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Archive for the ‘spreads’ Category

The Fed announced Tuesday that previously issued (legacy) commercial mortgage-backed securities (CMBS) will become eligible collateral for the Term Asset-Backed Securities Loan Facility (TALF). This comes less than three weeks after announcing that only newly issued CMBS would become TALF-eligible.

The mission of the TALF is to increase credit availability. So how does expanding TALF-eligible collateral to include legacy CMBS help the Fed achieve this goal? High yields on legacy CMBS discourage the extension of new credit towards the purchase of commercial property. From the perspective of a lender, owning senior CMBS arguably provides a safer exposure to commercial real estate than new loan extensions, while at the same time, delivers a yield well in excess of what could reasonably be obtained in the market for new credit extensions.

As of last Friday, the yield on TALF-eligible CMBS securities was 684 basis points above the 10-year Treasury rate. (This implies a yield near 10%.) By making legacy CMBS securities TALF-eligible, the Fed hoped to spur demand for these securities, and as a result, decrease their yield spread. A week later and three days after the Fed’s announcement, the spread on TALF-eligible legacy CMBS has narrowed to 495 basis points. This suggests that the Fed’s announcement has helped narrow spreads.

Furfine - TALF, CMBS

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The U.S. Treasury’s proposed bailout plan raises a number of serious questions, many of which have been well articulated by politicians and pundits. Many of the plan’s merits, however, have been shrouded by confusion.  Is the taxpayer losing $700bn to Wall Street?  Is the Treasury paying fair value for assets?  How will the bailout help Main Street?  In fact, there are a number of merits to this proposal which all stem from markets currently being extremely illiquid.

An easy way to illustrate the illiquidity in markets is to look at the price differences between liquid assets and less liquid assets. The figure below plots interest rates over the past month for the 3-month London Inter-Bank Offered Rate (LIBOR) and the 3-month U.S. Treasury bill. LIBOR reflects the rate at which a bank borrows funds from another bank. During less turbulent times, prior to last summer, the spreads between the LIBOR and T-bill rates average around 40 basis points (bps).  The spreads recently have been more than 100 bps, punctuated by the surge to 318 bps on September 17.

Interest rates: 3-month London Inter-Bank Offered Rate (LIBOR) and the 3-month U.S. Treasury bill

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