PrefBlog

Thursday! The day when the US Commercial Paper Outstandings get reported! The Fed reports that ABCP outstanding declined by $29.5-billion, a marked increase in pace over the past month, as deleveraging is quickly becoming a major issue in the States. Bloomberg provides a review.

Bernanke is clearly a reader of PrefBlog – his testimony to the Joint Economic Committe echoed what I’ve been saying about Super-Conduit:

So … if it works properly I think it would speed up the recognition of values in part because it would remove some of the risk of fire sales, of rapid drawing down of assets in some of these vehicles and allow the market to stabilize and begin to make a better longer term valuation of what these assets are worth.”

He added, “If that’s the way it works, and again it depends on execution, it would remove some overhang from the market, it would create a stable financing source for those assets and it ought not to be inconsistent with the price discovery process.”

Mainly, though, he just told the politicians on the committee to mind their own bees-wax. Good for him! He may have enough to worry about soon enough – there’s at least one analyst raising the spectre of 5% headline inflation as the Ghost of Christmas Present!

Despite this horrifying projection (noting that, gee, the projection for core inflation isn’t quite so bad), Treasuries were up on expectations of a Fed cut, as early indications point to a lousy Christmas for retailers. 

In SIV news that I missed yesterday … one of the SIVs affected by Moody’s mass review was Links Finance … proudly owned and operated by our very own Bank of Montreal:

Links Finance Corporation (US$1.9 billion of debt securities affected)

Mezzanine Capital Notes

New Rating: Aa2 on review for possible downgrade

Previous Rating: Aa2

Standard Capital Notes

New Rating: A3 on review for possible downgrade

Previous Rating: A3

Links Finance’s net asset value declined to 83% from 94% since Moody’s last review on September 5th. Moody’s review will focus on the potential for further market value deterioration.

Cheery, eh? There’s more:

Managers of structured investment vehicles don’t expect their business model to survive as the value of assets shrinks and the companies struggle to borrow, Moody’s Investors Service analysts said today.

Sic transit gloria mundi.

Apropos of nothing, I ran across a Ministry of Finance puff-piece today, which made the claim:

The World Economic Forum’s Global Competitiveness Report for 2001-2002 ranked Canadian banks among the soundest financial institutions in the world (see Chart 5). The soundness of the Canadian banking industry has been demonstrated many times over the past several years. Canadian banks weathered the debt difficulties of the less developed countries in the early 1980s, the decline in real estate values a decade later, and the Asian crisis in the late 1990s without experiencing any systemic problems.

… which was kind of cool. Our second place finish has been repeated in the 2007-2008 Report, although you have to poke around a bit to verify that. (hint: Country Analysis / Balance Sheet).

And, as far as preferreds go … another day of entirely reasonable volume but disappointing returns. The long corporates index is now yielding just a hair under 5.8%. So let me think about this. You can get the same pre-tax yield with better quality owning GWO.PR.H, at the closing bid. Potential tax benefits – or potential capital gains when others recognize the potential tax benefits – are merely icing on the cake. If this makes sense to anybody, please let me know.

There were twenty-three other index-included $25.00-equivalent issues trading over 10,000 shares today.

Update, 2007-11-09 Holy smokes! Yesterday I titled this “October 8” and have now changed it to, er, the right month. I had the day and year right! I must have been feeling nostalgic …

It looks like the Super-Conduit MLEC is having difficulty getting started even as SIVs are getting shakier by the day. Naked Capitalism reprinted a piece about a downgrade today by Moody’s of 16 SIVs representing about 10% of the market; but only two capital notes were actually downgraded; the senior paper and other capital notes are merely (!) under review according to Moody’s:

Moody’s Investors Service announced today that it has substantially completed another review of the Structured Investment Vehicle (SIV) sector following continued market value declines of SIV portfolios since our most recent review completed on September 5th of this year. As a result of this review, Moody’s has confirmed the short term ratings of the senior debt programmes of Kestrel Funding PLC and Kestrel Funding LLC (which hold approximately US$3 billion of debt securities) that were on review for possible downgrade. Moody’s also downgraded, or placed on review for possible downgrade, the ratings of 28 debt programmes of 16 SIVs (which hold approximately US$33 billion of debt securities) as described below.
…
The ongoing liquidity crisis facing SIVs has continued almost unabated since September 5th, when Moody’s completed its last review of the sector. The inability of some of the SIVs to issue sufficient Asset Backed Commercial Paper (ABCP) or Medium Term Notes (MTNs) over a prolonged period has led to the crystallisation of mark-to-market losses in some cases and the potential for such losses to be realised in others.
…
Moody’s has taken certain rating actions as a result of deteriorating credit and other market conditions. It seems clear that the situation has not yet stabilised and further rating actions could follow. As with previous actions, the rating actions Moody’s has taken today in response to the current situation are not a result of any credit problems in the assets held by SIVs, but rather a reflection of the continued deterioration in market value of SIV portfolios combined with the liquidity crisis.
…
SIV senior note ratings continue to be vulnerable to the unprecedented large and sustained declines in portfolio value combined with a prolonged inability to refinance maturing debt. SIV capital note ratings will be affected primarily by further deterioration in the market value of the portfolio. The risk of realised losses on capital and even senior notes is likely to increase significantly if the SIV is placed in a position where it must sell assets rapidly in a “fire sale.”

A lot of the problems are related to turmoil at Citigroup; its support of its SIVs (through the purchase of $7.6-billion in commercial paper) was discussed yesterday. Even worse, Citigroup has increased its exposure to CDO-issued CP, which has had the effect of ballooning the amount of Level 3 ‘Mark-to-Make-Believe’ assets. Citigroup’s cost of borrowing, as proxied through Credit Default Swaps, is skyrocketting.

They’re all in trouble! Latest estimates (which may have been padded to make them more interesting) are that Wall Street will take massive writedowns:

U.S. banks and brokers face as much as $100 billion of writedowns because of Level 3 accounting rules, in addition to the losses caused by the subprime credit slump, according to Royal Bank of Scotland Group Plc.

It would appear that at least some of the money written-off is finding its way into the profits of hedge funds:

Hedge funds returned 3.2 percent on average in October, the biggest gain in almost two years, as managers profited from rising stock prices and declining values of debt tied to home mortgages.

The monthly increase brought the advance to 12.3 percent so far this year, according to a report today from Chicago-based Hedge Fund Research Inc.

It should be noted that the dollar figures in the above paragraphs are US Dollars, not real money:

The dollar is “losing its status as the world currency,” Xu Jian, a central bank vice director, told a conference in Beijing. “We will favor stronger currencies over weaker ones, and will readjust accordingly,” Cheng Siwei, vice chairman of China’s National People’s Congress, said at the same meeting.

Chinese investors have reduced their holdings of U.S. Treasuries by 5 percent to $400 billion in the five months to August. China Investment Corp., which manages the nation’s $200 billion sovereign wealth fund, said last month it may get more of the nation’s reserves to invest to improve returns.

Analyst reactions to these specific remarks are split between yawning and mocking, but years of fiscal profligacy in the US are inexorably coming home to roost.  Maybe they should cut taxes again, or something. Giancarlo Corsetti provides a review of some possible outcomes; one scenario is

In their well-known work, Obstfeld and Rogoff (2005, 2007) propose the following scenario. Closing the US external deficit to within 5% of the US GDP will require the US terms of trade to fall between 5% and 15% – a surprisingly contained movement. By contrast, the fall in the internal relative price should be 3 to 5 times larger, namely the relative price of nontradeables inside the US must get between 20% and 30% cheaper.

To translate these figures into the current macroeconomic stance, keep in mind that, over time, productivity growth is faster in manufacturing (producing most tradables) than in services (mostly nontradables). These productivity differentials across sectors mean that the price of manufacturing decline steadily in terms of services. Now, relative to these long-run trends, we should see the price of US services drop by about one third in terms of US manufacturing, as the US eliminates their current account deficit.

… while another is …

Results from numerical exercises developed in joint work with Martin, and Pesenti, suggests that closing the US current account deficit (from 5% of GDP to zero) could lead to a combination of lower US consumption (-6%), and higher US employment (+3%), relative to trend. This would then correspond to a rate of real dollar depreciation of the order of 20% – close to what we have experienced so far.

We shall see! I will admit to having something of a bias in favour of Rogoff’s work – but only because he’s a chess player. I will have to ensure that bias doesn’t affect anything else!

To keep things interesting, there are predictions of bond-insurer failure:

MBIA may lose $20.2 billion on guarantees and securities holdings, Sean Egan, managing director of Egan-Jones, said on a conference call today. ACA Capital may take losses of at least $10 billion; New York-based Ambac may reach $4.3 billion; mortgage insurers MGIC Investment Corp. and Radian Group Inc. may see losses of $7.25 billion and $7.2 billion, respectively, Egan said.

“There is little doubt that the credit and bond insurers face massive losses over the next few quarters and many will be capital challenged,” Egan said.
…
Moody’s Investors Service and Standard & Poor’s will downgrade the ratings only after problems have become more obvious, Egan said.

Surprise!  Egan-Jones is a subscription-based rating service. Note that failure of an insurer could have serious knock-on effects in the US Municipals market.

Preferreds continued their recent showing of decent volume, but it seems like everybody was too busy financing their next trip to Buffalo by selling common shares to be fussed much about preferreds, which were … off a tad, but only technically.

There were twenty-one other index-included $25.00-equivalent issues trading over 10,000 shares today.

The big news recently has been the Citigroup writedowns, ouster of the CEO and downgrade by Moody’s (to Aa2 from Aa1). Accrued Interest is experiencing deja vu … the search for sub-prime exposure after the writedowns is like the search for fishy accounting after Enron. Naked Capitalism points out that while both Merrill and Citi have taken huge write-downs, Citigroup has done nothing to reduce its exposure.

Nouriel Roubini thinks this is the tip of the iceberg (as does CreditSights) and pays particular attention to mark-to-make-believe accounting. Accrued Interest explains the rating volatility of CDOs with a simple model. Giovannini and Spaventa attribute the snowballing effects of the credit crunch to the information gap between investors and exposures and propose some solutions – most of which impose extemely onerous supervision. While none of the following elements is explicitly spelled out in their paper, or unequivocally endorsed, I interpret the remarks as proposing:

• licensing of mortgage brokers
• regulation of credit rating agencies and inspection of their models
• standardization of products traded over-the-counter
• increased disclosure of bank exposures under Basel II

The first three recommendations are inappropriate in the context of bank regulation. While these matters may well be desirable from other perspectives – and should be argued within the context of those perspectives – they have little to do with the regulation for the purpose of ensuring the stability of the banking system. Even the fourth suggestion is far too prescriptive for a free market: I suggest that the policy objective would be met by stating simply that any instrument for which the banks’ assigned credit profile cannot be verified due to material information not disclosed to the regulators should be charged to risk-weighted assets as if it were equity. This is sufficiently punitive that:

• the policy objective of encouraging transparency will be served
• the stability of the banking system will not be compromised by debt-rated securities that behave with, shall we say, greater volatility and less liquidity than most debt.

Meanwhile, Citigroup filed its third-quarter ’07 10-Q today, chock-full of interesting information!

The current lack of liquidity in the Asset-Backed Commercial Paper (ABCP) market and the resulting slowdown of the CP market for SIV-issued CP have put significant pressure on the ability of all SIVs, including the Citi-advised SIVs, to refinance maturing CP.

While Citigroup does not consolidate the assets of the SIVs, the Company has provided liquidity to the SIVs at arm’s-length commercial terms totaling $10 billion of committed liquidity, $7.6 billion of which has been drawn as of October 31, 2007. Citigroup will not take actions that will require the Company to consolidate the SIVs.

Master Liquidity Enhancing Conduit (M-LEC)

In October 2007, Citigroup, J.P. Morgan Chase and Bank of America initiated a plan to back a new fund, called the Master Liquidity Enhancing Conduit (M-LEC) that intends to buy assets from SIVs advised by Citigroup and other third party institutions. This is being done as part of an effort to avert the situation where the SIVs will be forced to liquidate significant amounts of mortgage-backed securities, resulting in a broad-based repricing of these assets in the market at steep discounts.

SIVs, including those advised by Citigroup, have experienced difficulties in refinancing maturing commercial paper and medium-term notes, due to reduced liquidity in the market for commercial paper.

Well! As far as I know, that’s the first official admission that the Citigroup SIVs are in enough trouble that they’re going to sell to Super-Conduit (MLEC), assuming that Super-Conduit ever gets off the ground! This may not be a death-blow to my thesis that Super-Conduit = Vulture, but it’s a pretty good hit!

In a similar development that I missed on its publication October 18, there is speculation that BMO has purchased $13-billion of its own ABCP.

Citigroup has previously announced:

Citi also announced that, while significant uncertainty continues to prevail in financial markets, it expects, taking into account maintaining its current dividend level, that its capital ratios will return within the range of targeted levels by the end of the second quarter of 2008. Accordingly, Citi has no plans to reduce its current dividend level. 

But Accrued Interest – a bond guy after my own heart – has looked at the various impairments of the various banks with the horror that only a bond guy who’s afraid he won’t get paid can muster and has made a modest proposal:

This leaves the surviving banks with better pricing power and/or ability to dictate lending terms. Overall, the long-term prospects for banks should be quite positive.However, in order to realize this long-term opportunities, banks must find a way to survive the current contagion with as much capital preserved as possible. Long-term shareholders appreciate this need for capital preservation. It would not serve shareholders interests to sell assets at fire-sale levels to raise capital. Nor would shareholders benefit from a bank being forced to issue new equity shares, particularly at a time when equity prices are weak.

There is one obvious way for banks to retain more capital: eliminate the dividend.

We shall see if any of them take him up on it!

A good day for prefs, with perpetuals resuming their upward trend of the past week … but splitShares went out of style today, with some large declines.

There were thirty-three other index-included $25.00-equivalent issues trading over 10,000 shares today.