Archive for the ‘Fixed Income’ Category

Hedge Fund Pershing Square’s 1st Quarter 2012 Letter (Bill Ackman)

Monday, June 25th, 2012

Bill Ackman, legendary activist investor recently published its 1st quarter investment letter. The fund has performed strongly to date, with 9.3% returns and has large holdings in Canadian Pacific, General Growth Properties, Citigroup, and J.C. Penney. If he still owns them, the latter two companies may create some trouble for his firm in the future.

In this investor letter, Ackman discusses the idea of time arbitrage, which is taking advantage of forced sellers for the benefit of long term profit. This is because stocks are often more volatile than their underlying businesses, and few firms and individuals can stomach volatility.

He also discusses that private equity portfolio companies, because of their higher implied leverage, have much more volatile returns, but unfortunately, you do not see a mark-to-market as you do in publicly traded equities.

Enjoy the letter below:

Pershing-Square-Q1-2012


George Soros on European Fiscal & Banking Crisis and EU Summit on June 28-29, 2012

Monday, June 25th, 2012

Here I present key take-aways from George Soros’ in depth Bloomberg interview on the current European fiscal and banking crisis, Angela Merkel, the Spanish bailout, and Greece leaving the Eurozone.

The video is also below:

Banking & Fiscal Issues

  • “There is an interrelated problem of the banking system and the excessive risk premium on sovereign debt – they are Siamese twins, tied together and you have to tackle both.”
  • Soros summarizes the forthcoming Eurozone Summit ‘fiasco’ as fatal if the fiscal disagreements are not resolved in 3 days.
  • There is no union without a transfer.
  • Europe needs banking union.
    • Germany will only succumb if Italy and Spain really push it to the edge (Germany can live in the present situation; the others cannot)
    • Europe needs a fiscal means of strengthening growth through Treasury type entity
      • What is needed is a European fiscal authority that will be composed of the finance ministers, but would be in charge of the various rescue mechanisms, the European Stability Mechanism, and would combine issuing treasury bills.
        • Those treasury bills would yield 1% or less and that would be the relief that those countries need in order to finance their debt.
        • Bill would be sold on a competitive basis.
        • Right now there are something like over €700bn euros are kept on deposit at the European Central Bank earning a 0.25% because the interbank market has broken down, so then you have €700bn of capital that would be very happy to earn 0.75% instead of 0.25%, and the treasury bills by being truly riskless and guaranteed by the entire community, would yield in current conditions less than 1%.
        • Governments should start a European unemployment scheme, paid on a European level instead of national level.
        • Soros’ solutions, however, are unlikely to prove tenable in the short-term as he notes “Merkel has emerged as a strong leader”, but “unfortunately, she has been leading Europe in the wrong direction”.
          • “Euro bonds are not possible because Germany would not consider euro bonds until there is a political union, and it should come at the end of the process not at the beginning.
          • This would be a temporary measure, limited both in time and in size, and thereby it could be authorized according to the German constitution as long as the Bundestag approves it, so it could be legal under the German constitution and under the existing treaties.
          • The political will by Germany to put it into effect and that would create a level playing field so that Italy and Spain could actually refinance debt on reasonable terms.

Scenario Discussion

  • LTRO would be less effective now
  • At 6%, 7% of Italy’s GDP goes towards paying interest, which is completely unsustainable
  • Spain may need a full bailout if summit is not successful
    • Financial markets have the ability to push countries into default
    • Because Spain cannot print money itself
    • Even if we manage to avoid, let’s say an ‘accident’ similar to what you had in 2008 with the bankruptcy of Lehman Brothers, the euro system that would emerge would actually perpetuate the divergence between creditors and debtors and would create a Europe which is very different from open society.
    • It would transform it into a hierarchical system where the division between creditors and debtors would become permanent…It would lead to Germany being in permanent domination.
      • It would become like a German empire, and the periphery would become permanently depressed areas.

On Greece

  • Greece will leave the Eurozone
    • It’s very hard to see how Greece can actually meet the conditions that have been set for Greece, and the Germans are determined not to modify those conditions seriously, so medium term risk
    • Greece leaving the euro zone is now a real expectation, and this is what is necessary to strengthen the rest of the euro zone, since Greece can’t print money
    • By printing money, a country can devalue the currency and people can lose money by buying devalued debt, but there is no danger of default.
      • The fact that the individual members don’t now control the right to print money has created this situation.
      • A European country that could actually default. and that is the risk that the financial markets price into the market and that is why say Italian ten-year bonds yield 6% whereas British 10-year bonds yield only 1.25%.
  • That difference is due to the fact that these countries have surrendered their right to print their own money and they can be pushed into default by speculation in the financial markets.

On Angela Merkel

  • Angela Merkel has been leading Europe in the wrong direction. I think she is acting in good faith and that is what makes the whole situation so tragic and that is a big problem that we have in financial markets generally – she is supporting a false idea, a false ideology, a false interpretation which is reinforced by reality.
  • In other words, Merkel’s method works for a while until it stops working, and that is what is called a financial bubble
    • Financial bubbles look very good while they are being formed and everyone believes in it and then it turns out to be unsustainable…
    • The European Union could turn out to have been a bubble of this kind unless we realize there is this problem and we solve it and the solution is there.
    • I think everybody can see it, all we need to do is act on it, and put on a united front, and I think that if the rest of  Europe is united, I think that Germany will actually recognize it and adjust to it.

On Investing

  • Stay in cash
  • German yields are too low
  • If summit turns out well, purchase industrial shares, but avoid everything else (consumer, banks)

Conclusion: We are facing conditions reminiscent to the 1930s because of policy mistakes, forgetting what we should have learned from John Maynard Keynes.

Understanding Bankruptcy as the World Collapses Around You (1)

Saturday, June 9th, 2012

We have seen the dire economic consequences of excessive consumer, corporate, financial, and sovereign leverage of the past 5 years. Our global economy has been a punching bag for corporate greed, political incompetency, and poor central bank planning. From shadow banking and derivatives (“weapons of mass destruction” according to Mr. Buffet) in the United States to Greece’s fraudulent attempt to the enter the Eurozone, world markets have been whipsawed every year since 2007. I cannot help but feel deep remorse after witnessing multiple occasions of the VIX above 40, sovereign CDS making multi-year highs, and political uprising. Five years later, we have yet to learn that leverage is the primary cause of our pain.

Despite an Icelandic bankruptcy, 2 Greek bailouts, a Portuguese bailout, and Irish bailout, and a U.S. bank bailout, 35% of U.S. homes underwater, and 20%+ unemployment rates in certain Western nations, student loans have emerged as yet another bubble, the U.S. consumer savings rate remains below 4%, European banks are levered 26x on average, and countries continue to borrow at astronomical rates. Are we doomed to repeat our mistakes? Sadly, the answer seems to be yes.

Every 2 generations (70-80 years), individuals tend to forget the pain that their forefathers felt in a deep economic contraction. The Great Depression certainly did its job. Maybe we need a constant painful reminder to reign in our tendency to express “irrational exuberance?” Luckily, for learning purposes, a global debt deleveraging cycle is the most painful type of contraction. Hopefully, our children and grandchildren can learn from our mistakes.


Until then, I have started this series to explain the BANKRUPTCY process, specifically the U.S. Ch. 11 process, as I continue to do my part to clean up the riff-raff, the banksters, the incompetent politicians, and the corrupt corporate bureaucrats holding back true capitalism.

  • Bankruptcy is governed by federal statute (11 U.S.C., Section 101):
    • For the equitable distribution among creditors and shareholders of a debtor’s estate in accordance with either the principle of absolute priorities or the vote of bankruptcy majorities of holders of claims
    • To provide a reasonable opportunity, under Chapter 11, to effect a reorganization of business
    • For the opportunity to make a “fresh start” through, among other things, the discharge of debts

  • The goals of bankruptcy are:
    • To afford the greatest possibility of resolution for the estate as a whole, while maintaining the balance of power as between all creditors and the debtor as of the petition date
  • Debtor’s rights and protections include:
    • Automatic stay: an automatic injunction to halt action by creditors
    • Exclusivity to formulate/propose plan of reorganization
    • Continued control and management of the Company
    • Assumption/rejection of executor contracts and unexpired leases
    • Asset sale decisions
    • Avoidance actions
    • Discharge of claims
  • Secured creditor’s rights and protections:
    • Secured to extent of value of collateral
    • Limitations on debtor’s ability to use proceeds/profits of collateral (“cash collateral”)
    • Entitled to “adequate protection” for use of collateral or diminution thereof
    • Entitled to relief from automatic stay for cause shown
    • Entitled to interest and reasonable legal fees when collateral value exceeds debt
    • Entitled to be paid in full in cash or to retain lien to the extent of its allowed claim and receive deferred cash payments totaling at least the allowed amount of such claim

  • Unsecured creditors’ rights and protections include:
    • Majority voting controls
    • Improved and mandated disclosure by debtor
    • Committee representation at debtor’s expense
    • Ability to challenge business judgment of debtor
    • Absolute priority rule generally ensures payment before distribution to existing equity security holders
    • Ability to examine/challenge validity and enforceability of liens and, if debtor refuses, to obtain authority to bring fraudulent conveyance, preference and other actions
    • May continue to exercise corporate governance subject to limitations
    • Valuation as the fulcrum and equalizer of debt and creditor powers
  • Equity may also seek committee representation under certain circumstances and thereby obtain leverage similar to that of creditors’ committee

~Xavier, Leverage Academy Instructor

(All similar entries are in LA’s “Bankruptcy” folder on the right of the blog.)

Bank of Spain Nationalizes Bankia – Property Bubble Bursting

Wednesday, May 9th, 2012

According to ZeroHedge, the Bank of Spain has recently nationalized Bankia, the first of many nationalizations that have to occur in Spain because of poor underwriting by the cajas (regional banks/savings and loan institutions) and falling real estate prices. The Spanish housing price graph above shows how much further the property bubble went in Spain, where at one point, more than 15% of the labor force was working in construction.

With a government debt to GDP ratio of 70%, and another 30%+ of municipal debt, where is Spain getting the money to accomplish these bailouts?

By Alexander Lemming, Leverage Academy Associate

Statement on BFA-Bankia

The Board of Finance and Savings Bank (BFA) announced today the Bank of Spain its decision not to buy in the terms and conditions agreed to the securities issued in the amount of € 4.465m who signed the FROB (Bank Restructuring Fund). BFA has concluded that the most desirable to strengthen the soundness of the business project that began with the appointment of Jose Ignacio Goirigolzarri as president is to request the conversion of these titles in stock ordinary. This conversion must be authorized by the Bank of Spain and the other authorities Spanish authorities and community and will be conducted in accordance with the valuation process established in the indenture securities.

The Bank of Spain has worked hard in recent months with the group address BFA-Bankia to specify the measures to ensure compliance with the provisions of the RD-l 2/2012 for the sanitation Spanish financial system. BFA-Bankia late March presented a restructuring plan and restructuring that included measures that would comply with the RD-l, and standardize its financial  position.

After analyzing this reorganization plan, the Bank of Spain also ordered the entity measures complementary to streamline and strengthen management structures and management, increasing professionalization and a divestment program. These additional actions should serve to enhance the soundness of the institution and restore market confidence. The events of the past weeks and the growing uncertainty about the future of the company has made it advisable to go further and raise the providing resources to accelerate and increase public sanitation.

The changes in the presidency of BFA-Bankia is precisely oriented in the direction shown in professional management and allow the group to boost its restructuring program. The new address of the entity must submit in the shortest possible plan of reorganization strengthened that places BFA-Bankia able to cope with a full guarantee its future.

In any case, BFA-Bankia is a solvent entity that continues to function quite normally and customers and depositors should have no concern. (ZHedge)

Italian 10 year Yield Rises Above 7.4%, Country Theoretically Unable to Fund Itself at These Levels (Bankrupt), Prime Minister Offers to Resign

Wednesday, November 9th, 2011

November 9, 2011: After Italian Prime Minister Berlusconi offered to resign yesterday, the credit markets almost sighed in relief. But today, markets were punched in the jugular as LCH.Clearnet increased margin requirements on Italian bonds. Margins were raised because 10 year credit spread exceeded 450 bps, the same point at which Clearnet raised margins on the bonds of other peripheral countries in Europe.
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The pressure is certainly on the ECB and Italy now to find a solution to this debt crisis, as Italy is too large to be bailout out. Yesterday, known for his sex scandals and political corruption, Prime Minister Berlusconi was pressured to leave his post because Italian yields were creeping above 6.5%. According to the Times, “In the end, it was not the sex scandals, the corruption trials against him or even a loss of popular consensus that appeared to end Mr. Berlusconi’s 17 years as a dominant figure in Italian political life. It was, instead, the pressure of the markets — which drove Italy’s borrowing costs to record highs — and the European Union, which could not risk his dragging down the euro and with it the world economy. On Wednesday, yields on 10-year Italian government bonds — the price demanded by investors to loan Italy money — edged above 7 percent, the highest level since the adoption of the euro 10 years ago and close to levels that have required other euro zone countries to seek bailouts.”
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Currently, the Italian 10 year yield has exceeded 7.4%, and the 2 year note has risen more than 10 year rate. At this point, Italy is theoretically unable to fund itself and could theoretically be bankrupt. The margin call on bonds due between seven and 10 years was raised by five percentage points to 11.65%, for bonds due between 10 years and 15 years it was raised by five percentage points to 11.80%, while for bonds that mature in 15 years and 30 years the margin call was raised by five percentage points to 20%. The changes come into effect Nov. 9 and will have an impact on margin calls from Nov. 10, the French arm of LCH.Clearnet said.

MF Global Files for Bankruptcy and Plunges in First Day of OTC Trading

Wednesday, November 2nd, 2011

November 2, 2011 - MF Global (NYSE: MF) tumbled in its first day of over-the-counter trading after the futures brokerage filed for bankruptcy, prompting the New York Stock Exchange to delist the shares.  MF Global’s bankruptcy is the 8th largest bankruptcy of all time.

The stock, quoted under the symbol “MFGLQ,” declined 83 percent to 21 cents at 12:45 p.m. New York time on trading volume of 170.9 million shares. MF Global plunged 67 percent last week as the New York-based firm reported a record $191.6 million quarterly loss.

MF Global stock hasn’t changed hands during a regular trading session since Oct. 28. NYSE Euronext suspended the stock before the New York Stock Exchange opened on Oct. 31. MF Global filed the eighth-largest U.S. bankruptcy this week after failing to find a buyer over the weekend. The futures broker suffered a ratings downgrade and loss of customers after revealing it had investments related to $6.3 billion in European sovereign debt.

The night before MF posted its biggest quarterly loss, triggering a 48 percent stock plunge, Chairman and Chief Executive Officer Jon Corzine appeared at a steak dinner at New York’s Helmsley Park Lane Hotel for a speech to a group of bankers and traders.

“There was no sense at all that there was impending doom,” Kenneth Polcari, a managing director of ICAP Corporates, said of Corzine’s Oct. 24 address to the National Organization of Investment Professionals. “He gave a spectacular speech” about his decades at Goldman Sachs, life as a U.S. senator and New Jersey governor and his return to the private sector. “He’s had a full life, up until now.”

Corzine, 64, excused himself before the main course was served, saying he had to prepare for an earnings call the next day, said David Shields, vice chairman of New York-based brokerage Wellington Shields & Co. and a former chairman of the organization. The group seeks to foster “a favorable regulatory environment,” according to its website.

Timothy Mahoney, CEO of New York-based Bids Trading LP, said Corzine’s speech was “delightful.”

The next day, MF Global reported a $191.6 million net loss tied to its $6.3 billion wager on European sovereign debt. On Oct. 27, after the company’s bonds dropped to 63.75 cents on the dollar, Moody’s Investors Service and Fitch Ratings cut the firm to below investment grade, or junk. Unable to find a buyer, the company filed for bankruptcy on Oct. 31, the first major U.S. casualty of the European debt crisis.

‘Serve the Public’

At least two dozen U.S. lawmakers and regulators, including Representative Joe Barton, a Texas Republican, Carolyn Maloney, Democrat of New York, and former Securities and Exchange Commission Chairman Harvey Pitt have addressed the group, according to its website.

“There are many people in the group that do lobby and talk to regulators,” Shields said. “You talk to regulators, you talk to lawmakers and you try to get the points forward, things that will help the marketplace, that will serve the public.”

The group’s board includes head traders at firms such as Waddell & Reed Financial Inc., whose futures trade triggered the flash crash of May 6, 2010, according to a study by the SEC and the U.S. Commodity Futures Trading Commission.

Its members’ firms “trade approximately 70 percent of the institutional volume transacted daily in the New York and Nasdaq markets,” according to the website.

‘Difficult’ Day

The group’s current chairman, Dan Hannafin of Boston-based investment manager Wellington Management Co., declined to comment on the dinner. Corzine and Diana DeSocio, an MF Global spokeswoman, didn’t reply to an e-mailed request for comment.

Mahoney said he appreciated Corzine’s ability “to compartmentalize” and speak engagingly last week. Mahoney’s firm, Bids, runs a private trading venue known as a dark pool, and is a joint venture of banks including Goldman Sachs.

Before the speech, Moody’s cut MF Global’s credit ratings to the lowest investment grade. Polcari said there was one reference to Corzine’s “difficult” day.

While he was “cordial” and “positive,” the MF Global chief lacked his typical “sharp bounce,” Shields said. Corzine is “a member of the community,” and could be invited back after the bankruptcy, he said. “People go through bad times.”

To contact the editor responsible for this story: Nick Baker at nbaker7@bloomberg.net

Bank Stocks Beware: Bernanke & Fed Support Increasing Capital Requirements

Tuesday, June 7th, 2011

U.S. bank indices fell 2% yesterday after fears that capital requirements would increase as much as 7%.  Bank of America (NYSE: BAC), fell below $11.00, the lowest since last year.  The discussion came about after the Basel Committee on Banking revealed how levered large financial institutions still were, and tried to reconcile levels with future recession risks.  A 7% equity capital raise for most banks would be catastrophic and dilute equity by 50%+, but a 3% raise seems manageable in a functioning economy.  The problem is that the U.S. economy is on life support, and that life support is called Quantitative Easing 2.  Once this support fades on June 30th, how will U.S. banks (at their already low valuations due to real estate risk and put backs) raise new equity capital?  A replay of 2009?  You be the judge.

According to Bloomberg, “The Fed supports a proposal at the Basel Committee on Banking Supervision that calls for a maximum capital surcharge of three percentage points on the largest global banks, according to a person familiar with the discussions.

International central bankers and supervisors meeting in Basel, Switzerland, have decided that banks need to hold more capital to avoid future taxpayer-funded bailouts. Financial stock indexes fell in Europe and the U.S. yesterday as traders interpreted June 3 remarks by Fed Governor Daniel Tarullo as leaving the door open to surcharges of as much as seven percentage points.

“A seven percentage-point surcharge for the largest banks would be a disaster,” said a senior analyst at Barclays Capital Inc. in NY. “It will certainly restrict lending and curb economic growth if true.”

Basel regulators agreed last year to raise the minimum common equity requirement for banks to 4.5 percent from 2 percent, with an added buffer of 2.5 percent for a total of 7 percent of assets weighted for risk.

Basel members are also proposing that so-called global systemically important financial institutions, or global SIFIs, hold an additional capital buffer equivalent to as much as three percentage points, a stance Fed officials haven’t opposed, the person said.

Bank Indexes Fall

The Bloomberg Europe Banks and Financial Services Index fell 1.45 percent yesterday, while the Standard & Poor’s 500 Index declined 1.1 percent. The KBW Bank Index, which tracks shares of Citigroup Inc., Bank of America Corp., Wells Fargo. and 21 other companies, fell 2.1 percent.

In a June 3 speech, Tarullo presented a theoretical calculation with the global SIFI buffer as high as seven percentage points.

“The enhanced capital requirement implied by this methodology can range between about 20% to more than 100% over the Basel III requirements, depending on choices made among plausible assumptions,” he said in the text of his remarks at the Peter G. Peterson Institute for International Economics in Washington.

In a question-and-answer period with C. Fred Bergsten, the Peterson Institute’s director, Tarullo agreed that the capital requirement, with the global SIFI buffer, could be 8.5 percent to 14 percent under this scenario. A common equity requirement of 10 percent is closer to what investors are assuming.

‘Across the Board’

“I think 3 percent is where everyone expected it to come out,” Simon Gleeson a financial services lawyer at Clifford Chance LLP, said in a telephone interview. “If it is 3 percent across the board then it will be interesting to see what happens to the smallest SIFI and the largest non-SIFI” on a competitive basis, he said.

U.S. Treasury Secretary Geithner, in remarks yesterday before the International Monetary Conference in Atlanta, said there is a “strong case” for a surcharge on the largest banks. Fed Chairman Bernanke is scheduled to discuss the U.S. economic outlook at the conference today.

“In the US, we will require the largest U.S. firms to hold an additional surcharge of common equity,” Geithner said. “We believe that a simple common equity surcharge should be applied internationally.”

Distort Markets

Financial industry executives are concerned that rising capital requirements will hurt the economy, which is already struggling with an unemployment rate stuck at around 9 percent.

Higher capital charges “will have ramifications on what people pay for credit, what banks hold on balance sheets,” JPMorgan Chase & Co. chairman and chief executive officer Jamie Dimon told investors at a June 2 Sanford C. Bernstein & Co. conference in New York.

The Global Financial Markets Association, a trade group whose board includes executives from GS and Morgan Stanley, said the surcharge may apply to 15 to 26 global banks, according to a May 25 memo sent to board members by chief executive officer Tim Ryan.

Dino Kos, managing director at New York research firm Hamiltonian Associates, said the discussion about new capital requirements comes at a time when banks face stiff headwinds. Credit demand is weak, and non-interest income from fees and trading is also under pressure.

Best Result

U.S. banks reported net income of $29 billion in the first quarter, the best result since the second quarter of 2007, before subprime mortgage defaults began to spread through the global financial system, according to the Federal Deposit Insurance Corp.’s Quarterly Banking Profile.

Still, the higher profits resulted from lower loan-loss provisions, the FDIC said. Net operating revenue fell 3.2 percent from a year earlier, only the second time in 27 years of data the industry reported a year-over-year decline in quarterly net operating revenue, the FDIC said.

“You can see why banks are howling,” said Kos, former executive vice president at the New York Fed. Higher capital charges come on top of proposals to tighten liquidity rules and limit interchange fees, while the “Volcker Rule” restricts trading activities. Taken together these imply lower returns on equity, he said.

“How can you justify current compensation levels if returns on equity are much lower than in the past?” Kos said.

Martin J. Whitman on Distressed Investing – A Legend and Founder of Third Avenue

Monday, June 6th, 2011

Over the past two years, I have become a staunch follower of Martin J. Whitman, a legend in deep value investing and founder of Third Avenue. I have read his book, Distress Investing twice now, and wanted to share some excerpts with you. Hopefully you will pick up a copy too!

According to Whitman, there have been three major trends that have shaped the credit markets since the innovation of the high yield (junk bond) in the late seventies through 2008:

1)      Financial Innovation

2)      New Laws & Regulations

3)      2007-2008 Financial Meltdown

1)      New credit instruments, capital structures, and financial institutions grossly inflated the size of the credit and derivatives markets from the 1980s to 2008.  The shadow banking system (SIVs, SPEs) and securities this system issued like CLOs were part of this trend.  Credit default swaps eventually allowed banks and hedge funds to make highly levered bets against issuers, directly influencing market perceptions about credit worthiness.

New primary and secondary markets improved liquidity for below investment grade issues in the late 80s and early 90s.  Leveraged loans that one would have paid 40 cents for in the 1980s, investors were paying 85-90 cents for in the early 90s through the 2007/2008 meltdown.  Almost 70% of leveraged loans were held by nonbank institutions like hedge funds, CDOs, CLOs, etc.

2)      After Gramm-Leach Bliley passed in 1999, commercial banks also began to act more like underwrites, completely eschewing credit risks, and collecting fees on originating loans, bonds, and ABS.  Securitization allowed for the transfer of risk off of bank balance sheets.

BACPA, the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 imposed new time limits for filing a plan of reorganization (POR) and shortened the amount of time required for business bankruptcy filings.  It additionally shortened the time over which investors could decide to curtail payments on property and reject non-residential real estate losses.  Finally, it curtailed executive pay for firms under Ch. 11 and enhanced vendor rights, so trade vendors were pari passu with the unsecured creditors.

Many of these innovations drove litigation costs so high, that today most of the reorganizations done today are prepackaged or prenegotiated filings.

History

According to Whitman, since 1950, credit market debt has grown at 4.1% in real terms, while GDP grew at 2.7%.  In the 1970s, more of the below investment grade debt was classified as “fallen angel,” and was originally investment grade credit.  Originally issued high yield bonds, which were unsecured and had much less restrictive covenants than loans, were quite rare.  They took the form of Rule 144A securities (unregistered with the SEC).

Junk bonds were unsecured claims usually subordinate to senior loans and senior unsecured debt.  But by the 1980s, they were the preferred security for driving LBO and M&A transactions.  By 1989, high yield debt consisted of 20%+ of the non-financial bond universe. (to be ctnd…)

Cheers, Tom Rendon

Bill Gross of PIMCO Dumps U.S. Treasuries

Thursday, March 10th, 2011

As a follow up to our story on shorting treasuries using TMV, the Direxion Daily 30+ year treasury bear, the LA team wanted to discuss Bill Gross’s move to dump government securities.  Bill Gross runs the world’s largest bond fund and has surprisingly decreased his treasury holdings completely.  His fund is now in 23% cash, the highest cash balance since 2008.  PIMCO manages $1.24 trillion of assets, mainly fixed income securities.  According to Gross, if the U.S. transitions into quantitative easing v3 (QEIII), yields on government securities will may increase 150 bps by 2012, resulting in large gains for those net short the 30 year treasury.

According to Bloomberg, “Bill Gross, who runs the world’s biggest bond fund at Pacific Investment Management Co., eliminated government-related debt from his flagship fund last month as the U.S. projected record budget deficits.

Pimco’s $237 billion Total Return Fund last held zero government-related debt in January 2009. Gross had cut the holdings to 12 percent of assets in January, according to the company’s site. The fund’s net cash-and-equivalent position surged from 5 percent to 23 percent in February, the highest since May 2008.

Yields on Treasuries may be too low to sustain demand for government debt as the Fed approaches the end of its second round of quantitative easing, Gross wrote in a monthly investment outlook posted on Pimco’s website on March 2. Gross mentioned that Pimco may be a buyer of Treasuries if yields rise to attractive levels.

Treasury yields are about 150 basis points too low when viewed on a historical context and when compared with expected nominal gross domestic product growth of 5 percent, he wrote in the commentary. The Fed is scheduled to complete purchases of $600 billion of Treasuries in June.

Gross in his February commentary urged investors to reduce holdings of Treasuries and U.K. gilts and buy higher-returning securities such as debt from emerging-market nations. “Old- fashioned gilts and Treasury bonds may need to be ‘exorcised’ from model portfolios and replaced with more attractive alternatives both from a risk and a reward standpoint,” Gross wrote.

Emerging-Market Debt

Gross last month increased holdings of emerging-market debt to 10 percent, the highest since October, from 9 percent in January. He cut holdings of mortgage securities to 34 percent from 42 percent in January.

The Zero Hedge website first reported the change in assets today. Pimco doesn’t comment on changes in holdings.

Treasuries returned 5.9 percent in 2010, according to Bank of America Merrill Lynch Indexes. The securities lost 0.6 percent so far this year.

Ten-year Treasury yields have risen for each of the past six months, according to data compiled by Bloomberg, the longest run since June 2006, as the economy showed signs of improvement and prices of commodities climbed. The 10-year yield fell six basis points to 3.48 percent today.

Gross kept the holdings of non-U.S. developed debt at 5 percent in February.

Inflation Outlook

Gross’ fund has returned 7.23 percent in the past year, beating 85 percent of its peers, according to data compiled by Bloomberg. It gained 1.39 percent over the past month.

As the Fed maintains its target rate at a record low range of zero to 0.25 percent and has made an increase in inflation a cornerstone of its monetary policy, Gross noted that inflation may be a bigger factor than many suggest.

Gains in so-called headline inflation matter more for the U.S. than Fed Chairman Bernanke suggests and rising oil prices may cut U.S. gross domestic product by a quarter to half a percentage point, Gross said March 4 in a radio interview on “Bloomberg Surveillance” with Tom Keene.

“Bernanke tends to think this doesn’t matter — at least in terms of headline versus the core — we do,” Gross said.

Pimco’s U.S. government-related debt category can include conventional and inflation-linked Treasuries, agency debt, interest-rate derivatives, Treasury futures and options and bank debt backed by the Federal Deposit Insurance Corp., according to the company’s website. The fund can have a so-called negative position by using derivatives, futures or by shorting.

Derivatives are financial obligations whose value is derived from an underlying asset. Futures are agreements to buy or sell assets at a later specific price and date. Shorting is borrowing and selling an asset in anticipation of making a profit by buying it back after its price has fallen.

Pimco, a unit of the Munich-based insurer Allianz, managed $1.24 trillion of assets as of December.”

Check out our intensive investment banking, private equity, and sales & trading courses! The discount code Merger34299 will be activated until April 15, 2011. Questions? Feel free to e-mail thomas.r[at]leverageacademy.com with your inquiries or call our corporate line.


200 Years of U.S. Treasury Yields – Short the 30-Year, Ticker: TMV

Friday, March 4th, 2011

The Fed increased the Federal Debt Ceiling dozens of times over the past year, and it seems like it is not over for the Bernank.   The Fed’s balance has been growing every single day as he pumps the economy with more liquidity.  Here is a link to the NY Fed’s POMO schedule: http://www.newyorkfed.org/markets/tot_operation_schedule.html.

In the SocGen chart above, you can see 200 years of U.S. treasury yields.  From the chart, you can see why we are currently in danger of rising yields.  We have a combination of oil shocks and riots facing the world today, with the threat of stagflation.  Almost every emerging market has raised rates over the past 6 months: Singapore, Brazil, India, you name it.  Even Europe, which is in a MUCH worse fiscal situation than the United States, is now “vigilant” on inflation and may raise rates in April…http://www.independent.ie/national-news/trichets-bombshell-makes-bad-situation-even-worse-2565545.html.

According to Bill Gross of PIMCO, “Treasury yields are perhaps 150 basis points or 1½% too low when viewed on a historical context and when compared with expected nominalGDP growth of 5%…This conclusion can be validated with numerous examples: (1) 10-year Treasury yields, while volatile, typically mimic nominal GDP growth and by that standard are 150 basis points too low, (2) real 5-year Treasury interest rates over a century’s time have averaged 1½% and now rest at a negative 0.15%! (3) Fed funds policy rates for the past 40 years have averaged 75 basis points less than nominal GDP and now rest at 475 basis points under that historical waterline.”

In the charts here on the LA blog, you can see (1) the % of investors who own U.S. Treasuries, (2) who is currently buying, and (3) who will buy?  The third chart is in question.  Someone will buy, but at what price and yield?  What will this mean for the U.S. yearly interest burden, for U.S. tax hikes in the future?

One can conclude from these thoughts that yields will have to increase, especially if QE3 is announced in June, and unless the economy booms, so will tax rates.  Here are Mr. Gross thoughts on QE:

Most observers would agree with us at PIMCO that QE I and II programs were initiated and employed under the favorable conditions of (1) and (2). The third criterion (3), however, is more problematic. A successful handoff from public to private credit creation has yet to be accomplished, and it is that handoff that ultimately will determine the outlook for real growth and the potential reversal in our astronomical deficits and escalating debt levels. If on June 30, 2011 (the assumed termination date of QE II), the private sector cannot stand on its own two legs – issuing debt at low yields and narrow credit spreads, creating the jobs necessary to reduce unemployment and instilling global confidence in the sanctity and stability of the U.S. dollar – then the QEs will have been a colossal flop. If so, there will be no 15%+ tip for the American economy and its citizen waiters. An inflation-adjusted “negative buck” might be more likely.

Washington, Main Street – and importantly from an investment perspective – Wall Street await the outcome. Because QE has affected not only interest rates but stock prices and all risk spreads, the withdrawal of nearly $1.5 trillion in annualized check writing may have dramatic consequences in the reverse direction. To visualize the gaping hole that the Fed’s void might have, PIMCO has produced a set of three pie charts that attempt to point out (1) who owns what percentage of the existing stock of Treasuries, (2) who has been buying the annual supply(which closely parallels the Federal deficit) and (3) who might step up to the plate if and when the Fed and its QE bat are retired. The sequential charts 1, 2 and 3 are illuminating, but not necessarily comforting.

What an unbiased observer must admit is that most of the publically issued $9 trillion of Treasury notes and bonds are now in the hands of foreign sovereigns and the Fed (60%) while private market investors such as bond funds, insurance companies and banks are in the (40%) minority. More striking, however, is the evidence in Chart 2 which points out that nearly 70% of the annualized issuance since the beginning of QE II has been purchased by the Fed, with the balance absorbed by those old standbys – the Chinese, Japanese and other reserve surplus sovereigns. Basically, the recent game plan is as simple as the Ohio State Buckeyes’ “three yards and a cloud of dust” in the 1960s. When applied to the Treasury market it translates to this: The Treasury issues bonds and the Fed buys them. What could be simpler, and who’s to worry? This Sammy Scheme as I’ve described it in recentOutlooks is as foolproof as Ponzi and Madoff until… until… well, until it isn’t. Because like at the end of a typical chain letter, the legitimate corollary question is – Who will buy Treasuries when the Fed doesn’t?”

So, how do we short Treasuries at Leverage Academy?  Using TMV, Direxion Daily 30-Year Treasury Bear 3x Shares.  Actually, this security should not be used for prolonged periods of time, but has tracked treasury yields fairly well on a daily and weekly basis.  You can always maximize your return on your treasury short by using longer dated securities.

What can the House and Senate do to address the U.S. deficit?  We can only hope that they will act to preserve our currency’s status, otherwise global inflation will continue.  According to Reuters, “the Republican-controlled House of Representatives will hold off on raising the government’s debt limit until Washington is closer to exhausting its $14.3 trillion credit line, sometime after mid-April, party leader Eric Cantor said on Wednesday.

There is often a pitched battle in Congress over allowing the government to borrow more money, but if Congress does not take that step, Washington risks a default on its debt that could damage U.S. access to credit markets, force suspension of government payments, and close federal offices.

The U.S. Treasury Department estimates the debt ceiling could be reached between April 15 and May 31.

“We really don’t know exactly when the date will be that we’ll have to act,” Cantor said on MSNBC’s “Morning Joe.”

“You know, we’re waiting for April 15 and tax revenues to indicate exactly when the date is that the ceiling needs to be raised,” he added. The must-pass debt limit increase may be leveraged to rein in future spending, Cantor noted.

Cantor spokeswoman Laena Fallon later said the majority leader was not suggesting the House would act on April 15, a date both symbolically important to tax-conscious Republicans and practically important to the U.S. Treasury as the deadline for income tax payments.

“April 15th isn’t a date certain for consideration of the debt limit. But the revenues that come in from tax day will provide a good indicator in relation to when Treasury might determine when we will reach the debt limit,” she said.

Some Republicans, including Tea Party conservatives, have said they will not vote to allow the United States to go deeper into debt without agreement on controlling spending with Obama and Democrats.

“Along with that vote, we’re going to see a lot of things put in place, whether they be process reforms as far as the budget is concerned, spending caps, whether we can demonstrate that we are tightening the belt this fiscal year,” Cantor said.

“Those are all the kinds of things we’re going to have to do prior to seeing that that vote happens,” he added.

The Republican-run House has passed a budget bill for the current fiscal year that includes $61 billion in spending cuts, but the majority Democrats in the Senate say the cuts would endanger the economic recovery.

A debt limit increase would also have to be approved by the Senate and signed by President Barack Obama. (Editing by Jackie Frank)”

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