Bremner, Bird & Fortune do it again Sunday, November 09, 2008

I highly recommend you watch this excellent episode of Silly Money by Bremner, Bird & Fortune. 48 mins in length but well worth watching all the way through as the team discuss recent market events.

Labels: ,

posted by John Wilson @ 8:42 PM Permanent Link ,

newsvine reddit



City employment levels to be decimated Monday, October 13, 2008

According to a forecast from the Centre for Economics and Business Research (CEBR), financial firms in the City of London are set to cut 62,000 by the end of next year, taking employment back to levels last seen in 1998 falling from 353,000 in 2007 to 325,000 in 2008 and 291,000 in 2009.

It suggests that
Any suggestions for a retraining course I can take?

Labels: ,

posted by John Wilson @ 10:32 AM Permanent Link ,

newsvine reddit



HM Treasury get Buffett-style terms from the Banks

Extract from LloydsTSB regulatory news announcement this morning

HM Treasury will subscribe for £1.0 billion of Lloyds TSB preference shares. The preference shares will carry an annual coupon of 12% (non tax deductible), and will be callable after a period of five years.

Under the terms of the preference shares, the enlarged Group will be precluded from paying a cash dividend on its ordinary shares whilst any of the preference shares remain outstanding.

Not cheap financing for a Group that only two weeks ago was insisting it was in decent shape.


Related articles by Zemanta
Reblog this post [with Zemanta]

Labels: , , ,

posted by John Wilson @ 9:30 AM Permanent Link ,

newsvine reddit



CDO fantasy - to the tune of Bohemian Rhapsody Thursday, March 20, 2008

This is absolutely superb - courtesy of an email sent into FT Alphaville

CDO fantasy - to the tune of Bohemian Rhapsody

Is this the real price?
Is this just fantasy?
Financial landslide
No escape from reality

Open your eyes
And look at your buys and see.
I’m now a poor boy
High-yielding casualty

Because I bought it high, watched it blow Rating high, value low Any way the Fed goes Doesn’t really matter to me, to me

Mama - just killed my fund
Quoted CDO’s instead
Pulled the trigger, now it’s dead
Mama - I had just begun
These CDO’s have blown it all away

Mama - oooh
I still wanna buy
I sometimes wish I’d never left Goldman at all.

I see a little silhouette of a Fed
Bernanke! Bernanke! Can you save the whole market?
Monolines and munis - very very frightening me!
Super senior, super senior
Super senior CDO - magnifico

I’m long of subprime, nobody loves me
He’s long of subprime CDO fantasy
Spare the margin call you monstrous PB!
Easy come easy go, will you let me go?
Peloton! No - we will not let you go - let him go Peloton! We will not let you go - let him go Peloton! We will not let you go - let me go Will not let you go - let me go (never) Never let you go - let me go Never let me go - ooo

No, no, no, no, no, no, no, -
Oh mama mia, mama mia, mama mia let me go S&P had the devil put aside for me For me, for me, for me

So you think you can fund me and spit in my eye?
And then margin call me and leave me to die Oh PB - can’t do this to me PB Just gotta get out - just gotta get right outta here

Ooh yeah, ooh yeah
No price really matters
No liquidity
Nothing really matters - no price really matters to me

Any way the Fed goes…..

Labels: , ,

posted by John Wilson @ 10:13 AM Permanent Link ,

newsvine reddit



MF Global clients asked to take a hike Wednesday, March 19, 2008

FT Alphaville has a report that MF Global [where I once worked] has hiked its margin rates considerably. Under the heading "MF Global Reiterates Strong Liquidity Position (and tells clients to get lost)" it notes that

And when we say “hike” we mean a move, typically, from 25 per cent to 75 per cent or more. In fact, for UK small caps the requirement is now 90 per cent.

Those most notably affected are thousands of traders and speculators using CFDs, who have either had to deposit extra funds immediately, move their business elsewhere or liquidate their positions. And then there is MF’s own army of brokers - many of whom are on substantial commission arrangements and who have now lost much of their client base overnight.
According to well placed market sources, this has added “meaningfully” to some of the unexpected price swings seen across the London market in particular over the past 24 hours.

This is an interesting development for the following reasons:-
For the desk heads of the products affected e.g. CFDs, this will be a nightmare for their business, which they have developed and nutured over many years. Inevitably, these hikes will harm their P&L on which they are judged and bonuses paid [always a sensitive matter]. Even a reversal of the policy in a few weeks time, will not restore all of the business lost and whilst its' "quality" may be debated in some quarters, it will have wider implications. For example
For these reasons it will have undoubtedly been a hotly contested matter internally but evidently the senior executives decided the solvency of the firm and perceptions about it necessitated such action.

UPDATE: For whatever reason, FTAlphaville have removed the blogpost, which is almost unheard of. Of course, the post is already floating across the internet via rss, and so it's still showing in my Google Reader. Either they got the story completely wrong or someone didn't like its' tone. Meanwhile, CityIndex has also raised its' margin requirements to 10% on FTSE100 and 20% on FTSE250, but which suggest that collateral requirements in the stock lending market aren't high enough to warrant the increases by MF Global that FT Alphaville reported.

Labels: , ,

posted by John Wilson @ 4:28 PM Permanent Link ,

newsvine reddit



A deal too good to miss?

The panic in financial market is causing violent swings in prices. At the top and bottom of these, apparently even cautious investors are starting to re-enter the market to take advantage of the overshoot and comparative value implied.

For instance, the price of a 5 year Credit Default Swap on iTraxx Europe hit than 160 basis points this week. This means anybody selling protection on £10m would earn £160,000 a year. Of course, you face the potential of paying out £10m were the index constituents to default. However, if you believe that prices are very frothy and will return to levels consistent with the past, then you could close you CDS position out as prices fall i.e. you receive £160k today but if you can cover this risk in a month's time for say £140,000, then you have a clear £20k profit.

Similarly, the credit spreads on some banks such as HBOS and Lehmans, were at levels typically associated with Nigeria. In comparative value terms, does that make sense?

Labels: , ,

posted by John Wilson @ 10:32 AM Permanent Link ,

newsvine reddit



"Hear no evil, see no evil, speak no evil" if it relates to Lehmans Tuesday, March 18, 2008

According to CNN, the NewYork Fed has urged Wall Street firms to fend off attacks on Lehman Brothers, which is the next firm in the line of fire from rumours.

It claims that other banks' prime brokerage departments were 'under strict instructions not to do or say anything in the market that could damage Lehman.

Yet is anyone comforted by a "no comment" response?

Of course, the situation is exacerbated by the limited availability of white knights, noted here, of which everyone is aware. Other than the US Govt and possibly Bank of America, where can an institution turn to for a domestic injection of bail-out support? Might the protectionist elements in the USA have to swallow their pride and seek foreign assistance, assuming such support could be marshalled quickly?

Labels: , ,

posted by John Wilson @ 9:46 AM Permanent Link ,

newsvine reddit



The Weekend that Bear Stearns won't forget

The Wall Street Journal has an excellent chronology of events leading up to the Bear Stearns takeover here. The piece highlights the pivotal role played by the US Treasury Secretary, Hank Paulson, in the affair. It's hard to think of anyone better qualified to hold that role and to orchestrate such matters given his former role as CEO of Goldman Sachs. His incredibly insight into Wall Street and the respect he commands amongst his former peers made him a natural leader in this crisis, something not automatically granted to a Treasury Secretary.

There is some discussion in a number of financial blogs and online papers regarding the opportunity for Bear Stearns shareholders not to vote for the deal, but there is universal acknowledgement that no alternates appear to exist plus JP Morgan now has an option on 20% of the stock which could frustrate other buyers. Moreover, it is more politically more palatable for a US bank to be the buyer than, say, a sovereign wealth fund or its' nominee.

There is also much comment regarding the pain to be borne by Bear Stearns staff - not only do they face losing their jobs at a time when hiring elsewhere has effectively dried up, but many will have been historically rewarded with stock and/or options in the bank, whose value has collapsed.

Labels: ,

posted by John Wilson @ 9:16 AM Permanent Link ,

newsvine reddit



MF Global battered by storms. Monday, March 17, 2008

As I suggested last week here, firms like MF Global, where I used to work, were certain to fall under suspicion that they too would be encountering difficulties in the current climate. Today, the firm lost as much as 80 per cent of its value on rumours of financial difficulties. This comes on top of the falls resulting from a loss of $141m attributable to unauthorised trading in February.

At 27 Feb 2008, the shares were trading at $29.24 and today went as low as $3.64.

One of the few large brokers not to be owned by a bank, MF Global intermediates between its' customers and the Exchanges. As a generality, the firm does not take proprietary positions, but does remain exposed to counterparty and liquidity risk in these turbulent times.

As a major player, MF Global's client base will be split between those with long open interest positions and those with short i.e. some clients will be losing money in the market, but others will be profiting. The key challenge is therefore to manage the cash flows between the various parties, as I well recall from my role as Director of Treasury for the firm.

Exchanges can demand intra-day margin calls which have to be settled immediately - failure to so do can result in the firm being suspended from further trading until their balance falls back within headroom or calls have been settled. The consequences of this are so material that an Exchange will always be the first priority in allocating cash, assuming stock collateral isn't readily available. Often stock collateral cannot be moved sufficiently quickly to meet calls or the right "type" is not on hand.

Profiting clients may demand immediate repayment of their funds, especially if they have any concerns about the Broker. Conversely clients losing money may be slower in settling losses, despite intra-day calls being made on them. It is this timing difference between inflows and outflows has to be funded either from internal cash resources or from bank borrowings e.g. MF Global issued a statement it had a committed and used credit line of $1.4bn. In addition, it also denied claims that Joe Lewis, the investor who lost $1.16bn on his stake in Bear Stearns, was a client - the implication of the rumour being his broker would face substantial losses on his account.

Sadly, any doubts about the ability of a broker or its customers to settle margin calls, will normally prompt a "run" on the firm, regardless of the facts, even from segregated customers whose funds are held separately from the bank accounts of the company [albeit segregation in practice in the market has some notable weakness in terms of timing differences i.e. you segregate cash today in respect of the balances as at last night.

MF Global was not alone in being affected. Lehman was down 34% and ICAP 16%. Unfortunately, as it was hit hardest so MF Global has captured all the financial headlines which will exacerbate worries amongst clients. Moreover the wording of company statements that it "is very well capitalised" and has "sufficient funding to conduct our business in normal course" will not allay fears - if you'd noticed, Bear Stearns was well capitalised and these are not normal markets.

Unsurprisingly, other firms are seeking to disassociate themselves from any connection with MF Global eg Penson Worldwide which only adds to the gloom and fear.

Client/counterparty reaction in the coming days will determine the fate of the firm. As is the case for almost every firm, if these groups panic and pull funds in size, then MF Global will collapse - the firm is not in the category of "too big to fail" despite its chunky portion of business on derivatives exchanges, notwithstanding that the Exchanges and regulators would certainly try to organise an orderly transfer of business.

UPDATE: And now a class action is being launched against MF Global on behalf of investors as a result of the unauthorised trading loss, according to CNN.

Labels: , ,

posted by John Wilson @ 5:33 PM Permanent Link ,

newsvine reddit



Be afraid, be very afraid - this baby's gonna blow.

In Hollywood catastrophe movies, it's often only the heroes that are privy to the news that the earth is about to explode or that a new ice age is starting tomorrow.

The banking crisis is headline news and whilst the earth isn't going to explode, economic conditions are rapidly worsening. Banks are refusing to lend to each other, even overnight, at the moment and central banks are becoming pivotal players in the markets, almost acting as central counterparty in an effort to dampen the havoc.

Do most people understand the gravity of the situation - I doubt it and for understandable reasons. After all, to most people the banking system somehow just works and provided you can get a mortgage and use your ATM card, what else is there to know? Sadly, the fear in the banking community is going to hit everyone. Here's some examples of how
Alan Greenspan, who was the revered Chairman of the US Federal Reserve Bank until his recent retirement has today described the current crisis as the worst since the WWII and considerably worse than the Japanese Banking crisis of the 1990s given its' global reach.

The shock-waves from this crisis will reverberate widely and not be contained within the banking sector. Be warned.

Labels: , ,

posted by John Wilson @ 12:07 PM Permanent Link ,

newsvine reddit



Confidence virus widens on Wall Street

With the Bear Stearns deal done at a 93 per cent discount to Friday’s closing price, you can only surmise that Bear Stearns management felt it had no alternate course of action available to it. Whilst the Fed engineered/forced the deal, one either has to conclude that JP Morgan were terrified in taking the deal on unless it was so cheap as to cover as yet undiscovered horrors, or they were being incredibly opportunistic and decided to play hard ball as the only buyer at the table.

Leaving aside the impact this has on perceptions of JP Morgan's own ability to absorb Bear Stearns [confidence virus - does this move make them stronger or weaker?], it will also exacerbate concerns about the balance sheets of other banks. If Bear Stearns had so little of value on its balance sheet, surely similar banks must be facing the same challenges?

Lehman Brothers announces first-quarter results this week, after warning 5% of its' workforce were to be laid off and arranging a three-year unsecured credit line of $2bn from 40 banks last Friday.

Labels: ,

posted by John Wilson @ 9:02 AM Permanent Link ,

newsvine reddit



Twitter - yet to hit the banking/finance world Friday, March 14, 2008

Despite earnest demands that Twitter has broken out of geekdom into the wider world, given the storms surrounding the activities in credit markets this is the amount of attention it grabbed in Twitter since the service launched, reported by Twittervolume i.e. hardly any traffic.



Funny that.

Labels: , ,

posted by John Wilson @ 5:06 PM Permanent Link ,

newsvine reddit



We're bankers, not shopkeepers (unfortunately)

It was a well-worn quote of scorn that Britain was a nation of shopkeepers.

The Wall Street Journal has now corrected the record, “No large country is more dependent on the movement of foreign money through its banks: some $2.4 trillion flowed in and out of the UK in 2006, an amount equivalent to the country’s entire annual economic output”. It goes onto highlight that “the financial sector accounts for more than one-fifth of all UK jobs”. The comparable figure from the US, home to the subprime crisis is just 6%.

So when the UK Chancellor suggests we will avoid a recession despite facing a global banking and credit crisis, I wonder what happy pills he is taking.

Labels: ,

posted by John Wilson @ 4:58 PM Permanent Link ,

newsvine reddit



"Honey, get a doctor. I've got the confidence virus"

Confidence underpins business. Whenever you transact with someone, you demonstrate confidence that they can satisfy their end of the deal e.g. Amazon will deliver the book you ordered online and for which you gave your card details; the butcher is selling you fresh meat.

When confidence is lost, you stop doing business with that person/company and usually share that news with others.

In financial markets, loss of confidence about firms solvency is a primary contributor to the current paralysis - will this firm be able to pay me back or settle any trade I do with them? This is exacerbated by the viral nature of confidence. The demise of Carlyle Capital is now causing worries about the solvency of Bear Stearns, understood to be one of its prime brokers. Amplified by rumours and fears, this knock-on effect [systemic loss of confidence] is unconstrained.

In Bear Stearns case, solvency concerns exist because it is believed they will have seized collateral in the form of mortgage backed securities. Since this have become highly illiquid, so they cannot be easily converted to cash and will sit as idle assets. This is precisely why the Fed moved to offer the asset exchange facility, albeit I doubt they will publish which firms used it and in what size given the potential impact on confidence this may have - the use of such a facility may imply desperation and was the reason the run on Northern Rock began.

Elsewhere the move by the Chicago Mercantile Exchange ["CME"] to raise the margin limits for transacting five- and 10-year Treasury futures and currencies will have risk teams and dealers speculating on who will be hit by this drain on cash. Hence, CME will ask its' members for more margin, who in turn will demand higher margin from their customers. If clients can't meet these calls, they will either have to forcibly close positions and/or sell collateral, hoping that this will cover potential losses. Consequently, brokers like MF Global will be closely scrutinised/monitored in case any of their clients appears to be struggling that may have potential knock-on effects.

At the same time, the "generous" credit lines some hedge funds will have enjoyed will have been slashed by their brokers, reducing their trading capacity and requiring them to adjust portfolios i.e. trade, in smaller increments within the lower headroom they have. Combined with counterparty concerns, this has an effect on the depth of the market and the ability to trade in size [reference to the quantity of shares/units]. Trading in size matters, because if you can't trade in large quantities, then it becomes even harder to sell blocks assets at all or at least without triggering sizeable price falls.

Loss of confidence happens far faster than gains occur, so expect recovery to take a long time.

UPDATE: Just hours after writing this post, Bear Stearns shares collapsed by over 50% and it was forced to arranged emergency funding via JP Morgan with the New York Fed. Alan Schwartz, Bear Stearns CEO said in a statement that the bank’s liquidity had ”significantly deteriorated” in the last 24 hours as counterparties and clients rushed to close positions with the bank and withdraw funds. JP Morgan is provide back-to-back finance as an intermediary between the Fed and Bear Stearns, because technically Bear does not have access to the discount window. JP Morgan, notably, stressed it was just facilitating the deal and providing lending on identical terms to those of the Fed - it wouldn't wish to catch the confidence virus by association! It is hard to see a stand-alone future for Bear Stearns given the market-wide fear of trading with the Bank given its' evident insolvency.

Labels: , , ,

posted by John Wilson @ 9:38 AM Permanent Link ,

newsvine reddit



"We never sell at a loss" policy of accounting

This influence of this blog is astounding. Having only written about mark to market accounting yesterday with this piece, Steven Bensinger, AIG’s chief financial officer, has stepped into the limelight with AIG being the first company publicly to air a proposal to move away from “fair value” accounting [mark to market].

Joking aside, under AIG’s proposal, which has been presented to regulators and policymakers, companies and their auditors would estimate the maximum losses they were likely to incur over time and only recognise these in their profits. All other unrealised losses would be recorded on the balance sheet but would not affect profits. In AIG’s case, this method would have reduced the impact of the $11bn writedown on fourth-quarter results to $900m.

Besinger is reported to have said AIG’s proposed change could bolster financial institutions’ confidence and help thaw the current freeze in credit markets.

So the plan is to write down the assets on the balance sheet but tuck the away the adjustment in a balance sheet "revaluation reserve", out of the spotlight. Suddenly the apparent "health" of companies would be transformed and confidence restored to markets.

As I described here the mark to market policy forces companies to recognise losses even when they have no intention of selling assets at the current prices. However, decisions can change just as easily as prices, hence at the balance sheet date there may be no intention to sell but, a month later, a new decision may be reached. Hence the scope for manipulation increases.

Imagine the following scenario:
Of course, one might suggest that such profits should also only go through the balance sheet. Or perhaps previous years results should be re-stated on the basis people care less about old accounts than current triumphs.

Certainly, many private investors take the view that you don't lose money until you sell because your cash balance isn't affected until then and thereby end up kidding themselves that they are no worse off when prices fall. Yet is staggering for the CFO of a major financial institution to believe that sophisticated investors will not re-introduce such accounting adjustments when evaluating the company [I concede that some accounting stunts do appear to fool investors]. However, it wouldn't be the first time that policy makers adopt an idea allowing an artificial and brighter view of reality to be presented.

I think there is a simpler test to apply. Looked at from the viewpoint of AIG insurance [general or life] customers, would they prefer to know that the assets that were covering their policies and which might have to be sold to pay out claims, had dramatically fallen in value and as such may impair AIG's ability to payout?

Labels: ,

posted by John Wilson @ 8:35 AM Permanent Link ,

newsvine reddit



Bliss for those who can ignore mark to market Thursday, March 13, 2008

Warren Buffett recently warned his investors that, under mark-to-market rules, the funds he runs may encounter volatile earnings on trades that ultimately are safe, since they intend to hold the investments until maturity rather than trade them.

Presently, anyone capable of making long term investments and ignoring current price volatility can find some attractive opportunities. For instance, the imploding Carlyle Capital's portfolio consisted exclusively of $21.7 billion of triple-AAA mortgage backed securities issued by Fannie Mae and Freddie Mac. They are considered to have the implied guarantee of the U.S. government and pay par at maturity. However, because Carlyle Capital finds itself unable to meet margin calls from lenders, the fund is being liquidated and assets sold, with these assets likely to realise much less than par.

Few banks or funds want to buy these assets in the current market as they can't be easily recycled as collateral, except at punitive haircut rates. Hence prices have slumped and concerns about price volatility is discouraging any buying by those who have to report short-term earnings that include mark-to-market adjustments.

Mark-to-market has the key advantage of not allowing firms to hide worthless assets using historic costs, as was the case in the 1990s, and illustrates the approximately realisable value of the investments.

However, provided you believe that these assets will redeem at par, which is likely thanks to an implicit US Federal Guarantee, then buying these assets at a material discount to par locks in a profit, albeit the cashflow is some years hence. Should you need to realise the cash early, you may take a hit, and likewise you may miss out on other more profitable opportunities by trading short term volatility by putting your cash into a "sit and wait" asset.

Setting aside Keynes' famous morbid but accurate comment that in the long run we're all dead, these are opportune times for anyone presently sitting on cash who can afford to take a long term position.

Labels: ,

posted by John Wilson @ 8:57 AM Permanent Link ,

newsvine reddit



Locking the Mutual Funds door because of uncertainty Wednesday, March 12, 2008

Back in June, before the credit crunch took hold, I was talking with CIO of one of London's leading Fund of Hedge Fund firms about the issues I saw with hedge fund investors only being able to trade back with the manager. Specifically when you only have one counterparty with whom to trade, that counterparty can control the price, the terms of trade or simply refuse to trade. He dismissed these as theoretical problems, pointing out they had no problems redeeming funds whenever they choose.

Obviously 6 months on and the experience of many investors is very different. Many bond and property funds have suspended redemptions leaving investors unable to sell and exit their investment. Such suspensions have often been attributable to the inability of the fund to quickly realise sufficient cash to meet withdrawal requests either because they cannot find buyers or the price at which they would be forced to sell would be materially damaging to remaining investors in the funds.

However, another scenario exists which is cited by ING in suspending redemptions in two funds yesterday was that they couldn't price the fund in the absence of reliable market prices i.e. when no one is trading, there is no reference price for you to value fund holdings and thereby arrive at a "share/unit" price for the fund. Whilst a "guess" could be made of holding value, a price that was subsequently shown to be materially wrong would either affect the sellers or remaining investors and potentially open the managers to litigation.

A simple example to illustrate this:
In this example, the fund had the cash to pay the redemption and so it was not a fund liquidity issue that presented a problem, but a fair valuation issue - had both investors wanted to redeem then the fund would have faced a liquidity problem.

Leaving aside current market conditions, a similar situation could have historically arisen when a large fund investor wished to redeem. The prices achieved when quickly liquidating a large portfolio of assets to fund such a redemption are likely to be lower than trading small quantities - termed market impact, it is a reflection of few things including supply v demand conditions; the knowledge that there is a large "forced" seller; and the concern that the seller is exiting in a hurry because of something they "know". Consequently, a manager could impose a large redemption penalty [price = assumed fund value less a discount of say 25% to allow for market impact]. However, there may be such uncertainty about the prices that will be achieved that even a 25% discount may be insufficient and so it is considered safer to refuse to redeem. Alternatively, a manager could insist that the redemption be staged over an extended period to allow for an orderly wind down of a fund.

Labels: ,

posted by John Wilson @ 10:08 AM Permanent Link ,

newsvine reddit



US Fed tries to fill the liquidity pool and avoid a drought

Yesterday's pronouncements by a global consortium of central banks demonstrated how serious the current liquidity drought is.

The US Fed has further relaxed it's market intervention policies and to offered to accept triple-A rated private label mortgage backed securities (MBS) as collateral in exchange for lending primary dealers up to $200bn in Treasury securities for 28 days at a time.

The following example should helps explain how this helps
It is the recycling of funds that keeps the financial system working and on which the economy depends. Hence, the Fed's effort to oil the recycling system.

Notably, this move doesn't transfer ownership of the credit risk of MBS, which an outright purchase of the MBS by the Fed would do. This remains with the hedge fund in the example above. As I discussed here, falls in the price of MBS assets related to a loss of confidence that the MBS issuer can repay its' loans or make repayments as a result of losses of the underlying mortgages will hit the hedge fund and begin a vicious spiral. It is for this reason that commentators are wondering whether the Fed might ultimately need to actually begin buying the MBS, at which point the Fed [read US Govt] would bear the credit risk and shift lending from the private to public sector.

Labels: ,

posted by John Wilson @ 9:17 AM Permanent Link ,

newsvine reddit



Liquidity pool for Auction Rate Securities is running dry Tuesday, March 11, 2008

For many years, Auction Rate Securities ("ARS") have been a competitor of money funds by virtue of their apparent liquidity and higher rates. ARS are municipal bonds, corporate bonds, and preferred stocks whose rates, or dividend yields, reset through "Dutch auctions, which typically happen every 7, 28, or 30 days.

Investors enter a blind competitive bid process via a broker to set the rate on the securities, with the lowest rate to clear the market applying for the next period. Investors can elect to
- hold existing positions regardless of the rate determined
- sell them regardless of the rate
- re-bid on existing holdings, which will be automatically sold if they bid too high
- buy holdings via the auction

However, you can only liquidate your existing holdings if there are buyers in the auctions. When they aren't, as is currently the case, then you are forced to hold the assets. Of course, if you don't need the cash, the good news is that when the market fails to clear and determine a rate, the issuer of the ARS is normally required to pay a punitive rate specified at issue [this may be an absolute rate of say 20% or a reference rate e.g. LIBOR + 800bp]. Naturally not good news for the issuer though who can find itself hit with a huge hike in interest costs. To illustrate The Port Authority of New York and New Jersey, ended up paying 20% rather than 4% on their loan – costing them an extra $300,000 a week.

Depending upon their view of conditions and the terms of issue, issuer could redeem the bonds and re-finance them, but it's not obvious where such financing will come from in some cases. Bloomberg reports that New York plans to sell $448 million to refinance debt, including auction-rate securities. The Port Authority of New York and New Jersey is refinancing $700 million of auction-rate debt after interest costs jumped as high as 20 percent. The California Statewide Communities Development Authority may offer as much as $10 billion of notes.

Banks with stretched balance sheets are unwilling to act as buyer of last resort in these auctions, nor are they legally obligated to make a market in ARS.

From recollection, US money market funds cannot own the bonds. Thus, the biggest investors in auction-rate securities are individuals and corporations, some of whom are now insisting they were mis-sold the investment as "cash equivalents" by brokers - queue more litigation.

One group hard hit are VC-backed companies, which invested the cash they got from VCs in these securities, pending use. For me, this demonstrates dumbness on the part of the VCs affected as they evidently took little interest in how cash was being used - "the good news is the cash burn rate is low, but did we mention the mattress we used is burning?". Is it wise to leave cash investment to inexperienced firms? The result is that these early stage companies now find themselves strapped for cash.

SEC's Division of Corporation Finance has had to remind US corporations who made considerable use of these instruments to properly classify them. "Auction rate securities are not cash or cash equivalents -- they are investments," emphasising that impairments of the securities should make auditors give them a second look.

Labels: , ,

posted by John Wilson @ 4:40 PM Permanent Link ,

newsvine reddit



Haricuts - new fashion amongst banks

Continuing my recent theme on banks demanding extra margin, these news clips from Bloomberg illustrate the double whammy being felt by hedge funds

Margin Calls/Haircuts

- On Feb. 24, London-based Peloton Partners LLP gave up a ``night and day'' effort to stave off demands from banks, including Goldman Sachs Group Inc. and UBS AG, for as much as 25 percent collateral for securities that once required 10 percent, according to investors in the fund. Peloton, run by former Goldman partners Ron Beller and Geoff Grant, liquidated the $1.8 billion ABS Fund, its largest.

- Banks usually limit their risk on repos by lending less than the value of the securities used as collateral. Tequesta was able to borrow $95 on $100 worth of AAA rated jumbo prime mortgages in early 2007, meaning the bank took a $5, or 5 percent so-called haircut. By last month, the amount required had risen to as much as 30 percent

- For AAA rated residential mortgage backed securities, banks have raised haircuts 10-fold in the past year to 20 percent, according to estimates from Citigroup credit analyst Hans Peter Lorenzen in London.

- On AAA asset-backed securities, banks are demanding a 15 percent haircut, up from 3 percent last summer. Corporate bond haircuts have gone to 10 percent from 5 percent, bankers said.

- At least one bank has raised Treasury haircuts, which range from 0.25 percent to 3 percent, depending on the length of the loan and the creditworthiness of the borrower, said bankers, who declined to be identified. They said they wouldn't be surprised if the practice becomes more widespread, not because they expect the U.S. government to default, but rather because there have been bigger price swings in the Treasury market, which affects value.

- Christopher Cruden, CEO of Insch Capital Management said. "Prime brokers are there to do business, not be your friend."

As Gordon Gekko said in the film Wall Street "If you want a friend, get a dog".

As shown above, collateral haircuts vary by asset type which is reflective of several factors including price volatility, asset liquidity and potential of asset default. So to illustrate the double whammy, if you have borrowed $95 dollars to buy a bond for $100, [extra being $5 of fund money] the deemed collateral haircut is 5%. If the bond falls in value to $95, you would either have to repay part of the loan or add/substitute collateral.

However, because of the sharp falls in value of the bond which have also hit the fund valuation, the banks now increases the collateral haircut on such bonds to 15%. If similar bonds were used, it would now require bonds valued at $112 to cover a $95 loan. Alternatively the fund could reduce it's borrowings to $81 by repaying part of the loan. In either case, it has to fund the difference from its' own resources but such funds rarely have idle balances on which to draw. So the banks sell the collateral and thus prompt the fund's demise.

Layman explanation
You buy a house for $100k, with a 95% mortgage. When the house falls in value the bank asks you to either repay some of the mortgage or provide it with more security e.g. parental guarantee. When you can do neither, despite you being up to date with interest, they decide to avoid possible future losses and demand immediate repayment. With the deterioration in the housing market you find yourself unable to remortgage on the same terms and so are forced to sell your home.

Labels: ,

posted by John Wilson @ 11:46 AM Permanent Link ,

newsvine reddit