We’ve all seen pictures like this:
Even tweets sent out that discuss the possibility of such an event:
The Ice. Devastating. Even embarrassing. But the only thing that is worse? The Ice Block:
Ah, the Ice Block. In the bizarrely hilarious and demeaning game that is Icing, there are only two rules:
- Whenever and wherever you’re presented with an Ice, get down on one knee and chug. If you refuse you’re banned.
- You can Ice Block by presenting an Ice of your own in the event you’re presented with an Ice. Whomever presented the Ice to you now has to get down and chug.
The Ice Block, in simple terms, is a hedge. A hedge against an undesired outcome. I mean, even I spent some time in Manhattan this past week lugging around a 24oz bottle as insurance while I was out & about. Will I do it again? You bet. I’m risk averse when it comes to Icings. I may keep several with me. Like a building super with a giant belt full of Smirnoffs (I hear the Wild Grape or the Mango are particularly great).
Thinking about hedging makes this piece from Zero Hedge important in my mind, because there are some very serious questions about risk management that are brought up as a result. I wrote earlier in the week about my views on CRE and CMBS from a fundamental credit and asset valuation perspective, but this piece hits on some added dimensions worth considering with FinReg and the talk about the health of banks in the background. Let’s start with some stats:
- US CMBS delinquenices are now at 7.5%, an increase of 48bps according to Moody’s.
- Number of delinquent loans more than doubled from last year. There were 1,800 delinquent loans last year, now there are 4,400. Balances on delinquent loans more than tripled from $15.5bn to $48.8bn.
- Hotel and multifamily are the worst with delinquency rates above 13% while industrial and office are the best with delinquency rates between 5 and 6%.
Now why is that important? Because of the news that JPM launched a new CMBS offering this week. While they sold the AAA tranche rather easily, other pieces won’t be sold so the bank will retain them. Given the current state of the CRE market, I’d think they’d want to hedge that exposure (Call me crazy. You’re dying to anyway after I put that ridiculous image in your head of seeing someone walk around with a Smirnoff Ice utility belt). But here are some key pieces from Cheeky Bastard I want to highlight:
Therefore I ask this question in name of all potential future investors who might want to know who, where and based on which pricing method will sell the protection in form of a CDS on a CMBS structure which bears little resemblance to CMBS structures of the past.
I know of no derivatives desks who are willing to act as a counterparty in such a transaction; so JPMs Structured Products desk might have succumbed to hedging its exposure to non-investment grade tranche by buying in-house CDS from their derivatives trading brethren.
That’s a terrible state for the market to be in. Others have talked about the issues in the CDS market as is, which need to be addressed, but in the meantime let’s focus on what the bank is going to be able to do here. The short answer is not much. This is an individual transaction which will have very little correlation to previous transactions that made up CMBX indices in the past. Unhedged risk can be painful. Just like walking around without the ability to Ice Block.
I see some folks at JPM getting ready to take a knee and chug in the future…