Category: Market Action

The lawyers and do-gooders at IIROC are continuing their efforts to destroy the Canadian corporate bond market:

>Four years ago, the head of the investment industry’s self-regulator said that a plan to create surveillance to protect fixed income investors was a priority. At last, the final step needed to make that happen appears to be here.

The regulator has been taking things in bites. First, in 2009, there was a demand for better disclosure of what people were paying banks and securities firms to trade debt. Then, in 2011, a rule demanding that all securities firms “ensure clients received fair prices on debt transactions.”
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So now, the Investment Industry Regulatory Organization of Canada is amping up trade reporting requirements to create something at least resembling the kind of surveillance that has long been there in equity markets, where a computer system watches every trade to ensure investors are getting the best available price at any given point.

The new rule will require securities dealers to report every trade, once it’s done. IIROC will use that to build a database that is the start of a real surveillance mechanism. It’s still not the real-time computerized flagging of trades that aren’t done at the best possible price, but it’s perhaps the biggest step yet toward that happening.

As the linked article in the Globe shows, the IIROC honcho who started this mess was Susan Wolburgh Jenah who, as far as I can tell from her official biography, has never traded a security in her life.

To my chagrin, the proposed rule cites a paper promoted by the CFA Institute and published as part of their Codes, Standards and Position Papers and comes complete with an “Issue Brief”. The paper itself is titled An Examination of Transparency in European Bond Markets and I must say I consider it very disappointing in terms of rigour; however, a full rebuttal will require enough work and length that it will be more suitable to PrefLetter than PrefBlog.

The basic problem with this idea is that it makes it less lucrative for bond dealers to hold inventory. This means fewer offerings of individual bonds to retail and it means small size markets being called for institutional players. This in turn leads to a migration of bond issues to the private placement market and decreased functionality of the capital markets in general. Essentially, the problem that fairness brings to bond markets is the same as that of socialisn: in a socialist economy, everything’s cheap but nothing’s available; in a “fair” bond market, all the spreads are narrow, but the market makers won’t back up their quotes – when given – with significant risk capital.

It was a mixed day for the Canadian bond market, with PerpetualPremiums down 11bp, FixedResets up 9bp and DeemedRetractibles off 9bp. Volatility was low. Volume was extremely high.

PerpetualDiscounts now yield 4.90%, equivalent to 6.37% interest at the standard equivalency factor of 1.3x. Long Corporates now yield about 4.35%, so the pre-tax interest-equivalent spread is now about 200bp, a small rebound from the 195bp reported February 6.

We’ll begin with a condensed version of ‘The Old Order Passeth’:

RDA Holding Co., publisher of the 91-year-old Reader’s Digest magazine, filed for bankruptcy to cut $465 million in debt and focus on North American operations as consumers shift from print to electronic media.

The company is the latest in a line of iconic businesses to have recently sought court protection from creditors, after Hostess Brands Inc., maker of Twinkies and Wonder Bread, and Eastman Kodak Co., inventor of Kodachrome and the Instamatic camera.

Reader’s Digest, founded by DeWitt and Lila Wallace, went public in 1990. An investor group led by private-equity firm Ripplewood Holdings LLC bought it in 2007 for $1.6 billion and the assumption of about $800 million in debt. The company also filed for bankruptcy in August 2009, citing a drop in advertising spending and the debt load incurred in its acquisition.

The company listed assets and debt of more than $1 billion each in Chapter 11 documents filed yesterday in U.S. Bankruptcy Court in White Plains, New York. Under a restructuring agreement supported by Wells Fargo & Co., $465 million of remaining senior notes will all convert to equity. The company expects to have about $100 million in debt when it exits Chapter 11, about an 80 percent reduction.

GWO is buying in Ireland:

Great-West Lifeco Inc. is buying Ireland’s largest life, pensions and investment manager in a $1.75-billion deal.

Winnipeg-based Great-West says it has reached a deal with the government of Ireland to acquire, through subsidiary Canada Life Ltd., all of the shares of Irish Life Group Ltd.

Irish Life – which the government took over last year as part of its €4-billion ($5.4-billion Canadian) bailout of parent Irish Life & Permanent, has about $50-billion of assets under management and more than one million customers.
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Great-West’s Irish subsidiary, Canada Life (Ireland), will be combined with
Irish Life over an 18 month period.

The merged businesses should deliver about €40-million per year in cost savings, Great-West said in a news release Tuesday.

As previously reported, PWF is issuing a Straight Perpetual, 4.80%, $300-million to fund a purchase of GWO subscription receipts.

RBC today demonstrated the Acquire and Dismantle Model of Canadian Banking:

On February 1, 2013, Royal Bank of Canada announced it completed the acquisition of Ally Financial Inc.’s Canadian auto finance business (Ally Credit Canada Limited) and Canadian deposit business (ResMor Trust Company).

As a result of the acquisition, RBC Royal Bank has performed a comprehensive review of Ally’s‡ product portfolio, and implemented some changes that may impact your account(s):

• Effective February 15, 2013, you will not be able to open new accounts with Ally.
• You can continue to manage your existing Ally account(s) through Ally’s call centre and website.

As a part of the product consolidation, all Ally High Interest Savings Accounts (HISA) will be closed on April 30, 2013.

Be sure to write your MP, copy to OSFI, and thank him for protecting Canada from the evils of competition.

Justine Hunter of the Globe writes a piece about the intellectual poverty of the political-media establishment:

To move to surplus from what is now expected to be a $1.2-billion deficit in the current fiscal year, the government is relying on tax hikes, $800-million worth of asset sales, and stringent – perhaps optimistic – containment of spending growth.

In the wake of the Irish Life deal discussed above, DBRS confirmed GWO, although the last line of the press release may provoke some hollow laughs:

DBRS has today confirmed the ratings on Great-West Lifeco Inc. (GWO or the Company) and its affiliates following the announcement of the acquisition from the Government of Ireland of Irish Life Group (Irish Life) by the U.K. operation of GWO’s Canada Life Assurance Company (Canada Life) subsidiary for EUR 1.3 billion. All trends remain Stable.
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With a relatively low acquisition cost estimated at just 72% of Irish Life reported embedded value of EUR 1.8 billion and obvious expense synergies generated from merging Canada Life’s operation, accounting for 5% of the market, with that of Irish Life, representing 25% of the Irish life insurance market, the value proposition for GWO is compelling. Expected expense synergies between the acquired operations of Irish Life and the existing Irish operations of Canada Life will more than offset the increased financing expenses so that the acquisition is expected to be accretive to GWO before restructuring and acquisition-related costs. In addition, GWO could potentially benefit from revenue enhancements as it introduces different management approaches related to investment strategies and the use of reinsurance, which could enhance margins in the future.

The potential for adverse development post-acquisition is relatively small as there are limited guaranteed policy liabilities. Close to 80% of assets are unit-linked for the strict account of the policyholder. Combined with the Irish Life investment management operation, a substantial proportion of the Irish Life revenues take the form of investment management and administrative fees. The remaining assets are largely sovereign government bonds and, therefore, not likely to be a source of adverse credit experience.

Additionally, DBRS confirmed PWF:

DBRS has today confirmed its ratings on Power Financial Corporation (PWF or the Company) following the confirmation of Great-West Lifeco Inc.’s (GWO) ratings in the wake of its announced acquisition of Irish Life Group (Irish Life) from the Government of Ireland for EUR 1.3 billion. The trends remain Stable.

To partially fund this acquisition, GWO will be raising $1.25 billion in common equity, for which PWF will subscribe for $550 million, which will reduce its direct ownership stake in GWO to an estimated 67.0% from the current level of 68.2%. The Company in turn will raise up to $250 million in perpetual preferred shares, with the balance of funds to be provided from cash on hand, which is estimated at close to $1 billion as of year-end 2012.

The increase in financial leverage is manageable, with the expected earnings accretion largely offsetting the additional financial costs and foregone investment income. In any event, the Company’s total debt ratio (including preferred shares) remains close to 17%, which is well within tolerance for financial leverage at a financial services holding company according to the DBRS holding company methodology, especially given the high quality of financial leverage used by the Company. Pro forma fixed-charge coverage ratios are expected to be in excess of 13 times, which is very strong.

The Irish Life transaction is consistent with the stated intention of PWF to facilitate strategic acquisitions by its subsidiaries of major properties that are in line with broader strategic goals of expanding in existing markets while achieving meaningful market shares and expense efficiencies.

And to round out the day, DBRS confirmed FTS:

DBRS has today confirmed the Issuer Rating and ratings of the Unsecured Debentures and Preferred Shares of Fortis Inc. (Fortis or the Company) at A (low), A (low) and Pdf-2 (low), respectively, with Stable trends. The confirmation reflects the Company’s strong mix of earnings generated from regulated utilities and reasonable financing strategies for the acquisition of CH Energy Group Inc. (CHG) (the Acquisition; approximately US$1.5 billion, including US$500 million assumed debt) and the Waneta hydropower project, of which Fortis has 51% ownership.

Upon completion of the Acquisition and Waneta project, Fortis’ non-consolidated leverage is expected to increase modestly, but should be maintained within the 20% range as a result of a prudent funding mix.
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Fortis’ business risk profile is expected to improve moderately with the Acquisition, as approximately 97% of CHG’s earnings are generated from its regulated electric and gas businesses. This regulated earnings mix is higher than the Company’s consolidated mix of approximately 90% (remainder generated from higher-risk hotel properties and non-regulated generation businesses).

It was a mildly negative day for the Canadian preferred share market, with PerpetualPremiums losing 6bp, FixedResets down 2bp and DeemedRetractibles off 1bp. Volatility was good, but almost all in the low-volume Floater sector, so it’s not clear whether it means a row of beans. Volume was very high.

Has the tide turned for junk bonds?

The biggest buyers of junk bonds are in retreat as exchange-traded funds suffer unprecedented withdrawals with the debt facing its first losses in eight months.

The outflows sent the combined value of the five biggest junk-debt funds down 7 percent from a four-month high in January to $29.8 billion, according to data compiled by Bloomberg. State Street Corp.’s $11.9 billion fund reported withdrawals of about $988 million in the 12 days ended Feb. 13, the longest stretch since August 2011.

A pullback three times bigger than that for mutual funds which cater to individuals suggests investors such as hedge funds and banks are cherry picking rather than investing in the broader market, said Peter Tchir of TF Market Advisors. Almost six years after the first high-yield ETF was created, the funds have been drawing the interest of institutions seeking rapid entries and exits with securities that traditionally were traded over the counter.

The best story I’ve seen so far on the Russian meteorite explosion was in Cracked, an irreverent internet humour site.

It was an unevenly positive day for the Canadian preferred share market, with PerpetualPremiums gaining 1bp, FixedResets winning 23bp and DeemedRetractibles up 6bp. Volatility picked up a bit. Volume was quite high.

DBRS has confirmed TCL.PR.D at Pfd-3, Trend Negative:

The confirmation considers the declines in organic revenue and operating income over the past year, while acknowledging improvement in key credit metrics as a result of debt reduction. The trends remain Negative (as of April 20, 2012), based on DBRS’s view that weakening demand, combined with overcapacity, will continue to place pressure on the Company’s revenues, margins and cash flow generation going forward. The ratings continue to be supported by Transcontinental’s leading market position, economies of scale, and healthy free cash flow generation, while also reflecting its deteriorating earnings profile, which is being structurally affected by a consumer shift toward digital forms of media.
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In terms of financial profile, Transcontinental has remained prudent, preserving credit metrics by using much of its free cash flow over the past two years to repay debt. DBRS notes that our concern regarding Transcontinental’s credit risk profile is not based primarily on the Company’s debt level, but rather on its future income and cash-generating prospects. If the Company’s plans and performance lead to signs of stabilization in organic revenue and operating income over the near to medium term, the ratings outlook could stabilize. However, a continued and meaningful decline in organic revenue and operating income and/or in key credit metrics over this period could result in a downgrade.

It was a mixed day for the Canadian preferred share market, with PerpetualPremiums off 7bp, FixedResets down 8bp and DeemedRetractibles gaining 5bp. Volatility was low. Volume was on the high side of average.

Scandinavians might find increased bank capital to be a mixed blessing:

Swedish regulators will require banks to set aside capital equivalent to at least 10 percent of their risk-weighted assets this year, with the minimum rising to 12 percent in 2015. The country’s four biggest banks, including Nordea, already exceed this target.
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Investors have rewarded the lenders for the perceived extra hedge against losses. It costs about 12 basis points less to insure against losses on senior notes issued by Nordea than it does for equivalent securities sold by Deutsche Bank AG, using five-year credit default swaps. Handelsbanken default-swaps trade 36 basis points lower.
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The stricter rules now being implemented across Europe will cost banks as much as 115 billion euros ($155 billion) a year, a figure that exceeds total financial industry profits for 2011, Clausen said. In response, banks need to adjust their business models and focus on “capital-light” areas that don’t burden their balance sheets, [European Banking Federation President Christian] Clausen said in an interview last month.

Many lenders have already started adjusting their business and cut jobs in retail and corporate lending to focus instead on debt underwriting. Nordea and Danske are both hiring more bankers in units that help manage corporate and agency bond sales. That’s in contrast to cuts elsewhere. Nordea is cutting 10 percent of its workforce, while Danske this month reiterated plans to eliminate 3,000 jobs.

There’s an interesting observation about the profitability of High Frequency Trading:

GETCO gets almost all its revenue from what it calls “market making,” which is essentially the high frequency trading business. In the first nine months of 2011, It brought it $714.1-million in revenue from market making. In the first nine months of last year, that had plunged 44 per cent to $398.5-million. About 68 per cent of that revenue came from equity trading.

GETCO blamed “industry specific trends such as lower market volumes and volatility across all asset classes,” as well as the fact that other players in markets are increasingly “internalizing” their orders – matching buys and sells in house – rather than sending them to markets where GETCO can trade against them. That resulted in lower market share, GETCO said.

This suggests to me that order flow – which comes from clients – is becoming more valuable. Which should, ultimately, result in even better deals for clients. Not to mention increased promotion of idiocy like stop-orders by the brokerages, and perhaps punitive surcharges for limit orders.

The Bank of Canada has released the December Financial System Review, with yet another attempt to justify the reckless imposition of central clearing for derivatives:

Canadian authorities judge that global CCPs will provide a safe, robust and resilient environment for clearing OTC derivatives, provided they comply with the CPSS-IOSCO Principles, meet the four safeguards and comply with specific recognition requirements imposed by Canadian regulators. While work on the safeguards is ongoing, Canadian authorities are satisfied with the direction and pace of the international efforts, including their implementation at global CCPs serving the Canadian market.

SwapClear, in particular, has established:

• Fair and open access: SwapClear’s access criteria ave been revised and are in line with the CPSSI-OSCO Principles and the access safeguard.[note] Five major Canadian banks have direct clearing access to SwapClear, while another is in the process of obtaining membership.
• …

Footnote reads: For example, SwapClear has reduced the minimum net capital requirement for clearing members from $5 billion to $50 million, scaled according to the risk assumed by a member. The requirement that SwapClear members hold a swap book with $1 trillion in notional amount outstanding has also been removed.

Why, the notion of Fair and Open Access just makes my heart go pitty-pat, especially when the fairness and openness of the access will be judged by bureaucrats with no skin in the game. I wonder if SwapClear will allow membership by terrorists, such as Iceland and whoever else the UK happens to be angry with next time?

It was another modestly good day for the Canadian preferred share market, with PerpetualPremiums winning 11bp, FixedResets gaining 2bp and DeemedRetractibles up 10bp. Volatility was low. Volume was above average.

The Federal Reserve bank presidents have written a comment letter on MMF reform:

As support for the Council’s proposed determination and to set the context for identifying the essential elements of reform, we briefly discuss some of the risks associated with MMFs’ activities and practices in Section I. Section II focuses on issues that should be addressed as part of any prime MMF reform proposal – most notably, suggestions for the enhancement of the accuracy of market-based net asset values (“NAVs” and each, a “NAV”), particularly in the context of Alternative 1, the Floating NAV. Section III then presents observations concerning each of the three reform alternatives included in the Proposal. Section IV briefly discusses standby liquidity fees and redemption gates and explains why these mechanisms, as proposed by some industry participants, do not meet reform requirements. Finally, we conclude by concurring with the Council’s view that more than one MMF reform alternative could address the financial stability concerns posed by MMFs, in which case fund complexes could be permitted to choose from among multiple alternatives. For example, a complex could offer both a floating NAV fund and separately a stable NAV fund with a capital buffer (and possibly coupled with a Minimum Balance at Risk (“MBR”)), from which investors could choose.

I don’t like the “Minimum Balance at Risk” proposal (discussed on August 14, 2012), but the capital buffer idea is long overdue. I am not terribly enthusiastic about their idea that a floating NAV obviates the need for a capital buffer: MMFs are banks and should be regulated that way, as I have often argued in the past.

It was a mildly positive day for the Canadian preferred share market, with PerpetualPremiums gaining 4bp, FixedResets winning 8bp and DeemedRetractibles up 7bp. Volatility was minimal. Volume was average.

IIROC has gotten away with another shake-down, this time of Deutsche Bank. I’m sure every morally upright person will be shocked – shocked! – at their misconduct:

In late July and early August 2007, the Respondent failed to engage Compliance with emerging issues in the ABCP market.

That’s it. That’s the complete section titled “The Respondent’s Misconduct”. One part of the firm didn’t talk to another. No third parties were harmed – or even affected – in any manner whatsoever.

Aquiescing to this parody of justice were The Honourable Patrick Galligan and Mr. Michael Walsh. But there’s another million smackers in IIROC’s slush fund; I’m sure the folks at FAIR Canada will be pleased.

There’s a proposal for made-in-USA DSIBs:

The bill by [U.S. Representative John] Campbell would require banks with at least $50 billion in assets to hold an additional layer of capital in the form of subordinated long-term bonds totaling at least 15 percent of consolidated assets. If an institution were to fail, the long-term bondholders would be guaranteed at no more than 80 percent of the face value of the debt. As a result, banks would face pressure to reduce their balance sheets.

The extra layer of capital would be in addition to higher levels required as part of the Basel III international regulatory accords. The goal is to protect taxpayers from bailouts and equalize the competitiveness between large and small institutions, which face higher costs of capital, Campbell said.

Campbell also proposed using credit default swaps to help gauge when regulators should step in and assess a bank’s
riskiness. Under his bill, if the price of a bank’s credit default swaps increases more than 50 basis points, the Fed would
have to take steps to assess the banks’ soundness.

“We want this layer of debt to effectively be the canary in the coal mine,” Campbell said.

His legislation would also repeal Dodd-Frank’s heightened standards for systemic institutions and its ban on proprietary trading, known as the Volcker rule. Campbell said that with additional capital requirements, a ban on proprietary trading would be unnecessary.

The Governor Jeremy C. Stein gave a speech titled Overheating in Credit Markets: Origins, Measurement, and Policy Responses:

Let me suggest three factors that can contribute to overheating. The first is financial innovation. … The second closely related factor on my list is changes in regulation. …

The third factor that can lead to overheating is a change in the economic environment that alters the risk-taking incentives of agents making credit decisions. For example, a prolonged period of low interest rates, of the sort we are experiencing today, can create incentives for agents to take on greater duration or credit risks, or to employ additional financial leverage, in an effort to “reach for yield.”11 An insurance company that has offered guaranteed minimum rates of return on some of its products might find its solvency threatened by a long stretch of low rates and feel compelled to take on added risk. A similar logic applies to a bank whose net interest margins are under pressure because low rates erode the profitability of its deposit-taking franchise.

Moreover, these three factors may interact with one another. For example, if low interest rates increase the demand by agents to engage in below-the-radar forms of risk-taking, this demand may prompt innovations that facilitate this sort of risk-taking.
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One reason is that your view of the underlying mechanism shapes how you think about measurement. Consider this question: Is the high-yield bond market currently overheated, in the sense that it might be expected to offer disappointing returns to investors? What variables might one look at to shape such a forecast? In a primitives-driven world, it would be natural to focus on credit spreads, on the premise that more risk tolerance on the part of households would lead them to bid down credit spreads; these lower spreads would then be the leading indicator of low expected returns.

On the other hand, in an institutions-driven world, where agents are trying to exploit various incentive schemes, it is less obvious that increased risk appetite is as well summarized by reduced credit spreads. Rather, agents may prefer to accept their lowered returns via various subtler nonprice terms and subordination features that allow them to maintain a higher stated yield.
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It is interesting to think about recent work by Robin Greenwood and Sam Hanson through this lens.14 They show that if one is interested in forecasting excess returns on corporate bonds (relative to Treasury securities) over the next few years, credit spreads are indeed helpful, but another powerful predictive variable is a nonprice measure: the high-yield share, defined as issuance by speculative-grade firms divided by total bond issuance. When the high-yield share is elevated, future returns on corporate credit tend to be low, holding fixed the credit spread. Exhibit 1 provides an illustration of their finding. One possible interpretation is that the high-yield share acts as a summary statistic for a variety of nonprice credit terms and structural features.
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As can be seen in exhibit 2, issuance in both of these markets has been very robust of late, with junk bond issuance setting a new record in 2012. In terms of the variables that could be informative about the extent of market overheating, the picture is mixed. On the one hand, credit spreads, though they have tightened in recent months, remain moderate by historical standards. For example, as exhibit 3 shows, the spread on nonfinancial junk bonds, currently at about 400 basis points, is just above the median of the pre-financial-crisis distribution, which would seem to imply that pricing is not particularly aggressive.15

On the other hand, the high-yield share for 2012 was above its historical average, suggesting–based on the results of Greenwood and Hanson–a somewhat more pessimistic picture of prospective credit returns.
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Putting it all together, my reading of the evidence is that we are seeing a fairly significant pattern of reaching-for-yield behavior emerging in corporate credit.
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… one lesson from the crisis is that it is not just bad credit decisions that create systemic problems, but bad credit decisions combined with excessive maturity transformation. A badly underwritten subprime loan is one thing, and a badly underwritten subprime loan that serves as the collateral for asset-backed commercial paper (ABCP) held by a money market fund is something else–and more dangerous.

This article on plastic bag bans deserves wide distribution – particularly in Toronto:

Warning of disease may seem like an over-the-top scare tactic, but research suggests there’s more than anecdote behind this industry talking point. In a 2011 study, four researchers examined reusable bags in California and Arizona and found that 51 percent of them contained coliform bacteria. The problem appears to be the habits of the reusers. Seventy-five percent said they keep meat and vegetables in the same bag. When bags were stored in hot car trunks for two hours, the bacteria grew tenfold.

That study also found, happily, that washing the bags eliminated 99.9 percent of the bacteria. It undercut even that good news, though, by finding that 97 percent of people reported that they never wash their bags.

Jonathan Klick and Joshua Wright, who are law professors at the University of Pennsylvania and George Mason University, respectively, have done a more recent study on the public-health impact of plastic-bag bans. They find that emergency-room admissions related to E. coli infections increased in San Francisco after the ban. (Nearby counties did not show this increase.) And this effect showed up as soon as the ban was implemented. (“There is a clear discontinuity at the time of adoption.”) The San Francisco ban was also associated with increases in salmonella and other bacterial infections. Similar effects were found in other California towns that adopted such laws.

It was a mixed day for the Canadian preferred share market, with PerpetualPremiums flat, FixedResets up 14bp and DeemedRetractibles off 6bp. Volatility was normal. Volume was low, with a notable presence of ENB FixedResets, which go ex-Dividend on Wednesday.

Some pension notes from the States:

Scituate, Rhode Island, population 10,329, operates a pension plan for its police department. The plan is underfunded to the tune of $8.4 million, a liability that has quadrupled since 1999. That doesn’t sound like a big shortfall until you realize that Scituate’s pension plan has only 33 participants, meaning that it is short by more than a quarter million dollars per employee.

Worse, Scituate isn’t alone. Rhode Island, with just 41 cities and towns, has 36 separate municipal pension systems, and their unfunded liabilities total more than $2.3 billion. Most, like Scituate’s, are less than 50 percent funded. Cranston, Rhode Island’s third-largest city, has funded just 17 percent of its $330 million pension liability. All but one of these plans have fewer than a thousand members.
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The more promising long-term fix, floated by some Rhode Island lawmakers including State Treasurer Gina Raimondo, is to close municipal pension plans and have one pension system for municipal workers overseen by the state government. This would build on the progress Rhode Island has made in improving its statewide pension systems, which already cover some local employees. A 2011 reform improved the largest system’s funding ratio from 48 percent to 61 percent. Benefits were restructured so that some of the risk of investment returns is shifted from taxpayers to employees.

What a great way to balance the books! Just renege on your promises!

It was a positive day for the Canadian preferred share market, with PerpetualPremiums winning 12bp (as the median YTW dipped below zero again), FixedResets gaining 1bp and DeemedRetractibles up 3bp. Volatility was normal. Volume was above average.

Pension underfunding is becoming socially acceptable:

Some of Ontario’s largest companies, facing massive deficits in their pension plans, are turning to their employees in a bid to help solve a deepening funding crisis.

Chrysler Canada Inc., ArcelorMittal Dofasco Inc. and other companies – large and small – have asked their employees to let them take advantage of a special Ontario government rule that allows companies to stretch contributions to underfunded defined-benefit pension funds to 10 years from five.
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FSCO forecast that the average fund would have assets that would cover just 72 per cent of liabilities at the end of 2011, compared with 87 per cent at the end of 2010.

ArcelorMittal Dofasco shows a typical decline. As of Dec. 31, 2011, assets in the plan for non-unionized employees of the steel maker covered 52 per cent of liabilities, versus 65 per cent a year earlier.

In 2004, Don Pether, then chief executive officer of Dofasco Inc., (before it was taken over by ArcelorMittal) pointed to its fully funded pension plan as offering “a strategic advantage.” But in recent years, record low interest rates and lower returns on investments have caused the deficit, spokeswoman Marie Verdun said Wednesday.

Members of the ArcelorMittal Dofasco plan recently turned down the steel maker’s proposal to stretch out the funding.

It’s a difficult question for workers. On the one hand, crippling the company’s ability to operate doesn’t make a lot of sense. But on the other hand, making such a concession without getting something pretty solid in return doesn’t make a lot of sense either.

And what will the lenders think? It will be most interesting to see what happens as a result of the Indalex ruling:

But insolvency lawyers say this “deemed trust” issue simply creates more headaches for companies with big defined-benefit pension plans and those who lend them money.

This part of the ruling means lenders to thousands of companies with large defined-benefit pension plans just saw themselves pushed back in the line of creditors, behind potentially massive pension shortfalls, said D.J. Miller, an insolvency lawyer with Thornton Grout Finnigan in Toronto.

“All of those lenders that have money advanced right now, thinking they are in first position on inventories and accounts receivable, are sitting behind what can be a deficit that can be in the tens or hundreds of millions of dollars,” said Ms. Miller, who acted for the Insolvency Institute of Canada, which intervened in the case before the Supreme Court.

Plans that could be close to being wound up, or plans that have large shortfalls, will attract special attention, she said: “I think all of the lenders right now are doing a very careful assessment of their portfolios to determine what their potential exposure is.”

She warned that lenders might require extra guarantees and higher rates from companies with big pension plans. Other creditors might be tempted to push a company right into full-blown bankruptcy, which would nullify the pensioners’ new rights.

Jonathan Weil of Bloomberg publicizes an interesting tidbit about the S&P lawsuit:

The U.S. Justice Department made some peculiar allegations in its lawsuit this week against S&P and its parent, McGraw-Hill Cos. According to the government, Citigroup was defrauded by S&P credit ratings on subprime mortgage bonds that Citigroup itself created and sold. Bank of America, too, allegedly was defrauded by S&P in the same way.

If this doesn’t make sense, that’s the point. The notion is far-fetched. No wonder S&P wouldn’t agree to a settlement and told the government to see it in court.

Here’s the gist. Near the end of its 119-page complaint, the Justice Department listed about two-dozen collateralized- debt obligations issued in 2007 as examples where S&P allegedly defrauded banks and credit unions. It was important that the Justice Department be able to identify such lenders as investors, because it’s suing S&P under a 1989 statute that covers frauds against federally insured financial institutions.

Under the government’s theory, Citigroup and Bank of America paid S&P for ratings that convinced the banks their own CDO offal was rock-solid. And because S&P deceived them into thinking the best of their own rubbish, these banks and other lenders suffered more than $5 billion of investment losses, according to the suit.

There’s some concern that retail could stampede out of bonds:

Falling interest rates over the past decade has meant rising bond prices, delivering dazzling returns for bond mutual funds. Investors have responded by jumping in. Mutual, closed end and exchange-traded funds now own close to 20 per cent of all investment and high-yield corporate debt in the U.S.

In Canada, investors bought a net $19-billion worth of bond funds in 2012 (compared with total investment fund net sales of $30-billion), more than two and a half times larger than sales a year earlier, as they continued to trade out of equity funds. Investors in Canada now hold $132-billion worth of bond funds, according to the Investment Funds Institute of Canada – up from just $53.5-billion at the end of 2008.

The concern now is that interest rates rise too much, too fast. Rates on 10-year U.S. Treasury bonds have climbed markedly in recent months after hitting an all-time low last July. The rate hit 2 per cent last week for the first time since April (remember, when rates rise, bond prices fall). If they continue to rise to 3 per cent, there would be a “disorderly rotation out of bonds – characterized by higher interest rates and wider credit spreads,” warned Bank of America Merrill Lynch credit strategist Hans Mikkelsen in a research note this week.

But for now…

But a Canadian debt issue this week is a reminder that the bond market remains frothy by historical standards.

On Wednesday, Corus Entertainment Inc. priced a seven-year, $550-million bond deal at a yield of 4.25 per cent. The big news: That’s 3 percentage points lower than a similar offering in 2010 ($500-million, seven years), when its credit rating was the same BBB low from DBRS that it is today. (Its rating from Standard and Poor’s is one notch higher than it was in 2010, but still below investment grade.)

Better yet, sources in the Canadian bond market say there were 85 buyers, 50 per cent more than the 2010 offering.

There’s a term extension on Irish debt:

Ireland clinched a long-awaited deal on Thursday to ease the burden of its bank debts, sending its borrowing costs falling to pre-crisis levels and bolstering its chances of ending its reliance on EU-IMF loans this year.

After nearly 18 months of negotiation, Prime Minister Enda Kenny won European Central Bank (ECB) approval to stretch out the cost of bailing out Anglo Irish Bank, slicing billions off the country’s borrowing needs and cutting its budget deficit.
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>Under the terms of the deal, first reported on Wednesday, Anglo’s promissory notes, with an average maturity of between seven and eight years, will be exchanged for government bonds with an average maturity of over 34 years. The first principal repayment will be made in 2038 and the last in 2053.

The finance spokesman for the opposition Sinn Fein party said the agreement would burden future generations.

“This week my youngest son began to crawl. He wasn’t even born at the time the promissory note was issued, yet he’ll be 40 years of age and this state will be paying back the toxic debts of Anglo Irish Bank,” Pearse Doherty told parliament.

Anglo Irish’s near-collapse in 2008 pressured the government into guaranteeing the entire financial sector, sucking it into a downward spiral and in late 2010, a €67.5-billion loan from the EU and IMF.

Don’t worry Mr. Doherty! It’s government debt – it will be refunded, not redeemed! Bloomberg points out approvingly:

At issue is an obligation the Irish government took on in 2010, during the rescue of the now-defunct Anglo Irish Bank. At the urging of the European Union, and in return for emergency loans from the European Central Bank, the government issued an IOU that allowed Anglo Irish to pay its bondholders. The IOU has since been a heavy burden on Irish taxpayers, requiring annual payments of more than $4 billion.

This week, the ECB effectively accepted an Irish proposal to reschedule the debt — a move that the country’s extraordinary efforts to fulfill its EU-mandated austerity program thoroughly justify. The government will exchange the IOU, which consists of 10-year promissory notes paying an 8 percent interest rate, for longer-term bonds paying about 3 percent.

And who owned the promissory notes? The Financial Times untangles it:

For Anglo, the only asset it had left that was really worth anything and could be used as collateral was the sovereign promise from the Dublin government: the promissory note.

However, the Irish central bank is now part of the eurosystem, which means the ECB must sign off on any ELA assistance for Anglo and its successors. Since the promissory note is, in essence, the one thing the ECB has as collateral for its loans, it has to make sure whatever replaces them is still legitimate collateral. That gives it a veto in any attempt to restructure the notes.

OK – so Europe has had its 10-year 8% proms forcibly converted into 30-year 3% bonds. There’s a good deal!

It was a mixed day for the Canadian preferred share market, with PerpetualPremiums down 8bp, FixedResets up 10bp and DeemedRetractibles flat. Volatility picked up a little, with Straights on the low side. Volume was above average.

Bloomberg has an the regulatory realities of ratings:

The U.S. lawsuit against Standard & Poor’s raises pressure to accelerate competition in the ratings industry while the government itself has adopted rules that left the business dominated by the same companies whose flawed grades sparked the worst financial crisis since the Great Depression.
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Ann Rutledge, a structured finance specialist, has watched her application to become an NRSRO languish at the SEC for 20 months. Her company, R&R Consulting, has yet to be granted a license because some of the eight client letters don’t meet the requirements of a credit rating as defined by the 2006 law. The statute specifies that only written testimonials that are notarized from institutional buyers attesting to its ratings may be used. R&R’s clients include pension funds, hedge funds and governments.

Rapid Ratings International Inc., a New York-based firm that uses quantitative models to grade securities, hasn’t applied for the NRSRO designation, which would allow investors to buy securities rated by the company to meet regulatory requirements, because its costs would increase by 40 percent to hire compliance staff, James Gellert, chief executive officer, said in a Jan. 7 telephone interview.
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Meredith Whitney Advisory Group LLC, headed by the former Citigroup Inc. analyst, made a presentation to the SEC in November 2010 seeking NRSRO status and has yet to be approved, according to the SEC website. A woman who answered the phone in the company’s New York office Feb. 4 declined to comment on its application.

Costs have also kept PF2 Securities Evaluations Inc., a New York company that values structured products, from applying for the designation, according to Gene Phillips, a director.

Danish banks are having regulatory problems:

The Basel Committee on Banking Supervision, which brings together regulators from 27 nations including the U.S and China, last month expanded the range of easily sold assets banks must have on hand to weather a month of market turmoil. While policy makers approved company debt and equities, they kept limits on covered bonds, mortgage-backed securities that fund almost all Danish home purchases, and are rated higher than the sovereign debt of Japan, Italy and Spain.

Denmark, which doesn’t have a representative on the committee, has more of the securities outstanding per capita than any other nation, with its banks holding more than half of the 3.3 trillion-krone ($600 billion) market. Unless revised, lenders will have to find alternatives to fulfill the liquidity requirements at the same time Denmark is shrinking its issuance of government debt. Interest rates for Danish homeowners, the world’s most indebted, may also climb, creating reverberations throughout the economy, said Steen Bocian, chief economist for Danske Bank A/S, the country’s largest lender.
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Household debt is about three times disposable income, and most of it is in mortgages financed by covered bonds, a form of bank financing backed by mortgages, creating Europe’s second- largest residential covered bond market after Spain. Danish banks held mortgage bonds valued at 1.52 trillion kroner, or 46 percent of the 3.3 trillion kroner outstanding, in December, the central bank said Jan. 25.
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Basel has categorized government debt as level 1, allowing banks to fulfill 100 percent of their liquidity requirements with the assets. Mortgage-based debt is considered level 2, so there are caps on their use as liquid assets. Covered bonds will have a 40 percent ceiling, while securitizations can’t count for more than 15 percent of a lender’s liquidity buffer.

A major objective of Basel III is to force banks to own European government debt, since otherwise it might not get sold.

There’s another smoking gun in the LIBOR rigging scandal:

A Royal Bank of Scotland Group Plc trader colluded with a counterpart at UBS AG to pay almost 211,000 pounds ($330,000) in bribes to brokers willing to help them manipulate global interest rates, regulators said.

Neil Danziger, a London-based derivatives specialist at RBS, helped Tom Hayes, the former UBS employee at the center of the global investigation into rate-rigging, to bribe at least two brokers into persuading other banks to submit rates in line with their own, according to transcripts released by regulators that didn’t identify the traders by name. Two people with direct knowledge of the talks confirmed the traders’ identities. The regulators didn’t identify the brokers involved.
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“Can you do me a favor,” an unidentified broker asked Danziger on Sept. 19, 2008, according to a transcript of the conversation released yesterday by the U.S. Commodity Futures Trading Commission. “You’re not going to get paid any bro for this and we’ll send you lunch around for the whole desk.” As the broker outlined the trade, he said “Take it from UBS, give it back to UBS. He wants to pay some bro,” referring to fees.

“Yeah, yeah,” Danziger replied.

Later that day, the broker asked Danziger if he could “do another 100 yards” or 100 billion, increasing the size of the transaction. “Flat switch,” the broker said. “I know I’m pushing my luck.”

RBS then entered into a wash trade with UBS that enabled the Zurich-based lender to pay about $31,000 in fees to the broker for its help in rigging Libor, the CFTC said.

Cash Store Financial Services is fighting to retain its payday loan business:

Cash Store Financial Services Inc. says it will request a hearing before Ontario’s Licence Appeal Tribunal in response to government pressure on its lending businesses.

The company says Ontario’s registrar for payday loans wants to revoke the payday lending licences of its Cash Store Inc. and Instaloans Inc. businesses.
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Cash Store Financial says Ontario’s Ministry of Consumer Affairs has attempted since September, 2011, to force it to deliver payday loans in cash, rather than the electronic methods they now use.

The company says it’s unwilling to place employees and customers at risk by having them handling cash.

I cannot for the life of me determine why the Ministry wants to force them to use cash – what business is it of the Ministry? Naturally enough, I can’t find anything on the web to answer this question, as the media does nothing but re-write press releases.

This is just another example of creeping regulation. They don’t want to pass a law forbidding X, because that would expose the politicians for what they are. Instead, they install a licensing requirement and simply refuse to issue a license to those deemed unworthy. It’s pretty sleazy.

Anyway, it resulted in a downgrade by S&P:

• •The registrar for payday loans in Ontario issued a proposal to revoke The Cash Store Financial Services Inc.’s (CSF) payday lending licenses, and
  CSF announced that it has discontinued its payday loan product in the territory.

• •We are lowering our ratings on CSF and its senior secured notes to ‘CCC+’ from ‘B-‘.
• •The negative outlook reflects our view that a material portion of CSF’s business is being discontinued in Ontario and that the cash flows from its new credit product may not be able to replace those lost cash flows.

It was a fairly quiet, mixed day for the Canadian preferred share market, with PerpetualPremiums down 5bp, FixedResets gaining 1bp and DeemedRetractibles off 1bp. Volatility was low. Volume continued to be quite high.

PerpetualDiscounts now yield 4.89%, equivalent to 6.36% interest at the standard conversion rate of 1.3x. Long Corporates now yield about 4.4%, so the pre-tax interest-equivalent spread (in this context, the “Seniority Spread”) is now about 195bp, a significant narrowing from the 210bp reported January 23.