PrefBlog

Pump up the volume! It has been a weekend of massive bank (almost-) failure and state intervention.

Details are still sketchy, but Citigroup is taking over Wachovia:

Citigroup Inc., the biggest U.S. bank by assets, will acquire banking operations of Wachovia Corp. for about $1.6 billion after shares of the North Carolina lender collapsed under the weight of overdue mortgages.

The all-stock deal equals about $1 a share for the Charlotte-based bank, ranked sixth by assets in the U.S. All depositors will be protected, according to the Federal Deposit Insurance Corp., which helped broker the takeover by Citigroup. The New York-based bank plans to cut its own dividend in half and raise $10 billion in capital as it takes on Wachovia’s senior and subordinated debt.

The FDIC states:

Citigroup Inc. will acquire the bulk of Wachovia’s assets and liabilities, including five depository institutions and assume senior and subordinated debt of Wachovia Corp. Wachovia Corporation will continue to own AG Edwards and Evergreen. The FDIC has entered into a loss sharing arrangement on a pre-identified pool of loans. Under the agreement, Citigroup Inc. will absorb up to $42 billion of losses on a $312 billion pool of loans. The FDIC will absorb losses beyond that. Citigroup has granted the FDIC $12 billion in preferred stock and warrants to compensate the FDIC for bearing this risk.

Dealbreaker has the Citi Investor Presentation.

The status of the Canadian subsidiary, Congress Financial Capital Company, is not entirely clear at the moment; they raised CAD 400-million in 2005; but since they are (via intermediaries) 100% owned by Wachovia Bank National Association I am assuming (pending confirmation from the company) that their debt is covered under the deal, but I note that S&P put the issue on Watch-Negative this afternoon; its current S&P rating is A+.

In the meantime, the Europeans were busy:

European governments stepped in to rescue Fortis, Bradford & Bingley Plc, and Hypo Real Estate Holding AG as tremors from the U.S. credit crisis reverberated around the world.

The U.K. Treasury seized Bradford & Bingley, Britain’s biggest lender to landlords, while governments in Belgium, the Netherlands and Luxembourg threw an 11.2 billion-euro ($16.3 billion) lifeline to Fortis. Germany guaranteed a loan to Hypo.

… and the Fed is revving up the helicopters:

The Fed increased its existing currency swaps with foreign central banks by $330 billion to $620 billion to make more dollars available worldwide. The Term Auction Facility, the Fed’s emergency loan program, will expand by $300 billion to $450 billion. The European Central Bank, the Bank of England and the Bank of Japan are among the participating authorities.

The question remains: How many helicopters?

Nouriel Roubin loathes TARP:

Indeed, the plan also does not address the need to recapitalize those financial institutions that are badly undercapitalized: this could have been achieved by using some of the $700 billion to inject public funds in ways other and more effective than a purchase of toxic assets: via public injections of preferred shares into these firms; via required matching injections of Tier 1 capital by current shareholders to make sure that such shareholders take first tier loss in the presence of public recapitalization; via suspension of dividends payments; via a conversion of some of the unsecured debt into equity (a debt for equity swap). All these actions would have implied a much lower fiscal costs for the government as they would have forced the shareholders and creditors of the banks to contribute to the recapitalization of the banks.

As I noted on September 25, I would prefer a system whereby Treasury would buy senior preferred shares in distressed – but still solvent – banks, with a punitive coupon and the proviso that no dividends be paid on shares junior to the new issue until the issue was retired.

Via Dealbreaker comes a link … it appears that Richard A. Posner holds the same views:

A more palatable approach would be for the government to drive a Warren Buffett style hard bargain, in which, rather than buying anything from banks, the government would invest in them in a form, such as purchase of newly issued preferred stock, or bonds with a long maturity, that would augment the banks’ capital and thus enable banks to make more loans. That would avoid conferring a windfall on the banks by overpaying them for their bad securities; no one thinks Buffett is conferring a windfall on Goldman Sachs. After the industry was back on its feet, the government could sell the bank stocks or bonds that it had acquired.

… although I will note that his implication that long-term bonds are, or are equivalent to, capital is at best imprecise.

And in the end TARP failed:

Markets plunged as the House rejected, by a vote of 228 to 205, the $700 billion measure to authorize the biggest government intervention in the markets since the Great Depression. The Dow Jones Industrial Average fell 564 points, or 5 percent to 10,579, at 3:05 p.m. New York time.

The defeat of the legislation set off a scramble among the plan’s backers for additional support before another vote, which likely won’t come until later in the week.

We now await Son of TARP.

James Hamilton of Econbrowser has a good piece on understanding the TED spread.

There are interesting reports that Treasury repos are being done for fail-money; Dealbreaker notes that failed trades are increasing. Now there’s an indication of a locked up credit market if ever there was one!

Laeven & Levine have an article on VoxEU, Governance of banks, looking forward to the end of the crunch and the new – or changed – regulation that will be coming. They warn:

We find that banks with more powerful owners (as measured by the size of their shareholdings) tend to take greater risks.

This supports arguments predicting that equity holders have stronger incentives to increase risk than non-shareholding managers and debt holders and that large owners with substantial cash flows have the power and incentives to induce the bank’s managers to increase risk taking.

Furthermore, the impact of bank regulations on bank risk depends critically on each bank’s ownership structure such that the relationship between regulation and bank risk can actually change sign depending on ownership structure.

· For example, our results suggest that deposit insurance is only associated with an increase in risk when the bank has a large equity holder with sufficient power to act on the additional risk-taking incentives created by deposit insurance.

· The data also suggest that owners seek to compensate for the loss in value of owning a bank from capital regulations by increasing bank risk.

· Stricter capital regulations are associated with greater risk when the bank has a sufficiently powerful owner, but stricter capital regulations have the opposite effect in widely held banks.

Ignoring bank governance leads to incomplete and sometimes erroneous conclusions about the impact of bank regulations on bank risk taking.

PerpetualDiscounts fell in line with general credit markets today, with an average pre-tax bid-YTW of 6.29% … on the way up it hit that figure on July 9, on the way down on August 5. That’s about 8.81% at the standard 1.4x equivalency factor and Long corporates now yield about 6.5% … so the pre-tax interest equivalent spread to long corporates remains fairly constant at about 331bp.

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

This entry was posted on Monday, September 29th, 2008 at 10:38 pm and is filed under Market Action. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.