Archive for October, 2010

HIMIPref™ Index Rebalancing: October 2010

Sunday, October 31st, 2010
HIMI Index Changes, October 29, 2010
Issue From To Because
IGM.PR.B PerpetualPremium PerpetualDiscount Price
PWF.PR.H PerpetualPremium PerpetualDiscount Price
FTS.PR.H Scraps FixedReset Credit
FTS.PR.G Scraps FixedReset Credit
FTS.PR.F Scraps PerpetualDiscount Credit
FTS.PR.E Scraps OpRet Credit
CM.PR.R Scraps OpRet Volume
TRI.PR.B Scraps Floater Volume
BAM.PR.G Scraps FixFloat Volume
TCA.PR.X PerpetualDiscount PerpetualPremium Price
TCA.PR.Y PerpetualDiscount PerpetualPremium Price
IAG.PR.F PerpetualDiscount PerpetualPremium Price
CM.PR.P PerpetualDiscount PerpetualPremium Price
CM.PR.E PerpetualDiscount PerpetualPremium Price
GWO.PR.M PerpetualDiscount PerpetualPremium Price
TD.PR.P PerpetualDiscount PerpetualPremium Price

It’s very nice to see that there is now an issue in the FixFloat index! It became empty as of the June, 2010, rebalancing.

There were the following intra-month changes:

HIMI Index Changes during October 2010
Issue Action Index Because
FFH.PR.I Add Scraps New Issue
BPO.PR.P Add Scraps New Issue
BAM.PR.T Add FixedReset New Issue

Best & Worst Performers: October 2010

Sunday, October 31st, 2010

These are total returns, with dividends presumed to have been reinvested at the bid price on the ex-date. The list has been restricted to issues in the HIMIPref™ indices.

October 2010
Issue Index DBRS Rating Monthly Performance Notes (“Now” means “October 29”)
BAM.PR.O OpRet Pfd-2(low) -1.59% Now with a pre-tax bid-YTW of 3.60% based on a bid of 26.00 and optionCertainty 2013-6-30 at 25.00.
PWF.PR.A Floater Pfd-1(low) -1.13%  
BAM.PR.R FixedReset Pfd-2(low) -0.84% Now with a pre-tax bid-YTW of 4.35% based on a bid of 26.00 and a limitMaturity.
CU.PR.B Perpetual-Premium Pfd-2(high) -0.54% Now with a pre-tax bid-YTW of 4.35% based on a bid o 25.76 and a call 2011-7-1 at 25.25.
SLF.PR.G FixedReset Pfd-1(low) -0.51% Now with a pre-tax bid-YTW of 3.45% based on a bid of 25.28 and a limitMaturity.
BNS.PR.L Perpetual-Discount Pfd-1(low) +4.32% Now with a pre-tax bid-YTW of 5.03% based on a bid of 22.46 and a limitMaturity.
BNS.PR.M Perpetual-Discount Pfd-1(low) +4.55% Now with a pre-tax bid-YTW of 5.02% based on a bid of 22.50 and a limitMaturity.
GWO.PR.I Perpetual-Discount Pfd-1(low) +4.78% Now with a pre-tax bid-YTW of 5.41% based on a bid of 21.03 and a limitMaturity.
BNS.PR.K Perpetual-Discount Pfd-1(low) +5.17% Now with a pre-tax bid-YTW of 5.07% based on a bid of 23.75 and a limitMaturity.
BMO.PR.J Perpetual-Discount Pfd-1(high) +6.49% Now with a pre-tax bid-YTW of 4.91% based on a bid of 22.89 and a limitMaturity.

BAM.PR.T Debuts Soft on Subdued Volume

Sunday, October 31st, 2010

Brookfield Asset Management has announced:

the completion of its previously announced Preferred Shares, Series 26 issue in the amount of CDN$250-million. The offering was underwritten by a syndicate of underwriters led by CIBC, RBC Capital Markets, Scotia Capital Inc. and TD Securities Inc.

Brookfield Asset Management issued 10,000,000 Preferred Shares, Series 26 at a price of $25.00 per share, for aggregate gross proceeds of CDN$250,000,000. Holders of the Preferred Shares, Series 26 will be entitled to receive a cumulative quarterly fixed dividend yielding 4.50% annually for the initial period ending March 31, 2017. Thereafter, the dividend rate will be reset every five years at a rate equal to the 5-year Government of Canada bond yield plus 2.31%. The Preferred Shares, Series 26 will commence trading on the Toronto Stock Exchange on October 29, 2010 under the ticker symbol BAM.PR.T.

The net proceeds of the issue will be added to the general funds of Brookfield Asset Management and be used for general corporate purposes.

BAM.PR.T is a FixedReset, 4.50%+231, announced October 21. The issue traded 229,985 shares in a range of 24.60-90 before closing at 24.83-86, 300×200.

Vital statistics are:

BAM.PR.T FixedReset YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-10-29
Maturity Price : 23.03
Evaluated at bid price : 24.83
Bid-YTW : 4.16 %

Inflation Risk Premia

Saturday, October 30th, 2010

Joseph G. Haubrich, Peter H. Ritchken, George Pennacchi wrote a paper released in March 2009 titled Estimating Real and Nominal Term Structures Using Treasury Yields, Inflation, Inflation Forecasts, and Inflation Swap Rates:

This paper develops and estimates an equilibrium model of the term structures of nominal and real interest rates. The term structures are driven by state variables that include the short term real interest rate, expected inflation, a factor that models the changing level to which inflation is expected to revert, as well as four volatility factors that follow GARCH processes. We derive analytical solutions for the prices of nominal bonds, inflation-indexed bonds that have an indexation lag, the term structure of expected inflation, and inflation swap rates. The model parameters are estimated using data on nominal Treasury yields, survey forecasts of inflation, and inflation swap rates. We find that allowing for GARCH effects is particularly important for real interest rate and expected inflation processes, but that long-horizon real and inflation risk premia are relatively stable. Comparing our model prices of inflation-indexed bonds to those of Treasury Inflation Protected Securities (TIPS) suggests that TIPS were underpriced prior to 2004 but subsequently were valued fairly. We find that unexpected increases in both short run and longer run inflation implied by our model have a negative impact on stock market returns.

Of most interest to me is the conclusion on the inflation risk premium:

We can also examine how these risk premia varied over time during our sample period. Figure 8 plots expected inflation, the real risk premium, and the inflation risk premium for a 10-year maturity during the 1982 to 2008 period. Interestingly, while inflation expected over 10 years varied substantially, the levels of the real and inflation risk premia did not. The real risk premium for a 10-year maturity bond varied from 150 to 170 basis points, averaging 157 basis points. This real risk premium is consistent with the substantial slope of the real yield curve discussed earlier. The inflation risk premium for a 10-year maturity bond varied from 38 to 60 basis points and averaged 51 basis points. These estimates of the 10-year inflation risk premium fall within the range of those estimated by other studies.[Footnote]

Footnote: For example, a 10-year inflation risk premium averaging 70 basis points and ranging from 20 to 140 basis points is found by Buraschi and Jiltsov (2005). Using data on TIPS, Adrian and Wu (2008) find a smaller 10-year inflation risk premium varying between -20 and 20 basis points.

and

For example, D’Amico et al. (2008) find a large “liquidity premium” during the early years of TIPS’s existence, especially before 2004. They conclude that until more recently, TIPS yields were difficult to account for within a rational pricing framework. Shen (2006) also finds evidence of a drop in the liquidity premium on TIPS around 2004. He notes that this may have been due to the U.S. Treasury’s greater ssuance of TIPS around this time, as well as the beginning of exchange traded funds that purchased TIPS. Another contemporaneous development that may have led to more fairly priced TIPS was the establishment of the U.S. inflation swap market beginning around 2003. Investors may have arbitraged the underpriced TIPS by purchasing them while simultaneously selling inflation payments via inflation swap contracts.

and additionally:

Our estimated model also suggests that shocks to both short run and longer run inflation coincide with negative stock returns. An implication is that stocks are, at best, an imperfect hedge against inflation. This underscores the importance of inflation-linked securities as a means for safeguarding the real value of investments.

Joseph G. Haubrich of the Cleveland Fed provides a primer on the topic at A New Approach to Gauging Inflation Expectations, together with some charts:

The first chart is the model’s 1-month real interest rate

Click for big

 
Click for big

The methodology is used in the Cleveland Fed Estimates of Inflation Expectations:

The Federal Reserve Bank of Cleveland reports that its latest estimate of 10-year expected inflation is 1.53 percent. In other words, the public currently expects the inflation rate to be less than 2 percent on average over the next decade.

The Cleveland Fed’s estimate of inflation expectations is based on a model that combines information from a number of sources to address the shortcomings of other, commonly used measures, such as the “break-even” rate derived from Treasury inflation protected securities (TIPS) or survey-based estimates. The Cleveland Fed model can produce estimates for many time horizons, and it isolates not only inflation expectations, but several other interesting variables, such as the real interest rate and the inflation risk premium. For more detail, see the links in the See Also box at right.

On October 15, ten-year nominal treasuries yielded 2.50%, while 10-Year TIPS yielded 0.46%, so the Cleveland Fed has decomposed the Break-Even Inflation Rate of 204bp into 1.53% expected inflation and 0.51% Inflation Risk Premium.

I find myself in the uncomfortable position of being deeply suspicious of this decomposition without being able to articulate specific objections to the theory. The paper’s authors claim:

Comparing our model’s implied yields for inflation-indexed bonds to those of TIPS suggests that TIPS were underpriced prior to 2004 but more recently are fairly priced. Hence, the ‘liquidity premium’ in TIPS yields appears to have dissipated. The recent introduction of inflation derivatives, such as zero coupon inflation swaps, may have eliminated this mispricing by creating a more complete market for inflation-linked securities.

but I have great difficulty with the concept that there is no significant liquidity premium in TIPS. The estimation of the 1-month real rate looks way, way too volatile to me. I suspect that the answer to my problems is buried in the estimation methods between the market price of inflation swaps and the forecasts of estimated inflation, but I cannot find it … at least, not yet!

Flash Crash: Order Toxicity?

Saturday, October 30th, 2010

As reported by Bloomberg, David Easley, Marcos Mailoc Lopez de Prado and Maureen O’Hara have published a paper titled The Microstructure of the ‘Flash Crash’: Flow Toxicity, Liquidity Crashes and the Probability of Informed Trading:

The ‘flash crash’ of May 6th 2010 was the second largest point swing (1,010.14 points) and the biggest one-day point decline (998.5 points) in the history of the Dow Jones Industrial Average. For a few minutes, $1 trillion in market value vanished. In this paper, we argue that the ‘flash crash’ is the result of the new dynamics at play in the current market structure, not conjunctural factors, and therefore similar episodes are likely to occur again. We highlight the role played by order toxicity in affecting liquidity provision, and we provide compelling evidence that the collapse could have been anticipated with some degree of confidence given the increasing toxicity of the order flow in the hours and days prior to collapse. We also show that a measure of this toxicity, the Volume-Synchronized Probability of Informed Trading (the VPIN* informed trading metric), Granger-causes volatility, while the reciprocal is less likely, and that it takes on average 1/10 of a session’s volume for volatility to adjust to changes in the VPIN metric. We attribute this cause-effect relationship to the impact that flow toxicity has on market makers’ willingness to provide liquidity. Since the ‘flash crash’ might have been avoided had liquidity providers remained in the marketplace, a solution is proposed in the form of a ‘VPIN contract’, which would allow them to dynamically monitor and manage their risks.

They make the point:

Providing liquidity in a high frequency environment introduces new risks for market makers. When order flows are essentially balanced, high frequency market makers have the potential to earn razor thin margins on massive numbers of trades. When order flows become unbalanced, however, market makers face the prospect of losses due to adverse selection. The market makers’ estimate of the toxicity (the expected loss from trading with position takers) of the flow directed to them by position takers now becomes a crucial factor in determining their participation. If they believe that this toxicity is too high, they will liquidate their positions and leave the market.

In summary, we see three forces at play in the recent market structure:

  • Concentration of liquidity provision into a small number of highly specialized firms.
  • Reduced participation of retail investors resulting in increased toxicity of the flow received by market makers.
  • High sensitivity of liquidity providers to intraday losses, as a result of the liquidity providers low capitalization, high turnover, increased competition and small profit target.

Quick! Sign up the big banks to provide liquidity through proprietary trading! Oh … wait ….

Further, they make the point about market-making:

To understand why toxicity of order flow can induce such behavior from market makers, let us return to the role that information plays in affecting liquidity in the market. Easley and O’Hara (1992) sets out the mechanism by which informed traders extract wealth from liquidity providers. For example, if a liquidity provider trades against a buy order he loses the difference between the ask price and the expected value of the contract if the buy is from an informed trader. On the other hand, he gains the difference between the ask price and the expected value of the contract if the buy is from an uninformed trader. This loss and gain, weighted by the probabilities of the trade arising from an informed trader or an uninformed trader just balance due to the intense competition between liquidity providers.

[Formula]

If flow toxicity unexpectedly rises (a greater than expected fraction of trades arises from informed traders), market makers face losses. Their inventory may grow beyond their risk limits, in which case they are forced to withdraw from the side of the market that is being adversely selected. Their withdrawal generates further weakness on that side of the market and their inventories keep accumulating additional losses. At some point they capitulate, dumping their inventory and taking the loss. In other words, extreme toxicity has the ability of transforming liquidity providers into liquidity consumers.

The earlier paper by these authors, detailing the calculation of VPIN, was titled Measuring Flow Toxicity in a High Frequency World:

Order flow is regarded as toxic when it adversely selects market makers, who are unaware that they are providing liquidity at their own loss. Flow toxicity can be expressed in terms of Probability of Informed Trading (PIN). We present a new procedure to estimate the Probability of Informed Trading based on volume imbalance (the VPIN* informed trading metric). An important advantage of the VPIN metric over previous estimation procedures comes from being a direct analytic procedure which does not require the intermediate estimation of non-observable parameters describing the order flow or the application of numerical methods. It also renders intraday updates mutually comparable in a frequency that matches the speed of information arrival (stochastic time clock). Monte Carlo experiments show this estimate to be accurate for all theoretically possible combinations of parameters, even for statistics computed on small samples. Finally, the VPIN metric is computed on a wide range of products to show that this measure anticipated the ‘flash crash’ several hours before the markets collapsed

Although the calibration is interesting and perhaps valuable, the underlying theory is pretty simple:

classify each transaction as buy or sell initiated:[Footnote]
a. A transaction i is a buy if either:
i. [Price increases], or
ii. [Price unchanged] and the [previous transaction] was also a buy.
b. Otherwise, the transaction is a sell.

Footnote: According to Lee and Ready (1991), 92.1% of all buys at the ask and 90.0% of all sells at the bid are correctly classified by this simple procedure. See Lee, C.M.C. and M.J. Ready (1991): “Inferring trade direction from intraday data”, The Journal of Finance, 46, 733-746. Alternative trade classification algorithms could be used.

and VPIN is simply the absolute value of the difference between buy-volume and sell-volume, expressed as a fraction of total volume. Yawn.

The VPIN indicator is very similar to Joe Granville’s Technical Analysis indicator On-Balance Volume. While Easley, Lopez de Prado and O’Hara have dressed it up with a little math and illustrated it in the glorious TA tradition of anecdotal cherry picking, they have neither provided anything particularly new nor proved their case.

October 29, 2010

Saturday, October 30th, 2010

The EU is now openly discussing mechanisms for sovereign default:

European Union leaders endorsed German calls for a rewrite of EU treaties to create a permanent debt-crisis mechanism, while sparring over whether to force bondholders to help pay the bill for rescuing financially distressed states.

As the biggest contributor to this year’s hastily arranged 860 billion euros ($1.2 trillion) in loans and pledges to stem the debt crisis, Germany won backing to set up a permanent system by 2013. Deficit-strapped Spain warned that provisions to reschedule or cancel some debts would expose its markets to renewed selling pressure.

“We won’t allow only the taxpayers to bear all the costs of a future crisis,” German Chancellor Angela Merkel told a press conference in Brussels today after a summit of EU leaders. There is “a justified desire to see that it’s not just taxpayers who are on the hook, but also private investors.”

Germany rules out extending this year’s emergency taxpayer- funded financial assistance mechanisms when they expire in 2013. Merkel’s follow-up system would extend debt maturities, suspend interest payments and waive creditor claims, Handelsblatt newspaper reported yesterday, citing an unidentified government official.

Assiduous Readers will remember that on July 23 I reported:

But the best line in the farce comes from a central banker:

ECB Vice President Vitor Constancio called the tests “severe” and explained they didn’t include a scenario of a national default because “we don’t believe there will be a default.”

That’s just great, Vitor! Maybe you’ll be put in charge of the government run credit rating agency the Europeans are thinking about, you know, the ones that will be much nicer to sovereigns than those mean old-style CRAs!

There is no word yet regarding whether Vitor Constancio has resigned.

The Bank of Canada has released a working paper by Ali Dib titled Capital Requirement and Financial Frictions in Banking: Macroeconomic Implications:

The author develops a dynamic stochastic general-equilibrium model with an active banking sector, a financial accelerator, and financial frictions in the interbank and bank capital markets. He investigates the importance of banking sector frictions on business cycle fluctuations and assesses the role of a regulatory capital requirement in propagating the effects of shocks in the real economy. Bank capital is introduced to satisfy the regulatory capital requirement, and serves as collateral for borrowing in the interbank market. Financial frictions are introduced by assuming asymmetric information between lenders and borrowers that creates moral hazard and adverse selection problems in the interbank and bank capital markets, respectively. Highly leveraged banks are vulnerable and therefore pay higher costs when raising funds. The author finds that financial frictions in the interbank and bank capital markets amplify and propagate the effects of shocks; however, the capital requirement attenuates the real impacts of aggregate shocks (including financial shocks), reduces macroeconomic volatilities, and stabilizes the economy.

Commissioner Elisse B. Walter of the SEC delivered an interesting speech regarding the SEC review of the US Municipal market. A lot of familiar cross currents – exchanges for bonds! the Credit Rating Agencies are no good! brokers should tell us what to buy! – and discussion of the move from the Municipal rating scale to the global scale:

Three participants endorsed the principle of a global rating scale. However, one pointed out that during this time — where some rating agencies are moving to a global scale — investors may find it increasingly difficult to compare municipal credits against each other. Further, he thinks that despite recalibration, investors will continue to have a hard time comparing munis to corporates because municipal risk remains overstated relative to corporate risk.

Several others were critical of the notion of a global rating scale, arguing that municipal bonds and corporate securities are just not comparable. One panelist stated that munis should not be rated on a scale that focuses on default risk and recovery, since governments rarely default. Some of the participants would prefer a new rating scale for governments that could be tailored to the unique characteristics of governmental entities. We heard suggestions for a simple pass/fail scale, a three-part scale or a scale of 1-100.

Another area of concern was the impact of ratings on the cost of issuance. One panelist pointed out that higher ratings lead to lower borrowing costs and lower ratings lead to higher borrowing costs. He and a co-panelist highlighted the consequence of lower ratings: increased costs to taxpayers for financing critical infrastructure projects.

That last panelist should take a tip from the Europeans: set up a new rating agency with a mandate to be chipper and upbeat at all times.

Themis Trading points out signs of a high-level regulatory battle, with the NYSE opining:

NYSE Euronext Chief Executive Officer Duncan Niederauer said regulators will probably respond to the May 6 stock-market crash by extending obligations to buy and sell shares to more traders.

Niederauer, speaking in Washington today, said too many traders reap the benefits of making markets without responsibilities to keep providing liquidity when stocks are plunging. New rules may be in place as soon as January, he said.

Securities and Exchange Commission Chairman Mary Schapiro called on the agency in September to examine whether the loss of “old specialist obligations” has hurt investors after measures such as trading stocks in penny increments cut the number of market makers. With the facilitation of trading now dominated by hundreds of automated firms with few rules for when they must buy and sell, the SEC is considering ways to keep the biggest from abandoning the market at the first sign of trouble.

The astonishing part is in the third paragraph. Imagine! The regulators made it less profitable to be a specialist … and fewer firms wanted to be specialists. Well, who woulda thunk it?

NASDAQ takes the other view:

The head of Nasdaq OMX Group Inc (NasdaqGS:NDAQ – News) said on Friday he does not expect any new obligations or privileges for U.S. “market-makers” until 2012 at the earliest, calling any regulatory change “a slippery slope.”

“I don’t think something will happen in 2011,” Nasdaq OMX Chief Executive Officer Robert Greifeld said on a conference call, adding it would be “a difficult road to try to properly define what responsibility and privileges to give participants.”

Mervyn King made an excellent point in a speech at the Second Bagehot Lecture:

Second, the Basel approach calculates the amount of capital required by using a measure of “risk-weighted” assets. Those risk weights are computed from past experience. Yet the circumstances in which capital needs to be available to absorb potential losses are precisely those when earlier judgements about the risk of different assets and their correlation are shown to be wrong. One might well say that a financial crisis occurs when the Basel risk weights turn out to be poor estimates of underlying risk. And that is not because investors, banks or regulators are incompetent. It is because the relevant risks are often impossible to assess in terms of fixed probabilities. Events can take place that we could not have envisaged, let alone to which we could attach probabilities. If only banks were playing in a casino then we probably could calculate appropriate risk weights. Unfortunately, the world is more complicated. So the regulatory framework needs to contain elements that are robust with respect to changes in the appropriate risk weights, and that is why the Bank of England advocated a simple leverage ratio as a key backstop to capital requirements.

He also mentioned the Too Big To Fail problem:

But in most other countries, identifying in advance a group of financial institutions whose failure would be intolerable, and so are “too important to fail”, is a hazardous undertaking. In itself it would simply increase the subsidy by making it explicit. And it is hard to see why institutions whose failure cannot be contemplated should be in the private sector in the first place. But if international regulators failed to agree on higher capital requirements in general, adding to the loss-absorbing capacity of large institutions could be a second-best outcome.

… which has been a hot issue lately:

“Are we a systemically important bank in the world? I think (we’re) not. Nothing in my strategy is trying to make us that,” Toronto-Dominion Bank CEO Ed Clark said last week, although he also acknowledged that regulators may not agree with him.

“It’s not obvious that there will be no impact on us, and I don’t know that and I can’t get any assurance on that,” he said at a presentation in Toronto. TD is Canada’s No. 2 bank.

Rick Waugh, CEO of third-ranked Bank of Nova Scotia , has also said his bank is not systemically important.

Gord Nixon, head of Royal Bank of Canada , which is considered the Canadian bank most likely to be deemed “too big to fail,” said at a presentation Wednesday that the whole debate was “ridiculous” and suggested labeling a bank “too big” might compel it to shed assets to shrink.

It’s so far unclear how many banks will fit the bill, with some speculating regulators could name 30 or more lenders.

Canada’s bank regulator, which has objected to the idea of singling out large banks, is also pushing the point that Canadian banks should be left off the list.

“I’d say that 80 per cent of global financial intermediation goes through 20 institutions … and no Canadian financial institutions fit that bill,” said Julie Dickson, Canada’s Superintendent of Financial Institutions.

It is precisely to avoid such irresolvable arguments that I propose that regulation eschew the TBTF label; what should happen is that there should be a progressive surcharge on Risk-Weighted-Assets, so that the first 100-billion is requires less capital than the next 100-billion and so on.

The SEC has $450-million available for paid informers! Denounce your neighbor today!

Alackaday! TMX DataLinx has advised:

The daily Toronto Stock Exchange and TSX Venture Exchange Trades & Quotes files for Friday October 29, 2010 will be delayed due to systems testing and are expected to be available by 5:00 AM, Sunday October 31, 2010. We regret any inconvenience this may cause.

They like to do this on PrefLetter weekends and monthends. So we’re all gonna hafta wait. I will update with the day’s action when I can.

Update, 2010-10-31: The Canadian preferred share market closed the month with a small gain, PerpetualDiscounts up 3bp and FixedResets winning 2bp. Volume continued at elevated levels.

PerpetualDiscounts now yield 5.41%, equivalent to 7.57% at the standard equivalency factor of 1.4x. Long Corporates now yield about … oh, call it a hair over 5.2%, so the pre-tax interest-equivalent spread is now about 235bp, a slight (and perhaps meaningless) increase from the 230bp reported on October 27, but a sharp decline from the 260bp reported on September 30. The tightening was driven on both sides, as PerpetualDiscount yields fell while long corporate yields rose modestly; the performance of the BMO Long Corporate ETF shows how returns on the asset class plateaued in October.


Click for Big
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 0.0911 % 2,184.3
FixedFloater 0.00 % 0.00 % 0 0.00 0 0.0911 % 3,308.9
Floater 2.87 % 3.17 % 88,576 19.29 3 0.0911 % 2,358.4
OpRet 4.90 % 3.60 % 94,867 0.73 9 -0.0086 % 2,374.7
SplitShare 5.88 % -17.20 % 67,984 0.09 2 -0.3030 % 2,396.2
Interest-Bearing 0.00 % 0.00 % 0 0.00 0 -0.0086 % 2,171.5
Perpetual-Premium 5.70 % 5.05 % 152,219 5.33 19 0.0639 % 2,015.8
Perpetual-Discount 5.40 % 5.41 % 246,879 14.71 58 0.0324 % 2,024.4
FixedReset 5.26 % 3.00 % 379,806 3.24 48 0.0227 % 2,276.5
Performance Highlights
Issue Index Change Notes
IAG.PR.C FixedReset -1.49 % YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-01-30
Maturity Price : 25.00
Evaluated at bid price : 27.10
Bid-YTW : 3.63 %
CM.PR.G Perpetual-Discount -1.12 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-10-29
Maturity Price : 24.49
Evaluated at bid price : 24.77
Bid-YTW : 5.47 %
Volume Highlights
Issue Index Shares
Traded
Notes
BAM.PR.T FixedReset 229,985 New issue settled today.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-10-29
Maturity Price : 23.03
Evaluated at bid price : 24.83
Bid-YTW : 4.16 %
TRP.PR.C FixedReset 108,075 RBC crossed 100,000 at 25.53.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-10-29
Maturity Price : 25.46
Evaluated at bid price : 25.51
Bid-YTW : 3.55 %
BNS.PR.P FixedReset 104,900 RBC crossed 100,000 at 26.53.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2013-05-25
Maturity Price : 25.00
Evaluated at bid price : 26.54
Bid-YTW : 2.43 %
TD.PR.O Perpetual-Discount 62,665 YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-10-29
Maturity Price : 23.55
Evaluated at bid price : 23.80
Bid-YTW : 5.11 %
BAM.PR.B Floater 48,161 Nesbitt crossed two blocks of 20,000 each, both at 16.65.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-10-29
Maturity Price : 16.61
Evaluated at bid price : 16.61
Bid-YTW : 3.18 %
RY.PR.L FixedReset 45,660 RBC sold 11,200 to Nesbitt at 26.89 and 11,000 to TD at the same price.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-03-26
Maturity Price : 25.00
Evaluated at bid price : 26.93
Bid-YTW : 3.01 %
There were 37 other index-included issues trading in excess of 10,000 shares.

October 28, 2010

Thursday, October 28th, 2010

Econbrowser‘s James Hamilton discusses Negative real interest rates:

In terms of the Fed’s policy objectives at the moment, one of the problems with deflation is that it guarantees a positive real return just from stuffing cash under your mattress. A primary purpose of the Fed’s contemplated QE2 is to prevent this and spur consumers and firms to invest funds productively rather than hoard cash. Insofar as the recent moves in TIPS and other yields represent the market already pricing in the Fed’s next steps, one might conclude from the latest TIPS readings that this aspect of the Fed’s strategy is already working.

He attaches a good graph:


Click for Big

Although this appears to be the first time that newly issued TIPS have locked in a negative real return, that’s because TIPS have only been offered to U.S. investors since 1997. You can get a longer time series by comparing the yield on a 6-month T-bill at any date with what the CPI inflation rate actually turned out to be over the subsequent 6 months for which investors held that bill, a magnitude sometimes described as the “ex-post real interest rate.” That series is plotted below. We’ve actually been in a period for several years in which short-term loans to the government were a losing proposition in real terms, and the longer-term real yields such as the 5-year TIPS are only now coming down to join them. The recent era of negative real yields was briefly (if spectacularly) interrupted in the fall of 2008, when a sharp deflation in the CPI made short-term loans to the government an excellent deal for the lender in ex-post real terms.

The Canadian preferred share market continued its recent (boring) pattern with a good day on elevated, if somewhat lower than recent norms, volume. PerpetualDiscounts gained 10bp and FixedResets squeaked out a win of 2bp. It should be noted that, given about 250 trading days in a year, a daily win of just over 1bp is expected.

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 0.1643 % 2,182.3
FixedFloater 0.00 % 0.00 % 0 0.00 0 0.1643 % 3,305.9
Floater 2.87 % 3.18 % 89,685 19.27 3 0.1643 % 2,356.3
OpRet 4.90 % 3.36 % 95,667 0.58 9 0.2634 % 2,374.9
SplitShare 5.86 % -21.51 % 67,593 0.09 2 -0.0404 % 2,403.5
Interest-Bearing 0.00 % 0.00 % 0 0.00 0 0.2634 % 2,171.7
Perpetual-Premium 5.70 % 5.07 % 153,856 5.33 19 -0.0901 % 2,014.5
Perpetual-Discount 5.40 % 5.41 % 248,215 14.69 58 0.1040 % 2,023.8
FixedReset 5.28 % 3.01 % 371,237 3.24 47 0.0178 % 2,276.0
Performance Highlights
Issue Index Change Notes
BMO.PR.P FixedReset -1.48 % YTW SCENARIO
Maturity Type : Call
Maturity Date : 2015-03-27
Maturity Price : 25.00
Evaluated at bid price : 27.22
Bid-YTW : 3.09 %
RY.PR.H Perpetual-Premium -1.04 % YTW SCENARIO
Maturity Type : Call
Maturity Date : 2017-06-23
Maturity Price : 25.00
Evaluated at bid price : 25.78
Bid-YTW : 5.06 %
BAM.PR.I OpRet 1.04 % YTW SCENARIO
Maturity Type : Call
Maturity Date : 2010-11-27
Maturity Price : 25.50
Evaluated at bid price : 26.28
Bid-YTW : -24.65 %
GWO.PR.I Perpetual-Discount 1.16 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-10-28
Maturity Price : 21.01
Evaluated at bid price : 21.01
Bid-YTW : 5.42 %
MFC.PR.C Perpetual-Discount 1.21 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-10-28
Maturity Price : 20.00
Evaluated at bid price : 20.00
Bid-YTW : 5.71 %
BAM.PR.O OpRet 1.36 % YTW SCENARIO
Maturity Type : Option Certainty
Maturity Date : 2013-06-30
Maturity Price : 25.00
Evaluated at bid price : 26.15
Bid-YTW : 3.36 %
Volume Highlights
Issue Index Shares
Traded
Notes
BNS.PR.P FixedReset 110,058 RBC crossed 99,000 at 26.55.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2013-05-25
Maturity Price : 25.00
Evaluated at bid price : 26.53
Bid-YTW : 2.44 %
RY.PR.B Perpetual-Discount 109,193 RBC crossed blocks of 67,200 and 31,600, both at 23.00.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-10-28
Maturity Price : 22.81
Evaluated at bid price : 23.00
Bid-YTW : 5.10 %
TRP.PR.B FixedReset 86,368 RBC bought 34,300 from anonymous at 25.00.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-10-28
Maturity Price : 24.87
Evaluated at bid price : 24.92
Bid-YTW : 3.32 %
BNS.PR.M Perpetual-Discount 62,088 Desjardins crossed 20,000 at 22.50; RBC crossed 19,100 at the same price.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-10-28
Maturity Price : 22.33
Evaluated at bid price : 22.47
Bid-YTW : 5.03 %
CM.PR.I Perpetual-Discount 61,317 TD crossed two blocks of 15,000 each and one of 10,000, all at 22.50.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-10-28
Maturity Price : 22.37
Evaluated at bid price : 22.52
Bid-YTW : 5.24 %
CM.PR.G Perpetual-Discount 59,816 Scotia crossed 19,400 at 25.05 and 33,200 at 25.07.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-05-31
Maturity Price : 25.00
Evaluated at bid price : 25.05
Bid-YTW : 5.36 %
There were 38 other index-included issues trading in excess of 10,000 shares.

PIC.PR.A: Capital Units to be Consolidated

Thursday, October 28th, 2010

Premium Income Corporation has announced:

a consolidation of the Class A shares effective the opening of trading on November 1, 2010. The consolidation will ensure that an equal number of Class A shares and Preferred shares are outstanding subsequent to the special retraction. Each shareholder will receive 0.738208641 new Class A shares for each Class A share held. The total value of a shareholder’s investment will not change, however, the number of Class A shares reflected in the shareholder’s account will decline and the net asset value per share will increase proportionately. Investors are advised that the CUSIP number will change to 740910302. No fractional shares will be issued and shareholders are not required to take any action for the consolidation to be effective.

This is very significant news. The implication is that at least one-quarter of the outstanding PIC.PR.A were retracted – possibly more, depending on how many of the PIC.A capital units were also retracted.

The current Capital Unit NAV is $5.98 as of October 21, so after consolidation will become about $8, implying that Asset Coverage is now in excess of 1.5:1. Credit quality on the preferreds just got a whole lot better!

I confess to being surprised by the size of the retraction given that the month low for the preferreds was 14.90, just a dime under the retraction price. I would have thought more people would sell. One possible explanation is that a large portion of the retraction was by very large holders who were hesitant to unwind a large position in the market; another possibility is that holders with high transaction costs (e.g., clients of full service brokerages) took that into consideration.

PIC.PR.A was last mentioned on PrefBlog when it was downgraded to Pfd-5 last Friday; at that time, downside protection was about 27%. They might want to bump that up a notch now that the retraction implies (given a projected Capital Unit value of $8) downside protection of 35%!

PIC.PR.A is tracked by HIMIPref™, but is relegated to the Scraps index on credit concerns.

October 27, 2010

Wednesday, October 27th, 2010

Forbes has an unusual perspective on the flash-crash:

In a talk at Columbia University’s sociology department, renowned social scientist Donald MacKenzie gave some words of warning and advice about the financial markets. MacKenzie, a professor of science and technological studies at the University of Edinburgh, compared the flash crash with Black Monday crisis of October 19, 1987.

“Computer systems don’t have a sense of morality,” exclaims MacKenzie, noting the take-one-for-the-team role played by floor specialists in keeping an orderly market–a role that’s been marginalized with trading so widely dispersed. A specialist’s duty was to keep price continuity and to intervene when they found imbalances, “and they did so at a certain risk to themselves,” remembered MacKenzie, “In ’87, on aggregate these specialists lost about two-thirds of their capital” to save the markets, he says. The intervention of specialists becomes harder today because high-frequency trading algorithms are extremely explicit and are largely devoid of such considerations of civic duty.

I haven’t met a trader yet with a sense of civic duty, quite frankly, but what I found most interesting was the claim that specialists took large losses in the Crash of ’87. I don’t have any such recollection, and I would very much like to see MacKenzie’s source for this statement.

There is this, from the Brady Report:

According to a rough survey conducted by the NYSE, specialists’ buying power fell by more than 60 percent from $2,308 million at the close of business on October 16 to $852 million at the close of business on October 19. Whatever the cause for the reduced extent of specialist intervention later on October 19, the road picture that emerges from the analysis of half hourly activity is one of significant intervention to support the market early in the day, net sales during the midday decline and much less extensive (and less effective) support of the market in the sharp decline in the last hour of trading.

However, loss of buying power is not equivalent to loss of capital – it simply means that a good chunk of their capital was committed. However, one point in favour of the specialist system is that the figures mean they were willing to hold their position overnight (although, as the report shows, they squared their books the next day).

So here’s yet another idea for a MBA thesis, assuming those guys have theses: is there any way of telling how much hot money is out there? I mean, really really hot money, for which “overnight” is a lengthy hold. Has this amount increased or decreased (relative to market value, or even relative to market fluctuations) since the Crash of ’87. We can be sure that the amount of formal market-maker capital has decreased, but how about hedge funds and HFT?

My guess is that the total capital has increased, but the amount of capital prepared to hold a position overnight has decreased. Prove me wrong!

Meanwhile, emerging markets are choosing survival over altruism:

Finance chiefs from South Korea to South Africa signaled they may act to slow gains in their currencies, just four days after the Group of 20 vowed to soothe trade tensions in the $4 trillion-a-day foreign-exchange market.

Asian currencies fell to a one-week low after Bank of Korea Governor Kim Choong Soo said today that measures to mitigate capital flows could be “useful.” Hours later, the rand dropped as South African Finance Minister Pravin Gordhan said his government will use part of higher-than-expected tax revenue to build foreign reserves as it attempts to weaken the currency.

The shifts suggest G-20 members will keep trying to defend their economies from the slide of the dollar and capital inflows even after the group promised Oct. 23 to refrain from “competitive devaluation” and to increasingly embrace market- determined currencies.

Gee … I suppose those guys take their responsibilities to their own citizens more seriously than their responsibilities to me! How odd! How thoroughly unmutual!

BIS has released a paper titled Calibrating regulatory minimum capital requirements and capital buffers: a topdown approach.

BIS has also released a working paper by Stefan Avdjiev and Nathan S Balke titled Stochastic Volatility, Long Run Risks, and Aggregate Stock Market Fluctuations:

What are the main drivers of ‡uctuations in the aggregate US stock market? In this paper, we attempt to resolve the long-lasting debate surrounding this question by designing and solving a consumption-based asset pricing model which incorporates stochastic volatility, long-run risks in consumption and dividends, and Epstein-Zin preferences. Utilizing Bayesian MCMC techniques, we estimate the model by …tting it to US data on the level of the aggregate US stock market, the short-term real risk-free interest rate, real consumption growth, and real dividend growth. Our results indicate that, over short and medium horizons, ‡uctuations in the level of the aggregate US stock market are mainly driven by changes in expected excess returns. Conversely, low frequency movements in the aggregate stock market are primarily driven by changes in the expected long-run growth rate of real dividends.

The SEC is planning to ban one-third of the market and encourage paid informers:

SEC commissioners will vote Nov. 3 on a rule that would require brokerages to implement risk controls to monitor client trades, the agency said today in a statement on its website. SEC officials first proposed the regulation in January, saying they were concerned that a computer malfunction or human error might trigger an order that could erode a firm’s capital.

The proposed rule would “effectively prohibit broker dealers from providing” so-called naked-sponsored access, in which a customer bypasses pre-trade risk controls, according to the agency’s statement. Naked access accounts for about 38 percent of U.S. equities trading, according to a December study by Aite Group LLC.

Commissioners will also vote next week on a proposal to expand the SEC’s ability to reward whistleblowers who provide tips on fraud.

Ah, the good old paid informers! They made the Roman Empire, the Soviet Union and East Germany what they are today!

Julie Dickson gave a remarkably unimportant speech today, titled Changing Times: The Regulatory Future and Canada’s Banking Sector:

In sum, there is no silver bullet to achieving a safe and sound financial sector. Rather, it is multi-dimensional – all parties that touch the sector have a role – bank management and boards, regulators and supervisors, governments, central banks, markets (investors, analyst and rating agencies), and auditors. Emphasis cannot be placed on one area to the exclusion of others.

Human nature trumps all of these. In an effort to save us all from ourselves, policies aimed at our own weaknesses and biases may be the most important of all.

The Toronto Star advises that the federal government writes Credit Default Swaps with no documentation at all:

The federal government does not know how often the loan program is a victim of fraud. About $1 billion a year is lent in small business loans. The number of defaulted loans is steadily increasing. Last year, $106 million of taxpayers money was paid back to banks for defaulted loans. That’s up from $75 million a year in defaulted loans three years before.

Under the Canada Small Business Financing Program, Industry Canada gives banks the job of approving applications

It only sees the paperwork if the loan goes into default.

One of the problems the Star uncovered is there is little incentive for the banks to conduct detailed background checks.

That’s because banks get a guarantee that the federal government will refund up to 85 per cent of the money to the banks if the loan goes into default. The banks typically also take a personal guarantee from the borrower for the remaining 15 per cent.

Just one of life’s little mysteries! I can’t cash a cheque for $1.98 without a rectal probe, but that does not apply to everyone!

Another day of good performance on the Canadian preferred share market today, on continued heavy volume. This is getting dull. PerpetualDiscounts gained 11bp while FixedResets eked out a 1bp win.

PerpetualDiscounts now yield 5.41%, equivalent to 7.57% interest at the standard 1.4x equivalency factor. Long Corporates jerked up to about 5.3% (maybe a little under) so the pre-tax interest-equivalent spread is now about 230bp, a significant decline from the 240bp reported on October 20.

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 0.1279 % 2,178.7
FixedFloater 0.00 % 0.00 % 0 0.00 0 0.1279 % 3,300.5
Floater 2.88 % 3.19 % 90,562 19.25 3 0.1279 % 2,352.4
OpRet 4.92 % 3.83 % 97,409 0.58 9 0.1903 % 2,368.7
SplitShare 5.86 % -20.50 % 66,607 0.09 2 -0.3821 % 2,404.4
Interest-Bearing 0.00 % 0.00 % 0 0.00 0 0.1903 % 2,166.0
Perpetual-Premium 5.69 % 5.09 % 153,918 5.33 19 -0.0720 % 2,016.4
Perpetual-Discount 5.40 % 5.41 % 246,300 14.69 58 0.1141 % 2,021.7
FixedReset 5.27 % 3.03 % 343,656 3.24 47 0.0116 % 2,275.6
Performance Highlights
Issue Index Change Notes
GWO.PR.I Perpetual-Discount -1.14 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-10-27
Maturity Price : 20.77
Evaluated at bid price : 20.77
Bid-YTW : 5.48 %
BMO.PR.P FixedReset 1.00 % YTW SCENARIO
Maturity Type : Call
Maturity Date : 2015-03-27
Maturity Price : 25.00
Evaluated at bid price : 27.63
Bid-YTW : 2.70 %
BAM.PR.I OpRet 1.01 % YTW SCENARIO
Maturity Type : Call
Maturity Date : 2010-11-26
Maturity Price : 25.50
Evaluated at bid price : 26.01
Bid-YTW : -13.44 %
POW.PR.D Perpetual-Discount 1.22 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-10-27
Maturity Price : 23.02
Evaluated at bid price : 23.24
Bid-YTW : 5.41 %
Volume Highlights
Issue Index Shares
Traded
Notes
BNS.PR.P FixedReset 159,100 RBC crossed 50,000 at 26.51; Nesbitt crossed 20,000 at the same price. National crossed 50,000 at 26.52.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2013-05-25
Maturity Price : 25.00
Evaluated at bid price : 26.51
Bid-YTW : 2.47 %
CM.PR.K FixedReset 132,400 RBC crossed blocks of 50,000 and 72,800, both at 27.21. There were five inputs and four cancellations of the latter cross!
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-08-30
Maturity Price : 25.00
Evaluated at bid price : 27.15
Bid-YTW : 2.89 %
BNS.PR.O Perpetual-Premium 103,712 Desjardins crossed 100,000 at 25.70.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2017-05-26
Maturity Price : 25.00
Evaluated at bid price : 25.70
Bid-YTW : 5.13 %
RY.PR.I FixedReset 72,950 RBC crossed 50,000 at 26.40.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-03-26
Maturity Price : 25.00
Evaluated at bid price : 26.36
Bid-YTW : 3.11 %
BNS.PR.L Perpetual-Discount 67,110 Desjardins crossed two blocks of 25,000 each, both at 22.50.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-10-27
Maturity Price : 22.27
Evaluated at bid price : 22.41
Bid-YTW : 5.04 %
TD.PR.E FixedReset 63,300 TD crossed 50,000 at 27.77.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-05-30
Maturity Price : 25.00
Evaluated at bid price : 27.76
Bid-YTW : 2.98 %
There were 53 other index-included issues trading in excess of 10,000 shares.

LFE.PR.A: Warrants Expire Out-of-the-Money

Wednesday, October 27th, 2010

I haven’t seen a press release yet, but LFE.WT, which was issued in January, expired today way, way, way, WAY out of the money.

Exercise price for full units of Canadian Life Companies Split was 15.65, while the NAVPU on October 15 was 13.64.

LFE.PR.A was last mentioned on PrefBlog when the warrant offering was announced. LFE.PR.A is tracked by HIMIPref™, but is relegated to the Scraps index on credit concerns.