+ All Categories
Home > Documents > The Subprime Mortgage Crisis and Its Impact on the Tax ... Subprime... · Fear Factor: Credit...

The Subprime Mortgage Crisis and Its Impact on the Tax ... Subprime... · Fear Factor: Credit...

Date post: 02-Oct-2020
Category:
Upload: others
View: 0 times
Download: 0 times
Share this document with a friend
47
Presented by: Jeremy Bass The PFM Group 99 Summer Street, Suite 1020 Boston, MA 02110 The Subprime Mortgage Crisis and Its Impact on the Tax-Exempt Market CHEFA Board Meeting January 22, 2008
Transcript
Page 1: The Subprime Mortgage Crisis and Its Impact on the Tax ... Subprime... · Fear Factor: Credit Spreads Widen on Subprime PFM Mortgage Woes • The yield difference or spread between

Presented by: Jeremy Bass

The PFM Group99 Summer Street, Suite 1020Boston, MA 02110

The Subprime Mortgage Crisis andIts Impact on the Tax-Exempt Market

CHEFA Board Meeting

January 22, 2008

Page 2: The Subprime Mortgage Crisis and Its Impact on the Tax ... Subprime... · Fear Factor: Credit Spreads Widen on Subprime PFM Mortgage Woes • The yield difference or spread between

1

PFMTable of Contents

I. Housing Overview and Mortgage Securitization

II. Credit Spreads

III. Bond Insurance

IV. Variable Rate Debt Market

V. Swap Counterparty Risk

VI. Investment Considerations

VII. Summary and CHEFA Considerations

Page 3: The Subprime Mortgage Crisis and Its Impact on the Tax ... Subprime... · Fear Factor: Credit Spreads Widen on Subprime PFM Mortgage Woes • The yield difference or spread between

2

PFM

HOUSING OVERVIEW AND MORTGAGE SECURITIZATION

Page 4: The Subprime Mortgage Crisis and Its Impact on the Tax ... Subprime... · Fear Factor: Credit Spreads Widen on Subprime PFM Mortgage Woes • The yield difference or spread between

3

PFMHousing Market Boom…Existing and New Home SalesJanuary 2001 – December 2005

Source: Bloomberg

3,000,000

4,000,000

5,000,000

6,000,000

7,000,000

8,000,000

9,000,000

2001 2002 2003 2004 2005

New Homes

Existing Homes

Page 5: The Subprime Mortgage Crisis and Its Impact on the Tax ... Subprime... · Fear Factor: Credit Spreads Widen on Subprime PFM Mortgage Woes • The yield difference or spread between

4

PFMHousing Market Boom…Building Permits and Housing Starts

January 2001 – December 2005

Source: Bloomberg

05

1500

1600

1700

1800

1900

2000

2100

2200

2300

2400

Jan01

Apr01

Jul01

Oct01

Jan02

Apr02

Jul02

Oct02

Jan03

Apr03

Jul03

Oct03

Jan04

Apr04

Jul04

Oct04

Jan05

Apr05

Jul05

Oct

Building Permits

Housing Starts

Page 6: The Subprime Mortgage Crisis and Its Impact on the Tax ... Subprime... · Fear Factor: Credit Spreads Widen on Subprime PFM Mortgage Woes • The yield difference or spread between

5

PFMHousing Market Boom…Home Values

January 2001 – December 2005

Source: Bloomberg

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

14.00%

16.00%

18.00%

Mar01

Jun01

Sep01

Dec01

Mar02

Jun02

Sep02

Dec02

Mar03

Jun03

Sep03

Dec03

Mar04

Jun04

Sep04

Dec04

Mar05

Jun05

Sep05

Dec05

Page 7: The Subprime Mortgage Crisis and Its Impact on the Tax ... Subprime... · Fear Factor: Credit Spreads Widen on Subprime PFM Mortgage Woes • The yield difference or spread between

6

PFM…and Bust

Existing and New Home SalesJanuary 2003 – November 2007

Source: Bloomberg

3,000,000

4,000,000

5,000,000

6,000,000

7,000,000

8,000,000

9,000,000

2003 2004 2005 2006 2007

New Homes

Existing Homes

Page 8: The Subprime Mortgage Crisis and Its Impact on the Tax ... Subprime... · Fear Factor: Credit Spreads Widen on Subprime PFM Mortgage Woes • The yield difference or spread between

7

PFM…and BustBuilding Permits and Housing Starts

January 2003 – November 2007

Source: Bloomberg07

1100

1300

1500

1700

1900

2100

2300

2500

Jan03

Apr03

Jul03

Oct03

Jan04

Apr04

Jul04

Oct04

Jan05

Apr05

Jul05

Oct05

Jan06

Apr06

Jul06

Oct06

Jan07

Apr07

Jul07

Oct

Building PermitsHousing Starts

Page 9: The Subprime Mortgage Crisis and Its Impact on the Tax ... Subprime... · Fear Factor: Credit Spreads Widen on Subprime PFM Mortgage Woes • The yield difference or spread between

8

PFM…and BustHome Values

January 2003 – September 2007

Source: Bloomberg

-10.00%

-5.00%

0.00%

5.00%

10.00%

15.00%

20.00%

Mar03

Jun03

Sep03

Dec03

Mar04

Jun04

Sep04

Dec04

Mar05

Jun05

Sep05

Dec05

Mar06

Jun06

Sep06

Dec06

Mar07

Jun07

Sep07

Page 10: The Subprime Mortgage Crisis and Its Impact on the Tax ... Subprime... · Fear Factor: Credit Spreads Widen on Subprime PFM Mortgage Woes • The yield difference or spread between

9

PFMSubprime Lending

• The practice of making loans to borrowers who do not qualify for the best market rates because their credit history is less than ideal.– Benefits – Gives credit to people who would not otherwise not

have access to the credit markets– Downsides – Can likely lead to default, seizure of collateral and

foreclosures

Page 11: The Subprime Mortgage Crisis and Its Impact on the Tax ... Subprime... · Fear Factor: Credit Spreads Widen on Subprime PFM Mortgage Woes • The yield difference or spread between

10

PFMThe Subprime Mortgage/ Variable Rate Connection

Variable25%

Fixed75%

Variable67%

Fixed33%

Percent of Total Mortgages Percent of Subprime Mortgages

Source: Bloomberg and Bankrate.com

Page 12: The Subprime Mortgage Crisis and Its Impact on the Tax ... Subprime... · Fear Factor: Credit Spreads Widen on Subprime PFM Mortgage Woes • The yield difference or spread between

11

PFMForeclosures IncreaseAdjustable Subprime Foreclosures as a Percentage

of All LoansMarch 2002 – September 2007

Source: Bloomberg

Adjustable Rate

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

5.0%

Mar-02 Dec-02 Sep-03 Jun-04 Mar-05 Dec-05 Sep-06 Jun-07

Adjustable Rate

Page 13: The Subprime Mortgage Crisis and Its Impact on the Tax ... Subprime... · Fear Factor: Credit Spreads Widen on Subprime PFM Mortgage Woes • The yield difference or spread between

12

PFMSIV – Structured Investment Vehicles

• Companies created by banks and other firms to sell short-term debt to buy assets and finance company bonds with higher yields.

SIV InvestorsAsset-Backed

Securities

PurchasesSecurities

Repayments ofUnderlying Assets

IssuesCommercial Paper

Purchases CPReceive $

Page 14: The Subprime Mortgage Crisis and Its Impact on the Tax ... Subprime... · Fear Factor: Credit Spreads Widen on Subprime PFM Mortgage Woes • The yield difference or spread between

13

PFMAsset-Backed Securities

• Linked to packages of mortgages – including subprime mortgages

• Pass through Securities – As mortgage payments are made they are passed through to investors

• Defaults in Mortgages causing problems for owners of these securities– Cash Flows have essentially dried up– SIV are defaulting or near default– Causing Financial Institutions to report huge losses

Page 15: The Subprime Mortgage Crisis and Its Impact on the Tax ... Subprime... · Fear Factor: Credit Spreads Widen on Subprime PFM Mortgage Woes • The yield difference or spread between

14

PFM

CREDIT SPREADS

Page 16: The Subprime Mortgage Crisis and Its Impact on the Tax ... Subprime... · Fear Factor: Credit Spreads Widen on Subprime PFM Mortgage Woes • The yield difference or spread between

15

PFMFear Factor: Credit Spreads Widen on SubprimeMortgage Woes

• The yield difference or spread between risk-free (Treasury bills) and risky (LIBOR deposits) assets historically widens in times of financial stress

– After narrowing in September, spread has moved back out near August highs on new bank charges, losses

3-Mo LIBOR - Treasury Bill SpreadWeekly Data, December 10, 1993 - January 11, 2008

0

0.25

0.5

0.75

1

1.25

1.5

1.75

2

2.25

12/1

0/93

6/10

/94

12/1

0/94

6/10

/95

12/1

0/95

6/10

/96

12/1

0/96

6/10

/97

12/1

0/97

6/10

/98

12/1

0/98

6/10

/99

12/1

0/99

6/10

/00

12/1

0/00

6/10

/01

12/1

0/01

6/10

/02

12/1

0/02

6/10

/03

12/1

0/03

6/10

/04

12/1

0/04

6/10

/05

12/1

0/05

6/10

/06

12/1

0/06

6/10

/07

12/1

0/07

Spre

ad (

%)

Avg: 0.43% Min: 0.7 Max: 2.08 Std: 0.27

Russian debt default crisis

U.S. sub-prime mortgage crisis

Page 17: The Subprime Mortgage Crisis and Its Impact on the Tax ... Subprime... · Fear Factor: Credit Spreads Widen on Subprime PFM Mortgage Woes • The yield difference or spread between

16

PFMFlight-to-Quality in U.S. Bond Market

Rate Changes - January 2, 2007 to Present

2.50

3.00

3.50

4.00

4.50

5.00

5.50

6.00

1/2/

2007

2/2/

2007

3/2/

2007

4/2/

2007

5/2/

2007

6/2/

2007

7/2/

2007

8/2/

2007

9/2/

2007

10/2

/200

711

/2/2

007

12/2

/200

71/

2/20

08

Date

Inte

rest

Rat

eTreasury 1 yrTreasury 30 yrAAA GO 30 yr

BAA GO 30 yrA Hospital 30 yr

Source: Thomson Financial

IndexRate Change - 1/2/07 to

1/17/2008

Treasury 1 yr -2.19%

Treasury 30 yr -0.53%AAA GO 30 yr 0.04%BAA GO 30 yr 0.58%A Hospital 30 yr 0.58%

Page 18: The Subprime Mortgage Crisis and Its Impact on the Tax ... Subprime... · Fear Factor: Credit Spreads Widen on Subprime PFM Mortgage Woes • The yield difference or spread between

17

PFMFlight-to-Quality in U.S. Bond Market

Change in credit spreads - January 2, 2007 to Present

-0.60-0.40-0.200.000.200.400.600.801.001.20

1/2/

2007

2/2/

2007

3/2/

2007

4/2/

2007

5/2/

2007

6/2/

2007

7/2/

2007

8/2/

2007

9/2/

2007

10/2

/200

7

11/2

/200

7

12/2

/200

7

1/2/

2008

Date

Inte

rest

Rat

e Sp

read

Spread 30 Year Treasury to "A" Hospital

Spread 30 Year "AAA" MMD to "A"Hospital

Source: Thomson Financial

IndexSpread Change - 1/2/07 to

1/17/2008Spread 30 Year Treasury to "A" Hospital 1.11%Spread 30 Year "AAA" MMD to "A" Hospital 0.54%

Page 19: The Subprime Mortgage Crisis and Its Impact on the Tax ... Subprime... · Fear Factor: Credit Spreads Widen on Subprime PFM Mortgage Woes • The yield difference or spread between

18

PFM

BOND INSURANCE

Page 20: The Subprime Mortgage Crisis and Its Impact on the Tax ... Subprime... · Fear Factor: Credit Spreads Widen on Subprime PFM Mortgage Woes • The yield difference or spread between

19

PFMRadian

• On July 24th Radian, a “AA” bond insurer, reports net income of $21.1 million for Q2, a 86% decline from the period last year causing disruption for planned merger with MGIC.

• On July 31st Fitch puts Radian’s AA on negative watch, saying the rating would drop at least one notch if its merger with MGIC fails.

• One August 20th MGIC sues Radian in federal court, calling for it to turn over information MGIC says it needs to decide whether or not to move forward with the merger.

• On September 5th Fitch downgrades Radian to “A+” and the next day Radian asks Fitch to withdraw its ratings. Fitch is the only one of the major three rating agencies to downgrade Radian.

• Beginning in August and continuing today institutions with variable rate debt backed by Radian insurance saw their rates increase 75 – 300 basis points (depending on underlying rating and investors).

Page 21: The Subprime Mortgage Crisis and Its Impact on the Tax ... Subprime... · Fear Factor: Credit Spreads Widen on Subprime PFM Mortgage Woes • The yield difference or spread between

20

PFMRadian variable rate performance

Auction Rate Performance - Griffin Hospital (Radian Insured)

2.90%

3.40%

3.90%

4.40%

4.90%

5.40%

5.90%

6.40%

6.90%

7.40%5/

15/0

7

5/29

/07

6/12

/07

6/26

/07

7/10

/07

7/24

/07

8/7/

07

8/21

/07

9/4/

07

9/18

/07

10/2

/07

10/1

6/07

10/3

0/07

11/1

3/07

11/2

7/07

12/1

1/07

12/2

5/07

1/8/

08

Date

Inte

rest

Rat

e

Series C Series D - Taxable SIFMA 1-Month LIBOR

Page 22: The Subprime Mortgage Crisis and Its Impact on the Tax ... Subprime... · Fear Factor: Credit Spreads Widen on Subprime PFM Mortgage Woes • The yield difference or spread between

21

PFMOther Bond Insurers

• In October, the rating agencies announced they would be taking a look at the capital adequacy of all of the bond insurers to determine if those companies need to raise capital in order to preserve their existing ratings given exposure to subprimethrough direct guarantees and credit default swaps

Page 23: The Subprime Mortgage Crisis and Its Impact on the Tax ... Subprime... · Fear Factor: Credit Spreads Widen on Subprime PFM Mortgage Woes • The yield difference or spread between

22

PFMBond Insurance Residential Mortgage Backed Security (RMBS) Exposure

ACA Assured Guaranty Ambac CIFG FGIC FSA MBIA Radian XLCA

Total RMBS Exposure (Mil. $) $8.5 $10,325.0 $34,728.0 $3,348.2 $28,976.5 $18,635.8 $29,674.2 $627.2 $8,769.5

RMBS Rating DistributionAAA 0.00% 81.80% 18.00% 57.00% 12.30% 51.90% 26.10% 25.70% 34.30%AA 0.00% 3.40% 4.80% 0.80% 3.50% 4.20% 1.30% 3.00% 17.50%A 0.00% 1.70% 17.20% 11.00% 15.80% 0.70% 4.90% 12.40% 2.60%BBB 0.00% 12.50% 56.10% 30.20% 66.30% 26.30% 54.80% 31.00% 45.60%BB and lower 100.00% 0.50% 3.80% 1.00% 2.10% 16.80% 13.00% 28.00% 0.00%

Total Projected Losses (Mil. $) $0.0 $51.5 $1,647.3 $161.4 $2,305.3 $382.6 $3,009.4 $1.6 $596.0

Present Value of Losses (Mil. $) $0.0 $44.6 $1,426.4 $139.8 $1,996.2 $331.3 $2,605.9 $1.4 $516.1

After Tax Net RMBS Losses $0.0 $29.0 $927.1 $90.8 $1,297.5 $215.3 $1,693.8 $0.9 $335.4

Source: Standard & Poor’s report dated December 19, 2007

Page 24: The Subprime Mortgage Crisis and Its Impact on the Tax ... Subprime... · Fear Factor: Credit Spreads Widen on Subprime PFM Mortgage Woes • The yield difference or spread between

23

PFMBond Insurance Turmoil• The existing status of the bond insurers ratings is presented below

– FSA and Assured Guaranty are the only AAA insurers with stable ratings from all three agencies

– MBIA and Ambac put on Negative Watch last week by Moody’s– Ambac downgraded two notches by Fitch to “AA” on Friday, January 18th

Insurer Prior

RatingRevised Rating

Prior Outlook Revised Outlook

Prior Rating

Revised Rating

Prior Outlook Revised Outlook

Prior Rating

Revised Rating

Prior Outlook Revised Outlook

FGIC Aaa Aaa StableNegative Watch

(12/14/2007) AAA AAA StableNegative Watch

(12/19/2007) AAA AAA StableNegative Watch

(12/17/2007)

MBIA Aaa Aaa StableNegative Watch

(1/17/08) AAA AAA StableNegative

(12/19/2007) AAA AAA Stable Stable (1/16/08)

XL Capital Aaa Aaa StableNegative Watch

(12/14/2007) AAA AAA StableNegative

(12/19/2007) AAA AAA StableNegative Watch

(12/12/2007)FSA Aaa Aaa Stable Stable AAA AAA Stable Stable AAA AAA Stable Stable

CIFG Aaa Aaa StableNegative

(12/14/2007) AAA AAA StableNegative

(6/7/2007) AAA AAA Stable StableAssured Guaranty Aaa Aaa Stable Stable AAA AAA Stable Stable AAA AAA Stable Stable

Ambac Aaa Aaa StableNegative Watch

(1/16/08) AAA AAA StableNegative

(12/19/2007) AAA AA StableNegative Watch

(12/21/2007)

ACA NR ACCC

(12/19/2007)Negative Watch

Developing Watch(12/19/2007) NR

Radian Aa3 Aa3 Stable Stable AA AA Negative Stable (6/29/2007) AAA+

(9/5/2007)

Negative Watch

(7/31/2007)Evolving Watch

(9/5/2007)

Moody's Investor Services Standard & Poor's Rating Services Fitch Rating Services

Page 25: The Subprime Mortgage Crisis and Its Impact on the Tax ... Subprime... · Fear Factor: Credit Spreads Widen on Subprime PFM Mortgage Woes • The yield difference or spread between

24

PFMBond Insurance Trading Spreads• Currently FSA and Assured Guaranty have not

seen a material impact on their trading value – Assured Guaranty is trading roughly 10 basis points

lower than FSA which is consistent with historical spreads between the two companies

• The other bond insurance companies (MBIA, Ambac, FGIC, XL, CIFG, Radian) are trading primarily based on the underlying credit as investors are looking past the bond insurance

Page 26: The Subprime Mortgage Crisis and Its Impact on the Tax ... Subprime... · Fear Factor: Credit Spreads Widen on Subprime PFM Mortgage Woes • The yield difference or spread between

25

PFMBond Insurance Market for New Deals• We expect to see an increase in the price of the insurance

premium– Increased focus on the capital charges necessary for the rating

agency requirements– FSA and Assured Guaranty face less price competition given

the vulnerability of their competition and their prices will be increased accordingly

• FSA and Assured Guaranty may require additional security because they have a more favorable market position

• For the other AAA bond insurers, we expect financial covenants to be consistent with what has previously been required by the insurers

Page 27: The Subprime Mortgage Crisis and Its Impact on the Tax ... Subprime... · Fear Factor: Credit Spreads Widen on Subprime PFM Mortgage Woes • The yield difference or spread between

26

PFMBond Insurance Capital Infusion• Several of the bond insurers are in the process of raising capital or

evaluating strategies to raise capital in order to bolster reserves

– MBIA• $1 billion private equity capital infusion from Warburg Pincus in early

December• $1 billion surplus note offering in early January

– Fitch affirms the AAA rating/stable on January 16th in response to capital infusion

– Ambac announced its plan to issue $1 billion of equity linked notes to increase its capital reserves on January 16

• On January 18th Ambac announced that it will hold on it equity offering to raise capital stating that “it has determined that as a result of market conditions and other factors, raising equity is not at attractive option at this time. The Company is continuing to evaluate its alternatives.”

– Fitch downgraded Ambac two notches to “AA” that same day and kept Ambac on Negative Watch

Page 28: The Subprime Mortgage Crisis and Its Impact on the Tax ... Subprime... · Fear Factor: Credit Spreads Widen on Subprime PFM Mortgage Woes • The yield difference or spread between

27

PFMNew Player in Bond Insurance• On December 28, 2007 it was announced that Warren Buffet invested $105

million to fund Berkshire Hathaway Assurance Corporation

• Currently licensed in New York and seeking licenses in California, Texas, Puerto Rico, Illinois, and Florida.

– No word on plans to get license in Connecticut

• Preliminary review of capital capacity suggests underwriting capacity of $10 billion

– Modest in comparison to Ambac’s total muni portfolio of$550 billion for example

“Be fearful when others are greedy and be greedy when others are fearful” – Warren Buffet

Page 29: The Subprime Mortgage Crisis and Its Impact on the Tax ... Subprime... · Fear Factor: Credit Spreads Widen on Subprime PFM Mortgage Woes • The yield difference or spread between

28

PFM

VARIABLE RATE DEBT MARKET

Page 30: The Subprime Mortgage Crisis and Its Impact on the Tax ... Subprime... · Fear Factor: Credit Spreads Widen on Subprime PFM Mortgage Woes • The yield difference or spread between

29

PFMGrowth in the Variable Rate Market

• Over the past decade the variable rate market has more than doubled with most of the growth coming from the auction rate market

• The auction rate product was very attractive for borrowers because it traded at lower rates than VRDO’s and did not require liquidity support

VRDO vs. Auction Rate Issuance

-10,00020,000

30,00040,00050,00060,00070,00080,000

90,000100,000110,000

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Variable Rate Auction Rate

Page 31: The Subprime Mortgage Crisis and Its Impact on the Tax ... Subprime... · Fear Factor: Credit Spreads Widen on Subprime PFM Mortgage Woes • The yield difference or spread between

30

PFMAuction Rate Performance – CHEFA Higher Ed/Secondary Schools

• Another impact of the credit crisis has been the poor performance of the auction rate market driven several factors

– 1) Investors seeking liquidity in times of credit stress and thereby having discomfort with the no-put feature of auction rate securities

– 2) The turmoil with the bond insurers who insure most of the municipal auction rate market

– 3) Capital pressure on broker-dealers limiting their ability to provide aggressive bids to support their auctions at a favorable rate

Page 32: The Subprime Mortgage Crisis and Its Impact on the Tax ... Subprime... · Fear Factor: Credit Spreads Widen on Subprime PFM Mortgage Woes • The yield difference or spread between

31

PFM“AAA” Insured 7-Day Auction Rate Performance – CHEFA Higher Ed/Secondary Schools

Auction Rate Performance in 2007 - CHEFA Higher Education / Secondary Schools

2.90%

3.10%

3.30%

3.50%

3.70%

3.90%

4.10%

1/1/

07

2/1/

07

3/1/

07

4/1/

07

5/1/

07

6/1/

07

7/1/

07

8/1/

07

9/1/

07

10/1

/07

11/1

/07

12/1

/07

1/1/

08

Date

Inte

rest

Rat

e

Average Interest Rate SIFMA

Includes Fairfield University, Trinity College, and Choate Rosemary Hall

Page 33: The Subprime Mortgage Crisis and Its Impact on the Tax ... Subprime... · Fear Factor: Credit Spreads Widen on Subprime PFM Mortgage Woes • The yield difference or spread between

32

PFM“AAA” Insured 7-Day Auction Rate Performance –CHEFA Healthcare

Auction Rate Performance - CHEFA Healthcare

2.90%

3.10%

3.30%

3.50%

3.70%

3.90%

4.10%1/

1/07

2/1/

07

3/1/

07

4/1/

07

5/1/

07

6/1/

07

7/1/

07

8/1/

07

9/1/

07

10/1

/07

11/1

/07

12/1

/07

1/1/

08

Date

Inte

rest

Rat

e

Average Interest Rate SIFMA

Includes Hospital of Saint Raphael, William Backus Hospital, Danbury Hospital, Yale New Haven Hospital, and Middlesex Hospital

Page 34: The Subprime Mortgage Crisis and Its Impact on the Tax ... Subprime... · Fear Factor: Credit Spreads Widen on Subprime PFM Mortgage Woes • The yield difference or spread between

33

PFMImpact on Liquidity / Letter of Credit Market

• As auction rate securities continue to result in rates with significant spreads to the SIFMA Index, many institutions are considering converting their auction rate bonds to variable rate demand obligations supported with either liquidity or a letter of credit

– Several letter of credit and liquidity providers are providing feedback that they cannot support exposure to certain bond insurers

• Concern that the demand for letters of credit or liquidity facilities will be so great that the price will increase, security/covenants will be more stringent, facility term will beshortened and the availability with be limited

Page 35: The Subprime Mortgage Crisis and Its Impact on the Tax ... Subprime... · Fear Factor: Credit Spreads Widen on Subprime PFM Mortgage Woes • The yield difference or spread between

34

PFM

SWAP COUNTERPARTY RISK

Page 36: The Subprime Mortgage Crisis and Its Impact on the Tax ... Subprime... · Fear Factor: Credit Spreads Widen on Subprime PFM Mortgage Woes • The yield difference or spread between

35

PFMFinancial Institutions Report Losses

• Large Wall Street Firms Report large losses due to investments in subprime mortgage market have resulted in downgrades of several swap counterparties

Bank Counterparty Rating Agency Rating Change DateBear Stearns Capital Markets Inc. SnP A 11/15/2007Bear Stearns Capital Markets Inc. Moodys A2 12/20/2007Citibank, N.A., New York Fitch AA 11/5/2007Citibank, N.A., New York Moodys Aa1 12/13/2007Citibank, N.A., New York SnP AA 1/15/2008Citigroup Financial Products Inc. Moodys Aa2 11/5/2007Citigroup Financial Products Inc. Fitch AA 11/5/2007Citigroup Financial Products Inc. Moodys Aa3 12/13/2007Citigroup Financial Products Inc. SnP AA- 1/15/2008Deutsche Bank AG - New York Branch SnP AA 8/2/2007Merrill Lynch Capital Services SnP A+ 10/24/2007Merrill Lynch Capital Services Moodys A1 10/24/2007Merrill Lynch Capital Services Fitch A+ 10/24/2007Morgan Stanley Bank SnP AA- 7/30/2007Morgan Stanley Capital Group Inc. SnP AA- 7/30/2007Morgan Stanley Capital Services Inc. SnP AA- 7/30/2007SMBC Capital Markets, Inc. Fitch A+ 10/3/2007UBS AG SnP AA 10/1/2007UBS AG Fitch AA 12/10/2007

Page 37: The Subprime Mortgage Crisis and Its Impact on the Tax ... Subprime... · Fear Factor: Credit Spreads Widen on Subprime PFM Mortgage Woes • The yield difference or spread between

36

PFMIncreased Focus on Counterparty Risk

• Institutions that maintain contracts with a bank in the form of a swap agreement should be aware of the trigger points such that they can exercise the option to have collateral posted as creditprotection

• Institutions should also be aware that a downgrade to underlyingbonds caused by an insurer downgrade may trigger a collateral event in which Institutions may need to post collateral to swap counterparties depending on the severity of insurer downgrade and provisions in the swap documents

• Institutions should pay careful attention to the terms in the credit support agreement in structuring new swaps

Page 38: The Subprime Mortgage Crisis and Its Impact on the Tax ... Subprime... · Fear Factor: Credit Spreads Widen on Subprime PFM Mortgage Woes • The yield difference or spread between

37

PFM

INVESTMENT CONSIDERATIONS

Page 39: The Subprime Mortgage Crisis and Its Impact on the Tax ... Subprime... · Fear Factor: Credit Spreads Widen on Subprime PFM Mortgage Woes • The yield difference or spread between

38

PFMCredit Risk

• Risk of default or decline in security value due to conditions outside investors control

– Bankruptcy– Rating agency downgrades– Regulatory changes

• CHEFA investment typically fall into the lower credit risk

HighLow

U.s

. Tre

asur

y O

blig

atio

ns

U.S

. Gov

ernm

ent

Age

ncie

s an

d In

stru

men

talit

ies

Rep

os w

ith

Trea

surie

s as

C

olla

tera

l

Cor

pora

te

Obl

igat

ions

(CP,

C

Ds,

Not

es)

Credit Risk

Mun

icip

al

Obl

igat

ions

(S

tate

, Cou

nty,

C

ity)

Page 40: The Subprime Mortgage Crisis and Its Impact on the Tax ... Subprime... · Fear Factor: Credit Spreads Widen on Subprime PFM Mortgage Woes • The yield difference or spread between

39

PFMCredit Spreads – 2-Year U.S. Treasury & Agency

Spread Between Two Year U.S. Treasury and Two Year Agency YieldJanuary 2003 through January 2008

0.00

20.00

40.00

60.00

80.00

100.00

1/1/03 1/1/04 1/1/05 1/1/06 1/1/07 1/1/08

Average Spread - 26.68

• In recent months, spreads between Treasuries and Agencies have widened to levels of 49-60bps in the 2-5 year area of the curve.

Page 41: The Subprime Mortgage Crisis and Its Impact on the Tax ... Subprime... · Fear Factor: Credit Spreads Widen on Subprime PFM Mortgage Woes • The yield difference or spread between

40

PFMFlight to Quality and Breakdown of Asset-Backed CP Markets Impacts Financial Services Issuers

Money Market YieldsJanuary 2007 – January 2008

Source: Bloomberg

2.50%

3.00%

3.50%

4.00%

4.50%

5.00%

5.50%

6.00%

6.50%

Jan07

Feb07

Mar07

Apr07

May07

Jun07

Jul07

Aug07

Sep07

Oct07

Nov07

Dec07

Jan08

Asset-Backed CPFinancial CPIndustrial CPAgency DNTreasury Bills

Page 42: The Subprime Mortgage Crisis and Its Impact on the Tax ... Subprime... · Fear Factor: Credit Spreads Widen on Subprime PFM Mortgage Woes • The yield difference or spread between

41

PFMGUARANTEED INVESTMENT CONTRACT CONSIDERATIONS

• The relative yield spread between collateralized and uncollateralized agreements has widened substantially

• Issuers should monitor their GIC providers credit ratings to monitor events which may require calling for collateral

– Typically GIC providers will have to post collateral when their rating falls below the “AA” category

Page 43: The Subprime Mortgage Crisis and Its Impact on the Tax ... Subprime... · Fear Factor: Credit Spreads Widen on Subprime PFM Mortgage Woes • The yield difference or spread between

42

PFMOTHER INVESTMENT CONSIDERATIONS

• All Money market funds and investment pools are not created equal

– Several money market funds have been impacted to due underlying SIV exposure

– In extreme cases state-sponsored funds took down large losses causing concern for school and cities investing

• For example in Florida disclosure indicating that their fund held $1.5 billion of downgraded and defaulted debt prompted issues towithdraw funds and the state subsequently froze withdrawals on November 29th

• Issues should conduct due diligence in understanding the underlying security for money market funds in making investment decisions

Page 44: The Subprime Mortgage Crisis and Its Impact on the Tax ... Subprime... · Fear Factor: Credit Spreads Widen on Subprime PFM Mortgage Woes • The yield difference or spread between

43

PFM

SUMMARY AND CHEFA CONSIDERATIONS

Page 45: The Subprime Mortgage Crisis and Its Impact on the Tax ... Subprime... · Fear Factor: Credit Spreads Widen on Subprime PFM Mortgage Woes • The yield difference or spread between

44

PFMCHEFA Considerations• Decrease in the value of bond insurance due to several factors

– Credit scrutiny for most of the bond insurers has resulted in the bonds trading based on the underlying rating and not the AAA rating of the bond insurer (except in the case of FSA and Assured Guaranty)

– Expected increases in premiums due to rating capital pressure for bond insurers and decreased competition for FSA and Assured Guaranty

– Potentially more onerous security and covenants imposed by FSA and Assured Guaranty due to improved market position

• Expected increase in demand for letters of credit and liquidity facility will have several impacts on CHEFA borrowers

– Banks may have capacity issues resulting in them being more selective in choosing credits

– Facilities will likely become more expensive and covenants/security more onerous for borrowers

• Movement to unenhanced financing alternatives as a result of turmoil impacting credit enhancers & liquidity providers

– Private placements– Limited public offerings– Un-enhanced public offerings

Page 46: The Subprime Mortgage Crisis and Its Impact on the Tax ... Subprime... · Fear Factor: Credit Spreads Widen on Subprime PFM Mortgage Woes • The yield difference or spread between

45

PFMCHEFA Considerations Continued • Increased focus on credit quality of underwriters/swap

counterparties – Review collateral provisions in swap documents

• For reinvestment of bond proceeds increased credit diligence for structure investments and money market funds

Page 47: The Subprime Mortgage Crisis and Its Impact on the Tax ... Subprime... · Fear Factor: Credit Spreads Widen on Subprime PFM Mortgage Woes • The yield difference or spread between

46

PFMQuestions?• Feel free to contact me directly if you’d like to discuss more

Jeremy BassSenior Managing ConsultantPublic Financial Management, Inc.99 Summer Street, Suite 1020Boston, MA 02110617-330-6914 [email protected] email


Recommended