The Wall Street Journal reported yesterday that subprime mortgages, a distressed sector of the securitized debt market, have been smartly rallying in value since late 2011, as measured by the 2006 AAA slice of the ABX index. Currently, the index stands at about 50% — almost twice the value at its all-time low in early 2009. Does this mean that the party is getting started again? Well, it depends on your perspective. Analyzing securitized debt is not for the faint-hearted, even if it is on the most senior tranche, as the index level of the 2006 AAA ABX index can … Continue Reading →

The European Commission is not happy with the Volcker Rule, a provision found in the Dodd-Frank Act  that seeks to limit banks from taking on proprietary trading risks that can imperil client deposits — deposits which in the extreme might require further federal bailouts. The overall intent of the rule is to lower the probability of systemic risk so that banks won’t be able, in effect, to take on risky assets with an implicit federal put. But how can one systematically determine when a transaction is proprietary or market-making for the benefit of customers in nature? King Solomon’s dividing-the-baby dilemma … Continue Reading →

Credit Suisse bankers might not love their employer, but Main Street might. The company has segregated some 800 derivatives risk items to securitize a bond paying 5% to 6.5% to its bankers, in lieu of cash compensation, for at least four years and for as long as nine years. With the U.S. 10-year treasury sitting around 2%, this doesn’t seem like such a bad deal for the bankers. First, the optics: Those Wall Street bankers are finally taking on some responsibility for what they create. Main Street hasn’t had too much to celebrate lately, but can this mean that Wall … Continue Reading →

Basel III bank-capital-adequacy proposals are leaving large banks feeling cold. For the 29 “systemically important” global banks, Basel (Switzerland) regulators are expected to tack on an additional 1% to 2.5% of capital cushion to the required 7% capital base (as a percentage of risk-weighted assets) required for all banks. As such, banks (assets of less than US$50 billion) not deemed “systemically important” must be champing at the bit. In the spirit of forced global deleveraging (and then some — regulators cannot be any clearer about their intentions), risk-taking is to be made more costly. Concurrently, though, sovereign policymakers want banks … Continue Reading →

During the early part of December 2011 and per authorization of the Dodd-Frank Act, the Federal Deposit Insurance Corp., the Federal Reserve, and the Office of the Comptroller of the Currency proposed rules that will end the current regime of referencing credit ratings as part of a method of assessing portfolio risk for the purposes of capital retention at large banks. Though this has been much anticipated, extricating credit ratings from bank capital adequacy determinations is but a first step in terms of the financial industry to taking risk matters into its own hands. The change will have significant operational … Continue Reading →

The ongoing issues surrounding the Greek bond market might be downright dangerous for capital-building and -hedging endeavors — even for those on the right side of the trade. In late October 2011, the European Union came to an agreement with banks for a voluntary 50% write-down on their Greek bond holdings. The key term in the agreement is “voluntary.” Market participants that purchased credit default swaps (CDSs) in order to be insulated from credit-related principal losses of Greek sovereign debt must now reconsider the efficacy of buying protection. The International Swaps and Derivatives Association Inc. (ISDA), the body that governs … Continue Reading →

Mid-October found the U.S. Federal Housing Finance Agency (FHFA) — the regulatory overseer of government-sponsored entities (GSEs) Fannie Mae and Freddie Mac — and the Obama administration considering a limited pilot program that seeks greater private-investor participation through private purchases of first-loss positions in new GSE issuances of mortgage-backed securities (MBSs). This program does not require congressional approval, but it does require the FHFA to sign off. Fundamentally, this program is a risk-sharing arrangement that would allow GSEs to take losses only after the riskiest bonds in the capital structure (expected to be 5% to 10% in thickness) are first … Continue Reading →

The Federal Housing Finance Agency (FHFA), the conservator of Fannie Mae and Freddie Mac, recently announced that Freddie Mac used faulty analytical methodologies relating to mortgage buybacks in its US$1.35 billion settlement with Bank of America. In effect, FHFA contends that Freddie Mac underestimated questionable 2005 to 2007 Countrywide-originated mortgages and did not take into account teaser-rate loans, whose credit risks differ from more traditional mortgage products. The FHFA senior examiner concluded that the settlement was inadequate and that Freddie Mac had done so in order to preserve its relationship with Bank of America, a large underwriter of loans used … Continue Reading →

With much fanfare, the supposed bank risk-reduction proposal named after former U.S. Federal Reserve Chairman Paul Volcker has bumped up against market realities. As originally envisioned, this bank regulation was supposed to make proprietary trading a thing of the past (i.e., impermissible for banks to use bank capital to make risky trades on their own behalf). The rationale behind this was that depository institutions that had government-related guaranteed deposits (i.e., FDIC) should not have the ability to take risk positions as principal. The current draft proposal, which has received pushback from Wall Street firms since the Volcker Rule was first … Continue Reading →

The Securities and Exchange Commission is in late-stage talks with Citibank to settle civil charges related to a billion-dollar subprime mortgage-backed collateralized debt obligation (CDO) deal — Class V Funding III — for US$200 million. At the heart of the suit is the claim that Citibank held short subprime mortgage positions and could therefore profit at the expense of CDO holders. Additionally, the SEC is investigating Mizuho Financial Group and Magnetar Capital LLC, both collateral managers of other mortgage-backed CDO deals. Last year, Goldman Sachs Group settled with the SEC for US$550 million relating to its underwriting of Abacus 2007-AC1, … Continue Reading →