Archive for March, 2011

March 31, 2011

Thursday, March 31st, 2011

Europe’s on credit watch:

Moody’s Investors Service said it can’t rule out further credit downgrades for euro-region nations because the agreement on a permanent bailout fund, the European Stability Mechanism, doesn’t go far enough.

European Union leaders met March 25 and set out new rules on bailout loans. Their failure so far to provide a permanent system whereby stronger nations support the finances of their weaker counterparts leaves bondholders at risk, Moody’s said.

“The absence of a fiscal-transfer mechanism and the conditions under which assistance will prospectively be made available leave downside risk to private creditors,” the rating agency said in an e-mailed report today. “Consequently, further rating downgrades cannot be ruled out.”

… so the ECB is suspending credit quality requirements:

The European Central Bank said it will accept all debt instruments backed by the Irish government as collateral against ECB loans as the country attempts to shore up its banking industry.

The Frankfurt-based ECB said Ireland’s commitment to recapitalize its banks and comply with a consolidation program prescribed by the European Union and International Monetary Fund must be assessed “positively.” The suspension of the minimum credit-rating threshold is based on “this positive assessment of the program,” a capital increase for Ireland’s four banks and the decision to “deleverage and downsize the banking sector,” the ECB said.

It is not the first time the ECB has loosened its collateral rules to help a euro-area member state in distress. In May last year, the ECB announced it would accept all Greek government debt as collateral when lending to banks, suspending minimum credit-rating thresholds to support a 110 billion-euro bailout of the debt-strapped nation. Ireland was the second of the now 17 euro-area members to receive a bailout last year.

The ECB “deems debt instruments issued or guaranteed by the Irish government to fulfill the credit standards required for collateral in Eurosystem credit operations,” the bank said. “The relevant risk control measures will be reviewed on a continuous basis.”

It was a good day to end the month in the Canadian preferred share market, with PerpetualDiscounts gaining 10bp, FixedResets exactly flat and DeemedRetractibles winning 13bp. Volatility was muted, with only two entries on the Performance Highlights table. Volume was average.

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 0.1310 % 2,408.9
FixedFloater 0.00 % 0.00 % 0 0.00 0 0.1310 % 3,623.0
Floater 2.50 % 2.28 % 39,750 21.55 4 0.1310 % 2,601.0
OpRet 4.86 % 3.11 % 59,062 1.12 9 -0.0942 % 2,411.2
SplitShare 5.08 % 2.69 % 119,760 0.97 5 0.1427 % 2,489.8
Interest-Bearing 0.00 % 0.00 % 0 0.00 0 -0.0942 % 2,204.8
Perpetual-Premium 5.74 % 5.61 % 132,829 2.77 10 0.0020 % 2,041.3
Perpetual-Discount 5.50 % 5.54 % 131,014 14.46 14 0.0970 % 2,139.3
FixedReset 5.15 % 3.42 % 230,853 2.93 57 0.0000 % 2,290.2
Deemed-Retractible 5.20 % 5.11 % 305,763 8.23 53 0.1315 % 2,095.7
Performance Highlights
Issue Index Change Notes
HSB.PR.D Deemed-Retractible -1.27 % YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2022-01-31
Maturity Price : 25.00
Evaluated at bid price : 24.05
Bid-YTW : 5.50 %
GWO.PR.I Deemed-Retractible 1.24 % YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2022-01-31
Maturity Price : 25.00
Evaluated at bid price : 22.01
Bid-YTW : 6.05 %
Volume Highlights
Issue Index Shares
Traded
Notes
SLF.PR.A Deemed-Retractible 72,495 Nesbitt crossed 50,000 at 22.80.
YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2022-01-31
Maturity Price : 25.00
Evaluated at bid price : 22.80
Bid-YTW : 5.89 %
GWO.PR.G Deemed-Retractible 46,163 Nesbitt sold 11,100 to anonymous at 24.70, then crossed 20,000 at the same price.
YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2022-01-31
Maturity Price : 25.00
Evaluated at bid price : 24.69
Bid-YTW : 5.38 %
BMO.PR.Q FixedReset 41,995 Recent new issue.
YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2022-01-31
Maturity Price : 25.00
Evaluated at bid price : 25.00
Bid-YTW : 3.87 %
RY.PR.Y FixedReset 32,614 Scotia crossed 27,800 at 27.45.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-12-24
Maturity Price : 25.00
Evaluated at bid price : 27.45
Bid-YTW : 3.52 %
TD.PR.Q Deemed-Retractible 28,315 TD crossed 25,000 at 26.00.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2017-03-02
Maturity Price : 25.00
Evaluated at bid price : 25.94
Bid-YTW : 5.07 %
IAG.PR.F Deemed-Retractible 27,635 Desjardins crossed 25,000 at 25.39.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2019-04-30
Maturity Price : 25.00
Evaluated at bid price : 25.60
Bid-YTW : 5.57 %
There were 32 other index-included issues trading in excess of 10,000 shares.
Wide Spread Highlights
Issue Index Quote Data and Yield Notes
TRI.PR.B Floater Quote: 23.05 – 23.75
Spot Rate : 0.7000
Average : 0.4898

YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2041-03-31
Maturity Price : 22.77
Evaluated at bid price : 23.05
Bid-YTW : 2.24 %

BNS.PR.Z FixedReset Quote: 24.50 – 25.00
Spot Rate : 0.5000
Average : 0.3613

YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2022-01-31
Maturity Price : 25.00
Evaluated at bid price : 24.50
Bid-YTW : 4.14 %

ELF.PR.G Deemed-Retractible Quote: 20.31 – 20.73
Spot Rate : 0.4200
Average : 0.3014

YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2022-01-31
Maturity Price : 25.00
Evaluated at bid price : 20.31
Bid-YTW : 7.30 %

HSB.PR.D Deemed-Retractible Quote: 24.05 – 24.44
Spot Rate : 0.3900
Average : 0.2745

YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2022-01-31
Maturity Price : 25.00
Evaluated at bid price : 24.05
Bid-YTW : 5.50 %

BNS.PR.O Deemed-Retractible Quote: 26.12 – 26.49
Spot Rate : 0.3700
Average : 0.2559

YTW SCENARIO
Maturity Type : Call
Maturity Date : 2017-05-26
Maturity Price : 25.00
Evaluated at bid price : 26.12
Bid-YTW : 4.96 %

SLF.PR.F FixedReset Quote: 27.00 – 27.35
Spot Rate : 0.3500
Average : 0.2510

YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-07-30
Maturity Price : 25.00
Evaluated at bid price : 27.00
Bid-YTW : 3.49 %

TMX to Report Closing Quotes … Someday

Thursday, March 31st, 2011

Readers will remember that quotes provided by the TMX at the “end of the day” are not closing quotes: they are “last” quotes, measured at 4:30. They will differ from the Closing Quotes measured at 4:00 because orders may be cancelled, but not added, during the extended trading session – the one exception being that you can add as many orders as you like at the Closing Price.

I brought this to the attention of the TMX (I don’t think they’d ever really thought about it; my suspicion is that the code that worked perfectly well when there was not extended trading session simply got overlooked when the ETS was invented … put that is pure speculation on my part). The TMX took a survey of their customers and:

While we are not in a position to disclose survey results, we can tell you that there was limited interest from our clients with respect to the 4:00 PM closing bid/ask information. We are following up on adding 4:00 PM close bid/ask data to our end-of-day Trading Summary products and Market Data Web – Custom Query product. However, due to other development commitments and priorities, we can not say when this will be implemented.

I’m rather surprised and can only assume that the surveys were completed by database dorks rather than end users, because the Last Quote is only useful insofar as it reflects the Closing Quote – it has absolutely zero independent value.

I’m also surprised that there will be a potentially significant delay in giving users the option. I’ve never had the chance to examine the TMX code, so obviously I’m speculating again … but retrieval, storage and dissemination of Closing Quotes seems like a fairly trivial database operation. I don’t understand how implementation could possibly take more than a day.

I will, on occasion, spend some actual money to buy the “Trades and Quotes” output from the TMX – but not very often, because there is a charge for each quote and there can, conceivably, be several thousand quotes per minute. However, this will rarely be reported on PrefBlog in a timely manner, because I am separately advised that my problems nailing down IAG.PR.C on March 25 and CM.PR.K on March 28 were due to uploading schedules – detailed quote data is only put on DataLinx overnight, not within a few hours of the close.

March 30, 2011

Wednesday, March 30th, 2011

Europeans seem to want to blame commodity price inflation on speculators – Hoenig blames the Fed:

The Federal Reserve’s “highly accommodative” monetary policy is partly to blame for rapidly increasing global commodity prices, said Kansas City Fed President Thomas Hoenig, who called on colleagues to raise the benchmark interest rate toward 1 percent soon.

“Once again there are signs that the world is building new economic imbalances and inflationary impulses,” Hoenig, the central bank’s longest-serving policy maker and the lone dissenter at Fed meetings last year, said in the text of a speech today in London. “The longer policy remains as it is, the greater the likelihood these pressures will build and ultimately undermine world growth.”

This was also discussed in the post QE2 and Inflation.

It was a mixed day on the Canadian preferred share market, with PerpetualDiscounts getting whacked for 23bp, FixedResets down 2bp and DeemedRetractibles gaining 10bp. Not a lot of volatility, with only three entries in the Performance Highlights table. Volume was above average.

PerpetualDiscounts now yield 5.54%, equivalent to 7.20% interest at this year’s standard conversion factor of 1.3x. Long Corporates now yied 5.5%, so the pre-tax interest-equivalent spread (also called the Seniority Spread) is now about 170bp, a significant tightening from the 180bp reported on March 23.

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 0.2627 % 2,405.7
FixedFloater 0.00 % 0.00 % 0 0.00 0 0.2627 % 3,618.2
Floater 2.50 % 2.29 % 40,043 21.52 4 0.2627 % 2,597.6
OpRet 4.86 % 2.79 % 59,148 0.25 9 0.1630 % 2,413.5
SplitShare 5.09 % 2.63 % 124,706 0.97 5 -0.0468 % 2,486.3
Interest-Bearing 0.00 % 0.00 % 0 0.00 0 0.1630 % 2,206.9
Perpetual-Premium 5.74 % 5.70 % 144,723 2.44 10 0.0139 % 2,041.3
Perpetual-Discount 5.51 % 5.54 % 130,363 14.53 14 -0.2268 % 2,137.2
FixedReset 5.15 % 3.43 % 232,952 2.93 57 -0.0185 % 2,290.2
Deemed-Retractible 5.21 % 5.15 % 315,650 8.26 53 0.0989 % 2,093.0
Performance Highlights
Issue Index Change Notes
PWF.PR.K Perpetual-Discount -1.58 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2041-03-30
Maturity Price : 23.47
Evaluated at bid price : 23.73
Bid-YTW : 5.29 %
BNS.PR.K Deemed-Retractible 1.01 % YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2022-01-31
Maturity Price : 25.00
Evaluated at bid price : 24.91
Bid-YTW : 4.97 %
HSB.PR.D Deemed-Retractible 1.29 % YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2022-01-31
Maturity Price : 25.00
Evaluated at bid price : 24.36
Bid-YTW : 5.34 %
Volume Highlights
Issue Index Shares
Traded
Notes
NA.PR.N FixedReset 211,075 Issuer bid.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2013-09-14
Maturity Price : 25.00
Evaluated at bid price : 27.05
Bid-YTW : 2.15 %
BMO.PR.H Deemed-Retractible 84,813 Nesbitt crossed 75,000 at 25.45.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2013-03-27
Maturity Price : 25.00
Evaluated at bid price : 25.43
Bid-YTW : 4.67 %
CM.PR.G Deemed-Retractible 78,296 Nesbitt crossed 75,000 at 25.55.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-05-31
Maturity Price : 25.00
Evaluated at bid price : 25.44
Bid-YTW : 4.67 %
BNS.PR.X FixedReset 66,669 Nesbitt crossed 50,000 at 27.60.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-05-25
Maturity Price : 25.00
Evaluated at bid price : 27.62
Bid-YTW : 3.17 %
BNS.PR.R FixedReset 62,776 Nesbitt crossed 50,000 at 26.50.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-02-25
Maturity Price : 25.00
Evaluated at bid price : 26.48
Bid-YTW : 3.13 %
RY.PR.F Deemed-Retractible 58,423 RBC crossed 12,000 at 23.65.
YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2022-01-31
Maturity Price : 25.00
Evaluated at bid price : 23.72
Bid-YTW : 5.15 %
There were 39 other index-included issues trading in excess of 10,000 shares.
Wide Spread Highlights
Issue Index Quote Data and Yield Notes
FTS.PR.H FixedReset Quote: 25.23 – 25.74
Spot Rate : 0.5100
Average : 0.3630

YTW SCENARIO
Maturity Type : Call
Maturity Date : 2020-07-01
Maturity Price : 25.00
Evaluated at bid price : 25.23
Bid-YTW : 4.09 %

IAG.PR.F Deemed-Retractible Quote: 25.37 – 25.70
Spot Rate : 0.3300
Average : 0.1969

YTW SCENARIO
Maturity Type : Call
Maturity Date : 2019-04-30
Maturity Price : 25.00
Evaluated at bid price : 25.37
Bid-YTW : 5.71 %

BAM.PR.R FixedReset Quote: 25.63 – 26.13
Spot Rate : 0.5000
Average : 0.3935

YTW SCENARIO
Maturity Type : Call
Maturity Date : 2016-07-30
Maturity Price : 25.00
Evaluated at bid price : 25.63
Bid-YTW : 4.86 %

CIU.PR.A Perpetual-Discount Quote: 22.62 – 23.00
Spot Rate : 0.3800
Average : 0.2839

YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2041-03-30
Maturity Price : 22.46
Evaluated at bid price : 22.62
Bid-YTW : 5.13 %

FTS.PR.E OpRet Quote: 26.45 – 27.03
Spot Rate : 0.5800
Average : 0.4906

YTW SCENARIO
Maturity Type : Call
Maturity Date : 2013-07-01
Maturity Price : 25.75
Evaluated at bid price : 26.45
Bid-YTW : 3.68 %

BNS.PR.R FixedReset Quote: 26.48 – 26.69
Spot Rate : 0.2100
Average : 0.1376

YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-02-25
Maturity Price : 25.00
Evaluated at bid price : 26.48
Bid-YTW : 3.13 %

RF.PR.A: Shareholders to Vote on Manager Change

Wednesday, March 30th, 2011

C.A. BANCORP CANADIAN REALTY FINANCE CORPORATION has released an Information Circular:

You are invited to the Special Meeting of holders of Class A shares and Preferred shares, Series 1 (collectively, the “Shareholders”) of C.A. Bancorp Canadian Realty Finance Corporation (the “Corporation”) to be held at the offices of the Corporation, The Simpson Tower, 401 Bay Street, Suite 1600, Toronto, Ontario, M5H 2Y4 on April 25, 2011 at 2:00 P.M. (the “Meeting”). The purpose of the Meeting is to provide Shareholders with the opportunity to consider and pass a special resolution to approve the following proposed transaction:
  • (a) the acquisition of all of the issued and outstanding shares of C.A. Bancorp Ltd. (the “Manager”) by Green Tree Capital Management Corp. (“Green Tree”) (the “Change of Control”);
  • (b) an amendment to the commitment agreement dated January 31, 2008 between C.A. Bancorp Inc. (the “Parent”) and the Corporation (the “Commitment Agreement”) to permit the Commitment Agreement’s assignment from the Parent to Green Tree and the release of the Parent from any further obligations; and
  • (c) an amendment to the management agreement dated July 6, 2009 between the Manager and the Corporation (the “Management Agreement”) to provide that the Manager is not entitled to payment of a termination fee where the Management Agreement is terminated by the Corporation in the context of a material breach or default.

Approval of the proposed transaction will result in the transfer of control of the Manager from the Parent to Green Tree, an Ontario corporation established for the sole purpose of entering the proposed transaction.

If successful, portfolio management will be contracted to Quantus:

Jamie Spreng formed Quantus Investment Corp. (formerly Spreng Asset Management Inc.) in April 2010. The firm became registered as a portfolio manager and investment fund manager in July 2010. Its offices are located at 36 Toronto Street, Suite 1150 in Toronto, Ontario. The firm subsequently added the registration category of exempt market dealer at the end of 2010. Mr. Spreng acts as Chief Executive Officer, Chief Compliance Officer, Chief Operating Officer, and Ultimate Designated Person for Quantus Investment Corporation. For Quantus, the investment objective is to maximize risk-adjusted returns. The Quantus Funds only charge a performance fee, there is no management fee. Mr. Spreng’s objective is to generate steady, consistent returns for clients pursuant to various hedge fund products.

Super. So the mortgages will be run by a hedge fund specialist with zero track record.

I mocked this issue at its genesis, due largely to the huge leverage. The leverage problem was addressed with a warrants issue and Asset Coverage is now a much more respectable 1.8-:1 based on the December 2010 Financials. So far so good.

But look at the assets! 36.4-milion in mortgages, 18.4-million in cash and 6.4-million in publicly traded securities, including preferred shares and junk bonds! The circular explains:

the uncertainty relating to the ownership of the Manager has depressed the number and quality of new lending opportunities for the Corporation, resulting in the Board’s decision to suspend quarterly distributions on the Class A Shares;

The preferreds have a rather unusual NAV Test:

Pursuant to the Commitment Agreement dated January 31, 2008 between the Parent and the Corporation, the Parent has agreed that, for so long as there are Preferred Shares of the Corporation outstanding, if the Adjusted Net Tangible Asset Value2 is less than 111% of the Original Preferred Share Issue Price3 as at the end of such quarter, the Parent will subscribe for, or arrange for subscriptions for, additional Class A Shares in an amount at least equal to the deficiency, within 10 business days following the end of the quarter (or if a deficiency or increased deficiency is discovered, including as a result of an audit or a review of the financial statements of the Corporation by its auditors, within 10 business days of confirming the amount of such deficiency). If the Parent defaults in its obligation then:
  • (a) under the articles of the Corporation:
  • (i) steps shall be initiated to redeem the Preferred Shares, the funding of which would occur pro rata as funds become available to fund such redemptions;
  • (ii) the Preferred Shares become voting;
  • (iii) the Class A Shares and Class J Shares become non-voting;
  • (iv) the Board of Directors shall call a meeting of shareholders to elect a new Board of Directors, a majority of whom must be independent of the Parent and its affiliates; and
  • (v) the Board of Directors shall appoint a qualified firm or individual to supervise an orderly liquidation of the Corporation;

and from the prospectus:

No distributions will be paid on the Class A Shares if (i) the distributions payable on the Preferred Shares are in arrears, or (ii) after the payment of the distribution by the Corporation the Adjusted Net Tangible Asset Value of the Corporation is less than 111% of the Original Preferred Share Issue Price. See ‘‘Description of Share Capital — Description of Class A Shares’’.

Well, I just plain don’t like this issue and recommend that preferred shareholders vote against the plan. A change in recommendation will be dependent upon:

  • The company should obtain a credit rating for the preferreds
  • The company should present a credible plan for funding the redemption of the preferreds (e.g., a credit line with a major bank).
  • The NAV test should be more stringent.

March 29, 2011

Tuesday, March 29th, 2011

How ’bout them US house prices, eh?:

The S&P/Case-Shiller index of property values in 20 cities fell 3.1 percent from January 2010, the biggest year-over-year decrease since December 2009, the group said today in New York. The decline was in line with the 3.2 percent median forecast by economists in a Bloomberg News survey.

Rising foreclosures are swelling the number of houses on the market, which may put additional pressure on prices in coming months. At the same time, a further decline in home values may keep potential buyers on the sidelines as they foresee better deals, hurting construction and consumer spending as owners’ equity evaporates.

It’s an ill wind that blows nobody any good. We may be witnessing the birth of a few residential real-estate empires:

Delavaco Properties LP plans to spend as much as $30 million this year and $40 million in 2012 to buy bank-owned houses and condominiums in foreclosure-ridden South Florida. The private-equity fund will pay cash.

As lenders tighten mortgage standards and consumers stay on the sidelines amid a five-year slide in home prices, all-cash purchases are surging. The deals are done mostly by investors who can get properties for less than buyers needing loans, fix them up and resell or rent them.

But there’s finally a start to the eventual wind-down of Fannie & Freddie:

U.S. House Republicans proposed legislation that would begin reducing the influence of government-run mortgage companies Fannie Mae and Freddie Mac.

Representative Scott Garrett, a New Jersey Republican and chairman of the capital markets panel of the House Financial Services Committee, is leading the effort. Most of the Republican proposals line up with a list of recommendations put forth in February by the Treasury Department and the Department of Housing and Urban Development. Garrett’s panel will hold a hearing on March 31 on the proposals.

When it comes to the Treasury, “at the end of the day, we have the same ultimate goal to achieve here,” Garrett said at a press conference today. “If you look through their white paper, if you look at what we have, in essence we’re on the same page.”

Won’t last though – politicians love loan guarantees. ‘We can Do Good, and it doesn’t even cost anything!’

Europe’s politicians might find it harder to get co-investors:

Portugal and Greece were downgraded by Standard & Poor’s, which said the European Union’s new bailout rules may mean that both nations eventually renege on their debt obligations.

S&P cut Portugal for the second time in a week to the lowest investment-grade rating of BBB-, three steps below Ireland. Greece’s rating fell two grades to BB-, three levels below investment grade. S&P cited concerns that both countries may be forced to restructure debt after seeking European aid and that governments will be paid back before other creditors.

It was a strong day on the Canadian preferred share market, with PerpetualDiscounts winning 38bp, FixedResets up 13bp and DeemedRetractibles gaining 9bp. Volume was good and volatility jumped.

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 -0.1312 % 2,399.4
FixedFloater 0.00 % 0.00 % 0 0.00 0 -0.1312 % 3,608.7
Floater 2.51 % 2.29 % 41,501 21.51 4 -0.1312 % 2,590.8
OpRet 4.87 % 3.67 % 58,412 1.13 9 0.1288 % 2,409.6
SplitShare 5.08 % 2.67 % 129,342 0.98 5 -0.0547 % 2,487.5
Interest-Bearing 0.00 % 0.00 % 0 0.00 0 0.1288 % 2,203.3
Perpetual-Premium 5.75 % 5.53 % 132,112 1.20 10 0.1163 % 2,041.0
Perpetual-Discount 5.49 % 5.54 % 125,407 14.51 14 0.3768 % 2,142.0
FixedReset 5.14 % 3.42 % 234,918 2.93 57 0.1267 % 2,290.6
Deemed-Retractible 5.22 % 5.15 % 320,219 8.25 53 0.0918 % 2,090.9
Performance Highlights
Issue Index Change Notes
HSB.PR.D Deemed-Retractible -1.19 % YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2022-01-31
Maturity Price : 25.00
Evaluated at bid price : 24.05
Bid-YTW : 5.50 %
IAG.PR.F Deemed-Retractible -1.09 % YTW SCENARIO
Maturity Type : Call
Maturity Date : 2019-04-30
Maturity Price : 25.00
Evaluated at bid price : 25.38
Bid-YTW : 5.70 %
W.PR.J Perpetual-Discount 1.47 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2041-03-29
Maturity Price : 24.25
Evaluated at bid price : 24.55
Bid-YTW : 5.71 %
ELF.PR.G Deemed-Retractible 1.50 % YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2022-01-31
Maturity Price : 25.00
Evaluated at bid price : 20.52
Bid-YTW : 7.16 %
W.PR.H Perpetual-Discount 1.58 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2041-03-29
Maturity Price : 23.35
Evaluated at bid price : 24.35
Bid-YTW : 5.61 %
ELF.PR.F Deemed-Retractible 1.70 % YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2022-01-31
Maturity Price : 25.00
Evaluated at bid price : 22.50
Bid-YTW : 6.61 %
PWF.PR.K Perpetual-Discount 1.73 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2041-03-29
Maturity Price : 23.84
Evaluated at bid price : 24.11
Bid-YTW : 5.20 %
Volume Highlights
Issue Index Shares
Traded
Notes
TD.PR.Q Deemed-Retractible 68,065 TD bought 20,000 from Nesbitt at 25.85, then crossed the same number at the same price.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2017-03-02
Maturity Price : 25.00
Evaluated at bid price : 25.81
Bid-YTW : 5.17 %
MFC.PR.B Deemed-Retractible 54,997 RBC crossed 50,000 at 21.95.
YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2022-01-31
Maturity Price : 25.00
Evaluated at bid price : 21.87
Bid-YTW : 6.31 %
POW.PR.B Perpetual-Discount 51,590 RBC crossed 50,000 at 23.96.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2041-03-29
Maturity Price : 23.68
Evaluated at bid price : 23.95
Bid-YTW : 5.59 %
SLF.PR.F FixedReset 45,110 Desjardins crossed 40,000 at 26.82.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-07-30
Maturity Price : 25.00
Evaluated at bid price : 26.90
Bid-YTW : 3.60 %
BAM.PR.M Perpetual-Discount 42,665 Nesbitt crossed 10,000 at 20.90.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2041-03-29
Maturity Price : 20.91
Evaluated at bid price : 20.91
Bid-YTW : 5.72 %
BNS.PR.Z FixedReset 39,568 Nesbitt bought 25,000 from RBC at 24.50.
YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2022-01-31
Maturity Price : 25.00
Evaluated at bid price : 24.45
Bid-YTW : 4.16 %
There were 37 other index-included issues trading in excess of 10,000 shares.
Wide Spread Highlights
Issue Index Quote Data and Yield Notes
POW.PR.A Perpetual-Discount Quote: 24.35 – 24.71
Spot Rate : 0.3600
Average : 0.2364

YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2041-03-29
Maturity Price : 24.09
Evaluated at bid price : 24.35
Bid-YTW : 5.76 %

GWO.PR.L Deemed-Retractible Quote: 25.07 – 25.44
Spot Rate : 0.3700
Average : 0.2613

YTW SCENARIO
Maturity Type : Call
Maturity Date : 2019-01-30
Maturity Price : 25.00
Evaluated at bid price : 25.07
Bid-YTW : 5.64 %

IAG.PR.C FixedReset Quote: 26.95 – 28.25
Spot Rate : 1.3000
Average : 1.1936

YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-01-30
Maturity Price : 25.00
Evaluated at bid price : 26.95
Bid-YTW : 3.28 %

HSB.PR.D Deemed-Retractible Quote: 24.05 – 24.30
Spot Rate : 0.2500
Average : 0.1565

YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2022-01-31
Maturity Price : 25.00
Evaluated at bid price : 24.05
Bid-YTW : 5.50 %

POW.PR.B Perpetual-Discount Quote: 23.95 – 24.22
Spot Rate : 0.2700
Average : 0.1872

YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2041-03-29
Maturity Price : 23.68
Evaluated at bid price : 23.95
Bid-YTW : 5.59 %

HSB.PR.C Deemed-Retractible Quote: 24.37 – 24.69
Spot Rate : 0.3200
Average : 0.2422

YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2022-01-31
Maturity Price : 25.00
Evaluated at bid price : 24.37
Bid-YTW : 5.44 %

BCE.PR.G / BCE.PR.H Conversion Notice Sent

Tuesday, March 29th, 2011

BCE has mailed BCE.PR.H Conversion Notice:

Holders of BCE Inc. Series AH Preferred Shares have the right to convert all or part of their shares, effective on May 1, 2011, on a one-for-one basis into Cumulative Redeemable First Preferred Shares, Series AG of BCE Inc. (the “Series AG Preferred Shares”).

Registered holders electing to convert all or part of their Series AH Preferred Shares into Series AG Preferred Shares must complete and sign the conversion panel on the back of their Series AH Preferred Share certificate and deliver it, at the latest by 5:00 p.m. (Eastern time) on April 21, 2011, to one of the following addresses…

BCE.PR.H is the ratchet-rate preferred:

As of May 1, 2011, the Series AH Preferred Shares will pay a monthly floating dividend based on a dividend rate that will fluctuate over time between 50% and 100% of the Prime rate (“Prime”) for each month computed in accordance with the articles of BCE Inc. Accordingly, from May 1, 2011, the holders of Series AH Preferred Shares will continue to be entitled to receive floating adjustable cash dividends, as and when declared by the Board of Directors of BCE Inc., to be paid on the twelfth day of each month, commencing with the month of June 2011. The dividend rate will be adjusted upwards or downwards on a monthly basis by an Adjustment Factor (as described below) whenever the Calculated Trading Price, being the market price of the Series AH Preferred Shares computed in accordance with the articles of BCE Inc., is $24.875 or less or $25.125 or more, respectively.

Last night’s close was 23.00-24; it has been paying 100% of Prime for quite some time now.

There is also a conversion notice for BCE.PR.G:

Holders of BCE Inc. Series AG Preferred Shares have the right to convert all or part of their shares, effective on May 1, 2011, on a one-for-one basis into Cumulative Redeemable First Preferred Shares, Series AH of BCE Inc. (the “Series AH Preferred Shares”).

Registered holders electing to convert all or part of their Series AG Preferred Shares into Series AH Preferred Shares must complete and sign the conversion panel on the back of their Series AG Preferred Share certificate and deliver it, at the latest by 5:00 p.m. (Eastern time) on April 21, 2011, to one of the following addresses…

As of May 1, 2011, the Series AG Preferred Shares, should they remain outstanding, will pay, on a quarterly basis, as and when declared by the Board of Directors of BCE Inc., a fixed cash dividend for the following five years that will be determined by BCE Inc. on April 6, 2011 but which shall not be less than 80% of the five-year Government of Canada Yield (as defined in BCE Inc.’s articles) compounded semi-annually and computed on April 6, 2011 by two investment dealers appointed by BCE Inc.. The annual dividend rate applicable to the Series AG Preferred Shares will be published on April 8, 2011 in the national edition of The Globe and Mail, the Montreal Gazette and La Presse and will be posted on BCE Inc.’s website at www.bce.ca.

BCE.PR.G closed last night at 23.13-28. It currently pays 4.35% of par.

It’s too early to tell yet which of the two issues will be better as of May 1, but I’ll keep you posted!

March 28, 2011

Monday, March 28th, 2011

Holders of Lehman PPNs are getting 80% of their principal back:

Most Hong Kong holders of structured financial notes linked to Lehman Brothers Holdings Inc. (LEHMQ) will get more than 80 percent of their investment in the latest settlement, receiver PricewaterhouseCoopers LLP said.

The agreement, which covers most issues of the minibonds, will offer holders “significant recoveries” on their investment, according to statements by PricewaterhouseCoopers and 16 banks involved issued at a Bank of China Ltd. (3988) briefing in the city today.

About 43,000 investors in Hong Kong bought an estimated $1.8 billion of Lehman minibonds that were sold by commercial lenders before the New York-based investment bank’s 2008 collapse.

BOC Hong Kong (Holdings) Ltd., the Bank of China’s Hong Kong unit, and 15 other banks agreed to pay at least 60 cents on the dollar, for a total of HK$6.3 billion, in a settlement reached with the Securities and Futures Commission and the Hong Kong Monetary Authority.

BOC, the biggest seller of the notes in the city, offered in July 2009 to pay HK$3.11 billion ($400 million) to the Lehman minibond investors, almost half the total compensation extended by the 16 banks, while two units of Dah Sing Financial Holdings Ltd. will pay HK$444 million.

The notes have been characterized as almost worthless, so this is just another case of regulatory extortion. For a good laugh, try a Google search of “Lehman structured Notes” – it’s a good way of getting a list of ambulance-chasing legal firms.

In other adventures of the BooHooHoo Brigade, interest rate swaps are in the news again:

Faced with shrinking income and growing expenses, Italian cities bought swaps that would typically offer lower interest expenses in the near-term, while exposing the buyers to the risk of increased interest costs in later years. Italian cities faced losses of at least 1.2 billion euros from the transactions as of June, data compiled by the central bank show.

Cassino entered a seven-year swap with Bear Stearns in 2003 to adjust payments on about 22 million euros of debt. The swap switched the city’s 4.7 percent fixed interest rate payment for a variable rate, according to a June 2009 report by Italy’s financial police.

The city paid a floating rate based on the U.S.-dollar London interbank offered rate, an “extremely risky” bet given that Libor was at a record low, the police said in testimony to the Italian Senate in 2009.

Who needs investment managers when you’ve got the police? Fortunately, there’s a good laugh later in the story:

Bloomberg News sued the European Central Bank in December to make it release documents showing how Greece used derivatives to hide its fiscal deficit and helped trigger the region’s sovereign debt crisis. The case is pending.

Why, I’m sure the ECB knew nothing about it! It was a complete surprise! It was all Goldman’s fault!

The New York Fed’s blog has a piece by Beverly Hirtle addressing the question How Were the Basel 3 Minimum Capital Requirements Calibrated?. The blog itself, newly inaugurated and titled Liberty Street Economics, has been added to the blogroll.

I can’t help talking about the Toronto Community Housing Corporation thing, because it’s so illustrative of bad government and politics by sound-bite. A Toronto Star piece titled TCHC fête featured chocolate fountain and crème brulee makes the startling revelation:

The 2008 party for TCHC staff featured a chocolate fountain, an Italian spumante and strawberries station, crème brulee and a deluxe antipasto bar that included hot grilled calamari, mussels and smoked salmon.

In attendance were 760 guests, and the final bill from the Montecassino banquet hall in North York came to $47,715. Throw in costs for entertainment and other items, and TCHC forked out $53,500.

It was a significant change from the year prior. The 2007 celebration was a smaller scale event — 420 TCHC guests attended — and featured a less elaborate menu. Guests ate from an antipasto bar with no seafood, while chicken and pasta dishes were served at their tables.

The bill from Montecassino was $22,368.

OK, so this shocking news means that in 2008 the TCHC spent $70/head, while in 2007 the tab was $53/head. Hands up everybody who works for a major corporation that spent less than $100/head on their Christmas party! Don’t be shy … well, I didn’t think so.

Don’t get me wrong. There’s a lot wrong with the civil service in general and the TCHC in particular – but my desire for the efficient provision of services does not extend to treating staff like dirt on a permanent basis. When you treat your employees like shit, guess what kind of employees you get? I want them fired for incompetence, sure – that alone will save enough money to fund a hundred Christmas parties annually – but when it comes to governance I’d much rather talk about the single-source contracts that never get talked about.

It was another good day on the Canadian preferred share market, with PerpetualDiscounts up 10bp, FixedResets gaining 17bp and DeemedRetractibles winning 3bp. Not much volatility, with only two entries on the Performance Highlights table. Volume exploded and was very heavy … window dressing for quarter end?

The quote for CM.PR.K listed in the Wide Spreads table is a disgrace. Readers will remember that the reported value is the Last Quote, which may be wider than the Close. I have attempted to purchase Trades and Quotes for the issue, but all I get are trades. The TMX has been queried regarding this apparent shortcoming in their software. [See Update, below]

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 0.3350 % 2,402.6
FixedFloater 0.00 % 0.00 % 0 0.00 0 0.3350 % 3,613.5
Floater 2.50 % 2.31 % 40,867 21.47 4 0.3350 % 2,594.2
OpRet 4.87 % 3.72 % 57,385 1.13 9 0.1807 % 2,406.5
SplitShare 5.08 % 2.71 % 134,683 0.98 5 -0.0608 % 2,488.8
Interest-Bearing 0.00 % 0.00 % 0 0.00 0 0.1807 % 2,200.5
Perpetual-Premium 5.73 % 5.57 % 145,150 1.20 10 0.0674 % 2,038.6
Perpetual-Discount 5.50 % 5.54 % 127,225 14.51 14 0.1001 % 2,134.0
FixedReset 5.15 % 3.44 % 238,089 2.94 57 0.1703 % 2,287.7
Deemed-Retractible 5.22 % 5.14 % 330,630 8.27 53 0.0265 % 2,089.0
Performance Highlights
Issue Index Change Notes
BNA.PR.E SplitShare -1.01 % YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2017-12-10
Maturity Price : 25.00
Evaluated at bid price : 24.50
Bid-YTW : 5.29 %
BNS.PR.N Deemed-Retractible 1.03 % YTW SCENARIO
Maturity Type : Call
Maturity Date : 2017-02-26
Maturity Price : 25.00
Evaluated at bid price : 25.62
Bid-YTW : 4.96 %
Volume Highlights
Issue Index Shares
Traded
Notes
CM.PR.D Deemed-Retractible 65,801 Nesbitt crossed 50,000 at 25.35.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2011-05-30
Maturity Price : 25.25
Evaluated at bid price : 25.35
Bid-YTW : 0.41 %
BMO.PR.M FixedReset 54,601 TD crossed 41,100 at 26.30.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2013-09-24
Maturity Price : 25.00
Evaluated at bid price : 26.26
Bid-YTW : 3.04 %
HSB.PR.E FixedReset 52,234 RBC bought 11,500 from HSBC at 27.40; Desjardins bought 25,000 from Scotia at 27.42.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-07-30
Maturity Price : 25.00
Evaluated at bid price : 27.40
Bid-YTW : 3.59 %
BMO.PR.Q FixedReset 50,825 Recent new issue.
YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2022-01-31
Maturity Price : 25.00
Evaluated at bid price : 24.96
Bid-YTW : 3.89 %
TCA.PR.Y Perpetual-Premium 49,917 Nesbitt crossed 40,000 at 50.45.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2041-03-28
Maturity Price : 46.89
Evaluated at bid price : 50.41
Bid-YTW : 5.56 %
NA.PR.O FixedReset 41,235 Issuer bid.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-03-17
Maturity Price : 25.00
Evaluated at bid price : 28.32
Bid-YTW : 2.28 %
There were 67 other index-included issues trading in excess of 10,000 shares.
Wide Spread Highlights
Issue Index Quote Data and Yield Notes
CM.PR.K FixedReset Quote: 26.62 – 28.83
Spot Rate : 2.2100
Average : 1.2223

See Update, below

YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-08-30
Maturity Price : 25.00
Evaluated at bid price : 26.62
Bid-YTW : 3.21 %

FTS.PR.E OpRet Quote: 26.40 – 26.91
Spot Rate : 0.5100
Average : 0.3079

YTW SCENARIO
Maturity Type : Call
Maturity Date : 2013-07-01
Maturity Price : 25.75
Evaluated at bid price : 26.40
Bid-YTW : 3.76 %

IAG.PR.C FixedReset Quote: 27.00 – 28.25
Spot Rate : 1.2500
Average : 1.0770

YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-01-30
Maturity Price : 25.00
Evaluated at bid price : 27.00
Bid-YTW : 3.21 %

CU.PR.A Perpetual-Premium Quote: 25.14 – 25.42
Spot Rate : 0.2800
Average : 0.1830

YTW SCENARIO
Maturity Type : Call
Maturity Date : 2012-03-31
Maturity Price : 25.00
Evaluated at bid price : 25.14
Bid-YTW : 5.69 %

BNA.PR.E SplitShare Quote: 24.50 – 24.89
Spot Rate : 0.3900
Average : 0.3104

YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2017-12-10
Maturity Price : 25.00
Evaluated at bid price : 24.50
Bid-YTW : 5.29 %

RY.PR.G Deemed-Retractible Quote: 23.76 – 24.00
Spot Rate : 0.2400
Average : 0.1669

YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2022-01-31
Maturity Price : 25.00
Evaluated at bid price : 23.76
Bid-YTW : 5.18 %

Update, 2011-3-30: The TMX has sent me the Trades and Quotes report that I attempted to purchase. They are trying to determing why my attempt was unsuccessful and desperately clinging to the hope that it was somehow all my fault.

The last trade was at 15:56:27, for 100 shares at the offer price of 26.70. There were then 12 quotes prior to the close as algorithms jockeyed for position; the bid changed once, from 800@26.62 to 200@26.63; the offer bounced mainly lower, from 100@26.70 to 200@26.68. The closing quote was 26.63-68, 2×2. The offer was cancelled at 16:16:01 and the bid at 16:16:09, resulting in a Last Quote of 26.62-28.83, 800×400.

BoE's Haldane Supports McDonald CoCos

Monday, March 28th, 2011

I use the term “McDonald CoCo” to describe a hybrid security that is initially debt-like coverts into equity when the issuer’s common equity price declines below a preset floor. The conversion is performed at the equity trigger price.

I will note immodestly that, were there any justice in the world, they would be called Hymas CoCos, since I published first, but there ain’t no justice and McDonald has the union card.

Anyway, Andrew G Haldane, Executive Director of the Bank of England, has published remarks based on a speech given at the American Economic Association, Denver, Colorado, 9 January 2011:

For large and complex banks, the number of risk categories has exploded. To illustrate, consider the position of a large, representative bank using an advanced internal set of models to calibrate capital. Its number of risk buckets has increased from around seven under Basel I to, on a conservative estimate, over 200,000 under Basel II. To determine the regulatory capital ratio of this bank, the number of calculations has risen from single figures to over 200 million. The quant and the computer have displaced the clerk and the envelope.

At one level, this is technical progress; it is the appliance of science to risk management. But there are costs. Given such complexity, it has become increasingly difficult for regulators and market participants to vouch for the accuracy of reported capital ratios. They are no longer easily verifiable or transparent. They are as much an article of faith as fact, as much art as science. This weakens both Pillars II and III. For what the market cannot observe, it is unlikely to be able to exercise discipline over. And what the regulator cannot verify, it is unlikely to be able to exercise supervision over. Banks themselves have recently begun to voice just such concerns.

… and complexity is Bad:

This evidence only provides a glimpse at the potential model error problem viewed from three different angles. Yet it suggests that model error-based confidence intervals around reported capital ratios might run to several percentage points. For a bank, that is the difference between life and death. The shift to advanced models for calibrating economic capital has not arrested this trend. More likely, it has intensified it. The quest for precision may have come at the expense of robustness.

Hayek titled his 1974 Nobel address “The Pretence of Knowledge”. In it, he highlighted the pitfalls of seeking precisely measurable answers to questions about the dynamics of complex systems. Subsequent research on complex systems has confirmed Hayek’s hunch. Policy predicated on over-precision risks catastrophic error. Complexity in risk models may have perpetuated Hayek’s pretence in the minds of risk managers and regulators.

Like, for instance, in the run-up to the height of the crisis:

To see that, consider the experience of a panel of 33 large international banks during the crisis. This panel conveniently partitions itself into banks subject to government intervention in the form of capital or guarantees (“crisis banks”)
and those free from such intervention (“no crisis banks”).

Chart 5 plots the reported Tier 1 capital ratio of these two sets of banks in the run-up to the Lehman Brothers crisis in September 2008. Two observations are striking. First, the reported capital ratios of the two sets of banks are largely indistinguishable. If anything, the crisis banks looked slightly stronger pre-crisis on regulatory solvency measures. Second, regulatory capital ratios offer, on average, little if any advance warning of impending problems. These conclusions are essentially unchanged using the Basel III definitions of capital.


Click for Big

Got any better ideas?

What could be done to strengthen the framework? As a thought experiment, consider dropping risk models and instead relying on the market. Market-based metrics of bank solvency could be based around the market rather than book value of capital. The market prices of banks are known to offer useful supplementary information to that collected by supervisors when assessing bank health.8 And there is also evidence they can offer reliable advance warnings of bank distress

To bring these thoughts to life, consider three possible alternative bank solvency ratios based on market rather than accounting measures of capital:

  • Market-based capital ratio: the ratio of a bank’s market capitalisation to its total assets.
  • Market-based leverage ratio: the ratio of a bank’s market capitalisation to its total debt.
  • Tobin’s Q: the ratio of the market value of a bank’s equity to its book value.

The first two are essentially market-based variants of regulatory capital measures, the third a well-known corporate valuation metric. How do they fare against the first principles of complex, adaptive systems?


Click for big

Having set the stage, he starts talking about CoCos:

Alongside equity, banks would be required to issue a set of contingent convertible instruments – so-called “CoCos”. These instruments have attracted quite a bit of attention recently among academics, policymakers and bankers, though there remains uncertainty about their design. In particular, consider CoCos with the following possible design
characteristics.
  • Triggers are based on market-based measures of solvency, as in Charts 6–8.
  • These triggers are graduated, stretching up banks’ capital structure.
  • On triggering, these claims convert from debt into equity.

Although novel in some respects, CoCos with these characteristics would be simple to understand. They would be easy to monitor in real time by regulators and investors. And they would alter potentially quite radically incentives, and thus market dynamics, ahead of banking stress becoming too acute.

He points out:

CoCos buttress market discipline and help lift the authorities from the horns of the timeconsistency dilemma. They augment regulatory discretion at the point of distress with contractual rules well ahead of distress. Capital replenishment is contractual and automatic; it is written and priced ex-ante and delivered without temptation ex-post. Because intervention would be prompt, transparent and rule-based, the scope for regulatory discretion would be constrained. For that reason, the time-consistency problem ought to be reduced, perhaps materially. A contractual belt is added to the resolution braces.

These are the most important things. As investors, we want as much certainty as possible. Contractual conversion with a preset trigger and conversion factor removes the layer of regulatory uncertainty that bedevils most other approaches.

He highlights one concern that has been of interest to the Fed, and which seems to be the thing that industry professionals focus on when I discuss this with them:

If such a structure is for the best in most states of the world, why does it not already exist? At least two legitimate concerns have been raised. First, might market-based triggers invite speculative attack by short-sellers? The concern is that CoCo holders may be able to shortsell a bank’s equity to force conversion, then using the proceeds of a CoCo conversion to cover their short position.

There are several practical ways in which the contract design of CoCos could lean against these speculative incentives. Perhaps the simplest would be to base the conversion trigger on a weighted average of equity prices over some prior interval – say, 30 days. That would require short-sellers to fund their short positions for a longer period, at a commensurately greater cost. It would also create uncertainty about whether conversion would indeed occur, given the risk of prices bouncing back and the short-seller suffering a loss. Both would act as a speculative disincentive.

A second potential firewall against speculative attack could come from imposing restrictions on the ability of short-sellers to cover their positions with the proceeds of conversion.

I like the first solution and am particularly gratified that he chose essentially the same VWAP measurement period that I chose as a basis for discussion.

I don’t like the second firewall. Stock is stock is stock. Everybody knows you can’t cheat an honest man, right? Well, you can’t manipulate a healthy stock, either. Not on the scale of a 30-day VWAP, you can’t.

A related concern is that CoCos alter the seniority structure of banks’ capital, as holders of CoCos potentially suffer a loss ahead of equity-holders. But provided the price at which CoCos convert to equity is close to the market price, conversion does not transfer value between existing equity-holders and CoCo investors. And provided conversion is into equity it need not imply investor loss. If a market move really is unjustified, prices will correct over time towards fundamentals. The holder of a converted CoCo will then garner the upside.

I don’t understand this bit. As long as the trigger/conversion price is set well below the market price at CoCo issue time (I suggested that “half” was a good figure), then CoCos will retain significant first-loss protection.

MAPF Financials & Transactions Published

Monday, March 28th, 2011

I am pleased to announce that the 2010 Audited Financial Statements and 2010 Transaction Detail for Malachite Aggressive Preferred Fund have been published.

SEC Market Structure Report a Disappointment

Saturday, March 26th, 2011

On February 18 – sorry, I’ve been busy – the SEC released the RECOMMENDATIONS REGARDING REGULATORY RESPONSES
TO THE MARKET EVENTS OF MAY 6, 2010
, which is the Summary Report of the Joint CFTC-SEC Advisory Committee on Emerging Regulatory Issues.

I found it rather disappointing, but this is unsurprising. On February 7 I passed on a Reuters report in which it was stated:

While “Sunshine” laws have prevented the committee from regularly meeting, [Nobel Prize-winning finance professor at New York University Robert] Engle said the subcommittee has discussed a bevy of sometimes esoteric market structure issues

In other words, they knew that their process wouldn’t withstand scrutiny, so they hashed it all out in the back rooms instead.

The report in Bloomberg harshly criticized the recommendation for the “trade-at” rule:

Individual investors could be hurt should regulators alter an equities-trading rule limiting the prices at which brokers can execute orders away from public markets, an executive at TD Ameritrade Holding Corp. said.

An eight-member committee urged the Securities and Exchange Commission in a report yesterday to adopt a restriction called a trade-at rule. It would prevent venues and brokerages from executing orders within their walls unless they improve pricing by a specified amount versus the market’s best level.

“I was disappointed,” Nagy, a managing director for order routing, sales and strategy at the third-largest retail brokerage by client assets, said in an interview. “The report appears to be a politically motivated stalking horse to implement the trade-at rule. A trade-at would serve to increase costs for retail investors by creating an inconsistent trading experience.”

We never see TD criticizing the regulators so heartily in Canada. The regulatory-industry complex in Canada is way too cosy, as discussed on March 15.

Be that as it may, the committee was good enough to state the purpose of the report quite clearly:

One additional, specific point of background is appropriate to mention at the outset. The broad, visible, and often controversial, topic of High Frequency Trading (HFT)— including the definition of the practice, its impact on May 6, and potentially systemic benefits and problems that arise from the growing volume of HFT participants in all of our markets—has been pervasive in our discussions and in comments received from others. Rather than detail specific recommendations about HFT in this report, steps to address issues associated with this practice are evident throughout our report.

In other words, the committee was set up to do a hatchet job on HFT and eagerly went about its task of pleasing the established players, who are most upset that arrivistes are introducing competition to their comfortable lives. This serves – unsurprisingly – as a continuation of the intellectually dishonest Flash Crash report.

Anyway, back to the report – while skipping over the recommendations that don’t interest me! – which makes a point of telling the committee’s paymasters what an excellent job they’re doing:

The Committee supports the SEC’s “naked access” rulemaking and urges the SEC to work closely with FINRA and other Exchanges with examination responsibilities to develop effective testing of sponsoring broker-dealer risk management controls and supervisory procedures.

So what’s wrong with naked access? I mean, really? The official line:

According to the SEC: “The new rule prohibits broker-dealers from providing customers with ‘unfiltered’ or ‘naked’ access to an Exchange or ATS. It also requires brokers with market access – including those who sponsor customers’ access to an Exchange or ATS – to put in place risk management controls and supervisory procedures to help prevent erroneous orders, ensure compliance with regulatory requirements, and enforce pre-set credit and capital thresholds.”

I would like to see a lot more discussion of access as an economic transaction. Say we’ve got a small firm trading its own capital (call it $10-million) as principal. Why can’t the exchanges and marketplaces offer them direct access themselves? I have no idea what the requirements are for gaining such access, but I’ll bet it involves a lot of regulatory expense and rigamarole that is completely unnecessary in such a case.

Why isn’t it happening? What are the risks? What controls can be justified? And how would it interact with the rest of regulation?

Say, for instance, I am the risk manager at Very Big Brokerage Corp. (and I mean the real risk manager, not the clown with the title). And say, there is a marketplace (“Sleazy Trading Inc.”) that I’m not happy with, in terms of counterparty risk. I’ve looked at their controls and their access requirements and come to the conclusion that if I execute a big trade that makes a lot of money for me prior to settlement, I’m taking on too much exposure to the notion that the trade won’t settle. Or maybe I have made a decision on how much exposure I’m willing to take with Sleazy, and they’re currently over the limit.

Now, I’ve got a client order to sell 10-million shares of IBM and wouldn’t you know it, there’s a good bid – the best bid – for 10-million shares at Sleazy Trading. Will the regulations allow me to ignore it? I don’t believe so. And that is a problem.

In Canada, there are strong inducements that say that each “protected marketplace” is as good as any other protected marketplace.

We also applaud the CFTC requesting comment regarding whether it is appropriate to restrict large order execution design that results in disruptive trading. In particular, we believe there are questions whether it is ever appropriate to permit large order algorithms that employ unlimited use of market orders or that permit executions at prices which are a dramatic percentage below the present market price without a pause for human review.

Accordingly:
7. The Committee recommends that the CFTC use its rulemaking authority to impose strict supervisory requirements on DCMs or FCMs that employ or sponsor firms implementing algorithmic order routing strategies and that the CFTC and the SEC carefully review the benefits and costs of directly restricting “disruptive trading activities “with respect to extremely large orders or strategies.

Note how careful they are in restricting their concerns to “large orders”. In other words Stop-Loss orders, beloved of the brokerage community because they’re so insanely profitable, are not in the scope of this recommendation.

But, as I argued in the November, 2010, edition of PrefLetter, Stop-Loss orders appear to have been the exacerbating cause that turned a sharp decline into a rout. But the sheer size of the Stop-Loss avalanche only made it into one insignificant speech – never into any official report of any kind. Ms. Schapiro’s speech was reported on PrefBlog in an update to the post The Flash Crash: The Impact of High Frequency Trading on an Electronic Market.

Perhaps the committee’s most laughable recommendation is:

We therefore believe that the Commission should consider encouraging, through incentives or regulation, persons who regularly implement marker maker strategies to maintain best buy and sell quotations which are “reasonably related to the market.”

We recognize that many High Frequency Traders are not even broker-dealers and therefore their compliance with quoting requirements would have to be addressed primarily through pricing incentives. We note that these incentives might be effectively interconnected with the peak load pricing discussed above.
Accordingly:
9. The Committee recommends that the SEC evaluate whether incentives or regulations can be developed to encourage persons who engage in market making strategies to regularly provide buy and sell quotations that are “reasonably related to the market.”

Earth to Committee: Market Making loses money in a directional market. There is no amount of exchange pricing incentive that can possibly counteract this fact.

The original Flash Crash report makes some useful classifications of market participants:

In order to examine what may have triggered the dynamics in the E-Mini on May 6, over 15,000 trading accounts that participated in transactions on that day were classified into six categories: Intermediaries, HFTs, Fundamental Buyers, Fundamental Sellers, Noise Traders, and Opportunistic Traders.

Opportunistic Traders are defined as those traders who do not fall in the other five categories. Traders in this category sometimes behave like the intermediaries (both buying and selling around a target position) and at other times behave like fundamental traders (accumulating a directional long or short position). This trading behavior is consistent with a number of trading strategies, including momentum trading, cross-market arbitrage, and other arbitrage strategies.

It seems to me that if you want to encourage tranquility of market prices, you should be concentrating on the potential for getting contra-flow orders from Opportunistic Traders, rather than market makers; and the only way I can see that being done by regulators is encouraging the development and execution of opportunistic algorithms by “real money” accounts, rather than discouraging this process.

The committee has another recommendation good for not much more than a laugh:

Accordingly:
10. The Committee recommends that the SEC and CFTC explore ways to fairly allocate the costs imposed by high levels of order cancellations, including perhaps requiring a uniform fee across all Exchange markets that is assessed based on the average of order cancellations to actual transactions effected by a market participant.

Central planning at its finest, complete with the implicit assertion that prices can only be fair if they are both uniform and approved by the central planners. If data flow from order cancellations gets to be a problem, it’s easy enough to sever connection with the offending marketplace – which should be sufficient to ensure that fees are put in place to charge the cancellers and rebate the other participants. But, oops, sorry, not possible to sever connections. One market’s as good as any other – just ask the regulators.

The “Trade-At” recommendation is number 11; the committee’s justification is:

We believe, however, that the impact of the substantial growth of internalizing and preferencing activity on the incentives to submit priced order flow to public exchange limit order books deserves further examination. While the SEC has properly concluded in the past that permitting internalization and preferencing, even accompanied by payment for order flow agreements, increases competition and potentially reduces transaction costs, we believe the dramatic growth argues for further analysis. Notable in the trading activity of May 6 was the redirection of order flow by internalizing and preferencing firms to Exchange markets during the most volatile periods of trading. While these firms provide significant liquidity during normal trading periods, they provided little to none at the peak of volatility.

The last sentence is simply so much horseshit. The original Flash Crash report makes it quite clear that orders were routed to the public exchanges only when the internalizers has provided so much liquidity that they were up to their position limits.

The recommendation simply shows the committee’s total lack of comprehension of the market maker’s role; additionally, they didn’t waste their precious Nobel Prize-winning brain power discussing – or even considering – the possibility that such requirements will make internalization less profitable, therefore (surprise!) leading to a lower allocation of capital and therefore (surprise!) increasing the odds that another market break will exhaust that capital.

Update: Public comments are available.

Update: The CME comment letter recommends that regulators keep their cotton-picking hands off algorithms:

Large orders represent demand for liquidity and that demand necessarily informs price discovery. Participants typically rely on algorithms to execute large orders today precisely because sophisticated algorithms can employ intelligent real time analytics that allow traders to significantly reduce the market impact of their orders and enhance the quality of their execution. As discussed in our previously referenced letter on this topic, we do not believe the Commissions are equipped or should be involved in regulating the design of algorithms, and should instead focus on regulating conduct that is shown to be harmful to the market.

It also points out:

CME Group does not believe that high frequency traders, however such traders are in fact defined, should be required by third parties to put their own capital at risk when it is unprofitable to do so. High frequency traders, like other independent traders who are uncompensated by the trading venue, should quote responsibly based upon their ability to responsibly manage the risks associated with the orders they place. It would be extremely irresponsible for a high frequency trader, or any other trader, to continue to operate an algorithm under conditions in which it was not designed to operate or when the inputs to the algorithm are not reliable. Doing so could potentially put the firm itself at risk and arguably subject the firm to regulatory exposure if their algorithm malfunctioned and created or exacerbated a disruption in the market.

Rules that would undermine a trading firm’s own risk management processes by creating affirmative trading obligations in highly volatile periods are misguided. Assuming participants in fact complied with such obligations, which they likely would not, this “cure” would simply lead to the depletion of market making capital and result in less liquid and more volatile markets.

With respect to cancellation fees:

As an initial matter, the Committee has not identified how the market will be served by this proposal or how it will enhance the stability of markets. Other than apparently seeking to impose a tax on a high frequency trading, the objective is unclear.

CME Group additionally employs a CME Globex Messaging Policy that is broadly designed to encourage responsible messaging practices and ensure that the trading system maintains the responsiveness and reliability that supports efficient trading. Under this policy, CME Group establishes messaging benchmarks based on a per-product volume ratio which measures the number of messages submitted to the volume executed in a given product. These benchmarks are tailored to the liquidity profile of the contract to ensure that contract liquidity is not compromised. CME Group works with firms who exceed the benchmarks to refine their messaging practices and failure to correct excessive messaging results in a surcharge billed to the clearing firm.

Knight Capital’s letter commits lese majeste by asking for data:

Many have posed the following question time and again:
“What is the quantitative and qualitative justification for taking steps to change or slow internalization?”

To date, there has been no answer offered and no credible data presented to support such a dramatic shift in market structure.

and with respect to Trade-At:

In short, there has been no qualitative or quantitative data offered to suggest that such shift in market structure is warranted. Rather, the evidence offered in support has been anecdotal at best. As a result, we strongly encourage the SEC to proceed with the same thoughtful consideration that has guided its decisions in the past. It should demand empirical data, and thoroughly vet that data before making any determination to propose such a rule.