Daily commentary

There's not a lot of good news out there today. Credit spreads have caught the equity market malaise and are weaker today.

But bear in mind that over the last 30 day investment grade spreads have remain unchanged while the S&P has fallen ~11%. Here's some additional context, the Barclay's Credit Index closed last night at 445bps. The wides (weakest level) were 545bps and the recent tights were 424bps.

One continued sign of strength is the new issue market....we've seen deals from BAX, WU, WMI, Vanderbilt University and a small utility.

I found this data alarming....loans, which are the top of the capital structure, have historically had a recovery rate (after default) of ~81 cents on the dollar. The last 5 loan default recoveries have averaged 40 cents.

The Vix keeps creeping higher which could form a ceiling for spreads.

S&P notes that there have been 31 defaults for $49B YTD (as of Feb 17th). They also note that there are ~$174B in bonds that are on the verge of falling below investment grade which is the highest amount in 17 years. Given this information, I find it ironic that they have cut the corporate rating of Bankruptcy Management Solutions Inc. from B- to CCC+ here.

The snow beckons...therefore, the next daily commentary will be out Monday March 2nd.

Daily commentary

The market is having a schizophrenic opening today.  Spreads are slightly wider but off the wides this morning despite stocks being stronger and bank spreads being tighter.  There are no strong daily signals from any of the usual suspects of swaps spreads or the Vix.  I suspect it is a more simple 'risk indigestion' after a huge issuance month.  

The big story is obviously the potential larger government stake in Citi common equity.  WSJ article (see the last few paragraphs) says the move is largely driven by a shift in focus from watching a bank's Tier 1 capital ratio to watching their tangible common equity.  Citi's CDS levels are tighter by ~65bps to 410bps....if the US government is likely to back their debt, obviously their credit risk goes down.

There's talk in other sectors (government and mortgages) about a larger than average extension in the index this month.  This has and will force month end buying of long maturity bonds of all sorts as investors and indexers alter their portfolio to better match the Barclay's indices.  You see this after heavy issuance months....as 'new' 10yr and 30yr bonds replace old issues that have matured.  The official announcement will come at the end of the week.

Remember the beta vs VHS format battles?  Blu Ray vs HD?  We're seeing a similar intransigence in the competing entities for the CDS clearinghouse.  No one will dare trade on any of them until there's a clear winner.....and there will be no winner until someone starts trading on one of them.  In the old days, the government would let the markets settle it....I suspect Geithner may anoint a winner.  I usually deplore government intervention, but it may be a means to a needed end. 

If you believe CDS leads equities, it's time to buy the common for AES and CNA.  Both have very high Z scores and R squareds (1yr CDS vs equity price regression, JPMorgan data).  

Daily commentary

Nothing seems to be in the green this morning.  Spreads and equities are both weaker.  Interest rate swap spreads and the Vix both remain stubbornly higher too.  However, I've worked with more than one trader that fervently believed that you are supposed to fade the opening move on Fridays especially when it's a large one like this.

That all being said, technical demand remains strong (just not today!).  There has been $175B in maturing bonds in the last 6 months in finance names alone....couple that with $125B in coupons paid (across all sectors) and that creates one big pile of cash that must be put to work.  The tail wind of investor inflows on exacerbates this.

Yesterday was actually quiet on the new issuance front for the first day in quite some time with only some small deals (SNA being one of them).

Gold just broke through a $1000....does that still matter when the CRB is at multi year lows?

The NY Fed reports that dealer positions in corporate bonds (not just credit, includes some agency and structured product) is at the lowest point since 2003.  Their holdings are down ~60% since Oct '07 alone.  This is further data backing the massive shift in liquidity from a dealer principal market to an agency trading market.  Some will tell you that liquidity is just fine and cite the TRACE overall market volume data....but if you take out recent new issues, you'll find that it remains weak.  When new issue volume is heavy, overall secondary volume will 'look' heavy too....but liquidity remains very concentrated in large recent new issues. As a reminder, while the agency model does get trades done....it typically takes longer as the orders need time to get worked and shown around.  That latency is difficult to quantify and gets lost in any volume numbers. 

High yield and investment grade spreads have recently de-coupled.  JPMorgan has a great graph in their recent Credit Markets Outlook showing 3 cohorts....2 with 90+ R squareds....and the third most recent cohort with an R squared close to 0.  The nationalization of the banks is likely to be the primary driver here.

 

Daily commentary

Spreads are tighter this morning after yesterday's blockbuster issuance day and overnight global equity market strength.

I'm not seeing a ton of focus on this in the credit markets yet but the CRB hit 6+ year lows yesterday.  

Yesterday's $20B+ in new issuance (ex FDIC gtd) in investment grade debt was the highest 1 day total ever.  Roche issued $16B across 6 tranches.  While the deal came 'cheap' to existing secondary spreads, all tranches this morning are 30-50bps tighter than issued spread.  If I were the Roche treasurer, I'd inquire about the ~$60 million they left on the table.  Sometimes, if you want the deal to sell quickly, that's the price you pay.

Lipper data showed $14B in inflows into bond mutual funds in January.  This obviously drove the enormous demand for new issues last month.

Bank of America made the first TARP payment back to the government....granted it was only $402mm of the $45B they received but it's notable nonetheless.

The "Big Bang" for CDS is coming soon.  The governing body, ISDA, is about to propose a set of rules in advance of the eventual move to a central clearinghouse.  We should see the full proposal well ahead of the March 20th quarterly roll.  JPMorgan is predicting fixed coupons (either 100 or 500bps) and the elmination of ModR in favor of NoR.  When the proposal is released, I will write a separate piece about it.  In the meantime, if you have granular questions, please send them to me.

There are 3 primary competitors right now for the CDS clearinghouse.....ICE, NYSE/Euronext, and CME/Citadel.  ICE seems to have the most dealer support....and as I've said before, you cannot have liquidity without capital.  

Daily commentary

It's been a quiet mixed open for credit this morning.  Global equities were down slightly while swap spreads are slightly tighter.  Yesterday's equity move pushed the Vix higher in one of the largest one day moves in quite some time.  

Today is a heavy day for economic data so we'll likely take our directional cues from something in this slew.

Despite yesterday's markets, new issues from Dupont, Union Pacific and Coca Cola Enterprises were all successfully placed.  For full details, type NIM3 on Bloomberg.  Deals from Roche and Ameren are being marketed this morning.  

The negative basis (the measure of rich/cheap between bonds and CDS of the same name) moved inside -200bps for the first time since October.  When the basis is negative, as it is now, that means that bonds are cheap to CDS.  As this number shrinks and approaches zero, that means bonds and CDS are approaching fair value (to each other).  This tells me that the 'hot money' (hedge funds and dealers) continues to close out their CDS positions.

Former Fed Chairman Greenspan, he of fading relevance and influence, opined on possibly nationalizing the banks.  

The cheapest or widest sectors in the corporate bond market are currently REITs, diversified financials, insurance, financials and consumer/retail.

The richest or tightest sectors are healthcare/pharma, industrials, telecom, utilities and energy.

 

Daily commentary

Spreads are wider this morning due to a strong flight to quality.  Weak global equity markets and much wider swap spreads are what greeted credit investors this morning.

Swap spreads are wider largely on a Moodys' report highlighting the Euro-banks risk from exposure to Eastern European bloc.  As a reminder, swap RATES are where highly rated financial entities borrow from each other...the swap SPREAD is the difference between those rates and theoretical risk free levels.

Last week, asset backed spreads on highly rated credit card deals actually rallied by ~50bps on the Geithner speech.  Apparently structured product investors were encouraged by the prospect of the TALF actually working.

Also last week, the credit curve normalized (i.e. steepened) a bit.  This is a good sign....the primer on credit curves is here.  

The WSJ has a good article on the struggle for hedge funds to obtain prime brokerage services.  I'd do my best to continue to focus on the popular/crowded hedge fund trades in the market and watch them unravel.  

This may be a stretch, but I've noticed something unusual in the DTCC data on amounts outstanding in credit default swaps.  Credit default index tranche amounts outstanding have been increasing on a gross basis but decreasing on a net basis.  This is a pretty specific/arcane part of the credit world that is the playground primarily for the hedge fund and dealer community.  As the net outstanding falls, that tells me less players are involved....more signs of deleveraging in the market.

From the same data, tell me if you see a pattern....These are the top 5 highest amount of CDS outstanding versus real/actual public debt outstanding ratios (think of this as a 'biggest short' ratio):

BRK

PMI

MBI

MGIC 

RDN

Hmmmm......

Daily commentary

Spreads are a bit firmer today but I don't expect the market will move much either way ahead of the Geithner bailout speech on Monday. The WSJ had a little bit more clarity here about what to expect.

New issuance has taken a brief break today due to payrolls. Companys do not want to attempt to issue debt on a day when there could be loads of volatility.

As I mentioned recently, commercial mortgage backed securities (CMBS) are causing investors concern. Almost half the debt that Moody's rates was put on watch for downgrade. Remember, most CMBS investors are ratings sensitive so this could lead to some forced selling.

Daily commentary

Credit spreads are following the global equity markets weaker this morning.  

I've seen both positive and negative spins on today's same store sales figures.  "Not as bad as expected" on the optimistic side versus the pessimistic "sales may be up/OK but at the expense of margins".  Spreads within the retail space are actually flat to slight better.

JPMorgan has a proprietary global all industry PMI that showed a slight uptick in January....hope springs eternal.

Swap spreads are mixed and the Vix is higher.

Investment grade supply remains robust.....with $6.25B yesterday.  Altria's recent deal has a 10.2% coupon....and it's still investment grade.

Textron has drawn down the bulk of it's bank lines....occasionally this is perceived as precautionary or prudent....but not in this case.  Spreads are getting crushed and only high yield investors care about the name anymore.

Please pay attention to the commercial mortgage backed securities market.  The index (CMBX) has been weak of late as many investors don't believe the government will step in and save that part of the real estate market.  Saving mom 'n pop's home plays well on TV....not so much for a mall.

Daily commentary

I suspect President Obama's $500k pay cap is attracting most of the attention in the credit markets today.

Spreads are slightly better this morning but I don't think we'll see any large moves either way ahead of the TARP II announcement and/or payrolls on Friday.  A declining Vix strengthens my thesis as well.

The new issue supply in investment grade credit is keeping a torrid pace.  Yesterday saw $7.4B in non FDIC guaranteed debt alone.  Novartis, P&G and Altria were the headliners.  You can see details on Bloomberg by typing NIM3

While the investment grade market plugs along just fine, the high yield market is headed the other way...much weaker.  Defaults during January were the highest on record at $25.2B.  In addition, there are another $23.2B worth of bonds in their 30 day grace period (payments were not made but they have 30 days before it's an official default).  Those are staggering numbers.  

For those of you under 40 years old, Google Latitude is probably old news.  They continue to churn out interesting, simple and useful apps.  

Daily commentary

Stronger European equities, tighter swap spreads and continued evidence of healthy demand in the new issue market are all driving credit spreads better this morning.

Looming over the market are the pending TARP II proposal (Geithner speaks early next week) and the recent grim bank lending report where 2/3rds of the officers polled allowed how they had tightened standards.  

I wouldn't be surprised if this story about Iran launching a satellite gathers some momentum and pushes the Vix a bit higher today (for 4th straight day).

New deals from Wellpoint and Verizon Wireless have performed well while early indications for the pending Novartis deal seem to be shaping up nicely.  This is obviously an encouraging sign especially coming after a very healthy issuance month in January.

BBB rated bonds have outperformed single A rated bonds in this recent rally by ~15bps.  This is a good sign as it shows an increasing comfort with holding or taking 'risk'.

The cheapest sectors (i.e. widest spreads) are REITs, financials and basic materials.

The richest sectors (i.e. tightest spreads) are telecom, technology, and industrials.  

Why an exchange model won't work for corporate bonds

Here is some data that always surprises equity investors about the difference in the liquidity profiles between the equity and debt markets.

The US equity market has ~6k publicly traded listings of which ~99% trade daily.

The US corporate market has ~600k issues of which only 3% trade in a given week.  

Please note the obvious....an issuer typically only has 1 common equity....but could have dozens or even hundreds of senior unsecured debt issues.    

If you look at the top 25 most active corporate bond issues, they typically make up about 21% of the markets overall volume.  Typically, these issues are recent new issues.  It often seems to investors that the major underwriters are bringing new issues to market, trading them briefly in the secondary and then they go to 'bond heaven' (or hell as the case may be).

So, liquidity in the credit markets is very concentrated in a few recent new issues...and beyond these issues, the volume thins dramatically.  I've seen numerous instances where ~$5oomm deals don't trade even 1 bond for weeks and sometimes months on end.

As an aside, the sectors that habitually have the worst liquidity are REITs, insurance and bonds with a maturity of less than 5 years (all sectors).  

So, say a Rohm and Haas bond with a 2029 maturity fits the profile of a potential buyer that wants to asset/liability match....but the only seller in the market of that issuer is of the Rohm and Haas 2020 maturity bonds....nary the twain shall meet.  There would not be a trade.  This is what would occur in an 'exchange model'.  Please note, that I am using the term 'exchange model' but the same holds true for a matching network model as well.  

In the 'old days', when dealers devoted capital to trading corporate bonds, a dealer would buy the 2020s in the market and (short) sell the 2029s to the client that needed them.  The 9 maturity difference would not add too much risk to their balance sheet.  The shift from principle to agency trading has virtually eliminated this service.  I've said this once before, you cannot have liquidity without capital.

There are 2 hurdles to be overcome if an exchange model is to succeed.  

One is investor preference.  It's been my experience that investors often enter the market looking for a particular bond....and not looking for 'what's available at the right price'.  There's often a good reason why only particular bond (or risk profile) is needed.  A reasonable investor does not want to accumulate a mish-mosh of small positions in one issuer (which is what could occur under the 'what's available at right price').  Given the thin liquidity profile of the bond market that I described earlier, this existing investor preference would need to change.  

Two, issuers need to reduce the number of different bonds outstanding in their name.  Re-opening an existing issue may cause a less than optimal asset/liability match for them but it will enhance the liquidity in their name.  This will allow them better access to the capital markets in the future.  

There is little economic incentive for the major participants (issuers, investors and dealers) to adapt to the measures mentioned above.  To state the obvious, most folks have far greater and more imminent problems to focus on.  Until this dissipates, don't expect liquidity to improve or an exchange model to develop.

    

 

Daily commentary

Spreads are opening a bit weaker this morning in very light volume.  A heavy issuance week last week combined with a "paralyzing" snowstorm in the U.K. have most investors taking a break from buying.  Factor in a higher Vix and the fact that investment grade spreads have rallied far more recently than other fixed income asset classes (high yield and CMBS [commercial mortgage backed securities]) and you'll have little reason to rally.  

Swap spreads are mixed globally this morning.  As a reminder, swap spreads are the rates at which large highly rated entities borrow from each other.  The higher the rate, the less confidence these entities have in each other.  Wider/higher swap spreads usually mean that the finance names will be under pressure.

The good bank/bad bank 'solution' which was greeted positively last week is now being viewed from a different, more negative, perspective.  Yes, it's good news that the Fed (or TARP) will take some troubled assets of balance sheets....but what if the mark (the price at which they trade) is far below where banks are currently marking them on their balance sheets?  

Credit curves remain flat to inverted.   VZW and WLP recent new issues have come, or will come, with flat curves (see earlier post).

The CDS market continues to shrink (as dealers close out offsetting positions amongst each other...and I suspect they are trying to shrink that portion of their balance sheets ahead of the inevitable attempt to regulate this market.

JPMorgan research shows DHI, URI and AVB equity prices are underpriced given where their corresponding CDS levels have been (high Z scores for their 1 year regression).