C.M.O. 4.30.2009

Credit Market Overview
April 30, 2009

On Monday the headlines were all about the spread of the deadly Swine Flu. The S&P dropped 8.72 points, just a tad over 1% as fear of the unknown health hazard gripped the world’s population. One already weary of battling the financial pandemic brought on by the distribution of mis-rated securities.

The fear continued on Tuesday as more was learned of the disease and its reach. Those countries that are home to the emerging economies of the world seemed most at risk. Unwelcomed news both for the people in those regions and for the fact that many were looking to the emerging markets to pull this spec of dust out of its financial malaise. You got the feeling that the world was bracing for some bad news that was going to get worse and possibly much worse, before it was going to get better. (Again? Many were asking) The S&P was down another 2.35 points by the close, 0.27%, but had spent part of the day as low as 847.12 an additional 10.39 points or 1.22%.

As all of this was going on U.S. economic figures being released were showing some optimistic signs. Dallas manufacturing activity was better than the down 44.2% survey by 12.6 percentage points or 28% less than expected. The Case/Schiller index came out higher than forecast, albeit by .37 index points, but higher none the less. Consumer Confidence beat its surveyed numbers by a whopping 9.5 points, close to 32%. Were signs of economic life emerging even as real lives were being threatened? Given Tuesday’s action the market seemed to put more worried about the flu.

With the world’s anxiety levels high, one would have thought a 1Q09 GDP report 1.4% lower than forecast, a miss of nearly 30% off expectations would have been the nail in the proverbial coffin. Instead the reasoning that inventories were down to such spare levels that the wheels of industry were going to be forced to turn at some point in the future was the point of focus. Even as the number of countries affected by H1N1 grew.

It struck me in all of this that there was a separation growing how investors were reacting to the threat of the H1N1 on the world economy vs. the how the U.S. economy was fairing given the economic releases of the week.

The CDS for Mexico closed last Friday at 291 bps as the Bolsa closed at 22582.17 the highest level seen since January 6th of this year. Default protection for Mexico hit its high for this week (so far) on the 28th when it closed at 328 bps. The stock index hit its low on the same day at 21662.53; down 919.64 points or ~4% from the previous Friday. Yesterday’s CDS close for Mexico was 297.84bps; off Tuesday’s high but still above last Friday’s level. The stock market in Mexico recovered some as well yesterday with the Bolsa closing at 22079.34.

Uncle Sam’s CDS level closed at 45bps last Thursday and stayed at that level through Monday’s close. Tuesday saw a slight tick up to the 45.71bps level but yesterday’s move down to 42bps put the risk of a U.S. default lower than it was perceived to be during the stock market rally last week. The 42bp level was in fact lower, by 0.18bps, than the previous low for the move down in CDS levels that started after the 100bps level was reached on February 24th of this year. The last time anything south of 42bps was seen was 11/20/2008 when the cost of protection closed at 38.5bps. The high close for the move in the SPX was 869.60 on the 17th. Last night’s close eclipsed that level and if classic theory holds, lower CDS levels could point to higher index levels going forward.

Enjoy the week.

Jim Delaney

C.M.O. 4.29.2009

Credit Market Overview
April 29, 2009

At this point in the economic cycle we are all pretty familiar with what a “Junk” bond is. Some have learned this lesson by watching what they thought was not junk turn into junk. Others have hopefully learned the information without having to experience the pain. Learning is the key here as the constantly changing dynamics of the market place give us opportunities to, as the saying goes: “learn something new everyday.”

For those watching the box scores the CDX Hi-Yield CDS index closed yesterday at 1223.6 in New York. This is the lowest level seen in that index since December 24th of 2008 and 701bps or 36.4% lower than the recent high of 1924.6 on March 9th of this year.

Back to junk and learning . . . so, junk bonds have been in the popular lexicon for at least a generation and in existence for much longer than that. Using the term junk, up to this point at least, was so ingrained in our market psyche that the word bond did not have to follow it. Just like Cola doesn’t have to follow Coke and copy doesn’t have to follow Xerox for you to get your point across.

The use of the word Coke is probably even more powerful as it immediately brings to mind a brown, carbonated beverage that can take the paint off of cars regardless of whether the label says Coca-Cola, Pepsi or Royal Crown.

It now seems, however, that the “junk” tree has grown another branch as the term is being used for stocks trading below $5.00 that once traded well above that more modest level. If you don’t believe me check out Monday’s WSJ.

In setting up the universe of stocks to monitor for the CEC Portfolio the original criteria were simple; an actively traded CDS market in the name and a stock price over $10. There were originally about 375 names that made it over the bar. That number rose to about 425 at the height of the market. I have kept any name that continues to have an actively traded CDS market regardless of price as these are probably the names I will be trading actively again if/once things turn around.

After reading the article I thought it would be interesting to see how many of the CEC names had fallen into the new category of “junk stocks”. As of this morning there are 101 names in the CEC Universe (names the CEC Strategy could possibly position.) that were trading under $10 and 63 trading at less than $5.

This second category includes such august names as FRE, FNM, AIG, GM, F, HOV and many others. Also in this category are names that, although not defunct, are trading below the $2.00 level. (Should probably clean those out but, hey, you gotta have hope!)

Let’s look at a couple of familiar names and see what the CDS/equity relationship is saying.

SLM – Recent high in the stock was $11.74 on 1/13/2009, low in the CDS occurred on 1/7/2009 at 659bps. The stock started to crater after Feb 2nd falling from $11.67 to $3.19 by March 6th. The CDS went ballistic during this time period rising from 701bps on 2/9/2009 to 2966bps on 3/9. Since the 9th the CDS has narrowed more than the stock has risen closing last night at 1532bps and $4.63. Uncertainty regarding how SLM will fit into a nationalized student loan program could well be hampering the stock while recent improvements in the credit markets have allayed fears of SLM going belly up, for now.

RRI – The CDS/equity combo here has made a few distinct moves since the beginning of the year with the CDS range bound in the 1000bps – 1100bps range until 2/20/2009 after which it soared to 1624pbs on 3/5 only to come back down to it’s recent range around 800bps. The stock moved first, back on 2/9, falling from $5.78 on that day to $2.23 on 3/9. It has since moved up to $5.03 before settling at $4.41 yesterday.

DDR – An interesting name given all the commercial real estate news flying around has seen 4 tradeable moves since November 4th of last year when the stock closed at $13.15. The CDS bottomed just two days later at 1248bps on 11/6. From these levels the stock went as low as $2.58 on 11/21/2008 and the CDS peaked on 11/28/2008 at 2861bps. After that the stock rose to $7.39 on Jan 8th of this year just after the CDS bottomed at 1961bps on 1/7. It was off to the races for the CDS after that putting in a double top at 2966bps on 2/23 and 3/12 of this year while the stock sank to $1.34 on March 9th. The CDS has come down to 1848bps as of last night and the stock has done a “three-bagger” closing at $3.69 last night.

Not everyone is comfortable trading stocks in the low single digits but it is comforting to know that the same CDS/equity relationship that works in Blue Chipville works equally as well on the other side of the tracks.

Enjoy the week.

Jim Delaney

C.M.O. 4.28.2009

Credit Market Overview
April 28, 2009

As markets turn it is usually worth while to pay attention to the subtle signals that come along with the obvious ones. I’m not sure which category this fits into but I thought it was interesting that on a day where both Nouriel Roubini was speaking and the Milken Institute was holding its annual confab the latter was all over the media and if the former got a sound bite I didn’t see it.

Back when Drexel was getting drummed out of town and Boesky was looking for bail money it was said that one of the criteria for getting invited to a cocktail party in Manhattan was; “If you’re indicted, you’re invited”. Those days are long gone and people have all paid for their market sins but Mr. Milken still has the ability to pull an astounding group of people together as can be seen from the list of speakers he put together for this year’s event.

Not all of the conference was televised but I was able to see the segment on commercial real estate with David Simon CEO of Simon Property Group, Fritz van Paasschen, CEO of Starwood and the man himself, Sam Zell, Chairman and President of Equity Group Investments and the Tribune Company.

Sam didn’t have a lot of positive things to say about the commercial real estate market, or many other things, and much of the negative was the result of the lack of lending going on. Mr. Zell is not alone in his analysis as Dan Fasulo, MD at Real Capital has just authored the Global Capital Trends Report and a good portion of what he has to say is also focused on the commercial property market.

To start Dan reports that “The commercial-sales market as we once knew it is basically nonexistent”. With the bid/ask spread”as wide as it has has been since the early 90’s”. To back these claims up he cites worldwide sales volume of $47BN in 1Q09 which came in at just 1/6th of the level for the same period two years ago. The U.S. portion of that was $9BN; to which Mr. Fasulo adds could have been the amount paid for a single building in the not too distant past.

One of the reasons dollar volumes might not be going up is that the prices paid in the 1st quarter ranged from imperceptible gains to declines in the 40%-50% range. On top of this defaulted commercial mortgages and failed property companies totaled over $55BN in the first quarter, which when added to the properties already in that category brings the total to $153BN. DF doesn’t see things improving all that much as that best he can say is that “we’ve seen a trickle of things picking up just over the past few weeks.” To get that “tickle” Dan has had to keep his eye on cities like London and Paris.

With that said how are the likes of Simon, Paasschen and Zell doing with regard to where their stocks are trading? A year ago at this time the CDS/equity combo for SPG was 105bps/$101.57. The CDS peaked at 910bps on 12/15/2008 but the stock did not hit its nadir until 3/6/2009 at $26.19. Last night’s close was 467bps and $45.74 respectively.

HOT – 150bps/$52.61 a year ago. The CDS/equity combo for HOT looks like what I think the technicians call a double top/bottom depending on whether you’re looking at the CDS or the equity. The stock bottomed initially at $11.44 on 11/20/2008 and the CDS peaked a week or so later at 815bps. The second time around the stock also beat the CDS to the punch but the difference, time-wise, was just a day: $9.52 on 3/6/2009 and 844bps on 3/9/2009 (weekend in between). Last night’s close 515bps and $18.55.

Sam Zell doesn’t own BXP anymore but his sale of 573 properties to Blackstone for $39BN in 2007 will probably stand for a long time as the deal that top ticked the real estate market. The year-ago numbers for BXP are 123bps and $102.90. The low in the CDS came shortly after that on 5/2/2008 at 84bps but the stock had already hit its $105.04 high the day before.

Subsequently the CDS and stock moved sideways for the most part until early September of 2008 when the CDS jumped from 165bps on 9/11/2008 to 820bps on 11/20/2008. The stock has meandered down a touch more slowly but unlike the CDS continued to fall from its $103.15 close on 9/12/2008 until it bottomed recently at $31.49 on March 5th of this year. The combo closed last night at 505bps/$74.02.

And no, Zell still isn’t wearing a tie.

Enjoy the week.

Jim Delaney

C.M.O. 4.27.2009

Credit Market Overview
April 27, 2009

Missouri, or "Mi-zur-y", as it is pronounced by the residents there is also unofficially known as the “show me” state. The origin of this sobriquet is not certain but it is often attributed to U.S. Congressman Willard Duncan Vandiver, who served in the United States House of Representatives from 1897 to 1903. While a member of the U.S. House Committee on Naval Affairs, Vandiver attended an 1899 naval banquet in Philadelphia. In a speech there, he declared, "I come from a state that raises corn and cotton and cockleburs and Democrats, and frothy eloquence neither convinces nor satisfies me. I am from Missouri. You have got to show me."

Were the entire country to adopt Vandiver’s slogan the reaction to the housing numbers late last week might have been different. On Thursday, MoM Existing Home Sales were expected to come in at -1.5% but were actually down -3.0%. On Friday MoM New Home Sales were expected to be flat but were reported down -0.6%.

The XHB (SPDR S&P Homebuilders ETF)) sold off initially on Thursday’s number but closed close in the upper half of its range for the day and was followed on Friday by a solid upside move closing the week at $13.79 a level not seen since the $14.04 close on October 31st of last year. Evidently the market showed those from "Mi-zur-y" and the other 49 states that was and what is expected to be are two quite different things.

The National Association of Realtors (NAR) said that first-time home buyers accounted for half of the existing home sales numbers. This could, to some extent, be the result of the combination of progress being made by the Government in lowering mortgage rates and the first-time home buyers tax credit which is $8,000 nationally as a result of the stimulus bill and an additional $10,000 in California, one of the states hardest hit by the over-building that occurred during the credit boom that came before the credit bust.

A 30-year fixed rate mortgage averaged 4.80% last week; down just 0.02% from the previous week but down 1.23% from the 6.03% seen a year ago. Additionally, “Interest rates for one-year ARM’s exceeded those for 30-year fixed rate mortgages over the last two weeks; this is the first time this has happened since FRE began collecting data for ARMs in January of 1984” Frank Nothaft, FRE’s chief economist said.

MKM’s chief economist sees the effect of lower rates on conventional mortgages filtering through to “jumbo” mortgages as well as rates on the loans over $417,000 and in some areas over $729,000 are down to 6.3% from 7.7%. The difference between conventional and jumbo mortgages used to be 0.25% so while things are not back to where they used to be they are better than they were.

Adam York, not chief, but an economist none the less with Wachovia was a bit more measured in his assessment of last week’s numbers saying, “If buyers are tentatively walking back into the market-place, it’s certainly a positive sign; but the market remains under severe stress.” In describing the statistics Mr. York thought they weren’t “necessarily more bad news, but it certainly wasn’t better news either.”

The CEC Strategy is long DHI, HD, KBH and LOW in the homebuilder sector. Long positions are a result of narrowing CDS spreads and rising stock prices and that combination has to be evident to initiate positions. There are a total of 21 names in this area of the CEC’s universe. It will take continued negatively correlated movement between these two markets for the long exposure in this area to increase as in the CEC Strategy, like those from Missouri, it wants to be shown.

Enjoy the week.

Jim Delaney

C.M.O. 4.24.2009

Credit Market Overview
April 24, 2009

In writing this piece every day I always try to envision it from the reader’s perspective. This includes never saying things like: “Back on such and such a date we highlighted the problems with XYZ and today they went bankrupt”. Additionally, when necessary I have no qualms about taking myself to task about information that, although always well intended, I might have misinterpreted or a statistic I might have gotten wrong, even going so far as accepting grammatical help from a British friend and reader. After all, we are all just human.

With that in mind, I wrote yesterday about the widening CDS spreads and declining stock price in COF since their earnings announcement and the negative outlook proffered by their CEO when he said: “U.S. credit card charge-off rates are going cross 10% in the next couple of months, up from 8.4% in Q1.” Since I don’t give recommendations or opinions here I’m not going to climb into the stockade but I do think the COF situation requires a little more space this morning.

It would seem that in the face of what the company itself describes as “higher charge offs” in the months to come the management at COF decided to institute a $0.05 quarterly dividend yesterday. With the stock closing at $16.93 that works out to a yield of about 1.18% In the same breath it also announced that it would cut 58 employees from its credit card division. This is the same bank that sold $3.55BN worth of preferred stock and warrants which amounted to 26% of its market cap at the time to Uncle Sugar under the TARP.

I am as “free markets” oriented as the next person but something here just doesn’t seem to jive. The world is waiting on pins and needles for the Treasury’s Stress Test results; every pundit in the world is expecting unemployment in this country to cross over into double digit land and the Government has just spent the $1.197BN between the stimulus and the Omni-pork bill to stem the flood tide of out of work workers. COF itself said it expects worsening business conditions.

Even with the comment yesterday by KBW that “COF can avoid a capital raise even in an adverse scenario”, does it make sense to institute a dividend and layoff people on the same day? Evidently it does to the market place as the stock rose $2.55 or 15% yesterday while the CDS came in 13bps or 3.75%.

Isn’t this the kind of stuff that should get the boys and girls in D.C. blustering about wasting hard earned tax payer money meant to save the banks not profit the shareholders? Has COF used all of the commotion surrounding BAC’s acquisition of MER to slip by the bouncer unnoticed? Where is Barney Frank when you need him most?

Enjoy the week.

Jim Delaney

C.M.O. 4.23.2009

Credit Market Overview
April 23, 2009

As the mix of sometimes . . . alright constant contradictory evidence of a recovery vs. a continuation of the d . . de . . depre . . alright recession streams through much weight has been put on the shoulders of the stock market as a modern day equivalent of the Oracle at Delphi.

This being the heart of earnings season there has been, it seems, more emphasis on what management is saying with regard to future business prospects as opposed to current results. As Charles Revson, the race car driving founder of Revlon said: “In the factory we make cosmetics; in the store we sell hope.”

Capital One Financial (COF) released earnings on the 17th of $-0.39/share vs. a consensus estimate of $-0.08/share. With the release the CEO said: “U.S. credit card charge-off rates are going cross 10% in the next couple of months, up from 8.4% in Q1.” On 4/16/2009 the CDS for COF closed at 295bps with the stock at $17.86. Yesterday those numbers were 361bps and $14.38 respectively. It should also be noted that COF started dropping before the CDS began rising closing at $19.21 on April 13th. With the financial sector as battered as it is the last thing anyone wants to hear is that there will be more problems in the future. The stock was downgraded from Buy to Neutral by Goldman Sachs shortly there after.

United Technologies Corp. (UTX) reported earning in-line with expectations of $0.78/share while revenues fell 12.2% on a YoY basis. The difference here is that the CEO, Louis Chenevert, accompanied the earnings announcement with his outlook saying that “While orders are still down, the overall rate of decline in orders is slowing”. Adding that “they have stabilized across the businesses. Mr. Chenevert’s outlook going forward was that’ “For the full year, we still expect a better back half.” UTX stock had been rising since it hit its lows of $37.56 on March 9th of this year, closing yesterday at $46.89. The CDS did not peak until April 1st at 117bps closing yesterday at 90bps.

Heavy equipment manufacturer CAT reported its first quarterly loss in 17 years on the 21st of $112MM saying it was hurt by plunging sales and the cost of thousands of layoffs adding that the Obama administration “should have allocated more money for public works under its stimulus plan.” CEO, Jim Owens also cut CAT’s full-year sales and profit forecasts as continued uncertainty makes it “extremely difficult to know how our customers will respond.”

It appears, however, that Mr. Owens is much more pessimistic than the market place about CAT’s prospects as the stock bottomed at $22.17 on March 2nd just a few days before the CDS peaked at 427pbs on March 5th. Since then, in classic CDS/equity fashion, the stock has moved higher and the CDS lower closing yesterday at $32.45 and 248bps respectively. While “shovel ready” looks like it means we’re ready to check that there is a shovel here in the U.S. news of China’s stimulus projects, mainly focused on infrastructure, could be a reason for the market’s optimism on CAT.

Given what the world has been through it does not appear that the market is focusing on what was as much as it is looking towards what will be. Guidance from management seems to be the words everyone is hanging on as the results hit the tape. The movement in COF and UTX stand as testament. The good news is that there are cases where management is not that optimistic but the market still seems to think there is life after the first quarter.

Enjoy the week.

Jim Delaney

C.M.O. 4.22.2009

Credit Market Overview
April 22, 2009

Throughout the various stages of the global implosion in credit, liquidity and confidence there have been certain periods where the markets were said to have “decoupled”. In some instances that referred to the different markets within the U.S. e.g. stocks from bonds and at other times the U.S. markets as a whole from those in the U.K. and Europe. The latter by which, it was hoped early on, would get through the crisis unscathed while the demon credit mongers of the U.S. boiled in their own stew of suppurating securitized slop with rapidly rotting ratings.

Fast forward to the markets of the previous three days. On Friday the S&P closed at a six week high having risen every week in between. A streak to say the least! The much watched VIX closed at 33.94, a level not seen since before LEH went the way of the Dodo last September. Oil was up on the day and still within its $52-$56/bbl range basis the June contract on hopes of continued economic expansion. The Dollar had gained back most of what it lost against the Euro in late March and the Euro/Yen, a way to measure speculative tolerance in the other safe haven currency (JPY) without clouding the picture by including the Greenback, was falling confirming the move in the USD and that risk was once again righteous!

CDS spreads had joined the party too coming in from 1429bps and 201bps on the Hi Yield and Investment Grade CDX indexes respectively on April 1st to close Friday at 1247bps and 177bps keeping the same order moves of -12.7% and -11.9%.

On the other side of the pond the FTSE closed on its highs for the week just a hair’s breath from its most recent high close on April 2nd while the DAX beat its previous high set on February 9th by 10 index points to close at 4676.84.

The weather on Saturday seemed to cooperate as well with many New Yorkers sporting shorts and flip flops for the first time this year.

Enter Monday. CDS spreads shot up 42bps on the Hi Yield side and 9bps in Investment Grade land, the S&P dropped 37.21 points down 4.2% on the day. The Dollar lost close to 1¼ big figures vs. the EUR and EUR/JPY dropped over two points and more than 2%. Oil, having settled above $52/bbl basis the June futures on Friday lost $3.96/bbl or ~7.5%. The DAX lost 190 points or over 4% of its value and the FTSE re-crossed the 4000 level from over to under losing just about 102 points and just about 2.5%.

And the weather??? Walking around NY on Monday was like riding through a car wash with the windows open only the water was cold!

Yesterday was “recoil” day. Stocks here and abroad along with oil were up as was EUR/JPY. The VIX relaxed a bit falling below the 40 level inked into investors’ minds as the Maginot Line between good and evil. And yes, the rain stopped and the streets were just about dry for the evening commute.

The trick here is that credit spreads did not fall yesterday. They continued their rise from Monday. The Hi Yield number is now back over 1300 and the Investment Grade index added 2.3 points and 1.2% to close at 189.1.

Of all the changes described above that the CDS market’s move was in such tight synchronicity with the other, more reactionary markets, for two consecutive days is something rarely seen. That it did not participate in yesterday’s recovery is reason for pause. Given that the lead lag time between the CDS and equity markets can vary 20 days on either side of “coincident” means that it is something to be watched but not necessarily worried over, at least not yet.

Enjoy the week.

Jim Delaney

C.M.O. 4.21.2009

Credit Market Overview
April 21, 2009

Last week seemed like a good week to be a bank; GS painted a picture that, if you looked hard enough, contained small rays of sunshine. The view, it seemed, was so rare GS was able to hock it immediately for $5BN in stock which they are using to lead the parade to repay Uncle Sam, or Uncle Sugar as he is more frequently referred to these days given his propensity for largess, the $10BN in TARP funds “forced” on the bank last year.

JPM took advantage of its good earnings news as well but did so in a more daring fashion issuing $3BN in 10-year senior notes not backed by the FDIC. In a little bit of one-up-man-ship with GS, JPM was able to attract buyers at a mere 350bps above the UST 2¾ of 2019 for a total yield of 6.32% to the investor. This was the second non-FDIC backed bond issued by JPM, the first was a Euro 2BN ($2.64BN) deal on March 25th of this year.

The quote on the 10-year maturity CDS contact for JPM was trading at ~140bps at the time of the issue showing that there is still a premium that needs to be paid to get investors to part with real cash.

GS was the first to issue debt without the having the FDIC as a co-signer in a $2BN deal for 10-year paper back in January. That deal came with a 7.50% coupon and a spread above the Treasury curve of 500bps. The 10-year CDS was quoted around 235bps at the time.

JPM has now issued over $5BN giving them the top spot in this category. “J.P. Morgan is in the position to do this; they’ve been stronger than the bigger money-center banks.” Michael Kastner, head of fixed income at Stamos Capital Management said recently.

Jamie Dimon used the bank’s recent good fortune to send his own shot across the bow of that behemoth that shrinks even supertankers known as the U.S. Congress saying that “inadequate regulation of Fannie Mae and Freddie Mac was perhaps the largest regulatory failure of all time.”

Of note here is that while JPM has issued a little over $5BN of non-FDIC backed paper the bank has also issued $40BN in notes with Shelia Bair’s blessing and JPM is not alone. A total of $340BN has been sold since the FDIC started guaranteeing such notes six months ago. BAC has been the other big issuer with a total of $44BN in Bair bonds. The program is officially known as the FDIC Temporary Liquidity Guarantee Program or TLGP if you want to save the keystrokes.

Issuing debt at tighter spreads saves the sellers approximately 200bps which, given all that has been issued, is equivalent to $7BN in debt service that won’t have to be paid by the participating banks.

There have been questions raised as to how TLGP and TARP are related as the second is known to carry onerous oversight conditions and limits on nasty things like bonuses in the tens of millions of dollars range. GS has been the poster child in defining the separation as the $2BN in non-FDIC backed paper they have sold is just a fraction the $29BN of the debt they doled out under the program. David Vinar, GS’s CFO said “As far as we know, they aren’t tied together. There are participants in the TLGP that do not have TARP capital today, and we think that Congress has made it pretty clear that they are interested really in the equity investments in the firms that received TARP capital.”

After the beating the banks took yesterday it would seem that Wall St. is still the kind of place where you have to get while the getting is good.

Enjoy the week.

Jim Delaney

C.M.O. 4.20.2009

Credit Market Overview
April 20, 2009

With the stock market up for it’s sixth consecutive week the analysts will be all over the stats and comparisons on rates of change, Fibonacci numbers and whether the charts of the indexes look more like the 30’s or the 70’s. I am not sure about any of that but it does seem that when everybody is looking at one thing it pays to look at something else and that something else at the moment has a lot to do with what is actually going on in the economy.

California and North Carolina posted their highest jobless rates in three decades recently with CA’s at 11.2% and NC’s at 10.8%. The golden state’s chief economist, Howard Roth, said unemployment in California hasn’t been this high since reaching 11.7% in 1941 after peaking at 14.7% in 1940.

These numbers might be the worst those states have posted in a while but they weren’t the worst ones reported. MI has 12.6% of its residents out of work, which makes sense given the problems with America’s auto industry but Oregon with unemployment of 12.1% and South Carolina at 11.4% are also having trouble keeping people collecting paychecks. Eight states out of 50 are experiencing double digits unemployment rates as reported by the WSJ.

Joblessness is having varied affects as people who just two years ago were protesting the Resolution Copper mine project by Rio Tinto and BHP Billiton are now applying for jobs there. Marles Jimenez, a former protester who has been out of work since last October and was forced to sell his truck to pay the rent on his trailer said “The Leap is beautiful but we need jobs”. The Leap Mr. Jimenez is referring to is the Apache Leap a cliff adjacent to the mining site where it is said Apache warriors leaped to their death rather than surrender to the approaching U.S. Cavalry.

Although the mine is still years away from full operation the 1,132 jobs and $800MM it could add to AZ’s economy seem to be more important to local residents than worries about preserving the storied site.

The CDS level for Rio Tinto peaked on December 5th of 2008 at 1131bps. The stock hit its low one day earlier at $60.72. They closed on Friday at 561bps and $144.41 respectively.

Some other indicators of how the real economy is doing come from news of a 30% drop in net profit of rail carrier CSX after a 17.4% decline in rail volume in the first quarter. The fall in shipping volume has caused a rise in layoffs as the company was forced to furlough 1,000 workers and “park” thousands of rail cars. “What the company couldn’t overcome was is double-digit volume drops in a quarter. For the first time the industry seemingly is suffering along with everyone else.” Anthony Hatch a railroad consultant said.
On Friday the CDS/equity combo for CSX was 87bps/$31.38. In slightly off kilter fashion the CDS hit its high on 11/24/2008 at 222bps but the stock did not hit its low until March 9th of this year at $20.980.

The slowdown in economic activity is also affecting some of the country’s oil refiners. According to the WSJ, analysts believe gasoline demand peaked in 2007. The problem is that expansion plans started before the recession are still under way which could lead to over capacity in refining capability. “The sentiment among refiners is how to start to think about how to close, who is going to close.” Alan Gelder with Wood Mackenzie, an Edinburg consulting firm said. Sunoco and Conoco-Phillips are among the companies analyzing capacity.

SUN’s CDS and equity have had a very positively correlated relationship since October of last year with the CDS topping out in the 470bps region last December while the stock continued to climb and hit its high in January of this year at $47.21. Since then both have declined precipitously closing at 184bps and $28.15 on Friday.

Natural Gas is also feeling the effects of a slower economy. The futures contract for May delivery was down 2.6 cents or 9.4% late last week. Kent Bayazitoglu (5 times fast please) said the storage numbers 1.695TN cubic feet-34.8% higher than last year and 22.5% higher than the 5-year average “continue to support that we have excess gas in the system and that we will have a strong injection season”.

NiSource Inc. (NI) like CSX had a disconnected CDS equity relationship for a while in that the CDS hit its high on January 15th of this year at 690bps but the stock did not bottom until the 5th of March at $7.86. Since early March, however, the relationship seems to have come back into line with the CDS closing on Friday at 404bps while the stock closed at $10.62.

The markets may end the week higher or lower but watching some of the components of the real economy can, at times, give a pretty good look at those things that make the country go.

Enjoy the weekend.

Jim Delaney

C.M.O. 4.17.2009

Credit Market Overview
April 17, 2009

Wall St. used to be dominated by the “Bulge Bracket” firms; those that were in perennial competition, mostly amongst themselves, to see who could underwrite the most securities, trade the highest volume and generally prove which among them brought the most alpha to Alpha. Taking an example from the business that brought it all down, think of it as Alpha^2.

Today a better description might be “Bust Bracket” as all of those same firms, whether they still exist or not, were recipients of TARP money and even if for a nano-second needed that money or to have people know they received it, to survive. If they weren’t scared why did GS and MS pull a midnight morph and wake up as commercial banks?

Scroll forward a few months and GS, JPM and WFC are doing the alpha dance once again over who will actually write the check to Uncle Sam first. GS’s earnings wowed the market and JPM’s, while not Goldmanesque, proved that there is more than one dog in that pack.

C reports earnings this morning and some attributed yesterday’s late session sell-off to the possibility that while swinging at the piñata Vikram might miss and pop a few balloons. WFC numbers come out on the 22nd so should Pandit poop-out we won’t have to wait that long for Wells.

All of this repayment talk has taken place while the Treasury is conducting their stress tests and although GS has thumbed its nose at Congress’ efforts to socialize Wall St.’s pay scale by allocating more money for compensation in 2009 than it did in 2008, Tim Geithner isn’t accepting any checks before the results, in some form or fashion, are released.

That the worst case stress scenario: positive albeit anemic GDP growth by 4Q09 and an unemployment rate with a double figure handle is now most economists “most likely outcome” should not be berated as Uncle Sam’s rose colored glasses were welded in place ages ago and there will be, no doubt, at least one hapless soul that fails the test anyway.

The test results are posing a bit of a problem in this regard as the corner the government has now painted itself into has “being too soft” on one wall and “what happens to those banks that fail” on the other. John Dugan, Comptroller of the Currency said in almost perfect gov-speak recently; “there will be definitely some information that will be provided, exactly what that will be and when it will be provided will come forth later.” Gives you that warm fuzzy feeling doesn’t it?

In speaking about what happens to those that don’t come through with flying colors Eugene Ludwig, CEO of Promontory Financial Group and a former Comptroller of the Currency said, “You can create a run on a bank pretty quickly”. The good news here is that now we know the government can do something quickly.

As for keeping the results under wraps Wayne Abernathy, EVP of the ABA doesn’t “think they [Geithner & Co.] can ignore the appetite they have created for this information”. “It’s what we can say that is meaningful while still protecting the quality of the exam data.” I did say painted in a corner, right?

On top of all of this the Treasury gave a progress report on how the 21 alpha dogs that received TARP money have been doing with regard to lending it back out and the results are mixed at best. In total credit offerings were down 2.2% in February with the banks shying away from commercial real estate, general business lending along with student and auto loans.

On the plus side mortgage originations were up 35% in February. An article in the WSJ provided a case study with an owner of several car dealerships in Michigan having his bank fail to renew some of his credit lines prompting a reduction in 1/5th of the workers employed. How can we possibly get to anemic growth and 10+% unemployment if the banks actually lend the money they’ve been given?

Where does all of this leave us? The KBW Bank Index was up ~96% in the 38 days from March 6th to April 13th of this year and closed very close to that high last night. The XLF is up ~79% during exactly the same time frame and also closed neck and neck with its high last night.

GS had it CDS high and equity low last November at 381bps and $52 respectively. The CDS hit 371bps on March 9th but has since fallen to 201 as of yesterday while the stock closed at $121.19 last night down from its recent high of 130.15 on 4/13.

JPM’s experience is slightly different as it appeared immune to a spike in its CDS last fall when that number went to 224bps on 9/17/2008 but the stock continued moving higher until 10/2/2008 closing at 49.85 before becoming positively correlated with its CDS while both moved lower until early this year. The most recent high in JPM’s CDS was 242bps on 3/9/2009; the same day the $15.90 low was put in, in the stock. As of last night close the CDS was 165bps and the stock $33.24.

The low in C, on a closing basis, was achieved on March 6th at a price of $1.03. Between then and now the stock has moved up to $4.01 and the CDS down to 530bps, the latter did see a higher CDS level on 4/1/09 at 666bps signifying they could well have done a deal with the devil to stay alive, or maybe just Barney Frank.

The CDS for WFC made a “double top” in techno jargon on 3/9 and 4/1 of 2009 just over the 300bps level. The $8.12 low close in Wells’ stock was on March 5th. Last night those numbers were 218bps and $19.45.

Last but not least Fifth Third Bank, the institution responsible for the 20% reduction in the Michigan auto dealer’s workforce, has only a stock quote on Bloomberg. It bottomed on February 2nd at $1.03 and closed yesterday at $4.32. I guess it pays not to make loans.

Enjoy the weekend.

Jim Delaney

C.M.O. 4.16.2009

Credit Market Overview
April 16, 2009

Operating under the media’s microscope as the market has been since the phrase “credit crunch” shot to the top of the lexicon league tables. The causes and cures for how we got here and how we get back are daily fodder for the forecasters, pundits and practitioners.

Through all of this it is important to keep in mind that actions will always speak louder than words. In the marketplace those actions are the prices where buyer meets seller at a single point in time, plain, pure and simple.

Part of why we are where we are is because for a while, in some securities, buyers and sellers did not know where to meet. Not in a physical sense as the exchange hasn’t moved in 100+ years or so but with regard to price. Participants lost faith in price as a determinant of value. Buyers didn’t want to pay the offer price and sellers most definitely did not want to hit the bid. In stocks, yes there was a lot of bid hitting, but in the debt markets trying to assign a value to a piece of paper that had previously been rated AAA and was now rated “who knows what” created stagnation.

As such the sale of $2.7BN worth of high yield bonds by Crown Castle International Corp. and HCA made for the single highest day of issuance in the junk market since last June. We will look at the pricing in a moment but before doing so it should be recognized that just for this to happen is evidence that there is progress being made in re-establishing liquidity in the debt markets.

OK, enough with the sentimental stuff, let’s look at how this got done. CCI’s issue was rated Ba1e by Moody’s and BBe by S&P. $1.2BN was sold in the Euro-Dollar market, has a 7.75 coupon, matures in 2017 but is callable in 2013 at 103.88. The interpolated Treasury curve in 2017 is 2.50% which puts the spread at 525 over. The 2 3/8’s of 3/31/16 is the closest real issue and the spread above that note was 550bp. Unfortunately there is no CDS information on CCI so it is not possible to compare the CDS spread to the issuance spread to see what premium the market is adding for the use of real balance sheet.

HCA’s issues came at 624bps over the 2 3/8’s of 3/31/16 TSY at an issue price of 96.755. It has a coupon of 8.5%, matures in 2019 and is callable in 2014 at 104.25. There is an active CDS market on HCA and the 10-year CDS spread was ~818 yesterday. This is interesting as during the crux of the credit crunch balance sheet space was trading at a premium to the CDS market. In other words buyers of physical bonds required a higher return to use their cash than was implied by the CDS contract. This is the first time in a long time the reverse is true.


We have been hearing that one of the pillars that the economic recovery will be built on is the availability of credit. To the extent that is true yesterday’s issues in the high yield market might be early signs of a thaw.

Enjoy the week.

Jim Delaney

C.M.O. 4.15.2009

Credit Market Overview
April 15, 2009

“We have lent a huge amount of money to the U.S., so of course we are concerned about the safety of our assets. Frankly speaking, I do have some worries.” These words, spoken by Wen Jiabao, the Premier of the State Council of the People’s Republic of China, shortly before the G-20 started could well be seen as posturing. In a more genteel sense they were similar to the smack that’s gets “talked” across the line of scrimmage before the ball is snapped on any given Sunday. (Yes, I know it’s baseball season, and the start of it at, that but a guy can dream can’t he?)

That China is simultaneously making moves within its own country to increase the use of the Yuan for trade purposes might add a little weight to WJ’s pre-G-20 chatter. Last week the Chinese government designated five of its biggest trading cities to take part in a planned program allowing foreign trade to be conducted fully in Yuan, instead of in dollars or other major currencies.

Early beneficiaries of the new initiative will be China’s own industrial conglomerates as they currently price all intra-company transactions in Dollars. The next step is expected to be trade between Hong Kong and China as even though HK is officially part of China they have a separate financial system. There is no time table for the Hong Kong move but “We have the infrastructure ready to be the first”, under secretary for financial services and treasury in Hong Kong Julia Leung said recently.

Ready seems to be an apt word when discussing China these days as the $585BN stimulus package the Chinese put in place appears to be having an affect much quicker than the bang Uncle Sam seems to be getting for his buck.

Crude Oil imports in China hit a one-year high in March and steel mills imported record quantities of their key raw material, iron ore. The increase in activity is being seen on more than just the input side as banks have extended 2.7TN Yuan ($400BN) of new loans in the first two months of the year and the stock market as measured by the Shanghai Composite Index is up 22% from its March 3rd low and 48% from the November 2008 low. Car sales also hit a record last month.

“China is unusual in that it has this incredible capacity to mobilize all its institutions. There is now a growing degree of confidence that the stimulus package is having an impact.” The World Bank’s chief economist, Vikram Nehru said recently.

True coordination is something to be envied as it is doubtful the discussions on how much to spend and where by the Chinese government looked anything like the $787BN stimulus package passed by our own Congress or the $410BN omnibus spending bill that was “oinked”, sorry inked, shortly afterwards.

All of this has implications for us here in the U.S. as the global nature of the current slowdown that was caused by the global distribution of AAA rated BBB debt means that the world will come out of its hole sooner if Uncle Sam isn’t the only one pulling on the rope.

Of interest here is the difference in how this is being accomplished here and in China. The latter is working from massive reserves saved during the boom years in an economy that was based on exports and has one of the highest savings rates in the world.

The U.S. is the exact opposite; the boom for us was ignited by low interest rates and fueled by debt. Until recently we were a country of consumers not savers and whether the switch from one to the other is happening at the most propitious time is not the point of this note. The point here is that in order to pull ourselves back out of the hole we’ve dug we’ve got to spend even more of the money we don’t have and to get that done we need someone to lend it to us.

Re-enter the Chinese. According to the Treasuries own records (always good to know who your best customers are.) China’s holdings of U.S. debt exceeded Japan’s for the first time last September. Since it is baseball season the box scores on that are $618.2BN at the end of 3Q08 with $121.4BN added through the end of the first month of this year totaling $739.6BN. During the four months between September 2008 and January 2009 Japan added only $17BN more to it’s holdings of U.S. debt.

To put this in perspective in September 2001 there was just under $1TN of our I.O.U.’s held by other countries. At the end of January 2009 that number was a little over $3TN. During this same period the amount of U.S. debt that China held increased from $72BN to the $739.6BN mentioned above. U.S. debt held by foreigners up three-fold in seven and a third years the amount of U.S. debt held by China up ten-fold in those same seven and a third years. (Am I making my point?)

The CDS quote for China closed last night at 138.34 after a near term peak of 263.21 on March 2nd. The previous and all time high was reached back on 10/24/2009 at 295. The CDS for the U.S.A. closed last night at 44.42 and hit its high of 100 on February 24th of this year.

While the world still views America as the better credit risk it should not go unnoticed how much we are indebted, literally, to our global neighbors for our standing.

Enjoy the week.

Jim Delaney

C.M.O. 4.14.2009

Credit Market Overview
April 14, 2009

The U.S. Census Bureau will release numbers at 8:30 this morning that will provide their opinion on how the consumer is fairing in these treacherous times. Given that SKS, M, JCP and TGT announced same store sales figures that were -23.6%, -9.2%, -7.2% and -6.3% respectively last Thursday one might expect the government’s number to be lower as well.

Since it is the Uncle Sam’s ball and as such he can call the game as he sees it, it should come as no wonder that the forecast for that economic statistic is a positive 0.3% move vs. last month’s negative -0.1% move. Also of interest is that the Retail Sales Less Auto’s component is forecast to be a flat 0.0% vs. a positive 0.7% last month. I am hard pressed to think that the seven-tenths of one percent reduction in that number is the result of people postponing possible purchases pending bankruptcies at GM and Chrysler but I’m also pretty sure that the government’s economists will come up with a clever answer for what ever reality comes to be.

The changes in sales for the names above do bring to light a shift worth noting; that being the reduction in monies spent at the higher end of the retail spectrum (SKS) and the increase at the lower end, COST +3.0%. This is confirmed by even higher sales at those stores selling even less expensive goods BJ +8.5% (excluding fuel) and FDO +6.4%. Taking this all to the realm of beating a dead horse to make one’s point, sales at NMG were down 29.9% and ANF saw a 34% decrease.

This story is playing out in a physical sense as well as Chicago’s Miracle Mile (actually 0.8 of a mile) has the highest number of vacancies since 1992 with Lord and Taylor, TLB, and WSM’s Pottery Barn all closing stores on that tony stretch of road recently.

In total 6.3% of Michigan Avenue’s retail space was vacant last year vs. 4.4& in 2007 and 1.0% in 2002. Bruce Kaplan, SVP at CB Richard Ellis, whose firm conducts an annual rent survey of the MM said “people come from around the Midwest to shop here so it’s a little bit insulated from the economy, but not that insulated.”

The dichotomy between the two ends of the spending spectrum does not seem sequestered to the States either. Bain & Co., a consulting company that monitors the high end of things has increased the forecast of the decrease they see in luxury goods sales from 10% last October to 20% more recently and they look at things on a global basis.

“The situation is now is a little worse than we thought it would be back in October.” Claudia D’Arpizio, a consultant in the company’s Milan office said recently. Before we start “shaking the cup” on the behalf of luxury goods makers realize that even at down 20% we’re still talking about $180BN worth of jewelry, watches and leather goods.
How does all of this filter through to the markets you ask? Let’s start at the high end and work our way down and have a look at the CDS/equity relationships to find out. CDS for SKS peaked on 2/25 at 2325 and the stock closed at its low a few days later $1.57 on 3/10. Since then, however, the stock has gained 82% closing at $2.86 last night while the CDS has narrowed to 1716 or 73% lower than its recent peak.

M has done even better with the stock up 96.5% ($12.93) from its 3/5 low of $6.58 which was also the day the CDS peaked at 838. The CDS has narrowed -35% in the same time span closing at 540 last night.

Given the increase in sales announced by COST last week one would have thought that it would have come in as best of breed but the numbers show a bit of a different story. The recent high in the CDS was 110 on 3/5 and it closed down 16% at 92 last night while the stock which bottomed on 3/9 at $38.44 has only risen 8% to $7.97 last night which is actually down from $48.91 on April 3rd.

If there is something to be read from between the lines here it might come from the anticipatory quality everyone associates with the stock market. If that truly is the case than the moves in the stock prices of the higher end stores might suggest that the spenders are not as worried about things as Roubini & Co. would have us believe we should be and are putting their money where their mouth is.

On the other hand, if the affluent are practicing a little retail therapy, as they are want to do at times, they might be doing their best impression of Marie Antoinette by ignoring imminent disaster. Who knows, maybe they buy those big bags so they can fit the whole cake inside.

Enjoy the week.

Jim Delaney

C.M.O. 4.13.2009

Credit Market Overview
April 13, 2009

Moves in the equity markets like the ones just experienced in the holiday shortened week bring the statisticians out of the woodwork looking at the size of the moves, how fast they happened and where things stand in relation to the oft sited benchmarks. The talking heads will be inundating you with that for most if not all of today and by doing so could well help the prophesy of a pullback become self fulfilling.

I will to spend just only the space needed here discussing those things to lay the ground work for bringing to light some hopefully not so often looked at information which will, also hopefully, allow you to come to your own conclusions as to wear things might be headed.

The S&P has rallied 26.6% since closing on March 9th at 676.53 and the closely watched VIX has fallen 30.6% since its 52.65 close on March 2nd. At 1653 the NASDAQ’s 27.7% 5 week run is the best in its entire history while the Russell 2000 has gained 33.4% in the same time period. Banks, which every monkey’s uncle has said need to participate in any turn around, are now up 80% from their lows according to Kopin Tan in Barron’s.

Andrew Burkly of Brown Brothers Harriman says the index numbers are now ahead of the moves in 1932, 1938, 1974, 1982 and 2002 which were all the start of a new bull markets.

The numbers themselves are impressive but the acceleration of the move begs the question; where to from here? Probably a good time to have a look at the tea leaves.

Barry Knapp, a strategist at Barclays Capital sees some questions of sustainability with financial stocks 26% above their 50 day moving averages, which he says, is the widest gap in two generations. On top of this, with 84% of all stocks are now above their 50DMA; “To buy the equity market at these levels implies a degree of confidence in a sharp recovery that doesn’t seem to jibe with the available evidence”, is how Barry put it. Some, however, wonder whether Barry is including the easier mark to market rules the banks now have and the Fed’s quantitative easing actions in his “available evidence.”

Louise Yamada says, “The bottom isn’t a place, it’s a process. The indexes, except for the NASDAQ, have been outperforming, but are still in a pattern of lower highs; each rally has met with selling into strength. The first step would be to get through the December peaks across the board. It is a bear-market rally until proven otherwise.”

The recent uptick in home sales and reduction in mortgage rates have been greeted with enthusiasm as was PHM’s promise to marry CTX (The next reality show is going to be the “Real Homebuilders of America”.) Ronald Temple, Lazard Asset Management’s co-director of research asks us to remember, however, that homes are among the planet’s slowest moving assets. With the jobless ranks continuing to grow and the banks being less than effusive in their lending he feels we could see another 22% - 27% to the downside from January’s levels.

The Fed’s quantitative easing once again comes into play here as Ben’s plan to buy $1TN in mortgage securities will apply downward pressure on mortgage rates. Given that each 1% decline in rates reduces monthly mortgage payments by 10% RT thinks that even at 4% there is another 16%-21%% lower to go in home prices. Ron doesn’t see home prices stabilizing this year but thinks with all the work the government is doing they “may decline at a slower pace.” Stocks won’t need to see a recovery in housing but only “smell one” to begin to recover he says.

The actual effectiveness of the Government’s quantitative easing is coming into question as the announcement to purchase $300BN of its own paper in the open market initially pushed the 10-year yield (a key rate in the mortgage market) down to 2.5% from 3%. That rate had since risen back to 2.93% as of Thursday.

One cause for this is that “the Treasury auctioned far more than the Fed bought back” last week as was observed by Gray Smith of Arbor Research. Exact numbers for the week come in at $59BN sold; $36.6BN bought. “This leads many to question what impact the necessity of funding massive projected 2009 and 2010 federal deficits will have on interest rates over the next six to nine months.” If you’re wondering where the bond vigilantes are you need only ask the little girl in front of the TV in “Poltergeist II”.

In the market, as in many areas of life, perception is, or at least can quickly become, reality (just ask the “Housewives”). The reality of which I speak here is that perceived by the 50 economic forecasters who contribute their thoughts to Blue Chip Economic Indicators, a Kansas City based business sentiment aggregator. The good news is that the group has stopped lowering their expectations. This is not the same as raising them but with “not as bad as expected” becoming the new “good” beggars can’t be choosers.

BCEI’s nifty fifty sees all of 2009’s contraction occurring in the first half of the year with real GDP falling at annual rates of 5.1% and 2.1% in the 1st and 2nd quarters respectively. Beyond that they see growth of 0.4% and 1.6% in the last two quarters of the year. A year out they see 4Q10 GDP growing at 2.7%. They expect unemployment to peak at 9.6% in 1Q10 but they don’t see an unemployment rate without a 9 handle for any part of next year.

The wealthy, who for these purposes will include investors with $500,000 or more in liquid assets, (how many of those are left?) are feeling rather upbeat at the moment according to TNS, a research firm that monitors these types of things. They say 79% of the previously defined “wealthy” expect improvements in their households’ overall financial situation in the net 6-months; that is up from 69% in October of last year. Ellen Sills-Levy, a senior vice president at TNS thinks “the market always responds worse to uncertainty than to anything definitive – positive or negative. These results show us that affluent Americans are beginning to sense a ‘shift’ in the markets’”.

Where does this all bring us? Back to the one thing we monitor more closely than anything else at Market Strategies Mgmt., credit spreads.

Justin Lahart put a feather in my cap (without even knowing it) writing in the WSJ recently saying that “corporate bonds spreads have been far better at predicting where the economy is headed than anyone thought.” He sites the widening of spreads in the fall of 2007, even as the stock indexes made all time highs. The research Mr. Lahart sited also looked at a similar period in early 2000 which, as we all know, lead to similar results.

Spreads are not only good at detecting individual companies’ ability to service their debt but can also be the canary in the coal mine when disruptions occur in credit supply. Like when banks have so many toxic assets on their books that they can’t lend anymore, widening spreads which results in a contraction of expansion.

By now everyone has heard the soprano Meredith Whitney sing the aria “Insolvenza” from the new opera “Completa Rovina Finanziaria Globale” written by Nouriel Roubini. You haven’t?! Make sure you’re not the last on your block to do so or maybe you should just make sure you’re not the last one on your block!

The findings quoted by Justin are the work of Simon Gilchrist and Vladimir Yankov at Boston University and Egon Zakrajsek at the Federal Reserve. All of their work will be included in a paper due to be published in the Journal of Monetary Economics.

Until then what you should know is that the model these gentlemen have developed predicts industrial production falling an additional 17% by the end of 2009 with 7.8MM more people out of work than the 5.1MM already unemployed.

Those are the tea leaves.

Enjoy the week.

Jim Delaney

C.M.O. 4.9.2009

Credit Market Overview
April 9, 2009

If this crisis of credit and confidence has taught us anything it is that doing the same thing at a different time is not that same thing at all. Yesterday’s announcement that the Treasury Department will include the life insurers as eligible TARP fund recipients added a boost to the names in this sector. That this is was viewed positively by the market at the same time that the banks, both big and small, are wriggling like a ferret caught in a snare trap to get themselves out from under that very same umbrella is a study in something. Of what, however, I am not completely sure.

To make it even more interesting, alright a little less boring, some insurers seem in dire need of assistance while others appear to be in no danger of losing their coveted AAA status.

I thought, while seeing the list of names that have made the necessary changes to put themselves in line for TARP funds (more on that in a minute), it would be interesting to look at the difference between those names and the insurers that don’t appear to be in need of any assistance but Mass Mutual Life, New York Life and Northwestern Mutual are either private or unlisted and none of the three had active CDS quotes. This unto itself is probably testament to how a AAA insurer should be run but that’s not the point of this note.

Of the companies with hat in hand: HIG, GNW, LNC all acquired existing S&L’s (you know, the other massive bailout) last fall so that they could meet the TARP requirement. PRU already owned a thrift and MET owns a federally chartered bank.

Let’s have a look at the CDS/equity relationship for clues as to how things were pre and post announcement. (All CDS spreads are the 5-year most often traded and considered the benchmark by the market place.)

HIG: CDS peaked at 1151 back on March 3rd of this year but was trading as wide as 1119 on April 7th, closed last night at 846. The stock hit its low on 3/6 at $3.62 and has been moving higher in uneven fashion closing at 9.59 last night.

GNW: Pattern looks similar to HIG with different numbers. Stock low $0.84 on 3/6, CDS high 3639 on 3/9, recent CDS peak 3672 on 4/7. Last night’s close: 2834 on the CDS and $2.33 on the stock.

LNC: A little different with the stock putting in a low of $5.01 on 3/9 but the CDS moving rapidly higher from mid-February until its 4/7 peak of 3189 before closing last night at 2152. The stock has been range bound between $5-$10 since late February closing at $9.15 last night.

PRU: Different again with the CDS bouncing off the ~1100 level three times since the 3rd of March closing last night at 849 while the stock bottomed on 3/5 at $11.25 moved up to $24.92 on 3/18, backed off but then started moving higher again and closed at $23.81 last night.

MET: The chart of the CDS/equity relationship is the most symmetrical for this name with the stock hitting a low of $12.10 on 3/5 and the CDS peaking at 1028 on 3/9. Since then the CDS has moved lower (734 last night) and the stock higher closing at 24.73 last night.

The easy observation here is that inclusion in the TARP plan has lowered the implied risk of default for all of the names mentioned and this has been complimentary for the stock price.

It will be interesting to see how soon it will be before management of these companies begins to chafe under the restrictions that come from getting money from Uncle, or is that Comrade Sam.

If your holiday started yesterday I hope you enjoyed and will enjoy, if your holiday is Sunday, please enjoy, if you have tomorrow off, please enjoy and if you have Monday off, please enjoy. The key word here is enjoy!

Jim Delaney

C.M.O. 4.8.2009

Credit Market Overview
April 8, 2009

Moody’s Investor Service said yesterday that 35 companies defaulted in March, the highest single month total since the Great Depression, bringing the total for 2009 to 79. M.I.S. also said that the default rate in the high yield sector rose to 7% from 4.1% at the end of 2008. Additionally the company expects the existing rate to more than double to 14.6% by the end of this year. Which, if you’re looking for a spec of good news in all of this, is lower than the 15.3% rate Moody’s predicted as a year end rate last month. With news like that no wonder they call themselves moody!

This could make for another interesting year in the hedge fund community as during an interview published in Lipper HedgeWorld, Mark Kary, CEO of Polar Capital said he thinks: “There is a pretty scary consensus around ... a lot of people are chasing the same idea. People are looking at credit to the exclusion of everything else. In January last year, the three things people were looking at were commodities, real estate and emerging markets. Arguably they were the three disaster trades of last year. This year everyone is looking at credit, distressed (debt) and CTA's, every man and his dog is raising money for distressed."

I’m not quite sure if he has a dog as a pet but Leon Black who is top dog at Apollo AP Alternative Investments, seems to have a few in his portfolio. The fund was down 45% in 4Q08 and 60% for all of 2008 and is credited by Andrew Bary of Barron’s as having “orchestrated some of the worst LBO’s in the buyout boom of recent years.” These include three companies, Harrah’s Entertainment, the casino operator, Claire’s Stores, a retailer of costume jewelry and real-estate broker Realogy, with the dubious distinction of being on Moody’s “High Risk of Default” list.

Apollo’s bad luck with the casino doesn’t seem to stop there as the debt of 10 of the companies it has taken private since 2006 is now trading lower than $0.30 on the dollar, if you can get a quote, and the European listed shares of AP Alternative Assets (AAA.Euronext) are trading at $1.00 after having debuted at $20.00.

Mr. Black is not alone it seems as the venerable Kohlberg Kravis Roberts has met a similar fate with it’s LBO portfolio and KKR Private Equity Investors (KPE.Euronext) saw half of it’s assets disappear in 2008 pushing it’s stock price down to $12.78 at year end and around $3.00 more recently.

If players like Black and KKR, who both cut their teeth while Mike Milken was King of Junk, are having troubles one can only imagine what is happening at some of the less experienced shops. It also makes Moody’s glum forecast seem more fateful and Mr. Kary’s prescience more possible.

Enjoy the week.

Jim Delaney

C.M.O. 4.7.2009

Credit Market Overview
April 7, 2009

To say that these are unusual times would clearly be classified as a “marvelous grasp of the obvious”, but just as you find the best shells searching the beach after a storm there has been at least one benefit to the tumult the world is struggling through; the number of high profile people contributing their thoughts in the media on various ways to solve the multiple challenges we face.

Advisors, cabinet members, professors, market practitioners, both past and present have supplied a constant stream of ideas on how to overcome various aspects of the obstacles that must be surmounted for a meaningful recovery to begin. It has been a case study as none ever offered by Harvard B-school with a quorum of adjunct faculty no one could afford to pull together (especially not in these times). All there and costing nothing more than the price of the paper and the time it takes to read it.

There are so many submissions in fact, that on occasion, a point: counterpoint situation occurs. That is pretty much what happened recently between a piece published by Martin Feldstein, Chairman of the Council of Economic Advisors under President Reagan and Harvard professor and James Keller, former head of structured products at UBS. Understand that these were not published in the same paper and it was only after reading them both that the idea came to do a little comparative analysis.

Writing in the WSJ this past weekend Mr. Feldstein’s overall impression of Tim Geithner’s Public Private Investment Plan (PIPP) is a positive one. He champions the Treasury’s idea of getting private investment capital to determine the price of the assets and having the taxpayer go along for the ride with the FDIC providing the financing. Making the specific point that one of the key reasons this might work is that no one has to ask congress for the money.

From here, Marty seeks to put his own twist on things and adds a few tweaks. The first of which is that the Treasury must be willing to inject capital into the banks that sell assets as the prices the assets fetch could be a tad different than the price they are currently assigned on the bank’s books. (Imagine that!) The capital, Marty thinks, should be in the form of preferred shares or perpetual debt.

Second, MF raises the point that the banks now own $3TN of residential mortgages, $1.5TN of corporate real-estate loans and $1TN of consumer debt ($5.5TN in total) and he believes getting all of this off the books is going to take a wee bit more than the $0.5TN (9% of total assets) currently planned for the program so he suggests increasing the amount allocated.

Thirdly, Marty reiterates his earlier solution of having the Government issue “mortgage replacement loans”. This is where Uncle Sam offers homeowners with negative equity; low interest recourse financing for 80% of the existing mortgage, wiping out the existing one. The benefits here are lower payments for the home owner and a 20% cushion to keep home equity positive even if prices fall a bit further reducing the likelihood of defaults; emphasizing that participants would be personally liable for the money, a big difference from current mortgages.

Mr. Keller has a few problems with the PPIPlan but since the Keller piece was published in a different paper (Barron’s) and not specifically written to refute the professor Feldstein’s piece it stands on its own as another view point.

I must first say that James is a bit more opinionated and not quite as approving of Mr. Geithner’s plan as Marty’s was but then who knows with Larry Summers already in Washington, Marty might be waiting for the nod and Harvard might become the new Goldman as a source of financial intellect.

In any case one of the key issues James Keller has with the PIPP is the pricing of the assets. I will quote JK here because nothing I could write would sum it up so succinctly.

“One of the principal aims of Geithner's plan is to provide a market where none exists, so that these securities can be valued and traded. But it is not true that nothing is trading because nobody knows what things are worth. Nothing is trading because too many people know what things are really worth.”

As such Mr. Keller believes “Banks don't want to sell to astute investors, who are bidding conservatively for something that may continue to fall in value. Banks want to sell to investors who will overpay for noneconomic reasons.” and he thinks “Geithner proposes to give them that chance.”

The other issue James has is the structure of the deal itself as from his perspective, it looks a lot like a CDO which, he says is “the very structure that supposedly caused all the trouble.” He adds that cheap financing and leverage also added much fuel to the fire and wonders why if, given the combo above, investors would act any differently this time around than they did last time and the specific act he is talking about is the overpaying for financial assets by investors.

Keller closes with a quote from none other than Will Rodgers asking "If stupidity got us into this mess, why can't it get us out?"

I will leave you with that one to ponder for yourself.

Enjoy the week.

Jim Delaney

C.M.O. 4.6.2009

Credit Market Overview
April 6, 2009

Amid all the fanfare last week attached to the G-20, stocks crossing the imaginary 20% line that designates bull markets (The Dow creeped above 8,000 at the close while the VIX slipped below 40 at the close on Friday.) and the extremely well received news that there were only 663,000 more people out of work in March than there were in February there were some less heralded but equally significant events

While not specifically last week but still within the first 88 days of our new President’s first term Congress has enacted laws that have expanded health care to an additional 4MM children, another that makes it easier for women to sue for equal pay, the creation of 175,000 new public service positions and the protection of 2MM acres of wilderness; all admirable accomplishments for sure. These were, of course, in addition to a $787BN stimulus package, a $410BN omnibus spending bill and the 2010 budget which weighs in at a mere $3.6TN.

A few other items that did not make the front page include news that D.E. Shaw has paid Lawrence Summers about $5.2MM over the past year as well as the revelation that FNM and FRE will pay about $210MM in retention bonuses to 7,600 employees over the next 18 months. (7,599 of these employees placed there as favors to various members of Congress. JUST KIDDING!).

Given the commotion over similar types of payments to employees of AIG, James Lockhart, director of the Federal Housing Finance Agency defended the bonuses as “vital to retaining talent at the two companies”. This would appear to make total sense as it takes a lot of talent to wrack up only the $108BN in losses the two agencies booked in 2008 which was $42BN less than $150BN attributed to AIG.

The latter, we now all know, attempted to pay out $167MM in retention bonuses; minus of course the amount refunded by Jake DeSantis upon his resignation. Had AIG loosened the purse strings they might have fared better but in the end it was just another case of “you get what you pay for.”

The Federal Reserve came up empty handed last week but this was actually quite a good thing as the Term Securities Lending Facility, TSLF for you acronym addicts, received no bids for the $25BN it offered during Thursday’s auction. Louis Crandall, chief economist at Wrightson ICAP LLC, interpreted it as “a good sign when the Fed’s emergency facilities run off due to a lack of market demand”. But then, when you can “mark to make believe” there aren’t any problem assets left to use as collateral are there?

Also meeting with a lack of enthusiasm was the government’s overture to the banks that have lent Chrysler $6.8BN to swap $5BN of that debt for stock. JPM, GS, C and MS are secured lenders and as such have the right to take control of Chrysler’s plants, brands and other assets which were pledged as collateral if, in the immortal words of Nigel Tufnel in Spinal Tap, “this one goes to eleven”.

Given that, in Chrysler’s case, the parts are greater than the sum the four horsemen mentioned above are taking a tougher stance than either the unions or Fiat in the negotiations. With $2.5BN of Chrysler debt JPM is the largest of any single lender and appears convinced that it and the other lenders would have higher recovery rates in liquidation than the plan proposed by the government. Concerned with the welfare of their own shareholders JPM believes any concessions should be in line with those in a “normal” bankruptcy.

Making this all a tad more interesting is that the four lenders named have all received money from the Troubled Asset Relief Program and although the fact “hasn’t been mentioned, everyone is aware that the issue is there”, a person familiar with the talks was reported to have said by the WSJ on Saturday.

On the subject of things people are aware of but have not mentioned is the control it was feared the government would exert on the recipients of its largess. JPM seems to be having some success at “pushing back” for the moment but others have not been so fortunate.

On the list of quiet happenings this past week was the return of $340MM in TARP funds from four small banks in LA, NY, IA and CA. This would usually be considered a good thing by most but since the numbers aren’t in the trillions, it hardly qualifies as news no less headlines. What did make the news and also prompted Stuart Varney, a host on the Fox Business Channel, to write a piece published by the WSJ on Saturday is that an early recipient of $1BN of TARP money has been trying their damnedest to return those funds. The chairman of the unnamed institution has said he is prepared to write a check for the total amount with interest to the government.

Interestingly his offers have been turned down as Andrew Napolitano, a colleague of Stuart’s at Fox reported; the bank has been threatened with “adverse” consequences if they continue to push to return the money. The crux here is that the government’s initial injection was accomplished via the purchase of a class of preferred stock which gave Uncle Sam a small voting position in the bank.

Mr. Varney’s feeling here is that the government does not want the money returned so that they can keep their voting rights, small as they are, at the bank intact. SV sees this as just the first step in banks being told who to lend to and at what terms.

The prospect Stuart Varney lays out is not a pretty one, at least not from an economic stand point. Jamie Dimon’s actions, in the case of Chrysler at least, seem to run counter to Stuart Varney’s fears. Who will turn out to be right; only time will tell but it could turn into the Billion Dollar Question.

Enjoy the week.

Jim Delaney

C.M.O. 4.3.2009

Credit Market Overview
April 3, 2009

One of the lead articles in this weeks Economist is titled “Only halfway there”, “Saving America’s banks”. In it the author cites and justifies his arguments for why the plan to relieve the banking system of its toxic-assets will not truly be effective unless the loans as well as securities that fall into this category are removed.

If any further clarification is needed here then one only need to ask themselves whether they would believe they were cured if they underwent surgery to remove a malignant tumor from one organ but forbade the doctor to do the same to an equally destructive growth on another organ.

If you are following so far then let’s take the example one step further. How well could you truly feel if, after being diagnosed as above, the doctor opened you up, saw the two neoplasm’s, sowed you back up and told you that they were indeed life threatening but not to think about them as such?

An article earlier this week in the WSJ discussed the effects of allowing the banks to keep the toxic assets on there books. Robert Willens, who writes the eponymously named “Report” was asked his impression of the FAS 157 rule change by the reporter and thinks “There is a disconnect there between the two plans. Arguably, this new FASB rule will actually inhibit people from doing what the Treasury secretary would like them to do, which is sell the toxic assets. There is a little bit of the lack of coordination between the two concepts.”

A counter to Mr. Willens’ opinion was voiced by Christopher Hoeffel, president of the Commercial Mortgage Securities Association who heard “Some bankers are saying, ‘I don’t want sell these assets, because the loan might still be good – and if I hold it to maturity, I might get my money back.’” As they saying goes “every argument has at least three sides” and yes, when you flip a coin there is the chance, albeit small, that it will land on its edge and stay there.

Given, however, what we have been lead to believe regarding the immediacy of the problems in the financial system; which has resulted in the pouring of billions of tax payer dollars into the institutions themselves and billions more into stimulus packages, which the taxpayers of the future will be responsible for paying, to revive an economy hobbled by the anxiety surrounding a financial system which the country perceives as is still being in the I.C.U.; does it make sense to wait until maturity because the banks might get their money back?

I don’t know, I’m just asking.

Enjoy the weekend.

Jim Delaney

C.M.O. 4.2.2009

Credit Market Overview
April 2, 2009

The most recent Existing Home Sales figures (+5.1% in February) have given some reason to feel optimistic about the residential real estate picture but yesterday’s foreclosure auction of the John Hancock Tower, the tallest building in New England, for about half of its last sale value three years ago; might bring back the somber hues and this time instead of painting with brushes they could be using rollers.

Commercial property has taken quite a turn recently. Richard Parkhus, head of commercial mortgage securities research at Deutsche Bank described how “In just seven months, we’ve gone from the best of times to the worst of times”.

While that may be true hind sight is always 20/20 and there’s no telling that today’s “worst of times” might not be the “best of times” when we look back seven months from now. Comparing where we are currently to some of the other “worst of times” might help provide a better perspective. (At this point I feel like I should add one of those warnings that appear before some TV shows: “The following program contains graphic . . . “)

The Real Estate Roundtable estimates that commercial real estate in the U.S. is worth $6.5TN, about three times the size of the market in the early 1990’s. The leverage applied is about 50% as about $3.1TN $6.5TN is financed by debt.

Another way to look at this is in relation to Tier 1 capital. During the 1990’s less than 2% of the country’s banks and savings & loans had commercial real estate exposure exceeding 5 times their Tier 1 capital. At the end of 2008 this number was 12% or about 800 financial institutions.

General Growth Properties could stand as the poster child for the current commercial real estate environment as although they have stopped paying debt service on two of their key properties the lenders have not forced GGP into bankruptcy as they believe there is more to be gained by riding out the storm with a company whose tenants are happy with the way the Malls where they lease are maintained.

The potential for additional GGP’s exists as well as there are $154BN of securitized commercial mortgages coming due between now and 2012 according to Deutsche Bank, of which 2/3rds will not qualify for refinancing due to a decline in property values of anywhere between 35% and 45% from their 2007 peak.

Deutsche estimates that default rates on the $700BN of commercial mortgage backed securites that now exist could hit 30% and the loss rates, a key component of how much lenders recover, could exceed the 10% peak seen in the 1990’s.

All of this has not been lost on the REIT market as volatility in some shares has the day traders from the tech boom itching to get back in the game. During the 1st quarter of this there were 4 days where REIT stocks had intra-day swings greater than 10%. That is an improvement from 4Q08 when the number of days was 15 but still well above the figure for the first nine months of 2008 when there was just one.

On March 23rd for example the S&P rose 7% but ProLogis (PLD) went up 28%. This past Monday, March 30th the S&P fell 3% and PLD dropped 12%.

In total the Dow Jones Equity All REIT Total Return Index, comprised of 113 stocks, posted a negative return of 32% in the first quarter; better than the -39% realized in 4Q08. The index is down 68% from its February 2007 peak.

The foreclosure sale of the John Hancock Tower has proved that the commercial real estate sector is not immune from the current economic down turn. “The real danger is a repeat of what happened on the residential side: A complete choking up, foreclosure disasters and increased stress on the banking system.” As Jeffrey DeBoer, CEO of the Real Estate Roundtable so eloquently put it.

Enjoy the week.

Jim Delaney

C.M.O. 4.1.2009

Credit Market Overview
April 1, 2009

Vladimir Putin, Russia’s Prime Minister made a $1TN cash bid for GM’s Hummer brand last night with the only stipulation being that the 1MM people currently receiving health benefits from Hummer’s parent company GM continue to due so while the 96,000 active employees continue their normal contributions to the plan.

The PM gets two things in return: one kick-butt vehicle to drive around the steppes of Mongolia and living proof that Marx’s was right when he said: “From each according to his ability to each according to his needs”.

APRIL FOOLS!

With President Obama raising the probability of bankruptcy for what was once the crown jewel of American industry and enterprise I thought it would be interesting to look at some of the events in GM’s recent past and see where the stock and CDS were trading.

Nothing too intense, more like Sports Center’s Top Ten Plays.

November 2003: Bond’s of GM rose in value and the spread over Treasuries, at 100bps was the narrowest since 1999. Traders felt at the time that optimism surrounding the economic recovery would boost demand for corporate debt. No CDS data available the stock around $40.00

March 2004: GM’s EBITA hit a 9-yr high at $20.879BN a 30% increase over the year earlier period but cut’s target to $48 on higher health care costs. The company also announced the formation of a bank in Utah to cut borrowing costs and recalled 3.66MM pick-up trucks. No CDS data available stock trading around $45.

October 2004: GM reports a 3rd quarter profit of $440MM or $0.78/share after GMAC earns $656MM helping parent Corp. cover losses. S&P cuts GM’s credit rating to one notch above junk due to worries about the company’s auto business. Stock trading around $38; CDS 240bps.

April 2005: GM asks union for help in cutting benefit costs. Board appears to be losing patience with Wagoner over costs to restructure Europe where the company had already sustained $3BN in losses. Stock around $26; CDS around 850bps

May 2005: S&P cuts GM debt rating to junk. Kerkorian says “shares won’t fall further and can only go higher”. Stock around $31; CDS around 980bps

August 2005: GM rating lowered to junk by Moody’s. Stock around $38; CDS around 500bps

December 2005: S&P cuts GM debt rating to B from BB-. Lowest rating since 1953. Stock around $19; CDS around 1350bps


November 2006: GM offers discounts on 2006 and 2007 models by as much as $2,000 after sales drop 9.1% in past year and Toyota and Honda continue to gain ground. Stock around $30; CDS around 400bps


December 2006: Kerkorian admits to losing approximately $8.6MM in GM trades over previous 19 months. Stock around $30; CDS around 400bps

November 2007: Wagoner flies to Washington on private jet to seek Federal Bailout money. GM lowers earnings estimates ahead of Q3 announcements. Stock around $26; CDS around 825bps

December 2008: Wagoner appears before Congress to ask for $18BN in aid. (He drives this time) Stock around $4.70; CDS around 9925bps

March 2009: President Obama rejects GM turn around plan raising prospect of bankruptcy. Stock hits low of $1.45; CDS hits high of 16870bps.

Having watched GM through out the time period above it is amazing to see in hind sight what few saw coming just a short number of years ago.

Enjoy the week.

Jim Delaney