In a piece entitled "Senior Bank Bank Holders - At Risk Or Not" Moody's analyst Sean Jones (not be confused with Egan-Jones' cofounder Bruce Jones) "considers this risk to be unlikely for banks that enjoy high systemic support. Such actions would run counter to the overall policy objectives underlying the provision of support to the banking system."
The problem with Sean's assumption is that for him to be correct, and for the massively upside down banking balance sheet to get fixed as some point, the government would have to fill the insolvency delta in the asset shortfall through either through above-market asset purchases or new cash from equity raises. If Citi's recent bailout is any example, the administration has made it all too clear it will not pursue any of these actions, thus leaving creeping equitization as the only option (of course, absent nationalization), which is why Zero Hedge disagrees with Moody's on this one (and many more), and as I wrote previously, bank sub debt holders also do not share Sean's optimism.
Jones does cover some bases in case unbridled optimism (Moody's trademark) is not the right play anymore: "Even at banks that are very likely to receive support, there remain the risks of coupon suspensions or of distressed exchanges for preferred shares."
Moody's full statement on potential bondholder risks is presented below.
Senior Bank Bond Holders -- at Risk or Not?Sphere: Related Content
Over the past week, a growing number of bondholders have expressed concerns that they risk being forced to incur losses because of government pressure on the banks that receive public assistance. This concern has been fueled both by widespread media attention and by some members of Congress.
Nevertheless, we consider this risk to be unlikely for banks that enjoy high systemic support. Such actions would run counter to the overall policy objectives underlying the provision of support to the banking system. Having said this, risks to bondholders do indeed increase for lower priority capital instruments and for those that hold the debt of weaker banks that are less important to the nation’s financial system.
The US banks that we believe benefit from very high systemic support are the Bank of America, Bank of New York, Citigroup, JPMorgan Chase, and Wells Fargo; for these institutions, we see the likelihood of senior or senior subordinated creditors taking losses as being very modest. If senior or senior subordinated creditors were made to suffer losses, the risk that systemic credit flow would contract increases, thus prompting further market turmoil and economic damage. Such an outcome is directly contrary to the Administration’s policy goals, which are to instill confidence in the financial industry and to restore the flow of credit in the economy.
Of course, we do differentiate, or notch, ratings to reflect the relative positioning of various security classes. This is done based upon their positions in the capital structure or in the legal framework of an entity. Subordinated creditors are clearly in an inferior position to senior debtholders, and those owning holding company obligations are certainly behind bank creditors in priority. In both cases, however, we believe all of these creditors should benefit from some systemic support, albeit to different degrees.
Even at banks that are very likely to receive support, there remain the risks of coupon suspensions or of distressed exchanges for preferred shares. This situation is especially true for those institutions whose noncumulative preferred coupon payments impair their abilities to replenish capital from earnings. Consequently, the notching among these instruments and senior and subordinated debt ratings is likely to widen in cases where a bank’s financial strength rating declines.
Sean Jones
Senior Vice President
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18 comments:
Business as usual.
(link to Primus press release)
Tyler, why do you believe the government won't make (or rather incentivize others to make) "above-market asset purchases"? I thought that is the whole point of the PPIF. I am not trying to sound ironic or sarcastic. I would really like to know why you don't beleive that is treasury's true intent. Thanks for any response.
yves has a good post on the issue today:
http://www.nakedcapitalism.com/2009/03/now-its-official-public-private.html
also, i have written on the topic in a variety of posts here just dont remember which ones.
IF Moody's is right (and I dont believe they are) there are SCREAMING buys in the middle of the capital structure of these banks.
beyond belief
so the govt actually has the ability to make good in case of a credit event at one of these institutions?!
i recommend you take a look at lehman's recovery values for a reality check
beyond belief
so the govt actually has the ability to make good in case of a credit event at one of these institutions?!
i recommend you take a look at lehman's recovery values for a reality check
Tyler, isn't Yves post just the opposite of your stated position, that the Treasury will in fact arrange for above-market purchaes?
what are the odds that Sean lives to regret that letter............
not at all. the government has been trying ALL ALONG to find loopholes to buy toxic assets (or rather for banks to sell assets) at way above market prices. that is the only way for equity capital to be worth something above the debt. As Yves points out this was the thought behind MLEC, TARP and now TALF...even MTM suspension is essentially a way to short circuit price discovery and find greater fools to buy BBB rated CMBS (for example) at 80 cents when it barely trades at 35. the public is now on to this rouse which is why the admin has taken to looking at the liabilities side of the equation: you can only adjust two things: equity (i.e. issue more stock and dilute) or reduce debt (equitize). the last is exactly what Citi was and I believe (until proven otherwise) this is how the gov't will continue to try to allign assets with liabilities + equity
OK, so you are a senior bondholder and the government decides to give you a haricut of some sort. Can't you then legally put the company into liquidiation? The new owner (the government) isn't paying their obligations... that's bankruptcy right?
Well if the one thing the gov't wants to avoid is pushing the "systemically important" into bankruptcy, then why would the give SENIOR bondholders a haircut?
Please point out where I'm wrong.
the way it would work is a portion of holders would be "incented" to convert into a lower class of securities, the same way the public preferred got "preferrential" terms to convert to common. It is not a default as there has not been a trigger bankruptcy event. the co continues paying interest on the non-converting piece of sub/sr debt
Moody's can't be wrong all the time (as much as they try.) It is probably a fluke but I think they are correct in this instance, though their reasoning is flawed.
Give it up on the toxic assets. They are just like the Weapons of Mass Destruction we spent so many months searching for. The way you and Yves go on about them, you would think that they were 120% of bank assets.
There are assets that are marked down and assets that are non-performing but the current level of those are manageable. The problems that banks need to worry about is the assets that are currently performing but about to go bad especially Commercial Real Estate mortgages and Credit Card receivables.
The question is whether they can gouge their good customers enough to pay for all their bad customers. I personally have faith in the ability of banks to gouge their customers (having experienced it myself.)
In May, Moody's also said that the government wouldn't let any major CDS dealer (including Lehman) fail. From the May 2008 report:
"The more important the function played by an institution, the more likely it is to be considered by regulators to be 'too big to fail' or 'too complex to unwind'. Thus, a systemically important institution would be more likely to trigger intervention from the regulatory authorities to prevent a disorderly liquidation that may imperil the broader financial system. Indeed, this is what happened with Bear Stearns, when the Federal Reserve and JPMorgan Chase stepped in to save it from collapsing.
"The largest CDS dealers are highly rated securities firms and banks, which play systemically important roles in the efficient functioning of the financial markets. ... In Moody’s opinion, the systemic importance of these firms [which included Lehman] therefore provides meaningful incentives to regulatory authorities to prevent such firms’ disorderly failure, given the disruptive effect this would likely have on the derivatives market."
Moody's = garbage. End of story.
I'm not sure what the relevance of sub debt holders views is to the likelihood of senior debt holders being paid off. Nobody expects sub debt holders to be paid off in a worst case scenario, bailout or no. The whole point is that they're subordinated. Conversely, governments all over the world have gone to enormous lengths to indicate they will not let senior bondholders of systemically important firms take any credit losses. Now, they may not be able to follow through on that (think Iceland) but the argument is hardly Moody's alone.
Bank bondholders need to take haircut, probably from being forced to exchange their bonds for equity in the banks. But, if governments force this equitization, then a default event occurs and all the off-balance sheet CDS's written on those bonds become payable.
What if: To reduce to a more manageable level, the net proceeds of these CDS payouts due CDS holders, governments, collaborating worldwide, enact (say) a 90% tax on proceeds of CDS's to holders without an insurable interest. (see Willem Buitner's column "Should you be able to sell what you do not own? at http://blogs.ft.com/maverecon/ ). Then the various governments' share of CDS proceeds could simply be forfeited and left with the payor/obligor. It seems this would mitigate the panic from a forced equitization of bank bonds...
Got a question. If I have a contract with one of these banks (e.g. Citi or BofA) to receive a commodity every month for the next few years, what's the risk that they default on the contract? The contract is with the commodity arm of the bank and fully guaranteed by the parent bank.
I'd think that this sort of obligation is even more robust than a senior bond, as there is no way to force the commodity obligation into a lower part of the capital structure.
Any thoughts on this?
contracts and liens are the most difficult to modify in bankruptcy. for a contract to be reneged, things would need to get very ugly... although let's not forget lehman bonds which were 80 pre filing and 10 3 days post... another reason why nobody obviously mark anything even remotely close to market
"The US banks that we believe benefit from very high systemic support are the Bank of America, Bank of New York, Citigroup, JPMorgan Chase, and Wells Fargo; for these institutions, we see the likelihood of senior or senior subordinated creditors taking losses as being very modest."
Although I see your point, I'm going to go with Moody's on this as a political prediction.
Don the libertarian Democrat
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