Daily Commentary

Spreads are rallying again this morning on top of yesterday's strong rally.  Credit investors do not seem that concerned over the alleged DCX filing, bank stress tests or swine flu.  They are largely focused on extremely strong technical demand, a dropping Vix, normalizing credit curves, firm swap spreads and a shrinking negative basis (cash bonds outperforming CDS).

Most notable this morning is the inaugural US dollar corporate bond issue for Nokia.  They are bringing a 10 and 30yr bond to the market in the ~250-275bps range (over US treasuries).  Compare that to Motorola which trades ~660bps.  Bear in mind that Motorola is barely investment grade while Nokia has a strong single A rating from the agencies.

I'm surprised there is not more chatter about the potential FASB ruling on off balance sheet financing.  This could eventually bring billions of dollars of obligations back onto (already weak) bank balance sheets.  There's not much detail here yet but expect this to put pressure on bank spreads.

In a sign that sentiment seems much better, the Whistlejacket SIV liquidation occurred and it went fairly smoothly.  This was a notable and large investment vehicle that held ~$7B in assets (primarily structure product) when it was declared insolvent in February 2008.  Suffice it to say that this would not have occurred at all, let alone so quietly, unless confidence and demand were deemed strong enough.  

Eric Beinstein's excellent research group at JPMorgan shows that investment grade credit spreads are currently predicting that the S&P should be just above 1000 (1yr regression, Z score >2, R squared ~.8).  So, if you believe credit leads equities, it's time to buy stocks.

  

  

Daily Commentary

Despite a blizzard of what most would call bad news, equities are up on the day and credit spreads are starting the day much tighter.

As more of these stress test results are allegedly leaked, credit investors are clearly starting to view this as an equity story, not a debt one; witness, bank spreads are largely unchanged today.

Demand for credit remains quite robust.  Today alone, we are seeing new issues from Goldman (non FDIC), Diamond Offshore, Encana and Florida Gas.  Goldman's decision not to use an FDIC guarantee will add an additional ~3.75% to their annual borrowing costs. 

While there is a FOMC announcement today, most are not focused on it.  Fed Fund futures have shown little volatility in last several weeks with a gradual move from ~20bps (implied) to the current ~15bps.  Obviously, with rates so low already, eyes are 'quantitative easing' measures at this point.  

It is important to remember that TED spreads have remained below pre-Lehman levels for several months now:

                             

One should also note that UK short term rates have fallen for 44 consecutive days.

I thought this article in the New Yorker was quite interesting.  It discusses the historical success rates of companies that actually increased spending (R&D, advertising, M&A) during recessions versus those that did not.  

Daily Commentary

Secondary credit spreads are moving wider this morning lead by the underperforming banks and brokers.  Continued concerns over swine flu and new 'tough talk' from the GM bondholders group have credit investors picking and choosing their spots carefully.

A big jump in the just released consumer confidence number could turn this around quickly.

The new issue market continues to be impervious to broader market worries.  Potash announced a deal this morning and had ~$2B in interest in 34 minutes before the deal closed.  Several regional banks have or will come to market soon with new debt deals.

The sectors that could be negatively impacted by a potential epidemic have low index weights so that has had, so far, a muted impact on the index.  Conversely, the healthcare/pharma sub-sector could benefit and has a much larger index weight.

I'm surprised that CDS outstanding has not dropped post the mid-April Big Bang protocol.

A hedge fund is making some noise that MBIA may have triggered a succession event in their CDS when they split the company.  This could cause some volatility in the name.

Obviously, most of the chatter this morning is about the banks/brokers and potential need for further capital raises.  Here are approximate spreads over treasuries, in basis points, for ~10yr bonds and the change in spread overnight:

JPM ~350 +10

WFC       ~370 +5

GS ~430 unch

MS ~465  +15

BAC ~565 +15

C ~605 +25

MER ~680 +30

Predictably, spreads are headed wider following the equity markets concern over swine flu.

Other drivers this week will be continued earnings announcements, the Fed release on Tuesday, and a few pending auto headlines (Chrysler/Fiat and GM debt restructuring and a alleged UAW agreement).  So keep your eyes on the tape and for the moment, don't worry about the usual drivers of the Vix and swap spreads.  I suspect new issue supply will be muted considering all the potential "tape bombs" that could screw up a new issue.     

The Fed has released a study that shows the ideal current interest rate is -5%.  Details on how they'll achieve a negative interest rate were not released.

As I've mentioned a few times previously, the risk appetite is back.  Witness Goldman's VAR figure jumping over 20% for Q1.  Their absolute number is double the next broker/dealer.

How many times in the last 2 years did you hear "don't worry about AIG, they can always sell their crown jewel ILFC"?  Well, things do not look so rosy for the prospect of that sale.  Bids are coming in ~65% of book value.

Despite a rally in spreads, implied default rates are still well above historical norms.  Recent DeutscheBank data shows that current market spreads are implying that ~36% of investment grade bonds will default.  Compare this implied rate the worst ever actual rate of 2.4% and you can see the case for owning corporate bonds (if you can hold them long term).    

Daily Commentary

Today's strength in the credit markets is a reminder that when the mood and expectations are this low, even a slight 'beat expectations' can move the market.  Ford lost $1.8B and burned through almost $4B in cash....yet the market is rallying as many expected worse.  I'll attribute some of the enthusiasm to the animal spirits looking forward to great weather this weekend (on the east coast at least).

These very same animal spirits seem to think that Ayn Rand's Atlas Shrugged is more relevant today than Barack Obama's Audacity of Hope  as the former briefly outranked the latter on Amazon's sales rankings. 

While the new issue market is quiet in the U.S. today (because of earnings and pending stress test results), the new issue market in Europe continues to show strength.  AT&T brought a >30yr bond in UK sterling and it was gobbled up quickly....highlighting the demand globally for long duration assets.

Now, that being said, Moody's said that they UK government was taking "risks" and that their finances are "deteriorating" but for now their AAA rating was not under review.

Forgive the pun....but speaking of toxic assets, I missed this story last week about Lehman being long tons of yellowcake uranium. 

Daily Commentary

Tighter swap spreads and a lower Vix are pushing spreads tighter today despite weaker equities.  Credit curves continue to steepen (actually reverting towards 'normal') and the negative basis continues to narrow.....these are both strong signs that the spread rally is sustainable.

The top of everyone's discussion list is the pending bank stress test parameters and results.  Most notable is the (leaked) target for tangible common equity of 3% which is slightly lower than expectations.  I don't suspect they would target an insurmountable level....so expect results to come in close to that 3%.  Michael Milken reminds us that it's very important to focus on the proper capital structure.

Morgan Stanley's CFO says they would "consider" paying back their $10B TARP line.  This comes 1 month after their CEO Mack said "[it's the] wrong time" to pay it back. 

Hartford insurance is trying to sell it's property insurance unit for ~$4B.  Spreads were initially weaker as this was viewed as the crown jewel.  However, spreads have since recovered to only slightly weaker in line with the rest of the sector.

The UK government may embrace a very different way to sell their government debt (ahead of a pending flood of issuance).  They are considering syndicating the debt issuance in much the same way as corporate issuers do.  A pundit would view this as a sign of weakness....needing a broker/dealer to aggressively peddle that which previously 'sold itself'.

The ICE and CME are racing to gain share in the clearing and settling of credit derivatives.  Obviously, this will be quite lucrative given the triple digit growth over the past few years of credit derivatives.  At this point, ICE seems to be taking the lead.     

S&P cut their ratings on ~$8B of CDO's backed by residential mortgages.  29 of these 39 tranches face further pending cuts.    

Daily Commentary

There is little market driving news coming specifically out of the credit markets today so spreads are simply reacting, wider, to lower equity markets.

The pending bank stress test results and earnings are the primary subjects of conversation today.  The stress test criteria are supposed to be released this Friday with the results in early May.  However, if you'd like to see the alleged leaked results of the stress test, see this blog which has pretty grim results.

We're seeing a mini-spurt in issuance of a new type of bond called Build America Bonds (aka BAB).  This is very similar to what used to be called taxable muni's....where some portion of the coupon is tax deductible.  This won't necessarily impact credit spreads too much but could tighten muni spreads as some of that supply will hit the credit markets.

The inspector general for the TARP is concerned about the potential for abuse in the pending PPIP program.  See page 147 here.  

For a credit spread rally to become sustained, 'real money' needs to be buyers of off-the-run cash bonds (i.e. not only new issues or CDS).  The collapse of the negative basis inside -200 is another good sign that this rally could hold.  That basis has been in a negative 220 to 250 range for quite some time.   

Spreads are slightly better this morning.  Credit investors seem to have focused on the healthy trading revenues from JPM's release; equity investors seem to have focused on the weak retail banking numbers from same.  Investors will likely applaud their effort today to bring a new 10 year bond issue without the FDIC guarantee.

Moody's has warned that they may downgrade the commercial insurers citing litigation concerns on top of the standard 'investment losses'.  

The Treasury just announced ~$10B will be available to the banks to modify existing 'troubled' mortgages.  I'm told by mortgage traders that this has had little impact on spreads today.

The TARP program is in the news a bit today.  One, it's been noted that bank lending has actually shrunk amongst the banks that received TARP.  While this may surprise some, I'd remind folks that the economy is still shrinking so keeping lending standards prudent/unchanged will lead to less lending.  Also, we're starting to see some backlash against the rapid repayment of TARP loans as it could lead to less government control. 

The SEC seems to have re-focused their energy on revamping the ratings agencies.  "Change is a-coming" here.  Personally, I wouldn't want to own these equities as the oligopoly of Moodys, S&P and Fitch will clearly be diminished in the near future.  Also, expect investors,  rather than issuers, to be paying going forward.   This will lead to ratings volatility as issuers are no longer allowed to ask, in advance, "how can I structure this deal/news so that I keep my ratings?"

One would think that a company or country growing at 6.2% annual clip would be applauded.  However, when it's China and that's the lowest print since 1992, investors worry about it.

New issues continue to perform well at issuance and in the secondary market afterwards.  I've also heard of 'real money' investors delving into buying of off-the-run bonds.  This is an encouraging sign of broadening liquidity.  There's been depth (in new issues) and now there's breadth.  

  

Daily Commentary

The credit markets seem to be pretty spooked by the UBS earnings as spreads are slightly wider despite the stronger US equity open.

"Precarious" is not the term a CEO ever wants to use during an earnings announcement as UBS's Grubel did today.  Notable was their dwindling prime brokerage assets.  I'm a firm believer, and witness, that clients yanking their prime brokerage money can be the death knell to a firm....witness Bear, Lehman and other close calls.

At the risk of beating a dead horse, demand for credit spread product remains very strong.  Using some simple math, you'll note that, on average, there are $75B in bonds maturing monthly (including coupon payments).  This month alone, there has been only $21B in issuance.  In addition, much of this issuance has been in FDIC guaranteed debt which usually does not fit the target of a credit investor.  Please also bear in mind that Goldman noted they have $164B in cash and 'liquid' securities to invest in distressed assets.

It's no wonder then that HCA is bringing a deal in the high yield market.  The $1B issue will be the largest in 6 months....and at the tightest market spreads in 6 months as well.

The Vix remains tantalizingly low....approaching the September pre Lehman blow-up levels.  Historically, that has bode well for credit spreads.       

Daily Commentary

Oddly, spreads are a bit wider in light volume.  Given the backdrop of mixed European equities, a mild Vix, a strong new issue market and tighter US swap spreads, I would have thought the credit markets would shrug off a weaker US equity market.

Yesterday, Bernanke mentioned the word 'credit' 29 times yesterday in his speech at Morehouse College.  Perhaps he was acknowledging the well known predictive capacity of credit spreads for future economic activity; this was most recently discussed in academia here.  

MetLife has said it has adequate cash on hand and will not accept TARP funds.  Spreads were mildly tighter on this news.

While largely look-back (in impact), S&P has raised it's estimated European default rate for 2010 to 29% (E'09 11%).

Demand for credit, particularly new issues, continues unabated.  Witness today's announcement of a new issue for Rio Tinto at 8:40am.  By 9:45am, the deal was 'closed' with close to $10B in demand.  

I see 2 positive signs for risky assets.  One, hedge fund redemptions have slowed.  Two, the carry trade (in forex) is back which historically been a large driver of hedge fund returns.  Like 'em or hate 'em, hedge funds are the primary buyers/holders/traders of risky assets.  When they're healthy, risky assets have the tendency to outperform.

Quick...what's the largest bank in the world (by market value and deposits)?  No cheating...   (answer : here)

  

    

Daily Commentary

Despite higher Asian equity markets, the US equity market is opening weaker and dragging credit spreads with it.  Europe is closed for Easter Monday.

Here are the positive factors for the credit markets as I see them.....the Vix is dropping, credit curves are normalizing (steepening), inflows to the sector remain very strong (avg +$.3.3B a week), and Goldman is raising money to buy risky assets.

The negative factors are well known and will be confirmed or countered this week during earnings season.  I suspect the trend we could see emerge from the financials is raising equity (of some form) to pay back TARP.  This will allow the 'winners' to pay folks >$250k and quickly illuminate those that are struggling.   

In an odd turn of events, AIG Financial Products, the division that caused AIG all the pain, has decided against signing the recent Big Bang CDS protocol.  They allege it is due to the fact that all their positions are legacy and thus pre-protocol and that they are in wind-down mode.

This dovetails nicely with the most recent DTCC data which shows that net CDS outstanding (U.S. single name) is down 16% since October 31st.  The trend is fairly straightline showing drops for the last 1 month as well.    

Bloomberg has added a succinct summary of the new protocol to it's usual fine analytics.  Type SNAC on your terminal to see it. 

The richest (tightest) sectors are healthcare/pharma, industrials and telecom.

The cheapest (widest) sectors are REITs, financials and insurance.

The average price of a bond in the JPMorgan credit basket/index is ~$93.25.     

Daily Commentary

Credit spreads are tighter on the day as equity markets surge.  There is little else to talk about during this early-close-during-blackout-season type of day.  Same store sales seem to have a slightly better than expected bias with spreads performing in line with the general market.

Volumes are very light given the Big Bang and almost no new issuance (and a 2pm close so credit investors can honor passover/Maundy Thursday and pray for a bonus).

Tighter swap spreads, a subdued Vix and commodities and strong equity markets are more than enough to push spreads tighter.  Investors also seem to buoyed by the NYTimes article that the banks have passed the stress test.

Holders of insurance bonds/credit were certainly encourage by the TARP news.  However, some sobriety has crept into the conversation as they realize there's only ~$19B left for all of them (and loads of banks that have yet to apply).  

Berkshire Hathaway was dinged 2 notches by Moody's from AAA to Aa2.  CDS spreads were only  wider by ~10bps to ~340bps while the equity looks to be up on it's WFC holding (which announced strong earnings).  The finance sector is 20-35bps tighter today on this WFC news (MER and WFC performing the best).

Daily Commentary

Spreads are generically a bit tighter this morning in muted volumes.  Volumes are muted due to the CDS Big Bang occurring today as well as the beginning of earnings season.  I'm a bit concerned about widening swap spreads in Europe...that typically does not bode well for our financial sector spreads.  Expect new issue volume to be light as well with only 1 deal (from Qwest) done yesterday and none being bandied about.

Credit investors must believe that CTX/PHM merger is sure to happen as spreads almost immediately converged to the ~260 area.  CTX needed to tighten ~180bps to get there while PHM was only a few bps tighter.  Usually you see ~20-50bps in deal risk but not in this instance.      

As a reminder, all CDS trading for new contracts going forward will have fixed coupons.  This is a very very big deal as it helps reduces counterparty risk and should increase liquidity.  For a very good and detailed summary of why this is happening and why it matters, please see this excellent blog entry.  CDS volumes will be subdued for the next week or so as investors figure out how to trade, model, and settle them.  

The primary credit index (CDX) is now ~31 rich to it's underlying.  Until today's Big Bang that was very arduous to arb....but no longer....watch for that to shrink.

Equity and debt investors are both reacting the same way to the positive TARP news on the life insurers with most life insurer bonds up several points.  There seems to be some chatter that REITs are up next for a bailout.  Included in this sector rally is LNC which seems re-arranging deck chairs on the Titanic. 

ILFC bonds are up ~$5 on news of a possible Fed line of credit.  This has given confidence to the (alleged) 3 interested buyers in the aircraft leasing business.

Bloomberg released it's Q1 underwriting league tables for investment grade bonds (below, with market share %):

JPMorgan 14.4%

BoA 14.3%

Citi 14%

MS 10.8%

GS 10%

That's quite a concentration at the top...some would call it an oligopoly.  The #6 only has a share of 6.7%.  Given how I've noted that liquidity (and thus bid/ask spread profit) is concentrated amongst recent new issues, this will be a big boost to those banks at the top.

Daily Commentary

I'm a bit surprised that spreads are matching in lockstep with equities to wider levels.The Barclays Credit Index closed at +472bps (vs 3 month wide of 507 and tight of 424).

Morgan Stanley and George Soros both recently insisted that the bear market is not over.  I thought George Soros officially lost relevance in 1998 when he declared capitalism as flawed.    

A steady Vix, mixed swap spreads and bullish comments from the ECB (about possibly buying corporate debt) are usually enough to push spreads tighter.  I've heard from a few folks that there is a large SIV (structured investment vehicle) unwind going on in the market which may be enough to tip the scales.

Usually we hear about tighter regulation from politicians and aggrieved investors.  However, today we're hearing about tighter rules for money market funds from the investment managers themselves.  These changes sound likely to go through which will cause for further dislocations and odd technicals in the very short maturity bonds.....a quick drastic flight to quality.  

The PPIP program from the Fed was announced only days ago....and is now being expanded to include more managers.  Almost everything out of the Fed now feels ad hoc and soon-to-be duct taped.

There was some scary default data released recently.  High yield recovery rates (what's left after bankruptcy for creditors) have been ~10 cents for bonds and ~25 cents for loans this year; last year those were 39 and 55 cents respectively.  Moody's noted that their speculative grade default rate in Q1 was 7% (vs 1.5% Q1 '08).  They predict a peak of 15% during Q4 '09 with a 'recovery' to 12% in Q1 '10.  Remember that the credit market currently has a 45% default rate priced in to the market so buy buy buy. (JPM data; assumptions of 20% recovery rate, 10yr cohort).

Daily Commentary

Credit spreads are opening unchanged to slightly wider this morning. 

There are a few stories in the financial sector to mention in light of no economic data today.

Mike Mayo, bank wizard, is noting in a report that the bank sector will continue to struggle; he specifically notes that loan prices (at the very top of the capital structure) are still priced too high.  If you're a Calyon client (which I am not) make sure to get a copy to read...and send one to me when you're done.

There's an article in the FT noting what many have already felt.....wide bid/ask spreads and healthy client volumes are good for the banks/brokers.  In addition, most of these entities have a little bit more wiggle room with their marks given the recent FASB ruling (noted earlier). 

I don't think the IR folks are Lincoln National are particularly enamored of the WSJ today after their article citing pending liquidity issues.   

Credit traders are likely focused on Wednesday's launch of the new fixed coupon CDS protocols.  I suspect that this will dampen volumes as most proceed carefully.

Those very same credit traders will also likely commiserate with bond traders in other sectors about the recent draconian pronouncement from SIFMA  that the number of early closes due to holidays is being reduced.  

Daily commentary

The equity and credit markets are opening in slightly different directions this morning.  Credit spreads are slightly better as most credit investors realize employment figures are backward looking.  By nature, most credit investors are pessimists so it's only a 'bad' number if it's worse than expected.  I suspect, and hope, that credit investors are more focused on some consumer stabilization combined with sharp production cuts....or perhaps lending picking up in the UK.  

As I've mentioned previously, this recent easing by FASB of the mark-to-market accounting rules will help the financials.  Naively, I hope they reverse the ruling once this crisis passes as it's oft shelter for accounting shenanigans.

The FT's Lex, and others, have noted the irony in the recent interest of the banks in investing with the Fed's PPIP toxic asset program....yes, the same program that is allowing these very same banks to divest of their toxic assets.

The demand for credit continues.  Mutual fund flows into credit funds YTD are +$32B which is ~6.4% of AUM.  Contrast that with equity fund withdrawls of ~2% of AUM YTD.  Also, non traditional investors continue to express interest in buying distressed assets.   

Chapter 11 filings have been occurring at an increased pace.  To high grade investors, they largely pass unnoticed.  However, a recent filing by Idearc, has had wide, but not deep, repercussions.  Idearc is considered a 'successor' (in CDS terms) of Verizon.  Verizon was widely represented in the CDX investment grade credit indices.  Therefore, Idearc too had a tiny footprint in those same indices.  The notional amount for CDX indices 1 through 7 all must be adjusted slightly.  I note this as it serves as a reminder of the complexities of the credit derivatives market and how a seemingly unrelated event can have repurcussions in places you wouldn't expect.  For equity investors, imagine having to change the terms of the next 7 S&P futures contracts....systems, compliance, rich/cheap models....all have to change their inputs (albeit slightly).  The derivatives ops folks are busy today.