Category: Market Action

Price volatility slowed considerably today, although recent trends continued weakly, with PerpetualDiscounts gaining 7bp and FixedResets losing 7bp on continued heavy volume.

PerpetualDiscounts now yield 6.17%, equivalent to 8.64% at the standard equivalency factor of 1.4x. Long Corporates now yield about 5.7%, so the pre-tax interest-equivalent spread is now about 295bp, down substantially from the peak of 310bp reported April 7 though still wider than the 285bp reported at month-end.

Citigroup’s liquidity guarantees are attracting scrutiny:

Financial Crisis Inquiry Commission investigators may conclude a primary cause of Citigroup’s 2008 bailout was the use of “liquidity puts” by traders to bolster sales, Chairman Phil Angelides said in an interview yesterday. Those puts allowed customers to sell debt securities back to the bank at face value if credit markets froze, something that Citigroup’s traders bet would never happen, according to Angelides.
…
To raise money to buy the assets, Citigroup sold commercial paper, with the assets pledged as collateral. Commercial paper is a type of debt that matures in less than a year and was popular with money-market funds and corporate treasurers who want to invest their surplus cash in readily redeemable funds while earning higher yields.

Liquidity puts were added to “facilitate” the sales of the commercial paper, [Citigroup CDO boss Nestor] Dominguez said; investors could “put back” the commercial paper to Citigroup if the market went cold. Dominguez described this as a “significant widening in credit spreads or a temporary inability to issue commercial paper.” Widening credit spreads, or the gap between a bond’s yield and benchmark rates, indicate slackening investor demand.
…
Citigroup used the liquidity puts partly because they required less capital support than backup credit lines that bank’s typically offer, Georgiou said.

The liquidity puts were subject to a 0.8 percent capital charge, [commission member Byron] Georgiou said. Put another way, the bank had to set aside $1 of capital for every $125 of commercial paper. That compares with Citigroup’s overall ratio of $1 for every $14.50 of loans, securities and other investments as of Dec. 31.

The International Monetary Fund has released the April 2010 Global Financial Stability Report. I haven’t had a chance to do much besides skim it, but the big news is that they’re recommending capital charges on “systemically important” banks based on regulatory fiat, rather than any kind of formula:

Regulators may find it necessary to weigh “direct preemptive measures,” including constraining the size of certain activities to limit the emergence of “systemically important” firms, the Washington-based IMF said today in its bi-annual Global Financial Stability Report.

The report precedes an April 23 meeting of the Group of 20 nations in Washington, where the IMF plans to detail for finance chiefs ways that financial firms may help pay for the costs of bailouts. Since the start of the credit crisis, governments and central banks have spent more than $11 trillion to support the financial industry, according to the Paris-based Organization for Economic Cooperation and Development.

The capital surcharge would be “a buffer” designed to increase “the resiliency of the institution to sustain different shocks,” Juan Sole, one of the report’s authors, told reporters in Washington today.

Political momentum to overhaul financial regulations in some countries may be weakening as economic growth returns, IMF Managing Director Dominique Strauss-Kahn said in an interview in Kenya last month.

Parts of the financial industry have gone “back to practices of risk taking, which is probably not the most appropriate to have a stable financial system at the global level,” he said.

Now, more than ever, it is important for large banks to offer cushy jobs to ex-regulators!

The rebound in the market continued today on heavy volume, with PerpetualDiscounts up 26bp while FixedResets lost 4bp … taking the yield on the latter index within striking distance of 4%!

Greece is getting a bail-out:

Forced into action by a surge in Greek borrowing costs to an 11-year high, finance ministers from the 16 euro countries said they and the International Monetary Fund would offer the loans at non-subsidized interest rates in case Greece runs out of money-raising options. European Union Economic and Monetary Affairs Commissioner Olli Rehn said that the rate on the loans could be around 5 percent.

There’s no word regarding the attached strings.

PerpetualDiscounts continued their recovery today, gaining 38bp on continued heavy volume, while FixedResets were basically unchanged, gaining 1bp.

More news from the discount aisles of Greece, where burning Sappho lunched and swum:

European Union officials said they are ready to rescue Greece if needed as Fitch Ratings cut the country’s credit rating to the lowest investment grade and economists at UBS AG said that a bailout may be imminent.

Germany restated its opposition to below-market rate loans to Greece as officials in Brussels hammered out details to the framework calling for joint EU-International Monetary Fund aid.
…
The premium investors demand to buy Greek 10-year bonds instead of German bunds jumped to 442 basis points yesterday, the highest since the introduction of the euro. Prime Minister George Papandreou has said borrowing at those levels is unsustainable. Greece will need to seek emergency funding now to make debt repayments of more than 20 billion euros ($27 billion) in the next two months, UBS economists said in a note.

Yesterday I mentioned how Ontario is limiting pharmacists’ access to the trough; it appears that this action has been taken because they’ve been elbowed away by much sexier sucklings:

Residential customers in Ontario will pay $300 more a year on average for electricity by the end of 2011, an increase of 25 per cent, according to energy consultants. And the rate increases won’t end there. Investments of more than $8-billion in green energy projects unveiled by the Ontario government Thursday will add another $60 a year to hydro bills by 2012.
…
The Ontario Power Authority announced Thursday that it has approved 185 wind, solar and biomass projects capable of generating 2,500 megawatts of electricity, enough to power 600,000 homes.
…
Electricity consumers will pay another $5 a month by 2012, when the projects are up and running.

Let that be a lesson to everybody! University is useless! Go to charm school!

It was another counter-trend day for the Canadian preferred share market, as PerpetualDiscounts gained 74bp and FixedResets were down 11bp on continued heavy volume. To drive the point home, the volume highlights table was dominated by PerpetualDiscounts.

What’s a Grecian earn?:

Greece will probably be forced to request a financial rescue after a European Union aid pledge failed to stop Greek borrowing costs from surging, said economists at AXA Group and Nomura International Plc.

Greek bonds dropped for a seventh day today, driving up the yield on the 10-year security to 7.5 percent, with Prime Minister George Papandreou’s government needing to sell 11.6 billion euros ($15.4 billion) of debt by the end of May. The yield premium over benchmark German bonds widened to the most since the euro’s debut in 1999, based on Bloomberg generic data.

Let’s have a big hand for the newly Assiduous Reader mega56. Only been studying the pref market for twenty minutes and he’s already on the right track!

Regarding perpetuals and rising interest rates. I’ve read in many places that perpetuals are risky during a phase where rates are rising, stay away. When I’m looking at the numbers, I don’t see it.

Example: CM.PR.E currently sits at 22.43 @$1.40
a. if it gets called (worst), you’ve got a nice gain @25.00
b. if price drops with rising rates, you still get the dividend

I’m missing the downside here.

Geez, at this rate he’ll be my competition in a few weeks!

There was some testimony to the Crisis Committee regarding Citigroup and CDOs:

Nobody could have predicted that the bank’s highest-rated collateralized debt obligations — created by repackaging mortgage bonds into new securities — would lose so much money, Prince said. The chief risk officer didn’t understand the risks, nor did Citigroup’s senior traders and bankers, he said.

“Everyone, including our risk managers, other banks and CDO structurers, all believed that these securities held virtually no risk,” Prince, 60, said. “It is hard for me to fault the traders who made the decisions to retain these positions on Citi’s books.”

Not so hard for me! Assiduous Readers will know that CDOs have been in the news quite a lot lately:Tranche Retention in the sub-prime CDO Market, The Story of the CDO Market Meltdown and Hull & White on AAA Tranches of Subprime. In the last paper, Hull & White demonstrated that CDO risk evaluation was faulty as the distributions of the risks of the securities held in the CDO were significantly different from the distributions of the risks of more normal instruments.

But it doesn’t matter. It really doesn’t matter. It happened this time and it will happen next time. Traders are business school smiley-boys, who have the job of quoting securities, rolling over their inventory, making the spread each time and telling the customer whatever he wants to hear. Whenever they suffer from delusions of intelligence, trouble ensues. Trading is different from investing and the two simply don’t mix very well. The key mistake at Citigroup – and elsewhere – was allowing traders to accumulate aged inventory, and not to impose a capital charge on this aged inventory.

The Ontario government’s plan to reduce generic drug costs has led DBRS to put Shoppers’ Drug Mart on review negative. With respect to the plan itself, I’m amused by the existence of trailer fees in the drug business:

Eliminating abuse of the system by ending so-called ‘professional allowances’ – payments generic drug companies make to pharmacy owners intended to fund patient services, but are instead being used by many pharmacies as rebates to fund fringe benefits, bonuses, overhead costs and boost profits

… but perplexed by …

Lowering the cost of generic drugs by at least 50%, to 25% of the cost of the original brand name drug for Ontario’s public drug system, private employer drug plans, and people who pay for drugs out-of-pocket, saving taxpayers millions

How is this possible? Is there no competition for generic drugs? Has the drug plan been run with no attempt to lower the price to whatever the manufacturers will bear? Or has the price been supported by a dispensing oligopoly? How on earth is it even possible to reduce costs by 50% by simple government fiat? Shoppers’ response to the plan has the amusing phrase:

Key tenants of these proposals included:

… indicating illiteracy, but no real arguments about the economics of the Ontario drug plan paying for, you know, drugs.

The Canadian preferred share market continued to see heavy trading today and, in a sharp reversal of recent experience, PerpetualDiscounts gained 50bp while FixedResets fell 25bp, bringing yields on the latter up to 3.83%. Good volatility is evident on the Performance highlights table; FixedResets continue to dominate volume.

Think we’ve got it tough in the Canadian preferred share market? Be grateful you’re not holding Greek bonds!

U.S. and European stocks fell, led by commodity producers as oil and copper dropped, while the premium investors demand to hold Greek bonds widened to the most since 1998 on speculation the nation may default.
…
Greece’s 10-year bond yields rose 0.16 percentage point to 7.14 percent and the yield premium to German debt widened to 4.03 percentage points, the most since before the euro was introduced in 1999.

How bad is it? CDSs on Greece are now trading above terrorist levels:

Swaps tied to Greece rose to 415 basis points today while those on Iceland traded at about 400 basis points, according to Markit data. The North American Markit index climbed the most since March 22 amid investor concern that contagion from a Greece default could spread to other assets, said Gavan Nolan, an analyst at Markit Group in London.

Remember Jim Kelsoe, proud portfolio manager of the worst bond fund in the history of the universe (so far)? He was last mentioned on PrefBlog on May 9, 2008. Now the SEC is alleging that his fund returns were, in fact, overstated:

The SEC’s Division of Enforcement alleges that Morgan Keegan failed to employ reasonable procedures to internally price the portfolio securities in five funds managed by Morgan Asset, and consequently did not calculate accurate “net asset values” (NAVs) for the funds. Morgan Keegan recklessly published these inaccurate daily NAVs, and sold shares to investors based on the inflated prices.

“This scheme had two architects — a portfolio manager responsible for lies to investors about the true value of the assets in his funds, and a head of fund accounting who turned a blind eye to the fund’s bogus valuation process,” said Robert Khuzami, Director of the SEC’s Division of Enforcement.

William Hicks, Associate Director in the SEC’s Atlanta Regional Office, said, “This misconduct masked from investors the true impact of the subprime mortgage meltdown on these funds.”

According to the Commission’s order instituting administrative proceedings, the SEC’s Enforcement Division alleges that James C. Kelsoe, Jr., the portfolio manager of the funds and an employee of Morgan Asset and Morgan Keegan, arbitrarily instructed the firm’s Fund Accounting department to make “price adjustments” that increased the fair values of certain portfolio securities. The price adjustments ignored lower values for those same securities quoted by various dealers as part of the pricing validation process. The Enforcement Division further alleges that Kelsoe actively screened and manipulated the pricing quotes obtained from at least one broker-dealer. With many of the funds’ securities backed by subprime mortgages, Kelsoe’s actions fraudulently prevented a reduction in the NAVs of the funds that otherwise should have occurred as a result of the deterioration in the subprime securities market.

Lots of winners and losers on a volatile day of continued heavy volume in which selling pressure on PerpetualDiscounts eased off a bit … they were down only 2bp today which, considering recent returns, is practically a win! It is interesting to speculate that the buying came from switches out of FixedResets, as they were down 16bp on the day to take yields up to 3.74%. FixedResets again scored a shut-out on the volume table.

PerpetualDiscounts now yield 6.30%, equivalent to 8.82% interest at the standard equivalency factor of 1.4x. Long Corporates continue their insouciance towards whatever it is that’s causing the current paroxysm in the preferred share market, having returned +8bp (total return) on the month-to-date and are now yielding about 5.7% (maybe a bit over?). Thus, the pre-tax interest-equivalent spread (also called the Seniority Spread) stands at about 310bp, rocketting upwards from the +285 bp reported March 31 and pushing well over what had been until recently the one-year high in the low 290s.

With help from the clerk of the committee, I can now post a link to The Standing Committee on Government Agencies Report on the OSC.

Preferred shares took a massive whacking today on very high volume. PerpetualDiscounts lost 126bp, while FixedResets were down 43bp – about what one might expect, given the respective Modified Durations. FixedResets again scored a shut-out on the volume highlights table.

That’s the worst day in over a year for PerpetualDiscounts. There were two worse days in 2009, March 5 and March 9. There were 17 worse days in 2008, eight of them in November.

The bright side of this is that I anticipate increased opportunities for heavy relative-values trading. My reports of candidate trades are getting lengthier…

The jobs number on Friday was encouraging:

Payrolls rose by 162,000 workers last month, the third gain in the past five months and the most since March 2007, figures from the Labor Department showed today in Washington.
…
Among the top indicators the group uses is payrolls, according to its Web site. The government revised the January and February job count up by a combined 62,000, putting the March gain at 224,000 after including the updated data.

This knocked Treasuries for loop:

Government securities fell for a second consecutive week ahead of the Treasury’s scheduled offering of $82 billion of notes and bonds next week, including a record-tying $40 billion sale of three-year securities.
…
The 10-year note yield rose 9 basis points, or 0.09 percentage point, to 3.94 percent, according to BGCantor Market Data. The yield touched the highest this week since it reached 4 percent on June 11. Two-year note yields rose 6 basis points to 1.1 percent. Thirty-year bond yields increased to as high as 4.81 percent, also the most since June.

… and over the weak, investors decided that German debt is better than EU promises:

The yield on Germany’s 10-year bund, Europe’s benchmark government security, fell 7 basis points in the week to 3.09 percent as of 5:30 p.m. in London yesterday. It dropped to 3.05 percent on March 23, the lowest this year. The two-year note yield slipped 5 basis points to 0.95 percent.

The Greek 10-year yield advanced 33 basis points to 6.56 percent, and the two-year yield soared 69 basis points to 5.28 percent.

The New York Times has an editorial on taxation of hedge fund fees:

To add insult to injury, some hedge fund managers and, more commonly, private equity fund managers are able to pay a much lower rate of tax than the typical working professional.

The tax disparity results from an outdated rule that lets a money manager in a private partnership treat a chunk of his fees as if they were long-term capital gains, taxed at a special low rate of 15 percent. Fees for managing someone else’s money should be taxed as ordinary income, like wages and salary, at rates as high as 35 percent.

President Obama has included a provision to end that special treatment in his most recent budget. For three years running, the House has passed a bill to close the loophole. In the Senate both Democrats and Republicans have resisted, all for fear of losing lucrative campaign donations.

This has been an issue for quite some time I remember commenting on the issue on the old “Captain’s Quarters” blog (the principal, Ed Morrisey, has now moved to Hot Air) … the idea of fixing the loophole by other commenters as a tax increase. By me, it’a a loophole. Preferential taxation of capital gains – regardless of what it may actually accomplish – should be restricted to those who have skin in the game. A hedge fund manager who achieves a total return of -100% will suffer a loss of capital only to the extent he has invested in the fund: capital gains tax rates should apply only to his earnings on that capital at risk.

Assiduous Reader GAndreone sends in this chart of Exchange Market Share for MFC.PR.C for your edification:

Click for Big

An interesting trend is corporate bonds that step-up on downgrades:

Bonds with built-in protection against rating cuts are making up a record share of debt issues as investors hedge against a slowdown in the economic recovery.

Anheuser-Busch InBev NV, the brewer of Budweiser and Stella Artois, is among companies issuing so-called step-up bonds, whose interest increases if a borrower is downgraded. Sales surged to $37.3 billion in March, or 12.4 percent of all debt issued, according to data compiled by Bloomberg. Most of the notes are sold in the U.S., where almost half of bonds rated as so-called junk or on the cusp of non-investment grade include the protection.
…
Anheuser-Busch InBev, the world’s largest brewer, sold $3.25 billion of bonds with a step-up coupon on March 24, Bloomberg data show. The conditions require the Leuven, Belgium- based company to pay 25 basis points more in interest for every one rating notch it’s cut below investment grade, up to a maximum of 200 basis points, according to Bloomberg data. The brewer is rated Baa2 by Moody’s and one level higher at BBB+ by S&P.

It’s an interesting problem due to the potential for a cascading decline in credit quality. Quick! You’re the Grand Pooh-Bah of Financial Stability! Can you do anything? Should you do anything?

It has taken over a year, but finally the world is noticing the sheer brilliance and uncanny accuracy of PrefBlog’s commentary. Assiduous Readers will remember that I support internal management for large pension funds; not because of cost but because internal management has a captive customer, can concentrate of achieving good returns and doesn’t have to spend time, effort, and client portfolio positioning on the necessity of bringing in the Assets Under Management. As best as I can recall, I last discussed this on March 31, 2009. Janet McFarland has written a feature for the Globe, Canada’s Pension Funds: stronger returns, at a cost:

Despite the higher salary costs in Canada, internal management has been a bigger advantage than it has been a cost, said pension specialist Keith Ambachtsheer, director of the International Centre for Pension Management at the University of Toronto.

Research shows internal teams not only save money by cutting high external money management fees, but also perform better as investors because they are more closely aligned to the mission of the pension fund, he said.

According to data from CEM Benchmarking, internal management improves returns by 0.5 per cent annually over external management, Mr. Ambachtsheer said.

It is disappointing that the article followed fashionability to the extent it did, by focussing almost exclusively on the aspect of fees. It is far more interesting, and far more important for public policy purposes, to consider the aspect of the effects of structure on gross investment return.

The Globe also had an astonishingly patronizing editorial in today’s print edition (it does not appear to be available on-line) titled “The next complexity”:

The challenge for the future, however, is how to formulate rules that will cover the new mind-bending products that will emerge in the next wave of irrational exuberance and excessive financial ingenuity. In other words, legislators and regulators will need to decide what is too complex for unsophisticated investors.

I have some succinct advice for the Globe’s editorial board: shove it. While wearing my hat as a retail investor, I don’t want any pandering politician or smarmy regulator deciding what is and what is not too complex for unsophisticated investors who haven’t been annointed. Show me somebody – anybody – who got seriously hurt by ABCP and I’ll show you a fool. Canadian ABCP was a good product, of very good credit quality. The market was done in by lack of liquidity, not credit; and the only people who were badly hurt by it were the ones who were overexposed. Ain’t nothing gonna protect anybody from the downside of overexposure, whether it’s to ABCP or securities that have been blessed by the really, really savvy investors on the Globe’s editorial board.

I haven’t been able to find a copy of the report itself on-line. This may mean I’m insufficiently sophisticated at finding things, but it wouldn’t surpise me to learn that access to the report has been restricted to those smart enough to agree with the committee’s conclusions.

What the ABCP and Lehman crises showed was simply that the implicit sponsor guarantee on Money Market Funds needs to become explicit. Full stop.

Crash! Bang! Smash ’em up! PerpetualDiscounts got hit severely today, losing 76bp to bring median yield to 6.22%, while FixedResets were almost precisely flat. The performance highlights indicate that it was the major, high quality banks that bore the brunt of the sell off, although there are a few familiar names amongst the losers. Volume continued to be quite heavy and FixedResets scored a shut-out on the volume highlights table.

DBRS has concluded that the Brookfield Asset Management / General Growth Properties deal, as confirmed, continues to be credit-neutral. The original PrefBlog post on this issue has been updated with the link.

Volume continued to be elevated and the Canadian preferred share market continued to get hit, with PerpetualDiscounts down 32bp on the day and FixedResets losing 7bp.

Greek bonds are getting hammered:

Europe’s week-old rescue plan for Greece has so far failed to do what its leaders predicted: reduce borrowing costs for the region’s most indebted country.

The yield on 10-year Greek government bonds has increased 24 basis points to 6.522 percent since EU leaders agreed to the aid blueprint on March 25. That’s the highest in a month and more than double the rate paid by Germany. Seven-year bonds sold by Greece on March 29 fell for a second day today.

“What they were hoping for was to set up some sort of arrangement that never has to be used,” said Phyllis Reed, head of bond research in London at Kleinwort Benson, which manages about $32 billion. “The markets have sniffed that out and it seems like we’re heading back to square one.”

The Brookfield/General Growth affair is winding its way through court:

General Growth Properties Inc.’s proposal to exit bankruptcy with funding from Brookfield Asset Management Inc. has a clause that will give the company until the end of the year to complete a takeover deal with another party, according to two people with knowledge of the plan.
…
The provision would give Chicago-based General Growth time to explore a takeover bid from Simon Property Group Inc., whose $10 billion offer was turned down by its rival last month. Simon is preparing a new bid, according to a person with knowledge of that plan. Brookfield’s plan is subject to the approval of U.S. Bankruptcy Judge Allan Gropper, who gave General Growth an Aug. 26 deadline to control its case.

Citigroup has spent a lot of money upgrading its algorithmic trading software:

Citigroup Inc. is overhauling its platform of trading strategies in an attempt to grow its share of U.S. equities from 14 percent, according to Young Kang, global head of algorithmic products at the firm.
…
A global group of 20 quantitative analysts and more than 50 developers, overseen by Kang, built the algorithms and the technology supporting the new platform, which has been used on Citigroup’s cash equities and program trading desks. The strategies have been tested in recent months by some hedge funds and institutional clients.
…
Citigroup is also making changes to ColorBook, the smart router from Lava Trading, a unit within the broker, to execute orders faster. Smart routers are used by brokers to craft an execution strategy for the smaller orders generated once an algorithm or trading desk has decided how to transact a stock.

ColorBook currently executes orders in 700 microseconds, or 0.0007 second, Swanson said. The firm is trying to reduce that to 200 microseconds.

There is as yet no word on the take-up of the WFS warrants, which expired today out of the money, or regarding the SBN warrants, likewise.

Volume was highly elevated again today as the Canadian preferred share market staggered into quarter end. PerpetualDiscounts were down 35bp while FixedResets lost 38bp to take the yield on the latter index back above 3.50%, to 3.55%. The only winner in the performance highlights is W.PR.H, which is merely a dead-cat bounce from yesterday.

The yield on PerpetualDiscounts is now 6.16%, equivalent to 8.62% interest at the standard equivalency factor of 1.4x. Long Corporates now yield about 5.8%, having achieved a total return of +88bp on the month and +5.02% on the year-to-date, so the pre-tax interest-equivalent spread is now about 285bp, a sharp increase from the 265bp reported March 24 and getting very close to their one-year high in the low 290s.