There’s an interesting trend in US bank accounting:
Big U.S. banks have been shifting huge chunks of their securities portfolios from AFS to HTM as they seek to offset the coming impact of a rate rise. Bloomberg News reported last year that the share of securities that the five biggest banks keep in the HTM bucket jumped to 8.4 percent, the highest in almost two decades. The trend appears to have accelerated in the ensuing months, with almost a third of the MBS on bank balance sheets now classified as HTM, according to new research from JPMorgan.
…
As JPMorgan analysts note: “… [B]anks have shifted nearly a third of their MBS into HTM accounts, thanks to concern about capital volatility driven by recent regulatory changes. This means that banks should ultimately be less sensitive to rate moves, since fewer securities are being marked to market.” The shift makes some sense in the face of declining bank profit margins and the need to hold more lower-yielding assets that are considered super-liquid under other new banking rules.Buying longer duration MBS and then stuffing them in HTM portfolios can help banks offset some of the lower returns on offer from investing in things such as shorter-term U.S. Treasuries.
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It is interesting that the freeze on trading implied by Hold-to-Maturity status for these liquidity buffers will make MBS less liquid as a group; this is just another one of the inherent contradictions of capitalism.
Matt Levine explains:
If you own that bond for investment purposes, and you don’t have any “intent of selling it within hours or days,” you have an investment loss on paper, but you get to treat it a bit more gently. (This is called “available for sale,” or AFS.) The loss doesn’t flow through your net income; instead it flows through a different place called “other comprehensive income,” and everyone agrees to treat that as somewhat less important than net income.3 Everyone except Basel III bank capital regulation: Last year, regulators ungallantly decided to require you to treat those unrealized investment losses as reducing your capital.
If you have the “positive intent and ability” to hold the bond until it matures, then you can just ignore the economic loss until maturity. (This is called “held to maturity,” or HTM.) You just keep the bond on your books at the price you paid for it,[4] and at maturity you get back par and your loss vanishes.5 You ignore the loss in net income, other comprehensive income, your balance sheet, your capital, whatever.
Footnote 4: Amortized cost, but let’s not split hairs
Footnote 5: Which makes a sort of sense: If you never sell the bond in the market, you never realize the loss in the form of getting fewer dollars for your bond than you paid for it. Your loss becomes just an opportunity cost: Instead of getting 5 percent interest and your money back, you got 4 percent interest and your money back. But you got your money back. Everything is fine.
So it would seem that banks are now doing with long-term MBS what retail loves to do with GICs – carry the position at historical cost and blithely ignore market marks.
So, as Mr. Levine points out, one immediate problem is:
First, one reaction to a rising interest rate environment might be to reduce one’s holdings of long-dated fixed-income securities. One might say “hmm, I should maybe sell my trillions of dollars of very liquid Fannie Mae bonds that I expect to lose value in the next few years.” Or not, I mean, I’m not advising anyone to predict the timing of interest rate rises. The point is though that banks seem to be reacting to their expectations of rising interest rates with the opposite of the economically rational strategy: Not “sell bonds to avoid losses later,” but rather “reclassify bonds as hold-forever to avoid recognizing losses later.” The accounting provides opposite incentives from the economics.
Another obvious problem is that, in a scenario of higher interest rates, there will be a good chunk of unrealized and unrecognized losses on the books. Therefore, in a crisis when bank investors change their valuation paradigm from ‘going-concern’ to ‘break-up value’ we might just see some problems!
As we’ve learned in Ontario with respect to gender quotas on boards of public companies, protecting the interests of investors is BORING. So US regulatory agencies have now become soldiers in the great battle of social change:
The OCC, Board, FDIC, NCUA, CFPB, and SEC are issuing a final interagency policy statement establishing joint standards for assessing the diversity policies and practices of the entities they regulate, as required by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.
My favourite part is:
In addition, entities’ prime contractors often use subcontractors to fulfill the obligations of various contracts. The use of minority-owned and women-owned businesses as subcontractors provides valuable opportunities for both the minority-owned and women-owned businesses and the prime contractor. Entities may encourage the use of minority-owned and women-owned subcontractors by incorporating this objective in their business contracts.
Just like South Africa, that paragon of economic development!
SEC Commissioner Luis A. Aguilar doesn’t like it:
For example, the Final Policy Statement fails to address the following concerns raised by commenters:
- • First, that allowing the voluntary disclosure of information by regulated entities is prohibited under Section 342 of the Dodd-Frank Act because it renders the statute ineffective and fails to achieve the Congressional intent of advancing diversity in the financial services industry.
- • Second, that voluntary self-assessments are ineffective because, without specific obligations and requirements, few regulated entities will conduct assessments or share assessment information.
- • Third, that failing to include standard criteria and uniform metrics for assessing the diversity and inclusion practices at regulated entities will make it very difficult, if not impossible, to assess diversity at different firms.
- • Fourth, that a purely voluntary requirement, and one without a reporting timeline, lacks transparency and accountability. Firms can therefore decide not to conduct any assessment and treat any OMWI oversight as optional or irrelevant.
- • Fifth, that OMWI would fail to satisfy its Congressional mandate under Section 342 by simply monitoring voluntary reports that may or may not be filed by regulated entities.
- • Finally, that a definition of “diversity” that is too narrow would fail to accomplish the goals of Section 342. In fact, the Final Policy Statement’s definition of “diversity” excludes people with disabilities and excludes the entire LGBT community.
It was a mostly negative day for the Canadian preferred share market, with PerpetualDiscounts gaining 2bp, FixedResets down 27bp and DeemedRetractibles off 26bp. The Performance Highlights table is fairly lengthy, with a mixed bag of entries, mostly losers. Volume was average.
But, I mean, Holy Smokes! Here’s a picture of CPD total returns for the past month. Don’t these damn things ever go up?
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For as long as the FixedReset market is so violently unsettled, I’ll keep publishing updates of the more interesting and meaningful series of FixedResets’ Implied Volatilities. This doesn’t include Enbridge because although Enbridge has a large number of issues outstanding, all of which are quite liquid, the range of Issue Reset Spreads is too small for decent conclusions. The low is 212bp (ENB.PR.H; second-lowest is ENB.PR.D at 237bp) and the high is a mere 268 for ENB.PF.G.
Remember that all rich /cheap assessments are:
» based on Implied Volatility Theory only
» are relative only to other FixedResets from the same issuer
» assume constant GOC-5 yield
» assume constant Implied Volatility
» assume constant spread
Here’s TRP:
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TRP.PR.E, which resets 2019-10-30 at +235, is bid at 23.50 to be $1.21 rich, while TRP.PR.B, which will reset June 30 at 2.152% (+128), is $0.71 cheap at its bid price of 14.73
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Another excellent fit, but the numbers are perplexing. Implied Volatility for MFC continues to be a conundrum. It is still too high if we consider that NVCC rules will never apply to these issues; it is still too low if we consider them to be NVCC non-compliant issues (and therefore with Deemed Maturities in the call schedule). It is clear that the lowest spread issue, MFC.PR.F, is well off the relationship defined by the other issues, but this doesn’t resolve the conundrum – it just makes it more conundrous.
Most expensive is MFC.PR.M, resetting at +236bp on 2019-12-19, bid at 24.10 to be $0.49 rich, while MFC.PR.F, resetting at +141bp on 2016-6-19, is bid at 25.00 to be $0.50 cheap.
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The cheapest issue relative to its peers is BAM.PR.R, resetting at +230bp on 2016-6-30, bid at 21.00 to be $0.20 cheap. BAM.PR.T, resetting at +231bp 2017-3-31 is bid at 21.50 and appears to be $0.24 rich.
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FTS.PR.H, with a spread of +145bp, and bid at 16.15, looks $0.99 cheap and resets 2020-6-1. FTS.PR.K, with a spread of +205bp and resetting 2019-3-1, is bid at 21.65 and is $0.41 rich.
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Investment-grade pairs predict an average three-month bill yield over the next five-odd years of about 0.45%, with no ridiculous outliers now that the awful performance of FTS.PR.I today has brought the FTS.PR.H / FTS.PR.I pair into the fold. On the junk side, five out of the six pairs are outside the range of the graph: FFH.PR.E / FFH.PR.F at -1.23%; AIM.PR.A / AIM.PR.B at -0.41%; BRF.PR.A / BRF.PR.B at -0.36%; DC.PR.B / DC.PR.D at -0.47%; and FFH.PR.C / FFH.PR.D at +1.14%.
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Shall we just say that this exhibits a high level of confidence in the continued rapacity of Canadian banks?
| HIMIPref™ Preferred Indices These values reflect the December 2008 revision of the HIMIPref™ Indices Values are provisional and are finalized monthly |
|||||||
| Index | Mean Current Yield (at bid) |
Median YTW |
Median Average Trading Value |
Median Mod Dur (YTW) |
Issues | Day’s Perf. | Index Value |
| Ratchet | 0.00 % | 0.00 % | 0 | 0.00 | 0 | -0.2793 % | 2,198.0 |
| FixedFloater | 0.00 % | 0.00 % | 0 | 0.00 | 0 | -0.2793 % | 3,843.0 |
| Floater | 3.49 % | 3.54 % | 61,028 | 18.34 | 3 | -0.2793 % | 2,336.6 |
| OpRet | 4.44 % | -12.59 % | 28,214 | 0.08 | 2 | 0.0988 % | 2,782.9 |
| SplitShare | 4.59 % | 4.78 % | 70,975 | 3.31 | 3 | -0.2142 % | 3,244.9 |
| Interest-Bearing | 0.00 % | 0.00 % | 0 | 0.00 | 0 | 0.0988 % | 2,544.7 |
| Perpetual-Premium | 5.47 % | 5.09 % | 63,766 | 4.25 | 19 | -0.0270 % | 2,509.6 |
| Perpetual-Discount | 5.07 % | 5.05 % | 112,689 | 15.40 | 15 | 0.0197 % | 2,761.9 |
| FixedReset | 4.47 % | 3.87 % | 250,660 | 16.34 | 87 | -0.2703 % | 2,369.9 |
| Deemed-Retractible | 5.01 % | 3.41 % | 108,469 | 0.70 | 34 | -0.2597 % | 2,618.8 |
| FloatingReset | 2.51 % | 2.90 % | 57,234 | 6.13 | 9 | -0.1280 % | 2,330.3 |
| Performance Highlights | |||
| Issue | Index | Change | Notes |
| FTS.PR.I | FloatingReset | -3.14 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2045-06-09 Maturity Price : 15.40 Evaluated at bid price : 15.40 Bid-YTW : 3.34 % |
| MFC.PR.L | FixedReset | -2.65 % | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2025-01-31 Maturity Price : 25.00 Evaluated at bid price : 23.12 Bid-YTW : 4.48 % |
| BAM.PF.G | FixedReset | -2.10 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2045-06-09 Maturity Price : 22.88 Evaluated at bid price : 24.25 Bid-YTW : 4.12 % |
| GWO.PR.I | Deemed-Retractible | -1.95 % | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2025-01-31 Maturity Price : 25.00 Evaluated at bid price : 22.66 Bid-YTW : 5.77 % |
| GWO.PR.R | Deemed-Retractible | -1.84 % | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2025-01-31 Maturity Price : 25.00 Evaluated at bid price : 23.95 Bid-YTW : 5.36 % |
| NA.PR.W | FixedReset | -1.71 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2045-06-09 Maturity Price : 22.61 Evaluated at bid price : 23.60 Bid-YTW : 3.56 % |
| CM.PR.O | FixedReset | -1.67 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2045-06-09 Maturity Price : 22.63 Evaluated at bid price : 23.55 Bid-YTW : 3.64 % |
| HSE.PR.E | FixedReset | -1.59 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2045-06-09 Maturity Price : 23.11 Evaluated at bid price : 24.80 Bid-YTW : 4.50 % |
| MFC.PR.B | Deemed-Retractible | -1.51 % | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2025-01-31 Maturity Price : 25.00 Evaluated at bid price : 22.80 Bid-YTW : 5.87 % |
| TRP.PR.C | FixedReset | -1.42 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2045-06-09 Maturity Price : 16.63 Evaluated at bid price : 16.63 Bid-YTW : 3.98 % |
| PWF.PR.P | FixedReset | -1.35 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2045-06-09 Maturity Price : 18.30 Evaluated at bid price : 18.30 Bid-YTW : 3.72 % |
| HSE.PR.C | FixedReset | -1.06 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2045-06-09 Maturity Price : 22.94 Evaluated at bid price : 24.32 Bid-YTW : 4.27 % |
| ENB.PF.G | FixedReset | -1.06 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2045-06-09 Maturity Price : 20.58 Evaluated at bid price : 20.58 Bid-YTW : 4.76 % |
| POW.PR.G | Perpetual-Premium | 1.25 % | YTW SCENARIO Maturity Type : Call Maturity Date : 2021-04-15 Maturity Price : 25.00 Evaluated at bid price : 25.89 Bid-YTW : 5.09 % |
| MFC.PR.F | FixedReset | 2.42 % | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2025-01-31 Maturity Price : 25.00 Evaluated at bid price : 18.20 Bid-YTW : 6.47 % |
| GWO.PR.N | FixedReset | 3.50 % | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2025-01-31 Maturity Price : 25.00 Evaluated at bid price : 17.45 Bid-YTW : 6.73 % |
| Volume Highlights | |||
| Issue | Index | Shares Traded |
Notes |
| BMO.PR.Y | FixedReset | 116,300 | Recent new issue. YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2045-06-09 Maturity Price : 23.04 Evaluated at bid price : 24.68 Bid-YTW : 3.69 % |
| BMO.PR.S | FixedReset | 85,217 | Desjardins crossed blocks of 50,000 and 20,000, both at 24.45. YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2045-06-09 Maturity Price : 22.98 Evaluated at bid price : 24.28 Bid-YTW : 3.50 % |
| FTS.PR.M | FixedReset | 77,297 | RBC crossed 74,000 at 24.40. YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2045-06-09 Maturity Price : 22.98 Evaluated at bid price : 24.40 Bid-YTW : 3.63 % |
| RY.PR.N | Perpetual-Discount | 72,757 | Recent new issue. YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2045-06-09 Maturity Price : 24.52 Evaluated at bid price : 24.91 Bid-YTW : 4.93 % |
| RY.PR.F | Deemed-Retractible | 71,310 | Desjardins crossed two blocks of 34,000 each, both at 25.35. YTW SCENARIO Maturity Type : Call Maturity Date : 2015-07-09 Maturity Price : 25.25 Evaluated at bid price : 25.35 Bid-YTW : 1.93 % |
| BAM.PR.R | FixedReset | 58,306 | RBC crossed 50,000 at 21.00. YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2045-06-09 Maturity Price : 21.00 Evaluated at bid price : 21.00 Bid-YTW : 4.17 % |
| There were 31 other index-included issues trading in excess of 10,000 shares. | |||
| Wide Spread Highlights | ||
| Issue | Index | Quote Data and Yield Notes |
| GWO.PR.S | Deemed-Retractible | Quote: 26.05 – 27.00 Spot Rate : 0.9500 Average : 0.6415 YTW SCENARIO |
| BAM.PF.G | FixedReset | Quote: 24.25 – 24.81 Spot Rate : 0.5600 Average : 0.3198 YTW SCENARIO |
| MFC.PR.F | FixedReset | Quote: 18.20 – 18.90 Spot Rate : 0.7000 Average : 0.4866 YTW SCENARIO |
| MFC.PR.B | Deemed-Retractible | Quote: 22.80 – 23.21 Spot Rate : 0.4100 Average : 0.2504 YTW SCENARIO |
| MFC.PR.L | FixedReset | Quote: 23.12 – 23.43 Spot Rate : 0.3100 Average : 0.1932 YTW SCENARIO |
| CM.PR.O | FixedReset | Quote: 23.55 – 23.90 Spot Rate : 0.3500 Average : 0.2425 YTW SCENARIO |