Credit Equity Correlation

Credit Equity Correlation Has Moved!

2009-05-25T18:11:00.001-07:00

Please visit my new site at:

http://www.marketstrategiesmgmt.com/

Thank you,

Jim Delaney

C.M.O. 5.22.2009

2009-05-22T04:18:00.000-07:00

Credit Market Overview
May 22, 2009

The telegraph was one of the earliest forms of long distance communication. Longer than you can ride and shout from horseback, send smoke signals or spend hoping the carrier pigeon doesn’t soak up any lead on his way back home.

Like “Coke” and “Xerox”, “telegraph” has also become a generic term to denote the indication of one’s intended motive. Think The Babe pointing towards the fence in the ’32 World Series, Joe Namath, who’s raised index finger has been copied in every set of team colors imaginable and how can we leave out the Three Stooges and Marx Brothers whose antics are so predictable it adds to the anticipation of the laugh to come.

The U.S. Government has been doing a little “telegraphing” itself as of late. Unfortunately, however, this one doesn’t end with somebody getting a ring or millions of people enjoying a hearty guffaw. It ends with higher interest rates, a lower Dollar and inflation well above a nickel and heading towards double figures.

Now, as with Joe and the Babe, certainty only comes after the fact and if the events of the last little while have taught us anything it is that things can change very quickly so this is no raised index finger and there is no pointing going on. (At least not yet, anyway.) More, just observations, like a set of directions with landmarks to watch out for. Some of which are beginning to appear, hence today’s topic.

There was a precipitous drop in the price of U.S Treasuries yesterday. It was caused, possibly, by the announcement that S&P had put the U.K. on negative credit watch. The connection the pundits were making is that the two economies are very similar and the crisis of confidence has been handled similarly in both economies so the issuance of massive amounts of debt (18% relative to GDP) by our friends across the pond is a premonition of what’s to come back here in the colonies.

Many people, including Milton Friedman in his book Money Mischief, predicted the consequences of using huge amounts of debt by the Government to cure economic problems such as the ones we are now experiencing and they, the consequences, look a lot like a devalued Dollar and inflation that begins to increase at an increasing rate.

The yield on the UST 10-year has been as high as ~5.25% going back to July of 2006 and June of 2007. It has also been down very close to 2% (January 2009) and yesterday closed at ~3.35%.

Financing for $1.197TN in congressionally approved spending plus additional government bond issuance brings the expected issuance total up to $2.1TN for 2009 according to Barclays Capital. This should be compared to $880 in 2008.

Besides the increased issuance you must also consider the Fed’s quantitative easing strategy or more easily put; robbing Peter to pay Paul. We are now buying debt at relatively high prices when there is an awful lot of “telegraphing” going on that rates are headed up and not down.

Since, as we all know, the price/yield relationship in bonds, owning Treasuries doesn’t appear to be the smartest trade at the moment. Sean Kelleher, a partner at JGC Management over there in “Joisey” estimates that the Trillion dollars worth of debt the Fed now owns could become 2TN in fairly short order. A 1% increase rates on that amount could cost you and me about $140BN in price depreciation.

And we don’t even get the right-off!

Happy Memorial Day weekend! See ya Tuesday!

Jim Delaney

C.M.O. 5.21.2009

2009-05-21T04:03:00.000-07:00

Credit Market Overview
May 21, 2009

The amount of new issuance in the both the equity and debt markets has been prodigious since the first drips appeared to be falling from the ice that had frozen the capital markets after Lehman took on Arnold “Da Gubenator” Schwarzenegger’s character in Batman, Mr. Freeze.

This has been heralded as a sign of that we are on the road to recovery and the move in credit spreads has been impressive with the oft cited difference between risk free Treasuries and a pile of junk (bonds) moving from the big 2-0 down to the lowest “teen” there is.

There is another side to all of this joyous issuance however and it comes in the form of a “what-if”. Don’t they always?

This w/i comes from the middle word in one half the two elements that are used in the CEC Strategy. Since one half is equity we can leave that one out and go directly to the other half Credit Default Swaps. I think you can pick the middle out of those three.

Moody’s expects the default rate on junk debt outstanding to hit a high of 16.4% by November of this year. Standard & Poors has a slightly different trajectory projected with defaults hitting their apex in March of 2010 at the 14.3% level.

Since we can’t believe much of what either of these two say these days a look at hard facts might help. S&P recently put out a report that said that no less than 28 entities had negotiated with their lenders to “extend payment, convert debt to equity, purchase debt back at a discount, reissue debt at more favorable terms” or D, all of the above.

Those numbers are through the end of April and if you add 2, because you have to figure that’s already happened in May or will by month’s end, you get a total of 30 which is twice the total for all of 2008. Without adding the extras the existing total is still quadruple the occurrences of 2007.

Keep in mind as well that $190BN of this less than investment grade debt is due to come up for refinancing over the next three years. If there is a glimmer of hope it is that the schedule of maturities is $26BN, $44BN, and $120BN for 2009, ’10 and ’11 respectively.

This should work out just about perfect because 2011 is when a good portion of the “timely, targeted and temporary” monies in the pork-ulous bill hits the streets.

If, by chance, defaults do rise over the next trio of years Dianne Vazza, a MD with S&P is not too optimistic about what actual recovery levels would be. “I don’t expect recoveries to be as strong this time around as in the past cycles, when recoveries were typically around 45 cents on the dollar. They’ll be hurt by the lousy economy, wounded banking sector, a lack of debtor-in-possession financing and the crummy leveraged deals done by the private-equity sector in 2006 and 2007. There will be more liquidation, in which recoveries typically suffer, this time around.”

Well . . . thank you Ms. Vazza, I did not realize that the new Batman movie was going to feature a Ms. Freeze in the upcoming sequel.

The forecast for NYC is a very sunny high of 85 degrees. Take that Mr. & Ms. Freeze!

One more wake-up and a half-day for the bond market tomorrow. Almost there.

Jim Delaney

C.M.O. 5.20.2009

2009-05-20T03:42:00.000-07:00

Credit Market Overview
May 20, 2009

As the S&P does its damnedest to stay above the 900 line and the bulls root for last Friday’s close of 882.88 to be the next highest low that comes when strings of higher lows and highs attach themselves together and grow horns it is worth remembering that the 882 level had been crossed 30 times between November 20th of 2008 and last Friday. Also keep in mind that it has occurred 10 times in the last 29 trading days. Obviously 882 is making quite a name for itself in the fight between support and resistance.

Speaking of fighting, if wars are won or lost in the trenches then it is usually with a little help from above. I’m not talking Devine intervention here I’m talking about all those great contraptions that drop bombs and fire Gatling guns and shoot rockets.

The markets have had stuff raining in from on high but it seemed more inclined to impede progress than to assist it. The “stuff” of which I speak was $34BN worth of share offerings; both initial and secondary that have been brought to market over the last two weeks. Which, if you don’t keep track of those sorts of things is half the 2009 total. Closer examination of the aerial reconnaissance shows almost an equal split between the semanas of $17BN each.

$34BN worth of equity and some more “less bad” but most certainly not “great” economic data and the SPX moved from 929.23 on 5/8/2009 to 882.88 on 5/15/2009 and then moved promptly away from that much visited level on Monday to close at 909.71. Is that low rumble the hooves of the cavalry riding in or the more distant thunder of stampeding bulls?

There has been supply on the bond side as well and although totals, as provided for the equity markets above, are not readily available suffice to say that there has been over $6BN worth of debt issued already this week.

The way to measure the market’s receptiveness in stocks is price, in bond-land it’s the spread at which paper is purchased above the similarly tenored Treasury. These spreads have been doing their own equivalent of a rally, excepting that everything happens backwards in bond-land so down means up.

The benchmark for these spreads in the non-investment grade area is the Merrill Lynch High Yield Master II Index which has seen these aforementioned spreads move from 20 full percentage points above the Treasury de choix to a mere 13 since the start of 2009. If you were to translate this into price it would be like owning a bond that started the year trading at 55 cents on the dollar that is now worth 71 cents on the dollar.

This 29% return, quite a good investment during any 138 day period, looks even more spectacular when you realize that the S&P is trading right around where it sang Auld Lang Syne.

Enjoy the week.

Jim Delaney

C.M.O. 5.19.2009

2009-05-19T03:32:00.000-07:00

Credit Market Overview
May 19, 2009

Like the bedraggled hiker that catches up to the group only to have them start off again without the one who needs the rest actually getting any; Citigroup (C) issued $2BN bonds last Friday without the FDIC’s backing. The “too big to fail” guarantee, while not explicitly priced into the bonds is implicitly obvious as $50BN in TARP funds props up what would have long ago fallen down.

The $2BN issue which was over subscribed by $4BN is further evidence that 562.5bps above the 10-year Treasury that C paid investors was seen as the best ultimately risk-free risky asset for sale last week. Bid to cover ratios of 2:1 are seen as a sign of success when the Treasury itself issues debt and it will yearn, in the years ahead, for those types of numbers as it issues more and more debt. Bids for three times the amount of C paper for sale is enough to make even the Government jealous.

Citi’s CDS spread had come off its 666bps highs seen on April 1st of this year and traded as low as 343bps on May 8th. The 5 year benchmark quote was 412bps last Friday 20bps higher than yesterday’s quote. This would have put the 10-year CDS at ~373bps, about 190bps less than the market required to warehouse the Citi paper which, for intent and purposes, is white labeled Government debt. C closed at $3.64 yesterday down from $23.12 a year ago which would also be the 52 week high.

As for the group the hiker, we would say piker but there is nothing small about $50BN, was trying to catch up to? That would be Goldman Sachs (GS), Morgan Stanley (MS) and JP Morgan (JPM) who yesterday asked for approval to repay a combined $45BN in TARP funds. It should also be noted that the amount to be repaid for those three firms is less than the amount of TARP funds owed to the taxpayer by C.

A quick run through of how the troika stand. GS closed last night at $143.15 up from its March 9th low of $73.95. The CDS levels for GS were 371bps on 3/9 and 173bps yesterday. MS’s March 9th numbers were 476bps and $16.48 vs. 265bps and $28.28 last night. JPM numbers for the same dates were: 242bps, $15.90 and 110bps, $37.26

Going back a little farther the current levels for GS’s and MS’s CDS’s were last seen in early September (pre-LEH) of last year. A graph of JPM’s CDS’s looks a bit more like an EKG printout as the 110bps level, or thereabouts, has been seen a number of times over the past year. A low of 88bps was reached in mid-October of 2008 and a year ago JPM’s CDS’s were quoted at ~60bps.

How different things looked a year ago at this time.

Enjoy the week.

Jim Delaney

C.M.O. 5.18.2009

2009-05-18T03:54:00.000-07:00

Credit Market Overview
May 18, 2009

The only thing possibly shorter than a “New York” minute is a “TV” minute as the latter seems to go by in a handful of seconds and nothing even close to 60.

Having done research on the OTC derivatives regulation proposed in a letter to Congress by Treasury Secretary Tim Geithner for an appearance on CNBC’s Fast Money on Friday and only getting through the first two bullet points, I thought I would give you the benefit of all my hard work.

The four objectives included in the letter are: 1) Preventing activities in those [OTC derivatives] markets from posing risk to the financial system; 2) promoting efficiency and transparency of those markets; 3) preventing market manipulation, fraud and other abuses; 4) ensuring that OTC derivatives are not marketed inappropriately to unsophisticated parties.

We can lop off the last one right off the bat since the events of the last year and a half have proven that even those parties that were supposed to be sophisticated weren’t that smart at all.

As for the other three let’s go through them one at a time: 1) Preventing activities in those [OTC derivatives] markets from posing risk to the financial system. That OTC derivatives played a part in the collapse of the global financial system is similar only to removing one of the blocks out of a Jenga tower. The need to place blame for the crisis it seems is most vehemently practiced by those whose own implication they are trying to hide.

A point that is conveniently and continuously kept on the down low is that in 1998 then Chair of the CFTC Brooksley Born asked Congress for the power to oversee financial derivatives but was denied such power on the advice of then Fed Chairman Alan Greenspan and Treasury Secretaries Robert Rubin and Larry Summers. Mr. Rubin then went on to Citibank and . . . well; we all know how that turned out.

Pure plain and simple, anything that can be bought or sold exposes the buyer and the seller to risk. Buying or selling enough of it can expose the party to sufficient risk to cause that party insolvency. When everyone does it to an extreme the system itself can become insolvent. There is risk in everything we do. Know it, measure it, control it, but don’t believe you can legislate it away.

2) Promoting efficiency and transparency of those markets. Efficiency and transparency are a good thing and inspire confidence in market participants. Having OTC derivatives cleared through a central counter party should go a long way towards making necessary transaction information readily available.

There is a potential issue here, though, and that it one of multiple clearing entities. The CME and ICE are already operating separate clearing houses. Competition is a great way to find the most efficient way of getting something done. If the goal of clearing OTC derivatives is to have all of the information in one place should something untoward happen then having two or more clearing houses works at directly cross purposes to that goal.

If there is a competition to see who would be the best clearer, that is one thing, having competition between clearing entities is quite different and will only complicate things should another crisis erupt.

3) Preventing market manipulation, fraud and other abuses. There is a push, as part of the proposed regulation, to have OTC derivatives become exchange traded derivatives. Some see this as a way to bring the light of day to a market that is often accused to operating in the dark of night.

Exchanges are very good at trading standardized products. When lots of people are all trading the same thing the markets become deep and liquid. The OTC derivatives markets were not created to avoid standardization but to facilitate the needs of the corporate world. CEO’s and CFO’s are good and running companies and keeping books. They are not necessarily good at figuring out how to transfer the very specific risk they have as a normal part of their business to the market through an exchange traded product.

The sell side firms provide a service to the corporations by performing this translation with highly customized solutions. The needs of the corporations are not going to change just because there was a financial crisis. Patrick M. Parkinson, Deputy Director of the Board of Governors of the Federal Reserve told the Committee of Agriculture this very thing to last November when he said “many CDS’s will continue to be transacted other than through the clearinghouses because of the non-standardized nature of the market”. Such transactions, he said, are “integral to the functioning of today’s financial markets”.

If there is a parallel here I believe it is the Interest Rate Swap market, which by all accounts, dwarfs the CDS market in size but has never garnered similar distain. In the earliest days of the IRS market there was a single Eurodollar contract. Swap levels given to corporate clients were priced to include the risk associated with not having a direct hedge. As the IRS market grew the demand for more back month Eurodollar contracts also grew until there was a contract to represent every calendar quarter from the closest in to a point 10 years away.

Having a good source of price discovery and a liquid hedging vehicle has allowed the IRS market to grow to a size that would not have been achievable without them. A standardized CDS contract would not do away with the OTC market but could actually help it grow.

Profit margins in individual transactions might be narrowed as a result of an exchange traded contract but if the IRS market is any indication, the size of the pie should grow such that even a smaller slice will mean more to eat.

Lastly, there is the politicization of the OTC derivatives issue. Congress is hell bent on finding a straw dog for the financial crisis that they themselves helped create by allowing FNM and FRE to buy all those mortgages that were very much less than prime. FNM’s $0.78 share price and its 2Q09 loss of $23.17BN and necessary infusion of an additional $19BN of taxpayer money stands as testament to that.

In Congress’ efforts to find something to hang in effigy the risk becomes that excessively tight regulation will hamper transaction flow. Capital is like water, it will flow along the path of least resistance. If Congress learns anything from its forays on Wall St. let’s hope they learn that lesson first.

Enjoy the week.

Jim Delaney

C.M.O. 5.15.2009

2009-05-15T03:58:00.000-07:00

Credit Market Overview
May 15, 2009

. . . Slowly they turned, step by step, inch by inch. . .

No, it’s not an episode of I Love Lucy or The Three Stooges; it’s the banks and in another step towards normalcy(?) J.P. Morgan and American Express issued debt yesterday that was NOT backed by the FDIC. Besides, while I haven’t spent the time to count there are a lot more than 3 stooges in this caper.

JPM sold $2.5BN of 5 paper and American Express brought $3BN to the market successfully split between 5 and 10 year maturities. The JPM 5-year paper is a bullet with a 4.65% coupon and came at 275bps over the current 5-year TSY. The benchmark CDS on JPM was quoted at 120bps yesterday which puts the premium for balance sheet space at 155bps. Relatively speaking, not that onerous given some of the spreads seen earlier in the year. JPM is rated Aa3 by Moody’s, A+ by S&P and AA by Fitch.

AXP sold $1.25BN of 5 year notes with a 7¼ coupon at 530bps over the current TSY of the same maturity and $1.75BN 8 1/8’s maturing in 2019 at 505bps off the curve. The CDS levels in the 5 and 10 year area were 302bps and 234bps respectively. Notice here that as we discussed with GS the other day the CDS curve is still inverted with near term protection selling at a premium to the longer tenors. AXP is rated A3 and BBB+ by Moody’s and S&P in that order.

Whether it was patriotism shown by these two firms working so hard to get themselves to a point where they can repay the taxpayers their hard earned wages or the specter of having Uncle Sam’s nose in their business that, like a coyote caught in a trap willing to chew their own leg off, picked the lesser of two evils is for you to decide. I just think it’s worth mentioning that the credit markets are becoming amenable to taking on a little risk. Although, and this is just me speaking, buying AXP paper at 500+bps off the curve doesn’t seem that risky and is probably a pretty good deal.

Besides these debt issues GS, BK and MS have all sold bonds to investors this year with GS being the first to sell non-FDIC backed paper. Additionally there has been $19BN in stock issued since the Stress Tests results were announced on May 8th and another $14BN in equity related offerings in 1Q09.

All of this adds up to roughly $670MM in fees as estimated by the WSJ, which has mostly been paid amongst the banks themselves. But, as they say; “charity begins at home”. I don’t know how this compares to the trillions of dollars in write offs but given how bleak the outlook was just a few short months ago it has to be a welcomed sign

Enjoy the weekend.

Jim Delaney

C.M.O. 5.14.2009

2009-05-14T03:34:00.000-07:00

Credit Market Overview
May 14, 2009

Away from the much publicized bankruptcy of Chrysler and, shall we say, imminent entering of Chapter 11 by GM there is an interesting story going on in the REIT world with General Growth Properties.

What used to trade under the symbol GGP has now added that moniker reserved only for those that have gone to “11” instead of heaven the dreaded “Q” and trades as GGWPQ. This is the least of it however. It seems that on its way to bankruptcy General Growth or GG for short took 166 of its malls along with it.

This was an unprecedented move as the structure of these REITs separates the parent company from the operating properties through a “special purpose entity” which makes them in legal terms “bankruptcy remote”. As GG said in court recently, it doesn’t make them “bankruptcy proof”.

As the single largest CMBS borrower in a market that is itself $700BN this is not doing good things for CMBS’s or REIT’s. “The company is doing something that would damage the entire CMBS industry. The filing for so many of these well-capitalized performing malls is an outrage,” said Richard Jones, a lawyer at Dechert LLP, which represents some secured creditors in the bankruptcy case.

As it turns out the boards of these properties are small and their memberships are drawn from the same pool of candidates creating a lot of overlap amongst the 166 properties. Not unlike the stories we hear where the Chairman fill boards seats with cronies, just replicated 166 times from a group of what has turned out to be very sympathetic ears.

Adding to the intrigue is that Farallon Capital Management LLC just won a three way bidding war to provide DIP financing to GG yesterday over Bill Ackman’s Pershing Square and the usually victorious in all situations Goldman Sachs.

The interesting bit is not that GS lost but that Farallon, as well as some of the partners in the firm are already GG creditors holding an undisclosed amount of the debt.

J.P. Morgan once said that the way to make a lot of money was to “put all your eggs in one basket and then watch that basket very closely”. It would appear that Farallon is doing just that.

Since they are in bankruptcy proceedings the CDS levels for GG have been static since the filing. The news, however, has not been good for the REIT industry as a whole. The RWR an ETF constructed to track the Wilshire REIT index closed last night at $32.40 down from a recent high of $36.58.

In CDS land the spreads for the 17 REIT’s the CEC Strategy follows are all widening or begun to do so. Although there is no guaranty that things will happen in the future the way they have happened in the past, if the negative correlation usually seen between CDS levels and stock prices holds this would lead to lower prices for REITs.

Enjoy the day.

Jim Delaney

C.M.O. 5.13.2009

2009-05-13T04:24:00.000-07:00

Credit Market Overview
May 13, 2009

In bubble history, our current dilemma is being blamed on leverage. It is leverage in the traditional sense as it involves owning things without paying for them completely, up front and in cash. The banks and (ex) investment banks have been vilified for anteing up just over 3 cents of their own cash on some positions.

If this 30:1 ratio of real to monopoly money seems extreme let us not forget that through the wonder of “stated income loans”, originally designed for the self-employed whose write offs diminish income beyond recognizable amounts, people with W-2’s were able to create money out of thin air and purchase properties with absolutely no money down by using the same financial vehicle called by a slightly different name; “liar loans”. We’ll just call that infinity:1 leverage.

The bubble that burst in March of 2000 also had involved leverage but it was of the intellectual variety. While pennies might not have bought you dollars worth of exposure “.com” was a currency unto itself and having that suffix and an IPO put you in the same league as the best and the brightest from Silicon Valley without even having to move there.

Many of the companies, with market caps reaching into the hundreds of millions, don’t exist today as many of the financial entities that lent money without checking whether there was the slightest possibility of being repaid either no longer exist or won’t by the time this is all over.

Through all of this one name in the technology space stands alone, Microsoft. It is also one of just a handful of companies left that can boast an AAA rating and it sold some bonds yesterday. All three were bullets (non-callable) and ranged in maturity from 5 to 30 years.

Institutional bond investors need diversification just as much as a portfolio manager in equities does. Being able to add a new name, especially one with three A’s tagging along is a rare opportunity so needless to say there was good demand for MSFT’s paper yesterday.

Starting with the shortest maturity let’s have a look at each issue. $2BN of 5-year notes came with a 2.95% coupon at 95bps off of the UST 1 7/8 of 2014. The benchmark CDS level for “Softie” was 37.5bps mid-market yesterday so even with MSFT we see the lingering effects of the credit crisis as physical debt is priced cheaper (higher yield) than the synthetic that can be manufactured through the CDS market.

$1BN of 10-year paper had a 4.20% coupon and was priced at 105bps off of the UST 3 1/8 of 2019. The 10-year CDS market was ~38bps mid. The longest piece of paper was $750MM of debt that matures on June 1st of 2039. It also came at a spread off Treasuries of 105bps but the Treasury in this case was the 3½ of 2039 which gave the bond a 5.20% coupon. There is no easily available CDS quote for the 30 year area but as can be seen from the Treasury curve things tend to flatten out on the far end.

Because there are so few AAA issuers and none such in the tech space I thought the best way to give MSFT’s debt sale some perspective would be to look at another piece of tech debt and also another AAA name. (Triangulation in the financial sense of the word.) CSCO sold three issues back in February; only one of those was non-callable and since we’ve already got some apples and oranges mixed in it is probably best to leave the callable paper out of this.

CSCO’s 4.95% 10-year note came at 200bps off of the current Treasury at the time while the CDS for that maturity was trading at ~100bps. CSCO is rated A vs. MSFT’s AAA. From this we can see that the extra A’s and a slightly better credit environment allowed MSFT to issue paper 95bps better than CSCO.

JNJ is rated AAA by Moody’s, S&P and Fitch, which only gives MSFT AA+, so it is most certainly a premier piece of paper to own. Adding more oranges to the apple bin JNJ has not issued a 10-year non-call bond recently so we’ll have to use the 5.15% bond maturing on July 15th of 2018, issued last June.

This paper was sold at 103bps off the current TSY 10-year at the time. Here we have account for the optionality which would have made the spread wider but also that the markets had not completely imploded by last June so credit spreads were narrower. The CDX investment grade index was trading at ~113bps on 6/18/2008 vs. ~148 yesterday so that difference needs to be taken into consideration as well.

A lot of stuff to crunch on a Wednesday morning but hopefully an exercise that helps put the MSFT’s issues in perspective.

Enjoy the day.

Jim Delaney

C.M.O. 5.12.2009

2009-05-12T03:47:00.000-07:00

Credit Market Overview
May 11, 2009

With the release of the “Stress Test” results last Thursday Treasury Secretary Timothy Geithner said that he was “reasonably confident” that the information would “make it easier for banks to raise new equity from private sources” while admitting that “we have a lot of work to do in repairing the financial system.” Concluding that “there is reassurance in clarity.”

There were a few bank CEO’s that questioned just how much “clarity” the tests actually brought with Richard Kovacevich, WFC’s CEO going out of his way to ingratiate himself with the powers that be by characacterizing the tests as being similar to the other word we use to describe a mule. Being the good CEO that he is, he got right to work and Wells was the first to issue stock after the tests were announced. And some good work it was too as WFC Wells sold $7.5 billion worth of common, above its originally planned $6 billion, or more than half the $13.7 billion indicated by the stress test.

Never one to be left too far behind John Mack jumped right on the capital raising band wagon and raised $4 billion in common equity, twice as much as planned and more than twice the $1.8 billion called for by the stress test.

One of the reasons these two firms were able to raise more than expected was that "A lot of money managers were underweighted in bank stocks relative to their benchmarks, and they've been panicked buyers because of what they see as an inflection point," says John McDonald, banking analyst at Sanford Bernstein.

Why the turn-around? “In February, some financial stocks were trading like insolvency was a foregone conclusion. The market now realizes these banks are going to survive,” said Jeff Harte, senior banking analyst at Sandler O’Neill + Partners.

Jeff’s colleague at SO+P, Brian Sterling who is co-head of investment banking added to the positive tone, “What we’re starting to hear from investors is a view that these companies were oversold and, although things are bad, they’re not as bad as was baked into the assumptions.”

Be that as it may there are others who are a bit more cautious. Joshua Seigel, managing principal at StoneCastle Partners thinks “there is some demand in the market to raise a certain amount, but whether you could find $60 billion in the next couple of months is highly unlikely.”

That is an interesting viewpoint given that “analysts at RBC Capital Markets estimate that 60% of the top 100 U.S. banks that weren’t included in the stress tests would need to raise capital based on the Fed’s loss assumptions.”
While the 19 banks that were part of the stress test have gotten most of the press they are a small portion of the 8,000 banks that exist nationwide not including the 33 that have already failed this year bringing the total to 58 since the beginning of 2008.

The goal for all of the institutions included in the stress test and the even broader category of those that received TARP funds is to pay those monies back and get back to the business of banking. Ken Lewis the ex-Chairman but still CEO of BoA is looking at a variety of ways to get Uncle Sam out of the guest room including selling business lines and other assets in addition to raising capital. “Our game plan is designed to help get the government out of our bank as quickly as possible.”

“As quickly as possible”, sounds fast; but will it be?

Enjoy the day.

Jim Delaney

C.M.O. 5.11.2009

2009-05-11T03:43:00.000-07:00

Credit Market Overview
May 11, 2009

. . . Was your trip successful Mr. Holmes? The usual, Watson, murder, robbery; crime must pay as there hasn’t been any slow down in it that I can see.

Haven’t read a paper all week better catch up on the news. Hand me my glasses please Watson. Thank you. Gee, these seem a bit different; did you get me new glasses? Yes, Mr. Holmes they’re rose colored, seem to be quite the thing, everyone is wearing them now-a-days.

Well as long as they work . . . now let’s see Tuesday, May 5th “More Banks Will Need Capital”; Wednesday May 6th “BofA Faces $34BN Gap”; Thursday May 7th “Banks Need at Least $65 Billion in Capital”; Friday May 8th “Fed Sees Up to $599 Billion in Bank Losses”

None of this sounds too good Watson; markets must have gotten pummeled this week. Well actually quite the opposite Mr. Holmes, the Dow was up 362, or 4.4%, to 8575 on the week, the S&P 500 jumped 52 to 929, its 5.9% gain the biggest since late March while the Nasdaq rallied for the ninth straight week up 20, or 1.2%, to 1739. The Russell 2000 gained 25, or 5.1%, to 512 which puts it up 46% in the last nine weeks, Sir.

That’s amazing Watson. I wouldn’t have thought the market would have interpreted the news as positive but I have to tell you Watson, I do like these glasses. Everyone’s wearing them you say? Makes sense, I do feel better since I’ve put them on.

Since you seem to have followed the action pretty closely, Watson, what went on in the credit markets?

Well Sir, 3 month Libor was set at 93bps on Friday, which was the first time it has been below 1%. Below 1%, Watson, has that ever happened before? No Mr. Holmes, it hasn’t and if you remember it was as high as 4.87% just last October.

So Treasuries rising as well, Watson? Only the yields Sir, which you know is not good for prices. Yes, I know Watson, yields up; prices down, go on. Well Sir, Government debt is trading at yields we saw last November with the 10-year yield rising 13bps this week closing on Friday at 3.30% and the Long Bond yield rose even more, 19bps, which put that rate at 4.28% late Friday. People do seem to be concerned with how much debt it will take to finance the stimulus package, Sir.

So has that pushed up yields on Corporate debt as well Watson? No Mr. Holmes, spreads actually came in last week. Those CDX indexes you follow, well the Hi-Yield number is down to 1010 after closing last Friday at 1123 and the Investment Grade numbers were 143 this Friday versus 164 last Friday.

Well seems like people aren’t concerned about too much then Watson. Come to think of it, there probably isn’t anything to worry about. Where did you say you got these glasses from Watson?

Enjoy.

Jim Delaney

C.M.O. 5.8.2009

2009-05-08T04:13:00.000-07:00

Credit Market Overview
May 8, 2009

The free marketers . . . yes, I know it Friday morning but I said “free marketeers” not “three musketeers” have been clamoring lo’ this entire crisis of credit, confidence and confusion to let the forces of supply and demand do what they do so well and allow evolution sort out who really belongs on the next branch of the financial tree.

Dwight D. Eisenhower warned in a speech in 1961 of the growing symbiotic relationship between the military and the nation’s private corporations. The line from that speech that best sums Ike’s message is as follows: “In the councils of government, we must guard against the acquisition of unwarranted influence, whether sought or unsought, by the military-industrial complex. The potential for the disastrous rise of misplaced power exists and will persist.”

A little known fact here is that DDE originally named the issue by its three sources, military-industrial-congressional complex but removed the final element as that was the same august body the President was delivering his speech to and fellow Republicans did not want to deal with the repercussions of its inclusion.

There is at the very least the possibility for this same co-dependent relationship to form, if it hasn’t already, with our present day leaders owning portions of the institutions other offices of the government are supposed to regulate. The first evidence comes as the CEO of GM is ousted and the manner in which the surviving banks do business is examined at more microscopic levels.

It is good, in all of this, that there are some who are chomping at the bit to repay the Government its money and get on with their business. It is also interesting that the current plan for when to let that happen has elements that make sense from an economic standpoint.

The major obstacle or in the politically correct vernacular, challenge, that the banks must overcome before paying back TARP funds is the ability to issue debt without the FDIC subsidy, TLGP. Ah, Darwin at his finest!

For an example of what this means, economically, we need look need look no further than the poster-child for the financial-congressional complex, Goldman Sachs. GS recently issued $2BN five-year notes sans TLGP at around 4.1% over the 5-year T-note. A few weeks prior they issued some three year paper at 2.17% over the 3-year T-note.

Now, just so we don’t get the apples to oranges rebuttal let’s go to the CDS curve for GS to make apples into oranges or vice versa. The mid point of the 3-year CDS market in GS was 217bps as of last nights close, the 5 year CDS; 196. I will talk about this inversion in a minute but one thing at a time.

The difference between the two CDS tenors is 20bps. This would mean that 3-year GS paper sans TLGP should be around 410bps – 20bps or 390bps off of Treasuries. This compares to the 217bps the TLGP paper was issued. In this case the market is requiring 173bps of additional yield to compensate for not holding the FDIC’s hand. That equates to $17.3MM per BN issued more interest expense per year. On last year’s balance sheet GS had ~$185BN of long term debt. 173bps on that comes to about $3.2BN. Not an insignificant amount.

A firm like Goldman might be able to earn its way through the additional interest expense and could believe doing so is well worth the distance it would buy from Congress’ prying eyes. Others might not be so fortunate but if the goal is to get the credit markets flowing again maybe only those who can ride without training wheels should be allowed to ride alone.

OK, a quick bit about the CDS curve inversion and then it’s off you go. The difference between the 3 and 5 year CDS’s I mentioned before was 173bps. Looking at a wider maturity range we see an even wider disparity in the CDS levels as 6mos CDS for GS closed at 255bps mid last night while the 10-year closed at 165bps mid, a difference of 90bps.

That the 6mos level is higher than the 10-year level seems to run counter to all the “liquidity preference theory” stuff we learned in ECO-101, buy why? Very simply, and quickly, people are willing to pay more to insure against a GS default in the next six months than they are for 10 years because they see the default risk higher for GS in the short term. It’s one of those; “if we can just get through this we’ll be OK” sort of things.

So there it is a little history, a little economics and way too long before the weekend starts.

Enjoy.

Jim Delaney

C.M.O. 5.7.2009

2009-05-07T04:19:00.000-07:00

Credit Market Overview
May 7, 2009

The Oracle of Omaha said in his Op/ed piece in the NY Times last October that “a simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful”. Fittingly WB wrote that in the middle of a month that has some of the worst stock market memories history has known. The S&P closed at 940.55 on October 17, 2008 and if you pulled a “Van Winkle” between then and now you’d think: Not bad Warren, down a little over 2% but you’ve been down at least that much with your positions in Coke, and Salomon Brothers, back in the day so I’m sure you’ll be fine.

What you would have missed is the harrowing trip from the mid 900’s to the mid 600’s and back and while we will never know how greedy Mr. Buffett or anyone else was down where the devil plays it does make sense that capitulation came when everyone stopped looking for it and started looking for the nearest exit.

The rush to get out does not seem to have been countered by a rush to get in but the few brave souls that have ventured to the long side haven’t had to push very hard to move things up a fair amount in the process.

In some cases it might be argued that the only bravery needed was to keep the algorithm running, shut your eyes and hope for the best. Like the people who close their eyes and step on the gas when they have to pass a big truck on the highway; I might die doing this but at least it will be over quick!

It has also been interesting to see what has moved in this move and how some of the most time tested and oft-repeated axioms have once again held true. (How else to you get to be time tested and oft-repeated?)

“What leads you down will lead you up” comes to mind with the financials up 100% off their lows they have definitely been the poster child for this entire cycle. The Nasdaq too, made up of about 100 names you do know and many more you don’t, is far out pacing the broader, “higher quality” some might say, indexes.

This has also proved true on the fixed income side of things as High Yield bonds a.k.a. Junk is up 11.47% as a whole but digging a bit deeper we see that the stuff close to the border (BBB=good; BB=not so much) is up only about 7% while deep down in CCC land the price of paper has risen about 22%. For those not completely familiar with the ratings latter triple C is still three notches off of the bottom rating of D. (The numbers here are taken from the Merrill Lynch High Yield indexes.)

The warning that most often accompanied the hype of “spreads of 20% over Treasuries available on Junk bonds” a months or so ago was that the wave of defaults coming would do more damage to a portfolio of high yield bonds than the high spreads could fix.

This has not proved to be the case thus far as the HYG ETF a more readily trackable proxy for a portfolio of Junk was up almost 14% in April while 40 individual issues defaulted including the headline grabbing Chapter 11 filing of Chrysler in the last week of the month. HYG started the year at 76.01 and closed yesterday at 76.66 (let’s call it even for the year) while a total of 102 issues defaulted.

Steady and still floating looks a lot better than swamped and it’s also nice to see that through the worst of the storm the part of the bond market that is supposed to deliver “equity like” returns is doing just that.

I truly doubt we are out of the woods just yet and cannot get Marc Farber’s comment that “a true bull market never stands on one leg” out of my head. In present context that would mean a revisit to something near the devils playground. It also needs to be recognized that with stocks and bonds moving higher in tandem the progress the markets are making is balanced and that is never a bad thing.

One more wakeup!

Jim Delaney

C.M.O. 5.6.2009

2009-05-06T04:22:00.000-07:00

Credit Market Overview
May 6, 2009

Ever since Bear Stearns was medivac’d to the intensely expansive care unit at J.P. Morgan the markets have had to contend with processing not only the abnormal changes brought on by a global financial system moving quickly from Code Blue to Code Black (the latter being a D.O.A. without the O.A.) but the ad-hoc efforts of the Federal rescesitators trying any number of methods and approaches to keep the global economy from flat lining.

I have tried, in that time; to relate how changes on the credit side of things were affecting things on the equity side. I might have also slipped once or twice in the process with a snide remark on any given initiative’s purpose or actual effectiveness versus the spiel given to sell it to the taxpayers or the leaders of other nations.

As such and in the spirit of callin’em like I sees’em there were some interesting announcements this week that I think are worth relating here as they pertain to the credit markets and the possible first warm rays of sun they are feeling even as we here in New York slog through weather that seems more appropriate for early March than early May.

The news that really caught my eye was the release of lending numbers for the Small Business Administration. Some of these are for the period from January to mid-March which, given that we hadn’t even hit the lows in the stock indexes yet, make them all that more impressive.

The bellwether category for SBA loans is the 7(a) program. For this type of loan the average number of approvals has risen 28% to 796 totaling $796MM from 622 loans totaling $117.9MM in January. Additionally, since the mid-March date SBA administrator Karen Gordon Mills says the volume of new loans has risen another 20% to about $1.3BN. “We’re looking at that as certainly not conclusive that everything is fixed, but we may be turning a corner” SBA spokesperson Mike Stamler said.

Some of these SBA loans are bought and sold on GovGex.com an online secondary market exchange for bundled SBA-backed loans. According to the Government Accounting Office 35% of the loans approved in the 7(a) program were traded on the exchange in February up from 24% in January. To give you a bit of perspective, 45% of these same such loans were traded during the September 2007 – September 2008 period. Giving the quantitatively inclined a shiver you might say we’re halfway back from Code Black. Also encouraging is that the number of bids per loan has more than doubled to about 6.7 since mid-March.

The increase in volume and activity can be attributed to a few things including a mid-March speech by President Obama’s in which he indicated the allocation of up to $15BN in federal funds to unfreeze the secondary market for these loans as well as a temporary reduction in the fees paid by small business borrowers and an increase in the federal guarantee of these loans from 85% to 90%.

I don’t have the stat’s handy at the moment but we’ve all read the percentage of people employed by small businesses and the ripple effects (I’m talking positive here folks.) that growth in small businesses can have on the community and the economy as whole.

Beyond that any sign of credit moving more freely has got to be welcomed.

Enjoy the week.

Jim Delaney

C.M.O. 5.5.2009

2009-05-05T04:02:00.000-07:00

Credit Market Overview
May 5, 2009

We’ve all heard the market adage that a bull market climbs a wall of worry. I’m thinking they should change that last word to “wonder” as the move off of the March lows has been spectacular to say the least and if you can believe the media (rhetorical question) one that has left many wondering: “How did I miss that move?”

The “fake it till you make it” crowd also seems to be gaining some credibility as last month’s better than expected Industrial Production and GDP numbers in China were given an eye-roll by most as it was ventured that the long/strong arm of the government in the People’s Republic could manufacture economic statistics with the same efficiency that the factories there produce washing machines. (Disbelief runs deep after you see C trade at 79 cents.)

That there was so much emphasis on the personal consumption numbers portion of our own GDP figures last week seemed an equally implausible effort at making believe the car was running fine when it was just rolling down hill. All of this incredulity was given a jolt yesterday as the PMI index for China’s manufacturers came in at 50.1.

There is no doubt the car was rolling down hill but now the question must be asked whether it was to gain some momentum before popping the clutch and could the global economic engine, long thought to be China on the next leg up, be sputtering to life?

The move in the indexes, did leave some at the station but regardless of how little the financials now count in the indexes the move in the previously mentioned C from a low close of $1.02 on March 5th to $4.01 on the day before most of us pay our taxes, sans the head of the IRS of course, was a something only those who jump out of airplanes without parachutes would have participated in.

For all of the talk of the three letters of recovery; V, U and L, the last of which looks very little like a recovery at all, there has been adamant discourse about why this one [recovery] won’t look like the first one [V]. To the extent that this whole thing is far from over, the sliver of market time Feb 13th and March 23rd looks pretty “V” to me.

The credit markets experienced a bounce of their own during this period but only if you look at prices ass spreads look more like the ball was thrown against the ceiling. Here too the most drastic moves were in those bonds that looked most deadly, or really just mostly dead.

Laurence Fink, CEO of Black-Rock, said recently that the low yields on Treasuries was pushing investors further out the risk spectrum and in the time just past that meant paper branded CCC. Most of this paper was trading below 50 cents on the dollar while the S&P was clicking off triple sixes and the postponement of Armageddon has done for these bonds what it did for stocks and as such yields came down as prices rose.

We’re back to even, or thereabouts, on the year if your yardstick is the S&P. So far, so fast both down and up it’s been like getting caught in a revolving door and winding up right back where you came from.

The question is where do we go from here?

Enjoy the week.

Jim Delaney

C.M.O. 5.4.2009

2009-05-04T03:20:00.000-07:00

Credit Market Overview
May 4, 2009

The precipitous drop in real estate values, both residential and commercial is a pretty good indicator of just how much fluff the easy credit in the first part of this decade created. Confirmation of this, as if some were needed, can also be found in the art market. In 2006 a single painting by Pablo Picasso sold at Sotheby’s for an even $100MM.

This coming Tuesday, when the spring auction season starts, there are a dozen works, that if all sold at the high end of their estimates, might just make it to that same 9 figure number. The estimate for the entire spring auction series is expected to generate somewhere between $179MM-$256MM versus $411MM last fall and $742MM a year ago. What a difference a year makes!

For those of us who can only dream of making $100MM in a life time let alone pay that amount for a little binder, pigment and canvas, mortgage rates matched the record low rate set two weeks ago of 4.78% for a 30-year fixed rate loan according to Freddie Mac. In its quarterly refinancing report FRE said that about half the borrowers who refinanced lowered their annual interest rate by about 20%.

What makes this a little more interesting, if you can stand the suspense, is that the move in mortgage rates occurred during a week when the yield on the 10-year Treasury, the note used as the benchmark for mortgages, rose to its highest level in 2009. The latter caused in part by the record $71BN in 10 and 30 year securities to be auctioned by the Treasury in its May refunding. The other factor pushing Treasury yields higher was the sale of those securities by mortgage investors.

Investors in the mortgage market use Treasuries to adjust the duration of their portfolios. As rates in general rise the duration of mortgages tends to lengthen as less refinancings occur. To counter this effect players in the mortgage market will sell Treasury securities. The move higher in the 10-year note yield caused some of this duration adjustment. “It’s either happening, or it’s the fear of it happening and people not wanting to get caught in the trade”, Adam Brown of Barclays Capital said.

In this case it seems to have been caused more by the fear as the move down in mortgage rates would only serve to increase the number of refinancings, bringing in the duration of the mortgage backed securities. The movement in opposite directions for Treasury yields and mortgage rates also served to narrow the spread between those two securities and as we all know from reading this column every day narrower spreads occur when there is less perceived risk in the market place.

Enjoy the week.

Jim Delaney

C.M.O. 5.1.2009

2009-05-01T03:57:00.000-07:00

Credit Market Overview
May 1, 2009

The economic numbers yesterday continued to paint a less than sunny picture for the economy but from the market’s reaction to the recent statistical releases it would appear that investors are not only wearing rose colored glasses but that those glasses also have photo-chromatic lenses which increase the intensity of their “rosiness” as the news becomes less so.

Much has been written of the political wrangling going on over spending the stimulus money which is serving no other purpose than to delay the small portion of funds (20%) actually scheduled for this fiscal year.

Through all of this however there is a ray of light on the horizon and like the sun it comes from the east, only this east is the Far East and its source is China.

I do not speak or write Mandarin but I’m thinking the symbols for the phrase “shovel ready” must look like the outline of a crane (not the bird) and a bulldozer as just 11 days after the Chinese government approved a $930MM tunnel, bridge and expressway project in East China drilling equipment was already on site.

Where this helps the good ‘ol U.S. of A. is in places like Peoria Illinois; home of Caterpillar Inc. (CAT). James W. Owens left his [rose colored] glasses off when he spoke on a conference call following CAT’s 1Q09 earnings announcement on April 21st saying that plunging sales and the cost of thousands of layoffs were the factors contributing to the company’s first quarterly loss in 17years. He made specific mention at the time that he thought the Obama administration “should have allocated more money for public works under its stimulus plan”. Jim was equally less than optimistic when asked to project CAT’s full year sales and profit as it was at that time “extremely difficult to know how our customers will respond”.

Varying slightly from the well known song title, what a difference 11 days makes. A more recent conversation with Jim found him very much upbeat as CAT’s “excavator sales in China have returned to record levels in recent months, bouncing back from plummeting sales over the winter”.

When asked about future prospects from the land of a billion people he said China continues to have a great need for infrastructure and that projects there could start much more quickly there than could similar projects in the U.S. “It’s something like nine weeks in China versus nine months in the U.S.”

CAT’s CDS/equity relationship is a text book example of the negative correlation these two markets are supposed to exhibit. Additionally, given that the company’s fortunes are tied to global growth a chart of the two price streams represents a short history of the effects of the crisis we have experienced over the last 20 months or so.

With CAT’s CDS continuing to move lower from its March high of 427bps and the stock climbing off its March 2nd low of $22.17 (154bps, $35.58 as of last night’s close) things seem to be improving for CAT.

Who knows, maybe this recovery will have one of those little stickers on the bottom that says: “Made in China”.

Enjoy the weekend.

Jim Delaney

C.M.O. 4.30.2009

2009-04-30T03:48:00.000-07:00

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

2009-04-29T04:10:00.000-07:00

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

2009-04-28T04:21:00.000-07:00

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

2009-04-27T03:34:00.000-07:00

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

2009-04-24T03:36:00.000-07:00

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

2009-04-23T03:44:00.000-07:00

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

2009-04-22T03:08:00.000-07:00

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

2009-04-21T02:57:00.000-07:00

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

2009-04-20T03:53:00.000-07:00

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

2009-04-17T03:30:00.000-07:00

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

2009-04-16T03:54:00.000-07:00

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

2009-04-15T04:04:00.000-07:00

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

2009-04-14T04:09:00.001-07:00

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

2009-04-13T03:41:00.000-07:00

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

2009-04-09T04:21:00.000-07:00

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

2009-04-08T03:47:00.000-07:00

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

2009-04-07T03:41:00.000-07:00

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

2009-04-06T04:07:00.000-07:00

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

2009-04-03T02:35:00.000-07:00

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

2009-04-02T04:08:00.000-07:00

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

2009-04-01T04:24:00.000-07:00

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

C.M.O. 3.31.2009

2009-03-31T04:09:00.000-07:00

Credit Market Overview
March 31, 2009

This morning the U.S. Department of Agriculture issues its spring-plantings report. This will provide a window into the planting plans of the nation’s farmers. The major choices here, given the concurrent growing seasons, are corn and soybeans. The major factor, this year at least, is cost.

Producing high bushel per acre numbers when growing corn requires more fertilizer, also known as Anhydrous, than growing soybeans. For the City Mouses among us that might not mean much but the Country Mices know that NH-3 is one of the key factors in the cost per acre of things grown (you still have to run the tractor and harvester over the same ground regardless of what you plant) and hence is a major contributor/detractor of profit margins.

With things as tight as they are all over these days the farmers are going to be keeping a watchful eye on costs. The other side of coin, however, is what they can get for what they’ve grown once they’ve grown it. Soybeans traded as high as $9.1475 a bushel (basis December) last week up 10.5% recently but have been trounced by Corn’s 14% gain moving from $3.0825 on March 2nd to $4.3475 last week.

The early estimates for today’s report are show that farmers will probably increase the acreage devoted to soybeans by about 3.5MM and reduce corn’s acreage by about 1.5MM.

This might be seen by some as the simple forces of supply and demand at work but even with the demand for gasoline down the federally mandated amount of ethanol that needs to be produced is higher for 2009 than it was in 2008 therefore taking more of what ever corn is produced off the market. (We will leave alone for the moment the disaster that the whole ethanol initiative has been in the United States.)

The point in bringing this up this morning is inflation. “Beans” as they are affectionately called by those who grow them might be cheaper to put in the ground but corn is what is used by the food industry. Lower acreage numbers and a higher ethanol requirement will push prices for the corn that remains up which will force the Kellogg’s and General Mills of the world to pass through the cost increases or suffer lower margins.

The rumbling surrounding inflation due to the amount of money the Fed is pumping into the system is already growing. The counter to this, some say, is that the length and depth of the recession is more likely to cause deflation. That debate will only be decided in hindsight.

It does seem logical that lower supply and equal to higher demand could put some upward pressure on corn prices. How that ripples through the economy raises, once again, the specter of “unintended consequences”.

Enjoy the week.

Jim Delaney

C.M.O. 3.30.2009

2009-03-30T03:02:00.000-07:00

Credit Market Overview
March 30, 2009

When success depends on repeating a specific function with precision, minor variations in execution can wreak havoc with performance. Brain surgery, sports, and trading all come to mind. While trading is the least physical of the three, keeping one’s mind in the game is just as important when making split second decisions as it is when trying to hit the high inside fastball. When things are not going right, the place we are most often told to go is “back to the basics”, that is of course, when it’s not “to the locker room”.

Going back to the basics with regard to our current two outs in the bottom of the ninth, bases loaded, down by 3 runs, full count situation means looking for improvement in the two things that got us here. While I’m open for suggestion my candidates would be housing and the banks. Since the question of which came first is similar to the age old dilemma between the chicken and the egg I’m going with housing today.

There was recent news from Mountain House, CA of improvement in the home prices of that 2,600 unit master planned community which was followed by the announcement of a +5.1% MoM change in Existing Home Sales by the National Association of Realtors vs. an expected decrease of -0.9%.

Also of late, the Federal Housing Finance Agency reported that house prices rose 1.7% from December to January while the NAR’s Affordability Index (173.5 preliminary for February) is now 67% off its lows for this cycle and 52% above its 1991 year-end level after the 1990-1991 recession.

This was followed Friday by KB Homes’ (KBH) announcement of a “sharply” narrowed first quarter loss aided by fewer right downs and a 26% rise in net orders; the latter a result of reductions in cancellations. (Now before my perma-bear friends accuse me of going soft, I’m just talking about the news being less bad, not good, just less bad.)

The key to KBH’s recent success it seems is that they have been offering smaller, more affordable homes as a way to stay in the game while foreclosure sales push prices to bargain basement levels. “Homes must change with the times,” President and CEO Jeffrey Meager said in a recent earnings call adding that the “revamped” models will account for 50% of deliveries by year end.

Individual business strategy is a good way to differentiate yourself from your peers but it never hurts to fly with a tailwind and that extra push is being supplied by none other than Ben & Co. at the Federal Reserve. “The Federal Reserve’s announcement that it intends to purchase Treasury securities over the next six months caused bond yields to drop and mortgage rates followed.” Frank Nothaft, FRE CEO said recently.

“Rates for 30-year fixed mortgages peaked last year at 6.63% on July 24.” He continued, “With the most recent average 30-year fixed-rate mortgage, the interest rate difference is almost two percentage points; which amounts to a savings of about $225 in monthly mortgage payments for a $200,000 loan.” N.B. The average 30-year fixed-rate mortgage for the week ended 3/26/2009 was 4.85%, the lowest since FRE’s weekly survey began in 1971.

Take heart perma-bears, all is not, as the song goes; Sunshine, Lollipops and Rainbows. First there is the question of what happens if the recent improvements in housing turn out to be temporary. Peter Eavis reported in the WSJ that “policy makers fear that another downturn in housing prices could trigger a correlative increase in defaults, increasing foreclosures and forcing prices down even further”.

There is also the question of whether people are willing to take on new mortgages when the current raison d’être is to de-lever. During the ‘90-‘91 recession, personal disposable income covered 114% of household liabilities; that number was just 75% at the end of last year.

The other fly in the ointment is the jobs outlook. With non-farm payrolls decreasing by 650,000+ in February and a total of 12.5 million people out of work, not counting the “under-employed” we hear so much about, the propensity for even those with jobs to incur major expenses continues to ebb.

Data on delinquencies is not going in the right direction either. It appears defaults are now rising on loans made prior to 2006 when lending standards deteriorated quicker than good intentions at last call. First American CoreLogic reports that in January of this year Alt-A loans made in 2005 defaulted at a 4.2% rate up from 0.64% in January ’08. FACL also said that prime mortgages that didn’t qualify for FNM or FRE purchase were defaulting at a 0.56% rate vs. 0.07% in the same period a year ago.

The road ahead could also prove bumpy for KBH and other builders as the well of previously paid taxes begins to run dry. Loss-making companies can collect refunds on tax payments made over the previous two years. KBH is estimating a $220MM refund on that basis this year. Next year however, the refund bucket comes up with nary a drop.

Another builder, DHI, is expecting $677MM this fiscal year based on previously paid taxes and was lucky(?) enough to have paid taxes in 2007 so it will be in line for a similar albeit smaller refund next year. Beyond that only an improving economy can provide the foundation for profits.

Bringing this all back to the correlation between credit and equity; KBH’s stock price bounced off of the $8.00 level first set in November of 2008, in early March of this year and has since risen to $15.05, its closing price last Friday. The CDS market had not given a clear confirmation of that buy signal as CDS levels on KBH actually rose from 3/3/2009-3/9/2009 as the stock moved off the $8.00 support. The CDS price fell from 3/9/2009-3/18/2009 but leveled off before rising again on 3/23/2009.

The CEC Strategy requires consistent, negatively correlated movement between the CDS and equity to trigger buy and sell signals. The noise between these two markets in KBH at the moments brings to mind Robert Rodriquez’s of First Pacific Advisors response when asked if there was a key to his investment ethos. His mantra he said was “winning by not losing”.

Enjoy the week.

Jim Delaney

C.M.O. 3.27.2009

2009-03-27T04:22:00.000-07:00

Credit Market Overview
March 27, 2009

“Still waters run deep.” The origin of this statement comes from the fact that shallow rivers are rough with waves as the rocks are close to the surface. Deep rivers have a lot of water between the rocks on the bottom and their smooth surface. Additionally, while appearing placid they move much more water towards the sea.

Events this week have proved this to be true once again as the congressional henchmen (p.c. henchpeople) noisily took swipes at Ben and Tim over monies promised to people that had not caused the problems but signed on to bring AIG to an orderly end.

Ben Bernanke always seems especially uncomfortable during those hearings as it just might be possible that his studies of our Great Depression and the Japanese economy in the 1990’s puts a lot of water (knowledge) between his outward demeanor and the giant boulders he knows this economy is coursing over at the moment.

With this in mind Ben had an interesting answer to the question “What keeps you up at night?” during a recent television interview. It wasn’t anyone of the myriad problems he is contending with on the surface these days. Instead he said, “The biggest risk is that we don’t have the political will, that we don’t have the commitment to solve this problem and we just let it continue. In which case, we can’t count on recovery.” I will leave you to decide how shallow or deep that statement is but I thought it had a pretty smooth surface.

Speaking of hidden rocks, I attended a talk at the NYSSA last night which was titled “The Investment Process”. It was an enlightening and informative evening and the speakers included Jason DeSena Trennert of Strategas Research, Steven Frenkel of eponymously named Associates Inc. and Mark Sladkus of Red Lighthouse Investment Management with David Darst MD Morgan Stanley as the keynote speaker.

It would take too much space to review the entire evening but I will share a few things with you here. Jason Trennert believes the investment process [in equities] is moving from an income statement focus to one focused on the balance sheet. I include this because this is one of the major tenets of the Credit Equity Correlation Strategy I have developed as it looks at the CDS market to generate buy and sell signals for equities.

David Darst, as many of you know from his frequent appearances on television, is a wonderful speaker with an engaging personality and had the audience in stitches more than once.

But since this is about rocks in the water I must say that Steven Frenkel’s segment was the most foreboding. Steven is a technician, which begs the question as to how he got to speak to a room full of CFA’s, and has studied market movement going back to ancient Rome. Steve’s specialty is the 75-year cycle (still waters, my friend) and he says that the move down in the stock indexes in 2008 broke a trend line going back to . . . . you guessed it, 1933.

He had presented his work to a group about a year ago and his talk last night compared what he said would happen vs. what happened. I believe the term “spot on” will attest to his accuracy. Steve was also nice enough to inform the crowd that the 75-year cycle just ended was the 5th 75-year cycle and that what happens after the 375th year is the Mac Daddy of 75-year cycle reactions.

Many pundits have suggested moving financial assets into physical assets such as cash and gold held in safety deposit boxes. To the extent that this is the modern equivalent of digging a hole and putting your money in it I can say that after hearing Mr. Frenkel speak I wanted to dig a hole and put myself in it.

Enjoy the weekend.

Jim Delaney

C.M.O. 3.26.2009

2009-03-26T03:12:00.000-07:00

Credit Market Overview
March 26, 2009

In a sequence, were it scripted by Hollywood would not be believed, the media’s attention focused Tuesday on Messrs. Bernanke and Geithner tied to the stake as Congress fanned the flames and another episode of “Wall St. Witch Hunt” unfolded only to be followed yesterday by Jake DeSantis’ now famous resignation letter printed initially in the Op/Ed section of the New York Times but touched on by every news outlet by day’s end.

The pundits have been searching for capitulation since after Bear Stearns collapsed over a year ago and while still not evident in the indexes the 48 hours that encompassed Tuesday and Wednesday could well have been the equivalent if there was a measure for populist sentiment.

With all of the vilification those in the world of finance have received for assisting Congress in it’s quest to have every person in all 50 States own a home regardless of whether that was a prudent goal, given the pertinent economics, no one had cast the white light of truth on those on the dais.

No one until the people at the Essential Information and Consumer Education Foundation produced a recent report titled “Sold Out”. It has not been possible to read the entire 231 page report since first learning of it and this writing, but I will share with you a few fun facts:

From 1998-2008 the financial sector comprising the finance, insurance and real estate industries, contributed a total of $1.738BN to various political candidates. Additionally the group spent $3.3BN on officially registered lobbyists.

This was made up of $154MM in campaign contributions and $383MM in lobbying by Commercial Banks, $81MM and $122MM in those respective categories by Accounting firms, $220 and $1.1BN by Insurance companies and $512MM by Securities firms.

These numbers flowing from Wall St. to Washington do not exonerate the former in any way but just as important they provide at least a reasonable base from which to question whether those doing the skewering on Tuesday had not feasted on the spit-roasted pig themselves.

I quoted a line from Shakespeare’s Hamlet earlier this week with regard to the AIG mess but now it appears the age old advice that “people who live in glass houses should not throw stones” might be more appropriate.

It is hoped that Mr. DeSantis’ letter of resignation will once again allow all parties involved to focus on the real problem at hand and for a clue as to what that is we need only to remember the catch phrase from Bill Clinton’s 1992 campaign. “It’s the economy, stupid”

One more wake-up.

Jim Delaney

C.M.O. 3.25.2009

2009-03-25T03:55:00.000-07:00

Credit Market Overview
March 25, 2009

Wall St. has often been described as a jungle and from the stories we read as children we have been told that the lion is the King of the Jungle. If, for the sake of argument, we accept these as true then in his day, George Soros was a lion. Mr. Soros contributed a piece to the WSJ Op/Ed section yesterday on the CDS market and what changes he feels should be made in the way it operates.

Before addressing the specifics of Mr. Soros’s suggestions I think it is important to review what exactly it was that made George a lion in his time. In 1992 George thought the British Pound was over-valued and began selling the currency short in hopes of profiting from his view. It is equally important to note that GS was operating in the FX market which, while deep and liquid, is to this day one of the least regulated markets that exists.

George built a position of over $10BN pounds using the cash as well as OTC derivative markets and eventually forced the Bank of England to withdraw from the European Exchange Rate Mechanism (a pre-cursor to the Euro) and devalue the pound. Taking on a nation’s central bank is a courageous thing to do but in order to win Mr. Soros could not concern himself with how his actions would affect millions of work-a-day Brits or the effects of his actions on the British economy. It is, after all a jungle and a lion must eat.

Given his past accomplishments I found George’s opinions on what changes should be made to the CDS market not completely in line with someone who has proven by his actions to be a champion of free markets.

Early in his piece GS rightly describes the reason for AIG’s demise as the selling of large amounts of CDS’s without properly hedging its exposure. Very shortly after that, however, he says that AIG would not have gone under if people that did not own the underlying bonds were not allowed to participate in the CDS market.

With all due respect to Mr. Soros I am going to debunk that premise immediately before reiterating the points I raised after Mr. Santoli offered a similar solution in Barron’s a few weeks ago.

AIG became insolvent because of the first point George mentions. They did not manage their risk correctly. The amount of protection AIG wrote, however, was less than the total issuance of CDO’s that existed at the time so AIG problems were not caused by an amount of open interest in the CDS market greater than the existing paper. They were caused, plain and simply, by AIG management who demanded that the Financial Products unit generate $1BN in revenue per year regardless of the risks attached. Therefore limiting CDS participation to bond holders only would not have changed the outcome for the CDS poster child of the credit crisis.

Yesterday’s Op/Ed piece also sites the limiting of CDS purchasing to bond holders as a way to prevent bear raids on the likes of Bear Stearns and Lehman Brothers. George Soros conducted a bear raid on an entire nation. He did so because he thought the currency was over valued and he did so by selling that currency short in what ever form he could; the cash market as well as non-exchange traded currency swap and option contracts with banks and investment banks as counterparties. Additionally he telegraphed his move through the press so that without actually colluding he made it easy for others to jump on board his trade adding even more ammunition to his assault.

As it turns out Bear Stearns and Lehman were proper targets of bear raids as their management’s, like AIG’s, mismanaged risk. I think George, of all people, would agree that regardless of the rules in place there are ways to express one’s views in the market place and to profit by them. In other words; where there is a will there is a way.

I also agree with George that the CDS market needs regulation. Not because the product itself is poorly designed but because the participants in that market place have proven that greed rules until fear takes over. (I am not denigrating greed here, just stating one of the basic concepts of the jungle.)

As for what kind of regulation would work best I offer here the same suggestions I made back on March 9th:

1) Place position limits on all participants that don’t own debt on the entity in question. (This is not to be confused with holders of short positions in the paper.) These position limits should apply across all asset classes on a combined basis so that someone shorting the stock cannot get around the reporting requirements for equities by using a combination of instruments to acquire a larger short position than otherwise possible given the reporting rules.

2) Holders of debt on an entity should be allowed to hedge 100% of their net long holding and any amount, up to but not exceeding, the limits described in 1) above.

I am not convinced that CDS contracts need to trade on an exchange as the well-oiled machine that is the foreign exchange market trades and settles Trillions of dollars of exposure a day without cataclysmic affect. The populist movement en vogue today will probably require the politicians to make this happen. The ICE and CME have already set up clearing entities. My feeling here is that the participants in the CDS market brought this on themselves and now they will have to live with the consequence.

I am still curious as to why George Soros, vacuus par speculator that he was has turned away from the thing that made him great. The lion is old, yes, but one has to wonder; is he sharpening his claws or looking at his paw to see where they used to be?

Enjoy the week.

Jim Delaney

C.M.O. 3.24.2009

2009-03-24T04:04:00.000-07:00

Credit Market Overview
March 24, 2009

Steve Kroft admonished President Obama while interviewing him this past Sunday evening on 60 Minutes for mixing laughter with his discussion of a financial system that, even with the market’s latest run up from its March 6th lows, is still in precarious shape at best. “Are you punch drunk?” Kroft asked the President at one point. “No, No. There’s got to be a little gallows humor to get you through the day.” The President chuckled.

If there are laughs to spare someone should share one with Barney Frank whose latest solution to recovering the 0.0001th of the money the government has pumped into AIG is to sue the firm as a shareholder. If there is one thing Mr. Frank should know it’s that getting lawyers involved costs both time and money; neither of which AIG seems to have enough to spare at the moment. It brings to mind the line in Hamlet that ends “doth protest too much, methinks”.

Secretary Geithner did not spend any time on the lighter side of things during his interview with the Wall Street Journal on Sunday. He did, however, out line his plan (this time with specifics) for introducing private capital into the process for alleviating toxic assets from the balance sheets of the countries weakened banks. The market voted in favor of the plan, at least for one session, as the S&P index racked up gains that put a “7” handle on the percentage change number.

Accentuating the positive yesterday was the MoM change number for Existing Home Sales which increased 5.1% between January and February vs. an expected decrease of -0.9%.

While well aware that care must be taken when examining existing home sales numbers because of the foreclosure issue a look at the recent housing situation in Mountain House California by the Wall Street Journal might provide some clues as to what kind of progress is being made out where real people live in real homes.

At one point last year 90% of the mortgage holders in this 2,600 unit master-planned community owed more on their homes than the homes would sell for. 2009 has seen a bit of a turn around however as sales by one builder are already 30% over the run rate for all of 2008.

A couple bid on a house listed for $299,000 with hopes of taking advantage of the depressed housing market only to find they were one of 12 bidding on the home which ultimately sold for $330,000. There is no getting around the fact that the house in question here sold for $781,900 in 2007 but with 48 homes sold and another 59 in escrow vs. 19 sales in the year-earlier period, per MetroList Services Inc. there could be a glimmer of hope that, if nothing else, at least the rate of decline might be slowing.

Problems still exist and California’s unemployment rate of 10.5% in February is one of the highest in the Nation. Foreclosures rose 5% last month in the state so it would be foolish to believe that all of the problems are in the past but with the Mountain House Little League roster growing to 220 from 178 last year there might be specks of light on the horizon. The principal of the local elementary school recently remarked; “People I see here have as much hope as I’ve seen in a long time.”

We know from the movies that “Hope Floats” now let’s see if it can grow.

Enjoy the week.

Jim Delaney

C.M.O. 3.23.2009

2009-03-23T03:56:00.000-07:00

Credit Market Overview
March 23, 2009

David C. McCullough said “History is a guide to navigation in perilous times” and there are few who would not call these times perilous. A month or so ago comparison’s between the present and the Great Depression were every where and none of them encouraging. The volatility of daily market moves, the percentages lost by the indexes over various time periods as well as the number of unemployed and the rate at which their ranks were growing were the stuff of headlines and bylines.

The comparisons to history continue but there is an interesting twist as of late and it is shedding light on what, for most of us, was considered a very dark time. Paul Kasriel, director of economic research at Northern Trust and Michael Darda, chief economist at MKM Partners point out in this weeks Barron’s that the economy did quite well between 1933 and 1937 with GDP expanding at 9.5%/yr during the five year period. The key it seems was the government’s purchases of its own paper starting in 1932. Equities, always wanting to be where the action is, rose four-fold during the same quinquennis.

Aldous Huxley also thought there were things to learn from history but to AH the “enigmatic lesson of history” was “that from age to age nothing changes and yet everything is completely different”. Having all lived through the latest bubble, some of us a few more than that, hearing that “things are different this time around” produces that same queasy feeling you get between the time you hear the horn blow and tires squeal and then metal crunch and glass shatter.

Now, too, there are many disbelievers. John Gray of the London School of Economics reviews Globalization and Its Enemies a book by Daniel Cohen in the current “The New York Review of Books”. His comments include his opinion of quantitative easing which he sees as a way to “re-energize the economic activity so that society can borrow itself out of debt.” The possibilities for droll clichés here are endless so I will say nothing.

Peter Schiff of Euro-Pacific Capital who recently penned The Little Book of Bull Moves in Bear Markets is in the same boat with Mr. Gray stating recently, “The Federal Reserve finally made clear what should have been obvious for some: The only weapon that the Fed is willing to use to fight the economic downturn is a continuing torrent of pure, undiluted inflation”.

People with skin in the game a.k.a the “buy-side’ are not convinced the Fed’s latest moves work either as a recent poll by the “sell-side” found 20% or respondents über bearish seeing the low in the SPX in the 400-500 range, 30% thinking we revisit the 600-700 area with the remaining half thinking the low is in.

We could argue the semantics of which half carries more weight given that the 30% that sees another trip down to “6” handle land could prove to be right without disproving the 50% that think the low is in but the point here is that when asked “How are things in Glocca Morra?” it would not appear the answer is all “Sunshine and Buttercups”.

Enjoy the weekend.

Jim Delaney

C.M.O. 3.20.2009

2009-03-20T04:10:00.003-07:00

Credit Market Overview
March 20, 2009

There were some dramatic reactions to the Fed announcement of its planned purchase of treasuries and additional assets in mortgage backed securities. The bond market reacted immediately with the 30yr Bond contract settling up 5 2/32 on the day on Wednesday after establishing an 8 27/32 range for the day. To put this perspective the Bond contract’s range on March 18th eclipsed all of the price action going back to January 22nd. The stock market had a good day too albeit achieving a smaller net gain within a smaller daily range.

Moving outside these two markets Gold reversed a down move that had peaked on 2/20/2009 and looked set to close lower than all prices since that date before the Fed’s announcement. Afterwards it did a 180 and made a $64 move higher before settling ~$40 higher on the day. The U.S. Dollar, as measured by the DXY contract lost ~2.30 within a half hour of the announcement and traded as low as 82.63 or ~3.85 lower by 11:30 yesterday morning.

The price of a barrel of oil also moved higher as a result of the Fed’s action on Wednesday. Having made its lows for the session around 11:30 that morning (similar to the Dollar) and closed at its highs for the day afterwards. It, like the Dollar and Gold continued their moves yesterday as the market digested the Fed’s actions.

The interesting question here is what is the market digesting? The final round of G-20 talks occurs this weekend with all of the big machers heading to London. In the first two episodes of this mini-drama 3rd level and then 2nd level potentates met so that there would be no surprises when the big guns showed up. The U.S. has been pushing for globally coordinated round of stimulus while the Eurozoners have wanted to shift the effort towards increasing financial regulation.

Does the Fed’s action on Wednesday show that the U.S. is ready to put their money (literally) where there mouth is and inject liquidity into the system at all costs? Does the U.S. think this will help persuade the other nations to take complimentary actions?

It could be argued that the U.S. has the most at stake as the single super power left with more of its debt held by foreign nations than any other country and its currency considered the world’s reserve exchange mechanism. There are those too that see the current crisis as one stamped “Made in U.S.A.” on the bottom and as such expect Uncle Sam to clean up his own mess. Given the interconnectedness of the World economy, can this still be considered a rational approach?

The other question to be asked regarding Ben’s move on Wednesday is whether it will produce confidence that we are on the road to recovery or, like the drowning man, are we simply acting out of desperation? How this is seen is important here at home but isn’t it equally if not more important to consider how it will be viewed by the World whose nations represent our investors and trading partners?

The other set of questions that need to be considered are those of inflation expectation. Last year oil traded up to $147bbl and the media was howling that the government was focusing on the ex-food and energy component of CPI when the 95% of the people the President is redistributing wealth to spend a disproportionate amount of their income on filling up the car and putting food on the table. Will the Fed’s move on Wednesday bring back last year’s weak dollar strong oil environment? If so, is this what an economy struggling to its feet really needs?

Inflation also plays into the current budget projections. Without getting into whether Christina Romer’s projections for a 23% increase in U.S. economic output over the next 4 years is too optimistic when the compared to the 17% increase projected from the summary of private economists that make up the Blue Chip Consensus. Inflation, should it rear its ugly head in a meaningful way, could change the current budget projection for 70% of the 23% coming from real growth while 30% is the result of inflation.

A decrease in purchasing power brought on by inflation will help erase the massive debt load this country now carries and is projected to carry more of, but will it help the work-a-day folks that have dutifully paid their mortgages while they watched their retirement accounts lose 40% of their value?

This crisis, from its genesis in reduced lending standards by FNM and FRE, has produced a long line of unintended consequences. Most of these have come from the people we have entrusted not asking a simple question: What if?

Let us all cross our fingers and hope beyond hope that someone somewhere is asking that question now.

Enjoy the weekend.

Jim Delaney

C.M.O. 3.19.2009

2009-03-19T04:27:00.000-07:00

Credit Market Overview
March 19, 2009
http://creditequitycorrelation.blogspot.com/

Yesterday’s announcement that the Fed would purchase $300BN in long term Treasuries and boost its purchase of mortgage debt by $750BN to a projected total of $1.45TN caused a rally in the debt world that, at least in the case of the 47bps drop in the yield of the 10 year note, had not been seen since 1987.

It would seem, however, that the move was not totally unexpected. The Bank of England instituted its quantitative easing program last week with purchases of 2BN pounds worth of Gilts on March 11th followed by the announcement of additional 5BN pounds purchase scheduled for today. Yesterday the BOE unanimously voted to cut the base rate (equivalent to our Fed Funds rate) to 0.5%.

Brian Edmonds, head of interest rates for Cantor Fitzgerald was quoted this past Monday as saying that the BOE move “probably steps things up a notch” for the Fed. “I don’t think they have much choice here.” He went on to say when asked if the Fed would announce such a program after this weeks two-day meeting.

If you are wondering what is to be expected after such a historic move, a look across the pond might some yield clues. European companies offered a total of E10.0BN worth of bonds in the last week alone with issues from Phillip Morris International, Deutsche Lufthansa, Daimler, E.ON and Telefonica. This pushed the total for this year to E100BN vs. E105BN for all of 2008.

CDS and cash market spreads did not move in appreciably yesterday but this is not unusual on days when the volatility in the Treasury market is high. Similar to what occurs in the stock market when there is intervention; correlation has a tendency to move towards 1.0 while dispersion goes in the opposite direction (0.0). If anything a sharp rally in Treasuries usually causes some nominal widening of spreads on cash corporates as it can take a day for that market to catch up.

Mohamed El-Erian, the co-top-everything at Pimco but most probably single heir apparent to Mr. Gross was on the little screen speaking with Maria Bartiromo shortly after the close yesterday. In a possible attempt to draw the heat away from CNBC’s own Jim Cramer, Maria attempted to lure M. El-E into the bottom picking game asking him if he would put his own money in the stock market at the moment.

Cool, calm and collected Mohamed explained that while the Fed’s move would help increase liquidity in the debt markets it could take some time for these actions to filter through to the equity markets.

This is in line with previous comments we have heard from the folks at Pimco and almost every other guest given the chance to voice their opinion in the media.

If there is a speck of light at the end of the tunnel it is that Ben Bernanke, for what ever problems his actions cause down the road (those pesky unintended consequences), he is working to stem the spread of this crisis with tools rarely if ever used before.

As Dick Hoey said on Bloomberg TV yesterday, “If you have to use swamp water to put out a house fire you can’t worry about what it will do to the curtains.”

Enjoy the week.

Jim Delaney

C.M.O. 3.18.2009

2009-03-18T03:38:00.000-07:00

Credit Market Overview
March 18, 2009
http://creditequitycorrelation.blogspot.com/

Magicians and pickpockets practice the art of deception. In the first case we gladly pay to be deceived, in the second we would pay even more not to be. In order to perform their acts successfully however, both groups must understand the value of distraction; have quick hands and perfect timing.

It is not known whether Congress hopes to join the first or second group, but which ever book they are reading it is obvious they are up to the chapter on distraction as the bru ha ha they have sparked over the $167MM paid to AIG employees seems trifling when compared to the $170BN they pumped through AIG to settle that company’s seemingly ceaseless desire to continually double down on ever increasingly bad bets. If you stand back far enough it is quite a funny sight.

The rest of Wall St. and most probably Bank of America, is enjoying the brief respite of having their own compensation plans under the arc lamps and microscopic vision of Congress. I would imagine Ken Lewis is sleeping for the first time in weeks.

To show their appreciation the constituents of the XLF rallied 6.49% yesterday while the CDS for C, COF, MS, BAC, GS and JPM all continued to narrow with all but C and COF back below the levels seen on February 23rd and seeming to head for the end of February lows.

It has yet to be determined whether “what leads you down leads you up” or “new bull markets require new leaders” will win the battle of the adages but going into 1st quarter earnings season the one thing that can be said is that “hope springs eternal”.

Even further from the fray Fortress Group received a double mention in the papers yesterday. The first was an announcement that its 4th quarter net loss was $140MM or $1.50 a share vs. $29.3MM or $0.43 a share for 4Q07. The stock closed last night at $1.59 after having closed as low as $1.08 on March 6th so people must feel that the money they have refused to return to investors will produce enough fees to make up for the firm’s bad bets.

The other bit of news surrounding FIG was their interest in the TALF plan. That smart guys on Wall St. think they can beat the magicians, the pickpockets and the government at their own game is not news. What is interesting is how the banks have morphed their TALF oriented offerings for investors such as FIG.

Initially purchasing the TALF securities from a dealer would also give that dealer unfettered access to the customer’s books. This requirement was instituted by the Fed during the TALF creation process. It was not acceptable to FIG and its brethren so a few banks, JPM and Barclays PLC specifically, have created investment vehicles which allow investors to circumvent many of the Fed’s restrictions.

JPM and Barclays have now set up trusts to buy the TALF securities, (to say these vehicles look a lot like CDO’s would be an understatement) with money borrowed from the Fed. The investors then buy the trust certificates earning TALF security type returns without all those messy Fed regs.

This all obviously helps the Treasury spend an additional $1 Trillion of Federal Reserve financed money. Given that the investors only have to pony up between $5 and $14 to buy $100 worth of returns means that it cannot be hurting firms like Fortress either.

While Congress is diligently practicing its distraction exercises it had better keep its timing sharp or someone will ultimately figure out that not only are they trying to get back from AIG’s employees 1/1000 of what they spent on AIG’s IOU’s but that the TALF plan is a thinly veiled bailout of the hedge fund industry.

Hey, if you’re going to increase taxes on the top 2% of wage earners you have to make sure the 2% is worth taxing.

Enjoy the week.

Jim Delaney

C.M.O. 3.17.2009

2009-03-17T03:49:00.000-07:00

Credit Market Overview
March 17, 2009

“Beware the Ides of March”. For Caesar these words had dreadful consequences and from his point of you, yes, unintended too. In the financial markets there is a Caesar as well only this one might seem a cross breed with Medusa as many times throughout this financial crisis we have seen multiple extensions of this self-proclaimed “Emperor for life” appear in crucial positions in Washington simultaneously.

If all of that was not enough to give it away the company in question is Goldman Sachs and it seems as if being the co-focus of the cover page in this week’s Barron’s did as much for it’s stock as the seer in ancient Rome did for Caesar’s life expectancy.

GS was down $4.90 yesterday, 4.96% for those who prefer things in percentage terms. This needs to be put in context however as it had also enjoyed a 33.6% run off of its near term low close of $73.95 on March 9th. 33.6% is a pretty long way to go in 4 trading sessions and it is without question that any investor would think they had Caesaresque qualities if they could put together a portfolio of stocks to perform similarly every 5 days.

The CEC Strategy bought GS on March 12th and unfortunately, MS on Friday. There is hope, however, as the CDS spreads for each of these names (the main driver of the CEC Strategy) continued lower yesterday closing at 258.35bps for GS after peaking at 371.5bps on March 9th. The same day the stock closed at the previously mentioned low.

The move down in GS’s CDS equaled 30.46% by yesterdays close so the negatively correlated CDS/equity relationship seems to be moving in near lock step both with regard to timing and degree. From years of observation I can tell you that is a rare occurrence.

MS the other company to make Barron’s front page suffered a worse fate losing $2.39 or 9.40% yesterday. The CDS spreads here too continued lower yesterday having moved down 116.22bps or 24.45% since March 9th. The stock had outperformed GS in the short term gaining $8.95 or 54.31% in the same period GS rose 33.6%. The move in MS did not have the symmetry of GS’s and is much more typical of how the CDS/equity relationship seems to operate.

The financials, in general started the day strong only to fade in the afternoon. Exceptions here were C, FNM and FRE but gains of 30.90%, 28.57% and 21.43% respectively need to be put in context as starting the day with stock prices of $1.78, $0.42 and $0.42 it doesn’t take a big $ move to make a big % move.

In context, given the choice, how many would prefer to be among that group of three just mentioned vs. the co-stars of the cover page?

Enjoy the weekend.

Jim Delaney

C.M.O. 3.16.2009

2009-03-16T02:54:00.000-07:00

Credit Market Overview
March 16, 2009

CEC Portfolio Composition

Throughout the turmoil that has beset the markets and the economy since the housing market became a house of cards there have been certain words or phrases have dominated the lexicon. “Credit Crisis” and “Bailout” come to mind as does “irrational exuberance” for that period when the bubble was still inflating. It was de rigueur for a while to measure how important a word was by stating how many times it had appeared in the media in the recent past. I do not have access to any such word counters but I can tell you that the phrase I am constantly bumping into these days is: “unintended consequences”.

Konrad J. Friedman defines this phenomenon as “the proposition that every undertaking, however well-intentioned, is generally accompanied by unforeseen repercussions that can overshadow the principal endeavor.”

It would take at least a month’s worth of C.M.O.’s to discuss every instance where the government’s interventions in the financial markets have produced said “consequences” but I will limit it to one example on one day. There will be too much to discuss as the week unfolds to spend time tilting at every congressionally constructed windmill.

Kathleen Shanley, Senior Bond Analyst/Finance with Gimme Credit is interviewed in Barron’s this week. She begins by explaining the difference between a bond and a stock from the investor’s point of view saying; “The bondholder doesn’t have the potential to share in the upside of a company’s growth, so the most a bondholder gets back is their principal and interest.” Kathleen goes on to explain that in the case of a bankruptcy what the bondholder does have is a “senior claim in the capital structure.” “As a bondholder you don’t have the opportunity for a large upside [equity holders], but you are more protected on the downside.”

Ms. Shanley says that things now are different than a few years ago, when debt financed LBO’s and share buybacks favored equity holders as the leveraged transactions bought shareholders out at a high price while the debt got downgraded, sometimes to Junk.

Understanding that reward is in proportion to risk, it makes sense that there would be a group of investors that would eschew the upside of stocks for safety of bonds.

Based on there place in the capital structure along with the billions in dollars of aid they have received from the government one would expect that the bond’s of the nation’s largest financial institutions would be trading at levels indicative of a low risk of default.

Such, however, is not the case. Yield spreads on bank bonds are averaging 8.23% relative to Treasuries and 3.65% more than industrial companies according to Merrill Lynch index data. To put this in perspective this relationship was the opposite way before August of 2007.

The clue as to why this might be the case comes from U.S. Representative Brad Sherman, CA, Dem who was recently quoted as saying; “These banks can go into receivership, shed their shareholders, shed or reduce the amount they owe to their bond holders and come back out much stronger institutions.”

John Bartko, a credit analyst with S&P thinks the fears exhibited by the high spreads are well placed. “It’s only intuitive that the government would contemplate the thought, ‘why are we only putting this on the taxpayer?’” Additional government assistance could carry with it “the possibility that debt holders could then be required to participate”.

Mehernosh Engineer, a strategist at BNP Paribas SA, London thinks; “We’re seeing the start of next leg of the crisis and that’s going to be financial bondholders taking a haircut as lenders default. There’s been a perception that banks’ senior bondholders are untouchable, but that’s going to change.”

Where are the “unintended consequences” in all of this? According David Darst, an analyst at FTN Equity Capital Markets, “Most U.S. bank debt is held by insurers and foreign investors, with a small portion owned by mutual funds.” Foreign investors (China, the largest holder of U.S. Treasuries) are already voicing concerns regarding the quality of Uncle Sam’s debt and many have already been burned by investments in the preferred shares of FNM and FRE.

Raising the specter of senior debt losing its inherent protection for its holders will only add to the spreads required by investors to buy the debt. This can only increase the amount of interest these institutions are required to pay to service the debt and therefore delay if not prevent the return of these companies to profitability.

Equity holders are always aware of the risks they take when purchasing a stock and that risk is always 100% of the money invested. Bondholders, be they the insurance companies which many depend on for retirement income as well as the traditional “term” products or foreign investors who fund the massive deficit this country now has and which is expected to grow to previously unheard of levels in the years to come, did not sign on for the questionable return of their principal and interest.

So before Washington starts bringing bondholders to the barber shop one can only hope that they realize the repercussions of the “unintended consequences”.

Enjoy the weekend.

Jim Delaney

C.M.O. 3.13.2009

2009-03-13T04:14:00.000-07:00

Credit Market Overview
March 13, 2009

It’s a bit ironic that on Friday the 13th, after a three day 10.97% run off the lows in the SPX, the market seems to be gaining a bit of a pulse which cannot be said for any of Jason’s victims.

The CEC Strategy developed buy signals in GS, PHH, FCX, AGN, BBY, KSS, TJX, GLW and PX yesterday as well as short signals in ETR, FE and SO.

In late February it was the other way around with a majority of shorts being generated (AET, CI, GR, UNH, WLP, AYE, DTE, DUK, ED, FE, MIR, DVN, XOM, NUE, IR, MHK, RPM, AVP, JNJ, ABC, LLY, LLL, MDT, BA, GD) and just a few longs (MLM, PCG). These second set of positions was closed out on Monday in anticipation of “Turnaround Tuesday” and having a decent unrealized P/L number in the books.

CDS spreads, at the index level, spent from January 6th to March 9th of this year moving from 1100 to 1924.6 in the high yield area and 194.7 to 261.9 on investment grade paper. The high yield index has since come down to 1714.2 a 210.4 point or 10.93% reduction, while the investment grade index now sits 25.6 points or 9.78% lower at 236.3.

It should be noted that it is rare for the CDS and stock indexes to move in such close proportion, especially in the short term so no conclusions should be drawn from the similar percentages of those moves.

What has been good to see is that as CDS spreads have come down and as the market moved higher these past few days, correlation among the names in the CEC universe has come off the “lock limit up” figure of 1.0 that it had once again regressed to during the 1/6/ - 3/9 period. This had also occurred a number of times last year, Bear Stearns, TARP announcement, AIG and the pure despair that overtook the markets after Lehman’s collapse.

The high correlation, low dispersion (I say tomato, you say tah-mah-to) environment does not allow the CEC Strategy to fully exhibit its strengths as differentiation between the specific economics of individual companies is superseded by what can best be described as macro panic or euphoria depending on the government’s latest action.

Being up ~11% after starting the year down 226.72 S&P points or 25.1% and 888.62 points or 56.78% since October of 2007 doesn’t mean it’s all up from here by any stretch of the imagination. What is encouraging however, is that if even for brief periods, the natural characteristics of the markets come back when the imminent threat of “incoming” from Washington subsides, if even just at tad.

From the death toll it seems no one needs to spend time on Crystal Lake. I’m sure, however, that many of us wouldn’t mind a peak inside a crystal ball.

Enjoy the weekend.

Jim Delaney

C.M.O. 3.12.2009

2009-03-12T04:00:00.000-07:00

Credit Market Overview
March 12, 2009

In the first part of this millennium the two major rating agencies, Moody’s and S&P, competed fiercely to place “AAA” stamps on a host of collateralized debt products being produced by those that were paying their fees.

In a bit of a turn-around in late April of 2008 (post Bear Stearns) S&P published a report lowering its assumptions for the amount of money investors might receive after defaults of subprime mortgage bonds, leading to downgrades of the CDO’s they had given their blessings to.

The report said that S&P’s new recovery assumptions put the percentage of loss at 100% for any class of debt rated A or lower and moved just slightly above that (95%) to any class rated AA. Saving the best for last the company stated that junior AAA tranches should expect loses of 65% and super-senior AAA tranches, 40%.

S&P and its major competitor, Moody’s, did not stop there and have since downgraded CDO tranches numbering in the tens of thousands. Again, a case of closing the gate after the horse is gone. Additionally, these two companies have now focused on sovereign debt and appear to be falling over each other to add names from Western and Eastern Europe to the list of possible downgrades.

Speaking yesterday at the U.S. Chamber of Commerce Jamie Dimon asked the audience if at any point during the current crisis anyone had moved their money from more risky to less risky investments. Although the camera did not pan the room it appeared from Mr. Dimon’s expression that there was a healthy positive response.

Mr. Dimon then pointed to those same people and said that they helped contribute to the credit crisis. There was a bit of nervous laughter but stepping back for a moment it is easy to see that Jamie was right. By when you think about it by moving to more conservative investments (a.k.a. cash) the investing public had migrated away from the risk side of the spectrum creating more selling pressure on “undesirable” assets. JD immediately comforted those who had replied affirmatively saying it was the logical thing to do; intimating that it was completely in line with the constructs of basic human nature.

Taking this revelation from the individual to the institutional level it is easy to see that the rating agencies, while placing their seal of approval on instruments that were purchased by investors around the globe, helped to inflate the bubble, they have also added to the carnage via downgrades as the World’s economy has contracted.

While it is not a stretch to think that S&P and Moody’s are now taking a hard line on ratings to prevent the possible end of their current, albeit until recently, extremely lucrative business model by demonstrating that they’ve changed their fast and lose ways. Their actions also make clear that regardless of direction, the rating agencies have acted with only their own interests in mind and to repeat myself from above: “completely in line with the constructs of basic human nature”. As a result they have proven once again that in all things market related “caveat emptor” is the order of the day.

Jim Delaney

C.M.O. 3.11.2009

2009-03-11T03:46:00.000-07:00

Credit Market Overview
March 11, 2009

Given yesterday’s respite to the selling which had reduced the S&P from it’s 903.25 2008 year end close to 676.53 on Monday I thought I would discuss something that caught my eye in the papers recently and by papers I mean the two august publications put out by Dow Jones; The Wall Street Journal and Barron’s. Doing so before yesterday’s rally would have been a little too much like kicking a dog when it’s down and there’s no good karma coming from that.

The cover story in Barron’s this week, written by Andrew Barry, gives a litany of reason’s why calling for the Dow Jones Industrial Average to hit the 5,000 level was not something Andy and his editor thought was in the cards.

To bolster his argument Mr. Barry uses our President’s recent remark that “stocks are cheap for long term investors” as his opening salvo. He goes on to say that stocks also look cheap relative to book value, price/earnings multiples, U.S. economic output, gold, and a normal level of corporate earnings. Andrew adds that the huge amount of cash sitting on the sidelines argues well for impatient investors to release the hounds well before the big hand on the Dow clock points to 5 and the little hand points to 000.

Everyone is entitled to their opinion and a well structured argument carries its own merits. In light of this I am not going to work here dispel any of Andrew’s optimism. I would like to point out; however, that given the cover story I thought Barron’s would have peppered the paper with equally bullish articles and opinions as a show of real support.

What the paper did instead was to print excerpts of David Rosenberg’s piece “A Depression Style Jobs Report” in Alan Abelson’s column, a bearish follow up piece by Felix Zulaf on the page immediately preceding Mr. Barry’s article as well as an interview with David Levy, Chairman of the Jerome Levy Forecasting Center titled “No Doom, Just Gloom”.

Before I get into specifics of what the market practitioners had to say it should also be noted that the lead story in the Money & Investing section of Monday’s Wall Street Journal was titled: “Dow 5000? There’s a case for It”. Wouldn’t it have just been easier for Barron’s to give poor Andy a towel, point him towards the showers and say; “Not this week kid”.

Since his name came up first we’ll start with “Rosie” whose nickname inside “Mother Merrill” belies his outlook on all things economic at the moment. (Just in case the title of his piece didn’t give it away.)

With respect to the amount of space I have left I will repeat the one quote from Rosie I think reflects his sentiment. “The extensive deleveraging, as the credit excess and asset bubble of the last cycle continues to unwind, is exerting a powerful negative influence on the real economy that is far beyond our collective professional or personal experience.”

To summarize the Felix Zulaf follow up article one needs only to read the caption under the picture accompanying the article which reads: “It’s a depression environment”. To be fair, FZ said he saw a bear market rally in the offing of somewhere between 25%-40% lasting 2-4 months. Afterwards, however he predicts the S&P will bottom in 2011 with the SPX boasting a “4” out front. Felix believes that: “Policymakers and investors still don’t understand the process at work in the world economy”.

David Levy, as the title of his article reveals, doesn’t see the end of the world before us, just a million miles of swap to be slogged through. He does see some firmer footing some time in 2010.

Since we live in a democracy I think it best to count the votes and by my reckoning it looks like 1 yay and 4 nays if the vote is on whether the bottom has been reached.

Enjoy the week.

Jim Delaney

C.M.O. 3.10.2009

2009-03-10T04:05:00.000-07:00

Credit Market Overview
March 10, 2009

If there is any truth to the adage: “It’s not what you know, but who you know”; then you might consider a slight variation on that theme: “It’s not who you are but who you follow”. Jeffrey Immelt stands as testament to this second phrase as coming to the helm of luxury liner General Electric after Capt. “Neutron” Jack was never expected to be an easy voyage.

Investors on the good ship GE, enjoying quarter after quarter of Jack’s “perfectly groomed” earnings were lulled into complacency like those lying on the sun deck of a Caribbean cruise. Unfortunately, it wasn’t long after poor Jeffrey grabbed the wheel that hurricane season started.

If there is another old saw to be considered here it’s probably: “timing is everything in life” and due to factors way beyond his control Mr. Immelt’s timing in taking the helm could not have been worse.

JE most recent misstep was guaranteeing the safety of the dividend earlier this year and then cutting it by 68% in late February. Implied volatility on GE has closed as high as 149.5268 since its 97.5067 close on February 26th. CDS spreads have also widened during this time moving from 660bps on the benchmark 5-yr on 2/26/2009 to a new all time high of 1037.21 last Thursday. For some perspective realize that in the heady days before August 2007 CDS spreads on Junk were as low as 300bp.

Given the tumult in the world the question becomes not whether Jeff is as good as Jack but whether he is navigating the sea of tsunami’s well enough to get the ship and all its passengers back to port. (Read keep the AAA rating.)

On the dividend front it is safe to say GE is not alone. JPM, DOW, MOT, PFE, TXT, CBS and NYT have all cut dividends recently (apologies if I left anyone out). Howard Silverblatt, an analyst with S&P said recently that dividend payments among companies in the S&P 500 were down 24% from a year ago. Howard went on to say that this years projection for dividend cuts would be 23% which would make it the worst two year span for dividends since 1938.

One of the factors leading up to these cuts, HS believes, is that the market has grown less inclined to punish dividend reductions. “They are not as painful as they were a year ago” he was quoted as saying. (Someone please tell that to Mr. Immelt.)

While investors may not be punishing the “cutters” as harshly they seem even less enamored with the names that pay dividends as a whole. Nicholas Bohnsack of Strategas Research Partners, a New York research firm, recently found that since November 21, 2008 dividend paying stocks have underperformed their non-paying brethren.

“In an environment where there is a massive flight to quality, you would expect companies that are offering yields to do better. That has absolutely not been the case.” Mr. Bohnsack said recently. He goes on to reason that the price declines of the dividend paying stocks reflect the market’s perception of the eventual need for those companies to lower payouts in order to conserve cash flow and bolster the balance sheet. “It is almost the purest read on confidence that we have.”

If that is true it might be pure but it doesn’t seem all that confident.

Enjoy the week.

Jim Delaney

C.M.O. 3.9.2009

2009-03-09T03:05:00.000-07:00

Credit Market Overview
March 9, 2009

These are historic times for many reasons; The U.S.A. elected its first Black President and the economy is experiencing a contraction that brings to mind some of the most severe in this Nation’s existence.

Additionally a majority of investors have lost confidence in the markets. One of the most often sited reasons for this are the issues connected with the Credit Default Swap (CDS) market. It has been blamed for causing the downturn in stocks, the collapsing of the global economic system and if you look hard enough, the common cold.

Today the Intercontinental Exchange (ICE) begins operating a clearing house for CDS contracts after receiving approval from the SEC on Friday and the Federal Reserve last Wednesday.

I believe this step is a positive one for the CDS market and to the extent it helps bring back confidence a positive step for the marketplace in general.

There has been much written regarding the evil loosed by trading Credit Default Swaps. A lot of what I have read seems to have come more from emotion than fact and some, while eloquently written, was not authored by anyone with practical market experience.

I have purposely stayed out of the fray as it seemed best to ignore the static. In this weeks Barron’s Michael Santoli, whom I would expect to be knowledgeable in things market related, made the statement that the only people that should be allowed to trade CDS contracts are the people who own the bonds.

Having traded in the equity, fixed income and futures markets, the first two in both cash and derivatives and the third being a derivative itself I am a bit flummoxed as to why everyone is trying to reinvent the wheel with regard to CDS trading.

As a counter to Mr. Santoli’s point, there are two designations for participants in the futures market: hedger and speculator. Where would the hedgers lay off their risk if the market did not allow speculators to take the other side of the trade? The hedgers are people involved with the physical commodity, farmers, miners, processors and are in the market to reduce risk not increase it.

The speculators are in the market to profit from price movement regardless of direction and take the risk the hedgers are trying to alleviate. To prevent the speculators from controlling the price movement there are limits placed on the number of contracts they are allowed to hold.

The equity market too has controls in place to prevent misdeeds. Anyone owning more than 5% of a company is required to report his holdings to the SEC within 10 days of the “acquisition event”.

The equity and futures markets are deep, liquid, vibrant, healthy markets and while those with mal-intent might wish the rules did not exist it is a long term positive for the rest of us that they do.

The CDS market was extremely profitable for the dealer community for many years because of the products opaqueness and lack of regulation. Having worked at a firm that provided inter-dealer liquidity in the CDS market it was not unusual to see bid/offer spreads between the sell side firms 1/10th of the bid/offer spreads shown to buy side customers. This created an incentive to keep things as they were and make as much money as possible.

Given the products profitability it is not a stretch to think that anytime unpleasant noises were heard from those proposing regulation a call was made to the lobbyists in Washington and the game continued.

AIG is the poster child for what was wrong with the CDS market but here too it was not the product but more that AIG’s Financial Products subsidiary wrote billions of dollars of CDS contracts without hedging any of its exposure. Is that a problem with the product or with risk management at AIG?

As is clearly evident at this point the CDS market needs to be regulated to some extent as the major participants have proven through their actions, that they are unable to police themselves.

Before we put manacles on top of the handcuffs however let’s take a look at what regulations are in place in other markets that are operating efficiently and use those as a model for the CDS market.

Enjoy the weekend.

Jim Delaney

C.M.O. 3.6.2009

2009-03-06T03:42:00.000-08:00

Credit Market Overview
March 6, 2009

I have heard the current malaise described as the “Great Recession” and a “Contained Depression”. Both of these terms hesitate to put the current socio/economic environment into the same category as the Great Depression and possibly with good reason.

The Bureau of Labor Statistics releases employment numbers for February this morning at 8:30. Estimates range as high as 8% for the unemployment rate and non-farm payrolls could fall as much as 750,000.

Whatever the published number are there are also an additional 1.4MM people receiving government benefits under a new program launched last year and a sub-category I had not heard of until recently, mass layoffs (50 or more people at one time), doubled in January.

These all paint a pretty dire picture of the world as it stands today. The question is how does it really compare with that earlier time in our great Nation’s history?

By 1933, 25% of all Americans were unemployed, and 11,000 of the country’s 25,000 banks had failed. Household income had declined by 40% and home building had shrunk by 80%. Industrial production was down 45%.

I am not saying we’re going there and I’m not saying we’re not. The CEC Strategy has made most of its money on the short side of things since October of 2007 but I probably would have bet the house writing $2.00 puts on Citigroup (C) back then too!

Since we’re relating things to the GD today 6,860 was the level on the Dow that erased 50% of the rise from the 1932 low to the 2007 high. For those having a “slow” morning that’s half of 75 years worth of gains gone in 16 months.

For the S&P fans out there, an uptrend line initiated at the 1982 lows that had provided support for the market since was broken on the first close below 700.

Estimates for when positive growth returns seem similar to those orders you get from people that just can never pull the trigger and are a euphemistic variation on the Good Till Close order with the last word in this case meaning near and not the opposite of open.

This entire debacle has been a study in unexpected consequences. We can only hope the lesson ends soon.

Enjoy the weekend.
Jim Delaney

C.M.O. 3.5.2009

2009-03-05T03:49:00.000-08:00

Credit Market Overview
March 5, 2009

Do you remember those word problems in math class: A car is traveling west at 30 mph. Another car is traveling east at 20mph . . . etc. OK, so keep channeling your grade school math class and use the information below to answer the questions that follow.

If you agree to invest at least $10,638,297.87 you can:

a) Buy AAA bonds backed by loans from the sale of cars in the U.S. but not necessarily from an auto manufacturer headquartered in the U.S.A.

b) Achieve a yield to maturity of between 12%-16%.

c) Borrow up to 94 cents of every dollar you invest at Libor + 1.00% (~1.30% +1.00% = 2.30%) from a lender that can print money at will

d) Walk away from the non-recourse loan at anytime with no penalties

c) Pay your top executives as much as you/they please

Questions

1) Would you participate in this bond offering?

2) Do you think this bond offering will increase the number of cars sold in the U.S?

If you answered YES to question 1 than you could probably get a job at Blackstone, Fortress, Cerberus or Millennium as all four of these entities are looking seriously at the latest “fix” to come out of Washington to spur the economy back to it’s consuming ways. (An added benefit is that if you went to work at either of the first two names mentioned, given where the stocks of are trading, you wouldn’t have to worry about getting back dated options as the stocks are cheaper than most option premiums.)

Mr. Schwartzman, chairman of Blackstone Group LP, believes the plan will be successful in bringing investors back to the securitization markets saying: “You need a robust securitization market to reestablish a broad lending platform in the society.” (It is amazing to see how altruistic people become when they have their hand in Uncle Sam’s pocket.)

When asked about the new offering the President himself was quoted as saying: “This will help unlock our frozen credit market, which is absolutely essential for economic recovery.”

If you answered YES to question 2 I’m not saying you’re wrong but I would refer you to Mssrs. Gross and Attebury. “PIMCO Bill” is not so convinced of the programs resounding success. “It may be the same problem we have with the banks, you can bring the horse to water, but they may not drink.” Thomas Attebury, partner and PM with First Pacific Advisors, is “not a believer in this. There is a reason credit is contracting – because the economy is in recession and banks typically raise their lending standards to protect their precious capital.”

As with all things, time will tell. I do want to make one observation here. I find it interesting that Congress has gone out of its way to make a helluva lot of noise regarding the changes they want to make to reduce the attractiveness of choosing “Hedge Fund Manager” as a career goal. At the same time, however, they are going out of their way to design sweetheart deals like the one described above to fatten the purses of those managers and doing so with subsidies from the U.S. taxpayer.

Kind of like getting yelled at in the front yard where all the neighbors can see and then walking around to the kitchen window for your slice of fresh baked pie. After all, you have to protect those campaign contributions.

Enjoy the week.

Jim Delaney

C.M.O. 3.4.2009

2009-03-04T04:01:00.000-08:00

Credit Market Overview
March 4, 2009

After declaring GE’s dividend sacrosanct Jeffrey Immelt’s recent reversal begged of episodes that have become all too common since stocks peaked in October of 2007. (How different did things look back then?!). Members of the “C” suites of Bear Stearns and then a few months later, Lehman Brothers appearing on the small screen declaring “All is well in Happy Valley” only to collapse a short time later.

Cries of predatory hedge funds profiting from those events seem toothless now that many of those same funds had their worst year on record and have seen withdrawals of double digit percentages and as the WSJ recently reported are being besieged by additional requests in the 20%-30% range.

Credit default swap levels for GE have risen from as low as 324 on January 6th of this year to an all time high of 1029.44 in New York yesterday. Everyone it seems s been focusing on the problems the company is facing here in the States with it financial subsidiary GECC which, while not is involved in the residential mortgage market provides financing for commercial real estate and other ventures at the business to business level.

The recent troubles of countries like Poland, Turkey and some of the Baltic States are also having an affect on GE’s prospects. The company’s 2008 annual report said that 11% of it’s financial receivables were in developing markets (Eastern Europe and Mexico). The WSJ estimates that the Eastern European portion of this exposure could amount to $30BN.

Adding to investor’s anxiety is the current debate by European Union leaders as to how to handle what is becoming an increasing dicey situation in Eastern Europe. The EU’s charter expressly prohibits the bailing out of any one member by another member. That same set of rules also requires members to keep deficits below 3% but it looks like 7 of the 15 Eurozone countries could cross that line this year.

Germany has much to lose in all of this as the Eurozone countries are that nation’s leading export market. Having the most solid economy in the region is good for Germany in that there are fewer questions of it’s surviving the current global crisis.

That question doesn’t seem to elicit the same answer with regard to Germany’s weaker siblings however. While no one is asking out loud yet, there are doubts about how financially conservative Germany would react if asked to participate should one of the euro-family fall gravely ill.

With the gap between yields on German bonds and the bonds of some of the weaker links at levels not seen since the Eurozone’s inception 10 years ago it might be a question the market is already answering.

Enjoy the week.

Jim Delaney

C.M.O. 3.3.2009

2009-03-03T04:11:00.000-08:00

Credit Market Overview
March 3, 2009

Although this Nation’s financial brainiacs have created enough toxic assets to virtually sink the world’s economy, the U.S.A. has long stood as a symbol of capitalism in one of its purest forms. In a perverse sort of way, manufacturing AAA securities from sub-prime mortgages and selling them to unsuspecting buyers stands as a perfect example.

The current crisis is turning many things upside down at the moment so it should come as no wonder that there are lessons to be learned from two unexpected sources, namely the Germans on marketing and the Chinese on economic policy. Who’d a thunk a stodgy Western European nation could beat Madison Avenue at its own game and a Communist country could take the U.S.A. to school on stimulating the economy.

Germany has instituted a “scrap” bonus for people who trade in an old car to buy a new one. The E2,500 ($3,200) payment is made by the government to people who scrap a car that is at least nine years old and buy a new car that meets the latest emissions standards. Does it work? So far 134,000 people have applied for the bonus and that number is rising by upwards of 7,000 people a day.

“It’s a real sales boom” says Ceyhun Tan a Volkswagen dealer in Berlin whose February sales were two-three times what they were a year ago. Sabine Mumm, a librarian from the north of Germany said “All the available cars were gone, especially the small cars. It was really hard even to get the dealers attention.”

The program is so successful that France, Italy, Spain and even Slovakia are adopting the theory both with cars and other big ticket items. If there is a hitch in all of this for Detroit is that German auto manufacturers actually make cars people want to buy.

From the north of Germany we travel to Beijing where they are preparing for the parliament’s annual meeting which is heralded at China’s “political event of the year”. Eyes are on the world’s third largest economy as the country is one of the few left that is experiencing positive, albeit lower, growth. “China has the resources to reinvigorate and reorient its economy.” Cornell University professor, Eswar Prasad, recently stated. He went on to say “This could have a broader payoff for China in the international arena by providing support for global demand.”

Wen Jiabao, China’s premier said motivating buyers in China was different than in other parts of the world because “Consumption is not based on slogans, but on whether consumers really have money in their pockets.” The government is also encouraging workers that have lost their jobs to start their own businesses by offering tax incentives and training opportunities. In addition to only spending what they have the Chinese save around 25% of what they earn.

What’s interesting here is that a country founded on the principals of Karl Marx has only slated 8% of its 850BN Yuan($124BN) stimulus package for things like health care (1%) and public housing (7%).

So while they might like it in their fried rice the Chinese seem to have no room for pork in their stimulus.

Enjoy the week.

Jim Delaney

C.M.O. 3.2.2009

2009-03-02T03:01:00.000-08:00

Credit Market Overview
March 2, 2009

There seems to be one thing that still has value on Wall St. and that is scarcity. Chevron (CVX) and Abbott Labs (ABT) took advantage of the infrequency with which they issue debt to tap the capital markets for a combined $8BN last Thursday issuing $5BN and $3BN respectively. Total issuance in the investment grade space was $10BN on that day.

Jim Merli, head of U.S. Syndicate at Barclays Capital said “Right now, I do think the investment grade asset class is enjoying the spotlight.” Jon Duensing, a principal at Smith Breeden Associates thought one of the reasons the debt sold well was that “new or less-frequent high-quality issuers have generally met with strong demand as investors seek to add new issuers to their portfolios.”

The CVX offering was actually made up of three issues: a 3.45% note maturing in 2012, a 3.95% note maturing in 2014 and a 4.95% note maturing in 2019. All three pieces came at 195bps over their respective T-note maturity so there was no credit premium across the issuance curve for CVX. Looking at the CDS market for last Thursday mid-market spreads were 97bps, 102bps and 108bps for the 3, 5 and 10 year tenors which shows that investors required a premium of 97bps on the 2012 piece and 93bps and 87bps on the 2014 and 2019 pieces to tie up hard earned cash over where the bonds could be synthetically created.

ABT was the other big issuer last Thursday. Here too there were multiple maturities involved as $2BN of a 5 1/8 note came at 220bps over the T 2 ¾’s of 2019 and $1BN of a 6% bond maturing in 2039 was issued at 235bps over the T 4 ½’s of 2038. There was a 15bp credit premium for the longer dated ABT issue but since all of CVX’s issues were in the “intermediate” tenor and the 2039 ABT issue is definitely in the “long maturity” camp it is a bit like comparing apples and oranges.

With this in mind we can still look at the physical/synthetic premium on the two ABT pieces. We will, however, have to use the 10yr CDS spread for both since there is no readily available quote for 30yr CDS on ABT. Using a mid-market spread of 95bps for the 10yr CDS the note and bond required premiums of 125bps and 140bps respectively to attract buyers since of the physical paper over its synthetic equivalent.

Remember too, that as was stated earlier, there was strong demand for the CVX and ABT paper as they do not issue often. It is fairly safe to assume then that more frequent issuers will have to pay an even higher premium to their synthetic equivalents to raise capital.

That these two issuers were able to sell debt says that there is some thawing in the credit markets. That the spreads on the physical debt were reasonable says that people are willing to buy names that they don’t see that often. That the spread between the physical and the synthetic is as wide as it is shows that all is not quite right in the credit markets just yet.

There is scarcity and then there is scarcity. It was reported in the WSJ recently that a leather armchair once owned by Yves Saint Laurent fetched 21.9MM Euros or $28MM at a 3 day auction of the designer’s estate by Christies. Given his predilection for high ticket make-over’s it begs the question, was John Thain was the undisclosed telephone bidder?

Enjoy the week.

Jim Delaney

C.M.O. 2.27.2009

2009-02-27T03:28:00.000-08:00

Credit Market Overview
February 27 2009

I have offered in this space recently historical evidence of how fiscal stimulus is not the right prescription to bring the economy out of its current malaise by quoting FDR’s Treasury Secretary, Henry Morgenthau’s dairy entries including: “We have tried spending money. We are spending more than we have ever spent before and it does not work.” which rings so true in the face of the recent +/-$800BN spending bill just signed into law.

Additionally, I have also discussed the work of Friedrich Hayek a contemporary of John Maynard Keynes but an opponent of Keynes’ thinking “that general employment was always positively correlated with the aggregate demand for consumer goods."

As these do not seem to have made an impact I bring another more contemporary example; that of the great growth engine of the world at the moment, China. The government of the People’s Republic has put about 230BN Yuan ($34BN) into stimulus projects in that country recently. Immediately following the announcement of this package steel prices began to rise and bank lending increased. Affects the current administration is hoping will repeat themselves in the U.S.

The problem is that those affects are now proving to be superficial and do not appear to have restarted China’s real economy. Steel prices, which had gained 15% from the November lows to the beginning of February are now falling again, industrial output in Shanghai was down 12.7% in January from the same period last year and the 1.62TN in new loans made, twice the 2008 number, are being hoarded by those companies that borrowed the money so the usual expansive effect of “borrowing to build” is non-existent.

“Recent monetary and credit data do not reflect real economic demand.”;Ha Jiming, chief economist of China International Capital Corp. You see, even they realize it’s not working.

I quoted Robert Rodriguez, CEO of First Pacific Advisors, yesterday as recently saying that his investment mantra was: “Winning by not losing.” Proof of how RR’s words ring true in the current market place and especially for the CEC Strategy can be found by looking at the CDS/equity relationship of names in the healthcare field.

CVH is the most dramatic example as CDS spreads have recently come in from their highs around 570bps to the 475 level, a 95bp or 16.67% contraction. Moves lower in CDS spreads, ceteris paribus, usually portent higher stock prices but the just announced plan to pay for the health care plan by taxing the healthcare providers has thrown a “spanner in the works” as the stock has plummeted from the $16.87 recently to $11.88 yesterday. That’s $4.99 or 29.58% for all of you that had a “Thirsty Thursday” last night.

When the markets move as they have been and policy announcements change the economic landscape overnight, Mr. Rodriguez’s mantra seems to be a good one to keep in mind.

Enjoy the weekend.

Jim Delaney

C.M.O. 2.26.2009

2009-02-26T03:20:00.000-08:00

Credit Market Overview
February 26 2009

Robert Rodriguez, CEO of First Pacific Advisors, stated during a Barron’s interview recently that his investment mantra was: “Winning by not losing.” True to his word RR had up to 45% of his main fund in cash at certain points last year.

Although the VIX is down from its 52.62 close on 2/23/2009 that might be reflecting non-participation as much as a reduction in fear. Since 2/10/2009 there have been only 2 days with less than a 2% range from the previous night’s close on the SPX. The average daily range for this period has been 3.3% with a max of 5.2% on the 10th. While there might not be fear it would appear uncertainty abounds.

One of the things people do feel pretty certain about is that it will take a bottom in housing and the financials for any turn higher in the market to be more than an oversold technical rally.

Tuesday’s release of the Case/Schiller home price data showed prices 27% from their 2006 highs and inventory levels at 9.3 months of overhang vs. 11.2 months in November. While these numbers might seem encouraging Michelle Meyers, an economist at Barclays warns that the inventory numbers are not seasonally adjusted so they could rise again come spring.

The other two caveats she mentions are that a good portion of the recent purchases were by speculators who will not hesitate to dump their properties back on the market if the downturn persists. Additionally, while the current roughly 9 months of unsold home supply is better than the 11 number from November it is still twice the “normal” level of about 5 months. Michelle does not feel housing prices will bottom until a peak to trough number of about 40% is reached.

One can only imagine what the additional 13% drop in home prices will do to foreclosures and their ripple will affect on all things credit and confidence related.

An interesting piece in the WSJ Op/Ed section yesterday discussed how earnings were calculated for the S&P and how it differed from how the index itself was calculated. The index, as we all know is capitalization weighted so that a 1% move in XOM affects the index more than a 1% move in JNY.

The earnings it seems are not weighted in the same proportion so that if XOM makes a buck and JNY loses one S&P earnings are said to be zero. Using this methodology people are coming up with earnings numbers in the $40-$50 range and saying that the current SPX levels are too high as a result. The Op/Ed piece argues that earnings should be weighted in the same proportion as the stocks themselves. In doing this the author calculates that earning on the S&P are probably closer to $70.

I have never constructed or arbitraged indexes but the logic of the argument does seem to make some sense if only for reasons of consistency. As with all things, however, the market looks at what the market looks at and as we have all learned, the market is ultimately always right.

Enjoy the week.

Jim Delaney

C.M.O. 2.25.2009

2009-02-25T04:35:00.001-08:00

Credit Market Overview
February 25 2009

It was good to have things back to normal yesterday. Consumer Confidence, projected at a lofty 35 came in just 10 points below at 25; S&P cut Latvia’s credit rating to BB+ putting it in “Junk” land and the S&P saw all of the good news in those events and rallied 29.81 points.

CDS spreads which have been following the stock market as of late vs. made a move as well with the High-Yield index closing at 1477.2 in New York down 68.7bps or 4.44% from Monday night’s close which was through the February 5th close of 1494.4, it’s most recent high.

Investment grade spreads turned down as well but not nearly as dramatically as those on the other side of the investability tracks. At 215.5bps IG spreads are still above the “200” line but in this latest sprint they did not get above the 222.1 level seen on the 23rd of December last year.

Looking at a chart of the levels one could almost make the case for lower highs which the technicians out there know is at least half of the equation for a down trend. The other half is lower lows but we will have to get through 187.6bps, which occurred on February 9th for the second piece of the puzzle to fall into place.

It has been a rare occurrence as of late to have the markets respond positively when the cameras are pointed at anything in D.C. but the first day of Ben Bernanke’s semi-annual testimony in front of the Committee on Banking, Housing and Urban Affairs seems to have broken that trend as well. Chairman Dodd was down right obsequious when addressing the Chairman of the Federal Reserve and others on the panel acted as if they were wearing those white gloves workers in museums don when handling a work of fine art.

Sen. Bob Corker (R. Tenn) was the only one in attendance that was having a hard time understanding, in his dumb like a fox sort of way, how stress testing the banks and then giving them whatever they needed to pass the test was not ipso facto “Nationalization”.

Ben kept his cool and explained that to the extent there was still a stock price to be quoted, something which can’t be said for a handful of other institutions that were around this time last year, then the bank in question had not been nationalized.

I do find it amazing how smart you have to be to say really dumb things.

Enjoy the week.

Jim Delaney

C.M.O. 2.24.2009

2009-02-24T03:21:00.000-08:00

Credit Market Overview
February 24 2009

I read somewhere recently that people in government don’t spend much, if any, time gathering information from the media as the information they do process comes from more selective sources through established channels. I can only interpret that to mean that they get rid of those that don’t agree with their theories and then listen to the one’s left; but then watching the markets since the politicians took over the financial reigns can make you pretty cynical.

The real shame in all of this is that there are some pretty heavy weight characters being published in the op/ed columns these days and while they are out to make a point in many cases the arguments they proffer are cogent and concise.

This past weekend no less than Dr. Doom himself, Nouriel Roubini and Willem H. Buite were in print. The former is a household name at this point if from nowhere else but reading this piece. The latter, WHB, is a professor of European political economy at the London School of Economics and Political Science so there is some gravitas there as well.

Mr. Roubini is pushing a ‘90’s Swedish encore. “You take the banks over, you clean them up, and you sell them in rapid order to the private sector--it’s clear that it’s temporary. No one’s in favor of a permanent government takeover of the financial system. (Can someone tell Sen. Frank that please?)

Professor Buiter’s approach is slightly different in that he would prefer to create brand new institutions with the $1.4BN that is being bandied about as the amount of tax payer money it would take to restore the U.S. banking sector to its fall 2008 level.

The advantages here would be brand new management, with a new focus in a growth oriented environment. Since these new banks would be fresh ventures with no warehouse of toxic assets the possibility of attracting private capital would also be much greater than asking the capitalists to put their dead Presidents into a bank where the probability of losing most if not all of their investment is exceedingly high at the moment.

The “legacy banks” as Mr. Buiter calls them would not be allowed to make any new investments or loans and would simply manage the dross on their books. If things don’t go well Willem says, the secured creditors would be there to fight over the remains.

The market on Friday fell on news that some banks might be nationalized. It fell yesterday because nationalization was thrown out as an option although after contributing $45BN of taxpayer money already, the possibility of the government owning up to 40% and a $2 stock price if Citi isn’t nationalized I’m not sure what else to call it.

Being a “free-market” advocate I get what Nouriel and Willem are saying. Given how many of our Treasury bonds foreigners hold and are expected to buy in the near future I’m not so sure telling them that the common and preferred stock they were nice enough to buy from some of our premier financial institutions is now worth zero and we don’t care.

Enjoy the week.

Jim Delaney

C.M.O. 2.23.2009

2009-02-23T02:29:00.000-08:00

Credit Market Overview
February 23 2009

For anyone who is not a Citibank customer it is now cheaper to buy the stock than get cash through one of their ATM’s. Citigroup (C) closed at $1.95 on Friday, the non-customer access charge for cash is $3.00. For you history buffs the last time C was at these levels was 1991. Similarly, at $4.07 a share of stock in The New York Times Company (NYT) is just 7 cents more expensive than its Sunday “bulldog”.

Returning to the banking sector for a moment, while C priced at $1.95, BAC at $3.79 (24-year low) and WFC at $10.91 might appear cheap the same cannot be said about default protection on these entities’ bonds.

CDS levels on Citigroup have increased by 77% in the last 10 trading days closing on Friday at 465bps. BAC has seen a 62.5% increase in its 5 year benchmark CDS contract in the same period and Friday’s 273bps was also an all-time high for the name. Last but obviously not least WFC’s CDS’s have gone up 94.4% in just 8 trading sessions.

The Government was all over the media on Thursday and Friday saying that nationalization was not the preferred option and our erudite Fed Chairman himself has said: “it is challenging for the government to manage banks over long periods of time.” While that might be true who says it has to be a long period of time and possibly more important, what is the Fed going to do when the market pushes the stock prices of these three institutions and some of the other banks to zero?

The markets as a whole seems less than impressed with the verbiage coming out of Washington and one jokester quipped “The last thing that came out of Washington that most of the public was happy to see was the helicopter carrying President Bush to Texas on January 20th!

Craig Peckham, equity strategist for Jeffries says “It’s impossibly hard to call a bottom for bank stocks. With the inability of the marketplace to pinpoint any base value for banks; the loss story and capital erosion picture continue to drive shorts.”

Echoing Craig’s sentiment, Dave Henderson with Dru Stock Inc, described Friday’s saying “Everyone is selling first and asking questions later. I don’t know where the bottom is but we’re one day closer to it.”

With more than 8BN shares changing hands it would appear that those who look to volume for validation are getting the message loud and clear.

Enjoy the week.

Jim Delaney

C.M.O. 2.20.2009

2009-02-20T03:27:00.000-08:00

Credit Market Overview
February 20 2009

News of “The Donald’s” bankruptcy filing in Atlantic City was immediately countered by “The Donald” saying it was only a licensing deal representing less than 1% of his net worth. Representing a little more than 1% however is his latest project in Chicago, which brings to light the problems in the mezzanine financing market. Mezzanine debt fits between equity and 1st mortgage debt on the balance sheet.

The “Mezz” market is in the news these days because of the rising default rate among this type of financing. “If you count the total number of mezz loans there are, you have gotten close to the number of mezz loans that are going to have problems” Mission Capital Advisors’ David Tobin says.

Mezz financing is attractive to some investors as it could produce returns in the teens if levered and if the borrower defaulted the investor had the right to take over the property. “We were very comfortable when we underwrote these assets, if we end up owning them, then that’s just great.” Mark Nunneley, CAO of Ashford Hospitality Trust Inc. said in November of last year.

Great until you take over a property and the property stops generating enough cash to cover the 1st mortgages, no less the mezz debt. Other well known funds that are involved in the mezz debt market include FortressInvestment Group LLC, Fillmore Capital Partners LLC and Petra Capital Management.

To the extent that this will prove a money losing proposition for the hedge funds and private equity firms out there, a provision in the stimulus package could land up making all that back and more.

Sen. Max Bascus helped pushed through a measure on the stimulus bill that allow companies restructuring debt to defer possible taxes for as long as five years and then pay those taxes over the following five years.

The ultimate cost of the program to the Treasury was estimated to be about $1.6BN with ultimate being the operative word. The near term cost (next 3 years) will be closer to $42BN as the loss in tax revenue is front loaded and the receipts back loaded.

Enjoy the weekend.

Jim Delaney

C.M.O. 2.19.2009

2009-02-19T03:11:00.000-08:00

Credit Market Overview
February 19 2009

“In some ways, what the government says or does is becoming less important, since the market wants to see proof that the stimulus is working and the economy is bottoming.”

Although this quote by James Paulsen, chief investment strategist at Wells Capital Management, was made in time to be in last Saturday’s Barron’s it’s prescience rang true this week as Tuesday’s signing of the American Recovery and Reinvestment Act and yesterday’s mortgage relief plan were met by a two day drop of 38.42 S&P points or a 4.64% reduction from last Friday’s close.

Economists too are in synch with Mr. Wells. A recent poll of 52 leading economists by the WSJ shows that a previously hoped for “second-half recovery” is now looking much less likely. In September that same poll showed a consensus estimate of 1.2% of GDP growth in the 1st quarter of 2009. A more recent update puts this statistic at a 4.6% decline. Growth estimates for the April through June period has moved from up 1.9% to down 1.5% between the two sampling periods.

Responses by these economists regarding the stimulus package included the following: “too late”, “provides too little boost”, “trivial”, “too big” and “too small”. Those last two are probably the reason Harry Truman pleaded for “a one-armed economist”.

In response to statements that everything starts to clear up in the second half of 2009 David Shapiro, an economist at Penn State, said “If you look at the magnitude of this problem, the amount of debt relative to income, the credit and asset bubbles that have now reversed and it’s only just started, why is it going to end two quarters from now? To say ‘off we go’ in the second half of the year, I think that begs incredulity, I just don’t buy it. It’s a global thing, too; trade volumes are just cratering and our exports are getting pounded. There’s no where to hide.”

Brian Fabbri, chief economist at BNP Paribas agrees saying: “We’re in trouble. We don’t have sufficient economic plans at present to resolve the banking system or the financial crisis, and the stimulus package seems loaded for 2010.” Brian also sees the global nature of the downturn, increased savings by U.S. consumers and tightened lending standards as obstacles to a quick recovery.

Enjoy the week.

Jim Delaney

C.M.O. 2.18.2009

2009-02-18T03:33:00.000-08:00

Credit Market Overview
February 18 2009

One of the keys to successful investing it is said is to follow the “smart money”. This used to mean (before 2008) do what the professionals do when they do it, not what the individual investors do when they do it.

In this context a story in yesterday’s WSJ seems apropos in that individual investors have been big buyers of high-yield paper and as a result have pushed yields down to around 11% from rates in the high teens seen during the 4th quarter of 2008. Fund researcher EPFR Global says individual investors have purchased more than $4BN of high-yield bond funds since last November.

For all of their lack of sophistication it seems that individual investors are getting the joke as the WSJ also reported that money-fund assets have grown by $450BN since last September and are close to their all time record of $4TN.

Put most of your money in a safe bet and take a flyer on a small portion that if it works out will boost the performance of your whole portfolio by some incremental amount. A strategy like that would have worked wonders last year and to the extent we’re not out of the woods yet it can’t be said it’s the worst strategy for 2009. Maybe some of these people should be running hedge funds.

Now before the rest of us start feeling like we missed something there is a “fly in the ointment” and that is that high yield bonds pay high rates of interest because they have high rates of default. No risk, no reward and vice versa.

The economic situation at the moment seems to be raising the risk of defaults as Circuit City (11/10/2008); Nortel (1/14/2009); Tribune (12/8/2008); Pilgrim’s Pride (12/1/2008); Smurfit Stone (1/26/2009); LyondellBasell (1/6/2009); Spectrum Brands (2/3/2009) and VeraSun Energy (10/31/2008) have all filed for Chapter 11 bankruptcy since 4Q08.

To further the point the three main credit rating agencies expect default rates to hit levels last seen in 1933 according to Moody’s Investor Service’s 87 year’s worth of default data. According to the WSJ, as of 2/6/2009 U.S. companies have defaulted on $43.1BN of high yield and bank debt, which the article goes on to say, is higher than 2006 and 2007 combined and is more than 25% of the $157BN of high-yield loan and bond defaults in 2008.

Hitting the dollar volume of defaults in two months that it used to take three to achieve puts us . . . well . . . I was going to say it but Jeffery Werbalowsky, co CEO of investment banking firm Houlihan Lokey Howard & Zukin beat me to it, “You do the math, we are in the midst of the greatest pool of defaulted debt we have ever seen.”

Enjoy the week.

Jim Delaney

C.M.O. 2.17.2009

2009-02-17T03:19:00.000-08:00

Credit Market Overview
February 17 2009

In life, business and of course trading it is always good to learn form your mistakes. It appears Moody’s has taken this to heart as after having rated a whole bunch of mortgage backed paper AAA that probably didn’t deserve a single “Z” (not that there is such a rating) they have now examined the sovereign debt market and come up with three sub-categories for those countries whose debt they put on their top-shelf.

The categories are “resistant”, for those nations that are unlikely to be downgraded by the current global crisis; countries that fall into this category include Germany, Canada and (can you believe it) France. Their next category is “resilient”, for those nations that are being affected by the credit crisis but should be able to adjust and get themselves back to “resilient” status. The U.K. and ourselves fall into this category. Then there are those nations Moody’s deems “vulnerable”, with Ireland and Spain being the best examples.

The criteria Moody’s uses to decide which bucket a country belongs, or more importantly, what the cause of a downgrade could be are the material deterioration in the affordability of the debt, a deterioration in affordability relative to other sovereigns and the inability to correct the problem.

So after hearing about this I looked up the CDS spreads for the countries in question to see what the market thought. Germany trades at the lowest number of basis points, 70 with France in 2nd place at 74.5. I couldn’t find Canada’s CDS spread on Bloomberg but it might be tough to default on snow. In the next category the U.S. and U.K are trading at 87bps and 151.6 respectively while Spain is trading at 160 and Ireland at 376.63

87bps doesn’t seem that far away from 74.5bps which is France’s 5-yr CDS level but it does seem pretty far away the U.K.’s 151.6 so it’s not clear that the market agrees with Moody’s but it will be interesting to see how things change as the ever increasing deficit is financed through ever increasing quarterly refundings of U.S. Treasuries.

Already cognizant that the deficit is on its way to “way too big” Barack Obama has scheduled a “fiscal-responsibility summit” for February 23rd. On Friday the President told business leaders at the White House: “We are not going to be able to perpetually finance the levels of debt the federal government is currently carrying.”

This seems to be a realistic assessment but the risks taken by passing a massive spending bill can only be increased if an attempt is made to recover the spent monies too quickly. Christina Romer, chairman of he White House Council of Economic Advisors sites the “seesaw” nature of spending in FDR’s New Deal when Mr. Roosevelt would spend big one year and then back away the next, never allowing the economy to really get traction.

If this was never done before all arguments would be equal because the outcome would yet to be unknown. Given the mistakes made with the New Deal it doesn’t look like the government has learned from its mistakes. Hopefully Moody’s has.

Enjoy the week.

Jim Delaney

C.M.O. 2.13.2009

2009-02-13T04:28:00.000-08:00

Credit Market Overview
February 13 2009

The line “Misery acquaints a man with strange bedfellows” in William Shakespeare’s play The Tempest is best now known to most of us as in its modern form as “Politics makes strange bedfellows”.

The truth behind this statement in either form gathered strength yesterday as news of a meeting hosted by (you guessed it!) Goldman Sachs with the people key to getting the toxic assets off the balance sheets of the country’s major financial institutions (you guessed it) the same people who helped put them on, met with Tim Geithner to figure out how to execute the transaction.

It took the talking heads on TV about 9 milliseconds to start screaming about how TG is too close to his Wall St. buddies and the government is, once again, handing the keys to the hen house to the foxes. Charlie Gasparino tried to make the story into the hottest thing since Jessica Simpson’s “20 pounds in eight weeks” claim.

Meantime Bloomberg quietly reported that the meeting had been scheduled for over two months and that the timing only seemed questionable due to the delay of TG’s confirmation due to that nasty tax issue and not announcing his plans on Monday, as originally scheduled, because of last minute wrangling over the stimulus package. (You think Mike has higher office in mind?)

Say what you will but if New York was a maximum security prison and you did need to get out, who else would you want by your side but Snake Plissken?

The S&P closed above a down trend line many were watching on February 6th & 9th and spent part of yesterday through the bottom of an up trend line those same people had their eye on. The buzz going into yesterday’s close was about money getting thrown at the mortgage problem with FNM and FRE getting involved to house the dreck. Anyone remember the “Superfund” set up by the EPA after the Love Canal debacle?

In CDS land, spreads ain’t buying any of what Geithner or Goldman is selling. Unemployment is rising; people who don’t work can’t spend money like they do when they are. The last time I heard Louise Yamada she was telling everyone to sell all rallies until the Dow hits 6,000 or further notice.

Enjoy the weekend.

Jim Delaney

C.M.O. 2.12.2009

2009-02-12T02:56:00.000-08:00

Credit Market Overview
February 12 2009

After losing the election for Governor of California by almost 300,000 votes in 1962 Richard Nixon gave an impromptu concession speech the next morning saying to the press, whom he blamed for favoring his opponent Pat Brown, “You won’t have Nixon to kick around anymore.” Given the how things were in his final days as Treasury Secretary it would not be a stretch to think that Hank Paulson had similar sentiments.

Where the problems stopped for HP, however, they seem to be picking right up for poor ‘ol TG. If early indications hold out we might see a little more efficiency from Mr. Geithner as his renaming of TARP now only takes three letters FSR. Unfortunately the latter actually takes more effort to say. Let’s hope the rest of his accomplishments do not appear to be one thing while being something harder and not easier.

It would also appear that Timothy’s plight is creating a lot more frustration than sympathy by both Washingtonians and Wall Streeters. Christopher Dodd (D., Conn) is placing responsibility for the fix on the Treasury and the current administration saying that it is their job to “reassure the American people that their money is in good hands. The public simply has no understanding about how government assistance will help, if at all.”

Not for nothing but that is not how I want one of the guys who has just voted to spend +/-$800BN of my taxpayer money talking. Comments like that seem an early indication that even the Democrats that voted for the biggest stimulus spending bill in history don’t know if it will work. (Maybe he went back and read Treasury Secretary Morgenthau’s notes?)

Wall St. too is unimpressed by the efforts of the new kids in town. Douglas Dachille, CEO of First Principles Capital Management thinks, “The uncertainty the government has created has made it nearly impossible to price many securities.

The plan to have private equity get involved sounds great on CNBC but you have to remember. The P/E guys get their votes by delivering solid returns not pork so to think they’re going to get involved before the rules of the game have been laid out is a little naïve on whose ever part thinks that’s the way it’s going to happen.

One person, while not necessarily in Mr. Geithner’s corner, at least seems to appreciate his predicament is Sen. Robert Bennett (R., Utah) who described Tim’s challenge “as nasty a briar patch as anyone has ever tackled.”

Enjoy the week.

Jim Delaney

C.M.O. 2.11.2009

2009-02-11T03:06:00.001-08:00

Credit Market Overview

During the most of 2006 and the beginning of 2007 the demand for fixed income securities was such that investors were forced out the maturity and credit curves, sometimes simultaneously, to achieve whatever incremental yield they could obtain.

The CDS market saw a ratcheting in of spreads during this period, which would normally be good for equities but at times the stock price of the company in question declined along with spreads as well as bond and stock investors did not appear to be in synch.

Something similar is happening in the credit markets at the moment but this time for a different reason; CDS spreads for a good portion of the names in the CEC universe have come in since late January but the stocks have not rallied and in fact, most had a quite horrible day on Tuesday.

Every cross-asset relationship goes through periods when it works and other times when the answer to that question is “not so much”. This is one of those N.S.M. times but beyond the simple observation the question “why” needs to be asked.

Part of the answer comes from something I have written about often recently, the relative “cheapness” of corporate paper on a spread basis. That CSCO could issue $4BN in debt this past Monday, made up of $2BN of 10-year notes at 200bps over Treasuries and $2BN of 30-year paper at 225 bps over is testament to the demand for quality corporate paper. My CDS pricing source does not list 30-year CDS but the 10-year spread for CSCO was 96.3bps on Monday. This still shows some hesitancy by investors to use balance sheet space but that is a story for a different day.

CSCO is rated A1 by Moody’s and A+ by S&P and I think its safe to assume for the sake of this argument that since CSCO is not some CDO^2 that the two rating agencies have this one right. Additionally there have been $78.3BN worth of investment grade bonds issued in 2009 that were not supported by a government guarantee. (More evidence of demand)

The other part of the answer comes from looking at where spreads were and why they were there. Back on December 2nd of 2008 HPQ issued $2BN worth of 5-year paper but needed to pay a spread of 460bps over Treasuries to attract buyers. HPQ is rated A2/A so while slightly less credit worthy than CSCO the shorter maturity probably evens the rating difference out and we see that there was much more fear and less demand back in December. (The 5-year CDS spread for HPQ was 107.7bps at the time.)

Using these two debt issues as examples we can see that some of the fear has come out of the market and as that has happened the demand for paper has increased.

Stocks on the other hand are not enjoying the same resurgence. Many well known investors have been quoted in the media as saying that the stock market won’t come around until the credit market does, this makes sense given where the two asset classes reside on the balance sheet. The demand for paper is encouraging but the difference between CDS spreads and where corporations have to issue still shows some problems there.

People have also said that the “financials led us into this mess and they will have to lead us out”. I am not here to say whether those people are right or wrong but with the likes of BAC down 19.30%, C down 15.19% and WFC down 14.22% yesterday if they are correct we have some work to do.

Enjoy the week.

Jim Delaney

C.M.O. 2.10.2009

2009-02-10T09:11:00.000-08:00

Credit Market Overview

British Prime Minister Gordon Brown used it last week to describe the global economy but then it was called a slip of the tongue. Now IMF chief Dominique Strauss-Kahn is saying it about the world’s advanced economies: the U.S., Western Europe and Japan. What is it? The word depression.

Larry Summers disagreed on This Week with George Stephanopoulos saying “we were really in a very different situation then” the Great Depression.

The CIO of Bridgewater Associates, Ray Dalio, couches it slightly differently in Barron’s this week saying that what we’re going through is a “D-process” which to Ray is the combination of deflation and deleveraging and he says comparable periods are the Great Depression, the Latin American debt crisis and the Japanese experience.

Simon Johnson, former IMF Chief Economist and professor at MIT’s Sloan School of Management says the term refers to any significant contraction that lasts around 5 years.

What ever you do land up calling it Timothy Geithner is planning to announce measures today to fight its effects. These will include re-naming the TARP plan because it carries such negative connotations. Possibly of slightly more import are also plans to have the private sector become investors in the securities with the Treasury back-stopping losses over a certain threshold.

Industry people have a number of issues with the points that have been leaked so far including that it deals only with banks in the proper sense and with none of the institutions Bill Gross and others call the “shadow banking system”. Real banks it seems only account for 20% of the U.S. private credit market these days down from 40% in the 1970’s per Bianco Research in Chicago.

Vincent Reinhart of the American Enterprise Institute is a bit more acidic in his description saying, “What we need is a shock and awe campaign to fix the credit markets and what we’re getting instead is ‘aw shucks.’”

I have talked often in this space regarding the spreads on corporate debt at the moment and how, on a spread basis, they imply default rates exceeding those of the worst years of the Great Depression. Bill Gross echoes this sentiment and adds that the default rates could become self fulfilling prophesies if non-investment-grade corporations are forced to roll-over long term debt at levels of 20% or more.

There is a lot riding on Mr. Geithner’s plan. Let’s hope its more of Mr. Reinhart’s shock and awe and less of his aw shucks!

Enjoy the week.

Jim Delaney

C.M.O. 2.9.2009

2009-02-09T18:49:00.000-08:00

Credit Market Overview

From what has been published it appears that barely 1/5th of the stimulus that Congress passes will be spent in fiscal 2009 and with just 3% of that being anything that you could honestly call stimulus; Rohm Emanuel’s “never waste a good crisis” seems to be gaining momentum while Larry Summers’ “targeted, timely and temporary” seems to be losing it.

The market added 22.75 S&P points on Friday as anticipation that Timothy Geithner was now both current on his taxes and was going to announce his plans on how to clean up the financial mess on Monday. In comparison the S&P moved 98.69 points on the Thursday and Friday preceding the Monday when Hank Paulson was going to announce TARP 1.0.

Given that the market was 148.69 S&P points lower by the 29th of September and 345.16 points lower by the 8th of the following month maybe Friday’s smaller number will mean that the move from here will only be down 78.63 points once the market realizes that anything short of the Swedish good bank/bad bank approach will to little more than prolong the pain.

Just to close the loop on all of the index math 78.62 points would put the S&P at 789.97 near but not exceeding the November lows. The test many are expecting which also reduces the probability of it occurring.

High yield spreads moved from 1494.4 on Thursday to 1444.3 as of Friday’s close as measured by the CDX indexes published on Bloomberg. Investment grade spreads moved back below the 200 line again as the spread players in the debt market are swallowing all the bonds they can while the relative cheapness lasts and corporate treasurers and CFO’s are issuing as fast as they can while nominal yields are at close to all time lows.

Something else to keep in mind, the market had 6 counter trend rallies of at least 20% in the 30’s before the market had erased 89% of its pre-1929 value. As of Friday’s close we are down 44% from the October 2007 high and have had one.

In a sidebar in Barron’s this week Charlie Minter and Marty Weiner of Comstock partners did an analysis on the “E” of the P/E of the S&P. The last paragraph says it looks like 640 is a real possibility.

Enjoy the week.

Jim Delaney