Today's Tidbits

Bank of America Gets Sweetheart Deal Helping Countrywide
From Bloomberg: “Bank of America Corp., the second- biggest U.S. lender, is already up about $700 million on its $2 billion preferred stock investment in Countrywide Financial Corp. This is ``something of a sweetheart deal,'' David Hendler, an analyst at research firm CreditSights Inc. in New York, said in a report. Bank of America…can convert the preferred stock to common shares at $18 each, compared with a high reached today of $24.46. Countrywide, the biggest U.S. mortgage lender, will also pay interest of 7.25 percent on the preferred shares. Countrywide, which lost half its market value after peaking on Feb. 2, rose $1.07 or 4.9 percent…The deal, announced after the market closed yesterday, was made to help …Countrywide weather the global credit rout that had cut off its access to short-term financing. The investment reassured investors after Countrywide was forced last week to draw on $11.5 billion of bank credit lines and Merrill Lynch & Co. raised the prospect that the company may be headed for bankruptcy. ``The only time you see terms like this is if a company is really desperate for financing,'' …A 7.25 percent coupon on a convertible ``is pretty rare on a company that's investment-grade,''… Countrywide's ``funding problems will not be cured with a mere $2 billion infusion,'' said …JP Morgan Securities Inc. …``The main driver for the deal was a hope that the credit markets and CFC's depositors will see this as a reinforcement that CFC will survive the current liquidity crunch.'' The deal will increase Countrywide's diluted shares by 19 percent and cost about $145 million in dividends…`It was expensive for the company but it's ultimately better to keep the company in business,'' …``It helps to stabilize the company as a whole. On a personal basis, it's better for the world, for you and me going out to get mortgages, that they stay in business.''
From LEHC: “In an interview on CNBC today, Mozilo asked if he thought there would be a recession in the US, said "I think so ... I know I've been proven wrong so far, but I can't believe that when you're having a level of delinquencies, foreclosures -- equity has disappeared, equity is gone, the tide has gone out -- that this doesn't have a material effect… on the psyches of the American people, and eventually on their wallet." Mozilo also noted that the financial markets are in "one of the greatest panics I've ever seen in 55 years in financial services." Mr. Mozilo is 68 years old. Mr. Mozilo said that in his mind there was “no even thought” of BofA buying Countrywide. He said that BoA contacted him personally to see if BoA could “help”, and also noted that he would have loved to have “tapped” the discount window, but that he couldn’t, as the bulk of the company’s mortgage assets were not assets of Countrywide Bank. And finally, he said that he hasn’t seen any improvement in market liquidity, and overall he sounded pretty depressed.”
From Dow Jones: “The cost of protecting Countrywide Financial Corp.’s debt fell sharply after Bank of America Corp. acquired a $2 billion equity stake in the nation’s largest mortgage company. The credit default swaps, which measure the perceived risk of owning a company’s bonds, fell in price to $177,500 to insure $10 million of bonds annually for five years from $330,000 late Wednesday…That brings the CDS back to levels last seen at the start of the month, before Countrywide ran into trouble securing short-term funding. The CDS may be recovering, but it doesn’t mean Moody’s Investors Service thinks the mortgage company’s problems are over. The ratings agency, which downgraded the company three notches to its lowest investment-grade rating just last week, said it was keeping Countrywide’s ratings on review for possible downgrade.”

Bernanke Fed Less Inclined to Lower Rates and Risk Bubbles Than Greenspan Fed
From Fortune: “It may be the most important development to emerge from the recent market turbulence: The Federal Reserve, under Chairman Ben Bernanke, is going back to being a central bank. Judging by its cautious and finely-calibrated responses through a very ugly August, the Fed appears keen to put the Alan Greenspan years firmly in the past and take a much more orthodox approach to monetary policy. While the Fed will probably cut interest rates as early as next month, its behavior in August strongly suggests that Bernanke will avoid using interest rates to deliberately spark big increases in lending, the high risk strategy pursued by Greenspan from 2001 to 2004… A change at the Fed would have far-reaching consequences for the U.S. economy and the stock market. Initially, a much less accommodating Fed will be perceived as a reason for bearishness. But, over the longer term, market players may well see a less dysfunctional central bank as a good thing that could begin the process of cutting borrowing levels in the U.S., something that has to happen if the American economy is not going to seize up every time interest rates rise… this Fed has cut only the discount rate, a move designed to get healthy financial institutions trading with, and lending to, each other. Critically, Bernanke's Fed hasn't yet reduced the Fed funds rate, which does have a big impact on the economy. And it has not officially commented on what its next moves might be with that rate. And if it does lower the Federal funds rate next month, it's hard to see it rushing to further cuts, as happened in 1998. Why? Because there seems to be a recognition at the Fed that lending got out of hand in the past five years, and it's important now for markets to attach new, lower values to many loans and bonds. In a June speech, Bernanke commented on the shake-out in subprime mortgages in a conspicuously neutral way, suggesting the Fed was monitoring housing problems, but was not unduly concerned by adjustments taking place in it. "I think the Fed is happy to see that risk aversion is increasing," says Kasriel… Lacker argued that a reduction in a discount rate is a good thing to do because it can supply liquidity without leading the market to misprice credit once again. "Sound discount window policy, I believe, should aim at supplying adequate liquidity without undermining the market's assessment of risk," he stated. While Treasury secretary Henry Paulson is not a Fed member, it was more than interesting to see him making the same point, also on Tuesday, when he said: "As the Fed addresses liquidity this makes it possible, this makes it easier, for the market to focus on risk and pricing risk." What seems so different under Bernanke is a genuine recognition that interest rate cuts could spark another bubble, and thus must be enacted carefully. This appears to have been a big factor in the Fed's decision-making last week… The stand-back strategy of Bernanke's Fed was in many ways vindicated by news Wednesday night that Bank of America is making a $2 billion investment in Countrywide, the large mortgage company that is suffering a liquidity squeeze. It shows that stronger firms are capable of becoming part of the market adjustment by making investments in weaker companies during this crisis. This happened without a cut in the Fed funds rate… After nearly 20 years at the helm of the Fed, Greenspan left the U.S. economy more vulnerable to credit shocks than it has ever been.”
From Reuters: “Past experience suggests central banks overreacted, cutting rates more than was needed, says … an economist at Dutch investment bank ABN Amro. In the two weeks following the October 1987 market crash, the Fed cut its key interest rate by half a percentage point. The housing market took off and inflation kept creeping higher.
After LTCM's collapse triggered fears of a systemic crisis in late 1998, the Fed cut its key Fed Funds rate by 75 basis points, or three-quarters of a point, which was more than sufficient…In both cases, rates were higher within 18 months than prior to the crises, and it looked as if it had all been overdone. "In hindsight, it looks like the Fed over-reacted. Perhaps Mr (Fed chief Ben) Bernanke, a renowned U.S. economic historian, understands this better than some market commentators," … When Alan Greenspan ran the Fed, says [Morgan Stanley’s Steve] Roach, central bankers committed the "original sin of the bubble world", ignoring a surge in liquidity which fed directly into asset markets. "That set in motion a chain of events that has allowed one bubble to beget another, from equities to housing to credit,"… "The art and science of central banking is in desperate need of a major overhaul -- before it's too late," says Roach.”

Unemployment Claims Gradually Rising As Hiring Pace Slows
From FTN: “Initial claims filed for unemployment insurance were down 2k to 322k from a revised 324k last week (was 322k). The level of claims is at the high end of this year’s range, and the 4-week average has climbed very close to where it was in June, during seasonal auto layoffs. (Yes, these data are seasonally adjusted, but the layoffs were bigger than usual, and the timing shifts a bit year to year.) Essentially, this translates to a small, but by no means alarming, rise in layoffs. Continuing claims tell another story however. This is a measure of the total number of recipients receiving benefits, so it is a decent guide to the pace of net hiring. Continuing claims pushed to more than 2,550k in late June, remained high in July and is rising again in August. If the turmoil in the markets has only increased the pace of layoffs slightly, it has had a more substantial impact on hiring. (Remember, the turmoil in the money market is an August story, but the long end locked up in June after the bond market concluded the Fed would not ease within the next year.) The Fed will be paying more attention than usual to these data, just as we are, because they are starved for contemporaneous economic information. There is nothing in the data yet to justify an inter-meeting cut.”

Housing Industry Related Job Losses Accelerate
From AP: “…more than 25,000 workers nationwide who have lost jobs in the financial services industry since the beginning of the month -- with more than half coming since last Friday.…Since the start of the year, more than 40,000 workers have lost their jobs at mortgage lending institutions, according to recent company layoff announcements and data complied by global outplacement firm Challenger, Gray & Christmas Inc. Meanwhile, construction companies have announced nearly 20,000 job cuts this year, while the National Association of Realtors expects membership rolls to decline this year for the first time in a decade. It's an employment collapse that threatens to rival the massive layoffs in the airline industry that followed the Sept. 11, 2001, terrorist attacks, when some 100,000 employees lost their jobs… It's only been weeks," Challenger said. "These companies are acting remarkably quickly, stopping on a dime.””

As Expected, Fed’s Report on Commercial Paper Outstanding Shows Large Drop
From Bloomberg: “The amount of U.S. commercial paper outstanding had its biggest weekly percentage drop since 2000 as investors shunned debt that may be linked to mortgages and other risky assets and instead opted for the safety of Treasuries. The amount dropped $90.2 billion, or 4.23 percent, to a seasonally adjusted $2.04 trillion… Some companies that use commercial paper to buy asset-backed securities or collateralized debt obligations backed by subprime mortgages are having trouble finding investors. Commercial paper buyers, in the face of attempts by the Federal Reserve to ease the credit crunch, have headed for Treasury bills in which the yield on Aug. 20 fell the most since the stock market crash of 1987. ``There is a significant amount of cash in the system, it's just not getting to the parts of the market that need it,'' Conrad DeQuadros, a senior economist at Bear Stearns Cos., said in an interview today in New York. The Fed has lowered the interest it charges to lend to banks to encourage buyers of commercial paper after the market seized up last week for Countrywide Financial Corp. and other mortgage lenders. Countrywide, based in Calabasas, California, borrowed its
entire $11.5 billion in available bank credit lines in order to fund its operations…. The decline in outstanding commercial paper was driven by a 6.8 percent fall in asset-backed commercial paper, which represents about half the commercial paper market and has been used to finance purchases of subprime mortgages. The average yield on 30-day asset-backed paper rated A1, the second-highest short-term credit rating by Standard & Poor's, rose 5 basis points, or 0.05 percentage point, to 6.1 percent. It has risen 35 basis points in the past week.”
From JP Morgan: “…today we got the most recent data for CP outstanding (note this is a w/ a 1wk lag, so the data today is as of last Weds)...I think it's noteworthy that ABCP is down 70.9bb wk-over-wk...as we don't know of any defaults at this point, this decline in
notional outstanding appears to be a function of paying down CP (whether it's a result of bank lines getting tapped or de-levering is another question).”

Regulatory Bank Funding Requirements Reinforced Asset Price Spiral
From Barclays: “The root cause of this thirst for term finance is the near complete illiquidity in the term (one-month or longer) depo markets. The drought in the term money markets is attributable to banks' need to preserve liquidity to finance the involuntary growth in their balance sheets. This growth has been caused primarily by a rapid drawdown of standby credit lines extended to conduits and SIVs, [ Note – From The Financial Times: “SIV-lites are essentially collateralised debt obligations which pool together bonds backed by mortgages and other asset-backed debt. The main difference is that other CDOs sell long-term senior debt to fund their assets while SIV-lites raise senior debt in the short-term ABCP markets.] whose access to the CP market has been cut off by ABS-shy investors. In a similar vein, banks’ balance sheets have also been swollen by incoming collateral from margin calls. Most of this collateral is characterised by very weak or non-existent secondary market bids, so banks are opting – or being co-opted by circumstances – to keep these securities on their balance sheets. Banks have been forced to conserve liquidity to cover these contingent assets and as a result, have been unwilling to lend in the term depo market. Since all banks, to a greater or lesser extent, partly finance themselves in the money markets, the lack of offers much longer than a week left the system with a major headache. The regulatory framework sensibly prohibits banks from funding their entire balance sheet in the overnight market. Regulators require banks to maintain liquidity in certain maturity brackets in relation to the maturity of the assets they are financing. Since all the fresh assets – whether collateral or back-up credit lines – appearing on balance sheets are fairly long term and since the term depo market was not offering any liquidity, there is a potential liquidity ratio regulatory problem. And as each day passes, the existing financing shortens in maturity as the banking system’s term borrowing rolls-off, to be replaced by overnight finance. Unchecked, the net result would be a banking system that resembles a giant upturned pyramid resting on its apex. Needless to say, giant upturned pyramids resting on their apexes are not noted for their stability. Furthermore, as banks start hitting their regulatory liquidity ratio constraints, they are forced to shed assets in an effort to slim their balance sheets, adding to the pressure in secondary market valuations and contributing to the spiral of collateral liquidations and margin calls on levered investors… with improved access to term finance now available, banks may feel less inclined to shrink SIV and conduit balance sheets and therefore ease the fire-sale pressures on the underlying securities. Those pressures had been contributing to a spiral, whereby asset sales depressed secondary market valuations and therefore triggered more margin calls. So this move should help break this spiral and thus slow the involuntary expansion of bank balance sheets… Elsewhere in the money markets, we note one particular point that may be slowing the return to more normal conditions. Many of the contingent assets that are popping up on bank balance sheets are not eligible to be used as collateral at the central bank liquidity windows. This is particularly the case in the US, where banks cannot put up collateral in which they have a credit interest. This rules out assets that are appearing on balance sheets as a result of back-up credit lines being exercised. More generally, the flight to safety has resulted in a shortage of top quality collateral in the system, as the collapse in T-bill and repo rates for government securities suggests. In turn, there is a potential risk that this shortage of quality collateral is inhibiting access to liquidity… Outside the short-term money markets, one could be forgiven for imagining that the rest of the financial system inhabits a different planet. Both investment grade and high yield spreads have contracted very sharply. Since last week, the US investment grade CDX index has tightened some 28 bp or 34% of the widest levels attained. Since the end of last month, the US Crossover index has narrowed by 40% or around 150 bp. The primary market has also been active for investment grade bond and loan issuance. Indeed, as the Financial Times points out today, dollar-denominated investment grade bond issuance, at $28bn for the first three weeks of August, is actually up 47% from last year’s equivalent. Equally, the successful completion of the fourth largest syndicated loan ever issued – $40bn for Rio Tinto – tells us in no uncertain terms that the credit market are open for business, albeit much more selectively than before. The depth of this particular pool of liquidity – which is presumably real money rather then leveraged – is the matter of some conjecture. Equally, the $300bn overhang of bridge debt, which will be tapping the higher yield market, is a much harder test for the credit markets than good quality investment grade bond issuance. However, for the time being, the omens are relatively positive inasmuch as markets are becoming much more discriminating. Problems with asset-backed commercial paper are clearly not a pricing factor for corporate debt at the moment, while the illiquidity in the term money markets has not deterred value hunters in the equity market. Encouragingly, the recovery in longer-term credit and equity markets has taken place against a backdrop of fading rate cut expectations. This implies that investors are increasingly moving to the view that the various problems are contained and unlikely to be a decisive risk to economic growth – and by extension non-financial corporate earnings. Longer run, questions remain over the banking system’s ability to supply fresh credit for a while, given the sharp expansion in balance sheets. Given the efficiency with which most banks run their balance sheets, the recent involuntary asset growth from hung bridge loans, margined collateral and the exercise of back-up credit lines suggests that banks may soon approach capital adequacy limits. However, if real money investors are happy to finance an expansion of bank liabilities by buying bank bond issues – and this is the case at present – then this problem too will begin to fade in importance. We would caution that a lasting easing of this crisis requires these two preconditions to be met. Given the fragility of the financial sector, it is certainly too soon to sound the All Clear. However, compared to the position of the markets just one week ago, we appear to have successfully pulled back from the brink of what was looking like a very deep and dark abyss. ”

Rating Agencies Getting the Blame For Market Mayhem
From Economist: “Every crisis begets finger-pointing, and the blame now is falling on the rating agencies that helped structure these exotic instruments. The European Commission is understood to be reviewing why rating agencies failed to move more quickly in response to the growing crisis in subprime mortgages. Currently, they are guided by a voluntary code that aims to tackle potential conflicts of interest. The biggest is that the agencies are paid by the firms they rate. Rating CDOs was a profitable business. To understand why so much blame is being heaped on the rating agencies, consider how CDOs and collateralised-loan obligations (CLOs) came into vogue. In the mid-1990s individual loans looked appealing to investors, but their ratings (often below investment grade) made them too risky for conservative types. So whole forests of asset-backed securities were put together into a single CDO. These were structured so that the first losses would be taken by whoever had bought the riskiest, highest-yielding piece of the package. That piece had a low rating. But the piece at the top, which would take the last losses, was rated AAA—a reflection of how unlikely it was that all the loans in the CDO would default at once. Rather than standing back and observing this from the sidelines, the rating agencies got involved in structuring these products. Like schoolgirls asking for help with their homework, the banks would go to the agencies and ask how the different slices of the CDOs they were putting together would score. The agencies would suggest improvements based on their models. And lo, the senior tranches were given the ratings required to market them to banks, which liked the security the triple-A ratings conferred, especially because their yields were higher than those of American Treasuries… Goldman Sachs admitted as much when it said that its funds had been hit by moves that its models suggested were 25 standard deviations away from normal. In terms of probability (where 1 is a certainty and 0 an impossibility), that translates into a likelihood of 0.000...0006, where there are 138 zeros before the six. That is silly. "Securitisation," … "has meant that credit risks have moved from knowledgeable, long-term hands, to fast hands, where the principal risk-management strategy is to sell before prices fall more". Working out who has won and who has lost in this round will take a long time.”
Friedman Billings Ramsey Report Thinks Mortgage Markets Won’t Stablize for at Least 6 Months
From Dow Jones: “It may take a long time for investors to start bidding for mortgages again. In recent months, companies from mortgage lenders, hedge funds and firms investing in structured products - such as assetbacked bonds - have been racing to dump mortgage assets to repay creditors, as the fallout from the credit squeeze continues to reverberate. The upshot: Businesses are earning even less from selling loans, more lenders are failing, and investors - except for those savvy specialists in distressed investing – are reluctant to dip their toes back. In a report entitled “De-Leveraging Destroying Value - New Capital Needed,” analyst Paul Miller Jr. at Friedman Billings Ramsey estimated that it takes roughly $150 billion to $250 billion of new capital to “normalize pricing” in the mortgage market. But it’s also a kind of Catch-22 situation: Without new capital, it could be difficult for asset prices to come back up; without pricing adjustment and better returns, new capital may be hard to come by. Miller projected that it will take six to 12 months for the prices of mortgage assets to normalize and for capital to flow back into the space. “There is no quick fix here,” he noted. And until then, lenders will continue to come under pressure with respect to earnings and book values.”

Japan
From JP Morgan: “The Bank of Japan left policy rates unchanged at 0.5% on an 8-1 vote. Governor Fukui emphasized that investors are engaged in the repricing of risk and that this is a process that will take time to play out. As such, the BoJ needs time to assess how market developments might affect the economy. In its monthly report, the BoJ reaffirmed its assessment of current conditions (moderate expansion) and the longer-term outlook.”
From Bloomberg: “Japanese investors were net sellers of foreign bonds during the week ended Aug. 18 according to figures based on reports from designated major investors released by the Ministry of Finance in Tokyo.”
From Bloomberg: “The yen fell against the euro and dollar on speculation investors resumed riskier bets financed by borrowing in Japan.”
From Dow Jones: “The Bank of Japan’s governor said that investors have made “significant progress” in cutting from their portfolios risky yen-selling investments, but remained cautious about the resurgence of such bets. “I think there has been significant progress in the unwinding of short positions linked to yen-carry trades” during the past few weeks of turbulent global markets, Toshihiko Fukui said at post-policy board meeting news conference. Yen-carry trades refer to the strategy of borrowing money at Japan’s low interest rates and investing in more attractive assets outside Japan. But Fukui also indicated that he hasn’t let his guard down against another boom in such trades, and he signaled that the BOJ wants to raise interest rates partly to discourage such trades.”

MISC

From Lehman: “The pullback in mortgage origination continued, largely in subprime and Alt-A lending, as more mortgage lenders shut down operations. In addition, credit conditions in overall capital markets worsened. We now look for an even deeper housing recession: Sales and starts should continue to fall through the middle of next year. Inventory of new homes should fall at a faster pace than inventory of existing homes. National home prices should fall modestly; bubble regions will likely witness bigger declines.”

From Bloomberg: “BP Plc, the world's third-biggest oil refiner, may scrap a $3.8 billion expansion of its Whiting, Indiana, refinery, as public opposition increases…``Ongoing regional opposition to any increase in discharge permit limits for Lake Michigan creates an unacceptable level of business risk'' for the expansion, Bob Malone, president of BP's U.S. unit, said in the statement. ``If necessary changes to the project result in a material impact to project viability, we could be forced to cancel it.''”

From Time: “…Las Vegas--where 40% of the houses up for sale now sit vacant.”

From Merrill Lynch: “The majority of companies within the S&P 500 Index exceeded earnings expectations in 2Q, with the index in aggregate delivering 7.5% year-over-year quarterly growth…[but] earnings failed to break the 10% growth mark for the second quarter in a row.”

From Dow Jones: “The U.S. federal budget deficit will fall for the third year running, totaling $158 billion in fiscal-year 2007, the Congressional Budget Office estimated.
The budget deficit for fiscal year 2006 was $248 billion. A nominal-dollar record high annual deficit of $412 billion was set in 2004.”

End-of-Day Market Update

From SunTrust: “Things looked rosy early this morning. Equities were higher overnight, CFC got liquidity from BOA and the odds of a FED ease decreased considerably. It looked like we might see some increased activity in term cp issuance. But, it shaped up to be a lot like yesterday. Rates were mostly unchanged for A2/P2 (BBB+ long-term) names today and about 5bp higher for A1/P1 ABCP. The market continues to be very sloppy. Very similar credit quality names in both markets can trade 20bp away from each other. The major factor in deciding rates is the panic level of the issuers to get paper placed and the amount they need to issue. We saw additional activity in A2/P2 issuers hitting bank lines for more favorable financing. A1/P1 non-asset backed cp traded today at 5% for overnight maturities. ABCP and A2/P2s both traded today between 5.50 and 6.10 overnight and 5.90-6.20 term. The total amount of cp outstanding has decreased by $90B (4%) since last week and $181B (9%) from two weeks ago. ABCP is down by almost 7% for this week alone. ABCP outstandings could go down another 15% if most of the lower quality ABCP names disappear.”