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Daily Market Commentary

As the bond markets are relatively quiet this morning, the fixed income desk will engage in a musing about the current situation in the US financial sector.



The latest wave of investments by large sovereign wealth funds into America's largest financial institutions is disconcerting at best.


Citibank started this party by receiving $7.5 billion from Abu Dhabi in exchange for 11% convertible preferred shares.  Morgan Stanley followed suit with a $5 billion injection from China Investment Corp.  UBS - heavily involved in the structured debt market, although not a US bank, received $11 billion from an unidentified Middle Eastern investor (seriously - how long can the list of people who can pony up $11 BILLION be?), and Bear Stearns also received a $1 billion "cross investment" from China's Citic Securities (a government agency).  Now the latest rumour is that Merrill will receive cash from Singapore Finance ministry's Temasek, details yet to be disclosed.


  I won't even touch the issue of various sovereign funds buying up America's financial institutions, I will leave that to protectionist right wingers and the state department to worry about. 



We are concerned, however, about the phenomenon of the shares of these institutions actually rising on the news. Essentially, the terms of the cash injections indicate a skyrocketing in the cost of capital, to the extent that they feel it necessary to get their financing done in one very expensive private placement, rather than tapping the traditional capital markets. If these large financial institutions did not think the deals would get done through the regular channels of bond and stock offerings, this would not be a bullish sign for the existing securities holders.  In addition, many of the announced deals are likely to prove hugely dilutive to the existing shareholders. Hopefully the managers of these sovereign funds are savvy investors, rather than just looking for diversification alternatives to their traditional vehicle of US treasury bonds.  If they are right, they are getting the deal of the century.  If they are wrong however (god forbid governments should ever be wrong), their investments, along with those who are buying this news could be in for a tough ride.



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