August 25, 2010

As I have previously noted, I am very pleased to see that we are finally having a debate on the cost of bank regulation. Less, more, whatever … but let’s get some idea of the cost before swallowing OSFI’s Kool-Aid and saying more is always better. I’ve highlighted the BoC study and the BIS report … so our first debater is Terence Corcoran, who wrote a column titled The high cost of bank regulation … the web version is encouragingly headed by:

CORRECTION: Terence Corcoran’s column, The High Cost of Bank Regulation, contained several factual errors regarding a Bank of Canada report on increased bank capital ratios.

An increase in capital of 2% results in a long-run annual impact on the level of GDP of -0.3%, or cumulative -6.0 % (or $92-billion) in present value terms, not -0.5 or -13.0% (or $200-billion). If the increase is 4%, the costs are -10% (or $153-billion) in present value terms , which does not equal $300-billion.

By avoiding future financial crises, the economy will benefit anywhere from 21.6% to 32.0% in present value terms, which is $332-billion to $492-billion. The chances of a financial crisis elsewhere is every 20 to 25 years if the probability is 4.5%, not every 60 years. The benefits to Canada were based on the reduced chance of a foreign crisis.

The impact of a Canadian crisis was based on the lower probability (1.7%) of a Canadian crisis. Finally, bank capital is made of equity, retained earnings, reserves, etc.

The Post regrets the errors.

Next debater, please!

The Congressional Oversight Panel has released – with very little press attention – its report The Global Context and International Effects of the TARP:

The dealings of Goldman Sachs with respect to the CDSs on CDOs that were eventually acquired by Maiden Lane III provide a compelling example of the effect of counterparty relationships on the flow of funds across borders, as 96.9 percent of the cash received by Goldman effectively flowed to non-U.S. institutions. (footnote) (These institutions, as well as other indirect foreign beneficiaries of the AIG rescue – entities that sold hedges on AIG to Goldman and benefited from not having to make good on that protection – are listed in Annex II.)

Footnote reads: According to recently released documents, there were 32 Goldman CDS counterparties that benefited directly from government assistance provided through the Maiden Lane III facility, and 31 of these entities are foreign. Each of the foreign entities listed below held a CDO for which Goldman had written CDS protection and entered into contracts with AIG laying off that risk. While Goldman was required to perform under its contracts whether or not AIG performed, when the government made the decision to pay AIG‟s counterparties at par –including Goldman – the following foreign entities were direct beneficiaries:…

And in Annex 2:

As the following data make clear, taxpayer aid to AIG became aid to Goldman, and aid to Goldman became aid to a number of domestic and foreign investors. In some cases, the aid was in the form of repayment in full of obligations that, without government help, could have ended in default. In other cases, the aid was in the form of guarantees that other parties did not have to pay because the government prevented any defaults.

AIG provided credit default swap (CDS) protection on a number of collateralized debt obligations (CDOs), which were the source of continuing collateral demands on AIG. As part of the AIG rescue, the CDOs underlying the CDSs were acquired by a special-purpose vehicle primarily funded by the government, Maiden Lane III. The entities set out in the table below held CDSs written by Goldman against the CDOs that were eventually acquired by Maiden Lane III. In order to sell those CDOs to Maiden Lane III, in most cases Goldman had to obtain them from these counterparties, so the Maiden Lane III funds effectively flowed to Goldman‟s counterparties. Nearly all of these second-level counterparties, both by number and dollar amount, were non-U.S. institutions, with European banks making up by far the largest contingent.

It will be remembered that the US Congress is almost the opposite of a sausage factory … what comes out of it may certainly be deprecated, but the research that goes into it is first rate (at some point I want to take a look for myself at exactly what they had in front of them when voting to invade Iraq – but that was an issue that never had the slightest amount of fact-motivation from the beginning).

It’s very odd, but I have not been able to find the conclusions regarding Goldman Sachs’ hedging reported on any of the lunatic fringe sites. I tried searching for the phrase “Investigation has concluded that Goldman Sachs was indeed well hedged in its dealings with AIG. Its risk management process was robust even to the events of September 2008, and if all financial firms had been half as competent in managing their exposures, the Panic of 2007 would have been a mere bad spell, a footnote in the history of banking.”, but I have not yet been able to find such a statement. I will post further on this subject when I find such a sentiment, or something approximating it, expressed on the sites of any of Goldman’s erstwhile critics.

There was heavy volume today and minimal overall movement in the market indices masked a surprisingly large amount of volatility in individual issues. MFC prefs were hurt again today – just look at that MFC.PR.D FixedReset, now yielding close to 5% to the call date from the bid price; there are currently five issues trading more than 200bp through that level! You can tell me that BMO is a better credit than MFC and I won’t blink; tell me it’s worth a spread of 200bp for four year money and we might have something to discuss! The strong performance by IAG is a little odd … not that there’s anything wrong with IAG, but those issues went ex-dividend today and it appears nobody noticed.

Nesbitt had a good day, volume-wise, but there is no information available to me regarding what kind of crosses they did … if they were internal crosses, for instance, (between different accounts under the same investment manager), then they won’t have got much commission out of it.

PerpetualDiscounts squeaked out a gain of 1bp, while FixedResets were up 9bp. The median average weighted yield-to-maturity on FixedResets is now a mere 3.16%.

PerpetualDiscounts now yield 5.77%, equivalent to 8.08% interest at the standard 1.4x equivalency factor. Long corporates now yield about 5.3% (!), so the pre-tax interest-equivalent spread (also called the Seniority Spread) is now about 275bp, up marginally – and perhaps spuriously – from the 270bp reported on August 18.

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 0.1459 % 2,051.7
FixedFloater 0.00 % 0.00 % 0 0.00 0 0.1459 % 3,108.1
Floater 2.55 % 2.17 % 34,733 21.92 4 0.1459 % 2,215.3
OpRet 4.91 % 3.44 % 97,065 0.26 9 0.0863 % 2,345.2
SplitShare 6.05 % -26.48 % 65,325 0.09 2 -0.0209 % 2,327.7
Interest-Bearing 0.00 % 0.00 % 0 0.00 0 0.0863 % 2,144.5
Perpetual-Premium 5.77 % 5.41 % 100,608 5.56 7 -0.1573 % 1,959.9
Perpetual-Discount 5.73 % 5.77 % 186,462 14.12 71 0.0145 % 1,897.0
FixedReset 5.28 % 3.16 % 278,187 3.37 47 0.0878 % 2,247.8
Performance Highlights
Issue Index Change Notes
MFC.PR.D FixedReset -1.49 % YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-07-19
Maturity Price : 25.00
Evaluated at bid price : 26.36
Bid-YTW : 4.97 %
PWF.PR.L Perpetual-Discount -1.37 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-08-25
Maturity Price : 21.60
Evaluated at bid price : 21.60
Bid-YTW : 5.97 %
NA.PR.K Perpetual-Discount -1.34 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-08-25
Maturity Price : 24.56
Evaluated at bid price : 24.95
Bid-YTW : 5.90 %
PWF.PR.K Perpetual-Discount -1.21 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-08-25
Maturity Price : 21.25
Evaluated at bid price : 21.25
Bid-YTW : 5.89 %
MFC.PR.B Perpetual-Discount -1.12 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-08-25
Maturity Price : 18.55
Evaluated at bid price : 18.55
Bid-YTW : 6.28 %
PWF.PR.F Perpetual-Discount -1.02 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-08-25
Maturity Price : 22.03
Evaluated at bid price : 22.27
Bid-YTW : 5.95 %
W.PR.H Perpetual-Discount 1.05 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-08-25
Maturity Price : 23.04
Evaluated at bid price : 23.95
Bid-YTW : 5.78 %
IAG.PR.E Perpetual-Discount 1.17 % YTW SCENARIO
Maturity Type : Call
Maturity Date : 2019-01-30
Maturity Price : 25.00
Evaluated at bid price : 25.08
Bid-YTW : 5.91 %
IAG.PR.C FixedReset 1.28 % YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-01-30
Maturity Price : 25.00
Evaluated at bid price : 27.11
Bid-YTW : 3.41 %
IAG.PR.A Perpetual-Discount 1.69 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-08-25
Maturity Price : 20.06
Evaluated at bid price : 20.06
Bid-YTW : 5.73 %
Volume Highlights
Issue Index Shares
Traded
Notes
MFC.PR.A OpRet 382,365 Nesbitt crossed three blocks: 150,000 shares, 15,000 and 200,000, all at 25.00.
YTW SCENARIO
Maturity Type : Soft Maturity
Maturity Date : 2015-12-18
Maturity Price : 25.00
Evaluated at bid price : 25.00
Bid-YTW : 4.06 %
PWF.PR.I Perpetual-Discount 184,400 TD crossed 22,000 at 25.16; Nesbitt crossed 150,000 at the same price.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-08-25
Maturity Price : 24.72
Evaluated at bid price : 25.10
Bid-YTW : 6.03 %
MFC.PR.E FixedReset 177,830 TD bought 28,900 from RBC at 25.91. Nesbitt crossed three blocks, of 25,000 shares, 50,000 and 25,000, all at 25.85. TD crossed 12,500 at 25.91.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-10-19
Maturity Price : 25.00
Evaluated at bid price : 25.75
Bid-YTW : 4.71 %
SLF.PR.F FixedReset 171,625 TD crossed 21,700 at 27.75; Nesbitt crossed 136,000 at 27.53.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-07-30
Maturity Price : 25.00
Evaluated at bid price : 27.50
Bid-YTW : 3.13 %
CM.PR.D Perpetual-Discount 171,524 Nesbitt crossed 150,000 at 25.20.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2012-05-30
Maturity Price : 25.00
Evaluated at bid price : 25.17
Bid-YTW : 5.61 %
MFC.PR.D FixedReset 152,227 Nesbitt crossed 50,000 at 26.85; Scotia bought 21,000 from Dundee at 26.50. Nesbitt crossed another 38,000 at 26.47.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-07-19
Maturity Price : 25.00
Evaluated at bid price : 26.36
Bid-YTW : 4.97 %
BNA.PR.C SplitShare 101,300 RBC crossed blocks of 47,200 and 50,000, both at 21.25.
YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2019-01-10
Maturity Price : 25.00
Evaluated at bid price : 21.25
Bid-YTW : 6.73 %
There were 56 other index-included issues trading in excess of 10,000 shares.

One Response to “August 25, 2010”

  1. […] interest-equivalent spread is now bout 285bp, a significant increase from the 275bp reported on August 25 and the 275bp reported July 30. For another month, it’s simply a case of the preferred share […]

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