Tuesday, March 24, 2009

Structured credit cool on the Geithner Plan

As we know, equity markets greeted the Geithner toxic asset plans with joy - the Dow registered its fifth-biggest point gain in history.

The reaction in the structured credit markets on Monday was less enthusiastic as this this graphic from Bernstein Research highlights

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The structured credit markets did show some positive reaction, with AAA sub-prime up a point and AAA CMBS index up three points (about 5% in both cases), but this still leaves prices massively down YTD with sub-prime still down on prior month compares (CMBS is roughly at end February levels). Barring a continued revival over the next week, the Q1 marks could be uncomfortable given the YTD performance. The sub-prime and CMBS indices shown in Exhibit 1 below are an average of the Markit AAA ABX (subprime) and AAA CMBX (CMBS) vintages/series respectively.

Bernstein’s Bruno Paulson reckons the modest reaction in the ‘toxic’ markets could be down to uncertainties as to whether then plan will actually drive up prices.

And his reasoning;

The two issues are whether there will be buyers and whether there will be sellers. The government leverage should help buyers’ potential returns boosting the prices offered, as should the current depressed prices versus fundamentals. However the political environment may discourage investors, given the twin threat of ‘cram-downs’ on lending balances and arbitrary expropriation of profits.

On the seller side, institutions which do not mark-to-market through capital (either because they are marking to model or because the securities are tucked away as ‘Available for Sale’) have no incentive to realise losses, particularly if they (probably reasonably) think the ultimate losses will be lower than that implied in the prices. Even those who mark stuff to market may prefer to let someone else do the selling to raise prices, thus realising the gain without losing the future upside. Paradoxically, the belief that the securities are undervalued relative to fundamentals may constrain the number of transactions.

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