Monthly Archives: April 2015

Calculation of the Term Structure of Liquidity Premium

Traditionally, liquidity has been defined as:

  • A Russian problem;
  • An Asian problem;
  • Someone else’s problem;
  • A broker’s problem;
  • Not something to worry about since it is guaranteed by the Central Bank; or,
  • All of the above.

Even the Bard has commented on liquidity with the rather pithy ‘put money in thy purse’!

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Apple Inc. Bonds: How Much for the World’s Number One Brand?

Apple Inc. (AAPL) ranks number 1 on the Forbes “most valuable brand” rankings. What does it cost, in terms of brand premium, to buy the bonds of Apple Inc.?  We answer that question in this note. We last reviewed Apple Inc. on January 20, 2014. In this note, we turn to the U.S. dollar bonds issued by Apple Inc. and compare its current default probabilities and credit spreads with those on all heavily traded corporate fixed-rate bonds on March 3, 2015. A total of 307 trades were reported on 14 fixed-rate bond issues of Apple Inc. with trading volume of $145.2 million on March 3. Apple Inc. was the 11th most actively traded corporate bond issuer on March 3. We use this information for three purposes: to evaluate the risk and return on the firm’s bonds, to evaluate the firm’s credit risk-adjusted dividend yield, and to reach a conclusion on investment grade status by the modern “Dodd-Frank” definition.

Conclusion:   The passion that equity and bond investors have shown for the common stock and bonds of the world’s number one brand is easy to understand.  Apple Inc. literally has the lowest default probabilities of its peer group at every maturity from 1 month to 10 years.  The firm is as close to the best bond rating as one is able to come in the 2015 environment.  If there is any bad news for bond investors in Apple Inc., it’s that bond prices have been bid up so strongly that the firm’s bonds offer just average value, as measured by the ratio of credit spread to default probability.   There were 148 heavily traded bond issues that offered better value by this criterion than the best Apple Inc. bond on March 3.  For investors with long memories, you will recall that the 1 year default probability of Apple Inc. rose above 3.50% in 1997-1998. Euphoria can be misleading at times.

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S&P: Asia-Pacific Sovereign Borrowing Projection In 2015

Why Standard & Poor’s Ratings Services projects little growth in Asia-Pacific sovereign borrowing this year? What accounted for these trends? Kim Eng Tan, Senior Director of Asia-Pacific Sovereign Ratings, explains. Watch


The Rieger Report: Should Municipal Bonds be “Core”?

The often misunderstood municipal bond market is not considered a ‘core’ asset class by many investors and institutions offering financial products to investors.  Certainly investment grade municipal bonds have some qualifications to be ‘core’ and the proposed Qualified Public Infrastructure Bond (QPIB) might help change the way we think about this important asset class.

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Stressed Out: A Bond Market Risk Ranking Of Leading Financial Institutions

On March 13, 2014, we pointed out the many reasons why the Federal Reserve-mandated stress testing process will be a less accurate measure of financial institutions’ risk than the market’s price on those institutions’ promise to pay a dollar in the future.  The market place considers all scenarios, not just three as in the Fed’s CCAR stress tests.  The market place invests cold hard cash to price various financial institutions’ promises to pay.  In the stress testing process, those who prepare the stress tests are often in a conflict of interest position, since it normally serves them best financially if the CCAR results are prepared on the sunny side of the street.

In this note, we update our results from March 13, 2014 with the bond market assessments of financial institutions whose bonds were traded in the U.S. corporate bond market on Friday, January 23.  We use 1,281 trades on the bonds of 51 different legal entities in the financial services industry with underlying principal of $1.4 billion to rank those firms by riskiness.  We rank the institutions by credit spread and by spread to the U.S. Dollar Cost of Funds Index.

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Setting capital free: An interview with Tom McCabe of DBS Bank

With more than $330 billion in assets as of the start of 2015, DBS Bank is one of the largest banks in Southeast Asia. From its headquarters in Singapore, the bank oversees operations in 17 markets, serving more than 4.6 million customers, including 190,000 corporate and small- and midsize-business clients.

Recognizing pervasive changes in the needs of corporate clients, DBS launched a new program in early 2014 that builds the advisory skills of relationship managers (RMs)—enabling them to provide deeper supply-chain insights, help clients increase their free cash flow, and enhance innovation. Within six months, the initiative had trained more than 1,600 RMs, who collectively serve more than 30,000 clients.

The program’s architect is Tom McCabe, who served as managing director and global head of transaction banking until October 2014, when he became chief country officer for DBS’s US operations. McCabe spoke with us from his office in Singapore.


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Webinar : The Global Private Finance Opportunity: Searching the globe for the best relative value in private credit, Wednesday, 22 April 630pm IST

As investors continue to hunt for yield in this historically low interest rate environment, global private credit markets offer a potential solution for achieving both attractive returns and diversification. Attend on  Apr 22 2015 6:30 pm IST

Why Listen:

  • Learn about investing globally in private credit
  • Insights into private credit fundamentals worldwide
  • Learn how private credit is originated
  • Key thoughts and considerations around portfolio construction and diversification in North America, Europe, Australia/New Zealand and developed Asia
Register now >>
Eric Lloyd, head of global private finance
Eric Lloyd is Babson’s head of global private finance. His responsibilities include managing all aspects of the firm’s global private finance enterprise and participating on multiple investment committees. Eric has 25 years of industry experience that has encompassed investment banking, leveraged finance and risk management. Prior to joining the firm in 2013, Eric served as head of market and institutional risk for Wells Fargo and was a member of the board of directors of Wells Fargo Securities. Before the acquisition of Wachovia, Eric worked in Wachovia’s global markets investment banking (GMIB) division and served on the division’s operating committee where he oversaw capital deployment and allocation across Wachovia’s GMIB business. Prior to the operating committee, Eric was head of Wachovia’s leveraged finance group where he was responsible for the origination, structure, due diligence, execution, and distribution and trading of Wachovia’s core leveraged credit products, including syndicated bank loans, bridge loans and high yield debt. Eric holds a BSc in finance from the University of Virginia, McIntire School of Commerce.
Terry Harris, head of portfolio management, global private finance
Terry Harris is a member of Babson’s global private finance group and the group’s investment committees. He is responsible for supervising investment and portfolio management. Terry has 24 years of experience that has encompassed investing senior and mezzanine debt and equity in middle market companies operating in commercial and industrial as well as specialised industries. Prior to joining the firm in 2013, Terry was a partner of Tower Three Partners, and he served as chief investment officer of Firstlight Financial Corporation. Before Firstlight, he was chief risk officer for GE Capital’s global telecom, media & technology finance group. He also held senior credit positions at Bank of America Commercial Finance and Transamerica Commercial Finance. Terry holds a BSc and an MBA from Florida State University, and is a Certified Public Accountant (inactive).

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About Babson Capital Management
Babson Capital Management LLC (Babson) is a leading global asset management firm with over $212bn in assets under management as of 31 December 2014. Through proprietary research, analysis and a focus on investment fundamentals, the firm and its global affiliates develop products and strategies that leverage its broad expertise in global fixed income, structured products, middle market finance, commercial real estate, alternatives and equities. A member of the MassMutual Financial Group, Babson maintains a strong global footprint, with operations on four continents and clients in over 20 countries. Learn more

The Absolute Return Letter, April 2015 : The ‘Perfect Storm’


This month’s Absolute Return Letter is about the highly unusual set of circumstances which have underpinned the equity bull market of the last 35 years. Not one of the factors we identify did exceptionally well – they all did and, between them, they created the perfect breeding ground for exceptional equity performance. So far so good.
Unfortunately a reality check is required as it is exceedingly unlikely that those circumstances will be repeated in our lifetime. We should prepare for more modest returns ahead.

Enjoy the read.

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The Rieger Report: Boring is good! Municipal Bonds Return 9.26% in 2014

The Rieger Report: Boring is good! Municipal Bonds Return 9.26% in 2014

The municipal bond market steadily marched upward in 2014 and the S&P Municipal Bond Index ended up 9.26%.  The main ‘drama’ during the year came from the Detroit bankruptcy proceedings and wild swings of prices of bonds issued by Puerto Rico. Overall, low new issue supply and relatively attractive tax-free yields certainly helped keep the supply demand equilibrium to the demand side. Investment grade municipal bonds tracked in the S&P National AMT-Free Municipal Bond Index returned 8.92%.  In comparison, the S&P U.S. Issued Investment Grade Corporate Bond Index recorded a 7.71% return. The S&P Municipal Bond High Yield Index returned it’s third highest return in 16 years ending up 14.6%.  Junk corporate bonds tracked in the S&P U.S. Issued High Yield Corporate Bond Index returned 2.65%.  The tailwind for high yield municipal bonds was fueled by rebounds in both the Puerto Rico bond market and the tobacco settlement bond sector.  The S&P Municipal Bond Puerto Rico General Obligation Index was up 15.27% and the S&P Municipal Bond Tobacco Index returned 16.15%. Illinois wrestled with its pension obligations all year making headlines but it is general obligation bonds from New Jersey that underperformed the overall market.  The S&P Municipal Bond New Jersey General Obligation Index returned 3.7% significantly behind general obligations of other large issuers such as California (10.59%) , Illinois (9.63%) and New York (6%). Not a bad year for municipal bonds.  Boring is good.

Basel III Counterparty Credit Metrics

 Basel III Counterparty Credit Metrics

Click here for a *.pdf version of this document.

An important element of Basel III is the definition of minimum capital adequacy requirements for counterparty credit exposures (derivative instruments, long settlement transactions, securities financing transactions, and counterparty master agreements where the counterparty to the transaction is a credit-risky entity) held by banks.

Basel III defines two forms of capital adequacy requirements for counterparty credit exposures. The first form specifies the minimum capital required to cover potential future losses from counterparty defaults in terms of the probability of counterparty default (PD), the loss rate given default (LGD) on a defaulted exposure, the exposure at default (EAD) of the exposure, and the effective maturity (M) of the exposure. The second form specifies the minimum capital required to cover potential future losses from future changes in the credit quality of the counterparty that result in changes in the credit spreads for the counterparty’s credit exposures.

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Webinar : Understanding the Market Impact of News Sentiment Signals: From High-Frequency Event-Driven Signals to Low-Frequency Macro-Sentiment Indicators, 15th April, 730pm IST

Understanding the Market Impact of News Sentiment Signals: From High-Frequency Event-Driven Signals to Low-Frequency Macro-Sentiment Indicators

Date: 15 April 2015, Wednesday
Time: 3.00PM – 4.00PM BST
Presenter: Elijah DePalma, Thomson Reuters


About the webinar:

Financial markets are becoming increasingly efficient at incorporating news information into security market prices.

For scheduled economic news releases the latencies of market reactions are on the order of milliseconds and microseconds. Using a record of microsecond, time-stamped tick data from Thomson Reuters Tick History, we take a granular look at the market impact of US economic news surprises on trading and market by price level activity surrounding liquid index futures contracts.

For unscheduled news events, market reactions can be delayed by seconds or minutes. Thomson Reuters News Analytics (TRNA) is a natural language processing system that provides real-time linguistic and sentiment analytics on financial news, and TRNA can be used as an HFT event detection system to identify market moving news events. In this study we use TRNA over US and UK markets to identify news events which were followed by abnormal price returns, volatilities, and trading volumes at the one-second level. In addition, TRNA is expanding to include native Japanese natural language processing capabilities and using these capabilities, we identify Japanese language news events which significantly impacted JP equity markets at the one-second level.

We can also use TRNA to construct market-wide, macro-sentiment indices by aggregating news sentiment scores over broad universes of companies or asset classes.  We present recent research which demonstrates the significant, macro-behavioral influence of market sentiment on the future performance of market anomalies and fundamental style factors over monthly time horizons.

Speaker Profile:

Elijah DePalma is currently working in the most exciting business at Thomson Reuters – Machine Readable News and News Analytics – generating alpha over mid- to long-term trading horizons utilizing innovative quant signals from financial newswires and social media sources. He started his career with Thomson Reuters in Feb 2012, initially providing research support for Thomson Reuters MarketPsych Indices – a compelling product which provides macro-level, financial insights based on principles of modern psychology and behavioral finance. Prior to coming to Thomson Reuters, he completed a PhD in Applied Statistics from University of California, Riverside.

Registration link:


Interest rates and asset prices: A primer

Interest rates and asset prices: A primer
By Robert Barsky and Theodore Bogusz

Economic Perspectives article examines models of asset booms and busts, focusing on the various channels through which interest rates affect real asset prices. Read more

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The combination of increased global financial integration and the divergent monetary policy paths of major central banks create a new pattern for the U.S. benchmark yields with higher influence coming from Germany.

Contrary to previous predictions of normalization, the yield on the U.S. benchmark 10-year bond remains stubbornly low despite fundamental and textbook reasons for the yield to move higher. I think that’s partly because very loose monetary conditions in the Eurozone, reinforced by the European Central Banks’ (ECB) unconventional measures to counter deflation risks, is and will continue to increasingly play a larger role in determining both global financial conditions, including U.S. long yields than in previous periods.


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Business and Credit Cycles

While often attempted history proves that one cannot repeal the business and credit cycle.  The cycle always seems to be the same although the triggers and environment may be different.  Losses peak, loan demand and supply dry up, the appetite for risk evaporates while households and businesses begin the process of repairing their respective balance sheets.  Slowly investors start stretching for yield and lenders (banks, shadow banks and capital markets) begin to ease credit terms, soon followed by increased usage of leverage.  A review of the Federal Reserve Senior Credit Officer Survey bears out this cycle.

This cyclical nature of credit and default risk can clearly be seen from the history of the Kamakura Troubled Company Index going back to its introduction in 1990.

What Drives Bank Funding Spreads?


What Drives Bank Funding Spreads?  Thomas B. King and Kurt F. Lewis

We use matched, bank-level panel data on Libor submissions and credit default swaps to decompose bank-funding spreads at several maturities into components reflecting counterparty credit risk and funding-market liquidity. To account for the possibility that banks may strategically misreport their funding rates in the Libor survey, we nest our decomposition within a model of the costs and benefits of lying. We find that Libor spreads typically consist mostly of a liquidity premium and that this premium declined at short maturities following Federal Reserve interventions in bank funding markets. At longer maturities, credit risk explains much of the time variation in Libor, reflecting in part fluctuations in the degree to which default risk is priced in the interbank market. Our results are consistent with banks both under- and over-reporting their funding costs during the crisis but suggest that the incidence of this behavior may have subsequently declined.  Read more

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Revisiting The Asian Financial Crisis

I’ve received dozens of inquiries about the Asian Financial Crisis and its relevance to current market volatility, especially given recent Russian developments.  As a result of this interest, John Wiley & Sons has graciously released an electronic copy of my chapter about the 1997-1998 crisis.  Click the link below to download the PDF:

“The Asian Financial Crisis: The Mirage of a Miracle”


Identify red flags to avoid problem loans, Take the Red Flag Challenge

Identify red flags to avoid problem loans.

As you monitor a loan portfolio you need to be able to identify the changes in credit risk that may result in problem loans. Problem loans are loans that present greater than acceptable risk – they cannot be paid according to the terms specified and therefore have a high probability of nonpayment or loss.

Try the Red Flag Challenge

To begin, you will learn more about some of the scenarios that raise a red flag. Then you will play the red flag challenge game which will test your ability to identify red flags in a borrower’s financial statements.