2008

Weekly Business Digest

21st October 2008
The special feature of this edition is a primer on Credit Market Indicators

Networth- Everything Finance The Finance Club of IIMB 10/21/2008

Contents

Credit Market indicators A primer ... 3 Global News .......................................... 4 India News ............................................. 6 Corporate Scorecard........................... 7 Macroeconomic Indicators ................ 7

Special Feature: Credit Market indicators A primer

With the credit crisis accelerating and governments attempting a number of "solutions," investors are being introduced to a wide variety of credit metrics. Here is a quick list of the credit market indicators that really matter, and where you can find up-todate data on each. LIBOR LIBOR has gotten plenty of press, but many have been focused on the TED spread, which is the yield differential between 90day T-Bills and 90-Day LIBOR. TED is interesting in terms of historic comparison, but its the absolute level of LIBOR that is a better credit indicator right now. With T-Bill rates extremely low (0.19% as of 10/10), and intra-day T-Bill moves highly volatile, it would be entirely possible to see T-Bill rates rise by some degree without any significant improvement in conditions. Thus the TED spread would technically be tighter. Instead, watch 1-month and 3-month LIBOR rates. Both should be around 1.5-2%, based on where the Fed Funds target is. Watch Euro-denominated rates as well. A governmental guarantee of inter-bank loans would certainly drive LIBOR lower, as LIBOR is supposed to measure inter-bank lending rates. Otherwise LIBOR is expected to remain elevated until at least year-end. Get various LIBOR rates, including international levels at the British Bankers' Association website. Commercial Paper Term Spread Many have been watching commercial paper outstanding as a credit market indicator. The problem there is that CP issuance is bound to decline as the system falters, so total CP outstanding may see

year-over-year declines, even as credit conditions are improving. A much better indicator is the yield spread between overnight CP and 60-day CP. Currently over night AA-Finance CP costs firms 1.23%, according to the Federal Reserve, whereas 60-day CP costs 3.51%. Under normal conditions, those rates would be within 25bps of each other. Municipal Bond Swap Index This index measures the average reset rate on tax-exempt, weekly Variable Rate Demand Notes (VRDN) issued by municipalities. Basically, it is the cost of shortterm funding for municipal issuers. It is calculated by the Securities Industry and Financial Markets Association (SIFMA) and hence is often just called the SIFMA index. VRDN's are a mainstay of municipal moneymarket funds. Investors in a VRDN can put their bond back to the issuer at any reset date, which in this case is weekly. This liquidity is usually guaranteed by a highlyrated bank. With banks under such pressure recently (Wachovia and Dexia were major players in this business), and with municipal money-market funds seeing massive redemptions, VRDN rates have risen dramatically. Typically the SIFMA rate is between 60 and 80% of the 1-week LIBOR rate. So if LIBOR were 4%, SIFMA would usually come in around 3%. But the SIFMA rate spiked to 7.96% on September 24, and although it has fallen to 4.82% as of last week, the level is far above normal levels. If there rates remain elevated, municipalities will be under pressure to refinance their variable rate debt with long-term debt. And any kind of debt issuance is extremely expensive in this market. However, falling SIFMA rates would indicate investor confidence in municipal

issuers. SIFMA updates its index each Wednesday. Note that VRDNs are not the same as Auction Rate Securities, which remain highly illiquid. CMBX The CMBX is a basket of credit default swaps on commercial mortgage-backed securities (CMBS). It goes without saying that commercial mortgages are likely to suffer significant losses in the near future, likely larger than other recent recessions. At the same time, commercial mortgage securities are structured with significant levels of subordination. This means that junior securities take losses before more senior securities suffer. A typical CMBS deal would have 30% or so subordination beneath the AAA-rated tranche. So while losses may be high, not too many deals will suffer much more than 30% in losses (which implies a much greater default rate). In addition, principal payments go to retire higher-rated tranches first, therefore the subordination actually increases over time. Thus the spread on AAA-rated CMBS should remain relatively tight. Right now, the recent vintage AAA CMBX is trading in the 220bps area. The CMBX is maintained by MarkIt and is updated daily. There are a few other indicators which are commonly cited but I don't think are very useful. One is swap spreads. This is the spread between the fixed-leg of a fixed-tofloating swap and a corresponding Treasury. Classically this was seen as a generalized measure of counter-party risk, since normally a highly-rated bank would stand in the middle of any interest rate swap. However right now the swaps market is being driven by some unusual technicals. Note that the 2year swap spread is at all-time wides, where as the 10-year swap spread is only a couple basis points wider than its 10-year average. The 30-year swap spread is at all-time tight

levels. So as a day-to-day indicator, swap spreads aren't very informative. Another is Agency debt spreads. With Fannie Mae and Freddie Mac now fully backed by the Treasury, one would expect those spreads to collapse to near zero. Yet currently 2-5 year Agency debt is trading at 100bps or more above comparably Treasury rates. While this is indicative of how bad liquidity currently is in the market, this is as much a function of swap spreads as anything else. As long as swap levels remain elevated, so will Agency debt spreads. Finally, the various measures of borrowing at the Fed. This includes the discount window, the TAF, the TSLF, etc. Investors should realize that the mere existence of these facilities has an influence over how much institutions use them. Put another way, the fact that we need these programs is the real indicator. The most recent TAF auction on 10/6 produced the lowest stop-out rate since the program's inception. Yet its still a very hard time saying liquidity is improving.

Global News
AIG acts amid probe by attorney general AIG yesterday agreed to help recover any illegal compensation payments made to Martin Sullivan, former chief executive, and other senior management as part of an investigation by Andrew Cuomo, the New York attorney general. The company, which was rescued by the government last month with an $85bn loan, is also withholding an estimated $10m payment from Steven Bensinger, who served as chief financial officer until May, and is immediately cancelling all junkets or perks. The announcements came a day after Mr Cuomo threatened legal action unless AIG stopped "outrageous" expenditures and helped recover past ones, including certain

executive compensation. He said such expenditures could have violated a New York law. CDS market an easy, unfair scapegoat Credit-default swaps [CDS] have gotten a bad wrap during the financial crisis, undeservedly so according to Robert Pickel, CEO of the International Swaps and Derivatives Association. In testimony before the Senate, Pickel said the role of CDS in the crisis is 'greatly exaggerated' and 'to say that CDS were the cause, or even a large contributor, to that turmoil is inaccurate.' Lawmakers have called for greater oversight of the $54.6T CDS market since Lehman Brothers, one of the top ten backers of the contracts, went bankrupt. The Fed chose Pimco (a unit of Allianz (AZ)), the world's largest bond fund, to manage commercial-paper assets for its Commercial Paper Funding Facility (CPFF) program, while State Street (STT) gets the go-ahead as custodian and administrator. CPFF will allow the government to bring stability to the commercial-paper market, which is used by corporations to fund day-to-day operations. Fed chief Bernanke pledged Tuesday officials will not stand down until markets return to normal, and said he's confident the government's moves "will help restore confidence to our financial system and place our economy back on a path to vigorous, healthy growth."

stock-market selloff, the biggest since 1933, threatening to send the world into a global recession

Buffett throws his lot in with stocks Warren Buffett has stepped up his campaign to instil confidence in the markets, proclaiming in a newspaper that he is shifting his personal wealth into US stocks. Ill follow the lead of a restaurant that opened in an empty bank building and then advertised: Put your mouth where your money was, the billionaire investor wrote in Fridays New York Times. Today my money and my mouth say equities. Private equity cuddling huge loan losses Private-equity firms, including Apollo, Blackstone and TPG, which bought billions of dollars of senior debt 'on the cheap' from top-tier banks like Citigroup, Deutsche Bank and Royal Bank of Scotland, are sitting on major paper losses. The loans, bought for an average of $0.85 on the dollar, now trade for about $0.65. "The trouble is, things are still likely to get worse as the economy weakens. And private-equity firms acquired the leveraged loans with - yes - leverage. The selling banks financed the transactions, lending the buyers about 75% of the purchase price."

Unlimited liquidity hits $250B The ECB, Bank of England and Swiss National Bank loaned banks $254B in their first tenders of unlimited dollar funds, led by the ECB's $171B. Central bankers are trying to unfreeze credit markets and get banks lending to each other again (see next item) after a crisis of confidence led to last week's

Wachovia buyout hurried along The Fed is fast-tracking Wells Fargo's $15.1B acquisition of Wachovia, which it says could be consummated within five days. Wachovia said Sunday it will forego a shareholder vote on the issuance of preferred stock to Wells Fargo in favor of expediency. Shareholders still need to approve the proposed merger. Analysts say

Wells Fargo is likely to sell or downsize Wachovia's investment-banking unit. Ibanking is not Wells' strong suite.

U.K. takeover sinks RBS The U.K. government is set to buy majority stakes in Royal Bank of Scotland the nation's fourth-largest bank, and HBOS, its biggest mortgage lender. RBS will get 20B, with the government taking 5B in preference shares and underwriting 15B in capital. The aggressive move is aimed at shoring up the country's struggling financial system and flagging investor confidence, and falls in line with other governments across Europe which are taking radical steps to prevent systemic collapse. Shares of RBS are down 7.4% at 7:00 EDT. HSBC is up 8.5%, and Barclays is up 7%.

failure of Yamato Life is the 1st collapse of a Japanese insurance company in seven years. The insurance firms bankruptcy follows the collapse of Japans first listed real estate investment trust, New City Residence Investment, which failed with 112.3bn in debts. Yamato Life failed largely because of its problematic investments in securitisation products, rather than as a direct result of problems in the domestic insurance market

India News
RBI has cut the cash reserve ratio by 150 basis points to 7% from the earlier 9%. The cut in CRR is expected to release INR 600bn into the financial system. The Ministry of Finance has also announced set up of a Government panel that will review the liquidity situation in the India economy. The group will submit its interim report of the situation in the duration of one week

Bush to Host First in Series of Summits on Financial Crisis The leaders of the U.S., France and the European Commission will ask other world leaders to join in a series of summits on the global financial crisis beginning in the U.S. soon after the Nov. 4 presidential election. President George W. Bush, French President Nicolas Sarkozy and European Commission President Jose Barroso said in a joint statement after meeting yesterday that they will continue pressing for coordination to address ``the challenges facing the global economy.''

Japans Yamato Life Insurance files for bankruptcy Japans Yamato Life Insurance has filed for bankruptcy with $2.7bn in liabilities, to become the 1st financial sector casualty of US credit crisis in Japan. The

Airlines seek $1bn bailout The global credit meltdown has hit India. India's beleaguered airline sector has become the 1st industry to seek an official bailout from the government. The Federation of Indian Airlines (FIA) has asked for a $1bn interest free loan from the government to tide over the current crisis in addition to many other fiscal sops and easing of regulatory measures. FIA also wants a moratorium of three years on the repayment of the loan. Simply put, many an airline will be grounded which doesn't sound implausible considering that the $6bn industry is expecting losses to mount to $2bn this year

TCS acquires Citigroup's captive BPO for $505MM Tata Consultancy Services (TCS) has announced the acquisition of Citigroup's captive BPO arm Citigroup Global Services for $505MM. This deal marks the largest buyout of a foreign captive BPO in India, coming after acquisition of Aviva BPO by WNS for $230MM. TCS and Citigroup have also signed a contract under which the former would provide it with services totalling $2.5bn over the next 9.5 years. The Citi BPO has EBIT margins of 20% and is expecting the revenues to touch $278MM this year

instruments and stopped them from issuing fresh P-notes or renewal of old ones

Corporate Scorecard
Infosys has reported revenues of INR 54bn for Q2FY09, a QoQ growth of 11.6%, and net profit of INR 14bn, a QoQ rise of 10%. These numbers were ably aided by rapid depreciation of the rupee against the dollar. On a year-on-year basis, the revenues of Infosys grew by a healthy 32% and net profits went up by 30.2% Geojit Financial Services has reported a 58% drop in its consolidated net profit for Q2FY09 to INR 52MM, from INR 125MM in the corresponding year ago quarter. Total income decreased by 2% to INR 459MM from INR 470MM

Nomura to acquire Lehman's India BPO Finally there is some hope for the 2,000 odd employees of Lehman Brothers' back office in India. In a significant development, Japanese securities house Nomura Holdings Inc has reached a basic agreement to purchase Indian units of Lehman Brother. The Japanese firm has already accepted about 3,000 workers from Lehman Brothers' Asia-Pacific units and some 2,500 employees from Europe and the Middle-East to join Nomura. Lehman Brothers' Indian operations included tasks such as procedural work entailed by securities transactions besides IT development

Macroeconomic Indicators
Rupee vs. Dollar BSE Sensex Nifty Dow Jones Industrial Average Index 48.6800 9975.35 3074.35 8852.22

SEBI reverses the restrictions on P-Notes SEBI has reversed the restrictions on issue of participatory notes by foreign institutional investors against securities, including derivatives, as underlying. The move seems aimed at reversing the foreign fund outflows in recent times due to the credit crisis in the US and spread to Europe. In October last year, the markets regulator had put a 40% cap on FIIs total asset holding via participatory notes or overseas derivatives

NASDAQ Composite Index S&P 500 Nikkei 225 Crude Oil

1711.29 940.55 8693.82 71.85$