Market disruption language could hurt financials further

By Bryan Borzykowski | August 16, 2007 | Last updated on August 16, 2007
3 min read

The financial industry has taken a huge hit in the past few weeks, but more problems could be just around the corner, warns one Fidelity Investments portfolio manager.

Ken Anderson, a portfolio manager for Fidelity’s fixed-income division, says contagion is the biggest risk facing the markets right now. “We’re dealing first with the sub-prime mess then it moves over to leverage loans, and next does it start to affect corporate Canada and the U.S.?” he asked advisors in a conference call Thursday morning.

While the industry hasn’t seen any corporate defaults yet, Anderson says the possibility of companies shedding half their market cap in a short period of time — like Bear Stearns and Countrywide have — is the “type of contagion that keeps me up at night.”

Anderson also cautions advisors about market disruption language, which gives liquidity providers a way to step away from extending asset-backed commercial paper. He says while the extendable market is only $15 billion, the market for market disruption language is $160 billion. “This will be the main story going forward,” he says. “The market disruption language is a real out for any liquidity provider, and I think investors should be nervous about holdings in that type of paper.”

Coventree is a prime example of the extendable program. On Wednesday the company said it couldn’t find anyone to buy its ABCP, which forced it to extend the term of $410 million in notes. “If I bought a two-week security that rolls down, and [if] on the maturity date, these notes are extended, the notes will be extended for 11 months and two weeks,” says Anderson, explaining the ins and outs of the extendable market. “That is a very painful thing for a money market investor.”

A group of influential securities underwriters met to find a solution to the commercial paper problem. But Anderson isn’t sure their idea of terming the papers out in three- to five-year portions is a good idea. “In Canada we have one-year guidelines. We cannot invest out past one year,” he says. “I’m not sure what type of solution this is. I think the holders will be forced to sell and most likely take some losses in their funds.”

While this all sounds pretty gloomy, Anderson points out that the fixed-income market has been “very orderly and rational to date.” He says an argument could be made that it’s been “overly orderly.”

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“We’re seeing some triple B industrial names that are trading very close to par,” he says. “It seems to be avoiding all the issues in the market.” But, he adds, with that in mind, the sliding global equity market and widening investment grade debt should be carefully watched.

Of course, big losses can eventually produce big gains, and this situation is no different. Anderson sees some opportunities among all the trouble. “Whenever you have a washout, a lot of good bonds and paper becomes available,” he says. “We do think the market has a lot of opportunity here, and we are ready to dig in and take advantage of it.”

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Bryan Borzykowski