November 28, 2011 Credit Markets

Risk on readers, risk on. Decent initial estimates of US holiday sales and more European "solution pablum" lead the market down the "hakuna matata let's add some risk" path. Too early my friends, don't buy the hype. There has been no viable solution presented as there is no viable solution. There is no "periphery" issue, only a European issue.

Decent new issue calendar today:


Issuer                                Rating            Size             Mat      Pricing
Scripps Networks               Baa1/A-        $500mm        5y          T+180
National Fuel Gas               Baa1/BBB    $350mm       10y          T+295
Pacific Gas & Electric        A3/BBB+     $250mm       30y          T+160
AGCO Corp-CoC,144a       Ba1/BBB-    $300mm       10y           5.875%
Tesco-CoC,144a                 A3/A-          Bench            3y          T+165-170
Tesco-CoC,144a                 A3/A-           $                   5y          T+180-185
Canadian Pac Railway        Baa3/BBB-   $500mm      10y           T+275
Canadian Pac Railway        Baa3/BBB-   $                 30y           T+300
DTE Energy-$25                Baa3/BBB-   $150mm       50NC5      6.50%

The DTE's are junior subordinated debt ($25 par)where interest can be deferred for up to 20 quarters and callable at par in 2016.

You look at the spreads on the two energy companies and you realize that there is risk beyond their regulated subs (NFG does own timberlands). 

Breadth wasn't all that impressive in the credit markets today as Ig was decidedly negative, HY was almost flat and converts positive on small volume:

 

bottom line - don't like risk here.  The deals brought today are interesting and have decent risk premiums, but I don't see out-performance here.

Bond Market Monday - We Have Learned NOTHING!

As today's tile might suggest, I am thoroughly dismayed at the complete ineptitude our (yes, I am obviously from the states) elected officials are displaying.

(NY Times) Leaders of the Congressional committee charged with finding at least $1.2 trillion in deficit reductions conceded on Monday that panel members had failed, setting up what is likely to be a yearlong political fight over the automatic cuts to a broad range of military and domestic programs that would go into effect starting in 2013 as a result of their inability to reach a deal.  In a statement, the panel’s leaders, Representative Jeb Hensarling, Republican of Texas, and Senator Patty Murray, Democrat of Washington, said, “After months of hard work and intense deliberations, we have come to the conclusion today that it will not be possible to make any bipartisan agreement available to the public before the committee’s deadline.”

Really?  Imagine if you will a world in which these same officials could read the paper:

(WSJ) A selloff in euro-zone bonds continued on Monday, as investors shrugged off the election of a fiscally conservative government in Spain and continued to clamor for bold action by European policy makers. A day after Spain's Popular Party won a sweeping victory over the ruling Socialists in the general election, Spanish borrowing costs approached their highest levels since the European debt crisis began. Italy's 10-year yield continued to rise, as did yields for Portugal, Ireland and Greece. The yields on the highest-rated European bonds also pushed upward, with the Netherlands, Austria, Finland and France all rising.  The German government repeated its view on Monday that the euro-zone crisis was caused by a lack of fiscal discipline and economic competitiveness in some nations on the euro periphery—and that the solution therefore lies in overhauls in those countries, not in ECB bond buying or collective European debt issuance.

Sound familiar?  The US government seems focused on going down the same failed road as pressured European countries.  I guess its a good thing our GDP is much bigger and our printing presses are even bigger than that!  The US is rapidly going from the "last best hope" to the "least worst refuge".  Its only a hop, skip and stumble away from "Treasuries, yeah they used to be safe".  Imagine what the rating agencies might rate US debt if they weren't under scrutiny from the government - do you really want to downgrade the country that regulates you and is investigating you?  No sir, not me.

Standard & Poor's Ratings Services said its ratings on U.S. sovereign debt wouldn't change because of federal lawmakers' latest failure to reach a budget deal--as long as Congress continues to follow the rules it set in August.The short statement came after a congressional deficit-reduction committee tasked with slashing the U.S. budget gap failed to reach an agreement, a move that triggers mandatory cuts to military spending and some social programs starting in 2013.S&P still rates the U.S. at double-A-plus, the second-highest possible rating, and has a negative outlook on the debt. The credit-ratings service shook markets in August when it downgraded the country's then-sterling credit status, citing political gridlock that was hindering lawmakers' ability to significantly reduce deficits

Moody's Investors Service confirmed Monday its triple-A rating on the U.S., saying that the failure of the congressional supercommittee to reach a deficit-reduction agreement isn't decisive, according to a company representative."The rating for the U.S. government is Aaa with a negative outlook," the rating company said."As Moody's stated on Nov. 1, the deliberations of the Joint Select Committee would be informative for the rating analysis but not decisive, and failure to reach an agreement would not by itself lead to a rating change for the U.S. government," Moody's said Monday.

It's almost laughable.


In any event, here we are.  "Risk free" had a good day being the global safe haven.  Curve flattened a bit as buyers bid the long end.

Credit markets were somewhat silent as the holiday shortened week is not known for issuance - even at these lower absolute rates.  CDX IG was out 3bps, cash was weaker and thin.  CDX HY down a buck change to $88.75.  Financials continued to take it on the chin - out 5-30bps in the 5yr.  BAC and Goldie taking it the hardest - out around 30bps.  We are starting to see some interesting trading/swap opportunities in some of the financial names as you can shorten and pick (at the same level in the cap structure to boot).  MS is just one example here.  If you are going to own financials, optimize your positions (well, you should always be doing this, but.....)!

Volume in credit was lower and negative, reflected in today's Trace data:

Morgan Stanley printing all over the most actives with Jefferies absent (was one of the most active in convert space).   Compiling data and details on the Jefferies complex, not sure whether to post here or to my SeekingAlpha slot.  Got thoughts - hit me with them.

Sorry for the brief commentary, this guy is tired.  Lets see what happens tomorrow.  Reading that S&P futures are stronger overseas.

Later.

Europe - Nighttime in the Switching Yard

Once again (or better yet, still) all eyes are focused on Europe.  My take:



Europe's financial situation (sovereign and banks) is a trainwreck.  There is no solution for the situation.  It is too big, resources are too thin and political/economic idealogies are to far apart.

This morning the Daily Telegraph released a document sourced from the German government with suggestions for an EU treaty change.  Contained within it:

The establishment of a procedure for an orderly default as part of the ESM:

For member states that are covered by an ESM programme, but despite complying with it are unable to achieve debt sustainability, the possibility of budgetary interventions is not sufficient. Therefore, there must also be the option of an orderly default in order to reduce the burden on taxpayers ( in the other eurozone states), and also to provide the affected country with an opportunity for a fresh start.  In the present ESM Treaty the possible participation by private creditors through socalled "collective action clauses” (CACs) is not sufficient.

The ESM should consider the request made by a member state for relief loans against the criteria of debt sustainability. If this is negative, the affected member state would instead receive loans for a limited time only, during which the procedure for an orderly default would be prepared.

In order to make sovereign defaults possible where they are unavoidable, the threat of instability in the financial system resulting from such a default must be able to be credibly excluded. A plan to maintain the stability of the financial system in the event of an orderly default needs to be developed in close co-operation with European banking regulators. This would determine which banks would be restructured and/or recapitalised, which will necessitate the drawing up of Europewide rules on bank restructuring.

Document here:  s3.documentcloud.org/documents/267781/brusselsembed.pdf

Germany sees the writing on the wall - sovereign defaults and the recapitalization of the banks.  Prepare for the worst and hope for the best.  It is not time to enter the fray with value eyes for there is only a value trap waiting.  Liquidity is non-existant, buyers are gone and there is no plan.  Continue to avoid European issues.

November 17, 2011 Credit Market Recap

The tone in the fixed income markets today was one of de-risking as Spanish yields on the auction blew out.  Eurozone concerns continue to weigh heavy on the markets and the financial sector has been bearing the brunt of the smackdown.

The general tone in the credit market was somewhat negative as CDX NA IG/HY 17 were off a tad more than 1% with the indices adding 1.7 and 12.6 bps respectively.  European CDX fared slightly better with the series 16 shaving 5bps off the index.

Source: Markit

Breadth in the market was negative (as one would expect given the magnitude of financial issues)

FIG issuers have been body slammed by the turmoil with JEF (and brokers) leading the way:

The above chart is JEF 6.875% '21.  Closed out at $78 for a 10.6% yield (the 5.125 '18 are $78.25 9.8% and the 8.50 '19s are $86.25 11.2%).  I find this to be somewhat interesting.  Obviously these maturities are further out and should they come out of this situation, the bonds will perform well.  With this in mind, we buy the lowest cost exposure - the '21s.  Ahhhhh, but what do some of us who got kicked in the teeth in '08 remember?  FINANCIALS ARE BINARY!  They are good or not.  The equity continues to trade down after hours hitting fresh two year lows.  That said, this is a situation that warrants further investigation for value players (like myself).

And Morgan Stanley....well MS has never fully recovered from "the crisis" and gets taken to the woodshed faster than the rest.  See MS '21s closing +525 (remember a scant month ago the re-opened this baby at +335) out 50bps.   Ouch.   Goldie fared little better with GS '21s 425/15 out 35bps.


The new issue market was somewhat robust with approximately $5B in deals announced.

Personally, I have liked LLL in the defense space and think it warrants consideration in the 5yr.

Yield Pain in Spain

Ay, que es un alto rendimiento

The Spanish Treasury Thursday paid the highest yield on a 10-year government bond at auction since the inception of the euro but garnered enough demand to sell EUR3.563 billion of the bonds (the plan was EUR4 bil). The maximum yield paid for the 10-year bond, which matures January 2022, was 7.088%, a euro-era high.

Initial Claims 11-17 - My 2 Cents

From the initial claims release this morning:

In the week ending November 12, the advance figure for seasonally adjusted initial claims was 388,000, a decrease of 5,000 from the previous week's revised figure of 393,000. The 4-week moving average was 396,750, a decrease of 4,000 from the previous week's revised average of 400,750.

The advance number of actual initial claims under state programs, unadjusted, totaled 360,139 in the week ending November 12, a decrease of 42,355 from the previous week. There were 409,548 initial claims in the comparable week in 2010.

States reported 2,935,466 persons claiming EUC (Emergency Unemployment Compensation) benefits for the week ending October 29, a decrease of 18,358 from the prior week. There were 3,961,485 claimants in the comparable week in 2010. EUC weekly claims include first, second, third, and fourth tier activity.

We seem to be getting some traction in reducing the number of initial claims, which should begin to help prop up employment figures.  While not an out of the park number, it is a decent sign - especially when combined with the reduction in EUC and EB.



Now we have to make a more meaningful impact on the continuing claims series.



All in all, I think this should be taken as a modestly positive sign for the US economy.  Absent the problems in Europe, Treasuriy prices should drift lower (higher yields) given the firming employment picture.  Unfortunately, we can't invest "absent the turmoil in Europe" so it is still too early to set a short in UST.  This may, however, reinforce the premise that corporate America is solid credit iis still a decent play (the equity market is dictated by the European whack-a-mole).

November 16, 2011 Corporate Bond Issuance

Corporate issuance slowed today from its breakneck pace.

I personally think there is some value remaining in corporates as the credit risk premium is still attractive (not fat and juicy attractive, but attractive nonetheless).

November 16 Market Review

Another day of the "de-risking" trade.  Anyone else getting tired of the "Europe has a plan!", "Europe has no plan" volatility.  Lets cut straight to the point - there is no possible plan!  Brushing aside for the moment the constitutional crisis enveloping the continent, what we have is a downward spiraling ecosystem.  Debt piled on when times were good (and a haughty wink-wink, nod-nod by the EU regarding debt levels) turned to lead as the system slowed.  In order to tame the beast, austerity measures are bantered about which are growth killers (not to mention they get in the way of the mountain of entitlements the populace is used to) and result in higher relative debt/GDP ratios for the foreseeable future.  The populace chokes, governments collapse and the sovereign crisis continues.  Then comes the good part - the crisis spreads (probably a poor choice of words, I will admit) to the banking sector (poor choice because it has always been in the banking sector as well) which compounds the problem, further retards growth and ushers in a "new 2008" crisis.  Good stuff, no?  Yeah, just wait until we address the capital shenanigans the Eurobanks like to play with risk, risk models and risk management (recall what AIGFP was used for - removing capital hogs from Eurobank balance sheets).

In any event, enough of my discourse, what the hell did we see out there today:

Equities:

After grinding back up from an out of the gate drop, Fitch come out with a report on US banks and their exposure to Europe.  Some snippets:

Contagion Effects Potentially Large: U.S. banks could be greatly affected if contagion continues to spread beyond the stressed European markets (Greece, Ireland, Italy, Portugal, and Spain). Exposures to large European countries and banks are sizable. The ongoing economic and market effects are additional concerns. The crisis has been negatively affecting European credit profiles and has resulted in numerous rating actions recently.

Report here:  11-16 Fitch

Net exposure.  Gotta love it.  Ummmm, what happens when exchanges are voluntary and 50% of your holding is wiped out without triggering your insurance policy....  Yup, net is gross.  Honestly, is this news?

Gundlach on Corporates

Interesting article on Bloomberg:

Gundlach Has No Europe Bets, Likes Corporates

Excerpts:

Jeffrey Gundlach’s DoubleLine Capital LP is invested only in U.S. dollar-denominated assets in a bid to avoid losses stemming from Europe’s debt crisis.

“All of our international exposure is in dollars,” Gundlach, the founder and head of Los Angeles-based DoubleLine, said at a panel sponsored by the firm in New York today. “There’s a big loss in Europe and all we want to do as investors is make sure as best we can that we’re not the ones taking the loss. How do you do it? No investments in Europe.”

DoubleLine is also avoiding U.S. banks because of possible exposure to the crisis and favors investment-grade corporate debt because defaults may rise in lower-rated bonds next year. Gundlach, who managed the top-rated intermediate-term U.S. bond mutual fund for 15 years, began cutting exposure to junk bonds in the fourth quarter of 2010, even as Bank of America Corp. and Goldman Sachs Group Inc. strategists forecast the riskiest debt to return as much as 10 percent this year.

“Investment-grade corporate bonds have done very well,” said Gundlach, who has attracted $17 billion in assets since founding DoubleLine in December 2009. “The investment-grade bonds DoubleLine holds had a bad August with all risk assets, but prices are nearing their highs. It’s a totally different story in below investment-grade, where we see the market really has collapsed.”

“I like junk bonds a lot better than I did six months ago, but I am not ready to buy them yet,” he said. “The high yield bond market is going to have a default problem in late 2012 or 2013.”

Moody’s Investors Service forecast the speculative-grade default rate will “remain low” at 2.2 percent a year from now, compared with 2.1 percent in August, according to a Sept. 22 statement. That compares with a peak of 14.5 percent amid the credit crisis in November 2009.

“We’re not going to be ready to jump back in to high yield basically until Greece is solved,” said Bonnie Baha, head of DoubleLine’s global developed credit group.

Full article can be found here: Gundlach - Bonds

While I believe that the economy isn't as rosy as statistics might show, I do not expect defaults (ex-sovereign) to increase significantly and corporate balance sheets are in decent shape (although they could begin to erode should equity prices remain at current levels or go lower as the WACC will be reduced be the issuance of debt) which should help protect against a spike in defaults.

I also believe that the European issues (no, not just Greece which is the tip of the iceberg) present investors with some opportunities as the babies are going out with the bathwater.

In my opinion, 6B and 5B corporate debt is still attractive at these levels (relative spreads as they are the indication of a risk premium relative to the risk-free rate) and continues to warrant an overweight position.  There has also been some interesting preferred stock and "baby bond" issues lately that offer attractive yields.

Happy Wednesday.

Mike

Corporate Issuance Update

Busy couple of days on the new issue front as issuers look to take advantage of lower benchmark yields.  Yesterdays issuance consisted of:

Time Warner Cable (Baa2/BBB) - $1B 10yr, $1.25B 30yr.  +210/232 respectively
Heinz (baa2/BBB+) - $300MM 5yr, $400MM 10yr.  +110/125 respectively
Schlumberger Norge (A1/A+) $500MM 5yr +108
Schlumberger Lux (A1/A+) $600MM 5yr, $1.6B 10yr.  +108/130 respectively
Wisc Elec (A2/A) $300MM 10yr +105
Daimler Finance (A3/BBB+) $800MM 3y, $1.5B 5y, $750MM 10y.  +165/185/195 respectively
Xcel Energy (Baa1/BBB+) $250MM 30yr +150
France Telecom (A3/A) $1B 5yr, $1B 10yr.  +195/220 respectively
Pac Gas (A3/BBB+) $250MM 10yr +130

Would expect issuers to continue to step in at these levels.  While absolute yields are low, corporate spreads are still attractive relative to alternatives - especially given the current strength of corporate balance sheets and the risk premium relative to absolute yields.

WTO to China - They're not THAT Rare!

On the wire (NYT):

BRUSSELS — In a dispute that highlights growing tension between China and its Western trading partners, the World Trade Organization ruled Tuesday that Beijing violated global rules by restricting exports of nine raw materials used in the manufacturing of high technology products.

The case, lodged by the United States, the European Union and Mexico, dates from 2009 and underlines the anxiety in the West about the way China is consolidating its trading dominance.

Significantly, the ruling strengthens other European arguments against Chinese restrictions on another category of exports — rare earths, 17 minerals also used in the high-tech industry. However the case also demonstrates how dependent technology industries have become on some exports from China.

The W.T.O. panel rejected China’s argument that its restrictions were motivated by a desire to protect the environment and prevent a critical shortage of the materials.

The decision on Tuesday concluded that Chinese quotas, export duties and license requirements put in place a discriminatory system for the sale overseas of industrial raw materials widely used in the steel, aluminum and chemicals industries, including coke, zinc and bauxite.

“This is a clear verdict for open trade and fair access to raw material,” Karel De Gucht, the European trade commissioner, said in a statement. “ Furthermore, in the light of this result, China should ensure free and fair access to rare earth supplies,” he added.

The E.U. quota of Chinese raw earth elements declined to 30,000 tons in 2010 from around 50,000 tons in 2009, according to an E.U. official who was not authorized to speak publicly.

The U.S. trade representative, Ron Kirk, called the W.T.O. decision on the raw materials “a significant victory for manufacturers and workers in the United States and the rest of the world.”

“China’s extensive use of export restraints for protectionist economic gain is deeply troubling,” Mr. Kirk added in a statement. “China’s policies provide substantial competitive advantages for downstream Chinese industries at the expense of non-Chinese users of these materials. They have also caused massive distortions and harmful disruptions in supply chains throughout the global marketplace”

Americans and Europeans had challenged China’s environmental protection argument by pointing out that the raw material consumption was not being controlled domestically.

China must now either appeal the ruling or comply with it. If it fails to do so the United States, Europe and Mexico could eventually be allowed to respond with equivalent trade sanctions.

In a statement issued by its mission to the W.T.O. in Geneva, China said “that although these measures have certain impact on domestic and international users, they are in line with the objective of sustainable development promoted by the W.T.O. and they help to induce the resource industry toward healthy development.”

The nine raw materials covered by the ruling on Tuesday are used in medicines, CDs, electronics, the automotive industry, ceramics, refrigerators and batteries among other products.

Of all the E.U. imports of some categories of magnesium, 95 percent are sourced in China, as is 91 percent of imports of some categories of manganese while almost 30 percent of E.U. phosphorous imports are Chinese.

European officials say the export restrictions increased the global price for the raw materials, and gave Chinese companies a clear commercial advantage which, in effect, constitutes a hidden subsidy. They also made it harder for non-Chinese companies to source the raw materials by making them less readily available on the global market.

The impact can be to increase the price of some products by as much as 100 percent, according to E.U. officials.

The ruling was welcomed by BusinessEurope, the lobbying group. “The W.T.O. panel decision clearly stipulates that almost all export duties and restrictions imposed by China are incompatible with W.T.O. rules,” it said in a statement. “If confirmed, this decision will require China to remove all unjustified restrictive measures on raw materials.”

Certainly won't help the price of rare earth (not raw earth as stated in the article) companies which have been getting whacked over the last few sessions.  That said, I will believe it when I see it.

The EU - Part Problem Part Solution - Or Just FUBAR?

And you seriously thought it was getting better?

Moody's Investors Service has today downgraded Portugal's long-term government bond ratings to Ba2 from Baa1 and assigned a negative outlook. Concurrently, Moody's has also downgraded the government's short-term debt rating to (P) Not-Prime from (P) Prime-2. Today's rating action concludes the review of Portugal's ratings initiated on 5 April 2011.

The following drivers prompted Moody's decision to downgrade and assign a negative outlook:

1. The growing risk that Portugal will require a second round of official financing before it can return to the private market, and the increasing possibility that private sector creditor participation will be required as a pre-condition.

2. Heightened concerns that Portugal will not be able to fully achieve the deficit reduction and debt stabilisation targets set out in its loan agreement with the European Union (EU) and International Monetary Fund (IMF) due to the formidable challenges the country is facing in reducing spending, increasing tax compliance, achieving economic growth and supporting the banking system.

RATINGS RATIONALE

The first driver informing today's downgrade of Portugal's sovereign rating is the increasing probability that Portugal will not be able to borrow at sustainable rates in the capital markets in the second half of 2013 and for some time thereafter. Such a scenario would necessitate further rounds of official financing, and this may require the participation of existing investors in proportion to the size of their holdings of debt that will become due.

Moody's notes that European policymakers have grown increasingly concerned about the shifting of Greek debt held by private investors onto the balance sheets of the official sector. Should a Greek restructuring become necessary at some future date, a shift from private to public financing would imply that an increasingly large share of the cost would need to be borne by public sector creditors. To offset this risk, some policymakers have proposed that private sector participation should be a precondition for additional rounds of official lending to Greece.

Although Portugal's Ba2 rating indicates a much lower risk of restructuring than Greece's Caa1 rating, the EU's evolving approach to providing official support is an important factor for Portugal because it implies a rising risk that private sector participation could become a precondition for additional rounds of official lending to Portugal in the future as well. This development is significant not only because it increases the economic risks facing current investors, but also because it may discourage new private sector lending going forward and reduce the likelihood that Portugal will soon be able to regain market access on sustainable terms.

The second driver of today's rating action is Moody's concern that Portugal will not achieve the deficit reduction target -- to 3% by 2013 from 9.1% last year as projected in the EU-IMF programme -- due to the formidable challenges the country is facing in reducing spending, increasing tax compliance, achieving economic growth and supporting the banking system. As a result, the country may be unable to stabilise its debt/GDP ratio by 2013.

In other words, as the EU is increasingly looking for the private sector to share in the pain, we are going to help make sure it happens.  Over?  Not by a long shot.  Better?  No, but the direction is becoming clearer.

Greece - Balance Sheet is Unsustainable

In the news:

(Reuters) - Long-term investors standing aloof from the Greek debt crisis want holders of its government bonds to take a loss big enough to slash the country's debt to sustainable levels before they consider returning.

Greece is still expected to default at some point and for most investors who have dumped bonds over the past two years and who are crucial to put the ailing economy back on its feet, the longer that is delayed, the longer it will be before they consider looking at Greek assets again.

A likely second bailout -- currently under tortuous negotiation -- is seen only as a means to buy time for euro zone banks to provision for eventual losses and protect the bloc's larger economies from contamination, while the reforms attached to the package will be hard to implement in the face of deepening public resentment.

 Friends, Greece is not viable without a major restructuring of its debt.  Tax collections are laughable, tourism can only get you so far (see tax collections) and olives grow elsewhere.  This country cannot support the debt it has, will not support the debt its and any temporary fix is just that - temporary.  Debt needs to be almost halved in order for the country to make a go of it.  Propping up European banks and trying to keep the problem localized is not a strategy nor a solution.  Sometimes it just makes sense to mail the keys back.

Yasou!

New Issue Hype - Buyside Gets the Pipe

On the tape (Reuters):

LONDON, July 5 (IFR) - Rising disquiet over new issue bond market practices has prompted a rethink among debt syndicate officials regarding the processes they employ and the manner in which they transmit information to investors, bankers said.     Underwriters have been discussing ways to fairly provide investors with information on price and the size of order books.     So-called price whispers, where dealers float a level with a small group of investors could be a thing of the past, for instance.     Another practice that is about to change is regular updates on the size of order books and the controversial, some would say cavalier, use of internal tickets to inflate the magnitude of investor interest. 

Investors routinely overstate their true interest in order to receive a larger allocation of bonds at pricing.     "I think both sides need to be careful. The world has changed - all the clients we deal with are trying to operate higher standards," said the syndicate official.

 This has been the buy/sell side conundrum forever.  If the deal looks hot (and you know it was -as it always is - pre-shopped to the big guys) you have to double or triple what you want to end up with.  Then, god forbid, it falls apart you end up with an over allocation.  The street knows the chronic padders, but this crap inflates the book to monstrous proportions.  I can't think of a way around this.  Blame it on the street for hyping, blame it on the buyside for padding - whatever.  This is the way it is.  It also allows the street to reduce pricing due to demand and see how many people drop from a deal or increase the size of the deal to meet demand.  Accrues to the issuers benefit either way.  Who wins:  street gets underwriting commission and follow on trades, issuer gets lower rates and more money, and the buyside?  Well, someone has to be left holding the bag.

USA - CDS Spreads Higher than Mexico

Bloomberg:

Trading of credit-default swaps insuring U.S. Treasuries has doubled as the government struggles to agree on plans to cut its budget deficitand raise the $14.3 trillion national debt limit.

A total of 819 contracts covering a net notional $4 billion of debt were outstanding as of May 20, up from 449 contracts covering $2 billion a year ago, according to the Depository Trust & Clearing Corp. Average daily trading volume surged to $490 million last week from $10 million the week before, making the U.S. the fourth most active among 1,000 contracts tracked by DTCC, up from 633rd.

Swaps insuring Treasuries for five years are trading at 50 basis points, according to CMA. That compares with 37 basis points in April and a record 100 basis points at the peak of the financial crisis in 2009. One-year contracts are now more expensive than Panama, the Philippines and Mexico, CMA prices show.

Anyone else see the humor here?

More of the Same Change - The Patriot Act Lives

So much for change.


Congress on Thursday passed a four-year extension of post-Sept. 11 powers to search records and conduct roving wiretaps in pursuit of terrorists. Votes taken in rapid succession in the Senate and House came after lawmakers rejected attempts to temper the law enforcement powers to ensure that individual liberties are not abused.



The measure would add four years to the legal life of roving wiretaps — those authorized for a person rather than a communications line or device — of court-ordered searches of business records and of surveillance of non-American "lone wolf" suspects without confirmed ties to terrorist groups.


The roving wiretaps and access to business records are small parts of the USA Patriot Act enacted after the Sept. 11, 2001, attacks. But unlike most of the act, which is permanent law, those provisions must be renewed periodically because of concerns that they could be used to violate privacy rights. The same applies to the "lone wolf" provision, which was part of a 2004 intelligence law.


And Harry Reid:  "If the senator from Kentucky refuses to relent," Reid said, "that would increase the risk of a retaliatory terrorist strike against the homeland and hamper our ability to deal a truly fatal blow to al-Qaida."   Remember the foaming at the mouth when the act became law?  So much for that.


Sleep well America, you are being watched by Big Brother.  Emperor O.

Greece - Ouzo and Uh-Oh, Restructuring Lite

Greece continues to find ways to avert a default/restructuring of its debt. The problem here is that the austerity measures are not enough, there aren't enough assets to privatize (at fire sale prices) and the country just cant get its act together.

(NYT) Despite pressure from lenders for Greece to show a unified front in solving its debt crisis, Prime Minister George Papandreou had little apparent success Tuesday in persuading his political rivals to back additional tax increases and spending cuts. The ruling Socialists have a comfortable six-seat majority in the 300-seat Parliament and should be able to pass the measures without the support of the opposition. But Greece’s creditors have been pressing Mr. Papandreou to seek consensus for the deeply unpopular reforms before presenting them to a Greek public weary of a year of austerity, arguing that some degree of political consensus would make implementation easier. - New Democracy, a resolute "NO", Communists "NO", Popular Orthodox Rally "Unclear" (the Fed would be proud of their “We say no to indefinite consensus but yes to joint responsibility,”  Consensus?  Not happening.

And of course the many faces of the Eurozone and various lenders also throws confusion into the ring:

OECD head Angel Gurria said in an interview published on Tuesday that rescheduling Greece's debt would not be a bad idea as it would be the lesser of two evils, with many fearing the country could default. "The decision to move toward a rescheduling of Greek debt doesn't seem like a bad one to me," Gurria was quoted as saying in daily Le Figaro when asked whether Greece should restructure its huge debt. "It gives Greece time to digest its adjustment measures. For markets, allowing a delay in repayment is a lesser evil which does not imply a reduction in the principal," said Gurria, secretary general of the Paris-based Organization for Economic Co-operation and Development. Is this not still a default?????  Article here: OECD on Greek Debt

Hold it, stop the presses - note the word allowing?  From Citi:

“It is certainly possible to envisage forms of restructuring which fail to trigger CDS, but we are doubtful that they will be employed in practice,” said Michael Hampden- Turner, a strategist at Citigroup in London. “We suspect that European and ECB policy makers will duck the hard decisions.”

European officials are trying to avoid tripping swaps, with French Finance Minister Christine Lagarde saying this week that “anything that would constitute a credit event, is for me off the table.” Speculation is increasing that a restructuring of Greek bonds may be possible without meeting the International Swaps & Derivatives Association’s definitions of such an event.

That could be avoided if changes are voluntary rather than binding,Hampden-Turner said. But even a voluntary restructuring, or “reprofiling” as officials are calling a possible maturity extension, might still trigger the contracts, he said. 

Back to the show:

(Reuters) Dutch Finance Minister Jan Kees de Jager was quoted as saying by the paper that reprofiling of Greece's debt is a "serious option" but only as a possible final piece in a "total package."  De Jager said Greece should first fulfill its promises over reforms, but he also argued for a form of reprofiling in which private investors would remain involved to avoid the necessity for a 'credit event' (sounds like a credit event to me, just saying), the paper cited him as saying.  This could take place via a voluntary extension of the debt maturities by a maximum of three years, the paper said.The Dutch newspaper also said euro zone countries are considering a suggestion from De Jager to take the privatization process of Greek assets out of the hands of the Greek government and to hand it over to an independent organization.  Article here: Kees de Jager on Greek Debt

Moodys weighed in:

"A Greek default would be highly destabilizing and would have implications for the creditworthiness of issuers across Europe," Alastair Wilson said in a telephone interview. "This would result in more highly polarized credit worthiness and ratings among euro zone sovereigns, with the stronger countries retaining very high ratings and the weaker countries struggling to remain in investment grade." Wilson said that the focus after any Greek default would be on Portugal and Ireland, who have also agreed bailouts with the EU and the IMF. Asked if Portugal and Ireland would be at risk of falling into junk territory in case of a Greek default, he said: "Potentially yes ... If there were to be a Greek default there could potentially be multi-notch downgrades to the weakest sovereigns." He said Spain, Italy and Belgium were not in the same category as Portugal and Ireland but would also come under significant market pressure and could face rating downgrades.

Bottom line:  Initial thoughts seem to be pointing to a "voluntary" extension so as not to trip CDS.  Should this be the case, Greek 10 yrs in the low $50s might make sense.  If this is a precursor to  a haircut (CDS triggered), bonds are not as attractive.  Either way, Greek banks are hosed.

Rare Earth Processing - A Primer

I just wrote a piece on my rare earth thesis on Seeking Alpha, and thought I would put a primer on the processing of rare earths on the blog, so here it is (from Kidela Capital):


Cell phones, iPods, LCD screens, hybrid cars just some of the many devices containing Rare Earths that we’ve come to rely on in this green information age. While there’s a growing awareness of the importance of Rare Earths in these new technologies, the same can’t be said for the illusive question of just how Rare Earth Elements end up in these products. Mining REs is relatively simple but producing individual elements from the ore is tremendously difficult. Rare Earth processing often requires dozens of procedures each resulting in minute changes in the complex RE stream.

Separating and extracting a single Rare Earth Element especially one of the Heavy Rare Earths takes a great deal of time, effort and expertise. Not to mention money processing facilities cost hundreds of millions of dollars to build. It’s something to think about, next time you text a friend or take your Prius out for a spin. But wrapping one’s head around the vast array of separation and extraction techniques for REEs is far easier said than done. It’s terribly complex and there just isn’t much information out there. For your benefit, here’s a basic primer on RE processing.

1. Milling
After rocks containing REEs are removed from the ground, they go to a facility where the valuable mineral material in the ore is separated from impurities. This process is known as milling or beneficiation. Here’s how it works: The mined ore is crushed into gravel, which in turn is ground up into progressively smaller particles.

These particles are sifted and sorted by such means as flotation and electromagnetic separation to extract usable material and set the waste products called tailings aside. This milling process is usually carried at or near the mine site with the tailings stored in special facilities built to rigorous engineering and environmental standards.

For scarce resources like Heavy Rare Earths, this beneficiation process could be considered critical because it takes advantage of every scrap of material available. This practice can also make a marginal mining facility more practical than it might otherwise be and may in fact be used to extract ore from a facility previously believed to be exhausted.

2. Electromagnetic Separation
This milling method uses magnetic principals to separate Rare Earth bearing minerals from other materials in the mined ore. Monazite along with bastnaesite the primary commercial source of REs mined around the world is highly magnetic, meaning it can be separated from non magnetic impurities in the ore through repeated electromagnetic separation.

This technique uses a magnetic separator device that consists of a belt moving on two rollers, one of which contains strong magnets. When powdered ore is dropped onto the belt, magnetic and non magnetic particles within the ore will fall away differently from the magnetic roller.

3. Flotation Process
This is another beneficiation method that’s used to separate bastnaesite from other minerals. First, the ore is ground into a fine powder and added to liquids in flotation tanks. Chemicals are added to cause impurities to settle out and air is pumped in to create air bubbles. The finer bastnaesite particles stick to the bubbles which rise to the top and form a froth that is then skimmed off.

4. Gravity Concentration
Although they are commonly used in the gold industry, devices called Falcon Concentrators are also used in Rare Earth extraction at the milling stage. These concentrators contain rotating cones or bowls that are spun at high speed to generate a gravitational or centrifugal force which acts to separate small particles by exploiting minute differences in density and specific gravity between the valuable minerals and waste products.

Compared to other beneficiation technologies, gravitational separation offers lower installed and operating costs. It also tends to also have less environmental impact as gravity concentration does not require the use of chemicals. All of these milling processes produce mineral concentrates that contain a substantially higher proportion of REs. But there’s still much work to be done to separate the concentrate into its constituent REEs and this is why things start to get really tricky.

5. Hydrometallurgy
As the generations of scientists who have tackled the problem can attest, isolating REs safely and effectively is not only a very long and costly exercise but extremely complicated. The complex separation and extraction techniques in use today like ion exchange and solvent extraction are rooted in of a branch of geologic science known as hydrometallurgy.

In hydrometallurgy, mineral concentrates are separated into usable oxides and metals through liquid processes, including leaching, extraction and precipitation. By these means, the elements are dissolved and purified into leach solutions. The RE metal or one of its pure compounds is then precipitated from the leach solution by chemical or electrolytic means.

Although hydrometallurgy originated in the 16th century, its principal development took place in the 20th century. The development of ion exchange, solvent extraction and other processes now permits more than 70 metallic elements to be produced by hydro metallurgy including the REEs. Here is a run down on some of these techniques.

6. Fractional crystallization
Devised by British chemist Charles James in the early 1900s, fractional crystallization is based on differences in solubility. In this process, a mixture of two or more substances in solution is allowed to crystallize either through evaporation or by a changing the temperature of the solution. This precipitate will contain more of the least soluble substance. The process is repeated until purer forms of the desired substance are eventually attained.

Like all early extraction techniques, fractional crystallization is very slow and tedious. James found that an enormous number of stages of crystallization were required to get the high purity of individual REEs. Despite these constraints, James’ methods were widely adopted by other chemists. Fractional crystallization continued to be considered be the best technique of separating REEs until the discovery of ion exchange technology in the 1940s.

7. Ion Exchange
The ion exchange method was first used during Second World War as a way to separate fission products obtained from nuclear reactors. In this process, a solution containing a RE mixture is filtered through minerals called zeolites or through synthetic resins that act as zeolites. Zeolites exchange ions in the ion exchange process, zeolite ions are added to the solution and RE ions bind tightly to the zeolites.

Various solutions are then used to wash out elements one at a time. Each is then mixed with acid to create an oxalate compound and then heated to form the usable oxide. These oxides which are a mixture of various REEs and oxygen are now ready to be broken down into their constituent elements albeit through yet more complicated processing steps that we’ll talk more about later.

8. Solvent Extraction
The process of solvent extraction uses chemical agents to break down the components within a substance. Those materials which more soluble or react more readily to a particular acid or base get separated from the rest. The separated materials are then removed, and the process begins all over again with the introduction of more chemicals to leach out more components.

When it comes to Rare Earths, these steps need to be repeated again, again and again sometimes hundreds of times, depending on which REE you’re trying to produce. The solvent extraction method used today to separate REEs relies on the slightly different solubility of rare earth compounds between two liquids that do not dissolve in each other.

Because the Rare Earths are all so close to each other in terms of atomic weight, chemical separation methods require multiple stages to complete the extraction process. One stream in this process often takes hundreds of steps, involving a cascade of dozens of different tanks and machines for mixing, settling, filtering and evaporating all the various solutions. One advantage solvent extraction has over ion exchange is that it can be continuous a counter current system can be employed in which the many, many extraction steps are carried out in a continuous stream, progressively increasing the degree of separation until the substance in one phase in nearly pure.

9. Rare Earth Metals
These methods produce compounds like RE oxides, which have a growing number of useful applications today and as such can be considered end-products in the Rare Earth supply chain. However, demand is also growing for RE metals which means even more refining in the long hydro metallurgic process.

As is the case with every preceding step, it’s not easy turning chemical compounds into a single metal. Several techniques have evolved to meet the tremendous challenges associated with distilling Rare Earths down to their purest form. The primary types of metal recovery processes are electrolysis, gaseous reduction and precipitation. A common technique for REEs is metallothermic reduction which uses heat and chemicals to yield metal from RE oxides. In this process, the oxides are dispersed in a molten, calcium chloride bath along with sodium metal. The sodium reacts with the calcium chloride to produce calcium metal which reduces the oxides to RE metals.

Calcinations is an extraction technique that also employs thermal principles. In this instance, ovens and other devices like induction furnaces and arc furnaces are used to heat up substances to the point where volatile, chemically combined components like carbon dioxide are driven off. Another extraction technique is sorption, in which one substance takes up or holds another. It is actually a combination of the two processes absorption, in which a substance diffuses into a liquid or solid to form a solution, and adsorption, in which a gas or liquid accumulates on the surface of another substance to form a molecular or atomic film.

(Sourced from www.proactiveinvestors.com.au)

Portugal Investigating Rating Agencies

Via AP:

LISBON, Portugal -- Portuguese authorities have opened a criminal inquiry into three international credit rating agencies following a complaint, the Attorney General's office said Monday.

The inquiry is based on a complaint filed last month by four Portuguese academics, an official with the Attorney General's office said on condition of anonymity, in keeping with departmental regulations.

The four economists claimed the agencies _ Moody's, Standard & Poor's and Fitch _ caused severe financial losses for Portugal and demanded to know whether they profited from the ratings.

They also complained that the agencies dominated the ratings market and want to know whether competition rules were broken.

The inquiry will determine whether there is evidence for charges to be brought. The official declined to provide further details because the investigation is confidential.

Are you kidding me?  You get downgraded then you begin your investigation?  Could the timing have anything to do with Greece, knowing you are next?  While the incompetence and non-competitive nature of the agencies is hardly debatable, this move reeks of rating pressure.

AIG - Creative Till the End

From the WSJ:

American International Group Inc. in recent weeks has sought to rally support among investors and credit-ratings firms for a controversial deal: the sale of securities backed by insurance policies on the lives of older people.There have been few offerings of these types of securities, which critics have called "death bonds," "blood pools" and "collateralized death obligations" because they pay off when the insured dies. And AIG's effort so far isn't panning out. Standard & Poor's recently declined to provide a rating, an essential step in selling such securities to most investors.AIG's push highlights the giant insurer's outsize role as an investor in the market, known as life settlements—a role that has largely gone unnoticed.The giant insurer's life-settlements portfolio totals about $18 billion in anticipated death benefits, according to the company's financial filings—or well over a third of the estimated $45 billion that has changed hands since the market revved up about a decade ago.
Under AIG's recent proposal to sell securities based on part of its portfolio, a subsidiary of its Chartis property-casualty unit would collateralize notes worth $900 million with 1,157 policies acquired since 2001. AIG would sell $250 million to outside investors, according to its marketing materials.

Chartis also has been involved with life settlements in another way. It has sold "lender protection" insurance to a finance firm that lends to people to help them pay premiums on multimillion-dollar life policies, according to a prospectus for a stock offering by Imperial Holdings Inc. earlier this year.Chartis sold the "lender protection" coverage to Imperial from 2008 through 2010. It came in handy for Imperial, because borrowers, who typically take out two-year loans, have defaulted on 490 of 513 loans covered by the insurance and so far maturing, according to another Imperial filing. If borrowers cannot sell their policies profitably in the secondary market, Imperial can turn to AIG.As of Dec. 31, AIG had made good on 479 claims, paying more than $177.8 million and getting the policies in exchange, the filing shows. Imperial declined to comment.

Yes, this is the same AIG that took the other side of just about every derivative conceivable and blew up in the process.  Some firms never learn - even when owned by the US government.  I have reviewed these investments historically - even a synthetic one based on demographics and samples - and the investment is unwieldy.  Lets not forget about the actuarial assumptions used when underwriting the policy, how many investors can replicate that on a pool of policies.  Once again, we will enter the pool characteristics and sample data investment approach - seeing how well it worked out with past investments.  


Go figure.

Citizenship in the Banana Republic Formerly Known as the United States

Found the following amusing:

President Barack Obama says most Americans are confident that he is American-born and bred and says the “birther” issue could be a problem for Republican challengers in the 2012 presidential campaign.
Obama addressed the persistent questions about his place of birth when he was invited, during an ABC News interview, to size up his potential opponents.
He was also asked his thoughts on Donald Trump’s rise to the top of the Republican field on “fantasies” about the president’s background.
Obama seemed amused.
“Over the past two-and-a-half years there’s been an effort to go at me in a way that is politically expedient in the short-term for Republicans — but creates, I think, a problem for them when they want to actually run in a general election where most people feel pretty confident the president was born where he says he was, in Hawaii,” Obama said.
“He doesn’t have horns,” he added, laughing.

Friends, with three theaters of military operations and the financial situation of our fiscal banana republic, this is what the president feels the need to address?  This is a political issue?  I personally don't care if he is an extraterrestrial, it is the downfall of the republic and the inability of the elected "leaders" (yes, holding back the laughter) to rectify these problems that concern me.  


The heat the rating agencies have been taking lately (well deserved, I might add) over CDOs, CLOs, mortgages etc. is nothing compared to their outright ineptitude shown by the United States AAA rating. 

Greece - Sandy Beaches and Distressed Debt

Ahhh Greece, founder of democracy, philosophical masters, land of nice beaches good food and pretty women. Oh yeah, lets not forget fiscal austerity that stands no chance, land of the tax dodger and possibly debt restructurer.  Just wait for this one.  Its not like the country has no experience being in default, problem now is that its banks as well as European banks are gonna get whacked.


Greek 10 Year-Bund spreads just passed 1,000 for the first time ever and were last trading north. Following this statement from Germany's Hoyer, it seems all hell is about to break loose for peripheral spreads.

• *GERMANY WOULD BACK VOLUNTARY GREEK RESTRUCTURING, HOYER SAYS
• *GREEK DEFICIT CUTTING MAY NOT BE ENOUGH, HOYER SAYS
• *GERMANY ‘WORRIED’ ABOUT GREEK FISCAL DEVELOPMENTS, HOYER SAYS
• *GREEK DEBT RESTRUCTURING `WOULD NOT BE A DISASTER,' HOYER SAYS
• *GERMAN EUROPE MINISTER HOYER SPEAKS IN INTERVIEW IN BERLIN

Rising Greek yields reflected disappointment that the government only presented the outline of fresh fiscal plans but left the details to be spelled out after Easter.

Don't think the Easter bunny is going to leave an egg the size of Wisconsin full of money folks.


It also outlined how it intends to raise 50 billion euros from privatisations by 2015, a target which many analysts and Greek politicians see as optimistic. It said it planned to promote real estate asset sales from October 2011.


How much for Rhodes?

Portugal - Periphery Pain Continues

AP:

Portugal managed to raise about euro1 billion ($1.4 billion) in a Treasury bill sale Wednesday but paid a high rate for the cash as it appears inevitable the debt-stressed country will soon need a massive bailout.

The government debt agency sold euro560 million in T-bills that mature in October and euro450 million in bills maturing in March next year.

But investors asked for high interest rates -- 5.11 percent and 5.9 percent -- to part with their money. In similar auctions last month, Portugal paid a rate of just under 3 percent on 6-month bills and 4.3 percent on 12-month bills.

But wait, it gets better:

Reuters:  Two business newspapers said the public social security fund has been selling overseas financial asets in the last few days to help finance the state by buying sovereign debt at auctions. 

Back to AP:  The president of the Portuguese Association of Banks, Antonio de Sousa, said substantial financial support is "urgent."  "The banks have no more credit left to give," he was quoted as saying Wednesday by national news agency Lusa. 

Bottom line:  Portugal has no government, its borrowing costs are soaring, banks are no longer willing buyers so the social security fund has had to step in to buy rapidly depreciating bonds.  Does this sound like it is going to end well? 


The good news:  Overseas investors willing to roll the dice at the Portugal table are getting fat yields and an appreciating currency:

Public Sector Unions - Is the End Near?

Reuters:

Ohio's legislature on Wednesday passed a Republican measure to curb the collective bargaining rights of about 350,000 state employees, and Governor John Kasich said he will sign it into law.

The bill, which also bans strikes by unions for public employees, was approved in the Ohio Senate late on Wednesday following its passage in the state House of Representatives earlier in the day.

The amended bill removed jail time as a possible penalty for workers who strike. But it is in some ways tougher on unions -- it prevents nonunion employees affected by contracts from paying fees to unions and makes it easier to decertify a union.

While Wisconsin has gained more national attention, Ohio is far more important to unions. It has the sixth largest number of public sector union members among all the 50 states, twice the number of Wisconsin. With many auto and steel and manufacturing plants, Ohio is also a union bellwether.

 Full story:  Reuters - Ohio Unions


And in Idaho:

Idaho's Republican governor on Thursday signed into law a measure that strips public school teachers of some major collective bargaining rights and does away with teacher tenure.

Butch Otter is the second governor to sign such a measure this year, after Wisconsin Governor Scott Walker signed legislation curbing that state's public workers union last Friday.

The Idaho law limits collective bargaining by the 12,000 teachers represented by the Idaho Education Association, the state teachers union, to salaries and benefits.

That means educators can no longer negotiate such issues as teacher workload and class sizes. It also does away with teacher tenure and limits contracts to one year.

This is a true movement going on.  I fully expect more states to follow.  AFSCME must be pulling out their hair. Ultimately, I believe that this will be good for public sector financials and strengthen the attractiveness of municipal bonds and BABs.

US Tops Equity Issuance

From Reuters comes an equity issuance story.  Given all the tension in the world, I am amazed at the markets appetite for new risk,

The United States drove global equity issuance in the first three months of the year, stealing Asia's crown, after a spate of blockbuster U.S. IPOs backed by private equity firms.

Despite a tumultuous final few weeks which saw unrest in the Middle East and a nuclear crisis in Japan rock worldwide stock markets, global equity issuance rose 12 percent to $189 billion in the first quarter, compared with the same period in 2010.

U.S. issuance accounted for $66.5 billion, or 35 percent, of the capital raised, according to Thomson Reuters data.

Asia in recent years has dominated equity fundraising. In the first quarter,China, excluding Hong Kong, was only the second most-active issuer, making up 15 percent of activity.

"What we are seeing is a decoupling, whereby the U.S. seems to be breaking out and surging ahead, leaving Europe in its wake," said Viswas Raghavan, head of international capital markets at JPMorgan Chase & Co in London.

"There seems to be greater confidence in the U.S. amid an emerging belief that the worst is behind them whereas in EMEA there are a lot of macro issues ... weighing on the market."

Four of the top 10 IPOs globally were the buyout-backed U.S. share floats of measurement firm Nielsen Holdings, Florida lender BankUnited Inc, pipeline company Kinder Morgan Inc and hospital operator HCA Holdings Inc. The U.S. also had large follow-on share sales by MetLife Inc and Fifth Third Bancorp

Private equity is monetizing their investments while the getting is good.  This should shorten the runway for exit strategies as long as the market remains accommodative. 

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