PrefBlog

Accrued Interest opines on the future of CDOs.

Naked Capitalism collects some opinions on credit conditions.

Bloomberg reports on LIBOR reporting problems.

Bloomberg reports on how OIS is overtaking LIBOR as a measure.

Lou Crandall comments (a long time ago) on how LIBOR overtook US T-Bills as a measure.

Jeffrey Frankel defends his thesis that low real interest rates cause commodities to rise.

Standard & Poor’s points out that sub-prime borrowers bought cheap houses, which have less volatile prices than expensive ones … the mortgage carry quickly becomes comparable to renting, no matter how far underwater you are.

Standard & Poor’s Ratings Services’ current ratings on the 2006 subprime U.S. residential mortgage-backed securities (RMBS) vintage reflect, in part, an assumed loss severity of 45%. That assumption includes our estimate that, based on our views on the current housing market environment, foreclosure costs and market value declines account for losses of 26.3% and 18.7%, respectively, in the loan balances of these mortgages. We project a 19% aggregate loss for subprime mortgages backing U.S. RMBS sold in 2006 based on assumptions for foreclosure and loss severity. The 19% assumption is the product of projected foreclosures of approximately 42% and the assumed loss severity of 45%.

Standard & Poor’s current house price decline assumption is 33.4%, which is a 72% increase over the maximum price decline of 19.4% observed to date (see table 1). We believe this assumption appropriately protects against forecasted price declines through the housing downturn.

Dates have been set for the redemption of FAL.PR.A & FAL.PR.H; the post has been updated.

Plans – well, rumours of plans, anyway – are moving forward for a CDS Clearinghouse. I have updated my most recent post on the issue.

For those fascinated with all aspects of the David Berry affair, I’ve had a look at the career of Cecilia Williams, Scotia’s compliance officer, and have updated the most recent relevant post.

In case you missed the announcements amidst the Bank Capitalization posts, note that RY.PR.K has been called for redemption and TD has a new Fixed Reset, 5+160 … and the argument about the structure’s merits rages on. It takes two to make a market!

Good volume on the day, with some nice sized blocks going through for some Operating Retractibles. Prices were down … surely, people can’t be selling straights to buy fixed-resets?

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

It seems like most of the interesting news lately has been sufficiently important to merit separate posts, so these daily reviews have been suffering!

Today Mishkin announced his resignation from the Fed Board:

Mishkin, 57, on a leave of absence from [Columbia University], will step down as of Aug. 31, the Fed said in a statement today, also releasing his letter of resignation to President George W. Bush.

The departure may create an unprecedented third vacancy on the seven-member Fed Board of Governors this year as the central bank tries to ease the credit crisis. The vacancies mean that a new U.S. president to be inaugurated in January may have an opportunity to influence monetary and regulatory policy by nominating new members to the board.
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Senate Banking Committee Chairman Christopher Dodd, a Democrat from Connecticut, has already delayed a confirmation vote for three board nominees for more than a year. After gaining support from the committee, the nominations would go to the full Senate for a vote of final approval.

Hey, who cares about the direction of the world’s most important Central Bank when when there are political games that can be played?

It’s not like the Fed doesn’t have a plateful of problems – JPMorgan is calling for US Inflation of over 5%

Not bad, with long treasuries at 4.6%, eh? Fisher is continuing his anti-inflation drum-beating:

Federal Reserve Bank of Dallas President Richard Fisher said he expects the central bank would raise the benchmark U.S. interest rate should the public begin to expect greater gains in consumer prices.

“If inflationary developments and, more important, inflation expectations continue to worsen, I would expect a change of course in monetary policy to occur sooner rather than later, even in the face of an anemic” economy, Fisher said today in the text of a speech in San Francisco.

Fed bank presidents, including Gary Stern of Minneapolis and Thomas Hoenig of Kansas City, have expressed growing concern this month about rising prices. Fisher, 59, is the only member of the Federal Open Market Committee to dissent three times from decisions to lower the overnight bank-lending rate, favoring either no change or less aggressive reduction.

There’s an interesting and rather heretical piece on VoxEU by Cournand and Heinemann titled Can Central Banks Talk too Much?:

Public information is a double-edged sword: it conveys valuable information, but it leads agents pursuing coordination to condition their actions on public announcements more than optimal. In this respect, Morris and Shin (2002) have shown that noisy public announcements may be detrimental to welfare. They conclude that central banks should commit to withholding relevant information or deliberately reduce its precision. This result has received a great deal of attention in the academic literature, in the financial press (see for example the Economist (2004)), and among central banks.
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Far from being perfect, all these means of communication allow the central bank to provide partially public information and avoid market overreactions to information of poor quality. To some extent, these means play a role in the actual policy of central banks already. Therefore, our results give a rationale for central banks releasing partially public information in addition to official publications. Our main result shows that these means of partial publicity should only be employed for announcements of low precision.

In other words … the bond market is excitable, so let’s just feed it pablum.

I don’t like the idea: it’s too big-brotherish. Much better would be the use of fan charts, as mentioned on January 18 with other methods of conveying the idea that such-and-such information is only a best guess. Excitable bond markets are great! A long term investor with half a brain can make good money out of them! Why should I – or any other PrefBlog reader – seek to prevent cowboys from losing all their clients’ money?

As reported by Bloomberg, S&P today downgraded a swath of Alt-A paper:

The classes affected by the negative rating actions represent an issuance amount of approximately $33.95 billion, or about 13.92% of the par amount of U.S. RMBS transactions backed by Alt-A mortgage loans rated by Standard & Poor’s in the first half of 2007.
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Due to current market conditions,
we are assuming that it will take approximately 15 months to liquidate loans in foreclosure and approximately eight months to liquidate loans categorized as real estate owned (REO). In addition, we are assuming a loss severity of 34% for U.S. Alt-A RMBS transactions backed by fixed-rate and long-rest hybrid (fixed-rate period of at least five years) loan collateral issued in 2007. We are assuming a loss severity of 35% for transactions issued in 2007 that are backed by mortgage loans that have a negative amortization feature. We are also assuming a loss severity of 35% for transactions backed by adjustable-rate and short-rest hybrid loan collateral (fixed-rate period of less than five years).
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Monthly performance data reveal that delinquencies and foreclosures continue to accumulate for the 2007-vintage U.S. Alt-A RMBS transactions. As of the April 2008 distribution date, serious delinquencies (90-day, foreclosures, and REOs) among all U.S. Alt-A RMBS transactions issued during 2007 were 6.64%, up 64.76% since January 2008. During this same time, cumulative realized losses for 2007-vintage Alt-A deals increased to 0.08% from 0.02%.

The analysis performed during this review has allowed Standard & Poor’s to project losses for each of the three types of Alt-A transactions issued during the first half of 2007. We project aggregate lifetime losses of 8.15%-8.65% of the original balance for the transactions with negative amortizing collateral. We project aggregate lifetime losses of 6.40%-6.90% for the transactions backed by fixed-rate and long-reset hybrid collateral. Finally, we project
aggregate lifetime losses of 7.00%-7.50% for the transactions backed by adjustable-rate and short-rest hybrid collateral.
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Unless we observe a significant change in the macroeconomic environment, Standard & Poor’s considers today’s actions, except for the CreditWatch placements, to be the last major changes to the ratings on the U.S. Alt-A RMBS classes issued during the first half of 2007.

Moody’s has released a report (available to subscribers only) regarding the CDS market. According to their press release:

“The notion that credit default swaps represent this $62 trillion long credit exposure is not an accurate depiction of the market nor particularly helpful to investors in determining where the true risks lie,” says Moody’s AVP/Analyst Alexander Yavorsky, one of the authors of the report, referring to the oft-cited figure for the notional amount of CDS contracts outstanding.
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Yavorsky says a more useful number when looking at the CDS market is the gross replacement value, of outstanding contracts, which at just over $2 trillion is under 3.5% of the notional amount.
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More concerning to Moody’s than an increase in underlying credit losses is the potential for market disruption through the failure of a major bank or broker-dealer.

If a large CDS counterparty failed, this would very likely have a substantial market-wide re-pricing effect on the cost of CDS protection, and, by extension, the underlying cash bonds. The effect of this would be especially problematic for firms needing to replace the CDS trades they had with the failed counterparty. Until the trades were replaced — an operationally challenging and unprecedented undertaking — the firms that lost protection would be left with unhedged exposures amid what is likely to be a very volatile market environment.
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Moody’s also notes, however, that the systemic importance of the largest CDS dealers provides powerful incentives to regulators to prevent their disorderly failure, as demonstrated by the recent case of Bear Stearns. The more important the role played by an institution the more likely regulators will consider it to be too systemically important to fail.

The Canada Pension Plan released its 2008 Annual Report, showing a benchmark portfolio of 25% Canadian Equities, 40% Foreign Equities, 25% Fixed Income and 10% Canadian Real Return Bonds; benchmark performance for the year was -2.7% as foreign equities got hammered. They outperformed by 241bp; actual allocations – as reported – were 23.5% Canadian Equities, 39.2% Foreign Equities, 24.3% Fixed Income and 11.7% “Inflation Sensitive Assets”, which includes real-estate and infrastructure, not just RRBs.

So … it’s only one year and you’d have to do a whole lot more work before you took a view on their skill …. but it shows what you can do when you have a captive client and don’t have to worry about explaining the latest headline. For example:

As a result, in September, we committed a total of US$2 billion ($2 billion) in funds managed by Apollo Management and the Blackstone Group to begin to establish a diversified portfolio of senior secured loans that were available at significant discounts to face value, of which approximately US$667 million ($666 million) has been invested to date. The CPP Investment Board had both the liquidity and knowledge needed to prudently purchase this senior performing debt at discounted prices and we are confident that this investment will deliver superior long term risk-adjusted returns.

The second example is our investment in distressed mortgage funds to take advantage of heavily discounted prices following the credit crisis. During the fiscal year, we committed a total of $750 million to two distressed mortgage funds run by very experienced fund managers, Pacific Investment Management Company (PIMCO) and BlackRock, Inc. To date, approximately US$500 million ($513 million) has been invested.

It appears probable, therefore, that at least part of the CPP money was involved in the Hapaolim / PIMCO deal mentioned May 22 – which I suggested was a fantastic buy for PIMCO. You won’t find too many pension plans doing that sort of thing … first, it involved fund management hiring an external specialist (which, for most firms, involves sharing the fee) and second, everybody knows that all sub-prime securities are level-3 toxic trash that will go to zero soon, if not negative. It said so in the paper yesterday!

Volume was normal today, with no particularly violent price trends apparent.

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