Archive for April, 2008

April 30, 2008

Wednesday, April 30th, 2008

Professor Dennis Snower reminds us on VoxEU that the effects of the credit crisis will be with us for a while, due to influences that both lag and interact:

  • reduced interbank lending leads to less firm & household lending leads to reduced consumption and investment leads to reduced sales of goods and services leads to lower stock market valuations leads to lower interbank liquidity.
  • unpaid mortgages leads to increased foreclosures leads to forced sales leads to lower prices leads to increased foreclosures.
  • decreased household wealth leads to lower consumption leads to lower profits leads to lower investment leads to lower employment lads to lower labour income leads to lower consumption
  • reduced US lending rates leads to a lower dollar leads to higher import prices leads to inflation leads to lower consumption and investment

Cheery fellow, isn’t he?

With respect to lagging effects, a Reuters story picked up by Calculated Risk quotes S&P:

“Due to current market conditions, we are assuming that it will take approximately 15 months to liquidate loans in foreclosure and approximately eight months to liquidate loans categorized as real estate owned (REO),”

The Fed announced:

The Federal Open Market Committee decided today to lower its target for the federal funds rate 25 basis points to 2 percent.

Recent information indicates that economic activity remains weak. Household and business spending has been subdued and labor markets have softened further. Financial markets remain under considerable stress, and tight credit conditions and the deepening housing contraction are likely to weigh on economic growth over the next few quarters.

Although readings on core inflation have improved somewhat, energy and other commodity prices have increased, and some indicators of inflation expectations have risen in recent months. The Committee expects inflation to moderate in coming quarters, reflecting a projected leveling-out of energy and other commodity prices and an easing of pressures on resource utilization. Still, uncertainty about the inflation outlook remains high. It will be necessary to continue to monitor inflation developments carefully.

The substantial easing of monetary policy to date, combined with ongoing measures to foster market liquidity, should help to promote moderate growth over time and to mitigate risks to economic activity. The Committee will continue to monitor economic and financial developments and will act as needed to promote sustainable economic growth and price stability.

You, too, can be a Fed Watcher! According to me, the most telling change from the March 18 Statement is that April is missing the March sentence “However, downside risks to growth remain.” By me, I’d say the Fed’s done cutting. But what do I know? At least the Bear Stearns guy agrees with me. The fear is, as has often been mentioned here, that cuts in the Fed Funds rate are very broad in effect – perhaps too broad, they may be pushing on a string.

Accrued Interest, while careful not to get too precise, thinks that the 2-year note is cheap:

Unless the Fed’s favorite inflation gauges start rising, or the Fed really believes inflation expectations are rising, there will be no impetus for hikes any time in 2008.

Look back at the 2-year Treasury. The long-term spread between short-term inter-bank lending rates and Treasury rates is about 40bps. So if Fed Funds were going to remain at 2.25% for the next 2 years, fair value for the 2-year Treasury would be 1.85%. So with the 2-year actually in the 2.30% range, the market seems to be expecting Fed Funds to average something like 2.70% over the next 2-years.

Feels to me like that expectation is a bit high. If the Fed holds at 2% for 9 months, the Fed would have to hike 112bps immediately thereafter for Funds to average 2.70%. The hike would have to be more extreme if we used a discounting method rather than a straight average.

I’m not sure how much this analysis should be trusted, because the 2-year / FF spread is very sensitive to economics (it would be most interesting to know precisely how good a predictor of future Fed Funds rates the two year note is. I’m sure this has been looked at – post a link in the comments if you have one). AI has been taken to task in the comments …

Meanwhile, Carney said in Ottawa:

We at the Bank project that the Canadian economy will grow by 1.4 per cent this year, 2.4 per cent in 2009, and 3.3 per cent in 2010. The emergence of excess supply in the economy should keep inflation below 2 per cent through 2009. Both core and total inflation are projected to move up to 2 per cent in 2010 as the economy moves back into balance. There are both upside and downside risks to the Bank’s new projection for inflation; these risks appear to be balanced.

In line with this outlook, some further monetary stimulus will likely be required to achieve the inflation target over the medium term. Given the cumulative reduction in the target for the overnight rate of 150 basis points since December, including the 50-basis-point reduction announced last week, the timing of any further monetary stimulus will depend on the evolution of the global economy and domestic demand, and their impact on inflation in Canada.

Month end was no great shakes, with routine volume and few significant price changes. Of note was W.PR.H which, after a day of weakness, fell out of bed completely in the last hour.

And that’s another month! CPD finished the month with the same NAVPS as last month: $17.60, total return zip, zero, zilch. My actively managed fund did much better, returning … somewhere between 0.50% and 1.00% … the precise value, in all its four-decimal-place glory, will be posted on the weekend.

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 4.97% 4.99% 32,868 15.60 2 +0.1017% 1,094.6
Fixed-Floater 4.75% 4.99% 60,265 15.56 8 +0.6986% 1,058.5
Floater 4.48% 4.52% 60,410 16.37 2 +0.0540% 842.1
Op. Retract 4.85% 3.58% 87,432 3.34 15 +0.0304% 1,050.5
Split-Share 5.32% 5.77% 88,929 4.07 14 +0.1218% 1,041.9
Interest Bearing 6.16% 6.27% 60,813 3.85 3 +0.1016% 1,099.5
Perpetual-Premium 5.90% 5.08% 169,348 5.49 7 -0.1055% 1,020.9
Perpetual-Discount 5.72% 5.75% 332,677 13.88 65 -0.0135% 914.0
Major Price Changes
Issue Index Change Notes
W.PR.H PerpetualDiscount -5.1033% Now with a pre-tax bid-YTW of 6.15% based on a bid of 22.50 and a limitMaturity.
CIU.PR.A PerpetualDiscount -1.1294% Now with a pre-tax bid-YTW of 5.57% based on a bid of 21.01 and a limitMaturity.
BAM.PR.N PerpetualDiscount -1.1031% Now with a pre-tax bid-YTW of 6.72% based on a bid of 17.93 and a limitMaturity.
BNA.PR.B SplitShare +1.1673% Asset coverage of just under 2.7:1 as of March 31 according to the company. Now with a pre-tax bid-YTW of 8.04% based on a bid of 20.80 and a hardMaturity 2016-3-25 at 25.00. Compare with BNA.PR.A (6.35% to 2010-9-30) and BNA.PR.C (6.75% to 2019-1-10).
POW.PR.B PerpetualDiscount +1.2876% Now with a pre-tax bid-YTW of 5.71% based on a bid of 23.60 and a limitMaturity.
BCE.PR.C FixFloat +1.2876%  
PWF.PR.F PerpetualDiscount +1.6839% Now with a pre-tax bid-YTW of 5.60% based on a bid of 23.55 and a limitMaturity.
BCE.PR.Z FixFloat +2.4789%  
Volume Highlights
Issue Index Volume Notes
BAM.PR.I OpRet 157,422 Scotia crossed 150,000 at 25.50 just after the opening, then cleaned up with a cross of 5,500 at 25.51. Now with a pre-tax bid-YTW of 5.09% based on a bid of 25.65 and a softMaturity 2013-12-30 at 25.00. Compare with BAM.PR.H (4.94% to 2012-3-30) and BAM.PR.J (5.43% to 2018-3-30).
BMO.PR.J PerpetualDiscount 130,000 Now with a pre-tax bid-YTW of 5.65% based on a bid of 19.95 and a limitMaturity.
RY.PR.H PerpetualDiscount 101,970 New issue settled yesterday. Now with a pre-tax bid-YTW of 5.75% based on a bid of 24.68 and a limitMaturity.
BNA.PR.C SplitShare 50,200 Nesbitt crossed 50,000 at 21.00. See BNA.PR.B in Price Movers, above.
W.PR.H PerpetualDiscount 30,500 See Price Movers, above.

There were sixteen other index-included $25-pv-equivalent issues trading over 10,000 shares today.

GPA.PR.A Downgraded to P-4 by S&P

Wednesday, April 30th, 2008

Gatehouse Capital Inc. has announced:

Standard & Poor’s Ratings Services lowered the rating of Global Credit Pref Corp.’s (TSX:GPA.PR.A) preferred shares on April 29 to P-4. The rating on the preferred shares of Global Credit Pref Corp. mirrors the lowering of the rating on the $48,031,000 fixed-rate static portfolio credit linked note issued by The Toronto-Dominion Bank to B.

The Company has exposure to the credit linked note issued by The Toronto-Dominion Bank and held by Global Credit Trust, the return on which is linked to the credit performance of 127 reference entities.

This follows the April 11 Watch Negative and the March 17 downgrade to P-4(high).

Par value is $25.00. The sponsor claims that the NAVPS is $12.27. They closed on the TSX today at 10.11-55, 3×4. Ouch!

There are 1.6+ million shares outstanding. GPA.PR.A is not tracked by HIMIPref™.

DBRS Downgrades Loblaws but Weston Unaffected

Wednesday, April 30th, 2008


has today downgraded the long-term ratings of Loblaw Companies Limited (Loblaw or the Company) to BBB from BBB (high), maintaining the Negative trend. At the same time, DBRS has downgraded the Company’s short-term rating to R-2 (middle) from R-2 (high) and has changed the trend to Negative from Stable.

The status of the Company’s turnaround plan and most recent operating performance leads DBRS to the conclusion that stabilization of performance at a level that is commensurate with a BBB (high) rating over the course of this year is improbable.

The deteriorating operating performance, combined with the longer time period and mounting risks associated with changes to the turnaround plan and management team, result in a credit risk profile that is no longer consistent with a BBB (high) rating from DBRS.

In terms of outlook, DBRS has placed the trend at Negative as we believe a meaningful recovery will remain challenging, since Loblaw is expected to continue investing in pricing within an increasingly competitive environment.

DBRS’s ratings for George Weston Limited remain unchanged following the rating actions on Loblaw.

They weren’t impressed by the profit increase!

Assiduous Readers will doubtless remember their comment at the time of the Weston downgrade:

With the downgrade of Loblaw’s ratings to BBB (high) and R-2 (high), the ratings for Weston at BBB and R-2 (high) reflect more its operating businesses and less the support from the Loblaw rating. As such, if there is any further deterioration in Loblaw’s long-term rating, it will not necessarily affect the long-term rating of Weston.

Loblaw is currently rated BBB by S&P.

Weston has the following issues outstanding: WN.PR.A WN.PR.B WN.PR.C WN.PR.D WN.PR.E

RY.PR.H Hits Market – Not as Bad as Expected!

Tuesday, April 29th, 2008

RY.PR.H commenced trading today after being announced last week and did better than I had expected, trading 587,260 shares in a range of 24.65-78, closing at 24.69-74, 10×12.

Some comparables:

RY Perps 4/29
Issue Quote
Dividend Curve
RY.PR.A 20.01-10 1.1125 20.32 5.57%
RY.PR.B 20.80-88 1.1750 21.37 5.66%
RY.PR.C 20.22-29 1.15 20.88 5.70%
RY.PR.D 19.90-19 1.125 20.46 5.67%
RY.PR.E 19.85-90 1.125 20.44 5.68%
RY.PR.F 19.71-84 1.1125 20.24 5.66%
RY.PR.G 19.88-99 1.125 20.45 5.67%
RY.PR.W 21.88-17 1.225 22.17 5.61%
RY.PR.H 24.69-74 1.4125 24.59 5.75%

Note that “Curve Price” is a static calculation – it assumes that the yield curve will not change in the future. Convexity effects decrease the value of near-par-by-curve-price issues

Those comparing prices with those on announcement date should recall that RY went ex-dividend on April 22, the day after announcement. Cynics might speculate that the announcement of the new issue was actually timed in this manner, to make the calculated current yields of the extant issues lower than otherwise, which would make the calculated current yield of the new issue at issue price look relatively better … so it’s a good thing that PrefBlog readers aren’t cynics, isn’t it?

April 29, 2008

Tuesday, April 29th, 2008

OK, finance geeks, there’s a big treat for you today! I’ve had a little look at the Fed’s push to accellerate payment of interest on reserve balances:

The Fed got the authority to start paying interest in October 2011 under the Financial Services Regulatory Relief Act of 2006, signed into law on Oct. 13, 2006. The reason for the late implementation was budgetary. Paying interest on reserves will reduce the amount of income the Fed earns on its securities portfolio and remits to Treasury each year. Congress pushed back the date of implementation to minimize the near-term impact on the deficit.

The cost isn’t astronomical. The Congressional Budget Office estimated that the cost in the first year would be $253 million, rising to $308 million by the fifth year, for a total $1.4 billion over five years.

The Fed has already raised the issue with Congress, although it hasn’t made a formal push. Getting Congress to agree to swallow the cost a few years early in principle shouldn’t be hard since Congress has already set aside its adherence to the principal of “Paygo” — that all revenue reductions and cost increases need to be offset elsewhere. The Fed could also further reduce the cost by arranging to pay interest only on excess reserves — the amount that exceeds the required minimum.

The idea of paying interest on reserve balances was mentioned briefly on PrefBlog in the post US Fed and Negative Non-Borrowed Reserves, which was largely a copy/paste from January 29, 2008. The former post has just been updated, by the way, with a note from the Fed confirming that negative non-borrowed reserves is a mathematical triviality.

As mentioned there, the Fed has advocated interest payments on reserves for a long time:

The Fed has long advocated the payment of interest on the reserves that banks maintain at Federal Reserve Banks. Such a step would have to be approved by Congress, which traditionally has been opposed because of the revenue loss that would result to the U.S. Treasury. Each year the Treasury receives the Fed’s revenue that is in excess of its expenses. The payment of interest on reserves would, of course, be an additional expense to the Fed.

The Fed didn’t put a number on this additional expense but, as noted above, the Congressional Budget Office did … roughly $250-million to $300-million annually.

The Fed’s arguments in favour of the idea are two-fold, based on ideas of market efficiency and considerations of monetary policy implementation, as described by then-governor Laurence Meyer in 1998:

Reserve requirements are now 10 percent of all transaction deposits above a threshold level. Requirements may be satisfied either with vault cash or with balances held in accounts at Federal Reserve Banks. Depositories have naturally always attempted to reduce such non-interest-bearing balances to the minimum. For over two decades, some commercial banks have done so in part by sweeping the reservable transaction deposits of businesses into nonreservable instruments. These business sweeps not only avoid reserve requirements, but also allow firms to earn interest on instruments that are, effectively, equivalent to demand deposits.

In recent years, developments in computer technology have allowed depositories to begin sweeping consumer transaction deposits into nonreservable accounts. In consequence, the balances that depositories hold at Reserve Banks to meet reserve requirements have fallen to quite low levels. These consumer sweep programs are expected to spread further, threatening to lower required reserve balances to levels that may begin to impair the implementation of monetary policy. Should this occur, the Federal Reserve would need to adapt its monetary policy instruments, which could involve disruptions and costs to private parties as well as to the Federal Reserve. However, if interest were allowed to be paid on required reserve balances and on demand deposits, changes in the procedures used for implementing monetary policy might not be needed.

The prohibition of interest on demand deposits distorts the pricing of transaction deposits and associated bank services. In order to compete for the liquid assets of businesses, banks set up complicated procedures to pay implicit interest on what are called compensating balance accounts.

The payment of interest on required reserve balances could remove the incentives to engage in such reserve avoidance practices.

These arguments were largely repeated by then-governor Donald Kohn in 2004:

In conclusion, the Federal Reserve Board strongly supports, as its key priorities for regulatory relief, legislative proposals that would authorize the payment of interest on demand deposits and on balances held by depository institutions at Reserve Banks, as well as increased flexibility in the setting of reserve requirements. We believe these steps would improve the efficiency of our financial sector, make a wider variety of interest-bearing accounts available to more bank customers, and better ensure the efficient conduct of monetary policy in the future.

One gets the feeling that the Fed, if required, could supply an entire bibliography of its attempts to obtain this authority! So could the Treasury!

They finally got their wish in 2006:

Law Passed to Pay Interest on Reserves, Effective in 2011
The Financial Services Regulatory Relief Act of 2006 authorized the Federal Reserve banks to pay interest on reserve balances and gave the Board of Governors authority to lower reserve requirements on all transaction deposits (applied to deposits above a certain threshold level) to as low as zero percent, from their previous minimum top marginal requirement ratio of eight percent. These changes are not effective until October 2011.

I must confess failure in attempting to determing whether Fed Funds Loans are currently themselves reservable. The Reserve Maintenance Manual doesn’t cite these transactions explicitly. Sorry!

Now, there is some concern that this move will reduce interbank lending:

Reserve balances are like checking accounts: they don’t earn interest. For that reason banks have little incentive to hold more reserves than they need to meet the Fed’s requirements and clear transactions. Any excess reserves are loaned to other banks. As Greg Ip explains, “if the Fed paid, say, 2% interest on reserves, banks would have no incentive to lend out excess reserves once the federal funds rate fell to that level.”

This measure would lead to a higher equilibrium level of reserve balances, for a given value of the federal funds interest rate. It would also reduce the amount of inter-bank lending, as banks would keep more of their cash in their safe-deposit box at the Fed. That lending would be replaced by loans from the Federal Reserve.

… and, of course, we can always rely on Naked Capitalism to highlight scary bits.

One of the objectives in paying interest on reserve balances is, in fact, to ensure that reserve balances are still held, as explained by Governor Kohn in 2003:

However, if interest rates were to return to higher levels, sweep activity could intensify again and potentially become a concern. To prevent the sum of required reserve and contractual clearing balances from dropping even lower and to diminish the incentives for depositories to engage in wasteful reserve-avoidance activities, the Federal Reserve has long sought authorization to pay interest on required reserve balances and to pay explicit interest on contractual clearing balances. H.R. 758 would provide such authorization. With interest paid on required reserve balances, some sweep programs would likely be unwound, and new programs would be less likely to be implemented, thereby helping to boost the level of such balances. Eliminating such wasteful reserve-avoidance activities would also tend to improve the efficiency of the financial sector.

Payment of explicit interest on contractual clearing balances could result in an increase in the level of these balances; some depositories are currently constrained in the amount of such balances that can earn usable credits because of their limited use of Federal Reserve services. Moreover, payment of explicit interest would help to maintain the level of clearing balances at a time of rising interest rates. At present, some depositories pay for all their Federal Reserve services with credits earned on clearing balances; these institutions would not be able to use their additional credits if interest rates were to rise. If enough institutions were in this position, contractual clearing balances might drop below levels needed to be helpful for the implementation of monetary policy. With explicit interest, the level of balances on which interest could be effectively earned would not be limited to the level of charges incurred for the use of Federal Reserve services. Therefore, these depositories would not be impelled to reduce their balances when interest rates rise.

In other words, the Fed wants to be able to influence the market via the Fed Funds rate (as well as through reserve requirements, the discount rate and the hoped-for rate paid on reserves), but it won’t be able to do so if there is no Fed Funds market. In addition to the projected business efficiencies to be gained by allowing interest to be paid on demand deposits, the Fed hopes, by paying interest on the balances, to encourage participants to participate in the market in the first place.

There has been an interesting dust-up in the normally sedate world of analyst reports on Canadian banking … Citibank says Royal Bank of Canada might have billions in credit losses this quarter and Royal Bank says that’s horse-patootie. The analyst report is here (hat tip:Yahoo Message Boards). Citibank, by the way, is raising yet another $3-billion equity.

Via Bloomberg comes news that Markit is establishing a Municipal CDS Index. Whether or not contracts on this index will have a delivery option is unclear – I sure hope it does! Markit, by the way, is engaging in a live test of their disaster recovery plan:

Due to a flood in the London Bridge area which has caused an evacuation of the entire More London business district, Markit Group London is currently operating from its Disaster Recovery (DR) site. We appreciate your support whilst we strive to maintain full delivery of our products and services.

… good luck to them!

The Royal Bank new issue closed successfully, but had little impact on the overall market, in which volumes were normal and significant price changes rare.

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 5.00% 5.02% 32,411 15.55 2 -0.0603% 1,093.5
Fixed-Floater 4.77% 5.04% 60,893 15.44 8 -0.1118% 1,051.2
Floater 4.48% 4.52% 60,666 16.37 2 -0.3188% 841.6
Op. Retract 4.84% 3.70% 87,603 3.34 15 +0.1100% 1,050.2
Split-Share 5.33% 5.79% 87,730 4.06 14 -0.0236% 1,040.6
Interest Bearing 6.17% 6.27% 61,189 3.85 3 -0.1005% 1,098.4
Perpetual-Premium 5.89% 5.55% 171,631 5.83 7 -0.0055% 1,022.0
Perpetual-Discount 5.72% 5.75% 336,616 14.06 65 -0.0683% 914.1
Major Price Changes
Issue Index Change Notes
W.PR.J PerpetualDiscount -1.5805% Now with a pre-tax bid-YTW of 6.13% based on a bid of 23.04 and a limitMaturity.
MFC.PR.B PerpetualDiscount -1.3793% Now with a pre-tax bid-YTW of 5.50% based on a bid of 21.45 and a limitMaturity.
BCE.PR.C FixFloat -1.0717%  
BAM.PR.I OpRet +1.3481% Now with a pre-tax bid-YTW of 5.16% based on a bid of 25.56 and a softMaturity 2013-12-30 at 25.00. Compare with BAM.PR.H (4.97% to 2012-3-30) and BAM.PR.J (5.38% to 2018-3-30)
Volume Highlights
Issue Index Volume Notes
RY.PR.H PerpetualDiscount 587,260 New issue settled today. Now with a pre-tax bid-YTW of 5.75% based on a bid of 24.69 and a limitMaturity.
RY.PR.K OpRet 50,029 Scotia crossed 48,000 at 25.00. Now with a pre-tax bid-YTW of 0.94% based on a bid of 25.00 and a call 2008-5-29 at 25.00.
PIC.PR.A SplitShare (for now!) 59,332 CIBC crossed 49,300 in two tranches after hours at 14.84. Asset coverage of just under 1.5:1 as of April 24 according to the company. Recently downgraded to Pfd-3(high) by DBRS, will be removed from the SplitShare index at the April rebalancing. Now with a pre-tax bid-YTW of 6.34% based on a bid of 14.81 and a hardMaturity 2010-11-1 at 15.00.
BNS.PR.N PerpetualDiscount 28,195 Now with a pre-tax bid-YTW of 5.69% based on a bid of 23.22 and a limitMaturity.
RY.PR.E PerpetualDiscount 24,015 Now with a pre-tax bid-YTW of 5.68% based on a bid of 19.85 and a limitMaturity.

There were seventeen other index-included $25-pv-equivalent issues trading over 10,000 shares today.

BDS.PR.A: Exchange Proposed, Not Redemption

Tuesday, April 29th, 2008

Brompton Group has announced:

BG Income + Growth Split Trust (the “Trust”) announces that the special unitholder meeting previously described in the press release on April 18, 2008 has been advanced to June 9, 2008 to coincide with the meeting date for all other funds contemplated in the fund reorganization. In addition, the preferred securities will not be called in June 2008 as previously announced, but rather holders of the preferred securities will be asked at a meeting of such holders to be held on June 9, 2008 to authorize the exchange of the preferred security into an equivalent security with the same terms in the continuing fund. By exchanging the preferred securities of the Trust into preferred securities of the continuing fund having the same maturity date, coupon and other terms, holders thereof will obtain greater asset coverage as the continuing fund will comprise assets of up to seven funds managed by Brompton. In addition, holders of preferred securities who do not wish to exchange will be given the opportunity to redeem their preferred securities and receive $10.00 therefor.

The previous plan anticipated a forced redemption.

April 28, 2008

Monday, April 28th, 2008

An article in VoxEU draws attention to Chapter 3 of the IMF April 2008 World Economic Outlook, specifically Chapter 3, The Changing Housing Cycle and the Implications for Monetary Policy:

The main conclusion of this analysis is that changes in housing finance systems have affected the role played by the housing sector in the business cycle in two different ways. First, the increased use of homes as collateral has amplified the impact of housing sector activity on the rest of the economy by strengthening the positive effect of rising house prices on consumption via increased household borrowing—the “financial accelerator” effect. Second, monetary policy is now transmitted more through the price of homes than through residential investment. In particular, the evidence suggests that more flexible and competitive mortgage markets have amplified the impact of monetary policy on house prices and thus, ultimately, on consumer spending and output. Furthermore, easy monetary policy seems to have contributed to the recent run-up in house prices and residential investment in the United States, although its effect was probably magnified by the loosening of lending standards and by excessive risk-taking by lenders.

In other words, a well developed mortgage market has had the effect of increasing the liquidity of real-estate, and this effect must be explicitly considered when setting monetary policy.

I have to quibble with their table 3.1, which states that the average term of a Canadian mortgage is 25 years; it may be the average amortization, but the average term will be a lot closer to 5 years … perhaps much less, depending on the call provisions embedded in floating rate mortgages. Those who have endured my grumbling over the financing of long-term assets with short-term debt will note that financing houses with 5-year mortgages is a good example!

Box 3.1 is interesting, indicating (from IMF analysis) that while the US housing market appeared to get about 15% ahead of its fundamentals in the period 1997-2007, the crown is held by Ireland, with a 30+% pricing gap! Canada was negative – so those of us who are “property rich” can breathe a sigh of relief directly proportional to our trust in IMF analysis.

And, skipping along to the practical conclusions:

This chapter also examines the implications for monetary policy of changes in mortgage markets. First, it suggests that monetary policymakers may need to respond more aggressively to housing demand shocks in economies with more developed mortgage markets—that is, with higher LTV ratios and thus, presumably, higher stocks of mortgage debt. They may also need to respond more aggressively to financial shocks that affect the amount of credit available for any given level of house prices. Hence, the model would “predict” a more aggressive reduction of interest rates in the United States compared with the euro area in the face of recent turmoil in the credit markets—and this is in line with what has occurred so far.

Today’s fascinating fact is brought to you by Professors Kish & Robak in a paper published in September 2000:

Attaching a call feature to new debt for any reason was the norm for most of the twentieth century. For example, the majority of new bonds issued prior to 1986 contain a call provision. But over the past ten years, we observe that the number of call options on new debt is now a minority component. The intent of this study is to reproduce the work of Kish and Livingston (1992) for the period 1987-1996. The major structural change that occurred in the debt market warrants the reproduction of this study for the recent decade. For the 1977-1986 period, the ratio of callable to non-callable bonds is approximately 4:1, whereas the ratio during the 1987-1996 period approximates 0.5:1.

Thirty-year treasuries used to be callable after 25-years. One possibility that the authors did not examine was the possibility that embedded options may have simply been unbundled and are sold to the corporation as part of the underwriting package – which would certainly achieve the same sort of interest-rate protection to the company (albeit without the capital-structure flexibility) while giving the dealers some more chance to turn over their inventory. I honestly don’t know the answer to that question.

Main Man Flaherty was self-promoting again today:

Flaherty said the Canadian banks will establish and adopt leading practices for disclosure within 100 days, and expects the Bank of Canada to play a leadership role in some areas.

The minister said he plans to meet with the banks again “before the summer” to review the progress.

Sadly, there was no word regarding whether the seniority of Bankers’ Acceptances would ever be properly disclosed.

In what may well be related news, former World Bank President James Wolfensohn said:

said he’s “pessimistic” on the outlook for financial markets and predicted losses from the global credit turmoil may climb to $1 trillion.

“It does seem to be a major adjustment on any level,” Wolfensohn said, after addressing the European Pensions and Savings Summit 2008. “There may be a $1,000 billion worth of losses in it somewhere.” He said he “cannot recall anything similar, certainly in the last 30 to 40 years that I’ve worked.”

The International Monetary Fund predicts that losses from the crisis, including those tied to commercial real-estate, may total $945 billion and says global economic expansion may be the slowest since 2003 this year. Wolfensohn said the fund’s loss forecast of about $1 trillion is now a “consensus estimate.”

Now, I don’t want to give the impression that I’m taking serious issue with any scary kind of number anybody wants to throw around. I don’t have easy access to the source data and I wouldn’t have time to look at them carefully even if I did. But we’re seeing in Canada that Flaherty is using the credit crisis in general and ABCP in particular to promote a federal securities regulator. And there are problems with the consistency of calculations in the IMF report. It seems to me that if I was a typical bureaucrat and I thought that scaring people to death would advance my own regulatory agenda, I’d ensure that my estimates erred on the generous side … that’s an old trick.

You can’t trust anybody.

Volume was lightish today, but enlivened by some activity in SplitShares … some managers, perhaps, adjusting positions after Friday’s downgrades? Market direction was mixed with a downward bias … we’re not far off the trough, you know! Total return on CPD (as an indicator) hasn’t been much more than zero since the mark was set in November – so things could prove interesting.

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 5.01% 5.04% 32,971 15.5 2 +0.1587% 1,094.1
Fixed-Floater 4.75% 5.05% 61,875 15.38 8 +0.1000% 1,052.3
Floater 4.47% 4.51% 61,378 16.40 2 -0.0518% 844.3
Op. Retract 4.85% 3.70% 87,730 3.43 15 -0.0774% 1,049.1
Split-Share 5.33% 5.79% 87,373 4.07 14 +0.0934% 1,040.9
Interest Bearing 6.16% 6.13% 61,313 3.85 3 -0.0669% 1,100.0
Perpetual-Premium 5.89% 5.55% 176,463 5.83 7 +0.1351% 1,022.0
Perpetual-Discount 5.71% 5.75% 300,651 14.07 64 -0.1154% 914.7
Major Price Changes
Issue Index Change Notes
SLF.PR.C PerpetualDiscount -1.5500% Now with a pre-tax bid-YTW of 5.72% based on a bid of 19.69 and a limitMaturity.
SLF.PR.A PerpetualDiscount -1.2675% Now with a pre-tax bid-YTW of 5.49% based on a bid of 21.81 and a limitMaturity.
MFC.PR.B PerpetualDiscount -1.0014% Now with a pre-tax bid-YTW of 5.40% based on a bid of 21.75 and a limitMaturity.
FTU.PR.A SplitShares (for now!) +1.1401% Asset coverage of 1.4+:1 as of April 14, according to the company. Recenty downgraded to Pfd-3 by DBRS and will be removed from the index at the April month-end rebalancing. Now with a pre-tax bid-YTW of 7.48% based on a bid of 9.16 and a hardMaturity 2012-12-1 at 10.00.
Volume Highlights
Issue Index Volume Notes
BNA.PR.C SplitShare 67,565 Asset coverage of just under 2.7:1 as of March 31, according to the company. Now with a pre-tax bid-YTW of 6.84% based on a bid of 20.56 and a hardMaturity 2019-1-10. Compare with BNA.PR.A (6.51% TO 2010-9-30) and BNA.PR.B (8.22% to 2016-3-25).
PIC.PR.A SplitShare (for now!) 106,702 Asset coverage of 1.4+:1 as of April 17 according to the company. Recently downgraded to Pfd-3(high) by DBRS, will be removed from the SplitShare index at the April rebalancing. Now with a pre-tax bid-YTW of 6.04% based on a bid of 14.91 and a hardMaturity 2010-11-1 at 15.00.
BMO.PR.J PerpetualDiscount 60,005 Now with a pre-tax bid-YTW of 5.69% based on a bid of 20.15 and a limitMaturity.
SLF.PR.B PerpetualDiscount 51,763 CIBC crossed 50,000 at 22.10. Now with a pre-tax bid-YTW of 5.50% based on a bid of 22.05 and a limitMaturity.
NA.PR.K PerpetualDiscount 28,100 CIBC crossed 25,000 at 24.80. Now with a pre-tax bid-YTW of 5.93% based on a bid of 24.72 and a limitMaturity.

There were eleven other index-included $25-pv-equivalent issues trading over 10,000 shares today.

DeCloet, OSFI, ABCP, Dundee

Saturday, April 26th, 2008

Derek DeCloet wrote a column in today’s Globe, Watchdog could use more Bay Street bite, which has the major theme of arguing for higher salaries and more direct financial services involvement for senior staff:

Salaries for deputy ministers – Ms. Dickson is paid in line with them – begin at $174,000 and top out at less than $300,000. Even the higher figure is less than one-thirtieth of what Scotiabank CEO Rick Waugh earned last year (nearly $10-million). The Finance Minister earns about $230,000, plus perks. The top of the pay scale for the Governor of the Bank of Canada was $429,600 last year. So there you have it: the three people with the most to say about banking policy and oversight in this country earn a combined salary that’s less than a decent stock analyst or mutual fund manager would make. OSFI’s entire budget is equivalent to nine Rick Waughs.

It’s not all about money, of course – but rare is the person like Mark Carney, willing to forgo millions in riches at Goldman Sachs to become a public servant. And it wouldn’t hurt to have more Bay Street brainpower in Ottawa, even if the banks, who fund OSFI through fees, and taxpayers have to pay for it.

The public can hardly expect five-star regulation on a dime-store budget.

It’s not particularly convincing and DeCloet doesn’t spend a lot of his 750-odd words arguing the case. As far as pay scales are concerned, I don’t consider the salaries of portfolio managers or bank CEOs to be a particularly solid benchmark. The benchmark is: can you get people of the quality you want at the pay offered? There is no evidence introduced to suggest that the OSFI bureaucracy is befuddled at the clever stuff involved in banking; at any rate, should particulars be lacking, there is no consideration of the alternative – from time to time, consultants could be brought in, if expertise in a particular area is found wanting.

Apart from that … well, it’s not particularly apparent to me just how brainy Bay Street brainpower really is, but apart from that, such a staffing objective could very quickly segue into revolving door regulation. While I have no reason to believe that James Gilleran is anything other than a rock of integrity, is his career path something that should be held up for emulation?

However, my main objective in posting this is to take issue with Mr. DeCloet’s justification for addressing issues of staffing and remuneration:

To sum up Ms. Dickson: not my cow, not my farm. Take your complaints and ring the doorbell of the Ontario Securities Commission.

Technically, she may be right. Nothing says that the good superintendent must be overly technical about it, though. The “primary job” may be to watch out for bank customers, but the OSFI Act gives her agency broad responsibility for watching “system-wide or sectoral issues” that may hurt banks and other regulated deposit-takers. And to have a $32-billion frozen blob floating through the financial system, it’s clear enough now, is a pretty major negative. ABCP forced at least one bank, the Dundee Bank of Canada, into a fast sale to Bank of Nova Scotia. It caused a $365-million writedown at another, National Bank. OSFI regulates both.

Let’s look at the Dundee Bank of Canada first:

Dundee Bank Financial Strength
Item 2Q07 3Q07 4Q07
Total Capital $306-million $346-million $343-million
Tier 1 Ratio 12.82% 29.12% 29.85%
Total Capital Ratio 12.82% 29.12% 29.85%
Assets-to-Capital 10.20x 7.54x 9.01x

In the 2007 they lost a total of $146.7-million after tax effects – about half their capital, after ‘fessing up to holdings of about $400-million as reported by Mr. DeCloet last August.

Try as I might, I don’t see anything wrong in any major way with this. Dundee was quite agressive with their ABCP holdings, putting slightly more than their total capital into the sector … were I a shareholder, I would be most upset! But I am not a shareholder, and I am not looking at their financials from the perspective of a shareholder. It does not appear to me that the OSFI can be faulted here, which is the main thing. The bank took risks – large risks – risks larger than they preferred to have taken, in fact, due to their lack of distribution (whereby their money could have been invested in, for instance, mortgages and credit card receivables, like the big banks).

But that’s what businesses do. That’s what common shareholders want. And there was enough value on the balance sheet after this debacle for the bank to be taken over.

Mr. DeCloet has stated a problem – ABCP – and a potential solution – pay OSFI regulators more money – but these points are not adequately connected. What are all these Bay Street wunderkind supposed to do once they complete their hostile takeover of the OSFI? Outlaw leverage? Outlaw commercial paper that doesn’t meet some kind of test? Outlaw risk? Ensure that no investor, anywhere, ever gets hurt for any reason? Details are sadly lacking.

I should also note that the Bank of Canada, despite its apparently inadequate pay-scale, was expressing surprise at ABCP’s popularity in 2003 … but nobody listened. It is now attempting to get the market re-started.

April 25, 2008

Friday, April 25th, 2008

Lots of speculation and exhortation in the air about the Fed FOMC meeting next week! Econbrowser‘s James Hamilton wants the rate constant at 2.25%:

…there is a compelling case that by rapidly bringing the yield on short-term Treasury bills well below the prevailing inflation rate, the Fed has played a role in the significant depreciation of the dollar and increase in the dollar price of virtually every storable commodity that we’ve seen since the beginning of January.

If the Fed surprises the market with a pause, we should have unambiguous confirmation or refutation of the hypothesis that the Fed has been contributing to the commodity price run-up within 48 hours of the FOMC’s announcement. That knowledge in itself would also be extremely valuable– valuable to the Fed in calculating how to chart its course from here, and valuable in terms of making clear to the public why sometimes higher interest rates are the better choice for public policy.

Accrued Interest, however, is watching the unemployment numbers with more interest:

I think the worst of the liquidity crisis is past us, but we still have a weak economy will still be dealing with housing-related problems for a while. That will probably keep the Fed in a easy money mode for a while, which will be supportive of interest rates generally.

The thing to watch is primarily inflation data. I think bad housing data is mostly priced in (today’s rally supports this thesis), and while it could turn out worse than currently expected, inflation is actually the more important element for rates. Food and energy inflation has been problematic for a while, but the leakage into core inflation measures has been mild so far. The Fed has been gambling that it could afford to cut rates to improve liquidity because weaker employment would take care of the inflation problem.

If either employment is not as weak as currently expected and/or unemployment fails to contain inflation, the Fed will make a U-turn on rates.

Traders of 2-Years are betting there will be a pause:

“There’s been quite a shift in bond-market sentiment over the past few weeks,” said Nick Stamenkovic, a fixed-income strategist at RIA Capital Market Ltd. in Edinburgh. “The market has become increasingly confident that the worst is over for the financial sector and that the Fed is nearing the end of its easing cycle.”

Government bonds have lost 1.3 percent in April, indexes compiled by Merrill Lynch & Co. showed. The last time the securities declined was in June, when they fell 0.5 percent. The drop is the steepest since July 2003, when they shed 1.9 percent.

The two-year U.S. Treasury note yield rose to a three-month high of 2.50 percent today, before trading at 2.39 percent by 10:40 a.m. in New York, according to bond broker BGCantor Market Data. It has risen 65 basis points in the last two weeks. Yesterday’s government auction of $19 billion of five-year notes drew the least demand since 2003.

And, while financial companies are having to pay up for term money, they are able to issue in size:

Citigroup Inc. and Merrill Lynch & Co. led $43.3 billion of U.S. corporate bond sales, the busiest week on record, as financial companies sold debt at the highest yields since May 2001.

Sales compare with $31.2 billion last week and an average this year of $18 billion, according to data compiled by Bloomberg. Citigroup, the biggest U.S. bank by assets, sold $6 billion of hybrid bonds in the company’s largest public debt offering, while New York-based securities firm Merrill Lynch raised $9.55 billion by issuing debt and preferred securities.

On the other hand, the 30-day Fed Funds Contract is showing expectations of a hair over 2.00% until September, in line with the consensus reported by the WSJ of ‘one more, then stop’. Finally, the Cleveland Fed’s analysis of the options on this contract show an overwhelming expectation of 2.00%, with the “2.25% prediction” coming out of nowhere to take second place from the once strongly challenging “1.75% prediction”. We shall see!

There is a good story on Credit Rating Agencies published by the New York Times magazine:

Though some have proposed requiring that agencies with official recognition charge investors, rather than issuers, a more practical reform may be for the government to stop certifying agencies altogether.

Then, if the Fed or other regulators wanted to restrict what sorts of bonds could be owned by banks, or by pension funds or by anyone else in need of protection, they would have to do it themselves — not farm the job out to Moody’s. The ratings agencies would still exist, but stripped of their official imprimatur, their ratings would lose a little of their aura, and investors might trust in them a bit less. Moody’s itself favors doing away with the official designation, and it, like S.&P., embraces the idea that investors should not “rely” on ratings for buy-and-sell decisions.

It’s all reasonably fair minded – as reasonable as one can expect, these days! The author saves himself the unpleasant experience of PrefBlog’s wrath by prefacing his suggestion that the Fed, inter alia bring credit analysis in house with the word “if”.

It’s all craziness. There is no good way to forecast credit. It’s all forecasting, as prone to error and changing circumstances as any other forecast … you do the best you can and diversify, by name, by asset class, by any other source of risk exposure. The only solution for such apparent failures of forecasting as sub-prime and Canadian ABCP is to say something along the lines of … “You put all your money in this stuff and now it’s all gone? Well, you’re stupid. Go away.” But it won’t happen.

My other quibble with the author’s conclusion is:

This leaves an awkward question, with respect to insanely complex structured securities: What can they rely on? The agencies seem utterly too involved to serve as a neutral arbiter, and the banks are sure to invent new and equally hard-to-assess vehicles in the future.

How about … rely on your own credit analysis or don’t buy it?

The vote on the Canadian ABCP restructuring has, apparently, approved the proposed plan, although with some reservations:

However, Jeffrey Carhart, a representative for the ad hoc committee read a statement prepared by the group disputing part of the plan that could potentially release certain financial institutions from lawsuits over selling ABCP to their clients.

“Those who are voting Yes by proxy are preserving their ability to argue both the validity and fairness of the planned release” from legal challenges, Carhart read.

… and the final (?) hurdle comes next week:

Mr. Crawford acknowledged that the committee has “some work to do next week” to face the legal challenges, which the judge overseeing the restructuring will consider at a fairness hearing scheduled for next Friday. Without the judge’s approval, the plan cannot go ahead.

In a ruling this week, the judge said that the corporate challengers had raised “very forceful arguments” about “a very serious issue of law” – whether the plan to extend immunity from lawsuits is legal.

I’ll just bet the corporate challengers have raised very forceful arguments! In some cases, it would appear that glorified bookkeepers recklessly overinvested in the asset class … the investing corporations could well be looking at a few investor lawsuits themselves.

On another topic, the Ontario Teachers Pension Plan has released its 2007 results (hat tip:FWF). Very impressive! Most debates regarding the value of active management implicitly consider all active managers to be equal, which is not the case … active management needs to be marketted, with the result that (i) marketers are in control of the process, not investment managers, and (ii) even investment managers must give some thought to explaining their choices. The split is not passive/active, but passive/active-captive/active-marketted. I have no data, but I’m willing to bet a nickel that active-captive, as a class, handsomely outperforms its benchmarks.

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 5.02% 5.07% 33,026 15.4 2 +0.1624% 1,092.4
Fixed-Floater 4.75% 5.07% 62,482 15.37 8 -0.2442% 1,051.3
Floater 4.46% 4.50% 61,761 16.41 2 +0.9502% 844.8
Op. Retract 4.85% 3.41% 88,900 3.41 15 -0.0167% 1,049.9
Split-Share 5.32% 5.84% 85,484 4.07 14 +0.1828% 1,039.9
Interest Bearing 6.16% 6.09% 62,370 3.86 3 +0.1353% 1,100.2
Perpetual-Premium 5.90% 5.56% 181,252 7.33 7 +0.2439% 1,020.7
Perpetual-Discount 5.71% 5.74% 305,433 13.90 64 +0.0020% 915.8
Major Price Changes
Issue Index Change Notes
BCE.PR.I FixFloat -1.2757%  
IAG.PR.A PerpetualDiscount -1.1876% Now with a pre-tax bid-YTW of 5.59% based on a bid of 20.80 and a limitMaturity.
BAM.PR.I OpRet -1.0980% Now with a pre-tax bid-YTW of 5.43% based on a bid of 25.22 and a softMaturity 2013-12-30 at 25.00. Compare with BAM.PR.H (4.96% to 2012-3-30) and BAM.PR.J (5.31% to 2018-3-30).
PWF.PR.I PerpetualPremium +1.3121% Now with a pre-tax bid-YTW of 5.49% based on a bid of 25.48 and a call 2012-5-30 at 25.00.
BAM.PR.K Floater +1.3587%  
Volume Highlights
Issue Index Volume Notes
RY.PR.B PerpetualDiscount 177,300 Nesbitt crossed 100,000 at 20.89, then RBC crossed 75,000 at 20.89 on special settlement. Now with a pre-tax bid-YTW of 5.66% based on a bid of 20.80 and a limitMaturity.
TD.PR.R PerpetualDiscount 122,700 Nesbitt bought 20,000 from Anonymous at 25.00. Now with a pre-tax bid-YTW of 5.67% based on a bid of 25.00 and a limitMaturity.
WN.PR.B Scraps (would be OpRet but there are credit concerns) 113,800 Nesbitt crossed 107,200 at 25.10. Now with a pre-tax bid-YTW of 5.42% based on a bid of 25.02 and a softMaturity 2009-6-30 at 25.00.
BNS.PR.K PerpetualDiscount 92,900 Now with a pre-tax bid-YTW of 5.52% based on a bid of 21.80 and a limitMaturity.
BMO.PR.K PerpetualDiscount 91,590 Now with a pre-tax bid-YTW of 5.83% based on a bid of 22.91 and a limitMaturity.
MFC.PR.A OpRet 68,910 Now with a pre-tax bid-YTW of 3.85% based on a bid of 25.55 and a softMaturity 2015-12-18 at 25.00.

There were twenty-one other index-included $25-pv-equivalent issues trading over 10,000 shares today.

FTU.PR.A Downgraded to Pfd-3 by DBRS

Friday, April 25th, 2008


has today downgraded the Preferred Shares issued by US Financial 15 Split Corp. (the Company) to Pfd-3 from Pfd-2 with a Stable trend. The rating had been placed Under Review with Developing Implications on March 19, 2008.

There is a NAV test that prevents the Manager from paying out Class A Shares distributions if the NAV of the Portfolio is less than $15 per share.

The initial split share structure provided downside protection of 58% to the Preferred Shareholders (after expenses). Although the credit quality of the Portfolio is strong, the NAV of the Portfolio has experienced downward pressure due to its concentration in the financial industry. In the last year, the NAV has dropped from $24.14 per share to $14.19 (as of April 15, 2008), a decline of about 41%. As a result, the current downside protection available to the Preferred Shareholders is approximately 30%.

The redemption date for both classes of shares issued is December 1, 2012.

Downside protection of 30% equates to asset coverage of about 1.4:1.

This is part of DBRS’ mass review of financial splits which, I believe, marks an end (or at least an increased strictness) to what I perceive as their grandfathering of older, looser standards for split shares, discussed last fall.

The question of how to analyze FTU.PR.A has been discussed on PrefBlog, further to my comment in January that a downgrade looked likely. The issue is tracked by HIMIPref™ and comprises part of the SplitShare Index.