PrefBlog

Was it Joseph Mason who said it? Added 2009-7-15: Yes. It was. The fundamental problem with credit ratings and regulations thereof is that while the assumption is that you have a conservative investor looking for a conservative opinion, the regulatory use of credit ratings means that you have regulated investors looking for a license to invest. So, into the breach steps Realpoint:

U.S. credit rating company Realpoint on Thursday said insurers may soon be allowed to use its commercial mortgage bond ratings and preserve capital if rival Standard & Poor’s moves to slash its designations
…
The NAIC move would give insurers more flexibility in choosing ratings that determine their capital levels and avoid forced selling of the assets if S&P adopts more conservative models. Insurers can use the middle rating, if there are three, according to [Realpoint CEO] Dobilas.

S&P shocked the the CMBS market last week by advising that its new models, if adopted, would likely prompt ratings cuts on 95 percent of top bonds issued during the peak of the real estate cycle in 2007 and 85 percent of CMBS from 2006. S&P is mulling responses from a formal request for comment.

Some 50 insurers have contacted Horsham, Pennsylvania-based Realpoint over the last few days, saying, “you guys need to get approved” by the NAIC, Dobilas said.

This is of particular interest in light of today’s release of the BIS paper Stocktaking on the use of credit ratings:

In the United States, insurance regulators require bonds and preferred stocks to be reported in statutory financial statements in one of six National Association of Insurance Commissioners (NAIC) designations categories that denote credit quality. If an accepted rating organisation (ARO) has rated the security, the security is not required to be filed with the NAIC’s Securities Valuation Office (SVO). Rather, the ARO rating is used to map the security to one of the six NAIC designation categories.18 The NAIC designations are primarily designed to assist regulators (as opposed to investors) to monitor the financial condition of their insurers.

Finally, in light of the impact that the credit market crisis had on the credit ratings of the financial guarantors and the bonds they insure, the NAIC announced that the SVO will be issuing “substitute” ratings for some municipal bonds. In doing so, the NAIC will be assessing the creditworthiness of the municipality that issued the debt. These credit ratings will be used to determine the risk based capital charge for the security. The insurance regulators indicated that the proposal will “decouple” the NAIC rating from the rating agency process.

So NAIC is not just a regulator, it’s also a credit rating agency! Ain’t no conflict of interest there, eh? It sure is a good thing that regulators are infallible!

In Canada, by the way:

In Canada, a significant portion of an insurer’s capital requirement (especially for a life insurer) arises from its exposure to credit risk. This component of the overall insurer capital requirement is determined using asset default factors. For rated short term securities, bonds, loans and private placements, these factors are based on the rating agency grade. In its life insurer capital guideline, the Office of the Superintendent of Financial Institutions (OSFI) states that:

“A company must consistently follow the latest ratings from a recognized, widely followed credit rating agency. Only where that rating agency does not rate a particular instrument, the rating of another recognized, widely followed credit rating agency may be used. However, if the Office believes that the results are inappropriate, a higher capital charge would be required.” [page 3-1-3]

Further, in Canada, asset default factors for preferred shares, where rated, are based on the rating agency grade. For financial leases where rated, and the lease is also secured by the general credit of the lessee, the asset default factor is based on the rating agency grade.

IIROC has (Notice 09-0172) done its bit to ensure that investors are restricted to investments offered by large banks that employ many former regulators:

Leveraged exchange traded funds (ETFs) are probably not suitable for retail investors, the Investment Industry Regulatory Organization of Canada is warning its dealer members.
…
Leveraged ETFs are reset daily by the provider. This means if an investor does not rebalance their leveraged ETFs on a daily basis, there will be tracking error, which will be exacerbated the longer the investment is held.

Investors need to have both the right call on a market direction, and more importantly a stable path of direction for these products to work in buy and hold strategies. Volatility can seriously impair the performance of these ETFs if held for the long term.

In its notice IIROC said a Canadian ETFs that seeks to deliver twice the daily return of the COMEX Gold Bullion Index fell 5% between January 22, 2008 and May 29, 2009. However, its inverse fund (twice the inverse daily return of the index) fell 38% in the same time period even though the underlying COMEX Gold Bullion Index increased by 6% during this period IIROC.

“Due to the effects of compounding, their performance over longer periods of time can differ significantly from their stated daily objective. Therefore, leveraged and inverse ETFs that are reset daily typically are unsuitable for retail investors who plan to hold them for longer than one trading session, particularly in volatile markets,” the notice says.

I mentioned some trader-games in the CDS market on June 12 – James Hamilton of Econbrowser comments:

For my money, the first rule we need would be a law, not a rule, that notional not exceed actual.

Barring that, here’s another rule I trust: a fool and his money are soon parted.

I’m OK with the second rule, but strongly disagree with the first. Some idiot made a dumb trade and lost money. Why does this demand a regulatory response?

C-EBS has announced consultation on Large Exposure guidelines for banks. Sadly, these proposed measures appear to be all about reporting, giving more discretion to supervisory authorities. There are no current plans to make regulatory response fair and reasonable by simply applying a surcharge to the Risk-Weighted-Assets calculation.

There are mutterings that CAD strength may hasten (more) quantitative easing:

Bank of Canada Governor Mark Carney, who says a strengthening currency could choke the economic recovery, may be pressed into creating dollars and buying assets such as government bonds to offset the dollar’s rise.

A 16 percent gain for the Canadian dollar since March 9 is threatening to undermine the country’s already battered exporters. This raises the likelihood that Carney will follow the Federal Reserve, Bank of England and Swiss National Bank in pursuing so-called quantitative easing, said Nicholas Rowe, an economist at Carleton University in Ottawa.

Volume came down a little from the recent frenzy, but remains strong. A nothing day for PerpetualDiscounts, Floating Rate issues were down a bit and FixedResets continued to shine.

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	-2.6857 %	1,297.0
FixedFloater	7.02 %	5.51 %	32,138	16.28	1	-2.1465 %	2,150.2
Floater	2.94 %	3.30 %	82,825	19.00	3	-2.6857 %	1,620.3
OpRet	4.98 %	3.74 %	140,169	0.93	14	0.0339 %	2,189.1
SplitShare	5.82 %	6.41 %	56,739	4.23	3	0.0000 %	1,875.2
Interest-Bearing	5.99 %	7.77 %	22,982	0.52	1	-0.0998 %	1,989.2
Perpetual-Premium	0.00 %	0.00 %	0	0.00	0	-0.0440 %	1,737.1
Perpetual-Discount	6.33 %	6.33 %	157,137	13.46	71	-0.0440 %	1,599.8
FixedReset	5.68 %	4.84 %	548,135	4.36	39	0.1495 %	2,011.5

Performance Highlights
Issue	Index	Change	Notes
BAM.PR.B	Floater	-3.35 %	YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2039-06-15 Maturity Price : 11.82 Evaluated at bid price : 11.82 Bid-YTW : 3.32 %
TRI.PR.B	Floater	-2.94 %	YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2039-06-15 Maturity Price : 16.50 Evaluated at bid price : 16.50 Bid-YTW : 2.38 %
BAM.PR.G	FixedFloater	-2.15 %	YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2039-06-15 Maturity Price : 25.00 Evaluated at bid price : 15.50 Bid-YTW : 5.51 %
BAM.PR.K	Floater	-1.65 %	YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2039-06-15 Maturity Price : 11.90 Evaluated at bid price : 11.90 Bid-YTW : 3.30 %
GWO.PR.I	Perpetual-Discount	-1.15 %	YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2039-06-15 Maturity Price : 17.21 Evaluated at bid price : 17.21 Bid-YTW : 6.57 %
RY.PR.F	Perpetual-Discount	-1.09 %	YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2039-06-15 Maturity Price : 18.18 Evaluated at bid price : 18.18 Bid-YTW : 6.20 %
BAM.PR.O	OpRet	-1.02 %	YTW SCENARIO Maturity Type : Option Certainty Maturity Date : 2013-06-30 Maturity Price : 25.00 Evaluated at bid price : 23.26 Bid-YTW : 6.99 %
NA.PR.K	Perpetual-Discount	1.06 %	YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2039-06-15 Maturity Price : 23.57 Evaluated at bid price : 23.86 Bid-YTW : 6.20 %
GWO.PR.G	Perpetual-Discount	1.41 %	YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2039-06-15 Maturity Price : 20.20 Evaluated at bid price : 20.20 Bid-YTW : 6.47 %
IAG.PR.C	FixedReset	1.56 %	YTW SCENARIO Maturity Type : Call Maturity Date : 2014-01-30 Maturity Price : 25.00 Evaluated at bid price : 26.01 Bid-YTW : 5.18 %
BAM.PR.M	Perpetual-Discount	1.91 %	YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2039-06-15 Maturity Price : 16.00 Evaluated at bid price : 16.00 Bid-YTW : 7.46 %

Volume Highlights
Issue	Index	Shares Traded	Notes
MFC.PR.E	FixedReset	71,672	Recent new issue. YTW SCENARIO Maturity Type : Call Maturity Date : 2014-10-19 Maturity Price : 25.00 Evaluated at bid price : 25.23 Bid-YTW : 5.49 %
BNS.PR.T	FixedReset	55,480	National crossed 40,000 at 27.10. YTW SCENARIO Maturity Type : Call Maturity Date : 2014-05-25 Maturity Price : 25.00 Evaluated at bid price : 27.08 Bid-YTW : 4.60 %
SLF.PR.D	Perpetual-Discount	54,180	Desjardins crossed 50,000 at 17.00. YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2039-06-15 Maturity Price : 17.00 Evaluated at bid price : 17.00 Bid-YTW : 6.58 %
BAM.PR.P	FixedReset	51,100	Recent new issue. YTW SCENARIO Maturity Type : Call Maturity Date : 2014-10-30 Maturity Price : 25.00 Evaluated at bid price : 25.60 Bid-YTW : 6.57 %
RY.PR.D	Perpetual-Discount	38,155	YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2039-06-15 Maturity Price : 18.36 Evaluated at bid price : 18.36 Bid-YTW : 6.20 %
RY.PR.P	FixedReset	30,695	Desjardins crossed 19,400 at 27.10. YTW SCENARIO Maturity Type : Call Maturity Date : 2014-03-26 Maturity Price : 25.00 Evaluated at bid price : 26.91 Bid-YTW : 4.61 %
There were 36 other index-included issues trading in excess of 10,000 shares.

This entry was posted on Monday, June 15th, 2009 at 7:25 pm and is filed under Market Action. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.