PrefBlog

Are the bond vigilantes hanging up their spurs?

U.S. fixed-income mutual funds attracted investor deposits last week, rebounding from redemptions spurred by speculation that the Federal Reserve would scale back its unprecedented stimulus, while bond exchange-traded funds had withdrawals.

Investors put $219 million into U.S. taxable-bond mutual funds while pulling $456 million from bond ETFs in the week ended July 10, Denver-based research firm Lipper said yesterday in an e-mailed statement. They deposited more than $3 billion in bond mutual funds and ETFs combined during the week ended July 3, the first week of net deposits in five weeks. U.S. bond funds had withdrawals of $23.7 billion in the four weeks ended June 26, the most since October 2008, Lipper said.

“Taxable-bond fund investors were of two minds,” Lipper said in the statement. “Neither amount reflected a strong opinion on bonds.”

It’s always nice to see big banks hurt by negative convexity:

JPMorgan Chase & Co (JPM). Chief Executive Officer Jamie Dimon warned investors that higher interest rates could lead to a “dramatic reduction” in the bank’s profits by eroding demand for mortgage refinancing.

The surge in 30-year home-loan rates to 4.46 percent at the end of June from 3.51 percent in mid-May caused second-quarter mortgage-fee revenue to decline 20 percent, the New York-based bank reported today. Refinancing volume could fall as much as 40 percent in the second half if rates remain elevated, Chief Financial Officer Marianne Lake told analysts on a call today.
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Refinancings, which accounted for 76 percent of the industry’s $1.75 trillion in loan originations last year, slumped after 30-year rates surged in May and June, data compiled by Freddie Mac show. Applications to refinance loans fell 42 percent across the industry from May 17 to July 5, according to Joel Kan, an economist at the Mortgage Bankers Association, a Washington-based trade group.

Fortunately for Canadian banks, there is no real competition in Canada so we don’t have thirty-year open mortgages.

Electrical Engineering Professor Reza Iravani of the University of Toronto has come up with a a revolutionary idea for electricity delivery in Toronto:

“The delivery system has to be reinforced so even if you lose a station, the rest of the system can maintain operation without a major blackout,” he said.

Amazing. A system with some redundancy to make it more robust to single-point failure. Give the man a Nobel Prize – and, while you’re at it, a consulting contract to help the Bank of Canada with their Centralized Counterparty idea.

Investors in US Municipals have another thing to worry about:

Detroit bondholders may have a new worry after a judge ruled that Jefferson County, Alabama, could have paid legal bills for its bankruptcy from cash that was going to pay warrant holders owed $3 billion.

The ruling should concern bond investors whose revenue was previously protected from use by municipalities, said R. Dale Ginter, a bankruptcy lawyer at Downey Brand LLP in Sacramento, California. It may force those bondholders to reconsider waging an extensive legal fight to protect their interests, said Ginter, who represented retirees in the bankruptcy of Vallejo, California.
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The ruling could apply to any municipal bankruptcy with debt being paid by pledged revenues such as parking fees, airport lease payments or water and sewer charges, Ginter said. Detroit is in talks to get bondholders and current and former city workers to accept $2 billion in exchange for wiping out the $11.5 billion they may be owed. Kevyn Orr, Detroit’s emergency financial manager, said he may put the city into bankruptcy if they can’t strike a deal.

It was a mixed day for the Canadian preferred share market, with PerpetualDiscounts up 20bp, FixedResets off 2bp and DeemedRetractibles flat. Volatility was lower than normal – especially when compared with recent times – but what there was was all positive. Volume was a little below average.

Nothing happened today.

It was another day of solid recovery for the Canadian preferred share market, with PerpetualDiscounts winning 26bp, FixedResets gaining 10bp and DeemedRetractibles up 15bp. The Performance Highlights table is suitably bulky, comprised entirely of winners. Volume was above average.

Sorry this is so late, folks! Summertime and the living is easy!

More Fed-watching!

Federal Reserve Chairman Ben S. Bernanke called for maintaining accommodation even as the minutes of policy makers’ June meeting showed them debating whether to stop bond buying by the Fed in 2013.

“Highly accommodative monetary policy for the foreseeable future is what’s needed in the U.S. economy,” Bernanke said yesterday in response to a question after a speech in Cambridge, Massachusetts.

The Fed chairman spoke just three hours after the central bank released minutes of the June 18-19 gathering showing that about half of the 19 participants in the Federal Open Market Committee wanted to halt $85 billion in monthly bond purchases by year end. At the same time, the minutes showed many Fed officials wanted to see more signs employment is improving before backing a trim to bond purchases known as quantitative easing.

The debate underscores Bernanke’s challenge in affirming that, even after starting to reduce monthly bond buying, policy makers plan to maintain unprecedented stimulus with a record-high balance sheet and near-zero target interest rate.

The persecution of Fabulous Fab for doing his job is entering a new stage:

After the allegations, he kept his head down. He testified succinctly before Congress, left his job to enroll in a doctoral program, and popped up in Africa doing charity work.

This is the new Fabrice Tourre who will walk into Manhattan federal court July 15.
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In 2010, the Securities and Exchange Commission sued New York-based Goldman Sachs and Tourre for fraud for concealing the role of the hedge fund Paulson & Co., founded by billionaire John Paulson, in selecting the assets inside the Abacus portfolio — assets Paulson wanted to fail.

Goldman Sachs paid a then-record $550 million fine to settle the allegations. Tourre chose to fight them. U.S. District Judge Katherine Forrest, who will oversee the trial, summed up the SEC’s case like this: “Tourre handed Little Red Riding Hood an invitation to grandmother’s house while concealing the fact that it was written by the Big Bad Wolf.”
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Tourre’s court date threatens to undo some of the progress Goldman Sachs has made in rehabilitating its image. In the lead-up to his trial, the bank and its former employee have exhibited an awkward arm’s-length relationship. Goldman Sachs is paying for Tourre’s defense and for the use of a sophisticated public-relations team from Sard Verbinnen & Co., but the bank is limited by the terms of its SEC settlement in what it can say publicly about the Abacus deal.
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“This is so clearly a case of scapegoating,” said Dennis Kelleher, CEO of Better Markets, an advocacy group that has lobbied for the overhaul of financial regulations. “It’s one of the most egregious misuses of SEC power I’ve ever seen.”

If he loses – and he could go to jail over this – one lesson must be learned by all fund sponsors: it must be stated in the offering materials, in big bright red letters, that all the assets of the fund were bought from somebody else. Somebody who will not, presumably, be too upset if they subsequently decline in value.

As an aside, the HR departments are taking over:

Valerie Thompson went from a childhood hawking fish, fruit and vegetables in London’s run-down East End to a Eurobond star at Salomon Brothers Inc. when it was the world’s biggest trading firm. Like the successful trader she was, she got out at the top.

Eurobonds, international securities with untaxed interest payments, were only a decade old in 1973 when Thompson, who left school at age 15, landed a clerical job typing orders into a telex machine. She prospered as the market surged and was running new-issue strategy and managing the risk generated on London’s biggest bond trading floor when she left, just before the 1987 stock crash and as market returns began to diminish.

For all her acumen, Thompson, 57, says someone with her background couldn’t get a job in today’s financial industry.
“They closed the door,” she said in a lunchtime interview at Coya, the Peruvian restaurant on London’s Piccadilly, last month. “And they said, ‘You know what? To work in the City now you need three degrees.’ I find it downright wrong.”

When I got into this industry in 1986, I was working for Merrill Lynch as a temp; I applied for one of the posted jobs. HR told me they weren’t hiring … a chemistry degree? Why would we hire somebody with a chemistry degree? I don’t see any beakers around here, do you, Edna? My manager kicked ass and I got a new call offering me my pick of all the jobs in operations.

Tim Kiladze of the Globe has a very good article on the Canadian implications of the Basel 3 leverage ratio, titled How Canada’s banks benefit from OSFI’s leverage ratio:

While that might be a problem outside Canada, the Big Six argue that they already comply with OSFI’s asset-to-capital multiple, which limits a bank’s assets to 20 times their capital. Reverse that equation, and you get a 5-per-cent leverage ratio.

In other words, they should already exceed the coming 3-per-cent minimum, and even would be close to the 5- and 6-per-cent levels the U.S. just proposed for its own banks, depending on their size.

But it isn’t that easy. The way OSFI calculates leverage and capital differs from the new Basel standards. If you update OSFI’s model to abide by the new rules, our banks aren’t as well off.

The key difference, according to analyst Brad Smith at Stonecap Securities, is rooted in how you classify capital. Under OSFI’s model, Tier 1 and Tier 11 capital are included, whereas the Basel model has much stricter definitions. (Explaining these nuances gets incredibly wonky, but the main message is that OSFI is more lenient.)

By including Tier 2 capital, OSFI offers the Big Six a 26-per-cent leverage benefit – meaning their total capital jumps to $178-billion from just $141-billion of straightforward Tier 1 capital.

Mr. Smith also noted that OSFI’s calculation strips $167-billion of estimated securitized mortgages out of the Big Six’s asset exposure, lowering their asset total.

Removes these benefits and Mr. Smith calculates that Canadian banks would still meet the new Basel leverage requirements, but “fall well below” the proposed U.S. measure.

In order to meet a 5-per-cent minimum, “domestic banks would either have to reduce on-balance sheet exposure by over $700-billion (20 per cent) or add additional Tier 1 capital of approximately $35-billion even before considering the impact of off-balance sheet exposure levels,” Mr. Smith noted.

It may actually be worse than that. As I frequently complain, OSFI can boost the allowable leverage to 23x, and neither OSFI nor the bank benefitting has to give any explanation at all for the increased ceiling. I suspect it’s all just arranged over a friendly lunch.

A very nice day for the Canadian preferred share market, with PerpetualDiscounts winning 59bp, FixedResets gaining 9bp and DeemedRetractibles up 19bp. The Performance Highlights table is comprised entirely of winners, dominated by PerpetualDiscounts and PerpetualPremiums. Volume was above average.

It’s a Fed-Watching Frenzy!

“The minutes largely reiterated what the chairman said in June,” Ryan Larson, the Chicago-based head of U.S. equity trading at RBC Global Asset Management (U.S.) Inc., said by e-mail. His firm oversees $290 billion. “Tapering, whether it will be this year or next, is inevitable. The market was initially encouraged that the Fed is waiting on additional data, but possibly taken aback by the fact that about half the participants indicated that asset purchases should end later this year.”

Minutes from the central bank’s June 18-19 meeting, released today in Washington, showed that while several members judged that a reduction in asset purchases “would likely soon be warranted,” many officials want to see more signs employment is picking up before they’ll begin slowing the pace of $85 billion in monthly bond purchases.

The Globe was a bit more colourful:

The minutes show there was an intense debate about how to communicate the Fed’s intentions. A minority of policy makers are worried that the Fed’s policies are too aggressive, risking inflation and asset-price bubbles, and should be reversed as soon as possible. And among the supporters of more QE, there was a feeling that the central bank should nonetheless send the message that economic conditions were improving, heralding an eventual end to the bond-buying program.

It was decided that Mr. Bernanke should attempt to lay out a path for QE at the press conference that followed the meeting. That’s when he told reporters that if the economic outlook held, the Fed likely would slow its bond purchases later in 2014 and end the program in the middle of 2015, when the unemployment rate likely will have fallen to about 7 per cent.

Stock markets plunged immediately, as traders the world over largely disregarded Mr. Bernanke’s insistence that the Fed also could boost asset purchases if the economy failed to unfold as expected.

BIS has published a paper titled Analysis of risk-weighted assets for credit risk in the banking book:

The bottom-up portfolio benchmarking exercise (the hypothetical portfolio exercise, or HPE), under which banks were asked to evaluate the risk of a common set of (largely low-default) wholesale obligors and exposures, revealed notable dispersion in the estimates of PD and LGD assigned to the same exposures. The three wholesale asset classes covered by the HPE analysis (sovereign, bank, and corporate) account on average for about 40% of participating banks’ total credit RWAs. A rough translation of the implied risk weight variations into potential impact on banks’ capital ratios suggests that the impact could be material; at the extremes, capital ratios could vary by as much as 1.5 to 2 percentage points (or 15 to 20% in relative terms) in either direction around the 10% benchmark used for this study. However, most of the banks (22 of the 32 participating banks) lie within one percentage point of that benchmark (see Chart 1 below).

Click for Big
Change from 10% capital ratio if individual bank risk weights from the HPE are adjusted to the median from the sample. Each bar represents one bank. The chart is based on the assumption that variations observed at each bank for the hypothetical portfolios are representative for the entire sovereign, bank, and corporate portfolios of the bank and are adjusted accordingly. No other adjustments are made to RWA or capital.

A reader brings to my attention a debunking of green disinformation:

• The “Gas Town Steam Clock” is not powered by steam
• The iconic wind turbine at Grouse Mountain is an energy sink
• BC Hydro’s emissions reporting is highly misleading
• Vancouver is nowhere as near as green as it likes to thing it is

I left this one out yesterday: DBRS confirmed RY at Pfd-1(low), although its NVCC-compliant RY.PR.W is still under Review-Negative:

RBC’s diversified business model and geographic profile have provided the Bank with consistently strong profitability and return on equity throughout various business and credit cycles. RBC is the largest retail bank in Canada and currently holds first or second-ranking positions in each business it participates in domestically, with an objective to become the leader in every business. The Bank continues to build on its leading market positions within Canada and is expanding its presence globally, particularly in wealth management and capital markets, where the Bank has been increasing its market share among the top global banks.

Despite strong performance in recent years, continued long-term domestic growth within Canada is expected to be a challenge given the Bank’s significant market share positions, the mature Canadian banking industry and the competitive landscape. Domestically, RBC and its large competitors have little room to grow beyond market growth rates, which have been strong in recent years. Additionally, foreign banks that previously exited the domestic market during the crisis have re-emerged as competitors.

DBRS does not expect potential house price depreciation in Canada to result in material losses from the Bank’s real estate secured lending portfolio, notwithstanding the high indebtedness of the average Canadian consumer and significant increases in housing prices in certain sectors of the Canadian real estate market.

The rating on the Non-Cumulative First Preferred Shares, Series W remains Under Review with Negative Implications. DBRS hopes to resolve this rating in the near future after the publication of the results from DBRS’s recent Request for Comments on Rating Subordinated, Hybrids and Preferred Bank Capital Securities

It was another day of retreat for the Canadian preferred share market, with PerpetualDiscounts losing 24bp, FixedResets off 8bp and DeemedRetractibles down 13bp. The Performance Highlights table was at average length – it hasn’t been average for a while!

PerpetualDiscounts now yield 5.41%, equivalent to 7.03% interest at the standard equivalency factor of 1.3x. Long corporates now yield about 4.65%, so the pre-tax interest-equivalent spread (in this context, the Seniority Spread) is now about 240bp, unchanged from the figure reported July 3.