PrefBlog

The sale of Aviva’s US unit to Apollo has been approved with substantially the same conditions as the Sun Life – Guggenheim deal:

The key heightened policyholder protections to which Apollo agreed include:

Heightened Capital Standards. Apollo has agreed that Athene will maintain Aviva New York’s Risk-Based Capital Levels (RBC Levels) at an amount not less than 450 percent. (Capital serves as a buffer that insurers use to absorb unexpected losses and financial shocks – better protecting policyholders.)

Backstop Trust Account. Apollo has agreed that Athene will establish a separate backstop trust account totaling approximately $35 million to provide additional protections to policyholders above and beyond the heightened capital levels. If Aviva New York’s RBC levels fall below 450 percent, the funds in the backstop trust account will be used to replenish (“top up”) Aviva New York’s RBC levels to at least 450 percent. The $35 million in the trust account will be held separately from other Aviva New York’s funds for seven years and dedicated to the sole purpose of protecting policyholders.

Enhanced Regulatory Scrutiny of Operations, Dividends, Investments, Reinsurance. Apollo has agreed that any material changes to Athene’s plans of operations of Aviva New York, including investments, dividends, or reinsurance transactions will require the prior written approval of DFS.

Stronger Disclosure and Transparency Requirements. Aviva New York will file quarterly RBC level reports to DFS – rather than just the annual reports required under New York Insurance Law. Additionally, the insurer will disclose to DFS necessary information concerning corporate structures, control persons, and other information regarding the operations of the company.

The Bank of Canada has released the Bank of Canada Review – Summer 2013 with articles:

• CSI: A Model for Tracking Short-Term Growth in Canadian Real GDP
• The Accuracy of Short-Term Forecast Combinations
• Monitoring Short-Term Economic Developments in Foreign Economies
• Big Data Analysis: The Next Frontier

Nothing very interesting, I’m afraid – I didn’t read any of them.

Bonds got hit today:

Yields (USGG10YR) on 10-year notes, a benchmark for corporate and consumer borrowing rates, climbed above 2.8 percent for the first time in two years as reports showed U.S. initial jobless claims declined last week to the lowest level in almost six years and confidence among U.S. homebuilders rose in August to the highest level since 2005. Treasury data showed private investors abroad sold a record amount of notes and bonds in June, when Fed policy makers indicated they are considering a slowing of their quantitative-easing policy.

Yields on Canadian 5s, 10s and 30s were all up 4bp.

And, logically enough (which is not always the case) the Canadian preferred share market got thumped today, with PerpetualDiscounts losing 85bp, FixedResets off 16bp and DeemedRetractibles down 50bp. The performance highlights table is suitably enormous. Volume was extremely high.

Vasco Cúrdia (San Francisco Fed) and Andrea Ferrero (New York Fed) write a provocative note titled How Stimulatory Are Large-Scale Asset Purchases?:

In November 2010, the Fed’s policy committee, the Federal Open Market Committee (FOMC), announced a program to purchase $600 billion of long-term Treasury securities, the second of a series of large-scale asset purchases (LSAPs). The program’s goal was to boost economic growth and put inflation at levels more consistent with the Fed’s maximum employment and price stability mandate. In Chen, Cúrdia, and Ferrero (2012), we estimate that the second LSAP program, known as QE2, added about 0.13 percentage point to real GDP growth in late 2010 and 0.03 percentage point to inflation.

Our analysis suggests that forward guidance is essential for quantitative easing to be effective. Without forward guidance, QE2 would have added only 0.04 percentage point to GDP growth and 0.02 to inflation. Under conventional monetary policy, higher economic growth and inflation would usually lead the Fed to raise interest rates, offsetting the effects of LSAPs. Forward guidance during QE2 mitigated that factor by making it clear that the federal funds rate was not likely to increase.

Our estimates suggest that the effects of a program like QE2 on GDP growth are smaller and more uncertain than a conventional policy move of temporarily reducing the federal funds rate by 0.25 percentage point. In addition, our analysis suggests that communication about when the Fed will begin to raise the federal funds rate from its near-zero level will be more important than signals about the precise timing of the end of QE3, the current round of LSAPs.
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The second feature in our model concerns the transmission from the risk premium to the economy. We consider an economy with two types of investors. The first can invest in both short- and long-term assets. For them, a lower risk premium prompts them to reallocate their portfolios, but doesn’t change their spending behavior. If all investors behaved this way, a change in the risk premium would not affect the economy.

The second type of investor buys only long-term bonds, for example to match asset duration with life events, such as retirement date. If long-term yields fall, these investors have less incentive to save and may allocate more money to consumption or investment in nonfinancial assets. This boosts aggregate demand and puts upward pressure on inflation.

These two types of investors represent a form of financial market segmentation, allowing for the risk premium to affect economic activity. The degree of segmentation is determined by what fraction of investors buy only long-term bonds. The higher the proportion of such investors, the more LSAPs affect the real economy.
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Asset purchase programs like QE2 appear to have, at best, moderate effects on economic growth and inflation. Research suggests that the key reason these effects are limited is that bond market segmentation is small. Moreover, the magnitude of LSAP effects depends greatly on expectations for interest rate policy, but those effects are weaker and more uncertain than conventional interest rate policy. This suggests that communication about the beginning of federal funds rate increases will have stronger effects than guidance about the end of asset purchases.

I don’t find it entirely convincing but it is, after all, only a letter. Consider the first type of investor, the non-segmented one:

The first can invest in both short- and long-term assets. For them, a lower risk premium prompts them to reallocate their portfolios, but doesn’t change their spending behavior. If all investors behaved this way, a change in the risk premium would not affect the economy.

OK, so they reallocate their portfolios, but what do they buy? And, more importantly, what do the people they buy from do with their money?

One thing that they buy on reallocation, of course, is Apple Corporation bonds. Apple doesn’t need the money, they just stick it in the bank. No gain there. What does the bank do with the money? Ideally, they would lend it to a smaller business – or an expanding business – which will then buy equipment, hire staff, and produce YouTube videos of kittens and make immense profits.

But that’s kind of risky, so what they do – especially in Canada – is lend the money to government employees so they can buy larger houses. There’s not really all that much of a gain there, either.

I really have trouble conceptualizing the path of monetary stimulus throughout the economy, but I find it hard to believe that the asset reallocation of Investor #1 has zero effect, although I’m willing to believe that it may be small. I will also suggest that there is a third type of investor, such as pension funds and insurance companies, that get hurt to some extent (depending on how well they are hedged) by lower yields and actually have to reduce distributions and increase contributions when yields fall. Negative convexity! I hesitate to estimate the importance of this group, though – it might be just a rounding error.

Another problem is the nature of business today. How much capital do businesses really need in order to make their widgets? It’s not like the 1950’s, where you had to build a factory and the factory needed steel, so somebody else had to build a foundry. While capital is still needed – remember the price-tag on the Energy East pipeline? – I suggest that it is less important than it used to be.

I mean, look at my business! I would love to expand and I will, as soon as enough of youse guys get off your duffs and send me large quantities of money to manage. So what do I need to expand? A few computers … technically a capital expense, but in business terms it’s petty cash. Premises – that will come out of revenue. Salaries – that will come out of revenue. What do I need capital for? My decision as to whether to expand or not has absolutely nothing to do with the Prime Rate.

There are two types of business to be in: you can make things, or you can make entertainment. Entertainment (more formally, “services”) is not all that much capital intensive, and entertainment is taking over the economy. So how can you stimulate an economy with money if the system doesn’t need money? At least not directly. One might object – particularly if you are an economics lecturer hoping for tenure – that it does need education and therefore tenured professors and therefore lots of money. But, I say to that, we’re already saturated in education. It’s a very tricky question and someday I’ll take a rock-solid economics course so I can get a better handle on things.

Maybe my economics course should start with a piece from S&P titled Repeat After Me: Banks Cannot And Do Not “Lend Out” Reserves:

• Many talk as if banks can “lend out” their reserves, raising concerns that massive excess reserves created by QE could fuel runaway credit creation and inflation in the future. But banks cannot lend their reserves directly to commercial borrowers, so this concern is misplaced.
• Banks do need to hold reserves (as a liquidity buffer) against their deposits, and banks create deposits when they lend. But normally banks are not reserve constrained, so excess reserves do not loosen a reserve constraint.
• Banks in aggregate can reduce their reserves only to the extent that they initiate new lending and the bank deposits created as a result flow into the economy as new banknotes as the public demands more of them.
• QE does aim to ease financial conditions and spur more bank lending than otherwise would have occurred, but the mechanisms by which this happens are much more subtle and indirect than commonly implied.
• If the excess reserves created by QE were to be associated with too much credit creation, central banks could readily extinguish them.

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To understand the first issue, note the composition of a central bank’s balance sheet (see table 1) and note an identity linking the two sides. Abstracting from the central bank’s capital (5) and some other possible minor items, the central bank balance sheet identity is:

Assets (A) = Reserves (R) + Banknotes in circulation (BK) + Government deposits (GD).
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There you have it. This being an identity and reserves being a liability of the central bank, their aggregate level can change in three, and only three, ways (6). Reserves go up (or down) when:

(1) The central bank increases (decreases) its assets;

(2) The public decreases (increases) the amount of cash (banknotes) it wants to hold;

(3) The government reduces (increases) its deposits at the central bank because it makes net transfers to (receives net transfers from) the private sector (7).

Most importantly, banks cannot cause the amount of reserves at the central bank to fall by “lending them out” to customers. That possibility is not allowed for in the identity because bank lending does not enter into it. Assuming that the public does not change its demand for cash and the government does not make any net payments to the private sector (two things that are both beyond the direct control of the banks and the central bank), bank reserves have to remain “parked” at the central bank. To express wonder that banks don’t lend out their reserves or that they park them at the central bank is to fundamentally misunderstand the balance-sheet mechanics of credit creation and how QE works.
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None of this is to say that the unwinding of QE and other nonconventional policies will be smooth and will not cause volatility in financial markets. Volatility is to be expected and needs to be managed both by policymakers and by market participants. But fears that banks stand to “lend out” the excess reserves that they currently have “parked” at central banks is not something that anyone, least of all central banks aiming to speed up the recovery or defend their inflation targets today, should worry about. I doubt that Keynes would have.

There’s an interesting piece on Bloomberg about the Fed Governor Sweepstakes … it seems my preference for Summers is not widely shared:

Federal Reserve Vice Chairman Janet Yellen is the most qualified and most likely candidate to run the central bank, according to the majority of private economists in a Bloomberg News survey that showed Lawrence Summers trailing by wide margins in both categories.

Sixty-five percent said Yellen probably will be President Barack Obama’s selection to replace Chairman Ben S. Bernanke, while 53 percent said she would do the best job, according to an Aug. 9-13 poll of 63 economists. Twenty-five percent said Summers, Obama’s former top economic adviser, would be the nominee, while 10 percent said he would be best. Six percent said former Fed Vice Chairman Donald Kohn is most likely choice.
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Ward McCarthy, chief financial economist at Jefferies Group LLC in New York, said that Summers isn’t the best pick because he hasn’t served at the central bank and “has no experience with monetary policy.”
‘
“This is an important job, and as brilliant as he may be I don’t think this is a time for on-the-job training,” McCarthy said. Yellen and Kohn both “are the perfect choices for Fed chairman,” said McCarthy, a former Richmond Fed economist.

“They’re very credible,” he said. “They’re also very familiar with what the Fed is doing now so there’s no learning curve. They’ve committed their lives to monetary policy so there’s an accumulated body of knowledge and understanding and expertise that’s unparalleled.”

It was another mixed day for the Canadian preferred share market, with PerpetualDiscounts down 48bp, FixedResets up 23bp and DeemedRetractibles gaining 12bp. There was no clear pattern in the Performance Highlights table, except that there were a fair number of PerpetualDiscounts in the bad part. Volume was very high.

PerpetualDiscounts now yield 5.73%, equivalent to 7.45% interest at the standard equivalency factor of 1.3x. Long corporates now yield about 4.75%, so the pre-tax interest-equivalent spread is now about 270bp, a slight (and perhaps spurious) increase from the 265bp recorded August 7 but well above the post-Crunch, pre-Tapering average of around 200bp.

Everything is Morgan Stanley’s fault!

Institutional investors’ allocations to dollar-denominated bonds have dropped to the lowest level since 2007 as strategists at Morgan Stanley and JPMorgan Chase & Co. see a shift away from the debt that may fuel higher borrowing costs.

Holdings by investors from pensions to endowments fell to 26.2 percent of assets in the second quarter, from 30.1 percent in the corresponding period of 2012, according to the Wilshire Trust Universe Comparison Service, which tracks plans that oversee $3.46 trillion. Morgan Stanley’s $1.8 trillion wealth management unit has been advising clients to cut bond allocations to the lowest in more than five years, Chief Investment Strategist David Darst said.
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Institutional investors such as corporate and public pensions have reduced their median allocation to U.S. bonds from 32 percent of their assets in the last three months of 2011, according to data compiled by Wilshire Associates Inc., whose Trust Universe Comparison Service tracks more than 1,700 plans.
The current proportion of dollar-denominated debt holdings is the least since the fourth quarter of 2007, Kim Shepherd, a spokeswoman for the firm, said in an e-mail.

“There is movement by institutional investors out of investment-grade bonds,” said Eileen Neill, a managing director in the consulting division of Wilshire, a Santa Monica, California-based financial advisory firm. “It’s not out of fear of bonds, it’s out of necessity because of the low yields. They’re moving to higher yielding bonds and emerging markets debt.”

Individual investors have been shifting to stocks from bonds as well. The gap between flows into bond mutual funds and exchange-traded funds and those focused on equities widened to $70 billion in June, the most ever, according to JPMorgan analysts led by Nikolaos Panigirtzoglou in London.

The bank-owned Toronto Stock Exchange is up to its usual tricks today. It sold me very expensive data indicating that the “last” quote for CIU.PR.C was 6.83-23.99. When I went to their website to check the last few trades, I was informed that the “last” quote was 24.41-23.99 … bid bigger than the ask. Not even the most cursory editor … so in despair, I have put it into HIMIPref™ as 22.99-23.99.

Wonder of wonders, it was mixed day for the Canadian preferred share market, with PerpetualDiscounts off 12bp, FixedResets down 16bp and DeemedRetractibles gaining 9bp. Lots of volatility, with FixedResets prominent on the down side. Volume was high.

Nothing happened today.

The Canadian preferred share market got smacked again, with PerpetualDiscounts losing 113bp, FixedResets down 34bp and DeemedRetractibles off 28bp. BAM issues were prominent on the very lengthy Performance Highlights list, and not on the good part of it either! Mind you, the good part wasn’t all that lengthy. Volume was quite high.

Nothing happened today.

It was another terrible day for the Canadian preferred share market, with PerpetualDiscounts losing 67bp, FixedResets off 32bp and DeemedRetractibles down 63bp. The Performance Highlights table is suitably enormous, with bank issues making a relatively rare ascent into prominence amongst the losers. Volume was above average.

I’ve just had a look at A Review of the Oncology Under-Dosing Incident by Jake J. Thiessen, Ph.D. … the report on the chemotherapy scandal in which neither hospitals nor purchasing agents made the slightest effort to determine just what it was they were buying or had bought.

What a whitewash.

The early days of the incident began with the discovery of a questionable MHS GEMCITABINE product on March 20, 2013 at the Peterborough Regional Health Centre.

This, of course, is bullshit. The early days of the incident began with the tendering of the contract to supply the drug. The contract was incompetently drafted and handling of the delivered materials was also incompetent. He didn’t address (or even acknowledge) the kickback negotiated as part of the contract.

As a former chemist, the part I like best is:

The clear difference factor in bulk reconstitution preparation lies in the overfill within the normal saline bags used in hospitals and by MHS. That is, although a bag may be nominally labeled to contain 100, 250, 500 or 1000 mL of 0.9% sodium chloride, the actual volume may be somewhat larger. Such overfill is widely known and is not limited to diluents. For example, Baxter had declared its overfill (shown in Appendix 4). Both the GPO and MHS were apparently aware of such overfills. The degree of overfill is not standardized; it becomes part of a manufacturer’s finished product specifications. The reason for this overfill is that the fluid bags are to some extent permeable to water. That is, water can move through the membrane and then evaporate from the outside surface. On storage, the contents of the bags can thereby decrease. The product’s shelf life is defined by the length of time it would normally take before the contents are reduced to the aforementioned nominal contents (e.g., 100 mL) on the label. Obviously, the rate of loss is determined by the permeability of the bag, fluid volume to surface ratio, and the storage conditions. This influences both the overfill variability used by a manufacturer and the contents determined at any point in time

So it is known that the concentration of active material in the bags will increase over time, but the clowndorks in charge of preparing medication for administration use the bags as a source of stock solution at the concentration shown on the label.

Don’t get sick in Ontari-ari-ari-o.

As a nod to the ostensible subject of this blog (Canadian preferred shares. Remember?) I’ll highlight Assiduous Reader adrian2‘s trip down memory lane to May, 2008, when we were all trying to figure out just what these funny new Fixed-Reset thingamajigs were all about.

It was another day of sickness in the Canadian preferred share market, with PerpetualDiscounts off 1bp, FixedResets down 16bp and DeemedRetractibles losing 19bp. The Performance Highlights table is again very lengthy, but with no obvious patterns. Volume was high.