Credit Snapshot Reports moved to ZeroHedge

We have moved our Credit Snapshot Reports to ZeroHedge's
Distributed Analysis and Research Aggregation
project which is going to be launched soon.

The HY conundrum

The Merrill Lynch High Yield Master II Index, often used when assessing the
state of the broad High Yield market, suggests that Junk bonds have returned
a whooping 51% year-to-date, thereby outperforming the SPX by a cool 29%.



I am notoriously sceptical about indices (reasons include geometric returns
versus dollar weighted returns, index inclusion/exclusion problem, changes
in share of CCC rated paper, etc). Looking at High Yield mutual fund indices
only partly solves such issues as these indices have their own flaws but f.i.
Lipper's HY index ytd return was in the low 40's  and thereby almost 10
percentage points (so actually 20%) lower than the Master II's.

Mid August 2008 was the time when the HY market started its bold down
move of -31% in less than three months.


Since that same August 2008 the ML index recovered and has eventually
returned roughly +14%, indicating that everyone in HY land should be well
ahead of their high water marks (which I doubt) and have outperformed the
SPX by 28% during that time.


Issuers went into this period with very high leverage and during that same
period reported earnings plunged to a degree not seen seen since 1871
(by 99%, that is), with y-o-y industrial production at -10.7%, y-o-y retail sales
down -5.3% and capacity utilization at 66.6%.

Defaults have so far come in somewhat below consensus expectation but some
issuers just had their chance to buy some time by extending their maturity
profile selling new crap debt, some did exchange offers and/or were able to raise
some capital. However, things don't nearly look as good as indices may suggest in
my view.

So here is my conundrum, which is actually two-fold:

1) High Yield indexes show stellar performance (even those including only
investable mutual funds, such as Lipper), implying investors in HY land
should be well ahead of their high water marks. Is that actually the case?
And if it is not - which I assume - where has all the positive index performance
come from?

2) A very serious deterioration on the operations front meets a return of some
+14% for the asset class since August 08. Why is it the case? Looks like the
markets are incredibly confident they can buy themselves out of the doldrums.

Not sure if these questions best be addressed by micro- or macro economists
as the former seem to be mostly wrong on particular things with the later being
just as wrong in general.

Distressed: long ZLOMREX 8.5% 2014

thesis @ ZH

WATCH PRICE TARGET - SPX Corp SPW 7.625% 12/15/2014

download SPX Corp Credit Snapshot
 
SPX Corp. is a diversified industrial company with its global operations organized into four
segments:
Flow Technology
Test and Measurement
Thermal Equipment and Services
Industrial Products and Services. 
SPX's markets include Food and Beverage, Power and Energy, Process Industries,
Heating, Ventilating and Air Conditioning, General Industrial, and Transportation.
As a global multi-industry manufacturer they have operations in more than 40
countries and make revenues in more than 150 countries and focus on the
global infrastructure development market, which accounts for approximately
half of the company's revenues.
2008 revenues by segments:
The company is a leading provider of transformers, cooling towers, heat exchangers and
other industrial hardware for power and other infrastructure projects. 
Geographical split of 2008 revenues and LT-assets
SPX's markets are cyclical and were negatively impacted by the global economic slowdown
(f.i. the tools and diagnostics business is week because its dependence on the Auto sector)
with industrial segment backlog down 44% from its peak.
The 4% Sequential Increase in Backlog in Q2 09 was driven by foreign currency fluctuations
and dry cooling contracts in China.
 
 
Longer term business perspectives are dependent on energy demand and energy
infrastructure investment and SPX may benefit from its global diversification. However,
management is not optimistic that SPX will benefit from US stiumulus since investments
are mostly directed towards alternative energy.  
The company historically operates at a relatively low leverage multiple.
 
The company does pay dividends in a USD 52 to 73MM annual range. 
...and engages in stock repurchases (113MM in Q1 09)
SPX does acquisitions frequently with the most significant recent deal being APV PLC, UK which
was acquired in December 07 for GBP 250MM and contributed about USD 800MM in revenues. 
However, company management made a capital allocation commitment on July, 29th 2009
(its most recent Q presenation) to stay away from stock repurchases or acquisitions and to
reduce debt until they have reached a leverage multiple of 2x.
link to Q2 2009 presentations
 
 
Free cash flow guidance for 2009 is in the USD 230 to 270MM range (working capital improvements on
lower revenue outlook and lower cash taxes).
 
In the following are some links to most recent SPX Corp research notes. You
will need your own log-in and password to read it. If you don't have one don't
be depressed since the notes in general are not terribly informative. 
GS

JPM

Barclays
Boa I
Boa II
 
       
Investment Description: 
     
             
                     
Despite the low earnings visibility we are constructive on the 2014 notes as a long position
with a price target of 101.0 (+503bp vs TSY 2.35%) based on the following key points:

generation of free cash flow
 low leverage
strong liquidity position (projected to be 1bln by year-end 2009)
clear commitment to reduce debt

 
The interest payment dates for  these notes are June 15 and December 15. The notes are
redeemable,  in whole, or in part, at any time prior to maturity at a price equal to 100% of
the principal amount plus a premium, plus accrued and unpaid interest.  In addition, at any
time prior to December 15, 2010 SPX may redeem up to 35% of  the aggregate principal amount
of the notes with the net cash proceeds of  certain equity offerings at a redemption price of
107.625%, plus accrued and  unpaid interest. In case of a change of control transaction, SPX
must offer to repurchase the notes at 101% of the aggregate principal amount of the notes
repurchased, plus accrued and unpaid interest.The notes are unsecured and rank equally with
all existing and future  unsecured senior indebtedness, but are effectively junior to the senior
credit  facilities. The indenture governing the notes contains covenants that, among  other things,
limit the company's ability to incur liens, enter into sale and leaseback  transactions  and
consummate some mergers.
 

 
At December 31, 2008, SPX was in  compliance with all covenant provisions of these senior notes.
 

 
SPX has agreed to  conduct a registered exchange offer for the notes and will use commercially
reasonable efforts to exchange the notes for a new issue of identical debt  securities within 150
days from February 28, 2009, if the notes are not freely  tradable before this date, and file under
certain circumstances a shelf  registration statement to cover resales of the notes and to cause
the  registration statement to be declared effective by the SEC. If they fail to  satisfy these obligations,
they have agreed to pay additional interest to holders  of the notes under certain circumstances.
 

 
SPX has a $2.26 billion (originally $2.3 billion) senior secured credit facility consisting of a $600
million revolving credit facility, $712 million (originally $750 million) term loan and $950 million
Foreign Credit Instrument Facility. All of these facilities mature September 21, 2012. The credit
facility is secured by 100% of all material domestic subsidiary stock and 65% of the company's
major foreign subsidiaries' stock. All borrowings are guaranteed by SPX's domestic subsidiaries
and SPX will guarantee all foreign subsidiary borrowings.
 

 
The credit facility has a springing lien if the corporate family rating is rated Ba2 or less (or
withdrawn) by Moody's and BB or less (or withdrawn) by S&P. The revolving credit facility is used
for working capital and letters of credit needs. It could be used for the company's stock repurchase
program. The term loan amortizes 10% per annum with a bullet payment at maturity. The Foreign
Credit Instrument Facility is used to support SPX's foreign operations and may be utilized for the
issuance of performance letters of credit and other forms of bank undertakings. The senior secured
credit facility also benefits from priority of claims it has in relation to the company's $549 million in
senior unsecured notes. 
 
  

 
The 2014 notes are junior to the obligations of the $2.26 billion senior secured credit facility.
The unsecured notes are pari passu to each other and are the most junior capital within SPX's
capital structure.
 
  

SPX maintains a $130 million accounts receivable program, which is annually renewable. 
Noticeable liabilities include an underfunded pension- and underfunded post retirement plan
at USD 303MM and USD 148MM respectively. An operating lease adjustment at 8x annual
rental results in a USD 412MM debt equivalent.
 
Covenants:
Leverage 3.25x
Coverage 3.5x

Liquidity as per 6/09:
 
At the end of Q2 SPX had USD 435MM in cash and USD 325.9 of availability under the
revolver and USD 274.3 of  available issuance capacity under our foreign trade facility. 





        
         
 
        
Catalysts/Key Risk Factors: 
                                       
Q3 announcement: on October 29th, 2009
 
Risk Factors:
Economic environment
Change in financial policy
Acquisitions 
Stock repurchases
Foreign exchange
Raw material costs
Competition
Litigation
Accounting
...
Disclaimer: D your own work and do not to rely upon this short write-up which
just represents a personal view and is no recommendations to buy or sell any securities.

Making fun of bankers still on the rise

Distressed Hedge Fund and Fund of Fund Indices

A sound banker...

A Sound banker, alas! Is not one who foresees danger and avoids
it, but one who, when he is ruined, is ruined in a conventional
and orthodox way along with his fellows, so that no one can re-
ally blame him. 
John Maynard Keynes, "The Consequences to the Banks
of the Collapse in Money Values," 1931 as stated in CHARLES
CALOMIRIS's Jackson Hole paper: The Subprime Turmoil: What’s
Old, What’s New, and What’s Next

http://www.kc.frb.org/publicat/sympos/2008/Calomiris.03.12.09.pdf

Business spending looks sort of weak...

USEC

USEC's numbers continue to look crappy, bonds traded down on 89MM volume to
high 50's when the collapse of the American Centrifuge Plant project was
announced. Stock down from 6.2 to 3.89 (not reflected in snapshot numbers yet).

A very unstable situation with no obvious compelling reason to have
a closer look.


USEC Inc

Insane Material Economy

For every one garbage can of waste "YOU"
put out on the curb, 70 garbage cans of waste
were made upstream just to make the junk
in that one garbage can you put out on the
curb (as per Worldwatch 1994). Think twice

"YOU" needs some clarification. For demonstrative
purposes the assumption is made that you are a
U.S. citizen which is a pretty dire hypothesis in 
this context. However, wherever you are you better
think twice before purchasing anything and everyone 
executing and/or investing in ideas to increase the
efficiency in our unsustainable materials economy
should get an extra hug.

The Story of Stuff

BIZ annual report released

http://www.biz.org/publ/arpdf/ar2009e.pdf?noframes=1



"What seems clear is that the deterioration in credit quality will generate
more losses on banks’ loan books and other credit exposures (see Chapter III).
Banks may therefore have an incentive to delay recognising losses, aided
by accounting rules that provide management more discretion over when to
write down assets. Taxpayers will not want to be exposed to greater potential
losses, but key financial institutions are likely to require more government
support in order to facilitate the required adjustments, to restore confidence
in the financial system and to restart lending on a sustainable basis."

Biz Report 

Stock Prices Divided by a Ten-Year Moving Average of Earnings, 1880-2009

Source: Brad DeLong, The Simplest Possible Behavioral Finance Bubble
Model, June 09

Killer Chart on foreign investor demand for US government sponsored debt

Look at this chart which shows how foreign investor demand for
Freddie Mac debt has crashed from 50% to 20% within one year!
Thanks to movie character Tyler Durden from Zero Hedge who brought
this to our attention. 



So far there seemed to have been a common believe that demand for U.S. securities
will hold up sufficiently well. This is mostly based on the fact(oid) that US
securities markets are so deep and liquid, far developed and well ruled by law,...

I broadly agree but submit a few more charts showing the same trend on other
types of U.S. government related debt and I will think twice. And so may others 
which would be reflected in market prices. Generally I am optimistic that US 
funding will be addressed but there seems to be a fast growing need to work on
and formulate an exit strategy.

Wrong Only

The liquidity crisis is over while the credit crisis is still ongoing. 
How to make money and to protect capital in this environment remains
to be the question. Dominant forces (partly working against each other)
are de-leveraging, saving and high demand for cash, re-deployment of cash
into equities and risk markets, artificial economic stimulus effects,
inventory liquidation, decreasing earnings due to economic weakness and
and lower leverage. 

Long only managers have in particular been challenged, given that most
of them want fully exposed into the downturn. And ironically they had
such large exposure even without the direct application of leverage to
their portfolios. However, since equity is a leveraged asset class per se
(especially when it comes to finanicals) their losses were very competitive
compared to other strategies. Changing risk appetite helped some of them to
partly miss out the upside of the quick bounce. Now a lot have re-deployed
cash which was sitting on the sidelines to chase performance even when
there is very weak fundamental support to the harsh up-move. 

How much sense does the long only approach make going forward and how much
faith will investors have? In my view it makes more sense to apply a more
flexible approach. Historical perceptions based on historical data should
give way to a more opportunistic and selective approach. Shortened time
horizons with a focus on price discrepancies and taking money off the table,
when asset getting close to being rich. The use of shorting, hedging, leverage,
and using derivatives all seem to make perfect sense to me.

U.S. Senate Banking Committee following the FED in getting heavily involved in Financial Weapons of Mass Destruction

by www.highyieldblog.com


The banking committee discussion on derivatives included a comprehensive
list of (well known) issues of the field of financial weapons of mass destruction.
 
Derivatives, securitizations and off-balance sheet exposure all were
contributing factors to the current crisis (as they have been in 1987
and 1998). Credit Default Swaps seem to have been the hot topic.
CDS are often falsely compared with insurance but actually I think
they should just be seen to mimic a long- or short credit position rather
than representing an insurance contract. The only difference is that
financial institutions do have to properly account for credit positions
which they obviously don't have to for CDS.

I have made a small list of the topics covered (they were discussed mostly
 on a very general level if not to say that only phrases have been exchanged).
I don't think that it makes any sense to discuss any of them in great length,
because they are all knowns and most of what has to be done seems to be
quite obvious. However, at the end of this post you will find a list of the topics
discussed (in no particular order and of course incomplete):

But had I fallen asleep during the hearing or was there a ban of a few topics?
I have in no word heard anyone talking about accounting or mark-to-market.
Also structured finance (ABS's, CDO's, etc.), which in my view is a huge deal,
has rarely been touched even when unrealized/unrecognized losses are huge
(and continue to be under development). This factor may even a (bad) reason
for regulatory bodies to slow down the needed changes because institutions/
government have a hard time to stomach (and finance) such further losses.
 
So I maybe have a slight idea why they did not want to touch this too much
but accounting definitely is another major topic which has been addressed at all.
 
Treasury secretary to the President: "Hey Mister President, our
WS friends just wiped out the whole banking system, largely with
instruments they did (partly not understand) and did not have to
account for properly, should we fix it right away or should we first
dry to bring in some more equity from dumb SWF funds and
some greenshoot dummies?"
 
There also was, long overdue, discussion of the "empty creditor" problem. I
missed clear language on a solution on this. In my view every debtholder
(or debtholders acting as a group) which hold(s) a "blocking position" in
one class of debt instruments should be subject to disclosure similar as
equity holders. They should fully disclose their holdings (insiders should
do so in the same way) and they should have to disclose all their
derivatives dealings in this company (same thing with insiders).
 
Junior Credit Hedgie to his boss: "Hey master of the universe,
our huge basis trades which we so easily were able to put on
our credit arb book during the crisis when everyone had to de-lever
- you remember those with the wide and (almost) riskless spreads
may not be available to us in the next credit cycle because even
the banking committee has recognized what is going on with this so called
"extra return" basis trades". Master of the universe: "Oh my god!
Do you mean those where we can put the companies into bankruptcy
by not answering the phone when they need us for any kind of out of
court restructuring?" "Yes master, but don't worry, the companies
will all hit the wall before the new  rules are in place."
 
One final topic I wanted to mention is the enormous difficulty everyone seems
to have to evaluate and trade these extraordinarily complex structured securities
(CDO's & ABS's). This is especially the case since the market has turned.
The talent to master such challenges was flowing freely until prices turned south
but since then no one seems to have the slightest clue if they should trade at
10 or 80 cents on the dollar. I tell you something: There is no problem at all,
other than that the prices moves and risen liquidity discounts have wiped out
large portions of equity. There is no lack of willing buyers.

The extend to which the models have been false is not the problem, it is rather
that the input variables have to be changed. And come one, we are talking
about pools of assets withing asset classes which are not completely exotics.
Most of them are well understood and hundreds of billions and more than a
trillion in size. But certainly everyone thinks we are talking about and dealing
in rare stamps.

Here is my suggestion: Let every CDO and ABS transaction done by a
broker/dealer to be print on TRACE (the reporting system for USD corporate
bond trading) in the same way ad B/D's have to report all USD denominated
corporate bonds trades. Within a few days everyone who has a basic
understanding of securitizations will be able to price each of those tens of
thousands of "exotic" instruments on each layer of the capital structure
within a range of at least 5 points.

Bank CFO to Bank CEO: "Vikram, call the government".

It is true that only a few trades take place each day but it is just not true that
one could not price them based on some market price points. At least it will
be clear than someone could not mark a junior tranche above the level of
where senior tranches are trading. There are other relatively simple ways
to improve transparency in those structures as well but I think no one is
interested in them. To mention two: require all dealers transacting in such
securities to post the full set of documents (indentures, trustee reports,
payment reports, marketing books, rating reports, prospectuses, term
sheets and a summary of the capital structure/waterfall features) into
a central and freely available website.

Require or incentives to simplify capital structures, structural
features and prospectuses.

Obviously the market prices of structured instruments are lower than
most would like them to be but I think recognizing will work, remove
the zombie factor from the system and re-mobilize private capital. 
The later one most probably only over a longer period of time I guess.

 
List of issues discussed in the banking committee hearing: 

- counterparty risk, systemic risk (too interconnected and/or too
big to fail), centralized clearing and notional risk reduction,
exchange trading, netting, margins/collateral,  capital requirements
 
- customized versus standardized contracts, derivatives written on
illiquid cash instruments, future innovation, link of derivatives markets
to securities markets, replication of economics without purchasing
instruments, shorting without securities lending in cash market,
legitimacy of exotic and non standard products (more than half is
standardized)
 
- transparency, efficiency, disclosure rules, reporting, price discovery,
electronic transmission of price data, trade information warehouse,
detailed reporting to regulators and dissemination of aggregates to
public, disclosure of material contracts by companies, hidden ownership
issues (f.i. equity total return swaps to avoid disclosure)
 
- insurable interest/credit protection as source of incentive for lenders
to put "empty creditors" into bankruptcy
 
- regulation of participants and marketplaces, enforcement against
fraud, shutdown of problematic practices, regulatory bodies (SEC,
CFTC, FED, Systemic Risk Regulator),  capturing of all regulatory gaps,
risk of creation of perverse incentives. regulating dealers, settlement
process, encouragement for exchange trading and standardization
(higher capital requirements for non-standardized products), need for
international cooperation, standardization challenges, circumvention
of dealers to hide transactions
 
- benefits of OTC derivatives to society (f.i. important to manage risk,
influence on capital formation), private and social costs and benefits,
risk of regulation for smaller players, retail investor protection
 
- problems of OTC- and dealer centric markets, bilateral transactions,
customer margin segregation, exotic transactions, systemic risk,
integrity, business conduct
 
- dealers profits and incentives (information advantage/anonymity), risk
management processes (operational risk, model risk, financial risk) and
challenges (complex, opaque, illiquid, difficult to value), risk controls,
trading limits, stress testing, types of market participants, real economic
hedges versus investment/speculation & trading, credit procedures for
counterparties
 
- buy side investor concerns, need for transparency and third party as
holders of collateral, backlog of unconfirmed and unprocessed trades
 

Nice joke from Dr. Henry Hu in front of the Banking Committee on Derivatives

Three econometricians go out hunting in Canada and see deer.

The one econometrician shoots and misses three feet on
the left. The second econometrician shoots and misses three
feet on the right. The third econometrician does not shoot
but shouts: "We have got it! We have got it!"

Share of the financial sector in GDP (in per cent)

The Japan banking problem in context...

long term CPI chart

chart: Arbor Research via Barry's big picture blog

Hedge fund leverage

Via: EFSR