Sunday, June 28, 2009

FDIC guaranteed notes - opening up the credit markets

With a large slug of the TARP funds returned, many are questioning whether the "TARP-free" banks are truly on their own or are still relying on some form of government support. Here is a commentary from Adrienne Carter (Businessweek)
The big banks returning the TARP money show no signs of giving up this perk. Goldman has $21 billion of such debt; JPMorgan Chase $40 billion; Morgan Stanley $23 billion. (JPMorgan and Morgan Stanley did say they wouldn't issue any additional bonds backed by the FDIC. And JPMorgan recently sold corporate bonds without the U.S. backing.)

She is referring here to the FDIC guaranteed notes issued by banks in the early part of the year. This has been an extremely effective program, not only to help banks raise debt capital, but to also open up the credit markets as a whole.

In terms of giving up this FDIC guarantee however, the "non-TARP" banks have mostly already done so. Existing notes (those that have already been issued) obviously can not drop the guarantee. Otherwise if you are the Fidelity government money market fund, and you bought dome FDIC paper early in the year, you have a problem. If the guarantee is now all of a sudden lifted, not only are you violating your prospectus (because the government paper turned into corporate notes), but you will also take a loss. This would unfairly and severely punish those who have cash in money market funds.

However any new paper issued by these banks is no longer guaranteed by the FDIC. For example on May 11th Goldman issued 6.75% coupon notes maturing 5/15/19. The paper is NOT FDIC guaranteed and is also unsecured. It now trades above par, yielding 6.64% (3.1% above treasuries). The demand for paper is out there and unless you are GMAC (who sold FDIC notes early this month), FDIC guarantee is no longer absolutely necessary (at least for now). Even Citi can now sell non-FDIC paper (although Citi continues to use the program because it's so much cheaper).

Here is the historical yield on some early Goldman FDIC notes. This paper was issued at the end of last year and matures at the end of 09. You can see that in March-09 the market came to realize that the FDIC is not going away (in spite of the bank rescue mess they are in) and neither is Goldman (at least for now).

Here is a rough measure of the note's spread to a 1-year T-bill.

The FDIC notes opened up the credit markets. When fear ruled the day, this paper got placed, serving to calm the jittery credit investors' nerves. In March-09 (which will be remembered as the turning point in the credit markets), Pfizer sold $13.5 billion of bonds. About $1.25 billion of that was a 2-year floating note (LIBOR + about 2%), which looked similar to the FDIC notes placed by banks. This was a signal that corporates can in fact issue debt without the goverment guarantee. The market was starved for high quality investment grade corporate paper. We were off to the races. Huge amounts of both bank and corporate paper has been placed since.

Clearly FDIC guarantee together with TAF, as well as other programs created a thaw in the credit markets. Now let's hope these programs are soon going to become obsolete.

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