Category: Market Action

The federal budget came out today:

One major change is C$7.2 billion ($5.7 billion) less infrastructure spending through 2019, an amount that has been allocated to other departmental spending.
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On a cumulative basis, including risk buffers worth C$3 billion annually, deficits over the six years including 2017-18 are projected to total C$98 billion. That’s little changed from the October forecast.
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The government has implemented a watered-down version of reforms for “tax planning.’’
•On passive investment, the new system only gradually reduces access to the small business tax rate for corporations with significant passive investment.
•Measures will limit tax advantages that larger Canadian- controlled private corporations can obtain by accessing refundable taxes on dividends.
•The two changes combined, including new restrictions on so- called income sprinkling announced last year, will add C$925 million to government coffers annually by 2022.
•The Trudeau government is also promising new rules to prevent banks and other financial institutions “from gaining a tax advantage by creating artificial losses.’’ The move will create C$560 million annually by 2022.
•A tax increase on tobacco is worth C$1.5 billion over six years, and levies on cannabis are expected to generate C$690 million over six years after it is legalized this summer.
•Canada has also taken a C$2.1 billion hit over six years from lost tariffs due to the Trans-Pacific Partnership agreement.

I’m not happy about the continuing deficit. Government finances should be managed to break even on a through-the-cycle basis, which means that right now we should be running a small but increasing surplus.

I’m also not happy about the Inefficent Business Tax Subsidy; although there has been some progress, the legions of well-connected doctors and lawyers retain their special tax bolthole:

The budget unveiled new details on the taxation of passive investment income inside private corporations.

When companies earn between $50,000 and $150,00 in a given year from passive investments, a reduced amount of their active business income will be eligible for the small business tax rate, which will be 9 per cent in 2019. (The upper limit for business income that can be taxed at the small business rate is $500,000.) The reduction will occur on a straight-line basis, with eligible income decreasing by $5 for every $1 of passive income above the $50,000 threshold.

Companies exceeding $150,000 in passive income will no longer be eligible for the small business tax rate. Those with passive income under $50,000 will not be affected, as was mentioned in a revised proposal.

Davies Ward Phillips & Vineberg LLP has published a more detailed commentary.

In order to pay for this well-deserved reward for those old-stock Canadians who, by dint of hard work, integrity, stick-to-it-ivness and the fact that mommy and daddy were doctors and lawyers, have become doctors and lawyers, the practice of tax surcharges that increase the effective marginal tax rate on plebian scum have been retained:

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See that? The benefits claw-back represents an increase to the posted effective marginal tax rate of 14% immediately, planned to decline (precipitously!) to 12% in the future. From this one programme alone. Yes, sir, it’s very important to destroy incentive to pick up that extra shift, accept that extra responsibility, move to a new province to get that slightly better job! They can have a little extra welfare money, as long as they don’t get too uppity.

Hard on the heels of my mention of foreigner bashing in BC and the interesting discussion that followed comes a Bloomberg story about Canadian mortgage fraud:

Evidence of mortgage fraud amid surging home prices and household debt has prompted S&P Global Ratings to lower a key risk metric for Canadian banks.

The credit ratings agency dropped its economic risk assessment by one notch due to evidence of residential-mortgage fraud at smaller Canadian banks, which could compound existing risks from the country’s hot housing market, according to a statement Friday. S&P lowered the Canadian banks’ economic risk level to 3 out of 10, with a higher number representing great risk, revising the trend to stable. That puts Canada in line with the U.S., but lower than the U.K. and Australia.

High housing prices and debt loads increase incentives for fraudulent activity such as overstating a borrower’s income to meet qualifying criteria. Additionally, a growing share of mortgages is being originated by brokers who don’t bear the credit risk for the loans like lenders, according to the statement.

That second paragraph is very poorly written (I think the reporters had problems with “higher” and “lower” as it related to the scale used by S&P), but given the rest of the article I conclude it means they have reassessed “economic risk level” so that it is less desirable than it was before.

The S&P statement also referred to a press release from Equifax Canada about a report that I can’t find on their website (I can’t find the press release there, either!):

Equifax Canada (NYSE:EFX) data suggests high-risk and suspected fraudulent mortgage activity is on the rise noting a 52 per cent increase in suspected fraudulent mortgage applications since 2013.

According to data from Equifax’s enterprise fraud management solution, ‘Falsified Account Statements’ and ‘Falsified Documents’ were the most prominent application tags, as reported by investigators. The other was ‘Conflicting Information’. Of those applications flagged, 67 per cent were from Ontario while the next highest was 12 per cent from B.C.
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Little White Lies

With respect to mortgage fraud, the results of the recent Equifax survey showed:
•13 per cent of Canadians indicated they felt it was okay to tell ‘a little white lie’ when applying for a mortgage to get the house they want.
•16 per cent said they believe mortgage fraud is a victimless crime
•8 per cent admitted to misrepresenting the facts on a credit or loan application

The Cost of Buying a Home

When asked about housing prices, the results of the recent Equifax survey showed:
•84 per cent believe that the cost of home ownership is too high for first-home buyers today
•Nearly three-in-ten Canadians cite ‘more demand than supply’ (29 per cent) and ‘foreign buyers’ (27 per cent), as the main factors driving up home prices
•B.C. residents (compared to other provinces) were significantly more likely to cite foreign buyers as the top reason for home prices being driven up (75 per cent versus 42 per cent for all other provinces, respectively

So, we’ll see how it goes when mortgage renewal rates go up to 6%, which they probably will at some point, although not necessarily in my lifetime. I have a great personal interest in this matter, as every now and then a prospective client sneers at the pathetic yield offered by preferred shares and condescendingly informs me that he can get 8%, no problem, from a mortgage investment corporation. I don’t think these guys know about risk … but then, they don’t have to! Every one I’ve ever talked to is smart enough that he’ll get out before problems become apparent to the hoi polloi.

Don’t get me wrong! I’m sure that private mortgages are a decent enough asset class and I’m sure that there are some mortgage grantors who are better at their job than others. It’s just that I don’t think a lot of people enamoured of the sector know the ‘Capital Destruction Partners’ paradigm (where you make great returns for twenty years and get wiped out in the twenty-first); and all the MIC advertising I’ve ever seen plays to that ignorance.

For instance, let’s look at Income Trust One, which touts its 8.32% nine-year historical average return. The fund fact sheet refers to a “Weighted Average LTV” [Loan to Value] of 50.8%, which sounds pretty good, right? So I looked further down and got some more detail:

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This puzzled me. How does an LTV of 50.8% square with historical returns of 8.32% (and over 7% in each of the three quarters to the 2017Q3 publication date)? So I sent them an eMail:

I would like some clarification regarding your calculation of Loan to Value as reported on your Fund Fact Sheet as of September 30, 2017.

How do your calculations account for the Security Position of your mortgages?

For instance, if a property is considered to have a value of $800,000 and has a first mortgage outstanding with another firm for $400,000 and you have a second mortgage on the property for $200,000, what do you consider the LTV for your portion of the mortgage to be?

… and they were kind enough to answer …

Thank you for your email. Good question.

The loan to value (LTV) is calculated as the total amount of loan been borrowed (not just our portion) on a property (1st mortgage+ 2nd mortgage+…) / the appraisal value of the property.

Using your example below, the LTV will be (1st mortgage balance $400,000 + 2nd mortgage $200,000)/property appraised value ($800,000): ($400,000+$200,000)/$800,000 = 75%

So that seems reasonable enough and is actually quite heartening … but it’s not the whole story because it does not account for the subordination of the second mortgage; it treats the first and second mortgages equally for LTV calculation purposes and so is obviously not a metric one would wish to use much for risk evaluation purposes.

For instance, in a first-mortgage-only situation, a LTV of 75% means that if the property loses 25% of its value, then the mortgage debt is exactly covered. This is also the case when the $600,000 loan is split as above. So far, so good.

But say the property loses half its value. In this case, the first mortgage is precisely covered and the second mortgage is wiped out. That is the crucial difference. This is the structured finance conundrum that led to a lot of people getting nasty surprises during the Credit Crunch, as discussed long ago in the post Hull & White on AAA Tranches of Subprime.

Now I don’t want anybody to think that I’m picking on Income Trust One – I looked at them only because I saw their ad in the paper on the weekend when I had a little spare time that I created by neglecting my programming duties. It may be the best investment ever. It might not be. To take an informed view, I would have to do some very detailed work on the component mortgages of the Fund – and this level of detail is not available in the fund’s offering memorandum or the audited financial statements. Then I’d need some kind of covariance model and all that other good stuff we learned about during the Credit Crunch. Also, one notices from the 17Q3 Financial Statements (unaudited) that the fund is levered up: unitholders’ equity of $127-million is boosted with a $43-million loan, so that has to be accounted for. I’m not going to do all that work.

And I don’t think any of the guys who have sneered at the paltry expected yields on Canadian Preferred shares have done all that work either.

A recent survey shows Canadians don’t know the difference between their bank and their mommy:

Among the most common types of advice retail bank customers seek are investment-related advice (47 per cent); quick tips to help improve their financial situation (45 per cent); retirement-related advice (42 per cent); advice to help keep track of spending and household budgets (32 per cent); and in-depth financial review (30 per cent).

In addition, almost 30 per cent of customers younger than 40 years old say they are “very interested” in receiving advice from their bank.

There’s a good drone story from the UK:

A man who crashed his car in freezing night-time temperatures was saved from hypothermia when he was found by a police thermal-imaging drone.

He was discovered in a deep ditch, 500ft (160m) away from his car on the A16 near Ludborough, Lincolnshire.
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Sgt [Mike] Templeman said: “We didn’t know if this male had been picked up, [or] if he had carried on walking.

“We did extensive searches in the [police] vehicles, obviously we are very rural and it was very dark so you’re limited in what you can see.”

The OPP has a similar system, but I don’t know how widely deployed it is:

The OPP and Georgian Bay Volunteer Search And Rescue (GBVSAR) have taken over the Wye Marsh in a training session today [November 29, 2017]. Volunteers and officers have set up a command post to search for two “missing” men at the marsh. The scenario details that the men didn’t return to their vehicle early in the morning and the OPP and GBVSAR have been deployed to help look for them.

The OPP are able to bring in a UAS (unmanned aerial system), aka a drone, to help aid in the search. The drone has the ability to go up about 400 ft off the ground and travel up to speeds up 16-20 knots. There’s a thermal imaging camera on board to help the operator on the ground track what they are seeing from the sky. The camera is detailed enough to show the operator when something is an animal or a person in possible need of assistance.

BC has a formal testing programme:

A year into a pilot project to test unmanned aerial vehicles (UAVs) — commonly known as drones — for search and rescue, the province says the jury is still out on the high-tech helpers.

Search teams in Coquitlam and Kamloops got the go ahead from Emergency Management B.C. (EMBC) to test the tools last December [2016].
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But EMBC search and rescue specialist Andrew Morrison said the drones haven’t seen enough air time yet to draw any firm conclusions.

“For example, Coquitlam Search and Rescue had zero deployments. Kamloops Search and Rescue had requested a UAV 18 times and deployed nine times,” he said.

A Bank of Canada Staff Working Paper by Patricia Palhau Mora titled The “Too Big to Fail” Subsidy in Canada: Some Estimates contains a warning for future changes to Canadian bank credit ratings:

Despite progress on regulation, CRAs [Credit Rating Agencies] continue to generally factor in some (or even the same) expectation of public support, which suggests that challenges to effective resolution are expected to remain. In Canada, revisions to the ratings’ methodologies did not generally result in changes to state-support expectations for the domestic banks. Moody’s still rates Canada as a “supportive jurisdiction” in its government support assessment framework, reflecting an expectation that the government would still need to bail out a large financial institution given the size of Canadian banks relative to the national economy, and the potential for contagion among large interconnected players. Following the release of the 2014 bail-in consultation paper (Department of Finance Canada 2014), CRAs placed the credit ratings of the D-SIBs and Desjardins under negative watch, indicating they would likely be revised down “in the near future.”42 Moody’s kicked off the revisions in July 2014 by changing the outlook of the seven largest Canadian banks’ long-term senior unsecured debt and deposit notes’ ratings to “negative” from “stable.” S&P followed in August 2014, also revising the D-SIBs’ outlook to “negative” from “stable,” factoring in an expectation that extraordinary government support to D-SIBs’ senior bondholders would become less certain.

While bail-in legislation received Royal Assent in summer 2016, CRAs have not yet changed the support assumptions, publicly stating they are still awaiting more detail on the operational aspects of the regime. More recently, in a request for comments published on November 6, 2017, Moody’s proposed designating Canada as an “operational resolution regime,” given the introduction of preliminary bail-in rules, signalling that government support expectations for D-SIBs are likely to decrease soon. This would be consistent with large bank ratings being lowered up to three notches in the US and the EU in response to Dodd–Frank Title II and the EU Bank Recovery and Resolution Directive.

PerpetualDiscounts now yield 5.40%, equivalent to 7.02% interest at the standard equivalency factor of 1.3x. Long corporates now yield about 3.99%, so the pre-tax interest-equivalent spread (in this context, the “Seniority Spread”) is now about 300bp, unchanged from February 14.

Have no fear, Vancouver! The BC government is going to make BC great again!:

Starting Wednesday, foreigners will pay the province a 20 percent tax on top of the listing value, up from 15 percent now, and a levy on property speculators will be introduced later this year, according to budget documents released Tuesday. The government will also crack down on the condo pre-sale market and beneficial ownership to ensure that property flippers, offshore trusts and hidden investors are paying taxes on gains.
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[British Columbia Finance Minister Carole] James said a raft of new measures are intended to “moderate” the surge in housing prices, which she said had emerged as one of the top concerns of both residents and businesses struggling to recruit workers due to the high cost of living.

The new speculator tax takes effect this fall and will apply to foreign and domestic investors who don’t pay income tax in the province. It will start at 0.5 percent of the property’s assessed value in 2018 and rise to 2 percent thereafter. Primary residences and homes leased as long-term rentals will be exempt.

Swedish authorities are worried about the demise of cash:

“No cash accepted” signs are becoming an increasingly common sight in shops and eateries across Sweden as payments go digital and mobile.

But the pace at which cash is vanishing has authorities worried. A broad review of central bank legislation that’s under way is now taking a special look at the situation, with an interim report due as early as the summer.

“If this development with cash disappearing happens too fast, it can be difficult to maintain the infrastructure” for handling cash, said Mats Dillen, the head of the parliamentary review. He declined to give more details on the types of proposals that could be included in the report.
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An annual survey by Insight Intelligence released last month found that only 25 percent of Swedes paid in cash at least once a week in 2017, down from 63 percent just four years ago. A full 36 percent never use cash, or just pay with it once or twice a year.

In response, the central bank is considering whether there’s a need for an official form of digital currency, an e-krona. A final proposal isn’t expected until late next year, but the idea is that the e-krona would work as a complement to cash, not replace it completely.

I was pleased to see the following in a piece on Australia’s $20 minimum wage:

There is an often overlooked efficiency to high minimum wages. They can reduce the burden on the state and the taxpayer. Why, after all, should a person working full time depend on a patchwork of confusing and often arbitrary government entitlements and social programs funded through general tax revenue when they could more directly be paid a living wage by their employer? Government bureaucracies can be slow moving and uneven in their decision making. A low-wage system shifts the burden of providing the necessities of life from the employer to the taxpayer. It subsidizes marginal businesses with cheap labour. It disadvantages those employers who either voluntarily pay higher wages or are forced to do so through collective bargaining. Some credit the Australian “wages welfare state” as having contributed to a comparatively low level of sovereign debt (OECD data for 2015 puts Australia at 67-per-cent debt/GDP ratio and Canada at 114 per cent.)

It was a run-of-the-mill, slightly negative day for the Canadian preferred share market today … until about 3pm:

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Jobs, jobs, jobs! And pay, too!

U.S. hiring picked up in January and wages rose at the fastest annual pace since the recession ended, as the economy’s steady move toward full employment extended into 2018.

Nonfarm payrolls rose 200,000 — compared with the median estimate of economists for a 180,000 increase — after an upwardly revised 160,000 advance, Labor Department figures showed Friday. The jobless rate held at 4.1 percent, matching the lowest since 2000, while average hourly earnings rose a more-than-expected 2.9 percent from a year earlier, the most since June 2009.

Naturally, the bond market reacted … and then stocks reacted to bonds:

The Dow Jones Industrial Average tumbled 666 points in the biggest plunge since June 2016, as the worsening bond rout stirred angst that the Federal Reserve will accelerate its rate-hike schedule.
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•The yield on 10-year Treasuries rose five basis points to 2.834 percent. It touched 2.8525 earlier.

I believe that this is the worst week containing a super blue blood moon for equities for over one hundred and fifty years, which is probably pretty significant. Worst of all, some investors had their mellow harshed:

Marijuana stocks tumbled Friday amid a wave of “panic-selling” and concern that companies that had seen ballooning share prices recently are now overvalued. The BI Canada Cannabis Index plunged as much as 19 percent, its biggest intraday drop on record, while the nation’s largest producers including Canopy Growth Corp. and Aurora Cannabis Inc. tumbled more than 40 percent from their January highs.

However, five-year Canadas finished the day at 2.13%, up 5bp, which should be good news for FixedResets unless it isn’t.

Huffing and puffing over NAFTA continues:

Canadian Prime Minister Justin Trudeau made some of his most aggressive comments to date on dealing with U.S. demands to rework the North American Free Trade Agreement, adding he still thinks he can get the right deal for his country.

“We aren’t going to take any old deal,” Trudeau said Friday at a town hall in Nanaimo, British Columbia. “Canada is willing to walk away from Nafta if the United States proposes a bad deal. We won’t be pushed around.”

His comments come days after U.S. President Donald Trump threatened to get tough on trade, though he didn’t single out Nafta, in his State of the Union address. The latest round of Nafta talks wrapped up in Montreal on Monday, with all sides saying there had been progress, while acknowledging significant gaps remain on some issues.

I have decided that I’m a big Taylor Swift fan. She’s awesome. Just consider her latest achievement:

As she prepared to hit the road to support her latest album, Reputation, Swift and Ticketmaster Entertainment Inc. concocted a strategy to neuter the scalpers. They used Ticketmaster’s Verified Fan program, which utilizes in-house technology to identify actual fans and determine which of them should have access to fan-only presale tickets, based on their devotion to Swift as measured by their willingness to buy albums, sign up for a newsletter, and watch her music videos. While prices in the presale were fairly low for most people, Swift and promoter AEG Presents raised the cost of all the tickets in the later general sale to make them less attractive to scalpers.

Imagine that! The problem was scalpers taking too big a slice of the pie … so she raised prices for her shows to capture the increment for herself. It’s incredible! Conventional wisdom, of course, is to whine that the gubmint oughtta do sumpin, with ‘run crying to mommy’ running a close second … but my heroine Taylor Swift thinks way, way, way out of the box. I think she should get at least two Nobel Prizes in Economics for this breakthrough.

PerpetualDiscounts now yield 5.27%, equivalent to 6.85% interest at the standard equivalency factor of 1.3x. Long corporates now yield about 3.85%, so the pre-tax interest-equivalent spread (in this context, the “Seniority Spread”) is now about 300bp, a slight (and perhaps spurious) widening from the 295bp reported January 31.