Credit Metrics, Indicators That Matter

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cat233's picture
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Credit Metrics, Indicators That Matter

I found this useful, I hope it helps others as well.

RealMoney by
Know the Credit Metrics That Matter
Tuesday October 14, 7:59 am ET
ByTom Graff, RealMoney Contributor

With the credit crisis accelerating and governments attempting a number of
"solutions," investors are being introduced to a wide variety of credit
metrics. Here is a quick list of the credit market indicators that really
matter, and where you can find up-to-date data on each.

LIBOR, or the London Inter-Bank Offer Rate, has gotten plenty of press,
but many have been focused on the TED spread, which is the yield
differential between 90-day T-Bills and 90-Day LIBOR. TED is interesting in
terms of historic comparison, but it's the absolute level of LIBOR that is
a better credit indicator right now.

With T-Bill rates extremely low (0.19% as of Oct. 10) and intraday T-Bill
moves highly volatile, it would be entirely possible to see T-Bill rates
rise by some degree without any significant improvement in conditions.
Thus, the TED spread would technically be tighter, but to no import.

Instead, watch one-month and three-month LIBOR rates. Both should be
around 1.5%-2%, based on where the fed funds target is. Watch
Euro-denominated rates as well. A governmental guarantee of inter-bank
loans would certainly drive LIBOR lower, as it is supposed to measure
inter-bank lending rates. Otherwise, I'd expect LIBOR to remain elevated
until at least year-end.

Get various LIBOR rates, including international levels at the British
Bankers' Association website.

Commercial Paper Term Spread
Many have been watching commercial paper outstanding as a credit-market
indicator. The problem is that CP issuance is bound to decline as the
system de-levers, so total CP outstanding may see year-over-year declines,
even as credit conditions are improving. A much better indicator is the
yield spread between overnight CP and 60-day CP. Currently, AA-Finance CP
costs firms 1.71%, according to the Federal Reserve , whereas 60-day CP
costs 3.51%. Under normal conditions, those rates would be within 25 bps of
each other.

The Fed also reports on asset-backed CP rates in the same report. These
should converge with AA-Finance rates as conditions improve.

Municipal Bond Swap Index
This index measures the average reset rate on tax-exempt, weekly Variable
Rate Demand Notes (VRDN) issued by municipalities. Basically, it is the
cost of short-term funding for municipal issuers. It is calculated by the
Securities Industry and Financial Markets Association (SIFMA) and, hence,
is often just called the SIFMA index.

VRDNs are a mainstay of municipal money-market funds. Investors in a VRDN
can put their bond back to the issuer at any reset date, which in this case
is weekly. This liquidity is usually guaranteed by a highly rated bank.
With banks under such pressure recently -- Wachovia and Dexia were major
players in this business -- and with municipal money-market funds seeing
massive redemptions, VRDN rates have risen dramatically.

Typically the SIFMA rate is between 60% and 80% of the one-week LIBOR
rate. So if LIBOR were 4%, SIFMA would usually come in around 3%. But the
SIFMA rate spiked to 7.96% on Sept. 24, and although it has fallen to 4.82%
most recently, the level is far above normal levels.

If rates remain elevated, municipalities will be under pressure to
refinance their variable-rate debt with long-term debt. And any kind of
debt issuance is extremely expensive in this market. However, falling SIFMA
rates would indicate investor confidence in municipal issuers.

SIFMA updates its index each Wednesday. Note that VRDNs are not the same
as Auction-Rate Securities, which remain highly illiquid.

The CMBX is a basket of credit-default swaps on commercial mortgage-backed
securities (CMBS). It goes without saying that commercial mortgages are
likely to suffer significant losses in the near future, likely larger than
other recent recessions.

At the same time, commercial mortgage securities are structured with
significant levels of subordination. This means that junior securities take
losses before more senior securities suffer. A typical CMBS deal would have
30% or so subordination beneath the AAA-rated tranche.

So while losses may be high, not too many deals will suffer much more than
30% in losses (which implies a much greater default rate). In addition,
principal payments go to retire higher-rated tranches first, therefore the
subordination actually increases over time. Thus, the spread on AAA-rated
CMBS should remain relatively tight. Right now, the recent vintage AAA CMBX
is trading in the 245 bps area.

The CMBX is maintained by MarkIt and is updated daily.

There are a few other indicators which are commonly cited, but I don't
think are very useful. One is swap spreads. This is the spread between the
fixed-leg of a fixed-to-floating swap and a corresponding Treasury.
Classically, this was seen as a generalized measure of counter-party risk,
since normally, a highly rated bank would stand in the middle of any
interest rate swap.

However, right now the swaps market is being driven by some unusual
technicals. Note that the 2-year swap spread is at all-time wides, where as
the 10-year swap spread is only a couple basis points wider than its
10-year average. The 30-year swap spread is at all-time tight levels. So,
as a day-to-day indicator, swap spreads aren't very informative.

Another is agency debt spreads. With Fannie Mae and Freddie Mac now fully
backed by the Treasury, one would expect those spreads to collapse to near
zero. Yet currently, 2- to 5-year agency debt is trading at 100 bps or more
above comparably Treasury rates. While this is indicative of how bad
liquidity currently is in the market, this is as much a function of swap
spreads as anything else. As long as swap levels remain elevated, so will
agency debt spreads.

Finally, the various measures of borrowing at the Fed. This includes the
discount window, the TAF, the TSLF, etc. Investors should realize that the
mere existence of these facilities has an influence over how much
institutions use them. Put another way, the fact that we need these
programs is the real indicator. The most recent TAF auction on Oct. 6
produced the lowest stop-out rate since the program's inception. Yet I have
a very hard time saying liquidity is improving.


Carl Veritas's picture
Carl Veritas
Status: Gold Member (Offline)
Joined: Oct 23 2008
Posts: 294
Re: Credit Metrics, Indicators That Matter

This one is from the Labor Dept:

 $ 1.00  in  1913  =  $22.10  in  2008

What do you make of this?







krogoth's picture
Status: Platinum Member (Offline)
Joined: Aug 18 2008
Posts: 576
Re: Credit Metrics, Indicators That Matter

Yes, I too have questioned what makes the dollar lose so much value. It's covered in the Crash Course. I believe it's because we produce too much money, and by not destroying money (Federal Reserve) it devalues it.






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