Category: Market Action

Bank of England Governor Mervyn King had some apocalyptic things to say:

two British banks got within hours of a liquidity shortfall on Oct. 6, 2008, and the day after as the U.K. financial system came to the brink of collapse.

“Two of our major banks which had had difficulty in obtaining funding could raise money only for one week then only for one day, and then on that Monday and Tuesday it was not possible even for those two banks really to be confident they could get to the end of the day,” the BBC cited King as saying in an interview to be broadcast later today.

King was referring to Royal Bank of Scotland Group Plc and HBOS Plc, the BBC said. Prime Minister Gordon Brown’s government pledged to invest about 50 billion ($82 billion) pounds in the banking system on Oct. 8, 2008, to save it from meltdown in the aftermath of Lehman Brothers Holdings Inc.’s bankruptcy declared that September.

This meltdown-through-funding scenario ties in the the IMF conclusions on the resiliency of Canadian banks, but I confess that the entire mechanism of such a failure is somewhat opaque to me.

It was to prevent such crises of funding that Central Banking was invented; the Federal Reserve was created explicitly due to the funding difficulties that were at the centre of the panic of 1907 – so why should funding, in and of itself, be such a critical element?

This brings us back to the Northern Rock episode, where the announcement of liquidity support by the BoE actually made matters worse; I have previously speculated that this reflects public distrust of public institutions. If this is the case, then the fundamental assumptions of Central Banking will have to be revised – the discount window has been the most important tool in their box.

What? Public Institutions, civil servants and policitians at fault? Can’t be! It must be the fault of the Credit Rating Agencies:

Moody’s Investors Service, Standard & Poor’s and Fitch Ratings face scrutiny today by insurance regulators examining the role of the firms in evaluating fixed- income securities.

State insurance regulators are meeting in Maryland to examine the firms’ role in rating bonds held by insurance companies. A second hearing scheduled today, by Edolphus Towns, chairman of the House Oversight and Government Reform Committee, was postponed to Sept. 30. The panel will look at ratings companies amid allegations of continued conflicts of interest from a former Moody’s analyst.
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“The fundamental issue is if the bar is always moving, that makes it very difficult,” Connecticut insurance Commissioner Thomas Sullivan said in a telephone interview. “Magically overnight, what we thought was AAA is no longer AAA. That’s a big problem.”

Assiduous Readers will remember that actual market participants felt that a volatility scale would be a good adjunct to ratings, but this solution was disdained by regulators. Of some interest in the Bloomberg story was:

Moody’s originally declined to participate in the [NAIC] meeting but relented after New York’s regulator suggested scaling back the rating firm’s authorization if it skipped the session.

Congressional Hearing

The congressional hearing was postponed after the panel obtained an internal Moody’s staff memo written by Eric Kolchinsky, a former analyst at the firm, expressing his concern with how the company rated securities, said committee chairman Edolphus Towns. The panel didn’t have enough time to incorporate the information into the hearing, he said.

A Moody’s representative was invited to the session but didn’t come, Towns said.

“They basically didn’t show up, they ignored us” Towns said in an interview, referring to Moody’s. “I guess they didn’t realize we have subpoena power.”

See? Congressional sessions have subpoena power, but regulators have something even better: extortion.

The Fed has released the Shared National Credits Report:

Credit quality declined sharply for loan commitments of $20 million or more held by multiple federally supervised institutions, according to the 32nd annual review of Shared National Credits (SNC).
The credit risk of these large loan commitments was shared among U.S. bank organizations, foreign bank organizations (FBO), and nonbanks such as securitization pools, hedge funds, insurance companies, and pension funds. Credit quality deteriorated across all entities, but nonbanks held 47 percent of classified assets in the SNC portfolio, despite making up only 21.2 percent of the SNC portfolio. U.S. bank organizations held 30.2 percent of the classified assets and made up 40.8 percent of the SNC portfolio.

The 2009 review covered 8,955 credits totaling $2.9 trillion extended to approximately 5,900 borrowers. Loans were reviewed and categorized by the severity of their risk–special mention, substandard, doubtful, or loss–in order of increasing severity. The lowest risk loans, special mention, had potential weaknesses that deserve management attention to prevent further deterioration at the time of review. The most severe category of loans, loss, includes loans that were considered uncollectible.

Treasury’s wish-list of bank capitalization rules included many references to Tier 1 Financial Holding Companies, a concept I criticized – special status will only cause problems, I said. It would seem that Paul Volcker agrees:

Former Federal Reserve Chairman Paul Volcker criticized the Obama administration’s plan to subject “systemically important” financial firms to more stringent regulation by the Fed.

Volcker told lawmakers today that such a designation would imply government readiness to support the firms in a crisis, encouraging even more risky behavior in a phenomenon known as “moral hazard.”
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“The danger is the spread of moral hazard could make the next crisis much bigger,” said Volcker, who serves as an outside economic adviser to Obama. Volcker has criticized key elements of the Obama administration regulatory plan in recent public statements, and his remarks today largely reprised those criticisms.

I am particularly impressed by his reference to the next crisis … it is rare to fin a figure with any political clout not subscribing to the view that the New Millennium will arrive as soon as we get those pesky Credit Rating Agencies under control.

Good volume, soft returns in the preferred market today, with PerpetualDiscounts down 11bp on the day while FixedResets lost 8bp. This may be related to all the new issuance … there are, presumably, people still selling to make room for the monster TRP FixedReset settling September 30 and there was a (long awaited) new straight issue announced by GWO.

Today was Equity Through Education Day, a day on which institutional investors are encouraged to trade through BMO Capital Markets with commissions donated to charity. So far CAD 6.6-million in commissions has been skimmed off the hapless beneficiaries of participating institutional accounts, enabling institutional PMs to feel good about themselves.

Sadly, the website – again! – does not explain how discretionary participation (the kind they are attempting to encourage with their ads) can be squared with a PM’s duty to his client, or regulatory requirement to seek best execution. I’ve never understood that.

Realpoint, a CMBS credit rating agency last discussed on September 9, has been approved by NAIC:

The ruling by the National Association of Insurance Commissioners means state regulators can rely on Realpoint in determining how much capital must be held by insurers, Scott Holeman, spokesman for the group, said today. Realpoint provides analysis to bond buyers through subscription, while S&P and Moody’s are paid by companies that issue securities.

Realpoint started the process as reported June 15, when fears of a mass downgrade of CMBS by S&P led insurance companies to seek their ‘license to invest’ from more optomistic firms.

And there’s even more news on the credit rating front! First, William Galvin, Secretary of the Commonwealth of Massachussets is checking the quality of some ratings:

Massachusetts is reviewing DBRS Ltd.’s grades on investments tied to life insurance policies because they might be inflated like the discredited mortgage bonds at the center of the recession.
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“Bundling the policies to create another investment opportunity closely parallels the subprime mortgage market and subsequent meltdown, whose effects investors are still reeling from,” said Galvin, the state’s chief financial regulator, in the statement.

Regulators have said ratings companies were too generous in assigning top credit grades to securities comprised of bundled subprime mortgages before the financial crisis showed many of them were more prone to default than the ratings suggested.

Well, with respect to the last paragraph, hold on a minute! That’s certainly been implied, but I’m not sure whether the regulators have actually gone so far as to state definitely that the ratings were too high. Galvin’s quote, besides conflating two unrelated securities, is also ungrammatical. Was he drunk?

However, help is at hand: Government-Developed Credit Ratings:

“We at the National Association of Insurance Commissioners are studying the viability of creating our own rating agency, a not-for-profit one,” Connecticut Insurance Commissioner Thomas Sullivan said in a telephone interview today.
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“The fundamental issue is if the bar is always moving, that makes it very difficult,” Sullivan said. “Magically overnight, what we thought was AAA is no longer AAA. That’s a big problem.”
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Insurers, which are suffering from downgrades of their holdings, have urged regulators to seek alternatives. Rating cuts to structured securities in insurance portfolios have triggered increased capital requirements.

The American Council of Life Insurers has asked the NAIC to ease its standards after RMBS rating cuts pushed up carriers’ capital needs fivefold to $11 billion in the six months ended June 30. The ACLI is proposing regulators use “third party” predictions of credit losses on RMBS in place of their reliance on ratings firms.

The NAIC currently conducts some credit analysis on insurers’ investments through the group’s Securities Valuation Office in New York. The deliberations for a new ratings business at the NAIC are still preliminary.

“We’re in the formative stages,” Sullivan said. “Anything’s possible. Financing, legal hurdles, structure; all those things need to be dealt with and we’re examining all of them.”

I can’t wait.

Volume was very good today (possibly quarter end window-dressing / rebalancing, possibly triggered by the YPG.PR.C closing, maybe even clearing the decks for the massive forthcoming TRP settlement), with FixedResets seeing a good spike in volume with lots of blocks. That didn’t do prices much good, though, with PerpetualDiscounts down 11bp on the day and FixedResets losing 2bp.

PerpetualDiscounts closed with a weighted mean average YTW of 5.77%, equivalent to 8.08% at the standard equivalency factor of 1.4x. Long Corporates have backed up to just over 6.0%, so the pre-tax interest-equivalent spread is now about 205bp, a very slight – and possibly completely technical – tightening from the September 16 value and well within its September and Credit Crunch range.

YPG.PR.C, the 6.75%+417 FixedReset announced September 8 and promptly upsized to 7.5-million shares + greenshoe 1.125-million shares (I don’t know whether or not the greenshoe was exercised) has settled with results that many will find disappointing.

The issue traded 245,490 shares in a range of 24.50-75, before closing at 24.47-55, 6×83.

Vital statistics are:

The issue is tracked by HIMIPref™, but is relegated to the Scraps index on credit concerns.

To nobody’s surprise, the banks are starting to harness the hysteria over bonuses to alter the balance of power with their traders:

Canada’s biggest bank, Royal Bank of Canada, is changing the way its investment bankers and traders are paid, according to a memo it sent to employees Tuesday.
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The bank’s aim is not to decrease the amount its employees are paid, but rather to ensure that their pay packages are structured in a way that does not encourage them to take excessive risks.

That last paragraph should have been published as “The Morning Smile”.

For instance, a greater proportion of Royal Bank employees’ compensation will now be deferred, and managing directors will be required to own a certain amount of shares in the bank.

So RBC gets to slap the golden handcuffs on their traders for free, and managing directors will have their pay dependent on whether or not some bozo in the president’s office has lent $20-billion to Argentina. Cross your fingers, boys!

When it comes to calculating bonuses, the bank intends to pay more attention to how employees reached their results, not just what their results were. The bank is paying more attention to non-financial measures in part so it can take into account the amount of risk employees take on to achieve their financial goals.

Non-financial measures like ‘Did you suck enough management arse?’

ln addition, RBC told employees it is in the process of finalizing a claw back policy, for cases where misconduct or a failure to abide by proper procedures results in a loss or the need to restate financial results.

Opening up the gates for more abuse of the regulatory process. David Berry can tell you all about that one.

The paper also mentions changes at Scotia, but I haven’t heard much about that. The last major round of compensation rejigging I know of was at CIBC, where changes resulted in a flood of resumes hitting the streets and the institutional sales desks hastily restaffed by high school students.

All this, by the way, is just after the relevation (to me) that RBC routinely spies on its employees:

She accused another of using the made-up word “sensy” rather than “sexy” so that RBC’s monitoring system would not pick up his language.

What a charming example of the Thought Police kicking out any manager with a rational world view.

But where are the RBC guys going to go? Thanks to the Canadian oligarchy, there are very few opportunities to work as a prop trader – with good capital availability and good order flow – at a non-bank trading firm. I continue to believe that the Achilles heel of the Canadian banking sector is the potential for contagion between vanilla banking, wealth management and trading … and we’ll just have to hope it never takes effect, because OSFI won’t do anythng useful about it.

The CME is introducing a new US long bond futures contract, which will have a lower negative convexity that the current contract:

The “ultra” Treasury bond future will begin trading in the first quarter of next year, Chicago-based CME said today in a statement. The contract, designating Treasuries with maturities of 25 years or more for delivery, won’t replace the current 30-year bond future, which allows government bonds that mature in 15 years or more.
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“With the increased issuance because of the deficit over the last year and a half we now have an ample deliverable basket” of long-term bonds to underpin the futures contract, [CME managing director of interest-rate products Robin] Ross said. Two to three years ago there wasn’t enough supply of U.S. bonds maturing in 25 years or more to make the futures contract deliverable, she said.

The big excitement today was the new TRP 4.60+192 FixedReset; PerpetualDiscounts gained 3bp total return on the day while FixedResets were down about 22bp. Floaters continued yesterday‘s pop. There were no huge volume outliers, but volume was quite good across the board.

Jim Hamilton of Econbrowser points out that increased regulation of bankers’ pay mean increased risk of regulatory capture. While supporting the principle, he recommends:

Openness and transparency. Details of all regulations should always be extremely transparent and public, with high-profile communication of any proposed changes. I was unable to locate a public release of the specifics of the Fed’s proposal, but gather that the WSJ story was based on off-the-record statements from “people familiar with the matter”. I think one of the best disinfectants for preventing regulatory capture is to keep as bright a light as possible shining on all details of the regulatory process.

Simplicity and uniformity. The goal here is to be very clear about the basic principles we’re trying to implement and make sure they’re applied broadly, fairly, and consistently. Although the Fed is used to thinking in terms of preserving its discretion, it’s important that these regulations be implemented in a transparently uniform way.

The first, at least, of these principles is anathema to Canada’s OSFI.

Scott Sumner of Bentley University writes a provocative column on VoxEU, Misdiagnosing the crisis: The real problem was not real, it was nominal arguing that monetary policy was too tight in late 2008, and that this is what caused the awful events of 4Q08:

Woodford (2003) emphasised how expectations of future monetary policy and aggregate demand impact current demand. An explicit price level or nominal GDP trajectory going several years forward would have helped stabilise expectations in late 2008. Because the Fed failed to set an explicit target path (level targeting), expectations became very bearish in late 2008. Contrary to what many economists assumed, tight money was already sharply depressing the economy by August 2008. After the failure of Lehman most economists simply assumed that causation ran from financial crisis to falling demand. This reversed the primary direction of causation – as in the Great Depression, economic weakness worsened bank balance sheets and intensified the financial crisis in late 2008.

A recent Vox column by Carmassi, Gros, and Micossi expressed the widely held view that the roots of this crisis lay in overly accommodative Fed policy during the housing bubble. Policy was a bit too easy during that period, as nominal GDP growth was slightly excessive, but if we are going to take market efficiency seriously then the primary cause of the severe worldwide recession should have occurred when the markets actually crashed. Yes, the tech and housing bubbles showed that markets are not always efficient. But that is no reason to ignore market signals.

The preferred share market advanced today, with PerpetualDiscounts gaining 15bp while FixedResets were up 6bp. Floaters gained strongly, claiming the top three spots on the performance table to take that very volatile, small, BAM dominated index up 159bp, perhaps helped by Jonathan Chevreau’s endorsement of the asset class (hat tip: Assiduous Reader MP):

Floating Rate Preferred Shares pay a dividend based on the prime rate and provide tax-efficient income for non-registered portfolios. Compared to pure interest income, such preferred shares are taxed far less harshly because of the dividend tax credit. If the Bank of Canada boosts the prime rate and banks increase their prime rate in response, the dividend income on these shares will rise, as will its capital value. Palombi’s current favorite is the BCE Preferred Series, which pay 100% of the prime rate.

Volume was good.

European leaders continued to prefer talking about greedy bankers’ bonuses rather than their own regulatory, monetary and fiscal culpability for the Credit Crunch:

European Union leaders said the Group of 20 nations should agree on binding rules backed by national sanctions to curb bank bonuses, a week before a summit of the top industrial and emerging nations in Pittsburgh.

The EU agreement on the need for action failed to include details of how such curbs would be achieved, leaving any details to be negotiated at the G-20 summit. Leaders of the 27 EU states said voters would react with anger if bankers were allowed to award themselves large bonuses while relying on public money for their survival.

We’ve seen a fair number of CEOs trashing their employees in recent times. Today, Vikram Pandit joined their ranks:

Citigroup Inc. Chief Executive Officer Vikram Pandit said the bank will restructure its Phibro LLC energy-trading business as the bank faces what may be a $100 million payday for the unit’s chief, Andrew Hall.

“That business will be restructured and rationalized,” Pandit said yesterday at the 92nd Street Y in New York. When asked if $100 million was too much to pay, he replied, “Yes.”

Way to stand up for your employees, Mr. Pandit! Boy, don’t you sound like a wonderful person to work for.

The bankers’ bonus rules discussion is getting steadily more boring:

Global leaders meeting at the Group of 20 summit in Pittsburgh next week are moving toward a compromise on compensation rules that fall short of the political rhetoric branding banker pay a worldwide disgrace.

Pay caps, once pushed by French President Nicolas Sarkozy, were excluded from recommendations made by finance officials this month. European leaders may be willing to endorse linking bonuses to a bank’s capital level, moving closer to a U.S. position that avoids specific limits.

More interestingly, there’s some movement in the Money Market Fund world:

Fidelity Investments and Vanguard Group Inc. are among U.S. asset managers working on a proposal that would provide money-market mutual funds with an emergency pool of cash in the event of a run on deposits, according to two people who have been briefed on the plan.

Funds participating in the program would pay a fee to a bank, called the Liquidity Exchange Bank, to build a cash reserve that would help them handle investor withdrawals during a liquidity crisis like the one last September, the people said. The bank could also apply for emergency support from the Federal Reserve discount window.
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The program won’t seek to insure money funds against losses from defaulted securities, as does the Treasury Department’s emergency program that expires today, one year after its inception. The Treasury’s Temporary Guarantee Program for Money Market Funds explicitly insured deposits in participating funds as of Sept. 19, 2008, and succeeded in halting last year’s investor flight.

The industry plan would have more in common with the Fed’s Money Market Fund Liquidity Facility, which lends money to banks that buy asset-backed commercial paper from money funds. That program, also begun last September, provided cash to help funds meet withdrawal demands. It will expire Feb. 1.

Encouraging, but not consequential. If they want to get bank lines, they can get them now; this is merely a method whereby they get to keep the fees for the line in-house. The implicit guarantee of the stable value is much more important.

The preferred share market regained some ground today, with PerpetualDiscounts up 19bp and FixedResets plugging away with a gain of 4bp. Volume was very healthy, with five of the six names in the volume highlights table being insurers.

Paul Volcker is advocating hard caps and prescriptive regulation for banks:

In his speech, Volcker urged limits on the activities of banks that are considered “too big to fail,” going beyond what other officials in the Obama administration have advocated.

“I do not think it reasonable that public money –taxpayer money — be indirectly available to support risk-prone capital market activities simply because they are housed within a commercial banking organization,” Volcker said.

Since January, Volcker has advocated that regulators should prohibit financial companies whose collapse would pose a risk to the economy — those considered “too big to fail” — from engaging in certain types of trading and investing activities. The administration wants stricter oversight for such companies and tighter capital and liquidity requirements.

“Extensive participation in the impersonal, transaction- oriented capital market does not seem to me an intrinsic part of commercial banking,” Volcker said. “Substantial involvement in heavily leveraged finance and heavy proprietary trading almost inevitably entails risks.”

“I want to question any presumption that the federal safety net, and financial support, will be extended beyond the traditional commercial banking community,” he said.

Manulife is rejigging its seg fund guarantees:

• InvestmentPlus: With a choice of over 75 funds, this Series provides investors with the greatest range of investment choice available with management expense ratios competitively priced with most mutual funds. It offers investors basic protection and investment flexibility without the need of enhanced guarantees.
• IncomePlus (version 2): A new version of Manulife’s very popular IncomePlus has been designed to continue to meet the needs of investors in their pre- or early retirement years by offering guaranteed income for life, growth potential of the market and income protection from market downturns.

  IncomePlus (version 2) will continue to offer resets, annual income bonuses and a 100 per cent death benefit guarantee. In addition to these features, a new Joint Life Payout Option will also be available. In the event one spouse dies, this option can allow the surviving spouse to continue to receive income at the same level, uninterrupted for the balance of his/her life.

• EstatePlus: Is a new estate-planning-focused series offering a 100 per cent Death Benefit Guarantee with resets. This Series will help investors who do not require income protection to protect their legacy for their beneficiaries.

Meanwhile, Sun Life pledged not to cut their common dividend.

The Financial Stability Board is attempting to implement a reform agenda:

Improving compensation practices. The FSB will set out for the Pittsburgh Summit specific implementation guidelines on the governance, structure and disclosure of compensation, which will limit the level of compensation in the light of the need to conserve capital and ensure that the structure and incentives are aligned with good risk management, in line with the FSB Principles for Sound Compensation Practices in financial institutions issued in April.

Meanwhile, the Institute for International Finance published a letter to the G-20, stressing that this is not a time for business as usual. Rick Waugh, CEO of the Bank of Nova Scotia, is quoted by the Globe and Mail as explaining that “business as usual” means “competition”:

“Right now, there seems to be some rogue behaviour among certain institutions that have been offering, say, three-year guarantees to induce people to leave their firm to go to another one,” said Rick Waugh, chief executive officer of Bank of Nova Scotia and co-head of the IIF committee that came up with a list of recommendations for the sector. As a result, the IIF has written to its member banks to remind them of its principles on compensation, and it has spoken to politicians, he said.

Rick Waugh’s firm is known for its innovative approach towards revising compensation contracts.

Looks like the SEC will attempt to ban flash orders:

SEC commissioners unanimously voted today to seek public comment on a rule barring exchanges and trading platforms from giving clients access to information about stock orders a fraction of a second before the market.

“Investors that have access only to information displayed as public quotes may be harmed if market participants are able to flash orders and avoid the need to make the orders publicly available,” Chairman Mary Schapiro said.

Democratic Senators Charles Schumer and Ted Kaufman urged the commission to halt the practice, arguing frequent traders use technology to profit from access to information not available to retail investors. Direct Edge Holdings LLC has relied on flash orders to take market share from NYSE Euronext.

Unusual political news:

Industry executives have complained that the government’s plans to harmonize the provincial sales tax with the federal goods and services tax will siphon money out of the retirement nest eggs of Canadians. But after an article published in The Globe and Mail this week, officials in Finance Minister Dwight Duncan’s office said they are prepared to release a document on the negative impact of management fees for investors if executives continue to complain in public, industry sources said.

There better be a really good explanation of this – it sounds like political dissent will now be met by attacks on industry … to cheers from the avid crowd. Funny, I had a conversation just this week about the gradual, yet noticable, erosion of civil liberties.

Not a lot happened in the preferred market today, with the two main sectors up by marginal amounts, but volume was quite strong. There’s no colour on the volume table again, because the Financial Post is still reporting yesterday’s news as of 6:45pm.

Not much price action today, as PerpetualDiscounts resumed their downward drift, losing 8bp, while FixedResets gained about 2bp. Volume was strong.

PerpetualDiscounts now yield 5.78%, equivalent to 8.09% interest at the standard equivalency factor of 1.4x. Long Corporates yield a hair under 6.0%, so the pre-tax interest equivalent spread is about 210bp, a slight (and possibly simply tecnical) widening from the 205bp reported September 9 and at the upper end of the range it has reported through September – and in the pre-Lehman Credit Crunch.

Remember the world’s worst bond fund? I discussed it on February 15, 2008. Now the sponsor has received a comeuppance:

Former Chicago Bull Horace Grant won a $1.46 million arbitration award against Morgan Keegan & Co. for losses in some bond mutual funds, the largest victory against the brokerage firm to date for his Chicago-based lawyer.

The award, announced Friday, represents nearly all of the unrealized losses Grant allegedly suffered as of January 2008, said his attorney, Andrew Stoltmann.
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The brokerage firm, a unit of Regions Financial Corp., a bank based in Birmingham, Ala., faces a flood of arbitration claims from investors related to its high-yield bond funds. Investors in the funds reportedly lost more than $2 billion in 2007.

PerpetualDiscounts halted their recent slide today, gaining 3bp, but were outperformed by FixedResets which were up 15bp. Volume was quite good but there wasn’t much price volatility.

The Financial Post has updated its calendar and is again providing a timely block trade report.

The preferred share market continued to ease off in an orderly fashion today, with PerpetualDiscounts down 17bp and FixedResets losing 9bp. All the volume action was in FixedResets but unfortunately I cannot provide any details of the blocks since the Financial Post is reporting last Thursday’s news (as of 8:24pm, anyway).

The DC FixedReset 6.75%+410 new issue closes tomorrow – it will be most interesting to see what happens to the price.