GalaTime

• Paul Kedrosky: Top 20 CDS by Net Exposure: Italy/Spain Rule

Source: DTCC’s weekly CDS update

• Financial Times: Concern over shipping derivatives losses

Traders in forward freight agreements (FFA) – derivatives based on short-term charter rates – could owe significant sums if they were betting on a rise in charter rates for ships carrying coal, iron ore and other commodities.

The sector’s Baltic Dry Index of charter rates started the month at 3,025 points and closed on Friday at 851. The 80 per cent of trades made through clearing houses were being settled on Monday, while traders who bought cash-settled products through private transactions, known as over-the-counter trades, have until Friday to settle.

It is widely expected that hedge funds could be particularly badly hit.

No respite in bad news for hedge funds.

• Morgan Stanley: RBI’s Swift Policy Response to Large FX Outflows

India’s FX reserves declined by US$15.5 billion during the week ended October 24. This is the highest weekly fall in FX reserves on record. FX reserves have been declining since the last week of May 2008 and have cumulatively fallen US$57.7 billion from the peak to US$258 billion currently.

Our conversations with real estate market players indicate that many developers are facing serious financial management challenges. Some are borrowing at a cost of over 30% to complete their projects. Private sector banks already face a significant rise in NPLs on their unsecured loan portfolio. Banks also have exposure to non-banking financial companies, who, in turn, are also likely to face higher NPLs.

Some SMEs had not hedged the foreign exchange risk or had hedged under ‘knock-in knock-out’ (KIKO) agreements. Many hedges made under these KIKO contracts are lapsing, due to the sharp movement in the rupee in such a short time span. This has meant that many SMEs have seen losses on foreign external liabilities increase significantly.

• Bloomberg: Dollar Hoarding Fuels Won, Rupee, Real Drop on Losses

Exporters in emerging markets are hoarding dollars as losses on currency bets worsen the slump in the South Korean won, Brazilian real, Mexican peso and India’s rupee.

India’s biggest carmaker, Maruti Suzuki India Ltd., plans to wait for a weaker rupee before bringing profits home from outside the country.

Mumbai-based Sundaram Multi Pap Ltd., which makes school note books, is one of 12 companies that filed lawsuits against banks accusing them of hiding risks on the currency products they marketed.

• The Deal: Spread too far

Risk arb is essentially an M&A insurance business. When arbs buy into an announced merger, they accept the risk of losing an M&A premium if the deal does not close. To accept that risk, arbs charge a premium — the deal spread. Typically, that spread is a function of the cost of capital and knowable issues, such as antitrust and the time value of money. However, market turmoil, teeth-rattling volatility and government interventions in banking threw those risk assessments into disarray.

Redemptions have taken their toll, as funds have been forced to raise cash or have been caught on margin with failing or troubled brokerage companies.

. . . index funds have also been selling. When indexers are not willing to take risk, the selling becomes indiscriminate and the arb market is not big enough to absorb the volume.

Whatever can go wrong will go wrong.

• Business Standard: RBI cuts repo rate by 100 bps

The Reserve Bank of India (RBI) today lowered the repo rate, or the rate at which it lends to banks, by 100 basis points to 8 per cent. The reduction, the first since 2004, is effective immediately, RBI said.

Thanks to the RBI’s steps the liquidity conditions in the markets have eased a little with the weighted average call rate, according to data on the Clearing Corporation of India website, at 6.80 per cent. Call rates had touched 23 per cent on October 10 and banks have been wary of lending in recent weeks.

• Bespoke: High Yield Spreads at Everest Proportions

The TED Spread remains above 4.5. Not many signs of relaxation in credit markets.

• Morgan Stanley: Heightened Alert on Many AXJ Currencies

. . .  the adjustment of hedging strategies by local economic agents has been the single-most powerful driver behind the recent weakness in KRW, INR, BRL, and MXN. For countries that have experienced persistent currency strength in recent years, it is likely that the exporters are over-hedged (i.e., bought the local currency at the earliest opportunity for both the carry and the expectation that it will strengthen over time) and importers are under-hedged (i.e., sold the local currency at the latest opportunity).

The USD/INR’s price action is starting to accelerate, in our view. Indeed, we believe the risk is that the INR could trace out a similar price path to that of USD/KRW: both currencies share similar negative fundamentals, namely a negative macro-dynamic and rising banking concerns.

On top of this, India also faces fiscal risks in the form of: 1) the lack of fiscal flexibility to cushion the economic downturn; and 2) a potential credit downgrade, leading to 3) portfolio-rebalancing outflows. Moreover, we are also concerned about the macro deterioration in the South Asia region (especially in Pakistan), which is also likely to add to the poor sentiment for the INR.

• Economic Times: RBI cracks whip on fear mongers

RBI has told banks that overdue receivables from corporate clients on account of mark-to-market (MTM) value of a derivative contract will be treated as a non-performing asset, if these remain unpaid for 90 days or more. This would mean that all other funded facilities granted to the client will also be classified as NPA, following the principle of borrower-wise classification as per the existing asset classification norms.

. . . banks will now be allowed to take short positions in interest rate futures. This, in turn, will enable banks to hedge against interest-rate risks on their government securities portfolio. In its original guidelines on interest rate futures, the central bank had allowed only primary dealers to go short.

The October rupee future at the NSE is trading above 49:

And Morgan Stanley’s expecting worse: Real, Rupee to Lead Emerging Currency Drop, Morgan Stanley Says

Brazil’s real plunged 30 percent over the past three months, Poland’s zloty is down 22 percent and India’s rupee 10 percent as so-called carry trades are unwound and domestic importers and exporters reassess currencies. Slowing global growth will cut capital flows to emerging markets to between $400 billion and $450 billion from $750 billion in 2007-08.

“We are likely to see a global EM currency `moment’ in contrast to history, which is marked by regional currency crises.”

• PIMCO: Nothing to Fear but McFear Itself

We believe that the Federal Reserve must now act as a clearing house, guaranteeing that institutional transactions clear (and investors receive) their Big Macs at the second window. They must also take another bold step: outright purchases of commercial paper. They should also cut interest rates to 1%, because we are experiencing asset deflation, and the threat of headline inflation is long past. 

• Investors Insight: The International Currency Crisis

Now, not only are those who borrowed Yen and bought EURs, or Aussie dollars, or Russian Rubles, or gold, or equities anywhere around the world, or debt securities of almost any kind, finding that they are losing money on the “cross” itself, they are losing more and vast sums on the investments they made.

Dr. Milton Friedman once said regarding the EUR… in which he tended to have very little confidence…that he doubted it would last through its first real recession. His fears are being put to test today.

. . . for the Euro to survive, either a) it will have to be a structurally weak currency or b) some of the weakest links (i.e.: Portugal? Italy? Greece? Spain?…) may end up being forced out. The path of least resistance is, of course, for the Euro to a structurally weak currency.

• Economic Times: MFs raise load to stop investor exits

Mutual funds are attempting to minimise outflows from their equity funds in the current difficult market scenario via increasing the exit loads on their SIP plans. In the various equity fund schemes of mutual funds, nearly 80-85% of the total equity fund corpus of Rs 1.44-lakh crore is contributed by retail investors.

“We are trying to send a strong signal to investors that SIP investments should be made from the point of view of long-term investments.” 

• Brad Setser, CFR: The worse the US does, the better the dollar does …
  

The dollar hasn’t fallen along with the US stocks, US Treasury yields or US employment. There is now a broad consensus that the US is currently in a recession, something that might be expected to lead to a fall in the dollar.

A recent research piece from Sophia Drossos and Yilin Nie of Morgan Stanley argues that global deleveraging is a major current source of support for the dollar. Drossos and Nie note that US banks have grown reluctant to lend to banks abroad — and many banks abroad have significant holdings of dollar debt and thus need dollar financing.

. . . the US became the new Japan after the Fed’s rate cuts — despite a large current account deficit. And the US dollar has started to act like a “funding” currency in times of stress. And in general, when risk aversion goes up and risky bets are pulled, funding currencies rally …

• Washington Post: Bad Medicine

When, in 2006, the roof began to fall in, Wall Street was in a quandary. It held outsize volumes of triple-A-rated mortgage-backed securities (MBSs). That they were not, in fact, triple-A, had become painfully obvious. Curious analysts consulted the financial statements of the top mortgage dealers, including Bear Stearns, Goldman Sachs, Lehman Brothers, Merrill Lynch and Morgan Stanley, for clarification.

Readers, however, found no clarification and no foreshadowing of the troubles to come. Neither in Bear’s year-end 2006 report (10K, in Securities and Exchange Commission jargon) nor in its March 31, 2007, quarterly filing was there a meaningful word of warning about the sagging prices of the MBSs that did so much to pull Bear down. Those seeking to learn Merrill’s exposure to the mortgage contraptions called collateralized debt obligations, or CDOs, were similarly stymied. Although Merrill was to write off $23 billion worth of CDOs in 2007, the phrase “collateralized debt obligation” did not appear once in its 2006 10K. 

• Deal Breaker: Dear Investor

TPG Axon Investor Letter [PDF]

Tontine Investor Letter [PDF]

Cerberus Investor Letter [PDF]

Greenlight Capital Investor Letter [PDF]

Read the letters. Eye-opening stuff.

• Bloomberg: Indian Rupee’s `Unprecedented’ Decline Not Over, Treasurers Say

India’s rupee may extend yesterday’s drop to a five-year low as the trade deficit swells and overseas investors dump local shares.

The rupee has dropped 16 percent this year, heading for its worst annual performance since 1991, when India devalued the currency as a balance-of-payments crisis forced it to pawn gold from its reserves.

The Reserve Bank of India will stem rupee losses and may halt the currency’s slide at about 47 per dollar, according to Larsen’s Deosthalee and Essar’s Paramasivam. A steeper drop would draw speculators, possibly causing the rupee to spiral down into a “bottomless pit,”

• Business Standard: 1,000 stocks hit 52-week lows

Over 1,000 actively-traded stocks hit their 52-week lows during intra-day trades on Monday.. . . as many as nine Sensex components — ICICI Bank, TCS, Tata Steel, DLF, Reliance Communications, Satyam Computer Services, Ranbaxy Laboratories, Jaiprakash Associates and Hindalco — closed the day at their 52-week lows.

Real-estate and infrastructure stocks such as HDIL, Parsvnath Developers, Gammon India, Unitech, Indiabulls Real Estate and Jaiprakash Associates have not only closed at 52-week lows, but have also declined by over 80 per cent from their respective 52-week highs.

I guess this will continue today with most Asian markets down ~ 4%.

• Bespoke: Corporate Bonds Worse Than Equities

Hard to imagine something worse than the 8 -9% drop in major US indices!

• Morgan Stanley: Capital Flows and the BRIC Currencies

On trade, India stands out as the only country in this group with persistent and growing trade deficits.  Recently, India’s monthly trade deficit just set an all-time record as it exceeded 10% of GDP on an annualised basis.

On FDI flows, again India stands out as the country that has received the lowest amount of net FDI inflows, in proportion to the annual accumulation of official reserves and in absolute terms.

. . . looking at the BoP positions of the BRIC economies, a prospective decline in capital flows into EM might be most damaging for the INR, and least so for the CNY.  RUB looks somewhat better positioned than BRL.  Thus, CNY > RUB > BRL > INR.

In addition to robust economic fundamentals, investors should also be aware that India does not have a problem with external debt.  Total external debt, as a percentage of exports, has declined from around 150% in 2002 to 96% now.  The interest payment on external debt is around 3.5% of exports.

• Business Week: Look Out for Bloody Tuesday

Bloody Tuesday, which is the deadline for hedge fund investors to put in requests to get their money back by year’s end.

. . . it’s not uncommon for investors to wait until the last moment to submit a redemption demand. Sources say at some funds investors are seeking to recoup about 10% of their money, which is relatively high.

The trouble is that most managers don’t keep too much cash on hand. To comply with their investors wishes, hedge fund managers may have to start selling lots of stocks—a move that could push equity prices even lower in the coming months.

Note the steady intraday down-trend in Indian stocks & the steady pressure on the rupee (held at 47 by RBI). I guess those are foot-prints of hedge fund / FII sales to meet redemptions.

• DNA: Overbuilding promises a kick in the gut for realtors

. . . the number of information technology parks and special economic zones in the 21-km Old Mahabalipuram Road — popularly known as OMR — in Chennai surpasses demand in the entire IT industry in India.

Lower Parel has a ready office space of 4.5 million sq ft and will add a minimum 5 million sq ft by 2009, taking the total commercial space to 9.5 million sq ft.

Developers have built projects in Delhi that exceed Rs 75 lakh per unit but the demand is in the Rs 25-55 lakh segment.

And of course, the BSE Realty Index hit yet another all-time low today at 3202. That’s a whopping 77% down from the January peak of 13848!

Asian markets are down 3-7%, the SGX Nifty future is trading ~ 3915, down 3.5%. With cost of capital going up at a rapid clip, watch the interest-rate sensitive stocks.

• DNA: Rupee hit by an invisible force

. . . the one-year forward rate in the domestic market is 46.70/$1 (46.05 is the rupee rate plus a 65 paise forward premium), but in Hong Kong, the same forward is quoting at 47.68/$1 —- a clear arbitrage of 98 paise. The RBI can’t do anything to stop the trades since they are executed outside its jurisdiction, on foreign shores.

“It’s illegal so we can’t even talk about it. But it’s a peculiar situation because the rupee is not fully convertible here, but countries where these trades are settled have fully convertible currencies. Also, the RBI can’t just go ahead and legalise these trades because it would mean that they are jumping the regulation just because there are some players using this route,”

. . . volumes have at least increased eight times from $100 million in 2003 to more than $800 million a day now.

No end to stupidity on currency regulation.

• Bloomberg: CRB Commodity Index Falls, Down for Year, Erasing Record Rally

Gasoline, crude oil and copper plunged and the Reuters/Jefferies CRB Index of 19 commodities erased its gain for the year.

The gauge has tumbled 27 percent since reaching a record high on July 3, dropping into a bear market as tighter credit markets and bank losses threatened the global economy. Crude oil settled at its lowest close since February, cotton touched the lowest price in a year, and gasoline dropped to its lowest level since March.

What is interesting is that even gold, for it’s ’safe haven’ status, isn’t doing all that great. As Hussman says, information is in the divergences.

• NY Times: Fed Takes Steps to Aid A.I.G.

The complex discussions, continuing into the night as a deal was sought before United States markets open on Tuesday, involved New York state regulators, federal regulators, private equity firms and Wall Street banks that rely on A.I.G.’s ability to honor its derivatives contracts, as they do with Lehman Brothers.

Ratings agencies had threatened to downgrade the insurance giant’s credit rating by Monday morning, a step that could allow counterparties to A.I.G.’s swap contracts to require A.I.G. to post collateral of up to $13.3 billion. One person close to the firm said that if such an event occurred, A.I.G. might survive for only 48 hours to 72 hours.

A 90-year old company whose future is being counted in terms of hours!

• Wealth Bulletin: Firms set to earn up to $9bn in ‘dry powder’ fees

Buyout firms have amassed $450bn of committed money to their funds that has yet to be used, according to data provider Preqin. This so-called “dry powder” of uninvested money has been committed by investors keen to tap into average returns over the past few years of about 25%.

Preqin estimates private equity firms could be paid between about $6.75bn and $9bn on the $450bn. Private equity firms usually earn between 1.5% and 2% in management fees at the same rate as drawn-down money invested as the equity in buyouts.

Reminds me of the gobs of money that mutual fund managers are making this year for doing nothing.

• Bloomberg: JPMorgan Recommends Options as Indian Rupee May Slide

Investors should buy rupee put options granting the right to sell the currency against the dollar, said Vikas Agarwal, a strategist at the third-biggest U.S. bank. The rupee will fall to a two-year low by Dec. 31 as funds pull money out of emerging markets.

JPMorgan recommends buying options as “insurance” against such a slump, forecasting the Indian currency will drop to 45 per dollar, its lowest since November 2006, by the end of this year.

Note that the rupee has now dropped to 45.4!

• Hindu Business Line: Some steel cos cut prices by Rs 2,000

Primary steel makers appear to be under pressure from softening global prices. On Wednesday, JSW Steel and Ispat Industries said they have cut prices by about Rs 2,000 a tonne with effect from September 1.

Prices for long-term contracts have been cut to the extent of Rs 2,000 to Rs 3,000 a tonne. Following the price cut by the private producers in the long-term contracts, spot prices were also witnessing a downward moment in the last few days, said the SAIL official.

“we expect steel prices to witness a sharp decline before settling at $700-750 a tonne by the end of the financial year 2009.”

So much for the expected 5% price hike, eh?