CREDIT MARKETS: Bank Earnings Damp Tone Across Markets

January 20, 2010

By Kellie Geressy-Nilsen

NEW YORK (Dow Jones)--Less-than-inspiring bank earnings led to continued investor concerns about the future of the financial industry and damped credit markets Wednesday.

While three of Wall Street's major banks - Bank of America Corp. (BAC), Morgan Stanley (MS) and Wells Fargo & Co. (WFC)- reported some improvement during the fourth quarter, continuous loan losses and heavy TARP repayments left a major dent in the banks' profits and chipped away at investor confidence.

Risk premiums widened on bank bonds while the cost to insure those bonds rose.

"Bank earnings are weighing on the market," said Scott MacDonald, head of research at Aladdin Capital Holdings.

Earlier this week, J.P. Morgan Chase & Co. (JPM) and Citigroup Inc. (C) reported improved quarterly results from the prior year, but Citigroup still registered a loss.

Still, some think banks are on the right track.

"This really is not all that bad as after TARP Bank of America loss was only $194 million," said Keith Springer, president of Capital Financial Advisory Services in Sacramento, Calif. He said that since Bank of America added $10 billion to its loan loss reserve during the fourth quarter, which is down from $11.7 billion in the third quarter, "it looks like asset values are stabilizing and we have seen the worst of the write-offs."

Investment-Grade Corporates

About $2 billion in new high-grade bonds were offered Wednesday, but demand continues to outstrip supply.

Investors weary of no returns on money market funds and insurance companies flush with cash to invest are supporting the market, said Jason Brady, portfolio manager at Thornburg Investment Management. "There is still a lot of [cash] chasing less supply," he said. "Low rates really tend to drive cash movement because no one wants to be stuck with zero."

Nissan Motor Acceptance sold the largest deal, with $1 billion in three- and five-year notes. Proceeds are slated toward general corporate purposes, including debt repayments and refinancings.

Reinsurer Validus Holdings also was offering $250 million 30-year bonds, its first senior debt issue for the firm, according to Dealogic, although it has sold subordinated debt.

The most active investment-grade issue was a 5% note from Citigroup that last yielded 5.345%, according to Trace data.

Slumping stocks took a toll on the benchmark high-grade credit derivatives index, the Markit CDX IG13. It weakened to 86.3 basis points from a Tuesday close at 84.5 basis points, according to CMA DataVision. Earnings reports from Bank of America, Morgan Stanley and Wells Fargo had both good and bad aspects, prompting bank credit default swaps to widen moderately, said Markit vice president, credit research, Gavan Nolan.

Junk Bonds

There are some $8 billion of junk bonds on tap in the junk bond primary market, including large deals from Williams Partners, Energy Transfer Equity and Vanguard Health, according to KDP Investment Advisors.

U.S. accounts are also considering a multi-million pound issue from Britain most famous soccer club, Manchester United, which is expected to price later this week. The management has met with investors in Europe, Asia and the U.S. over the last two weeks to encourage portfolio managers interest in the deal. The 18-time English football champions are due to finish marketing the issue Thursday. Portfolio managers this side of the Atlantic seem that impressed by the deal, however.

"Buying this bond is probably the equivalent of an American investor investing in the National Football League," said James Lee, a fixed-income analyst at Calvert Asset Management in the U.S. "...but in the U.S. we don't have that same kind of passion for soccer that they do in Europe."

Lee went on to predict that issuance could be "front-ended" this year. "Companies know they have to tap the market while it's flush and investors have cash to out to work," he said.

Bryan C. Krug, portfolio manager of the Ivy High Income Fund, also said he doesn't see supply slowing in the near-term.

"I don't think there is any shortage of supply. Issuers had no access to capital for 9 - 12 months and that's scary for them, but they have been incredibly disciplined in waiting for the market to open. They all need to refinance and this is a cheap and easy insurance for them," he said.

Asset-Backed Securities

Two deals were in the market on Thursday.

World Omni's is selling a $917 million auto loan-backed deal, according to a person familiar with the matter.

The deal, dubbed, WOART 2010-A, is likely to price later this week.

Price guidance on the largest triple-A rated tranche worth $241 million is in the 30 basis points over benchmark area.

The deal is not eligible for cheap funding under the Federal Reserve Term Asset-Backed Securities Loan Facility, or TALF.

Additionally, Bank of America Corp.'s self-led $1.496 billion auto loan-backed deal was in the market.

The bond, dubbed BAAT 2010-1 is also not eligible for cheap loans under the Fed TALF program.

The collateral backing the World Omni bond is 98% Toyota Motor Corp. (TM, 7203.TO) collateral and 88% new vehicles.

Issuers of asset-backed securities seem to want to "feed the buyers," said Jim Harrington, senior portfolio manager at Ryan Labs Asset Management in New York, hence the bout of issuance this week. The total of deals seen this week is higher than average for a non-TALF week.

Also, that the deals are being marketed away from the loan application deadlines for cheap loans from the Fed through the TALF program is a sign "of the healthy condition that currently exists in ABS," Harrington said.

Agency Debt

FHLB increased their outstanding $3 billion 1.00% issue due Dec. 28, 2011, by $1 billion on Thursday. The issue was sold at a premium, or a price of 100.057 to yield 0.97%, FHLB said. The amount outstanding now totals $4 billion.

Risk premiums on agency debt were a tad wider across the board, according to TradeWeb. FHLB 1% note due 2011 was recently quoted at 13.3/10.8, 1.80 basis points wider on the day.

"The better shopping opportunities are in off-the-run agencies when available and well structured callables," said Jim Vogel of FTN Financial in a note. He thinks that theme could "easily last well into February."

Agency Mortgages

Agency mortgage-backeds were slightly wider on Wednesday, according to Walt Schmidt at FTN Financial. The 5-10 year blend was at 133 basis points, he noted.

Treasurys

Prices of low-risk Treasury securities rallied Wednesday afternoon as investors dumped riskier assets from U.S. stocks to commodities over concerns about tightening monetary policy in China and fiscal health in Greece.

Long-dated Treasurys led the buying. The 10-year note yield touched 3.632%, the lowest level since 3.52% on Dec. 21.

Bond prices bounced off the best levels of the day in late-afternoon trade as U.S. stocks moved off the session lows and as investors prepared for announcement Thursday morning from the Treasury Department on the sizes for next week debt sales.

Economists from Wrightson ICAP forecast the government to sell a record-tying $118 billion in total, including $44 billion in two-year notes, $42 billion in five-year notes and $32 billion in seven-year notes. All sizes of the three auctions will match the sales a month earlier.

As of 2:57 p.m. EST, the price of the two-year Treasury note was 1/32 higher at 100 7/32, to yield 0.88%. The 10-year note was 13/32 higher at 97 22/32, pushing the yield down by 5 basis points to 3.66%, as prices and yields move inversely. The 30-year bond was 28/32 higher to 97 7/32 to yield 4.55%.

Keith Springer is President of Capital Financial Advisory Services, a registered investment advisor, providing Wealth Management and Mortgage Consulting Services.  For more information on how to build and maintain a solid retirement plan, please contact Keith Springer at 916-925-8900 or Keith@KeithSpringer.com