Monday, August 27, 2007

You have controlled your fear

Are we safe from sub-prime contagion? For the moment. At least in terms of the unadulterated fear punishing credits of all sorts. It appears that the Fed's actions have had a significant calming effect on the market, as the last couple days have witnessed orderly trading in the credit markets.

So now the real trick is to find the opportunities. The following is a quick list of some housing/sub-prime related names and where the CDS is trading currently.

  • Bank of America: CDS = +35, Ratings = Aa1/AA, recently made a $2 billion investment in Countrywide.
  • HSBC: +52, Aa2/AA-, one of the first large banks to do a significant sub-prime related write down.
  • Goldman Sachs: +65, Aa3/AA-, large underwriter of CDO/MBS/everything else, but not especially hit by sub-prime problem.
  • PMI: +90, A1/A, provider of mortgage insurance.
  • Washington Mutual: +90, A2/A-, well-known mortgage originator, especially on West Coast, also has traditional bank operations.
  • Capital One: +95, A3/BBB+, credit card issuer, particular within lower income bracket.
  • Lehman Brothers: +105, A1/A+, operated a sub-prime originator, which was recently shuttered.
  • Bear Stearns: +115, A1/A+, suffered through some high-profile hedge fund failures.
  • MBIA: +125, Aa2/AA (corporate rating, insurance sub rated Aaa/AAA), insured some sub-prime/CDO deals.
  • H&R Block: +170, NR/BBB+ (neg. watch), owns a sub-prime lending unit, rumored to be a LBO candidate, going through a proxy battle.
  • Countrywide: +200, Baa3/A- (neg. watch with both), you know this story.
  • CIT Group: +200, A2/A, owns a home mortgage unit, viewed as possible takeover candidate ala SLM Corp.
  • Centex: +245, Baa2/BBB, large home builder.
  • GMAC: +545, Ba1/BB+, obviously have their own problems, but also exposed to consumer credit.
  • General Motors: +720, Caa1/B-, for perspective.
  • Residential Capital: +1000? (trading with points up front), Ba1 (neg. watch)/BBB-, former mortgage arm of GMAC.

For some additional perspective, here are the 3 largest non-finance IG issuers:

  • Verizon: +25, A3/A
  • Comcast: +41, Baa2/BBB+
  • Sprint Nextel: +46, Baa3/BBB

They are ordered from tightest to widest, but is this order of things correct? Are the tightest names really the safest? Are the widest names really most likely to go bankrupt? Feel free to post your own thoughts in the comments, I'll post my opinion in a day or two.


Anonymous said...

I am a fix income newbie.
However I have a question.
Any idea who are the holders of the non AAA rated CDOs? As far as I know all these funds and institutions say they are holding only the AAA stuff (Even thought TripleA is a mark to model fantasy for these instrutments). Who are the lower grade holders. And if the Triple A holders are suffering this much what about the rest of the market?

Anonymous said...

Why I didn't see TMA, MTG, LEND in your list. Especially TMA, with Debt/Equity ratio of 20.

Anonymous said...

I would buy the WM CDS, with 80bn of balance sheet assets either vulnerable to resets (20bn subprime) or recasts (60bn arms). MBI might be the sleeper short, as their insurance is attached at high levels and are not subject to liquidity-related markdowns.
There is no credit traded in TMA, as they are short term financed.

Anonymous said...

How about GE Capital? Where is protection on that trading in relation to HSBC finance?

Anonymous said...

I would be away from corporate bonds for a long time as I have my doubts on the low yields offered by goverment bonds trading as if these are not risky(considering the macro aspects of the us economy). Rates are to increase globally , spreads are still low. Besides about 70% of corporate bonds are below investment grade and their ratings are based on access to capital markets since their cash flow hardly covers interests, so sooner o later default rates will increase as us econonomy enters recession.

Accrued Interest said...

Anon #1: AAA holders aren't suffering that much. I mean, you have to define suffering. CLO's aren't doing too badly, and even ABS CDO's, the AAA tranche performance depends on the deal. And I'm sick and tired of this mark to model myth floating around. CDO's don't mark to anything.

Accrued Interest said...

Anon #2: MTG is about +170, the others don't have actively traded CDS. Generally there won't be a CDS contract unless there are publically traded bonds outstanding. So most of the little mortgage originators never had CDS contracts.

Anon #3: I assume by "buy WM" and "short MBI" you mean you'll bearish on WM and bullish on MBI? (Just clairifying for those not used to CDS terminology). I like WM because I think they have much better liquidity than other big originators. I'm concerned about their relatively low loss reserve. I wouldn't expect much movement in WM CDS for a while, because they can't get as tight as BAC or JPM. So at +90, you're upside can't be more than like 20-30 bps max.

Accrued Interest said...

Anon #4: GECC is like +40. They've always traded wide of other AA/AAA names.

Anon #5: I think you are grossly over simplifying.

Anonymous said...

Completely random off-topic comment:

The subtitle of your blog is "... of the investment world, its Accrued Interest". That should be "it's".

Sorry to be such a pedant.

Anonymous said...

I am a newbie at all, can some let me know what is that "CDS = +35" means? Should I assume all others such as "MTG +170" also means "MTG's CDS=+170"

Anonymous said...

i think wm would become a takeover candidate before they ever came close to ch 11.

Accrued Interest said...

CDS are quoted in spread, which is the periodic payment the buyer of protection makes to the seller of protection. So the higher the spread, the more expensive insurance against bankruptcy is. So if GE is +40, that means you pay 40bps on whatever notional amount of protection you want.

Anonymous said...

Typically these are quoted on 5 year contracts with 10 million dollars notional. 1 basis point = 0.01%. Premiums are typically paid quarterly on the notional.

Accrued Interest said...

I posted a CDS primer here...

Anonymous said...

I'd much rather know which banks have been using FASB Statement No. 157 -- commonly known as the approval and acceptance of "mark-to-make-believe" -- for their valuation of assets and earnings. And what the change (upwards, shockingly) in those assets has been since they've been allowed to effectively self-appraise their own asset value.

Oooh, we're using this method for "illiquid instruments" says wall street - wrong, the market is not illiquid, it's zero.. there is no market for CDO's on foreclosed houses.

How in blue blazes does this not affect their bond rating and CDS spread?

Accrued Interest said...

Are you trying to say that any security for which there is no bid should be marked to zero? That would mean that any time we have a liquidity crunch, bank balance sheets would be creamed. Is that what we want?

Anonymous said...

That idea would make shorts interesting when they go bid-without!

Anonymous said...


Re: comment that any security that has no bid should marked at "0"....yes, at least in theory. If ANYTHING has no buyers, it has no "market value".

Unknown said...

Does Bloomberg quote CDO spreads?

Accrued Interest said...

Bob: No CDO quotes on BB.

Anon: I think that would more often distort reality less often than it reflected anything. Banks would fear that if they put anything funky out for a bid, there was a chance they'd have to write it down to zero.

Plus, as I think Jim is alluding to, banks would suffer large paper losses, and I suspect that would confuse the equity market more than it would help.

Anonymous said...

tddg: Thanks for circling around to my point ;)

" anything funky "

As explained more long-windedly this morning over on naked capitalism, the problem is lack of complete information on what is being sold, not the methodology of selling it.

If a bank puts a bond out for bids that has only 10% assets and the rest some sort of CDS / derivative construct, they SHOULD be forced to mark it down to 0 when it comes back with no bids!

Bonds with derivatives are crocks.. the reason there was no bid (in that example) is because the seller tried to warm up dog food and call it pate!

Anonymous said...

Anonymous 10:42 - Would you advocate this method for houses, too? If I put a 'For Sale' sign on my front lawn this afternoon and don't get a qualified offer by 8pm, should I write off the house?

"No Bid" does not mean the recalcitrant market maker thinks it's worthless. It just means that, at that moment in time, he doesn't want to own it.

That market maker does not consider it his job to assist in the functioning of efficient markets by helping other participants to value their inventory. It's his job to make boatloads of cash for his firm; if that leaves all other participants naked and hungry, that's a good thing.

He does not make boatloads of cash for his firm by buying a bond and holding it to maturity. Ideally, he wants to buy from you at a nickel and sell to me at a dime, within five minutes.

I do agree that lack of access to information is a problem - for example, I've been told by some dealers here in Canada that they can't give me the prospectus and pricing supplements on some Maples [Foreign issuers' Bonds / Canadian Market / Canadian Funds] because it would be illegal (they're private placements. I think they're wrong, but I don't get a vote).

So, since I can't tell what the terms are (sure, the information's on Bloomberg. But if I underperform because there's an early call not reported there, it's not Mr. Bloomberg who gets fired) I don't buy.

But that doesn't mean I think the Lehman 4.73% of '11 are worth zero.

What I would certainly hope to see at some point in the future is a much better use of the internet by issuers. I should be able to punch www.112585880.cusip into my browser window and get all the information that exists about BAM.PR.J ... prospectus, filings, news releases, dividends, the works.

As soon as enough PMs agree with me that it makes an appreciable difference to the cost of financing, I'll get it. But right now, such sites, when they do exist, are strictly retail oriented (e.g.

Accrued Interest said...


If you come up with such a system, I'd sure as hell invest in it. I think a lot of non-investment people would be shocked at how little information we (as pros) are given and yet are still expected to make a bid.

Anonymous said...

They are quoted on B Berg. Use CDSD and hit GO for the main page and navigate from there.

Accrued Interest said...

CDS are quoted not CDOs