Archive for October, 2007

HIMIPref™ Preferred Indices : August 2002

Friday, October 26th, 2007

All indices were assigned a value of 1000.0 as of December 31, 1993.

HIMI Index Values 2002-8-30
Index Closing Value (Total Return) Issues Mean Credit Quality Median YTW Median DTW Median Daily Trading Mean Current Yield
Ratchet 1,365.9 3 2.00 4.45% 16.6 209M 4.56%
FixedFloater 1,922.5 8 2.00 4.17% 16.3 134M 5.72%
Floater 1,512.6 4 1.74 3.85% 16.0 69M 4.35%
OpRet 1,574.6 29 1.24 4.01% 2.3 65M 5.56%
SplitShare 1,529.9 10 1.70 4.70% 2.0 52M 5.72%
Interest-Bearing 1,859.3 11 2.00 6.95% 2.0 137M 7.77%
Perpetual-Premium 1,202.4 10 1.50 5.48% 6.6 178M 5.66%
Perpetual-Discount 1,371.8 11 1.54 5.62% 14.3 174M 5.68%

Index Constitution, 2002-08-30, Pre-rebalancing

Index Constitution, 2002-08-30, Post-rebalancing

Loan Default Correlation

Friday, October 26th, 2007

This post was originally intended to be part of the report of the BoE Financial Stability Report … but it got too interesting and too long! So here it is … an introduction to Loan Default Correlation:

Box 2 of the report, Valuing sub-prime RMBS, provides a primer on the pricing of loan pools. Of great importance is the correlation of the default probability … we might say, for instance, that a sub-prime borrower has a 15% chance of defaulting and be perfectly correct, as far as that goes. It would be a mistake to construct detailed probability charts of default proportion within the pool, however, because this 15% default probability is not an asystemic risk that can be diversified away – there is a great deal of systemic risk in the pool.

For instance, while 5% of the total 15% default probability might be due to factors unique to the individual borrower – he loses his job, or gets sick or whatever – 10% of the total might be a response to broader factors that will affect the entire pool in much the same way – an economic depression causes unemployment to rise sharply, a pandemic makes everybody get sick, or whatever.

Thus, correlation must be estimated. The Bank reports:

Scenario C is the same as Scenario B except that it also has a higher rate of default correlation. As Chart A shows, this increases the chance of extreme outcomes, raising the price of the BBB tranche and reducing the price of the AAA tranche.

Comparing Table 1 with Chart 1.9 suggests that expectations about both default rates and correlations may have increased during July and early August, as the prices of both junior and senior RMBS tranches fell sharply. Views about default correlation may subsequently have been revised down, however, with prices of senior tranches recovering while the prices of junior tranches have continued to fall.

The correlation of 5% used for their base-case and for their scenarios A and B is consistent with research presented to a Fed Conference by Cowan & Cowan; scenario C increased the correlation to 15%. The Cowan & Cowan reports states:

This paper presents the first formal study of default correlation within a subprime mortgage loan portfolio. We find generally that default correlations for the specific portfolio studied are insignificant until the portfolio is segregated into appropriate risk groups. We analyze six month default correlation using both actual default (foreclosure) and a more broad definition of delinquency which is consistent with previous literature. Contrary to our expectations, actual defaults generally result in higher default correlations than delinquencies. As anticipated, the magnitude of default correlation increases as the internally assigned risk grade declines.

Briefly reviewing the results from actual defaults, we obtain a six month default correlation of 6.2% for CC-rated borrowers as compared with a miniscule 0.1% for AArated borrowers. If loans are grouped by occupancy type, the default correlation increases to 8.7% for second home loans and 2.6% for non-owner occupied homes. In contrast, classification by property type results in a maximum default correlation of 4.6% for multi-unit properties.

If default correlations are very low within subprime portfolios, then an expensive investigation of default correlations is not an efficient use of resources. However, our findings, combined with the findings of Loffler (2003) that lower grade portfolios are more sensitive to changes in default correlations, suggest that the industry needs to focus on this issue. Although it represents but one lender, it clearly provides sufficient insight to suggest a direction for further investigation. If, as Carey (2000) suggests, bad tail loss rates are understated by estimating portfolio loss distributions by equally weighting events in each database year, then our results should compel both subprime lenders and regulators to further investigate the impact of default correlation.

October 25, 2007

Thursday, October 25th, 2007

A bit more news came out regarding the Aastra lawsuit mentioned yesterday. In a Globe story:

Mr. Del Sorbo was an investment adviser to Aastra for about seven years, according to the lawsuit. During May and June, rising interest rates caused paper losses in the company’s bond and preferred share holdings. As a result, the company told Mr. Del Sorbo in June “that it wished to invest only in conservative, short-term, liquid securities with no exposure to interest rates and very low default risks,” the suit said.

As the portfolio was being reassessed, Mr. Del Sorbo talked about non-bank asset-backed commercial paper, “which he described as primarily baskets of residential mortgages with limited car loans and credit card debt, bundled together to produce a high-quality short-term investment product,” the suit said.

In July, Aastra put $8.5-million into an ABCP trust called Structured Investment Trust III, which was priced to yield 4.62 per cent.

That’s one of the issuers whose business was frozen under the Montreal Accord.

As it turns out, the underlying assets were about 94 per cent credit default swaps on long-term bonds, the lawsuit said. The claims have not been proven in court.

John Tobia, Aastra’s general counsel, would only say that “from our perspective, the pleadings speak for themselves.”

Finding Structured Investment Trust III on the DBRS website is a little tricky (they’re not exactly unique keywords, are they?), but one can quickly find the May 11 Press Release:

The Trust is a vehicle that is designed to purchase structured securities including CDOs.

The press release also states that Coventree is the sponsor, and a quick trip to Coventree’s site yields the conduit’s page which has links to the full rating report and the Information Memorandum. Coventree’s site also has Monthly Conduit Reports which are password protected; I can’t be bothered to get a password because, well, because I’m not putting $8.5-million into the thing. However, the Information Memorandum states:

The Financial Agent prepares a monthly Investor Report and makes this report available on-line to purchasers of Notes on a password-protected basis at http://www.nereusfinancial.com/. The Investor Reports contain information about the specific Purchased Securities held by SIT from time to time. Purchased Securities are obtained by SIT from Originators in major international credit default, CDO and associated markets. In order to secure optimum execution and terms, in accordance with prevailing practice in these markets, the identities of Originators are shared with the Rating Agency but are otherwise kept confidential by the Financial Agent.

It’s right there, in the summary, page 4, under the heading “Investor Information”. If anybody didn’t know what was in the thing, it’s because they couldn’t be bothered to find out.

Aastra’s counsel is quoted as stating that “from our perspective, the pleadings speak for themselves.”, but oddly, I don’t see the pleadings disclosed on their website; I guess they don’t really have a lot to say. Or maybe it’s just an oversight. Or something.

Speculation is building regarding next week’s Fed meeting, with a cut of 25bp being forecast by some. The November Fed Funds contract implies that this forecast has some general acceptance; trading at 95.54 today implying a projected effective rate of 4.46%. The actual trading rates for this month have been choppy, but it appears that the current 4.75% target is holding and being defended.

Meanwhile, the credit crunch continues, with another SIV indicating it is having difficulty financing:

MBIA Inc., owner of the world’s largest bond insurer, said a $1.8 billion structured investment vehicle it runs through its asset management business is having trouble raising money and is seeking funding alternatives.

MBIA has invested $15.8 million in the capital notes of Hudson-Thames Capital Ltd. and said it has no obligation to provide the SIV with liquidity support or guarantees. MBIA today reported its first quarterly loss ever after marking down the value of mortgage-related debt it guarantees by $342.1 million.

In what may or may not be interpreted as a positive sign (depending on what answer you want) US ABCP outstanding declined by only USD 4.6-billion in the past week – practically a rounding error. November could be interesting, however: there are persistent, if unofficial and unconfirmed reports that there will be a big whack of MTN paper maturing, that may well be very difficult to roll.

One of the more entertaining things I’ve read recently is an ‘I toldja so’ puff-piece by Nouriel Roubini – for instance:

In March, when this author wrote a long (30 pages), serious semi-academic research analysis – with Christian Menegatti – of why the housing recession had not bottomed out and why home prices would sharply fall further, this scholarly analysis was summarily and cheaply dismissed in the most crass terms (“the paper is really just a longer-than-usual blog”) by a popular blogger who had barely bothered even to read it. At least Daniel Gross – a very smart blogger – had the decency to literally eat pages of his own writings – as he had promised he would – when one [of] his financial predictions failed.

Cassandra’s Revenge!

I’ve updated the post regarding the BoE Financial Stability Report and will add more as I work through it. It’s good stuff, it really is; beautifully researched. If I made a special note of everything it contains that is interesting, my post would be longer than the report itself; those with an interest in this sort of thing are strongly encouraged to read the full publication.

As far as preferreds are concerned … PerpetualDiscounts continued to decline, much to my chagrin. One participant on Financial Webring Forum noted today:

I suppose this may have answered my question I had been pondering for some time about the recent MAPF sectoral allocation shift toward discount issues. The low coupon discounts seem like a bit of a trap to me, and although I hadn’t ruled out that you’d simply lost your mind, I suspect you know what you’re doing……………….

Well, it’s nice to know he presumed I had a mind to start with! As it is, I fear that results for the fund for this month will be summed up as “Too Soon”. As has been noted here in the past, sectoral shifts within the fund do not reflect an attempt at market timing; merely an analysis of the curve that shows that one sector has gotten out of whack with another. Over time, this works quite well; but not this time.

HPF.PR.B was down over 7% today, presumably due to yesterday’s downgrade. I suppose there are some non-PrefBlog-reading investors out there who considered the downgrade a surprise.

Good volume today, which is certainly meaningful. Just precisely what it means changes every time, of course, but in a month or so the technical analysts will be pleased to tell us what we obviously should have done.

Note that these indices are experimental; the absolute and relative daily values are expected to change in the final version. In this version, index values are based at 1,000.0 on 2006-6-30
Index Mean Current Yield (at bid) Mean YTW Mean Average Trading Value Mean Mod Dur (YTW) Issues Day’s Perf. Index Value
Ratchet 4.90% 4.86% 475,262 15.58 1 0.0000% 1,043.7
Fixed-Floater 4.88% 4.80% 101,651 15.77 7 +0.0651% 1,039.5
Floater 4.49% 3.85% 69,348 10.76 3 +0.5925% 1,045.5
Op. Retract 4.86% 3.57% 79,980 3.36 15 +0.0683% 1,027.7
Split-Share 5.18% 5.13% 86,233 4.11 15 +0.0049% 1,040.8
Interest Bearing 6.22% 6.23% 61,323 3.62 4 -0.0238% 1,063.5
Perpetual-Premium 5.75% 5.63% 100,741 9.85 17 +0.1047% 998.8
Perpetual-Discount 5.57% 5.61% 320,031 14.51 47 -0.3591% 906.3
Major Price Changes
Issue Index Change Notes
IAG.PR.A PerpetualDiscount -3.6127% Now with a pre-tax bid-YTW of 5.81% based on a bid of 20.01 and a limitMaturity.
SLF.PR.E PerpetualDiscount -3.0993% Now with a pre-tax bid-YTW of 5.69% based on a bid of 20.01 and a limitMaturity.
GWO.PR.G PerpetualDiscount -2.2621% Now with a pre-tax bid-YTW of 5.74% based on a bid of 22.90 and a limitMaturity.
HSB.PR.D PerpetualDiscount -1.8947% Now with a pre-tax bid-YTW of 5.42% based on a bid of 23.30 and a limitMaturity.
BAM.PR.N PerpetualDiscount -1.4846% Now with a pre-tax bid-YTW of 6.48% based on a bid of 18.58 and a limitMaturity. Closed at 18.58-81, 3×5, while the virtually identical (and now even more distressed) BAM.PR.M closed at 19.83-85, 1×12. I’ve seen a lot of things in the preferred share market that make no sense at all; but if this doesn’t take the cake, it’s at least worth a few pop-tarts.
RY.PR.D PerpetualDiscount -1.4016% Now with a pre-tax bid-YTW of 5.52% based on a bid of 20.40 and a limitMaturity.
RY.PR.G PerpetualDiscount -1.3410% Now with a pre-tax bid-YTW of 5.47% based on a bid of 20.60 and a limitMaturity.
ELF.PR.F PerpetualDiscount -1.3363% Now with a pre-tax bid-YTW of 6.03% based on a bid of 22.15 and a limitMaturity.
GWO.PR.I PerpetualDiscount -1.2677% Now with a pre-tax bid-YTW of 5.62% based on a bid of 20.25 and a limitMaturity.
RY.PR.A PerpetualDiscount -1.1572% Now with a pre-tax bid-YTW of 5.43% based on a bid of 20.50 and a limitMaturity.
BNS.PR.L PerpetualDiscount -1.0466% Now with a pre-tax bid-YTW of 5.44% based on a bid of 20.80 and a limitMaturity.
POW.PR.D PerpetualDiscount +1.0134% Now with a pre-tax bid-YTW of 5.75% based on a bid of 21.93 and a limitMaturity.
GWO.PR.E OpRet +1.0392% Now with a pre-tax bid-YTW of 4.49% based on a bid of 25.28 and a call 2011-4-30 at 25.00.
FTS.PR.F PerpetualDiscount +1.1021% Now with a pre-tax bid-YTW of 5.91% based on a bid of 21.10 and a limitMaturity.
CM.PR.P PerpetualPremium (for now!) +1.1594% Now with a pre-tax bid-YTW of 5.58% based on a bid of 24.43 and a limitMaturity.
POW.PR.A PerpetualDiscount +1.2180% Now with a pre-tax bid-YTW of 5.85% based on a bid of 24.10 and a limitMaturity.
ELF.PR.G PerpetualDiscount +1.2264% Now with a pre-tax bid-YTW of 6.05% based on a bid of 19.81 and a limitMaturity. Somebody should call up E-L Financial and tell them they’re distressed!
BAM.PR.B Floater +1.3361%  
BNS.PR.K PerpetualDiscount +1.8519% Now with a pre-tax bid-YTW of 5.48% based on a bid of 22.00 and a limitMaturity.
Volume Highlights
Issue Index Volume Notes
MFC.PR.B PerpetualDiscount 422,515 Now with a pre-tax bid-YTW of 5.39% based on a bid of 21.85 and a limitMaturity.
SLF.PR.C PerpetualDiscount 208,485 Nesbitt crossed 150,000 at 21.01, then another 50,000 at the same price. Now with a pre-tax bid-YTW of 5.39% based on a bid of 20.90 and a limitMaturity.
PWF.PR.F PerpetualDiscount 129,350 Now with a pre-tax bid-YTW of 5.71% based on a bid of 23.06 and a limitMaturity.
BMO.PR.H PerpetualDiscount 103,200 Desjardins crossed 100,000 at 24.90. Now with a pre-tax bid-YTW of 5.34% based on a bid of 24.79 and a limitMaturity.
BNS.PR.M PerpetualDiscount 82,100 Now with a pre-tax bid-YTW of 5.42% based on a bid of 20.89 and a limitMaturity.

There were thirty other index-included $25.00-equivalent issues trading over 10,000 shares today.

ABK.PR.C Considering Term Extension

Thursday, October 25th, 2007

Allbanc Split Corp. has announced:

The Company is scheduled to terminate on March 10, 2008. The Board of Directors is currently reviewing alternatives to termination, including a possible extension of the term of the Company, but there can be no assurance that any alternative will materialize.

Allbanc has been discussed here before and the same things previously written still apply: the NAV per Unit is $205.35 as of October 18, giving an asset coverage ratio of just under 3.4:1. Slightly more than half of the original issue has been retracted since their issuance in 2003; but a unit was worth only $102.81 back then.

Geez, the banks in their underlying portfolio have done well in the past five years, eh? DBRS continues to rate the issue as only Pfd-2; presumably the rating is constrained due to the focus on the financial sector, but the asset coverage suggests to me that Pfd-2(high) would be more appropriate.

The split-share vehicle has actually been around since 1998; after the first five year term they reorganized and:

redeemed all of its outstanding Capital and Preferred Shares for an aggregate redemption amount of approximately $92 million and has completed its public offering of Class A Preferred Shares, raising approximately $55 million through the issuance of 897,444 Class A Preferred Shares. The Class A Preferred Shares were offered to the public by a syndicate of agents led by Scotia Capital Inc.

Pursuant to a capital reorganization approved by shareholders on January 14, 2003, the holders of 897,444 Capital Shares converted such shares into 897,444 Class A Capital Shares on January 17, 2003. The Class A Preferred Shares were offered in order to fund in part, the redemption of Capital and Preferred Shares and to maintain the leveraged “split share” structure of the Company.

More details regarding the potential for another reorganization will be forthcoming. The capital unit-holders of long standing will be sitting on such ridiculously large unrealized capital gains that there will be a strong incentive for them to support a continuation of the company. Given that the preferreds pay a dividend of 5% of par, any extension might have to sweeten the deal a little to get preferred shareholder support, if current market levels persist until decision time.

Bank of England Discusses Role of Credit Rating Agencies

Thursday, October 25th, 2007

Geez, I was just locking up when I saw a story on Bloomberg – BOE Says Intervention May Be Required Over Credit Ratings. The third paragraph is considerably less emphatic than the first:

Credit-rating firms should face “public sector intervention” if they don’t overhaul the way they grade so-called structured debt products and provide more information to investors, the Bank of England said.

“These actions might occur voluntarily in the light of recent market experience,” the Bank of England said in the report. “Without this market evolution, there might be a case for public sector intervention to specify and encourage higher and common standards of assessment and disclosure.”

The BoE news release doesn’t mention the agencies; but I’ll include some quick snippets from the actual report:

Some end-investors and fund managers may have mistakenly assumed that the credit ratings of these products provided information on other risks. Many of these instruments are ‘buyand hold’ securities for which there is not always a readily available secondary market. A single rating does not capture adequately all of the risks inherent in these products — for example, liquidity risk — as reflected in the differential pricing of products within a similar ratings band.

The controversial stuff is in box 6 on page 56 of the report. Five suggestions for possible improvements are made – and I’m not going to comment on them now. However, these suggestions are inspired by a false premise:

These suggestions aim to facilitate a more sophisticated use of credit ratings by investors.

To which – as one last sally before switching off – I’ll say:

  • If a more sophisticated use of credit ratings by investors is desired, then it would appear more appropriate to concentrate any regulatory action on such investors. Yank a few licenses for imprudent conduct such as unsophisticated use of credit ratings, for instance. Make it clear that CEO’s who play at being Portfolio Managers with shareholder money are civilly liable if found negligent or reckless.
  • investors – taken as a group, with plenty of exceptions – do not want to use credit ratings in a more sophisticated way. They want one number that doesn’t need to be thought about in order to offload their responsibilities

Update, 2007-10-25: I must admit to some confusion regarding one of the Bank’s recommendations:

In moving forward, there are several areas in which further work is needed by market participants and the authorities in the United Kingdom and internationally to restore confidence in the financial system

The smooth functioning of markets in complex instruments depends on clarity about their content and construction. As discussed in Box 6 on page 56, rating agencies should support this process by clarifying the information available to investors on the risks inherent in products and the uncertainties around their ratings assessments. Recent events have demonstrated to investors the dangers of using ratings as a mechanical input to their risk assessment.

Why is it the ratings agencies’ job to clarify “the information available to investors on the risks inherent in products”? Just coming up with an assessment of credit risk is a pretty big job, and quite enough for one army of specialists. There is a very real danger here that the current fad for blaming the ratings agencies will lead to a situation in which they are held accountable for making market recommendations. That’s the job of investors! And if there are “risks inherent in products”, these are supposed to be disclosed in the prospectus – you know, around page 400, along with risks of meteorites wiping out head office.

Fans of the Black Swan model of Nassim Taleb will be gratified by the Bank’s note that:

It is striking that a market as small as US sub-prime RMBS, with a size of around $700 billion, had such pervasive effects on much deeper and more liquid markets, such as the asset-backed securities (ABS) markets (with a size of $10.7 trillion).

I prefer to think of financial markets as a chaotic system … which might be criticized as mere definitional quibbling, but even fat-tailed distributions strike me as being too deterministic. The universe is an unfriendly place; there is no telling which part of it is going to swoop down and kick you next.

Update, 2007-10-26: I became so interested in Box 2 of the report, Valuing sub-prime RMBS that I had to create a post dealing specifically with the issue! Default probabilities for lower grade retail credits are highly correlated – responding as they do to broader economic conditions – and the degree of correlation has important implications for pricing the various tranches of RMBS.

October 24, 2007

Wednesday, October 24th, 2007

Well … there won’t be much today!

All my non-preferred-trading-and-carnage-watching time today was spent puzzling over Capital Tax … some bond investments are subject to capital tax and some other bond investments are not subject to capital tax. The difference is, ostensibly, to avoid double taxation; I suspect that the real goal is to

  • raise money in a manner that will be invisible to Joe Lunchbucket
  • provide employment for retired politicians

Friend Flaherty is, of course, too busy grandstanding with ATM fees, National Securities Regulators and the price of eggs & milk in Buffalo … no, scratch that, the price of eggs and milk in Buffalo SHOULD be cheaper than in Toronto, because otherwise farmers with quota might have to work for a living … the price of Harry Potter books in Buffalo to be worried about doing something useful. Like eliminating busy-work taxes that have economically negative effects.

Some readers might surmise that I’m not in the best of tempers. Some readers might win a kewpie doll if they can do it three times running.

So … just time for one snippet of interesting financial news … there’s an ABCP lawsuit announced:

A potential flood of lawsuits over asset-backed commercial paper could hit courts in the coming weeks after Aastra Technologies Ltd. (TSX: AAH.TO) became the first to launch a legal action against adviser HSBC Securities for exposing the IT company to the troubled investment vehicle.

Aastra’s press release states:

Finally, as previously announced during the quarter, the Company currently holds $13.7 million of non-bank owned asset-backed commercial papers for which, currently, there is no active market. Of these investments, $8.5 million is invested in Structured Investment Trust III and was not repaid to the Company when it became due on October 10th while $5.2 million invested in Lafayette Structured Credit Trust is not yet due until October 30th of this year.

As a result of the developments above, Aastra commenced legal proceedings today against its investment advisor, HSBC Securities (Canada) Inc. and one of its employees, in the Ontario Superior Court of Justice seeking damages relating to investment advice provided with respect to Aastra’s purchase of the Structured Investment Trust III asset-backed commercial paper.

On August 23, they stated:

As of August 23, 2007, Aastra had $13.7 million, or approximately 11% of its cash and short-term investment balances, invested in asset-backed commercial paper.

So … a couple of observations … most of which are really queries:

  • HSBC Securities? So it’s a stockbroker they’re blaming? What was his Money-Market track record? I wonder how much due diligence they did before hiring him.
  • Frankly, 11% of a money market portfolio in ABCP doesn’t sound all that actionable to me. It’s aggressive, sure, but it doesn’t sound all that reckless.
  • Every time the market goes down a nickel, the OSC gets bagfulls of complaints. The favourite story I’ve heard is of a guy who got angry with his advisor during the Tech Boom (not the Wreck … the Boom). He had a portfolio and received a total of sixteen (if memory serves) recommendations. Fifteen of them made money. One of them lost a little bit. His portfolio did quite well. The client went completely berserk over the one unfortunate recommendation and made life miserable for everybody, for literally years, with complaints.
  • Is Aastra serious about the lawsuit, or just grandstanding for their shareholders? If they’re serious, they’ll post all the court documents on their website; if they’re grandstanding, they’ll just send out the occasional press release.

Prefhound commented on yesterday’s post regarding current market conditions and – to my gratification – did not cast aspersions on my observation that perpetual/retractible spreads were starting to look awfully juicy! I had hoped to comment further on these spreads today, but as it is, I will set some homework for the blog’s readers (BOTH of them! That means you, too, Dad!).

In my article How Long is Forever?, I compared a perpetual with a retractible by:

  • Calculating the total return of the retractible to the Retraction Date
  • Determining what price the perpetual would be on that date to provide the same total return
  • Determining what yield would give rise to that price
  • Laughing

Recent events have increased yields of the retractibles to the point where they’re not completely stupid any more … and increased the term to their presumed retraction/redemption date to the point where meaningful comparisons can be made (if the YTW is just six months off, you’re basically comparing the perp to cash, which is silly). There’s even enough that we can choose pairs for which credit quality will cancel – or, at least, cancel as much as one can for a perp.

So, here’s your homework: What will be the perps’ yield on the retractibles’ end-date in order for the two total returns to the end-date to be equal?

Perpetual/Retractible Comparisons
Retractible Pre-tax
Bid YTW
End-Date Perpetual Pre-tax
Bid YTW
GWO.PR.E 4.78% 2014-3-30 GWO.PR.H 5.73%
PWF.PR.J 4.47% 2013-7-30 PWF.PR.L 5.90%
MFC.PR.A 3.97% 2015-12-18 MFC.PR.B 5.37%
BAM.PR.J 4.90% 2018-3-30 BAM.PR.N 6.38%
TD.PR.N 3.74% 2014-1-30 TD.PR.O 5.47%

I’ll try to get to this … but maybe somebody else will get there first! Just for fun, I’ll do a really quick back-of-the-envelope calculation for the PWF.PR.J / PWF.PR.L pair:

  • L gets about 1.4% more yield annually than J
  • For six years
  • Total 8.4% more return
  • Therefore can withstand 8.4% capital loss and still break even
  • Current bid price of L is 21.67
  • Less 8.4% is 19.94
  • Dividend is $1.275
  • Therefore, yield on 2013-7-30 can be 1.275 / 19.94 = 6.39% and still break even

Now, I’m not going to suggest that this calculation automatically shows that PWF.PR.L is a screaming buy for everybody. Hell, they were down 4.58% today! But I do wonder how many people have actually performed the calculation and decided they want the safety of the retractible anyway!

Total carnage for preferreds today – I can only imagine that people saw the Merrill Lynch downgrade and decided that

  • All financials were at risk
  • The preferreds as much as the common

The PerpetualDiscount index hit a new 18-month low and now has a total return of about negative nine percent for the 15-odd months since 2006-6-30. And, for the first time, the PerpetualPremium index has gone below the 1,000.00 starting figure. I should have stood in bed.

Note that these indices are experimental; the absolute and relative daily values are expected to change in the final version. In this version, index values are based at 1,000.0 on 2006-6-30
Index Mean Current Yield (at bid) Mean YTW Mean Average Trading Value Mean Mod Dur (YTW) Issues Day’s Perf. Index Value
Ratchet 4.88% 4.84% 494,981 15.61 1 0.0000% 1,043.7
Fixed-Floater 4.89% 4.80% 101,535 15.78 7 -0.0970% 1,038.9
Floater 4.52% 4.54% 68,595 16.29 3 +0.0829% 1,039.2
Op. Retract 4.87% 3.67% 79,922 3.51 15 -0.2283% 1,027.0
Split-Share 5.18% 5.15% 85,985 4.12 15 -0.2619% 1,040.8
Interest Bearing 6.22% 6.18% 60,212 2.20 4 -0.3652% 1,063.7
Perpetual-Premium 5.76% 5.63% 98,823 9.83 17 -0.4358% 997.8
Perpetual-Discount 5.55% 5.59% 320,672 14.54 47 -0.6785% 909.5
Major Price Changes
Issue Index Change Notes
PWF.PR.L PerpetualDiscount -4.5795% Now with a pre-tax bid-YTW of 5.90% based on a bid of 21.67 and a limitMaturity.
BAM.PR.I OpRet -2.6707% Now with a pre-tax bid-YTW of 5.21% based on a bid of 25.51 and a softMaturity 2013-12-30 at 25.00.
ELF.PR.G PerpetualDiscount -2.6368% Now with a pre-tax bid-YTW of 6.12% based on a bid of 19.57 and a limitMaturity.
RY.PR.C PerpetualDiscount -2.6279% Now with a pre-tax bid-YTW of 5.55% based on a bid of 20.75 and a limitMaturity.
POW.PR.A PerpetualDiscount -2.5777% Now with a pre-tax bid-YTW of 5.92% based on a bid of 23.81 and a limitMaturity.
BAM.PR.N PerpetualDiscount -2.5323% Now with a pre-tax bid-YTW of 6.38% based on a bid of 18.86 and a limitMaturity. Closed at 18.86-92, 1×5. The virtually identical BAM.PR.M (touted recently as a [very badly categorized] Distressed Preferred closed at 19.80-95, 7×4. So go figure.
BSD.PR.A InterestBearing -2.1494% Asset coverage of just under 1.8:1 as of October 19, according to Brookfield Funds. Now with a pre-tax bid-YTW of 6.93% (mostly as interest) based on a bid of 9.56 and a hardMaturity 2015-3-31 at 10.00.
GWO.PR.H PerpetualDiscount -2.1043% Now with a pre-tax bid-YTW of 5.73% based on a bid of 21.40 and a limitMaturity.
GWO.PR.I PerpetualDiscount -1.7720% Now with a pre-tax bid-YTW of 5.55% based on a bid of 20.51 and a limitMaturity.
NA.PR.K PerpetualPremium (for now!) -1.5789% Now with a pre-tax bid-YTW of 6.02% based on a bid of 24.31 and a limitMaturity. 6.02%? Interest-Equivalent of 8.4%? For a Pfd-1(low) BANK? National is not my favourite bank – their management has been severely criticized here in the past and may well be severely criticized in the future … but enough is enough, already!
RY.PR.W PerpetualDiscount -1.5385% Now with a pre-tax bid-YTW of 5.47% based on a bid of 22.40 and a limitMaturity.
BMO.PR.H PerpetualPremium (for now!) -1.5145% Now with a pre-tax bid-YTW of 5.36% based on a bid of 24.71 and a limitMaturity.
GWO.PR.E OpRet -1.4961% Now with a pre-tax bid-YTW of 4.78% based on a bid of 25.02 and a softMaturity 2014-3-30 at 25.00.
PWF.PR.E PerpetualPremium (for now!) -1.4374% Now with a pre-tax bid-YTW of 5.69% based on a bid of 24.00 and a limitMaturity.
BNA.PR.C SplitShare -1.3488% Asset coverage of 3.8+:1 as of 2007-7-31 according to the company. Now with a pre-tax bid-YTW of 6.37% based on a bid of 21.21 and a limitMaturity.
PWF.PR.K PerpetualDiscount -1.2488% Now with a pre-tax bid-YTW of 5.83% based on a bid of 21.35 and a limitMaturity.
BAM.PR.M PerpetualDiscount -1.2469% Now with a pre-tax bid-YTW of 6.07% based on a bid of 19.80 and a limitMaturity. See BAM.PR.N, above.
IAG.PR.A PerpetualDiscount -1.1899% Now with a pre-tax bid-YTW of 5.60% based on a bid of 20.76 and a limitMaturity.
DFN.PR.A SplitShare -1.1696% Now with a pre-tax bid-YTW of 5.10% based on a bid of 10.14 and a hardMaturity 2014-12-01 at 10.00.
SLF.PR.E PerpetualDiscount -1.1489% Now with a pre-tax bid-YTW of 5.51% based on a bid of 20.65 and a limitMaturity.
PWF.PR.F PerpetualDiscount -1.1154% Now with a pre-tax bid-YTW of 5.71% based on a bid of 23.05 and a limitMaturity.
SLF.PR.B PerpetualDiscount -1.0643% Now with a pre-tax bid-YTW of 5.43% based on a bid of 22.31 and a limitMaturity.
CM.PR.H PerpetualDiscount +1.0000% Now with a pre-tax bid-YTW of 5.69% based on a bid of 21.21 and a limitMaturity.
RY.PR.G PerpetualDiscount +1.8537% Now with a pre-tax bid-YTW of 5.39% based on a bid of 20.88 and a limitMaturity.
Volume Highlights
Issue Index Volume Notes
CIU.PR.A PerpetualDiscount 143,180 Nesbitt crossed 157,700 at 21.25. Now with a pre-tax bid-YTW of 5.51% based on a bid of 21.24 and a limitMaturity.
PWF.PR.F PerpetualDiscount 106,330 Desjardins crossed 100,000 at 23.05. Now with a pre-tax bid-YTW of 5.71% based on a bid of 23.05 and a limitMaturity.
MFC.PR.C PerpetualDiscount 64,330 Now with a pre-tax bid-YTW of 5.34% based on a bid of 21.33 and a limitMaturity.
BNS.PR.L PerpetualDiscount 54,309 Now with a pre-tax bid-YTW of 5.38% based on a bid of 21.02 and a limitMaturity.
CM.PR.H PerpetualDiscount 47,230 RBC crossed 17,200 at 21.25. Now with a pre-tax bid-YTW of 5.69% based on a bid of 21.21 and a limitMaturity.

There were twenty-seven other index-included $25.00-equivalent issues trading over 10,000 shares today.

HPF.PR.A & HPF.PR.B Downgraded by DBRS (finally!)

Wednesday, October 24th, 2007

DBRS:

has today downgraded two series of Preferred Shares issued by High Income Preferred Shares Corporation (the Company). The Series 1 Shares have been downgraded from Pfd-1 (low) to Pfd-2 with a Negative trend, and the Series 2 Shares have been downgraded from Pfd-2 (low) to Pfd-3 with a Negative trend.

The termination date for each series of shares is June 29, 2012 (the Redemption Date).

Approximately 33% of the gross proceeds from the initial offering were used to enter into a forward agreement with the Canadian Imperial Bank of Commerce (the Counterparty) to provide for the full repayment of the Series 1 Shares principal on the Redemption Date. The remaining net proceeds from the initial offering were invested in a portfolio of common shares (the Managed Portfolio), which initially provided asset coverage to the Series 2 Shares of about 1.8 (downside protection of 44%). In addition to providing coverage to the Series 2 Shares principal, the Managed Portfolio is used to pay annual fees and expenses, as well as monthly distributions to the Series 1 and Series 2 Shares (5.85% and 7.25% per annum, respectively).

Since inception, the Managed Portfolio’s net asset value (NAV) has declined 28% from about $27 to $19.38 per share (as of October 19, 2007), providing downside protection of 24% to the Series 2 Shareholders. It is the Company’s intention to suspend both Series 1 and Series 2 dividend payments if the Managed Portfolio’s NAV drops below $14.70 per share. On the Redemption Date, the holders of the Series 1 and Series 2 Shares will be entitled to receive all cumulative dividends in arrears before the principal repayment to the Series 2 Shareholders. As a result, the ultimate payment of cumulative dividends to the Series 1 and 2 Shareholders is likely, but the timing of those payments is uncertain.

The downgrade of the Series 1 Shares is based on the risk that not all Series 1 dividends will be paid in a timely manner. The downgrade of the Series 2 Shares is based on the risk that dividends will not all be paid in a timely manner, as well as the eroding asset coverage available to cover the repayment of the Series 2 principal.

What can I say? I’ve complained about these issues’ ratings in the past. The vehicle has performed extremely well over the past year, with the Managed Portfolio providing returns of over 10% (which is not really such a wonderful accomplishment, given that the S&P/TSX 60 Index benchmark returned 22.5%) … so … one has to wonder … if it’s being downgraded now, after a year of great (absolute) performance, why wasn’t it downgraded earlier?

I haven’t pulled the numbers apart yet, but the rating on HPF.PR.B still looks pretty high to me. Yes, asset coverage is about 1.32:1, which in and of itself isn’t the worst ratio in the world. But, as DBRS points out: In addition to providing coverage to the Series 2 Shares principal, the Managed Portfolio is used to pay annual fees and expenses, as well as monthly distributions to the Series 1 and Series 2 Shares (5.85% and 7.25% per annum, respectively).

Distributions & Expenses come to a little over $4.4-million annually, including a doubtlessly richly deserved management fee of over half a million. This is $3.33 per Series 2 share. So the $19.38 per share assets are being eroded by $3.33 fees/expenses/distributions (FED). Five years until termination. Total FED $16.65, after which you’ve got to pay $14.70 principal on the Series 2 shares. So … that $19.38 has to grow to $14.70 + $16.65 = $31.35 in five years if default is to be avoided. That’s a total return of 61% over the five years; that’s 10% p.a. portfolio return just to avoid default by a penny.

Pfd-3 is way too high for these turkeys.

HPF.PR.A & HPF.PR.B are both tracked by HIMIPref™ with the security codes A46300 and A46301, respectively. Entries have been made to the creditRatings table to reflect today’s change.

HIMIPref™ Preferred Indices : July 2002

Wednesday, October 24th, 2007

All indices were assigned a value of 1000.0 as of December 31, 1993.

HIMI Index Values 2002-7-31
Index Closing Value (Total Return) Issues Mean Credit Quality Median YTW Median DTW Median Daily Trading Mean Current Yield
Ratchet 1,514.2 2 2.00 4.14% 17.2 288M 4.15%
FixedFloater 1,945.9 9 2.00 4.05% 16.8 130M 5.63%
Floater 1,509.1 5 1.79 4.18% 16.4 41M 4.33%
OpRet 1,559.4 28 1.21 4.08% 2.2 85M 5.61%
SplitShare 1,495.7 10 1.69 5.05% 5.0 68M 5.86%
Interest-Bearing 1,835.9 11 2.00 7.39% 2.2 158M 7.86%
Perpetual-Premium 1,186.0 10 1.50 5.56% 6.6 149M 5.75%
Perpetual-Discount 1,352.6 12 1.58 5.72% 14.3 200M 5.75%

Index Constitution, 2002-07-31, Pre-rebalancing

Index Constitution, 2002-07-31, Post-rebalancing

SPL.A Downgraded by DBRS

Wednesday, October 24th, 2007

DBRS announced today that it:

has today downgraded the Class A Shares issued by Mulvihill Pro-AMS RSP Split Share Corp. (the Company) from Pfd-3 to Pfd-4 with a Negative trend.

The rest of the net proceeds from the initial offering were invested in a diversified portfolio of Canadian and U.S. equities (the Managed Portfolio). After offering expenses, the Managed Portfolio provided asset coverage of approximately 1.8 times to the Class A Shares (downside protection of about 44%). In addition to providing principal protection for the Class A Shares, the Managed Portfolio is used to make distributions to the Class A Shares equal to 6.5% per annum and pay annual fees and expenses. Also, the Company has been making semi-annual contributions of $0.43 per Class A Share from the Managed Portfolio to a forward agreement with the Counterparty for the repayment of the Class A Shares principal on the Termination Date. Currently, 75.6% of the Class A principal is guaranteed by the Counterparty on the Termination Date.

The Managed Portfolio has declined about 79% since inception. About one-third of the decline has resulted from the semi-annual contributions to the Class A Forward Account.

The main constraints to the rating are the following:

(1) The Managed Portfolio’s NAV is currently $3.83 per share, providing very little dividend income

(2) The Company’s annual expenses, dividend commitments and forward contributions cause a severe grind on the Managed Portfolio’s NAV

(3) Reliance on management to effectively budget the Managed Portfolio’s NAV

SPL.A is tracked by HIMIPref™ with a securityCode of A43400. The creditRatings table of the permanentDatabase has been updated to reflect the new information.

October 23, 2007

Tuesday, October 23rd, 2007

More details are emerging regarding the SIV situation: FT-Alphaville has republished a Fitch graph showing the NAV of the SIVs it rates:

In this case, “NAV” is a measure of the asset coverage provided to the equity noteholders; therefore, when it’s below 100%, they’ve lost money. These numbers have no independent implications for the asset coverage ratios for the senior noteholders; that will depend on the original capital structure of the SIV.

Naked Capitalism discusses this and other tidbits from the SIV front. An anonymous Fed tipster is putting out the word that the Fed’s silence should not be misconstrued. The WSJ has published an extract from an interview with the head of the Basel Committee on Banking Supervision – he’s not impressed by the Super-Conduit idea. One question-and-answer brought tears of gratitude to my eyes:

Might Basel II’s reliance on rating agencies, for instance, come under consideration?

There are problems to be solved with rating agencies. … but you remain responsible at the end of the day, yourself, and you have to make your own assessments.

Fitch Ratings has published an initial review, dated September 20, and an update, dated October 12, of the SIVs it rates (the chart above is taken from the update). Credit Sights, an independent credit rating agency (that is, one paid by its subscribers rather than – gasp! – the issuers) that delights in being gloomier than the the issuer-paid credit rating agencies, has released a report (to paying clients) that claims:

Many structured-investment vehicles may be forced to close in the next few months as defaults by SIVs run by European hedge funds make it harder for others to avoid selling off their assets

So if Super-Conduit ever gets off the ground, there is every indication that it will have plenty of assets to choose from!

I mentioned the issue of bank purchases of ABCP held in their money-market funds on August 20 in the context of managerial independence, but there are other problems with the idea. Mainly, is a MMF a stand-alone investment vehicle, or is it a bank deposit? There are some US banks purchasing SIV paper from their MMFs; this is not a right and proper thing to do. I hope that the OSFI in Canada and the Fed in the US will nail these banks to the wall on their next audit; unless unitholders are taking ALL the risk of the investment, EVERY SINGLE PENNY, then the MMF is not a stand-alone vehicle.

Given all the excitement regarding the issuance of covered bonds, it would seem that if bank-run MMFs are really “covered bank deposits” then the banks’ balance sheets should be grossed up by the size of their funds and capital adequacy determined from these figures. The National Bank, for example, has total assets of about $117-billion and a total of about $1.7-billion in various MMF vehicles: Money Market Fund, Treasury Bill Plus, US MMF, Corporate Cash Management, Treasury Management and Strategic Yield. Grossing up the balance sheet would not be the biggest charge in the world, but if the banks are going to give implicit support to their funds, it is a charge that should be taken in order to protect depositors.

Business Week has a fascinating story on the implosion of the two Bear Stearns hedge funds that triggered the whole crisis. I have updated my post on stress-testing of Australian mortgages with a report from Bloomberg that one of the largest mortgage insurers is being downgraded.

The decline in perpetual preferreds actually accellerated today; to me, the yields have gone beyond “wow!” and into “outlandish” territory … but those who are selling evidently disagree with me!

There are some proxy-variables in the yield curve analysis that lead me to suspect that there is a definite bias towards selling the newer issues – by which I mainly mean everything issued in the last year; this is a change from the situation last spring. I had mentioned at that point that liquidity appeared to be at a premium – and so it was, according to the analysis. I am beginning to suspect, however, that the yield curve needs some kind of – yech! – momentum indicator, because I am now hypothesizing that the liquidity premium was actually a proxy for a “recent issue premium”. Currently, I am analyzing a premium being paid for “cumulative dividends”; this might be a proxy for “recent issue discount”.

There’s always something new, something to be tested, that becomes apparent only in times of extreme stress. ‘Nature reveals her secrets best under torture’, and all that. If Bacon didn’t say it, then I will.

I should note – for those who might be alarmed at the idea that I don’t know everything already – that yield curve analysis is the least of my analytical worries right now. Fits to the curve are excellent; it’s diversification that has me concerned. The yield pick-up of Perpetuals over Retractibles is now so extreme it’s becoming harder and harder to justify any holdings of the latter at all!

Note that these indices are experimental; the absolute and relative daily values are expected to change in the final version. In this version, index values are based at 1,000.0 on 2006-6-30
Index Mean Current Yield (at bid) Mean YTW Mean Average Trading Value Mean Mod Dur (YTW) Issues Day’s Perf. Index Value
Ratchet 4.85% 4.82% 515,214 15.65 1 0.0000% 1,043.7
Fixed-Floater 4.88% 4.79% 102,556 15.80 7 +0.1108% 1,039.9
Floater 4.52% 4.54% 69,471 16.29 3 -0.1101% 1,038.4
Op. Retract 4.86% 3.91% 79,823 3.13 15 -0.0733% 1,029.4
Split-Share 5.16% 5.03% 86,188 4.13 15 -0.0030% 1,043.5
Interest Bearing 6.20% 6.16% 58,669 3.64 4 +0.7660% 1,067.6
Perpetual-Premium 5.74% 5.60% 98,396 9.89 17 -0.2768% 1,002.1
Perpetual-Discount 5.51% 5.55% 321,954 14.61 47 -0.5871% 915.7
Major Price Changes
Issue Index Change Notes
CM.PR.H PerpetualDiscount -3.6697% Now with a pre-tax bid-YTW of 5.75% based on a bid of 21.00 and a limitMaturity.
PWF.PR.K PerpetualDiscount -3.3095% Now with a pre-tax bid-YTW of 5.74% based on a bid of 21.62 and a limitMaturity.
ELF.PR.F PerpetualDiscount -2.7706% Now with a pre-tax bid-YTW of 5.94% based on a bid of 22.46 and a limitMaturity.
ELF.PR.G PerpetualDiscount -1.9990% Now with a pre-tax bid-YTW of 5.96% based on a bid of 20.10 and a limitMaturity.
RY.PR.G PerpetualDiscount -1.7435% Now with a pre-tax bid-YTW of 5.49% based on a bid of 20.50 and a limitMaturity.
SLF.PR.E PerpetualDiscount -1.6941% Now with a pre-tax bid-YTW of 5.45% based on a bid of 20.89 and a limitMaturity.
PWF.PR.L PerpetualDiscount -1.6883% Now with a pre-tax bid-YTW of 5.64% based on a bid of 22.71 and a limitMaturity.
BAM.PR.M PerpetualDiscount -1.4742% Now with a pre-tax bid-YTW of 6.00% based on a bid of 20.05 and a limitMaturity.
CM.PR.I PerpetualDiscount -1.4078% Now with a pre-tax bid-YTW of 5.62% based on a bid of 21.01 and a limitMaturity.
GWO.PR.H PerpetualDiscount -1.3093% Now with a pre-tax bid-YTW of 5.61% based on a bid of 21.86 and a limitMaturity.
BSD.PR.A InterestBearing +2.3037% Asset coverage of just under 1.8:1 as of October 19 according to Brookfield Funds. Now with a pre-tax bid-YTW of 6.55% (mostly as interest) based on a bid of 9.77 and a hardMaturity 2015-3-31 at 10.00.
Volume Highlights
Issue Index Volume Notes
PWF.PR.K PerpetualDiscount 260,500 Now with a pre-tax bid-YTW of 5.74% based on a bid of 21.62 and a limitMaturity.
BMO.PR.J PerpetualDiscount 220,300 Now with a pre-tax bid-YTW of 5.38% based on a bid of 21.25 and a limitMaturity.
MFC.PR.B PerpetualDiscount 140,482 Now with a pre-tax bid-YTW of 5.33% based on a bid of 22.05 and a limitMaturity.
CM.PR.E PerpetualPremium 59,025 Desjardins crossed 50,000 at 25.15. Now with a pre-tax bid-YTW of 5.52% based on a bid of 25.10 and a call 2012-11-30 at 25.00.
BAM.PR.M PerpetualDiscount 51,880 Now with a pre-tax bid-YTW of 6.00% based on a bid of 20.05 and a limitMaturity.

There were twenty-eight other index-included $25.00-equivalent issues trading over 10,000 shares today.