Posted by June 3, 2008
The tri-party repo reform project remains very interesting and I went to a big lunch meeting where President Geithner was in attendance, along with Christine Cummings, the First Vice President of the bank, and Tom Baxter, the Chief Counsel. The start of the meeting was a little unsettling. I show up about three minutes early for the meeting, so that’s cool, but when I get off the elevator, I notice that everyone is wearing a suit, except me. Then I realize that I actually DID wear a suit today – no tie though – but I’m not wearing my suit jacket. So, no big deal, I go back to my desk for the jacket but that causes me to arrive just a tiny bit late to the meeting. I end up last in line at the lunch buffet table although an SVP does join in the line behind me after a minute or two. I’m obviously not going to get the most powerful seat in the room, but while I’m waiting on line, I notice that the room appears to be short one chair. So, I let the SVP take the remaining chair and I just stand in the back near a wall waiting for the staff to figure it out. In the meantime, Ms. Cummings goes out of the room and returns with an ornate chair and puts it next to her. So I ended up sitting next to the First VP in a chair that was unique among the 25 meeting participants. My take-away from the meeting: reforming this $2,500,000,000,000 market is not going to be easy.
Last Friday, May 30, was a financial statement quarter-end date for three of the remaining four non-bank dealers: Goldman, Morgan Stanley and Lehman. The current economic landscape is naturally difficult for the dealers and a major ratings agency, S&P, just downgraded the long-term debt ratings for both Lehman and Merrill to ‘A’. That doesn’t sound too bad, does it? There is near cliff on the horizon for those dealers, however. Just one notch lower, to ‘A minus’, will reduce their short-term debt rating from ‘P-1’ to ‘P-2’, and a ‘P-2’ short term rating could be a problem. It doesn’t even sound good: “P-2, ☹ P – U”! The first page of today’s WSJ had an article that estimated Lehman will have a $300 million loss for the quarter, prompting them to probably look to raise about $3.0 to $4.0 billion in equity soon. That doesn’t sound that bad, does it?
During the day, stock market participants read this article and think, “losses, equity raises, … dilution”. The book value of Lehman shares will be less valuable after the loss, while the scarcity value will all also go down as Lehman is going to issue more shares – the current ones will become “diluted”. Lehman’s shares drop 10% in value today, in addition to the 8.0% or so share price decline that happened yesterday. Of course, Lehman equity holders are not the only ones who are concerned. Entities that lent Lehman money in the funding and bond markets are now thinking, “what’s up with that 18% drop in their stock price over the last two days?” So quarterly earnings are prompting concern about dealer liquidity; can you say, “run on the bank?” hopefully not! In addition to Lehman, I get the feeling that Merrill Lynch will be under pressure until they release their second quarter results at the end of June.
June 4, 2008
Lehman’s stock price ends up 2.0% on the day and that makes me feel a little uncomfortable. My recollection of how the end played out for Bear Stearns: on good days the stock goes up a little bit, on bad days it gets slaughtered.
A couple of emails crossed my desk which indicated that some, very few in fact, but some, investors in the short-term debt markets were leaving Lehman. It probably doesn’t take much for momentum to build …further, NO bank or dealer can survive a true “run on the bank”.
One of my peers at work came up with a chart that shows book value / market value of the traditional group of five large independent dealers (Merrill Lynch, Goldman Sachs, Lehman, Morgan Stanley, Bear Stearns). The chart was very easy to read: Lehman’s book value / market value ratio is currently about 75% which is almost exactly where Bear Stearns’ ratio was as they approached the cliff. Yikes! My goal of developing financial ratios that would be relevant across different dealers keeps getting sidetracked with all this talk of Lehman. Right now, I’m hoping to see two market functioning improvements: the tri-party repo market gets “better”, ie stronger, more resilient, etc. AND a central clearing house develops for derivative trading. Is that too much to ask? I hope not!
June 11, 2008
Something different, the highlights this week were developments with financial guaranty insurers and Lehman. Starting with the latter, Lehman announced preliminary second quarter results (for quarter end of May 30th) were a loss of $2.8 billion. They were also very clever, announcing a completed $6.0 billion private placement equity issuance at the same time – $4.0 billion in common stock, $2.0 billion in mandatory convertible preferred stock. Creditors should be comfortable with the $3.2 billion (-2.8 +6.0 = 3.2) increase in equity, right? Well, not exactly. Lehman’s CDS spreads are about 40 basis points wider on the week. Can’t blame CDS traders for being freaked out about the fall in Lehman’s stock price, I suppose.
I remain impressed by Lehman’s execution. The stock was trading around $31.50 at Friday’s close and the new shares were issued on Monday at a price of $28.00 a share – nice discount, but hardly a fire sale. On Monday morning, I was expecting the $28.00 share price would form a floor, or support level, for Lehman’s stock and that the “run risk” mania would transfer to Merrill, whose quarter end is about three weeks away. Well, the $28.00 resistance level lasted about a day and a half. Lehman’s closing share price on Wednesday was $23.75 a drop of 13% from the “floor” level while the S&P 500 index was down only 1.7%. Fittingly the percentage decline for every dealer’s stock price exceeded the S&P index’s decline. Still Lehman’s decline was more than twice that of their main competitor, Merrill Lynch, whose share price dropped 6.0% over the three days. Lehman’s equity raise is probably showing through to their current CDS spread of around 290 basis points, which is about 200 basis better than Bear Stearns’ CDS was about a week before they went under. I also have to give a shout out to the Fed’s Primary Dealer Credit Facility (PDCF) as likely providing some support to Lehman’s credit profile. Recall the PDCF allows non-bank dealers to pledge collateral to, and borrow from, the Fed’s discount window, a privilege previously reserved only for banks. Nevertheless, Lehman’s equity price is a cause for concern and the recent price action, if it continues, could prompt the start of a dreaded “run”.
On the financial guarantor front, this week saw S&P downgrading the financial strength ratings of both MBIA and Ambac to ‘AA’. I sent an email to my old Desk colleagues about the developments, they think Ambac is “done”. There wasn’t much initial price action in the stock prices of the financial guarantors, but structured short term municipal markets aren’t doing well. So far so good, though. I also recently read that MBIA is reconsidering how they’re going to allocate proceeds from a $900 million stock offering, since they have been downgraded anyway. Fair enough, but like I’ve said before, they shouldn’t cordon off assets for the benefit of some, but not all, policyholders.
Not much progress on the financial ratio development front, but I am attending another meeting of an internal tri-party repo group next week. Looking forward to the discussion. Should the Fed get involved in setting or approving collateral haircut levels? Should we help define what collateral is eligible to be pledged in the platform? Stay tuned.