Category: Market Action

PerpetualDiscounts now yield 5.51%, equivalent to 7.16% interest at the standard equivalency factor of 1.3x. Long corporates now yield a little under 3.80%, so the pre-tax interest-equivalent spread (in this context, the “Seniority Spread”) is now about 335bp, a slight (and perhaps spurious) narrowing from the 340bp reported June 20.

I’ve never really understood the stock market excitement about marijuana. Sure, there will be some good money to be made in branding and retailing, but at its core the business is about farming. Now it’s even more about farming:

However, new regulations the federal government is expected to unveil this week will open the door to commercial outdoor cultivation. While it is too late in the production cycle in most of the country to start outdoor cultivation this year, the new rules will be in place for next year’s production season.

“Our decision to allow outdoor grow under strict rules is the result of extensive consultations and will contribute to creating a diverse and competitive legal cannabis industry with the ultimate goal of displacing the illegal market,” said Thierry Bélair, a spokesman for Health Minister Ginette Petitpas Taylor.

Nothing wrong with farming and a lot of people earn their daily bread by farming … but it’s not a business that gushes money. Now, if we can only convince the politicians that it cannot be infinitely taxed, we might even be able to squeeze organized crime out of the picture.

I indulged myself on February 26, complaining about sales competition from Mortgage Investment Corporations:

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.

So I’m following the Fortress receivership with great interest:

Syndicated mortgage loans for real estate projects developed by Fortress Real Developments Inc. are “under considerable stress,” and lenders could face “significant losses,” according to a new report from a court-appointed receiver.

In its first update since it was appointed in April, FAAN Mortgage Administrators Inc. said some of the largest loans provided for Fortress projects are at risk because senior mortgage lenders are moving to foreclose on the properties.
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FAAN said it needs more time and money to do more appraisals of the projects to find the best potential outcomes for the syndicated lenders, whose loans often rank in third place or lower to those of other lenders.
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FAAN’s update also said about 35 per cent of the money raised from syndicated lenders was used to pay “development consultant fees,” about half going to the brokers who raised the funds from individual investors, and the other half paid to BDMC in its capacity as the borrowers’ broker and to Fortress.

It’s hard to make money when 35% of your investment pays up-front brokerage fees!

FAAN is communicating well, with links to relevant material prominently displayed on the index page of their website. There are a few juicy bits in the Report of the Receiver:

Moreover, many Investors agreed to terms that permit repayment “waterfalls” that, at least in some instances, appear to permit owners of the real estate (including the borrowers and owners of the borrowers) to recover some of the amounts they invested in the developments in priority to the amounts loaned by the Investors.
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The Trustee has been advised that many of the projects need further funding to permit developments to continue and that such funding is only available if the security interests granted to BDMC are further postponed and subordinated to new financing.

Professional fees appear to be $150,000 monthly, according to Paragraph 53 of the report. Oh, it’s a great business!

Manulife is exiting the fixed annuities business:

Toronto-based Manulife Financial Corp.‘s decision to discontinue external sales of individual fixed annuities will mean there are fewer options in an already limited annuities marketplace for clients who are seeking a guaranteed income stream during retirement.
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Manulife became one of the largest providers of annuities in Canada following its acquisition of Montreal-based Standard Life Assurance Co. of Canada in 2015, the latter of which offered a “full spectrum of products,” according to Lawrence Geller, president of L.I. Geller Insurance Agencies Ltd. in Campbellville, Ont.

Manulife’s exit from the annuities business leaves a big gap. In fact, Geller says, there are “fewer and fewer” insurers offering annuities.
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In 2011, Manulife’s U.S. subsidiary, Boston-based John Hancock Financial, discontinued several annuities lines because of low interest rates and volatile equities markets. That year, Manulife’s income statement took a hit of $900 million triggered by John Hancock’s annuities-related losses.

Then, in 2013, Toronto-based Sun Life Financial Inc. sold its U.S. annuities business following earlier losses for reasons similar to those suffered by John Hancock, which forced Sun Life to beef up its reserves.
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Although Manulife is exiting this space, other big insurers, such as Toronto-based Canada Life Assurance Co., Winnipeg-based Great-West Life Assurance Co. and Sun Life, continue to offer fixed annuities in Canada.

The Canada Five-Year yield dropped below 2% today (1.97%, to be precise), the first time it’s been there in a while. But the preferred share market had a good day anyway. So go figure …

In a rare outbreak of common sense, the Canadian Securities Administrators have decided not to ban trailer fees, but spoiled it by adding a lot more paperwork:

The Canadian Securities Administrators (CSA) has decided not to ban embedded commissions after all. Instead, the group of provincial and territorial regulators have proposed new rules for dealers and financial advisors to address any potential conflicts of interest in clients’ best interest or avoid them altogether, as well as to eliminate all forms of deferred sales charges (DSCs).

In addition, the CSA has decided to prohibit dealers that don’t make a suitability determination when selling mutual funds, such as discount brokerages, from receiving trailing commissions.

The long-awaited decisions were delivered on Thursday in a staff notice outlining these measures and in a 120-day comment period proposing amendments to registrant conduct provisions. (The CSA stated in the staff notice that it anticipates publishing a notice and request for comment in September.)

Although the CSA’s staff notice points out that “regulatory action is required to mitigate the inherent conflicts of interest associated with embedded compensation and to ensure the investor’s interest is paramount,” the regulators are instead proposing enhanced conflict of interest mitigation rules and guidance for dealers and advisors on all securities because these conflicts “are not unique to mutual funds.”

Thus, as part of the proposed amendments to the registrant conduct provisions, dealers and advisors will be required to: address conflicts of interest in clients’ best interest, including those resulting from compensation arrangements and incentive practices; put clients’ interests first when making a suitability determination; and do more to clarify for clients what they should expect from registrants.

Trade politics are complicating projections of Canadian interest rates:

The gap between September 2018 and December 2018 bankers’ acceptance futures narrowed to 14.5 basis points Tuesday amid record two-day volumes in the spread. Market participants are now pricing in just 41 basis points of additional policy tightening by year-end, down from more than 60 basis points as recently as last month. The Canadian dollar has declined in tandem, sliding 2.6 per cent against the greenback since the start of June.

Expectations for future BOC rate hikes are waning as the outlook for North American Free Trade Agreement negotiations grows increasingly fraught.
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The odds of a rate increase at the BOC’s July 11 meeting have dwindled to about 67 percent, according to overnight index swap pricing, from roughly 80 percent in the aftermath of the bank’s May 30 meeting.

The Canadian dollar has tumbled more than 5 per cent versus the greenback in 2018, making the loonie the second-worst performing Group-of-10 currency in the span.

PerpetualDiscounts now yield 5.55%, equivalent to 7.22% interest at the standard equivalency factor of 1.3x. Long corporates now yield a little over 3.80%, so the pre-tax interest-equivalent spread is now about 340bp, a significant widening from the 330bp reported June 13.

The New York Fed has released a paper by Andreas Fuster and James Vickery titled Regulation and Risk Shuffling in Bank Securities Portfolios:

Bank capital requirements are based on a mix of market values and book values. We investigate the effects of a policy change that ties regulatory capital to the market value of the “available-for-sale” investment securities portfolio for some banking organizations. Our analysis is based on security-level data on individual bank portfolios matched to bond characteristics. We find little clear evidence that banks respond by reducing the riskiness of their securities portfolios, although there is some evidence of a greater use of derivatives to hedge securities exposures. Instead, banks respond by reclassifying securities to mitigate the effects of the policy change. This shift is most pronounced for securities with high levels of interest rate risk.
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Quantitatively more importantly, we found evidence that treated banks respond by actively reshuffling their portfolios, and in particular classifying risky securities as “held to maturity” (HTM) rather than available for sale (AFS). The use of detailed security-level data allow us to control in a precise way for security characteristics – most finely by including both BHC fixed effects and a vector of CUSIP-by-calendar quarter fixed effects in our specifications. This is an important feature of our analysis, since it allows us to isolate the effects of the accounting classification decision for a given security from changes in the composition in investment securities portfolios which was occurring during this period. In these specifications, our preferred point estimates suggest that a security is 20 percentage points more likely to be classified as HTM rather than AFS if owned by a BHC subject to the AOCI rule (measured on a fully phased-in basis), or 38 percentage points measured on a weighted basis. For both agency MBS and Treasury securities, we find that these effects are concentrated among bonds with higher duration.

It’s a common fallacy – you will often find people arguing vociferously that a five year GIC is less risky than a five year bond because the reported price doesn’t change and the holder doesn’t intend to sell it anyway. Crazy.

In another paper released today, Richard Crump, Domenico Giannone, and Sean Hundtofte claim that volatility has meaning in a paper titled Changing Risk-Return Profiles:

We show that realized volatility, especially the realized volatility of financial sector stock returns, has strong predictive content for the future distribution of market returns. This is a robust feature of the last century of U.S. data and, most importantly, can be exploited in real time. Current realized volatility has the most information content on the uncertainty of future returns, whereas it has only limited content about the location of the future return distribution. When volatility is low, the predicted distribution of returns is less dispersed and probabilistic forecasts are sharper. Given this finding on the importance of financial sector volatility not just to financial equity return uncertainty but to the broader market, we test for changes in the realized volatility of banks over a $50 billion threshold associated with more stringent Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) requirements. We find that the equity volatility of these large banks is differentially lower by 9 percentage points after Dodd-Frank compared to pre-crisis levels, controlling for changes over the same period for all banks and all large firms.
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Our paper is most closely related to Cenesizoglu and Timmermann (2008) who study whether economic and financial variables can help improve prediction of the quantiles of the return distribution. Cenesizoglu and Timmermann (2008) also find evidence of predictive power especially in the upper tail of the return distribution. Our paper is also related to Massacci (2015) who evaluates the accuracy of density forecasts but restricts the economic and financial variables to predict the location of the distribution only. Durham and Geweke (2014) predict higher-frequency, daily returns allowing for realized intraday volatility and option-implied volatility but restrict these variables to predict the scale of the distribution only.

Our paper is also related to those papers that investigate interactions between financial crises (high periods of market volatility) and equity returns. For example, Baron and Xiong (2017) ex-amine changes in skew of bank equity returns in response to changes in economic leverage (bank credit/GDP). Moreira and Muir (2017) look at the returns of a market portfolio managed by lagged volatility, finding investors are not compensated for risk in periods of lagged high volatility. Similarly, when we examine the distribution of aggregate returns conditional on realized volatility we find no predictability in the average return, but do find predictability in the risk to holding the
market portfolio (either in terms of variance at short horizon, or skew at longer horizons), indicating a breakdown in a risk-return tradeoff. Adrian et al. (2017b) document a strongly nonlinear dependence of stock and bond returns on past equity market volatility as measured by the VIX with expected stock returns increasing for stocks when volatility increases from moderate to high levels.