Let's focus on the domino theory starting with State St-managed CDO is liquidating assets.
The trustee of a $1.5 billion collateralised debt obligation [CDO] managed by State Street Global Advisors has started selling assets, apparently starting a process of liquidation, Standard & Poor's said late on Thursday.Professor Depew was all over this story in parts 1-5 of Friday's Five Things.
S&P said it slashed its ratings on Carina CDO Ltd's top tranche of securities by 11 notches to the junk level of BB from the top-notch triple-A after it received a notice on Nov. 1 saying that the controlling noteholders had told the trustee to liquidate. S&P also chopped its ratings on the subordinate levels of the CDO, with two falling to CCC- and eight to CC. The ratings were first assigned in November 2006.
"We believe the liquidation process has begun," S&P said in its statement.
Following are snips from numbers 1, 4, and 5.
1. Carina: CD-Oh-NoFlashback October 13, 2007
- Carina CDO Ltd., the CDO in question, is the first CDO to begin unwinding.
- The most senior class of Carina CDO Ltd. were lowered to BB, two levels below investment grade, from AAA, while another AAA class was slashed 18 steps to CCC-.
- For all intents and purposes that means it is practically bankrupt.
- "The chance of material losses to noteholders is high, New York-based S&P said," according to Bloomberg.
The liquidation of the Carina CDO was one of the issues Citigroup (NYSE:C) was concerned about in their conference call this week; the point at which holders of senior notes say they are no longer willing to risk the fact that the current cash flows will continue on without impairment.
5. Capitulation vs. Kickoff
- In the conference call Citigroup Chief Financial Officer Gary Crittenden said that although the ABX Indices were implying serious value declines in real estate and ultimately cash flow impairment, Citigroup is not yet seeing these cash flows impaired.
- As a result, they are not yet conceding defeat to the ABX Indices and not yet willing to mark accordingly, opting instead for a projected range.
- Crittenden put it like this: "I guess our view is that it's unlikely that those very high levels of price reduction in real estate will take place so what's actually happening is implicitly the market is saying that the cash flows associated with those securities have become more risky and so as we have thought about valuing those cash flows we have put different discount rates on those cash flows and that's reflecting the range that you see in the estimate here and we'll see obviously how that actually plays out over time."
- It took less than a week for the first move in this waiting game to play out.
- The forced liquidation of the Carina CDO will likely have a domino effect, spreading into the pricing and ratings of other CDOs.
- At this point it's a game of faith.
- Once investors lose faith the "reality of pricing" detaches itself from tangible meaning, creating a new world with different rules.
- Citigroup, and other firms, have been hoping to ride out the irrationality of the ABX Indices.
- They haven't counted on the fact that what once appeared irrational might soon dissolve into reality.
- One of the issues Citigroup was concerned about in their conference call this week; the point at which holders of senior notes say they are no longer willing to risk - important word - risk the fact that current cash flows will continue on without impairment.
- Consequently, the Carina CDO Ltd. liquidation event is a hallmark move toward risk aversion where the holders are saying We no longer are willing to accept the risk of potential cash flow impairment.
- They are saying We just want to get whatever price we can get for the securities.
- Now, the important risk for us going forward is that this is not a capitulation event, as equity market participants perceive, but a kickoff event precipitating increased risk aversion across the spectrum, not to mention the creation of "observable inputs" in pricing.
Super SIV Bailout Plan Doomed To Fail
Don't Ask - Don't Sell
- The Super SIV bailout plan boils down to this: Don't Ask - Don't Sell.
- Don't Ask what the asset is worth.
- Don't Sell or you will find out and not like the result.
The asset valuation problem and the strategy of Don't Ask, Don't Sell goes beyond SIVs to CDOs, REOs (Real Estate Owned), and all sorts of other bank assets that are already on the balance sheets.
Dual Accounting at the S&P
Here is a summary of the CDO ratings scam.
- The S&P is only downgrading the Carina CDO because it has to.
- Why does it have to?
- Because by State Street's selling, we will find out what those assets are really worth.
- The S&P knows the answer is "not much" as evidenced by downgrading garbage it rated as AAA all the way to CCC-
- The rated value of assets by Moody's, Fitch, and the S&P are one thing. What those assets are really worth on the open market are another thing.
- The difference can be as much as 18 notches.
You can now ask the same question of the S&P and Moody's.
On November 8th Bloomberg reported Asset-Backed Commercial Paper Drops Most in 2 Months.
Debt maturing in 270 days or less and backed by mortgages, credit-card loans and other assets fell $29.5 billion, or 3.4 percent, to a seasonally adjusted $845.2 billion for the week ended yesterday. "The psyche right now is getting worse and worse," said Neal Neilinger, co-founder and managing director of NSM Capital Management in Greenwich, Connecticut. "It's all risk aversion, and the trend is for people to buy T-bills."My comment: That is exactly what Citigroup and Paulson are trying to prevent with the Super SIV bailout plan - Debt being put back on balance sheets. It is however, unavoidable. The SIV model is dead.
Simba Funding Corp. and Mane Funding Corp., asset-backed paper conduits set up by Amsterdam-based ING Groep NV, are being shut down because of the deteriorating market conditions, Bank of America Corp. said in a report yesterday. The conduits had 21 billion euros ($30.9 billion) of assets, according to the report. The debt is being put back on ING's balance sheet, the report said.
SIVs Cheyne Finance and Rhinebridge Plc defaulted on more than $7 billion of debt last month after being unable to roll over their commercial paper. Sachsen Funding 1 Ltd., a $2.2 billion debt fund set up by Landesbank Sachsen Girozentrale, was prevented from tapping the market last week after its asset values fell.My comment: SIVs, toggle bonds, leveraged buyouts at insane debt fundings, debt sponsored share buybacks and other financial wizardry are all going to go away.
"The SIV market is probably going to wither away," said Jay Mueller, who manages about $3 billion of bonds as an economist and portfolio manager at Wells Fargo Capital Management in Menomonee Falls, Wisconsin. "People will be reluctant to lend to anything that looks like a SIV in the near future."
For more on the Ponzi scheme of toggle bonds, please see It Toggles the Mind.
For more on the insanity of debt funded share buybacks, see Stock Buybacks: A Good Thing Or Slipped DISCs?.
Jim Jubak was writing about financial wizardry in Wall Street doesn't want you. "The Street has abandoned individual investors in favor of big institutions and wealthy private traders. It's time for big changes."
Financial wizardry in SIVs has nearly run its course.
- New York-based Citigroup, the largest U.S. bank by assets, provided $7.6 billion of financing to the seven SIVs it runs after they were unable to repay maturing debt.
- SIV managers don't expect the investment model to survive as the value of their assets shrinks, Moody's analysts said today.
- The net asset value of debt held by SIVs has fallen to 71 percent of initial capital from 102 percent in June, Moody's said.
The attempt by the Fed, the Treasury, and those stuck in SIVs and other level 3 assets is to delay the inevitable as long as possible, hoping the problem subsides over time. It won't.
If anything, delays only make the problem worse. Expect the unwinding of this mess and the repercussion from the unwinding to last for years, not months. Twenty years of financial engineering and various Ponzi schemes of central bank bailouts are not resolved in a matter of months. Ask Japan.
Is Don't Ask, Don't Sell Failing Already?
State Street is clearly willing to settle for what it can get.
It's likely a smart move too.
After all, Paulson Announced A Super-SIV Failure Already.
In an interview on Thursday, before the latest agreement was made, Paulson acknowledged that the proposed backup fund would not rescue troubled SIVs, only lead to a longer and more orderly demise.This is an amazing admission of failure right on the eve of agreement as to how the bailout plan will work. For details, click the above link.
“This is something that is not a savior,” Mr. Paulson said, noting that he expected the fund to begin operating by the end of the year. “Anything at the margin that will speed up liquidity is worth trying.”