Page 3 of
3 PATHOLOGY OF DEBT PART 2: Commercial paper and
pesky SIVs By Henry C K Liu
Rate by 50 basis points to
5.75% and change to the rules for access by banks
to the Fed discount window, that its discount
window was prepared to accept the new commercial
paper backed by asset-backed securities as
collateral from banks for loans with which to fund
bank credit lines to otherwise distressed
borrowers.
Fed data show the supply of
ABCP slumped by a record US$77
billion in the week to August
22. Overnight yields on top-rated commercial paper
dropped 5 basis points to 6.04 percent but still
up 78 basis points in the past 30 days. As of
August 22, Fed data show about 86% of all ABCP
coming due within seven days, and about 50%
maturing overnight. Yields on the US$1.2 trillion
market for ABCP had been rising because the money
market funds might have to liquidate assets
quickly to pay back short-term debt. That could
set off spiraling losses in the money market for
other structured finance instruments even if
synthetic ''mark-to-model'' face values had not
yet been adjusted to ''mark-to market'' reality as
the housing crisis deepens to further adversely
affect the credit market.
Seasonally
adjusted outstanding commercial paper fell US$90.2
billion to US$2.04 trillion in the week ended
Wednesday August 24, after falling US$91.1 billion
in the previous week. Most of the decline came in
ABCP. In August, ABCP fell more than US$170
billion from the level at the end of July. The
previous monthly record was a decline of US$78
billion in January 2001 that signaled the ''Early
2000s'' recession identified by the National
Bureau of Economic Research (NBER).
About
US$125 billion in ABCP was withdrawn from the
market in September, a sign that banks were
stepping in under their liquidity agreements to
make good on their customers' maturing debt in the
commercial paper market. As of the week of October
17, outstanding commercial paper was US$1.88
trillion, down US$300 billion from US$2.18
trillion in the first week of August.
Pesky structured investment
vehicles About 43% of the assets in
structured investment vehicles (SIVs) - which hold
mainly highly rated asset-backed securities and
fund themselves using the short-term commercial
paper market - is financial institution debt. If
the SIVs were forced to make fire sales to raise
cash, it would drive down prices and lift funding
costs for banks, which could respond by tightening
the supply of credit. Investors are demanding much
higher yields on bank debt because of concern over
the effect on their balance sheets of the subprime
mortgage meltdown.
Citigroup, with another
US$11 billion of writedowns on its holdings of
subprime-related investments, was forced to pay
1.9 percentage points more than US Treasuries in
the second week of November, 0.7 point more than a
similar sale three months ago, before the August
liquidity crisis, on a 10-year US$4 billion bond
issue. Yields on financial bonds are on average
1.49 percentage points more than Treasuries, while
the premium on industrial bonds is 1.34 points.
For the first time since the beginning of
the liquidity boom several years ago, credit
default swaps on financial companies are now
trading in line with, or even wider than,
industrial companies, costing more to insure
financial debt against default.
After the
August liquidity crisis, Citigroup paid US$25
million more in annual borrowing charges to raise
US$4 billion in 10-year fixed rate bonds compared
with a similarly structured deal in February. It
also paid US$5 million more in annual interest
rate fees than a similarly structured bond in
August, showing the outlook for the largest US
bank had deteriorated further from the height of
the crisis at the end of the summer. In a further
sign of falling confidence in the bank, insurance
for Citigroup bonds against default in credit
derivatives now costs more than for emerging
market countries such as Mexico and Malaysia.
Troubled bond insurer ACA Capital Holdings
is reportedly facing credit rating cuts, which
would set off a chain reaction requiring banks to
put an estimated additional US$60 billion of CDO
obligations on their balance sheets. S&P
reviewed ACA’s ''A'' rating in early November when
the company reported a US$1.04 billion
third-quarter loss. ACA noted in an SEC filing in
the third week of November that it would not meet
collateral obligation requirements if its rating
should fall below ''A-''.
ACA is one of
nine key bond insurers threatened with a credit
rating downgrade. Together, the nine are
responsible for insuring about US$2.4 trillion of
debt. Bear Stearns’ private equity group bought a
29% stake in ACA for US$100 million in 2004.
Market capitalization of ACA fell to US$29 million
after its stock fell more than 90 per cent from
year-end December 2006 to mid-November 2007. If
ACA defaults, Merrill Lynch may have to take an
additional US$3 billion writedown from CDO
exposure. Shares of ACA fell another 22.7% to
US$0.85 on November 21, while Merrill Lynch traded
down 3.5% to US$51.81 and Bear Stearns dropped
2.8% to US$91.28.
PART 3: Credit
guns heard around the world
Henry C K Liu is chairman of a
New York-based private investment group. His
website is at http://www.henryckliu.com.
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