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Bank Confidence Wanes After MF Global Failure: Credit Markets

This is an article appearing in the SF Gate originally from Bloomberg…

Great reporting

Bank Confidence Wanes After MF Global Failure: Credit Markets

Mary Childs and Shannon D. Harrington, ©2011 Bloomberg News

Tuesday, November 22, 2011
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Nov. 23 (Bloomberg) — Credit traders are punishing U.S. banks and brokers after wagers on European sovereign debt felled MF Global Holdings Ltd., as lender reliance on capital markets for funding is exposed by the region’s crisis.

The cost of protecting bonds from Morgan Stanley rose 47 percent this month and Goldman Sachs Group Inc. has climbed by 39 percent. Both are approaching levels reached in the first week of October that were the highest since the failure of Lehman Brothers Holdings Inc., according to data compiled by CMA and Bloomberg. Debt of New York-based Jefferies Group Inc. reached distressed levels last week.

Credit-default swaps and bond yields are soaring even as banks seek to reassure investors that they’re able to manage their sovereign-debt holdings. A gauge of banks’ reluctance to lend to each other, the so-called Libor-OIS spread, is at the highest level since June 2009 as Italian and Spanish yields climb and the U.S. economy grew at a slower-than-estimated 2 percent annual rate in the third quarter.

“On the heels of MF Global, the market has remained concerned about financials and the potential for a surprise,” said David Brown, a money manager who helps oversee $82 billion of fixed-income assets at Neuberger Berman LLC in Chicago.

The extra yield investors demand to hold the debt of banks has jumped 77 basis points this month to 391 basis points, or 3.91 percentage points, according to Bank of America Merrill Lynch index data. That compares with the 39 basis points increase to 261 for investment-grade debt overall.

‘Mercy of the Markets’

Goldman Sachs’s $3.75 billion of 5.25 percent debt due in July 2021 fell to 91.8 cents on the dollar yesterday to pay a spread of 448 basis points, according to Trace, the bond price reporting system of the Financial Industry Regulatory Authority.

Morgan Stanley’s $2.5 billion of 5.5 percent notes, also due that month, traded at 86.2 cents on the dollar to pay 562 basis points more than similar-maturity Treasuries.

Jefferies’ $550 million of 6.875 percent notes maturing in April 2021 are at 82 cents paying 793 basis points more than the benchmark, Trace data show.

Banks that don’t have a large deposit base are “pretty much at the mercy of the markets,” said Bonnie Baha, head of the global developed credit group at DoubleLine Capital LP in Los Angeles, which oversees $19.5 billion.

Elsewhere in credit markets, Norway’s Eksportfinans ASA was cut to junk by Moody’s Investors Service after the lender failed to meet European Union regulatory requirements. Speculative- grade defaults may double next year in Europe, Royal Bank of Scotland Group Plc said. Lenders led by JPMorgan Chase & Co. have committed $4.5 billion in financing for a KKR & Co.-led group to buy most of Samson Investment Co.

Bank of America Trades

Bonds of Charlotte, North Carolina-based Bank of America Corp. were the most actively traded U.S. corporate securities by dealers yesterday, with 118 trades of $1 million or more, Trace data show.

Eksportfinans, which helps foreign investors buy Norwegian goods and services, had its issuer and senior-debt ratings reduced seven steps to Ba1 from Aa3 by Moody’s. The Oslo-based company had 192 billion kroner ($33 billion) in outstanding debt securities at the end of September, according to its website.

The cost of protecting corporate bonds from default in the U.S. rose for the sixth time in seven days, reaching the highest level in almost seven weeks.

The Markit CDX North America Investment Grade Index, which investors use to hedge against losses on corporate debt or to speculate on creditworthiness, increased 1.5 basis points to a mid-price of 140.9 basis points in New York, according data provider CMA. The measure, which reached its highest level since Oct. 5, has climbed from 113.6 on Oct. 27, which was the lowest in more than two months.

Credit Swap Prices

In London, the Markit iTraxx Europe Index of 125 companies with investment-grade ratings rose 1.6 basis points to 199.7, the highest since Oct. 4. In the Asia-Pacific region, the Markit iTraxx Asia index of 40 investment-grade borrowers outside Japan advanced 9 basis points to 227 basis points as of 10:45 a.m. in Singapore, Royal Bank of Scotland Group Plc, prices show.

The indexes typically rise as investor confidence deteriorates and fall as it improves. Credit-default swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.

European high-yield corporate defaults may rise to 5.6 percent in 2012 as the region enters recession and banks curb lending, said Alberto Gallo, a senior credit strategist at RBS in London. The 12-month trailing rate for the region reached 2.6 percent in October from 1.4 percent in September, according to Moody’s. That may climb to as high as 7 percent next year under a worst-case scenario of 11 percent unemployment, Gallo said.

Leveraged Loans

The Standard & Poor’s/LSTA U.S. Leveraged Loan 100 index fell for a sixth day, losing 0.18 cent to 90.74 cents on the dollar. The measure, which tracks the 100 largest dollar- denominated first-lien leveraged loans, has declined from this year’s high of 96.48 on Feb. 14.

Leveraged loans and high-yield bonds are rated below Baa3 by Moody’s and lower than BBB- by S&P.

JPMorgan leads 11 lenders that would provide financing for a purchase of Samson, a family-owned oil and gas producer, according to a person with knowledge of the matter. The KKR-led group is close to an agreement to buy Samson for about $7 billion. The deal would be the biggest corporate takeover by a private-equity firm this year, Bloomberg data show.

Stress Measures

The rate that London-based banks say they pay for three- month loans in dollars has fallen only one day in the past three months, according to the British Bankers’ Association. The London interbank offered rate, or Libor, climbed to 0.5 percent, and the dollar Libor-OIS spread reached 40.1 basis points yesterday from 12.4 in August.

Credit-default swaps on Goldman Sachs have climbed 110.7 basis points to 396.5 basis points since the end of October, CMA data show. That means investors are paying $396,500 annually to protect $10 million of debt for five years. Contracts on Morgan Stanley have added 160.9 to 502.9, the data show.

The average of contracts on the six biggest U.S. banks, which includes Wells Fargo & Co., Bank of America, JPMorgan, and Citigroup Inc., has gained 84 to 331 this month, according to CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market.

For Morgan Stanley and Goldman Sachs, which converted to banks in the aftermath of Lehman’s failure three years ago, reliance on capital markets instead of depositors has remained a concern among investors.

Deposit Funding

Both firms got less than 10 percent of their funding from depositors as of Sept. 30, according to company filings with the Securities Exchange Commission.

“Institutions with a high degree of wholesale borrowings are, as has often been the case, experiencing greater spread widening,” Guy LeBas, chief fixed-income strategist at Janney Montgomery Scott LLC in Philadelphia, said in an e-mail. “The primary risks for the banking system are related to liquidity– i.e., the markets freezing up, and banks having challenges accessing needed cash.”

Morgan Stanley has sought to assure investors that it has limited exposure to Europe and a more stable funding base than it did in 2008. The firm said this month that it had $2.11 billion of net funded exposure to the five peripheral European countries, and negative $286 million of exposure to France.

Chief Financial Officer Ruth Porat said last month that the firm’s liquidity pool was $180 billion at the end of the third quarter, an increase from an average of $138 billion in 2008. Morgan Stanley also receives about 25 percent of its funding from equity and deposits, up from 10 percent at the end of 2007, Porat said in September.

Secured Borrowing

Morgan Stanley also increased the duration of its secured borrowing, Porat said. Weighted average maturity on lending against assets other than Treasuries and agency bonds rose to more than 120 days in the second quarter from less than 30 days in the first quarter of 2008, she said.

Goldman Sachs said this month it had $4.16 billion of gross funded exposure to governments, financial institutions and companies in Greece, Ireland, Italy, Portugal and Spain as of Sept. 30, with Italy accounting for more than half.

Mark Lake, a spokesman for Morgan Stanley, and Michael DuVally, for Goldman Sachs, declined to comment.

Jefferies bonds and shares plunged in the wake of MF Global’s Oct. 31 bankruptcy filing on concerns tied to its funding sources.

MF Global filed for bankruptcy after a downgrade to junk by Moody’s and Fitch Ratings triggered an increase in the margin needed to back its transactions, squeezing its available cash, according to an affidavit the company’s president, Bradley Abelow, filed with the court.

European Debt

The downfall centered around $6.3 billion in bets on the debt of European sovereign bonds through so-called repo-to- maturity transactions, which involve borrowing money to fund investments.

Jefferies derives 26 percent of its liability funding from repo transactions, Daniel Harris, an analyst at Goldman Sachs in New York, wrote in a Nov. 20 report.

“Jefferies’ ability to fund in the repo market is likely secure unless continued duress in short-term markets drives a ratings downgrade for either” the broker-dealer or the broader sector, Harris said in the report. A downgrade “could increase collateral requirements and negatively impact leverage,” he said.

‘Unprecedented’ Steps

Jefferies has taken what Chief Executive Officer Richard Handler called “unprecedented” steps to disclose its exposure to European sovereign debt and short-term funding markets, including a letter on the company’s website this week that speculation in securities markets is being driven by “half- truths, false rumors and lies being disseminated with malice” by a group it didn’t identify.

“We have no need to access the debt markets at this time,” Handler, 50, said in a Nov. 15 interview at Jefferies’ headquarters in Manhattan. The company’s equity and debt will recover “as time goes by and people realize Jefferies is the same well-funded company it was two weeks ago.”

For the second time this month, Jefferies said Nov. 21 that it cut its gross exposure to Greece, Ireland, Italy, Portugal and Spain and said when accounting for hedges, it was net short $134 million, meaning it overall was betting against the debt. It also said 87 percent of its repurchase transactions use collateral eligible for transactions with clearing utilities, which sit between participants in the market.

Counterparty Risk

“Put differently, 87 percent of our repos end up with clearing utility counterparties who are blind to the Jefferies name in the same way that we are blind to their names,” Handler and Chairman Brian Friedman wrote in the letter.

Jefferies’ 7.75 percent bonds due March 2012 rose 0.7 cent to 99.3 cents on the dollar yesterday, Trace data show. The bonds fell to 97.9 cents on Nov. 17, according to Trace, to yield 14.1 percentage points more than similar-maturity U.S. Treasuries, exceeding the 10 percentage-point spread considered distressed.

“Current levels for Jefferies must be taken in the context of where the larger U.S. banks currently trade,” said Neuberger Berman’s Brown. “All financials are pricing in a relatively high probability of a negative tail outcome.”

Thornburg Investment Management Inc. is looking at institutions that seek to be “well-funded in terms of deposit franchises,” according to Lon Erickson, a money manager who helps oversee $9 billion of fixed-income assets.

JPMorgan’s $3 billion of 4.35 percent notes due in August 2021 are trading at 97.7 cents to pay a spread of 272 basis points. Wells Fargo’s $2.5 billion of 4.6 percent notes that come due in April 2021 are at 106.5 cents on the dollar with a spread of 179 basis points, Trace data show.

Bank with deposit franchises, “would suggest they’re a little bit more structurally sound from a funding standpoint, so we don’t have to have as much to worry about in terms of a run on the bank so to speak that can kill a financial institution overnight,” he said in a telephone interview from Santa Fe, New Mexico.

–With assistance from Josiane Kremer in Oslo, Lisa Abramowicz, Zachary R. Mider, Cristina Alesci, John Parry and Laura Marcinek in New York. Editors: Pierre Paulden, Alan Goldstein

To contact the reporters on this story: Mary Childs in New York at; Shannon D. Harrington in New York at

To contact the editor responsible for this story: Alan Goldstein at

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