My Virtual Display
 Random thoughts and notes to self

From International Tax Review:

Cayman Islands agrees to tax information exchange with Netherlands

The Cayman Islands signed a tax information exchange agreement (TIEA) with the Netherlands on July 8. This brings the number of TIEAs signed by the Cayman Islands to 11, one short of the OECD’s requirement of 12 required to be recognised as being compliant with international requirements.

McKeeva Bush, the Cayman Islands’ new leader of government business and minister for financial services, has signed tax treaties with the UK, Ireland and the Netherlands since his election on May 20.

Bush’s government is in the advanced stages of negotiation with several countries, including Italy, Mexico, Germany, France, Australia, New Zealand, Portugal and Canada.

There has been some indication that the OECD may look at the quality of the agreements rather than just the number in determining whether countries are removed from the grey list of those that have signed up to information exchange standards but have not implemented them.

“I realise there are some concerns being aired regarding the possibility of the OECD moving the goal post so to speak or that the stated number of 12 agreements may be changed. However based on the discussions I have had with OECD officials, this is highly unlikely,” said Bush.

From Business Week:

In China, a Burst of Corporate Bonds

Thanks to streamlined regulations, more companies are issuing debt cheaply and fast
By Frederik Balfour

Hong Kong – Here’s a little-known fact: Chinese companies now issue more corporate debt than their counterparts in Japan, making the yuan-denominated bond market the world’s No. 3, after those for dollars and euros. In the first five months of 2009, mainland companies sold $82 billion worth of debt, vs. $51 billion for the Japanese. “The growth in issuance has been phenomenal,” says Liao Qiang, credit analyst at Standard & Poor’s (MHP) in Beijing.

Bond sales in China started to come to life when the mainland’s equity markets headed south in late 2007. As sellers parked their stock proceeds in deposit accounts, banks found themselves flush with money they couldn’t lend because of government limits on loans. To give banks somewhere to put their excess liquidity, regulators in April 2008 streamlined rules on bonds.

Before the changes, corporate bonds had to be listed on the stock exchange. That required approval by exchange regulators, which was costly, time-consuming, and subject to political whims. So most issues were enterprise bonds—money raised by state-owned companies to finance big infrastructure projects such as the Three Gorges Dam or new railways. These all had state guarantees and offered identical yields.

The new rules make things simpler. While all issues require a credit rating, they no longer need to be traded on the exchange. The market got an added jolt last September when Beijing halted new domestic stock offerings as Shanghai shares tumbled. That forced companies to look elsewhere for capital. And with interest rates down worldwide, bonds have become yet more appealing. In the first five months of 2009, corporate bonds accounted for 22% of all debt issued in China, including government debt, vs. 3% in 2007.

Corporate bonds will be crucial to Beijing’s efforts to make the yuan a global currency. For that to happen, the mainland’s capital markets need to be far more sophisticated and better integrated into the international financial system than they are today. “The government is pushing to make financial markets more broad-based and mature, and without debt you cannot say that is complete,” says Frank Gong, chief China economist at JPMorgan Chase (JPM).

More than 100 companies have issued bonds. The largest offering to date came in May when Agricultural Bank of China raised $7.3 billion, priced to yield 3.3% for five years, vs. 2.4% on government bonds. Billions more are in the pipeline, including issues by International Commerce Bank of China, Bank of Communications, and Bank of China.

“STILL QUITE THIN”
But for cash-starved private companies the market is still hard to penetrate. The minimum flotation is $141 million, and issuers must have a AAA or AA+ rating from one of the five domestic or joint-venture ratings agencies that have been licensed. That precludes all but a handful of private companies from participating, so more than 80% of bond issuers are state-linked companies. And because most purchasers of corporate debt hold it until maturity, bond trading after issuance is “still quite thin,” says Frances Cheung, fixed income strategist with Standard Chartered Bank in Hong Kong.

The bond market could get a further boost once Beijing opens up the market in “panda bonds”—yuan-denominated issues by foreigners. So far, the International Finance Corp. and Asian Development Bank are the only organizations that have issued panda bonds, although HSBC (HBC) and Bank of East Asia have been approved to sell them in Hong Kong. And later this year locally incorporated subsidiaries of foreign companies may be allowed to issue panda bonds on the mainland. Among the first will likely be London-based Standard Chartered, which aims to raise some $500 million to shore up its mainland balance sheet. Although stocks are climbing and IPOs are set to resume, “we’ll still see strong demand” for bonds, says Chris Zhou, director of debt capital markets at UBS Securities in Beijing. “The bond market is a relatively easy and cost effective way to get money.”

From Institutional Investor:

At the Market Deal for Bank of America

03 Jun 2009
Steve Rosenbush

BofA issues stock to withstand market volatility.

Raising $33.9 billion in capital is no mean feat for a bank, especially given the violent mood swings that have gripped the financial markets of late. Nonetheless, such were the marching orders that the Federal Reserve Board handed Bank of America on May 7, when the Fed announced the results of its stress test of 19 U.S. lenders. The financial giant sprang into action the very next day, announcing that it would reduce a big part of the capital deficiencies identified in the stress test by issuing $13.46 billion in equity.

The issue took an unconventional form. Instead of executing the deal in one fell swoop, as companies commonly do, BofA parceled out the shares over the next eight trading sessions. This piecemeal approach, pioneered more than 15 years ago by utilities and real estate investment trusts, which recapitalize frequently, is known as an at-the-market offering, or “dribble out.” The bank’s ATM was the largest in history.

BofA had determined that the structure made sense, given the volatile nature of the market. Its own shares — whipsawed, like those of many big banks, by investor fears over the health of the industry — had plunged 93.6 percent, from a 52-week high of $39.50 on September 19 to a low of $2.53 on February 20, before recovering somewhat. “In a volatile market, the ATM structure is beneficial because it allows you to sell shares when you like the price and leave the market when you don’t,” explains Lisa Carnoy, global co-head of equity capital markets at BofA, which was book runner on its own deal. “It was a perfect approach for us. We were able to minimize dilution and maximize flexibility.”

Demand for the shares was strong, according to Carnoy. In an ATM, the sale of a fixed amount of equity can be stretched out over a month or more, but the company decided to complete the sale on the eighth day, in a so-called cleanup trade. The shares, which had rallied in anticipation of the offering, closed at $14.17 on May 8, dipped to an issue low of $10.67 on May 15 and finished the offering on May 19 at $11.25. The bank sold 1.25 billion shares at an average price of $10.77.

“In this environment, the ATM is a flexible way to raise money. However, with the capital markets open, it made sense to get the equity offerings behind them,” says Jason Polun, a large-cap-bank analyst at T. Rowe Price, a major holder of BofA shares. Polun has a favorable view of the company. And many apparently agree. Hundreds of institutional investors, including pension funds and mutual funds, lined up to participate in the offering. “We could have kept selling, but we just decided to get it done,” Carnoy says.

An ATM structure helps maximize price, minimize dilution and maintain flexibility with respect to size and timing of a deal. In BofA’s case, timing mattered because it had to coordinate the issue with other components of its capital raising plan, including asset sales and conversion of preferred shares. By June 25 the effort was all but complete.

The case for the ATM was bolstered by the disappointing performance of more-traditional offerings, says Carnoy, citing secondary placements this year that have priced as much as 15 percent below where they launched. Morgan Stanley issued $4.5 billion worth of stock in a follow-on offering on May 8 at $24 a share, an 11.57 percent discount, according to research firm Dealogic. And on May 12, bank BB&T offered $1.75 billion worth of shares priced at $20, which Dealogic pegs at an 11.11 percent discount. By May 28, BB&T shares had gained 5.95 percent and Morgan Stanley was up 19.21 percent, according to Dealogic. “If the market happens to be down on the day that you initiate a secondary offering, you are simply out of luck,” Carnoy says. BB&T says it was pleased with the demand for the issue.

BofA’s success with its ATM has already inspired one bank to follow its lead. Fifth Third Bancorp announced on May 20 that it would issue as much as $750 million worth of stock and sell the shares “from time to time” using the structure. It has hired BofA and Morgan Stanley as co–book runners on the deal.

From Institutional Investor:

The Big Public Pension Squeeze

10 Jun 2009
Steven Brull

U.S. public sector pensions are facing massive budget shortfalls.

Vallejo, a working-class community of 120,000 northeast of San Francisco, has long been a strong union town. Like many cities, it gives its workers generous retirement benefits: Police and firefighters can retire as young as age 50 with a pension equal to 90 percent of their final salary, and they enjoy free health care for life. Salaries, which serve as the base for determining pension levels, have also been generous: Forty-four percent of the city’s 613 employees had gross wages in excess of $100,000 in 2008.

Financing such largesse isn’t easy in the best of times. But in the midst of the worst economic downturn since the Great Depression, such salaries and benefits are becoming unsustainable. So facing an $8 million budget deficit and nearly $200 million in unfunded pension and health care liabilities, Vallejo filed for bankruptcy in May 2008, making it the largest governmental body to go bust since Orange County did so in 1994. In March a federal bankruptcy judge ruled that the city could tear up existing contracts as part of its reorganization, a landmark verdict that paves the way for cuts in once-sacrosanct public sector salaries and retirement benefits.

Earlier this year the city reached a deal with police to cut salaries by 18 percent through June 2010 and cap medical benefits; the agreement also imposes a 6 percent pay cut on managerial employees and requires new hires to contribute 20 percent of the cost of their medical insurance. City negotiators are playing hardball with other unions that have yet to settle; they rejected a firefighters’ proposal to take a 6.5 percent pay cut, forego previously agreed-to pay raises of 13 percent and cap health care benefits.

As goes Vallejo, so may go the nation. The cost of public sector pensions is set to soar in coming years because the recent meltdown in the financial markets has worsened the health of systems that were already badly underfunded. Municipal and state governments across the country are struggling with massive budget shortfalls, leaving them in no position to fill the pension gap. As a result, public workers look likely to bear the burden through cutbacks in their salaries and benefits and increases in their pension contributions.

“No one can isolate themselves from the effects of the economy,” Gray Davis, the former governor of California and currently counsel at Los Angeles law firm Loeb & Loeb, told Institutional Investor in a recent interview.

Pension benefits enjoy constitutional or statutory protections in many jurisdictions, and reducing them may not be easy or straightforward. But analysts say governments can use a variety of means — freezing or cutting salaries, requiring higher pension contributions, delaying retirements and reducing retiree health care benefits, among others — to yield immediate budget savings and dramatically reduce pension costs in the long run.

“The majority of the pain will ultimately be borne by people who will see their pensions cut,” says Jacob Funk Kirkegaard, who studies pension issues at the Peterson Institute for International Economics in Washington.

Change is already under way in a number of states. Under an agreement reached in April, public employees in New Mexico will kick in an extra 1.5 percent of their salaries next year to pay for pensions and contribute more to the cost of their health benefits. In February, California adopted changes that will require most of the 114,000 employees of the University of California to begin paying 2 percent of their salaries to fund pension benefits, with the contribution rate rising by 1 point a year until it reaches 5 percent in 2013. It will be the employees’ first contribution in 20 years to what had been an overfunded pension plan. Connecticut’s state workers made wage and other concessions in May that will save the government about $700 million through mid-2011.

California, which faces a $24 billion projected shortfall over the next year, has already begun slashing salaries. In February, Governor Arnold Schwarzenegger began furloughing the state workforce two days a month, which effectively reduces pay by more than 9 percent. Now he wants the legislature to cut salaries by a further 5 percent and fire 5,000 workers, about 2.5 percent of the total. The state’s largest public employees’ union, the Service Employees International Union Local 1000, is proposing to give up previously negotiated pay hikes of 4.6 percent for 17 months in exchange for having only one furlough day a month, but the legislature has twice voted down the suggestion.

Imposing cuts on existing workers isn’t easy, given the strength of public sector unions in many parts of the country. Many governments have therefore been reducing salaries and benefits for new employees. Kentucky last year adopted changes that will allow public employees to retire as early as age 57 if they have worked for at least 30 years; previously, they could retire at any age after 27 years of service. New York Governor David Paterson has proposed setting a minimum retirement age of 50 and requiring workers to put in at least 25 years of service, up from 20 currently. He also wants to limit annual cost-of-living adjustments to 1.5 percent and require new hires to contribute 1 percent of their salary for retiree health benefits. And several states, including Florida, Illinois and Oklahoma, have begun to replace traditional defined benefit pensions with defined contribution accounts for new hires.

Union leaders believe that defined benefit systems are a shared responsibility and that workers are willing to fairly share the cost of maintaining adequate funding. “In a critical situation when budgets need to be balanced, to the extent we need to contribute something — particularly to preserve traditional defined benefit plans — you’ll find that our members are realistic about the situation,” asserts Richard Ferlauto, director of corporate governance and pension investment for the American Federation of State, County and Municipal Employees, the nation’s largest public employees’ union, with 1.6 million members. But Ferlauto and others are adamant that workers shouldn’t bear the full burden of fixing the pension problem. They contend that some of the most severe budgetary and pension shortfalls, in states such as California, Illinois and New Jersey, reflect inadequate tax revenue and a failure by government to make necessary contributions. “Our state income tax is only 3 percent. It should go up,” says Ken Swanson, president of the Illinois Education Association. Late last month state lawmakers rejected a proposal by Governor Patrick Quinn to raise the tax rate to 4.5 percent.

The scale of the public sector pension problem is making reform increasingly urgent. According to the Center for Retirement Research at Boston College, state and local pension plans have seen their portfolios plummet since October 2007 as a result of the stock market collapse — assets are down $1.2 trillion from what the total would have been if the market had produced the 8 percent annualized returns that most actuarial calculations assumed. These plans now have some $2.3 trillion in assets and $3.6 trillion in liabilities. To achieve full funding over a typical 30-year amortization period, the plans would have to increase aggregate contributions by a total of $205 billion from 2010 to 2013. By contrast, actual contributions to the plans amounted to $107 billion in the year ended June 30, 2007.

The full force of last year’s market collapse won’t be felt until 2014. That’s because pension plans typically smooth their asset values, which actuaries rely on to determine contribution rates, over five years. So the cost of amortizing last year’s market losses would require an extra $102 billion a year in contributions from 2014 to 2039.

The growing cost of providing pensions has been borne almost entirely by employers in recent years. From 2002 to 2006, for instance, public employees who also have Social Security paid an average of 5 percent of their salaries in pension contributions. Employers, meanwhile, saw their contributions rise from an average 6 percent of payroll in 2002 to 8.5 percent in 2006, according to the National Association of State Retirement Administrators. Girard Miller, a benefits consultant with PFM Group, reckons that employer costs would have to rise to 12 percent of payroll by 2012 to keep up with obligations. “Unless there’s a dramatic rally in the stock market, we could see a doubling of employer costs from 2002 to 2012,” he says. “That’s unsustainable. There will have to be a rebalancing. We’ll clearly see a paring of benefits for new employees, layoffs, and in some cases the only way will be to gouge younger workers to pay benefits to older employees.”

The situation in some localities is particularly dire. The Cincinnati Retirement System’s annual contributions for pensions and health care for city employees could jump from 86 percent of payroll this year to 132 percent in 2013 to put the system on track to achieve full funding, Cavanaugh Macdonald Consulting of Kennesaw, Georgia, told the system’s board last month. San Jose, California, projects that its pension contributions for police and firefighters will jump from 23 percent of payroll this year to as much as 58 percent in fiscal 2011 and 70 percent in 2013 to close a funding gap. In Detroit contribution rates for police and fire pension plans are projected to double, to 50 percent of salary, over the next three years. Most of these governments lack the resources to make such increases and are likely to boost contributions by less than their actuaries recommend, which would only exacerbate the funding shortfall.

State budgets are also squeezed. Sixteen states have enacted tax increases this year and 17 more are considering them, according to a May report from the Center on Budget and Policy Priorities in Washington. At the same time, at least 36 states have cut funding for public services, including education and assistance for low-income residents. Notwithstanding these measures and an influx of some $140 billion in federal stimulus funds into their coffers, states face a combined budget gap of more than $350 billion over the next two years. “The stimulus program has given the states the wherewithal to weather the worst of this,” Governor Ed Rendell of Pennsylvania, who also is chairman of the National Governors Association, tells II in a recent interview. “Where the rubber will hit the road for states is when the stimulus drops off. If the economy hasn’t recovered by then, it’ll be a tough situation.”

There are practical limits to raising more revenue. Many states, including California and New Jersey, have laws that limit property tax increases. Nor can cities and states do much about slumping sales and income taxes. “Municipalities will face a challenge in revenue collection,” notes Mike Ross, a municipal credit strategist at Memphis-based investment firm Morgan Keenan & Co. “Unemployment is rising. Corporations have tax-loss carryforwards. Consumers are tightening up, hurting sales tax revenues.” Then there are politics to consider. Taxpayers, their retirement savings ravaged and their job security threatened, are in no mood to reach deeper to support public workers with benefits far better than their own. “Politicians who raise taxes will be voted out of office,” asserts Davis. He should know. In 2003, following a spike in energy costs and an increase in California’s vehicle registration tax, he became only the second governor in U.S. history to be recalled.

Cutting budgets to finance public sector salaries and benefits is not likely to be any more popular, particularly as the biggest source of potential cuts is education.

Hence public employees are likely to face the biggest squeeze. Although the basic pension benefits formula — how the number of years an employee works and his or her final salary translate into a monthly annuity — can’t be changed for active workers in most jurisdictions, governments can carve out important savings from other compensation elements. Freezing or lowering salaries, eliminating cost-of-living adjustments and requiring workers to contribute more for pensions and retiree health care benefits can produce immediate budget savings and yield major reductions in long-term obligations. Marcia Fritz, vice president of the California Foundation for Fiscal Responsibility, a group dedicated to reigning in pension costs, says encouraging workers to stay on the job longer would produce some of the biggest budget benefits. The cost of providing benefits is cut in half if an employee works an extra five years, she says, thanks to added employee contributions and reduced benefits payments.

Some public pension fund officials urge patience, arguing that the markets and the economy will improve in time, averting the need for major changes in benefits and contributions. “Required increases will be forestalled by a couple of years, and the hope is that markets and fiscal conditions will recover by then,” says Keith Brainard, research director for NASRA.

The idea that public funds can earn their way back to health seems unlikely, though, especially as many funds are looking to invest less aggressively than they have in the past. Many funds ran short of cash last year and had to sell stocks at depressed levels to finance benefits and meet capital calls from private equity and real estate funds. Going forward, more funds are likely to put a premium on liquid assets, including cash, even though they pay lower returns. The board of the California Public Employees’ Retirement System was due to approve plans this month to allocate 2 percent of its $185 billion portfolio to cash. The Pennsylvania State Employees’ Retirement System and the South Carolina Retirement Systems are decreasing risk by reducing exposure to equity futures in their portable-alpha strategies. Liquidity concerns will only grow as a spike in baby boomer retirements makes a growing number of public funds cash-flow-negative.

Imposing cutbacks on workers’ pay and benefits may be the obvious solution to the funding crisis, but it won’t be easy, given the clout of public sector unions. In May, for instance, teachers in Illinois forced Governor Quinn to withdraw a proposal to increase their pension contributions by 2 percent of salary, to 11 percent. “We made a full-scale effort, with thousands and thousands of calls and e-mails and hundreds of members meeting with legislators,” says the Illinois Education Association’s Swanson. Other politicians, daunted by the size of the pension problem, have sought to defer action, a step that may only exacerbate the chronic underfunding of some systems. In New Jersey, Governor Jon Corzine in March won passage of a bill that will allow cities to defer half their pension contributions from this year until 2012; in May he slashed the state’s pension contributions by $150 million, notwithstanding the fact that the system’s $60.5 billion in assets represents just under half of its liabilities. Philadelphia’s pension fund used actuarial sleight of hand to save $172 million in pension contributions, lengthening the period for smoothing asset values from five years to ten and stretching the amortization period for paying off the unfunded liability from 20 years to 40.

It’s a tactic that Rendell says he’d like to see emulated by struggling pension systems across the state. “It doesn’t help them in the long run, but it certainly helps them get by over the next couple of years,” he tells II. “Without it, I don’t know if municipalities can survive.”

To critics, delaying contributions is a step in the wrong direction, and cutting future benefits — as drastic a measure as it might be politically — doesn’t come close to what’s necessary financially.

Indeed, Kirkegaard believes that the funding situation is far graver than official estimates, which are based on the assumption that assets will grow by 8 percent a year, with liabilities discounted by 8 percent annually. “In general, public accounting for pension and health retirement benefits uses constructs that might be regarded as economic fictions,” notes Orin Kramer, chairman of the New Jersey State Investment Council. “We use discount rates for which people in the corporate world would go to jail.”

Plug in more realistic numbers, financial economists say, and unfunded obligations explode. Valuing liabilities at the risk-free U.S. Treasury rate of less than 4 percent, reckon Robert Novy-Marx and Joshua Rauh of the University of Chicago Booth School of Business, the amount of pension promises made by states will more than double, to approximately $7.9 trillion, in 15 years. Unfunded liabilities of state pensions are north of $3.1 trillion, they estimate.

Kent Smetters, an associate professor of insurance and risk management at the University of Pennsylvania’s Wharton School, whose estimates of Social Security funding as a deputy assistant secretary of economic policy in George W. Bush’s Treasury Department earned him a reputation as “Dr. Doom and Gloom,” expects states and cities to begin lobbying for a federal bailout of pension obligations by the end of this year. “They’re going to have to start reaching out for dollars, and as the midterms approach there will be political pressure for this to happen,” he predicts. Smetters expects that a federal pension bailout could reach $1 trillion — or more than the $787 billion economic stimulus package that Congress approved earlier this year.

Some states have already begun appealing to Washington. California is lobbying federal officials to backstop at least $13 billion in short-term municipal notes this summer. In November the mayors of Atlanta, Philadelphia and Phoenix appealed — unsuccessfully — to the U.S. Treasury to be allowed to use a portion of the Troubled Asset Relief Program funds to provide loans to cover unfunded pension liabilities.

In April, South Carolina Governor Mark Sanford won approval from President Barack Obama’s administration to channel some of the state’s $2.8 billion in federal stimulus money toward closing the $27 billion unfunded liability of the South Carolina Retirement Systems.

A large-scale federal bailout of state pension funds, though, appears highly unlikely. Aside from mounting worries over the federal deficit, there’s the fact that some states have succeeded in funding their pensions and won’t want to see Washington bail out others. “It wouldn’t be responsible just to shovel money to California and not the other states,” notes Davis.

In past decades public employees have used their considerable political clout to boost wages and benefits. Now the pendulum has begun a long swing in the opposite direction.

From Business Week:

Bonds for Microsoft

Cash is king these days—so much so that even debt haters are willing to take out loans to get more of it. On May 12, Microsoft sold bonds for the first time in its cash-rich history, adding $3.75 billion to its already impressive stash of $25 billion. Rumors of potential acquisition targets soon followed—not just Yahoo! (YHOO) but also business software rival SAP (SAP). So far, CEO Steve Ballmer is denying he’s got any mega-deals in the works.

Funny as it is, I’ve been assigning my students a problem involving bond issuance by Microsoft since 2002 or so…

From Institutional Investor:

Turkey’s Military Pension Fund Reaps Windfall

Jonathan Kandell
08 Jan 2009

Despite tensions between Turkey’s generals and the moderate Islamic government, OYAK, the military pension fund, has made the most of the country’s pro-business policies.

For emerging-markets economies, it’s a sign of maturity to develop truly world-class enterprises. Mexico can boast of cement producer Cemex, Brazil of aircraft maker Embraer, South Korea of electronics giant Samsung or automaker Hyundai.

In Turkey arguably the best claim to such lofty status belongs not to an industrial company but to a pension fund – and the military’s at that. Ordu Yardimla¸sma Kurumu, or OYAK, as it is known, operates like a private equity fund rather than a portfolio investor, is more profitable than any of Turkey’s family-run conglomerates and enjoys a higher credit rating than the government. The man responsible for that success, Co¸skun Ulusoy, is a military history buff who approaches the art of the deal like a general preparing for battle. Since taking over as CEO in 2000, his investing acumen has helped OYAK deliver a sixfold increase in retirement benefits to the country’s military brass – and earned him a reputation as Turkey’s Warren Buffett. He describes his strategy bluntly: “We buy companies, manage them, turn them around and sell them for big profits.”

After a run of stellar returns, however, Ulusoy today finds his 22.41 billion Turkish lira ($14.4 billion) fund threatened on two fronts. Rising political tensions between Turkey’s military and the moderate Islamic government of Prime Minister Recep Tayyip Erdogan, whose pro-business policies have contributed to OYAK’s stunning success, are threatening to undermine the country’s economic gains. At the same time, a deepening global recession is thrashing stock markets around the world, slowing capital inflows into Turkey and provoking a sharp slide in the lira. The sudden deterioration in the investment climate threatens to dent the pension fund’s returns and stall Ulusoy’s plans to expand internationally.

Notwithstanding those challenges, OYAK’s bold commander remains remarkably upbeat about the outlook. The pension fund has amassed an acquisition war chest of $3.2 billion, thanks to astutely timed divestments of some of its banking and insurance holdings in the past 18 months – at virtually the peak of the market. Although he put his shopping plans on hold late in 2008 because of the global market turmoil, Ulusoy hopes to find attractive assets at even cheaper prices in the upcoming year.

“We have plenty of cash on hand for future investments,” the blunt, 58-year-old executive tells Institutional Investor in an interview at OYAK’s spartan offices overlooking the Bosporus in central Istanbul. He says potential targets include construction, energy and mining projects in Europe and North America. “We definitely want to go abroad, and this is the time to diversify,” he says. “We can’t keep all our investments in Turkey for risk reasons.”

Those risks have ratcheted up sharply in recent months. Weakening global demand has taken a huge bite out of Turkey’s exports. In the third quarter of 2008, GDP expanded by an anemic 0.5 percent compared with the same period in 2007 – the slowest rate since 2002. Yarkin Cebeci, an Istanbul-based economist for JPMorgan Chase & Co., predicts growth will slow to 2.5 percent in 2009 from 3.5 percent in 2008. The lira plunged by 26 percent against the dollar in October alone and was trading just below 66 U.S. cents in late December, down 24 percent for the year. The Istanbul Stock Exchange’s 100 index was off nearly 53 percent since the beginning of the year. And according to Cebeci, foreign direct investment into Turkey will likely have fallen to less than $15 billion by year-end 2008 from $22 billion a year earlier.

With the global credit crisis reducing inflows of foreign loans and investments upon which Turkey has depended for its high economic growth, the government has been forced to turn to the International Monetary Fund for the fourth time in ten years. Negotiations were under way in December for an IMF loan that could reach $40 billion. (The Turkish government hopes to announce a deal in January when an IMF delegation is scheduled to visit the country.)

Still, given the tough environment, Ulusoy plans to go ahead with his international expansion plans, says OYAK chief investment officer Caner Öner. He acknowledges that OYAK companies are vulnerable to the sliding stock market, and “returns may be affected as a result of decreasing dividends,” but notes that the $3.2 billion the pension fund has set aside for acquisitions is distributed between lira, dollars and euros – and is mostly liquid.

As markets and growth projections have tumbled, political friction has mounted between Turkey’s secular establishment, which enjoys strong backing from the military, and Erdogan’s ruling Justice and Development Party, known by its Turkish initials AKP. The government earlier this year passed a law to allow women to wear headscarves at Turkish universities. Opponents promptly challenged the move in the constitutional court, arguing that the change violated the secular traditions established by Mustafa Kemal Atatürk, who founded modern Turkey in 1923.

The court overturned the headscarf law in June, but one month later it narrowly rejected a request by the country’s top prosecutor to ban the AKP, which would have provoked a political crisis and forced early elections. The court decided instead to cut state funding to the party in half. The ruling sparked a brief rally in Turkish markets, but tensions between the military and the government flared anew in October when 86 people, including several retired generals, went on trial on charges of carrying out assassinations and bomb attacks in a bid to sow chaos and provoke a coup to overthrow the government. The case is not expected to end for at least several months.

The infighting between the military and the government is no small irony – retired army officers, after all, have benefited economically as much as anyone in Turkish society from the Erdogan government. The AKP took power in 2001 when the country was struggling to recover from a severe economic crisis that had forced it into the arms of the IMF. Erdogan’s government implemented IMF-endorsed reforms that slashed inflation to single digits, fostered robust growth of 6 percent a year and attracted unprecedented inflows of foreign investment.

OYAK took advantage of that turnaround to generate average annual returns of 47 percent from 2000 to 2007, compared with an average annual rise of 14 percent on the Istanbul stock market during the period. The fund generated net income of TL3.2 billion in 2007 alone, up 54.2 percent from a year earlier. Ulusoy, a former banker whose father was a military doctor, likes to point out that OYAK’s 2007 profits easily outdistanced those of the Koç Group (TL2.29 billion) and Sabanci Holding (TL969.5 million), two giant Turkish business conglomerates.

OYAK has steered clear of politics, preferring instead to focus on performance. The fund avoids investments in defense-related activities, pays taxes like any other business and is not subsidized by the government. At the end of 2007, OYAK had 235,818 members, of whom 36,390 were retirees. Besides a lump sum for retirement – a brigadier general who put in 30 years of service received TL270,910 in 2008 – members can buy homes at a price just above construction cost and take out personal loans from the pension fund’s credit union.

OYAK’s stellar performance has won it a reputation of near-infallibility among Istanbul’s financial elite. “They are Turkey’s only real institutional investor,” says Mehmet Sami, an executive board member at ATA Invest, an Istanbul-based brokerage, who has sometimes found himself on the losing side of business battles with the pension fund. In 2005 he advised Luxembourg-based Arcelor (acquired by India’s Mittal Steel the following year) as it competed with OYAK to acquire steelmaker Erdemir. “Their cash flows and returns are fantastic, more like a successful private equity fund than a pension fund.”

OYAK’s private equity strategy was born of necessity. The fund was founded in 1961, one year after a military coup brought to power a government that sought to ingratiate itself with the electorate by broadening social security coverage to include blue-collar civil servants and creating independent, private pension funds for groups such as the military and the police. Only OYAK, with its unique approach to investing, survived. When it began collecting 10 percent of its members’ monthly base salaries, it soon faced the problem of what to do with the capital – it was the 1960s, and there were no money-market accounts or local stock exchange listings. It appeared that OYAK’s only investment option was to put the money into savings accounts, but individuals could do that on their own.

Instead OYAK opted to buy companies and use their dividends to finance its members’ pensions. That led to a private equity approach to investment decades before it was popularized in the U.S. and Europe. “Because there was no effective corporate governance in Turkey – no transparency or clear accounting rules – the only way to know that you were doing the right thing with members’ money was to acquire enough of a stake in a company to join management and see how well it was being run,” explains Ulusoy.

OYAK took majority stakes in domestic companies that operated in iron and steel products, cement and concrete, food processing and distribution and financial services and also formed a few joint ventures. In 1969 it picked up a 49 percent stake in an automobile venture with France’s Renault Group, which owns the remaining 51 percent. The company now dominates Turkey’s car market and has become a major exporter to the European Union. In 1994 giant French insurer AXA acquired 11 percent of OYAK Insurance Co. for $9 million and over time upped its stake to 50 percent. In February 2008, OYAK sold its half of the firm to AXA for €355 million ($525 million). In 2004, OYAK took a 24 percent share in a partnership with Germany’s Evonik Industries that operates a coal-fired power plant, Isken, that produces 7 percent of Turkey’s electricity. It has since upped its stake to 49 percent.

Ulusoy received a doctorate in economics from the University of Pittsburgh in 1980, then returned to Istanbul, where he held positions at Citibank, Morgan Grenfell & Co. and Turkey’s Halk Bank. From 1988 to 1994 he was CEO of the largest state-owned lender, T.C. Ziraat Bankasi, and from 1994 to 2000 headed Koç Consumer Finance Co.

A few months after he became CEO of OYAK in June 2000, a banking crisis gripped the Turkish economy, causing the lira to tumble and interest rates to soar. Ulusoy responded by suspending acquisitions and slowing down credit union lending to the pension fund’s members. He also converted OYAK’s cash holdings from lira into dollars. It was unusual, to say the least, for the military’s pension fund to bet against the country’s currency, but the move paid off spectacularly when the lira plunged by 52 percent against the dollar in 2001 alone. “The economy remained troubled through 2000 and 2001, but because all our liquidity was in dollars, we made a lot of money.”

Besides his banker’s résumé, Ulusoy boasted longtime personal ties to the armed forces. He grew up an army brat, moving around the country as his father, an ophthalmic surgeon in the armed forces, was posted from base to base. Though Ulusoy served only briefly – completing Turkey’s required 18 months of military service as a naval officer – he has lectured on military strategy and history, subjects on which he is a passionate aficionado. He splices business explanations with quotes from warfare philosophers like Carl von Clausewitz and Sun Tzu. On OYAK’s need to grab a bigger share of Turkish steel production, he says, “There’s a war going on; just look at what’s happened with world steel prices, and everybody is trying to capture steelworks.”

On a more pragmatic level, Ulusoy developed ties with military officers when he was CEO of Ziraat, which handled much of the armed forces’ payroll accounts and personal loans. He contends that familiarity with the military gave him the necessary backbone to demand more independence than any of his predecessors at OYAK had. When the pension fund’s board offered him the job, he agreed to accept only if it stayed out of management decisions. “I told them it’s like the signs in the Greyhound buses in the U.S. that warn passengers: ‘Stay behind the line and don’t talk to the driver,’” says Ulusoy.

He brought a few colleagues with him: Öner, OYAK’s CIO, and Aydin Müderrisoglu, vice president for new business development. Like their boss, both have doctorates, Öner in public and international affairs from the University of Pittsburgh, and Müderrisoglu in business administration from Pennsylvania State University. Müderrisoglu was vice president for strategic planning for the Koç Group while Ulusoy was there, and Öner worked under Ulusoy at Ziraat Bankasi as executive vice president.

The trio’s arrival shook OYAK to the core. The pension fund had always operated as a secretive enterprise that never showed its books to anyone. Shortly after assuming control, Ulusoy announced that the pension fund would begin publishing annual reports. With his new leadership team, he also decided to adopt international financial reporting standards at OYAK and at all 60 companies in which it had investments. And he implemented a hiring ceiling that has kept the pension fund’s total of employees at 200 since 2000.

OYAK’s board members endorsed the changes because Turkey’s economic crisis threatened to undermine the pension fund, which had seen its net income drop 19.7 percent, from $431.6 million in 1999 to $346 million in 2000. A year later, thanks largely to Ulusoy’s currency speculation, net income rose to $476.7 million.

But the Ulusoy team continued to raise eyebrows. Particularly controversial was a decision to raise outside financing for future acquisitions. “Some board members screamed that OYAK never borrowed, that it was outrageous to take loans we didn’t need,” says Ulusoy. But he went ahead and took out two syndicated loans in 2004 to raise $240 million. The money was used to purchase OYAK’s initial stake in the Isken power plant.

The new transparency and financial track record quickly paid off with credit ratings from both Standard & Poor’s and Moody’s Investors Service in 2005, the first ever granted to a Turkish nonbank company. Today, OYAK’s ratings of BB from S&P and Ba2 from Moody’s are higher than the Turkish government’s BB- and Ba3 ratings. “OYAK invests in low-risk targets that provide long-term, stable, recurrent dividends,” says Stuart Clements, a London-based credit analyst for Standard & Poor’s. The pension fund set its sights on the large state companies that the government was putting on the auction block in 2005, in particular, the biggest state-owned steel group, Eregli Demir ve C,elik, or Erdemir. It’s the country’s only producer of integrated flat steel used in automobiles and domestic appliances, and it also produces long steel, used in lower-value products for construction and infrastructure projects. With steel prices rising worldwide, spurred on by demand in China and India, OYAK’s executives were convinced they could not afford to let Erdemir slip away. Before the auction, the steelmaker had a market value of $3.3 billion. Ulusoy’s $2.96 billion bid for less than half the shares – which valued the group at $6 billion – far exceeded the government’s most optimistic expectations. But Erdemir’s market value rose to a high of $8.5 billion in June 2008, and OYAK purchased enough additional shares to give it slightly over 50 percent ownership. (As a result of the global economic meltdown, Erdemir’s market cap had plunged to $3.52 billion by mid-November). The pension fund used nearly $500 million of its own money and borrowed the remaining $2.5 billion to finance its $2.96 billion outlay. OYAK reported $110 million in cost savings at Erdemir in 2006 and another $50 million in 2007. In the first half of 2008, net profits were TL854.8 million, a 118 percent increase over the first half of 2007.

The pension fund’s most profitable deal to date was the $2.67 billion sale of OYAK Bank in June 2007 to ING Group, the Dutch banking and insurance company. When Ulusoy took over as chief executive in 2000, OYAK had a small, debt-ridden bank with 11 branches and a single ATM that didn’t work. Rather than cut its losses, the pension fund decided to increase its banking footprint. “We pursued a traditional military strategy and went on the attack,” says Ulusoy. In 2001, OYAK bought state-owned Sümerbank, a money-losing conglomerate of six small banks, with 135 branches and 230 ATMs, for $36,000 and a commitment not to sell Sümer for at least five years. Sümer and OYAK’s small bank were merged, given a $700 million capital boost and renamed OYAK Bank.

By 2006, OYAK Bank was offering corporate, small business and retail banking services through a countrywide network that had grown to 349 branches and 1,094 ATMs. It boasted 10,000 small and medium enterprises and 1.2 million consumers as clients. The bank ranked sixth among private sector banks, with TL12.5 billion in assets in 2007; net profits increased 29 percent that year, to TL135 million.

But OYAK Bank faced stiffening competition from larger foreign rivals including Citi, the Dutch-Belgian Fortis Group and France’s BNP Paribas. “How were we going to compete with the big boys?” asks Ulusoy. “We knew it would be a lot more costly for us to borrow than for them.” He found a willing buyer in ING, which was concerned it was losing out in the foreign scramble for Turkish banking assets. “The multiples were ratcheting ever higher, and there were a dwindling number of banks that fit our needs,” says John McCarthy, chairman of ING’s Turkish subsidiary. ING paid 3.26 times book value for OYAK Bank, and Ulusoy was exultant. “To get back almost $2.7 billion on a $36,000 investment in six years – now that’s what I call a good private equity story.”

The pension fund has also sold its holdings in retail operations in recent years, including a supermarket chain and a tire company. The asset sales have given OYAK its $3.2 billion stash for acquisitions. The domestic energy sector is emerging as one likely target area. According to the National Energy Forum of Turkey, the country will require $125 billion in new energy investments by 2020.

But Ulusoy saves his real enthusiasm for investment plans abroad. He and his team are poring over targets in Europe and North America, including bridge, energy and mining projects.

Credit rating agencies endorse the idea. “If OYAK had more investments based in countries with a higher credit rating, then its financial profile would probably merit a higher rating,” says S&P’s Clements.

The global financial crisis and Turkey’s political tensions continue to dampen growth prospects, but Ulusoy remains optimistic. After all, he points out, the country was undergoing a far worse crisis when he arrived at OYAK. “If we survived that, we will survive anything that comes out of this situation.”

Quant. Shop Offers Heady Long/Short Hedge Fund

December 17, 2008 | Source: FINalternatives

Santa Monica, Calif-based MarketPsy has launched a quantitative hedge fund that incorporates psychology into its trading strategy. So far, the firm’s Long-Short Fund has outperformed its discretionary counterparts, returning 6.03% since inception in September.

MarketPsy’s fund, which focuses on U.S. mid- to large-cap names, profits from what it calls psychology-driven movements in equities prices.

“Our investment strategy is based on the fact that innate psychological biases distort investors’ perceptions of stock value,” said Richard Peterson, managing director. “We find misvalued stocks by examining investors’ and executives’ language in SEC filings, executive conference calls and stock message boards. We have performed extensive software development, trade back testing, and portfolio simulation. Our long-short strategy is based on our discoveries of the psychological factors that predict stock price movement.”

In September, Peterson said the fund’s performance lagged because investors were not emotionally overreacting to the crises surrounding Fannie Mae, Freddie Mac and AIG, the bankruptcy of Lehman Brothers, and the credit freeze. The fund lost 6.7% that month.

However, the firm says investors began to overreact to news reports and media the following month, resulting in a 9% gain. In November, the firm’s short positions in solar stocks performed well after the U.S. presidential election, consistent with the classic “buy on the rumor and sell on the news” price pattern, said Peterson.

“We also performed well in November due to strategic long positions in financial stocks during the bailout of Citigroup.”

The fund charges a 1% management fee and a 10% performance fee with a $100,000 minimum investment requirement. It has a one-year lockup period.

Steven Levitt writes:

Back in the old days, banks didn’t package and resell the mortgages they wrote. So when a homeowner got into trouble, they could go down and talk with the bank about working out some solution other than foreclosure. For instance, the bank could allow the borrower to pay back the loan over 30 years instead of 15 years, reducing the monthly payment.

Not really… Even in the old days (unless we’re talking really old days), the homeowner would not talk to the lender. Instead, they would talk to the servicer in charge of their loan (in the really old days, servicers were units of lender banks, but eventually, independent servicing companies sprang out all over the place). Here’s how Fannie Mae explains what servicers do and how they are compensated:

We do not perform the day-to-day servicing of the mortgage loans that are held in our mortgage portfolio or that back our Fannie Mae MBS… Typically, lenders who sell single-family mortgage loans to us initially service the mortgage loans they sell to us. There is an active market in which lenders sell servicing rights and obligations to other servicers.

Mortgage servicers typically collect and remit principal and interest payments, administer escrow accounts, monitor and report delinquencies, evaluate transfers of ownership interests, respond to requests for partial releases of security, and handle proceeds from casualty and condemnation losses. For problem loans, servicing includes negotiating workouts, engaging in loss mitigation and, if necessary, inspecting and preserving properties and processing foreclosures and bankruptcies. We have the right to remove servicing responsibilities from any servicer under criteria established in our contractual arrangements with servicers. We compensate servicers primarily by permitting them to retain a specified portion of each interest payment on a serviced mortgage loan, called a “servicing fee.” Servicers also generally retain prepayment premiums, assumption fees, late payment charges and other similar charges, to the extent they are collected from borrowers, as additional servicing compensation. We also compensate servicers for negotiating workouts on problem loans.

So from the borrower’s standpoint, not much has changed because of securitization; the borrower still deals mostly, of not exclusively, with the servicer.

I have four questions:

OK, let’s take them one at a time, keeping in mind that there are servicers…

1) With mortgage-backed securities, is it really the case that a given mortgage is stripped into multiple pieces held by different entities?

Not exactly. First, mortgages are assembled into a pool, which is structured as a separate legal entity with mortgages as its assets. Then, this pool can be stripped, with strips becoming the pool’s liabilities; the alternative is a simple pass-through structure. The company that puts the pool together (such as Fannie Mae) is the sole equity holder.

2) If mortgages really are stripped into pieces, how does foreclosure work? If many different firms hold a piece of the mortgage, who initiates foreclosure? Who pays the costs of foreclosure? It would seem to me that many of the same obstacles to working out a refinancing deal would be present for foreclosing as well.

Foreclosure works just as it used to before securitization. “Many firms holding pieces of the mortgage” are creditors and thus have no say in the foreclosure matters. The out-of-pocket costs of foreclosures are paid by the pool (meaning that in the end they accrue to the company that created the pool); the decision to initiate foreclosure is also made by the pool (meaning, essentially, by the company that has created the pool).

3) If mortgages are not stripped into pieces, are there firms out there trying to scoop up failing mortgages at rock-bottom prices and getting on the phone with the homeowners to try to negotiate deals to avoid foreclosure? If mortgages are not stripped into pieces, I don’t understand why it is so hard to value these mortgage-backed securities.

Where would those firms “trying to scoop up failing mortgages at rock-bottom prices” come from? By now, whoever wanted to invest in mortgages, already has more than they know what to do with; that’s why we have a credit crunch on hand… As to difficulties in valuation, they come not so much from stripping, but from uncertainties surrounding mortgages; the borrower can default (and the amount to be recovered from selling the foreclosed home is highly uncertain, as house prices change over time) or refinance. Neither of these eventualities is in control of the lender, so valuation ultimately depends on assumptions the lender makes about probabilities and timing of default and/or refinancing, as well as about the likely value of the home in the event of default.

4) If indeed mortgages are stripped into pieces, weren’t people worried about the complications that would result when these mortgages were divided into pieces?

Yes and no. Complications should be weighted against opportunities they afford. Mortgage securitization offered an easy and cost-effective way to invest in mortgages for mutual funds and insurance companies…

How Options Saved Mexico’s Budget
Nov-14-2008 | Source: Futures and Options Intelligence

The news that Mexico has locked in prices of at least $70 a barrel for 90% of next year’s oil exports has surprised many traders, and demonstrated the depth of the oil derivatives markets.

If reports are correct, Mexico has protected $37bn of revenue from oil sales, vital to its 2009 budget, at a cost of just $1.5bn. It is believed to have done so, far-sightedly, in late September and early October, while oil was falling from about $120 towards $90.

The government has already revised its budget, lowering its oil price target from $80 to $70.

With oil now dropping through $60, the country’s budget would have been devastated if it had not hedged so much of its production and if prices stay low. Oil revenues make up nearly 40% of public sector income.

By warding off this disaster, Mexico will likely have protected the public finances, its credit rating, its currency and its stockmarkets.

Moreover, Mexico used put options for the hedge, so that it will still be able to benefit if oil prices go high again, by choosing not to exercise its options.

News of the transaction appears to have broken in Reforma, a Mexican newspaper, on November 6.

The story was based on a footnote in the finance ministry’s quarterly report for the third quarter of 2008, saying that Ps15.5bn ($1.5bn) was spent from the country’s $10bn oil stabilisation fund on “financial investments, as part of the measures taken for risk management, and the payment of fees to the trustee and its auditors/advisors”.

It was then picked up by a team of UBS analysts in Mexico City, including strategist Tomás Lajous, who wrote a detailed and apparently well informed report on the deal the same day.

On November 11 the Financial Times reported the story, adding that Barclays Capital and Goldman Sachs had arranged the hedge.

Those banks have declined to comment, as has the Mexican Treasury. Deutsche Bank and Morgan Stanley are said to have participated in Mexico’s oil hedging programme in the past, but this could not be confirmed – nor is it clear why they were not involved this time.

Lajous believes the transaction was arranged privately in the over-the-counter market. The banks would then have hedged their own exposure in the open market.

Lajous estimates Mexico hedged about 90% of its annual production, expected to be 533m barrels, or 1.46m barrels per day (bpd).

He calculated the cost at $1.5bn, based on the Treasury report and the fact that in the past, Mexico has usually spent about $500m to hedge 20%-30% of its production.

That would mean the country bought put options for 480m barrels, which Lajous believes were at strike prices of $70-$100.

Based on options at $70 for a barrel of Mexican crude oil mix, equivalent to $82 for West Texas Intermediate, the hedge will be profitable for Mexico if WTI oil trades next year at any level below $80. In other words, the higher revenues Mexico obtains by selling through the options rather than in the open market will exceed the $1.5bn option cost.

Between $80 and $85 for WTI, the option cost will exceed any gain – above $85, the revenue from selling oil at higher prices again pays for the option cost and leaves a profit.

But this analysis clouds the real virtue of the hedge, which Lajous calculates is to lock in a maximum revenue shortfall, compared to budget, of $3bn, including the option cost, even if WTI oil falls to $40.

That cost is 7% of budgeted oil revenues. Without the hedge, at $40 a barrel for WTI, Mexico would lose 59% of its budgeted oil revenue.

Yet if oil goes back to $100 or $120, Mexico will still make $10bn-$20bn of extra revenue, and only give up $1.5bn of this.

The urgency of hedging is even more clear when one recognises that Mexico’s oil production – the sixth largest in the world – is falling steeply. In 2006 the country pumped 1.6m bpd. This dropped to 1.4m last year and is projected by some to fall to 0.9m in the coming years.

“A few years ago Mexico had more leverage to impact the market. But with demand rising and production on the low, after 2010 Mexico may no longer be an exporter of oil,” said Adam Sieminski, chief energy economist at Deutsche Bank. “It is no surprise that the Mexican government wants to see how much revenue it can get by selling oil, even just for forecasting purposes. It makes sense to do this.”

Food for thought

That Mexico was able to execute such a beneficial hedge on such a large scale may change the way other producers operate, and make market participants reconsider some of their assumptions.

If Goldman Sachs and Barclays Capital were indeed hedging their options during the last week of August and first half of September, that would coincide with a period of steeply falling oil prices.

Lajous analyses the six month out WTI future, which slid from about $118 to $91 in that time, before rebounding to nearly $110.

He argues this pattern of trading “supports the view that the hedge took place (and confirms oil market trading comments from the time, which suggested that a LatAm producer was involved in transactions that put pressure on the futures curve)”.

Raymond Carbone, president of Paramount Options in New York, told FOi: “There were clear signals that an oil producer was hedging over the summer. The December 2009 contract experienced a surge in volumes.”

Carbone believes Mexico’s hedging could have added some downward pressure to oil prices as the banks involved would have been pushed to sell the commodity in the derivatives markets to manage their risk.

But there is strong reason to believe that the mid-September bounce in the crude oil price was caused partly by US oil refiners being caught with an oil shortfall in the wake of Hurricanes Gustav and Ike (see the link below to Futures and Options Intelligence’s story on September 30).

And after the bounce, oil resumed its steady downward course until it sank below $70 in late October.

So there would seem to be little evidence that Mexico’s trading affected prices substantially.

The average daily trade in Nymex’s Light Sweet Crude Oil future was 504,000 contracts in August and 550,000 in September, representing about 500m barrels of oil a day for all delivery dates.

The corresponding option trades about one fifth as much: 111,000 in August and 146,000 in September, or roughly 100m barrels a day.

If the hedging was spread out over three weeks, it would therefore have constituted about 30% of daily trading in the WTI options markets, or 6% of the futures market – perhaps enough to move a placid market, but not one in which sentiment was being whipped by contrasting forces of economic gloom and hurricane damage.

However, stealth must have been an important part of the trade’s success. If the market had seen the two banks coming with $37bn of hedging to do for Mexico, it could not have got such good pricing.

“They have to be careful how they do this,” said Michael Wittner, global head of oil research at Société Générale. “They don’t want to sell too much or there will be too much downward pressure – they will end up shooting themselves in the foot.”

Mexico is said to be among the oil producing countries that is fairly transparent about its hedging strategy, while others are more secretive.

It will be a high priority for oil strategists to discover in the coming months how successful other nations and large oil companies have been at protecting themselves from what is already a savage fall in the oil price.

TED spread shot to all-time high in October, and then “subsided” to the level of ordinary panic: