Category: commercial paper

Florida halts withdrawals after bank run

Over the last several weeks more light has been shed on the State of Florida’s investment pool. Approximately three weeks ago some of the various school boards and smaller governments began questioning the composition of short-term instruments found in the Local Government Investment Fund. This coincided with SIV and other conduit headlines from Citibank leading to a multi billion dollar “bank run“.

Florida officials voted to suspend withdrawals from an investment fund for schools and local governments after redemptions sparked by downgrades of debt held in the portfolio reduced assets by 44 percent.

“If we don’t do something quickly, we’re not going to have an investment pool,” [Coleman] Stipanovich [executive director of the State Board of Administration which manages the fund] said at the meeting, held at the state capitol in Tallahassee. The fund was the largest of its kind, managing $27 billion before this month’s withdrawals.

Local authorities contemplate ways to stop the bleeding.

“We need to protect what is there in the interim,” said Governor Charlie Crist, a Republican and one of three trustees of the State Board of Administration along with Florida Chief Financial Officer Alex Sink and Attorney General Bill McCollum.

The fund has invested $2 billion in structured investment vehicles and other subprime-tainted debt, state records show. About 20 percent of the pool is in asset-backed commercial paper, Stipanovich said at the meeting today.

“There is no liquidity out there, there are no bids” for those securities, he said.

My comments:

  1. According to Bloomberg.com, “The pool was created in 1982 to provide higher short-term returns for local schools and governments than were available at banks.” Just another example that “more money is lost reaching for yield than at the point of a gun.”
  2. Liquidity breeds illiquidity.

Lenders of last resort

Since the implosion of asset backed commercial paper market 11 weeks ago lenders have implemented contingency plans for future funding requirements. According to a recent Bloomberg article, the 12 regional Federal Home Loan Banks came to the rescue as other government sponsored agencies moved to the background.

Countrywide Financial Corp., Washington Mutual Inc., Hudson City Bancorp Inc. and hundreds of other lenders borrowed a record $163 billion from the 12 Federal Home Loan Banks in August and September as interest rates on asset-backed commercial paper rose as high as 5.6 percent. The government-sponsored companies were able to make loans at about 4.9 percent, saving the private banks about $1 billion in annual interest.

Of course the funding was subsidized by the American taxpayer…

To meet the sudden demand, the institutions sold $143 billion of short-term debt in August and September, according to the FHLBs’ Office of Finance. The sales pushed outstanding debt up 21 percent to a record $1.15 trillion, an amount that may become a burden to U.S. taxpayers because almost half comes due before 2009.

The government is “taking a lot of risks through the Federal Home Loan Banks that are unnecessary,” according to Peter Wallison, a fellow at the American Enterprise Institute, a Washington-based organization that analyzes public policy, and general counsel at the Treasury Department from 1981 until 1985.

More moral hazard?

A loss of confidence in the companies could prompt investors to dump FHLB debt, potentially causing the collapse of one or more banks, according to Wallison and lawmakers including Representative Richard Baker of Louisiana. If others were unable to meet the liabilities, taxpayers would be on the hook, they said.

U.S. lawmakers need to ensure “the institutions don’t blow up in the taxpayer’s face,” Representative Christopher Shays of Connecticut, a Republican on the House Financial Services Committee that is responsible for oversight of the system, said in an interview.

My comments: Where will the marginal mortgage companies go for future funding since all government entities have hit a wall? Looks like Bernanke will be fielding lots of phone calls this holiday season.

Fed hot air fails to reflate structured finance balloon

Now that the dust has settled regarding the latest Fed rate cuts, most bond fund managers seem rather unenthused. According to PIMCO group:

“The reality is the fundamentals haven’t gotten any better, and, if anything, they’ve gotten worse,” said Mark Kiesel, an executive vice president at Newport Beach, California-based Pimco who oversees $85 billion in corporate bonds.

While concerns from many professional money managers involve credit disruptions.
About three-quarters of 30 fund managers who oversee $1.25 trillion expect a hedge fund or credit market blowup in the “near future,” according to a survey by Jersey City, New Jersey-based research firm Ried, Thunberg & Co. dated Oct. 1.

Is it fair to say a return to normal (pre Fed) market behavior is out of the question?

More than 65 percent of investors in mortgage-backed securities are struggling to find bids for their holdings, according to a survey of 251 institutions last month by Greenwich Associates, a Greenwich, Connecticut-based consulting firm. Among holders of CDOs, the figure is 80 percent.

The U.S. commercial paper market is shrinking. The amount of debt outstanding that matures in 270 days or less fell $13.6 billion the week ended Sept. 26 to a seasonally adjusted $1.86 trillion, according to the Fed. It’s down 17 percent in the past seven weeks.

My comments: There is maybe $6 trillion in mortgage-backed securities outstanding so 65% of that amount would be $4 trillion. In addition, there is approximately $2.5 trillion in CDOs outstanding so 80% of that amount would be $2 trillion. We are probably very close to reaching a situation where there would be NO BID on these securities. Can someone tell me how the world financial system could even function with NO BID on $6 trillion in securities stashed in financial institutions worldwide?

Barclays throws another lifeline

Barclay’s provided $1.5 billion to Golden Key, another highly geared commercial paper fund undergoing liquidity issues.

It is the third SIV-lite arranged by Barclays to announce a restructuring, following in the footsteps of vehicles managed by Britain’s Cairn Capital and Solent Capital Partners.

These structures use short-term funding to invest in portfolios of longer-term securities, mainly in the asset-backed bond market. They have suffered a double hit as investors have shunned their commercial paper, and the value of their investments have fallen sharply due to contagion from the U.S. subprime mortgage market to all forms of structured finance.

My comments: Over the next several days over $100 billion in commercial paper is scheduled to rollover. Bottlenecks should persist as brokers, hedge funds and investors refuse mark to market on the underlying CDOs. In November, FASB changes go into effect on many mark to model securities creating another headwind for the twilight zone economy.

From off balance sheet to on

Since the ABS commercial paper market locked up several weeks back the guilty have slowly disclosed some of their off balance sheet conduits. Today news from down under as the largest bank in the country, National Australia Bank, moved $4.9 billion of funding back on to their balance sheet.

“The banks are not totally immune and the credit shakeout is bound to have some effect on them,” said Hans Kunnen, who helps manage the equivalent of $117 billion at Colonial First State Global Asset Management in Sydney. “They have to take appropriate action when circumstances become extreme, but have big enough balances sheets to absorb most of the pain.”

My comments: Mr Kunnen makes the statement about large enough balance sheets but it appears the Reserve Bank of Australia has already hit the panic button. Both Australia and Europe have experienced uncontrollable spikes in overnight lending rates since the credit revulsion began. In fact, Libor surged today as apprehension among lending institutions becomes the norm. The confidence game is waning as most players have no idea what the real balance sheets entail.

Moody’s beginning to wake up from its commercial paper slumber

From today’s Bloomberg: “Moody’s Cuts Outlook on $14 Billion of Commercial Paper Funds.”

Moody’s Investors Service said it had downgraded or placed on review for downgrade $14 billion of bonds sold by funds known as structured investment vehicles.

The credit rating firm also changed the way it rates the funds, citing ”unprecedented market volatility”.

This is the equivalent of shutting the barn door in Idaho when the horse is already in Montana.

Banking’s perfect storm

Returning from the long holiday weekend bulls continue to bank on several rate cuts by Mr. Bernanke while George Bush relieves a segment of subprime borrowers. More and more we witness “portfolio managers” recommending banks based on above average earnings or low price to book. Like the housing bulls several years ago we believe the ‘analysis” is flawed on several fronts:

1) Banks hold over $1.27 trillion in asset backed securities on their balance sheet, mostly mortgage related. Recent collateral repricings caused by tighter lending standards and ongoing foreclosures will create mark to market problems intermediate term. For example, due to national house price declines thus far and 2008 projections one could make the case for a 15% haircut to present valuations.

2) LBO debt exposure is roughly $300 billion, most of which has already declined by 10-12% due to the recent credit crunch. As deals get restructured and or cancelled write downs could approach $40-50 billion.

3) Banks are potentially on the hook for several hundred billion in asset backed commercial paper conduits which remain “off balance sheet” until something breaks. Accounting rules don’t require banks to separately record anything related to the risk that they will have to loan the entities money to keep them functioning during a markets crisis. Several bailouts both here and abroad have already been announced over the past few weeks. Today in the WSJ Citigroup reluctantly disclosed some of these off balance sheet conduits known as SIVs:

Conduits and SIVs are entities that banks use to issue commercial paper, which are usually highly rated, short-term notes that offer investors a safe-haven investment with a yield slightly above certificates of deposit or government debt. Banks use the money to purchase longer-term investments such as corporate receivables, auto loans, credit-card debt or mortgages. The two kinds of vehicles are closely related, although SIVs can also issue longer-dated notes, can use leverage and have tended to have greater exposure to mortgage debt.

Banks affiliated with the vehicles typically agree to provide a so-called liquidity backstop — an assurance the vehicles’ IOUs will be repaid when they come due even if they can’t be resold, or rolled over — for all the paper in a conduit. For SIVs, three to five banks typically offer a liquidity backstop, but only for a portion of the vehicles’ assets.

Those liquidity backstops have become important because gun-shy investors are in some cases refusing to buy commercial paper. That could force banks to ride to the rescue if it happened to one of their affiliated conduits or SIVs.

These conduits are substantial in some cases. Take Citigroup, the nation’s largest bank as measured by market value and assets. Its latest financial results showed that it administers off-balance-sheet, conduit vehicles used to issue commercial paper that have assets of about $77 billion.

My comments: In a U.S. banking industry with $857 billion in equity, roughly $1.75 trillion dollars of securitized real estate loans, LBO debt and off (soon to be on) balance sheet ABS commercial paper exist, certainly not an insignificant number. The threat to the banking system might not present itself in the amount of questionable loans it currently holds, rather in the number of good loans that might later prove vulnerable as weak holders of loan obligations in other sectors of the economy liquidate these loans. Even in a highly leveraged society in which the risk is widely dispersed, the unwinding process can quickly escalate. Housing bulls learned a lesson; will the bank buyers take notice?

Commercial paper still shrinking

Despite several attempts by the Fed to alleviate credit bottlenecks, the recent commercial paper market figures point to a continual slowdown.


Outstanding paper fell by $62.8 billion, or 3.1%, in the week ending Wednesday to $1.98 trillion, bringing the total decline in the past three weeks to $244 billion, or 11%, the Federal Reserve reported Thursday.

The declines in outstanding paper have been felt strongest in the asset-backed portion of the market, which represents about half of all commercial paper. These securities are backed by assets such as credit-card receivables or mortgages. In the latest week, asset-backed paper fell by $59.4 billion, or 5.6%. In the past three weeks, this kind of paper has fallen by $184.9 billion, or 15.6%.

Today’s WSJ discusses in detail the problems with conduits and structured investment vehicles.

These days, skittish investors are shunning even typically safe commercial paper that doesn’t necessarily have mortgage exposure. As a result, some banks can’t resell the commercial paper when it matures and in some cases are being forced to step in and provide the funding instead. That is why investors are nervous about the banks’ exposure to these conduits.

The problem is these conduits are created as independent entities, so they don’t sit on the banks’ balance sheet, at least until the things go bad. “The extra step we’re missing is the added bit of disclosure saying what you are on the hook for,” said David Zion, an accounting analyst at Credit Suisse. “I don’t think putting these on the balance sheet is necessarily the perfect answer,” he says, “It’s maybe just giving investors enough information.”

The worry is that banks could have to divert resources if they have to take conduit assets onto their own books because of commitments to provide funding for the conduits.
“The more that comes on balance sheet and the fewer the funding options, the less liquid the banks and the banking system,” said Chip MacDonald, a securities lawyer at Jones Day’s Atlanta office.

The same issue that has hit the banks also slammed investment firms such as Carlyle Group, Cheyne Capital Management and Kolhberg Kravis Roberts & Co. These firms and others operated funds, sometimes known as structured investment vehicles, or SIVs, that tried to profit by selling commercial paper that paid a certain interest rate and used the money to buy higher yielding mortgage securities, pocketing the difference.

When their commercial paper matured and there were no buyers, the firms either said they would put up cash or sold securities. SIVs differ from conduits because conduits have bank-supported credit lines to carry them through if they can’t roll over their commercial paper, while SIVs receive only limited support.

The banks aren’t violating accounting rules by keeping these conduits off their balance sheets. Indeed, the accounting gurus tightened these off-balance-sheet rules dramatically after Enron Corp. collapsed under debt issued by its off-balance-sheet entities. But conduits were structured in such a way that they didn’t have to come onto the books. That is because conduits are strange beasts and, essentially no one lays claim to them. While banks and other financial companies set them up, they don’t own the conduits.


My comments: If the Fed can’t prevent the ABS commercial paper market from contracting then most banks will end up moving these liabilities (potentially $1 trillion +) onto their balance sheets at a time when real estate foreclosures continue to escalate. Bernanke’s new conundrum?

State Street’s off balance sheet headache

State Street, the largest money manager for institutions, revealed potential liabilities of $27 billion today almost four times shareholder equity. Evidently, the Boston based firm has experienced difficulty in refinancing asset backed commercial paper potentially forcing off balance sheet liabilities back to the parent companies’ books. Many of these conduits, especially European entities, were prevented from rolling over short term asset backed commercial paper leading to another bottleneck in the structured finance assembly line. More importantly, these off balance sheet liabilities ($891 billion) may end up back on the balance sheets of commercial banks creating another layer of credit contraction hence the Fed’s recent discount window panic.

Lenders have about $891 billion supporting asset-backed commercial paper funds and similar investment pools, Fitch Ratings said last week. Some funds, including those managed by KKR Financial Holdings LLC, haven’t been able to refinance by selling new commercial paper. Their lenders may seize assets to get repaid, though the assets may not fully cover the loans if prices have fallen amid the subprime-mortgage crisis.

“There is a growing recognition that there is a crisis in the commercial paper market,” Bove said. “This is a big risk for State Street.”

My comments: Over the past several weeks global central banks have pumped over $400 billion into the system to re-liquefy vulnerable commercial banks exposed to asset backed commercial paper. How much longer before questionable collateral impairs lending abilities of commercial banks?

The market is now in the process of repricing risk in the structured finance world while the credit arb game runs out of players. Welcome to a modern day run on the bank.

Hedge fund R.I.P.

According to Bloomberg, earlier this year Queen’s Walk Investment Ltd, a structured finance hedge fund managed by Cheyne Capital dropped over 22% after disclosing substantial losses in subprime mortgages. Today another vehicle managed by Cheyne announced a liquidation of their $20 billion commercial paper program.

The program, called Cheyne Finance LLC, is a structured investment vehicle that purchases securities by issuing short-and medium-term debt, S&P said in a statement today. It breached a test based on losses in the portfolio that may force liquidation, S&P said. London-based Cheyne Capital is the portfolio manager.

The Cheyne portfolio is primarily invested in “real estate securitizations” and none of the assets have had downgrades, S&P said. Structured investment vehicles often aren’t backed by credit lines from banks like asset-backed commercial paper programs, of which there is $1.05 trillion outstanding.

S&P cut the credit rating on the commercial paper issued by Cheyne Finance by two levels to A-2 from A-1+. The rating on senior debt was reduced six levels to A- from AAA, the highest rating.

My comments: Another hedge fund seemingly posting above benchmark returns in a mark to model world is forced to mark to broker. The great unwind saga continues.

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