This morning we’ve got CSPAN on in the background to keep up with the latest house hearings on the TARP program. Each time a congress person speaks I’m reminded of why our problems are going to be with us for a while. Here is a big part of the problem...I heard a politician say the following:
“the problem is that to date the Treasury hasn’t come up with a loan modification program to help worthy borrowers stay in their homes.”
This congress person is one of many that are in a position to influence the course of this “financial rescue/bailout/TARP boondoggle/yard sale/circus” and they don’t even understand that WORTHY borrowers don’t need loan modifications. Worthy borrowers can manage their finances, worthy borrowers pay you back, worthy borrowers honor their commitments. I heard a lot of talk in those hearings from politicians telling banks how to run their shop. I heard no mention of credit quality from those that are pushing banks to deploy the TARP money in loans. The rhetoric is essentially “we gave you this TARP money now you need to go lend it out in the same manner that got us into this mess. Loan it to anybody…give people more loans and credit cards regardless of whether they can pay you back.” I find it disturbing…we just turned off the TV.
Asking congress to fix the financial crisis is like asking the trash man to do brain surgery (no offense to any sanitation engineers that may be on this distribution list).
What’s available?
As I look across the short end of the yield curve I see lot of products trading at yield levels lower than one-quarter of one percent.
Fed Funds 6 basis points (per Bloomberg)
1 month T bill 2 basis points
3 month T bill 1 basis point (yesterday this was a negative 1 basis point)
1 year T bond 46 basis points
On the short end banks have been buying a lot of seasoned MBS paper at great spreads. Short corporate bonds with “A” or better ratings that have also received government support are trading at very high spreads to Treasuries and offer a great alternative to Fed Funds. We’re seeing 3 to 6 month paper in this sector trading anywhere from 3% to 7% (these are the same companies that are CURRENTLY issuing FULL FAITH AND CREDIT PAPER under the TLGP program!). Agency Callable bonds in the 1 to 3 year range are trading from 1.3% to just over 3.00%.
On the longer end, seasoned 20 year SBA paper has been in high demand due to the full faith and credit guaranty, monthly cash flow, and wide spreads. One additional benefit is that the cash flows on SBA paper are driven by different factors than MBS cash flows, which provides a nice bit of cash flow diversification for those that already have a high concentration of MBS in the portfolio.
There is a brand new bond available to you…Full Faith and Credit Corporate bonds issued through the TLGP program. These are corporate bonds that are 20% risk weighted that carry the explicit full faith and credit guaranty of the US Government. The TLGP Full Faith and Credit guaranty runs through June of 2012. If you buy bonds that mature on or before that date you have the same credit quality as a US Treasury bond. Two examples are:
Regions Bank 3.25% due 12/09/11 offered at approximately a 3.13% yield. That is 200 bps over the 3 year Treasury…on a full faith and credit, 20% risk weighted, corporate bullet.
Suntrust Floating rate bond due 12/16/10, full faith and credit, floats at 3 month Libor +65 bps…currently a 2.09 yield (109 bps over Target Fed Funds).
What to watch for:
Spreads on Agency bonds over Treasury securities have been widening since May. This spread widening is the reason the Agencies haven’t been able to call a lot of their outstanding debt. In a more normal market the Agencies would have had a tremendous opportunity to refinance a large percentage of their outstanding debt by calling bonds and re-issuing them at lower rates. Spreads have begun to tighten recently and we’ve already seen an uptick in called bond activity. With Treasury yields at 60 year lows it won’t take much in the way of spread tightening on Agencies to unleash an avalanche of called bonds. We have analytics available to help you monitor bonds that are likely to be called based on current rates. If you’d like to monitor your potential cash flow volatility with this report just let us know and we’ll get you set up.
After reaching a crescendo in November, MBS spreads have tightened dramatically over the last few weeks. The Treasury and the Fed are committing a lot of resources to drive spreads on MBS product lower. The graph below shows the benchmark 15 year current coupon MBS yield as a spread over the 5 year Treasury. That spread has collapsed from 311 basis points in mid-November to 210 basis points this morning. The long term average spread on this index is around 125 basis points. There is still room for more spread tightening as we move through this crisis toward a more normal market.
The Fed Funds futures market continues to price in a 100% chance of a 75 basis point cut at the December 16 FOMC meeting…this would put the target rate at 25 basis points. The Fed will pay you the target rate so you could get that level from them…correspondent banks will likely be paying far less. If you’re looking for places to keep short term liquidity…Fed Funds will likely remain the least attractive option.
If you have any questions on this material or if there is anything I can be doing for you just let me know.
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