Today, my colleagues and I received many calls regarding the new FDIC-Guaranteed Goldman Sachs three-year bond. There seems to be some confusion about the structure. Let me try to make sense (that sounds familiar) of the structure.
Goldman Sachs issued a three-year note with an explicit FDIC guarantee. This means that the bonds a directly and explicitly backed by the U.S. government. Although this is an attractive feature, the guarantee comes at a price. In this case, the price is a relatively-low yield. The bond carries a coupon of 3.25% and was trading around +190 basis points over the current three-year treasury note (about 3.20%) late this afternoon. This was shocking to many financial advisers and their clients. After all, three-year CDs are offering yields approaching 4.00%. Put a half of a point sales credit on top and the Goldman bond yields approximately 2.90%. Why does the FDIC-guaranteed Goldman bond trade at yields which are far below CD yields? It is a function of the market.
The Goldman bond was an institutional deal. Institutions do not purchase CDs as their trade sizes (5mm, 10mm or more) are well beyond the FDIC limits (now $250,000). Since, in the case of the Goldman issue, it is the bond and not the investors which is insured, size does not matter. This makes yields in the low 3.00% area attractive for institutions with conservative risk tolerance levels.
More deals are in the pipeline. GE, JPM MS and a certain large bank are said to be poised to enter the market with FDIC-backed bonds. Look for yields to be unattractive versus CDs. Also, do not expect to receive allocations when indicating interest in these deals in syndicate. Institutions will have these oversubscribed well before price guidance is posted. Also, in the cases of JPM, MS and that certain large bank will likely run their own books as Goldman did. This means that institutional clients of the issuing firm will receive preference.
Yesterday, I mentioned that FDIC-guaranteed corporate bonds carry a stronger government guarantee than Freddie and Fannie bonds and that could divert investment dollars from the GSEs to the new FDIC-backed corporate bonds which could increase GSE borrowing costs and, therefore, mortgage rates. Today the government responded. The Federal Reserve Bank will purchase up to $100 billion in direct obligations (agency bonds) of FHLMC, FNMA and FHLB. It will also purchase up to $500 billion of mortgage-backed securities issued by FHLMC, FNMA and GNMA.
Finally, the Fed is addressing the real problem. Banks cannot lend unless they can securitize the loans and recoup capital to continue lending. This cannot occur if buyers for MBS are scarce. The Fed's stepping in for buyers could be a win / win situation. Banks can begin lending again as they have buyers for their MBS and the Fed owns MBS consisting of GSE-conforming loans which are not laden with hidden land mines. This could be a money-maker for taxpayers.
The Fed is also going to institute a $200 billion program which will purchase receivables consisting of consumer debt and business loans. This collateral is as safe as GSE-conforming mortgages, but the higher coupons and straightforward structures could also be money makers. This should have been among the earliest actions by the Fed. Fed Chairman Bernanke actually discussed such programs when outlining possible Fed responses to a financial crisis when he was a Fed governor six years ago. What took you so long, Ben?
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