C.M.O. 6.19.2009
Credit Market Overview
June 19, 2009
The President, in his speech on Wednesday, outlined his plans for financial regulatory reform. The raison d’etre of this effort, it would appear, is to prevent what just happened from happening again. “Happened” might be a poor choice of words here as the world is still reeling from the effects of one of the greatest credit bubbles in its history but possibly more apropos when you consider that it is the elements of the disaster that the government expects to hinder in their constant effort to combine. Those elements being risk taking and its consequences.
It is interesting to think that with the Federal Reserve, the Treasury’s Office of the Comptroller, the Office of Thrift Supervision, FDIC, National Credit Union Association, SEC and CFTC all in place there could be any more possible supervision but since I don’t work in Washington I’m obviously not in the know.
One of the main elements of the new plan gives the Federal Reserve the power to form a “regulatory regime” with standards set for the amount of capital, leverage and liquidity for any firm “who’s combination of size, leverage and interconnectedness could pose a threat to financial stability if it failed”. The crux here is that should this situation arise, again, the Treasury is to be given the power to “stabilize it”.
Prior to Wednesday’s speech the market had a mechanism in place for firms that did not have enough capital and were overleveraged; it was called bankruptcy. The new method will be to appoint a conservator or receiver to nurse the naughty company along.
By designating a financial institution too big, too leveraged and too interconnected the government is, in effect created a tiered market where those under its umbrella would gain competitive advantage through cheaper funding than a smaller firm not considered “too big to fail”.
This would in the end create what is known as an oligopoly which is defined as a market form in which a market or industry is dominated by a small number of participants. If you need an example just cast your eyes towards Moscow.
A similar theme seems to be evolving among the nation’s power producers. I’m not talking here about our Congress people I’m talking about Unistar Nuclear Energy, NRG Energy Corp, Scana Corp and Southern Co. These four companies (the perfect size for an oligopoly) are expected to share a set of loan guarantees totaling $18.5BN to build the next generation of nuclear reactors. For everyone that thinks electricity comes from a the light switch this would be “the biggest step in three decades and one that could vault the [named] utilities ahead of some of the sector’s strongest players”.
The “winners” were chosen from a list of seventeen companies that had applied for $122BN in federal loan guarantees. The power generators represent a mix with SCG and SO being traditional utilities and NRG and Unistar (private) being what is known as “merchant” generators which means that they sell electricity at unregulated prices. Merchant generators, it should be noted, are among those companies that will be most affected by the “Cap and Trade” program once the free permits the government is expected to hand out, run out.
The CDS/equity combination for NRG show the CDS hitting its highs on March 9th and the stock bottoming two days later on March 11th The numbers are 700bps and $16.34 respectively. The stock retested those lows on April 28th ($16.50) and the CDS made a slight move higher during the last half of May to 584bps after hitting and interim low of 500bps on May 6th. Since then the CDS has traded as low as 440bps and the stock as high as $24.37 on exactly the same day (June 12th). Last night’s close 484bps and $23.70.
SO’s CDS/equity combo looks very much different with an unusual degree of positive correlation between the two. The highs in both markets were hit back January 2nd of this year; 160bps/$37.47. From there they both traded lower with the stock hitting its nadir on March 12th at $26.81. Since then the stock has traded within a range bounded by that low and a $31.82 high while the CDS has meandered down to a recent low of 61bps on June 15th.
As mentioned Unistar is a private company and there are no CDS’s traded on Scana.
Enjoy the weekend, Comrade.
Jim Delaney
