PIMCO

One of the consequences of Meredith Whitney's recent prognostications that we could be facing hundreds of billions worth of municipal defaults, is that after tens of billions of investor capital have been pulled out of municipal funds, with last week seen record $5.8 billion in redemptions alone, virtually the bulk of this money has been recycled in the form of inflows into equity instruments. As such, it is surprising why so much energy is wasted to attempt to debunk Whitney's thesis: after all, she has done more to stimulate equity inflows than years of government/CNBC propaganda ever could. Yet one firm which certainly stands to lose should the ongoing muni redemption wave not moderate, is everybody's favorite PIMCO, which is oh so good at bashing the Fed and Satan Bernanke with one half of its mouth, while with the other investing tens if not hundreds of billions in federally subsidized Build America Bonds, which for the past month have been in free fall. It is therefore not surprising that as Charlie Gasparino points out, Bill Gross "has launched an all-out war to discredit Whitney’s research in an attempt to restore confidence in the $3 trillion municipal-bond market." Of course, this is nothing more than a good old-fashioned book talking campaign: Meredith, who after have failed to predict anything notable at her new venture, needs to return to her shock factor roots, and Gross, whose TRF fund, after seeing nearly two years of AUM increases in his flagship TRF, has been having a bit of a hard time recently, all due to the firm's huge municipal exposure.

PIMCO, that tried and true client of Fed "expert network" Larry Meyer who just loves 'hinting' at what the Fed will be doing in the next 3-6 months in exchange for a modest retainer, has just released the December composition of its flagship Total Return Fund. Despite declining for a second month in a row, from $250 billion to $240.7 billion, the world's largest bond fund has once again increased its MBS holdings, this time from 43% to 45%. Keep in mind this was at 18% in July, and in the meantime Bill Gross has gone from $5 billion in net cash to $17 billion in margin. It is obvious that Bill Gross, who already has a major position in municipal debt, and will thus benefit from the imminent state and muni bail outs, also believes that once the Fed is content with having sacrificed 100 bps in the rates to generate 10% in the S&P, will soon be forced back into the mortgage market, and will be buying MBS once again. Based on Gross' ongoing accumulation of MBS, we are now fairly confident that the "expansion" to QE2 (really, QE3 but who keeps count) to be announced sometime in May, will contain Treasurys, Municipal bonds and Mortgage Backed Securities among the asset permitted for purchasing. Unlike the BOJ, we don't think the Fed will announce ETF purchases yet. That will be reserved for QE4, to be announced some time in early 2012.

Just headlines for now. And so we have gotten to the point where even the 'smart money' is publicly denouncing the global Bernanke put, and the world's central bank "white knights" in the form of China (whose real debt number is wrapped in boxes, mysteries and enigmas), and Japan (which has more debt as a % of GDP than any other developed country). Luckily both can afford to buy a little debt of some other Ponzi nation, and thus preserve their own trade surplus status quo for a few more months. In the meantime the world's biggest bond fund is implicitly saying that frontrunning the last recourse EUR backstops is too risky for him.

PIMCO, which was one of the firms spearheading the putback push against BofA, has put together a useful and rather objective analysis though Executive Vice President, Global Structured Finance Specialist, Rod Dubitsky, titled "Foreclosure Flaws Trigger New Round of Uncertainty." While not surprisingly the baseline case presented by PIMCO is a moderate one, as the asset manager claims the most likely impact is "moderate" it does acknowledge that there is a possibility for substantial complications (although Fannie's recent bail out of BofA pretty much takes cares of that). The two main adverse consequences are "corrupted title" - a topic beaten to death previously, and, more importantly, "Tax issues relating to RMBS issuance entities" on which PIMCO says "Some have argued that assigning the note for the mortgage loan so long after closing would run afoul of REMIC rules, which could subject RMBS deals to adverse tax consequences." Of course, as an escalation of these developments would bring the entire $8 trillion RMBS structured finance industry to a halt, we are fairly confident that as more and more settlements are instituted, that the whole fraudclosure issue will be very soon completely forgotten.

RanSquawk is reporting that according to "sources", PIMCO's total return fund may buy up to 10% in equity securities. We have not seen another confirmation yet on this very material development which, if true, will confirm that Bill Gross is starting to sound the retreat on rates (his deceptive de minimis purchase of $17 worth of closed-end mutual funds notwithstanding), and that PIMCO may soon become the most unique experiment in a fund transitioning from pure bonds to hybrid (or all out) equity.

After it was earlier announced by the WSJ that BofA was in settlement discussions with the various parties seeking putbacks on $47 billion worth of mortgages, the bank has just released an statement that while there is no settlement imminent, the bank is merely extending the period of negotiation, which started on October 18 and had a 60 day duration. This is not surprising: after all the bank has a mere $872 million in amounts reserved for putbacks. This amount will be laughable should even 10% of the total amount sought to be put to BofA be formally repurchased by the undercapitalized bank.

From Pimco, which is heavily invested in munis, and has a very vested interested in the extension of the BAB program:

• The initial catalyst for the selloff in the tax-exempt muni market
  was the sharp selloff in the U.S. Treasury market. Also, a significant
  increase in supply weighed heavily upon the muni market.
• It now appears that the BABs program could be in jeopardy, as a
  provision to extend the program has not been included in the current
  Senate tax bill.
• The supply of tax-exempt municipals remains robust at a time when
  many investors do not have the cash flow to add to their muni holdings.

First the bad news: in November the AUM of Pimco's flagship TRF fund did something it hasn't done since the Lehman collapse: it declined. After hitting an all time high of $255.9 billion in October, the fund's net assets dropped by $6 billion to "just" quarter of a trillion. Now the good news: Bill Gross is long ever longer duration positions, with his holdings of sub-3 Year paper the lowest since November 2008. The fund raised its Treasury holdings from 28% to 30%, and continues to accumulate ever more paper in the belly of the curve- between 3 and 10 years, which this month amounted to a total of 67% of all exposure. This is also the area that over the past month has gotten hit the worst, and is one part of the reason why the various publicly traded PIMCO indices have gotten whacked. But another far more important reason is that for the 6th month in a row the TRF's MBS holdings continue to scream higher, and have now are at 43% (with 10% margin cash): the highest since July 2009 when PIMCO was actively selling its MBS holdings to the Fed in anticipation of the end of QE1. With such a jump in duration, PIMCO better hope that inflation concerns don't pick up, as their part of curve exposure will be the first to be impacted.

Wonder why various PIMCO funds are getting hammered over the past week? Simple: the fund's recent push into mortgages, especially on margin, has backfired, and courtesy of the surge in mortgage rates which we highlighted yesterday, has left the world's biggest bond fund, second only the Federal Reserve, hoping for a last minute Hail Mary (Pimco can't print money unlike the former). As a reminder, while Pimco's TRF is positioned well to benefit from the steepening in the 2s10s courtesy of its 4.86 effective duration, we are unsure how the massive flattening of the 10s30s is impacting the firm. What we are absolutely sure of, is that the plunge in MBS prices in the recent week has left the fund gasping for air. Recall that the TRF has increased its MBS holdings by $50 billion in the prior two months (and likely continued in November), which is why the entire rates complex must prevent the ongoing rout in 10s and 30s as otherwise the negative convexity threatens to force an avalanche of selling first by the PIMCOs of the world, then everyone else. We present some very relevant commentary out of CRT on the MBS crunch conundrum.

Bill Gross continues to telegraph that an MBS monetization announcement is just a heart beat away. Either that, or the firm is now fully convinced it will be able to putback every single MBS in its book (and then some) to some soon to be sad shell of a bank (read- Bank of America and/or Wells Fargo). In October, Pimco's Total Return Fund saw its margin cash jump by the most since February 2009: the time when the full QE1 was announced: at $28.1 billion in margin cash, the firm increased it dry leverage powder from $7.6 billion to $28 billion. And where did this money go? Virtually all of its went in Mortgage Backed Securities, which stood at $100 billion as of October 31. This is a $50 billion increase in the past two months, and brings the total to the highest since February 2009, again - just before the Fed started monetizing UST and MBS/Agency debt in earnest. As Gross never does anything without a reason (and fundamentals are never a "reason" for the Fashion Island denizens) there are only two possible explanations: either Gross knows that the Fed will have no option but to promptly shift from monetizing MBS in addition of USTs (now that rates have once again started leaking wider), a topic we have covered repeatedly in the past, of the firm is convinced it will be successful in getting the BofA's to accept all of its putback demands, and possibly more. As both outcomes will result in a material profit on all recent purchases, the bottom line is that taxpayers (either via QE or via TARP2) are about to make the GEM (Gross-El Erian-McCulley) even more valuable.

PIMCO selling more 126/129 strangles in tyz0 @ 30...10k all day

It seems like it was yesterday that Bill Gross was bemoaning the sad American state of a QE2 driven affairs. Oh wait, it was. Yet less than 24 hours later, courtesy of some dealer insight into the market we realize that it is precisely this same Bill Gross who is aggressively anticipating to profit specifically from the launch of QE2 in less than a week. To wit:

In the U.S., PIMCO still crushing the 10yr Volatility selling your amount of strangles, they are now short about 200K TYZ0 strangles, various strikes including and inbetween 124P and 129C.....

Good of Bill to hand out indulgences with one hand, and to wave bonds in (sell vol) with the other.

As the putback parade gets going, the question is not whether the banks can afford to buy back the mortgages. The question is “Can the Banks Afford the Instantaneous and Guaranteed HIT to CAPITAL?” What investors will lend money to see it instantly evaporate, and how much will they charge for those evaporation services? TARP 3.0 coming to a door step near you!!!

Putbacks, bitches! This headline that has just flashed, can not be right. Otherwise it would mean the New York Fed (and Bill Gross) is preparing to sink Bank of America with hundreds of billions of par MBS putbacks. It would however explain why PIMCO has been gobbling up MBS on margin in the past month as we highlighted. We will bring you more as we see it, because this could be a groundbreaking development.

Update: Blackrock joins too! The "soured mortgages" in question amount to $47 billion (to start). We are now just waiting for BofA to next demand TARP 2 and the circle jerk will be complete.

Update 2: Full Bloomberg story attached.

Reminder: Here is JPM's presentation on what the total putback risk is for the Big Banks. As the lawsuit seeks to putback $47 billion one wonders just how accurate JPM's estimate of a $55 billion max pain truly is...

Reminder 2: As our whistleblower pointed out earlier today, the issue of misrepresentation of all mortgage related items (not just titles) is precisely what would destroy the mortgage originators and servicers. Today, Countrywide, its former orange CEO, and Bank of America are the first to realize just how correct he or she was.

As we pointed out last month, in June and July Pimco raised its allocation to government bonds to the highest ever, or 63% and 54% of its then-$239.3 billion Total Return Fund. As a reminder this is when the 10 year was well above 3%, and which proceeded to plunge in yield (soar in value) in August, as the sheer panic of QE Lite (and what it means for QE 2) enveloped the market, and when the Hindenburg Omen correctly predicted a 5% drop in stocks beginning in August 12. Stocks have now risen by over 7% in September, which was to be perfectly expected considering the market has seen $10 billion in redemptions (don't ask... bizarro), yet bonds have only gradually sold off, and as rumors of QE persist, the 10 Year continues to be just off its all time tights. This may change now that it has been made clear that Pimco sold over $40 billion in UST bonds in the month of August, just as bonds reached all time highs. Yet to get the sense of urgency behind Gross' earlier actions, consider that the bulk of the purchases were done on margin (pink line in chart below) as the fund borrowed $35 billion in June (and $29 billion June), using all the borrowed cash to fund Treasury purchases. And since the cash repo rate would have effectively wiped out the carry profits on the bonds, it is now blatantly obvious that Gross was very well aware there would be a massive capital appreciation in Treasuries beginning some time in July or August (cough QE Lite cough), and was actively buying all he could on margin in advance of the move.That's right, ladies and gents - we have just discovered Bill Gross' frontrunning "tell" - 1-2 months before every Fed intervention, he loads up the securuity that will benefit the most from any particular round of QE using borrowed cash. As the effective duration of the fund increased substantially in June and July it is obvious that Gross was buying up the long end of the curve, expecting a major flattening of the curve. Which, once QE Lite was announced, is precisely what happened. Incidentally, this purchasing on mega margin was repeated by Gross just once before: when Pimco's holdings of MBS surged from $80 billion to $113 billion in January 2009... just before Ben Bernanke announced QE1. What a series of lucky coincidences!!!