2008 – Page 32 – The Aleph Blog

National Atlantic Notes, Part II

Posted on 22 April 200822 April 2008 by David Merkel

National Atlantic has filed its Preliminary Proxy Statement. I’m only going to tackle one part of it here tonight — the section starting on page 24, “Opinion of the Financial Advisor.” Those who have read me for a long time know that I am neither biased for or against any “fairness opinion.” For those who want to go back to my early days on RealMoney, you can view what I wrote on the MONY acquisition by AXA. The fairness opinion was correct, and the contesting value investors were dead wrong. Part of the problem was not understanding the insurance accounting.

With National Atlantic, I think the fairness opinion does not truly represent the value of the company. Let me go through a few critical bits of the fairness opinion:

(Page 26)

     Selected Publicly Traded Companies Analysis. Banc of America Securities
reviewed publicly available financial and stock market information for National
Atlantic and the following seven publicly traded personal lines property and
casualty insurance companies with a market capitalization below $2.5 billion:

        o   Mercury General Corporation
        o   State Auto Financial Corporation
        o   Horace Mann Educators Corporation
        o   Infinity Property & Casualty Corporation
        o   Safety Insurance Group, Inc.
        o   Donegal Group, Inc.
        o   Affirmative Insurance Holdings, Inc.

Banc of America Securities reviewed, among other things, per share equity
values, based on closing stock prices on March 7, 2008, of the selected publicly
traded companies as a multiple of calendar years 2008 and 2009 estimated
earnings per share, commonly referred to as EPS, and as a multiple of book value
per share as of December 31, 2007 (in the case of Safety Insurance Group and
Affirmative Insurance Holdings, as of September 30, 2007).

Affirmative and Infinity do not belong in this group, because they are both nonstandard auto writers, which get lower valuations than standard writers. Donegal is mainly a commercial writer when last I looked… the rest are fine. I might have included Gainsco, Commerce Group, or Universal Insurance Holdings. In any case, it biases the calculation of the estimated price low.

     Implied Per Share Equity Value Reference Ranges for National Atlantic         Consideration
     ---------------------------------------------------------------------         -------------

          2008E EPS                                    2007 Book Value
       ---------------                               -------------------

        $3.27 - $4.20                                   $5.24 - $7.85                   $6.25

It also would have been better to do a scatterplot of Price-to-book versus expected ROE on compared companies. I will have to perform that analysis eventually.

(Page 27)

Selected Precedent Transactions Analysis. Banc of America Securities
reviewed, to the extent publicly available, financial information relating to
the following twenty selected transactions involving property and casualty
insurance companies with a transaction value below $500 million:

Announcement
Date Acquiror Target
- --------------- -------------------------------------------------- -----------------------------------------

2/20/08 o Meadowbrook Insurance Group, Inc. o ProCentury Corp.
1/3/08 o QBE Insurance Group Ltd. o North Pointe Holdings Corp.
4/4/07 o Fortress Investment Group LLC o Alea Group Holdings Ltd.
3/14/07 o Argonaut Group, Inc. o PXRE Group Ltd.
12/4/06 o Elara Holdings Inc. o Direct General Corp.
11/22/06 o Clal Insurance Enterprises Holdings Ltd. o GUARD Financial Group Inc.
11/13/06 o Tower Group Inc. o Preserver Group Inc.
10/31/06 o American European Group, Inc. o Merchant's Group Inc.
10/6/06 o Affordable Residential Communities Inc. o NLASCO, Inc.
10/3/06 o Affirmative Insurance Holdings, Inc. o USAgencies, L.L.C.
9/28/06 o Arrowpoint Capital Corp. o Royal & Sun Alliance Insurance
8/16/06 o QBE Insurance Group Ltd. o One Beacon Insurance Group, Ltd.
8/4/06 o Delek Group, Ltd. o Republic Companies Group, Inc.
7/19/06 o Inverness Management L.L.C. o Omni Insurance Group Inc.
11/4/05 o General Motors Acceptance Corp. o MEEMIC Insurance Company
5/22/03 o Liberty Mutual Holding Company Inc. o Prudential Financial Inc.
5/22/03 o The Palisades Group o Prudential Financial Inc.
3/26/03 o Nationwide Mutual Insurance Co. o Prudential Financial Inc.
11/1/00 o American National Insurance Company o Farm Family Holdings, Inc.
10/25/00 o State Automobile Mutual Insurance Company o Meridian Insurance Group, Inc.

The only deal here that would truly be a “comparable” might be Republic Companies. It was a company that was mainly a personal lines company, unlike many of the rest of these deals which are for commercial insurers and reinsurers (I am not familiar with all of them). Republic was sold significantly over its book value. And, where is Commerce Group? I know it is too big to meet the cutoff, but there is a sale of a single state insurer. I would think that valuation would be relevant.

                 Implied Per Share Equity Value
              Reference Ranges for National Atlantic            Consideration
            ------------------------------------------        ------------------
               2008E EPS             2007 Book Value
            ----------------       -------------------

             $5.36 - $6.30             $8.51 - $9.82                $6.25

So, I think these values are low as well. There is far more certainty to the valuation of the reserves of a short-tailed insurer, which usually deserves a higher valuation.

(Page 28)

     Discounted Cash Flow Analysis. Banc of America Securities performed a
discounted cash flow analysis of National Atlantic to calculate the estimated
present value of the standalone unlevered, after-tax free cash flows that
National Atlantic could generate during National Atlantic's fiscal years 2008
through 2012 based on the National Atlantic management forecasts. Banc of
America Securities calculated terminal values for National Atlantic by applying
terminal forward multiples of 7.0x to 9.0x to National Atlantic's fiscal year
2013 estimated GAAP earnings and of 0.40x to 0.70x to National Atlantic's
estimated 2012 year-end book value. The cash flows and terminal values were then
discounted to present value as of March 7, 2008 using discount rates ranging
from 15% to 17%. This analysis indicated the following implied per share equity
value reference ranges for National Atlantic as compared to the Consideration:

             Implied Per Share Equity Value
          Reference Range for National Atlantic             Consideration
     -----------------------------------------------  --------------------------
                       $5.42 - $7.42                            $6.25

I’d like to see them spill the guts of the calculation, and the other calculations above as well. Using “0.40x to 0.70x to National Atlantic’s estimated 2012 year-end book value” and “discount rates ranging from 15% to 17%” is too severe. This is a company with no debt. It’s marginal cost of capital, using the “pecking order” theory is low. Also, short-tail P&C companies under competent management teams don’t retain valuations below 0.8x book.

     Run-off Analysis. Banc of America Securities also performed a run-off
analysis of National Atlantic to calculate the net present value of dividends
that would be paid to shareholders over the remaining life of the company
assuming that it serviced its existing policies without writing any additional
policies or renewing any existing policies. Based on the assessment of National
Atlantic management that the company would not be permitted to pay annual
dividends by the New Jersey regulators, this analysis calculated the net present
value of the final dividend available for distribution to shareholders after all
payouts on loss reserves and losses on unearned premium reserves, estimated to
be approximately $88.0 million payable in 2016. Banc of America Securities
applied a sensitivity analysis to assess a range of values if the loss reserves
were inadequate by up to 10% or were overstated, showing a redundancy of up to
10%. The range of final dividend distributions were then discounted to present
value as of March 7, 2008 using discount rates ranging from 13% to 17%. This
analysis indicated the following implied per share equity value reference ranges
for National Atlantic as compared to the Consideration:

             Implied Per Share Equity Value
          Reference Range for National Atlantic             Consideration
     -----------------------------------------------  --------------------------
                      $1.36 - $3.60                             $6.25

Again, the discount rate is too high. Beyond that, they make the fatal assumption that the company can’t close its books until 2016. If National Atlantic stopped writing policies today, then, one year from today, it would receive its last premium. The company would operate with a skeleton staff for one more year, after which, the remaining book could easily be sold to a company specializing in run-offs. You wouldn’t get your money in 2016. It would be more like 2010. Six years of interest discount at 13-17% makes a huge difference in the price.

=-=-=-=-=-=-=-=-=–=-==-=–=-==-=-=–=-==–=

I have more work to do here, but my fundamental view is not changed. I will be voting against the deal, and encouraging others to do the same. Should the deal succeed, I will likely file for appraisal rights. As I have noted before, I believe that I have meritorious arguments for a better price.

Full disclosure: long NAHC SAFT

The Financings of Last Resort, Part II

Posted on 22 April 2008 by David Merkel

When I wrote my last piece, “The Financings of Last Resort,” I did meant to add that this will be a common phenomenon for a year or so. Pretend you are part of a senior management team of a credit-sensitive financial institution, and your worst nightmare is slowly unfolding in front of you. You’re looking looking at delinquency and loss statistics stratified by year of issuance (“vintage”) and time since issuance. Every vintage since 2003 looks worse than the prior year, and the loss seasoning curves are all pointed upward — in the early vintages, mildly, and in the 2006-2007 vintages, wildly.

You are seeing current losses come through, and they are erasing much of current profits, or, creating crushing losses if you try to get ahead of the loss curve and put in sufficient reserves to handle likely future losses. Any loan loss estimate toward the beginning of a “bust” phase is a wild guess, and management teams are often behind the curve as they hope that the most recent data point was a statistical fluke.

But management teams often think along two tracks. The first is the “best current estimate,” which they give to the market through GAAP accounting. The second is “What if things get bad, and we run short of capital? Better to get financing now, while our stock price is relatively high, and bond and preferred spreads low.”

That reasoning drives two types of capital raising — financings of last resort, and protective financing. That second class of financing was what I commented on at Felix Salmon’s blog regarding JP Morgan.? Borrow when you can, not when you have to.? Get in front of the loss curve, not behind it.

But, for those that are behind the curve, the financings of last resort are protective, at least for a little while, of management teams and bondholders.? Consider the actions at:

But who loses? Current stockholders get diluted.? I can imagine the management consoling their consciences with the thought, “Yes, the stockholders lose, but what would they get in bankruptcy if things got worse, and we didn’t raise capital?”

So, even if credit-sensitive financial companies avoid going broke, they may not be good equity investments because of the dilution.? I said that early on with the financial guarantors.? The big guys are still alive, but their stock prices are down significantly.? (Oh, and note that the regulators like this approach.? No public funds get used.? No embarrassing front page insolvency news.? “What was the regulator doing?”)

How long will this continue?? Financings of last resort can go on until the stockholders rebel and throw out management (hard to do), or the estimated net present value of the profit stream of the company is negative; no one will finance that.? (Think of ACA Capital Holdings, maybe.)? The nature of a financing of last resort is that the financier hands over cash in exchange for cheap equity that can be recycled into the market.? It’s a coercive way of doing an equity or debt offering, and requires a significant discount to current financing valuations.

So, how long will the bailouts go on?? I think for quite some time, which I why I am avoiding that area of the market.? Avoid the equity “fire sales” if you can.? Remember, management teams usually know more than the average analyst when it comes to knowing the true value of cash that can be generated from illiquid assets.? So when you see financial firms pursuing liquidity during a time of debt deflation, don’t be a hero — avoid those companies.

Angry Freeholders?

Posted on 19 April 200820 April 2008 by David Merkel

After seeing the website Angry Renter, I considered my own position in the matter, because I’m not in favor of bailouts either.? I own my home free and clear, and I paid off my mortgage well in advance of when I had to.? I own a house smaller than I could afford, and with eight kids, sometimes I wish I had chosen otherwise.

But I love our little hovel, and wouldn’t have it any other way.? That said, there would be reason for people like me to be annoyed at any bailout.? I stayed within my means; I sacrificed other goals to own my home free and clear of any encumbrances.

Here is my version of the Angry Renter graph, with one major modification.? Using data from First American (LoanPerformance), I estimated what percentage of homeowners will be vulnerable if home prices fall another 10% or so.? They fall into my “under stress” bucket.? My view of the situation is this — over the next two years, with a fall in housing prices of 10%, roughly 12% of the housing stock of the US will be in a negative equity position, and more so, if one considers closing costs.

Remember, default in housing means negative equity in a sale, plus a negative life event: unemployment, death, disability, disaster, or divorce.

The problem is bigger than Anger Renter represents, which is why the politicians will do something (though it will likely be ineffective).? Politicians care about the banks, also… bank failures are not conducive to a happy economy.? Renters tend to not have much political clout, because they aren’t usually well-off.? My view is that Angry Renter as a movement goes nowhere.? Now, if you could get the relatively well-off freeholders involved, that could be another thing, but, I still think opposing a bailout would fail politically — politicians care about the banks.

The US Dollar and the Limits of Irresponsibility

Posted on 19 April 200820 April 2008 by David Merkel

Promises, promises.? How many ways can the politicians dream up to spend money that they don’t have?? Perhaps it’s easy when you are the world’s reserve currency, and few argue with taking down IOUs denominated in US Dollars, at least for now.

But there are limits.? When looking at the US Dollar today the markets have kind of a benchmark that they use as their default scenario:

Fed funds will not drop below 1.5% at the bottom of this cycle.
CPI inflation will not rise above 5% for this cycle.
Nominal GDP growth will not drop below 4% for this cycle.
The US current account deficit will improve, albeit fitfully.
?Total Federal Debt will not grow faster than $600 billion per year.? (you didn’t know it was growing that fast, now did you? 😉 )

Of course, this is just my view, and I could be wrong.? But the US Dollar has gotten trashed, and in order for it to get hit further, the powers that be will have to exceed the current “Limits of Irresponsibility.”? As for the default scenario that I have laid out above, those are key parameters that I think are baked into the current low level of the US Dollar.? Violate those levels, get a lower Dollar.?? Get further away from those levels, and dollar could rally.

When I gave my talk to the Society of Actuaries, one of my recurring themes was, “It is wonderful to be the world’s reserve currency.”? Consider especially slide 32, where the weak dollar combined with strong overseas equity markets flattens out the net foreign assets to GDP ratio at near -20%.? We ship our losses overseas, and that isn’t counting all of the subordinated structured product that they bought… yet.

I am not a doom-and-gloomer by nature.? I try to recognize what is wrong, analyze what could be done to ameliorate the situation, and consider what could go right.? I am not an optimist on the US Dollar, though I don’t see how it falls much further from here.? There is room for the US Dollar to rally, if only a few things go less wrong.

In the long run, though, there are imbalances that the US needs to change, and the long run path of the Dollar will rely on those changes.? I believe that the markets embed an improvement in US policies long run; if that fails, we will continue to see the Dollar deteriorate.

Why I like TIPS

Posted on 18 April 2008 by David Merkel

I have received a little criticism regarding my liking for TIPS.? Much of it falls along the lines of James Grant’s criticisms of the securities, given that the government controls the definition of inflation, it can discriminate against TIPS holders.

Inflation as it pertains to TIPS has been running at a rate of 4% year-over-year.? I think that level will rise from here.? For those that are not constrained to fixed income investing, you can speculate in a variety of commodities and similar investments.? Have fun.? But for those that have to invest in fixed income, TIPS should be attractive, given the low rates on nominal Treasury Notes.

I? realize this involves speculation on future inflation and interest rates, but the margin of safety versus a 2-2.5% yield in short Treasury Notes makes TIPS compelling to me.

It’s That Season, Again

Posted on 18 April 2008 by David Merkel

I don’t celebrate Easter or Passover, though it is intriguing how far apart the two days are this year.? The season that I am talking about is annual reports and proxies.? This is just a friendly reminder to say that voting your proxies is something that helps keep capitalism legitimate.? Granted, I think that board elections should always be contested, and that access to the proxy should be available to anyone with more than 1% of outstanding shares, but my view is that both amateur and professional investors should take the time to evaluate proxies, vote accordingly for their interests, and not blindly side with management.

I vote down:

All directors at firms that have lost money for me.? (And the auditor!)
Most options and supplemental pay plans.? Pay people cash, not contingent stock that dilutes me.? And, most of the officers earn enough already.? If you don’t do your job because you love it, you’re not the right person for the job.
Shareholder proposals limiting executive pay, environmental issues, and other liberal folderol.

I vote up:

Proposals for greater shareholder democracy.
Plans to de-classify boards, and eliminate poison pills.
Proposals to split the Chairman and CEO positions.

If we’re going to be capitalists, let’s exercise our responsibilities, and have our companies act fairly and ethically.?? When we do that, it helps give capitalism a good name, and maximizesw the benefits in the long run to shareholders.

The Source of Most Economic Prediction Errors at Present

Posted on 18 April 2008 by David Merkel

This should be regarded as a small “opinion piece” of mine.? My big gripe with economic predictions over the past five years, is that forecasters use the old closed economy simplifications that worked when the US was a unique capitalist economy, and international trade flows did not affect the total picture much.

Today, I don’t try to analyze the US economy as a whole.? I look at its sectors and try to analyze them in a global context.? Even if the domestic US economy is in a funk, it is possible for sectors that serve other countries that are growing to do well.

So, I don’t make much of those who assume a recession will restrain inflation.? Perhaps a global recession will do so, but a US recession will not.? We need to look more closely at how the US is devaluing its currency versus other countries, and that might give us better clues regarding future inflation.

It is much richer to look at the sectors of the US economy, and look at them separately.? They have varying exposure to the US and Global economies.? That difference is critical now for investment decisions.

Not Concerned About Reinsurance Group of America

Posted on 18 April 200818 April 2008 by David Merkel

So Reinsurance Group of America missed estimates. Big deal; they’ve had good-to-excellent earnings for the last ten quarters; they have a bad quarter now and then when the “law of small numbers” catches up with them. Look at 2Q05 and 4Q01 for examples. The law of small numbers means that every now and then, you get a random gaggle of deaths with high face amounts, and the quarter is bad. This is often a good buying opportunity, because Wall Street, which only understands that the earnings missed, without understanding the underlying model, assumes that the miss will persist into the future. That has not been true of RGA.

I have met the CEO and CFO of RGA, and I think they know what they are doing, more than all of the other companies that do life reinsurance. They are the quality name in the space, including their more complex European competitors.

The stock price is currently way above my lower rebalance point, but I would be a buyer on weakness if I did not have a position. This is one of those stocks that you tuck away for 5-7 years, and you find that it doubles. The current oligopolistic nature of life reinsurance may shorten that timespan.

Full disclosure: long RGA

Ten Things To Be Concerned About

Posted on 17 April 2008 by David Merkel

1)? Picking up on some comments from last night’s post, why I am I not concerned about counterparty exposure?? Because Wall Street has always been very good at cutting off overleveraged clients in the past.? LTCM was an exception there, and only because Wall Street gave in to their request for secrecy.? Wall Street grabs collateral first, and then lets the client argue to get it back.? The investment banks require a significant margin, and when there is significant concern about getting paid, the lines get pulled.

The real worry here is that the investment banks don’t have good enough risk controls for each other.? Note that Bear’s crisis started when other banks stopped extending credit to Bear, and the fear fed on itself.

I liken the investment banks to long-tail commercial casualty insurers.? No one knows whether the reserves are right.? No one can.? Confidence is a necessary part of the game, which is made easier at lower levels of leverage.? But high leverage and opaqueness are a recipe for disaster when volatility rises.

2) Should you worry about Fed policy?? Yes.? The Fed is steering away from the Scylla of a compromised financial sector, and into the Charybdis of inflation.? As I will point out later, that is already having impacts on the rest of the world.? As for now, there are a few ill-informed writers who say that a negative TIPS yield on the short end is a reason not to buy TIPS.? That might be correct if inflation mean-reverts.? Given the short-term resource scarcity building in our world, I don’t think that is likely.

3) Should you worry about the US Government budget deficit?? A little — oh, and worry about the real deficit, one that puts the wars and other emergency appropriations on-budget, and takes out the excess cash flow from Social Security.? In a macro sense, for the nation as a whole, the impact isn’t that great… but it sends a message to foreign creditors who wonder what the value of the dollars will be when they get paid back.? When they see the Fed running an aggressive monetary policy in the face of rising inflation and a weak dollar, it makes their heads spin, as they contemplate the hard choices the weak dollar forces on them.

4) Could the falling dollar cause a crisis in China?? Maybe.? China is levered to US growth, which is slowing, and their export competitiveness versus the US declines as the dollar declines.? And what will they do with all of those dollar reserves?? Beats me.? After a certain point, additional reserves are useless — it is akin to lending more to an entity that you know is insolvent.? My guess is that the yuan will get revalued after the Olympics, and then the real slowdown will hit China.

5)? What of foreign food riots; are they a worry?? (More, and more.)? A little.? They are a canary in the coal mine.? They point to the short-term scarcity of total resources in our world, which only becomes obvious as a large part of the world tries to develop.? But, one practical thing that it implies is that energy and food prices will remain high for some time.? We are one global market at present, and energy and food prices are interlinked through the energy and fertilizer costs of farmers, and through stupid ideas like corn-based ethanol.

6) What of flat crude oil? production?? Yes, worry.? As I have said before, the government oil companies of OPEC countries control most of the supply, but they don’t always manage their resources as well as a capitalistic oil company.? Mexico, Venezuela, and Russia have declining production, to name a few.? The Saudis may not want to produce more, because they don’t know what to do with all the US dollar reserves that they have today.? Or maybe they can’t…

7) Worry about falling housing prices?? Yes.? The problems in the housing market stem from overbuilding.? There are too many houses chasing too few solvent borrowers.? This will eventually affect prime mortgages, because declines of 15-20% in housing prices mean that many prime loans would be underwater in a sale.? Remember, an underwater loan becomes a default after a negative life event — unemployment, death, disability, divorce, and uninsured disaster.

Before all of this is done, one of the major mortgage insurers should fail.? We aren’t there yet.

8 ) What of falling residential real estate prices in foreign countries? Yes, worry.? For Europe, it could lead to the end of the Euro, as countries needing looser monetary policies get tempted to abandon the Euro.? If the Euro’s existence becomes questioned, it will be a systemic risk to the world.

9) What of credit card delinquencies?? Yes, worry.? It shows that total financial stress on the consumer is high, particularly when added to the problems in mortgage and home equity loans.

10) Should you worry about bank solvency?? A little.? All of these previously described stresses have some bearing on the ability of the banking system to make good on their obligations.? Be aware that the FDIC was designed to handle sporadic losses, not systemic crises.? The odds of these problems affecting the depositary financials is still low, but the protective measures will not be capable of dealing with the worst case scenario, should it arise.

Perhaps I have more to worry about.? As I close up here, I haven’t mentioned the PBGC, Medicare, and a variety of other problems.? But, I have to call it a night, and symmetry with last night’s piece is worth a little to me.

Ten Things Not To Worry About

Posted on 16 April 2008 by David Merkel

There are many that cover the markets that try to get you to worry about things that aren’t real problems.? Here’s a sampling for the evening:

1) Changes in accounting standards, or ineffective/opaque accounting standards.? Take Goldman Sachs and level 3 assets as an example.? The accounting standard is fine, so long as you understand it.? In general, the higher the level of level 3 assets, the more opaque the valuation of assets is, and a valuation haircut gets assigned to the stock.? This is proper, because it happens to all companies with high or cloudy accrual figures.? It makes it hard to estimate free cash flow.

Should we move from US GAAP to IFRS, it should not affect the valuations of stocks on average, though it will make it a little harder to do financial analysis.? What does not change is free cash flow, which is not subject to accounting rules.? The money that can be withdrawn from a business without harming its current prospects (free cash flow) is the key metric for understanding business value.

2) Counterparty risk.? In derivatives, for every loser, there is a winner.? So long as the appropriate margin levels are maintained at the main brokerages, and the main brokers don’t experience conditions that dramatically change their credit quality, counterparty risk is not a problem.? (Or maybe, I should say, worry about the brokers, not the other counterparties.)

3)? Investors moving to cash.? Money rarely leaves the market.? When funds raise cash (and here), others buy their shares at a discount.? Typically, they are stronger holders than those that sold.? I wouldn’t be too bullish over stories of investors moving to cash, but I certainly would not be bearish.

4)? Rating agency downgrades, unless they trigger a debt covenant.? For the most part, market spreads and yields are set independently of debt ratings.? Sophisticated investors dominate the market, not the rating agencies.? As an example, suppose the US were downgraded to Aa1/AA+/AA+.? After a week, I doubt yields would change much at all, because the fundamental view of the US would not be changed by a change in its rating.

5) High credit spreads.? Those are a reason to be optimistic, because it means pain has been taken already.? Spreads can’t get higher than a certain level, or companies start delevering, because it is profitable to do so.? So when you see spreads near record highs, that is a buying signal, at least for the debt.

6) Retailers in trouble.? Some retailers are always in trouble during hard economic times.? It’s a tough business model, so expect some defaults; it is normal and healthy for the economy as a whole.

7) Collapse of a large portion of the auction rate securities market. ? Most borrowers will refinance.? In the interim, speculators are driving down the rates that get paid.

8) Downgrades of the major financial guarantors.? The market has priced it in, and perhaps we just run off MBIA and Ambac.

9) Tranche warfare in CDOs.? Read your prospectus with care, but when the seniors grab hold of a deal after and event of default, that is a step toward normalizing the market, though the mezzanine holders may ineffectively object as they end up getting nothing.

10) The ABX indexes, etc.? I’ve written about this before, but the various synthetic indexes — ABX, CMBX, LCDX, etc., are very hard to arbitrage against the cash market bonds that they represent.? The indexes should not be used for pricing as a result.? Whenever the synthetic market gets too much bigger than the cash market, it becomes a bettors market, and becomes incapable of delivering pricing signals to the underlying cash markets.

There are enough real things to worry about.? Perhaps I will write about those tomorrow.