CreditTrader's Comments

Why I Favor High Yield and Preferred Stocks

Fri, 13 Feb 2009 07:52:41 -0500

Don't forget to hedge your Treasury risk! Given where we all know Treasuries are going, your willingness to buy JNK or HYG on valuation basis requires that you sell TLH or some such to benefit from the cheapness of spreads relative to real default risks. I have heard so much from the mainstream talking heads on buying bond ETFs and yet none of them undertand the difference between yield, spread, and real performance.

High Yield Credit Spreads Out of Control

Thu, 04 Dec 2008 17:40:24 -0500

Hey Guys, love your stuff. Just thought an FYI was needed on this one. Corporate bond land is incredibly illiquid currently (especially HY) with very little actual trading going on. Primary issuance is up a little this month (though not in HY) but concessions remains extreme. What this means is that using corporate bond spreads to judge HY default compensation is a little tricky. As an example, in general, bonds are trading over 200bps wider than CDS on the same name due to counterparty risk in CDS, funding costs for bonds (hedgies), risk aversion, and liquidity. This so-called basis is what has undone Citadel for instance and we note that in CDS land, HY11 seems to have found a cap at around 1400bps this week (as IG continues to widen). This is a CDS spread (similar to a spread over Libor) so you must adjust for the swap spread to compare apples to apples with your data BUT Merrill's bond indices may not be the best indication of just how stressed HY is. We are big bears on HY but if average spreads were indeed north of 2000bps then we would see significantly more people dipping their toes (but in fact liquidity is just not there to support this level). With CDS at 1400bps ish for HY, we remain sellers with a view that default gains will swamp carry costs as refinancing is basically impossible at current levels.

A good indication of just how messed up this can be is the Muni market today (which now trades wide of the IG Corporate Bond market) - yes, you heard me - MCDX at 285, IG11 at 275!!! MCDX is 80bps wider today as state after state reports drastic drops in revenues...

CDS Prices Due for Sharp Adjustment Today

Thu, 16 Oct 2008 13:24:02 -0400

Few points worthy of discussion -
1) None (that is zero) of the nine entities that the US injected capital into on Monday are a part of the CDX or iTraxx indices, so be careful about broad index-related comment based on the positive/negative views of these financials.
2) We did see spread decompression in these names (or at least the seven that trade) in the 5Y but <3Y (which is the guarantee's maturity) compressed significantly and curves steepened considerably.
3) Historically, IG spreads must be around 140bps to cover investors for 'actual' realized losses through a 'normal' recessionary period. With IG around 200 in the US, we are clearly seeing a more prolonged and severe recessionary period with far higher defaults being priced in.
4) We would expect corporates to see some unthawing of the primary IG new issue markets as traditional managers can once again (in the absence of short-term default risk) buy the new issues and then buy protection from their favorite (guaranteed) broker to cover any concerns over credit quality. Given the concessions, this is likely to start soon (e.g. IBM's bonds went out well over 120bps cheap to CDS).

Hope this provides a little more color

When Hedgies Attack: Morgan Stanley Drops 40% on Rumors

Wed, 08 Oct 2008 01:41:06 -0400

Dear TomArmistead, a) what makes you think Dinallo knows anything about CDS markets, b) what has his comments got to do with my comments on the action today in MS CDS markets and the LACK of directional flow, c) what about short-sellers?, d) what about put buyers? and e) I GUARANTEE you that if and when we regulate CDS trading (which could mean many things from a clearing house to insurance) that the credit crisis will not be over, house prices will not rise, and stocks will still fall.

Moreover, if you understood the nature of CDS markets (NOT CDO, or ABS CDS), then you wouldf realize the need for the CDS to isolate credit risk and allow real money accounts (you know the big pension funds and traditional asset managers NOT hedgies) to actively BUY new issues in the primary bond market with less downside risk. The need to put money to work means that there is a natural demand for IG issuance, and obviously there is a natural supply for refis in IG markets. However, without a functioning CDS market (without the need for insurance-style regulation), these non-fast money accounts would be unable (or unwilling at anything other than uneconomical spreads) to buy new issues. Even with a massive cash-CDS basis currently, counterparty risk is keeping these guys on the sidelines. If we put CDS on an exchange with a central clearing house, I GUARANTEE once again that new issue markets will pick up and the liquidity freeze will thaw in corporate credit.
This is not an issue of 'naked short selling' but more of risk transfer and risk premia - no-one is willing to act coz no-one knows who is infected - if counterparty risk is removed from the picture then liquidity will thaw and as far as i can see, insurance regulators have not exactly been at the top of their game in terms of regulatory control (ABK, MBI, FSA, AIG, HIG)?
Sorry to nag on this one BUT it is really important that people understand the markets that provide a platform for their stock market speculation and how a simple over-regulation can have huge impacts.
Remember - counterparty risk (sometimes called Herstatt risk) is the issue - NOT regulatory control/restriction on protection buyers.

as far as po'd in Plano is concerned, CIT and SLM are in even nore trouble in CDS land, trading considerably wider (riskier) than MS or any of the brokers - you are absolutely right - they are all in the same fund short and lever up boat and CDS simply reflect the reality of their chances of default.

When Hedgies Attack: Morgan Stanley Drops 40% on Rumors

Tue, 07 Oct 2008 19:50:47 -0400

Just for all those conspiracy theorists, CDS markets in MS were pretty much frozen this afternoon. There was no rush to buy protection, there was no massive entrant(s) into the market ahead or after the rumor, there was simply no trading (some indicative levels) but no major trading. Noone is willing to sell protection and thopse that are are not good enough quality to encourage buyers to act...sorry guys, this one is simple, who would want to own a highly leveraged, low quality balance sheet entity whose business model faces significant (understatement) headwinds...and on a day when the CDS market begins to look seriously at a buy-side driven trading and clearing platform. Dealers in general can expect margins to drop significantly (that is why they have been so vociferous over defending the opacity of OTC markets - coz they get the flows and the margins). Sorry to go on - but this whining/blaming CDS for the current situation just shows the level of general ignorance among both retail and professional investors when it comes to financials and credit markets.

Broker Default Risk

Thu, 05 Jun 2008 14:19:17 -0400

The disconnect is simply due to the underlying backstop that the Fed put into the market. This has spread across much of the financials universe where we now see equity levels modestly cheap to where CDS would imply them to be BUT I do also note that implied vol is considerably too low among these names relative to their CDS levels - so a long delta-hedged Put versus CDS protection position should pay out well and also i would expect equity to underperform as the firms are forced to use equity issuance rather than debt/hybrids as Tier 1/leverage ratios come under pressure...love to hear your thoughts...

When Hedges Fail

Thu, 22 May 2008 11:13:18 -0400

Hey Felix, love your stuff (though think Walnut Creek/East Bay can be beautiful!) - wanted to get your opinion on the UBS/BX deal. Seems to me like they are doing nothing but the old super senior play. Pool up crappy loans, sell BX first-loss piece (at a discount), and then lend them the rest - nice bit of Basel II arbitrage (lowers capital coz first loss is gone) but the risk remains and the loan terms (we don thave them) must have been spectacular for BX to take this...also check out the Fed's lending activities in the last few days...and the US brokers are spiking in CDS land...keep up the great work.