Wednesday, September 30, 2009

NY Fed Buying More 5.5s MBS

The NY Fed established its Agency Mortgage-Backed Securities Purchase Program to prop up mortgages and their liquidity. The NY Fed seems to be shifting its purchases in the coupon stacks, from 5s to 5.5s -- a few months after another purchase shift, from MBS with 4.5% coupons to MBS with 5%-coupons. Given the amounts, the Program could move the markets in these different segments.


(Source: NY Fed, dataforthoughts. Click to enlarge.)

TSLF's Loans of Agency Debt

Another NY Fed program is the Term Securities Lending Facility (TSLF). Effective July 9, 2009, the Federal Reserve Bank of New York’s Open Market Trading Desk began to offer for loans direct obligations of housing-related government-sponsored enterprises (GSEs) Fannie Mae, Freddie Mac, and the Federal Home Loan Banks. Note that such Agency debt are securities lent by the NY Fed (in addition to Treasuries and TIPS already available in previous auctions), not collateral pledged by borrowers. Since then, demand for Agency paper has been a success, and is trending higher:


(Source: NY Fed, dataforthoughts. Click to enlarge.)

Follow Up on the CHK / FST Stat Arb

As of 1:30 pm today, CHK has dropped 1.92% to $28.55 since the post, and FST has gained 5.39% to $19.93...

Tuesday, September 29, 2009

Future U.S. Rates -- And the Aussie Dollar

The future rates implied by markets always offer food for thought. First, let's look at the Fed's target rates expected by the markets, according to Bloomberg:



As most of us would expect intuitively, the Fed is believed to stay on hold his year. Where opinions differ is as to when in 2010 it will begin to increase its rate target by 25bp increments: at its January meeting, or the one in March? In any case, the target rate would be at, or close to, 1% in the middle of next year.

This is consistent with future 90-day Eurodollar rates implied by the markets:



As the graph nicely shows, the rate should approach 1% by the middle of 2010, and be around 2% by the middle of 2011 -- with confidence intervals color-coded with different shades of blue.

Now, comparing futures dollar rates with that of the Australian dollar makes me pause:



By the middle of next year, their interest rates will hover around 4.5%; by the middle of 2011, around 5.5%! The carry trade between the two currencies is not finished; if nothing changes, the AUD will certainly strengthen against the dollar.

To that topic, as an aside: Deutsche Bank has the Euro at USD 1.25 in a year and the USD at 100 Yen.

Monday, September 28, 2009

Citi's Savings

On Sept. 17, Bloomberg indicated that Citigroup plans to sell $2 billion of five-year notes that aren’t guaranteed by the Federal Deposit Insurance Corp. This senior debt may price to yield about 325 basis points more than similar-maturity Treasuries. Looking at today's levels, the YTM on 5-yr Tsy is about 2.372%, so adding 3.25 implies the yield on Citi's debt would be 5.622%.

Now, just a few days earlier, again according to Bloomberg, Citigroup issued $1.5 billion of two-year fixed-rate bonds guaranteed by FDIC. (The FDIC program guarantees debt maturing in 3 years or less, so Citi had to do without to issue 5-year bonds.) Thanks to the Government guarantee, the issue priced to yield 3 basis points less than the benchmark mid swaps rate; with the 2yr swap rate at 1.306%, that’s 1.276%. So if Citi had to pay 2-yr Tsy rate + 325bp, its cost would have been 0.992 + 3.25 = 4.242%. Its savings are thus 2.966%, or $44.5mm per year.

On the same day, Citi also issued two more notes guaranteed by FDIC: First, $2.5 billion of three-year fixed-rate notes at the mid swaps rate. The 3-yr swap rate, mid, stands at 1.9%, but if Citi had to pay at the non-guaranteed (3-yr Tsy rate plus the same spread debt, 325bp), the firm would have to pay 1.478 + 3.25 = 4.728%. So its rates savings is 2.828%. Second, it issued $1 billion of three-year floating-rate debt at the three-month London interbank offered rate, where 3-mo LIBOR today is at 0.2825%. Now, assume the funding cost are the same as for fixed-rate (at origination, that should be true): that's another saving of 2.828%, or $99mm par year for both 3-yr notes!

To sum up, this back-of-the-envelope calculation tells us that the Gov't guarantee will save Citigroup $143.5mm per year over the next 2 years, and $99mm in 3 years -- and that, just on the bonds the bank issued in September!

CMBS Issuance and Issuers

CMBS issuance is still anemic at $8bn YTD, compared to $16bn in 08 and $203bn in 07. Not a single floating-rate deal this year, compared to 40.7% ($11bn) of 08 issuance and 20% ($50bn) in 07. The secondary market for floating-rate CMBS is also weak.

Looking at the issuers' ranking tables, Jefferies is coming strong, out of nowhere: #2 in Q3'09, was #6 in Q2, and virtually inexistent in past years. Loop Capital has been in the top 10 since Q3'08, but also coming out of nowhere -- they star started to rise even before they were selected by the NY Fed, on Sep 1, 09, as one of the four "non-primary dealer broker-dealers" (a mouthfull) for TALF. Morgan Stanley, which was at the top of the league table in 07 and 08, seems to be losing most.

Personal Bankruptcy Filings

Mary Kane at Citi “calls for roughly 24-34% growth in personal bankruptcy filings for the year ending June 30, 2010 – i.e., roughly 1.5-1.7 million personal bankruptcy filings.” Given her credentials (she and her team placed second in Institutional Investor's Sept 09 ranking of the best analysts of the year, category ABS/Consumer), the prognosis is worth keeping in mind.

Sunday, September 27, 2009

CMBS Remittance Reports

Interesting data aggregated over the latest remittance reports on about 45 CMBS deals, about evenly split among 06-1, 06-2, 07-1 and 07-2.
  • Serious delinquency for the aggregate deals alarmingly increased again, by 1%, to 47%.
  • Severity in aggregate stands at a staggering 71.6%, but is down 140 bp from August.
  • CDR in aggregate declined by 50bp to 18.8%.
  • Cumulative loss is up by 55bp and now reaches a severe 12.2 %.

Reallocation Out Of Cash

From Barclays Capital's Asset Allocation report dated Sept 24: "The environment of near zero interest rates means that savings are being slowly forced out of cash and into riskier asset classes. Around $350bn has left US money market funds this year, while $185bn has moved into equity, bond and hybrid mutual funds. Roughly 2/3 of the reallocation out of cash has headed into bond and credit funds. This move out of cash into riskier assets represents just 23% of the $1.5trn flight into cash that occurred over the 2007-Q1 09 period. As such, the remaining volume of savings that remain in near-zero yielding cash offer a considerable potential fuel for a continued rally in riskier asset classes."

Fly on Swaptions on 2y/5y/10y Rates

As discussed in previous posts, 1:2:1 flies on short-expiry options on 2y, 5y and 10y rates reached historical peaks recently. They retraced nicely, offering profit opportunities. Below, the fly on 6-month expiries:

Number of U.S. Banks Has Been Dropping... For 20 Years

Amazing stats from the St Louis Fed: there were more than 12,000 banks in the U.S. in 1990, more than 8,000 in 2,000, and about 7,000 at their latest count.



The original data can be found here, and match the numbers reported in this FDIC paper.

Friday, September 25, 2009

ABX After Remittance Reports

ABX tranches took a beating after the latest remittance reports: for example, ABX.HE.07-2 lost one point, closing Wednesday at a bid of 30 and change and an ask a tad higher than 33. It closed yesterday at a bid-ask of about 29-32.

Follow-up on Swaptions on 1-Year Rates

We had noticed that the vol surface on options on 1-year swaps was humped for 6-month expiries, indicating these options were relatively rich. The volatility surface regained a smooth look over short expiries:

How U.S. Banks Help Fund the Deficit -- And Prop Up the Price of Treasuries

U.S. banks have been piling on U.S. Government securities since the beginning of the crisis:


(Source: Board of Governors of the Federal Reserve System; St Louis Fed. Click to enlarge.)

This can be explained by the need for banks to reduce risk on their balance sheet, and by their inability to find borrowers at the rates they suddenly began to charge. This renewed demand certainly helped push the Treasury prices higher despite the massive supply of the last couple of years.

Looking at absolute numbers is also informative:


(Source: Board of Governors of the Federal Reserve System; St Louis Fed. Click to enlarge.)

We learn that about $300bn of Govt securities were absorbed by US banks alone, thus helping fund the stimulus and the deficit. (Which in turn may explain the relatively lenient attitude of the Government toward banks, capital requirements, compensation, etc.)

Thursday, September 24, 2009

Real Rates on (Inflation-Protected) TIPS

According to Bloomberg, real yields to maturity are negative, mostly, for inflation-protected U.S. Government bonds (also known as TIPS) maturing over the next 6 years. To look at their inflation assumptions and corresponding real yield calculations, you just need to go to their DES screen for a given bond. The few exceptions may even offer arbitrage opportunities: The TIPS with CUSIP 912828HW, maturing on April 15, 2013, has a positive real YTM; but the two TIPS with closest maturities, 912828AF and 912828BD maturing on 7/15/2012 and 7/15/2013 respectively, have inflation-included YTMs of -1.093% and -0.814%, respectively...


(Source: Bloomberg, dataforthoughts. Click on chart to enlarge.)

Swaption Fly on 3m Expiries on 2y/5y/10y Rates

The 1:2:1 butterfly on 3m-expiry swaptions on 2y/5y/10y rates reached levels not seen in years and several standard deviations away from its historical average.

Wednesday, September 23, 2009

The Rates Banks Charge Vs. Their Funding Cost

In an article in the Washington Post today, Steven Pearlstein wrote that "the Fed was [..] lowering the interest rate at which banks borrow from the Fed and each other, to pretty close to zero. What didn't change was the interest rate banks charged everyone else. As a result, "spreads" between what banks pay for money and what they charge are near record highs."

We can relatively easily find hard data to back up that claim. For example, we can look at the average 24-month finance rate for a personal loan by a commercial bank. If you want to try this at home, I'm using the CCOI24MO Index on Bloomberg. (FYI, the Bloomberg description adds that "the index is taken from the G.19 report disseminated by the Federal Reserve, and is not seasonally adjusted.") The value of that index dropped to a rate of 11.25%, much lower than in recent past. But to echo
Pearlstein's point, we want to compare it to the cost of funding that banks themselves face, i.e., to LIBOR. The graph of the spread makes the point clear:



The spread hasn't been that high since the early 2000's and the early 1990's.

Tuesday, September 22, 2009

Stat Arb on Chesapeake and Forest Oil?

For those stat-arb minded: The stocks of Chesapeake and Forest Oil are correlated at 95.9% (R squared at 92%), but Chesapeake is historically high. Both CDS spreads tightened recently and widened out a bit yesterday. We'd need to do more homework on both companies of course, but selling CHK against a long position in FST may be a good idea for a pair trade.

Monday, September 21, 2009

Jumbo ARM Deliquencies At 10.5% in August

Worrisome news in Moody's ResiLandscape report published Friday 9/17: "Jumbo delinquencies continue to rise rapidly, increasing to 10.5% in August 2009 from 2.7% a year ago for jumbo ARM pools issued in 2007." Also, "average loss severity has climbed to 45% as of August 2009 from 39% a year ago for 2007 vintage securitizations."

Following Up On the 3m1y/6m1y/1y1y Swaption Fly

A few days ago, we observed that the 1:-2:1 butterfly of 3mx1y, 6mx1y and 1y1y swaption vols was a historically low level, breaking -25bp. (i.e., confirming the observation made earlier than the 6m1y swaption was rich.) The fly nicely retraced above -17bp.

CDS Spreads on Local Governments

The cost of CDS protection on local governments is at its tightest since the beginning of the year. Interestingly, they all seem to have moved in a very correlated manner.


(Click to enlarge)

Thursday, September 17, 2009

Term Structure of CDX IG 12, Continued

In a previous post, we noticed that the term structure of the CDX IG Series 12 was surprising. It reverted to normal, with the cost of protection increasing with maturity. The graph below shows the cost of protection for 1-, 3-, 5-, 7- and 10-year contracts.


(Click to enlarge)

Another Way To Play The Richness of the 6m1y

Another way to play the richness of the 6m1y swaption is through a 1:-2:1 fly with the 3m1y and 1y1y at the wings. It broke its record last week but was still incredibly dislocated this morning.

Wednesday, September 16, 2009

Humped Vol Surface of Swaptions on 1-Year Rate

In a previous post, we noticed that the ratio of implied vols of 6m1y and 6m2y swaption was 4.4 standard deviations from its historical mean. The ratio retraced but still 3.3 std devs away.

It is also worth noting the current hump on the vol surface on the 1-year rate. Typically, the implied vol of a swaption on a given tenor decreases monotonically with expiries. Today however, volatility peaked at 6-month expiries -- i.e., the vol of 6m x 1y swaptions of all strikes is high relative to same-strike options of shorter or longer expiries.


(Click to enlarge)

International Demand for Long-Term U.S. Assets is NOT Much Weaker

Bloomberg News published today, on its terminals and on the web, an alarming article entitled "International Demand for Long-Term U.S. Assets Weakened in July" decrying that "foreigners sold a net $97.5 billion [of US securities] in July, compared with net selling of $56.8 billion the previous month." It also lamented that "foreign demand for U.S. agency debt from companies such as Fannie Mae and Freddie Mac weakened, with net sales of $4.6 billion in July after buying of $5.1 billion in June, according to the Treasury." Supposedly, that is due to "record amounts of debt sales to fund a $787 billion stimulus spending package" and to "the U.S. budget deficits [being] off the charts."

Well, the stimulus and the deficits don't help, but let's first look at facts.

Using data from the same company, let's first look at total net foreign purchases of US assets: that time series can be found on the Bloomberg terminal by typing FRNTTNET . The plot for the last few years is as follows:


(click to enlarge)

We can see that the July number is far from being as bad as that of Jan 09, or that of August 2007!

Let's now look at net foreign purchases of US Agency debt, using the FRNTUSGV index on the Bloomberg terminal. We see that the July number is in fact more than 10 times better than the October 08 number, when net foreign sales were $50.2bn, and much better than the July 08 or December 08 numbers!


(click to enlarge)

So, the numbers are not good, but nothing new, and nothing worse...

Tuesday, September 15, 2009

The US High-Yield Bond Market Is Dependent On Foreign Inflows

That may not be a surprise, but here are some facts to back up the claim that the domestic high-yield bond market depends on foreign purchases.

Comparing the Credit Suisse HY index to the volume of US Corporate bond purchases from foreign funds (Ticker FORPUSCB on Bloomberg) shows that both peaked at the end of April 07, and that the CS HY index plummeted after foreign investments dropped. A revival of foreign investments this year was later followed by a nice performance of the index.



How statistically significant is the relationship? Correlation, over almost 15 years, is 93%:

Swaptions: 6m1y / 6m2y Vol Ratio At 4 Standard Deviations

The ratio of vols (6m1y over 6m2y) stands at more than 4 standard deviations from its mean over the entire period covered by Bloomberg's data, which is more than 12 years. In that respect, the 6m1y clearly is expensive relative to the 6m2y.


(Click to enlarge.)

AMR: The Equity Market Was In Fact Right!

In a previous post, we noticed that the cost of CDS protection on American Airlines was increasing while the stock was going up, i.e., that the two markets were contradicting each other. I suspected the credit market knew something equities didn't know; well, it looks like the opposite was true: AMR's stock rose even further while the CDS spread (5yr protection on bonds) tightened violently.

Monday, September 14, 2009

1y x 2y ATM Swaption Straddle Rich Relative to 1y x 5y

The ratio of implied vols of the 1y x 2y and 1y x 5y ATM straddles just reached historical highs. It slightly retraced already but is still 2.34 standard deviations away from its historical average. (As for any option, the value of a swaption increases with vol, so a high implied vol on the 1y x 2y option relative to another swaption indicates relative richness.)

2-Year Swap Rate at Historic Lows

The 2-year USD Swap Rate reached historic lows last year and widened out only slightly today. The chart below covers the last 15 years.

Friday, September 11, 2009

Leading Indicators of Financial Turmoil?

In earlier posts, we discussed the spread between LIBOR and OIS, the VIX, and the bid-ask spread on CDX protection. But let's look at the three of them together:


(Click to enlarge)

The VIX is in blue, following the blue right-hand scale; LIBOR-OIS is in white, on the white right-hand scale; and the CDS bid-ask appears in red, on the left-hand scale.

Clearly, all three are almost synchronous indicators of stress in financial markets. The bid-ask spread on CDX protection seems however to be a slightly earlier indicator than the two others. In particular, it jumped before the others in July 2007 and in September 08.

Thursday, September 10, 2009

CMBS Amortization Type By Loan Vintage

In an earlier post, we noticed that, although the jury is still out, default rates on recent vintages of CMBS seem to be picking up. On the positive side, however, looking at the amortization type of CRE loans shows that interest-only loans, which were all the rage as in residential mortgages, gave way to fully amortizing loans -- a good sign of course.


(Source: Bloomberg, dataforthoughts. Click to enlarge.)

Wednesday, September 9, 2009

Term Structure of CDX NA IG

The term structure of MarkIt's CDX North America Investment Grade index, Series 12, shows some anomalies:


(click to enlarge)

A few months ago, the spread on 1-year protection (in white) was higher than 2-yr (amber), itself higher than 5-yr (yellow), itself above 7-yr (green) , itself higher than 10-yr (purple). Recently however, 5-year protection has been more expensive than protection at any other tenor. The most probable explanation I believe: a sudden demand of index protection to hedge portfolios, which typically is done using the most liquid maturity (5 years), drove that price up. The demand of protection in other tenors is less while suppliers are indifferent, creating this purely technical anomaly.

AMR: Are Credit Markets Telling Us Something the Equity Market Doesn't Know?

Typically, a company's stock moves in tandem with the CDS spread. As illustrated below for American Airline's parent, AMR, when equity (shown in white) moves up, the cost of CDS protection (in amber) goes down. And when CDS spreads widen out, the stock price drops.


(Click to enlarge)

In the case of AMR, this has been true for most of the past few years. Recently, however, the cost of protection on AMR has gapped out significantly while the stock has gone slightly up. It's not easy to see it on the chart given its time scale, but the stock went from the low $5's to almost $6 in the last few days, while at the same time the CDS spread kept widening. A temporary anomaly, or a message from credit markets?

Tuesday, September 8, 2009

CMBS Default Rates by Vintage

Will the 2008 vintage be a good one for CMBS? It's too early to say, but it doesn't look good. The chart below shows cumulative default rates, in percent of notionals, for the 2004-2008 vintages, as a function of quarters passed since the end of each of these years.


(Source: Blomberg, dataforthoughts. Click to enlarge.)

We can see that it took 14 quarters for both the 2004 and 2005 vintages, on average, to reach a 6% default rate. The 2006 vintage reached 4% after just 10 quarters, but is not markedly worse than its predecessors. The 2008 vintage, however, already reached 1% after just 3 quarters, which is ominous.

Monday, September 7, 2009

CMBS Issuance

Plotting issuance volume of CMBS in the US and Moody's Commercial Property Price Index is quite informative.


(Source: Bloomberg. Click to enlarge)

First, CMBS issuance was almost inexistent in 2008, and will probably be even worse this year. We're back to early-1990's levels. We can also note that CMBS had the same gogo years as Residential MBS, in 05, o6 and 07.

Second, the impact of CMBS issuance, or lack thereof, on values of commercial properties is quite clear, as we would intuitively expect. Property prices peaked with CMBS issuance, and are falling with it -- although fortunately at a slower pace.

BTW, for those interested in this topics, here's an interesting link on CMBS issuance in Europe.

Saturday, September 5, 2009

The Economics of Negative Bond-CDS Basis Trades

The bond-CDS basis is the difference between the cost of a credit default swap and the yield on a corresponding bond. When you own a bond, you receive its yield (in the form of both coupon payments and price convergence to par) but also take the risk of the issuer defaulting. Buying CDS protection eliminates that risk, at a cost that is typically a percentage of the notional amount you’re insuring, paid quarterly. Until recently, the basis was typically positive, i.e. buying insurance was more expensive than the yield you were getting from the bond. Many more bonds now have a negative basis, implying that indeed you can earn a yield from the bond, use some of it to remove all issuer-linked credit risk, and still make money. (Buying CDS protection leaves you exposed to the risk that your CDS counterparty blows up. You also have interest-rate risk, which is discussed later.) You can also potentially make money on the mark-to-market of both the bond and the CDS.

Let’s say you’re a hedge fund and buy $10MM of the Eastman Kodak bond maturing on Nov 15, 2013, paying a 7.25% coupon and currently trading at 63 cents on the dollar. (Note: this work was done on June 15, 2009. I haven't updated any numbers.) You finance half the purchase by borrowing from your prime broker at 1-month Libor + 150bp, but pay the other half ($3.15MM) cash. You’re getting $725k annually in coupons, and pay $57k in interests.

Now you’re buying CDS protection for a Spread-DV01-neutral notional amount, which in this case, as we’ll see later, is $4.799MM. As of today (Again: June 15, 2009), the cost of that protection is 5% of insured notional i.e. $240k annually (but paid in four quarterly installments of $60k). There is also an upfront payment of 28.04%; the capital needed up-front is thus $1.35MM, but you should be able to get 10x leverage from your PB and thus only post 10%, or $135k, as margin.

You also want to keep some cash reserve, let’s say $1MM in this case, so the capital used in this trade is $3.15MM for the bond, plus $0.135MM for the CDS margin, plus a $1MM reserve, totaling $4.285MM. The carry is $428k, annually, since you’re receiving $725k in coupons, paying $57k in financing interests and paying $240k in CDS protection.

The terms and price of the CDS can be read off Bloomberg using their CDSW page. The following screen shot shows the 5-year CDS on senior debt, where the bottom line of the “Deal Information” pane indicates that the upfront payment is 28.04% and the running spread is 500bp. (These are of course the numbers used earlier.)



This bond-CDS basis trade can be structured, in part, using Bloomberg. One way is, from the CDSW page shown above, to click on the “Bond Hedge” red button in the top banner, then on “Bond vs CDS hedge.” This leads us to the HGBD page, which can also be accessed directly of course. The page calculates the notional amount on the CDS and the notional on the interest-rate swap (IRS) that will hedge the rate exposure on the bond-CDS package.



In the top panel, we recognize the $4.799MM notional amount used earlier for the CDS. The middle panel confirms that the exposure on credit default (Spread DV01, i.e. the change in Dollar Value of the instrument for an upward, parallel 1bp move of the credit curve) is 100% hedged, and that sensitivity to rates (IR DV01, or dollar value change for a 1bp upward parallel shift in interest rates) is hedged to zero. In the bottom panel, the price and Z-spread of the bond are summarized. (The asset-swap spread, not the z-spread, is used in practice.) The cost of CDS protection is also shown, assuming no up-front payment and assuming a 40% recovery rate -- of course, different scenarios should be tried out to project the impact of actual recovery rates on the economics of the trade. Converting the CDS cost to an all-running format, as opposed to the actual upfront+running payments, helps compare the protection cost to the bond yield. Here, the basis is 1,532bp for the CDS, less a z-spread of 1,774bp for the bond, giving a basis of negative 242bp.

So, the negative basis trade has a positive carry even net of interest rate risk. But what if the issuer defaults on its debt? Assume the firm defaults 1 day before the next CDS payment is due, that is 89 days after the basis package is put on. Your initial outlay was as computed earlier, $4.26MM. You made no subsequent CDS payment and received no coupon, so the only additional cash inflows are the recovered amount on the bond, and the CDS payment. Assuming again a 40% recovery rate, you recover 40% times the bond’s face value, i.e. $4MM, and the seller of CDS protection pays you (100% - 40%) times the CDS notional of $4.799MM, i.e. $2.88MM. You also free up your $1MM reserve and thus end up with $7.88MM just 89 days after laying out $4.26MM.

Hey, wait! These calculations do not include mark-to-market gains or losses on the bond, the credit default swap, or the interest swap. It’s hard to predict what their values will be in the future, but the “horizon” tab of the HGBD page projects these MTM changes based on the yield curve and on the credit curve of the issuer. On an 89-day horizon, the MTMs are shown in the bottom right corner of the screen shot below.



So, if all curves stay where they are, we would after 89 days be making $67k on the bond and $35k on the CDS, but losing almost $17k on the interest rate swap -- resulting in a net gain of $86k on top of the $7.88MM profit calculated earlier!

Let us now assume the issuer defaults after a year. In this scenario, you had the same outlay and the same terminal payment, but the 4 quarterly cash inflows would be $107k, equal to the annual $428k carry divided by 4. (Bond coupons are usually semi-annual, so the actual cash-flows would be slightly different.) Turning now back to Bloomberg to get projected P&L on the bond and the swaps, we see the following:



This example trade looks so juicy that we may think hedge funds are piling on all negative basis trades. (They were!) However, a quick look at the bond universe seems to show that, although many bonds currently sport negative basis, relatively few are expected to post mark-to-market profits according to the horizon analysis done above. Also, as demonstrated above, returns are higher if the issuer does default and defaults relatively early after the trade is put on, further narrowing the opportunity set.

You can try for yourself to find negative basis packages and look for the “best” opportunities for early defaults using the SRCH page on Bloomberg: go to Advanced Search and select a country (selecting a country is not mandatory but significantly trims down search time), then go to the “inventory” section and select a basis range (e.g., from -200 to -100bp) in the appropriate fields at the bottom right of the page. Among the numerous answers, you will want to do the horizon analysis to make sure the positive carry on the trade won’t be killed by MTM changes.

Friday, September 4, 2009

Expect A Downgrade on MSC 1998-XL1 G?

Another mall, known as the Charlestowne Mall, went in REO yesterday. This may impact one CMBS deal, MSC 1998-XL1. That deal has only two loans as collateral: Charlestowne Mall, which is 27% of the collateral, and CenterAmerica Mall for the rest, 73%. According to servicer's reports, the property was appraised on May 11, 2009 at 18.82% of its appraisal value on June 1, 1998. So it is not unreasonable to fear a loss severity of 80% on this loan.

According to Bloomberg's SPA simulation page, that would not be enough to create a loss on the investment grade tranches. But the first IG tranche, the G tranche, would then be at the mercy of a default on the other loan even is loss severity is a mere 10%. The corresponding SPA page appears below. A downgrade of tranche G, and perhaps even F, is thus looming.

Thursday, September 3, 2009

Downgrades of AAA RMBS Tranches: The Case of CountryWide's CWALT 2005-J11

On Sept 1, S&P downgraded the 1A4 tranche (among others) of a CountryWide deal, CWALT 2005-J11, from AAA to CCC. Investors were certainly shocked to face such a drastic drop in rating, especially since collateral performance has been deteriorating for quite some time on this deal. The chart belows shows the percent of loans on this deal that is delinquent for 90 days.



As early as Q1’08, it was thus obvious things were not going as planned and that defaults would increase. And on this deal, it doesn’t take a lot of defaults to cause loss on AAA tranches. As can be seen on the simulation below, a modest CDR of 4.2 causes a loss of 2.51% of principal on this AAA paper. (The 1A4 tranche is highlighted in blue.) I used a severity of 50%, which is typically true for Alt-A loans such as thos in this deal.



Red bars indicate, quite intuitively, losses. Note however that the x-axis represents time, so the length of the red bar is not proportional to loss severity: a long red bar only means the first loss occurred early and that the last principal repayment happened late.

If you enlarge this graph and peruse the tranche labels, you'll notice that most of the tranches on this screen are senior or super-senior tranches, and suffer their first loss simultaneously. That's because subordinated and support tranches were already wiped out and that, from then on, losses were shared pro-rata between the senior tranches. (Thanks Jack!)

Inverted or V-Shaped CDS Term Structures

What drives the term structure of CDS spreads? Given that only the 5yr CDS is liquid, technicals and fast money accounts often drive the 3yr-, 7yr- and 10yr-buckets. But that's not always the only parameter. Consider for instance the maturity distribution of Gannett's debt, for example:



The firm has large amounts of loans to pay back or refinance in 2012. It is then not surprising to see that, although CDS spreads are elevated for all terms on this issuer, the 3-year CDS is most expensive:



If the company can survive that 2012 hurdle, then markets imply a lower probability of default after that.

Note that, on this issuer, it would be too expensive to put on the trade discussed in the previous post: the cost of the option would here be 640bp (the cost of buying 10yr protection) after the long CDS position (3yr or 5yr here) expires.

Inverted CDS Term Structures, At Very Low Spreads

Incredible term structure for the CDS of some companies, like Duke Energy below:



By buying protection for 10 years at 38bps and selling protection, on the same notional amount, for 50bps, you pocket 12bps risk free for 5 years. Not only that, you get a high-value option for cheap: you get the right to start paying, in 5 years, 38bps per year to profit (handsomely!) if Duke's situation deteriorates in years 6 through 10.

Wednesday, September 2, 2009

What's Ahead for Commercial Real Estate and CMBS

Interesting to compare the Case-Shiller home price index to Moody's CPPI index, a monthly index reflecting prices of commercial real estate (CRE).


(Click to enlarge.)

CRE has been following the same trajectory as residential, although it kept rising while residential began to crumble. Residential is now slightly up, but it's hard to tell when CRE will follow: According to Trepp (and as reported here), delinquencies on commercial mortgage-backed securities (CMBS), overall, breached the 4% mark in August. The chart below provides a finer break-down per CMBS type.


(Delinquency rate of CMBS. Source: Trepp. IN = Industrial, LO = Lodging, MF = Multi-family, OF = Office, RT = Retail. Click on figure to enlarge.)

Even though CMBS issuance is now minuscule, they represent about $700bn of the ~$3.5tn CRE market if I remember correctly. Thus that delinquency number should be a good proxy for the broader commercial market.

ABCP Again: Now Paying the Highest Rate

It wasn't planned that way: now commercial paper backed by assets offer a higher yield than any other type of CP.



Also interesting: Corporations do not seem to save anymore by issuing directly themselves.