Wednesday, March 11, 2009

I still think that senior unsecured debt of most major banks is probably safe

From Felix Salmon:

Bank Funding Datapoint of the Day

Bloomberg reports:

Contracts on the Markit iTraxx Financial index of credit-default swaps linked to the senior debt of 25 banks and insurers were more expensive today than the Markit iTraxx Europe corporate index. That hasn't happened since Lehman Brothers Holdings Inc. went bankrupt in September and, before that, JPMorgan's takeover of Bear Stearns, according to BNP Paribas. It reflects "systemic stress" in the financial system.

So much for rallying confidence in the banking system. This is senior debt we're talking about here, not subordinated debt (which often doubles as regulatory equity). Another word for senior debt is "wholesale funding": if a bank doesn't have a large deposit base, then it makes its money on the spread between its senior debt and the rate at which companies and other clients borrow from it. If that spread is now negative, then it's hard to see how the banking system as a whole can be nearly as profitable as the likes of John Hempton seem to think. (Yes, I know I'm conflating CDS spreads with actual funding costs. I suspect that the actual funding spreads are if anything wider than the CDS spreads.)

Indeed, far from seeing profits, the markets seem to be forecasting outright defaults, certainly on the subordinated debt, and possibly on the senior unsecured as well:

"The current prices imply that the companies' equity is worthless, the government's investment is worthless and subordinated debt holders will lose some of their investment," said David Darst, an analyst at FTN Equity Capital Markets in Nashville, Tennessee.

What's more, if bank-debt spreads stay at their present level for any length of time, they're likely to become increasingly self-fulfilling. Right now, these prices represent significant unrealized losses for people who bought at par. But increasingly they're going to start representing significant potential gains for people who are buying at today's levels and hoping to be paid off at par -- paid off, that is, essentially by taxpayers. Since those people can be broadly characterized as hedge-fund managers, one can foresee a lot of Congressional pushback if a large number of hedgies start pulling in tens of millions of dollars just by playing the moral hazard trade. Or, to put it another way, it's a lot easier to impose a haircut when a haircut is priced in than when it isn't.

I still think that senior unsecured debt of most major banks is probably safe, although the WaMu precedent does give me pause. But anything which can be considered equity is increasingly looking like fair game."


"But anything which can be considered equity is increasingly looking like fair game."

Fair game? More like game over. I'm ready to throw in the towel. William Gross has won this round. Some of these bondholders are going down with the system. They're taking us with them if they can. Some of them are countries, after all. Let's just guarantee these bondholders and regroup, if we've got the brass. They were toying with us. They hold all the cards right now anyway. It's time to start humming "Brazil".

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