Archive for June, 2009

June 30, 2009

Tuesday, June 30th, 2009

Sorry, folks! The June 30 closing price data is not yet available from the TSX, so I can’t close off the day.

When I have the data, you’ll get the data!

Update: Continued heavy trading and positive performance closed the month. Preliminary index figures indicate a gain for PerpetualDiscounts of 1.66% on the month, while FixedResets returned +2.70%.

PerpetualDiscounts closed the month yielding 6.36%, equivalent to 8.90% at the standard 1.4x equivalency factor. This compares to Long Corporates at about 6.4%, so the pre-tax interest-equivalent spread is near-as-dammit to 250bp, as declines in PerpetualDiscount yields did not keep pace with the extraordinary strength of the long corporate bonds … they returned +6.14% for the month and are now +17.55% YTD, which ain’t bad!

HIMIPref™ Preferred Indices
These values reflect the December 2008 revision of the HIMIPref™ Indices

Values are provisional and are finalized monthly
Index Mean
Current
Yield
(at bid)
Median
YTW
Median
Average
Trading
Value
Median
Mod Dur
(YTW)
Issues Day’s Perf. Index Value
Ratchet 0.00 % 0.00 % 0 0.00 0 -0.1628 % 1,186.7
FixedFloater 7.08 % 5.49 % 35,110 16.33 1 0.1305 % 2,129.4
Floater 3.21 % 3.63 % 83,213 18.22 3 -0.1628 % 1,482.6
OpRet 4.95 % 3.53 % 120,027 0.89 14 -0.0758 % 2,208.6
SplitShare 5.74 % 6.24 % 69,944 4.20 3 0.0151 % 1,900.9
Interest-Bearing 5.98 % -0.66 % 23,573 0.08 1 0.0998 % 2,023.1
Perpetual-Premium 0.00 % 0.00 % 0 0.00 0 0.2313 % 1,748.9
Perpetual-Discount 6.31 % 6.36 % 161,926 13.44 71 0.2313 % 1,610.8
FixedReset 5.62 % 4.61 % 484,161 4.35 40 0.1825 % 2,032.8
Performance Highlights
Issue Index Change Notes
TD.PR.Q Perpetual-Discount -1.66 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-06-30
Maturity Price : 22.96
Evaluated at bid price : 23.11
Bid-YTW : 6.17 %
W.PR.J Perpetual-Discount -1.27 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-06-30
Maturity Price : 21.52
Evaluated at bid price : 21.78
Bid-YTW : 6.45 %
CU.PR.A Perpetual-Discount 1.22 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-06-30
Maturity Price : 23.69
Evaluated at bid price : 24.00
Bid-YTW : 6.11 %
IAG.PR.C FixedReset 1.34 % YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-01-30
Maturity Price : 25.00
Evaluated at bid price : 26.51
Bid-YTW : 4.75 %
BMO.PR.H Perpetual-Discount 1.43 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-06-30
Maturity Price : 21.74
Evaluated at bid price : 22.05
Bid-YTW : 6.08 %
HSB.PR.D Perpetual-Discount 1.43 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-06-30
Maturity Price : 19.80
Evaluated at bid price : 19.80
Bid-YTW : 6.36 %
TD.PR.P Perpetual-Discount 1.47 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-06-30
Maturity Price : 22.02
Evaluated at bid price : 22.12
Bid-YTW : 6.04 %
BAM.PR.M Perpetual-Discount 1.54 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-06-30
Maturity Price : 15.86
Evaluated at bid price : 15.86
Bid-YTW : 7.56 %
RY.PR.H Perpetual-Discount 1.60 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-06-30
Maturity Price : 23.91
Evaluated at bid price : 24.11
Bid-YTW : 5.94 %
GWO.PR.I Perpetual-Discount 2.62 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-06-30
Maturity Price : 17.99
Evaluated at bid price : 17.99
Bid-YTW : 6.30 %
Volume Highlights
Issue Index Shares
Traded
Notes
TD.PR.O Perpetual-Discount 191,794 TD bought 25,000 from anonymous at 20.09; then National Bank crossed 122,700 at 20.10.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-06-30
Maturity Price : 20.15
Evaluated at bid price : 20.15
Bid-YTW : 6.14 %
GWO.PR.X OpRet 118,532 Nesbitt crossed 10,000 at 26.00; RBC crossed 100,000 at the same price.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2010-10-30
Maturity Price : 25.67
Evaluated at bid price : 26.00
Bid-YTW : 3.70 %
TD.PR.M OpRet 102,170 RBC crossed 100,000 at 26.20.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2010-05-30
Maturity Price : 25.75
Evaluated at bid price : 26.17
Bid-YTW : 3.60 %
MFC.PR.E FixedReset 85,935 Recent new issue.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-10-19
Maturity Price : 25.00
Evaluated at bid price : 25.50
Bid-YTW : 5.29 %
TD.PR.S FixedReset 65,322 RBC bought 10,000 from anonymous at 25.00; then another 14,000 at the same price; then bought 10,200 from National at the same price again.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-06-30
Maturity Price : 24.90
Evaluated at bid price : 24.95
Bid-YTW : 4.35 %
BMO.PR.P FixedReset 65,257 Recent new issue.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-06-30
Maturity Price : 23.22
Evaluated at bid price : 25.30
Bid-YTW : 4.90 %
There were 58 other index-included issues trading in excess of 10,000 shares.

The Optimal Level of Deposit Insurance Coverage

Tuesday, June 30th, 2009

The Boston Fed has released a working paper by Michael Manz, The Optimal Level of Deposit Insurance Coverage, in which a model of depositor behaviour leads to some interesting conclusions:

The model derived in this paper allows for a rigorous analysis of partial deposit insurance. The benefits of insurance involve eliminating inefficient withdrawals and bank runs due to noisy information and coordination failures, whereas the drawbacks consist of suppressing efficient withdrawals and of inducing excessive risk taking. A hitherto hardly noticed conclusion is that a high level of coverage can even be detrimental if bank risk is exogenous, because it undermines the occurrence of efficient bank runs. An extended version of the model shows that systemic risk calls for a higher level of deposit insurance, albeit only for systemically relevant banks from which contagion emanates, and not for the institutions that are potentially affected by contagion.

A vital contribution of the model is to provide comparative statics of the optimal level of coverage. In particular, the results imply that while tightening liquidity requirements is a substitute for deposit insurance, increasing transparency is not. Rather, the optimal coverage increases with the quality of the information available to depositors. Perhaps surprisingly, the degree of deposit insurance should not vary with expectations regarding the development of the real sector. This suggests that countries that in the past turned to increased or even unlimited deposit insurance as a reaction to a crisis, such as Japan, Turkey, or the United States, would do well to pause for thought on whether this is the right measure to strengthen their banking systems. The model also demonstrates why the presence of large creditors with uninsured claims calls for a lower level of insurance and why a high coverage is foremost in the interest of bankers and uninsured lenders. Moreover, it is consistent with small banks being particularly active lobbyists in favor of extending deposit insurance.

Another key advantage of the model is its applicability to various policy issues. In practice, only a small, albeit growing, number of countries maintaining deposit insurance require bank customers to coinsure a proportion of their deposits. According to the model, however, an optimal design of protection should build on coinsurance rather than on setting caps on insured deposits. It further indicates that deposit insurance becomes redundant in combination with full bailouts or optimal lending of last resort. While an unconditional bailout policy is about as inefficient as it can get, an optimal LolR policy combined with perfect public disclosure comes closest to the first best outcome in terms of welfare. Yet such an optimal policy, which requires protection to be contingent on bank solvency, seems far more demanding and hence less realistic in practice than unconditional deposit insurance. If regulators or central banks cannot precisely assess whether a bank is solvent, interventions are likely to be a mixture of the benchmark policies considered. Investigating these cases opens an interesting avenue for future research.

Moody's Contemplates Downgrading Bank Prefs / IT1C / Sub-Debt

Tuesday, June 30th, 2009

Moody’s has announced:

In Canada, proposed changes to the methodology used by Moody’s Investors Service to rate bank subordinated capital (i.e., subordinated debt, preferred shares, and other hybrid securities) could lead to ratings being lowered by an average of two to three notches on $65 billion of rated instruments.
Neither bank financial strength nor deposit ratings would change as a result of implementing Moody’s bank subordinated capital ratings proposal, the rating agency said. “These potential rating actions do not reflect on the underlying financial strength of the Canadian banking system, which Moody’s views as one of the soundest globally,” said Moody’s Senior Vice President, Peter Routledge. “Rather, they would capture the risk that subordinated capital generally does not benefit from systemic support and take into consideration the risk posed by each instrument’s features.”

Before the current financial crisis, Moody’s had assumed that any support provided by national governments and central banks to shore up a troubled bank and restore investor confidence would not just benefit the bank’s senior creditors but, at least to some extent, investors in its subordinated capital.

The rating agency notes that with recent government interventions oustide Canada, investors in certain types of subordinated capital have been left to absorb losses. In some cases, support packages have been contingent upon the banks’ suspension of coupon payments on these instruments as a means to preserve capital.

In other words, this is the same rationale as that used by DBRS when it mass-downgraded bank preferreds and IT1C.

DBRS Releases Bank Preferred Share Rating Methodology

Tuesday, June 30th, 2009

DBRS has announced that it:

has today released its methodology for rating Bank Preferred Shares and Equivalent Hybrids.

This methodology addresses the level of notching for preferred shares and equivalent hybrid instruments (collectively, preferred shares) relative to issuer ratings for banks and other financial institutions that are highly leveraged relative to the leverage seen in most corporate issuers. For simplicity, we will refer to banks, but the methodology applies to certain other financial institutions that fit this profile. The combination of high leverage and the importance of adequate capital for a bank’s viability increase the risk of nonpayment of preferred share dividends and/or adverse exchange offers of common equity for preferred shares relative to the risk for similarly-rated corporate issuers. These actions provide ways for a bank to quickly build up loss-absorbing common equity. The inclusion of “equivalent hybrid” denotes that this methodology also applies to hybrid securities that either convert into preferred shares rather than into junior subordinated debt or have other characteristics whereby DBRS would treat the instrument in the same fashion as it would preferred shares.

In summary, there are two major changes occurring in this methodology relative to the prior DBRS methodology for rating bank preferred shares.

(1) For those banks that benefit from support, the starting point for notching preferred share ratings will now be based on the intrinsic assessment (IA) rating rather than on the final senior debt rating. The DBRS support assessment methodology means that the IA is usually lower than the final senior debt rating for such banks. This change reflects the view that external support should provide no rating uplift for equity-type securities.

(2) The degree of notching from the IA rating to the preferred share rating has been widened to reflect our perception that the risk in these capital instruments has increased, although there is some flexibility to make adjustments to reflect the position of individual banks. This extends the long held core principle of rating more junior securities at lower levels. In addition to the implied higher risk of default, this also in part recognizes that there is a higher expected loss for junior securities that default than for more senior ranking securities.

The methodology itself has been made available. A lot of the rationale for the changes is regulatory:

Increasing the risk in these instruments is DBRS’s perception that regulators and governments are now more committed to making capital instruments play the role that they were created to play – that is, to provide capital. To get government support, banks may face greater pressure to take such capital-enhancing actions either before or in conjunction with getting government support.

An additional factor that is likely to increase the risk of such adverse actions for preferred shares appears to be the reversal of more than a decade of increased reliance on preferred shares and other hybrid instruments to bolster regulatory capital. Given the loss-absorption role of common equity, the financial markets and increasingly the regulators are looking to banks to bolster their common equity capital as opposed to other forms of capital. This drive has become more acute after the rapid erosion of common equity that some banks experienced due to significant writedowns.

Notching will vary with issuer strength:

The weaker the institution, the greater the probability that a nonpayment of preferred shares will occur after a significant loss or deterioration in fi nancial health. That suggests a widening gap as a bank’s senior issuer rating is lowered. For example, in the base notching scale shown below, for banks with an intrinsic assessment rating of A (low) or below, the risk for preferred shares is perceived to be non-investment grade.

They provide a base-case notching yardstick:

DBRS Notching Guideline
Senior Preferred Shares Notes
Three Notches
AA (high) A (high) DBRS alerts investors to higher risk of nonpayment, even for highly rated banks
AA (low) A (low) Risk is still very low as identified by “A” category
Four Notches
A (high) BBB For A (high) banks, less resiliency and increased risk of adverse events affects the preferred share rating
A (low) BB (high) Risk of falling into BBB category with higher capital stress means non-investment grade rating for preferred shares
Five Notches
BBB (high) BB (low) More immediate pressure to raise capital, if needed, but may be more difficult for weaker BBB bank
BBB (low) B Bank is only one notch away from non-investment grade, making capital more difficult to raise if needed

While the base notching as discussed above is the starting point for every rating decision on bank preferred shares, DBRS policy permits exceptions to the base notching for all rating levels (either above or below) to reflect the unique considerations of individual banks. Key considerations include the following:
• Mix and strength of the capital structure (including the proportion of preferred shares in the capital structure).
• Actions taken on common dividends (recognizing that these actions are the first buffer).
• Any other unique stresses or lack of stress within the domestic financial system, such as the expected actions possible from external parties (regulators, governments).
• The robustness and expected consistency of the bank’s earnings.
• Accessibility to capital markets.
• When the aforementioned factors present a strong case, other possible considerations may also include where the IA rating is within the broader rating category and whether the issuing entity is the bank or the holding company

This is the methodology used in the course of the recent DBRS Mass Downgrade of Banks.

What is the Yield of BPP.PR.G?

Tuesday, June 30th, 2009

The effect of changes in Prime is interesting … but the reported effect of changes in Prime is even more interesting! I received an inquiry today:

I have been trying to learn more about preferred shares and find the whole matter of floating rates quite perplexing.

If you would kindly spare me just a moment of your time, would you please explain briefly (again I don’t want to take up much of your time) how the following dividend yield from the globeinvestor.com website is arrived at for the BPO Properties stock with a floating rate listed below.

Using BPP.PR.G as an example.

The following dividend information is provided on the globeinvestor.com site:

Annual Div. 0.61 Yield 5.90

The following Annual Dividend information comes from your http://www.prefinfo.com/ website:

Floating Rate Start Date : 2001-05-07

Floating Rate Index ID : Canada Prime

FR Formula : 70% of index (#3)

How please is the listed 5.90% yield ($0.61/share) arrived at? This amount seems to be higher than the (if I am correct) present 2.25% Canada prime rate.

I thank you in advance for your assistance.

BPP.PR.G closed last night at 10.50-bid, but pays its dividend on the issue price of $25.00. The Globe (and virtually everybody else) reports the Current Yield, which is the annual dividend divided by the market price; but they use historical dividend.

Thus, the dividend paid for BPP.PR.G is 2.25% [Prime] x $25.00 [Par Value] x 70% [Fraction of Prime Paid] = $0.39375 and the price is $10.50 so the current yield – as reported by Hymas Investment – is 3.75%.

Trouble ensues when prime drops precipituously. The projected quarterly dividend based on Prime of 2.25% as calculated above is just under ten cents. But the recent dividend history of BPP.PR.G is:

BPP.PR.G, Recent Dividends
Ex-Date Record
Date
Pay-Date Amount
2008-07-29 2008-07-31 2008-08-14 0.266610
2008-10-29 2008-10-31 2008-11-14 0.207813
2009-01-28 2009-01-30 2009-02-14 0.196994
2009-04-28 2009-04-30 2009-05-14 0.153601
Total 0.825018

When we divide the total for the last four quarters – which we note is more than double the amount we expect going forward – by the price of $10.50, we get 7.86% But that’s not where the Globe gets its dividend from.

As far as I can tell, the Globe has estimated the annual dividend going forward by multiplying the previous quarterly dividend of $0.153601 by four; that results in an estimate of 0.614404 and an estimated Current Yield of 0.614404 / 10.50 = 5.85% which, I suppose, the Globe rounds to 5.90%.

I remarked on the effect of the precipituous decline in prime during my Seminar on Floating Rate Issues (which is available for purchase) … but I confess, the idea that buyers could be trading based on yields reported by the Globe calculated in such a manner was something I missed completely!

I congratulate my interlocutor for checking the Globe’s reported yield!

June 29, 2009

Monday, June 29th, 2009

Bernanke roughly handled by the House Oversight Committee:

Republican lawmakers who have consistently opposed government rescues of financial companies have accused the central bank of overstepping its authority in pressuring Bank of America to absorb Merrill Lynch.

Republican congressional staff wrote in a memo on documents received by the House panel from the Fed through a subpoena that a “gun placed to the head of Bank of America” forced the Charlotte, North Carolina-based bank to go through with the merger, which was announced in mid-September.

but has found defenders in Econbrowser‘s James Hamilton’s post On Grilling the Fed Chair:

It is one thing to have different views from those of the Fed Chair on particular decisions that have been made– I certainly have plenty of areas of disagreement of my own. But it is another matter to question Bernanke’s intellect or personal integrity. As someone who’s known him for 25 years, I would place him above 99.9% of those recently in power in Washington on the integrity dimension, not to mention IQ. His actions over the past two years have been guided by one and only one motive, that being to minimize the harm caused to ordinary people by the financial turmoil. Whether you agree or disagree with all the steps he’s taken, let’s start with an understanding that that’s been his overriding goal.

and in a somewhat more lukewarm manner by Accrued Interest’s Ben Bernanke: Smooth Criminal:

Now the morons in congress are coming for Ben Bernanke for how he handled the Bank of America/Merrill Lynch merger. Seriously? Now, let there be no doubt. Ken Lewis was pressured by the Fed in a way that should leave a bad taste in the mouth of any free citizen. But we were in the middle of an economic war. Sometimes some bad shit happens on the battlefield and sometimes its OK if we look the other way.

Willem Buiter remarks that Too Big to Fail is Too Big (emphasis added):

In banking and most highly leveraged finance, size is a social bad. Fortunately, there is quite a list of effective instruments for cutting leveraged finance down to size.
  • Legally and institutionally, unbundle narrow banking and investment banking (Glass Steagall-on-steroids).
  • Legally and institutionally prevent all banks (narrow banks and investment banks) from engaging in activities that present manifest potential conflicts of interest. This means no more universal banks and similar financial supermarkets.
  • Limit the size of all banks by making regulatory capital ratios an increasing function of bank size.
  • Enforce competition policy aggressively in the banking sector, by breaking up banks if necessary.
  • Require any remaining systemically important banks to produce a detailed annual bankruptcy contingency plan.
  • Only permit limited liability for narrow banks/public utility banks.
  • Create a highly efficient special resolution regime for all systemically important financial institutions. This SRR will permit an omnipotent Conservator/Administrator to financially restructure the failing institutions (by writing down the claims of the unsecured creditors or mandatorily converting them into equity), without interfering materially with new lending, investment and funding operations.

The Geithner plan for restructuring US regulation is silent on the too big to fail problem. That alone is sufficient to ensure that it will fail to result in a more stable and safer US banking and financial system.

Of the laundry list, Assiduous Readers will know that I am most in favour of making regulartory capital requirements an increasing function of bank size: it requires the least judgement by regulators and politicians, is the most transparent and allows the highest degree of forward planning by the banks and by the investors in those banks.

I also want to see an unbundling of narrow banking and investment banking, but preferably not by legislative fiat. I want to see the regulations altered to recognize that there is a difference in institutional culture between these two activities and offer institutions a choice between capital requirement regimes. Those opting for Narrow Banking will find they can lever up their buy-and-hold holdings of consumer loans a little more, but find their trading activities require more capital to cover; those opting for Investment Banking will find it relatively easier to lever up a trading operation, but when paper stays on the books for more than a few months it requires progressively more capital.

I recently read a fascinating paper on the origins of corporate boards; Franklin A. Gevurtz’s The Historical and Political Origins of the Corporate Board of Directors:

Prompted by the litany of complaints about corporate boards – as once again highlighted by recent corporate scandals – this paper seeks to add to the literature on why corporation laws in the United States (and, indeed, around the world) generally call for corporate governance by or under a board of directors. Moreover, this paper takes a very different approach in searching for an answer. Instead of theorizing, this paper examines historical sources in order to look at how and why an elected board of directors came to be the accepted mode of corporate governance. This will entail a reverse chronological tour all the way back to the antecedents of today’s corporate board in fourteenth through sixteenth century companies of English merchants engaged in foreign trade. The central insight of this chronology is that the corporate board of directors did not develop as an institution to manage the business corporation. Rather, it is an institution the business corporation inherited when the business corporation evolved out of societies of independent merchants. This paper also shows how these merchant societies based their adoption of the antecedents of today’s corporate board on widespread political theories and practices in medieval Europe that, although hardly democratic, often called for the use of collective governance by a body of representatives. The discovery of the historical and political origins of the corporate board, besides being interesting in its own right, suggests that the current frustration with corporate boards may arise from confusing an institution designed to achieve political legitimacy through consent of the governed, with the goal of assuring efficient management of a business on behalf of passive investors.

A good solidly strong day for preferreds as FixedResets continued to rock ‘n’ roll on continued heavy volume. I will be most interested to see what tomorrow brings, given the DBRS Mass Downgrade of Bank Prefs & IT1C … probably not much effect, but the banks that got downgraded two notches (HSB, NA, LB) rather than just one (BMO, BNS, CM, RY, TD) might see some effects.

HIMIPref™ Preferred Indices
These values reflect the December 2008 revision of the HIMIPref™ Indices

Values are provisional and are finalized monthly
Index Mean
Current
Yield
(at bid)
Median
YTW
Median
Average
Trading
Value
Median
Mod Dur
(YTW)
Issues Day’s Perf. Index Value
Ratchet 0.00 % 0.00 % 0 0.00 0 -1.4702 % 1,188.7
FixedFloater 7.09 % 5.51 % 35,562 16.31 1 0.0000 % 2,126.6
Floater 3.20 % 3.59 % 76,896 18.30 3 -1.4702 % 1,485.0
OpRet 4.94 % 3.47 % 121,412 0.89 14 0.2391 % 2,210.2
SplitShare 5.74 % 6.31 % 69,731 4.20 3 0.2717 % 1,900.6
Interest-Bearing 5.99 % 0.35 % 22,795 0.08 1 0.2000 % 2,021.1
Perpetual-Premium 0.00 % 0.00 % 0 0.00 0 0.2709 % 1,744.9
Perpetual-Discount 6.32 % 6.37 % 161,445 13.41 71 0.2709 % 1,607.0
FixedReset 5.63 % 4.64 % 486,697 4.35 40 0.3178 % 2,029.1
Performance Highlights
Issue Index Change Notes
BAM.PR.K Floater -2.25 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-06-29
Maturity Price : 10.86
Evaluated at bid price : 10.86
Bid-YTW : 3.62 %
MFC.PR.C Perpetual-Discount -2.01 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-06-29
Maturity Price : 17.54
Evaluated at bid price : 17.54
Bid-YTW : 6.48 %
TRI.PR.B Floater -1.63 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-06-29
Maturity Price : 15.05
Evaluated at bid price : 15.05
Bid-YTW : 2.61 %
BAM.PR.O OpRet -1.26 % YTW SCENARIO
Maturity Type : Option Certainty
Maturity Date : 2013-06-30
Maturity Price : 25.00
Evaluated at bid price : 23.51
Bid-YTW : 6.76 %
CM.PR.D Perpetual-Discount -1.07 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-06-29
Maturity Price : 21.95
Evaluated at bid price : 22.26
Bid-YTW : 6.45 %
HSB.PR.D Perpetual-Discount 1.04 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-06-29
Maturity Price : 19.52
Evaluated at bid price : 19.52
Bid-YTW : 6.45 %
SLF.PR.B Perpetual-Discount 1.04 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-06-29
Maturity Price : 18.50
Evaluated at bid price : 18.50
Bid-YTW : 6.54 %
CU.PR.A Perpetual-Discount 1.11 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-06-29
Maturity Price : 23.42
Evaluated at bid price : 23.71
Bid-YTW : 6.18 %
PWF.PR.E Perpetual-Discount 1.12 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-06-29
Maturity Price : 21.60
Evaluated at bid price : 21.60
Bid-YTW : 6.50 %
GWO.PR.F Perpetual-Discount 1.35 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-06-29
Maturity Price : 22.38
Evaluated at bid price : 22.56
Bid-YTW : 6.58 %
GWO.PR.G Perpetual-Discount 1.38 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-06-29
Maturity Price : 20.51
Evaluated at bid price : 20.51
Bid-YTW : 6.39 %
BAM.PR.H OpRet 1.39 % YTW SCENARIO
Maturity Type : Call
Maturity Date : 2010-10-30
Maturity Price : 25.25
Evaluated at bid price : 25.50
Bid-YTW : 4.94 %
GWO.PR.H Perpetual-Discount 1.41 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-06-29
Maturity Price : 18.66
Evaluated at bid price : 18.66
Bid-YTW : 6.55 %
BAM.PR.J OpRet 1.59 % YTW SCENARIO
Maturity Type : Soft Maturity
Maturity Date : 2018-03-30
Maturity Price : 25.00
Evaluated at bid price : 22.40
Bid-YTW : 7.06 %
CU.PR.B Perpetual-Discount 2.17 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-06-29
Maturity Price : 24.71
Evaluated at bid price : 25.00
Bid-YTW : 6.06 %
HSB.PR.C Perpetual-Discount 3.54 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-06-29
Maturity Price : 20.45
Evaluated at bid price : 20.45
Bid-YTW : 6.28 %
Volume Highlights
Issue Index Shares
Traded
Notes
GWO.PR.X OpRet 208,558 Nesbitt crossed blocks of 150,000 and 25,000 shares, both at 26.00; RBC crossed 30,000 at the same price.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2010-10-30
Maturity Price : 25.67
Evaluated at bid price : 26.00
Bid-YTW : 3.69 %
GWO.PR.F Perpetual-Discount 203,313 Nesbitt crossed 160,000 at 22.20 and another 40,000 at 22.40.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-06-29
Maturity Price : 22.38
Evaluated at bid price : 22.56
Bid-YTW : 6.58 %
TD.PR.M OpRet 125,600 RBC crossed three blocks, 49,000 and 30,000 and 19,000 shares, all at 26.16; Desjardins crossed 25,000 at the same price.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2010-05-30
Maturity Price : 25.75
Evaluated at bid price : 26.20
Bid-YTW : 3.47 %
BMO.PR.P FixedReset 114,910 Recent new issue.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-06-29
Maturity Price : 23.22
Evaluated at bid price : 25.32
Bid-YTW : 4.90 %
GWO.PR.J FixedReset 81,700 Nesbitt sold 33,900 to RBC at 26.25, then crossed 43,500 at the same price.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-01-30
Maturity Price : 25.00
Evaluated at bid price : 26.25
Bid-YTW : 4.80 %
TD.PR.S FixedReset 72,875 RBC bought 18,800 from Anonymous at 24.95, then crossed 26,000 at 24.94.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-06-29
Maturity Price : 24.86
Evaluated at bid price : 24.91
Bid-YTW : 4.37 %
There were 44 other index-included issues trading in excess of 10,000 shares.

DBRS: Mass Downgrade of Bank Preferreds & IT1C

Monday, June 29th, 2009

DBRS has announced that it:

has today downgraded the preferred shares and innovative Tier 1 instrument ratings of the Canadian banks it rates, following the application of changes in DBRS’s global banking methodology. The ratings have been removed from Under Review with Negative Implications, where they were placed on April 20, 2009. All other ratings for the Canadian banks are unaffected; related rating trends remain unchanged. The downgrades reflect the revision of DBRS’s views on external support as it relates to preferred shares and the elevated risk of non-payment of preferred dividends relative to the risk of default indicated by senior debt ratings. The downgrades do not reflect any specific credit event at any of the listed institutions or related entities.

The change in methodology affects preferred shares ratings in three ways:

(1) The change in the global banking methodology dictates that the starting point for notching preferred shares will be based on the intrinsic assessment rating, rather than the senior debt rating (which may incorporate the benefit of external support). The primary factor that has led to this change in the methodology is recent actions taken in other jurisdictions that demonstrate no systemic external support for preferred shares. As such, the preferred shares and Tier 1 innovative instruments ratings of the listed institutions and their related entities that benefited from a one-notch uplift in October 2006 (due to the support assessment designation of SA2) will now be removed.

The preferred shares and Tier 1 innovative instruments of the affected institutions are: Bank of Montreal, Bank of Nova Scotia, Canadian Imperial Bank of Commerce, National Bank of Canada, Royal Bank of Canada, and Toronto-Dominion Bank.

(2) The other change in the global banking methodology incorporates the elevated risk of non-payment of preferred dividends relative to the risk of default for more senior debt instruments. As such, the changes in the methodology have increased the base notching, even within the strongest rating categories, and the base notching now expands as the credit quality of the bank migrates downward. Within this approach, there exists some flexibility to adjust the notching for factors that reflect the position of individual banks. Historically, DBRS’s methodology resulted in a fixed relationship across all rating categories.

The preferred shares and Tier 1 innovative instruments of the affected institutions are: National Bank of Canada and Laurentian Bank of Canada.

(3) The final change in the global banking methodology affects SA1 category banks. The preferred shares rating for the subsidiary will be notched relative to the preferred share of the parent in the same way that all debt ratings are notched between the two entities.

The preferred shares and Tier 1 innovative instruments of the affected institution is: HSBC Bank Canada.

DBRS will host a teleconference tomorrow morning, Tuesday June 30, at 11:00 am ET, to discuss today’s rating action.

Interested callers should dial the appropriate number listed below at least five minutes before the 11:00 am ET call time.

Local Callers: 416-695-5800, quoting passcode: 5742370

Toll Free Callers: 800-408-3053, quoting passcode: 5742370

This follows the original announcement that they were on Review-Negative.

Affected issues are:

DBRS Mass Bank Downgrade
2009-6-29
Issue Old Rating New Rating
BMO.PR.H Pfd-1 Pfd-1(low)
BMO.PR.J Pfd-1 Pfd-1(low)
BMO.PR.K Pfd-1 Pfd-1(low)
BMO.PR.L Pfd-1 Pfd-1(low)
BMO.PR.M Pfd-1 Pfd-1(low)
BMO.PR.N Pfd-1 Pfd-1(low)
BMO.PR.O Pfd-1 Pfd-1(low)
BMO.PR.P Pfd-1 Pfd-1(low)
BNS.PR.J Pfd-1 Pfd-1(low)
BNS.PR.K Pfd-1 Pfd-1(low)
BNS.PR.L Pfd-1 Pfd-1(low)
BNS.PR.M Pfd-1 Pfd-1(low)
BNS.PR.N Pfd-1 Pfd-1(low)
BNS.PR.O Pfd-1 Pfd-1(low)
BNS.PR.P Pfd-1 Pfd-1(low)
BNS.PR.Q Pfd-1 Pfd-1(low)
BNS.PR.R Pfd-1 Pfd-1(low)
BNS.PR.T Pfd-1 Pfd-1(low)
BNS.PR.X Pfd-1 Pfd-1(low)
CM.PR.A Pfd-1
[Trend Negative]
Pfd-1(low)
[Trend Negative]
CM.PR.D Pfd-1
[Trend Negative]
Pfd-1(low)
[Trend Negative]
CM.PR.E Pfd-1
[Trend Negative]
Pfd-1(low)
[Trend Negative]
CM.PR.G Pfd-1
[Trend Negative]
Pfd-1(low)
[Trend Negative]
CM.PR.H Pfd-1
[Trend Negative]
Pfd-1(low)
[Trend Negative]
CM.PR.I Pfd-1
[Trend Negative]
Pfd-1(low)
[Trend Negative]
CM.PR.J Pfd-1
[Trend Negative]
Pfd-1(low)
[Trend Negative]
CM.PR.K Pfd-1
[Trend Negative]
Pfd-1(low)
[Trend Negative]
CM.PR.L Pfd-1
[Trend Negative]
Pfd-1(low)
[Trend Negative]
CM.PR.M Pfd-1
[Trend Negative]
Pfd-1(low)
[Trend Negative]
CM.PR.P Pfd-1
[Trend Negative]
Pfd-1(low)
[Trend Negative]
CM.PR.R Pfd-1
[Trend Negative]
Pfd-1(low)
[Trend Negative]
HSB.PR.C Pfd-1
[Trend Negative]
Pfd-2(high)
[Trend Negative]
HSB.PR.D Pfd-1
[Trend Negative]
Pfd-2(high)
[Trend Negative]
LB.PR.D Pfd-3(high) Pfd-3(low)
LB.PR.E Pfd-3(high) Pfd-3(low)
NA.PR.K Pfd-1(low) Pfd-2
NA.PR.L Pfd-1(low) Pfd-2
NA.PR.M Pfd-1(low) Pfd-2
NA.PR.N Pfd-1(low) Pfd-2
NA.PR.O Pfd-1(low) Pfd-2
NA.PR.P Pfd-1(low) Pfd-2
RY.PR.A Pfd-1 Pfd-1(low)
RY.PR.B Pfd-1 Pfd-1(low)
RY.PR.C Pfd-1 Pfd-1(low)
RY.PR.D Pfd-1 Pfd-1(low)
RY.PR.E Pfd-1 Pfd-1(low)
RY.PR.F Pfd-1 Pfd-1(low)
RY.PR.G Pfd-1 Pfd-1(low)
RY.PR.H Pfd-1 Pfd-1(low)
RY.PR.I Pfd-1 Pfd-1(low)
RY.PR.L Pfd-1 Pfd-1(low)
RY.PR.N Pfd-1 Pfd-1(low)
RY.PR.P Pfd-1 Pfd-1(low)
RY.PR.R Pfd-1 Pfd-1(low)
RY.PR.T Pfd-1 Pfd-1(low)
RY.PR.W Pfd-1 Pfd-1(low)
RY.PR.X Pfd-1 Pfd-1(low)
RY.PR.Y Pfd-1 Pfd-1(low)
TD.PR.A Pfd-1 Pfd-1(low)
TD.PR.C Pfd-1 Pfd-1(low)
TD.PR.E Pfd-1 Pfd-1(low)
TD.PR.G Pfd-1 Pfd-1(low)
TD.PR.I Pfd-1 Pfd-1(low)
TD.PR.K Pfd-1 Pfd-1(low)
TD.PR.M Pfd-1 Pfd-1(low)
TD.PR.N Pfd-1 Pfd-1(low)
TD.PR.O Pfd-1 Pfd-1(low)
TD.PR.P Pfd-1 Pfd-1(low)
TD.PR.Q Pfd-1 Pfd-1(low)
TD.PR.R Pfd-1 Pfd-1(low)
TD.PR.S Pfd-1 Pfd-1(low)
TD.PR.Y Pfd-1 Pfd-1(low)

The main effect of this, I feel, is the decreased notching between the top banks and the top insurers. Previously, MFC, SLF, PWF & GWO had been ranked a notch below the Big 5 … and I thought that was a little on the skimpy side. Now there’s no notching. Interesting…

Update: It is interesting to note that this is largely a reversal of the the October 2006 Mass Upgrade of Banks.

Why are Most Funds Open-Ended?

Monday, June 29th, 2009

This paper was highlighted in the BIS Annual Report, so I had a look.

The full title of the paper is Why are Most Funds Open-Ended? Competition and the Limits of Arbitrage:

The majority of asset-management intermediaries (e.g., mutual funds, hedge funds) are structured on an open-end basis, even though it appears that the open end form can be a serious impediment to arbitrage. I argue that the equilibrium degree of open-ending in an economy can be excessive from the point of view of investors. When funds compete for investors’ dollars, they may engage in a counterproductive race towards the open-end form, even though this form leaves them ill-suited to undertaking certain types of arbitrage trades. One implication of the analysis is that, even absent short-sales constraints or other frictions, economically large mispricings can coexist with rational, competitive arbitrageurs who earn small excess returns.

One implication of this is that the connection between arbitrageurs’ profits and overall market efficiency is very tenuous. In Example 1, the ex ante gross return to investors of 1.10 translates into a 2 percent annual alpha for professionally-managed money, assuming a five-year horizon. This looks relatively small, in keeping with the empirical evidence on the performance of fund managers. Yet this small alpha coexists with an infinitely elastic supply of the UC [Uncertain Convergence] asset, which can be thought of as having a price that deviates from fundamental value by a factor of three. Indeed, fund managers barely touch the UC asset, even though eventual convergence to fundamentals is assured, and there are no other frictions, such as trading costs or short-sales constraints. As noted in the introduction, this kind of story would seem to fit well with the unwillingness of hedge funds to bet heavily against the internet bubble of the late 1990s, by, e.g., taking an outright short position on the NASDAQ index—something which would certainly have been feasible to do at low cost from an execution/trading-frictions standpoint.

Footnote: Brunnermeier and Nagel (2003) give a nice illustration of the risks that hedge funds faced in betting against the internet bubble. They analyze the history of Julian Robertson’s Tiger Fund, which in early1999 eliminated all its investments in technology stocks (though it did not take an outright short position). By October 1999, the fund was forced to increase its redemption period from three to six months in an effort to stem outflows. By March 2000, outflows were so severe that the fund was liquidated—ironically, just as the bubble was about to burst.

The central point of this paper is easily stated. Asset-management intermediaries such as mutual funds and hedge funds compete for investors’ dollars, and one key dimension on which they compete is the choice of organizational form. In general, there is no reason to believe that this competition results in a form that is especially well-suited to the task of arbitrage. Rather, there is a tendency towards too much open-ending, which leaves funds unable to aggressively attack certain types of mispricing—i.e., those which do not promise to correct themselves quickly and smoothly. This idea may help to shed light on the arbitrage activities of another class of players: non-financial firms. Baker and Wurgler (2000) document that aggregate equity issuance by non-financial firms has predictive power for the stock market as a whole. And Baker, Greenwood and Wurgler (2003) show that such firms are also able to time the maturity of their debt issues so as to take advantage of changes in the shape of the yield curve. At first such findings appear puzzling. After all, even if one grants that managers have some insight into the future of their own companies, and hence can time the market for their own stock, it seems harder to believe that they would have an advantage over professional arbitrageurs in timing the aggregate stock and bond markets. However, there is another possible explanation for these phenomena. Even if managers of non-financial firms are less adept at recognizing aggregate-market mispricings than are professional money managers, they have an important institutional advantage—they conduct their arbitrage inside closed-end entities, with a very different incentive structure. For example, it was much less risky for the manager of an overpriced dot-com firm to place a bet against the internet bubble in 1999 (by undertaking an equity offering) than it was for a hedge-fund manager to make the same sort of bet. In the former case, if the market continued to rise, no visible harm would be done: the dot-com firm could just sit on the cash raised by the equity issue, and there would only be the subtle opportunity cost of not having timed the market even better. There would certainly be no worry about investors liquidating the firm as a result of the temporary failure of prices to converge to fundamentals.

There are some interesting corrollaries to the BIS desire for increased arbitrage:

  • Hedge Funds are Good
  • Shorting is Good
  • Credit Default Swaps are Good

One wonders how much consistency we may see in their views going forward!

BIS Releases Annual Report

Monday, June 29th, 2009

The Bank for International Settlements has released its Annual Report 2008-09; some of the policy recommendations are contentious!

One interesting reference is:

Moreover, managers of assets in a given asset class were rewarded for performance exceeding benchmarks representing average performance in that investment category. As a result, even if managers recognised a bubble in the price of some asset, they could not take advantage of that knowledge by selling short for fear that investors would withdraw funds. The result was herding that caused arbitrage to fail.

Footnote: For a discussion of how arbitrage fails when individual investors cannot distinguish good asset managers from bad ones, see J Stein, “Why are most funds open-end? Competition and the limits of arbitrage”, Quarterly Journal of Economics, vol 120, no 1, February 2005, pp 247–72.

I’ll have to read that reference sometime!

The regulators continue to deflect blame for the crisis onto the Credit Rating Agencies:

In the end, the rating agencies– assigned the task of assessing the risk of fixed income securities and thus of guarding collective safety – became overwhelmed and, by issuing unrealistically high ratings, inadvertently contributed to the build-up of systemic risk.

Footnote: Differences in the methodologies used by the rating agencies also provided incentives for the originators to structure their asset-backed securities in ways that would allow them to “shop” for the best available combination of ratings (across both rating agencies and the liabilities structure of those instruments). See I Fender and J Kiff, “CDO rating methodology: some thoughts on model risk and its implications”, BIS Working Papers, no 163, November 2004.

Which is, of course, self-serving nonsense. It is the regulators who have been assigned the task of guarding collective safety. CRAs merely publish their opinions, the same way I do and the same way any idiot with access to the internet can do. As discussed by researchers at the Boston Fed in Making Sense of the Sub-Prime Crisis (which has been discussed on PrefBlog), the tail risk of sub-prime securities was well-known, well-publicized and ignored.

And as for their observation that:

And because of the complexity of the instruments, reliance on ratings increased even among the most sophisticated institutional investors.

… well, if I don’t understand something and can’t understand how to model it, I don’t buy it. I guess that makes me the most sophisticated investor in the world.

They do make one sensible observation:

Finally, there were governance problems in risk management practices. For both structural and behavioural reasons, senior managers and board members were neither asking the right questions nor listening to the right people. The structural problem was that risk officers did not have sufficient day-to-day contact with top decision-makers, often because they did not have sufficiently senior positions in their organisations. Without support from top management, it didn’t matter much what the chief risk officer said or to whom he or she said it. The structural problem was compounded by the behavioural response to a risk officer whose job it is to tell people to limit or stop what they are doing. If what they are doing is profitable, it is going to be difficult to get managers and directors to listen.

However, I don’t see anything addressing the obvious corrollory that bank size must be controlled, preferrably through the imposition of progressively increasing capital requirements based on size. After all, if all the big international banks disappeared, where would an intelligent and knowledgable BIS employee look to for future employment? To achieve the desired end, it’s probably better to insist on a greater and better paid head-count in the Risk Management division.

The recommendation that has attracted the most attention (e.g., a Reuters report) is:

Balancing innovation and safety in financial instruments requires providing scope for progress while limiting the capacity of any new instrument to weaken the system as a whole. Balance can be achieved by requiring some form of product registration that limits investor access to instruments according to their degree of safety. In a scheme analogous to the hierarchy controlling the availability of pharmaceuticals, the safest securities would, like non-prescription medicines, be available for purchase by everyone; next would be financial instruments available only to those with an authorisation, like prescription drugs; another level down would be securities available in only limited amounts to pre-screened individuals and institutions, like drugs in experimental trials; and, finally, at the lowest level would be securities that are deemed illegal. A new instrument would be rated or an existing one moved to a higher category of safety only after successful tests – the analogue of clinical trials. These would combine issuance in limited quantities in the real world with simulations of how the instrument would behave under severe stress.
Such a registration and certification system creates transparency and enhances safety. But, as in the case of pharmaceutical manufacturers, there must be a mechanism for holding securities issuers accountable for the quality of what they sell. This will mean that issuers bear increased responsibility for the risk assessment of their products.

In other words, if I want to sell you a product with a complex pay-out and you want to buy it … too bad; we’ll both go to jail on charges of not being smart enough. Similarly, if I sell you an investment product and you lose money, you can get your money back from me because it is quite obvious that I sold you something you’re not smart enough to buy.

I wonder what that little change will make to the deemed capitalization of securities firms!

Update, 2009-7-2: Regulation of product types endorsed by Willem Buiter:

What I have in mind is an FDA for new financial instruments and institutions. Like new medical treatments, drugs and pharmacological concoctions, new financial instruments, products and institutions are potentially socially useful. They can also be toxic and health-threatening.

OSFI Seeks Comments on P&C Capitalization!

Monday, June 29th, 2009

The Office of the Superintendent of Financial Institutions has announced:

The Office of the Superintendent of Financial Institutions and the Canadian P&C insurance industry are working together through the Minimum Capital Test (MCT) Advisory Committee to develop more advanced risk measurement techniques (internal models) for incorporation into the MCT / Branch Adequacy of Assets Test. These techniques will include the development of risk management and disclosure criteria for risk-sensitive methodologies for use by companies that have the commitment and resources to implement them.

The MCT Advisory Committee has developed and proposed a set of high level key principles to guide the development of a new capital framework. Please provide your comments by August 31, 2009.

This is significant. In the past I have harshly criticized OSFI’s lack of consultation. There’s no way of telling at this point whether this is genuine consultation or merely window-dressing, but it is undeniably a step forward.

The Key Principles are, unfortunately, so generic as to be useless. Like, f’rinstance:

Capital requirements should be risk-based.

It’s pretty hard to argue about that!

The section that might prove contentious is:

To allow market discipline, the meaning and methodology for, and the factual disclosure related to, regulatory capital and capital requirements should be transparent.

Assiduous Readers will know of my long-standing complaint about the lack of disclosure of the double-leverage inherent in the holdco/sub structure. The accompanying letter provides information regarding submission of comments:

For comments or questions, please contact Bernard Dupont at (613)990-7797 or bernard.dupont@osfi-bsif.gc.ca or Judith Roberge at (613) 990-4412 or judith.roberge@osfi-bsif.gc.ca.

I suggest that all those with an interest in the preferred shares issued by P&C holdcos (e.g., ELF.PR.F, ELF.PR.G) write in and suggest that ownership of a controlling interest in a P&C operating company be made conditional on the holdco publishing deconsolidated financial statements.

And, with respect to procedure, it will also be worthwhile to suggest that

  • All comments be made public
  • The response of the committee to the comments be published