Friday August 17 – No one leaves unscathed

COPYING AND DISTRIBUTING ARE PROHIBITED WITHOUT PERMISSION OF THE PUBLISHER: SContreras@Euromoney.com

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"It's really troubled. Everything is being tarred with the same brush and investors in funds that buy commercial paper are ringing and asking: 'You're not in that asset backed CP are you?' And if funds have bought ABCP, investors don't want to hear about whether it's good ABCP or not, they're out of there"

The week Wall Street went into meltdown


So Bernanke blinked. One week on from the start of giant central bank liquidity injections and deus ex machina time rolls round again. The morning clouds lift with news that the Federal Reserve is cutting by 50bp the discount rate at which banks can raise emergency funds to 5.75% from 6.25%, leaving it just 50bp above the Fed funds rate, which is the general base rate.

In addition, it is to widen eligible collateral for these loans to include certain mortgage-backed securities. News emerges of a conference call this morning between Fed officials and the CEOs of leading financial institutions including Bank of America’s Ken Lewis, Citi’s Chuck Prince, JPMorgan’s Jamie Dimon and Lloyd Blankfein of Goldman Sachs. In the days ahead, the Fed will press the country’s leading banks to make use of this facility even if they don’t face a funding emergency, in an effort to remove the stigma associated with drawing on it. Of course, this fools no one. The banks are desperate to point out it is a symbolic gesture and the market is poised to flee from any smaller institution that is known to have used the discount window. Still, it now stands there, open.

This is exactly what many in the markets have been hoping the Fed would do. One of the investors Euromoney most keenly follows is in no doubt as to the longer-term significance: the interest rate cycle has turned. The Fed will cut rates, and cut them again and again. The bad news is that it will have to, because of what now faces the economy.

Shares rise, led by Countrywide moving back up by 13%.

Before traders and investors have fully digested the news, Euromoney stops by the office of the chief financial officer of one of the largest broker dealers. Share prices of the top five US investment banks have been highly volatile as investors have looked uneasily at the amount of earnings they derive from the fixed-income and mortgage markets and their leveraged loan exposure.

Today their share prices are bounding up. The CFO is still worried by what’s going on in the core money markets, especially the commercial paper market. "It’s really troubled. Everything is being tarred with the same brush and investors in funds that buy commercial paper are ringing and asking, ‘you’re not in that asset backed CP are you?’ And if funds have bought ABCP, investors don’t want to hear about whether it’s good ABCP or not, they’re out of there."

Will the Fed’s actions save the day? "The Fed is acting as a market participant posting a competitive rate for 30-day funding. I think it will be helpful."

“News emerges of a conference call this morning between Fed officials and the CEOs of leading financial institutions including Bank of America’s Ken Lewis, Citi’s Chuck Prince, JPMorgan’s Jamie Dimon and Lloyd Blankfein of Goldman Sachs. In the days ahead, the Fed will press the country’s leading banks to make use of this facility even if they don’t face a funding emergency, in an effort to remove the stigma associated with drawing on it. Of course, this fools no one”

"News emerges of a conference call this morning between Fed officials and the CEOs of leading financial institutions including Bank of America’s Ken Lewis, Citi’s Chuck Prince, JPMorgan’s Jamie Dimon and Lloyd Blankfein of Goldman Sachs. In the days ahead, the Fed will press the country’s leading banks to make use of this facility even if they don’t face a funding emergency, in an effort to remove the stigma associated with drawing on it. Of course, this fools no one"

 

How does he feel the firm is fitted for the latest storm? He says it is set up to survive 12 months of a highly stressed market environment with no access to unsecured capital. "Of course, we have certain instruments we can continue to finance in the repo markets. Should we find ourselves unable to do that with reliable counterparties, we can finance the rest of the firm from long-term capital. That’s the way we work. We don’t regard our bank lines as a last resort. We regularly draw on them. It costs us a little more to operate like this but we think that cost is offset by how this framework helps our rating."

Monday August 13 –
No precedent, no rescue, no clue?


Tuesday August 14 –
Out of control


Wednesday August 15 –
Skin in the game


Thursday August 16 –
Crescendo of panic


Friday August 17 –
No one leaves unscathed


Lessons of the market seizure

They said it
He wants to make another point about the firm’s reported commitments to fund leveraged loans, which are now weighing on its market rating. When the firm offers a 100% commitment to a private equity sponsor to fund a purchase, it reports that fully in its 10-Q. But other firms will also have provided 100% guarantees for the funding and, when the time comes to execute a deal, it will always be paired with at least one other firm, possibly three or more, sharing the underwriting equally. So it’s not as bad as it looks. It might be on the hook for only 25% of the headline commitment. Have analysts overestimated the Street’s exposure to these toxic loans?

"We need to fix these problems in the short-term markets and then we’ll see about the leveraged loans." He doesn’t hold out huge hopes for forbearance but sees the chance for some adjustments. "Borrowers might give on some things. If the no covenants is really important they might give a little on price, or if the price is key, then on covenants. Buyers are definitely in charge but even then I don’t see a lot of this going at 90 or below. We see a fair amount of bottom-fishing at 92. And even at 95, there’s incentive for CLOs to re-form."

Unfortunately, he sees continued deleveraging by hedge funds continuing to depress asset values and much of the smart money still on the sidelines. "The smart guys might tell us, ‘yes I love that price, but I see redemptions coming from my funds’."

There has been much talk of a federal government initiative to relieve the stress in the mortgage market (and at the end of the month president Bush announced programmes for the Federal Housing Administration to help some delinquent sub-prime borrowers refinance). Nice idea, but this CFO isn’t banking on late-in-the-day government interference in the cold-blooded financial markets. "Sure, servicers of securitization trusts will be doing the right thing, trying to extend terms for borrowers who continue to pay. But there’s a limit to what they can do. Can the federal government really tell lenders not to enforce rate step-ups en masse. What about those who have already been stepped up, and what about those who have shorted this market? There’s a lot of skin in this game."

AA-rated assets’ widening

Sub-prime infects high grade CDOs...

Source: Citi, Dealogic CPWare

AA- rated assets’ widening (continued)

... and pushes spreads up alarmingly on ABX

Source: Banc of America Securities LLC, Markit


Is it possible to make predictions about the outlook for investment banking businesses? Tough, says the CFO. "The debt and equity origination and financing businesses will slow. For now, volatility and high turnover is benefiting flow businesses, especially equities." Are the structured credit markets dead? "No, but fewer participants will operate within them and investors, originators and rating agencies will have to rethink their models."

No one is coming out of this unscathed. "We’re in a confidence-sensitive industry and it remains to be see how the American psyche is affected by all this."

The overwhelming sense of relief at the end of a tortured week is tempered by the suspicion that although a meltdown in the money markets and systemic risk has narrowly been averted, this financial crisis will claim many more victims before it abates.

Lessons of the market seizure

They said it