In response to concerns from their broker-dealer clients, Thomson Financial’s Municipal Market Data created a new variable-rate demand obligation average yesterday that will exclude all floating-rate paper insured by a monoline insurer.
Michael Downing, team leader for MMD’s short-term desk, said yesterday that after the Friday downgrade of Ambac Assurance Corp. to double-A from triple-A the market began to trade short-term floating paper insured by Ambac and other triple-A insurers significantly cheaper. As a result, the daily VRD average that MMD produces was significantly higher on Monday than what the market was expecting. It is from this daily average, but with added criteria for stabilization, that the Securities Industries and Financial Market Association’s widely used Municipal Swap Index, which resets weekly, is derived.
On Friday, before the Ambac downgrade was taken into account for the average, the daily VRDO rate from MMD for the general market, non-alternative-minimum tax paper was 3.03%. On Tuesday, after the holiday, it jumped 20 basis points to 3.23%. This was due to the market pricing the impact of all insured floating-rate paper trading cheaper, even if it was not Ambac insured.
“Our clients began calling up on Monday and trying to make sense of why our averages had gotten so cheap,” Downing said. “So in response we decided to put a new average out there that is stripped of all the monoline insurers. People needed it immediately, so we just put out this as a pilot program for now. The response has been very favorable.”
By noon on Tuesday, MMD had tallied the new VRD average excluding monolines. The verdict was that the average for the non-AMT, general market without the monolines was 2.68%, and with the monolines the average was 3.26%, a difference of 58 basis points.
“This is a good thing for the market because it gives a statistical way to quantify the differential risk between insured and non-insured,” said Jonathan Fiebach, co-founder of Duration Capital Management, an arbitrage fund. “We would hope that the market would start to bifurcate into the good quality index — the new average — and the bad quality index, or a sort of junk index and that would be the SIFMA one.”
Downing was clear that for now, he did not consider the new average a full index product for MMD. He said the average does not have any of the criteria that the SIFMA weekly reset has.
“This is just primary VRD stuff, it is none of the derivatized programs, none of the TOB programs or stuff like that,” he said. “This is simply the primary VRD paper market average. There is no weighting, no standard deviation, no credit minimum. Whereas the SIFMA average has some things built it to make for stability.”
Regardless, Fiebach said that if this average grows, and a market develops for it, he could see his fund using it as the basis for swaps down the road.
The most recent weekly SIFMA reset came in Tuesday afternoon at 2.78%, down from the previous week of 2.93%. Some market participants were surprised, expecting the reset to increase as a result of insurer woes. Downing attributed this move to the criteria the index uses to make sure the reset remains a high-grade product and a good representation of the entire market.
He did note that the standard deviation of floating paper used in the reset increased 28 basis points from 21 basis points last week to 49 basis points this week. This is a reflection of increased spreads as a result of insurance issues.
The SIFMA swap index was created in 1991. Thomson’s municipal group does most of the legwork in compiling the index. The short-term group pulls weekly rates from more than 25,000 high-grade active VRDs from more than 80 remarketing agents throughout the country. The new average is also compiled from the same base of remarketing agents.