.

    Any transmission to future stock prices would, presumably, be via a Taylor-Rule mechanism acting via the Fed Funds rate.

    Does this mean I think that stock prices can be predicted? Nope.

  3. jiHymas says:

    Oh dear, oh dear, oh dear.

    Yesterday was a bad day for me, full of fuzzy thinking and fuzzier communication. I dug a hole for myself in the post, and dug it deeper with my last comment.

    There were two things that caught my eye about the Accrued Interest post … first, that a crystal ball would not have worked and second, that only one episode was examined.

    A single episode does not prove a theory and a single counterexample doesn’t disprove it.

    I should have just mentioned that and left it at that.

  4. madequota says:

    Is it not amazing that “people in high places” can make this kind of statement, and actually get away with it? Anybody make any sense of this remark, namely the last line?


    REUTERS Canada’s Flaherty expects G7 to adopt FSF [HSBQDDR]

    OTTAWA, April 9 (Reuters) – Canadian Finance Minister Jim
    Flaherty said on Wednesday he expects Group of Seven finance
    ministers to adopt the Financial Stability Forum report with
    “perhaps some amendments.”

    The FSF, made up of central bankers and finance ministers
    of major economies, has drafted a list of recommendations that
    will be discussed by G7 officials on the weekend.

    One of the many options is a plan to recapitalize banks and
    repurchase mortgages, with the possible use of taxpayer money.
    (Reporting by Louise Egan, Writing Frank Pingue; Editing by
    Peter Galloway)

  5. jiHymas says:

    There’s an article about a possible Fed purchase of mortgages in today’s WSJ.

    What is it about the last line of the Reuters piece that you don’t understand?

  6. madequota says:

    Actually, having re-read this brief piece a few times, it now occurs to me that this recap of banks is a statement made by the FSF, pertaining to world banks in general. On the first read, I was thinking this was Flaherty talking about Canadian banks . . . which of course, would be a bizarre comment . . . even for Flaherty. duh. Sorry about that.


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