Archive for May, 2008

New Issue: TD Perpetual Fixed-Floating-Reset 5% + 160bp

Thursday, May 29th, 2008

And now there are four.

Hard on the heels of their second quarter report comes a new issue announcement:

it has entered into an agreement with a group of underwriters led by TD Securities Inc. for an issue of 8 million non-cumulative 5-Year Rate Reset Preferred Shares, Series S (the “Series S Shares”), carrying a face value of $25.00 per share, to raise gross proceeds of $200 million. TD intends to file in Canada a prospectus supplement to its January 11, 2007 base shelf prospectus in respect of this issue.
TD has also granted the underwriters an option to purchase, on the same terms, up to an additional 2 million Series S Shares. This option is exercisable in whole or in part by the underwriters at any time up to two business days prior to closing. The maximum gross proceeds raised under the offering will be $250 million should this option be exercised in full.
The Series S Shares will yield 5.00% per cent annually, payable quarterly, as and when declared by the Board of Directors of the TD, for the initial period ending July 31, 2013. Thereafter, the dividend rate will reset every five years at a level of 160 basis points over the then five-year Government of Canada bond yield.
Holders of the Series S Shares will have the right to convert their shares into Non-cumulative Floating Rate Preferred Shares, Series T (the “Series T Shares”), subject to certain conditions, on July 31, 2013, and on July 31 every five years thereafter. Holders of the Series T Shares will be entitled to receive quarterly floating dividends, as and when declared by the
Board of Directors of TD, equal to the three-month Government of Canada Treasury Bill yield plus 160 basis points.
The issue qualifies as Tier 1 capital for TD and the expected closing date is June 11, 2008.

Issue: Non-Cumulative 5-Year Rate Reset Class A Preferred Shares, Series S

Size: 8-million shares @ $25.00 = $200-million

Greenshoe: 2-million shares (= $50-million) up to two days prior to closing.

Ratings: DBRS: Pfd-1; S&P: P-1(low); Moody’s: Aa2

Dividends: 5.00% until first Exchange Date; reset to 5-Year Canadas + 160bp every exchange date.

Convertible: Back & forth between Series T Floaters every exchange date. Series T pays 90-day T-Bills + 160bp

Exchange Date: July 31, 2013 and every five years thereafter

Redemption: Series S & Series T redeemable every exchange date at $25.00. Series T redeemable any other time at $25.50.

Rank: Parri Passu with all other preferreds, senior to common

Closing: June 11, 2008

Well … if I didn’t like the other ones, I’m not going to like these ones! But it looks like the structure is popular, so I guess I’d better start going over the HIMIPref™ code and determining just what will need to be done before I can add them to the universe.

As I’ve stated before … I’ll be adding the class to HIMIPref™ as soon as there are enough outstanding so that one could reasonably expect to execute profitable trades within the class.

Update, 2013-6-22: This trades as TD.PR.S

May 28, 2008

Wednesday, May 28th, 2008

It seems like most of the interesting news lately has been sufficiently important to merit separate posts, so these daily reviews have been suffering!

Today Mishkin announced his resignation from the Fed Board:

Mishkin, 57, on a leave of absence from [Columbia University], will step down as of Aug. 31, the Fed said in a statement today, also releasing his letter of resignation to President George W. Bush.

The departure may create an unprecedented third vacancy on the seven-member Fed Board of Governors this year as the central bank tries to ease the credit crisis. The vacancies mean that a new U.S. president to be inaugurated in January may have an opportunity to influence monetary and regulatory policy by nominating new members to the board.

Senate Banking Committee Chairman Christopher Dodd, a Democrat from Connecticut, has already delayed a confirmation vote for three board nominees for more than a year. After gaining support from the committee, the nominations would go to the full Senate for a vote of final approval.

Hey, who cares about the direction of the world’s most important Central Bank when when there are political games that can be played?

It’s not like the Fed doesn’t have a plateful of problems – JPMorgan is calling for US Inflation of over 5%

Not bad, with long treasuries at 4.6%, eh? Fisher is continuing his anti-inflation drum-beating:

Federal Reserve Bank of Dallas President Richard Fisher said he expects the central bank would raise the benchmark U.S. interest rate should the public begin to expect greater gains in consumer prices.

“If inflationary developments and, more important, inflation expectations continue to worsen, I would expect a change of course in monetary policy to occur sooner rather than later, even in the face of an anemic” economy, Fisher said today in the text of a speech in San Francisco.

Fed bank presidents, including Gary Stern of Minneapolis and Thomas Hoenig of Kansas City, have expressed growing concern this month about rising prices. Fisher, 59, is the only member of the Federal Open Market Committee to dissent three times from decisions to lower the overnight bank-lending rate, favoring either no change or less aggressive reduction.

There’s an interesting and rather heretical piece on VoxEU by Cournand and Heinemann titled Can Central Banks Talk too Much?:

Public information is a double-edged sword: it conveys valuable information, but it leads agents pursuing coordination to condition their actions on public announcements more than optimal. In this respect, Morris and Shin (2002) have shown that noisy public announcements may be detrimental to welfare. They conclude that central banks should commit to withholding relevant information or deliberately reduce its precision. This result has received a great deal of attention in the academic literature, in the financial press (see for example the Economist (2004)), and among central banks.

Far from being perfect, all these means of communication allow the central bank to provide partially public information and avoid market overreactions to information of poor quality. To some extent, these means play a role in the actual policy of central banks already. Therefore, our results give a rationale for central banks releasing partially public information in addition to official publications. Our main result shows that these means of partial publicity should only be employed for announcements of low precision.

In other words … the bond market is excitable, so let’s just feed it pablum.

I don’t like the idea: it’s too big-brotherish. Much better would be the use of fan charts, as mentioned on January 18 with other methods of conveying the idea that such-and-such information is only a best guess. Excitable bond markets are great! A long term investor with half a brain can make good money out of them! Why should I – or any other PrefBlog reader – seek to prevent cowboys from losing all their clients’ money?

As reported by Bloomberg, S&P today downgraded a swath of Alt-A paper:

The classes affected by the negative rating actions represent an issuance amount of approximately $33.95 billion, or about 13.92% of the par amount of U.S. RMBS transactions backed by Alt-A mortgage loans rated by Standard & Poor’s in the first half of 2007.

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). In addition, we are assuming a loss severity of 34% for U.S. Alt-A RMBS transactions backed by fixed-rate and long-rest hybrid (fixed-rate period of at least five years) loan collateral issued in 2007. We are assuming a loss severity of 35% for transactions issued in 2007 that are backed by mortgage loans that have a negative amortization feature. We are also assuming a loss severity of 35% for transactions backed by adjustable-rate and short-rest hybrid loan collateral (fixed-rate period of less than five years).

Monthly performance data reveal that delinquencies and foreclosures continue to accumulate for the 2007-vintage U.S. Alt-A RMBS transactions. As of the April 2008 distribution date, serious delinquencies (90-day, foreclosures, and REOs) among all U.S. Alt-A RMBS transactions issued during 2007 were 6.64%, up 64.76% since January 2008. During this same time, cumulative realized losses for 2007-vintage Alt-A deals increased to 0.08% from 0.02%.

The analysis performed during this review has allowed Standard & Poor’s to project losses for each of the three types of Alt-A transactions issued during the first half of 2007. We project aggregate lifetime losses of 8.15%-8.65% of the original balance for the transactions with negative amortizing collateral. We project aggregate lifetime losses of 6.40%-6.90% for the transactions backed by fixed-rate and long-reset hybrid collateral. Finally, we project
aggregate lifetime losses of 7.00%-7.50% for the transactions backed by adjustable-rate and short-rest hybrid collateral.

Unless we observe a significant change in the macroeconomic environment, Standard & Poor’s considers today’s actions, except for the CreditWatch placements, to be the last major changes to the ratings on the U.S. Alt-A RMBS classes issued during the first half of 2007.

Moody’s has released a report (available to subscribers only) regarding the CDS market. According to their press release:

“The notion that credit default swaps represent this $62 trillion long credit exposure is not an accurate depiction of the market nor particularly helpful to investors in determining where the true risks lie,” says Moody’s AVP/Analyst Alexander Yavorsky, one of the authors of the report, referring to the oft-cited figure for the notional amount of CDS contracts outstanding.

Yavorsky says a more useful number when looking at the CDS market is the gross replacement value, of outstanding contracts, which at just over $2 trillion is under 3.5% of the notional amount.

More concerning to Moody’s than an increase in underlying credit losses is the potential for market disruption through the failure of a major bank or broker-dealer.

If a large CDS counterparty failed, this would very likely have a substantial market-wide re-pricing effect on the cost of CDS protection, and, by extension, the underlying cash bonds. The effect of this would be especially problematic for firms needing to replace the CDS trades they had with the failed counterparty. Until the trades were replaced — an operationally challenging and unprecedented undertaking — the firms that lost protection would be left with unhedged exposures amid what is likely to be a very volatile market environment.

Moody’s also notes, however, that the systemic importance of the largest CDS dealers provides powerful incentives to regulators to prevent their disorderly failure, as demonstrated by the recent case of Bear Stearns. The more important the role played by an institution the more likely regulators will consider it to be too systemically important to fail.

The Canada Pension Plan released its 2008 Annual Report, showing a benchmark portfolio of 25% Canadian Equities, 40% Foreign Equities, 25% Fixed Income and 10% Canadian Real Return Bonds; benchmark performance for the year was -2.7% as foreign equities got hammered. They outperformed by 241bp; actual allocations – as reported – were 23.5% Canadian Equities, 39.2% Foreign Equities, 24.3% Fixed Income and 11.7% “Inflation Sensitive Assets”, which includes real-estate and infrastructure, not just RRBs.

So … it’s only one year and you’d have to do a whole lot more work before you took a view on their skill …. but it shows what you can do when you have a captive client and don’t have to worry about explaining the latest headline. For example:

As a result, in September, we committed a total of US$2 billion ($2 billion) in funds managed by Apollo Management and the Blackstone Group to begin to establish a diversified portfolio of senior secured loans that were available at significant discounts to face value, of which approximately US$667 million ($666 million) has been invested to date. The CPP Investment Board had both the liquidity and knowledge needed to prudently purchase this senior performing debt at discounted prices and we are confident that this investment will deliver superior long term risk-adjusted returns.

The second example is our investment in distressed mortgage funds to take advantage of heavily discounted prices following the credit crisis. During the fiscal year, we committed a total of $750 million to two distressed mortgage funds run by very experienced fund managers, Pacific Investment Management Company (PIMCO) and BlackRock, Inc. To date, approximately US$500 million ($513 million) has been invested.

It appears probable, therefore, that at least part of the CPP money was involved in the Hapaolim / PIMCO deal mentioned May 22 – which I suggested was a fantastic buy for PIMCO. You won’t find too many pension plans doing that sort of thing … first, it involved fund management hiring an external specialist (which, for most firms, involves sharing the fee) and second, everybody knows that all sub-prime securities are level-3 toxic trash that will go to zero soon, if not negative. It said so in the paper yesterday!

Volume was normal today, with no particularly violent price trends apparent.

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 4.37% 3.37% 52,379 0.08 1 +0.3840% 1,114.6
Fixed-Floater 4.85% 4.69% 63,968 16.01 7 -0.4083% 1,030.9
Floater 4.08% 4.13% 62,999 17.10 2 +1.1541% 925.6
Op. Retract 4.82% 2.39% 89,315 2.69 15 -0.0762% 1,056.7
Split-Share 5.27% 5.42% 69,232 4.15 13 -0.0486% 1,058.9
Interest Bearing 6.12% 6.09% 53,543 3.81 3 +0.7086% 1,113.3
Perpetual-Premium 5.88% 5.51% 129,584 2.89 9 +0.0396% 1,023.5
Perpetual-Discount 5.65% 5.70% 291,408 14.33 63 -0.0290% 927.8
Major Price Changes
Issue Index Change Notes
BCE.PR.I FixFloat -1.8565%  
DFN.PR.A SplitShare -1.0952% Asset coverage of 2.5+:1 as of May 15 according to the company. Now with a pre-tax bid-YTW of 4.94% based on a bid of 10.18 and a hardMaturity 2014-12-1 at 10.00.
NA.PR.L PerpetualDiscount -1.0952% Now with a pre-tax bid-YTW of 5.89% based on a bid of 20.77 and a limitMaturity.
SLF.PR.E PerpetualDiscount -1.0120% Now with a pre-tax bid-YTW of 5.48% based on a bid of 20.54 and a limitMaturity.
GWO.PR.H PerpetualDiscount +1.7759% Now with a pre-tax bid-YTW of 5.31% based on a bid of 22.80 and a limitMaturity.
BSD.PR.A InterestBearing +2.1875% Asset coverage of just under 1.8:1 as of May 23 according to Brookfield Funds. Now with a pre-tax bid-YTW of 6.62% (mostly as interest) based on a bid of 9.66 and a hardMaturity 2015-3-31 at 10.00.
BAM.PR.B Floater +2.2671%  
Volume Highlights
Issue Index Volume Notes
CM.PR.A OpRet 356,755 Nesbitt crossed 200,000 at 26.10, then another 150,000 at the same price. Now with a pre-tax bid-YTW of -6.38% based on a bid of 26.11 and a call 2008-6-27 at 25.75.
CM.PR.R OpRet 269,290 Nesbitt crossed 200,000 at 26.20, then another 65,000 at the same price. Now with a pre-tax bid-YTW of -7.0401% based on a bid of 26.11 and a call 2008-6-27 at 25.75.
BNS.PR.L PerpetualDiscount 87,764 Now with a pre-tax bid-YTW of 5.46% based on a bid of 20.86 and a limitMaturity.
MFC.PR.B PerpetualDiscount 61,300 RBC crossed 25,900 at 21.55, then the same amount at the same price. Now with a pre-tax bid-YTW of 5.42% based on a bid of 21.52 and a limitMaturity.
BNS.PR.M PerpetualDiscount 57,268 Nesbitt crossed 50,000 at 20.85. Now with a pre-tax bid-YTW of 5.47% based on a bid of 20.82 and a limitMaturity.

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

TD Capitalization: 2Q08

Wednesday, May 28th, 2008

TD has released its Second Quarter 2008 Report and Supplementary Package, so it’s time to recalculate how much room they have to issue new preferred shares – assuming they want to!

Step One is to analyze their Tier 1 Capital, reproducing the prior format:

TD Capital Structure
October, 2007
& April, 2008
  4Q07 2Q08
Total Tier 1 Capital 15,645 16,646
Common Shareholders’ Equity 131.5% 169.6%
Preferred Shares 6.2% 10.1%
Innovative Tier 1 Capital Instruments 11.1% 10.4%
Non-Controlling Interests in Subsidiaries 0.1% 0.1%
Goodwill -49.0% -90.2%

Next, the issuance capacity (from Part 3 of the introductory series):

Tier 1 Issuance Capacity
October 2007
& April 2008
  4Q07 2Q08
Equity Capital (A) 12,931 15,069
Non-Equity Tier 1 Limit (B=A/3), 4Q07
(B=0.428*A), 2Q08
4,310 6,450
Innovative Tier 1 Capital (C) 1,740 1,736
Preferred Limit (D=B-C) 2,570 4,714
Preferred Actual (E) 974 1,675
New Issuance Capacity (F=D-E) 1,346 3,039
Items A, C & E are taken from the table
“Regulatory Capital”
of the supplementary information;
Note that Item A includes Goodwill, FX losses, “Other Capital Deductions” and non-controlling interest

Item B is as per OSFI Guidelines; the limit was recently increased.
Items D & F are my calculations

and the all important Risk-Weighted Asset Ratios!

Risk-Weighted Asset Ratios
October 2007
& April 2008
  Note 2007 2Q08
Equity Capital A 12,931 15,069
Risk-Weighted Assets B 152,519 178,635
Equity/RWA C=A/B 8.48% 8.43%
Tier 1 Ratio D 10.3% 9.1%
Capital Ratio E 13.0% 12.7%
Assets to Capital Multiple F 19.7x 19.2x
A is taken from the table “Issuance Capacity”, above
B, D & E are taken from TD’s Supplementary Report
C is my calculation.
F is from Note 9 of the quarterly report

The reported Assets-to-capital multiple reflects that goodwill is deducted from total capital (the denominator) AND FROM TOTAL ASSETS (the numerator); given TD’s huge goodwill, this makes rather a difference!

IOSCO Releases New Credit Rating Agency Rules

Wednesday, May 28th, 2008

Bloomberg reports:

Ratings companies face rules including one prohibiting them making recommendations on the way products they grade are structured, the Madrid-based International Organization of Securities Commissions said today. IOSCO, the main forum for more than 100 securities regulators worldwide, said there should also be independent reviews of the way firms assign ratings.

Ratings companies will have to “differentiate ratings of structured finance products from other ratings, preferably through different rating symbols,” the regulators said in an e- mailed summary of the code.

Fitch said April 29 it received “limited interest” from market participants in adopting a different rating scale.

Market participants who responded, including investors together holding more than $9 trillion in fixed income securities, “overwhelmingly” rejected the idea of a separate rating scale for asset-backed securities, Moody’s said May 14.

Nobody in their right minds really cares about a different rating scale for structured instruments – this is simply cosmetic nonsense, invented to persuade the gullible public that the Wise Regulators are Taking Firm Action. I would certainly not expect any regulator to pay the slightest attention to the overwhelming majority of credit professionals who think the idea is just a touch on the rinky-dink side.

In their “Global Structured Credit Strategy” report of May 13, 2008, Citi’s Structured Credit Products Group opined:

So we repeat the plea that we made in our earlier note4 when discussing rating agencies’ proposals for reforming their criteria in light of substantial ABS CDO downgrades. We see the emphasis on expected loss — and the comparability this creates between structured and flow credit ratings — as a tremendous advantage. Unquestionably, give analysts greater powers, and create governance procedures to make them more independent. By all means, add additional dimensions (or even pictures of return distributions) to capture tail risk. (We were thus more supportive of Moody’s proposals for providing an additional “volatility” dimension, leaving the “core” rating still intact yet providing important new information).

This makes sense … I would consider a second dimension in credit ratings to be valuable advice and I would take such advice seriously when formulating my own views. This would, however, require some thought and consideration on the part of third parties to be useful, and requiring such thought and consideration would make it virtually impossible for untrained bank tellers to sell the product; and one purpose of regulation is to make all investments plain vanilla, so they can be sold efficiently with huge profits by banks, which will in turn enable them to hire even more ex-regulators.

This is important! IOSCO notes in its press release announcing changes to the code of conduct:

CRAs should … establish policies and procedures for reviewing the past work of analysts that leave the employ of the CRA

The actual report states:

A CRA should establish policies and procedures for reviewing the past work of analysts that leave the employ of the CRA and join an issuer that the analyst has rated, or a financial firm with which an analyst has had significant dealings as an
employee of the CRA.

Sauce for the goose is most emphatically not sauce for the gander, is it?

Another howler from IOSCO’s press release is:

CRAs should … to discourage “ratings shopping,” disclose in their rating announcements whether the issuer of a structured finance product has informed it that it is publicly disclosing all relevant information about the product being rated;

Now, you’ll never hear me complain about too much disclosure, so I don’t have any major problems with this one … but I’d like to hear a discussion of just how well the philosophy behind this recommendation ties in with Regulation FD and National Policy 51-201.

Somewhat to my surprise, their actual report manages to come up with a sensible comment about the relationship between credit quality, liquidity and price (emphasis added):

The subprime market turmoil has also highlighted another common misperception that credit risk is the same as liquidity risk. Historically, securities receiving the highest credit ratings (for example, AAA or Aaa) were also very liquid – regardless of market events, there could almost always be found a buyer and a seller for such securities, even if not necessarily at the most favorable prices. Likewise, prices for the most highly rated securities historically have not been very volatile when compared with lower-rated securities. Indeed, in some jurisdictions regulations regarding capital adequacy requirements for financial firms implicitly assume that debt securities with high credit ratings are both very liquid and experience low volatility. However, the links between low default rates, low volatility and high liquidity are not logical necessities. Particularly with respect to certain highly-rated, though thinly-traded subprime RMBSs and CDOs, a high credit rating has not been indicative of high liquidity and low market volatility.

The credit crunch was largely just another episode of animal spirits and irrational exuberance. There are certainly some relatively innocent victims – those unable to get a mortgage, for instance, or who have to refinance as usurious rates – but really, no more or less unpleasant than any other episode. I graduated from university during a recession. Life’s unfair. Get used it to it.

To the extent that serious harm was done, it was largely the product of regulation. Regulators in many cases did not impose a rational cap on the Assets to Capital Multiple for many banks; guarantees (both explicit and implicit) for off-balance sheet instruments were not charged against capital at a high enough rate (one example is money market funds, not just SIVs); concentration risk was not charged to capital (at least, not sufficiently) and big changes in capital requirements upon credit downgrade fostered cliff risk and crowded trades. It also strikes me that capital requirements on debt could be adjusted by issue size (as an objective, albeit sometimes incorrect, proxy for liquidity) … there is clearly a difference between US Treasuries, where investors want a minimum $20-billion issue size and a tranche of RMBS with perhaps $300-million issued.

But the credit raters are a convenient target.

Research: Analysis of Perpetual Resets

Tuesday, May 27th, 2008

The first one came in March at +205bp. Then Fortis at +213. Today BNS came again at +170. If this keeps up much longer, I’ll be forced to add them to the HIMIPref™ universe … particularly if the index definers pull the old Innovative Tier 1 Capital so-called bond trick and add them to the index!

My conclusion in this article was:

My disdain has not been shared by the market in general. The issue, trading as BNS.PR.P on the Toronto Stock Exchange, had a very successful underwriting and strong secondary demand. But I worry that many investors will have bought this with the assumption, probably valid in most cases but not certain, that the issue will be called in five years. It is the pretense that borrowers can access long term funds from borrowers assuming short-term risks that, after all, caused the credit crisis in the first place.

But … look for the research link!

May 27, 2008

Tuesday, May 27th, 2008

Menzie Chinn of Econbrowser posted a good piece over the weekend, How Effective Will Monetary Easing Be? The Bank Lending Channel and the Implications of Increasingly Internationalized Banks, reviewing a paper presented at a recent Bundesbank conference:

The results of this paper are consistent with the view that while loosening of US monetary policy might induce greater lending overseas by branches of US banks, thereby tending to support rest-of-world economic activity, they also imply that negative shocks to the assets of US banks will also tend to reduce lending abroad. Hence, deleveraging by domestic banks has global (or at least rest-of-OECD) implications. That means both negative and positive shocks will be propagated abroad. In this sense, I think decoupling of the major developed economies is even less likely to occur.

It seems to me that this in turn will have some effect on currency rates, because whenever the banks deliberately mismatch their balance sheet in different currencies they are, for all intents and purposes, engaged in a carry trade.

It is my guess – as a non-specialist! – that these transactions would incur an additional capital charge equivalent to that of a long dated currency forward, according to the schedule given on page 73 (paragraph 92) of the OSFI Guidelines for Basel II … with the assumption that such loans would be unhedged. Hedging such transactions would largely reduce their point, as long-date FX trades at spot + government yield difference; therefore hedging would destroy the point.

The OSFI guidelines look reasonable to me … if my interpretation is correct … but I’d sure like to see some specialist discussion of the issue!

Every now and then I mention revolving-door regulation on this blog … like, f’rinstance, yesterday. I should emphasize that ill effects stemming from this can arise without anybody having any venal intent, as opined by Willem Buiter:

It is rather rare, I believe, in well-established parliamentary democracies, for the process through which power corrupts to be a direct and conscious one: “I have power. I control this license that you want; I can give you a tax break; I can make sure government procurement favours your company; I can acquit your useless son on manslaughter while DUI charges. Here is the number of my Swiss bank account. ”

It may happen, but more common and possibly more insidious and dangerous is the gradual transformation (I would say, distortion) of both the value system and the world-view or perception of reality that afflicts those elected or appointed to high office. This occurs through a gradual re-socialisation of those in power, which results in them gradually identifying with different peer groups and with different reference groups for benchmarking normal or acceptable behaviour.

A quiet day today on the preferred market, with no real trends evident.

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 4.40% 4.43% 54,405 16.5 1 +0.0393% 1,110.3
Fixed-Floater 4.83% 4.67% 65,539 16.01 7 +0.4153% 1,035.1
Floater 4.13% 4.17% 64,200 17.00 2 +0.0994% 915.0
Op. Retract 4.82% 2.60% 88,749 2.50 15 +0.1372% 1,057.5
Split-Share 5.25% 5.49% 69,578 4.15 13 +0.0481% 1,059.4
Interest Bearing 6.13% 6.21% 53,816 3.78 3 -0.9793% 1,105.4
Perpetual-Premium 5.88% 5.49% 132,479 3.34 9 -0.1309% 1,023.1
Perpetual-Discount 5.65% 5.70% 292,477 14.19 63 +0.0079% 928.0
Major Price Changes
Issue Index Change Notes
BSD.PR.A InterestBearing -2.9323% Asset coverage of just under 1.8:1 as of May 23 according to Brookfield Funds. Now with a pre-tax bid-YTW of 7.02% (mostly as interest) based on a bid of 9.60 and a hardMaturity 2015-3-31 at 10.00.
CIU.PR.A PerpetualDiscount -1.9118% Now with a pre-tax bid-YTW of 5.78% based on a bid of 20.01 and a limitMaturity.
BCE.PR.R FixFloat -1.1173%  
FAL.PR.B FixFloat +1.0040%  
BNA.PR.C SplitShare +1.1538% Asset coverage of just under 3.2:1 as of April 30 according to the company. Now with a pre-tax bid-YTW of 6.45% based on a bid of 21.04 and a hardMaturity 2019-1-10 at 25.00. Compare with BNA.PR.A (6.10% to 2010-9-30) and BNA.PR.B (6.90% to 2016-3-25).
BCE.PR.I FixFloat +1.2388%  
SLF.PR.E PerpetualDiscount +2.2167% Now with a pre-tax bid-YTW of 5.42% based on a bid of 20.75 and a limitMaturity.
BCE.PR.Z FixFloat +2.4229%  
Volume Highlights
Issue Index Volume Notes
CL.PR.B PerpetualPremium 145,002 RBC crossed 144,300 at 25.35 for delayed delivery. It goes ex-Dividend tomorrow for $0.390625. Now with a pre-tax bid-YTW of 5.54% based on a bid of 25.71 and a call 2011-1-30 at 25.00.
RY.PR.H PerpetualDiscount 74,449 Now with a pre-tax bid-YTW of 5.71% based on a bid of 24.99 and a limitMaturity.
GWO.PR.H PerpetualDiscount 61,450 Now with a pre-tax bid-YTW of 5.43% based on a bid of 22.70 and a limitMaturity.
BMO.PR.L PerpetualDiscount (for now!) 31,180 Now with a pre-tax bid-YTW of 5.86% based on a bid of 25.15 and a limitMaturity.
BNS.PR.M PerpetualDiscount 24,400 Now with a pre-tax bid-YTW of 5.48% based on a bid of 20.80 and a limitMaturity.

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

XTM eXchange Split Corp. Offering in Trouble?

Tuesday, May 27th, 2008

XTM eXchange Split Corp. has announced:

that the deadline for investors to deposit securities of TSX Group Inc. in connection with the purchase of Units, consisting of Priority Equity Shares and Class A Shares, of the Company pursuant to the Exchange Option, as outlined in the preliminary prospectus of the Company dated April 30, 2008, has been extended to 5:00 p.m. (Toronto time) on June 11, 2008. The applicable exchange ratio will now be based on the volume-weighted average trading price of the common Shares of TSX Group Inc. on the TSX during the three consecutive trading days ending on June 11, 2008.

Prospective purchasers pursuant to the exchange option may acquire (i) Units (one Class A Share and one Priority Equity Share) or (ii) Class A Shares of XTM eXchange Split Corp. Prospective purchasers may also continue to acquire Class A Shares and/or Priority Equity Shares and pay the purchase price in cash.

I noted this potential new issue in a post written on May 5. I haven’t heard anything concrete … and I don’t know what the original closing date was supposed to be … but an extension of the closing date is not usually considered to be a Good Sign.

Exchange Traded CDSs & Accrued Interest

Tuesday, May 27th, 2008

Accrued Interest has come out in favour of Exchange Traded Credit Default Swaps in a new post:Bailouts, Wall Street, and the Bad Motivator, although he does not go so far as some in claiming that over-the-counter trading should be (effectively) banned.

I addressed a similar exhortation in my post Leverage, Bear Stearns & Econbrowser.

I’m not a proponent of Exchange Trading for CDSs – I can see a useful purpose being served by a clearinghouse, but exchanges are set up so that non-institutional players get to play. I will defer to any those with better information, but I don’t sense any clamour from retail to trade in Credit Swaps … several attempts to set up an exchange have died on the vine (see Update #4 to the ‘Econbrowser’ post) although I don’t know to what extent retail was invited to the party. By me, exchange trading will involve enormous listing fees and a huge bureaucracy to list a plethora of CDSs that will trade by appointment only at 100bp spreads. What’s the point?

While I have great respect for Accrued Interest, I think there are a number of misconceptions embedded in his post:

Had Bear Stearns been allowed to fail, banks world wide would have lost their counter-party on various derivative transactions.

Well, no. As I pointed out on the ‘Econbrowser’ post:

as far as the counterparties were concerned, their counterparty was not BSC per se, but wholly-owned, independently capitalized, highly rated subsidiaries of BSC. Just how adequate the capital, accurate the ratings, and ring-fenced the assets actually were is something I am not qualified to judge – seeing as how I haven’t even seen any of the guarantees and financial statements in question. But neither, it would appear, has Prof. Hamilton.

I should note that I brought this up in the comments to the Accrued Interest post:

JH: I don’t believe that this is correct. See my post Leverage, Bear Stearns & Econbrowser

James: I read your piece at the time. My reaction is that we don’t really know what would have happened if BSC actually declared bankruptcy.

Accrued Interest goes on to postulate:

Let’s say you allow Bear Stearns to fail and that caused XYZ bank to fail. Is that capitalism? Forcing XYZ to suffer for the sins of Bear Stearns?

I say … yes, that is capitalism, but no, it’s not forcing XYZ to suffer for the sins of BSC. It is forcing XYZ to suffer for their own sins in not demanding adequate collateralization from BSC when their position started winning (if XYZ’s trade was losing, BSC’s bankruptcy would not affect them). If XYZ failed, it would be due not only to insufficient collateralization, not only due to their extending far too great a credit line to BSC, but also a failure of regulation in not having previously assigned a capital charge to XYZ that reflected their risk.

When a position – of any kind – gets marked-to-market, P&L changes. If the position is winning and profit increases, then shareholders’ equity increases. So far, so good. But the credit exposure to the counterparty has also increased … it’s a loan to the counterparty and gets charged as such. In any reasonable regime, collateralization will reduce the risk measured from the gross exposure. It may, upon sober review of the evidence, be deemed necessary to fiddle with these various calculations of Risk Weighted Assets, but I fail to see a need for anything more.

Next! Accrued Interest then claims:

The first step is obvious. Credit-default swaps need to be exchanged-traded.

I don’t see that at all. If we accept for a moment that counter-party risk is out of hand (I don’t accept it, but let’s continue the discussion) then exchange trading is only one option. The option that minimizes change would be a clearing-house, whereby the clearing house acts as the counterparty for all trades and the clearing-house itself is guaranteed by each of its members. An exchange would incorporate this function, but the functionality does not require an exchange.

Accrued Interest continues:

There would be some relatively simple ways to bring such a thing about. What if banks were required to recognize the credit risk of their counter-parties directly?

They are. Assiduous Readers will remember that I looked at Scotiabank’s capitalization today. According to page 23 of their supplementary information, their Basel-I Risk-Weighted-Assets of 252.8-billion includes 240.5-billion of credit risk, which includes 34.0-billion of “Off-Balance Sheet Assets – Indirect Credit Instruments”. If we go to the OSFI website and look at Scotia’s 1Q08 “BCAR Derivative Components”, we find that they have Credit Derivative Contracts [OTC] of $108.9-billion outstanding (and those are REAL dollars, none of that sub-par American muck) giving rise to a replacement cost of $3.1-billion and a credit equivalent amount of $8.1-billion which (when combined with other derivatives) gives rise to a Risk-Weight-Equivalent of $10.7-billion … just over 4.2% of their total risk-weighted assets.

One may wish to twiddle with the numbers – converting the notional amounts and unrealized P&L in different ways to get different Risk-Weighted-Assets. But it is not correct to imply that the credit risk is not currently recognized.

Accrued Interest continues:

I think back to banks needing to reserve for losses dealt to them by XLCA/FGIC/Ambac/MBIA’s potential failure to perform on CDS contracts.

Now, this is a legitimate concern. According to OSFI Guidelines (Section 3.1.5, page 31) claims on Deposit Taking Banks of an AAA to AA- sovereign carry a risk-weight of 20%, which is the same as similarly graded corporates (section 3.1.7). Single A comes at 50%, BBB+ to BB- is 100% and let’s not go further.

If we look at the quarterly report for CM, we find:

During the quarter, we recorded a charge of US$2.30 billion ($2.28 billion) on the hedging contracts provided by ACA (including US$30 million ($30 million) against contracts unrelated to USRMM unwound during the quarter) as a result of its downgrade to non-investment grade. As at January 31, 2008, the fair value of derivative contracts with ACA net of the valuation adjustment amounted to US$70 million ($70 million). Further charges could result depending on the performance of both the underlying assets and ACA.

The problem here is: they (effectively) made a loan of USD 2.37-billion to ACA and have now written down 2.30-billion of it. Why were they making (effective) loans of this size to a single (effective) borrower?

It is my understanding that many of the monolines were refusing to write protection unless they were exempted from collaterallization, on the grounds that they were AAA rated. It is my further understanding that this was just fine by some of the banks and brokerages. Well, it’s a business decision. As long as it’s adequately charged, it can remain a business decision.

I will certainly agree that loans of this size to a single party (equivalent to about one-sixth of their October 2007 capital) should have attracted a concentration charge, on top of the regular charge for corporate debt. But this – the existence or lack thereof of concentration charges in capital requirements – is what we need to talk about, without jumping into mandatory exchange trading of CDSs!

Accrued Interest concludes:

Why not just make them reserve a larger amount for this possibility up front? Efforts to start an exchange would begin the next day.

Well … maybe. To the extent that the exchange’s clearing-house’s credit would be better than the sum of its sponsoring parts, it is entirely reasonable to suppose that $1-billion exposure to a clearing-house would be charged at less than 10x$100-million to its individual members. It may also be assumed that netting and novation will be facilitated with a clearing house, which will further reduce exposure.

Whether or not the improvement in credit quality and consequent (we hope) reduction in capital requirements balances the guaranteed extra costs and reduced flexibility implied by a clearing-house is something that can be discussed … and the decision regarding institutional participation in such a scheme becomes just another business decision. But let’s see some numbers first.

Update, 2008-5-28: Naked Capitalism reprints a Financial Times rumour of an announcement tomorrow. This will, as far as I can tell, make formal a proposal aired in April that has been well reported:

“There is not one element that is going to solve all the problems, but it is one piece of the puzzle that will help us create a more robust framework. The timing is right – whether it will be successful or not, only time will show,” says Athanassios Diplas, chief risk officer and deputy chief operating officer, global credit trading, at Deutsche Bank, speaking at Isda’s twenty-third annual general meeting in Vienna on April 17.

The initial focus of those involved in the discussions has been on index products. Over time, efforts will extend to single-name CDSs. According to Diplas, this will remove risk from the system and the worry that the failure of one dealer could cause a hazardous shock in the market.

No details were given on a time frame for when a central clearing house would be established, but Diplas says the admission criteria for participants would be strict. “The criteria will take into account how well capitalised the firm is, how the risk is dealt with, how the variation margins are going to be posted and what the expected gap risk is going to be. All these issues have to be dealt with carefully – we are not going to jump into something unless we are very confident it will work.”

Update, 2008-6-19: See the market update of June 9 for news of how the proposal is moving along. Accrued Interest has posted another good piece about CDS clearing and exposures.

BNS Capitalization : 2Q08

Tuesday, May 27th, 2008

BNS has released its Second Quarter 2008 Report and Supplementary Package, so it’s time to recalculate how much room they have to issue new preferred shares – assuming they want to!

Step One is to analyze their Tier 1 Capital, reproducing the prior format:

BNS Capital Structure
October, 2007
& April, 2008
  4Q07 2Q08
Total Tier 1 Capital 20,225 21,073
Common Shareholders’ Equity 81.5% 83.9%
Preferred Shares 8.1% 10.5%
Innovative Tier 1 Capital Instruments 13.6% 13.0%
Non-Controlling Interests in Subsidiaries 2.5% 2.8%
Goodwill -5.6% -10.3%

Next, the issuance capacity (from Part 3 of the introductory series):

Tier 1 Issuance Capacity
October 2007
& April 2008
  4Q07 2Q08
Equity Capital (A) 15,840 16,113
Non-Equity Tier 1 Limit (B=A/3), 4Q07
(B=0.428*A), 2Q08
5,280 6,896
Innovative Tier 1 Capital (C) 2,750 2,750
Preferred Limit (D=B-C) 2,530 4,146
Preferred Actual (E) 1,635 2,210
New Issuance Capacity (F=D-E) 895 1,936
Items A, C & E are taken from the table
“Regulatory Capital”
of the supplementary information;
Note that Item A includes Goodwill, FX losses, “Other Capital Deductions” and non-controlling interest

Item B is as per OSFI Guidelines; the limit was recently increased.
Items D & F are my calculations

and the all important Risk-Weighted Asset Ratios!

Risk-Weighted Asset Ratios
October 2007
& April 2008
  Note 2007 2Q08
Equity Capital A 15,840 16,113
Risk-Weighted Assets B 218,300 218,900
Equity/RWA C=A/B 7.26% 7.36%
Tier 1 Ratio D 9.3% 9.6%
Capital Ratio E 10.5% 11.7%
Assets to Capital Multiple F 18.22x 17.68x
A is taken from the table “Issuance Capacity”, above
B, D & E are taken from BNS’s Supplementary Report
C is my calculation.
F is from OSFI (4Q07) and BNS’s Supplementary Report (2Q08) of total assets ($452.6-billion) divided by total capital ($25.588-billion)

New Issue: BNS Perp Fixed-Reset-Floater (+170bp)

Tuesday, May 27th, 2008

BNS has announced another issue, similar in structure to their March issuance.

Issue Name: Non-cumulative 5-Year Rate Reset Preferred Shares Series 20

Amount: 12-million shares @ $25 = $300-million

Greenshoe: 2-million shares (= $50-million) up to 48 hours before closing

Initial Rate: 5.00%, quarterly, until 2013-10-25 pay-date.

Reset: Resets every five years to 5-Year Canadas + 170bp, determined 30 days prior to the first day of a reset period.

Exchange: Exchangeable on every reset date to Series 21 (the Floaters), which pays 90-day bills + 170bp

Redemption: Redeemable every Exchange Date at $25.00. Floaters are redeemable every Exchange Date at 25.00 and at $25.50 at all other times.

Priority: Parri Passu with all other preferreds, senior to common, junior to everything else.

Ratings: S&P: P-1(low); DBRS: Pfd-1; Moody’s: Aa3

None for me thanks! I’ve commented on this structure previously and don’t like the fact that I’m expected to take perpetual credit risk for 5-year rates. It’s just another attempt to finance long with pretend-short-term paper … which was a major contributing factor to the Credit Crunch. However … some people like ’em!

Update: Oops! Forgot the closing! As noted on Scotia’s Press Release:

The Bank has agreed to sell the Preferred Shares Series 20 to a syndicate of underwriters led by Scotia Capital Inc. on a bought deal basis. The Bank has granted to the underwriters an option to purchase up to an additional $50 million of the Preferred Shares Series 20 at any time up to 48 hours before closing.
Closing is expected to occur on or after June 10, 2008. This domestic public offering is part of Scotiabank’s ongoing and proactive management of its Tier 1 capital structure.