Thursday, April 30, 2009

Maiden Lane

The NY Fed has released a lot of information HERE.

Alea comments on Maiden Lane I, so I won't bother. Except to say that it isn't the assets -- look at the whole balance sheet.

Per Maiden Lane III:

ML III LLC borrowed approximately $24.3 billion from the New York Fed in the form of a senior loan (Senior Loan)....

As of October 31, 2008, the Asset Portfolio had a par value of approximately $62.1 billion.

Per Maiden Lane II :
ML II LLC financed this purchase by borrowing $19.5 billion (Senior Loan) from the New York Fed.

As of October 31, 2008, the Asset Portfolio had a par value of approximately $39.3 billion.

These are not great assets. The Fed needs ML III to pay out @ 40% of par and ML III at 50% of par.

The detailed audited year end financials are quite interesting but mostly ramble on about fair value/M2M values. You can see what the assets consist of, but they have a decent chance of paying back the NYFRB with interest.

Sunday, April 5, 2009

Are Creditors Sharing the Pain???

Tyler Cowen's NYT's article, titled,  Why Creditors Should Suffer, Too, slides over some fairly common misperceptions.  First, the counterparty issue:
The great beneficiaries have been the creditors and counterparties at the other end of A.I.G.’s derivatives deals — firms like Goldman Sachs, Merrill Lynch, Deutsche Bank, Société Générale, Barclays and UBS.
These firms engaged in deals that A.I.G. could not make good on. The bailout, and the regulatory regime outlined by Timothy F. Geithner, the Treasury secretary, would give firms like these every incentive to make similar deals down the road.
First, these are primarily counterparties, not creditors. They bought credit default swaps from AIG on multi sector super senior CDO's.  The counterparties used contracts that provided for collateral to be posted based on both the rating of AIG and the market value of the underlying CDO.  Because of this, they were largely protected from any deterioration in AIG's financial position.  In fact, by the time these were settled, the counterparties held about 50% of the face value of CDO's.
Thanks to an exemption from the Codes automatic stay - which bars all other creditors from terminating contracts with or seizing assets from a firm in bankruptcy - counterparties to derivatives contracts are free to terminate the contracts and then seize collateral to the extent that they are owed money.
It isn't clear what the actual losses are on the underlying credits, but the counterparties were very aggressive in demanding collateral, and may have held enough to completely avoid loss, regardless of AIG's future financial status.  So it was not possible to cram down losses to the counter parties on the most problematic AIG CDS's.  In fact, it was the continuing demands for collateral that precipitated AIG's initial cash problem in September.  

One could argue that the entire credit derivatives market should be eliminated or regulated, but at the time, the counterparties were fully collateralized and had no net risk.  

As far as the creditors, they have faced some steep haircuts already.  Citi put together a deal to essentially force holders of convertible preferred stock to swap it for equity.  Right now, Citi exchange traded debt sells for about 25 cents on the dollar, so to say they aren't sharing the pain isn't accurate.  From their press release
As announced on February 27, 2009, Citi is seeking to exchange approximately $27.5 billion in public and private preferred securities with a commitment from the U.S. Treasury to convert up to an additional $25 billion of its preferred securities for common stock. Assuming full participation of public preferred shareholders, Citi will convert into common shares approximately $52.5 billion in aggregate liquidation preference of preferred shares.
Exchange traded debt for Bank of America is currently selling for 50% of par. These shares sold at close to par within the last year, so the markets see the debt as being distressed.  Here are quotes on some BAC issues, which all have a par value of $25:

BAC-W BAC Capital Trust I $13.15
BAC-V BAC Capital Trust II $13.04
BAC-X BAC Capital Trust III $13.44
BAC-U BAC Capital Trust IV $11.11
BAC-Y BAC Capital Trust V $11.47
BAC-Z BAC Capital Trust VIII $11.29
BAC-B BAC Capital Trust X $11.40
BAC-C BAC Capital Trust XII $12.72

The markets are saying that the debt is distressed, and this exchanged traded debt trades frequently and in significant volume. Before encouraging the Treasury to push for some sort of concessions on these issues, don't forget that the original TARP invested public money in BAC preferred, pari passu with the existing preferred issues.  If it is necessary to convert shares similarly to Citi, it should be done by all means.  However, any debt above this level in seniority would require the more junior debt to take the first loss, and the Treasury needs to make sure that this step is essential.  

The equity goes first, then the preferred, and then the senior debt.  This is simply the capital structure of the bank, and losses must be taken in order of seniority.  This is the case, in or out of bankruptcy.  

All debt holders have taken a market loss so far.  The idea that they are being sheltered is exaggerated.  In addition, the senior debt holders aren't necessarily the enemy.  They are pension funds, mutual funds, etc.  Protection of the debt holders is, in some respects, an unintended consequence of a bailout, but it may well be fortuitous rather than unfortunate. 

Thursday, April 2, 2009

FASB Change

Based on the belief that it is important to go to primary sources, here it is for today's FASB board meeting.

All I will say is that it is complicated and defies summarization.

It clarifies what constitutes an orderly market.

It discusses how to measure and account for OTTI (other than temporary impairment).  As complex as this is, don't forget that the income has two components in GAAP -- Income and OCI or Other Comprehensive Income.  A huge amount of effort goes into this distinction that is important in theory but much less so in practice.  OCI hits the balance sheet.  I am a balance sheet type and don't really care so much for this single, arbitrary distinction.  
At the March 16, 2009 meeting, Chairman Herz announced that the FASB also would address other-than-temporary impairment issues, in conjunction with the project intended to improve the application guidance used to determine fair values under Statement 157. Proposed FSP FAS 115-a, FAS 124-a, and EITF 99-20-b on other-than-temporary impairments (OTTI) is intended to provide greater clarity to investors about the credit and noncredit component of an OTTI event and to more effectively communicate when an OTTI event has occurred. As proposed, the FSP would apply to both debt and equity securities. The proposed FSP requires separate display of losses related to credit deterioration and losses related to other market factors on the income statement. Market-related losses would be recorded in other comprehensive income if it is not likely that the investor will have to sell the security prior to recovery.
What this means is that a debt security (CDO, for example) can lose value due to either expected credit losses OR other factors including liquidity preferences, market or presumed market changes, etc. The non credit components would be amortized over the remaining life of the instrument.  This goes into a new bucket in the OCI statement:
The proposed FSP would result in a new category within other comprehensive income for the portion of the other-than-temporary impairment that is unrelated to credit losses for held-to-maturity securities.

This is similar to the treatment of unrealized capital gains(losses) in the income statement.  Presumably, the decision that more securities aren't valued based on orderly markets means that the details of how to account for changes in model valuation are now more important.  Hence the linking to OCI and OTTI.

OTTI has to hit regular income.  If a firm intends and has the ability to hold a security to maturity, then the market impairment that is not credit related does not go into OTTI but into this new bucket of OCI.  

Confused?  I'm sure that the intent is to exclude the non credit based piece from regulatory capital requirements.  

Derivative Accounting aka M2M Modified

I have blogged about this a number of times.  I have been against the expansion of mark to market accounting for a number of reasons.  Here are links/reasons.

1.  Mark to market liabilities are an inherent problem.  You don't want to do it, because of the GAAP going concern principle, but in for a dime.  Most people don't know about this or believe it.

3.  Citi books M2M liabilities.  Do people really want to do this?  The reason I wrote this is that people seemed to flat out deny that this was being done.

4.  An extensive comment on someone else's blog post regarding M2M.  

5.  A comment on a confusing WSJ article on m2m.  

6.  GE could, in theory, buy back some of its debt at a discount.  Hence the rationale for m2m liabilities.

As a general comment, people are finally starting to say things that aren't blatantly false or stupid on CNBC and in blogs and blog comments.  

It's about time.