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Thursday, July 1, 2010

Trust Preferred CDO Update

We ended last year with a special report on what we saw as the changing nature of banks’ “choice” to defer. Our piece, entitled “The Tripping Point” concluded as follows:

“…while data remain scarce for the illiquid, opaque world of bank trust preferred securities in TruPS CDOs, our preliminary analyses tend to support the theory that not all deferring banks are poorly positioned, under-capitalized institutions. As we monitor the situation and continue to gather further evidence to either support or reject this argument, we eagerly anticipate a conclusion that not all deferring banks are doomed to fail.”
Since January 1, 2010, we have an increasing DEFAULT rate on banks in general. Using the FDIC’s cohort of 8,012 FDIC-insured financial institutions as of 12/31/09, we calculate a roughly 2.24% annualized default rate as of June 18, 2010. This default rate constitutes a 46% increase since the September 30, 2009 annualized default rate of approximately 1.53%, which was based off a 12/31/08 cohort of 8,305 FDIC-insured financial institutions.

(PF2’s base projections anticipated a roughly 50% weighted average increase of this 1.53% default probability over the forthcoming two years. Having realized this 46% increase, and from our various conversations with market participants and regulators, our best guess estimate is to anticipate another weighted average increase of 35%, over the forthcoming two year period. Thus, over the coming period, we attach an expected default probability of 3.02% to the average performing bank in our analysis of TruPS CDOs.)

We also encourage you to visit some of the excellent investigative journalism that’s been covering the TruPS market this year. Here follow some key pieces that provide insights into the differing pressures on and by banks, CDO investors, and external market participants. Amongst other things, the two June articles throw further light on the possibility that certain banks are opting to defer simply as a ploy to encourage investors to allow them to pre-pay their preferred securities at a discounted. (Of course this is not always the case, and banks certainly have the right to defer on their preferreds.)

June 11, 2010; American Banker: Blocking Rescues, or Challenging Bum Deals?

June 8, 2010; Bloomberg: Banks in `Downward Spiral' Buying Capital in CDOs

March 19, 2010; Bloomberg BusinessWeek: CDO ‘Samaritan’ Hildene Duels Funds Over Collateral

April 27, 2010; American Banker: TruPS Leave Buyers in CDO Limbo;