FDIC Guaranteed Notes Thaw Credit Markets

With a large slug of the TARP funds returned, many are questioning whether the "TARP-free" banks are truly on their own or are still relying on some form of government support. Here is a commentary from Adrienne Carter (Businessweek):

The big banks returning the TARP money show no signs of giving up this perk. Goldman (GS) has $21 billion of such debt; JPMorgan Chase (JPM) $40 billion; Morgan Stanley (MS) $23 billion. (JPMorgan and Morgan Stanley did say they wouldn't issue any additional bonds backed by the FDIC. And JPMorgan recently sold corporate bonds without the U.S. backing.)

She is referring here to the FDIC guaranteed notes issued by banks in the early part of the year. This has been an extremely effective program, not only to help banks raise debt capital, but to also open up the credit markets as a whole.

In terms of giving up this FDIC guarantee however, the "non-TARP" banks have mostly already done so. Existing notes (those that have already been issued) obviously cannot drop the guarantee. Otherwise, if you are the Fidelity government money market fund, and you bought dome FDIC paper early in the year, you have a problem. If the guarantee is now all of a sudden lifted, not only are you violating your prospectus (because the government paper turned into corporate notes), you will also take a loss. This would unfairly and severely punish those who have cash in money market funds.

However, any new paper issued by these banks is no longer guaranteed by the FDIC. For example, on May 11th Goldman issued 6.75% coupon notes maturing 5/15/19. The paper is NOT FDIC guaranteed and is also unsecured. It now trades above par, yielding 6.64% (3.1% above treasuries). The demand for paper is out there and unless you are GMAC (who sold FDIC notes early this month), FDIC guarantee is no longer absolutely necessary (at least for now). Even Citi (C) can now sell non-FDIC paper (although Citi continues to use the program because it's so much cheaper).

Here is the historical yield on some early Goldman FDIC notes. This paper was issued at the end of last year and matures at the end of 09. You can see that in March-09 the market came to realize that the FDIC is not going away (in spite of the bank rescue mess they are in) and neither is Goldman (at least for now).

Goldman FDIC notes yield:

click to enlarge

Here is a rough measure of the note's spread to a 1-year T-bill.

Source: Bloomberg

The FDIC notes opened up the credit markets. When fear ruled the day, this paper got placed, serving to calm the jittery credit investors' nerves. In March-09 (which will be remembered as the turning point in the credit markets), Pfizer (PFE) sold $13.5 billion of bonds. About $1.25 billion of that was a 2-year floating note (LIBOR + about 2%), which looked similar to the FDIC notes placed by banks. This was a signal that corporates can in fact issue debt without the goverment guarantee. The market was starved for high quality investment grade corporate paper. We were off to the races. Huge amounts of both bank and corporate paper has been placed since.

Clearly, FDIC guarantees together with TAF, as well as other programs created a thaw in the credit markets. Now let's hope these programs are soon going to become obsolete.

Disclosure: no exposure to GS, C, GM, PFE

Comments

[Stimpy]

But how can they become obsolete? You can't "unbreak" a dish. Sure, the FED can let these programs expire as the market remains convinced that, if necessary, the FED will put them back in place. Isn't that just a continuation of the guarantee?

The ONLY question for investors right now should be: what do the credit markets look like after the smoke clears.

If they are truly private, risk will price correctly and stability is possible.

If they reamain quasi public (with or without balances outstanding in the TGLP, TALF, CPLF etc) , risk is mispriced and the system will continue to crash over and over.

2009 Jul 27 10:09 AM

[whidbey]

I like this, like a supermarket, one can shop for the program that will be government supported, or taxpayer supported go to the counter and check out with any obligation to return the used money bags.

We are indeed living in fortunate times.

2009 Jul 27 03:27 PM