Saturday, August 30, 2008
Thursday, August 28, 2008
Wednesday, August 27, 2008
Tuesday, August 26, 2008
Monday, August 25, 2008
Sunday, August 24, 2008
Investors are said to “roll” their MBSs if they execute a simultaneous TBA sell order for one settlement month and a buy order for the same MBS issue in the same amount (such as $10 million of Freddie Mac 30-year 5.5%) for the next settlement month.
The TBA market structure of settlement dates is perceived to enhance liquidity by concentrating trading in a particular product (like 30-year conventionals) into a single settlement date each month. Dollar rolls provide a mechanism to help ease supply/demand imbalances for a particular settlement month. (Dealer is buy august/sept roll).
For example, if a dealer is having trouble obtaining collateral for a new August CMO deal that is about to close, the dealer could bid up the August/September roll (by essentially bidding up the price of August settlement collateral) to a level that induces an investor to do the roll (by essentially selling the collateral to the dealer for August settlement and purchasing the collateral for September settlement). If supply for September settlement is sufficient, this provides a means of alleviating a shortage of collateral for August settlement.
A dollar roll is analogous to a repo, but there are important differences: (1) the party borrowing the securities in a dollar roll does not have to return the same securities, but can instead return “substantially similar” ones; and (2) the original owner gives up principal and interest to the temporary holder of the securities (assuming record dates are passed during the period of the roll).
Leverage buyout boom loaded many companies with substaintial debt. As economy slows down, they are hitting the wall. The default rate is on the rise, exceeding that of junk-bonds that is usually considered riskier. Furthmore, the recvery rate is expected to be worse than norml, though higher than that of junk-bonds, due to the riskier composition of the market: more second-lien loans, convenate lite loans, and loan-only....
There's nothing like a bad bust to make investors regret a good boom.
The feeling is particularly acute in the leveraged-loan market, where during the bull years of 2006 and early 2007, investors felt emboldened to take on excessive risk.
As a result, the rate of defaults -- instances where a company is unable to make its interest payments or meet the obligations in its debt agreements -- is higher in the loan market than it is in the junk-bond market, which has traditionally been perceived as the riskier of the two markets. To make matters worse, investors stand to recover less in leveraged-loan defaults than what was historically normal because of the riskier composition of the market.
"What that tells you about is the tremendous amount of poor quality financing in the easy money period of 2004 to 2007 and now, when the economy slows down, these companies have way too much debt and they're hitting the wall," Margie Patel, portfolio manager at Evergreen Investments, said. "It also tells you why loans have been trading, in general, at a substantial discount to face value."
The average price in the loan market is around 88 cents on the dollar these days, according to Standard & Poor's Leveraged Commentary & Data unit, down from above 100 cents before the credit crisis.
During the boom, it wasn't uncommon for companies to bring their entire debt package to the market in the form of loans rather than split between bonds and loans. That means some of the riskiest debt, which normally would have been issued in the bond market, is now part of the loan market.
According to S&P's LCD unit, these "loan-only" deals account for a much larger percentage of defaults in the market than in prior years. Of the 25 defaults in 2008, 44% were for companies that didn't have bonds, whereas before 2008, that level was around 12%.
"As the current credit crisis unspools, the loan market's glorious past as a default underachiever might well be history," Steve Miller, managing director of S&P's LCD, said in a research report on the topic. "That's not to say that loan defaults are likely to leapfrog bond defaults. More probable, leveraged loan and high-yield bond defaults seem likely to track more closely in the future than they did in the past."
The trouble is that on top of rising defaults -- the rate in the loan market is currently around 2.92% whereas it is 2.37% for bonds according to S&P -- the prevailing expectation is that recoveries postdefault are going to be lower than they used to be. That is the result of the extra risk-taking investors were partaking in before the blow-up.
Meredith Coffey, senior vice president at the Loan Syndication and Trading Association, points to a number of reasons that recoveries will be lower. Investors allowed companies to issue loans that were less secure, known as second-lien loans. They also accepted fewer protective provisions on loans that became known as "covenant-lite." Investors also allowed companies to add very heavy debt burdens to their balance sheets.
"I think people do expect the loan recovery rate will be lower than historical norms," Ms. Coffey said. "But if you look in the context of high-yield bonds, the expectation is still that loan recoveries are much higher than high-yield bonds."
That's some reassurance for investors, yet hardly enough to keep them from bidding up the price of loans, which are hovering around historic lows. Even in the market meltdown of 2002, the average price of loans remained above 95 cents on the dollar, according to S&P.
Market participants expect that this default cycle will prompt companies and their underwriters to retrench and come back to the market with debt deals that more closely represent the deal-making done before the recent boom, meaning companies will have bonds subordinated to loans, stricter covenants on their loans and lower debt burdens overall.
In this market, the future means a return to the past. Yet the loan and bond markets have already lived through a buyout boom and bust where risk-taking like this was to blame. The question is whether market participants will learn enough from this bust to prevent the cycle from repeating itself again after this credit crisis is over.
Friday, August 22, 2008
Thursday, August 21, 2008
Spreads are still gapping, exceeding the level in March 08. Junk-Bonds spreads rose over the level in 2002. Financial institutions are bogged down on concerns about their ability to raise funds under prolonged credit crunch, weakening economy, and slumping home prices. A string of bonds sales also hamper the market....
The credit markets are treacherous ground for financial institutions, and their recent struggles raising money are dragging down the corporate bond markets.
In recent days, price declines among investment-grade bonds have pushed their spreads -- the gap between their yields and those of ultrasafe Treasury securities -- to a multidecade high, according to Merrill Lynch data. These bonds now yield 3.11 percentage points more than Treasurys on average, exceeding their recent March peak at 3.05 points.
That erases the improvement that took place from April to June, after investors were heartened that Bear Stearns's problems didn't topple the financial system.
Junk-bond spreads are also growing, but at 8.3 percentage points, the gap over risk-free Treasurys remains below March's high of 8.6 points. The current junk spread is still well under multidecade highs at 11 percentage points hit November 2002 -- the bottom of the tech-driven downturn that included large bankruptcies such as Enron and WorldCom.
The investment-grade bonds of banks, brokerage firms and other financial companies have suffered the most pronounced decline. Spreads on their debt have reached new highs as well, at 3.78 percentage points over Treasury bonds, significantly higher than the 3.62 point peak in March.
Investors and analysts are concerned about the ability of financial institutions to withstand the now yearlong pressures on their balance sheets from illiquid assets and deteriorating loans, a weakening economy and a mountain of debt coming due in coming quarters. Fears about the future of housing-finance companies Fannie Mae and Freddie Mac are also weighing on the market for corporate debt.
"I don't have an appetite for financial institution debt at all," says Tom Atteberry, partner at First Pacific Advisors LLC. "They are still early in the process of deleveraging," he adds, referring to financial institutions' raising capital and cutting back on borrowed funds in the wake of massive write-downs and losses.
Some financial institutions are selling their best assets to raise funds, a sign they have few options left for raising capital, says Mr. Atteberry. For example, Merrill Lynch & Co. recently sold its stake in Bloomberg LP, and Lehman Brothers Holdings Inc. is shopping pieces of its investment-management business, including parts of Neuberger Berman.
Indeed, one catalyst behind the recent decline in investment-grade corporate bonds, and financial-company debt in particular, was a string of bond sales last week by Citigroup Inc., American International Group and American Express Credit Corp. To sell a combined $8.25 billion in debt, all three companies had to pay investors significantly higher yields than what the firms had hoped. They paid 0.75 of a percentage point to one full point more than recent similar offerings by these companies, according to Thomson Reuters.
Most of those bonds didn't do well in secondary market trading. It surprised many investors, who worried that the trend might indicate deeper problems among the financials. Bankers say several financial firms postponed their near-term debt offerings until the fall after seeing the weak performance of last week's deals.
Financial institutions can't put off their fund raising forever. They have $660 billion of U.S. dollar-denominated long-term corporate bonds coming due in the next 12 months, the highest volume ever for such a period of time, according to J.P. Morgan Chase & Co. research.
"The market this August is as thin as we've ever seen it, and borrowers have had to pay very significant premiums to get investor focus," said Therese Esperdy, head of global debt capital markets at J.P. Morgan, adding that there's been a bit of a "downward spiral in valuations."
Investment-grade corporate bond issuance has also slowed with the market malaise this summer. After hitting a record level for corporate bond deals in May at $141 billion, June, July and August combined have seen only $106 billion in new investment-grade offerings, according to Thomson Reuters. Thus far this month, just $25 billion of such bonds have been slated for sale, a weak total even for the traditionally slow month of August.