Category: Market Action

Inflation expectations can become self-fulfilling, which worries Richard Fisher:

Federal Reserve Bank of Dallas President Richard Fisher said the central bank’s third round of large-scale asset purchases has led to an increase in market expectations for higher inflation without more job creation.

“I do not see an overall argument for letting inflation rise to levels where we might scare the market,” Fisher said on Bloomberg Radio’s “The Hays Advantage” with Kathleen Hays and Vonnie Quinn. “We have seen a sharp rise in inflation expectations. If you let this get out of hand, then I think we will have a market reaction.”
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Measures of expected future inflation “have ramped up pretty quickly,” Fisher said. The five-year, five-year forward breakeven rate, which projects the pace of price increases starting in 2017, rose to 2.88 percent on Sept. 14, the day after the FOMC decided on QE3. That was up half a percentage point from July 26.

Congress’s inaction on fiscal policy and excessive government regulation are holding back businesses from spending on hiring and investment, Fisher said in a later Bloomberg Television interview. The Fed’s stimulus efforts, or so-called quantitative easing, won’t work because the central bank can’t address those obstacles to growth, he said.

There might be another SEC attempt to destroy the public bond market:

The U.S. Securities and Exchange Commission should scrutinize corporate bond markets to determine if retail investors can find fair prices, said Commissioner Daniel Gallagher.

Gallagher, a Republican on the five-member commission that regulates securities trading, called for the agency to look at the imbalance of information available to retail investors and institutional traders in a speech today at a financial-markets conference hosted by Georgetown University’s McDonough School of Business in Washington.

“Retail investors continue to face significant headwinds in the bond markets,” Gallagher said. “Unlike their large institutional counterparts, retail investors generally have less expertise in the basics of bond trading and cannot tap into large dealer networks for quotes in order to shop around for the best prices available.”

Gallagher said the SEC issued a report this year on the state of the municipal securities market and should consider a similar effort with the corporate bond market, “given how large and important that market has become.” That doesn’t necessarily mean more regulation, he said.

You know what regulators mean when they say a study won’t necessarily mean more regulation, don’t you? I don’t have to spell it out for you, do I?

Westcoast Energy, proud issuer of W.PR.H and W.PR.J, has been confirmed by DBRS at Pfd-2(low):

DBRS has today confirmed the Unsecured Debentures, First Preferred Shares and Commercial Paper ratings of Westcoast Energy Inc. (Westcoast or the Company) at A (low), Pfd-2 (low) and R-1 (low), respectively, all with Stable trends. The rating actions incorporate DBRS’s expectation that Westcoast’s significant capex program (projected to be $1.2 billion in 2012, including only $426 million spent through June 30, 2012, and likely to remain elevated in the medium term), will result in negative free cash flows and pressure its credit ratios, as incremental financing will likely come from increased long-term debt issuance.
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The Company’s financial profile remains relatively strong despite rising capex related to its medium-term growth program. Increasing earnings and cash flow from expansions placed in service to date have resulted in relatively strong credit ratios. Westcoast should generate sufficient cash flow to meet a significant portion of its capex and dividend payments going forward, with manageable funding needs at both Union Gas Limited and the Company. Westcoast’s consolidated credit metrics will likely continued to be pressured over the medium term as a result of its significant growth capex, although the metrics are underpinned by Westcoast’s mostly low-risk and regulated operations and will likely remain within the parameters of the current ratings.

It was a good day for the Canadian preferred share market, with PerpetualPremiums and DeemedRetractibles gaining 9bp and FixedResets up 3bp. Volatility picked up a little. Volume was average.

PerpetualDiscounts now yield 4.93%, equivalent to 6.41% interest at the standard equivalency factor 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 200bp, unchanged from the September 12 report.

TD says the housing bubble is yesterday’s news:

TD Economics has gradually reduced its estimate of the overvaluation in Canada’s house prices, as the growth in people’s disposable income picks up while the market stagnates.

The quarterly economic forecast that the bank released Tuesday pegs the current overvaluation in the market at 10 per cent. It had previously estimated that prices were 15 per cent too high, and then suggested a range of 10 to 15 per cent.

Rick Waugh says the same thing:

Canada’s housing market is “at worst” destined for a soft landing, the head of one of the country’s largest banks predicted Tuesday.

Speaking in Toronto, Bank of Nova Scotia chief executive officer Rick Waugh said even though there is a housing bubble in Canada, he doesn’t expect the residential real estate market to crash.

I don’t have figures on how good either party is at predicting house prices.

The slow-motion bank run (is that a jog?) in Europe continues:

An accelerating flight of deposits from banks in four European countries is jeopardizing the renewal of economic growth and undermining a main tenet of the common currency: an integrated financial system.

A total of 326 billion euros ($425 billion) was pulled from banks in Spain, Portugal, Ireland and Greece in the 12 months ended July 31, according to data compiled by Bloomberg. The plight of Irish and Greek lenders, which were bleeding cash in 2010, spread to Spain and Portugal last year.

The flight of deposits from the four countries coincides with an increase of about 300 billion euros at lenders in seven nations considered the core of the euro zone, including Germany and France, almost matching the outflow. That’s leading to a fragmentation of credit and a two-tiered banking system blocking economic recovery and blunting European Central Bank policy in the third year of a sovereign-debt crisis.

It was a quiet day for the Canadian preferred share market, with PerpetualPremiums off 1bp, FixedResets up 4bp and DeemedRetractibles gaining 2bp. Volatility was muted. Volume was below average.

Let’s all reach for yield!

Rates on U.S. high-yield corporate bonds fell below 7 percent for the first time last week, according to Bank of America Merrill Lynch index data.

Average borrowing costs for speculative-grade companies from Sprint Nextel Corp. (S) to HCA Holdings Inc. (HCA) dropped to an unprecedented 6.965 percent Sept. 14 from 7.07 percent the day earlier, Bank of America Merrill Lynch’s U.S. High Yield Master II index data shows. The gauge was at 8.54 percent at year-end and 8.79 percent a year ago, the index data show.

There’s a good editorial on Bloomberg about licensing:

The average cosmetologist in the U.S. trains for 372 days before earning a license. The average emergency medical technician spends 33 days in training. From this, one might conclude that Americans are obsessed with primping but tragically unprepared for emergencies.

Actually, the disparity merely confirms what a muddle the process of occupational licensing is. In 1952, fewer than 5 percent of U.S. workers required a state license. By 2006, according to a survey that year by the Gallup Organization, 29 percent of workers said they needed a government-issued license to do their job.

It’s a serious concern for civil liberties: governments should be in the business of prohibitions – with the growth in licensing, they are in the business of permissions.

Bloomberg’s editors have been on a hot streak lately, bringing to my attention a reckless change in US pension law:

So Congress changed the discounting rules, allowing companies to choose discount rates based on a 25-year average of corporate bond yields instead of using an average of just two years.
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Meanwhile, companies that go bankrupt will tend to have accrued larger unfunded liabilities. The bulk of those liabilities are covered by the Pension Benefit Guaranty Corp., a federal agency backstopped by taxpayers.

The pension legislation also raised the premiums that companies pay into the agency, which, in theory, should offset costs to taxpayers. But Congress counted the increased premiums as funds available to pay for highway construction, essentially double-counting the money.

This relief of pension funding obligations will undermine the solvency of pension funds in part to address a problem that doesn’t exist. Companies protest that they can’t afford to adjust to sharply falling discount rates. The costs they face, however, are a mix of costs they should have been able to control and costs they do control.

In the first category is any increase in unfunded pension liabilities due to lower discount rates. It’s true: Given the crashing bond yields of recent years, without relief, pension funds would be told to start holding many more assets. But the flip side of falling yields is that bond prices have risen significantly.

If a pension plan invested in bonds with maturities matching its obligations — that is, enough 10-year bonds to cover the payments due in 10 years, and so forth — the value of its holdings should have risen enough to cover its added asset needs. Only companies that chose not to properly match their maturities are left closing a gap.

But immunizing liabilities is BORING!

Spanish banks are slowly but surely bleeding deposits:

Spanish banks, already hooked on cheap European Central Bank loans, are hemorrhaging deposits as the government debates whether to seek a bailout.

Households and companies drained 26 billion euros ($34 billion) from Spanish bank accounts in July, driving the ratio of loans to deposits among lenders to 187 percent from 183 percent in December and 182 percent a year earlier, according to data compiled by the Bank of Spain.
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There is “a clear underlying trend of accelerating deposit decline,” Nomura’s Quinn wrote in a Sept. 4 report. Term deposits by households fell 6.9 percent in July from a year earlier, while those of companies fell 24 percent, which “points to continued deposit declines in the future,” he said.

It was a mixed day for the Canadian preferred shares market, with PerpetualPremiums gaining 4bp, FixedResets up 3bp and DeemedRetractibles down 6bp. Volatility was muted. Volume returned to “lousy”.

As I have often complained, there is a growing trend in securities administration la-la-land to treat creditors according to who they are rather than what they have. The receiver’s response to a Lehman creditor is another example:

Defunct brokerage Lehman Brothers Inc., which hasn’t paid institutional creditors a dime of its $25 billion hoard after four years in liquidation, is being urged to settle fights with affiliates and pay up.
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Elliott Management Corp., a New York hedge fund, demanded in June that brokerage trustee James Giddens sell securities and pay an initial $3.2 billion soon. Giddens responded this week, saying Elliott is a “claims trader” and doesn’t share other customers’ interests. Yesterday, two creditor groups sided with Elliott, with an unofficial group in favor of giving Giddens just 60 days to resolve claims with a European affiliate. The official group didn’t set a deadline.
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By March 30, Giddens had $25.4 billion of securities in hand, Elliott said. By selling securities, he could pay almost 26 cents on the dollar of allowed claims totaling $12.2 billion, while still reserving enough money for disputed claims, the hedge fund said.

Goldman Sachs Group Inc. (GS) disagreed, saying customers should get the securities in their accounts, which may be worth more than money poured from a cash pool.

Giddens shouldn’t be treating traders differently from other customers, said Joseph Sarachek, managing director of claims trading at CRT Capital Group LLC, which buys and sells distressed debt.

“There is really no basis in law,” he said. “In the long run, this will hurt liquidity in the marketplace.”

One problem, of course, is that receiverships are a very nice meal ticket for all involved, except the creditors. The company can’t fight back!

DBRS confirmed Brookfield Renewable Energy Partners, proud guarantor of BRF.PR.A:

DBRS has today confirmed the ratings of Brookfield Renewable Energy Partners L.P. (BREP or the Company) and its related security instruments, including the Company-guaranteed Senior Unsecured Debentures and Notes at BBB (high) and Class A Preference Shares, Series 1 at Pfd-3 (high). All trends are Stable. The ratings reflect BREP’s lower-risk renewable generation mix supported by a high level of long-term contracted output, geographical diversification and operating efficiency. Constraints on the ratings include earnings and cash flow volatility resulting from fluctuation in hydrology and wind resources, high dividend payout ratios despite continued high growth-capital spending, and structural subordination to project-level debt. DBRS expects BREP to fund any material acquisition in the future and refinance maturing project debt with non-recourse project-level debt and equity to maintain a reasonable financial profile for the assigned rating category.

The credit metrics of BREP are within range for the current rating profile. Operating cash flow remains well in excess of maintenance capital expenditure requirements. However, significant growth capex and dividends have resulted in free cash flow deficits, which have been funded with a reasonable mix of debt and equity. As a result, leverage has remained relatively stable.

Additionally, DBRS confirmed IGM Financial, proud issuer of IGM.PR.B:

DBRS has today confirmed the ratings of IGM Financial Inc.’s (IGM, or the Company) Unsecured Debentures at A (high) and the First Preferred Shares at Pfd-2 (high). Trends for both are Stable.

IGM is one of the most consistently profitable financial services companies in Canada, reflecting a leading market position in the mutual funds manufacturing and distribution market through the operations of both Investors Group Inc. (IG) and Mackenzie Financial Corporation (Mackenzie). The rating is primarily based on the profitability, operating cash flow and business strengths of the Company’s IG subsidiary, while recognizing the complementary positive contribution of diverse products, brands and distribution channels offered through Mackenzie and Investment Planning Counsel Inc.

In addition to strong profitability, the Company has a conservative financial profile. Debt plus preferred shares-to-EBITDA was less than 1x in 2011, which is conservative, and the Company’s ratio of debt plus preferred shares-to-total capitalization remains appropriate for the rating, at just over 25%. While IG’s redemption rates are better than the industry average, the continuing net mutual fund redemptions at Mackenzie are not yet a major concern in determining IGM’s rating.

As a member of the Power Financial Corporation (Power) group of companies, IGM benefits from the additional financial flexibility of having a strategic shareholder and the associated strong governance and risk avoidance management model typical of Power subsidiaries.

It was a good day for the Canadian preferred share market, with PerpetualPremiums and DeemedRetractibles gaining 10bp and FixedResets winning 11bp. Volatility was average. Volume was average.

The Fed will continue its monetization policy:

To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate, the Committee agreed today to increase policy accommodation by purchasing additional agency mortgage-backed securities at a pace of $40 billion per month. The Committee also will continue through the end of the year its program to extend the average maturity of its holdings of securities as announced in June, and it is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities. These actions, which together will increase the Committee’s holdings of longer-term securities by about $85 billion each month through the end of the year, should put downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative.
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To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens. In particular, the Committee also decided today to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that exceptionally low levels for the federal funds rate are likely to be warranted at least through mid-2015.

There is also language about employment levels:

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee is concerned that, without further policy accommodation, economic growth might not be strong enough to generate sustained improvement in labor market conditions. Furthermore, strains in global financial markets continue to pose significant downside risks to the economic outlook. The Committee also anticipates that inflation over the medium term likely would run at or below its 2 percent objective.

Some people take this as an abandonment of the inflation mandate:

Gold jumped to a six-month high near $1,770 (U.S.) an ounce on Thursday, rising 2 per cent after the U.S. Federal Reserve launched an aggressive stimulus program and vowed it will keep buying assets until the outlook for jobs improves substantially.

The metal received a huge boost after the U.S. central bank tied its unconventional bond-buying directly to economic conditions, marking a significant shift in the direction of U.S. monetary policy.

Market watchers said the Fed was essentially shifting its focus to maximum employment at the expense of maintaining stable prices. The two objectives are often called the Fed’s dual mandate.

“They are emphasizing the growth mandate, and that means they don’t care about inflation other than giving lip service to it,” said Axel Merk, chief investment officer at Merk Funds, which has around $600 million in currency mutual-fund assets.

“The price of gold will do very well in the years to come,” Merk said.

Mr. Merk writes quite a bit about gold.

The equity guys were pleased:

U.S. stocks rose, sending the Standard & Poor’s 500 Index to its highest level since 2007, as the Federal Reserve said it will buy mortgage-backed securities to bolster the economy.

The S&P 500 rallied 1.6 percent to 1,459.99 at 4 p.m. in New York.

“It was a very powerful statement,” Kevin Caron, a market strategist at Stifel Nicolaus & Co. in Florham Park, New Jersey, said in a telephone interview. The firm oversees about $127 billion. “The Fed is going all in here, especially with their commitment to continue asset purchases until they see the desired result in the form of a lower unemployment rate. This statement removes a lot of uncertainty about the Fed’s commitment to maintaining price stability.”

The thugs at Telus have managed to stamp out an unfortunate bit of shareholder activism:

The debate over so-called empty voting has more fuel after a much-anticipated decision from a judge in the case of Telus Corp. and its fight against hedge fund Mason Capital, but there is still a lingering lack of clarity on just what is allowed.

Mason put on a trading position that would enable it to benefit from the failure of a Telus proposal to collapse the company’s dual class share structure on a one-for-one basis. Mason did it by buying shares of one class and selling short shares of the other class. The hedge fund’s hope is to force a conversion ratio that favours the shares that it bought, and it sought to call a shareholders meeting that would enshrine such a ratio in the articles of Telus.
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So how did Telus win? In large part because Mason’s shareholder requisition for a meeting did not properly identify the hedge fund as the real owner of the shares.

As far as I know, there’s no doubt in anybody’s mind that Mason owns a big chunk of Telus voting shares and wants to force a vote. But they didn’t fill out the forms properly. Gotcha! The particulars of the decision are that CDS, the registered shareholder, did not properly identify the beneficial owner.

[64] Assuming but not deciding that CDS can issue a requisition on behalf of aparticipant or beneficial shareholder, in my opinion the Requisition must identify thebeneficial shareholders behind the requisition so the directors can meet their dutiesunder ss. 167(2), (3) and (7). The subject Requisition fails to do so.

[65] In the circumstances, in my opinion, the directors were not obliged to send anotice of meeting as the Requisition does not comply with ss. 167(2) and (3).

Very little overall movement in the Canadian preferred share market today (although I retain a faint hope that the Fed will start buying Canadian preferred shares. Well, I did say it was a faint hope!), with PerpetualPremiums and DeemedRetractibles flat while FixedResets gained 1bp. Volatility was no great shakes. Volume was surprisingly low, considering that the new issues of ENB.PR.P and BPO.PR.T (today) and BAM.PF.B (yesterday) should be causing some portfolio shuffling. Maybe the Fed bought all the new issues?

The Great Regulatory Job Creation Scheme is gathering steam:

U.S. regulators are set to choose the first non-bank companies likely to be branded potential risks to the financial system, according to two people with knowledge of the plans.

The Financial Stability Oversight Council intends to request confidential data from as many as five U.S. firms at a meeting this month, said the people, who declined to be identified because the plans aren’t public. The request is a step toward deciding whether the companies should be subject to Federal Reserve supervision, including stress tests, higher capital levels and tougher liquidity requirements.

So the Fed will have to hire more regulators to administer the expanded mandate and then more regulators to replace the old regulators who have been hired by the affected companies at fat salaries. It’s win-win!

Wow! The US Mortgage almost-agencies have a radical new business model!

Edward J. DeMarco, the overseer of taxpayer-supported Fannie Mae (FNMA) and Freddie Mac, said the firms need to increase the fees they charge to guarantee mortgages in states where it’s costlier for them to deal with bad debt.

Can you imagine? Charging for services based on expected costs? I think Mr. DeMarco should get the Nobel Prize in Economics.

It was another day of little movement for the Canadian preferred share market, with PerpetualPremiums down 3bp, FixedResets gaining 4bp and DeemedRetractibles off 2bp. Volatility was minimal. Volume was average – which is a huge improvement from recent levels, probably helped along by the BAM.PF.B new issue.

PerpetualDiscounts (all three of them!) now yield 4.92%, equivalent to 6.40% interest at the standard equivalency factor of 1.3x. Update Long Corporates now yield about 4.4%, so the pre-tax interest-equivalent spread (in this context, the “Seniority Spread”) is now about 200bp, sharply tighter than the 215bp reported September 5.

There’s a new wrinkle in the financial repression chronicles:

JPMorgan Chase & Co. (JPM) and Bank of America Corp. are helping clients find an extra $2.6 trillion to back derivatives trades amid signs that a shortage of quality collateral will erode efforts to safeguard the financial system.

Starting next year, new rules designed to prevent another meltdown will force traders to post U.S. Treasury bonds or other top-rated holdings to guarantee more of their bets. The change takes effect as the $10.8 trillion market for Treasuries is already stretched thin by banks rebuilding balance sheets and investors seeking safety, leaving fewer bonds available to backstop the $648 trillion derivatives market.

The solution: At least seven banks plan to let customers swap lower-rated securities that don’t meet standards in return for a loan of Treasuries or similar holdings that do qualify, a process dubbed “collateral transformation.” That’s raising concerns among investors, bank executives and academics that measures intended to avert risk are hiding it instead.

Adding to the concern is the reaction of central clearinghouses, which collect from losers on derivatives trades and pay off winners. Some have responded to the collateral shortage by lowering standards, with the Chicago Mercantile Exchange accepting bonds rated four levels above junk.

The potential reward for revenue-starved banks is an expanded securities-lending market that could generate billions of dollars in fees. JPMorgan and Bank of America, which have the biggest derivatives businesses among U.S. bank holding companies with a combined $140 trillion of the instruments, are already marketing their new collateral-transformation desks, people with knowledge of the operations said.

As discussed on August 31, directed lending to the government is a form of financial repression.

The US has to force people to buy its bonds! The outlook isn’t getting any better:

Moody’s warned Tuesday it could strip the United States of its coveted triple-A credit rating if Congress fails to produce a budget that will bring down the federal debt burden.

“Budget negotiations during the 2013 Congressional legislative session will likely determine the direction of the U.S. government’s Aaa rating and negative outlook,” the ratings firm said in a statement.

If the negotiations lead to specific policies that produce a stabilization and then downward trend in the ratio of federal debt to GDP over the medium term, the rating will likely be affirmed and the outlook returned to stable, it said.

“If those negotiations fail to produce such policies, however, Moody’s would expect to lower the rating, probably to Aa1.”

Moody’s said it was unlikely it would keep the Aaa rating with a negative outlook into 2014.

“The only scenario that would likely lead to its temporary maintenance would be if the method adopted to achieve debt stabilization involved a large, immediate fiscal shock – such as would occur if the so-called ‘fiscal cliff’ actually materialized – which could lead to instability,” it said.

There was very little movement in the Canadian preferred share market today, with PerpetualPremiums and FixedResets both gaining 3bp; DeemedRetractibles were off 2bp. Volatility was average. Volume improved a little, but was still below what I would call ‘average’ levels; but on a brighter note, RBC owned the board today, with no other dealer mentioned in the Volume Highlights.

There are rising expectations for low rates forever:

Just six months ago, money market traders expected the Federal Reserve to raise interest rates by the end of 2013. Now, they see borrowing costs staying at record lows for about three more years as the economic outlook worsens.

Bond market measures from overnight index swaps, which indicate no increase in the federal funds rate until mid-2015, to a 62 percent decline in a measure of volatility in government bonds signal that rates will stay near zero for longer. The gap between two- and five-year Treasury yields, which decreases when traders expect benchmark rates to remain subdued, is more than 50 percent narrower than its average since 2008.

It was an off day for the Canadian preferred share market, with PerpetualPremiums and FixedResets down 7bp, while DeemedRetractibles lost 9bp. Volatiltiy was average, all on the downside. Volume continued at holiday levels.

US Payrolls weren’t very encouraging:

Payrolls rose less than projected in August and the unemployment rate was unexpectedly driven down by Americans leaving the labor force, boosting the odds of additional Federal Reserve easing to spur a faltering recovery.

The economy added 96,000 workers after a revised 141,000 increase in July that was smaller than initially estimated, Labor Department figures showed today in Washington. The median estimate of 92 economists surveyed by Bloomberg called for a gain of 130,000. The jobless rate fell to 8.1 percent.

European banks still aren’t doing very well:

ECB President Mario Draghi said yesterday the central bank will lend against assets in dollars, pounds and Japanese yen, as well as in euros, reopening a program that ran for two years following the September 2008 bankruptcy of the U.S. investment bank. The ECB also eased borrowing against government-issued or guaranteed assets by dropping rating requirements.

Investors’ reluctance to lend to banks in countries where bond yields soared has forced those banks to fund at the ECB. Spanish banks borrowed 375.5 billion euros ($476 billion) from the central bank as of the end of July, sucking collateral out of a government bond market that totals about 690 billion euros, according to data compiled by Bloomberg.

The ECB’s 1 trillion-euro longer-term refinancing operations in December and February took collateral out of the market, in particular in Spain and Italy, whose banks were the biggest borrowers. ECB bond buying as part of its new Outright Monetary Transactions program will pile more pressure onto a market that is already “highly illiquid,” said Chris Clark, a strategist at ICAP Plc, the largest broker of transactions between banks.

“There’s so little Spanish paper that hasn’t been lodged at the ECB that pretty much every single bond has gained a very significant premium to borrow,” he said. “If the ECB buys more bonds, it may dry up liquidity in the Spanish government bond market even more. These looser collateral rules will help.”

Apropos of which, Fitch Ratings has a most interesting report titled U.S. Money Fund Exposure and European Banks: Shift to Japan Continues:

U.S. prime money market funds (MMF) continued to increase their exposure to Japanese banks, which as of end-July represent 12.3% of total MMF holdings or a 118% increase on a dollar basis since end-May 2011 (see Shift to Japan Continues chart and Change in Exposure [on a Dollar Basis] table). This exposure exceeds aggregate MMF allocations to eurozone banks, which increased moderately since the prior reporting period and now constitute 8.5% of total MMF assets, still 76% below end-May 2011 levels on a dollar basis. This “disengagement” between MMFs and eurozone banks appears to be persisting, as MMF risk aversion continues and both eurozone banks and their regulators seem cautious towards this potentially volatile form of funding. Aggregate MMF allocations to European banks outside of the eurozone also grew with allocations to Nordic, Swiss, and U.K. banks all rising since end-June on a dollar basis. Outside of Europe, MMF allocations to Canadian banks declined slightly, while exposures to Australian banks remained constant over the same period. However, since end-January 2012, MMF exposures to Australian banks have declined by roughly 25%, consistent with efforts by these banks to gradually reduce their use of short-term wholesale funding. U.S. banks remain the largest single-country exposure at 12.4% of MMF assets as of end-July.

I am pleased to announce the existence of a prominent adult investor:

Mark Cuban, owner of the Dallas Mavericks basketball team, wrote a post on his blog in response to a column in which Andrew Ross Sorkin of the New York Times pinned the blame on David Ebersman, Facebook’s chief financial officer. Cuban said:

“I bought and sold FB shares as a TRADE, not an investment. I lost money. When the stock didn’t bounce as I thought/hoped it would, I realized I was wrong and got out. It wasn’t the fault of the FB CFO that I lost money. It was my fault. I know that no one sells me shares of stock because they expect the price of the stock to go up. So someone saw me coming and they sold me the stock. That is the way the stock market works. When you sit at the trading terminal you look for the sucker. When you don’t see one, it’s you. In this case it was me.”

Amazing, isn’t it?

There’s a (very US-centric) article on preferred shares in the Wall Street Journal, titled Playing ‘Preferred’ Shares.

DBRS confirmed MFC:

DBRS has today confirmed its ratings on Manulife Financial Corporation (Manulife or the Company) and its affiliates, including The Manufacturers Life Insurance Company, its primary operating company. The rating trend is Stable.
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While DBRS is prepared to acknowledge that, barring a major economic crisis, the Company has probably hit its nadir, it does not believe that the lost profitability associated with the U.S. operation will recover quickly, especially since the former earnings levels benefited from favourable equity markets and a more favourable interest rate environment. DBRS is also mindful that the Company’s core earnings performance is dampened by hedging costs, reduced earnings opportunities related to potential recovery in capital markets, and more competitive market conditions. The Company has indicated that it also expects to take another material charge in Q3 2012 related to changes in actuarial assumptions driven by new standards of practice and the ambient macroeconomic environment, though much of this specific charge will relate to products and policy liabilities that are not part of the Company’s current growth plans. Other sources of potential earnings volatility relate to the indeterminate policyholder behaviours that are not addressed by current hedging activity, and a possible additional write down of goodwill reflecting the adverse interest rate environment.

At the Company’s current level of core earnings as DBRS defines them, fixed charge coverage ratios are below 5x with a core return on equity (ROE) of about 10%, well below the greater than 10x coverage and greater than 15% ROE reported prior to the onset of the 2008 financial crisis. Without the heft of the Company’s business franchises in Canada, Asia and the United States, such ratios and the accompanying earnings volatility would not be consistent with the DBRS quantitative criteria for Company’s rated at the current levels. Should these business franchises deteriorate, there could be negative rating implications.
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To meet its regulatory capital requirements over the same period of market disruption, the Company has raised over $14 billion in net capital through market issues of common and preferred shares, reduced cash dividends and senior and subordinated debt issues. Correspondingly, the Company has consistently reported strong regulatory capital ratios, as its financial leverage ratios (total debt plus preferred as a proportion of capitalization) have increased to 32.2% from 17.1% in 2007, and remain above the Company’s 25% target. The Company reported an MCCSR ratio of 213% for the period ending June 30, 2012, which is among the strongest ratios in the industry and well above a reasonable minimum level, especially given the Company’s risk-mitigating hedges for which the regulatory ratio gives no credit. However, given the unstable economic environment regulatory uncertainty associated with Solvency II, IFRS accounting for Insurance Contracts and Employee Benefits and OSFI’s and the Canadian Institute of Actuaries requirements regarding required capital for variable annuity guarantees, DBRS feels that the relatively high regulatory capital ratios are prudent at this time.

DBRS also confirmed GWO:

DBRS has today confirmed the ratings of Great-West Lifeco Inc. (GWO or the Company) and its affiliated operating subsidiaries, including the Claims Paying Ratings at The Great-West Life Assurance Company, The Canada Life Assurance Company and London Life Insurance Company; all trends are Stable. The existing ratings for the Company and its operating subsidiaries reflect the continuing strong financial performance and the notable absence of earnings volatility associated with recent exogenous market factors. Stable earnings are a testament to the Company’s diversification by product and geography, as well as its conservatism with respect to embedded product risks, actuarial assumptions and asset quality.

Like its major peers, the Company is anchored by Canadian operations that benefit from an oligopolistic industry structure, which limits the worst of price competition.
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The MCCSR ratio of the Company’s major regulated operating subsidiary has hovered just over 200% for the last two years. While this is lower than that of some major competitors, it reflects the Company’s lower-risk asset portfolio and insurance liabilities, and does not include $825 million of cash at the holding company that could easily be advanced to the regulated entities in the form of capital, if required. With longer experience as a shareholder-owned company, GWO has traditionally operated with higher financial leverage than most of its Canadian peers, a reflection of its debt-financed mergers and acquisitions activity and the historical attention paid to the efficient use of shareholder capital. At 32.2% at the end of June 2012, the Company’s total debt plus preferred has come into alignment with that of the peer group, as Great-West has reduced financial leverage and de-mutualized competitors have increased theirs. Fixed-charge coverage ratios at GWO nevertheless remain healthier than those of its peers, reflecting stronger profitability. The Company is actively retiring capital instruments issued at its operating companies in order to have a higher proportion of capital issuance at the holding company level, which will serve to reduce its double leverage ratio. In short, DBRS considers the Company’s financial leverage and capital position to be consistent with the current rating category, as long as it continues to operate conservatively.

As an integral component of Power Financial Corporation’s group of companies, GWO benefits from its parent’s financial support and its strong governance and risk management controls and procedures, which reinforce the conservative bottom-line focus of the Company.

It was a mixed day for the Canadian preferred share market, with PerpetualPremiums gaining 6bp, FixedResets off 2bp and DeemedRetractibles up 4bp. Volatility was minimal. Volume remained at holiday levels.

The European Central Bank is going to purchase sovereigns:

As announced on 2 August 2012, the Governing Council of the European Central Bank (ECB) has today taken decisions on a number of technical features regarding the Eurosystem’s outright transactions in secondary sovereign bond markets that aim at safeguarding an appropriate monetary policy transmission and the singleness of the monetary policy. These will be known as Outright Monetary Transactions (OMTs) and will be conducted within the following framework:
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Transactions will be focused on the shorter part of the yield curve, and in particular on sovereign bonds with a maturity of between one and three years.

No ex ante quantitative limits are set on the size of Outright Monetary Transactions.

Creditor treatment The Eurosystem intends to clarify in the legal act concerning Outright Monetary Transactions that it accepts the same (pari passu) treatment as private or other creditors with respect to bonds issued by euro area countries and purchased by the Eurosystem through Outright Monetary Transactions, in accordance with the terms of such bonds.

Sterilisation The liquidity created through Outright Monetary Transactions will be fully sterilised.

Transparency Aggregate Outright Monetary Transaction holdings and their market values will be published on a weekly basis. Publication of the average duration of Outright Monetary Transaction holdings and the breakdown by country will take place on a monthly basis.

Pari passu treatment for ECB holdings would be a pleasant change … provided one can count on the Europeans to keep their word.

Jason Heath writes a piece in the Financial Post regarding a CDHowe report on Annuities:

But the C.D. Howe report is really interest-rate agnostic — focused more on reasons other than interest rates that Canadians are not opting for annuities. Among those reasons: poor annuity market infrastructure and pricing; non-integration of insurance, banking, pension and tax regulations; insufficient annuity product options; and a lack of government websites and resources to assist in our decisionmaking.

The CDHowe commentary by Norma L. Nielson is titled Annuities and Your Nest Egg: Reforms to Promote Optimal Annuitization of Retirement CapitalRetiring. I’ve scanned it – it follows the basic Financial Economist reasoning that Liquidity Value = 0, therefore Annuities = Good. I was particularly struck by the suggestion:

In some cases, public policymakers decide there is a need to subsidize one group at the expense of another. State social security systems may incorporate a significant element of wealth transfer from the rich to the poor, for example. In the case of decumulation products, it may be determined that it is socially desirable to provide gender-neutral annuities; i.e., for men to subsidize women.

Interesting report from a relatively free-market airline business:

Qantas Airways Ltd. (QAN)’s decision to drop a 17-year pact with British Airways (IAG) in favor of a deal with Dubai-based Emirates reveals the potential for fast-growing Gulf carriers to shatter the established airline order.

The 10-year accord, announced yesterday, will lead Qantas to scrap its revenue-sharing pact with British Airways to gain access to 70 Emirates destinations. While the Australian carrier will carry on code-sharing with BA, the move puts in doubt the standing of the Oneworld global alliance the pair helped form.

Too bad we won’t even let Emirates fly here as much as they like! But it’s just another example of the extent to which competition and efficiency is stifled in Canada. When politicians (such as Junior Minister Carney) say “Productivity!”, I say “Milk.”

It was a mixed day for the Canadian preferred share market, with PerpetualPremiums gaining 1bp, FixedResets down 8bp and DeemedRetractibles off 2bp. Volatility was minimal. Volume remained very low.