Credit Market Overview

March 12, 2010

http://www.marketstrategiesmgmt.

As Chris Dodd prepares for retirement, possibly to his 10-acre plot on Inishnee Island on Galway Bay (a story for another day as while it is part and parcel of the seedy side of Washington I can’t, for the life of me, figure out how to work the CDS market into it.), he will attempt to bring a financial reform bill that can actually pass both houses.  The bill was originally intended to fix every last thing that was wrong with Wall St., the credit card companies, the mortgage industry and a whole host of other businesses whose raw material and finished product is the $ sign.

As time passes and emotions cool CD’s bill is having a tougher and tougher time reaching the finish line.  This has been decried by some as evidence that no meaningful regulation will be enacted and we will be that much more vulnerable to the next bubble, pop and crash.  I will leave out the part here that if the regulation that existed prior to 2007 was enforced as intended and not by those who hoped to eventually work for those they were regulating we probably wouldn’t be where we are today.

Financial reform, with all of its populist trappings makes for great headlines but the recoil from draconian change is also being seen in other areas of the economy.  It gets less play because it is more Main St. than Wall St. but it goes equally as far in leaving whatever inefficiencies that existed before the crisis in place during the still evolving recovery.

Example 1 is General Motors or Motors Liquidation Company (MTLQQ).  During the Congressional inquiries and the subsequent bailout it was decided that Mo-Liquid’s product line needed to be rationalized along with its dealer network.  Very profitable SUV’s were to be cut and “government subsidy required to break even” electric cars were to be produced instead.  On the dealer side about 1,100 were slated for closure representing about 2,000 showrooms.

The intended moves showed a clear path to profitability for a company whose marketing campaign compares it to apple pie, the most American of metaphors.

The list of 1,100 got a lot shorter recently as 660 dealers were told they were getting a reprieve and could continue to sell MTLQQ’s cars and trucks.

To put all of this in perspective for you, the company formerly known as GM had about 5,500 dealers last year which sold an average of 376 cars each.  Pre-accelerator-problem Toyota had 1,452 dealers in the states last year each which sold about 1,219 vehicles.

I don’t believe I’m going too far out on a limb here in thinking that the gas-pedal problem can be fixed relatively easily while the problems embedded in an inefficient dealer network will be a lot tougher to address.

The cries against using government money to bail out Wall St. still echo in the media while the monies used to keep GM afloat are deemed a patriotic attempt to save an American icon.  What is interesting is that Wall St. was profitable last year and has, for the most part, paid back the funds received from Uncle Sam.  GM couldn’t say that last year and it might not be able to say it after 2010 either.

John Q. Public obviously prefers the emotional lift associated with demonizing Wall St. than concerning himself about wasteful tax-payer financed initiatives to subsidize inefficiency.  As they say, be careful what you wish for.

There are no CDS contracts traded on MTLQQ since the entity was formed out of the bankruptcy of GM.  GMAC, the financing arm, is quoted in the CDS market and the benchmark 5-year closed at 408bps last night, closer to the 365bp level seen on Jan14^th of this year than the 2051bp level seen on April 1^st of 2009.  MTLQQ has hovered around $0.60 for quite a while now sans a few blips up and down based on news that something might have changed only to be realized later that it hadn’t.

Enjoy the weekend.

Jim Delaney



Credit Market Overview

March 11, 2010

http://www.marketstrategiesmgmt.

Recent findings that certain scientists were being ostracized for disagreeing with the widely circulated and publicized theory that Mother Earth was warming at an alarming rate are evidence that human nature is fiercely competitive regardless of whether the human in question is writing liar loans in Vegas, securitizing them into AAA bonds on Wall St. or proposing theories that include six feet of water sloshing around everything south of Canal St. in New York City.  It is, as they say, the nature of the beast.

As it pertains to taking care of this small spec of dust the world calls home, responsible management of the limited resources available; as vast as they may be, seems logical.  After all, if there is no playing field there cannot be a game and without a game no one can be victor.

So while being green can be as annoying as cleaning your room was when you were a teenager, it is the responsible thing to do.  I use that word responsible here because there are a number of responsibilities that go along with being green and one of them is the fiscal responsibility of deciding which projects will provide recognizable benefits without bankrupting the beneficiaries.

The current feud raging between two sources of “clean energy” come to mind as owners of natural gas fired power plants are tilting against the providers of wind energy as the first provides a constant source of power while the second is subject to the whims of Mother Nature.

The fight, as you might expect, comes down to money as energy providers have historically been required to pay penalties when they don’t supply the power they are supposed to.  These rules, it seems, have been suspended for wind-energy providers as they claim they cannot control “which way the wind blows” to quote Bob Dylan.

According to the American Wind Energy Association, Texas alone has 9,400 megawatts of wind-power generation capacity, more that all the power plants of any kind in Utah.  That figure has increased from 2% to 6% in the last three years while NG’s share of the power market has shrunk from 46% to 42%.  The percentage of power by wind is expected to double by 2013.  Needless to say the “gas guys” aren’t too pleased with the prospect of losing 12% more market share in the near future.

The variability of the wind and the related inconsistencies in power production are at the heart of the matter as Kevin Forbes, director of the Center for the Study of Energy and Environmental Stewardship at Catholic University summed up the issue recently saying, “What wind is doing is giving us the feeling that we’re making progress displacing carbon, when in fact it isn’t displacing coal plants.  It is getting rid of your cleanest fossil-fuel source [natural gas] and it is making the challenge of running a grid much more challenging, because you never know when your forecast for the wind is right or wrong.  You are flying blind.”

As always the truth lies far behind the headlines.

FPL Group Inc. (FPL) is one of the nation’s largest developers of wind-farms through its NextEra Resources division.  Interestingly the company also generates most of Florida’s power needs using natural gas and nuclear power to do so.  CDS spreads for FPL traded as low as 55bps in September of last year, reached a recent high of 106bps on 2/17 of this year and closed last night at 87bps.  The stock had declined from $56.25 on 12/11/2009 to $27.51 on 2/12/2010 before recovering to $46.97 last night.

General Electric (GE) is also a big player in the wind game manufacturing the 400-foot tall wind turbines used in Texas and elsewhere in the world.  GE’s CDS trade under the Credit Corp entity as that is where a majority of the funding occurs.  Spreads have come down from the high 700bps level last spring to about 200bps give or take 25bps depending on things the company has no control over.  The 52-week high in GE was $17.01 on 9/22 of last year.  It has traded pretty much sideways since then closing at $16.51 last night.

It should be noted that in the spirit of greening America, Sen. Charles Schumer (D. NY) recently introduced legislation that would restrict all taxpayer money awarded through a wind-energy grant program to those companies that use the funds to create U.S. jobs.  The purpose of this legislation is to prevent a $15BN wind-energy project in West Texas which is a joint venture between China’s Shenyang Power Group, Texas-based Cielo Wind Power and the U.S. Renewable Energy Group.

I guess Chuck just wants the hole in the ozone layer over the lower 48 fixed.  You have to admit though, that takes “Think global, act local” to a whole new level.

The U.S. hegemonics out there will also not be pleased to hear that the U.K. has announced plans to develop 32 gigawatts of off-shore wind-generating capacity by 2020.  This would put the U.K. at the top of the wind-power league tables in a sector that currently provides 150 gigawatts world wide, 1% of which is offshore with half of that in the U.K.  That effort will require the installation of 6,400 turbines over the next ten years.

There are no “Buy Britain” restrictions on who is able to supply the equipment.  Instead interested suppliers will enter competitive bids.  Imagine that, no legislative barriers, just the best price for the taxpayer’s money. 

Enjoy the week.

Jim Delaney



Credit Market Overview

March 10, 2010

http://www.marketstrategiesmgmt.

Before there were dedicated 24-hour sports networks ABC would broadcast “Wide World of Sports” every Saturday afternoon.  The tagline for that show: “Spanning the globe to bring you the constant variety of sport… the thrill of victory… and the agony of defeat… the human drama of athletic competition… This is ABC's Wide World of Sports!", seems as if it could apply to today’s financial markets without too much editing, “Spanning the globe to bring you the constant variety of economic indicators…the thrill of finding an indicator you can believe….the agony of finding out you can’t…the human drama of trying to make sense of all of the cross currents of information…these are today’s financial markets.”

In my effort to “span the globe” in search of information indicating whether this recovery is lasting or temporary I thought we might look at those things that span the globe.  Well, span might be a bit overarching, but at least those things that criss-cross it frequently and that would be the massive container ships carrying raw materials in one direction and finished goods in the other.

One of the main indices for shipping activity is the Baltic Dry Index (BDI), the “dry” here meaning not “wet” which really means anything that is not oil.  The problem is that what was a very accurate indicator of global commerce is being watered down by the supply of new ships that were ordered when it looked like the world would continue on its path to ever higher consumption. 

Given the lag between order and launch those ships are hitting the water at a time of less than peak demand.  “What you’re witnessing is a huge number of ships ordered during the peak of the market in 2007-08 being delivered now due to the usual lead times involved,” was how Amrita Sen, a commodities analyst at Barclays Capital in London put it.  Because of this Plamen Natzkoff, a dry bulk freight strategist at Citigroup in London, believes that the BDI “will be less responsive to shifts in demand as the over supply of vessels becomes more pronounced.”

Interestingly, as the fog rolls in on the BDI Genko Shipping has decided to carve out a piece of itself and offer 16.3MM shares of an entity it will call Baltic Trading (BALT) at about $15 per share.  This equity is meant to mimic movements in the BDI and if the IPO is successful, BALT will use the $245MM raised to buy six big bulk carriers which will ply the planets oceans in search of spot shipping assignments.  The entity will have no debt so its shares are designed to more accurately reflect changes in global shipping rates.

To the extent that BALT will provide a lighthouse of information on the dark waters of global commerce data there is a risk that folks might not like what they see. 

Shedding some of its own light on shipping, A.P. Moller Maersk AS (MAERSKB DC DKK) recently reported its first loss since the company floated its first boat in 1904.  “The loss was significant, but 2009 was an extraordinary year with historically low rates and low demand”, was how CEO Nils S. Andersen put it.  Nils went on to say that he expected Maersk to turn “a modest profit” in 2010.  Emphasizing his view that “shipping is not a commodity” and that Maersk “wants to provide superior service based on customer needs”.  These are wonderful sentiments but the BDI and BALT could make for some rough seas in convincing people of such.

There are no CDS traded on Maersk and there are no good substitutes within the CEC universe as all of the names there represent air and ground shippers.  It should be noted, however, that the CEC strategy is currently long 10 of the 11 stocks in that sector with the exception of YRC Worldwide (YRCW) which is more of a story stock at this point given its brush with bankruptcy caused by outsized pension obligations.

As for shipping in general, needless to say it would be a good thing if all those ships “spanning the globe” pulled into harbors of profitability.

Enjoy the week.

Jim Delaney



Credit Market Overview

March 9, 2010

http://www.marketstrategiesmgmt.

In solving most white color crimes the key to finding the culprits is following the money.  While in no way suggesting such nefarious goings on, it is quite useful to apply this tactic to Wall Street when trying to determine where the strength and weakness might be across various business lines and asset classes.

In early February Barron’s interviewed Roger C. Altman, CEO of Evercore Partners.  The part of that Q&A most germane to today’s theme was this “A” that came after one of Larry Strauss’s “Q’s”: “Historically, you see that the upcycles last five to eight years, and the downcycles typically two to three years. We have just come through more than a two-year down cycle, and it is clear to me that we have turned the corner.”

This view was bolstered when it was reported last week that when data from Capital IQ was analyzed by the WSJ it was found that the 382 non-financial firms in the S&P 500 were sitting on top of $932BN in cash and short term securities.  The answer to the question of what to do with all that dough has been in part supplied by the fact that stocks are still trading about 27% below their 2007 highs.

The result is best exemplified by Walgreen’s (WAG) $618MM cash bid for Duanne Reade (Private).  Wade Miquelon, CFO of WAG reasoned it this way: “We are sitting on a lot of cash and generating a lot as well, sitting around on all that cash and have it earn very little really does not make a lot of sense.”  Wade went on to say, “We are conservative with our cash, but hoarding it right now isn’t probably the best use of it.”

Like the WAG deal, cash does seem to be king at the moment, or at least the preferred method of acquisition as through 2/28 the percentage of cash deals in the U.S. more than doubled from the same period in 2009 according to Thomson Reuters with 50% of this years deals being paid for outright vs. about 24% in 2009.

The activity appears to be stretching across wide swaths of the economy as India’s Essar Group just agreed to fork over $600MM greenbacks to buy U.S. coal producer Trinity Coal from U.S. based P.E. firm Denham Capital.  Additionally, while not the major thread of this morning’s monologue it should not be lost that there is increasing demand by the world’s fastest growing economies (India and China) to lock up supply of the raw materials those countries need to continue their growth.

Coal is used is used in those industries where a lot of heat needs to be generated and the two that come most quickly to mind are energy and steel.  That second use is adding more fuel to the M&A fire as Wayzata Investment Partners, a P.E. firm has been quietly acquiring small foundries across the U.S. in places like St. Cloud, Minn., New Castle , Ind. and Iron Mountain, Mich.  While the deals are not big ($70MM for Grede Foundries in St. Cloud) the folks at Wayzata believe the resurgent economy will make foundries a “hot” investment.  In support of their idea the national trade group for America’s foundries is quick to note that 90% of man-made products in the U.S. contain a part made in one of this or another country’s 2,100 foundries.

For proof of the “other country” part of that last statement we need to look no further than two of the grand pillars of the private equity business Kohlberg Kravis Roberts & Co. and TPG Capital who appear close to inking a deal to buy Morgan Stanley’s stake in China Capital Corp.  If successful KKR and TPG would split MS’s current 34.3% stake in CICC with Henry Kravis and David Bonderman, founders of their respective firms, gaining seats on CICC’s board.

Needless to say none of this activity would be going on if all of the very smart people involved in these deals didn’t believe the outlook for the world’s economy was more positive than negative.  It is also worth being reminded that bids, whether they come from another company or a P.E. firm, are usually at a premium to current market prices in order to entice holders to surrender their stakes.  As such M&A activity is usually not a bad thing for anyone lucky enough to own part of a target company or for stocks in general.

Investment grade CDS spreads continued lower yesterday closing at 83bps.  That level was last seen on Jan 10^th of this year while spreads were on their way up to their 106bps peak on 2/8.

High Yield spreads closed at 519bps yesterday which matched the 1/20 close, which like IG spreads, were on their way higher at the time cresting at 637bps on 2/15.

In the period leading up to the market’s highs in October of 2007 M&A deals were paid for with heaps of debt which was used to pay the acquirers huge upfront dividends.  The current mode of cash acquisitions leaves the acquisitors with a lot more skin in the game.  Needless to say, if you follow the money, this should lead to more careful corporate stewardship.

As for Mr. Altman’s view on the prospects of M&A, all we can say is roger, Roger.

Enjoy the week.

Jim Delaney

Credit Market Overview

March 8, 2010

http://www.marketstrategiesmgmt.com

Ben Bernanke has, at almost every opportunity imaginable, made it clear that interest rates will remain at “exceptionally low levels for an extended period”.  The only issue with any of this is that Ben works in Washington and whether the Fed is independent or not, you just can’t believe anyone in D.C. 

In order to corroborate Ben’s story a review of the opinion of some of the major financial institutions view on when rates will rise was published in the WSJ recently.  The results were that Morgan Stanley and UBS think it happens this July, Citigroup this October, Bank of America in January of next year, J.P. Morgan Chase in April 2011 and Goldman Sachs in January of 2012.

The markets, for just about the entire time since the first tremors of the credit crisis were felt in July of 2007, have reacted to every event, both positive and negative, with highly correlated moves among assets within a specific class as well as the across the various asset classes themselves.  Evidence of this can be found in examining the moves of the major stock and commodity indices which rose in tandem from 2006 to mid-2008 and the fell in sync until March of 2009.  They have both since risen from the March lows and even stayed highly correlated in the latest mid-January to mid-February sell off, also recovering as if joined at the hip.

The pundits place the reason for this synchronicity as a result of the global nature of the crisis and the realization that a global recovery will ultimately be necessary to right the ship that is the super duper tanker of the planet’s economy.

With that in mind it is worth noting, Ben Bernanke’s intention for interest rates not withstanding, that rates on the short end of the curve have begun to move higher.  The yield on the 3-month T-Bill closed at 0.1359% on Friday after having bounced off of 0.0051% on 11/19/2009 and 0.0203% on Jan 11^th of this year.  3-month LIBOR has been as low as 0.24875% on four different occasions in the last four months; most recently on the 4^th of February.  That rate was set at 0.25219% on Friday.

Higher rates, in this context and coming from such low levels, can be viewed as a positive for the global economy as even with the sovereign debt problems of the PIIGS, 9.7% of the world’s largest economy officially out of work which speaks nothing of 16MM underemployed and a host of other worries the fact that 3-month Bills are no longer trading at -0.0410% as they were on 12/4/2008 shows the market’s confidence that the worst is behind us.

Given the empirical evidence stated above regarding the relationship between stocks and commodities it is also worth noting that Crude Oil closed at $81.50/bbl on Friday, the highest price seen for that contract since January 13^th of this year and 2 cents shy of $10.00 higher than its February 5^th close.  To the extent that stocks and commodities will continue to be linked this could portend well for equities.

Another member of the supporting cast for seems to be the hottest new play in town; “Bull Run” is volatility as measured by the VIX which closed at 17.42 on Friday.  That is the lowest close for that index since Mid-May of 2008 and if not for the opening level of 16.93 on 1/11 of this year the lowest level seen on even an intraday basis since the spring of ’08 I just mentioned.

Not to be left out in any of this Investment Grade CDS spreads as measured by the CDX IG Index closed at 85bps on Friday a level last seen on Jan 20^th.  As loyal readers of this space know, lower CDS spreads can be an indicator of higher equity prices both on an individual and index basis.  If there is a note of caution attached to the CDS level it is that unlike in more settled times, CDS spreads have a tendency to become more coincident during periods of high cross-correlation in asset classes.  That doesn’t take away anything from the 85bps close on Friday but only removes the tendency for CDS to be a leading indicator.

If the past 2½ years have taught us anything it is that anything can happen.  As such the only thing we can say with complete certainty is that as of the close on Friday things looked positive for Friday’s close.

Enjoy the week.

Jim Delaney

Credit Market Overview

March 5, 2010

http://www.marketstrategiesmgmt.

At at least one in our lives we have all heard or thought of the adage; “If you want something done right, you have to do it yourself”.  While many of the Bills clawing their way through Congress at the moment would seem to refute this as the government seems hell bent on legislating away the responsibility we all have  to ourselves, there are many instances where regardless of the outcome we will really only feel comfortable with the result if we are the one’s taking action.

With the “too big to fail” institutions now well along in the process of mending themselves, with much government help of course, the headlines are focused on the next attention grabbing event, wherever in the world that might be.  Back here in the good ‘ol U.S. of A. there is still a lot of mending that needs to be done and a most of that needs to occur at levels of the economy that rarely make the headlines, namely, the small and new businesses that employ many people and on whose growth the economy depends.

The Federal Reserve, Federal Deposit Insurance Corp and a host of other federal and state regulators issued a joint statement recently voicing their concern about the contraction of lending to small businesses as banks tighten lending standards in the wake of the credit crisis.  Part of that statement said that the regulators were working to, “ensure that supervisory policies and actions do not inadvertently curtail the availability of credit to sound small-business borrowers”

Sen. Jim Bunning (R., KY) believes it is those exact regulators that are the problem saying, “It’s the Fed regulators that have stopped the flow of money out of the community banks to the small-business person”.

In many cases the frustration in trying to get money from the banks has prompted the “I’ll do it myself” response and various types of lending, some formerly shunned, are rising to meet demand.

The National Small Business Association said in its semiannual survey that about 25% of business owners relied on vendor credit to meet their capital needs between August of 2008 and December of 2009.  That was up from about 18% prior to the start of the crisis.  Additionally vendors appear more open to extend interest-free pay cycles and offer discounts on promptly paid invoices.

Justin Schaldone, CFO of eFashion Solutions LLC, says he is paying more of his vendors directly giving him some negotiating power which has resulted in and extension of pay cycles to 60days and discounts of between 5%-10% for prepayments.

Weezabi LLC, a three person company, and one of the few licensed to make “Crimson Tide” merchandise for the University of Alabama, needed to fund the production of 60,000 T-shirts after the school’s football team made it to the National Championships in December.  Since no banks were willing to lend the needed funds, Seth Chapman, CEO, turned to FTRANS an Atlanta-based lender.  “If it wasn’t for that loan, we would have missed the boat on all of this hot-market stuff”, he said.

None of the companies mentioned in today’s piece are big enough to have CDS contracts traded on them.  I couldn’t even find stock symbols.  The important point here, however, is that the small companies mentioned are, in many ways, the life blood of this economy and economies around the world.

The good news is that one way or another and against some pretty tall odds the spirit of entrepreneurs has not been dented.  I started this piece with one adage and I will finish it with another, “Where there’s a will, there’s a way”.

I am confident there isn’t anyone in Washington that can legislate that away.

Enjoy the weekend.

Jim Delaney