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Asset Swaps Are Adding To The Problem
Via Peter Tchir of TF Market Advisors
“Asset Swaps” make it more difficult for banks to sell
Banks will often buy a fixed rate bond and enter into an interest rate swap to “effectively” turn it into a floating rate asset. It should come as no surprise that banks that rely the most on rolling over short term debt are the ones most likely to asset swap bonds – yes the “weak” banks are the ones that hold bonds in this form.
The Italian 3% of 11/1/15 is a perfect example. It was a new issue that was done in November 2010. The price at issue was 99.01. It is currently trading at 87.5, so a loss of 11.5% of notional. This was an ideal bond for banks to buy – a new issue with a 5 year original maturity. That loss is likely unrealized at a lot of banks that hold the bonds, as they put it into a hold to maturity account. That is a big enough problem, but the banks are losing on their swaps as well. On November 5th, 2010, the 5 year “mid-swaps” rate was 2.09%. Banks would have agreed to pay that rate and receive a floating rate in exchange. Currently, the 4 year “mid-swaps” rate is 1.66%. On a mark to market basis, they are down 43 bps, with a duration just over 3. That means they are down about 1.25% on their interest rate swap, in addition to being down on their bond purchase.
Banks that participated in the 3.75% of 4/15/2016 are in even worse shape. That bond came at a price of 99.79 and is now at 89.75, so down 10 points on the bond. On April 7th (when the bond was announced) the 5 year “mid-swaps” rate was 3.14%. They would have agreed to pay that rate vs receiving floating. The rate to that date is now about 1.74%. That is down 140 bps, with very close to a 4 year duration, so a mark to market loss on their interest rate swap of about 5.5%. The asset swap package is down 15.5 points and adds the element of counterparty risk.
Yes, there is that ugly term again, counterparty risk. Who is owed money on the swap by the banks that bought bonds via asset swaps? It is another dynamic that is at play that we just don’t know. It also makes it harder for banks to sell their assets because they would have to close out the interest rate swap at the same time.
This problem is much bigger for Italy and Spain than it was for Greece, Ireland, or Portugal. The size of the underlying markets means the amount of unmarked interest rate swap losses is also much larger. The other difference is that the loss on the swap is proportional to the loss on the underlying bonds. On Greece, or even Portugal and Ireland, the losses on the bonds quickly dwarfed the interest rate swap losses. On the second example, the loss on Italian bonds is only 10 points, and the loss on the interest rate swap is about 5.5 points, so it increases the loss on the positions by almost 40% - from down 10 points to down 15.5 points.
Since many of the banks may have entered into the swap agreement without margin requirements, closing the position would not only cause them to recognize the loss, but they would have to put up the cash. In a time where so many of the banks (the weakest ones in particular) are struggling with raising money, this makes it even more difficult to cut losses on positions.
The interest rate or asset swap exposure is still secondary to the losses on the underlying bonds, but is non trivial. The April 2016 bond is 15 billion in size, so if 100% had been asset swapped, that would be an unrealized and unmarked loss of €875 million.
I’m guessing most of the asset swap positions are 5 years and in, but I think the amount at risk is non-trivial but is opaque, concentrated with the weakest banks, and not uniformly well risk managed by their swap counterparties.
Asset swaps work fine so long as the underlying bond never becomes a “credit” problem. So long as it moves more in line with rates than with credit it is a sensible strategy. As Italy and Spain have become credit problems, they are no longer moving with rates, and these positions are adding to the problem. The banks that like asset swapping bonds typically rely the most on short term funding (because they were playing the spread curve), so this problem is amplified as they are the same banks that cannot afford the hits and will have the most difficulty raising new money.
I’ve never understood why banks in particular don’t demand more floating rate new issues, especially when I suspect that Italy went and did swaps with the street to turn some of their fixed rate funding into floating rate funding.
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OWS NY Overrun! In Middle of the NIght
http://www.youtube.com/watch?v=EIUTZJ2FsIA&feature=youtube_gdata
Yup, co-ordinated take-down all around it seems.
So, asset swaps aside. I have a hypo-thesis.
In the current global western system, debt = power.
Ergo, is Germany actually the second most in-debted nation in the west?
And that is the only reason France gets to be a part of Merkozy?
Debt = power. That power is sucked up the pyramid by allowing the burden to trickle down.
THAT, by the way, was the essence of RegaThatcherism. Debt Burden trickle-down. Look at how tax rates have moved since, and it's all too clear.
Ergo, Germans are the most debt enslaved folks after USSA.
What is Hypo Hiding? My memory of German TV is Soft Porn, Phone Sex Line Ads and mortgage sellers. The ultimate "soft" sell.
Makes perfect sense to me.
ORI
Mandlebrot Magic
All this paper horseshit is just excellerating the end. Fine with me and my employees, crash the fucking system so we can find out right quick precisely what the value of everyone's labor really is.
another thing the regulators couldn't be bothered getting on to an exchange
Who coulda knowed?
Nearly all banks are so wildly upside down that they must cut corners and steal from their depositors.
Very soon, millions of people will wake up one morning and discover that their lives savings are gone, poof!
And the very next day a lot of "banksters" don't wake up at all ....
WHY CENTRAL BANKS ARE DOING THE JOB OF POLITICS???
SO, WE DONT NEED POLITICS, ALL GO HOME PLEASE, WHAT WE NEED IS ONLY BANKS AND MONEY FOR THEM...
ALL RUBBISH...
Problems? What problems? Economic data all coming up roses the economy is now rocking, who's up for a game of croquet?
Yeah, I brought my mallet.
http://www.atomicathletic.com/store/ProductInfo.aspx?productid=SH1220
Lets knock some balls around.
Has anyone asked Siri how to fix this world wide economic cluster fuck?
The thing is, they designed the economic clusterfuck...and now apparently have cold feet and trying to find way to backpeddle, they see it going wrong or the 'White Dragon Society' is winning against them or whatever the fuck but something is wrong theres a disturbance in the force! They designed the bank collapse, the economic collapse and its good enough complete now, so what are they nervous about? Realization OWS is only the tip of the iceberg or what?
My White Dragon Card has special powers.
The world should switch to a seamless, global, electronic trading card based economy.
Even five year old kids will understand the difference between price and value.
ORI
Had to do a double take on this headline
Without my glasses it read to me ASSit sWipes adding to the problem
Negative value asset swaps are being wrapped into structured products that end up in one of the many ‘fancy books’ where positions are marked to unicorn. This is massive! Amazing how these banksters managed to immensely fck up the financial system with the blessings of corrupt and irresponsible politicians.
Keep selling guys…
Explains why Timmay! exempted FX swaps from regulation under Dodd-Frank. "FX swaps can also be used to mimic interest rate swaps and thus can be used as a speculative bet."
Link to article:
http://www.economicpopulist.org/content/geithner-exempts-30-trillion-derivatives-market-regulation-and-oversight
>>>
I’ve never understood why banks in particular don’t demand more floating rate new issues...
<<<
Maybe the issuer doesn't want the credit transparency given by the price of an FRN.
I’ve never understood why banks in particular don’t demand more floating rate new issues, especially when I suspect that Italy went and did swaps with the street to turn some of their fixed rate funding into floating rate funding.
Ask to their swap conterparties ...
NASDAQ megaphone pattern on daily chart indicates a big move lies ahead.
SP500 monthly chart remains bearish and USDX weekly remains bullish, so it’s only a matter of time until the market makes its move.
http://stockmarket618.wordpress.com
In a prior life I helped close a few banks and thrifts and managed their securities, derivatives, loan... portfolios. I never met a CFO or CIO who didn't swear (as I watched them falling backwards from the cliff) that they were, "Perfectly hedged." For a few, the main reason they were being closed is because they were anything but 'perfectly hedged.'