PrefBlog

The Apocalyptionists will be upset! Not only did DTCC close out Lehman’s CDS book without loss:

it successfully closed out over $500 billion in market participants’ exposure from the Lehman Brothers, Inc. (Lehman) bankruptcy which occurred the week of Sept. 22. This was the largest close-out in DTCC’s history. DTCC reports it does not expect there to be any impact to its retained earnings or to market participants’ clearing fund deposits as a result of closing out these pending trade obligations.

“The liquidation of Lehman was complex, involved multiple asset classes, and required a methodical approach to mitigate potential losses from outstanding trading obligations,” said Donald F. Donahue, DTCC chairman and CEO. “Without question, our ability to manage risk and see exposure from a central vantage point was instrumental in helping us ensure that market risk – and systemic risk – was avoided.

… but settlement of CDS obligations on Lehman itself proceeded seamlessly …

On Oct. 21, DTCC also completed, without incident, the automated credit event processing of Lehman Brothers Holdings Inc. (LBHI) involving $72 billion of credit default swaps. DTCC calculated and bilaterally netted all amounts due on credit default swaps written on LBHI. This resulted in approximately US$5.2 billion owed from net sellers of protection on LBHI to net buyers of protection. The portion of this net funds settlement allocable to trades between major dealers was handled through the normal settlement procedures of CLS Bank International, DTCC’s settlement partner for the Warehouse and the world’s central settlement bank for foreign exchange.

DTCC also announced:

it will begin to publish aggregate market data from its Trade Information Warehouse (Warehouse), the worldwide central trade registry it maintains on credit derivatives. Starting Tuesday, November 4 and continuing weekly, DTCC will post on its website www.dtcc.com/derivserv the outstanding gross and net notional values (“stock” values) of credit default swap (CDS) contracts registered in the Warehouse for the top 1,000 underlying single-name reference entities and all indices, as well as certain aggregates of this data on a gross notional basis only. The data is intended to address market concerns about transparency.

According to their 2007 Annual Report:

While the total outstanding of credit default swaps (CDS) has grown to $45.5 trillion in 2007 from $3.7 trillion in 2003, our Deriv/SERV platform has been credited with significantly reducing the risk previously associated with unconfirmed trades. Today, over 90% of CDS trades are matched and confirmed through Deriv/SERV, compared with 15% late in 2003.

I have added the warehouse information address to the links, under “US Fixed Income Data”.

The Treasury guarantee of bank debt – reported on October 27 as seeming cheap – is mired in confusion:

Almost three weeks after the government threw its guarantee behind new bank bonds, no U.S. finance company has braved the market.

While Citigroup Inc., JPMorgan Chase & Co. and Bank of America Corp. were the three largest U.S. banks issuing debt last year, they haven’t sold dollar-denominated corporate bonds since August.
…
Banks are hamstrung because they’re waiting for the “fine print,” said Ira Jersey, an interest-rate strategist at Credit Suisse Group AG in New York. Because they don’t know if the debt will be guaranteed under all circumstances, bonds are difficult to price, he said.

Mind you, the Commercial Paper programme – that is busily grossing up the Fed’s balance sheet – is working great!

Interest rates on U.S. commercial paper fell to about the lowest in four years after the Federal Reserve said it absorbed more than 9 percent of the market.

Interest rates on the highest-ranked 30-day commercial paper dropped 39 basis points to 2.02 percent, about the lowest in four years, according to yields offered by companies and compiled by Bloomberg. Yields on overnight and seven-day paper fell to the lowest levels in at least 13 years, Bloomberg data show.

Naked Capitalism reprints a Financial Times article regarding the effect of changes in bankruptcy law on the recent investment bank collapses:

The 2005 changes made clear that certain derivatives and financial transactions were exempt from provisions in the bankruptcy code that freeze a failed company’s assets until a court decides how to apportion them among creditors.
…
Lawyers said under the old rules, creditors of companies facing financial difficulties were wary of settling trades or seeking extra collateral because they knew such demands could precipitate a bankruptcy filing and potentially freeze their claims.

However, when the financial health of Bear, Lehman and AIG took a sharp turn for the worse this year, their trading counterparties – mainly hedge funds and other banks – were not deterred from seeking to settle their trades or forcing the three companies to put up more collateral.

Such pressure exacerbated the liquidity squeeze that ultimately forced the three companies to hoist the white flag. Bear was sold to JPMorgan in a cut-price deal in March, while Lehman filed for bankruptcy last month and AIG was rescued by a $120bn government loan.

Calculated Risk provides a thoroughly fascinating graph (via Dealbreaker and Abnormal Returns) [click for big]:

And, just to make Hallowe’en a little scarier, the FDIC closed down another bank:

As of October 17, 2008, Freedom Bank had total assets of $287 million and total deposits of $254 million. Fifth Third agreed to assume all the deposits for a premium of 1.16 percent. In addition to assuming the failed bank’s deposits, Fifth Third will purchase approximately $36 million of assets. The FDIC will retain the remaining assets for later disposition.
…
The FDIC estimates that the cost to the Deposit Insurance Fund will be between $80 million and $104 million. Fifth Third’s acquisition of all deposits was the “least costly” resolution for the FDIC’s Deposit Insurance Fund compared to alternatives. The last failure in Florida was First Priority Bank, Bradenton, which was closed on August 1, 2008. Freedom Bank is the seventeenth FDIC-insured institution to be closed this year.

A small bank, but look at the proportions! They had $287-million in assets, and Fifth Third is buying $36-million of them. That leaves the FDIC with $251-million and they’re expecting a loss of between $80-million and $100-million. Now that’s a whacking!

And that’s the end of another month – and it was a pretty horrible one for prefs, believe me! I’ll be doing all the usual posts shortly, but a brief examination is sufficient to conclude that CPD lost 7.21% on the month … a huge number for such a thoroughly diversified fund. MAPF, on the other hand, traded like gangbusters – an absolutely massive trading month – and, while still having lost money, will have out-performed CPD substantially.

The key to portfolio management is to arrange your portfolio into various asset classes that will meet your long terms goals without subjecting the portfolio as a whole to extreme short term risk. Then – and this is where I come in – you attempt to outperform within each asset class.

What a day on the market! Hefty volume, some very chunky crosses and a sharp move upwards! If only there had been more days like that this month!

PerpetualDiscounts were up 1.6586% to yield 6.90% (pre-tax price-weighted mean YTW). At the standard 1.4x equivalency factor, this is equivalent to 9.66% interest; long corporates ar at 7.5%, so the pre-tax interest-equivalent spread is 216bp … starting to narrow, but the bonds are wide!

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

This entry was posted on Friday, October 31st, 2008 at 10:14 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.