Category: Miscellaneous News

Miscellaneous News

Altamira Preferred Equity Fund Launches Quietly

Many will remember that when Omega Preferred Equity Fund was closed to new investors, it was also announced that National Bank would be starting a new fund with in-house management.

It’s here, but it seems to be operating very quietly!

The portfolio management firm is Fiera Sceptre Inc., which has a “strategic alliance” with and is partly owned by National Bank, as announced in February. The portfolio manager is Catherine Payne:

Catherine Payne is a member of the Active Fixed Income team and is responsible for managing certain corporate bond, high yield bond, preferred share and convertible bond portfolios.

Ms. Payne has 19 years of industry experience and has been with the firm and a predecessor since 2003. Prior experiences include positions as Portfolio Manager, Senior Credit Analyst, and Assistant Vice President at major Canadian investment management, credit rating and brokerage firms.

Ms. Payne graduated from the University of Toronto with a Bachelor of Commerce (BComm). She later received the Chartered Financial Analyst (CFA) designation.

As is usually the case, there is lots of chatter about experience and not a line about performance.

There are four classes to the fund, three of them with an estimated MER of 1.50%, the F-Class with an estimate of 50bp. I am fascinated to see that NBC510, the Deferred Sales Charge option, pays the salesman a 5% commission on the sale with a trailer to follow. I’m in the wrong business!

According to the Globe and Mail Fund Quote the fund was 64% in cash on October 31, which I presume had more to do with start-up frictions than long-term asset allocation goals.

I’ll keep an eye on the fund and report its performance together with those of my other competitors.

Issue Comments

Omega Preferred Equity Fund to be Closed to New Investors

National Bank Securities has announced:

the Omega Preferred Equity Fund’s closure to new investors as of September 30, 2012. The closure of the Omega Preferred Equity Fund will allow the fund’s portfolio manager (Intact Investment Management Inc.) to continue applying its current investment philosophy. After the fund’s closure to new investors, the fund will continue to be available to existing investors, and shall also remain available to certain other investors, including funds that are managed by NBSI or its affiliates.

“The Omega Preferred Equity Fund was launched in 2007 and has proven to be a superior investment product for investors looking for stable distributions of tax-efficient dividend income” said Michel Falk, President of NBSI. The fund has grown steadily in size since its inception, recently surpassing $470 million in assets under management.

NBSI will be launching the Altamira Preferred Equity Fund for new investors seeking dividend income and capital preservation. This fund will aim to invest in a diversified portfolio of dividend-paying preferred equities.

A preliminary simplified prospectus relating to the Altamira Preferred Equity Fund has been filed with the Canadian securities authorities. Units of the Altamira Preferred Equity Fund cannot be acquired until the relevant securities authorities issue receipts for the simplified prospectus of the fund. Please read the prospectus before investing. There may be commissions, trailing commissions, management fees and expenses associated with mutual fund investments. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated.

Essentially, this means that National has decided that all new money will be managed in-house. It will be remembered that National Bank owns Altamira.

I can’t find anything about “Altamira Preferred” on SEDAR.

Miscellaneous News

DBRS Changes SplitShare Rating Methodology

DBRS has announced that it:

has today published updated versions of two Canadian structured finance methodologies:

— Stability Ratings for Canadian Structured Income Funds
— Rating Canadian Split Share Companies and Trusts

Neither of the methodology updates resulted in any meaningful changes and as such, neither publication has resulted in any rating changes or rating actions.

The new methodology institutes a formal procedure for Reviews:

Rating actions taken on the preferred shares of an issuer are based on the following guidelines:

  • • If the downside protection available falls outside the expected range by a signifi cant amount for two consecutive months, the preferred shares may be placed Under Review with Negative Implications to indicate the high likelihood of an impending downgrade.
  • • After a rating has been placed Under Review with Negative Implications, it maintains its status until one of the following scenarios occurs:
    • – If the downside protection fell outside expected levels for two consecutive months subsequent to the rating being placed Under Review with Negative Implications, then the preferred shares will likely be downgraded. The revised rating level will depend on the path of downside protection levels during the Under Review period, as well as on other factors such as changes in the dividend coverage available and the credit quality of the portfolio.
    • – If the downside protection levels are consistent with the then-current rating for two consecutive months subsequent to being placed Under Review with Negative Implications (likely due to an increase in downside protection), the Under Review status will likely be removed with a confi rmation of the rating.
  • • If the downside protection indicates that an upgrade is warranted for four consecutive months, then the
    transaction will likely be upgraded. The revised rating level will depend on the path of downside protection levels during the previous four months, as well as other factors such as changes in the dividend coverage available and the credit quality of the portfolio.

They’re still using VaR based on one-day drops:

Volatility Rating

  • • DBRS analyzes the historical volatility and performance of the portfolio’s underlying securities to estimate the likelihood of large declines in downside protection.
  • • Historical performance data for a defi ned period is used (normally ten years).
  • • Daily returns are annualized; only negative returns count as potential defaults.
  • • A probability of default is calculated that will yield a one year VaR at the appropriate dollar-loss amount equating to the downside protection available.
  • • The probability of default is linked to a long-term rating by using the one-year default rates from the DBRS corporate cumulative default probability table.
  • • The long-term rating is converted to a preferred share rating using a notching assumption that the preferred shares of a company should be rated two notches below the company’s issuer rating.

A Diversification adjustment has been formalized:

  • • Portfolios with greater diversifi cation will generally exhibit less volatility and a lower probability of a large decline over time.
  • • As the diversifi cation of a portfolio by industry and by number of securities decreases, the diversification factor applied will increase.
  • • See the Downside Protection Adjustments for Portfolio Diversification table in this methodology, which shows the adjustment factor for varying levels of diversification.

The Cash Grind is treated as an adjustment:

  • • Higher capital share distributions increase the grind on the net asset value (NAV), which results in the portfolio requiring to earn a certain percentage return from capital appreciation (the percentage grind) to cover the amount that portfolio expenses and distributions exceed dividend income.
  • • The percentage grind will have less of a negative effect if there is an asset coverage test preventing capital share distributions once the NAV drops below a certain value.
    • – A higher NAV cut-off value will provide greater protection to the preferred shares.
  • • A longer transaction term increases the cumulative effect of any
    grind on the portfolio.

  • • The methodology shows the impact of capital share distributions on the maximum preferred share rating.
    • – More aggressive distribution policies and asset coverage tests will result in notching below the maximum preferred share rating (see the Impact of Capital Share Distributions on Initial Ratings table in this methodology).

They had this to say about option writing strategies:

DBRS views the strategy of writing covered calls as an additional element of risk for preferred shareholders because of the potential to give up unrealized capital gains that would increase the downside protection available to cover future portfolio losses. Furthermore, an option-writing strategy relies on the ability of the investment manager. The investment manager has a large amount of discretion to implement its desired strategy, and the resulting trading activity is not monitored as easily as the performance of a static portfolio. Relying partially on the ability of the investment manager rather than the strength of a split share structure is a negative rating factor.

Miscellaneous News

FAIR Canada: Another Suckle at the Public Tit

Fair Canada has announced:

FAIR Canada will be receiving funding from the Ontario Securities Commission (the OSC) and the Investment Industry Regulatory Organization of Canada (IIROC). The OSC has committed to funding FAIR Canada in the amount of $500,000 per year for a two-year period. IIROC will be contributing $350,000 per year over two years. The funds come from money collected by the regulators from monetary sanctions and settlements.

“On behalf of staff and the Board of Directors of FAIR Canada, I want to express my appreciation and gratitude to the OSC and IIROC for making use of their enforcement/restricted funds to finance our work representing the interests of investors and consumers of financial services,” said Ermanno Pascutto, Executive Director of FAIR Canada. “There is very little funding available for consumer groups in Canada and the use of these funds for this purpose will benefit both the investing public and the Canadian financial markets.”

The funding will also benefit Ermanno Pascutto, a former Executive Director and head of staff of the Ontario Securities Commission (OSC) in the 1980′s, but that part’s played down. Other staff members are

  • Ilana Singer, a former Senior Advisor, International Affairs at the OSC
  • Marian Passmore, a former Associate Director in the Regulatory Affairs Group at Advocis
  • Lindsay Speed, who interned and completed her articles at a leading national law firm, but does not appear to have worked for them after articling

Notables on the board of directors include:

  • Stanley Beck, a former Chair of the Ontario Securities Commission
  • Stan Buell, who was appointed to the Ontario Securities Commission Investor Advisory Panel in 2010
  • Neil de Gelder, a past Executive Director of the British Columbia Securities Commission
  • Claude Lamoureux who serves on the board of the OSC Investor Education Fund
  • Dawn Russell, a former Public Governor of the Canadian Investor Protection Fund

Well, it certainly is nice that the regulators will be getting a fresh and independent perspective on regulation from the ex-regulators who they’re funding, isn’t it?

I have previously published an article regarding the provenance of FAIR’s prior funding tranche, titled IIROC’s Slush Fund. In the press release announcing the launch of FAIR Canada, it was stated:

The Boards of the IDA and RS, which recently merged to form the Investment Industry Regulatory Organization of Canada (IIROC) have approved one time start up funding from their discretionary and restricted funds to create FAIR.

Well, maybe two times. But who’s counting? Anyway, it’s nice to see that current funding totaling $850,000 annually is less than the original rate:

The Organization has agreed to establish the Canadian Foundation for the Advancement of Investor Rights (FAIR). The Organization is committed to funding the foundation over a three-year period to a maximum of $3,750 [thousand]. As at March 31, 2009, the remaining commitment is $1,922 [thousand].

FAIR’s expenses in 2011 and 2010 were $924,067 and $933,455, respectively … but they still had working capital of over half a million on 2011-6-30.

Miscellaneous News

US Covered Bond Legislation Passes Another Milestone

The House Financial Services Committee has approved draft Covered Bond legislation:

The committee voted 44-7 today to approve the bill, which would provide a regulatory framework for covered bonds by giving the Treasury Department oversight of the market and creating a separate resolution process in order to bolster investor interest.

“The FDIC’s concerns, I believe, continue to be legitimate,” said Representative Barney Frank, the senior Democrat on the committee, who unsuccessfully offered two amendments drafted with the agency to change the measure. “The FDIC believes, I think correctly, there will be problems in some of these cases and the FDIC will not be fully protected.”

In an effort to alleviate some of the agency’s concerns, Representative Carolyn Maloney, a New York Democrat, offered a successful amendment that extended to one year, from 180 days, the amount of time the FDIC would have in event of a bank failure to hold the exclusive right to transfer the covered pool to another eligible issuer.

The panel also agreed, by voice vote, to a requirement that the Treasury write rules to cap the maximum amount outstanding, as a percentage of total assets, that any one issuer can hold.

Andrew Gray, the FDIC’s spokesman, said in an e-mailed statement that the bill would subsidize covered bond investors with the deposit insurance fund and “will add to the funding advantage” of large banks.

The FDIC’s Deputy Chairman, Michael H. Krimminger, testified in September 2010 regarding FDIC concerns regarding super-priority:

Unfortunately, H.R. 5823 would restrict the FDIC’s current receivership authorities used to maximize the value of the failed bank’s covered bonds. The bill leaves the FDIC with only two options: continue to perform until the covered bond program is transferred to another institution within a certain timeframe; or hand over the collateral to a separate trustee for the covered bond estate, in return for a residual certificate of questionable value. The FDIC would not have the authority – which it can use for any other asset class – to repudiate covered bonds, pay repudiation damages and take control of the collateral. This restriction would impair the FDIC’s ability to accomplish the “least costly” resolution and could increase losses to the DIF by providing covered bond investors with a super-priority that exceeds that provided to other secured creditors. These increased losses to the DIF would be borne by all of the more than 8,000 FDIC-insured institutions, whether or not they issued covered bonds.

Limiting the time in which the FDIC could market a covered bond program to other banks will constrain the FDIC’s ability to achieve maximum value for a program through such a transfer. Similarly, preventing the FDIC from using its normal repudiation power will prevent the FDIC from recapturing the over-collateralization in the covered bond program. The ‘residual certificate’ proposed in H.R. 5823 is likely to be virtually valueless. More importantly, the legislation would provide the investors with control over the collateral until the term of the program ends, even though the FDIC (and any party obligated on a secured debt) normally has the ability to recover over-collateralization by paying the amount of the claims and recovering the collateral free of all liens. Providing the FDIC a residual certificate instead of the ability to liquidate the collateral itself would reduce the value to the receivership estate and would not result in the least costly resolution.

So long as investors are paid the full principal amount of the covered bonds and interest to the date of payment, there is no policy reason to protect investment returns of covered bond investors through an indirect subsidy from the DIF

The FDIC issued a Covered Bond Policy Statement in 2008.

There is an excellent discussion of the legislation available by Barton Winokur, Chairman and Chief Executive Officer of Dechert LLP, and is based on a Dechert publication by Patrick D. Dolan, Robert H. Ledig, Gordon L. Miller and Kira N. Brereton, titled Reform for the Covered Bond Industry on the Horizon.

US Covered Bond legislation was last mentioned on PrefBlog when it passed the Capital Markets Subcommittee. Consultations in Canada are taking place behind closed doors, as is only right and decent.

Update, 2011-6-24: I note from Chart 3.15 of the BoE June 2011 Financial Stability Report that covered bonds comprise 5% of 2011-13 maturities, but 16% of planned 2011-13 issuance in the UK.

Miscellaneous News

Ottawa Issues Covered Bond Consultation Paper

Ogilvy Renault has reported Canadian Covered Bond Legislation Consultation Paper Released:

Following the Canadian Government’s announcement in its 2010 budget of its intention to introduce a legislative framework for covered bonds, the Department of Finance yesterday released its much anticipated consultation paper on the proposed framework.

In the consultation paper, the Government reiterates its objective of ensuring financial institutions have access to covered bonds as a funding source. It also acknowledges the increased importance of covered bonds to Canadian banks in recent years with issuances by Canadian financial institutions having increased to over $30 billion since the first covered bonds were issued by a Canadian bank in 2007. Further, the Government recognizes that the stability of financial institutions and the financial sector can be enhanced by providing funding options that are robust under stress and that a legislative framework for covered bonds will benefit Canadians.

It this wasn’t a PrefLetter Weekend, I’d be spending a lot more time on this … but I’ll have to leave that until later. From a quick glance, it does not appear as if Bankers’ Acceptances are intended to be covered by the legislation – they should be!

Covered Bonds were last discussed in the post US Covered Bond Legislation Moving Forward. A previous article discussed the question of BAs or BDNs: What’s the Difference?.

Hat tip to Assiduous Reader GA, who brought the Ogilvy Renault article to my attention.

Update, 2011-5-25: The consultation period ends 2011-6-10.

Miscellaneous News

BofA Maple Sub-Debt: Pretend-Maturity Will Be Ignored

Boyd Erman of the Globe & Mail reports in a piece titled Bank of America shocks Maple market:

Bank of America (BAC-N12.680.342.76%) has broken an unwritten rule and shocked the Canadian bond market by deciding not to redeem a $500-million bond issue.

But the unwritten, wink-and-nod agreement with the investors who bought them was that the bonds would be called at the end of five years so that investors would never have to face the lower rates.

Bank of America has decided not to call the bonds and will take advantage of the lower rates. For investors in the bonds, it means lower prices and lower interest income, and a tough decision about what to do next.

My suggestion is that they make a note to read the terms of the issue next time, but what do I know?

The bonds were originally sold with a coupon of 4.81 per cent. Now, under the floating structure, they will pay interest rate at a short-term benchmark plus a fraction of a percentage point. At the moment, that works out to about 1.8 per cent.

The bonds are now being quoted at about 96 to 97 cents on the dollar by some desks after being marked at par in the days before this on expectations that they would be called at 100 cents on the dollar, market sources said.

The comments on the Globe site are a hoot.

There’s not much information available on this issue, but it’s mentioned briefly in the RBC-CM Maple Guide of 2H08 – with all the pseudo-analysis based on a certainty of call, of course, as is usual with subordinated debt.

I last reviewed this topic in the post Bank Sub-Debt Redemptions.

Miscellaneous News

TMX to Report Closing Quotes … Someday

Readers will remember that quotes provided by the TMX at the “end of the day” are not closing quotes: they are “last” quotes, measured at 4:30. They will differ from the Closing Quotes measured at 4:00 because orders may be cancelled, but not added, during the extended trading session – the one exception being that you can add as many orders as you like at the Closing Price.

I brought this to the attention of the TMX (I don’t think they’d ever really thought about it; my suspicion is that the code that worked perfectly well when there was not extended trading session simply got overlooked when the ETS was invented … put that is pure speculation on my part). The TMX took a survey of their customers and:

While we are not in a position to disclose survey results, we can tell you that there was limited interest from our clients with respect to the 4:00 PM closing bid/ask information. We are following up on adding 4:00 PM close bid/ask data to our end-of-day Trading Summary products and Market Data Web – Custom Query product. However, due to other development commitments and priorities, we can not say when this will be implemented.

I’m rather surprised and can only assume that the surveys were completed by database dorks rather than end users, because the Last Quote is only useful insofar as it reflects the Closing Quote – it has absolutely zero independent value.

I’m also surprised that there will be a potentially significant delay in giving users the option. I’ve never had the chance to examine the TMX code, so obviously I’m speculating again … but retrieval, storage and dissemination of Closing Quotes seems like a fairly trivial database operation. I don’t understand how implementation could possibly take more than a day.

I will, on occasion, spend some actual money to buy the “Trades and Quotes” output from the TMX – but not very often, because there is a charge for each quote and there can, conceivably, be several thousand quotes per minute. However, this will rarely be reported on PrefBlog in a timely manner, because I am separately advised that my problems nailing down IAG.PR.C on March 25 and CM.PR.K on March 28 were due to uploading schedules – detailed quote data is only put on DataLinx overnight, not within a few hours of the close.

Miscellaneous News

SplitShare Capital Unit Debate

Assiduous Readers will remember that I was quoted in a recent article by John Heinzl expressing a strong opinion on the Capital Units issues by SplitShare corporations:

For those reasons, Mr. Hymas says the capital shares are only appropriate for “suckers.”

This statement has attracted a certain amount of commentary and I have received some material criticizing my views. All further quotes in this post have been taken, in order, from an eMailed commentary – it has been interspersed with my commentary, but is quoted verbatim and in its entirety.

Response to “Ups and Downs of Doing The Splits” – John Heinzl, Globe and Mail, March 2, 2011

I have had a lot of involvement in split shares over the last two years, and I have to differ markedly from the assessment of Mr. Hymas, who prefers the preferreds to the capital units. I believe the exact opposite to be the case.

The split-share preferreds have limited upside, yet unlimited downside. They are essentially equity investments with a ‘preferred share’ wrapper. Most have downside protection to some degree, but rest assured, they can fall pretty well as much as the equity market can.

Asymmetry of returns is a feature of all fixed income, not simply SplitShare preferreds. Naturally, they can default, and one must take account of the chance of default: but firstly most will have Asset Coverage of at least 2:1 at issue time – meaning that the underlying portfolio can drop by half before the preferred shareholders take any loss at all – and secondly the Capital Unitholders will be wiped out before the preferred shareholders lose a penny.

No, there are no guarantees – there never are. But the preferreds have at issue time a significant amount of first-loss protection provided by the Capital Units.

The capital units are a whole other story. In my view they offer the BEST deal out there.

Imagine if you had a $100,000 portfolio of Canadian equities. You are totally exposed to the performance of the underlying assets, so a market fall of 50% takes an equivalent bite out of your assets. Now suppose instead you invest in a capital share with the following characteristics: leverage factor is 3.75 times. Discount to NAV is 20%. Maturity is 3 years. (These numbers are most assuredly achievable).

These numbers can be illustrated by the following:
Preferred Par Value: $10.00
Whole Unit NAV: $13.64
Price of Capital Units: $2.91

However, the capital units are issued at a premium to NAV (since they absorb all the issue expenses) of 5-10%. Thus, by choosing this example, you are to a degree saying that the Capital Units are only worth buying once they have lost about 25% of their value relative to NAV and have lost most of their NAV as well. I claim that this shows that the guys who paid full price for them are suckers.

While discounts of market price to intrinsic value are not unknown, they are by no means automatic. I gave a seminar on SplitShares in March, 2009 – the very height of the crisis! – and used the following chart to illustrate the fact that, even (or particularly!) when distressed, these things will generally trade at a premium to intrinsic value:


Click for Big

The seminar was videotaped and is available for viewing (and downloading in Apple QuickTime format for personal use) for a small fee.

You could invest $26,667 in the capital units, and put the remainder in cash or investment grade bonds yielding , say, 3.5%. By doing so you get the same upside as the underlying assets.

Actually, it will be a bit better, because at maturity the discount will be made up, so you get an extra kicker of 6% per year. But in the event of a 50% fall in the market, although you would probably lose all of the value of the capital units, your cash would remain at $73,333, plus interest. You have dramatically outperformed on the downside, losing about 27% vs. 50%.

Yes, certainly, but you are not looking at the situation at issue time. You are looking for a distressed situation, in which somebody (the sucker) has already taken an enormous loss, not just on the NAV but also on the market price relative to NAV. Your illustration relies on the same presumption as the attractiveness of the preferred shares: the willingness of the sucker to take the first loss.

Not all split share capital units are attractive: some trade at premiums, and offer little leverage. Remember, these things are effectively long-dated options or warrants, although – even better – they can receive dividends. Any option or warrant calculator will tell you that if the capital units are priced correctly they should trade at a premium, not a discount, especially when leverage increases.

I discussed the valuation of Capital Units as options in my Seminar on SplitShares and provided the following charts. The first shows the theoretical value – given reasonable assumptions regarding volatility – of the capital units as the Whole Unit NAV changes. I will also note that this computation of theoretical value ignores all of the cash effects in the portfolio – dividends in, dividends out, fees and expenses out and portfolio changes to offset these effects – that will, in general, reduce the attractiveness of the Capital Units.


Click for Big

The second shows the premium of expected market price over intrinsic value as the NAV changes:


Click for Big

Instead, over the last few years I have seen cases where capital units offered leverage of up to 20 times, and yet still traded at a discount to NAV. That remarkable set of circumstances enabled investors to replace all-equity portfolios with a capital shares and cash combination portfolio which limited their equity exposure, and hence risk, to a fraction of what would otherwise be the case. Yet without losing any upside.

The remarkable paradox about capital units is that the higher the leverage, and hence the risk, in these things, the more one can reduce portfolio risk.

Scott Swallow, Financial Advisor
Manulife Securities Incorporated

Scott, I suggest that the critical element of your argument is the phrase “remarkable set of circumstances” and that, in the absence of such remarkable circumstances, our views are probably not very different.

Perhaps, as printed, my “sucker” epithet was too general – I certainly did not mean to suggest that all capital units were always bad all the time at all prices. If somebody offers to sell me capital units with an intrinsic value of $10 for a penny each, I’ll back up the truck! As I like to say, at the right price, even a bag of shit can be attractive: I buy fifteen of them every spring for my garden! So, perhaps I can be faulted for not qualifying my statement enough – but the reporter and I were talking about the issuance of these securities and he only had 1,000 words or so to work with – a full investigation of Split Shares takes considerably more space than that.

But your argument, as stated earlier, rests on the assumption that somebody else has taken a double loss – first on NAV, then on market price relative to NAV. I claim, that given the risk-reward profile of capital units at issue time in general, the IPO buyers (and most of those in the secondary market) are suckers.