Collateralized Loan Obligations
Tomorrow we prepare for a “new” Fed. It looks a lot like the old Fed, but one can hope. In the meantime we wonder if QE is worth it? Does it do what it is “supposed” to do? No. We don’t think it has done much for jobs or inflation or housing. We look at the pre QE data and the post QE data and we are underwhelmed. But what real evidence is there that QE is helping the economy? Would we be the same without it? Better even? I am told no, but I am told a lot of things that turn out not to be true. If it was clear that QE was really helping the economy, I wouldn’t be wondering why we do it. But is there any harm to QE? That is the other side of the coin. Ask any person from an Emerging Market whether QE is harmful and you will likely get a very different answer than the one Ben has given.
- Emerging markets pray for Wall Street tumble (Reuters)
- Yellen Faces Test Bernanke Failed: Ease Bubbles (BBG)
- Samsung sets new smartphone sales record in fourth quarter, widens lead over Apple (Reuters)
- China’s Foreign-Reserves Investment Chief Said to Depart Agency (BBG)
- China’s Rescue of Troubled Trust May Stoke Risk-Taking (BBG)
- Ukraine PM Azarov offers to resign 'to help end conflict' (Reuters) ... And Russia says may reconsider aid if this happens
- But... but... it was all gold's fault: India Unexpectedly Raises Rate as Rupee Risks Inflation Goal (BBG)
- Former Belgian king 'boycotting' public events after complaining £760,000 is not enough to live on (Telegraph)
- Greek disposable income tumbles 8% in Q3 (Kathimerini)
So much for the strict, evil Volcker Rule which was a "victory for regulators" and its requirement that banks dispose of TruPS CDOs. Recall a month, when it was revealed that various regional banks would need to dispose of their TruPS CDO portfolios, we posted "As First Volcker Rule Victim Emerges, Implications Could "Roil The Market"." Well, the market shall remain unroiled because last night by FDIC decree, the TruPS CDO provision was effectively stripped from the rule. This is what came out of the FDIC last night: "Five federal agencies on Tuesday approved an interim final rule to permit banking entities to retain interests in certain collateralized debt obligations backed primarily by trust preferred securities (TruPS CDOs) from the investment prohibitions of section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, known as the Volcker rule." In other words, the first unintended consequences of the Volcker Rule was just neutralized after the ABA and assorted banks screamed against it.
- Winter storm lashes eastern U.S., threatens Thanksgiving travel (Reuters)
- Fed Reveals New Concerns About Long-Term U.S. Slowdown (BBG)
- Private equity keeps $789bn of powder dry (FT) - because they are "selling everything that is not nailed down"
- Merkel and SPD clinch coalition deal two months after vote (Reuters)
- Japan approves new state secrecy bill to combat leaks (BBC)
- CLOs are the new black: Volatile Loan Securities Are Luring Fund Managers Again (WSJ)
- Health website deadline nears (WSJ)
- Norway Debates $800 Billion Wealth Fund’s Investment Options (BBG)
- Set of global trade deals stalls (WSJ)
- Berlusconi To Learn Fate In Senate (Sky)
- Silvio Berlusconi withdraws support from Italy’s government (FT)
As we warned two months ago, the bubble in credit markets (which if you ask anyone at the Fed, except Jeremy Stein, does not exist) is nowhere more evident than in the explosive growth of so-called cov-lite loans. While total volumes of cov-lite loans are already at record, as the FT reports, we now have 55% of new leveraged loans come in “cov-lite” form, far eclipsing the 29% reached at the height of the leveraged buyout boom just before the financial crisis. LBO multiples have reached record highs and demand for secutizations of these levered loans (CLOs) has surged on the back of the Fed's repressive push of investors into more-levered firms and more-levered instruments.
This week marked what we suspect will become an important inflection point when the world looks back at this debacle of a bubble. The Fed, having already warned in January of 'froth' in credit markets (and ths the fuel for 'hope' in stocks) proposed tougher underwriting standards for leveraged loans. Credit markets have underperformed since; but as Diapason Commodities' Sean Corrigan notes, the baleful impact of the central banks is still everywhere to be seen in the credit markets. From junk issuance to the rapid regrowth of the CDO business to the 'record' high multiples now being exchanged for LBOs; Central Banker's monomaniacal fixation on zero interest rates and artificial bond pricing is setting us up for the next, great disaster of misallocated capital and malinvested resources.
Frequent readers will recall that in the past, on several occasions, we expected that MBIA would rise due to two key catalysts: a massive short interest and the expectation that a BAC settlement would provide the company with much needed liquidity. That thesis played out earlier this year resulting in a stock price surge that also happened to be the company's 52 week high. However, now that we have moved away from the technicals and litigation catalysts, and looking purely at the fundamentals, it appears that MBIA has a new problem. One involving Zombies. These freshly-surfacing problems stem from a particular pair of Zombie CLO’s – Zombie-I and Zombie-II (along with Zombie-III, illiquid/black box middle-market CLO’s). While information is difficult to gather, we have heard that MBIA would be lucky to recover much more than $400 million from the underlying insured Zombie assets over the next three years, which would leave them with a nearly $600 million loss on their $1 billion of exposure which would materially and adversely impact the company's liquidity. And as it may take them a while to liquidate assets in a sure-to-be contentious intercreditor fight – their very own World War Z – MBIA may well have to part with the vast majority of the $1 billion in cash, before gathering some of the potential recovery.
As part of the Appendixed disclosures in the aftermath of JPM's London Whale fiasco, we learned the source of funding that Bruno Iksil and company at the firm's Chief Investment Office used to rig and corner the IG and HY market, making billions in profits in what, on paper, were supposed to be safe, hedging investments until it all went to hell and resulted in the most humiliating episode of Jamie Dimon's career and huge losses: it was excess customer customer deposits arising from a $400+ billion gap between loans and deposits. After JPM's fiasco went public, the firm hunkered down and promptly unwound (or is still in the process of doing so) its existing CIO positions at a huge loss. However, that meant that suddenly the firm found itself with nearly $400 billion billion in inert, nonmargined cash: something that was unacceptable to the CEO and the firm's shareholders. In other words, it was time to get to work, Mr. Dimon, and put that cash to good, or bad as the case almost always is, use. So what has JPM allocated all those billions in excess deposits over loans? Courtesy of Fortune magazine we now know the answer - CLOs.
Another day of fraught wonderment ahead of us. What does it all mean? China economic data increasingly suggests there is a serious problem, (that’s still a few points below crisis – but recent experience suggests the politics of mobs can turn ugly with surprising speed!). On the other hand, yesterday’s US auctions went swimmingly well – so we can all relax about the taper? Er.. no. And while Spain gets a cheeky 15-yr bond issue completed (driven on the back of a large single order we strongly suspect), the Italians then get downgraded because of the weakening economy, deteriorating competitiveness and 1.9% negative growth outlook... “You can’t make this stuff up,”
The gaps between markets (credit, equity, and volatility) and economic (macro- and micro-) reality have seldom been larger. What is just as concerning as this yawning chasm is the similarity of a number of activities to the 'bubble' in credit in 2007 - from record CLO issuance to covenant-lite loans resurgence. As Citi's Matt King notes, the past fortnight’s virtual melt-up in all things high yielding has been accompanied by a growing sense that markets are breaking out of the patterns of the past few years. In the near term, there is no reason in principle why the moves cannot go further; but unless more of the central bank stimulus finds its way through to the economy, this opens up the risk of sudden corrections as markets fall back to earth. How long will it take for that to occur, and for markets to become scared once again? It is hard to tell, and yet, as we have noted numerous times, we have been in this situation before. In 2009, the divergences took 6 months before stocks corrected, in 2011 it took 4 months, and in 2012 it took just 1 month. It's not different this time.
The underlying question in Bill Gross' latest monthly letter, built around Jeremy Stein's (in)famous speech earlier this month, is the following: "How do we know when irrational exuberance has unduly escalated asset values?" He then proceeds to provide a very politically correct answer, which is to be expected for the manager of the world's largest bond fund. Our answer is simpler: We know there is an irrational exuberance asset bubble, because the Fed is still in existence. Far simpler.
With a modest premium over yesterday's closing price (and 25% premium to Jan 11th price), and thanks to a big hand from Microsoft (with a bridge not an equity participation), Michael Dell (and Silver Lake) are taking Dell private.
- *DELL TO BE ACQUIRED BY MICHAEL DELL-SILVER LAKE FOR $13.65-SHR
- *DELL TO BE BOUGHT IN DEAL VALUED AT $24.4 BILLION :DELL US
- *DELL DEAL TO BE FINANCED BY FUNDS INCLUDING $2B MICROSOFT LOAN
- *DELL SAYS THERE IS NO FINANCING CONDITION :DELL US
- *DELL PACT PROVIDES GO SHOP PERIOD FOR 45 DAYS :DELL US
Funding by BofAML, Barclays, CS, and RBC - better hope the CLO demand keeps up. Full PR below:
A week ago, when Wells Fargo unleashed the so far quite disappointing earnings season for commercial banks (connected hedge funds like Goldman Sachs excluded) we reported that the bank's deposits had risen to a record $176 billion over loans on its books. Today we conduct the same analysis for the other big two commercial banks: Wells Fargo and JPMorgan (we ignore Citi as it is still a partially nationalized disaster). The results are presented below, together with a rather stunning observation.
By the Deceptive means of Misinformation and Manipulation of economic data the Federal Reserve has set the stage for broad based moral hazard. Through Distortions caused by Malpractice and Malfeasance, a raft of Unintended Consequences have now changed the economic and financial fabric of America likely forever. The Federal Reserve policies of Quantitative Easing and Negative real interest rates, across the entire yield curve, have been allowed to go on so long that Mispricing and Malinvestment has reached the level that markets are effectively Delusional. Markets have become Dysfunctional concerning the pricing of risk and risk adjusted valuations. Fund Managers can no longer use even the Fed's own Valuation Model which is openly acknowledged to be broken.