PrefBlog

We may be nearing the point of crisis.

Accrued Interest is getting panicky:

Unfortunately, the panic is legitimate. No one knows what a GSE bailout will look like.
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There are also rumors that PIMCO and SAC were not trading with Lehman. Both PIMCO and SAC have denied the rumor. Worth noting that PIMCO was one of the first to stop trading with Bear Stearns.
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The more panicky things get, the more likely we get a relief rally after bank earnings are out. Odds are good that it will be a mixed bag, with some banks looking particularly ugly (Wachovia this morning warned of a huge loss) and others will be bad but not that bad.

What’s all this about? The GSEs are looking sick … very sick indeed:

Chances are increasing that the U.S. will bail out Fannie Mae and Freddie Mac because they don’t have enough capital to weather the worst housing slump since the Great Depression, former St. Louis Federal Reserve President William Poole said in an interview. Freddie Mac owed $5.2 billion more than its assets were worth in the first quarter, making it insolvent under fair value accounting rules. The fair value of Fannie Mae assets fell 66 percent to $12.2 billion, data provided by the Washington- based company show, and may be negative next quarter, Poole said.

“Congress ought to recognize that these firms are insolvent, that it is allowing these firms to continue to exist as bastions of privilege, financed by the taxpayer,” Poole, 71, who left the Fed in March, said in the interview yesterday.

There are soothing words from the administration:

U.S. Treasury Secretary Henry Paulson said he’s been assured by the regulator for Fannie Mae and Freddie Mac that the two government-chartered mortgage companies have enough capital.

The Office of Federal Housing Enterprise Oversight “has made clear that they are adequately capitalized,” Paulson told the House Financial Services Committee.

… but as of noon:

Freddie Mac (FRE US) sank 16 percent to $8.57, a 16-year low. UBS AG analysts cut their price target on the second-largest mortgage-finance company to $10 from $28, citing growing credit losses and problems raising capital.
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Fannie Mae slumped 5.2 percent to $14.52, the lowest since July 1991. MGIC Investment Corp. (MTG US), the largest U.S. mortgage insurer, lost 17 percent to $5.55.

… even while the implicit guarantee became a whole lot more explicit …

Fannie Mae and Freddie Mac, the largest buyers of U.S. home loans, are too big for the government to let them fail, leading Republican and Democratic lawmakers said.

The government-chartered companies, which own or guarantee about half the $12 trillion of U.S. mortgages, can count on a federal lifeline, said Republican Senator John McCain of Arizona and Democratic Senator Charles Schumer of New York.

The remarks by the presumptive Republican presidential candidate and the head of the congressional Joint Economic Committee followed a slide in the firms’ shares to the lowest level since 1991. They indicate Congress would push the administration to use government funds to prevent the companies failing and threatening a deeper housing recession.

Naked Capitalism reviews media stories on disaster planning

I said it most recently on May 2:

The GSEs have to start being regulated like banks; there’s no question in my mind about that.

If Congress wants to cut a special deal with them to achieve politically favourable goals, it should simply buy a preferred share – with cash – make it puttable to the company unless the company does A, B and C, and write a specific exclusion to the capital rules allowing this to be Tier 1 capital. Then … walk away and let the regular regulators do as they please.

Yet another thoroughly appalling day, with PerpetualDiscounts getting absolutely hammered. The average yield of 6.34% is equivalent to 8.88% interest (with a conversion factor of 1.4x), representing a spread of about 278bp over long corporates.

You know … I’m not worried about myself so much (I’m fairly phlegmatic about market prices), and I’m not worried about the fund so much (while it’s underperforming due to PerpetualDiscount exposure, it’s executing a steady stream of little income-enhancing trades that will eventually pay off), and I’m not worried about the market so much (all we have to fear is defaults, and none of those are even on the horizon, for instruments I hold. None of this excitement is showing up in the Canadian bond market at all.), but I am worried about retail. This is the type of environment where even very reasonable people might panic – or, worse, indulge in a little market timing – and these investors could hurt themselves badly.

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

Times are tough! European banks are paying a spread of 542bp for Innovative Tier 1 Capital:

European banks are having to pay the highest costs in at least a decade to raise capital reserves required by regulators.

Investors now demand 542 basis points of extra yield over government debt to buy so-called Tier 1 securities, which regulators demand banks hold to buffer depositors and senior bondholders against losses, according to Merrill Lynch & Co.’s Euro Sub-Debt Tier 1 Index. The index started the year at 284 basis points.
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Regulators consider Tier 1 securities as close to equity because in some circumstances issuers can defer interest payments. Instead of a fixed due date, the bonds often give the issuer the option of redeeming them after five or 10 years and inflict higher interest payments if that doesn’t happen.

As financing costs increase banks may no longer view a higher coupon as penalizing them, meaning investors risk holding bonds that may never mature, said Simon Adamson, an analyst at debt research firm CreditSights Inc. in London.

I don’t know the details of the “Euro Sub-Debt Tier 1 Index”, but the spread probably relates to 10-year governments; the so-called bonds will (probably!) have a call and step-up provision at that time so the salesmen can pretend it’s 10-year money.

By way of comparison, we know from yesterday that PerpetualDiscounts are trading to yield 265bp over long corporates, and long corporates are trading about 200bp over Canadas. As a further comparison, the NBC CaPS II, 7.447% until the pretend-maturity 2020-6-30 (after which it’s BAs + 409bp), are quoted at 370bp over the Canada 2018s.

No prizes will be awarded for guessing which direction the market took today! This is getting awfully depressing, you know? But there’s no way of telling when this trend will reverse … and in the meantime, there are some awfully juicy swaps popping up often enough to make life interesting for a fully invested portfolio that isn’t afraid of trading.

The sloppiness of the market is well illustrated by the fact that the market did not appear to notice that National Bank went ex-Dividend today.

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

Bradford & Bingley, a small UK mortgage bank with a market cap of about $400-million seems to be in trouble:

Bradford & Bingley dropped as much as 26 percent, the largest decline since it sold shares to the public in 2000, and was down 8 pence to 34 pence at 11:30 a.m. The shares fell 16 percent yesterday and 18 percent July 4, bringing this year’s decline to 88 percent and valuing the bank at 212 million pounds ($419 million).
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Bradford & Bingley has been hurt by the seizure in credit markets because it depends on capital markets for about 52 of its funding. Leicester, England-based Alliance & Leicester Plc, which gets about 59 percent from wholesale markets, declined as much as 10 percent today in London and traded at 226.25 pence at 11:20 a.m.

As a warning to those who might put too high an emphasis on the (very important) Tier 1 ratio and Total Capital ratio … as of Dec. 31/2007 they had GBP 1.4-billion in Tier 1 Capital, Tier 1 Ratio of 8.6%, Total Capital Ratio of 15.1%. You can’t put all your trust in one number!

Meanwhile, OFHEO says that, contrary to yesterday‘s speculation, Fannie & Freddie don’t need capital:

Freddie Mac and Fannie Mae, whose shares have tumbled more than 60 percent this year, have enough capital to survive a slump in the housing market and meet new accounting rules, their regulator said.
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“An accounting principle should not drive a capital decision by a regulator,” Lockhart later told reporters at a mortgage conference in Arlington, Virginia, today sponsored by the Federal Deposit Insurance Corp.

However, there’s lots of bad news to go ’round! IndyMac is looking fairly ill:

IndyMac Bancorp Inc., the California- based lender that is firing half its employees, is facing “elevated levels of deposit withdrawals” after U.S. Senator Charles Schumer said the bank may be on the brink of failure.
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Because it doesn’t have enough capital to meet the “well capitalized” threshold set by regulators, IndyMac said it can’t fund its lending with deposits acquired through independent brokers. IndyMac’s request for a waiver from the FDIC to allow for brokered deposits hasn’t been approved, the company said.

Naked Capitalism has more details.

Remember my table of CM issues on June 26? And the table of PWF issues yesterday, that Assiduous Reader prefhound noted was the last cum-dividend day? Well, here’s the table again, now that the dividend has gone ex:

I said it yesterday … I’ll say it again: Negative Convexity? Negative Schmonvexity! It just doesn’t make any sense!

I hate to say it … but it was yet another bad day for PerpetualDiscounts! This is the ninth consecutive loss; the last gaining day was June 24; the cumulative loss since then is 3.73%.

Long corporates still yield about 6.1% … the perpetualDiscount weighted mean pre-tax bid-YTW of 6.25% dividend is equivalent (with a 1.4x factor) to 8.75% … spread to long corporates is now 265bp.

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