February 28, 2008

Accrued Interest leads off today with a very good piece on credit ratings, concluding:

On Monday, the Dow rallied nearly 200 points, and credit spreads almost universally tightened. Why? Because a AAA rating for MBIA and Ambac means that banks won’t have to pledge more capital against downgraded ABS. This gives them more capital to lend into the economy. No matter what you think of S&P’s analysis, that’s the reality. If that reality bothers you, perhaps your derision should not be aimed at S&P or MBIA, but at the banking regulations that are so heavily reliant on ratings.

Indeed. For an investor, a credit rating is an opinion; for a bank, a credit rating is the law. It was the regulators who made this move – with a certain amount of sense; the credit ratings agencies have a better track record than most – and now the regulators are busy trying to make the agencies the villains. 

There are howls of outrage over reports that the agencies encouraged the monolines to diversify:

Insurance regulators did not stop the financial guarantors from expanding their busineses out of the muni market, a dynamic that one of the moderators suggested could nevertheless play out in future business cycles. In response, Dinallo said his understanding of the current crisis was the the bond insurers were encouraged to expand into the structured finance by the rating agencies, who asked them to expand their books of business.

“From what I have learned so far, the bond insurers were encouraged by the rating agencies to improve their returns on equity and seek diversification through doing this structured business,” Dinallo said.

And Naked Capitalism further indicates displeasure at bank-operated credit analysis :

That procedure allows them to tell the regulators how much equity they need to hold, putting the inmates in charge of the asylum.

The source document for that post urges three steps to improve internal credit analysis:

  • Do a follow-up study using data from the Credit Crunch!
  • Enforce a “raw leverage” maximum … no risk weights, no credit conversion factors, just a straight assets/equity thing.
  • Make some amount of subordinated debt mandatory

All that’s reasonable enough (the second item is a standard feature of North American regulation); the uncertain desirability of mandatory sub-debt has been previously discussed.

Naked Capitalism also publicizes charges that the Auction Rate Securities market has always been manipulated:

DealBreaker does some serious reporting today, informing us that some traders have told them that the failed auction rate securities market was always dependent on stabilization by dealers.

But this raises the question of why the markets were faltering in the first place. In our earlier reporting, we revealed how accounting changes may have set some corporate buyers running for the exits from this market. More recent conversations with a broader array of bond traders and dealers points toward another possiblility—the market never had enough buyer demand to support itself and has been dependent on stabilization from the banks for a very long time.

I find it fascinating that there are some implications from accounting changes; if anybody can track down what that little snippet is all about, please let me know! But, as with taxation, accounting has become a complex system – a complex chaotic system – and seemingly small changes can lead to huge, unforseen and (practically speaking) unforseeable consequences. On the bright side, of course, it creates work for lawmakers, regulators, accountants and lawyers; while providing Portfolio Managers more credence for the “Well, gee, how was I supposed to know that?” defense of poor returns. All is for the best in this, the most perfect of all possible worlds.

From the what goes up must come down department comes story about dead cowboys:

Peloton Partners LLP, the London- based hedge-fund firm run by former Goldman Sachs Group Inc. partners, is liquidating its ABS Fund after “severe” losses on mortgage-backed debt and demands from banks to repay loans.

Peloton, founded by Ron Beller and Geoff Grant in 2005, is seeking buyers for the $1.8 billion fund’s assets, according to a letter sent today to investors. Firms including Citadel Investment Group LLC and GLG Partners Inc. have made bids, two people familiar with the situation said.

The fund’s demise after an 87 percent gain last year highlights the severity of the U.S. subprime-mortgage collapse, which has spread to AAA-rated securities and triggered bank margin calls.

Sitka & Apex Trusts, mentioned yesterday have basically defaulted, according to DBRS:

On February 27, 2008, DBRS confirmed the ratings as Under Review Negative following an agreement between Sitka Trust and a swap counterparty to Sitka Trust to extend the due date of a collateral call notice received by Sitka Trust to the close of business on February 27, 2008. That agreement has expired. Moreover, as of the date of this release, no restructuring proposal has been agreed to by the relevant transaction parties. DBRS stated in the press release of February 25, 2008, that failure to enter such an agreement would likely result in substantial rating action.

In addition to the failure of Sitka Trust to fulfill its obligations to fund a collateral call by the close of business on February 27, 2008, DBRS was informed after close of business on February 27, 2008, by BMO Nesbitt Burns Inc., as Securitization Agent and Sub-Agent of Apex Trust and Sitka Trust respectively, that on February 27, 2008, Apex Trust failed to roll over all of its Series A, Class A Notes which came due on that date. As a result, pursuant to the terms of the Apex Trust indenture, the failure to pay the principal of or interest on the Series A Notes when due is considered to be a trust default if it continues for a period of two business days after a notice in writing has been given by the Indenture Trustee to the Trust. Due to the nature of certain agreements between the Trusts, a default of Apex Trust would result in a default of all of the Notes of Sitka Trust.

It’s interesting. My guess is that the default is real and will be confirmed in two days … but the two day grace period does leave open the possibility that BMO is engaged in high stakes brinksmanship with the swap counterparty. You never get to hear the good parts about these stories!

A Globe story about the situation noted:

The bank now has just two days to make a tough call. It can support the trusts by meeting the collateral calls, which means putting more capital at risk in what may be a vain bet on a recovery in capital markets, or Bank of Montreal can cut its losses by writing off $495-million of exposure to the trusts and letting them wind down.

The costs likely wouldn’t end there, though, because the bank is the biggest player in Canada’s securitization market with a business that generated about $296-million in revenue last year. That business would be in jeopardy if Bank of Montreal let Apex and Sitka fail, analysts said.

“Now the question is how committed BMO is to the securitization business in Canada because letting these trusts go down would decimate them in the eyes of customers,” said industry consultant Daryl Ching, managing partner of Clarity Financial. “The problem for BMO is if they meet these collateral calls they could easily be faced with more in a month if credit markets continue to worsen.”

The $296-million figure is from 2007 Annual Report; it is not even completely clear whether Sitka/Apex feed into this number at all; over half the amount is derived from selling credit card loans to existing vehicles. Whether or not letting Sitka/Apex go down would jeopordize the revenue is a matter of opinion … my opinion is “not”.

Meanwhile, the Alt-A RMBS market is looking pretty sick:

Typical 6 percent securities rated AAA and backed by 30-year fixed-rate Alt A loans of more than $417,000 on Feb. 22 fell to 12 cents less per dollar of principal than similar “agency” securities guaranteed by government-linked entities such as Fannie Mae, according to a report this week by JPMorgan Chase & Co. That was up from 5.5 cents on Jan. 25.

AAA bonds with 6 percent coupons backed by 30-year, fixed- rate “jumbo” prime loans of more than $417,000 probably traded for 2.5 cents per dollar less than similar agency securities, the report said, compared with 2.25 cents last month.

… and this has caused yet another good sized hedge fund to call it a day

Peloton Partners LLP, the London- based hedge-fund firm run by former Goldman Sachs Group Inc. partners, is liquidating its ABS Fund after “severe” losses on mortgage-backed debt and demands from banks to repay loans.

Peloton, founded by Ron Beller and Geoff Grant in 2005, is seeking buyers for the $1.8 billion fund’s assets, according to a letter sent today to investors. Firms including Citadel Investment Group LLC and GLG Partners Inc. have looked at the portfolio, two people familiar with the situation said.

The fund’s demise after an 87 percent gain last year highlights the severity of the U.S. subprime-mortgage collapse, which has spread to AAA rated securities backed by safer loans and triggered bank margin calls.

Volume picked up today and, the market was steady. Of interest was a plunge in price of NTL.PR.F and NTL.PR.G: there are lots of headlines. Whether the plunge reflects a genuine reevaluation of the prospects for default, or whether just being in the headlines was sufficient reason … is something we’ll never know.

Note that these indices are experimental; the absolute and relative daily values are expected to change in the final version. In this version, index values are based at 1,000.0 on 2006-6-30
Index Mean Current Yield (at bid) Mean YTW Mean Average Trading Value Mean Mod Dur (YTW) Issues Day’s Perf. Index Value
Ratchet 5.52% 5.53% 36,749 14.6 2 +0.0000% 1,085.4
Fixed-Floater 4.98% 5.67% 71.918 14.69 7 -0.1239% 1,031.0
Floater 4.93% 5.00% 67,129 15.44 3 +0.0002% 857.1
Op. Retract 4.81% 2.37% 76,588 2.48 15 +0.0642% 1,050.0
Split-Share 5.27% 5.28% 96,863 4.06 15 +0.0894% 1,050.3
Interest Bearing 6.22% 6.35% 56,518 3.36 4 +0.1263% 1,089.7
Perpetual-Premium 5.71% 3.77% 331,865 4.79 16 +0.0089% 1,034.4
Perpetual-Discount 5.36% 5.39% 273,230 14.82 52 -0.0273% 961.6
Major Price Changes
Issue Index Change Notes
IAG.PR.A PerpetualDiscount -2.9242% Now with a pre-tax bid-YTW of 5.25% based on a bid of 21.91 and a limitMaturity.
NA.PR.L PerpetualDiscount -1.8625% Now with a pre-tax bid-YTW of 5.52% based on a bid of 22.13 and a limitMaturity. 
PWF.PR.L PerpetualDiscount -1.6694% Now with a pre-tax bid-YTW of 5.47% based on a bid of 23.56 and a limitMaturity.
BAM.PR.I OpRet -1.4291% Now with a pre-tax bid-YTW of 5.29% based on a bid of 25.52 and a softMaturity 2013-12-30 at 25.00.
W.PR.H PerpetualDiscount -1.2381% Now with a pre-tax bid-YTW of 5.77% based on a bid of 23.93 and a limitMaturity.
RY.PR.B PerpetualDiscount -1.1419% Now with a pre-tax bid-YTW of 5.25% based on a bid of 22.51 and a limitMaturity.
BCE.PR.I FixFloat +1.0101%  
GWO.PR.H PerpetualDiscount +1.1742% Now with a pre-tax bid-YTW of 5.21% based on a bid of 23.23 and a limitMaturity. 
BAM.PR.M PerpetualDiscount +1.4644% Now with a pre-tax bid-YTW of 6.24% based on a bid of 19.40 and a limitMaturity. 
GWO.PR.I PerpetualDiscount +1.7873% Now with a pre-tax bid-YTW of 5.11% based on a bid of 22.00 and a limitMaturity.
Volume Highlights
Issue Index Volume Notes
BMO.PR.J PerpetualDiscount 176,105 Now with a pre-tax bid-YTW of 5.27% based on a bid of 21.51 and a limitMaturity.
CM.PR.I PerpetualDiscount 42,195 Now with a pre-tax bid-YTW of 5.63% based on a bid of 21.15 and a limitMaturity.
W.PR.H PerpetualDiscount 36,021 Bolder (who?) bought 10,000 from Nesbitt at 24.00. Now with a pre-tax bid-YTW of 5.77% based on a bid of 23.93 and a limitMaturity.
BNS.PR.O PerpetualPremium 30,526 Now with a pre-tax bid-YTW of 5.36% based on a bid of 25.60 and a limitMaturity.
TD.PR.Q PerpetualPremium 26,142 Now with a pre-tax bid-YTW 5.39% based on a bid of 25.58 and a call 2017-3-2 at 25.00.

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

7 Responses to “February 28, 2008”

  1. madequota says:

    Is the pref party over . . . again?

    Here’s the situation:

    1) the long bond is approaching historic highs, with the yield down again today, approaching 4%.

    2) Royal Bank just reported another massive $1B+ profit for the first quarter.

    3) The central bank will be announcing a 25 bp cut, and maybe a 50bp cut in rates next Tuesday.

    4) RBC is pounding the market with sell orders primarily on their own preferreds, driving most of them well away from recent levels.

    Can someone please explain the logic behind this reality?

    madequota

  2. jiHymas says:

    Bonds have never been a particularly good indicator of prefs on a day to day basis … the trends are basically congruent, sure, but there’s a lot of noise.

    Canadas have been even more decoupled from prefs than usual since the start of the credit crunch last summer.

    Explanations of day to day moves? A retail broker will give you half a dozen of them, each one sounding wiser than the last. And each one bullshit.

    I long ago learnt to concentrate on trying to figure out whether ABC at ten cents was sufficiently cheaper than XYZ at fifteen cents to justify a trade. I don’t listen much to stories.

  3. cowboylutrell says:

    Most preferred split shares remain surprisingly strong in the face of weakening unit prices.

    This must be part of the strenghtening of the preferred share market, but still…

  4. madequota says:

    Yes, Mr. Hymas, I understand the pitfalls of day-to-day comparisons, etc. . . . but look at my 4 points as listed . . . each of these items is significant, and each one is current to the minute.

    There must be more of an explanation of RBC’s actions than just day-to-day fluctuations. RBC’s icebergs today have been upgraded to 5000 shares per release, and he’s got plenty of them out there right now. This is a philosophical move, not a random one.

    I just don’t get their philosophy.

    madequota

  5. jiHymas says:

    cowboylutrell – I suspect that there are a lot of investors who want retractible product, but can’t stomach the very low yields available on the Operating Retractibles. The capital units are (mostly, anyway) getting hit, but even the relatively bad (but still Pfd-2(low)+) split preferreds still have asset coverage in the 1.6:1 area; less than we’d all like, of course, but not an immediate cause for concern.

  6. jiHymas says:

    Here’s one for your notebook, madequota!

    RBC crossed 40,000 BAM.PR.N at 19.07, while the virtually identical BAM.PR.M is quoted at 19.35-53.

    Mind you if the only thing the client owns is BAM.PR.N then the only thing the client can sell is BAM.PR.N.

    Ah, the sweet mysteries of life! When somebody gives me a dollar, I don’t ask why!

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