Category: Market Action

Sorry folks! Not much by way of commentary today!

PerpetualDiscounts were off again to yield 7.46%, equivalent to 10.44% interest at the standard equivalency factor of 1.4x. Long Corporates continue to hold at 7.50%, so the pre-tax interest-equivalent spread is now 294bp … who knows? It won’t take much before we’re breaching 300bp again.

Bernanke gave testimony today, making the important point:

With such large near-term deficits, it may seem too early to be contemplating the necessary return to fiscal sustainability. To the contrary, maintaining the confidence of the financial markets requires that we begin planning now for the restoration of fiscal balance. As the economy recovers and resources become more fully employed, we will need to withdraw the temporary components of the fiscal stimulus. Spending on financial stabilization also must wind down; if all goes well, the disposition of assets acquired by the Treasury in the process of stabilization will be a source of added revenue for the Treasury in the out years.

I want to see stimulus spending, yes. But I also want to see a plan – with immediate tax increases – that will provide some credence to the view that it will be paid for eventually. Aint seen such yet.

Separately, the Fed announced that TALF has been launched:

Under today’s announcement, the Federal Reserve Bank of New York will lend up to $200 billion to eligible owners of certain AAA-rated ABS backed by newly and recently originated auto loans, credit card loans, student loans, and SBA-guaranteed small business loans. Issuers and investors in the private sector are expected to begin arranging and marketing new securitizations of recently generated loans, and subscriptions for funding in March will be accepted on March 17, 2009. On March 25, 2009, those new securitizations will be funded by the program, creating new lending capacity for additional future loans.

The program will hold monthly fundings through December 2009 or longer if the Federal Reserve Board chooses to extend the facility.

Bernanke & Geithner minced no words when asked about the AIG bail-out:

“If there is a single episode in this entire 18 months that has made me more angry, I can’t think of one other than AIG,” Bernanke told lawmakers today. “AIG exploited a huge gap in the regulatory system, there was no oversight of the financial- products division, this was a hedge fund basically that was attached to a large and stable insurance company.”

Bernanke’s comments foreshadow tougher oversight of systemically important financial firms, and come as President Barack Obama seeks legislative proposals within weeks for a regulatory overhaul.
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The company “made huge numbers of irresponsible bets, took huge losses, there was no regulatory oversight because there was a gap in the system,” Bernanke said. At the same time, officials “had no choice but to try and stabilize the system” by aiding the firm.
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“AIG is a huge, complex, global insurance company attached to a very complicated investment bank, hedge fund that was allowed to build up without any adult supervision,” U.S. Treasury Secretary Timothy Geithner said today during testimony to the House Ways and Means Committee.

One fascinating sub-theme of the banking crisis has been the attempts by the Fed to insinuate itself into securities regulation, with proposals that it should be supervising large brokerages, the conversion of some of these large brokerages into banks, and the CDS clearinghouse coming readily to mind. Could this testimony be indicative of a desire to have a hand in the insurance supervision pie?

I will need a lot of convincing before I accept that idea. Whether central banking and bank regulation mix is a question debated world-wide; my instinctive reaction is that it gives one set of bureaucrats too much power. And if we’re going to talk about systemic risk, let us not forget that it was the Fed in charge of supervising Citibank.

Sweetness & Light unveiled his market recommendations today, in direct competition with What-Debt?. His market timing track record was not disclosed.

PerpetualDiscounts had another unhappy day.

Whoosh! In like a lion, all right!

Suncor Energy Inc. dropped 10 percent after its shares were downgraded at Raymond James & Associates Inc. on expectations of lower oil and gas prices. Potash Corp. of Saskatchewan Inc. fell 9.8 percent on speculation that the recession will cut demand for grains and fertilizers. Manulife Financial Corp. slumped to the lowest in almost nine years on renewed speculation that it will sell stock to cover investment losses and pay for an acquisition.

The Standard & Poor’s/TSX Composite Index fell 5.4 percent to 7,687.51 in Toronto, the steepest loss since Dec. 1. Only 20 of Canada’s main stock benchmark’s 215 members rose. The S&P/TSX is down 14 percent this year, adding to a 2008’s 35 percent drop.

How bad is liquidity? I understand TD Waterhouse refused to bid on about $20,000-worth (present value) of 20-year Ontario Hydro coupons for a retail account. Now, that’s bad.

Prefs were not unscathed, but managed to stagger to a not-as-horrible-as-November finish amidst very light volume. Given all the recent hand-wringing about MFC, it will be interesting to see how their new and wildly popular Fixed-Reset opens on Wednesday.

PerpetualDiscounts closed the month on a sour note, losing nearly 80bp to close yielding 7.29%, equivalent to 10.21% interest at the standard equivalency factor of 1.4x. Long Corporates now yield about 7.5%, so the pre-tax interest-equivalent spread now stands at 271bp – another updraft!

Whoosh! The seminar was a lot of fun but it took a lot out of me!

There’s an amusing story in the Financial Times:

A whistleblower contacted US regulators more than five years ago with allegations that Sir Allen Stanford’s businesses were involved in an “illegal Ponzi scheme”, the Financial Times has learnt, raising new questions about why authorities waited until last week to shut down the alleged $8bn fraud.

Leyla Basagoitia, a former Stanford employee, raised a series of red flags about the tycoon’s empire in a 2003 employment dispute with her company at a tribunal run by the finance industry’s self-regulatory body. Ms Basagoitia also alerted the US Securities and Exchange Commission at about the same time, her lawyer said, echoing criticisms the agency ignored early warnings about the alleged $50bn Ponzi scheme run by Bernard Madoff.

I think we’re going to see stories like this regarding every fraud for the next five-odd years. It’s hard to know how seriously take them … it’s like the “US was warned of Pearl Harbour” stories one sees … yes, I’m sure the US was warned about Pearl Harbour. I’m equally certain they were warned about Japanese alliances with Mexico (a la Zimmerman) and little green men in Idaho. What was the backup?

Sad but true … Bernanke did not resist a suggestion that the uptick rule be reinstated. We can only hope that cooler heads will prevail:

“In the kind of environment we have seen more recently” the so-called uptick rule “might have had some benefit,” Bernanke said in testimony before the House Financial Services Committee today. The rule, scrapped by the U.S. Securities and Exchange Commission in 2007, barred investors from betting against a stock until it sells at a higher price than the preceding trade.
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The SEC approved the rule in 1938 to prevent bear raids on companies. The agency eliminated the regulation after studying its effect on share prices and determining it was no longer relevant in markets dominated by fast-paced electronic trading.

Executives at UBS AG, Deutsche Bank AG and Knight Capital Group Inc. said in December that bringing back the rule wouldn’t reduce volatility in stock prices.

If a portfolio manager sees a price go down for a reason he doesn’t understand, there are three possibilities:

• Insider information
• The market’s being stupid and should be ignored or, better yet, exploited
• He isn’t doing his job

Crack down on insider information, tipping and rumour-mongering by all means. That’s a valid regulatory function. But let’s also see a crackdown on underperforming PMs – any advisor with discretionary authority should definitely see their results published by the regulators; same goes for advisory relationships, although I am more willing to listen to arguments about that one – and the cult of the salesman that regards investment management as being nothing more than an unfortunate cost.

PerpetualDiscounts were off marginally today to yield 7.23%, equivalent to 10.12% interest at the standard conversion factor of 1.4x. Long Corporates appear to have found a level at 7.5% (maybe just a hair under), so the pre-tax interest-equivalent spread has widened again, to … call it 265bp.

SplitShares had a good day, helped along, I think, by bidders failing to notice (or care) that there were a lot of ex-Days today.

Assiduous Readers will be aware that I am wary of regulatory initiatives that seek to protect investors from themselves. Well … if the following catches on and spreads, it may become illegal to buy equities in your RRSP:

[Vanguard Founder and Zombie Master] Bogle recommended a single defined contribution plan with annuities from low-cost providers. The single system would be overseen by an independent Federal Retirement Board to protect the interests of plan participants, Bogle said.
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Retirement savings are too exposed to market risk, according to Dean Baker, co-director of the Center for Economic and Policy Research in Washington and another witness at today’s hearing. Baker proposed a government-managed system that would provide a modest rate of return for employees. He said it would build on Social Security and allow workers a voluntary default contribution of at least 3 percent of their salaries.

Employees must work longer to extend retirement savings and Social Security, which “has shined during this crisis,” could be stabilized and supplemented by target-date funds, said Munnell. Target-date funds shift money into more conservative investments as an investor approaches retirement.

Dealbreaker reports an amusing anecdote regarding regulatory capture. It’s sad, but we never see any statistics regarding job migration between regulatory and industry roles. Golly, I wonder why that is!

There is a bit more news on the Lyondell bankruptcy:

Lyondell asked U.S. Bankruptcy Judge Robert Gerber to approve the loan at a hearing tomorrow. The financing terms, which may return as much as 20 percent in fees to some lenders, are the best and only terms available, Lyondell said. It also said a proposed “roll-up,” which would allow pre-bankruptcy lenders to convert old debt to new debt with a priority for repayment, is “permissible.”
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The so-called debtor-in-possession loan, designed to fund operations while Lyondell reorganizes, wasn’t made in “good faith,” the company’s committee of unsecured creditors said in court papers. They alleged the loan’s December maturity date is too early, and other financial covenants are “tripwires” for defaults that would hand control of the company to the lenders.

The Lyondell situation is interesting because of the allegations that CDS-protected creditors are not acting in good faith.

Another poor day for PerpetualDiscounts, with Royal issues again getting hit hard. SplitShares enjoyed a dead-cat bounce; and after the bell, MFC announced a new Fixed-Reset, 6.60%+456.

The Fed has announced:

a new section of its website expanding the information provided about the policy tools the Federal Reserve has employed to address the financial crisis and simplifying access to that information.

The website section–“Credit and Liquidity Programs and the Balance Sheet”–presents a wide range of material, including a detailed explanation of the Federal Reserve’s balance sheet; descriptions of all of the Federal Reserve’s liquidity and credit facilities; discussion of the Federal Reserve’s risk-management practices; information on the types and amounts of collateral being pledged at the various lending facilities; and an extensive set of links to congressional reports and other resources.
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The new section of the Board’s website can be accessed at: http://www.federalreserve.gov/monetarypolicy/bst.htm.

There has also been a Treasury, FDIC, OCC, OTS & the Fed regarding yet another iteration of TARP:

“We announced on February 10, 2009, a Capital Assistance Program to ensure that our banking institutions are appropriately capitalized, with high-quality capital. Under this program, which will be initiated on February 25, the capital needs of the major U.S. banking institutions will be evaluated under a more challenging economic environment. Should that assessment indicate that an additional capital buffer is warranted, institutions will have an opportunity to turn first to private sources of capital. Otherwise, the temporary capital buffer will be made available from the government. This additional capital does not imply a new capital standard and it is not expected to be maintained on an ongoing basis. Instead, it is available to provide a cushion against larger than expected future losses, should they occur due to a more severe economic environment, and to support lending to creditworthy borrowers. Any government capital will be in the form of mandatory convertible preferred shares, which would be converted into common equity shares only as needed over time to keep banks in a well-capitalized position and can be retired under improved financial conditions before the conversion becomes mandatory. Previous capital injections under the Troubled Asset Relief Program will also be eligible to be exchanged for the mandatory convertible preferred shares. The conversion feature will enable institutions to maintain or enhance the quality of their capital.

Rather than the either/or choice envisaged in the release, I would rather see a system whereby Treasury backstopped a public offering of the securites. There’s a lot of private capital that would love to get involved if it could invest on the same terms as the government.

Yet another proposal for resolution of the credit crisis has come forward … but I don’t think it will find a lot of political support!

Creating a “bad bank” or “aggregator bank” that would use federal funds to acquire and warehouse the assets, as some have proposed, would be costly for taxpayers and require too much government interference, say two experts on distressed securities who have pitched an alternative plan to officials.

John Ryding, chief economist at RDQ Economics LLC in New York, and Matt Chasin, chief operating officer of Sorin Capital Management LLC, a Stamford, Connecticut-based hedge fund that manages about $1 billion, say the Treasury Department should provide loans at commercial rates to investors for up to 50 percent of the purchase price of securities. The financing would be for as long as the maturities of the assets being acquired.

“One of the problems the banks have been facing is that the markets have forced artificially low prices on these assets because there’s not enough financing available for buyers,” said Ryding, 51, a former Federal Reserve economist who advises hedge funds. “There’s a lot of capital looking for distressed assets, if hedge funds can get good financing.”

Along similar lines, the Bank of Canada is adding corporate bonds to the acceptable collateral list for Term PRAs. The lowest rated, longest term bonds accepted, A- & 10+ years, will be subject to a 15% haircut.

Whoosh! Prefs got hammered today – particularly PerpetualDiscounts and SplitShares – as common equity got hammered:

Canadian stocks fell, driving the Standard & Poor’s/TSX Composite Index to the lowest level since 2003, as worse-than-estimated retail sales signaled the recession is deepening while oil and metal prices retreated.
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Canadian retail sales fell 5.4 percent in December, the most since January 1991 and twice the average economist estimate, as consumers curtailed spending on cars, building supplies and clothes, Statistics Canada said today in Ottawa. Bank of Canada Senior Deputy Governor Paul Jenkins said 2009 will be a difficult year for the Canadian economy, reiterating the central bank’s forecast that the economy will shrink 1.2 percent.

Bernanke gave a speech to the National Press Club dismissing concerns about the Fed’s credit risk:

for the great bulk of Fed lending, the credit risks are extremely low. The provision of short-term credit to financial institutions–our traditional function–exposes the Federal Reserve to minimal credit risk, as the loans we make to financial institutions are generally short-term, overcollateralized, and made with recourse to the borrowing firm. In the case of the liquidity swaps, the foreign central banks are responsible for repaying the Federal Reserve, not the financial institutions that ultimately receive the funds, and the Fed receives an equivalent amount of foreign currency in exchange for the dollars it provides foreign central banks. The Treasury stands behind the debt and other securities issued by the GSEs.

Our special lending programs have also been set up to minimize our credit risk. The largest program, the commercial paper funding facility, accepts only the most highly rated paper. It also charges borrowers a premium, which is set aside against possible losses. And the TALF, the facility that will lend against securities backed by consumer and small business loans, is a joint Federal Reserve-Treasury program, as I mentioned, and capital provided by the Treasury will help insulate the Federal Reserve from credit losses.

The transactions we undertook to prevent the systemically destabilizing failures of Bear Stearns and AIG, which, as I noted, make up about 5 percent of our balance sheet, carry more risk than our traditional activities. But we intend, over time, to sell the assets acquired in those transactions in a way that maximizes the return to taxpayers, and we expect to recover the credit we have extended.

Not much meat on those bones, but at least he’s putting his name on the claims!

Biovail’s lawsuit against short sellers has been dismissed:

A federal judge threw out a Biovail Corp. shareholder lawsuit against a group of hedge funds including SAC Capital Advisors LP in which investors in the Canadian drugmaker accused them of driving down its share price.
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The Biovail shareholders had accused SAC of helping “ghostwrite” negative and false analyst reports in 2003 and 2004 to lower the share price after the Stamford, Connecticut- based hedge fund manager took short positions in the stock. Short sellers borrow shares in anticipation of making a profit by paying for them after the price drops.
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In March 2008 the company agreed to pay $10 million to settle Securities and Exchange Commission charges that it lied to investors to boost its share price in 2003 and 2004. In January the drugmaker agreed to pay $5.4 million to settle the same charges with the Ontario Securities Commission.

Biovail also pleaded guilty to criminal charges of paying doctors in 2002 and 2003 to buy Cardizem. It was fined $24.6 million.

Strong companies respond to criticism with a sigh and a press release. Adults too, for that matter.

Easy come, easy go:

As recently as October 2007, Barron’s magazine ranked Highland CDO Opportunity third among the top 50 hedge funds, with an average annual return of 44.12 percent during the three-year period ended that June. Its fortunes reversed last year, as the securities it invests in, known as collateralized debt obligations, plunged in value amid the credit crunch and downgrades by ratings firms.

The fund became insolvent after assets values were eroded by “the unprecedented market volatility and disruption to the financial system, and the market for structured products assets in particular,” Highland Capital said in the letter, a copy of which was provided by an investor to Bloomberg News. Assets were valued at $361.6 million, according to a June 2008 regulatory filing.

OSFI is increasing required derivatives disclosures:

Banks, authorized foreign banks in respect of their business in Canada – foreign bank branches (FBBs), bank holding companies, trust and loan companies, life insurance companies and insurance holding companies should disclose the positive replacement cost, credit equivalent amount and the risk-weighted equivalent by class of derivative instrument.

An improvement, but basically cosmetic. I consider disclosure by class of counterparty (credit strength, degree of collateralization) to be much more important.

I’m of two minds about the Olympics. On the one hand, they’re egregiously expensive and nowadays should be awarded for two successive events; so that at least the velodrome and bobsled track get used more than once. On the other had, the one in Vancouver is countercyclical with a vengeance:

DBRS has today downgraded the Long-Term Debt rating of the City of Vancouver (the City or Vancouver) to AA from AA (high). The trend is now Negative.
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On February 18, 2009, the City announced it had secured a $400 million revolving line of credit, $90 million of which has so far been used to buy out the original lender to the project along with $240 million from reserves. Additionally, $134 million in construction advances have been made to the developer by the City since September 2008. This brings Vancouver’s total investment in the project to $464 million, leaving more than $400 million in additional funding required to complete the project by the November 2009 deadline.

Trouble is, it’s just dumb luck that we actually need stimulus right now – they made the committment in 2003 – five years after becoming the official Canadian contender.

HSBC Bank Canada has announced financials for the year ended 2008-12-31 that look pretty good:

The bank’s Tier 1 and overall capital ratios calculated in accordance with the new framework were 10.1 per cent and 12.5 per cent respectively
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The total allowance for credit losses, as a percentage of loans and acceptances outstanding, was 1.24 per cent at 31 December 2008 compared with 1.09 per cent at 30 September 2008 and 1.03 per cent at 31 December 2007.

Full financials are not yet available.

Everybody sold preferreds to buy gold today:

Gold futures for April delivery rose $25.70, or 2.6 percent, to $1,002.20 an ounce on the New York Mercantile Exchange’s Comex division. Earlier the price touched $1,007.70, the highest since March 18. Gold, the only metal to advance in 2008, has rallied annually since 2000 and is up 13 percent this year.

Global stocks extended an eight-session slide, erasing 54 percent of their market value since the start of last year on concern that the economic slump may worsen and wipe out corporate earnings.

Splits got hit especially hard, not surprising because many of them now have direct downside exposure to the underlying equities and many others are getting close. It will be most interesting to check back in a few years and see what this episode has done to the split-share market.

John Hemption wrote a piece on Bronte Capital titled Bank Solvency and the Geithner Plan:

The spread between the origination value of a loan and its secondary value is huge. It simply makes no sense to originate new loans when you can buy old loans so cheap. Because it makes no sense to originate loans banks will not do it unless they are driven by an “institutional imperative” (they don’t know what else to do) or they are forced to by regulators or they are trying to prove their solvency by using capital (something I have accused Barclays of).

James Hamilton of Econbrowser picks up the thread in a post titled Prospects for the US Banking System but he is handicapped by the notion that markets are efficient and rational:

As I understand it, Hempton is claiming that there is a probability distribution for what the true value of the assets held to maturity is going to be– might be higher than 75 cents, might be lower than 75 cents, but with expected value of 75 cents. There’s no question that risk premia at the moment are very high, but a figure of a 15% expected return seems hard to defend. The highest differential we’ve seen between Baa-rated and Aaa-rated bonds over the last century was 550 basis points in 1932. The spread fell from 340 basis points in December 2008 to 310 this January.
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If purchasing bank assets today at 50 cents on the dollar doesn’t offer an expected return as high as 15%, then it’s hard to claim that the expected value of the assets held to maturity is as high as 75 cents. Either 50 cents is too low a valuation, or 75 cents is too high an expectation.

Although I’m not sure which numbers to use, this seems like exactly the right way to frame the problem. Figure out what are the possible parameters for the capital loss that is to be allocated among the various parties– specifically, a loss that must be borne by some combination of stockholders, creditors, managers, employees, and the taxpayers– and try to reconcile those numbers with the current liquidation value of the banks.

Assiduous Readers will remember the Bank of England April ’08 Financial Stability Report, which opined that banks were, in fact, over-reserved against losses to maturity. That was, of course, nearly a year ago, back in the good old days before Lehman blew up and took the economy with it. I can only hope that some similarly authoritative work will become public soon.

Split-shares got creamed again … much more of this and retraction will become attractive again! It wasn’t just that bids disappeared, either … there were willing sellers at low prices.