Archive for October, 2014

October 23, 2014

Friday, October 24th, 2014

It would appear that Parakeet Poluz was instructed to say some upleasant things at Wednesday’s aborted press conference:

Our outlook for the global economy continues to show stronger momentum in 2015 and 2016, but the profile has been downgraded since July. The good news for Canada is that the U.S. economy is gaining traction, particularly in sectors that are beneficial to Canada’s exports.

And our exports do appear to be responding, with some additional help from a lower Canadian dollar. Our conversations with exporters indicate that they are seeing a better export outlook from the ground.

However, it is clear that our export sector is less robust than in previous cycles. Last spring, as you may recall, we identified which non-energy subsectors could be expected to lead the recovery in exports, and which would not.

We have since investigated in more detail the subsectors that have been underperforming. After sifting through more than 2,000 product categories, we have found that the value of exports from about a quarter of them has fallen by more than 75 per cent since the year 2000. Had the exports of these products instead risen in line with foreign demand, they would have contributed about $30 billion in additional exports last year.

By correlating these findings with media reports, we could see that many were affected by factory closures or other restructurings. In other words, capacity in these subsectors has simply disappeared. This analysis helps us understand a significant portion of the gap in export performance.

Our research also tells us that most of the sectors expected to lead the non-energy export recovery still have some excess capacity. Our Business Outlook Survey (BOS) interviews indicate that while companies plan to invest in new machinery and equipment, few are planning to expand their capacity, at least so far. This helps explain why business investment might be delayed relative to what would be expected in a normal cycle.

Another important building block of our policy framework is the neutral rate of interest. Carolyn discussed this in an important speech last month; there is also a discussion paper about it, and a box in this MPR. The neutral rate, too, is uncertain. We estimate that it now lies between 3 and 4 per cent, which is well below pre-crisis levels. But since the difference between current rates and the neutral rate is our best estimate of monetary stimulus, understanding the risks around this is also important.

After weighing these considerations, it is our judgment at this time that the risks around achieving our inflation objective over a reasonable time frame are roughly balanced. Accordingly, we believe that the current level of monetary stimulus remains appropriate.

Some of you may be wondering why we aren’t being more specific about the likely future stance of monetary policy. Let me answer by saying that forward guidance remains a key element of the policy tool kit – but one that we will reserve for times when we believe there are net benefits to its use. There will no doubt come a day when we will offer forward guidance again – but not this day.

David Parkinson of the Globe is impressed:

Bank of Canada Governor Stephen Poloz has just sat Canadians down and given us a national the-dog-has-died talk. The country lost some things in the Great Recession that ain’t never coming back.

Until recently, opening remarks for MPR press conferences were word-for-word regurgitations of the bank’s interest-rate-setting statements released at the same time as the MPR. That all changed in July, when Mr. Poloz used his opening statement to provide a detailed explanation of how the bank was interpreting inflation risks. He has now followed this up with October’s frank statement.

For people (including me) who have gone through years and multiple Bank of Canada governors playing “find the hidden meaning” in cryptic central-bank speak, this may take some getting used to. But Mr. Poloz is a pretty folksy guy, at least as far as central bank bosses go. Expect him to continue to pull us aside as a nation once in a while for these friendly and plain-spoken chats, even if the message is sometimes hard to hear.

The Toronto Stock Exchange has issued a corporate plan titled Reshaping Canada’s Equities Trading Landscape:

Today, we again find ourselves at a point where industry challenges require decisive action to preserve the efficiency and integrity of our markets. There are three significant issues that require our attention and action:
  • • Canadian order flow is migrating to the United States (U.S.)
  • • Technology-driven markets are not optimized to serve all
  • • Market complexity is on the rise

We have examined each of these issues at great length and through extensive consultation with our clients and a broad group of other market participants. After careful analysis we are now proposing bold steps to tackle each one.

Huh. It was consultation and deep thought that have led to the current practice of selling Last Quotes instead of Closing Quotes. So their claim of consultation, in and of itself, does not impress me.

The first section is titled Canadian order flow is migrating to the U.S.:

In the U.S., market structure allows wholesalers and other intermediaries to offer attractive options to Canadian securities dealers. In return for the order flow of certain types of natural investors in the most active Canadian securities, dealers receive executions with more favourable economics.

However, the same model cannot be replicated in Canada within the existing regulatory framework including rules governing fair access, banning payment for order flow between dealers and setting minimum standards for price improvement when trading with dark orders.

As a result, some Canadian dealers are considering – or have already begun – changing their order routing practices to execute immediately tradable (active) Canadian retail and institutional flow with U.S. wholesalers, rather than on our domestic public markets. This movement of liquidity to the U.S. represents a serious risk to the quality and vibrancy of Canada’s capital markets as a whole, and may have irreversible consequences.

They’re talking about market orders of retail clients. It’s nice to see some recognition that the regulatory environment is harmful to Canadian interests.

In June 2015, we plan to introduce an innovative trading model on Alpha that will significantly improve the economics and quality of execution for active natural order flow, while improving trading conditions for liquidity providers willing to commit to a minimum order size.

The new Alpha model is built on the premise that most active institutional and retail order flow values certainty and size of execution over speed, and that dealers executing those orders seek to minimize trading costs while meeting best execution obligations.

The superior execution will be achieved by applying an order processing delay (a “speed bump”) for orders that have the potential to remove liquidity from the order book, enforcing a minimum size for liquidity providing orders and providing rebates for active flow.[Footnote: TSX has filed a patent application]

A speed bump will be imposed on orders that have the potential to trade with passive liquidity – specifically, all orders not designated as Post Only. The speed bump will be applied equally to these orders of all participants – natural investors and others – and is expected to be set between 5 and 25 milliseconds.

Post Only liquidity providing orders will not be subject to a processing delay, allowing liquidity providers to effectively manage their risk.

The speed bump will discourage latency sensitive active strategies, but will not deter active natural order flow for which a delay in milliseconds is insignificant. This means that providers of passive liquidity will have an increased likelihood of interacting with active orders of natural investors, while being protected against opportunistic, latency sensitive active strategies.

Increased interaction with natural investors combined with the ability to bypass the speed bump when managing passive orders will encourage liquidity provision, better visible prices and an increase in displayed volume, resulting in better execution for natural order flow.

In return for bypassing the speed bump, all Post Only orders will be subject to minimum size requirements.

The size threshold will ensure that liquidity providers post sufficient volume against which active orders can execute, contributing to higher average trade sizes, as well as improved fill quality and fill rates for natural active order flow.

This, in turn, will minimize the signaling of liquidity bound for other markets and will reduce market impact. Recognizing that securities exhibit a variety of liquidity profiles, the minimum volume requirement may differ across symbols.

An inverted maker/taker fee model will provide a rebate for active orders, reducing trading fees for retail and institutional dealers and any other non-latency sensitive liquidity taking strategies.

It’s not clear to me whether or not the speed bump will apply to a limit order meeting the Post Only minimum size requirements that can interact with existing resting orders; e.g., what happens if I post a limit order to buy at 25.11 when there’s an extant resting offer at 25.10? And does it matter if my buy is for larger or smaller size than the offer? How about if it’s more than double the size of the offer, so the net change in resting orders would be positive after execution?

The second section is titled Technology-driven markets are not optimized to serve all:

As we embrace this change in technology-driven capital markets, it has become clear that in an environment where some participants increasingly compete on speed, others are challenged and concerned about compromised quality of execution and market integrity.

Specifically, apprehensions around excessive short-term intermediation, the technology race to zero latency and the disenfranchising of the human trader have eroded some participants’ confidence in a market that is meant to balance the needs of all stakeholders.

“disenfranchising of the human trader”, I bet! Prep School weenies can’t cut it in the new meritocracy. And that kindergarten level drivel about ‘a market that is meant to balance the needs of all stakeholders’ is ridiculous. It’s a market. You buy things, you sell things. If you’re good, you do well. If you’re an ignorant bag of dirt, you whimper to the regulators and hope that one of them’s a relative of a friend of Daddy’s.

In Q4 2015, TSX and TSXV plan to implement changes which will enhance the quality of execution for natural investors and their dealers – both retail and institutional – by rewarding those willing to commit liquidity to the book for a period of time by using the new Long Life 2 order type.

Long Life orders will be committed to a minimum resting time in the book – measured in seconds – and cannot be cancelled during that time. In return for providing committed liquidity, these orders will receive priority over orders at the same price that are not subject to the minimum resting time. Trade allocation therefore becomes Price/Broker/Long Life/Time rather than the current Price/Broker/Time matching sequence.

By choosing to use the Long Life order type, natural investors, their dealers and other non-latency sensitive participants will be able to more effectively and confidently participate in the markets without having to compete on speed.

This is somewhat similar to the concept of minimum order exposure times (MOET), which was discussed extensively on April 3, 2014, although in this case the MOET will be both voluntary and set by the exchange, which is greatly preferable to a mandatory MOET set by regulators. To refresh your memory of that spring discussion:

In fact, I have learned from a paper by Charles M. Jones of Columbia Business School titled What do we know about high-frequency trading? that:

He also points out – bless the man – that:
Minimum order exposure times: Under these proposals, submitted orders could not be cancelled for at least some period of time, perhaps 50 milliseconds. This would force large changes in equity markets and could severely discourage liquidity provision. The economic rationale here is particularly suspect, as the overriding goal in market design should be to encourage liquidity provision.

Securities transaction taxes: The evidence indicates that these taxes reduce share prices, increase volatility, reduce price efficiency, worsen liquidity, increase trading costs, and cause trading to move offshore.


He is referring to frequent batch auctions, which were discussed on PrefBlog on March 19. It was also given a brief mention in the CFTC Concept Release on Risk Controls and System Safeguards for Automated Trading Environments, which also asked a question dear to Assiduous Reader PL’s heart:

96. Should exchanges impose a minimum time period for which orders must remain on the order book before they can be withdrawn? If so, should this minimum resting time requirement apply to orders of all sizes or be restricted to orders smaller than a specific threshold? If there should be a specific threshold, how should that threshold be determined?

99. Would batched order processing increase the number of milliseconds that are necessary for correlations among related securities to be established? If so, what specific costs would result from this change and how do those costs compare to the potential benefits described in recent research?

The comment period on this concept release was extended to Valentine’s Day; fifty-seven comments have been published on the CFTC website. I simply do not have time to comb through all these things, especially since it would seem that this is viewed as simply a preliminary skirmish in a long war, but I did read a comment by Thomas McCabe of One Chicago LLC:

Market participants should be free to enter, cancel, or cancel/replace their orders at will, as they assume the risk of execution or non-execution. Exchanges are in a unique position to understand the strain on their systems caused by orders and should be allowed to independently govern throughput into those systems. Accordingly, we oppose the Commission mandating that exchanges impose minimum time periods for orders.

Anyway, with respect to the Toronto Stock Exchange proposals, the first problem I can see is that “Long Life” orders will go stale. Stale on a time-frame of milliseconds, but still stale; they will therefore find themselves predated by nimbler HFT firms who will make a practice of arbitraging small ticks in highly correlated stocks. Whether or not that will offset the benefits is something I don’t know, although I suspect not.

Another issue, probably minor, is that cash management may become more difficult, because having more limit orders on the board than you actually need to execute in order to achieve your cash objectives may lead to more situations in which you overshoot your target because you can’t cancel quickly enough.

The third section of the Toronto Exchange proposals is titled Market complexity is on the rise:

We plan to close TMX Select and decommission Alpha IntraSpread in June 2015.

With this change, we will reduce complexity, fragmentation and dealer costs without compromising on choice. The mandate
to provide a premium destination for active retail order flow, previously maintained by Alpha IntraSpread and TMX Select,
will now be fulfilled by the new Alpha model.

So this section is just a joke; the bank-owned exchange taking advantage of the monopoly for which it is paying the regulators.

Boyd Erman of the Globe points out:

Because the TMX is heavily regulated, all the changes will require both regulatory review and comment from market users. That will take months, and so [head of the TMX equity trading businesses ] Mr. [Kevan] Cowan said the company is hoping to have the changes in place by June.

I will be most interested in the comment letters. One thing that puzzles me at this point is the distribution of orders by the exchange itself. Say a market buy order comes into Alpha (sender expecting a rebate) and the best offer is on the TMX (limit order placer expecting a rebate). Who gets paid? How will uncertainty over payment factor into the various decisions? Game theory, here we come!

Finally, equities continued bouncing:

U.S. stocks rallied, recovering from yesterday’s loss, as earnings from Caterpillar (CAT) Inc. to 3M Co. exceeded analysts’ estimates and data signaled stronger growth in the European economy.

Benchmark indexes pared gains following a New York Post report that a doctor who had been treating Ebola patients in Africa was rushed to a New York hospital with symptoms of the virus. The paper cited unnamed sources.

The S&P 500 gained 1.2 percent to 1,950.82 at 4 p.m. in New York after earlier surging as much as 1.8 percent. The index recouped losses from yesterday, when it slid 0.7 percent.

The S&P 500 has risen five times in the past six days, pushing the gauge up 4.7 percent since Oct. 15 and recouping about half the losses from a selloff that began in mid-September. The equity benchmark is still down 3 percent from a record.

Economic data today suggested the euro-area economy may have moved one step away from another recession. A Purchasing Managers’ Index showed manufacturing in the region unexpectedly grew this month, while Spain’s economy showed signs of a further recovery, with third-quarter unemployment dropping to the lowest level since 2011. In Germany, factories rebounded from a slump in September.

Fewer Americans filed applications for unemployment benefits over the past month than at any time in 14 years as an improving economy prompted employers to hold on to staff. The four-week average of jobless claims, a less-volatile measure than the weekly figure, dropped to 281,000, the lowest since May 2000, from 284,000 the week before, a Labor Department report showed.

It was a good day for the Canadian preferred share market, with PerpetualDiscounts up 14bp, FixedResets gaining 12bp and DeemedRetractibles winning 15bp. Volatility was low. Volume was extremely low, with the highlights comprised entirely of FixedResets.

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 3.15 % 3.14 % 20,063 19.35 1 0.1681 % 2,653.7
FixedFloater 0.00 % 0.00 % 0 0.00 0 -1.0972 % 3,944.1
Floater 3.03 % 3.14 % 64,145 19.38 4 -1.0972 % 2,648.3
OpRet 4.04 % 1.42 % 100,999 0.08 1 0.0788 % 2,737.9
SplitShare 4.29 % 3.91 % 81,619 3.81 5 -0.0159 % 3,152.0
Interest-Bearing 0.00 % 0.00 % 0 0.00 0 0.0788 % 2,503.5
Perpetual-Premium 5.48 % -0.24 % 71,727 0.08 18 0.0583 % 2,458.8
Perpetual-Discount 5.30 % 5.14 % 95,824 15.15 18 0.1381 % 2,604.8
FixedReset 4.22 % 3.61 % 166,874 16.73 75 0.1202 % 2,554.5
Deemed-Retractible 5.02 % 2.11 % 101,617 0.34 42 0.1480 % 2,566.1
FloatingReset 2.55 % -6.10 % 58,635 0.08 6 0.0327 % 2,546.3
Performance Highlights
Issue Index Change Notes
PWF.PR.A Floater -4.00 % Moderately real. There were some trades at 19.50.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-10-23
Maturity Price : 19.20
Evaluated at bid price : 19.20
Bid-YTW : 2.72 %
CIU.PR.C FixedReset 1.96 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-10-23
Maturity Price : 20.80
Evaluated at bid price : 20.80
Bid-YTW : 3.46 %
Volume Highlights
Issue Index Shares
Traded
Notes
NA.PR.W FixedReset 70,905 Recent new issue.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-10-23
Maturity Price : 23.09
Evaluated at bid price : 24.85
Bid-YTW : 3.63 %
TRP.PR.E FixedReset 34,090 TD crossed 25,000 at 25.21.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-10-23
Maturity Price : 23.23
Evaluated at bid price : 25.20
Bid-YTW : 3.71 %
BMO.PR.T FixedReset 20,550 YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-10-23
Maturity Price : 23.31
Evaluated at bid price : 25.43
Bid-YTW : 3.58 %
BAM.PF.G FixedReset 20,159 Recent new issue.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-10-23
Maturity Price : 23.16
Evaluated at bid price : 25.10
Bid-YTW : 4.20 %
ENB.PF.A FixedReset 19,525 YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-10-23
Maturity Price : 23.20
Evaluated at bid price : 25.13
Bid-YTW : 4.05 %
TRP.PR.A FixedReset 16,178 YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-10-23
Maturity Price : 21.50
Evaluated at bid price : 21.50
Bid-YTW : 3.92 %
There were 13 other index-included issues trading in excess of 10,000 shares.
Wide Spread Highlights
Issue Index Quote Data and Yield Notes
PWF.PR.A Floater Quote: 19.20 – 20.50
Spot Rate : 1.3000
Average : 1.1155

YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-10-23
Maturity Price : 19.20
Evaluated at bid price : 19.20
Bid-YTW : 2.72 %

NEW.PR.D SplitShare Quote: 32.65 – 33.13
Spot Rate : 0.4800
Average : 0.3627

YTW SCENARIO
Maturity Type : Call
Maturity Date : 2015-06-26
Maturity Price : 32.07
Evaluated at bid price : 32.65
Bid-YTW : 1.93 %

PVS.PR.B SplitShare Quote: 24.81 – 25.12
Spot Rate : 0.3100
Average : 0.1959

YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2019-01-10
Maturity Price : 25.00
Evaluated at bid price : 24.81
Bid-YTW : 4.72 %

CGI.PR.D SplitShare Quote: 25.24 – 25.80
Spot Rate : 0.5600
Average : 0.4530

YTW SCENARIO
Maturity Type : Soft Maturity
Maturity Date : 2023-06-14
Maturity Price : 25.00
Evaluated at bid price : 25.24
Bid-YTW : 3.69 %

ELF.PR.F Perpetual-Discount Quote: 24.20 – 24.47
Spot Rate : 0.2700
Average : 0.1738

YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-10-23
Maturity Price : 23.95
Evaluated at bid price : 24.20
Bid-YTW : 5.50 %

BNS.PR.P FixedReset Quote: 25.30 – 25.51
Spot Rate : 0.2100
Average : 0.1313

YTW SCENARIO
Maturity Type : Call
Maturity Date : 2018-04-25
Maturity Price : 25.00
Evaluated at bid price : 25.30
Bid-YTW : 2.97 %

BPO.PR.A Firm On Excellent Volume

Friday, October 24th, 2014

Brookfield Office Properties Inc., a division of Brookfield Property Partners (NYSE: BPY; TSX: BPY.UN), has announced:

the completion of its previously announced Preferred Shares, Series AA issue in the amount of C$300 million. The offering was underwritten by a syndicate led by RBC Capital Markets, CIBC, Scotia Capital Inc. and TD Securities Inc.

Brookfield Office Properties issued 12.0 million Preferred Shares, Series AA at a price of C$25.00 per share yielding 4.75% per annum for the initial period ending December 31, 2019. Net proceeds from the issue will be used for general corporate purposes, including, but not limited to, repayment of revolving debt, acquisitions, capital expenditures and working capital needs. There are no acquisitions at this time for which Brookfield Office Properties is intending to use the net proceeds of this offering.

The Preferred Shares, Series AA will commence trading on the Toronto Stock Exchange on October 23, 2014 under the ticker symbol BPO.PR.A.

BPO.PR.A is a FixedReset, 4.75%+315, announced October 7. The issue will be tracked by HIMIPref™ but relegated to the Scraps index on credit concerns.

BPO.PR.A traded 1,154,714 shares today (consolidated exchanges) in a range of 24.92-25.01 before closing at 24.96-00, 3×177. Vital statistics are:

BPO.PR.A FixedReset YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-10-23
Maturity Price : 23.13
Evaluated at bid price : 24.95
Bid-YTW : 4.52 %

Implied Volatility is still very high, implying that

  • investors have incorporated a lot of expectation of price directionality in their forecasts for these issues, and
  • investors are paying too much for the lower-reset issues, relative to the higher-reset issues
ImpVol_BPO_FR_141023

PIC.PR.A To Get Bigger

Thursday, October 23rd, 2014

Strathbridge Asset Management Inc. has announced:

Premium Income Corporation (the “Fund”) (TSX:PIC.A)(TSX:PIC.PR.A) is pleased to announce that it has filed a preliminary short form prospectus relating to a treasury offering of preferred shares and class A shares. Investors may purchase preferred shares or class A shares by way of cash payment or through an exchange of freely tradable shares of the five banks included in the portfolio and of shares of the National Bank of Canada. For any purchase by way of exchange in excess of $1 million purchasers may elect to defer any accrued gains through a tax-deferred rollover.

The Fund invests in a portfolio consisting principally of common shares of Bank of Montreal, The Bank of Nova Scotia, Canadian Imperial Bank of Commerce, Royal Bank of Canada and The Toronto- Dominion Bank (the “Banks”). To generate additional returns above the dividend income earned on the Fund’s portfolio, the Fund will selectively write covered call options in respect of some or all of the common shares in the Fund’s portfolio. The Fund may also, from time to time, write cash-covered put options in respect of securities in which the Fund is permitted to invest. The manager and investment manager of the Fund is Strathbridge Asset Management Inc.

The preferred shares pay fixed cumulative preferential quarterly cash distributions in the amount of $0.215625 ($0.8625 per annum) per preferred share representing a yield of 5.75% on the original issue price of $15.00. The class A shares currently pay quarterly distributions in the amount $0.20319 ($0.81276 per annum) per class A share.

The syndicate of agents for the offering is being led by Scotiabank and RBC Capital Markets and includes BMO Capital Markets, CIBC, National Bank Financial Inc., TD Securities Inc., Raymond James Ltd., Canaccord Genuity Corp., Desjardins Securities Inc., Dundee Securities Ltd. and Mackie Research Capital Corporation.

For further information, please contact Investor Relations at 416.681.3966, toll free at 1.800.725.7172, email at info@strathbridge.com or visit www.strathbridge.com.

PIC.PR.A was last mentioned on PrefBlog at the time of its rights expiry in December 2012. PIC.PR.A is tracked by HIMIPref™ but is relegated to the Scraps index on credit concerns.

Update, 2014-10-30: Strathbridge has announced:

Premium Income Corporation (the “Fund”) (TSX:PIC.A)(TSX:PIC.PR.A) is pleased to announce the exchange ratios for the Fund’s exchange option with respect to its follow-on offering. Under the exchange option, investors could purchase Units of the Fund, consisting of one Class A share and one Preferred share by way of an exchange of freely tradable shares of the five banks included in the Fund’s portfolio and of shares of the National Bank of Canada (the “Exchange Eligible Issuers”). For any purchase by way of exchange in excess of $1 million purchasers may elect to defer any accrued gains by completing a joint election with the Fund to achieve a tax-deferred rollover.

Under the exchange option, the number of Units issuable in exchange for shares of any Exchange Eligible Issuer was determined by dividing the adjusted weighted average trading price of the respective Exchange Eligible Issuer on the TSX for the three consecutive trading days ended October 28, 2014 by the Unit Offering price of $24.52 (consisting of one Class A Share at a price of $8.92 and one Preferred Share at a price of $15.60). Fractional Units will not be issued. The following table outlines the adjusted weighted average trading price and the exchange ratio for each respective Exchange Eligible Issuer. The Exchange Ratio indicates the number of Units of the Fund to be received for each share of an Exchange Eligible Issuer.

Exchange Eligible Issuer TSX Ticker Symbol Adjusted Weighted Average Trading Price Exchange Ratio
Bank of Montreal BMO $81.04 3.3051
The Bank of Nova Scotia BNS $68.15 2.7794
Canadian Imperial Bank of Commerce CM $101.48 4.1387
National Bank of Canada NA $52.59 2.1448
Royal Bank of Canada RY $79.19 3.2296
The Toronto-Dominion Bank TD $54.47 2.2215

The Fund invests in a portfolio consisting principally of common shares of Bank of Montreal, The Bank of Nova Scotia, Canadian Imperial Bank of Commerce, Royal Bank of Canada and The Toronto-Dominion Bank (the “Banks”). To generate additional returns above the dividend income earned on the Fund’s portfolio, the Fund will selectively write covered call options in respect of some or all of the common shares in the Fund’s portfolio. The Fund may also, from time to time, write cash-covered put options in respect of securities in which the Fund is permitted to invest. The manager and investment manager of the Fund is Strathbridge Asset Management Inc.

The Fund intends to file a final prospectus tomorrow morning (October 31, 2014) in each of the Provinces of Canada in connection with the offering. The offering is expected to close on or about November 10, 2014 and is subject to customary closing conditions including approvals of applicable securities regulatory authorities and the TSX.

The Preferred shares pay fixed cumulative preferential quarterly cash distributions in the amount of $0.215625 ($0.8625 per annum) per Preferred share representing a yield of 5.75% on the original issue price of $15.00. The Class A shares currently pay quarterly distributions in the amount $0.20319 ($0.81276 per annum) per Class A share.

The syndicate of agents for the offering is being led by Scotiabank and RBC Capital Markets and includes BMO Capital Markets, CIBC, National Bank Financial Inc., TD Securities Inc., Raymond James Ltd., Canaccord Genuity Corp., Desjardins Securities Inc., Dundee Securities Ltd. and Mackie Research Capital Corporation.

Update, 2014-11-28: They raised $22.1-million:

Premium Income Corporation (the “Fund”) is pleased to announce that it has completed a treasury offering of 900,000 class A shares and 900,000 preferred shares for aggregate gross proceeds of $22.1 million. The class A shares were priced at $8.92 per share and the preferred shares were priced at $15.60 per share. The pricing of the issue was determined so as to be non-dilutive to the most recently calculated net asset value per unit on the date of the pricing of the issue. The class A shares and the preferred shares will continue to trade on the Toronto Stock Exchange under the existing ticker symbols PIC.A and PIC.PR.A respectively.

October 22, 2014

Wednesday, October 22nd, 2014

With every day, the stock market’s gyrations grow:

U.S. stocks retreated, after the Standard & Poor’s 500 Index rose the most in a year yesterday, as energy shares led losses amid a drop in oil prices.

The S&P 500 slipped 0.7 percent to 1,927.11 at 4 p.m. in New York. The Dow Jones Industrial Average slid 153.49 points, or 0.9 percent, to 16,461.32. The Nasdaq Composite Index lost 0.8 percent. Crude oil slid 2.4 percent to $80.52 a barrel, the lowest level on a closing basis in more than two years, after a U.S. report showed inventories increased by 7.11 million barrels last week.

Four consecutive advances in the S&P 500 through yesterday pushed the gauge up 4.2 percent since Oct. 15, recouping half the losses from a selloff that began in mid-September. The equity index surged 2 percent yesterday, its best day since October 2013, as speculation the European Central Bank will boost stimulus to spur growth in the region.

The cost of living in the U.S. barely rose in September, leaving inflation below the Federal Reserve’s goal as fuel prices plunge this month. The consumer-price index climbed 0.1 percent after decreasing 0.2 percent in August, a Labor Department report showed.

… and there is chatter about currency wars:

Weak price growth is stifling economies from the euro region to Israel and Japan. Eight of the 10 currencies with the biggest forecasted declines through 2015 are from nations that are either in deflation or pursuing policies that weaken their exchange rates, data compiled by Bloomberg show.

“This beggar-thy-neighbor policy is not about rebalancing, not about growth,” David Bloom, the global head of currency strategy at London-based HSBC Holdings Plc, which does business in 74 countries and territories, said in an Oct. 17 interview. “This is about deflation, exporting your deflationary problems to someone else.”

Bloom puts it in these terms because, when one jurisdiction weakens its exchange rate, another’s gets stronger, making imported goods cheaper. Deflation is a both a consequence of, and contributor to, the global economic slowdown that’s pushing the euro region closer to recession and reducing demand for exports from countries such as China and New Zealand.

Hungary and Switzerland entered deflation in the past two months, while Swedish central-bank Deputy Governor Per Jansson last week blamed his country’s falling prices partly on rate cuts the ECB used to boost its own inflation. A policy response may be necessary, he warned.

But there will be no deflation in North America … will there?

The cost of living in the U.S. barely rose in September, restrained by decelerating prices for a broad array of goods and services that signal the Federal Reserve can keep interest rates low well into 2015.

The consumer-price index climbed 0.1 percent after decreasing 0.2 percent in August, a Labor Department report showed today in Washington. Over the past year, costs increased 1.7 percent, the same as in the 12 months through August.

While plunging fuel costs are one reason for the restraint in pricing, clothing retailers, medical-care providers and airlines are also among those keeping a lid on charges. With inflation falling short of the Fed’s goal, policy makers need not rush to raise rates even as the world’s largest economy shows no sign of succumbing to a slowdown in global growth.

… so the Bank of Canada is maintaining its policy rate:

The Bank of Canada today announced that it is maintaining its target for the overnight rate at 1 per cent. The Bank Rate is correspondingly 1 1/4 per cent and the deposit rate is 3/4 per cent.

Inflation in Canada is close to the 2 per cent target. Core inflation rose more rapidly than was expected in the Bank’s July Monetary Policy Report (MPR), mainly reflecting unexpected sector-specific factors. Total CPI inflation is evolving broadly as expected, as the pickup in core inflation was largely offset by lower energy prices. Underlying inflationary pressures are muted, given the persistent slack in the economy and the continued effects of competition in the retail sector.

In this context, Canada’s exports have begun to respond. However, business investment remains weak. Meanwhile, the housing market and consumer spending are showing renewed vigour and auto sales have reached record highs, all fuelled by very low borrowing rates. The lower terms of trade will have a tempering effect on income.

Canada’s real GDP growth is projected to average close to 2 1/2 per cent over the next year before slowing gradually to 2 per cent by the end of 2016, roughly the estimated growth rate of potential output. As global headwinds recede, confidence in the sustainability of domestic and global demand should improve and business investment should pick up. Together with a moderation in the growth of household spending, this is expected to gradually return Canada’s economy to a more balanced growth path. As the economy reaches its full capacity in the second half of 2016, both core and total CPI inflation are projected to be about 2 per cent on a sustained basis.

Weighing all of these factors, the Bank judges that the risks to its inflation projection are roughly balanced. Meanwhile, the financial stability risks associated with household imbalances are edging higher. Overall, the balance of risks falls within the zone for which the current stance of monetary policy is appropriate and therefore the target for the overnight rate remains at 1 per cent.

The Monetary Policy Report highlighted housing:

Housing starts have remained broadly in line with demographic demand in recent months (Chart 24). However, sales of existing homes have picked up noticeably since the beginning of the year, to a four-year high (Chart 25). This is contributing to sizable increases in house prices, although the national picture continues to mask important regional divergences (Chart 26 and Chart 27). In general, with historically low price increases and sales volumes, markets in Eastern Canada appear to show signs consistent with a soft landing. This contrasts with major cities in Ontario, Alberta and British Columbia, where housing markets are generally robust and much tighter.

… and the Globe chimed in with:

According to the Teranet-National house price index, home prices in Canada rose 0.3 per cent in September from August and 4.9 per cent from a year earlier.

Notably, Calgary, Toronto and Vancouver were well above the national average, at 9.5 per cent, 7.4 per cent and 6.5 per cent, respectively.

It was a good day for the Canadian preferred share market, with PerpetualDiscounts up 10bp, FixedResets winning 13bp and DeemedRetractibles gaining 2bp. Volatility was average. Volume was low.

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 3.15 % 3.15 % 20,898 19.34 1 0.0000 % 2,649.2
FixedFloater 0.00 % 0.00 % 0 0.00 0 0.5452 % 3,987.9
Floater 2.99 % 3.15 % 65,125 19.35 4 0.5452 % 2,677.7
OpRet 4.04 % 2.26 % 101,617 0.08 1 0.0000 % 2,735.7
SplitShare 4.29 % 3.90 % 82,216 3.81 5 -0.0582 % 3,152.5
Interest-Bearing 0.00 % 0.00 % 0 0.00 0 0.0000 % 2,501.5
Perpetual-Premium 5.48 % -0.15 % 73,560 0.08 18 -0.0437 % 2,457.4
Perpetual-Discount 5.30 % 5.14 % 95,792 15.15 18 0.0953 % 2,601.2
FixedReset 4.22 % 3.60 % 167,507 16.73 75 0.1301 % 2,551.5
Deemed-Retractible 5.02 % 2.49 % 103,051 0.34 42 0.0200 % 2,562.3
FloatingReset 2.55 % -6.10 % 60,705 0.08 6 -0.0719 % 2,545.5
Performance Highlights
Issue Index Change Notes
CIU.PR.C FixedReset -1.21 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-10-22
Maturity Price : 20.40
Evaluated at bid price : 20.40
Bid-YTW : 3.53 %
TRP.PR.B FixedReset 1.51 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-10-22
Maturity Price : 18.80
Evaluated at bid price : 18.80
Bid-YTW : 3.64 %
PWF.PR.A Floater 1.93 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-10-22
Maturity Price : 20.00
Evaluated at bid price : 20.00
Bid-YTW : 2.61 %
FTS.PR.J Perpetual-Discount 1.98 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-10-22
Maturity Price : 23.76
Evaluated at bid price : 24.15
Bid-YTW : 4.97 %
Volume Highlights
Issue Index Shares
Traded
Notes
BMO.PR.K Deemed-Retractible 131,289 Scotia crossed 40,000 at 26.05; Nesbitt crossed blocks of 35,000 and 50,000 at the same price.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-11-25
Maturity Price : 25.50
Evaluated at bid price : 26.03
Bid-YTW : -8.09 %
NA.PR.W FixedReset 67,325 Recent new issue.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-10-22
Maturity Price : 23.09
Evaluated at bid price : 24.85
Bid-YTW : 3.63 %
TD.PF.B FixedReset 64,463 Scotia crossed 51,000 at 25.15.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-10-22
Maturity Price : 23.23
Evaluated at bid price : 25.15
Bid-YTW : 3.54 %
BAM.PR.R FixedReset 53,235 RBC crossed 46,800 at 25.25.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-10-22
Maturity Price : 23.74
Evaluated at bid price : 25.18
Bid-YTW : 3.74 %
GWO.PR.N FixedReset 39,397 Nesbitt crossed 35,000 at 21.82.
YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2025-01-31
Maturity Price : 25.00
Evaluated at bid price : 21.75
Bid-YTW : 4.47 %
ENB.PF.G FixedReset 34,284 Recent new issue.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-10-22
Maturity Price : 23.14
Evaluated at bid price : 25.08
Bid-YTW : 4.07 %
There were 19 other index-included issues trading in excess of 10,000 shares.
Wide Spread Highlights
Issue Index Quote Data and Yield Notes
W.PR.H Perpetual-Premium Quote: 25.02 – 25.35
Spot Rate : 0.3300
Average : 0.2080

YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-10-22
Maturity Price : 24.80
Evaluated at bid price : 25.02
Bid-YTW : 5.53 %

TRP.PR.B FixedReset Quote: 18.80 – 19.20
Spot Rate : 0.4000
Average : 0.2881

YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-10-22
Maturity Price : 18.80
Evaluated at bid price : 18.80
Bid-YTW : 3.64 %

CGI.PR.D SplitShare Quote: 25.25 – 25.68
Spot Rate : 0.4300
Average : 0.3357

YTW SCENARIO
Maturity Type : Soft Maturity
Maturity Date : 2023-06-14
Maturity Price : 25.00
Evaluated at bid price : 25.25
Bid-YTW : 3.68 %

FTS.PR.H FixedReset Quote: 20.11 – 20.40
Spot Rate : 0.2900
Average : 0.2130

YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-10-22
Maturity Price : 20.11
Evaluated at bid price : 20.11
Bid-YTW : 3.64 %

TD.PR.S FixedReset Quote: 25.07 – 25.34
Spot Rate : 0.2700
Average : 0.1991

YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2022-01-31
Maturity Price : 25.00
Evaluated at bid price : 25.07
Bid-YTW : 3.16 %

TRP.PR.C FixedReset Quote: 20.92 – 21.19
Spot Rate : 0.2700
Average : 0.2047

YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-10-22
Maturity Price : 20.92
Evaluated at bid price : 20.92
Bid-YTW : 3.63 %

RY.PR.Y Called For Redemption

Wednesday, October 22nd, 2014

Royal Bank of Canada finally announced:

its intention to redeem all of its issued and outstanding Non-Cumulative 5-Year Rate Reset First Preferred Shares Series AX (the “Series AX shares”) on November 24, 2014, for cash at a redemption price of $25.00 per share.

There are 13,000,000 Series AX shares outstanding, representing $325 million of capital. The redemption of the Series AX shares will be financed out of the general corporate funds of Royal Bank of Canada.

Separately from the redemption price, the final quarterly dividend of $0.38125 per share for the Series AX shares will be paid in the usual manner on November 24, 2014 to shareholders of record on October 27, 2014.

No surprises here, since the issue commenced trading April 29, 2009 and came with a massive Issue Reset Spread of 413bp. It is tracked by HIMIPref™ and has been assigned to the FixedReset index since inception.

SBN.PR.A Term Extended

Wednesday, October 22nd, 2014

Strathbridge Asset Management Inc. has announced (although not yet on their website):

S Split Corp. (the “Fund”) (TSX:SBN)(TSX:SBN.PR.A) is pleased to announce that holders of Class A Shares and holders of Preferred Shares of the Fund have approved a proposal to extend the term of the Fund for seven years beyond its scheduled termination date of December 1, 2014, and for automatic successive seven-year terms after November 31, 2021.

As a result, holders of Class A Shares will continue to benefit from the potential for leveraged capital appreciation in a portfolio consisting of common shares of The Bank of Nova Scotia and monthly distributions of 6.0% per annum of the net asset value of the Class A Shares. Holders of Preferred Shares will continue to benefit from fixed cumulative preferential monthly cash dividends in the amount of $0.043750 per Preferred Share representing a yield of 5.25% per annum on the original issue price of $10.00 per Preferred Share.

As part of the extension of the term of the Fund, the Fund will also make other changes, including: (i) provide a special redemption right to enable holders of Class A Shares and Preferred Shares to retract their shares on December 1, 2014 on the same terms that would have applied had the Fund redeemed all Class A Shares and Preferred Shares in accordance with the existing terms of such shares; (ii) change the monthly retraction prices for the Class A Shares and the Preferred Shares such that monthly retraction prices are calculated by reference to market price in addition to net asset value; and (iii) consolidate the Class A Shares or redeem the Preferred Shares on a pro rata basis, as the case may be, in order to maintain the same number of Class A Shares and Preferred Shares outstanding.

Shareholders who exercise the special redemption right will receive the amount which they would have received had the December 1, 2014 termination date not been extended. Payments for shares tendered pursuant to the Special Retraction Right will be made no later than 10 business days after December 1, 2014, provided that such shares have been surrendered for redemption on or prior to 5:00 p.m. (Toronto time) on November 17, 2014. The retraction price per Class A Share to be received by a holder of Class A Shares under the Special Retraction Right will be equal to the greater of (a) the NAV per Unit on December 1, 2014 (the “Special Retraction Date”) minus $10.00 and (b) nil. The retraction price per Preferred Share to be received by a holder of Preferred Shares under the Special Retraction Right will be equal to the lesser of: (a) $10.00; and (b) the NAV of the Fund divided by the number of Preferred Shares outstanding on the Special Retraction Date. Any declared and unpaid distributions payable on or before the Special Retraction Date in respect of Class A Shares or Preferred Shares tendered for retraction on the Special Retraction Date will also be paid on the retraction payment date.

For further information, please contact Investor Relations at 416.681.3966, toll free at 1.800.725.7172 or visit www.strathbridge.com.

The term extension was proposed on September 8, 2014.

The Information Circular dated 2014-9-11 has some more details (note that the Class A shares are the Capital Units):

No distributions may be paid on the Class A Shares if (a) the distributions payable on the Preferred Shares are in arrears; or (b) the NAV per Unit is equal to or less than $16.50. In addition, the Fund will not pay special distributions, meaning distributions in excess of the targeted 6.0% per annum monthly distribution, on the Class A Shares if after payment of the distribution the NAV per Unit would be less than $25.00 unless the Fund would need to make such distribution so as to fully recover refundable taxes.

Holders of Class A Shares and Preferred Shares are being asked to extend the term of the Fund for an additional seven years by changing the redemption date of the Class A Shares and the Preferred Shares to November 30, 2021. The redemption date will be further extended for successive seven-year terms thereafter and shareholders will be able to retract their Class A Shares or Preferred Shares at NAV prior to any such additional extension. In such circumstances, the Fund will provide at least 30 days’ notice to shareholders of the retraction date by way of press release.

The Fund proposes to extend the redemption date to November 30, 2021, with possible additional extensions of the term of the Fund, so that it may continue to provide shareholders with the opportunity to participate in the performance of the Portfolio.

Following the Reorganization, the Fund would initially maintain the current dividend rate on the Preferred Shares at 5.25% per annum on the $10.00 original issue price. However, the Board of Directors would be permitted to change the dividend rate on the Preferred Shares to reflect future market conditions following November 30, 2021. Any such change would be announced by way of the press release issued in connection with such extension of the term of the Fund.

To preserve the rights that were originally provided to holders of Class A Shares and Preferred Shares, the Fund proposes to amend the terms of such shares to permit holders of such shares to retract such shares (the “Special Retraction Right”) on December 1, 2014 (the “Special Retraction Date”) on the terms on which such shares would have been redeemed had the December 1, 2014 redemption date not been extended.

If more Class A Shares than Preferred Shares are retracted under the Special Retraction Right, the Fund will redeem Preferred Shares (the “Call Right”) on a pro rata basis to ensure an equal number of Class A Shares and Preferred Shares remain outstanding from and after the effective date of the Reorganization.

Going forward, the Annual Valuation Date, which is the time at which the annual concurrent retraction right may be exercised, will be changed to the November Valuation Date from the June Valuation Date, commencing in 2015. In addition, the Special Retraction Right will replace the annual concurrent retraction right in each year in which the Fund’s existing term is subsequently extended.

Shareholders whose Preferred Shares are retracted on a Valuation Date are entitled to receive a retraction price per share (the “Preferred NAV Retraction Price”) equal to 95% of the lesser of (a) the NAV per Unit as of the applicable Valuation Date less the cost to the Fund of purchasing a Class A Share in the market for cancellation and (b) $10.00.

Under the Reorganization, the monthly retraction price for the Preferred Shares will be changed and shareholders whose Preferred Shares are retracted on a Valuation Date will be entitled to receive a retraction price per share equal to the lesser of:
(a) the Preferred NAV Retraction Price; and
(b) 95% of the lesser of (i) the Unit Market Price less the cost to the Fund of purchasing a Class A Share in the market for cancellation and (ii) $10.00.

Class A Market Price means the weighted average trading price of the Class A Shares on the principal stock exchange on which the Class A Shares are listed (or, if the Class A Shares are not listed on any stock exchange, on the principal market on which the Class A Shares are quoted for trading) for the 10 trading days immediately preceding the applicable Valuation Date.

Unit Market Price means the sum of the Class A Market Price and the Preferred Market Price.

So on the bright side, it’s nice to see that big fat 5.25% coupon being extended for another seven years. Regrettably, the incorporation of “Unit Market Price” in the preferred share retraction price formula means that monthly retractions will no longer act as a price support in times of crisis; the chance of making a fast whopping profit when the units are trading below NAV has now disappeared. On the other hand, since there is no longer a price support, maybe the preferred shares will fall even more in such a crisis and become even more attractive purchases. We will see!

From the original prospectus:

Annual Concurrent Retraction: A holder of Class A Shares may concurrently retract an equal number of Class A Shares and Preferred Shares on the June Valuation Date of each year (the ‘‘Annual Valuation Date’’) at a retraction price equal to the NAV per Unit on that date, less any costs associated with the retraction, including commissions and other such costs, if any, related to the liquidation of any portion of the Company’s portfolio required to fund such retraction. The Class A Shares and the Preferred Shares must be surrendered for retraction at least 10 business days prior to the Annual Valuation Date. Payment of the proceeds of retraction will be made on or before the fifteenth business day of the following month. Such retractions are subject to a Retraction Fee. See ‘‘Details of the Offering — Retraction Fee’’.

The above isn’t affected by the extension, which is good. Some Split Share Corporations have provisions whereby the Capital Units can be retracted at the NAV on the annual date, with any imbalance of Capital Units over retracted Preferred Shares being made up by a par call. This is bad for holders, since calls are bad.

SBN.PR.A is a small issue, with only 2.9-million shares outstanding according to TMXMoney. Consequently, volumes are low.

SBN.PR.A is tracked by HIMIPref™ but is relegated to the Scraps index on both volume and credit concerns. It was last mentioned on PrefBlog with respect to the 2010 Annual Report.

October 21, 2014

Tuesday, October 21st, 2014

It was a nice day to own equities:

The S&P 500 climbed 2 percent to 1,941.28 at 4 p.m. in New York, its best gain since October 2013. The equity gauge is up 4.2 percent since Oct. 15 in the biggest four-day rally since January 2013. The Dow Jones Industrial Average climbed 215.14 points, or 1.3 percent, to 16,615 today. The Nasdaq 100 surged 2.6 percent, the most since January 2013, as about 7.2 billion shares traded hands in the U.S.

The ECB bought Italian covered bonds as it returned to the market for a second day under its asset purchase program, according to two people familiar with the matter. Debt issued by Intesa Sanpaolo SpA was included in the purchases, according to one of the people, who asked not to be identified because the information is private.

The ECB entered the 2.6 trillion-euro ($3.3 trillion) covered bond market after President Mario Draghi unveiled plans last month to bolster companies’ and households’ access to financing. Draghi, who also included asset-backed securities in the program, intends to expand the bank’s balance sheet by as much as 1 trillion euros to stave off deflation in the euro area.

U.S. stocks have rallied after St. Louis Federal Reserve Bank President James Bullard said on Oct. 16 that policy makers should consider delaying the end of bond purchases. He was the first Fed official to publicly suggest the central bank should extend its asset-purchase program when policy makers meet later this month.

CWB.PR.B has been confirmed at Pfd-3 by DBRS:

CWB’s has strong asset quality as evidenced by its history of low write-off rates, a proven niche strategy using relationship-based lending, a favourable efficiency ratio that reflects its business mix and strong internal capital generation. Challenges remain, though, particularly concentration in the loan book, both geographically (Alberta and British Columbia) and by industry (commercial, construction and real estate lending). Like its Canadian peers, the Bank has exposure to Canadian real estate-supported lending. A slowdown in the real estate markets may slow earnings generation and could hurt asset quality indicators, which ultimately may have an impact on provisioning levels. Funding diversification at CWB has been slowly improving over the past several years, but continues to rely heavily on brokered deposit.

CWB recently reported earnings available to common shareholders of $160 million (a return on equity of 14.7%) for the nine months ended July 31, 2014, an 18% increase over the same period in 2013. The earnings increase was largely due to loan growth year-to-date and higher non-interest income, offset by a narrower net interest margin in the continued low interest environment. CWB’s 105th consecutive profitable quarter was accompanied by low loan loss provisions. Capital levels are viewed as strong with a Basel III Common Equity Tier 1 ratio of 8.0% based on risk-weighted assets calculated using the standardized approach.

I recently came across a very good review of the US TruPS market by Yalman Onaran and Jody Shenn of Bloomberg. An oldie but goodie!

Bloomberg also has a good review of CoCos, by John Glover:

Regulators noted that investors often did a better job of predicting which banks would buckle in the crisis than they had themselves. CoCo bonds are designed to harness this “wisdom of the crowd” by putting bondholders on the front line, giving them a vested interest in the health of wobbly banks. The problem is that they are untested: When the first one goes sour and halts coupon payments, it’s possible investors could suddenly wake up to the inherent risk and flee all CoCos, destabilizing the corporate bond market and possibly even the financial system. Critics charge that the securities are too complex to be properly understood, too varied and too much like equity to be considered bonds. The banks themselves are opaque, definitions of capital vary from bond to bond, and the distance between a bank’s current position and the moment disaster will strike is almost impossible to calculate. When the first one blows, regulators will get a better sense of whether CoCos helped save the banking system, or sink it.

I feel that the current model for CoCos is inherently flawed since the triggers are based on regulatory capital, which didn’t work out all that well during the Credit Crunch; I continue to advocate high-trigger CoCos with a conversion trigger based on the common stock price.

It was a mixed day for the Canadian preferred share market, with PerpetualDiscounts up 30bp, FixedResets off 7bp and DeemedRetractibles gaining 11bp. Volatility was high, notable for FixedReset losers and Floating Rate winners. Volume was low.

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 3.15 % 3.15 % 21,768 19.34 1 -0.7506 % 2,649.2
FixedFloater 0.00 % 0.00 % 0 0.00 0 2.1920 % 3,966.2
Floater 3.00 % 3.15 % 65,855 19.35 4 2.1920 % 2,663.2
OpRet 4.04 % 2.12 % 100,680 0.08 1 -0.0787 % 2,735.7
SplitShare 4.29 % 3.88 % 85,593 3.82 5 0.5594 % 3,154.3
Interest-Bearing 0.00 % 0.00 % 0 0.00 0 -0.0787 % 2,501.5
Perpetual-Premium 5.48 % -0.10 % 74,099 0.08 18 0.1095 % 2,458.5
Perpetual-Discount 5.31 % 5.12 % 96,031 15.14 18 0.3012 % 2,598.7
FixedReset 4.23 % 3.61 % 169,544 16.73 75 -0.0664 % 2,548.2
Deemed-Retractible 5.02 % 2.62 % 103,192 0.34 42 0.1147 % 2,561.8
FloatingReset 2.55 % -6.10 % 61,142 0.08 6 -0.0522 % 2,547.3
Performance Highlights
Issue Index Change Notes
TRP.PR.B FixedReset -2.22 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-10-21
Maturity Price : 18.52
Evaluated at bid price : 18.52
Bid-YTW : 3.70 %
TRP.PR.A FixedReset -1.05 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-10-21
Maturity Price : 21.47
Evaluated at bid price : 21.77
Bid-YTW : 3.84 %
FTS.PR.K FixedReset -1.00 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-10-21
Maturity Price : 23.09
Evaluated at bid price : 24.65
Bid-YTW : 3.54 %
IAG.PR.A Deemed-Retractible 1.05 % YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2025-01-31
Maturity Price : 25.00
Evaluated at bid price : 23.10
Bid-YTW : 5.65 %
CIU.PR.C FixedReset 1.23 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-10-21
Maturity Price : 20.65
Evaluated at bid price : 20.65
Bid-YTW : 3.48 %
CGI.PR.D SplitShare 1.56 % YTW SCENARIO
Maturity Type : Soft Maturity
Maturity Date : 2023-06-14
Maturity Price : 25.00
Evaluated at bid price : 25.40
Bid-YTW : 3.60 %
BAM.PR.B Floater 1.70 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-10-21
Maturity Price : 16.75
Evaluated at bid price : 16.75
Bid-YTW : 3.15 %
BAM.PR.C Floater 1.71 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-10-21
Maturity Price : 16.68
Evaluated at bid price : 16.68
Bid-YTW : 3.17 %
BAM.PR.K Floater 1.82 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-10-21
Maturity Price : 16.75
Evaluated at bid price : 16.75
Bid-YTW : 3.15 %
PWF.PR.A Floater 3.35 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-10-21
Maturity Price : 19.75
Evaluated at bid price : 19.75
Bid-YTW : 2.68 %
Volume Highlights
Issue Index Shares
Traded
Notes
ENB.PF.G FixedReset 115,860 Recent new issue.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-10-21
Maturity Price : 23.13
Evaluated at bid price : 25.06
Bid-YTW : 4.07 %
NA.PR.W FixedReset 78,851 Recent new issue.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-10-21
Maturity Price : 23.10
Evaluated at bid price : 24.87
Bid-YTW : 3.62 %
RY.PR.Y FixedReset 71,482 There is still nothing on their website about the upcoming call date. C’mon, Royal, hurry up and call this thing so I don’t have to check any more! CIBC bought 20,000 from RBC at 25.40, and blocks of 10,000 and 25,000 from TD at the same price.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-11-24
Maturity Price : 25.00
Evaluated at bid price : 25.36
Bid-YTW : 1.02 %
BAM.PF.G FixedReset 56,256 Recent new issue.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-10-21
Maturity Price : 23.17
Evaluated at bid price : 25.14
Bid-YTW : 4.19 %
TRP.PR.A FixedReset 26,123 YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-10-21
Maturity Price : 21.47
Evaluated at bid price : 21.77
Bid-YTW : 3.84 %
ENB.PF.C FixedReset 23,592 YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-10-21
Maturity Price : 23.16
Evaluated at bid price : 25.05
Bid-YTW : 4.05 %
There were 17 other index-included issues trading in excess of 10,000 shares.
Wide Spread Highlights
Issue Index Quote Data and Yield Notes
ELF.PR.H Perpetual-Discount Quote: 25.00 – 25.50
Spot Rate : 0.5000
Average : 0.2965

YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-10-21
Maturity Price : 24.56
Evaluated at bid price : 25.00
Bid-YTW : 5.52 %

FTS.PR.F Perpetual-Discount Quote: 24.30 – 24.74
Spot Rate : 0.4400
Average : 0.2923

YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-10-21
Maturity Price : 24.04
Evaluated at bid price : 24.30
Bid-YTW : 5.10 %

BAM.PR.E Ratchet Quote: 23.80 – 24.46
Spot Rate : 0.6600
Average : 0.5666

YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-10-21
Maturity Price : 23.46
Evaluated at bid price : 23.80
Bid-YTW : 3.15 %

TRP.PR.B FixedReset Quote: 18.52 – 18.77
Spot Rate : 0.2500
Average : 0.1653

YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-10-21
Maturity Price : 18.52
Evaluated at bid price : 18.52
Bid-YTW : 3.70 %

NEW.PR.D SplitShare Quote: 32.59 – 32.99
Spot Rate : 0.4000
Average : 0.3262

YTW SCENARIO
Maturity Type : Call
Maturity Date : 2015-06-26
Maturity Price : 32.07
Evaluated at bid price : 32.59
Bid-YTW : 2.19 %

MFC.PR.B Deemed-Retractible Quote: 22.88 – 23.14
Spot Rate : 0.2600
Average : 0.1921

YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2025-01-31
Maturity Price : 25.00
Evaluated at bid price : 22.88
Bid-YTW : 5.85 %

DBRS Upgrades LB to Pfd-3(high) and Pfd-3

Monday, October 20th, 2014

DBRS has announced that it:

has today upgraded Laurentian Bank of Canada’s (Laurentian or the Bank) long-term ratings, including its Issuer Rating and Deposits & Senior Debt ratings, to A (low) from BBB (high) and its NVCC Preferred Share rating to Pfd-3 from Pfd-3 (low). DBRS has also confirmed Laurentian’s Short-Term Instruments rating at R-1 (low). All trends are now Stable.

The ratings upgrade resolves the positive trend which DBRS has held on Laurentian’s long-term ratings for two years. Laurentian’s credit profile has benefitted from diversification both geographically, through increased presence outside of Québec, and by business line, notably with the growth of B2B Bank. Efficiency at the Bank has been more recently trending in the right direction, and management has targeted further efficiency improvements over the medium term, particularly through the expansion of higher margin products and business lines which, if realized, should support the earnings profile of the Bank. DBRS anticipates that efficiency and geographic diversity should continue to improve, particularly as B2B Bank becomes a larger contributor. The rating is supported by the Bank’s overall lower-risk business profile, which is focused on retail lending funded by retail deposits, real estate and mid-market commercial financing, serves financial advisors and brokers through B2B Bank and includes a mid-sized Montréal-based capital markets business. Its high-cost structure and remaining geographic concentration remain challenging.

The affected issues are:

LB Preferred Shares Upgrade
Ticker Type of Preferred NVCC Status New DBRS Rating
LB.PR.F FixedReset
4.00%+260
Non-Compliant Pfd-3(high)
LB.PR.H FixedReset
4.30%+255
Compliant Pfd-3

LB.PR.F and LB.PR.H were last mentioned on PrefBlog when they were downgraded by S&P earlier this month. Both are tracked by HIMIPref™ but relegated to the Scraps index on credit concerns.

October 20, 2014

Monday, October 20th, 2014

On September 22 I highlighted the Blackrock publication CORPORATE BOND MARKET STRUCTURE: THE TIME FOR REFORM IS NOW, but it turns out they’ve been pushing the ‘scheduled issuance’ idea for a while. It’s also been proposed in their May, 2013, publication Setting New Standards: The Liquidity Challenge II, which comes with some great illustrative charts.

concession
Click for Big

If the Shitty Price Hypothesis (described in the post TRACE and the Bond Market is correct, we expect to see a decrease in the concession from pre-TRACE days, perhaps even going negative.

dealerInventory
Click for Big

This one is interesting in conjunction with the Trading Volume chart below. Note that dealer inventories have dropped by about half since 2005.

friction
Click for Big

So a bigger proportion of the spread-to-Treasuries is being eaten up by the bid-ask spread.

issuance
Click for Big

Issuance is huge relative to outstanding, which may be why the world hasn’t ground to a halt despite the pernicious influence of TRACE.

issuanceTenor
Click for Big

But it could be that decreasing liquidity is reducing the tenor of new issues. Investors have to get their liquidity somehow!

liquidityPremium
Click for Big

An increasing liquidity premium is consistent with the Shitty Price Hypothesis

newIssueTrading
Click for Big

New issues will change hands a few times, then settle into their permanent homes.

tradingVolume
Click for Big

This is particularly interesting in conjunction with the Dealer Inventory chart above. Note that although trading volume has decreased, it has decreased less, proportionally, than dealer inventories have, indicating that dealer inventory turnover is increasing. This is consistent with the Shitty Price Hypothesis

Victoria Stilwell of Bloomberg complains:

Federal Reserve policy makers are missing a key element as they assess the health of the labor market: data that includes whether those who are employed are overqualified for their job or would like to work more hours.

As a result, the “significant underutilization of labor resources” that Fed officials highlighted last month as they renewed a pledge to keep interest rates low for a “considerable period” is probably even more severe than currently estimated. And the information gap means policy makers may have more difficulty gauging the right moment to raise rates off zero.

Private surveys have attempted to fill in the gaps. Some 46 percent of workers who graduated from college in 2012 or 2013 said that they were in a job that did not require their degree, according to a study released in May by Accenture Plc. That’s a five percentage point increase from last year, the New York-based management-consulting company’s report showed.

So, the study, titled Great Expectations: Insights from the Accenture 2014 College Graduate Employment Survey states:

46 percent of 2012/2013 grads working today report that they are underemployed (meaning they are working in a job that does not require their college degree). This is a 5 percent increase from last year’s survey.

I’m not sure I agree with that, entirely. It has been a long time since somebody asked me to explain the Schrödinger Wave Equation for a hydrogen atom, or to whip them up a batch of cis-stilbenes with a 4-substituent. So my chemistry degree hasn’t been required for a while. But I don’t feel underemployed!

It was a mixed day for the Canadian preferred share market, with PerpetualDiscounts up 15bp, FixedResets off 2bp and DeemedRetractibles gaining 4bp. Volatility was average, but enlivened by some sloppy trading at the close in PWF.PR.A. Volume was very low.

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 3.13 % 3.11 % 22,123 19.40 1 0.0417 % 2,669.3
FixedFloater 0.00 % 0.00 % 0 0.00 0 -2.6600 % 3,881.2
Floater 3.07 % 3.21 % 64,680 19.22 4 -2.6600 % 2,606.1
OpRet 4.04 % 1.02 % 101,190 0.08 1 0.1577 % 2,737.9
SplitShare 4.31 % 4.03 % 84,793 3.82 5 -0.1994 % 3,136.8
Interest-Bearing 0.00 % 0.00 % 0 0.00 0 0.1577 % 2,503.5
Perpetual-Premium 5.49 % 1.16 % 73,386 0.08 18 0.1272 % 2,455.8
Perpetual-Discount 5.32 % 5.15 % 96,596 15.16 18 0.1508 % 2,590.9
FixedReset 4.22 % 3.60 % 170,794 16.73 75 -0.0190 % 2,549.8
Deemed-Retractible 5.03 % 2.78 % 102,712 0.44 42 0.0382 % 2,558.9
FloatingReset 2.55 % -6.10 % 61,836 0.08 6 -0.0848 % 2,548.6
Performance Highlights
Issue Index Change Notes
PWF.PR.A Floater -7.95 % It appears that Desjardins put in a Market or low-limit order at 3:58, which took out the bid – Five hundred went at 20.00 and 20.01, time-stamped 3:58, then six hundred shares traded at 19.02 and 188 at 19.01, time-stamped 3:59. Whoosh!

YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-10-20
Maturity Price : 19.11
Evaluated at bid price : 19.11
Bid-YTW : 2.77 %

CGI.PR.D SplitShare -1.54 % YTW SCENARIO
Maturity Type : Soft Maturity
Maturity Date : 2023-06-14
Maturity Price : 25.00
Evaluated at bid price : 25.01
Bid-YTW : 3.81 %
MFC.PR.F FixedReset -1.12 % YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2025-01-31
Maturity Price : 25.00
Evaluated at bid price : 22.10
Bid-YTW : 4.54 %
PWF.PR.F Perpetual-Premium 1.12 % YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-11-19
Maturity Price : 25.00
Evaluated at bid price : 25.21
Bid-YTW : -6.75 %
Volume Highlights
Issue Index Shares
Traded
Notes
TRP.PR.A FixedReset 207,140 RBC crossed two blocks of 100,000 each, both at 21.97.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-10-20
Maturity Price : 21.63
Evaluated at bid price : 22.00
Bid-YTW : 3.79 %
NA.PR.W FixedReset 163,450 Recent new issue.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-10-20
Maturity Price : 23.06
Evaluated at bid price : 24.77
Bid-YTW : 3.64 %
FTS.PR.M FixedReset 90,638 Scotia crossed blocks of 22,000 and 16,100, both at 25.20. Nesbitt bought 17,500 from RBC at the same price.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-10-20
Maturity Price : 23.20
Evaluated at bid price : 25.15
Bid-YTW : 3.81 %
FTS.PR.H FixedReset 81,452 RBC crossed two blocks of 40,000 each, both at 20.39.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-10-20
Maturity Price : 20.30
Evaluated at bid price : 20.30
Bid-YTW : 3.60 %
ENB.PF.G FixedReset 61,675 Recent new issue.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-10-20
Maturity Price : 23.13
Evaluated at bid price : 25.06
Bid-YTW : 4.07 %
IFC.PR.C FixedReset 54,411 RBC crossed 50,000 at 25.54.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2016-09-30
Maturity Price : 25.00
Evaluated at bid price : 25.50
Bid-YTW : 3.27 %
There were 18 other index-included issues trading in excess of 10,000 shares.
Wide Spread Highlights
Issue Index Quote Data and Yield Notes
PWF.PR.A Floater Quote: 19.11 – 20.75
Spot Rate : 1.6400
Average : 0.9689

YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-10-20
Maturity Price : 19.11
Evaluated at bid price : 19.11
Bid-YTW : 2.77 %

CGI.PR.D SplitShare Quote: 25.01 – 25.60
Spot Rate : 0.5900
Average : 0.3772

YTW SCENARIO
Maturity Type : Soft Maturity
Maturity Date : 2023-06-14
Maturity Price : 25.00
Evaluated at bid price : 25.01
Bid-YTW : 3.81 %

HSB.PR.D Deemed-Retractible Quote: 25.20 – 25.78
Spot Rate : 0.5800
Average : 0.3743

YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-12-31
Maturity Price : 25.00
Evaluated at bid price : 25.20
Bid-YTW : 2.34 %

TD.PR.Q Deemed-Retractible Quote: 25.92 – 26.24
Spot Rate : 0.3200
Average : 0.2030

YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-11-19
Maturity Price : 25.75
Evaluated at bid price : 25.92
Bid-YTW : -4.52 %

MFC.PR.F FixedReset Quote: 22.10 – 22.50
Spot Rate : 0.4000
Average : 0.3095

YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2025-01-31
Maturity Price : 25.00
Evaluated at bid price : 22.10
Bid-YTW : 4.54 %

BNS.PR.N Deemed-Retractible Quote: 25.78 – 26.00
Spot Rate : 0.2200
Average : 0.1367

YTW SCENARIO
Maturity Type : Call
Maturity Date : 2015-01-28
Maturity Price : 25.50
Evaluated at bid price : 25.78
Bid-YTW : 0.57 %

TRACE and Structured Credit Products

Sunday, October 19th, 2014

The FINRA page titled “Independent TRACE Studies” leads me to some studies that have come out of mandatory TRACE reporting for Structured Credit. The data collected are not made public in raw form, but aggregate data is made available on a daily and monthly basis.

Structured Credit is a little far from my bailiwick, but some of the statistics cited are so entertaining I just had to highlight them here.

A 2013 paper by Hendrik Bessembinder, William F. Maxwell and Kumar Venkataraman is titled Trading Activity and Transaction Costs in Structured Credit Products:

After conducting the first study of secondary trading in structured credit products, the authors report that the majority of products did not trade even once during the 21-month sample. Execution costs averaged 24 bps when trades occurred and were considerably higher for products with a greater proportion of retail-size trades. The authors estimate that the introduction of public trade reporting would decrease trading costs in retail-oriented products by 5-7 bps.

An acknowledgement in this paper, by the way, introduced me to the Montreal Institute of Structured Finance and Derivatives, which appears to be funded by agencies of the Province of Quebec and provides modest funding to genuine research – only $300,000 p.a., but that’s not bad when compared to their 10-year total budget of $15-million (meanwhile, here in Ontari-ari-ari-owe, we fund ex-regulators and lawyers at FAIR Canada. Gag.) You learn something new every day!

Anyway, back to Bessembinder et al. and the amazing statistics:

Notably, less than twenty percent of the SCP universe trades at all during the twenty-one month sample period. One-way trade execution costs for SCPs average about 24 basis points. However, trade execution costs vary substantially across SCP categories, from 92 basis points for CBOs to just 1 basis point for TBAs. We show that trading costs depend in particular on what we term the product’s “customer profile,” which depends on issue size and the proportion of Retail- versus Institutional-size trades. Sub-products with an Institutional Profile tend to have lower costs. The highest average trading costs are observed for Agency CMOs (74 basis points) and CBOs (92 basis points), each of which has a low (22% or less) proportion of large trades. The lowest average trading cost estimates are observed for TBA securities (1 basis point), CMBS (12 basis points), and ABS secured by auto loans and equipment (7 basis points), each of which has a large (54% or greater) percentage of large trades.

Structured Products (SCPs), including asset-backed (ABS) and mortgage-backed (MBS) securities, comprise one of the largest but least-studied segments of the financial services industry. As of the end of 2012, there was $8.6 trillion outstanding in mortgage-backed securities and $1.7 trillion outstanding in asset-backed securities, implying that the SCPs markets are comparable in size to the $11 trillion U.S. Treasury Security market

Increased transparency has the potential to reduce the dealer mark-ups or bid-ask spreads, provide more information on the fair price of the security, and improve regulators and customers’ ability to control and evaluate trade execution costs. These ideas have been emphasized by Rick Ketchum, Chairman and CEO of the Finance Industry Regulatory Authority (FINRA):
“From the standpoint of investor protection, which is and always will be FINRA’s top priority, we simply must shed more light on the darker areas of the fixed income market.

That last quote from Rick Ketchum illustrates the big problem with securities regulation nowadays. They have swung so far over to the ‘consumer protection’ objective that they have – at least to some degree – lost sight of why capital markets exist in the first place: to get money from savers to those who want to invest in their businesses. I will certainly agree that investor protection is a worthy objective; and I will agree that it is related reasonably closely to the objective of having a well functioning capital market; but for it to be called the “top priority” shows very strange priorities.

So the first amazing statistic is:

The MBS database provided to us by FINRA contains almost 1.1 million distinct securities. The large number of securities reflects that a basic pool of assets may have more than a hundred tranches, each with a unique payoff structure, and assets can be re-securitized (By comparison, less than 5,000 companies were listed on the U.S. equity exchanges at the end of 2012). However, as Panel A of Table 1 shows, many of these issues are very small, as the 25th percentile issue size is less than $2MM. The median issue size is less than $5MM. However, the distribution is positively skewed, as the mean issue size is $22.8MM. The MBS securities are of long average maturity, as shown on Panel B, with a mean maturity close to 19 years.

Holy smokes! I knew there were lots, but I would have guessed ‘under a million’. Hundred-tranche structured products sound pretty amazing, too.

Table 2 reports on trading activity for MBS. Notably, only 17.8% of the issues traded at all during the twenty one month period studied. The mean dollar volume traded across the full sample of MBS securities is $106MM, with an average of only 4.1 trades in each security. Fannie’s issues average six trades during the sample, and the average trading volume for Fannie issues is almost three times as large as for the next most frequently traded issue (Ginnie). Freddie’s issues are traded significantly less than either of the other agencies. Non-Agency issues trade an average of only 1.8 times each, but surprisingly have the largest proportion of issues (23%) that trade at all. Non-Agency issues have an average of 3.5 dealers at issuance, compared to slightly over four dealers for each Agency issue

Table 3 contains information regarding the ABS data, which contains slightly over 300,000 issues (compared to 1.1 million issues in the MBS universe).5 The ABS issues are larger than MBS issues, with the mean ($114MM) and median ($29MM) issue size each close to five times larger than for ABS. Still, some ABS issues are very small; the 5th percentile of the issue size distribution is only $100,000 for ABS, compared to over $1MM for MBS. ABS issues have an average maturity of 23.2 years, about 5 years longer than MBS products.

Panel B of Table 3 reports on trading activity in the ABS market. Like MBS, ABS trade infrequently, but the percentage of issues that trade at all is almost 30%, considerably higher than MBS at 18%. The average number of trades per security is 4.97, but the trades are on average smaller for ABS; the mean cumulative trading volume for ABS is $16.3MM, compared to the $106MM for MBS issues. The likelihood of trading and mean number of trades is surprisingly homogenous across issue size terciles. However, average trade size and cumulative dollar volume is larger for ABS of greater issue size.

And what are these trades?

Table 5 reports on the distribution of trade sizes in SCPs. We consider a trade to be small if it is for less than $100,000 and large if it is for more than $1MM.

For comparison purposes, we examine the distribution of trade sizes for corporate bonds during the six months before and after the introduction of public transaction dissemination. Our analysis includes 1.9 Million trades in 10,108 corporate bonds phased into TRACE dissemination between January 2003 and March 2011.8 We find that 72% of corporate bond trades are small (less than $100,000), both before and after trades were publicly disseminated. We conclude that, on average, the market for corporate bonds is more similar to the retail-oriented markets for SCPs, including CMOs and MBSs, and is more distinct from the institutionally-oriented markets for CMBS and TBA securities.

And the cost?

The resulting estimates of customer trade execution costs are reported on Table 6. For the full
sample, the estimated average one-way trade execution cost is 24 basis points. Consistent with results previously reported for corporate and municipal bonds, trade execution costs for SCPs decline with trade size, averaging 83 basis points for small trades, 24 basis points for medium-sized trades, and only five basis points for large trades. Trade execution costs also vary depending on trading frequencies. Average costs for the least-heavily-traded tercile of securities are 31 basis points, compared to 28 basis points for the second tercile and 24 basis points for the most frequently traded tercile. The finding that trade execution costs for SCPs decline with trade size mirrors the findings reported for corporate bonds by Edwards, Harris and Piwowar (2007) and Goldstein, Hotchkiss and Sirri (2007) and for municipal bonds by Harris and Piwowar (2006) and Green, Hollifield, and Schurhoff (2007). The overall level of estimated trading costs for SCP is in line with estimates for corporate bonds.

Bessembinder, Maxwell and Venkataraman (2006) study institutional trades in corporate bonds, and report average one-way trade execution costs (prior to transaction dissemination) that average 10 to 20 basis points. Schultz (2001) also studies institutional trades in corporate bonds and estimates that trading costs average 27 basis points. Edwards, Harris and Piwowar (2007) study a broader cross-section that includes retail trades, and estimate that one-way trade execution costs for corporate bonds range from 75 basis points for very small trades to 4 basis points for very large trades.

And the effect of TRACE?

We first implement expression (2) for the full set of corporate bonds that became TRACE-eligible in March of 2003, including in the analysis trades executed six months before to six months after the initiation of public trade dissemination. We find that trading costs for corporate bonds were reduced after the introduction of price dissemination by 9 basis points for small trades, 6 basis points for medium trades, and 3 basis points for large trades. These results are quite similar to those reported by Edwards, Harris, and Piwowar (2006), who study the same sample but rely on more complex estimation techniques.

I take issue with the authors when they claim:

These estimates of lower trading costs for SCPs have important implications for security issuers, investors in these products and broker-dealers who supply liquidity. Improved liquidity that is attributable to post-trade price transparency has the potential to affect the valuation of the bonds themselves and lower yield spreads (see Chen, Lesmond and Wei (2007) for evidence from corporate bonds) for SCP issues. Additionally, the cumulative dollar impact of these trading cost reductions is potentially large. In the case of the transparency experiment for corporate bonds, Bessembinder, Maxwell and Venkataraman (2006) estimate annual trading cost reductions of about $1 billion for the full corporate bond market. In addition, they document the existence of “liquidity externalities”, by which improved transparency for some products can lead to improved valuation and lower trade execution costs for related securities.

As I pointed out in an earlier post, a tighter spread between the dealer buy price and dealer sell price does not necessarily indicate “fairer” prices, since the dealer may well quote only stink bids on customer sales so that a profitable re-sale can be executed quickly. This mechanism, if correct, would actually mean that the liquidity-seeker in the chain of trades is paying more for liquidity under TRACE and that both the interim and ultimate liquidity providers are making excess profits (I refer to this as the Shitty Price Hypothesis). The authors do not examine how the execution prices in the secondary market compare with new-issue prices, which renders their conclusion regarding the “improvement” in liquidity dubious.

In addition to this, the putative benefits of TRACE, estimated as “annual trading cost reductions of about $1 billion for the full corporate bond market”, does not make any attempt to compare this with the cost of the programme. And I don’t mean direct costs, either. If the Shitty Price Hypothesis is correct – and it is consistent with the finding of lower trading levels in the Asquith, Covert and Pathak paper, then actual liquidity has decreased, which means issuers will have to pay more for funds, which means that some bricks-and-mortar projects will be abandoned (this link in the chain is the entire basis for central banking policy rates) … and how much does that cost? Huh?

Anyway, the authors told us to “see Chen, Lesmond and Wei (2007) for evidence from corporate bonds”, so let’s look at Chen, Lesmond and Wei (2007) and see what they have to say.

The paper by Long Chen, David A. Lesmond & Jason Wei is titled Corporate Yield Spreads and Bond Liquidity and it turns out that the last named author is from our very own Rotman School of Management at UofT:

We examine whether liquidity is priced in corporate yield spreads. Using a battery of liquidity measures covering over 4000 corporate bonds and spanning investment grade and speculative categories, we find that more illiquid bonds earn higher yield spreads; and that an improvement of liquidity causes a significant reduction in yield spreads. These results hold after controlling for common bond-specific, firm-specific, and macroeconomic variables, and are robust to issuers’ fixed effect and potential endogeneity bias. Our finding mitigates the concern in the default risk literature that neither the level nor the dynamic of yield spreads can be fully explained by default risk determinants, and suggests that liquidity plays an important role in corporate bond valuation.

The notion that investors demand a liquidity premium for illiquid securities dates back to Amihud and Mendelson (1986). Lo, Mamaysky, and Wang (2004) further argue that liquidity costs inhibit the frequency of trading. Because investors cannot continuously hedge their risk, they demand an ex-ante risk premium by lowering security prices. Therefore, for the same promised cash flows, less liquid bonds will be traded less frequently, have lower prices, and exhibit higher yield spreads. Thus, the theoretical prior is that liquidity is expected to be priced in yield spreads. We investigate bond-specific liquidity effects on the yield spread using three separate liquidity measures. These include the bid-ask spread, the liquidity proxy of zero returns, and a liquidity estimator based on a model variant of Lesmond, Ogden, and Trzcinka (1999). We find that liquidity is indeed priced in both levels and changes of the yield spread.

Contemporaneous studies by Longstaff et al. (2004) and Ericsson and Renault (2002) also relate corporate bond liquidity to yield spreads.

Historically, the lack of credible information on spread prices or bond quotes has been a major impediment in the analysis of liquidity (Goodhart and O’Hara, 1997) and liquidity’s impact on yield spreads. We employ Bloomberg and Datastream to provide our three liquidity estimates. Among them, the bid-ask spread is arguably the most demonstrable measure of liquidity costs, while the percentage of zero returns is increasingly used as a liquidity proxy in a host of empirical studies.2 Despite the clear intuition surrounding the zero return proxy, it is a noisy measure of liquidity, since it is the combination of a zero return and the simultaneous movement of bond price determinants that more properly estimates liquidity costs, not the lack of price changes per se.

We find a significant association between corporate bond liquidity and the yield spread with each of the three liquidity measures. Depending on the liquidity measure, liquidity alone can explain as much as 7% of the cross-sectional variation in bond yields for investment grade bonds, and 22% for speculative grade bonds. Using the bid-ask spread as the measure, we find that one basis point increase in bid-ask spread is related to 0.42 basis point increase in the yield spread for investment grade bonds, and 2.30 basis point increase for speculative grade bonds.

So I don’t find anything objectionable in the conclusion; I’ve argued in this blog for a long time that liquidity is a major factor in corporate bond yields, far outweighing credit quality considerations. I will, however, point out that their primary liquidity estimator is at least a little suspect:

Data on the quarterly bid-ask quotes are hand-collected from the Bloomberg Terminals. Most quotes are available only from 2000 to 2003. For each quarter, we calculate the proportional spread as the ask minus the bid divided by the average bid and ask price. The bond-year’s proportional bid-ask spread is then calculated as the average of the quarterly proportional spreads. To include as many bonds as possible, we compute the annual proportional spread as long as there is at least one quarterly quote for the year. The bid-ask quotes recorded are the Bloomberg Generic Quote which reflects the consensus quotes among market participants.

I have to point out that Bloomberg quotes are suspect according to the Jankowitsch, Nashikkar and Subrahmanyam paper referenced in an earlier post, with almost half of actual trades executed outside the quote. This doesn’t necessarily mean that the Bloomberg quotation spreads are useless as a liquidity estimator, but it does mean that somebody has to do some work to show that Bloomberg spreads do in fact have a solid relationship to real life (e.g., that if the bid on bond A is less than the bid on bond B, then you can in fact sell B at a higher price than A).

So what it comes down to is that I agree with Bessembinder, Maxwell and Venkataraman that if TRACE does improve liquidity, then this is a good thing, but I will claim that you cannot measure liquidity in a practical way by comparing dealer sell prices with dealer buy prices if the Shitty Price Hypothesis holds.

As it happens, there is a paper by Nils Friewald, Rainer Jankowitschy and Marti G. Subrahmanyamz which seeks to validate the round-trip trading cost as a measure of liquidity, titled Transparency and Liquidity in the Structured Product Market:

We use a unique data set from the Trade Reporting and Compliance Engine (TRACE) to study liquidity effects in the US structured product market. Our main contribution is the analysis of the relation between the accuracy in measuring liquidity and the potential degree of disclosure. We provide evidence that transaction cost measures that use dealer-speci c information can be eciently proxied by measures that use less detailed information. In addition, we analyze liquidity, in general, and show that securities that are mainly institutionally traded, guaranteed by a federal authority, or have low credit risk, tend to be more liquid.

For example, measuring liquidity based on the round-trip cost uses the most detailed information, i.e., each transaction needs to be linked to a particular dealer, on each side of the trade. Other liquidity metrics, such as the effective bid-ask spread, do not need such detailed trade information for their computation; but, transactions need to be flagged as buy or sell trades. Many alternative liquidity measures rely on trading data as well: However, they use only information regarding the price and/or volume of each transaction. On the other hand, product characteristics or trading activity variables represent simpler proxies, using either static or aggregated data.

Exploring the various liquidity metrics and focusing on the predictive power of transaction data, we show that simple product characteristics and trading activity variables, by themselves, may not be sufficient statistics for measuring market liquidity. In particular, when regressing state-of-the-art liquidity measures on product characteristics and trading activity variables, we find that the various liquidity measures over significant idiosyncratic information. Thus, dissemination of detailed transaction data, necessary for the estimation of liquidity measures, is of importance in the fixed-income structured product market. However, there is evidence that liquidity measures based on price and volume information alone (e.g., the imputed round-trip cost measure) can explain most of the variation observed in the benchmark measure, which uses significantly more information and certainly runs the risk of compromising the confidentiality of trader identity. In a second set of regressions, we explain the observed yield spreads using various combinations of liquidity variables and nd similar results: Liquidity measures provide higher explanatory power than product characteristics and trading activity variables alone. However, this result is mostly driven by price and volume information. Thus, details regarding the identities of the specific dealers involved with a particular trade or the direction of the trade are not an absolute necessity in terms of their informational value to market participants: Reasonable estimates of liquidity can be calculated based on prices and volumes of individual trades, without divulging dealer-specific information. This is an important result for all market participants, as it provides valuable insights concerning the information content of reported transaction data.

They acknowledge the Bessembinder paper and discuss the differences:

However, our paper is different from Bessembinder et al. (2013) for at least five important reasons, relating to various aspects of liquidity effects in the structure product market: First, while their analysis is based only on one single estimate of liquidity, we, in contrast, rely on a much broader set of liquidity proxies, which allows us to discuss the information contained in measures employing reported data at different levels of detail. Second, while Bessembinder et al. (2013) use a regression based estimate of liquidity, our round-trip cost measure (which serves as our benchmark) reflects the cost of trading more accurately, since it is based on detailed dealer-specific transaction costs, which are straightforward to compute, and does not depend, in any way, on modeling assumptions. Third, in their analysis, they focus solely on customer-to-dealer trades which constitute only a rather small fraction of all trades in the structured product market, whereas our analysis is based on all customer-to-dealer and dealer-to-dealer transactions. Fourth, unlike their study, we analyze different sub-segments (e.g., tranche seniority, issuing authority, credit rating) of the overall market in much more detail. These sub-segments have either turned out to be important in other fixed income markets, or are unique to the structured product market. Finally, a novel contribution of our paper is that we also analyze which of the liquidity measures best serves to explain yield spreads in the securitized product market.

So more particularly:

Thus, we ask how much information should be disseminated to allow for the accurate measurement of liquidity, compared to our benchmark measure using the most detailed information, in particular trader identity and trade direction, which certainly runs the risk of compromising the identities of individual traders or their trading strategies. Therefore, we measure the efficacy of liquidity metrics that require different levels of detail in terms of the information used to compute them. We analyze two aspects of this question, using different sets of regressions: First, we explore to what extent product characteristics, trading activity variables and liquidity measures using less information can proxy for the benchmark measure which is based on all available information. Second, we study which liquidity measures can best explain the cross-sectional differences in yield spreads for our sample.

Product characteristics are rather crude proxies of liquidity that rely on the lowest level of informational detail of all the categories.13 Thus, product characteristics are typically used as liquidity metrics when there is a limitation on the level of detail in the transaction data. In particular, we use the amount issued of a security measured in millions of US dollars. We presume securities with a larger amount issued to be more liquid, in general. Another important product characteristic is the time-to-maturity, which corresponds to the time, in years, between the trading date and the maturity date of the security. We expect securities with longer maturities (over ten years) to be generally less liquid, since they are often bought by “buy-and-hold” investors, who trade infrequently. We also consider the instrument’s average coupon as a relevant proxy. Despite the ambiguity of the relationship between the coupon and both liquidity and credit risk, we expect that instruments with larger coupons are generally less liquid.

Trading activity variables such as the number of trades observed for a product on a given day represent the aggregate market activity.15 Other similar variables that we calculate on a daily basis, for each product, are the number of dealers involved in trading a specific product, and the trading volume measured in millions of US dollars. We expect these variables to be larger, the more liquid the product. On the contrary, the longer the trading interval, which refers to the time elapsed between two consecutive trades in a particular product (measured in days), the less liquid we would expect the product to be.

Note that the Shitty Price Hypothesis negates this last assumption: dealers will set prices so they can exit their positions quickly.

Liquidity measures are conceptually based, and hence, more direct proxies for measuring liquidity, and require transaction information for their computation. However, the level of detail concerning the required information set varies considerably across measures. The liquidity measure that uses the most detailed information and, thus, serves as our benchmark measure, is the round-trip cost measure, which can be computed only if the traded prices and volumes can be linked to the individual dealer; see, e.g., Goldstein et al. (2007). It is defined as the price difference, for a given dealer, between buying (selling) a certain amount of a security and selling (buying) the same amount of this security, within a particular time period, e.g., one day. Thus, it is assumed that in a “round-trip” trade, the price is not affected by changes in the fundamentals during this period. Following the literature, the round-trip trade may either consist of a single trade or a sequence of trades, which are of equal size in aggregate, on each side. The effective bid-ask spread, proposed by Hong and Warga (2000), can be computed when there is information about trade direction available. The effective bid-ask spread is then defined as the difference between the daily average sell and buy prices (relative to the mid-price).

Many other liquidity measures use only the price and/or volume of each transaction, without relying on dealer-specific or buy/sell-side information. A well-known metric proposed by Amihud (2002), and conceptually based on Kyle (1985), is the Amihud measure. It was originally designed for exchange-traded equity markets, but has also become popular for measuring liquidity in OTC markets. It measures the price impact of trades on a particular day, i.e., it is the ratio of the absolute
price change measured as a return, to the trade volume given in US dollars. A larger Amihud measure implies that trading a financial instrument causes its price to move more in response to a given volume of trading and, in turn, reflects lower liquidity. An alternative method for measuring the bid-ask spread is the imputed round-trip cost, introduced by Feldhutter (2012). The idea here is to identify round-trip trades, which are assumed to consist of two or three trades on a given day with exactly the same traded volume. This likely represents the sale and purchase of an asset via one or more dealers to others in smaller trades. Thus, the dealer identity is not employed in this matching procedure; rather, differences between the prices paid for small trades, and those paid for large trades, based on overall identical volumes, are used as the measure. The price dispersion measure is a new liquidity metric recently introduced for the OTC market by Jankowitsch et al. (2011). This measure is based on the dispersion of traded prices around the market-wide consensus valuation, and is derived from a market microstructure model with inventory and search costs. A low dispersion around this valuation indicates that the nancial instrument can be bought for a price close to its fair value and, therefore, represents low trading costs and high liquidity, whereas a high dispersion implies high transaction costs and hence low liquidity. The price dispersion measure is defined as the root mean squared difference between the traded prices and the average price, the latter being a proxy for the respective market valuation.

The Roll measure, developed by Roll (1984) and applied by Bao et al. (2011) and Friewald et al. (2012), for example, in the context of OTC markets, is a transaction cost measure that is simply based on observed prices. Under certain assumptions, adjacent price movements can be interpreted as a “bid-ask bounce”, resulting in transitory price movements that are serially negatively correlated. The strength of this covariation is a proxy for the round-trip transaction costs for a particular nancial instrument, and hence, a measure of its liquidity. This measure requires the lowest level of detail as only traded prices, and not trading volume or dealer-specific information, are used in the computation.

Whoosh! That’s a lot of liquidity measures! And I thought I was obsessive!

The descriptive statistics and correlations presented in Section 5.1 provide initial indications of the informational value of the various liquidity measures. When analyzing the liquidity of the different markets and their sub-segments, the liquidity measures offer additional insights compared to the product characteristics and trading activity variables. For example, when comparing the different market segments, higher trading activity is not always associated with lower transaction costs. The correlation analysis hints in the same direction: There is low correlation between the product characteristics and the liquidity measures (the highest correlation coefficient is 0.26 in absolute terms) and between trading activity variables and liquidity measures (less than 0.20 in absolute terms). Thus, it seems that liquidity measures that rely on more detailed transaction data can provide important additional information, based on this perspective.

Table 10 shows the results for this analysis, presenting the six specifications. In regressions
(1) to (5), we use each of the liquidity measures in turn, plus all trading activity variables and product characteristics, to explain the round-trip costs. When we add just one individual proxy to the regression analysis, we find that the imputed round-trip cost, the effective bid-ask spread and the price dispersion measure are the best proxies, with R2 values of around 50% to 60%, whereas the Amihud and Roll measures slightly increase the R2 to around 40% compared to regressions without liquidity measures. When adding all the liquidity measures to the regression equation, in regression (6), we obtain an R2 of 67%, i.e., the explanatory power increases considerably when we include all these proxies. We consider this level of explanatory power quite high, given the rather diverse instruments with potentially different liquidity characteristics and the low number of trades per security and day, in general. We get similar results (not reported here) when explaining the effective bid-ask spread with liquidity measures using less information. Thus, we find evidence that liquidity measures using more detailed data can be proxied reasonably well by similar measures using less data. We further discuss this issue in the next section and analyze the importance of the disclosure in the context of pricing.

And correlation with yields?

Analyzing the effect of the trading activity variables in the full model, we find economically significant results only for the trading interval: An increase in the trading interval by one standard deviation is associated with an increase in the yield spread of 15 bp. The information contained in the other trading activity variables, e.g., traded volume, seems to be adequately represented by the liquidity measures. However, more important are the results for the product characteristics. The most relevant variable in the full model turns out to be the coupon. A one-standard-deviation higher coupon results in an increase of 137 bp in the yield spread. Thus, the coupon rate has the highest explanatory power of all the variables, indicating that a higher coupon is also associated with higher credit risk for certain products, in particular when there is no credit rating available. The amount issued shows important effects as well, where a one-standard-deviation increase leads to an 19 bp decrease in the yield spread: Larger issues have lower yield spreads. The maturity of a structured product is related to the yield spread as well, indicating that longer maturities are associated with somewhat lower spreads. However, compared with the other product characteristics, the maturity is of minor importance. Overall, the full model has an R2 of 69.9% with significant incremental explanatory power shown by the liquidity measures. Thus, liquidity is an important driver of yield spreads in the structured product market; therefore, the dissemination of trading activity information is important, given the size and complexity of this market.

And they conclude:

Exploring the relation between the various liquidity proxies and the depth of disseminated information, we find that product characteristics or variables based on aggregated trading activity, by themselves, are not sucient proxies for market liquidity. The dissemination of the price and volume of each individual trade is important for the quantification of liquidity effects, particularly for explaining yield spreads. However, we also provide evidence that liquidity measures that use additional dealer-specific information (i.e., trader identity and sell/buy-side categorization) can be efficiently proxied by measures using less information. In our regression analysis, we find that liquidity effects cover around 10% of the explained variation in yield spreads. Thus, the dissemination of trading activity is essential, given the trade volume and complexity of this market. These results are important for all market participants in the context of OTC markets, as it allows establishing an understanding of the information content contained in the disclosure of trading data.