Category: Market Action

There is a kerfuffle in the UK regarding the FSA’s attempt to increase the bank’s liquidity requirements, in accordance with the Turner Review (previously discussed on PrefBlog):

Similarly, if banks have to hold more assets in liquid form, and more of those in super-liquid form, like cash or government bonds, their income will decline. The FSA’s proposals on the subject accept these increased costs, though they are only sketchily estimated. Against these vague costs it sets a massive “reduction in the costs of systemic instability” of “3 billion to 5 billion bounds on an annualised basis.”

The problem for the banks is that, in contrast to the past, they will bear the costs of increased stability, while the taxpayer will enjoy the benefits.

The BBA’s tactic of playing the UK competitiveness card to stall the unilateral introduction of liquidity requirements is a clever one: international agreements can take years to complete.

It is also politically astute to play up the tension for banks between increasing their liquidity reserves at a time when the government is pressing them to increase lending to homeowners and businesses.
While Knight did not exactly put it like this, the FSA is asking banks to lend to government at the expense of the private sector. But the government is very strapped for cash right now. With regulatory and political interests fully aligned in favour of reform, this looks like a battle the banks will lose.

Those interested in hedging hyperinflation may wish to follow the strategy of Excelsior Fund:

The Excelsior Fund targets returns that will be five times the average annual rate of inflation of the Group of Five economies — France, Germany, Japan, the U.K. and the U.S. — should the rate exceed 5 percent, Jerry Haworth, co-founder of the firm, said yesterday. Raising $100 million for the fund would be a “good” amount, he said.
…
36 South’s Excelsior Fund will buy long-dated options it considers cheap and that “stand a good chance of outperforming in an inflationary environment,” Haworth said. Options are contracts to buy or sell a security by a certain date at a specific price.

The fund will wager on an increase in commodity and equity prices, bond yields and increased currency volatility.

“It’s a very high-risk, high-return fund,” said Haworth, who has been trading derivatives for more than 20 years as the former head of equity derivatives at Johannesburg-based Investec Ltd., and co-founder of Peregrine Holdings Ltd., a South African money manager and stockbroker.

The General Secretary of United Soviet Socialist America gave an indication of his plans today:

“Wall Street seems to maybe have a shorter memory about how close we were to the abyss than I would have expected,” Obama said in an interview with Bloomberg Television today at the White House. “All we’re doing is cleaning up after the mess that was made.”
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Crafted by Treasury Secretary Timothy Geithner and National Economic Council Director Lawrence Summers, Obama’s plan would put the Federal Reserve in charge of regulating companies whose collapse could damage the entire financial system. It would also create a new agency for overseeing consumer financial products, such as mortgages and credit cards.

The proposal encompasses areas ranging from derivatives to executive pay to the mortgage-backed securities that helped fuel the housing boom and then touch off the credit crisis.
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Obama called the derivatives market “an entire shadow system of enormous risk” and pledged to make it more transparent.

“Derivatives are a huge potential risk to the system,” he said. “We are going to make sure that they have to register, that they are regulated, that you have clearinghouses.”

However, I like this bit, somewhat:

Financial firms deemed too-big-to-fail will be required to maintain extra capital cushions, which are designed to curb the excessive risk taking that led to the collapse of last year of Bear Stearns Cos. and Lehman Brothers Holdings Inc. and the government seizure of insurer American International Group Inc.

I would like it a lot more if it was rules based … with a progressive risk-weight surcharge applied to risk-weighted assets in excess of a manageable level.

I find it most interesting that political culpability in the crisis has been ignored. If prime mortgages had yielded a little more, maybe the banks wouldn’t have plunged so heavily into sub-prime. But prime mortgages were wink-wink NOT guaranteed by Treasury nudge-nudge and hence traded at razor-thin spreads to Treasuries.

PrefBlog’s One-Born-Every-Minute Department passes on this SEC news release:

The Securities and Exchange Commission today obtained a court order halting an $11 million Ponzi scheme in which a Chicago-based promoter who is a convicted felon promised investors unusually high returns from purported investments in payday advance stores.

The SEC alleges that David J. Hernandez, who was convicted in 1998 for wire fraud arising from his previous employment at a bank, sold “guaranteed investment contracts” through his company that, unbeknownst to investors, was actually out of business. Hernandez promised returns of 10 percent to 16 percent per month and made false and misleading statements about his background, the use of investor proceeds, and the safety of the investment.

Actually, I only looked at the SEC site hoping for a definitive statement regarding a rumoured Madoff settlement, but nothing shows up yet.

Good performance from preferreds of all classes (well … except the single member of the FixedFloater subindex) with continued elevated volume.

Was it Joseph Mason who said it? Added 2009-7-15: Yes. It was. The fundamental problem with credit ratings and regulations thereof is that while the assumption is that you have a conservative investor looking for a conservative opinion, the regulatory use of credit ratings means that you have regulated investors looking for a license to invest. So, into the breach steps Realpoint:

U.S. credit rating company Realpoint on Thursday said insurers may soon be allowed to use its commercial mortgage bond ratings and preserve capital if rival Standard & Poor’s moves to slash its designations
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The NAIC move would give insurers more flexibility in choosing ratings that determine their capital levels and avoid forced selling of the assets if S&P adopts more conservative models. Insurers can use the middle rating, if there are three, according to [Realpoint CEO] Dobilas.

S&P shocked the the CMBS market last week by advising that its new models, if adopted, would likely prompt ratings cuts on 95 percent of top bonds issued during the peak of the real estate cycle in 2007 and 85 percent of CMBS from 2006. S&P is mulling responses from a formal request for comment.

Some 50 insurers have contacted Horsham, Pennsylvania-based Realpoint over the last few days, saying, “you guys need to get approved” by the NAIC, Dobilas said.

This is of particular interest in light of today’s release of the BIS paper Stocktaking on the use of credit ratings:

In the United States, insurance regulators require bonds and preferred stocks to be reported in statutory financial statements in one of six National Association of Insurance Commissioners (NAIC) designations categories that denote credit quality. If an accepted rating organisation (ARO) has rated the security, the security is not required to be filed with the NAIC’s Securities Valuation Office (SVO). Rather, the ARO rating is used to map the security to one of the six NAIC designation categories.18 The NAIC designations are primarily designed to assist regulators (as opposed to investors) to monitor the financial condition of their insurers.

Finally, in light of the impact that the credit market crisis had on the credit ratings of the financial guarantors and the bonds they insure, the NAIC announced that the SVO will be issuing “substitute” ratings for some municipal bonds. In doing so, the NAIC will be assessing the creditworthiness of the municipality that issued the debt. These credit ratings will be used to determine the risk based capital charge for the security. The insurance regulators indicated that the proposal will “decouple” the NAIC rating from the rating agency process.

So NAIC is not just a regulator, it’s also a credit rating agency! Ain’t no conflict of interest there, eh? It sure is a good thing that regulators are infallible!

In Canada, by the way:

In Canada, a significant portion of an insurer’s capital requirement (especially for a life insurer) arises from its exposure to credit risk. This component of the overall insurer capital requirement is determined using asset default factors. For rated short term securities, bonds, loans and private placements, these factors are based on the rating agency grade. In its life insurer capital guideline, the Office of the Superintendent of Financial Institutions (OSFI) states that:

“A company must consistently follow the latest ratings from a recognized, widely followed credit rating agency. Only where that rating agency does not rate a particular instrument, the rating of another recognized, widely followed credit rating agency may be used. However, if the Office believes that the results are inappropriate, a higher capital charge would be required.” [page 3-1-3]

Further, in Canada, asset default factors for preferred shares, where rated, are based on the rating agency grade. For financial leases where rated, and the lease is also secured by the general credit of the lessee, the asset default factor is based on the rating agency grade.

IIROC has (Notice 09-0172) done its bit to ensure that investors are restricted to investments offered by large banks that employ many former regulators:

Leveraged exchange traded funds (ETFs) are probably not suitable for retail investors, the Investment Industry Regulatory Organization of Canada is warning its dealer members.
…
Leveraged ETFs are reset daily by the provider. This means if an investor does not rebalance their leveraged ETFs on a daily basis, there will be tracking error, which will be exacerbated the longer the investment is held.

Investors need to have both the right call on a market direction, and more importantly a stable path of direction for these products to work in buy and hold strategies. Volatility can seriously impair the performance of these ETFs if held for the long term.

In its notice IIROC said a Canadian ETFs that seeks to deliver twice the daily return of the COMEX Gold Bullion Index fell 5% between January 22, 2008 and May 29, 2009. However, its inverse fund (twice the inverse daily return of the index) fell 38% in the same time period even though the underlying COMEX Gold Bullion Index increased by 6% during this period IIROC.

“Due to the effects of compounding, their performance over longer periods of time can differ significantly from their stated daily objective. Therefore, leveraged and inverse ETFs that are reset daily typically are unsuitable for retail investors who plan to hold them for longer than one trading session, particularly in volatile markets,” the notice says.

I mentioned some trader-games in the CDS market on June 12 – James Hamilton of Econbrowser comments:

For my money, the first rule we need would be a law, not a rule, that notional not exceed actual.

Barring that, here’s another rule I trust: a fool and his money are soon parted.

I’m OK with the second rule, but strongly disagree with the first. Some idiot made a dumb trade and lost money. Why does this demand a regulatory response?

C-EBS has announced consultation on Large Exposure guidelines for banks. Sadly, these proposed measures appear to be all about reporting, giving more discretion to supervisory authorities. There are no current plans to make regulatory response fair and reasonable by simply applying a surcharge to the Risk-Weighted-Assets calculation.

There are mutterings that CAD strength may hasten (more) quantitative easing:

Bank of Canada Governor Mark Carney, who says a strengthening currency could choke the economic recovery, may be pressed into creating dollars and buying assets such as government bonds to offset the dollar’s rise.

A 16 percent gain for the Canadian dollar since March 9 is threatening to undermine the country’s already battered exporters. This raises the likelihood that Carney will follow the Federal Reserve, Bank of England and Swiss National Bank in pursuing so-called quantitative easing, said Nicholas Rowe, an economist at Carleton University in Ottawa.

Volume came down a little from the recent frenzy, but remains strong. A nothing day for PerpetualDiscounts, Floating Rate issues were down a bit and FixedResets continued to shine.

More trader games in the CDS market – and now the rules might change:

At issue in the Amherst trades is whether sellers of protection on mortgage bonds can purchase loans underlying the debt at above-market prices to prevent a default that would trigger payments to buyers of the contracts. Credit-default swaps pay the buyer if the securities aren’t repaid as expected.

The call of the securities at their face value of $29 million, the amount remaining in the 2005 subprime-mortgage bond issue, caused the banks to lose money. Bankers on the American Securitization Forum call probably couldn’t ban the strategy for existing trades, the people said.

Proposals included creating agreements for new swaps that would force sellers to disclose whether they have the right to call the securities, and “best practices” guidelines to say such trades shouldn’t be executed, they said.

$29-million? Banks are prepared to admit that their traders lost a lot of money in a $29-million market?

They haven’t learned a damn thing, have they? Giving a block of capital to some kid with an MBA but not enough brains to realize you don’t play in a rigged market – or one that’s small enough to rig. $29-million? That’s not even a big ticket.

What does buying CDS protection mean, anyway? It’s nothing more nor less than shorting a bond. What kind of moron shorts into a $29-million market? What kind of useless twerp is the moron’s supervisor?

Let’s not have any more rules. Let’s just see a few bozos get fired. Or, at least, eating their losses like big boys and learning from the experience. As I have stressed many times on this blog, debt decoupling can result in strange things happening … particularly in a rinky dink $29-million market.

The Federal Reserve Bank of Boston has released a working paper by Todd Prono that looks interesting, but which I don’t have time to read now. So, without comment, here’s the abstract:

A pricing restriction is developed to test the validity of the CAPM conditional on a prior belief about the correlation between the true market return and the proxy return used in the test. Distinguishing this pricing restriction from competing tests also based upon the relative efficiency of the proxy return is a consideration for the proxy’s mismeasurement of the market return. Failure to account for this mismeasurement biases tests of the CAPM towards rejection by overstating the inefficiency of the proxy. A time-varying version of this pricing restriction links mismeasurement of the market return to time-variation in beta

Pretty much a nothing day in the major sectors of the market, but volume continued heavy and Floating Rate issues continued to shine.

Incompetent Portfolio Managers now have a new object of veneration: the Globe and Mail has published a hagiography of St. Busseri the Crybaby after he squared his rot for a good boo-hoo-hoo:

Mr. Busseri found himself in the crosshairs of what he called a “character assassination” attempt by TriNorth.

The attack came in the form of a published group letter that criticized his management skills at previous jobs, including his stint restructuring Environmental Management Solutions Inc., a onetime proxy battle target now known as Englobe Corp.

“When you’re married and have kids, it’s disturbing and disappointing when people behave like this,” Mr. Busseri said. “It feels like intimidation.”

The published group letter makes interesting reading:

Busseri has no record of creating shareholder value as a leader of a public company.
The facts are:
• From October 2004 to January 2008, while Busseri was President and CEO and a Board Member of EnGlobe Corp. (TSX: EG) the company share price fell 58%.
• The TSX Composite rose 56% over the same period.
• Between 2004 and 2007, EnGlobe had cumulative operating losses of about $8.2 million, on $317 million of revenues
• Busseri led Capital Environmental Resources Inc. (later re-named Waste Services Inc.) from 1997 until his departure in August 2000.
• In the last 14 months of Busseri’s tenure, Capital / Waste Services share price fell 73%.
• The S&P rose 17% over the same period.
• Busseri was no longer employed with the company after Capital / Waste Services reported a loss of $6.6 million – its largest loss ever.
• Busseri recently left the position of Executive Vice President at Hanfeng Evergreen Inc. in April 2009 after a four-month tenure.

Um … where’s the character assassination? Where’s the stuff that makes marriage and kids such an issue?

I have no idea who is better suited to lead Trinorth. I don’t care. It makes no difference to me. But in mounting his proxy battle, Busseri has necessarily voiced his opinion on the competence of Trinorth’s board:

It is clear to the Concerned Shareholders that the Current Board – the same directors being nominated by management of TriNorth – are either unable or unwilling to preserve, protect and build value for all shareholders.

OK, so he’s got an opinion. It’s necessarily an opinion. So the competence of the person giving that opinion is fair game. I see nothing in the Trinorth letter that is objectionable: they didn’t make any allegations regarding his personal life; they stuck very closely to the man’s business track record.

When I read someone’s opinion about the markets, I want to know their track records – which is why opinions from journalists and sell-side analysts are ignored, although data is always gratefully received. I suppose, in Mr. Busseri’s eyes – and in the eyes of the extremely sympathetic Globe reporters – my desire to review performance track records when assessing opinion makes me a Bad Person. And, I suppose, non-disclosure of performance history is to be considered an entirely reasonable adjunct to dispensing portfolio advice.

The Basel Committee on Banking Supervision has expanded:

The Basel Committee on Banking Supervision decided to broaden its membership and to invite as new members representatives from the G20 countries that are not currently in the Basel Committee. These are Argentina, Indonesia, Saudi Arabia, South Africa and Turkey. In addition, Hong Kong SAR and Singapore have also been invited to become members. The Basel Committee’s governing body will likewise be expanded to include central bank governors and heads of supervision from these new member organisations.

Since the New Activism will create a lot of jobs for ex-regulators, it’s important that regulators everywhere have a chance to burnish their resumes!

The Bank of Canada has published a new working paper by Bruno Feunou, Jean-Sebastian Fontaine and Romeo Tedongap, The Equity Premium and the Volatility Spread: The Role of Risk-Neutral Skewness:

We introduce the Homoscedastic Gamma [HG] model where the distribution of returns is characterized by its mean, variance and an independent skewness parameter under both measures. The model predicts that the spread between historical and risk-neutral volatilities is a function of the risk premium and of skewness. In fact, the equity premium is twice the ratio of the volatility spread to skewness. We measure skewness from option prices and test these predictions. We find that conditioning on skewness increases the predictive power of the volatility spread and that coefficient estimates accord with theory. In short, the data do not reject the model’s implications for the equity premium. We also check the model’s implications for option pricing and show that the information content of skewness leads to improved in-sample and out-of-sample pricing performances as well as improved hedging performances. Our results imply that expanding around the Gaussian density is restrictive and does not offer sufficient flexibility to match the skewness and kurtosis implicit in option data. Finally, we document the term structure of option-implied volatility, skewness and kurtosis and find that time-dependence in returns has a greater impact on skewness.

I do not pretend to be an expert on option pricing theory, but the paper looks very interesting!

Mark Carney made a speech today – nothing much new, but he wants to create new jobs for regulators:

Fourth, all countries must accept their responsibilities for promoting an open, flexible, and resilient international monetary system. Responsibility means recognizing spillovers between economies and financial systems and working to mitigate those that could amplify adverse dynamics. It means submitting to peer review within the Financial Stability Board and external review by the International Monetary Fund.

Treasuries bounced back when the long bond auction did not go as badly as expected:

The yield on the 10-year note fell nine basis points, or 0.09 percentage point, to 3.86 percent, after climbing as high as 4.0038 percent, at 4:40 p.m. in New York, according to BGCantor Market Data. The yield last touched 4 percent on Oct. 16. The 3.125 percent security maturing in May 2019 rose 23/32, or $7.19 per $1,000 face amount, to 94.

The 30-year bond yield fell seven basis points to 4.69 percent. It earlier touched 4.8391 percent, the highest since October 2007.

The bonds sold today drew a yield of 4.72 percent, the highest since August 2007. The average forecast by eight bond- trading firms surveyed by Bloomberg News was 4.80 percent. The sale is a reopening of the $14 billion 30-year bond auction on May 7, which drew a yield of 4.288 percent.

Incidentally, those who are impressed by how much long corporates have tightened may be interested to learn … it ain’t just Canada:

One veteran salesman and friend of the blog notes that there are no sellers and only buyers. He offers that volume is lighter than one would expect because the street is not carrying much paper and that has made some paper very prices.

By way of example of the steaminess of the market he cited the McDonald 2018 bond which traded at T + 90 today. One month ago the bond was at 150 and two months ago around 20.

There is a 2035 Walmart which traded + 105 yesterday. That boond was T+ 200 a month ago.

The rally is relentless and marches on.

Mind you, that’s not as impressive as it sounds. A month ago, long Treasuries were at 4.18%.

PerpetualDiscounts shone today on continued heavy volume.

Here’s a switch! Treasuries were under pressure today … Russia’s concerned about credit quality:

Thirty-year bond yields reached the most in a year after a Russian central bank official said the nation may buy International Monetary Fund bonds.
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Russia’s central bank may switch some of its reserves from Treasuries to International Monetary Fund bonds, the bank’s first deputy chairman, Alexei Ulyukayev, said in Moscow today. His comments were confirmed by a bank official who declined to be named, citing bank policy.

Finance Minister Alexei Kudrin said last month that Russia planned to buy $10 billion of IMF bonds using money from its foreign reserves.

Russia holds $138.4 billion of U.S. debt. China is the largest U.S. creditor, with $767.9 billion. The U.S. government must rely on foreign investors to sustain record borrowing.

The dollar fell as Russia’s announcement added to speculation central banks around the world may try to diversify their reserves away from the U.S. currency. The Dollar Index, used by the ICE to track the greenback against the euro, yen, pound, Canadian dollar, Swiss franc and Swedish krona, decreased 0.2 percent to 79.649, after sliding 1.3 percent yesterday.

“The market is reacting to this Russia thing,” said Arthur Bass, a managing director of derivatives in New York at the brokerage Newedge USA LLC. “The dollar has restarted its dive to lower levels.”

Perhaps not surprisingly, the Treasury 10-year auction was horrible:

Treasuries declined, pushing 10-year yields to the highest level since October, as the government sold $19 billion of the securities and Russia said it may switch some reserves from U.S. debt.

The notes drew a yield of 3.99 percent, the highest since August 2008. The auction was the second of three sales this week that will raise $65 billion, part of the government’s record borrowing program. A Russian central bank official said the nation may buy International Monetary Fund bonds.

“There are an awful lot of Treasuries being auctioned and there’s going to be more and more and more and more,” said Jay Mueller, who manages about $3 billion of bonds at Wells Fargo Capital Management in Milwaukee.

The yield on the 10-year note rose seven basis points, or 0.07 percentage point, to 3.92 percent at 2:44 p.m. in New York, according to BGCantor Market Data. It earlier reached 3.99 percent, the highest since Oct. 16. The 3.125 percent security maturing in May 2019 declined 1/2, or $5.00 per $1,000 face amount, to 93 1/2.

The 30-year bond yield touched 4.83 percent, the highest in a year. The government is scheduled to sell $11 billion of the securities tomorrow.

Lots of volume but not much price action for preferreds today, although Floaters got hit – largely due to TRI.PR.B, which had low volume and a high closing spread, so it’s not clear how seriously the decline should be taken. PerpetualDiscounts closed with a yield of 6.35%, equivalent to 8.89% interest at the standard equivalency factor of 1.4x; long corporates are now yielding about 6.6%, having returned +3.43% on the month-to-date, so the pre-tax interest-equivalent spread is now about 229bp … up from the 213bp calculated on June 4 due almost entirely to a decline in long corporate bonds that has – over the week – been unmatched by preferred shares … the yield on PerpetualDiscounts is actually fractionally higher that it was at the last calculation.

Here’s another good reason to avoid working for a bank:

Treasury Secretary Timothy Geithner said federal bank regulators and the Securities and Exchange Commission will play key roles in the administration’s effort to change the way financial executives are paid.

Geithner said the Obama administration is moving ahead with its guidelines on corporate compensation, part of a broader plan for an overhaul of financial regulation that will be announced next week. Changes are needed so bank executives aren’t enticed to take on too much risk, he said.

You will note that regulators are the chosen method of enforcement, not ownership – so efforts to repay TARP funds will only go so far. It will be most interesting to see how this plays out … will the big banks start contracting out work they want done properly? Or will they embrace the Canadian cult of mediocrity?

DBRS today revised its methodology for Secured Leveraged Loans:

Under the revised policy, the result of any notch-up of the instrument rating for a high-yield issuer will be limited to an instrument rating of BBB (low), regardless of the level of the recovery rating that may have been assigned to the instrument.

In assigning ratings to leveraged finance (i.e., high-yield) issues, DBRS first assigns an issuer rating that reflects the default risk of the issuer itself, then assigns separate recovery ratings and instrument ratings to the issuer’s specific debt instruments. The instrument rating is a blend of both the issuer rating and the recovery rating and, therefore, may be notched up from the issuer rating in cases where the recovery rating reflects above-average post-default recovery prospects. Likewise, the instrument rating may be notched down in cases where the recovery rating reflects diminished recovery prospects.

The likelihood of default is more remote for investment-grade issuers, which is why DBRS only assigns recovery ratings to non-investment-grade issuers. The effect of this policy refinement is to lessen the weighting of recovery on the instrument ratings of non-investment-grade credits that are on the cusp of becoming investment grade. DBRS believes – and empirical data demonstrates – that default is a substantial possibility for issuers in the B category and below; therefore, the recovery outlook should weigh relatively heavily on the instrument rating. As a company moves through the BB range and approaches investment grade, the likelihood of default is significantly less, and it is appropriate to restrict the beneficial impact of the recovery rating on the final instrument rating outcome.

This resulted in changes of rating for Sears MTNs:

In Sears Canada’s case, the Company was originally assigned an issuer rating of BB. However, based on DBRS’s recovery analysis, expected recovery is 90% to 100% for the MTN holders in a post-default scenario. This level of recovery equates to a recovery rating of RR1 and an MTN rating of BBB, or three notches above the issuer rating (see the DBRS rating report dated September 19, 2008).

In reviewing our leveraged finance methodology, DBRS noted that as a company moves through the BB rating range and approaches investment grade, the likelihood of default is significantly less; therefore, DBRS felt it appropriate to restrict the beneficial impact of the recovery rating on the final instrument rating outcome. Thus, the effect of this policy refinement is to lessen the weighting of recovery on the instrument ratings of non-investment-grade credits that are on the cusp of becoming investment grade.

The revised leveraged finance methodology has therefore capped Sears Canada’s MTN rating at BBB (low), two notches above the issuer rating.

… and Domtar:

Domtar was originally assigned (and maintains) an Issuer Rating of BB. However, based on DBRS’s recovery analysis, the Secured debt was assigned a recovery rating of RR1, which assumes an expected recovery of 90% to 100% in a post-default scenario. The RR1 equated to a Secured rating of BBB, or three notches above the issuer rating (see rating report dated May 12, 2009).

In reviewing our leveraged finance methodology, DBRS noted that as a company moves through the BB rating range and approaches investment grade, the likelihood of default is significantly lower. Therefore, DBRS felt it appropriate to restrict the beneficial impact of the recovery rating on the final instrument rating outcome. The effect of this policy refinement is to lessen the weighting of recovery on the instrument ratings of credits that are on the cusp between investment grade and non-investment grade.

The revised leveraged finance methodology has therefore capped Domtar’s Secured rating at BBB (low), which is effectively a two-notch upgrade above the issuer rating.

Connor Clark has announced:

the closing of the initial public offering of Canadian Banc Capital Securities Trust (“Canadian Banc” or the “Fund”). The Fund raised gross proceeds of $96,289,000 from the issuance of 3,600,000 Class A Units and 251,560 Class F Units (collectively the “Units”) at a price of $25.00 per Unit.

Excuse me for living, but this product looks completely insane to me. Expenses are:

• 5.25% New issue selling commission on the Class A units. (one-time)
• About maybe 0.7% issue expenses (one-time)
• Management fee of 0.50%
• Service fee of 0.40% on Class A units
• 0.35% Counterparty fee
• Ongoing expenses of 0.15%

Amortizing the issue expenses over the five year life of the fund and assuming all units are Class A gives you an MER of 2.45%. The counterparty fee is there because the fund is structured to pay the income as return of capital / capital gains.

And all for what? A FIVE YEAR investment in PERPETUAL SECURITIES. That fact alone makes my hackles rise; you can just bet it’s being sold to Granny as a five year investment. They justify this in the prospectus by using pretend-maturities:

The Portfolio Manager uses the first date upon which the securities may be called at par (rather than the legal maturity) in order to calculate duration. Based on this approach, the duration of the Indicative Portfolio is approximately 6.4 years.

The preferred share market had another strong day today, as FixedResets continued their march towards a zero percent yield-to-call!

More evidence that the credit markets are mending, this time from the CDO market:

A “remarkable change” in investor sentiment has doubled the price of some collateralized loan obligation securities in the past month, according to Morgan Stanley analysts.

CLOs are a type of collateralized debt obligation that pool high-yield, high-risk, or junk, loans and slice them into securities of varying risk and return. Pieces graded AA, the third highest-level of investment grade, rose from 23 cents on the dollar to 47 cents in the past month, Morgan Stanley analysts led by Vishwanath Tirupattur wrote in a June 5 report. Securities ranked A have gained 13 cents from 10 cents since the end of last month, the report said.

Ares Management LLC and Boston-based Sankaty Advisors LLC are among investors that started bidding on CLO securities in late April and the first week of May. Prices for the single-A portions had dropped 90 percent since the financial crisis began in 2007 even as the loans packaged in them had regained some their value. The S&P/LSTA U.S. Leveraged Loan 100, an index of loans rated below investment grade, rose 12 cents from Dec. 31 to 73.6 cents on the dollar on May 1. Loans have since increased in value to 79 cents.

“The continuing rally in underlying leveraged loans has been a major driver of this change in investor sentiment,” on CLOs, the analysts wrote in the report. A “fierce rally” is under way, they wrote.

The top-rated CLO bonds have risen from 71 cents on the dollar to 77 cents since May, the report said.

At the same time, hedge fund financing is getting a little harder:

HSBC Holdings Plc’s U.S. securities division will no longer extend structured financing to hedge-fund investors to leverage their investments, a person familiar with the company’s plans said.

The bank is halting the financing by its structured-funds products division and eliminating an unspecified number of jobs in New York, said the person, who asked not to be identified because the information hasn’t been made public. The group reports to Steven Phan, global head of the investment access and solutions groups in London, the person said. Phan declined to comment.

Remember those charts comparing the current bear to others? They’re looking a lot better now, but into the breach step Barry Eichengreen & Kevin H. O’Rourke, just in case anybody’s feeling cheerful, with a piece on VoxEU A Tale of Two Depressions:

This is an update of the authors’ 6 April 2009 column comparing today’s global crisis to the Great Depression. World industrial production, trade, and stock markets are diving faster now than during 1929-30. Fortunately, the policy response to date is much better. The update shows that trade and stock markets have shown some improvement without reversing the overall conclusion — today’s crisis is at least as bad as the Great Depression.

Click for big

Click for big

On a brighter note, equities were rescued from a bad day by Nobel Laureate Paul Krugman:

The U.S. economy probably will emerge from the recession by September, Nobel Prize-winning economist Paul Krugman said.

“I would not be surprised if the official end of the U.S. recession ends up being, in retrospect, dated sometime this summer,” he said in a lecture today at the London School of Economics. “Things seem to be getting worse more slowly. There’s some reason to think that we’re stabilizing.”

FixedResets had another good day, bringing the median YTW down to 4.81%. Since 5-Year Canadas have now gapped up to 2.69%, it is interesting to speculate on the terms of the next FixedReset issue. Could a bank do something at 5.00%+230?

The recession is getting worse more slowly than expected:

Payrolls fell by 345,000, the least in eight months, after a revised 504,000 loss in April, the Labor Department said today in Washington. The jobless rate increased to 9.4 percent, the highest since 1983, in part as more people joined the labor force to look for work.

“The recession is very close to an end,” said Nariman Behravesh, chief economist at IHS Global Insight in Lexington, Massachusetts, whose payrolls forecast matched the closest estimate in a Bloomberg News survey. “The labor market is still pretty awful, but vastly better than it was.”

The jobs number had an immediate effect on Treasuries:

Yields on two-year Treasuries increased 28 basis points to 1.24 percent, the biggest one-day increase since Sept. 20. The price on the benchmark 0.875 percent note maturing in May 2011 fell 17/32, or $5.31 per $1,000 face value to 99 98/32, according to BGCantor Market Data.

Implied yields on eurodollar futures as well as federal fund futures contracts, both used to speculate on changes in central-bank policy, surged, with further-deferred contracts posting the largest increases. The yield on the December 2009 eurodollar contract rose 26 basis points today to 1.26 percent, while the December federal-funds futures contract yield increased 21 basis points to 0.54 percent.

Fed-funds futures contracts, which traded on the Chicago Board of Trade, show traders see a 65.7 percent probability the central bank will lift its target rate for overnight bank borrowing by at least 0.5 percent by November from its current zero-to-0.25 percent range. That’s up from 26.8 percent odds yesterday.

But Across the Curve thinks this is ludicrous:

Someone just pointed out that typically the Federal Reserve does not raise rates and unravel an ease until there has been at least six months of job growth. So any possibility of the FOMC raising rates this year is virtually nil.

The trade today is about position management. The entire world is (was) long the yield curve. Profit taking began and forced more profit taking as investors and traders dis not want to watch profits evaporate.

The Canadian jobs picture was awful, but you will look in vain for any worst-case scenarios in 5-year-old government budget documents to assess the effectiveness of contingency planning.

The Kansas City Fed has released its Spring 2009 edition of TEN, it’s general-readership publication. It reprints a speech by Thomas Hoenig, the President, titled “Too Big has Failed”, which mainly addresses current and future cures, rather than prevention. He does note:

We must also look for other ways to limit the creation and growth of firms that might be considered “too big to fail”.

… without making any suggestions. There’s also an article on the markets in water which many will find of interest; I continue to believe that Cleveland will rise again due to its proximity to the Great Lakes; just maybe not this century.

In these uncertain times, it is difficult for regulators to decide what to do. There’s no rule-book, precedents are scarce and there is a high risk of unintended consequences. It is therefore a pleasure to see that in the case of Bank of America, increased regulatory scrutiny – not to mention increased regulatory bullying, with Hank Paulson as the primary enforcer, as mentioned on May 14 – has achieved its objective:

Bank of America Corp., facing the biggest projected losses among lenders subjected to stress tests, will remake its board by adding two ex-regulators and two former bankers as directors.

The new directors are Susan Bies, 62, a former Federal Reserve Board governor; Donald Powell, 67, an ex-Federal Deposit Insurance Corp. chairman;

Now all they have to do is get rid of those damn bankers…

The preferred market continued its ascent today on continued good volume.

I noted yesterday that there had been a huge rally in junk bonds fuelled – at least in part – by issuer bids. The same thing is happening in asset-backeds:

European companies have increased purchases of their asset-backed bonds tenfold this year, taking advantage of prices that slumped 70 percent and signaling to investors that the worst of the recession may be over.

HSBC Holdings Plc, Europe’s biggest bank, is offering to buy as much as 4 billion pounds ($6.5 billion) of its notes secured by company loans. Canary Wharf Group Plc bought 119.8 million pounds of debt backed by offices in London’s second financial district in April.

All told, more than $1.8 billion of the debt was repurchased through public auctions this year by banks, real estate companies and the owner of the Greene King pub chain, according to data compiled by Bloomberg. That’s up from $164 million in all of 2008.

The Bank of Canada kept the overnight rate at 25bp:

Information received since the Bank’s April Monetary Policy Report (MPR) is broadly consistent with the Bank’s medium-term outlook for output and inflation in Canada. The economy is undergoing major restructuring in a number of sectors. The already significant output gap will continue to widen through the third quarter, putting downward pressure on inflation. The Bank continues to expect that the global and Canadian recoveries will be more muted than usual.

In recent weeks, financial conditions and commodity prices have improved significantly, and consumer and business confidence have recovered modestly. If the unprecedentedly rapid rise in the Canadian dollar (which reflects a combination of higher commodity prices and generalized weakness in the U.S. currency) proves persistent, it could fully offset these positive factors.

The outlook is subject to considerable uncertainty. While the underlying macroeconomic risks are roughly balanced, the Bank judges that, as a consequence of operating at the effective lower bound, the overall risks to its inflation projection remain tilted slightly to the downside.

Conditional on the outlook for inflation, the target overnight rate can be expected to remain at its current level until the end of the second quarter of 2010 in order to achieve the inflation target.

After today’s gains, PerpetualDiscounts now yield 6.31%, equivalent to 8.83% interest at the standard equivalency factor of 1.4x. With all these gains they still lagged long corporates, which now yield 6.7%, so the pre-tax interest-equivalent spread is now about 213bp.

The recent rally in junk bonds is having some interesting knock-on effects:

The biggest high-yield rally ever is punishing the lowest- rated companies that may no longer be able to afford avoiding bankruptcy by exchanging or buying back debt at the lowest prices on record. The “cruel irony” of rising prices means the neediest businesses will have a harder time finding financing, Morgan Stanley analysts led by Jocelyn Chu in New York said in a May 15 report. That may lead to more defaults than anticipated.

Freescale Semiconductor Inc., part-owned by 62-year-old Schwarzman’s Blackstone Group LP, wiped away $1.9 billion of debt in March by giving investors an average of 32 cents on the dollar in loans. Since the bond exchange was announced March 4, the securities have tripled to as high as 54.1 cents on the dollar, curtailing the chipmaker’s ability to cut the rest of its $7.5 billion debt load.

C-EBS is hosting a public hearing on liquidity buffers, in an attempt to finalize a framework for EU national bank supervision. There is a a wide range of industry practices:

– Within the industry, most banks either formally define a liquidity buffer or alternatively it is a concept implicit in their liquidity management policy.

– One institution formally defines its liquidity buffer as highly liquid unencumbered assets set at a level to get through the initial stages of a liquidity shock. It also defines a maximum amount of collateral that may be needed for intraday payment system purposes and deducts this from the stock of unencumbered assets. Buffers are formed for each of the currencies in which it is active. A survival period of 90 days is defined and liquidity shock scenarios developed to calibrate the size of the buffer.

– Another bank defines the buffer as a liquidity gap based on a runoff scenario (all maturing assets and liabilities not renewed during a 4 week period) that can be covered from high quality funding sources.

– Another bank defines the buffer over 30 days but does not use stress tests to measure the required size of buffer. Instead, expert judgement from the ALCO sets the buffer level. The quality of the assets in the buffer also impacts the level of buffer held.

– Another bank does not formally define a buffer. Instead it manages its overall counterbalancing capacity. As part of this, it uses projected flows to estimate a level of unencumbered assets that will cover the liquidity gap such that no change to the bank’s business model is required. This output is an input to the overall policy on managing its counterbalancing capacity.

The Globe and Mail has a story on Property & Casualty insurers:

The Office of the Superintendent of Financial Institutions (OSFI), which regulates about 200 companies in the sector, is worried about capital levels in the industry.

“It’s a period of great uncertainty right now,” said Bruce Thompson, a director in the supervision sector of OSFI’s Toronto office. “Our expectation is that 2009 is going to be a difficult year for the industry.”
…
Its total capital level dropped last year for the first time since 2003. The key measure of a property and casualty insurer’s financial cushion is called the Minimum Capital Test. The sector-wide ratio fell to 238 per cent at the end of 2008, from 252 per cent at the end of 2007. (Regulators require it to remain above a floor of 150 per cent, but Mr. Thompson pointed out that “companies know darn well that 150 is a territory you don’t go.”)

A basically flat day for preferreds amidst continued heavy volume.